g m g D e s i g n . c o m

Obama may very well rule from the center. Despite previously endorsing wasteful farm subsidies (McCain voted against those subsidies), Obama suggests he’ll pare back those very subsidies. Good for him.

… so argues the WSJ. I.e., by virtue of pleading for money, they’re admitting that they’re bleeding cash. Editorial also dispels five myths about the Big 3. Myths are:

1. The Big 3 aren’t bankrupt already (see above)
2. Management changes would be useless (not sure who believes that “myth”)
3. Bankruptcy of any of the Big 3 would mean that company’s demise (not true, as we’ve seen with domestic airlines, not that they should be imitated)
4. Banning executive bonuses and/or mandating greater fuel economy will save Detroit
5. Merger of GM & Chrysler will bring prosperity to both

Yes, according to this commentary in Esquire magazine.

His “3 myths” and his refutation of those myths…

Myth: Investment banks are an indispensable source of “innovation” and liquidity.

There are now no (major) investment banks. And no one will miss them. Like lawyers, these parasites basically create nothing, add no value. And now they don’t exist. The global financial system will survive not giving tranches of ten thousand combined mortgages from the farthest-flung sections of America. And whoever invented these CDOs, these “collateralized debt obligations,” should . . . find meaningful work.

Myth: Home ownership is an unalloyed good.

It’s not. Not just because it’s expensive and illiquid, but because it’sinappropriate for many kinds of people. And I don’t mean just in a class-division way. (Although that’s true, too, and Fannie and Freddie never should have been tasked with the social mission to “improve” the lots of poor people by saddling them with loans they couldn’t repay.) I mean for economic reasons. Fifty percent is about the maximum number of households that should ever own homes in a society. A modern, efficient workforce needs its members to be mobile and nimble and not tethered to homes they barely own and cannot sell.

Myth: “Deregulation” caused this.

We’re so, so, so not deregulated. The institutions that are failing are some of the most heavily regulated in the world. Investment banks are regulated by the SEC, the Federal Trade Commission, state attorneys general, and state banking commissions. But too many regulators are as bad as no regulators–none of them feels responsible since a failure can be blamed on all the others. Hedge funds are a great example. For years, people have been crying about the wild world of hedge funds. But hedge funds have actually held up well during this meltdown. Effective regulations are needed and possible. But any rush to clamp down willy-nilly will result in an even deeper freeze on liquidity and push this crisis deeper and longer.If you’re an investment banker or a mortgage broker, yes, these will be prolonged and difficult times. You should consider coaching Little League. But the rest of us? On October 10, I bought GE stock for $18.77 and Altria for $16.58–wildly profitable companies with price-earnings ratios under 10 and yields of about 7 percent. There are great American companies paying out suddenly valuable American dollars as dividends. I just can’t cry too hard when the stock market is holding the greatest sale of my lifetime. It’s enough to make me want to write a bullish finance column.

Blogs, search engines, e-commerce sites, video and social-networking portals are thriving today thanks in large part to the notice-and-takedown regime ushered in by the much-maligned copyright overhaul. A decade ago, when the DMCA was enacted, these innovations were unheard of, embryonic or not yet conceived. Now, Google has grown into one of the world’s largest companies, and its video-sharing site YouTube has left an enduring mark on public discourse. The Mountain View, California, company is one of many that openly acknowledges the DMCA’s role in its success, a view shared by public interest groups.

That’s from a blog-article on Wired magazine’s site. Tech geeks dogmatically hate the DMCA, but the article makes a compelling case that it’s a good thing overall.

Postponing the ‘end times’

Intro:

The doom-and-gloomers own the field right now with this global financial panic — no surprise there. But gleeful proclamations about the “death” of globalization, capitalism, the West, America, America’s superpower status, and so on are a bit much. A lot of celebrated experts, starting with Karl Marx, have made such claims before.

Strategist Thomas Barnett debunks the idea that, during this time of relative crisis (the financial panic in this case, not the US election), it’s the end-of-the-world-as-we-know-it argument and categorizes groups that tend to make that argument. Groups include (and I’m paraphrasing): old, cranky technocrat; old, cranky guy who thinks the next generation is inept; cynical futurist who wrongly projects current trends; “soft racist” who doesn’t think next gen–who is increasingly non-anglo saxon–is up to the task of continued prosperity; last, the slippery slope crowd.

All will make more sense if you read the column. The most interesting to me is the one who extrapolates current trends (the 3rd one mentioned above). Excerpt:

Third, there’s the senseless extrapolation — ad infinitum — of current trends. The most prevalent one: if everyone in the world joins a middle class modeled on our own, we’ll need multiple planets to accommodate all their resource demands, the assumption being that standard of living is rigidly tied to consumption. But of course, that’s never been the case. Technology always advances, meaning we accomplish more with less.

Labor Unions Prolonged the Depression

By the mid-1930s, the U.S. economy appeared to be climbing out of the Great Depression. The Dow Jones Industrial Average (DJIA), which had bottomed out at 41 in 1932, was advancing. It increased 73% from the beginning of 1935 through the end of 1936, when it hit 180. The number of unemployed, 13 million in 1933, dropped to 9.5 million in 1935 and 7.6 million in 1936.

Then, in 1937, the DJIA plunged 33% in what is often called “a depression within a depression.” Joblessness skyrocketed.

A principal factor in the meltdown that year was the U.S. Supreme Court’s surprise 5-4 decision in early April to uphold the constitutionality of the Wagner Act, which had passed two years earlier. This measure, which is still the basis of our labor relations regime, authorized union officials to seek and obtain the power to act as the “exclusive” (that is, the monopoly) bargaining agent over all the front-line employees, including union nonmembers as well as members, in a unionized workplace.

[...]

If the mislabeled “Employee Free Choice Act,” becomes law, it will likely have a similar effect on the economy as the original Wagner Act, transforming what could have been a recovery into a lengthy, deep recession, or worse.

Trading Partners

If Democrats emerge with control of both the White House and Congress next week, they are promising to take U.S. trade policy in a more protectionist direction. That might assuage the Democrats’ labor union base, but it will put the U.S. at a disadvantage against countries that are liberalizing trade apace.

The Age of Prosperity is Over

This editorial by Art Laffer (the famous economist) provides a sobering view of the American economy and the coming years of governmental interventionism, regardless of who gets elected this November. I don’t share his pessimism (and, truth be told, I think his tone is admonishing so as to change the course of events), but still, unneeded intrusions into the market by our government overlords have a real effect on our everyday lives–usually for the worse.

CS Monitor has an editorial on why the government is to blame for the current economic woes and why we don’t need more regulation–as many politicals are screaming–but less.

The WSJ has a similarly themed editorial on the government’s journey into the domestic car business.

First, a choice excerpt from the WSJ’s car editorial:

Our other concurrent bailout — of the banking industry — has been accompanied by a debate of laissez faire versus intervention. How amusing. Banking in fact illustrates what might be called the GM Effect, for both industries have been around long enough to have accrued an almost incalculable baggage of government intervention, which explains why more intervention is demanded today.

Why don’t the auto makers limit themselves to paying competitive wages and benefits in line with what workers could earn elsewhere? Because, in the 1930s, Congress passed the Wagner Act with the nearly explicit purpose of imposing a labor monopoly on Detroit to keep wages at higher-than-competitive levels.

CS Monitor discusses the housing/mortgage crisis. Choice quote:

Throughout the 1990s, Washington encouraged these GSEs [government sponsored enterprises, referring to "Fannie Mae" and "Freddie Mac"] to expand home-ownership among lower-income, and thus more risky, borrowers. In 2004 and 2005, following the accounting scandals at Freddie, both GSEs paid penance to Congress by agreeing to expand their direct lending to low-income, higher-risk customers. Both acquired more subprime and Alt-A loans, making it profitable for banks to originate them, confident that the US taxpayers ultimately stood behind Freddie and Fannie. From 2003 to 2006, the percentage of loans the GSEs made in those riskier categories grew from8 percent to about 20 percent in 2006. This meddling helped drive up housing prices, leading other players to pile fancy new instruments on top of those mortgages, leading to a speculative bubble that was, at root, caused by the actions of two government-sponsored entities unleashed from the normal profit-and-loss checks of the free market.

Fueling this speculative fire was the Federal Reserve, also a government-sponsored organization. The Fed moved interest rates to extraordinarily low levels beginning in 2001. The additional credit it provided artificially lowered the cost of mortgages and dramatically accelerated the housing boom begun in the 1990s.

Did people suddenly get greedy in their pursuit of McMansions, second homes, and flipping homes for easy profit? Yes, but only because abnormally low interest rates made it foolish not to be. This was hardly a failure of free markets or greed. It was the predictable consequence of government distorting the interest rate.

I’m not dogmatically against all regulation or government intervention across the board. Some level of “involvement” serves a rational purpose. But most involvement is purely political. Some just accumulates over time, multiplying and reducing market efficiency. The answer to any economic problem that was caused, in part or in full, by market intervention by the government is not more regulation, but less.

Here’s some evidence that the editorial board of the NY Times is clueless about econ. The board proposes that, in addition to the bailout, the US gov’t do the following:

• extend unemployment benefits
• allow bankruptcy courts to reduce homeowner’s mortgages
• provide subsidies to cities/states for food stamps and financial aid for health care, construction jobs, etc.

In economics, there’s no free lunch, so money that subsidizes the unemployed comes from somewhere in some form, such as from taxes–from companies. I.e., the companies that provide employment. Additional taxes on those companies reduce their capacity to provide employment. Sorry, but I measure progress not by how many are “successfully” on unemployment benefits, but how many people are off such benefits. Providing economic incentives for people to remain unemployed is a bad idea.

I have no idea why bankruptcy courts should arbitrarily be allowed to alter mortgages. Maybe there’s a compelling reason (seriously). But it seems like a perversion of normal market incentives. In fact, I can see the number of bankruptcies going up for people who are on the “edge” financially, banking on a reduction in their monthly mortgage rate. Oh, and how would this affect lenders’ willingness to lend? Probably not positively, knowing that the state could dissolve loan agreements en masse. Sounds like a bad idea to me.

Bottom line is that the editorial is economically simplistic, revealing an underlying lack of understanding of basic economics (or a failure at explaining their points rationally). I’m all for an improvement in living standards and an easing of the stress from the current market turmoil. But fiat manipulation of markets by the government often winds up doing much more harm than good for Wall Street and Main Street alike.

After reading plenty of the bailout plan, I’ve become convinced that, while there is a role for the central government in all this, the bailout plan is sub-optimal, and possibly very dangerous to our long-term economic health.

Here’s a post by John Cochrane on why the bailout plan is a dreadful idea. Concluding para:

Yes, we need to do something. But “doing something” that will not work — with potentially dire consequences — is not the right course, especially when sensible and well-understood options remain.

Another editorial on RealClearPolitics on why the bailout plan is a bad idea (one of the better one’s I’ve read that explains itself without going into so much detail as to be too abstruse for laymen). Beginning para:

The proposed bailout of the financial system is a misguided scheme that will hurt the U.S. economy in the short run and long run. The economy currently is stumbling as a consequence of a government-created housing bubble, but a bailout of companies, executives, and shareholders that made unwise decisions would, at best, extend the economy’s adjustment process. More likely, the bailout would impose considerable additional economic damage because political factors would at least partially supplant market forces in determining the allocation of resources.

Quoting large chunks of the editorial, the author claims that the bailout is a bad idea for the following reasons:

• The bailout is bad for the economy. The unfortunate truth is that bad government policy has resulted in excess investment in the housing sector, and the inevitable reallocation of labor and capital is going to cause some economic dislocation. The good news, though, is that this process - if not hindered - will create a stronger and more vibrant economy. A bailout, however, will discourage this process and reduce economic efficiency. This may not seem important in the short run, since modest changes in the rate of economic growth are difficult to perceive. But in the long run, because of compounding, even small changes in the rate of growth can have a significant impact on living standards. Small differences in annual growth rates are why disposable income in the United States is substantially higher than disposable income in nations that practice economic interventionism, such as France, Germany, and Japan.

• The bailout repeats the mistakes Japan made in the 1990s. There are several historical episodes that indicate the dangers of government intervention to prop up a bubble. Japan faced a similar situation at the end of the 1980s, with real estate prices rising to absurd levels. The bubble then burst, but rather than let market forces operate, Japanese politicians sought to prop up both insolvent institution and asset prices. This interfered with the orderly reallocation of labor and capital, created considerable uncertainty, and contributed to a “lost decade” of economic stagnation. Another worrisome parallel is what happened during the 1930s. Policy mistakes such as protectionism (Hoover), higher tax rates (Hoover and Roosevelt), increased government spending (Hoover and Roosevelt) and increased intervention (Hoover and Roosevelt), helped turn a stock-market correction into the Great Depression.

• The bailout will increase corruption in Washington. When politicians have more power over the allocation of economic resources, people have an incentive to play the “rent-seeking” game of exchanging campaign contributions and hiring lobbyist in hopes of obtaining unearned wealth (or, more honorably, taking the same steps in hopes of protecting themselves from those seeking unearned wealth). The squalid mess at Fannie Mae and Freddie Mac was made possible in part because politicians received enormous amounts of money from advocates of the two government-sponsored enterprises. If the government obtains power over financial markets, including the ability to steer money to particular firms, it will create a feeding frenzy of lobbying and influence peddling.

• The bailout rewards executives and companies that made poor choices. Unfettered markets are the best generator of prosperity because people have incentives to make wise decisions. If an entrepreneur figures out a way to provide a valued good or service to others, he can become wealthy. But if that entrepreneur makes a mistake, he will suffer losses and maybe even bankruptcy. If investors put money into a well-run company, they can increase their wealth. But if they put their money into a poorly-run firm, the opposite can happen. In other words, market forces encourage people to make smart decisions so they can prosper. But it is equally important that people bear the consequences when they make wrong choices.

• The bailout will encourage imprudent risk in the future. The debacles at Fannie Mae and Freddie Mac, as well as the savings & loan failures from the late 1980s/early 1990s, are compelling examples of the negative economic consequences that occur when profits are privatized but losses are socialized. Faced with this perverse incentive structure, people engage in riskier behavior (analogously, if you are in Vegas, and somebody else is going to cover your losses, you obviously have an incentive to make bigger bets). A bailout would extend this risky behavior to the whole financial system, if not the entire economy.

Ironically enough, the writer espouses the idea (supported by many others, but disputed by some) that the government had a role in creating the problem in the first place (I support this view as well, though not dogmatically). In other words, through legislation like the Community Reinvestment Act (which encourages lending to the non-credit worthy–you know, subprime lending), lenders took unreasonable risks that they would not have taken in non-manipulated markets. I.e., the conservative concept that the government is often the problem is corroborated by this view point.

That editorial referenced above is a good one and one that largely concurs with my thinking on the issue. I.e., we need to “do something,” but let’s not pervert normal market incentives as a result of this crisis. Let’s not permanently wreck our financial system due to the lending fiasco.

My biggest worry is not whether or not we’ll get out of this mess. I think we will. My concern is that, for the foreseeable future, the idea that free markets are a good thing and that wasteful regulation is a bad thing will take a back seat to the illiberal economic view points espoused by the more socialist-inclined members of Congress. I.e., we’re already seeing calls for a “New, New Deal.” A tighter regulatory regime might be helpful, so long as the scope is rationally defined, but a “New New Deal” sounds disastrous to our economic freedom and our prosperity. I foresee calls for government intervention all over the economy (including where government is already involved, and often doing harm, such as health care), despite the lack of relevance that that has in the current fiscal crisis.

Free-market, laissez-faire types will have to take a back seat to illiberal socialists. But then again, with socialism, we wouldn’t have this problem: our economy would never have generated the wealth for this to ever have become an issue.

Regarding the current financial woes, the Freakonomics blog poses the question of why, if the troubled securities are truly bargains, hedge funds or non-risk-averse investors aren’t buying them up?

Also on that blog, Justin Wolfers writes about deep concern that 100+ well-known economists have with the bail-out plan being devised. They boil down to:  fairness, ambiguity, and long-term effects (my top concern).

Paul Krugman has an analysis as well. In his “four-step view” on the situation:

1. The bursting of the housing bubble has led to a surge in defaults and foreclosures, which in turn has led to a plunge in the prices of mortgage-backed securities — assets whose value ultimately comes from mortgage payments.

2. These financial losses have left many financial institutions with too little capital — too few assets compared with their debt. This problem is especially severe because everyone took on so much debt during the bubble years.

3. Because financial institutions have too little capital relative to their debt, they haven’t been able or willing to provide the credit the economy needs.

4. Financial institutions have been trying to pay down their debt by selling assets, including those mortgage-backed securities, but this drives asset prices down and makes their financial position even worse. This vicious circle is what some call the “paradox of deleveraging.”

Krugman doesn’t like the current “bail-out plan” (for lack of better words). He ends with this:

But I’d urge Congress to pause for a minute, take a deep breath, and try to seriously rework the structure of the plan, making it a plan that addresses the real problem. Don’t let yourself be railroaded — if this plan goes through in anything like its current form, we’ll all be very sorry in the not-too-distant future.

I’m already sorry. I foresee many years of unnecessary government intervention in the name of “running the economy.” The government has a role in the market, but not in micro-managing it. I hope our luminaries in DC keep that in mind.

Thomas Friedman, in summary, argues for regulation–but not too much regulation–in the financial markets. Last para:

In sum, government’s job is to police that fine line between the necessary risk-taking that drives an innovation economy and crazy gambling with other people’s savings in ways that threaten us all. We need to make sure that what happens in Vegas stays in Vegas — and doesn’t come to Main Street. We need to get back to investing in our future and not just betting on it.

Yep. The neighborhood effects of the banking/insurance/mortgage/lending industry means that other, non-involved parties are affected by the actions of others, meaning that government action/regulation/what-not might be appropriate (and is, in this case). Regulation, as always, should go far enough, but not too far. (Else, we’re left with the potentially worse bail-outs that we have now.)

David Ignatius - “Palin Pick Shows a Reckless McCain.”

Not flattering for McCain. I agree w/ him. Palin’s certainly not the most qualified to be VP. That’s not good for America (oh, yeah, and not good for women, since Palin’s performance will be generalized, fair or not). McCain pandered to women and to evangelicals (the latter being a recurring Republican mistake in recent times, it seems). Just sad to see McCain doing this sort of thing. Palin may be a quick study, but the VP position isn’t one you learn on the job.

From the NY Times Economic Scene…

If Chrysler had collapsed, he argues, vulture investors might have swooped in and reconstituted the company as a smaller automaker less tied to the failed strategies of Detroit’s Big Three and their unions. “If Chrysler goes belly up,” he says, “it also might have forced some deep introspection at Ford and G.M. and might have changed their attitude toward fuel efficiency and manufacturing quality.” Some of the bailout’s opponents — from free-market conservatives to Senator Gary Hart, then a rising Democrat — were making similar arguments three decades ago.

[...]

Speaking of which, Detroit’s Big Three have come back to Capitol Hill lately, lobbying for billions of dollars in handouts. This time, their executives insist, they’ll use the money to solve their problems.

Not saying the Feds were wrong to bail out Bear Stearns, Fannie, Freddie, and AIG (and others?). Failing financial/mortgage/insurance companies might have far more troubling rippling effects than a failing car company. Still, bailouts aren’t free, and the consequence of a bailout can be long-term, and not always in a good way.

Kiplinger’s forecasts that an exodus of foreign investment from Russia by the US/Europe will curtail Russian expansionism and aggression abroad. Excerpt:

Capital flight may prove the most effective check on Russian aggression in Georgia, as well as a means to prevent similar moves by Russia elsewhere in the “near abroad” of former Soviet republics. Moscow will ignore diplomatic efforts by the U.S. and Europe to persuade it to back off and give its neighbors room. But it’ll be harder for the Kremlin to ignore the more immediate and harsh discipline of the market.

I’m sometimes told (by people who don’t understand economics) that I put too much stock in economics and the role of the market in shaping world events. This is but one example of the efficient global market in action–for good.

Politicians, esp Dems, rail about the health uninsured. Invariably, this is followed by a proposal by the speaker to “do something” in the form of health legislation that shackles insurance companies or “universal healthcare,” which, using the most extreme definition, bestows healthcare to all Americans and is administered by the government (like the VA, but for everyone).

The government’s bad enough at what is ought to be doing to be doing something it shouldn’t have any business doing whatsoever. Centralized planning is derided by economists for a very good reason, and centrally planned, government administered healthcare sounds awful. Think of the courtesy of the IRS and the efficiency of FEMA… doing triple bypass on you.

We need a national market for health insurance. We need more freedom to shop around, not the reduction in freedom that is innately the result of additional legislation. Currently, shopping across borders for health ins is disallowed, reducing market competitiveness and consumer freedom of choice.

It’s ironic that people who deride our current (flawed) system of healthcare propose a socialist one as the only alternative solution. It’s clear that our current system is flawed in part because of the fiat and often arbitrary requirements in the legislation. So we don’t need more government intervention, but less of it.

There are other reasons why healthcare is pricey, some that are fixable, others that are more complicated. But the legislation that restricts our freedoms and makes us serfs to the state bureaucracy are needlessly making health insurance unaffordable or, at best, cumbersome for far too many Americans.