Economics

American Society / Business / Economics / Financial / Political — 0 Comments
2
Sep 10

The Economy at Street Level

While we have examined macroeconomic issues extensively, rarely do we focus on the micro. We need to look at what is happening to real people.  Examining economics at street level is not as scientific or as mathematically precise as our econometric brethren would be.  We would probably fail the basic intro econ course at a prestigious academic institution.  Nevertheless, the timeless philosopher, Yogi Berra, says it well: “you can observe a lot by just watching.”

Walking

The best way to learn what is going on somewhere is to walk, not drive.  I live in a small city, a bedroom community for a larger city.  The median family income is $62,000 and the per capita income $35,000.  The city is racially diverse and attempts to cater to its upscale resident consumers.  Dropping my car for service at the local auto dealer (there are Porsche, Volvo, Mercedes, Lexus, Subaru and Buick dealers within walking distance),  I politely declined the courtesy shuttle and, to observe business conditions, walked home.   Covering about a mile through one part of our retail  and commercial district, I observed the following:

  • Ten retail establishments were vacant.
  • Each of several small office buildings had “space available” signs.
  • Each of the apartment buildings and garden apartment complexes I passed advertised one and two bedroom apartments for rent.
  • An office building which started construction six months ago has not progressed.
  • Almost every retail establishment had sales in progress, and restaurants advertised specials.
  • A major wind and rain storm hit our city in March.  Several damaged city trees have not been removed and badly buckled sidewalks have yet to be repaired.

Listening

The economy continues to impact friends, neighbors and family.  Here is what the Washington beltway political elites are not hearing:

  • One question, I regularly ask: on a percentage basis how much has your income declined from your most recent peak earnings year?  Other than one medical specialist who said his income has not declined, the response is a decline of 25-50%.
  • For an over-fifty executive, attorney, senior information technologist or finance specialist the job prospects are almost nil.   These are highly trained, experienced competent individuals who have been out of work from one to two years.  Unarticulated age discrimination is endemic in our system.  This type of candidate probably has a better chance of getting hit by a meteorite than getting a full time position with a firm.
  • Sending a high school senior to the state university has come back in vogue.  In the past, State U lacked the cache of the Ivy League or better private schools.  Suddenly this option has gained new luster.
  • Instead of the direct path to graduate school, new college graduates, even Ivy League grads, are scrambling for jobs.  Many new alumni of prestigious universities are interning with no pay or $10 per day stipends.  The entire economic value of graduate and even undergraduate degrees is under question.
  • Overseas vacations are out and domestic, and automobile vacations are in.  And we’ve all recently heard a new word:  staycation.
  • Since the banks have tightened lending requirements, the re-sale house market is virtually dead.  Sellers cannot find qualified buyers.
  • Small business owners and professionals have had their credit lines reduced, which de facto has cut back on business expansion.
  • Friends who are doctors and dentists are finding that they cannot fill their weekly schedules and are going to 3 and 4 day workweeks. Even in large firms, attorneys are having difficulty generating billable hours.
  • Home equity lines have been slashed, further undercutting spending plans.  I question why some of my high earning friends were using these lines for luxury expenditures in the first place.

It May Not Be Science but It Is Real Life

Again I have presented “street level” anecdotal information on the real economy.  I believe this anecdotal information more accurately presents the state of the economy, compared to the endless cheerleading from financial media and the Administration.

Perhaps some of the elite should bring their own cars in for service, avoid the courtesy shuttles, and walk home.    Rather than this cheerleading, what Yogi might say about our current recession is the real truth for many people: “it ain’t over until it’s over.”

GD Star Rating
loading...
  • Share/Bookmark
Banking / Economics / Financial / Political — 0 Comments
26
Aug 10

Artificial Sweeteners Turn Sour

Last week in Artificial Sweeteners we discussed how government intervention has distorted the economy, the stock market and the housing market.  The basic thesis:

Excessive economic stimulus and a misguided zero interest rate policy has created false bottoms in the housing and stock markets.   See Artificial Sweeteners

Dour economic statistics released this past week only confirm that thesis.  While extrapolating from one month’s statistics is dangerous, nevertheless the numerosity and interrelated nature of recent reports raises questions whether there ever was an economic recovery.

Scanning the Headlines

The past week we have been bombarded by negative economic reports from housing to employment to durable goods.  A quick look at the headlines:

The Super Sweetener

The Congressional Budget Office calculates that stimulus added 4.5% to GDP.  Further, these programs created up to 3.3m jobs.   One estimate is that without stimulus, GDP would have been negative 3.5%.   What happens next?

So now that the stimulus is tapering off, America has the following rather unpleasant things to look forward to: a 4.5% reduction in run rate GDP as the direct economic boost disappears, the gradual loss of 1.4 to 3.3 million jobs, and the eventual realization that non-recurring, one time items can not be projected into perpetuity, despite what Keynesian dogma may preach. See CBO Estimates that Stimulus Boosted Q2 GDP by 4.5%, Standalone Number is likely under around -3.5%

Shoveling Money to No Avail

Morton Zuckerman captures the folly of current economic policy:

Tons of money have been shoveled in to rescue reckless banks and fill the huge hole in the economy, but nothing is working the way it normally had in all our previous crises. See End of American Optimism

All we have created is a “new normal” of slow or little growth. Compared to sales growth of 4% in past recessions, sales are increasing at a little over 1%.

…there are at least 14.5 million Americans still searching for work: 1.4 million of them have been jobless for more than 99 weeks, 6.5 million have been jobless for over 27 weeks. This is a stunning reflection of the longer-term unemployment we are coping with.

The unemployment numbers are worse than reported. Last year the Labor Department admitted it over-counted the number of jobs by 1.4 million….

Since April, the Labor Department has counted 550,000 nonexistent jobs under this so-called birth/death series. Without these phantom jobs, the economy this year created virtually no jobs—certainly not the 600,000 the administration has been touting.

The Obama administration projects the unemployment rate will drop to 8.7% by the end of next year and 6.8% by 2013. That is totally unrealistic. See The End of American Optimism.

A policy of artificial sweeteners has misled the American public and merely put off the day of reckoning.  Trillions of stimulus dollars have masked underlying weakness in the American economy.  Instead of these sweeteners, banks should have been forced to write off bad debt, insolvent firms should have gone bankrupt, government interference in the economy should have dwindled,  and programs increasing employment costs should have stopped.

If the economy were permitted to self correct, we would be on our way to recovery rather than be suffering the sour aftertaste of artificial sweeteners.

GD Star Rating
loading...
  • Share/Bookmark
Economics / Political / Tax Policy — 0 Comments
23
Aug 10

Magical Thinking

“Just as in the late stages of the Roman Empire, magical thinking abounds. This is America, the capital of can-do! We are audaciously hopeful because we always arise, newly envigorated by the unquenchable spring of American innovation….” Nothing has Changed, Charles Hughes Smith

How ironic that we live in an age of magical thinking.  We have never had more information and commentary a mere computer keystroke away.   With all this information, one would think that we could easily accept reality and think critically.   Perhaps reality is so discouraging and the consequences of our current path of behavior so awful to contemplate that we prefer magical thinking, hoping against hope that a solution will appear.

Nowhere is magical thinking more evident than in our current economic plight.

The Land of Endless Deficits

Paul Krugman, Professor of Economics, influential Democrat and New York Times columnist, is the high priest of deficit spending.  His philosophy in short:

Spend now, while the economy remains depressed; save later, once it has recovered.  How hard is that to understand? See Now and Later

First, we never save later, as Congress would rather keep spending to buy votes than be fiscally prudent.   Second, the US is absorbing a large portion of the world’s savings to fund the ongoing $1.3 trillion dollar per year deficit.  Third, even Krugman realized that our debts are growing exponentially.  His view is that with high unemployment this is the not the right time to become fiscally prudent.  Fourth, taxpayers have paid $3.7 trillion over the last year to achieve a modest economic recovery which is currently fading.   In the 1950′s one dollar of debt added a dollar to GDP;  recently it took $5.57 to add a dollar to GDP.  Source Contrary Investor. We have reached the point of debt saturation.

Why Not Cut Taxes?

Republicans have an equally magical mantra:  “just cut taxes.”   Back to the Reagan era, Republicans have been enthralled by the Laffer Curve:

Economist Arthur Laffer made a very interesting supposition: If tax rates are high enough, then cutting taxes might actually generate more revenue for the government, or at least pay for themselves. (In one of life’s great coincidences, he first sketched a graph of this idea on Dick Cheney’s cocktail napkin.) If the government cuts taxes, then Uncle Sam gets a smaller cut of all economic activity — but reducing taxes also generates new economic activity. Laffer reasoned that, under some circumstances, a tax cut would stimulate so much new economic activity that the government would end up with more in its coffers — by taking a smaller slice of a much larger pie.  See Debunking One of the Worst Ideas in Economics

If the US had a 99% marginal tax rate,the rate paid on the last dollar of taxable income, Laffer’s theory might work.  But, we do not:

We don’t have a 99 percent marginal tax rate. Or 70 percent. Or even 50 percent. We start with low marginal tax rates relative to the rest of the developed world. (Yes, I understand that it may not feel that way after the check you wrote last month.)

So cutting the tax rate from 36 percent to 33 percent is not going to give you the same kind of economic jolt as slashing a tax rate from 90 percent to 50 percent. There’s no huge black market to be shut down, no big supply of skilled workers to be lured back into the labor market, and so on.  See Debunking One of the Worst Ideas in Economics

The ultimate problem is that even if the economy grows, government revenues shrink, government spending continues and deficits widen.

Bring in the Grown Ups

Former Reagan budget director David Stockman recognizes that, if honestly measured, the budget deficit would be a Greek-like 120% of GDP by 2015.  Stockman excoriates the Republicans for cutting taxes and failing to balance the budget.

…the new catechism, as practiced by Republican policymakers for decades now, has amounted to little more than money printing and deficit finance — vulgar Keynesianism robed in the ideological vestments of the prosperous classes.

This approach has not simply made a mockery of traditional party ideals. It has also led to the serial financial bubbles and Wall Street depredations that have crippled our economy. See Four Deformations of the Apocalypse

His prescription is both simple and logical: “…balanced budgets, sound money and financial discipline — is needed more than ever.”

Without Keynes, Laffer or Friedman

Keynes’ “pump priming” through endless deficit spending and Milton Friedman’s monetarism call for expansion of money supply to ward off deflation.  These flawed strategies have captured our Treasury Secretaries from Republican Henry Paulson to Democrat Timothy Geithner.  Reviving Laffer’s arguments, and ignoring widening deficits, Congressional Republicans argue for extension of the Bush tax cuts.  Unfortunately, these theories have not extricated us from the current economic morass.

Faced with reality, the political elite would rather delude themselves with hope and magical thinking than confront the harder realities of austerity and living within our means.  We appear doomed to repeat these failed policies until it is too late.  Perhaps an economically rational adult will arrive to break the magic spell.

GD Star Rating
loading...
  • Share/Bookmark
American Society / Economics / Financial / Municipal Finance / Political / State Finance / investing — 0 Comments
19
Aug 10

Artificial Sweeteners

Artificial sweeteners have been the subject of health concerns.  Aspartame, for example, has been found to be a migraine headache trigger.  Products containing it carry a health warning for PKU, a rare hereditary disease.  Today we learn that diet sodas markedly increase the risk of pre-term deliveries.  See Add Diet Soda to the List of Things to Avoid While Pregnant.

Similarly, the Federal Reserve and the Administration have not trusted that the economy can heal through natural market forces.  Instead we have been served up the economic equivalent of artificial sweeteners.  Concerned by slow growth, not even negative growth, the government again is firing up the machinery for money printing and stimulus.

In each instance, the government is intervening, distorting, and artificially “sweetening”  the bond market, the housing market and, indirectly, the stock market.  What are the consequences?

There is No Free Lunch

Martin Hutchinson in The Peril of False Bottoms targets faulty government policy as the reason for our anemic economic recovery.  Excessive economic stimulus and a misguided zero interest rate policy has created false bottoms in the housing and stock markets.    A false bottom is defined as a stabilized “price far above the likely long-run price equilibrium of the assets concerned.”

Bernanke has precedent for providing excessive liquidity and holding interest rates too low for too long.  Greenspan reacted to the internet stock market crash by flooding the market with liquidity.  Doing this drove the market to over 14,000 on the Dow Jones Index and created a housing boom.   In the 2008-2009 real estate and stock market crash we learned  how flawed this policy was.

More on False Bottoms

Hutchinson points out federally inspired housing market distortions:

House prices are currently 47% above their level in January 2000, according to the S&P Case-Shiller 20-city index, compared to a 49% rise in prices since that time – in other words, they are in real terms at the same level as at the top of an immense speculative boom.During the recent contortions, the U.S. monetary and fiscal authorities have established false bottoms in two markets. The first is housing, where subsidies to first-time buyers, ultra-low mortgage rates, government guarantees on $700,000 home mortgages and foreclosure-avoidance schemes have prevented the housing market from falling even to its average level where the average house price is about 3.4 times average earnings. The Peril of False Bottoms

These misguided policies have consequences:

…with additional buyers having been sucked into the market, it is now likely that house prices will fall further than this. Indeed, if the appalling suggestion put forward last week that the government through Fannie Mae and Freddie Mac forgive $1 trillion of defaulted home mortgages is put into effect, they will undoubtedly do so. Nothing could be more designed to destroy confidence in the housing market than a massive subsidy to the most foolish and improvident home buyers, at the expense of the thrifty and careful renters who are the major source of potential new demand for housing.

If the buyer pool is attacked in this way, or forced into unnecessary losses by being made to buy too soon, house prices may not bottom out at the market-clearing level … but may continue falling.  The Peril of False Bottoms

Wither the Stock Market?

The stock market is the second false bottom:

Currently at 10,650 as I write, the market is 35% above its appropriate “middling” target. The “trailing” P/E ratio of 20.4 on the Standard and Poors 500 is also above its historic average, even though corporate and bank earnings are currently inflated by ultra-low financing costs and a steep yield curve. Thus at some point we can expect reality to intrude, and the market to drop to its likely cycle low in the region of 5,000 on the Dow Jones index.

Again market prices are too high for any intelligent buyer.  And worse, buyers will then be unavailable to buy stocks at the bottom. The Perils of a False Bottom

Politics v. Economics

Politicians are worried about the next election.  Thus, we see the desperation of the Administration to throw economic caution to the wind.   Zero interest rates, forgiveness of imprudent debt, subsidies to overpaid public sector workers (with no corollary “give backs”) are all hallmarks of erratic and misguided government policy.  They also sacrifice long-term prudence for the feel good of short term stimulus.

Who will pay this price?  Unfortunately, it will be stock market investors, pension plans, life insurance companies and homeowners.  Directly or indirectly, that is virtually all of us.  We need to beware politicians handing out artificially sweetened candy. Just like aspartame and our physical health, artificial economic sweeteners can be harmful to our financial health.

GD Star Rating
loading...
  • Share/Bookmark
American Society / Economics / Municipal Finance / Pensions / Political / State Finance — 0 Comments
11
Aug 10

Awash in Legacy Costs

Legacy costs have strangled many American iconic and venerable American industrial firms.  The automobile and steel companies are recent victims of this growing scenario:  diminishing work force and profits supporting large and growing pension and retiree medical costs.  In many instances bankruptcy has been the corporation’s only way out.

The Financial Dictionary defines legacy costs in the private sector as follows:

Ongoing costs to a company that come from funding activities that, by definition, do not increase revenue. Perhaps the most prominent example of legacy costs is the funding of pension plans. Legacy costs often accrue when a company takes on too many responsibilities in times of strong performance or when it takes on an appropriate level of responsibility and then its priorities change.

Legacy costs also include retiree medical, life insurance and other promised benefits.

The recent turmoil in the financial markets has revealed a potentially larger legacy problem.  Not only is private industry suffering this stranglehold; legacy costs are also drowning state budgets in red ink. Like private business, the public sector is also saddled with pension, retiree medical and life insurance benefits.   Completing the analogy, many of these costs were taken on when state tax revenues (think profits) were high.  Politicians avoided confronting public employees and unions and chose the path of least resistance; that is, they capitulated to exorbitant demands.  Then they compounded the problem:  instead of direct layoffs, states resorted to early retirement pension sweeteners, which depleted pension assets.

The Current Status of Public Pension Plans and Other Benefits

On August 6th, the New York Times reported the massive underfunding of public pensions.  See Battle Looms over Huge Cost of Public Pensions. The Times discovered a February Pew Center for States study showing a $1 trillion pension underfunding. (We could have a whole different post as to why it took until August for the Times to report a study published in February.)   Worse yet, the Pew study may have been overly optimistic.  In other words, their methodology understated the liability and the deficit.  In contrast, the National Center for Policy Analysis’ Unfunded Liabilities of State and Government Employee Retirement Benefit Plans found that states were using too high a discount rate to determine employee liabilities.  Under the National Center for Policy Analysis deficits are far more alarming:

  • Unfunded liabilities for health and other benefits are
    $558 billion, compared to the reported $537 billion.
  • Thus, total unfunded liabilities for all benefit plans are an
    estimated $
  • Unfunded pension liabilities are approximately $2.5
    trillion, compared to the reported amount of $493 billion.
  • 3.1 trillion — nearly three times higher than
    the plans report. See Reality Beckons (Government Pensions)

While pensions are funded, other benefits like retiree medical, vision and dental have no assets side aside to fund them.  Moreover, based on current trends, medical costs are growing exponentially.

The New Battle Ground

Colorado undertook modest changes to its pension plans to lower future pension payments. The state legislature reduced its cost of living adjustment cap from 3.5% to 2%. The result was an immediate lawsuit from public employees:

Earlier this year, in an act of rare political courage, a bipartisan coalition of state legislators passed a pension overhaul bill. Among other things, the bill reduced the raise that people who are already retired get in their pension checks each year.

This sort of thing just isn’t done. States have asked current workers to contribute more, tweaked the formula for future hires or banned them from the pension plan altogether. But this was apparently the first time that state legislators had forced current retirees to share the pain.

Sharing the burden seems to be the obvious solution so we don’t continue to kick the problem into the future. See Battle Looms over Huge Cost of Public Pensions

Employees view their pensions as inviolable contracts, while the state is invoking changes as actuarial necessities.

Who Thinks About the Taxpayers?

Taxpayers are facing unemployment, the risk of losing their jobs and increasing costs of education, medical and energy.   Public employees are well paid, largely insulated against layoffs, and receive top of the line current and retiree benefit packages.  Barron’s points out that: “[m]ost public employees, if they hang around to retirement, can count on pensions equal to 75% to 90% of their pay in their highest-earning years.”  The $2 Trillion Hole.  Frequently, supervisors and employees collude to inflate final pay with shift and overtime pay in the last year of work.  Current and retiree medical benefits require minimum or no contribution.

In contrast, private sector benefit plans pale in generosity to public benefit plans.  I worked for a company for 32 years and my pension is a little more than 40% of my last five years of pay.  Retiree medical requires a 20% contribution.   Our plans had no cost of living adjustments.   My company’s plans were probably in the top 5% of benefit plans in America.   Most companies offer little more than a basic medical plan and no retiree benefits.

The federal government will soon run out of borrowing capacity.  In addition, there are questions of federalism; that is, the states are supposed to be responsible for their own finances.   Federal and state legislators and public unions  have to be far more realistic than they have been.  If they are not,  some of our largest states (think New York, New Jersey, California, Illinois) will suffer as did  GM and  Greece:  drowning in legacy costs.

GD Star Rating
loading...
  • Share/Bookmark
Economics / Financial / Political — 0 Comments
5
Aug 10

Zero Interest Rates Equals Zero Jobs

Following World War II, typical economic downturns and recoveries have been “V” shaped.  That is, a sharp downturn in Gross Domestic Product and rising unemployment followed a quick turnaround in both economic activity and employment numbers.   This time is different.  We are witnessing zero or negative job growth and an anemic recovery.

Today’s situation is a different animal: a balance sheet recession.  Both businesses and individuals took on too much debt. And that debt was unsupported by income.  We are now saving to pay down that debt (the most recent savings rate increased to 6.4%), or defaulting on obligations (in May home foreclosures rose 44% to a new record).

Paradoxically, second quarter earnings demonstrate that corporations are beating earnings estimates and reporting healthy profits.   Gluskin, Sheff reports that

…78% of the companies reporting have beaten estimates and earnings per share are up 42% year over year versus initial expectations of 27%.

Companies have focused on tight cost controls to achieve these results.  The most recent durable goods report provides a clue to how costs are being controlled.

Orders for non-military capital equipment excluding aircraft climbed 0.6 percent last month after jumping 4.6 percent in May, more than previously reported, figures from the Commerce Department showed in Washington. See Second Quarter Earnings: Companies Beat But Investors Shrug

Looking further, we see we are in a jobs depression. Karl Denninger slices through the obfuscatory government data and finds that from July 2009 to July 2010 unemployment is 17% worse. See Watch the Birdie (Jobless Claims). After trillions of dollars of stimulus and guarantees and a zero interest rate policy, all we have to show for the effort is zero, or negative, job growth.

My strong suspicion is that management is substituting capital for labor.

A Brief Anecdote

One of my friends is the cost cutting guru for his company.  Always on the lookout for new labor saving technology, he found a type of packaging machine that could replace five employees currently performing the function manually.  His view is that labor saving technologies are the only thing preventing the economy from crashing.  By laying off those five employees, the machine pays for itself in two years or less.

On the other hand, employees unionize, get sick, go on vacation, file worker’s compensation and discrimination claims, and go out on pregnancy and family medical leave.  As an employer, machines suffer none of these disabilities.  Substituting capital for labor is firmly rooted in all corporate cost cutting strategies.

Unintended Consequences

With Obama, Bernanke, Geithner and Summers setting economic policy, I always feel it is improvisation night.   This team seems to bounce from one economic policy to the next with little thought given to unintended consequences.

-          Zero Interest Rates – I have written about the pernicious effect of zero interest rates on savings, especially for senior citizens.  See e.g. Is the Administration Determined to Make the Elderly Poor? Nothing from Nothing.  However, the upside is that low interest rates encourage the creditworthy to borrow for capital investment.  For example, IBM was able to borrow at 1% for 3 years.  If you can purchase labor saving machines with low interest rate loans and tax depreciation savings, why not?

-          Expensive Social Programs – Ignoring high levels of unemployment and economic stagnation the Obama Administration pushed ahead to pass health care reform.  The law does not apply to businesses with less than 50 employees.  The perverse effect is obvious:

…potential tax penalties for employers with more than 50 workers could cause many smaller businesses to rethink any hiring or expansion plans.

“It could have a negative effect on hiring as businesses figure out just how much the new law and offering health benefits will actually cost them,” many … small business clients have kept their staffs below 50 workers to avoid the complicated compliance requirements of laws such as the Family and Medical Leave Act.

“The new tax penalties for businesses with more than 50 employees will certainly make many business owners think twice about expanding and hiring more people….”  See Small Businesses Ponder Impact of Health Care Reform

Add in the threatened expansion of unions through the Employee Free Choice Act and no wonder large and small businesses are reluctant to hire.

Machines Make Better Employees

At its core, the Democratic Administration has failed in its campaign promises to reduce unemployment and get the economy back on track.  Through its zero interest rate policy the Federal Reserve and the Administration have “manufactured” our current high unemployment rate.  Today’s jump in new unemployment claims, to a weekly rate of only emphasizes the point. See Weekly Initial Unemployment Claims Increase to 479,000

The net effect is that machines provide better value than employees.  The labor market has structurally changed and not for the better.  Zero interest rates coupled with zero forethought is harming the working population.

GD Star Rating
loading...
  • Share/Bookmark
American Society / Business / Economics — 0 Comments
3
Aug 10

The Two Americas

Taking a vacation is a great way to expand one’s perspective.   For the past several years our family has vacationed in the Berkshire mountains of western Massachusetts.   There is nothing better than to get away from the congestion of the New York metropolitan area, breathe the clean mountain air and experience cool nights with low humidity.  To expand business perspective, it is also an opportunity to take a break from the mindset of friends and colleagues in the financial industry and observe the other America.

A Look at the Other America

Anecdotal economic observations can be hazardous, but probably no worse than a day watching CNBC for what passes as economic wisdom.   While the folks at CNBC are constantly finding signs of economic recovery, I did not see such signs.  In fact, things in western Massachusetts seem a little worse than last year.  The area is interesting, with some contrasts and paradoxes.  Old industrial America is still in evidence, for example GE Plastics in Pittsfield, which is now SABIC Innovative Plastics, Saudi Arabian owned.  The vacationing financial elites from Boston and New York can enjoy fine restaurants, upscale galleries, museums and cultural events that are active in the summer there, while year-round residents shop for food, clothing and necessities in decidedly middle or lower class venues because there are few others to be found.

Some observations:

  • The Boston Symphony Orchestra performances at The Tanglewood Music Festival were sparsely attended.  In years past tickets had to be purchased months in advance and one would have to arrive hours before a concert to get a picnic spot on the lawn.  We were able to purchase seats and find a central picnicking location near the music shed 45 minutes before the concert.  The shed itself was about half full.
  • Lenox has a large, modern, Super Stop and Shop.  At 7 PM on a Monday night we counted exactly four customers in the store.  We made several food buying trips during the week and each time employees outnumbered customers.
  • Tickets for the summer theater festivals are usually nearly impossible to purchase, as most tickets are reserved for subscribers.  Just hours before curtain we purchased great orchestra seats for two well reviewed shows, Lombardi and After the Revolution.  Both shows are scheduled to open in major venues in New York in the fall.
  • It is back to school shopping season.  Despite large sale postings, WalMart had few customers in the store.  I noticed many of the shoppers using food stamps for grocery purchases.
  • I asked a local clergyman how his congregants were faring during the economic downturn.  His view is that if one is not a doctor attached to the regional medical center or an attorney, it is extremely difficult to earn a living.
  • Previously popular restaurants, that required reservations in advance, invited us to come virtually any time. When we arrived the restaurants were half full.
  • Everywhere we went, high end retail and commercial space was empty and available to lease.

Two Americas

The Bush and Obama administrations made a conscious decision to provide bailouts to Wall Street and the unionized auto industry.  Small business and the middle class have been left behind.   It is not just rumor:   there are two Americas and the other America is seeing no signs of recovery.

Today’s headlines emphasize the divide between these two Americas:

-          Wells Fargo/Gallup Small Business Index Hits Record Low, Future Expectations Dip Below Zero First Time Ever

-          Pending Home (Sales) Fall to Record Series Low in June

-          Personal Income, Spending Flat in June

If western Massachusetts is any indication, the November elections will be quite interesting.

GD Star Rating
loading...
  • Share/Bookmark
American Society / Banking / Business / Corporate Behavior / Economics / Financial / Political / Regulation — 0 Comments
8
Jul 10

The Tragedy of the Commons Part II: Modern Finance and BP

In Part I, we discussed the “tragedy of the commons” paradigm.   Financial excess in the housing market was a major factor leading us into the current financial crisis.  Finance is not the only area of concern.  Let’s turn our attention to BP.

BP, the Gulf of Mexico and the Eastern Seaboard

We are now approaching 80 days after the BP Deepwater Horizon oil rig spill.  Up to 100,000 barrels of oil are still spilling into the Gulf of Mexico.   The government now believes that by August 2010 there is an 80% chance that the spill will reach Miami coastal waters.  Once the oil slick starts moving up the Atlantic coast, some experts believe it will damage the fishing industries as far away as the Chesapeake Bay and even the Grand Banks off Newfoundland. See BP’s Crude Politics and the Looming Environmental Mega-Disaster

A dynamic tension exists among private profit, America’s need for oil, especially domestic oil, the government’s need for lease and tax revenue from the industry, and environmental concerns.  Despite campaigning against lax Bush Administration enforcement of oil drilling limits the Obama Administration ignored an environmental warning contained in a DC Court of Appeals decision.  Citing financial necessity, the Administration was able to overturn the ruling:

Less than four months after President Barack Obama took office, his new administration received a forceful warning about the dangers of offshore oil drilling.

The alarm was rung by a federal appeals court in Washington, D.C., which found that the government was unprepared for a major spill at sea, relying on an “irrational” environmental analysis of the risks of offshore drilling.

The April 2009 ruling stunned both the administration and the oil industry, and threatened to delay or cancel dozens of offshore projects in Alaska and the Gulf of Mexico.

Despite its pro-environment pledges, the Obama administration urged the court to revisit the decision. Politically, it needed to push ahead with conventional oil production while it expanded support for renewable energy. Obama Decried, Then Used Some Bush Drilling Policies.

The Risk of a Pro-Drilling Policy

A pro-drilling policy with minimal governmental supervision set the stage for the Deepwater Horizon tragedy.  Macondo History Before the Blowout provides a full analysis of the mistakes made at Deepwater Horizon.  First, Congressional investigators documented that BP took numerous short cuts: a cement log was not run, a lockdown sleeve was not used, they failed to circulate a sufficient quantity of mud, instead of a more sturdy liner they used a weaker production casing, and 6 rather than the recommended 21 centralizers were used.   While these shortcuts most likely contributed to the problem, the author focuses on human error.  The BP drilling engineer in charge ignored four major well events, referred to as “kicks” in the industry.  These are warning events.  One can surmise the engineer was trying to complete an over budget drilling project, quickly.  Drilling engineers are trained in mandatory safety courses to recognize “kicks” and take appropriate action.  Perhaps in a desire to expedite the project, he chose or was pressured to disregard obvious safety warnings.

Blowouts are a strong possibility when drilling. They are not rare events.  The author goes on to state “it is inexcusable that BP should have been so completely unprepared for the aftermath. BP should have had the containment built and tested ahead of time.”  By contrast, the Shell Corporation had a system on standby.

In pursuing its private interest in increasing shareholder value, BP despoiled a very large “commons.”  Avoiding an obvious extra expense, BP did not have a containment system on standby.  If the worst happens, BP will have fouled fishing grounds as far north as Newfoundland, and part of the Gulf region will become uninhabitable.  Of course, if BP goes bankrupt,taxpayers again will be asked to shoulder the clean up expense.

Private Interests, Public Policy and Protection of the Commons

The message and lesson of the Tragedy of the Commons is that there are dangerous activities requiring strict, intelligent and active regulation.  Neo liberal economists believe that regulation should not hinder the free market.  They assert that the free market will always self correct.  But in a technologically advanced and interconnected world, the stakes are far higher.  Unfettered capitalism can literally collapse the financial system as demonstrated by the recent financial crisis, or the eco system as demonstrated by the ongoing BP oil spill.

No one would question the right to limit private profit made through the sale of anthrax or nuclear materials.   We know that some activities are so inherently dangerous that the state should intervene and carefully control usage.   We are now learning that previously deemed “safe activities” can now have horrendous and unacceptable societal cost.

Nothing would please me more than for the financial industry to pursue whatever risky schemes they wish to engage in.  Just be prepared to bear your own losses.  Unfortunately, we learned that when it all explodes, we deem it a national crisis requiring domestic intervention to save the banks, insurance companies and industrial companies with finance arms (GE and GM).   In a parallel analogy, we have learned that an oil spill could paralyze an entire region of the country and perhaps the entire eastern seaboard.

We cannot afford too many more tragedies in our commons.  If we find ourselves privatizing profits and socializing losses, proactive and aggressive government regulation and intervention is going to be required.  At issue now is the viability of society itself, and that outweighs private gain anytime.

GD Star Rating
loading...
  • Share/Bookmark
American Society / Economics / Political / Regulation — 0 Comments
7
Jul 10

The Tragedy of the Commons Part I: Modern Finance and BP

“Regulation of derivatives transactions that are privately negotiated by professionals is unnecessary.”
Alan Greenspan,  Senate Agriculture Committee testimony – July 30, 1998.

BP’s Hayward conceded that his giant oil company had been unprepared for this disaster.  “What is undoubtedly true,” he said, “is that we didn’t have the tools you would want in your toolkit.”  Tony Hayward, June 4, 2010 interview with the Financial Times

A powerful and controversial precept in economics is the “Tragedy of the Commons.”  University of California biology professor Garret Hardin introduced the concept in a 1968 paper published in Science:

The tragedy of the commons develops in this way. Picture a pasture open to all. It is to be expected that each herdsman will try to keep as many cattle as possible on the commons. Such an arrangement may work reasonably satisfactorily for centuries because tribal wars, poaching, and disease keep the numbers of both man and beast well below the carrying capacity of the land. Finally, however, comes the day of reckoning, that is, the day when the long-desired goal of social stability becomes a reality. At this point, the inherent logic of the commons remorselessly generates tragedy.

As a rational being, each herdsman seeks to maximize his gain. Explicitly or implicitly, more or less consciously, he asks, “What is the utility to me of adding one more animal to my herd?”

The tragedy is overgrazing:

…the rational herdsman concludes that the only sensible course for him to pursue is to add another animal to his herd. And another; and another…. But this is the conclusion reached by each and every rational herdsman sharing a commons. Therein is the tragedy. Each man is locked into a system that compels him to increase his herd without limit–in a world that is limited. Ruin is the destination toward which all men rush, each pursuing his own best interest in a society that believes in the freedom of the commons. Freedom in a commons brings ruin to all.

We do not have a problem with herdsman.  Unfortunately, we have evolved to deadlier pursuits which threaten us all.  Let us examine the cases of the post-1999 financial world and the BP Deepwater Horizon tragedy.

The World of Modern Finance

Modern finance was born in 1999 with the passage of the Gramm Leach Bliley bill, ironically named the Financial Service Modernization Act, which repealed the Glass Steagall Act of 1933.  Glass Steagall among other reforms required a separation of commercial and investment banking activities.   Further, a commercial bank could not hold a brokerage firm.  With the passage of the Gramm bill the line between traditional and investment banking was obliterated and permitted  the merger of commercial and investment banks, brokerage and insurance firms.   The financial “commons” was now open for all to graze in.  The result:

-          Excessive use of leverage.

-          Large scale subprime lending.

-          Exotic mortgage products such as interest only, adjustable rates, and ALT-A.

-          Securitization of everything from mortgages to car loans to credit card debt.

-          Expansion of consumer lending facilities such as home equity line of credit, automobile leasing and mass issuance of credit cards to anyone who could fog a mirror.

-          Predatory private equity corporate takeovers amplifying leverage with “pick or pay” payment options.

-          Conflicts of interest between credit rating agencies and issuers and the ultimate purchasers of securities.

-          Credit derivatives wherein firms could bet on and simultaneously attempt to engineer the demise of other firms.

Before being distorted beyond their original purpose, these practices started from a rational base.  Take for example housing.   The reigning ideology supporting aggressive lending practices was that housing prices would always rise and homeowners would do everything possible to avoid foreclosure of their homes.  Banks armed with AAA ratings from the credit rating agencies and sophisticated models predicting default rates could bundle mortgages, create securities and sell them to “confident” investors.

The tragedy of this commons was that loose credit increased both real estate prices and supply to the point where incomes could not support repayment.  In turn, the packaged securitized mortgages did what no one unpredicted, failing at an alarming rate in excess of mathematical projections.  Soon the “housing commons” was littered with foreclosed homes, plunging prices, impaired bank balance sheets and the ultimate failures of Bear Stearns and Lehman.

Each participant: banker, builder, lender, appraiser, credit agency, and homeowner was merely pursuing his own economic interest.  If this was merely private participants losing money, it would create economic difficulties but not a financial crisis.  Unfortunately, two of the major players in the mortgage market were Fannie Mae and Freddie Mac, government sponsored enterprises with an implicit guarantee from the Treasury.  These entities are sporting losses which will exceed $1 trillion or more.  We the taxpayers through TARP and government guarantee programs are subsidizing these losses.  See Shredding the Social Fabric. We are still paying the price for this disaster with 8 million unemployed and countless millions more underemployed.

Part II will examine BP’s ill-fated sojourn into a “common” otherwise known as the Gulf of Mexico.

GD Star Rating
loading...
  • Share/Bookmark
American Society / Economics / law — 0 Comments
30
Jun 10

He Who is Wise Does Not Work for the Fed

Who is wise? He who learns from all men, as it is written (Psalm 119:99) “I have gained understanding from all my teachers.” Chapter 3 (Ethics of the Fathers)

Kartik Athreya, an economist with a PhD from the University of Iowa, published a paper on the Richmond Virginia Federal Reserve’s website: Economics is Hard.  Don’t Let Bloggers Tell You Otherwise.  The gist of the paper is that bloggers with little formal economics training are performing a disservice to the public with their uneducated commentaries.  I will let some of Dr. Athreya’s comments speak for themselves (thanks to zerohedge.com, Fed Economist: Bloggers are Stupid):

The general public are (sic) simply being had by the bulk of the economic blogging crowd. In this essay, I argue that neither non-economist bloggers, nor economists who portray economics — especially macroeconomic policy — as a simple enterprise with clear conclusions, are likely to contribute (sic) any insight to discussion of economics….

Writers who have not taken a year of PhD coursework in a decent economics department (and passed their PhD qualifying exams), cannot meaningfully advance the discussion on economic policy.

The response of the untrained to the crisis has been even more startling. I listen to Elizabeth Warren on the radio fearlessly speculating about the nature of credit market dysfunction, and so on.

The general public are (sic) simply being had by the bulk of the economic blogging crowd.

There has been much excellent commentary on this clearly offensive piece.  I would like to make some additional observations.

Credentials are the Last Bastion of the Incompetent and Insecure

Dr. Athreya invokes his University of Iowa PhD to squelch economic criticism from the uncredentialed.   The credential game is always dangerous.  What is an Iowa PhD compared to other economic faculty powerhouses like MIT, Harvard, Chicago, Stanford or Princeton?  Comparing one’s credentials is an endless and fruitless game.  Why not focus on competence, judgment, creativity and insight?

Competent professionals do not have to wave around credentials.  A moment of non-traditional wisdom from the movie Cool Runnings: “…a gold medal is a wonderful thing. But if you’re not enough without one, you’ll never be enough with one.”  If you are not confident in your own opinions and views, no fancy credential or set of professional initials, e.g. MD, JD, or PhD, is going to impress a patient or client.

My experience has always been that when attorneys start with their law school bona fides, law review membership or fancy clerkship, the legal advice that follows will be less than stellar.   Just as “patriotism is the last refuge of the scoundrel,” fancy credentials are the last bastion of the incompetent and the insecure.

PhD’s Got Us Into This Mess

Two of the most prominent PhD economists, Alan Greenspan and Ben Bernanke, never predicted the current great financial crisis.  They never warned us about the low interest rate policies, easy money, ill-conceived tax cuts, loose fiscal policy and dangerous lending practices that led us to this economic quagmire.  Dr. Bernanke assured Congress and the American public that the subprime crisis was well contained.  See Bernanke: I was Wrong About Subprime Crisis. Dr. Greenspan encouraged Americans to avoid fixed rate mortgages and take out adjustable rate mortgages (“ARMs”).  And lo and behold, ARMs were a major culprit in the slide toward too much unaffordable homeowner debt.   When these ARMs reset from their initial low “teaser rates” to higher market rates these unsuspecting homeowners simply lost their homes. See Don’t Take Mortgage Advice from Alan Greenspan.

The Pseudoscience of Economics

Economics is as much art as science.  In the Organic Economy, I wrote about the fallacy of econometric mathematical modeling.   The use of mathematics disguises the fact that economies are often too complex for modeling, as money collides with unpredictable human behavior.   It is pure hubris to believe that professionally trained economists have a monopoly on economic forecasting.

The Decline of the Free Press

The First Amendment ethos to support a vigorous press is integral to a well functioning American society. Starting with Ben Franklin’s musings on independence to the (originally anonymous) Federalist Papers, and continuing with today’s investigative journalism, an adversarial and aggressive press keeps government and other powerful interests in check.

But now great newspapers have either gone out of business or have pared their staffs. A recent report detailed the dearth and dying gasps of investigative journalism:

Thirty-seven percent of newspapers had no full-time investigative or projects reporter on their staffs. The majority had two or fewer, and only 10 newspapers had four or more investigative or projects reporters working for them.

In addition, 61 percent of the newspapers had no investigative or projects team. Of those, 16 percent had teams in the past, but they have been disbanded. Sixty-two percent of the newspapers surveyed did not have a single editor specifically charged with working on investigations. See Today’s Investigative Reporters Lack Resources.

Television news is now more “infotainment” than hard-hitting reporting.  We are left with a neutered corporate media, and a compromised press.  Rather than independence, they are more interested in not offending their sponsors.  They eschew the expensive, risky and controversial path of investigative journalism and criticism, whether it be print, visual or virtual.

Bloggers and alternative media like Rolling Stone (see e.g. Wall Street’s Bailout Hustle) have filled this investigative void.  Often for free or very little compensation, bloggers have taken on the powers that be.  Bloggers expose and criticize dangerous and often wrong economic policies.

Trust Me; I am a PhD Economist

The economics profession has a long way to go to earn the trust of the American public.  Attacking bloggers reveals a “weak hand.”  Instead of spending public money writing a paper with a ridiculous premise (note the paper has been removed from the Richmond Fed’s website), perhaps some of the bloggers have it right.

And so, to Dr. Athreya (and other Fed academicians) from a non-PhD blogger:  it is time to step down from that academic pedestal, display some humility and learn from all men and women (even the blogging ones).

GD Star Rating
loading...
  • Share/Bookmark