Economics

Banking / Economics / Financial / Real Estate / Sovereign Debt — 0 Comments
28
Sep 11

How Did We Get Here?

Karl Denninger makes a simple but telling point.  Since 1984 GDP growth has averaged 4% per year, debt growth has averaged 7% per year and government spending growth has also averaged 7% per year.  In no quarter did real economic growth exceed credit growth.   Europe Goes Enron (blog radio podcast).   Simply put, we are inflating credit faster than we are raising real economic output.  To repay debt, sufficient income must be generated to reduce this debt.  Thus, when the economy lags in a recession or depression, debt will go into default and must be either written off or restructured.

Also simply put, credit growth unsupported by income growth has distorted the economy.  In essence, the “easy money” fostered in a lax credit environment has sent the wrong signals to the real economy.  Some examples:

Real Estate

Lax bank lending and governmental programs encouraged homeowners to take on more debt.  The mantra was that house prices always rose. So bankers were eager to lend too much and borrowers were anxious to borrow too much, both believing that house price inflation would sustain the process.  Both parties ignored simple economic principles.  Incomes have been stagnating for more than ten years.  The housing boom expanded the supply of housing beyond demand.  Worse, the peripheral costs of owning a home (taxes, insurance, utilities and the like) ate into the income available to service those over-sized mortgages.   Loans were secured with little or no money down.

In the commercial real estate market, we massively overbuilt.   Again we mistakenly believed that inflation would bail out lenders and owners.   The demographic trend is for large companies to reduce use of commercial space.  Increasingly, employees work from home and technology requires fewer workers and less commercial space.  Internet shopping further lessens the need for brick and mortar retailers.  As with homes, the peripheral costs of commercial ownership kept rising.

Government

A falsely expanding, credit driven economy also sends false signals to government and their employees.   Tax receipts were on the rise from real estate transfer fees, expanding income taxes and capital gains from a rising stock market.    But these gains were bogus, a chimera.  And they did not benefit the average consumer.    Why shouldn’t the largesse of rising tax receipts be shared with employees, who also happen to be a powerful voting bloc?   Politicians were all too willing to grant pay increases, job security guarantees and costly pension and post-retirement benefits to government employees, especially those represented by powerful public unions.  Soon total compensation packages for public employees exceeded their private sector counterparts.

Sovereign Debt

And so the good times seemed to roll. What better way to finance government projects and even foreign wars than through inexpensive sovereign debt?  Dick Cheney once loudly proclaimed that “deficits don’t matter.”  Republicans and Democrats seemed to compete to see which party could run the largest deficits.  Believing that debt could be paid off through ever rising tax receipts, the government made more promises (like expanding Medicare coverage to include prescription drugs).   What were they thinking?  Borrow today and worry about repaying and credit collapse tomorrow?

Macro Trends

The credit binge occurred against a background of unfavorable macro economic trends.   First, US and European population growth, and therefore the supply of workers, slowed.  Second, free trade and free movement of capital and technology has exposed the American worker to foreign competition.  Seventy-dollar an hour (fully-loaded cost) Big Three unionized auto workers cannot compete with their Asian counterparts.   [Heritage Foundation study].  Third, technology has viciously cut into employment in the retailing, telecommunications, banking, insurance, travel and other industries.   Software programs now perform the job functions formerly executed by highly-paid skilled workers.  Fourth, zero interest policy has cut the income of savers and pension funds, impoverishing a class of consumers who supported the economy in the past.  Fifth, regulation is on the rise, increasing business operating costs.

The Debt Bubble

Thus, we have inflated a giant credit bubble without the resources to repay these debts. It is happening both here and in Europe.  Each government maneuver to save a bank (Bank of America) or a country (Greece) is merely an attempt to hide the real problem or shift it from private parties to taxpayers.  We undertook debt that we cannot repay.   We need to write off or restructure this debt, and yes, it will result in losses to the government and major financial institutions.  Restructuring could take the form of increasing the time to repay, reducing the interest rate or swapping equity for debt.  This outcome is unfortunately unpleasant but necessary.

Governments continue to conjure exotic, “cutting edge,” “outside the box” programs which merely delay the day of debt reckoning.   We borrowed too much and we now need to pay the piper.

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13
Sep 11

Re-Arranging the Furniture

Rarely do I look at the myriad sale flyers that seem to be staples of our mail these days.  However, my wife called my attention to a going out of business sale.  Bograd’s Fine Furniture, a store with deep roots in Paterson, N.J., sent out an unusual closing announcement.  It was not the usual notice trumpeting the final days of the company (for the umpteenth time) and hawking goods at deep discounts for a final selling splash. Rather, the announcement seemed from the heart of the owner and his family.  Its message encapsulated what is wrong with our economy and the burdens government puts on small business.

History

On August 1, 1930, two immigrant brothers opened a furniture store in Paterson, NJ.  Five years later they built a bigger store on Main Street in that city. The store remained there for over sixty years.

In 1975, I began my clerkship for a Superior Court Judge sitting in Paterson.  I walked by Bograd’s every day on the way to the government parking lot.  At that point, my wife and I were married for three years, but we had always lived in student housing.  We had our first rental apartment, which needed furnishing, at that same time.  Bograd’s carried quality brands that we could only dream about but could not afford.   Even then, our belief was that we should save and buy quality goods rather than settle for inferior goods.  Bograd’s represented quality, albeit at higher than department store prices.  We window shopped a lot more often than we bought.

At about the same time, Paterson was becoming a dangerous city, where once had been a prosperous town.  The population declined nearly 5% in the 1970’s.  White residents fled to nearby suburbs and now make up only 13% of the population.  Poverty is rampant, with 29% of families below the poverty line.  As in many urban areas, quality stores abandoned Paterson for the suburbs of Bergen and Passaic counties.  Bograd’s, however, held out until 1996 when it moved to a warehouse showroom in a suburban area near major highways.

The End of an Era

Instead of the traditional “going out of business sale,” the Bograd family calls their closing event “Bograd’s Last and Best Sale.”   Even though the store will no longer be operating, Mr. Bograd and his company  will  “be around after the sale is over operating out of our warehouse until every order is delivered, every customer satisfied.”

Below is a summary of the company’s decision to close.   It is a microcosm of what ails small American businesses.  I will provide commentary on each item:

  • We cannot and will not compete with stores who have lowered their standards by selling low quality merchandise.  We have always sold high end American-made furniture, often pieces signed by the craftsman while our competitors are bringing in low quality pieces from Indonesia and China. Comment – US free trade policy has permitted the importation of low quality, often shoddy, low price furniture.  How can a high quality US manufacturer expect to compete with near slave labor, foreign work conditions?  One cannot compare beautifully finished high end domestically made furniture and imports from China.
  • We will not employ a low quality, low paid sales force that cannot provide outstanding customer service.  Comment – Customers view items like furniture as disposable, so quality service is no longer factored into the price.  Only low price matters.  The US educational system produces employees without the educational background or mindset to invest years in developing expertise in high-quality furniture manufacturing or sales.
  • Given the state of the mortgage market we cannot refinance our store which we own or obtain favorable financing terms from our supplier.  Mentioning that we are in the furniture industry ends discussions with lenders.  Comment – The failure to resolve our banking crisis and forcing the banks to write off bad loans has tightened credit markets.  Tight credit has had the most impact on small businesses.  Banks would rather hold excess reserves with the Federal Reserve than take on more risky lending.
  • As a small business we receive no support from any level of government.  Comment – Complex business regulations coupled with the uncertainty of Obamacare make it almost impossible for a small business to succeed.  Government policy openly favors large enterprises, who also happen to be major campaign contributors, at the expense of the small business person.
  • Decline in trust between and among retailers, banks, and suppliers. Comment – Government policies which created the housing bubble and other speculative bubbles inevitably lead to an economic bust.  Stop-and-start economic policies destroy trust between economic parties. See Bograd’s Fine Furniture Latest Victim of Tough Economy, Eight Decades of Selling Furniture Coming to a Close, Bograd’s Historic Closing Sale – The End of an Era

Left unsaid is a major change in our culture and values.   As young adults we understood that to buy quality furniture we would need to save and defer our major purchases. When we bought a house, rooms remained empty until we could afford quality furnishings.  In a culture of instant consumer credit and shoddy goods, that ethic of saving and deferring gratification has eroded, placing a firm like Bograd’s at a disadvantage.

American Jobs Act

The much awaited announcement of President Obama’s American Jobs Act does little for the small business person. Small business is the lynchpin for both creating new jobs and for economic recovery in general.  Like Bograd’s, there are thousands of small businesses hanging on by their economic finger tips.   A large labor union (teacher, police or fire) or a large financial business (banks, insurance companies) gets the government’s attention and fiscal favor, but  if one is a small business, I guess one might  just fade into economic history, like the 81-year old Bograd’s.

Gresham’s Law says that bad money drives out good money.  In the case of Bograd’s Fine Furniture, bad furniture drove out quality furniture.  We have flawed government policy to thank, and a consequent culture which would rather spend today than invest in the future.

 

 

 

 

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28
Jul 11

It Isn’t That Easy to Avoid a Crisis

David Goldman continues to insist that all is under control.  See my previous discussion in Random Observations.  That is, he insists that current debt and especially sovereign debt problems will not cause another crisis like that of 2008:

More drivel has been written about the probability of financial crisis during the past month than at any time during my lifetime. There’s no crisis–not when all of the problems are transparent, on the table, and subject to negotiation. Instead, there is a change in lifestyle underway for Greek railway conductors, Minnesota firemen, New York City teachers, and a great many other people. Folk who only a few years ago expected to retire at sixty and spend their golden years on cruises will work until seventy and be thankful for a roof over their heads. See Not a Crisis, But a Negotiation

Goldman’s crisis avoidance stands on the following pillars:

  • The problems are known.
  • Because the problems are known they can be negotiated away.
  • Since the financial system has reduced its leverage, a crash cannot occur.  Why?   Because leveraging leads to sales of assets at distressed prices in a crisis.
  • If the US suffers a downgrade, the Federal Reserve and Treasury can easily implement financial maneuvers to work around the downgrade.
  • Finally, we have reduced complex, structured investment vehicles.

Risks We Knew, and Ignored, in the Last Decade

We knew about the overheating housing market and reckless subprime lending for several years before the crash of 2008.  We knew about the problem of excess leverage in the system. (In fact, the Federal Reserve relaxed leverage requirements, allowing firms like Lehman, Bear Stearns and Goldman Sachs to leverage 30-1 to 40-1).  Ben Bernanke claimed that the subprime crisis was “well contained” and would not affect the overall residential housing market.

None of these known problems could be “negotiated away.”  The financial system indeed seized up and nearly ended in total system breakdown.

What are the Current Risks?

Do we really know the current problems?  Last week, Bank of America wrote off $19.2b in bad loans.   Besieged by lawsuits and an unrecovered housing market, Bank of America can no longer hide behind “extend and pretend” fictional accounting.

…the bank appears to be in denial:

The crucial question today is whether Bank of America needs fresh capital to strengthen its balance sheet. Moynihan emphatically says it doesn’t, pointing to regulatory-capital measures that would have us believe it’s doing fine. The market is screaming otherwise, judging by the mammoth discount to book value. Then again, for all we know, the equity markets might not be receptive to a massive offering of new shares anyway, even if the bank’s executives were inclined to try for one.

Weil correctly depicts BofA as a systemic risk.  See Is Bank America at Risk of a Death Spiral?

And Bank of America is not the only “too big to fail” American bank:

And let us tell you a dirty secret: while Bank of America, thanks to Countrywide, is patient zero of the housing mess, Wells is next in line. Residential real estate is proportionately even bigger relative to the bank’s earnings and balance sheet, its accounting has been somewhere between aggressive and misleading, and despite its pious claims otherwise, it is no better than any of the other big banks. Stay tuned. See Is Bank America at Risk of a Death Spiral?

Both Wells Fargo and Bank of America are large, publicly held corporations subject to scrupulous reporting requirements. Nevertheless, large, unpleasant surprises appear seemingly out of nowhere.  Goldman misses the point, that future financial crises are in plain sight and we seem incapable of dealing with them.  The interconnectedness of credit default swaps makes these banks even riskier.  How can we gauge the effect on these banks of a crisis in Greek, Italian or other sovereign debt?

Being dismissive of the plight of highly paid Minnesota firemen and New York City teachers incorrectly trivializes their key role in any future financial crisis.   The fireman and teacher are both current and future homeowners.   They are also consumers.   The financial world ultimately comes down to discounted future cash flows.  Cut the income of enough highly paid workers and suddenly future corporate, governmental and individual cash flows do not look so rosy.  Moreover, this scenario keeps the housing market under pressure assuring future damage to bank balance sheets.

We need to stop denying our financially interconnected world.  Goldman’s analysis makes two mistakes: it skips over the effect financial austerity will have on housing, banks and tax revenues, and it believes our government and financial leaders can solve crises, even crises that are well understood and “transparent.”   The quagmire of our current debt level discussions only proves my point.

 

 

 

 

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19
Jul 11

Random Observations

What an exceedingly strange period in our economic and financial history!  Amidst a non-recovery economic recovery we have below par growth and high unemployment.  Coupled with economic weakness we have above trend inflation.  Let us consider some of the odder stories from last week:

Ben Bernanke and QE3

The first two exercises in quantitative easing have had mixed to negative consequences.   While the stock market has almost doubled from its low, the “real economy” has languished.   We can further document the relationship between QE and poor economic performance with a look at price hikes in key commodities such as food and energy.

Yet here is Dr. Ben Bernanke before Congress, once again selling us a product repair that simply does not work. On Wednesday, he made it clear that QE3 was part of his thinking. And even he is not altogether sure. On Wednesday, he backed away from an immediate move to start a third round of Fed money printing and bond buying.  See QE3 Guaranteed to Fail

Is there any reason that Dr. Bernanke still holds his job?  While his supporters point to a rise in stocks, the “real economy” has suffered.  Aren’t there better candidates for his job, who will try some new ideas? Are money printing and market manipulation the only ideas that any of our leaders can come up with? And to further the irritation with our Princeton economic guru, note that stocks used to rise and fall on company earnings and the economic outlook, not on which side of the bed the Fed chairman woke up on.

Don’t Worry Be Happy: Just Disregard Europe’s Problems  

David Goldman in Inner Workings points out that the financial crisis in Europe will not be a rerun of Lehman’s 2008 meltdown:

Under the headline “A Fate Worse Than Banking Crisis” my friend John Dizard at the Financial Times points out that any run on Europe’s banks would be instantly countered by swap lines from the Fed and ECB. His point (one I have been making for some time) is that the scope of the European banking problem is well known and that mechanisms have long been in place to deal with the worst-case scenario. Not so with Lehman, where a sort of China syndrome applied: no-one knew the amount of contingent liabilities that might be affected. See Once Again: It’s Not Lehman II

Mr. Goldman continues to calmly assure us that European problems will not create another financial meltdown:

My conclusion: there is no reason to panic over the present kerfluffle, but there is no reason to own any exposure to southern Europe. Ever again.  See Hopeless, But Not Serious: Once Again.

It’s too early to blow the “all clear” whistle on capital markets, but today’s recovery in the major US stock indices reassures me that this is not another financial crisis on the September 2008 scale, just a particularly nasty negotiation after which Italians, Greeks and Spaniards will end up poorer (along with Minnesota teachers, Wisconsin firemen and New Jersey policemen). It was amusing to see the usual suspects among the Street strategists issue dire warnings about increased tail risk just as markets turned around. See Ken Lewis, George Soros and Other Hedgehogs

So Mr. Goldman is assuring us of financial recovery based on one day of a US stock market rally?  His prognostications eerily remind me of 2007 and the assurances from Ben Bernanke, Hank Paulson and other financial luminaries that the subprime crisis was well contained.  Stock markets rallied then too, only to decline disastrously a year later.

Yesterday was a stark reminder of how unsafe Europe really is:

Greece 2 year interest rate on sovereign date: 34.5%
Portugal 2 year:  21.2%
Ireland 2 year : 23.3%
Italy 2 year : 4.65%
Spain 2 year:  4.55%

America is only marginally safer than Europe.   American research firm Egan-Jones recently also downgraded US Treasury debt.  See Europe is *Not* “Safe”

Are We Better Off Now Than In 2008?

We live in a financially interconnected world, and I am not at all reassured by Mr. Goldman.  I doubt that anyone knows what the effect of a bankruptcy in Portugal or Italy would have on world financial markets.   Could anyone have predicted that the 2008 financial crisis would take down AIG and Lehman and send US banks scurrying to the Treasury for TARP funds?  Do we think the world and the major financial institutions can better weather a storm now than in 2008?  While I may not know, I am more fearful that Bernanke, Goldman, Dimon and Blankfein do not know either, and they are out there making predictions and advocating policy.

Europe, China and the US have spent trillions of dollars trying to bolster their economies.  What if we have used all our money-printing ammunition and the next crisis is even worse?

 

 

 

 

 

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13
Jun 11

The New York Times Finally Discovers Structural Unemployment

We have visited the issue of structural unemployment several times.  See, e.g. Unemployment and the Fall of Labor, Why this May be Worse than the Great Depression and The New Reality: Permanent Job Loss.   Let’s define it again:

Joblessness caused not by lack of demand but by changes in demand patterns or obsolescence of technology, and requiring retraining of workers and large investment in new capital equipment. Source:  Business Dictionary

How incredulous that it took until June 9th, more than three years into the current recession, for The New York Times to finally discover this “new” reality. Companies Spend on Equipment, Not Workers.

What Did the Times Discover?

Workers are getting more expensive while equipment is getting cheaper, and the combination is encouraging companies to spend on machines rather than people. See Companies Spend on Equipment Not Workers

The article at issue focuses on a Minnesota plastic products manufacturer which hired only two workers, but spent almost three times more on new labor saving machinery. The Times attempts to draw from this example some larger societal and economic points:

  • American workers just can’t compete with Chinese and other low cost foreign workers.
  • Since the recovery began, equipment prices have declined 2.4% while labor costs are increasing about 6.7%.
  • The four newly purchased machines mentioned in the article all come from foreign suppliers.
  • Much of the labor cost increase arises from increasing health care costs and other benefits.
  • Hiring has hidden costs:  including days spent culling the resumes of unqualified applicants.
  • Many applicants lack basic writing, mathematical, technical or computer skills.
  • New employees must go through a federally required safety program, be drug tested at a cost of $150 and require ongoing training, which diverts management from other work.
  • “You don’t have to train [or drug test] machines.”  Generous depreciation allowances and tax credits favor investment in machinery rather than people.

I would argue that The Times article misses one key point, zero interest rates.  Holding interest rates at artificially low levels further encourages equipment purchase rather than new employment.

Complete Lack of Journalistic Insight?

The Times has an amazing lack of self awareness.  Perhaps reporters and editors forget their own editorial stance on key issues:

  • Free Trade – We were implored by The Times to support free trade and open our borders to foreign goods.  These goods are often produced by workers earning less than a dollar a day without employment, safety or environmental protections. How could American business hope to complete with this?
  • Economic Stimulus – Among other incentives, The Times has advocated liberal tax breaks for equipment purchases.  Is it surprising that employers indeed invest in labor saving equipment?
  • Zero Interest Rates – Krugman and other Times editorial and op-ed writers have favored Bernanke’s zero interest rate policy.  With ultra low borrowing rates, of course employers purchase equipment rather than higher cost labor.
  • Obamacare – Once again, The Times has supported a government initiative that effectively has put a stranglehold on employer benefit costs.
  • Other Pro-Worker Legislation – The Times has long promoted employment and labor law reforms which make hiring expensive: The Family and Medical Leave Act, The Americans with Disabilities Act, The Older Workers Benefit Protect Act all have hidden costs which make hiring unattractive.  Couple that with attempts to expand union involvement, and employers are compelled to favor machines over people.

Late to the Party Again

Once again, the pre-eminent New York Times is not reporting the news, but rather restating the obvious. Why have they missed another major economic trend?  Their reporters are smart but ideological.  They are ideologically and emotionally wedded to Keynesian nostrums of economic stimulus and ultra loose monetary policy.  If instead they took a holistic view of what is happening in the real economy, following real business people making real hiring and investment decisions, they would be forced to reassess their adherence to old and dubious politics and theory.

If The Times is about all the news that’s fit to print, it should be least be subjected to  intellectual rigor, and critical and honest thinking.  And let’s not forget timeliness; do we really need to clutter Page One with what we already know?

 

 

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1
May 11

Business as Usual?

In Economics and the Welfare State: Oil and Water we discussed the flaws of current economic policy.  The Federal Reserve continues zero interest rates and quantitative easing in hopes of controlling interest rates, the stock market and re-igniting inflation.  The Administration and Congress are locked in a meaningless battle over the debt ceiling and budget cuts.  We are in a morass.  Where did we go wrong?

The Failure of the Two Party System

The current budget and debt ceiling debate demonstrate the intellectual bankruptcy of the two party system.   We are saddled with an annual federal budget deficit of $1.6t.  We can only expect this number to increase.  Congress and the Administration have agreed on a deficit reduction of $38 billion which in reality may be a reduction of an even more paltry $353m.  See $38 Billion in Cuts? Make that $353 Million.

While Americans believe there are major differences between the parties, is there really a large ideological divide on economic matters between Democrats and Republicans, liberals and conservatives?   A close analysis reveals little difference.  And they both close ranks in support of the Central Welfare State.  Wittingly or not, both parties have weakened regulatory oversight.  Both parties participate in bureaucratic fiefdoms immune from budget cuts.

Thus, we see support for:

  • Dysfunctional health care
  • Medicare
  • Defense spending
  • Foreign military adventures
  • A tax code laced with corporate loopholes
  • Social security
  • Crony capitalism where losses from the financial system are transferred to the public

See Paradoxes at the Heart of the Conservative Project, Paradoxes at the Heart of the Progressive Project.

The Pernicious Federal Reserve

For almost three years, Fed policies have had a deleterious effect on the economy.  Every few weeks a Fed spokesperson announces while there are signs of economic growth, it is too soon to raise interest rates or end quantitative easing.  See, e.g., Bernanke Sees Economic Growth Through 2013, Fed’s Yellen Says Economy’s Improvements Don’t Warrant Exit from Stimulus.

Perhaps the Federal Reserve’s continuous support for the economy through its easy money policy is the cause, not a consequence, of the economy’s weakness.  The Fed has created a dangerous co-dependency.  Analogizing the Federal Reserve’s pathological support of the economy to patients on a ventilator, Brian Pretti found:

…the fact is that the longer a patient remained on a ventilator, the greater the chances they would not be able to be weaned off of the machine.  The body “learns” not to breathe on its own after a period of time.  Essentially a patient would pass a critical window of recovery weaning period opportunity.

Pretti uses the example of the Japanese economy:

…this analogy is incredibly apt in terms of describing the reality of the sovereign debt fiscal trap.  The longer Japan has been on the artificial zero interest rate “breathing machine” over the last decade plus, the harder it has become to wean itself off.  Although I could spend an entire discussion on Japan alone, I personally believe Japan has already passed the critical “weaning period” demarcation line for zero bound interest rate/monetary policy.  We’re Just Gonna Inflate Our Way Out of It?…Oh Really?

Current Federal Reserve policy is mirroring the actions of the Japanese central bank.

We Need New Policies

We cannot sustain the current economic path. David Stockman, in a CNN interview with Elliott Spitzer, laid out simple, workable solutions.   We must enact budget cuts and increase tax revenues.   We must significantly cut the defense budget and civilian entitlement programs.  The Bush era tax cuts need to end.

http://money.cnn.com/video/news/2011/04/12/n_stockman_0412.cnnmoney/

Stockman is advocating what I have advocated before: shared sacrifice.  In his words, the “wolf is at the door.”

Failure of Business as Usual

Continuing business as usual will result in a financial crisis many times the magnitude of 2008.  We need to cut deficits, raise taxes, end Federal Reserve intervention and end profligate Congressional and Administration spending.  We need to give this sick patient, the economy, a chance to breathe… before it suffocates.

 

 

 

 

 

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16
Mar 11

Economics and the Welfare State: Oil and Water?

Despite the constant cheerleading from the White House, the Federal Reserve and main stream media, we are still mired in the financial crisis of 2008.  While skeptics argue that the stock market recently has made a recovery high from its March 2009 low, major negative macro trends remain unresolved.  A look at these trends:

  • The Burgeoning Welfare State – Government at every level made too many expensive promises to too many citizens.  In the US we created and expanded entitlement programs: health care (worsened by the new Obamacare initiatives), food stamps, extended unemployment benefits, social security and prescription care coverage among others.
  • Unwillingness to Use Taxation to Pay for the Welfare State – Whether it is called Reaganomics or supply side economics, government policy has been to reduce taxes and to ignore the growth in entitlement and defense spending.   We have endured endless deficits for more than a decade, and are projected to endure more1 through 2020.  Political leaders are incapable of rejecting new entitlements or increasing taxes to pay for them.
  • A Love Affair with Debt – Government policy favored debt over equity.  Borrowing was encouraged at every level of the economy: states borrowed to excess to cover budget shortfalls, and artificially low interest rates lured home purchasers into huge mortgages. Homeowners then used home equity to extract cash through multiple re-financings and home equity loans. Corporations borrowed to buy back stock and to acquire other companies; the finance industry borrowed to speculate.
  • Global Wage Arbitrage – The US and other Western economies became high wage countries.  Manufacturing workers, state and federal employees, finance, insurance and real estate workers earned high wages disproportionate to their contributions to the economy. At the same time, improvements in high speed telecommunications and shipping permitted outsourcing of manufacturing and service jobs in low wage countries.  Frankly, western workers became massively overpaid.
  • An Over-Financialized Economy – Our best and brightest workers were wooed to Wall Street to develop non-productive products such as credit default swaps, interest rate derivatives and mortgage backed securities.  As a result careers in manufacturing, engineering, and science attracted less talent.  An inadequately regulated Wall Street continued to assume risk, threatening the entire global financial and economic system.  These risks have been hidden through extend and pretend accounting devices and reflating bank balance sheets with loans at zero interest rates.  Compared to outstanding liabilities and risk, banks remain woefully undercapitalized.
  • Imperial Over Reach – The end of the cold war left the US as the only superpower.  Instead of truly creating a lasting “peace dividend” and reducing our military, the US continues to maintain more than 750 military bases around the world.  Further, in the past decade we have been engaged in wars in Afghanistan and Iraq, fueling an ever increasing defense budget that we cannot reduce or afford.
  • Peak Resources – Whether we are truly living through “peak oil” the current soaring prices of basic commodities and energy demonstrate that we are facing peak everything.   With a falling dollar engineered by the wizards Bernanke and Geithner, Americans are forced to spend more of their incomes on basic foodstuffs and energy.  Not only are we in a wage competition for jobs, we are in a competition for the basics of life.  Inflation in basic foodstuffs was a trigger in the Tunisian and Egyptian revolutions and unrest throughout the Middle East and North Africa.

At A Cross Roads

No longer is this a Republican or Democratic issue, or a conservative or liberal issue.  These may no longer be just American issues.  Conventional politics has failed.   Western nations and Japan (after its current crisis) need to re-think welfare state promises.  Politics as usual cannot continue.

We need a new paradigm to adjust to our economic situation.  World crises, both natural and political, that we never could have predicted, will now impact our economic future.  These are subjects for future posts.

 

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22
Feb 11

People Who Need People

To begin my one course in demography, the professor cheerily introduced the subject: “it is not that we are living longer, it is just that we are dying at a slower rate.”  Until recently, this was the last time that I thought about demographics. A blog post by David Goldman for the Asia Times explores the generational factors affecting our currently depressing housing trends. See Housing Prices and Demographics

Baby Boom Retirement and New Families

Demographers have been warning about a generational oversupply of homes.   Baby boomers are retiring, seeking to sell their current residences and move into smaller digs.  At the same time new family formation has plunged, weakening demand for the homes those retirees are leaving.

Sometimes it helps to look at the world with a kind of simplicity. Think of it this way: Credit markets derive from the cycle of human life.  Young people need to borrow capital to start families and businesses; old people need to earn income on the capital they have saved.  We invest our retirement savings in the formation of new households. All the armamentarium of modern capital markets boils down to investing in a new generation so that they will provide for us when we are old. See Housing Prices and Demographics

Two parent families with children are the driving force in housing demand.   While US population has jumped from 200 million to 300 million since 1970, two parent families have remained at 25 million. Housing units with three or more bedrooms were 36 million in 1973 and72 million in 2005.   Thus, the growth in home ownership for affluent two-parent families is lagging behind that for relatively poorer childless and single parent families.

Implications

In David Goldman’s world the cycle has gone wrong, with negative implications for our capital markets:

….something different is in play when investors are reasonably panicked. What if there really is something wrong with our future–if the next generation fails to appear in sufficient numbers? The answer is that we get poorer.

The declining demographics of the traditional American family raise a dismal possibility: Perhaps the world is poorer now because the present generation did not bother to rear a new generation. All else is bookkeeping and ultimately trivial. This unwelcome and unprecedented change underlies the present global economic crisis. We are grayer, and less fecund, and as a result we are poorer, and will get poorer still–no matter what economic policies we put in place.  See Housing and Demographics

Completing his thesis, unless we restore the traditional family to a central position in American life, we cannot expect the same level of wealth accumulation we experienced in the 1980’s and 1990’s.  Immigration and foreign investment cannot sufficiently compensate for the lack of family formation and capital.  The end result:

We are going to be poorer for a generation and perhaps longer. We will drive smaller cars and live in smaller homes, vacation in cabins by the lake rather than at Disney World, and send our children to public universities rather than private liberal-arts colleges. The baby boomers on average will work five or ten years longer before retiring on less income than they had planned, and young people will work for less money at duller jobs than they had hoped. See Housing and Demographics

The Job Corollary

I have the highest respect for David Goldman, but one area that he did not touch on is jobs or the lack thereof.   It is a bit like the chicken and egg problem.  Do secure jobs come first, so that workers start families, have children and ultimately buy houses?  Or are families formed, children born, houses purchased and jobs created and procured as an outgrowth of this cycle?  I think that a secure job environment must come first.

Jobs are critical to any analysis of societal wealth.   One could expand upon Mr. Goldman’s thesis and posit that we have too many people in the modern labor force. As we have discussed in this blog, technology and changing societal patterns have created a surplus of labor:

Right now the supply of people is too high.  How has this happened?  Medical technology has slowed infant mortality.  Better medical care and pharmaceuticals lengthen lives.  Women can control their own reproduction.  They can enter the workforce rather than tend to large families.

On the demand side, technology has dramatically changed the nature of work. A modern factory no longer has thousands of people producing cars or steel.  Gone are the Dickensian portraits of 19th century factory life. Computers, robotics and other labor saving devices allow smaller factories to produce cheaper and better products.  Brains have trumped brawn, but the result is a surplus of labor.  Combine improved productivity with a surplus of people and large scale unemployment ensues.  To offset declining incomes households piled on debt over the last 20 years. Income can no longer can support the ever expanding amount of debt in society.  See Are There Too Many People?

The trend to substitute capital for human labor has only been worsened by the Fed’s radical zero interest rate policies:

Low interest rates reduce the cost of capital, hence increase the propensity of employers to use capital-intensive technologies, substituting capital for labor wherever possible. Conversely high interest rates, by making capital more expensive, increase the propensity of employers to hire more labor and train its existing workforce to produce more output rather than investing in capital-intensive equipment….While the Greenspan/Bernanke monetary policies have increased recorded productivity growth, therefore, they have reduced job creation, in this recession creating a pool of long-term unemployed that will remain a miserable underclass until they pass on, decades in the future. See Paradise Regained

Where Are We Now?

We are in the worst of all possible economic paradigms.  We have high structural unemployment, meaning that it will not be easy to reduce the unemployment rate as many jobs do not need doing.   With the combined problems of a lack of jobs and poor level of family formation, housing will continue to suffer.  We built too many houses with too much debt.  We have not let house prices fall to clear this market of its surplus.   Zero interest rates and federal supports to the banks continue to impoverish the middle class and impede job formation and hiring.  Finally, food and energy inflation require an ever greater percentage of family income, and reduce needed savings for house down payments and upkeep.

People who need people also need lower prices and secure jobs.  And they need them fast.

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4
Jan 11

From Under-Reaction to Over-Reaction

DC Beltway insiders, abetted by their friends in academia, are expert at identifying and recommending political curatives for the ills of society. At the most sophisticated and effective level, punditry has a predictable genesis and trajectory.  First, from the chaos of all manner of the environment’s input, whether in universities or “think tanks” academics identify a societal problem that needs correction.  Many times, what follows is often widespread agreement that a problem exists and needs correction.  When that occurs, the process gains momentum, traction, attention and support from different constituencies.  Politicians whip up widespread public support.  Pundits produce inspirational articles and editorials in support of the corrective action.  Myriad examples emerge of the consequences of the unsolved problem.  Some examples may emerge of solutions to the problem, albeit solved on a finite, boutique, scale.  Soon we have groundswell support to “do something.”  We lobby, pass legislation, establish agencies and write regulations.  At the beginning all goes well, but soon problems arise. We experience administrative overreach, which is often worse than the original problem.  So what has begun as a good idea becomes misshapen beyond recognition and becomes its own societal problem. Some examples:

-          The problem: discrimination on the basis of race or sex.  The solution: Passage of the Civil Rights Act of 1964.  Starting with a simple corrective of ending discrimination we have built an administrative Rube Goldberg empire: the Equal Employment Opportunity Commission, the Office of Federal Contract Compliance, state anti-discrimination agencies. Soon class action and affirmative action programs were introduced as mandates.  Further, the Obama Administration now desires to expand the scope of anti-discrimination laws regarding the concept of equal pay for equal work to a new more troubling concept of “comparable worth.”  Employers are now beset with charges of discrimination and class actions. See ‘Comparable Worth’ Rears Ugly Head in Age of Obama

-          The problem: America lacks universal health care coverage.  The solution: The passage of Obamacare.  The law is byzantine beyond explication:

…the health system is complex, yes, but also ornate. The new law creates 68 grant programs, 47 bureaucratic entities, 29 demonstration or pilot programs, six regulatory systems, six compliance standards and two entitlements.

Getting that massive enterprise up and running will be next to impossible. So Democrats streamlined the process by granting Health and Human Services Secretary Kathleen Sebelius the authority to make judgments that can’t be challenged either administratively or through the courts.  See Obamacare Only Looks Worse on Further Review

The law has other consequences: 117 million current health care plan participants may need to change plans in 2013; 16 million new participants may be forced into Medicaid: Medicare benefits will be reduced to pay for the program; a 3.8% additional tax will be imposed on investment income; a 40% excise tax on “Cadillac” health plans and a $2100 increase for families buying private insurance plans.

-          The problem: Public employees need employment workplace protections. The solution: In 1962, President Kennedy extended collective bargaining rights to federal employees.  While federal employees could only bargain over working conditions, not salary and benefits, this precedent set the stage for widespread collective bargaining rights for public unions.  At the state and local level bargaining occurs over all issues.  Politicians have recognized the efficacy of acceding to union demands.

Thus, we have had an explosion in public sector salaries and benefits, especially lucrative pension plans.  As states and municipalities face huge budget deficits and massive pension plan underfunding, these entities are considering benefit cutbacks, bankruptcy and large tax increases.  The public, facing job insecurity or unemployment are revolting against increased taxes.  See Strained States Turning Laws to Curb Unions; Cash-Strapped States Seeks Laws to Curb Labor Union Power

-          The problem: The financial crisis threatens the solvency of US banks. The solution: The government ignores its own advice to the troubled Japanese financial system.  Instead of forcing the banks to write down bad assets, the government undertakes a costly and legally and economically dubious program of buying trouble assets.  It has  forced $700b dollars of funds on troubled banks, and continued to guarantee bankrupt Fannie Mae and Freddie Mac, and maintain a zero interest rate policy for over two years.   The economic consequences have been enormous:  unemployment near 10%; savers and retirees punished;  oil and other commodity prices exploded and the dollar substantially lower.

Taking it to the Limit it Too Many Times

We have lost the ability to identify a societal problem and implement a measured and thoughtful solution.  We have also lost the ability to forebear, take no action and let the problem work itself out.  We move from under-reacting to over-reacting.  Over-reacting imposes enormous costs on society.  Thus, we have backlashes against affirmative action, a move to repeal Obamacare, tax revolts against the privileged financial protections afforded to public employees, and simmering resentment toward Treasury and Federal Reserve policies which favor Wall Street over Main Street.

Perhaps in matters of important policy, more thoughtfulness, realism and humility, rather than brash hubris and impulsiveness, would restore confidence in both our government and our economy.

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20
Dec 10

The Dignity of Work

Then:  Bosses and Workers

During a tour of his new automated plant, a famous exchange took place between auto maker Henry Ford and Walter Reuther, president of the United Auto Workers:

Ford: “Well, Walter, how are you going to get these machines to pay union dues?”

Reuther: “But Henry, how are you going to get them to buy cars?” Quotes

One of my college jobs was working for my university’s Labor Education Center.  Many of the faculty members were ex-UAW officials.  These men had witnessed the bloody organizing campaigns at Ford and other manufacturers.   After law school and clerkship my first associate’s job was with a small law firm representing unions. I confess to a bit of a soft spot for the old time labor unions that looked out for the welfare of the working man.  Unfortunately, in their current incarnation unions deliver less protection to workers, and arrogate more power unto themselves.

The director and senior professor of the Labor Education Center began as a factory worker, became a union organizer and earned a doctorate.  He was dedicated to the education of workers and union leaders.   A valuable lesson he taught was the simple dignity of work, regardless of status, pay or title.  A working person possessed a quiet and mostly unsung nobility:  producing a decent day’s labor, supporting a family, being a role model for his or her children, contributing to community.

I remember once being in the hallway of the Labor Education Center chatting with another student intern.  A janitor was cleaning the hallway. The director, by this time my valued mentor, walked up to me and said, “if you cannot help this hardworking janitor, at least get out of his way.”

Now:  The Reality of Unemployment

The most recent new claim number for unemployment is 427,000.   Despite the media spin of an improving job market, this still connotes a troubling and recessionary employment level.   Missing from the media coverage is that 893,000 workers moved into the extended unemployment coverage category.   In Who’s Lying, James Quinn deconstructs the government’s employment statistics:

The number of Americans employed over the last few years is as follows:   2007 – 146.0 million,  2008 – 145.5 million,   2009 – 139.9 million,  2010 – 138.9 million.

It seems there are 7.1 million less employed people than there were three years ago. Contrary to the spin from the White House, there are 1 million less people employed today than during the horrific 2009 year.  Luckily, another 6 million people left the work force, or we’d really have a problem. The truth is that if the government actually counted everyone in the country who wants a job, the unemployment rate is not 9.8%, but 23% and it continues to rise. Who’s Lying, See also Shadow Government Statistics.

Losing Our Way

In the employment arena America has lost its way.  We have focused on short term profits to the detriment of the long term welfare of our society.  Outsourcing and layoffs have been the means to achieve short term performance.

Corporate human resource departments once protected and educated their employees.  In the modern world human resource departments view employees as adversaries: costly, demanding and ungrateful.  Few employees today believe corporate sloganeering that employees make the key competitive difference in the marketplace.

Government policy is less than supportive of hiring.  The morass of workplace rules, tax policy that favors off shoring and outsourcing, and expensive health care mandates are all disincentives to hiring.

An effective 23% unemployment rate denotes a troubled and unfair society.

We have forgotten the simple dignity of work.  Even worse, we have forgotten how to respect the simple and mostly unsung work of others.  The Reuther-Ford conversation resonates today:  if we keep laying everyone off, who will buy our cars?

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