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American Society / Banking / Financial / Housing / International Finance / law / Political / The Federal Reserve — 0 Comments
20
Feb 12

The State of Things

At a meeting of corporate counsel I spoke with Kenneth Starr, a former federal appeals court judge and Solicitor General of the United States.   Judge Starr opined that recent Supreme Court rulings demonstrated a tilt toward the conservative wing of the Court.  On the other hand, I argued that the Supreme Court was really split between statist versus libertarian philosophies.  Statism is the theory that political and economic planning power should be concentrated in the state, in effect weakening the individual or the community.  Libertarians hold the opposite view: we should maximize individual rights and minimize the power of the state.  Further, they decry Supreme Court decisions that have focused on maximizing the power of the state at the expense of the individual and the community.  After pausing for a moment, Judge Starr agreed that statism versus libertarianism may be a better way to frame the debate occurring in the US Supreme Court.

2012 is an election year.  Republicans and Democrats seem to be drawing battle lines, but in fact little difference exists between the two parties.  Both espouse statist solutions to America’s economic woes.  The Republicans would utilize the state to enforce a conservative social agenda (pro-life, marital fidelity, “family values”) and channel money to the defense complex.  Democrats would utilize the state to enforce a seemingly different agenda: pro-choice, mandatory medical insurance, social equality and a secure network of social services (unemployment insurance, social security, welfare).  Except for Ron Paul, who has been marginalized, no one debates the proper role of the state.  All the candidates give lip service to reducing budget deficits, but little serious discussion to the proper role of the state.

The Long Emergency

Current economic policy demonstrates the state’s overbearing hand.   Doug Noland, in A New Bull Market?  analyzes current government economic policies.   We have had four years of unprecedented economic stimulus with, among other artifices: zero interest rates, Federal Reserve asset purchases, economic stimulus, and Federal Reserve participation in worldwide liquidity operations (outright money printing).  Further, these unprecedented economic interventions show no signs of abating.   On the contrary, The Federal Reserve trumpets that it will keep interest rates at near zero through 2014.  Further, the Fed and the Treasury have assumed the role of supporting the stock market, housing prices, Fannie Mae, Freddie Mac, private banks and virtually decreeing the current artificial 2% inflation rate.  And even worse, no one in a position of policy or decision making seems self consciousness or regretful that these policies go on and on without an exit strategy.

We arrived here through past government interventions and bailouts.  The history of bailouts is long and undistinguished:  The Penn Central Railroad (1970); Lockheed (1971); Franklin National Bank (1974); New York City (1975); Chrysler (1980); Latin American Debt Crisis (1982); Continental Illinois National Bank (1984);  Savings &Loans (1989);  Mexico (1994); Russia (1998); Long Term Capital Management (1998);  Airline Industry (2001);  Bear Stearns (2008); Fannie Mae and Freddie Mac (2008); AIG (2008); Auto Industry (2008);  Troubled Asset Relief Program – leading banks (2008); Citigroup (2008); and Bank of America (2009).  See History of U.S. Gov’t Bailouts; Top 6 U.S. Government Financial Bailouts; A Brief History of Government Bailouts; Are Financial Crises Alike?; A New Bull Market?

In every bailout we pay a high price for these statist solutions to economic problems.  A bailout is nothing more than a monetary transfer.   Instead of bondholders or shareholders in flawed enterprises taking a loss, the US taxpayer, essentially all of us, are paying for the mistakes of others.  This practice is a cowardly undermining of the essence of capitalism.   In true capitalism we would punish failure and reward success.  This government cowardice also distorts the legal system, as the government unilaterally claims a superior economic right over other creditors to economic relief.

Statism, Capitalism and Freedom

Ideally, capitalism and freedom are intertwined; that is, we are free to make mistakes. Yes, in this scenario our mistakes are punished in the marketplace.   But the rule of law in this scenario can also proceed as intended; that is, a poorly run enterprise can go through bankruptcy and either liquidate or reorganize.   If we want political freedom, we need economic freedom.  It is risky and sometimes painful, but the imprudent among us need to be economically punished and the rightful parties, rather than the entire electorate, need to bear the losses.

What Questions Should We Be Asking?

The political debate should ask the hard questions:

  • Why is the Federal Reserve keeping interest rates at zero until 2014 when we are supposedly in the fourth year of a recovery?
  • If we are in the fourth year of a recovery why are we fiddling with the capital markets with Operation Twist and talk of QE 3?
  • With unprecedented levels of fiscal and monetary stimulus, why has government intervention produced only below average and mediocre economic growth? Why is there no recovery in housing prices?  Or no growth in jobs?
  • Why is the Federal Reserve targeting 2% inflation when the legal mandate is no inflation?
  • Why is the Federal Reserve artificially supporting the stock market?
  • When will we ever return to a “normal economy” without the need for outsized deficit spending and monetary stimulus?
  • Why are we privatizing profits and socializing losses?

These are but some of the important questions.   The key question to ask is where did genuine capitalism go?  We pride ourselves as the land of free market capitalism.  Unfortunately, it has not been practiced in the United States since the 1920’s.  Right now we have fascism, state socialism, crony capitalism, but certainly not the real thing.  And that is scary.  Someone should be asking where free market capitalism went.

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American Society / Banking / Financial / Housing / Pensions / The Federal Reserve — 0 Comments
5
Apr 11

Rates Are Low, Morals Are Lower

Monday, the Wall Street Journal awakened to “discover” the plight of the elderly: Fed’s Low Interest Rates Crack Retirees’ Nest Eggs by Mark Whitehouse.  The Journal describes elderly Americans, who worked all their lives and saved what they thought were sufficient funds to live out their remaining years in comfort. With the Federal Reserve’s zero interest rate policy retirees are realizing miniscule returns on their savings. They must therefore resort to spending their principal and cutting back on all expenditures.  Some examples of this new reality:

Forrest Yeager, a 91-year-old resident of this seaside community, had been counting on his retirement savings to last until he died. The odds are moving against him. With short-term bank CDs paying less than 1%, the World War II veteran expects his remaining $45,000 stash to yield just a few hundred dollars this year. So, he’s digging deeper into his principal to supplement his $1,500 monthly income from Social Security and a small pension.

“It hurts,” says Mr. Yeager, who estimates his bank savings will be depleted in about six years at his current rate of withdrawal. “I don’t even want to think about it.”  See Fed’s Low Interest Rates Crack Retirees’ Nest Eggs.

Most recent (2009) Labor Department data  show that annual investment income over the last two years examined for 24.6 million households headed by a person 65 and over has fallen 37 % to a meager $2564.    In 2010, 33% of retirees dipped into savings to pay living expenses.

Hand Wringing

At this time, investing in short-term certificates of deposit, time deposits and money market funds would yield .24% annually, one-tenth the level of late 2007.  Inflation is now running at an annualized rate of 5.6%.   Richard Fisher, President of the Dallas Federal Reserve is quoted in the article:

“Americans who have done everything right, have worked hard, saved their money and stayed out of debt are the ones being punished by low interest rates,” says Richard Fisher, president of the Federal Reserve Bank of Dallas and a voting member of the Fed’s policy-making open market committee. “That state of affairs is not sustainable for a long period of time.”  See Fed’s Low Interest Rates Crack Retirees’ Nest Eggs

While recognizing the problem, Mr. Fisher’s comments strike me as surrealistic and disingenuous in the extreme.  Why is he hand wringing when he, more than most others, can effect change?  He is a voting member of the Federal Reserve!  In his position of influence, he can actually change the insane policies of the Fed.

Our Golden Years?

What are senior citizens doing to get by?  Mr. Whitehouse’s article lists a number of changes he is observing in financial behavior:

  • Investing in the stock market, even though much retirement saving has been devastated in the last two bear markets (2000, 2008)
  • Shopping at thrift shops and eating in subsidized community centers
  • Cutting or eliminating all other expenses such as movies or hobbies
  • Invading principal for living expenses

Re-entering the workforce is not an option for most retirees, as jobs are more scarce, or a senior age candidate may have more physical limitations on their employment options.

Unintended Consequences

The Journal recognizes that zero interest rate have been a windfall for the banks at the expense of the elderly.   All savers are hurt by the zero interest rate policy, but that is the obvious consequence.

Low rates don’t just hurt retirees. They also penalize people of any age hoping to build up funds for the future, and discourage rainy-day savings that could make U.S. consumers more resilient to job losses and other financial jolts. Americans’ net contributions to their financial assets, such as bank and 401(k) accounts, amounted to 4% of disposable income in 2010, according to the Fed. That’s the lowest level since it began maintaining records in 1946—except for 2009, when people actually pulled money out. See Fed’s Low Interest Rates Crack Retirees’ Nest Eggs

No wonder we have a sluggish economic recovery: we have no new savings to invest in the economy.  Further, if we want housing prices to recover, how does a young couple develop sufficient savings for a house down payment?

Return to Sanity

Zero interest rate policies punish the elderly in two ways: reducing personal income, and driving up basic need cost, such as food and energy.  Expecting the elderly to reenter a workforce that already has too many unemployed and underemployed individuals is absurd.  We are punishing that part of society who played by the rules: they worked hard, lived within their means, paid off their mortgages and saved for retirement.  Unfortunately, the Federal Reserve and the Obama Administration decided to reward the banks who made ridiculous loans, created fraudulent mortgage backed securities, overpaid their executives and nearly crashed the entire financial system.  Where is the morality of favoring the profligate over the thrifty?

Mr. Fisher and his colleagues could end the insanity tomorrow.  Stop the Federal Reserve’s interventions in the financial markets and let the market determine the true rate of interest.  Savers everywhere, elderly or not, will thank you.

 

 

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American Society / Demographics / Economics / Housing / Technology / The Federal Reserve — 0 Comments
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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