Friday, March 27, 2009

Bukowski On Writing

Towards a New, Better, Different Deal

National Lead, follow or get out of the way: In 1936 F.D.R. said at a campaign rally:

"We had to struggle with the old enemies of peace—business and financial monopoly, speculation, reckless banking, class antagonism, sectionalism, war profiteering. They had begun to consider the Government of the United States as a mere appendage to their own affairs. We know now that Government by organized money is just as dangerous as Government by organized mob. Never before in all our history have these forces been so united against one candidate as they stand today. They are unanimous in their hate for me—and I welcome their hatred. "

Nothing changes; Barack Obama could almost say the same thing today. Not a single Republican voted for the bailout bill and three Republican senators held the bill hostage until its provisions were so watered down enough to almost become ineffective. The Republican hatred is so pervasive it extends to public pronouncements that they "hope he fails." The right to bear arms apparently includes the right to shoot oneself (and ones neighbor) in the foot.

The Secretary of the Treasury, Tim Geithner, went before Congress to ask for the power to regulate and take over any financial institution in trouble that is large enough to cause havoc in the banking system. Everyone admits that the Federal takeover of AIG was necessary even if there was no law explicitly permitting it. The Treasury took over AIG after it had failed. It failed because there was no one watching. "Credit default swaps," were an unregulated form of insurance which is why AIG, an insurance powerhouse, became so heavily involved.

Credit default swaps were created in the early 1990’s as a way to insure commercial loans . If a bank loans a million dollars to a company it could buy insurance, a credit default swap, to protect itself. By the late 1990’s CDS were being sold to cover Corporate and Municipal bonds. By 2000, the CDS market was approximately $900 billion and was working reliably. For example, CDS payments were made to cover some of the Enron and Worldcom bonds. In the original from CDS contracts were purchased by those who actually held the bonds and stood to loose if the bonds defaulted. As the new decade progressed a substantial change occurred in the market for CDS.

First, a secondary market developed for both sellers and buyers of CDS. The result was that it became impossible to determine the financial strength of the insurer since the chain of CDS coverage, the provenance of the CDS could not be determined.

Second, CDS were being traded for all sorts of exotic investments like asset backed securities (ABS), mortgage backed securities (MBS) and other exotic financial instruments. The problem was these new investments no longer had a known entity like a company or a municipality to follow to determine the strength of a particular loan or bond.

Third, speculation became rampant in the market. Sellers and buyer of CDS were no longer owners of the underlying asset (bond or loan), but were just betting on the possibility of a "credit event" for a specific asset.

By the end of 2007 the CDS market had a value of $45 trillion, but the underlying corporate bond, municipal bond, and structured investment vehicles market totaled less than $25 trillion. That leaves $20 Trillion in bets. Because of the secondary market for CDS the original two parties that entered into the CDS contract may very well not be the current holders of the rights of the protection buyer and protection seller. Some CDS contracts are believed to have passed through 10-12 different parties. The financial strength of all the intervening parties may not be known so it has became very difficult to determine, or "unwind," the final ownership and value of the CDS after our massive "credit event" in the fall of 2008.

Credit default swaps are really just the tip of the unregulated iceberg. The problem is that the FDIC, which insurers individual bank depositors, and the SEC, which oversees securities marketed to the general public, have no oversight authority for securities that aren’t sold to the public. The underlying issue is that deposits from the public are going into these unregulated financial instruments and that’s what the Treasury Department wants to be able to regulate just like the FDIC regulates banks.

Enter the time machine: Between 1910 and 1920 an average of less than 6 banks failed per year but from 1921 through 1929 more than 600 banks failed per year . The stock market crash of October 1929 triggered a huge wave of bank failures, almost 1400, and huge amounts of wealth disappeared over night. Borrowing money from banks to buy stocks, known as buying on margin, became the CDS of the 1920’s.

Prices began to slide in late September and early October of 1929, but speculation continued, fueled in many cases by individuals who had borrowed money to buy shares—a practice that could be sustained only as long as stock prices continued rising. On October 18 the market went into a free fall but the first day of real panic, October 24, is known as Black Thursday; on that day a record 12.9 million shares were traded as investors rushed to exit the market and salvage their losses. Still, the Dow average closed down only six points after a number of major banks and investment companies bought up great blocks of stock in a successful effort to stem the panic that day.

The panic began again on Black Monday (October 28), with the market closing down 12.8 percent. On Black Tuesday (October 29) more than 16 million shares were traded. The Dow Jones Industrial Average lost another 12 percent. President Hoover and Treasury Secretary Andrew W. Mellon declared that business was "fundamentally sound" and that a great revival of prosperity was "just around the corner."

The panics fed on themselves and investors sold stocks to cover margin calls the market sank triggering further margin calls which could no longer be repaid. Banks failed. Rumors of bank failures triggered "runs on the bank" as people took their deposits in cash. The Federal Reserve did nothing to ease the liquidity problems of even solvent banks and lending, for all intents and purposes, stopped.

To Hoover’s credit he created the Reconstruction Finance Corporation (RFC), financed with taxpayer’s money, to lend banks money and the Glass-Steagall Act which broadened the circumstances that the Federal Reserve could lend to member banks. In 1929 not all banks in the US were members of the Federal Reserve System. "Transparency," Congress desire to see where the money went put a quick end to the RFC effectiveness because banks that borrowed from the RFC were seen as unsound.

A failure to act early and decisively by both the U.S. Treasury and the Federal Reserve Bank is widely seen by economists today as the cause for the depth of The Great Depression. Waves of bank failures and a sinking stock market drove the depression deeper and deeper. By the winter of 1932-33 the banking system was in near collapse. The banking panic reached its peek in the three days leading up to F.D.R.’s inauguration on March 4th 1933. Visitors arriving in Washington to attend the presidential inauguration found notices in their hotel rooms that checks drawn on out-of-town banks would not be honored. By March 4, Inauguration Day, every state in the Union had declared a bank holiday. As one of his first official acts, President Roosevelt proclaimed a nationwide bank holiday would start on March 6 and last four days

On March 9th the Senate passed the Emergency Banking Act which legalized the national bank holiday, set standards for the reopening of banks after the holiday and expanded the RFC's powers by authorizing the RFC to invest in the preferred stock and capital notes of banks and to make secured loans to individual banks.

Throughout the 1920’s and early 1930’s there had been repeated attempts to introduce some form of depositors insurance. Many states had insurance systems but they were largely voluntary and were quickly overwhelmed by the circumstances of the early depression. On June 16th 1933 F.D.R. signed the Banking Act of 1933 which created the Federal Deposit Insurance Corporation and the Federal Reserve Open Market Committee. The Federal Reserve Open Market Committee sets monetary policy for the United States. In doing so it sets interest rates by buying and selling (mostly) government bonds.

In 1933 banking interests viewed federal deposit insurance with distaste. The President of the American Bankers Association declared that deposit insurance was "unsound, unscientific and dangerous."

Fast forward: It is the Federal Reserve Open Market Committee that has been buying so called toxic assets from banks and commercial paper from large corporations and loaned almost $200 billion to AIG in an effort to stabilize the financial system. The FDIC has been closing, reorganizing banks while the Treasury, with TARP money has prevented the largest banks from failing by investing in the preferred stock and capital notes of huge failed banks and by making secured loans to smaller troubled banks just as the Reconstruction Finance Corporation did 76 years ago.

The Secretary of the Treasury, Tim Geithner, is simply asking for the authority to regulate financial institutions large enough to wreck havoc on the Worlds Financial system. It’s a simple request, a conservative request, given the magnitude of the problem and the speed with which it arose.

See also:
FDR speech
History of Credit Default Swaps
History of the FDIC
Battles Over Reform Plan Lie Ahead

Wednesday, March 25, 2009

Recession? What recession?

National Lead, follow or get out of the way: In 1932, at the depths of the Great Depression, Franklin Roosevelt declared, "the only thing we have to fear is fear itself." Economists tell us that the psychological effects of fear on the economy can never be underestimated. When the real-estate bubble burst in the middle of a presidential election its effects were exacerbated by the pronouncements of aspiring politicians as well as the media. Nothing sells (fill in your media of choice) like a disaster. Fear and fear alone drove the public to withhold spending even while personal incomes rose. Fear and fear alone drove people out of the stock market. Of course the consequences of fear were the very things people feared most, rising unemployment and declining sales etc. Besides the momentary freezing of the banking system there were little signs of an impending recession. Inventories of everything except new and existing homes for sale were steady as was employment data. Auto sales were weak but only for American flagged manufacturers. In a more regulatory era "default credit swaps" and "mortgage backed securities" would not have been allowed and AIG, which triggered the calamity, would not have failed and taken the banking system with it. Make no mistake about it, AIG, Citybank, Bank of America as well as GM and Chrysler, all the brand name stock brokerage houses and many, many others failed. Without the intervention they would all be in federal bankruptcy court right now.

The source of the rise in bogus securities can be tied directly to our balance of trade deficit with the rest of the world, especially China. We sent so much money overseas we became a debtor nation while much of that money returned to U.S. financial institutions and was made available for loans. When financial institutions have too much money they begin to make dumb investments and there are no limits to the creativity of crooks willing to take advantage of dumb bankers. Fortunately the right lessons were learned from the mishandling of the Great Depression and the Federal Reserve Bank and the Treasury Department appear to have stepped in and solved the bank liquidity problem just in time. The first sign of success was the announcement in early March that Merck was going to buy Schering-Plough for $41 billion. Merck didn’t write a check for that amount, it was arranged by an investment bank someplace in the world with access to that kind of money. In November this transaction could not have taken place.

The tragedy of the Great Depression was that the crash of 1929 was not addressed until the election of F.D.R. in 1932 and an "economic stimulus" large enough to jolt the U.S. out of the depression wasn’t applied until the massive expenditures of WWII. By 1932 the recession had become endemic. People had three years to tighten their belts, loose their jobs and close down both banks and businesses. By 1932 demand for all things reached a low point. How people spend their money is largely a result of their psychological status. In certain times we may be willing to go out on a financial limb knowing there will be a paycheck tomorrow. In uncertain times we will be more cautious, spend less and save for a rainy day which could be tomorrow. By 1932 there had been enough rainy days to systemically reduce demand and anyone who still had money kept it in their proverbial mattress not in a bank.

Fortunately, our current crisis has not festered long enough to reduce underlying demand for goods and services. We may have 8, 9, 10% unemployment but that still means that over 90% of us are still taking home a paycheck and largely unaffected by the shenanigans of AIG executives or Bernie Madoff. Economic statistics showed that we paused briefly but that we are bouncing back, perhaps it’s just the Great American habit of shopping for bargains. For example:
  • The Commerce Department said durable goods orders rose 3.4 percent to $165.6 billion in February, the biggest increase since December 2007. January orders fell a revised 7.3 percent. The Commerce Department had previously reported a 4.5 percent decline.
  • Non-defense capital goods orders excluding aircraft, a closely watched proxy for business spending, expanded 6.6 percent in February. January orders fell an adjusted 11.3 percent.
  • Inventories of manufactured durable goods fell for a second consecutive month in February, easing 0.9 percent to $336.8 billion, after dropping 1.1 percent in January. Falling inventories means that industry will be re-hiring workers to start up the assembly lines soon.
  • The Commerce Department also said that sales of sales of newly built homes in the U.S. rose 4.7 percent to a 337,000 annual pace, the fastest increase since April last year, from 322,000 in January. The inventory of homes available for sale in February was the smallest since June 2002.
  • The Mortgage Bankers Association (MBA)'s index of mortgage applications, which includes both purchase and refinance loans, increased 32.2 percent to 1,159.4 for the week ended March 20. Refinancing accounted for 78.5 percent of all applications.
  • Borrowing costs on 30-year fixed-rate mortgages, excluding fees fell to an average 4.63 percent, the lowest since MBA began its weekly survey in 1990.
  • The Stock Market rebounds – Ever since the Treasury Department announced a way to remove "legacy loans" from banker’s books it’s become apparent that the sluice gates are opening and the smart money is getting out of "safe" investments and back into the stock market.

It’s hard to say if we’ve dodged the bullet but the data looks good and Americans are spending again.

Personal Income Rise Lifts Consumer Spending
Merck to buy Schering-Plough for $41 billion
Durable goods orders rebound in February
U.S. home sales climb at fastest pace in 10 months
Obama Rally Reaches 22% in Recovery From Bear Market

Monday, March 23, 2009

Feds to suck poison from economic wounds

National lead, follow or get out of the way: There is a new buzz word circulating in Washington D.C. Bundled defaulted mortgages are no longer to be called "toxic assets" but rather "legacy assets." In this new guise the Treasury announced today that it plans to buy up to a trillion dollars worth of these "legacy assets" from banks … sort of.

The problem is simple: So long as the economy was growing and home sales appreciating wildly banks were more than happy to buy mortgages and mortgage backed derivatives. When the bubble burst banking rules required the banks to list these "legacy assets" at their current value. The trouble was that the market for mortgages and their derivatives stopped so it became impossible to sell these assets at any price. The value of these assets effectively fell to zero.

When this new reality became apparent most large banks, AIG and all the Investment Banks suddenly found themselves well underwater. Without these "toxic assets" most banks, insurance companies and investment bankers were as profitable as they were, say, five years ago. The bulk of their assets were still good but banking regulations required that the banks close up shop until their balance sheets met reserve requirements. This is the so called "mark to market" rule that bankers whine about. However, even with a change in accounting rules these assets would weigh heavily on the balance sheets of many financial institutions. The new Treasury Plan unveiled today by Timothy Geitner promises to begin removing these now "legacy assets" from the books of the banks.

The Treasury had two problems it had to solve before it began buying these assets: First, what should it pay for assets that couldn’t be sold at any price, second, how to create a market for these assets that no one clearly wants, least of all the U.S. Treasury. The hoped for solution includes a public/private scheme to remove these assets from Americas financial institutions. Here is how it is supposed to work:
  1. Banks identify the assets they want to get rid of
  2. The FDIC will conduct an auction of these assets. The highest bidder can ask the Feds to share up to 50% of the cost of the assets. This established a price and a market for these "legacy assets."
  3. Here’s the kicker: If the seller agrees to the price (and the seller might rethink the value of their assets) then the buyer can sell FDIC guaranteed bonds to finance the purchase while paying the FDIC a fee for that guarantee. If the bonds default then the FDIC owns the underlying asset.
  4. The private buyer will manage and control the assets until they are finally liquidated (subject to FDIC oversight) and the Treasury paid off.
The beauty of this plan, if it works, is that it re-starts a market for these assets and established a price without the U.S. Government having to simply buy everything. When the price for real estate begins to rise again (and it will) the U.S. Treasury may make some serious money.

See also The Fed Plan, Mark to Market

Friday, March 20, 2009

Bernanke to China: buy our debt or else

National Lead, follow or get out of the way: On Friday the 13th 2009 the Prime Minister of China, Wen Jiabao, publicly worried about the safety of China’s one trillion dollar investment in U.S. Treasury Notes. On Wednesday March 18th 2009 the Federal Reserve Bank announced that it was going to buy one trillion dollars in U.S. Treasury Notes. Coincidence? Not likely.

This is a game of very high stakes poker. What the Prime Minister of China did was threaten to stop buying U.S. debt. What he doesn’t realize is that he has no choice but to continue and we hope he knows it. He wants us to thinks that if he stops buying U.S. debt the recovery might falter. He thinks that he has the leverage to change U.S. policy. Perhaps he thinks he can make us stop talking about the Dali Lama and forget about Taiwan or Tiananmen Square. Chinese money financed George Bushes war deficit but our trade deficit with China created the great business boom that China has been enjoying and gave them that same cash that has been returned to the US in the form of investment in our debt. It was the industriousness of the Chinese people not the policies of the Chinese government that created the boom. The boom and the wealth it created could just as easily gone to India, the Philippines or even Mexico had the drive and talent become manifest at the right time.

There are advantages to being the world’s largest economy. The U.S. can do things that few second and no third world country can do effectively, that is, print money. When Ben Bernanke, chairman of the Federal Reserve Bank, announced that he was going to buy one trillion dollars worth of U.S. Treasury notes he was effectively telling the Chinese that he was going to print a trillion dollars and buy the notes that the Chinese threatened to balk at. Balking has its penalties. In baseball the runner gets to advance one base, in this case the threat is inflation.

Bernanke’s message to Wen Jiabao was play ball by the rules we’ve agreed to or we’ll make your investment worthless through inflation and we’ll inflate the U.S. Dollar to the point where it’s value is very low relative to the currency of, say, China. Chinese goods won’t look all that cheap and U.S. goods will begin to look very reasonable to the world. Bernanke was telling China that the U.S. was still the big guy on the block and ready and willing to compete.

It will be interesting to see if the Chinese get the message or if they are as dumb as the U.S. Congressman who asked Bernanke if the Federal Reserve Bank was solvent. Hint: Of course they are solvent if they need money they just print it.

See also
Wen Jiabao, Balk, How the Fed prints money

Wednesday, March 18, 2009

75% unemployment

Local all politics is local: John, that’s not his real name, is embarrassed to be unemployed. At 57 he hasn’t collected unemployment since 1978 when his first job out of college was outsourced to Ireland. John is a software engineer whose career spans IBM Mainframes through the birth of the Internet. Most of his career has been spent working for startups. He’s worked for Apolo Computers, Sun, DEC, Compaq and HP as well as a legion of dot bombs. He’s never been unemployed for more than a few weeks and hasn’t collect unemployment in decades.

"I managed a data center for yet another Internet startup," says John with enthusiasm, "but I had prostate surgery and was out for a month and a half. When I got back I learned that my job had been outsourced again, this time to an Indian company. Makes sense, I was the only non-H1B type in the building." John sits with a grin shaking his head, "You have to love the H1B visa system. Speaking Hindi is quickly becoming a prerequisite in my old industry."

Since being laid off John has applied for nearly 300 jobs. He’s received four polite rejections and has had one interview. "I didn’t get the job," he said laughing," they were obviously looking for someone very young, someone they could pay zilch to and I wasn’t inexperienced enough for that."

John’s two adult daughters, we’ll call them Melissa and Mary are also unemployed and that has worried John more than his own predicament. Melissa, a Grad School student working on her Masters in Architecture, had a well paying job as a draftsman but as the economy sank she was the first to be laid off. "I’m spending more time looking for a job as a bartender than I am looking for drafting jobs," she laughed, "Even those are becoming hard to find. I guess bagging groceries is next." Melissa has sold almost everything she owns, including her art and her car, to stay in school and remain independent and has downsized to a very small apartment that she shares with two others. The prospect of having to move home frightens everyone.

Mary, the older of the two sisters, was a mid career pharmaceutical advertising copywriter in New York City with a six figure income. She decided to move back to Boston with the promise of a job and to be closer to her family. She moved to an ocean view penthouse condominium in South Boston just in time for her promised job to disappear. Mary isn’t worried … yet and spends her time working on her version of the great American novel and doing pro-bono marketing and PR for a collection of non-profit organizations.

John’s wife Sally, that's not her real name either, is the only one working. She’s a unionized nurse with nearly 30 year’s seniority at the same hospital. "I’m the only security blanket we have," said Sally, "I’ll never be laid off but on the other we can’t move without losing all my benefits and seniority. About ten years ago John was offered an incredible job in Cleveland but when we looked at what we would have to give up it wasn’t worth the move."

"We are stuck no matter what we do," said John, "Our mortgage us underwater by $50,000 and so is my car which is only worth $4,000 although I still owe $7,000. We owe $30,000 in credit cards (which we mostly used to get the kids out of college) and almost $100,000 in student loans that we couldn’t get rid of even if we went through bankruptcy, which we can’t do anyway because Sally’s income puts us above the threshold." John says he’s missed several payments on his life insurance so that was cancelled and has cashed in his 401k retirement plan to keep the mortgage current. John is not sure what will happen but remains optimistic. "This too shall pass," he says with a smile, "In the mean time I look forward to coming out of retirement." John, when not scouring the Internet for jobs spends his time writing poetry and shooting photographs while Sally is at work.

Monday, March 16, 2009

Where we stand today, March 16, 2009

National Lead, follow or get out of the way: Conservative commentators have been screaming that Barack Obama is a socialist or worst. The great fear they wish to engender in their readers and viewers is that the economy will collapse fully if the income tax is raised on the wealthy. The belief in conservative circles is that the rich are the only necessary force driving the economy, the old "trickle down" theory. Conservatives thrive on this fear without ever examining the data.

Top chart: Lets start with income tax rates. Income taxes on the wealthiest Americans reached a peek of 95% at the end of World War Two. The agreement was that no one should profit from the war and few did. Under President Eisenhower, a conservative Republican, the tax rate on the wealthiest Americans remained at 91%. It took Jack Kennedy to begin the reduction of taxes on the super rich. President Obama simply wants to restore the tax rate to where it was at the end of the Reagan administration.

Second Chart: The conservative theory is that by giving money to the rich they will spend it and it will trickle down the rest of us. The alternative theory is that the rich are entrepreneurs that will create jobs and stimulate the economy. The truth is that it’s the middle class that are the entrepreneurs (the rich have ancestors that were entrepreneurs) that create most of the jobs and most of the wealth. Between 1965 and 2005 the income tax rate on the richest Americans was cut in half yet only the rich benefited. They didn’t spend it, they saved it.

Third Chart: If the conservatives are right then personal net worth should grow following a reduction in taxes. It hasn’t. Personal income has grown at a pretty steady rate while household net worth has largely been a combination of savings rates and fluctuations in the stock market. During the 1950’s when the income tax on the richest Americans was over 90% the net wealth of American households rose an average of 5.5% per year. The greatest years of growth in personal net worth began during the hyper-inflation years of the Carter administration and continued at at slower pace through the Reagan years.

Fourth Chart: The moral of the story is "Look at the data" before pronouncing one philosophy right or wrong. The press and even some in government have been screaming "Depression." Our current situation is no where near what it was during the Great Depression. This last chart shows how far away we are from our parents and grandparents nightmare. Note, however, that current unemployment statistics do not reflect the tsunami of State and Municipal layoffs that will begin in May as Budgets and services are slashed in the effort to balance the books. (Note U3 are conventional unemployment statistics while U6 include discouraged and those no longer eligible for unemployment - data comes from the U.S. Census Bureau)

According to economic theory Barack Obama and his minions are doing the right thing and the educated in the far right know it leaving only the hysterical fringe to comment.

See also Historical Unemployment In Relation to Today

Friday, March 13, 2009

Where we stand today – Friday, March 13, 2009

International – it’s a mean place out there: There are lots of people out there that don’t like us. For some it’s jealously for others its ideology and for others its just business. Then there are those who, for political reasons, find it expedient to blame everything wrong in the world on the U.S. This includes both enemies and friends. Finally there are those who think of the Western Democracies as weak, effete examples of decay much like we are taught to look upon the final years of the Roman Empire.

Still an awful lot of folks outside the US want to come here, invest here and carry a U.S. passport. It’s become common for wealthy foreign couples (especially from South Asia) to fly in just to have their first baby here, an "Anchor baby," an American Citizen, so should all else fail they will have a way back into the U.S. That’s flattering considering the opinion many of their countrymen share about us.

For all the yelling and screaming in the media about where America stands and is headed people elsewhere believe America is still the best place to be. Take for example, a corner of the world where people of the local culture were expelled and replaced by a different but culturally similar group. We’re not talking about Israelis and the Palestians but rather Tibetans and Chinese. On the 50th anniversary of his exile, the Dali Lama said that the Chinese had turned Tibet into a "Hell on Earth."

The people in the Chinese government are not nice people. Like the Chinese emperors before them the government of the Peoples Republic of China believes in its divine right to govern as they please. In 1949 the government confiscated all western owned property but now they are complaining that their investment in the US, totaling over a Trillion dollars, may not be safe. The Chinese Prime Minister had the temerity to ask that the U.S. government "maintain its good credit, to honor its promises and to guarantee the safety of China’s assets." Of course the US will honor its obligations, they are illusory anyway. One way to eliminate this debt is to simply print more money. As a last resort the Federal Reserve could simply print money and buy the Chinese Treasury notes. That’ll put an end to Chinese prosperity in a hurry by making their goods more expensive out ours cheaper through inflation.

These are not nice people. These same people massacred their children at Tiananmen Square in 1989, invaded Tibet in 1959 and plan to invade Taiwan as soon as they think no one is watching. These are the same people that have invaded India, Vietnam and even the old Soviet Union. China is a crowded country but claiming jurisdiction over culturally similar neighbors smells of "lebensraum (breathing room)", which is the word Hitler used justified his invasion of Poland.

We need to remember who it is we are dealing with. Not everyone in the world shares our ideals and ethics. What might be considered normal behavior in the US could easily be considered foolish elsewhere. It’s scary out there but they still want to come here.

Dalai Lama Says China Has Turned Tibet Into a ‘Hell on Earth’

China Tightens Security in Tibet
China’s Leader Says He Is ‘Worried’ Over U.S. Treasuries

Wednesday, March 11, 2009

Where We Stand Today, March 11, 2009

National – lead, follow or get out of the way: "It’s the economy stupid," has been the political cry from the Democratic left for over two decades. It got Bill Clinton elected and it got Barack Obama elected. Back in the days of Ozzie & Harriet, the 1950’s, America really was built on one income families. Mothers in the 1950’s were happy to be at home. Many of them had worked during World War II and were happy to be "just homemakers." The tax rate on the wealthiest individuals in Post-War America was 90% and everyone (except perhaps the newly wealthy) was happy. America prospered even while fighting a "cold war."

During the Nixon administration our national philosophy changed. We often credit Ronald Reagan for America’s sharp turn to the right but it was the centrist Nixon who brought tax relief to the wealthy and deregulated everything under the sun. It was Nixon’s inflation that paid off the Vietman War and put Jimmy Carter in office and Jimmy Carters efforts to fight inflation that put Ronald Reagan in office. Somewhere in that period the two income family became a necessity for the Middle Class.

Things have changed, we can feel it. Where do we stand? Economists have identified at least four cycles governing the world’s economy:

1. The Business Cycle, also known as the Kitchin inventory cycle – a 4 to 7 year oscillation between excess inventory and excess labor. If you have too much inventory you don’t need anyone making new things and vice versa. This cycle normally governs the boom and bust of a Bull or Bear market.

2. The Juglar fixed investment cycle of 7–11 years –Is just like the Business Cycle but governed by the stock of "durable goods" and other longer term assets. Think of how long an automobile or dishwasher lasts on average.

3. The Kuznets infrastructural investment cycle of 15–25 years – Think of our inventory of roads, bridges and housing. The boom years from 1990 till roughly now overbuilt our infrastructure. We have more houses than we can sell, more office space than we can fill and more capacity to build more automobiles than we need.

4. The Long Wave also known as the Kondratieff wave or long technological cycle of 45–60 years – defines what we normally associate with "Depressions." The same principles apply. In the Long Wave the growth of a new technology spends itself until it becomes ubiquitous. In the early Industrial Revolution there was a sudden need for dams, water wheels, tool smiths and other professionals who could build the factories that produced the goods. Eventually almost everything was industrialized and the need for large numbers of new factories diminished and the resulting unemployment caused a Depression. The initial crash traditionally has been triggered by the "last man in" going broke and unable to pay back debt needed to build the long term infrastructure.

Our current problem appears to be the unfortunate congruence of multiple cycles. The collapse of the automobile industry (and they were in trouble well before the housing bubble burst) signals Juglar cycle while the housing bubble signals a trough in the Kuznets cycle. Unfortunately we appear to be at the confluence of a Long Wave as well as the great Electronics Age wave has crested and is coming to an end just as the age of steam did. In case you haven’t noticed most of the electronics firms that made Route 128 famous are gone. DEC is gone, Data General is gone Prime Computer is gone … and the list goes on and on and on.

Since we’re postulating that this is going to be a bad one it will require a name. Periods of economic upheaval acquire names like "Tulip Mania" or "The Great Depression," "The Long Depression" of the 1830’s and "The Panic of 1873" which lasted 65 months. Go back far enough and you find references to "Goldsmiths crises" in the Middle Ages. We would like to propose a name for our current troubles: "The Great American Transfer of Wealth."

The early 20th century economist Vilfredo Pareto once said, "History is a graveyard of aristocracies." Pareto suggested that for stable economies there is a golden income ratio of the richest to the poorest and whenever the income ratio becomes too low as in socialist countries there is a middle class revolution (Think post-Soviet Russia) but if the ratio is too high there is a revolution of working people (Think French Revolution).

The collapse of the stock markets has eliminated massive amounts of wealth, most of it owned by the rich and super rich. It’s a sign of the times that the U.S. government has attached strings to bank bailouts that allow stockholders to vote on executive compensation. An article in the March 11 2009 New York Times (Some Banks, Feeling Chained, Want to Return Bailout Money) suggested that bank executives are having second thoughts about accepting bailout but the choice for many is accept the funds and strings or be taken over by the FDIC. If the solution to the survival of General Morors and Chrysler is bankruptcy then while labor contracts will be voided, stockholders and bond holders will be wiped clean since the loans made to these companies by the U.S. government takes precedence. Barack Obama is talking about universal health care. Whatever form it takes it will likely reverse the policy of deregulation of the insurance industry by Richard Nixon, the health care will become a non-profit industry again.

By all measures we are in the middle of "The Great American Transfer of Wealth." What it will look like is that the claim on Americas output will shift toward the middle and working class and away from the rich. No doubt it will swing too far. It’s just the nature of all economies.

Monday, March 09, 2009

Where We Stand Today Monday, March 09, 2009

Local – where all politics begin: For most Americans and certainly most Bostonians our current economic troubles are hearsay and rumors whose only outward manifestation is fear. Most people have good stable jobs. The unemployed are a small percentage of the population and most of them are collecting something from the government. No one is starving.

The realities and dimensions of this little problem are just about to hit home. The Governor has been forced to cut his budget by over a Billion dollars while the "recovery act" so widely touted in Washington and opposed by EVERY Republican in the House of Representatives is only going to bring in a couple of hundred Million dollars. The difference is about to become evident. All over the Commonwealth Mayors, City Councils and Selectmen are struggling with the same question: Who is essential to keep the government running, to everyone else … You’re Fired! Between now and June expect the unemployment rate in Massachusetts to skyrocket.

Desperate times are ahead. Boston’s Mayor Minino has asked the unions not to take their raises scheduled to go into effect in June. He admits that won’t solve the problem. He may ask for rolling furloughs, no overtime or even temporary pay reductions. Boston may be able to keep most police and firefighters employed but the slack will be taken up by other departments. It’s clear that the net income of the Commonwealth is going to go down leaving more and more homeowners underwater. At what point do people start walking away from homes they can no longer afford?

Debt is the killer here. Without access to relatively easy credit no one from the Commonwealth to the average Joe can get anything done. This is not an issue of using a debit card instead of a credit card it’s the larger issue of how do you buy a car where there is no public transportation or how to you buy or sell a house if there is no credit available? How do you rebuild roads if you can’t issue bonds? Access to credit is essential but with declining asset values and incomes the majority of us are burdened with massive amounts of unserviceable debt. Something has to give before this is over.

Next time: exploring our National Problem.