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

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

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

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

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.

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

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.

See
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

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.

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.

humor is the best gift for Christmas and the only one I can afford

Merry Christmas to all and happy holidays to the rest.

Bailout

My first car was a 1971 GM Chevy Vega station wagon. I paid $150 in 1974, for a car that had about 40,000 miles. I say about 40,000 miles because the odometer cable had broken but that was the least of its problems. The car had so much rust that the windshield was only held against the car by the windshield wipers and when I depressed the clutch I saw the open road beneath my feet. It was on its third engine. GM’s experimentation with aluminum blocks was a disaster. This was a lot more than simple planned obsolescence.

The Vega died for good in front of a Chevy dealership after I drove it for about a year. The Chevy dealer gave me $150 trade-in towards a Chevy Chevette. It lasted 79,000 miles before so many things were broken it wasn’t worth fixing. This was a lot more than just planned obsolescence. I got $150 trade-in for it. GM made crap in the 1970’s and used up all my good will. I’ll personally never buy a GM car again and I personally don’t care if they survive. They don’t deserve to get bailed out.

I tried Chrysler next. In the 1980’s I used up three Caravans (one was totaled in a rear end collision) and a Eagle Eclipse which I later learned was actually made by Mitsubishi. None of these cars lasted more then 50,000 miles. Lee Iacoca used up all my good will there as well. They were so badly managed that even Mercedes-Benz couldn’t break them of bad habits. Chrysler doesn’t deserve to survive either.

Somewhere around 1990 I paid $500 for an old 1970 Mercedes 220D. It had 345,000 miles on the odometer. Odometers on American cars only had 5 digits. Odometers on my Mercedes had 6 digits. To me that says a lot. Over roughly 3 years I put 100,000+ miles on that Mercedes before it disintegrated in my driveway at 487,000 miles. I was very disappointed that I couldn’t stretch its life to half a million miles. I sold the hulk for parts for $500. I bought a Ford Explorer next.

Actually I leased the Explorer on the theory that if I didn’t like it I could turn it back in. I didn’t turn it back in but Ford burned their bridges too. During the 1980’s the cost of a medium sized car doubled. I paid around $10,000 for my first Caravan and about $18,000 for the last one. The Ford Explorer was around $18,000.

When it comes to cars I have a bit of OCD, obsessive-compulsive disorder. I want a car that not only looks sharp but also feels and sounds sharp. When I close a car door I want to hear that special “thunk” that only comes from perfectly matched machined parts. Most European cars have “it” and keep it, so do a large number of Japanese cars. My Ford Explorer had “it” when I bought it. My “German Junker” Mercedes 220D still had it at 487,000 miles. None of my GM or Chrysler cars ever had “it.”

Since it was leased I only kept my Ford Explorer for 45,000 miles. I didn’t ride it very hard. I used 4 wheel drive in the winter a few times and went off road twice but by the time the 3 year lease was up the doors no longer had that special “thunk.” By 45,000 miles they went “ka-thunk,” making the sound of mismatched metal climbing into the lock position. I could easily picture what happened. To save a little money, Ford used slightly thinner sheet metal and fewer welds than their Japanese or German competitors. It seems American cars are designed by accountants not by engineers who know what it takes to make a “tight” car. By 45,000 miles the hinges on the doors of my Ford Explorer began to sag from their own weight. When the door is closed there is little weight on the hinges so the hinges can only sag when the door is open. How long do the doors of a Ford Explorer have to be open before the metal warps and the doors are misaligned? Three years, roughly 1000 days, four trips a day, 8 opening and closes of the door times 20 seconds equals only about 45 hours of open doors. Aluminum foil and duck tape anyone?

At the end of the lease I knew I didn’t want to keep that Explorer but I wasn’t ready to give up on Ford as I had GM and Chrysler. I asked the salesman what deal I could get for a new Explorer. He said that the new Explorers were $32,000. I looked at him in astonishment and with some disgust yelled, “It’s just a fucking truck!” My daughter piped in loud enough for everyone in the showroom to hear, “You know Dad, for that price you could buy a Lexus.” So I did and I’ve never bought an American made car since and probably never will.

I no longer care about any of the American auto companies. They don’t deserve to survive. They have proven over and over again that they are not willing to manufacturer what I want with the quality I want for a price I consider reasonable. Some talking head on television said that Toyota and GM sold the same number of cars last year and that Toyota made a profit of $7 billion while GM managed to loose over $35 billion. They don’t deserve to survive. Under the tutelage of all those Harvard MBA’s American manufacturing has become a joke, close what we used to think of when we saw the label “made in China,” in other words Junk.

What would happen if we let Ford, GM and Chrysler go belly up? After the weeping, wailing and gnashing of teeth died down, nothing would happen. We would still have to buy automobiles and we’d continue to buy them from the same companies we’ve been buying them for the last few years, which is from Japanese, Korean and European companies. Most of those “foreign” companies manufacturer their cars here in America anyway so what’s the difference? American Workers will still make the cars Americans drive. The only jobs that will be lost are the management tier of the Big Three automakers. Is that a loss? Is that worth a bailout? Maybe it is.

When I was a kid memories of the World War were still fresh and the Cold War was hardening into the very real possibility of a nuclear Armageddon. We practiced ducking under our desks and at the edge of town was an active armory full of weekend warriors. A few miles further down the road was a Nike anti-aircraft missile base. There were all sorts of military installations hidden in nooks and crevices all over America. They were the “Strategic Reserves,” kept in mothballs for years, just in case. Every county had its “Army airbase” that turned into the county airfield, which by 2000 had become either a golf course or a towering row of condominiums. We’ve closed so many bases and sold so much “national” infrastructure you have to wonder if we could again mount the same kind of effort needed to win World War Two. That’s where an automaker bailout makes sense. We need heavy industrial manufacturing capacity just in case. Think of this nightmare: China in conjunction with Iran declares war on us. Stranger things have happened. We loose our source of oil and computers. Suddenly we need to build lots and lots of heavy equipment. Think of the scale: The air force currently has about 1000 fighters during WW2 we manufactured over 200,000. GM made many of them.

Michael Moore, that icon of personal grooming, made a suggestion worth repeating. In World War Two, President Roosevelt told GM to stop making automobiles and to start making tanks and aircraft. Moore said that President Obama should tell GM to stop making cars since they don’t know how to make them anyway and start making railroad cars for public transportation. That would be ironic. In the early years of the twentieth century a network of light railed vehicles, trolleys, crisscrossed America. It was said that at one point you could take trolleys and heaver rail from the Canadian border in Maine to the tip of Key West. During the 1920’s GM bought up independent trolley companies and ripped up their track forcing people into automobiles. We didn’t complain.

President (elect) Obama wants a massive works project that will fundamentally change the way America operates while creating millions of jobs. What could be better than building a public transportation infrastructure that lets people get from anywhere to anywhere in America, without a car just like we could a hundred years ago.

America is going to change one way or the other. If we do nothing we may find ourselves with just one American automobile manufacturer, Ford, and a vast belt of rusting, empty and dilapidated former automobile factories. We have let American industry languish while we’ve become a country of consumers. In the 1960’s the Iron and Steel industry left America following the textile industry in the 1950’s. In the 1990’s the electronics and computer industry followed. If we allow the automobile industry to go as well the only thing left will be the rape and export of our natural resources and our once mighty industrial fortress will have been replaces with endless strip malls. Do you want fries with that?

For what its worth

For those of you interested in economics and who read my blog on our current crisis, I just discovered this tidbit:

In August 2007, the Federal Reserve Bank had assets of $850 billion. The Fed buys assets like U.S. Bonds, and now "asset backed junk" with "fiat" money. That's how they "print" money. As of last week, that figure totaled $2.2 trillion — nearly a threefold increase. Yesterday they announced another $800 billion spending spree. Remember the multiplier effect of cash in a bank?

Will it cause inflation? Yes, eventually, but only when the economy gets started again. Nothing changes.

Volume 3 number 3 of the Wilderness House Literary Review has been released

I am pleased to announce that Volume 3 number 3 of the Wilderness House Literary Review has been released on the Web. This edition of www.WHLReview.com includes works of fiction by John Hanson Mitchell as well as short fiction by Denis Emorine, Jessica Keener, Jim Parks and Shannon O'Connor. As well as essays by Charles F. Campbell, Irene Koronas, Ashley Taylor, Doug Holder and Steve Glines and poetry by A. D. Winan, Chris Crittenden, Eric Greinke, Howard Good, Howard LeeKilby, Jackie Biederman, John Hildebidle, John Thomas Clark, Kathleen Haskard, Lawrence Kessenich, Lo Galluccio, Lyn Lifshin, Michael Amado, Peycho Kane, Raymond Diandrea, Robert K. Johnson, Shannon O'Connor, Sherry O'Keefe, and Susan Tepper.

How books are printed: Letterpress to Laser Printer

When I was about ten my grandfather gave me a book he had been saving just for me. It was my first book. I don’t remember the title or content but it was a beautiful book, my own book. It had a dust jacket that my grandfather removed and tossed aside to reveal a soft brown leather book with the title and author embossed in 18 carat gold on the cover and spine. Both the cover and spine had been tooled with a beautiful border. I thought the spine especially beautiful. The hide had been glued to a form of cardboard made of cotton fibers and the endpapers of the book itself were glued to the spine with the glue joint covered over with a beautiful hand made gold and green marbled paper. The body of the book had been printed by letterpress in giant 16 page signatures then sewn into a cloth backing with a Smyth Sewing machine. The first signature of the book, only 4 pages, had been printed by engraving and contained the title page with a florid design together with a portrait of the author reminiscent of those found on currency. There was a phantom signature of tissue paper between each of the engraved pages to protect the engravings.

You could tell the book had not been opened and read because the signatures had not been cut. The binding process included folding and gathering the signatures then sewing them into the backing but the resulting signatures were not trimmed as they are today. My grandfather ceremoniously handed me his paper cutter and instructed me to cut the signatures firmly but gently. For him learning how to properly open a book was a sacred right of passage. As I slowly sliced the first signature open I could feel the individual cotton fibers stretch then break as I drew the dull knife upwards. By the time I had cut the last signature the book had become mine. I would be the first person to set eyes on the printed page since they had come off the press. There was magic in that.

When I opened the book and looked at the first page in the first signature I could see the slightly uneven imprint of the type in the soft textured paper. Even without a magnifying glass I could see the needle edge of the types serifs where it cut into the paper carrying with it the carbon black filled ink. It was beautiful.

Books were made this way for several hundred years. Typesetting was a tedious, expensive and challenging work when done by hand and dangerous when done by a linotype machine that cast individual lines or slugs of metal type from negatively shaped type masters and hot molten lead. These slugs were then printed for proofing on small presses called galley presses. When all was well the slugs were then placed in a large 2 x 4 page panel for printing. Two of these were required to print one sixteen page signature. It was a slow tedious labor intensive process.

Before about 1970 fine, hardbound books were only printed by letterpress. I am old enough to remember when the change occurred. Offset printing was considered cheep and not worthy of a fine printed book. By 1980 all hardbound books were printed by offset lithography.

Offset lithography printing uses a flat metal or plastic sheet called a plate that has been photographically prepared so that ink sticks to the image area and is rejected elsewhere. Ink is transferred from the plate to a roller that presses into ink into the paper. One of the drawbacks to offset lithography is that the offset plate cannot carry as much ink to the paper or press as hard as a letterpress. Because of this the paper used in offset printing must be very flat and without the “tooth” that characterizes the “fine” papers used in letterpress. When the thin film of ink on an offset roller is pressed against the very flat paper, fine lines, dots and type serifs tend to spread so serif type faces printed by offset tend to look a little muddy when compared to identical type printed by letterpress. This feature of offset printing lead directly to an explosion in the use of san-serif type faces like Helvetica, Universe and others in book design. One good feature of offset printing is the ability to print photographs with a resolution many times greater than letterpress offers.

In older books photographs were often printed individually then glued or “tipped” into the book or entire signatures of photographs or drawings were printed by etching presses then sewn into the book. The maximum resolution of a letterpress was about 45 dots per inch using newsprint and as much as 85 dots per inch using paper specially prepared for the purpose. This paper was often hard and brittle from the clay used to prepare the paper to take a very sharp image. The harder and flatter the surface the sharper the dots could be. Etching presses or rotogravure, are capable of impressions of up to 200 dots per inch but this process is very expensive and gravure doesn’t print type very well at all. The colorful magazines distributed with Sunday Newspapers were always printed by rotogravure. That was then; today both newspapers and the colorful magazines they contain on Sunday are printed by offset. Because offset printing was an inexpensive way to print both type and art on the same page it became very popular with textbook publishers. It didn’t take long for paperback publishers to switch to offset followed quickly by traditional publishers.

Not only did the switch to offset represent a revolution in printing at the same time there was a revolution in typesetting. Letterpress printing was a part the old industrial revolution characterized by big dirty machines, steam engine technology. Typesetting was a blue-collar profession conducted in the bowls of a factory. Type was literally hot as the liquid lead flowed down open channels to form the slug in a linotype machine. In the late 1960’s “cold type” became popular. Early “cold type” systems came from IBM Selectric ™ Typewriters modified to print real typographers’ fonts onto specially prepared paper and Compugraphic ™ and other brands of machines that composed type onto photographic paper. These galleys would then be used to “paste-up” a dummy of the publication which then was then used to photographically create an offset plate.

Today, of course, hot type and paste-up is a thing of the past because of the multitude of personal computer programs that can electronically paste-up, proof the image on ink jet or laser printers and electronically create an offset plate. Xerox, Hewlett Packard and Kodak all pioneered in the use of ink jet and laser as “page-proof printers” with a quality image that rivaled or bettered that produced by an offset press.

The best offset printers can print images with a resolution of 300 dots per inch at a rate measuring in the thousands of impressions per minute but an offset pressman might have to print as many as 50 sheets to get the inking on a plate exactly right before turning up the press. Because of the tuning required an offset job is cheaper than a proofing press only of the print run exceeds many hundred or thousands of impressions. For many years book publishing has been constrained by the economies of scale in offset printing. For example, printing a 200 page paperback book might cost as much as $2000 to set up and 2 cents per impression. Printing and binding 100 copies could cost $35 or more per book but in quantities of 50,000 the cost falls into the range of pennies per book.

Modern proofing presses, for example Hewlett Packard’s Indigo series of industrial laser printers, are capable of printing an 11” by 17” images in full color with a resolution of 1200 dots per inch at the rate of up to 1000 pages per minute. The quality of the image produced by these printers is superior to almost all offset printing but cost considerably more than offset at its optimum but considerably less than offset in very small quantities. With the introduction of home, commercial and industrial laser printers “printing on demand” was born and “publishing on demand” soon after.

Publishers face two dilemmas: First, Can they sell enough books to make publishing worthwhile? Second, how can publishers keep their back list alive without having to print and stock uneconomical quantities of books? For most mainstream publishers pre- and post-publication costs dictate an initial print run of many thousands of books. These same economics prohibit the publication of books with potentially smaller audiances and prohibit altogether books on the backlist that could have long but active tails. A book by a major publisher that might sell 100 – 300 books a year in perpetuity is quickly marked out of print.

“Publishing on demand,” or POD, is a technology that solves the problem of small press runs. POD marries laser proofing technology with conventional bindery equipment to create a book production system that is as efficient at printing a one-of book as it is 2,000 books. Of course the unit cost is much, much higher and the production rate much lower than offset but back listed books that once would have gone out of print can be quickly and effectively produced by a Lulu or Lightning press one at a time at a cost point guaranteed to earn the publisher a profit.

To a small to medium sized publisher POD is a revolution. Not only does the use of POD eliminate an investment in inventory but the quality of publication is greater or equal to that produced by offset. The simple elimination of large inventories allows smaller publishers to publish more books than they otherwise could and the availability of POD published works guarantees that no book will ever go out of print. The agility of POD will almost guarantee that new and exciting works will flow to those publishers who using POD, will be able to respond quickly and decisively to the market. By reducing the cost to market while maintaining expected quality will insure the publisher using POD will have an advantage over their more conventional competition.

The books my grandfather kept were the classics but in that age and the one immediately after it how many books, good books, were never published because a publisher didn’t think there was a market big enough to make money? Today every book can get published and linger in obscurity until someone finds the gem they were looking for.

Roosting Chickens

In 1978 I had the opportunity to buy a house in Cambridge Massachusetts for about $75,000. I turned it down because had I bought it, after paying $10,000 up front for a down payment my mortgage would be $300 a month more than I had been paying to rent the house. If I bought the house I would get a negative return on my investment. Real estate has been immune from that logic for most of my lifetime because of the almost universal belief that all real estate appreciates quickly. The house was sold and I had to move. I drive by it occasionally and realize that at the peek of the real estate boom that ramshackle house could have sold for $900,000.

The problem is that someone did buy that house for a price nearer $900,000 than the $75,000 I had been offered. For the last 50 years the expectation that real estate will appreciate has been proved more or less true. Unless incomes grow at least at the same rate as the price of housing eventually the average person cannot purchase the average home. My guess is that that line was crossed somewhere in the mid 1990’s. Unfortunately bankers, brokers and consumers all assumed that the party would continue forever, that there would always be a greater fool willing to pay just a little bit more but as the prices rose relative to our incomes the number of fools willing to pay absurd prices approached the vanishing point.

Banks recognized the problem they were facing. When a depositor places money in a bank it is a liability. To turn that liability into an asset it must be invested which for a bank means loaning the money out. Because that money is then returned to the bank in the form of a new deposit or liability, it must be loaned out again. Without limits the amount of money “created” could approach infinity. To prevent that from happening a “reserve” of about 20% is held back. This reserve requirement is adjusted by the Federal Reserve Bank to speed up or slow down the economy as it effects the creation of money, it’s a multiplier effect. As the Real Estate market began running out of new suckers, banks began running out of new places to put their money. The banks return on investment began to falter; the rise in the price of Real Estate began to falter. The first part of the Real Estate Bubble was at an end, the second part was just about to begin.

We have become a very short sighted society. Executives are rewarded for what results they got last quarter and their vision rarely extends beyond the next. The “future” has been foreshortened to not much beyond this fiscal year. A mortgage is a 30 year investment, a deposited liability is now. The question became one of how to turn all that liability into high paying short term loans. Some financial genius with an HP-35 calculator realized that the adjustable rate mortgage, or ARM, was a perfect vehicle to keep the good times rolling.

An ARM is based on the notion that a security can be sold based on the cash flow over the life of a loan while low payments at the start mean more people can afford the payments at least initially. For example a loan can have very low payments for the first 24 payments then those payments rise over time with a huge balloon payment at the end. If the bank resells the the loan while the payments are low and still in good standing then the bank is off the hook. A loan priced at 2% then 6% then 25% could average, over the life of the loan as 7%. This financial genius figured the bank could have it both ways:

1. By charging a very low interest rate (or low repayment rate) initially, a lot more people could qualify for loans and since, so the theory went, most people refinance (in 3 years for example on a 30 year note) before the high payments kick in the security was safe. In theory someone could continually refinance a house with an ARM every couple of years forever.

2. Since the sale price of the security is based on the cash flow over the life of the security, 30 years, the bank could bundle thousands of these loans and sell them as “tranches” to large investment banks as well as Fanny Mae and Freddy Mac. Banks typically mix good, bad and mediocre loans in a tranche and sell these to the highest bidder. They need to sell tranches to prevent buyers from cherry picking only the best loans leaving the bank with the trash. We’ll see in a moment what Freddy, Fanny and the investment banks did with these securities that made the situation worse.

The availability of cheep loans jumpstarted the Real Estate market as new “greater fools” flowed into the housing market. Hundreds of thousands of jobs were created as millions of dollars worth of new housing was built. The monster fed on itself as deposits flowed into the banks and unstable loans flowed out.

Greed has no limits. Fanny, Freddie and the investment banks were not happy holding five year notes, much less 10, 15 or 30 year notes. To make these assets liquid, to create even more money, these institutions created “Asset Backed Securities.” An Asset Backed Security is created when an investment bank merges all it’s “tranches” together then splits them into different grades of investment bonds. A new “tranche” of, for example, $100 million worth of mortgages (at present value) is bundled together and bonds created that represent some percent of the total. These ABS’s were then sold on the open market creating new cash, new liabilities. The problem is that in a declining market no one knows what these asset backed securities are worth because they don’t know what the underlying mortgages are worth. It’s a Ponzi scheme, it works only while there is a greater fool willing to buy whatever is being sold.

Again! Unfortunately bankers, brokers and consumers all assumed that the party would continue forever, that there would always be a greater fool willing to pay just a little bit more but as prices rose the number of fools willing to pay idiotic prices approached the vanishing point. Suddenly all those 2, 3, and 5 year ARMS began to come due. A 2% interest rate became, 4% and 4% became 6, 7 or 8%. A mortgage payment of $1000 became $2000 and promised to go to $4000. The greater fools could not refinance their mortgages and the prices began to fall. The monster fed on itself.

Remember that money you deposited in a bank back at the beginning of this story? Let’s say you deposited $100. Given the 20% reserve requirement the bank was able to loan out $80, then $64 then $51.20 …. This creates a total of about $450 in new deposits and about $350 in new loans. If some of those loans go sour then the bank has to either find more money to maintain the reserve requirements or stop making loans while those loans that are still good are paid back.

The way banks find more money is to either sell the assets they have or get new deposits. Here’s the problem: No one is willing to buy these “assets.” Even Fanny and Freddy have suffered terminal indigestion, having purchased enough ABS junk bonds and toxic mortgages that they had to be taken over and resuscitated by the U.S. Government. That leaves option number two: wait until existing loans mature and are paid back. The cash coming in from maturing loans fills the bank’s vault until the reserve requirements are met. In the mean time they don’t have any money to loan out. That is where we find ourselves right now but that’s only half of the story.

It gets worse. We live in a world where we finance everything. No one pays cash for their homes or cars or washing machines. Likewise companies finance as much of their operations as they can get away with. Every automobile dealership finances their inventory and look inside any store and you will see nothing but bank owned inventory, fixtures and infrastructure. Most companies as well as most individuals are “leveraged” to the max. On paper this looks great: Grow with other people’s money. What happened when all this toxic debt began clogging the market is that the whole house of cards started falling. It’s already begun and like the twin towers once the collapse starts no one knows if it can be stopped.

The cards at the top of the pyramid are crumbling: General Motors has tapped out its last $2 billion line of credit. Once that’s spent it will have to live on its cash flow, something it hasn’t been able to do for the better part of a decade. GMAC, GM’s finance arm and a big player in the toxic security market, announced it could no longer finance the inventory of its dealers and almost immediately the largest GM dealership in the US went bankrupt sending thousands of employees to the unemployment lines.

All five of the of the largest investment banks, creators of those toxic Asset Backed Securities, have, one way or another, gone out of business so has the largest insurance company in America, a major buyer of the ABS junk. We may celebrate the demise of incompetence but historically these same investment banks were instrumental in the creation of most of America’s largest companies. In the future it will be foreign investment banks, Chinese, Russian, Arab and European that will dictate the direction America’s economy will go. Almost unnoticed was the largest bank failure in American history when Washington Mutual discovered that it could not raise enough cash to meet its commitments. Then Wachovia, who’s next? This is just the tip of the iceberg.

So the Federal Government is going to bail out the financial system by buying $700+ billion in bogus, toxic, ABS, “derivative” securities. With luck it will work but please note that the Feds aren’t buying the original mortgages, heavens no, they might have some value, rather the Feds are buying the Asset backed Securities created by the now defunct Investment Banks. If (and only if) the Real Estate market “recovers” and somehow still greater fools are found will those ABS ever have value.

If $700 billion is the size of the problem we would be very lucky. $700 billion is only about half the size of the annual Federal Budget, that’s manageable. Fortunately only a small portion of those questionable mortgages were converted into ABS’s, the vast majority of those loans are still on the books of banks and Freddy and Fanny as assets. If the sale price of these assets continue to decline they will poison the balance sheets of more and more banks and cause many to fail. If you don’t like a $700 billion bailout you’ll love the price tag if this bailout doesn’t work. It’s something like $100 trillion or about half of the mortgages out there.

It might be interesting to stop for a moment and look at how and why we got here. We know greed got us here but it was greed at every level, from the most petty real-estate salesman through Wall St. to the Congress and the President of the United States. Greed has many forms and in politics is often disguised as altruistic actions. We want all sorts of services from our government but none of us want to pay for these services. No problem we’ll charge it and leave the debt to another generation. Our national debt, money we have borrowed to run the national government, has grown from $2 Billion in 1980 to $10 Billion today. Historically our debt has been eliminated by monetary inflation. Inflation is a hidden tax shared evenly across the country. Let’s take a look at the last 100 years.

In 1900 the average person earned $300 a year. In 2005 the average person earned over $40,000 per year. Of course in 1900 the average person didn’t have the costly amenities we have today like indoor plumbing and electricity but still the majority of the difference in incomes between 1900 and 2005 is inflation. Inflation is defined as an increase in the amount of money in circulation relative to the goods and services available for sale. It sounds simple and concrete but is really nebulous because as we saw banks can create money simply by making loans.

Economists have a name for different kinds of money much like Eskimos have names for different kinds of snow. Hard currency is called M0, M0 plus bank deposits are M1, M1 plus medium term deposits (like CD’s and savings accounts) are called M2 and M2 plus the longest term deposits (like 2 year treasury notes) are called M3. Most of us treat our real estate investments as part of our personal M3 although most economists don’t count it. In the past we have treated real estate as money since we could always go to the bank and get a loan based on the value of our houses. I would also argue that our 401K plans are also part of our personal M3 since we can dip into them on occasion too. The point of this exercise is that we measure our economy and our salary in money terms measured in dollars but that term has different meanings depending on context. A dollar means different things depending on when and where it’s used so talking about inflation around economists is as slippery as an eel but a change in incomes from $300 to $40,000 speaks for itself.

What happened at the beginning of the Great Depression was almost the same thing that’s happening today. When deposits aren’t reinvested, new money isn’t created and when money is transferred from M3 to M2 (by loan defaults or by paying off loans faster then new loans are made) then to M1 and cash (as confidence in longer term securities dwindles) the combined money supply shrinks. So long as all those ARM’s are not being refinanced the money supply will shrink. When the money supply shrinks prices fall. At the height of the Depression the average price level actually declined, we had deflation.

When Roosevelt came into office the new thinking in economics was to stimulate the economy by increasing the money supply. It did so by purchasing all the bonds issued during the First World War and by buying gold at the, then, unheard of price of $35 an ounce. The national debt was “monetized.” Still it took the demands of the Second World War to put the malaise of the Great Depression behind us, monetary policy wasn’t enough. Fortunately for us a combination of aggressive monetary expansion and an incredibly fast growing economy put the debt of the Second World War behind us very quickly. The cost of Vietnam was different.

There is an old saying that “you can’t have both guns and butter” and during both world wars there were shortages and rationing. Vietnam was different. For the first time in history politicians tried to have it both ways. President Johnson’s “Great Society” combined with a booming post-war economy and a festering and expensive war in Vietnam lead to a relatively massive national debt. The solution the Federal Reserve choose to solve the problem was to monetize the debt to pay for it with “fiat,” invented, money. Of course this lead the wild inflation of the Nixon and Ford and Jimmy Carter years but it solved the problem of the debt. It got rid of it. It also stimulated the economy and the 1980’s were golden years.

This magic potion was not lost on Ronald Reagan who doubled the national debt as well as the size of the federal budget and managed to bankrupt the Soviet Union in an arms race Russia realized they could not win. Unfortunately Reagan also appointed Allan Greenspan to head the Federal Reserve.

Alan Greenspan did two things that made free market economists drool in delight. He attacked inflation with a vengeance by raising interest rates sky high. This made investments in America look very attractive while at the same time removing money (that mysterious M3) from the system. He was so effective in removing money that he caused the recession of 1988-89 which cost George H.W. Bush the presidency and forced President Clinton to create budgets with a surplus. Regains debt could not be paid for with inflation so Clinton had to arrange to pay for it with taxes. Fortunately the end of the cold war reduced the need for military spending. We had a peace dividend and the economy grew and grew and grew. The economy grew because there were more goods and services available to buy since the capacity of our economy to manufacture goods for human consumption rather than military consumption grew. The good times came to an end with George W. Bush.

George thought he could do old Ronald Regain one, maybe two better. After nine-eleven George conjured up the most expensive war in American history. If Regain only doubled the national debt from $2 trillion to $4 trillion, George managed to double it again from $4 trillion to $8 trillion through a combination of tax cuts and uncontrolled spending. Contrary to their political doctrine Republicans have been unable to restrain themselves when it comes to spending your money. With the financial rescue plan in place it is not unreasonable to expect the final bill to push our national debt well over $10 trillion.

So how are we going to solve this problem? This is a ~$30,000 problem for every man woman and child in the US, it’s the cost of a low end luxury car or a year at a middle of the road private college. It is “doable” if any of us really thought that would be the end of it but it would destroy the hopes of retirement for the current generation and hobble the start of the next. Even if we did pay it off in a static economy would it have any effect? Who do we owe this money to anyway?

In the aggregate we owe it to ourselves but the devil is in the details. When Ross Periot sold Electronic Data Systems to General Motors for a couple of billion Dollars he put his money in U.S. Government bonds, he bought part of our national debt. When he ran for President and paid for his campaign “with his own money” he actually paid for it with interest on those bonds. We actually paid for his campaign with that portion of our taxes that pays the interest on the national debt. It’s the very rich of the world, rich individuals, rich corporations and rich countries like Dubai and China that own the promissory notes of the United States. If we default, and default we must, it will be a massive transfer of wealth from the rich to the poor.

Why must we default? Simple, we must default because there is historical precedent for it and in the end there is no other way. Trickle down economics never worked. The rich don’t spend the way you and I do. They invest, they create more money, and they create additional claims on our national productive capacity. They own or have a lean on the means of production and they demand their due. Eventually the economy grinds to a halt as it becomes tied up in servicing its own debt.

I’m not inventing economic theory here, just observing the patterns of history that have been observed in every society since man began recording history. In our own era it has been called long economic wave or Kondratieff Wave after a Soviet era economist who first described a 50-80 year wave of economic growth and contraction in the modern era. Nilolai Kondratieff observed the expansion and contraction of economies and described it as a cycle of strong economic growth followed by a period of debt repudiation and commodity price collapse. The price collapse is a result of the contraction of the money supply brought on by debt repudiation or default.

In earlier times what economists now call the Kondratieff wave was observed as “goldsmith crisises.” Vilfredo Pareto, an economist and early contemporary of Kondratieff was able to isolate data showing signs of long economic waves going back into Roman times. It appears that in societies lasting long enough to observe their internal economics institutionalize their debt repudiation. For example in the Old Testament there is the observation of the “Jubilee Cycle” every 49 years, a feature of which is the forgiveness of debts.

There are many ways to default on the national debt. The most obvious way and the least likely to take place is to simply repudiate the debt, just announce that we will no longer honor the debt. The second way is through monetary inflation. The Federal Reserve adjusts the money supply by buying or selling debt instruments like Treasury Notes. When the Feds buy notes they introduce money into the system, when they sell securities they remove money from the system. What do you think will happen when $700 billion in cash is spent buying up defaulted mortgages and “toxic” securities? A lot of money will be introduced into the system and according to classical (or neo-classical if you like) economic theory one of two things will happen. If there is pent up demand (i.e. if there are people who could qualify to buy a house but can’t because of the mortgage crisis) then the economy will boom as money changes hands again at an accelerating pace. This is called a simple increase in the velocity of money if any of you reading this are economists. If, however, the economy is saturated, if there are no more “greater fools” out there then this sudden increase in the money supply will cause nothing but inflation. This is good!

Why is this good? For one it reignites the housing market as outrageously expensive houses become relatively cheaper. It also allows us to pay down the national debt with inflated dollars. It’s a game of musical chairs where those who hold enormous wealth on paper are least likely to end up with a seat at the table. Still inflation is a hidden tax on all of us that history has shown to be a universal but, ultimately, welcome leveler.

Paris Hilton to run for President

See more Paris Hilton videos at Funny or Die
"See you at the debate, bitches."

Appleman Triathlon 2008

Liz and Olga about to swim
As the Star Spangled Banner waved

How we are different from them

He’s the one that used to mow your lawn. His father remembers your father. They are fifth generation “landscape architects.” The grandfather used to own the farm that became this neighborhood. His uncle works in the industrial greenhouse. His mother works as a nurse’s aid. They are all around you. You think they only drink beer.

They have no history. They live for now, working just hard enough to pay for life’s necessities and a little extra. Tomorrow will be the same. Nice life. This is how they have lived for thousands of years. Ambition is something for the foolhardy dreamers that life leaves by the side of the road like so much roadkill. Ambitious men fail. The prodigal son was ambitious. It’s dangerous to dream, it wastes time and doesn’t feed the chickens, goats, horses or car. The only good ambition is getting a new roof on your shed, a new cast iron pot, a new knife, a new gun, a new car, a new HD TV. The only safe goal (it’s not quite an ambition) is getting that one more little thing that makes life enjoyable. Its all about life, liberty and the pursuit of happiness; wine, women and song; sex, drugs and rock and roll. In whatever order you prefer, it doesn’t really matter as long as there is bread and circus.

For all their faults they are still the salt of the earth. Without them there would be no harvest, no tailor, no roads to drive that new car on. Someone has to do the work and they are both grateful and resentful at the same time that there is work to be done. You can count on them. They work hard and at the end of the day they die and their children work hard too. It has been this way for millennia and will be for many more. They are eternal and blind.

We are different of course. We have a vision! A vision not shared with them. It’s this vision, not ambition, that drives us and we pursue it with a blindness beyond foolish. A curse they say. They mock us when we fail and despise us when we succeed but without us there would be nothing. We built the pyramids with their labor. We painted the Mona Lisa and the Sistine Chapel; we carved the pieta and build the Grand Coulee Dam; we said we would send men to the moon and we did.

We crafted each Civilization with our minds but we grew tired and let the Goths, the Huns, the Hordes in and presided over the last meeting of the Roman Senate. We built the great engines of industry and, when they fail they ask us to fix it. They won’t fix it, they can’t. We can’t always fix it ether; being mortal our vision is only so large, so comprehensive.

Our soul cries out to the Universe, to God: You made us in your image, perfect our vision, our wisdom, our understanding so that this time it will be perfect.

You want to melt into them. No cares, no worries, just life but your mother said you were special. “You come from a long line …,” she said, “You must be better than the best of them.”

Wilderness House Literary Review Volume 3 Numer 2

I am pleased to announce that the Summer 2008 issue of Wilderness House Literary review is now online. Of course it's the best issue yet. http://www.whlreview.com/