Tuesday, June 30, 2009

Cap & Trade (Carbon Tax) – Part 1 – I Wonder

President Obama and Nancy Pelosi, his enthusiastic sycophant in the House of Representatives, are concocting a disastrous bit of legislation. Reportedly, the House passed it while parts of it were still being written.

When they passed the “stimulus” bill earlier this year at least they had a one-thousand plus page document. The ink wasn’t dry, but the ink was on paper. I wonder if the sections written after the bill was “passed” are legally part of the bill. Logically, they couldn’t be, but a lack of logic has never been an obstacle to Congress and it’s been only a minor obstacle to the Supreme Court.

I wonder why Nancy Pelosi and Barack Obama are pushing so hard for this “Cap and Trade” legislation. I wonder why Congress doesn’t have hearings to look at the scientific evidence that supports a global warming trend and also the evidence that refutes it.

I wonder why this is a crisis when global temperatures have cooled over the past 11 years. I wonder how any member of congress can consider increasing the cost of doing business in the United States, and on living in the United States, when the economy remains in recession and the financial crisis may not yet be over.

I wonder why any member of Congress who truly thinks global warming is a crisis could support a bill that is predicted by its scientific supporters to reduce overall global warming by 0.07 degrees Fahrenheit after 50 years.

I wonder if there isn’t some completely different agenda at work here. I cannot believe 218 members of the United States House of Representatives are stupid enough to vote for this job-killing, recession prolonging, retirement damaging, freedom reducing, and completely ineffectual in obtaining its official purpose monstrosity.

I’m not a conspiracy theorist. In general, I think real conspiracies can’t be kept secret and anyway people aren’t smart enough to pull them off. In this case though, I hope there is a conspiracy. To think otherwise one would be forced to conclude that “The Keystone Cops” and “The Three Stooges” have a majority in Congress and a moron lives in the White House.

Tuesday, June 23, 2009

Economic Stimulus: Part 5 – Government Policy Options

Current United States government policies are inappropriate to the objective of ending the recession and starting a sustainable economic recovery. They are not directed at reducing the private debt-service to income ratio.

So what government policies might help people reduce their debt-service to income levels? The strategy is simple. Debts must be reduced, incomes must be increased, or some combination of the two.

There are three mechanisms to reduced debt service. (1) It can be paid down. (2) It can be refinanced at lower interest rates. Or (3), it can be repudiated. Two mechanisms could increase incomes. (1) Taxes could be cut to increase net incomes after taxes. Or (2), inflation could push up wages across the board.

For government policy to assist in paying down private debt the government would have to directly pay on the debt or provide additional money so people could pay down their own debt.

For government to increase private refinancing, government could reduce interest rates. However, many people who most need to refinance cannot because the value of their homes have fallen below the balance on their mortgages. In this situation, banks won’t write refinance mortgages. So, to affect this objective, government may need to purchase the current mortgages and reissue them at lower fixed interest rates. This might be accomplished through Fanny Mae, Freddie Mac, or even by the Federal Reserve Bank.

In order for government to increase debt repudiation the bankruptcy laws would need to be rewritten loosening the requirements for Chapter 7 bankruptcies. Or, the government might directly purchase bad debt from lenders and simply forgive the borrowers while writing the debt off the government’s books. This would probably be poorly received politically because of the perception of unfairness to all other borrowers.

For government policy to immediately increase incomes across the board tax cuts and tax rebates are the only tools available. Spending is too localized in its affects.

For government to increase nominal incomes broadly and continuously government could inflate the currency in a controlled and consistent manner.

Real government policy options for reducing private debt-service to income ratios are: (1) tax cuts and rebates; (2) buying private debt directly; (3) relaxing the bankruptcy laws; and (4) inflating the currency.

The United States government has cut the payroll tax slightly but is proposing income tax increases on high earners, the establishment of a new European style value added tax, and the imposition of carbon use taxes. These tax increases will have the reverse affect from what is needed. They will reduce net incomes and make private debt service more difficult.

The Federal Reserve has purchased some private debt in the form of mortgage backed derivatives; but they have no stated intention to forgive the debt or rewrite the terms at low fixed interest rates. Freddy Mac and Fanny Mae are offering somewhat helpful subsidized low fixed rate refinanced mortgages to borrowers who meet certain criteria. However, only a small fraction of at risk borrowers meets the criteria.

I’ve heard of no initiative to relax the bankruptcy laws. On the other hand, the government is doing everything possible to inflate the currency. The Federal Reserve is rapidly increasing the money supply and the Treasury is selling government debt overseas, repatriating dollars at rates unimaginable before it actually started happening. So far, the efforts to inflate the currency have been unsuccessful, but they will certainly succeed eventually.

Unfortunately, when the inflation begins it will drive up interest rates, slow the economy, and increase the cost of selling more government debt.

Current government policy is not helping to restart the economy.

Links to Other Topics in the Special Report: Economic Stimulus


Tuesday, June 16, 2009

Economic Stimulus: Part 4 – Reducing Debt vs Increasing Consumption

This recession was caused by debt from banks financing their lending operations, from families taking on mortgages beyond their ability to pay, and from individuals financing personal consumption with credit cards, home equity loans, and refinanced mortgages.

When the ratio of private debt to private income shrinks to its historical norm, private consumption will naturally increase from its new lows. Until then, the folks will save and pay down debt and, where they can, defer consumption to make room in their budgets for saving and debt service.

Government policy may be able to reduce the severity and length of the recession if it is directed at helping families reduce their debt and increase their savings. A successful policy would help people restore their personal debt-service to income ratios faster creating the conditions necessary to sustain economic growth sooner.

Stabilizing the banking system was and is necessary to continue financing viable businesses, especially small businesses. But increasing government consumption will not end the recession. Government spending, as opposed to tax cuts or rebates, is necessarily targeted at things government can spend money on.

Projects that receive government money will prosper while the rest of the economy continues to founder because the people still must pay down their debt. Families and individuals must reduce their debt payment obligations and save money for the proverbial rainy day.

For some the rain has already arrived and they were caught without an umbrella. These folks are reducing their debt through bankruptcy and foreclosure. The rest of the folks can see the storm coming and are trying to restore their debt-service to income ratios before the rains reach them.

Links to Other Topics in the Special Report: Economic Stimulus

Tuesday, June 9, 2009

Economic Stimulus: Part 3 – Why Government Spending Will Not Work

Government spending will not lead us out of the current recession. The economy of the United States will eventually recover but government spending will not “prime the pump” to use FDR’s words. This recession was caused by too much debt. So much debt that it couldn’t be paid back or serviced by overextended borrowers.

Citizens have started saving, paying down debt, and in some cases defaulting on it. This must happen. The level of debt must come down to historically normal levels as a percentage of incomes in order for a recovery to sustain itself.

Since the federal government’s income from taxes is falling, and since the government has zero savings, the expansion of government spending is funded with borrowed money through the selling of Treasury Bonds.

With the yields (the effective interest rate based on the price paid) of Treasury Bonds creeping up past 4.0% there are not enough buyers. The Federal Reserve (Fed) is, therefore, buying Treasury Bonds for its own account in order to keep the yields from rising higher and faster.

However, when the Fed buys Treasury Bonds they don’t use real money. The Fed pretends to have the money. They literally just send data indicating the amount they are supposedly paying for the bonds to the accounts of the US Treasury Department. Individuals who attempt this are guilty of a felony; bank fraud jumps to mind.

The financial press, when referring to this process, say the Fed is “printing money”. The Fed doesn’t actually print it – they make fraudulent accounting entries; Sarbanes-Oxley jumps to mind.

In addition to the purchases of bonds by the Fed, many bonds and the shorter term Treasury Bills are purchased from outside the United States - especially by foreign governments – especially by China. Foreign purchases have the same effect as purchases by the Fed; more dollars become available for circulation in America.

All of these dollars are briefly in the hands of the federal government.

The idea is that since the people are spending less (they are busy paying down debt) the government must spend enough to make up for the lack of private spending. The problem is two-fold. (1) Government is creating public debt faster than people and corporations can pay down private debt so the total debt problem continues to grow. (2) Government borrowing from overseas, and from the Fed’s creative accounting, increases the number of dollars in circulation without increasing goods and services available to buy.

Government is also diverting some economic activity to low priority projects not previously deemed worthy of funding. The people, meanwhile, still must pay down their debt. So, consumer spending will remain suppressed as the excess dollars find their way into circulation. Eventually price and wage inflation will become noticeable - and then alarming.

Inflation will help some people service their debt since fixed debts like 30 year fixed rate mortgages will remain unchanged while wages increase. These people will have more dollars available to make the same monthly payments. Their debt will be a smaller portion of their inflated income.

People with variable debt (adjustable rate mortgages and credit card debt for example) won’t be so fortunate. Their interest rates will rise - perhaps faster than their wages. Inflation will also hurt the banks as their portfolios of fixed rate loans lose value.

Independently of government spending and inflation issues, banks and housing prices are already queued up for another round of mortgage defaults. There is a large group of mortgages out there with balloon payments or major payment resets due in 2010 and 2011.

It’s an open question whether these mortgage payment resets will, by themselves, delay the recovery and the ensuing inflation, or whether the recovery and inflation will start first and the new mortgage resets, and subsequent defaults, abort the recovery and throw us into a double-dip recession.

Another possibility is that the second round of mortgage defaults will join the inflation in progress - resulting in recession with inflation similar to the “stagflation” of the late 1970’s and early 1980’s.

The least likely possibility is a recovery without inflation and without a double-dip recession. The probability of this rosy scenario is slightly higher than a snowball’s chance in Hell.

Links to Other Topics in the Special Report: Economic Stimulus

Tuesday, June 2, 2009

Economic Stimulus: Part 2 – How We Got Here

Recessions and depressions have triggers. They also have fundamentals. They are always the result of some excess. They are the practical, ironic, and perhaps divine response to academic arguments that markets are efficient and reflect in prices all known facts.

Some recessions are triggered by disasters – natural or man-made. Normal recessions are about reducing excess inventory. When one company cuts back production because its inventories are too high a few people temporarily lose some wages. When many companies cut back at the same time it’s called a recession.

Excess inventories build up because of excessive optimism by some critical mass of producers. When the critical mass cuts production their suppliers see reductions in demand and therefore instant excess inventories. Of course, they respond by cutting production as well.

The current recession is different. It’s not about excess inventory it’s about excess debt. It was triggered by rising interest rates resetting upward the monthly payments of certain classes of mortgages. Fundamentally, far too many people bought homes they could not afford, financed by mortgages with terms that were absurd under any conditions save one – that of continuously and forever raising real estate values.

We should have known we were in trouble when “house flipping” turned into prime-time television entertainment; when 5-year interest only balloon mortgages were resurrected from the their 1930’s graves.

But when mortgages were written allowing borrower’s to “name their own” monthly payment for the first five years while tacking the unpaid interest onto the principle – sirens should have sounded - whistles should have blown.

But no – for fifteen years the nation was “charging it.” Personal credit card debt doubled, tripled, and then quadrupled. Home mortgage debt did the same. Corporate debt, especially bank and finance company debt led the way with banks borrowing cheap from Uncle Sam, lending dear to the public, and raking in leveraged profits for as long as the party lasted.

And government? Government was the cheerleader encouraging and enabling every additional dollar of debt – while simultaneously running up government spending and just “charging it.”

Congress eliminated the wall of separation between commercial banks and investment banks. Congress encouraged writing mortgages to “sub-prime” borrowers. The Federal Reserve reduced bank capital requirements and kept interest rates too low for too long. The FDIC waived premium payments from the bank’s for their deposit insurance. The regulators of Fanny Mae and Freddie Mac stood aside as the two government-sponsored lending agencies purchased and created bundles of high risk loans and called them AAA securities. Congress then stood aside refusing to consider tighter regulation of Fanny and Freddie.

Government enabled and encouraged the conditions that led to the recession but government did not cause the recession. Excessive optimism about real estate values and excessive debt serviced by insufficient income caused this recession

Links to Other Topics in the Special Report: Economic Stimulus