Saturday, November 29, 2008
As pictures are 'worth a thousand words,' consider the graphic on the left which appeared in Prof. Taylor's piece.
It clearly displays that monthly disposable personal income did, in fact, rise due to the recent 'stimulus' checks, but spending did not.
As Taylor writes,
"The argument in favor of these temporary rebate payments was that they would increase consumption, stimulate aggregate demand, and thereby get the economy growing again. What were the results? The chart nearby reveals the answer.
The upper line shows disposable personal income through September. Disposable personal income is what households have left after paying taxes and receiving transfers from the government. The big blip is due to the rebate payments in May through July.
The lower line shows personal consumption expenditures by households. Observe that consumption shows no noticeable increase at the time of the rebate. Hence, by this simple measure, the rebate did little or nothing to stimulate consumption, overall aggregate demand, or the economy.
These results may seem surprising, but they are not. They correspond very closely to what basic economic theory tells us. According to the permanent-income theory of Milton Friedman, or the life-cycle theory of Franco Modigliani, temporary increases in income will not lead to significant increases in consumption. However, if increases are longer-term, as in the case of permanent tax cut, then consumption is increased, and by a significant amount."
Instead, Taylor recommends that any further economic 'aid' by the government meet three criteria:
"- Permanent. The most obvious lesson learned from the first stimulus is that temporary is not a principle to follow if you want to get the economy moving again. Rather than one- or two-year packages, we should be looking for permanent fiscal changes that turn the economy around in a lasting way.
- Pervasive. One argument in favor of "targeting" the first stimulus package was that, by focusing on people who might consume more, the impact would be larger. But the stimulus was ineffective with such targeting. Moreover, targeting implied that increased tax rates, as currently scheduled, will not be a drag on the economy as long as increased payments to the targeted groups are larger than the higher taxes paid by others. But increasing tax rates on businesses or on investments in the current weak economy would increase unemployment and further weaken the economy. Better to seek an across-the-board approach where both employers and employees benefit.
- Predictable. While timeliness is an admirable attribute, it is only one property of good fiscal policy. More important is that policy should be clear and understandable -- that is, predictable -- so that individuals and firms know what to expect."
When you consider the income, tax and spending expectations and plans of an average American household, it's easy to see why Taylor, and others, are right, while the current Congress and incoming President are wrong to have both pushed the first 'stimulus,' and be planning another $500B spending jolt to the economy.
If someone flies over your home and air-drops a $600 check, then departs over the horizon, you treat the money as a one-time gift. It is, in all likelihood, going to be factored into this year's income and affect spending as an additional percent increase in annual earnings. For a couple earning just $60,000 per year, that's only 1%. Hardly enough to make a big difference, before factoring in a 'marginal propensity to consume,' to use Keynesian lingo.
If, instead, you are told that, effective with this tax year, and henceforth, your tax rates will be lower at each income level by a known amount, you have been given a permanent increase in income. In effect, the government, rather than your employer, has given you a raise.
This results in a much different perspective on the government's economic action. With a permanent earnings increase, more spending is likely. Spending which will also be permanent, resulting in a comparable and permanent expansion in business investment and spending to provide supply for the added consumer demand.
Professor Taylor ends his piece by noting,
"Some who promoted the first stimulus package have reacted to its failure by saying that we must now switch to large increases in government spending to stimulate demand. But government spending does not address the causes of the weak economy, which has been pulled down by a housing slump, a financial crisis and a bout of high energy prices, and where expectations of future income and employment growth are low.
The theory that a short-run government spending stimulus will jump-start the economy is based on old-fashioned, largely static Keynesian theories. These approaches do not adequately account for the complex dynamics of a modern international economy, or for expectations of the future that are now built into decisions in virtually every market."
For example, forget the hoary old Keynesian argument that, because governments run deficits, government "pump-priming" will have a greater impact on the economy than the same amount of money in consumers' hands, because consumers have a higher propensity to save than does the government. In Keynes' day, this may have worked, by assuming fixed exchange rates. Not anymore.
In the modern economic environment, large-scale government borrowing will push rates up and currency values down. Maybe not right away in today's context of financial panic, but eventually, it will.
Additionally, government spending of this sort is of the explicitly programmatic, or 'one-off' variety. Not so a permanent cut in tax rates.
So when we hear new plans for an even larger economic 'stimulus' package by Congress and the newly-elected President, you know the end result will be lower-than-expected and/or later-than-expected consumer spending, accompanied by, in time, higher interest rates on the ballooning Federal deficit.
Why don't the new powers in Washington shelve the added governmental spending plans and simply provide real tax rate cuts across all income levels, for both businesses and consumers?
Friday, November 28, 2008
The article begins,
"As Detroit's auto makers seek a government bailout, the resilience of their foreign rivals could vault the South to the forefront of the U.S. car industry.
Foreign makers have been lured to South Carolina, Alabama and other Southern states over the past decade by generous tax benefits and laws that make it easier to build a largely nonunion work force.
Foreign-owned car makers are adjusting to the sales slump with assembly lines that can make multiple models and labor rules that allow faster downsizing.
That labor flexibility has emerged as a key advantage during the industry downturn, allowing foreign-owned plants to rapidly downshift in ways their unionized U.S. competitors cannot. Looser work rules are allowing German automaker BMW AG to lay off up to 733 employees at its Greer, S.C., plant by the end of the year. And Toyota Motor Corp said Wednesday it plans to let go at least 250 people at a Georgetown, Ky., factory in the first quarter of 2009.
Such moves would be largely out of reach for the Big Three U.S. auto makers, which have been saddled with stricter labor rules as vehicle sales have plummeted. Union rules often guaranteed jobs for workers along with generous benefits and wages that surpass those of most other U.S. manufacturing sectors.
The foreign manufacturers -- which are also reaping benefits of advanced production lines and a more popular lineup of models -- are positioned to grab market share from domestic competitors when demand revives. "If the American car companies died, this is what would replace them," said Laurie Harbour-Felax, an auto industry consultant.
Michigan and Ohio are still dominant centers of U.S. vehicle making, producing more than 38% of all cars and trucks in 2007, but Southern states are making gains as foreign car makers add more plants in that part of the country. Four Southern states were responsible for 24% of U.S. production last year, according to Automotive News, a trade publication.
Volkswagen AG, Toyota and Kia Motors Corp., which collectively will benefit from more than $1 billion in government incentives, are pushing through the downturn to complete new factories in Tennessee, Mississippi, and Georgia.
Foreign makers, which currently operate eight plants in the South, have the firm support of many Southern legislators and governors, who have spent much of the past week giving high-profile denunciations of a Detroit bailout. They argue that buttressing ailing U.S. car companies would create unfair competition to foreign makers that have brought thousands of jobs and billions of dollars in investments to the region.
"We shouldn't reward bad business practices made by competitors to the company that is about to employ 2,500 workers coming to my district," said U.S. Rep. Lynn A. Westmoreland (R, Ga.) in an interview. Rep. Westmoreland represents the area around West Point, Ga., where Kia of Korea is building a $1 billion plant set to open next year. At the same time, General Motors Corp. closed a plant in September in Doraville, Ga., that employed 1,000."
I think this is the missing picture of the US auto sector that many in America overlook. And it's fair to say Wagoner, Mulally and Nardelli would like them to continue to overlook this Southern state auto manufacturing success.
Of course, this success looks different than the Detroit failure. It's non-union. And it's owned by auto makers whose headquarters are in other countries. But these plants still employ American workers. And drive economic prosperity in American towns and states.
The nearby map from the article is fascinating. To me, it shows the completion of the original US worker migration up the middle of the country from the South, Kentucky and Tennessee to Chicago and Detroit in the 1940s for war production.
Now, US manufacturing is thriving in the states that gave up population in that initial, largescale northern war and post-war industrialization.
So, when Michigan Senator Debbie Stabenow contends that to lose the Detroit Three auto makers is to lose US manufacturing, this picture shows how totally wrong she is. Simply put, she's lying.
Further paragraphs in the article discuss the economic realities of these Southern car manufacturers. It's not all sweetness and light, but you don't hear the local and state governments complaining,
"And in Vance, Ala., Daimler AG's Mercedes-Benz factory slowed one of its assembly lines, cut back shifts and offered buyouts to its 4,000 workers. The cutbacks are the most severe for Alabama since the state began attracting foreign car makers, but "flexibility has allowed them to manage their operations in a way that will make them competitive in the long term," said Steve Sewell, executive vice president of the Economic Development Partnership of Alabama.
After a 12% drop in sales in October, Toyota this week said it would suspend assembly work at all North American plants for two days in December and trim output at plants in Indiana, California and Kentucky. Though it could delay the 2010 startup of its $1.3 billion plant in Blue Springs, Miss., which will build the Prius hybrid vehicle instead of the Highlander SUV it was originally meant to produce, "we are committed to the project," said Mike Goss, a spokesman. "The concrete is poured and the roof and walls are up and the equipment has been ordered." "
These US states- Alabama, Mississippi, Georgia, South Carolina, Tennessee- are among those with the lowest incomes, educational levels, and economic opportunities. It is simple Schumpeterian dynamics that US jobs and economic manufacturing activity should flow to those areas most able to compete, and most in need of the opportunities.
Moreover, the fact that these states can provide the necessary labor at lower costs suggests just how unnecessary much of the self-proclaimed value the UAW union workers actually provide a modern auto manufacturer.
It's an eye-opening article and graphic presentation of the shifting sands of US auto production. Even a few billion dollars of uncollectable loans aren't going to change the long term economics of this picture.
Detroit is finished as a viable long term future home of significant US auto production.
Wednesday, November 26, 2008
First it was Congressional Democrats and Presidential candidates all referring, with various riffs on the main theme, to 'failed economic policies' of the Bush years. And 'deregulation.'
Then, in the weeks since the election, there has been a sudden, mewling outpouring of sentiment that the newly-elected President 'will have a plan,' whereas the Bush administration's team have, to use words of a pundit I heard Monday morning,
'...been working weekends to contain financial market damage. You wonder what new event in financial markets will have occurred to greet you when you awake on any Monday morning.'
I think these criticisms, particularly the latter ones, widely miss the point of governmental action in the face of plummeting consumer or investor confidence and the early stages of a contagion among heretofore-untested linkages between abstruse financial instruments.
For example, I have had many discussions with experienced, educated friends, among whom is my business partner, regarding steps that 'should have' or 'could have' been taken as far back as August of 2007.
For example, my own perfect response, in retrospect, would have included:
-July, 2007: modify 'mark to market' valuation by executive order, in response to the two Bear Stearns' funds collapse due to failure to rollover debt of leveraged funds as the assets failed to find priceable markets.
-August, 2007: no Fed rate cuts, but an announcement of increased audits by all Federal oversight agencies with respect to mortgage loan paperwork, criteria, and loan performance status.
I contend that these two steps, and especially the first, would have avoided the worst of the vaporization of market-valued capital due to the senseless insistence that a lack of current market prices for held-to-term structured financial instruments, necessitated their near-total markdowns. This large-scale vaporization caused the hundreds of billions of dollars of bank asset writedowns, irrespective of the actual performance of the securities, which triggered the credit contraction and led to the ability of the CDS market to wreck AIG and the investment banks.
If these steps had not worked, I'd have preferred Treasury and the Fed to have begun an organized nationalization of the banking sector by early this year.
Most of my friends, however, believe such radical, early steps would have triggered even more panic and loss of confidence in financial markets. They contend that early, large-scale steps would have led to investors having a reaction something like,
'Oh my God! If Bernanke and Paulson are pulling out such radical, sector-shaping solutions NOW, this must be one of the worst financial/economic crises since the Great Depression!'
And, of course, amidst a Presidential election, the out-of-power party would have trumpeted precisely this message. Which it did, anyway, but with much less actual evidence.
As a result, it's clear that Bush, Paulson, Bernanke and Bair preferred to handle each new problem incrementally.
Once the lending functions has seized, as I discussed in this recent post,
"Since leverage, a function of debt, implies confidence in the future returns of loans placed with various enterprises, its unwinding corresponds to a loss of such confidence. The forced reduction in this leverage began, understandably, with the short-term borrowing instruments of both financial and non-financial instruments- commercial paper, most notably.
As this massive de-leveraging of fixed income instruments occurred, the simultaneous drop in real estate values and equity market values caused several consequences.
First, large-scale losses in US, and other nation's market, i.e., societal capital stocks, valued notionally, plunged. Those who previously owned the capital suffered large losses. In the US, the Treasury and Fed moved to support the Federally-registered banks via direct preferred equity purchases and, separately, takeovers of Fannie Mae, Freddie Mac and AIG."
Again, with each new institution's survival in doubt- Bear Stearns, Fannie, Freddie, AIG, Lehman, Merrill, WaMu, Wachovia, Citigroup- Bush's team moved to contain the damage a failure might create.
If, at any time, they had come forth with a stated list of criteria, upon which some action would be taken, you can be sure that large-scale investors, including hedge funds, would promptly take short positions in suspect firms, then drive the criteria over the trigger points, in order to reap their gains.
Anyone who fails to understand this, does not understand markets.
People who criticize Bush's team for 'having no plan,' fail to realize that, in financial markets, such a plan would only result in investors rushing to make the plan reality, while profiting on the downside from having done so.
Amity Schlaes and other researchers have noted that, without Hoover's tentative steps to lessen the damage from the financial market crash and resulting economic recession/depression in 1929-32, FDR could never have launched his massive, but ultimately failed socialistic agenda in 1932-38.
In that same sense, the newly-elected President's team has both an easy target at which to take shots, and a considerable base of effective actions on which to build, thanks to the Bush team's quick responses to each emerging shock in the financial markets during the past eighteen months.
I write 'effective,' because, as of the date of this post, we have avoided the actual rerun of the Great Crash and Depression.
Equity markets are not dead. Banks did not have a 'holiday.' An orderly liquidation of various weak institutions prevented an unchecked spread of loss of confidence in: money market funds, bank deposits, and commercial paper.
I'm quite sure, were the roles reversed, the incoming President would have acted with no more of a long-term plan to 'solve the crisis' than Bush has. Just like the current administration, you can bet that the newly-elected Democrat's team, too, would have acted step by step to minimize each new threat's effect on the nation's financial markets and banking system.
The fact is, unveiling an explicit plan, either last August, or now, to nationalize the banking system and provide a wholesale redesign of the US financial sector, while it is under threat of unraveling, is simply unrealistic.
Bush's team did a good job in an unforeseen, novel situation. And let's be clear, unless Hank Greenberg, Hank Paulson, John Thain or some other financial luminary is elected President, you can be sure that the sitting President is never the one dreaming up the solutions for our financial sector's ills.
This is one area where the President's role as CEO is paramount, in that s/he must wisely choose an effective, intelligent and experienced team of cabinet and other agency officials to advise her/him on what actions to take.
But don't think, for a second, that the incoming President has any more sense of what's going on in financial markets or the banking sector than does our current President, George Bush.
Berman's piece in yesterday's Journal is an unusual exception. Entitled, "One Cure for Financial Mistrust: Create New Banks," is one of the worst columns I've ever read. By anyone. Frankly, coming from Berman, I am shocked. Here are the salient portions of his article,
"The financial system is in tatters. It is time to build from scratch.
One provocative, and perhaps inevitable, path is for the government to directly fund the formation of new banks. It could give incentives to private investors to form banks free from the taint of the old economic order.
The benefits of new banks are immediate. They could begin lending at once, freed from the worries of coming write-offs and off-balance-sheet shenanigans that have paralyzed Citigroup and others. They also would represent a psychological turning point, separating the future from our current period of panic. It is the kind of step that seems custom-made for President-elect Obama.
"What we need are new bankers, not new banks," says economic historian Richard Sylla of New York University.
It would, of course, be impossible to instantly duplicate the deposit base and infrastructure of large banks such as Citi or Bank of America. A new bank -- let's call it Hamilton Bank -- could take as long as a year to get off the ground, say bankers.
And there would be plenty of room for Andrew Jackson-style worry about new institutions, especially leverage ratios and management. Perhaps the best path would be to start with two or three government grubstakes of $10 billion, with the hope that private investors would push the capital base to $50 billion each. Leveraging that at a conservative ratio of six or seven times would form a group of solid medium-size banks for attracting deposits. The next step would be to provide incentives to private investors -- with, say, dollar-for-dollar matching sums or tax credits -- to start their own institutions.
Strict deadlines would be necessary to get the banks started quickly. And much like its recent preferred-stock investments, the government would sell its bank stakes over time, eventually returning the banks to private hands."
There are, in my opinion, several serious errors of fact, analysis and judgment in Berman's piece.
Let's begin with the simplest one. It's not at all difficult to start a commercial bank. The sheer number of small and medium-sized banks currently existing, and the large number of financial service consulting and software firms is all the evidence you need to understand this point.
Perhaps the most time-consuming task in beginning a bank from scratch is common to all retail businesses; choosing a site, building the structure, hiring and training employees. Everything else can basically be outsourced and bought turnkey or off the shelf- software, hardware, furnishings, etc. This alone tells you our problem is too many undifferentiated, badly-run banks, not too few.
As for new banks being free of old, bad loans and other purchased toxic waste, new banks are far from necessary to achieve this end. Treasury just used the TARP on Monday to do this for Citigroup, backstopping $306B of asset value. Whether it is formally spun into a separate entity now, or not, hardly matters. What does matter is that the Federal government, as the representative of our entire society, has begun to take possession of hundreds of billions of dollars of questionable assets, the better to free the inept banks which ended up with these assets to continue business without the burdens of their prior, enormous mistakes.
But the most important reason why Berman's idea is flawed involves management. Look at the collapse of Wachovia, Washington Mutual, and Citigroup. These were highly-regarded, large, seemingly-unassailable commercial banks.
If asset concentrations of such size were, in fact, susceptible to inept (mis)management and poor leadership, where are we to magically find new, green executives now suddenly capable of doing a better job? And with taxpayer money, to boot?
If anything, you should worry that Berman's new, small banks will run into massive trouble as the senior executives hurry to grow their new institutions as quickly as possible. This is precisely what led to our current troubles.
Instead, we need, if anything, to simplify the existing banking structures, without government backing, or encourage further concentration of them, with explicit governmental ownership, heavier regulation, and effective conversion of them to financial utilities.
In neither case does Berman's vision of pristine, newly-minted banks run by mystery CEOs with sterling credentials, experience and qualifications, fit the needs of an effective future US banking system.
Tuesday, November 25, 2008
Citigroup has declined by about 70%, while the S&P has lost a relatively modest, by comparison, 40% over the past twelve months.
Further, as taxpayers, we've agreed to absorb the losses, beyond $29B, on some $306B of the bank's questionably-valued assets.
With this action, which is very similar in effect to Paulson's original plan of buying troubled assets with the TARP, Citigroup has been rewarded for its inept and inappropriate lending, buying and securitization behavior of the past few years under ex-CEO Chuck Prince.
The moral hazard risk has been completely removed with this act, in an attempt to prevent worries that the bank's equity would become of such little market value as to leave the bank in violation of various regulatory capital requirements and, of course, subject to further speculation, both verbal and financial, that it would shortly be bankrupt.
Then, this morning, Henry Paulson also announced the TALP for government purchase of shorter termed assets for which markets are currently 'frozen,' including car and student loans.
Back in October, I wrote this post regarding the past and probably nationalized future of US banking.
In that post, I contended, in part,
"Simply put, you cannot have a system dependent upon an illusive, nearly non-existent resource: the well-informed, experienced, competent bank CEO. There simply are not sufficient, qualified business people available to staff each of hundreds of US banks. So allowing that many banks to exist is to invite the next financial panic, courtesy of thousands of bad credit and investment decisions on the part of hundreds of inept, boneheaded, mediocre small- and medium-sized bank CEOs.
Far better to so rigorously nationalize core banking via draconian regulation of allowable businesses, lending standards, etc., and government ownership of preferred shares, as to reduce this sector to a barely-disguised government-guaranteed conduit for safekeeping savings and making consumer mortgage and revolver loans.
Further, each of the classical Glass-Steagall era bank functions can be largely reduced to automated, pre-determined, quantitative standards with little or no room for subjective judgment.
To achieve a truly safe, well-regulated US core banking system, I believe you need the following (there are more, I've just included one for this post):
-Federal government guarantee of all core banking businesses, i.e., deposits, credit card balances, mortgage balances, trust accounts. In short, by forcible, draconian regulation of lending and deposit-investment practices, the government will be able to insure all banking activity, because it will all be reduced to ultra-safe, near-riskless levels.
That's a financial sector in which you could place trust. Core banking functions would be safe, heavily-regulated and totally guaranteed by society, i.e., our government. Riskier financial functions would be totally firewalled from core banking and well-capitalized. Trading of financial instruments would be safely confined to exchanges."
And that is nearly where we are. The strict confinement of trading important, widespread instruments, such as mortgages, mortgage securities and CDSs still require exchanges. But, other than that, Paulson, Bernanke and Bair have pretty much arrived at my prediction in just a month.
Will these steps be eventually retracted by the next administration, or a subsequent one?
I doubt it. Like a new stake in a garden supporting plant growth, new financial services structures will develop around these programs, necessitating their continuing existence.
Whether we ever formally identify these steps as nationalization of the US banking sector, it's what we've done. And, as I argued in that linked post, and others, probably a good thing.
Monday, November 24, 2008
Without trying to recount all the detail in the very long and well-written story, suffice to say that it has now been shown that Morgan Stanley's equity price was, indeed, affected by a sort of squeeze created by hedge funds and other investment banks buying credit default swaps, CDSs, on Morgan Stanley debt, along with shorting or buying puts on the firm's equity.
This activity pre-dated the TARP, and Treasury investments. However, Santelli noted the parallel of Morgan Stanley's troubles with those of Citigroup's recent problems, and wondered aloud how much taxpayer money was engaged in far-from-transparent speculation and similar squeezes on Citigroup's shares.
Upon being challenged by Squawkbox's Joe Kernen for suddenly being for more regulation, Santelli sensibly replied, to paraphase him (since I can't recall his exact words),
'Free and fair market capitalism doesn't mean no regulation. You need some regulation to keep things fair, and avoid insider and crony capitalism. We read today about the goings-on regarding Morgan Stanley's CDSs and equity in September. How about some transparency for today's activity in Citgroup instruments?'
As I wrote here last Thursday, in reference to AIG's troubles, the swaps market needs to become far more transparent, via a regulated, explicit exchange. Santelli raises an equally-valid reason for such an exchange.
As tools for squeezing and manipulating markets have multiplied, the old regulatory model of the 1930s is hopelessly, laughably outdated. The Journal piece indicated how a small purchase of CDSs to drive their prices up would yield outsized gains on short positions or puts of the same company's equity. Yet the former markets is completely opaque, consisting of phone calls and even IMs as its method of operating.
Santelli's concluding point was that, with taxpayer money in practically every large, remaining commercial bank, we can no longer risk having these institutions use 'our' money to engage in the activities which nearly triggered Morgan Stanley's demise and, certainly, forced its conversion to a Federally chartered commercial bank.
Sunday, November 23, 2008
'Will the market sell off today?'
'Will we see a rebound today?'
'Will the market test new lows today, then rebound?'
You get the idea.
Is it me, or is this not just about the most asinine, improper and irresponsible behavior in which CNBC could engage?
Now, more than ever, most retail investors should be on the sidelines, or simply hunkered down with their current portfolio allocations. The last thing they should be doing is looking for advice on how to time daily market moves.
Of course, since most retail investors can't watch CNBC all morning/afternoon, this 'advice' is probably wasted on them. Thank God.
As for institutional investors, who might actually watch and trade, you and I had better hope they don't constitute a roaming herd of buyers or sellers, hanging on every word of some other portfolio manager talking his book on CNBC. Or some pundit giving his opinion on the random intra-day and closing market performance for the day.
Further evidence of how much CNBC engages in pure entertainment programming, to the exclusion of responsible business and financial market analysis.