Coyote Blog

I'm thinking of the three major consumer purchases that are probably at the base of the hierarchy of needs:  Fuel, food, and shelter.  Its interesting how very different the media and public perception is of price changes in these areas.

The reaction to fuel price increases is easy to predict - they are always portrayed as bad.  Rising prices hurt everyone, producers are evil, and speculators who make bets on rising prices are even more evil.

The reaction to rising food prices is more mixed.  That's because we have come to the collective decision that producers of food are sympathetic figures whereas producers of oil are unsympathetic.  So media laments about rising food prices are often tempered by good news stories about rising farm profitability.

And then there is shelter.  For this category of consumer expenditure, everything is flipped on its head.  Rising prices are good, and falling prices are bad.  One might argue that housing is different, because consumers often take an equity position in shelter that they do not take in food or fuel.  But all this means is that home buyers are speculating on the price of shelter, going long on bets that prices will rise.  They could easily just rent, and pay for their shelter month-to-month like they pay for their food or fuel, but many consumers bet on rising rents and shelter prices by buying shelter futures (ie purchasing a home).  In a real sense, home buyers are all speculators (using margin accounts at that!), but this is one case where we encourage speculation, and even have tax subsidies for it.

If the reader finds this a funny way to think of home ownership, here is a thought experiment.  Let's say at the age of 30 I wanted to take an equity stake in my current and future fuel needs.  I take out a loan to buy enough Exxon stock such that the annual dividends will cover my fuel purchases for the year.  If fuel prices go up, the dividends likely go up as well, so I am sheltered from the vicissitudes of worrying about my monthly fuel bill, and all I have to do is pay off a regular and predictable mortgage on my Exxon stock.  In 30 years, when the note is paid off, likely I have a big capital gain in my Exxon stock, which I could cash in at retirement if I want to downsize to less driving and fuel use.  Or I can pass it on to my kids.

The only difference I can come up with, economically, between this example and how we do housing is that in my example, consumer capital is invested in productive enterprises rather than dead real estate.

LOL, via Phil Miller:

Please join me in support for poor, beleaguered gas station owners, the victims of unconscionable price gouging by ruthless consumers who are taking advantage of market conditions to reduce their demand for gasoline,  riving down the price by nearly $2 per gallon over the last four months. Fortunately, governments are swinging into action. Georgia governor Sonny Perdue issued this statement:

"The financial crisis has disrupted the consumption of gasoline, which will have an effect on prices. However, we expect the prices that Georgian gasoline station owners receive at the pump to be in line with changes in consumers' incomes and the prices of substitutes and complements. We will not tolerate consumers taking advantage of Georgian business owners during a time of emergency."

As usual, Michael Lewis is a great and informative read, trying to unravel the whole subprime mortgage / CDS / CDO bundle somewhat for laymen.  The article does not excerpt well, but I would summarize it in saying he identified four mistakes by the financial world.  The first two I would describe as real problems but not really new mistakes -- something similar could have been said about S&L's in the 1980's.  These are:

1. A lot of subprime loans were issued to people with no freaking hope of repaying them, in an incredible general lowering of underwriting standards.  (we all should remember, though, the government and the media was trumpeting this as good news -- increase in home ownership rates, blah blah blah).
2. People who bought these securities grossly underestimated the default risks, particularly in the crappiest tranches  (securitized packages of loans are resold in tiers, with a AAA tranche getting first call on any payouts, and the tail end BBB tier getting high interest rates but who takes the first principal losses if the loans default).

   But Lewis highlights two mistakes that are in some sense brand new.  These mistakes were effectively vast increases in leverage that acted as a multiplier for the subprime problem, while simultaneously spreading the problem into the hands of AAA investors who accepted the higher returns without paying too much attention to how they were obtained

3. Someone started scooping up the BBB tranches from various securities packages, bundled these together, and somehow got a ratings agency to declare that the top 60% tranche of these repackaged dog turds were AAA. 
4. Credit default swaps, originally insurance policies on loan portfolios, turned into a sort of futures market on subprime mortgage packages.  But, unlike futures markets, say in oil, where the futures trading volume are generally well under the total volumes of the underlying commodity flowing around the world, CDS values grew to as much as 100x the underlying commodity volume (in this case subprime mortgage securities).  CDS's went from a risk-management tool to a naked side-bet.

This is interesting stuff, and it was really only reading this piece that I think I started to understand #4 above (though if readers think I am describing this wrong, let me know).  All of this leads me to a few thoughts:

• Nothing about this convinces me any of these firms need to be saved or bailed out.  Let them die.  Maybe the guys who rebuild the industry in their place will be smarter and more careful.  The country is going to face a recession whether Wall Street is bailed out or not -- too much (paper) value disappeared from consumer's net worths (or their perceptions of their net worth) for that not to be the case.  I lived through Texas in the 1980s when the S&L industry went bust almost to the last institution.   Nearly every one of the top 10 banks in the state went into FDIC recievership. 
• I have seen people observe that this is an indictment of capitalism because so many people made such bad mistakes.  Sure.  No one said capitalism is a gaurantee against stupidity, or even fraud.  The difference is that the consequences of said stupidity and fraud have to be less in a free market system than if the same people had the power of cersion via government.  In a free market, these guys will fail and be wiped out and get washed away.  The people who they drag down may consider themselves to be innocent, but they participated of their own free will -- if they did not understand what they were doing, that is their problem.  In a statist system, you still have mistakes like this, but they are infinitely more catastrophic, as the stakes in play are often higher.  And the people who made the mistakes are never punished financially, because they are in charge of the machinery of state  (or friends of those in charge).  They make damn sure the power of the state is used to make everyone else pay for their mistake, kind of like ... this $700 billion bailout.
• Lewis seems to have a hypothesis that the main system change that allowed all this to happen was the shift in ownership structure from partnerships to publicly-held corporations.  And certainly you do get some added agency risks with this, though I find this explanation a bit shallow.  I do think that folks with money are going to approach Wall Street "experts" and rating agencies with a lot more skepticism for a long time, and that can't be a bad thing.
• The opportunity really exists for someone smart to start a brand new rating agency from scratch.  The only reason the current ones won't get wept away is simply that there are not many alternatives right now.  Warren Buffett should partner with someone well-connected with the new administration (Maybe Larry Summers, since there is no way he will survive a confirmation hearing with his men-are-from-large-standard-deviations-women-are-from-narrow-distributions baggage.)
• Lewis is unfair in depicting all the mortgage lenders as predatory.  I am sure some were cheats, but remember that as far as Congress, the Administration, the Federal Government, and the media were concerned, these lenders making subprime loans were doing God's work -- they were expanding home ownership and bringing the dream of owning a home to poor people historically redlined, blah blah blah.  It is only with hindsight that we demonize them for doing the wrong thing -- at the time, absolutely everyone on in the country was pushing them to do exactly what they did.  This is also why Democrats struggle to suggest a resposive regulatory package to this whole mess, as any real reform would have to address minimum underwriting standards, which in turn would have the direct effect of limiting lending to the poor, an outcome with which no Democrat wants to be associated.

Update:  Just to be clear, as I have said before, this is about half of what happened.  There are really two stories, and usually authors focus on one or the other.  Story 1 is the steps taken by the Federal Government  (Fannie, Freddie, Community Reinvestment Act, mortgage interest deduction, low interest rates) that fueled the housing bubble and the expansion of credit to questionable borrowers.  It is described here, among other places.  Story 2 is the one above, how private firms decided not only to purchase these questionable loans made on bubble-inflated assets, but to leverage these assets up to staggering levels. 

Don Boudreax shares this leftish view of the auto bailout from Pat Garofalo:

More importantly though - as Pelosi and Reid said - "federal aid should come with 'strong conditions,' such as requirements that car makers build more fuel-efficient vehicles." Bill Scher at OurFuture writes, "With the auto industry in dire straits, we taxpayers have maximum leverage to demand the cars necessary to help lower energy costs, cut carbon emissions and reduce our dependency on foreign oil."

So, uh, only when the government gets involved do consumers have any leverage with producers in terms of what products they produce?  Hello?  I'm sure Circuit City execs will be relieved to hear this.

In free markets, consumers have all the leverage in determining perhaps not what gets produced, but at least what gets sold in any marketplace.  Producers who are unable to match what they produce to what consumers buy eventually go bankrupt.  In fact, it is this process of consumers exercising their leverage with GM that Congress is attempting to interrupt with a bailout. Consumers are telling GM loud and clear that GM is not making the cars at the price points they want.  Unable to do so, GM will likely fail.  This failure will result either in 1) GM, under bankruptcy protection, shedding any number of constraints that are preventing it from making what the consumers want or 2) GM liquidating its production assets to other owner/management groups who can do a better job with them.

This quote is a great example of the technocratic bent many leading Democrats bring to economics.  What these guys are asking for is not leverage for consumers, but leverage for a few Democratic technocrats to makeover the auto industry the way they want it.  People like Nancy Pelosi who would never in a million years be given the keys to a manufacturing corporation by a sane ownership group can effectively grab that jobs via the leverage her seat in Congress gives her.

Postscript: Garofalo adds:

and if you think about the ripple effects, they are the backbone of our manufacturing economy." Indeed, according to estimates, one in 12 U.S. jobs is tied to car manufacturing, and a bailout of the industry could help boost the U.S.'s ailing manufacturing sector.

A couple of points.  First, a GM bankruptcy is hugely, enormously unlikely to mean the whole company is just shut down.  If you have flown in the last 10 years, unless you have favored only Southwest Airlines, you probably have traveled on a carrier in chapter 11.  That's what chapter 11 is - a breathing space while the company continues to operate but is able to restructure its liabilities.  Personally, I would love to see the company go chapter 7 and have a new wave of innovative people take over the assets and see what they could do with them.  But it is not going to happen.  GM may shed jobs over the next year, but they are going to do so anyway in the teeth of a recession, not because they went bankrupt.

Podesta must know that the issue in a bankruptcy will not be jobs, but labor contracts  (airlines have practically patented the chapter 11 vehicle for renegotiating union contracts).  Most GM manufacturing employees would probably keep their jobs through a bankruptcy, but they may well lose their contract that says they get paid $75.86 an hour with 34.5 days a year of paid leave.  Garofalo and Podesta are shilling for the union over wage bargaining, not jobs.

The other observation I want to make is to ask why the loss of these 250,000 jobs is going to be so much worse than the loss of 500,000 jobs over the last several years.

I know parts of Michigan suffered, but Podesta is claiming knock-on effects for the whole country.  So where were they?

A while back, when I discussed the stagnating wage myth, I observed that folks spreading this meme were careful to show figures only for cash wages, and not for total compensation.  In the period from 2000-2006, which is the typical period critics focus on (in part because it implies blame on the Bush administration, and in part because it lets them measure economic peak to trough) there has been a substantial shift in compensation mix from cash to non-cash benefits, including health care and paid time off.  Ignoring these components is particularly disingenuous given that many of these same critics have been long-time supporters of more paid time off and better company-funded health care.

As an example, this data (courtesy of Mark Perry) on the Big 3 automakers contracts is telling.  In 2000 (table page 3) it shows cash wages per hour worked at $22.71 and total comp at $43.57.  In 2006, the most recent year of data, it shows cash wages per hour worked at $29.15 and total comp at $75.86.  So, while cash wages per hour have increased about 4.25% compounded each year, total compensation has increased more than twice as fast, at 9.7% a year.  That latter increase is due both to a rapid rise in health care expenditures for employees as well as an increase in paid day off to 34.5 a year.  (by the way, if you are wondering why the UAW is fighting so hard for a government bailout, look no further than jobs with $75.86 an hour total comp. and seven weeks a year of paid days off.)

I worked for several years for AlliedSignal engines, now Honeywell, here in Phoenix.  At our main engine plant here, we endured a couple of union organizing campaigns that both fell just shy of winning a position for the union.  A reasonable manager might expect that under the Democrat's proposed card-check system which replaces anonymous votes with open petitions, that enough hijinx could be brought to bear to put the union over the top.  I don't now if this is what they have in mind, but...

Phoenix-based Honeywell Aerospace plans to move 700 manufacturing jobs from Phoenix to Mexico and the Czech Republic.

Employees were notified Thursday of the cuts, which will begin in the second quarter of 2009 and continue for three years. Most of the job cuts are expected in the first year.

Workers who asked not to be identified said the news caught employees completely off-guard.

I think the timing just a day after election results in, and the level of surprise, are telling.  Time to get this done now, before the owners have to go cap in hand to their employees to ask permission to run their business as they see fit.  I thought this last bit they added brings a nice irony to the situation:

The announcement came two days after Barack Obama, who has promised to take a hard line with companies that move manufacturing jobs overseas, was elected the 44th U.S. president.

Whatever that means, but it does give yet another reason to get out fast.

Yesterday I posted on the irony that in the name of "change" and "dynamism," the Democrats are pushing for what basically is an inherently more conservative (little-c), less dynamic economic system that mirrors that of many continental European countries.

Daniel, an American reader who does quite a bit of work in Europe, wrote me:

1) The static nature of the Euro mentality assigns a high cost to ... people ... who try to break the mold. Cost of failure is relatively high. In Italy if your small business declares bankruptcy, you forfeit the right to vote.

2) In Germany, workers are sorted at an early age into "blue collar schools" and "professional schools". I know from my youth, if I had grown up in Germany instead of America, I probably would not be a consultant but more like a janitor (not that there is anything wrong with janitors...).

3) Social services in Europe are hit and miss. In Germany, many people carry private insurance despite the availability of public insurance because of the lack of quality.

4) (this may be a good thing) Italian school children go through a less harsh puberty than American kids. Society has drilled into them that it's not cool to be different, so there are less cliques. When I share my experiences in school with most Europeans they usually make some snide remark about how growing up in a battle zone (primary school) has caused the Iraq war.

5) Highly skilled workers are in many cases no better paid than unskilled staff. In the south of Italy a senior programmer may make 2K euros per month. A secretary might make 1.5K a month. If it weren't for most Europeans fear of moving to new cities, there would be no programmers to hire.

6) Speaking of being afraid to move, many Europeans find the thought of moving to a different city complete alien concept.

7) Life in Euro is a much more comfortable than in America *if* you are European. If you are an immigrant, forget it. After two years of pitching companies in the South of Italy, I have never seen a black person be more than a street side vendor of trinkets. In Italy, there is an unsaid rule that you must be an Italian to ever be a professional.

8) Don't get me started on France.

9) It is illegal for a business to stay open more than it's quota in most European countries. It is illegal to operate a barber shop on Mondays.

A lot of folks, particularly on the left, look with some fondness at the political economy of continental Europe.  They are attracted by high job security, short work weeks, long vacations, and a strong welfare system.  They make the mistake of seeing in these traits a more promising society "for the little guy," when in fact just the opposite is true.

The European Corporate State

The political economy of companies like Germany and France are actually incredibly elitist, dominated by perhaps a hundred guys (and I do mean guys) who run the country in a model only a few steps removed from Mussolini-style fascism or the Roosevelt's National Industrial Recovery Act.   In these countries, perhaps 20 corporations, ten or fifteen large unions, and a group of powerful politicians and regulators run the economy.

US workers sometimes make the mistake of seeing the political power of European unions and equating this power with being a more egalitarian environment for workers.  But the European political economy is rule by the in-crowd over the out-crowd that exceeds any of the patronage relationships we complain about in this country.  What we don't often see from our American perspective is the way the system is structured not to protect poor from the rich or the weak from the strong, but to protect incumbents (whether they be corporations or skilled workers) from competition.

In the European labor markets, mobility is almost impossible.  The union system is built to protect current high-skilled workers from competition from new workers, whether in the same country of from abroad.  Large corporations that form part of the cozy governance of the country are protected from new competition, and are bailed out by the government when they hit the rocks.

As a result, unemployment is structurally high in countries like France and Germany, hovering for decades between 8 and 12% -- levels we would freak out at here.  Young and/or unskilled workers have a nearly impossible time breaking into the labor market, with entry to better jobs gated through apprenticeships and certifications that are kept intentionally scarce.  Joe the plumber is an impossibility in Europe.  Some Americans seem to secretly love the prospect of not easily being fired from their job, but they always ignore the flip side -- it is equally hard to ever be promoted, because that incompetent guy above you can't be fired either.

Entrepreneurship in Europe is almost impossible -- the barriers just to  organizing your own corporation legally are enormous.  And, once organized, you will quickly find that you need a myriad of certifications and permissions to operate in your chosen field -- permissions like as not that are gated and controlled by the very people you wish to compete with.  The entire political economy is arrayed in a patronage system to protect current businesses with their current workers.

Here is a test, that works most places in the US except possibly in Manhattan.  Ask yourself who are the wealthiest and/or most succesful people that you know.  Then think about where they went to school.  Sure, some of the more famous Fortune 25 CEOs went to name schools, but what about the majority of succesful people you meet in your life?  If you are like me, most of them did not go to Ivy League or what one might call elite schools.  They had normal state college educations.  You will typically find a very different picture in Europe.  While of course there are exceptions, it is much more likely that the wealthy people one meets were channeled through a defined set of elite schools.

Corporations in Europe, particularly the cozy few who wield influence with the government, seldom fail and/or really gain or lose much market share.  I always thought this a telling statistic:  (Fortune 100 by year here)

[Olaf Gersemann] points out that of the top 20 largest publicly traded companies in the US in 1967, only 11 are even in the top 60 today, much less the top 20.  In contrast, he points out that of the 20 largest German companies in 1967, today, thirty-five years and nearly two generations later, 19 are still in the top 60 and 15 are still in the top 20.

Its also an inherently anti-consumer society.  The restrictions on foreign trade, entrepreneurship, and new competition all reduce consumer choice and substantially increase prices.  EU anti-trust enforcement, for example, barely pretends any more to look out for consumer interests.  Most of the regulators decisions are better explained by protection of entrenched and politically influential European competitors than it is by consumer power or choice.

"Progressives" in this country often laud the lower income inequality numbers in Europe vs. the United States.  The implication is that the poor in Europe are somehow better off.  But in fact this is not true.  Careful studies have shown that the poor are at least as well off in the US as in Europe, particularly when one corrects for the number of new immigrants in the US.  (That's another difference, by the way -- Europe is virtually closed to immigration, at least as far seeking new integrated citizens is concerned).  What drives income inequality is that our middle class is richer than Europe's middle class, and our wealthy have more income than Europe's wealthy.

To this last point, I have always felt that comparisons of the wealthy in the US to those in Europe, and comparison of income inequality numbers, are a bit apples and oranges.  The US is a country where access to most of the best perks is via money - they have a price.  In Europe, access to most of the best perks can't be bought by money, they can only be accessed by those with the elite establishment club card.   To some extent, the income numbers understate the difference between rich and poor in Europe for this reason.

Next Stop:  America

We see many of the elements of the European economic system slipping into the US today.  An increasing number of professions require certification by the government, with this certification often either controlled by the incumbents in the profession or with criteria that essentially require new entrants to compete in the same way incumbents do.  We see the top companies with political influence, from Wall Street firms to banks to automobile manufacturers getting government assistance to stay in business or maintain their status.  This, from the proposed GM bailout, is the European system personified:

General Motors and Cerberus Capital Management have asked the U.S. government for roughly $10 billion in an unprecedented rescue package to support a merger between GM and Chrysler, two sources with direct knowledge of the talks said on Monday....

one of the conditions of the merger would be that GM-Chrysler would spare as many jobs as possible in order to win broad political support for the government funding needed to complete the deal, people familiar with the merger discussions said.

This is the same political deal cut in Europe.  Large powerful company is protected from failure by government.  In turn, powerful company protects interest of powerful union.  The only thing missing here, which I think is clearly on the agenda for the Obama administration, is a large protective tariff to shield this inefficient mess from competition.  Left out of the equation are consumers, who get more expensive cars and suffer because GM is again given a hall pass from producing cars that people actually want to buy.  Also left out are potential competitors, who don't get the government deal and who miss out on the chance to buy up GM assets and hire ex-GM employees out of bankruptcy and do a better job with them.  This European system puts a premium on keeping productive assets in their current hands, rather than in the most productive hands:

Corporate DNA acts as a value multiplier.  The best corporate DNA has a multiplier greater than one, meaning that it increases the value of the people and physical assets in the corporation.  When I was at a company called Emerson Electric (an industrial conglomerate, not the consumer electronics guys) they were famous in the business world for having a corporate DNA that added value to certain types of industrial companies through cost reduction and intelligent investment.  Emerson's management, though, was always aware of the limits of their DNA, and paid careful attention to where their DNA would have a multiplier effect and where it would not.  Every company that has ever grown rapidly has had a DNA that provided a multiplier greater than one... for a while.

But things change.  Sometimes that change is slow, like a creeping climate change, or sometimes it is rapid, like the dinosaur-killing comet.  DNA that was robust no longer matches what the market needs, or some other entity with better DNA comes along and out-competes you.  When this happens, when a corporation becomes senescent, when its DNA is out of date, then its multiplier slips below one.  The corporation is killing the value of its assets.  Smart people are made stupid by a bad organization and systems and culture.  In the case of GM, hordes of brilliant engineers teamed with highly-skilled production workers and modern robotic manufacturing plants are turning out cars no one wants, at prices no one wants to pay.

Changing your DNA is tough.  It is sometimes possible, with the right managers and a crisis mentality, to evolve DNA over a period of 20-30 years.  One could argue that GE did this, avoiding becoming an old-industry dinosaur.  GM has had a 30 year window (dating from the mid-seventies oil price rise and influx of imported cars) to make a change, and it has not been enough.  GM's DNA was programmed to make big, ugly (IMO) cars, and that is what it has continued to do.  If its leaders were not able or willing to change its DNA over the last 30 years, no one, no matter how brilliant, is going to do it in the next 2-3.

So what if GM dies?  Letting the GM's of the world die is one of the best possible things we can do for our economy and the wealth of our nation.  Assuming GM's DNA has a less than one multiplier, then releasing GM's assets from GM's control actually increases value.  Talented engineers, after some admittedly painful personal dislocation, find jobs designing things people want and value.  Their output has more value, which in the long run helps everyone, including themselves.

The alternative to not letting GM die is, well, Europe (and Japan).  A LOT of Europe's productive assets are locked up in a few very large corporations with close ties to the state which are not allowed to fail, which are subsidized, protected from competition, etc.  In conjunction with European laws that limit labor mobility, protecting corporate dinosaurs has locked all of Europe's most productive human and physical assets into organizations with DNA multipliers less than one.

Beyond the actual legislation, the other sign that the European model may be coming to the US is in attitudes.  I think Michelle Obama is a great example of this.  She and her husband checked all the elite boxes - Princeton undergrad, Harvard Law - but she is shocked that having punched her ticket into elite society, society didn't automatically deliver, as it might in, say, France.  She's actually stunned that, had it not been for Barack's succesful books, they might have had to give up their jobs as community organizers and at non-profits to actually earn enough to pay back their 6-figure school loans.

Despite their Ivy League pedigrees and good salaries, Michelle Obama often says the fact that she and her husband are out of debt is due to sheer luck, because they could not have predicted that his two books would become bestsellers. "It was like, 'Let's put all our money on red!' " she told a crowd at Ohio State University on Friday. "It wasn't a financial plan! We were lucky! And it shouldn't have been based on luck, because we worked hard."**

The Progressive Irony

In all this, I think there is an amazing irony.  In a nutshell its this:  The "Change" that Barack Obama is selling to the electorate is in fact the creation of a government infrastructure to fight change.  I have written before that progressives are actually inherently conservative.

Ironically, though progressives want to posture as being "dynamic", the fact is that capitalism is in fact too dynamic for them.  Industries rise and fall, jobs are won and lost, recessions give way to booms.  Progressives want comfort and certainty.  They want to lock things down the way they are. They want to know that such and such job will be there tomorrow and next decade, and will always pay at least X amount.  That is why, in the end, progressives are all statists, because, to paraphrase Hayek, only a government with totalitarian powers can bring the order and certainty and control of individual decision-making that they crave....

One morning, a rice farmer in southeast Asia might faces a choice.  He can continue a life of brutal, back-breaking labor from dawn to dusk for what is essentially subsistence earnings.  He can continue to see alarge number of his children die young from malnutrition and disease.  He can continue a lifestyle so static, so devoid of opportunity for advancement, that it is nearly identical to the life led by his ancestors in the same spot a thousand years ago.

Or, he can go to the local Nike factory, work long hours (but certainly no longer than he worked in the field) for low pay (but certainly more than he was making subsistence farming) and take a shot at changing his life.  And you know what, many men (and women) in his position choose the Nike factory.  And progressives hate this.  They distrust this choice.  They distrust the change.  And, at its heart, that is what the opposition to globalization is all about - a deep seated conservatism that distrusts the decision-making of individuals and fears change, change that ironically might finally pull people out of untold generations of utter poverty.

Don't believe me?  Below is from an email I received.  The writer was outraged that I would have the temerity to say that the middle class in the US had it better than even the very rich in the 19th century.

Sure, the average rural resident of a developing country earns more in dollars today than before. But you're missing the big picture. Wealth is about so much more than just money, and status symbols. It is about health, and well being, and contentedness, and happiness. The average peasant family in India in 1900 may have lived a spartan lifestyle by today's standards, but it probably could rely on more land per family, crops uncontaminated by modern pesticides and fertilizers, a stronger social network and village-based safety net. These peasants were self-sufficient. That is no longer the case

Progressives want to eliminate risk and lock in the current world.  New technologies, new competitors, new business models all need to be carefully screened and gated by a government-labor-corporate elite.  Entrepreneurship, risk, mobility, achievement all should be sacrificed to a defined and steady paycheck. In the name of dynamism, progressives, as well as many modern politicians, want to limit the dynamism of the American economy.  In the name of egalitarianism, they wish to create a small political elite with immense power to manage everyone's life.  In the name of progress, they wish to lock current patterns and incumbents in place.

** Postscript: By the way, here is how I responded to Michelle Obama's education debt rant

I don't know why I can't just move along from Michelle Obama's rant about the terrible cost of her Princeton / Harvard Law degree.  Maybe its because I attended the same schools (different degrees) and my reaction is just so different -- I had a fabulous experience and live in awe that I had such a unique chance to attend these schools, while Michelle Obama seems to experience nothing but misery and resentment.  Granted that I did not have to take on a ton of debt to get these degrees, but I have plenty of friends (and a wife) that did.

This analogy comes to mind:  Let's say Fred needs to buy a piece of earth-moving equipment.  He has the choice of the $20,000 front-end loader that is more than sufficient to most every day tasks, or the $200,000 behemoth, which might be useful if one were opening a strip mine or building a new Panama Canal but is an overkill for many applications.  Fred may lust after the huge monster earth mover, but if he is going to buy it, he better damn well have a big, profitable application for it or he is going to go bankrupt trying to buy it.

So Michelle Obama has a choice of the $20,000 state school undergrad and law degree, which is perfectly serviceable for most applications, or the Princeton/Harvard $200,000 combo, which I can attest will, in the right applications, move a hell of a lot of dirt.  She chooses the $200,000 tool, and then later asks for sympathy because all she ever did with it was some backyard gardening and she wonders why she has trouble paying all her debt.  Duh.  I think the problem here is perfectly obvious to most of us, but instead Obama seeks to blame her problem on some structural flaw in the economy, rather than a poor choice on her part in matching the tool to the job.  In fact, today, she spends a lot of her time going to others who have bought similar $200,000 educations and urging them not to use those tools productively, just like she did not.

Us non-financial types are always learning something new.  After a lifetime of thinking that our economy rests on free markets, entrepreneurship, an educated and flexible labor force, risk-taking, etc., we suddenly find that everything depends on the TED Spread, a metric most of which most of us were blissfully ignorant 2 months ago.

The TED spread is basically the difference or spread between short term inter-bank loan rates and short term treasuries or T-bills.  It is in some sense a measure of perceived risk of lending to banks vs. (what are considered) low or near-zero risk US treasury obligations.  One way to think about it in the current market is how much extra would you need in interest to lend to your slacker brother-in-law Earl vs. say to Bill Gates.

Not surprisingly, the TED spread has shot up over the last few weeks, and it tends to be the #1 metric cited in declaring impending doom for the US economy.  But Alex Tabarrok looked at a longer view of the TED spread, and found this:

Now, the period from 1970-1983 were not by any means an economic glory period, but on the other hand its clear that TED spreads of the order of magnitude we have seen in the past weeks are not unprecedented by any means.

The problem I have with the TED spread is that higher recent spreads are being used as an indicator that credit has "dried up" and lending is at a standstill.  Why do I resist this conclusion?  Because of this chart:

So, gasoline prices rocketed from $1.50 a gallon to over $4.00 a gallon.  Does this mean that gasoline purchases have stopped?  Has the gasoline market closed up shop?  Of course not.  It just means the price went up.  It is absurd to show me a price chart, which is what the TED spread graph is, and infer from it changes in the underlying transaction volume.

In fact, when one looks at actual volume, of inter-bank loans or new commercial lending, there is not (at least yet) any of the drop-off everyone seems to assume exists.  For example:

I said it a couple of weeks ago:

Economists will be poking through this situation years from now, and may well find the bunkers
empty of WMD's.  Another trillion dollar commitment and unprecedented
expansion of executive power ramrodded on the back of fear mongering
and chicken-little crisis declaration.

And even before that on October 1

Well, they're picking through the bunkers now, and its not at all clear the threat was what it was portrayed to be.  The Fed of Minneapolis debunks four myths (pdf)

Myth 1. Bank lending to non…nancial corporations and individuals has declined sharply.
Myth 2. Interbank lending is essentially nonexistent.
Myth 3. Commercial paper issuance by non…nancial corporations has declined sharply and rates have risen to unprecedented levels.
Myth 4. Banks play a large role in channeling funds from savers to borrowers.

Apparently, others are starting to make the WMD comparison.

A couple of examples below.  First, sure looks like all the inter-bank lending has dried up:

Yep, and no one is lending to Main Street businesses either, so we better do something!

Just to avoid confusion, that upward spike began in September, well before the Lehman bankruptcy.  Similar stories in commercial paper, consumer lending, leases, etc.  See the whole thing.

From the WSJ:

Despite recent declines, prices are still higher than they were a
year ago. But the recriminations over what went wrong have begun,
complete with calls for more government involvement, efforts to make
the industry more transparent and reforms to restore market confidence....

"[the market] is out of control," says H. Djusdil Akrim, director of a
factory in Makassar, Sulawesi's biggest city.... "It's a wild, wild market
-- and no one is running it," he says. "I think we need more
regulation."...

No one knows when the market will hit bottom. Some
traders are sitting on stockpiles they bought when the market was hot,
and if global growth slows further, as expected, demand could weaken.

Whatever happens, the latest volatility is a wake-up call for the ... industry, which has been growing steadily for years.

I blame George Bush.  Oh, by the way, the industry is seaweed.

One of the pieces of data that turns out to be nearly impossible to find is a direct comparison of the median income by quartile on a PPP basis between countries.  In other words, how does the income of, say, the US lower quartile compare to other countries?  There are a zillion sites with metrics of income inequality and GINI indexes and such, but to my mind these are meaningless.  OK, the poor in the US are much less wealthy than the rich in the US, but how do they compare to the poor of other nations.  The few studies I have seen have reluctantly (remember, these are leftish academics) admitted that the US poor do pretty well vs. the poor in other nations.  Here is data for US vs. Europe.

I got a lot of grief a few years ago when I said, related to Kwanzaa:

Every African-American should wake up each morning and say "I give
thanks that my ancestors suffered the horrors of the slavery passage,
suffered the indignity and humiliation of slavery, and suffered the
poverty and injustices of the post-war South so that I, today, can be
here, in this country, infinitely more free, healthier, safer and
better off financially than I would have been in Africa."

I wanted to actually make this comparison more real.  I used the CIA Factbook to estimate the share of per capita GDP on a PPP basis earned by the top decile, or top 10% wealthiest individuals, in a number of African nations (Example page here for Ethiopia -- calculation would be [25.5%/10%] x $700 per capita). 

So here are the results:

• Ethiopia top 10%:      $1,785
• Nigeria top 10%:        $6,972
• Zimbabwe top 10%:    $800

Hopefuly this is enough of a sample to give you an idea of the range.  Only South Africa is a real outlier from this range.  Now, by the same methodology and source, here is the average share of the per capita GDP for the bottom 10% of earners in the US:

• United States bottom 10%:   $9,160
• United States African-American avg (est):  $32,060**

Wow!  This means that the average person in the bottom 10% in the US, most of whom we classify as below the poverty line, would easily, by multiples and orders of magnitude, be in the top 10% richest people in most African nations.   And the surviving decedents of those poor folks who got dragged to the US in slavery would be the Bill Gateses of their mother countries.

The point being, of course, that the size of the pie is typically more important than how you divide it up.  And it is nearly an axiom that government efforts to divide the pie more evenly almost always make it smaller.

** estimated based on 2006 median black household wages being about 70% of the US median household wages.  Yes, I know, we are wildly mixing apples and oranges here to get African American share of GDP per capita in the US, but its in the ballpark -- certainly close enough to make my basic point.  And yes, I know there are flaws in measuring income across countries even on a PPP basis.  If anyone knows of how to get this data more directly, please email me.

The media is really bending over backwards to find ways to twist earnings data for average Americans to try to make the point that real income for many folks has stagnated or dropped.  They are doing this to support a two-pronged legislative strategy in the next Obama administration:

1. Use the power of the government to further tilt the balance towards unions and against employers in wage negotiations  (this strategy having worked out so well to create prosperity in the automobile and airline industries)
2. Further modify the income and Social Security tax structures to make them even more regressive than they are today.

They are firing on all cylinders behind this strategy.  They are even mobilizing the neo-Keynesians to make the pitch that the Great Depression and the current financial crisis were caused by a shift in wealth from laborers to the capital classes, and that the only way to prevent future crises and depressions is to, wait for it, increase the power of unions and institute more wealth redistribution  (Example here, via Kevin Drum).

I was going to do a post fisking the James Livingston article linked above on Kevin Drum's site, but Livingston's hypothesis was such a mess that it was just going to take too much of my day.  But in doing some research, I found this chart from a couple of years ago in the NY Times that really caught my attention:

Talk about chutzpuh -- look at the lede on the chart and then look at the chart itself.  Yes, the lede is correct, but only if you choose the totally meaningless number of "cash wages" rather than total compensation.  If one looks at total compensation (or what they call "overall" compensation), the entire argument falls apart.   Workers have maintained about their same "share" of the economy.

Sure, a large percentage of that is now in health care benefits, but that's a choice workers have made (and the government has encouraged through tax policy).  In fact, this compensation mix has been driven in large part by the Left's beloved unions, so on what basis can folks say that these other benefits somehow "don't count?"  Certainly, they cost their employers equally, whether it is cash or health care.  Corporate profits are up a bit, but in line with their normal historical levels in the 1950s and 1960s, the golden age of the US economy, according to the Left.  (By the way, the pattern of falling wage shares and rising profit shares after recessions is a well-documented one.  Wage-earners do best at the end of an economic cycle, employers more towards the beginning.  The chart cut off after 1997 would look about the same as the last several years).

I will tell you right now that every time you hear someone bemoaning the stagnation of wages, they will never, ever, ever be talking about total compensation per individual.  Having, through government policy and union activity pushed the compensation mix to non-cash elements, they then play a heads-I-win-tails-you-lose game of not giving any credit for those compensation elements.

Other games that are played to try to make the case that real earnings have stagnated include:

• Time frame selection. Everyone making this argument will choose 2000 as a starting point.  They justify it by saying it is the beginning of the Bush years, but 2000 is really selected because it is a pre-recession peak, and they have to measure peak-to-trough of the economic cycle to try to make their point.  Just as an example, if you look at the household income numbers below, you can see there is very typically a 5-year drop after a recession followed by net gains.  If we chose, say, the first Clinton term we could play the same game, showing a peak-to-trough drop in real incomes.
• Household income game. The household income numbers are fraught with peril, because companies don't pay households, they pay individuals.  And household makeups are changing simultaneous to income changes.  For example, imagine the economy was just my household.  If my wife were to get fed up with my shtick and divorce me tomorrow, average household income would drop by 50% in one day (as our total income stays the same but we go from one to two households).  If my wife were to go back to her high-paying pre-kids job tomorrow (if only it were so!) our household income would go way up, in part because the labor department does not capture the value of the labor she provides at home.Mark Perry has a lot more on the household income numbers here, but he shows that the household size number has been changing a lot, causing the metric to understate income changes per individual:

• Individuals matter. Median income looks at the middle person on the ranked list of US incomes.  So, for example, if there are 100 million income earners, the median income is the income of number 50 million on this list.  But whoever the person is at spot 50 million is almost certainly not the same person who was at spot 50 million last year.  They might have fallen on the list, but the odds are they moved up.  As folks age and gain experience and/or seniority, they tend to increase income faster than inflation.  Most minimum wage earners, for example, tend to be under 25.  The number of families supporting three kids on minimum wage (at least of the primary bread-winner) at the age of 45 is really, really low, despite the anecdotes we are bombarded with in the media.

• Immigration has a huge effect. The total number of foreign born people in the labor force is estimated around 21 million, of which perhaps 6.3 million are illegal immigrants.  Positing that at least 10 million of these arrived in the last two decades, and that many of these folks began at relatively low, below-median incomes, means that median incomes are hugely affected by immigration.  Leaving immigrants out so the comparison is close to apples and apples, to find the true median income gain over the last 20 years one would have to count up 10 million or so spots on the list.  Again, as in the previous point, most individuals can be better off even if the median stagnates  (presumably immigrants coming in at the bottom are also better off, even at the bottom, than where they were before, or they would not have come.  We often forget that much of our bottom quartile of income in this country would be upper middle class in many other nations).  This is a classic mix problem that most people, and the media, almost always get wrong.  In a situation with a changing mix of multiple groups, each of the groups can be improving on some metric, but the overall metric can go down.  You can see the income stats by race here.  Every race group has increasing median income, but since the Hispanic group has grown 8x faster than the anglo population in the US, the total results are mixed downwards.Here is a quick example.  Group A has values of 5,6,6,7.  Group B has values of 1,2,3.  Ten years later Group A is the same size and has values of 6,7,7,8.  Group B has doubled in size, and now has values of 2,3,4,2,3,4.  In these examples, every single individual has a higher value.  Also, Group A's median has increased from 6 to 7, and Group B's has increased from 2 to 3.  But the median for the whole combined group A+B has dropped from 5 to 4.  Both medians (and averages) can do funny things when mix is shifting.
• Even the NY Times. The NY Times actually makes two of these points for me in another article, arguing that historic median income drops were concentrated in areas of high immigration, and reported drops were due to the choice of the economic peak as a starting point.  WOW?  Is this the same NY Times I began this post criticizing.  Yes it is, the only difference is that this article ran in 2001, when they were reporting on the economy during a Democratic administration.
  
• Income taxes are already wildly progressive.  While I would love to be in that top 1% group, I don't really begrudge them their success.  Besides, who can look at the chart below, again from Mark Perry, and come to the conclusion that the top 1% are being treated unfairly generously.

• Every country that has implemented this plan (government-backed unions and wildly progressive tax policy), including most of Western Europe, is demonstrable worse off than the US on absolute measures.  This is both the median, but also in every quintile, including the poorest.  While it is true the poorest quintile has a bigger gap from the riches in the US vs. France for example, on an absolute basis our poorest are at least as well off  (particularly when differences in immigration policy are taken into account).

Believe it or not, I think this picture is actually good news:

This is a little flawed, since we would expect a constant trend to be a constant percent increase each year, which would be upward curving on this chart, not a straight line trend  (it would be straight on a log scale).  Never-the-less, it makes a point  (by the way, it is interesting the 1980's are considered the decade of greed on Wall Street rather than the 1990s, from this chart).

Here is a better way to make my point.  We get a similar chart if we look at PE ratios for the S&P500  (the chart below is on trailing 10 year average earnings).

Why is this anything but depressing?  Because I get the sense that many people, without any other general indicator of how bad things are in the financial markets, are using the steep drops in the stock market as a proxy measure.  The stock market looks like a disaster, so everything else must be a disaster.

But in a large sense, at least so far, all the stock market has done in the last 2 weeks is return to historical norms.  This tells me that there is nothing about the current level of the stock market that is screaming disaster signals.  In fact, the current level of the stock market is screaming normalcy. 

Of course, this does not mean the drop will stop here.  PE's in the worst of times have headed on down to 5 (which would be about DOW 3000, yuk).  And corrections seldom stop at the mean - they usually over-correct on below the mean.  But seen on these charts, this recent move looks more like the completion of the correction to the late 1990's bubble rather than necessarily an indicator of current financial disaster.

The best way to mobilize people is to make them panic.  That is why so many institutions have incentives to may you panic over the environment, or global warming, or the threat of terrorism, or the economy.  In most cases (Naomi Klein's hypothesis not-withstanding) these folks want you to get so worried you will give up something, either money or freedom or both.

Some kind of recession at this point is unavoidable, I guess.  But in fact, we really haven't seen what I would call a real recession since the early 1980's.  We've had a really long run, and now its time to cut back on that spending and board up the financial windows for a little while.  The economy has to de-leverage itself some, and that is going to slow things down for a while.  People keep talking about the Great Depression, and I don't see it.  I don't even think its going to be the 1970's.

The most visible symbol of financial problems seems to be the falling stock market.  But all those companies in those indexes are the same ones that were there a month ago, and are still healthy and making money.  The fall in the markets does not represent and change in the current health of industrial America.  The lower prices reflect a changing expectation about those company's future prospects, but the folks driving the market are just guessing, and really, their guesses aren't really any better than yours or mine.  Similar expectations drove oil up to $145 and now back down under $80.  Wall Streeters work really hard to portray themselves as smarter than you or I, but they are not.  I went to school with them.  I know these guys.  They aren't smarter, and they aren't any less susceptible to panic.  In fact, because they are often highly leveraged and are worried about making payments on that new Jaguar they just bought for their mistress, they tend to be more easily stampeded.

In October of 1987, the stock market fell 22.6% in one day.  If you date the current financial issues to about September 22, when the market closed around 11,000, then the market has fallen over these tumultuous weeks by 22.0% at last night's close -- dramatic, but still not as bad as the one day drop in '87. 

There are a lot of incredibly good reasons to favor a carbon tax over cap-and-trade if we simply most reduce CO2 emissions.  Even a minor inspection of the inner workings of the California Air Resources Board under their AB32 cap-and-trade style program provides lists of examples of abuses, rent-seeking, inefficiency, etc. under cap-and-trade.  But Joe Nation, one of the California legislators who authored AB32, told me that he could not get even a 5-cent gasoline tax through a legislature that enthusiastically embraced the 100x (or more) expensive AB32.  Why?  Silly rabbit, because public costs of cap-and-trade can be fudged, hidden, ignored, and, when they absolutely have to be recognized, blamed on private companies.

Via a reader, here is our Arizona governor discussing the costs of cap-and-trade in Arizona:

Napolitano brushed aside questions of what effect the plan will have on utility rates.

"First of all, that it may increase electric bills doesn't mean it will increase them now," Napolitano said.

Brave, isn't she?  They are already preparing the story line to blame private industry for future price increases:

Napolitano said there is "lots of data" to suggest that utilities
eventually will be able to save money "by moving to a system of 'green'
energy."...

Fox said that, on a long-term basis, there may be cost savings.

You get that?  We smart government guys conducted a lot of really high-power circle jerks among graduate students and the consensus was that forcing the electrical industry to obsolete much of its current capacity and rebuild with some other uproven but more expensive technology would save them money in the long term.  If utilities raise prices, it's because they were not smart enough to figure out what we already know and they are just greedy capitalist pigs so blame them for the price increases, not use faithful public servants.  You see?  Cap-and-trade is like money laundering for taxes.  The tax is there, but its hidden well enough that a lazy media will not bother to trace it back to its owner.

But I wouldn't want you to take my assertion on faith (as Obama does with his 5 million green jobs promise), so lets look at what will have to happen.

The exact goals are hazy, but it appears our governor has committed the state to cutting CO2 emissions by 15% over the next 10 years.  One of the main ways that calling CO2 "pollution" is misleading is to imply it is some kind of combustion by-product, like soot or SO2, that could be scrubbed out.  But it is not.  It is fundamental to combustion.  So a 15% cut in CO2 emissions is 10-15% cut in power generation  (we likely get numbers lower than 15% by assuming cuts in production are preferentially from higher carbon sources like coal plants). 

So, basically this law requires the state's electrical utilities to obsolete 10% of its installed capacity, and either a) have tons of rolling blackouts; b) raise prices enough to force a large cut in demand  (remember, demand must be cut 10% AND all future growth must be halted); or c) the industry must spend hundreds of billions of dollars to build a ton of capacity in some other technology.  Option a will never fly politically.  Option c is almost sure to fail as well.  The permitting and construction processes can take decades.  From a cold start, I don't think its possible to rebuild 10+% of the states generation capacity in 10 years, either in nuclear or some other not-yet-ready technology.  The numbers simply don't work.  The only possible way I can imagine is maybe to install a zillion natural gas turbines, but to make the CO2 balance work out, you probably would have to rebuild 15% or more of the capacity, not just 10%, because there would still be some carbon emissions. 

Really, realistically, one is left with option b.  Prices are going to go up (just they would have to in option c to pay for replacement production capacity).  The price increases would be about as much as the carbon tax would have had to be to get the same effect, but price increases are corporation's fault while taxes are politicians' fault.  See?  The only good news is that the price increase will go to private players rather than the government.  That is until someone thinks to put in a windfall profits tax on utilities that are making lots of money on the government-enforced shortage.

I haven't posted at all on the brouhaha about mark-to-market accounting of derivatives and whether it was a contributor to the recent financial mess.  If I had to summarize the issue, I would describe it thus:  Investors want something more trustworthy than just management estimates of the value of complex securities -- so they would like an outside market-based reference point -- but the very complexity that makes these contracts hard to value as an outsider also tends to make their markets illiquid and volatile, making it difficult to get a good market value. 

Tom Selling addresses the problem of accounting for the value of credit default swaps here.  He makes what seems to me to be a common sense suggestion:

Requiring the asset and liability sides of derivatives to be separately
measured and reported seems like an amazingly simple fix that could
simplify regulation of the financial and insurance industries, reduce
the need for the disclosures in financial statements written so as to
discourage one from reading them, and help investors more easily assess
risk.

This certainly seems reasonable to me.  When one buys a revenue producing asset with debt financing, the two are listed separately as an asset and a liability, rather than as one "net" asset, even though they may be inextricably linked (say if the asset is collateral for the loan and the loan has high pre-payment penalties).  Any thoughts?  Does this make sense, or is it naive?

Paul Kedrosky reports:

The Federal Reserve Board on Tuesday announced the creation of the
Commercial Paper Funding Facility (CPFF), a facility that will
complement the Federal Reserve's existing credit facilities to help
provide liquidity to term funding markets. The CPFF will provide a
liquidity backstop to U.S. issuers of commercial paper through a
special purpose vehicle (SPV) that will purchase three-month unsecured
and asset-backed commercial paper directly from eligible issuers.

Kedrosky has a lot of interesting coverage of the current financial crisis.  He observes:

As Buffett has said, everyone in the world is trying to deleverage at
once -- which is unworkable -- leaving the U.S. as the only institution
in the world that can lever up at all -- and levering up it is. I just
wish it was more obvious to me how you exit the other side of programs
like this. Would we not be better off to quickly recapitalize and
backstop some banks?

I share his concerns, but I actually kind of like the idea of bringing liquidity to main street business directly, rather than indirectly by bailing out failing financial institutions.  The problem of unwinding the program is a big one.  Right now, I get the sense that the financial markets are operating almost entirely on expectations of government action -  will the Feds buy back mortgages, will the Feds keep the overnight borrowing window wide open, will the feds gaurantee commercial paper, how much commercial paper will they buy.  This latter actually seem the least bad of a lot of other options.  At least the Feds are buying good assets from good companies.

No, at least not yet, with the dollar at a 13-month high.

OK, I know burn-out is setting in.  I certainly think that explains, in part, why the House voted for a demonstrably worse bill than they voted against the week before.  But John Moore has a number links to an interesting set of charts from the Milken Institute on the financial meltdown.

They hit on many of the things I discussed earlier, but put a greater emphasis on 1) securitization, and the effect it had on good underwriting standards and 2) on interest rates as a driver of the housing bubble.

Update:  And an interesting post on the link between credit default swaps and short-selling.  My personal view is that credit default swaps will someday be looked at like earthquake insurance -- nice premiums today, but too much systematic risk, too much certainty that in 10 or 20 years there will be an event that forces nearly every policy to pay simultaneously, wiping out the insurer.  You can't get earthquake insurance, and you nearly can't get hurricane insurance, and I think the default insurance market may go the same way.  Or, as a minimum, the price is going so high few people will buy it.  This is not a market failure, it is a market lesson learned and adjustment to reality.

Update #2:  Even more from economists on the rush to bailout.

After having time to think more about the current crisis, I think the reason it is confusing is that it is the result of two parallel but largely independent causes that worked together to create this mess.  I told my mother-in-law in an email last week that the financial crisis would likely be a Rorschach test where everyone sees the crisis caused by all the things they opposed before the crisis.  Conservatives will see government intervention, liberals will see greed and deregulation.

What makes this situation particularly confusing is that of the two causes I believe led to the crisis, each has been embraced by one of the two parties as the only cause.  It's a case where everyone is half right, but the other half is important too.  It's a two part recipe, with neither active ingredient causing much of an explosion until mixed with the other. (special thanks to the folks at Q&O who have had a lot of good posts on these issues).

Cause 1:  Creating the Asset Bubble

The first thing that had to happen for the crisis was the creation of an asset bubble.  We need some type of over-valued asset whose prices crash to earth to spark the crisis.  So we begin with housing.

Home prices have gone through boom-bust cycles for years, just as have many commodities.  There is a whole body of literature on such cycles, so we will leave that aside and accept their existence as a feature of markets and human behavior. 

But this housing bubble had a strong accelerant, in the form of the Federal government.  For years, this nation has made increasing home ownership a national goal and many laws and tax policies have been aimed at this goal.  The mortgage interest deduction on personal income taxes is just one example.

Starting in 1992, Fannie Mae and Freddie Mac, which were strange quasi-public / quasi-private entities, came under pressure from the Congress (e.g. Barney Frank) and the Clinton administration to add increasing home ownership to poorer people part of their missions.

Fannie Mae, the
nation's biggest underwriter of home mortgages, has been under
increasing pressure from the Clinton Administration to expand mortgage
loans among low and moderate income people and felt pressure from stock
holders to maintain its phenomenal growth in profits.

In
addition, banks, thrift institutions and mortgage companies have been
pressing Fannie Mae to help them make more loans to so-called subprime
borrowers. These borrowers whose incomes, credit ratings and savings
are not good enough to qualify for conventional loans, can only get
loans from finance companies that charge much higher interest rates --
anywhere from three to four percentage points higher than conventional
loans.

''Fannie Mae has expanded home ownership for millions of
families in the 1990's by reducing down payment requirements,'' said
Franklin D. Raines, Fannie Mae's chairman and chief executive officer.
''Yet there remain too many borrowers whose credit is just a notch
below what our underwriting has

The results were astonishing:

Beginning in 1992, Congress pushed Fannie Mae and Freddie Mac to
increase their purchases of mortgages going to low and moderate income
borrowers. For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target "” 42% of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50% in 2000 and 52% in 2005.

For 1996, HUD required that 12% of all mortgage purchases by Fannie and Freddie be "special affordable" loans, typically to borrowers with income less than 60% of their area's median income. That number was increased to 20% in 2000 and 22% in 2005. The 2008 goal was to be 28%. Between 2000 and 2005,
Fannie and Freddie met those goals every year, funding hundreds of
billions of dollars worth of loans, many of them subprime and
adjustable-rate loans, and made to borrowers who bought houses with
less than 10% down.

Fannie and Freddie also purchased hundreds
of billions of subprime securities for their own portfolios to make
money and to help satisfy HUD affordable housing goals. Fannie and
Freddie were important contributors to the demand for subprime
securities.

Simultaneously, the 1977 Community Reinvestment Act was pushing private banks to make more loans to less qualified borrowers:

The Community Reinvestment Act (CRA) did the same thing with
traditional banks. It encouraged banks to serve two masters "” their
bottom line and the so-called common good. First passed in 1977, the
CRA was "strengthened" in 1995, causing an increase of 80% in the
number of bank loans going to low- and moderate-income families.

These actions had a double whammy on the current crisis.  First, by pushing up housing demand, they inflated the housing pricing bubble.  Second, it meant that these inflated-price homes were being bought with lower and lower down payments.  In effect, individuals were taking on much more leverage  (leverage is a term that I will use to mean the percentage of debt used to finance a set of assets -- more leverage means more debt and less equity.  The term comes from the physics of a mechanical lever, in that more debt, like a lever, can magnify force.  Profits from assets are multiplied by leverage, but, alas, so are losses.) 

When the economy softened and the housing bubble started to burst, these new mortgage customers the government went out of its way to bring into the system did not have any resources to handle the changes -- they did not have the down payment to cushion them (or the banks) against falls in asset value and did not have the cash flow to cushion them against falling income in the recession and/or rising interest rates. 

The result:  Huge portfolios of failing loans with rapidly falling collateral values.

Cause 2:  Over-leverage of Risky Assets and Related De-regulation of Capital Requirements

I think the word "greed" was used about a zillion times last night in the Vice-Presidential debate.  But what does it mean in this context?  After all, we are all greedy in one way or another, if one equates greed with looking after one's self-interest.

So I will translate "greed" for you:  When you hear "greed on Wall Street", think leverage.  Remember, we said above that as long as the underlying asset values are going up, leverage (ie more debt) multiplies profitability.  [Quick example:  Assume a stock that goes from $100 to $110 in a year.  Assume you pay 5% interest on money.  No leverage, you make $10 on a $100 investment.  With 95% leverage -- ie buying $2000 worth of the stock with $100 equity and $1900 debt -- you would make $105 on the same $100 equity investment.  Leverage multiplied your returns by more than a factor of 10]

Remember that around the year 2000 we had the Internet bubble burst in a big way.  A lot of companies not only dropped, but went to $0 in value.  This was painful, but we did not have a cascading problem.  Why?  In part because most of the folks who invested in Internet companies did not do so in a highly leveraged way.  The loss was the loss, time to move on.  Similarly in this case, if these mortgage packages had been held as a piece of a un-leveraged portfolio, like a pension fund our an annuity, the loss would not have been fun to write off but it would not have cascaded as it has.  The government would have had to bail out Fannie and Freddie, a few banks would have failed, but the disaster would have been limited.

One reason this problem has cascaded (leaving aside blame for Henry Paulson's almost criminal chicken-little proclamations of doom to the world) is that many of these mortgage packages or securities got stuck in to highly leveraged portfolios.  The insurance contracts that brought down AIG were structured differently but in the end were also highly leveraged bets on the values of mortgage securities in that small changes in values could result in huge losses or gains for the contracts.   (Some folks have pointed to actual securitization of the loans as a problem.  I don't see that.  Securitization is a fabulous tool.  Without it, we would be seeing a ton more main street bank failures, as they would have had to keep many more of these on their books.) 

If this all sounds a bit like cause #1 above, ie buying inflated assets with more and more debt, then you are right.  There is an interesting parallel that no one wants to delve into between the incentives of home buyers trying to jump into hot housing markets with interest-only loans and Wall Street bankers putting risky securities into highly leveraged portfolios.  Leverage is really the key theme here.  In a sense, houses were double-leveraged, bought the first time around with smaller and smaller down payments, and then leveraged again as these mortgages were tossed into highly-leveraged portfolios.  Sometimes they were leveraged even further via oddball derivatives and insurance contracts whose exact operation are still opaque to many.

Those who have read me for a while know that I am in the "let them die" camp.  These Wall Street guys have been living high on the extra profits from this leverage in the good times.  They knew perfectly well that leverage is a two-edged sword, and that it would magnify their losses in a bad time.  But their hubris pushed them into doing crazy things for more profit, and I am all for a Greek-tragedy-like downfall for their hubris.  The sub-prime, first-time home buyer can claim ignorance or unsophistication, but not these guys.

During the Bush Administration, these bankers came to the SEC trumpeting their own brilliance, and begged to be allowed to leverage themselves even more via a relaxation of capital requirement rules.  And, in 2004, without too much discussion or scrutiny, the SEC gave them what they wanted:

Many events in Washington, on Wall Street and elsewhere around the country have led to what has been called the most serious financial crisis
since the 1930s. But decisions made at a brief meeting on April 28,
2004, explain why the problems could spin out of control. The agency's
failure to follow through on those decisions also explains why
Washington regulators did not see what was coming.

On that
bright spring afternoon, the five members of the Securities and
Exchange Commission met in a basement hearing room to consider an
urgent plea by the big investment banks.

They wanted an
exemption for their brokerage units from an old regulation that limited
the amount of debt they could take on. The exemption would unshackle
billions of dollars held in reserve as a cushion against losses on
their investments. Those funds could then flow up to the parent
company, enabling it to invest in the fast-growing but opaque world of
mortgage-backed securities; credit derivatives, a form of insurance for
bond holders; and other exotic instruments.

In part they traded capital requirements for computer models, a very dubious decision in the first place, made worse by the fact that most of the banks were gaming the models to reduce the apparent risk.  The crazy thing is that, in gaming the models, they really weren't trying to fool regulators, who pretty much were not watching anyway, but they were fooling themselves!  Certainly I would not expect government regulators to do a better job of risk assessment in this environment, which argues for a return to the old bright-line capital requirements that are fairly simple to monitor.  Investment banks played a game of Russian Roulette, and eventually blew their own brains out.  Which begs the question of whether the government's job is to protect consumers at large or to protect financial institutions from themselves.

"We foolishly believed that the firms had a strong culture of
self-preservation and responsibility and would have the discipline not
to be excessively borrowing," said Professor James D. Cox, an expert on
securities law and accounting at Duke School of Law (and no
relationship to Christopher Cox).

The Dog that Didn't Bark:  Ratings Agencies

Clearly, ratings agencies have really failed in their mission during this fiasco.  Right up to the last minute, they were giving top ratings to highly risky securities.  But I think folks who want to lay primary blame on the rating agencies go to far.   Ratings agencies are for individuals and state pension funds and the like -- I have a hard time imagining Goldman or Lehman depending on them for risk assessment.  Its a nice excuse, and we may well have very different companies rating securities five years form now, but its just a small contributor.

The Fix

So you see what is going on.  Republicans are running around saying "the government caused it with the CRA" and Democrats are saying "it was greed and deregulation."  Incredibly, both parties seem to come to the conclusion that sickly mortgage securities need to be pulled out of the hands of the folks who created and bought them and put in ... my hands.  I had smugly thought that I had avoided buying a home with zero-down at the peak of the market, but I was wrong.  Via the federal government, I have bought a lot of them!

I personally would let the whole thing sort itself out, and live with the consequences.  My hypothesis is that much of the current credit squeeze in the money markets is due to Henry Paulson's clumsy public statements and the Fed's busting open the door to overnight borrowing.  Everyone is frozen not by the crisis, but by the prospect of some sort of government action.  Short term borrowers and lenders are doing their business with the Fed, as the government crowds out the private short term markets and causes the very problem it is trying to prevent. 

Without the government bending over backwards to take in short term money from lenders, private firms would be forced to find private options.  Lenders have to lend to stay alive financially, just as much as borrowers have to borrow.  Money may go into the mattresses for a week or two or three, but it can't stay there forever.

I do know that the fix is NOT. 

Fixing these financial problems listed above does not include:

Sec. 101. Renewable energy credit.
Sec. 102. Production credit for electricity produced from marine renewables.
Sec. 103. Energy credit.
Sec. 104. Energy credit for small wind property.
Sec. 105. Energy credit for geothermal heat pump systems.
Sec. 106. Credit for residential energy efficient property.
Sec. 107. New clean renewable energy bonds.
Sec. 108. Credit for steel industry fuel.
Sec. 109. Special rule to implement FERC and State electric restructuring policy.
Sec. 111. Expansion and modification of advanced coal project investment credit.
Sec. 112. Expansion and modification of coal gasification investment credit.
Sec. 113. Temporary increase in coal excise tax; funding of Black Lung Disability
Trust Fund.
Sec. 114. Special rules for refund of the coal excise tax to certain coal producers
and exporters.
Sec. 115. Tax credit for carbon dioxide sequestration.
Sec. 116. Certain income and gains relating to industrial source carbon
dioxide treated as qualifying income for publicly traded partnerships.
Sec. 117. Carbon audit of the tax code. Sec. 111. Expansion and modification of advanced coal project investment credit. Sec. 113. Temporary increase in coal excise tax; funding of Black Lung Disability Trust Fund. Sec. 115. Tax credit for carbon dioxide sequestration. Sec. 205. Credit for new qualified plug-in electric drive motor vehicles. Sec. 405. Increase and extension of Oil Spill Liability Trust Fund tax.Sec. 306. Accelerated recovery period for depreciation of smart meters and
smart grid systems. Sec. 309. Extension of economic development credit for American Samoa. Sec. 317. Seven-year cost recovery period for motorsports racing track facility. Sec. 501. $8,500 income threshold used to calculate refundable portion of child tax credit.

And, of course, the big one:

Sec. 503 Exemption from excise tax for certain wooden arrows designed for use by children.

All of these, however, are part of the bailout bill approved by the Senate.  Sources here and here.

Apparently Zimbabwe had an inflation rate of 14,000% last month, for a total of 531 billion percent inflation this year.  If we assume for simplicity that inflation occurs only during working hours, if we spread if over 22 days a week, this means that ones pay at the end of the day is worth only 1/3 its value by lunch the next day, and 1/6 its value by the end of the next day.  My understanding is that Zimbabwe companies pay their employees several times a day and let them go out at lunch and buy something, anything, tangible with the cash before it is worthless a few hours later. 

By the way, I have my Zimbabwe 50 and 100 billion dollar notes on the wall of my office.  I am hoping for a trillion dollar note to go with it.  Meeses and Gippers coming soon.

The US Conference of Mayors has introduced a "study" extending on Obama's idea of millions of new green jobs:

A major shift to renewable energy and efficiency
is expected to produce 4.2 million new environmentally friendly "green"
jobs over the next three decades, according to a study commissioned by
the nation's mayors.

The study to be released Thursday by the U.S. Conference of Mayors,
says that about 750,000 people work today in what can be considered
green jobs from scientists and engineers researching alternative fuels
to makers of wind turbines and more energy-efficient products.

But that's less than one half of 1 percent of total employment. By
2038, another 4.2 million green jobs are expected to be added,
accounting for 10 percent of new job growth over the next 30 years,
according to the report by Global Insight, Inc.

Well, lets leave aside the measurement issue of making forecasts and establishing targets for metrics like "green jobs" that can be defined however the hell someone wants.  For example, if they really were to define "green jobs" as they say above "makers of ... more energy-efficient products," then nearly everyone in industrial America already has a green job.  Every car made today is more fuel-efficient than the equivalent car made 20 years ago, every motor more efficient, every machine more productive.

But lets discuss that word "incremental."  Politicians NEVER, EVER cite job growth projections that are truly incremental.  For example, tariff program X might be billed as saving 100 jobs in the steel industry, but what about the jobs lost in the steel-consuming industries due to higher costs?  The same is most certainly true in this whole "green jobs" fiasco.  It is the perfect political promise - impossible to define, impossible to measure, and therefore impossible to establish any accountability.  Everyone who makes the promise knows in his/her heart the jobs are not truly incremental, while everyone who hears the promise wants to believe they are incremental.  Politics thrives on this type of asymmetry.

I looked before at the impossibility of these numbers being incremental, but here is a second bite of the apple.  The article says specifically:

The report, being presented at a mayor's conference in Miami, predicts
the biggest job gain will be from the increased use of alternative
transportation fuels, with 1.5 million additional jobs, followed by the
renewable power generating sector with 1.2 million new jobs.

Let's take the second number first.  Here are the current US employment numbers for the US power generation field:

Construction of power generation facilities:	137,000
Power generation and supply:	399,000
Production of power gen. equipment	105,000

That yields a total of 641,000.  So is it really reasonable to think that these green plans will triple power generation employment?  If so, then I hate to see what my electricity bill is going to look like.

The fuel sector is similar.  There are about 338,000 people employed in petroleum extraction, refining, transportation and wholesale -- a number that includes many people related to other oil products that are not fuels.  Add in about 100,000 for industry supplies and you get perhaps 450,000 jobs current tied to fuel production plus 840,000 jobs in fuel retailing (ie gas stations).  How are we going to add 1.5 million net new jobs to a fuel production sector with 450,000** currently?  And if we do, what is going to happen to prices and taxes?  And if the investments push us away from liquid fuels to electricity, don't we have to count as a loss 840,000 retail sector jobs selling a product no longer needed?

** Your reaction may be that these job numbers look low.  They are all from the BLS here.  Here is a quick way to convince yourself there really are not that many people working in the US oil and gas industry:  Despite years of mismanagement and government subsidies, politicians continue to fawn over auto companies.  Despite years of excellence at what they do, politicians demonize oil companies.  The reason has nothing to do with their relative performance, ethics, importance to the country, greed, etc.  The difference is that the auto companies and their suppliers employ millions of voters.  Oil companies employ but a few.

This is such ridiculous garbage as to be unbelieveable, but every paper in the country will print this credulously.  Because if journalists were good with numbers, they wouldn't be journalists, they'd be doing something that pays better.

The comedians have pretty much nailed it, via Jeffrey Tucker

I know this may be pointing out the obvious, but I think it needs to be said:  Lenders have to lend, just as much as borrowers have to borrow.  I know most people understand the "borrower" part of this phrase, but they seem to act as if lenders are somehow only putting their money on the street as some sort of charitable activity, and if we don't sufficiently kow-tow to all their needs, they will run away and never help us all again.

The fact is that people with large pools of money -- banks, pension funds, insurance companies -- HAVE to lend.  And in a time where stocks are dicey, they probably have more, not less, cash than normal they want to lend, much of it short-term.  Now, they may be temporarily scared off from doing so for a few days or weeks as they try to assess what is safe and what is not, but they can't stick their money in a mattress or buy tons of gold or invest in ammunition and run for the hills.  Banks have to pay off depositors; insurance companies often aim to break
even on premiums and payouts and make their money on investing the cash
in between; pension funds can't make their long-term obligations
without making steady returns.Their very survival, in many cases, depends on making continuous returns off their free cash. 

Wisdom from Schoolhouse Rock:

You got a couple hundred bucks saved up in your birthday stash.Why not deposit them dollars in the bank instead?
Then at the end of the year you'll come out way ahead,
Because the bank'll pay you money in exchange for the use of your cash!
And that's called interest; you're makin' money that way,
And you can buy that gear about a year from today.