Coyote Blog

I got a lot of email that Republicans aren't libertarians and to stop complaining that they are not.  OK.  But let's look at their campaign messaging in the context of their own values.

Republicans had a golden opportunity to use the results of a natural experiment over the last four years between red and blue states.  Obama constantly harped on the fact that 3.5 million new jobs had been created on his watch.  Rather than play dueling statistics or end points in this analysis, the Republicans should have taken advantage of existing red/blue data:

Yes.  And the vast majority of these jobs were created in states like Texas which have been successful precisely because they have labor and tax policies which you, Mr. Obama, oppose.  And they have been created in industries like Oil and Gas production that you, Mr. Obama, have done your best to hinder.  All the jobs you claim to have helped to create were actually facilitated by a philosophy of government you oppose, by regulatory policy you would overturn if you could, and in industries you would prefer did not exist.   States like Texas -- with organic growth driven by private capital -- stand in stark contrast to your investments of our taxpayer money in bankrupt companies like Solyndra.   If you had had your way, Mr. Obama, few of these jobs would have been created.  Yes, this country saw some job creation, but it occurred despite your efforts, not because of them.

Instead of this clear kind of message, we get a bunch of wonky stuff about tax deductions vs. tax rate changes.  Heck, even if you told me I had to run my campaign on the single plank of eliminating tax deductions, I could have done a better job.  I saw this part of the debate that Romney supposedly won.  His explanation was lame.  What about this instead:

This country over the past several decades has increasingly become plagued by cronyism.  Whether it be Wall Street bankers or public employees unions or casket sellers in Louisiana, everyone wants to try to convert influence with the government into taxpayer money for themselves.  We have to end this.  And a good place to start is with the tax code.  Every special deduction and tax credit in the tax code is a giveaway to some special interest.  At best it is a misguided attempt, like the money we wasted in Solyndra, of politicians to try to pick winners and losers, to say that one kind of spending is somehow better than another.  At worst, these deductions are a crony giveaway.  Sure, it's  eliminating these deductions will help reduce the deficit.  But even more importantly, eliminating them would be an opening shot in the war to take cronyism and corporatism out of Washington.

C. Boyden Gray and Adam White make the case that Dodd-Frank is an enormous gift to big banks, for two reasons:

• By putting large banks in a special class -- essentially too big to fail -- it ensures that these banks will be able to raise capital far more easily than can smaller banks, since investments in larger banks are essentially guaranteed by the US government.  This is the same mechanism by which Fannie and Freddie crowded out most other sources of mortgage financing.
• By creating an enormous mass of new regulations, large banks get a cost advantage because they can much more easily pay these fixed costs as they are amortized over a much larger business.

I know what you are thinking -- in this post title Coyote has engaged in some exaggeration to get our attention.  But I haven't!  Felix Salmon actually says this, in reaction to a group of CEO's who wrote an open letter to the feds seeking less deficit spending.

There are lots of serious threats out there to the economic well-being and security of the United States, and the national debt is simply not one of them.  Nor is it growing. The chart on the right, from Rex Nutting, shows what’s actually going on: total US debt to GDP was rising alarmingly until the crisis, but it has been falling impressively since then. In fact, this is the first time in over half a century that US debt to GDP has been going down rather than up.

So when the CEOs talk about “our growing debt”, what they mean is just the debt owed by the Federal government. And when the Federal government borrows money, that doesn’t even come close to making up for the fact that the CEOs themselves are not borrowing money.

Money is cheaper now than it has been in living memory: the markets are telling corporate America that they are more than willing to fund investments at unbelievably low rates. And yet the CEOs are saying no. That’s a serious threat to the economic well-being of the United States: it’s companies are refusing to invest for the future, even when the markets are begging them to.

Instead, the CEOs come out and start criticizing the Federal government for stepping in and filling the gap. If it wasn’t for the Federal deficit, the debt-to-GDP chart would be declining even more precipitously, and the economy would be a disaster. Deleveraging is a painful process, and the Federal government is — rightly — easing that pain right now. And this is the gratitude it gets in return!

I seldom do this, but let's take this apart paragraph by paragraph:

There are lots of serious threats out there to the economic well-being and security of the United States, and the national debt is simply not one of them.  Nor is it growing. The chart on the right, from Rex Nutting, shows what’s actually going on: total US debt to GDP was rising alarmingly until the crisis, but it has been falling impressively since then. In fact, this is the first time in over half a century that US debt to GDP has been going down rather than up. 

So when the CEOs talk about “our growing debt”, what they mean is just the debt owed by the Federal government.

Duh.  Of course they are talking about the government deficit and not total deficit.   But he is setting up the game he is going to play throughout the piece, switching back and forth between government debt and total debt like a magician moving a pea between two thimbles.  We can already see the game.  "Look folks debt is not a threat, it is going down", but it is going down only at this total public and private debt number.  The letter from the CEO's made the specific argument that rising government debt creates current and future issues (see: Europe).  Just because all debt may be going down does not mean that the rise of one subset of debt is not an issue.

Here are two analogies.  First, consider a neighborhood where most all the residents are paying down their credit card debt except for Fred, who is maxing out his credit cards and has just taken out a third mortgage.  The total debt for your whole neighborhood is going down, but that does not mean that Fred is not in serious trouble.

Or on a larger scale, take consumer debt.  Most categories of consumer debt are falling in the US.  But student debt is rising alarmingly.  Just because total consumer debt may be falling doesn't change the fact that rising student debt is a serious threat to the well-being of a subset of Americans.

And when the Federal government borrows money, that doesn’t even come close to making up for the fact that the CEOs themselves are not borrowing money

What??  Whoever said that the role of the Federal government is to offset changes in corporate borrowing?  In his first paragraph, he already called the rise in total debt "alarming", and I get the sense that both CEO's and consumers agree and so they have been trying to reduce their debts.  So why should the Feds be standing athwart the private unwinding of an "alarming" problem?    And how does he know CEO's and their corporations are part of this deleveraging?  I see no evidence presented.  Corporate debt is but a small part of total US debt.  Corporations may be a part of this, or not.

In fact, they are not.  Corporate borrowing in the securities market has increased almost every quarter since 2008, such that total corporate bond debt is about 10-15% higher than in 2008 (see third chart here).  And here is total debt to GDP broken down by component  (this is for non-financial sectors) source.

Government debt is basically offsetting the consumer deleveraging.  Since consumers have to eventually pay this government debt off, as they are taxpayers too, then the government is basically flipping consumers the bird, forcing them to take on debt they are trying to get rid of.  Hard working consumers think they are making progress paying off debt, but the joke is on them - the feds have taken the debt on for them, and the bill will be coming in future taxes for them and their kids.

He might argue, "this is Keynesianism."  But is it?  If corporations are actually deleveraging, we still don't know how.  Is it through diverting capital investment to debt repayment (as I think Salmon is assuming) or are they raising capital from other sources and rejiggering the right side of their balance sheets?  And even if this deleveraging is coming at the expense of corporate investment, I thought Keynesians virtually ignored investment or "I" in their calculations  (you remember, don't you, from macro: C+I+G+X-M?).  In fact, if I remember right, "I" is treated as an exogenous variable in the famous multiplier "proof".

Money is cheaper now than it has been in living memory: the markets are telling corporate America that they are more than willing to fund investments at unbelievably low rates. And yet the CEOs are saying no. That’s a serious threat to the economic well-being of the United States: it’s companies are refusing to invest for the future, even when the markets are begging them to.

This is the real howler -- that "markets" are sending a low-interest signal.  Markets are doing nothing of the sort.  The Federal Government, via the Fed, is sending this signal with near-zero overnight borrowing rates and $30-$40 billion a month in money printing that is used to buy up government debt from the market.  If any signal is being sent at all, it is that the Federal Government is main economic priority is continuing to prop up the balance sheet and profitability of major US banks.

Investment is also not solely driven by the price of funds.  There must be opportunities where businesses see returns that justify the spending.  Unlike the Federal government, which is A-OK blowing billions on companies like Solyndra, businesses don't invest for the sake of spending, they invest for returns.  A soft economy combined with enormous government driven uncertainties (e.g. what will be our costs to comply with Obamacare) are more likely to affect investment levels than changes in interest rates.

 Instead, the CEOs come out and start criticizing the Federal government for stepping in and filling the gap. If it wasn’t for the Federal deficit, the debt-to-GDP chart would be declining even more precipitously, and the economy would be a disaster. Deleveraging is a painful process, and the Federal government is — rightly — easing that pain right now. And this is the gratitude it gets in return!

This is where economic thinking has ended up in 2012:  To Salmon, it does not matter where the Federal government spends this money, so long as it is spent.  He never even tries to justify that the government is running up debt in a good cause, because what it spends money on does not matter to him.  For him, the worst possible thing for the economy is for people to spend their money paying down debt.  Spend it on more drone strikes or more Solyndras or more squirrel research -- it does not matter to Salmon as long as the money is used for anything other than to pay down debt.

Here is the bottom line:  Businesses and individuals are trying to reduce their debt.  And many hard-working people think they are being successful at this.  But the joke is on them.  The government is running up trillions in debt in their name, thwarting American's desire to de-leverage.  Mr. Salmon wants us to thank the government for this.  Hah.

All-in-all, this is an awful argument to try to justify Congressional and Presidential fecklessness vis a vis  the budget.

A new California mandate on employers I completely missed:

California Governor Jerry Brown signed a law that permits as many as 6.3 million private workers without a pension plan to set aside retirement money for management by the state.

It is the first state-run pension program for nongovernment employees and may add as much as $6.6 billion to funds managed by the California Public Employees’ Retirement System, the biggest U.S. pension. Calpers, as the fund is known, has assets of $242 billion.

The law is aimed at businesses with five or more employees that don’t offer pensions or 401(k) savings programs. The law requires companies to contribute 3 percent of a worker’s salary to a retirement account. Workers will be enrolled in the program unless they choose to opt out.

This is just insane, and I don't remember any public debate on it.  Given that the government already has a forced retirement program with a much higher percentage contribution (Social Security with 16% of wages when including the employer piece), my guess is that this is meant as a bone for or a bailout of Calpers.  Calpers wields enormous political power in the state, and it is entirely believable that they alone are behind this.  Calpers is about to be forced to acknowledge that it is billions short of what it needs to cover future pension obligations because it has been assuming unrealistically high returns form its investments.  Without those high returns, more money needs to be put in the fund to cover public employee pensions that march to ridiculous levels.

I have skimmed the law, and there is nothing in there about what returns will be paid to these new private employees.  My guess is that private contributions will be used as a slush fund to make sure public employees get paid, because they DO have defined benefits, as well as a justification to pay Calpers managers more money.  I can absolutely guarantee that when push comes to shove and Calpers is short of money, private employees will see their benefits rolled back and their contributions going to public employees' pockets.

This is also insane for two other reasons:

1. In California, there has probably been a zillion lawsuits with the state punishing private entities for running "opt-out" rather than "opt-in" systems.   Having to explicitly opt out to keep ones money is a scam only the government is allowed to get away with
2. In our company, all but a few of our workers are already retired, working part-time for us to keep busy.  The vast majority of our employees, for example, are on Social Security and many also have private pensions.  So why am I forced to set up all the expensive infrastructure to provide 401K contributions to people who are all drawing down their 401k's?

Rolling Stone Magazine has an good story on the conviction of a number of banks and brokers on charges of bid-rigging, specifically on contracts for short-to-medium term management of municipal bond cash accounts.  Apparently brokers were paid by certain banks to be given a look at all the other bids before they made their final bid.  The article focuses mainly on the ability of winning bidders not to bid any higher than necessary, though I would suppose there were also times when, given this peek, the winning bidder actually raised its bid higher than it might have to ace out other bidders.

This is classic government contracting fraud and it's great to see this being rooted out.  I am not wildly confident it is going to go away, but any prosecutorial attention is welcome.

But I am left with a few questions:

• It seems that government contracting is more susceptible to this kind of manipulation.  Similar stories have existed for years in state highway contracting, and the municipal bond world has had accusations of kick-backs for years.  Is this a correct perception, or is the rate of fraud between public and private contracting the same but we just notice more with the government because the numbers are larger, the press coverage is greater, and the prosecutorial resources are more robust?
• If government contracting of this sort is more susceptible to fraud, why, and how do we fix it?

The latter is not an academic question for me.  I run a company that privately operates public recreation areas.  I bid on and manage government contracts.  Frequently, a major argument used against the expansion of such privatization initiatives is that past government outsourcing and contracting efforts have been characterized by fraud and mismanagement.  The argument boils down to "the government has so many management problems that it can't be trusted with contracting for certain services so it needs to operate those services itself."

The only way to reconcile this view is to assume that private actors are more likely to act fraudulently and be dishonest than public employees.  If this were true, then the public would be safer if a public management process of questionable ability were applied towards public employees rather than outside private contractors, because those who were being managed would be less likely to take advantage.  And certainly there are plenty of folks with deep skepticism of private enterprise that believe this.

However, I would offer that only by adopting an asymmetric view of what constitutes fraud would we get to this conclusion.  Clearly, banks colluding to shave a few basis points off municipal asset returns is fraud.     As the author of the Rolling Stone piece puts it several times, the crime here is that the public did not get the best market rate.  So why is, say, elected officials colluding with public employees unions to artificially raise wages, benefits, and staffing levels above market rates not fraud as well?  In both cases insiders are manipulating the government's procurement and political processes to pay more than the market rates for certain services.

This is Bastiat's "seen and unseen" of the privatization debate.   Yes, the world is unfortunately littered with examples of government procurement fraud.  This is often cited as a reason for maintaining the status quo of continued government management of a diverse range of services.  But what we miss, what is unseen, is that these government services are often run with staffing levels, work rules, productivity expectations, and pay rates that would constitute a scandal if uncovered in a division of a corporation, particularly if the workers were spending a lot of money to make sure the manager handing them this largess was able to keep his job.

Yes, the public lost several basis points on its investments when it did not get the market rate of return from cheating bankers.  But it loses as much as 50% of every tax dollar sent to many state agencies because it does not get market rates (and practices) for state labor.

Turns out the guy who gasses up a school bus has a green job.

When Bureau of Labor Statistics Acting Commissioner John Galvin balked on what qualifies as a green job under the agency definition, Issa responded, “Just answer the question.”

“Does someone who sweeps the floor at a company that makes solar panels -- is that a green job?” Issa asked.

“Yes,” replied Galvin, who also acknowledged that a bike-repair shop clerk, a hybrid-bus driver, any school bus driver and “the guy who puts gas in a school bus” are all defined as green jobs.

He also acknowledged that an oil lobbyist, if his work is related to environmental issues, would also have a green job.

It gets better.  Apparently, when I worked at the Exxon refinery in Baytown, TX, I had a green job:

The Bureau of Labor Statistics states a green job is either: a business that produces goods or provide services that benefit the environment or conserve natural resources, or a job in which a worker's duties involve making their establishment's production processes more environmentally friendly or use fewer natural resources

I have never encountered an industrial engineering job anywhere that was not concerned with having their processes use fewer natural resources.

I would argue the greenest of jobs are held by oil and other commodity speculators and traders.  They ensure that prices at all times accurately match our current understanding of the scarcity of each resource.  Without these accurate pricing signals, all efforts to properly invest to use more or fewer of these materials would be impossible.  Just look at the "success" of investments like Solyndra that were made irregardless of these market pricing signals.

Whether crimes were involved in the failures of Enron, Lehman, & Bear Stearns is still being debated.  All three essentially died in the same way (borrowing short and investing long, with a liquidity crisis emerging when questions about the quality of their long-term investments caused them not to be able to roll over their short term debt).  Just making bad business decisions isn't illegal (or shouldn't be), but there are questions at all three whether management lied to (essentially defrauded) investors by hiding emerging problems and risks.

All that being said, MF Global strikes me as an order of magnitude worse.  They had roughly the same problem - they were unable to make what can be thought of as margin calls on leveraged investments that were going bad.  However, before they went bankrupt, it is pretty clear that they stole over a billion dollars of their customers' money.  Now, in criticizing Wall Street, people are pretty sloppy in over-using the word "stole."  But in this case it applies.  Everyone agrees that customer brokerage accounts are sacrosanct.  No matter what other fraud was or was not committed in these other cases, nothing remotely similar occurred in these other bankruptcies.

A few folks are talking civil actions against MF Global, but why isn't anyone up for criminal charges?  Someone, probably Corzine, committed a crime far worse than anything Jeff Skilling or Ken Lay were even accused of, much less convicted.   This happens time and again in the financial system.  People whine that we don't have enough regulations, but the most fundamental laws we have in place already are not enforced.

Swiss government bonds are trading at rates that imply a negative interest rate.  The German government is issuing bonds with interest rates of zero that are actually trading above face value.

This is really bad news.  Investing in these securities is effectively the equivalent of putting money in one's mattress -- it means that investors don't perceive any money-making uses for their money better than paying paying financially strong governments to keep it safe for a while.   I am far from an expert on banking regulations, but my first guess on this is that this is at least in part a function of bank capital requirements that effectively require banks to put a lot of cash into government securities no matter how bad the return.

Germany and Switzerland certainly are providing some value in creating a safe haven for capital, but I wonder if in the long-run this is anything but destructive, shifting wealth and investment out of the private economy and into investments with no return.

Mark Tapscott writes:

Legislators in the California Assembly have approved on a 68-0 vote a bill that would exempt multiple categories of state and local government employees from having their names disclosed in public property records, according to Steven Greenhut....

Greenhut, who is vice president of the Franklin Center for Government Public Integrity points out that such a measure has implications far beyond public safety concerns: "Public officials and their family members will be able to hide their identities, which will undermine the reliability of property transactions. Dirty officials will pull off real estate scams without scrutiny," he said.

As it turns out, Arizona has a prohibition from publishing the home addresses of government officials over the Internet.  Which Sheriff Joe Arpaio (who else) has used to try to thwart investigations of his real estate dealings

In 2004, during an election cycle, reporter John Dougherty found that Arpaio had over a million dollars of investments in commercial real estate parcels.  Dougherty asked the question, how does a lifetime public official making $78,000 a year have so much real estate?  Arpaio could have replied that his family was independently wealthy or that he had parlayed his real estate investment from rags to riches.  Instead, Arpaio used an obscure law aimed at protecting the home addresses of government officials to remove access to any public records of his commercial real estate transactions at the same time he removed his home address from these data bases.  Instead of explaining where the money came from, he used his power to cover his tracks.

If passed, this means that California officials can take bribes with impunity, as long as they take these bribes in the form of real estate.

In a Senate budget hearing with the Department of Energy, one would have expected a lot of questions about the loan program to avoid future Solyndras.  But Al Franken uses his time to pester the DOE to give taxpayer money to a corporation in his state.

This is the answer as to why so many bone-headed loans were made despite evidence of likely disaster.  You can bet that Boxer and Feinstein were all over the DOE several years ago pushing for the Solyndra loan.  Franken doesn't give a rip whether the loan is smart or not, or whether the taxpayers' money is safe or not.  He wants a multi-million dollar press release to get himself in the Minnesota news for a newscycle or two helping out the home state.  After that, the money's purpose has been achieved and I can't imagine him caring what happens to it.  Certainly that is the fate of most of these jobs-related government investments - big splashes up front with promises of hundreds of new jobs, but absolutely no scrutiny in the back end when, likely as not, these jobs don't actually materialize.

Investors have a saying - your first loss is your best loss.  In other words, if you think an investment sucks, swallow your pride, take your lumps, and get out entirely now.

This is NOT how we have dealt with the financial crisis.  Through a series of bailouts, we have tried to keep failing financial institutions and countries on life support.   We have dragged out the reckoning on mortgages, so we still have not had a real clearing in the real estate market.  Worse, we have postponed, even entirely interrupted, financial accountability for those who made bad investments or took on too much debt.

Here is an interesting counter-example - Iceland, which basically went entirely bankrupt along with pretty much all their banks, is on the road to recovery.

Looks like I will be on Fox & Friends at 8:15 EST tomorrow (Wed) to discuss the State of the Union, and specifically the Obama administration and public vs. private investment.  That will make four national TV appearances and 4 entirely different topics (parks, minimum wage, electric car efficiency, and infrastructure investments).  I'm really honing a razor-sharp personal brand.

As I predicted, the various highly touted European debt and currency interventions last month did squat.  This is no surprise.  The basic plan currently is to have the ECB give essentially 0% loans to banks with the implied provision that they use the money to buy sovereign debt.  Eventually there are provisions for austerity, but I wrote that I don't think it's possible these will be effective.   It's a bit unclear where this magic money of the ECB is coming from - either they are printing money (which they refuse to own up to because the Germans fear money printing even more than Soviet tanks in the Fulda Gap) or there is some kind of leverage circle-jerk game going where the ECB is effectively leveraging deposits and a few scraps of funding to the moon.

At this point, short of some fiscal austerity which simply is not going to happen, I can't see how the answer is anything but printing and devaluation.  Either the ECB prints, spreading the cost of inflation to all counties on the Euro, or Greece/Spain/Italy exit the Euro and then print for themselves.

The exercise last month, as well as the months before that, are essentially mass hypnosis spectacles, engineered to try to get the markets to forget the underlying fundamentals.  And the amazing part is it sort of works, from two days to two weeks.  It reminds me of nothing so much as the final chapters of Atlas Shrugged where officials do crazy stuff to put off the reckoning even one more day.

Disclosure:  I have never, ever been successful at market timing investments or playing individual stocks, so I generally don't.  But the last few months I have had fun shorting European banks and financial assets on the happy-hypnosis news days and covering once everyone wakes up.  About the only time in my life I have made actual trading profits.

Thought problem:  I wish I understood the incentives facing European banks.  It seems like right now to be almost a reverse cartel, where the cartel holds tightly because there is a large punishment for cheating.  Specifically, any large bank that jumps off the merry-go-round described above likely starts the whole thing collapsing and does in its own balance sheet (along with everyone else's).  The problem is that every day they hang on, the stakes get higher and their balance sheets get stuffed with more of this crap.  Ironically, everyone would have been better getting off a year ago and taking the reckoning then, and certainly everyone would be better taking the hit now rather than later, but no one is willing to jump off.  One added element that makes the game interesting is that the first bank to jump off likely earns the ire of the central bankers, perhaps making that bank the one bank that is not bailed out when everything crashes.  It's a little like the bidding game where the highest bidder wins but the two highest bidders have to pay.  Anyone want to equate this with a defined economics game please do so in the comments.

Investors everywhere were shocked to see that MF Global seems to have lost over a billion dollars of their customers capital.  In most cases, this capital was cash customers thought was sequestered as collateral for their trading accounts.  MF Global took its customers money and used that money as collateral in making risky, leveraged bets on European sovereign debt, bets that fell apart as debt prices fell and MF Global faced margin calls on its bets that it did not have the liquidity to cover.

Certainly it strikes most folks as unethical to lose the assets in your customers' brokerage accounts making bets for the house.  But it turns out, it may have been entirely legal.  This article is quite good, and helps explain what was going on, what this "hypothecation" thing is (basically a fancy term for leveraging up assets by using them as collateral on loans), and why it may have been legal.

In short, the article discusses two regulatory changes that seemed to be important.  The first was a 2000 (ie Clinton era, for those who still think these regulatory screwups are attributable to a single Party) relaxation in how brokerages could invest customers' collateral in their trading accounts.  The second was a loophole where brokerages created subsidiaries in countries with no controls on how client money was re-used (in this case mostly the UK) and used those subsidiaries to reinvest money even in US brokerage accounts.

The increase in leverage was staggering.  Already, cash in most commodities trading accounts is leveraged - customers might have only 30% of the value of their trading positions as collateral on their margin account.  Then the brokerage houses took this collateral and used it as collateral on new loans.  Those receiving the collateral on the other end often did the same.

MF Global would be bad if it were fraud.  But it is even worse if MF Global is doing legally what every other brokerage house is still doing.

Here is the minimum one should do:  Diversify brokerage accounts.  We diversify between bonds and stocks and other investments, but many people have everything in one account with one company.  I am not sure anyone can be trusted any more.  My mutual funds are now spread across three firms and, if I grow my brokerage account for individual stocks and investments (right now it is tiny) I will split that as well.

1.  Accepting for a moment that the purpose of the loan program under which Solyndra received its money was truly reduction of CO2 output and fossil fuel use, what is the metric the DOE uses to score these investments against these goals (e.g. tons of CO2 output avoided over the next 10 years per dollar of government investment).

2.  How did Solyndra and other companies that were accepted for the program score on your metric?  How did companies that were turned down score?

Of course there was no such analysis -- the government appears to have invested in whatever companies raised the most money for Obama or got Joe Biden's heart palpitating or both.  Even if one pulls the obvious politics out of it, it appears they invested in stories they found appealing, the same mistake many novice investors make.

The Left works hard to wrap itself in the mantle of science, and Republicans just let them do so.  If Chu wanted to take the high ground of  trying to do the right thing for US energy policy, questioners should have taken him at his word and challenged how well his internal process matched his bold words.   Politicians are too obsessed with finding some crime or smoking gun.  The underlying failure is that the loan process does not, never will, and in fact cannot match the stated ideals and goals of the program.

I hinted at it in my last post, but have addressed it in more depth in my column this week at Forbes.  A brief excerpt:

The theme from all these failures is distorted signals and corrupted communication.  People, no matter how savvy, cannot possibly research every nook and cranny of the economy before making an investment.  They make decisions, therefore, based on signals – prices, interest rates, perceived risks, and the profit history of other similar investments.  If these signals are artificially altered or corrupted, bad decisions that destroy wealth and growth will result.

Which brings me back to education.    I will tell you something almost every business owner knows:  We business owners may whine from time to time that banks won’t lend us money, but what really is in short support are great people.  Nothing has more long-term impact on an economy than amount and types of skills that are sought by future workers.  That is why everyone accepts as a truism that education is critical to economic health.

Unfortunately, there is good evidence that our education policies have already done long-term harm.   The signals we send to kids making their higher education plans have disconnected them from reality in a number of fundamental ways, causing them to make bad decisions for themselves and the broader economy.

Examples follow.  Read it all.

From AutoGreenBlog

Output of cellulosic ethanol will surge starting in 2013, according to the U.S.' largest corn-based biofuel production firm, Poet LLC.

Poet says 2013 marks the start of commercial-scale cellulosic ethanol production in the U.S. and predicts its lone facility will "open the floodgates" for the advanced biofuel....

As Poet exec Greg Hartgraves points out, production of cellulosic ethanol is expensive and that means those floodgates need to be helped open with federal monies. Without an energy policy mandating its production, U.S. firms are likely to shy away from the cellulosic biofuel, he said.

Duh.  It's a substitute that is both less effective (lower btu per gallon) and more expensive that what it is supposedly substituting.   I am just floored at the number of investors who are putting money up on the come with an expectation that somewhere down the road they can convince the government to subsidize them.  Poet knows this plant is uneconomic but has built it anyway, probably hoping to extract promises of support from candidates in the Iowa caucuses.  Kleiner Perkins did the same think with Fisker Automotive, making early stage investments that could only be bailed out by future political largess.  As Ayn Rand would say,the aristocrats of pull.

Ray Lane of VC Kleiner Perkins is seen in this video trumpeting how the Obama Administration is, for the first time in his memory, succesfully making investments in private companies.  His main example:  Solyndra!

The reason this is particularly timely and fascinating is that just a few weeks ago, Ray Lane took delivery of the first Fisker Karma electric car, financed with $529 million of our tax money and promoted with $7500 of our tax money on every sale,  Mr. Lane and Kleiner are investors in Fisker (and Lane is Fisker's Chairman) and therefore huge beneficiaries of Obama's largess, and Mr. Lane got the first Karma as a big thank you for his political connections that helped score the cash.

Of course Kleiner (who also hired green Crony-in-chief Al Gore) is going to be thrilled with the government money. Nothing is worse than being a VC in with a large early round position in a company and being unable to get the next stage of investment. Since it appears they could not get any private investors to fund this, the taxpayer money probably saved their investment .... at least for a while.

Update: Ray Lane is apparently ticked off by the negative publicity surrounding the Fisker Karma and the money they received from taxpayers. Tough. Surely he is used to his investors being ticked off about bad outcomes. Well, now he gets to see how REALLY ticked off his investors can be when their money was taken against their will, even without their knowledge. At least he can tell his institutional guys, when things go bad, that they came in with eyes open. What's his response to taxpayers?

For those who have not seen it, my article on how the Fisker Karma, even on all electric, uses more fossil fuels per mile than an SUV is here.

Or maybe it is more correct to say that the taxpayer is being set up to keep BofA counter-parties whole. From Bloomberg, via Zero Hedge:

Bank of America Corp. (BAC), hit by a credit downgrade last month, has moved derivatives from its Merrill Lynch unit to a subsidiary flush with insured deposits, according to people with direct knowledge of the situation.

The Federal Reserve and Federal Deposit Insurance Corp. disagree over the transfers, which are being requested by counterparties, said the people, who asked to remain anonymous because they weren’t authorized to speak publicly. The Fed has signaled that it favors moving the derivatives to give relief to the bank holding company, while the FDIC, which would have to pay off depositors in the event of a bank failure, is objecting, said the people. The bank doesn’t believe regulatory approval is needed, said people with knowledge of its position.

Three years after taxpayers rescued some of the biggest U.S. lenders, regulators are grappling with how to protect FDIC- insured bank accounts from risks generated by investment-banking operations. Bank of America, which got a $45 billion bailout during the financial crisis, had $1.04 trillion in deposits as of midyear, ranking it second among U.S. firms.

“The concern is that there is always an enormous temptation to dump the losers on the insured institution,” said William Black, professor of economics and law at the University of Missouri-Kansas City and a former bank regulator. “We should have fairly tight restrictions on that.”

Obviously I am not a huge fan of bank regulation, but if the taxpayer is going to insure deposits, then the government has got to set and enforce capital restrictions on how those deposits are invested.  How many times do we have to learn this lesson?  The S&L crisis and the Texas bank collapse of the 1980's was caused by the exact same BS, investing taxpayer insured deposits in increasingly risky investments.

Normally, in a free economy, we expect lenders to enforce rules and discipline on those to whom they lend, just as fire insurers in the 19th century developed the first building codes and inspections to protect their themselves.  But if depositors are insured, they are not going to get worked up too much about BofA -- I am a depositor but I know the Feds will make me whole if the bank crashes.  Deposit insurance provides comfort to depositors and pays some dividends in heading off bank panics, but at the same time it relieves the bank of any accountability for how the deposits are invested unless the US government takes on that role.  Of all the BS regulations financial firms have to put up with, this is the one that should actually exist, and the implication in this article is that despite thousands of pages of new regulation, these basic protections still don't exist.  Sure, they exist in law, but there seems to be nothing to stop an agency from issuing exemptions, and this Administration has shown itself to love giving exemptions.

This reminds me a ton of the AIG bailout.  For some reason, there are a group of Wall Street companies (cough Goldman cough) that seem to have immense political power to protect investments in which they are a counter-party.  To this point, people have been expecting that the BofA holding company might soon fail, but the underlying banks would be fine and just sold off in pretty good shape.  Most of the trash is apparently at the holding company level.

The losers in all this are the counter-parties to these various derivatives, who would rather have a better set of assets to grab if the ship starts sinking.  Of course, they don't have any right to this -- they didn't make these original deals with the depository banks, they made them with Merrill Lynch and other trash BofA has bought.  But never-the-less, the Fed seems fired up to give these guys a special deal.  It reminds me of the Solyndra deal where the Administration allowed certain private parties to move ahead of the US Government on the creditor list, though at least in Solyndra's case these parties actually put some money into the pot for the privilege.  This seems to be a straight giveaway, and it is no surprise that the FDIC is apoplectic.

Megan McArdle looks into where all that green seed capital is going.  It turns out it is going the same place most other government "investments" go -- to large, well-connected companies who don't actually need the money but will sure appreciate it come election time.

But I have highlighted what jumped out at me: most of the money has gone to enormous companies that should have no trouble accessing capital.  Established utilities, large multinational auto manufacturers, a global warehouse owner.  The bulk of these funds are not going to rectify some gap in the capital markets.  They're straight subsidies to huge corporations.  Even some of the smaller firms/deals are owned by large corporations like Total SA.

Giving large, established companies extra-cheap loans to build power plants, run transmission lines, and fix up the roofs of their warehouses is, in the immortal words of P.J. O'Rourke, like paying a Dairy Queen owner to keep his ice cream freezers on.

From my Forbes post today, the following letter:

From:  The Consumers and Small Businesses of China

To:   The United States Senate

Re:  Currency Exchange Rate Oversight Reform Act of 2011

Dear Senators:

Thanks!  For years, our government has pursued a currency and trade policy that has subsidized your American consumers at the expense of our own here in China, and while we are unsure exactly why you would want to end this arrangement (we presume due to powerful lobby by your large manufacturers), we are happy that you are doing so....

A low yuan makes Chinese products cheap for Americans but makes imports relatively dear for Chinese.  So-called "dumping" represents an even clearer direct subsidy of American consumers over their Chinese counterparts.  And limiting foreign exchange re-investments to low-yield government bonds has acted as a direct subsidy of American taxpayers and the American government, saddling China with extraordinarily low yields and creating inflationary pressures.

Every single step China takes to promote exports is in effect a transfer of wealth from Chinese citizens to Americans, and we are tired of it.

Read it all.

From my own state of Arizona (emphasis added)

A group of small-business proponents is asking the Legislature to guarantee startup money for Arizona enterprises.

The backers of a so-called Arizona Fund of Funds made their pitch to a handful of lawmakers Monday, saying businesses need government help to start hiring again.

That help should come in the form of tax credits, said John Kowalski, who is promoting the idea through the Arizona Growth Foundation, a group of venture capitalists working to bring more investment to the state.

The credits would be a safety net to encourage venture capitalists to invest in a pool of money that would be distributed to emerging businesses, said Kowalski, a former executive with the Arizona Small Business Association....

The government's role is to serve as a guarantor, through the tax credits, in case the investments don't yield the projected results.

While this is being sold as something for small business, what it looks like to me is just more of the same socialization of bankers' losses that helped get us into this financial mess.  I suppose this "profits are mine if it makes money, losses are the governments if it loses money" never grows old for investment bankers and VC's, but why is anyone taking this seriously anymore?

Faced with serious questions after the Solyndra failure as to their ability to make intelligent investments, the government is reacting by.... accelerating the approval of other green energy loans.  Again, the difference with the private sector is not that the private sector makes no mistakes, but there is real accountability for those mistakes which lead to changes in behavior.

I have argued many times that private investors, over the long haul, will make better investment choices than the government, in part because they have better incentives and information to guide their decision-making.  The straw-man argument against this is to point out anecdotes of failed private investments.  Heck, I can do that.  Pets.com famously blew through $300 million of private capital with a corporate strategy that never made much sense to people.

The Pets.com investors were chagrined, and probably learned a lesson from their mistake.  Certainly most of us thought the blame, if blame existed, for the debacle rested on the investors for pouring money into a bad proposition.  Certainly no one accused the management of fraud -- I am sure they were diligently, honestly trying to make the company a success, even if they were misguided as to where that success lay.

As it turned out, everyone, not just the Pets.com investors, learned from the mistake.  The failure was an important driver in an industry-wide rethink as to what a successful Internet business model might look like.  This benefit only came because people were willing to acknowledge not just that the Pets.com investment was flawed, but that it represented a systematic mistake that was being made vis a vis Internet startup investments.

Now, consider solar manufacturer Solyndra.  It failed this week, likely taking with it most of $535 million in taxpayer money that the Obama Administration was so eager to give them that it short-cutted its internal processes to fork over the cash more quickly.

Many of us on the outside would love to see the government rethink such investments in a systematic way, and reconsider if it is even possible for the government to make such investments, and in particular whether "green jobs" investments make any sense at all.

But the likelihood of that kind of introspection happening in the public world is about zero, and my bet is that Obama is going to propose more of the same tonight in his speech.

In fact, the Department of Energy (the source of the loan) and the FBI have today sent armed agents into Solyndra looking for evidence of fraud.   While Zero Hedge argues that fraud would be bad for Obama, in fact I think it would probably be the best possible outcome and one he is hoping for.  If he can say, "wow, you and I both got tricked here by some evil folks we are going to put in jail" it deflects attention from the fact that he put a half billion dollars of taxpayer money into a business plan that never made a lick of sense.

Another me-too solar manufacturer with a factory in California of all places was never going to compete in a global commodity market.  This company's plan was always to sell dollars for 50 cents and to make it up on volume.  I don't see how any investor thought this was going to work.  My guess is that the private investors didn't know much about solar and invested because it had a certain hip-ness to it, or less charitably, they knew it never made sense but hoped that Uncle Sam, once it was already in for a half billion, would keep more money flowing or perhaps agree to buy out their production at above market prices.

There may have indeed been fraud, but as in the case of Pets.com, it is perfectly possible no real internal fraud existed and they ran through a ton of money against a stupid business plan that should never have been funded.  Obama would greatly prefer to call it fraud rather than his own failure of judgement.  As an aside, Fannie and Freddie are pursuing exactly the same course in suing banks, arguing that they were defrauded by the banks in buying mortgages, a fairly laughable proposition in the great scheme of things when one considers Fannie and Freddie were at the forefront of the industry in driving down lending standards and promoting the expansion of the mortgage market.

My new column is up at Forbes, and discusses why politicians, particularly this administration, think they can allocate capital better than the market

The problem is that this top-down override of market capital allocations is almost certain to destroy wealth, because there are at least two problems with it (beyond the obvious liberty and property rights issues).

First, the decisions are being made by, at most, a few hundred government workers.  There is no possible way these workers can ever gather the knowledge and information posessed by millions of private actors making similar investment decisions.  Like monkeys throwing darts, some of the investments will work out, but on average their success rate has to be far lower than the network of individuals in the broader economy.

Second, and probably more important, government decisions-makers have terrible incentives when making these investments.  Seldom, if ever, are government re-allocations of capital made with an expectation of earning a return.  In fact, many of these programs promote themselves explicitly as shifting capital to investments no rational private investor would touch.  These investments are undertaken because they promote some sexy technology, or create jobs among a favored constituency, or even just because they make for a nice bullet point on a politician’s reelection web site.

Obama’s investment of taxpayer money into Solyndra is a great example.  It is clear little due diligence was completed before the loan guarantees to Solyndra were rushed out the door in 2009 in time to meet Energy Secretary Steven Chu’s artificial target date for the first loan of Obama’s green jobs program.  A good, well-timed sound bite on the evening news was more important that the actual details of the investment.

But, in fact, little due dilligence should have been necessary. ....