Obama Makes Safe Bet With Bernanke Reappointment

President Obama chose to go with the status quo and not shake things up at the Fed by reappointing Ben Bernanke. Despite widespread criticism, Obama praised Bernanke for helping the US avoid another Great Depression. Tim Iacono discusses how investors can be take advantage of from this latest development.

President Obama made it official this morning by nominating Federal Reserve Chairman Ben Bernanke to a second four-year term as reported by MarketWatch.

In a short statement in Martha's Vineyard with Bernanke standing at his side, Obama said Bernanke's background, temperament, courage and creativity helped to prevent another Great Depression.

"Ben approached a financial system on the verge of collapse with calm and wisdom; with bold action and outside-the-box thinking that has helped put the brakes on our economic free fall," Obama said.
...
In a brief statement, Bernanke said the goals of his second term at the central bank will be fostering stable economic conditions and financial markets. "We have been bold or deliberate as circumstances demanded, but our objective remains constant: to restore a more stable economic and financial environment in which opportunity can again flourish," Bernanke said.

"Mr. President, I commit today to you and to the American people that, if confirmed by the Senate, I will work to the utmost of my abilities -- with my colleagues at the Federal Reserve and alongside the Congress and the Administration -- to help provide a solid foundation for growth and prosperity in an environment of price stability."

While Bernanke may face some testy questioning during his confirmation hearings this fall, a result of last year's bait-and-switch bank rescue package and other questionable dealings with giant Wall Street firms while standing at the side of former Goldman Sachs CEO Hank Paulson at the Treasury Department, approval for a second term is a virtual lock.

This is good news for financial markets in general and will likely spur even higher prices for many commodities, one commodity in particular.

You see, Ben Bernanke has been a veritable one-man gold price appreciation machine.

References to the government's printing press earlier in the decade and his eagerness to use it as Fed chairman apparently have a way pushing the gold price higher.

Since his initial nomination in 2005, when gold was trading at only about $465 an ounce, the yellow metal has more than doubled, besting just about any other asset class during that time, so gold bugs should welcome today's news.

Let's just hope that the next four years are as good as the last four - $2,000 an ounce gold in the year 2013 when it comes time for his next re-nomination sounds about right to me.

This post has been republished from Tim Iacono's blog, The Mess That Greenspan Made.

Obama's Mortgage Aid Plan Will Pay Homeowners To Pay Their Mortgage

The latest mortgage aid plan proposed by the Obama administration seeks to encourage underwater homeowners to keep making mortgage payments by paying down a portion of their principal. This could prevent many homeowners from walking away from their mortgages when they owe much more than what their home is currently worth. The following article from Blown Mortgage, explains more details of the plan.

Home mortgage aid plans are hard to design. Because of how the ideologies behind open market and social responsibility are polarized no matter what you do with a mortgage aid plan pretty much half the nation is going to disagree with you.

Obama’s new mortgage plan is not perfect, not even his closest aides will say that. Its strongest opponents will point out that the new mortgage plan does not really cover for homes that have seriously dropped in value in the last months/years. Most of the families in trouble live in homes that have lost serious value, so there is a question mark in how effective this mortgage modification plan is going to be.

However the new plan has managed to incentivize the payment of mortgages and their previous modification so that it is worthwhile for banks and borrowers. This might not be enough to tip the scales on the millions of households that are at risk of losing their home this year but then again, it might.

If anything does help to tip the scales on the current crisis is to make it attractive for homeowners to pay their mortgage as well as reducing it’s principal and making it affordable on a monthly basis. Let’s face it, if your home is under water (it is worth less than what you owe on it) and there is no prospect of prices going up and you are struggling to pay the mortgage you might be inclined to cut your losses, give up and let the home go. Of course if someone is willing to give you some extra incentive to pay your mortgage and make it affordable, you might just give it a try.

What incentives does the Obama Mortgage Plan offer?
There are two main benefits or incentives homeowners that are in the red can take advantage of.

1. Once their mortgage has been modified and monthly payments begin the Treasury will pay an incentive for every mortgage payment a borrower pays on time that goes to pay the principal balance of the loan(The cash you actually borrowed, not the interest). This is interesting because it will help reduce the length of the loan and the amount of interest paid on it. Over a five year period this “incentive” could help reduce the principal on the loan by $5,000. Reducing the principal of the mortgage has of course even greater repercussions as years go by. If you have a 15 year mortgage and you reduce your principal by $5,000 in the first five years you will be actually saving yourself over $3,000 in interest by the end of your mortgage.

2.There is a trial period of three months before any modification is permanent. During those three months the homeowner must pay his mortgage on time. If he does he gets $1,000 from the government every year for next three years. If the mortgage isn’t paid on time there is no deal.

These are not huge benefits but they are something and they might just help people start thinking in a different way and help people dig themselves out of financial trouble.

This article has been republished from Blown Mortgage.

Can Obama Convince The World To Buy US Debt?

As the government plans to sell $65 billion in notes and bonds this week, we will see whether Obama, Geithner, and Bernanke were able to renew the confidence of overseas investors in America's ability to repay debt. Will countries like China and Saudi Arabia continue to buy US debt? Peter Schiff from Money Morning discusses this in the following post.

Just last week, Team Obama took its financial-crisis dog-and-pony show on the road. U.S. Treasury Secretary Timothy F. Geithner went to China. Federal Reserve Chairman Ben S. Bernanke visited Capitol Hill. And President Barack Obama, himself, embarked on a Mideast tour that started in Saudi Arabia.

This full-court press is not coincidental, and comes just as the federal government began unloading trillions of dollars in new U.S. Treasury obligations. The coordinated charm offensive is meant to assure the world-at-large that the United States can repay these obligations - without destroying the dollar.

Given the renewed weakness in the dollar and the recent expressions of concern from China-our largest creditor-about the safety of its current holdings, this is no easy sell. Not only must our leaders convince holders of our debt not to sell what they already own, U.S. officials must persuade these same foreign investors to back up the truck and buy a whole lot more. The hope is that a Dream Team - consisting of a charismatic politician, a skilled Wall Street banker with longstanding ties to China, and a respected Fed chairman - can close the deal. However, no matter how slick the sales pitch, no amount of lipstick can dress up this pig.

The most obvious fear the trio must address is that oversized deficits will persist indefinitely. Reading from a carefully scripted rebuttal book, all three proclaim that as soon as the stimulus revives our economy, the government will take all necessary steps to reign in the deficits that result. Bernanke’s testimony showcases this rhetorical shift. The Fed chairman claimed that catastrophe has been averted and that the recession is nearly over. As a result, he advised Congress to now focus on debt management. How he expects U.S. lawmakers to do that was left unexamined.

Setting aside the fact that the recession is far from over and that the stimulus will actually weaken the economy in the long run, Bernanke’s words were less a practical guide to Congress than a bromide for our foreign creditors. Meanwhile, President Obama carefully peppers his speeches with calls for Americans to live within their means, to save more and spend less, to produce more and consume less. But nothing in the government’s current fiscal or monetary policy will encourage such behavior. In fact, the objective of economic stimulus is to prevent such changes from taking place!

The laughter of Chinese students that greeted Secretary Geithner at Peking University shows how ridiculous this spiel sounds overseas. Actions speak louder than words, and the actions of the Obama administration are deafening. Multi-trillion-dollar deficits, bailouts, nationalizations, quantitative easing, and grandiose plans for government-provided healthcare, education, and alternative energy, render all of the administration’s claims of future prudence meaningless. If our leaders will not make tough choices now, why should anyone believe they will do so later, when those choices will be even harder to make?

Of course, it’s not just major holders - such as China and Saudi Arabia - that need to be convinced. Since the largest holders are already in so deep, they have the greatest short-term incentive to play ball. While throwing good money after bad is certainly a lousy investment strategy, it is politically expedient as it delays the need to officially acknowledge losses.

The spin is designed to keep all the smaller, more nimble holders from dumping their U.S. Treasury securities. The major holders can publicly pledge their commitment to Treasuries, while they privately planning their exit strategies, as long as they feel that the smaller holders won’t spook the market by front-running their trades.

However, once the psychology turns, there is no way to stop the rush for the exits. Remember how quickly the secondary market for subprime mortgages collapsed? One day, investors were lining up to buy; the next day, the stuff couldn’t be given away.

Make no mistake about it, we are issuing subprime paper and no amount of political spin can alter that reality. Bogus credit ratings aside, I think the world already knows this and it’s just a matter of time before someone admits it.

In the meantime, by continuing to lend, our creditors merely supply us the shovels to dig ourselves into an even deeper economic hole. Their credit enables our government to grow when it needs to shrink, finances bailouts of companies that should be allowed to fail, and enables a nation that should be saving and producing to continue borrowing and spending. As a result, the more money the world loans us, the less capable we are of paying it back. I really wish the world would stop doing us favors, as neither party can afford the consequences.

For a timely example, just look at California. With an unmanageable $20 billion deficit, California recently asked Washington for a bailout. With none immediately forthcoming, California was forced to make real and needed budget cuts. The hard choices, which will benefit California in the long run, would not have been made if federal funds had been committed. We all should be so lucky.

This article has been reposted from Money Morning. You can view the article on Money Morning's investment news website here.

Is The Obama Administration Covering Up What Really Happened In Treasury Meeting?

One watchdog group is accusing President Obama's administration of covering up what really went down during the major Treasury meeting that ended with 9 major banks selling equity stakes in their companies to the government for $250 billion. The Treasury originally stated that it had no documentation from the meeting, however, some documents were later obtained. The watchdog group insists some documents — potentially implicating current Treasury secretary Timothy Geitner — are being withheld. Who knows what is true and not in all this, but it will certainly be interesting to see how it all plays out. For more details about the meeting, along with what the watchdog group thinks happened, read the following article from Money Morning.

Despite promises of open government, the Obama administration tried to “cover up the very existence of smoking-gun documents” prepared for a meeting in which former U.S. Treasury Secretary Henry M. Paulson allegedly coerced major banks to allow the government to take equity stakes, according to conservative watchdog group Judicial Watch.

Judicial Watch said the Treasury initially said it had no records about the meeting. It didn’t release a transcript of discussions between government officials and bankers.

However, documents obtained under a Freedom of Information Act request confirm that Paulson and other Treasury officials gave nine major banks no options other than allowing the government to take $250 billion in equity.

Judicial Watch said on its Web site that after it made inquiries, the Treasury insisted on Feb. 4 it had no documents about the historic meeting.

Furthermore, “the cover-up continues, as the Obama administration protects Timothy Geithner by withholding a key document about his role in this infamous bankers meeting,” Judicial Watch president Tom Fitton said in a statement.

The group says suggested edits of the “talking points” for the meeting by Treasury Secretary Tim Geithner, then President of the New York Federal Reserve are being withheld by the Obama administration.

Saying the nine U.S. banks were “central to any solution” of the credit crisis, Paulson told their leaders in the meeting in Washington on October 13, 2008, to take the government aid voluntarily or be forced to by regulators.

“We don’t believe it is tenable to opt out because doing so would leave you vulnerable and exposed,” the document said, citing Paulson talking points. “If a capital infusion is not appealing, you should be aware your regulator will require it in any circumstance.”

Within four hours of the start of the meeting the CEOs wrote by hand the names of their institution and multibillion dollar amounts of “preferred shares” to be issued to the government, the documents show.

“These documents show our government exercising unrestrained power over the private sector,” Fitton said in a statement.

The banks were represented by Vikram Pandit of Citigroup Inc. (NYSE: C), Kenneth Lewis of Bank of America Corp. (NYSE: BAC), John Thain of Merrill Lynch & Co., now part of BofA, Jaime Dimon of JP Morgan & Co. (NYSE: JPM), Richard Kovacevich of Wells Fargo (NYSE: WFC), John Mack of Morgan Stanley (NYSE: MS), Lloyd Blankfein of Goldman Sachs Group Inc. (NYSE: GS), Robert Kelly of Bank of New York Mellon Corp (NYSE: BK), and Ronald Logue of State Street Corp. (NYSE: STT).

A spokesman for the Treasury, Andrew Williams, didn’t return calls seeking comment from Bloomberg News.

The Treasury has invested $199.1 billion in the bank-preferred share program, with $1.2 billion since returned by 12 institutions, according to government data, Bloomberg reported.

Despite his heavy-handed nature, Paulson succeeded at stabilizing the financial services industry, J.P. O’Sullivan, an SNL Financial bank analyst in Charlottesville, Va., told Bloomberg.

“It was a calming mechanism,” O’Sullivan said.

This isn’t the first time Paulson has been accused of strong-arming bankers to bend to his will.

As previously reported in Money Morning, Bank of America CEO Kenneth Lewis said in testimony before New York’s attorney general that Paulson and Federal Reserve Chairman Ben S. Bernanke pressured him not only to move ahead with a merger with Merrill Lynch despite reservations, but also to stay quiet about the mounting losses at the crumbling investment bank.

Lewis went on to testify that he felt Paulson threatened him with losing his job if he didn’t go along with completing the Merrill Lynch deal.

“I can’t recall if he said, ‘We would remove the board and management if you called it [off]‘ or if he said ‘we would do it if you intended to.’ I don’t remember which one it was,” Mr. Lewis said.

This article can also be viewed on moneymorning.com.

What Is The Likelihood Of The U.S. Losing Its AAA Credit Rating?

A few months back — after Moody's issued a warning — there was a lot of talk about the possibility of America losing it's AAA credit rating. Of course that never materialized. Now after a recent report on the health of Social Security and Medicare, the talk is resuming. The question still remains though of whether all this talk, is just talk, or if there is any merit to it. Kathy Lien looks closer at the question in her blog post below.

In today’s Financial Times, there is an op-ed article by David Walker, the CEO of the Peter G. Peterson Foundation pondering the possibility of the U.S. losing its prized AAA credit rating. The paper focuses on a warning that was issued by rating agency Moody’s months ago. Moody’s has not issued a new warning, yet Walker and in turn, the FT has decided to re-inject uncertainty into the financial markets by resurrecting this fear. What has prompted this article is most likely the recent comments about the insolvency of the Social Security and Medicare systems. According to the trustees for the systems, the Social Security trust fund could be depleted by 2037 while Medicare could be insolvent by 2017. These dates of insolvency have been pushed up as the weak labor market reduces contributions. The Obama Administration has pressed the importance of gaining control of the growth in Medicare costs and their desire to tackle Social Security insolvency once health care reform is passed.

According to Walker, if the health care reforms strains finances further or if the federal government fails to monitor spending, tax or budget control, rating agencies could strip the U.S. of its credit rating.

Is Losing AAA Rating that Big of a Deal?

But is losing the AAA rating that big of a deal? Yes. A credit rating reflects the risk of default. Therefore a lower credit rating means that a country is at greater risk of defaulting on their debt. Some global funds are mandated to invest only in AAA debt and therefore if the U.S. loses its AAA rating, we could see a massive outflow of foreign investment. Also, a credit rating downgrade is the perfect excuse to push through an alternative reserve currency to replace the dollar because it would strip the confidence of sovereign funds like China that have been buying dollars to prop up the U.S. economy. Yes, investors will still buy U.S. Treasuries, but their purchases will be less. It could also have a spillover effect on corporate debt and will raise the cost of borrowing for the U.S. government.

How Real is the Risk?

Now with the risk in mind, I think that ratings agencies talk a good game but they will face problems following through. The consequences of downgrading U.S. sovereign debt is huge both politically and economically. Therefore Moody’s or any rating agency for that matter may be reluctant to the first to pull the trigger. Downgrading the U.S. is very different from downgrading Ireland. Based upon how the rating agencies have handled the credit derivatives bubble, chances are they will be behind the curve once again.

With that in mind, U.S. finances are deteriorating significantly, raising the concern of Asian nations. However if President Obama is successful at turning around the U.S. economy, America will be well equipped to meet its debt obligations.

This post can also be viewed on kathylien.com.

Obama Pushes For $17 Billion In Budget Cuts...That's It?

In what seems like joke, President Obama has sent lawmakers a proposal that aims to cut over a hundred programs, and save us $17 billion. When you look at the fact our deficit this year will be a projected $1.85 trillion, you can start to see that $17 billion in cuts is next to nothing. It's almost as if Obama is simply trying to appear like he is making an effort to trim spending. The worst part is that it appears Obama will be fought tooth and nail to get these cuts through. If he can't manage to get $17 billion cut off the budget, what hope does this country really have forbalanced budget? For more on this, read the following article from Money Morning.

President Barack Obama sent lawmakers a budget package today (Thursday) that proposes to shrink or eliminate 121 federal programs and save almost $17 billion in the fiscal year that begins Oct. 1. But the budget plan contains cuts that will face vigorous opposition in Congress and fierce resistance from special interest groups.

The package of proposed reductions fills in the fine print of a $3.55 trillion budget outline approved by lawmakers in April that contains Obama’s top agenda items, including a health care overhaul, a push for renewable, clean-energy sources and changes in education funding.

The President wants to cut or end a number of programs that he feels are wasteful or ineffective to take the first toward getting spending under control. But the administration’s attempt at bringing fiscal discipline to Washington has already been met with skepticism by analysts.

“Every government program - no matter how wasteful - will be defended by its recipients and congressional champions,” Brian Riedl, a budget expert at the Heritage Foundation, a Washington-based research group told Bloomberg News. “Unless Obama puts the weight of the White House behind his spending cuts, Congress will ignore them.”

The cuts are miniscule compared to the overall budget package and deficits that will be ushered in the next few years. The $787 billion stimulus package Obama pushed through Congress combined with the $700 billion Troubled Asset Relief Program (TARP) bank bailout will come on top of the $1 trillion deficit the administration inherited when he took office in January.

Total savings from the cuts, even if they were accepted by Congress in their entirety, would represent a paltry 0.4% of the overall budget. The Congressional Budget Office projects the deficit will be $1.85 trillion this year, about four times the previous record, and $1.38 trillion in fiscal 2010.

“Even if you got all of those things, it would be saving pennies, not dollars. And you’re not going to begin to get all of them,” Isabel Sawhill, a Brookings Institution economist who waged her own battles with Congress as a senior official in the Clinton White House budget office, told the Washington Post. “This is a good government exercise without much prospect of putting a significant dent in spending.”

Only about 80 of the proposed cuts are new - the others had been previously revealed. And most of the cuts will be from the “discretionary” budget, avoiding the so-called untouchable “third-rail” entitlement programs of Social Security and Medicare.

Those two programs account for more than 40% of government spending, meaning the more difficult work on deficit reductions has been left for another day.
“More serious efforts at deficit reduction are going to require entitlement and tax reform - that’s where most of the money is.” Marc Goldwein, policy director of the bipartisan Committee for a Responsible Budget, a Washington-based research group, told Bloomberg. “To really get the deficit under control, we’re going to have to start thinking bigger,” he said.

But some in Congress defended the administration’s approach, saying the list of program reductions is just the start of a more comprehensive effort to cut spending and pull the reins on the skyrocketing deficit.

“It depends on what it means over the scope of five and 10 years.” Representative John Larson (D-Conn.) told Bloomberg. It’s a “deep, cavernous hole where we have been left, we’re looking a long way up but it’s a steady climb” using the budget plan agreed to by Obama and Congress, he said.

This post can also be viewed on moneymorning.com.

How Is The Economic Medicine Working?

The government has been injecting trillions of dollars into the economy, but how has it been working so far? James Picerno looks at recent events and attempts to answer that question in his blog post below. In addition Picerno takes a look at what lies ahead for the U.S. economy, and offers some words of wisdom for investors.

In late-March, we asked: Is the medicine working? By medicine we meant the massive injection of liquidity into the economy as a cure for fending off deflation and laying the groundwork for recovery. At the time, we were mildly encouraged, in part due to the rising inflation forecast as derived from the spread between the nominal and inflation-indexed 10-year Treasuries.

More than a month later, there's still reason for optimism, perhaps more so, thanks to the so-called green shoots that suggest better days ahead. Yet the rate spread, which is to say the market's inflation outlook, hasn't changed much since late-March. The current forecast is for inflation of 1.4% for the next 10 years, just barely up from around 1.3% from the end of the first quarter. In both cases, that's a healthy change from expecting flat pricing, as was the case at the end of 2008. Low inflation as far as the eye can see would be nice, but is that a reasonable expectation?

In the months ahead there will be a thin line between a healthy rise in inflation expectations and the potential for burdensome pricing pressures later on. Deflation is a hazard to be avoided for a number of reasons. Although we can't quite shut the book on the danger, the odds look increasingly in favor of mild inflation for the foreseeable future, as the chart above suggests. Behind this reasoning is the growing sentiment that the recession is at or near a bottom. Is it time for the Fed to begin tightening? Or are the green shoots still too tentative?

"We're seeing more indications of perhaps a bottoming in the economy," Bill O'Neill of LOGIC Advisors tells Dow Jones. "So there is an increasing—and it will continue to increase—concern surrounding inflation potential."

Gold, the perennial inflation hedge, seems to be considering the possibility, although this market hasn't quite made up its mind. The price of the metal has been hovering around $900 for much of this year, just below its all-time high of $1,033, set back in March 2008. The 10-year Treasury yield, meanwhile, has been climbing, recently bumping up against 3.2% on renewed worries that inflation may now be the bigger risk. Even so, a 10-year yield of 3.2% is still quite low.

None of the inflation anxiety is worrying the stock market, which has now reversed the selloff in the first quarter. Indeed, the S&P 500 is now marginally up on the year, as of last night's close, on expectations that by the end of this year the economy will be sitting up and prepared to get out of bed.

The big question is whether all the renewed hope that the worst is over is really just the byproduct of a bear market bounce in markets and inflation expectations? Given the extreme waves of selling last year and into March, a rebound was all but assured if the world economy didn't collapse. As we now know, it didn't. There are still lots of problems, but we'll all be here next year and so it was time to reprice assets upwards to reflect a humbled but otherwise enduring economic climate.

Investors have cheered the signs that the U.S. economy no longer seems to be contracting at an accelerating pace. Given the fears of what could have happened, that's certainly a reasonable response. Deciding that you're not going to fall into the abyss is always encouraging. But that's still a long way from arguing that growth is imminent, or that the economy won't tread water for a year or two.

The first phase of the post-apocalyptic visions that prevailed six months ago may be over. If so, now we're faced with the more difficult chore of deciding how to repair and rebuild the economy to foster growth while containing inflation. The hardest days are yet to come. Unless you're expecting a seamless transition, keeping some cash at the ready still makes sense, albeit less so than in past months. Volatility isn't banished, it's only hibernating, which suggests another round of value-oriented pricing opportunities in the major asset classes.

This post can also be viewed on capitalspectator.com.

We Need A Root-And-Branch Reorganization Of The Financial System

Some people are open to the government handing over trillions of dollars to the banks, but no taxpayers want the money handed over without proper controls in place that will ensure it goes to good use. This has been one of the biggest issues the public has had with the bailout efforts thus far. For that reason Steve Waldman is calling for a root-and-branch reorganization of the financial system. For more on this, read the following blog post from Mark Thoma.

Steve Waldman says "we need a root-and-branch reorganization of the financial system":

Value for value, Steve Waldman: Would it have been better if Timothy Geithner had had the power to guarantee all bank debt early on? As James Surowiecki reminds us, that was part of the Swedish solution. Justin Fox plausibly suggests that we might have avoided a lot of pain with a fast, full guarantee.

But that's not the point. The question isn't whether we could have avoided this crisis, if only we had cut a big check. We could have, and that was not lost to any of us debating these issues more than a year ago. (See e.g. me or Mark Thoma.) Had we done so, the near-to-medium term fiscal costs might have been less than they probably will be now. So, with 20/20 hindsight, would it have been a good idea?

How you answer that question depends upon how you view the crisis. Is it an aberration, a shock to a basically sound financial system, or is it a painful symptom of an even more dangerous condition? ...

If you think that our financial system just needs some tweaks, some consolidation of regulators' organizational charts and sterner supervision, then you should prefer that we had just cut a check, passed Sarbanes/Oxley Book II, and moved on. But that is not what I, or most proponents of temporary receivership for insolvent banks, believe.

If you believe, as I do, that we need a root-and-branch reorganization of the financial system, which must necessarily involve the dismemberment and intrusive restraint of deeply entrenched institutions, does that mean pain is the only way forward, "the worse the better" in the old revolutionary cliché? It need not mean that. But it does mean that palliative measures, like giving the banks money, would have to be attached to curative measures, like enacting capital requirements and imposing regulatory burdens that would force financial behemoths to break themselves up or become boring narrow banks. For almost two years, policymakers at the Fed and the Treasury, including Secretary Geithner, have offered bail-out after bail-out and asked for nothing serious in return.

Do I regret that Henry Paulson was not empowered to issue a blanket guarantee of bank assets early on, as the Swedes did? No, I don't regret that at all. Why not? Because I think that "Hank the Tank" was a crappy negotiator... He would have offered the financial system sugar without requiring it to make the medicine go down. He may believe, quite sincerely, that a cure would be worse than the disease. He may believe that, but he is wrong. ...

You may believe that we have learned our lesson, that if we can just get some stability and comfort for a while we are prepared to do what must be done. That's a respectable position. But I don't share it, and neither do the majority of Americans who are unwilling to allow their representatives to sign off on any more expensive aspirin. We want value for value, an ironclad commitment of root and branch reform in exchange for the unimaginable sums of money we are being asked to hand over. ... Congress would, because the public would, support large, explicit transfers, if they were attached to reforms sufficiently radical to prevent a recurrence, and suitably punitive towards the people who managed the system that brought us here. Value for value. ...

I ... would be willing to hold my nose and tolerate a Swedish-style guarantee of bank creditors. I'd acquiesce to that even without formal nationalization. Nationalization is ... a means to an end, and the desired end is a world in which too big to fail is too big to exist for any financial institution that originates or holds credit risk in any form. Secretary Geithner could send a bill to Congress today that would put all banks with a balance sheet of over $50B into run-off mode... I'd fax my Congressman and support a $2T on-budget buyout of bank creditors as part of that bill, as long as it had teeth. ("Teeth" would imply making sure that off-balance-sheet and derivative exposures were included in the size cap, etc.)

It's not that us pitchfork-totin' populists are unwilling to pay the bill. It's that we want to know that in exchange for writing a very, very large check, the people that we are paying will actually deliver the goods. Given the behavior of bankers before the crisis and of shifty policymakers during, we have every reason to watch warily and to insist upon every precaution while we hand over suitcase after suitcase of freshly printed Federal Reserve notes.

This post can also be found on economistsview.typepad.com.

Stress Tests Reveal Three Banks In Need Of Additional Funding

The controversial stress tests commissioned by the government on the 19 largest financial institutions have revealed at least 3 in need of additional funding. These stress tests were meant to ensure that banks have enough capital reserves to last through the recession. For more on this, read the following article from Housing Wire.

At least three of the 19 financial institutions with assets in excess of $100bn may face pressure to build up capital reserves after failing to meet desired operational projections through the government-mandated stress tests, unnamed sources told the Wall Street Journal. The identities of the three firms remained confidential at the time this story went to press, but analysts told the Journal they likely include regional banks with commercial real estate exposure in the Midwest and Southeast.

The stress tests aimed to determine whether major US banks retain enough capital to weather even the more adverse economic projections. Federal officials offered three alternatives to banks that lack sufficient reserves: raise private investor funds, receive additional government aid or convert the government’s existing preferred shares into common shares, effectively placing part of the firm in government ownership.

The Federal Reserve, in reporting stress test methods late Friday, say most banks retain enough capital to weather a longer, more severe recession, although deteriorating economic conditions affect the reserve capital held among some banks.

This article can also be found on housingwire.com.

Depression Looms Without More Stimulus

Do we really need more economic stimulus? We have already spent trillions of dollars attacking this financial crisis, and unfortunately we also have seen billions apparently wasted by poor policy decisions and implementation. All that aside, according to famed economist Robert Shiller, we need more economic stimulus or else we are likely facing another depression. For more on this, read the following blog post from Mark Thoma.

Robert Shiller says we need to continue with the monetary and fiscal policies we are pursuing, but both efforts need to be larger:

Depression Lurks Unless There’s More Stimulus, by Robert Shiller, Commentary, Bloomberg: In the Great Depression ... the U.S. government had a great deal of trouble maintaining its commitment to economic stimulus. “Pump- priming” was talked about and tried, but not consistently. The Depression could have been mostly prevented, but wasn’t. ...

In the face of a similar Depression-era psychology today, we are in need of massive pump-priming again. We appear to be in a much better situation due to the stronger efforts to date. Still, there is a danger that, because of a combination of faulty economic theory and inadequate appreciation of human psychology, as well as deep public anger, we will not continue with such stimulus on a high enough level. ...

In our analysis of the current economic crisis, we conclude that the government should have two targets. One would be a joint fiscal-monetary policy target. The same kind of expansionary policies embodied in the government expenditure stimulus and tax cuts that are already being tried have to be done on a big enough scale and for a long enough time in the future. ...

The government should also have a credit target. Once again, we are calling for more of the same kinds of existing policies... Achieving this requires new approaches, like those announced by the Bernanke Fed and the Obama administration, but on a continuing and even larger scale. ...

In this crisis, acceptance of these measures is being replaced with outrage. It is increasing the blood pressure of the public, and that can’t continue without damage to our system. ... It is time to face up to what needs to be done. The sticker shock involved will be large, but the costs in terms of lost output of not meeting either the credit target or the aggregate demand target will be yet larger.

It would be a shame if we are so overwhelmed by anger at the unfairness of it all that we do not take the positive measures needed to restore us to full employment. That would not just be unfair to the U.S. taxpayer. That would be unfair to those who are living in Hoovervilles...; it would be unfair to those who are being evicted from their homes, and can’t find new ones because they can’t find jobs. That would be unfair to those who have to drop out of school because they, or their parents, can’t find jobs.

It is now time to keep our eye on the ball and set clear targets to fix a system that broke when our animal spirits got out of bounds.

This post can also be viewed on economistsview.typepad.com.

Treasury Yield: What Does The Future Have In Store?

A lot of people have been turning to Treasuries as the investment of choice in these unpredictable and rough economic times, but will it ultimately prove to be a good move? While widely considered "risk free" investments, that is far from the truth. There are many things that perspective Treasury investors need to keep in mind when weighing their investment options. The following blog post from James Picerno offers some insight into what is going on right now in the Treasury market, and hopefully will help investors make an a better informed decision.

It's hard to dismiss the ongoing news about China's anxiety over its massive holdings of American debt. What's worrisome for China is ultimately a concern for the U.S., with fallout that may come sooner than we think.

“We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried," Chinese prime minister, Wen Jiabao, said last month. It was a rare public admission of apprehension by a high-ranking Chinese official on the delicate and increasingly precarious lender-borrower relationship that describes the U.S. and China.

Yesterday came word that China's purchases of U.S. bonds slowed in the first two months of this year, according to new data from China's central bank, The New York Times reports. "Chinese reserves fell a record $32.6 billion in January and $1.4 billion more in February before rising $41.7 billion in March, according to figures released by the People’s Bank over the weekend," the Times notes. The trend may now be reversing, although the notion that a pivotal point in the U.S.-China financial relationship may be near remains intact.

The fear is that China will slow (cease?) buying new Treasuries, a decision that's likely to force up interest rates in the U.S. For the moment, there's no reason to dismiss that scenario, at least when it comes to the recent trend in the yield on the benchmark 10-year Treasury Note. As the chart below shows, the march upward to the 3% mark is alive and well.

What makes the rising yield in the 10-year so striking is that it comes in the wake of the Federal Reserve's announcement last month that it would directly target lowering rates on long Treasuries. The market's initial reaction was to buy Treasuries, which resulted in one of the biggest one-day drops in interest rates on record. For a time it looked like Bernanke and company had struck gold. But confidence that the central bank has complete control over the long end of the curve has been evaporating in recent weeks.

As the above chart shows, the 10-year yield collapsed by around 50 basis points on March 18, down to around 2.5%. As of April 9, the 10-year's yield had climbed by to roughly 2.9%, just under the level where when the Fed made its bombshell announcement last month.

High interest rates in the U.S. necessarily make the dollar more attractive, at least for a time. No wonder, then, that the buck's value is rising in forex markets in recent weeks, in sympathy with higher interest rates on the 10-year. The U.S. Dollar Index is just about at the highest level since the Fed's March 18 disclosure, a news event that had initially sent the buck tumbling. Meanwhile, commodity prices generally have been inching higher as well, as per the CRB Index. Commodities are generally priced in dollars, so it's no surprise that a strong dollar equates with higher commodity prices.

Higher interest rates are almost surely the path of least resistance in the years ahead, in part because the U.S. deficits are sure to be large in the wake of all the monetary and fiscal stimulus of late. The problem is that the arrival higher interest rates now, this week, next month, next quarter come at an especially inopportune time: before the economy has sufficiently recovered. The Fed surely seeks to keep long rates below 3% for the rest of the year, or so one might speculate. But it's not clear that the markets are willing to go along for the ride.

In the old days, the Fed's powers were such that it had more control over keeping interest rates low and thereby providing the economy with ample monetary stimulus until the forces of growth rose anew. Engineering that scenario this time may be tougher, much tougher. One reason is that much of the control over future rates has been transferred to foreigners, courtesy of holding large quantities of U.S. debt. That may not be fate that rates will rise. Indeed, China surely wants to keep U.S. rates low in order to boost growth here, which will promote imports of Chinese goods. But no one really knows how these forces will play out.

Perhaps the cycle will be salvaged if the economy rebounds quicker than the crowd expects. Alternatively, the Chinese and other foreigners decide to buy large quantities of Treasuries in the months and quarters ahead. There are solutions to the current dilemma, but no one should expect that they're a forgone conclusion.

This post can also be viewed on capitalspectator.com.

The Fed Is Running A "Laboratory Experiment" On What Drives Inflation

A former Fed governor says the Fed is basically running a laboratory experiment on what drives inflation. Of course that terminology probably doesn't sit well with most Americans, who are looking to the government to fix our economy, it is close to the truth. Beyond the laboratory experiment, though, there is a potentially bigger problem with the Fed. It is looking more and more like the Fed's independence is being squandered...again. There is a reason why the Fed was made independent, and it wasn't to succumb to every whim of the Federal government. For more on this, read the following article from Tim Iacono.

With growing optimism that the worst may now be behind it for the U.S. economy, a growing number of observers are starting to look at what sort of an economic landscape might take shape should the optimists be right, given all the money creation over the last year or so to bailout financial firms and effectively nationalize the mortgage lending industry.

According to Allan Meltzer, one of the world's foremost experts on U.S. monetary policy, the outlook is not good and it has much to do with the historical role of the Federal Reserve as an independent organization as described in this report at Bloomberg.

Meltzer says political pressure will prevent Bernanke, 55, and fellow policy makers from withdrawing liquidity quickly enough as the economy recovers. That’s similar to the pattern that occurred back in the 1970s, he says. Then-Chairman Arthur Burns allowed excessive money-supply growth because he was unable or unwilling to resist pressure from President Richard Nixon’s White House to hold down unemployment, leading to the “great inflation” of that era, he says.

Now, Bernanke and fellow policy makers have “squandered their independence” by becoming involved in bailouts of financial firms and by taking long-term and illiquid assets onto their balance sheet, Meltzer says. “They don’t have the political ability to control inflation.”

It really is too bad for the central bankers of the world that the labor market is a lagging indicator. During the latter stages of a recession, when other economic statistics begin pointing unambiguously upward, job losses generally continue at a healthy pace and this can make reining in easy money an exceedingly difficult task.

That's one of the most important reasons why the Federal Reserve was created as an independent organization - to do what's best for the economy in the long-term regardless of the political whims and wishes in Washington.

[Note: Yes, the most important reason for the Fed's independence is its unholy relationship with big New York banks, but that's an entirely different discussion.]

Anyway, with many now seeing "green shoots" all over the landscape, the inflation/deflation debate looks set to heat up once again, and Fed policy is right in the thick of things.

“All that money is going to find a home,” says Ken Mayland, president of ClearView Economics LLC in Pepper Pike, Ohio. He sees oil prices increasing to “$80, $90, $100 before the end of next year” from $52 a barrel now.

Commodity prices may be more prone to rise as the world economy recovers because tight credit and volatile pricing will discourage investment in new supplies, says Mark Zandi, chief economist at Moody’s Economy.com, in West Chester, Pennsylvania.
...
Some Fed policy makers seem more worried about deflation than they do about inflation. A sustained fall in prices can debilitate the economy by causing consumers and businesses to postpone purchases.

“For some time to come, disinflation, and even deflation, will represent greater risks than inflation,” San Francisco Fed President Janet Yellen said in a speech on March 25.

At the root of that concern is substantial and growing slack in the economy, which, according to White House chief economist Christina Romer, is operating 5 percent to 10 percent below potential. That means the economy will have to grow a percentage point above trend -- reckoned by the administration to be about 2.5 percent annually -- for five or more years before the slack is used up.

The Phillips curve -- developed by economist A.W. Phillips using Keynesian concepts -- posits that such excess will reduce inflation as firms stuck with idle capacity cut prices and workers facing layoffs accept smaller wage hikes.

Not everyone at the Fed buys into that argument. Noting that some economists forecast substantial slack will keep inflation low for several years, Richmond Fed President Jeffrey Lacker said in a March 26 speech that he would be “cautious about relying on this correlation.”

The Fed is “running a laboratory experiment” on what drives inflation: the money supply or the output gap, says Laurence Meyer, a former Fed governor and now vice chairman of St. Louis-based Macroeconomic Advisers

“How it turns out will do a lot to influence the economic debate,” he says, adding that his money is on Bernanke.

How it turns out will also do a lot to influence whether the Federal Reserve continues to exist in its current form and whether there are major revisions to current economic theory.

If the amount of inflation bears any resemblance to the size of recent asset bubbles or the volume of money printing deemed necessary to combat their bursting, there may be a wholesale rethinking of what a central bank is and what economists do.

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Longing For The Days Of Boring Banking

When the financial industry gets too creative, bad things tend to happen. The current financial crisis was not the first example of this either. If you look all the way back to before the Great Depression, whenever the financial industry was loosely regulated, and overly creative, things would eventually blow up. Paul Krugman is calling for us to return to the days of boring banking, but wonders if that is going to happen anytime soon. For more on this, read the following blog post from Mark Thoma.

Does congress have the will to pursue serious financial reform?:

Making Banking Boring, by Paul Krugman, Commentary, NY Times: Thirty-plus years ago, when I was a graduate student in economics, only the least ambitious of my classmates sought careers in the financial world. Even then, investment banks paid more than teaching or public service — but not that much more, and anyway, everyone knew that banking was, well, boring.

In the years that followed, of course, banking became anything but boring. Wheeling and dealing flourished, and pay scales in finance shot up... And we were assured that our supersized financial sector was the key to prosperity. Instead, however, finance turned into the monster that ate the world economy. ...

Thomas Philippon and Ariell Reshef ... show that banking in America has gone through three eras over the past century. Before 1930, banking was an exciting industry featuring a number of larger-than-life figures, who built giant financial empires (some ... based on fraud). This highflying finance sector presided over a rapid increase in debt: Household debt as a percentage of G.D.P. almost doubled between World War I and 1929.

During this first era of high finance, bankers were, on average, paid much more than their counterparts in other industries. But finance lost its glamour when the banking system collapsed during the Great Depression.

The banking industry that emerged from that collapse was tightly regulated, far less colorful than it had been before the Depression, and far less lucrative.... Banking became boring, partly because bankers were so conservative about lending: Household debt ... stayed far below pre-1930s levels.

Strange to say, this era of boring banking was also an era of spectacular economic progress for most Americans.

After 1980, however, as the political winds shifted, many of the regulations on banks were lifted — and banking became exciting again. Debt began rising rapidly, eventually reaching just about the same level relative to G.D.P. as in 1929. And the financial industry exploded in size. By the middle of this decade, it accounted for a third of corporate profits.

As these changes took place, finance again became a high-paying career... Indeed, soaring incomes in finance played a large role in creating America’s second Gilded Age. Needless to say, the new superstars believed that they had earned their wealth. ... And many economists agreed.

Only a few people warned that this supercharged financial system might come to a bad end. Perhaps the most notable Cassandra was Raghuram Rajan... But other[s]..., including Lawrence Summers..., ridiculed Mr. Rajan’s concerns.

And the meltdown came.

Much of the seeming success of the financial industry has now been revealed as an illusion. ... Worse yet, the collapse of the financial house of cards has wreaked havoc with the rest of the economy, with world trade and industrial output actually falling faster than they did in the Great Depression. And the catastrophe has led to calls for much more regulation of the financial industry.

But my sense is that policy makers are still thinking mainly about rearranging the boxes on the bank supervisory organization chart. They’re not at all ready to do what needs to be done — which is to make banking boring again.

Part of the problem is that boring banking would mean poorer bankers, and the financial industry still has a lot of friends in high places. But it’s also a matter of ideology: Despite everything that has happened, most people in positions of power still associate fancy finance with economic progress.

Can they be persuaded otherwise? Will we find the will to pursue serious financial reform? If not, the current crisis won’t be a one-time event; it will be the shape of things to come.

This post can also be viewed on economistsview.typepad.com.

Why Dropping "Mark to Market" Rules Won't Solve Anything

In an effort to shore up the balance sheets of banks the government decided to drop the "mark to market" rules that have been causing so much trouble in the financial industry. As Peter Schiff points out in his article, though, this won't solve anything. The rule was created in order to give investors a better idea of the true value of bank assets — basing the valuations on market activity rather than arbitrary assessments by the bank's accountants. Letting the banks decide how much their assets are worth, rather than the market, is a recipe for deception and ultimate failure. Read about what Schiff has to say in the article below from Money Morning.

When elementary school kids want to escape the confines of their circumstances, they pretend to be pirates, princesses and Jedi knights. Now, with the relaxation of "mark to market" valuation rules announced by the accounting trade’s self-regulatory body, our bankrupt financial institutions can escape their own reality by pretending to be solvent.

The unraveling of our fairytale economy over the last few months has not yet convinced us that the time has come to put away childish things. The applause that greeted the Financial Accounting Standards Board’s (FASB) ruling on Wall Street is a clear sign that we still have some growing up to do.

The imaginative conceit that lies behind the accounting change is that the toxic assets polluting bank balance sheets are not really toxic at all. They are in fact highly valuable assets that for some irrational reason no one wants to buy.

Using the "mark to market" accounting method, mortgage-backed securities were valued relative to the latest prices fetched by the sale of similar assets on the open market. Currently, those bonds are being sold at deep discounts to their original value. By "marking" their unsold bonds down to those prices, the insolvency of our financial institutions had been laid bare. But the new accounting changes will allow the nervous owners to assign more "appropriate" (i.e. higher) values. Problem solved.

It is important to note that the FASB made its rule modifications only after both Washington and Wall Street applied intense pressure. In their heart of hearts, I can’t imagine that there are too many bean counters happy with the outcome.

The banks and the government have argued that the assets should be valued based solely on current cash flow. Most mortgages, after all, are not delinquent. Therefore, a few bad apples should not spoil the whole bunch, and those that are not yet delinquent should be valued at par. This method assumes we have no ability to look into the future and make assumptions about what is likely to happen, which is presumably what the market is already doing by valuing the assets lower than the banks wish.

All kinds of bonds (corporate, government and municipal, etc.) that are not in default frequently trade at discounts. In fact, the reason agencies such as Moody’s Corp. (MCO) and Standard & Poor’s rate bonds is to assess the probability of default. The higher that probability, the lower the value placed on the bonds, regardless of their current cash flow.

For example, General Motors Corp.’s (GM) 10-year bonds currently trade for only 8 to 10 cents on the dollar, despite the fact that GM is current on all interest payments. The 90% discount reflects investor awareness that GM will likely default long before the bonds mature. By the new logic, financial institutions with GM bonds on their balance sheets should be able to ignore the market and value these bonds at par.

Some argue that the comparison is invalid because GM’s bonds are liquid while mortgage-backed securities are not. However, if sellers of GM bonds were holding out for 70 or 80 cents on the dollar, those bonds would be illiquid too. The reason GM bonds are trading is that sellers are realistic.

The same should apply to bonds backed by mortgages. To assume that a 30-year, $500,000 mortgage on a house that has declined in value to $300,000 has a high probability of remaining current to maturity is ridiculous. The borrower could lose his job, his adjustable-rate mortgage (ARM) might reset higher, or he may simply tire of paying an expensive mortgage for a house that is unlikely to be sold at a profit.

Any bond investor with half a brain will factor in these probabilities and look for deep discounts. The only way to accurately assess a real present value is to let the market discover the price.

Despite the pleas from bankers and politicians, mortgages are not plagued by a lack of liquidity but a lack of value. If sellers would be more negotiable, there would be plenty of liquidity. Who knows, at the right price I might even buy a few. The problem is that putting a market price on these assets would render most financial institutions insolvent, which is precisely why they do not want to let that happen.

Simply pretending that all these mortgages will be repaid does not solve the underlying problems. It may keep some banks alive longer, but when they ultimately do fail, the losses will be that much greater. In the meantime, solvent institutions are deprived of capital as more funds are funneled into insolvent "too big to fail" institutions - hiding their toxic assets behind rosy assumptions and phony marks.

Going from the sublime to the completely ridiculous, in a speech at the just-concluded Group 20 summit in London, President Barack Obama urged Americans not to let their fears crimp their spending. It would be unwise, he argued, for Americans to let the fear of job loss, lack of savings, unpaid bills, credit card debt or student loans deter them from making major purchases.

According to the president, "we must spend now as an investment for the future." So in this land of imagination (where subprime mortgages are valued at par), instead of saving for the future, we must spend for the future.

I guess Ben Franklin had it wrong too – apparently a penny spent is a penny earned.

This post can also be viewed on moneymorning.com.

Geithner's Bank Bailout Plan: Privatizing Gains And Socializing Losses

There is no shortage of opposition to Treasury Secretary Timothy Geithner's new bank bailout plan, and while some arguments are unfounded, Joseph Stiglitz does make a good point. According to Stiglitz the worst part about the bailout plan is that it will privatize gains while socializing losses. With this in mind it makes it an overall losing proposition for taxpayers. In addition to this argument Stiglitz makes several others against the bailout plan in his article below as presented by Mark Thoma.

Joseph Stiglitz is not a fan of the Geithner bank bailout plan:

Obama’s Ersatz Capitalism, by Joseph E. Stiglitz, Commentary, NY Times: The Obama administration’s $500 billion or more proposal to deal with America’s ailing banks ... is based on letting the market determine the prices of the banks’ “toxic assets”... The reality, though, is that the market will not be pricing the toxic assets themselves, but options on those assets.

The two have little to do with each other. The government plan in effect involves insuring almost all losses. ... This is exactly the same as being given an option. ...

Under the plan by Treasury Secretary Timothy Geithner, the government would provide about 92 percent of the money to buy the asset but would stand to receive only 50 percent of any gains, and would absorb almost all of the losses. Some partnership! ...

But Americans are likely to lose even more ... because of an effect called adverse selection. The banks get to choose the loans and securities that they want to sell. They will want to sell the worst assets, and especially the assets ... the market ... is willing to pay too much for...But the market is likely to recognize this, which will drive down the price... Only the government’s picking up enough of the losses overcomes this “adverse selection” effect. ...

The main problem is not a lack of liquidity. ... The real issue is that the banks made bad loans... They have lost their capital, and this capital has to be replaced.

Paying fair market values for the assets will not work. Only by overpaying for the assets will the banks be adequately recapitalized. But overpaying for the assets simply shifts the losses to the government. In other words, the Geithner plan works only if and when the taxpayer loses big time.

Some Americans are afraid that the government might temporarily “nationalize” the banks... What the Obama administration is doing is far worse than nationalization: it is ersatz capitalism, the privatizing of gains and the socializing of losses. It is a “partnership” in which one partner robs the other. ...

So what is the appeal of a proposal like this? Perhaps it’s the kind of Rube Goldberg device that Wall Street loves — clever, complex and nontransparent, allowing huge transfers of wealth to the financial markets. It has allowed the administration to avoid going back to Congress to ask for the money needed to fix our banks, and it provided a way to avoid nationalization.

But we are already suffering from a crisis of confidence. When the high costs of the administration’s plan become apparent, confidence will be eroded further. At that point the task of recreating a vibrant financial sector, and resuscitating the economy, will be even harder.

This post can also be viewed on economistsview.typepad.com.

America's Tarnished Reputation Threatens Global Response To Financial Crisis

One of the biggest casualties from the financial crisis — and our handling of it — has been the loss of America's reputation on financial matters. As far as most of the world can tell we are the ones who started this financial mess — which is enveloping much of the world — and even worse we have appeared incompetent to fix it. Why then would the rest of the world listen to us when we try to piece together an effective global response? As Paul Krugman points out in his recent article, America quite possibly could have lost one of its most valuable assets — its reputation — right when they — and the world — need it most. For more on this, read the following blog post from Mark Thoma.

The financial crisis has damaged our global authority, credibility, and leadership, and that will make it much harder for the world to accomplish the essential task of coordinating a common response:

America the Tarnished, by Paul Krugman, Commentary, NY Times: Ten years ago the cover of Time magazine featured Robert Rubin,... Alan Greenspan,... and Lawrence Summers... Time dubbed the three “the committee to save the world,” crediting them with leading the global financial system through a crisis..., although it was a small blip compared with what we’re going through now.

All the men on that cover were Americans, but nobody considered that odd. After all, in 1999 the United States was the unquestioned leader of the global crisis response. ... The United States, everyone thought, was the country that knew how to do finance right.

How times have changed..., ... our claims of financial soundness — claims often invoked as we lectured other countries on the need to change their ways — have proved hollow.

Indeed, these days America is looking like the Bernie Madoff of economies: for many years it was held in respect, even awe, but it turns out to have been a fraud all along. ...

Simon Johnson..., who served as the chief economist at the IMF..., declares that America’s current difficulties are “shockingly reminiscent” of crises in places like Russia and Argentina — including the key role played by crony capitalists.

In America as in the third world, he writes, “elite business interests — financiers, in the case of the U.S. — played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive.”

It’s no wonder, then, that an article in yesterday’s Times about the response President Obama will receive in Europe was titled “English-Speaking Capitalism on Trial.”

Now, in fairness ... the United States was far from being the only nation in which banks ran wild. Many European leaders are still in denial about the continent’s economic and financial troubles, which arguably run as deep as our own... Still, it’s a fact that the crisis has cost America much of its credibility, and with it much of its ability to lead.

And that’s a very bad thing... I’ve been revisiting the Great Depression,... one thing that stands out ... is the extent to which the world’s response to crisis was crippled by the inability of the world’s major economies to cooperate.

The details of our current crisis are very different, but the need for cooperation is no less. President Obama got it exactly right last week when he declared: “All of us are going to have to take steps in order to lift the economy. We don’t want a situation in which some countries are making extraordinary efforts and other countries aren’t.”

Yet that is exactly the situation we’re in. I don’t believe that even America’s economic efforts are adequate, but they’re far more than most other wealthy countries have been willing to undertake. And by rights this week’s G-20 summit ought to be an occasion for Mr. Obama to chide and chivy European leaders, in particular, into pulling their weight.

But these days foreign leaders are in no mood to be lectured by American officials, even when — as in this case — the Americans are right.

The financial crisis has had many costs. And one of those costs is the damage to America’s reputation, an asset we’ve lost just when we, and the world, need it most.

This post can also be viewed on economistsview.typepad.com.

Fed Ups Balance Sheet $1.2 Trillion: Irresponsible, Or Just What The Economy Needs?

With the recent announcement that the Federal Reserve plans to buy up $1.2 trillion in mortgage backed securities and other financial instruments, there has been a economic divide created. On one side Americans will benefit from reduced mortgage rates, however, opponents to the decision argue that this will lead to major inflation and devalue the savings of responsible Americans. It seems that anyone "responsible" is getting victimized in all these stimulus measures. Furthermore there is always the worry that the foreign buyers of our debt will be turned off by our actions and decide to stop buying these assets, or even worse sell off what they already own. For more on this, read the following blog post from Tony Straka.

Word has probably spread around by now that the Federal Reserve is going to buy everything in America that's not nailed down, throwing another $1,150,000,000,000 lifeline at markets. (Click here to see what a trillion looks like.)

The Federal Open Market Committee (FOMC) yesterday informed the public that it will expand its dominating position in the MBS market, throwing an additional $750 billion there. The buying spree does not end there. Having arrived at zero interest rate policy 3 months earlier the Fed now hopes to control interest rates by monetizing US Treasuries equalling $300 billion. Stirring still more Bourbon in the punch bowl the Fed will also up its portfolio of agency debt by another $100 billion.

Markets rallied on the news with Treasuries shedding up to 51 basis points. Gold outshone everything and spurted more than $50 on the FOMC's news that will ultimately lead to higher inflation rates despite the FOMC statement that said,

In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued.

Surprisingly chairman Ben Bernanke and his troops are more worried about possible deflation despite the Fed's balloning balance sheet that will pass the $3 trillion mark this year.

Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

Latest CPI figures show a different picture. Inflation rose to 0.5% (January: 0,4%) or 6% annualized in February.

GRAPH: Gold reacted with the biggest jump seen in decades, rising more than $50 after the Fed released more measures that are designed to fuel monetary inflation. Chart courtesy of kitco.com

Economists were up in arms about the Fed's measures. Stephen Stanley of RBS Greenwich Capital said via the WSJ blogs:

The agency MBS market is close to $4 trillion, so the Fed will end up owning almost one-third of the agency mortgage market. If this was a “rigged market” (to quote one of my learned colleagues on the mortgage desk) before, what should we call it now?! … $50 billion per month in Treasuries pales in comparison to new supply. Just to flesh that point out, we project that auctions of 2’s, 3’s, 5’s, 7’s, and 10’s will total $150 billion in March. In essence, even if all the purchases are limited to 2’s to 10’s, the Fed’s program will merely be a third of the new supply (and far short of one-third of the total market, as is the case for agency MBS).

Morgan Stanleys David Greenlaw said,

Even with energy prices having flattened The Fed’s Treasury purchases will absorb a very significant portion of the amount of gross issuance that we anticipate to occur over the next six months… The Fed’s announcement signals a clear intent to continue to drive mortgage rates lower and we expect them to meet this objective. This could represent a powerful source of stimulus for the household sector of the economy. In 2008, the average mortgage rate on the outstanding stock of loans was about 6.50%. So, if the Fed brings 30-yr fixed rate mortgages down to 4.50% and all homeowners are able refi, the aggregate permanent cash flow savings would be on the order of $200 billion per year.

Bloomberg summed it up in the lead of their coverage:

By committing to buy Treasuries and double his purchases of mortgage debt, Federal Reserve Chairman Ben S. Bernanke signaled his determination to avoid a repeat of the Great Depression and his willingness to pump as much cash into the economy as needed to end the current crisis.

I conclude nothing has changed in the Fed's perception that new fiat money will also solve this crisis. Taking gold's reaction as the canary in the coal mine markets will recognize that the Fed is on the way towards hyper inflation. As in the Weimar republic the US central bank spins up the presses to monetize the debt. At the end of the Weimar republic one percent of government income came from taxes and 99% came fresh from the printing presses.

President Barack Obama may have no other choice than to take this route as foreign investors grow wary about the capability of the USA to serve its debts and we may see less participation in Treasury auctions also for the reason that sovereign wealth funds will spend a bigger portion domestically as nearly every nation is confronted with the economic downturn. For the time being gold investments may turn out again to be the safest asset to hold.

UPDATE: Mint.com says one trillion greenbacks could fund an inflation-adjusted New Deal twice over. Check out their way of visualizing what one trillion can buy and be in for a dose of reality.

I especially liked this one. Do you still say this crisis is manageable? Illustration courtesy of Mint.com.

This post can also be viewed on prudentinvestor.blogspot.com.

Does Obama Deserve An "F" Grade For His Economic Policies?

There has been a lot of criticism lately of President Obama's economic policies, but are they really so bad to deserve the "F" grade recently given to them by the Wall Street Journal? Obviously a good deal of economists think so, but economics professor Mark Thoma has a different view. For more on this, read the following post from Mark Thoma.

I was asked about the grade of "F" the WSJ gave to the economic policies of Obama and Geithner:

Grading Obama on the economy, by Mark Thoma, Comment is Free, UK Guardian: Obama hasn't received high marks for his handling of the financial crisis. Does he deserve a failing grade?

The Obama administration's economic policies received a low average rating from 54 economists participating in a recent poll appearing in the Wall Street Journal, low enough to allow the paper to award an "F" grade to the president and US Treasury secretary Timothy Geithner. (Ben Bernanke fared a bit better.)

However, there was considerable variation across the 54 responses, perhaps because the question was too broad. In particular, when assessing the administration's policy successes or failures to date, it's important to separate the stimulus package from the bailout package, and to separate the economics from the politics.

Though they are often confused, the stimulus package is intended to jump-start the economy and is largely independent of Geithner and the Treasury, while the bailout policies are directed at repairing the financial sector and are, to a large extent, a direct product of the Treasury's efforts.

The economic policies underlying the stimulus package do not, in my opinion, deserve a failing grade, or anything close to that. The policies the administration would have liked to have implemented were based upon solid principles. But I was disappointed with the actual legislation.

The problem was the politics, not the economics. The administration did not get out in front and dominate the political message. Instead, the framing was left to the opposition, and that forced compromises in the stimulus legislation that limited its potential effectiveness, perhaps to the point of falling below the critical threshold needed to get the economy moving.

For example, the bill that actually emerged slanted too much toward tax cuts that are likely to be saved rather than spent, thus reducing the impact on aggregate demand. There was not enough help for state and local governments, and there was not enough help for struggling households who have taken big balance sheet and employment hits as the crisis has unfolded. So while I would give the policy design decent marks, the actual implementation has fallen short, largely due to a tendency to compromise instead of taking control of the political battlefield.

The financial bailout suffers from a similar problem, but here the economics have been problematic as well. The plan has been slow to develop, and does not seem to recognise the nature of the problem. However, this may be due to fear of the politics associated with nationalisation rather than a lack of understanding of the problem and then potential solutions to it. Or it could be from a genuine belief that nationalisation ought to be a last resort.

But all of the false steps, the hesitation, the lack of a firm commitment to a particular course of action look to me like they have been driven by a desire to find some way, any way, of avoiding the political consequences of doing what they know needs to be done in their heart of hearts: take temporary control of the banks, separate the good assets from the bad, recapitalise the banks as necessary, then sell the reconstituted banks back to the private sector.

But instead of leading the political argument, they have allowed the opposition to dominate the political landscape and that has forced the administration's hand in terms of the policies they are able to pursue. In the case of the financial sector, it's time to stop hoping that muddling along until the economy recovers will somehow solve the problem, and to get out in front and lead. As for the stimulus package, the message is the same. Given that the first package may not be enough due to the lack of a proper political foundation, and therefore that a second round may be needed, it would be helpful to begin paving the political path forward here as well.

This post can also be viewed on economistsview.typepad.com.

Nice...AIG Is Paying $165 Million To The People That Ruined The Company

What is going on over at AIG? The latest fiasco coming from AIG is the news that $165 million in bonuses are scheduled to be paid out to the financial products unit. Oh, one other thing, that is the unit that basically bankrupted the company. How on earth are these people still even working for the company, let alone getting bonuses? Typically when someone screws up that much they get fired, not rewarded. Meanwhile the American public is left completely baffled at the situation. So far we have given AIG about $170 billion, — which kept the company in business — and now AIG is telling us that we have to allocate $165 million of this tax payer money to give to the people who caused us to have to pony up the $170 billion to begin with? I know they have some contract things in place and all, but as Laura Wilson from Information Security Resources points out in her blog post below, I'm sure there is a way for us to get around that contract considering the situation. Oh yeah, here is a thought too: how about we FIRE some of these people! There are a lot of good financial people looking for jobs right now, and a little shake up over there might not be such a bad thing.

The plaint that credit default swap-promulgating AIG (AIG) is contractually obligated to pay out millions in bonuses to the same pitted brass that led the company, the industry, and the entire economy off a cliff is a bunch of horse hooey.

If you are on the management team of a company that lays off workers, can’t pay its bills, leaves shareholders holding nothing, and has to take public bailouts, it’s your damn job to make a deal to restructure that company, or wind it down responsibly.

Your bonus is getting to keep porking up to the paycheck trough while other workers are losing salary, severance, and health care.

New York Times: The payments to A.I.G.’s financial products unit are in addition to $121 million in previously scheduled bonuses for the company’s senior executives and 6,400 employees across the sprawling corporation. Mr. Geithner last week pressured A.I.G. to cut the $9.6 million going to the top 50 executives in half and tie the rest to performance.

The payment of so much money at a company at the heart of the financial collapse that sent the broader economy into a tailspin almost certainly will fuel a popular backlash against the government’s efforts to prop up Wall Street. Past bonuses already have prompted President Obama and Congress to impose tough rules on corporate executive compensation at firms bailed out with taxpayer money.

A.I.G., nearly 80 percent of which is now owned by the government, defended its bonuses, arguing that they were promised last year before the crisis and cannot be legally canceled. In a letter to Mr. Geithner, Edward M. Liddy, the government-appointed chairman of A.I.G., said at least some bonuses were needed to keep the most skilled executives.

I sure would like to see those AIG contracts - I’ll bet I can poke a hole in the specious supposition that the company really, really wants to do the right thing, but its little hands are tied. Since the public bailout of AIG, we all have an ownership interest in where the money is going, and are entitled to ask probing questions.

New York Times: “We cannot attract and retain the best and the brightest talent to lead and staff the A.I.G. businesses — which are now being operated principally on behalf of American taxpayers — if employees believe their compensation is subject to continued and arbitrary adjustment by the U.S. Treasury,” he wrote Mr. Geithner on Saturday.

Still, Mr. Liddy seemed stung by his talk with Mr. Geithner, calling their conversation last Wednesday “a difficult one for me,” and noting that he receives no bonus himself.

“Needless to say, in the current circumstances,” Mr. Liddy wrote, “I do not like these arrangements and find it distasteful and difficult to recommend to you that we must proceed with them.”

I know contracts inside and out, at the real-world, down and dirty level, not the black-box, ivory tower, theoretical stratum that gets adjusted as the tectonic plates of business deals crash into each other.

Although I have chosen not to practice law anymore, I am really good at understanding the terms of these agreements, and evaluating when it would appropriate to reward corporate players for their performance.

And, when it is not.

New York Times: Of all the financial institutions that have been propped up by taxpayer dollars, none has received more money than AIG, and none has infuriated lawmakers (and Ben Bernanke per 60 Minutes) more, with practices that policy makers have called “reckless”

The bonuses will be paid to executives at A.I.G.’s financial products division, the unit that wrote trillions of dollars’ worth of credit-default swaps that protected investors from defaults on bonds which were backed in many cases by subprime mortgages.

The bonus plan covers 400 employees, and the bonuses range from as little as $1,000 to as much as $6.5 million. Seven executives at the financial products unit were entitled to receive more than $3 million in bonuses.

Any attorney who advises that these bonuses are appropriate ought to have his or her head checked.

Base salary, maybe, if not outrageous. No bonus. No severance unless everybody else also received proportionate assistance. Don’t care what the contract says - attack it in bankruptcy or wind down - I saw it many times in the Silicon Valley meltdown.

But the official also said the administration will force A.I.G. to eventually repay the cost of the bonuses to the taxpayers as part of the agreement with the firm, which is being restructured.

AIG’s main business is insurance, but the financial products unit sold hundreds of billions of dollars’ worth of derivatives, the notorious credit-default swaps that nearly toppled the entire company last fall. AIG had set up a special bonus pool for the financial products unit early in 2008, before the company’s near collapse, and when problems stemming from the mortgage crisis were just becoming clear.

There were concerns that some of the best-informed derivatives specialists might leave.the company. AIG then locked in $450 million for the financial products unit, and prepared to pay it in a series of installments to encourage people to stay.

This poignant issue is near and dear to me, as I have shut down management bonuses before, even when I would have received some of that money, and even when I really needed it.

I also have been lucky enough to work with one of the premier corporate governance experts in the country and with a bankruptcy and wind down expert whom I hope will end up on the federal bench.

In the past, I have known both of these gentlemen to express support for my assertion that it is appalling for a destitute company to pay out management and deal bonuses to the team that took the company under.

New York Times: A.I.G.’s main business is insurance, but the financial products unit sold hundreds of billions of dollars’ worth of derivatives, the notorious credit-default swaps that nearly toppled the entire company last fall.

Under a deal reached last week, A.I.G. agreed that the top 50 executives would get half of the $9.6 million they were supposed to get by March 15. The second half of their bonuses would be paid out in two installments in July and in September. To get those payments, Treasury officials said, A.I.G. would have to show that it had made progress toward its goal of selling off business units and repaying the government.

Nice. You just keep holding that moral compass you got there, guys.

Laura is a business consultant and an advocate for information security, consumer protection, long-term shareholder value, and better management decisions. Her specialty is finding and fixing risks and threats to sensitive data. Her experience includes international banking, credit card, and mortgage companies, venture capital portfolio companies, and software and technology providers. She practiced law in Silicon Valley during the tech boom and meltdown, handling corporate governance and information protection.

This post can also be viewed on yourmortgageoryourlife.wordpress.com.

China Beginning To Use Monetary Leverage On U.S.

While the U.S. has racked up trillions in debt, China has been buying up this U.S. debt. Now China owns more U.S. debt than any other country on the planet, and of course with that comes a great deal of political power over the U.S. China owns so much of our debt that if they were to start selling it off in mass quantity it could collapse our entire financial system. China has not said that they have any intention of doing so, nor would it be financially wise for them to, however, the threat alone carries a lot of weight. One of Obama's campaign claims was that he intended to fight China's monetary manipulation, but with little surprise — after urging from China — the U.S. backed down. Now China is urging the U.S. to be more prudent with their stimulus spending — in order to protect the value of their investment. Kathy Lien dives more into this story in her blog post below.

According to the latest data from Treasury, foreign investors were net sellers of U.S. dollars. The Madoff scandal led to a tremendous amount of liquidation by hedge funds in the Caribbean and Luxembourg but we have our eye on China. The Asian Giant continues to be a net buyer of dollar denominated investments, albeit at an increasingly sluggish pace. For the third month in a row, China has slowed their purchase of U.S. dollars. There are many reasons why their demand for dollars is waning, but don’t expect them to become net sellers of U.S. dollars anytime soon ahead of the Treasury’s report on Currency Manipulation next month.

With a month to go before the report is due for release, China is flexing their muscles. This weekend, Chinese Premier Wen Jiabao signaled to the U.S. that they are fully aware of the power they have on the U.S. economy and how the U.S. needs China just as much as China needs the U.S. He said that “we lent such huge funds to the United States, and of course we’re concerned about the security of our assets.” If China decided that U.S. investments are no longer safe, their liquidation would drive yields significantly higher and stocks significantly lower. The consequences of infuriating China are severe because they have the power to retaliate.

China’s continual accumulation of U.S. Treasuries is also political. With a growing U.S. deficit, there are much better ways for China to spend their money such as investing in resource companies. The sharp decline in Chinese exports also automatically reduce their need to weaken the Yuan by buying U.S. dollars. However for political reasons, the Feb and March TIC data should continue to report that China is a net buyer of U.S. dollars.

CNBC VIDEO: Is US Debt Still Desirable to China?

This post can also be viewed on KathyLien.com.

Misguided Optimism From The White House

While the White House seems to be in a cheery mood about the future of the economy, you might want to hold off your enthusiasm. As Tim Duy points out, the economic data being released is in no way positive — and of course the administration fresh off the passing of their new stimulus package isn't going to admit defeat anytime soon. Mark Thoma looks closer at a recent article from Tim Duy that addresses the misguided optimism coming out of the White House in his blog post below.

Tim Duy doesn't see the light at the end of the tunnel that the administration says may be there:

Optimism Abounds at the White House, by Tim Duy: With the ink barely dry on the recent stimulus package, commentators are already calling for a fresh round of stimulus. But will these calls be heeded, or fall on deaf ears? For now, it looks like the Obama Administration is standing firm. And, really, what else could we expect? A call for more stimulus at this juncture is only a signal that the first package was destined to be a failure from the beginning, an admission that this Administration could not afford so early in the term. Christina Romer, chair of the Council of Economic Advisers, delivered a clear message today:

“We absolutely need to let this one work,” Christina Romer, chair of the White House’s Council of Economic Advisers, said Monday at the Brookings Institution. Tax withholding tables are just now being changed to get more money into consumers’ pockets, she said, and many forecasters are saying the recent uptick in consumption may mean the economy is approaching bottom. “I think people are perhaps seeing some light at the end of the tunnel,” Ms. Romer said.

Light at the end of the tunnel...what information exactly is flowing into the Oval Office? Did the White House get the same jobs report the rest of us saw last Friday? Not so much light in that report as pitch black. Another 651k employees cut from payrolls, unemployment pushed to 8.1%, and the U6 rate pushed to a whopping 14.8%. These numbers are all expected to deteriorate in the months ahead. What else did we see last week? Perhaps the light was the in the ISM reports? Manufacturing barely budged, and remains mired deep in recession territory; nonmanufacturing tells a similar tale. Initial claims fell, but at 639k still signalscontinued sharp deterioration in the labor market, and the 4-week moving average still edged up. Maybe she is referring to the downward revision to 4Q08 productivity, which suggests firms still have more work to do in reducing labor costs.

Recent data shows little light, in my opinion. It describes an economy in virtual free fall. Romer appears to be holding onto the hope that the relative stabilization in real consumption expenditures signals a bottom of activity. I hope she is correct, but I remain cautious - households are getting a significant boost right now from declining energy prices, but with oil prices settling out in the $35 to $50 zone, future gains are less likely. Moreover, the confidence numbers are not supportive of a bounce back in consumer spending:

Most irritating is that Romer knows all this; she is much too smart to not appreciate the severity of the data. But once you go are in the Administration - whatever Administration - you heed to the party line. Romer continues the line:

The White House is betting that addressing the root cause of the economic downturn — the housing and financial-sector trouble — will be enough (along with the stimulus spending) to return the U.S. to growth. Tim Geithner, the Treasury secretary, “loves to say, ‘There’s more stimulus in financial rescue than in stimulus,’” Ms. Romer said. “By getting our financial markets back, getting lending going again, that’s incredibly important for aggregate demand and for spending.”

Sometimes I feel like I am in Oz. And I want to go home, so badly do I want to go home. To a time that credit flowed like water from a spring, and the answer to all life's problems could be found in a home equity line of credit. And Geithner is whispering to me, "just click your heels, and say 'I want to go home.'" Yet for months I have been clicking my heels - since Fall of 2007 - and still I am stuck in Oz.

Efforts to unglue the financial system are important, but I sense that the Administration's expectations of what will by delivered by a fix will fall far short of what is necessary to fill the growing hole in the US economy. Even BOA CEO Ken Lewis, in a self-serving WSJ oped, admits as much:

Second, one of our greatest challenges is balancing the need to extend credit with the need of households to pay down excessive debt. In an economy that became too dependent on debt-driven consumption to create growth, the prospect of household deleveraging is sobering. The answer, in my view, is to let competitive forces lead us back to responsible lending practices, not the type of indiscriminate lending that has created so many problems.

Even if households suddenly rediscover their love affair with credit, a big if given the destruction of wealth in recent months, they will find themselves stymied by tighter credit conditions. A healthy, well functioning financial system simply will not extend credit on the scale seen in recent years. Without a replacement for that demand, economic activity will slide into a sub par equilibrium, and would likely remain sub par for an extended period of time as structural imbalances are corrected. David Altig at macroblog summarizes:

When I look ahead, I envision the U.S. economy over the next several years in terms of a simultaneous process of recovery and reformation: Recovery in the sense that the actual contraction of GDP will end, but reformation in the sense of structural transformation in financial markets, consumer behavior, and perhaps an adjustment of the global imbalances that are arguably at the root of much of the financial instability that has characterized the past decade.

Additionally, what is the time line for a financial market fix? One month, or one year? Will TALF jump start the securitization market overnight? How much damage will be done to the US economy while we wait? This Administration appears willing to find out.

In short, I grow increasingly fearful that the pace of economic deterioration will leave the US economy in a much deeper hole than this Administration expected, swallowing the stimulus package. Moreover, that even with a functional financial market, crawling out of that hole will be difficult at best. I see little but fiscal stimulus that could fill that hole. You might not like it, you might worry about the long term budgetary consequences, but we all might soon fall back on the old battlefield adage: There are no atheists in foxholes.

This post can also be viewed on economistsview.typepad.com.

How Does U.S. Stimulus Spending Compare To The Rest Of The World?

The current economic crisis has lead to the fastest rate of job loss in any period since 1974, according to the New York Times. To help curb this disturbing trend President Obama has spent billions. But how does this recession's unemployment figures compare to past recessions? How much has the U.S. spent on our stimulus compared to other countries? Kathy Lien shows us some charts which answer those questions in her blog post below.

The labor market in the U.S. is weakening and the Obama Administration is trying to compensate by spending aggressively. The NY Times and Wall Street Journal released some great images on how job losses in the current recession compares to previous downturns and how the current degree of U.S. spending compares to the rest of the world.

Also check out the NY Time’s interactive How the Government Dealt With Past Recessions

This post can also be viewed on kathylien.com.

Obama's Stimulus Plan Won't Be Enough, And Could Even Ruin Him

Politics is a tricky game, and President Obama could be setting himself up for a tremendous fall. Right now his approval rating is sky high, but so too are his expectations. As famed economist Paul Krugman points out in his article, Obama's recent economic stimulus plan is much too small, and in all likelihood he is going to be forced to ask for more money. When that time comes people are going to assume the last stimulus package was a failure, and naturally Obama will take the brunt of the blame for it. He had a hard enough time garnering the necessary Republican support (3 votes) to get the first bill passed, and you can bet the next time around will be 100 times harder. For more on this, read Mark Thoma's blog post below:

I've heard people say the debate over the size of the stimulus package was misrepresented in the media, that the media rarely presented the view that the plan was too small.

President Obama’s plan to stimulate the economy was “massive,” “giant,” “enormous.” So the American people were told... Watching the news, you might have thought that the only question was whether the plan was too big, too ambitious.

Yet many economists, myself included, actually argued that the plan was too small and too cautious. The latest data confirm those worries — and suggest that the Obama administration’s economic policies are already falling behind the curve.

Why do you say that? Won't his plan create millions of jobs?

Mr. Obama’s promise that his plan will create or save 3.5 million jobs by the end of 2010 looks underwhelming, to say the least. It’s a credible promise... But 3.5 million jobs almost two years from now isn’t enough in the face of an economy that has already lost 4.4 million jobs, and is losing 600,000 more each month.

Ah, I see. Even though it's likely to create 3.5 million jobs as promised, it's still millions short of what is needed. So how do we improve the plan?

There are now three big questions about economic policy. First, does the administration realize that it isn’t doing enough? Second, is it prepared to do more? Third, will Congress go along with stronger policies?

What are the answers?

On the first two questions, I found Mr. Obama’s latest interview with The Times anything but reassuring.

“Our belief and expectation is that we will get all the pillars in place for recovery this year,” the president declared — a belief and expectation that isn’t backed by any data or model I’m aware of. ... And there was no hint in the interview of readiness to do more.

Do you mean he doesn't seem ready to do more in terms of fiscal policy, or that he's not ready to do more of anything, in particular, more to help the banking system recover?

A real fix for the troubles of the banking system might help make up for the inadequate size of the stimulus plan... But he went on to dismiss calls for decisive action... As I read it, this dismissal — together with the continuing failure to announce any broad plans for bank restructuring — means that the White House has decided to muddle through on the financial front, relying on economic recovery to rescue the banks rather than the other way around. And with the stimulus plan too small to deliver an economic recovery ... well, you get the picture.

Yep. It's like one of those bad dreams where your feet won't move fast enough to get away from the impending doom closing in on you. Will the administration wake up and get moving?

Sooner or later the administration will realize that more must be done. But when it comes back for more money, will Congress go along?

One side won't, that's pretty clear, and I'm not so sure about the Democratic side of the aisle either.

Republicans are now firmly committed to the view that we should do nothing to respond to the economic crisis, except cut taxes — which they always want to do... If Mr. Obama comes back for a second round of stimulus, they’ll respond not by being helpful, but by claiming that his policies have failed.

And if there are any small successes to point to Republicans will, of course, insist it was because of the tax cuts in the first round of stimulus. Where does the public stand at this point?

The broader public ... favors strong action. ... But will that support still be there, say, six months from now?

I wouldn't count on it.

Also, an overwhelming majority believes that the government is spending too much to help large financial institutions. This suggests that the administration’s money-for-nothing financial policy will eventually deplete its political capital.

I don't suppose we can borrow political capital from China?

So here’s the picture that scares me: It’s September 2009, the unemployment rate has passed 9 percent, and despite the early round of stimulus spending it’s still headed up. Mr. Obama finally concedes that a bigger stimulus is needed.

And at that point, he begins pushing a new plan?

But he can’t get his new plan through Congress because approval for his economic policies has plummeted, partly because his policies are seen to have failed, partly because job-creation policies are conflated in the public mind with deeply unpopular bank bailouts. And as a result, the recession rages on, unchecked.

Would you bet some of your Nobel money on that prediction?

O.K., that’s a warning, not a prediction. But economic policy is falling behind the curve, and there’s a real, growing danger that it will never catch up.

This post can also be viewed on economistsview.typepad.com.

Is Obama Killing Capitalism?

Most of Obama's recent moves have been heavily opposed by Republicans, but is he single handedly killing Capitalism — and Wall Street — as some are claiming? Economics professor Mark Thoma thinks that the claim is absolutely absurd, and in fact agrees with Robert Reich that Republicans are more responsible for the falling markets than Obama is. Thoma looks at a couple articles, and gives his input on the subject in his blog post below.

Republicans made the bed, now they want someone else to sleep in it:

Is Obama Responsible for Wall Street's Meltdown? Where Populist Rage is Heading, by Robert Reich: Is Obama responsible for the meltdown of the Dow? The consistently wrong-headed Wall Street Journal's editorial page says so, as does Republican Fox News, CNN's reliably demagogic Lou Dobbs, and now CNBC... CNBC's Jim Cramer, who bloviates nightly about stock picks, says Obama is pushing a "radical agenda" that's destroying investor's wealth. My friend Larry Kudlow, who rants nightly about nearly everything, says Obama is destroying capitalism. CNBC reporter Rick Santelli's ballistic nonsense about Obama's mortgage plan made him a pop-populist icon for a week or so.

The argument that Obama is somehow responsible for the collapse of Wall Street is absurd. First, every major policy that led to this collapse occurred under George W's watch (or, more accurately, his failure to watch). The housing and financial bubbles were created under Bush and exploded under Bush. The stock market began to collapse under Bush.

Second, it's inevitable that stocks, led by the bloated financial sector, would lose their remaining hot air as the new administration begins "stress-testing" the big banks, many of which are technically insolvent. After all, their share prices were built on a tissue of lies and dreams. Other sectors whose values were similarly distorted and distended by years of financial deception and regulatory disregard, such as housing and insurance, will also have to return to the real world before they can recover. Which could mean more stock losses.

Finally, none of the financial wizards who are now charging Obama with leading America into the abyss has offered an alternative plan for getting us out of the mess that, not incidentally, many of these same wizards happily led us into. For years, the Wall Street Journal editorial page and the financial gurus of cable news cheered as Wall Street leveraged its way into oblivion.

This bizarre charge wouldn't be worth mentioning were it not a market test for a more intense attack from Wall Street and Republican media outlets next year as the nation moves into ... range of the 2010 midterm elections. Republicans have made no secret of their wish to blame Obama for the bad economy, and to stir up as much populist rage against his so-called "socialist" tendencies as politically possible. History shows how effective demagogic ravings can be when a public is stressed economically. Make no mistake: Angry right-wing populism lurks just below the surface..., ready to be launched not only at Obama but also at liberals, intellectuals, gays, blacks, Jews, the mainstream media, coastal elites, crypto socialists, and any other potential target of paranoid opportunity.

To complicate matters for Republicans, however, grass-roots populist rage is also building against Wall Street itself, and with some justification. Top Wall Streeters who raked in tens of millions of dollars a year for more than a decade have now effectively eviscerated the pension fund savings of millions of middle-class American workers and destroyed millions of Main Street jobs. The public is understandably appalled that its tax dollars are being used to pay and prop up the very people and institutions responsible for this debacle. And there seems to be no end in sight... Yet no one seems to know exactly where these dollars are going, or why. ...

The Wall Street and Republican media attack machine doesn't know exactly what to make of this. The Wall Street Journal's editorial page, along with CNBC, alternates between attacking Obama for bailing out Wall Street and excusing Wall Street's excesses. But then again, Obama doesn't seem to know exactly what to make of it either. He seems to vacillate as well -- one moment scorning Wall Street, the next moment justifying further bailouts. I do hope he takes a firmer hand, drawing a clearer distinction and making a clearer connection between clearing up these financial balance sheets and helping average people. Otherwise, the next populist uprising will be born in this moneyed quagmire. It is here -- within the muck that was created by AIG, Citigroup, Fannie and Freddie, other giant financial institutions, now in combination with the U.S. Treasury and Fed -- that the public is most confused, bears its most serious scars, and is potentially most burdened in future years...

Why people should ignore Larry Kudlow:

The Housing Bears Are Wrong Again, by Larry Kudlow, NRO, June 2005: This tax-advantaged sector is writing how-to guide on wealth creation.

Homebuilders led the stock parade this week with a fantastic 11 percent gain. This is a group that hedge funds and bubbleheads love to hate. All the bond bears have been dead wrong... So have all the bubbleheads who expect housing-price crashes in Las Vegas or Naples, Florida, to bring down the consumer, the rest of the economy, and the entire stock market.

None of this has happened. ... Meanwhile, the homebuilders index has increased 76 percent over the past year, with particularly well-run companies like Toll Brothers up about twice as much. The bubbleheads missed all this because they haven’t done their homework. If they had put a little elbow grease into their analysis, they would have learned that new-housing starts for private homes and apartments haven’t changed much during the past three and a half decades. ...

Which leads to a final thought: Why not apply the same tax laws that have benefited home owners to stock market investors and home buyers? If this were to come about, even more wealth would be created in America, leading to even more new business and job creation. ...

Yes, too bad we didn't make the bubble even bigger. If capitalism is destroyed, something that's highly unlikely, it won't be Obama's fault. It will be the fault of people like Kudlow who "haven’t done their homework" and who opposed any and all attempts to temper the housing bubble through regulation or any other means - see the ridicule of "bubbleheads" above - and who continue to oppose such measures today. Capitalism may change, in fact it needs to change - the excesses that allowed the housing bubble to develop need to be tempered through regulation and other means - but if Kudlow and company have their way and continue to assert that what's good for the rich is good for America, that regulation was the problem not the solution, and that tax cuts are the answer to every problem, the change that is needed won't happen. It's easy to understand why they are so vocal in their opposition to the kinds of changes that are being proposed. The change that is needed to help stabilize the system will bring about destruction (creatively we hope), and people like Kudlow will likely be the ones who feel the brunt of that change as the advantages unregulated markets brought them disappear. But they shouldn't confuse the destruction of the elements that allowed them to take advantage of the system with the destruction of the system itself.

This post can also be viewed on economistsview.typepad.com.

Obama's Housing Plan Will Just Create Another Housing Crash

Obama's new housing stability plan has some blatant flaws, including most notably that it is setting us up for another crash 5 years from now. In addition the way the plan is structured it is setting itself up for abuse — this will cost taxpayers a lot of money when all is said and done. Tim Iacono looks at the new housing plan details, and addresses some concerns he has about the program in his blog post below.

Details of the Treasury Department's Homeowner Affordability and Stability Plan were announced today. It's quite an interesting undertaking that seems like it will be good fun for at least the next couple years as stories of abuse and odd goings-on come to light.

There are three basic components - aid for refinancing, foreclosure avoidance, and more support to Fannie Mae and Freddie Mac. It is the middle component, more properly known as the "Homeowner Stability Initiative", that is most intriguing and most likely to be abused in ways that can only be imagined today. Here's how the plan will work:

- The lender will have to first reduce interest rates on mortgages to a specified affordability level (specifically, bring down rates so that the borrower's monthly mortgage payment is no greater than 38% of his or her income).

- Next, the initiative will match further reductions in interest payments dollar-for-dollar with the lender, down to a 31% debt-to-income ratio for the borrower.

- To ensure long-term affordability, lenders will keep the modified payments in place for five years. After that point, the interest rate can be gradually stepped-up to the conforming loan rate in place at the time of the modification. Note: Lenders can also bring down monthly payments to these affordability targets through reducing the amount of mortgage principal. The initiative will provide a partial share of the costs of this principal reduction, up to the amount the lender would have received for an interest rate reduction.

The old days of a maximum 28 percent of income toward servicing a mortgage have almost returned. Over the years, many have been turned down for mortgages because they failed to meet this requirement - it's crazy to think that this figure got as high as 50 or 60 percent a few years back and then, well beyond that, when people started to lie about how much they made.

In the second step above - where government money enters the picture - there is a downward limit of two percent for the mortgage rate which, effectively, creates a lower limit on income for qualifying.

In other words, your mortgage payment won't get reduced to zero if you lost your job.

Here's an example of how it would work for "Family C" who, back in 2006, took out a 30-year subprime mortgage of $220,000 at 7.5 percent, on a house worth $230,000 at the time. Since the purchase, their home's value has fallen 18 percent to $189,000 and their income has shrunk such that their monthly mortgage payment of $1,538 is now 42 percent of their $3,650 monthly income.

Here's how lucky "Family C" gets their mortgage payment reduced by $406.
Here's the part about the lower limit on the new interest rate:

Protecting Taxpayers: To protect taxpayers, the Homeowner Stability Initiative will focus on sound modifications. If the total expected cost of a modification for a lender taking into account the government payments is expected to be higher than the direct costs of putting the homeowner through foreclosure, that borrower will not be eligible. For those borrowers unable to maintain homeownership, even under the affordable terms offered, the plan will provide incentives to encourage families and lenders to avoid the costly foreclosure process and minimize the damage that foreclosure imposes on lenders, borrowers and communities alike. Moreover, Treasury will not provide subsidies to reduce interest rates on modified loans to levels below 2%.

In the first part of the passage above, it's not clear how they'll determine if it makes more sense to modify the loan or to foreclose, but the two percent lower limit is very clear.

You can just see some of the possibilities here where people will figure out what they need to do to get their income down to that two percent rate - it will usher in a whole new wave of "liar loans", only this time people will be wanting their income to show up on the paperwork at a lower level.

Most importantly perhaps, this sets up a whole new wave of mortgage rate resets in five years as all of these loans revert to market rates which are sure to be much higher than the temporary rate.

This is, effectively, a government subsidized 5-year ARM with rates as low as 2 percent.

My, what progress we're making...

This post can also be viewed on themessthatgreenspanmade.blogspot.com.

Obama's Budget Looks Great According To Krugman

President Obama at least has one big supporter of his new budget, famed economist Paul Krugman. Krugman believes that this budget is just what the country needs to turn things around and applauds Obama for his efforts. Mark Thoma looks at a recent article from Krugman in his blog post below.

Paul Krugman finds lots to like in Obama's proposed budget:

Climate of Change, by Paul Krugman: Elections have consequences. President Obama’s new budget represents a huge break, not just with the policies of the past eight years, but with policy trends over the past 30 years. If he can get anything like the plan he announced on Thursday through Congress, he will set America on a fundamentally new course.

The budget will, among other things, come as a huge relief to Democrats who were starting to feel a bit of postpartisan depression...: fears that Mr. Obama would sacrifice progressive priorities in his budget plans ... have now been banished.

For this budget allocates $634 billion over the next decade for health reform. That’s not enough to pay for universal coverage, but it’s an impressive start. And Mr. Obama plans to pay for health reform, not just with higher taxes on the affluent, but by putting a halt to the creeping privatization of Medicare, eliminating overpayments to insurance companies.

On another front, it’s also heartening to see that the budget projects $645 billion in revenues from the sale of emission allowances. After years of denial and delay by its predecessor, the Obama administration is signaling that it’s ready to take on climate change. ...

Many will ask whether Mr. Obama can actually pull off the deficit reduction he promises. Can he actually reduce the red ink from $1.75 trillion this year to less than a third as much in 2013? Yes, he can.

Right now the deficit is huge thanks to temporary factors (at least we hope they’re temporary)... But if and when the crisis passes, the budget picture should improve dramatically. ... So if Mr. Obama gets us out of Iraq (without bogging us down in an equally expensive Afghan quagmire) and manages to engineer a solid economic recovery — two big ifs, to be sure — getting the deficit down to around $500 billion by 2013 shouldn’t be at all difficult. ...

So we have good priorities and plausible projections. What’s not to like about this budget? Basically, the long run outlook remains worrying.

According to the Obama administration’s budget projections, the ratio of federal debt to GDP. ... will soar over the next few years, then more or less stabilize ... at a debt-to-GDP. ratio of around 60 percent. ... [S]ooner or later we’re going to have to come to grips with the forces driving up long-run spending — above all, the ever-rising cost of health care.

And even if fundamental health care reform brings costs under control, I at least find it hard to see how the federal government can meet its long-term obligations without some tax increases on the middle class. Whatever politicians may say now, there’s probably a value-added tax in our future.

But I don’t blame Mr. Obama for leaving some big questions unanswered in this budget. There’s only so much long-run thinking the political system can handle in the midst of a severe crisis; he has probably taken on all he can, for now. And this budget looks very, very good.

More on the budget:

• Finally a Progressive Budget, Robert Reich
• Higher Taxes: Will The Republicans Cry Wolf Again? - Bruce Bartlett
• Obama’s Budget Plan Sweeps Away Reagan Ideas, by David Leonhardt, New York Times

This post can also be viewed on economistsview.typepad.com.

Why We Should Break Up The Big Banks

Last week there was a lot of speculation that the US government would privatize mega banks, Citigroup and Bank of America, but now it appears that they are going to be happy with large stakes in the banks. The government believes that nationalizing the banks would ultimately cause more harm than good, and would like to avoid that path. Simon Johnson has a different view, though, he believes that the best course of action is to nationalize the big banks causing us so much grief, and then sell them off again in smaller pieces. This would ultimately remove much of the political power these monsterous institutions have over the government and our economy as a whole. Mark Thoma from the Economist's View looks at Johnson's article and adds some thoughts of his own in his blog post below:

Simon Johnson:

Privatize The Banks Already, by Simon Johnson: ...In some important and not good ways, we have already nationalized the financial system.

There’s the direct ownership that the government received through TARP and the reupping with Citi, BoA and some others. These stakes are obviously not (yet) voting stock, but the taxpayer certainly has capital at considerable risk.

Then we have the lines of credit provided by the Federal Reserve which, without a doubt, were instrumental to the survival of almost all major banks during the fall - and arguably remain critical today. The taxpayer has further downside risk here.

And, most importantly perhaps, we have the expansion of the Fed’s balance... In effect, the Fed is becoming a commercial bank as well as a central bank.

The government is essentially taking over the role of intermediation - take funds in and lend them out - for the US economy. This is a form of nationalization, and it will lead to all the lobbying and politically directed credits we have seen in other nationalized financial systems; taking away this credit once the economy starts to recover will not be easy. We have state control of finance without, well, much control over banks or anything else - we can limit executive compensation (maybe) but we don’t get to appoint directors (or replace entire boards) and we have no say in who really runs anything. Responsibility without power sounds accurate. ...

How then do we really privatize? By exercising leadership: take over insolvent banks and immediately reprivatize them. ... The taxpayer retains a significant number of shares (or the option to buy common stock) as a way to ensure upside participation...

Above all, we need to encourage or, most likely, force the large insolvent banks to break up. Their political power needs to be broken, and the only way to do that is to pull apart their economic empires. It doesn’t have to be done immediately, but it needs to be a clearly stated goal and metric for the entire reprivatization process.

No argument here. If there are good reasons to have banks so large their failure could bring down the entire system, a situation that gives them quite a bit of political leverage, I haven't heard them. There are questions about whether having many small banks as opposed to a few big banks reduces systemic risk, and if not, whether having lots of small banks makes policy intervention to stabilize and clean up the system more difficult when problems do arise - having just a few banks might be easier. But breaking up the banks does reduce political and economic power and I see no reason not to make this "a clearly stated goal and metric for the entire reprivatization process."

This post can also be viewed on economistsview.typepad.com.

Secret TARP Bailout Details To Be Released By Court Order

It appears that we finally (hopefully) will be able to see where our tax dollars are going, thanks to a recent court ruling. This court order will force the Treasury to release some of the information that they have been concealing from the American public in regards to the massive bailout of the country's financial system. Anthony Freed provides us with more information on this development in his blog post below:

Advocates of an open Government and transparent allocation of taxpayer funds celebrated the news late Friday afternoon (2-20-09) that the U.S. District court has moved to enforce a Freedom of Information Act (FOIA) request to release more details about exactly how TARP bailout funds have been and are being used.

The TARP was passed in early October, 2008, in an effort to stem the damage to the nation’s financial industry incurred during a decade of lax risk-abatement that pervaded the banking culture after the legislative emasculation of the Glass-Steagall Act.

FOX Business sued Treasury on Dec. 18 over failure to provide information on the bailout funds or respond to FBN’s expedited requests filed under the FOIA. The initial request, filed on Nov. 25, sought actual data on the use of the bailout funds for American International Group (AIG) and the Bank of New York Mellon (BK), and an additional request, filed on Dec. 1, sought similar data on the bailout funds for Citigroup (C).

FBN asked the Treasury Department to identify, among other issues, the troubled assets purchased, any collateral extended, and any restrictions placed on these financial institutions for their participation in this program.

The Treasury Department - along with the other banking regulators like the FDIC, OTS, and the Federal Reserve - are notoriously secretive concerning the data they collect and their subsequent analysis of the viability of any particular institution, preferring to operate instead behind closed doors.

This tendency often leaves investors in the dark, which generally tends to work in the banks’ favor. Regulators would argue that they are not in the business of moving markets, and that some data may be misinterpreted and inadvertently cause a run on funds at named institutions, evidenced by Schumer’s now infamous disclosure of details that may have led to the collapse of Indy Mac Bank in 2008.

That argument may have held some water until the TARP bailout effectively made the U.S. taxpayer a shareholder in any number of as yet identified institutions, and the owner of any assortment of exotic financial instruments which have proved toxic to Global capital markets.

Judge Richard J. Holwell of the U.S. District Court for the Southern District of New York said in a decision Friday that the government is directed to comply with FOX Business’s request under the FOIA “within 30 days and to produce a Vaughn index with 45 days.” That means Treasury must comply with FOX Business’s request by Monday, March 23, and must produce a Vaughn index by Monday, April 6.

The Treasury will have the chance to withhold some documents and information they deem too sensitive, but now have to provide an itemized “Vaughn index” of which documents and information have been redacted, and for exactly what reason.

“A Vaughn Index must: (1) identify each document withheld; (2) state the statutory exemption claimed; and (3) explain how disclosure would damage the interests protected by the claimed exemption.”

This may open the door to further FOIA challenges to release the remaining information if the Treasury fails to convince the courts that their vetting of information was reasonable.

I don’t think Treasury has realized that they are not the only ones who have new powers and responsibilities in the implementation of this historic bailout - the courts have yet to weigh-in on much of this, including who is ultimately going to be held responsible for the mess that is the economy, even if it is still taxpayers who have to foot the bill to clean it all up.

My guess is that the courts feel very differently about full disclosure than does the insider Wall Street elite who regulate themselves from Washington D.C. in seeming perpetuity.

Frank Rich of the New York Times wrote a good op-ed piece called What We Don’t Know Will Hurt Us, which helps further the argument that it is time to get to bottom of exactly what is going on with our economy, and why their seems to be so little consequence for the perpetrators of so much devastation.

Americans are right to wonder why there has been scant punishment for the management and boards of bailed-out banks that recklessly sliced and diced all this debt into worthless gambling chips. They are also right to wonder why there is still little transparency in how TARP funds have been spent by these teetering institutions. If a CNBC commentator can stir up a populist dust storm by ranting that Obama’s new mortgage program (priced at $75 billion to $275 billion) is “promoting bad behavior,” imagine the tornado that would greet an even bigger bank bailout on top of the $700 billion already down the TARP drain.

Remember, the fundamental point of the TARP bailout is to funnel incredible amounts of taxpayer money - debt, actually - to the very institutions and people who are responsible for driving the markets off the cliff in the first place.

And they got paid handsomely for doing it.

It is time for our nation’s financial machine to drop the self-righteous arrogance they have cloaked themselves in for too long, for all of those paper-pushing money lords to release their false sense of entitlement, relinquish their ill-gotten wealth from the last 10 years, and to return to their proper place in the economic landscape as facilitators of capital creation, not the creators of capital.

Accountability in the largest disbursement of public funds in history is not only a good idea, it is essential to our democracy, as is ending the revolving door between corporate boardrooms and the regulatory offices of our government.

The Fox Business FOIA request and the court’s decision to release more information should serve as a warning to the Wall Street good ol’ boys that their orgy of omnipotence is truly over, and that the era of accountability is in.

This post can also be viewed on yourmortgageoryourlife.wordpress.com.

We Should Be Looking Out For American Jobs, Not Just American Companies

The protectionist movement has been growing in America, and with every new layoff announcement it only gets stronger. Only adding fuel to the fire is the billions upon billions of taxpayer money that the government is handing out to American companies. Naturally there would have been mass outrage if the U.S. government gave this money to foreign corporations. However, as Robert Reich explains in a recent article the country just might be better off if some of these foreign corporations received funds instead of some of the American companies. After all what good is it to unemployed American workers if these American companies take the bailout money and use it to expand operations in some foreign country? Reich's point is that we should be focusing on what will create the most American jobs, rather than just focusing on supporting American companies. Mark Thoma presents the article by Reich in his blog post below:

Robert Reich:

The Perils of Confusing American Companies With American Jobs, by Robert Reich: Do not confuse American companies with American jobs. The new stimulus bill, for example, requires that the money be used for production in the United States. Foreign governments, along with large U.S. multinationals concerned about possible foreign retaliation, charge this favors American-based companies. That's not quite true. Foreign companies are eligible to receive stimulus money for things they make here... For example, Alstom, the French engineering company, is eligible to receive stimulus funds for the power turbines it produces in Tennessee... On the other hand, U.S. Steel may not be eligible for stimulus money for the steel slabs it casts in Ontario, Canada.

I'm not defending the "buy American" provisions... I'm just saying they're not the same as "buy from American companies." And although these provisions skate close to protectionism and risk foreign retaliation, at least a case can be made that if American taxpayers are footing the bill..., the jobs should be created, well, here in America.

The same confusion haunts the debate over the auto bailout. Advocates of bailing out GM and Chrysler, and most likely Ford, say America can’t afford to lose "its" auto industry. But ... foreign-owned automakers, already producing cars here in the United States, employ – directly or indirectly – hundreds of thousands of Americans. ...

Meanwhile, the Big Three themselves are global. A Pontiac G8 shipped by GM from Australia has less American content than a BMW X5 assembled in the United States. ...

I’m not arguing against an auto bailout. But it ought to be focused on helping American auto workers rather than helping global auto companies headquartered in America. Why pay the Big Three billions of taxpayer dollars ... when, even after being bailed out, they cut tens of thousands of American jobs, slash wages, and shrink their American operations...?

That’s backwards. The auto bailout should help American autoworkers keep their jobs or get new ones that pay almost as well.

Whether it’s stimulus or bailout, policy makers must remember that American companies aren’t the same as American workers – and our first responsibility is to the latter.

"I'm not defending the 'buy American' provisions..." Neither am I.

This post can also be viewed on economistsview.typepad.com.

American's Worth Less Than In 2001, And It Is Getting Worse

According to a recent Federal Reserve report American's are actually worth less today than they were in 2001. Well known economist Paul Krugman blames the American tendency to spend instead of save for limiting our net worth growth, which should be of little surprise. Now it appears that this trend is ready to reverse, which will only exacerbate the economic problems the country is facing. Krugman also makes an interesting comparison to the Great Depression, and how we eventually were able to escape it. At the end of the day, though, he doesn't see the outlook for the economy as very good at all. Economics professor Mark Thoma looks at Krugman's article in his blog post below.

Do we have what it takes "to boot the economy out of a debt trap"?:

Decade at Bernie’s, by Paul Krugman, Commentary, NY Times: By now everyone knows the sad tale of Bernard Madoff’s duped investors. They looked at their statements and thought they were rich. But then, one day, they discovered to their horror that their supposed wealth was a figment of someone else’s imagination.

Unfortunately, that’s a pretty good metaphor for what happened to America as a whole in the first decade of the 21st century.

Last week the Federal Reserve released the ... latest ... report on the assets and liabilities of American households. The bottom line is that there has been basically no wealth creation ... since the turn of the millennium: the net worth of the average American household, adjusted for inflation, is lower now than it was in 2001.

At one level this should come as no surprise. For most of the last decade America was a nation of borrowers and spenders, not savers. ... Why should we have expected our net worth to go up?

Yet until very recently Americans believed they were getting richer, because they received statements saying that their houses and stock portfolios were appreciating in value faster than their debts were increasing. ... Then reality struck... The surge in asset values had been an illusion — but the surge in debt had been all too real.

So now we’re in trouble — deeper trouble, I think, than most people realize... For this is a broad-based mess. Everyone talks about the problems of the banks... But the banks aren’t the only players with too much debt and too few assets; the same description applies to the private sector as a whole.

And as the great American economist Irving Fisher pointed out in the 1930s, the things people ... do when they realize they have too much debt tend to be self-defeating when everyone tries to do them at the same time. Attempts to sell assets and pay off debt deepen the plunge in asset prices, further reducing net worth. Attempts to save more translate into a collapse of consumer demand, deepening the economic slump.

Are policy makers ready to do what it takes to break this vicious circle? In principle, yes. ... In practice, however, the policies ... don’t look adequate to the challenge. The fiscal stimulus plan, while it will certainly help, probably won’t do more than mitigate the economic side effects of debt deflation. And the much-awaited announcement of the bank rescue plan left everyone confused rather than reassured.

There’s hope that the bank rescue will eventually turn into something stronger. ... But even if we eventually do what’s needed on the bank front, that will solve only part of the problem.

If you want to see what it really takes to boot the economy out of a debt trap, look at the large public works program, otherwise known as World War II, that ended the Great Depression. The war didn’t just lead to full employment. It also led to rapidly rising incomes and substantial inflation, all with virtually no borrowing by the private sector. By 1945 the government’s debt had soared, but the ratio of private-sector debt to G.D.P. was only half what it had been in 1940. And this low level of private debt helped set the stage for the great postwar boom.

Since nothing like that is on the table, or seems likely to get on the table any time soon, it will take years for families and firms to work off the debt they ran up so blithely. The odds are that the legacy of our time of illusion — our decade at Bernie’s — will be a long, painful slump.

[Note: James Kwak has balance sheet calculations based upon the Federal Reserve report showing the severe deterioration in household balance sheets.]

This post can also be viewed on economistsview.typepad.com.

Geithner's Misstep

Treasury Secretary Timothy Geithner's recent speech failed to inspire investors, and if anything spread more doubt. The market's expected a clear solution to be laid out, and that just did not happen. One thing was for certain, though, huge numbers were being thrown around by Geithner. As James Picerno details below in his blog post, Geithner is promissing to release more details about the rescue plan in the coming weeks. We'll have to wait and see if he actually delivers as promised this time?

It's big, it's bold, but it's also vague. And that's the problem.

Treasury Secretary Timothy Geithner yesterday explained the new new plan to solve the financial crisis that ails America. Alas, as articulated yesterday, the plan is short on solution details and long on general notions of what needs to be done.

The challenge is figuring out how the latest effort will work and, more importantly, deciding if it'll fare any better than its misguided predecessors. At the moment, that's a challenge with no immediate answer. As the David Byrne and Brian Eno audio montage intones, "America is waiting for a message of some sort or another."

Certainly the size of the announced plan is a bold stroke. How could $2 trillion be otherwise? We know that some of the money will go to buying up the so-called toxic securities that weigh heavily on the health of banks, and that's a step in the right direction, as the experience with the Resolution Trust Corp. suggests. Taking some of illiquid assets off banks' balance sheets should, in theory, help increase lending, which remains tight even at low interest rates. But the details matter, and it's not yet clear what the fine print will say.

“We need more details from Treasury on how exactly it plans to remove bad assets while protecting the taxpayer,” Senator John Kerry, a Democrat and a senior member of the Senate Finance Committee complains via The New York Times. “We have zombie banks that are weighed down because their liabilities exceed their assets. Without a precise mechanism for addressing toxic assets, it will be difficult to increase lending.”

Similar opining can be heard from economists, including a former IMF economist who now teaches at Harvard. “Tim Geithner did a great job in painting the broad strokes of the problem and laying out general principles, but it was a big disappointment not to have more details,” Ken Rogoff tells Bloomberg News.

Yes, Geithner promised to "flesh out the details" soon, presumably within the next few weeks, maybe in the next few days. Unfortunately, in the current climate, the only thing the secretary managed to do was to stoke more anxiety by introducing yet another strain of uncertainty into the marketplace. The last thing we need now is more indecision and ambiguity.

Sure, the government needs to act, but it needs to act intelligently. If yesterday's Geithner show is an indication, the latest round of talking points isn't quite ready for prime time. We feared as much when we learned over the weekend that the Treasury Secretary's scheduled speech to the Congress would be delayed 24 hours. As it turns out, Geithner should have delayed it a few more days, perhaps by a week or even more. As we learned yesterday, in the wake of a sharp selloff in the stock market, it's better these days to say nothing than to make broad comments that leave much to the imagination.

Meanwhile, the administration has been at fault by lifting expectations over the past week that it was going to announce a solution. The President has been talking up Geithner's big debut in Congress. But the optimist talking points, as much as they're welcome, were premature. No wonder, then, that the markets suffered an attitude adjustment as the reality set in that the big solution was really just another bout of talking without backing up the chatting with a concrete plan of action.

The good news is that the Geithner has only lost the first battle rather than the war. But time's running out, and so is patience. Certainly he'll have another chance to repair some if not all of the damage. But neither the Obama administration nor the economy can afford another halfway effort at explaining what happens next. The stakes now are higher than they were on Monday for bringing clarity and intelligence to the fore. Another stumble may result in even bigger financial pain, and not just in the price of equities.

"The uncertainty the government has created has made it nearly impossible to price many securities," says Douglas Dachille, chief executive of First Principles Capital Management, tells The Wall Street Journal.

At this point, no one's sure how the money will be deployed or what the rules are that will govern its usage. That's a problem. Yes, the White House is talking to Congress about just those details and a clearer plan will undoubtedly be hammered out, perhaps within a few days. Meanwhile, this is water torture, and the Obama administration probably recognizes the misstep in speaking out before a sufficient level of specifics was available for public consumption. Meanwhile, we're told that the plan was intentionally vague. Really? The White House reportedly says it wanted to be warm and fuzzy on the plan so as to give everyone an opportunity to put their two cents into the $2 trillion idea. So much for good intentions.

"First, we're going to require banking institutions to go through a carefully designed comprehensive stress test," Geithner advised yesterday. Apparently he's not kidding. But stressing out the financial industry with half-formed commentary isn't helping.

So far, however, the damage is still minimal, at least in terms of the term spread in government bonds, which is one measure of the credit crunch that's taking a toll. Nonetheless, the spread in the 10-year Note and 3-month T-bill is still over 250 basis points while the 10-year/2-year spread is just a hair under 200 basis points. By comparison, a year ago the 10-year/3-month spread was 130 basis points and the 10-year/2-year spread was 169 basis points. At the extreme low levels of interest rates generally in 2009, a wider spread would reflect running for cover into the arms of short-term government paper. That's a sign of distress in this climate if the spread is primarily a function of near-zero rates on the short end, which basically describes the current situation.

One test of the Obama administration's success on its bailout plan in the coming weeks and months will be to convince investors to move assets out of T-bills and into risky assets. An indication of that will be higher yields in T-bills, which are just hovering above zero. So far, no one's budging.

This post can also be viewed on capitalspectator.com.

Why The Government Can’t Fix The Housing Crisis

It appears the government is ready and willing to do whatever it takes to fix the housing crisis, but there is one little problem: They can’t. As part of the new stimulus package, there will likely be a $15,000 homebuyer tax credit, and not just for first-time homebuyers, but for all homebuyers purchasing a primary residence. In addition, the government will likely attempt to drive mortgage rates down to around 4.5 percent and work particularly hard to modify troubled loans to keep homeowners out of foreclosure. With these new measures in place the housing market will surely recover…right?

The answer to that question depends on your definition of recovery. Will it be enough to stop prices from falling, and possibly even help them start going up again? It’s definitely possible, but the problem won’t be fixed even if prices do turn around. Artificially inflated prices caused the housing crisis in the first place. Homeownership became an attractive option for more people than ever before through financing options that were cheap and widely available—a little too widely available, we are now discovering. ARMs, interest-only and other creative loan programs kept monthly payments low, and people could suddenly afford a more expensive house—or so it appeared. When interest rates started rising and ARMs reset, housing values stopped climbing and all hell broke loose.

So why would we believe that artificially boosting housing values will be sustainable this time? What do we think will happen when mortgage rates rise again and the tax credits expire? We won’t have to worry about ARMs resetting this time around because they are now shunned by banks for the most part, but the fundamental problem remains that housing is just too expensive compared to income. Interest rates can’t stay this low forever, and the tax credit will expire after the end of the year. Then homebuyers will only have their personal income to rely on to pay for their homes. This is how it has always been (minus government intervention), and it is how it should be. People making $50,000 a year shouldn’t be living in a $400,000 house—It’s that simple. People need to live within their means, but the government doesn’t seem to grasp this and keeps pushing measures to modify home loans. We can try to modify people’s loans all day long, but if they can’t afford their homes, then they can’t afford their homes. According to the Wall Street Journal, over 40 percent of borrowers were at least 60 days past due eight months after their loan was modified. It seems to me that these loan modifications are just delaying the inevitable and costing banks and taxpayers more money.

Before the housing crisis can truly end, housing prices must come into balance with incomes. When this happens, the problem will solve itself. When buying a home starts to make more sense than renting, people will start buying again. It isn’t that hard to figure out. Spending taxpayer money to prop up housing is not only a waste, but an unethical perpetuation of the problem. It is completely unfair to renters as well as our youth. Unfortunately, those groups represent the minority, so their voice isn’t likely to be heard. If these measures are passed, expect to pay handsomely for it and to see another bubble burst a few years from now. At least this time no one should be able to use the excuse that they didn’t see it coming.

Tax Cuts Could Deepen The Recession

There has been non-stop debate between Republicans and Democrats for the past couple weeks regarding how the economic stimulus bill should be structured. Republicans want a majority to go towards tax cuts, and the Democrats want to see high levels of spending. It appears that the Democrats are going to win out in this debate, thinks to their heavy numbers advantage, but according to the New York Fed's Gauti Eggertsson that is a good thing. He wrote a paper theorizing that in today's economic environment tax cuts have the potential to backfire, and possibly even deepen the recession. Economics professor and author of the Economist's View blog, Mark Thoma, looks at this closer in his blog post below.

Justin Wolfers summarizes a paper that suggests government spending would be better than tax cuts at reviving the economy:

Tax Cuts vs. Government Spending, by Justin Wolfers: As the Senate and the House look to reconcile competing stimulus plans, the big debate is whether to emphasize government spending or tax cuts. A new paper by the New York Fed’s Gauti Eggertsson argues that the risk of deflation should tilt the balance to government spending.

Our current problem is deficient aggregate demand. The government can raise total spending either by buying more stuff, or it can lower taxes and hope that consumers take their tax breaks to the mall. ...

But that’s not the whole story. Tax cuts stimulate both aggregate demand and aggregate supply. If taxes are temporarily lower, they make working today more attractive than working tomorrow, and thus increase labor supply. This boost to the nation’s productive capacity means that a tax-cut-based stimulus doesn’t do as much to narrow the gap between output and what we can produce.

Under normal circumstances, this doesn’t present a problem, because the Fed can lower interest rates to close this output gap. But right now, the Fed has set interest rates as low as they can go, and so different principles apply. Eggertsson’s concern is that a big output gap will lead inflation to fall, leading real interest rates to rise in the middle of the recession. These higher real interest rates further dampen economic activity, and with the Fed powerless to offset this, there’s the very real risk of a deflationary spiral. And so a tax-cut-based fiscal stimulus might actually backfire. In fact, Eggertsson reckons there’s a chance that tax cuts could even deepen the recession.

Is Eggertson’s conjecture right? Unfortunately the historical record can’t tell us: there’s never been an episode in which we’ve tried reducing taxes when interest rates were this low. When we’re in uncharted waters, we’ve got nothing but economic theory to guide us. And the theory says it’s safer to stick to a spending-based stimulus plan.

I'd like to be able to rely on this as one more piece of evidence for government spending over taxes, but I have doubts that the aggregate supply (labor supply) effect would be large enough to make much of a difference. The author also suggests caution:

I am bit hesitant to draw the lesson from this paper that it would be ideal to raise payroll taxes to stimulate the US economy today, although this clearly is a direct implication of the analysis

And he also says:

What should we take out of all of this? ...[One] lesson is that policymakers today should view with great deal of skepticisms any empirical evidence on the effect of tax cuts or government spending based on post war US data. The number of these studies is high, and they are frequently cited in the current debate. The model presented here, which has by now become a workhorse model in macroeconomics, predicts that the effect of tax cuts and government spending is fundamentally different at zero nominal interest rates than under normal circumstances.

This post can also be viewed on economistsview.typepad.com.

Geithner's Financial Stability Plan

This morning the new plan to rescue the financial system was unveiled by Treasury Secretary Timothy Geithner, but so far the markets have not reacted very positively to the news. It is still early, but it appears investors are not sold on the proposed government actions. In his speech Geithner threw around numbers as high as $1 tillion, which represents the expansion of a key Federal Reserve lending program, according to the Associated Press. But even that failed to impress investors. Kathy Lien talks more about the new rescue plan and the impact to currency and financial markets in her blog post below.

The Treasury Secretary has finally spoken and the markets are disappointed!

The price action in the currency markets suggests that investors are disappointed by the lack of details from the Treasury’s new Financial Stability Plan and are skeptical about the effectiveness of getting the private sector involved. Furthermore, investors are not happy about being apart of an experiment (although I think this is the only way to go because all of the old measures have proven effective).

Geithner announced a cocktail of initiatives using “things we haven’t tried before” and warned “that we will make mistakes.” If the Treasury Secretary is not 100 percent confident in his own plan, how could investors be?

Traders have plowed right back into the US dollar on the fear that the US government is rolling the dice once again. Equities have also fallen as much as 300 points.

The Treasury’s Super TARP plan, which is now renamed as the Financial Stability Plan has 3 core components:

1. More Capital for Healthy Banks

2. New Financing for as Much as $1 trillion of Consumer and Business loans

3. Public Financing for Private Investors Willing to Buy Distressed Debt (details of private/public investment fund have not been released)

Read the rest of this analysis on FX360.com

This post can also be viewed on kathylien.com.

Krugman Rips Into Senate Centrists

If you have read a newspaper, or watched the news, recently you are probably aware of the difficulties that Republicans and Democrats have had in coming to a consensus on the new stimulus bill. It appears that Democrats have been able to win the vote of at least a few Republicans, enough to get the bill passed, however, at what cost have those votes come? According to well known economist Paul Krugman, the price was extremely high. Mark Thoma from The Economist's View, looks at Krugman's article in his blog post below.

President Obama's net return on his investment in bipartisanship isn't very good:

The Destructive Center, by Paul Krugman, Commentary, NY Times: What do you call someone who eliminates hundreds of thousands of American jobs, deprives millions of adequate health care and nutrition, undermines schools, but offers a $15,000 bonus to affluent people who flip their houses?

A proud centrist. For that is what the senators who ended up calling the tune on the stimulus bill just accomplished.

Even ... the original Obama plan — around $800 billion ... with a substantial fraction ... given over to ineffective tax cuts — ...wouldn’t have been enough to fill the looming hole in the U.S. economy... Yet the centrists did their best to make the plan weaker and worse.

One of the best features of the original plan was aid to cash-strapped state governments... But the centrists insisted on a $40 billion cut in that spending.

The original plan also included badly needed ... school construction; $16 billion of that spending was cut. It included aid to the unemployed, especially help in maintaining health care — cut. Food stamps — cut. All in all, more than $80 billion was cut..., with the great bulk ... falling on ... measures that would do the most to reduce the depth and pain of this slump.

On the other hand, the centrists were apparently just fine with one of the worst provisions in the Senate bill, a tax credit for home buyers...: it will cost a lot of money while doing nothing to help the economy.

All in all, the centrists’ insistence on comforting the comfortable while afflicting the afflicted will, if reflected in the final bill, lead to substantially lower employment and substantially more suffering.

But how did this happen? ... Mr. Obama ... offered a plan that was clearly both too small and too heavily reliant on tax cuts. Why? Because he wanted the plan to have broad bipartisan support...

Mr. Obama’s postpartisan yearnings may also explain why he didn’t do something crucially important: speak forcefully about how government spending can help support the economy. Instead, he let conservatives define the debate...

And Mr. Obama got nothing in return for his bipartisan outreach. Not one Republican voted for the House version of the stimulus plan...

In the Senate, Republicans ... decried the bill’s cost — even as 36 out of 41 Republican senators voted to replace the Obama plan with $3 trillion, that’s right, $3 trillion in tax cuts over 10 years.

So Mr. Obama was reduced to bargaining for the votes of those centrists. And the centrists, predictably, extracted a pound of flesh — not, as far as anyone can tell, based on any coherent economic argument, but simply to demonstrate their centrist mojo. They probably would have demanded that $100 billion or so be cut from anything Mr. Obama proposed; by coming in with such a low initial bid, the president guaranteed that the final deal would be much too small.

Such are the perils of negotiating with yourself.

Now,... it’s possible that the final bill will undo the centrists’ worst. And Mr. Obama may be able to come back for a second round. But this was his best chance to get decisive action, and it fell short.

So has Mr. Obama learned from this experience? Early indications aren’t good.

For rather than acknowledge the failure of his political strategy and the damage to his economic strategy, the president tried to put a postpartisan happy face on the whole thing. “Democrats and Republicans came together in the Senate and responded appropriately to the urgency this moment demands,” he declared on Saturday, and “the scale and scope of this plan is right.”

No, they didn’t, and no, it isn’t.

This post can also be viewed on economistsview.typepad.com.

Concerns About The Economic Stimulus Package

The Senate is expected to vote on the new economic stimulus bill on Tuesday, according to the Wall Street Journal, and it appears it will be able to squeak through. Once the Senate passes the bill it will need to go through House-Senate negotiations, but it should just be a matter of time before the bill ends up on the President’s desk for signing. The bill has not seen the sweeping bi-partisan support that President Obama was hoping for, but could we honestly expect anything but controversy? Senate Democrats only needed a couple Republican votes to make it happen, and that is exactly what they were able to get. So what exactly about this bill has Republicans up in arms? And do their concerns have any merit?

The biggest complaint coming from the Republican side is that the bill is full of wasteful spending. According to an analysis in the Washington Post, the new version of the bill is 78 percent spending and only 22 percent tax cuts. Naturally this type of break down isn’t going to sit well with most Republicans. To make matters worse, the urgency with which supporters want to pump money into the economy has many questioning how well this massive spending will be regulated—if at all. According to the Post, “The stimulus plan presents a stark choice: The government can spend unprecedented amounts of money quickly in an effort to jump-start the economy or it can move more deliberately to thwart the cost overruns common to federal contracts in recent years.”

“’You can't have both,’ said Eileen Norcross, a senior research fellow at George Mason University's Mercatus Center who studied crisis spending in the aftermath of Hurricane Katrina. ‘There is no way to get around having to make a choice.’”

The objections to the spending portion of the bill prompted Obama to make the following statement at a recent House Democratic retreat, according to the Wall Street Journal: “So then you get the argument, ‘Well, this is not a stimulus bill, this is a spending bill.’ What do you think a stimulus is? (Laughter and applause.) That's the whole point. No, seriously. (Laughter.) That's the point. (Applause.)”

The Republicans continue to claim that tax cuts are more efficient than many of the spending proposals being included in the bill. If you are interested in hearing more about that, here is a good opinion piece recently published in the WSJ.

The way that I look at it, we have already tried tax cuts, and they didn’t work out quite as well as we had hoped. Though I don’t think that means we should give up on them all together, I am willing to give other things a try. What I don’t like is the lack of oversight on the spending. If we are going to spend $600 billion, I sincerely hope that we can spare a few million to ensure that these billions are used effectively. I don’t want to see us squander this stimulus money the way that we have the in past. This article in the Post gives a good walk-through of the potential problems with spending oversight as it sits now. Leaders would do well to read this and think hard about how they can ensure that we stimulate the economy in the most efficient and cost-effective manner possible.

Unemployment Surges Again. Stimulus Debate Continues.

In an alarming trend, the recent unemployment report was yet again worse than economists expected. January nonfarm payrolls fell by a seasonally adjusted 598,000, according to the Bureau of Labor Statistics (BLS). Economists surveyed by MarketWatch expected to see 525,000 job losses, considerably less than what was actually reported. In addition to the 598,000 job losses reported for January, the BLS also revised the job loss tally for December from 524,000 to 577,000. Sadly people are growing accustomed to this sort of news, but that doesn’t make this latest report any less grim. "The only 'positive' of today's report is that these ugly numbers put even more pressure on policymakers to finally agree on fiscal measures to stop the downward spiral of the economy," wrote Harm Bandholz, economist for UniCredit Markets as reported by MarketWatch.

This latest report just might be what is needed to get the new stimulus bill passed. I for one did not expect there to be as much debate as there has been. Although Democrats are only a couple votes away in preliminary projections, they want to ensure that the bill is in a form that is guaranteed to pass when it’s time to vote. It will be interesting to see how the bill evolves as the parties negotiate. Both sides want to see something passed, and so eventually something will get passed in one form or another. Senate Majority Leader Harry Reid has given the group of 20 bipartisan senators working to put this bill together a deadline of today to resolve their differences, according to CNN.

President Obama is pushing the Senate hard to get something passed, stressing that time is of the essence. “If we do not move swiftly to sign [the act] into law, an economy that is already in crisis will be faced with catastrophe," Obama was quoted as saying by CNN. "This is not my assessment. This is not Nancy Pelosi's assessment. This is the assessment of the best economists in the country. This is the assessment of some of the former advisers of some of the same folks who are making these criticisms right now."

Obama’s goal has been to have the legislation on his desk and ready to be signed into law on Presidents Day, February 16^th, according to CNN. There is still a lot of work to be done on the bill, but I imagine that they will have something ready by the end of the weekend, if not by the end of the day.

Roads, Bridges, Sewers And...Disc Golf Courses?

A large portion of the proposed $800 to $900 billion stimulus plan is directed toward infrastructure projects. The goals of these projects are first and foremost to create jobs and stimulate the economy, but also to complete vital upgrades to infrastructure that is terribly outdated and failing. When you think about these vital projects, you might picture 100-year old leaky underground water lines or bridges that are nearing collapse. These are projects that will create jobs and without a doubt fulfill a severe need for renovation. What you probably don’t picture when you think about these infrastructure projects are things like a 36-hole disc golf course (price tag $886,000), replacement tennis courts ($1.8 million) or an eco-park complete with a butterfly garden ($4.5 million), but these are all things that could potentially be paid for as part of the new stimulus package.

It should be noted that the above mentioned projects were only part of the nearly 19 thousand projects submitted by local governments as “Ready to Go” according to the Wall Street Journal (WSJ). They have not yet been approved, and it is not certain that they will become part of the final stimulus package. One would think, though, that these local governments would think a little harder before submitting potentially egregious projects like these, considering the recent taxpayer outrage expressed at how banks are using their stimulus money. In addition to the WSJ article, you will also find one that talks about teacher layoffs and large scale cuts to education budgets across the country. Don’t get me wrong, disc golf and butterflies are great, but why would we even consider investing millions of dollars into projects like this when we have so many other places where the money could be put to better use.

President Obama has said repeatedly that this bill will be entirely free of ear marks, and I certainly hope that is the case. I’m not sure how the public would react if they found that their tax dollars were going to fund disc golf courses and tennis courts while their kid’s teacher is laid off. I know we want to get the bill passed quickly, but let’s make sure we do it the right way. We need to make sure that this money is put to its best possible use. We don’t have billions of dollars to waste here, and I hope that the proponents of this bill recognize this.

Kiss The US Economy Goodbye!

Those might be extreme words, but one well known financial writer is thinking just that in relation to the new proposal that is being seriously discussed right now, aimed at saving the banking industry. You might have thought the proposal was bad, but could it potentially cause serious problems for the US economy down the road? To see just how bad Yves Smith thinks the proposal is, read the blog post below from The Economist's View.

Yves Smith is not very pleased with the administration's bank bailout plan:

The Bad Bank Assets Proposal: Even Worse Than You Imagined, by Yves Smith: Dear God, let's just kiss the US economy goodbye. It may take a few years before the loyalists and permabulls throw in the towel, but the handwriting is on the wall.

The Obama Administration, if the Washington Post's latest report is accurate, is about to embark on a hugely costly "save the banking industry at all costs" experiment that:

1. Has nothing substantive in common with any of the "deemed as successful" financial crisis programs

2. Has key elements that studies of financial crises have recommended against

3. Consumes considerable resources, thus competing with other, in many cases better, uses of fiscal firepower.

The Obama Administration is as obviously and fully hostage to the interests of the financial services industry as the Bush crowd was. We have no new thinking, no willingness to take measures that are completely defensible (in fact not doing them takes some creative positioning) like wiping out shareholders at obviously dud banks (Citi is top of the list), forcing bondholder haircuts and/or equity swaps, replacing management, writing off and/or restructuring bad loans, and deciding whether and how to reorganize and restructure the company. Instead, the banks are now getting the AIG treatment: every demand is being met, no tough questions asked, no probing of the accounts (or more important, the accounting). [...continue reading...]

This post can also be viewed on economistsview.typepad.com.

How To Prevent Another Depression

We are no where near a depression yet, but many people are worrying that we are heading for one. So what can the government do to prevent another depression? According to Brad DeLong we have 4 options. Mark Thoma from The Economist's View looks at DeLong's 4 options in his blog post below.

What can governments do to try to keep the economy out of a depression?:

Depression economics: Four options, by J. Bradford DeLong, Commentary, Project Syndicate: When an economy falls into a depression, governments can try four things... Call them fiscal policy, credit policy, monetary policy, and inflation.

Inflation is the most straightforward to explain: The government prints lots of banknotes and spends them. The extra cash in the economy raises prices. As prices rise, people don't want to hold cash... - its value is melting away every day - so they step up the pace at which they spend... This spending pulls people out of unemployment..., and pushes ... production up to 'potential' levels.

But sane people would rather avoid inflation. It is a very dangerous expedient, one that undermines standards of value, renders economic calculation virtually impossible, and redistributes wealth at random. ... But governments will resort to inflation before they will allow another Great Depression. We just would very much rather not go there, if there is any alternative...

The standard way to fight incipient depressions is through monetary policy. ... The problem with monetary policy is that ... the ... nominal interest rate on government securities is zero. ... And this is too bad, for if we could prevent a depression with monetary policy alone, we would do so, as it is the policy tool for ... stabilisation that we know best and that carries the least risk of disruptive side effects.

The third tool is credit policy. We would like to boost spending immediately by getting businesses to invest... Risky projects are at a steep discount today... No one is willing to buy assets and take on additional uncertainty... Although the world's central banks and finance ministries have been devising many ingenious and innovative policies to stimulate credit, so far they have not had much success.

This brings us to the fourth tool: fiscal policy. Have the government borrow and spend, thereby pulling people out of unemployment and pushing up capacity utilisation to normal levels. There are drawbacks: the subsequent dead-weight loss of financing all the extra government debt..., and the fear that too rapid a run-up in debt may discourage private investors from building physical assets...

But when you have only two tools left, neither of which is perfect for the job - credit policy and fiscal policy - the rational thing is to try both, at the same time. That is what the Obama administration ... and other governments are attempting to do right now.

This post can also be viewed on economistsview.typepad.com.

Stimulus Bill Now Being Debated In Senate

A new $819 billion stimulus bill was passed by the House earlier this week, and the debate has moved on to the Senate, despite major opposition from House Republicans. Not a single Republican voted in favor of the bill according to the Wall Street Journal, but to get the 60 votes necessary to clear the Senate, the bill’s supporters will need to garner at least some Republican votes without losing any of the 58 Democrat senators. To secure those necessary Republican votes, some concessions will likely need to be made. One way or another, it is expected that this bill will be passed, but it remains to be seen how much political capital Obama will have to spend to make it happen.

The major divide between the two parties on the bill basically boils down to the allocation of the funds. Both parties support a stimulus bill in principle, but Republicans want to see the funds going toward things such as tax-cuts where as Democrats prefer government spending. In reality, this debate isn’t new, and considering the heavy numbers advantage that the Democrats enjoy in the House, Senate and now White House, the bill should lean toward their ideology. However, it is likely that Republicans will get a bone or two thrown their way in the process. Obama has stated time and time again that he wants broad, bi-partisan support for this bill, but it is unlikely that Democrats will be willing to give up too much considering their steep numbers advantage.

As a side note, the Wall Street Journal reported the formation of a coalition which backs the stimulus bill and which includes labor and environmental groups. The purpose of the group is to raise pressure on senators—specifically Republican senators—to support the bill. They announced Thursday that they will air ads around the country to encourage Republicans, "to support the Obama plan for jobs, not the failed policies of the past." The ads will run in Maine, New Hampshire, Iowa and Alaska according to the Journal. You can be certain that Democrats will remind Republicans and their supporters that their policies have been nothing but failures of late. The public is largely on board with this sentiment, evidenced by numerous polls. If nothing else we should get a chance to see how these new policies actually work in today’s economic climate.

GDP Falls Sharply, But It Could Have Been Worse

The GDP report for the fourth quarter of 2008 showed a steep decline, however, experts thought it was going to be even worse than it was, so that is positive news. There are certainly some indicators that show we should be alarmed about the economy right now, but there are also some positive sparks coming out of these reports that we shouldn't overlook either. James Picerno from the Capital Spectator looks closer at the report and shines some light into what this all means in his blog post below.

Today's report on last year's fourth-quarter GDP wasn't good. In fact, it was quite ugly. But it could have been a lot worse.

Even so, the 3.8% contraction in the economy in 2008's final three months was the steepest decline since 1982. The previous recession in 2001 never came close to what's unfolding now. The 1990-91 slump was deeper, but even that will look mild by the time the current downturn has run its course.

In other words, we're now in the thick of the worst recession since the early 1980s. That said, the crowd was expecting a far deeper loss. The consensus forecast for Q4 GDP was -5.5%, according to Briefing.com. By that standard, the reported 3.8% retreat was a surprise.

Of course, today's GDP report is the first of three estimates from the government and so we must brace ourselves for the possibility of downward revisions. But for the moment, it's fair to say that the recession isn't quite as bad as some had feared, at least if we're using GDP as a benchmark.

That's a thin reed, of course, since it's likely that the pain will run on for some time. Meanwhile, no one should be complacent about the trend. Last year's third quarter posted a mild -0.5% setback, but the wealth destruction became materially worse in Q4. The first three months of this year are likely to be no better and even money says it's likely to get worse for a quarter or two.

Indeed, there's no way to put a positive spin on the fact that consumer spending—the main engine of economic growth for the U.S.—continued to decline at a robust pace in Q4. Personal consumption expenditures fell a hefty 3.5% in last year's final three months, almost as fast as Q3's 3.8% decline. The pain is especially acute in durable goods spending, the so-called big ticket items such as appliances. The huge 22% fall in durable goods spending in Q4 is certainly humbling; it's also a sign of just much has changed in the consumer mindset.

Yet there was a bit of good news. Spending in services by consumers actually rose in Q4, advancing by 1.7%. That compares favorably to Q3's marginal loss. Given the heft of services in the economy, the growth is particularly important to offset weakness almost everywhere else.

Alas, the export machine that had offered so much hope last year as a buffer to economic pain elsewhere is now in full retreat. Exports fell 20% in Q4, the deepest drop in many a moon. Imports slid as well, although not quite as fast.

Overall, today's GDP report is a reminder that we're now in the midst of what promises to a deep recession, perhaps the worst since the Great Depression. The great question is how all the government stimulus will affect GDP this year. The monetary stimulus is only now starting to filter through the economy, and it will be soon followed by another round of fiscal stimulus. Stay tuned.

This post can also be viewed on capitalspectator.com.

Is Free-Market Ideology Flawed?

In a controversial article published in the Guardian, Jeffrey Sachs calls out free-market ideology as flawed and applauds the measures being taken by Obama to get the government more involved in business. America is known for its relatively free-market economy, and for years it seemed to work great, but Sachs argues that things have changed. Whether or not one agrees with Sachs it is interesting to hear his perspective on things. Mark Thoma from the Economist's View presents Sach's article in his blog post below.

Jeff Sachs seems to be pleased with the new administrations commitment to "a new age of sustainable development":

Rewriting the rulebook for 21st-century capitalism, by Jeffrey Sachs, CIF, The Guardian: One of President Barack Obama's historic contributions will be a grand act of policy jujitsu - turning the crushing economic crisis into the launch of a new age of sustainable development. ... Obama is already setting a new historic course by reorienting the economy from private consumption to public investments directed at the great challenges of energy, climate, food production, water and biodiversity.

The new president has taken every opportunity to underscore that the economic crisis will not slow, but rather will accelerate, the much-needed economic transformation to sustainability. ... The fiscal stimulus ... will lay down the first steps of a massive generation-long technological overhaul...

Obama has started with the most important first step: a team of scientific and technological advisers of stunning quality... He has also focused on two core truths of sustainable development: that technological overhaul lies at the core of the challenge, and that such an overhaul requires a public-private partnership for success. Taking shape, therefore, is nothing less than a new 21st-century model of capitalism ... committed to the dual objectives of economic development and sustainability...

Consider the challenge of a bankrupt automobile sector... In the Obama strategy, GM will not be closed to punish it... It's worth far too much as a world leader in the electric vehicles of the 21st century. ...

Conservatives are aghast. The bail-out of the auto industry was hard enough to swallow. Government investments in infrastructure and research and development are viewed with scorn, compared with the tried and true (if disastrously failed) tax cuts of the Bush era. Rightwing pundits bemoan the evident intention of Obama and team to "tell us what kind of car to drive". Yet that is exactly what they intend to do (at least with regard to the power source under the hood), and rightly so. Free-market ideology is an anachronism in an era of climate change, water stress, food scarcity and energy insecurity. Public-private efforts to steer the economy to a safe technological harbour will be the order of the new era.

There is plenty of room for blunders... Government activism can founder on the shoals of massive budget deficits, tax-cutting populism pushed by the right, politically motivated investments such as corn-based ethanol..., and more. Yet Obama is absolutely correct that we have no choice but to try...

This post can also be viewed on economistsview.typepad.com.

All States Are Suffering From Job Losses

A report issued by the Labor Department yesterday indicated that unemployment rose in every single state in December. When oil was still near record highs a few months ago, at least the big energy-producing areas were doing well, but now they are suffering like everyone else. This goes to show you that no area is being spared from economic turmoil. The states that lead the housing boom—such as California, Nevada and Florida—were the first ones to really feel the pain from the downturn. One would think that because they led the downturn they might also lead the rebound, but if that is the case then we still have more pain coming because things are still going from bad to worse in those states. According to the Wall Street Journal, California saw an increase in unemployment of 0.9 percent in November and December, while Florida and Nevada saw increases of 0.7 percent and 1.0 percent respectively.

The last 4 months of 2008 were especially bad. Around 2 million jobs were eliminated from September 2008 to the end of the year. Then on Monday this week—now dubbed “Black Monday”—over 70,000 jobs were cut on a single day. So when is the carnage going to end?

Certainly the new stimulus package won’t hurt the employment outlook, with early projections estimating that the bill will create or save around 4 million jobs, according to the Associated Press. The bill is being reviewed by the House and it is expected to be passed later in the day according to the Wall Street Journal. After passing the House, the bill will then make its way to the Senate. There is still some lobbying to change parts of the bill, but it is widely expected that it will pass in one form or another and arrive on the President’s desk within the next few weeks.

It remains questionable at best whether the bill will work as planned. This current economic environment is different than anything we have ever seen before, and we are really just guessing on the true impact of these initiatives. Will $825 billion be enough? Is the money being allocated to the appropriate places? Will borrowing the money to finance the programs cause problems in the debt markets? These are just a few of the many questions that lawmakers are trying to answer. The truth is, though, that no one knows the answer. They can make educated guesses at best. Let’s just hope that Obama knows what he is doing...and wishing for a little luck won’t hurt either.

Bad Arguments Against Obama's Stimulus Plan

The debate is heating up now surrounding Obama's $825 billion stimulus plan, with conservatives leading the opposition. They are making all kinds of arguments for why the plan won't work, but according to Paul Krugman most of them are bad arguments at best. Seeing as the opposition ranks are pretty small at this point, it just seems like a matter of time till the bill gets passed, and thus a moot point. But just for fun, let's look at a recent article from Krugman, and his response to the objections, curtesy of Mark Thoma at The Economist's View.

How to identify "fundamentally fraudulent antistimulus arguments":

Bad Faith Economics, by Paul Krugman, Commentary, NY Times: As the debate over President Obama’s economic stimulus plan gets under way, one thing is certain: many of the plan’s opponents aren’t arguing in good faith. Conservatives really, really don’t want to see a second New Deal, and they certainly don’t want to see government activism vindicated. So they are reaching for any stick they can find with which to beat proposals for increased government spending.

Some of these arguments are obvious cheap shots. John Boehner ... has already made headlines with one such shot:... he derided a minor provision that would expand Medicaid family-planning services — and called it a plan to “spend hundreds of millions of dollars on contraceptives.”

But the obvious cheap shots don’t pose as much danger to the Obama administration’s efforts to get a plan through as arguments and assertions that are equally fraudulent but can seem superficially plausible... So as a public service, let me try to debunk some of the major antistimulus arguments... Any time you hear someone reciting one of these arguments, write him or her off as a dishonest flack.

First, there’s the bogus talking point that the Obama plan will cost $275,000 per job created. Why is it bogus? Because it involves taking the cost of a plan that will extend over several years... and dividing it by the jobs created in just one of those years. ... The true cost per job of the Obama plan will probably be closer to ... $60,000...

Next, write off anyone who asserts that it’s always better to cut taxes than to increase government spending because taxpayers, not bureaucrats, are the best judges of how to spend their money.

Here’s how to think about this argument: it implies that we should shut down the air traffic control system. After all,... surely it would be better to let the flying public keep its money rather than hand it over to government bureaucrats. If that would mean lots of midair collisions, hey, stuff happens.

The point is that nobody really believes that a dollar of tax cuts is always better than a dollar of public spending. Meanwhile, it’s clear that ... public spending provides much more bang for the buck than tax cuts — and therefore costs less per job created (see the previous fraudulent argument) — because a large fraction of any tax cut will simply be saved.

This suggests that public spending rather than tax cuts should be the core of any stimulus plan. But rather than accept that implication, conservatives take refuge in a nonsensical argument against public spending in general.

Finally, ignore anyone who tries to make something of the fact that the new administration’s chief economic adviser has in the past favored monetary policy over fiscal policy as a response to recessions.

It’s true that the normal response to recessions is interest-rate cuts from the Fed, not government spending. ... But ... we’re in a situation not seen since the 1930s: the interest rates the Fed controls are already effectively at zero.

That’s why we’re talking about large-scale fiscal stimulus: it’s what’s left in the policy arsenal now that the Fed has shot its bolt. ...

These are only some of the fundamentally fraudulent antistimulus arguments out there. Basically, conservatives are throwing any objection they can think of against the Obama plan, hoping that something will stick.

But here’s the thing: Most Americans aren’t listening. The most encouraging thing I’ve heard lately is Mr. Obama’s reported response to Republican objections to a spending-oriented economic plan: “I won.” Indeed he did — and he should disregard the huffing and puffing of those who lost.

This post can also be viewed on economistsview.typepad.com.

Existing Home Sales Rise Unexpectedly: Is The End Near?

There has been a lot of talk this morning about the unexpected rise in existing home sales in December, and specifically whether or not it signals the beginning of the end. Unfortunately, we also saw a less positive statistic released: The median home sale price fell 15.3 percent in 2008—the largest drop on record since 1968, according to the Associated Press (AP). So what exactly are we to make of these statistics?

In my mind, this is positive news overall. First and foremost, property values are still too high and they will continue their decline until they reach equilibrium with income levels. That prices dropped so much means that we are ever closer to that point. Increased home sales in December is also a good sign, but one must wonder how much can be attributed to suppressed mortgage rates.

Most homebuyers do not look at the overall cost of the home, but rather focus on how much money they need to put down and the resulting monthly mortgage payment. When mortgage rates were under 5 percent, that dream home was suddenly within reach, and many people came down off the fence to buy. As rates rise again the opposite will happen.

Let’s also not lose site of the fact that thousands of people are losing their jobs every day, and as long as job losses and layoffs are on the rise, it is hard to imagine that the real estate market or any other sector of the economy will recover any time soon. And let’s keep in mind that although home sales increased in December, overall 2008 saw 13 percent fewer home sales than in 2007 and the lowest total since 1997, according to the AP.

This correction was necessary, and we are closer to recovery every day. I wouldn’t get too excited about it yet, as we should expect to see an over-correction before total recovery in this type of market, but as the chart below further illustrates, we are getting closer to what appears to be an historical equilibrium.

*Chart from The Mess That Greenspan Made.

Political Lobbying Behind TARP Funding Decisions

In case you need more examples of how the Troubled Asset Relief Program (TARP) has failed us, a recent article in the Wall Street Journal describes several instances where politicians were able to directly influence the decision of whether or not to provide TARP funds to banks. States that have had the most political lobbying or representatives in the right committees have enjoyed the highest success rates for getting help for their local banks.

It probably should go without saying, but shouldn’t the decision of whether or not to allocate funds to these banks be based on something more fundamental than the lobbying efforts of politicians? Remember that they are using taxpayer money to make these capital injections. By offering money to these banks, we are betting that they will turn around, and if they go on to lose the TARP funds, taxpayers are just out of luck. However, if they are able to use the funds to turn their operations around and once again become profitable, then taxpayers will get their money back, and possibly even a little extra. With this in mind, shouldn’t our goal be to identify those banks which we believe can and will revitalize their operations with this borrowed capital? It appears that instead of creating a system with the goal of achieving highest taxpayer return (both monetary and economic), the program has turned into a display of political lobbying power.

I hope that the new administration fixes the TARP before the second round of funding is spent in the same fashion as the first round. This whole program was hastily put together to begin with, and we are now paying dearly for the lax regulation that was included with the bill. Due to the lack of direction, politicians and regulators are able to lobby for their own best interests. President Obama and Treasury Secretary Timothy Geithner need to step up and fill these holes in the program. The U.S. government doesn’t have $350 billion more to waste. We have to ensure that every dollar is used in the most effective manner possible, and I think it is safe to say that we aren’t anywhere near maximum return. Here’s hoping that we figure out a way to keep politics out of this program and focus on how we can allocate this next $350 billion to best help the economy and taxpayers.

Welcome President Obama: Now About The Economy...

Yesterday was basically one big party, everyone it seemed was excited to welcome in our new President. Now the party is over and it is time for Obama to get to work, and he had better act fast. The economy is struggling mightily and Americans expect, albeit a tad unfairly, that Obama's administration is going to be able to fix the problem. James Picerno from The Capital Spectator paints a dreary picture for the economy over the coming months, while holding out some hope for a recovery, in his blog post below.

Today is the first full day of President Barack Obama's administration and, as everyone knows, the new commander in chief has his work cut out for him. With a fresh start before us in Washington the question on the home front remains: What's up (or down) with the economy?

In broad terms, the answer is obvious, and the numbers only lend statistical support. Clearly, tough times lie ahead, with the next 6 months or so looking set to be the toughest. But how does that square with our proprietary measure of U.S. economic activity (CS Economic Index), which bounced sharply higher in November, the last month with the full compliment of data pieces for calculating this benchmark? What's more, based on preliminary data for December, the November bounce looks set to hold.

Alas, the rise is something of an illusion for the time being since only two factors out of the 17 in our economic index are driving the bounce skyward. Granted, the pair is on steroids trying to bring aid and comfort to the ailing economy. Statistically, the changes in those two factors are enough to push the entire index upward. Even so, those two lone bullish factors alone, unfortunately, aren't likely to spark a recovery of any substance for the foreseeable future. Looking out later in the year offers some hope, but first let's talk about the immediate future.

The two factors doing all the heavy lifting in our economic index are money supply and the interest rate spread. Both were in overdrive in November in terms of generating pro-recovery fuel to an otherwise shrinking economy. The rate spread was particularly bullish, although the growth-oriented bounce from money supply was robust too. Collectively, the pair overwhelmed the negative energy elsewhere in the economy, at least when measured on an average basis.

By rate spread we're talking of the difference between the yield on the 10-year Treasury Note less the effective Fed funds. Thanks primarily to the dramatic fall in Fed funds in November, which continued in December, the rate spread widened sharply and thereby moving definitively into positive territory, which generally is a bullish signal for the economy. Why? Because a positive sloping yield curve—rates are higher as bond maturities lengthen—historically accompanies economic growth. By contrast, a negatively sloping yield curve—rates fall as maturities lengthen—is a sign of distress/economic contraction.

Based on the rate spread, this measure went negative in July 2006 and stayed negative until February 2008, when the spread moved back into positive territory. Looking back, it turns out that the recession warning posed by the arrival of a negative yield curve in mid-2006 was an accurate forecast of an approaching recession, which officially began in December 2007.

Fast forward to November 2008 and the rate spread is telling us that it's now in high gear as an economic stimulus. That is, short rates are extremely low relative to long rates—despite the fact that long rates are also bouncing around at historically low absolute levels. Based on this measure alone, one might be bullish on the immediate future, assuming this was a normal cycle. But as we know, the times are anything but normal and so even the unusually bullish stimulants coming from the money supply and interest rate factors aren't yet dispensing their usually pro-growth influence. The reason is that the negative drag from everything else is, for the moment, still too much to overcome. Indeed, the lagging and coincident factors in our broad economic index are either flat lining or still declining.

The good news is that at some point all the monetary stimulus will take root and promote expansion. All the money has to go somewhere and eventually it'll go into corners of the economy other than banks accounts and T-bills. Banks will one day lend and businesses will borrow. In addition, now that the Obama administration is at the helm, we expect a fresh round of fiscal stimulus to compliment the monetary efforts now running at full speed.

Guessing when all this will produce some measurably positive change in the economy proper is the great question. Given the depth and magnitude of the economic headwind, we're not expecting much for the first half of this year, perhaps longer. Even when signs of growth, or at least stabilization emerge, they're likely to be tenuous, slipping temporarily back into negative territory and keeping everyone on pins and needles.

Recovery worth the name is going to take time, and perhaps a fair degree more time than we've come to expect over the past generation, when growth returned fairly quickly after a downturn.

As such, strategic-minded investors should pace themselves and use the next several quarters productively to restructure their portfolios for the day when the storm passes. As we'll discuss in more detail in the February issue of The Beta Investment Report, the ongoing economic and financial turmoil is wrenching but it also offers substantial opportunities for dynamic asset allocation strategies.

That said, the next several months are undoubtedly going to be rough, replete with surprises, false starts and lots of noise in the markets. Economically speaking, there are still a number of big unknowns lurking in the near-term future too. Investors should brace themselves for more volatility, and at the same time prepare to take advantage of it.

Risk management, in other words, has never been more important, or potentially more rewarding.

This post can also be viewed on capitalspectator.com.

An Increasingly Popular Alternative To Layoffs

Companies in the U.S. laid off over 2 million jobs in 2008, but another expense cutting measure which is less often utilized also saw a major increase. A growing number of companies are choosing to cut pay rather than cutting jobs. Layoffs are typically preferred over pay cuts because among other things firms are afraid it might lead to an exodus of top workers. However, in this job market that isn’t a big worry. The last time there were nominal pay cuts was back in the Great Depression according to Price Fishback, an economic historian at the University of Arizona, as stated in the Wall Street Journal.

Because they remove spending capital from consumers while fostering additional fear and uncertainty, pay cuts are bad for the economy just as layoffs are. By now, practically everyone knows someone who has been laid off or had a salary cut, and even if one believes that one’s job is secure, the threat of a pay cut is encouragement to spend less. That said, though pay cuts will always be painful—especially if they become more widespread—they are still preferable over layoffs for consumers and the economy. After pay cuts, workers still have a source of income and don’t need to claim unemployment, which saves taxpayer dollars.

The inauguration is tomorrow, and I’ve never before seen this amount of anticipation for a new President. The state of the economy has brought a great deal of excitement, as many Americans believe that Obama is the man to rescue us from this recession. The thinking seems to be that once Bush is out of the White House and Paulson is out of the Treasury, all will be well. It is great to get excited, and Obama just might be the man to bring us out of this economic darkness, but people should remember that these things take time. Obama isn’t a miracle man, and he isn’t going to magically fix the economy. There is a lot wrong with the economy and there is a huge amount of work that needs to be done. We can hope for a quick turn around, but don’t expect it because it is not likely to happen that way.

Why The "Bad Bank" Is A Bad Idea

There is a lot of momentum gaining right now behind the idea to create a so called, "Bad Bank." This bank would be set up by the government and would be used to take toxic debt off of the balance sheet of the banks like Citigroup and Bank of America. Paul Krugman thinks this "Bad bank" is simply a bad idea. Economics Professor Mark Thoma revisits Krugman's article in his blog post below.

Are policymakers about to take another wrong turn?:

Wall Street Voodoo, by Paul Krugman, Commentary, NY Times: Old-fashioned voodoo economics — the belief in tax-cut magic — has been banished from civilized discourse. The supply-side cult has shrunk to the point that it contains only cranks, charlatans, and Republicans.

But recent news reports suggest that many influential people, including Federal Reserve officials, bank regulators, and, possibly, members of the incoming Obama administration, have become devotees of a new kind of voodoo: the belief that by performing elaborate financial rituals we can keep dead banks walking.

To explain..., let me describe ... a hypothetical bank that I’ll call Gothamgroup, or Gotham for short.

On paper, Gotham has $2 trillion in assets and $1.9 trillion in liabilities, so that it has a net worth of $100 billion. But a substantial fraction of its assets — say, $400 billion worth — are mortgage-backed securities and other toxic waste. If the bank tried to sell these assets, it would get no more than $200 billion.

So Gotham is a zombie bank: it’s still operating, but the reality is that it has already gone bust. Its stock isn’t totally worthless — it still has a market capitalization of $20 billion — but that value is entirely based on the hope ...[of] a government bailout.

Why would the government bail Gotham out? Because it plays a central role in the financial system. ... Gotham has to be kept functioning. But how can that be done?

Well, the government could simply give Gotham a couple of hundred billion dollars... A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to ... the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners.

The current buzz suggests ... policy makers aren’t willing to take either of these approaches. Instead, they’re reportedly gravitating toward ... moving toxic waste from private banks’ balance sheets to a publicly owned “bad bank” or “aggregator bank” ... “The aggregator bank would buy the assets at fair value.” But what does “fair value” mean?

In my example, Gothamgroup is insolvent... The only way a government purchase of that toxic waste can make Gotham solvent again is if the government pays much more than private buyers are willing to offer.

Now, maybe private buyers aren’t willing to pay what toxic waste is really worth... But should the government be in the business of declaring that it knows better than the market what assets are worth? And is ... paying “fair value,” whatever that means,... enough to make Gotham solvent again?

What I suspect is that policy makers — possibly without realizing it — are gearing up to attempt a bait-and-switch: a policy that looks like the cleanup of the savings and loans, but in practice amounts to making huge gifts to bank shareholders at taxpayer expense...

Why go through these contortions? The answer seems to be that Washington remains deathly afraid of the N-word — nationalization. ...Gothamgroup and its sister institutions are already ... utterly dependent on taxpayer support; but nobody wants to recognize that fact and implement the obvious solution: an explicit, though temporary, government takeover. Hence the popularity of the new voodoo, which claims, as I said, that elaborate financial rituals can reanimate dead banks.

Unfortunately, the price of this retreat into superstition may be high. I hope I’m wrong, but I suspect that taxpayers are about to get another raw deal — and that we’re about to get another financial rescue plan that fails to do the job.

This post can also be viewed at economistsview.typepad.com.

Most Americans Support New Stimulus Proposal

House Democrats released the latest version of a new stimulus package meant to turn our struggling economy around. Most notably, the stimulus package swelled from $775 billion to $825 billion with a proposed $550 billion in spending and aid to states and $275 billion in tax cuts, according to CNNMoney. Despite the large price tag, Americans are generally perceived to be on board with the plan, according to a recent Wall Street Journal/NBC News poll. 43 percent of the people surveyed called the plan a “good idea,” while 27 percent said it was a “bad idea.” The remaining portion had no opinion either way.

The most pressing concern for the people surveyed was unemployment, followed by the federal budget deficit which came in at a distant second. 63 percent of the surveyed individuals felt that government spending should be the biggest priority of the bill, while 33 percent felt that tax cuts should be the main catalyst.

It would be interesting to compare this current poll to how people felt about these priorities prior to the last stimulus package. I have a sneaking suspicion that more people would have been in favor of tax cuts back then. Because those didn’t work as planned, people are turning to a different strategy to fix the problem.

President-elect Obama is enjoying unprecedented support for his plan and his administration as Americans look to him to get us out of this mess, but if Obama’s stimulus plan doesn’t get succeed, it will be interesting to see how quickly that support wanes. President Bush once had the highest approval rating ever (90 percent in September 2001), and now has the second lowest approval rating ever, only bested by Richard Nixon after the Watergate scandal. The American people are ready for results, and Obama may learn, as George W. did, that opinions can change drastically and quickly.

Obama's Stimulus Plan Will Fall Short

Surely the $775 billion stimulus plan being proposed by President-elect Obama involves a huge sum of money, but at least one expert thinks that it won't be nearly enough to fix our troubled economy. Economics professor Mark Thoma looks at a recent article written by Paul Krugman that attempts to answer the question of whether Obama's plan will be enough, in his blog post below.

Is the incoming administration's proposed economic recovery plan large enough to get the job done?:

The Obama Gap, by Paul Krugman, Commentary, NY Times: “I don’t believe it’s too late to change course, but it will be if we don’t take dramatic action as soon as possible. If nothing is done, this recession could linger for years.”

So declared President-elect Barack Obama on Thursday... He’s right. This is the most dangerous economic crisis since the Great Depression, and it could all too easily turn into a prolonged slump.

But Mr. Obama’s prescription doesn’t live up to his diagnosis. The economic plan he’s offering ... falls well short of what’s needed. ...

Earlier this week, the Congressional Budget Office came out with its latest analysis of the budget and economic outlook. The budget office says that in the absence of a stimulus plan, the unemployment rate would rise above 9 percent by early 2010, and stay high for years to come. Grim as this projection is, by the way, it’s actually optimistic compared with some independent forecasts. ...

[T]he C.B.O. says ... that “economic output over the next two years will average 6.8 percent below its potential.” This translates into $2.1 trillion of lost production. “Our economy could fall $1 trillion short of its full capacity,” declared Mr. Obama on Thursday. Well, he was actually understating things.

To close a gap of more than $2 trillion — possibly a lot more... — Mr. Obama offers a $775 billion plan. And that’s not enough.

Now, fiscal stimulus can sometimes have a “multiplier” effect... Standard estimates suggest that a dollar of public spending raises G.D.P. by around $1.50.

But only about 60 percent of the Obama plan consists of public spending. The rest consists of tax cuts — and many economists are skeptical about how much these tax cuts, especially the tax breaks for business, will actually do to boost spending. ... Howard Gleckman of the nonpartisan Tax Policy Center summed it up in the title of a recent blog posting: “lots of buck, not much bang.”

The bottom line is that the Obama plan is unlikely to close more than half of the looming output gap, and could easily end up doing less than a third of the job.

Why isn’t Mr. Obama trying to do more?

Is the plan being limited by fear of debt? There are dangers associated with large-scale government borrowing... But it would be even more dangerous to fall short in rescuing the economy. The president-elect spoke eloquently and accurately ... about the consequences of failing to act — there’s a real risk that we’ll slide into a prolonged, Japanese-style deflationary trap — but the consequences of failing to act adequately aren’t much better.

Is the plan being limited by a lack of spending opportunities? There are only a limited number of “shovel-ready” public investment projects... But there are other forms of public spending, especially on health care, that could do good while aiding the economy in its hour of need.

Or is the plan being limited by political caution? Press reports ... indicated that Obama aides were anxious to keep the final price tag on the plan below the politically sensitive trillion-dollar mark. There also have been suggestions that the plan’s inclusion of large business tax cuts, which ... will do little for the economy, is an attempt to win Republican votes...

Whatever the explanation, the Obama plan just doesn’t look adequate to the economy’s need. To be sure, a third of a loaf is better than none. But right now we seem to be facing two major economic gaps: the gap between the economy’s potential and its likely performance, and the gap between Mr. Obama’s stern economic rhetoric and his somewhat disappointing economic plan.

This post can also be viewed at economistsview.typepad.com.

Obama Plans To Stimulate Economy With Big Tax Cuts

President-elect Barack Obama’s plan to fix America’s ailing economy has become a little clearer with the latest announcements. It appears that the biggest cog in the plan will be around $300 billion in tax cuts. Last year President Bush offered around $130 billion in tax rebates, which only briefly helped spark spending. Obama hopes that his measure has a bigger impact, and is electing to structure it in the form of a tax cut than a tax rebate. Along with the consumer tax cuts, Obama is also planning to cut taxes for businesses as well in an attempt to ward off the increasing level of layoffs and hopefully once again spur business investment. In addition to the tax cuts, Obama’s plan calls for around $200 billion to go to cash-strapped states, according to Daily News.

In total, this new economic stimulus plan could cost as much as $775 billion according to the Daily News. I’ll refrain this time from talking about the potential impact of this plan on the ballooning debt load we will likely leave for our children, but we should always remember that in the end someone has to pay for all these bailouts/stimulus packages. What I want to address is whether or not this program stands a chance. I would love to say that I believe that Obama’s plan is going to fix everything, but I’m just not feeling too confident. This plan is an improvement over Bush’s because it is meant to be lasting, not temporary. The rebates spurred spending for a few months, but the economy just continued to slide once the money was gone. Taxpayers were left with a huge bill and little to show for it other than a delayed recession. Obama’s plan could spread the goodwill out over a much larger period, but the question is whether it will be enough to really push us up and out of this economic rut.

About half of the total stimulus package funds are meant to spur job growth, with a goal of 3 million new jobs. In my mind 3 million seems a little high, and a tad unrealistic for us to obtain, but it sure sounds good. If we can get anywhere close to that number we will be doing extremely well. The plan calls for jobs to be created in infrastructure, energy, education and health care according to ABCNews.com. A major concern here should be how past government job creation movements have panned out: “’Time and again history has proven government-centered job creation doesn't work. Under [President] Carter in the late '70s people had all sorts of plans and ignored larger economic realities,’ former House Speaker Newt Gingrich told ABCNews.com.”

“‘In Japan they spent 13 years building an airport no one [once used]. Under the Socialists the French tried over and over again to create jobs and it didn't work. We know what creates jobs and it isn't putting the Treasury Department at the center of American capitalism. We need an investment strategy that supports the private sector and small entrepreneurial businesses,’ he said.”

Will the plan work or not? If past performance is any indicator it seems likely that this will just end up being another futile—and expensive—attempt to rescue the economy. No one wants to sit idly by and do nothing in the midst of this economic turmoil, but we shouldn’t blindly throwing away money at the problem either. This plan is definitely better than the last one put together by President Bush, but will it be enough? I have my fingers crossed, but if they had odds on this in Vegas I wouldn’t be betting for its success.

Removing Sales Tax Is The Best Stimulus Plan

President-elect Obama is intent on stimulating the economy once he takes office, and while he has a couple different plans the big one everyone is talking about is the infrastructure rebuild. Many people have questioned whether this is the best plan of action, but if rebuilding the infrastructure isn't the best course of action, what is? Mark Thoma from the Economist's View looks at an opinion from Susan Woodward and Bob Hall in his blog post below.

Susan Woodward and Bob Hall have expanded their views on the type of stimulus package they believe would be the most effective:

Options for Stimulating the Economy, by Susan Woodward and Robert Hall: In 2009, GDP in the U.S. is expected to be about $900 billion below its normal growth path. The ideal stimulus would have most of its effect in 2009 and would close a reasonable fraction of that gap. We see five general strategies for stimulus:

• Further expansion by the Fed
• Income tax cuts with rebates, as earlier this year
• Tax cuts that reduce the prices of consumer goods temporarily
• Tax cuts that reduce the cost of labor to businesses
• Increase in purchases of goods and services by state and local governments

... Conclusions We foresee a mixture of stimulus policies for the coming year. Monetary policy can only [add] a small further contribution. Income-tax rebates seem to have little support and would probably have relatively small effects within the year, with undesirable continuing effects in later years. We are enthusiastic about removing sales taxes for the year and perhaps somewhat longer, with a phase-out. We are not sure that an employment stimulus from a reduced business payroll tax would raise employment enough to be a contender as a stimulus and to prevent the flowing through of the funds to business owners rather than workers. We believe that some federal subsidies to state and local spending would make sense, but are concerned that too large a program would result in stimulus continuing past the time when it would be needed and that it would create excessive rents for contractors and skilled workers. Thus the sales-tax buyout seems to be the best way to spend the bulk of the stimulus dollars.

In the accompanying argument, they explain their lack of enthusiasm for infrastructure spending:

President-elect Obama supports federal funds for state and local construction projects as an element of a stimulus package. ... Government units have backlogs of projects waiting for funding. The questions are how big are the backlogs, how quickly spending can accelerate, and how beneficial are the projects.

State and local construction spending is currently $300 billion per year. The Obama team is hard at work trying to find out how much of a backlog is “shovel-ready”... We are not aware of any easy source for this information.

Timing may be a problem, as it was in the old days when these kinds of projects were called public works. Complicated projects take time to ramp up... Some interstate repairs can be executed in a year, as was the case in rebuilding the collapsed I-35 bridge in Minneapolis last year and in re-opening earthquake-damaged freeways in Los Angeles in 1994, while it took many years to reopen all the damaged roads in San Francisco after the 1989 earthquake.

The president-elect has also mentioned less conventional spending programs, including broadband facilities and online medical records facilities.

All of these proposals for stimulating state and local spending suffer from a common problem–they will end up generating employment for highly specialized businesses and workers, rather than stimulating economic activity more broadly. The consensus of macroeconomists ... is that a spending stimulus raises total spending by between 1.0 and 1.5 times the amount of the direct increase in spending. The follow-on or multiplier effects are between zero and half the direct increase in spending. Thus a program that funnels money to construction firms and their workers mainly raises their incomes and employment levels and has relatively little effect elsewhere. Rebuilding aging interstates and upgrading the energy efficiency of public buildings calls for highly specialized skills. A large-scale infrastructure program will drive up the profits of the limited number of firms capable of doing this type of work and drive up the wages of the skilled workers who know how to do the work.

It’s hard to imagine that a significant fraction of the large stimulus under consideration for 2009 will take the form of state and local construction and other infrastructure spending. We are hoping that discussion of stimulus will not become sidetracked over this part of the program and neglect the opportunities to stimulate consumer spending broadly without complicated, detailed, and time-consuming decisions.

This article has been reposted from the Economist's View. The full post can also be viewed on the Economist's View.

The Oil Bubble Has Burst—What Now?

I think it is safe to say that the oil bubble has gone the way of the housing bubble, exploding with a loud pop. The price of oil this morning has fallen below $42, and some analysts see it falling as low as $25 next year. That is a far cry from the high price we saw not too long ago of $147. During the oil boom, everyone was focused on doing what they could to conserve oil, and alternative energy investments were the rage. Oil companies were vilified and at the same time oil workers and oil dependant economies were rolling in cash. We have seen oil booms and busts before, but we kept hearing arguments that this boom was different: This one would never end because there just wasn’t enough supply. In the long run we will surely succumb to supply issues, but for now the world is flush with oil and the boom is over. What does this mean, though?

What this likely means is that Americans will once again return to their old ways. That means that instead of fighting over hybrid cars, people will once again buy SUVs. Instead of doing what we can to conserve energy, we will revert to our wasteful ways. As for the government, there was a lot of talk about new alternative energy projects, and how we wanted to eliminate our dependence on foreign oil. However, with oil prices in check you can bet that the government is going to be much more concerned with the financial crisis on hand rather than starting alternative energy projects that won’t offer returns for several years.

The reason why we continue to see these oil booms and busts is because each time they come around we fail to adequately prepare. During the boom we talk about all the wonderful things we are going to do to prevent this from happening again, but then once the boom ends we fail to start or finish the projects that will actually solve the problem. Obama seems intent to follow through on the alternative energy plans he so heavily promoted during his campaign, but I have a feeling that his priorities once he takes office will reflect other, more immediate needs.

That means that this won’t be the last oil boom and bust cycle, and one thing is certain: The next time around is going to be even worse than this one. Each time we fail to solve the problem, the cycle becomes more painful. In the meantime investors might want to think twice before investing in those alternative energy projects and companies that they are hoping Obama will give a boost to. Real estate investors might also want to rethink investing in oil dependant economies. As existing contracts run out, and oil companies cut back on new projects, these economies are going to feel the pinch. Many of these areas look great on paper, because they seemingly have avoided the real estate bubble, but now that the oil bubble has popped, so too will these local real estate markets.

$2 Trillion In Consumer Credit Lines Could Be Cut, Spelling Disaster

It is no secret that the U.S. economy runs on credit, and has for some time. When credit flowed freely, our economy boomed. When credit became restricted, our economy started crumbling and turned into what we see today. As we attempt to rebuild our beleaguered economy the last thing we need is a cut in available consumer credit. But according to at least one analyst we could soon be faced with that reality. Prominent banking analyst Meredith Whitney was quoted by Reuters as projecting consumer credit to be cut by as much as $2 trillion over the next 18 months.

To make matters worse, the outlook for the job market isn’t looking any better. People are losing jobs right and left, and now they could be faced with cuts to their credit lines as well. From the bank’s perspective, it makes sense to cut credit lines now. With people racking up record debts, and some having no means to repay them, the risks are extremely high. The responsible thing for banks to do is to cut credit lines for those consumers who show any signs of causing trouble down the road.

From an economic view, though, we need to boost spending any way we can. Consumer spending makes up the largest portion of economy and consumer spending must improve before the economy can rebound. The fact that jobs are being lost and credit lines cut means that consumer spending will be likely to tank. When that happens business will suffer, leading to more layoffs and an even bigger hit to consumer spending. I think you can see the vicious cycle that is being formed here.

You can bet that Obama and the new administration will do whatever they can to jump start spending. This would include the stimulus package that is being considered, as well as placing added pressure on banks to increase lending.

President-elect Barack Obama Asks Americans For Patience

During his presidential campaign Barack Obama made many promises to the American people, and there will be a lot of pressure to deliver when he takes office. Americans are losing their jobs, and to say that the economy is struggling is an understatement. The voters who showed up in record numbers to select Obama as our next president expect results, and fast. Knowing that he is going to be on the hot seat, Obama has done the smart thing by reminding people that fixing these problems isn’t going to happen overnight. "The economy's likely to get worse before it gets better. Full recovery will not happen immediately," Obama said Monday, according to CNN.

In a society that wants and demands immediate results, this is a hard pill to swallow, but Obama is right. If we want to fix the economy—and by fix I don’t mean slap a band aid on—it is going to take time and things will get worse before they get better. Americans need to understand this and give Obama a little slack. We need to look at the big picture, not at what will just get us through the next year.

However, though Obama is saying the right things right now, whether he will actually do the right things is an entirely different matter. I don’t agree with many of Obama’s plans to correct the financial crisis, but no one on this planet knows for certain how to fix this thing. There are various and potentially valid opinions on the best course of action, and I don’t intend to sit here and say that I have the perfect plan. I also don’t envy the position Obama is in. He will listen to plan after plan from top economic experts, and then choose the one that will either save us or sink us, and forever bear the weight of that decision on his legacy. Not a pleasant task. I think Obama is a very smart man, and I think that it is important that we give him a chance. This is the man that America selected to get us out of the current crisis and we need to accept that. It is scary to think that one man will have such a huge role in deciding our future, but Obama is the man chosen for the job.

So, President-elect Obama: Even though I might not agree with all of your decisions, this blogger promises to give you the time that you’ve requested. Just do your best to make the right decisions, because my daughter’s future is in your hands.

Another $800 Billion Committed: Crisis Tally Tops $8 Trillion

Yesterday on Bloomberg, I saw a disturbing article that disclosed that the government had already committed $7.76 trillion to fix the credit crisis. This number was staggering to me. I write about this stuff every day and yet even I didn’t realize the tally had gotten that high. The $7.76 trillion number includes the over $300 billion committed to Citigroup, but another $800 billion to free up the credit markets was announced this morning. So far this week—which isn’t even two days old yet—the tally has already surpassed a trillion dollars. This is absolutely insane, and you can bet that there will be more where that came from once the new administration takes over.

I don’t know about you, but these numbers are freaking me out. Sure a lot of these commitments have an investment component, but I don’t believe claims that we will make a bunch of money from these deals. I would consider us lucky if we are able to recover the principal. Things have only gotten worse of late, and we seem prepared to throw as much money at the problem as needed, so what will the final tab be? When will this spending spree stop?

Obama is prepared to open up the taxpayer checkbook when he takes office, recently announcing plans to roll out a new stimulus package estimated to cost $500 billion to $700 billion according to CNN. In addition, his selection for Treasury Secretary, Geithner, has had a huge part in the economic decisions made by Treasury Secretary Paulson, and it seems unlikely that he will stray far from the current path. With these combined factors, we could face countless trillions more before all is said and done. Where is this going to leave our children?

The answer to that question of course is that our children will be unfairly burdened by an absolutely enormous debt. Their financial prospects will be dim as they are forced to deal with higher taxes and other restrictive policies. Personally I find this completely unacceptable, and I hope beyond hope that it doesn’t come to that. I’ve mentioned this before in some of my posts, but to knowingly leave a burden such as this on the future generation is immoral to the fullest extent. We need to pay for our own mistakes, and our own excessive lifestyles. Our children have enough to worry about, and paying for the previous generation’s debt shouldn’t be one of them.

Homebuilders Next In Line To Beg For Bailout Funds

Detroit automakers recently received the cold shoulder from Congress on their quest for a piece of the $700 billion bailout pie; next in line are the homebuilders. Hopefully they will learn from the automakers and won’t fly to Washington in private jets to beg for these funds, although at this point it appears doubtful that their wishes will be answered anyway. The homebuilders are prepared to request an aid package estimated at $250 billion and aptly called “Fix Housing First”, according to the Wall Street Journal. The homebuilders are trying to convince Congress that the rest of the financial system will continue to deteriorate until home prices stabilize.

The “Fix Housing First” plan calls for two parts, a large tax credit for homebuyers and a government subsidy of mortgage rates. The tax credit that the homebuilders are proposing would equal 10 percent of the home’s purchase or $22,000, whichever is less according to the Wall Street Journal. The mortgage subsidy requested by the homebuilders would aim to bring interest rates on government backed 30 year fix loans down to 3 percent for loans made in the first half of 2009, and 4 percent for loans made in the second half of the year, according to the Wall Street Journal. The Wall Street Journal also notes that Realtors are pushing a 4.5 percent interest rate buy down for new mortgage loans. It is their estimation that for each 1 percent that rates fall, 500,000 to 800,000 additional homes could be sold.

It seems very unlikely that any variation of the “Fix Housing First” plan will get passed before Obama takes office, but once he does all bets are off. I seriously doubt that the plan would remain intact as is, but some variation of the proposal could be possible. There is a lot of support for the idea that the housing crisis is the underlying cause of the greater financial crisis, and most Americans are more likely to approve of measures that will aid the housing and mortgage markets before aiding banks and other financial institutions. We have been trying to prop up the financial industry for a long time, without much avail. Why not give housing a try?

Of course the problem is that this will simply artificially inflate housing prices yet again. We did that before and look where that has left us. If we are able to inflate housing prices, that will alleviate many of the problems plaguing the financial industry and homeowners alike, but it is not sustainable. Housing simply became too expensive, and it will become too expensive again if we inflate it, and the next time it will cost us even more to fix the fallout. Housing prices need to rise in correlation with a rise in income, which is the only sustainable way. I hope that Congress and the next administration know better than to rely on biased research when looking to spend hundreds of billions in taxpayer money.

Citigroup Bailout, Deflation And The Worldwide Financial Epidemic

The news of Citigroup's $300 billion bailout seems like déjà vu, and the scary word "deflation" that is being thrown around seems distant compared to everything else we are dealing with. The U.S. is not the only country with problems either, this is without a doubt a global financial epidemic. James Picerno from The Capital Spectator wonders, though, if the cure might be worse than the disease.

Have we seen this movie before? It certainly sounds familiar.

Once again, the government steps in to bail out a financial institution and Mr. Market takes kindly to the idea. Initially. But then reality sets in and the process starts anew. Perhaps it'll be a true sign of a bottom when the Feds engineer a bailout and the market tanks on the news.

But not yet. The latest installment of rescue revolves around the once mighty Citigroup. A giant among giants, this behemoth of financial behemoths surely fits the bill as too big to fail. If such a thing exists as a financial institution that must be saved at any cost, Citigroup looks like the poster boy for this idea.

Total assets for Citigroup were a bit more than $2 trillion in September. For those who like to keep score, that's roughly 14% of the annualized value of U.S. GDP for this year's third quarter.

The days of pulling another Lehman and letting a big bank fail are history. Better to bailout more rather than less and deal with the consequences later. The grand strategy here is that if the government bails out enough banks (and perhaps an auto company or two) while spitting out stimulus in various forms as far as the eye can see, the system will correct itself, or at least stop bleeding. At a time when deflationary risks are rising, this plan is considered prudent and timely by a growing swath of economists and voices from the peanut gallery, including yours truly. The risk of an even deeper implosion of prices and confidence must be avoided lest the vortex of deflation pull everything down the rat hole. Preventing deflation is the last battle in this horror film because once the big "D" takes hold, in sentiment and prices, the challenge becomes much, much tougher.

The problem is that no one's really quite sure if deflation with a big "D" is on our doorstep. Quite possibly it is, or so one could reason after witnessing consumer and wholesale prices fall last month on a scale unmatched since the government began keeping tabs on such things in the late-1940s. Waiting for definitive signs risks letting the monster out of the cage. Decisions, decisions. Nonetheless, there's a strong case for assuming deflation is coming. If we're wrong, we'll have more inflation on our hands than we otherwise would. But the world knows how to fight inflation, even if the political will is sometimes lacking. Attacking deflation, on the other, is another story.

Any way you slice it, there's bound to be more than a little disappointment and finger pointing in the months and years ahead. Indeed, no one should think that the necessary but risky strategy of preventing deflation is destined to end in triumph, or quick results. The stakes are high, in part because the government's moving quickly toward betting the house on a fiscal/monetary solution. On the opposing shore is the unwinding of excess, some of which has been decades in the making. When an immovable force meets government printing presses, the outcome isn't entirely clear.

All the more so if the world is looking for signs, one way or the other, by next Wednesday. It's difficult to gauge expectations as we run from one crisis to another. But this much is clear: the financial and economic problems will take time--years--to solve, and to the extent that the crowd thinks otherwise, the seeds of disenchantment have been planted.

The U.S. economy is sick, and getting sicker. Europe has the disease and Asia is at risk of contracting the same, albeit in a milder form. Looking back on the past five decades offers no clue for what may be coming. Growth has been a constant, according to GDP numbers from economist Angus Maddison, emeritus professor, University of Groningen (Netherlands). As the chart below shows, outright contraction is unknown in the postwar era.

Fifty years is a long time, virtually an eternity for mere mortals studying the past in search of clues about the future. It's all too easy to look at this track record and conclude that real declines in global GDP aren't possible, or are so unlikely as to be unworthy of considering. The IMF forecast, for one, still imagines more of the same with next year's estimate for real global GDP rising by a respectable if not impressive 2.4%.

Of course, the crowd used to think in persistent-growth terms for housing prices, and how they never fall on a year-over-year basis. Oh, sure, that happened in the Great Depression, but such episodes were dismissed as a thing from the past.

Perhaps it's time to consider the unthinkable. We've all received a crash course in just that over the last few months. But has the education so far been sufficient? Or do we still need to spend more time studying?

There are many dangers stalking the global economy, and at the top of the list is the assumption that the governments of the world can spend their way out of the slump on our collective doorstep. In the U.S. alone, the government now stands at the ready to spend $7 trillion--yes trillion with a "t"--to bring financial salvation to the system, according to Bloomberg News. That's the equivalent of three-and-a-half Citigroups, or half the U.S. economy. Scale no longer looks to be a stumbling block.

By spending enough money, governments are likely to keep inflation-adjusted global GDP floating somewhere above zero, if only slightly. That would still bring a fair amount of pain and repricing, but embedded in the expectation is the notion that a floor can be built under the crisis.

Perhaps, although at some point one might wonder if the cure will be worse than the disease. There are some awkward questions that will accompany the mother of all spending sprees now underway. First up: Is there some point at which additional government spending becomes counterproductive because a) it encourages future inflation on a scale that will be excessively burdensome; and/or b) the prospect of the government owning ever-larger chunks of the economy risks institutionalizing mediocrity or worse in the economy?

There are two great episodes of deflation in modern history, and each continues to raise questions about the associated lessons. Yes, spending is the only hope of sidestepping the beast, and if that means artificially engineered demand from the government, so be it. But it's not clear that the strategy leads to happy results all around. Meantime, there's more than one way to fight deflation.

That's not to say we shouldn't try to spend our way out of a deflationary trap. We should. We must. And we will. The risk is real this time, unlike the previous worries over deflation in 2001-2003. But the details of how we engage our anti-deflationary war may matter as much, if not more, as the decision to wage the war in the first place.

The dismal science has precious little experience with fighting deflation and so we must recognize that we may soon be caught up in an economic experiment on a scale that has little or no precedent. By all means, let's fight this war ferociously. But it also needs to be fought intelligently. What exactly do we mean by "intelligently"? We can't say for sure. No one can, and therein lies the greatest risk.

This article has been reposted from The Capital Spectator. The full post can also be viewed on The Capital Spectator.

How Much Damage Can Be Done Before Obama Takes Office?

The economic prospects of this country are getting worse everyday, and the current administration seems content to sit back and do nothing. This transition period, before the new administration officially takes power, has caused problems before, way back in 1932, and we all saw how that turned out. It makes you wonder, just how much can the current administration further mess things up before Obama takes power? Economics professor Mark Thoma looks at an opinion piece from Paul Krugman on the topic in his blog post from Economist's View.

The outlook for the economy is deteriorating, yet economic policy "seems to have gone on vacation":

The Lame-Duck Economy, by Paul Krugman, Commentary, NY Times: Everyone’s talking about a new New Deal, for obvious reasons. In 2008, as in 1932, a long era of Republican political dominance came to an end in the face of an economic and financial crisis that, in voters’ minds, both discredited the G.O.P.’s free-market ideology and undermined its claims of competence. And for those on the progressive side of the political spectrum, these are hopeful times.

There is, however, another and more disturbing parallel between 2008 and 1932 — namely, the emergence of a power vacuum at the height of the crisis. The interregnum of 1932-1933, the long stretch between the election and the actual transfer of power, was disastrous for the U.S. economy, at least in part because the outgoing administration had no credibility, the incoming administration had no authority and the ideological chasm between the two sides was too great to allow concerted action. And the same thing is happening now. ...

How much can go wrong in the two months before Mr. Obama takes the oath of office? The answer, unfortunately, is: a lot. ... The prospects for the economy look much grimmer now than they did as little as a week or two ago.

Yet economic policy, rather than responding to the threat, seems to have gone on vacation. In particular, panic has returned to the credit markets, yet ... Henry Paulson ... has announced that he won’t even go back to Congress for the second half of the $700 billion already approved for financial bailouts. And financial aid for the beleaguered auto industry is being stalled by a political standoff. ...

What’s really troubling ... is the possibility that some of the damage being done right now will be irreversible. I’m concerned, in particular, about the two D’s: deflation and Detroit.

About deflation: Japan’s “lost decade” in the 1990s taught economists that it’s very hard to get the economy moving once expectations of inflation get too low (it doesn’t matter whether people literally expect prices to fall). Yet there’s clear deflationary pressure on the U.S. economy right now, and every month that passes without signs of recovery increases the odds that we’ll find ourselves stuck in a Japan-type trap for years.

About Detroit: There’s now a real risk that, in the absence of quick federal aid, the Big Three automakers and their network of suppliers will be forced ... to shut down, lay off all their workers and sell off their assets. And if that happens, it will be very hard to bring them back.

Now, maybe letting the auto companies die is the right decision, even though an auto industry collapse would be a huge blow to an already slumping economy. But it’s a decision that should be taken carefully, with full consideration of the costs and benefits — not a decision taken by default, because of a political standoff between Democrats who want Mr. Paulson to use some of that $700 billion and a lame-duck administration that’s trying to force Congress to divert funds from a fuel-efficiency program instead.

Is economic policy completely paralyzed between now and Jan. 20? No, not completely. Some useful actions are being taken. For example, Fannie Mae and Freddie Mac ... have taken the helpful step of declaring a temporary halt to foreclosures, while Congress has passed a badly needed extension of unemployment benefits now that the White House has dropped its opposition.

But nothing is happening on the policy front that is remotely commensurate with the scale of the economic crisis. And it’s scary to think how much more can go wrong before Inauguration Day.

This article has been reposted from Economist's View. The full post can also be viewed on Economist's View.

Does Anyone Know How To Fix This Financial Crisis?

I read a couple interesting articles this morning that I thought I’d share. One article talks about how no one, including President-elect Obama, knows how to fix the financial crisis. The other offers a potential solution that will cost more than $1 trillion. I’ll summarize the two articles below:

The first article was written by Russell Roberts, economics professor at George Mason University, and published in Forbes. In his article, Roberts equates this financial crisis to raising children, saying that each one is different and there is no official manual on how to raise the perfect child. He goes through the measures that have already been enacted, saying how each one thus far has failed miserably. Many people have this belief that Obama will miraculously save the day, but Roberts points out that the only solution Obama has really posed thus far is to offer another stimulus package, and idea that has already been tried and failed. Paulson is lost at this point, and he doubts Obama will be the answer either. He ends his article saying:

“What if doing whatever it takes means doing less, rather than more?

That is the conundrum for Obama and the successor to Paulson. The more options there are, the harder it is to know which one is the right one. The more options you try, the more uncertainty is injected into the economy, and the more cautious are investors and employers and consumers.

Nobody knows what it takes to move the economy forward right now.”

The second article was written by Neha Singh and published by Reuters. This article is about the findings of Paul Miller, an analyst for Friedman Billings Ramsey. Miller has come up with a plan to save the U.S. financial system, and it will cost only $1 trillion to $1.2 trillion in additional capital. Basically, he says that in order to restore confidence and improve liquidity in the credit market, this injection needs to happen. In addition, rather than the investments being made via preferred shares or long term debt mechanisms, Miller thinks that in order for the plan to work the investments need to be common equity injections. The following is a quote from Miller: “Debt or TARP capital is not true capital. Long-term debt financing is not the solution. Only injections of true tangible common equity will solve the current crisis.” Miller says that even his plan will take a few years to fix things.

Obviously these two articles have very different views, but one thing they have in common is that they agree that the solutions proposed or enacted thus far have failed.

Of the two views, I tend to side with Roberts, author of the first article. I think that pretty much we are lost in the forest and going around in circles trying to get out, and as they teach you in Boy Scouts, when you get lost sometimes it is best to wait it out.

Miller’s suggestion, on the other hand, I find completely ludicrous. So instead of the government (i.e., taxpayers) getting preferred treatment for their extremely risky investments into struggling companies, they should settle for common equity investments that would surely lose a ton of taxpayer money? Sorry, but that sounds pretty dumb to me. And I’m certainly not willing to lose $1 to $1.2 trillion of taxpayer money to find out that this crazy idea isn’t going to work. There are a lot of ways that we can help the economy with that kind of money that would have a bigger impact. Besides, there is no way that plan would ever get approved without people rioting in the streets and threatening rebellion. People are already outraged at the current investments we are making into these companies, and if we were to take even lesser terms in exchange, look out. The only people who would support this plan would be shareholders in these institutions, and I don’t think anyone feels bad for them at this point.

Bush And Paulson Tell Obama To Clean Up Their Mess

It appears that Bush and Paulson are content to leave their mess for Obama to clean up. Rather than push forward with new initiatives that can help relieve pressure on the financial system, they would rather wash their hands of the situation. Considering the magnitude of our problems, though, the economy might not be able to wait for Obama to take command. Kathy Lien investigates this issue in more depth in her blog post below.

There are increasing signs that the Bush Administration wants to leave the clean up job to Barack Obama.

According to Treasury Secretary Paulson, even though the first half of the $700 billion bailout package is being used up quickly, the Bush Administration will not be asking Congress for the remaining $350 billion.

With 8 weeks to go before Bush leaves office, the current Administration is more focused on wrapping things up than starting new initiatives.

Paulson said it best:

“I’m going to do what we need to do to keep the system strong but I’m not going to be looking to start up new things unless they’re necessary, unless they make great sense” and “I want to preserve the firepower, the flexibility we have now and those that come after us will have.”

This was the same spirit that Bush took at this weekend’s emergency meeting of G20 nations that I talked about this morning. The meeting was a big disappointment as the Group failed to deliver any specific solutions. Instead, they set an action plan for March 31 and another meeting for April 30th. The G20 is clearly waiting for the new Administration to take charge before putting the pedal to the medal. The only question is, will the global economy be able to wait that long.

This article has been reposted from Kathy Lien. The full post can also be viewed on KathyLien.com.

What Does Barack Obama Have In Store For Us?

President-elect Barack Obama certainly will have his hands full when he takes office in January. Considering all the problems that he will be faced with what can we really expect him to deliver? Mark Thoma takes a closer look at this below in his post from the Economist's View.

Thinking bigger than the small-minded pundits:

The Obama Agenda, by Paul Krugman, Commentary, NY Times: ...If the election of our first African-American president didn’t stir you, if it didn’t leave you teary-eyed and proud of your country, there’s something wrong with you.

But... Can Barack Obama really usher in a new era of progressive policies? Yes, he can.

Right now, many commentators are urging Mr. Obama to think small. Some make the case on political grounds: America, they say, is still a conservative country, and voters will punish Democrats if they move to the left. Others say that the financial and economic crisis leaves no room for action on, say, health care reform.

Let’s hope that Mr. Obama has the good sense to ignore this advice.

About the political argument: Anyone who doubts that we’ve had a major political realignment should look at what’s happened to Congress. ... Democrats have won back-to-back victories, picking up at least 12 Senate seats and more than 50 House seats. They now have bigger majorities in both houses than the G.O.P. ever achieved in its 12-year reign.

Bear in mind, also, that this year’s presidential election was a clear referendum on political philosophies — and the progressive philosophy won. ...

Mr. Obama ran on a platform of guaranteed health care and tax breaks for the middle class, paid for with higher taxes on the affluent. John McCain denounced his opponent as a socialist and a “redistributor,” but America voted for him anyway. That’s a real mandate.

What about the argument that the economic crisis will make a progressive agenda unaffordable?

Well, there’s no question that fighting the crisis will cost a lot of money. ... And on top of that, we badly need a program of increased government spending to support output and employment. Could next year’s federal budget deficit reach $1 trillion? Yes.

But standard textbook economics says that it’s O.K., in fact appropriate, to run temporary deficits in the face of a depressed economy. Meanwhile, one or two years of red ink ... shouldn’t stand in the way of a health care plan that, even if quickly enacted into law, probably wouldn’t take effect until 2011.

Beyond that, the response to the economic crisis is, in itself, a chance to advance the progressive agenda.

Now,... it would be fair for the new administration to point out how conservative ideology, the belief that greed is always good, helped create this crisis. What F.D.R. said in his second inaugural address — “We have always known that heedless self-interest was bad morals; we know now that it is bad economics” — has never rung truer.

And right now happens to be one of those times when the converse is also true, and good morals are good economics. Helping the neediest in a time of crisis, through expanded health and unemployment benefits, is the morally right thing to do; it’s also a far more effective form of economic stimulus than cutting the capital gains tax. Providing aid to beleaguered state and local governments, so that they can sustain essential public services, is important for those who depend on those services; it’s also a way to avoid job losses and limit the depth of the economy’s slump.

So a serious progressive agenda — call it a new New Deal — isn’t just economically possible, it’s exactly what the economy needs.

The bottom line, then, is that Barack Obama shouldn’t listen to the people trying to scare him into being a do-nothing president. He has the political mandate; he has good economics on his side. You might say that the only thing he has to fear is fear itself.

This article has been reposted from the Economist's View. The full post can also be viewed on the Economist's View.

Who Will President-Elect Barack Obama Choose As Treasury Secretary?

One of the longest and most contentious elections in American history is over and Democrat Barack Obama has emerged as president-elect, defeating Republican candidate John McCain. Because Obama will inherit an economy in a shambles, instead of basking in the glow of his win, he is going to have to get to work. He has already offered Rahm Emanuel, a congressman from Illinois, a position as his chief of staff. One of his next appointments is likely to be the person who will become Treasury Secretary Henry Paulson's successor.

This appointment will be of particular importance because the federal government has already stepped into the financial markets in never-before-seen ways to try to quell the financial crisis, and could take more such steps in the future. The next Treasury secretary play a key role in the deciding how to spend much of the $700 billion from the bailout bill passed in October.

Because further decisions on spending that money are likely to be made in the coming weeks, Obama will need to name Paulson's successor sooner rather than later. In fact, experts predict that the new Treasury secretary will be named prior to the economic summit in Washington D.C. scheduled for Nov. 14 and 15, which will be comprised of 20 of the world's top economies.

The fact that Obama and his campaign have been mum on potential Treasury secretaries hasn't stopped speculation on who he will nominate.

Purported to be on the short list:

-Sheila Bair, chairman of the Federal Deposit Insurance Corp.

-Warren Buffet, chairman of Berkshire Hathaway and an economic adviser to Obama

-Jon Corzine, governor of New Jersey, former U.S. senator and former CEO of Goldman Sachs

-Timothy Geithner, president of the New York Federal Reserve

-Robert Rubin, former Treasury secretary (though Rubin has ruled out a return to Washington)

-Lawrence Summers, former Treasury secretary

Source: CNNMoney

Falling Gas Prices Aren’t Making Everyone Happy

Most of the country is ecstatic that gas prices are falling. Just the other day I was able to fill up my car for less than $50--I know I certainly was ecstatic. But while most of the country is happy to see gas prices fall, there are certain pockets that are going to suffer for it. Texas is the energy capital of the country, and when gas prices are up, cities such as Houston and Fort Worth boom. This was certainly the case of late. These energy hubs continued to boom despite the rest of the country suffering from the credit crisis; it seemed as if they were immune. But now that gas prices are falling, these places are starting to feel the pinch--and it is likely to get worse.

Unemployment is rising in these areas as energy companies start to cut back. Projects that made since when oil was at $140 a barrel just don’t look as good now that it is less than $70 per barrel. It isn’t just unemployment either; many residents in these areas lease their land out to energy companies and depend on these payments to support their lifestyles. You can bet that as these energy companies continue to cut back, businesses in the area--along with the local real estate markets--will suffer. While many of these places avoided the big run-ups in housing prices that were so prevalent throughout the rest of the country during the housing boom, the real estate prices here never really experienced the falls, either. I would suspect that they will begin to fall a bit now, although not nearly as heavily as in most other places in the country.

As jobs dry up and the real estate and business markets contract, investors need to be extra careful when dealing in these areas. The numbers may look attractive right now thanks to low unemployment, low vacancy and real estate prices that have stayed study despite the economic turmoil, investors need to look beyond past performance and into the future. Now that Obama is president-elect, things could get even worse for some of these energy hubs. He wants to make a huge push for alternative energy, which could very well push the price of oil down even further. While some of these places are focused entirely on oil and gas, others are diversified into alternative energy, which would obviously be a preferable place to invest at this point. If you want to invest in these areas, look hard at diversification. Are there many jobs outside the oil industry? If the area is completely dependent on oil and gas, I would suggest you move on (think Fort McMurray in Alberta, Canada).

Does The Winner Of Today’s Presidential Election Stand A Chance?

Today is election day, the day Americans get to choose their next leader. This election is considered by many to be one of the most important in recent memory. This is evidenced by the record number of voters expected at the polls this year. With the economy tanking, and so many other problems looming in the U.S., Americans are looking for the new president to come in and make everything better. A lot is going to be expected of the new president, and it certainly is not going to be easy to deliver. This begs the question: Does the next president even stand a chance for success?

My first thought on this is, not really. I don’t think the new president, be it Barack Obama or John McCain, has much hope to be remembered as a successful president. The situation they are going to come into is just too problematic. We are already scheduled to add another $2 trillion to the national debt next year, according to Goldman Sachs as reported by the Wall Street Journal. With this debt level already basically committed, the new president would be hard-pressed to justify even more spending. That means that many promised programs will likely get shelved. While this would certainly be for the greater good, people won’t necessarily remember that part. What they remember is what life was like for them during the term of the previous president. Considering the factors we are faced with today, I don’t see how life is going to get better for Americans, and this is likely to reflect poorly on the new president.

Really, I feel bad for whoever becomes our president-elect today. It was not their failed policies that put the U.S. in the place it is today, but they certainly will have to deal with the mess. They don’t have a hard act to follow, and they will likely be remembered more fondly than their predecessor, but with their hands essentially tied behind their backs it will be difficult for them to be remembered for much of anything beyond the man who preceded them, George W. Bush.

The next president is going to inherit one of the toughest jobs of all time. Americans want change and the president is going to be pressured to deliver, and quickly, without selling out America’s future generations. How are they going to do it? Honestly, I have no idea, and I certainly do not envy the situation they are faced with. I look forward to seeing how they handle it, though, and I wish them the best of luck. No matter which candidate is elected, I know I’m looking forward to change. I am tempering my expectations somewhat, considering the circumstances, but at this point we are in need of new leadership and I hope America chooses the right man for the job.

Case-Shiller Home Price Index Shows Another Record Decline, But…

Every month now, the Case-Shiller home price index is setting a new record for the largest price drop, but some are seeing a silver lining in that cloud. There are a couple cities tracked by the index that appear to be heading in a positive direction. Cleveland and Boston both showed a price increase over the previous month. Cleveland lead the way with a 1.1 percent month-over-month price increase, while Boston barely held positive ground, with a 0.1 percent month-over-month increase. This came on the heels of some other positive news regarding the housing market, which is leading some to say the market rebound is coming.

The other positive news regarding the housing market was that new home sales rose by 2.7 percent in September, beating expectations. In addition, it looks like the Fed is preparing to lower interest rates, and the $700 billion bailout money is starting to get circulated, which many hope will soon jump start lending. Will this all be enough to fix the mess that is the housing market right now? I doubt it.

The real determinate in all of this is whether or not you feel that the U.S. economy is on the right track. If you think that all these fancy bailout measures are going to fix the problems we are facing, then you can probably figure that the housing market is going to rebound as well. On the other hand, if you don’t think that the economy is heading in the right direction, then calling a real estate market rebound is very premature. There is a lot of hope that the measures already in place--along with the fact that the election is next week--will bring stability to the markets. While I certainly think it might, at least for a brief period of time, I just don’t see how it will last. The fundamentals that brought the economy to its knees are still in place, and in some cases are even worse than before. So how can we say that a new president is going to magically make everything better? The answer is that he won’t, but he might make people forget about all the underlying problem--at least for a little bit.

The latest consumer confidence poll from The Conference Board fell to an all-time low of 38 percent, according to the Wall Street Journal; this is down from more 64 percent in last month’s poll. People are extremely fearful and cautious right now, and any glimpse of stability is likely to help somewhat. The election will certainly bring that, but again, the new leader is going to come into an exceptionally difficult situation. Layoffs keep coming and the credit markets still haven’t been opened. The government has written a lot of checks, but so far the only thing they have accomplished is adding to the already astronomical national debt tally. I certainly do not envy the position the new president is going to be put in, and no matter how good they are, I just don’t see how they are going to be able to fix all these problems. It is going to take a lot of time and heartache to get this ship righted. I certainly wish the new president the best, and I hope he does an amazing job, but I’m not holding my breath that he is going to be a miracle worker. It is likely that we will see the markets rally after the election, but investors beware.

Barack Obama And John McCain’s Effect On Your Pocket Book

With the election coming up next week, voters on the fence really need to start looking long and hard at the candidates' positions on key topics. And what topics could be more important than those affecting voters' pocket books? The Wall Street Journal just published a great article that breaks down the views of Barack Obama and John McCain on various issues that affect voters' pocket books, so let’s take a closer look at them:

Short-Term Relief:

Obama wants to stimulate the economy through a tax rebate of $1,000 for families and $500 for individuals. In addition, he is proposing that we allow for penalty free withdrawals from 401(k)s and IRAs, up to 15 percent of the account value or $10,000, whichever is lower.

McCain wants to stimulate the economy by cutting the capital gains tax for stock held more than one year to 7.5 percent. He also wants to increase the amount of stock losses deducible against ordinary income from $3,000 to $15,000. In addition, McCain would tax withdrawals from seniors' retirement accounts no more than 10 percent.

Analysis: If you are wealthy and have a lot of money in stocks McCain is your man. If you don’t, then Obama will likely provide your family with more short-term relief.

Income Taxes:

Obama wants to raise taxes on the wealthy. Families making more than $250,000 and individuals making more than $200,000 will likely see tax increases. The top two marginal tax rates will be increased to 36 percent and 39.6 percent, respectively. Obama also plans for some tax cuts for lower and middle class families.

McCain wants to keep all the Bush tax cuts, and also plans to gradually extend tax credits for dependents from $3,500 to $7,000 over time.

Analysis: Again, if you are wealthy, McCain’s plan will benefit you much more as you will actually see tax cuts as opposed to tax increases. If you have a lot of kids, McCain’s plan might also make sense for you, but that probably depends on your income bracket. For most people not in the wealthy category, Obama’s plan will offer them more benefit. This, of course, is not taking into account the potential for job losses that could stem from these measures as McCain proclaims would happen.

Investments:

Obama wants to raise capital gains tax from 15 percent to 20 percent for the wealthy. At the same time, though, he wants to eliminate capital gains tax on start-up and small businesses.

McCain wants to keep capital gains taxes right where they are, at 15 percent.

Analysis: We don’t get much insight as to the full extent of Obama’s plan for small businesses, so it is difficult to opine on that piece, but the basic trend is the wealthy are going to be taxed more by Obama while McCain wants to stimulate the economy through tax breaks to this class.

The full Wall Street Journal article covers other areas as well, so if you are really on the fence as a voter, make sure to read the full article; I just pulled out the sections most applicable to investors. The theme you will see in pretty much all of these issues is that, in terms of your pocket book, if you are lower to middle class you will probably do better with Obama in office. If you are upper class, McCain definitely favors you. The problem is that nothing is quite as straightforward as that. You also need to take into account the potential impact that these policies could have on the overall economy. It certainly appears that Obama’s policies would add a great deal more to the balance sheet of the U.S. government, but a lot of things could potentially change that. McCain stresses that Obama’s plans would be deadly to small businesses; obviously Obama doesn’t agree with that, and he does offer several measures to aid small business.

The bottom line is a lot of this stuff that the candidates are saying could go either way. We just don’t know how the economy is going to react to the policy changes, or what limits the economy will place upon their plans and their ability to act, and we will never get to see how the losing candidate’s policies would have turned out. At the end of the day, voters are going to have to use their own judgment and decide whether Obama or McCain is the best man for their family and their country. These are difficult times right now, and this is certainly a difficult decision that we all are faced with. Who is the best person to deliver our country out of this mess? You have a week and a day to figure it out…good luck, and remember to vote next Tuesday.

Any Homeowner Bailout Will Come Loaded With Problems

The calls for a homeowner bailout are becoming louder and louder. After all, why should we bailout Wall Street, but not but Joe Homeowner, who was the victim in all this? Then, of course, there are the financial ramifications to consider. Foreclosures are bringing down the real estate market right now, and isn’t it our duty to save it? If we save the real estate market, then we can go back to the way things were before and everyone will be happy, right? Obviously it isn’t as easy as that, but let’s look at some of the proposals and some the problems that could arise.

We will begin with John McCain’s proposal. McCain would like to see us use $300 billion, taken from the $700 billion bailout package already passed, to buy up mortgages of troubled homeowners. We would then renegotiate the terms of these mortgages to make them affordable for the homeowners. These mortgages would be purchased in reflection of the current diminished value of the properties, according to the New York Times. “Is it expensive?” McCain said of the proposal, as quoted in the New York Times, “Yes. But we all know, my friends, until we stabilize home values in America, we’re never going to start turning around and creating jobs and fixing our economy.”

Sounds pretty fantastic, huh? Couple questions, though: How are we going to make sure that only people who truly need the help get it? It sounds like to me this plan would encourage people to stop paying their mortgage so that they could get some principal reduced and a lower monthly payment. Furthermore, why should responsible homeowners--and renters for that matter--who have been diligent with their finances subsidize the bad mortgages that these homeowners entered into? What kind of message are we sending when we start rewarding people for not paying their bills? There are many other potential issues with this plan, but for the sake of time, let’s move on to Barack Obama’s plan.

Obama is proposing that we issue a 90-day moratorium on foreclosures, according to the New York Times. So we would halt foreclosure proceedings for 90 days in order to accomplish what, exactly? I’m trying to figure it out, but all I can get from this is that we are giving these homeowners 90 more days to live in their homes rent-free at the bank's expense. Is this a new version of economic stimulus we are trying to get banks to pay for? The problem is, because the government now controls Freddie Mac and Fannie Mae, taxpayers are going to be on the hook for a good portion either way. So, really, what’s the point? I assume that they are trying to encourage lenders to work out a deal with the homeowners, but how successful do we really think this is going to be?

The biggest positive I think I see in this plan is that it will force banks to work with short sale buyers. Right now all I’m hearing (I personally don’t do short sales anymore for this exact reason) are horror stories about how all these people are trying to buy short sale properties, but the banks just aren’t cooperating. If they are going to have to sit on these properties for another 90 days, that might be enough to motivate them to make a deal. What does this really accomplish for the economy, though? We would have fewer people with foreclosures on their credit reports, but really, this isn’t preventing a property from hitting the market, it is just selling the property earlier on. For the most part, I see this 90-day moratorium as simply delaying the inevitable, and something that people are just going to unscrupulously try to take advantage of. For the clincher, though, let’s look at Obama’s own statement against this plan from back in February, as published by the Los Angeles Times:

“A ‘blanket freeze,’ Obama added, might ‘drive rates through the roof for those trying to buy or refinance. Experts say the value of homes will fall even more, and even more families could face foreclosure.’” It’s got to be hard to argue with yourself, but I think the February Obama is right on this one.

There are lots of other ideas being thrown around as well, but every one of them has flaws. Frankly, I don’t see how it would even be possible to create a plan that works for everyone. Somewhere along the way, someone is going to get screwed; unfortunately I don’t see how it isn’t going to be renters and responsible homeowners. Any bailout plan is certain to reward the people who simply don’t deserve it. Maybe we should send out tax rebates to everyone who is current on their mortgage or rental payment instead--at least that would encourage the right set of principles. The problem, of course, would be that these responsible people are the same ones who would put that rebate check right into savings instead of spending it on useless stuff. Again, no plan is going to be perfect.

Is Another Economic Stimulus Package Imminent?

Now that the effects of the first economic stimulus package are wearing off and consumer spending is dropping like an anvil, taking America’s economic prospects with it, how long will it be before we see the next brilliant economic stimulus package? The government seems intent on avoiding a recession at all costs, so it seems almost inevitable that a second stimulus package will be unleashed, especially if Obama takes office.

Democrats in House are pushing for more economic aid to be sent out, but in this version they want to see money sent to local governments along with infrastructure improvements and assistance to certain families and workers in need, according to the Economist. Their proposal totals around $50 billion. So far President Bush seems intent to avoid another stimulus package, but who knows if he will change his mind or not. In all likelihood, though, nothing would happen until early next year, under the new President’s leadership. Since Obama has been pushing for a second stimulus package, it seems that if he is elected we can pretty much expect to see one next year, unless the economy makes a miraculous recovery in the second half of 2008 (not likely). McCain, on the other hand, seems opposed to one for the most part, but with Democrats expected to rule in both chambers, according to the Economist, he might be easily swayed if elected.

If I had to guess, I would say chances are more likely than not that we will see another stimulus package. The question that always comes up in my mind though is, “Who’s going to pay for it?” It seems rather silly to tax people in order to give them money back via an economic stimulus, which means we are going to rack up some more IOUs. What’s another $50 billion when you are already $9.9 trillion in the hole, right?

History Sides With Barack Obama’s Tax Plan, But What About The Future?

The New York Times published a compelling opinion piece this weekend written by Alan Blinder, an economics professor at Princeton and Democratic advisor, titled, “Is History Siding with Obama’s Tax Plan?” In his article Blinder uses historical figures to make the statement that Obama’s tax policy will be better than McCain’s. On the other end of the spectrum, the Wall Street Journal published an opinion piece this morning by Martin Feldstein and John Taylor, economic professors at Harvard and Stanford and advisors to McCain, titled, “John McCain Has a Tax Plan to Create Jobs.” Both articles make great points, but the authors are obviously biased. So who are we to believe? Which Presidential nominee ultimately has a better tax plan?

Of course, what candidates say in a campaign and what they do in office can be completely different, but even if we assume that the winner will follow through on his tax promises, we can only make an educated guess. McCain plans to keep the existing Bush tax cuts in place, which will help wealthy Americans and investors who pay capital gains taxes. McCain also wants to cut business taxes among other things, which Feldstein and Taylor believe will create jobs, spur growth and benefit virtually everyone. That certainly sounds lovely, but Blinder makes some great points that seem to counter such praise of McCain’s plans.

Blinder makes the case in his article that Democratic Presidents have greatly outperformed Republican Presidents while in office, economically speaking. From 1948 to 2007 the U.S. economy has grown 1.64 percent per year under Republican Presidents and 2.78 per year under Democratic ones. Blinder estimates that this difference in growth over an 8 year period would mean an additional 9.33 percent of additional income for every American. Blinder then goes on to point out that income inequality widens when Republicans are in office and shrinks when Democrats are in office. This point of course is fairly obvious given the policy of Republicans and Democrats, but worth noting nonetheless.

So where exactly does this leave us? One article focuses on the future, while the other focuses on the past. Can one really look at the past as an accurate predictor the future? The past certainly does not guarantee future results, but by what other means can we make projections?

Blinder’s article had the bigger impact on me because he actually supports his points with statistical facts. Whether or not they accurately represent what the future holds for Obama or McCain, they do give us a basis for conjecture. Feldstein and Taylor claim that jobs will be created, but they don’t support this claim with anything. Though the logical side of my brain tells me that tax cuts for businesses will lead to job creation, where is the proof? After reading Blinder’s article one is certainly left to wonder.

Another interesting piece of information I learned watching I.O.U.S.A. was that the national debt has tended to increase at a much faster pace when Republicans were in office. This coincides well with the GDP growth mentioned in Blinder’s article, but also, as pointed out in the movie, is a result of tax cuts. This again leaves one to wonder and even rethink one’s perceptions about the validity of certain tax policy reforms, though one must still question whether the past performances of a few Presidents can accurately predict future results.

Are McCain and Obama likely to follow in the footsteps of past Republican and Democratic economic performance, or are their plans different? Voters must decide for themselves, and I urge anyone who hasn’t yet read these two articles to do so, as they might encourage readers to think more seriously about this issue.

Barack Obama Wants Taxes To Be Fair, But What Is Fair?

On Saturday Barack Obama and John McCain debated, among other things, their tax policies. One of the main points drawn from that debate on the side of Obama was his goal to make taxes fair. He went on to say that wealthy people were not paying their fair share, himself included. He specifically targeted families earning more than $250,000 a year as wealthy. A point brought up by William McGurn in an opinion piece published in the Wall Street Journal, though, begs some thought. “As we come to the end of the Bush administration, the top 1 percent of American taxpayers already pay 40% of all income taxes -- the highest level in 40 years. The top 10 percent of income earners pay 71 percent of the taxes.”

McGurn asked, “What specific rate of individual taxation would it take for the rich to be paying their fair share?”

This is an interesting question to ponder. The rich obviously are in a better position to pay more taxes and still live comfortably, but at what point does it no longer become fair for them to support the poor and middle class masses? In another Wall Street Journal opinion piece, this one by Peter Ferrara, it is pointed out that the bottom 60 percent of income earners pay less than 1 percent of federal income taxes on net. This means that the top 10 percent pays 71 percent of all taxes, the next 30 percent pays around 29 percent of all taxes and the bulk of employees, the remaining 60 percent, only pay 1 percent. Strictly on appearances here, one would think that the wealthy are paying significantly more than their fair share. The top 1.5 percent of earners in the U.S. made more than $250,000, according to the 2005 U.S. Census. It is that 1.5 percent that is specifically being targeted by Obama. Do these taxpayers get more services in exchange for their increased tax payments? The answer is a most definite no. They actually receive much less in return, because their payments go to support all the social programs and so on for which they aren't eligible. Is this fair?

Moreover, according to Ferrara, if Obama is successful in his plan to increase Social Security payments for those making over $250,000 a year from 16 percent to 32 percent, they will receive less than a 0 percent real return from their lifetime payments. So they will actually end up paying for other people’s retirement. Again, this begs the question: is this fair? The answer, of course, will vary from one person to another, depending on their personal beliefs--and perhaps their income level.

Personally, I don’t think the word “fair” is appropriate. In my mind this tax structure is obviously not “fair.” In order to be “fair” people should only have to pay for the services they expect to receive or in some way benefit from. A wealthy person paying for the care of 1,000 poor people doesn’t qualify as “fair” in my book. That being said, I would never want to see 1,000 people dying of starvation so that a wealthy person could buy a new fancy sports car to add to their collection; I understand there has to be some sort of compromise. I think most wealthy people would probably say the same thing, but there is always something about giving money to the government through taxation that just gets on people’s nerves. Maybe it is because we constantly watch how they waste it. Because of this the wealthy always seems to find a sneaky way around these increased taxes.

Obama wants to raise taxes to pay for more social programs, but instead of increasing taxes for the wealthy, why don’t we appeal to their charitable side to accomplish the same social impact. We could get a little creative and try to figure out some ways to increase charitable donations from the wealthy, perhaps through tax incentives, but it could be done any number of ways. In the end, though, charitable organizations (at least good ones) are going to provide much more social impact for the buck than the U.S. government ever will. In addition, wealthy people are going to feel much better about giving more money to charity then they will about giving more money to the government. As a result, they might actually pay it as opposed to finding loopholes in the system. So to me this seems like a no-brainer: more change, happier taxpayers and less for the government to worry about.

It shouldn’t be about being “fair,” rather Obama should focus on accomplishing his goal of social change. He needs the wealthy to contribute more in order to see his goal to fruition, but increasing taxes isn’t the only, or even the best, way. Wealthy people have hearts, too--he should try appealing to those instead of trying to steal money from their pocket books.

Paris Hilton For President: Energy Policy For People (magazine)

Paris Hilton has recently released a video rebuttal to a rather ill-advised John McCain ad which compares Barack Obama with “celebrities” such as Hilton and Britney Spears, suggesting a lack of substance despite their charisma. The original ad seems desperate and is as insulting to the viewer as it is to those mentioned. Meanwhile, Paris’ ad is actually witty, albeit a touch misinformed about energy policy.

Who would have thought that perennial tabloid darling Paris Hilton could actually deliver a speech more effectively and with greater poise than our president of eight years? It seemed, in fact, that her relevance was beginning to fade until the McCain ad was released. While I doubt that Ms. Hilton will win a single state in November, this may have the unfortunate side-effect of reinvigorating the public’s fascination with her. Thanks, John; I guess we’ll always have Paris. Still, we could do worse than President Hilton: I dare say that she would have looked as convincing as Bush did arriving in a flight suit on the USS Lincoln to announce “Mission Totally Accomplished! Luvz it!” She might even be able to pronounce Sarkozy properly.

But my praise of Ms. Hilton stops there. In the video, she suggests combining the two energy policies of McCain and Obama to help solve the energy crisis. Her suggestion is to allow offshore drilling to tap those rich deposits for cheap, easy fuel as we work on alternatives. Appropriately enough, the last time I used the words “rich,” “cheap” and “easy” in the same sentence, it was to describe Paris Hilton, but unfortunately her plan is as superficial as her cult, and it is flawed for the same reason that McCain’s “solution” is flawed.

Offshore drilling would be a placebo for the problem at best, as the restricted areas would provide only a drop in the proverbial barrel of our oil consumption. Furthermore, it will take several years to construct derricks and refine the crude, providing no immediate relief and precious little when the wells truly begin to produce. All of this assumes that the oil would be sold exclusively to Americans, and we should know by now that this is not a given.

The Paris for President campaign is off to a rocky, though amusing start. I’m afraid she won’t have time to really establish a solid platform by November. That said, I think her decision to start this late in the campaign is a refreshing one. This overextended campaign season has been costly and grueling for everyone involved, and though I can’t get behind Hilton on her energy policy, her frank approach is a balm in this hostile election year. She even may have a running mate selected before the Republicans or the Democrats. She mentions Rihanna, but a ‘Hilton Clinton’ ticket has such assonant appeal, and it’s better to be called assonant than asinine, which is how I would describe the campaigns of other nominees at this point.

Luvz it, indeed.

What Is The Gravest Long Term Threat To The U.S. Economy? Radical Islam, Says John McCain

In an interview with Fortune, Republican presidential candidate John McCain was asked what the single gravest long term threat to the U.S. economy was. This is not an easy question, with so many choices and all. Is it the housing crisis or the credit crisis? What about the huge deficit the country is running, or the rising cost of energy? How about Social Security? McCain didn’t select any of those options; instead, he said that radical Islam was the single biggest threat to the U.S. economy. Pardon me a moment while I let this sink in a bit…nope, still don’t see it…oh well, maybe it’s beyond me. Why don’t we analyze it a little more and see if that helps?

Okay, so 9/11 did a number on our economy, I give him that. I can also understand the argument that terrorist attacks, or even the threat of them, can upset consumers, thus affecting the economy. So radical Islam can have an impact on the economy, but is it really the biggest threat? Wait…I think I get what he is trying to say--maybe McCain is telling us that radical Islam is the biggest economic issue because it is forcing us into war and costing us not only billions of dollars each year to fight abroad, but also billions to fight here at home. Oh, and it is also a problem because the movement keeps growing stronger the more we fight it--kind of like using fire to put out fire. Wow, I totally understand now, this fight is going to go on forever--man, that is going to be a downer for our economy. Okay, so now I see why it is such a huge problem…

In all seriousness, I could go on for awhile about why radical Islam is, and has, been fueled by our actions, but for the sake of brevity I will not (for more information here is a good write up). Based on the fact that we in essence created (in many cases) and have fueled radical Islam, maybe the biggest long- term threat to the U.S. economy is not radical Islam, but rather poor foreign policy. That might not be such a bad selection after all. We could look at the national debt as a big one, but we can also say that a lot of that debt was created because of poor foreign policy decisions. We could make the same case for several other problems as well.

At the end of the day, we know exactly why McCain chose radical Islam as the biggest problem, and that is because he is riding the “national security” ticket. If any voter has serious doubts about our national security, McCain is their man. The politics of fear, as it is called, is probably the biggest thing McCain has going for him right now, and he wants to milk it for all he can. The more American voters he can convince that national security is an issue, the better chance he has to win. It also doesn’t hurt that Barack Obama, the Democratic candidate for president has family ties to Islam, a point which has unfairly caused accusations that he is supporting terrorists--despite the fact that Obama himself is a Christian, not a Muslim. Long story short, McCain chose this reason for political purposes, yet he might not be too far off in actuality--only he needs to focus less on the effect and more on the cause.

Senator Christopher Dodd Implicated In Mortgage Scandal

Senators Christopher Dodd (D-Conn.) and Kent Conrad (D-N.D.) have been implicated in a mortgage scandal involving Countrywide bank. This is obviously a touchy issue considering that Dodd is the chairman of the Senate banking committee, it is an election year and a $300 billion lender bailout is supposed to be voted on today in the Senate.

In Dodd's case, the accusations basically boil down to whether or not he was given special pricing in relation to a couple refinance loans he got from Countrywide in 2003. Dodd denies receiving any special rates and adamantly claims that the rates were at market, but he does admit that he was likely on Countrywide’s VIP list.

Dodd's accusers have e-mail evidence apparently showing that Countrywide did, in fact, give Dodd preferential treatment. Countrywide sent an internal e-mail message that said to give Dodd a 0.5 discount on his rates because he was a U.S. senator, according to Portfolio.com.

Dodd denies any wrongdoing and is prepared to fight all allegations against him. Considering the facts that I have read, I don’t think they will ultimately find him guilty, yet the effects could be hard-felt nevertheless. The major $300 billion mortgage bailout bill has already been delayed while this investigation is underway, according to the New York Times. In a time when Democrats are trying to support their presidential candidate, Barack Obama, any bad press for the party certainly affects him. Dodd is a high-ranking Democrat who was a candidate in the 2008 presidential election himself, and whether or not Obama has anything to do with Dodd, it won’t change how the Democratic party in general is perceived by some.

Personally, I’m all for the investigation. If Dodd did, in fact, take advantage of his position, then he should have to pay the consequences. More importantly, this has held up the $300 billion bailout bill. Since I am adamantly opposed to a mortgage bailout, I hope that this bill gets delayed permanently.

Barack Obama And John McCain Battle Over Economic Policy

Does Barack Obama or John McCain offer the best hope for the U.S. economy? This, of course, is the number one issue on everyone’s mind for the upcoming presidential election. The candidate who is able to best answer this question, and do so in a way that Americans can understand, stands a great chance of becoming our next president. So which candidate does offer the best hope for our economy anyway? Well, it depends on who you ask.

Yesterday in Raleigh, Obama attacked McCain’s economic policy, calling it a repeat of Bush’s miserable failure. Obama’s own plans for the economy include an expansion of unemployment benefits, another economic stimulus package of $50 billion, tax cuts for the middle and lower classes and relief for homeowners facing foreclosure, according to the International Herald Tribune. Obama was quoted in the article as saying, "We were promised a fiscal conservative. Instead, we got the most fiscally irresponsible administration in history. And now John McCain wants to give us another. Well, we've been there once. We're not going back."

The McCain campaign didn’t take the attacks sitting down, though. "While hardworking families are hurting and employers are vulnerable, Barack Obama has promised higher income taxes, Social Security taxes, capital gains taxes, dividend taxes and tax hikes on job-creating businesses," McCain spokesman Tucker Bounds said in a statement issued before Obama's remarks, according to the International Herald Tribune. "Barack Obama doesn't understand the American economy, and that's change we just can't afford.” McCain’s plans for the economy include keeping the Bush tax cuts in place as well as tax cuts for businesses.

In the end it comes down to two schools of economic thought. Obama believes that government spending and policies can help us get out of the economic rut. His policies are going to increase government spending, and overall government involvement in the economy. McCain, on the other hand, belongs to the school of thought that says the economy revolves around businesses. In his mind, the best way to stimulate the economy is to put money into the hands of businesses, who will then be able to add more workers and so on, which ultimately will lead to improvement in the economy.

One thing I haven’t talked about yet is the Iraq war. Obama, of course, wants to start drawing troops out of Iraq, potentially saving us a lot of money (money he wants to put back into our economy). On the other hand, McCain plans to keep troops there for a long time, continuing to add to our government spending on the war (much of this spending is not directly aiding America's economy). That being said, Obama’s overall plans for government spending far exceed McCain's. For the most part I tend to agree more with McCain’s policies than Obama’s, but I do side with Obama in relation to the Iraq war. While I don’t agree with pulling out altogether at this point (because it would hang those Iraqis who trusted us with their lives out to dry), I do think we need to figure out a better plan. The plan to occupy Iraq indefinitely is not a good plan. We never should have gone there in the first place, in my mind. It has cost us billions of dollars and many American lives, but that is another post for another day.

The bottom line is these two candidates differ greatly in their policies: One thinks the government can get us out of this mess, and the other is going to rely on business and the markets to turn things around. Which one is correct? We will have to wait and see. Either way, though, the new president is going to have their hands full, and I seriously doubt either one is going to be able to come up with the magic elixir that rights this thing over night. Turning this ship around is going to take some time and diligence.

Will We See Another Economic Stimulus Package?

After the latest round of unemployment figures, there is renewed buzz for another economic stimulus package. At this point it is just talk, but depending on how the first economic stimulus package pans out, and whether the price of oil comes down, we may see the talk turn to action sooner rather than later.

President Bush has expressed interest in more economic stimuli, but he wants to wait until we can see how the first round performs first. In addition, Bush has his hands full at the moment trying to get his tax cuts to become permanent, according to CNN. A couple of the plans being proposed in the Senate, though, are increasing unemployment benefits and a $300 billion FHA loan boost, according to CNN.

Those of you who are frequent readers of my blog probably know that I wasn’t a big fan of the first economic stimulus plan, and I’m certainly not in favor of another one. Without getting into a full on tirade about how irresponsible our government is, we are more than $9 trillion in debt, and we should not be going further in debt in order to “attempt” to artificially rouse our economy. Contrary to popular belief, we can’t keep borrowing or printing money indefinitely without recourse. We are walking on thin ice right now, and who knows when it is going to break--but the more weight we add, the higher the chance goes.

Ultimately, I expect we will see some sort of economic stimulus because I seriously doubt the first one is going to have the effect that Bush is hoping for. It was a poorly devised plan to begin with, and things are only getting worse for American consumers. When it gets a little closer to election time (assuming the economy doesn't miraculously get better) you can bet that Bush is going to put his best foot forward for the American public in order to attempt to gain support for the Republican presidential candidate: John McCain. He will propose some miracle plan--that is completely full of hot air--which he will claim will fix everything, and then dare the Democrats to shoot it down. As long as Bush does it right and positions it so that the American public agrees with it, then if the Democrats don’t vote it through they will look like the bad guys and then Obama will take the hit. By the time the public finds out that the net effect of this plan leaves us worse than where we started, it will be too late.

I don’t want to be pessimistic, but I have a hard time not being so when talking about our government right now. I hope that the government thinks twice about another stimulus plan, and actually takes into account our budgetary deficiencies, but when has that ever stopped them before? If you are wondering where I am, I’m heading out to get a wet suit, because the water under the ice looks awfully cold.

Barack Obama: Guilty By Association?

By now everyone knows the Rev. Jeremiah Wright and what he has done to the Obama campaign, but what about another of Barack Obama’s friends, Deval Patrick, the governor of Massachusetts? I just read an interesting opinion piece in the Wall Street Journal by Jon Keller in which Keller essentially called out all of Patrick’s faults and proceeded to say that Obama would end up just like Patrick. The article brings up many similarities between Obama and Patrick: They are both African American, they both attended Harvard Law and they both frequently focus on “change” in their rhetoric. Earlier this year in a campaign speech, Obama even borrowed some words from one of Patrick’s speeches and was accused of plagiarism. The two are close friends, and may be similar in some ways, but is the assumption that Obama will follow the same path as his friend really fair?

I am not personally an Obama supporter, and I am not planning to vote for him come election time, but this is not because of the actions of his friends and acquaintances. To judge him solely on that would be short-sighted, and I feel for the guy for enduring so much judgment, even if this sort of scrutiny does come with the territory. While I do think Obama might be promising more than he can deliver, the main reason I don’t support him is that I don’t agree with many of his major policies. One of Keller’s major criticisms of Obama in the article revolves around these promises of change. Deval Patrick has failed on several occasions to see his promised changes through, and Keller thinks Obama is likely to do the same. I, too, question whether Obama will be able to carry his changes to completion, as I am always skeptical of politicians that make grand promises, but one thing makes me think that he perhaps isn’t just paying lip-service.

A gas tax holiday has recently been proposed, which McCain and Clinton are supporting and Obama is opposing. I firmly agree with Obama on this, and I respect that he is holding his ground. Most Americans don’t understand economics all that well, and many will jump on the gas tax holiday bandwagon. It would have been easy for Obama to support the tax holiday along with Clinton and McCain and gain the goodwill of millions of Americans who are faced with the reality of $4 a gallon gas, but it wouldn’t have been the best move for the country. Obama may be more perseverant than people think, and these allegations that he will be another Deval Patrick may prove to be a bit premature.

Barack Obama Could Win The Election Thanks To Ron Paul?

The fact that the Ron Paul Revolution is still kicking, despite the fact that the Republican nominee has already been decided, could potentially help Barack Obama and hurt John McCain’s chances at the presidency. I read an interesting blog post from Tommy Christopher at the Political Machine that brought up a key point. According to Christopher, one of the strongest ties of the Ron Paul revolutionaries is that they strongly oppose the war in Iraq. Since McCain plans to keep the Iraq war going indefinitely, this will likely lead to many Ron Paul supporters crossing party lines to vote for the Democratic candidate, which will likely be Obama.

McCain’s party hasn’t worried too much about the Ron Paul fallout, probably assuming that it would taper off once he clearly won the nomination, but that doesn’t appear to be happening. In the recent Pennsylvania primary, Ron Paul won 16% of the vote, which in itself is not a huge number, but if a majority of these Ron Paul supporters turn to Obama come election time, they could easily swing the race.

Ron Paul seems intent on continuing to use his platform as a presidential candidate to spread his revolutionary ideas for as long as he can. The more people who hear Paul’s message, about the Iraq war in particular, the more people who could demand the end to this war, which would likely only come if Obama is elected president.

By staying in the race Ron Paul is in effect helping Obama. I don’t think that Ron Paul supporters are truly excited about the prospects of McCain or Obama, or they would be supporting one of these candidates by now. Which way they go in the end though could possibly decide the presidential race, and it is hard to ignore that the biggest issue in many of the Ron Paul Revolutionaries minds is the Iraq war. I can’t imagine many things more upsetting to Republican leaders than the idea of the Ron Paul Revolution helping Obama win the presidency, but it just might happen.

Iraq War: Is It The Cause Of The U.S. Economic Recession?

The Iraq war is being debated on many different levels. One is the idea that it could be the cause of the U.S. economic recession. Politicians and economists are divided on the subject. Most Democrats, including presidential candidate Barack Obama, claim that the Iraq war has had a substantial effect on the U.S. economy and should be examined as one of the primary reasons for the U.S. recession. Most Republicans quickly dismiss the claim as being without merit, but a growing number of Republican s, including Republican Presidential candidate Ron Paul, strongly oppose the war based on its economic fallout. But is the Iraq war to blame for our economy’s problems? Let’s look at arguments from both sides of the debate:

The Iraq War caused the U.S. economic recession

In a Washington Post article, Nobel Prize-winning economist Joseph Stiglitz argues that the Iraq war is to blame for the economic recession for the following reasons:

• The oil-producing countries have so much money that they don’t need to produce much oil. Because they don’t have the immediate need for cash, they are able to plan better for the future by pumping less oil and charging more for what they do produce. By doing this they are able to keep more oil for future use.
• The government has spent so much on the Iraq war and gone so far into debt that it has been unable to keep the domestic economy in check through tax cuts and other internal investments.

Senator Barack Obama had the following to say at a recent forum, according to the same Washington Post article: "If we can spend $10 billion a month rebuilding Iraq...we can spend $15 billion a year in our own country to put Americans back to work and strengthen the long-term competitiveness of our economy."

Senator Obama has a valid point to his argument. This war was entirely financed with debt, which in itself is bad, but ultimately what has our country received in return for that investment? At least if we are going to go deeper in debt, we should probably be using those funds for something that might actually help our economy, and our country.

According to a CNN poll, 71 percent of Americans believe that the Iraq war is at least partially responsible for the economic downturn.

The Iraq War Is NOT responsible for the U.S. economic recession

While it is easy for politicians to say the Iraq war has caused many of the world's problems, there is little evidence that the war is directly responsible for the economic recession. In response to the arguments made by Stiglitz, according to the Washington Post most economists believe that the price of oil is rising because of increased demand rather than a shortage of supply. Furthermore, Martin Baily, former chairman of Bill Clinton’s council of economic advisors, had this to say: “The credit crisis we got into is because of the housing boom, the relaxation of lending standards and certainly a lack of adequate supervision," Baily said. "I don't see a connection with government borrowing."

Conclusion

I can see validity in the arguments from both sides. Considering all the other problems that the U.S. is facing—in particular, the housing bubble—while I think it is a little farfetched to say that the Iraq war was the sole cause of the economic recession, it is equally foolish to say that the costs of the Iraq war have had little if any impact on the U.S. economy. Wars are not free, and the U.S. has spent billions of dollars on this war, financing it entirely with debt, which will have to be repaid one way or another.

Think Barack Obama Is Going To Be The Next President? Wanna Make A Bet?

If you are so confident that your candidate—be it Barack Obama, Hillary Clinton, Ron Paul or John McCain—will become the next President of the United States, then why don’t you put your money where your mouth is? To show just how far the free market has come, there is now a website that allows you to make money by betting on the outcome of world events from the U.S. presidential race to whether or not Venezuela or Ecuador will declare war on Colombia. The company, which operates out of Ireland, is called Intrade. The website offers a trading platform similar to the U.S. stock exchange, but traders on Intrade buy and sell options on things most people might consider a bit out of the ordinary.

Investors who consider placing bets on Intrade should keep in mind that Intrade is still a small marketplace. This means that positions can be volatile and may be difficult to close out of. Therefore, Intrade should not make up a large portion of an investment portfolio, and should probably be viewed more in terms of entertainment than an actual investment.

Smart investors may be able to profit from some of the holes in the Intrade system and capitalize on the small marketplace. According to an article by The New York Times, a professional poker player named Serge Ravitch made a 35 percent return on his money in just 6 weeks by identifying these weaknesses. One trade he took advantage of was based on the Republican Presidential nomination, which more than 10 percent of traders on Intrade thought would go to Ron Paul. No one in the Republican Party—or any party for that matter—was giving Ron Paul a prayer to win the nomination. Because of the market’s small size, the diehard supporters of Ron Paul raised the percentages in his favor higher than they really should have been.

For other events, Intrade’s predictions have proven surprisingly accurate. The following is a quote from The New York Times article:

“In 2004, President Bush won every state in which Intrade’s contracts—as of the night before Election Day—gave him a better than 50 percent chance of winning. He lost every state where the traders thought Mr. Kerry was the favorite. Late on election night in 2006, while the talking heads on CNN and MSNBC were still saying that the Republicans would hold onto the Senate, Intrade knew better.”

Investors should take caution when making bets on Intrade, and not invest too much at this point. If nothing else, Intrade could prove to be a source of entertainment for investors who want to see if they can outsmart the public. For those investors who want the entertainment value without putting up real money, Intrade also offers play money accounts for free.

As Obama And Clinton Fight, McCain Is Closing In On Presidency

There have been some interesting turns of events in the Presidential race. Last month, Barack Obama enjoyed a huge lead over Hillary Clinton, and was largely favored to win over John McCain. Obama is now only slightly ahead of Clinton, and the margin seems to be getting tighter. Even worse for the Democratic Party, the new Reuters/Zogby poll released on Wednesday shows that McCain is now favored over Obama.

The problems began for the Democrats for two main reasons: 1) McCain clinched the Republican nomination early on, and has been able to focus his full efforts on the race for the Presidency. 2) Tactics and arguments have gotten dirty between the two Democratic nominees. Clinton especially has bombarded Obama with attacks in an effort to expose alleged weaknesses.

Whether or not the attacks on Obama are warranted, they have changed public opinion. If nothing else, they have worked to cast doubt in voters’ minds about the chances of Obama to win against McCain. During the Republican primaries, McCain’s biggest problem was fundraising, and his early victory has aided him greatly. Not only was he able to conserve funds, but his clear nomination allows him an advantage in raising additional funds going forward.

Results differ greatly from poll to poll, and many voters don’t really decide until the very end, so no poll will be perfectly accurate. Democrats probably shouldn’t worry about the Reuters/Zogby poll at this point, but they should be aware that the longer the battle for the Democratic nomination draws out, and the more intra-party fighting goes on, the more advantage McCain will gain.

Summary of Barack Obama, Hillary Clinton and John McCain Tax Policy

I came across an article today by Jeremy Siegel on Yahoo Finance that gives a nice summary of each Presidential candidate’s tax policy. I will attempt to summarize the summary.

Barack Obama

Obama wants to increase the dividend and capital gains tax rate to 24 percent. At the same time, Obama recognizes the power of start-up companies to create jobs, and wants to eliminate capital gains tax on them. Obama would also like to raise the top income tax bracket to a 39.6 percent tax rate.

Hillary Clinton

Clinton is essentially advocating for the same rates as when her husband was in office, before the Bush tax cuts. That would mean capital gains taxes would be raised to 20 percent from their current 15 percent rate, and dividend income would be taxed at a maximum 35 percent. Clinton also supports a raise in the upper tax bracket rate to 39.6 percent, same as Obama.

John McCain

McCain wants to keep the current tax rates, but Siegel points out that he may not be able to. The Bush tax cuts are set to expire in 2011, and taxes will revert to pre-Bush rates if the cuts are not re-approved. Seeing as the Democrats strongly oppose the Bush cuts, and that they are likely to control Congress, McCain could have a difficult time getting the necessary laws passed. It should be noted that McCain and several other Republicans voted against making the Bush tax cuts permanent, which is why Bush had to settle for a test run of the current rates.

Barack Obama Is Taking Shots From The Left And The Right

Barack Obama is getting attacked from all sides now, and it appears that no place is safe for him. On the left he is being attacked by Hillary Clinton, with accusations of plagiarism among other things. On the right he is being bombarded by supporters of John McCain, who are setting him up as a supporter of terrorists. I sincerely feel bad for the guy right now.

I’m not a big supporter of Obama, but I’m also not a supporter of low blows (I don’t support Obama because of his huge spending proposals and other polices, not personal issues). The latest blow coming from McCain supporters at a recent rally was especially distasteful. There the speaker who introduced Obama repeatedly called out his full name Barack Hussein Obama, and suggested that he was being friendly with our terrorist enemies. I was upset with Clinton’s plagiarism accusations, but this is 100 times worse. It would be one thing if they had proof that he is working with terrorists. But to accuse him of what amounts to treason just because the guy was born into a Muslim family (although it is debated whether they were even practicing) and has the middle name Hussein...give me a break. Not that religion even matters, but they guy is a renowned Christian now, not Muslim. All this does is make the McCain campaign look like an ignorant bunch of bigots, which is not exactly the image one wants to portray in a campaign.

To his credit, McCain did repeatedly apologize for the remarks made by his supporters, and he said that he expects that it won’t happen again. I certainly hope that is the case.

In every election, things eventually turn nasty, and it has been one of the biggest turn-offs to me for politics. For once, I would like to see the candidates fight a nice, clean fight and stick to the issues. If you have a problem with a candidate’s proposals...great, let’s debate them. Topics involving religion, race, and family...lets keep those out of it. Here’s hoping for a good clean Presidential race, whichever candidates it may involve.