The subprime culprit

Currently, home ownership is under assault. Mind you its under assault from those who probably already own their homes and are not renters (unless they are New York media types). First, the right blame the government’s encouraging home ownership and pressuring lenders to lend to the unqualified thereby causing the great recession by fostering the subprime crisis. Second, the left is also critical of subprime because they assert it is predatory. Of course they are both wrong. As I have pointed out before, subprime is just a convenient whipping boy for those who have agendas. It was not large enough to cause the entire real estate market to crash. It was part of the overall mortgage bubble created by the Fed’s low interest rate policy which was a result of their supporting increased government spending. The right by attributing this to subprime think that they are attacking government social policies – when they just look like racists. The left attack subprime because it ultimately means financial independence for poor people – especially poor minorities. Americans traditionally build wealth through the growth in home equity. Now that we have entered a period in which equity is eroding everyone is piling on home ownership as being bad. In doing so they remind me of the commentators of the NBA finals. When Miami won the first game, they all said that Dallas was dead and the series was over. The Dallas won game two and they all foresaw the demise of Miami. The Miami won game three and they all flip flopped again. Now with Dallas winning game four, they are all piling on one Miami star and saying that Miami is in serious trouble. The conclusion is that they don’t have as clue. The same is true about the critics of home ownership. They are only critical when home values fall. We all know that home prices will eventually recover and wealth will again be built through home ownership. It is a shame that the Fed has written rules that essentially kill subprime. Sure, subprime’s risk assessment did not work in the face of an overall collapse in the market – but which one did? Still, 80 percent of all subprime loans are current and giving home ownership to a group that has been ill-served by traditional mortgage lenders. As the market recovers, they will build wealth much to the chagrin of the critics on the right and on the left. A pox on both of their houses.

Poor University of Chicago (redux)

Last January I lamented in a posting about the University of Chicago having Obama's chair of the council of economic advisors on its faculty. While I am certain that Austan Goolsbee has a sterling record of economic academic achievement to be a full professor at Chicago, he is also a liar. He has uttered a constant stream of pronouncements about the economy that not even the most ardent cheerleader believes. When the current rate of job creation was announced along with anemic economic growth, he actually said that we were on target. He along with Treasury secretary Geithner were spreading doom and gloom about not raising the debt ceiling - causing the effects "catastrophic". As I have pointed out before, no one believes that. The US takes in enough "revenues" to service the debt, pay entitlements and some other bills. Politicians consider it a catastrophe if they cannot spend ever increasing amounts of taxpayers monies. Since the debt ceiling is the only real hard stop to this government's profligateness, then it may be our only realistic solution to government spending excesses. While his predecessor Christie Romer (see my posting "Poor Christie Romer") actually had a pained look on her face when she uttered lies for the administration, Goolsbee actually looked like he believed the nonsense that came from his lips. I simply amazes me that he could do all this in good conscience. Now he returns back to the university where he can also make up stuff when he lectures to students. Hopefully they are smart enough to discount whatever he is opining.

All that glitters

I am not a gold bug. Sure gold has its uses but its just not to my taste. I don’t own any jewelry, I don’t collect coins, and my fillings don’t glitter. Today there are two issues: should I buy gold and should the US go on the gold standard? Should you buy gold? I don’t really care but I won’t. Gold has now ventured into the greater fool territory as in “I know the price is high but there is a greater fool than me out there who will pay more.” If that were not the case then no one would buy it – the old buy high sell low axiom. Sure gold was a good buy when it was $350 an ounce but at $1,500? Not a chance. Throughout my lifetime gold has proven to be a lousy investment. Its natural price seems to be below $400 an ounce so a buy and hold strategy is a losing one. People do not buy gold as an investment, rather they buy it as a hedge against inflation. Thus, knowing when to sell to that greater fool is as important as knowing when to buy. The key is to not be that greater fool. Personally I would rather buy real estate. Its price is low and edging even lower. Real estate is cheap and we all know it will eventually go up. Just like we all know that gold will eventually go down. But do what you think is best but know that you cannot find any evidence that a buy and hold gold strategy is a good one.

Well what about a return to the gold standard? Those who advocate this argue that a gold standard would stop the government from controlling the money supply. All governments it is argued are tempted to inflate the money supply and cause inflation, devaluing the currency. If money creation were tied to gold, the argument goes, then there would be no inflation. Such an argument is naïve at best. Governments under the gold standard have always found ways to create more money. The easiest way is simply to change the value of the currency in terms of gold. Instead of a $1,000 an ounce make it $2,000 an ounce. Voila! The money supply is doubled! Governments have also debased the currency by adding lead to the coin or by decreasing the purity of gold coin. Where there is a will there is a way.

What is more curious is that most of the gold standard advocates profess to favor free markets – that is markets free from government interference. How they can reconcile a gold standard with that philosophy is beyond me. The government would have to artificially set a price for gold and then manipulate prices to maintain that standard. This is the antithesis of the free market. First, what should the price be? What about the market price? Well the market price is the price today. If we set it at that price, then what happens when the market price changes? Do we increase the money supply when the price of gold rises and then decrease it when the price of gold falls? What about economic growth? Historically the US economy grows at about 2 percent real GDP per annum. If the money supply grows at that rate then we have economic growth without inflation. The question is what is the growth rate in gold? It is around 50 million ounces per year ,If the gold supply increases faster then we have inflation. If it increases slower then we have deflation. Do you really want economic growth dependent upon how much gold is dug out of the ground or that flows into the US Treasury? I don’t. Next consider that we set the price at around today’s price ($1,400 an ounce). The last time I looked, the US held a little more than 8,900 tonnes of gold (a tonne is 2,204 pounds). If my math is correct, then that would leave the US a money supply of $390 billion. Well currently M2 is $8,900 billion. US GDP is $15 trillion. This means that velocity is around 2. So under the gold standard we would have to shrink GDP by around 15 times to around $1 trillion. Say what? Moreover, there are around 140,000 tonnes of gold out there which means that US reserves are around 6 percent of the total. If you look at the amount of US debt held around the world, the top fifteen countries hold more of our debt than what would be the US money supply under the gold standard. Any of these countries and many others could show up and say “exchange your debt for your gold” any essentially plunge the US economy into depression. Then there is the famous Gresham’s law – bad money drives out the good”. Historically this is one of the biggest problems of the gold standard in that gold has a price as a commodity which is determined by the market and a price as money which is determined by the government. The two are only equal by happenstance. If gold is worth more as a commodity it flows out of circulation and the economy slows down and deflates. If it is worth more as money, then gold flows into circulation and causes inflation. Lastly, one of the largest private owners of gold lies with the enemy of the right – George Soros who could manipulate the US supply. Do we really want to turn over the fate of the US economy to George Soros. Hum. Maybe he is secretly financing those pushing for a gold standard.

Bullets or Wizards?

Several years ago political correctness came to the NBAs Washington Bullets who became the Washington Wizards. That transition is even more appropriate today when I see headlines like "To keep his job, Obama needs more jobs" coupled with "Has the Fed run out of bullets?" If Obama could transform bullets into wizards, he might get re-elected. Actually it is a sad commentary - and probably an incorrect one - to say that despite a record of consistent failure and incompetence, Obama is re-electable. A president that has given us unprecedented government spending, additional regulatory burdens, socialized healthcare, burdensome and often stupid legislative initiatives (Dodd-Frank, Obamacare, cap and trade), hundreds of czars and czarinas finds his re-election hinging only current unemployment rates? Give me a break. However, he can get re-elected and fairly easily. Most observers admit that Obama seems likable - if you like aloof snobs with a great smile. Here's how he can be re-elected. First he admits that his administration is staffed with Keynesians who believe - despite the evidence - that government can get the economy out of a recession. So all his policies were driven by that belief. However, the competing school of macroeconomic thought believes the opposite: government spending drives out private investment and reduces employment; increased regulation adds cost to employing people and also reduces employment; the legislative initiative of Obamacare also increased the cost of employment and reduces employment; the threat of cap and trade and Dodd-Frank have increased uncertainty and reduced employment; the Federal Reserve has monetized the national debt by directly buying Treasuries to support the increase government spending with the results of driving interest rates to zero, pushing capital offshore, devaluing the dollar and weakening the dollar as a reserve currency. So Obama should say "Keynesianism has failed. It is obvious that none of this has worked to get America working. As a matter of fact it has done the opposite. So it is now time to try something different. It may just be a theory because it has really never been tried in this country. Although politicians on the right have paid lip service to it, they never implement it because it reduces their power. What is it? Its the free market." Obama should say, "From this point forward, I will suspend Obamacare, cap and trade, and put a moratorium on Dodd-Frank. I will sign the free trade agreements with Chile, Columbia and Korea. I will move to reduce government spending back to 19 percent of GDP. I will reduce Federal employment across the board at each agency by three percent per annum for the rest of my term. I will introduce legislation to make it illegal for the Fed to monetize the national debt except in the case of a national emergency. I will adopt all the provisions of the bipartisan Bowles-Simpson committee on social security reform, medicare/medicaid, discretionary spending and income tax reform. I will eliminate for the rest of my term as president the capital gains tax and the corporate income tax. And lastly, we as a grateful national will eliminate the Federal income tax for all active duty military personnel." I guarantee you that if Obama said these things and implemented them, regardless of the outcome he would be re-elected in a landslide.

With Successes Like These …….

We have come a long ways. In 1979 when Chrysler was bailed out by Jimmy Carter, the initial cost was $1.2 billion and rather than an infusion of cash from the government, the $1.2 billion was in guarantees for Chrysler loans. Although that bailout was also touted as a success, research by the Heritage Foundation showed that the overall job loss at Chrysler would have been little different than if the company had gone through bankruptcy. The only difference was that stockholders were bailed out but at a cost of reduced net wealth suffered by the drop in share price.
It probably comes as no surprise that the president and his men – Timothy Geithner and Joe Biden - have been going around touting the automobile bailout as a success. However, what constitutes success. The Wall Street Journal says that after shedding 334,000 jobs, Chrysler and GM have hired 55,000. So is the loss of 279,000 jobs a success? The bailout cost $60 billion and I won’t calculate how much this is per job since it would not take into account suppliers and other ancillary factors. Nevertheless, the administration is also telling us that in the end the loss will be $16 billion. Actually the loss is more because the $16 billion does not include the $4 billion in Chrysler debt that was forgiven by the Treasury Department.
Now we have the definition of success: it is a loss 279,000 jobs and $20 billion. The president seems to have conveniently forgotten that he initially promised that the taxpayers would not lose a dime. What is disappointed is that the otherwise clear thinking Bob Coker (R-TN) seems to have bought into this curious definition of success. He told Investor’s Business Daily "The resurgence of the companies would not have occurred without the tough restructuring measures I laid out and the administration generally followed. Like most Americans, I am glad the companies are doing well ... and that taxpayers are being repaid." Apparently, Coker the politician has trumped Coker the business man on this issue. What Coker has also forgotten is that the GM IPO was $35 and now is $28. A price of $54 would mean no taxpayer loss and that seems like a pipe dream. But just like the Chrysler bailout of 1979, the essential question is whether the same results would have been achieved under normal bankruptcy proceedings without costing the US taxpayer billions of dollars. The answer can be found in the excellent piece by Professor Todd Zywicki (http://www.nationalaffairs.com/publications/detail/the-auto-bailout-and-the-rule-of-law) who finds little merit in the government bailout. Finally, if GM and Chrysler lost 279,000 jobs and $20 billion on their own and their CEOs had run around the country proclaiming success, the rest of us would have looked upon them as fools (unemployed fools).

Another bad idea: No surprise given the source

In May Barney Frank announced that he was introducing a bill to reform the Fed. After co-authoring one of the worse pieces of legislation in history (the Dodd-Frank Financial Reform Bill), Frank is now outdoing even himself. The new proposed legislation would strip the reserve bank presidents from the Fed's Open Market Committee. This committee has the responsibility for the conduct of monetary policy and is currently composed of the seven Fed governors, the president of the New York Fed and four of the other 11 reserve bank presidents who rotate on one year terms. Although at the FOMC meeting all reserve presidents attend, only five have a vote. Why Frank wants to get rid of the reserve bank presidents is anyone's guess. He states that he doesn't like it that they are not political appointees and are chosen by the directors of their reserve bank. The elimination of the presidents would make for bad policy. As I have written before, one of the problems with the Fed is that it is based in Washington and would make better policy if it were located somewhere else - say Kansas City. Historically, the reserve bank presidents have been a moderating voice on the FOMC. The problem with the Fed's policy making is the opposite of what Frank is trying to accomplish. Instead of getting rid of the presidents, all the presidents should have a vote. This would mean that the governors would no longer have a majority on the FOMC. The presidents have generally been a ballast, tempering the influences of Washington. To get rid of them would make for policy that is more political and less in the interests of the economy. Washington's influence is bad enough, leading this fed to monetize the national debt, to support out of control government spending, driving interest rates down, causing capital flows out of the country, depressing the value of the dollar, driving the monetary base through the roof and paving the way for inflationary recession. Only an idiot would think that we need more of this. And more of this would be precisely what we would get if Frank's bill became law. Perhaps the republicans are asleep at the wheel - no surprise there. But instead of simply opposing Frank's bill, let's hope that someone introduces a bill to expand the FOMC to include all the reserve bank presidents.

Medicare versus Mediscare

The recent discussions on Medicare remind me of the old saying that everyone wants to go to heaven but no one wants to die. In the case of Medicare everyone knows that the current structure is not sustainable. Current retirees will receive over $100,000 in benefits than they paid into the system. That difference grows each year. If left unchecked the federal budget by 2040 will go almost entirely to Medicare, Social Security and debt payments. Social Security is a simple problem that can be dealt with simply by gradually raising the age of full benefits. Note I did not say "the age of retirement" - a mistake made by almost everyone but me. You can retire anytime you wish. However, Social Security payments are made beginning at a certain age dictated by law. As to Medicare, there are currently two approaches. The Ryan approach is to address the issue now. The Administration approach is to criticize the Ryan plan without offering any other solution. What is interesting is that the press and the pundits also have their heads in the sand. They all are interpreting the recent democratic congressional victory in New York as a repudiation of Ryan. Nothing could be further from the truth. Polling indicated that voters understand the problems inherent in Medicare but also do not want the entitlement cut. Well the Ryan plan does not affect those 55 years old and older. So it does not cut their benefits. What it does is give a voucher to those under 55 when they reach the benefit stage. The voucher allows them to choose their medical provider and limits the budgetary drain of the current system. What is ironic is that Obamacare actually made Medicare worse off by taking $500 billion away. So the republicans should argue that they are addressing the budget problems, restoring the money taken away by the democrats and not taking away benefits. What is there not to like? Since they are not going to get help in the media that is not named Fox or talk radio, they need to hammer these points over and over. One day the message will get through. As I used to tell my students "the world is made up of three types of people: the 1 percent that makes things happen, the 4 percent that know whats happening and the 95 percent that haven't a clue as to whats happening." The challenge to the republicans is to move enough of that 95 percent who vote into the 4 percent category.