Watch out! There is Cap and Trade in Your Future

I am amused by the Exxon/Mobil commercial where we are told that the company uses new technology to drill efficiently and lowers costs to consumers. The commercial also goes on to state that we need energy from all sources. I am also amused by the coal commercial touting clean coal. I then tell the TV "It doesn't matter!" Whatever the oil companies and coal companies are doing does not matter to this administration. It doesn't matter that we have incredible stores of coal, natural gas, and oil that can give us plenty of cheap, clean energy. What is important to this administration is costly energy that is touted as being green (they conveniently forget about the biofuel mess).  This administration hates fossil fuels. The excuse they use is that fossil fuels generate CO2 which contributes to greenhouse gases which in turn create global warming. They conveniently ignore all of the mounting evidence that shows no relationship between greenhouse gases and global temperatures. Indeed, I read elsewhere where the author stated that there is a "growing consensus" among scientists that humans do not cause global warming (see http://mises.org/story/3421). This does not matter. For many, global warming is a religion and so no amount of evidence can change their minds (the true definition of faith). That global warming is now a religion is apparent when all the evidence starting mounting that we were actually going through a period of global cooling. Then the "greenie weenies" converted global warming to global climate change. Give me a break. Since Obama now runs GM, he will demonstrate that he is not interested in the company returning to profitability since GMs profitable cars are its SUVs and pickups - vehicles that the greenie weenies hate. Rather Obama will have GM produce teenie little hybrids and electric cars that look like prey to my F-350 pickup. Obama will then tax heavily fossil fuels, put a luxury tax on SUVs and nonfarm pickups and subsidize cars using alternative energy sources. It won't be pretty my friends when we see the travel trailer and boat industries tanking because they can no longer be towed. Itsn't it ironic that Obama touted his stimulus package in Elkhart, Indiana, the home of the RV industry when his cap and trade proposal will kill that industry? Speaking of cap and trade, would someone kindly explain to me why policies that have always failed are still being proposed. Cape and trade has been a disaster in Europe, raising unemployment, decreasing production while generating emissions above the levels in the United States! I cannot see any politician voting for it given its impact on energy prices, inflation, interest rates, unemployment, and industry dislocation. So I was stunned to see Henry Waxman and Ed Markey actually have written a cap and trade (648 page) bill. I bet it gets no co-authors from Kentucky, West Virginia, Ohio or Pennsylvania! Since it has no chance of passage, the EPA has taken up the mantle by declaring CO2 emissions hazardous. Pretty sneaky. That means we will get cap and trade and the politicians are given cover since they did not vote for it. For the rest of us, though and all Americans, it will mean a permanent lower standard of living. Lastly, the reasons the politicians love cap and trade is obvious. It is a huge tax increase (projected to be $650 b over 8 years). It also increases the politicians power because they can pick winners and losers. They tax the unfavored industries and subsidize the favored ones. Who cares what the market wants? Who cares what the people want? Its all about power.

How did I get this out of touch?

This morning looking at the news and then driving in listening to the radio I realized that I was completely ignorant of much that had been discussed. I did not recognize any of the the winners of the Country Music Awards. To be perfectly honest I never realize that any country music "artist" deserved any awards in the first place. I had never heard of any of the top 10 videos, the top ten best selling downloads, seen any of the top ten movies or heard any of the top ten cds or heard of any of their artists either. I didn't know what was a "twitter" or a "facebook". Yet later that morning I downloaded modern 5 cds from itunes and Amazon. Music is a passion of mine as is reading novels - mostly science fiction, military history and military fiction. Although I don't go to movies, I do purchase dvds to watch on long trips. When I take my annual bear hunting trip to Canada next month I will start to watch "Hill Street blues". I am also fond of film noire (The Grifters, Jackie Brown, Pulp Fiction, The Moderns, Choose Me and assorted Humphrey Bogart). So I like old stuff. But I do like new stuff too, its just the new stuff that is in the tradition of the old stuff like Branford Marsalis, the Clayton Brothers, Eliane Elias and Sean Jones. No hip hop. No rap. But no country either. Just music I understand and love. Does this mean I am old. Yes and no. When I was a teenager I listened to Monk, Miles, Mingus and Coltrane. My father thought it was just noise. Yet one of my fondest memories is that the year before he died he picked me up at the Atlanta airport and had Atlanta's only classical jazz station on the radio. They were playing Coltrane's Ballads when we pulled into the garage and we sat in the car listening until it finished. I also recalled playing John Lewis' Wonderful World of Jazz when my son was in middle school. He said "what is that"? I told him it was the first LP I had ever purchased and I bought it when I was his age. I said "do you think you will be listening to the same music when you are my age that you are listening to now"? His answer was "I hope not."

Independent No Longer?

When the Fed was created as an independent agency, the intent was to insulate it as much as possible from being a pawn of either the congress or the executive. Fed independence was assured because after being appointed by the president and confirmed by the senate, Fed governors cannot be fired - only impeached. Also the Fed is self financing and isn't dependent on budget appropriations. Lastly the Fed chairman's term does not coincide with the president's making a new president wait two years before a new fed chairman can be named. This independence has historically served the country well. The Fed has often taken policies that were opposite that of the congress and the president to ensure price stability in times of congressional largesse. Go back to your history books and read about the Treasury Accord during the Korean War for an example. However, Fed independence waivered when Alan Greenspan endorsed George Bush and the republican congress' spending spree that increased the federal budget by $1 trillion. To finance that surge in spending without increasing taxes, the Fed bought treasury bills through its open market desk. The result was persistently low interest rates which led to the housing boom and the rest is history.

The Bernanke Fed has followed Greenspan in its complicity with the congress and the executive spending spree only it has done one better. In addition to aggressively engaging in open market operations with the public, it has also bought treasurys directly from the Treasury, and purchased $2 trillion and counting in asset-backed securities. The question is why? Why is the Fed acting in concert with the president and congress? Isn't it curious that if borrowing and spending got us into this mess, that the Fed would endorse a policy of more borrowing and spending rather than fiscal restraint? The only answer I can come up with is that Bernanke wants to be reappointed to another four year term as chairman. If he exercises his independence, then Obama would likely appoint some else, like Larry Summers, who is one of the chief architects of this financial irresponsibility.

What makes Bernanke's actions so troubling is that the Fed, being independent, is also not accountable. It refuses to reveal who it has loaned to and what amount. Congress can change all this by changing the Federal Reserve Act. Maybe it is time to do just that. In that manner at least the public will be informed as to what its government is doing. Lastly, Bernanke's complicity, the incredible surge in bank reserves, the monetizing of the national debt have led me to conclude that it is time to take money creation out of the hands of the Fed. Do I hear "gold standard"?

Why I am no socialist

It has often been said that socialism fails everywhere but in the minds of academics and liberals. Oh contraire. In yesterday's lecture to my financial markets class on interest rates, I cited Sen. Durbin's bill to impose a national usury ceiling of 36 percent on consumer lending as a classic example of government interference into markets. I tell the students that if they know supply and demand and present value, then the course is easy. As an illustration of government imposed floors and ceilings, I asked how many favored minimum wage legislation. Disappointingly most raised their hands - and they are finance majors and seniors! I then drew a supply and demand curve for low wage labor with the minimum wage above equilibrium. Labor markets with wages above the minimum are not affected. However for the market affected, the impact is that at that wage, there are more laborers demanding employment than there are jobs resulting in unemployment. The empirical evidence bears this out and it is a well know fact that raising the minimum wage increases unemployment among those at that wage. Given the excess of workers, I then show the students that employers deciding among who to hire will make that decision based on the employer's tastes and preferences. Therefore, the government interference in the market causes the employer to engage in discrimination against workers. Likewise, if Durbin's 36 percent usury ceiling is enacted and is binding, supply and demand tells us that if it is binding, then there will be a greater quantity of loans demanded than lenders are willing to lend. Again, in deciding who to lend to, lenders will make that decision based on their tastes and preferences rather than letting the market allocate based on the price of the product. Once more, the lenders will engage in discrimination against borrowers. As I then said to the class, this is the result of socialism where markets are not allowed to function and allocate resources based on supply and demand. In socialism the allocation of resources is decided by the taste and preferences of the state and those who administer the programs for the state. Then looking at my students, I said that this is why I reject socialism because I would rather be discriminated against by the market than by you.

Welcome to the Third World

Correct me if I am wrong, but I thought that monetizing the national debt was confined to third world banana republics. In those countries, governments are hard pressed to sell their debt offerings because of either of the threat of default or because the value of the offerings is constantly being debased by inflation. Thus, in order to finance ever growing deficits, those governments resort to "printing money". They actually don't simply print money, rather they have their central bank purchase the securities directly from their treasury department. In this way, the central bank props up the government and allows it to keep spending. The inevitable result is inflation.

Well, the United States is now an official banana republic (I can hear the reggae playing in the background). The Fed announced that it is buying $300 billion in long term Treasurys, essentially monetizing the national debt by "printing  money". Not surprising, the instant result was a sharp decline in long term treasury yields and a likewise sharp decline in the value of the dollar. What prompted the Fed to embark on such a course? Was it the worry by the Chinese Premier Wen Jiabao about the integrity of all the billions of US debt that China holds? Was Mr. Wen intimating the reluctance of China to buy a large chunk of the $2 trillion that will have to be borrowed by the Treasury to finance TARP/"stimulus"? Or for that matter was it the realization of the Fed about the Treasury's ability to borrow to finance the $2 trillion period?  

The Fed's  essentially  increased the demand and caused the yields on 10 year Treasurys to plummet as prices on those bond prices rose. However, the lower yields meant lower returns on dollar denominated instruments leading to the largest single day decline in the dollar vis-a-vis the euro in history. The Fed has rightly been criticized for this "lets cheapen the dollar policy" during the Greenspan era but this policy of monetizing the debt goes even farther. Now its cheapen the dollar, make it even more less attractive to buy Treasurys and increase inflation to boot. I have written elsewhere that once upon a time the Fed was actually the guardian of the economy making inflation job 1. I recall textbooks writing about the Treasury Accord during the Korean War when the Congress wanted low interest rates to reduce the cost of fighting the War while the Fed insisting on raising interest rates to help fight the inflation that would result from the increased levels of government borrowing and spending. Oh for those good old days! In the past, Congress was a bunch of children and the Fed was the adult. Today, there are no more adults.

Why Do Democrats Hate Black Kids?

Pardon me for getting personal but this has been a distressful week. Barack Obama gave what I thought was a very brave speech before the Hispanic Chamber of Commerce. He broke ranks with the Democrats and the teachers' unions by advocating merit pay for teachers. Then the very next day, he signed a bill that contained a provision inserted by Dick Durbin (D-Ill) that eliminated school vouchers for children in the District of Columbia. I was appalled. How could he embrace merit pay and then condemn black kids to purgatory the same week? Please would someone tell me why Democrats hate black children?  When I was younger I argued that once blacks took over the cities, elected their own leaders and took over the boards of education, then the educational achievement levels of black kids would rise. I was wrong. The opposite happened. Black educational levels plummeted, drop out rates, soared, and illiteracy increased among black youth. What happened? Let us return to those days of yesteryear. When I grew up in urban Atlanta, society was so segregated that I never talked to a white person before I went to college at the University of Georgia. I was educated in all black schools with all black teachers. Back in those days, being a teacher was a very good job because educated blacks either had to work for the government or be self employed entrepreneurs. Teachers took pride in their work and I got a great education. How do I know it was great? Well when I went to the University of Georgia in September 1962, hardly any of my classmates had ever had a class with a black student. The University had said that in its history it had never discriminated against blacks, they had simply never gotten an application for any blacks who were qualified. Since we were there by court order, it naturally followed that except for the courts, we would have been rejected as well as being not qualified. So imagine the surprise of my classmates and my professors when the main challenge was to see if there were any students in any of my classes who were smarter than me. Sure there were a handful in my four years at Georgia who were as smart but I never met anyone I considered smarter. This changed when I went to Ohio State for graduate school. However, my great education was in spite of the all white Atlanta board of education. We got hand-me-down textbooks that were older editions that were discarded by the white schools. If we had lab equipment, it was out of date and old. Teachers provided supplies out of their own pockets. My parents were teachers and I know how much of their salaries they spent on supplies for their students. So I thought that once the blacks took over, we would still get a great education, only now we would have new books and new stuff for the labs. I also thought that we would have access to the public libraries rather than to the dinky branch that we were allowed to patronize. Boy was I wrong. Instead of getting an education in urban schools, its just enough to maintain order. It has been demonstrated again and again that vouchers work. Yet they are rejected by the democrats and the teachers' unions. The educational system clearly doesn't work. Urban black kids are not dumb. Any kid who knows the lyrics of some rap song after only two hearings could learn Tolstoy if there were a War and Peace rap. I have suggested in the past that we take the money currently being spent per student and contract education out to the Catholic church or to private schools. Black urban education is a national disgrace. Any black leader who ignores the problem is not a leader and should be dismissed out of hand - and this includes Barack Obama.

Are CRA, Clinton and Carter Really to Blame?

I am fed up with the conservative talk show hosts putting the blame of the current economic crisis on the Community Reinvestment Act. I’ve heard them say that the CRA was signed into law by Jimmy Carter and aggressively expanded under Bill Clinton forcing banks to make loans to people who could not afford them. Fannie Mae and Freddie Mac were also forced to buy these loans. Since people could not afford them, they defaulted causing the failure of Fannnie and Freddie and precipitating the crisis.

As my father used to tell me, “Harold, that sounds good if you are interested in sounds”. But what is the truth? The truth is that republican presidents rather than democrats were ultimately responsible. When I was Deputy Director of Economic Research at the Comptroller of the Currency, the Congress passed the Equal Credit Opportunity Act in 1974 and the Home Mortgage Disclosure Act in 1975. I was charged with determining if national banks (those who received their charter from the federal government) were guilty of discrimination and of redlining. Discrimination is the act of denying a person a loan based on a prohibited basis such as race. Redlining is the denying a loan to anyone regardless of race who is applying for a loan in a specific geographical area. My study (published in the American Economic Review, "Discrimination in Mortgage Lending," (with R. L. Schweitzer and L. Mandell), May 1978, v. 68, n. 2, pp. 186-192) showed weak statistical evidence of racial discrimination in the accept/reject decision but no evidence of redlining. These acts and our research at the OCC laid the foundation for other research on discrimination and to the passage of the CRA in 1977.

Although the CRA was signed into law by Jimmy Carter, two other important acts the Equal Credit Opportunity Act (ECOA) and the Home Mortgage Disclosure Act (HMDA) were signed by a republican, Gerald Ford. The talk show hosts also state that Bill Clinton was responsive for the expansion of CRA and forcing the banks to make bad loans. However, the two major changes in the CRA occurred in 1989 with the passage of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) and the Federal Housing Enterprises Financial Safety and Soundness Act of 1992. Both were signed into law by George H. W. Bush. Under FIRREA, the reporting requirements of CRA compliance were expanded. The latter act required Fannie Mae and Freddie Mac to support affordable housing by purchasing CRA-qualifying loans. Even though the talk show hosts have said that up to one half of Fannie and Freddie loans were CRA loans, the act suggests that by the year 2010, that one-third of their purchases be affordable housing loans.

If there were pressures to expand CRA lending, it came in part from the banks themselves. As a result of the Riegel-Neal Interstate Banking and Branching Act of 1994, signed into law by George W. Bush, CRA ratings became an important factor in determining if banks could merge or acquire across state lines. Because advocacy groups would use CRA ratings as a protest against the banks in order to get additional CRA lending, the banks greatly expanded these types of loans. I recall going to a Fed Atlanta conference on CRA lending, compliance and enforcement. A banker told me that the Feds never pressured him into making a bad loan. However, because they wanted to expand into other states, they had instituted a more liberal CRA lending policy.So the truth is that if there is blame to be handed out for a misguided CRA policy, it has to be laid at the feet of the republicans and the banks. Jimmy Carter and Bill Clinton are convenient whipping boys and are well deserving of other blame but CRA lending is not one of them.

As to the banks making loans to people who could not pay them back? We in Finance have a technical term for such lenders – it is a fool. This makes no sense at all. Some people will say that the bankers could make bad loans because they would be sold to Fannie Mae and Freddie Mac. Well most CRA mortgages and subprime mortgages were sold to private investors. If these loans defaulted within 90 days, then the purchasers would put them back to the originator, If they defaulted later and more bad loans were made by the originator, then the investors would either not buy them or would offer low prices on mortgage pools of the originator. Either way, the originator would lose and would quit making bad loans.

Lastly, there are too few subprime mortgage to have caused the financial crisis. At year end 2008, there were $1.3 trillion in subprime mortgages. The default rate on subprimes had increased from 8 percent to around 20 percent. If you assume 100 percent loss on the defaulted mortgages, then this totals $260 billion. Well in 2008 the total loss in mortgage backed securities was $435 billion. If subprime defaults were at fault, then there would have been no need for the $800 TARP package. So like Carter and Clinton, subprime is just a convenient whipping boy. As my readers know, I am a laissez-faire free market conservative. But that does not blind me to the truth.