Monday, December 29, 2008

A Bet You Won't Forget

I just sent the following to the Letters to the Editor section of the Wall Street Journal. I doubt the editors there have the fortitude, testicular or otherwise, to publish it so I post it here. I am quite serious about the wager. Yes, the national debt is a problem but the notion of the United States dissolving in the next few years I find ludicrous.

Igor Panarin thinks there is a 50 percent chance that the United States will dissolve in 2010 (Wall Street Journal, 29 December 2008, A1). In the spirit of the late Maryland University economist Julian Simon, I'd like to wager an ounce of gold (presumably Mr. Panarin is not daft enough to accept a dollar denominated bet) that the United States will substantially retain its current borders through 2010. Even money of course.

Depending on the odds offered, I might also like to make additional bets that Mr. Panarin's "Texas Republic" and "Central North American Republic" would annex Mexico and Canada, respectively, before falling under their sway.

Sunday, December 21, 2008

Why is the Federal Reserve contemplating issuing bonds?

When I first saw a little news squib that America's current central bank, the Federal Reserve, wanted Congress to grant it the power to issue bonds (long term IOUs), I thought it was a piece from The Onion, the hilarious king of print news satire. Had the story been real, I told myself, it would be plastered on every front page of every self-respecting business periodical in the country and CNN would soon have 15 to 20 talking heads babbling about what the news means for the nation and its teetering economy.

Well, it appears the story is real but hardly anyone noticed it or gave a thought to its implications. The Fed already issues debt, zero-interest debt, in the form of Federal Reserve notes. (You know, the money you used to carry around in your purse or wallet before the September crash.) It also issues deposits called bank reserves, on which it now pays a little interest but completely controls. It puts those liabilities or "sources of funds" to work on the asset side of its balance sheet, which includes interest-bearing Treasury bonds and loans to banks (and now non-banks too), gold, and some other physical assets. It's quite a lucrative business.

If the Fed wants to issue interest-bearing bonds, as the Treasury does, it must think that the demand for dollars (at 0% interest) is weakening or will weaken.* (Why issue debt at > 0% when you can issue at 0%?) But who would want dollars in the future if they don't even want dollars today? As Peter Schiff recently noted: "Perhaps the Fed feels this [paying interest] will make holding its notes more appealing. However, since the interest will be paid in more of its own script, I do not believe this con will work."

So what is going on? One possibility is that the Fed is preparing to issue bonds denominated in one or more foreign currencies. It can/will do so more quietly and privately than the Treasury can and will use its vaunted "independence" to hide the fact as long as possible. Or, perhaps, it will issue bonds that will be denominated in dollars but pay interest in a foreign currency or in gold or some other commodity. Or maybe the bonds will be collateralized by specific sets of its assets. The bonds it wants to issue, in other words, will have to be "sweetened" in some way in order to get people (firms, other nations' central banks) to hold them.

Another possibility is that this is just a ruse to keep the bailout from showing up in the national debt, which by convention includes only the Treasury's bonds. That was why the GSEs were spun off from the government in the late 1960s, btw, to get their debt off the Treasury's books. What I suggest is that we don't fall for the ruse and count any interest bearing bonds issued by any federal agency as part of the national debt.

Needless to say, we've been down this road before. Check out One Nation Under Debt for details.

Happy Holidays! It may be the last normal one for a long time.

*This is not as crazy as it sounds. During the Great Depression, Mexican pesos circulated in the border areas of the United States. Mexican pesos! See Amity Shlaes, The Forgotten Man, 138. Also, in the late 1970s the U.S. Treasury resorted to selling bonds, called Carter bonds, denominated in German marks. See this article for details.

Saturday, December 13, 2008

Save the Economy: End Prohibition

At the end of the First Great Depression (1929-1933), the U.S. federal government ended the so-called Noble Experiment, known by most today as Prohibition. It was a shrewd move. Banning the manufacture, sale, and transportation of alcohol did not end the consumption of alcohol in the United States, not by a long shot, but it did decrease the quality and increase the cost of what alcohol was consumed (after existing stocks were depleted). Worse, the policy was a boon to organized crime and wasted huge amounts of police resources. Ending Prohibition freed up human capital to engage in more productive pursuits and stimulated investment in legal alcohol production and distribution.

Here at the beginning of the Second Great Depression (2007-??) the government ought to end its long, expensive War on Drugs. We simply can't afford to continue the fight, no matter how noble some think it. Like prohibition of alcohol, prohibition of marijuana and other controlled substances has decreased their quality and increased their price without coming close to ending their consumption. Legalization would free up a non-trivial amount of police resources and stimulate investment in the production and distribution of hash, cocaine, and so forth. It might not be enough to save the economy, but at least we can get high safely and legally until it improves.

Thursday, December 11, 2008

Who is the bigger scammer, Extreme Acai Berry or Target National Bank?

The financial system continues to crumble and 4Q 08 GDP may plummet 6 to 8 percent and I have to deal with this bull-oney. My wife, God bless her (because I won't), fell for the Extreme Acai Berry scam. This website sells a trial sized package of acai berry pills for, like, $3.95. It has a little disclaimer that says if you don't cancel within the 14-day trial period it will automatically ship a slightly bigger bottle for $89 and some change. In even smaller type (at least on the day I looked at the site), it said that the trial period began immediately, not upon receipt of the product, which, in our case anyway, was 12 days after purchase! Customers who call the number to cancel are greeted with a message saying that they should call back due to high call volumes. So it is basically impossible to cancel even if you figure out that the "trial period" is not a "trial period" in any meaningful sense of the word.

For additional details, see these sites:

This is what really peeves me, though: the credit card issuer that my wife used to make the purchase, Target National Bank, will not credit us the $89 and is continuing to do business with the scammers! There is no way that the government can police all of cyberspace but it certainly can ensure that Visa, Mastercard, Discover, and other transaction service companies are punished if they co-operate with known scam artists. These companies should regulate themselves before the government does. As soon as people start calling in to complain about the scam, they need to alert the offending firms to make good. If they don't, they need to cut them off. Otherwise, the transaction service companies are enabling the scam artists. They are accomplices, if you will. Suing some fly-by-night isn't worth it but suing Target National Bank could be lucrative. Until it goes bankrupt that is. Any class action lawyers out there who want a piece of the action?

In the meantime, I cannot stand doing business with companies that don't even understand their own interest so I've severed our relationship with Target National Bank and urge everyone else with a target on their credit card to do likewise. You shouldn't be charging much in this environment anyway.

Sunday, November 30, 2008

The Housing Bubble and the American Revolution

The New York Times today (30 November 2008) ran a very nice piece (The Housing Bubble and the American Revolution, WK5) by Tim Arango about the book Ron Michener and I have been working on (Yale University Press, forthcoming) regarding New York's colonial money system and the financial crisis of the 1760s. It is nicely balanced, with obligatory retorts by Gordon Wood and Edward Countryman. Of course these folks have had nothing to say about One Nation Under Debt because it is unassailable. The next book will be even more formidable so I'm glad they got their shots in now, when it is cheap to do so.

Thursday, November 27, 2008

Irresponsible Reporting at CNN and the Wall Street Journal: Don't Believe Everything You See or Read

The financial crisis exposed Wall Street's weaknesses in visible and dramatic fashion. It has also exposed the weaknesses of the media, but in a way that is much more difficult for the public to discern. Members of the media sometimes report on their own industry's problems but more often they don't, largely because they are blind to them. (Btw, no cracks about professors being blind to the problems with higher education. I've written a book on the subject of how much we suck and hope one day to find a publisher with the testicular fortitude to publish it.) I've done quite a bit of media since Lehman Brothers and AIG bit it and what I've seen is enough to make me question the efficacy of the so-called fourth estate. Thank goodness for bloggers ... I mean real bloggers and not traditional media types with blogs.

Here is a case in point. On Tuesday past (25 November 2008), Wall Street Journal columnist Dennis K. Berman published a column called "One Cure for Financial Mistrust: Create New Banks." This is the type of piece that makes my blood boil as it is nothing more than an op-ed dressed up like news. The argument was that the government ought to put up $10 billion, solicit private subscriptions for another $50 billion or so, and start a new bank or banks because the old ones can't be "trusted" anymore. In support, Berman made some allusions to the first (1791-1811) and second (1816-1836) Bank of the United States but got some of the facts wrong. Worse, the piece was premised on the mistaken belief that the financial system is based on "trust." The biggest blunder was that Americans create scores of new banks, called de novo banks, every year and are in the process of creating more community banks as we eat the bird today. (Most community banks, by the way, have weathered the crisis beautifully.) Finally, while it would be an exaggeration to say that government money is retarded, it is safe to say that most people do not believe that government money is smart money, so government participation in an IPO would likely backfire.

Imagine my delight, therefore, when CNN's Situation Room contacted me to go on the show to discuss the piece. I demurred as I was at home grading but they begged and we compromised and I ran into Philly to tape the segment. I patiently explained that Andrew Jackson did not create the second Bank of the United States but rather killed it by not renewing its charter, that community banks stand ready to lend to people and businesses with good applications, that scores of new banks form in the U.S. every year, and that while the chartering process could be sped up and streamlined we do not want to let just anyone have a bank. I invoked Tony Soprano (The Sopranos boss) and Avon Barksdale (a drug kingpin on The Wire) on that one. And I also explained that government participation in an IPO would not necessarily be a buy signal to private investors. (In a developing country it would because of the expectation of graft but here that is less likely. In the early nation government participation in the Bank of the United States was a buy signal because the great Alexander Hamilton was behind the project.) Most importantly, I debunked the myth that the financial system runs on trust. Rather, it runs on collateral and contracts and, in some cases, a repeated prisoners' dilemma. After all that, after dragging me away from grading on their urgent behest to set the record straight, CNN didn't run the interview. Not one second of it according to the transcripts. In retrospect, they were looking for a yes man, for someone to say, oh gee Berman is so smart why didn't we think of that, duh!

After taping, I stayed in the city in order to do a live appearance later for Fox News. This, too, was disastrous. They plugged my book but they owed me that from an earlier appearance where they promised it but did not deliver. That one would have paid off big in terms of sales -- I was literally bombarded with requests for my presentation -- but it appears I got nary a sale from my very brief live appearance this week. The opportunity costs were enormous: forty minutes of makeup for like 2 minutes on the air and an abrupt cut off. And why? Because the host didn't like where I was going, which was to argue that at this point the Fed ought to be using Hamilton's nee Bagehot's rule and lending to everyone with sufficient collateral to put at a penalty rate. Once again, I suspect Fox thought I was going to say something different than I did. When I flummoxed them they cut away and didn't even say thanks. I should have known as this was the same outfit that claimed in a voice over that I called financiers "witch doctors." I never did that. Alchemists maybe, but never witch doctors. ;-)

The takeaway from all this is Americans need to read substanstive documents if they want to have a deep understanding of the current crisis. TV and the WSJ are not enough and in fact a case could be made that the pablum they shovel out in censored measured doses actually infantilizes the audience.

There are some exceptions, of course, like the article "The Housing Bubble and the American Revolution" in this Sunday's New York Times "Week in Review" section about the financial crisis of the 1760s. Of course even The Times got my name wrong, replacing my middle initial E with a W!

Tuesday, November 18, 2008

Another Modest Proposal

This is my first post in November because I've been very busy prepping my Money and Banking textbook for publication with Flat World Knowledge, among other things.

My brother, the state of Oregon and its Death with Dignity Act, and The Economist, however, have given me an idea for "Another Modest Proposal" that I feel compelled to share. The original modest proposal was a satire in which wit Jonathan Swift argued that the way to solve the world's problems was to eat Irish babies. This last week, The Economist had "a modest proposal" for the inhabitants of islands being swallowed by the ocean due to global warming. My brother suggested that, with the imminent demise of his 401K, his retirement plan will be a .357 magnum and a bullet.

See where I am going with this? Our personal and public finances would be greatly simplified if we knew when we were going to die, or rather had an upper bound on our death date. Instead of going out in agony, at the cost of millions, we should be able to choose our exit date well in advance and plan for it both financially and medically. (We should be able to "no code" ourselves starting x time before our respective exit dates. Why suffer heart surgery if we plan to die the next week, month, year, etc. anyway?) Social Security benefits would be based on two ages, age at retirement and age at planned death. If the exit date comes and the person wants to continue living, s/he can opt to do so, but will be "dead" to the state and will stop receiving S.S. and other entitlements and will also lose the right to vote. If s/he opts to die, there should be some better method available than a bullet or one of those suicide booths from Futurama.

Friday, October 31, 2008

Book Review: Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve by William A. Fleckenstein with Frederick Sheehan

Book Review: Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve by William A. Fleckenstein with Frederick Sheehan. McGraw Hill ● 2008 ● 194 pages ● $21.95

Have you lost your job, house, or retirement nest egg? Does your Social Security check buy less than you thought it would? Do the economic stresses currently pervading the atmosphere give you insomnia, impotence, and alopecia? According to money manager and investment columnist William Fleckenstein (“with,” whatever that means, Frederick Sheehan), the nation’s financial woes are due to the bumblings of Alan Greenspan, the slow-witted former chairman of the Federal Reserve. Greenspan, they claim, single-handedly caused the tech bubble of the late 1990s and the current subprime mortgage debacle. The dimwit did so by forcing interest rates too low for too long because he believed too fervently in the productivity advances of the so-called “new economy,” particularly the revolution in cheap networked computing. “Easy Al” also signaled Wall Street firms that they should go hog wild because the infamous “Greenspan put” would save them if they stumbled. Fannie Mae, Freddie Mac, Bear Stearns, Lehman Brothers, Merrill Lynch, and others were happy to oblige, running up huge profits before going quietly into that dark night, sticking the American taxpayer with their “final expenses.”

There is an element of truth to all this. The real world in real time is a confusing and complex place and the data and models available to central bankers are limited, lagged, and often deeply flawed, so nobody should expect perfection. Stabilizing financial markets to prevent decreases in output and employment comes at the dear cost of increasing moral hazard and risk-taking. Greenspan exaggerated the risks of a Y2K meltdown and failed to detect, much less stop, the irrationality at the heart of the dotcom and housing bubbles. As one would expect, his recently published memoirs are skewed in his favor.

Fleckenstein and Sheehan’s book is perhaps even more skewed, however, though of course in the opposite direction. Much exaggeration and sensationalism pervade the book, which contains nothing that anyone familiar with Fleckenstein’s columns, which are quoted as some length in the book, will be surprised by. The tone throughout is such that neutral observers will suspect that personal animus was a major motivation for the book’s creation. The authors claim that “the evidence speaks for itself” (p. 187), yet they felt compelled to interject editorially, often several times, in every Greenspan passage they quote. In addition to being distracting, the intrusions sometimes display the authors’ rush to judgment. For example, when Greenspan says “we are getting increasing evidence that we are probably expensing items that really should be capitalized,” they interject “That is, they should be treated as an asset, not as an expense [p. 34, their emphasis].” In fact, Greenspan was arguing for a change in accounting standards (depreciating software like a capital expenditure) rather than restructuring balance sheets. In another embarrassing editorial insertion, the authors reveal their ignorance of the nature and importance of network externalities (p. 97). Elsewhere, they quote Greenspan out of context to make it appear that “he was flying by the seat of his pants” (p. 109), as if their book were a segment on some late night fake news program. Greenspan was certainly imperfect but he was far from the feckless moron they portray.

Greenspan’s Bubbles is simply too thin to adequately address twenty years of U.S. monetary history. (I read it cover to cover on the Acela between New Haven and Philadelphia.) The endnotes are few (only 21) and of little help to readers interested in substantiating the book’s most important claims, which is ironic given that the authors chastise Greenspan on the same grounds (p. 136). Bold assertions appear to be based on nothing more than FOMC transcripts, not interviews, beige books, or any number of other potentially illuminating source materials. The authors rightly point out that financial history is too often neglected but then ignore it themselves, save for short and hackneyed allusions to the Tulip Mania and the South Sea Bubble. They know that interest rates are important to their story but fail to make the critical distinction between nominal and real (inflation-adjusted) rates. To make the most recent housing bubble appear of unprecedented proportions, they display a graph of nominal median U.S. house prices since 1972 (p. 172) instead of showing the percentage increases (or graphing the data on a log scale).
The book’s biggest flaw, though, is its failure to come to grips with the Fed’s power, or rather lack of it. Throughout, Fleckenstein and Sheehan argue that Greenspan could have controlled the financial system and indeed the entire economy if only he had possessed the prescience to, a claim that Greenspan himself repeatedly rejected. Fed chairmen, I submit, are more akin to a cowboy trying to stay atop a raging bull than a rider on a steeplechase horse. Markets, especially modern financial markets, are powerful forces. Central bankers can certainly influence them but they cannot control them in any significant way for long. Instead of blaming Greenspan for the nation’s economic ills, we might instead view him as yet another failed central planner. Despite the book’s subtitle, the Fed’s pre-Greenspan record is far from admirable. It performed poorly, especially in the 1930s and the 1970s, though not as badly as Soviet and Chinese planners sometimes did. What America needs is to reevaluate its fiscal, monetary, and regulatory systems and more generally to reexamine the ways in which government interacts with the economy. What it does not need are more diatribes.*

Robert E. Wright is Clinical Associate Professor of Economics at New York University’s Stern School of Business and the author of 10 books on financial and economic history, including most recently One Nation Under Debt: Hamilton, Jefferson, and the History of What We Owe (2008).

*For an excellent study of U.S. monetary history and policy, see Robert L. Hetzel, The Monetary Policy of the Federal Reserve: A History (New York: Cambridge, 2008). It's a tough slog, but this is serious stuff that demands serious treatment.

Sunday, October 26, 2008

Yoda on the Subprime Mortgage Crisis

For too long interest rates too low, the Federal Reserve did keep.

In myriad ways, home ownership the government did encourage.

Sign up everyone and anyone for a mortgage, originators had incentives to.

Their heads up their butts regulators had. Hmmmmmm.

Ever higher, housing prices rose.

To buy people began, with borrowed money, to sell again only. Herh herh herh.

To go up forever seemingly everyone expected housing prices.

But to be it was not. Herh herh herh.

Prices plummeted, with negative equity burdening over-leveraged borrowers. Hmmmmmm.

Reigned supreme the dark side did.

Defaults soared and banks teetered as billions of federation credits vanished.

With Hope for Homeowners the government responded, and with TARP, direct bailouts, contrived mergers, and a doubling of the Fed's balance sheet. Yeesssssss.

But the stock market still tanked and credit spreads remained wider than the Millennium Falcon, they did.

Bring what the future will, I know not. Hmmmmmm.

Jedi, I am, not a fortune teller.

Created with the aid of Learn to Talk Like Yoda.

Coming soon, a Battlestar Galactica version.

Never coming, a Klingon version.

Why we laugh at misfortune.

Friday, October 24, 2008

Declare Shenanigans!

My brother has a bailout plan too. He thinks we should declare shenanigans. Those of you who don't know what this means can click here and get schooled. If you want a more technical definition, click here.

How would one declare shenanigans against the financial crisis? Start by telling the government to stop distorting just about every major economic decision we make, from saving for retirement to buying a house to safeguarding our income, physical assets, and health. Then tell entrenched managers that they are no longer going to be able to run publicly traded corporations for their own enrichment. Then start the game over from scratch and for goodness sake stay vigilant this time. Check out public policy blogs instead of surfing for eye candy. Ask questions instead of FLAMING. But most importantly, read my books (and those of similar scholars) instead of wasting time watching TV!


The Economist and the Wright Rescue Plan

The Economist this week (25 October 2008) claimed that the U.S. national debt is at 38% of GDP (page 40, column 2). I'm still scratching my head over that one. Apparently it thinks U.S. GDP is like $30 trillion or the national debt is only about $5 trillion. No wonder it won't review my book. (It also unfairly ripped Abington, Pa. a few weeks ago.)

More importantly, The Economist also reported (p. 92) that "a growing number of economists, and now the Bush administration, believe that the credit crunch also has to be addressed at its source -- in America's housing market, where prices have fallen almost one-fifth from their preak, and foreclosures have soared." Perhaps there is still hope for the Wright Rescue Plan! Unfortunately, the magazine again ignores my work, though it mentioned plans by Feldstein, Zingales, Hubbard, and Mayer. It recommends Zingales' plan, which entails forced loan renegotations, but notes, correctly, that such a policy could "well lead to a higher cost of credit in the future." No kidding! No other scheme that I have yet seen has hit upon the key insight of the Wright Rescue Plan, that if lenders can mortgage foreclosed property mortgage backed securities can be priced and balance sheet uncertainty will end. And that will be the beginning of the end of the crisis.

Wednesday, October 22, 2008

Mortgage difficulties in 1830: Henry Van Der Lyn as Nostradamus

Reading through part of the Diary of Henry Van Der Lyn (New York Historical Society, Vol. 1, pps. 245-46) today, I was struck by the following entry, dated 1830. It isn't written in quatrains but it does reinforce Mark Twain's notion that history, if it doesn't repeat, at least rhymes:

There was a company chartered Last winter by the Legislature in N.Y. called the Trust Co[mpan]y which is now lending money all over the state, where ever they have applicants, at 7 percent on Bond & Mortgage. They have the lands of each applicant appraised & lend him 1/2 of the appraised value for a term of years. Interest payable every six months. This is a dangerous business both for the Company & the Applicants. Many persons will take larger sums of money than they otherwise would, merely because it [is] as easy to get a large as a small sum and will thus encumber their property by a claim they never can meet, when it is called for & will be disabled by the every encumbrance to obtain any new credit. They will thus live with[ou]t hope and their mortgaged farms will soon show all the ruin & waste attendant as an occupant who has no interest in keeping up the constant repairs necessary to maintain a farm in good condition. Others will endeavor to Mortgage their farms for all the money they can get & never intend to repay the money, making use of this scheme of borrowing in order to sell their farms to the company. Thus in the end a Number of farms will fall into the hands of the Co[mpan]y which they will not be able to rent for any cash rent, and which they will not be able to sell for 1/2 of the money they advanced. At this moment a great deal of money is (I may say a very unusual quantity) is loaned by the Banks at Utica & by this Trust Co[mpan]y on apparently very easy terms, but the time for repayment will soon come & a reaction on the very Banks, who are now so profuse is at hand, when many borrowers will be cramped & be ruined & property will have to change hands; and a general depression, confusion & scarcity of money, will inevitably follow. In short, the Co[mpan]y at N.Y. should not lend their money on the security of farms in the Country: & Persons here, should never, without the most despearate necessity encumber their farms by a Mortgage as they thereby at once lose their independence, their spirits & their Ambition.

Monday, October 13, 2008

Interest in the debt rises (on the debt too)

As the financial crisis drags on, people are beginning to pay attention to the national debt again. It has soared over $10 trillion, sparking a slew of stories about the national debt clock in New York City running out of digits. Soon, scientific notation may be necessary to express what we owe.

The silver lining is that the federal government is borrowing money very cheaply right now because investors see it as the safest thing going. The trouble is that it is all of short duration and will need to be refinanced in a few years, perhaps at much higher rates if we begin to feel the sting of inflation.

One Nation Under Debt has benefited a little from this resurgence of interest but let's face it, the book has not really received its just due yet in terms of reviews. I just found more evidence of the book's main thesis, that the non-predatory nature of the U.S. government after the ratification of the Constitution was the main reason for the country's economic success, which of course was a necessary precondition to debt repayment. The evidence bolsters the book's main counterfactual, the relative poverty of Canada, which labored under arbitrary, authoritarian rule until well into the 19th century. Its economy suffered accordingly as the following passage shows.

At the other side of the [St. Lawrence] river, which is here about two miles in breadth, we saw a rising village, called, I think, Ogdensburgh. I asked my host whether they held any intercourse with the yonder town? 'Yes,' said he, 'we smuggle across all their commodities, notwithstanding the extreme rigor of the revenue laws.' What, continued I, could they possess that you possess not; is not your climate as good, soil as fertile, and your skill in agriculture equal, if not superior to theirs? 'All that is true,' replied the loyal Scotchman, 'but the governments are not alike.' Then he began in the Highlands squawking, drawling tone, a long history of 'the enormous duties on tea, the total absence of internal improvements &c. in the Canadas.' -- Jeremiah O'Callaghan, Usury, Funds, and Banks (Burlington, Vt.: For the Author, 1834), 20.

Thursday, October 09, 2008

Government Ownership of Banks

I see that the federal government is now considering taking equity positions in banks.

This is not as crazy or unprecedented as it may sound.

The federal government owned shares in both the first Bank of the United States (1791-1811) and the second Bank of the United States (1816-1836). There is a nice article about this in the William and Mary Quarterly by Carl Lane.

Early state governments owned considerable amounts of state bank stock, some of which it purchased and some of which it received as a sort of tax or quid pro quo for granting an act of incorporation.

The benefit of stock ownership was that it provided the government with a nice revenue stream.

The cost of stock ownership was the conflict of interest it created. Pennsylvania and New York, for example, were stingy with new bank charters because they did not want to hurt the value of their stock portfolio or decrease their dividends by allowing competitors to enter. That, of course, hurt both depositors and borrowers.

By the 1830s/40s, national and state governments began to divest their bank and other corporate stocks because of such conflicts of interest.

On net, therefore, I think it would be better simply to adopt my plan (see below), or similar ones recently proffered by Glenn Hubbard, Robert Shiller, or Martin Feldstein. (McCain's plan is too vague to evaluate but note its similarities to mine.)

Another thing we might think of doing is walling off safe institutions -- those with minimal exposure to derivatives -- behind very strong government guarantees and letting the rest crash and burn. The billions could then be spent on unemployment and re-education benefits and we could end this nasty moral hazard problem once and for all.

Wednesday, October 01, 2008

The Wright Rescue Plan

Last Friday (see below), I posted some ideas about how to rescue the economy from recession. I alerted numerous individuals about the plan by email and also sought media attention for it, thus far to no avail (that I know of, anyway). During the course of email and blog comment discussions, it became clear to me that some readers had not grasped the plan's most important features. In this post, I will be more specific.

The heart of the plan is to give homeowners (including financial institutions that come to own homes via foreclosure) the option of refinancing with the Federal government at 7 percent for up to 50 years. The 7 percent will ensure that most Americans will not opt for the Federal refinance (re-fi) because most already have mortgages at a lower APR. The 50 years is to help lower the monthly payments of homeowners who got in over their heads.

The government will pay off the existing principal balance on the mortgage with Treasury bonds. Right now, the government can borrow at low yields. It is the only large economic agent at present that can with great certainty generate a positive spread between its assets (7% mortgages) and its liabilities (2-3% Treasury bonds).

The plan should provide immediate relief to the financial sector because it will effectively remove uncertainty about the value of mortgage-backed securities (and hence credit default swaps, etc.). Either:
a) borrowers will continue to pay their existing mortgages
b) borrowers will re-fi with the Federal government, thus removing the risk of their default from the financial system
c) borrowers will default, in which case the lenders can re-fi, which will replace the "toxic" asset on their balance sheet with a safe and liquid one (Treasuries).

With the uncertainty gone, the credit markets can again function and mortgage backed securities will rise in value and will begin trading again, ending the cycle of write downs that has caused the recent bankruptcies.

The Wright Rescue Plan is also much more politically astute than the administration plan because it offers aid to homeowners first. While the total amount of aid needed cannot be known with certainty, the plan is clearly not a "bailout" because the government will almost certainly profit from it (at least at today's gross spreads). The sums already appropriated to the Hope for Homeowners program may very well suffice. Finally, and I can not stress this point enough, the plan could be implemented without creating a new federal bureaucracy. The Treasury and IRS already know how much people earn, whether they have existing mortgages, and so forth. They also have the power to garner wages and track people across state lines, so defaults on the re-fi's should be low. If the government comes to own some homes through default, it alone can afford to hold them until the market turns or to re-purpose them. As noted in various posts below, governments have successfully run mortgage programs in the past.

The Philadelphia Fed's Money in Motion Exhibit and the Subprime Mortgage Crisis

Thanks to the Jewish holiday, I had the opportunity to take 5 children, including 3 of my own (yes, Alexander Hamilton Was Wright too) to spend the day in Philly. After the obligatory Duck tour, we checked out the Philly Fed's Money in Motion Exhibit. As a guest museum curator myself (for the Museum of American Finance), I appreciated the exhibits in a new way and the kids had a blast. (I suspect they think, wrongly of course, that they can reassemble the shredded money the Philly Fed hands out upon each visitor's exit. Hey, what else are you going to do with the stuff?)

The exhibit "Supervision Mission" was particularly fascinating and provides unintended insights on the subprime mortgage crisis. The exhibit is a computerized game where the visitor starts off as a trainee. After mastering a basic multiple choice test, the trainee becomes a loan officer who has to make decisions about whether or not to lend to various fictional applicants. It was great fun for the kids and even for me, until I started to get the "wrong" answers, invariably because I turned down loans that my electronic boss thought were "good business for the bank." One applicant wanted a $1 million loan on terms that would have had her repaying some $50,000 per month on expected income of like $20,000 per month. She had other collateral of $2 million but the collateral was not income earning. I turned the sucker down only to be chastised for it!

I managed to get promoted (I think everyone does, eventually) to the final level, investment manager. Here, again, my decisions (60% domestic loans, 15% foreign, 15% Treasuries, 10% cash) were chastised as too conservative. Apparently, they wanted primary reserves of less than 5 and secondary of less than 10.

If this is the sort of supervision the Fed gives its banks I have only two words to say:
No wonder!

Cause of, and Cure for, Hard Times (New York: 1818)

I'm writing a variety of things right now, including a book called Fubarnomics and a book chapter on corporate capitalism. To help with both, I pulled an old pamphlet out of my collection -- Cause of, and Cure for, Hard Times (New York: 1818) -- and was struck by the similarities with our financial struggles today. I received a photocopy of the pamphlet the hard way, via ILL, about a dozen years ago but if readers are interested it is on Google books and also available for purchase in a 2008 edition on Amazon.

Friday, September 26, 2008

A Simpler Plan

I missed a chance to be on CNN again (gosh darn it!) in order to do an hour long show on NPR Oregon with economist Brad DeLong. The show got me thinking about a simpler way to fix the current problem than doing reverse auctions of toxic assets. Simpler economically and politically.

Here it is:

Any American with a mortgage can trade it in for a government one for the same principal amount, at a fixed 7 percent interest per annum, for any term up to 50 years. In return, the government will pay off the existing mortgage with a Treasury bond with the same market value and maturity as the mortgage it is replacing. The lender can then hold the bond on its balance sheet until maturity, sell it in the market, use it as collateral for a loan, strip and sell the coupons, etc.

Because the government can at present borrow at far less than 7 percent, and because it can easily garnish wages using existing (tax) infrastructure, this will not be a bailout but rather a source of revenue which can be applied to pay down the national debt. (See my blog entry below about the colonial loan offices, which prove that governments can and have profited by providing mortgages to citizens.) The two keys are extending the term of the mortgage to the point that homeowners can afford to make the payment and making sure that borrowers don't default simply because they are "in the bucket" (have negative equity) by using the coercive power of the state. Anyone who prefers to default rather than take the government loan may do so, at which point the lienholders (new owners) may, if they wish, mortgage the property to the government for the amount they are owed. (Or they can resell or rent it, as they prefer.)

The plan is also much more palatable politically than the current administration plan, for several reasons:

a) as noted above, it is not a bailout, but rather the entry of a new lending competitor that can win borrowers away from current mortgage lenders due to its long time horizon and low cost of funds. This is a major point because NOBODY wants a bailout if one can be avoided;
b) it does not require the creation of a new government bureaucracy (like the Homeowners Loan Corporation of the Great Depression) because existing agencies and workers can handle the minimal work involved, so fiscal responsibility types (who I admire) can support it without hypocrisy;
c) helping financial services firms by eliminating their root problem (defaulted mortgages) is much more popular than directly bailing out "Wall Street fat cats," which is especially important in an election year;
d) since any American with a mortgage automatically qualifies, this proposal does not directely discriminate against fiscally careful Americans nor does it unduly reward the fiscally profligate.

Of course most of those who will take the government mortgages will be subprime borrowers paying greater than 7%, those who got caught with teaser rates, ARMs, etc., and those about to be foreclosed upon.

This is a half hour's work, so I reserve the right to modify details if I have erred conceptually.

Finally, if done just right this is an example of a Pareto improving policy, a concept I urged politicians earlier this month to consider more carefully before going for the partisan jugular.

Your Humble and Obedient Servant ...

Tuesday, September 23, 2008

I received this email several times today ...

and I think it might be spam:









An Easy Analogy

I first used a version of this analogy in Richmond on CBS 6's "Virginia This Morning," on 4 September 2008. It seemed to work well and some people seem flummoxed by the recent market disturbances so I thought I'd share it here.

The national debt is like a guy sitting in a boat called The Economy. When the national debt is small, the guy is skinny and there is plenty of distance between the boat and the waterline. If a wave (a crisis or shock) comes along, the boat may rock but it will stay afloat.

When the national debt is big, by contrast, picture a big dude -- South Park's Eric Cartman in the Kathy Lee Gifford episode, Marlon Brando near the end, or Jared before he found Subway sandwiches. Barely afloat on calm seas, the first big wave that comes along may swamp the poor little boat.

Now, because the boat is an analogy for the economy, we have to allow it to change size. Until recently, the boat was growing, albeit more slowly than the guy (debt). That gave advocates of the debt (of which there are too many, imho) reason for hope. But consider this: the boat has stopped growing and may actually shrink and at precisely the same time the guy is scarfing greasy donuts and washing them down with beer, and not even the light stuff.

Add on top of this the fact that a big wave may come along, perhaps a manmade one at that, and you can see why everyone is spooked.

Monday, September 22, 2008

Political Risk

In addition to the potential random and kick-em-when-they're-down shocks I discussed in yesterday's post, we also face tremendous political risk. 2008 is starting to look eerily similar to 1932 -- an unpopular Republican president in office, a pending election, and a financial crisis that won't go away. The threat before the election is that both parties will try to use the crisis to score political points. The threat after it, especially if the Democratic candidate wins as in 1932, is that the Republicans will sit on their hands while the minds of market participants race wondering what the incoming administration will do.

The good news is that the new president will be inaugurated in late January instead of early March. The bad news is that the world moves much faster now so late January is still a very long way away indeed. In early 1933, the payments system actually broke down just before FDR took office. You can't imagine what chaos that would cause today ... credit cards would stop working, ATMs would run dry, and Americans would learn the dirty little secret that their bank deposits are not convertible into Federal Reserve Notes on demand. Banks will exchange deposits for cash when it's convenient but they don't have to do it and in fact holding nothing close to enough vault cash to meet even a modest run. Let's hope it doesn't come to this but it would behoove policymakers to consider the possibility. We don't need a financial Katrina.

Sunday, September 21, 2008

The Next Great Crisis

We're entering a dangerous period indeed. The government is currently planting the seeds of the next crisis. As I argued in One Nation Under Debt, we should never have allowed the debt to grow so large (2/3rds of GDP) in what was essentially peacetime. If the bailout doesn't go well and if the economy remains soft (and hence government receipts low), we could be looking at a national debt to GDP ratio of 100%. We could probably survive that, if nothing else bad happens. But guess what? The mere fact that we are down greatly increases the likelihood of getting whacked by additional negative shocks.

The probability of a natural catastrophe has not increased but our ability to respond effectively to one is impaired due to the difficulties at AIG (a major insurer) and in the capital markets more generally. At least two major recessions were exacerbated by natural catastrophes. The explosion of Mount Tambora in 1815 led to the "year without a summer" in 1816, disrupting agricultural markets in North America and Eurpe that culminated in the Panic of 1818/19. The Great San Francisco earthquake (1906) has been implicated in the Panic of 1907 because it created a massive flow of gold from British insurers to the West Coast, which induced the Bank of England to raise interest rates, which, in turn, burst an asset bubble.

Of course we don't know when or where the next major hurricane, earthquake, or volcanic eruption will occur. Nobody (I hope!) can cause one, and nobody can stop one, so such a shock will be random, dumb luck. Maybe one will hit us, maybe one won't. Such is not the case for manmade catastrophes. Terrorists must be salivating at the thought of hitting us hard while we are down. Hackers are undoubtedly gearing up to make attacks on technical network infrastructure that might fall into disarray during bankruptcies, quick forced mergers, and the like. And nation state enemies like North Korea and Russia are already beginning to behave badly. Another big shock might be all she wrote for the U.S. dollar.

I'm not being alarmist here, or if I am so is the Wall Street Journal which ran a short article yesterday (Septembe 20, 2008, B16) called "Stocks Gain -- So Does the National Debt." The article notes that the dollar could go either way at this point because "currency markets might see the fiscal cost [of the bailout] as a good trade-off against the bigger risk of letting the U.S. slip into a deep recession." That's right. But, as noted above, if the bailout does not go well, the national debt swells further, and we get whacked with another shock, the dollar could plummet again, to the point where the U.S. government may have to borrow in euro, sterling, yen, etc. At that point, we have to suffer very high interest rates and borrow only domestically or revert to emerging market status and borrow in other currencies, with all the attendant default risks.

Alexander Hamilton Was Wright

Yes, the Wall Street Journal correctly reported yesterday (September 20, A3 "Government Bailouts: A U.S. Tradition Dating to Hamilton") that I named one of my sons Alexander Hamilton Was Wright. I just couldn't resist the play on my last name, which sounds like "right" (correct) but actually means "maker" (as in wheelwright, cartwright, etc.) . So, yes, Hamilton was both correct and one of America's makers. For details, see Financial Founding Fathers (with David J. Cowen), The First Wall Street, and, of course, One Nation Under Debt. (Hamilton Unbound, by contrast, is actually a Hamiltonian interpretation of early U.S. history rather than a biography. It's a pun too.)

Saturday, August 30, 2008

Fannie, Freddie, the National Debt, and the Federal Loan Office (FLO)

In an article entitled "Fire the bazooka," The Economist, that unbelievably witty British weekly news mag, says it is "time to nationalise [i.e., nationalize] America's mortgage giants," namely Fannie Mae and Freddie Mac. The mag realizes that a government takeover would "technically add huge liabilities to the government's balance sheet" but quickly notes that "these would be offset by mortgage assets that are almost as large." What it doesn't say is that nobody wants those assets and that is why ole Freddie and Fannie are in such a pickle in the first place.

It IS possible for a government to run a mortgage office successfully. Before the American Revolution, several colonies, most notably Pennsylvania, sponsored "loan offices" or "land banks" that lent what were then large sums for long periods on the collateral of improved land and other hard assets. The loan offices were far from perfect. They usually lent for less than the going market rate so the quantity of mortgages demanded exceeded the quantity the government was willing to supply. In some places, like Massachusetts, some nasty political non-price rationing closed the gap. (Read corruption.) Also, if times were tough the government did not foreclose as vigorously as private lenders did. But maybe that was a virtue and that interest on the loans made other forms of taxation almost completely unnecessary in colonial Pennsylvania certainly was a good thing!

The Fed has always lent to member banks. Recently, in response to the subprime mess, it began lending to other types of financial institutions as well, in the name of financial system stability. The message it has sent is loud and clear and consistent with earlier pronouncements: get as big and risky as you want because we have your back. And so Fannie, Freddie, Indy, Bear, and many others did, and we and our kids are going to be asked to pay for it. Some people consider this arrangement unfair and it is difficult to argue with them.

Perhaps what we need is a Federal Loan Office (FLO) that will make mortgage loans to any bona fide American citizen for any 1 to 4 unit residential building that s/he can afford. (The IRS can help out with that one.)* The government's cost of funds is zero so it can set the interest rate where it pleases, higher to slow the economy down and lower to speed it up. The Fed would still control monetary policy, sterilizing mortgage flows with open market purchases or sales of Treasury bonds when necessary. All interest payments would be credited to the Treasury and the mortgage interest tax deduction would be eliminated. Like the Fed, the FLO would be a quasi-independent government "profit center" rather than an additional burden on the federal budget.

It could also be used to provide effective fiscal stimulus. Instead of sending out stimulus checks 6 times too small and 6 months too late, the government could use the mortgage loans to stimulate the economy quickly by telling borrowers, to wit most American families, that they need pay only half or some other fraction of their usual payments for the next x months. It could even pass a moratorium on all payments to combat particularly large shocks, postpone payments in disaster areas, and so forth. We'll have to think carefully, however, about how to spot and stop potential political abuses of these powers and there will be some tricky issues during the transition period.

*Mortgage loans should have two bases, the value of the mortgaged property and the borrower's income. The IRS knows Americans' income history better than anyone; perhaps people will think twice about cheating on their taxes if it affects their ability to obtain a mortgage. Assessments should be done by at least three randomly chosen local assessors.

Thursday, August 14, 2008

Fixing healthcare with pay for performance

Even if our national government somehow gets its fiscal act together and pays the funded national debt down, or at least slows its rate of increase below that of real economic growth, the American people will still face two other daunting financial problems, Social Security and healthcare entitlements. I'll tackle S.S. in a future post and concentrate on healthcare in today's installment.

The debate over healthcare tends to revolve around insurance. I think that emphasis is misplaced. Insurance is an issue only because healthcare has become so expensive. In the 19th and early 20th centuries, people wanted reimbursement for lost wages due to illness, not for healthcare costs. That changed as the cost of doctor visits, surgery, hospitalization, and medication soared faster than inflation year after year in the last three quarters of the 20th century.

But the real problem is not simply the cost of healthcare, it is the value proposition. People would happily pay high prices for medical treatment if they actually worked to alleviate suffering, stop further damage, and so forth. Modern medicine does some things very well and the doctors, nurses, and other specialists who provide those services ought to be well compensated for them.

Unfortunately, however, modern medicine is far from flawless. Many diseases and disorders continue to flummox it. My parents, brother, and wife, as well as several colleagues, suffer from chronic medical problems that doctors can't, or won't, fix. Here is where the value proposition comes in. Why do we pay doctors (etc.) even when they don't make us better? Would we pay an auto mechanic who looked at our car, maybe changed out a part, but didn't fix the rattle? Would an accountant expect payment for just looking at your taxes? Why should we pay our doctors just for seeing us?

I recently suffered from a viral infection in my throat that led to acute pharyngitis. I couldn't even swallow my own spit. The ER staff got the swelling down but sent me home without trying to ascertain the cause. Unsurprisingly, I ended up going back to the ER two days later. This time the docs did not even alleviate my pain, sending me home with a concoction I suspect was a placebo. Whatever it was, it didn't work. A week later, I recovered thanks to my own immune system but the ENT insisted that I pay him an office visit anyway. He actually had the nerve to request that I come back 2 weeks later, even though he admitted he could do nothing to help me or to prevent another bout of this nasty ailment. All told, I shelled out almost $200 in co-pays for this "treatment." Lord knows how much my insurer will pay, and all for nothing.

If the government said patients only had to pay when doctors actually helped them our national healthcare bill would be slashed, perhaps by as much as half. That would go a long way toward alleviating the entitlement burden and decreasing health insurance premiums. Some smart egg would have to create a system that would minimize abuse (doctors claiming to do more than they did; patients claiming that they were not helped when in fact they were); entry into the healthcare professions would have to be opened to more people (which in and of itself would be ameliorative); our tort/medmal system would need to be revamped (it needs it anyway).

Imagine, though, how differently doctors would behave if they only got paid based on proven results. Unnecessary office visits and long waits would vanish, doctors would specialize around symptoms/diseases rather than body systems, and referrals to doctors better equipped to handle particular problems would come more rapidly. As long as the rewards matched the risks, doctors could be found who would take on any medical problem, including gunshot wounds and advanced cancer. Overall, doctors would have to work harder and smarter.

Healthcare professionals will therefore come up with all sorts of reasons why this proposal is dumb. As they mumble and bumble, just ask yourself if you would believe the same sort of story from any other professional services provider.

Wednesday, July 30, 2008

The Trouble with Balance Sheet Analysis

In my never ending quest to alert the American people to the avalanche of debt about to befall them (and sell a few books at the same time), I sometimes stumble across otherwise rational looking and sounding people who claim that the national debt is no big deal. Such folks sloughed off this week's increase in the debt ceiling (to over $10 TRILLION) and the announcement of a $.5 TRILLION annual federal deficit, the largest in nominal terms in U.S. history. Their main line of counterattack is that while we OWE a lot we also OWN a lot so the debt is no big deal. Our assets exceed our liabilities (at least they claim) so the country is basically sound.

That sounds a lot like Bear Stearns and Fannie Mae thinking. The trouble with balance sheet analysis of the national debt is that the value of assets can change, and usually much more quickly than the value of liabilities. If interest rates were to spike, due to some shock and/or high levels of inflation, the value of most assets would drop (yet more) but the government would still owe $9.5 TRILLION (and growing). And of course most government assets are not liquid.

Cash flow issues loom large as well. Say we borrowed another $10 TRILLION to fix our aging bridge and highway infrastructure. For the balance sheet types, there is no problem here because our nation's assets will increase by the same amount of the debt. (Implausibly assuming, of course, that the public gets $10 TRILLION worth of construction for its money. See for a counter view.) But the interest due on the debt would double. To pay that additional interest the government could always print more money, but that would further fuel inflation, which is already getting to scary levels. It could also increase tax revenues but that seems unlikely, at least this election cycle.

I'm increasingly convinced we need major changes to the way our government gets and spends our money. Unfortunately, we'll probably have to suffer through a major crisis to get reforms passed and then they will be rushed and grossly suboptimal.

Monday, July 07, 2008

Walking the Walk: Can McCain Do It?

I caught a bit of a John McCain speech today. He is certainly "talking the talk" regarding fiscal responsibility. But can he really walk the walk? A message I received today from a government budget bureaucrat in response to my op-ed in the Free Lance-Star suggests not.

My correspondent, who I shall call Shallow Throat, says that our budgeting system is broken because at the unit level it builds in automatic yearly increases and fails to create incentives to cut back spending. If McCain wants my vote, he should address this important issue in a concrete way.

I suggested to Shallow Throat that what we need to do is to build in the expectation of annual budget decreases, at least in real (inflation-adjusted) terms. That way, front line government managers will have incentives to cut fat because the money that pays for it will disappear soon, and automatically.

Sunday, June 08, 2008

Eminent Domain in Reverse

One reason the national debt is so damn big is that the federal government owns and operates assets that it shouldn't, like Amtrak.

What we need is a sort of eminent domain in reverse, a right vested in the American people to purchase government-owned assets at fair market prices. If the government wants to put a road through your property, or thinks a corporation would do more for the economy than you're doing, it can force you to sell it. Why can't We the People do the same for government assets? I'd exempt military bases and national parks but everything else should be on the table, especially businesses like Amtrak.

This would force the government to run their business interest profitably or lose them to the highest bidder. The proceeds of sales should be used to pay down the debt; the subsidies saved in future years will of course reduce the budget deficit.

Saturday, June 07, 2008

The Poor Person's Inflation Hedge

I taped my June 22, 9:30 PM appearance on Larry Kane's Voice of Reason show here in Philly yesterday. (CN8 in the Philly market; if you get Comcast, check your local listings). The subject of consumer debt came up and I pointed out that inflation expectations are such that Americans act rationally when they run into debt, especially if they can reasonably expect their wages to keep up with price increases. Borrowing is of course the poor person's hedge against inflation: there's little better investment than having a big fat mortgage inflated away in real terms.

Say you have a $100,000 mortgage (perhaps on what today is a $75,000 house) and earn $20,000 per year -- the debt is 5x your earnings. If inflation runs at 10% per year for a few years and your wages keep up, or eventually catch up, you'll still owe $100,000 (minus any principal repaid, which is minimal at first on a 30 year mortgage) but make say $25 or $30k per year -- only 3 or 4x your earnings. The higher inflation is, the easier it is to repay the debt. Why do you think the government isn't quaking in its boots about the cheap dollar and high prices for everything from oil to bread? It's $9.4 plus perhaps $99 TRILLION in hock. (See the counters on this page and Thursday's post.)

Running up credit card debt is not such a good hedge against inflation because the interest rates on consumer revolving credit are, and likely to remain, well above the rate of inflation (even the actual rate the government is hiding). But cc debt offers a second type of hedge, one against falling real wages (when wages lag inflation). Bankruptcy laws are more stringent than they were a few years ago but until they bring back debtors' prisons ...

So if you don't like what is going on in the economy, watch the show, and buy the book!

Friday, June 06, 2008

99 Trillion! and I know why.

Richard Fisher, top dog at the Dallas Fed, says that the present value of the cost of Medicare, the new drug benefit, and Social Security is $99.2 TRILLION, or about 10 times the funded national debt (see the counters on this page):

Holy Moose!

The saddest thing about this figure is that it is completely unnecessary. American's would save more if our financial securities firms, markets, and regulations were not so completely screwed up.

Personal story: Today, I closed a small 401k account with Ameriprise Financial. Why? Because they were sucking me dry with fees (to which they tacked on an extra fiddy bucks today). After taxes, I will actually lost money on this "investment." No wonder Americans spend every dime they make, borrow to the hilt, and hope the government will bail them out when they get old and sick.

Monday, May 12, 2008

Returning to the Path of Fiscal Responsibility

What do John McCain, PATH (Port Authority Trans-Hudson), and the national debt have in common, besides all being very old? More than you might think!

America’s national debt is almost $9.4 trillion, a stack of $100 bills almost 6,300 miles high. That’s over $30,000 per legal resident, an already ominous figure growing rapidly with no end in sight. While most of the mass media lavishes attention on the rants of Jeremiah Wright (no relation), the federal government’s fiscal situation worsens, the dollar weakens, and the nation’s aging infrastructure further deteriorates. In March, an elevated section of I-95 in Philadelphia almost collapsed but nobody but truckers and Philly commuters paid much attention. On Wednesday, April 30, a fire near the PATH’s Christopher Street station shut down the 33rd Street-Journal Square and 33rd Street-Hoboken lines, forcing tens of thousands of people to find alternate ways of returning to their homes or cars in New Jersey.

PATH responded reasonably well to the fiasco -- nobody was hurt and service was restored the next morning. But as I waited for the E train to take me to the World Trade Center so I could transfer to PATH’s still functioning WTC-Hoboken line, and as I crammed into the car gizzard to gizzard with other disgruntled commuters, I wondered if there might be a better way. And there it was, behind the rotund woman with the oversized purse! PATH is celebrating its centennial by reminding commuters that it began life as a private company, the Hudson and Manhattan Railroad. That company eventually went bankrupt, the story goes, and the beneficent government, in the form of the Port Authority, stepped in to provide cheap, reliable transportation under the mighty Hudson.

The real story is more complex. Myriad government regulations pushed the H&M, and many other fine American railroads, into bankruptcy. Even with the fare increase, the PATH system is indeed cheap. Anyone who has used it, however, knows that the stations are oppressively hot and dank and the rides slow, herky jerky, and crowded. The system is in the middle of getting a long overdue facelift but the improvements made thus far have been marginal at best. And much of the money for those improvements, and indeed the system’s day-to-day operations, originate in cross subsidies from the Port Authority’s more lucrative assets, like its bridges. Were the Port Authority a for-profit company, it would have long since sold PATH to an entity better able to run it. If New Jersey’s recent abortive attempt to sell its turnpike is any indication, however, a proposal to privatize PATH would be a non-starter even though its sale to a competent private owner would likely lead to better service for commuters and a reduced strain on taxpayers.

It’s ironic that the victors in the Cold War still cling tenaciously to remnants of communism like state ownership of mass transportation infrastructure. Even more ironic are voters who complain about big government, high taxes, and fare increases but who refuse to take obvious steps toward reducing them. I’ve little doubt that John McCain (well, his staff) can find many hundreds of billions to try to trim from the bloated federal budget. I’m less confident, however, that Americans are prepared to allow the government to return important services to the private sector. Until voters are ready to let the market work, the national debt clock is going to continue to spin wildly upward as our dreams for future generations grow ever more pessimistic.

Tuesday, May 06, 2008

What We Really Need Is A Bigger Gasoline Tax

Our presidential candidates have hit new lows calling for a federal gas tax holiday. What a real leader, a good old-fashioned statesman (statesperson today I guess) would call for would be increases in the gasoline tax. Here's why:

1. The federal budget deficit (and subsequent national debt) is rapidly getting out of control. Check out the counters on this page for details. We certainly do not need further tax cuts at this juncture.

2. The current fossil fuel based system may be destroying the environment and is certainly a strategic risk to U.S. security. We therefore need to cut down on fossil fuel use, not encourage it.

3. Investment in alternative fuels is relatively low (and hence slow) because of the uncertainty of future oil/gas prices.

The government could solve, or at least mitigate, all three problems by imposing an escalating gasoline tax and committing to it. A quarter a quarter would probably be sufficient to spur investors to back hydrogen and battery service stations, breaking the chicken-egg problem. (I want a car that runs on X but there are no places to buy X because nobody owns cars than run on X.) And a buck a year would probably not shock the economy too much. Reasonable people would realize that in a decade gasoline would be well north of $10/gallon and make their next vehicle purchase accordingly.

In the meantime, the feds would collect large sums that they could use to pay down
the national debt. We paid off our first national debt thanks to a similar combination of statesmanship and a powerful source of revenue (customs). But let's not learn from the past, let's just talk about people's pastors and flag pins.

Monday, April 21, 2008

Compensation Incentives and Financial Instability

It’s official. America’s financial system is a mess once again. It isn’t a good feeling, being the laughingstock of the world. (If you haven’t yet seen the hilarious PowerPoint presentation called “The Subprime Primer” or the even funnier YouTube video, “The Long Johns – The Last Laugh – George Parr – Subprime,” by all means find them as soon as you are done clicking on the ads supporting this blog.) Suffering through an economic recession, caused by the subprime debacle and exacerbated by decades of governmental, corporate, and personal financial profligacy, is even less fun, especially if you lose your job, car, credit rating and/or house during what could become a long and ugly shakeout period.

In the past, Americans have responded to financial and economic turmoil with hasty and ill-conceived reforms. From the Panic of 1792 to the accounting scandals earlier this century, crisis has spawned regulations, some salutary, most not. I hope things will turn out differently this time around. What regulators and reformers need to concentrate on is what really matters, the nature and timing of compensation for everyone from the CEO to the lowliest trader. If the last year or so has shown anything, it is that people do precisely what they are given incentives to do. If you pay people upfront to originate 15- or 30-year mortgages, they will sign up everyone they can, even “ninjas” (people with no income, no job or assets). If you give people outsized annual bonuses based on what they appeared to do for your company that year, they will create, support, and implement crazy, short-sighted schemes. Many people on Wall Street knew that the subprime bubble was unsustainable. But what does that matter when those most responsible for letting it happen raked in seven-figure bonuses for a year, or two, or maybe five? The huge golden parachutes most executives wear these days are inducements to take big risks. If those in charge messed up, their parachutes opened and glided them comfortably to earth even while their former employer bursts into flames.

What rogue traders, accounting scandals, and the subprime mess tell us is that it is as easy to fake financial profits in the short term as it is for Meg Ryan to fake a raging orgasm in a crowded restaurant. (When Harry Met Sally for the uninitiated.) Longer term, the truth becomes known but irresponsible millionaires, and sometimes billionaires, have already been made. That is not to say that some Bear Stearns managers aren’t feeling a bit crimped for cash right now – they owned about a third of the failed investment bank, the share price of which plummeted from $170 to $2 over the last year – but don’t expect to see many of them in soup lines.

It doesn’t have to be this way; there are examples of how to do it right. “Conservative” financial institutions, for example some mutual life insurers, counter short-term thinking by deferring compensation, paying comfortable monthly salaries but reserving big bonuses until profits are actualized, not merely booked. They have long done so for their sales agents, who otherwise would try to saddle them with terminal cancer patients, daredevils, and Alaska crab fishermen, and more recently have extended the idea to executives and board members. Other financial institutions should consider following their example. If they don’t, the government will sooner or later try to do it for them, with predictably unpredictable consequences.

Financial crises and economic recessions are not the end of the world. They are costly, however, so it is important to try to limit their number and extent. In the future, we need more proactive analysis of skewed incentives, unintended consequences, and conflicts of interest and less reliance on reactive monetary and fiscal policies. Will managers and shareholders clean their own house or will they have it scrubbed for them?

The National Debt and the Poor

At first glance, America’s poorest citizens ought to be indifferent about the national debt. To pay if off, or at least down, the federal government will have to begin to spend less than it earns and that means some combination of tax increases and spending cutbacks that may injure society’s least well off. Another look, though, suggests the poor should hate the national debt, which now stands at about $9.3 trillion or over $30,000 per person.

The economy appears to be going to Limbo if not Hades itself. To stop its descent, the Federal Reserve is cutting interest rates like mad and inventing (or reinventing) new ways of adding liquidity to the financial system and shoring up confidence. It may succeed, as it did in the wake of the S&L crisis, when it stopped a stock market panic in 1987 and kept the 1990-91 recession short and mild. Its predecessor, the Bank of the United States, made similarly short work out of the Panic of 1792. Even if we get out of the current mess relatively unscathed, however, we will remain poised for another bout of financial indigestion at some point in the future, perhaps the very near future, because the Fed’s actions, while necessary, reward risky behavior. (That is what economists and pundits mean when they refer to “moral hazard.”)

The government is just as likely to fail to stop the slide. In 1929, the government did too little. Prices dropped, companies went out of business, millions lost work, defaults climbed, and banks began dropping like flies. It took years to recover and guess who suffered most? That’s right, the poor. Today’s government certainly doesn’t want another depression but one of its hands is tied. In addition to easing monetary policy (cutting interest rates), governments can thwart economic downturns with fiscal stimulus, cutting taxes or borrowing and spending in order to stimulate demand, keep companies in business, and people employed. Our monstrous national debt, coupled with the weak dollar, means the fiscal path is almost closed. The government could do more than the paltry tax rebate checks it has promised, but not much more.

So the Federal Reserve has had to reduce interest rates rapidly and will likely make more cuts. But here looms another bogeyman, runaway prices, as during the “Great Inflation” of the 1970s and early 1980s. Guess who gets hurt most by inflation? People rich enough to buy TIPs, gold, and other inflation hedges? Professionals who can easily negotiate higher fees? No, it is the poor, who will have a difficult time increasing their wages enough to match the higher cost of “little luxuries” like gasoline, electricity, clothes, and food.

The Founding Fathers knew better than to paint themselves into this corner. The new nation ran up a large debt winning its independence, fighting pirates and the French, and buying Louisiana. But it paid it all off by the mid-1830s because its leaders knew that a large, perpetual debt would injure the poor by redistributing resources from the masses to bondholders. The Founders also knew that too much debt would weaken the nation militarily. War threatened the safety of the entire country but weighed especially heavily on those who would have to join the line, then as now overwhelmingly the poor.

Not much can be done about the national debt right now, except to watch it grow. When the financial system and the economy regain their footing, however, we need to have a long, hard conversation about how to repay what we owe, if not for our own sake then for those most threatened by it, the poor.

Broken Bridges and the National Debt

The good news is that nobody was killed last month before authorities shut down a busy 2-mile stretch of I-95 in Philadelphia to repair a badly cracked concrete pillar. The bad news, besides the inconvenience the shutdown caused commuters, truckers, and various Philly neighborhoods, is that we may not be so lucky next time. This is not hype. A bridge collapsed in Minnesota last summer, killing 13 and injuring five score more, and thousands of U.S. bridges and overpasses are in need of repair. Solving this pressing problem will not be easy.

A hike in the gas tax is not in the cards, not with oil above $100 a barrel. (In fact, John McCain, Mr. Alleged Fiscal Conservative, is calling for suspending the gas tax this summer!) Using general tax revenue raises sticky questions of equity like why non-drivers should subsidize automobile ownership. We could borrow and worry about repaying later but unfortunately that little game may be just about over. The national debt is now about $9.3 trillion. That’s over $30,000 for every person legally resident in the country. With the dollar so weak – it takes about 2 of them to buy a British pound, over 1.5 of them to buy a euro, and about 1 of them to buy a Canadian dollar – foreigners are understandably wary of purchasing Treasuries. At home, fears of inflation loom larger every time the Federal Reserve cuts interest rates and that is bad for bonds. (To his credit, Philadelphia Fed president Charles Plosser wanted the Fed to cut the overnight rate only 50 basis points instead of the 75 it ultimately decided upon on Tuesday.)

Another approach is to try to make the construction industry more efficient. As Barry LePatner (with help from myself and Tim Jacobson) argued in Broken Buildings, Busted Budgets (2007), there is a lot of fat in the industry. Trimming it would help taxpayers get more bang for their infrastructure buck, regardless of its ultimate source. But it will still take a lot of money to fix all of our crumbling bridges, money we don’t seem to have.

The Founding Fathers offer yet another approach. They groaned under a massive national debt, incurred fighting wars and buying Louisiana, that they wished to pay off as soon as it was economically prudent to do so. They succeeded in the 1830s in part because they kept the federal government out of the infrastructure business altogether (with a few minor exceptions). Ingenious early state governments farmed the job out to corporations – for-profit toll bridges, turnpikes, and canals. Pennsylvania led the way in 1792 with its charter of the Philadelphia and Lancaster Turnpike. The system worked tolerably well then and could work even better today because technology has greatly reduced the cost of collecting tolls. New Jersey recently considered selling or leasing its turnpike to a for-profit corporation before jettisoning the idea after a popular uproar. That may have been a mistake; corporate-owned for-profit roads have succeeded elsewhere despite barriers built into the tax code against them.

I know having corporations in charge of our roads, tunnels, and bridges will seem like a big step for many Philadelphians and Americans more generally but they have little to fear. Corporations can maintain our roads and bridges more cheaply than governments currently do. They have incentives to complete construction projects quickly, with few disruptions, because they do not want traffic volume and hence tolls to suffer. Because they can be sued and need insurance, infrastructure corporations are also safety-minded.

Clearly, our bridges need repair. The question is how best to pay for all the work that needs to be done. Letting corporations do the job in exchange for tolls is a very old idea whose time may have come again.

How Historians Caused the Subprime Mortgage Mess

A hopeful sign that the credit crisis precipitated by the subprime mortgage disaster of ‘aught seven’ has run its course is that the blame game has begun in earnest. With typical abandon, liberals cast aspersions on the market while conservatives chastise the government. Poor Alan Greenspan, a conservative who long served as chairman of the government’s primary monetary policy instrument, the Federal Reserve, has been forced to walk a tenuous tightrope as he tries to vindicate both himself and the financial system. Almost simultaneously, The Economist ran an article suggesting that the root cause of the subprime debacle was a deficient educational system. Apparently, Americans, Brits, and the citizens of most of the world’s nations know so little about money they can’t be trusted with any, especially their own. Economists strenuously demur, preaching to an increasingly incredulous audience that humans are innately rational beings.

I want to join the blame game because it looks like such great fun. It doesn’t take much effort to concoct some controversial yet plausible-sounding monocausal explanation for our economic ills. All of us chiming in can get on television and talk past each other in short, vacuous, but strangely alluring sound bites. Nothing of value will come out of it, but we’ll have a grand time defending the indefensible while distracting people from ‘slightly’ more important topics like the war in Iraq, the burgeoning national debt, and global climate change. So here goes …

Historians caused the subprime mortgage mess. They did so by spending the last umpteen years studying increasingly narrow cultural topics to the exclusion of important stuff. Broad concerns about race, ethnicity, class, and gender devolved into minute studies of if not nothing then next to nothing. Those who preferred to stay off the cultural bandwagon were marginalized, shunted aside, and barred from the profession’s most important associations and laurels. One by one, the great pillars of the discipline’s once mighty edifice crumbled. Political, diplomatic, military, and economic historians fled for the greener pastures of retirement or professional schools. The Queen of the Social Sciences, as History was once known, abdicated her throne.

Few outside of academe knew, or cared, much about this strange transformation. It did not take long, however, for them to lose faith in the new cultural historians, who tended to be either ivory tower types with obvious, and often radical, political agendas or glib public intellectuals who supplied gobs of edutainment but little depth. Both quickly sank into irrelevance; policymakers public and private increasingly turned to political scientists, economists, and other non-historians for guidance about the past. Though adept with statistics and mathematical models, social scientists of the past often lacked skills that historians exude in ample quantities, especially archival research skills and the ability to think contextually. Largely devoid of those crucial skills, the social scientist of the past also proved insufficient to the task of providing deep historical insights relevant to major policy questions but clouds of fancy math and jargon delayed recognition of the fact.

While historians stood in the corner talking to themselves about next to nothing and social scientists of the past obsessed over their numbers and models, American investment banks blindly stumbled onto a ‘new’ idea, securitization, or the packaging of mortgages into bundles for resale to institutional investors throughout the world. The idea appeared brilliant because it took the risk of a mortgage default and spread it out, ostensibly to the point of eliminating it. Predicting whether in a given year a particular mortgage would go bust was as difficult as predicting whether a specific individual would die. But thanks to the law of large numbers, the percentage of a population that will die in a year can be known with great precision. So, too, it was thought, could the number of mortgage defaults. Investors could therefore buy even the riskiest mortgages so long as they diversified their portfolios by buying a lot of them offered together in a single security or bond.

One problem with that reasoning is that people usually do not want to die, but their desire and ability to pay their mortgage can change over time, and quite dramatically at that. Another problem is that life insurance agents typically receive their commissions over a period of years in order to give them incentives to sign up healthy people with safe occupations and lifestyles. Mortgage originators, by contrast, receive their payments upfront, at closing. They therefore have no reason to concern themselves with borrowers’ ability to repay their mortgages and in fact had incentives to help weak applicants to borrow the most they possibly could. NINJA loans (no income, no job or assets) and other absurdities are the result.

The most damning evidence against securitization, however, was purely historically. Between the Civil War and World War II, six America mortgage securitization schemes went belly up. None caused as much economic heartache as the current one but they nonetheless left ample evidence in the historical record. Each centered on a profitable-looking new market, eastern, western, rural, urban, local, and national. And each failed after a few years for precisely the same reason the subprime market was bound to, the skewed incentive scheme discussed above. A few scholars, those conversant with Kenneth Snowden’s chapter on the topic in Anglo-American Financial Systems (Michael Bordo and Richard Sylla, eds., 1995), knew about those foreboding precedents. It was difficult for them to get a word in edgewise, however, because they were few and not well respected by their historian or social science colleagues. That, in turn, rendered it impossible for them to gain the ear of regulators and investment bank executives. The rest is, or rather will be, history. Or will it? If the lessons of securitization are allowed to slip out of our historical consciousness again, our children or grandchildren could suffer a similar debacle, perhaps involving Artic beachfront property.

Historians need not drop what they are doing and rush off to study financial institutions and markets. It would be helpful, though, if they recognized the importance of their own discipline and unique scholarly skills to all aspects of contemporary life, not just culture. That might entail rendering their journals fairer and more inclusive, giving awards and other laurels to a wider group than hitherto, and occasionally hiring someone whose research might help save the nation from its next political, military, diplomatic, or economic crisis.

Tuesday, March 18, 2008

I did not forget you, Libertarians!

Some libertarians are all in tizzy because I didn't mention their party in my Los Angeles Times op ed today:,0,3662044.story. I'm sorry there wasn't enough space to work y'all in. The Libertarian Party deserves many more words than I was given space for. Moreover, I'm not sure that it fits the bill as it tries to cover too many areas. What I'd like to see is a party narrowly-focused on getting our economic, financial, and fiscal houses in order. Then we can worry about gun control, national id cards, immigration, abortion, and all that very divisive jazz. On its website, the LP ( says it is the third largest party in America, but it only has about 200,000 registered voters nationwide. That isn't very big; there are more people in my neighborhood! I think most Americans are centrists, both left to right (Democrat to Republic) and up to down (libertarian to statist). To win national or big state elections, you have to be close to the center, to found common ground upon which to unite the most people possible. I think that means appealing to things like the budget and the debt and keeping one's mouth shut on social issues. To the extent that other issues impinge on the budget/debt, they should be discussed in those "dollars and sense" terms rather than in ideological ones (e.g. governments or markets suck).

Friday, March 14, 2008

What Does Spitzer Have to Do With the National Debt?

How are Eliot Spitzer and the national debt linked?

Most importantly, for me, his story got my op-ed in the LA Times bumped into next week!

Seriously, his little ... indiscretion ... shows, once again, that our elected officials are as human as the rest of us. Some of them have trouble keeping their penises in their pants, others can't keep their hands to themselves, their mouths shut, or their driving safe and sober. Still others couldn't balance a checkbook if their lives depended on it or, more importantly, balance the government's budget if the entire national economy depended on it. This is why it is so important to look for structural ways of tying politicians' hands, of building more checks and balances into what matters most, the power of the purse.

One idea I throw out in One Nation Under Debt is to make one house of Congress responsible for spending and the other for taxing and borrowing. That way, the spending house (the House of Representatives?) can't spend more than the taxing and borrowing house allows. It'll give 'em what economists call a binding budget constraint. During wars and disasters the other house (the Senate?) would provide ample resources but in fat years will have a better chance of keeping a lid on spending. Chew on that.

Wednesday, March 12, 2008

Universal National Service

Finished reading Sabato's A More Perfect Constitution today. (A very interesting read for a wonky scholar like me. The writing is fluid but doesn't soar.) In Chapter 5, Sabato advocates the formation of a near mandatory Universal National Service, two years of public service for young people. The idea is to get our yutes to join the military, Habitat for Humanity, the Red Cross, something. Unless they opted for the military, they'd only get minimum wage or so but they would also get a great experience, some job training, friends for life, and a sense of civic responsibility.

I find the proposal interesting for two reasons. For starters, I suggested the same thing a few years ago in my ill-fated book ms., "America Down: The Failure of U.S. Higher Education ..." In that ms., I suggest that putting 18 to 22 year olds out in the real world instead of the college classroom would benefit everyone. They could sow their wild oats and earn some dough for college, so work, sex, and drugs don't distract them from their studies when they get to college at age 22 or 23. Secondly, Sabato claims that "the benefits that will accrue as a result of Universal National Service will far outweight the annual price tag for the federal Treasury" (173). He doesn't really demonstrate that in any rigorous way but the idea is fascinating ... with a slight nudge, our wayward youth could be put to work to help pay off the national debt instead of increasing it by wasting the massive educational subsidies we lavish upon them at frat parties and football games. ... Hey, I'm allowed to dream aren't I?