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.

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.

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.

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:
http://www.sybervision.com/reviews/Extreme-Acai-Berry.php
http://www.ultimatefatburner.com/extreme-acai-berry-review.html
http://www.ripoffreport.com/reports/0/372/RipOff0372878.htm

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.

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.

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!

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.

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.

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.

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!

;-)