This is just an AP article, but I think it illustrates well the problems with offering free healthcare to certain citizens who "need" it for free. The state of Hawaii quickly figured out that providing free health insurance for middle class children was a bad idea. This also proves that President Bush's reasons for vetoing the SCHIP expansion was completely accurate when he said that it would encourage those with coverage to drop it in favor of the cheaper government subsidized health care.
"People who were already able to afford health care began to stop paying for it so they could get it for free," said Dr. Kenny Fink, the administrator for Med-QUEST at the Department of Human Services. "I don't believe that was the intent of the program."
State health officials argued that most of the children enrolled in the universal child care program previously had private health insurance, indicating that it was helping those who didn't need it.
The universal health care system was free except for copays of $7 per office visit.
Friday, October 17, 2008
Wednesday, October 15, 2008
Irrational Investors?
Today, I wanted to talk about something a little more philosophical. In the world of economics there seems to be quite the debate over people behaving rationally versus irrationally. We are told repeatedly these past few weeks that investors are behaving irrationally. That we humans are digressing into the primitive parts of our brains and basing decisions on emotion and not on reason. This is where I disagree. I do not think that irrational behavior is even possible.
First, let’s define rational and irrational behavior. If, like some seem to think, that rational behavior is based on facts and irrational behavior is not based on facts, then this makes it difficult for me to conceive of an irrational thought. Do investors panic for no reason at all? Is it merely a phenomenon where many people randomly panic and start to sell everything? Not likely. As has been the case in recent weeks, dark clouds have been slowly growing for months. People were acting on facts.
Now the retort will be that people oversold in the market, and that they were selling stocks whose true value is more than current prices. More simply, that people are acting on a limited number of facts, but not on the full truth. If the definition of rational behavior requires omniscience, this creates an impossible hurdle and no thought can be considered rational.
As an example, imagine that you are in the middle of a crowded theater and a teenage boy yells “Fire!” Should you race to the rear exit, or stay in your seat assuming the kid is just pulling a prank? I would say that either choice is rational depending on what you know. Is it irrational to flee a burning building? Is it irrational to ignore some teenager yelling “Fire!” when you can’t see it or smell anything? Neither is irrational given the information that you have at the time. If in reality there was an unlit exit at the side of the theater that no one else could see, this would not make the other thoughts irrational.
Many people invest without much knowledge of finance or economics. They generally stick to a few rules about their choices. Their brokers tell them to “buy and hold” and not to try to time the market. These are nice rules, but in 1929 in the U.S. and 1989 in Japan these were horrible strategies. It took 23 years for the DJIA to recover its losses and the Nikkei is less than a quarter of its 1989 high (was 38957 is ~9600).
What naïve investors often do is look at trends (i.e. they extrapolate). Extrapolation is a very important and rational approach to life, but it is a very inaccurate way to judge stock prices. If floodwaters are rising, extrapolation tells you to get the heck out of there. We don’t call people irrational because they didn’t know that a 5 inch rain event in their watershed would leave them 3 or 4 feet above the flood waters. When time is of the essence we have to rely on less information. This is rational and pragmatic.
In the long run, those who base their decisions on more precise techniques and more complete sets of information are going to make fewer mistakes, but all decisions are based on limited information and imprecise techniques. The difference between rational and irrational investing in the common lexicon is arbitrary. I conclude that irrational investing does not exist.
In essence, we have economists on the left trying to help protect those who are “irrational”. What they truly are doing is rewarding ignorance by taxing the prepared.
First, let’s define rational and irrational behavior. If, like some seem to think, that rational behavior is based on facts and irrational behavior is not based on facts, then this makes it difficult for me to conceive of an irrational thought. Do investors panic for no reason at all? Is it merely a phenomenon where many people randomly panic and start to sell everything? Not likely. As has been the case in recent weeks, dark clouds have been slowly growing for months. People were acting on facts.
Now the retort will be that people oversold in the market, and that they were selling stocks whose true value is more than current prices. More simply, that people are acting on a limited number of facts, but not on the full truth. If the definition of rational behavior requires omniscience, this creates an impossible hurdle and no thought can be considered rational.
As an example, imagine that you are in the middle of a crowded theater and a teenage boy yells “Fire!” Should you race to the rear exit, or stay in your seat assuming the kid is just pulling a prank? I would say that either choice is rational depending on what you know. Is it irrational to flee a burning building? Is it irrational to ignore some teenager yelling “Fire!” when you can’t see it or smell anything? Neither is irrational given the information that you have at the time. If in reality there was an unlit exit at the side of the theater that no one else could see, this would not make the other thoughts irrational.
Many people invest without much knowledge of finance or economics. They generally stick to a few rules about their choices. Their brokers tell them to “buy and hold” and not to try to time the market. These are nice rules, but in 1929 in the U.S. and 1989 in Japan these were horrible strategies. It took 23 years for the DJIA to recover its losses and the Nikkei is less than a quarter of its 1989 high (was 38957 is ~9600).
What naïve investors often do is look at trends (i.e. they extrapolate). Extrapolation is a very important and rational approach to life, but it is a very inaccurate way to judge stock prices. If floodwaters are rising, extrapolation tells you to get the heck out of there. We don’t call people irrational because they didn’t know that a 5 inch rain event in their watershed would leave them 3 or 4 feet above the flood waters. When time is of the essence we have to rely on less information. This is rational and pragmatic.
In the long run, those who base their decisions on more precise techniques and more complete sets of information are going to make fewer mistakes, but all decisions are based on limited information and imprecise techniques. The difference between rational and irrational investing in the common lexicon is arbitrary. I conclude that irrational investing does not exist.
In essence, we have economists on the left trying to help protect those who are “irrational”. What they truly are doing is rewarding ignorance by taxing the prepared.
Tuesday, October 14, 2008
One Crisis Begats Another
Unemployment rates have been rising, which is unfortunate. I have lost my job before and I think that these people should do exactly like I did. Namely, mail out dozens of resumes, make phone calls, send e-mails, contact recruiters, and start looking at other cities where you might consider work. My wife was pregnant at the time, so I had a big incentive to quickly find another job. However, our unemployment insurance system eases the pain and lessens the incentive for many to quickly take another job.
Here in the United States we get a small percentage (bigger if you don't make much) of our previous salary for 26 weeks. Every week you have to file information showing that you applied for a certain number of jobs. In Germany, they have had an unemployment insurance system that paid 80% of previous salary for 2 years. They required no evidence that re-employment was being pursued by the recipient of funds. Not too surprisingly, America's unemployment rate hovers around 5%, while Germany's unemployment rate hovered around 9 or 10%.
Now, Barack Obama and Nancy Pelosi have both suggested that we extend unemployment benenfits and temporarily eliminate income tax on those benefits. CBS News quotes Obama as saying "we should extend expiring unemployment benefits to those Americans who've lost their jobs and can't find new ones." This summer, the Democrats added a rider to an Iraq War Funding bill that extended unemployment benefits by 13 weeks to a total of 39. Now, Obama is asking for an additional 13 weeks. What do you suppose will happen if we extend unemployment benefits? Higher unemployment? You are correct.
John Lott, whom I've had the pleasure of conversing with a few times, has an op-ed at Investor's Business Daily writes about the effects of the first extension of unemployment benefits driving up unemployment:
Indeed, dozens of economic research papers predicted this outcome. When you extend or increase jobless benefits, you extend unemployment. If you set a date certain for getting rid of benefits, people find jobs. You get more of what you subsidize, and here we are subsidizing unemployment.
...
For the benefit hike that just took effect, these research papers imply a rise in unemployment to 6.4% from 5.5% in June. So, for the next month or two expect to see repeated bad news from labor markets. Perfect timing for the Democrats for the election.
Now, if unemployment rises another 0.9% to 7.3%, what do you suppose the Democrats will do at that point? Almost assuredly they will use the high unemployment rate as an excuse to expand government intervention in the economy. Their cure for the "unemployment crisis" will only exacerbate the situation and the failed results will be used to justify even more market distortions.
It's Crisis and Leviathan.
Here in the United States we get a small percentage (bigger if you don't make much) of our previous salary for 26 weeks. Every week you have to file information showing that you applied for a certain number of jobs. In Germany, they have had an unemployment insurance system that paid 80% of previous salary for 2 years. They required no evidence that re-employment was being pursued by the recipient of funds. Not too surprisingly, America's unemployment rate hovers around 5%, while Germany's unemployment rate hovered around 9 or 10%.
Now, Barack Obama and Nancy Pelosi have both suggested that we extend unemployment benenfits and temporarily eliminate income tax on those benefits. CBS News quotes Obama as saying "we should extend expiring unemployment benefits to those Americans who've lost their jobs and can't find new ones." This summer, the Democrats added a rider to an Iraq War Funding bill that extended unemployment benefits by 13 weeks to a total of 39. Now, Obama is asking for an additional 13 weeks. What do you suppose will happen if we extend unemployment benefits? Higher unemployment? You are correct.
John Lott, whom I've had the pleasure of conversing with a few times, has an op-ed at Investor's Business Daily writes about the effects of the first extension of unemployment benefits driving up unemployment:
Indeed, dozens of economic research papers predicted this outcome. When you extend or increase jobless benefits, you extend unemployment. If you set a date certain for getting rid of benefits, people find jobs. You get more of what you subsidize, and here we are subsidizing unemployment.
...
For the benefit hike that just took effect, these research papers imply a rise in unemployment to 6.4% from 5.5% in June. So, for the next month or two expect to see repeated bad news from labor markets. Perfect timing for the Democrats for the election.
Now, if unemployment rises another 0.9% to 7.3%, what do you suppose the Democrats will do at that point? Almost assuredly they will use the high unemployment rate as an excuse to expand government intervention in the economy. Their cure for the "unemployment crisis" will only exacerbate the situation and the failed results will be used to justify even more market distortions.
It's Crisis and Leviathan.
Saturday, October 11, 2008
Jonathan Macey Nails It
Jonathan Macey, a law professor at Yale, absolutely nailed the cause of the market collapse in recent weeks. While the market was down, it was panic by the government that caused panic in the private sector. Your average American is not a market expert, so they take their cues from "qualified" individuals. When those that are supposedly in-the-know panic, we all panic.
Some excerpts:
Despite all the hard work and good intentions on the part of our public officials, when economists and historians look back on the current financial crisis they are likely to conclude that government intervention prolonged and deepened it. In particular, officials at the Federal Reserve, the Securities and Exchange Commission and the Treasury Department are to blame for publicly losing confidence in the very economic system they are supposed to protect.
The original Treasury plan -- which called for the transfer of virtually unlimited taxpayer dollars and unlimited spending discretion to Treasury with no judicial or congressional oversight -- sent a very bad signal to the markets. Instead of restoring confidence, this approach to the crisis instilled more fear and panic in the markets.
The Bear Stearns bailout, the restrictions on short-selling and the government's new $700 billion commitment to buy toxic mortgage-based assets all share the same fundamental flaw: They prevent the market from imposing discipline on banks guilty of massive over-leveraging and excessive risk-taking. Moreover, they punish prudent managers who invested conservatively, kept their companies' debt at reasonable levels and worked hard to raise new capital when necessary. The SEC's attack on short-selling punishes savvy traders who invested resources and effort in identifying companies with too much debt and unrealistically valued assets.
Preach on Mr. Macey, preach on.
Some excerpts:
Despite all the hard work and good intentions on the part of our public officials, when economists and historians look back on the current financial crisis they are likely to conclude that government intervention prolonged and deepened it. In particular, officials at the Federal Reserve, the Securities and Exchange Commission and the Treasury Department are to blame for publicly losing confidence in the very economic system they are supposed to protect.
The original Treasury plan -- which called for the transfer of virtually unlimited taxpayer dollars and unlimited spending discretion to Treasury with no judicial or congressional oversight -- sent a very bad signal to the markets. Instead of restoring confidence, this approach to the crisis instilled more fear and panic in the markets.
The Bear Stearns bailout, the restrictions on short-selling and the government's new $700 billion commitment to buy toxic mortgage-based assets all share the same fundamental flaw: They prevent the market from imposing discipline on banks guilty of massive over-leveraging and excessive risk-taking. Moreover, they punish prudent managers who invested conservatively, kept their companies' debt at reasonable levels and worked hard to raise new capital when necessary. The SEC's attack on short-selling punishes savvy traders who invested resources and effort in identifying companies with too much debt and unrealistically valued assets.
Preach on Mr. Macey, preach on.
Thursday, October 9, 2008
Book Review - The Forgotten Man, Amity Shlaes
Amity Shlaes, columnist for Bloomberg, has written an accessible and well paced book chronicling the myriad mistakes of Herbert Hoover, but more significantly, Franklin Roosevelt. While it didn't always dig into the deeper economic consequences with a more academic approach, there was still enough depth to weave a concise narrative of America's misteps during the 1930's. I would likely have torn through the pages of a libertarian polemic, but it was probably better for my blood pressure that she presents a more evenhanded presentation. However, do not fear that she wallows in any left wing apologetics. She does not coddle any of the actors in power.
If you are only vaguely familiar with the events before and during the Great Depression I would recommend picking up a copy. A paperback version is available here at Amazon.
My only warning is not to read this book right after reading Jonah Goldberg's Liberal Fascism and Robert Higgs' Crisis and Leviathan. In his speeches, Barack Obama might as well be quoting some pretty notorious people from the 1930's. It will scare the crap out of you.
If you are only vaguely familiar with the events before and during the Great Depression I would recommend picking up a copy. A paperback version is available here at Amazon.
My only warning is not to read this book right after reading Jonah Goldberg's Liberal Fascism and Robert Higgs' Crisis and Leviathan. In his speeches, Barack Obama might as well be quoting some pretty notorious people from the 1930's. It will scare the crap out of you.
Wednesday, October 8, 2008
Lies about AIG
Doing a little bit of research from my Bio, you would be able to determine that I am currently an employee of AIG. I am not an executive, nor do I even work in the division that set up the retreat. I am also not one of those odd individuals with immense loyalty to my employer. Having said that, there have been several news reports like this one. In the article they report the White House's comments on the events:
The problem with the news story and the wildly inaccurate statements of Sen. Obama, is an enormous ignorance of how insurance is sold in America. Virtually every company that sells life insurance annually offers free trips to the agents that sell the most insurance policies. Think of those crappy fundraisers in grade school where you could get a Nintendo if you sold $5,000 in wraping paper. If an insurance company tried to skip out on these prizes we would likely lose our best sellers to other firms. If we can't sell our insurance products we go out of business. The ruckus compelled our new CEO to send a letter to Hank Paulson, Treasury Secretary. Employees received a copy of the letter at work, but I wasn't sure if it was meant for public distribution so I have not included it.
However, this link here provided an accurate description of the letter.
Executives did not attend the trip. The trip, while costing over $400,000 was attended by over 100 people. My job is in jeopardy, but I hold no ill towards those who attended this event.
The White House said on Wednesday it was "despicable" that American
International Group Inc. executives spent hundreds of thousands of dollars on a
posh California retreat just days after getting a federal bailout.
The problem with the news story and the wildly inaccurate statements of Sen. Obama, is an enormous ignorance of how insurance is sold in America. Virtually every company that sells life insurance annually offers free trips to the agents that sell the most insurance policies. Think of those crappy fundraisers in grade school where you could get a Nintendo if you sold $5,000 in wraping paper. If an insurance company tried to skip out on these prizes we would likely lose our best sellers to other firms. If we can't sell our insurance products we go out of business. The ruckus compelled our new CEO to send a letter to Hank Paulson, Treasury Secretary. Employees received a copy of the letter at work, but I wasn't sure if it was meant for public distribution so I have not included it.
However, this link here provided an accurate description of the letter.
Executives did not attend the trip. The trip, while costing over $400,000 was attended by over 100 people. My job is in jeopardy, but I hold no ill towards those who attended this event.
Shoulda, Coulda, Woulda
How McCain could have trounced his way to victory.
As I watched the debate between McCain and Obama last night, I began to realize that if McCain had voted against the bailout he could completely slaughtered Obama. Had he kept his vote close to the vest and rebuked the bailout at the very end, it would have passed the Senate and likely the House, and Obama would be left holding the blame.
What we now know is that even with the bailout passing, the stock market has tanked anyway. It has fallen over 1200 points since the moment the bailout passed in the House (as of close 10/7/08) . The S&P has fallen almost 14%. McCain would have been called reckless, but with the stock market plunging even with it passing, it would be hard to defend the bailout with evidence. There would be some risks, but it would be a defensible position.
However, the rhetorical gain that McCain could have achieved would have been absolutely lethal. Obama would now be in a position of handing hundreds of billions of dollars to Wall Street to save the greedy and evil CEOs and “Fat Cats” he has been attacking for months. Any use of his class warfare rhetoric would blow up in his face. Tax hikes on the rich, but bailouts for the rich?
Adding to his maverick image, McCain could have stood out as a dogged defender of his principles. When the bailout failed the House, it was then sent to the Senate where it was loaded up with over $100 billion in “sweeteners”, i.e. Pork. Imagine the albatross hanging on Obama’s neck when trying to defend this monstrosity.
Imagine the comebacks…
“You believe that $700 billion is too much to help our troops win in Iraq, but it’s not too much for Wall Street fat cats?”
“Let me get this straight. He has $700 Billion for Wall Street, $800 Billion in new spending on top of a $500 Billion budget deficit, tax cuts for virtually everyone, and he’s going to balance the budget. Does someone have a calculator? I don’t see how this adds up. Because it doesn’t add up. You know it. I know it. He knows it.”
Grrrr…Shoulda, Coulda, Woulda
Note – I do not propose that these rhetorical points are factually precise, but Presidential campaign strategy demands generalities or you will be crushed.
As I watched the debate between McCain and Obama last night, I began to realize that if McCain had voted against the bailout he could completely slaughtered Obama. Had he kept his vote close to the vest and rebuked the bailout at the very end, it would have passed the Senate and likely the House, and Obama would be left holding the blame.
What we now know is that even with the bailout passing, the stock market has tanked anyway. It has fallen over 1200 points since the moment the bailout passed in the House (as of close 10/7/08) . The S&P has fallen almost 14%. McCain would have been called reckless, but with the stock market plunging even with it passing, it would be hard to defend the bailout with evidence. There would be some risks, but it would be a defensible position.
However, the rhetorical gain that McCain could have achieved would have been absolutely lethal. Obama would now be in a position of handing hundreds of billions of dollars to Wall Street to save the greedy and evil CEOs and “Fat Cats” he has been attacking for months. Any use of his class warfare rhetoric would blow up in his face. Tax hikes on the rich, but bailouts for the rich?
Adding to his maverick image, McCain could have stood out as a dogged defender of his principles. When the bailout failed the House, it was then sent to the Senate where it was loaded up with over $100 billion in “sweeteners”, i.e. Pork. Imagine the albatross hanging on Obama’s neck when trying to defend this monstrosity.
Imagine the comebacks…
“You believe that $700 billion is too much to help our troops win in Iraq, but it’s not too much for Wall Street fat cats?”
“Let me get this straight. He has $700 Billion for Wall Street, $800 Billion in new spending on top of a $500 Billion budget deficit, tax cuts for virtually everyone, and he’s going to balance the budget. Does someone have a calculator? I don’t see how this adds up. Because it doesn’t add up. You know it. I know it. He knows it.”
Grrrr…Shoulda, Coulda, Woulda
Note – I do not propose that these rhetorical points are factually precise, but Presidential campaign strategy demands generalities or you will be crushed.
Tuesday, October 7, 2008
I Don't Mean to Brag, but...
Since September 23, the S&P 500 Index has dropped over 11%. What’s interesting about September 23rd? Nothing, except that was the day that I decided to sell half of my stocks (which are almost entirely in S&P 500 index funds) and move the money into an interest bearing account. My strategy until that date was buy and hold. I have never tried to time the market, so why would I start on September 23rd? My faith in the free market led me to fear that the single largest intervention in the history of the American economy could only lead to stagnation in the stock market.
Let me explain in a little more detail, however, why I did not and do not like the bailout. The bailout, eh hem, excuse me, the “rescue plan” is specifically designed to attract capital away from successful uses and put it back into failing financial services firms. This misallocation of capital will slow the economy’s recovery.
The theory for the bailout says that panic set into the first circle of financial services firms and spread to other institutions. The panic would continue to spiral in a vicious circle until all commerce stopped and no credit would be offered anywhere. Those on the Left allege that this cycle of greed and bust is an endemic problem of an unbridled free market and could become permanent, holding the economy back for years and years. Washington, being beset by that other human frailty, panic, simply had to pass the bailout. Investors, seeing the brilliance of Congress, proceeded to pull money out of the market in droves, dropping the Dow Jones Industrial Average down 1,200 points in the next 8 hours of trading.
The problem that I have with the bailout thinking is three fold. To have a “credit freeze”, enormous amounts of capital must be withdrawn and hoarded metaphorically if not literally under the mattress. Eventually, people are going to use that capital again. People won’t forget how to make medicine, drill for oil, or program computers. The incentive to exchange what I can produce, but don't need today, for what you can produce and I do need today will still be there. The economy will go on.
Second, as the panic pushes prices down the opportunity to make a killing gets bigger. I suspect that if the Porsche dealer in town were panic selling Carreras at 20 cents on the dollar, I would not be the only person in line. Many of the “toxic” mortgage backed securities already offer fantastic rates of return with little risk if you hold them to maturity. Now the government plans to borrow $700 Billion from the public. To get us to lend them the money they have to convince us, with higher interest rates, that loaning them money is better than loaning money to other businesses. This moves capital away from companies with sound business models and moves it to those without sound business models. This decision to move capital away from good companies will slow economic growth and the rate of return available in the market.
Lastly, banks are not necessarily the best arrangement to help capital find its most productive use. With the advent of the internet, we have seen the demise of many a middleman. The music industry is in shambles because entertainers no longer need the lumbering distribution companies thanks to iTunes. Venture capital funds capitalize the tech industry in Silicon Valley, not banks. The next Google does not dress up and go down to First National of San Jose to get a small business loan. Even the news industry is dying because bloggers connect average people with news and ideas that need no filtration and distribution. If someone in Minnesota wants to find out about a news conference at a NASA, they don’t have to read a reporter’s opinion, they can watch it on YouTube. Innovation should not be stifled by helping the old guys stay in business.
Banks are inherently unstable by design. They guarantee a rate of return to depositors and then loan out the money to someone else. A bank invests on the margin, also known as leverage. Banks have a nasty habit of getting over leveraged leading even small panics to become meltdowns. Maybe banks should be allowed to fail because they are simply risky relics that have passed their prime.
You might ask, “How will companies who need loans get money? Where would I put my savings?” Just look at mutual funds. A mutual fund company doesn’t borrow and lend, it only recommends to average people where to put their savings (i.e. their capital) and then charges a fee for the advice and administration. There are hedge funds that allow individuals to lend mortgages directly to other individuals, skipping the whole mortgage bank model. Maybe financial experts should be giving advice instead of taking risks. If we allowed banks to fail the financial services industry might be forced to evolve to a more stable system. What have we chosen to do instead? We have decided to bailout the banks so we can keep doing things the way they have always been done. The bailout keeps the big banks big and status quo humming.
To help you wrap your head around this, let me use a metaphor from nature. When someone yells “Help, help there's a fire!” it's likely to send a chill down the neck of the steeliest men. For years, the forest service instinctively reacted this way trying to douse every fire. They finally realized, however, that nature needs those fires to clear out the dead wood, prevent disease, and allow the forest to bloom in new splendor. This bailout, like all meddling, keeps us loaded down with dead wood. It slows growth and reduces opportunities in the economy and the stock market.
Let me explain in a little more detail, however, why I did not and do not like the bailout. The bailout, eh hem, excuse me, the “rescue plan” is specifically designed to attract capital away from successful uses and put it back into failing financial services firms. This misallocation of capital will slow the economy’s recovery.
The theory for the bailout says that panic set into the first circle of financial services firms and spread to other institutions. The panic would continue to spiral in a vicious circle until all commerce stopped and no credit would be offered anywhere. Those on the Left allege that this cycle of greed and bust is an endemic problem of an unbridled free market and could become permanent, holding the economy back for years and years. Washington, being beset by that other human frailty, panic, simply had to pass the bailout. Investors, seeing the brilliance of Congress, proceeded to pull money out of the market in droves, dropping the Dow Jones Industrial Average down 1,200 points in the next 8 hours of trading.
The problem that I have with the bailout thinking is three fold. To have a “credit freeze”, enormous amounts of capital must be withdrawn and hoarded metaphorically if not literally under the mattress. Eventually, people are going to use that capital again. People won’t forget how to make medicine, drill for oil, or program computers. The incentive to exchange what I can produce, but don't need today, for what you can produce and I do need today will still be there. The economy will go on.
Second, as the panic pushes prices down the opportunity to make a killing gets bigger. I suspect that if the Porsche dealer in town were panic selling Carreras at 20 cents on the dollar, I would not be the only person in line. Many of the “toxic” mortgage backed securities already offer fantastic rates of return with little risk if you hold them to maturity. Now the government plans to borrow $700 Billion from the public. To get us to lend them the money they have to convince us, with higher interest rates, that loaning them money is better than loaning money to other businesses. This moves capital away from companies with sound business models and moves it to those without sound business models. This decision to move capital away from good companies will slow economic growth and the rate of return available in the market.
Lastly, banks are not necessarily the best arrangement to help capital find its most productive use. With the advent of the internet, we have seen the demise of many a middleman. The music industry is in shambles because entertainers no longer need the lumbering distribution companies thanks to iTunes. Venture capital funds capitalize the tech industry in Silicon Valley, not banks. The next Google does not dress up and go down to First National of San Jose to get a small business loan. Even the news industry is dying because bloggers connect average people with news and ideas that need no filtration and distribution. If someone in Minnesota wants to find out about a news conference at a NASA, they don’t have to read a reporter’s opinion, they can watch it on YouTube. Innovation should not be stifled by helping the old guys stay in business.
Banks are inherently unstable by design. They guarantee a rate of return to depositors and then loan out the money to someone else. A bank invests on the margin, also known as leverage. Banks have a nasty habit of getting over leveraged leading even small panics to become meltdowns. Maybe banks should be allowed to fail because they are simply risky relics that have passed their prime.
You might ask, “How will companies who need loans get money? Where would I put my savings?” Just look at mutual funds. A mutual fund company doesn’t borrow and lend, it only recommends to average people where to put their savings (i.e. their capital) and then charges a fee for the advice and administration. There are hedge funds that allow individuals to lend mortgages directly to other individuals, skipping the whole mortgage bank model. Maybe financial experts should be giving advice instead of taking risks. If we allowed banks to fail the financial services industry might be forced to evolve to a more stable system. What have we chosen to do instead? We have decided to bailout the banks so we can keep doing things the way they have always been done. The bailout keeps the big banks big and status quo humming.
To help you wrap your head around this, let me use a metaphor from nature. When someone yells “Help, help there's a fire!” it's likely to send a chill down the neck of the steeliest men. For years, the forest service instinctively reacted this way trying to douse every fire. They finally realized, however, that nature needs those fires to clear out the dead wood, prevent disease, and allow the forest to bloom in new splendor. This bailout, like all meddling, keeps us loaded down with dead wood. It slows growth and reduces opportunities in the economy and the stock market.
Monday, October 6, 2008
2009 State Business Tax Climate Index
The Tax Foundation recently put out their annual state business tax climate index. I reproduced a graphic found in the pdf that sums up the findings.
HT: Club for Growth
Did Low Interest Rates Cause the Housing Boom? No.
Michael Spence, a 2001 Nobel Laureate for economics wrote a column for Forbes today. In it, he makes this spurious claim, as have a few others:
His article “Will the Bailout Work?” goes on to defend the current narrative on the glorious bailout. The problem is that his above statement fails to match reality as I suspect he simply hasn’t done his homework.
This thinking is wrong. It fails to explain differences in geography and historical evidence that contradicts the logic in previous periods of falling interest rate.
Using national average mortgage rates, we find that prime mortgage rates were at a peak of 8.64% before the boom on May 19,2000 (which really began in earnest in 2001), and then hit an all time low of 5.21% on June 20, 2003. That seems dramatic, so let’s do the math. Assuming that all mortgages were at 8.64%, but were all refinanced at 5.21%. This would imply a 41% increase in purchasing power. That seems to correlate to the increasing prices, but let’s dig a little deeper.
The problem with this thinking is that it would imply no increase in the housing supply. People did not merely bid up the existing housing stock; they built new and bigger houses, remodeling older ones. Furthermore, increased purchasing power does not immediately drive up the cost of construction. In a city with ample supply of land and few development entanglements, there is no reason why an increase in debt purchasing power would be wiped out by a commensurate inflation in the price of building materials. Home construction is a very competitive market, and the price of homes should approximate the cost of construction plus a muted profit margin.
There is also the notion of cross-price elasticity. That is, when people gained debt purchasing power, many chose to refinance and pocket or spend the savings on other things. While this interest rate assumption may correlate well to housing price behavior in California, it doesn’t explain why home prices increases in Atlanta ran at a fairly smooth rate of 4% a year between 1991 and 2007 (S&P Case Shiller). Of course, in California, it also doesn’t fully explain why prices surged by 147%. In short, the cross-price elasticity effect would water down the effects of lower interest rates.
Another problem with this line of thinking is that significant drops in interest rates should have caused housing bubbles in the past. If mortgage rates dropped by 3.5% during the this decade, why wasn’t there a huge bubble after mortgage rates fell from 18% in 1981 to 10% in 1987? Or when they fell from 10% to 7% between 1990 and 1993? In fact, home prices in Los Angeles declined significantly between 1990 and 1993. There is little historical correlation between interest rates and housing price swings.
Explanations for the housing boom and bust:
Interest rate changes – Bogus
Greed – Nice and vague and conveniently impossible to measure
Deregulation – So far, I have seen few specific deregulations mentioned, so I will relegate this to ideological rhetoric until I see evidence
Government mandated sub-prime lending through the Community Reinvestment Act along with Fannie Mae and Freddie Mac – Bingo!
Local and state residential development restrictions that constrained the market and drove up prices – Bingo!
“One should ask why a housing bubble caused by low interest rates…”
His article “Will the Bailout Work?” goes on to defend the current narrative on the glorious bailout. The problem is that his above statement fails to match reality as I suspect he simply hasn’t done his homework.
This thinking is wrong. It fails to explain differences in geography and historical evidence that contradicts the logic in previous periods of falling interest rate.
Using national average mortgage rates, we find that prime mortgage rates were at a peak of 8.64% before the boom on May 19,2000 (which really began in earnest in 2001), and then hit an all time low of 5.21% on June 20, 2003. That seems dramatic, so let’s do the math. Assuming that all mortgages were at 8.64%, but were all refinanced at 5.21%. This would imply a 41% increase in purchasing power. That seems to correlate to the increasing prices, but let’s dig a little deeper.
The problem with this thinking is that it would imply no increase in the housing supply. People did not merely bid up the existing housing stock; they built new and bigger houses, remodeling older ones. Furthermore, increased purchasing power does not immediately drive up the cost of construction. In a city with ample supply of land and few development entanglements, there is no reason why an increase in debt purchasing power would be wiped out by a commensurate inflation in the price of building materials. Home construction is a very competitive market, and the price of homes should approximate the cost of construction plus a muted profit margin.
There is also the notion of cross-price elasticity. That is, when people gained debt purchasing power, many chose to refinance and pocket or spend the savings on other things. While this interest rate assumption may correlate well to housing price behavior in California, it doesn’t explain why home prices increases in Atlanta ran at a fairly smooth rate of 4% a year between 1991 and 2007 (S&P Case Shiller). Of course, in California, it also doesn’t fully explain why prices surged by 147%. In short, the cross-price elasticity effect would water down the effects of lower interest rates.
Another problem with this line of thinking is that significant drops in interest rates should have caused housing bubbles in the past. If mortgage rates dropped by 3.5% during the this decade, why wasn’t there a huge bubble after mortgage rates fell from 18% in 1981 to 10% in 1987? Or when they fell from 10% to 7% between 1990 and 1993? In fact, home prices in Los Angeles declined significantly between 1990 and 1993. There is little historical correlation between interest rates and housing price swings.
Explanations for the housing boom and bust:
Interest rate changes – Bogus
Greed – Nice and vague and conveniently impossible to measure
Deregulation – So far, I have seen few specific deregulations mentioned, so I will relegate this to ideological rhetoric until I see evidence
Government mandated sub-prime lending through the Community Reinvestment Act along with Fannie Mae and Freddie Mac – Bingo!
Local and state residential development restrictions that constrained the market and drove up prices – Bingo!
Friday, October 3, 2008
After the Bailout - Dow DOWN 470 pts
I added the area shaded in gray around the time the bailout passed at 1:22 pm.
I thought that the bailout was supposed to help the markets prevent a sell off. Oops! I guess the media got it wrong again.
Credit Crunch is a Farce - No to the Bailout!
I began to believe within the last few days that the "Credit Crunch" was an illusion, and the more I have dug the more I have come to the conclusion that the Crisis Does Not Exist. It is a false narrative told by those with vested interests and insular Wall Street viewpoints.
According to the FDIC, only 13 banks have failed so far this year. This compares to 11 in 2002, and thousands after the Savings and Loan debacle. We have yet to reach a level of bankruptcies to warrant dramatic action.
Looking at total bank lending according to the Federal Reserve, again I do not see contraction of loan activity as is claimed. Link here. Lending is flat over the last few months, but similar events happened in 2003, 2002, 2001, and 1999. Furthermore, Commercial and Industrial loan activity has not contracted at all. Link here. The press keeps claiming that businesses can't get loans. Between 2001 and 2004, Commercial and Industrial loan activity contracted by around 18%, but we have yet to see any fall in recent history.
Mind you, the links I provide only show data up until the beginning of August. However, Alan Reynolds has written a piece for Forbes that includes data up through September 17th. (Includes a nice table) He is coming to the same conclusion that I am.
The bailout will not work. The "Credit Crunch" is a farce. This is a Wall Street problem, NOT a Main Street problem. Encourage your Congressman to Vote NO to the bailout.
Update: - Unfortunately, it passed. Not good for the economy. What do we do in 3 months when the bailout clearly did not work.
According to the FDIC, only 13 banks have failed so far this year. This compares to 11 in 2002, and thousands after the Savings and Loan debacle. We have yet to reach a level of bankruptcies to warrant dramatic action.
Looking at total bank lending according to the Federal Reserve, again I do not see contraction of loan activity as is claimed. Link here. Lending is flat over the last few months, but similar events happened in 2003, 2002, 2001, and 1999. Furthermore, Commercial and Industrial loan activity has not contracted at all. Link here. The press keeps claiming that businesses can't get loans. Between 2001 and 2004, Commercial and Industrial loan activity contracted by around 18%, but we have yet to see any fall in recent history.
Mind you, the links I provide only show data up until the beginning of August. However, Alan Reynolds has written a piece for Forbes that includes data up through September 17th. (Includes a nice table) He is coming to the same conclusion that I am.
If all the recent hysterical chatter about lending being "frozen" or "shut down" refers to anything real, it is not about banks loans (through Sept. 17) but about such arcane financial markets as asset-backed commercial paper or loans between banks. But this too is mainly about financial firms, not Main Street.Adding to the case is anecdotal evidence from my hometown paper, the Houston Chronicle.
To top it all off is economist Alex Tabarrok of Marginal Revolution blog:"It has not had any change to the way we offer and extend credit to our customers," Mike Poppe, chief financial officer for Beaumont-based electronics and home furnishings retailer Conn's
"Everything is the same," said Mike Even, Finger Furniture's general manager. "I don't see any changes anytime soon."
There is also a consensus among economists that the bailout bill is not the right policy. None of the above economists, for example, is enthusiastic about the bailout. My bet is that all of us think that the bailout has a substantial likelihood of failing. The support that exists is born out of hope and fear not judgment and experience. Nevertheless, the political consensus is that a bailout is what we will get whether it is likely to work or not. (bold is mine)The above economist are: Paul Krugman, John Cochrane, Luigi Zingales, Douglas Diamond, Raghuram Rajan
The bailout will not work. The "Credit Crunch" is a farce. This is a Wall Street problem, NOT a Main Street problem. Encourage your Congressman to Vote NO to the bailout.
Update: - Unfortunately, it passed. Not good for the economy. What do we do in 3 months when the bailout clearly did not work.
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