Subsidizing Irresponsible State Governments

Don't cut spending, increase your begging.

In recent months, a number of states, especially New York, have been cranking up the volume on their need for bailouts. Their tax revenues have fallen sharply and they are facing large budget deficits. As far as I am aware, no state allows itself a budget deficit. If revenues drop, they have to cut spending. Those who believe in Big Government don't think they should be bound by budget constraints. Now they have found powerful friends in Congress to help them out.

The Wall Street Journal quotes Congressman Charlie Rangel:

Our hope is that the leadership of both parties will be able to confer and come back after the election, and see what we can do to provide assistance to our local and state governments, as we have been able to do for our banking and finance industry

Moral Hazard is the result of removing the downside risks of personal behavior. In my industry, Insurance, we see this all the time. Even in Life Insurance, people are slightly more likely to commit suicide when they have significant coverage.

Now we have states that spent more during the good times, and don't want to have to cut back in the bad times. Bailing these states out will insure that their spending continues to climb in the future. What lesson does this provide for other states, like Texas, that have braved political fallout by ruthlessly cutting spending during previous downturns?

The simple message of this plan to state politicians is: If you cut spending you'll get bad press and your citizens will have subsidize the bailouts of states more wasteful than your own. Don't cut spending, increase your begging.

Nice Essay on Property Rights, Houston, and No Zoning

Brian Phillips at his Live Oaks blog has a nice essay about Houston and it's rejection of zoning. He makes the moral case of maintaining my home town's rejection of a rampant form of anti-market thought that has gone mostly unnoticed by most national economists.

His words:

Those in favor of tighter land use regulations voice numerous arguments in support of their proposals. Such controls will improve our quality of life, stabilize property values, and empower the citizens. But underneath all of these arguments lies one unspoken premise-- some individuals may impose their values upon others. Some individuals may use force to dictate the actions of others. Which means, the values of some may be sacrificed to others.

...

Houston has become the star of the Lone Star state because it has implicitly rejected this premise. Houston has largely respected property rights, and has thus not used political coercion to dictate the actions of individuals.

A Partial Victory for Mexico

The Houston Chronicle reports that Felipe Calderon's legislative attempt to allow foreign investment into Pemex operations has passed. I have tried to push a bilateral agreement between the U.S. and Mexico to liberalize their Oil industry in exchange for more open worker programs and citizenship agreements.

The pertinent excerpts.

"The measures also will create a plan for performance bonuses for drilling and production contractors and will permit Pemex to sell bonds to the public, according to George Baker, a Houston analyst who specializes on Mexico's energy industry."

"While infuriating many on the left, the package fell short of what free-market proponents and private companies had hoped."

"Mexico's oil industry, which funds nearly 40 percent of the government's budget, has seen its production plummet in recent years as the huge Cantarell field, in the southern Gulf of Mexico, has begun to play out."

"Baker said the reforms may be a step in the right direction, but he added that that they do little to improve the chances of attracting foreign companies to drill in Mexico's deep-water Gulf. And, he said, time is running out."

"They have declining production, declining prices," Baker said. "There's even a greater urgency now than there was before."

A Look Back At My Housing Predictions

In late February, I made some predictions on housing prices in five cities. I predicted that home prices in these five cities would continue to fall based on an assumption that property values would go back to their long-term trend using the S&P Case Shiller index. The starting values were those reported for December of 2007. Here are those predictions:

Miami – 32% drop
Los Angeles – 31%
Tampa, FL – 28%
Las Vegas – 28%
Washington – 24%

Here are the numbers today:

Miami – 21% drop
Los Angeles – 19%
Tampa, FL – 13%
Las Vegas – 23%
Washington – 11%

Conclusion: While prices in many markets are continuing to fall, Washington and Tampa will not reach the depth that I projected unless something else happens. The month-to-month numbers for those two cities show that prices have leveled out and are at or near their bottom. Miami and Los Angeles may approach my prediction. Las Vegas will almost assuredly meet my prediction as prices there are continuing to fall by 2+% per month with little indication that this rate will change soon.

Katy Freeway Needs a Bailout – Fast!

A little levity for today. If you’re not from Houston, the Katy Freeway (I-10) is home to major operational centers for Exxon, Chevron, Conoco and Royal Dutch Shell, amongst many other smaller firms.

From Kansas to Qatar, investors are pulling their money out of oil until they know how low oil prices will really go. The market is plunging as oil prices have fallen by over 50% in the last few months. If the government doesn’t act soon, this crisis will spread from the Katy Freeway to Main Street. Oil companies are quickly finding that no one wants to buy their oil at its true value.

There are already unsubstantiated rumors of some highly leveraged oil speculators shutting down production. The panic setting in on the Katy Freeway is spreading. Although, only two oil companies have declared bankruptcy so far this year for seemingly unrelated reasons, experts believe that dozens of oil companies are on the brink of bankruptcy. The fear gripping the market right now could lead oil companies simply to halt drilling and production until the bottom is reached.

The U.S. Energy Secretary has announced an $800 Billion plan to purchase oil wells around the country, and possibly outside of the United States, to drive up prices and get oil companies drilling again. The Secretary and Federal Reserve Chairman Ben Bernanke argued before Congress that the American taxpayer would not be left holding the bag, as they have already agreed to debase the value of the dollar to drive up oil prices and make a killing.

Ample evidence abounds that the “Energy Crunch” is spreading from the Katy Freeway to Main Street. Power outages from the shortage of oil have been widespread. Jim Boone, of Louisville, Kentucky, reports no power for up to three hours yesterday at his Burger Barn restaurant saying, “Power just isn’t available anywhere.” The fear on Main Street is just as palpable as it is on the Katy Freeway.

Many experts believe that if the government doesn’t marshal a plan to rescue the price of oil, we could see mass shortages soon. Bob Samuelson, President and Chief Strategist of BS Investments comments, “Prices at the pump may fall under $2, but there won’t be any gas to be had. It’s simple economics.” He also adds, “Some investors may want to consider melting down their cars to build bicycles to weather the current crisis.” However, Warren Buffet has tried to reassure Americans in an op-ed for the Wall Street Journal that, “In the long run, the automobile will get you where you need to go at a much faster pace than a bicycle.” Warren Buffet in another interview for CNBC reiterated this point by revealing plans to buy a grossly underpriced late model Buick he saw on Craigslist over the weekend.

Tonight, the President will deliver a speech to the American people to reassure them that the government will be able to solve this crisis.

O'Grady Corrects Obama

Mary Anastasia O'Grady is one of my favorite columnists because she seems to be one of the few people on the planet with both a good knowledge of economics and South America. Obama being terribly misguided on the first and woefully ignorant on the second spewed some nonsense in the last debate, and she calls him on it. I have supported Colombia before and the Colombia FTA.

A few excerpts:

He reached into his memory bank for whatever he had been told to say about Colombia. He seems to have found his hard drive loaded with Big Labor talking points. Here's what it spit out: "The history in Colombia right now," he said, "is that labor leaders have been targeted for assassination, on a fairly consistent basis, and there have not been prosecutions."

By the time President Alvaro Uribe took office in August 2002, Colombia was almost a failed state. That year there were 28,837 homicides nationwide, making it one of the most dangerous places on planet Earth.

As a Journal editorial on Friday explained, from 2002 to 2007 the number of murdered Colombian union members dropped by almost 87%. By any fair standard that is progress, especially considering the pattern Mr. Uribe inherited. In 2000, 155 unionists were murdered and in 2001, 205 died. The numbers only started to come down when he took the helm.

We could help the economy a bit by passing the Colombia FTA, but I guess that helping a booming Colombia that has enacted rapid deregulation, free trade, and privitization would be an embarrassment for Leftist ideology.

Credit Crunch a Farce - Federal Reserve Agrees

Economist Mark Perry, at his blog Carpe Diem, comments on a working paper written by the Minneapolis Federal Reserve. I concured with Mr. Perry's evidence when he initially started expressing his doubts. It blasts a hole in what I referred to as the "false narrative told by those with vested interests and insular Wall Street viewpoints".

Here is an excerpt that he pulls from the paper:

The financial press and policymakers have made four claims about the nature of the crisis.

1. Bank lending to non-financial corporations and individuals has declined sharply.
2. Interbank lending is essentially nonexistent.
3. Commercial paper issuance by non-financial corporations has declined sharply and
rates have risen to unprecedented levels.
4. Banks play a large role in channeling funds from savers to borrowers.

Here we examine these claims using data from the Federal Reserve Board. At least based on data up until October 8, 2008, we argue that all four claims are false.

I find #1 to be the most egregious, as it was the primary claim repeated incessantly by the press that convinced many Americans and their Congressmen to vote for the bailout.

Top Ten Reasons To Expect a Long and Ugly Recession

A few weeks ago, I wrote that I did not yet see a Depression coming. However, as the election becomes less and less in doubt, everything is pointing to a painful contraction. The horrid mistakes I thought might not come to pass are looking more and more certain.

The real damage will be caused by the destruction of capital. Financial capital, being the net savings held by individuals, is the lifeblood of economic growth. Without a growth in capital, there cannot be economic growth. If capital is contracting then growth will contract.

1. Second Stimulus – As I wrote before, the stimulus destroys capital. It borrows from the capital market and gives to lower income individuals who have a lower personal savings rate. Capital will disappear as it is used to consume and not invest. Odds of passing? Certain.

2. Health Care Plan – While Obama’s economists claim that this will only cost $60 Billion per year, it is likely to cost more than twice that amount. Furthermore, once it goes in front of a Democratic Congress the largess will balloon the price further north. This will require massive borrowing or higher taxes (which will certainly be on the “wealthy” holders of capital) capital will decrease as it is used to consume and not invest. Odds of passing? Certain.

3. Higher marginal taxes – The supply-siders are correct that this will reduce the incentive to work. Those at the top have a much higher savings rate and thus accumulate far more capital. Higher taxes means lower work incentive and lower savings rates. Capital will be taken out of the market and given to the government. The tax “cuts” are unlikely to offset this hike because lower income people will consume almost all the savings. Odds of passing? Certain.

4. Capital gains tax hikes – At the very least, higher capital gains taxes explicitly take away capital growth which reduces economic growth. However, they also have the effect of driving investment out of the United States. Ironically, history has shown higher capital gains taxes will produce little to no additional revenues for the government. Odds of passing? Very high.

5. No new free trade and renegotiated trade agreements – No new free trade reduces the potential growth of capital. As Al Gore is fond of saying, "there is a scientific consensus" that free trade improves the economy. Fair trade is a euphemism for less free trade. Any renegotiated trade agreements with fair trade ideas in mind will mean a contraction in the economy. Odds of passing? No new free trade agreements – Certain. Mostly worthless fair trade agreements – Certain. Renegotiations - Thankfully, unlikely.

6. Government spending – I don’t see how anybody in their right mind thinks that the party who wantonly spent ever increasing amounts of money whenever in power over the last 80 years is suddenly going to reform themselves. Until I see Pat Toomey baptizing Sen. Robert Byrd on the shore of the Potomac, I’ll remain skeptical. More government spending, more borrowing. Borrowing capital to use for consumption reduces growth. Odds of passing? More than certain.

7. Wall Street Bailout – Even though I believe this to be temporary, it is still a misallocation of capital. Government misallocations of capital happen all the time, but not of this size. This is $700 Billion dollars. Much of this will lie stagnant in banks to provide unneeded capital to restore confidence in the banking system for the next two years.

8. Lengthening unemployment benefits – I have talked about this one as well. Studies, and logic, show that lengthening unemployment benefits increases unemployment. A good guess is that the rate will increase by an additional 1%. Fewer workers means less output. Not only does the surplus labor pool slow growth, but becomes a net negative because the government allows them to continue to consume. Odds of passing? Certain.

9. Other job interferences – Expanding food stamps, free/subsidized housing, increased minimum wage, etc… None alone will create significant damage, but the accumulation of all the feel good bills will give enough incentive to stay unemployed so the rate will be higher than it needs to be. Odds of passing? Certain.

10. Another moronic Keynesian spending package that has yet to be announced – After the economy continues to stagnate next year another misguided Keynesian style “Stimulus” plan will be revealed. We’ll call it Stimulus 3. Paul Krugman, of the New York Times and patron saint of the Democratic economic thinkers, is already pushing for increased “infrastructure spending”, by which he means haphazard government consumption of resources. This will require more borrowing of capital. This will reduce capital, and reduce growth. Odds of passing? Likely.

The coming Pyrrhic victory for the Leftist ideology almost amuses me, if not for the carnage they leave behind.

Another Stimulus

Federal Reserve Chairman Ben Bernanke said yesterday that “consideration of a fiscal package by the Congress at this juncture seems appropriate”. President Bush is open to the idea, and Nancy Pelosi is chomping at the bit to pass it during the lame duck session after the election. It is almost certain the pass, and the size I have seen tossed around is $300 Billion.

What will the stimulus do?

I will assume for now that the stimulus is once again a simple mail out of checks. I have heard of other spending possibilities, but it has all been rather vague. Even some free market types who have not completed their Jedi training, would have you believe that all we are doing is borrowing future growth for present growth. The costs, they believe, are small to reduce the hardship of recession.

However, there is an additional problem with the “stimulus” that reveals that it will do nothing to help the economy, just like the first “stimulus”. To pay for it, the government will have to borrow funds from the capital market. To induce private holders of capital to loan money to the government they have to increase interest rates to gain a larger share of the capital market. This increased demand on capital causes all interest rates to rise as people and their businesses compete for the limited supply of capital. An increase in the real interest rate makes the rate of return on business investments lower, and thus fewer private business deals happen. In short, less economic growth in the private sector offsets the increase in the economic growth in the public sector.

In general, the stimulus will be a net drag on the economy. It’s really a stretch to believe that forgoing long-term business investments in hopes that individuals will profligately gobble up our limited resources is good for the economy. Don’t gripe at AIG for spending precious funds on spa treatments for sales reps, when your economic plan relies on Americans doing the exact same thing.

Government Run Health Insurance: More Hope than Reality

In 1993, President Clinton tried to pass a single payer government run healthcare system, derisively labeled “HillaryCare” as Hillary became the first First Lady to take on such a public role. This system was to move the United States to a system like the U.K. where the government owns all the hospitals and clinics, and employs all of the doctors. Because of the failure of HillaryCare and the truly abhorrent stories that come out of Canada and the U.K., Democrats have now switched to pushing government run health insurance. Barack Obama is pushing his own version on the campaign trail.

The question then becomes, did these arrangements cost as little as promised where they have been tried in the United States.

Romney Care

Mitt Romney, former governor of Massachusetts and Republican Presidential Primary Candidate helped craft a universal health care plan for that state. Included in that plan was a subsidized health care insurance program called Commonwealth Care. It was designed to offer competitive insurance for those currently without insurance and incomes below 300% of the federal poverty line. (For a family of 4 that would be $63,600 a year.)

The insurance program was supposed to be relatively inexpensive. Like Obama’s plan there is a fine for not signing up for insurance. The theory went that if they could pool all the uninsured, including a large number of young people who use very little medical services, the premiums wouldn’t have to be very high. This is the essence of Barack Obama’s plan as well.

Did the plan stay in budget? Not by a long shot. According to Massachusetts Governor Patrick’s new 2009 budget, how big will this next year’s budgeted amount and increase have to be?

“$869 million for Commonwealth Care, an 84 percent increase over the fiscal year 2008 General Appropriations Act”

Furthermore, according to an article from the Boston Globe:

“...the state expects to spend substantially more for insurance subsidies than the $869 million Governor Deval Patrick proposed in his 2009 budget just two months ago, because of increasing enrollment and higher payments to insurers. In private briefings, she has told coalition members that the cost could be $100 million more, according to several who were present.”

If you do the math, that’s a 105% increase in costs for the program in a single year.

Keiki Care

In 2007, Hawaii created a free insurance program called Keiki (Child) Care. Like the SCHIP expansion championed by the Democrats and vetoed by President Bush in the same year, children who’s parent(s) made too much to qualify for Medicaid could get free basic health insurance.

The Washington Times quoted the President after vetoing the SCHIP expansion:

"If this bill were enacted, one out of every three children moving onto government coverage would be moving from private coverage."

When Hawaii passed a very similar program, what happened? According to the Associated Press:

“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.”

"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."

So, President Bush was wrong. It was not going to be just 1 out 3 children dropping out of private coverage to get the free government insurance, it was more than 1 out of 2.

What did Hawaii do once they figured out that the insurance plan was going to cost far more than estimated? They ended it, after a mere 7 months. How refreshingly responsible.

Obama’s Plan

What will Obama’s plan cost? Whatever you hear them quote, it could easily be double. Will people drop their private health care coverage to get on the government dole? By the millions. Can we really believe that Obama and his fellow skeptics of the free market could so blindly underestimate the costs of their plans? Everyone together: YES, WE CAN!

My Long Lost Twin

I happened to be doing a little surfing of Econ blogs and found this blog post at The New Yorker Magazine by James Surowiecki. His post is virtually identical to one I posted on Friday. Even though the article was an AP story available in many locations he linked the exact same yahoo news source that I used in my post.

October 17, 2008
No, This Is Good News

Trying to explain why markets are acting in a particular way on a particular day is a classic mug’s game (although I should say that it’s a game that I myself will play in another post later today). Nonetheless, it’s good that everyone in the financial media is constantly trying to do it, because it helps clarify the assumptions that shape their view of the economy.

Take, for instance, this headline from this morning’s A.P. story on pre-market action: “Stocks open lower after data show larger-than-expected drop in new home construction.” The assumption in that headline is that a big drop in new home construction is a bad thing for the economy. And it’s true that in the short run, the drop in home construction is not great for construction companies, homebuilders, equipment manufacturers, etc. But for the economy as a whole, this drop is actually a very good thing. In fact, it’s precisely what we want.

One of the biggest problems the economy faces is the mismatch between supply and demand in the housing market, because of the lingering effect on prices of the housing bubble (prices are still too high in much of the country), and because there was massive overbuilding in much of the country. So things that get supply and demand back into sync—like steep cutbacks in the number of new homes being built—are good things. This really is a case of short-term pain leading to long-term gain. And I suspect that investors probably understand that, even if the A.P. thinks they don’t.

Fewer Housing Starts is Good News, Not Bad

Another AP article. This time at Yahoo!Finance. The lead story on their site says "US stocks set to open lower after housing data". In their imbecilic efforts to attribute every stock movement to a news story they misunderstand that this is good news for the financial panic.

Home prices across the United States are still falling. Not as quickly as they were earlier this year, but most major markets are still dropping. The price of anything falls for the sole reason that there is more of the product than people want to buy at the current price. What would be truly scary is if home construction was increasing during a glut.

For all of these mortgage backed securities to attract investors we need the price of the underlying assets (houses) to stop falling. Few want to buy these securities because they are uncertain what they will eventually be worth (Well, security holders are also hoping the Hank Paulson is going to give them an above market price). The more rapid the decline in home construction, the sooner we hit the bottom of the contraction. In short, not only is it good news that home construction is declining, but it is better news that home construction is declining faster than originally predicted.