Coyote Blog

Everything Explained

The comedians have pretty much nailed it, via Jeffrey Tucker

Lenders Have to Lend

I know this may be pointing out the obvious, but I think it needs to be said:  Lenders have to lend, just as much as borrowers have to borrow.  I know most people understand the "borrower" part of this phrase, but they seem to act as if lenders are somehow only putting their money on the street as some sort of charitable activity, and if we don't sufficiently kow-tow to all their needs, they will run away and never help us all again.

The fact is that people with large pools of money -- banks, pension funds, insurance companies -- HAVE to lend.  And in a time where stocks are dicey, they probably have more, not less, cash than normal they want to lend, much of it short-term.  Now, they may be temporarily scared off from doing so for a few days or weeks as they try to assess what is safe and what is not, but they can't stick their money in a mattress or buy tons of gold or invest in ammunition and run for the hills.  Banks have to pay off depositors; insurance companies often aim to break even on premiums and payouts and make their money on investing the cash in between; pension funds can't make their long-term obligations without making steady returns.Their very survival, in many cases, depends on making continuous returns off their free cash. 

Wisdom from Schoolhouse Rock:

You got a couple hundred bucks saved up in your birthday stash.
Why not deposit them dollars in the bank instead?
Then at the end of the year you'll come out way ahead,
Because the bank'll pay you money in exchange for the use of your cash!
And that's called interest; you're makin' money that way,
And you can buy that gear about a year from today.

      

In Praise of Price Gouging

As I have pointed out any number of times, when supplies of something are short, you can allocate them either by price or by rationing.  Robert Rapier, via Michael Giberson made the point that combining shortages with tough state price-gouging laws inevitably led to rationing and long lines:

Someone asked during a panel discussion at ASPO whether we were going to have rationing by price. I answered that we are having that now. But prices aren't going up nearly as much as you would expect during these sorts of severe shortages. Why? I think it's a fear that dealers have of being prosecuted for gouging. So, they keep prices where they are, and they simply run out of fuel when the deliveries don't arrive on time. If they were allowed to raise prices sharply, people would cut back on their driving and supplies would be stretched further.

Neal Boortz made the same point yesterday, as the gas shortages in the southeast dragged out (unsurprisingly) for a second week:

nearly 200 gas stations in Atlanta are being investigated for price gouging.  Don’t investigate them!  Reward them!  Price gouging is exactly what we need!  It should be encouraged, not investigated....

The real problem now is panic buying.  People will run their tanks down by about one-third and then rush off to a gas station.  Lines of cars are following gas tanker trucks around Atlanta. The supplies are coming back up, but as long as people insist on keeping every car they own filled to the top and then filling a few gas cans to boot, we're going to have these outages and these absurd lines. 

So, how do you stop the panic buying?  Easy.  You let the market do what the market does best, control demand and supply through the price structure.  The demand for gas outstrips the supply right now, so allow gas stations respond by raising the price of gas .. raise it as much as they want.  I’m serious here so stop your screaming.  The governor should hold a press conference and announce that effective immediately there is no limit on what gas stations can charge for gas.  I heard that there was some gas station in the suburbs charging $8.00 a gallon.  Great!  That’s what they all should be doing.  Right now the price of gasoline in Atlanta is artificially low and being held down by government.  That’s exacerbating the problem, not helping it.  Demand is not being squelched by price. 

As the prices rise, the point will be reached where people will say "I’m fed up with this.  I'll ride with a friend, take the bus or just sit home before I'll pay this for a gallon of gas."  Once the price of a gallon starts to evoke that kind of reaction, we're on our way to solving the problem.  When gas costs, say, $8.00 people aren't going to fill their tanks.  They also aren't going to rush home to get their second car and make sure it is filled up either ... and you can forget them filling those portable gas cans they have in the trunk.  Some people will only be able to afford maybe five gallons!  Fine!  That leaves gas in the tanks for other motorists.  Bottom line here is that people aren’t going to rush out to fill up their half-empty tanks with $8.00 gas.

Here is something else to think of about lines and shortages.  What is the marginal value of your time?  I think most people underestimate this in their day to day transactions.  Some will say it is whatever they make an hour at work, and that is OK, but I will bet you that is low for most folks.  Most folks would not choose to work one more hour a week for their average hourly rate.  Start eating into my free time and family time, and my cost goes up.  That's why overtime rates are higher.   

So let's say an individual values his/her time at the margin for $25.  This means that an hour spent waiting in line or driving around town searching to fill up with 10 gallons raises the cost by $2.50 a gallon.  And this does not include the fuel or other wear on the car used in the search.  Or the cost of that sales meeting you missed because you did not have the gas to get there.  So an anti-gouging law that keeps prices temporarily down by a $1 or so a gallon may actually cost people much more from the shortages it creates.   

The Alternate View

Several people I know have argued with my "do nothing" approach to the current mortgage and liquidity mess.  Their argument is that the current crisis has frozen the short term money market, with banks refusing to lend to each other, and only doing so via central banks.  The problem, they claim, is that this could lead to an extended drying up of business to business credit.  For example, two people both used the fuel retailing example, arguing that inventory purchases are made on credit, and paid off as the inventory is sold.  The logic, I assume, is that businesses have all reduced their working capital, and so a drying up of short term business credit will cause the economy to lock up, with producers and retailers unable to buy components and inventory.  One such argument here.

I guess the questions are 1) for how long and 2) how best to fix it.  To the first question, this is by no means the first time in my lifetime that short-term credit has dried up.  Liquidity eventually returns, mainly because lenders need to lend as much as borrowers need to borrow.  As to the second question, central banks are currently handling this by increasing the amount of money they will lend short term.  Rather than lend to each other directly, bank A deposits with the Fed and then the Fed lends to bank B.  The cycle ends NOT when every bank is healthy but when banks and other institutions are confident they know which banks are healthy.  All the bailout is doing is delaying this reckoning.  I don't think it matters that banks and certain financial institutions survive, I think it matters that the ones who are not going to survive are identified quickly so the rest can start lending again to each other.

Given these concerns, I reiterate my position that if the government is going to inject liquidity and create new financial asset insurance programs, it makes more sense to me to do it at the point of concern, i.e. in the credit market to main street businesses, rather than dumping the money into the toxic sludge of credit default swaps. 

Two MILLION Visitors

 

Thanks, folks.  I still remember the first month I blogged about four years ago, when I wrote and wrote and was fairly sure not a single person was reading.  Like performing to an empty room.

Where is the Credit Crisis?

Mark Perry observes that if we are in for a credit crunch, its not showing up in the numbers yet, as bank loans and leases hit an all-time high and most other types of lending are still near their peaks.

Shadegg on the Bailout

I missed this excellent interview with my local Congressman, John Shadegg, whom I don't always agree with but is still way better than 99% of Congress:

 

David Freddeso: Is a bailout necessary to save the economy at this point from complete collapse — from a major failure of multiple institutions at the same time?

Shadegg: I think that’s the most difficult question that could be posed under these circumstances, and it’s the question that I have struggled all week to find the answer to. I have talked to a lot of smart people who know Wall Street, know banking, know the economy quite well, and you hear different opinions. Some will tell you that it is absolutely essential. Quite frankly, I’m skeptical about that.

But I think that in some ways the question doesn’t matter any more. Because Secretary Paulson chose to raise the matter in the way he did — that is, to go public in a very high-profile way, not just with his concern, but with a kind of Chicken-Little, the-sky-is-falling kind of demand — it became a self-fulfilling prophecy.

That is to say, once the secretary of the Treasury announces to the world that there is a pending financial collapse, perhaps as great as the Great Depression, and Congress must act — he has sent a signal that essentially tells world markets that Congress must act. I will tell you that has been one of the most frustrating things about this since the very beginning...

I can’t tell you how many members of Congress were stunned at that news, and were stunned that none of their local bankers were calling them. And then they called their local bankers, as I called my local bankers, and my local bankers said, “I think things are just fine.” I talked to one banker who said, “Gosh, we’ve got money, and we’re liquid, and we’re making a profit. And we’re in the market selling loans, and we’ve got competitors trying to sell loans against us.”

So, at that point, there’s a disconnect. Secretary Paulson is claiming that this is a catastrophe of generational proportions that could go worldwide. And none of what we were hearing back home matches that. And I’m not speaking just for myself, but also for many of my colleagues who were making similar calls. They weren’t being called by their bankers, or by any of the businesses back home saying, “I can’t borrow any money”.... If, in fact, Paulson had struck a chord with the American banking community, wouldn’t you think that after he announced on Friday that there was a crisis of liquidity that threatens the entire nation’s financial solvency and Americans’ jobs from coast to coast, that my community bankers in Arizona wouldn’t have been picking up the phone by Monday morning, if not over the weekend, to say that “I share the Secretary’s concerns”?

 

Dale Franks on the Bailout

I thought Dale Franks has a really good post on why the bailout is a crock.  Its quite long, but here is one excerpt:

Banks that made bad mortgage choices get a buttload of money for their bad MBS paper. Banks that charted a more reasonable course—and yes, there are quite a few—get no reward.

In a real free market, of course, the banks that made bad decision would have to take the hit. They’d auction them off at whatever price the market would bear, and they’d have to suck up the losses on the difference between face value and sale value, even if that meant driving them out of business. Meanwhile, the more rational banks would be able to pick up the MBS paper at a discount, and make some cash off of the distress sale from the incompetent banks.

And, of course, the incompetent banks would probably be driven out of business.  Which, after all, is how it is supposed to work. But, the government seems entirely uninterested in letting the market work this out, which brings me to my next point....

I keep hearing over and over again—and I’ve even said it—that no one knows what these mortgage backed securities are worth. But let’s be clear here: the reason we don’t isn’t because the price is mystifyingly unknowable. It’s because they haven’t even tried to sell them off yet. We already know it’s possible to find out what the price is, simply by offering them up for sale. Indeed, we did it in July when Merril Lynch sold off its entire MBS portfolio.

The reason we’re not doing it now is because the holders of MBS paper expect a government bailout, and they expect to receive through it a price significantly higher than they would in the secondary market. If it were otherwise, they’d already be auctioning them off.

After all, we’re talking about securities based on the value of mortgage repayments. We already know that the default rate on most of the MBS paper will be around 5%, with a maximum of probably no more than 10%. Everybody already knows this. Now, just to turn the screw, a buyer might want a discount of over—perhaps well over—50%. after all, it’s a fire sale, and everybody wants a bargain, right.

But there is a market-clearing price for these securities, and everybody on the street knows it. What they also know is that they have an excellent chance of receiving a much better price from the Feds, and that waiting for the bailout gives them a better chance to stay in business, even if the Treasury is a large shareholder in the company. And, after all, if the Treasury is a shareholder, how likely is it that the government will let them fail, losing all that equity?

The bailout doesn’t solve the problem. It keeps the bad banks in business, lets them escape the worst consequences of their malfeasance, and prevents the better run banks from taking up the reins that would be otherwise dropped when the bad banks went out of business.

Exactly

Sometimes I snap at someone for their criticism of a particular politician.  Typically, they assume I am doing so because I support that politician.  But in reality, I am using just sick of the implication that somehow other politicians would have been much better.  I absolutely agree with Don Boudreaux's comment:

Fareed Zakaria (author of a truly fine book and columnist for the Washington Post) rightly argues that Sarah Palin is unqualified to be president of the United States (and, hence, by extension, unqualified to be V-P). Mr. Zakaria is correct that Gov. Palin's recent answer to a question about the economy "is nonsense - a vapid emptying out of every catchphrase about economics that came into her head." He's correct also that she's unfit to be entrusted with the power of the modern presidency.

But Mr. Zakaria is incorrect to suppose that these traits separate Gov. Palin from other candidates for high political office. Calls by Senators McCain and Obama for cracking down on "speculators" are full of classic and wrongheaded catchphrases, as is Sen. Obama's vocal skepticism about free trade. Gov. Palin is merely less skilled in passing off inanities and claptrap as profundities.

My Alternative to the Bailout

This is taken from and expanded from the end of this post.

Everyone involved in the bailout plan says, at least publicly, that they are not trying to bail out a bunch of Wall Street folks who lived high off the risk premium of these investments but now want to avoid the costs when the actual risks become clear.  They claim to be bailing out Wall Street and various large banks because they fear that a financial meltdown and liquidity crisis will starve main street businesses of cash, and create a deep economic slowdown.

OK, if this is the real policy goal -- to maintain the ability of main street businesses to borrow -- then here is my alternative proposal:

1. Immediately increase the SBA loan gaurantee authority by $100 billion dollars.  That is enough for a million new small business loans of $100,000 each.
2. Authorize treasury to spend up to X hundred billion to buy rated new issues of bonds and commercial paper of US non-financial companies.  Some limits should be applied - such as the feds cannot buy any more than 30% of a single issue and/or more than 10% of the entire outstanding debt of one company.

That's the plan.  Here are the advantages:

• The government is addressing the actual policy goal of keeping liquidity in main street business directly
• The government is investing in success, in main street companies trying to grow, and not in failed banks and financial institutions
• Moral hazard issues are avoided with financial institutions. 
• The SBA loan guarantees cost nothing today.  In fact, they are cash positive in the short term due to loan guarantee payments by borrowers.  Of course, they risk future losses,  but such losses in the future are in part covered by the guarantee payments, and a future loss is cheaper than a loss today.
• Investments in corporate bond issues are much easier to value, and are far less risky, than investments in illiquid mortgage securities.  The taxpayer is far less likely to take a beating on these purchases.
• Banks may still fail, but the FDIC has an infrastructure and experience for handling this.  If necessary to calm people, the FDIC could make a public commitment to assisted mergers to maintain all depositors.
• If there is some big financial meltdown, which I still doubt, there might be a need to inject some mortgage liquidity, but since the Feds now own Fannie and Freddie, the vehicle for doing so is easily available.

Update:  I was not clear -- this is actually an alternative to by alternative.  My first, preferred alternative plan is "do nothing."

Final Thoughts on the Bailout (I Still Don't Like It)

I sat this weekend and pondered the pending financial bailout.  A number of fairly smart people who know more about Wall Street than I seem to think it a necessary evil, and this includes several folks who are nearly as libertarian as I.  Is a sort of knee-jerk libertarianism preventing me from accepting a necessary step to avert economic Armageddon?

I don't think so.  By the light of day on Monday morning, I still think it a bad idea.

Here is some of my thinking (to some extent my last point is the one that is most important to me -- if we want liquidity, let's put it in the right place).

• I am tired of businesses heading to the government bailout trough and arguing that the continued functioning not only of their industry, but of all the existing players in their industry, is critical to the health of the US economy and thus requires some sort of government subsidy/bailout/protection.  Coyote's first law of rent-seeking is that companies will always claim that failure of their business will have a disproportionately negative effect on the economy.  Coyote's first corollary to this law is that Congress usually accepts this argument at the exact point in time when it is no longer true.
• This bailout is even more grotesque than a normal industrial bailout.  GM can be said to have honestly tried to make the right cars, and just failed.  I don't like bailing them out, because I don't particularly like diverting capital into the hands of organizations that are proven failures at using capital well.  But the financial investors that we are bailing out today knew they were taking a lot of risk by purchasing risky securities and then leveraging them up on their balance sheets.  They lived high for years off of the fat returns for taking this risk, arrogantly explaining that they made lots of money because they were smarter than everyone else and because they were being rewarded for taking on risk.  But then they come running to the government when the returns on their risky securities turned south, which just makes me sick.  They were paid for taking this risk, so take it.  I am sorry that you have no cushion because all those earlier returns are already spent on Maserati's for your mistresses, but that is what chapter 7 is for.
• As many as 300,000 small businesses go bankrupt every year (this number is very, very hard to pin down, as it is hard to separate personal from business bankruptcy with small business).  Something like 299,998 of them do not get bailed out by the feds.  Why do the other 2 get special treatment vs. other US taxpayers?  Because they are better at lobbying Washington that they are essential?
• Yes, the government created the Alt-A and sub-prime mortgage markets,and caused them to flourish via Fannie and Freddie aggressively asking for and buying these loans.  And the feds, via tax policy, and local governments, via zoning, helped pump up the housing bubble.  But nothing forced private companies, particularly highly leveraged institutions like banks, to load up their balance sheets with these things, or, crazily, to write insurance policies on their value.  Libertarians want to use these government interventions as an excuse for the bailout, but it doesn't wash. I do think many banks reasonably have lawsuit material against ratings agencies Moodys and S&P, which is fine.  I think new blood in that business would be a very good thing.
• The total market capitalization of traded equities of public corporations on NYSE and NASDAQ is between $15 and $20 trillion.  That means that the first $150 billion of the bailout is equivalent to about a 1% price move on the exchanges, something that occurs almost every day.  Have we really close-coupled everything so tightly that a cumulative balance sheet hole on the order of magnitude of a 1% move on the stock market can bring down the whole financial system?  If so, we should just let the whole thing come down and rebuild itself in a more robust form.
• Wall Streeters pat themselves on the back all the time for how creative they are financially.  So get creative here.  Create some sort of new entity and have banks contribute toxic mortgages into the entity in exchange for equity.  Find some pension funds to invest in the new entity at a deep discount.
• These banks, who are experts in this stuff, claim they cannot value these failing, complex, illiquid mortgage packages.  OK, that may be true.  But how is the government possibly going to do any better?  Such a situation cannot possibly end well for the taxpayers. 
• I saw folks writing in fear last week that the commercial paper market might dry up.  The commercial paper market dries up all the time.  It comes back eventually.  People treat lending markets like they are charities or something, and they fear that lenders will give up and never come back.  But they are not charities.  They serve just as much of a purpose for lenders and for borrowers.  Businesses and folks with capital need to make money on short term cash.  They are not going to stop lending forever.  Even capital markets dry up from time to time.  The IPO market has disappeared several times, including several years in the post-Internet-bubble period. The junk bond market comes and goes.
• What is the government really worried about?  I presume that they are worried that liquidity will dry up and the ability of main street businesses to borrow will be impaired.  OK, then save the freaking $700 billion and if main street starts to have trouble borrowing, have the government participate somehow in that lending market.  Buy corporate bond issues, and/or increase the limit on SBA loan guarantees by a $100 billion  (this latter would allow a million new $100,000 SBA loans, and would actually generate money now in guarantee fees and only potentially cost money much later if the loans fail).  This way, we are investing liquidity in successful companies trying to grow rather than in failing banks that got us all into this.  Let's invest in success rather than in failure.

Why Phoenix Light Rail is Doomed in One Chart

The Arizona Republic had another of its cheerleading articles on light rail this morning.  In it was a chart that, contrary to the intent of the article, summarized exactly why Phoenix light rail is doomed.  Below is a chart of the employment density (top chart) and population density (bottom chart) at each stop along the first rail route.  Note that this line goes through what passes for the central business district of Phoenix and the oldest parts of town, so it was chosen to run through the highest density areas - all future extensions will likely have lower numbers.  Unfortunately, they do not reproduce this chart online so here is a scan:

Take the population density chart.  As a benchmark, lets take Boston.  The average density for all of the city of Boston is 12,199 people per square mile.  Phoenix's light rail line cut through the highest density areas of town has only one stop where density reaches this level, and most stops are less than half this density.  And this is against Boston's average, not against the density along its rail routes which are likely much higher than the average.

Rail makes zero sense in a city like Phoenix.  All this will do is create a financial black hole into which we shift all of our bus money, so the city will inevitably end up with a worse transportation system, not a better one.  Cities that build light rail almost always experience a reduction in total transit use (even the great God of planners Portland) for just this reason - budgets are limited, so since rail costs so much more per passenger, other transit is cut back.   But the pictures of the train will look pretty in the visitor's guide.

Postscript: Phoenix's overall average density is around 2,500 per square mile.  Assuming that the 12,000 in the chart above is one of the densest areas of Phoenix, this gives a ratio of about 5:1 between peak and average density.  This same ratio in Boston would imply peak density areas of 60,000 per square mile.  This may be high, but indicates how much higher route densities on Boston rail should be.  Oh, and by the way, Boston rail is losing a ton of money.

Other city densities here from 1990.  People think of LA as spread out, but LA has a density over three times higher than Phoenix!

So We Can't Have Even One Candidate Who Truly Understands Free Speech

I stand by my no-McCain vow I made years ago after his role in campaign speech limitation.  But Obama does not look like a very promising alternative:

The Obama campaign disputes the accuracy of the advertisement, which is fine. It has also threatened regulatory retaliation against outlets that show it, which isn't fine. Instead of, say, crafting a response ad, Obama's team had general counsel Robert F. Bauer send stations a letter [pdf] arguing that "Failure to prevent the airing of 'false and misleading advertising may be 'probative of an underlying abdication of licensee responsibility.'" And, more directly: "For the sake of both FCC licensing requirements and the public interest, your station should refuse to continue to air this advertisement."

In particular, I would love to see Obama actually say what positions that are ascribed to him on gun control are false, and what his actual, specific positions are.  A vague, gauzy support for the second amendment does not necessarily mean he has walked away from his earlier positions.  In fact, I am sure that McCain would say he supported the First Amendment but I would certainly feel comfortable pointing out how he fails to do so in the details.

How Much Authority Are We Proposing to Give the Treasury?

Much has been made of the bailout legislation provision that the administration would be immune to any scrutiny of any sort for any decision made vis a vis the $700 billion in bailout funds and the resulting spending decisions.  But I thought this was equally telling of the over-broad power grab that is going on at Treasury:

The SHR [senior House Republican] calls this an insurance program and the original Paulson plan a purchase program. He says Treasury Department people have told him that they considered an insurance program but decided that a purchase program would be better. But he also added that in the draft legislation Paulson has advanced, the Treasury would have the authority to set up such an insurance plan without congressional authorization. From what he said, it struck me that both courses could be followed. After all, neither purchases nor insurance is contemplated to take place unless and until a financial institution comes forward and requests one or the other.

Jeez, how much latitude are they asking for?  Is the bill really so broad that the secretary of the treasury could set up an entirely new government insurance program for financial assets without further Congressional approval?

While I think Cantor is being overly-optimistic about the near-term cash flow of his insurance proposal, it does seem to be at least an incremental improvement over Paulson's plan.

Critique of the Bailout, From A Banker

From John Allison, CEO of BB&T  (via TJIC).  Here is a taste:

Download bailout_critique.pdf

 

Couldn't The Taxpayer Make Money From the Bailout?

So, apparently the US government is going to authorize up to $700 billion taxpayer dollars to purchase distressed financial assets.  I had an email today that said, to paraphrase, couldn't the government make money off these assets if they buy them for the right price?

My first thought was that this was theoretically possible, though my internal cynic found it unlikely in a pricing game run by elected officials between the taxpayer and powerful Wall Street interests that taxpayers would get the upper hand.

But then I realized there was no possible way this will end well for taxpayers.  Because the government cannot exercise discretion in day to day financial decisions.  It establishes rules and benchmarks and the typical bureaucrat is punished far worse for violating these processes and rules than he/she ever is for reaching a bad result.  So the government will establish rules and benchmarks for what price at which they will buy assets (this will be all the more true given the great rush everyone seems to be in).  And having set this in place, do you know what assets will be put to them?  All the ones that the current holders think are worth less than the benchmark.  This is the winners curse on steroids.

Update from Megan McArdle:

there's a gigantic asymmetrical information problem:  the owners of these securities know much more about them than the Fed.  And there isn't (obviously) a large liquid market for the Fed to check against. So the Fed is likely to overpay, because there won't be a lot of bidders in any one auction.

Megan, of course, reluctantly supports the bailout where I do not.  But she has her eyes open about what she is buying into. 

Can We Go Back to Ignoring Naomi Klein Now?

In her wild and somewhat bizarre polemic aimed at Milton Friedman, Naomi Klein argues that major historic crises have always been manufactured by capitalists to slip free market principles into action against the wishes of the socialist-leaning masses. 

Really?  In what crisis, ever, did the government end up smaller?  What about the current crisis and the government response to it carries any good news for free marketeers?  History is a series of problems created by government intervention but blamed on the free market, which can supposedly only be solved via more government intervention.

Update:  Critique of Klein here.  Seriously, it is amazing that this rings true with anyone:

Klein's basic argument is that economic liberalization is so unpopular that it can only win through deception or coercion. In particular, it relies on crises. During a natural disaster, a war, or a military coup, people are disoriented, confused, and preoccupied with their own immediate survival, allowing regimes to liberal-ize trade, to privatize, and to reduce public spending with little opposition. According to Klein, "neoliberal" economists have welcomed Hurricane Katrina, the Southeast Asian tsunami, the Iraq war, and the South American military coups of the 1970s as opportunities to introduce radical free market policies. The chief villain in her story is Milton Friedman, the economist who did more than anyone in the 20th century to popularize free market ideas.

As is typical, Klein confuses support for capitalism with government support of individual capitalists.

Michael Lewis on the Bailout

I liked this bit in particular:

Think of Wall Street as a poker game and Goldman as the smartest player. It's sad when you think about it this way that so much of the dumb money on Wall Street has been forced out of the game. There's no one left to play with. Just as Goldman was about to rake in its winnings and head home, the U.S. government stumbles in, fat and happy and looking for some action. I imagine the best and the brightest inside Goldman are right this moment trying to figure out how it uses the Treasury not only to sell their own crappy assets dear but also to buy other people's crappy assets cheap

Update:  LOL, via Q&O:

In fact, some of the most basic details, including the $700 billion figure Treasury would use to buy up bad debt, are fuzzy. 

"It’s not based on any particular data point," a Treasury spokeswoman told Forbes.com Tuesday. "We just wanted to choose a really large number."

Could these be the dumbest guys in the room?   

I Think I am Voting for Obama

I am tired of watching the free markets trashed by people who claim to champion capitalism and free enterprise.  Better, I am starting to think, to have free markets trashed by someone who does not pretend to support them.  Besides, the Republicans in Congress tend to be much stronger supporters of small government, low taxes, and light regulation when they are in opposition.  Except possibly for Jeff Flake, who always seems to have his head in the right place.

Update:

"When it comes to this I should prefer emigrating to some other country where they make no pretense of loving liberty - to Russia, for instance, where despotism can be taken pure, without the base alloy of hypocrisy."

            -- Abraham Lincoln

Think Again

Been smugly thinking that you were smart enough not to take out an interest only mortgage to finance a house at the peak of the market?  Or savvy enough not to invest your savings in a mortgage portfolio or some sort of interest rate swap?

Sorry, think again.  Because GWB and the US Congress have decided to force you to be an investor in crappy, devalued investments.  To the tune of at least $700 billion.

Four years ago, privatization of Social Security was scuttled in large part because Congress thought it unfair to toss the average taxpayer into the volatile marketplace with his/her retirement savings.  Now, the government is forcing us all to participate in the financial markets, but only allowing us to invest in the worst assets.  Just great.

Climate Presentation

One of the reason my posting has been light of late is that I was working on a climate presentation for the California Regional Council of Rural Counties.  That's behind me now, but you can read a brief report on the meeting and download my presentation here.

Save Our Industry, The Economy Depends on It

I have been on a Civil War reading binge lately, which began when I read "Time on the Cross", which is a really interesting economic analysis of American slavery.  Since I have read a number of other Civil War and Ante-Bellum history books, including James McPherson's excellent one volume Civil War history.

I was struck in several of these books by the reaction of British textile manufacturers to the war and, more specifically, the informal southern embargo of cotton exports in 1860-61.  These textile producers screamed bloody murder to the British government, demanding that they recognize the Confederacy and intervene on their behalf, claiming that the lack of cotton would doom their industry and thereby doom the whole country.  On its face, this was a credible argument, as textiles probably made up more of the British GDP at the time than any three or four industries account for in the US today. 

Fortunately, the British chose not to intervene, and risked the economic consequences of not supporting the textile industry by jumping into the American Civil War.  As it turned out, the British economy was fine, and in fact even the textile industry was fine as well, as demand was still high and other sources around the world stepped up (because of the higher prices that resulted from the Southern boycott) with increased cotton supplies.

This Seems Kind of Obvious in Hindsight

Saul Hansell at the NY Times has an interesting article about why risk assessment programs in investment banks were not sounding the alarm coming into the recent turmoil.  The article contains this gem:

Ms. Rahl said that it was now clear that the computers needed to assume extra risk in owning a newfangled security that had never been seen before.

“New products, by definition, carry more risk,” she said. The models should penalize investments that are complex, hard to understand and infrequently traded, she said. They didn’t.

I continue to see parallels between recent problems and the meltdown at Enron.  In fact, in many ways events in the natural gas trading market were a dry run for events in the mortgage market.   One filmmaker coined the phrase "Smartest Guys in the Room" to describe the hubris of the guys who ran Enron.  To some extent the phrase was absolutely true - I knew Jeff Skilling at McKinsey and he was indeed the smartest guy in the room.  But everyone can be wrong, and sometimes the smartest guys can be spectacularly wrong as they overestimate their ability to predict and control complex events.  I think this is a fair description of what went on in Wall Street over the past several years.

Best Take Yet on the Bailout

Via Scrappleface:

The foundation of the U.S. economy could crumble, President George Bush said today, if Congress fails to approve a U.S. Treasury plan to take over foundering financial firms, a proposal which the president called “a much-needed 21st-century civil rights act for stupid people.”

“To sustain this shining city on a hill,” Mr. Bush said, “we need to rescue the ignorant, irresponsible folks — from Wall Street to Capitol Hill to Main Street — who got us to where we are today. We must guarantee that no American suffers the soft bigotry of being forced to live with the consequences of his bad decisions.”

The president, in remarks to the news media clearly aimed at reluctant Republicans in Congress, said, “Our financial system rests on a foundation of huge banks, brokerage houses and quasi-governmental agencies that followed Washington’s lead by gambling on long-shot, poorly-collateralized investments. Now this glorious way of life is threatened, and we must act to preserve it.”

“We need to guarantee that the structures, systems, people and products that got us to this point won’t be tossed on the ash heap of history,” said Mr. Bush. “If these giant companies fail, then America will be left with nothing but thousands of small to mid-sized financial firms that made prudent investment decisions during the past 15 years.”

I'm Sure This Is Not In Any Way Relevant To Recent Events

Via Carpe Diem, comes this September 30, 1999 NY Times story:

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets -- including the New York metropolitan region -- will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.''

Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''

Those heartless free marketing guys at the AEI -- always predicting doom every time we open our hearts to poor people.  Bailout?  What ridiculous scare-mongering.

Thoughts on Green Bay

I really enjoyed the game last night in Green Bay.  It is impossible on TV to communicate the energy and decibel level of that crowd, particularly in the first half before Dallas opened up a large lead.  But even with victory pretty much out of reach with 5 minutes to play, virtually no one left  (our Arizona fans would already have been out of the parking lot by then).

The game featured a 72,000 person crowd in a town of 100,000.  In a world where traditional groups are increasingly fragmented, the entire town is united in their dedication to the team.  The Packers are ubiquitous in town, so much so I can't even think of any good major-city analogy.  The best analogy I can come up with is that the game was more like a high school football game in west Texas than a typical NFL game.  Even the cheerleaders look like a high-school cheer squad with girls in jumpers and guys with megaphones, in a world where the other 30+ teams all have pinup girls with breast enhancement. 

The Ultimate Lottery Ticket

A government job can be a great deal.  Likely it pays more than a comparable private job, it's generally impossible to get fired from, and it has outrageously good medical and pension plans.  And, if you don't shy away from a bit of perjury, can be made to pay off spectacularly:

During the workweek, it is not uncommon to find retired L.I.R.R. [Long Island Railroad] employees, sometimes dozens of them, golfing there. A few even walk the course. Yet this is not your typical retiree outing.

These golfers are considered disabled. At an age when most people still work, they get a pension and tens of thousands of dollars in annual disability payments — a sum roughly equal to the base salary of their old jobs. Even the golf is free, courtesy of New York State taxpayers.

With  incentives like these, occupational disabilities at the L.I.R.R. have become a full-blown epidemic.

Virtually every career employee — as many as 97 percent in one recent year — applies for and gets disability payments soon after retirement, a computer analysis of federal records by The New York Times has found. Since 2000, those records show, about a quarter of a billion dollars in federal disability money has gone to former L.I.R.R. employees, including about 2,000 who retired during that time.

97 percent?  Wow!  And just to demonstrate that year was not some kind of outlier:

In each year since 2000, between 93 percent and 97 percent of employees over 50 who retired with 20 years of service also received disability payments.

The article goes on to demonstrate that this is occurring at what appears, from the injury statistics, to be one of the safest railroads in the area.  Say what you will about the NY Times, but when they get their teeth into local corruption they can still do a masterful job, as evidenced by this long article discussing many apparently ridiculous payroll situations at the LIRR.

I can say from experience that there is a group of people in this country for whom getting a lifetime disability payment (e.g. from the Social Security Administration) is as good as hitting the lottery.  I remember one time I got a survey form from the SSA asking about a former employee.  I didn't pay much attention to the form's purpose as I filled it out -- I get all kinds of such government wastepaper with breathless admonishments about the urgency of my reply.  Anyway, about 2 weeks later I got a very threatening letter from the attorney for this former employee, threatening me with all kinds of dire consequences if I did not immediately retract my (honest) answers to the SSA inquiry.  Apparently, I was endangering a lifetime disability determination that this person had been working on obtaining for years. 

Every day, in fact, I get job applicants who try to cut deals with me of one sort or another (e.g. can you pay me under the table in cash?) because they say they are fully able to do outdoor maintenance work but they can't show any income because it might endanger their lifetime disability payments.  In a similar vein, I have three cases I know of in my company today where workers filed workman's compensation claims of injury several days after they were terminated.

I've said it before, but the reckoning is coming on state and local government pensions, which in most cases are unfunded, undisclosed liabilities of startling magnitude.  The disaster that is fast approaching in these state and local government finances will make Social Security's problems look pitiful by comparison.

Postscript:  Railroad labor law is just weird and a total mess.  Being the first major industry, and the first major industry that was regulated, a whole regulatory structure was put in place for railroads that (fortunately) has been applied to few other industries.  Whatever the problems we have with state workman's comp programs, they are models of governance compared to how things work in the railroad industry.

For example, I remember when I worked for a railroad in the 1990's, carpel tunnel claims were common.  By the nature of the comp system, workers got cash payments for injuries in addition to medical treatment (I recall a figure at the time of $7500 per wrist for carpel tunnel, but that may be off).  It was a common piece of advice among railroad workers that if one wanted to get the money together for a down-payment on a new pickup truck, one only had to go to Dr. X or Y and get a carpel tunnel diagnosis.

Blogging on the Bailout

I would blog on the most recent bank bailout, but I don't really understand what the proposal is.  The administration apparently wants to take $700 billion and ... do something with it.  Frankly, I would prefer them to just let the banks totter over and spend the money, if they really feel it necessary, to clean debris up afterward, as they did with the RTC in the 1980s.   At least that way we would avoid the moral hazard and know the money was going to cleaning up the worst messes.  My guess is that $700 billion pseudo-randomly injected into whatever companies can cry the loudest at the treasury's door is not only creating bad incentives, but is probably going to waste at least half of the money.

Greetings from Green Bay

I am here in Green Bay checking off another item on my sports bucket list: seeing a game at Lambeau Field.  And it should be a really good one. 

We went out last night on the town to various bars, mostly on Washington street, after a ritual visit to "fuzzy's."  (Packers fans can tell me later if we were on the right track with these choices).  My friend (who lives in DC) and I were shocked to pay only $2 a beer at the first bar we were at.  It turned out that this was virtual price gouging in the local market.  We never paid more the rest of the evening than $1 for a mug of draft, on a Saturday night yet.  Yet another good reason to stay off the coasts.

For the record, Green Bay is really a very nice, tidy little town.  Kind of quiet, like many small towns -- they set all the traffic lights to flashing yellow last night about 8PM.  The only difference between it and any other nice midwestern town is that every single business has "packers" in its name somehow and roughly 30% of the population at any one time is wearing something with "FAVRE" on the back.  Who is this Favre guy?  I thought he played in New York  ;=)

I Want the Builder Who Built the Yellow House

Click to enlarge.  From here.

Differential Inflation

I am seeing an increasing number of articles of late about differential inflation rates, and how changes in income inequality may be overstated by using a single inflation rate for rich and poor.  The argument goes that lower income folks who spend a relatively high share of income on goods that Wal-Mart and China have made cheap are experiencing a lower inflation rate than wealthier folks who have seen huge price increases at their favorite Four Seasons resort.  Mark Perry has two interesting articles along these lines.

Another Reason Bailouts are Bad

I think the incentives issue has been beaten to death pretty well, but there is another problem with bailout:  They leave the productive assets of the failed company in essentially the same hands that failed to make good use of them previously.  Sure, the management has changed, but a few guys at the top of these large companies don't really mean squat.  To this point:

A corporation has physical plant (like factories) and workers of various skill levels who have productive potential.  These physical and human assets are overlaid with what we generally shortcut as "management" but which includes not just the actual humans currently managing the company but the organization approach, the culture, the management processes, its systems, the traditions, its contracts, its unions, the intellectual property, etc. etc.  In fact, by calling all this summed together "management", we falsely create the impression that it can easily be changed out, by firing the overpaid bums and getting new smarter guys.  This is not the case - Just ask Ross Perot. You could fire the top 20 guys at GM and replace them all with the consensus all-brilliant team and I still am not sure they could fix it. 

All these management factors, from the managers themselves to process to history to culture could better be called the corporate DNA*.  And DNA is very hard to change.  Walmart may be freaking brilliant at what they do, but demand that they change tomorrow to an upscale retailer marketing fashion products to teenage girls, and I don't think they would ever get there.  Its just too much change in the DNA.  Yeah, you could hire some ex Merry-go-round** executives, but you still have a culture aimed at big box low prices, a logistics system and infrastructure aimed at doing same, absolutely no history or knowledge of fashion, etc. etc.  I would bet you any amount of money I could get to the GAP faster starting from scratch than starting from Walmart.  For example, many folks (like me) greatly prefer Target over Walmart because Target is a slightly nicer, more relaxing place to shop.  And even this small difference may ultimately confound Walmart. Even this very incremental need to add some aesthetics to their experience may overtax their DNA.

David Leonhart (via Carpe Diem) argues that this was exactly the long-term downside of the Chrysler bailout:

Barry Ritholtz — who runs an equity research firm in New York and writes The Big Picture, one of the best-read economics blogs — is going to publish a book soon making the case that the bailout actually helped cause the decline. The book is called, “Bailout Nation.” In it, Mr. Ritholtz sketches out an intriguing alternative history of Chrysler and Detroit.

If Chrysler had collapsed, he argues, vulture investors might have swooped in and reconstituted the company as a smaller automaker less tied to the failed strategies of Detroit’s Big Three and their unions. “If Chrysler goes belly up,” he says, “it also might have forced some deep introspection at Ford and G.M. and might have changed their attitude toward fuel efficiency and manufacturing quality.” Some of the bailout’s opponents — from free-market conservatives to Senator Gary Hart, then a rising Democrat — were making similar arguments three decades ago.

Instead, the bailout and import quotas fooled the automakers into thinking they could keep doing business as usual. In 1980, Detroit sold about 80% of all new vehicles in this country. Today, it sells just 45%.

As I wrote about GM:

Changing your DNA is tough.  It is sometimes possible, with the right managers and a crisis mentality, to evolve DNA over a period of 20-30 years.  One could argue that GE did this, avoiding becoming an old-industry dinosaur.  GM has had a 30 year window (dating from the mid-seventies oil price rise and influx of imported cars) to make a change, and it has not been enough.  GM's DNA was programmed to make big, ugly (IMO) cars, and that is what it has continued to do.  If its leaders were not able or willing to change its DNA over the last 30 years, no one, no matter how brilliant, is going to do it in the next 2-3.

So what if GM dies?  Letting the GM's of the world die is one of the best possible things we can do for our economy and the wealth of our nation.  Assuming GM's DNA has a less than one multiplier, then releasing GM's assets from GM's control actually increases value. Talented engineers, after some admittedly painful personal dislocation, find jobs designing things people want and value.  Their output has more value, which in the long run helps everyone, including themselves.

Wa' Happen?

I know that most non-financial folks, including myself, have their head spinning after this past few weeks' doings on Wall Street.  Doug Diamond and Anil Kashyap have a pretty good layman's roundup on Fannie/Freddie, Lehman, and AIG.  My sense is that their Lehman explanation also applies to Bear Stearns as well.  Here is just one small piece of a much longer article:

The Fannie and Freddie situation was a result of their unique roles in the economy. They had been set up to support the housing market. They helped guarantee mortgages (provided they met certain standards), and were able to fund these guarantees by issuing their own debt, which was in turn tacitly backed by the government. The government guarantees allowed Fannie and Freddie to take on far more debt than a normal company. In principle, they were also supposed to use the government guarantee to reduce the mortgage cost to the homeowners, but the Fed and others have argued that this hardly occurred. Instead, they appear to have used the funding advantage to rack up huge profits and squeeze the private sector out of the “conforming” mortgage market. Regardless, many firms and foreign governments considered the debt of Fannie and Freddie as a substitute for U.S. Treasury securities and snapped it up eagerly. 

Fannie and Freddie were weakly supervised and strayed from the core mission. They began using their subsidized financing to buy mortgage-backed securities which were backed by pools of mortgages that did not meet their usual standards. Over the last year, it became clear that their thin capital was not enough to cover the losses on these subprime mortgages. The massive amount of diffusely held debt would have caused collapses everywhere if it was defaulted upon; so the Treasury announced that it would explicitly guarantee the debt.

But once the debt was guaranteed to be secure (and the government would wipe out shareholders if it carried through with the guarantee), no self-interested investor was willing to supply more equity to help buffer the losses. Hence, the Treasury ended up taking them over.

Lehman’s demise came when it could not even keep borrowing. Lehman was rolling over at least $100 billion a month to finance its investments in real estate, bonds, stocks, and financial assets. When it is hard for lenders to monitor their investments and borrowers can rapidly change the risk on their balance sheets, lenders opt for short-term lending. Compared to legal or other channels, their threat to refuse to roll over funding is the most effective option to keep the borrower in line.

This was especially relevant for Lehman, because as an investment bank, it could transform its risk characteristics very easily by using derivatives and by churning its trading portfolio. So for Lehman (and all investment banks), the short-term financing is not an accident; it is inevitable.

Why did the financing dry up? For months, short-sellers were convinced that Lehman’s real-estate losses were bigger than it had acknowledged. As more bad news about the real estate market emerged, including the losses at Freddie Mac and Fannie Mae, this view spread.

Lehman’s costs of borrowing rose and its share price fell. With an impending downgrade to its credit rating looming, legal restrictions were going to prevent certain firms from continuing to lend to Lehman. Other counterparties that might have been able to lend, even if Lehman’s credit rating was impaired, simply decided that the chance of default in the near future was too high, partly because they feared that future credit conditions would get even tighter and force Lehman and others to default at that time.

A.I.G. had to raise money because it had written $57 billion of insurance contracts whose payouts depended on the losses incurred on subprime real-estate related investments. While its core insurance businesses and other subsidiaries (such as its large aircraft-leasing operation) were doing fine, these contracts, called credit default swaps (C.D.S.’s), were hemorrhaging.   

Furthermore, the possibility of further losses loomed if the housing market continued to deteriorate. The credit-rating agencies looking at the potential losses downgraded A.I.G.’s debt on Monday. With its lower credit ratings, A.I.G.’s insurance contracts required A.I.G. to demonstrate that it had collateral to service the contracts; estimates suggested that it needed roughly $15 billion in immediate collateral.

A second problem A.I.G. faced is that if it failed to post the collateral, it would be considered to have defaulted on the C.D.S.’s. Were A.I.G. to default on C.D.S.’s, some other A.I.G. contracts (tied to losses on other financial securities) contain clauses saying that its other contractual partners could insist on prepayment of their claims. These cross-default clauses are present so that resources from one part of the business do not get diverted to plug a hole in another part. A.I.G. had another $380 billion of these other insurance contracts outstanding. No private investors were willing to step into this situation and loan A.I.G. the money it needed to post the collateral.

In the scramble to make good on the C.D.S.’s, A.I.G.’s ability to service its own debt would come into question. A.I.G. had $160 billion in bonds that were held all over the world: nowhere near as widely as the Fannie and Freddie bonds, but still dispersed widely.

In addition, other large financial firms — including Pacific Investment Management Company (Pimco), the largest bond-investment fund in the world — had guaranteed A.I.G.’s bonds by writing C.D.S. contracts.

Given the huge size of the contracts and the number of parties intertwined, the Federal Reserve decided that a default by A.I.G. would wreak havoc on the financial system and cause contagious failures. There was an immediate need to get A.I.G. the collateral to honor its contracts, so the Fed loaned A.I.G. $85 billion.

Update:  Travis has an awesome post with his own FAQ about what is going on.  Here is a taste:

Lots of financially naive folks think that we can remove all risk, inflation, etc. by only ever trading apples for chickens on the barrel head, and doing away with paper money (so that all money is gold) and doing away fractional reserve banking, so that when I deposit one gold coin in the bank, the bank can then take that actual physical gold coin and loan it to someone else. It turns out that the friction involved in doing things this way is so huge that the effect would make The Road Warrior look like a children’s bedtime story. You want to borrow money to buy a car? The bank can’t just loan money that’s been deposited in someone else’s checking account - the bank has to get that person to sign a note saying “yes, I understand that this money is on deposit until that dude buying the card pays the bank back IN FULL”. And the lender, if he wants his money out ahead of time, is SOL. And even then, there can be a flood, and your car gets totaled, and you get Legionaire’s disease, and you can’t make the payments.

or this:

Now, for the next complication, let’s also imagine that there are 300 million other people watching all of this, thinking “How bad is this? Should I go down to the gun store, stock up on .223 and 12 gauge shells, then stop by the veterinarians to see how much antibiotics I can cadge before heading to the hills” ?

And the Feds really don’t want 300 million armed folks heading for the national forests, so they first try to tell everyone who owns a bicycle “Hey, the value of your bike didn’t really drop! It’s still worth $9!”.

But no one wants to believe that.

So then they go to the guy who’s writing insurance policies on the value of bikes and they say “if you got $100 million, would that calm things down a bit?”.

Quote of the Day

"I think it was exciting to some that she was a woman"

- Bill Clinton on Sarah Palin  (via)

Cargo Cult Regulation

Someone noticed that just before certain stocks crash in value, there is a lot of short-selling.  So the US government has banned short-selling, at least temporarily.  Classic cargo-cult logic. 

Boy this sure makes perfect sense in a time when we are concerned about speculative bubbles -- let's ban one of the most important tools that exist for bubbles to be shortened and made less, uh, bubbly.  Here is why (very briefly and non-technically) short-selling takes the edge off speculative excesses.

At the start of the bubble, a particular asset (be it an equity or a commodity like oil) is owned by a mix of people who have different expectations about future price movements.  For whatever reasons, in a bubble, a subset of the market develops rapidly rising expectations about the value of the asset.  They start buying the asset, and the price starts rising.  As the price rises, and these bulls buy in, folks who owned the asset previously and are less bullish about the future will sell to the new buyers.  The very fact of the rising price of the asset from this buying reinforces the bulls' feeling that the sky is the limit for prices, and bulls buy in even more. 

Let's fast forward to a point where the price has risen to some stratospheric levels vs. the previous pricing as well as historical norms or ratios.  The ownership base for the asset is now disproportionately made up of those sky-is-the-limit bulls, while everyone who thought these guys were overly optimistic and a bit wonky have sold out. 99.9% of the world now thinks the asset is grossly overvalued.  But how does it come to earth?  After all, the only way the price can drop is if some owners sell, and all the owners are super-bulls who are unlikely to do so.  As a result, the bubble might continue and grow long after most of the world has seen the insanity of it.

Thus, we have short-selling.  Short-selling allows the other 99.9% who are not owners to sell part of the asset anyway, casting their financial vote for the value of the company.  Short-selling shortens bubbles, hastens the reckoning, and in the process generally reduces the wreckage on the back end.

Update:  From Don Boudreaux:

To ban short-selling of stocks is to short-circuit an important mechanism through which people share their knowledge and expectations with others.  Banning a mechanism that better allows share prices to reflect the expectation that the underlying assets are not worth as much as current market prices suggest does nothing to change the underlying reality.  Such a ban merely distorts knowledge of this reality

Canada to Join EU Free Trade Zone?

If so, great for them.  The more free trade in the world, the better:

Canadian and European officials say they plan to begin negotiating a massive agreement to integrate Canada’s economy with the 27 nations of the European Union, with preliminary talks to be launched at an Oct. 17 summit in Montreal three days after the federal election.

Trade Minister Michael Fortier and his staff have been engaged for the past two months with EU Trade Commissioner Peter Mandelson and the representatives of European governments in an effort to begin what a senior EU official involved in the talks described in an interview yesterday as “deep economic integration negotiations.”

If successful, Canada would be the first developed nation to have open trade relations with the EU, which has completely open borders between its members but imposes steep trade and investment barriers on outsiders…

A pact with the United States would be politically impossible in Europe, senior European Commission officials said.

I would have said that changing the last statement would be a great goal for an Obama administration that wants to make Europe love us again (did they ever?)  But he has made clear that trade does not count in his definition of good relations, and in fact has already committed to initiating trade wars against our neighbors Mexico and Canada.

I Guess I'm Not Patriotic

I have always been mildly suspicious of the word "Patriotism," particularly when it is used to mean supporting one's country even when it is behaving badly.  I prefer to say that I respect, even love this country for the high values it has historically set for itself.   But when it falls short of those values, it is going to hear it from me, patriotism or no.

But if patriotism is defined as having my money put in someone else's pocket, I am not a patriot.

Thoughts on the Lehman Bankrupcy

While I am not happy to see a historic company go bankrupt, and have vague but unspecific worries about some kind of general cascading financial problem, I am happy to see the government let Lehman go bankrupt without any sort of special intervention or bailout for a number of reasons:

• Bailouts create awful incentives for other large companies managing their risk portfolios
• I know many small business people who have gone bankrupt, and I once lost my job in a company bankruptcy.  There is no reason Lehman equity holders and managers should be immune from the same process just because their company is large and old. 
• Lehman's management has failed to get a positive return from the assets in their care.  A bailout only keeps these assets under the same management.  A bankruptcy puts these assets in the hands of new parties who hopefully can do a better job with them. 
• I strongly suspect that the hole in Lehman's balance sheet from underwater assets like certain mortgages is large compared to its equity but small compared to its total assets.  If this is true, equity holders will end up with nothing, but most creditors should come out close to whole when everything is unwound.

Like Megan McArdle, I found Obama's recent reaction to the Lehman bankruptcy to be wrong-headed but unsurprising.  Obama is blaming recent financial problems on an overly laissez faire approach by GWB in general (LOL,that's funny) and a lack of strong enforcement by the SEC in particular. 

But one has to ask, what laws were not enforced?  My sense is that these are all perfectly lawful portfolios of mortgages in which the one mistake was systematically being too generous in giving out credit.  Mr. Obama's party has always been a strong advocate of pushing banks to be more generous with credit, particularly to the poor, and of promoting home ownership as a national goal.  If anything, financial institutions are struggling because they were too aggressive in these goals.  McArdle writes:

This was not some criminal activity that the Bush administration should have been investigating more thoroughly; it was a thorough, massive, systemic mispricing of the risk attendant on lending to people with bad credit. (These are, mind you, the same people that five years ago the Democrats wanted to help enjoy the many booms of homeownership.) Lehman, Bear, Merrill and so forth did not sneakily lend these people money in the hope of putting one over on the American taxpayer while ruining their shareholders and getting the senior executives fired.  They got it wrong.  Badly wrong.  So did everyone else.

It appears from further Obama statements talking about lack of enforcement for predatory lending laws that the Democrats want to get back on the rollercoaster of whipsawing banks between charges of redlining (you are not lending enough to the poor) and predatory lending (you are lending too much to the poor).

Postscript:  While in retrospect there may turn out to have been laws broken, in situations like this, particularly when a management team is trying to head off a liquidity crisis, these tend to be of the reporting and disclosure ilk.  We saw back during the Enron failure that people tend to assume law-breaking of some sort to be the cause of a major bankrupcy or collapse, and to satisfy this notion the government aggresively pursued Enron executives.  But nothing for which Enron was prosecuted had anything to do with their failure -- all the violations were about disclosure and accounting methodologies.  The company would have still crashed, probably faster, without these violations.

Update:  More here

More on California's Big Dig

The Anti-Planner has more on the California high speed rail proposal I wrote about earlier.  My guess was that the first $9 billion bond issue, on the ballot this fall, would not get the train out of the LA metro area.  Well, I was right and wrong.  The smart money thinks the line will start at the other end, in San Francisco.  But the betting is that for $9 billion the line won't even get out of the San Francisco metro area, making it perhaps as far as San Jose. 

But we have a second data point -- there is a proposal on the table to extend BART from Fremont to Santa Clara for $4.7 billion, a distance (as shown on the map below) about a third of that from San Francisco to San Jose.

I am not sure what high-speed rail technology that they are considering, but a true high-speed line requires special alignments, track, and signaling that should make it FAR more expensive per mile than a BART line (just as an example, a true high-speed line could take miles to make a 90 degree turn, eating up land and reducing alignment flexibility in a very congested and hilly area).  And remember, the BART cost estimate is probably low.

No way these guys get to San Jose for $9 billion, much less to LA for $40 billion.  Just what Californians need with their massive budget deficit:  a brand new white elephant.

Re-Evaluating Home Ownership

Mark Perry has had a series of posts of late presenting the hypothesis that high rates of home ownership in the US may be detrimental as it reduces labor mobility.  The argument goes that homeowners have a harder time moving for new jobs than renters do.

Homeownership impedes the economy’s readjustment by tying people down. From a social point of view, it’s beneficial that homeownership encourages commitment to a given town or city. But, from an economic point of view, it’s good for people to be able to leave places where there’s less work and move to places where there’s more. Homeowners are much less likely to move than renters, especially during a downturn, when they aren’t willing (or can’t afford) to sell at market prices. As a result, they often stay in towns even after the jobs leave. And reluctance to move not only keeps unemployment high in struggling areas but makes it hard for businesses elsewhere to attract the workers they need to grow.

The argument makes sense on its surface, but I am having a bit of trouble buying into it (though I will admit that as an American, I am steeped in decades of home-ownership-boosterism, so I may not be approaching the problem without bias).

On the plus side, the selling a home and buying a new one certainly has more costs than switching apartments, particularly if you add in a moving premium for home owners who can accumulate a lot more stuff than apartment dwellers and the switching costs due to emotional attachment to the current house.  Also, on its face, the argument is similar to criticisms of the economy of the antebellum south, where too much capital was invested in land and assets tied to the land.

However, I see a couple of problems with it.  First, its hard to find an increase in structural unemployment rates in the past decades to correlate to the increase in home ownership.  Second, the costs to change homes has been falling of late as the government-protected Realtor monopoly is finally being broken by technology and commission rates are falling.  Third, my sense is (though I can't dig up the data) that the average time in a home is dropping, meaning homes flip owners more frequently, again indicating a decreasing barrier to moving.

I would, however, be willing to accept that in a high home ownership regime, falling home prices and lengthening for-sale times could exacerbate an economic downturn by slowing mobility and thereby slowing the correction.  I would have argued in the past that this was offset by home equity as a savings tool and a source of cash in difficult times, but that could be different this time around as mortgage policies have tightened, drying up the ability to convert equity to emergency cash.

Is There a Zero-Cost Regulatory Solution to Energy Efficiency?

A while back, I criticized a story in the NY Times, as quoted by Kevin Drum, that said that California had among the lowest per capita electricity usage of any state (true) and that this was because of the intelligent regulation regime in the state (yes, but not the way they meant).  The implication of Drum's argument was that there was some sort of efficiency ideal that a smart group of technocrats could reach at limited cost to the state (false). Specifically, Drum argued:

Anyway, it's a good article, and goes to show the kinds of things we could be doing nationwide if conservative politicians could put their Chicken Little campaign contributors on hold for a few minutes and take a look at how it's possible to cut energy use dramatically — and reduce our dependence on foreign suppliers — without ruining the economy. The energy industry might not like the idea, but the rest of us would.

My response, in part, was this:

Well, here are the eight states in the data set above that the California CEC shows as having the lowest per capita electricity use: CA, RI, NY, HI, NH, AK, VT, MA.  All right, now here are the eight states from the same data set that have the highest electricity prices:  CA, RI, NY, HI, NH, AK, VT, MA.  Woah!  It's the exact same eight states!  The 8 states with the highest prices are the eight states with the lowest per capita consumption. Unbelievable.  No way that could have an effect, huh?  It must be all those green building codes in CA.  I suspect Drum is sort of right, just not in the way he means.  Stupid regulation in each state drives up prices, which in turn provides incentives for lower demand.  It achieves the goal, I guess, but very inefficiently.  A straight tax would be much more efficient.

As part of a presentation I am working on about global warming and proposed California CO2 abatement bill AB52, I had the occasion to do a bit more research.  All of my data is from the Energy Information Administration, whose page URLs keep changing and thus breaking my links but this index page to data seems to stay the same.

I found three factors that seem to be the main drivers of state electricity demand (which is measured in all of the charts below in thousands of kw-h per capita).  The first factor is climate, and certainly California has one of the milder climates.  The chart below looks at residential electricity demand vs. cooling degree days (weighted for population location).  Each data point is a state, with California is shown as the red data point:

We get something similar for heating degree days, with electrical use going down as the climate gets milder, though not as good of a fit, which is not surprising since electricity is less important to heating than cooling.  Since California is well below the line, mild climate can be said to explain some of its lead on other states, but not all.

So I looked next at the percentage of electricity demand that goes to industry.  More heavily industrialized states will have a higher total per capita demand, because heavy industry chews up electricity that other types of businesses do not.  It turns out that California has a relatively low industrial use, which is not surprising given the regulatory environment there and the degree to which industry has been chased out of the state (one would have to be a madman to, all things considered, set up a new factory in California).  So here is the same type of chart of total electrical per capita use by state vs. the % industrial demand, again with each data point a state and California in red:

Again there is a pretty strong relationship, and again we see some but not all of California's low per capita consumption explained.  In effect, states on the left have exported their high-electricity-use industries to the states on the right (or to other countries).

I have saved the most obvious relationship for last:  price.  It turns out unsurprisingly that the states with the highest electricity prices have the lowest per capital consumption:

Rolling climate, industrial intensity, and price together, these factors seem to explain at least 80% of California's efficiency lead over other states.  California government regulatory policy does indeed drive lower electrical consumption, just not exactly the way they would like you to think.  By chasing industries out of the state and raising electricity costs above those of almost every other state, California has reached a lower per capita consumption level.

Dumbest Thing I Have Read Today

From the department of wishful thinking comes this:

The worst oil shock since the 1970s has put a permanent mark on the American way of life that even a drop in oil's price below $100 a barrel won't erase.

Public transportation is in. Hummers are out. Frugality is in. Wastefulness is out....

As prices come falling back to earth, Americans aren't expected to drop their newfound frugality. The jarring reality of $4-a-gallon gasoline stirred up an unprecedented level of consumer angst that experts say will keep people from reverting to extravagant energy use for years to come - if ever again.

High gas prices prompted calls to lower speed limits to 55 mph in some states and touched off a seemingly endless wave of "Go Green" campaigns.

"I see a permanent shift," said Kit Yarrow, a consumer psychologist at San Francisco's Golden Gate University who has studied how high oil prices have affected Americans' buying behavior. "Historically, when gas prices come down, people use more. But we've learned a lot of new things during this period and it will be hard to go back to our gas-guzzling ways."

Really?  I could have sworn people said that in 1972 and again in 1978.  But the SUV and the Hummer were not even invented until after these oil shocks.  He mentions the 55 mph speed limit, but we once had a national speed limit at 55 in the 1970s and we chucked it.  What possible evidence does this guy have, particularly since the recent shock was not nearly as bad as 1972 or 1978.  In fact, you can see that here in this graph of gas price pain:

And, we have not seen the absolute shortages and gas lines we saw in the 1970s.  Usually these weird statements like this published by the AP are the start of some kind of broader political campaign.  The only thing I can guess is that this is the front end of some leftish/Obama polical message that we need to keep slamming on government conservation directives and alt-energy subsidies even as prices fall.

Windows Users: Beware the New iTunes Update

Via ZDNet:

I’m reading lots of complaints about the new iTunes 8 update causing horrific problems on Windows machines, including widespread reports of STOP errors, aka the Blue Screen of Death. My colleague Adrian Kingsley-Hughes has asked readers for reports and Gizmodo has a sketchy post as well.

The author goes on to blame some extra software Apple is "sneaking" into the download.  I tend to doubt there is some deep conspiracy here, but you can read more if interested. (remember Coyote's Law: 

When the same set of facts can be explained equally well by

1. A massive conspiracy coordinated without a single leak between hundreds or even thousands of people    -OR -
2. Sustained stupidity, confusion and/or incompetence

Assume stupidity.)

I think I will wait a while before updating, though.

Update:  Apple has a new version of iTunes 8 for windows

Don't Panic!

OK, the light at the end of the tunnel may be a train, but so far it is too soon to panic about bank failures.*  Mark Perry brings us this chart for perspective:

Of course, since we are in an election cycle, current problems are going to be portrayed as the worst economy since the Weimar Republic, or whatever.  Perry has a lot more in the post.

Thinking about Jeff Skilling

I was thinking a bit about Jeff Skilling (former Enron CEO) today.  What must he be thinking as a series of large firms that were supposedly far more stable than Enron go down one after the other to liquidity crises much like that of Enron?  Bear Stearns and Lehman, two firms that should have been rock solid, go down in the blink of an eye in a credit crunch, and all we hear from the media is how the firms fell victim to larger forces beyond their control.  At least at Enron they were up-front with the market about their taking on large risks.  Now, the government is running around in the background trying to match-make these failing companies and helping to save at least a squidge of shareholder equity.  The only thing the government did in the Enron collapse was hound Skilling and others into jail.   

Sure, Skilling may have made some overly optimistic statements about his company as he was trying to stave off the crunch, but no more so that the happy-face statements issuing from Bear or Lehman in their final days.  Executives who find themselves in a credit crunch are in a nearly impossible position.  The best way they can serve equity holders is to downplay or even bury bad news to head off the looming crisis of confidence.  But if they do so, they face presecution for making false statements about the company, ironically under laws meant to protect equity holders.

No Surprise To Anyone Who Is a Fan of "The Wire"

One of the recurring themes in HBO's fabulous series "the Wire" was how well-intentioned government officials could be led astray by perverse incentives, and, tied to this, the overwhelming pressure that can build up in government to fix the metrics rather than the problem.

In Charleston, they apparently thought they had a real public school success story on their hands:

Sanders-Clyde is a school in downtown Charleston that serves some of the poorest students in the county. Most of its children come from the nearby homeless shelter or public housing apartments. Its test scores once were the worst in the county, and its future was so bleak that the county board planned to close it.

Then MiShawna Moore became the school's principal in 2003. She tailored lessons for students, helped their parents pay bills, washed students' clothes and opened the school building on weekends. The school's test scores began to rise.

By 2007, the school outscored state and district averages, far exceeding the progress of schools with students from similar backgrounds. Educators hailed Moore as a model for other principals, the community showered her school with praise, and federal and state awards went to the school in recognition of its achievement. Moore was so successful that she was asked to lead a second downtown school, Fraser Elementary, to duplicate her accomplishments.

But suddenly, the bottom dropped out:

This year, the school's PACT results fell sharply in every subject and at every grade level.

So what changed?  The curriculum?  The students?  No, what changed was who was in charge of compiling the scores.  For the first time, they took the measurement process out of the hands of the person being rewarded for the measure:

This was the first time that the school district monitored the school's testing. District officials took tests away from the school each night and put monitors in classrooms daily. Janet Rose, the district's executive director of assessment and accountability, told The Post and Courier in May that the extra scrutiny would validate the school's scores.

Oops.  It seems the former high-flying principal suddenly needs to spend more time with her family

A few weeks after the tests this spring, in a move that surprised parents and officials, Moore announced that she was leaving Charleston County.

Hat tip to Andrew Coulson

Volume Gouging

I was just volume-gouged on gasoline today in Atlanta.  I was returning my rent car, and needed to fill the tank.   Stations here seem to fear a hurricane-related gas shortage, to the first station would only sell me 10 gallons maximum.  The second claimed to be out of gas.  At the third I was able to fill my tank the rest of the way.  These stations gouged me on volume, simply because they didn't have the simple courtesy to re-price their product upwards in a shortage in order to ensure continued availability of supply.

By the way, memo to news guys -- telling everyone to run out and fill their tanks RIGHT NOW in order to avoid a possible gasoline shortage will only precipitate said shortage.  If everyone fills his or her tank at the same time, this shifts inventory from large regional reservoirs to individual reservoirs (e.g. gas tanks), the most inefficient of inventory storage models.  Having every car's gas tank go nearly instantaneously from 5/8 full to full requires something like 600 million gallons of draw down from retail and wholesale inventory to car fuel tanks.  The system cannot survive that in 24 hours, and the hypothesized shortage becomes a reality.

Postscript:  By the way, the question of whether to run out and fill your tank tonight is a classic prisnoners dilemma game.  We are all better off if no one does it, but each invidividual probably maximizes his or her well-being by deciding to fill up, so everyone does it.

Flying on 9/11

Seven years ago today, my wife came down to my hotel breakfast meeting at a midtown Manhattan hotel and told us that there was something we needed to see.  We went upstairs to one of my investor's rooms, which had a balcony, and watched the disaster unfold.  Several of our friends died that day, though we wouldn't know that for weeks.  In between was a bizarre cross-country drive from Manhattan to Seattle.

I am on the road again today, and will observe that the airport is pretty empty today.  I don't know if this is an anomaly, or a general reluctance to fly on 9/11.

PS- Ironically, I was making a presentation that morning to potential investors telling them that the commercial airline business, on which our small company depended, was due for a turnaround.  Oops.

Cool Gear

These are really expensive and the performance is limited, but hey, what else would a bleeding-edge buyer expect?   They are super-small LCD projectors to take on the road for presentations and such, and they are barely bigger than an iPod.

Local Papers and the Growth of Government

In some sort of synergistic relationship I haven't fully figured out, local newspapers love to cheerlead the expansion of government programs.  Here is a great example, via Rick Perry.  The headline in the Detroit Free Press web site reads:

State venture capital funds starting to pay off

But then we go on to read:

Michigan's two venture capital investment funds are starting to generate results, state economic  officials said Monday.

Since their formation in 2006, the $95-million Venture Michigan Fund and the $109-million Michigan 21st Century Investment Fund have invested in six venture capital firms with either a headquarters or an office in the state. These firms have used the money and other capital to invest in 11 fledgling Michigan companies that have added 40 workers in recent years.

The two funds have made investment commitments of $116.3 million, or slightly more than half of their total capital.

So out of $204 million in taxpayer funds (why the state has entered the venture capital business with state funds is anybody's guess) the state has invested $116 million to create 40 jobs.  Given that the notion of the government venture fund was to create state jobs, its not clear how $3 million per job is a really good return.  Further, there is no mention of the government has gotten any kind of financial return from this investment, so I will presume it has not. So how can the paper possibly with a straight face say that the funds are "starting to pay off?" 

Eleven companies with an average of 3 employees each somehow each got $10 million in state funds.  I bet it would be fascinating to see just who these 11 companies are, and how their owners are connected into the political power structure. 

Ecoterrorism Vindicated in England

Apparently 6 vandals who cause $60,000 damage to a power plant in England were acquitted solely on the argument that they were helping stop global warming -- in other words, they admitted their vandalism, but said it was in a higher cause.

It's been a pretty unusual ten days but today has been truly extraordinary. At 3.20pm, the jury came back into court and announced a majority verdict of not guilty! All six defendants - Kevin, Emily, Tim, Will, Ben and Huw - were acquitted of criminal damage.

To recap on how important this verdict is: the defendants campaigners were accused of causing £30,000 of criminal damage to Kingsnorth smokestack from painting. The defence was that they had 'lawful excuse' - because they were acting to protect property around the world "in immediate need of protection" from the impacts of climate change, caused in part by burning coal.

So the testimony centered not on whether they actually vandalized the power plant - they never denied it - but on whether the criminals were correct to fear global warming from power plants.  I don't know much about British law, but this seems to be a terrible precedent.  Or maybe not - does this mean that I can go and legally vandalize every Congressman's house for wasting my money?

Silly Season is Here

I seldom comment on politics per se, but the whole brouhaha about Obama's use of the phrase "lipstick on a pig" somehow referring to the Republican VP nominee is just silly.  I used the phrase myself the other day.  "Pig" no more was meant to refer to Ms. Palin than using the terms "slavish devotion" or "niggardly" are meant to be racist (though they have similarly been so interpreted). 

PS-  It is entertaining to see that Republicans will play the race/gender victim card as quickly as will the Democrats.

The Opposite Problem

Megan McArdle writes:

Let's be honest, coastal folks:  when you meet someone with a thick southern accent who likes NASCAR and attends a bible church, do you think, "hey, maybe this is a cool person"?  And when you encounter someone who went to Eastern Iowa State, do you accord them the same respect you give your friends from Williams?  It's okay--there's no one here but us chickens.  You don't.

Maybe you don't know you're doing it.  But I have quite brilliant friends who grew up in rural areas and went to state schools--not Michigan or UT, but ordinary state schools--who say that, indeed, when they mention where they went to school, there's often a droop in the eyelids, a certain forced quality to the smile.  Oh, Arizona State.  Great weather out there.  Don't I need a drink or something? This person couldn't possibly interest me.

People from a handful of schools, most of them hailing from a handful of major metropolitan areas, dominate academia, journalism, and the entertainment industry.  Our subtle (or not-so-subtle) distaste for everything from their entertainment to their decorating choices to the vast swathes of the country in which they choose to live permeate almost everything they read, watch, or hear.  Of course we don't hear it--to us, that's simply the way the world is. 

I have written before that I go out of my way not to mention my double-Ivy pedigree within my business dealings because it tends to cause my employees (who often have no degree at all) to clam up.  I absolutely depend on their feedback and ideas, and those dry up if my employees somehow think that I'm smarter than they are and they start to be afraid to "look stupid."

But McArdle's post causes me to think of another reason not to be snobbish about my eastern degrees.  I meet a lot of rich and succesful people out here in the Phoenix area, and I can't remember the last one that had an Ivy League degree.  I am thinking through a few of them right now -- ASU, ASU, Arizona, Kansas State, Tulane, no college, San Diego State....  Getting uppity about my Harvard MBA around here only leaves me vulnerable to the charge of "Person X went to Montana State and is worth $10 million now -- what the hell have you been doing with that Harvard MBA?"  Here in flyover country, college degrees and family pedigree are not really strong predictors of business success.

Now I Understand - Obama Means Five Million New Government Jobs

I have not been able to figure out how Obama gets to a 5 million job creation number from his alternative energy plans.  As I pointed out,

OK, so the total employment of all these industries that might be related to an alternate energy effort is about 2.28 million.  So, to add 5 million incremental jobs would require tripling the size of the utility industry, tripling the size of the utility construction and equipment industry, tripling the size of the auto industry, tripling the size of the aircraft industry, and tripling the size of the shipbuilding industry.  And even then we would be a bit short of Obama's number.

But now I think I am starting to understand.  Tom Nelson gave me the clue with this article from the town of Frankfort, Kentucky:

Commissioners again discussed the possible creation of a sustainability coordinator position for the city.

Andy MacDonald, of the Mayor's Task Force on Energy Efficiency and Climate Change, told commissioners that the creation of the position is "the next critical step" to reduce the city's environmental footprint.

Commissioner Doug Howard brought up the possibility of asking the city's recycling coordinator to fulfill part of the proposed position's duties until money is available.

OK, so we need both a recycling coordinator and a sustainability coordinator for a town of 27,741 people (2000 census).  At this rate, that would imply nearly 22,000 government jobs across the country just in the government recylcing and sustainablity coordination field.  Now I am starting to understand.  Obama means five million new government jobs.

Crowding Out Private Alternatives

Due to the very nature of political pressures as well as poor accounting, a lot of government services are provided to the public below their true cost or market clearing price  (there are exceptions, like intra-city mail, but in these cases the government must pass laws to prevent private competition in order to maintain its market share).  When the government provides these below-cost or below-market-price services, it tends to crowd out private options.  So I am wondering why Kevin Drum is so surprised:

I guess rescuing them was the right thing to do. I'm still a little taken aback by the apparent fact that American banks are now almost flatly unwilling to make mortgage loans unless they're backed by Fannie or Freddie, but that seems to be the case whether it takes me aback or not. So rescue them we must. I suppose my next question is whether it's worth thinking about how to restructure the American home mortgage industry so that it can operate efficiently even in the absence of massive levels of government backup. Or is Fannie/Freddie style backup just the way the world works these days and there's no point fussing over it?

As evidenced by the current bailout (and their huge accretion in market share over the last several years), Fannie and Freddie were under-pricing the service they were providing.  So of course, all things equal, bankers will demand the Fannie/Freddie backing because that will be a more profitable product and will be less work for the banker.  This seems like a "duh" kind of thing.  Like the "mystery" of why in Massachussetts, while everyone is obligated to sign up for health insurance, only the ones who were eligeable for free coverage did so.

I have written before of a similar phenomenon in business loans, where loans with SBA backing have crowded out everything else out there, such that a small business really can't find a lender who will make small business loans except with SBA backing.  Bankers are people too, and they can get lazy.  They have come to rely on these government programs, but certainly the lending function would still exist in a robust form if these programs did not exist.  Bankers would have to find other risk-mitigation tools, or else the loans would be more expensive, reflecting that the banks could not get rid of all the risk and had to price that into the loan.

By the way, don't you love the technocratic hubris of "thinking about how to restructure the American home mortgage industry so that it can operate efficiently even in the absence of massive levels of government backup."  Why do I, or Drum, or anyone outside of banking have to think about this at all?  I don't personally know the best private alternative to government mortgage gaurantees.  So what?  The financial field has been rife with innovation over the last several decades.  Just remove the government backup and let the the banks figure it out.  And let them go bankrupt when they figure wrong.

Postscript: As an ironic aside, the bank that holds my SBA loans was closed by the FDIC last week, my guess is due to a bad mortgage book in the Las Vegas area.  This doesn't have a lot of impact on me except that as I have paid down my loans, they became wildly overcollateralized, and I was in the process of trying to renegotiate some of my collateral out of the deal.  That will have to be put on hold, I guess.

Update:  More on government crowding out private options, in an entirely different industry:

Basic dental care in Britain is free to those under 16 or over 60, the unemployed, students, military veterans and some low-income families. For others, government dentists offer lower prices than private practitioners.

However, the government does not cover cosmetic dentistry, and a recent reorganization of the way dentists work has prompted many to leave the public sector. Katherine Murphy, a spokeswoman for The Patients Association, an advocacy group, said it was proving increasingly difficult for Britons to get anything beyond basic dental care from Britain's National Health Service.

Update #2: More on Fannie and Freddie, again via Rick Perry:

The Fannie Mae-Freddie Mac crisis may have been the most avoidable financial crisis in history. Economists have long complained that the risks posed by the government-sponsored enterprises were large relative to any social benefits.

We now realize that the overall policy of promoting home ownership was carried to excess. Even taking as given the goal of expanding home ownership, the public policy case for subsidizing mortgage finance was weak. The case for using the GSEs as a vehicle to subsidize mortgage finance was weaker still. The GSE structure serves to privatize profits and socialize losses. And even if one thought that home ownership was worth encouraging, mortgage debt was worth subsidizing, and the GSE structure was viable, allowing the GSEs to assume a dominant role in mortgage finance was a mistake. The larger they grew, the more precarious our financial markets became.

It Sucks to be a Woman

This weekend, I had a conversation with a group of people about the upcoming election.  As is typical in a fairly diverse group, at least one woman said that she was voting for Obama to protect "women's rights."  When pressed, this seemed to boil down to support for abortion rights. 

Boy, I am sure glad that I am a man, where my rights are not narrowly defined around the availability of a single out-patient surgical procedure.  I get to define my rights to include free speech, commerce, property, gun ownership, immunity from arbitrary search and seizure, and habeus corpus.  Even in the narrow world of medical care, I can aspire broadly to rights such as the ability to use medications not necessarily labeled safe and effective by the FDA, the ability to contract for whatever procedures I want even if the government is not willing to pay for them, and the abilty ride my motorcycle with or without a helmet as long as I am willing to bear the cost and consequences of my actions.

I will confess that this broader view of my rights makes voting more difficult, as neither the Coke nor the Pepsi party consistently protects my rights defined this broadly.

The $9 Billion Dollar Toe

A few weeks ago I was amazed at the story of the city of Chicago spending hundreds of millions of dollars to build the terminal rail station of a rail line that had no plan, no route, no approval, and no money.  Why spend hundreds of millions on a station that could well be orphaned?  The reason, I supposed, was to make a toe in the water investment where the public could later be shamed into voting more funds for building a rail line to actually connect to their fabulous new station.

It appears that California may be doing the same thing. This November, voters in that state will have the chance to approve a $9.95 billion rail bond issue.  $9 billion of this is earmarked for building a high-speed rail line from Anaheim to San Francisco.  But current estimates for this line's cost, which are always way too low, are for $30 billion.  Who in their right mind would proceed with a $30 billion (or likely more) project when only $9 billion of funding has been obtained?  Only scam artists, Ponzi schemes.... and the government.

Update:  Wow!  Boy, I must be dumb or something.  The website supporting this bond issue says that this project will create 450,000 permanent new jobs.  How can anyone oppose that?  This is really amazing, since the entire US railroad industry currently employs 224,000 people, but this one rail line will create 450,000 jobs! 

Update #2:  I like to make predictions about government rail projects, so here is mine for this one:  I don't know what end they are starting with, but if they start from the south, I will bet that $9 billion does not even get them out of the LA area (say past Santa Clarita or Santa Barbara), much less anywhere close to San Francisco.

Good Money After Bad

If the world's citizens will not freely lend the Big Three automakers money of their own free will, then Congress is considering using force to make it happen.

Auto industry allies hope to secure up to $50 billion in federal t loans this month to modernize plants and help struggling car makers build more fuel-efficient vehicles.

Congress returns this coming week from its summer break, and the auto industry plans an aggressive lobbying campaign for the low-interest loans.

I wrote earlier on why we should not be afraid to let GM fail.  Paul Ingrassia makes this point:

Any low-interest loans to develop fuel-efficient cars should be made available to all car companies, not just the Detroit Three. The law passed by Congress last year is framed to make this highly unlikely. But if developing fuel-efficient and alternative-energy cars is deemed worthy of taxpayer subsidies for public-policy purposes, it's just common sense not to put all our eggs in Detroit's basket.

I would have gone further and said that US automakers are perhaps the last one's one would entrust with limited capital resources to develop such a new technology.  What would have happened to the PC revolution had the government circa 1975 limited all the available investment capital for new computing technologies to IBM, DEC, Honeywell, etc.

Good News on the Free Speech Front

Last year, a University of Delaware student was banned from campus and ordered to undergo psychological testing before he could return.  This was the administration's reaction to another student's complaint about certain content on his website, which was described as "racist, sexist, anti-Semitic, and homophobic."

Now, I have a guess that I would not have thought much of this student's professed opinions, but the first amendment is there to protect speech we don't like from punishment by government bodies such as the state-run University of Delaware.  So it is good to see that the US District Court for Delaware granted this student summary judgment on his free speech claim.

In particular, I was happy to see this:

The court also noted that speech is constitutionally protected when it does not cause a substantial disruption on campus—even if an individual student feels so upset by the speech that she feels threatened by it, and even if university administrators strongly dislike what is being said. That is, the complaining student's reaction, together with the administrative trouble involved in dealing with the situation, was not enough to show a substantial disruption requiring punishment for Murakowski's protected speech.

This is important.  While it seems odd, college campuses have been the vanguard for testing new theories for limiting free speech over the last several years.  One popular theory is that offense taken by the listener is sufficient grounds to hold speech to be punishable.   This definition kills any objective standards, and therefore is a blank check for speech limitation, something its proponents understand all too well.  It is good to see a higher court very explicitly striking down this standards.

New Unemployment Numbers

US unemployment in August "jumped unexpectedly" to 6.1%, by the oddest of coincidences in the first full month just after new, 12% higher US minimum wages took effect. 

The unemployment rate is higher than it has been in the United States in the last 5 years, but substantially lower than the rate most Western European countries like France and Germany experience even during peak economic times. 

In response, the Obama campaign is urging further increases to the minimum wage and emulation of labor policy and legislation in France and Germany.

That's Depressing

No, the news itself is good news, not bad:

This week, the Republican Party in its national platform called for an end to ethanol mandates in just the latest shot at a fuel alternative that, in some circles, has grown more target than treasure.

This was the part that was depressing:

High ranking politicians, including presidential candidate John McCain, have publicly opposed ethanol subsidies before, but the platform approved during the Republican convention in St. Paul, a corn-belt capital, marks the first time a major U.S. party has taken an official stance against publicly funded ethanol incentives.

Talk about the emperor's new clothes.  If only we could get the first step on the campaign trail out of Iowa.

Yea! The NFL is Back!

The only time my son (born in Dallas) has every been sympathetic to Adolph Hitler.  Enjoy this bit of Friday randomness:

Our Bodies, Ourselves

I have written on a number of occasions that I thought it odd that the left (and women's groups in particular) don't see a contradiction between their support for government health care and their long-held abortion beliefs that people should be free of government coercion when it comes to decisions about their body and their health.  These views certainly don't seem compatible in England:

A cancer charity has today published research that shows doctors are keeping   cancer patients in the dark about new treatments that could extend their lives.

Myeloma UK, which conducted the research, said a quarter of myeloma   specialists questioned in a survey admitted hiding the facts about   treatments that may be difficult to obtain on the NHS.

The main reason given was to avoid distressing or confusing patients.

Myeloma is a bone marrow cancer that affects around 3,800 people each year in   the UK. Of these, 2,600 are likely to die from the disease.

Someone Else Joins the "Peak Whale" Bandwaggon

Katherine Mangu-Ward makes a point I have also made on occasion:

take a moment to thank the man who really saved the whales: John D. Rockefeller.

In 1846, Americans dominated the whaling industry with 735 ships. John D. Rockefeller gets into the oil refining business in 1865. By 1876, kerosene is routing whale oil, and the whaling fleet was down to 39 ships, because kerosene was just so darn cheap:

The price of sperm oil reached its high of $1.77 per gallon in 1856; by 1896 it sold for 40 cents per gallon. Yet it could not keep pace with the price of refined petroleum, which dropped from 59 cents per gallon in 1865 to a fraction over seven cents per gallon in 1895.

This dynamic is also instructive for those fretting that we're going to run out of oil, just as many undoubtedly worried that we were going to run out of whales. (Note to self: Check historical record for instances of the phrase "Peak Whale.")

I don't want to be overly self-referential here, but I actually "found" this reference to peak whale theory over two years ago when digging through the archives of this blog's 19th century predecessor, the Coyote Broadsheet:

As the US Population reaches toward the astronomical total of 40 million persons, we are reaching the limits of the number of people this earth can support.    If one were to extrapolate current population growth rates, this country in a hundred years could have over 250 million people in it!  Now of course, that figure is impossible - the farmland of this country couldn't possibly support even half this number.  But it is interesting to consider the environmental consequences.

Take the issue of transportation.  Currently there are over 11 million horses in this country, the feeding and care of which constitute a significant part of our economy.  A population of 250 million would imply the need for nearly 70 million horses in this country, and this is even before one considers the fact that "horse intensity", or the average number of horses per family, has been increasing steadily over the last several decades.  It is not unreasonable, therefore, to assume that so many people might need 100 million horses to fulfill all their transportation needs.  There is just no way this admittedly bountiful nation could support 100 million horses.  The disposal of their manure alone would create an environmental problem of unprecedented magnitude.

Or, take the case of illuminant.  As the population grows, the demand for illuminant should grow at least as quickly.  However, whale catches and therefore whale oil supply has leveled off of late, such that many are talking about the "peak whale" phenomena, which refers to the theory that whale oil production may have already passed its peak. 250 million people would use up the entire supply of the world's whales four or five times over, leaving none for poorer nations of the world.

I wrote more about John D. Rockefeller (including his role in saving the whales) in my praise of Robber Barrons several years ago.  In addition to Rockefeller, the article also discussed Cornelius Vanderbilt as the 19th century precursor to Southwest Airlines.  From the Harper's Magazine in 1859:

...the results in every case of the establishment of opposition lines by Vanderbilt has been the permanent reduction of fares.  Wherever he 'laid on' an opposition line, the fares were instantly reduced, and however the contest terminated, whether he bought out his opponents, as he often did, or they bought him out, the fares were never again raise to the old standard.  This great boon -- cheap travel-- this community owes mainly to Cornelius Vanderbilt".

When Government Tries to Pick Winners

Folks like Barrack Obama have decided that wind power is the answer.  They haven't studied the numbers or really done much to investigate the technology, and god forbid that they have put any of their own money into it or run a company trying to make thoughtful investment decisions.  But he's just sure that such alternative energy technologies work and make sense because, uh, he wants them to.

But when government picks winners, disaster almost always follows.  Oh, sure, the programs themselves get a lot of positive attention in the press, and people are happy to line up to accept subsidies and tax rebates.  But the result is often this:  (ht: Tom Nelson)

According to the Massachusetts Technology Collaborative, the agency that oversees the state’s major alternative energy rebate programs, the small wind initiative was canceled because the turbines it has funded are producing far less energy than originally estimated.

An MTC-sponsored study released earlier this summer found that the average energy production of 19 small turbines reviewed was only 27 percent of what the installers had projected. The actual production for the 19 turbines, which received nearly $600,000 in public funding, ranged between 2 and 59 percent of the estimates.

A $75,663 turbine at Falmouth Academy that received $47,500 in state money, for example, has produced only 17 percent of the projected energy in the year since its installation. Another, smaller device in Bourne is producing only 15 percent of the originally estimated energy.

So the state government funds 2/3 of the project and the project still doesn't make sense

Mr. Storrs criticized the state for dropping the rebate program, which over two years has covered upward of half the cost of several turbines on Cape Cod and dozens of others throughout the state, saying, “It is not what you would hope a progressive [state] like Massachusetts would cancel. You would hope that they are supporting alternative sources of energy.”

Actually, he is correct.  Sinking hundreds of thousands of dollars into faulty technology for terrible returns based solely on the fact that a certain technology is somehow politically correct is exactly what I too would expect of a progressive state like Massachusetts.

The state board complains that the technology choices and siting decisions were wrong.  Well, who would have imagined that investors in certain projects would be lax in their engineering and due diligence when the government was paying 2/3 of the freight, and when the main reason for the projects was likely PR rather than real returns?

If the bit about PR and political correctness seems exaggerated to you, check this out:

During the hearing on the proposal two months ago Mr. Storrs told the planning board that the project was meant in part to help educate the public about wind energy. Town Planner F. Thomas Fudala said it would be informative to see whether the roof-mounted ones actually work. “Even if this fails, it will be useful information,” he said.

Mr. Storrs responded, “I know that sounds weird, Tom, but you are absolutely right.”

Wow, I bet this kind of investment decision-making really give the local taxpayers a big warm fuzzy feeling.  By the way, this article also includes an example of why Al Gore and others proposing 10-year crash programs to change out the entire US power infrastructure are impossibly unrealistic, even forgetting about the cost:

Mr. Storrs said he first ordered the Swift brand turbines last year as part of a bulk order along with the Christy’s gas station in West Yarmouth.

But the planning board had already adopted its new turbine regulation, which, in part on the advice on Ms. Amsler, had prohibited the roof-mounted machines.

“The town was just trying to be responsible in terms of looking out for its residents, trying to make sure these things are not going to pop up everywhere if they aren’t going to work,” said Thomas Mayo, the town’s alternative energy specialist.

At Mr. Storrs request, however, the planning board then went back and reconsidered its regulation. After a public hearing featuring testimony from Ms. Amsler as well as from a representative of Community Wind Power who argued that the Swift turbines work well and as advertised, the planning board decided to change the bylaw and allow Mashpee Commons to move forward with its project.

The Mashpee bylaw requires a return on investment plan, a maintenance plan, as well as proof that the proposal meets several safety and aesthetic prerequisites.

Town Meeting adopted the new bylaw in May, Mashpee Commons quickly filed its application, and received a special permit in early June. During the comment period for the special permit, the state program was suspended.

After receiving the special permit, Mr. Storrs said he applied for Federal Aviation Administration approval, which is required for any structure over three stories in town. More than two months later, he said he is still awaiting that approval.

Mr. Mayo said the town’s application for FAA approval of a site under consideration for a large municipal turbine took six months to approve.

So Wrong, I Almost Wish It Would Pass

Sometimes a proposed law is so wrong and so destructive, but so typical of a certain philosophical bent, that I almost wish it would pass, if for no reason than to have an Atlas Shrugged-type object example of disastrous results.  Such is the case for a California ballot initiative that has qualified for the signature-gathering stage.  The initiative, in part:  (full text linked here)

• Imposes one-time tax of at least 55% on property exceeding $20 million of a California resident or held in California by nonresident.  [note that this is an asset tax, not an income tax]
• Imposes one-time tax (between 36.5% - 54.3%) on income exceeding $10 million when resident dies or leaves California.
• Imposes additional 17.5% tax on total incomes of taxpayers with income exceeding $150,000 if single, $250,000 if married; 35% if incomes exceed $350,000 if single, $500,000 if married.
• The proceeds of this money will be used to:
  • To purchase 30% to 51% of the outstanding shares of stock in ExxonMobil, Chevron, General Motors, Ford, Goldman Sachs, JP Morgan Chase, and Citigroup, in order to ensure California has an uninterrupted source of energy and financial capital.
  • To drain and restore the Hetch Hetchy Valley to it’s condition at the beginning of the 20th century.
  • Use any Surplus funds to combat Global Warming, make infrastructure repairs and improvements, and to research alternative energy sources.

Beyond the unbelievably Marxist confiscation going on here, it begs the question of just what supply of energy and financial capital that California is not getting today that this will somehow ensure.  The implication seems to be that ExxonMobil, GM, and Citigroup are too fair-minded, selling their wares too even-handedly, and that California would prefer their attention tilted towards California.

Of course this initiative is profoundly immoral, so I can't do anything but deride it, but it would make for a spectacular object lesson (though one would have thought the Soviet Union's experience to be sufficient to this task, but apparently not).  I am sure GM's troubles would be greatly helped by replacing its board of directors with the California State Legislature  (the only American organization running a bigger deficit than GM) and replacing Citigroup's credit analysists with California social services beauracrats.  I would kind of like to see this in the same way I would love to see what happens if I threw a crate of flourescent tubes off a 10th-floor roof  -- I would never actualy do it, because it would be unsafe and destructive, but I can still dream about how compelling the disaster would be.

Postscript: One could probably label this the Arizona and Nevada economic stimulation act and probably not be far off the mark.

Ubiquitous and Unknown and the Same Time

Don LaFontaine died the other day (ht Whatever).  You definitely know who this guy was, even if you don't.

When Did the Media Stop Distringuishing Between Facts and Guesses?

The Associated Press has an article on how the demographics of New Orleans changed post-Katrina:

Those who have moved back to New Orleans in the three years since Hurricane Katrina devastated the city are likely to have higher incomes and more education than people who haven't come back, demographic data shows.

New Orleans remains predominantly black, as it was before Hurricane Katrina struck in 2005, U.S. Census Bureau figures show. But people who have some college education, are above the poverty line, own homes and have no children are more likely to have returned to the city than others, says William Frey, a demographer at the Brookings Institution in Washington.

The city was 59 percent black in 2006, the most recent census figures available, compared with 68 percent in 2005. Census data shows 20.6 percent of New Orleans residents were below the poverty level last year, compared with 24.5 percent in 2005.

OK, the fact that the demographics of New Orleans have changed coincident with the Katrina evacuation  is a fact.  It is based on probably the best demographic data available, though it is not clear that Mr. Frey has the evidence at hand to separate the effects of economic growth in New Orleans from migration patterns in explaining the drop in people below the poverty line, but I will cut him some slack compare to this next statement:

"The people who have come back are the people with the best resources to come back," said Frey, a demographer at the Brookings Institution in Washington who has studied the demographics of New Orleans. "The people who have not come back are lower-income, minorities, largely renters. They were the least equipped to come back and have not been able to."

This is a guess.  The data Mr. Frey is working with sheds no light on the reason certain groups did not return.  His statement that they did not come back because they did have the resources to do so is an unproven hypothesis.  I could easily offer a counter-hypothesis, that the issue was that these folks did not have the resources or the knowledge to leave New Orleans to find opportunities to escape their poverty, and having been granted the unique opportunity by the Katrina evacuation to get out, they have found opportunity elsewhere and see no reason to return to the place where they were formerly impoverished.  I actually think my hypothesis is more likely than Mr. Frey's, but in the end both of us are guessing.