Wednesday, August 27, 2008

Is Housing Stablizing?

There are plenty of people who will tell you that we are in a recession and several more who will tell you we are headed for some kind of new depression. They may ultimately be proven correct, but so far the economic statistics haven’t cooperated. Most of these people will also tell you that the housing market is the key to stablizing the economy. If real estate stabilizes, the mortgages on the books of all those banks that are in trouble will also stabilize and only then can the system start to heal. I’m not sure that is all it will take to stabilize the banking system, but it sure wouldn’t hurt. Taking a look at this map showing the four quarter change in real estate prices (from OFHEO) gives one some hope that the process is already well under way:

What this shows is that over the trailing four quarters, house prices have risen in 30 of the 50 states. California, Nevada and Florida are going through a real estate bust. The rest of the country? Not so much…

House prices may continue to decline and the economy may fall into a deep recession/depression. Anything is possible. But so far, I don’t see it.

This is cross posted at our new site (Don't forget to bookmark the new site):

AI Report

Monday, August 25, 2008

The Worst Tax

Richard Rahn has an article posted at the Cato Institute about the corporate income tax:

Rank the following taxes from best to worst: individual income taxes; payroll taxes, corporate income taxes, sales or consumption taxes, and residential property taxes. The vast majority of economists would rank the corporate income tax as being worst and the sales tax and residential property tax as the best.

Unfortunately, the corporate income tax is often the favorite tax of fiscally irresponsible politicians because it is not easily seen. In fact, the corporate tax is paid by workers in lower wages and fewer new jobs, by consumers in higher prices and by savers and investors in lower rates of return. The Organization for Economic Cooperation and Development (OECD), based in Paris and not known for favoring lower taxes, published a new study last month, "Tax and Economic Growth," which provides more evidence that the corporate income tax interferes most (as compared with other taxes) with proper resource allocation, productivity growth, and economic efficiency.

I think the corporate tax should be eliminated. It is ineffective and produces a small portion of the total tax take. It defies common sense to believe that the tax falls on some evil entity known as a corporation. All taxes, are paid by individuals as corporations just pass the tax along either to employees, customers or investors. If the goal is to increase job creation, I can think of no better way to do so than to reduce or eliminate corporate taxes.

The Root of the Housing Problem

Amity Shlaes has an article at Bloomberg that takes a different view of the housing problem:

Aug. 20 (Bloomberg) -- Everything will be all right if we just fix the housing problem. That was the hope investors clung to as they watched Fannie Mae and Freddie Mac crumble this week.

The presidential campaigns reflect a similar faith in housing's curative power. Senator John McCain recently suggested that not merely mortgage-loan defaults but also anxiety about those mortgages was our worst problem: ``Americans are uncertain about this crisis.''

``Three-Bedroom Ranch,'' a Barack Obama campaign commercial, suggests that America needs a ``plan to build'' for the middle-class rather than subsidize corporate interests. The candidates seem to believe that recovery is something with French doors and a new roof.

But what if houses aren't a haven but a prison? What if even a booming real estate market itself is a problem? That's the theory of a winning Phelps -- not Michael Phelps, the Olympic swimmer, but Nobel Prize economics laureate Edmund Phelps of Columbia University. Phelps deplores the collective energy Americans spend on family housing.

``It used to be said that the business of America was business,'' Phelps says. ``Now the business of America is homeownership.'' To grow optimally, he says, America needs to get beyond its house passion.

It seems obvious to me that since the government subsidizes home ownership, we probably invest too much in housing. The mortgage tax breaks, as well as the subsidy provided by a Federal Reserve keeping interest rates too low, traps too much of our capital in the housing market. If the government removes the subsidy, that capital would be invested in more productive activities.

Wednesday, August 20, 2008

Auction Rate Update

I haven't done an update on the auction rate security mess for quite a while, but now that some firms are starting to settle with their clients, it seems a good time to review.

The large brokers of auction rate securities, who were also the underwriters, have all mostly agreed to buy back auction rate securities from their clients. This was forced by Andrew Cuomo, the AG of the state of NY. Other state AGs have also been active in pursuing settlements. So if you are a client of Citigroup (Smith Barney), Merrill Lynch, UBS or JP Morgan, you will be getting your money back, probably by the end of the year - well that depends. It may be this year or more likely next year but possibly not until 2010. If you are a client of a smaller firm that wasn't among the underwriters, you aren't so lucky - yet.

The AGs forced these settlements by concentrating on the marketing of these instruments, which they said was fraudulent. Auction rates were sold as money market alternatives and clients were told that these were liquid instruments. That turned out not to be true and the firms were facing multiple lawsuits and arbitrations which they would likely lose.

Smaller firms used the same marketing tactics but have not joined the settlements for a variety of reasons. First, they probably don't have the money. Second, they can claim that they were depending on the underwriters to maintain a market and that they were victims as well. My guess is that the solution for the smaller firms will include admitting some guilt on their sales practice, but the underwriting firms will take the majority of the blame.

There is one other class of firms that really shouldn't be included in a settlement. Discount firms that didn't actively market the auction rates should not be held liable. Firms like Fidelity and Schwab were not out soliciting clients to invest in these things but just made them available. As such they really didn't do anything wrong. Full Disclosure: My firm uses Fidelity as our primary custodian.

That hasn't stopped the state of MA from pressuring Fidelity to buy back the securities:

NEW YORK (MarketWatch) -- After reaching deals with many of the top Wall Street banks over the auction-rate-securities mess, regulators are now turning their focus on brokerage firms not covered by those agreements.

Massachusetts Secretary of the Commonwealth William Galvin has written to Edward "Ned" Johnson, CEO of Fidelity Investments, asking that Boston-based Fidelity buy back the auction-rate securities that it sold to its clients.
"It is my hope that Fidelity will follow the industry trend and promptly repurchase these securities that it has sold to it customers, many of whom now find themselves unable to access money that they thought was as liquid as cash," wrote Galvin.

"Therefore, I request that Fidelity take immediate steps to resolve this matter on behalf of those customers."

Fidelity obviously does not agree:

Fidelity, though, stood firm in the face of Galvin's letter. "Fidelity is [not] the issuer, underwriter or sponsor of auction-rate securities," said Vin Loporchio, a spokesman for Fidelity. "We do not proactively market auction-rate securities. We believe the underwriters should stand by their securities."

I think Fidelity is right on this and the state would have a very hard time convincing a jury that Fidelity is liable.

One mystery is where the banks are getting the money to buy back these securities. They are already facing significant capital impairments from mortgage and private equity debt and would seem to have limited access to capital to use for this. Will the Fed be accepting auction rates at the discount window? I don't know but my guess would be yes. This will probably also force the issuers of auction rates, primarily fund companies like PIMCO, to come up with a solution. The banks cannot just carry this illiquid stuff on balance sheets already gummed up with illiquid mortgages. Expect to see signficant pressure on the fund companies to replace these and pay back the brokers/bankers.

Fannie and Freddie Death Watch

The Fannie Mae and Freddie Mac deathwatch continues today with the stocks both making new lows. It seems inevitable at this point that Hank Paulson will have to whip out the government check book and take these things over. The question seems more a matter of structure at this point.

This week's selloff was spurred by an article in Barron's over the weekend:

IT MAY BE CURTAINS SOON FOR THE MANAGEMENTS and shareholders of beleaguered housing giants Fannie Mae and Freddie Mac . It is growing increasingly likely that the Treasury will recapitalize Fannie and Freddie in the months ahead on the taxpayer's dime, availing itself of powers granted it under the new housing bill signed into law last month. Such a move almost certainly would wipe out existing holders of the agencies' common stock, with preferred shareholders and even holders of the two entities' $19 billion of subordinated debt also suffering losses. Barron's first raised the possibility of a government takeover of Fannie and Freddie in a March 10 cover story, "Is Fannie Mae Toast?"

As the Barrons article points out, the shareholders will likely be wiped out by any bailout - or at least they should be. The board of directors and managers will also likely get the axe. While that is necessary, it is not enough if taxpayers are asked to fund these two. The companies should not be operated as government agencies and allowed to just keep expanding their book of business.

Fannie and Freddie, if taken over, should be broken up and privatized. Even as semi-private companies Fannie and Freddie greased a lot of palms in DC. Imagine the potential for corruption if they become protected government entities. They are already the dominant players in the industry and if allowed to continue operating under the umbrella of explicit government guarantees, the number of competitors will just shrink further.

Furthermore, if taxpayer funds are used to prop these companies up now, then taxpayers should benefit when they are sold off. If we are to assume the downside of guaranteeing their existing mortgages, we should get the upside when they recover. The government should get some kind of equity kicker (warrants probably) when the companies are fully privatized. I would even go further and say that any equity retained by the government in these deals should be distributed to taxpayers rather than retained by the government. How can government be expected to regulate an industry in which it holds a stake?

Tuesday, August 19, 2008

How to Kill a Recovery

Amity Shlaes, author of The Forgotten Man: A New History of the Great Depression, lays out the non monetary mistakes made that turned the Crash of '29 into the Great Depression. They sound a lot like Obama's economic platform:

Giving in to protectionism - In Herbert Hoover's time, Sen. Reed Smoot and Rep. W.C. Hawley proposed a tariff that was to raise effective duties by as much as half. More than a thousand economists signed an open letter warning that the duties would "raise the cost of living and injure the great majority of our citizens."

Blaming the messenger - Punishing the stock market for the 1929 crash was popular in Washington in the early 1930s. Lawmakers attacked the practice of short selling; Senate Banking Committee counsel Ferdinand Pecora hauled J.P. Morgan and other Wall Streeters in for hearings. By 1934, Congress was creating the Securities and Exchange Commission. The Roosevelt administration also prosecuted business leaders, including former Treasury secretary Andrew Mellon and utilities magnate Samuel Insull. The new regulatory culture cut crime and protected investors. But the arbitrary nature of the assault petrified Wall Streeters.

Increasing taxes in a downturn - Hoover more than doubled income tax rates, taking the top marginal rate to 63 percent from 25 percent. FDR hiked the top rate to 90 percent. Perhaps worse, Roosevelt's Treasury crafted taxes to punish business, including an undistributed profits tax and an excess profits tax, that ultimately sucked cash from a capital-starved economy.

Assuming bigger government will bring back growth. There's a sense today that Washington has retreated too much from daily lives. Wall Streeters mutter that "the system" (the financial markets) doesn't work anymore. In the 1930s, people didn't just mutter that -- they believed it. Public-sector expansion seemed the only way to sustain America's promise. New Deal programs did much to alleviate the pain month to month -- many found dignity in six months of work at the Works Progress Administration, the Public Works Administration or the Civilian Conservation Corps. But economics is a competition for scarce capital. Such state solutions tended to suppress the creation of long-term private-sector jobs, as did the aggressive Wagner Act for organized labor.

Ignoring the cost of inconsistency. FDR spoke of "bold persistent experimentation." Obama speaks of "change." Both can do damage. What's more, the list of experiments is always finite. Our bailouts look reassuring, but even Washington cannot rescue the entire economy. And foreign investors wonder where Washington will stop. Already concerned about the inconsistent dollar policy, China is now troubled by the inconsistent rescues.

My greatest fear about the economy is the fiscal response out of Washington after the election. I have previously written about the Great Recession of 2010 and if we follow this path, I may have to change the title.

Wesbury Agrees

Brian Wesbury's Op-ed in today's WSJ sounds familiar:

The Fed's "dual mandate" -- to keep the economy strong and prices stable -- serves to support this mistake. In contrast, the European Central Bank has a single mandate: price stability. No wonder the dollar has been so weak relative to the euro. Imagine two football teams. One with a single mandate: win. The other with a dual mandate: win and keep your uniforms clean. It's clear that the one with the single mandate will have more success in achieving its goals over time.

It is this combination of denial of actual inflation, bad economic models and the political expediency of keeping interest rates low that makes a repeat of past policy mistakes likely. In the end, inflation can be controlled -- the Volcker-Reagan strategy of tight monetary policy and tax cuts still holds the key -- but only if policy makers find the courage.

From my article at RealClearMarkets the other day:

The problem then and the problem now is the supply and demand for US dollars. Soon after Reagan’s inauguration in 1980, the dollar started a rise that continued until the Plaza Accord of 1985. The trade weighted dollar rose roughly 50% and the price of oil fell by a similar amount. That rise was no accident. It happened because of the tight monetary policy of Paul Volcker and the growth promoting tax policies of Ronald Reagan.


The fist step should be to clarify the Fed’s mandate. Now, the Fed is tasked with maintaining growth and minimizing inflation. The only way for the Fed to truly accomplish the first goal is to concentrate exclusively on the second. It should also be made clear that inflation is defined as an expansion of the money supply and not a rise in price of an arbitrary basket of goods. The best way to accomplish currency and price stability is to adopt a gold standard but in the absence of political will for such a policy, a single mandate is a good first step.

It's nice to know that I'm in such good company.

Monday, August 18, 2008

Greenspan has a Good Idea

Greg Mankiw quoting from a WSJ article cites a proposal by Alan Greenspan to aid in the recovery of the housing market:

He did offer one suggestion: "The most effective initiative, though politically difficult, would be a major expansion in quotas for skilled immigrants," he said. The only sustainable way to increase demand for vacant houses is to spur the formation of new households. Admitting more skilled immigrants, who tend to earn enough to buy homes, would accomplish that while paying other dividends to the U.S. economy.

He estimates the number of new households in the U.S. currently is increasing at an annual rate of about 800,000, of whom about one third are immigrants. "Perhaps 150,000 of those are loosely classified as skilled," he said. "A double or tripling of this number would markedly accelerate the absorption of unsold housing inventory for sale -- and hence help stabilize prices."

So for once, Greenspan actually has a good idea. The housing market will only get better when the inventories are worked off and the best way to do that is to increase the pool of buyers.

Friday, August 15, 2008

A Strong Dollar will Reduce Oil Prices

I have a new article up at

In less than one month, oil prices have fallen nearly 22%. That drop happened during a period when our leaders in Washington accomplished exactly nothing of importance that could account for the fall. Sure, President Bush lifted the moratorium on offshore drilling, but that action will have no effect unless Congress follows suit.

Most likely the fall had nothing to do with the impending expiration of the drilling moratorium, but rather is a reaction to the recent strengthening of the US dollar. There has been a lot of discussion over whether the dollar has risen because oil has fallen or if the reverse is true, but based on history, it seems obvious to me that it is the dollar driving oil prices and not the other way around.

Read the rest by clicking on the title of this post.

Self Inflicted Wounds

The WSJ has an editorial today entitled, "American the Uncompetitive", which details the excessiveness of our corporate income tax:

The new international tax rankings are out for 2008, and congratulations to Washington, D.C., are again in order. Our political class has managed to maintain America's rank with the second highest corporate tax rate in the world at 39.3% (average combined federal and state).

Only Japan is slightly higher overall, though if you are silly enough to base a corporation in California, Iowa, New Jersey, Pennsylvania, or other states with high corporate levies, your tax rate on business income is even higher than in Tokyo. For the first time, the U.S. statutory rate is now 50% higher than the average of our international competitors, continuing a long-term trend as the rest of the world keeps reducing corporate tax rates. (See nearby chart).

A new OECD study, "Taxes and Economic Growth," examines national tax burdens and their impact on growth and incomes in member countries. It concludes that "corporate taxes are most harmful for growth, followed by personal income taxes, and then consumption taxes." The study adds that "investment is adversely affected by corporate taxation," and that the most profitable and rapidly growing companies tend to be the most sensitive to high business tax rates.

There is, of course, no such thing as a corporate tax. Taxes are always paid by individuals. If a corporation pays a tax it is coming from either their customers (in the form of higher prices), their employees (in the form of lower wages), or shareholders (in the form of lower returns). So, corporate taxes are ultimately just another way for DC to take money out of your pocket.

At a time when there is considerable debate about whether we will follow Japan's path of the last 15 years of stagnation, you would think someone in DC might look at the fact that our tax rate is about the same as theirs and ask if that might have an impact. Alas, no. Politicians are in populist mode and blaming corporations for all our troubles, from high oil prices to expensive health care.

If we want to attract capital to the US, and we must with our deficits, we have to make it attractive to investors. Frankly, I think the corporate income tax should be eliminated. In the editorial, the WSJ quotes a Tresury study:

The average European nation has tax rates on corporate income 10 percentage points lower than the U.S., but those countries on average raise 50% more as a share of GDP in corporate taxes than does the U.S., according to a 2007 study by the Treasury Department. Ireland with its 12.5% rate captures a higher share of its GDP (3.4%) in corporate taxes than the U.S. does (2.5%) with its 39.3% rate.

Doesn't that make it obvious that we are past the peak of the Laffer curve? Furthermore, considering the distortions caused by corporate taxes and the small amount of revenue collected, why not just eliminate the tax? I don't know if it would pay for itself, but it seems likely that higher growth would generate more personal income and thus more tax revenue from that source. In addition, eliminating the corporate tax would increase the demand for dollars and thereby reduce inflation. Finally, the real bonus is in the reduction of corruption on Capital Hill. With no corporate tax to avoid and no loopholes to create, the only losers here would be lobbyists and politicians. That's something that everyone should be able to get behind.

Wednesday, August 13, 2008

Robert Reich Hates the Fed

Robert Reich has a post today lamenting the power of the Fed. Of course, he dislikes the power of the Fed for different reasons than I but at least he finally understands that they are the problem:

Chinese authoritarian capitalism, on display this week in Beijing, has me thinking about America’s democratic capitalism and how we practice it.

Start with the U.S. economy’s most powerful government agency: The Fed, of course. Its decision this week to hold short-term interest rates steady was wrong, in my view; it should have lowered them because recessionary forces continue to increase while wage-price inflation doesn't exist. Wages are dropping in real terms. But my opinion and your opinion count for nothing. The Fed is not directly accountable to American voters, or even to Congress or the President.

In Robert Reich's world the solution to inflation is more inflation. How that works, I'm not sure. He might be right that if the Fed lowered rates more and cranked up the printing press, that wages would rise. Of course, prices would also rise, so I'm not sure how that is supposed to help the working man/woman.

He's right that the Fed has too much power, but he offers no solution. You can't make the Fed more responsive to politicians. Can you ever imagine Congress urging the Fed to raise interest rates? The only answer to limiting the Fed's power is to adopt a gold standard and Reich will never advocate that. A gold standard would drastically limit government spending and since he sees every problem as an excuse for more government, a gold standard is not possible.

Retail Sales

Retail sales, which account for about one-third of gross domestic product, have weakened further in July, as most of the tax rebate checks have been distributed and used. Retail sales dropped 0.1% in July, slightly ahead of expectations. Excluding a 2.4% decline in automobile purchases, sales were up 0.4%, the slowest since February. Excluding gas purchases, and that number falls to -0.2%. Economists were expecting a 0.3% decline in total sales and a 0.5% gain ex-auto.

In the past year, retail sales are up 2.6%. Excluding gasoline, sales are up just 0.2%. The figures are not adjusted for price changes.

Report Details

Sales at furniture stores rose 1%, the biggest gain in 18 months.

Sales at electronics and appliance stores rose 0.8%.

Sales at hardware and garden stores rose 0.3%.

The higher cost of gasoline was evident not only in the 0.8% rise in sales at gas stations, but also in the 1.1% increase at non-store retailers, such as catalogs and online stores.

Sales at the malls were soft in July. Sales at general merchandise stores rose 0.3%, including a 0.1% increase at department stores. Sales at clothing stores rose 0.2%.

Sales at bars and restaurants fell 0.2%. Sales at food stores rose 0.4%. Sales at health and personal care stores were flat.

See Full Report.

Tuesday, August 12, 2008

The View from Here

Last week, Wall Street lost it's most erudite spokesman when Michael Metz, the longtime market strategist at Oppenheimer & Co., passed away. Mr. Metz was best known as a bear on Wall Street, especially during the internet bubble, but for those of us who had the privilege of Mike's counsel as Oppenheimer employees, he was much more than a perma bear. I spent 10 years at Oppenheimer & Co. and while I valued his market observations, the thing I remember the most is that he was a true gentleman. Despite the abuse he took on CNBC from the cheerleaders during the internet bubble, Metz never responded in kind. He was always polite. He took his revenge by being quietly right.

I remember distinctly when it was announced that he was stepping down from the strategist post. Oppenheimer was owned by CIBC at the time and while Mike never complained about it, I always believed he was eased off the public stage for being too bearish. I also remember thinking at the time that if the last bear was being silenced, the top had to be near. Of course, Metz was right about the internet bubble, as he was about so many things. CIBC sold the firm soon after at a fire sale price to Bud Lowenthal at Fahnestock, proving once again that they had little concept of the value of Mr. Metz or the firm. It's been a while, but my recollection is that Mr. Lowenthal restored Metz to his old position as strategist, the first of what proved many good business decisions.

I will miss reading Mr. Metz' market commentaries. They were always wide ranging, interesting and thought provoking, although it was always a good idea to keep a dictionary at hand during the reading.

Michael Metz was a throwback to an earlier time on Wall Street when it was more important to be conservative with client's assets than to jump on the bandwagon of the latest fad. The view from here is that he can't be replaced and is already sorely missed. May he rest in peace.

Thursday, August 07, 2008

Initial Jobless Claims

The number of people filing for first time unemployment benefits held steady at recession levels in the week ending August 2nd, according to the US Department of Labor. Claims jumped 7,000, to 455,000, after an upwardly-revised gain of 45,000 last week. Economists were expecting 430,000 new claims for the week. Today's reading is the highest reading in six years.

A large portion of [the recent gains] is due to the extension of unemployment insurance benefits, and thus does not necessarily suggest a severe loosening in the labor market.

Having witnessed extremely volatile measurements in the past few weeks, it is wise to consider the four-week moving average of initial claims, which smooths out one-time factors such as bad weather or holidays. The four-week moving average was also higher, by 26,750 in the latest week, to 419,500.

Initial claims running consistently atop the 350,000 mark would signal some weakening in the labor market. Claims above 400,000 are seen by many as a signal of recession.

See Full Report.

Tuesday, August 05, 2008

FOMC Statement

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

Economic activity expanded in the second quarter, partly reflecting growth in consumer spending and exports. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and elevated energy prices are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred an increase in the target for the federal funds rate at this meeting.

Monday, August 04, 2008

Defending Obama on Trade

Susan Ariel Aaronson, an Associate Research Professor of International Affairs at George Washington University, tries to defend Barack Obama on trade with an article at

Around the world, the press has portrayed the 2008 US presidential election as a choice between freer trader John McCain and “protectionist” Barack Obama. That traditional paradigm has helped the media simplify the differences between the two men. However, such these labels do not accurately describe either candidate. And it does not fully portray the candidate, Mr Obama, who has the more optimistic vision of trade.

Her argument is that although he wants to include "global governance" issues such as labor and environmental rules in trade agreements that Obama is really in favor of free trade. Of course, that assumes that agreements can be reached on these other items, which I find highly doubtful. The US should not be dictating labor and environmental standards to other countries. While it sounds good to say we are trying to protect workers in these countries the reality is that adhering to our standards will mean that many of these workers won't have jobs at all. Given that choice, my guess is that these foreign workers would tell Obama to mind his own business.

Free trade does not require any negotiation. A true free trade agreement would need to be no longer than one sentence.

Personal Spending

Despite a better-than-expected gain in nominal spending, real personal spending decreased 0.2% for the month of June. Nominal spending increased by 0.6%, above the 0.5% expected by economists. But the increase was mainly due to a sudden spike in prices, as inflation increased 0.8% for the month. Adjusted for inflation, real consumer spending was down, by 0.2 percentage points. The spike in inflation was the worst for a month since 1981- 27 years.

Real spending on durable goods fell 1.6%, the biggest drop in a year, while real spending on nondurable goods slipped 0.4%. Real spending on services rose 0.2%.

Nominal personal incomes grew 0.1% in June, way ahead of expectations. Economists were expecting a 0.1% decrease.

The impact of the tax rebates on personal incomes was reduced in June: After getting $48.1 billion from the government in May, individuals received $27.9 billion.

See Full Report.

Friday, August 01, 2008

The Effects of Raising the Minimum Wage

The employment report today showed that the biggest jump in unemployment was in the 16-24 age group, up 0.8%. This group has lost 550,000 jobs in the last three months and the unemployment rate is up 2.4% during that time. The unemployment rate for those over age 25 is up by 0.5% during the same time.

Is it possible that raising the minimum wage had something to do with the rise in youth unemployment? Certainly the economic slowdown has had an effect on these workers and seperating out the part that is due to the rise in the minimum wage is probably impossible, but it seems logical that it has had an effect. I don't care if someone has a study that claims that raising the minimum wage has no effect on employment, common sense says it must have an effect. Businesses only have so much revenue to go around. Given a choice between hiring another slacker teenager and reducing owner profit or not hiring the slacker teenager, I think I know what choice the owner will make.

Obama's $1000 Rebate Plan

Forcing big oil companies to take a reasonable share of their record breaking windfall profits and use it to help struggling families with direct relief worth $500 for an individual and $1,000 for a married couple. The relief would be delivered as quickly as possible to help families cope with the rising price of gasoline, food and other necessities.

The rebates would be fully paid for with five years of a windfall profits tax on record oil company profits. This relief would be a down payment on Obama’s long-term plan to provide middle-class families with at least $1000 per year in permanent tax relief.

What happens if the Oil companies don't have "windfall" profits for all of those five years? How do we define "windfall"? Is it a windfall when Angelina Jolie makes $20 million for a film? Can we take some from her too? What about Google? Their profit margins are much higher than Exxon Mobil's. Can we take some of their profits too? Just asking....

The key word in the above paragraph is "Forcing". All taxes are ultimately about force. The government takes from one group and gives to another. So Obama wants to take money from oil company shareholders and distribute it to other citizens. Why do those who didn't take the risk of owning oil company shares deserve to reap the benefits of ownership? Is it possible that would have an effect on the desire to own oil company stocks? Will that have an effect on the returns of pension funds who invest on behalf of the same Americans who receive the windfall tax proceeds? Is it possible that oil companies will just pass through the tax to consumers? If they do, who benefits from this other than Barack Obama? Has anyone on Obama's economic team thought about this?

Stupid is as stupid does....

Dividends Paid by the Taxpayer

Larry Lindsay makes a fine point in his editorial today in the WSJ, Hank Paulson's Fannie Gamble, that I hadn't thought of:

First, Congress rejected a proposal that Fannie and Freddie be barred from paying dividends if they are receiving injections of capital from the federal government. This idea would seem to be the first lesson in a course on Government Bailout 101. The government shouldn't be shoveling taxpayer money in the front door while the company is shoveling dividends to shareholders out the back door.

Freddie Mac paid $1.6 billion in dividends last year while Fannie Mae paid $2.5 billion. Both have dividend yields that are many times higher than the norm. Congress chose to protect the shareholders at the expense of the taxpayer.

Our politicians really drove a hard bargain with Fannie and Freddie. No one in the boardroom or executive suite got canned. Shareholders keep getting their dividends. And they keep all the upside. If they fail we just get the bill. Is it any wonder that politicians don't work in the private sector? No investment banker would last long making a deal like this. Just another example of politicians looking out for themselves rather than us.

Willful Blindness

Nancy Peolosi recently said that she didn't want to drill for more oil in the US because she was "trying to save the planet". Charles Krauthammer points out that not drilling here is only good for the parts of the environment that Pelosi can see:

Does Pelosi imagine that with so much of America declared off-limits, the planet is less injured as drilling shifts to Kazakhstan and Venezuela and Equatorial Guinea? That Russia will be more environmentally scrupulous than we in drilling in its Arctic?

The net environmental effect of Pelosi's no-drilling willfulness is negative. Outsourcing U.S. oil production does nothing to lessen worldwide environmental despoliation. It simply exports it to more corrupt, less efficient, more unstable parts of the world -- thereby increasing net planetary damage.

That's something that seems obvious to me but apparently not to Pelosi. I live in Miami and Cuba, Venezueal and China will be drilling off our coast. Would I rather it be an American company with a better track record on the environment? You bet.

US Non-Farm Payrolls

Nonfarm payrolls in the US fell for the 7th straight month, as 51,000 more jobs were lost in July. Although negative, the consensus tabbed July for 70,000 job losses, so the report is somewhat bullish. The unemployment rate, in contrast, surged ahead of expectations,to a 5.7% annual rate. Economists were anticipating a number between 5.5 and 5.6%. The unemployment rate is at a 4-year high, and its meteoric rise of 0.7% in the past three months is the fastest increase in the past 26 years.

Manufacturing employment fell by 35,000 in July, bringing losses over the past 12 months to 383,000. Over the month, job losses were widespread with notable declines in transportation equipment (-8,000), wood products (-4,000), and textile mills (-3,000). Machinery added 6,000 jobs over the month.

Employment in construction was down by 22,000 in July. Construction has shed 57,000 jobs since its September 2006 employment peak, with nearly three-quarters of the decline occurring since October 2007. Nearly all of the July employment
decrease came among specialty trade contractors (-20,000), with both the residential and nonresidential components contributing to the decline.

Within professional and business services, employment services lost 34,000 jobs in July, with nearly all of the decline in temporary help services (-29,000). Since January 2008, employment in temporary help services has declined by 185,000. Computer systems design and related services added 7,000 jobs in July.

Wholesale trade employment decreased by 17,000 over the month, with declines in both the durable and nondurable components. Since its peak in November 2007, wholesale trade has lost 57,000 jobs.

Year to date, US payroll employment has fallen by 463,000.

See Full Report.

Thursday, July 31, 2008

2nd Qtr US GDP Report

According to the Bureau of Economic Analysis, US gross domestic product - the output of goods and services produced by labor and property located in the United States - accelerated in the latest quarter, to a 1.9% annualized pace. The number, reported by the Commerce Department, was slightly below expectations, as economists had expected a number closer to 2.3%.

The increase in real GDP in the second quarter primarily reflected positive contributions from exports, personal consumption expenditures, nonresidential structures, federal government spending, and state and local government spending that were partly offset by negative contributions from private inventory investment, residential fixed investment, and equipment and software. Imports, which are a subtraction in the calculation of GDP, decreased.

Consumer spending was supported by the largest increase in disposable personal income in six years, thanks largely to about $80 billion in tax-rebate checks from Washington.

Real personal consumption expenditures increased 1.5 percent in the second quarter, compared with an increase of 0.9 percent in the first. Durable goods decreased 3.0 percent, compared with a decrease of 4.3 percent. Nondurable goods increased 4.0 percent, in contrast to a decrease of 0.4 percent. Services increased 1.1 percent, compared with an increase of 2.4 percent.

Annual revisions in the report also showed that the economy contracted in the fourth quarter of 2007, falling 0.2%. It was the the first drop in real gross domestic product since the recession of 2001. The economy grew at a revised 0.9% annual rate in the first quarter.

See Full Report.

Initial Jobless Claims

The number of people filing for first time unemployment benefits rose sharply in the week ending July 26th, according to the US Department of Labor. Claims jumped 44,000, to 448,000, way above expectations. Economists were expecting 398,000 new claims for the week. Today's reading is the highest reading since April 2003.

Having witnessed extremely volatile measurements in the past few weeks, it is wise to consider the four-week moving average of initial claims, which smooths out one-time factors such as bad weather or holidays. The four-week moving average was also higher, by 11,000 in the latest week, to 393,000.

Initial claims running consistently atop the 350,000 mark would signal some weakening in the labor market. Claims above 400,000 are seen by many as a signal of recession.

See Full Report.

Tuesday, July 29, 2008

I’m Mad as Hell and…..I guess I’ll Have to Stay that Way

In 1976, Howard Beale, a character in the movie Network, urged Americans to get up, go to their windows, open them and yell out, “I’m mad as hell and I’m not going to take this anymore!” The preamble to Beale’s speech chronicles the problems of the 1970s: inflation, a falling dollar, unemployment, environmental degradation and crime. Here we are over 30 years later and we’re living another Howard Beale moment. Unfortunately, based on the solutions offered by our political leaders, I guess I’ll have to stay that way. What I don’t have to do is remain quiet about it.

There are real problems that face our country now and our political leaders cannot be trusted to provide the only solutions. Most do not have the guts to say what needs to be said for fear of alienating some group of supporters. And many do not have the integrity to stand on principle and advocate unpopular but necessary policies. Too often, politicians tow the line of special interest groups and campaign contributors instead of doing what is right for the country. It is high time that politicians were held responsible for the damage done by policies that benefit the few at the expense of the many.

In this election year, the greatest concern for most Americans is the economy and there is good reason for that. Unemployment, foreclosures and prices are all rising. The stock market, home prices and the dollar are all falling. Economic growth is still positive but well below potential. The situation is not as bad as during the 70s, but they are moving in that direction. And Americans are rightly worried.

At whom should we direct our anger? That is the question that is not being asked by enough Americans and not being answered to anyone’s satisfaction. Politicians and others are manipulating public opinion through the media by offering seemingly made-to-order villains such as Angelo Mozillo, Exxon-Mobil and the amorphous but always reviled “speculator.” Americans with little understanding of economics are easily misled by propaganda that indicts the market on charges of perfidy while sanctifying politicians who cast themselves as champions of the downtrodden. The true villains remain hidden away from public view.

Complicating the task of unmasking those villains is the resilience of the US economy. Keep in mind, the country’s economic growth has been weak but we have yet to register a negative quarter. Second-quarter growth will probably be reported at around 3% and you can bet there will be a line of politicians eager to take credit. Most economists expect the second half of the year to be weaker but if oil prices keep falling they may be as wrong about the second half as they were about the first.

The underlying problems, however, will not have been solved no matter what the performance of the economy is over the next few quarters or years.

In a recent market commentary, Bill Gross called access to credit “the mother’s milk of capitalism.” That sentiment, echoed by our politicians and policy makers, is the source of our problems. It is not credit but capital that is the lifeblood of capitalism and the US doesn’t accumulate enough capital to support the growth that we’ve become accustomed to. The savings rate has ticked somewhat higher over the last few months, but for years we’ve saved too little and spent too much. To make up for that difference we’ve depended on other countries, such as China, which now owns over $1 trillion of US debt. Middle Eastern countries own even more of us.

In their efforts to revive the credit markets, the Federal Reserve and their political enablers may have averted an economic crisis in the short-term, but the long-term implications have yet to be reckoned. Bear Stearns, Fannie Mae and Freddie Mac – deemed too big to fail – were given access to the public purse rather than face the consequences of excessive leverage. Now the acceptable cure for excessive private indebtedness is more public indebtedness. Private players will reap the benefits if these transactions turn out profitable while the public will pay the price if they don’t.

Large financial institutions were encouraged to take on too much leverage and take too many risks by a Federal Reserve that held interest rates at artificially low levels for far too long. Rather than allow these companies to suffer the consequences of their actions our leaders are working overtime to ensure they continue to take imprudent risks in the future. The Fed has allowed overleveraged institutions to borrow funds at attractive rates with dubious collateral. Savers are punished with low interest rates while speculative players are encouraged to find new avenues for their speculation. Oil prices would seem to indicate they’ve found a new outlet for their speculative impulses.

The same is true of individuals who borrowed too much to buy homes they couldn’t afford. I feel for the people who face foreclosure but why should those of us who were prudent be forced to bail out those who weren’t? The recently passed housing bill will allow both lenders and borrowers to forgo the consequences of their actions. And again, if everything works out the lenders and borrowers will benefit while failure is assigned to the taxpayer. It would be better for the foreclosures to proceed and former homeowners to become renters again. The real estate market would face a further increase in inventory but prices could finally fall to market clearing levels. That would make housing affordable for those who have saved and acted prudently.

Over the last 50 years (at least) but especially during the last 30 years, every economic problem has been buried under another layer of credit and government intervention. The Federal Reserve and Congress have worked together to promote an economic environment where failure is deemed a threat to the “system” and all economic ills are “solved” by reducing the cost of credit. The result is plain for all to see. The US has moved from creditor to debtor nation. Debtors are bailed out through the tax code while savers are consigned to a prison of low interest rates. It is no surprise that we must import capital to cover our debts when we encourage debt and discourage saving.

The long-term problems facing our economy will not be solved painlessly, nor will they be solved by providing more of the same policies that got us to this point in the first place. While the Federal Reserve sits at the center of our problems the institution itself is not at fault. They have been given an impossible dual mission to maintain economic growth and to limit inflation. Having control only over the money supply, it is beyond the capabilities of the Fed to create growth. Inflation and credit expansion do not add anything to the amount of resources available or the capital stock. The Fed cannot create universal prosperity by creating more money. Inflation consumes precious capital by misdirecting resources into non economic investments. If you have any doubts about that, think of all the empty houses sitting around the country which attracted so much investment over the last decade. The capital devoted to housing was diverted from more productive uses and is now being destroyed as banks are forced to write off bad loans.

The villains in this story are the inhabitants of our political institutions. They seek to buy our votes with our own money and when they find that is not enough, they turn to the Federal Reserve and the banking system to create more. Rather than raise taxes to pay for the goodies they promise or the wars they deem necessary, they depend on debt and inflation. They do not create jobs, but destroy them. They do not create equality but exacerbate the divide between the haves and have nots and manipulate the divide to accrue more power. They do not create capital but rather destroy it. They are not special but mere mortals susceptible to the same failings as all people. They are self interested actors acting on a stage of their own design in a play written for their own benefit.

It seems evident that the housing bubble that is the source of the current economic malaise was caused by Federal Reserve policy. Does it not seem perverse to turn to the same institution for a remedy? How can they be expected to prescribe a remedy when they obviously don’t understand the malady?

It would seem more logical to proscribe the manipulation of interest rates for any purpose other than to achieve price stability. While a gold standard or some other real asset backed currency would be preferable and less susceptible to political manipulation, setting a single goal for the Fed is preferable to the current situation. Higher interest rates are obviously needed to reduce the inflation evident to everyone except the government statisticians. Higher interest rates would also encourage saving and discourage further debt accumulation.

It also seems evident that the government budget deficit is a result of excessive spending rather than a lack of taxation. Tax revenue has been remarkably stable as a percentage of GDP for many years, ranging between 18% and 21% regardless of tax rates. Right now it stands at 19%. Furthermore, other countries, such as Hong Kong, are able to collect nearly the exact same percentage of revenue with much lower tax rates. Hong Kong has income tax rates, personal and corporate, of less than 20% and generates a budget surplus while spending over 15% of GDP on government services. Hong Kong also doesn’t tax capital gains or dividends. We do not need higher taxes to generate the revenue needed for essential government services. We do need to decide what is essential.

In particular, it is illogical to raise taxes on capital when the basic problem we face is a lack of capital. If anything, taxes on capital should be further reduced to encourage accumulation of the capital needed to fund our growth. As for income taxes, it is time for Americans to assess the wisdom of taxing the very thing we wish to generate. If it is logical to tax cigarettes to discourage smoking, what is the logic for taxing income? A consumption tax coupled with repeal of the income tax would realign incentives toward a more rational economy based on thrift and savings rather than conspicuous consumption.

It is time for the citizens of these United States to take back our Republic from the thieves and parasites that occupy the seats of power. Power in this country was intended to reside in the people and the states. A class of citizens numbering less than 600 now hold that power in Washington, D.C. and we have no one to blame but ourselves. It is time to get angry.

The Truth About Drilling in ANWR

The argument those opposed to opening ANWR and other areas to oil exploration use is that it won't have an impact on today's prices because the oil won't come to market for years. Of course, that argument seems silly since any plan they offer for alternatives also will require years to produce results, but even absent that argument, it is highly likely that opening these lands to drilling in the future will change prices today:

Now what happens if we are at an initial equilibrium, and then all of a sudden the US government relaxes the prohibitions on ANWR drilling? If oil traders really believe the policy shift is permanent, and that up to a million extra barrels will be hitting the market in a decade, then this will obviously reduce the expected world price of oil starting at that time. Consequently, any oil producers who had previously settled on a production rate with "excess capacity" — i.e., where they could have produced and sold more barrels today, but decided not to for reasons of profit — will re-evaluate their decision.

Without specifics we have no idea how much the new information will change their output plans, but surely they will pump more in the present than they had previously decided.

If we step back and survey the big picture, what would happen is that the market in a sense would be transferring some of those future ANWR barrels to the present. It's true, the market doesn't have recourse to time machines. But physical barrels of oil that would have otherwise sat underground in 2008, 2009, and so on, will now be brought to the surface and sold, because they have been displaced by the barrels currently buried in Alaska that will be brought to the surface and sold in 2018, 2019, and so on.

It is even possible that the mere threat of opening these areas to drilling has an effect on today's prices:

If this seems too theoretical and farfetched, consider this: In May, the Saudis officially rebuffed President Bush's request for them to increase their output. Yet one month later, they reversed their position. What changed in the interim?

Obviously I don't know for sure what motivates oil barons, but the political mood in the United States shifted in between those two announcements. All of a sudden, opening up ANWR and offshore areas for drilling was "on the table." The mere possibility of an extra million or more competing barrels per day may have been enough to reverse the Saudis' stance.

Markets are wonderful things when they are allowed to work.

Will Speculators Get Credit for Driving Down Oil Prices?

A lot of economically illiterate people have blamed speculators for driving up oil prices. Will they now thank speculators for driving prices down?

Crude Oil Long Change Short Change
Large Speculator 198,019 -11,994 201,659 14,028
Commercial Hedger 641,265 -28,870 626,528 -60,219
Small Trader 55,452 -39,045 66,549 -33,718

Speculators can go short as well as long. If they weren't in the crude oil market right now, prices would be higher. Commercial hedgers are actually net long oil and as you can see, they are much bigger than the speculators who are net short.

I have no expectation that Congress will lay off the speculators though. If they admit that this was all just a witch hunt, they'll have to actually do something in an election year. And we can't have that.

Friday, July 25, 2008

Scientific Consensus on Global Warming? Maybe Not...

The number of scientist questioning the thesis that CO2 is the cause of global warming continues to grow. Considering the economic consequences of the plans for reducing CO2 emissions, it is time we had a serious debate about this. Up until now, the debate has been one sided and anyone who dared to question the Al Gore led consensus was ridiculed or worse. Now the consensus is starting to crack as more evidence becomes available.

I DEVOTED six years to carbon accounting, building models for the Australian Greenhouse Office. I am the rocket scientist who wrote the carbon accounting model (FullCAM) that measures Australia's compliance with the Kyoto Protocol, in the land use change and forestry sector.

FullCAM models carbon flows in plants, mulch, debris, soils and agricultural products, using inputs such as climate data, plant physiology and satellite data. I've been following the global warming debate closely for years.

When I started that job in 1999 the evidence that carbon emissions caused global warming seemed pretty good: CO2 is a greenhouse gas, the old ice core data, no other suspects.

The evidence was not conclusive, but why wait until we were certain when it appeared we needed to act quickly? Soon government and the scientific community were working together and lots of science research jobs were created. We scientists had political support, the ear of government, big budgets, and we felt fairly important and useful (well, I did anyway). It was great. We were working to save the planet.

But since 1999 new evidence has seriously weakened the case that carbon emissions are the main cause of global warming, and by 2007 the evidence was pretty conclusive that carbon played only a minor role and was not the main cause of the recent global warming. As Lord Keynes famously said, "When the facts change, I change my mind. What do you do, sir?"

There has not been a public debate about the causes of global warming and most of the public and our decision makers are not aware of the most basic salient facts:

1. The greenhouse signature is missing. We have been looking and measuring for years, and cannot find it.

2. There is no evidence to support the idea that carbon emissions cause significant global warming. None. There is plenty of evidence that global warming has occurred, and theory suggests that carbon emissions should raise temperatures (though by how much is hotly disputed) but there are no observations by anyone that implicate carbon emissions as a significant cause of the recent global warming.

3. The satellites that measure the world's temperature all say that the warming trend ended in 2001, and that the temperature has dropped about 0.6C in the past year (to the temperature of 1980).

4. The new ice cores show that in the past six global warmings over the past half a million years, the temperature rises occurred on average 800 years before the accompanying rise in atmospheric carbon. Which says something important about which was cause and which was effect.


The world has spent $50 billion on global warming since 1990, and we have not found any actual evidence that carbon emissions cause global warming. Evidence consists of observations made by someone at some time that supports the idea that carbon emissions cause global warming. Computer models and theoretical calculations are not evidence, they are just theory.

Al Gore and others who believe that man is the cause of global warming are right that this is the most important issue facing us today, but not for the reasons they believe. It's important because if we get this wrong and spend even more than the $50billion we've already spent to solve a problem that doesn't exist, we will have to forgo more important issues. There is no free lunch and there are always tradeoffs in economics. If we spend money to reduce the effects of global warming, that is money we can't spend on other things.

Thursday, July 24, 2008

Wesbury - 3% Growth in the 2nd Quarter

As I pointed out in my last market update, despite all the bad news out there, the economy is not in recession and the 2nd quarter was likely much better than expected. We'll find out next week, but in the meantime, here's what Brian Wesbury has to say:

Late next week the government will release initial estimates of real economic activity in the second quarter. Not long ago, in early April, when the quarter was just beginning, the consensus forecast for Q2 2008 real GDP growth was 0.0%, with as many economists predicting contraction as were predicting growth.

Now, three months later, the consensus is up to 2.2%. And no surprise - we are forecasting a 3% growth rate, more bullish than almost any other economist. Yes, it is true that the home building and autos sectors have been hammered. But, it is not true that this weakness has spread. Outside those sectors, the economy is not just healthy but downright strong, reflecting relatively low tax rates and loose monetary policy......

Many say it feels like a recession and predict negative growth. Then the data arrive, and show growth. The pessimists then say it doesn’t matter because it’s “old” news. After all, the quarter is already over and the evidence of recession will be clear by next quarter, they say.

Eventually, those forecasting recession are going to run out of time. The clock is already ticking and the economy remains resilient. Construction and auto related layoffs account for more than all the job losses in the past year. Initial unemployment claims remain below 400,000 and the financial sector appears to be bottoming.

I have said consistently since the credit problems started last year that this would not produce a recession and so far, I've been right. It's been extremely frustrating to be right about the economy and watch the stock market take a dive, but eventually the stock market will respond to the positive economic data.

Odds of Recession

Futures markets are not infallible, but they are remarkably accurate at predicting future events. Prediction markets are now available from a variety of sources, including InTrade. Here's the current contract on the likelihood of a recession in 2008:

Stock market investors may be worried about the economy but apparently no one is betting directly on that outcome. If you're convinced of the doom and gloom that pervades much of the press, I suggest you go and make a bet at InTrade.

Existing Home Sales

The US housing market continued its downward slide into June, as resales of homes and condos fell 2.6% for the month. Sales fell from a seasonally adjusted annualized rate of 4.98 million in May to 4.86 million in June. It is at its lowest level in 10 years. The number was well below expectations, as economists estimated sales at a rate of 4.95 million. Resales of US homes have fallen 15.5% in the past year.

Regionally, resales fell 6.6% in the Northeast, 3.4% in the Midwest, and 3.1% in the South. Resales rose 1% in the West.

Inventories of unsold homes increased for the month, gaining 0.2% to 4.49 million units for sale. That represents a 11.1-month supply, the second highest inventory level since the 1980s.

See Full Report.

Initial Jobless Claims

The number of people filing for first time unemployment benefits rose sharply in the week ending July 19th, according to the US Department of Labor. Claims jumped 34,000, to 406,000, way above expectations. Economists were expecting 380,000 new claims for the week. Today's reading is the highest reading since late March.

Having witnessed extremely volatile measurements in the past few weeks, it is wise to consider the four-week moving average of initial claims, which smooths out one-time factors such as bad weather or holidays. The four-week moving average was also higher, by 4,500 in the latest week, down to 382,500.

See Full Report.

Thank You Congress, May I have Another?!!

The House of Representatives passed the The American Housing and Foreclosure Prevention Act and President Bush will apparently sign it into law. Congratulations, taxpayer! You've just been stuck with the bill for bailing out not only "homeowners" who bought something they couldn't afford, but also the institutions that loaned them the money to make the purchase.

This bill will allow some homeowners to refinance their mortgages if they can talk their lender into reducing the principal balance on the loan by about 10%. My guess is that banks will be glad to do this since, FHA will then insure the mortgage. So if these "homeowners" get in more trouble down the road, taxpayers will take the loss rather than the banks. I could be wrong but it seems to me that this is exactly what led us to the problem we have now. Banks loaned to anyone who could plausibly lie their way through an application because the banks knew they would just package up the loans into CDOs, pay a rating agency to slap AAA on the cover and let someone else worry about actually collecting on the loan. Now banks will just offload their worst loans on the American public.

The bill also provides a tax credit for first time homebuyers, because obviously the problem with the housing market is that the government just hasn't subsidized it enough with mortgage interest deductions and special capital gains treatment. There's also $4 billion for "community development" which has worked so well over the years. Everyone in Miami knows that this money will be used for the intended purpose and not doled out to favored developers. And everyone in Chicago knows that community activists tend to spend this money more wisely than taxpayers.

Fannie Mae and Freddie Mac will also get an explicit guarantee for their debt from the taxpayer. In exchange, taxpayers will get....well, we don't get anything really. If Fannie and Freddie survive, their shareholders, managers and directors will benefit. If they fail, well, then we get the bill. What we are basically being asked to do is act as a guarantor for a giant hedge fund for which most taxpayers wouldn't qualify as investors. Unlike hedge fund investors though, if it makes money we don't get any but if it loses we have to pay. Is it any wonder that the government is in debt up to our eyeballs?

In exchange for taxpayer backing, the GSEs are supposed to get a tough new regulator. Considering that the regulator will require Congressional approval from the very same pols who drove this hard bargain, count me among the skeptical. What are the chances of a real tough regulator getting past a Congress filled with recipients of Fannie and Freddie campaign contributions and lobbying dollars?

So no one gets fired at Fannie or Freddie, their stockholders don't get wiped out (as they should if they are truly insolvent) and their bondholders don't have to worry about losing any principal. Sounds like a good deal for everyone - except the poor (and getting poorer) taxpayer.

Wednesday, July 23, 2008

Who was the Bartender?

At an allegedly private fundraiser, President Bush had this to say about the cause of the current economic problems:

"Wall Street got drunk -- that's one of the reasons I asked you to turn off the TV cameras -- it got drunk and now it's got a hangover," Bush said Friday, according to a video obtained by Houston's ABC affiliate KTRK. "The question is how long will it sober up and not try to do all these fancy financial instruments."

I actually think that is a pretty good analogy, although I would add condo flippers to the list of those who got hammered during the real estate boom. But if Wall Street got drunk, Alan Greenspan was the bartender. I think continuing to serve drinks to someone well after they have had enough is something for which bartenders can be held responsible. I suggest we sue Mr. Greenspan for the $500 billion or so that has been written off by the banks and brokers so far.

As for the hangover cure, Bernanke has come up with a cure:

1 shot of interest rate cuts
1 shot of TAF
1 shot of TSF
1 investment bank bailout
2 GSE bailouts
1 dash of talking nicely about the dollar

It's called Hair of the Dog but its effectiveness is still unknown. Wall Street has built up such a big resistance at this point that it may take two of these to reach that Greenspan buzz.

Fed Beige Book

Reports from the twelve Federal Reserve Districts suggest that the pace of economic activity slowed somewhat since the last report. Five eastern Districts noted a weakening or softening in their overall economies, while Chicago characterized its economy as sluggish and Kansas City noted a moderation in growth. St. Louis said activity was stable and San Francisco reported little or no growth. Cleveland and Minneapolis reported slight increases in economic activity, while Dallas described growth as steady and moderate.

Consumer spending was reported as sluggish or slowing in nearly all Districts, although tax rebate checks boosted sales for some items. Tourist activity was mixed, with residents in several Districts choosing to vacation closer to home due to high gasoline prices. The demand for services was also mixed across Districts, with strength in the IT and health care industries offsetting some weakness in other service sectors. Manufacturing activity declined in many Districts, although demand for exports remained generally high. Residential real estate markets declined or were still weak across most of the country. Commercial real estate activity also slowed or remained sluggish in a majority of Districts, although a few Districts noted slight improvement. In banking, loan growth was generally reported to be restrained, with residential real estate lending and consumer lending showing more weakness than commercial lending. Districts reporting on agricultural activity said conditions were mixed, based largely on how June precipitation affected them. Districts reporting on the energy sector said it continued to strengthen.

See Full Report.

Tuesday, July 22, 2008

Only Peasants Pay Taxes

This really doesn't require much commentary:

The committee hosting the Democratic National Convention is using the city's gas pumps to fill up on fuel, avoiding state and federal highway taxes, officials said today.

"There's something there that just doesn't seem right to me because, in a sense, you're saying then that the officials who pass the laws are not willing to live by them, and that concerns me," Councilwoman Jeanne Faatz said.

The issue came up during the council's weekly meeting with Mayor John Hickenlooper when the Public Works Department requested authorization to be reimbursed by the Denver 2008 Convention Host Committee for use of "fueling facilities, fuel and car washes."

"By doing it this way, by running it through our Fleet Maintenance, that means that that fuel does not pay state or federal highway taxes," Faatz said.

Christine Downs, a public works spokeswoman, said the host committee is not paying the city's locked-in fuel rate but one that's based on the weekly cost of gas. Downs was unable to provide council members an example.

Faatz asked if it was customary to have "fleets for dignitaries" not pay for highway taxes if they're using government fuel facilities.

Hickenlooper said it was.

"I believe this is only for elected officials, government dignitaries," Hickenlooper told Faatz.

"My understanding is in Washington or wherever where this happens on a regular basis, that it's standard operating procedure. I do know for a fact that they're doing the same exact thing in Minneapolis," which is hosting the Republican National Convention, the mayor said.

Teresa McFarland, a spokeswoman for the Minneapolis-St. Paul host committee, said they're getting their gas at the pump.

"We're not getting a tax break on fuel," she said. "That's not the set-up at this end."

"The DNC is not government. The RNC is not government," said Faatz, who, at the time, had been told that the "same exact thing" was happening in Minneapolis-St. Paul. "They are political parties and they are putting on a huge party, and that is not providing services to each and every citizen each day."

In Colorado, consumers pay 40.4 cents in taxes on every gallon of gasoline. That includes the federal gasoline tax of 18.4 cents per gallon and the Colorado gasoline tax of 22 cents per gallon.

"If you've got a 14-gallon tank, on the average, that's about $5.66 that they don't have to pay for fill up," Councilman Charlie Brown said.

Who are these people we've hired to run our government? What gives them such a sense of entitlement? According to the story, the Republicans aren't getting the same deal in MN, but you can bet they are getting something or they wouldn't be there.

Speculating about Speculation

I haven't said much about the search for a scapegoat on which to blame the rise in energy prices. Congress has held endless hearings and have alternately blamed oil companies and the undefined "speculators", but frankly I figured that the price would drop before our politicians did something stupid. That might not be a good bet in an election year. The Senate is considering a bill called the Stop Excessive Energy Speculation Act of 2008 and if it is enacted there will be negative consequences.

In futures markets there are two kinds of traders. Commercial traders are those who are using the futures market to minimize risks to their business by locking in the future price of energy. This allows them to plan their business with known costs rather than being subject to the wide swings sometimes seen in the price of commodities. Examples of commercial traders could be airlines or oil companies. Speculators are traders who are betting on the price of the underlying commodity for a financial gain. They are also often the traders who take the other side of the trade from the commercial hedgers. Without the speculators, commercial hedgers will find it more expensive or impossible to lay off their risks. So speculators play an important role in the markets - specifically they provide liquidity to the market for the commercial hedgers.

The bill under consideration will give the CFTC (Commodity Futures Trading Commission) the authority to end "excessive speculation". As with many bills passed by Congress, the definition of excessive speculation will be left to the regulators. How will they determine what constitutes excessive speculation? Is there any such thing as excessive speculation? In the futures market if one person wants to sell there needs to be someone else who wants to buy. It is a zero sum game. And it is voluntary. So what is excessive? The only thing that defines excessive in my mind is if someone wants to buy and there is no one to sell, but in that case the buyer will adjust his price until he finds a willing seller. Again, this is a voluntary transaction. No one is down on the floor forcing traders to take positions they don't want. Why should Congress be concerned with voluntary transactions among willing participants?

Speculators are not to blame for the rise in oil prices. Oil prices have risen because the demand for oil is greater than the supply. That is the only reason. The question of why there is an imbalance between supply and demand is a different question altogether. It could be because China is growing rapidly along with other emerging markets. Or it could be because investors are looking for ways to hedge against the inflation caused by the Federal Reserve. Or it could be because OPEC is withholding oil from the market. Or it could be because we've been pouring oil into the SPR. But this much is certain - the reason is irrelevant.

As an investor I believe that commodities are in important part of my portfolio because they are the best hedge against inflation. And that inflation is something that has existed since the day the Federal Reserve Act was passed. As long as we have a central bank with the ability to print unlimited quantities of money and politicians willing to spend it, we will have inflation. I believe it is my fiduciary duty to my clients to protect them from the devaluation of their assets through monetary manipulation. And the best way to do that is by owning real things such as commodities. Am I a legitimate hedger? Apparently Congress doesn't think so.

If this bill is passed it won't end "excessive" speculation. The speculators will just move to overseas markets with more friendly regulations. Futures markets are not some high tech item that only Americans can produce. In fact, they are pretty simple to operate since all that is really needed is a place for traders to exchange information. You don't even need a trading floor anymore. The victims of this bill will be the legitimate hedgers and the US futures exchanges. And the price of oil will not be affected one bit.

Monday, July 21, 2008

Jim Grant's Outrage

It is rare to find a financial writer who has the ability to see markets clearly and also write in a way that non financial types can understand. Jim Grant is one of the finest financial commentators alive today and his recent article in the WSJ linked above is one of his finest efforts:

"Raise less corn and more hell," Mary Elizabeth Lease harangued Kansas farmers during America's Populist era, but no such voice cries out today. America's 21st-century financial victims make no protest against the Federal Reserve's policy of showering dollars on the people who would seem to need them least.

Long ago and far away, a brilliant man of letters floated an idea. To stop a financial panic cold, he proposed, a central bank should lend freely, though at a high rate of interest. Nonsense, countered a certain hard-headed commercial banker. Such a policy would only instigate more crises by egging on lenders and borrowers to take more risks. The commercial banker wrote clumsily, the man of letters fluently. It was no contest.

The doctrine of activist central banking owes much to its progenitor, the Victorian genius Walter Bagehot. But Bagehot might not recognize his own idea in practice today. Late in the spring of 2007, American banks paid an average of 4.35% on three-month certificates of deposit. Then came the mortgage mess, and the Fed's crash program of interest-rate therapy. Today, a three-month CD yields just 2.65%, or little more than half the measured rate of inflation. It wasn't the nation's small savers who brought down Bear Stearns, or tried to fob off subprime mortgages as "triple-A." Yet it's the savers who took a pay cut -- and the savers who, today, in the heat of a presidential election year, are holding their tongues.

Grant is right of course and the public in a way is outraged, but in my opinion they are outraged at the wrong people. The public seems intent on finding a scapegoat in the banks and oil companies when the real culprits hide at the Federal Reserve and in a Congress that has abrogated its oversight responsibilities. As Grant points out, the populists of the late 19th century essentially won the argument. The system we have today is largely the one that the William Jennings Bryans of the world wanted. And its failures are blamed on the very market that hasn't been allowed to work as it should.

It is frustrating for people like Jim Grant (and me although I don't claim to be nearly as smart as Jim Grant) that the public doesn't seem to understand that more credit is not the cure for too much credit or that more government is not the cure for too much government. I suspect it will take more dire circumstances for the public to understand that the enemy of economic progress has been found and it is reflected in the mirror of every American who reflexively calls for government intervention for every economic ill that befalls the country.

Read all of Grant's article. It is excellent.

Sunday, July 20, 2008

Who Says the US Doesn't Make Anything Anymore

Okay, so here's a question. Rank these countries according to total exports:

Hong Kong

Click here to find the answer.

Exports are not magical; economic growth depends on many factors of which exports are just one.

The Cause of Recessions

It is not capitalism that causes all the turbulence that we see in financial markets. It is government intervention to prevent the proper functioning of markets that causes most of the problems. Foremost among these interventions is the setting of monetary policy by the Federal Reserve. The Fed causes the credit expansions which lead ineveitably to the corrections. Now comes some scientific proof of that:

Hayek was right. The cause of business cycles and market turbulence is – governments.

In the latest New Scientist, a bunch of 'econophysicists', using sophisticated computer analysis, suggest that crashes might well have something to do with the euphoric levels of credit that precede them. In other words, the cause of your hangover is the binge you went on the night before.

The geeks used some pretty impressive technology – not just looking at portfolios, but programming virtual hedge funds and brokers to see how they react to market conditions. In stable times, they conclude, these agents all work pretty well, spotting under-priced stock and borrowing to invest in it. But when credit is cheap and they borrow and buy more is when they can get into difficulties. Some single chance event can send waves through the entire market: because when everyone's borrowing, one person's failure becomes everyone else's problem.

So that's it. Politicians and monetary authorities love it when we're all borrowing to spend wildly. It's boom-time, everything succeeds, employment rises, production soars, house prices rocket, we all feel rich. And then pop! – the first person who can't pay the bills leaves a second short of cash, which knocks on to a third, a fourth, a fifth... Pretty soon the economy's in a tailspin. All those people the banks and building societies lent to suddenly can't pay it back.

You could mitigate this by regulating the gearing of financial institutions. Much better to do it through a sensible monetary policy that doesn't make credit too easy and keeps a close and concerned watch on the monetary aggregates. The quasi-independence of the Bank of England has probably helped: but it evidently needs tougher targets if boom and bust is truly to be eliminated for the future.

This is from the Adam Smith Institute and references the Bank of England but the same applies to the US where the Fed is probably more interventionist than the BOE.

Tuesday, July 15, 2008

Good News From the Credit Crunch

Considering the crap coming out of Hollywood, I'll put this in the Good News category:

The credit crunch has hit home in Hollywood after Paramount Pictures, which has released a string of hit movies this year, was forced to suspend plans for a $450m film financing.

The studio has been working with Deutsche Bank on financing that would have provided funds for up to 30 films, including possible blockbusters such as the sequel to Transformers and a new version of Star Trek.

More From Bunning

Here's the entire statement from Jim Bunning today:

Thank you, Mr. Chairman. I know we have a lot of ground to cover today, but I want to say a few things on the topic of this hearing and of the next.

First, on monetary policy, I am deeply concerned about what the Fed has done in the last year and in the last decade. Chairman Greenspan’s easy money the late nineties and then following the tech bust inflated the housing bubble and created the mess we are in today. Chairman Bernanke’s easy money in the last year has undermined the dollar and sent oil to new record highs every few days, and almost doubling since the rate cuts started. Inflation is here and it is hurting average Americans.

Second, the Fed is asking for more power. But the Fed has proven they can not be trusted with the power they have. They get it wrong, do not use it, or stretch it further than it was ever supposed to go. As I said a moment ago, their monetary policy is a leading cause of the mess we are in. As regulators, it took them until yesterday to use power we gave them in 1994 to regulate all mortgage lenders. And they stretched their authority to buy 29 billion dollars of Bear Stearns assets so J.P. Morgan could buy Bear at a steep discount.

Now the Fed wants to be the systemic risk regulator. But the Fed is the systemic risk. Giving the Fed more power is like giving the neighborhood kid who broke your window playing baseball in the street a bigger bat and thinking that will fix the problem. I am not going to go along with that and will use all my powers as a Senator to stop any new powers going to the Fed. Instead, we should give them less to do so they can do it right, either by taking away their monetary policy responsibility or by requiring them to focus only on inflation.

Third and finally, since I expect we will try to get right to questions in the next hearing, let me say a few words about the G.S.E. bailout plan. When I picked up my newspaper yesterday, I thought I woke up in France. But no, it turns out socialism is alive and well in America. The Treasury Secretary is asking for a blank check to buy as much Fannie and Freddie debt or equity as he wants. The Fed’s purchase of Bear Stearns’ assets was amateur socialism compared to this.

And for this unprecedented intervention in the markets what assurances do we get that it will not happen again? None. We are in the process of passing a stronger regulator for the G.S.E.s, and that is important, but it allows them to continue in the current form. If they really do fail, should we let them go back to what they were doing before?

I will close with this question Mr. Chairman. Given what the Fed and Treasury did with Bear Stearns, and given what we are talking about here today, I have to wonder what the next government intervention in private enterprise will be. More importantly, where does it stop?

I added the emphasis. Giving the Fed less to do rather than more sounds like a fine idea to me. I don't know much about Bunning other than that he has been a critic of the Fed for a very long time. He may be just as bad as every other politician when it comes to things like earmarks and campaign contributions, but at least on monetary policy, he is dead on.

Is Bernanke a Gnome?

My wife pointed out the resemblance of Bernanke to a gnome. Put a pointy hat on him....

Bunning's Comments

For those of you who don't want to watch the entire video of Jim Bunning below, here are some excerpts (via TMTGM):

I'm deeply concerned about what the Fed has done in the last year and in the last decade. Chairman Greenspan's easy money in the late 90s and then following the tech bust inflated the housing bubble and created the mess we are in today. Chairman Bernanke's easy money in the last year has undermined the dollar and sent oil to a new high every day and an almost doubling since the rate cuts started.

The Fed is asking for more power but the Fed has proven that they can not be trusted with the power they have. They get it wrong, do not use it, or stretch it farther than it was supposed to go in the first place. As I said a moment ago, their monetary policy is the leading cause of the mess we are in. As regulators, it took until yesterday to use the power we gave them in 1994 to regulate all mortgage lenders and then they stretched their authority by buying $29 billion worth of Bear Stearns assets so J.P. Morgan could buy Bear Stearns at a deep discount.

Now the Fed wants to be a systemic risk regulator, but the Fed is a systemic risk. Giving the Fed more power is like giving a neighborhood kid who broke a window playing baseball on the street a bigger bat and thinking that will fix the problem.

Finally, a politician who gets it.

FDIC Halts Foreclosures at IndyMac

WASHINGTON (Reuters) - The Federal Deposit Insurance Corp has temporarily halted any foreclosures on the $15 billion of bank-owned mortgage loans found in IndyMac's portfolio, FDIC Chairman Sheila Bair said on Monday.

Bair has scolded mortgage lenders for being too slow to help distressed borrowers restructure their home loans.

If Ms. Bair thinks this is how banks should be run, might I suggest she buy one and operate it as she sees fit.

Von Mises on the Moral Implications of Inflation

Ludwig Von Mises published Human Action in 1949, but this sounds quite relevant today:

The boom produces impoverishment. But still more disastrous are its moral ravages. It makes people despondent and dispirited. The more optimistic they were under the illusory prosperity of the boom, the greater is their despair and their feeling of frustration. The individual is always ready to ascribe his good luck to his own efficiency and to take it as a well-deserved reward for his talent, application, and probity. But reverses of fortune he always charges to other people, and most of all to the absurdity of social and political institutions. He does not blame the authorities for having fostered the boom. He reviles them for the inevitable collapse. In the opinion of the public, more inflation and more credit expansion are the only remedy against the evils which inflation and credit expansion have brought about. (Human Action, p. 576)

By the way, you can read Human Action on line at the Von Mises Institute's web site.

Bunning Strikes Out Bernanke

As the only Senator to vote against the nomination of Ben Bernanke as Fed Chairman, Jim Bunning is the only Senator who can honestly say he saw this mess coming. He spent years criticizing Greenspan, so he's not new at this. Today, he threw nothing but strikes (Bunning spent 17 years as a major league pitcher) in his questioning of Bernanke. Watch the video.

Retail Sales

Despite the help of Uncle Sam and his $50 billion in rebate checks thus far, retail sales managed only a 0.1% gain for the month of June, well below expectations. Excluding automobile purchases, sales were up 0.8%, the slowest in three months. Excluding autos and gas purchases, and that number falls to 0.2%. Economists were expecting a 0.3% gain in total sales and a 1.1% gain ex-auto.

In the past year, retail sales are up 3.0%. The figures are not adjusted for price changes.

Report Details

Auto sales dropped 3.3%, the biggest drop since February 2006.

Sales at furniture stores dropped 1.4%.

Sales at electronics stores fell 0.6%.

Sales at building materials stores fell 0.9%.

Sales of essentials were brisk, in part because of higher food and gas prices. Gas station sales rose 4.6%.

Food and beverage store sales rose 0.7%.

Sales at restaurants and bars dropped 0.2%.

Sales at drug stores and personal care stores rose 0.6%.
Sales at nonstore retailers, such as catalogs and online stores, rose 0.8%.

Sales at clothing stores rose 0.6%. Sales at general merchandise stores rose 0.4%.

Sales at sporting goods, book and hobby stores rose 0.7%.

See Full Report.

Economic Truth from the Onion

The Onion has a classic satire about the economic situation:

WASHINGTON—A panel of top business leaders testified before Congress about the worsening recession Monday, demanding the government provide Americans with a new irresponsible and largely illusory economic bubble in which to invest.

"What America needs right now is not more talk and long-term strategy, but a concrete way to create more imaginary wealth in the very immediate future," said Thomas Jenkins, CFO of the Boston-area Jenkins Financial Group, a bubble-based investment firm. "We are in a crisis, and that crisis demands an unviable short-term solution."

This is closer to the truth than anyone at the Fed would ever admit.

Saturday, July 12, 2008

Dionne Bashes Capitalism

E.J. Dionne says that capitalism is ailing:

WASHINGTON -- The biggest political story of 2008 is getting little coverage. It involves the collapse of assumptions that have dominated our economic debate for three decades.

Since the Reagan years, free market cliches have passed for sophisticated economic analysis. But in the current crisis, these ideas are falling, one by one, as even conservatives recognize that capitalism is ailing.

You know the talking points: Regulation is the problem and deregulation is the solution. The distribution of income and wealth doesn't matter. Providing incentives for the investors of capital to "grow the pie" is the only policy that counts. Free trade produces well-distributed economic growth, and any dissent from this orthodoxy is "protectionism."

Dionne is not the first, nor will he be the last, to blame capitalism for our current problems. His list of talking points isn't one that any true free market capitalist would produce. No economist that I've read (event the dumb ones) believes that income and wealth distribution don't matter or that providing incentives is the only policy that counts. Dionne's statement about free trade is closer to the parody of free trade presented by those like Dionne who are employed in the media rather than any self respecting economist. Free trade does not produce well distributed economic growth but it does make efficient use of limited resources. It is dissent from common sense and freedom which gets one labeled a protectionist.

It does seem though that we go through these periods of doubt about capitalism:

This is the third time in 100 years that support for taken-for-granted economic ideas has crumbled. The Great Depression discredited the radical laissez-faire doctrines of the Coolidge era. Stagflation in the 1970s and early '80s undermined New Deal ideas and called forth a rebirth of radical free market notions. What's becoming the Panic of 2008 will mean an end to the latest Capital Rules era.

Dionne misses the common element of all these periods. They are all preceded by periods of extraordinarily bad monetary policy. Every time the Fed screws up, people start to doubt the benefits of capitalism. That the Fed is not part of a free market, capitalistic system seems to matter little to those who prefer the government making economic decisions rather than individuals. It is ironic and maddening that an institution that represents the failure of monopolistic, centralized government planning could be the cause of so much doubt about the wonders of free market capitalism.

Update: Art Carden at Mises has similar thoughts.

Thursday, July 10, 2008

Initial Jobless Claims

The number of people filing for first time unemployment benefits fell sharply in the week ending July 5th, according to the US Department of Labor. Claims fell by 58,000, to 346,000. Economists were expecting 399,000 new claims for the week. It is the lowest reading since April and the largest one-week decline in more than 2 years.

Having witnessed extremely volatile measurements in the past few weeks, it is wise to consider the four-week moving average of initial claims, which smooths out one-time factors such as bad weather or holidays. The four-week moving average was also lower, by 10,000 in the latest week, down to 379,250. A year ago, the four-week average stood at 305,000.

See Full Report.