Polartics

Thoughts on Income Inequality - Part I

2012-02-10T23:13:00.000-08:00

Ever since I wrote this post on President Obama’s increasingly strident language about the unfairness of reported increases in US income inequality, the issue has only become more prevalent in our Oped pages, political blogs and journals. The fervor of this newfound fascination is perhaps not surprising given the popular backlash against mind-numbing Wall Street compensation during these times of high unemployment and stagnating wages.

I have earnestly sopped up much of the recent writing and some of the scholarship on the issue, even wading into the pages Mother Jones (here is a good example). And while many of these authors bring up reasonable and concerning points, I find that they all suffer from the same fatal flaw of logic: they assume that the simple act of decreasing income inequality will, by itself, help the neediest among us. I do not necessarily subscribe to this view, and will outline common flaws in the typical analysis below.

First, let me make a stipulation: in any given society, there is a meaningful correlation between freedom and wealth. If you disagree with this stipulation, then you can stop reading right now – you will disagree with my conclusions. However, in order to disagree with it, you’d have to disagree with quite a lot of scholarship and some very simple, but quite compelling analysis. For instance, the chart at right from economist Scott Sumner is a linear correlation between the Heritage Freedom Index and GDP per capita for all the countries of the world with GDP per capita greater than $23,000. The picture is quite demonstrative: it suggests that the more economically free a country, the higher its GDP per capita.

Now, I’ll acknowledge that there are numerous problems with such an analysis. Historical circumstance, lack of natural resources and other considerations may depress a certain country’s GDP per capita in ways that would not be captured by a Freedom Index. Conversely, countries like Norway, with its vast oil wealth, and Switzerland, as the banker to much of the world, skew the analysis in another direction. Therefore, I only introduce this chart as reasonably compelling evidence that, on average, within certain boundaries, the more free a country, the more chance it will have larger GDP per capita. Finally, I hope it goes without saying that although economic freedom may be a necessary precondition for wealth, it certainly is not sufficient.

Next let me stipulate that the tools and policies which a country like the United States might employ to reduce income inequality would, in all cases, serve to reduce economic freedom. The most common solutions to the income inequality dilemma are increasingly progressive taxation schemes, transfer payments such as food stamps and unemployment insurance, and, in some cases, increased regulation to reign in the worst perceived cases of wealth generation (think of the call for regulation of compensation during the financial crisis and the more recent calls for hedge fund taxation reform and registration). Each of these things might be effective in reducing income inequality, but they would undoubtedly also place a country lower on the Economic Freedom Index. When someone finds a way around this, please let me know – we’ve solved the problem!

One implication of my initial stipulation is that there is an unintended consequence of the adoption of these policies: the whole pot gets smaller. If freedom means wealth, and reducing income inequality requires reducing freedom, then reducing inequality requires reducing wealth. Liberals, including many economists, tend to ignore this point in their editorializing; sometimes it’s simply due to ignorance, sometimes I’m convinced it’s disingenuousness.

Now, these policies may be implemented with endless variety, each having a different effect on GDP. In economic terms, the negative multipliers of various policies are different, and economists could fine tune a set of recommended policies to minimize the effect on the country’s ability to provide for itself. Unfortunately, I suspect that the Policies which might have the greatest effect on income inequality might also be the ones which depress GDP the most.

But let’s revisit my initial thesis: that liberals’ distaste for income inequality, qua income inequality, is misguided. Let’s look at the current income distribution in the United States. In its various reports on gross income, the Commerce Department divides Americans into quintiles. The chart to the right shows the mean gross income for households in each quintile, with the poorest 20% of households bringing home $11,000 per annum and the richest 20% bringing home $169,000. Indeed, the rich have a lot more income than the poor.

Two comments are in order before we proceed. First, by organizing the analysis by quintiles, I am really talking about the vast majority of Americans. Conversely, when one sees statistics about income inequality bandied about in the liberal press, the conversation usually compares the top five percent, the top one percent, or sometimes even the top one-tenth of one percent of earners to the rest of America. While the numbers might look incredibly compelling when viewed this way, the numbers of the truly, truly wealthy are so small that it is of little use to economists or legislators in crafting policy. There are not enough billionaires to make a real difference on the deficit, for instance, solely by taxing them.

Second, please note that these figures relate to mean gross income, not including transfer payments. In order to be truly fair, any analysis of income inequality should really be done on a median basis, net, after tax, including transfer payments. Those numbers are hard to come by, however (and they don’t look as compelling to liberals!), so most people use mean gross income. I’ll stick to the traditional method and remind readers of any misleading points. [For instance, if one divided the sum of welfare payments, Medicaid, food stamps, and child subsidies by the number of households in the bottom quintile and added the result to their mean income, I suspect Figure 2 would look somewhat different. It’s why conservatives often point out that the average household living under the poverty line owns multiple cars, even more television sets, and the most significant health issue for impoverished American children is obesity].

Let’s assume that a liberal administration implements a tax policy with a goal of both raising revenue and reducing income inequality. Presumably the intent of any such Policy would be to change the income distribution from the figure above to look more like the green line in this chart to the right. (Let’s ignore the fact that we are analyzing income on a gross, not net basis!).

But we’ve already established that these policies might also likely reduce the amount of GDP per capita. As such, we should ask ourselves a question: is it possible that rather than the new targeted distribution, we might actually get one which looks more like the one here to the right? This new income distribution also decreases income inequality, but everyone is worse off. Importantly, even the poorest people in the nation are worse off than before.

I would like to think that even the most die-hard liberal would concede that this is a suboptimal result, but I am not so sure. The prevalence of recent opinion pieces which conjure up happiness studies and other evidence suggesting that income inequality itself is a cause of mental distress may suggest that liberals are intent on providing cover for this dirty little secret. The line goes like this: well, yeah, maybe nobody in Europe has as much money as Americans at any level, but, hey, they’re all a lot happier than we are! This line of thinking has so many faults that it will require a separate post to deal with – here I’ll move onto more pressing topics.

Given the possibility that any particular policy might affect all points on the income distribution curve, it seems to me that each policy ought to be analyzed not solely on its capacity to flatten the curve, but also its likelihood of affecting income generally (either positively or negatively). Politicians should be required to tell us what they think the optimized income distribution curve ought to look like: how flat it should be and how much net, adjusted income should be claimed at the lower quintiles. It seems to me that the very least important consideration should be the steepness of the curve at the far right of the distribution, and yet this is the very point over which so many people are expelling so much hot air!

Unfortunately, economics being the dismal science, it’s not so easy to determine the true effect of a given policy on the shape of future income distribution curves. I suspect Paul Krugman would give a very different answer than Art Laffer if President Obama asked each of them to analyze his pending tax proposals. Nevertheless, this should not stop politicians from being required to tell us what they think the curve ought to look like and how we’re going to get there. Then, we can have a national debate comparing the merits of Laffer’s model against Krugman’s as a means to analyze the proposals.

Doubly unfortunately, this is not how politics works. I have been dismayed at the breathtaking disingenuousness of the current rhetoric surrounding Obama’s proposed “Buffet Rule” – the fuzzy notion that millionaires ought not pay a lower effective tax rate than secretaries. In the thousands of words that Obama has spent on this issue, he’s never once admitted that there is a difference between the taxation of labor and the taxation of capital, and the reason that Warren Buffett pays a very low effective tax rate is because virtually 100% of his income is from dividends and capital gains rather than salary. Somehow, it doesn’t matter anymore that we got here (i.e. Buffett paying 15% effective tax rate) for a reason. That reason is because people argued, correctly or not, that low tax rates on dividends and capital gains would be good for all of us, including those at the bottom of the income distribution. Instead of revisiting that proposition, for some reason, we’ve skipped the analysis and started appealing to Obama’s sense of “fairness.” Obama’s fairness may end up costing all of us – even those at the bottom of the income distribution – a whole lot.

In fairness to Obama, I do not know the answer. My gut tells me that low tax rates on dividends and capital gains are good for poor people, but I have not personally analyzed the issue yet to my satisfaction (another Polartics post coming!). But we should not let liberals jam policy down our throats without a clear answer from them on this issue. We should call out any politician, blogger or editorial page writer who favorably invokes the Buffet Rule, but does not tell us why they think raising Buffett’s effective tax rate won’t affect everyone negatively, including poor people. That even goes for Warren Buffett!

That’s it for now, but if you want more good thoughts on the issue, here is a splendid article (from the reliably unreliable Economist) on “fairness.”

And for those of you who suspect this article may be self-serving, unfortunately, I have not achieved that level of success yet where the majority of one’s income is comprised of dividends and capital gains; my effective tax rate last year was 30.1%.

Japan's Nuclear Meltdown

2011-03-15T10:43:00.000-07:00

As of today:

Number of people killed by Japan's recent earthquake: 10,000?
Number of people injured by Japan's earthquake: hundreds of thousands

Number of people killed by nuclear meltdown: 0
Number of people injured by nuclear meltdown: 0

Ability of CO2 emission-free nuclear power to avert climate change: virtually limitless

Come on, people! We need to start getting serious about how to measure risk!

A Proposal for my Liberal Friends

2010-08-28T13:17:00.000-07:00

With the most liberal President in my lifetime proposing policies which cause some to deem him a Socialist, and with a countervailing popular sentiment having arisen in the form of the Tea Parties, it seems that the people of the United States are engaging in a more substantive debate about the best principles for governing than at any time since the 1930s.

In celebration of this national debate, I offer a proposal to my more liberal friends: you read one book of my choosing, and I’ll read one book of your choosing, and then we’ll meet for beers and discussion.

The books I have chosen for your pleasure are one (or both) of the following: Hayek’s The Road to Serfdom or Rand’s Atlas Shrugged. No cheating, you’ve got to read every single page from beginning to end. No skimming just to get a feel for it. You’ll notice that I’ve included a novel among the choices (making no representation about the quality of Rand’s prose), although I am quite willing to wade through an excruciating tome on Economics if that is most appropriate.

The problem is, I have no idea what liberals consider to be the most compelling literary work to elucidate their modern ideal. Please help me out by suggesting works in the comments here or on my Facebook page. If it seems like there’s a consensus, I’ll read it.

Then, when I see you next, we can talk about it. I’ll buy the beer.

Prediction

2010-07-14T15:15:00.001-07:00

Lee Bollinger will not be President of Columbia University in 18 months.

My Views on Climate Change

2010-06-16T11:45:00.000-07:00

I would call myself of a skeptic of the most aggressive theories of Anthropogenic Global Warming (AGW). Upon hearing that, many people would assume that I have stuck my head in the sand - that I don’t believe, for instance, that global temperatures have increased, or that Arctic sea ice is disappearing, or that glaciers are retreating.

Nothing could be further from the truth. I do not dispute facts (although it is true that there are facts, and then there are other facts). In fact (ha ha), most thoughtful skeptics do not dispute facts. Facts are stubborn things, as Ronald Reagan used to say, so such a strategy would be a waste of time.

No, the beliefs of most skeptics are actually quite a bit more nuanced than your average bear is willing to admit. Mine, in fact (there he goes again), take quite a long time to explain, so I don’t often do it. However, I’ve wanted to catalog a short list of my AGW beliefs so that I can track them and see how they change as I continue to learn about the issue. So I’ve gone and done it here.

Some of the beliefs below are factual and some of them are just beliefs. It’s hard to organize them, but I’ve done the best I could. They do not constitute one long argument; they jump around a bit.

If you dispute any of the beliefs here, please feel free to post a response and I’ll try to engage in a civil debate. You score a point if you can educate me and get me to change one of my beliefs. If I educate myself and am forced to change a belief, I’ll post a blackline.

My Beliefs about Anthropogenic Global Warming
• Global temperatures have increased by approximately 0.4 -0.5C since 1979 (that's when the satellite record began)
• Global temperatures likely increased between the beginning of the thermometer record (1850s) and 1979, but the magnitude of that increase is more uncertain
• This temperature increase has been more severe in the Arctic than just about anywhere else; the Antarctic has shown very little, if any, temperature increase
• Atmospheric CO2 concentrations have increased in a manner highly correlated to man’s industrialization
• It is likely that the majority of the increase in global CO2 concentration is due to man, and particularly his emissions (watch out – I said nothing about temperature here)
• The land temperature record has been significantly corrupted by land-use changes and urban heat island (UHI) effects and requires adjustment to eliminate those effects
• Adjustments to the land-temperature record lack rigor, but may be approximately correct on average
• It is reasonable to conclude that a meaningful percentage of the increase of global temperatures since the mid-1800s may be entirely natural; after all, at the time we were still emerging from the Little Ice Age
• It is reasonable to conclude that a doubling of atmospheric CO2 concentration might result in a further rise in global temperatures of at least 1C; without taking into consideration feedback mechanisms, simple physics would seem to suggest such a result
• The science regarding climate feedback mechanisms, particularly cloud cover, are not well understood
• It is not reasonable to assume that virtually all important feedback mechanisms are positive
• Climate models are essentially useless without well-understood feedback mechanisms
• Virtually 100% of future climate predictions are based on advanced climate models
• Therefore, future climate predictions of a rise in temperatures of between 3-5C based on a doubling of CO2 concentration are highly uncertain
• It is certainly possible that a doubling of CO2 would result in an increase in global temperatures of between 3-5C, but as of today that conclusion is not proven
• Personally, I have no guess what temperature increase would result from a doubling of CO2

Considerations of the Hockey Stick and Paleo Reconstructions
• An important aspect in the argument for a link between the rise in CO2 and the rise in global temperatures is the contention that the current rise in temperatures is unprecedented
• Studies which purport to show unprecedented warming have largely been discredited; until the theory of AGW became de rigueur, scientists generally believed that the Medieval Warm Period (MWP) was warmer than today
• While the discrediting of paleo reconstructions has not disproven the theory of AGW – surely there is considerable other evidence – it has clearly affected the first argument above, and claims based on reconstructions should be removed from the literature

Other Important Considerations
• There are important benefits of increasing CO2 concentrations, including increasing crop yields and a more robust biosphere
• It is extremely important to study the benefits of increasing CO2 concentrations at the same time as we are studying their deleterious effects
• It is highly likely that aggressive AGW prevention strategies would have certain unintended consequences
• It is possible that aggressive AGW prevention strategies would have meaningful negative unintended consequences

Supremely Important But Highly Uncertain Conjectures and Conclusions
• The true cost of weaning ourselves off CO2 emissions is orders of magnitude larger than the assumptions of most proponents of aggressive AGW prevention strategies (with one exception mentioned below)
• Even if the theory of AGW is true (say, the midpoint of IPCC projections), the net present value of 100% of the costs (including loss of human life) of mitigating the effect of AGW are lower than the costs of preventing AGW starting now, even using very low discount rates
• Regardless of whether the theory of AGW is true as outlined by the IPCC, it is incumbent upon us to research mitigation strategies in addition to prevention strategies
• If we are to truly undertake aggressive prevention strategies, the laws of physics are too rigid: nuclear is our only option if we are to maintain global economic prosperity

A Few Assertions whose Logic Should Withstand Scrutiny
• The disappearance of Arctic sea ice may simply be due to the fact that it’s getting hotter in the Arctic (see above!) – this does not prove the theory of AGW – it only proves it’s getting hotter in the Arctic
• It is possible to believe in the fact of AGW but not necessarily the scope as outlined in the IPCC
• Being a "skeptic" is a good thing; that is why AGW proponents have changed their terminology to "deniers". There are undoubtedly "deniers" out there, but they're mostly quacks. Unfortunately, most AGW proponents do not take the time to distinguish who is a skeptic from who is a denier.

You Know You Live in a Rich Country #2

2010-05-04T13:19:00.000-07:00

I devised the “You Know You Live in a Rich Country When…” series to illuminate other people’s faulty logic when they rail about the unfairness of it all in the United States. (To pick an easy example - the single largest health problem for young poor people in the US is obesity). Sometimes, though, the theme comes up in respect of my own personal foibles. It is perhaps an understatement to say that I am not a perfect human being (no need to go further with that one, thank you), but sometimes it is important to consider these small inconsistencies, ponder how they are prompted by our human-ness, and think about whether one can overcome them and thus be a better person for it.

The occasion for my thinking such things was while taking a shower in a Hyatt Regency the other day (ironically, in Mendoza, Argentina, which does not quite qualify as a prototypical Rich Country…). After luxuriating in the hot, cascading flow for a good ten minutes, I was pleased to find that the tiny bottle of hotel shampoo had a cap with a snap top on it. Often, these little bottles have screw off caps which require two hands – one hand to hold the bottle, and the other to hold the top as you screw it back onto the tiny little bottle. The problem, of course, is that one’s hand is often full of shampoo when the screwing-back-on is supposed to happen. When you turn your hand to screw the cap back, you must contort your hand a bit to keep from pouring that dollop of shampoo onto the shower floor. A snap top clips back shut with one hand – no contortion required! A small victory, but a victory indeed.

It occurred to me as I reveled in this packaging delight that my pleasure could qualify as a variant of the “You Know You Live in a Rich Country When…” theme. In this case, the theme was more like “You Know You’re Doing OK When Your Main Concern Relates to Keeping a Dollop of Shampoo on Your Hand…” The fact that such a victory even occurred to me probably meant that I wasn’t going hungry at that particular moment. Nor was I in need of clothing or housing. Probably, most of my other bodily needs were being met as well, maybe even amply. No personal crisis was overwhelming my brain, and no heavy world events were weighing on me. If the Greek debt crisis hadn’t been solved yet, it had no bearing on me at that particular moment, etc. etc.

OK, so such small victories are probably sweeter when all other concerns are satisfied, but what is the problem there? Where’s the inconsistency?

Well, for one thing, I hate packaging. I find extravagant packaging to be one of the worst sins of a consumerist economy. Though small, that snap top probably doubled the amount of plastic in the cap, and, millions of times over, added considerably to the hydrocarbons that needed to be sucked out of the ground, bubbled through a refinery, separated into resin, injected into a mold and distributed to all the showers of the Hyatt Regencies of the world and wherever else they may have gone.

And yet I took great pleasure in that tiny snap top.

I thought about it for a moment, thought about my dislike for packaging, and was confused for a moment. I couldn’t reconcile the two. They’re just incompatible.

Try as I might, I couldn’t make myself feel better for taking satisfaction from the snap top.

I am on the airplane now, coming back from Argentina several days later, and still haven’t made sense of it. The only thing I can conclude is that life is messy and filled with instances where one must make choices between inconsistent ideals and desires. I guess you just have to do the best you can, and when the issue is not a big one (like a shampoo bottle), don’t make a big deal out of it. Life’s too short.

I am still going to hate packaging, and I’m still going to choose products partially based on the efficiency of their packaging. But the next time I see a snap top on a bottle of hotel shampoo, I’m going to let myself enjoy it.

Part II

I am several weeks late finishing this post, having let it sit unedited on my computer’s hard drive instead of cleaning it up and putting it on my blog. In the meantime, I have travelled to various new ports of call, each, ironically, with a snap-top cap in the hotel room. I happen to be sitting in the Minneapolis airport right now, victim of a delayed plane.

I started to complain to myself about my travel misfortunes when I simultaneously realized that 1) I hadn’t finished this post, and 2) complaining about travel difficulties itself qualifies as a symptom of the “You Know You Live in a Rich Country When…” theme.

So - I guess I’ll shut up and get on with it.

A New Healthcare

2010-03-24T09:20:00.000-07:00

Note: I am writing this blog post partially in response to a Facebook thread which you can find on my FB page.

President Obama signed the Democrat’s healthcare legislation into law yesterday amid the lamentations of me and millions of other freedom-loving Americans. A constant refrain from those who support this legislation is that the opposition is devoid of ideas and relies on lies and distortion to paint the healthcare legislation as an abomination.

So here I will set out my ideas of what a conservative restructuring of our healthcare system might look like.

In my estimation, the principal problem with the current healthcare system in the United States is that it is employer-centric, rather than individual or family-centric. Insurance is not portable, either from job to job (or to unemployment...), or across state lines. But the American economy is mobile and dynamic, and this sets up a clash of structures. As a result, the healthcare insurance market is unwieldy and beset by bureaucratic costs.

If we are serious about making real changes to our healthcare system while retaining consumers’ freedom, then there are several things we could do to help with these problems.

• Cancel the business healthcare tax deduction: The first thing we should do is make the provision of healthcare by employers taxable again. As it is, businesses have a massive advantage over individuals in providing healthcare. So the system has grown up around employers. There are two negative effects of this: 1) individuals do not have incentive to keep healthcare costs down and as a result we have massive healthcare inflation; and 2) it is difficult for the self-employed or unemployed to purchase affordable health insurance. In a system where individuals are on the same economic footing as businesses in the purchase of health insurance, there is a chance that these difficulties could be overcome. However, the implementation of such a system would require several changes to the way we do business. So, for example, we must

• Require businesses to administer any registered plan: Health insurance is a major financial undertaking such as social security and income tax. So the payroll deduction is an appropriate method for paying the cost. But getting business to subtract individually-owned insurance premiums from paychecks would require some arm-twisting. We’d probably need to legislate it. These administrative costs would go up slightly. Payroll processors such as ADP could implement this in a heartbeat, but it would take some small business some time to adapt.

In a world contemplated by a system such as this, the purchase of an individual’s first healthcare insurance policy would be a coming of age rite of passage, much in the same way that purchasing a first car or getting a first mortgage is today. Once purchased, this insurance policy would grow and offer new services (and premiums would likewise grow) as the individual aged and his family grew. It would follow the individual as he changed jobs, moved across state lines, became unemployed and reemployed, went freelance, and then it would finally disappear when the individual was covered by Medicare.

Such a system would be very powerful in helping us to reign in healthcare inflation. First, in the same way that automobile insurance tends toward catastrophic coverage and ignores the little dings and scratches, personalized health insurance would automatically tend toward catastrophic coverage. People would begin to utilize fee-for-service facilities for things like runny noses, bronchitis, allergy medicines and other small health annoyances. An entirely new service industry of general practitioners would grow up to service this type of consumer, who would end up paying $30 or 40 for a five minute visit with a physician instead of the $170 that gets charged to the insurance company today. Broken bones and real health problems would be dealt with in the industry as it appears today. The growth of health care expenditures in this world would be naturally restrained by the invisible hand, rather than by the authoritative but inefficient hand of a central bureaucracy. Furthermore, people would be free to purchase healthcare in the manner in which they see fit.

In this world, catastrophic healthcare policies for the young and healthy would be very cheap. The struggling 26 year old artist in New York City would easily be able to purchase insurance, and would visit clinics for life’s small inconveniences. A huge percentage of what is now deemed the uninsured could become insured again. (Note: the truly poor and indigent are already covered by Medicaid. That’s what Medicaid is for. Liberals often seem to forget this when they talk about the uninsured. If Medicaid needs to be expanded, then let’s contemplate that, but don’t lump the indigent into the “uninsured”).

In this world, most individuals would always actually have an insurance policy, so the difficulty of new policies for preexisting conditions would largely disappear. Those who fell through the cracks somehow and could not afford coverage would need to be picked up by Medicaid or be covered in the way they are today: by hook or by crook.

The best insurance policies in a world such as this could also include monthly additions to a reserve which would serve as “unemployment health insurance” in the same way that whole-life insurance policies have a measure of principal security. In this manner, individuals and their insurance companies could privately account for certain periods of unemployment (or underemployment), in the same way that, for instance, AFLAC provides supplemental disability.

The success of the real cost reductions and thus the affordability of personal catastrophic insurance for the now-uninsured would be truly dependent on the growth of this new fee-for-service model of private pay healthcare. In such a system, doctors would need to be able to make good-faith healthcare decisions without fear of bankruptcy. So, we will need to

• Cap punitive damages in malpractice judgments: Yes, I know all you fans of the trial bar will be upset with me for pushing this old conservative bugaboo. But any analysis of fixed versus variable costs of a small healthcare practice would need to acknowledge that a huge portion of the difference between my $40 mythical fee and the $170 real fee is comprised of malpractice insurance. I am not suggesting that we dispense with reasonable judgments in case of real loss caused by bad medicine, but rather only punitive damages. These are the judgments which make our system unaffordable. We need to start acting like grownups.

I would not be surprised if such a system resulted in the reduction of our total healthcare expenditures in the United States down to the single-digit percentages of GDP which is the norm in other Western countries at the same time as it offered better care with more options. In total, the system in the United States would always be more expensive than socialist systems, because there will always be people who will be willing and able to afford expensive services of questionable effectiveness or benefit, simply because they can. And a rich society can afford things like new, $10,000 titanium hips for 90 year olds – something which would be preposterous in a poorer socialist country.

A system such as this will leave quite a bit of discretion to the consumer, so it would need to be coupled with a genuine attempt to educate people about healthcare. I do not have any problem with using public funds for programs such as this, particularly since our education is largely public in the United States. Like your car comes with a user’s manual with a recommended maintenance schedule, people should be generally aware of good health care practices.

To be sure, there are problems with my system, both in the getting there and when we’ve arrived. Solving the interstate dilemma would be difficult under any circumstances. Medicaid is so entrenched with the regulatory apparatus at the state level that it has affected all attempts to make healthcare portable across state lines. Also, there will still be people who fall through the cracks of such a system, and there would continue to be horror stories, although hopefully diminished in number. Medicaid may need to grow.

However, like democracy is the least-worst form of government, I believe that this system would be the least-worst form of healthcare, both in its efficiency and its flexibility. I believe that the benefits of such a system in terms of cost-effectiveness and ability to provide quality care quickly would be unmatched in the world.

The current healthcare legislation signed into law by President Obama yesterday is like doubling down on a bad hand. It takes our bad system and makes it much worse. Honestly, I would almost prefer single payer to what is coming upon us soon. Consider that the IRS is being required to hire 17,000 new agents right now to enforce the individual mandate. Now that’s efficiency for you! The bureaucracy in Washington is going to be mind-boggling, and that’s before the plan is even implemented by state regulators!

But there is a general, more important point to be made here. With the passage of this healthcare legislation (and the ensuing, ineluctable flow toward a single-payer system), the third leg of the stool of European-style socialism has now been constructed right here on US soil.

I read yesterday that in the UK last year, government expenditures exceeded 50% of GDP for the first time in history. In the United States, the number is about 44% if we add federal, state and local expenditures. Almost fifty percent of every dollar spent in the United States now comes from some form of taxes. And it’s quickly going north.

I’ve made this point in these pages before, but I’ll make it here again. When I was a boy, growing up here in the United States, we took pride in saying “Hey, it’s a free country…”

Well, at what percentage of GDP consumed by taxation are we no longer free? Are we free when 50% of our money goes to other people and things? If it’s not 50%, then when is it? When are we not free?

Bipartisanship

2010-03-22T07:19:00.001-07:00

I'd simply like to point out that the only thing that was bipartisan in last night's passage of Obamacare was the opposition.

The Limits of Clean Energy

2009-11-02T20:51:00.000-08:00

Introduction

Last Wednesday, October 27, 2009, President Obama toured a solar facility in Florida where he announced certain investments in clean energy technologies as part of his stimulus package. I sincerely hope that, all the lofty rhetoric notwithstanding, Obama’s science advisors are suitably realistic about the limits of solar and other clean energy technologies. They may pin great hopes on our ability to engineer a solution to our energy dilemmas, but they must also understand the facts as they currently stand.

I have no such faith in the press, the blogosphere, or the common man. Lately, I have heard and read accounts of renewables’ promise which are so far removed from reality as to verge on the absurd.

I am a big fan of clean energies, but I also am painfully aware of their limitations. In particular, I am not hopeful that we may soon generate a significant percentage of our energy from clean or renewable sources. I am on the board of directors of a company which makes products for the solar industry, so I have looked fairly deeply into the subject and am not sanguine about it.

In working these issues out for myself, I have concluded that there are at least two difficulties which keep people from truly understanding the limits of clean energies.

The first is human beings’ inability to conceptualize, and therefore to contextualize, large numbers. This phenomenon affects the understanding of more than just clean technologies. For instance, there are plenty of people who don’t really know the difference between a billion and a trillion. To them, both are just really large numbers. Thinking so, however, makes it awfully difficult to understand the issues at the bottom of last year’s financial crisis, for instance. In fact, a trillion is a thousand billions. They are vastly different numbers. If one doesn’t conceive the difference between several orders of magnitude, it will be frustratingly difficult to understand much about macroeconomics, and it will be even harder to understand the science of energy. Unfortunately, most people don’t.

The second reason people have difficulty with the science of renewables is unfamiliarity with the metrics used in describing and measuring energy. For instance, the cost of manufactured solar silicon panels is measured in dollars per watt. Well, what the heck is that? Most people have no way to put that figure in context. Most people know that a watt is a very small amount of energy, but they have no idea how small. At the other end of the scale, our typical power plant in the US generates something like 1,000 megawatts of electricity. Again, what the heck is that? Normal people just have no way of understanding the scale of that number. That particular metric also combines both difficulties I’ve mentioned, insofar as it is a very large number (1,000 megawatts is 1,000 million watts of electricity) and it also mentions the frustratingly opaque “watt”.

To a certain extent, I’ve struggled with these difficulties too when thinking about energy. In such situations, I’ve always found it helpful to write it down – to do the math, do the conversions. In my case, I generally write these things down on an Excel spreadsheet. So several years ago, I started to dig into the science of renewables by putting it all in a spreadsheet. And I found out some interesting things. Furthermore, I found that by doing a few extra calculations, I could then explain the issues in terms that people could really understand.

So now I have taken it upon myself to remedy these difficulties for the faithful readers of Polartics. In blog posts over the next several weeks, I will put the physics and economics of clean energy into terms that people can understand. Here is what I will do:

• I will develop a metric of energy that people can understand because it is based on human activity. As an aside, at this time I will also perform a few calculations comparing this metric to our current use of energy so that we can see just how much energy the average American actually uses (and how much we take that energy for granted).

• Second, I will perform an energy audit of my own home. Many readers of this blog no doubt live in digs similar to my own, and can probably assume that the scale of their energy use is roughly similar to mine (it may be off by a percentage, but it will not be off by an order of magnitude!). Once done, this energy will be put into the context of the understandable energy metric which I devised in step one.

• Third, I will translate the capabilities of today’s solar technologies into my energy metric, and use the result to calculate the amount (and cost) of solar technology which would be necessary to take my house “off the grid” (not just for electricity, but for all of my energy uses, including oil heat and hot water, and propane cooking).

• Fourth, I will perform a similar analysis with wind energy.

• Finally, I will wrap it all up in a post which will, among other things, discuss the preceding two posts taking into account the economies of scale which may be achieved with very large green energy power plants. I will also discuss the limitations presented by the unpredictable nature (no pun intended) of the sun’s shining and the wind’s blowing, and I will come to some conclusions about the topic.

So then, without further ado, let us begin!

Chapter One - The Energy Metric

Ever since I busted up my knee playing soccer three years ago, this is how I get my exercise during the winter:

I generally max out at about an hour. It’s hard to ride on rollers such as these, because you can’t stop pedaling or you’ll fall down. I’ve done that a few times, and it’s not pleasant.

In an hour, I generally burn just under 1,000 calories. I know this because I wear a heart monitor. These monitors are not perfect, but they’re close enough for our purposes. Since calories and watts are both simply different measurements of energy, it’s very easy to convert from one to another if you know the conversion factor. It turns out that if I ride on my rollers for an hour and burn slightly less than 1,000 calories, then I am generating just over 100 watts of energy the whole time. It’s pretty darn hard work. I don’t know if you could see it, but there was a lot of sweat dropping off my face in that video.

To put 100 watts in perspective, an elderly person out for a leisurely stroll might generate about 5 watts of energy. Conversely, a professional bike racer may generate over 400 watts while climbing up the steepest climbs in the Tour de France, but he can’t sustain it for very long – maybe 30 minutes to an hour.

So, that’s it. The metric I will use to explain the physics and economics of energy is the amount of energy that I generate while riding on my rollers. I’m going to call this unit of energy a Matt. Once again, a Matt equals 100 watts. If I were to generate this amount of energy for an hour, I would call this energy a Matt-hour. If I were to ride my bike like this (I couldn’t, but just imagine I could), for an entire day, it would be called a Matt-day. For a month, it would be a Matt-month; for a year, a Matt-year, etc. Essentially, it is a way to put energy into human terms. A Matt-month is approximately the amount of energy that I could produce, working really hard, in a month. Similarly, a Matt-hour is that amount of energy that I could produce in an hour.

OK, so now that we have this energy metric, let’s determine how many Matt units are in some other sources of energy that people often talk about. For instance, how many equivalent Matt-units are in a barrel of oil? How long would it take me, working hard enough to have sweat dripping off my face, to generate the energy which is contained in a barrel of oil?

Why don’t you take a guess.

Two days?

Five days? In five days of furious work, could I generate the energy in a barrel of oil?

Well, not quite...

Ten days?... Fifteen days?... A month?

In order to make this analysis really visceral, really understandable, let’s make a Matt-day only that amount of work that I could do in a real work-day, meaning eight hours, from nine to five. Furthermore, let’s assume that I would get my weekends off, and I’d get some holidays and a vacation. There would therefore be eight work hours in a day, 20 work days in a month, and 250 work days in a year. These would all be translated into Matt equivalents, which is that amount of energy which I could generate while riding my rollers (i.e. 100 watts).

Under these definitions, how much Matt work is in a barrel of oil?

Keep guessing.

The answer, ladies and gentlemen, is 8.5 years. (The math is not all that complicated. You can skip to the end of this blog post to see the calculations.)

There are 8.5 years of my hard, sweat inducing, thirst generating labor in a single barrel of oil.

Wow. A barrel of oil today costs just under $80. Compare that to the actual cost of human labor. Let’s say my landscaping guy pays his workers $20/hour. By the time those workers have toiled for 8.5 years, he would have paid them $340,000. And yet I can buy the equivalent amount of energy in a barrel of oil for $80. Are you starting to see why I said we take our energy for granted? Oil is ridiculously cheap.

Those numbers sound almost absurd, so let’s do a quick sanity check to make sure that we’re not screwing something up. Let’s compare those calculations to some other ones which you might be familiar with.

There are 42 gallons in a barrel. My car weighs about 3,000 pounds. It gets about 25 miles per gallon. That means that a barrel of gasoline (let’s ignore the difference in energy between crude and gasoline for the moment) would propel my car 42 * 25, or 1,050 miles.

How long would it take me, with my bare hands, to carry or push 3,000 pounds 1,050 miles? Let’s ignore the practical difficulty of that question (I’d have to break the car up into small pieces in order to do it), but let’s only consider the scale. I’ve got to move 3,000 pounds 1,050 miles. How long would it take? That’s from Far Hills, NJ to about Des Moines, Iowa. If I could push 300 pounds at once, that would take me ten trips walking back and forth. How long would that take? 8,5 years? Certainly sounds reasonable.

Let’s face it, driving a car uses an absurd amount of energy, and we take it for granted. In fact, if you do this math with virtually all of our uses of energy, you’ll find the same thing. Flying to Vail, heating your house, running your dishwasher, taking a hot shower, blow drying your hair. Compared to Matt-units, these things just suck energy away like it’s free. I read on some other blog page that it would take an elite athlete 30 minutes of vigorous work to heat a liter of water to 100 degrees Celsius to make a pot of tea.

We are hopelessly, hopelessly addicted to cheap energy. And that could be a problem.

In my next post I am going to calculate exactly how much of this cheap energy I use in my home, and then in subsequent posts, I am going to see how difficult it might be to generate that energy through clean technologies.

So, get your calculators all warmed up for next week’s blog post. Goodbye for now.

Calculation of Matt energy in a barrel of oil

How much energy in a barrel of oil? (from Wikipedia)
6.1178632 × 10⁹ Joules

1 Joule = I watt/second

So, divide by 100 to get seconds of Matt energy in a barrel of oil = 6.1178632 x 10⁷

Divide by 60 to get minutes of Matt energy = 1,019,644

Divide by 60 to get hours of Matt energy = 16,994

Divide by eight to get work days of Matt energy = 2,124

Divide by 250 to get work years of Matt energy = 8.5 Years!

Healthcare as a Right

2009-08-21T15:14:00.000-07:00

Life continues to be busy, so I have not had the chance to dig into the various healthcare bills being bandied about the House. To do the topic justice would require prodigious amounts of time, so I’ve resigned myself to being a spectator in this particular debate.

However, there is one issue upon which I’d like to comment, and that is the tendency of various liberal defenders of Obama’s healthcare plans to declare that healthcare is a right. This tendency seems wrongheaded to me for at least two reasons.

For one thing, healthcare is not yet a legal right. There is no Amendment 10.5 which states that individual citizens have a right to healthcare. It may be proper to discuss (or even declare) that healthcare ought to be a right. But to declare that healthcare is a right gets ahead of ourselves.

I acknowledge there were times in our history when thinkers have declared one right or another to exist in advance of its being codified in law. However, these statements have traditionally referred to natural rights, such as life, liberty and the pursuit of happiness. I don’t think that John Locke was thinking about government-sponsored healthcare when he developed his theory of natural rights in the context of the social contract.

We do now have certain legal rights: a right to practice religion of our choosing, a right to peacefully assemble, a right to bear arms, a right to free speech. These things are codified in the Constitution. Other rights, such as the right to abortion, or the right counsel upon being arrested, have been conferred upon us by the courts.

But we do not yet have a right to healthcare. It is reasonable to argue that we should have one, but we don’t have one yet.

The second reason why the “right to healthcare” is misguided has more to do with the goals of those who would utter such a phrase. I would bet that a great majority of those who consider healthcare to be a right do so in furtherance of a policy of government-sponsored healthcare.

But rights are restrictions on government power, not grants of government power. The fact that I have a right to my religion means the government must allow me to practice this religion in a manner of my choosing. It does not mean that government will construct my church, pay the preacher and provide a bus for me to get back and forth on Sunday mornings. Same for a right to free speech. Government may not abridge that right. It does not mean that government must purchase me a megaphone, buy me a television advertisement or procure a spot for me on Larry King.

Under this reading, a right to healthcare means that government should get out of the way and allow people to pursue the thing in as efficient or inefficient manner as they see fit.

And here’s the great irony: any reasonable reading of Obama’s healthcare plans would have to acknowledge that healthcare rationing is part of the plan. In order to make it public, and to make it affordable, it would be necessary to ration it in some form. Obama himself has acknowledged as much, although in Clintonesque doublespeak.

Think about that: the very people who argue that healthcare is a right are the same ones who would abridge that right by mandatorily providing healthcare to certain people in such a way as to diminish their ability to procure it.

You Know You Live in a Rich Country When #1

2009-05-12T10:37:00.000-07:00

Like most busy people, I am choosy with my reading material. I simply don’t have time to read every glossy magazine that comes within my field of vision.

The Yale Alumni Magazine gets the same treatment as any other glossy, with one exception: without fail I will pick up the magazine and flip to the Alumni Notes to see what my classmates are up to. I’ll even quickly scan the nearby classes to see if I recognize any names.

Something struck me as I read last month’s issue. Virtually every Note from one of my fellow alumni/ae in nearby classes was penned by someone who was an activist, advocate or organizer of some sort. There were environmental activists, community organizers, women’s advocates, and numerous other designations of people who do nothing other than think or communicate about a cause.

It further struck me how extraordinary this was: that a non-trivial percentage of highly educated, highly paid people might be engaged in nothing but advocacy.

I travel quite a lot in the third world for my job. At MidMark, we own a number of manufacturing companies which have facilities in places like China, India and Mexico. I can say with some confidence that there are not a lot of people in such places who are highly paid advocates. In fact, the kinds of concerns which occupy people in the third world are things such as feeding themselves, clothing themselves, and making sure they have reasonable living quarters. Most people have jobs which are either directly related to manufacturing or are somehow related to those very basic concerns of food, clothing and housing. Who has time for women’s issues when one is concerned about where your next meal is coming from?

Last month’s Alumni Notes could only have been written in a country with a tremendous amount of wealth. At the risk of shocking people with irony, I must say it would behoove all those American advocates to consider, from time to time, how we got here. As we consider our future and the policies we craft in pursuit of it, we need to make sure that we do not kill the goose which lays the golden eggs (or the golden advocacy jobs, as the case may be). From my perspective, the goose’s head is right now on the chopping block. Obama’s holding the axe. I’m hoping someone stops him before he brings it fatally down.

For brevity, I’ve skipped several logical steps in this last paragraph. Those who know me will know what I’m talking about. If these steps were too fast for you, please leave a comment here, and I’ll be happy to elaborate.

NOTE: I see so many examples of the irony of living in a wealthy country that I will make the topic a regular series. Therefore, this is #1 in the You Know You Live in a Rich Country When series.

Tax Deductions for Charity

2009-03-25T16:19:00.000-07:00

Last night Obama held a press conference during which a reporter asked him about his administration's plans to reduce tax deductions on residential mortgages and contributions to charitable organizations.

I'd like to make two comments about this topic: one about the issue generally, and another about Obama's specific answer to the question.

First, a comment on the more despicable of the two.

Here is a portion of Obama's answer to the reporter:

"In that sense, what it would do is it would equalize -- when I give $100, I'd get the same amount of deduction as when some -- a bus driver who's making $50,000 a year, or $40,000 a year, gives that same $100. Right now, he gets 28 percent -- he gets to write off 28 percent. I get to write off 39 percent. I don't think that's fair..."

This logic is either twisted, or fundamentally dishonest. Because it fails to acknowledge that the reason the wealthy tax payer gets a 39% deduction and the bus driver gets a 28% deduction is because the wealthy tax payer pays a 39% marginal tax rate and the bus driver pays a 28% marginal tax rate. It is only by virtue of a person's paying money to the government that he or she gets a tax deduction!

When I hear someone making an argument like this I honestly want to know what has caused him do so. There can only be a couple of reasons: 1) he's dishonest, and doesn't mind pulling the wool over the eyes of modestly stupid people; or 2) he's modestly stupid himself; or 3) he believes that all money is actually the government's money, so it doesn't matter what marginal tax rates are when contemplating tax deductions; or 4) he's a sadist, and wants to hopelessly complicate the tax code.

In this case, I believe Obama's words were some combination of #1 and #3, with a wee, tiny bit of #2. (I say #2, because I don't think that Obama has ever operated an Excel spreadsheet, so probably has a hard time visualizing things like gross and net). In any event, it makes me sick to my stomach.

But onto the issue itself, because it illuminates another of piece of Obama's mind which has always been blindingly clear to me, but apparently was not to such people as Christopher Buckley or David Brooks.

In a later portion of his answer, Obama said "there's very little evidence that this has a significant impact on charitable giving."

Now, every study I've ever seen concludes the exact opposite. Common sense would conclude the exact opposite. The Executive Director of every 501(c)(3) in this country would probably conclude the exact opposite.

I do not believe for a moment that Obama actually believes what he said. But, it really does not matter. Because Obama really would like it if government expenditures crowded out private donations.

Why would we need privately funded soup kitchens if the government provided soup for everyone? Why would we need privately funded performing arts centers (disclosure: I am on the board of a privately funded performing arts center) if the government, through the NEA, funded all of our performing arts centers? Why would we need any 501 (c)(3) if government provided all the goods and services that these organizations provide?

Well, we wouldn't.

So, what I've concluded is that Obama was dishonest about the issue in furtherance of his ultimate principle: that government is the solution to everyone's problems.

Overwhelmed

2009-03-25T15:57:00.000-07:00

It's been a while since I've posted here, but don't think my silence is some indication of contentment. On the contrary, my silence is a combination of two things:

** I've been busy in Korea, China, Vermont and France, and

** The sheer enormity of outrage flowing from the Obama administration has made it hard to know where to start. First came Obama's stimulus package, which I've previously commented on, and then came his inaugural budget, which upped the ante considerably. Obama's disingenuousness in selling both pieces of legislation has been nothing short of historic. Pretending that we need to compensate for the sins of our leveraged, profligate ways by taking on ever more towering leverage in order to provide for ever more profligate spending is something which only someone as silver-tongued as Obama could pull off. The only question is how he does it with a straight face.

And with regard to contentment, the opposite is true. I have settled into a deep and lasting pessimism. I am beginning to feel that the steps that are being taken right now to launch the United States toward a European-style social democracy may well be irreversible. Even if some Ronald Reagan were found in the next eight or ten years, the damage may have been done. The miracle which is the United States may be being lost, right now.

The only person who seems to be taking notice of this deplorable situation is Charles Krauthammer. Regular ole Americans are so distracted by the economic turmoil that they are, in my opinion, largely unaware of what is going on.

Anyway, a couple of things have happened in the last few days which I have a particular experience, or interest, in, so I will be posting on those things. Then, I head to Paris for two weeks, so you may or may not hear from me depending on how it goes.

Obama Hoisted on His Own Petard

2009-02-17T12:35:00.000-08:00

Re: my gripes about Obama's double-talk regarding bi-partisanship (see here and here), here is an absolutely fascinating passage from his 2006 book The Audacity of Hope (presumably written when Republicans were still in control of Congress):

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"Genuine bipartisanship," he wrote, "assumes an honest process of give-and-take, and that the quality of the compromise is measured by how well it serves some agreed-upon goal, whether better schools or lower deficits. This in turn assumes that the majority will be constrained -- by an exacting press corps and ultimately an informed electorate -- to negotiate in good faith.

"If these conditions do not hold -- if nobody outside Washington is really paying attention to the substance of the bill, if the true costs . . . are buried in phony accounting and understated by a trillion dollars or so -- the majority party can begin every negotiation by asking for 100% of what it wants, go on to concede 10%, and then accuse any member of the minority party who fails to support this 'compromise' of being 'obstructionist.'

-----------------------

I could not come up with a better description of what happened in the last two weeks if I tried.

Hat tip: Bill McGurn of the Wall Street Journal today

More Cost of Energy Stuff

2009-02-17T10:25:00.000-08:00

Remember my blog post (here) where I conjectured that the recent economic slump might trace its origins to a massive increase in the cost of energy?

Well, listening to JP Morgan's Chief Economist while at an ACG-NJ meeting this morning, a thought occurred to me: The two largest post-war economic crises are today and 1982.

Look at this chart below of the real cost of a barrel of oil:

(Click in the image to enlarge)

Interesting, eh? Seems like we've been here before... I am starting to convince myself that I might be right.

People keep talking about the sub-prime crisis being the cause of our economic slump. I don't think that's right. I think an energy crisis caused the beginning of a sub-prime crisis, which caused the current economic slump to be worse than ever before.

The Stimulus of Partisan Warfare

2009-02-06T10:14:00.001-08:00

Last week, after reading several hundred of the 700 page stimulus bill passed by the house, I chided myself for not knowing what was going on (see here).The bill read exactly as it is: an orgy of spending on the far left’s long-standing Christmas list.

The fact that it had been crafted by Nancy Pelosi and the House Democrats left open the possibility that Obama had originally been intending to contrive a stimulus bill in earnest, but that he was forced to capitulate when the process in the House took on a life of its own. At least that’s the way I wanted it to be.

Well, based on Obama’s comments last night at a Democratic retreat in Williamsburg, he was in on the plan from the very beginning. Here are some of his comments regarding the stimulus bill:

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THE PRESIDENT: Now, I just want to say this — I value the constructive criticism and the healthy debate that's taking place around this package, because that's the essence, the foundation of American democracy. That's how the founders set it up. They set it up to make big change hard. It wasn't supposed to be easy. That's part of the reason why we've got such a stable government, is because no one party, no one individual can simply dictate the terms of the debate…

So I welcome this debate. But come on, we're not — we are not going to get relief by turning back to the very same policies that for the last eight years doubled the national debt and threw our economy into a tailspin.

We can't embrace the losing formula that says only tax cuts will work for every problem we face; that ignores critical challenges like our addiction to foreign oil, or the soaring cost of health care, or falling schools and crumbling bridges and roads and levees. I don't care whether you're driving a hybrid or an SUV — if you're headed for a cliff, you've got to change direction. That's what the American people called for in November, and that's what we intend to deliver.

So the American people are watching. They did not send us here to get bogged down with the same old delay, the same old distractions, the same talking points, the same cable chatter. You know, aren't you all tired of that stuff?

AUDIENCE: Yes!

THE PRESIDENT: They did not vote for the false theories of the past, and they didn't vote for phony arguments and petty politics. They didn't vote for the status quo — they sent us here to bring change. We owe it to them to deliver. This is the moment for leadership that matches the great test of our times. And I know you want to work with me to get there.

------------------

Obama admits it: this isn’t a stimulus bill! This is the beginning of his “Change.” What does foreign oil or healthcare or SUVs have to do with stimulus? Nothing. This is his big, grand opportunity, only two weeks into the new administation. A new beginning. And oh, what a beginning. A trillion dollar beginning. Boy, does this ever set the bar low for incremental change.

And here I was, naively believing Obama’s pre-election rhetoric about a new post-partisan world! This bill is the old, hyper-partisan world on speed and crack, driving a turbocharged crotch rocket.

Guess what, Mr. Obama. This is now war. And you are in our sights. I haven’t been this mad in a long, long time.

The Stimulus of My Current Anger

2009-01-28T21:28:00.000-08:00

Life has been busy lately. MidMark has not been immune to the economic malaise, and we have been busy trying to keep our portfolio working properly.

So while I have read the headlines occasionally, I have not spent much time digging into the details. The topic dominating the headlines recently has been the stimulus package, which passed the House today (apparently without a single Republican vote – so much for Obama’s post-partisanship!).

Not knowing much about it except that it included a lot of money for infrastructure projects like bridges and highways, I assumed that it had been crafted largely by economists who had sat in a room somewhere trying to think of all the ways that we could get our economy rolling again by using the treasury to spend money on stuff. Presumably, there was a method to the madness.

Hearing that the stimulus bill had passed the house, I set out tonight to find out some details of this $900 billion bill. I searched around Google for a summary of the stimulus, but found only either vaporous news articles, light on facts but heavy on politics, or true position papers from the online blogs and opinion journals. I didn’t want someone’s opinion, I just wanted the facts! What’s in this damn bill?

One of the blogs I read had a link to the actual bill itself (I’ll have a link at the end of this post). Having recently spent a good portion of my life perusing voluminous legal documents, I’ve become quite a good speed reader, so the prospect of actually reading the bill rather than someone else’s version of it was appealing. I clicked right in.

First thing I found: 647 pages. Ugh. But I’m a really good speed reader, so, undeterred, I read on. I flashed through the first 50 or so pages which covered policies & procedures, transparency, oversight boards & the like. Pretty boring.

Soon, I got to the good stuff. It’s not a complicated bill. It’s written clearly in very simple language. First, I found an appropriation of $44 million for “Agriculture Buildings and Facilities.” Not much of any explanation, just $44 million for some buildings. Huh? But I continued. Then, there was $2.825 billion for “the cost of broadband loans and guarantees.” Huh? Where’d that number come from? Then, there was $50 million for “Youthbuild activities” and $750 million for “a program of competitive grants for worker training and placement…”

My heart started to sink. I was starting to get it. I started flipping through pages faster. $120 million for “community service for older Americans.” $462 million for “disease control, research and training.” No explanation, no details, just that: $462 million for disease control, research and training.

On page 131 I stopped flipping through pages. Shame on me. Shame, shame, shame on me for not knowing what was going on here. All these past few weeks, I was blithely carrying on, thinking that Obama and his smartest economists were sitting around with charts and graphs, trying to figure out the most effective way to deploy government dollars into our markets in order to grease the wheels of commerce.

Instead, what happened was that he went to Congress and said: “hey, what do you guys want?”

This damn bill is full of $900 billion worth of pet projects that people could not get passed or funded under normal circumstances! Where’d all those odd numbers come from? Certain people had been thinking about those things for years! When Obama said – hey, we don’t have to worry about deficits anymore – everyone just piled their favorite spending into a bill and they hid their true intentions by calling it a stimulus bill!

Read it. Please. Follow this link and read it. This bill is simply horrifying.

Let me be clear – I am not coming down on one side or the other of the current argument about the effectiveness of fiscal stimulus. I am simply pointing out that this particular bill is not a stimulus bill. It is an orgy of spending. It is Santa’s bag of gifts for House and Senate democrats. It is the far left’s greatest, sweetest dream come true.

I’ve been reasonably willing to cut Obama some slack over the last few weeks. He’s seemed smart and pragmatic, and has seemed to solicit opinions from just about everyone before making any decisions. But now, whatever my thoughts on the effectiveness of a true stimulus, one thing is very clear: my short honeymoon with Obama is OVER!

Too Much

2009-01-22T09:21:00.000-08:00

For some years, I have been something of a climate-change skeptic. Let me note here that that being a “skeptic” is a good thing, especially in the case of science, and especially-especially in the case of complicated science.

To be sure, I am not a scientist myself. But I have spent several years studying certain data associated with real climate change (i.e. world temperatures do seem to have climbed approximately 0.7 degrees Celsius over the last 100 years). I have done many indepent regressions testing out various local temperature trends. And I do have many years of computer programming, and (more important) computer modeling experience (this is important insofar as most of the significant conclusions of the climate change crowd can only be reached by relying on the output of complicated computer models which attempt to predict future climate).

I have slowly come to the conclusion that we know far less about our future climate than most climate alarmists would have you believe. Furthermore, I have also come to the conclusion that there is a fair bit of dirty ball being played by the other side to get the data to work out correctly. It seems that every time a skeptic points out a legitimate inconsistency in the climate change theory, after several years, somebody else comes out with some harebrained (but peer reviewed!) paper about why that particular inconsistency was actually consistent with the theory all along (and, obviously, thereby changing the theory along the way). My gut has told me that Michael Mann and his compatriots at RealClimate were, consciously unscrupulous or not, masters at this particular game.

Until now, aware of my own limitations, I have been reluctant to post about this topic. But upon seeing yesterday’s headlines, I knew something was up, and I lost patience. This is just too much.

PS: Pielke’s last statement is the greatest unanswered question in the climate change world.

Whose Fault is All This?

2009-01-09T08:55:00.000-08:00

As reports roll in about unemployment reaching levels last seen in the Great Depression (this is not yet true on a percentage basis, but that does not stop the press from reporting such things), and as scandals such as the Madoff affair unfold, our collective national psyche is searching for villains to blame.

There are quite a few to choose from: Stan O’Neal of Merrill Lynch, Franklin Raines of Fannie Mae, Madoff himself. Others would like to paint the entirety of Wall Street itself (as distinct from “Main Street”) as the villains. Still others have found even more specific grievances to air: Deborah Spar, President of Barnard College, has recently pointed out in a Washington Post Op Ed that most of the guilty parties identified so far are men, and wonders whether there isn’t some innate difference between the sexes which accounts for the more testosterone-enhanced among us being more prone to the types of excess which led to the current financial collapse.

While there may be something to Ms. Spar’s thesis, I can’t help but wonder whether all of these thousands or hundreds of thousands of people (some of whom I know, by the way) can all be truly evil (or even just stupid).

I suspect not.

Taking the argument one step further, why do we suppose that, while the great things that make our economy dynamic and lead to ever greater standards of living are somehow widespread and universal, the opposite, those which cause financial distress and cause decreasing standards of living, are somehow always the result of individual turpitude?

As most of us know, Adam Smith described the former as the “invisible hand.” This is the principle that hundreds, thousands, perhaps even millions of individuals, each pursuing their own particular utility, will collectively result in the betterment of mankind.

But is it not possible that the invisible hand is also responsible for economic turmoil? I think it was Benjamin Graham who, when asked what was going to happen in the stock market, said it was going to go up and it was going to go down. Is it not possible that there is some equivalent with regard to the economy in general? Is it not possible that the invisible hand moves economies down as much as it moves them up (although inexorably, over longer periods of time, mostly up)? Is it not also possible, therefore, that these downward economic dislocations are simply the result of hundreds, thousands, perhaps even millions of people, each pursuing their own particular utility?

I suspect so.

The implication of this theory is that some people are going to be frustrated very soon. One class of people will be frustrated because their search for villains will prove more elusive than hoped. They will look deeply into the actions of the purported villains only to find, surprisingly, that each of these people acted somewhat in accordance with accepted strategies and procedures, and further, that they probably behaved rationally given the information available to them.

Another class of people, for whom I have the deepest empathy, will be crucified, notwithstanding that they acted rationally and in accordance with generally accepted strategies and procedures. Stan O’Neal particularly comes to mind. He’s probably a decent fellow, and when things were going well, boy, they were going really well. But now that they’re not going so well, nobody really remembers the circumstances under which he made his decisions. The assumption is that he was complicit in some great theft from the masses, rather than just a CEO trying to make the most money for his corporation, and generally unaware of the financial disaster looming ahead. Frankly, nobody saw this coming. I listen to Chief Economists all the time, and not one of them gave us a whisper of what was to come.

And now it’s all Stan O’Neal’s fault?

There are people who will go to jail because of this unquenchable thirst of ours for fault-finding. The Bernie Madoff’s of the world certainly deserve to go to jail, and for a long time. But I will guarantee you that more than just a few Stan O’Neals will go to jail, too, just to satisfy a weird craving humans all have to blame someone when something goes wrong. And that’s a shame.

The Irrational Demonification of the SUV

2009-01-02T19:16:00.000-08:00

There is a lot of bad math and bad logic on the topic of energy being cast about these days.

The example of sloppy thinking which irks me the most is the simple use of miles per gallon as the final arbiter on energy efficiency, and thus, in the minds of many, moral cleanliness.

In my estimation, an SUV which gets 15 miles per gallon but regularly carries five people and all their gear is about five times as efficient as a Porsche 911 which gets 15 miles to the gallon and regularly carries one person and maybe a cellphone. When people rail about wasted energy, why do they talk about SUV's instead of sports cars?

As I drove my family home from a short vacation in Washington, DC, today, all five of us in the car, stuff packed to the rafters, I realized that the more appropriate measure for energy efficiency should be person-miles-per-gallon.

Under that standard, we were cruising along at about 80 PMPGs. In order to commute alone as effectively, our neighborly Prius driver would have to pitch his prized hybrid in favor of a motorcycle. I try to take it one step further by riding a bicycle to and from work as much as I can.

Full Disclosure: until very recently, I also regularly drove a Porsche. Please realize, I am not moralizing here, only pointing out faulty logic.

Two Greatest Mysteries of the Early 21st Century

2008-12-29T08:56:00.000-08:00

When I look back at the almost-complete first decade of the 21st Century, I can make sense of most of it. But there are at least two mysteries which continue to vex me. Although I’ve read a lot about each of these issues, I have not read any truly satisfactory explanations.

1. Why did Saddam Hussein act guilty?

There is no way to describe Saddam Hussein’s behavior in the months and years leading up to the second Iraq war except as that of a man who had something to hide. Even though Hans Blix, the U.N.’s designated inspector, increasingly insisted he was making progress, Hussein never provided the transparency required to make the western world believe he had nothing to hide. Even in the winter of 2003, Hussein had declared all of his Presidential Palaces, which covered 32 square kilometers and possessed hundreds of buildings, completely off-limits to UN inspectors. The only explanation that makes sense is that a violation of his Presidential Palaces was somehow a matter of personal honor and, until the very end, he thought George Bush was bluffing. But it’s hard to imagine that Hussein thought Bush was bluffing in the winter of 2003, when Bush practically started using the word “when” rather than “if” as he spoke about an imminent invasion of Iraq. I suppose the western world had been so wimpy for so long in this respect (remember the UN’s 19 sanctions after the first Iraq War?) that Hussein just couldn’t imagine the cowardly infidels following through with their threats. Considering how he was found living alone in a ratty hole one year later, I’m sure that Hussein rued his faulty judgment to the day he died, swinging from a noose (an Iraqi one!). It is a conundrum which bothers me to this day.

2. Why is OPEC so secretive with its oilfield data?

There is perhaps nothing more important to the well-being of the modern world than energy. So when oil prices began an upward climb in 2003, leading to a peak of $147/barrel in the summer of 2008– an order of magnitude higher than it had been for 20 years – the world sat up and took notice (Indeed, I happen to believe that energy prices might have actually caused the beginnings of the financial crisis which began in 2008 – see here).

In order to figure out what is going on with energy prices at any given time, one is tempted to construct a bottoms-up analysis of both energy supply and energy demand. While the demand side of the equation is relatively easy to figure out given masses of available correlated financial data, the supply side of the equation is an informational black hole. We must simply admit that we don’t know. OPEC spokesmen are no help. At the height of the crisis this summer, they were insisting that supply was plentiful and orders were being filled on an orderly basis, all evidence to the contrary. Supply concerns got so dire, and the spot price of oil got so high, that people were looking to Matthew Simmons and his Peak Oil theories for help. Unfortunately, the only data he had was vague or old. OPEC has no interest in letting the world know what is going on within its tight confines, other than to brashly assert that it can cheaply meet projected demand for 50 years. Meanwhile, the self-declared “fair” price of oil had gone from around $20/barrel to $30-40, to $60, and then to $70-80, all within the space of about five years. And yet we are now hearing that various middle eastern governments don’t work (and appropriate investments will not be made) with the price of oil less than something like $80-90.

With the IEA releasing a decidedly glum report at the end of 2008 (for a summary, read this) which essentially confirmed the major tenets, if not necessarily the exact timing, of Peak Oil, the world has begun an ever increasing clamor for data from OPEC producers. But they remain mum. So my question is: if there is truly no practical limit to the amount of oil which OPEC can supply to the rest of the world, why don’t they show us? Why won’t they provide us with as much rig-level specificity as the oil analysts of the world would require? What, exactly, do they have to lose? The absence of such data will, at the very least, result in continued volatility of energy prices.

OPEC's reticence strikes me as very similar to Saddam Hussein’s in early 2003, and I am extremely uncomfortable with it. More than just about anything else, it makes me think that Peak Oil theories are more correct than not. And if so, then we’re all in for trouble, because $147 is going to seem cheap.

Comparative Health Care Disadvantage

2008-12-25T09:09:00.000-08:00

At the request of my stepfather-in-law during a Christmas dinner table discussion, I am here taking up the topic of the comparative disadvantage of the U.S. Auto companies (or any other U.S. company, for that matter) in competition with companies from countries with socialized medicine.

I’ll start with my answer first and then work backward.

The comparative disadvantage that US companies face in a global world is equal to the difference in average per capita health care spending by the company in question versus the per capita healthcare tax burden of the competing nation in question.

First, let’s recognize that health care is not free in countries with socialized medicine. The money must come from somewhere. In fact, it comes from workers, too, just not directly in the form of health care compensation, but indirectly through taxation.

All other things being equal, a company in a country with socialized medicine must pay a worker a higher wage so that he can afford the incremental tax associated with socialized medicine.

For simplicity’s sake, let’s look at workers in two countries. Let’s assume that the economies of the two countries are roughly similar, so that those workers are going to demand the same net disposable income for their labor. Let’s further assume that the two countries spend roughly the same amount of money on healthcare. Let’s also ignore administrative costs.

The company ends up paying the same total compensation to each of the workers, so there is no comparative advantage to one country or another under these strict assumptions. Socialized medicine alone does not save a company anything.

If there is any comparative advantage then, it has something to do with the assumptions I mentioned above.

This is a topic for another day, as it is simply ginormous in scope.

However, let me point out that Americans are profligate health care spenders. Anyone who has a bad knee or bad hip in the United States just goes out and gets a new one, at a cost of 15 or 20 thousand dollars. We have cancer centers in the United States where the cost of outfitting a single screening room might be several million dollars. I myself have had two knee surgeries in the past three years, trying to get one recalcitrant joint to behave properly so I can ski and play tennis. My similar counterpart in the UK has probably had only one surgery, and possibly none.

In my opinion, the single most compelling benefit of a socialized system of medicine would be to keep the cost of health care down. Such systems are like austerity programs for healthcare spending.

However, such a benefit comes at a tremendous cost of freedom, and I am not yet willing to give that up. I’d rather have Americans spending too much money on healthcare by choice than spending considerably less by necessity. For we can always choose to spend less if we can’t afford it. The converse is not true in a socialized system. I might not be skiing this year if I lived in the UK.

Merry Christmas

2008-12-24T11:16:00.000-08:00

To all my faithful readers, and to everyone else, too, Merry Christmas.

It's a good thing we're about to get this awful year behind us!

As much as we might gripe, most of us still have much to be thankful for. Let's hope the new year brings hope and joy to everyone.

Blagojevich

2008-12-09T13:29:00.001-08:00

I can't decide whether this is gut-bustingly hilarious, or just plain old depressing.

I tend toward the former, although the mirth it provides can be muted at times by the thought that someone like Blagojevich could actually be elected to the governorship of a relatively large state. Are there no barriers at all to elected office? Shouldn't we have some? Maybe make them take a civics test or something?

Oily Chickens and Eggs

2008-12-04T15:38:00.000-08:00

Sitting at lunch today, I had some rather profound thoughts regarding the financial crisis which has been unfolding around the world. It was in thinking about the validity of Peak Oil theories that these thoughts occurred to me.

Please bear with me, because I am just starting to work this out, and will use these pages to record my thoughts as they occur to me.

The question is this: is it possible that the beginnings of Peak Oil actually caused much of the financial distress we are encountering today?

The Cost of Energy in Layman’s Terms

Before I get to the main argument, let me go through some quick calculations.

In the United States, we consume about 20 million barrels of crude oil per day. Multiply by 365, and you get about 7.3 billion barrels of oil per year.

For the fifteen years just prior to about 2003, a barrel of oil traded at a price of just under $40 in real dollars (i.e. adjusted for inflation). In that year, the price of a barrel started climbing rather dramatically, as shown below:

The price of oil peaked just shy of $150 per barrel in the summer of 2008. That’s a rise of about $100 per barrel. Well, if we multiply that increase by the number of barrels we consume in a year, 7.3 billion, we understand that there was an economic cost to consumers of oil products in the United States of at least $730 billion per year if the price of oil were to remain at that level. These increases would be both direct (cost of auto fuel or heating oil) and indirect (increase in the cost of eggs which are transported to market with fuel).

Does that number, $730 billion, sound familiar? Doesn’t it sound like the amount of money that Hank Paulson requested from the Treasury to bail out the world financial system?

Now, please don’t get confused that these numbers have anything to do with each other – they are different things. But I mention the relationship so that you reader have some sense of the scale of the increase in the cost of oil.

In the summer of 2008, compared to all previous years, consumers in the United States were sending an additional $730 billion of annualized costs to producers of crude oil. That’s $730 billion less money that those consumers had for other things, like mortgages, car payments, tuition or earrings from Tiffany. There are about 110 million households in the United States. Do the math, and it turns out that this number is $6,636 per household per year.

That is an enormous number. The 2005 US Census estimated that median household income in the United States was just over $46,000 per year. So the increase in oil prices, by the summer of 2008, was consuming just shy of 15% of the entire income of the median American family.

Now, please also note that the American family is quite leveraged. A vast majority of the American family’s income is already pledged to other things, including mortgages, car payments, food and other such necessities. Where the heck is such a family going to get an extra $6,000?

When economists calculate the effects of increases in the cost of energy, they generally do their analyses on a net basis. In some sense, this is entirely appropriate, because the money which is spent on energy doesn’t actually disappear, it just gets rearranged. It goes from the consumers of energy to the producers of energy. It is not a surprise that Abu Dabi and Dubai are pretty fancy places these days; money has been flowing there in a torrent in recent years.

The point is that, when money flows to producers of oil, it is then invested back into the various world economies, promoting economic growth in one place or another. So the net effect of these increases in energy costs may not be that dramatic in terms of measuring global GDP growth.

However, getting back to our median household and that $6,000, I am beginning to think that the word of economists on global GDP growth may not mean much in the current context. As consumers in the United States have gotten more and more leveraged in the new century, I think that extra $6,000 of expense has become more and more dear.

In fact, I am beginning to believe that such an expense would create enough distress at the margin to increase, say, mortgage default rates up to the current level of 5.5%. And as you know (largely from my post here), that increase in mortgage default rates has rippled through our economy, creating further distress. That distress has unfolded in such a dramatic fashion as to cause the demise of the entire investment banking industry. We are in the midst of an unprecedented situation. I woke up yesterday to hear that the US government now had to bail out Citibank, to the tune of $306 billion of federal loan guarantees!

[ Side Note (don’t read this part if you don’t like economics): Another reason that economists may have underestimated the devastating effect of higher energy prices is that they generally perform their analyses taking into account inflation, as measured by a broad index like the CPI. Well, inflation tends to help consumers insofar as it makes their fixed obligations (mortgages, rents, car payments, etc.) easier to meet as prices & wages increase, but those fixed obligations stay the same. In this case, however, any inflation we’ve had is specifically tilted toward an increase in the price of energy costs, and it has not been accompanied by corresponding rise in wages. Therefore, the increased costs have imposed a true burden on consumers.]

So, I have come to the conclusion that, based on the sheer scale of the increase in the cost of energy, it is quite possible that the chain of events which has led to our current economic catastrophe could very well have started with energy costs.

A Connection to Peak Oil?

Peak Oilers were nodding their heads as the price of oil started to really skyrocket in 2006, saying “I told you so!” Conversely, however, as the price of a barrel has come back down to just over $50 per barrel in November, 2008, others have been reiterating their contention that the unprecedented run on the price of oil was due to the exploding existence of financial speculators in the marketplace, and as the asset bubble has burst and these speculators have disappeared, the price of oil has come back down to normal market prices.

I don’t know which of these two scenarios is correct. But anyone who knows me knows that I am intrigued, if not completely convinced, by the theories of Matthew Simmons and his fellow Peak Oilers.

As such, I have a competing theory for what has been going on in the world markets lately, given that it’s possible that the current financial crisis was set in motion by the spike in energy prices. And the conclusion is not pretty.

Let me explain.

It has been thought for some time that demand for oil is generally quite price inelastic. It has been shown in several studies with extensive historical data that the consumption of oil is highly insensitive to changes in price. The price of oil can go up fairly dramatically without really affecting people’s demand for it. This seems to comport with reality; in the United States, until about midway through 2008, even though the price of oil was rising fairly dramatically, people’s consumption patterns did not really change all that much. We still need our gasoline to get to work.

In fact, if one looks at the recent statistics, the theory is pretty much borne out:

The chart above shows supply of crude oil products from the U.S. DOE. It shows that, although the price of oil started to spike starting as early as 2003, consumption patterns were not really affected until sometime in the middle of 2008. This suggests that oil consumption, within some parameters at least, is indeed relatively unaffected by the price.

Here’s where it starts to get tricky, because, like most problems in macroeconomics, we are presented with a bit of a chicken and egg problem.

Most economists would probably contend that the unprecedented rise in oil prices in recent years was an anomaly, and that the reduction to $50 in the second half of 2008 is proof. Although most will admit some connection, they’ve dissociated the vast majority of the decrease in the price of energy from the recent economic distress.

Yikes!

But what if the rise in price was actually caused by real, Peak Oil, demand-curve economics? What if the world demand for oil was actually bumping up against the physical constraints of pumping an additional barrel of oil from the ground, and plain old supply-demand theories could actually explain 100% of the rise to $147/barrel? Certainly there’s plenty of data on the demand side of the equation to support this claim.

We’ve already established that demand for oil is relatively price inelastic. So the increasing price wouldn’t automatically quash demand.

But one thing we do know, with utmost certainty – one thing that all economists would agree upon – is that the demand for oil is highly correlated with economic activity. When economic activity ceases – as it has now – the demand for oil, and energy in general, plummets. Less tankers traverse the seas to deliver goods. People fly on airplanes less. Families stay home for vacations, instead of driving to Vermont. Power plants deliver less juice to manufacturing plants.

Is it possible that economists have gotten the chicken and egg reversed? What if Peak Oil issues actually created most of the increase in energy costs? What if those energy costs increased in unprecedented ways, such that, for the first time in history, they actually became an economic burden on the average American household just when it was most leveraged? That $6,000 per year we calculated at the beginning of the article sure seems like a lot of money, doesn’t it?

What if Peak Oil caused a rise in the price of energy, and because of the inelasticity of demand, that price didn’t come back down until the price of oil itself had caused enough of an economic cycle to cause significant demand destruction?

The implications of this point of view are simply chilling. It suggests that the limits to our future growth, indeed the extent to which we are going to be able to pull ourselves out of this financial mess, are dictated primarily by the supply of cheap energy.

Get growing again, and the price of oil goes up again. Soon enough, the world can’t maintain the economic dislocation from energy costs, and we’re back in an economic cycle.

Furthermore - and this is probably a topic for another day - because of the relative inelasticity of oil demand and the way that such dynamics exhibit themselves in the marketplace, it suggests that we might be in for quite a bit more volatility in our economic cycles than we have ever experienced, at least since the Great Depression. The latest events unfolding around the world seem to confirm at least this part of the theory.

Conclusion
These are cloudy thoughts I am having. If you’ve read this far, I appreciate your patience, as I’m unsure of them myself. I just wanted to get them down in writing so that I could test my thoughts against history as it unfolds over the next several years and decades. Obviously, I will revisit all of these thoughts from time to time and update as appropriate. Please feel free to comment, though save any ad hominem attacks for other blogs.

High Larity in Venezuela

2008-12-01T08:11:00.000-08:00

I was listening to NPR on my way to work this morning. They did a short piece on the presence of Russia’s Navy in the Caribbean for the first time since the Cold War. Russia has apparently accepted an invitation from Hugo Chavez to perform naval maneuvers with the Venezuelan Navy. The media is all a-titter about it.

The NPR correspondent attended, and recorded, a brief ceremony at La Guaira, the port city near the capital, Caracas. President Chavez spoke at the ceremony, as did one or more Russian naval officers. During the course of the piece, NPR played various marches performed by the Venezuelan military band whose performance preceded the talks.

The band sounded eerily similar to my son’s middle school band. The horn section, in particular, created a jovial dissonance with its off-key harmonies. I imagined uniforms with buttons missing, hats askew and soldiers wearing two different boots.

If the competence and professionalism of the Venezuelan Navy is at all comparable to that of the Venezuelan Navy Band, I think we don’t have much to worry about. Chavez has got some work to do before their Naval breast-beating is something to take seriously.

DIP Financing for the Big Three

2008-11-14T10:30:00.000-08:00

As MidMark Capital has a few auto suppliers in its portfolio, I have been intimately involved in various aspects of the current mess in Detroit, and have a few thoughts on how it ought to be handled.

Washington is now mulling over how to handle the crisis, and it has quite a few options. With Washington just having just offered up $750 billion to save the financial industry, there seems to be little popular or legislative support for the same thing again. It seems as if a consensus is growing that the government ought to just let the auto companies go bankrupt and come out the other side smaller, nimbler, more efficient, and making better products.

I generally agree, especially as bankruptcy would allow the court to invalidate prohibitively expensive labor agreements with the UAW. Bankruptcy will not be a panacea, however, and Ron Gettelfinger will still have enormous power in determining what the restructured industry looks like. It may take four of five bankruptcies over the next 50 years in order to finally make the US auto industry competitive in a global marketplace. So, let's get started with the first.

However, there are some very serious issues which need to be worked out before any of these companies can file. First, they will need cash to operate while in bankruptcy. In a normal bankruptcy proceeding, a company will receive DIP (Debtor-in-possession) financing from a bank while in bankruptcy.

But DIP financing for the big auto companies would be simply ginormous. There is no clear indication that it would be available anywhere in the marketplace, especially since we are still in the midst of an unprecedented credit meltdown. Where are these companies going to get DIP financing?

Letting any of the big three go into Chapter 7, or liquidation, would be simply disastrous. Plenty of people have written extensively on this issue, so I won't go into it, except to say that there would be job losses in the millions amongst the Big Three and their suppliers. Ultimately, the cost would make any rescue package today seem like small potatoes.

The obvious answer, to me, is the that U.S. government should step in as the source of DIP financing, and then get out of the way as the auto companies declare bankruptcy. That way, we could be assured that the OEMs would have enough liquidity to operate through bankruptcy, but the private markets could work their magic to shrink the companies and enable them to come out the other side as more robust companies.

One other note: the government should also step in temporarily as guarantor on all of the auto companies' payables to its supply base. If those payables (in the many billions) were to go bad, there would be enough bankruptcies among the supply base to make it seem like the OEMs themselves had gone bankrupt.

Lula

2008-11-08T20:28:00.001-08:00

Mark my words: Brazil is going down.

I've watched the Brazilian economy with interest ever since I visited two years ago to arrange bank financing for one of our companies down there. I was surprised at the strength of the real, and was told with conviction that the country had developed a strong currency by offering very high interest rates, and therefore foreigners were investing heavily there.

Well, in my modest opinion, that kind of expediency cannot last. Something's got to break.

There was a gathering of world economic leaders in Brazil last week, and Brazil's president Lula was extremely aggressive in taking developed nations to task for creating a worldwide economic meltdown.

I can only imagine that Lula was setting up to blame developed economies for trouble brewing there. I would not be surprised to see the real continue to fall over the next six months, and possibly to see another debt crisis in Brazil in '09.

The Coming Apocalypse

2008-11-07T16:32:00.000-08:00

It is the fall of 2008, and the inevitable now seems upon us.

The auto industry is burning rubber, headed straight to insolvency. It may not happen tomorrow, or even the next day, but news sources are reporting that at least two of the big three have less than a year of cash left. GM and Chrysler are in deep trouble. Ford, luckily, seems to have quite a bit of cash, and thus has more time to work things out.

There will be much gnashing of teeth in the Obama administration this winter as it takes the reigns of the world’s largest economy and realizes that the largest sector in that economy is essentially moribund. There will be an almost unquenchable desire on the part of the new administration, and the complicit press, to blame it all on George Bush, who by that time will be riding into the Texas sunset.

This desire willfully ignores 75 years of history.

Those in the know have seen this state of affairs coming since Walter Reuther dramatically increased the scale and power of the UAW in the 1930s and 40s. Put simply, US auto OEMs cannot compete with their existing cost structures. It is that simple. This was a disaster in the making for 75 years. That it took so long is a small miracle.

If you want a graphic illustration of why the industry is going bankrupt, just stare at this timeline of the UAW for a moment. Look at all those accomplishments. All in one place, it is a truly remarkable list of benefits that the UAW has secured for the American worker.

Now, consider that there are something like 700 million Chinese people who are willing – nay, begging – to work for under $1/hour.

In a truly global economy, how could a company possibly pay someone over $40/hour to sit at a press and push a button every five seconds?

It can’t. End of story.

I would bet bundles of money that, in every single one of the contract negotiating sessions which the big three have had with the UAW over the last 75 years – there have probably been hundreds of them – someone from management has looked in the eye of the UAW rep and said something like this: “You know you are going to bankrupt this industry… Maybe not today or next week. And maybe not because of the specific concessions we are granting today… But add them all up, and, bit by bit, you’re stealing the future of this industry by creating an artificially high wage structure.”

Now, in the coming years you will read all sorts of stories which purport to explain why the US auto industry caused its own demise. People will say that Detroit bet too heavily on trucks and SUVs while the world was shifting to smaller cars. This ignores the fact that those trucks and SUVs were enormously profitable to Detroit, while Toyota loses money on every Prius it ships. If the industry had done what these pundits proposed, the day of reckoning would only have come sooner. This argument also ignores the fact that the US OEMs have always had very full product lines, including smaller, fuel efficient cars. For some reason, Americans bought big cars from Americans and small cars from foreigners. It was a problem of the marketplace, not management.

You will also hear that management in Detroit was inept – they could not design their way out of a box. This argument ignores the fact that foreign automakers have something like a $5,000 cost advantage on every car that it builds and sells. The US auto industry sells something like 8 million cars. Multiply those two numbers together, and that’s $40 billion worth of profit for R&D which the US auto industry did not have. It’s a little easier to develop snappy, highly engineered cars when you have a practically unlimited R&D budget compared to your largest competitors. No, Detroit’s management was not the problem.

Now, I do not hold any grudges against the UAW. It did what it was designed to do, and it did it well. I honestly believe that every local rep who ever negotiated with management on behalf of a plant’s employees had those very employee’s best interests in mind.

Unfortunately, imputing honorable intentions to 75 years worth of UAW negotiators does not get us out of our current mess. And what a mess indeed.

I am not hopeful.

This is a topic for another post on another day, but essentially I believe that the US economy will be under pressure of some sort – waxing and waning but nevertheless constant – until the average hourly wage for those 700 million Chinese equals the average wage for our own hourly workers.

How long will that take? 100 years? Maybe less? In any event, it’s depressing.

A Silver Lining

2008-11-05T09:20:00.000-08:00

So Obama has won. It will be some time before I've sorted through all of my thoughts about this, but a few comments are in order.

Congratulations to Obama on his victory. He was a masterful politician, and he is to be congratulated. But there are even more important issues I mean to discuss.

First, the election itself is inspiring. We have elected a black man to the highest office in the land. Race is not, by itself, a reason to elect someone to office, but, having done so, we should celebrate the inspirational story it represents. On January 21st, 2009, the most powerful man in the world will be black, and it has happened in the United States.

Conservatives and certain others like Bill Cosby have been fighting a kind of cultural war related to race for quite a long time. The conservative line in this cultural war says that the darkest days of racism are behind us, and now it is up to black people themselves to craft their own success. It has implored black people, particularly in poor, inner city locations, to shape up. Pull up your pants. Learn to speak proper English. Speak it. Value education. Clean up your streets. Invest in your homes. Stay married. Keep your job.

To a certain extent, these exhortations have fallen on deaf ears. OK, says the inner city black man, I could do all of those things, but to what end? Where have I gotten myself? I do all of those things, and then I am still just a poor black man in the inner city with his pants pulled up and a low paying job. My drug dealer friend down the street is driving an $80,000 Mercedes! It doesn't make sense!

The logic is understandable. But the black man, in this case, is constrained by his own perceptions about the limitations of his success. So he never actually pulls up his pants and strives to learn proper English. It's a vicious cycle, and he stays poor.

But, guess what. Now, there's nothing that a black man cannot do. A black man has ascended to the very pinnacle of human achievement. Barack Obama was born to a man whose father was a Kenyan goatherder. He was raised by a single mother. He faced every possible roadblock put in the way of a young man, and he beat back every single one of them, and now he is poised to lead the greatest nation on earth.

Every myth, every lie, every roadblock to the black man's success has now been demolished. And so now that poor black man in the inner city can have faith that his efforts will be rewarded. That the investments he makes will bear fruit. That the education he gives himself will not be a waste of time. Because success is possible. And that is a thing to be celebrated, because the black man's belief in himself is the only thing which will ultimately rid us of racial economic inequality.

A second major benefit of last night's election is that Obama's success will deflate the insidious philosophy of entitlements which animates people like Jesse Jackson, Al Sharpton, Louis Farrakan and others. That philosophy of entitlements for black people rests on the convenient fiction that racism is rampant in this country, and that we need special dispensations to make up for it.

But, if America is nothing but a boiling pot of racist enmity, then how is it possible that we just elected a black man (and a liberal one, to boot) to the highest office in the nation? Al Sharpton will have nowhere to turn. Whatever he says or does, will sound utterly fake, when the man occupying the White House is black. And he knows it.

Well, I've gotten myself all enthused here, but don't be misled. I have grave concerns about an Obama presidency. It is unclear to me which Obama will show up to work on January 21st: the most liberal senator one with radical past associations and beliefs; or the more moderate one which was presented to the American public during the election process. I am hopeful that the latter will be more prevalent in Obama's future dealings, but still scared that the former might pop up his head from time to time and wreak havoc with freedom and the American economy.

But in the meantime, since he will be our new President whatever I do, good luck and Godspeed to President-elect Obama.

A Modest Proposal

2008-11-02T08:55:00.001-08:00

Those of you who have followed this blog know that I don't believe Obama will actually implement the modest proposals he has put forth. I believe that his political philosophy calls for much more intrusive government, and that, ultimately, this will result in much greater taxes, and a massive increase in the scale of the federal government. This is the logical result of his health care proposals, for one, since what he has actually proposed can only be analyzed as a step toward a more comprehensive public health care. It doesn't make sense any other way.

Furthermore, you know that I believe that the full implementation of Obama's political philosophy will result in several adverse consequences: permanently higher unemployment; permanently lower growth rates; diminished innovation and lower choice and freedom generally.

So, I have a modest proposal of my own.

I propose that we keep track of who votes for whom.

Then, when unemployment goes up to the 8-10% range permanently in 4-5 years, those people who voted for Obama will be required to pay some additional sum of taxes into a pool of money which will be used for unemployment insurance.

Also, when, in 7-8 years, we have completed some portion of the switch to public health care, and I must then wait 9-12 months to get some uncomplicated knee surgery (if I get it at all), I propose that everyone who voted for Obama will have to pay extra sums of money into a special tax pool that will be used for people who voted for McCain to get access to health care on an expedited basis.

Seems fair, right? Isn't Obama all about fairness?

The election in a nutshell

2008-10-29T21:20:00.000-07:00

I can boil this election next Tuesday down to one question for you:

Do you believe that life should be difficult if you are on welfare?

For me, the answer is easy. Yes, life should be difficult for those who are on welfare. Every person should have incentive to not be on welfare. It's that simple.

Now, do not be confused: I am not saying that there should not be welfare. Life is certainly cruel, and events conspire against well-meaning people such that they are not able to take care of themselves. It is incumbent upon us to take of them in such circumstances.

However, in my opinion, it is also incumbent upon us to give those people both the incentive and the means to better their lot. If we make their lives comfortable, they will do no such thing.

If you disagree with me, if you believe that life should be easy for those on welfare, then you should vote for Barack Obama.

Because that's what he believes. He believes that the Constitution should guarantee each and every one of us a certain standard of living, regardless of what we do to earn such a living. He would enact such a guarantee by taking hard working people's money and redistributing to others, some of whom may not be working quite so hard.

In fact, if he had his druthers, even the judiciary would get involved in the act. He has implied that he is disappointed that the Supreme Court has not broken "free from the essential constraints that were placed by the founding fathers in the Constitution..." That the Constitution "doesn't say what the federal government or the state government must do on your behalf."

What the government must do on your behalf?! What ever happened to "ask not what your country can do for you, but what you can do for your country"?

If adopted by a majority in a democracy, Obama's politicial philosophy is insidious. In its fullest implementation, it has the ability to destroy us from within.

Here are the words of science fiction author Robert Heinlein from To Sail Beyond the Sunset (1987):

The America of my time line is a laboratory example of what can happen to democracies, what has eventually happened to all perfect democracies throughout all histories. A perfect democracy, a "warm body" democracy in which every adult may vote and all votes count equally, has no internal feedback for self-correction.... [O]nce a state extends the franchise to every warm body, be he producer or parasite, that day marks the beginning of the end of the state. For when the plebs discover that they can vote themselves bread and circuses without limit and that the productive members of the body politic cannot stop them, they will do so, until the state bleeds to death, or in its weakened condition the state succumbs to an invader — the barbarians enter Rome.

Two Reasons Why Polls May Be Misleading

2008-10-29T20:18:00.000-07:00

Two quick notes about the polls:

1) Most analysts, when they describe how the polls might be underestimating McCain's strength, point to the possible "Bradley Effect", which states that certain people who tell pollsters that they are going to vote for Obama, in fact are not, because of racial bias.

It's possible that there will be some Bradley Effect, especially in the kinds of places that Murtha denigrated last week.

However, there may be another effect which is also underestimating McCain's strength. In places with an educated, politically correct electorate, people might have a lightly considered, visceral inclination to back Obama (and thus tell pollsters that they intend to do so), because it seems like the right thing to do. The New York Times sure seems to like him ... I'm going to support him, too! Supporting Obama is the politically correct thing to do. I am quite sure that there are a number of dinner parties on the Upper Westside that people would not get invited to if it were generally known that they were McCain supporters. Again, these are not heavily researched, deeply held convictions, but rather lightly considered, visceral feelings.

But is it not possible that the doubts that McCain has tried to plant in people's minds might actually be working, and some of these people might end up pulling the lever for McCain because, in the end, when they actually get to the voting booth, they view him as the safer candidate? In fact, my gut tells me that this effect could be as large (on national vote totals) as the Bradley Effect, although it will have less of an effect on the election itself, since it would tend to be felt in the blue states rather than red ones and therefore may not effect electoral college math. If big enough though, it could make a difference in certain towns like Philadelphia, Minneapolis, Charlotte, etc, which could be important at the margins.

2) People are simply not paying enough attention to how charged up the Republican base is because of Sarah Palin.

George Bush beat John Kerry, in large part because the conservative base showed up in numbers heretofore not seen in a national election.

This could happen again. Ironically, many of the polls which show large national advantages for Obama do so because they calculate huge voter turnouts from younger, black and hispanic voters.

Wouldn't it be interesting if that effect was cancelled out by the huge, Sarah Palin influenced turnout of the Republican base?

A Whole New Constitution

2008-10-28T11:53:00.000-07:00

If you weren't spooked by Obama before, these comments from a radio talk show in 2001 ought to do it:

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If you look at the victories and failures of the civil rights movement and its litigation strategy in the court, I think where it succeeded was to vest formal rights in previously dispossessed peoples. So that I would now have the right to vote, I would now be able to sit at the lunch counter and order and as long as I could pay for it I'd be okay.

But the Supreme Court never ventured into the issues of redistribution of wealth and sort of more basic issues of political and economic justice in this society. And to that extent as radical as people tried to characterize the Warren court, it wasn't that radical. It didn't break free from the essential constraints that were placed by the founding fathers in the Constitution, at least as it's been interpreted, and the Warren court interpreted it in the same way that generally the Constitution is a charter of negative liberties. It says what the states can't do to you, it says what the federal government can't do to you, but it doesn't say what the federal government or the state government must do on your behalf. And that hasn't shifted. One of the I think tragedies of the civil rights movement was because the civil rights movement became so court focused, I think that there was a tendency to lose track of the political and community organizing and activities on the ground that are able to put together the actual coalitions of power through which you bring about redistributive change and in some ways we still suffer from that.

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Obama strongly implies that he would like to "break free from the essential contraints that were placed by the founding fathers in the Constitution."

I am constantly having arguments with various people about whether Obama is really as radical as I think he is, or whether he is the moderate that he portrays right now on the national stage.

How can one read that sentence and not conclude that he is a dangerous radical? To break free from the essential contraints that were placed by the founding fathers in the Constitution? Doesn't that sound like a pretty good definition of a radical? These are his words! When are people going to wake up!

Is Obama's Poll Strength a Chicken or an Egg?

2008-10-21T10:10:00.000-07:00

The overwhelming consensus suggests that as the financial crisis has unfolded, and as the stock market has tanked, Obama has gained substantially in the polls.

There is certainly a great amount of truth in the analysis, especially in the early days of the financial crisis. But that may not be the entire story. As this financial abyss widens, and as I sit here today watching the Dow fall yet again by hundreds of points, I am beginning to wonder if there is not also something else going on.

I would suspect that a great percentage of people and institutions who are causing the fall of equity markets today are reasonably sophisticated financially. This is especially so if a good portion of the movement in equities is, as has been suggested in many financial publications, due to massive redemptions in hedge funds.

The implications of Obama's "spread the wealth" philosophy are anathema to the health of corporations and the robustness of financial markets. The implementation of Obama's worldview would result in the institutionalization of high unemployment and low growth rates.

Is it not possible that we are seeing, right now in the equity markets, a reaction to a general consensus that Obama is going to win this election? The market may be tanking because it thinks Obama's going to win. While Obama may have benefited from the beginning of this financial mess, we are all suffering greater financial distress because of Obama's benefit.

What cruel irony!

The Great, Shrinking Income Inequality

2008-10-13T10:34:00.000-07:00

Caution, Blog Post Wonk Index: High

Not many themes have recieved more airtime in the Obama repertoire than the issue of widening income inequality in the United States over the past eight years. He doesn't really talk about the data explicitly, but the idea forms the foundation of many of his most forceful arguments. The issue has been smoldering in the more thoughtful left-leaning press for the past several years. With each passing year, new data seem to add fuel to that fire. More than any other, the issue seems to fill Obama with an almost saintly glow, as he rails about the unfairness of it all.

First, let me state unequivocally my belief that income inequality, in and of itself, is no vice. If, by virtue of the policies we choose to add dynamism to our economy, we end up with a very high income inequality, but also have the richest poor people in the world, that is an end which should be pursued under all circumstances. The opposite, low income inequality, but poorer poor people, might somehow seem more fair, but is clearly less desirable for everyone. One day I'll expound upon this at length. I'd like to do some country-by country comparative income distributions by decile, and regress the slope of the curve to something like a Freedom Index, and then determine how much purchasing power each of the countries has at the lowest decile. Maybe the study is out there somewhere already, but I haven't seen it.

But now to the issue at hand. My gut tells me that the party is over at the top of the income distribution. We've just lost, over the course of several weeks, many trillions of dollars of wealth because of stock price declines. Perhaps another couple trillion of equity in real estate has vanished. Finally, something like 100,000 bankers and Wall Streeters are out of work. The ones that remain are working in a very different world, where compensation expectations have declined precipitously as financial institutions are in need of deleveraging in order to stay afloat. Anecdotal evidence suggests that the current financial mess is something akin to nuclear winter in the most high-flying of locales like Greenwich and Darien, CT.

The vast majority of this loss of wealth and income has obviously hit the top of the income distribution. We may find that when all is said and done, we're back to normal with regard to the slope of the curve. After all, people have been saying that the early part of the 21st Century has been an anomaly with respect to all sorts of measures, from the use of leverage to savings rates to real estate values. Why should not the increasing income inequality also be an anomaly?

Of course, it will take many years for the results of this mess to show up in the official, published statistics. In the meantime, Obama will continue to glow when he talks about fairness, even though income inequality may have already reverted to its historic norm.

Is Logic a Heritable Trait?

2008-10-12T19:44:00.000-07:00

I was disappointed to read that Christopher Buckley had come out for Obama yesterday. I met the man at at a National Review party at his parent's Park Avenue apartment a couple of years ago. He seemed a nice and thoughtful guy, and his demeanor seemed in keeping with his self description in the Obama endorsement as "a small-government conservative." Although he writes in National Review from time to time, I do not profess to know much about his political thinking.

In his endorsement, Buckley makes an assertion that I've now heard from several different people who are uncharacteristically backing Obama: that Obama is smart enough to know that he will be unable to implement much of a liberal agenda because there's just not enough money right now. From the endorsement:

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But having a first-class temperament and a first-class intellect, President Obama will (I pray, secularly) surely understand that traditional left-politics aren’t going to get us out of this pit we’ve dug for ourselves. If he raises taxes and throws up tariff walls and opens the coffers of the DNC to bribe-money from the special interest groups against whom he has (somewhat disingenuously) railed during the campaign trail, then he will almost certainly reap a whirlwind that will make Katrina look like a balmy summer zephyr....

...Necessity is the mother of bipartisanship.

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My goodness. What does this mean? Would Buckley be supporting McCain if we were not in the midst of a financial crisis? Why would the current mess change anyone's thinking about who to support for President?

Furthermore, and more important, just listen to Obama talk for a minute or two. It seems blindingly clear to me, at least, that Obama thinks that a liberal agenda is precisely the remedy for what ails us. He's going to tax us, redistribute the wealth, and make us all better off.

Being a good politician, Obama has dressed up what is essentially additional welfare (tax credits) in the cloak of tax relief for lower income people, and he's tricked people like Buckley into believing that he thinks like a small government supply-sider. But a tax credit is not a tax cut. It's a payment of cash from the Federal government. Most of the people receiving Obama's tax credits will not have even paid any Federal income tax.

People, this is the most liberal person in the United States senate. There is no bipartisanship in Obamaland! Mr. Buckley, if Obama is elected, you can kiss your small government goodbye. We had better hope that the Dems don't end up with filibuster proof majorities!

The Regulations are Done!

2008-10-08T12:26:00.001-07:00

From time to time, I venture on over to the other side to see how the thinking is going over there. Who was it that said "know thine enemy"? Sun Tzu? Did he use the word "thine"?

But I digress (and I joke).

I did venture over to The Nation, and read this fluffy piece of wonderbread (Born Again Democracy). It's all about how the federal government needs to take over the economy, and it's filled with all sorts of vapid proposals. At least at the end, the author admits that "These ideas and many others are in gestation." If there ever was a need for abortion, this may be it...

Anyway, it reminded me of a thought that I'd had recently, and that is this: we don't need to regulate, because it's already been done for us!

Consider: Set aside the rating agencies (and the complicit federal government) for a moment. Whose behavior was the most damningly irrational in getting to the present mess? Is it the people who took advantage of aggressive mortgages when they were available? Was it the mortgage bankers who swam in fees? The investment bankers?

No, each of those people had their own (albeit selfish) reasons for doing what they did. The most irrational among all of the players were the fixed income managers who bought all of the toxic mess which had been packaged up into CDO's. What were they thinking? Didn't they do any due diligence?

We don't really need to go into it, because that's history, but one thing is for sure: private markets are very good at recognizing mistakes like this and correcting for them. You can be sure that fixed income portfolio managers won't be buying a lot of CMO's with dodgy mortgages in them any more.

It's very hard to regulate an industry that isn't there. The recent troubles have effectively killed the CMO market - it doesn't exist! The regulation has already been done for us!

Tax Rates for the Unemployed

2008-10-06T19:59:00.000-07:00

I find it almost counter-intuitive that Obama's lead in the polls has been growing over the past few weeks as the financial crisis enveloping our nation has deepened.

Republicans have always been the business friendly party. Why now, all of a sudden, is it the Democrats who are going to come to the rescue of the nation? I can only surmise that most people are just simply confused. They are tired of the barrage of financial news, and they think that any change is good.

Well, that's just sloppy thinking. Take one look at Obama's prescription for our country, and his philosophy of entitlements, and one can only conclude that an Obama Presidency would only make things worse, not better. It's simply infuriating.

Obama likes to point out (misleadingly) that he will lower tax rates for the middle class. Well, it doesn't make any difference what tax rate you pay if you don't have a job!

A Scared Accountant is a Dangerous Thing

2008-10-06T12:09:00.000-07:00

Alright, ladies ‘n germs, you might as well settle in, because this is going to be a long one. If you’re a pro in the financial world, you might want to skip to the end, where I describe the hellfire wrought by mark to market accounting. For others, the good news is that by the end of this post, you will understand, or at least know about, most of the salient aspects of the recent financial crisis. More important, you will understand why this particular financial dislocation has been so severe.

Here’s the part you probably already know: this financial crisis has been created, in large part, by a bubble in asset values and the underlying financing for those assets. In this case, the assets concerned were real estate assets, and the financing were residential mortgages, for both first homes and investment properties.

Now, economies suffer bubbles in asset values all the time. We had the stock market bubble in 2000. We had a similar real estate bubble in the 1980’s. There was the quintessential tulip bubble in Holland in the 1600’s. Often, these bubbles were accompanied by “easy money”, which led to the proliferation of unsustainable financial contracts like we have seen in this most recent bubble.

However, most of the bubbles in history did not cause the extinction of the investment banking business. This bubble has been markedly different in the severity of the liquidity crisis which has unfolded, and its effect on financial institutions.

What caused this crisis in the first place? Well, there are a lot of people who have been keen to point the finger at one particular thing or another. It was either the “predatory lenders” or the easy money of Alan Greenspan which caused it. Barney Frank is my favorite bogeyman.

In reality, there were a number of trends which, together, created this mess. Then, there was one thing which made it much, much worse than any other bubble we’ve seen, possibly since the Great Depression.

Very quickly, let me explain the conclusion, and then I will give you details later in the post.

The Things Which, Together, Contributed To The Bubble:

Relaxing of mortgage underwriting standards
Very efficient, but complex, capital markets
Low interest rates

The Thing Which, in Turn, Caused the Wholesale Destruction of the Financial World:

Mark to market accounting

Without this last item, mark to market accounting, in my opinion, we would be facing issues in our financial system not much more severe than that which we suffered during the Russian debt crisis or any number of other financial dislocations over the course of the last century.

Instead, this time, Merrill Lynch is gone. Goldman Sachs has converted itself into a commercial bank. Lehman Brothers has been liquidated. After two hundred years of being in business, Wall Street is simply gone.

If you’d like to know why, read on.

First, the bubble itself.

The Things Which, Together, Contributed To The Bubble:

Relaxing of mortgage underwriting standards: For most of recorded history, the mortgage business has been quite mundane. Banks had rules of thumb, developed over decades, which determined how large a mortgage a person could secure, given his particular financial situation. They used a ratio of mortgage payment to total monthly income, a ratio of downpayment to total value, and various other measures, and were generally quite inflexible. At some point in the 1990’s the federal government got involved in a crusade to increase home ownership, particularly among the poorer, which often meant minority, populations. In the course of doing so, the government applied pressure to financial institutions, often in the form of regulations and pressure to meet requirements of the Community Reinvestment Act of 1977, but also by simply urging financial institutions to relax their underwriting standards for minority populations. A very hot smoking gun can be found here (http://www.bos.frb.org/commdev/commaff/closingt.pdf), a 1998 manual printed by the Federal Reserve of Boston specifying the ways that banks might do such a thing, including overlooking those old standards I mentioned. The result was that banks began to relax those standards, and people who previously could not qualify for a mortgage became able to do so. In addition, truly creditworthy people started being able to get more aggressive mortgages, including no downpayment, interest-only, etc. This trend was magnified by the actions of Freddie Mac and Fannie Mae, which could (and did) purchase or guarantee the payments on certain qualifying mortgages and resell them to investment banks or other institutions.

Very efficient, but complex, capital markets: This one is little more difficult for those not in the financial industry to understand, but the development of the collateralized debt obligation (“CDO”) and collateralized mortgage obligation (“CMO”) massively increased the scale of the financial difficulties associated with the real estate bubble. In developing a CMO, an investment banking firm would purchase a great number, say 5,000, mortgages, and pool them together, creating a massive set of cash flows from the payments on the combined mortgages. Then, they would take these cash flows and divvy them up into slices, some of which were senior to the others, and thus more secure, and others of which were junior, and thus more risky, but which would pay higher interest rates. All of the slices would be rated by the rating agencies and sold to institutional investors of all stripes. The development of these financial instruments is a wonderful idea, and they will be permanent parts of our financial industry for years to come, but they added several elements of risk to the financial system which helped to create the current mess:
Complex and opaque financial instruments: CMO’s are inherently complex. Any analysis of the cash flows underlying such securities is time consuming and difficult, since the securities are an aggregate of hundreds and sometimes thousands of other financial contracts, each of which has its own particular complexities. While it is possible to estimate certain risks associated with such securities, such analysis is, at best, a guess, especially when unexpected events occur (like economic cycles or, as in this case, a housing bubble).
Distance between the originators of mortgages and the ultimate owners of mortgages (the “agency” problem): With the advent of the CMO, the entity which ended up holding a mortgage was very rarely associated with the entity which originated the mortgage. In fact, mortgage bankers, operating by themselves instead of on behalf of banks, started gaining market share in the mortgage marketplace. These mortgage bankers were incentivized solely by the number and amount of mortgages that they originated, rather than the quality of those mortgages, since they generally sold them very quickly to investment bankers eager to pool them into CMOs. The problem with this scenario is that it tended to magnify the shortcuts that mortgage originators took in the due diligence they performed on their borrowers, since they would not be the ones to suffer if the mortgage became impaired at some point in the future.
Low interest rates: With the advent of the CMOs, the increasing aggressiveness of mortgage bankers, and the ubiquity of financial information on the internet, it became increasingly easy to obtain an aggressive mortgage starting in the late 1990’s, a trend which increased into the early 2000’s. In addition to these trends, the United States (and the world) saw a very low interest rate environment early in the 2000’s as the federal reserve attempted to jump start the US economy after the recession of 2000-2001 associated with the collapse of the dotcom equity bubble. With low interest rates, borrowers started to be able to obtain even more aggressive mortgages, since there is an inverse relationship between interest rates and the amount that someone could borrow, given their income. “Mortgage Calculators” became ubiquitous on the internet, wherein a person could input various financial figures, and then, based on the prevailing (low) mortgage rates, figure out how much he could borrow to purchase a home. As people were given more and more money to purchase a home, not surprisingly, home prices continued to rocket skyward.

The situation was a bit like the old snowball rolling down the hill. Sometime in the 1990’s a bit of snow got kicked of the top of a mountain and started rolling down the hill. The federal government added a bit more to the snowball in the 90’s and into the 2000’s as it encouraged the loosening of credit standards for mortgages. It continued to get bigger and bigger as Wall Street developed fancy new ways of packaging mortgages and selling them to unsuspecting institutional investors. Finally, as interest rates achieved new lows in the 2000’s, and consequently home prices began to surge, the snowball was by now huge, and flying down the hill, approaching the bottom. People and events started to get in the way of the hurtling snowball.

Sometime in 2006, people started to notice that the default rates on the most aggressive mortgages (mostly what they call “sub-prime”) started to creep up. There are reasons why the default rates were higher than in days past, but we shall not go into them here, because it is not particularly germane to the discussion. But business continued as usual. In fact, people were so pleased with the surging housing markets, that normal Joe Sixpacks were buying up real estate on speculation, hoping that they would make a killing when they resold the property six or nine months later.

By August of 2007, however, the snowball really started bashing into things at the bottom of the hill. Default rates on mortgage portfolios had started to climb to almost unprecedented rates. Because of the opacity and complexity of the securities which actually held most of the aggressive mortgages, people in the financial world had a hard time even figuring out which securities would be affected, and by how much. In that month, trading of most types of these securities ceased altogether for a period, as people backed off to try to understand what was happening.

Investment banks, which had put together billions of dollars of these types of securities in hopes of selling them to long-term institutional buyers, were caught with illiquid securities on their balance sheets. Nobody would buy them, because nobody knew what effect the surging default rates would have on the complex cash flows of these securities. Banks could neither originate, nor package new mortgages into new CMO’s.

At the same time, the freezing up of the mortgage origination marketplace started to affect home prices. For the first time in ten or fifteen years, home prices were starting to drop, furiously in some places. The snowball was now massive, and crashing into the entire housing marketplace with a fury.

This was the situation in the winter of 2008. No bank or financial institution had yet failed, but people were getting increasingly concerned about the amount of collateralized debt obligations sitting on the balance sheets of financial institutions. In the quarter ended September 30, 2007 and December 31, 2007, banks, investment banks, insurance companies and other financial institutions started trying to estimate their financial exposure to the worsening housing crisis, and started taking charges, aggregating into the hundreds of billions of dollars by early 2008.

Trading in the most exotic of collateralized securities had virtually ceased. Since nobody had the time to figure out what they were really worth, nobody would bid for them. Rumors started to fly to the effect that certain institutions were more exposed to losses than others, and people and institutions started pulling their money out of the accounts of certain institutions. There was a run on Bear Stearns, one of the most aggressive banks, in March, and it was swallowed up by JP Morgan over a tense weekend.

Then, it just kept getting worse. By September, the federal government had to step in and save both Fannie Mae and Freddie Mac, the entire investment banking industry was gone, and Congress was forced to provide up to $700 billion for a bailout of the world’s financial institutions.

How did we go from having an asset bubble, which may have been no more significant than others in history, to the extinction of the investment banking business and governments around the world having to commit hundreds of billions of dollars to prop up failing credit markets?

In my opinion, there is one overriding reason, and that is mark to market accounting.

The Thing Which, in Turn, Caused the Wholesale Destruction of the Financial World:

Mark to market accounting:

First, let me do a little bit of back of the envelope mathematics for you. Currently, in October 2008, the aggregate default rate on mortgages in the United States is about 6%. Most people, even though they may even have a home which is worth less than the amount outstanding on their mortgage, are still paying their mortgages, because they don’t want to default! Now, 6% is a very high default rate given historical averages. It’s scary high, but let me continue, because it’s not as bad as you may think. Let’s make some obscenely aggressive assumptions. Let’s say that 100% of the defaulting mortgages are foreclosed (it would never happen…). Further, let’s assume that the original loan to value ratio of all of those mortgages is 100% (again, absurd). Finally, let’s assume that the actual market value of the homes underlying those mortgages is only 70% of the mortgaged amount (likewise, absurd). The lenders on those homes will loose 30% of their principal, ignoring transaction costs. OK, so now let’s do the math. The total value destruction so far should be the total mortgage market times 6% times 30%, or 1.8% of the total mortgage market. The total mortgage market in the United States is about $10 trillion. 1.8% of that number is $180 billion. A big number, to be sure.

But, as of today, the financial industry has taken something like $800 billion worth of write-downs, and still the carnage continues. When it’s all said and done, people are estimating that the problem might cost well in excess of $1 trillion in aggregate, and possibly many trillions.

What gives? How can $180 billion of possible losses translate into a $1 trillion of actual losses?

Well, by an accounting adjustment.

Remember those opaque CMOs that nobody could figure out? Well, those securities are holding all of the defaulted mortgages. But since they’re so complicated, and since the housing market is so dynamic at the moment, nobody can really figure out which CMOs are going to be affected in what amounts. So nobody will buy them. They sit, illiquid, on the balance sheet of the institution which happened to own them when the music stopped.

Excluding Fannie Mae and Freddie Mac, financial institutions might have several trillion dollars worth of these securities sitting on their balance sheets, and, as we have calculated before, there may be something like $200 billion of real losses hiding in there so far.

But how do these financial institutions value these complex securities which sit on their balance sheets? Do they make a bunch of assumptions about the economy and housing markets, and analyze the resulting cash flows and pick a discount rate and assign a value to them?

As of the last several years, the answer is no. Because of increasingly aggressive accounting policies which finally resulted in the adoption of something called SFAS 157, financial institutions have been required to value those securities at the price which others in the marketplace would be willing to bid for them. This is called “mark to market” accounting. When markets are liquid and functioning properly, and when institutions hold securities primarily to sell them or trade them, mark to market accounting makes a lot of sense. It is the most appropriate measure of value of a security which is held for sale.

But, didn’t we just conclude earlier that the market for these securities has become almost illiquid? At what price would people be willing to purchase complicated securities with unknown values in an illiquid marketplace? At the very least, someone would have to be given a very substantial discount to a security’s true value in order to induce them into a trade under such circumstances.

In fact, this has been the case. Whatever trading has occurred in the marketplace has been at severely discounted prices, for all of the reasons that we have discussed. The most talked about example has been the $30.6 billion worth of CDOs which Merrill Lynch sold to a private equity investor called Lone Star Financial for approximately 22% of the stated face value of those securities.

If we had to value all of the CDOs sitting on the books of financial firms at those kinds of discounts, there would be paper losses at those firms amounting to many hundreds of billions of dollars, maybe even trillions of dollars.

In fact, this is exactly what has happened, notwithstanding the likely fact that the real losses which will be incurred because of the housing crisis will be much, much less. All of this would be fine if financial institutions did not have capital requirements (regulatory, in the case of banks, and simply as a matter of creditworthiness for everyone else). Mark to market accounting has created its own, self-fulfilling prophecy. Because accountants have marked these securities down to a value far below their true, intrinsic value, credit markets have seized up as nervous institutions have stopped lending to other institutions with suspect balance sheets.

And, since institutions are not being able to borrow, based on paper losses, they are forced into liquidity crises. Often, those liquidity crises force the institutions to actually sell their suspect securities at firesale prices, well below their true intrinsic values, thereby turning paper losses into permanent reductions of capital.

This is how Bear Stears, Lehman Brothers and the others disappeared on various Sunday nights. A simple accounting treatment has outrageously caused a crisis of confidence which has resulted in an historic credit meltdown and the extinction of the investment banking business.

And it did not have to happen.

When I catch my breath, on another post I will describe how all of this could have been avoided.

PS: Understanding all this, if you want another villain, how about the trial bar? Here’s how it goes: Enron -> trial lawyers -> collapse of Arthur Anderson -> Sarbanes-Oxley -> proliferation of outrageously, ridiculously conservative accounting principles -> SFAS 157 -> extinction of the investment banking industry.

I am only half-kidding.

Burning Down the House

2008-10-01T13:18:00.001-07:00

Anyone who's on this blog has probably already seen this video, but if not, please take a look:

http://www.youtube.com/watch?v=JqbgcejIT_k

I don't know who produced this video, but it is extroardinary, and it tells the whole truth about the current financial crisis unfolding around the world.

Viral marketing on the web will change forever the way politics works. In two week's time, I would not be surprised if John McCain were back on top in the polls...

Obama's Infuriating Disingenuousness

2008-09-29T19:11:00.000-07:00

So I've been speaking to people - well meaning, reasonably informed (NYT, generally), middle of the road people - who seem not to be terribly concerned about the prospects of an Obama Presidency. In fact, some of them are downright enthused. Many saw the debate last Friday night, and thought that Obama did a fine job (which, in some manner, he must have), and are convinced that certain of his positions have merits (cough, cough).

My question is this: how is it that reasonable, middle of the road types are not scared witless by Obama, when the man, based on his voting records as tallied by several watchdog organizations, ranks as one of the, if not the very most, liberal members of the Senate?

Now, the Senate is not the House, but being the very most liberal member of even that august body must place someone just to the right of Joseph Stalin. If all that I hear about his legacy and his real, deeply held philosophical positions is true, then he is, at heart, a socialist, or something very close to it. Let's put all our money in a pot and divvy it up equally.

So how is it that all these people are flocking to him? Would these people not see that such a figure would, especially when coupled with Democrat majorities in both houses, result in the largest power grab by the federal government since FDR and the great depression? Do people not understand the risk to our economy and our nation?

My inclination is to assume that Obama is simply lying to people. He is trying to portray himself as a middle-of-the-roader himself. He is hiding the truth of his real beliefs. He is pulling a fast one on the American public - he's a liberal wolf in centrist sheep's clothing.

I must admit that until very recently, these thoughts were almost articles of faith with me - I had not yet dug deeply enough into Obama's stated positions to conclude whether or not they truly qualified for my scorn.

So, I set about to remedy my own lack of understanding. I went to Obama's website, and read up on his stated positions, and I compared them with my preconcieved notions about what they would be.

Guess what. I was right. He's a lying sack of horseballs. His website and his stated positions are so full of holes, so full of contradictions, and so full of meaningless rhetoric, that I am having trouble deciding whether he is the most masterful obfuscator in history, or whether he is just simply an idiot.

Let's look at his health care plan, just for one. Obviously, it's a much larger topic than can be reasonably handled in a short blog post, but after five minutes looking at it, a general theme unfolded - there's all savings, and no cost. Everything gets better, but nothing costs more. It's magic. He has discovered alchemies which have eluded witches and warlocks for millenia! He can turn iron into gold!

A couple of examples which stood out:

Obama will save money to pay for a part of the increased cost of his health care plans by eliminating the restriction on direct negotiations with drug companies for prescription drugs. Fine. He thinks this could save $30 billion. Fine. Apparently, he also believes that this $30 billion is free. This is breathtakingly ignorant. Drug companies spend about 50% of their free cash flow on R&D and the rest they dividend out to shareholders. If Obama has his way, approximately $15 billion of critical drug R&D will vanish. Swoosh. With regard to dividends, Obama needs to understand that it's something of a zero-sum game. If a company's earnings available for dividends decreases, that company will reduce their other costs commensurately so that they can maintain a certain percentage of dividends. That means jobs, other r&d, overhead expenses, etc. etc. etc. In a flash, $30 billion disappears, and it's got to be accounted for somewhere else! If he's proposing $15 billion of federal drug R&D, that's one thing, but he's not. It's free! The same logic, by the way, can be applied to his idea to reimport drugs from lower cost countries (which, by the way, negotiate with the drug companies!). If he has a plan to get other countries to pay more for their drugs while we pay less, then fine. But in the absense of that, again, it's a zero-sum game.
Obama thinks that his health care plan will save American families approximately $2,500 by, among other things, making investments in healthcare IT. This is one part arrogance and one part ignorance. First, guess what! IT investment requires, get this: investment! It costs money! Second, if he doesn't think that every single health care CEO in this country already has gobs of incentive to save costs by making their IT work better, then he's got another thing coming to him. They're doing the best they can. To suppose that Obama is going to come along, wave his wand, and make it all work better is, I dare say, a tad arrogant. I think Hillary found this out it 1993.
He wants to reduce health care expenditures by making health care universal, and thereby reducing spending on uncompensated care. Sorry, but somebody's got to explain that logic to me. If he's saying that doctors charge payors more for uncovered patients than for covered patients, then we're back to the zero-sum game logic. If those doctors are then going to charge the uninsured less because they're now insured, then they're going to charge the rest of us more for the foregone incremental earnings! It's not free! He can't get free health care for uninsured people by making them insured! Am I the only one who has noticed this? As they say, where's the outrage?
Mandatory coverage for children. Barack Obama will mandate that all children will be covered by medical insurance. Ah, the children! But what does this mean? Are children more important than other people? What about their parents - aren't they important too?Will children get healthcare insurance but their parents won't? This is a platitude masquerading as a policy. It has no place in serious discussions, and it makes me think little of Barack Obama. And don't say that I don't love children. I know that all conservatives are baby-killers, but I, for one, am not. I love children, but if they have healthcare, I want mine, too.
Other, more general inconsistencies in the plan: First, Obama points out that health care costs have been rising dramatically lately (true). Then, he states that his plan will save the average family approximately $2,500 per year (great!). Finally, after all that cost savings, here's what you're also going to get: guaranteed eligibility and comprehensive benefits for all of the uninsured in the nation; subsidies for low-income families; expansion of medicaid and SCHIP; employer contributions (think: zero-sum); support for small businesses; etc. etc. BUT, it's going to cost you $2,500 per year less! What he doesn't tell you, is that your taxes are going to have to go up by many multiples of that number. Net, net, you're way, way behind. But you'd never figure that out from listening to Obama, or reading his puff pieces. You'd actually have to read it, and think about it like I have.

I could go on and on. He's pulling a fast one on the American public.

Honestly, I don't have a problem with people who favor nationalized health care, but are honest about the implications for our economy, tax structure, etc. Reasonable people can disagree. This is different.

My conclusion: I don't care which one it is. He is either a liar or an idiot. Either way, he is dangerous to freedom in America.

First Political Blog

2008-09-29T19:04:00.000-07:00

Well, here I am, at it again - this time about politics, though. This crazy political season has gotten the better of me, and I can't seem to shut my flapper.

If you can't stand it, well then don't read it!