Joe The Economist

The Value Of The Social Security Trust Fund

2011-06-30T05:24:00.000-07:00

"What I enjoy most, is living like an aristocrat without the burden of having to be one…. I don't envy them. It's only the trappings of aristocracy that I find worthwhile - the fine furniture, the paintings, the sliver--the very things they have to sell when the money runs out. And it always does, and all they are left with is their lovely manners." - Jim Williams in Midnight In The Garden Of Good And Evil.

It is de rigueur conservative politics to call the Social Security Trust Fund a collection of worthless IOUs. This presents a serious problem for Americans worried about the subject because hyperbole will condition people to believe that the Social Security system can't get into worse shape, when in fact the situation can and will get much worse.

These are serious think tanks, journalists, and investment magazines.

As they are bonds not backed by any real assets, the government will have to either borrow or raise taxes to pay for them", The Heritage Foundation

"They do not consist of real economic assets that can be drawn down in the future to fund benefits." In other words, the Social Security trust fund contains - nothing.", Charles Krauthammer

"Officially, the trust fund holds $2.6 trillion in special-issue Treasury bonds. In reality, it has no assets of any value", IBD

According to IBD, 28% of Americans have already become comfortable with the idea that Social Security contains nothing but worthless IOUs when in fact the assets are far from worthless. No hard assets? The government has significant hard assets in gold and oil. It is the largest land holder in the country. It has a pending revenue stream coming from 16 trillion dollars held in tax deferred accounts. The government today has the hardest asset in the country – the power to print money. This power is absolutely the hardest asset because it undermines every other asset in the country.

The problem isn’t that the securities held by the Trust Fund are worthless. The problem is that they are worth less every day, and will be worthless one day. Every day the government makes more promises, borrows more money and prints more money. The collective promises are growing much faster than our hard-assets. They are growing faster than our tax base. We are basically a family living on wealth which is running out. And if you don’t think it can get worse just wait until all we have left is our lovely manners.

USA Today's Dangerous Minds

2011-06-22T10:31:00.001-07:00

http://www.usatoday.com/news/opinion/editorials/2011-06-16-Payroll-taxes-raid-Social-Security_n.htm

In an editoral, USAToday offers "For almost three decades, Social Security was the only major government benefit program that generated more money than it cost, thanks to hefty payroll tax revenue that exceeded benefit payments to seniors." It is dangerous thinking.

The only way you can say the Social Security has generated more money than it cost, is to ignore the real costs of the system. In 2010, Social Security generated a total of 677 billion and paid out 584 billion. But the 584 billion does not include the cost of future promises. In exchange for the 677 billion, we give pension promises to the working generation who pay Social Security. Social Security is only cashflow positive to the extent that we intend to renege on these commitments.

What USAToday says is based on "cash-accounting". Before you roll your eyes, here is a practical example of "cash-accounting": Wells is a beer drinking college student, who goes daily to the ATM to retreive his balance. He doesn't bother with the other checks that he has written or the impending tuition payment. Whatever the ATM says is how much beer he can buy. That is how cash-accounting works.

Now you may think that Wells is not a problem because he is not your son. But he is your problem if he is the chief accountant for the Social Security system. And there is no way to say he is not when you look at the way that the accounting is handled. When you hear that Social Security is 'making money' you need to think of Wells standing at the ATM shaking a receipt in your face and saying "come-on you cheap skate I'm buying".

The take home here is that cash accounting is illegal for all public companies. There is a reason. It is grossly misleading. Social Security does not generate more than it takes in. It has generated unfunded liabilities in the trillions of dollars.

Does Social Security Add To The Deficit

2011-06-17T08:16:00.000-07:00

"Does. Does Not. " And the argument goes on forever.

The short answer is that Social Security in our view is a contributor to the deficit. The amount is less important because the short answer is no one knows the extent.

FICA taxes contribute to the deficit today, not just in the future. FICA taxes restrict the economic activity which generates income taxes that would pay down the deficit. They lower the incentive to work, and increase the incentive to evade or avoid the tax system all together. They make the cost of goods produced in the United States less competitive in the world markets, which costs us jobs.

The larger impact on the deficit comes as FICA diverts taxable income away from the general fund to the retirement system. FICA and Income taxes are connected because they compete for resources within the same tax base. They are like two straws drinking from the same soda. What one takes is not available for the other. This impact is enormous.

There are people who will disagree with our position. These people will argue that FICA isn't a tax at all. It is an economic investment which will pay-off at retirement. Further they suggest that it is an investment which lowers the overall borrowing costs of the government. Our surveys find very little public support for this theory. ABC News/Washington Post polls showed that 81% of Americans believe that Social Security is heading for a crisis without changes. So if it is an investment, most people think it is a pretty bad one.

No one can tell you how much Social Security contributes to the deficit. The more it is a tax, the more it contributes to the deficit. The more it is an investment, the less it contributes.

FICA Is A Tax

The flaw in most commentary about Social Security is that it assumes that FICA taxes and Income taxes are unrelated. They are related because FICA taxes and Income taxes compete for resouces within the same tax base. You might view them like two straws drinking from the same soda. What one takes, the other cannot. Every dollar that is collected by FICA is a dollar that could have been raised to pay down the deficit. In the extreme view, we are allocating our tax base to our own retirement system and putting the rest of the government on our kids credit card.

The more people view that it is a tax, the more it adds to the deficit. As a tax, it directly contributes to the underground economy - now estimated to be about 2 trillion dollars. As a tax, it creates a significant pushback on general taxes. It is not possible to miss the correlation between rising FICA taxes and increasing pushback on income taxes. Today 47% of American households had no income tax obligation, and yet more than half of them had a FICA contribution.

FICA Is An Investment

The other extreme view is that FICA isn't a tax at all. It is an insurance premium which people treat like an investment. Many years ago people though of it as an investment at least to some extent. The terms were so generous that my father worked two summers away from home just to qualify. His salary barely covered his gas and lodgings, but it added the two quarters necessary for him to qualify for Social Security. He not only thought of it as an investment but a good one. In the extreme view, it is just a forced investment which induces a reduction in personal savings.

Does Social Security Add To The Deficit?

Anyone telling you that Social Security does not contribute to the deficit believes that FICA is an investment. They believe that every man, woman, and yes child(contributing) to the system believes that it is an investment. We will tell you that people have different views of what FICA is or isn't. To the extent that FICA is considered a tax, it adds to the deficit in a significant way.

Hauser's Law

The proposition was first put forward in 1993 by William Kurt Hauser, who wrote, "No matter what the tax rates have been, in postwar America tax revenues have remained at about 19.5% of GDP." That means that as FICA taxes go up, some other tax revenue must go down.

Why People Hate Discussions Of Social Security

2011-06-17T07:00:00.000-07:00

One reason that people avoid the discussion of Social Security is that Yes is not necessarily the opposite of No. This is the result of politics in which the answer is less important than the framing of the question. Case in point.

This is : Yes, Social Security adds to the budget deficit

"These deficits, which began in 2009, could add trillions to the federal debt held by the public and hundreds of billions in annual interest costs. "

This is : No, Social Security does not add to the budget deficit

"In fact, Social Security’s Old Age and Survivors Insurance Trust Fund and its Disability Insurance Trust Fund are prohibited from paying benefits unless those funds have sufficient income and assets to cover the cost, and they have no borrowing authority to acquire the requisite income and assets. Consequently, Social Security is prohibited by law from deficit-spending and thus contributing to the federal deficit"

Both are true statements, but they don't actually refer to the same thing. The difference is "Held By The Public". The Social Security Trust Fund is not the public. It is an intergovernmental agency. So as we liquidate the Trust Fund, we will have to borrow from "the public", and we will see higher interest costs as a result.

Why does the public get a better deal than Social Security? Because "the public" has options to invest its money at the best rate. Social Security doesn't - and no one is talking about fixing that. (other than us)...

source :
http://jec.senate.gov/republicans/public/?a=Files.Serve&File_id=0edfdbbe-6f48-4007-a429-6ef64fda10cb

What Washington Is Missing

2011-06-15T20:01:00.001-07:00

The biggest challenge for Social Security is the stubbornness of Washington where our leaders are focused on yesterday's news, and promote ideas which are yesterday's answers. The experts believe that the problem is demographic in nature, ie too many retirees for each worker. While demographics may be a problem, it isn't the imminent problem.

The pressing problem is stagnant wages. Social Security depends upon wages from the private sector to pay benefits. While public sector jobs may contribute to the system, these jobs are funded again by private sector wages in the form of income taxes. Over the past 10 years, the problem of demographics has been replaced by a much larger problem of economics: jobs, wages, and productivity.

The following article is important to read. Here is its connection to Social Security. There are fewer jobs to pay into Social Security. The job mix is shifting to lower paying work. Finally, much of the wage growth is in benefits which are not subject to FICA tax. In conclusion : you can't increase wage growth with higher taxes.

http://www.investors.com/NewsAndAnalysis/Article/573982/201106020800/10-Year-Real-Wage-Growth-Worse-Than-During-Depression.aspx is a worthwhile article to see what is happening our labor markets.

Here are some highlights:

There has been a net loss of 2.7 million private nonfarm jobs since March 2001. (Government payrolls rose by 1.2 million over that span.)

The problem is worse than lost jobs, as job losses have been concentrated in higher-paying goods-producing sector, including construction and manufacturing, which has shed 26% of its workers. Job growth has been in typically lower-paying service industries have kept growing their payrolls: social assistance (41%), nursing homes (21%), leisure and hospitality (10%).

Globalization of production has fed a "the substitution of capital for labor" amid a push for productivity and competitiveness.

The increase in nonwage compensation — fueled by the growth of tax-free health care spending — which has eroded real wage gains.

Higher Taxes And Lower Benefits Will Only Make Social Security Worse

2011-06-06T17:44:00.000-07:00

Last summer, Congressional Budget Office scored 30 potential solutions for Social Security for the effectiveness of each in dealing with the financial imbalances in the system. Every solution was either a tax increase or a benefit cut. More recently, the President’s Financial Commission on Fiscal Responsibility outlined yet more solutions which consisted of benefit cuts and tax increases. It is a frightening statement on how little our leaders understand the problem.

The solvency of the Trust Fund is not the primary problem in Social Security. The question of solvency is the unavoidable outcome of a deeper problem within the system, return on contribution(“ROC”). It is terrible, particularly for younger workers. If so raising taxes and cutting benefits will only make the core problem worse and the whole system less stable because while these solutions will make the Trust Fund last longer, it also discourages people from participating.

Social Security is unfortunately a pay-as-you-go system for which the Trust Fund provides very little economic support. According to the Social Security Administration, the OASI Trust earned only 118 billion dollars in 2009 while distributing 564 billion dollars in payments . Moreover, the role of the Trust Fund in providing for Social Security benefits is likely to drop going forward . So the solutions in Washington largely provide 15% of the solution and put the rest of the system at risk.

The problem is return on contribution. When the ROC drops, so does the willingness of people and business to participate. They either evade or avoid the system. In a recent study, it was estimated that two trillion dollars of the economy is underground hiding from the tax man . The hidden economy costs Social Security as much as 250 billion dollars last year. The larger problem is that the ROC encourages business to allocate labor earnings away from wages into benefits which are not subject to FICA tax. Data from the Labor Department shows that wages are only 70% of employee compensation. The remaining wages are paid in benefits which are not subject to FICA taxes.

How bad are the returns in Social Security today? Last summer, the government provided a periodic moneys-worth study of the Social Security system, which compares a dollar of contribution with the present value of future benefits. A moneys-worth ratio of 1 means that you are getting back exactly what you put into the system. In the report, the government predicts that some workers will get back as little as .50 cents on the dollar . The report paints, however, a rosy picture of the real returns from the system by using assumptions which artificially inflate the ROC. The report assumes that all workers given a choice would invest the money as poorly as the Trust Fund does. Social Security for younger workers isn’t terribly different than spending quarters to buy dimes.

Washington’s solution to this problem is to get younger workers to spend quarters to buy nickels.

The Crisis Is Social Security Is Bigger And Closer Than You Think

2011-06-06T14:46:00.000-07:00

The Social Security Administration shortened its timeline for the depletion of the Social Security Trust Fund. Now the Social Security Administration projects that the Trust Fund will be exhausted in 2036. This change in timeline means that if you are 43, you are scheduled to retire the year that the Trust Fund hits zero.

This story shouldn’t be ignored by anyone of any age because Washington’s record in financial forecasting is astoundingly bad. The government was wrong about Freddie and Fannie. The government was wrong about the housing bubble. The government was wrong about derivative exposure of the banks. The government wasn’t just wrong it was wrong on scales never seen in human history. Can you afford for them to be wrong again?

There are two huge differences between failing to see the dangers of the banking crisis and failing to foresee the collapse of Social Security. First, the government served as a backstop in the banking crisis. There isn’t anything to backstop a crisis in Social Security. Second, if the government had allowed banks to fail during the banking crisis, the bankers would have adapted, and become something new. Social Security primarily serves the elderly and disabled. This audience consists of people who are not equally suited to adapt to change. If a crisis erupts in Social Security, the consequences will be severe, and will have human consequences not seen in this country since the 1930s.

The problem is much bigger and closer than Washington understands. The projections of how long the Trust Fund will last are based on a number of economic assumptions. If one assumption is wrong, then the projection will be wrong. For example, if real interest rates are 2.9%, the Trustees project that the fund will last until 2036. If real interest rates fall to 2.1%, the Trustees project that the fund will last until 2034. The fact is that the real interest rate is closer 1.5%, and will be for some time as the Trust Fund replaces maturing high-yield debt with debt based on today’s interest rate structure. So prepare for next year’s exhaustion point to be less than 2036.

The problem is much bigger as well. Washington is looking at the wrong metric as usual. Washington and the talking heads in the mainstream media believe that the key figure is the support ratio, the number of workers to retirees. It is dangerous to think of this relationship as a useful number because workers do more than support retirees. Workers also support the interest cost of the government. A better picture of the problem is looking at debt burden + retiree cost / worker. The situation is much worse in that light.

People have talked about the crisis in Social Security for so long that most people are immune to the idea that there will be a crisis. I want to change the discussion from whether a crisis will occur to how it will take shape when it occurs. The crisis will form out of the deficit, and the interest burden to support it. Interest cost currently consumes 30% of our tax base, and that percentage is growing. Interest is not negotiable, and it will over time set-off a national debate about how taxes are raised and how money is spent. The Teaparty is just the beginning of that discussion.

Many people look at Social Security as independent of the deficit because it is funded by payroll taxes not income taxes. The problem is that both taxes draw on the same tax base, so they are somewhat mutually exclusive. They are like two straws drinking from the same soda. Any dollar raised in payroll taxes is a dollar that cannot be raised in the form of income taxes. In this sense, Social Security will become a major target when interest cost force a discussion about how the taxes will be spent. To pay down the deficit, the working generation need only vote to increase income taxes and decrease payroll taxes. When that happens, Social Security will simply be re-written on very different terms.

It will have to be re-written because Social Security will have to depend upon the Trust Fund once the payroll taxes are cut. While 2.5 trillion may sound like a lot of money, it is basically economic parsley when compared to outgo of the system. Without payroll taxes, the Trust Fund would last less than 4 years. When the crisis forms, the economic support for the retired really will come down to how much payroll taxes the working generation is willing to pay.

The support for Social Security within the working generation may be very modest. It is virtually impossible to believe that the working generation will not resent the obligation to take care of both the deficit and the retirees who largely created it as younger voters. For years, baby boomers have talked about the burden that they are putting on their children. The fact is that it is a burden that their children can largely shake-off simply by diverting payroll taxes to pay down the deficit. It is naive to believe that politicians will not serve that audience.

You will start seeing this politician much sooner than you think. According to the US Census bureau, 2010 was the first year that a majority of voting aged Americans can expect to less than what was promised. 2012 will be the first year where a majority of registered voters can expect to get less than what was promised. That trend continues until a majority of registered and active voters can expect to get less than what was promised. To believe that Social Security will survive in its current state, one has to believe in a majority of people will vote against their own self interest.

Politicians will emerge to play on this block. They will say: Interest is the cost of government that the retired generation wanted but was unwilling to pay for. They will say: the retirees padded their retirement accounts (ie Social Security) while putting the rest of the government on your credit card. They will say those retirees had pensions that you don’t. They had healthcare costs that weren’t burdensome. They had 4 years of college for what you pay per class. And they will get elected on that message.

Of course, I could be wrong, and Washington might be right. Maybe deficits don’t matter. Maybe foreigners will continue to lend us dollars knowing that they will be repaid in pennies. It all comes back to the real question : can you afford for Washington to be wrong again?

Social Security Number Watch

2011-06-04T14:53:00.000-07:00

Be very careful when you are looking at numbers about Social Security.

Numbers about Social Security do not lie, but they can mislead not only the public but policy makers as well. The numbers watched by the experts in Washington suggest that Social Security is slowly moving to crisis. The numbers have lulled even the harshest critics of the system into believing that the system is many years from crisis. The problem is in the numbers : we are looking at the wrong numbers.

This article isn’t for policy wonks. It is intended for average Americans who get pounded with useless statistics about the system. This is a typical quote that a reader will see when researching Social Security : “When Social Security started, there were 16 or 17 workers for every retiree. When the baby boom finally finishes retiring, there will be 2 workers for every retiree.”

It sounds scary, but it is completely uninformative. The statistic in this case is the Support Ratio[1]. It doesn’t accurately track what it is suppose to track, and authors subsequently quote bad data out of context. In the process, the statistic goes from simply bad economic theory to dangerous public policy.

First, the number of workers includes government workers who have been purchased with debt, or future tax revenues. This debt inflates the number of workers today by pulling future jobs into the today's numbers. If as CBO has warned, the government is unable to place debt at reasonable prices, these jobs will disappear. Worse, if the productivity of the public-sector jobs doesn't create sufficient wealth to pay off this debt, the debt becomes a drag on future jobs.

Second, the number does not factor in the impact of the Trust Fund[2]. The Trust was designed to hold excess cash in the system, so that the Trust Fund could serve as an addition worker as the Baby Boomers started to retire. Hence some of the workers from the 1990s were really working to support 2010 beneficiaries – the first year that outgo of the system exceeded payroll tax contributions. In 2009, the Trust Fund generated about 110 billion dollars of interest income. That is about 16% of the total income of the system. So the workers per retiree should have been roughly .5 workers higher.

Even if one had an accurate Support Ratio, the number isn't very informative because it does not factor in productivity. As productivity increases, it takes fewer workers to support a retiree. When Social Security started, we had something like 25% of our workforce in argricultural production. Today it is something like 3%. Telling someone that there are too few workers without knowing what their productivity is, is just like telling someone that they are over-eating without considering their exercise regime. That is where the data goes from wrong to pointless.

Experts use this statistic far out of context, as you can see in the example above. In the context above, the author assumes that workers are the same today as in 1955. The assumption is horribly wrong. Today’s worker contributes at a higher rate and against a larger cap. In 1955, the maximum contribution was an inflation adjusted $168. Today it is more than $13,000. In other words there are workers in 2011 who effectively are the same as 77 workers from 1955.

Like the workers who are counted like beans, the beneficiaries are not the same today as they were in 1955. According to JustFacts.Com, “Benefits have not remained constant. If they had, SS would now be collecting roughly three times more in taxes than it is paying in benefits.” I haven’t seen their data, but it is not unreasonable. Beneficiaries are living longer and may well be retiring earlier. Comparing the number of beneficiaries over time when pay-outs are changing is simply pointless.

A reader might arrive at this point in the article feeling relieved that the Support Ratio suggests that the problem is smaller than the raw data suggests. And that belief would be correct if workers did nothing but support retirees. The fact is that they do substantially more than support retirees. Workers through wage taxes also support the budget deficit. The budget deficit is growing and so is the interest cost to support it. Today’s worker carries about $75,000 in look through debt from the government. Assuming that workers today are in the same position to provide financial support for retirees as they were 40 years ago, or even 5 years ago, is where authors cross the line from bad economics into dangerous public policy.

In summary, there very well may be a shortage of workers to provide benefits for all of the Baby Boomers. My guess is that there is a dramatic shortage but I don't have any data to support that belief. The actual data that you need to see is compensation slack - which would measure the ability of workers to support a retiree. If you had that data, I suspect that the slack has dropped radically and you would see that the crisis is now, not some stardate in the distant future.

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[1] The SUPPORT RATIO, which measures the number of beneficiaries to number of retirees. Data Source Social Security Administration

http://www.ssa.gov/OACT/TR/2010/lr4b2.html

[2] There are some who question the existence of the Trust Fund. Here is why I discount their view. The government holds a number of hard assets such as oil, land, and gold. Beyond that, the government has future revenue streams based on 16.6 trillion dollars in retirement assets which are tax deferred. Beyond that, the government has the ultimate power of taxation, printing money. As long as the citizens grant the power to print money to the government, US Treasury debt will represent the safest investment in the country.

How Corporate Darwinism Caused The Credit Crisis

2010-02-15T14:35:00.002-08:00

There are numerous forces to blame for the financial crisis. Some blame the government. Others blame greed. Still others blame slumbering regulators. While everyone has a point, the real cause of the financial crisis is corporate Darwinism. Over 20 years of boom times, natural selection picked bankers, and bureaucrats, and elected officials who were great for the boom, but completely ill-suited to respond or even understand a credit crisis, particularly one of the magnitude which our country experienced in 2008.

The principle of Darwinism is pretty simple. Organisms adapt to changes in their surroundings by nature selecting traits that are suitable to survival. Whether it is a finch in the Galápagos Islands or a moth in London, spices that cannot adapt to change will die off. This process is normally associated with animals, but it affects all organisms including abstract ones like corporations.

The process works within a corporation surprisingly similar to that which operates in nature. The only difference between evolution in nature and evolution in a corporation is the speed of the transformations. Corporate Darwinism moves much faster because humans can learn traits where as a bird in the Galapagos requires generations to grow a longer beak.

Corporate Darwinism selects traits by promotion. Once a trait is promoted, the corporation seeks to replicate that trait across the organization. The best example of this is when a manager is hired from the outside, and the first thing he or she does is hire people from his old organization. When someone is promoted internally, everyone around that person tries to emulate the traits which resulted in promotion. Promoted traits literally breed into a corporate culture.

To understand how the process works in corporations you need only study the reward system. If the system rewards long hours, you will find people at the company who are willing to sacrifice personal lifestyle for the good of the company. It isn’t that they are more selfless, but anyone unwilling to work within the system of rewards normally leaves or is pushed out.

I worked in and around banking for 20 years. During that time, I saw only one recurring system of reward, the willingness to take risk. I saw bright people promoted. I saw charming people promoted. I saw tall and short people promoted. The common thread in all promotions was the willingness to push buttons without regard to possible consequences. This selection process started at a very low level, and persisted through-out the organization. It isn’t that they were not bright or talented, but all of them had one thing in common, risk tolerance.

During my time in banking, I also knew very talented people who weighted the cost and benefit of their decisions. These people were systemically removed from the pool because the trait wasn’t valued. In the absence of a reward, people leave. Probably the best manager of people with which I worked was at Citibank. Eric Snead was a very talented manager who brought all of the skills needed for management. He recognized talent. He was very good at scoping work, measuring ability of people on his team, and motivating them to get the task done. He unfortunately had sensible view of risk, and his management did everything that they could to get him to leave, which he eventually did.

Over time, Corporate Darwinism selected risk tolerance as a survival trait in banking. That trait became more significant to survival during the economic boom because people at some level are promoted because they produced earnings streams, or sales, or some measure of profitability. The boom made stupid transactions seem wise, and foolish risks were rewarded. In boom times, the more risk tolerant the person the better his level of success. This is what Chuck Prince meant, when he said that you have to dance as long as they play the music. The most important thing to understand about booms and Darwinism is the statistically likelihood of the system promoting someone with a sensible risk perspective becomes lower and lower.

So the boom introduced a bias to people who discounted risk. At the same time, one of the causes of the boom was changing the selection process, cheap money. Over the past 20 years, the response of the Federal Reserve to every economic crisis was increased liquidity. That is a fancy way to say give bankers very cheap borrowing costs. Over time, Darwinism selected the managers who treated capital as though it were free and endless.

So by 2007, it should surprise no one that Darwinism had selected companies like Bears Sterns for survival. It was levered 30 to 1. The economy had made its corporate culture wildly successful. It made billions packaging and selling loans. When one bet was rewarded, they took on more risk in the next one. This is how you expand from prime loans to alt-A to sub-prime. Bankers call this universe expansion. The bankers didn't make the era. The era made the bankers.

Unfortunately, the traits which led to success in the boom era were exactly what made them unable to survive in 2008. Darwinism had selected decision makers who had virtually no sensitivity to risk and people who were oblivious to the cost of capital. The survivors of 20 years of success were simply unable to grasp bets losing. The head of Bear Sterns appeared on CNBC to assure the investors days before it was to be forced into bankruptcy. Many of the companies who caused the credit crisis could have tapped the capital markets for equity within months of complete failure. Those who did pursue additional equity only took very little. Darwinism had selected bankers and regulators who never considered that a credit crunch was even possible. When it happened, they were just deer staring at headlights of the oncoming traffic.

There is one other factor to consider. In 1998, the United States government repealed Glass-Stegal which had placed strict limits on how much risk a bank could assume. Much more than the legal aspect, the repeal of this regulation altered the pool of applicants on which the bank could draw. The change introduced a pool of candidates that were much more willing to take risks, ones that were backed by the taxpayer.

My guess is that many corporate cultures outside of banking encourage risk. They do so however with their own capital. So the market place manages these entities. If the maker of widgets takes on poorly placed risk, the market punishes the widget maker. The problem with banks is that if the banker takes on poorly placed risk, the market punishes the taxpayer.

The short version here is that animals called bankers grew in size and proportion in a boom environment. Nature selected those who were the fittest for that environment. In 2008, the environment changed and the animals were like dinosaurs looking at the glaciers.

How Lower Interest Rates Are Stalling The Recovery

2010-01-16T14:19:00.001-08:00

If Neville Chamberlain were alive today, he would be an economist instead of a diplomat. He would be creating jobs instead of peace. He would champion the Federal Reserve line that we need low interest rates to stimulate the economy. He would get off the plane with the Beige Book to proclaim: “We have jobs in our time”.

The common economic analysis says that low interest rates spur investment which creates the jobs that are needed to drive the economy. Unfortunately, this economic myopia works only in the world of academia where it is possible to hold the world ceteris paribus and keep the forces of unintended consequences in the footnotes.

The basic flaw in this economic model is that it assumes that all investment is good and that resources put to work were idle. The model works well when an unemployed person borrows to open a business which is profitable enough to repay the loan. The model works less well as the quality of the investment erodes, or the resources employed were drawn away from productive uses. For example, it is possible that lower interest rates will encourage a good baker to become a bad house flipper. Does that help the economy?

What economists need to explain is how the economic transfers actually make the economy better. Lower interest rates transfer economic activity from the future to the present. It transfers wealth from lenders to borrowers. It transfers demand from unleveraged purchases to leveraged purchases. But how does all of this economic activity help the economy?

Interest is the cost of money over time and risk. Lowering the cost of money today means that you will push demand forward, getting people to buy things today that they would have bought in the future. This demand comes from somewhere. It is shifted from other current demand, or it is brought forward from the future to the present. When I buy a $30,000 car today on leverage, it is $30,000 of purchases of other things that I am not making in the future. Debt is not spurring the economy. It is borrowing prosperity from the future.

It is the purchases ‘not made’ that economists never factor into a ceteris paribus model. Economists focus solely on the borrower who invests the money, but they forget that for every dollar of interest saved someone has lost a dollar of payment. The bank is not a lender, but rather a conduit to the lender which may be an 85 year-old retiree. When the Federal Reserve lowers interest rates by 90%, it is effectively cutting the pay of the 85 year-old retiree. It is cutting the pay of businesses which no longer enjoy the patronage of the 85 year-old retiree.

This activity will help the economy only to the extent that the borrower spends the money more wisely than the 85 year-old retiree would. This is a pretty dubious assumption given that the interest rates are a function of risk. So lowering interest rates encourages marginal borrowers to open businesses which would not exist under a normal interest rate structure. In the case where lower interest rates encourage a good baker to become a bad house flipper, the economy is going to be hurt.

One should ask what will happen to these businesses once the interest rate structure normalizes. As the cost of funds rises, will these new businesses survive? Some will not, and you have to ask how does it help the economy to have someone leave a productive job to start an unproductive business that ends in bankruptcy?

It is economically unreasonable, if not counter-intuitive, to suggest that desensitizing the users of capital from the cost will lead to a better economy. To suggest that the lowering the cost of money is good for the economy is no more reasonable than saying that lowering the cost of bread will help the economy. In this case, the buyers of bread win and the bakers of bread lose as people buy more bread. The bakers of muffins lose as more people eat bread than muffins. There are winners and losers, but the problem with the logic isn’t in the winners and losers – it is in the bread crumbs. If you lower the cost of bread people, both consumers and producers, will leave more crumbs.

To illustrate the ‘bread crumbs’ of capital that are lost to lower interest rates, drive to any new housing development. There are 5 or 6 where I live. While these developments serve different markets and different pricing points, they all have one thing in common – no workers and no occupants. If you call the realtors you get the same story – we are waiting for the market to turn. It is only possible to hold these economic assets inactive because of the internal cost of funds at the bank.

The owners of capital have no reason to pick-up the ‘bread-crumbs’ when interest rates are .25%. People will let the penny jar grow. What is the point of putting them in a bank when the rate is .07%?

One of the inescapable ends of lowering interest rates the way is a rising foreclosure rate. Levered assets will flow over time the lowest cost of funds just as water runs down hill. If the marginal homeowner pays 6% and the bank pays .25%, the cost of owning the home by the bank is fractional compared to that of the homeowner. The bank will hold real estate longer, and be less willing to renegotiate existing loans. There is nothing in that outcome that helps the economy.

The whole point of lowering interest rates isn’t to improve the economy. It is to give the voting public a nearterm feel-good number that makes them think that the economy is turning around. The fact is that all of what we are doing is making the crisis worse and last longer than it should.

Why Should The Elderly Bear The Burden For The Financial Crisis

2010-01-16T14:15:00.000-08:00

This is an open letter to the AARP.

AARP
601 E Street N.W.
Washington, DC 20049

Dear AARP,

I would like to know more about your organization, and give you a chance to reply to what in my mind seems like an irreconcilable contradiction between the stated goals of your organization and what appears to be a complete indifference to the welfare of your members.

Your members are largely retired, and in some part dependent upon generating a fixed return from their life’s savings. This income is their paycheck, and provides in many cases necessities of life. That paycheck has been cut by more than 90% by the Federal Reserve which has forced interest rates down to help stabilize the global financial system.

In the last two years your members have watched their money market rates drop from over 5% to .07%. The percentages don’t tell the story of your members, though. The 85 year-old retiree who saved $30,000 through hard work has watched his paycheck drop from $1,500 to $21 by government fiat. Every year this person gets to loses $1,479 of things that they don't eat, children they don't see, and basics that they don't have. And for what: so that bankers can take millions in bonuses to their homes in the Hamptons.

Your organization seems OK with this pay cut to help the country. So I have to ask whether you took a 90% pay cut to help the country? Ben Bernanke didn’t take a pay cut, and neither did Geithner. But you are letting the government force a 90% pay cut on your members, who are now forced to rethink the basic needs of life. Frankly I have a difficult time reconciling the amount you are paid with the nothing that you are doing.

While every American is ready to do his part to fix our country, I am pretty sure that asking $1,479 per year from someone bordering on the poverty level is more than his fair share. Fairness is of course always debatable. Maybe you think that is fair. Is it fair to ask the elderly to bear the brunt of the burden for solving this crisis? Is it fair to ask why AARP hasn’t asked this question? I will tell you that it is fair to ask why AARP has been completely silent on the issue.

What isn’t debatable is the fact that the members of AARP had statistically the least to do with the causes of the crisis. Statistically, AARP members own their homes with no ARM leverage. They don’t flip homes. They didn’t originate, package, rate, or sell toxic assets to institutional investors. Punishing the elderly for the casino lifestyle led by others is no more sensible than kicking the dog when your kid brings home bad grades.

Your silence on the Bernanke policies is shameful and reprehensible. What should bother you most is that he is not even an elected official. He is a bureaucrat who has decided one group of people should benefit at the expense of the dues paying members of the AARP. And your organization does nothing to protect those who pay dues to you.

I am writing you so that I can be wrong. I would welcome hearing that you have engaged your lobbying team to protect your members. I would welcome hearing that you took a pay cut so that you could share in the pain of your community. I want to be wrong, and look forward to getting a letter from you explaining how I am wrong. Here is where I am not wrong - what our country is doing to people living on a fixed income is wrong, and no one seems to be doing anything about it.

The Stock Market Faces Headwinds From Falling 401K Contributions

2009-10-31T07:19:00.000-07:00

There a relatively new correlation between the stock market and employment, 401K contributions, that isn't receiving the attention that it deserves. Over the last 20 years, the stock market has enjoyed the benefit of a positive inflow of cash from 401Ks and retirement plans. It is likely that you will see this tailwind become as headwind for the market as more people draw on 401Ks and fewer people contribute. While there may be a net positive inflow in different sectors, inflows will be significantly lower than in the past.

There are three factors driving increased use of retirement savings. First, people are getting older and need income to live. Second, the unemployed will need a way to live and retirement savings is much cheaper than consumer debt. Third, even those that keep their job will need to need to paydown debt. Borrowing against a retirement plan will be attractive to many. In short, people are going to start using retirement accounts more and more.

This capital drain will cause some headwind for the market. This drain is going to occur at the exact same time as people reduce their commitment to retirement savings. There are three factors which will make people realize that saving for retirement makes no sense when they face insolvency in the present.

First, many of the unemployed have lost access to 401K plans which will constrain the inflow of capital into the market. They can't contribute a portion of a salary even if they have found a parttime job. Beyond the loss of employee contributions, the market is going to lose capital committed by employers as a match. In the net, the capital inflows from retirement plans will be growing more slowly over the next few years.

Second, companies are looking for ways to cut costs. As part of this initiative, employee benefits are under constant scrutiny. This scrutiny may play out in 1 of 3 ways. Companies may eliminate the benefit outright. Even if they keep the benefit, they may reduce or alter the matching payments. Even if the companies keep the benefit with the same matching terms, the market will still feel the loss of inflows if the company changes the match from cash to restricted stock. Given the labor market, it is difficult to image many companies increasing the capital allocated to matching retirement savings for employees.

Third, the most likely factor in reducing retirement savings will be the deleveraging of America. It is very difficult to justify saving for the future when the present is insolvent. Americans will shift resources currently set-aside for retirement to paydown debt. This process will be exacerbated by banks which are increasing interest rates and fees on access to credit. The basic problem is that consumer debt isn't tax deductible where retirement income is.

To give you some idea of how unfavorable retirement saving is vs consumer debt. If an employee puts away $1,000 with a $1,000 employer match, it will be worth almost $300,000 when the employee retires after 30 years (assuming an 8% return). After taxes, it will be worth something less. $1,000 of consumer debt at 14% will be almost 5 million dollars after 30 years. It isn't going to take a CFA for people to figure out that retirement savings simply makes no sense when they owe any consumer debt much less 2 trillion dollars of it.

The New Normal

2009-10-14T08:19:00.000-07:00

The government’s efforts to save the economy have met to date with mixed results. On the positive side, the larger banks have shown profits, where even Citigroup has shown a profit of sorts. On the negative side, unemployment is increasing and underemployment is skyrocketing. The media has termed this the new normal. I would prefer the term what-the-hell-did-you-expect to describe the near-term prospects for the economy.

Here is the problem. The economic equivalent of Boyle’s Law is that you cannot create or destroy economic demand without creating wealth. The government cannot create wealth. The government can shift demand from one business to another by changing the relative cost of goods. It can shift demand from the future to the present by lowering the cost of consumption, ie interest. The government cannot create demand by itself, nor can induce economic prosperity with fiscal stimulus.

Stimulus without innovation is nothing more than borrowing prosperity from the future. It is unavoidable truth that when you create demand in one industry, say in autos with a cash-for-clunkers program, you are reducing demand somewhere else. When I spend $20,000 on a car, it is $20,000 that I am not spending elsewhere. In the case where I borrow the $20,000, it is $20,000 that I am not spending sometime else. The sum of the government’s effort is zero, where we are pushing demand from one business to another or from the future to the present.

I serve as an illustration of the problem. I am replacing perfectly workable air conditioners and heaters because the government is taking money from someone else to help me pay for it. The money that I am spending replacing the perfectly good air conditioners and heaters means that I am not doing the painting which actually needs to be done until next year. This is a zero sum game at best – and a negative sum-game should we find that good painters become bad air conditioner installers.

The government’s current approach to stimulus is far from a best case situation. We are heavily subsidizing the auto and lending industries. Both of these industries suffer from massive excess capacity. In the best case of the example above, a good painter becomes a good air conditioner installer because the increase in demand will lead to hiring. In the America in 2009, however, businesses aren’t hiring because the increase in demand serves only to soak-up excess inventory. So, the painters just become unemployed. This is why you see the GNP bottoming but unemployment increasing.

Price is the market mechanism for clearing inventory. Instead of allowing the price to clear excess inventory, the government is stealing demand from elsewhere to justify the existing price. The market works best when it is allowed to punish these people who cannot price products well. In this case, the market is punishing random people who had nothing to do with the poor decisions in the first place. The consequence is socialization of stupidity, in which the foolish benefit at the expense of everyone else.

This consequence is most clear in banking, where the government has decided to subsidize risk. We have lowered the cost of capital well below it true value. These subsidies have led many businesses to form a bank holding company. Subsidies in the case of health care and agriculture are of debatable merit, but they at least subsidize a public good. Comically enough, we are encouraging people to take risk during a credit crunch when capital should be treated with a premium. This is a level of stupidity that should be beyond even government bureaucrats.

The earnings report from Goldman Sachs is an unavoidable outcome of our folly. 80% of Goldman’s earnings came from proprietary trading. The report doesn’t indicate the amount of public assistance that Goldman received. But, as a bank holding company, it is entitled to borrow at the discount window. It can access the Treasury Auction Facility. It can issue debt backed by the FDIC. So while it may have paid back the TARP funds, Goldman Sachs has many lines of public assistance to subsidize its proprietary trading group. Is proprietary trading a public good?

Folks if you are wondering why we are seeing mixed messages in the economic results. It is because the government has one of the worst economic agendas since the Great Depression.
Even by government standards, this is simply stupid.

"What Conservatives Don’t Get"

2009-10-13T22:54:00.000-07:00

The Conservative mantra of the day blames the current financial crisis on the government’s over-regulation of an otherwise sound banking system. They want you to believe that the crisis stems from an intrusive government forcing lending standards lower by government fiat, namely the CRA. While the government is at fault here, the government's intervention in the banking system is only a component of a much larger problem.

People think for a second. The entire sub-prime market is only 500 billion dollars. Every mortgage could go bad, and you are looking at a something less than a 250 billion dollar loss. The real estate market has lost over 3 trillion in value or more than 10 times as much – and we have yet to see even 50% of the sub-prime mortgages default. If the Community Reinvestment Act was a fault, why is the housing crisis centered in the condo markets of Vegas, Phoenix, and Miami.

The housing crisis is a serious problem, but it is only a part of the larger problem which is debt, specifically consumer debt. In economic terms, investment debt is unpredictable, where the economic impact of the debt depends on the success of the investment. Consumer debt on the other hand is very predictable. It pushes demand forward getting consumers to buy today what they would normally wait to buy. When we express future demand today, we pull revenue streams forward, thereby overstating present revenue.

The builder, unfortunately, doesn’t think that his revenue is overstated, and neither does the banker who starts lending on looser and looser terms. To them, the boom will never end. So the builder, in turn leverages his wealth, buying things from people who find themselves suddenly richer. Those people in turn leverage their wealth, and so on and so forth, until the economy is brimming with imaginary wealth entirely built upon imaginary revenue.

The problem is that at some point there isn’t enough future demand to pull forward. We hit that point in 2007. Housing demand for 2007, 2008, and 2009 had been depleted, having largely been filled in 2004, 2005, and 2006. There was no cheaper capital to pull into the game of low interest rates. In fact, we were experience the opposite as interest rates on variable notes reset higher, forcing the housing crisis. Higher rates forced people to sell at the exact same time that demand was falling. This was the housing crisis.

In the net, the problem wasn’t the marginal poor person buying a house that he couldn’t afford. The problem was the near-rich person who bought the swimming pool for the house that he couldn’t afford. It was people spending imaginary wealth, borrowed from bankers who imagined growing revenue streams. Having worked in banking for 20 years, I can assure you that the government didn’t force bankers to make bad loans any more than the zoo keepers force lions to eat red meat. The government simply lowered interest rates below the rate of inflation and stood back to watch economic gravity take hold.

The government is almost entirely responsible for this mess, but as conservatives lets at least blame the right people, and learn the right lesson. Failing to assign the blame for economic bubbles is the reason that so many politicians try to create them.

A Market Solution For Solving The Housing Crisis

2009-09-28T07:00:00.001-07:00

While there is a lot commentary on the failures of the government’s plan to address the housing crisis, few offer alternative solutions. This article outlines a better way to deal with this problem, and not surprisingly, it is by letting the market work.

The government has thus far employed the Neville Chamberlain approach to economics: “we have jobs in our time”. An $8,000 tax credit will stimulate demand this year, but mostly by pulling demand forward from 2010 and 2011. Low interest rates do not help housing unless you lower the risk inherent in the loan. Lowering the cost of risk or giving people $8,000 tax credits is welfare. It simply shifts demand from the future to the present, and from non-housing goods to housing.

The downside to the government's effort is, of course, that we will get to the future at which point slack demand will prolong the recession. We have not only pulled demand from the future into housing, but we have pushed it away from productive sectors. So government’s solution is in short: fix housing by breaking everything else. The net effect is to encourage people to build houses that no one wants, nor can afford.

Unlike the government’s approach, this solution actually changes the dynamics of housing. It lowers the likelihood of future foreclosures even if asset values continue to fall. It is a series of incentives which get people to refinance their loans with additional capital. This is materially different than what the government is doing because the refi’s under the current program require neither additional financial or human capital. (Human capital is the upkeep you do on your house).

Here is the consequence. There is a home in Michigan the mortgage on which is about 25% underwater. The owner likes the place enough to keep the mortgage current. But in the back of his mind, he knows that it is likely that this house is going into foreclosure, so he invests zero into the house beyond the monthly mortgage. In his mind, he no longer owns the home, but is simply renting it from the bank. He treats the house like rental property.

Incentives can take many forms, but I will illustrate one as an example. Currently people are not allowed to take a tax loss on a primary residence. The government could enable people who refinance an upside-down mortgage with additional capital to take a tax loss based on the amount of the capital that they add to the loan. No one would dispute that paying say $10,000 into a loan that is $25,000 underwater is a tax loss. No sensible lender on a non-recourse loan would refuse to accept said money to refinance the loan.

Here is why this approach is better than what the government is doing. The market knows more about loan quality than the government does. The government’s approach is unfocused, wasting billions of dollars on loans that no one intends to repay as demonstrated by the default rate on loan modifications (more than 50%). People will only put more money into a loan that they plan to pay-off. So the market will direct the incentives to loans which the borrower at least thinks are good.

This transaction isn’t for everyone, and really is meant to show the consequences of the incentive. The guy in MI would take this deal because he doesn’t want to be a renter. More important than increasing the loan quality, this approach gives him an incentive to invest human capital in the house, if nothing more than raking up leaves. He happens to be rather handy with tools, and is more than willing to work on the house provided that the he shares in the benefit of the work. At this point, however, all of his work goes to the bank because that house is heading for foreclosure when he gets tired of paying so much in rent.

Again, this is just an example, here are the factors that you want to see in any incentive :

1) Verifiable : In the case above, the mortgage lender will get a check for additional principal.
2) Tied To Existing Housing : We do not want to encourage people to build more houses
3) Focused: The government may create the incentive, but the market must allocate it for it to work.

2009-09-14T19:15:00.001-07:00

The current discussion of inflation and deflation is focused narrowly on money supply, which is important but only a small part of the equation. Gold bugs worry that printing money will lead to massive inflation. Deflation proponents argue that the government is not adding to the money supply because the new money simply replacing demand that has been lost to the deleveraging process. These oversimplied views of inflation miss the point: inflation is as much a function of the supply of goods and services as it is a function of money supply.

Once you factor in the supply of goods, and services you will see a struggle between inflationary and deflationary forces that will play out in this country on an uneven basis across the economy. Inflation will affect industries differently based on capacity, profit margins, productivity and exposure to a falling dollar. Secondly, you have to consider on what the government spends money rather than how much money is printed. Some industries will experience inflationary pressures sooner than others, while some industries are going to be stuck in a deflationary cycle for a long time.

For the near term, inflation in aggregate is unlikely. Today, the economy has massive over capacity, resulting from a decade long build-out to support consumer demand that was fueled by debt. That debt pulled consumption forward from the current recession into the boom years. So our industrial capacity exceeds consumption demand, and will for a long time. That demand is gone, but the capacity is here, and it will be here fighting inflation until it is worked off over a longer period of time. Basically it is very difficult to pass along higher prices when you have 10 competitors who are willing to hold the line on prices.

The discussion also misses the question: how is the money going to be spent? Not all government spending is equal. It is possible that, and has on rare occasions, government deficit spending leads to disinflation. For example, the money that the government spent on building out the Internet, has had significant deflationary affects by promoting productivity and competition. The inflationary impact of government spending is really a question of ROI. Wisely spent money isn’t inflationary, where as poorly spent money is.

As you consider what the government is spending the money on, you should worry more about inflation. The bulk of the money has gone into the financial system where it creates no supply of goods or services. The vast majority of the new money enables the Fed to hold troubled assets. This new money serves only to protect the foolish from the consequences of their action. Only the silliest of bureaucrats talk about making money on these investments. We are making pennies on the Goldman Sachs and State Streets while losing dollars in AIG, Citibank, and the rest of the portfolio.

Worse, the government is altering consumer demand in order to fight deflation where it is needed, at the expense of creating it where it is not needed. Housing in this country is overpriced. Cars in this country are overpriced. Yet, the government encourages us to buy houses, cars, and energy efficient products. When a buyer takes these incentives, it is at the expense of other parts of the economy. In my specific case, I am replacing a perfectly good air conditioner which is an energy efficient one solely because the government will pay me to do something stupid. Given the size of that expense, I am not painting my house which actually needs to be done. While this is my individual decision, it is clear from the statistics on car sales and retail sales that there is a transfer of consumption from retail to autos that is in part caused by cash for clunkers program.

The net effect of this is going to be terrible for the long-term economy, which leads me to believe that inflation wins out in this struggle over time. The government thinks that it is smarter than the market. In my case, the air conditioner company wins, while the painters and my neighbors lose. Whatever economic activity that is created by the winners will be more than offset by the economic loss created by the losers. People who need to be farmers, or painters, or waiters will continue to live on the government’s dime working in banking, and auto production, and whatever other business the government decides is good for the economy. At which point, money supply is somewhat beside the point.

Why The TARP Has Made Things Worse

2009-03-09T08:58:00.000-07:00

Ronald Reagan once observed that the most terrifying words in the English language are: I’m from the government and I’m here to help. In the past year, the government has proved that he was a master of understatement.

In March of 2008, Congress spent billions of dollars to stave off financial calamity when Bear Sterns closed in on failure. Six months later Congress spent hundreds of billions to stave off financial calamity when Lehman did fail. Now six months later we are being told that we need to spend over a trillion dollars to stave off financial calamity. As the economic outlook continues to worsen, why isn’t someone asking whether the government‘s actions are helping or hurting the economy.Why are things are getting worse each time the government tries to help?

The answer is in a house in Michigan, another in Kansas, and a mostly vacant lot near my home in Marietta. It is in the 401K statement of virtually all Americans. The answer is evident to very person who runs a yard service. The answer is all around us. The real question is why is no one in Congress listening.

The answer is in a Michigan home which has lost approximately 35% of its value. The owner started with 20% equity, but his mortgage is underwater and falling. He likes his home so he keeps the mortgage current, but is not investing in it beyond the mortgage payment. He isn’t painting the house, replacing the wiring, or many of the other things that he would be doing without government interference. He is letting the house devalue because in his mind he expects the government to renegotiate his mortgage based on the appraised value of the house. In his mind, any investment in the house actually has a negative return.

The answer is in a mostly vacant lot in Georgia. The bank has replaced the developer as a patient investor in a partially completed condo project. The bank has a generous uncle who provides the 5% capital that makes patience possible. If the bank had to pay market rates for capital, this property would have been sold to an entrepreneur willing to invest new capital and new ideas into the project. Instead of producing jobs and wealth in Georgia, the property sits idle, depreciating.

The answer is the 401K statement of virtually all Americans. The government borrowed the money which it gave to the banks allowing them to comfortably hold depreciating real estate projects. That capital came from somewhere. In all likelihood, that capital came from the stock market, which is down 40% since the government started helping. It also came from real estate projects that were never started. It came from Christmas presents that were never bought. Basically we fixed the banking industry by breaking everything else.

Whether it is the Treasury’s Asset Relief Program (more commonly known as “TARP”) or buying bad mortgages, the government’s efforts are creating enormous economic displacements some of which are counter-productive. The TARP, for example, traps capital in the hands of the people who didn’t see the crisis coming. If that isn‘t foolish enough, the government also limits what these companies can pay to attract better managers of capital. At the same time, this program penalizes better-run banks which have to raise capital in the open market where it is much more expensive. In short, we subsidize weak managers of capital at the expense of good managers, and we wonder why the economy is faltering.

Capitalism is simple. It requires two things: stability and confidence. Confidence drives investment because it stems from the belief that tomorrow will be better than today. Instability translates to risk, which is ultimately priced into every transaction. Risk is sand in the machine. Last summer, my yard service increased my prices by 22% because of rising energy cost. When I asked them about the impending price decreases to reflect falling energy prices, the owner shrugged and said he couldn’t lower prices because he had no idea when energy inflation would return. He smiled and offered me a variable rate indexed to oil. I declined because I have no idea what the price of oil will do.

We may have fixed the banking crisis, but we did so by breaking everything else. Now the government is going to help fix the housing crisis. Where is Ronald Reagan when you need him?