Wednesday, December 02, 2009

Signs of a Declining Empire

Sometimes it appears that the country is stuck in a quagmire from which it cannot remove itself. We are a divided country along partisan lines. The Republican Party is controlled by the right wing, moderates having almost completely disappeared. The Democratic Party is controlled by the coalition developed during the Clinton administration which is in bed with commercial and banking interests, not unlike the GOP of old. Neither party can muster a controlling majority and candidates who would bring about real change cannot get elected. Obama is the classic example of a candidate that can get elected. He is charismatic, a good orator, and continuously triangulates in an attempt to please everyone. Unfortunately, that means perpetuating the stasis with which we are confronted. This stasis has led to several disheartening consequences.

1) We have become a nation of consumers, not producers, dependent on foreign countries for most of our consumer goods. Trade decisions are heavily influenced by international corporations that profit from favorable trade agreements. The economy is heavily influenced by a Federal Reserve Bank that does the bidding of Wall Street at the expense of average people. Trickle down is the modus operandi, and promoting the general welfare is on the back burner. Laws to limit speculation and prevent excesses are undone. Speculative bubbles are left to burst with catastrophic consequences.

2) We no longer can pass any real reform legislation, due to our inability to overturn the filibuster rule in the Senate. With the country nearly equally divided, with few prospects of sixty percent majority, legislation is watered down to where it is just nibbling at the margins of real reform. Major decisions boil down to catering to a few Senators from small states who are riding the political fence.

3) There is no will in either party to confront the dangers of the military industrial complex. The Republican Party never met a war it didn’t like and the Democrats are scared to death of being labeled weak on defense. We have supported a client state, Israel, in the Middle East that has resulted in our not being able to be an unbiased arbiter of thorny issues there.

4) We have left the prosecuting of military adventures around the world to a small group of volunteer service people, largely from the poorer segment of society, while the children of the rich and powerful are safe at home to pursue their personal ambitions. This has led to a lack of appreciation of the horrors of war and the terrible after effects on the participants in combat.

5) Foreign policy, heavily affected by multiple foreign wars and threats of war, has been been delegated to the military command structure to a large extent. What the generals want they get, so as not to anger the Republican right wing and make the Democrats appear weak. The money for war and the number and length of wars is increasing dramatically. Congress seems incapable of limiting war spending of any kind, while scrutinizing every penny spent to promote the general welfare.

Unfortunately, there are few signs that anything will change for the better in the future. We seem resigned to letting the system drift downward, like lemmings going over a cliff. There is no great outrage toward the intractability of our problems. The old don’t seem to be concerned about the state of affairs they are leaving their children and grandchildren. And, the young seem content to wile away their time in the fantasy of video games and reality television, rather than in preparing themselves to tackle the problems ahead of them. It’s all very disheartening.

Sunday, June 21, 2009

Our UnRepresentive Democracy

Some aspects of our constitution have constricted us in adapting to changing circumstances over time. Other western countries with parliamentary systems have been able to adopt programs such as universal health care, while we have been unable to do so because our system allows a minority to block major legislation. This is primarily due to how our Senate operates.

Consider the chart below which shows how many people are represented by each senator from the several states. The average number of constituents represented by a senator, that is, the total population less Washington DC, divided by 100, is about 3 million people. In contrast, Wyoming senators each represent only 266,334 people while California senators represent 18,378,333 people each.

To compound the problem people in overrepresented states are more Republican. From the House representation which is nearly one person, one vote, there are 59.1% Democrats and 40.9% Republicans in the country. The overrepresented small states have 46% Republican senators vs. 54% Democrats, while the underrepresented large states have only 35.3% Republicans and 64.7% Democrats.

To compound the problem even further it only requires 40 senators to stop key legislation due to the filibuster rule. This enables lobbyists to concentrate their time and money on 40 people to block any legislation. And, if a Republican president is in office there is no hope of overriding a veto. This phenomena enabled Bush to get almost anything he wanted while the Republicans had a slim majority in congress, whereas the Democratic legislation can be easily blocked even with Democratic majorities in both houses. Since small conservative states are overrepresented in the Senate, it is nearly impossible to get a majority necessary to prevent legislation from being blocked.

A recent poll showed that the country supports the Obama health care program by a sizeable majority.

From Reuters:

“A Times/CBS poll found 85 percent of respondents wanted major healthcare reforms and most would be willing to pay higher taxes to ensure everyone had health insurance. An estimated 46 million Americans currently have no coverage. Seventy-two percent of those questioned said they backed a government-administered insurance plan similar to Medicare for those under 65 that would compete for customers with the private sector. Twenty percent said they were opposed.”

Yet the latter program has been taken off the table by a small state senator from Montana, Max Baucus because he said it’s a non-starter in the Senate.

A similar situation exists in the effort to reregulate banks. The powerful banking lobby can easily round up 40 senators to block the effort, in spite of the fact that the majority of Americans want it done.

Senate representation

Tuesday, March 10, 2009

A few words in support of our government

Our government has made the decision that there will be no more Lehman's. That's probably a decision forced upon them by the specter of a complete collapse of the financial system if a big bank like Citi were to go under. Furthermore, our government has concluded that it can't convince Congress to provide the funds to bail out the banks without some help from private sources. But, private funds sit on the sidelines, too afraid to invest in the toxic waste.

The government has given the banks bailouts at little or no interest to beef up their balance sheets. And, since the government has driven down interest rates to near zero, the banks are also getting deposits from private sources at near zero rates. The government has noticed noticed that the banks have developed a strong revenue stream from these sources of funds, due to the huge spreads between the cost of funds and the rates they can charge on new, healthy loans. Both Warren Buffet and John Hempton have provided evidence for this.

These revenue streams will enable the banks to write down their toxic loans against income, if they withhold dividends. The government can apply pressure to ensure this gets done. As the loans are written down they can be sold off to private buyers, who, in turn, can renegotiate the terms with the distressed borrowers and make a reasonable profit on the deal.

But private buyers are wary that the downside risk is too great to be buying up the toxic loans, even at a discount. To reduce the downside risk and bring buyers into the market, the government is willing put a floor under the losses on prospective buyers of problem loans and are willing to make low interest loans to the buyers to leverage the investment and increase their return. This all is part of the Geithner plan.

So the question arises, why should the government do this? The government is essentially using taxpayer resources to bail out the system? True, but if the system will collapse if it's not done, what is the alternative?

There are a couple remaining question to be answered. First, where is all this bailout money coming from. And, second, can the taxpayers be made whole, or at least partially compensated. To answer the first question, we must ask what private investors are doing with their money if they are not spending it to stimulate the economy or investing in, or lending to, businesses, including banks. Mostly, they are buying treasuries at little or no interest. So, if the investors won't spend or invest, and are giving the money to the government, all the government has to do is spend and invest it for them, which is what they are doing by bailing the banks and funding the stimulus. What better use could the government put this money toward than saving the country from the calamity that could arise if the system crashed?

Now, is there a way to make the taxpayers whole, or at least partially compensate them? If the government really wants to compensate the taxpayers who did not contribute to the problem they first have to identify who these taxpayers are, as opposed to the ones that contributed to the problem. This shouldn't be that hard. If we look at who profited from the bubbles, it was clearly the investor class, particularly high income investors and speculators, and the financial and insurance sectors that were so busy profiting that they overlooked the fact that what they were doing was putting the whole country in jeopardy. Some investors have already suffered from losses on their investments, but others have still prospered more than they suffered.

Obama has already taken steps to try to correct the problem. He has proposed raises taxes on the high income investor class, and taxing profits from investments at higher rates than currently are in effect. This is not soaking the rich. It's just taxing them to pay for the trouble they've caused with their hedge funds and derivative investments that have nearly driven the country into a second depression. This is one way of partially compensating low income people who have not profited from the bubbles over the last couple decades, who have seen their paychecks stagnate, and now are losing their jobs. They have suffered enough. And, their children and grandchildren don't need to be saddled with debt that more properly belongs to those who have profited from the growth in the financial sector over the last several decades.

Further measures may need to be taken. A financial transactions tax may need to be implemented after the crisis to make taxpayers whole. The whole financial and insurance industry may need to be restructured to prevent the development of businesses that are to big to fail. Laws to reign in greed and irrational exuberance seem not to have worked, so it may be time for the government to take a more active role in the financial and insurance industries which have caused this crisis. When finance grows from 19% of GDP to 30% in a couple decades it saps the talent from other industries that actually produce goods and services that are necessary to the economy. It's time to reign in these industries to a more reasonable size relative to the rest of the economy.

Thursday, February 26, 2009

How the government is bailing out banks at your expense

Banks have made bad loans and are leveraged to the hilt so investors will no longer lend them money or invest in them. The fair thing to do when banks are in this condition would be to take them over and reorganize them to put the losses they have accrued in the hands of the shareholders and creditors where they belong. But, the banks have tied themselves in a Gordian knot by insuring loans with phony insurance called credit default swaps. So the government is afraid that reoganizing them could result in a cascade of bank failures that could jeopardize the whole financial system. So, instead, it has chosen to flood the financial system with free money from taxpayers by lowering interest rates to near zero and lending money to every bank that has a problem.

With rates low, banks can get nearly free money from depositors and they can borrow from the government without limit, as long as the congress is willing to appropriate the funds. These funds are used to make new loans at very attractive spreads. These interest earnings have gone way up over the last several months. The government looks at this and says, Hey! These banks are really making money. All that's needed is for us to keep pouring money into the system and keep interest rates low until they get well. As the income flows in, banks can improve their balance sheets and gradually write off their bad debts instead of paying dividends. What the government doesn't seem to care about is that banks are able to do this because the government has driven deposit rates down to near zero and is running up debt at the expense of taxpayers. In this way the same people who caused the problem are benefiting from the government solution.

Since the government probably can't supply enough money for the whole bailout, because taxpayers won't allow congress to appropriate the necessary funds, the government has devised a clever way to get private investors to participate in the bailout. As banks write down their bad loans, they can sell them off to private investors, who in turn can buy them at a price which allows them to renegotiate the loans and make a nice profit. Some private hedge funds are already doing this. But most are still sitting on the sidelines, spooked by the possibility that they will get burned by the bad loans. To sweeten the deal enough to get private investors cash into the game, government has decided to lend these private investors money to leverage the deal, thus increasing their returns. And, on top of that, it will guarantee the loans from downside risk, another gift from the taxpayers to the capitalists.

An interesting point illustrated here is that it's not necessary to be a recipient of bailout funds to profit from bailout deluge. If banks don't have too many bad investments they can use the windfall profits afforded them by the government dictated low deposit rates to get well and claim they did it without a government bailout. But, this is hardly the case, and I'm sure they're not going to volunteer to help pay off the national debt the government has run up to afford them the windfall profits.

It's all one big oligarchy. Once the taxpayers have paid a big price to buy time for the banks to work off their bad investments, the people at the Fed and Treasury can go back to the banks where they used to work and get fat salaries and bonuses for saving the banks with taxpayer money. And, we and our descendants will be left to pay off the federal debt they have run up.

Saturday, February 14, 2009

What will the stimulus bill accomplish?

The financial crisis does not yield easily to stimulus because it's primary cause is an overhang of debt built up over several decades. How this occurred is explained in a previous post on this blog, My Short Explanation of the Financial Crisis. Consumers are no longer spending on discretionary purchases and businesses are not investing because demand is declining. As the government pumps money into the system to replace that previously supplied by consumers and businesses, only that which is given to consumers that are just getting by will be spent to sustain demand. Consumers that are meeting their basic needs will use the money to pay off debt or save it. Businesses that are burdened with debt will use it to pay off debt, which may be due to bad investing or a result of the crisis. Those that are not will pay it out in dividends or bonuses, since opportunities for expansion are limited due to reduced demand for their products. The primary useful effect of the stimulus will be to keep workers in productive jobs rather than just pay them to be unproductive. In this sense it is not really a stimulus program, but a program to reduce the severity of the consequences of the crisis and shorten the recovery time, as the debt overhang is worked off. To not have any government spending could worsen the consequences and possibly lead to a deflationary spiral that could lead to a depression.

The key to how the stimulus should be used relates to who should be helped and who should not. Banks and investors that invested unwisely should suffer the losses. Right now this segment is sitting on the sidelines with their money in treasuries making little or nothing. They are not investing, because demand is dying and investing would be unproductive. But, they have reaped large rewards over the last several decades through leveraging, which caused the crisis, and should now be willing to now take their losses. Reducing capital gains and dividend taxes, especially retroactively, would just be a windfall for banks and other large investors that have reaped the gains, but now want to socialize the losses. Income tax rebates for wealthy investors will not stimulate the economy. They will be used to pay down debt from leveraging bad investments. Consumers are already paying the consequences for their spending euphoria over the last several decades. They are not being bailed out. And they will continue to suffer the consequences, for as long as the recovery takes.

So, is the stimulus package configured right? To the extent that tax cuts are going to investors who made bad decisions, it's not. To the extent that the cuts are going to people just getting by, it is stimulative. There appears to be an argument over specific spending projects in the package and how quickly the money is spent. Since the primary effect of the program will not be to stimulate the economy, but to reduce the severity of the consequences while debt is being worked off, any programs that keep people employed productively are worthwhile. If the money is spent so quickly that it becomes inefficient and wasteful, it will be counterproductive. If is spent so slowly that people are not employed productively, it will be inefficient, cause more pain, and lengthen the recovery period. Since it will take considerable time to work off the debt, the most important consideration is to keep the spending at a pace that keeps people employed productively without waste or undue hardship.