Monday, October 06, 2008

A Replay Of 1929? Don't Count On It

Today some have questioned whether we could have another 1929-style Depression. The answer is no — at least, it shouldn't happen.

Then we had over 25% unemployment; now it's 6% and could move somewhat higher, which is typical for economic corrections (see chart above). Then, by 1934 about one-half of mortgages were in default, today it is only 6%. Nearly 94% of homeowners are still making their monthly payments.

So what's the big lesson to be learned here by the public? That this financial crisis was the result of yet another Big Government program that had great intentions but created devastating unintended consequences that hurt millions of people.

It was not the fault of African American groups, which naturally want to help their people. Nor was it the fault of America's free enterprise system, or a lack of enough regulation. No, it was Big Government once again trying to run a private industry.

Mortgage Lessons From Down Under: US Politicians Were Wrong to Pimp The Homeownership Fraud

Lessons To Learn From Mortgage Lending in Australia:

Maybe only a friendly foreigner could say this. But America needs to realize that not everyone can own a home. The American Dream of home ownership for all is a fraud. Politicians who pimped this dream created an unsustainable mortgage industry whose collapse is only surprising because it didn't happen earlier. America's mortgage industry will not recover, nor deserve to recover, unless it is prepared to challenge this politically unpalatable reality.

Now, Australians -- and others -- place a high value on homeownership too. But they are aghast at the dumb things America has tolerated in pursuit of that goal. Even more dumbfounding is that nobody in Washington seems to be talking about fixing it.

~Editorial in today's WSJ by Australian journalist

The editorial points out some significant differences between mortgage lending in the U.S. and Australia - the U.S. has nonrecourse, 30-year fixed rate mortgage loans, typically without prepayment penalties, and we also passed the CRA, and all of these uniquely American features of mortgage lending serve to "stack the cards against lenders and in favor of risky homeownership." And it's safe to say that all or most of these pro-borrower, anti-lender mortgage policies in the U.S. are government-mandated.

In contrast, mortgage loans in Australia are recourse, so "When Australians borrow money to buy a house, they know that if they default and the mortgaged property doesn't cover the debt, they will be responsible for the shortfall. And the lender will chase them for it. It's a neat way of reminding Australians to borrow responsibly."

Australian mortgages have either variable rates of interest, or fixed rates for periods of a maximum of five years, and they face a prepayment penalty when refinancing a mortgage to compensate the lender for the "lost interest the loan would have brought in had it been carried to term."

Bottom Line: One part of fixing our credit crisis is to consider reversing the pro-borrower, anti-lender mortgage policies in the U.S. Moving towards the Australian system would go a long way towards solving our mortgage troubles, and would stabilize our credit market and banking system and make them less vulnerable to credit shocks in the future.

Expected Inflation At a Six-Year Low (Unadjusted)

10-year TIPS-derived expected inflation

The charts above show the market-based 10-year TIPS-derived expected inflation from the Cleveland Fed (both unadjusted - top two charts, and adjusted - bottom chart), calculated from the difference between 10-year nominal treasury notes and 10-year treasury inflation-protected securities. On an unadjusted basis, inflation expectations fell to a six-year low of 1.47% last week, falling below 1.5% for the first time since September of 2002 (see top chart above).

After adjusting for an inflation-risk premium and a liquidity premium (see details here), the Cleveland Fed's adjusted measure (2.45%) shows that expected inflation is the lowest since early November 2007 (see bottom chart above).

MP: As Frederic Mishkin wrote several weeks ago in the WSJ, "Don't worry about inflation." We might have many other economic concerns right now, but I think it's time to take inflation off the list of economic variables to worry about.

Sunday, October 05, 2008

Lesson of I-35W Bridge: Private Enterprise Works

So what is the primary lesson of the St. Anthony Bridge (I-35W bridge in Minneapolis, see photo above) rebuild? Private enterprise works. Most road and bridge construction in America gets performed by state agencies who subcontract bits and pieces out while retaining the general-contractor role. In this case, the bridge replacement was so badly needed that Minnesota dumped that model to use one that would produce a bridge in a shorter period of time — and incentivized the contractor to get it done fast.

Private enterprise works. Businesses understand this. When they need project work done, especially for projects where speed is essential and the work outside the scope of their expertise, they hire contractors to do it rather than hire the expertise onto their own payrolls. Contractors who fall behind can be penalized or even replaced without having to worry about employment law and other administrative headaches. They can also get bonuses without invoking other kinds of payroll issues.

Related 1: "5 Engineering Lessons From the New, Reopened Minnesota Bridge" in Popular Mechanics

Related 2: As economist Steven Landsburg reminds us, "Most of economics can be summarized in just four words: People respond to incentives. The rest is commentary."

Tina Fey As Sarah Palin Nails It Again on SNL

Just in case you missed it last night.

Capitalism vs. Socialism In a Single Picture

North Korea vs. South Korea at night. (HT: OBloodyHell)

According to the CIA World Factbook, 2007 GDP per capita (PPP) was $25,000 in S. Korea vs. $1,700 in N. Korea.

In "Why Socialism Failed," I concluded that "The main difference between capitalism and socialism is this: Capitalism works."

Markets In Everything:Heavy Equipment Play Arena

For the first time in history, you can test your skills behind empowering earth-moving machines. Dig This invites individuals and groups to operate dozers and excavators and complete invigorating material moving projects. Adventures can be structured as just-for-fun recreational diversions or we can incorporate team building games and activities.

Farm Subsidies Gone Wild: Cows in Europe Earn More Per Day ($2.20) Than 1.2 Billion Poor People

1. Primary farm producers in the world's developed countries receive about $280 billion a year in government support. In the European Union, farmers receive a third of their income from government subsidies. Beef and veal producers get more than 70% of their income from subsidies. A typical cow in the European Union receives a government subsidy of $2.20 a day. The cow earns more than 1.2 billion of the world's poorest people.

~Mark Vaile, Australian trade minister in 2005

2. The developed world funnels nearly $1 billion a day in subsidies to its farmers, encouraging overproduction. That drives down prices and leaves farmers in poor nations unable to compete with subsidized products, even within their own countries. In recent years, American farmers have dumped cotton and other products on world markets at prices that do not begin to cover their cost of production. Europe's system is even worse; the United States' farm subsidies are only a third of Europe's. A cow in France shouldn't make more than a farmer in Burkina Faso. That is just shameful.

~NY Times editorial "Cow Politics" in 2005

3. In 2006, expenditures on the Common Agricultural Policy (farm subsidies) were €49.8 billion, compared to €48.5 billion in 2005. This represents 47% (the largest component) of the EU's expenditures in 2006, up from 46% in 2005.

~Financial Management in the European Union

And just in case, 47% seems high, it's actually "low" compared to the past. Until 1992, farm subsidies represented nearly 61% of the EU's budget. Reminds me of the joke:

Q. How do you starve a European farmer?

A. Weld his mailbox shut.

Saturday, October 04, 2008

As A Share of Income, U.S. Has Lowest Food Prices on the Planet; Europeans Spend Almost 2X As Much

Click on the chart above to enlarge, it shows the "Percent of personal consumption spent on food by selected countries, 2007" based on data available from the Department of Agriculture.

Notice that spending on food consumed at home in the U.S. is only 5.7% of total household consumption (disposable personal income), by far the lowest in the world, at least for the 71 countries in this study. Spending on food in the EU countries at 12.1% of disposable personal income is more than twice the U.S. rate. Japan's rate of 14.6% is more than 2.5 times greater than the U.S. and even Canada at 9.2% doesn't even come close to the U.S.

Russians spent almost 29% of their income on food in 2007, the Chinese 35% and the Indians 32.4%, levels even higher that the U.S. rate of 21.2% in 1930. That is, the average American in 1930 spent less of their disposable income on food than the average person in almost half of the countries list above spent in 2007.

Bottom Line: When it comes to affordable food (as a share of disposable income), there's no place on the planet where it's cheaper than the U.S. And it's gotten better and better over time, as food expenditures in the U.S. have fallen from 21.2% of income in 1930 to only 5.7% in 2007.

Pork Breakdown Of the Bailbout Bill + Ron Paul

Ron Paul: "You take the original bailout bill, make it a lot worse and you get 57 congressmen switching from no to yes."

Demystifying the Mortgage Meltdown

Via Coyote blog, the webcast of The Milken Institute presentation "Demystifying the Mortgage Meltdown: What It Means for Main Street, Wall Street and the U.S. Financial System," (October 2) is available, slides available here. The slides contain loads of great graphical information about the credit crisis (like the one above).

When It Comes To Charity, It's Not Even Close. The Palins Are Almost 12X As Charitable As the Bidens

A recent CD post reported Joe Biden's miserly charitable contributions (averaging less than $300 per year from 1998 to 2006 on average annual income of $237,000). CD reader Kansas Bob provided the link to Sarah Palin's Tax Records, providing data for a comparison of the vice-presidental candidate's records of charitable giving.

When it comes to giving money to charities, it's not even close: the Palins are almost 12 times as generous as the Bidens, when measured by charitable contributions as a percent of Adjusted Grosss Income (AGI) in 2006 and 2007: 2.79% average for the Palins in those two years, vs. 0.24% for the Bidens (see top chart above).

And even though the Palins ($294,000) earned only about half the income of the Bidens ($569,000) in 2006 and 2007 combined, the Palins gave almost 6 times as much to charity ($8,205) in those two years as the Bidens ($1,375), see bottom chart above.

In Defense of Speculators and Short-Sellers

Everywhere today government bureaucrats and media pundits blame unwanted price movements on speculators and short-sellers. If prices are “too high”--it’s the fault of greedy speculators; if prices are “too low”--it’s the work of evil short-sellers. To hear these critics tell it, speculators have the ability to create artificially high prices, while short-sellers can wantonly destroy sound companies.

The critics then claim that since neither speculators nor short-sellers perform any positive economic function, barring them from the marketplace is an appropriate remedy, one that’s long past due.

If prices are to reflect reality, they must be the result of an objective process of discovery and judgment performed by interested actors. Just as doctors specialize in identifying and evaluating the facts affecting health and disease, speculators and short-sellers specialize in identifying and evaluating the facts pertinent to market prices. They make it their business to understand economic facts like supply and demand, and then risk their capital on their judgment, properly profiting if they’re right and losing if they’re wrong. Thus in a free market, rather than prices being set by wish or decree, they are set by a rational process, one which benefits from the knowledge of all who participate.

Speculators and short-sellers don’t create facts, they seek to identify and respond to them; and in the process they help adjust prices to economic conditions and establish smooth and liquid markets. As a result--instead of being scapegoated and banished--they should be respected and welcomed for the productive role they play in our markets.

~Trader, speculator and short-seller
Amit Ghate

Friday, October 03, 2008

Reason.TV on Social Security: "Pimp My Walker"


U.S. Dollar Hits 13-Month High

The U.S. dollar reached a 13-month high today versus major currencies (see graph above), the highest level since September 5, 2007.

Gas Falls Below $2.95 in Missouri

15 gas stations are selling gas for $2.94 per gallon in Missouri.

Update: A comment by djb asks, "Are they prosecuting all the customers who continue to gouge the gas stations?"

How Government Stoked the Mania And Turned Good Renters Into Irresponsible Homeowners

Before we conclude that markets failed, we need a careful analysis of public policy's role in creating this mess. Greedy investors obviously played a part, but investors have always been greedy, and some inevitably overreach and destroy themselves. Why did they take so many down with them this time?

Part of the answer is a political class greedy to push home-ownership rates to historic highs -- from 64% in 1994 to 69% in 2004. This was mostly the result of loans to low-income, higher-risk borrowers. Both Bill Clinton and George W. Bush, abetted by Congress, trumpeted that rise as it occurred. The consequence? On top of putting the entire financial system at risk, the hidden cost has been hundreds of billions of dollars funneled into the housing market instead of more productive assets.

By pressuring banks to serve poor borrowers and poor regions of the country, politicians could push for increases in home ownership and urban development without having to commit budgetary dollars. Another political free lunch.

Beware of trying to do good with other people's money. Unfortunately, that strategy remains at the heart of the political process, and of proposed solutions to this crisis.

~George Mason economist Russell Roberts
in today's WSJ

Federal Prisons:Mackerel Is The Currency of Choice

WSJ: There's been a mackerel economy in federal prisons since about 2004. That's when federal prisons prohibited smoking and, by default, the cigarette pack, which was the earlier gold standard.

Prisoners need a proxy for the dollar because they're not allowed to possess cash. Money they get from prison jobs (which pay a maximum of 40 cents an hour) or family members goes into commissary accounts that let them buy things such as food and toiletries. After the smokes disappeared, inmates turned to other items on the commissary menu to use as currency.

Books of stamps were one easy alternative. Elsewhere in the West, prisoners use PowerBars or cans of tuna. But in much of the federal prison system, he says, mackerel has become the currency of choice.

So inmates stash "macks" (prison lingo for mackerel) in lockers provided by the prison and use them to buy goods, including illicit ones such as stolen food and home-brewed "prison hooch," as well as services, such as shoeshines and cell cleaning.

HT: Clover Aguayo

Related: "
The Economic Organization of a P.O.W. Camp" in Economica 1945, a classic article about the "cigarette currency" system that emerged in most POW camps in WWII

Related: The word "salary," and the expression "being worth one's salt," derive from the word "salt," which was once a commodity form of money.

Thursday, October 02, 2008

What Happened? From A McCain Lead 3 Wks. Ago, To A Tie 2 Wks. Ago, To A 31 Point Lead for Obama

Just about three weeks ago, McCain had almost a 6-point lead over Obama on, about two weeks they were tied, and now Obama has more than a 31-point lead, and is almost a 2:1 favorite (see chart above).

New Record for Inflation: 531,000,000,000%

According to the Cato Institute: As of September 26, 2008, Zimbabwe’s annual inflation rate was 531 billion percent. Give or take a few billion. Now that's a real economic and financial crisis, by anybody's definition.

Why the Bailout is Bad for America

From Dan Mitchell at Cato:

• The bailout is bad for the economy.
• The bailout repeats the mistakes Japan made in the 1990s.
• The bailout will increase corruption in Washington.
• It rewards executives and companies that made poor choices.
• The bailout will encourage imprudent risk in the future.

Bottom Line: When government tries to redistribute wealth from rich people to poor people, it causes economic damage by discouraging productive activity by the most successful and by discouraging productive activity from those who are lured into government dependency. The proposed bailout is even more pernicious. It would redistribute wealth from poor people to rich people, and simultaneously encourage reckless behavior by recipients and impose an immoral burden on those that behaved responsibly.

HT: Don Boudreaux

Homes: Saginaw $1.75, Moscow $99m, Detroit $1

House for $1.75 in Saginaw, Michigan:
Townhouse for $99 million in Moscow:
And just in case anybody felt like they lost out on the Saginaw home for $1.75, there are actually 5 homes for sale in nearby Detroit for only $1, including several two-unit properties (one pictured below). Just wondering, would it take a full-price offer to get this one, or would they entertain offers below the list price?

Cell Phone Text Messaging: Wireless Telegrams

The phone was invented as part of the attempt to multiplex the telegraph. It was first thought to be impractical because who would want to go down to the telegraph office to talk when the telegram message could be brought to you. Western Union (the telegraph monopoly) was offered and turned down the rights to the phone.

And here we are, 130 years later, and young people are sending telegrams over their phones and it's us old fuddy duddies who think they should only be used for voice, their original purpose. The phone has now achieved something even better than the original intent - wireless telegrams.

~An interesting comment from Kevin Murphy on this CD post about how there are now more text messages than phone calls.

Monster Index Up, College Job Outlook Stable

The Monster Employment Index edged up one point in September, as online recruitment activity increased slightly for the second consecutive month.

“The modest rise in the Monster Employment Index in September reflects the typical pick up seen in overall recruitment activity during the outset of the fall hiring season,” said Jesse Harriott, Vice President of Research at Monster Worldwide. “Although the Index is down 14% year-on-year, there are some bright spots, including increased online demand for occupations in public administration and healthcare.”

During September, online recruitment activity increased in 17 of the 28 U.S. metro areas monitored by the Index. Cincinnati showed the largest gain over the month, driven mainly by heightened demand for IT, healthcare and office/administrative occupations.

MP: It's not great labor market news, but it's somewhat positive. The September unemployment rate will be released tomorrow, and the market expectation is for it to remain at 6.1%.

More moderately good news comes from The National Association of Colleges and Employer's Job Outlook 2009 Fall Preview, which reports that:

The outlook for college hiring appears to be stable for the Class of 2009. Despite a sluggish economy, employers responding to NACE’s 2009 Job Outlook Fall Preview Survey report plans to hire 6.1% more new graduates in 2008-09 than they did in 2007-08. This is the sixth straight year that employers have projected an increase, although this year marks the first in six that the projected increase is not in the double digits (see chart below).

Wednesday, October 01, 2008

September Auto Sales: Canada +1.7% vs. U.S. -27%

United States: Every single carmaker saw big shortfalls in September, as Nissan, Ford, GM, Honda, and Toyota all posted double-digit declines.

U.S. auto sales in September fell 27%, to 965,160—the first submillion sales month since January 1993—with Detroit automakers getting hammered the worst as consumers stayed away from showrooms in the last week at levels not seen since the terrorist attacks in September 2001. Industrywide, sales fell for the 11th month in a row, the longest slide in 17 years.

Canada: Auto sales in Canada rose 1.7% year-over-year in September as a 14% increase for Toyota vehicles helped outweigh declines at General Motors and Ford. The monthly increase, the second in five months, was buoyed by car sales, which climbed 5.1%. Light truck sales fell 2.2%.

80% of Congress Has No Background in Economics

As Congress works on one of the most important pieces of economic legislation in a generation, a Washington research group has pointed out that more than 8 in 10 members of Congress don’t have a formal educational background in the business, economics, or finance fields.

The research by the Center for Economic and Entrepreneurial Literacy, which aims to educate the general public about finance issues, showed that about 14% have degrees in economics-related fields and just 6.7% specifically have an economics degree. More than 30% of members have degrees in politics and government, while 18% majored in humanities.

It’s interesting that those who are responsible for solving the biggest economic crisis in generations don’t have the educational background to know the difference between commercial paper and copy machine paper,” said James Bowers, managing director of CEEL.

Whole thing here.

Markets In Everything. Not. Market Pricing To Relieve Airport Congestion Banned by GAO

From a previous CD post:

Proposition 1: Anytime you have congestion or shortages, it's almost guaranteed that market pricing is absent.

Proposition 2: Market pricing will almost always reduce or eliminate congestion and shortages.

WASHINGTON (AP) U.S. aviation officials have no legal authority to auction off takeoff and landing slots at airports, a scheme the government devised to try to curb crippling traffic jams at major airports, congressional investigators say.

Transportation Secretary Mary Peters proposed the auction plan after widespread complaints last year about rampant flight delays across the country. The government says two out of three flights delayed 15 minutes or more were due to cascading backups beginning at one of the New York metropolitan area's three airports: Newark, John F. Kennedy, and LaGuardia.

Trying to fix the problem, the government imposed new limits on the airports and announced plans to auction off some takeoff and landing slots to control the crushing demand for time and space. By auctioning slots, the government reasons, market forces will help restrain such demand and make the system operate more efficiently.

MP: Without market pricing, the congestion at airports during peak times will continue with 100% certainty.

Today's Humor: Investment Advice

If you had purchased $1,000 of Delta Air Lines stock one year ago, you would have $49 left.

With Fannie Mae, you would have $2.50 left of the original $1,000.

With AIG, you would have less than $15 left.

But, if you had purchased $1,000 worth of beer one year ago, drunk all of the beer, then turned in the cans for the aluminum recycling REFUND, you would have $214 cash.

Based on the above, the best current investment advice is to drink heavily and recycle.

Turning Good Renters Into Bad Homeowners

Much of the current credit crisis can be blamed on the fact that U.S. public policy (and monetary policy) encouraged excessive homeownership (tax deductibility of mortgage interest, government creation of GSEs, forcing the GSEs to promote subprime mortgages, enacting the CRA, historic low mortgage rates in 2003, etc.), and in the process we turned "good renters into bad homeowners."

Here's an idea about how good renters becomes bad homeowners.

Wouldn't it be the case that greater financial discipline is typically imposed on a renter than a homeowner? And isn't it typically the case that financially irresponsible behavior might be tolerated to a greater extent, and for a longer period, by a mortgage company than by a landlord?

For example, consider a renter living paycheck-to-paycheck, with weak credit, and monthly rent of $800. Faced with the threat of eviction within a few months of non-payment of the rent, most renters would make the rent payment a fairly high priority to avoid eviction. Also, the renter would typically be dealing directly and personally with either the landlord or a property manager, someone they would probably know by name.

Now if that tenant becomes a howeowner, possibly because of the availability of subprime lending and the CRA, several things happen. First, the renter-turned-homeowner is now making monthly mortgage payments by mail to a bank or mortgage company, often in another part of the country, and is no longer dealing directly with a landlord or property manager. Second, the the homeowner no longer faces the threat of almost immediate eviction (or within a few months, depending on the state) for non-payment of the mortgage.

According to this foreclosure timeline from, foreclosure and sale of a property can take up to 415 days (more than 13 months) after a mortgage payment is late (depending on state law), and it might take even longer for the eviction process. Knowing that non-payment of the monthly mortgage to a faceless company in another state won't result in eviction for possibly a year or more, wouldn't the new homeowner act much more irresponsibly as a homeowner than as a tenant?

That is, wouldn't the significantly greater default-foreclosure-eviction time frame for homeowners compared to tenants encourage more reckless behavior, and turn a good tenant making regular monthly rent payments into a bad homeowner, with delinquent monthly mortgage payments? And even if the "bad homeowner" doesn't default completely, late mortgage payments might be tolerated more by the mortgage company than late rent payments would be tolerated by the landlord.

Gas Price War In Lebanon, Missouri?

Affirmative Action Grading? Bs for Asians, Arabs?

Voters in Colorado and Nebraska will decide in November whether their state governments have to discontinue discriminating against certain groups based on race and sex.

The ballot language in Colorado reads "NONDISCRIMINATION BY THE STATE: The State shall not discriminate against, or grant preferential treatment to, any individual or group on the basis of race, sex, color, ethnicity, or national origin in the operation of public employment, public education, or public contracting."

Similar proposals have passed in California (in 1996, 54% in favor), Washington (in 1998, 58.3% in favor) and Michigan (in 2006, with 58% in favor; by county, the vote was 80 out of 83 counties in favor of Proposal 2, only 3 opposed).

When Proposal 2 was being considered in Michigan two years ago, I had the following commentary in the Detroit Free Press, suggesting that affirmative action grading would be an unacceptable practice by professors when dealing with students once they are admitted to a university and start taking classes, so it should also be an unacceptable practice by admissions officers when dealing with students before they are admitted to a university.

As President John F. Kennedy said: "Simple justice requires that public funds, to which all taxpayers of all races and national origins contribute, not be spent in any fashion which encourages, entrenches, subsidizes or results in racial discrimination."

Quotes of the Day: George Will

From George Will's column today:

Suppose there had never been implicit government backing of Fannie Mae and Freddie Mac. Better yet, suppose those two had never existed -- there was homeownership before them, just not at a level that the government thought proper. Absent Fannie and Freddie -- absent government manipulation of the housing market -- would there have developed the excessive diversion of capital into the housing stock?

The entitlement mentality fostered by the welfare state includes a felt entitlement to a standard of living untethered from savings.

Tuesday, September 30, 2008

US: More Text Messages Than Phone Calls

American cell phone users are sending more text messages than they are making phone calls, according to a Nielsen Mobile survey. For the second quarter of 2008, U.S. mobile subscribers sent and received on average 357 text messages per month, compared with making and receiving 204 phone calls a month (see chart above). In the first quarter of 2006, Americans sent and received 65 text messages per month. The number of messages sent and received today has increased 450%.

Gas Spotted Below $3 in Missouri


Bankruptcy, Not Bailout, Is The Right Answer

This bailout is a terrible idea. Here's why.

The current mess would never have occurred in the absence of ill-conceived federal policies. The federal government chartered Fannie Mae in 1938 and Freddie Mac in 1970; these two mortgage lending institutions are at the center of the crisis. The government implicitly promised these institutions that it would make good on their debts, so Fannie and Freddie took on huge amounts of excessive risk.

Worse, beginning in 1977 and even more in the 1990s and the early part of this century, Congress pushed mortgage lenders and Fannie/Freddie to expand subprime lending. The industry was happy to oblige, given the implicit promise of federal backing, and subprime lending soared.

This subprime lending was more than a minor relaxation of existing credit guidelines. This lending was a wholesale abandonment of reasonable lending practices in which borrowers with poor credit characteristics got mortgages they were ill-equipped to handle. Once housing prices declined and economic conditions worsened, defaults and delinquencies soared, leaving the industry holding large amounts of severely depreciated mortgage assets.

The fact that government bears such a huge responsibility for the current mess means any response should eliminate the conditions that created this situation in the first place, not attempt to fix bad government with more government. The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.

Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.

In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy's allocation of its financial resources.

The right view of the financial mess is that an enormous fraction of subprime lending should never have occurred in the first place. Someone has to pay for that. That someone should not be, and does not need to be, the U.S. taxpayer.

~Jeffrey A. Miron, Senior Lecturer in economics at Harvard University and Director of Undergraduate Studies

The Four Horsemen of the Financial Panic

From Americans for Tax Reform: No matter what one thinks of the financial bailout package, we ought to at least agree how we got here. Below are the real actors behind the mortgage panic of 2008:

1. Government-sponsored enterprises (GSEs). Fannie Mae, et al, bears a large share of the responsibility.

2. Easy money from the Federal Reserve. On January 3, 2001, the Federal Reserve cut the federal funds rate by 50 basis points, to 6.00%. They continued to do so until the rate hit a bottom of 1.00% on June 25, 2003.

3. Community Reinvestment Act (CRA). This legislation, first passed in 1977, gave federal regulators the power to encourage banks to issue loans to high-risk households and small businesses.

4. Mark-to-market accounting rules. This refers to an accounting practice that forces a balance sheet to value an asset at its current market price (that is, what it could be sold for at the time). Mark-to-market is an arbitrarily-restrictive accounting practice that should be scrapped for assets like securities which generate current income. Doing this alone would solve much of the problem.

Quote of the Day

The SEC's ban on short selling is a perfect illustration of the dangers of regulators taking a cartoon view of the world, where evil villains are responsible for all the chaos in fair Gotham. In their monomaniacal focus on the manipulative potential of short selling, Cox and his his minions have completely overlooked its benefits, and implemented policies that have inflicted substantial collateral damage on other portions of the financial market, including parts of the market that could facilitate fixing problems at the institutions allegedly protected by the regulations–banks.

This is particularly tragic given that the rationale for the policy is based on anecdote–to put it as charitably as possible. Remember what George Stigler said: The plural of “anecdote” is not “data.”

~Streetwise Professor

Gas Prices: $3 Per Gallon in MO and OK, $8 in GA

Gas prices are approaching $3 per gallon in Missouri and Oklahoma.

Meanwhile, in Georgia, "The state has received 1,300 complaints of gas gouging and has subpoenaed sales records from 130 gas stations to determine if they illegally jacked up prices in the wake of Hurricane Ike. There was one report that a station was charging $8.82 a gallon, but that report hasn’t been verified." (Another link here.)

To which columnist Neal Boortz replies "Don’t investigate them! Reward them! Price gouging is exactly what we need! It should be encouraged, not investigated."

HT: Larry Russell

Real Estate Roller Coaster

The Housing Bubble in 4 Easy Steps, from the Mises Institute:

1. Cut Fed Funds rate from 6.5% in 2000 to 1% by 2003.
2. 30-year mortgage rates fall to all-time low by June 2003.
3. Because of low interest rates, mortgage loans double between 2001 and 2006.
4. All these low-interest loans had to be extended to people with weak credit ratings and this increased the demand for homes and other real-estate assets. It should not be surprising that home prices skyrocketed. Click on the arrow below to the Real Estate Roller Coaster:

Fannie Mae, Freddie Mac, mortgage-backed securities, and credit derivatives were simply the conduit that made all these bad loans and investments seem less risky than they really were. In this manner the Federal Reserve can fool the market, at least temporarily. In the end the market always reasserts itself.

When Government's In Charge, Expect Shortages

WASHINGTON (AP)The U.S. Mint is temporarily halting sales of its popular American Buffalo 24-karat gold coins because it can't keep up with soaring demand as investors seek the safety of gold amid economic turbulence. Mint spokesman Michael White said Friday that the sales were being suspended because demand for the coins, which were first introduced in 2006, has exceeded supply and the Mint's inventory of the coins has been depleted.

The Mint had to temporarily suspend sales of its American Eagle one-ounce gold coins on Aug. 15 and then later that month announced sales of the American Eagle coins would resume under an allocation program to designated dealers. White said the Mint expected to soon start distributing available Buffalo gold coins through a similar allocation program.

NUMISMATIC NEWS - Coin dealers and collectors are still reeling from the U.S. Mint's announcement that it had run out of American Eagle gold coins. But what ought to surprise every American isn't that a government agency came up short. It's that the U.S. government should be making little metal discs at all.

Recall the plight of consumers under socialism: socialist governments tried to make everything and eventually ran out of everything. Now socialism is dead, but not when it comes to coining. So coin shortages keep breaking out, as they have ever since governments first monopolized coin making in ancient times.

Thomas Sowell On The Current Financial Crisis

As always, economist Thomas Sowell puts the current situation into perspective - here are some key points from his most recent column "Bailout Politics":

1. Nothing could more painfully demonstrate what is wrong with Congress than the current financial crisis. Among the Congressional "leaders" invited to the White House to devise a bailout "solution" are the very people who have for years created the risks that have now come home to roost.

2. The idea that politicians can assess risks better than people who have spent their whole careers assessing risks should have been so obviously absurd that no one would take it seriously. But the magic words "affordable housing" and the ugly word "redlining" led to politicians directing where loans and investments should go, with such things as the Community Reinvestment Act and various other coercions and threats.

3. If Fannie Mae and Freddie Mac were free market institutions they could not have gotten away with their risky financial practices because no one would have bought their securities without the implicit assumption that the politicians would bail them out. It would be better if no such government-supported enterprises had been created in the first place and mortgages were in fact left to the free market. This bailout creates the expectation of future bailouts.

Monday, September 29, 2008

Homeowners, Lenders Last Line of Defense: Denial

1. Looking backward, home buyers paid too much, and lenders wrote contracts that exposed them to the homeowners’ losses. With home values declining by something like $2 trillion, we are in a mad scramble to divide the loss between homeowners, lenders and taxpayers. In the meantime, homeowners and lenders are exercising their last line of defense: denial. Many homeowners are refusing to sell their homes at prices that can attract buyers. Many lenders are refusing to sell their mortgage-backed securities at prices that can attract buyers. All this denial gets in the way of the normal price discovery process, leaving stranded assets held by owners who think they are worth more than potential buyers.

2. Nonetheless, our financial institutions are doing a pretty good job. Our financial markets are supposed tell us how wealthy we are. This year the large drop in equity valuations is sending a pretty clear message: we are not as wealthy as we thought. That seems adequately accurate; no big problem there. Our financial markets also provide credit to consumers and businesses to help grow our economy. Outside of housing the economy is doing pretty well, and there is no clear evidence of a credit crunch seriously impinging on either business spending or consumer spending even though Wall Street pundits for more than a year have been ringing out loud alarm bells about an imminent credit contraction (see
related CD post). Though business spending and consumer spending are a bit weak, that weakness properly reflects the fundamentals of the economy and is not a symptom of a credit crunch. So what’s the problem, Mr. Secretary?

3. One honest way to transfer the losses directly to the taxpayers would have the Treasury buy homes directly at inflated prices and rent them to deserving Americans. Though the Treasury Plan involves buying mortgage backed securities at inflated prices, keep in mind that foreclosures will then turn the homes over to Uncle Sam. For $700 billion, the Treasury could purchase 2.3 million homes at an average price of $300,000. That is way more than is necessary. A half a million should be enough to unclog the system. Uncle Sam could purchase foreclosed homes, mow the lawns, fix the broken windows and rent them out to deserving families. That would help the other homes in the neighborhood sell at favorable prices.

Edward Leamer, UCLA economics professor

New Banking Data: Where's The Credit Crisis? Total Bank Loans and Leases Exceed $7T For First Time

New banking data were released today from the Federal Reserve on bank loan volume through September 17 (for weekly data and August for monthly data), showing that "Total Loans and Leases at All Commercial Banks" reached an all-time high of $7.026 trillion (reported weekly) in mid-September, going over $7 trillion for the first time in history (see graph below).

Consumer loans (reported monthly) hit an all-time high of $845 billion in August:

Real estate loans (reported monthly) peaked out this year at about $3.642 trillion, and increased slightly in August from July:

Commercial and industrial loans at large commercial banks (reported weekly) were close to an all-time in September, just slightly below record levels reached in July:

Q: Where's the credit crisis?

American Manufacturing Workers Are World-Class

To balance all of the bad news about the U.S. economy, here's some good news today from the BLS: Not only are American manufacturing workers probably the most productive in the world, they keep gaining on workers in other countries.

The top chart above lists the productivity gains for manufacturing workers from 2006 to 2007 (most recent data available) in 16 countries, and the U.S. gain of 4.1% in just one year was higher than the productivity gains in all countries except for Taiwan, Korea and Germany.

Over a longer period of time (1979-2007), American manufacturing workers had higher average annual gains in productivity (3.9%) than all countries except for Taiwan and Sweden during that period.

Bottom Line: One of the reasons that there are 6 million fewer U.S. manufacturing jobs today (13.428 million) than in 1979 (19.553 million), an average annual decline of 1.2%, is that American workers have become 4% more productive each and every year.

U.S. Consumers Are Being Taken to the Cleaners

In May, I posted about tariffs on hangers from China, enacted to protect the only remaining domestic supply of hangers, M&B Hangers in Leeds, Alabama, and to "punish" Chinese manufacturers for "dumping."

Economist Frank Stephenson now reports in The Freeman that hanger tariffs are responsible for doubling the price of hangers from $28 to $56 per box over the last year, which will cost each dry cleaner $4,000 or more per year.

Bottom Line: If you thought your dry cleaning bills were high in the past, well "hang on," because as surely as night follows day, higher hanger prices will be passed on to U.S. consumers in the form of higher dry cleaning prices. Tariffs, which are simply taxes on Americans buying imported goods, ultimately "punish" U.S. consumers and firms with higher prices more than they "punish" China.

Further, Stephenson cites this analysis that divides the total cost of the hanger tariff to U.S. dry cleaners ($4,000 x 30,000 dry cleaners = $120 million year), by the number of potential domestic jobs saved (564 jobs) in the U.S. hanger industry, indicating that each American job saved costs us about $212,765 per year. Since the typical full-time worker in this sector earns about $30,000 per year, it would be cheaper for the U.S. to eliminate the tariff, purchase cheaper hangers from China, let the domestic industry die, and pay each American hanger worker $30,000 per year to retire.

Like thousands of other examples, trade protection of inefficient American producers always imposes much higher costs to the country (measured in higher prices and jobs lost) than it generates in benefits (measured in jobs saved). And it's usually not even close, it's typically $2 in cost per $1 of benefits, or 2 lost jobs per job saved, when Americans are "punished" with trade protection.

Frank's Fingerprints Are All Over Financial Fiasco

Barney Frank: "The private sector got us into this mess. The government has to get us out of it."

Jeff Jacoby in yesterday's Boston Globe:

While the mortgage crisis convulsing Wall Street has its share of private-sector culprits, they weren't the ones who "got us into this mess." Barney Frank's talking points notwithstanding, mortgage lenders didn't wake up one fine day deciding to junk long-held standards of creditworthiness in order to make ill-advised loans to unqualified borrowers. It would be closer to the truth to say they woke up to find the government twisting their arms and demanding that they do so - or else.

The pressure to make more loans to minorities (read: to borrowers with weak credit histories) became relentless. Congress passed the Community Reinvestment Act, empowering regulators to punish banks that failed to "meet the credit needs" of "low-income, minority, and distressed neighborhoods." Lenders responded by loosening their underwriting standards and making increasingly shoddy loans. The two government-chartered mortgage finance firms, Fannie Mae and Freddie Mac, encouraged this "subprime" lending by authorizing ever more "flexible" criteria by which high-risk borrowers could be qualified for home loans, and then buying up the questionable mortgages that ensued.

HT: Cafe Hayek

Sunday, September 28, 2008

The High Cost of Living vs. The Cost of Living High

Based on a suggestion yesterday from a student in my MBA class (MGT 551 Business Economics), the graph above shows the declining share of disposable personal income (data) spent on food (data), clothing (data), and shelter (housing and household operation) since 1929. From a high of almost 59% in 1933, the percent of disposable income spent on food, clothing and shelter today has continually fallen, and today (2007) is only 33%.

Bottom Line: When people today talk about the "high cost of living," they’re usually talking about the "cost of living high" (see Dallas Fed), because they're certainly not spending very much on the basics: food, clothing and shelter - that spending is at an all-time low as a percent of disposable personal income.

Saturday, September 27, 2008

Hey, What About Wikipedia?

50 of the Most Dependable Web Resources for University Students, (minus one).

HT: Craig Newmark

If I had to guess whether Wikipedia or the median refereed journal article on economics was more likely to be true, after a not so long think I would opt for Wikipedia.

~Tyler Cowen

A Bad Bank Rescue

In the 1980s, the government did not need a strategy to decide which bad loans to take over; it dealt with anything that fell into its lap as a result of a thrift bankruptcy. But under the current proposal, the government would go out and shop for bad loans. These come in all shapes and sizes, so the government would have to judge what type of loans it wants. They are illiquid, so it's hard to know how to value them. Bad loans are weighing down the financial system precisely because private-sector experts can't determine their worth. The government would have no better handle on the problem.

In practice this means the government would make subjective choices about which bad loans to buy, and it would pay more than fair value. Billions in taxpayer money would be transferred to the shareholders and creditors of banks, and the banks from which the government bought most loans would be subsidized more than their rivals. If the government bought the most from the sickest institutions, it would be slowing the healthy process in which strong players buy up the weak, delaying an eventual recovery. The haggling over which banks got to unload the most would drag on for months. So the hope that this "systematic" plan can be a near-term substitute for ad hoc AIG-style bailouts is illusory.

~Sebastian Mallaby
in the Washington Post

Friday, September 26, 2008

Tragedy of the Commons and Economies of "Scales"

THE ECONOMIST -- Like most other fisheries in the world, Alaska’s halibut fishery was overexploited—despite efforts of managers. Across the oceans, fishermen are caught up in a “race to fish” their quotas, a race that has had tragic, and environmentally disastrous, consequences over many decades. But in 1995 Alaska’s halibut fishermen decided to privatize their fishery by dividing up the annual quota into “catch shares” that were owned, in perpetuity, by each fisherman. It changed everything.

In the halibut fishery the change in incentives that came from ownership led to a dramatic shift in behaviour. Today the halibut season lasts eight months and fishermen can make more by landing fish when the price is high. Where mariners’ only thought was once to catch fish before the next man, they now want to catch fewer fish than they are allowed to—because conservation increases the value of the fishery and their share in it. The combined value of their quota has increased by 67%, to $492m.

By giving fishermen a long-term interest in the health of the fishery, individual transferable quotas (ITQs) have transformed fishermen from rapacious predators into stewards and policemen of the resource. The tragedy of the commons is resolved when individuals own a defined and guaranteed share of a resource, a share that they can trade. This means that they can increase the amount of fish they catch not by using brute strength and fishing effort, but by buying additional shares or improving the fishery’s health and hence increasing its overall size.

Sadly, most of the rest of the world’s fisheries are still embroiled in a damaging race for fish that is robbing the seas of their wealth. Overfished populations are small, and so they yield a small catch or even go extinct.

For example, consider the situation of collapsing blue crab industry in Maryland, which was so bad this year that the "federal government is bailing out hard-pressed watermen with a disaster declaration."

Maryland lawmakers had sought the declaration by the Commerce Department since May, after Virginia posted a record-low harvest for the delectable crustaceans and Maryland had its lowest catch since 1945. Crabs remained the last thriving fishing industry in the Chesapeake until the 1990s, when pollution and overfishing finally took their toll. The stock is down by about 65% since 1990, according to Virginia and Maryland officials.

MP: Instead of another federal bailout for the blue crab industry ("too tasty to fail"?), maybe lawmakers should consider ITQs instead?

HTs: NCPA (halibut) and Peter Grose (blue crab)

See related
Economist story on privatizing fisheries.