The Recession According to South Park

This is the best explanation of what went wrong during the last decade's spending binge I have seen. The economy as god analogy is only something Trey Parker and Matt Stone could come up with. Enjoy!

http://www.southparkstudios.com/search/?search=Margaritaville&type=episodes

Glass-Steagall Redux

Last Thursday president Obama launched what could be the first of many attacks on the country’s financial system. The target last week was the practice known as proprietary trading. A proprietary trade is when a bank uses its own money to buy or sell equities, derivatives, or anything else they can find laying around that looks more profitable than loaning people money. The president wants banks to stop this because he and others believe that this activity is too risky for banks and helped lead to the financial implosion of 2008/2009. Many of the fungi interviewed in the financial press described the president’s move as ‘curious’ or ‘a step backward’. Backward, that is, towards the repealed law known as Glass-Steagall that separated commercial and investment banking. If the president’s proposal brings us ‘backwards’ to Glass-Steagall than it’s the most (only?) sensible move to date the administration has made in the area of finance and economics.

Here’s why: Back in May I tripped all over myself trying to explain how and why the financial markets started to behave like Artie Lange. One of the reasons I cited was the repeal of the Glass-Steagall Act. Having a bank play the equivalent of the house while its customers play poker is not conducive to good moral or economic outcomes. So by not allowing a commercial bank to act like, or own, a hedge fund may seem restrictive, it’s much needed.

The president’s proposal lacked details but that may have been a calculated move to make Congress fight it out while being soaked in cash from lobbyists. The lack of clarity made markets nervous and helped send the Dow down over 5% by the end of Friday. It seems bankers and institutional investors sell stuff when they think they’re about to get shafted, making sure to sell their stuff before yours (the house bets last but holds the cards). This lack of clarity coupled with the notion of reversing direction on the so called ‘modernization’ of securities laws in the late nineties fueled skepticism in the press.

Peter Wallison, writing in the Wall Street Journal, put up a clever argument as to why the ban on proprietary trading is not such a good idea:

“Because banks are government-backed, and privileged in many ways, their activities are limited by law and regulation. They are restricted in how they can use their insured deposits. The Glass-Steagall Act, despite what we constantly hear in the media and from people who should know better, still applies to banks; it forbids them from engaging in underwriting or dealing in securities. This should prohibit them from engaging in proprietary trading to the extent that this is dealing in securities. Bank holding companies, however, because they are not banks and not government-backed, can engage in any financial activity, including securities dealing. Why would we prohibit them from doing so when they are using their own funds? “

I count myself as one of the people Mr. Wallison believes should know better but gosh darn it here I goes anyway. If it turns out that Congress passes a law telling bank holding companies they can’t play online Texas hold ‘em with their own money, good! Yes, they are not using directly backed government funds but neither were AIG, Citigroup, or GM for that matter. But they all got infusions of government (taxpayer) funds because without their continuing operation, the economy would supposedly fall deeper into the abyss. By default (punny!) these large financial institutions are backed by the government just like a sixteen year old is backed by her parents when the gas money accidentally goes towards a new pair of Uggs. The fact there are financial institutions so large that their demise would sink a $14 trillion economy was also addressed by the Obama administration on Thursday but it’s not as exciting as the rise from the dead of Glass-Steagall (I know, I have goose bumps too!) so I won’t go there.

I like the president’s proposal in two ways. First, Glass-Steagall never should have been repealed. Second, the specificity of the proposal hopefully signals an end to this administration’s jones for huge, un-passable chunks of reforms.

Later

Over Stimulated

Can government spending end a recession? Those crazy bastards at the Heritage Foundation think not. In a well written piece in last week’s Wall Street Journal, Brian Riedl (the Grover M. Hermann Fellow in Federal Budgetary Affairs in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation (1)) argues that the great Keynesian federal money enema of 2009/10 will not only add bupkis to the short term national income, it will kill us in the long term.

Riedl sums up his argument by explaining where stimulus money comes from:

“Congress cannot create new purchasing power out of thin air. If it funds new spending with taxes, it is simply redistributing existing purchasing power (while decreasing incentives to produce income and output). If Congress instead borrows the money from domestic investors, those investors will have that much less to invest or to spend in the private economy. If they borrow the money from foreigners, the balance of payments will adjust by equally raising net imports, leaving total demand and output unchanged. Every dollar Congress spends must first come from somewhere else.”

Those in favor of stimulus and yet more stimulus may concede the “where it comes from” argument but would counter by noting the benefits of pumping magic money into the economy. Stimulus seekers could say that there is a multiplier effect from government spending. In fact, the Obama administration contends that virtually all stimulus spending creates or saves jobs and therefore has a multiplier effect of around 1.5. Simply put, for every $1 sent out through stimulus spending a $1.50 is eventually created in the wider economy.

Now comes the fun; It is impossible to measure a multiplier and anyone who says they can is either a college professor or someone trying to sell you something. But let’s not allow spurious data and intellectually bankrupt methodologies to slow us down. Let’s accept the idea that multipliers are measurable and see where it takes us.

Let us assume a revenue neutral program in the same vein as food stamps or unemployment insurance in that we are not expecting an annual return from the expenditure. What we are expecting is the passing along of that $100 to other participants in the economy thus promoting growth. Now let’s say the government borrows $100 from you or increases your taxes by the same amount and uses it to plant grass in an old parking lot to make it look better, become green, and provide a frequently unemployed local (we’ll call him Cletus) with a modest steady job mowing the grass. At first blush this seems like, and can even be measured as, a win/win. Let’s also assume all materials are purchased locally and all pre-Cletus labor is local as well.

So what’s bad about our imagined cash for grass program? As the saying goes, it’s what happens next that counts. Your $100 is a one time multiplier. It added value once and cannot create additional value to support the new lawn or Cletus. Eventually, additional funds will have to be allocated to maintain the Fescue-Cletus industrial complex. The value of the money you gave to or was taken from you by the government drastically decreases over time. Had that money stayed in a bank (and been loaned out) or invested in a business it would have had a much better chance of generating lasting value and thereby providing a long term multiple. The economy may have to wait longer and experience a smaller rush than with the cash for grass program but over time there would be greater benefit. How much is arguable depending on the nature of the investment or savings.

Could there be a different result had your $100 gone to a green energy startup? My guess is yes but there are private sector players in place who can invest your $100 in startups and can do it with less overhead and are held accountable in ways government can’t be (when was the last time a congressman from Massachusetts was fired?).

So what’s my point? If the government insists on redistributing or borrowing money to put a spark in the economy, let’s make sure it’s limited to those things the it can do that the private sector can’t (not much), like properly funding unemployment insurance and food stamps. And as for Cletus and his family, we should ensure his participation in the economy through providing opportunity and support rather than a push onto a government plantation.

Later.


(1) I’m wondering if the Heritage Foundation is going the way of the college bowls in its approach to sponsorship. Could we eventually see the Tostitos and Miller Lite Fellow in Consumer Affairs in the National Car Rental/Chick-fil-A Institute of Over Consumption?

Preparation GMAC

To prevent or to prepare? It’s a question you probably ask yourself a lot more than you realize. In relationships, business, and even our health we often have to decide if it is better to try to prevent something from happening than it is to prepare for it (or vice versa). Charles De Gaulle once said we should all make use of the inevitable. He was a preparer and an expert survivor. He was also French and a real asshole.

Chuck, however, was able to secure French participation in the division of Germany post World War II, avoid having American troops stationed in France, and even develop advanced nuclear power and weapons capability largely without American or British help. In short, he led France out of a horrible period of war and despair into a period of independence and abundance without having to give up much. De Gaulle had the insight that France would be better off understanding and adapting to post war change than trying to prevent that change from altering the country(1).

Unfortunately the US Treasury Department does not share De Gaulle’s philosophy. On December 30th the Treasury Department announced a $3.8 billion capital infusion into General Motors Acceptance Corporation (GMAC) extending it’s ownership of the one time General Motor’s division to 56%. The intent is to "protect taxpayers and put GMAC in a position to raise private capital and pay back taxpayers as soon as practicable," announced the Treasury. The reason the government feels the need to ‘protect’ taxpayers is because it already shelled out $12.5 billion to keep GMAC solvent. From a tax payer perspective it’s a lot like betting the over/under to make up for a loss if the Colts don’t cover against the Bills. A strategy traditionally referred to as throwing good money after bad.

So what the hell does this have to do with my prevent or prepare question three paragraph’s ago? The Treasury is trying to prevent GMAC from biting the big one when it may be cheaper and less risky to put a bullet in it. Here’s my reasoning, or more accurately put my rant: A free market should allow for the destruction of participants that can not survive through self generated value. This assumes it is more costly and risky trying to prevent such a loss than to prepare for it. We’ve seen above how the U.S. Treasury is trying to prevent the loss of a major financial player under the assumption that its demise would negatively impact auto and home lending. Could it be cheaper and less risky if we prepared for it? I vote yes.

Here’s how preparation makes more sense than prevention. First, allow GMAC to go bankrupt. I’m not talking about bankruptcy light like chapter 11. No, no, I’m talking lucky 7; liquidation. The good loans would find a home and the bad loans would be written off. The argument against liquidation is that there would be less lending bandwidth for cars and houses and would thus impact economic growth. That’s not a bad thing because too much lending got us into the current mess.

Another part of the preparation would be to insure loans properly, as savings accounts are today, so that defaults would be covered. This approach is somewhat robbing Peter to pay Paul in that higher interest rates are the preferred mechanism to protect against defaults. However, adding default insurance could be better for consumers and lenders by offering more appropriate pricing.

In short, we can prepare for economic tsunamis by constantly adding taxpayer bricks to the seawall or we can pick our beachside property more carefully and put our houses on pilings. We can fall prey to the hubris of believing we can control complex events and systems or we can recognize the inevitable and make use of it.

Later


(1) Shady note: Isn’t it interesting how France is viewed today as being regressive and insular? Another De Gaulle quote “I have tried to lift France out of the mud. But she will return to her errors and vomitings. I cannot prevent the French from being French.”