Resurrect Capitalism!

March 7, 2009

Rewarding Irresponsibility

Filed under: bailouts, injustice, socialism — Tags: , , — admin @ 9:13 pm

The Obama administration is intent on rewarding the irresponsible members of our society.  This includes irresponsible borrowers and irresponsible lenders.  Resentment is building up among the responsible.

Lenders who steered away from reckless lending are now being forced to bailout their reckless peers.  As you might guess they are not happy about this prospect.

TCF Financial Corp., the Wayzata, Minnesota-based bank that never made a subprime loan and hasn’t lost money since 1995, is asking why it should help clean up the mess made by Wall Street.

“I’m kind of bitter,” said William Cooper, chief executive officer of the 448-branch bank, adding that over the years TCF has invested about $1 billion in the Federal Deposit Insurance Corp.’s fund that guarantees bank deposits. “We pay for the excesses of our competitor over and over again.”

The FDIC fees keep increasing.  If we were capitalists the bankers like William Cooper would be scooping up market share as the irresponsible giants stagnated or failed.  Instead we allow those most responsible for this economic crisis to survive, even profit from being so incompetent that they would cause politically unacceptable fallout if they failed.

In every segment of our economy those who pull their own weight and live with the consequences of their actions are forced to socialize the losses of the irresponsible.  This is NOT RIGHT!  This is a grave injustice that will have devastating long-term consequences.

Another important observation here: Obama and other socialists are insisting that our economy has no life.  But institutions like TCF Financial Corp-  not a small lender by any means-  is alive and well without any government support.  Actually government support  is hurting it as TCF is forced to subsidize its rivals.

This is not capitalism that we are living under.

January 15, 2009

Zombie Banks: Why Bailouts Fail

Filed under: bailouts, bubbles, economics — Tags: , , — admin @ 12:17 pm

A good article about a relatively small bailout recipient, Independent Bank of Michigan.  It has received a “mere” $72M in bailout bucks but is a good microcosm of what went wrong in our economy. 

Like many other lenders Independent Bank went overboard with lending in the Great Credit Bubble, granting loans too freely.  They priced risk too cheaply.  Now they are reeling from the consequences of their poor lending decisions and defaults are destroying their balance sheet. 

As of the end of September, the bank was burdened by $115 million in bad debts, or nearly 5 percent of its overall loan portfolio, compared with less than 1 percent in 2005. Each of these failed projects has something essential in common, [senior V.P. of Independent Bank] Lightbody said.

“We didn’t step back and look at the big picture, asking ourselves, are we really doing the right thing with this loan?” he said. “Everyone was making a lot of money.”

Unfortunately it looks like the best course of action for 144 year old Independent Bank is to go under.  This is the downside to capitalism:  you make a sufficiently large number of bad decisions and you are gone.  While unpleasant in the short term it is ultimately a highly effective feedback mechanism. 

Of course our politicians and economists don’t trust capitalism and instead gave a relatively large cash infusion to Independent Bank.  [I don't blame Independent Bank- if I was drowning I wouldn't care who threw me a life preserver or what strings were attached to it. ]

They received bailout bucks so they would start lending again, but that hasn’t happened:

“It is like if you are in an airplane and the oxygen mask comes down,” said Stefanie Kimball, the bank’s chief lending officer. “First thing you do is put your own mask on, stabilize yourself.”

This is not what the Treasury Department had in mind when it started this program, saying it would give the nation’s “healthy banks” enough money to start lending again, so that people could buy homes and businesses could invest and create jobs, thereby invigorating a disintegrating economy.

So Independent Bank isn’t lending much.  They don’t want to lend freely as they have seen the error of their ways and are suffering the consequences (that is, they have experienced a psychology change from “euphoria” to “despair”).  Due to the state of the economy they are even less inclined to lend.  Besides which they need the bailout funds just to stay solvent and cover losses on loans they’ve already made. 

The stimulus is really just life support.  This bank isn’t doing what banks are supposed to do (lend prudently).  Independent Bank is basically a zombie bank.  The important thing to realize is that Independent Bank wasn’t particularly bad compared to its peers. 

Taxpayer money that would otherwise go to more productive uses is now going to keep these Zombie banks alive.  This has all been done before.  The healthy are burdened to keep the vegetables on life support. 

Our government might drag us into a full-blown depression.  If they really wanted to help they could eliminate some cost barriers.  Tax cuts would be great but for the overwhelming deficit.  Overly burdensome regulations could be lifted and it would stimulate the economy while costing essentially nothing from a public finance standpoint.  I will explore this in more detail in the future.

January 12, 2009

Achieving Real Economic Growth

Filed under: bailouts, economic growth, economics, politics — Tags: , , , — admin @ 9:03 pm

One of the main reasons I’m so highly critical of these trillions of dollars of bailouts is because they are an attempt to extend exactly the type of behavior that got us into this mess we’re in.  We got into trouble because we (businesses, consumers, governments) took on so much more debt than we could service.  In a perfectly rational response, individuals and businesses are cutting back consumption to sustainable levels.

Politicians and economists want us to keep spending so we can attempt to consume our way out of this decline. Besides reinforcing bad behavior and racking up frightening debts I think this approach is doomed to fail.

What we need is real growth, not the spurious inflation of GDP that politicians are seeking through jaw-dropping bailouts.  I think the core of the problem is that politicians, many of whom have never had real jobs in their lives, do not really understand or trust what drives growth and progress.

The commonly accepted definition of economic growth:

Economic growth is the increase in the amount of goods and services produced by an economy over time.

By this definition a nation’s GDP is a measure of economic growth.  While GDP is a good indicator I don’t believe it encompasses the true essence of what growth is.

For instance, let’s say you stop mowing your lawn and hire a landscaper to do it.  What was formerly an investment of your time now becomes a formal cash transaction.  According to the standard definition economic growth has occurred in this scenario.  I argue that this example shows no economic growth. By simple extension using a daycare service instead of having a stay at home parent represents economic growth, and so do many other service arrangements.

Hedge fund traders who shuffle slips of paper back and forth are “causing growth” according to the standard definition.  The boom in subprime and other high-risk lending was recorded as “economic growth”, even though we now know how destructive such financial instruments ultimately were.

What’s missing in the standard view is the notion that to get economic growth something must be improved.  I don’t think politicians understand this.

My criticism of the standard definition of economic growth led me to challenge myself to devise a better one.  I think any definition of growth should encompass the notion of dynamism and improvements that we typically associate with growth and progress.

The ResurrectCapitalism.com definition of economic growth:

Economic growth occurs when demand is better satisfied

A more informal restatement of the growth principle:

Economic growth occurs when problems are lessened

Applying the growth principle in the negative direction we arrive at:

Economic decline occurs when demand is poorer satisfied

or

Economic decline occurs when problems are worsened

One must be careful with “better satisfied”.  “Better” implies a long-term improvement.  For example, subprime debt was the market’s response to the demand for higher yielding debt instruments.  Temporarily it increased profits and by the conventional definition it increased growth for a time.  But it did not better satisfy the demand for higher yields as it ultimately caused large negative yields.

One of the problems with my definition of economic growth is that it is difficult to measure.  How does one measure improvements in problems?  I’m not so sure.  But I’d gladly exchange vague measures of growth (with known limitations) for misleading ones.  Vague growth proxies with known limitations would also have the advantage of being less appealing for central planners (that is, central bankers) to manipulate.

Growth can be obtained through technological innovation but is not limited to that.  For instance, a change in a company’s supply chain that causes a reduction in damaged product is growth, as the same demand (the same number of goods) can be satisfied with a lower cost.

The invention of a “better” form of energy that is cheaper and has less pollutants would be a phenomenal dose of growth for the entire economy.

A reduction in taxes can cause growth by enabling the development of new businesses and investment in new technologies.   [One must be nuanced here- if taxes are cut but spending isn't then debt is accumulated.  Over time the net effect of the tax cut can be stagnation or decline, as the accumulated debt from the tax cut can end up costing dearly].

One of the nice aspects of my definition for economic growth is that it so naturally coincides with how a capitalistic economy works.  A business grows when it provides solutions / improvements for someone else.  Individual income grows as one gets more knowledge and expertise, i.e. as one is better able to add value to a business.  Why shouldn’t it be the same for the economy as a whole?

If our government really us wanted to grow our way out of this problem they would cut taxes, cut spending, and (at least temporarily) loosen many regulations that hinder commerce.  Instead they seem to be obsessed with having their cake and eating it too.  Our politicians and economists do not fundamentally trust capitalism- they think that they know better than we do.

January 10, 2009

The Entitlement Bubble

Filed under: bailouts, bubbles, economics, entitlements, politics — Tags: , , , , — admin @ 7:59 pm

Last week I got my annual statement in the mail from the Social Security administration that listed my contributions for 2008.  I was disgusted by the number!  When thinking about alternative uses for that money my mind races with possibilities.  That is MY MONEY and at the end of it all I will probably never get one dime of my contributions back.

Through no decision of my own I spend more on SS than I spend on my own children.  I involuntarily spend more on Social Security than on anything else except for housing.  I wish I had the option of not paying into Social Security in exchange for not receiving any future benefits.  Alas that will not happen any time soon as our government has too much invested politically in intergenerational Ponzi schemes (the fact that SS is a Ponzi scheme is a future post in and of itself).

My SS statement got me thinking about the larger problem of funding entitlements.  Most people don’t realize how large benefits expenditures are.  Social Security comprises 20.9% and Medicare / Medicaid comprises 20.4% of the entire federal budget.  In comparison, total military spending accounts for 20.1% of the federal budget.  Just at the federal level we are spending twice as much on entitlement programs as we are on military expenditures.  Let that sink in.  2/5 of our federal expenditures are going to entitlements.  As the Baby Boomer generation nears retirement the proportion of federal spending that goes to entitlements is going to increase a bit.

In the late 1990’s / early 2000’s we had a massive stock bubble.  Then we had a real estate and credit bubble.  European investors inflated an emerging markets bubble.  In 2007-2008 we had an oil and commodity bubble.  As all of these bubbles fade away it is clear that we still have a massive bubble to lance, far larger than all other bubbles: entitlements.  The entitlement bubble has existed since the New Deal but the magnitude of the problem has grown ever larger since.

Simply put, we have too many people receiving too many entitlements.  Our federal, state, and local governments have made promises that they will not be able to keep for too much longer.  The situation is unsustainable and the entitlement bubble problem is becoming more obvious as our economy slumps further.

Demography exacerbates the entitlement funding problem.  The people who are or soon will be receiving entitlements didn’t have enough children.

The entitlement bubble grows differently from other bubbles in a key way: it is funded not by voluntary market participants but by involuntary taxes.  Stock, real estate, and other market-based bubble participants have to pony up their own cash (or borrowed cash they they are responsible for) to keep the bubble growing.  Recipients of the entitlement bubble can vote to inflate the bubble further and it doesn’t directly cost them anything.

And that is the crux of the problem.  Politicians have a very strong incentive to expand or at least maintain the entitlement bubble because entitlement recipients vote in large proportions and they tend to vote with their wallets. Many politicians see the problem but they don’t dare try to scale back the entitlements for fear of backlash at the next election.

Social Security is going to start running in the red in 2017, or perhaps a bit earlier due to the recession we are in.  [Many people claim that SS will be solvent until 2041 or so due to the "trust fund"- but you must understand that our federal government has spent every single cent of the "trust fund"].  Obama says that he is going to reform entitlement programs but I am extremely skeptical.  We shall see.

Many individual states are running into entitlement funding problems for their own employees, so this is not just a federal government problem.

I see no magic way out of this problem.  There are just too many wards of the state and too few productive people to support them.  Promises will need to be broken.  Any way you dice it taxes will go up and entitlement payouts will decline.  There will be changes to entitlement adjustment formulas.  Means testing will be introduced.  Taxes will one way or another rise.  They will probably be called “fees” or something that doesn’t sound as harsh.  Entitlement recipients will wail and cry and try to convince you that the world is about to end.

Ideally programs like Social Security would just be gradually phased out of existence but I don’t see any politician with the nerve to even hint at that.  Somehow we got along just fine before Social Security, Medicare, and the like were introduced and we will be fine without them.  I think there are two main solutions to get by without Social Security:

  1. able-bodied and minded people with insufficient savings shouldn’t retire, at least not fully
  2. families (children in particular) should pick up a greater portion of the care and cost of elderly relatives

People do not like to consider these options but sometime in the not too distant future reality will intrude.  We will be better off without these massive entitlement programs.  Think of all the alternative uses for the capital that goes to entitlements!

January 6, 2009

The Current Bailout Total: $7.2T

Filed under: bailouts, economics — Tags: , — admin @ 10:27 pm

Yes, you read that correctly: the current sum total of all bailout bucks is 7.2 TRILLION DOLLARS.  Our government is pulling out all the stops to spend money at a faster rate than at any time in world history.  The details are in this article.  To be fair a good chunk of the $7.2T is for the acquisition of assets that will likely have some payout (though presumably much less than what our government paid for them).

A true gem of a quote in the article:

“While it seems like quite a lot, we don’t really need to focus on the cost due to the depth of the recession,” said Mark Vitner, economist with Wachovia.

With guys like this it’s no wonder Wachovia went belly up.  This quote reinforces my contempt for economists.  We are selling out our future in a futile attempt to avoid pain today.  What will we tell our children when they are paying off this debt-  we went on a bailout orgy so that people didn’t have to sleep in the bed they made?

Here’s a more detailed breakdown of the specific bailouts.

Just for comparison:

We probably could’ve conquered the entire world for less than money than we’ve spent on these bailouts.  And for what?

The main thrust of these bailouts is to stimulate lending and credit.  Interestingly the massive bailouts do not seem to be stimulating credit much.  In the original article:

The economy nevertheless entered a recession in December 2007. Though the Fed rate is now at a targeted level of close to 0%, economists have noticed little change by way of increased availability of credit, lower private interest rates or a booming stock market.

The banks on the receiving end of the bailouts are not using the funds to extend credit.  They are using the money to repair their battered balance sheets.  Increasingly this is playing out like a replay of 1990’s Japan.

January 4, 2009

The Upside to Downturns

Filed under: bailouts, economics — Tags: , — admin @ 9:22 am

I find that I am a bit of a contrarian by nature.  In the great real estate and credit bubble I was very bearish and pessimistic when everyone else seemed to be pretty optimistic.  Now the massive losses that I have long predicted have been realized and even larger losses loom on the horizon.  The mass psychology has shifted to despair and pessimism but I feel optimistic for the future, so long as our government doesn’t kill our economy by “saving” us.

I’m of the opinion that recessions are not bad things in the long term.  With the boom comes the bust.  Everyone wants to reap the rewards of capitalism when things are going well (which is most of the time) but they simultaneously want to be shielded from the tradeoffs of capitalism when corrections occur. Privatize the gains, socialize the losses.

One of the most vital features of capitalism is feedback, and recessions are a very explicit form of feedback.  The weak are culled from the herd, thereby limiting the misallocation of capital into non-viable companies. You don’t see the pets.com dog sock puppet anymore and it took the early 2000’s internet meltdown to stop the flow of capital to such non-viable investments.

In the great bubble real estate and commodity prices (most notably oil) exploded to ludicrous levels.  With the onset of recession capital flow to these asset classes dried up and the great bubble was popped.  As a result housing and oil by-products (gasoline, home heating oil, etc.) have become a bit cheaper, two major expenses for most people.

home_price_index

composite housing price index for American cities

NYMEX crude oil futures price for barrel of oil

NYMEX crude oil futures price, $/barrel of oil

Another important effect of recessions is that they make individuals correct attitudes and behaviors that aren’t  sustainable.  When a deep recession hits many people are (temporarily) out of work  and those that stay employed feel a strong push to save more in case they themselves become jobless.   Every dollar must be stretched further.  Credit becomes tighter and individuals must think further ahead about the allocation of their own household capital (spending and saving decisions).

Recessions help to tame over-optimism.  They embed very vivid memories of what can go wrong and reinforce traditional values like frugality, self-reliance, and living within ones means.  Recessions help to tame personal and societal excesses.

In essence recessions should serve as learning experiences with the lesson hitting you hard.

Of course we are no longer capitalists in this country.  Politicians tell us they can help to avoid the damage, they can soothe the pain that recessions bring.  But financial losses are financial losses-  they have to be borne by someone.  The government cannot create economic growth to offset the losses merely by signing a bill, which is what a bailout attempts to do.  The government can however shift the burden of recovering losses to the people and companies that are not responsible for the financial losses. In bailouts the natural feedback processes of capitalism are distorted.  Let’s hope they are not distorted too much by wannabee saviors in Washington, D.C.!

All of this is not to say that recessions are to be desired.  Recessions bring about a lot of collateral damage.  Many people who worked hard and lived within their means will find themselves struggling to stay afloat in this recession.  Companies that have no direct exposure to the toxic financial instruments that felled the investment banks are nonetheless finding that their access to credit is limited.  “A falling tide sinks all boats”, as the saying goes.

Recessions are not all doom and gloom.  I hope that in this recession Americans reduce their debt and increase their saving rates.  Ideally governments would trim back to a more sustianable size but the exact opposite is happening.  This may come back to haunt us in a very dire way.

January 2, 2009

This Isn’t Capitalism!

Filed under: bailouts, economics — Tags: , , — admin @ 10:50 pm

The increasing magnitude and frequency of government bailouts is the real reason why I started this blog.  Few things make my blood boil more than corporate bailouts financed with taxpayer money.  One of the best features of capitalism is also one of its most ruthless: the weeding out of entities that cannot compete.  This Darwinian feedback mechanism, while painful in the short term, is ultimately beneficial as it limits the misallocation of a precious, finite resource with multiple alternative uses (money).

Government bailouts short-circuit this weeding out function of the market.  Inefficient, obsolete organizations can limp along indefinitely with sufficient government support. In command economies organizations with the right political connections could and did survive for years at a time while doing almost nothing.

Bailouts also set a horrible precedent.  That is, bailouts propagate.  As we are seeing now, a bailout of one company increases the likelihood that other companies will get bailouts.  After all, if company A gets a bailout then why don’t competitors B, C, and D also get bailouts?  It’s only fair.

And if the finance industry gets jaw-dropping $700B bailouts in addition to assuming trillions of dollars of questionable assets, why does the auto industry not deserve but a small fraction of that?  And if the auto industry gets loans, why not the steel industry? And what about the newspaper industry?

Why stop at companies?  State and local governments feel entitled to bailout bucks, too.  They can’t be expected to live within their means.

The real remedies to the problems are clear in all cases.  Banks that made catastrophic financial decisions should go out of business.  The Detroit automakers need to go bankrupt and dramatically slash their labor and benefits costs so that they can be competitive.  Governments at all levels (especially the federal government) need to spend less.

govt_cheese

Take a bite, everyone else is!

Of course, none of these straightforward solutions will buy votes.  Nobody wants to sleep in the bed they made (unless things turn out well, of course).  People are panicking and politicians have an irresistible urge to be seen as part of the solution. Everyone is afraid to let capitalism run its course.

When will these bailouts end?  I don’t want to contemplate this but I will track the bailouts all along the way.  Keep in mind that bailouts are self-propagating.  Once the “free” money spigot has been opened all the pigs line up at the trough, grunting and shoving for what they claim to be their fair share.

pigsatthetroughmodern CEO’s

It is shameful but due to the massive bailouts the goal for many CEO’s these days is not to generate profits.  A better strategy is to fail spectacularly and then spin a sob story to Congress about how you are “too big to fail”.  Then grab a cut of the bailout bonanza.  It’s pathetic but in sheer dollar amounts CEO’s are the biggest socialists in America.

Perhaps the most troubling aspect of these bailouts is the question no one is asking: how are we going to pay for this shit? That will be the subject of future posts. Get out the antacids because there are no good options.

Above and beyond all these practical difficulties inherent to bailouts is the immorality of it all.  A bailout is ultimately a transfer of wealth from people and companies who have made rational economic decisions to people and companies who have not.  That’s what gets me angry about bailouts.  People act as though the government has a magical ability to erase losses.  It cannnot fix problems in one company without taking money from others, from those who have not misallocated capital to the extent that they are insolvent.

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