warren · j. · dew

The latest economic news incudes administration complaints about the prospect of high bonuses at invesment banks. So why are these bonuses expected to be so high?

Well, as it turns out, the investment industry has done extremely well this year - as might be expected given the recovery of stock indices like the DJIA and S&P 500, which are up more than 50% since their lows near the beginning of the year. Good performance is reflected in high bonuses - exactly the kind of performance based pay the administration was advocating a few months ago.

It's more than just that, though. The investment industry is to a large extent what's driving the recovery; without their putting their money back into the market, the Dow would still be languishing at 6,000, instead of having recovered to 10,000. Without the recovery in the market, people who watch their retirement accounts would not have started spending again. We wouldn't have what little recovery we've seen, and the unemployment rate might be climbing towards 20% rather than stabilizing at 10%.

Now, it's certainly true that some investment banks were the beneficiaries of some government bailouts - especially indirectly, through the guarantee of AIG swaps that those banks had purchased. But you know what? If the government gives out money, whether in bailouts or other handouts, you have to expect that people's performance will including playing the government for as much of that money as possible. The answer here is to stop bailing people out, so their performance will be based on productivity, rather than on playing the game.

The administration can hardly complain when people are taking their advice, and compensating based on performance. And if they're unhappy with what that performance is based on, they should be learning instead of lecturing: in this case, learning that bailouts and handouts are counterproductive when trying to get people to be productive and to get the economy back on track.

Article on administration statements:
http://www.washingtonpost.com/wp-dyn/content/article/2009/10/18/AR2009101802542.html?hpid=topnews

Here's a breakdown of how fast the $787,000,000,000 of Federal stimulus money approved early this year is being spent:

151 billion has been spent so far and $185 billion will be spent by year's end. Another $399 billion will be spent next year ... and $134 billion will be spent by the end of 2011 ...

I guess Congress was planning for a slow recovery.

A week ago, the Obama administration imposed a 35% duty on Chinese tires:

http://timesofindia.indiatimes.com/news/business/international-business/US-imposes-35-additional-duty-on-Chinese-tyres-/articleshow/5003191.cms

The American owner of a couple of the Chinese tire factories waited only a few days to pass along the cost to the consumer:

http://www.tirebusiness.com/subscriber/headlines2.phtml?cat=1&headline=Cooper+raising+prices+on+most+consumer+tire+lines&id=1253220210

Basically the duty ends up as a tax on discount tires that are bought primarily by the poor and marginally employed.

Who benefits? JK Tyre, with factories in India and Mexico, may benefit from low cost labor outside of China. Goodyear might benefit somewhat, but even with the duties, they'll find it difficult to compete in the discount market. Probably the biggest beneficiary is Bridgestone, the big Japanese tire manufacturer.

So basically, the working poor in America end up subsidizing the Japanese tire industry. Brilliant.

I recently started seeing, up close, the first solid evidence of this year's economic stimulus plan. It was really solid evidence, too: replacement granite curbs at a couple of intersections along our street.

You hadn't realized that granite curbs wore out to the point they needed replacement? Well, neither had I. However, work doesn't have to be produce something useful to stimulate the economy: as long as workers get hired and paid, they have more money to spend than they otherwise would have, and the additional spending will help restore demand for actual useful products. Eventually, so the theory goes, the extra demand will result in rehiring of the workers laid off earlier in the recession, ending the recession.

You may have noticed a slight flaw in this theory: if the laid off workers have already been rehired for the unproductive work, they won't be available for rehiring for actual productive work. Instead, the supply of useful products will continue to be limited, and with more money chasing after the same amount of goods, we'll see inflation instead.

As usual with the economy, government intervention is likely to have the opposite of the intended effect: in this case, it is prolonging actual recession conditions of limited useful production and employment. Fortunately for the government, statistics will be able to cover that up by valuing the new granite curbs as if the old ones had actually worn completely away.

You may have heard of the banking industry "stress tests" - "what if" scenarios to see how the government thinks banks would fare under a variety of economic scenarios. The most stressful case is an assumption that the current recession gets even worse, deepening and continuing past the end of the year.

The result is government pressure for banks to increase their equity ratio significantly beyond what is required by regulations. ( There are two ways to achieve this. )

Either way, it seems the government's analysis of a "worst case" recession could become something of a self fulfilling prophecy. We're currently set to come out of the recession this summer, but the government's preparing for it to continue through next winter may cause just that to happen.

Articles, one listing the results, the others discussing them:
http://www.bizjournals.com/birmingham/stories/2009/05/04/daily44.html
http://www.washingtonpost.com/wp-dyn/content/article/2009/05/07/AR2009050704257.html
http://online.wsj.com/article/SB124172137962697121.html

With Chrysler finally in bankruptcy, the spotlight in the auto industry shifts to GM. And with the government using the Chrysler creditors as a scapegoat, the spotlight is now squarely on the GM creditors.

Evidently the GM creditors realize this. ( They've provided a counteroffer that makes more business sense - but may be less acceptable politically - than the government's offer. )

The effects of government profligacy are beginning to show. The government managed to run up a bigger deficit in the first six months of this fiscal year - $956,800 million - than in all twelve months of the previous fiscal year - $454,800 million - which itself was a record. The runaway deficit is partly because tax receipts are down, by about 15%, but mostly because the spending rate has nearly doubled from last year. If things keep going this way, we'll manage to top the previous record deficit by a factor of four.

There's a limit to how long we can get away with this. While the recession continues, it may hide the inflationary effects of the extra spending; however, when we do pull out of the recession, we may quickly go to stagflation and not to a long term healthy economy.

One source for more specific numbers:
http://online.wsj.com/article/BT-CO-20090410-704541.html

Today's big news on U.S. auto makers is that Ford, which refused Federal bailout funds, today retired $9,900 million in debt - 38% of their outstanding debt - for $2,400 million in cash plus about a 20% equity stake. Evidently capital availability is not as bad as it has been made out to be.

Meanwhile, GM, which borrowed $13,000 million from the government, still needs to borrow $16,000 million more, and is talking about bankruptcy anyway. One of the problems there seems to be that administration pressure to go harder on some groups and softer on others is interfering with a deal.

Just a little lesson about government interference with the economy.

Links, first on Ford, then on GM:
http://voices.washingtonpost.com/economy-watch/2009/04/ford_slashes_debt_stays_ahead.html?hpid=moreheadlines
http://www.bizjournals.com/stlouis/stories/2009/04/06/daily4.html

Amidst the continuing bad economic news dominating the headlines, there was some good news this week: home sales were up about 5% in February, contrary to predictions, and durable goods sales were also up more than expected. The reason is simple: prices are down, in the case of homes by about 15-20% from a year ago. As with any product, when there is a pricing bubble, people usually figure it out eventually and stop buying; when the bubble bursts, people start buying again.

Now if the government would just quit interfering, we might see the rest of the economy recover, too.

Links:
http://www.cbc.ca/money/story/2009/03/25/us-homes-new-orders.html
http://online.wsj.com/article/SB123781706899814483.html?mod=googlenews_wsj
http://www.foxbusiness.com/story/markets/economy/existing-home-sales--february/

A few days ago, I went out to a restaurant for lunch with a friend from work. I haven't gone out for lunch for a few months - usually I get something and bring it back to the office - and it struck me that there were only perhaps half as many people in the restaurant as usual. ( why encouraging savings might be as good as encouraging spending for preventing this )

I see bonuses at financial services companies are in the news again. I was going to comment on bank bonuses last time around, but procrastinated too long, so I'll take the opportunity now.

To understand the issue regarding banking bonuses, one has to understand how banks operate. ( A lot of those 'bonuses' are part of the ordinary pay package for ordinary employees, like overtime is for auto workers. )

Finally, it's to be noted that the total amount of the AIG bonuses in question is only about 1/1000th the amount that the government is spending on bailing out AIG (165 million vs 171 Billion - 171,000 million - which itself is small compared to recent federal bailout spending). If these bonuses are profligate, the government is being 1000 times as profligate by doing the bailout in the first place.

If anyone needs to commit seppuku, maybe it's Sen. Grassley, Barney Frank, and the rest of the "bailout congress".

We've heard a lot about government bailouts in the past few months. So what exactly are these bailouts? After hearing some more griping about one of them - the part of the Troubled Assets Relief Program (TARP) that was devoted to stable banks like Wells Fargo and Bank of America - I decided to read up on some of the details.

( it turns out it's as much the banks bailing out the government as the government bailing out the banks. )

Finally, some sense from the government on the economic situation: Bush is suggesting that the proper course for GM and Chrysler might be "orderly bankruptcy". If that amounts to Chapter 11 reorganization with the government bridge financing, that might be okay - though hopefully it's done under a bankruptcy judge rather than under a political appointee.

That said, the last time the federal government did something responsible, they changed course almost immediately, so there's still time to snatch disaster from the jaws of victory here.

Detroit Free Press article:
http://www.freep.com/article/20081218/BUSINESS01/81218051/?imw=Y

Federal Reserve Chairman Ben Bernanke has a theory that the great depression was caused by a loss of confidence in the banking system. He's trying to prevent that now by injecting cash into the system.

The problem is that confidence isn't a concrete thing like cash. It's a psychological thing: more about trust and sense than about dollars and cents.

If you wonder what's happening to the stock market - or to your retirement plan - right now, it's directly related to lack of trust in Bernanke, and in the government in general. The stock market trusts capitalism and the private sector; the more government intervention it sees - especially with talk going around about nationalizing banks and such - the less confidence it has that stock certificates mean anything, and the lower the value it assigns to those certificates.

The answer is not, as Bernanke and Paulson and Bush and Pelosi seem to suggest, more intervention. The answer is for the government to back off and let the free market do its thing.

As I mentioned yesterday, Citigroup's agreement to purchase Wachovia's banking assets on Monday was an illustration of how the present system can work, without new forms of government intervention. ( Now Wachovia has even attracted a second, competing offer from Wells-Fargo )

This is the way the system should work - and the way it does work when the government relies on well thought out institutions, like the FDIC, instead of on having wannabe cavalrymen taking precipitate action.

One good article on Wells-Wachovia deal:
http://www.iht.com/articles/2008/10/03/business/04bank1.php

This was originally composed as a comment to a post on a friend's blog, entitled "The Next Great Depression? When Trust Vanishes, Worry". Unfortunately I can't seem to get a comment through to his site, so I'm posting it here instead.

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When people talk about the banks being scared to lend, I have to laugh. I received two 0% credit card offers yesterday - and they were good, too, 0% for a full year. I haven't received offers like that since the internet bubble.

Are banks going to start looking more carefully at subprime mortgages? ( more on bank responsibility and how the Fed could cause far bigger problems than they're trying to cure. )

That's what the worst case economic scenario really is - and that's where the bailout is taking us. Fortunately, we still have a chance to say no.

For the first time in the last few years, the house has made a sensible fiscal decision.

I've been wanting to write a longer post on this, but here's the quick version: Ben Bernanke, chairman of the Federal Reserve Board, sees housing crises under his bed. He and Paulson, the treasury secretary, engineer a takeover of FNMA and FHLMC that triggers a bunch of hedge contracts and causes a minor liquidity crisis and a major financial panic. They then use that panic to try to stampede Congress into approving a huge $700 Billion bank "bailout".

This is a perfect recipe for years of double digit inflation, loss of confidence in the dollar, and possibly the first depression since the 1930s.

Fortunately the House has voted against the bill. Hopefully they can hold the line in any revote that's scheduled.

The administration is projecting a Federal deficit of $482 Billion next year. This is bigger than the entire Federal budget was back when I was in DC. For a more recent comparison, it's bigger than the current combined budgets of the Army, Navy, and Air Force.

Naturally, each Presidential candidate's campaign is taking the opportunity to say how he will balance the budget, while his opponent will make the deficit worse.

A quick look at this year's veto overrides calls those claims into question. One override was a $100 Billion water projects bill that was almost entirely pork barrel expenditures - the first time congress overrode a veto by the current president. Another was a $300 Billion agriculture bill that included at least $100 Billion in obvious pork, quite possibly a lot more depending on what one considers to be pork. That's $400 Billion in vetoed expenditures right there, that congress insisted on spending anyway. The new president's vetos won't be any harder to override, so it's doubtful that the president alone can change the trend.

What could help is a little more responsibility in congress. Perhaps we need to pay attention to more than just the presidential election this fall.

The UK has government health care. Sometimes, their National Health Service funds IVF. When it does, it usually just funds one cycle. Still, even that one cycle is sometimes successful. A successful cycle means one or more children, which means more health care costs.

The solution? Put in rules that force clinics to transfer fewer embryos - preferably only one. The claimed benefit is that that will reduce the chances of twins, but it will do so mostly by reducing the chances of success at all. Fewer pesky children to deal with means lower health care costs.

Fortunately, the UK now allows people to pay for their own health care if they want more than their national health insurance provides. If people need IVF, it seems fair to ask them to pay for their own, right? Unfortunately, the new rules will apply to clinics across the board - even prospective parents willing to pay for their own IVFs will now have to deal with lower success rates due to government restrictions.

Of course, it could be worse. The system could prohibit people from buying health care outside the government system at all, which is what some people are advocating in the U.S.

Wednesday, U.S. Secretary of State Condoleezza Rice called for "creative solutions" for dealing with the middle east.

Thursday, Hamas knocked down the fence between the Gaza and Egypt, temporarily ending the isolation of Gaza.

Well, that's pretty creative.