Wednesday, December 30, 2009

Markets fail. That’s why we need markets.

It may sound odd, but only free and open markets, not government regulation, can quickly and effectively clean up the mess that markets sometimes make.

By Arnold Kling and Nick Schulz / December 28, 2009
Arlington, Va.; and Washington Two camps have fought the political and philosophical battle for influence over the economy in the United States for the past 100 years. They differ in their views over the nature of markets and government. And both are wrong.
One camp makes it sound as if markets can do no wrong. Their views were ascendant in the 1920s and again in the 1980s.
The other camp argues, “Markets fail, and that’s why we need government.” The idea is that markets are prone to excesses and imbalances and need the thoughtful, steadying hand of government to protect consumers and investors from flaws and uncertainties of the market. This camp believes that wise technocrats can and will bring order to the markets.
In the wake of the financial crisis that gave way to the broader economic downturn, the advocates of government involvement in the economy are once again on the march and traditional defenders of markets are in retreat. And so we have seen government advance its role with partial ownership of many big banks, with a take-over of automotive firms, with a large “stimulus” program, with proposals for cap-and-trade for carbon emissions, and with a major initiative on healthcare.
The traditional defenders of free markets have had a rough time getting a hearing lately. After all, it certainly appears as if markets don’t work in any meaningful sense. The Dow rises and plummets in harrowing fashion, the housing market balloons and then craters, financial services firms teeter on the edge of extinction one minute and swing to record profitability the next.
Surely, government can do better.
Or can it? Over the past two generations, a different view of markets and government has begun to emerge, one whose moment may have arrived. It is a view that believes both traditional camps have overlooked some important aspects of markets.
What’s more, it is a view that, if embraced, helps reinterpret market gyrations and government interventions in a way that better reflects reality. The view is subtle, but it has a profound influence on how the public and policymakers should think of markets and, ultimately, the role of government in the economy.
This view can be summarized as “Markets fail. That’s why we need markets.”
This seemingly paradoxical view is based on several overlapping strands of research in economics as it pertains to development, history, technology, business expansion, and new-firm formation. According to this view, entrepreneurs at work in the economy – in finance, high tech, manufacturing, services, and beyond – are constantly experimenting, creating new business models, techniques, and technologies that upend the established order of things.
Some new technologies and innovations are genuine improvements and are long-lasting welfare enhancers. But others are the basketball equivalent of pump fakes – they look like the real deal and prompt market actors to leap hastily into action, only to realize later that their bets were wrong.
Given this dynamic, markets are unpredictable, prone to booms and busts, characterized by bouts of exuberance that are rational or irrational only in hindsight.
But markets are also the only reliable mechanism for sorting out this messy process quickly. In spite of the booms and busts, markets drive genuine long-run innovation and wealth creation.
When governments attempt to impose order on this chaotic and inherently risky process, they immediately run up against two serious dangers.
The first is that they strangle new innovations before they can emerge. Thus proposals for a Consumer Financial Protection Agency, a systemic risk regulator, a public health insurance plan, a green jobs policy, or any attempt at top-down planning may do more harm than good.
The second danger has to do with the nature of political economy. Politics creates its own kind of innovators who can be as destabilizing to markets as market actors themselves – but in far more pernicious ways.
Economists call these political entrepreneurs “rent-seekers.” Rent-seekers gain wealth, not by creating it, but by channeling it through political favors. Examples include government-sponsored monopolies, “targeted” tax breaks for special industries, and legislative loopholes inserted by lobbyists.
The boom in housing and mortgage securities that ended so badly was fueled by government policies that were encouraged by rent-seekers in the real estate, home building, and mortgage finance industries.
Rent-seekers aren’t partisan. They used President Bush’s push for an ownership society to promote sketchy mortgage products. Before that, they used President Clinton’s push for a fairer economy to compel banks to make loans to poorer neighborhoods. In both cases, rent-seekers turned political slogans into profit, but at a steep cost to society when the boom ended.
The response to the current economic crisis has perpetuated and even intensified this process, as hundreds of billions of dollars of taxpayer funds have been used to prop up the very firms that took such reckless risks. The bigger the bad bet, the bigger the bailout.
This gets to the key difference between markets and governments. When innovation-driven excesses and imbalances are recognized in the marketplace, the system can correct itself quickly. This is less the case when government policy failure occurs.
Because political failure is less publicly tolerable than market failure, the temptation becomes for policymakers to avoid acknowledging their role in creating or perpetuating problems. Or they double down on bad bets. So rather than recognize the government’s central role in the housing boom and bust and quickly changing its ways, we see the federal policy apparatus continuing to throw good money after bad in the mortgage market and on Wall Street.
Markets fail; but they learn from their failures. That’s why we need markets. Government can promise to guarantee our prosperity; but only markets can really deliver.
Arnold Kling is an economist with the Mercatus Center’s Financial Markets Working Group at George Mason University. Nick Schulz is DeWitt Wallace Fellow at the American Enterprise Institute for Public Policy Research. They are coauthors of “From Poverty to Prosperity: Intangible Assets, Hidden Liabilities and the Lasting Triumph Over Scarcity.”


Prepare for a Keynesian Hangover

Our government's spending orgy will haunt us in 2010.

In 2008, as the U.S. economy teetered under the weight of years of reckless credit expansion, the Bush administration decided against proposals to sweep out the bad debts from the banking system and then fix the regulatory structure—an approach based on tried and tested models from the S&L crisis and other financial crises.
We will pay the price for this decision in 2010. That's because the Obama administration and the Federal Reserve are plowing forward with Plan B: Nationalize credit creation and "stimulate" the private sector by spending in its stead.
Richard Nixon's famous line, "We're all Keynesians now" never seemed more apropos. With the budget deficit at an eye-popping $1.4 trillion, and on track to stay above $1 trillion indefinitely, Berkeley economist Brad DeLong writes breezily in his Nov. 30 blog that "anything that boosts the government's deficit over the next two years passes the benefit-cost test—anything at all."
On the monetary side, the fireworks have been even more spectacular. Since the financial crisis of late 2008, the Fed has flooded the globe with newly conjured dollars in an unprecedented no-holds-barred effort to prod private credit expansion. Watching the booms in the markets for distressed debt, junk-rated corporate bonds and poor-country sovereign bonds since the summer, one might be forgiven for concluding that the Fed had succeeded well beyond its expectations, and that the market's flight to safety had given way to a flight to Vegas. Yet "the truth is that policy should be piling on," Princeton economist and New York Times columnist Paul Krugman writes in his Nov. 25 blog, "not looking for the exit."
Fed Chairman Ben Bernanke wants it both ways. On the one hand, he regularly reminds the market that he's already found the exit: continuously lending out its securities short term in order to soak up cash. The so-called reverse repo market through which this would be done is probably too small for the task of controlling inflation. But such a softly-softly approach is much more attractive politically than actually collapsing the Fed's bloated balance sheet, which would require dumping hundreds of billions of dollars of stockpiled mortgages.
On the other hand, Mr. Bernanke continues to berate the banks for failing to lend while the government continues to do so with heroic abandon.
Former Salvadoran finance minister Manuel Hinds points out in the latest issue of International Finance that banks have indeed been shirking on their day job of transforming increased deposits into increased private-sector credit. But they haven't quit entirely. In fact, they've funneled significant new funds into nonbank financial institutions—which have not lent them on. What's happening is that U.S. banks have been behaving exactly like developing country banks during earlier crises, such as Indonesian banks in the late 1990s—raising lending to their worst borrowers to keep them alive, lest the banks themselves collapse from their borrowers' defaults.
For U.S. banks, these zombie borrowers are their affiliated financial entities set up to manage so-called off-balance-sheet activities—such as the famous SIVs (structured investment vehicles) created by Citigroup and others during the boom. Thus, the massive fiscal and monetary bailouts of the banks have served to worsen the credit misallocation that led to the general economic collapse in 2008.
What is the right solution? The same one that most observers, including the U.S. government, backed until late 2008: Get the bad assets off of the banks' balance sheets. Banks will continue to use accounting gimmicks for window dressing, but as long as they know the truth—that their assets remain seriously impaired—they will continue to starve far too many sound commercial ventures.
Those who insist that the government buying up soured private assets amounts to an unacceptable bailout should be reminded that the market-driven alternative is called bankruptcy. Unfortunately, this option is now considered too politically toxic.
So what we're left with is the type of government-sponsored orgy of spending and money creation that Washington used to condemn with all-knowing righteousness when undertaken south of the border. But the effect of our doing it is far more consequential, since America possesses the exorbitant privilege of minting not only its own but the world's money.
As we move into 2010, no doubt the horns will be blowing for the long-awaited U-shaped recovery. I suspect it won't be long before we realize we've drunk too much, and that the second dip of a W-shaped recession awaits us.
Mr. Steil is director of international economics at the Council on Foreign Relations and co-author of "Money, Markets, and Sovereignty" (Yale University Press, 2009).


Monday, December 28, 2009

Adjusted for Inflation, Dow's Gains Are Puny

Many investors realize that stocks have been among the worst investments of the past decade. But they may not realize quite how bad the decade was, because most people forget about the effects of inflation.
Despite its 2009 rebound, the Dow Jones Industrial Average today stands at just 10520.10, no higher than in 1999. And that is without counting consumer-price inflation. In 1999 dollars, the Dow is only at about 8200 and would have to rise another 28% or so to return to 1999 levels. Using today's dollars and starting at 10520.10, the Dow would have to surpass 13460 to get back to its 1999 level in real, inflation-adjusted terms.
Controlling for inflation takes extra work and makes stock gains look punier, so it is easy to see why stock analysts almost never do it. The media almost never do it either.
But other things do get measured in real dollars. When economists report whether the economy is growing, they account for inflation. When analysts judge long-term gains in commodities such as gold or oil, they often adjust for inflation, noting that gold hit a record this month in nominal terms but remains far from its 1980 record in real terms. Because analysts almost never do the same with stocks, it leaves investors with an exaggerated view of their portfolios' performance over time.
"Looking at returns on a nominal basis can be very misleading," says Richard Bernstein, a former chief investment strategist at Merrill Lynch who is launching a New York money-management firm called Richard Bernstein Capital Management. He checks inflation-adjusted performance to monitor investments' real value.
Bloomberg News
Traders work on the floor of the New York Stock Exchange in New York, U.S., this summer.

A few analysts trying to get a better perspective on investments' performance have taken to measuring the Dow in a variety of unconventional ways. Gold bugs look at the Dow based on gold prices, which makes its performance look much worse over the past decade. Europeans and others with international investments sometimes measure the Dow's return in euros. That makes the Dow look worse since 2006, a time when the euro has been rising. The dollar's recent rebound has helped make the Dow look a little better against the euro and gold, however.
Mr. Bernstein says some investors saving for education expenses compare returns to tuition inflation. If the portfolio doesn't rise as fast as education expenses, these investors reason, they will need to boost contributions. The same is true for someone saving for retirement expenses or for future medical costs.
Garrett Thornburg, founder of Thornburg Investment Management in Santa Fe, N.M., calculates what he calls "real-real" returns, adjusting stock performance not only for inflation but also for real-world drags such as taxes and fees.
Nominally, a dollar invested in the stocks of the Standard & Poor's 500-stock index at the end of 1978 had blossomed to $22.88 at the end of 2008, including dividends, a sweet gain even after the 2008 meltdown. But once estimates of inflation, taxes and costs are removed, he figures, the investment was worth only $3.76.
All of this might be enough to put investors off stocks entirely, until they consider the long-term alternatives. Measured over the 1978-2008 period, rather than over just one decade, stock performance in real-real terms actually is better than that of just about any other major investment class, Mr. Thornburg found: 4.5% a year. Stocks' ability to keep up with inflation over the very long haul may be their best selling point.
In real-real terms, stocks did better over that period than municipal bonds (2.5% a year), long-term government bonds (2% a year) and corporate bonds (0.2% a year). Real-real home prices were unchanged over those 30 years. Both short-term government bonds and commodities suffered losses. (Mr. Thornburg has experience investing in all these areas, although his mortgage affiliate went bust in last year's housing collapse.)
Figuring out how to adjust for inflation can mystify some investors, although the Internet now offers several Web sites that quickly adjust numbers for inflation and some mutual funds and independent mutual-fund analysis services calculate returns adjusted for fees and taxes.
[ABREAST] Reuters
Some analysts measure the Dow against the performance of gold, which further dents the record of the blue chips over the past decade. Above, gold bars in Mumbai earlier this month.
Prof. William Hausman at the College of William & Mary long has urged the media to offer people inflation-adjusted stock charts. He says newspapers and analysts frequently point to the Dow's 2007 record of 14164.53 and talk about how far the Dow would need to climb to return to that level. In inflation-adjusted terms, however, the Dow in 2007 never quite surpassed its 2000 record, Prof. Hausman calculates. To return to an inflation-adjusted record now, he adds, the Dow would need to break 15000.
"It really puts in perspective how stocks are doing," he says.
Stock analysts sometimes like to note that the Dow today is worth 27 times its value at its 1929 pre-crash peak, meaning that even if you bought at the worst moment, your stock still would be way up over time. In inflation-adjusted terms, however, the Dow today is only a little over twice its 1929 peak, according to Ned Davis Research.
Lately, some investors have gotten interested in measuring the Dow in gold rather than dollars. Gold has rebounded since 1999, and the fascination with the yellow metal has made investors start thinking of it again as a currency.
Ned Davis, the founder of Ned Davis Research, referred to gold as "real money" in a recent report and published charts of bonds, home prices and stocks measured in gold rather than dollars. Even with gold's swoon in recent days, the Dow looks a lot weaker over the past decade measured in gold than in dollars.
Of course, it is possible to find a hot investment that dwarfs the Dow's gains over any period, which makes many analysts question the value of adjusting the Dow for gold's gains. Such skepticism doesn't stop gold's supporters from pointing out how much weaker the Dow looks when measured in "hard" money.
In 1997, the Dow looked strong at 40 times the dollar value of an ounce of gold, notes John Hathaway, who oversees more than $5 billion at the Tocqueville Gold Fund at New York's Tocqueville Asset Management. With gold's rebound since 1999, the Dow now is worth about nine times an ounce of gold, meaning simply that gold has performed a lot better than the Dow.
For those who like bandwagons, that suggests that it is time to buy gold. For those who like to buy things when they are cheap, it suggests that gold was cheap in 1997, and stocks have gotten cheaper since, at least when they are measured against gold.
Write to E.S. Browning at

Wednesday, December 23, 2009

Citigroup Untarped

The megabank remains the biggest challenge to Washington's muddle-through approach to the banking crisis.

Once again Citigroup looks like the sad sack of the bunch as banks exit TARP, thanks to its poorly orchestrated capital raising and the government's abortive attempt to sell down its own stake last week. But it pays to remember what a bad idea TARP capital injections were in the first place.
The nature of the problem was first apparent, ironically, in the rush of healthy banks to join Citi and friends under the so-called Troubled Asset Relief Program, fearing the lack of an imprimatur as a bank Washington had decided would not "fail."
That dynamic ran in reverse last week as banks rushed to pay back TARP money and shed the onus of government support. Bank of America had to be hurried out because Bank of America was looking for a CEO, and couldn't find one or pay one as long as it was laboring under Washington's populist pay restrictions.
Acknowledging TARP's perverse impact on Bank of America's CEO dilemma, Treasury and FDIC could hardly pretend it wasn't deleterious for Citi and Wells Fargo's ability to run their own businesses. Terms were quickly hammered out to let them escape too.
Getty Images
Citi CEO Vikram Pandit

Voila, a scheme designed to strengthen confidence in the financial system had become the opposite, in compounding fashion.
In and of itself, of course, there was nothing urgent about returning the government's capital. Warren Buffett, Wells Fargo's biggest shareholder, certainly made it clear he would prefer the bank rely on earnings to rebuild capital rather than selling cheap stock to the public to repay Uncle Sam. Rushing the paybacks only increases pressure on the other wobbly legs of Washington's bailout stool, which include regulatory forbearance (i.e., regulators gaming their own capital standards) and the Fed's loose-money policy, which may not be doing much for job creation but is certainly having a marvelous impact on financial industry profits.
Let's have a moment of realism: Policy toward these giant banks always had as its primary goal saving the government from having to take them over and run them, as it has (wretchedly) AIG. It was to avoid the disaster of nationalization.
Legs one and two (plus the FDIC's guaranteeing of bank debts) were always sufficient to meet this goal and keep the giant banks stumbling along under private management and control. TARP capital injections were not only superfluous but invited the calamity they were meant to avoid, with politicians running rampant in the hallways. Take the cautionary example of Fannie and Freddie, which today are not being "conserved' in federal conservatorship but are being used to prop up home prices. For the banks, exiting TARP at least reduces the risk of similar corruption.
Citi, though, is an especially borderline case. Citi was sued last week by its big investor Abu Dhabi, presumably the Arab state's way of expiating the classic sin of trying to catch a falling knife. Abu Dhabi's "rescue" of Citi with a $7.5 billion investment in late 2007 sent the stock market up 200 points. At the time Hank Paulson had just floated his idea for a "super SIV," a thinly disguised bailout of Citi.

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Peter Wallison: Lack of Candor and the AIG Bailout
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It didn't fly. Abu Dhabi was about three rescues too early. It would take several more attempts by the triumvirate of Mr. Paulson, Tim Geithner and Ben Bernanke before Citi was seemingly stabilized, and by then Abu Dhabi was deeply underwater.
We say "seemingly" stabilized because Citi's floundering exit from TARP last week has destabilized it again. Vikram Pandit, Citi's CEO, is trying to rebuild its business the best he way knows how, i.e. not too different from Citi's previous business. That's presumably why he considers it essential to escape TARP so he can pay Wall Street-style bonuses in competition with Goldman Sachs and Morgan Stanley (and Bank of America and JP Morgan).
Washington chose not to dismantle Citi, so it should have expected no less. Oh well. In a crisis, politicians will look around for businesses "too big to fail," and any conceivable Citi would likely fit the bill, as it has since the 1970s. This problem may not be fixable, but what are fixable are the deeper antecedents of last year's troubles.
Fewer banks would have inflicted such damage on themselves if not for the government's role, eight ways from Sunday, in encouraging Americans to incur housing debt, with direct subsidies, tax incentives and the use of Fannie and Freddie to channel China's surpluses into a U.S. housing boom.
If the word "bubble" has any valence at all, it describes what happens to asset prices when the public believes it has been granted a one-way bet. Sadly, much of the history written in the past 14 months had redounded to the salvation of parties who will be tempted to make the same mistake again.


Tuesday, December 22, 2009

A God of the Copybook Headings

The uncommon wisdom of George Melloan.

In the Carboniferous Epoch we were promised abundance for all;
By robbing selected Peter to pay for collective Paul;
But, though we had plenty of money, there was nothing our money could buy;
And the Gods of the Copybook Headings said: "If you don't work, you die."
—Rudyard Kipling
In a couple of days, the Senate will give its 60 ayes to the largest expansion of government since the Great Society. The Obama administration is proposing a third round of fiscal stimulus, because the first two worked so well. And Ben Bernanke is, without irony, Time's Person of the Year.
All of which is a reminder that, unlike vampires, there's no driving a stake through the heart of a bad idea. Karl Marx will always be with us, at least at the New Yorker. So will Jean-Jacques Rousseau, the patron saint of environmentalists even if they don't know it. And so will John Maynard Keynes, godfather of Obamanomics. History is only repeated as farce to those who either have forgotten it or enjoy the sick humor of a disaster foretold.
Then again, as George Melloan reminds us in "The Great Money Binge: Spending Our Way to Socialism," just as bad ideas never quite go out of fashion, neither do good ones. Readers looking for an antidote to this season's political gloom will find more than the full dose in this splendid book.
Mr. Melloan was, of course, the writer of this column for many years, one of the labors in a career at the Journal that spanned 54 years as a reporter, editor and commentator. Among the benefits of a long career is a long memory and an imperviousness to intellectual fads. In Kipling's terms, he is one of the Gods of the Copybook Headings—the unfashionable keepers of hard truths about which we must occasionally be reminded.
Associated Press
John Maynard Keynes

In today's economy, the hard truth is that we can't spend, consume, manipulate and inflate our way to general prosperity—as opposed merely to the enrichment of Democratic Party interest groups. This was the dominant economic model of the 1970s, with results that were once well known. "The Great Money Binge" makes short work of the theory:
"Demand-side economics holds that the economy derives its momentum from consumption, and it is of little moment if that consumption is financed by credit," he writes. "But if that were true, everyone could merrily use his credit card to supply his wants and never have to work. Maybe there's a logical flaw there somewhere."
The great strength of Mr. Melloan's book is to show, in exacting detail, not only how we came to our current crisis—thank you, Barney Frank, Chris Dodd, Alan Greenspan and Tom DeLay—but where that logical flaw is destined to take us again.
The alternative is supply-side economics, which, for all the invective heaped upon it, boils down to the inescapable fact that "consumption must be paid for with production"—that if you don't work (i.e., produce) you die (i.e., can't consume). The obviousness of this is so manifest that the real wonder is how it has escaped the grasp of otherwise intellectually competent people.
Perhaps more interesting is how it didn't escape the grasp of Mr. Melloan, one of whose principal achievements was his role—along with the late Bob Bartley—in turning the Journal's editorial pages into the great disseminator of supply-side thinking. Mr. Melloan chalks it up to his background as the son of an Indiana yeoman farmer for whom there was nothing abstract about the words property, production and market. "We Journal editors were a rather proletarian lot to be promoting capitalism," he writes. "We were not the voice of big business, as our critics glibly called us at the time, but exponents of free-market capitalism, an economic system that allows any individual to build a business and compete with the big boys. The two things are definitely not the same."
But what Mr. Melloan doesn't say is that he is also an heir to the antisophistic tradition of Western philosophy—stretching from Socrates to Paul to William of Ockham to Jean-Baptiste Say to Karl Popper—that insisted that truth was more likely to be found in simplicity than complexity. No surprise, sophists of every age have attacked this tradition (sophistically) as "simplistic," and people like Mr. Melloan have had to endure it.
Yesterday, President Obama made the remarkable observation that "we can't continue to spend as if deficits don't have consequences, as if waste doesn't matter, as if the hard earned tax dollars of the American people can be treated like Monopoly money." Maybe he's finally learned, as Kipling taught,
That after this is accomplished, and the brave new world begins
When all men are paid for existing, and no man must pay for his sins,
As surely as Water will wet us, as surely as Fire will burn,
The Gods of the Copybook Headings with terror and slaughter return!
Then again, maybe the president finally got around to reading George Melloan.


Friday, December 18, 2009

Banks Don't Belong in the Student Loan Business

They get billions in federal subsides that can provide financial aid to needy students.

Since I arrived in Washington, I've been looking at every line item in the budget of the U.S. Department of Education with two questions in mind: Is this program helping students learn? And is it a good use of taxpayer money? In the case of the Federal Family Education Loan (FFEL) program, the answer to both questions is no.
Under the current FFEL program, banks make loans to students. While those students remain in school, the federal government pays the interest on their loans; otherwise the interest accrues. Once the borrowers leave school or graduate, the lending agency collects on the loans. But if the student defaults, my department pays back the loan—plus the interest owed. The FFEL program, in short, is a great deal for bankers but a terrible one for taxpayers.
Over the next decade, according to the Congressional Budget Office, the Education Department is slated to subsidize banks to the tune of $87 billion to enable them to make federal student loans. All of this money would be put to better use providing financial aid directly to millions of needy students who want a college education. The Education Department will be able to accommodate the new loans through an existing federal public-private partnership, Through that partnership, the federal government makes loans directly to students and uses companies that will provide better service to borrowers at a lower cost to taxpayers
Critics contend that the government is trying to nationalize a private industry and do away with competition. Our real aim is to simply stop using banks as the middle man for student loans.
The banking industry would continue to compete in the marketplace to finance mortgages, business start-ups, and other forms of credit. But we are intent on stopping subsidies to bankers who make student loans at no risk because they know the federal government will bail them out in case of default.
By working with private sector companies with expertise in the field, we are prepared to initiate all new student loans in the existing federal Direct Loan program. Right now, the Education Department already owns and services 80% of the student loans made last year. It owns such a high volume of loans chiefly because it had to take emergency action in 2008 to ensure students had access to loans when lending in the nation's credit markets was frozen.
Our experience handling the bulk of student loans makes me confident in our capability. This year alone, an additional 500 colleges and universities joined the Direct Loan program. Just last month, the department's independent inspector general's office issued a report documenting that the Education Department had taken the right management steps so that all loans can be serviced by the Direct Loan program.
In a recent survey by the National Association of Student Financial Aid Administrators, schools that have made the switch to direct lending overwhelmingly reported the conversion was easy and quick. That is just one reason why that association of financial aid experts, along with organizations representing the nation's largest public and private universities, community colleges and college students, support the department's Direct Loan proposal.
The private sector would continue to play an important role in servicing loans. Last summer, the department's Federal Student Aid Office awarded contracts to four companies to service federal student loans, following an intense competition among the best companies in the loan servicing business. These companies are paid more when borrowers are in good standing, and those that keep defaults down and provide the best customer service will be given the most work.
We are preparing to make the switch to direct loans as easy as possible for colleges and universities. We appreciate their feedback, and their ideas will help us transition smoothly from FFEL to direct loans once Congress has passed a bill authorizing the switch to 100% direct loans
As for the $87 billion we'll save from ending the troubled FFEL program, the administration seeks to use that money for important programs that will improve our economic future. We propose to substantially increase scholarships in the Pell Grant program and other financial aid for low-income students. We would start new programs to raise college graduation rates and strengthen our community colleges. We will expand our investment in early childhood education. Plus, $10 billion would be set aside to reduce the deficit.
Now is the time to allocate resources to students—not to banks—so they have access to college and other educational opportunities. We cannot in good conscience let $87 billion in subsidies go to banks when our students desperately need financial help to realize the dream of getting a college education.
Mr. Duncan is the U.S. secretary of education.


The 100 Years Chip War

The FTC piles on Intel, after a settlement

When computer chip rivals Intel and Advanced Micro Devices announced an agreement last month to end their legal disputes, Intel CEO Paul Otellini expressed hope that it would provide "some level of comfort" for regulators. What rational oasis did he think he was living in?
This week the Federal Trade Commission sued Intel, alleging that the industry leader has stifled competition to strengthen its market dominance. According to the feds, Intel has used "threats and rewards" to prevent computer makers like IBM from buying chips from competitors. The FTC also claims Intel has blocked these manufacturers from marketing computers with non-Intel chips. It's worth noting that several of the companies that Intel is accused of muscling are every bit as big as Intel—and in the case of Dell and Hewlett-Packard, bigger in revenue terms.
But the real problem with the government's case is the lack of evidence that consumers have in any way been harmed by Intel's practices. The FTC is tasked with protecting the interests of consumers, not competitors. And consumers are benefiting from an intensely competitive and highly innovative computer chip industry.
Data from the Bureau of Labor Statistics show that between 2000 and 2006—a period that includes Intel's supposed monopolistic behavior—the quality and performance of microprocessors improved while prices fell at an annual rate of 48.9%. Over the same period, the prices of related items such as personal computers, storage devices and software also decreased. The typical goal of anticompetitive corporate behavior is to raise prices, yet computer products that cost thousands of dollars a few years ago now cost hundreds.
Intel doesn't deny that it competes aggressively for customers, or that it offers deep discounts and rebates to win business. But these actions are pro-competitive, and the courts have consistently ruled that so long as Intel is pricing its products above cost, its business practices are lawful. Over the past two decades the Supreme Court has repeatedly rejected antitrust challenges to above-cost price cuts.
Settlement talks between Intel and the government reportedly stalled when regulators insisted on remedies that would turn the company into something resembling a public utility. The lawsuit states that the FTC seeks a remedy "[r]equiring Intel to make available technology . . . to others, via licensing or other means, upon terms and conditions as the Commission may order." The government also wants to micromanage how Intel prices its products and prevent it from offering better deals to its best customers. The company understandably concluded that such conditions "would make it impossible for Intel to conduct business."
The government's intervention here is both unprecedented and unnecessary. The bulk of the charges are recycled complaints first made by Intel's main rival, AMD, more than four years ago. But the deal reached last month resolved all of their differences and was approved by both boards.
Antitrust laws exist to promote business and price competition, not to protect less successful competitors. And the competition among microprocessor makers has rarely been more ferocious. The FTC is proposing remedies in search of a problem, and harassing a successful U.S. company in the bargain.


Thursday, December 17, 2009

Obama vs. the Banks

Why make risky loans when you can exploit the Fed-Treasury interest rate spread?

Over the weekend, President Barack Obama went on the offensive against Wall Street for not lending more to Main Street. On CBS's "60 Minutes," the president declared, "I did not run for office to be helping out a bunch of fat cat bankers on Wall Street." He was joined on the Sunday morning circuit by his chief economic adviser, Lawrence Summers, who echoed the message of intimidation.
Wall Street fat cats are always a convenient political target, but bankers are responding to the incentives generated by the economic policies of the Treasury and the Federal Reserve. First and foremost is the Fed's policy of near-zero interest rates.
What this means is that banks can raise short-term money at very low interest rates and buy safe, 10-year Treasury bonds at around 3.5%. The Bernanke Fed has promised to maintain its policy for "an extended period." That translates into an extended opportunity for banks to engage in this interest-rate arbitrage.
Why would a banker take on traditional loans, which even in good times come with some risk of loss? In today's troubled times, only the best credits will be bankable. Meanwhile, financial institutions are happy to service their new, best customer: the U.S. Treasury. That play on the yield curve is open to banks of all sizes.
The Fed's policy makes sense if the goal is restoring bank profitability by generating cash flow. It is a terrible policy if the goal is fueling small business, the engine of economic growth and job creation. Large, nonfinancial corporations have access to banks. They can also tap the public credit markets and have access to internally generated funds. Not so for small business, which depends heavily on banks for credit.
Since the financial crisis began, the Fed has worked in tandem with the Bush/Paulson Treasury and now with the Obama/Geithner Treasury. One must assume its policies have the administration's approval. That puts the administration's policies at war with its stated goals. Larry Summers is a first-rate economist and must understand the economic incentives those policies have created. In short, the weekend interviews, along with the president's meeting with bankers on Monday, was political theater.
While the public is upset with $10 million to $20 million banker bonuses, public policy should focus on what is generating them. The largest banks have had their risk appetites whetted. They are not looking to traditional lending, but to proprietary trading and a renewed commitment to innovative financial products. But as Obama adviser and former Fed Chairman Paul Volcker noted, financial products such as credit default swaps and collateralized debt obligations brought the economy to the brink of disaster. It is excessive risk-taking by Wall Street that is generating the profits from which the bonuses are being paid. Curb the former and you curb the latter without government planning of banker pay.
Has recent experience taught the leaders of large financial institutions the need to curb their risk appetite? Not really. The lesson they have learned is that presidents of both parties, the Fed and Congress will come to their rescue when they get in trouble. Under a vague set of ideas, scarcely a theory, some banks are viewed as too big to fail. They will be propped up, bailed out and generally protected from the consequences of their own bad decisions. That generates incentives to engage in excessively risky activities.
A few bankers lost their jobs or quit in the aftermath of the financial crisis, but that small risk is evidently one most of Wall Street's fat cats will accept. Mr. Obama may not have run for president in order to reward them, but that is the effect of his policies.
Sending scarce resources to major banks in the form of funds from the Troubled Asset Relief Program (TARP), ultra-low interest rates, and the Fed's targeted credit schemes has diverted needed capital from real, productive activity. Now the politicians feel the public's anger and are complaining about the lack of lending and the size of executive compensation. If Congress wanted banks to lend and to limit pay packages, it should have put those in as conditions in the TARP legislation.
The TARP was hastily arranged, poorly designed and badly executed. Nonetheless, Congress acted in haste and now gets to repent at leisure. Meanwhile, the totality of the policies to aid the major financial institutions is delaying the recovery of the broader U.S. economy and the hiring of its unemployed workers.
Mr. O'Driscoll, a senior fellow at the Cato Institute, was formerly a vice president at the Dallas Federal Reserve Bank and a vice president at Citigroup.


U.S. National Debt Tops Debt Limit

Updated 5:45 p.m. ET

The latest calculation of the National Debt as posted by the Treasury Department has - at least numerically - exceeded the statutory Debt Limit approved by Congress last February as part of the Recovery Act stimulus bill.

The ceiling was set at $12.104 trillion dollars. The latest posting by Treasury shows the National Debt at nearly $12.135 trillion.

A senior Treasury official told CBS News that the department has some "extraordinary accounting tools" it can use to give the government breathing room in the range of $150-billion when the Debt exceeds the Debt Ceiling.

Were it not for those "tools," the U.S. Government would not have the statutory authority to borrow any more money. It might block issuance of Social Security checks and require a shutdown of some parts of the federal government.

Pending in Congress is a measure to increase the Debt Limit by $290 billion, which amounts to six more weeks of routine borrowing for the federal government. (The House just passed the increase, though the Senate has yet to act. It is expected to approve the measure.)

Republicans and conservative Democrats blocked moves by House leaders to pass a $1.8 trillion dollar increase in the Debt Limit so the Democratic majority would not have to face the embarrassment of raising the Debt Limit yet again before next November's midterm elections.

The Debt Limit has been raised about a hundred times since 1940, when it was $49 billion - about five days worth of federal spending now.

The White House projects a record $1.5 trillion dollars deficit this year alone, and a 5-year deficit total of $4.97 trillion.

The Debt figure goes up and down on a daily basis based on government borrowing and revenue. Technically, not all of the National Debt is subject to the Debt Limit - a small percentage is exempt.

Wednesday, December 16, 2009

A Nation That 'Builds Things'

It's time to recognize we have trade competitors, not partners.

With the official unemployment rate at 10% and the real unemployment rate over 18% (accounting for people who can only find part-time employment or have given up looking for work), it's clear that job creation should be the country's top priority. That is why I firmly believe we need additional economic stimulus. But this time we need to do it the right way.
Here are three steps we can take that will move the economy forward without increasing the federal budget deficit. These steps will also dramatically reduce our trade deficit, promote genuine rules-based free trade, and position us to remain the world's leader.
Replace foreign sources of energy with domestically produced energy. Oil imports account for about half of our trade deficit. Government policy must encourage drilling for oil and natural gas, foster the construction of dozens of new nuclear power plants, and help develop multiple forms of renewable energy like wind, solar and biomass.

OpinionJournal Related Articles:

•Christina Romer: Putting Americans Back to Work
•Michael Boskin: An Alternative Stimulus Plan
•Edward Lazear: Stimulus and the Jobless Recovery
Powering the economy with domestic oil and natural gas will not increase carbon emissions more than if we use imported fuels. But it will create millions and millions of jobs—great jobs in energy infrastructure and domestic manufacturing.
Tax revenues will pour in from all directions because of a massive effort to achieve energy independence. Increased domestic oil and gas production will thus reduce our budget deficit, national debt and interest payments on the debt, as well as our trade deficit.
It will take decades to transition to a low-carbon economy. But getting there does not require taxpayer dollars. It does require a cooperative effort by government and the private sector that would allow for the necessary increase in domestic exploration and production, and the building of more distribution infrastructure such as natural gas pipelines on a scale that will enable us to replace foreign energy sources, while we transition to a low-carbon economy.
Balance our trade deficit. We need to correct the mercantilist and predatory trading practices of our principal trading competitors—yes, competitors not partners. These countries such as China won't be partners until they stop using opportunistic and illegal trade practices like currency manipulation, illegal subsidies and border-adjusted taxes (especially the value-added tax).
Ending these trade distortions will result in a resurgence of domestic manufacturing. It will also foster long-term, balanced, and healthy trade relationships.
This should be part of an overall government effort to refocus itself as a champion of U.S.-based manufacturing and the American middle class. This undertaking will be a major shift from recent decades, when the government ignored this responsibility.
Rebuild outdated and unsafe infrastructure. The American Society of Civil Engineers has stated earlier this year that we need to spend $2.2 trillion over the next five years to improve our country's roads and bridges. The money to do so can come from unspent funds from the stimulus bill passed earlier this year, and from some of the revenues that will come from increasing our domestic energy production.
These policy changes by our government—in conjunction with leadership and financing from the private sector—will drive the creation of the more than 20 million jobs we need to rebuild our economy, our country, and our middle class. They will get us back to being a nation that makes and builds things.
We are being called to address and succeed at resolving the current economic crisis. Make no mistake: We must change our direction as a country for the betterment of current and future generations of Americans and, as a result, the rest of the world.
Let's seize this opportunity as one country—the government and private sector working together to overcome the greatest economic crisis since the Great Depression.
Mr. DiMicco is chairman and CEO of Nucor Corporation, a steel producer based in Charlotte, N.C.


Producer Price Jolt

What was that about deflation again?

The Federal Reserve's Open Market Committee meets today, and right on time. Yesterday's producer price report showed that wholesale business prices rose 1.8% in November, or a 6.3% annual rate over the past three months and 2.4% over the past year.
The news hit markets with a jolt, because investors have become accustomed to the Fed's assurances that it must keep interest rates at their current historic lows for an "extended period" because the only real economic risk is deflation. Investors reacted by sending bond prices down sharply, as they wondered if the Fed may have missed its bet and will have to change course sooner than it has advertised.
Fed Chairman Ben Bernanke is notoriously stubborn, at least when he's easing money. And no doubt someone at the Fed will point out that if you remove food and energy from yesterday's report, then producer prices rose by only 0.5%. However, this is the same "core" price rationalization the Fed used earlier this decade to keep monetary policy too easy for too long. Deflation was another siren song that the Fed used in 2003 and 2004 to build the credit mania that led to the bubble, the blowoff and recession.
Like $1100 gold and $70 oil amid weak global energy demand, the producer price report is a warning that the Fed should already have begun to move back to a noncrisis monetary stance. This does not mean "tightening" in any normal definition of that word. Moving from near-zero rates to 1% would not be moving to a restrictive policy. It is the equivalent of slowing down from 200 miles per hour to 180 or 160. A more careful monetary policy will help the Fed's credibility and reduce the chances that the recovery is later cut short by an abrupt shift in policy.


Debt Fears Rattle Europe

The euro tumbled as debt woes spread around the euro zone from Greece, where pledges of austerity and fiscal rigor failed to stem growing fears that the Continent's economic recovery could be derailed.
The euro fell as low as $1.4505 on Tuesday, its lowest level since early October. New worries about Austrian banking also roiled markets, with rumors of trouble at an Austrian lender with shaky investments in Eastern Europe following Monday's surprise nationalization of another Austrian bank at the behest of the European Central Bank.
Bloomberg News
A pedestrian makes a purchase with a 50 euro note in a shop in Frankfurt.

Greece is just "the tip of the iceberg," said Norbert Barthle, budget spokesman for the ruling Christian Democratic Union of German chancellor Angela Merkel. The exploding budget deficits of weaker economies have forced Germany and other financially stronger countries to think about how to shore up other members of the euro zone against a potential financial-market rout.
Portugal, Ireland, Italy, Greece and Spain, a group traders have disparagingly dubbed "PIIGS," all have huge budget deficits and very low growth prospects, which means their debt is on course to rise further, fast.
The countries' wages and costs have steadily risen, but as euro-zone members they can't respond by devaluing their currency, a problem that strains the bonds tying together the currency bloc. Their soaring deficits are testing the credibility of the euro zone's so-called stability pact, in which governments promise not to spend wildly.
"Greece is seen in the market as an example of what may happen to other countries in the euro zone," says Diego Iscaro, economist at IHS Global Insight in London. "Europe has a lot of treaties but no clear mechanism for how to deal with such cases."
So far, attempts by Athens to assuage the market's concerns have fallen short. Late Monday, Greek Prime Minister George Papandreou promised to cut his country's budget deficit from nearly 13% of gross domestic product this year to under 3% -- the euro zone's cap -- in four years. "We must change or sink," Mr. Papandreou said.
Greek bond prices did sink Tuesday, as investors reacted with disappointment to the absence of austerity measures in the speech. The interest yield on Greek 10-year bonds reached more than 2.5 percentage points higher than ultrasafe German bond yields in Tuesday's trading, up from around two percentage points the day before. Other euro-zone government bonds reacted less sharply, but risk premiums for most weaker euro-zone members have risen in the past month.
Greek Finance Minister George Papaconstantinou visited Berlin and Paris Tuesday to try to reassure governments and markets; he next visits London and Frankfurt. Mr. Papaconstantinou told reporters in Paris he wasn't discussing a bailout.
In an earlier interview, the finance minister said he understands the risk if the newly elected Socialist government can't show by early 2010 that a decisive overhaul of public finances is under way. He expects to have to borrow just over €50 billion ($73.22 billion) from bond markets next year.
"There is a scenario in which the market dries up" for Greek bonds, he said. "I wouldn't say it's completely out of the question, but it's not likely by any stretch of the imagination." If it happens, Greece would have to go to fellow European Union member countries or the International Monetary Fund for loans, which would come with stringent conditions. "I don't want to be the finance minister who took Greece to the IMF," Mr. Papaconstantinou said.
EU officials, publicly and privately, stress that Greece is unlikely to need a bailout provided it follows its words with actions. The treaty on monetary union banned bailouts of euro members, but senior European officials say there are ways around it. One option would be a loan from a financially strong country such as Germany.
EU authorities including the ECB would prefer the euro zone handle any assistance internally. But German Chancellor Angela Merkel would favor the IMF as the source of funds, says a senior aide. (Similar divisions were evident when the EU and IMF bailed out Hungary last year.) An IMF-led package might be politically more humiliating for Greece, but better for the credibility of the euro-zone's no-bailout clause, and thus for fiscal discipline in the zone over time, analysts say.
Mr. Papandreou called IMF Managing Director Dominique Strauss-Kahn last week, Greek officials say -- but only to discuss the overall situation, not to ask for aid. The two men know each other well, these officials said.
In much of southern Europe, declining competitiveness is linked to structural flaws including heavy and inefficient bureaucracy. Recent growth in Spain and Greece depended heavily on construction and consumer bubbles. Italy and Greece have particularly dysfunctional public administrations and chronic tax evasion.
"It's hard to see how Italy, Spain and Portugal are going to generate enough growth" to rein in their debts, says Simon Tilford, chief economist at the Center for European Reform, a London think tank.
Ireland's economy is more flexible, and Ireland's younger population makes growth easier to achieve, but Ireland is suffering from the weakness of the British pound and U.K. economy, a major Irish market.
So far the Greek government has shied away from deep cuts in state spending and wages that Ireland announced to tame its deficit. EU governments, financial markets and credit-rating agencies are piling pressure on Greece to flesh out its promises with a concrete plan by January.
But the prospect of Greek austerity has already sparked protests by pensioners, students and public-sector unions in the past two weeks, and officials fear a wave of social unrest.
Politicians and financial markets "want to make us wear an Irish costume," says shipyard worker and labor leader Theodoros Koutras. Mr. Koutras's Communist-backed union confederation, the All Workers' Militant Front, aims to mobilize hundreds of thousands of workers in a nationwide strike on Dec. 17 Thursday.
Greece had no problem selling bonds in November, despite riling markets by stating that this year's budget deficit would be nearly 13% of GDP -- twice the previous government's estimate only weeks earlier.
Prime Minister Papandreou, attending an EU summit in Brussels on Friday, said massive inefficiency and "widespread corruption" are keeping investment away and hobbling the economy.
Athenian cafe owner Costas, who gave only his first name, testifies to that. He says he's had to budget about €10,000 in bribes to various public agencies that he says wouldn't give him various permits he needs until after his new cafe opened for business last month. He is still waiting for a permit to put out chairs and tables.
The government admits it doesn't know exactly how many people work for it. That's partly due to a history of haphazard hiring by politicians who have traditionally rewarded supporters with public-service jobs.
Greece's finance minister George Papaconstantinou

A hiring spree in the month before the election brought in thousands of salaried "trainees" who have no posts and in many cases no office to go to, according to the finance ministry.
Public servants often leave work at 2 p.m., and "many are doing a second job in the afternoon, very often without declaring their second income for tax," says Evangelos Antonaros, a conservative legislator who was the previous government's spokesman.
The gray economy extends to the education system, where many Greek students pay on the side to fill in holes left by lackluster teaching. Katerina Karamatsiou, a young Athenian, recalls her high-school physics teacher telling the class: "What's the point in teaching you? You all go for private tuition after school anyway." He offered such after-hours, tax-free tuition himself, she says.
Mr. Papaconstantinou says such experiences are common in public services. "When you have to pay doctors in public hospitals with an envelope of money, then there is no public system," he says. As a result, he says, many Greeks ask themselves: "So why pay taxes?"
Despite the government's campaign to persuade Greeks that the old ways can't go on, many believe the media and financial speculators are exaggerating the country's problems. Greece, says shopkeeper Athanasia Katsigianni, "is like a creme caramel: Always trembling, but it stays standing."
—Brian Blackstone in Frankfurt, Alkman Granitsas in Athens and Andrea Thomas in Berlin contributed to this article. Write to Marcus Walker at

Tuesday, December 15, 2009

Banker Baiting 101

Obama's latest populist turn won't help the recovery.

The Obama Administration desperately wants a strong economic recovery, or so it says, but does it have any idea how to encourage one?
It says it wants job growth, but its policies keep raising the cost of creating new jobs. It says it wants small business to take risks, but it keeps reducing the rewards if those risks succeed. And it says it wants banks to lend more money, even as it keeps threatening to punish bankers if they make too many bad loans or make too much money.


The last contradiction is again on display as President Obama rolls out his latest populist blame-the-bankers campaign. This is becoming a White House financial staple. Recall how the President joined the Congressional posse amid this year's earlier AIG bonus uproar, until it threatened to run out of control. Later Mr. Obama targeted Chrysler's bond holders who weren't eager to accept the government's meager dictated terms. The bond holders rolled over, but everyone in financial markets got a message about what this Administration thinks about the sanctity of contracts.
Associated Press
President Barack Obama meets with members of the financial industry in the Roosevelt Room of the White House in Washington, Monday, Dec. 14, 2009, to discuss the economic recovery.

Now, amid Democratic panic over 10% unemployment heading into an election year, the President is attempting a double populist play: Blame the bankers for causing the financial crisis and recession by lending too much, and blame them again for causing high joblessness now by lending too little.
"I did not run for office to be helping out a bunch of fat cat bankers on Wall Street," Mr. Obama said in an interview on CBS's "60 Minutes" on Sunday. "They're still puzzled why it is that people are mad at the banks. Well, let's see," he said. "You guys are drawing down $10, $20 million bonuses after America went through the worst economic year that it's gone through in—in decades, and you guys caused the problem. And we've got 10% unemployment."
He followed up that warm encouragement yesterday by hauling the bankers in to the White House to receive the command that "we expect an extraordinary commitment from them to help rebuild the economy."
This blame-the-bankers rhetoric is worse than a distraction as the recovery tries to gain solid footing and become a durable expansion. It risks obscuring two critical and related problems: Federal policy is discouraging both lending and borrowing.
If there is a lack of lending by banks to small businesses, the President might consider cutting out the CEO middlemen and speaking directly to the regulators who work for him, as well as to the Federal Reserve Chairman he recently nominated for a second term.
Forcing banks to write down the value of small-business loans that are still performing has become the specialty of bank regulators who are now trying to make up for the bubble years. Whenever a commercial building serves as collateral, no matter the quality of the borrower, the loan becomes suspect.
The result is a reduction in bank capital, a disincentive to make the next loan and perhaps even a calling of the loan, forcing a sale of the property. Operating with perfect pro-cyclical precision, regulators who were asleep during the housing boom and its epidemic of liar loans now target current loans to companies with steady cash-flow. This does not encourage new lending.
Meanwhile, Fed Chairman Ben Bernanke's near-zero-rate interest policy encourages banks to borrow cheaply and then invest in safe long-end Treasurys instead of riskier commercial loans. The Obama Treasury has explicitly supported this Fed policy as a way for banks to play the yield curve to rebuild their balance sheets.
But if Mr. Obama wants the banks to lend more, he should tell the Fed to start to rein in its excessively easy credit now that the financial crisis is over and the economic recovery gains steam. The longer the Fed keeps rates artificially low, the longer banks will get used to this implicit subsidy and the rougher their adjustment when it inevitably ends. Meanwhile, weren't higher bank profits to raise capital a major goal of the bailout?
Regarding small business, not everyone agrees that lack of credit is the main economic problem. William Dennis of the National Federation of Independent Business says that for most small companies the problem is a lack of customers, not credit. "There aren't a lot of folks who want to borrow. Our challenge is getting people in the front door," he says.
A recent NFIB survey of small-business owners found only 10% reporting problems obtaining financing. The government's own data tell a similar story. The Federal Reserve reports that business loan demand remains at depressed levels, while data from the Federal Deposit Insurance Corporation show $6 trillion of unused lending commitments at FDIC-insured institutions.
Mr. Dennis reports that small-business owners are much more concerned about other Washington issues, namely the uncertainty created by the Obama policy agenda: When will the taxes arrive to pay for Washington's spending binge? How much will health-care reform cost? What will be the impact of cap-and-trade legislation to address climate change?


Mr. Obama summed up his White House meeting with the bank CEOs by once again blaming them for the financial crisis and suggesting that they have an obligation to support new regulation being written by Barney Frank (D., Mass.) and Senator Chris Dodd (D., Conn.).
You have to smile at that irony. No two Members of Congress did more to encourage the financial crisis, by preventing reform of the government-sponsored housing behemoths Fannie Mae and Freddie Mac. By ignoring Washington's role in creating the credit mania, Mr. Obama is hardly offering confidence that his financial reform efforts will prevent a repeat.
Yet none of this seems to count for much at a White House that is reading the polls and sees a political opening because bankers aren't popular. Someone in that power palace ought to consider that you don't encourage capitalism by beating up capitalists, and you aren't likely to encourage more lending by whipsawing lenders.

Keynesians Need Plan to Tame Debt Soon, Experts Say

By Andy Sullivan

WASHINGTON, Dec 14 (Reuters) - The U.S. government must craft a plan next year to get its ballooning debt under control or face possible panic in financial markets, a bipartisan panel of budget experts said in a report on Monday.
Though the government should hold off on immediate tax hikes and spending cuts to avoid harming the fragile economic recovery, it will need to make such painful changes by 2012 in order to keep debt at a manageable 60 percent of GDP by 2018, according to the Peterson-Pew Commission on Budget Reform.
Without action, investors could lose confidence in the United States, driving down the dollar and forcing up interest rates, said the former lawmakers and budget officials who crafted the report. That could cause a sharp decrease in the country's standard of living.
"We will be less free if we don't tackle this," said Jim Nussle, a Republican member of the commission who earlier served as a White House budget director and chairman of the budget committee in the U.S. House of Representatives.
The 34-member commission published its report as Congress was poised to raise the debt limit from its current $12.1 trillion level to allow the government to continue operating.
The national debt has more than doubled since 2001, thanks to the worst recession since the 1930s, several rounds of tax cuts and wars in Iraq and Afghanistan.
A looming wave of retirements over the coming decade is expected to make the situation worse.
The national debt currently accounts for 53 percent of GDP, up from 41 percent a year ago. That's likely to rise to 85 percent of GDP by 2018 and 200 percent of GDP by 2038 unless dramatic changes are made, the commission said.
The commission did not issue specific prescriptions but said tax increases and spending cuts would probably be needed.
It said Congress and the Obama administration should set specific targets each year, with automatic spending reductions and tax increases kicking in if they are not reached.
The Democratic-controlled Congress is unlikely to fix the problem on its own given the highly partisan atmosphere, commission members said.
"You've got to have a few Republican votes, and there have been none. And there has been no possible way in the current political system yet to find that sensible center," said former Democratic Representative Charlie Stenholm.
The commission backed the creation of an outside commission, similar to one used to close miliary bases, to create the necessary political cover.
Such a proposal is included in a crush of year-end legislation that could clear Congress this week but it is opposed by many key Democrats.
The United States must act to ensure that it does not join Dubai, Greece, and other countries that risk losing the confidence of investors, the commission said.
"It's imperative that we take action before the financial markets force us to," said Douglas Holtz-Eakin, a former Congressional Budget Office director who advised Republican John McCain's presidential campaign last year. (Editing by David Storey)

Monday, December 14, 2009

Bad or Good News Could Cause Market Trouble

If this were an ordinary year, you'd be crazy not to buy stocks over the next few weeks, when the Wall Street pros typically gussie up their portfolios so they can show their customers just how smart they are.
But there's nothing ordinary about 2009 -- especially the last nine months.
Stock prices zoomed from their depths mainly on hopes that the economy was turning around (and it did improve somewhat).
Or was it because the labor market seemed to be doing better starting in the spring -- a fact that is now in dispute.
Maybe the market rallied simply because people saw other people making so much money that they just couldn't resist following the leader.
Whatever the reason, this much is clear: Stock prices have gone up a lot, for little reason, and investing in the market now isn't nearly as easy a call as it was last year.
If you've been monitoring this column for a while you'll know that I told readers to buy stocks last December but to get out in January. That was simply a calendar call: The pros usually buy reflexively at the end of the year when trading volume lightens and the market can be pushed around.
After the pros do that, they take a look at market fundamentals like corporate profits -- as they did in January -- and say, "Whoa, what the hell did I do?"
Then they retreat faster than the average person can.
I also wrote at the beginning of this year that the economy would start to look better -- not necessary be better -- in the spring because of seasonal adjustments to economic reports and a favorable quirk in how the Labor Department records its jobs data.
At the time, I said that these events could be used by Wall Street to boost stock prices. And that happened -- in spades.
For all of 2009, the Dow Jones industrial average is up a healthy 17 percent. But the gain from the lowest prices in March has been an amazing 57 percent.
To be sure, the index is still 27.5 percent off the all-time high it recorded in October 2007 and people still have massive losses.
But we are now a heck of a lot better than the 54-percent loss the market was suffering before the rally began last March.
Where will the market go next?
That's the problem: It could go down as quickly as it has gone up.
In the first place, most of the action lately seems to be coming from professional traders. Day trading by amateurs also appears to be picking up, if anecdotal evidence gleaned at bars and coffee shops is any indication.
But average buy-and-hold investors still don't seem to trust the market, and anyone who is venturing into stocks is doing so mainly because the Federal Reserve continues to punish savers with low interest rates, which help banks record profits.
If anyone wants a reasonable return on their investments, they have little choice than to become a stock-market speculator. A 57-percent gain in nine months' time looks a lot like another bubble, and this bubble may not be as durable as the last few.
A lot of things could go wrong, especially in an era where Washington feels obliged to spend money it doesn't have on stimulus programs that haven't worked before and which may not have any better luck this time.
But my biggest concern is that the stock market could be hurt if the economy weakens (bad for business), or if the economy strengthens.
The latter is the quickest road to concerns about a Fed tightening of interest rates, which, of course, would make other investments more competitive with stocks and rein in speculators.
Just look at what happened last Friday: The Labor Department reported an unexpectedly good employment situation in November and Wall Street didn't respond with the joy it should have had.
I've said this before, but I want to say it louder now -- be very careful if you get lured into the stock market.
That steady 1.5 percent interest you're getting from the bank could look pretty good if this hard-to-figure stock market decides to correct its latest excesses.
The other day at breakfast I ran into Louka Katseli, the economics minister of Greece, a country that is rumored to share Dubai's problems with making debt payments.
So, I asked, should Wall Street be concerned about Greece reneging on its debt?
Katseli, who was educated in the US and taught at Princeton, responded: "I would be more concerned about US debt." Touché!
An Irish bookie is taking bets on who will make the next 911 call from Tiger Woods' house.
Woods is the favorite at 6-to-4. The gardener is the long shot at 18-to-1.
Put me down for $10 on the paperboy, if cellphone calls from outside the house are counted.
The bookie, Paddy Power, thinks Ac centure -- a manage ment firm -- is a 9-to-4 favorite to drop Woods as its spokesman, followed by watch maker TAG Heuer at 3-to-1.
Titleist, which, of course has a lot of balls, is the least likely at 33-to-1.

Obama's policies risk another Depression

Scott S. Powell and Ron Laurent

Light at the end of the tunnel or an oncoming train wreck?
In the panic following the insolvency of Fannie Mae, Freddie Mac and Lehman Brothers in September 2008, the American taxpayer was stampeded into bailing out AIG and Wall Street. We were told that $700 billion was needed to establish the Troubled Asset Relief Program (TARP) because the country faced nothing less than a collapse of its financial system.
Inexplicably after Congress passed it -- almost like a bait and switch -- TARP was directed at banks rather than troubled assets. A little more than a year later, TARP Inspector Neil Barofsky reports that AIG's $1.5 trillion in credit fault swaps did not, after all, pose systemic risk. So if we were misled about the TARP bailout, it seems appropriate to question other aspects of government intervention since unemployment, foreclosures and bank failures have risen.

Should we believe Federal Reserve Chairman Ben Bernanke and Treasury Secretary Tim Geithner that there is daylight at the end of the tunnel or could it be the beam of an oncoming locomotive pulling more economic wreckage?
The Fed is essentially out of bullets with the funds rate at 0 percent. Accommodative monetary policy may be necessary to revive economic activity, but it is neither sufficient nor without risk. Clearly help is needed from effective trade, fiscal and regulatory policy.
Trade policy is the first to consider since the decline in commerce during the Depression was largely due to the Smoot-Hawley Act's increased tariffs. Today, Washington is at odds with free trade, inserting a "Buy American" provision in the stimulus bill and pandering to labor unions.
The Obama administration has overlooked the importance of trade in other ways, such as the failure to get approved free-trade pacts already negotiated with South Korea, Columbia and Panama; new tariffs on Chinese tires and steel products; and letting our competitors race ahead in securing new free trade agreements.
Turning to fiscal policy next, historians recognize that the Hoover administration's sharp tax increases on personal, corporate, inheritance, gift and excise taxes -- all passed on and added to by Franklin Roosevelt -- were a defining feature of the Depression years. In this regard, the Obama presidency will be the first administration since Eisenhower to raise taxes during a recession.
In fact, campaign promises notwithstanding, Obama has one of the most ambitious tax increase agendas of any President. He proposes new taxes on health plans, surcharges on the wealthy, drug companies and device-makers, foreign-source earnings, capital gains, personal income, estate, financial transaction, carried-interest and energy -- through a cap-and-trade regime.
In addition, Roosevelt created an alphabet soup of new regulatory bodies and unprecedented regulations to redress business and investment excesses following the stock market crash of 1929. In a new script of the old play, Washington is now similarly intent on massive enlargement of government bureaucracies, expansion of labor unions and regulation of the health care, banking and finance as well as the utility and energy sectors.
If the missteps in trade, tax and regulatory policies were not enough, the killer bullet to the U.S. economy could be the shrinking of available credit to private business, which is the mother's milk of recovery.
In the last year, the federal budget deficit soared 207 percent to $1.42 trillion, all of which is financed with increased U.S. Treasury debt. Successive years of additional red ink will likewise require issuing more government debt at a time when our largest creditors, notably China and the OPEC countries, have signaled reluctance to increase their exposure. The most likely investors to pick up the slack in buying this debt will be domestic banks, which will crowd out lending to businesses that need capital for expansion and job creation.
If tempting fate with a second Depression is too abstract, what may prove to be the turning point on both sides of the political aisle is the harsh reality of hitting the federal government's $12.1 trillion debt ceiling by year end. A fitting New Year's resolution would then be to vote against anyone who favors continuing down failed paths and cannot commit to debt reduction.
Scott S. Powell is managing director of AlphaQuest LLC and a visiting fellow at the Hoover Institution. Ron Laurent is the managing partner and chief investment strategist of Veritas Partners LLC.

Friday, December 11, 2009

Obama's 2008 Campaign: A Job Creation Lesson

By John Tamny

With the federal government's measure of unemployment in the double digits, President Obama has unsurprisingly moved job creation to the top of his list of initiatives. And while his priorities could surely be worse, his approach has been contradictory to that which might actually lead to the creation of new jobs.

Some will no doubt say Obama's propoals on job creation are evidence of his lack of private sector experience, but it could be argued that his success in raising money for and running a national presidential campaign speaks to intimate knowledge. There are some similarities to say the least.

Indeed, when Obama sought financial support for what was at the time a long shot bid for the Democratic presidential nomination, he surely didn't wax poetic to potential supporters about all the workers he was hiring and equipment he was purchasing in order to run the campaign. More realistically he pointed to a lean operation (including voluntary workers) and polls suggesting he had a chance to secure the nomination; those polls and subsequent primary wins the "profitable returns" that campaign donors were interested in given their desire to achieve a return on their investment in him.

As every politician knows, there are no donors without promising polls and victories. Sadly, those same politicians - including Obama - haven't seen how clearly this correlates with businesses and jobs.

To use but one example, last weekend Obama talked up a recovering economy while at the same time expressing concern that rising business profits were a function of layoffs and businesses generally doing more with less. But had he applied his significant campaign experience to what businesses are presently doing, his outlook might have been more sanguine.

Just as campaign funds dry up due to a lack of success at the ballot box, so do investors shun businesses that aren't profitable.

As opposed to altruistic public goods created to employ those looking for work, businesses exist thanks to the self-interest of investors seeking profits. In that sense company heads don't mesmerize investors with tales of all the jobs they're creating, instead they do their best to exhibit their ability to generate the greatest amount of profits with the least number of workers possible.

Paradoxically, their skill when it comes to running lean, profitable businesses is what ultimately leads to job creation. Just as Obama's rising success in the Democratic primaries emboldened him to ask donors for more money to expand his campaign, business profits embolden company CEOs to ask investors for more capital in order to expand their operations.

With businesses, the efficiencies and profits wrought by painful layoffs are the "seen", but the positive "unseen" is the investors those profits attract who will fund company expansion, and with expansion, job creation. There is no investment without profits, and there are no jobs without investment.

This is important when we consider looming healthcare legislation. President Obama has made plain that he would like all Americans to be insured. But whatever one's opinion of Obama's healthcare views, the simple truth is that healthcare is a cost, and a significant one at that.

Applied to his initially cash-strapped presidential campaign, imagine if in addition to all of his other expenses, Obama had to buy health insurance for his employees? If so, he would have had to divert significant funds from television ads and get-out-the-vote initiatives that would have made funding his nascent presidential bid more risky. When donors are considered, healthcare costs would undeniably have factored into their willingness to support Obama altogether.

Investors in businesses of all sizes must think the same way. Quality healthcare has myriad benefits, but looked at objectively, it is a cost that diverts what is limited capital from potentially profitable initiatives. Healthcare mandates placed on businesses will not only raise the cost of hiring workers, they will also weigh on future returns on capital so important to investors.

Some might reply that a "public" healthcare option would free businesses of those costs, but there it must be stressed that there's no such thing as public healthcare. With governments lacking any resources other than those they tax or borrow from the private sector, businesses will either pay for the public option through taxes, or through reduced investment thanks to the federal government vacuuming up capital to fund its initiatives. With regard to "stimulus", the same scenario applies.

Considering small businesses, President Obama has regularly said that they are the source of the majority of new job creation. And while there's some truth to his assertion, it's also true that by virtue of being small, the businesses founded in the nations' garages are the riskiest kinds of investments. Much the same, Obama's campaign was at least in the beginning the proverbial small, risky business.

This looms large when Obama's tax plans are considered. He's made it clear that he would like the richest Americans to pay a higher percentage of their incomes to the federal government in taxes. The problem there is that if higher taxes reduce the amount of disposable income among those who have it to dispose, small businesses and quixotic political campaigns will suffer the most.

Indeed, rare is the individual who will take a flyer with limited savings on unproven businesses or politicians. But when money is plentiful thanks to low levels of taxation, there's a greater willingness among those with means to speculate on business concepts and politicians possessing potential, but slim track records.

Long before President Obama came onto the scene, politicians have suffered the perception that their lack of real world experience makes them unsuited to pursue economic policy of any kind. No doubt there's some truth to the assertion, but it should also be said that their rise as politicians speaks to real knowledge of how businesses grow and create jobs. If they would take the time to analyze what drove their success in politics, they might become better at fashioning policies that lean toward economic freedom, and which foster a business climate characterized by growth and low unemployment.

John Tamny is editor of RealClearMarkets, a senior economic adviser to H.C. Wainwright Economics, and a senior economic adviser to Toreador Research and Trading ( He can be reached at