As is often the case for me, I'm about to mention a couple economics problems that will likely depress people.  Consider yourself warned.  Particularly I want to talk about the recent evidence of some kind of turn around and how real that might be.  I see a couple big problems that I think are worth mentioning:

Unemployment

Unemployment is almost always a trailing element in an economic recovery.  Until companies are making profits again they don't want to hire new people.  However, in a seemingly positive sign, even though the unemployment rate is at 9.4%, the actual rate of job losses has tapered off.  So, not great news, but presumably the first evidence of a turnaround, right? 

Well, here's the problem, you see the actual aggregate number of hours employees are working is down to the lowest level since 1964.  Furthermore, and perhaps more worrying is that the rate of decline is about the same as it has been since things began to seriously melt down in September. 

Because this statistic is about the working hours, it also accounts nicely for people who are working part time, have had over time cut, etc.  If you have a job and keep the job, you don't get accounted for in unemployment figures.  If you have a job, but are working reduced hours, then this statistic tracks that change.  So it gives a more accurate depiction of overall productivity and labor demand.

So essentially, labor demand is falling and it's been falling at the same rate since last fall.  If people aren't making money and don't feel secure in their jobs, they don't spend money.  Hard to get out of a recession if nobody's spending money.

Mortgage Rates

We did see a slight improvement in home sales going into May, but since then mortgage rates have been climbing.  Mortgage rates are climbing because treasury rates are climbing.  Treasury rates are climing because the economy sounds like it's getting better and investors are moving back into the market. 

So while that's seemingly positive (i.e. recovery in the broader markets) the problem is that this is going to make it harder to refinance and it will drive down demand for homes.  That means home prices will have to fall ever further.  That's less wealth for people, of course, and with higher rates, adjustable rate mortgages are going to get more expensive. 

Green shoots maybe...

There are some signs that things are getting worse at a slower rate, and maybe it's the beginnings of a turn around but we are not out of the woods.  Remember, during the Great Depression, there was a turn around and then in '37 things headed back down again.  In the 80's, we had a double dip recession.  So, while things may be improving in some ways we are definitely not out of the woods.

The bailout of GM is costing us $50 billion.  In the process, GM is planning to close several plants and layoff thousands of workers.  Now, if you accept the premise that a large reason for keeping GM around  is to keep it's employees employed in the down turn, then I wonder whether we're getting good value for our money.  If there's going to be closings and layoffs anyhow, what are we really accomplishing?

Consider this, for a moment.  In 2008 GM had 248,000 employees according to Wikipedia.  That means we're paying $201,613/employee to bail GM out.  So I find myself wondering if perhaps we couldn't have done this instead:

1. Pay each employee $60K, tax free, in severance this year
2. Pay each employee $50K, tax free, in severance in the second year
3. Pay each employee $40K, tax free, in severance in the third year

That's $150K/employee.  Then provide an additional $50K that could be put towards relocation expenses, education costs, etc, that would help these workers land new jobs. 

Now there's some flaws in what I'm describing.  For example, I don't deal with the secondary effects of a GM liquidation in terms of the parts supplier market, etc.  But still, I think what I'm describing does lend some perspective to what we're doing.  $50 billion is a hell of a lot of money, and there's no guarantee that, when we're done, GM becomes a sustainable company. 

As talk of a turnaround grows, it's worth considering what that turnaround will look like.  While it can be safely said that the with the Fed and the Treasury turning on the money spigots, we can expect the economy to turn around, it leads to two big questions:

1. When do we actually reach bottom?
2. What does the future of the economy look like after we hit bottom?

For the first question, nobody's really sure, and a lot of that depends on how you define the bottom.  So I'm not going to get into that, but I wanted to talk more about the second question.  A lot of people have been assuming that this is just a worse than usual down turn and that we'll go right back to the way things were since the Great Depression: moderate 3-4% growth with occasional recessions.

Personally I'm skeptical about that because there's a lot of drag on the economy that didn't exist previously.  First of all, in order to bail ourselves out of this current crash, we're borrowing scads of money.  This will crowd out investment into the private market and we're going to have to divert resources to paying that deficit down for some time to come.  That will have consequences for growth in the long run.

Second of all, if you remember what started the bubble burst was oil prices.  Well, given that we're in the vicinity of a peak in global oil production, I expect we're going to start running into that problem again once any recovery really gets going.  Check out this blog post for some pretty graphs explaining the problem. 

Third of all, we've got a generation of retiring baby boomers.  These people are going to be pulling their money out of the markets and spending it.  While this will inevitably be good for those industries positioned to take advantage of it, it does mean an overall reduction in the amount of private capital in the system.  Thus good ideas that would lead to long term economic growth may not be able to get the funding they need.  We'll also be paying out a lot in Social Security and Medicare to add further to the overall economic drag. 

In addition to these drags on the economy, I'm concerned that there's not nearly the kind of drivers for growth that we saw after the Great Depression.  The long term recovery we experienced then was largely driven by three things:

1. Massive government spending during the New Deal and World War 2
2. Investments in education for returning soldiers that created a skilled work force
3. Demand for US manufactured goods to fill the gap from war torn Europe and Japan

Sure, we can do a lot of spending to turn things around a bit, but there's simply not the kind of drivers for growth that we had in the past.  During the New Deal we could provide power to places that hadn't had it before.  Now, we're talking about making marginal improvements to electrical grid efficiency.  So the net effect of our investments are smaller than they might have been in the past.

So, in the long run, I'm not convinced that we're looking at the kind of growth we've been used to.  We have finite resources on this planet, and while we can increase efficiency, there is a diminishing point of returns on those improvements.  Eventually we hit a wall where we simply can't get enough more productivity out of our existing resources for any reasonable cost. 

This isn't to say that it will all suddenly turn into some kind of Mad Max apocalypse world.  However, it does mean a lot of our assumptions about how an economy works will have to change and that day to day life will be more of a struggle than it has been since the 30's.  We can certainly make that adjustment, but it's probably time now to start correcting our rosier predictions about future economic growth.

In the WSJ there's an article about how Maryland created a tax on incomes over a million dollars and what the results of that were.  Here's the gist of it:

One thing that it took me a while to wrap my brain around is how the Fed actually "prints money".  The reality is that most of what they do to affect the supply of money has nothing to do with the printing of physical currency.  Instead, what they do, is they buy assets and make loans using money that previously did not exist. 

So let's say a bank has an asset worth $1 million that the Fed is going to buy and assume that the Fed has no money in it's accounts for simplicity sake.  What happens is the Fed just simply creates the $1 million out of thin air and drops it into the account of the bank from whom they are buying the asset.  Ultimately all of the banking is electronic, so there's no need for them to actually print that physical money, it's just ones and zeros in their accounting software.

Prior to this crisis the Fed had roughly $900 billion in assets.  They are expecting to buy up as much as $3 trillion in assets which means they are effectively printing about $2 trillion.  Ultimately this increases the supply of money, and causes inflation.  However, because the banks that are getting this money are largely hoarding it, we don't actually see it showing up as inflation right now.

However, once the economy starts to turn around and those banks start to make that cash available to the market, then we're going to see a rise in the supply of dollars in circulation and thus a decline in the value of those dollars.  Unchecked, this would lead to inflation.  So in order to correct for that, the fed would have to increase interest rates. 

So basically once we get out of the immediate crisis, we can expect either significant inflation or higher interest rates to be a drag on the overall economy.  It's the price we pay for getting ourselves out of an asset price bubble. 

Here's a telling chart:



This is a chart by percentages.  So, for example, the lowest quintile gets 3.9% of the income in this country and pays 4.9% of the taxes.  This is not talking just income taxes, but is inclusive of all taxes paid.  So the wealthiest quintile get 55.7% of the revenue in this country yet pay only 25.8% of the taxes.  That's an enormous disparity compared to the other quintiles which actually pay pretty proportionally to their income.

From economist, Professor Roubini:

So apparently all the banks are just peachy:

A chart comparing global stock markets between the 1929 crash and today as seen on Andrew Sullivan:


That's like bad and stuff...

Geitner on trying to better regulate the markets:


Good theory, but there's a huge problem with it.  This charges some agency with enforcing some vague set of standards.  A synonym for vague is "uncertain".  Uncertainty is the last thing you want in the market.

The problem with this sort of set up is that it provides no guarantees that any of these large financial operations are behaving or are solvent.  So what happens is that some hedge fund starts to go crazy, and one of two things happen:

1. The regulator notices the problem, somehow, and decides to step in and put some changes in place
2. The regulator doesn't notice the problem

The side effects of #2 are obvious.  The side effects of #1 though may be just as bad.  The moment the government steps in, it could create a cascading series of problems.  The fund may have various connections to other funds that could be damaged by the regulatory changes.  Stepping in to correct that fund might cause a panic as investors worry that the problems at one fund aren't limited to that fund.  The result is that regulators could become very hesitant to take the pain of making needed corrections in the short run and allow things to get worse.

What we need are actual rules, not this vague gobbledygook.  Hedge funds, private-equity firms, derivatives markets, and their investors, all need to have clear rules about what is and is not allowed.  They need clear capital requirements.  We need a clear separation between commercial banking and these riskier enterprises. 

It's worth remembering that all of the crazy crap that was going on the last few years was largely ignored.  While many voices were calling out the problems we had, the government and wall street largely bought into this all being normal and sustainable.  So even if these powers had existed back then, it's not clear to me that the regulators would have stepped in and done anything.  On the other hand, if there were basic capital requirements, etc, then the rules of the game would be clear.  Then stepping in wouldn't be a guessing game, it would be just cleaning up the mess after the fund failed to meet it's obligations.

Quoting Obama:
Here's your answer, Mr. President: THEY ARE RECKLESS AND GREEDY!!!! 

Why is anybody shocked that a bunch of greedy opportunists are taking free taxpayer money and handing out to themselves?  Of COURSE they are!  Why on God's earth are people still trusting these companies to do the right thing?  These people drove our economy off a fucking cliff, and yet we're still pretending that:

1. They are competent
2. They will do the right thing

Folks, if either of those conditions were true our economy wouldn't be going down the shitter right now.  Now, after the fact, the government is starting to put these people's feet to the fire.  Glad you guys are finally getting around to it.  I'm sorry your friends from the cocktail party circuit have turned out to be assholes, but I'm not exactly thrilled with continuing to subsidize their lavish lifestyles while our economy disintegrates.  I'm even less thrilled with our politicians being either ridiculously naive or deliberately ignorant about these greedy assclowns.

*sigh*


 

The Employee Free Choice Act has been in the news and so it's worth talking about the value of unions a bit.  The basic role of this act would be to make it easier for employees to unionize by simply signing up rather than having to get a vote together.  The vote process sounds democratic but it makes it easy for employers to shut down unionizing activities.  A sign up system allows organizers to operate more secretly and thus increase their chances or organizing without retribution.

Anyhow, it's worth discussion at this point what the value of unions are.  Ultimately, a union raises wages and benefits for the effected employees, but of course those costs are, to some extent, passed on the customer in the form of higher prices.  So that's bad for customers right?  It's not quite that simple.

Basically there's a fixed cost of living in this country.  If you make less than that amount of money you can't afford to cover your basic necessities.  This leaves you in a position that you have to find other means to make up for the missing amount.  You have to work multiple jobs, get government support, get charity support, or go into debt.  Conceivably you might even turn to crime.  In the end, you can't operate on an income below that level in this country.

Now, let's say just for simplicity of math that the number is $20K.  You have to make $20K/year to cover basic necessities.  That $20K must cover food, shelter, transportation, clothing, health care, education, and any other basic costs you need to be a worker in our country.  If you make only $10K, you do not have enough, so that missing $10K must be made up elsewhere.

So, let's say you're at WalMart, making $10K/year working full time.  Once again this isn't a real number, just using it for math simplicity.  You're $10K short of where you need to be.  So you manage to get a second job.  Awesome.  But now you're working 80 hrs a week instead of 40.  This means you have less time to spend with your family.  It means you have less time to raise your kids.  It means you have less time to relax and so your productivity declines. 

So the result is that you get less done in the two jobs you are working which effectively increases costs.  You have less time to raise your kids and as a society that means we have to invest more in helping you raise your children.  With less down time, you get sick more further driving down your productivity.  Overall the end result is that there are costs that WalMart isn't paying that we as a society will have to pay.

That case is more abstract, so let's say you can't get that second job.  You get your 40 hours in but it's not enough to make ends meet.  So you put the other costs on credit.  You do this for a year or two, then you're in a hole and can't afford to pay it off.  So you declare bankruptcy.  Those costs are carried all through the system in making credit more expensive.  If you can't get further credit after bankruptcy, you will now have to make up for that missing $10K elsewhere.

Let's say instead of going into debt, you get Government or Charitable aid.  Great.  Now you're making $20K/year when you add it all up.  But of course the rest of us are paying higher taxes or we're having to make more donations to charity in order to sustain you.  Yet again, we bear the cost of WalMart not paying enough.

So the problem we face is that WalMart and companies like that are paying artifically low unsustainable wages.  Unionizing gives the employees collective bargaining, and a chance to bring their wages to sustainable levels.  Sure, we have to pay more, but we're already paying more.  Yeah, we're not paying higher prices at WalMart, but we are paying higher taxes.  We are paying for the inefficiencies created by overworked, burned out employees.  We are paying for having society raise children who do not have parents around enough to properly do the job themselves. 

So a union, though an imperfect solution, does provide a bridge to insuring the costs of doing business are fully realized by the employers doing that business.  Instead of us paying for medicaid, the employer is paying for health insurance.  Instead of us paying for food stamps, the employer is paying a living wage.  So why not make the companies hiring these employees pay what they actually cost rather than having that burden passed on to taxpayers.  If we don't do this, then companies who would otherwise provide such benefits because they see the positive effect it has on their workers can't do so because it would make them uncompetitive. 

I think it's fair to say that you've fallen deep into the fail hole when you feel you have to complain about how unfair Jon Stewart is:

He's a comedian and, as such, his job is to be funny.  His job is not to be unbiased.  His job is not to be fair.  His job is to point out the foibles of people in power for entertainment value.

Sure, when Bush was in office Stewart went after Bush all the time.  Bush was a tool.  He was tossing up comic softballs on a daily basis.  Stewart hasn't gone after Obama as much because Obama makes it more difficult by demonstrating competence and by taking the job seriously.  Even so I've seen Stewart go after Obama on more than one occasion. 

Stewart goes after Cramer because Cramer failed spectacularly.  Yes, he's recommending stocks on a daily basis using whatever information he has, and invariably he's going to be wrong from time to time.  It's predicting the future, and so there's a pretty sizeable margin for error.  But when you call for people to buy stock in Bear Stearns and within days the stock collapses as we discover they are effectively insolvent, you should expect some people to poke fun at you.

 

So an ABC reporter went out and found people who, in response to Obama's plan to increase the top marginal tax rate are planning to make less money because of it:


The way our tax system works is that as you reach higher brackets, the taxes you pay are raised only on the amount you pay above a given dollar value.  So, if you make $250,001 then Obama is raising taxes on that $1 over $250K.  Not the whole $250K.  So this person is actually destroying her business because she doesn't understand how taxes work.

Oi...

Oh and I love her comment about people working less hard.  I gurantee you that people working multiple part time minimum wage jobs are working as hard as this woman even though they are getting paid jack for it. 

In watching the economy, and our government response to it, there is one big question on my mind: what happens to AIG?

The thing is, most of what's going on right now is pretty straight forward.  We're in a bad recession where people aren't buying and there's layoffs, etc, etc.  It's pretty much a standard economic mess with fairly clear remedies available to us.  The government has to spend money to prop up the economy while the bad debts are cleared out of the system.  Then once growth starts again, the government backs off and recovers.  It's basic macroeconomics.

However, AIG, is a real X-factor in this whole thing.  See, AIG got into the situation it's in by selling Credit Default Swaps which are, in essence, insurance against the failure of various securities.  What happens is you would buy into a big package of mortgages, and then buy insurance against those mortgages defaulting.  This is how pension funds, and other more risk averse investors were able to buy into these mortgage backed securities. 

The problem is, as the economy continues to go down, the exposure of AIG could be enormous.  The CDS market is worth 10's of trillions of dollars and large chunk of that exposure is AIG.  So far we've given them $180 billion since last September, but there's really no downside limit on AIG.  As the economy does worse, more CDS' will be activated and AIG's losses will grow.  The government has little choice but to pay these off or risk the collapse of the financial system.

Basically, imagine if the Great Depression happened with large chunks of the economy being insured against loss by the federal government.  That's what we're looking at.

You see, what happens is that state and city governments, as well as big corporations got loans based on a presumption of certain amounts of risk.  The risk was mitigated by insurance from AIG in the form of Credit Default Swaps.  In the event that AIG were to become insolvent (i.e. the governemnt stopped pouring money in), then all of those bonds would suddenly kick in clauses that would require immediate repayments, penalties, etc.  Of course nobody would be able to pay these off and it would basically render large chunks of our economy totally insolvent.

So we've got huge exposure here, potentially to such an extent as to risk the solvency of the federal government.  Our peak debt was 110% of GDP during WW2 (remember war bonds?).  For perspective, that would be about $28 trillion in today's dollars.  We've got about $11 trillion in debt right now.  So to get to that severe level of debt, we've got about $17 trillion to go.  The entirety of the credit default swap market is $45 trillion.  See why I'm worried? :)

A comparison of the biggest bear markets since the 1929 crash:



Notice that while this down turn took longer to build up, it's now verging on being worse than the 29-32 market crash. 

Here's what Chase CEO Jamie Dimon thinks about foreclosure:

So a couple bits of news worth mentioning on the state of the US financial system:

1. Chase is going to begin charging a $10/month fee on card holders who carry a "large" monthly balance.  Of course, since it's a change to the terms of the credit card agreement, you can choose to cancel your card instead.  However, if you cancel it, you need to pay off the balance in full.  
2. Citi admitted that they are raising rates on cardholders to help offset their losses.  They've changed things such that now if you are late for a single payment, they will crank your interest up to 30%.  Keep in mind that the entire theoretical point of the bailout was to create liquidity in the credit market.
3. We've already injected $350 billion into these banks under TARP and will be injecting at least another $350 billion.  That money is tax payer money or, more to the point, money borrowed from various creditors that we'll eventually have to pay back with our tax dollars.  That will mean higher taxes and reduced services in the long run.
4. Caps on the pay of executives at these banks, while in the stimulus bill, are a sham.  The caps only apply to contracts signed after the bill goes into effect.  This means that the executives at these banks, the ones who got us into this mess in the first place, will still be able to take home large salaries, bonuses, and options.
5. The major banks continue to spend millions on lobbyists who are trying to convince the government to keep the status quo, allowing them free reign to jack up rates, and keep their salaries.

I believe Richard Clarke said it best we he said, "Your government has failed you."

We are committing to trillions of dollars in guarantees, bailouts, and other measures to keep the economy going.  Yet while all this is happening, these banks are actually making the problem worse.  Stimulus isn't going to do any good if people are being forced to pay 30% interest on their credit cards.  We need that money to be freed up from debt maintenance and put back into the economy. 

Banks are run by rich greedy people who do what you would expect.  Our only check against them is the government and so the blame for this continuing should lie squarely on them.  I fully supported Obama in the election and I do believe he's far better than McCain would have been on these issues.  However, we need some genuine reform and we need it now.  Throwing money at these problems is only going to put things off, not solve them.

We need to get these banks in line and get them to start doing what will help the economy.  The only way that's going to happen is by serious government regulation or outright nationalization.  We cannot continue to expect them to do the right thing because they haven't and continue to have no incentive to change.  We need a whole lot of change we can believe in if we're going to pull this economy out of the spiral it's in now.

There's been a lot of talk about nationalizing some of the banks that are effectively insolvent right now.  Obama and Geitner are shying away from this, trying to find ways to underpin these banks while cleaning out a lot of the garbage on their balance sheets.  It's entirely possible that their approach might work, but I still think nationalizing them would be better.

The reason for this is that we've created a tremendous moral hazard in the banking system.  Bank of America, Citi, Chase, etc, all know that they've been officially deemed too big to fail.  In the short term they'll try to minimize reasons for the government to just come in and take them over, but what happens after the crisis is past?  They will be even bigger than they were before this happened and on top of that they'll know full well that they are untouchable.  That they can take any crazy risk they want because if things go badly, the government will come to the rescue and they'll still get their bonuses and options.

We need to nationalize these banks so that we can move in and break them up into smaller banks that we can more adequately regulate.  Having these megabanks is extremely dangerous for the economy because if any one of them fails it causes a chain reaction that takes the economy as a whole down.  So unless we move in and resolve that problem we're only pushing back the catstrophe, rather than preventing it.