Taking Care of the Pence

"Take care of the Pence and the Pounds will take care of themselves."

Saying printed on posters in the late 19th century for Penny Bank, founded in Yorkshire in 1859.

The President's Financial Regulation

Tom Brown over at Bankstocks.com has posted a superb analysis of the financial regulations being put forth by the President:

How to describe President Obama’s newest proposals to reform the country’s financial system? A string of adjectives comes to mind:

1. Ineffective. The President says his proposals to limit the size of banks and restrict their proprietary trading will prevent a rerun of the crisis that hit the financial markets in 2008. Wrong.

Lehman Brothers, whose demise in September of 2008 kicked the crisis into high gear, didn’t fail because it had gotten too big or was overly involved in risky proprietary bets. It failed because it became over-levered and then loaded up on a narrow subsector of assets that we now know were doomed. Even if Obama’s new rules were fully in place back then, the firm would have gone under anyway.

The president’s new bugaboo about size is particularly misguided. Too-big-to-fail, as Warren Buffett says, is a “genie that can’t be put back into the bottle.” And the bottle seems to be getting bigger, not smaller. During the current economic slowdown, we found out that TBTF doesn’t just apply to big banks anymore, but also to insurance leviathans, automakers, and non-bank mortgage lenders. Next cycle, we might find out that, depending on who’s defining the country’s “national interest,” certain airlines, defense contractors, technology companies, and who knows what else might be deemed too big to fail, as well. In the meantime, insisting that companies not get too large seems a little beside the point. And what all this has to do with proprietary trading is beyond me.

2. Harmful. On the one hand, the president wants to ensure that another financial crisis never happens again, and wants to tax banks to recoup the costs of TARP. But on the other hand, he wants banks to loosen their lending standards and make more loans. The uncertainty this contradiction has produced (not to mention the verbal jihad the president has inflicted on the banking industry) isn’t going to spur bankers to ease their lending standards. It will have the opposite effect. Taxing banks and trashing bankers will simply result in less lending, not more.

3. Unfair. Most people seem to have forgotten, but the TARP program was a thinly veiled attempt by the government to bail out a handful of financial institutions (most notably Citigroup) without highlighting to a panicky public the fact that those institutions were so weak they needed a bailout. So not only did Citi get an infusion, but a bunch of healthy institutions, such as JPMorgan and Wells Fargo, were forced to take preferred stock investments from the government, as well. They didn’t want the cash, nor did they need it. No matter: the banks had to pay 5% of the TARP principal in after-tax dividends to the Treasury annually, and agree to pay back the entire investment within five years. On top of that, they had to issue warrants to the government, as well.

But the banks did as they were told. Now, a year later, they have all repaid their TARP investments, or will do so shortly. And what is their reward? The president wants to tax them some more because the non-banks that wheedled themselves in on the TARP deal (that would be the automakers and AIG) are still flailing, and are nowhere near repayment.

This makes no sense, and is incredibly unfair. Why single out one class of TARP recipients to pay for the errors and missteps of another?

In addition, if you combine the president’s proposed new taxes and restrictions with the “unofficial” new, higher capital standards that U.S. bank regulators are now imposing, U.S. banks figure to soon find themselves at a significant disadvantage in competing with foreign banks.

4. Disingenuous. Most commentators see the president’s latest proposals for what they are: a ploy to divert the public’s attention away from voters’ disenchantment with his big-spending, big-government plans and the backroom tactics he’s engaged in to try to implement them. This sudden war against the big banks is a transparently political attempt to exploit populist anger at the banking industry. How post-partisan.

If you look at the hastiness with which these latest proposals were put together, and the lack of accompanying detail, it’s hard not to come to the conclusion that the White House’s first, last, and only motivation was to get the media to talk about something else than the walloping the Democrats took in Massachusetts last week.

Put all these adjectives together (ineffective, harmful, unfair, and disingenuous) and then try to distill them down into one single word that can adequately describe the president’s policy toward the financial industry, only one word will do: asinine! Hopefully, as Congress looks at the details (whenever they come out), it will reject the president’s latest ideas. The president’s plans won’t prevent another financial meltdown, or encourage prudent lending. They are worse than useless.

In fact, from nearly first to last, the President’s entire remarks on financial reform last Thursday seemed to be shot through with misinformation and faulty judgment. Here are some highlights:

“We intend to close loopholes that allowed big financial firms to trade risky financial products like credit default swaps and other derivatives without oversight.”

Taken at face value, the premise of the statement is simply false! Every firm that traded CDSs and other derivatives is regulated. The problem wasn’t a lack of regulation; the problem was ineffective regulation!

“. . . to identify system-wide risks that could cause a meltdown.”

For as long as there has been a financial system, there have been financial panics. By their nature, they can’t be predicted. President Obama may believe he can identify all the possible risks than can lead to a meltdown, but here’s a little secret: he can’t. No one can. No human being is capable of predicting the next Black Swan, unless you simply want to prohibit all financial transactions. (And even those systems tend not to end well.) This cycle, the B.S. arrived in the form of incredibly high default rates and loss severity associated with instruments rated AAA by the rating agencies. (In retrospect, of course, the problems seem obvious. They always do.) It is simply unrealistic for the president to think he can create a “systemic regulator” who would miraculously see the next Black Swan.

“. . . to strengthen capital and liquidity requirements to make the system more stable.”

The most highly levered financial institutions (investment banks, AIG, Fannie Mae, and Freddie Mac) operated outside of the capital and liquidity guidelines that govern commercial banks. Just because those organizations had bad business models doesn’t mean the government should change the requirements placed on the banks.

The President seems to not realize that large U.S. banks have to compete globally. The major industrial nations have adopted common capital requirements to level the playing field. The administration can temporarily hold U.S. banks to significantly higher capital standards, but if it tries to make those higher standards permanent, U.S. banks would be at a serious disadvantage competing against foreign-regulated institutions.

“So if these folks want a fight, it’s a fight I’m ready to have. And my resolve is only strengthened when I see a return to old practices at some of the very firms fighting reforms . . .”

Mr. President, you must be kidding! Your regulators already have all the power and authority they need to stop any unsafe, unsound banking practices. If you know of a bank that’s doing something it shouldn’t and is getting away with it, fire the relevant regulator. And if you don’t know of any bad behavior, stop with the false accusations!

And you don’t think banks should publicly object to your nutty proposals? Give me a break. When the unions didn’t like your plan to tax luxury health care plans, you didn’t tell them to shut up. No, you invited them to the White House and gave them a disgusting sweetheart deal!

“. . . when I see soaring profits and obscene bonuses at some of the very firms claiming that they can’t lend more to small businesses…”

What is it with the President and bonuses for bankers? These companies paid back the TARP investments that had been forced on them, with interest. Determination of the size of bonuses bankers should receive is a decision best left to management, the board of directors, and, ultimately the shareholders. Does the president think that bankers’ bonuses, by virtue of their sheer size, are inherently objectionable? If so, why don’t we hear him railing against other high-wage earners like pro athletes and Hollywood stars?

I’ve never understood the President’s belief that these “fat cat bankers” won’t lend money to small businesses. If bankers are as greedy as Obama seems to think, they’d be lending money hand-over-fist to small businesses, at positive spreads, and would be earning more money for their institutions that would then fund even bigger bonuses! It’s in bankers’ self-interest to make loans with positive spreads to credit-worthy borrowers!

“. . . they can’t keep credit-card rates low . . .”

Mr. President, you signed a bill last year that limited the ability of credit card lenders to reprice for risk. Don’t tell me now you’re surprised that they raised rates ahead of the new rules.

“. . .they can’t pay a fee to refund taxpayers for the bailout without passing on the cost to shareholders or customers . . .”

Whoops! Mr. President, first, if banks don’t pass the along the cost of your new large-bank tax to customers, the profitability of the big banks will go down, the banks’ shareholders will be hurt, and the recovery of the financial system will be delayed. If banks’ do pass along the cost, fees will go up. By passing a new tax, Mr. President, either the banks’ customers or their shareholders’ (or both) will be hurt! How is it that the president doesn’t understand that someone will actually pay the new taxes he is proposing?

My head hurts! The President has decided to attack the banks with his idiotic proposals and populist, bank-bashing rhetoric in order to (I assume) buck up his sagging poll numbers. If his proposals are passed (which I believe is unlikely) they won’t help the financial services industry. What’s more, I suspect the resulting tighter credit and higher fees won’t win him many votes!

Injustice in the Tax System?

Burt Fulsom makes an incredibly important point on his blog regarding our current tax system and debt burden:

When we look at the runaway deficits of the last few years (especially the last one year), we can see the dangers of inflation, the ruin of our currency, and even the potential bankruptcy we may face. I want to focus on something else that is often neglected–the sense of injustice in the tax system to pay off the debt. Why is it unjust? Because almost half of all Americans pay no income taxes. What that means is that these non-taxpayers have every incentive to pressure politicians for government services because the burden of paying for these services will fall on others. That fact compounds the problem, and contributes to a real sense of injustice–others get services free, and I have to pay for them. Certainly that contradicts the spirit of the 14th amendment, with its stirring promise that no state could “deprive any person of life, liberty, or property without due process of law.”

The other problem with the “I get government services and you pay for them” mentality is that basing a tax system mainly on wealth taxes is unstable. What about recessions when rich people lose wealth and withdraw investments? Then revenue sharply declines, and deficits get larger. In the current tax system, the top one percent of taxpayers pay almost 40 percent of all income taxes. In California, which has a highly progressive state income tax, 84 percent of taxes are collected from people earning over $100,000 per year, according to Scott Hodge of the Tax Foundation. When those taxpayers suffer in recession, the whole state budget is thrown into jeopardy.

Our Founders were wise. They encouraged a revenue system based on tariffs on imports and excise taxes (especially on vices such as tobacco and whiskey). Those are indirect taxes, and they are paid by people who purchase certain goods. If you can afford the product, you pay a small tax. Such a system is broad-based, and the revenue generated does not fluctuate wildly from year to year. Let’s never forget that under that system, the U. S. paid off the entire national debt by 1836. I salute our Founders for their wisdom.

George Will Sunday Column

From George Will's column today:

In 2013, when President Mitch Daniels, former Indiana governor, is counting his blessings, at the top of his list will be the name of his vice president: Paul Ryan. The former congressman from Wisconsin will have come to office with ideas for steering the federal government to solvency.

Not that Daniels has ever been bereft of ideas. Under him, Indiana property taxes have been cut 30 percent, and for the first time Standard & Poor's has raised the state's credit rating to AAA. But in January 2010, Ryan released an updated version of his "Roadmap for America's Future," a cure for the most completely predictable major problem that has ever afflicted America.

.......To make the economy -- on which all else hinges -- hum, Ryan proposes tax reform. Masochists would be permitted to continue paying income taxes under the current system. Others could use a radically simplified code, filing a form that fits on a postcard. It would have just two rates: 10 percent on incomes up to $100,000 for joint filers and $50,000 for single filers; 25 percent on higher incomes. There would be no deductions, credits or exclusions, other than the health-care tax credit (see below).

Today's tax system was shaped by sadists who were trying to be nice: Every wrinkle in the code was put there to benefit this or that interest. Since the 1986 tax simplification, the code has been recomplicated more than 14,000 times -- more than once a day.

.......Ryan would eliminate taxes on interest, capital gains, dividends and death. The corporate income tax, the world's second-highest, would be replaced by an 8.5 percent business consumption tax. Because this would be about half the average tax burden that other nations place on corporations, U.S. companies would instantly become more competitive -- and more able and eager to hire.

Medicare and Social Security would be preserved for those currently receiving benefits or becoming eligible in the next 10 years (those 55 and older today). Both programs would be madepermanently solvent.

Universal access to affordable health care would be guaranteed by refundable tax credits ($2,300 for individuals, $5,700 for families) for purchasing portable coverage in any state. As persons younger than 55 became Medicare-eligible, they would receive payments averaging $11,000 a year, indexed to inflation and pegged to income, with low-income people receiving more support.

Ryan's plan would fund medical savings accounts from which low-income people would pay minor out-of-pocket expenses. All Americans, regardless of income, would be allowed to establish MSAs -- tax-preferred accounts for paying such expenses.

Time to Pick It Up Men!

Taxation without Representation

All I can say is shame on us for the massive and crippling tax we are building up to hammer down on the heads of future generations of Americans.

Spend just a few minutes on this site and tell me when are not facing an imminent challenge in this nation: http://usdebtclock.org/

The Super Bowl on the Big Screen?

The folks over at Slate have put together an awesome little montage in honor of Super Bowl Sunday:

SCARY STUFF

When you consider the history of socialism (a history of abject failure), the chart below will send a chill through your spine.

Opportunity Cost

This is one of the best and most concise articles I have ever read on the idea of opportunity cost.

The point Mr. Horowitz makes in this article is lost to 99% of people, and I really think it's one of the most important learning points of economics:

Over the weekend, the White House released a report indicating that the stimulus program had directly funded about 600,000 jobs and indirectly "created or saved" a total of 1.5 to 2 million jobs. Later investigation will likely reveal that a good number of these created jobs are non-existent or otherwise shouldn't have been counted. Politicians, both national and local, have every reason to exaggerate numbers like this, and expecting accounting accuracy from the people who pay hundreds of dollars for a hammer has long been an exercise in faith over reason.

Moreover, one can raise all kinds of questions about whether "creating jobs" should be the goal of economic policy. There's a story about Milton Friedman in China that may be apocryphal but illustrates this point. In observing hundreds of Chinese workers clearing land for a new building using shovels, Friedman asked his hosts "Why are they using shovels? Why not use heavy equipment like an earth-mover?" The Chinese official said "If we did that, we'd lose all of those jobs!" Supposedly Friedman said "Oh, you're trying to create jobs! I thought you were trying to build a building. If you want to create jobs, why not take away their shovels and give them spoons?" I'm sure the Chinese host didn't find that funny, but it perfectly illustrates the point that "creating jobs" is easy (another example: we could destroy all farm machinery); the tougher thing is creating value by saving labor in one place to use it where it is more urgently needed elsewhere. The benefits associated with the disappearance of jobs in making candles or horse-drawn carriages should make us skeptical of the rhetoric of "saving jobs."

Even with those flaws, the Administration's accounting is still one-sided. What it doesn't consider are the jobs lost due to the very policies that are "saving" jobs. Government can only spend what it takes from the private sector one way or another, either through taxation, borrowing, or the redistribution effects of inflation. For every dollar that government spends, there is one less dollar being spent somewhere else in the economy. The jobs that weren't created because the private sector lacked access to capital due to increases in government borrowing should be offset against whatever jobs the stimulus supposedly is creating.

The problem, of course, is that what was never created cannot be seen and therefore cannot be counted. The French economist Frederick Bastiat once defined economics as the art of seeing the unseen. It may be true that we can "see" it by recognizing the unseen effects of policies, but if you can't count what you can't see, you'll always lose out in the numbers game. The result is that estimates of the net employment effects of government programs will always be biased in favor of the program's effectiveness. The inability to count what we can't see should give us long and serious pause when reading about the jobs "created or saved" by the stimulus package.

Paul Ryan is on Fire

Congressman Paul Ryan has really been on fire of late.

Here are his thoughts on President Obama's budget and a few charts for good measure:

Over the past few weeks, President Obama has sounded ready to moderate his agenda - and has trumped his ostensible plans for fiscal discipline.

Regrettably, the budget the Administration today submitted to Congress is nothing more than a plan for more of the same - a very aggressive agenda of more government spending, more taxes, more deficits, and more debt - with just a few cosmetic budget maneuvers to give the illusion of restraint. Despite my hope that the President would alter his course, his budget will make an already unsustainable budget outlook much worse.

For the duration of the Administration's 10-year budget, the deficit never falls below $700 billion, and never falls below 3.6 percent of GDP - a level the Administration's own budget director has called 'unsustainable.' Debt held by the public doubles over 5 years, triples over 10, and exceeds 60 percent of GDP as a share of the economy this year - surpassing last year's 50-year high. Debt continues to rise to consume 77.2 percent of our economy by the end of the budget window. Even the countries of the European Union, hardly exemplars of fiscal rectitude, are required to keep their debt levels below 60 percent of GDP.

The Administration will attempt to focus attention on a handful of proposals supposedly aimed at tempering the Federal Government's explosive growth. But these have far more to do with calming Americans' concerns than with doing anything to address them. His pay-as-you-go proposal has been waived or circumvented and only locks in deficits at their current high levels. His non-binding commission simply punts on the critical budget decisions that Members of Congress got elected to make. Finally, his so-called 'freeze' on some discretionary spending follows an 84-percent increase - and has no clear means of enforcement.

The President has contended that many of our nation's problems - fiscal and otherwise - lie in petty bickering and partisanship in Washington. I agree that we should avoid the politics of personal destruction. But, we also should not get lulled into avoiding rigorous debate on policies that will increase spending, deficits, taxes, and debt and hasten our nation's march down a disastrous economic and fiscal course - which, regrettably, is just what this budget would do.