A couple of random things

I want to address three main issues in this post:
1) What happened on last night's episode of I Love Money 2;
2) President Obama and Sec. Geithner's plan for dealing with toxic bank assets; and
3) A few of the reasons I don't buy 95% of what comes out of Paul Krugman's mouth.

Now numbers two and three deserve their own posts, but unfortunately I don't have the time to write three separate posts right now. So instead I am going to introduce my arguments and hopefully come back to the issue at a later time. Let's see how it goes.

First, it finally happened. Frank "The Entertainer" was kicked off of I Love Money 2 last night. I have been waiting for this to happen for weeks. Frank was a stupid person who yelled so loud that he could manipulate many of the people with feeble minds (cough, cough, 20 Pack, Onyx, Frenchie, Heat) who were on the show. Finally enough dumb people were gone so that an alliance led by Tailor Made finally was able to stand up to him. After winning the episode's challenge, Tailor Made convinced It to join his alliance. It was then able to convince Saphari that if she didn't vote Frank into the box, she would be the one put in the box herself, along with Myamee and It. She would then be the person went home, which is all most likely true. Instead Myamee, It, and Saphari's votes for Frank were enough to stalemate the vote, allowing the paymaster, Tailor Made, to choose who was put in the box. He obviously chose Frank, and after making Saphari sweat for a little while, sent him home. I couldn't be happier, and I can't wait to see where the show goes now that the individual challenges are starting.

Secondly, I have read a few reports on the Obama administration's new bank asset relief plan, and as you may have guessed, I am not impressed. As I understand it, and I may be wrong because I am not particularly well educated on these types of securities, first the banks will auction off the assets, often taking losses just so that the bad investments are off their books. Next, the treasury will use the remaining $100 billion or so in unused TARP funds to go in as a 50/50 partner with the private investor who wins the auction. However, instead of requiring full payment for the asset, the private investor and the treasury will only be required to put up 1/14 of the purchase price each. The rest of the price will be paid for from a FDIC in the form of a non-recourse loan which would be lent to the new public-private partnership at a 6-to-1 debt-to-equity ratio.

This is simpler to understand using the example given by the treasury department. Say a bad bank asset is really worth $1, but it is sold at the auction for $0.84. In this case the private buyer and the treasury would each put up $0.06, while the remaining $0.72 would be financed buy a loan by the FDIC. Basically the tax payer is on the hook for 90% of the investment.

The first problem I have with the plan is the pairing of private investors with the treasury, each sharing profits. After seeing how the house acted last week when AIG used federal funds to pay their top executives, why would anyone in their right mind want to accept federal funds to buy a troubled asset. Imagine, for example, that some lucky investor ends up purchasing a tremendously undervalued asset (not out of the realm of possibility), and sees tremendous profits. I can just see Nancy Pelosi now, yelling on the house floor about "windfall profits" and attempting to implement a 90% tax retroactively on private investor despite the fact that the federal government will also see similar profits.

Secondly, tax payers bear way to much of the risk. As I stated, the treasury will match the private investors capital investment while the rest will be financed through FDIC and federal reserve loans. Although the toxic bank assets may turn out to be undervalued, there will undoubtedly be a large number that will fail, and the federal government, well actually tax payers, will be forced to front the bill.

Lastly, although this system may work for banks that are not in terrible shape, there is almost no chance it will work for someone like CitiBank. There assets will most likely be sold at such a low price at auction that they will be unlikely to accept the price and the loss associated with it. Executives who accept short term losses like that see stock prices tumble even farther, destroying their compensation and most likely costing them their job. A more likely scenario is that the will refuse the sale price, and in order to keep them on their books continue to hoard funds and refuse to lend. Basically it will be exactly the opposite of the desired goal of the plan, as the markets will fail to be recapitalized.

Now like I said, I will continue to follow the proposal and will comment as new ideas and issues emerge. Hopefully, this will work, but I have a sneaking suspicion that it won't, and that Congress will step in a few months with now with actual legislation that will only further exacerbate the problem or cause brand new ones. For a better alternative check out the blog that I follow (Link in the box to the right) entitled The Road from Serfdom. Although it isn't written yet, I am going to force my roommate to write it tonight because I don't want to take credit for what I think is a very good idea. So get writing Andy Maran.

Finally, I just want to write a paragraph or two on a few of the reasons I don't think Paul Krugman really knows what he's talking about when he attempts to predict the future of the economy. Now Krugman is an excellent research economist, and his work won him a noble prize in 2008. However, he has a history of being a very poor forecaster, based mainly on his reliance on Keynesian models. For one example, see this link which outlines how he wrongly predicted massive inflation in the 1980's while working for the the Council of Economic Advisers for the Reagan administration.

Now I can't base my entire dislike for his theories one one prediction, but when he doesn't believe one the the most fundamental issues of my economic beliefs, that inflation is a pure monetary phenomenom, then how can I accept anything he says. In his memo Krugman uses indicators such as oil and commodity prices as well as exchange rates to predict further inflation. However, these indices are not inflation causing, they are only inflation spotters. Inflation is caused by nothing more than in an increase in monetary supply relative to output. If output and monetary supply remain the same, then there is little or no inflation. When the monetary supply increases faster than a nation's output, that nation will experience inflation.

Krugman also uses misrepresentations to make political points as well. For example, Krugman's attack on Milton Friedman's theory that the federal reserve's failure to end its tight money policy prior to the great depression may have been a contributing factor to the extent of the economic downturn (Link to the article here). Krugman claimed that since the monetary base (i.e. currency and central bank deposits within the federal reserve) had risen rapidly prior to the current downturn and has failed to curb the current economic fall, so the federal reserve could have done nothing to soften the great depression. However, the truth is that Friedman's argument was that the fed's failure to increase the true money supply (i.e. money contained in deposit accounts and currency in circulation) made the great depression worse. And that also explains why an increase in the monetary base has not helped soften the current downturn. Banks are currently hoarding money with deposits at the Federal Reserve. This explains the increased monetary base and in reality the true money supply has not increased recently, perhaps exacerbating the current downturn.

Anyway I'm tired of typing. I'm sure I'll complain more later.

First Thoughts on the Obama Housing Plan

Although I have yet to read the specifics regarding Obama's new mortgage bailout, I do want to comment on such governmental actions on a more fundamental level. Traditionally, progressive politicians have attempted to redistribute wealth in America to create a more equitable allocation of capital. In other words, they would tax wealthier individuals at higher marginal and average rates than the poorest people. These higher taxes would then be used to pay for programs that helps the poorest Americans. Regardless of how you feel about these policies, at least the Democrats were honest and straightforward, stating that this was their ultimate goal. This mortgage bailout plan is not a redistribution of wealth in the traditional sense though. Instead it is a redistribution of debt, where fiscally sound Americans who did not take on bad debt are forced to pay for unresponsible Americans who took out mortgages that they could not afford.

No doubt that the banks and financial institutions who approved these suspect mortgages, such as sub-prime and option ARM mortgages, are also to blame. However, what did the Bush administration and now the Obama administration do to hold these lenders accountable? Nothing but give them billions in bailout money. Of course at this point it would be extremely difficult for let these huge financial institutions fail, especially after companies like Fannie May and Freddie Mac have received implicit guarantees from the federal government for years, taking risk out of the financial system. But regardless of how this crisis started, we now must decide how to fix it. My question to you is if we aren't sure how the housing crisis began, how do we expect to fix it on a fundamental level so that it won't happen again?

The answer is no one really knows how to fix it at this point. Over the past year, it has been shown that our current system of assessing risk through institutional credit ratings is flawed, and it is extremely hard to assess the value of mortgage backed securities for a large number of reasons. It is hard to tell how many foreclosures there will be, what if any aid will come from the government, and the securities have been partitioned/repackaged/resold so many times it is hard to tell who owns what. However, it is fundamentally unfair in my opinion to make fiscally responsible americans to pay for the excesses of those who didn't wait to put a full down payment on their homes, and were then forced to accept more unfavorable loan rates.

Over the twentieth century, economists worldwide have rejected central planning of economic forces as the most efficient way to run an economy in favor of the price mechanisms of capitalism. Regardless of how intelligent you think Obama is, even he doesn't know how to distribute this debt in an efficient and fair way. The way to rid our economy of this bad debt fastest, and in a way that is most fair to the large majority of the public, is to let bad contacts default, and force the debt on those who took the risk: the lenders and borrowers of the bad loans. Let our free market system work. The bankruptcy system is the U.S. is designed to protect people in these situations and will quickly and efficiently remove the bad debt from the system. Obviously this is a difficult option. The markets will fall, people will lose their homes, and financial institutions may be bankrupt. In the long run, however, this will be a much cheaper solution for a majority of americans, who would be forced to pay higher taxes and an inflated rate for goods and services if we finance a bailout using borrowed money.

Everyone likes capitalism during economic booms, as it effectively distributes income in a fair way. However, now that we are in an economic downturn, people are scared to let bad debts be payed by the people who created them. Until we hold the bad debts accountable, risk will still be absent from our financial system, leading us to repeat this same mistake once again farther down the road. And perhaps at that time we won't be able to borrow our way out of it.