Reason Magazine - Topics > Economics

Cyclones and Sanctions

khowley@reason.com (Kerry Howley) — Mon, 19 May 2008 15:00:00 EDT

In the mid 1950s, denizens of Burma, Thailand, and South Korea were about equally wealthy, but one nation seemed especially likely to prosper. In contrast to the others, Burma was already an exporter of rice and oil, had a relatively high literacy rate, and seemed well on its way toward a parliamentary system of government. It was full of teak, gems, and rich soil. As David Steinberg points out in Burma: The State of Myanmar, any observer “would have pointed to Burma as the potential economic and political leader of the three.” War-torn, resource-poor South Korea “would not have been a contender in anyone’s imagination.” In 2006, South Korea’s GNP per capita was $24,500; Burma’s was $1,800.

Look closely enough at the pictures of destruction wrought by Cyclone Nargis, and you begin to realize how very little there was to destroy. There, a bamboo house in shambles; here, a thatch roof torn off; there, a dirt road obscured by scattered palm fronds. When the cyclone struck, tens of thousands of people had no solid structure to cling to, and the cyclone’s ghastly death toll is as much a function of the country’s poverty as is the storm’s strength. Had the same cyclone hit the prosperous Burma that might have been, the death toll would have been far less dramatic.

The South Korea comparison matters because Burmese poverty is so often treated as an inevitability rather than a byproduct of bad governance. The imprisonment of activist Aung San Suu Kyi is well known and roundly denounced; the junta’s punishing monetary policy, which maintains an official exchange rate 200 times lower than the market rate in order to benefit state-owned businesses, is less often noted. Burma’s banking system is barely functional, and the government tightly controls trade. According to the Progressive Policy Institute, Burmese rice exports have dropped by 99 percent since 1950. The junta says it is committed to a market-oriented economy, but it has reversed most of the gestures it has made in that direction.

No one is nominating Than Shwe, Burma's military leader, for Administrator of the Year, and it’s not news that the junta has been the cause of suffering. But Burma’s poverty, and the deaths it causes in the best of monsoon seasons, is at the center of a significant debate about the way the West should approach Myanmar. The most extreme advocates of Burmese sanctions, among them Sens. John McCain (R-Ariz.) and Mitch McConnell (R-Ky.), tend to assume that the lives of Burmese people cannot improve without regime change. Economic development is being held hostage to political reform, but there is little reason to expect political reform any time soon.

“I am new to work on Burma, but in my eight weeks of involvement to date I am finding the world of Burma advocacy rigid and doctrinal,” writes Joel Charny, Vice President for Policy at Refugees International, on the organization’s blog. “There is just one overarching narrative: the struggle of the Burmese democracy movement, led by Nobel Peace Laureate Daw Aung San Suu Kyi, against the repressive Burmese generals.”

Based on the assumption that Burma must change politically before it can engage economically, American Burma activists support sanctions and isolation, and many are skeptical of independent humanitarian work. “The Burma solidarity adherents often evoke ‘the courageous Burmese people’ to support the aid embargo,” Charny continues. “This is an easy rhetorical device, and may sound plausible, but it is based on discussions with a narrow set of political actors, most of them outside the country.”

On the flip side, development advocates claim that sanctions and aid restrictions have had no discernible benefit for the Burmese, the majority of whom make less than $200 a year. The National League for Democracy is weak and disorganized, and so dependent on Suu Kyi that it seems unable to operate when she is under house arrest. Our refusal to trade with the Burmese has brought democracy no closer to realization.

Sanctions are a sacrifice we make on behalf of other people; we have volunteered the Burmese to undergo painful economic deprivation in the hope that poverty will drive them to a better future. It hasn't worked, whether because Burma's neighbors have rejected the U.S. approach or because the United States never had much economic leverage in the first place. An alternative approach, one that does not assume the Burmese people’s assent in a scheme to impoverish them, involves coaxing the regime toward basic economic reforms that would at least allow Burma’s rice farmers to move out of their bamboo-and-thatch homes in preparation for the next monsoon season.

Cyclone Nargis is no longer just a natural disaster, British Prime Minister Gordon Brown declared on May 17^th as the junta continued to refuse to allow food and medical supplies to reach victims: “It is being made into a man-made catastrophe.” But Cyclone Nargis was a “man-made catastrophe” the moment the first shoddily built shack was swept out to sea. Burma is poor because it has been made so, and the military has been isolating and impoverishing the country for 45 years now. Why are we helping them?

Kerry Howley is a reason senior editor.

Republicans and Tax Realities

schapman@tribune.com (Steve Chapman) — Thu, 15 May 2008 12:00:00 EDT

In the 1980s, a Republican House member, fed up with bipartisan efforts to reduce the budget deficit, denounced Republican Sen. Bob Dole as the "tax collector for the welfare state." Newt Gingrich, who later became Speaker, had captured something essential about the party's mood. It was not against the welfare state. It was just against paying for it.

That remains the case today, as John McCain and his supporters make clear. He rules out tax increases to cut the deficit, while vowing to get tough on spending. But the Committee for a Responsible Federal Budget says that while his proposals would slow the growth of spending, total outlays would still rise faster than inflation. Result: a larger deficit.

Republicans used to argue that keeping taxes down was the only way to restrain spending. But as taxes have been cut under President Bush, spending has soared by 29 percent (after adjustment for inflation). Meanwhile, a $236 billion budget surplus has morphed into a deficit of more than $400 billion.

If we want to cut federal spending, apparently we have to do it directly. And if we don't want to cut spending, the least we can do is pay for it ourselves instead of running up debts for our children to pay.

But Republicans object to raising taxes in general, and one in particular: the tax on capital gains. Obama's plan to increase the rate applied to the sale of assets has provoked howls of outrage on the right.

McCain said it proves Obama "doesn't understand the economy." An editorial in The Wall Street Journal claimed that lower rates yield higher revenues and drew a damning conclusion: "Either the young Illinois senator is ignorant of this revenue data, or he doesn't really care because he's a true income redistributionist who prefers high tax rates as a matter of ideological dogma regardless of the revenue consequences."

You don't have to be a Democrat to doubt that logic. Conservatives regard Obama as a true-blue liberal who itches to expand the size of the federal government. Do they think he would forfeit money to do that just for spite?

As it happens, Obama is the one who is heeding data rather than ideology. Most economists believe that in the long run, the 2003 cut in the capital gains rate reduced revenue rather than raising it. For that matter, even the Bush administration's budget admits as much. Keeping the rate at 15 percent rather than letting it revert to 20 percent, it estimates, would cause a revenue loss of $79 billion over the next decade.

It's true that rates and revenues may sometimes move in opposite directions. When the rate rose in 1987, capital gains realizations dropped. But there's an obvious explanation for that transitory effect. In 1986, seeing the increase coming, people hurried to cash in capital gains while the rate was low.

It's also true that after the rate fell in 1997, realizations rose. But as University of Michigan economist Joel Slemrod notes, that increase began well before the cut—and they plunged after 2000, without any rate increase. Assessing the last two decades, the Congressional Budget Office reports that any positive effect on realizations is "certainly not large enough to offset the losses from a lower rate."

Sensible people might not mind the lost revenue if the change strengthened the economy. But chances are it does just the opposite, by encouraging taxpayers to jump through hoops to reduce their tax liability.

A low capital gains rate hinders the free market by inducing people (especially very wealthy ones) to find ways to take earnings as capital gains instead of ordinary income. In other words, it encourages them to do things that would not make economic sense otherwise. A modestly higher rate would discourage such wasteful avoidance.

Like all taxes, capital gains taxes are a burden. But given that the federal government spends nearly $3 trillion a year, taxes are a regrettable necessity. When we cut capital gains taxes, we have to raise other taxes to make up the loss. Or we have to borrow more money—which means raising taxes in the future.

Republicans may abhor the obligation of paying for the welfare state they helped preserve. But for the moment, the only real choice is between doing that job better and doing it worse.

COPYRIGHT 2008 CREATORS SYNDICATE, INC.

You'll Be Happy to Hear the Revolutionary State Has Seized Everything Except the Insurance Industry

jwalker@reason.com (Jesse Walker) — Wed, 14 May 2008 09:58:00 EDT

Talk about markets in everything:

I became intrigued by an oddity that I came to think of as the end-of-the-world trade. The trade is the purchase of insurance against what would in effect be the failure of the modern capitalist system. It would take a cataclysm -- around a third of the leading investment-grade corporations in Europe or half those in North America going bankrupt and defaulting on their debt -- for the insurance to be paid out.

I asked one investment banker what might cause half of North America's top corporations to default. No ordinary economic recession or natural disaster short of an asteroid strike could do it: no hurricane, for example, and not even 'the big one', a catastrophic earthquake devastating California. All he could think of was 'a revolutionary Marxist government in Washington'. That's not a likely scenario, yet the cost of insuring against it had shot up ten-fold. Normally one can buy $10 million of end-of-the-world insurance for between two and three thousand dollars a year. By early last November, the prices quoted were between twenty and thirty thousand, and even then it was difficult to buy in quantity -- at least, said the banker, 'not from anyone you trusted'.

Via Ken MacLeod, who comments: "You can insure against the revolution? Who knew?"

The Coming Recession

Mon, 05 May 2008 12:05:00 EDT

As this issue of reason goes to press, the dollar is at a record low against the euro, oil is more than $100 a barrel, consumer prices are up 4 percent from a year ago, and Federal Reserve Chairman Ben Bernanke is cutting interest rates so often that the guys at the office have taken to calling him Edward Scissorhands. The subprime mortgage fallout has yet to finish wreaking its havoc, Bear Stearns is holding on by the skin of its teeth, and the government’s bucket may not be big enough for all the bailouts under way. Gloomy faces dominate CNBC and the Fox Business Channel, muttering long-forgotten terms like inflation and recession.

President George W. Bush, by contrast, is relatively cheery, conceding that we are in “challenging times” but arguing that “our financial institutions are strong” and the capital markets “functioning efficiently and effectively.” “In the long run,” Bush said in a March 17 White House address, “our economy is going to be fine.” And some statistics back up the sunny view: Unemployment is still at a low 5.1 percent, and productivity remains high.

Presidential hopefuls are offering a variety of explanations and possible solutions for what 42 percent of voters say is the most important issue to them, according to a recent CNN poll. At a March 20 rally, Sen. Barack Obama (D-Ill.) suggested the problem was a combination of “special interests” and war: “At a time when we’re on the brink of recession, when neighborhoods have ‘For Sale’ signs outside every home, and working families are struggling to keep up with rising costs, ordinary Americans are paying a price for this war.” Sen. Hillary Clinton (D-N.Y.) took a different tack: The “economic crisis is, at its core, a housing crisis,” she said in a major Philadelphia address on March 24, but she cited other factors as well, including Bush’s “brain dead energy policy.” Sen. John McCain (R-Ariz.) won the Republican nomination without really talking much about the economy.

How will we know when it’s fair to speak the dreaded r-word? In general, a recession is defined as a decline in a country’s gross domestic product for two or more successive quarters. In the United States, an official pronouncement is required from the professional doom diagnosticians on the business-cycle dating committee of the National Bureau of Economic Research, who often take other aspects of an ailing economy into account. GDP growth slowed dramatically at the end of 2007 and is projected to be zero in the second quarter of 2008, so we look to be well on our way.

As oil prices continued to climb and housing prices continued to slide, Reason assembled a panel of economists and other market watchers to help make sense of the headlines, point some fingers, figure out how we got where we are, and offer advice about how to get out with our wallets intact.

Blame the Fed
Gerald P. O’Driscoll Jr.
The U.S. economy is in the midst of an old-style credit crunch brought on by a combination of bad policies and incredibly lax underwriting standards at financial institutions. The biggest policy failure was the decision by Alan Greenspan’s Federal Reserve to hold interest rates too low for too long. That led to a tsunami of credit that inundated the economy with cheap money. Mortgage lenders in particular were flush with funds and searched for deals wherever they could be found. Heretofore unqualified borrowers suddenly “qualified” as underwriting standards relaxed and then disappeared.

Egged on by statements from Chairman Greenspan, market participants came to believe the era of low interest rates would last indefinitely. But the era did come to an end as the Fed was forced to begin raising interest rates. Faced with the prospect of paying higher rates on their mortgages in the future, borrowers began defaulting. First home prices stopped rising, and then home prices began dropping—precipitously in some overheated housing markets. Now we are approximately six months into a new cycle of lower interest rates, but with no end in sight to the crunch.

At least two other factors stoked the crisis. First, many exotic financial products were issued whose value was tied in one way or another to home prices and the value of the securities into which home mortgages were bundled, such as collateralized mortgage obligations. The pricing of these financial products was the product of complex economic models, not the outcome of market transactions. As the value of the underlying homes and mortgages declined, pricing of the financial exotica became nearly impossible. As we learned in the collapse of Long Term Capital Management, these pricing models fail precisely when their accuracy is most important—in times of financial turbulence. The inability to price the financial products has exacerbated losses among the firms holding them.

There is a wonderful parallel here to the collapse of the Soviet Union. As the great Austrian economist Ludwig von Mises argued almost 100 years ago, central planning inevitably fails because there are no market prices to allocate resources. Market prices can only be the outcome of actual market transactions among buyers and sellers. Planners used mathematical formulas to value resources, especially capital. Now Wall Street wizards have imported Soviet thinking to allocate financial capital. Is it any wonder that it failed?

The second factor contributing to the housing market collapse was the federal government’s commitment to “affordable housing.” Lenders, especially Fannie Mae and Freddie Mac, were pressured into promoting housing to low-income groups that could not qualify for normal loans. That policy is predicated on the belief that there is an underserved group of people who, but for economic discrimination or some other market failure, would be homeowners. That social goal and the credit-driven desire for more deals merged into mortgages made without adequate collateral.

We learned two lessons from the drive to make home ownership available to the heretofore underserved. First, many of these were not homeowners because they could not afford a home. Only under the temporary “hothouse” conditions in mortgage markets did they seem to qualify. Second, people who have no equity in their homes cannot meaningfully be said to be owners. When times turn tough, they will walk away. They were effectively renters, not homeowners.

The crisis will end when housing markets hit bottom and the prices of mortgage securities stabilize. Banks also need to unwind their positions in exotic financial derivatives.

The Fed needs to understand it is facing a capital crisis, not a liquidity crisis. The very low interest rates on safe assets show there is ample liquidity in financial markets. The Fed should not supply capital. That is the job of markets, and they are doing it.

Gerald P. O’Driscoll Jr., formerly a vice president and economic adviser at the Federal Reserve Bank of Dallas, is a senior fellow at the Cato Institute.

No Hoofing to Hooverville
Megan McArdle
Just one thing puzzles me about the race to the White House: Why would anyone want to get there? I know that being crowned prettiest girl at the prom is the great lasting rejoinder to everyone who made fun of you in middle school, but given the economic condition of the country, the next four years seem like a rotten time to reign.

Ignore the econopundits making comparisons to the 1930s. While the parallels are striking, we are missing the key ingredient in the onset of the Great Depression: tight Fed policy that caused the money supply to shrink by 25 percent. You can put away that bindle and push the apple cart back in the garage.

But if we’re not exactly hoofing it to Hooverville, we nonetheless face one hell of a rough patch. Record high oil prices, surpassing even the momentous spikes of the 1970s, have brought with them another piece of ’70s memorabilia: stagflation. Federal Reserve bankers are faced with an extremely unpalatable choice. They can tighten up the money supply to combat inflation, at the cost of making the probable recession even deeper. Or they can hang loose and watch inflation march upward while the economy does God knows what. With the credit markets broken, the Fed may end up losing its hard-won credibility as an inflation fighter while producing only marginal benefits to growth.

The president has no control over any of this, but that won’t stop people from blaming him anyway. He will also almost certainly have to come up with some regulatory scheme for increasing transparency and accountability in the vast new financial markets that have been created by the securitization of loans during the last 30 years. It will be a tough order to give investors better information without strangling valuable financial innovation.

But by far his biggest quandary will be the budget. Obama (who I assume will be the Democratic nominee) wants a big new health care entitlement; John McCain wants even more tax cuts. Both will be frustrated by adverse budget math. The economic slowdown is going to cut into tax revenues, and most economists agree that a recession is not a good time to raise taxes—nay, not even on “the rich.” Meanwhile, the baby boomers are about to start retiring, turning Social Security, Medicare, and Medicaid into the sucking chest wound of the federal budget. Assurances that the trust fund won’t run out until 2042 notwithstanding, the president will have to start coping with Medicare deficits as soon as next year, and a falling Social Security surplus soon thereafter. All this will be compounded by the slowdown in GDP growth made inevitable by declining labor force participation and service-intensive elder care.

Any future president should be panicking. That doesn’t mean the rest of us should. At the end of the day, America has the most flexible and resilient economy in the world. We’ll pull through somehow, although a lot of us won’t be very happy in the process. But least happy of all will be the president—the bum we get to throw out when things don’t go our way.

Megan McArdle blogs about economics at The Atlantic.

First, Do No (More) Harm
Ron Paul
This nation is facing an economic crisis the likes of which have not been seen in several generations. It is crucial that we take to heart the lesson that should have been learned after the Great Depression, which is that the central bank should do nothing.

I have been writing and speaking for years about the dangers of the Federal Reserve, but the importance of the actions of the Fed in laying the groundwork for the downturn in the business cycle pales in comparison to the damage done by actions the Fed takes once the downturn arrives. At the first sign of crisis, even with growing inflation, the Fed began to further inflate, lowering interest rates, stepping up open market operations, and injecting liquidity. World markets, already jittery, see these steps as affirmations of their worst fears and react accordingly by selling assets denominated in smoke-and-mirrors fiat currency and fleeing to the solid value of gold, oil, and commodities.

Every action the Fed takes sends a signal that the U.S. dollar will continue to be inflated and therefore debased, which is why the correct action is no action at all. Lower interest rates and liquidity injections are viewed with alarm by foreign markets, while higher interest rates and money tightening are anathema to many domestic investors. The Fed is between a rock and a hard place, and its insistence on inflating the money supply to manage the brittle economy will likely be our undoing.

Until we realize that the Federal Reserve system itself is flawed, and until we recognize that no one economic maestro or committee of economic experts can set prices and plan the economy, this nation will continue to flounder about in an economic malaise. Ending that may take a much more serious downturn than anything we’ve seen yet. It is beyond doubt that our economy is in recession, and the only rational response is for the government to allow malinvested resources to liquidate so that we can return to a stable economy.

While the Fed should take a hands-off approach, Congress should aggressively cut taxes and spending and repeal regulations that stifle economic growth, such as the Sarbanes-Oxley Act. This country has enormous economic potential, an industrious work force, and an enviable history of innovation and entrepreneurship. If the government would learn from its past mistakes and abstain from further interference, we could get back on a solid footing and grow to our full potential.

My fear is that the Fed will continue with its policy of inflation and Congress will be pressured to continue to stimulate the economy with government spending, probably extending to even more outright taxpayer-funded bailouts of financial institutions, subprime mortgages, and government-sponsored enterprises that are “too big to fail.” These debt-funded efforts reward the recklessness of some institutions at the expense of the productive sectors of our economy. Until the federal government acts to extricate itself from intervention in the markets, economic activity will be hindered and true recovery will not take place.

Rep. Ron Paul (R-Texas) is a nine-term congressman and a candidate for the Republican presidential nomination.

The Vicious Ethanol Cycle
Robert Bryce
I see three big dangers to the global economy: the ongoing fallout from the mortgage mess, rising energy prices, and rising food prices. That last item is the most maddening, because surging food prices are largely the result of the ethanol scam.

As U.S. ethanol distilleries vacuum up ever increasing quantities of corn, and corn takes up an ever larger percentage of arable land, prices for all types of food are skyrocketing. During the last two years, corn prices have more than doubled and soybean prices have nearly tripled. In 2007 food prices in the U.S. increased by nearly 5 percent. Bill Lapp, of the Omaha-based research firm Advanced Economic Solutions, told The Boston Globe in March that he expects food prices to increase at an annual rate of 7.5 percent for the next five years.

Because of mandates requiring gasoline producers to mix ethanol with their fuel, 20 percent of the U.S. corn crop in 2006—about 2.1 billion bushels—was diverted into ethanol production. By 2009, according to the National Corn Growers Association, about one-third of the expected crop—some 4 billion bushels—will be used to make motor fuel. And those projections were made in April 2007, eight months before Congress passed the Energy Independence and Security Act of 2007, which requires the consumption of 36 billion gallons of ethanol by 2020, a fivefold increase over current levels.

The far-reaching economic impact of ethanol mandates is already being felt. In early 2007, tens of thousands of people marched in the streets of Mexico City to protest the rising cost of tortillas, an increase that Mexico’s secretary of economy, Eduardo Sojo, blamed on American corn ethanol production. In March of this year, Pilgrim’s Pride, the world’s largest poultry processor, shuttered a plant in Siler City, North Carolina, and fired 1,100 workers. Company CEO Clint Rivers laid the blame squarely on the ethanol mandates, predicting that “there is much more to come” in the way of food price increases. “We’re spending our tax dollars to raise the price of our food to subsidize the ethanol industry,” he said.

Congressional meddling in the energy market has created what Lester Brown, the president of the Earth Policy Institute, calls an “epic competition” between “the world’s supermarkets and its service stations.” Therein lies the perversity of ethanol mandates: As the global economy heads for rougher times, food prices are soaring. And those prices will increase anxiety among consumers, who will further reduce their discretionary spending. Congress has created a negative feedback loop that will reverberate for years to come.

Robert Bryce is the managing editor of Energy Tribune. His latest book is Gusher of Lies: The Dangerous Delusions of “Energy Independence” (PublicAffairs).

War Is the Health of the Civilian State
Robert Higgs
Adam Smith famously observed that there is “a great deal of ruin in a nation”—that is, nations can take a lot of abuse. Let’s hope he was right, because the George W. Bush administration has taken a great many actions during the past seven years that contribute to economic ruin.

Much of the White House’s faulty economic policy can be traced to its wars in Afghanistan and Iraq, especially the latter because it has been larger, costlier, and more diverting. I use the word diverting deliberately to emphasize that the government’s military adventures in southwest Asia have served to draw the public’s attention away from economic measures that otherwise would have attracted more notice and hence more resistance.

One reason war is always associated with especially rapid growth in the size, scope, and power of the state is that it focuses people’s attention on what is seen as the most urgent matter, so they simply don’t notice what the government is doing in other areas. Another reason is that during wartime many people increase their broad support for the government and are less inclined to challenge its actions even when those actions have little or nothing to do with the war.

Hardly anyone was surprised that real military spending (measured in accordance with the government’s own narrow definition) increased by almost 60 percent between 2000 and 2007, compared to real GDP growth of 18 percent during that time. Note, however, that the government’s real nondefense outlays increased concurrently by more than 24 percent—an increase one-third greater than that of GDP. When people let down their guard in “supporting the troops,” they permit the government to make greater headway in its ceaseless quest to enlarge spending in a wide range of areas, many of them strictly civilian in nature.

The administration has partially concealed the burden of its spending binge by resorting to deficit finance. Federal debt held by the public increased by 49 percent between the end of fiscal 2000 and the end of fiscal 2007—a 24 percent increase after adjusting for inflation. To facilitate this surge in public borrowing, the Federal Reserve engineered a 40 percent increase in the monetary base, easing credit conditions in the commercial banking sector. The real estate bubble (now bursting) and the substantial depreciation of the dollar’s international exchange value are but two of the consequences of these reckless, war-spawned fiscal and monetary policies.

In view of the plunging stock market, my guess is that the current recession—in which many of the easy-credit-induced malinvestments of the past seven years are being liquidated by means of write-offs, loan defaults, bankruptcies, and other asset forfeitures—has much further to run. If you like the present worsening economic situation, write the president and your congressional representatives a letter and thank them for their war and their related economic spoliation.

Robert Higgs, a senior fellow in political economy at the Independent Institute, is author of Crisis and Leviathan: Critical Episodes in the Growth of American Government (Oxford University Press) and many other books.

Stagflation or Depression?
Robert E. Wright
The current U.S. economic outlook is as bleak as it was in 1974 or even 1930. Will the economy wither? Or will it just wilt a little before blossoming in a bath of Fed-supplied liquidity? Nobody knows for sure, but I fear the former. Here’s why:

Our educational system does a poor job of teaching people how to think independently. It always has, but until recently that wasn’t a big problem. Today’s globalized economy, however, demands ever larger numbers of engineers, doctors, scientists, and sundry creative types. We probably won’t create enough independent thinkers until we have school choice at the primary, secondary, and tertiary levels.

Thankfully, entrepreneurs abound. They’ve pulled us out of the economic fire in the past and could do so again. But they are more hamstrung than ever with high, uncertain, and often capricious taxes and regulations that do not appear to be going away anytime soon.

Something stinks in our financial system. Six different mortgage securitization schemes blew up between the Civil War and World War II for exactly the same reason that subprime mortgages tanked last year: very poorly designed incentives for mortgage originators. Why don’t financiers and their regulators pay more attention to America’s rich financial heritage? Their modeling is more sophisticated than ever, but their economic reasoning is not.

The national debt is so high ($9.4 trillion, or almost $31,000 per person) that the government must largely rely on monetary stimulus rather than more salubrious fiscal measures, such as permanently cutting taxes. Too much easing by the Fed could lead to 1970s-like inflation and further financial havoc.

Urged on in part by the example set by their profligate leaders, Americans wallow in a huge pile of private debt as well. A high level of individual leverage has become a permanent fixture of the nation’s landscape. Americans owe so much that to keep growing, financial institutions have to push the margin of safety by making loans on ever thinner collateral and ever weaker covenants. If the economy slows significantly, many more poor-quality loans will hit the proverbial fan. The ensuing mess will stink and take a long time to clean up.

Even if the Federal Reserve manages to save the economy this time, these problems may continue to fester, breeding the next economic catastrophe. Perhaps, though, even greater levels of incompetence in other countries will break our fall.

Robert E. Wright is the author of One Nation Under Debt: Hamilton, Jefferson and the History of What We Owe (McGraw-Hill) and a curator for the Museum of American Finance. He teaches business, economic, and financial history at New York University’s Stern School of Business.

The Only Thing to Fear Is Fear-Driven Government ‘Control’
Donald J. Boudreaux
New York Times columnist Gail Collins was underwhelmed by the president’s folksy course-things-ain’t-great-now-but-we-Americans-with-our-rebate-checks-and-incessant-complaining-about-congressional-earmarks-are-gonna-be-just-fine address to the Economic Club of New York on March 14. She complained that “in times of crisis you would like to at least believe your leader has the capacity to pretend he’s in control.”

This is the attitude that scares me. I worry not a whit that the subprime crisis or falling share prices will cause long-term economic woe. As unnerving as the current downturn might be today, people in competitive markets always find ways of regaining their economic footing tomorrow. Investors recalibrate their expectations and entrepreneurs redirect their energies to take better advantage of the changing economic landscape. Workers’ pay and consumers’ standard of living, after blipping briefly downward, resume their upward trend.

“Nonsense!” a chorus yells. “What about the Great Depression? Or the 1970s?” The experiences of these decades are indeed relevant. They are, however, precisely why the clamor for putting someone “in control” of this crisis is so frightening.

Contrary to the conventional wisdom, whose strength of empirical support rivals that for the flat-earth hypothesis (“It seems so obvious!”), the massive move toward centralized control of the economy during the administrations of both Herbert Hoover and Franklin Roosevelt did not “rescue” Americans from economic hardship. All that FDR’s soaring rhetoric and army of officials manning newly created alphabet-soup agencies managed to do was to prolong an economic downturn into America’s deepest and longest depression—one that showed no reliable signs of ending until after Roosevelt met his maker. As the economic historian Robert Higgs documents in his 2006 book Depression, War, and Cold War, investors were terrified by the very real risk during the 1930s that government would extend its control over the economy even beyond what it achieved with its New Deal programs.

The 1970s weren’t as bad as the 1930s. Most important, there was no serious talk during the ’70s of nationalizing industries or socializing investment decisions. International trade was expanding rather than being suffocated by a disco-era Smoot-Hawley tariff. Still, wage and price controls were in vogue (and in effect), Congress and Richard Nixon were keen on command-and-control regulations, and Fed chairmen Arthur Burns’ and G. William Miller’s control over the money supply was injuriously inflationary. Shot through with so many interventions giving government more “control,” the economy slipped into an infamous malaise.

My only fear, therefore, is fear itself—fear that deludes people into believing that giving government greater control is the key to earthly salvation. As I write these words, the Fed’s aggressive moves to bail out Bear Stearns and prevent other necessary market corrections—along with increasing public support for protectionism, anti-immigrant nativism, and environmental hysteria—send shivers down my spine. The threat of a long-term crisis is only as real as is the likelihood that government will try to exert more control.

Donald J. Boudreaux is a professor of economics at George Mason University.

John McCain's Plan to Keep Employer-Provided Health Insurance While Moving Away From It

jsullum@reason.com (Jacob Sullum) — Wed, 30 Apr 2008 18:11:00 EDT

Severing the government-supported, market-distorting connection between health insurance and employment would promote choice, allowing people to select the medical plans that best suit their circumstances, and security, addressing one of the main anxieties about health care by making coverage portable. This is one of the few areas where the Bush administration was on the right track, and I'm glad to see John McCain picking up the idea. But I wish his talk were a little straighter on this subject. Here is how he describes the current system, in which most Americans with health insurance get it through their employers, and the change he'd make:

Under current law, the federal government gives a tax benefit when employers provide health-insurance coverage to American workers and their families. This benefit doesn't cover the total cost of the health plan, and in reality each worker and family absorbs the rest of the cost in lower wages and diminished benefits. But it provides essential support for insurance coverage. Many workers are perfectly content with this arrangement, and under my reform plan they would be able to keep that coverage. Their employer-provided health plans would be largely untouched and unchanged.
But for every American who wanted it, another option would be available: Every year, they would receive a tax credit directly, with the same cash value of the credits for employees in big companies, in a small business, or self-employed. You simply choose the insurance provider that suits you best. By mail or online, you would then inform the government of your selection. And the money to help pay for your health care would be sent straight to that insurance provider. The health plan you chose would be as good as any that an employer could choose for you. It would be yours and your family's health-care plan, and yours to keep.
The value of that credit—$2,500 for individuals, $5,000 for families—would also be enhanced by the greater competition this reform would help create among insurance companies. Millions of Americans would be making their own health-care choices again. Insurance companies could no longer take your business for granted, offering narrow plans with escalating costs. It would help change the whole dynamic of the current system, putting individuals and families back in charge, and forcing companies to respond with better service at lower cost.

Although you might not guess it from McCain's gloss, the "tax benefit" in question goes to employees, not employers. Companies can deduct money spent on employee compensation as a business expense whether it takes the form of wages or health benefits. But since the government does not treat employer-provided health insurance as taxable income, there's an artificial incentive for employees to prefer compensation in that form, rather than the cash equivalent. If both kinds of compensation were treated the same, most employees presumably would prefer the money; employers would respond by ditching health benefits and offering higher wages instead. Equal tax treatment could be accomplished either by taxing the health benefits as income or, as McCain seems to be proposing, making the money an employee independently spends on health insurance tax-free as well.

Although the policy change has to do with taxes paid by employees, The New York Times has McCain "eliminating the tax breaks that currently encourage employers to provide health insurance for their workers," which makes it sound as if employers are the ones getting the breaks. And the McCain campaign seems to be downplaying the impact that equalizing the tax treatment of health benefits and wages would have on the prevalence of employer-provided medical coverage. According to the Times, McCain's domestic policy adviser "said he believed that many employers would still offer health insurance to try to attract the best workers." McCain himself says "employer-provided health plans would be largely untouched and unchanged" for the "many workers" who "are perfectly content" with the status quo. Maybe this is just his way of reassuring people that changes in the compensation mix would be driven by employee preferences. But the main economic rationale for eliminating the health-benefit tax preference is to make employer-provided medical coverage the exception rather than the rule; otherwise we would still have a system in which medical coverage is both artificially expensive, since patients have little opportunity or incentive to economize, and insecure, since losing a job often means losing health insurance.

Up From the Depths

info@reason.com (Jeff Taylor) — Fri, 18 Apr 2008 12:00:00 EDT

The latest sign of trouble in America's stressed credit system can be found not in some arcane Wall Street hedge fund, but deep in Alabama. There the mundane civic chore of providing water and sewer service drove one county to the edge of bankruptcy and sent federal regulators into a tizzy.

On Tuesday, creditors, led by JP Morgan and urged on by the feds, hammered out an agreement with Jefferson County, Alabama officials to avoid default on some $3.2 billion in public sewer bond obligations. For now, the county has another 30 days to come up with a $53 million payment. As financial mishaps go, it's perhaps not the sexiest storyline. But that is precisely what should scare anyone who has followed the way local governments have thrown debt around this decade.

Much like home buyers seduced by the largest possible mortgage, local officials were wooed by bankers and bond underwriters to float the largest possible debt they could afford. Given historically low interest rates, on one level it was good advice. But it is also true that—exactly as in the mortgage making market—the bigger the debt, the bigger the commission for the banks and bond traders.

However, unlike a home purchase with a borrower and lender, the ratepayers and taxpayers who ultimately have to stand behind and payoff any deals gone bad are left out of the loop. The finances are often complex and local media outlets seldom have reason to delve into the specifics. And local officials are typically most concerned with how much they can build with the money and what constituents they can "service" with the new debt.

This is particularly true when water and sewer service, or an airport, or some other revenue-generating unit of government is set up as a separate enterprise fund. Too often this confuses lines of responsibility and obscures total public obligations to pay for things. Of course, bond sellers like the enterprise fund and dedicated revenue streams concept. They provide slightly lower interest rates in exchange for the perceived "sure thing" of dedicated revenue. And then localities often turn around and take the lower rate in order to increase the total amount they borrow. Just like house-hungry consumers who bit on low, low introductory rates.

However, this local aspect of chasing big money was glossed over in many accounts of the Jefferson County trouble, with focus instead on the change in the debt rating brought on by the failure of bond insurers. This had the effect of jumping the interest payment on the debt to $250 million a year, swamping the $138 million in revenue the system collects. But bad luck, bad timing, or even incompetence on interest rates swaps it not the only way local utilities can come up short.

A couple weeks ago my stomping ground of Charlotte, NC was confronted with a $30 million projected shortfall in water and sewer revenue. Debt payments would have to be restructured as a result—or more precisely, the local utility would be in violation of covenants made to bond holders. Such covenants or promises to maintain a certain capital position or cash flow are another way local governments have priced their debt loads for perfection in recent years.

In exchange for the promises, the utility or fund receives a lower interest rate. And what do they do with the lower interest rate? Borrow more. And who gets bigger commissions?

In Charlotte's case, the shortfall was resolved—one that was induced by mandatory water usage limits enforced by the city under threat of fine, a wonderfully top-down response to drought—by hiking water rates by 16 percent. Looking across the country, rates are also going up from Oregon to Vermont, often in response to a need to finance additional the construction of capacity.

The great unknown is the extent to which these new debt issues—together with recurring obligations—are not ready for a new credit marketplace in which risk is rapidly being reprised. The only sure thing is that those who sit at the table and make the deals will not be asked to make up any shortfall.

Jeff Taylor writes from North Carolina.

Phone Power to the People

jwalker@reason.com (Jesse Walker) — Wed, 16 Apr 2008 10:05:00 EDT

There are, roughly speaking, three broad approaches to Third World development. There are those who would preserve poverty by keeping development itself at a minimum. There are those who would modernize poverty by imposing coercive, centralized systems on indigenous societies. And there are those who want to make more tools available to Third World people themselves, to accept or reject as they see fit, to discover their own uses for the technologies, to adapt them to their own evolving ways of life.

One potential tool for autonomy, resting at the intersection between high tech and the human scale, is the cell phone. Sara Crobett writes in The New York Times:

Something that's mostly a convenience booster for those of us with a full complement of technology at our disposal -- land-lines, Internet connections, TVs, cars -- can be a life-saver to someone with fewer ways to access information. A "just in time" moment afforded by a cellphone looks a lot different to a mother in Uganda who needs to carry a child with malaria three hours to visit the nearest doctor but who would like to know first whether that doctor is even in town. It looks different, too, to the rural Ugandan doctor who, faced with an emergency, is able to request information via text message from a hospital in Kampala.

[Anthropologist] Jan Chipchase and his user-research colleagues at Nokia can rattle off example upon example of the cellphone's ability to increase people's productivity and well-being, mostly because of the simple fact that they can be reached. There's the live-in housekeeper in China who was more or less an indentured servant until she got a cellphone so that new customers could call and book her services. Or the porter who spent his days hanging around outside of department stores and construction sites hoping to be hired to carry other people's loads but now, with a cellphone, can go only where the jobs are. Having a call-back number, Chipchase likes to say, is having a fixed identity point, which, inside of populations that are constantly on the move -- displaced by war, floods, drought or faltering economies -- can be immensely valuable both as a means of keeping in touch with home communities and as a business tool. Over several years, his research team has spoken to rickshaw drivers, prostitutes, shopkeepers, day laborers and farmers, and all of them say more or less the same thing: their income gets a big boost when they have access to a cellphone.

It may sound like corporate jingoism, but this sort of economic promise has also caught the eye of development specialists and business scholars around the world. Robert Jensen, an economics professor at Harvard University, tracked fishermen off the coast of Kerala in southern India, finding that when they invested in cellphones and started using them to call around to prospective buyers before they’d even got their catch to shore, their profits went up by an average of 8 percent while consumer prices in the local marketplace went down by 4 percent. A 2005 London Business School study extrapolated the effect even further, concluding that for every additional 10 mobile phones per 100 people, a country’s G.D.P. rises 0.5 percent.

One unexpected outcome: a burgeoning alternative banking system.

It's also the precursor to a potentially widespread formalized system of mobile banking. Already companies like Wizzit, in South Africa, and GCash, in the Philippines, have started programs that allow customers to use their phones to store cash credits transferred from another phone or purchased through a post office, phone-kiosk operator or other licensed operator. With their phones, they can then make purchases and payments or withdraw cash as needed. [Al] Hammond of the World Resources Institute predicts that mobile banking will bring huge numbers of previously excluded people into the formal economy quickly, simply because the latent demand for such services is so great, especially among the rural poor.

"Frankly, These People Are Economically Illiterate"

kmw@reason.com (Katherine Mangu-Ward) — Thu, 10 Apr 2008 12:00:00 EDT

Here's a tasty tidbit from a Roll Call story about the many members of Congress--especially those who will be making decisions about congressional action in response to the banking crisis and coming recession--who have been taking a beating in the market:

Cleta Mitchell, a lawyer who works with many GOP Members on their financial disclosure statements, suggested...that it's not surprising that nearly 10 percent of lawmakers may be out millions of dollars because of the current credit collapse.

“Frankly ... these people are economically illiterate,” she said.

Sen. John Kerry (D-Mass.), for example, may face as much as $2.9 million in banking stock losses, according to the story. None of the affected senators have announced any intention to recuse themselves from decisions about bailouts and regulatory changes, either on the grounds of conflict of interest or on the ground of economic illiteracy.

Via The Weekly Standard

Boo on That Mortgage Bailout!

gillespie@reason.com (Nick Gillespie) — Wed, 09 Apr 2008 20:13:00 EDT

Over at Rough Cut, the video blog of reason.tv, check out Mike Flynn saying to mortgage bailouts on CNBC's Task Force. Flynn is director of government affairs at Reason Foundation, the nonprofit that publishes the print and online editions of reason.

Click on the image below to hear a rollicking good argument against government intervention in the economy—for strapped homeowners and investment banks alot.

War Is the Health of the Economy

matt.welch@reason.com (Matt Welch) — Mon, 07 Apr 2008 17:28:00 EDT

Hyper-influential foreign policy intellectual establishmenteer Frederick Kagan has a long new piece in the National Review attacking, um, "hyper-sophisticates of the American foreign-policy and intellectual establishment." Or at least, the ones who aren't named Kagan.

One of his rebuttals to critics of the Kagans' War is sure to win over you FDR fanboys out there:

Modern economics has long understood that the notion of a one-for-one guns-versus-butter trade-off is simply wrong. A high proportion of money spent on defense goes back into the U.S. economy in the form of salaries paid to the more than 5 million Americans employed directly or indirectly by the Defense Department, and payments to the defense industry and the long and complex supply chains from which they draw their raw materials. Military spending has traditionally been a form of economic stimulus, and wars more commonly end recessions or depressions than start them.

Whole Kagger here; thanks to commenter Don for the link. And for something completely different, a reminder to check out Veronique de Rugy's cover story from reason's May issue. Excerpt:

How much money is $1 trillion? Enough to pay for the entire 1976 federal budget, adjusted for inflation. Enough to write a check for $37,500 to every Iraqi man, woman, and child. Enough to buy 169,492 Black Hawk helicopters, or 455 stealth bombers. Enough, in nominal terms, to pay for the entire federal government from 1789 to 1957. And it's 10 times more than what specialists predict it would take to eradicate malaria once and for all.

To distract people from the real price tag of a two-front war, the president and Congress have used an unprecedented and fiscally irresponsible budgetary trick: a series of "emergency" supplemental spending bills totaling hundreds of billions of dollars. This scheme has allowed them not only to hide the costs of the conflicts but also to avoid painful budget choices while funneling billions of dollars in unvetted goodies to favored interest groups.

Capitalism No Longer in "Favor" After 15 Largely Uninterrupted Years of Growth and Job Creation

matt.welch@reason.com (Matt Welch) — Wed, 02 Apr 2008 09:12:00 EDT

Expect to see a whole lot more like this, from the news pages of your morning paper:

Former senator Phil Gramm, with his aw-shucks Texas drawl, may at first blush have little in common with Carly Fiorina, the telegenic former chief executive of Hewlett-Packard. But they share a bond: Both are leading economic advisers of Sen. John McCain (Ariz.), the presumptive Republican nominee for president, and both have reputations as the kind of aggressive capitalists that may be sliding from favor as the nation's economy edges toward recession.
Democratic opponents are already plotting attacks on two advocates of what Robert Reich, a former Clinton labor secretary, described as "dog eat dog capitalism," an economic philosophy that works well when the economy is on the upswing but may not play so well in a trough.

I shudder to imagine what will happen to capitalism's wobbly reputation when unemployment creeps above 5.0%.

For an actually literate take on McCain's economic team, I'll again recommend the Weekly Standard's Andrew Ferguson.

Because it Worked So Well Last Time

matt.welch@reason.com (Matt Welch) — Mon, 31 Mar 2008 11:05:00 EDT

Bloomberg:

Treasury Secretary Henry Paulson proposed the broadest overhaul of U.S. financial regulation since the Great Depression, saying the system for overseeing American capitalism needs to be better prepared for "inevitable market disruptions."
"Our major financial services companies are becoming larger, more complex and more difficult to manage," Paulson said in remarks at the Treasury in Washington. "The real threat to market stability is below ground, at the root level where the health of financial firms is intertwined." [...]
The Treasury recommended that the Fed share authority over banks, securities firms and insurers in monitoring corporate disclosures, writing rules and stepping in to prevent economic crisis.
"To do its job as the market stability regulator, the Fed would have to be able to evaluate the capital, liquidity and margin practices across the financial system and their potential impact on overall financial stability," Paulson said. [...]
"The Fed would have the authority to go wherever in the system it thinks it needs to go for a deeper look to preserve stability," Paulson said.
"The Fed will collect information from commercial banks, investment banks, insurance companies, hedge funds, commodity- pool operators,'' he added. "Rather than focus on the health of the particular organization, it will focus on whether a firm's or industry's practices threaten overall financial stability."

A good idea? I rather doubt it. Aside from the merits (and lack thereof) of this particular case, the American track record of ambulance-chasing bureaucratic and regulatory overhauls is not a very pretty sight. See, for example, Brian Doherty on Sarbanes-Oxely in January 2006, James Bovard on post-9/11 airline security in February 2004, and Julian Sanchez on the PATRIOT Act in July 2005. We will be hearing a lot in the coming months about how "complexity" needs to reined in by sober-minded government managers.

In an unrelated story, Housing and Urban Development Secretary Alphonso Jackson is reportedly stepping down amid criminal allegations that he awarded federal contracts to his pals.

Don't Just Do Something; Stand There

jsullum@reason.com (Jacob Sullum) — Fri, 28 Mar 2008 12:59:00 EDT

I don't know if he really means it (not long ago he was confessing that economics is not his strong suit), but John McCain is making the right noises about the mortgage mess, braving derision as a do-nothing, head-in-the-sand market worshiper from Democrats who are eager to intervene:

Drawing a sharp distinction between himself and the two Democratic presidential candidates, Senator John McCain of Arizona warned Tuesday against vigorous government action to solve the deepening mortgage crisis and the market turmoil it has caused, saying that "it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers."...
"Rampant speculation" on both sides is the root cause of the crisis, Mr. McCain said. He placed part of the responsibility for the mortgage mess on lenders, who he said had grown "complacent" in a rising market and as a result acquired a "false sense of security" that caused them to "lower their lending standards."
But in a departure from Democrats, who have focused on the lending industry's role in the crisis, Mr. McCain suggested that some homeowners had also engaged in dangerous practices, including borrowing too much in hopes that a rising market would cover their mortgages....
"Some Americans bought homes they couldn't afford, betting that rising prices would make it easier to refinance later at more affordable rates," he said. Later he added that "any assistance must be temporary and must not reward people who were irresponsible at the expense of those who weren't."

That last part does leave the door open a bit to some sort of bailout. But on this issue McCain sounds more sensible than Barack Obama, who in turn sounds more cautious than Hillary Clinton.

They Want to Buy Our Crappy Assets. Run For Your Lives!!!

matt.welch@reason.com (Matt Welch) — Thu, 27 Mar 2008 09:12:00 EDT

Sovereign wealth funds, this year's Dubai Ports World-style ooga-booga man of international finance, are the subject of an interesting Washington Post feature today.

The star of the piece is Bader al-Saad, a former Chase Manhattan and First National Bank of Chicago man who came to the Kuwait Investment Authority in 2003 and started remodeling the state-owned, oil-fed investment fund on the endowments of Harvard and Yale, which meant getting out of the Persian Gulf and looking for diversified opportunities abroad. And it turns out, with the U.S. dollar and American asset prices deflating, those opportunities began presenting themselves in these United States. Excerpt:

It was not Bader al-Saad's idea to buy huge chunks of Citigroup and Merrill Lynch.
It was early January and Saad ... was in his office as usual, reviewing potential deals in Kuwait and elsewhere in the Persian Gulf region, when the banks asked him to invest, he recalled.
"They called us.... We receive calls on most transactions," said Saad, whose fund bought stakes of $3 billion in Citigroup and $2 billion in Merrill Lynch. [...]
He said the next big purchases of assets in the United States may be in the real estate sector, which he expects will peak as an investment target -- in other words, hit rock bottom -- in the next few months. Saad said he also thinks U.S. telecommunications companies and more financial firms would make good investments.
"There are certain opportunities which do not come every day," he said. "We consider the recent crisis as creating some opportunities in certain sectors. I look at history, such as the savings-and-loan problem. It created golden opportunities."

But fear not -- legislators are busy looking for ways to discourage global liquidity from washing in to cash-starved Washington. The EU and U.S.-backed International Monetary Fund are drawing up targeted regulations and extracting you-will-only-come-seeking-profit pledges from the scary foreigners. Future president Barack Obama vows to stop "transferring wealth to these countries." The Council of Foreign Relations has issued a jeremiad against the "New Financial Superpower" [PDF] who will bring us to our knees by, uh, selling the U.S. assets they have already bought? It's all very confusing.

Some thoughts from Marginal Revolutionary Tyler Cowen here. Science Correspondent Ron Bailey explained how foreign ownership is not a threat, but stupid legislation is back in March 2006. And Kenton E. Kelly explained how a bogus security panic is alienating an ally and endangering our country in February 2006.

Putting the "Loss" Back in "Profit and Loss"

matt.welch@reason.com (Matt Welch) — Wed, 26 Mar 2008 09:53:00 EDT

George Mason University professor and economics romantic Russell Roberts is not so happy about the Fed bailing out Bear Stearns:

Yes, letting Bear Stearns go under would have been dangerous. But helping JP Morgan devour Bear Stearns is dangerous, too. Where does the government stop in protecting people from irresponsibility? Home owners and lenders are next. The political pressure is inexorable for some sort of bail out. And then comes more regulation of investment banks.
In a world where people who make bad decisions are spared the full consequences, only one thing is certain. We've encouraged more people to make more bad decisions in the future. The real price to be paid isn't the dollar costs of any bail out but the encouragement of recklessness and irresponsibility. That will make all of us poorer down the road.

Logical to the point of obviousness, sure, but it's the kind of the thing that bears repeating in the coming months. Whole thing here.

Rhymes With "Male Lout"

matt.welch@reason.com (Matt Welch) — Mon, 24 Mar 2008 09:25:00 EDT

Be very afraid of some of the "solutions" being proferred to the subprime-triggered credit crunch:

The Fed, the Bank of England and the European Central Bank are exploring the feasibility of using taxpayers' money to shore up the mortgage-backed securities market, the Financial Times reported on March 22 [...]
The only tool left may be for the Fed to help facilitate a Resolution Trust Corp.-type agency that would buy bonds backed by home loans, said Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co. While purchasing some of the $6 trillion mortgage securities outstanding would take problem debt off the balance sheets of banks and alleviate the cause of the credit crunch, it would put taxpayers at risk.

Ya think? Meanwhile, the Washington Post today asked each major presidential campaign their big ideas for Solving the Economy. Some excerpts:

Barack Obama's Austan Goolsbe:

Obama supports efforts to create a new FHA Housing Security Program to provide significant incentives and guarantees for lenders to buy out mortgages that exceed the value of homes and convert them into stable 30-year fixed-rate mortgages that homeowners can afford. This is a responsible plan designed to help responsible homeowners without rewarding borrowers or investors who helped create the problem by gambling recklessly or committing fraud, and it asks both sides to contribute to the solution.
Obama would couple this plan with a direct interest-rate subsidy for low- and middle-income borrowers patterned on the mortgage interest deduction now predominantly used by high-income itemizers, as well as with comprehensive credit counseling, additional aid for loan workouts and reform of the bankruptcy code.

John McCain's Douglas Holtz-Eakin:

McCain will not play election-year politics with the mortgage crisis. In evaluating any proposal, he will apply four principles: (1) No taxpayer dollars should bail out real estate speculators or financial market participants who failed to do due diligence in assessing credit risks. (2) Any financial assistance should be accompanied by reforms that ensure that we never face this problem again. (3) Too little equity -- small down payments by home buyers and too little capital at our financial institutions -- was a source of the housing and credit problem that must be reversed. (4) Where government assistance is merited, lenders and homeowners should make financial sacrifices to qualify.
The financial markets are suffering the after-effects of the bursting of a housing bubble. As with the technology bubble of the late 1990s, much of the difficulty has been created by speculators looking for quick profits and by investors and bankers who ignored basic rules of risk management in an attempt to cash in while times were good. John McCain will not dip into pockets on Main Street to reward these people with a bailout.

Hillary Clinton's Gene Sperling:

Clinton called on regulators to take preemptive action -- including a foreclosure timeout, strengthening the Federal Housing Administration's capacities to respond to a crisis and cracking down on predatory lending practices with plain-language disclosure requirements. She has since called for a plan to encourage the restructuring of viable mortgages through a voluntary agreement to freeze interest rates on subprime adjustable-rate mortgages and a 90-day foreclosure moratorium. She immediately supported the legislation introduced by Rep. Barney Frank and Sen. Chris Dodd seeking a more systemic effort to unlock and restructure mortgages, and she continues to consult experts over the most effective method for doing so. [...]
On Thursday, Clinton proposed a second stimulus package, focused on helping at-risk homeowners and communities. Across the nation, concentrated foreclosures and vacant buildings are leading to downward spirals; they threaten to bring crime and blight into once-viable neighborhoods. In early January, Clinton called for a $30 billion Emergency Housing Fund to give localities broad tools to head off this threat, including the latitude to buy and rent out or resell such vacant properties. Today, even Fed Chairman Ben Bernanke is calling for policies to confront the community harm traced to "clusters of foreclosures." If we can provide a $30 billion lifeline for Bear Stearns, can't we afford $30 billion to prevent Main Streets from turning into mean streets?

Discuss.

Bear Stearns Roundup

jwalker@reason.com (Jesse Walker) — Mon, 17 Mar 2008 11:18:00 EDT

Megan McArdle:

A couple of years ago, I had dinner with an investment banker who had gone to Chicago a few years before I did. He spent a great deal of the time extolling the virtues of modern markets, proclaiming that over the last ten years, we'd become massively better at pricing risk.

Being a great fan of John Kenneth Galbraith's work on asset-price bubbles, I felt the hair go up on the back of my neck. "Are we really better at it?" I asked. "Or do we just think we are?"

"No, we're really better," he assured me. Ooops.

Sheldon Richman:

The subprime problem has its roots in pro-business government intervention; the policies at fault were designed to help the housing industry and the lenders who write mortgages. Now the other shoe is falling. Big lenders and investors handling securitized mortgages who are in over their heads will get their promised bailout under the "too big to fail" doctrine. And the rescue will set the table for the next round of bad business decisions and the next bailout. It's called moral hazard.

What does this have to do with the free market? As Kevin Carson likes to say, if this is the free market, then I'm against it. Of course, it is not the free market. The free market is a profit and loss system void of privilege. When businesses fail, they are supposed to actually fail, not turn to the taxpayers.

Jay Hancock:

Market purists gasped when the British government nationalized mortgage lender Northern Rock last month. But how would you describe tonight's Bear Stearns bailout? It wears the costume of a market transaction. JP Morgan is "buying" Bear for $2 a share. But the Federal Reserve is taking the unprecedented step of seizing control of Bear's investment portfolio. And it is giving JP Morgan Chase a $30 billion loan to take Bear over. So the Fed is simultaneously financing the deal and managing the workout. Why not end the charade and hand Ben Bernanke the keys?

Sudha Shenoy:

Federal Reserve officials twisted J P Morgan's arms -- which was why the latter 'agreed' to buy. Officials had to provide Morgan's with a loan & a guarantee against the weakest ‘investments' -- bad mortgages -- in the Bear Stearns portfolio. These dubious liabilities amount to some $US 33,000 million -- or some 138% of its total purchase price. Thus its unsound investments are one reason for the very very low price that Bear Stearns' shareholders received -- even from J P Morgan's & even after a Federal loan + guarantee.

In the absence of Federal Reserve intervention & arm-twisting, Bear Stearns would undoubtedly have had to cease trading. And no doubt it would've been taken over, eventually -- at an even lower price. All that govt officials could do was to shorten this time period, & possibly prevent Bear Stearns' value from falling even further. But even the almighty Federal Reserve -- the world's largest & most powerful central bank -- could not prevent the huge capital losses that Bear Stearns' shareholders suffered. In short, even the Fed could not stop the de facto failure of one of the world's largest investment companies.

Confidence Game

matt.welch@reason.com (Matt Welch) — Mon, 17 Mar 2008 08:10:00 EDT

Bear Stearns becomes the latest financial institution deemed by the government as too big to fail. It clearly won't be the last. From the Washington Post:

J.P. Morgan was unwilling to assume the risk of many of Bear Stearns's mortgage and other complicated assets, so the Federal Reserve agreed to take on the risk of about $30 billion worth of those investments. [...]
Bear Stearns, in particular, was confronting a run on the bank as investors were too fearful of the future to make even overnight loans to the nation's fifth-largest investment firm. If it had been allowed to fail, senior officials believed, it would have created a cascading crisis of confidence that could well have brought down several other leading firms and dragged world markets with them.
Policymakers weighed that risk against the risk that their actions would create "moral hazard," or greater willingness of companies to take inappropriate chances.

Hard to believe that "moral hazard" is a serious concern, given that the Fed has now -- for the first time in history -- wrapped its security blanket around investment banks:

Since the central bank was created in 1913, it has served as a lender of last resort for ordinary banks, allowing them to post high-quality loans at a "discount window" in exchange for cash.
Last night, it announced a new provision that will in effect do the same for major investment firms. Starting today, and lasting for at least six months, this new operation will allow "primary dealers," which are 20 major Wall Street firms, access to cash in exchange for assets in which the market is not currently functioning.

Sure is a bad time to have your savings in dollars!

In November 2006, Brian Doherty asked a bunch of economist types: Can we bank on the Federal Reserve?

Fiscal War, AWOL Candidates

schapman@tribune.com (Steve Chapman) — Mon, 17 Mar 2008 07:00:00 EDT

For some time now, the three presidential candidates have been striving to outdo each other on what Hillary Clinton calls "the commander-in-chief" test. She says that she and John McCain have passed it. McCain's response has been on the order of, "What do you mean, 'we'?" Recently, Barack Obama assembled a passel of retired generals and admirals to publicly salute him.

It's good to know they are preparing themselves for that 3 a.m. phone call. But I'm not convinced any of them is ready for the 8 a.m. call from the budget director reporting that the deficit is raging out of control. When it comes to combating the fiscal menaces we face, these three are all absent without leave.

The budget situation is already dire. In the last six years, the federal government has spent some $1.8 trillion more than it has taken in. This year, the deficit will hit an estimated $410 billion. If the economy falls into a recession, the gap will grow.

Believe it or not, these are the good old days. In the next few years, the budget will begin to show the effects of a mammoth event that has long been dreaded: the retirement of the baby boomers. Social Security and Medicare already account for one-third of federal spending, and over the next 30 years, they are expected to nearly double in cost as a share of the total economy.

A recent report from the Brookings Institution found that just to pay for all federal outlays, we would have to raise taxes by at least one-third by 2030. To avoid such tax increases without cutting Social Security, Medicare and Medicaid, our leaders would have to make cuts of 50 percent or more in all the other federal programs. Or we could slash benefits for the elderly.

Clearly, some hard fiscal decisions will have to be made. But you would never know any of this from listening to presidential campaign speeches. The candidates all act as though we've time to kill and money to burn. None has made a priority of finding ways to live within our means.

The parties do have their differences. Obama and Clinton spend most of their time dreaming up new programs. The National Taxpayers Union Foundation (NTUF) estimates that his plan would boost federal spending by some $287 billion a year, while hers would carry an annual price tag of $218 billion.

They claim they can pay for most of this by raising taxes on the wealthy and ending the war in Iraq. But the first would bring in no more than $100 billion a year or so. And the money we are spending in Iraq is money we don't have in the first place. It's like saying, I can't afford a Hawaiian vacation, so
I'll take the money I'm not spending on that to buy a Mercedes. The clear implication is that either of the Democrats will finance their proposals the same way President Bush has financed his—by sending the bill to our kids.

For all his stern talk about eradicating earmarks, John McCain would take a similar approach. True, he is much less inclined to launch new initiatives, but he spurns the notion of paying for all the expenses we currently have, much less the ones looming ahead.

He says he would not increase taxes under any circumstances. That would be lovely if McCain were proposing deep cuts in the federal budget to eliminate the growing deficit. In fact, NTUF calculates, his plans would increase federal spending by $7 billion a year.

As the Brookings report put it, "Some people might believe that the federal government should both tax and spend at about 18 percent of gross domestic product (GDP), while others might believe it should tax and spend at about 30 percent of GDP. No reasonable person, however, would argue that the government should tax at 18 percent and spend at 30 percent. ... Yet, this is the future we will get if we try to fund the spending required by current law with today's level of taxation."

It's 8 a.m., a fiscal crisis is at hand, and the phone is ringing in the White House. Will the next president take the call or let it go to voicemail?

COPYRIGHT 2008 CREATORS SYNDICATE, INC.

Oil Price Bubble?

rbailey@reason.com (Ronald Bailey) — Wed, 12 Mar 2008 12:00:00 EDT

Oil prices climbed to their highest level ever, reaching over $108 per barrel this week. And Americans are feeling this price spike at the pump, with gasoline averaging $3.22 per gallon. An analysis released by the investment firm Goldman Sachs suggested that oil prices might soar to $200 per barrel. Does this make sense?

Not really. Although U.S. crude oil inventories have fallen, gasoline inventories are at their highest since March, 1993, notes Tim Evans, an energy futures analyst at Citigroup's Futures Perspective. World oil production was up 2.5 percent in the first quarter of 2008 over the same period in 2007 while world oil consumption rose by just 2 percent. In fact, world production is projected to be 3.3 percent higher in the second quarter and 4.1 percent higher in the third quarter than the same periods a year ago. On the other hand, world demand is projected to rise by just 1.6 percent over the next six months.

In fact, demand is falling in some countries. According to economist John Kemp at the commodities firm Sempra Metals, the U.S. consumed 4 percent less petroleum in January 2008 than it did the year before. Evans agrees, noting that the U.S. demand for petroleum products began falling off last July. Interestingly, this drop in U.S. oil consumption began before crude prices turned vertical and before we began to see weakness in the broader economy. Even China's thirst for oil is abating somewhat. Its demand for oil, which once rose at 10 percent per year, has now dropped to 6 percent per year. In addition, world surplus oil production capacity has gone from a very tight 1.5 million barrels per day a couple of years ago to more than 3 million barrels today, says petroleum economist Michael Lynch.

So supply is up; relative demand is down and yet, the price of oil is soaring. What's going on? Last week, Exxon Mobil CEO Rex Tillerson blamed a third of the recent run up in oil prices on the weak dollar, another third on geopolitical uncertainty, and the rest on market speculation.

Let's start with geopolitical uncertainties. Last year, oil consumers watched warily as unrest in Nigeria's oil fields, the possibility of war between the U.S. and Iran, and the antics of Venezuela's Hugo Chavez threatened to disrupt oil supplies. That analysis may have once made sense, but most of those tensions have abated in recent months. Nevertheless, it remains true that most of the world's oil is produced in volatile regions and by erratic governments, so the price of crude must still include some kind of political risk premium.

What effect does the falling dollar have on the price of crude? Most oil price contracts are denominated in dollars. The dollar has fallen in value by more than 30 percent against a Federal Reserve index of major currencies since 2002. This means that the price of imports, including oil, have gone up. To some extent, the chief of the Organization of Petroleum Exporting Countries (OPEC) Chakib Khelil was correct when he said earlier this week, "What's happening in the oil market is due to the mismanagement of the U.S. economy." Continuing U.S. trade and fiscal deficits along with lower interest rates are stoking inflationary fears.

That brings us to speculation. Evans observes that since September 2003, the total number of open crude oil futures and options contracts rose by 364 percent. Meanwhile the global demand for petroleum rose by just 8.2 percent. "So the futures and options market has become more important than the physical supplies in driving the price," concludes Evans. "We are seeing investment flows into the oil market that don't have anything to do with the demand and supply of oil."

Investors are treating oil as a hedge against inflation and a falling dollar. Oil markets are part of a ~~negative~~ positive feedback loop in which higher oil prices contribute to higher inflation, which in turn lowers the value of the dollar, which boosts oil prices, and so forth. In other words, the oil market is coming to resemble the gold market (which has also been soaring). Evans notes that most gold traders don't even ask the question of how much gold was mined last year or how much spare gold mining capacity there is.

In the short run, oil prices are very inelastic: A large change in price produces only a small change in demand. If the price of gas goes up a dollar per gallon overnight, you still have to fill your tank to get to work. However, over the long run, consumers and producers respond to higher oil prices. For example, Americans are driving less and have switched to buying more fuel efficient cars.

Higher prices also encourage innovation. Economist Richard Rahn from the Institute for Global Economic Growth believes battery technologies are improving so rapidly that the majority of cars sold in 10 years will be all-electric. This would certainly help drive down the price of oil. Supply is also inelastic—it takes a long time to do the exploration, drilling, and refining necessary to boost production in response to higher prices. This inelasticity of demand and supply means that petroleum prices are very sensitive to relatively small changes in either. This means that prices can fall as steeply has they rose.

Whenever you begin to hear market gurus decree that "this time it's different," as we did during the dot-com bubble and the housing bubble, that's a sure sign of danger in the market. Naturally, proponents of the peak oil theory claim that the recent run up in prices is evidence that the end is nigh. Evans responds, "Fears of peak oil are what this market has in common with the 1980s, not what is different." Recall that during the "oil crisis" of the 1970s when oil prices were as high as they are today, U.S. oil consumption declined by 13 percent between 1973 and 1983. The higher prices of the 1970s led eventually to an oil glut and prices fell to about $10 a barrel by 1986.

So what will happen to oil prices over the next few years? No one is predicting $10 per barrel oil. However, once the current bubble bursts, both Evans and Lynch believe that the price of crude will settle at around $60 to $70 per barrel in the next couple of years. "It's very hard to pinpoint just how long a bubble can expand before it breaks. Getting the timing right is not an easy matter," says Evans. But he adds, "I think that this is the riskiest time to be long in crude oil since 1980."

Ronald Bailey is reason's science correspondent. His most recent book, Liberation Biology: The Scientific and Moral Case for the Biotech Revolution, is available from Prometheus Books.

The Sins of Affluence (and Effluents)

jsullum@reason.com (Jacob Sullum) — Mon, 10 Mar 2008 14:09:00 EDT

Bloomberg reports that the Vatican has drawn up a list of "seven social sins" to complement the more traditional (and more fun) seven deadly sins. Farting, singing along with your iPod, and going on and on about your adorable children did not make the cut.

The seven social sins are:
1. "Bioethical" violations such as birth control
2. "Morally dubious" experiments such as stem cell research
3. Drug abuse
4. Polluting the environment
5. Contributing to widening divide between rich and poor
6. Excessive wealth
7. Creating poverty

Clearly, there are some definitional problems here. When, for example, does drug use become drug abuse? Does it have to cause demonstrable problems, or does the Vatican agree with drug warriors the world over that any use of an illegal intoxicant automatically qualifies as abuse? And how do you know when your wealth is "excessive"? Does the dollar figure vary from country to country, and does it depend on how expensive your tastes are?

Several of these sins seem to overlap. Couldn't "bioethical violations" and "morally dubious experiments" be collapsed into one category? Then again, the Vatican shows admirable sensitivity to the hectic schedules of successful businessmen: If a wealthy entrepreneur fires an unproductive employee, he not only increases the efficiency of his business; he maximizes his sins as well, potentially committing 5, 6, and 7 simultaneously. And if his business is birth control devices or fetal stem cells, which he produces while generating pollution and snorting cocaine to compensate for his lack of sleep, he can be damned to Hell by lunchtime.

Rant: Take Them Back to Dear Old Blighty

mmoynihan@reason.com (Michael C. Moynihan) — Thu, 06 Mar 2008 15:00:00 EST

Last December, Ricky Hatton, a stout-chugging, ruddy-faced British boxer, was laid out on a Las Vegas canvas by the American welterweight champion Floyd Mayweather. The crowd of Union Jack–bedecked fans —“drunken dullards” and “boors,” according to The Daily Telegraph’s horrified sports correspondent—became so unruly that for the first time in its history, the MGM Grand casino shut down its archipelago of bars. Hatton’s troglodyte supporters achieved what was long considered impossible: They managed to class-down Vegas.

Drawn by a plummeting dollar, the British are arriving en masse on American shores. In the streets of Manhattan, pale-skinned men in Manchester United shirts marvel loudly at what all these iPods, “trainers,” and Nike track suits would cost them back home. While generously pumping much-needed money into the U.S. economy, the feral packs of lager louts are, one hopes, helping correct America’s long-held misperception that the English are a nation of Inspector Morse bit players—sophisticated, fastidious, snobby—especially when compared to us rubes.

We’re not quite free of our inferiority complex just yet. After a 2005 stint playing on London’s West End, former Top Gun actor Val Kilmer enthused that English audiences were “smarter” than their American counterparts because “they read books.” (This is true, though if the current British bestseller list is any indication, our bibliophilic cousins are feeding their heads with diet guides and biographies of topless models.) The American blogger Matt Janovic, enraged by his intellectual isolation in the Midwest, summed up the prevailing confusion nicely: “Face it: an English schoolgirl sounds more authoritative than the voice of most American politicians…we sound like the cavemen that many around the world (rightly) think we are.”

And the filmmaker Michael Moore, always eager to play suck-up abroad, told one English audience in 2003 that the “dumbest Brit here is smarter than the smartest American.” In other words, theirs is a nation of abeyant Evelyn Waughs.

Waugh himself bristled at such stereotypes—insisting, for instance, that in etiquette “Americans are immensely the superiors of the English.” When Esquire asked the curmudgeonly novelist to write of the “crudeness” of America’s literary milieu, Waugh demurred, arguing that the Yanks were far more “literate” than his London-based contemporaries.

It’s high time that self-hating, pusillanimous Americans everywhere revisit Waugh’s assessment. And there is no better educational tool than extended encounters with that breed of Britons known colloquially as the chav, a pejorative recently added to the Collins English Dictionary to describe “a young working class person who dresses in casual sports clothing.” (Also added, incidentally, was asbo, an acronym for youths racking up violations of the “anti-social behavior order,” a malady which midwifed the British reality show ASBO Teen to Beauty Queen.)

While Britain is fast catching up to America—and leading Europe—in illiteracy, obesity, and violent crime (despite ubiquitous surveillance cameras and an ineffective ban on handguns), the Wittgenstein references in Monty Python still shape our assumptions of British cultural supremacy. But as the English social critic Theodore Dalyrymple observed in 2004, to profess an interest in high culture in today’s Britain is to be met with accusations of homosexuality.

So before President Ron Paul restores the gold standard, it should be acknowledged that the sagging dollar is providing one useful service: a long-overdue corrective to our self-image as lesser Brits. Europeans, who ranked the English as the “world’s worst tourists” in a recent Expedia poll, have long ago disabused themselves of such stereotypes. Take a look around New York, Boston, or Los Angeles, and spot the omnipresent gaggle of chavs, waddling through the Adidas shop, shouting drunken insults in local Irish pubs, converting the currency on every product within reach. England is just America writ small.

Michael C. Moynihan is an associate editor of Reason.

Fueling Fuel Inflation

jwalker@reason.com (Jesse Walker) — Thu, 06 Mar 2008 09:27:00 EST

Jay Hancock blames the Fed for rising gas prices:

Lower interest rates have made things worse. Bernanke and the Federal Reserve have cut short-term rates by more than 2 percentage points since late summer to try to lower business costs and spur growth. That nudges investors to sell dollar-denominated paper and seek higher returns elsewhere.

Once the dollar was an automatic refuge, the first place international investors socked dough in uncertain times. Lately, however, the most popular safe harbor isn't the dollar, the Swiss franc or even the euro. It's energy.

People are piling into oil and gas futures, probably with money they raised by dumping dollar-denominated stocks and bonds. Oil investments are seen as protection against further dollar declines.

Bernanke's lower rates have fueled the trend by furnishing cheap funds for investors to spend on the New York Mercantile Exchange. So he's simultaneously hurting the greenback and driving up gas prices -- even though inventories are at a six-year high. That won't help the economy recover.

Energy may be the next bubble investment. Each time the Fed breathes life into the economy with lower rates, the extra money floods into some fad asset -- first Internet stocks, then housing, now oil?

The whole argument is here.

Graft Paper

mmoynihan@reason.com (Michael C. Moynihan) — Thu, 28 Feb 2008 16:30:00 EST

In his nondescript office on Massachusetts Avenue in Cambridge, nestled in a far-off corner of Harvard Square, Ben Olken ruminates on the economic consequences of tyrannicide, the damaging effects of television on social cohesion, and the byzantine system of bribery in Indonesia. Olken, a 32-year-old with an undergraduate degree from Yale (in mathematics and “ethics, politics, and economics”) and an economics doctorate from Harvard, is a rising star in the field of developmental economics. Olken is currently a member of Harvard’s Society of Fellows, a prestigious institution within the institution, where the best young scholars pursue what interests them. Among economists alone, former Junior Fellows include Paul Samuelson, Carl Kaysen, Jeffrey Sachs, Steven Levitt, and James Tobin.

Olken is “one of the most exciting young scholars in economics,” his Harvard adviser, Lawrence F. Katz, former chief economist to the U.S. Labor Department, told The Chronicle of Higher Education. He is.

Read the entire article at The American.

Obama Hearts Economists and Vice Versa

kmw@reason.com (Katherine Mangu-Ward) — Thu, 28 Feb 2008 16:05:00 EST

The Obama campaign is rife with academic economists, according to the latest issue of The New Republic, including some unlikely University of Chicago-types:

The Obamanauts are decidedly non-ideological. They occasionally reach out to progressive think tanks like the Economic Policy Institute, but they also come from a world-- academic economics--whose inhabitants generally lean right. (And economists at the University of Chicago lean righter than most.) As a result, they tend to be just as comfortable with ideological diversity as the candidate they advise. Just before the Iowa caucus, I saw [Obama adviser] Goolsbee approach New York Times columnist David Brooks in Des Moines and gush when the quirky conservative agreed to pose for a picture.

Meanwhile, according to a new L.A. Times/Bloomberg poll, people think McCain will do a better job handling the economy than Obama, 42 per cent to 34 per cent. This despite his now-famous line: "I'm going to honest. I know a lot less about economics than I do about military and foreign policy issues. I still need to be educated." (see clip above)

It could be true, of course, that a McCain presidency would be better for the economy, even if the man himself isn't a particularly subtle economic thinker, because of better underlying ideology or disposition. I think it probably would be. But I would rather have seen a story about all the super-smart econ nerds flocking to the McCain campaign and the candidate welcoming them with open arms.

The again, maybe I never would have seen that story, or at least not in The New Republic, since it wouldn't be news. Most people (certainly the people who answered the latest L.A. Times poll) already think Republicans are the more economically literate party.

UPDATE: I should have said "when it comes to the presidency, people already think Republicans are the more economically literate party." Polls do find that in recent months people prefer Dems to Republicans on the economy, but that captures overall party sentiments, including feelings about Congress.