Blog of Jeff

I’m still mulling the bailout. I have read so many differing theories that I thought I would start categorizing them.

Theory 1 says that Henry Paulson is a brilliant investment banker from Goldman Sachs with the perfect resume to buy securities, stabilize the market and resell those securities down the road. He did the right thing in saving Fannie, Freddie and AIG while letting Lehman’s fail to purge some bad debts out of the system through the bankruptcy. Nobody else is as qualified as he is to do this work.

Theory 2 says that Henry Paulson is an idiot who has been saying the markets are fine for a couple of years, is going to hire a bunch of his billionaire buddies to manage these new accounts for the government and they are the same buddies who created these risky derivitaves in the first place. He only saved AIG because his buddies at Goldman Sachs were hooked into AIG for $20 billion. Nobody else is less qualified than him to do this work.

Theory 3 says that this issue was largely caused by too many individuals, companies and countries going into debt. Some proponents of this theory embrace the idea of the government borrowing $700 billion to attempt to fix the problem. Other proponents believe that more debt will only delay and deepen the invevitable as the only real solution is to tighten belts, accept a lower standard of living and start moving forward in a world with less credit.

Theory 4 says this issue was largely caused by the government’s policies to encourage home ownership among people who really couldn’t afford a home.

Theory 5 says that regardless of government policies, mortage companies should have had enough common sense not to make stupid loans that didn’t require down payments and had risky terms for the home buyer with the belief that ever escalating home prices would allow for perpetual refinancing and everybody would win.

Theory 6 says that deregulation allowed companies’ greed to overwhelm their common sense. Depending on their particular party, theory 6 people either blame Barney Frank and the dems for blocking Fannie/Freddie reform or Bush and company for pushing deregulation in other areas.

Theory 7 says that deregulation had nothing to do with it as many regulations that were in place were not followed. This theory is more about how existing regulations were not enforced.

Depending on my mood at the time, I find all of these theories to be believable. The one area of blame/anger that I have that never wavers is for the finance and banking committees on congress. Based on the revelations of how many donations they received from the industry they were regulating and how big this implosion was, I think everyone on those committees from both parties should be removed from those committees (ideally from office as well, but some of them aren’t up for re-election any time soon). I just don’t see how any of them can look people in the eye and say they deserve to still be there. Barney Frank is particularly annoying as he runs around trying to take credit for the bailout plan and never accepting any responsibility for his committees’ failures that led to this point.

The bailout is an interesting quandry. The first issue is that from the moment Paulson’s idea went public, the markets absorbed the idea of the bailout, making it a self fulfilling event. Once people/companies buy stock expecting 700 billion in help, there is no way to not give it to them. My general thought is pretty much the consensus opinion. It wasn’t a very good bill but the government did have to do something.

I think the best idea I saw in terms of being fair and feasible was for the government to set up a giant refinancing program through Fannie and Freddie. People would be able to refinance to a 6%, 30-year loan for no fees through the government program. It would be fair, since anyone with a mortgage could participate; it would help those financial companies higher up the food chain because many of the loans that their derivitaves are based on would get paid in full; and it would directly help people in danger of foreclosure. People who couldn’t afford their home even with that assistance would still need to move. Markets have to be allowed to adjust some.

The biggest thing that I think this will do is change the national perspective and debate on the free market, which is unfortunate, because a lot of that is misplaced. It is true that the market ran wild and better regulations might have at least slowed down or reduced the bubble. However, the government has been intervening in the housing market for years and greatly increasing its intervention in recent years. Both parties pursued policies to encourage home ownership. Mortage payments as tax shield have been inflating home prices in the US for decades. The recent push for Fannie and Freddie to get more low-income families into houses made an even bigger impact.

These policies were based on two goals. The first was altruistic, in that people believe families in homes are more independent, resilient and less needy on government assistance. The second was greed. People started smelling money and believing that this government intervention would indefinitely keep home prices climbing. One interesting piece of data that I would like to see is how many people didn’t just buy one home they couldn’t afford but multiple homes by selling one to pay for the next one with ever-climbing home prices. I’m sure there were some folks in that category and they got caught holding an expensive house that they thought they could sell if they got into trouble. But when the property nose-dived, there was no recovery in a home sale.

India is running out of females and a major contributing factor is that India doesn’t want any. A Wall Street Journal story (http://online.wsj.com/article/SB117683530238872926.html, subscription required to read the full story) talks about GE’s role in selling large numbers of ultrasound machines in India and how they are being used by people wanting to abort female fetuses. Both the Indian government and GE are trying to prevent abortions based on the baby’s gender, but it is hard to prevent technology from giving a culture exactly what it wants.

This is a classic example of Adam Smith’s ‘Invisible Hand’ in action. Since having a daughter means having the massive debt of a dowery, people’s self interests lie in avoiding daughters. According to economic theory, the only way to stop this sort of practice is to change the balance of self-interests. The ideal solution would make having a daughter more economically beneficial than having a son with minimal government involvement. But India is still clinging to the crazy notion that people will listen to their government when it wags its finger in your face and tells them not to do something because it is bad.

This is the same notion that has led to our highly successful war on drugs for the exact same reason. Criminalizing something does change the calculus about whether something is in our self-interests or not, because some people do not wish to break the law or are scared of the consequences of getting caught. However, it also greatly increases the self-interests of those who have no qualms about breaking the law, making drugs a great money maker for criminals.

I’m not saying that drugs should be legalized in the U.S. anymore than gender selection in India. But I am saying that the solutions to these problems have to have an economic foundation to succeed. As long as there are strong financial incentives to sell drugs in the U.S. or have male babies in India, that is what people will do, no matter how much money those governments pour into their marketing, enforcement and finger wagging policies.

I just caught a CSPAN moment where a Republican representative was giving a passionate speech about how our recent tax policy created jobs, increased treasury revenues and grew the gross domestic product. He was really excited about the recent past and gave a horrifying view of upcoming giant tax increases by Democrats.

I lean a little on the conservative side, so I was willing to give the guy a chance. However, after watching the entire spiel, I have to admit that I am a little confused about how he could be so happy about our recent move from no deficit to giant deficit. Sure, we can create jobs, increase the GDP and be swimming in cash if we borrow trillions of dollars from China to pay for things that our tax revenues can’t afford. I can also live in a giant mansion if I can get my credit card limit upped a couple of million dollars. That doesn’t make it a good idea.

It’s one thing to believe that low taxes encourage growth and productivity, which I do believe. It is quite another to believe that borrowing money is the best way to fund wars, education, security, Medicare and those silly bridges that Senator Stevens always gets for Alaska. (Here’s a good rule of the GOP. He had to give up his chairmanship of the appropriations committee due to a term limit on chairmanships. That rule probably saved us from building a bridge from Alaska to Japan.) (This is probably also a good time to remember that he threatened to quit if his funding for one of those precious bridges was redirected to hurricane relief efforts. That’s the sort of pro-Alaska, anti-America sentiment that makes the Senate great.)

Anyway, I am pretty annoyed at this young Republican shmuck for talking about his party’s great job of managing our fiscal policy the past 6 years without even mentioning that it was made possible by massive deficit spending. Every soldier and contractor we have in Iraq and Afghanistan should probably carry a thank-you letter that reads “this war was made possible by generous loans from China and other nations.”

That last paragraph made me think for a minute about the potential irony of countries like China opposing the war and yet loaning us the money to wage it. Then I remembered my MBA studies and realized that there is no irony to it, because it was a logical economic decision. China decided it could get a better return on investment by loaning us money than they could get through business dealings with Sadam. If there was no war, however, they would have kept right on dealing with Sadam. Economically, they positioned themselves to win either way.

It may be time to stop talking about China’s primitive free market system and start talking about how much money China is making by loaning us the cash for our domestic and foreign policies.