Machiavellian Economics

Here is a great video for discussion:



OK, some thoughts on this video:

At about the 6:00 mark, the speaker talks about the system as a "Ponzi scheme." I think this is inaccurate. I think it is more accurate to describe it as "parasitical." I think this is a more accurate way of thinking about it as those who loan money live off of the production of others. Granted, a Ponzi finance system is a very simple parasitical system where either one person, or a small group, feeds off of the production of other "investors." But the relationship between banks and lenders isn't purely a Ponzi system (it can be symbiotic, believe it or not).

At about the 6:30 mark, the speaker remarks that "people are realizing their debt slavery condition." I am not so sure. They might have a really good sense that something is wrong; but I think we are at a point where a straw man or red herring can be successfully employed.

At a little before the 11:00 minute mark, the speaker talks about "return on capital." This works as long as people pay back their debts. However, herein lies the risk. If the debt is not paid back, who suffers the risk of loss? On the one hand, (in theory) the holders of capital lose (because they lose their expected return and any capital that is not repaid). What they get in return, however, is control of any land or assets used as capital. Even if money is lost, power is gained (which I thought was his point based on the title referencing Machiavelli -- i.e. "power is it's own reward").

A Beautiful Model for Fraud

Take a look at this:

A Beautiful Model for Fraud and here is the accompanying article:

The great credit unwind of '08.

How To Spot A Scam, Part 6: Roommate Scam

This is the way the scam works:

A person claiming to be a potential roommate sends a check for an amount far above the amount owed (this is a HUGE red flag). They then request that the balance be sent back to them so that they can buy an airline ticket or some other expense (which is bogus). The check they send is fake.

Check the links and instructions I provide in this post.

Also, go to FakeChecks.org and report it.

Don't Know What To Buy? Try Amazon.com Gift Certificates

Amazon.com has sent me an e-mail with a special announcement: I get a whopping 6% return if you buy a Gift Certificate through my site (this month only). So, if you are one of those people who have trouble thinking of what to buy for Christmas, Hanukkah, Kwanzaa or any other special occasion, would you consider a Amazon.com Gift Certificate?

Eating the Seed Corn

After reading this short article today, Employees Raiding 401(k)s, CFOs Say (hat tip Calculated Risk), all I could do was shake my head. From the short article:

The survey finds that nearly 20 percent of companies have seen increased hardship withdrawals from 401(k) accounts, often to cover mortgage payments or to avoid personal bankruptcy.

"In the last four or five months we have seen an absolute onslaught of people trying to do hardship withdrawals and loans out of 401(k)s," Mark Anderson, CFO of Granite City Electric, told CFO magazine in October. "What has happened with housing and the economy has really blown up for people at the lower end of the spectrum."

Considering that 401(k) accounts are almost always exempt in bankruptcy proceedings, my first thought is that people are eating their seed corn. There are rare situations where this is to the debtor's benefit. But something tells me most of these cases don't fall into those rare exceptions.

Lately, I have been thinking of the song Santa Monica by Everclear. In my own way I can identify with some of the lyrics of the song. The song is actually about a bad relationship breakup; but for me the selected lyrics sound somewhat like my new life by the Gulf Coast.

With my big black boots and an old suitcase
I do believe I'll find myself a new place
I don't want to be the bad guy
I don't want to do your sleepwalk dance anymore
I just want to see some palm trees
(I will) Go and try to shake away this disease

We can live beside the ocean
Leave the fire behind
Swim out past the breakers
Watch the world die

...

I'll walk right out into a brand new day
Insane and rising in my own weird way
I don't want to be the bad guy
I don't want to do your sleepwalk dance anymore
I just want to feel some sunshine
I just want to find some place to be alone

We can live beside the ocean
Leave the fire behind
Swim out past the breakers
Watch the world die

How To Spot A Scam, Part 4

As a follow-up to my post on How To Spot A Scam, here is a link to a website dedicated to helping potential victims spot fake checks: FakeChecks.org.

Here is a PSA advertising the site:



There are more videos here.

We're All Subprime Now

Today, blogger Tanta, who writes for Calculated Risk, today wrote about predatory practices in the mortgage industry in HMDA Data on High Priced Loans. A clip:

This whole dynamic may be hard for the WSJ and its fellows in the Big Paid Media, so let me explain this very clearly. In 1975, some folks accused lenders of redlining, which means not granting credit at all to some people. The lenders said they weren't doing that. Congress passed HMDA, and then there was actual data about geographic lending patterns to analyze instead of anecdotes. Once we got some HMDA data under our belts, the Community Reinvestment Act came into being (in 1977) precisely because it was clear that redlining had been going on. CRA in essence forces lenders to show that they are willing to make loans in neighborhoods in which they are willing to take deposits (i.e., those deposits need to be "reinvested" in the neighborhood they came from in the form of loans, not just mortgage loans, to that neighborhood. You can't extract deposits from poor people and use them exclusively to fund loans to rich people.) CRA does not mandate price levels, or even address the question of price levels.

You may be surprised to hear this, but over time accusations of discriminatory lending practices did not go away. In a number of cases, "mystery shopper" tests were performed, in which a white applicant and a black applicant each applied for credit at the same instutition with identical credentials (employment, income, credit history, loan terms), and the results showed that black applicants were more likely to be turned down. This cast some doubt on the lenders' claims that loan rates in minority neighborhoods were a function of the lower credit quality of those borrowers. That became a hypothesis in need of some testing, you see, not an accepted explanation.

So the 1989 revision to HMDA forced collection of demographic data, for the precise purpose of testing the assumption that poor and minority people are just always bad credit risks. This resulted, as you might expect, in conjunction with CRA and other fair lending laws, in much higher rates of home mortgage lending in those areas that were once redlined.

But were these poor and minority people happy, at last? Why no, they weren't. Turns out, anecdotal evidence began to emerge that while these good people were finally getting loans, they were getting them at much higher interest rates than higher-income folks and whites generally got, and that this could not be accounted for by the difference in creditworthiness of the borrowers or the quality of the collateral (the latter proxied by census tract).

...

The bottom line is, as [Calculated Risk] notes, that "high-risk" lending was everywhere in the boom years. Of course there is a desire to collapse it all into the easy category of "subprime." And there has for a long time been a lot of political pressure to keep the association of "subprime" and "urban minorities" in place, because it has functioned as a good excuse for the subprime lenders (they "help" the poor and minorities, remember?). My view is that a whole lot of parties are very interested in maintaining rather than seriously analyzing a lot of faulty assumptions about risk, rates, and borrower credit characteristics. If this ain't "just a subprime problem," then an entire debt-based economy in which even the middle and upper middle class cannot afford homes given [real estate] inflation and wage stagnation is suddenly in question. The last thing certain vested interests want to hear is that, basically, "we are all subprime now."

My favorite comments:

At least then, when they say the problem is contained to subprime, they'd be correct.
daveNYC | 10.11.07 - 10:47 am |


What about the revelations coming forward that a lot of these sub-prime loans were to people who would/could /should have qualified for prime loans. My gut feeling is that the lending industry realized that there was more money to be had in the sub-prime market and rationalized the use of the product by telling borrowers your can always refinance. So while I can see the possibility that we are all becoming sub-prime candidates because of high LTV due to lack of down payments or low rates to buy the MacMansion, I cant help but feel it was the lenders looking to sack the borrower for higher fees and on top of that being bale to book unrealized profits from the fully adjusted loans. Now there is a racket!!
formerly known as... | 10.11.07 - 11:41 am | #


Down where the rubber met the road, '04-06 subprime was a broker-dominated and refinance-oriented business. Those brokers tend to chase after big fish. Which would you rather do? ONE loan for a cardiologist with a bunch of lates thanks to the ex-wife or TEN deals involving city bus drivers with gambling problems, immigrant cleaning ladies with thin credit files, single moms with three jobs, dancers with cash wages and voracious drug habits? - oh, wait, that's alt-a - anyhow, you get the gist. It's not that subprime was ever AIMED at low-income - quite the contrary - it's just that median income of those with impaired credit happens to lower.
Shnaps Parlor

The last paragraph raises an interesting point. We have been told that FICO scores are not related to race, sex or economic status. However, it is also true that women, minorities and lower-income individuals not only have less economic power as a group, but also are at a greater risk that the above examples and medical problems/debt are more likely to adversely affect their ability to pay their bills. Hence, lower credit scores.

The end result is that it contributes to the disparity between the wealthiest (who have the highest credit scores, due to the ability to weather unexpected expenses, and therefore who borrow at lower interest rates), and the poor (whose credit scores crash after one adverse event and have to borrow at higher interest rates). (BTW: I have been meaning to write about how banks charge fees on small balances that can quickly sap wealth from poor patrons.)

The answer is to provide social insurance on some costs (medical debt and education) and living wages that allow for even the poorest to save for the future. There are some costs which cannot be defrayed: rent, electricity and natural gas, food, transportation and personal hygiene. Even the lowest wage should be enough to cover these costs and provide enough to save for the future.

Securitization

Today, over at Sudden Debt, an anonymous commenter named Bernard left a comment on the post A Tale of Two Recessions:

Under the Basel Accord for every $100 of AAA securitized assets, a bank need only hold $0.60 of equity, to back up that debt. The theory is AAA assets are among the highest rated and thus the risk of default is virtually nil. However, for every BBB securitized asset, a bank would have to hold almost $5.00 of equity for every $100.

Gold: The Collapse of the Vanities

In other words, if a AAA-rated security is downgraded to BBB, the bank will have post up almost 10 TIMES MORE CAPITAL.

Where are they going to get that capital from at that point?

Are they going to sell the security?

I don't think so--there will be NO BID.

Bernard

The blog's author, Hellasious, responded thus:

Bernard,

You have hit upon a very important element in the whole MBS/ABS situation. While AAA paper won't be downgraded to BBB in one step, the combination of a series of consecutive downgrades and SIV assets going back onto balance sheets (and thus having to be covered by equity) means that the process of painful adjustment will take a long time. In other words, the credit crunch will last.

THIS IS NOT a replay of LTCM, for the simple reason that in its case the banks saved LTCM, so as not to get hurt themselves from the fallout. Today it is the banks/brokers that are in trouble: who's going to save THEM?

Or, to look at it another way: Who will save us from them?

Cram Down

Sorry about the lack of posts, but the internet here is rather persnickety. It doesn't work half the time; and when it does work, it seems that I can't post for one reason or another. I also have the problem that sometimes I can only read one e-mail, and then it just locks up.

Anyway, back to reality...

In the news today, Bankruptcy Change Could Save 600,000 Homes:

NEW YORK (CNNMoney.com) -- One consumer group estimates that 600,000 foreclosures could be avoided over the next two years by making a simple change to the bankruptcy code.

The Center for Responsible Lending (CRL) calls it a tweak, but it could be a significant change for homeowners and the market for mortgage-backed securities.

CRL's proposal - reflected in a House bill recently introduced - would make changes to the regulations for Chapter 13 bankruptcies, which don't wipe out debts, but rather establish a repayment plan.

Under current law, when a person files for Ch. 13 bankruptcy, judges cannot reduce mortgage debt owed on a person's primary residence, although they may modify mortgages on investment property or second homes.

Under the House bill, the bankruptcy judge would have the option of reducing what the homeowner owes the lender. Say a homeowner's property is worth less than what he owes. The judge could reduce the principal to match the home's current market value as well as reduce the loan's interest rate.

The rest of the original principal would then be treated as unsecured. That means it becomes a lower priority for repayment than the borrower's secured debt, such as the newly reduced principal on his home. Unsecured debts may be discharged.

OK, indulge me while I give you some "inside" information. Allowing a debtor to pay what the collateral is worth on a secured debt is called a "cram down" in bankruptcy lawyer-speak. A recent Supreme Court case already allowed debtors to cram down the interest rate to the discount rate plus a point or two (or three) on personal items such as cars, furniture and jewelry. Before the 2005 changes, you used to be able to cram down cars, furniture and the like to their value as well. After the BAPCPA law was passed, the feeling among the debtor's counsel was that we should make car dealers "eat steel" unless they agreed to negotiate with the debtor on the price.

The proposed changes in the bankruptcy law would allow debtors to "cram down" the debt to the value of the house in the current market and it seems that they propose that the interest rate rule in Till v. SCS Credit Corp. be extended to houses as well.

I agree with the article that this is more than a tweak, but it is probably a necessary tweak. The representative for the mortgage industry is quoted in the article as saying:

If investors in mortgage debt knew that mortgages could be adjusted by the courts without the consent of the lender, that could increase their perceived risk and change their valuation.

Yes, and some would argue that that is precisely the problem. That is to say: mortgage backed securities (MBS) are not currently getting marked-to-market, but instead are getting marked-to-model.

I admit I am just a lawyer -- not an economist or Wall Street whiz kid. But if I am understanding it right, this article at Sudden Debt: Rocks, Hard Places and Pricing Models probably explains it pretty well. From Hellasious's post:

Which finally brings us to the subject of the pricing models used to issue and mark-to-model all those structured finance securities. It is quite obvious that the primary variable in all pricing models is their sensitivity to credit risk, i.e. the risk of default. During the "virtuous" cycle, when credit risk goes down, such models indicated higher prices, which were used to issue structured finance securities at higher prices and with higher proportions of readily salable AAA-A merchandise. But as the cycle turned "vicious" those models started throwing out lower prices - and when the credit risks signaled by the CDSs jumped suddenly and substantially, as happened in August, those model-calculated prices moved radically down, causing havoc in the balance sheets of existing CDO holders such as banks, SIVs and hedge funds. The trouble was further enhanced by the fact that many holders were highly leveraged, i.e. they had borrowed heavily through ABCPs and prime-bank margin to buy those securities. Judging by market action quite a lot of margin came from the yen carry tactic. Live by the sword, die by the sword...

But why did participants choose to mark-to-model instead of mark-to-market? Two reasons:

(a) Because of the fragmentation in the structured finance business there were thousands of "made to order" issues that had next to zero secondary market liquidity. Usually the issuers pledged they would maintain a secondary market, but for practical purposes this was an empty promise. Even in good times the spreads between quoted bid-offer prices routinely exceeded 5 points ($50 per $1000 face) and in tiny amounts (eg $500k). We call this "trading by appointment only". Therefore, they couldn't truly mark-to-market because there simply was no active market.

(b) During the "virtuous" cycle marking-to-model served to hide the enormous embedded fees paid by real money buyers in the new issue market. For example, pension funds bought large amounts ($50 million and more) of such securities at par, a price that routinely included 5-8% underwriting fees - an atrocious percentage for AAA-A bonds when bought in size. I know of several instances where fees even exceeded 10%. By comparison, highly rated agencies and straight corporates are issued with fees of 0.5-1%.

Which brings us to what could be the "next shoe to drop". As defaults in the mortgage and junk loan sectors rise, as they are already, the models will calculate significantly lower prices, particularly for those issues that were put together with overly optimistic default assumptions. I won't be surprised to see some issues eventually model-priced at 10-20 cents on the dollar, even if their prospects for partial recoveries mean that their true values are double that. In other words, just as the models produced "garbage" prices on the upside, they have the potential to come up with "garbage" prices on the way down.

Also, some mortgage companies don't want to negotiate precisely because they win even if all of their properties go into foreclosure, apparently. From today column by Paul Krugman in the New York Times Enron's Second Coming?:

But Countrywide made more questionable loans than anyone else — and its postbubble behavior does stand out. As Ms. Morgenson reported in yesterday’s Times, Countrywide seems peculiarly unwilling to work out deals that might let borrowers hold on to their homes — even when such a deal, by avoiding the costs of foreclosure, would actually work to the benefit of both sides.

Why block mutually beneficial deals? As the article points out, Countrywide can make money from the fees it charges on foreclosures, while the losses from mortgages that could have been saved, but weren’t, are borne by others.

I think this is an example of moral hazard at work.

Actually, changing the bankruptcy laws to allow debtors to "cram down" their mortgage debts just might be the thing we need to bring back some sanity to this insane housing market in much of the country.

I'm Not A Central Banker, But I Can Play One In This Game

Monetary Policy Simulation Game

Hat Tip: Sudden Debt

Inflationary Depression Update

Most of the sites I explored to explain an inflationary depression turned out to be right-wing conspiratorial sites or Christian "the end is near" kind of sites (that often were also right-wing in their rhetoric). But I found a site written by David Petch that didn't come across as extremist or conspiratorial. Here is a some of what he wrote:

The US was the world’s power when it was the world’s largest exporter of oil and manufacturing center. Since the end of WWII, the US global output has declined from 50% to an estimated 20-22%. Dollars flow to sources of manufacturing, which now is the domain of China and India. The US economy has been rolling along with the aid of other countries purchasing US debt instruments to fund the current account deficit. Removal of this additional money and the US faces a sudden negative influx of capital. When this situation arises the US government has 2 choices:

Deflation, which would absolutely collapse the entire US economy to a functional level of less than 20% of the population.

Monetary inflation to cover the bills so that the economy hobbles along.

The important item to remember is that ALL global economies are linked and any country that expands its own currency will automatically cause monetary expansion of any country it does trade with. China has nearly 1 trillion US dollars in its reserve, but what if they lost 1 trillion with internal loans to cancel their reserves? They simply print a trillion of their own currency and buy more US debt. This perpetuates the cycle in which we exist, so until the consumer goes into the bunker, this facade will continue.

Once the consumer retreats and the bad loans begin to hit the banks, governments will have to bail out a multitude of companies to keep the economy running. Remember that if the debt is mopped up with mad money, then it matches and raises any money that evaporated, hence inflation. On this basis, it is nearly impossible to consider any form of deflation until the inflationary cycle is over.

War cycles are always inflationary and countries tend to go off of gold standards to ensure supplies and oil are not limiting to try and ensure victory. This has been the case for many currencies of the past 200 years and will continue into the future. Interestingly, Portugal, England, Spain and France during the 1500's to the 1700's were able to grow their economies by stealing gold from the South American countries during their global conquest phases. Their gold was basically free, which was able to feed their fleets and government purchases etc. With the abolishment of slavery and loss of control of the "New World" from feuds with other European countries and the locals, this form of a gold-backed currency system for funding wars and growth no longer exists. Stealing from other countries for nothing was a form of printing money except it came from the ground and went to European banks with no purchase of cash required. Today, instead of robbing countries of gold and silver, banks print money to allow credit expansion for citizens to go into debt to have a household containing the latest gadgets. Money today is basically digital, a total 360 going from physical to money transferred electronically.

Any attempt to implement a purely digital economy never could and never will exist. People would return to bartering and ignore the electronic money system, which would negatively affect government revenues. This would collapse economies, so I would hazard a guess this system would never fully be implemented. Most transactions nowadays are electronic but there always is the basic need to transfer money between individuals. Another reason to own gold and silver: the government can not trace it.

...

As I stated earlier, the amount of money circulating in the globe is expanding and just because the US is going through hard times does not remove inflation from the global scene. The scenario of an inflationary depression is what I would expect and is worse than a deflationary depression. During an inflationary depression the price of food and goods rises above many households’ range of affordability.

In the end, there will be a deflationary collapse following the current period of inflation and it will be due to a zero velocity of money compounded with plummeting manufacturing output. At this point in the future, owning cash and bullion will be important.

I don't know anything about David Petch's politics. But the explanation in Diatribes of Deflationists: Why They Are Still Wrong Pt. 2 comes across as a reasonable explanation of how an inflationary depression could happen.

Inflationary Depression

The 1930s Great Depression was a deflationary depression. I have heard talk that the next Great Depression will be an inflationary depression. I heard this (and discussed it) many months before the Federal Reserve dropped interest rates (with the subsequent market movement toward protection against inflation).

Now I am once again trying to get my mind around this idea and trying to understand how an inflationary depression would potentially play out. From what I have read, Ben Bernanke was a student who studied the Great Depression and is trying to prevent it from happening again. The question is: will the cure end up being worse than the disease? Can reducing interest rates prevent a severe economic downturn while still maintaining international currency stability?

Stay tuned.

Moral Hazard Insurance

From Answers.com:

Moral Hazard: The risk that a party to a transaction. . .has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles.

I think that is very risk that the Federal Reserve took yesterday when it decided to lower its rate on a key short-term interest rate by half of a percentage point Tuesday to 4.75%. A bubble was created in the credit market which contributed to asset inflation in the housing sector. Obviously (to me, anyway), the fact that the markets immediately saw an increase in the price of gold, oil, metals and other commodities indicates that traders expect the Fed's action to lead to inflation in commodity prices -- particularly gold and oil. Oil is currently priced in dollars and gold is often bought as a hedge against inflation.

So where does one go to buy insurance against the moral hazard of bailing out speculative investors and financial institutions that made what they knew were bad loans?

Worst Is Yet To Come?

From the article Housing seer says there's worse to come:

So, with subprime mortgage losses and credit woes now the No. 1 topic in the markets, what does the former Goldman Sachs investment banker see next for the housing market and the U.S. economy?

Well, if you thought things were bad now, just wait. Think bank failures, recession, soaring default rates, home prices plunging by at least one-third and layoffs rippling across the economy. The unwinding could take five to seven years before the housing market hits bottom, he says.

As a former Wall Street insider, Mr. Talbott has a better appreciation than most for how large financial institutions operate. And what he senses now is a massive effort to conceal the extent of the toxic sludge buried beneath some of the biggest names in the business.

"Everybody is hiding and not disclosing losses," he says. "They're all winking and nodding at each other because they've all got this stuff on their books."

With 40 per cent of some banks' assets invested in residential mortgages, they won't be able to conceal their losses forever. Faced with rising defaults, banks are already pulling back on lending. The lack of credit, in turn, will exert a major drag on the economy, which for years has been fuelled by easy money. That's why Mr. Talbott says a recession in the next 12 to 18 months is a certainty.

...

The subprime meltdown has been described as a liquidity squeeze, which makes it sound like a temporary problem that can be cured with an injection of cash. But the problem is far more serious, he says.

"Giving a bank more cash doesn't solve the problem. What they're sitting on is huge losses and they can't recognize those losses without endangering their entire book equity and threatening bankruptcy and threatening a run on the banks."

I don't know if things will get that bad, but it's a potential scenario. I suspect this very scenario that could happen is what is worrying many Americans.

Favoritism for the Wealthy

From Jonathan Chait at the TPM Book Club:

Class War and the Big Con

Some of the debate in the blogs last week focused on whether, or to what degree, leading Republicans actually believe the arguments they make on behalf of tax cuts, such as the common claim (made by leading Republicans everywhere, starting with President Bush) that tax cuts have caused revenues to grow. I think many of them do believe it. But the extent to which they believe it is fairly beside the point. The wealthy interests who favor tax cuts, and other pro-rich items, aren’t motivated by supply-side ideology. While they may believe that tax cuts help the economy, their deeper belief is that every dollar they have, including the dollars they inherited, is a reflection of their success and a measure of their virtue. So, in this sense, supply-side ideology simply plays the same role that Social Darwinism did a century ago and that economic orthodoxy did seventy years ago.

Or maybe they are just different justifications for the same mindset. I have argued before that we are starting to see a return of Social Darwinism as an accepted idea. I'm not convinced it has died out. I suspect it is more that Social Darwinism is being downplayed to some extent in favor of a new repackaged argument that rich=moral. Social Darwinism has at its core a belief that those who have attained wealth and status have done so due to their moral or genetic superiority.

It has even taken root in Christianity. If you look at the "Gospel of Wealth" being preached in conservative churches, you can see what I mean. I have seen people in conservative churches told that they are just not rich because they are not right with God.

I don't want to get too far off of the main subject, but certainly wealth does not equate in any way with moral superiority. "All great wealth starts with a crime" as we lawyers would say. In the Christian context, there is this from the Epistle of James:

2:1 My brethren, do not hold your faith in our Lord Jesus Christ, the Lord of glory, with partiality.
2:2 For if there comes into your assembly a man with a gold ring, in fine apparel, and there also comes in a poor man in shabby clothing,
2:3 And you pay special attention to him who wears the fine clothing, and say to him, Sit here in a good place; and say to the poor man, Stand there, or sit here beside my footstool:
2:4 Have you not then discriminated among yourselves, and become judges with evil thoughts?
2:5 Listen, my beloved brethren, Has not God chosen the poor of this world to be rich in faith, and heirs of the kingdom which he has promised to those who love him?
2:6 But you have despised the poor. Is it not the rich who oppress you, and drag you into court?
2:7 Is it not they who blaspheme the noble name by which you have been called?
2:8 If you fulfill the royal law, according to the scripture, You shall love your neighbour as yourself, you do well,
2:9 But if you show partiality, you commit sin, and are convicted by the law as transgressors.
2:10 For whoever shall keep the whole law, and yet stumble at one point, is guilty of breaking it all.

I think too many Christian leaders are skipping over these type of texts in both the Gospels and the other writings in the New Testament.

Anyway, back to the main subject: I found this quote at The New Republic's excerpt from Chait's book.

From 1947 to 1973, the U.S. economy grew at a rate of nearly 4 percent a year--a massive boom, fueling rapid growth in living standards across the board. During most of that period, from 1947 until 1964, the highest tax rate hovered around 91 percent. For the rest of the time, it was still a hefty 70 percent. Yet the economy flourished anyway. None of this is to say that those high tax rates caused the postwar boom. On the contrary, the economy probably expanded despite, rather than because of, those high rates. Almost no contemporary economist would endorse jacking up rates that high again. But the point is that, whatever negative effect such high tax rates have, it's relatively minor.

First, what needs to pointed out was that this referred, I think, to income tax rates. But the super-rich make much of their income from investments (i.e. passive income). Even if these were tax rates on capital gains, this would be taxation 1) only on the highest earners; and 2) on income not drawn from labor. The principle that we once had is that we want to encourage people to produce and contribute to the betterment of society and the economy. We don't want "trust fund babies" who don't have to work because their talents and abilities will have a tendency to go wasted. And as successive generations are born into wealth, they will have less appreciation for the benefits that their ancestor's labors brought to the betterment of their community.

Kids that come from wealthy homes already have lots of assets to draw from. Taking from the wealthy to help provide an equal access in the areas of health care and education -- just to name two services -- is only fair...especially given how beneficial those services are for the advancement of the economy and social well-being. There is a certain point where having too much wealth has a detrimental effect on productivity and social progress (political conservatives certainly never talk about this aspect of the acquisition of wealth). Proper use of the tax code can encourage talented and capable people to keep producing and innovating precisely because they want more.

Now, I'll grant -- for the sake of argument -- Arthur Laffer's central argument that there is a point where tax rates become so confiscatory that tax revenues will start to drop due to the negative effects it has on investment and labor; but we're certainly not there now. Furthermore, deficit spending (read: national government credit card) will crimp investment just as much; as the national debt (and its concomitant interest payments) is simply deferred taxation. Having the federal government file bankruptcy is just unthinkable. And lack of access to health care will lead to less productivity due to untreated illnesses or injuries (and, specifically, illnesses can sometimes spread due to their non-treatment -- leading to further drops in productivity). So exactly how do we benefit from denying access to health care based on ability to pay again?

To sum up, higher tax rates (than what we have currently) and implemented in the right places, can actually have a beneficial effect for society.

Moral Hazard Hypocrisy

Conservatives love to argue against national healthcare on moral hazard grounds; but somehow we taxpayers and the Federal Reserve are supposed supposed to bail out educated, smart, wealthy and powerful people when they take they know -- or should know -- are excessively risky financial instruments.

Here is a snippet from Robert Reich's excellent post:

When it comes to risky behavior in the market, America has a double standard. We’re told that economic risk-taking as the key to entrepreneurial success, but when big entrepreneurs take big risks that fail it’s amazing how often they get bailed out. Indeed, the history of modern American business is littered with federal bailouts, loan guarantees, and no-questions-asked reorganizations. Some are well known, such as the Chrylser bailout of 1979, the savings and loan bailout of 1989, and the airline bailout of 2001. Most occur in the relative dark, such as the 1998 bailout of giant hedge fund Long-Term Capital Management (courtesy of former Fed chair Alan Greenspan), the not infrequent bailouts of under-funded corporate pension plans by the government’s Pension Benefit Guarantee Corporation, price supports for big agribusinesses facing market downturns, or the current bailout of Wall Street being engineered by Ben Bernanke’s Fed. Behind every one of these bailouts are CEOs or financial executives who were rescued from their bad bets.

Mr. Reich has a new book out called Supercapitalism.

What's Wrong With America and What Will You Do About It?

I like the question asked and the answer given. We must answer this question to determine who we are as a people. It is central to our value system as a country.

The Dangers of Retirement Hedge Funds

This is what an editorial in the New York Times entitled Pensions and the Mortgage Mess had to say about risky mortgages being added to pension funds today:

Even as the plunge continues in investments tied to dicey mortgages, government regulators remain skeptical of the need for new rules to cover these newfangled derivative products or the hedge funds that tend to buy them.

The Federal Reserve chairman, Ben Bernanke, rightly argues that these are important instruments, making credit more available and allowing risk to be spread broadly. But as the casualties mount to more than just a few buckled hedge funds, it is important to address the downsides.

There is a real danger that the casualties to come will include a more vulnerable set of investors: the pension plans of working Americans. Mr. Bernanke recently told Congress, “In most cases, I think that pension funds should probably not, you know, go heavily into these types of instruments.”

But faced with growing numbers of retirees, some pensions — including those for police and firefighters in Ohio and Dallas — have been unable to resist making these risky investments in an attempt to increase their returns. Public and private pension funds have also plowed tens of billions into hedge funds, which have been piling into mortgage-related securities.

Many pension plans lack the analytical skills needed to evaluate these investments, relying on outside advisers and rating agencies. But the stellar triple-A rating assigned to many of these bonds proved to be misleading — with the agencies now rushing to downgrade them.

So far there have been no reports of pension plans in trouble because of the mess in the mortgage market, but we fear that it might only be a matter of time. The fact that pension plans are insured — private plans by the Pension Benefits Guaranty Corporation, a federal agency; state and municipal plans by taxpayers — makes the case for enhanced regulation even stronger.

Protecting pensioners from bad investments will not be easy. A good place to start would be to make rating agencies more accountable, perhaps by asking regulators to monitor their quality. Pension law should also be changed to ensure that the premium that private pensions pay into the P.B.G.C. takes into account the risk of their investments.

What is crucial is to ensure that pension managers perform adequate due diligence to understand what it is that they are buying. Regulators must make sure of that.

Given what we have seen happen to the working class' retirement funds through corporate bankruptcy and schemes like this, I am not yet convinced that expanding Social Security into a full pension plan for the elderly isn't a better, more secure way to go. Can we really trust private entities with pension funds anymore? In any case, even if my idea is not adopted, premiums paid the the PBGC reflecting the risk of pensions failing due to riskiness of their investment portfolio would be a good start.

Are College Tuition Costs That Bad?

Teen Accused of Robbing Bank for Tuition
From Associated Press
July 20, 2007 1:47 PM EDT

CINCINNATI - A college student accused of robbing a bank had been worried for months about his mounting tuition bills, his mother said.

"He just really was struggling, working two jobs here, you know, temp jobs, two jobs and trying to get the money," said Franki Butler, whose son Andrew was charged this week with robbery. Andrew Butler, 19, and another man were arrested Tuesday after a Valley Central Savings Bank in suburban Reading was robbed, police said. Police recovered an undisclosed amount of cash.

A judge set bond Wednesday at $50,000 for Andrew Butler and Christopher Avery, 21, also of Cincinnati. Both are charged with aggravated robbery.

Avery, a student at the University of Cincinnati, posted bond and was released. Butler, a University of Toledo student, remained in custody Friday at the Hamilton County jail.

The sad part about this is that the college student will probably get a minimum sentence of 25 years if convicted. The real travesty of this is that -- while this is an aberration, if true -- no one should have to imagine such a choice in an attempt to get an education.

The New Gilded Age

On Diane Rehm's show this morning, Ms. Rehm had a panel of guests that discussed The New Gilded Age -- a discussion about the "trends in the U.S economy and implications of the growing disparity between this country's super rich and everyone else."

You can listen to the program in Real Audio or Windows Media.

Robert Rubin discussed his new book In an Uncertain World. A lot of good points were made, but I don't yet have the ability to give snippets from the show.