Calornia Propositions A-F election today

Well, today is our election in California. The date got here fast and I haven't done my research into these propositions. The usual newsprint pamphlet containing the legislative analyses is missing from our house. Either we've misplaced it or we never got it.

I noticed a huge lack of URLs for information about the propositions. The single paragraph blurbs on the ballot don't mean anything. The basically explain nothing about the proposition, except the subject from the 60,000-foot level. And especially in this election, I don't believe what I've heard and seen in the political print ads and on TV. The ads are so slanted that they don't really make sense to me. The marketing program for these propositions basically "stink to high heaven"!

If you want to research these, here are some links.
http://www.voterguide.sos.ca.gov/pdf-guide/props/prop1a-analysis.pdf
http://www.voterguide.sos.ca.gov/pdf-guide/props/prop1b-analysis.pdf
http://www.voterguide.sos.ca.gov/pdf-guide/props/prop1c-analysis.pdf
http://www.voterguide.sos.ca.gov/pdf-guide/props/prop1d-anaysis.pdf
http://www.voterguide.sos.ca.gov/pdf-guide/props/prop1e-analysis.pdf
http://www.voterguide.sos.ca.gov/pdf-guide/props/prop1f-analysis.pdf
Gotta love the one for 1D. I don't know how much stock I should put in an analysis when they can't spell the word.
For other info and .htm presentations of the information, go to http://california.gov/ and search with "proposition 1x legislative analysis", where x is the prop of your choice.

Over the course of the last month, I've noticed that any economic analyst I've considered intelligent has recommended "no" votes on all of these propositions. I'll probably vote "no" myself.

Having said that, are California's political process and budget processes broken? Certainly. They are also wildly pro-cyclical, where spending goes up during good economic times, followed by budget crunches during bad times. This was true since before the defense-related recession in California in the late 80's, the Silicon Valley / dot-com boom-and-bust of the 90's and early 2000's, and so on. So the processes certainly need to be changed. As an aside, the "rainy-day fund", known in the analyses as the "BSF" seems designed to smooth the cyclicality to the upside, with more taxes, instead of forbearance of possible spending during good times!

One glaring, flashing omission from these proposals is discussion spending cuts. There's a lot of rearranging of deck chairs and debt, shall we say, and some sizable tax increases. There is discussion around protecting certain "sacred cow" spending areas. But the whole thing seems built around the idea of "Don't look at the spending behind the curtain!"

Talk with you soon. I'm off to study and Vote!

T.E.A. Party Day

Hooray for the Tea party organizers. I'm going to my local Tea party today to see what happens.

The stimulus bills and associated pork may have been the catalysts for the Tea party movement. However the larger and longer term issue is the growth of government spending as a percentage of GDP. That is bad, on top of all the other reasons, because a dollar cycled through the government has a lower multiplier than a dollar kept circulating in the private sector. That subject is explored in detail in any good first- or second-year economics course.

For those that don't care about wealth, or want to lower it, the lower multiplier is not a problem. For the rest of us it's a key issue, even if it's not usually argued in those terms.

So I'm off to my local Tea party. Here's an article that surveys the Tea party phenomenon.
http://online.wsj.com/article/SB123975867505519363.html

What Should be Done About AIG Bonuses?

Absolutely nothing should be done about the bonuses paid to AIG employees, at least not legislatively. To understand why, please take out a calculator now and do this simple division. Enter 165, to represent the $165 million in bonus compensation. Divide that by 170,000 to represent the $170 billion in bailout money that AIG has received. Look at the result. Adjust your calculator's display to show 5 digits to the right of the decimal point if your calculator doesn't already show them. The number you'll see is 0.00097. What does this mean? It means that the bonus money is less than one one-thousandth of the bailout money going to AIG.

This money, on a percentage basis, is less then the rounding error in many calculations. While $165 million is a huge amount of money to most of us, it's just not meaningful in the scope of AIG's problems or it's bailout, or the problems in the banking system, the government or the economy.

So I watch with sadness and amuzement while the House rants and then passes a bill that is reckless on several levels. It's reckless on constitutional grounds. If the Senate and President pass and sign anything like it, it may get struck down on those grounds in the courts. It's reckless on business grounds because of the perceptions of recklessness, fickleness and inconsistancy it will create for businesspeople. Who'd want Congress as a business partner? And it's reckless on political grounds, if there is a backlash against things going further wrong due to this bill.

This week we seem to be moving past the AIG furor, and focusing on the Geithner plan. That's great. We should forget about the AIG bonus issue and hope the legislation lapses into irrelevancy.

Is getting the bad assets out of the banks the way to go?

Today Federal Reserve Bank of Boston President Eric Rosengren said about getting the bad assets off the banks' books that it is "desirable to move quickly". I believe even more strongly than that, that it is essential. And that the people and institutions responsible for helping the economy recover are making a strategic mistake if they don't move quickly on it. They may be working on this in the background, and may even be finding problems and making progress. If so, the mistake is then one of communication.

Rosengren's study of the Japanese banks experience points to getting the bad assets out as cucial.

Rosengren points out from almost an organizational studies point of view that while the bad assets are on a bank's books, management stays fixated on the losses and mistakes at the cost of not moving forward into new, good loans. And as a trader, I know that sitting around looking at losses is not helpful in finding and making the next profitable trade. Instead, one should analyze the bad trade, learn what can be learned, and forget about the pain of the loss and move forward.

Getting the bad assets out of the institutions is of course easier said than done. That doesn't affect at all whether doing so is crucial to recovery. As we see with the Citibank bailout effors to date, the sick assets essentially sicken the whole institution. I've listened to many commentators about this, especially over the last three months. And it seems to me that the smart ones are essentially in agreement that paths always lead back to the bad assets in the institutions and their value. Washington and others may want that fact to go away, but it won't.

Neither is the fact that the root cause of the creation of those bad assets was the government's driving the banks to make lousy loans they would not otherwise have made. But I've covered that particular point already in this blog.

Here's a list of issues I've seen regarding the bad assets. Specifically these assets are the CDO's containing subprime loans, and derivatives based on these and other troubled assets, including CDS's.

1) There are losses on derivatives created out of thin air. That is, not just derivatives based on CDO's that actually exist. For the best explanation I've seen of this, see the article "The End" in Portfolio magazine, Dec08/Jan09.

2) The question is how to value assets, and after determining what are they worth. Of course the simple answer is that they *should* be valued by price discovery in an open, regulated, undistorted market. Since that option is not available, some form of modeling must be used.

3) The "taxpayer" has an interest in this. Politicians of any skill at all learned quickly months ago to recite phrases like "protect the taxpayer", "make the investment back" for them, "protect their interest" and the like. Nice to consider, but our situation is so bad that there will just be costs. This situation seems to be worse than the savings and loan debacle, and its relatively successful bailouts. The models for valuing the assets become mechanisms for allocating the losses. Not pretty.

4) The FASB changed an accounting rule earlier in the crisis, known as "mark-to-market" and also "Fair Value Accounting". I feel I understand FASB's basic motivation to make the rule change. A huge theme in accounting is knowing the present value of everything, even things that won't be realized as a financial entry until the distant future. However, this rule change, accompanied by a lack of guidance at the time, did serious but quiet harm to banks and other institutions. This harm is not yet fully discovered. Over-the-counter, unregulated markets and the end of markets and price discovery at all combined with the rule to force banks losses. The get close to declaring the losses; they need the bailouts.

5) The "bad-bank" discussions are about creating containers for the toxic assets outside the instituions. If we had liquid markets for the assets, we wouldn't need the containers. Every few days there's a story about a firm that wants to buy some toxic assets, but learn that they can't. In a sense it's too dangerous to establish a price by selling assets to them. Go figure.

6) In the end, leaving the toxic assets in a fully public "bad bank" wouldn't be as bad as the government nationalizing banks, or almost so. Why? The government can boss the assets around all it wants to, and then sell them later. This will cause less long-term damage to markets and American free enterprise then the government bossing around banks, and creating long-term, heinous market distortions.

Obama Starts Down the Dreaded Path

Here a some beefs I have with President Obama's and the Democratic majority's recent actions and positions.

1) The so-called stimulus bill is full of pork. I'm hearing about more items all the time that sound more like ornaments on a Christmas tree of pork than elements of a well-thought-out and effective stimulus bill.

2) The stimulus bill is too light on tax cuts and too heavy on spending. I'll detail why tax cuts are more effective in a later post.

3) The Columbian Free Trade Agreement isn't passed yet. Remember this? It still matters. The U.S. so far has failed to lock in free trade and economic recovery advantages and the drug war advantages of passing the FTA. Stratfor and other sources have warned about Mexico's dire straits. We need to watch our southern border closely.

4) There's a "buy American" clause in the stimulus bill. It's nonsense to codify that in a bill. If a private party wants to pursue a buy America ad campaign that's fine. But massive sellers of treasury notes and the beacon of democracy and free markets, not to mention chief advocate of free trade, can ill afford to do this. It's stupid and economically wrong.

5) The Obama administration naively stated the obvious about China's handling of its currency relative to the dollar. Of course they manipulate it. It's officially pegged, after all. It doesn't even pretend to float in a free market relative to the dollar. But it was a stupid thing to say so. To do so within a week of the passage of a giant spending bill to be financed by government borrowing was a whopper. The Chinese have good reason to fear sanctions and legal consequences if what they are doing is called what it is. And of course a backlash to those actions would hit us. Hard. Please guys, try to act sophisticated even if you aren't. The U.S. and China are in a dance together and it will take at least another generation to unwind things enough to be free-market rational.

6) The "Card Check" pro-union bill lurks in the halls of congress. The election mechanism is un-American and I would think it would be unconstitutional. I'd have to look. The bill will also advance the government's role from referree to dictator of terms after a set time period of negotiations between a company and a union. That's bad on several levels. More on this later. For some detail see today's editorial page in Investor's Business Daily.

7) Obama signed the "Lilly Ledbetter" bill. That's a bill that sounds appealing to people who think with their hearts instead of their brains. But it sets up some incentives and legal mechanisms which will be abused, to the short-term detriment of businesses and the long term detriment of employees.

8) Closing Gitmo? Dumb. Castro's already making hay, and that's before we've let anybody out! We close Gitmo and celebrate only after we're out of Iraq and Afghanistan, UBL is proven dead, al Queada is discredited and dismantled, Iran has been shorn of nukes, the Isreal-Palestinian question has been resolved to the degree that Palestinians move forward economically instead of work to dismantle the present situation, and Hamas and Hesbollah in their present forms are nothing but bitter memories.

My relief at the perceived quality of Obama's cabinet picks is giving way to the forlorn environment I feared before Obama was elected.

What’s the root cause of the sub-prime and credit debacle?

In the present housing and credit market problem sets, there has been limited commentary about the root causes and in my view over half of it has been completely distorted. The problem’s root cause is a market distortion caused by the government encouraging the residential real estate industry to get a higher percentage of Americans into home ownership. I recall reading about President Carter’s CRA and later about the ramp-up of this initiative in the 1990s. By 1996 this had resulted in President Clinton’s “National Partners in Homeownership” initiative, and a dramatic strengthening of the CRA.

How would this have worked if viewed from a market perspective? If the residential real estate market was generally at equilibrium before the government started this initiative, then who was there to find to increase the percentage of home ownership? Less credit-worthy borrowers was the only place to look. There was almost certainly not a meaningful percentage of Americans who could easily qualify to buy a house who had chosen instead to rent out of ignorance. The “secret” of the advantages of homeownership was pretty well out by the 1990’s. While financial education and increasing prosperity resulting in more homeownership are laudable goals, I lay root responsibility for the housing debacle on the government. And this is before any discussions of mortgage lending regulations and Freddie Mac and Fannie Mae, and cross-incentives at work between those GSEs and members of Congress.

Others have pointed to Wall Street executives’ and firms’ greed as the root cause. They created the loan instruments and derivatives and sold them. Also blamed are the bankers and brokers who originated the loans. Certainly there was some greed and some money made. But before you can conclude that these parties were the root cause, you must first ask yourself: Are bankers idiots? They most certainly are not. They may not be into charity, but they're not idiots. In undistorted markets they act with meticulously calculated self-interest. They make their profits in a world enumerated in Basis Points, which are 1/100^th (one-one-hundredth) of a percent. So you must ask, what made them start making loans that were idiotic by banker's historical credit standards? And the answer is the incentives and controls in the CRA ratings. And, as has been explored elsewhere, no less than four regulating agencies provided the teeth and force that backed up the CRA and its bank rating system.

As the finger-pointing continues over our present problems there are plenty of parties to take the blame. The mortgage industry got creative and sold loans to people who shouldn’t have taken them. Home builders make money by building and selling homes, and were happy to fuel the boom. Realtors and real estate commentators fed the frenzy. Buyers can be excused for financial ignorance only so far. The housing market expansion took on a life of its own. We couldn’t have expected a mortgage lender or broker to be happy reporting lower sales numbers in the middle of a boom, even when the supply of reasonable marginal borrowers was getting thin. But I return to the idea that the original instigation was a market distortion started by the government. The initiative to raise the percentage of American homeowners was good as a starting concept, but very harmful when it devolved into putting unqualified buyers into homes who couldn’t afford them in the long term. And we all can see that now.

Lastly, one thing that surprised, amused, and saddened me was the Democratic campaign’s success in painting Republicans and free-market advocates as the root cause of the debacle. If I had run the Democratic campaign, I’d have pursued the same strategy. But if I had run the Republican campaign, I’d have not let that one go. I’d have made a tremendous amount of noise about the history and issues as they are laid out here. I was surprised to hear John McCain attack Wall Street over the issue instead.

Please read my first post below. That's where I lay out the basic free-market vs. Socialism logic.