A Fannie/Freddie By Any Other Name

Politicians are now paying lip service to reforming Fannie/Freddie. I wouldn't expect anything to actually get done but be prepared for all sorts of hair brained ideas. The first is by Congressman Barney Frank.

The more things change, the more they stay the same. Take the case of Barney Frank, Chairman of House Financial Services Committee. In an interview with FOX Business’ Neil Cavuto, he called for Fannie Mae and Freddie Mac to be abolished. “The only question is what do you put in their place,” he said.

...

What would he propose? He said, “I’ve worked closely with the Financial Services Roundtable… They are talking about the following: first of all, you separate it out, so there’s no more hybrid public-private. So, Fannie and Freddie and anything like them go out. You have a purely public FHA [Federal Housing Administration]… [that is] fully self-financing.”

Frank added, “If we want to subsidize housing then we could do it upfront and let the budget be clear about that.”

Clearly, Barney Frank hasn't been paying attention to me. Beyond that, Frank clearly doesn't understand why Fannie/Freddie are such a problem. It's as though the problem is the names. They've become too toxic and so if we change them and have another mechanism that does the exact same thing everything will be fine.

Let's start at the beginning. Mortgage securitization is a very complicated process but, in my opinion, it's a necessary one. It provides liquidity in the market and it transfers risk from banks to speculators. All of that is good. That means more people get loans and rates will be lower.

The problem is that in loan securitization there's only two games in town, Fannie Mae and Freddie Mac. That's duopoly and those never work. The second problem is that both are extensions of the government. So, what we had was a government run monopoly on securitization. Fix both problems and you fix Fannie/Freddie.

Instead, Barney Frank wants to go the other way. He wants to stop simply having an implicit government guarantee and just have an explicit government guarantee. Of course, that perpetuates the problem.

Dow Futures Down: Progressive Economics Feared

The DJIA will test four digits again as its hovering near 10000 again today. The Eurozone is again worried that everyone will be bankrupt soon.

Two days of little movement for U.S. stocks is likely to end Tuesday, with renewed worries over euro zone debt pushing overseas markets lower, as well as U.S. stock index futures.

The Dow, the S&P 500 and the Nasdaq all registered single-digit moves both Friday and Monday, but this morning's worries likely mean a sharply lower opening, and those worries have also sent many investors to U.S. Treasuries. The 2-year yield hit a record low in overnight trading, while the benchmark 10-year note's yield hit a 14-month low.

Let's all remember that the president attended the G20 and demanded that everyone else continue to spend.



Yet, the entire rest of the G20 rejected this idea wholesale. The only person at this point that thinks that Obama should continue to borrow and spend, besides Obama, is Paul Krugman.

We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.

And this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending.

The rest of the world has realized that endless spending of money the government doesn't have is not only inefficient but leads to borrowing and/or taxation and both of those are contractionary. As such, the rest of the world gave Obamanomics a chance and now it's being rejected entirely.

New Jobless Claims Point to More Problems

Just as the jobless claims inched toward four hundred thousand, they took a step back this week.

Initial claims for jobless benefits rose by 12,000 to a seasonally adjusted 472,000, the Labor Department said Thursday. It was the highest level in a month.

First-time jobless claims have hovered near 450,000 since the beginning of the year after falling steadily in the second half of 2009. That has raised concerns that hiring is lackluster and could slow the recovery.

Yesterday, there was a poor real estate number. On the other hand, there's some good news from manufacturing.

Manufacturing in the Philadelphia region expanded in May for a ninth straight month, another sign factories are leading the recovery.

The Federal Reserve Bank of Philadelphia’s general economic index rose to 21.4 during the month from 20.2 in April. Readings above zero signal growth.

Since the economy began recovering last summer, a pattern has emerged. For every two steps forward, the economy takes a step back. So, a year into this so called recovery things remain very choppy. Meanwhile, Keynesian policies have drowned the nation's economies in debt. That, along with the choppy recovery, has given rise to a world double dip recession.

The risk of a double-dip recession is growing, especially in the euro zone, where restructuring Greece's debt is inevitable, famous economist Nouriel Roubini told CNBC Tuesday.

Moody's became the second major agency to cut Greece's debt ratings to "junk" late on Monday, as it admitted that the country does not face immediate liquidity problems due to a joint IMF/EU aid package, but that the austerity program will probably weigh on its economic growth prospects.

"I would say that the risk of a double-dip recession is highest in the euro zone… I would say there is a more than 50 percent probability," if not of a technical double-dip then of economic stagnation in the area, Roubini said.

A double dip recession is nothing more than an economic term. What is clear is that our economy isn't strong, isn't going to strengthen soon, and it will cause pain for years to come.

Stimulus Surprise

Harvard University recently published the findings of an interesting study about government pork and its effect on local private investment.

Recent research at Harvard Business School began with the premise that as a state's congressional delegation grew in stature and power in Washington, D.C., local businesses would benefit from the increased federal spending sure to come their way.

It turned out quite the opposite. In fact, professors Lauren Cohen, Joshua Coval, and Christopher Malloy discovered to their surprise that companies experienced lower sales and retrenched by cutting payroll, R&D, and other expenses. Indeed, in the years that followed a congressman's ascendancy to the chairmanship of a powerful committee, the average firm in his state cut back capital expenditures by roughly 15 percent, according to their working paper, "Do Powerful Politicians Cause Corporate Downsizing?"

The study looked at the last forty years and considered the states in which their Representative ascended to chairmanship of powerful committees. First, the study found that earmarks went up 40-50% and discretionary spending went up by 10% in those states. Meanwhile, private investment, R&D, and sales went down over those same periods. That puts serious cold water to Keynesian theories.

The Corrosive Effect of Class Warfare

The debate of the moment is all about jobs.

A bipartisan jobs bill cleared a GOP filibuster on Monday with critical momentum provided by the Senate's newest Republican, Scott Brown of Massachusetts.

The 62-30 tally to advance the measure to a final vote on Wednesday gives both President Barack Obama and Capitol Hill Democrats a much-needed victory — even though the measure in question is likely to have only a modest boost on hiring.

Brown and four other Republicans broke with GOP leaders to advance the measure. Most other Republicans opposed the bill because Democratic Majority Leader Harry Reid of Nevada stripped out provisions they had sought and wouldn't allow them to try to restore them.

While it seems everyone has their own opinions of the best way to gain jobs, almost everyone agrees that we need to help two groups: small business owners and local banks.

I have nothing against small businesses or local banks. Still, to target small businesses while ignoring big businesses is entirely political not economic. Big businesses provide millions of jobs, just look at WalMart. The same is true of big banks and small banks. Big banks provide needed capital for millions of businesses and individuals. Yet, giving them aid has turned into a politically toxic proposal. At the same time, politicians are jumping over each other to provide a way to make life easier for community banks.

This has everything to do with class warfare. Small businesses have become a sympathetic group. Meanwhile, big businesses are viewed as powerful and corrupt. As such, you can get all sorts of populist cred if you provide help for small businesses while demonizing big businesses. There's a similar process for banks. Yet, these are entirely political calculations. There's no economic logic to helping small businesses while punishing big businesses. It's an entirely political logic and it's rooted in class warfare.

The Coming Small Business Bubble?

The situation seems eerily familiar. Our economy is weak. Money is cheap, and loan standards are then loosening.

President Barack Obama is asking Congress to extend the provisions that helped revive U.S. Small Business Administration lending this year.

The economic stimulus bill provided the SBA with $375 million to increase the loan
guarantee on the agency’s flagship 7(a) business loans to 90 percent, and to reduce or eliminate fees on 7(a) loans and 504 loans, which primarily finance real estate. The higher guarantee brought more than 1,000 lenders back to the SBA’s loan programs, and the lower fees made the loans more affordable to borrowers.

Thanks to these enhancements, SBA lending hit a record high in November.

That was the set up for the real estate boom, bubble, and bust. Our economy was weak. The Fed made money cheap. Banks began to extend mortgage terms to levels never seen before.

What do we have now? Our economy is weak. The Fed Funds Rate is zero and now President Obama has designed a plan so that small businesses will get loans at loan to values and sizes never seen before.

I have been forecasting the creation of a bubble in the economy since Bernanke lowered the Fed Funds Rate to zero. That's no especially astute analysis. Cheap money creates an artificial stimulus to spend and invest. Banks had a lot of cheap money in 2002-2003. They needed a place to put it and they found one in sub prime.

The same is true now only now the administration is determined to make as much of the final place small business loans. That's a set up for a small business loan bubble.

It's the Deficits Stupid

The administration came out with their deficit projections for FY 2011 and they are staggering.

President Obama sent Congress a $3.8 trillion budget Monday for fiscal year 2011, pushing a plan that includes new jobs-creation programs but is projected to add nearly $1.3 trillion in deficit spending on top of the current year's projected $1.6 trillion deficit.

According to the plan, the 2011 deficit of $1.267 trillion would fund nearly the entirety of the year's discretionary spending, which is $1.415 trillion or 37 percent of the government's total outlays. Mandatory spending on items such as entitlements and interest payments make up the rest.

This is the FY 2011 budget so this includes the so called spending freeze. That should put to rest the so called effectiveness of this freeze. If these projections materialize, this will be the biggest deficit ever.

The nexis of the president's problems start and end with this deficit. It's the easiest way to explain his problems. The president claims that these deficits are necessary to stimulate the economy. It's true. Almost everyone agrees that deficits are a natural and necessary parts of recessions. It's not true, however, that deficits must reach these levels.

People are afraid of the consequences, long and short term, of these massive deficits. As a result, they've rejected his entire agenda. As long as we see $1 trillion deficits and more the president will have this as an anchor.

The president in his remarks again tried to blame Bush for this. He claimed, again, that he inherited this deficit. That's of course non sense. This is the FY 2011 budget. This is a full year after Bush left office. This has nothing to do with Bush. These deficits are his responsibility and his alone. The folks aren't stupid and still blaming Bush is now just boring.

The President and the Double Dip

The president sat down with Major Garrett of Fox News finally and the news appears to be that the president is concerned about a double dip recession.

The United States' climbing national debt could drag the country into a "double-dip recession," President Obama warned in an interview with Fox News Wednesday from China, though he said he's still considering additional tax incentives for businesses to reverse the rising unemployment rate.

The president, who is in Beijing as part of his tour through several Asian countries to address economic challenges, spoke candidly about the precarious balancing act his administration is trying to perform. He wants to spend money to kick-start the economy, but at the same time is in danger of creating too much red ink.

Now, the president worrying about a double dip recession caused by too much red ink is sort of like your bar tender worrying about what all your alcohol consumption is doing to your liver.

A double dip recession, also called a W shaped recession, occurs when the economy begins to recover and then falls back into a recession. There's two famous cases: the early 1980's and the late 1930's. In the early 1980's, tax cuts were combined with interest rate increases. Paul Volcker, then head of the Fed, began to raise rates to deal with inflation. When Ronald Reagan took over, he was facing stagflation: recession and high inflation dually.

The other double dip happened in 1936-1938. That occurred as the unemployment dropped to 13% from its highs of 25%. With growing red ink, FDR began raising tax rates. This caused the economy to worsen.

President Obama is taking the FDR approach to recovering the economy. He wants to spend, spend, and spend some more. That has consequences and those consequences are massive deficits.

The president is worried about the consequences of said deficits even as he fails to acknowledge that he created them. It's curious and peculiar for the same person that pushed hard for the $787 billion stimulus, fully embraced the bank bailouts, and is now pushing the $1 trillion plus health care bill to know say he's concerned about the deficits all of this will cause.

At some point a sea of red ink will cause high interest rates. More expensive borrowing costs will cause a stunt in the economy and that's what the president means by a double dip recession. The sea of red ink will lead to high interest rates which will stunt the economy. All of this is simple and basic and that's why his admission now is both peculiar and disingenuous. If this was his fear then the stimulus, the bank bailouts, and the current health care plan would not be policies he would be championing.

Next Stop: Economic Propaganda

Joe Biden delivered a speech yesterday in which he made this, shall I say, laughable quote.

President Joe Biden on Thursday said the government's sweeping stimulus effort "is in fact working" despite steady Republican criticism and public skepticism.

"The recovery act has played a significant role in changing the trajectory of our economy, and changing the conversation in this country," Biden said. "Instead of talking about the beginning of a depression, we are talking about the end of a recession."

Nearly 200 days into the effort, Biden delivered an upbeat report card about the $787 billion rescue effort that President Barack Obama pushed through Congress. He quoted estimates by private analysts that the plan has created or saved 500,000 to 750,000 jobs so far. But many million people remain out of work.

If you think that's a whopper, just wait until September 10th. That's when the Council on Economic Advisers will present their status report for the amount of jobs created or saved so far as a result of the stimulus. If you know anything about economics, you know that it is a multi dimensional science. As such, anyone with any agenda can spin anything in any which way. I can't wait to hear the whoppers that the Council will present upon the nation in presenting jobs saved or created.

That's because the administration has created an economic statistic that can't be measured. You can measure how many jobs the economy has created or shrunk. You can measure current wages, hours, etc. You can't possibly measure what a specific policy has done. Just think about how many liberals still fail to acknowledge that the Reagan tax cuts lead to the economic recovery. So, how do you measure the immeasurable? It's easy you do it through propaganda.

The administration is losing the faith of the nation. People believe that all the stimulus did was add deficits we can't afford. So, the president needs to convince the public that his policies are working. So, the administration will do it through propaganda. Jobs saved or created isn't a statistic. It's a fantasy. So, anyone that makes a speech based on jobs saved or created is engaging propaganda. Joe Biden just did it but we're all really in for a treat on the tenth.

Of course, the President isn't the only one that engages in economic propaganda. I'm always amused by Republicans that bemoan a lack of jobs. President Bush went nearly two years losing jobs. That happened in the aftermath of 9/11. It was natural we would lose jobs. What President Obama inherited is even worse, and yet, not eight months in, the Republicans are already bemoaning a lack of jobs.

Looking at a lack of jobs in a vacuum is absurd. The president walked into office and in his first month the economy shed 700,000 jobs. Is it really realistic to expect that the jobs picture would be rosy already. In fact, since he walked into office the jobs picture has progressively gotten better minus the June numbers which were a hiccough. Now, you could argue that all of this is unnatural and it will eventually lead to a stunted recovery. In fact, that's what I would argue. That's a lot different than bemoaning a lack of jobs. That's just unrealistic.

In my opinion, one of the worst offenders is the web site, Hot Air. One of that web site's favorite tricks is to pick and choose which weekly initial job claims numbers to cover. It's so sloppy and propagandist that it's absurd. Every week BLS comes out with the weekly first time claims for unemployment. It's such a wonky statistic that most people don't cover it. It's covered in business journals and television. That's the proper place for it. If you're going to cover it, you must cover it each and every week for perspective. Hot Air picks and chooses those weeks that are bad and proclaims that Obama's policies have failed as a result. Today, they run the headline Unemployment rate at 9.7%. What they don't mention is that jobs lost this month were the lowest in a year. They don't mention the downward trajectory of losses. There's absolutely no context. It's absurd.

I see this sort of thing all the time. Politicians who try and prop up the President's policy will suddenly proclaim something like the ISM manufacturing index just broke 50. Those that oppose him will say consumer spending is still flat. What does it all of it mean? It means absolutely nothing, that's what.

Here's the reality. We are in an economic murky time. Things aren't nearly as bad as they were. Things are still horrible. Things appear to be improving, but it's unclear how much they'll improve and where the economy will be when improvement stops. So, that gives spin meisters on all sides the opportunity to proclaim anything they want. There are thousands of economic statistics. Anyone can pick the ISM index, or some weekly jobs number, or consumer spending, and make some nonsensical economic statement based on that isolated number. We are in for economic propaganda.

Just take the unemployment rate. Robert Gibbs just said "we are seeing a lessening of the economic contraction" Meanwhile, opponents fixate on the unemployment rate which jumped to 9.7%. Of course, there's a million ways to look at that. The unemployment rate itself is calculated in a rather obtuse way. For instance, all those that are "frustrated" and unemployed aren't included. Who is frustrated? Who knows? The bottom line is that sometimes the unemployment rate jumps because people stop being frustrated and look for work. So more people are looking for work. So, it's not necessarily a bad thing to see the unemployment rate jump. That won't stop both sides from engaging in economic propaganda.

No Insurance Club Vs. President Obama

Chad Harris is an entrepeneur. As such, health insurance was always expensive for him because he never had group insurance through an employer. (after all he's his own employer) It could cost well over a $1000 monthly for his family. One day he was on a business trip when his wife was discussing the difficulties of getting health insurance with her doctor Dr. Sam Sannoufi, MD. Her doctor came up with an idea. The doctor would provide a menu of basic medical care for her and her family for $599 for the whole year and the whole family. It would allow for up to 12 hospital visits and several basic tests and procedures. She was stunned and so she wrote out a check before even speaking with Chad.

Once Chad heard about the arrangement, his entrepeneurial instincts took hold. He immediately arranged a meeting with the doctor. He found out that the doctor arranged about 500 such arrangements. By doing so, patients received most basic health services cheaply. They could still get catastrophic health care coverage and that would be at a reasonable rate. Meanwhile, the doctor had unshackled himself from the bureaucracy of the insurance companies, at least with these 500 patients. He no longer needed to have basic procedures approved by an insurance bureaucrat. He no longer had to send in mountains of bills to insurance companies and carry a collections department to make sure the bills were paid.

What eventually was born was No Insurance Club. It creates an internet market place where patients and doctors come together and prices for basic medical care is transparent. Harris saw an inefficiency in the market. He said that three people could be in the same doctor's office at the same time for the same procedure and each be charged a different price. That's because each insurance company negotiates prices with the doctors separately. So, a routine check up might cost $100 with one company and $200 with another.

With No Insurance Club, doctors' services would be transparent and available for all consumers to see. Harris exploited another inefficiency in the market. There is no car insurance policy in which your oil change, tire reallignment, and tune up is covered. Instead, what is covered is damage you can't afford on your own. Yet, with health insurance, we have plans that cover every sngle medical procedure. This creates out of control medical costs. That's because it creates waste, excess administration, and it forces doctors to go to insurance company for permission to run nearly every single medical procedure.

So, if you could set up a system where most basic medical procedures can be provided outside the insurance system, you could contain costs. That's what No Insurance Club does. Doctors provide basic sets of services. Patients pay No Insurance Club and they receive most basic services. The payments, ranging from $499-$899 yearly, are much cheaper than most insurance. There's no more dealing with insurance bureaucracy, billing codes, and administrators. This puts the patients and the doctors right in front of each other.

Finally because No Insurance Club is NOT insurance, they can sell their services in multiple states. (they're currently in ten states) So, effectively, No Insurance Company, on its own, accomplishes everything that President Obama claims to want to accomplish and NO tax payer money is used. Costs are lowered. Costs are affordable. Insurance bureaucrats are no longer in charge.

Now, I don't want anyone to think that I am simply promoting No Insurance Club, and I get nothing for this story. The reason that I set all this up is that ironically enough, if HR 3200 passes No Insurance Club goes away. That's because HR 3200 would force everyone to get all the services that No Insurance Club provides to be mandated under some sort of a health insurance plan.

In fact, No Insurance Club and President Obama see the same problem and come up with two different solutions. Harris is an entrepeneur. He believes health care costs are out of control, health insurance is structured all wrong, and as such, costs are not transparent. As such, he has created a company that will exploit all those inefficiencies. That's what entrepeneurs do. That's what the free market provides. President Obama is a politician and he sees the exact same problem. He believes that government regulation and control will solve it.

Isn't it ironic though that a bill that supposedly expands choice would immediately take away this particular choice. I don't know if No Insurance Club will blow up and become a major player in health care. As I told Harris, it sounds like a good idea but the market place is full of good ideas. It's all about execution. I do know that No Insurance Club is an example of the free market allowing for opportunities to exploit inefficiencies to benefit both the entrepeneur and the consumer.

I think there's a certain irony here. President Obama wants the government to regulate and control because he thinks that leaving the free market to its own devices wouldn't produce the necessary reforms to bring down costs. Yet, No Insurance Club is proof that he's wrong. No Insurance Club is a consummate free market idea. Yet, this free market idea would be eliminated by a government hell bent on trying to solve the exact same problem that No Insurance Club. By imposing HR 3200, No Insurance Club would not survive. All its services would be mandated under a gold plated health insurance plan. That's because President Obama believes that preventative medicine is far too important and so everyone must have preventative medicine covered under insurance. He can't imagine that the free market could possibly create an alternative that would accomplish the same thing. So, unbeknownst to him, his plan would eliminate No Insurance Club which attempts to do the same basic thing as he is. One uses the free market. One tries to impose it by government decree. Which do you believe in?

Democrats Infight...Blame Republicans

Try and figure this out. If the health care legislation currently being debated has the public option, then the Democrats will lose most of the 52 Blue Dogs and most of the 15 moderate Democrats in the Senate. If it doesn't have the public option, then Democrats will lose most of its liberal wing. Either way, the Democrats can't put together a bill that will have enough votes to pass. Now, that sounds to me like a problem that affects Democrats and Democrats only. In fact, with 60 votes in the Senate and 256 in the House, the Democrats have no one to blame but themselves for not passing any legislation. They have enough votes to create a sort of Parlimentary majority. (by parliamentary I mean like the British parliament where the ruling party passes its entire agenda and when something doesn't pass that's a no confidence vote)

The Democrats can bemoan and cry about the Republicans refusal to get on board, but all of it is nonsense. First, they don't need Republicans to get on board. Second, if they had a bill that the people wanted, they wouldn't care if Republicans were on board. Third, and most importantly, if they wanted a bi partisan bill, why is the bill they have crafted so liberal. It's 1017 pages. It has 53 new bureaucracies. It expands Medicaid and Medicare. It includes business and individual tax increases. It doesn't include health savings accounts. It doesn't allow for health insurance to cross state lines. It has no tort reform. Just think about that for a minute. The Democrats craft a bill with every liberal fantasy and allow for no conservative ideas, and then bemoan the Republicans' lack of bi partisanship.

Yet, that's exactly what they are doing.

President Obama sharply criticized Republicans on Tuesday for following a “familiar script” to “block healthcare reform.”The president, seeking to prod the Democratic-controlled Congress to show significant progress on healthcare reform before the August recess, directed blame at the GOP for the stalled legislation.Obama blasted the "familiar script" of Republicans who "have openly declared their intention to block healthcare reform."

Here's Harry Reid.

On something as important as health care you would think people would be interested in working together,” Reid told reporters Tuesday. “Republicans aren’t interested in working with Democrats. That’s pretty clear.”

Here's Nancy Pelosi.

House Speaker Nancy (D-Calif.) told a small group of reporters Wednesday that the GOP, whatever its policy concerns, was intent on blocking health care reform out of fear that it will give a generational boost to the Democratic Party.

Pelosi, in painting the debate in starkly political terms, was careful to say clearly that it was the Republican Party that did so first. But underlying her remarks is a belief held by many in both parties that if Democrats can pass health care legislation that expands coverage and brings down cost they can lock up the majority for years to come, much as the party did after implementing the New Deal reforms.

And..

Democrats should remember that as they go it alone on health care reform. It should be obvious by now that Republicans are bent on sabotage.

The last straw was Iowa Sen. Chuck Grassley's giving credence to the "death panel"
nonsense. (Grassley was supposed to be one of the reasonable Republican negotiators.) Party leaders just shot down the idea of consumer-run insurance co-ops, designed to appease Republicans as an alternative to the public option.

Every compromise President Obama offered in the name of bipartisanship was read as a sign of weakness. For Republicans, sticking it to the Democrats trumps doing what's good for the country. The heck with them.

Think about the irony of someone saying "the Republicans are bent on sabotage" then bemoaning Grassley as saying "nonsense". To the Democrats and their allies, a compromise from government run health care known as the "public option" is pseudo government run health care known as Co Ops.

And...

Given the heinous dust that's been raised, it seems likely that end-of-life counseling will be dropped from the health-reform legislation. But that's a small point, compared with the larger issue that has clouded this summer: How can you sustain a democracy if one of the two major political parties has been overrun by nihilists? And another question: How can you maintain the illusion of journalistic impartiality when one of the political parties has jumped the shark?

There's more. Here's a commentary from my local Sun Times.

Faced with strident and at times destructive resistance from Republican leaders, particularly in the last few weeks, top Democrats are looking inward.

The Democrats can reform health care without significant Republican help, and we urge them to go for it.

With 47 million Americans uninsured, and health-care costs expected to account for one out of every four dollars in our national economy by 2025, reform cannot wait. That means forging ahead with Democrats, who represent a range of views on how best to improve our health-care system, including an element that rejects a publicly run health plan, or public option.

It also means rejecting any bill that, in the name of winning a few token Republican votes, is so watered down that it's not worth doing -- the likely outcome if Obama continues to seek the holy grail of bipartisanship.

This sort of delusional revisionism is stunning. There is delicious irony in pundits and presidents demonizing the other side with explosive language and then bemoaning the fact that the other party uses explosive language to block health care. Are all these folks really lacking this much self awareness? The reason that health care is still not law has nothing to do with the Republicans. It's because the Democrats spent months fighting amongst themselves. They finally got a draft in the House and the Blue Dogs freaked out and demanded that no final vote be taken until after the break. The Republicans have nothing to do with this.

The idea that the Democrats will be "looking inward" is fantasy. They've been looking inward and they can't find a consensus. In mortgages, something like this happens all the time. Things blow up and everyone points fingers at everyone but themselves. The president can't craft a bill that will pass and so it's everyone's fault but the president himself. It's the "misinformation". It's the Republican's " strident and destructive opposition". It's the fact that it's just so complicated. Of course, it's so complicated because it's a radical change in health care.

Now, I will say that there a few Democrats and liberal pundits that admit what is obvious to everyone besides the Democrats, that most of the fault lies in the president and the Democratic leadership. Still, it's hard to find any Democrat not follow that up with talking points about how Republicans are slowing this process down for political purposes. This sort of propaganda doesn't really work and so I suggest the Democrats act like adults, something rarely seen in politics, and accept responsibility for the mess they created.

Free Market or Government Rationing

With the specter of government rationing provided in the health care bill, many liberals have taken to pointing out that we already have rationing today. They are absolutely correct. In fact, economics, by nature, is all about rationing. Economics figures out how the production of goods and services are distributed with the limited resources of the world. In fact, life is all about rationing. If it weren't, I would be writing this piece from some tropical island in Hawaii off my 50000 square foot cruiser. I am not because I can't afford that. So, of course liberals are right. The free market rations health care right now. The lates liberal to make this argument is Fromma Harrop in this piece.

Death panels"? I'll tell you about death panels. My husband faced one some years ago, and it didn't involve any government bureaucrat. It was run by our private insurer, the sort of corporate entity that foes of health care reform say will give you anything you want.

My husband was diagnosed with liver cancer. We were "insured" by United Healthcare. The deal was as follows: You had to use doctors on its list, but if you needed specialized care outside the network, United's health-maintenance organization would pay for it. Fair enough.

A liver expert within the network said point blank that for my husband's case, there was but one place to go, a specialized chemotherapy program at Deaconess Hospital in Boston. Fortunately, it was only 50 minutes away.

In fact, we've all heard stories of insurance companies denying treatment for many reasons. In fact, President Obama famously tells the story of his mother. In that story, his mother battled with the insurance company all while lying on her death bed. Frankly, if insurance companies are gaming the system, there are ways to fix that. No matter what there will be rationing. Donald Trump will always receive better health care than a garbage man. That's because like everything health care is a limited resource. As such, it must be doled out based on its limitations. That's the nature of economics, but that doesn't mean that government rationing is suddenly all right or better.

Of course, there's a huge difference between an insurance company rationing your care and the government. You can always choose another insurance company. What happens when the government decides your care is not cost effective?

When you choose an insurance company, you enter into an agreement. When the government rations your care, that's then by governmental fiat. We'd all like to see insurance companies pay for their insured's treatment when they are sick, however those are business decisions made with their own money. The government is working with someone else's money.

More than that, insurance companies work in a market. If they cut people off far too often, they get a bad reputation and they don't get new customers. Personally, I believe that insurance companies pull these stunts far too often because there isn't enough competition. That insurance isn't sold across state lines is, in my opinion, a major contributing factor to the explosion insurance companies cutting off payments at the worst times. That's because their ability to create regional monopolies create a market place that is frankly something much less than a real market.

Of course, if the government is the final arbitor that is a true monopoly. Unelected bureaucrats are answerable to no one. Insurance companies are answerable to the insured they cover. Of course, the market rations health care right now. Economies ration everything right now and all the time. That's how economies work. The question is do we want the purity of the market to ration or a government bureaucrat.

Taking Stock of the Economy

Over the last four weeks or so almost all major corporations announced their earnings, the second quarter GDP came out, and July's employment numbers came out. There's a lot to view positively about the numbers, however there is also still plenty of work to be done.

Of the 500 companies on the S&P 500 about three in four either beat or matched their earnings estimates. That's great, however there's a few things to keep in mind. First, the first quarter of this year was one of the most awful in the last 30 years. Our economy contracted by 6.4% and the earnings in that quarter and the earnings of all these companies reflected that. So, estimates for the second quarter were based in some part on just how bad the first quarter was. So, while a lot of companies beat their earnings estimates, they were beating fairly conservative estimates for the most part. Since this quarter was better than expected, estimates going forward will reflect that. If earnings continue to beat estimates in Q3, then we are seeing a very positive trend. Now, we should all be cautiously optimistic.

The most significantly positive news was the second quarter Gross Domestic Product number. The economy only contracted by 1%. I say only because estimates were a contraction of 1.5%. Furthermore, given that the economy contracted by 6.4% in the quarter previous, that's a massive improvement. Now, this marked the fourth quarter in a row of contraction. That was once a definition of a depression though most economists no longer hold to that strict definition. It's also the six straight quarter of below par economic growth. It's very possible that the economy will actually grow in the third quarter as the Fed has predicted. That of course doesn't mean we are out of the woods at all. When an economy goes through this severe a contraction, it needs a serious jolt before we'll all feel out of the recession. The economy will either need to grow by 5% or more in a given quarter or it will need sustained, four or more quarters, of 3+% growth.

We are still a long way away from that. If the economy grows toward the end of the year, the president will use that to boost his popularity. It will no doubt be a good sign if the economy grows slightly like 1%, and certainly better than continued contraction. Still, the final verdict on our economic recovery is still a long ways off. I personally believe that the massive borrowing will stunt the recovery and keep the economy from growing at the pace necessary to make up for the sustained contraction. Whether I'll be proven right or wrong is still at least a year off.

Finally, we had the July unemployment numbers. There was a lot to get excited about there also. First, these were the best numbers in almost a year. The economy only lost 247,000. I say only because not only did it beat estimates, but again, it was the best number since last summer. Furthermore, two troubling trends reversed themselves. Workers were working more hours this month, 33.2, than last month. Worker hours had been contracting for several months. Furthermore, wages began increasing again after a couple months of decreasing wages. Employment continues to be totally unpredictable. We've gone from a high of 700,000 jobs lost in February down to 247,000 in July. Yet, in May were supposed to lose nearly 500,000 jobs but only lost 345,000. Meanwhile, in June were supposed to lose just more than 300,000 jobs and instead lost 460,000 jobs. The trend is definitely improving but also unpredictable. Furthermore, it's important to keep in mind that our economy needs to gain roughly 150,000 jobs in a month just to keep pace with added workforce. We've been losing about 350,000 jobs for nearly two years. 250,000 lost jobs represents a 400,000 shortfall still. It's still at least a year before we are just gaining enough jobs to keep up with added workforce. In the meantime, we are almost certain to see double digit unemployment.

Finally, the news is not all good. Both oil and interest rates have risen in response to all this good economic news. Both can have corrosive effects on the recovery. Oil is now trading at near $72 a barrel. A hundred dollars a barrel represents somewhere between $3.25-$3.50 a gallon gasoline. In fact, lately consumer spending has gone up nearly entirely because of increased gas prices. We aren't going to have much of a recovery if everyone is paying $3.50 a gallon to fill up their tank. Meanwhile, interest rates have also risen since many of these positive economic numbers have materialized. The 30 year mortgage is back above 5.5%. The ten year U.S. Treasury Bond is approaching highs over the las twelve months. Unfortunately, massive borrowing has weakened the dollar and put upward pressure on all rates and thus contributes to both. Those are two of many reasons why I believe that the president's massive borrowing scheme will ultimately doom this recovery.

Finally, everyone wants to take credit for the recent spat of economic numbers. The president has proclaimed that his stimulus has contributed to bringing the economy back from the brink. White House adviser Christina Romer even proclaimed that the President's recovery package added 2% to the GDP. This is of course a statement that can't possibly be proven and so it's good only for political posturing. It's hard to see how the recovery plan played much of a role given that most of it is still not spent. Some argue that the prospect of government spending helps create confidence, however we didn't see the same "confidence" when the Fed brought rates to zero. Ultimately, no one will ever know what did what. We'll never know if it was the stimulus, the Fed, or if the economy simply recovered on its own. (despite what some pols will tell you economies have cylces and after a bust there is a recovery and that's actually natural)

All that we can guage now is that this economic recession will be somewhere between the one in the early 1980's and the one in the 1930's. How close to each is still to be determined.

Some Perspective on GDP Growth and the W Shaped Recovery

Here is a chart of GDP growth from 1929-1940.

Now, if you just looked at the years 1933-1940 you might not even know that we were in a depression. In fact, from the period of 1933-1940 unemployment never reached single digits. In fact, by 1938 unemployment was still at 19%. GDP growth was solid all the way from 1933-1937. Of course, in order to recover from the economic contraction of 1929-1932, it was going to take more than merely "solid" growth. That's why despite what looked like solid GDP growth all throughout the Presidency of FDR we continued in a depression.

Under Reagan's term, Reagan came in with an economic contraction that wasn't nearly as dramatic but still intense. In fact, the second quarter of 1980 saw the economy contract by 10.2%. It dipped another 5.7% and 5.6% in the last quarter of 1981 and the first quarter of 1982. So, it wasn't going to take a solid economic growth to get the economy out of that recession. In the second quarter of 1983 that's exactly what happened. The economy grew by 10.2% and every quarter after that for the rest of the year the economy grew at 6% and more.

The recession of 2001 was even more mild. The economy never even contracted. Instead, it barely grew in 2001 (.02%) and grew somewhat slowly in 2002 (1.9%). By 2003, the economy was growing at 3.7% and we entered a four year period of not economic properity.

We'll have no such luxuries this time. Here are the last six quarterly GDP growth numbers -1%, -6.4%, -5.4%, -2.7%, +1.5%, and -.7%. Now if 2.5% GDP growth is enough to keep an economy growing at a decent or C average pace, and we've lost an average of 2.6% over the last six quarters, then the economy would need to grow by just over 5% over the next six quarters just to get us back to normal.

Now, Fed Chairman Ben Bernanke believes that the economy will start to grow the next quarter of the final quarter of 2009. That's when the real work will begin for the economy. The economy will need some remarkable growth in the next six quarters in order to usher in a recovery.

That's when all the new debts the government has taken on will become an albatross. If the economy were to show that kind of recovery, then that would create higher interest rates. That's when all the deficits that we've built up not only over the last six months but the last eight years and more will kick in. Either remarkable growth will lead to massive inflation or it will lead to higher interest rates that will stunt the recovery and a W shaped recovery. So, we still have plenty of potential pitfalls in front of us and there are no good options.

The Velocity of Money and the Chatham Walmart Proposal

I have spoken on more than one occasion about the velocity of money. The velocity of money is essentially how many times a given dollar is spent during a fixed time period. During periods of economic contraction, like now, velocity of money is low. That's because people are scared and they hoard every dollar they can get their hands on. In my opinion, the key to any stimulation is to increase the velocity of money. Once velocity of money increases the economy will recover.

Right now, Walmart is sitting on tens of millions of dollars that the company has earmarked to build and operate a store in the Chatham neighborhood of Chicago. If that store is given the go ahead to get built, Walmart will immediately sign several project managers. That team will move forward with acquiring all appropriate permits. Once those are secured, Walmart will break ground on a 150,000 square foot superstore. Building this project will require hiring about 500 UNION contractors, construction workers, electricians, plumbers, etc. Those companies will have to buy equipment, parts, and material. The folks hired will have to get to work somehow. They will have to eat lunch in the area.

Then, once the store is built, there will be 400 people hired to operate it. It will sell everything under the sun and will attract thousands of shoppers daily. Now, let's think about this. The current scenario has Walmart's money sitting in a bank account. How quick is the velocity of money in that scenario? The second scenario has that money being spent on labor, parts, equipment, etc. It is a scenario in which those hired will themselves need to buy parts and equipment. It will mean that 400 people currently sitting at home will be going to a job everyday. They will either drive costing gas or take public transportation putting money into the coffers of the city. In either scenario, they will be spending more money than they are now as well as receiving a paycheck.

I haven't even begun to discuss the velocity of money created once the store is built. There will be electricity, gas, and water bills that will all be paid. There will be 500 new paychecks to receive. All those people will need to come to work. So, they will spend money on either gas or public transportation. (unless they walk which some will) With more money in their pockets, these employees will spend more money on things they need and want. I haven't even mentioned the enormous velocity of money created by Walmart increasing their orders of goods to stock the store and then having those goods get bought.

The velocity of money increase in building and operating this Walmart superstore is exponential. Tens of thousands of businesses and individuals will see business transactions in crease as a result of it being built and operated. Instead, right now, only two entities see any transactions, Walmart and the bank their money is at.

It sounds so simple. What the city, and country, need right now is to increase the velocity of money. We need people to spend and invest more. That's what this Walmart proposal would do, and it would do it in an enormous way. Unfortunately, a theoretical increase in the velocity of money does nothing. So, until the politicians in Chicago brush up on their economics, the velocity of money that this Chatham store would provide won't happen.

The Confusion of Paul Krugman

The only reason that I write about Paul Krugman as often as I do is because I am stunned and amazed that this individual is not only a New York Times columnist but an economics professor at Princeton, not to mention a Nobel Prize winner. It appears tha multiple institutions are willing to pay this man hundreds of thousands of dollars yearly to speak in gibberish. About a month ago, Krugman blamed some obscure law created in the Reagan administration for the current financial crisis. In fact, Krugman is determined to do everything he can to try and muddy Reagan's record for years.

It's also important to understand that universal health care, in its current House form, is a pillar in Krugman's big government liberal vision. This is, after all, the same Paul Krugman that screamed and yelled that the stimulus wasn't big enough. He suggested a stimulus as large as $5 trillion to turn the economy around. Krugman is a true believer Keynesian. Krugman is also a classic liberal that believes the U.S. should become an exact replica of most of Western Europe.

So, Obama's health care reform would be a major pillar in Krugman's dreams of seeing the U.S. turn into a socialist Democracy like France. The problem is that the Blue Dogs have stopped it in its tracks just as it was on the verge of passing. Krugman simply can't imagine that someone, especially a Democrat, could possibly be against his vision of health care reform, and so, naturally, he thinks the Blue Dogs are confused. Of course, what's really confusing is his attack on the Blue Dogs. First, Krugman starts with the four pillars of health care reform: regulation, mandates, subsidies, and competition. Now, if these are the four pillars, everyone must have been keeping them under wraps because this is the first that these four have been referenced together.

Obama has said the pillars are everyone is covered, costs get curbed, and no increase to the deficit. Obama's pillars are statements of purpose. Krugman's pillars are statements of policy. So, the first question is why are the four pillars Krugman references the key to successful health care reform. On top of this, Krugman has a peculiar view of these policies. \Krugman's idea of "competition", for instance, is the inclusion of the public option into the health insurance market. Our country already has over 1300 health insurance companies and yet Krugman never explains how one more will suddenly be the key to competition.Krugman doesn't even address that because he just assumes that his vision is right.

Krugman then acknowledges that health care reform will cost a trillion dollars over the next ten years, raise taxes, and then mentions there will be savings elsewhere to cover some of the shortfall. Then, he chastises the Blue Dogs for being concerned not only with the massive bill but with some of the ways that this bill will be paid. What Krugman never squares is how the same bill can increase costs by one trillion dollars over the next ten years and still be cost effective. Krugman doesn't seem to realize that if a bill costs a trillion dollars over the next ten years it isn't cost effective.

First, Krugman calls the Blue Dogs hypocrites for not speaking out on run away spending back in 2001 when the Republicans were in charge. This is turning into a worn out and boring attack. No matter who proclaims that we have too much government spending is immediately taken to the woodshed because they weren't this vocal eight years ago. As Bill O'Reilly likes to say, that is excusing bad behavior by pointing to worse bad behavior. If no one is allowed to question runaway spending now unless they also questioned it in 2001, then no one will question it and our government will spend with absolutely no limits. He also proclaims that these deficit hawks signed onto a $1.35 trillion tax cut which he claims added $1.35 trillion to the deficit. Of course, that's nonsense. Governmnet revenue increased by 20% in Bush's term. What added to the deficit was runaway spending. Though, Krugman's disgust for allowing people to keep more of their money is evident in that statement.

Then, Krugman can't seem to understand why the Blue Dogs are worried that the House bill forces almost all businesses to provide health insurance for their employees.

But Blue Dogs have also been complaining about the employer mandate, which is even more at odds with their supposed concern about spending. The Congressional Budget Office has already weighed in on this issue: without an employer mandate, health care reform would be undermined as many companies dropped their existing insurance plans, forcing workers to seek federal aid — and causing the cost of subsidies to balloon. It makes no sense at all to complain about the cost of subsidies and at the same time oppose an employer mandate.

So what do the Blue Dogs want?

Maybe they’re just being complete hypocrites. It’s worth remembering the history of one of the Blue Dog Coalition’s founders: former Representative Billy Tauzin of Louisiana. Mr. Tauzin switched to the Republicans soon after the group’s creation; eight years later he pushed through the 2003 Medicare Modernization Act, a deeply irresponsible bill that included huge giveaways to drug and insurance companies. And then he left Congress to become, yes, the lavishly paid president of PhRMA, the pharmaceutical industry lobby.

So, of course, Krugman thinks that anyone that takes a position opposite of his must be a tool of corporate interests. I don't know the CBO study he references but there are other reasons besides government revenue to oppose mandating that all employers have to provide health insurance for their employees. For one, this is a massive burden for small business owners and will likely cost millions of jobs. For another, this is a massive intrusion on freedom. Neither of those reasons necessarily have anything to do with being a tool of corporate interests. Krugman finishes the piece with this point.

Now, however, they face their moment of truth. For they can’t extract major concessions on the shape of health care reform without dooming the whole project: knock away any of the four main pillars of reform, and the whole thing will collapse — and probably take the Obama presidency down with it.

Is that what the Blue Dogs really want to see happen? We’ll soon find out.

Of course, that's both correct and misleading. The Blue Dogs have a fundamental problem with the vision of health care reform that President Obama has. They don't believe it limits costs, encourages competition, and won't add hundreds of billions to the deficit. If the only health care reform is Obama's health care reform, then, yes, they do want to kill it. They have a totally different vision for health care reform. It would focus on moving away from employer sponsored health care, tort reform, and attacking corruption and waste. That, apparently, is something that Krugman can't imagine because, apparently, the only vision for health care reform is Krugman's vision for health care reform.

CIT and the Corrosive Power of Moral Hazards

Most folks have never heard of the CIT Group. It's like that even now you haven't heard of the commercial lending and financial services firm. It's likely that over the next couple weeks you will hear a lot about this company. CIT Group is now struggling just to survive. They have about a billion dollars worth of bonds due, and they simply don't have enough capital available to cover the due date.

CIT has a $1 billion payment due in mid-August and it is unclear the company "will be able to handle that," said this person. The company will give more guidance when it discusses second quarter earnings in two weeks.

CIT declined to comment on whether it was preparing a filing or why it had retained Skadden Arps. But if CIT did file, the consequences could be considerable, because the 101-year-old company, as of March 31, had $68 billion of liabilities.

So, with a month to go before the due date, CIT appears to be doing whatever company and government is doing these days. They are coming hat in hand in begging the government for help.

CIT Group Inc. rose in New York trading and the cost to protect its debt against default fell after the lender said it’s in talks with regulators about a rescue.

The lender’s stock jumped 36 cents, or 27 percent, to $1.71 at 9:42 a.m. in New York Stock Exchange composite trading, boosted by CIT’s statement that it was in “active
discussions” with regulators about federal aid. CIT has $1 billion of bonds maturing next month, and the firm so far has been unable to persuade the U.S. to back its debt sales. Those talks continued yesterday, said Curt Ritter, a CIT spokesman.

Furthermore, CIT is framing their need in the context that their failure would send ripples through not only the financial system but our economy as a whole.

The collapse of the company, run by Chairman and Chief Executive Officer Jeffrey Peek, would put 760 manufacturing clients at risk of failure and “precipitate a crisis” for as many as 300,000 retailers, CIT said in internal documents obtained by Bloomberg News.

It would also be the biggest bank failure measured by assets since regulators seized Washington Mutual Inc. in September. CIT reported $75.7 billion in assets and $68.2 billion in liabilities, including $3 billion in deposits, at the end of the first quarter

.

Does this sound familiar? It should. It's what we heard from an entire banking system back in October before we passed TARP. It's what we heard at the end of the year from GM and Chrysler when they were also on the verge of collapse. Do you remember CEO's of GM and Chrysler proclaiming that their failure would lead to the failure of thousands of suppliers? Doesn't that sound an awful lot like the argument made by CIT? In effect, like other banks, GM, Chrysler, and California, CIT is essentially arguing that they are too big to fail. It's roughly the same sob story that California is still using in hopes that the Federal government will back their debt. (so far they're the only ones that have been unsuccessful) Every industry from manufacturing, news, and small businesses have been mentioned as those deserving bailouts because their survival is necessary to the economy.

I have spoken often of the concept of moral hazard.

Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. In insurance, moral hazard that occurs without conscious or malicious action is called morale hazard.

Now, we'll never know why CIT, just a month before doom, now suddenly is begging the government for a bailout. In fact, I posed that very question to the author of the Bloomberg piece, Pierre Paulden, and he correctly pointed out that this would require that he speculate about someone else's thought process.

Yet, it's without a doubt that CIT continues a very troubling patter. Companies and even governments take on too much risk, too much debt, and then wait until the last minute to figure out what to do. Then, immediately come to the federal government for bailout. Furthermore, company and other entities continue another pattern. They frame their bailout as necessary because their failure, CIT, GM, California, would send a ripple effect throughout the economy. If large corporations and states get the idea that their scope can strong arm and extort the federal government into bailouts because they are deemed "vital to the economy", that's the very definition of a "moral hazard". We'll never know if that's what happened in the case of CIT. We can only say that this case has all the characteristics of moral hazard. We can, further, say that critics of TARP and bailouts predicted just such scenarios in opposing them.

The Case for Regulation (Not Deregulation) Causing the Financial Crisis

Introduction: In response to a comment, I want to make it clear that I don't blame regulation exclusively for the crisis. The crisis is a confluence of events. Here is my thesis. The reason for this piece is NOT to claim that regulation is the cause. More than that, as our policy makers debate new regulations, I want to point out how prior regulation turned counter productive as a frame for future regulations.

...

Right after the mortgage crisis occurred, I bet most of the layman in the country got a quick lesson in the complicated nature that is our mortgage market. For instance, I'm sure that most folks thought that the banks that approved your loans also were the ones that kept them and made money on them. That's not so in the majority of cases because of a process known as mortgage securitization. In this process, a financial firm bundles hundreds, thousands, and even tens of thousands of loans together turn them into bonds and sell them on trading markets. We've learned that those that securitized often put far too many risky loans together with less risky loans. In fact, we've learned that credit cards were bundled together with loans. We've learned that there was so much excess in loan securitization that it was really nearly impossible to measure just how risky the end bundled products were.

Here's a question very few people have asked. Why would banks need to sell these loans so that someone else could securitize them? The process of securitization has all sorts of positive effects in the market. For instance, it keeps banks liquid so that they have more money to lend to new people. Without securitization, a lot less people would qualify for loans. It also spreads interest rate risk. Finally, it takes advantage of economies of scale to create lower rates.

So, why wouldn't banks merely securitize the loans themselves and turn them into bonds? After all, banks are sophisticated financial institutions with plenty of capital. The reason lies in a law first created in response to the depression, the Glass Steagall Act. This was a sweeping piece of legislation but the pertinent portion, for this discussion, mandated that there be a wall between commercial banks and investment banks. As such, if a bank lent money, it couldn't also be involved in investment activities, like mortgage securitization.

The irony is that at the time of the act there was no such thing as mortgage securitization. That wasn't created until later first by Congress itself through the creation of Fannie Mae, and later Freddie Mac, and then by Lew Ranieri, through Mortgage Backed Securities. Here's the logic behind this portion of the act.

In the nineteenth and early twentieth centuries, bankers and brokers were sometimes indistinguishable. Then, in the Great Depression after 1929, Congress examined the mixing of the “commercial” and “investment” banking industries that occurred in the 1920s. Hearings revealed conflicts of interest and fraud in some banking institutions’ securities activities. A formidable barrier to the mixing of these activities was then set up by the Glass Steagall Act.

Regulations often have a way of solving one problem by merely creating another one. Yes, there was fraud and conflicts in banks that did many different activities all at once. Yet, as financial products became more sophisticated, Glass Steagall forced multiple financial institutions to work together to create these sophisticated products. Glass Steagall was ironically enough repealed largely in 1999, but by then, our system of financial lending and securitization had already been designed and functioning in a manner that responded to the original Glass Steagall legislation.

Think of this as the story I tell you, you tell your friend, and so on. What started as me going to the ball game winds up as me partying with twelve strippers. It's the same thing here. Because sophisticated financial products had to pass through so many hands in order to comply with Glass Steagall, the end product was a perversion of what was meant to be created. Because one entity would underwrite the loans and another would securitize and package the loans, this made it much easier for the end product to pervert itself from its desired effect. These securitizers would often buy loans, credit card portfolios, and other debt instruments from many banks all at once. Then, they would be mixed and matched into a financial instrument who's risk was difficult to determine.

That would have been a lot less likely if the same bank that underwrote the loan was also the one that securitized the loan. Yet, it was government regulation that forced this to not be an option. First, Glass Steagall created a barrier between banks and securitizers. This forced an extra layer of financial firms in the process. Then, the creation of Fannie/Freddie meant that two securitizers would dominate the prime market. Ultimately, it was this layering of the creation of the financial product that contributed to the system's downfall much more than any supposed deregulation.

What is Stimulus

Conservatives are working themselves up into a lather over two stories today. The first came from testimony from Ed Rendell's testimony on Capitol Hill.

I would like to see a second stimulus devoted solely to infrastructure," he said. "It's what produces jobs, and produces orders for factories, American factories."

...

Look, I think the stimulus bill was misnamed," he said. "Part of it was stimulus, part of it was job creation, but a lot of it was relief," such as increased unemployment insurance and food stamps.

Rendell suggested that a second stimulus creating more infrastructure projects can lead more directly to jobs.

The seccond came from the Government Accountability Office's report on the stimulus.

GAO estimates that the Treasury Department has paid out approximately $29 billion to states and cities so far this year, about 60 percent of payments estimated for fiscal year 2009, which ends Sept. 30.

Of that total, most of the funds paid out to states have come from increased Medicare and Education Department grants to state governments.

But the most visible demonstration of stimulus funding is on American roads. As of June 25, the Transportation Department had paid out $15.9 billion for more than 5,000 projects nationwide. Most of that money has been put towards road reconstruction and pavement projects.

Now, anyone that is upset about this NOW shouldn't be. That's because the president always intended to have stimulus dollars for such things as unemployment payments, Medicare, and food stamps. In fact, there are plenty of liberals out there that think we need to do more of this.

The stimulus package the president signed soon after taking office did provide extended benefits, and boosted weekly payments. But even that extension runs out on Dec. 26, and would not apply to all the unemployed. Does anyone really believe that a significant portion of the unemployed will have found new work by then? Hardly. Both private and government economists now predict that unemployment will continue to rise at least through the end of this year.

"We can't ignore this moment when all these folks are running out (of benefits)," says Maurice Emsellem of the National Employment Law Project. "That needs to be a top priority, to help these workers."

Let's stop kidding ourselves. In no contemporary economic crisis -- not even those that unfolded on the Republicans' watch -- has Congress left the unemployed completely in the lurch. So some sort of spending package -- call it stimulus, call it stopgap emergency aid, whatever works -- is going to have to be passed.

The president would argue that putting money into the pockets of the unemployed allows them to pay their rent, buy food, etc. and all of that stimulates the economy. After all, if the unemployed can't pay their rent, the landlord also suffers. The president would argue that if states don't pay their Medicare bills, then hospitals aren't paid their bills and doctors and nurses would have to get laid off. So, in the view of the White House, why isn't fully funding food stamps, unemployment and Medicare stimulus?

In fact, economists will argue till the end of time what exactly will and will NOT stimulate an economy. I believe that it's anything that increases the velocity of money.

The velocity of money is the average frequency with which a unit of money is spent in a specific period of time. Velocity associates the amount of economic activity associated with a given money supply. When the period is understood, the velocity may be present as a pure number; otherwise it should be given as a pure number over time. In the equation of exchange, velocity of money is one of the key variables determining inflation.

During any recession, money isn't filtered through the economy quickly enough. The key to stimulus is to get money to move faster. You need to get those with money to spend and invest it more quickly.

Well, the first thing we know is that government spends money very slowly. After all, the stimulus is nearly six months old and the government has managed not to even spend $100 billion of the $787 billion that was earmarked. Furthermore, poor people already live pay check to pay check, and spend every penny they get their hands on. So, unless you make poor people wealthy, you aren't going to increase the velocity of money.

In fact, increasing the velocity of money is as much a psychological skill as it is an economic one. The people, en masse, need to feel better about the future so they spend and invest more. The best way to do that is to have them keep more of their own money. That includes corporations and small businesses.

Just imagine a $50k a year teacher keeping an extra $150 monthy. Whether it comes from a raise or simply a tax cut, that teacher will feel more comfortable about all their finances. Those are the folks that start a college fund for their kids, finally buy that new car, etc. The same is true only a bigger scale for corporations and small businesses. How much better does a corporation feel when they know that they would keep an extra $100 million this year? Those are the corporations that hire on new people and expand. It's those activities that increase the velocity of money. Put more money into the hands of the productive among us and watch the velocity of money expand.

It's All Reagan's Fault?

Paul Krugman continues his one man assault on the legacy of Ronald Reagan with a column today that essentially blames the entire financial meltdown on one obscure law passed during the Reagan era, the Garn-St. Germain Depository Institutions Act of 1982. This is an act that essentially deregulated S&L's and was one factor in their eventual demise in the late 1980's. Now, Krugman purports to blame this very same act on the current crisis. Now, I was very skeptical of Conservatives blaming the Community Reinvestment Act for the crisis. It's very rare that an obscure law actually creates this much damage. That's because if it did, we would have heard of it long before. Krugman attempts to do the same thing here. Here is some of his thesis.

The immediate effect of Garn-St. Germain, as I said, was to turn the thrifts from a problem into a catastrophe. The S.& L. crisis has been written out of the Reagan hagiography, but the fact is that deregulation in effect gave the industry — whose deposits were federally insured — a license to gamble with taxpayers’ money, at best, or simply to loot it, at worst. By the time the government closed the books on the affair, taxpayers had lost $130 billion, back when that was a lot of money.

But there was also a longer-term effect. Reagan-era legislative changes essentially ended New Deal restrictions on mortgage lending — restrictions that, in particular, limited the ability of families to buy homes without putting a significant amount of money down.

These restrictions were put in place in the 1930s by political leaders who had just experienced a terrible financial crisis, and were trying to prevent another. But by 1980 the memory of the Depression had faded. Government, declared Reagan, is the problem, not the solution; the magic of the marketplace must be set free. And so the precautionary rules were scrapped.

Here, Krugman, the economist, simply doesn't know his economic history. He purports to blame this act for the explosion of such aggressive loans as no money down loans. Of course, this is totally baseless. First, FHA has always been around and it always required only 3% down. Second, sub prime had been around long before this act. The explosion of sub prime had to do with a man named Lew Ranieri who created and innovated the process of mortgage securitization. This lead directly to mortgage backed securities. Please note, I don't blame Ranieri for this crisis anymore than I blame Reagan.

Second, sub prime was always a place where folks could go to for little and no money down loans. Remember, sub prime offered significantly higher rates. As such, there had to be something that it offered to attract business. One of those things was the ability to put little or no money down.

When I first entered mortgages, no money down sub prime loans were fairly popular. They were also carefully contructed. Never could you get a no money down loan without proving income for instance. Bankruptcies, foreclosures, a lack of credit depth and far too many previous lates were often also deal killers. Also, credit scores were required to be relatively high, 660 or so.

That all changed at the end of 2003 and the beginning of 2004. From then until the end of 2006, sub prime loans became more and more aggressive and less and less restrictive to no money down loans. By the end of 2006, it was not uncommon to get a no money down loan without proving income with as low a credit score as 620.

In fact, it wasn't the explosion of no money down loans per se that created this crisis, but rather, that explosion while forgiving other risk factors. None of this had anything to do with the obscure act that Krugman is fixated with. As I have said over and over, I believe this was directly related to the Fed's lowering the Fed funds rate below one percent and keeping it there for nearly two years. This allowed banks to borrow cheaply. Real estate was the only thing moving then and so banks put a great deal of money there. Since they then had more money than loans, they wound up creating new ones.

Krugman has been on a tear against deregulation since this crisis started. Yet, Krugman mistakes one very important point. It wasn't deregulation that caused any of this to begin with. It was in fact a lack of enforcement. Most of these stated loans were done fraudulently. Fraud was always illegal. It wasn't as though the government made a new rule that allowed someone to lie about how much income they made. They didn't. They just didn't enforce this critical regulation. Had mortgage professionals faced any penalty for systematic fraud most of this wouldn't have happened. So, as Krugman goes on a tear about the evils of deregulation, he misses the point entirely. This wasn't caused by deregulation but a lack of enforcement.