Wake Up to Wake Up Walmart

If you watch enough tv, you'll soon see this commercial.



This ad paints Walmart as not only heartless but in effect taking a bailout from the tax payers. It's a remarkable accusation to make for a company that continues to enjoy billions in profits even into the teeth of the biggest recession in years.

The ad comes to this conclusion because Walmart doesn't provide health insurance benefits for all its employees. As such, the ad makes the claim that this is a bailout since those employees must then go to the government to get their health care.

Now, I am not insensitive to the idea that corporations have a responsibility to society. I don't believe that corporations can make a profit at the expense of our environment. I also don't believe that corporations should make a profit at the expense of our national security. I don't believe that corporations should make a profit by manipulating markets.

That said, private businesses must be free to make internal decisions without the pressure of outside influence. Community organizations, for instance, are fond of demanding that all retailers pay a living wage. They rarely define a "living wage" and they aren't afraid of picketing and boycotting to force retailers to pay their workers more than the corporation is willing to pay.

This is a perversion of reality. A job is not a right. A retailer has no responsibility to provide health insurance any more than a living wage. The free market takes care of that. The retailer that does the worst job of providing for their employees gets the worst employees. That's where it should be left. Walmart gets ten applications for every position so it's totally absurd to demand that they do anything more than they do already for their employees.

There's of course something more sinister at play here. The group behind these ad is the United Food and Commercial Workers International Union. Walmart is not unionized but if it were, you can bet that this group would get a large portion of the workers. That's not something that the ads reveal. This isn't so much about holding Walmart accountable for mistreating their workers, as it is a public relations campaign to convince the country their workers will only be treated right if they're organized.

I have said before that the reason that Walmart refuses to organize is because Walmart has built its business on the concept of economies of scale. Their whole entire operation is predicated on lowering costs, all costs, labor included. Unions raise costs and so Walmart has resisted the unions.

With or without the unions, Walmart has no trouble getting employees. Often, attacks on Walmart turn into little more than rank propaganda. This is just one example. For instance, on the site, there is one campaign to "stop Walmart's war on free speech" and this campaign is directly below "end Walmart's support for Glenn Beck". So, it appears to this union, free speech is a selective right.

Never have I seen a private company attacked and demonized the way that Walmart has been. Walmart isn't doing business with Iran. There's no evidence of a monopoly, polluting the environment, or manipulating markets. In fact, what makes Walmart the enemy of many is their stead fast refusal to unionize and their ability to sell things cheaper and better than their competition. The market should decide their fate not a union with an agenda they don't readily admit.

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?

I Agree with George Soros?

A few weeks back, I wrote this piece analyzing the different forms of an economic recovery: indicated by the letters l, u, v, and w. In it, I predicted that we would form a W shaped recovery. In a W shaped recovery there are one or more false rallies only to find the economy back in a recession.

I believe that we will see this W shaped recession. It's why I am still bearish. Whatever short term signs we see of a recovery, they are, in my opinion, overwhelmed by the long term problems caused by the action in response to the recovery. In other words, I believe the medicine will wind up worse than the ailment.

Between the Fed's quantitative easing (creating money out of thin air and buying bonds with it), the massive stimulus, the bank bailouts, all of these things have run up our debt to massive levels. What does this cause? First, it causes higher interest rates, high inflation, and a weak dollar. Already, we are seeing signs of the negative effects of this. Oil has steadily been rising over the last two months. That's partially to do with the dollar, as oil is priced in dollars.

What will $3 a gallon gas prices do to our recovery? I have spoke often about the rising interest rate in the Ten Year U.S. Treasury. That's back to just under 3.7%. This has recently caused a massive short term run up in mortgage rates. What will 6% or even 7% mortgage rates do to our recovery?

Speaking in front of business interests today, George Soros echoed my beliefs.

Billionaire investor George Soros on Tuesday predicted a "stop-go" economy for the United States, saying fears of inflation will drive up interest rates and choke off growth.

Soros, one of the world's most successful hedge fund managers who was speaking at a breakfast hosted by the Wall Street Journal, said borrowing costs are the major headwinds for the economy.

"As markets revive, fear of inflation will drive up interest rates, which will choke off recovery," he said.

Rising U.S. Treasury yields have driven mortgage rates back up, threatening a recovery in the housing market and a refinancing boom that has helped preserve the still-fragile health of recession-weary households and the banks that lend to them.

The rise in bond yields and mortgage rates may also act to check the huge recent rally in global stock markets of the past three months, with the Federal Reserve trying to end an 18-month recession and yet not spur inflation.

What Soros never addressed is the role of President Obama, the candidate he furiously supported in the race, in engineering the recovery he now predicts. In fact, Soros was downright disingenuous to the point of suspicious in his speech. Soros went on to claim that bubbles can't be avoided, that government must limit the dangers of bubbles, and that regulators are always less knowledgeable than the market itself. In fact, if I didn't know Soros any better, I would say he's a free market champion after reading the notes of this speech. Yet, I know him better. This is the same George Soros that is a major funder of the universal health care campaign. While he speaks about light regulation out of one side of his mouth, he funds Socalist causes out of the other side. So, it would seem he got what he wanted, and yet, in this speech, he indicts the entire domestic policy of President Obama regardless.

Soros is no dummy. He knew exactly what platform Obama was going to implement when he threw the entire weight of his multi billion dollar fortune behind him. Yet, now, suddenly, he comes out to indict that very same platform in its entirety. That obvious dichotomy was neither asked nor answered. That's too bad because it's awfully suspicious.

Building My Case to Break Up Big Oil

I have made no secret of my distaste for big oil. So, now, I will build a case why it would not only be beneficial for society to break them up, but, under Sherman Anti Trust it is perfectly legal. Here is the relevant portion.

The Sherman Antitrust Act (Sherman Act,[1] July 2, 1890, ch. 647, 26 Stat. 209, 15
U.S.C. § 1–7) was the first United States Federal statute to limit cartels and monopolies. It falls under antitrust law.

As such, if big oil is in fact a cartel then they must be broken up. Here is the definition of a cartel.

A cartel is a formal (explicit) agreement among firms. It is a formal organization of producers that agree to coordinate prices and production.[1] Cartels usually occur in an oligopolistic industry, where there is a small number of sellers and usually involve homogeneous products.

A homogeneous product, by the way, is a commodity much like gasoline. First, the biggest six oil companies in America account for about 60% of all the gasoline sales here. The rest is controlled by bit and regional players. One of the characteristics of a cartel is that it is in an oligopoly. A market controlled by a small group of players. Clearly, gasoline is controlled by six companies. More than that, there is a mammoth barrier to entry into this market. It takes billions of dollars to start a gasoline company. Furthermore, each of these six companies have already rooted themselves in every neighborhood in every city in every state. As such, any new competition is nearly impossible to create. Their enormous historical profits also mean that almost no one has the capability to take them on. You could combine the wealth of T. Boone Pickens, Donald Trump and Warren Buffet and they'd still get wiped out by the combined power of big oil.

The next piece we need is price manipulation. Everyone agrees that gasoline is derived from oil. So, we should all assume that gasoline and oil should move up and down in tandem. Furthermore, we should expect that if one company tries to overcharge the rest will undercut if we are truly dealing with a fair and free market.

This is the historical chart for oil. (to the left)

This is the price of gasoline. (above)

Now, oil and gasoline track each other up and down but they certainly don't track each other up and down in any uniform percentage. For instance, oil bottomed out at $46 a barrell in November. By April 1, it was just over $50. That's only a 10% increase. Yet, in that exact same time frame, the price of gasoline went from $1.56 to $1.86. Why would gasoline need to increase 20% when oil only increased by ten percent?

This only gets more insidious when you see that gasoline prices are set to be exactly the same regionally and locally. In other words, the oil companies would argue that there are other factors besides strictly the price of oil that determine the price of gasoline. If that's the case, then why do they all arrive at the exact same price in the end? Has anyone ever seen a difference in price between different companies? The only time there is a difference in price is when the location of a gas station allows for more traffic. So, I must ask a question. If there are a variety of factors that determine the final price of gasoline, why do all of the companies always arrive at the exact same final price? Isn't this the definition of price collusion?

Then, there is the issue of innovation. When General Electric was started, it was started as a vehicle for the light bulb. Now, that company is a conglomerate. Motorola was originally created as a company that sold car radios. Now, it is a technology firm. Yet, big oil sells the exact same product in the exact same form as it did nearly a century ago. Where's the market innovation and evolution?

Now, we all want to be energy independent. We all want to stop relying on the Saudis for most of our energy needs. How can that happen when the companies providing our fuel for our automobiles refuse to innovate so that the fuel comes in some form, any form, besides the one derived from oil?

Here's the summary. We have six very powerful companies. All of these companies manage to make obscene amounts of money, all at the same time, in almost every environment. Even though their product is derived from a market traded commodity, the final price doesn't necessarily correspond to that commodity. Even so, the final price ALWAYS corresponds to each other. Furthermore, all of these companies have managed to continue to sell the exact same product they did nearly a century ago even though all other markets evolve much more than that in every other industry. That, to me, sounds like a cartel. It needs to be broken up.

Both Parties Clueless on Energy

Yesterday, the Republicans unveiled their plan for energy independence. Here are some highlights.

Among the highlights: Nuclear power would be the battle horse, with a call to build 100 new reactors. The GOP plan takes aim at all the industry’s hurdles. Long lead times and pricey components? Streamline nuclear licensing and slash import tariffs on nuclear components. Iffy economics? Give nuclear power tax credits like wind and solar power. Questions about waste storage? Revive and expand Yucca Mountain, and start reprocessing spent nuclear fuel.

The Republican plan would also heavily support clean energy, something that never seemed to happen when the GOP did have the votes. It would make clean-energy tax credits permanent. It would also create a clean-energy trust fund financed by selling off all the new oil and gas leases meant to promote domestic oil production. It would also cut environmental red tape surrounding new renewable-energy projects. The plan would also extend and expand tax-credit programs for hybrid and electric cars, and for energy-efficiency measures.

The plan would also support dirty energy, repealing federal prohibitions on using oil from Canada’s oil sands, and ramping up support for coal-to-liquids technology.

On the Democratic side, we have cap and trade, huge increases in emissions standards, more tax breaks for energy efficiency, as well as massive increases in the budget of the Energy Department.

From my perspective, we have two parties equally as clueless, and you are merely choosing your poison over which plan would fail worse. Neither plan will make us very much more energy independent, and the Democrat's plan will likely cost a lot more. Though, even that is debateable.

For instance, the Republicans call for building one hundred new nuclear power plants. That sounds like a good idea only it costs $5 billion just to build one nuclear power plant. Since no private company would ever invest those kind of dollars, I can only assume the Republicans want the Federal government to pick up the tab. Given that our deficit is already almost $2 trillion, I don't think that it is very fiscally responsible to add another half a trillion dollars to an already ballooning deficit. Whatever the potential benefits of nuclear power, they are years if not decades away. Meanwhile, the cost for all of these nuclear power plants must be paid now. Now may not be the time to add to our deficit.

Furthermore, the Republicans are now behind this "all of the above" approach as though this is a new concept. All of these technologies: nuclear, wind, solar, biothermal, etc. have long been around. Both public and private entities have studied, researched, and attempted to market them for years. So far, most have been totally unsuccessful in gaining anything more than a marginal foothold in the market. We've tried tax breaks and credits. It doesn't work because most are far too expensive with very little mass reach. Making a renewed effort to all of these frankly identifies the wrong problem.

Meanwhile, the Democrats think the road to energy independence lies in willing a revolution in our economy. Our cars aren't energy efficient enough for them so they will mandate more energy efficiency. We have far too much CO2 burning energy, so we will cap it and force companies to come up with alternatives even if those alternatives aren't ready for any mass scale. On top of this, they'll just increase the budget of the Energy department. Keep in mind that the energy department has been working on alternatives for half a century and more. So far, the success has been nearly non existent. Throwing more money at the problem appears to be a bad use of our tax dollars.

Both parties, however, miss the point. Our energy dependence centers around one main problem, our dependence on oil. That dependence centers around one main problem. Almost all our cars run on gasoline derived from oil. The problem there is that to fill up our cars we are almost exclusively resigned to using one of six companies: BP Amoco, Mobile, etc. These companies have absolutely no motivation to ever create any other fuel that can be an alternative to the one derived from oil to act as an alternative at any of their several million gas stations in our country. If we can't fill up with an alternative fuel, no alternative fuel will ever exist on anything more than a marginal level.

Neither party addresses the main problem. The oil companies are making all sorts of dollars giving us gasoline derived from oil. They control this market. This market has massive barriers to entry. Their collasus size means that they can demolish any competition. At the same time, they have no intention of ever providing anything but gasoline derived from oil. Until this problem is resolved, all energy indepence plans will be bound for failure.

Here are my proposals to make us energy independent.

Now Short Term Bearish and Here's Why

Introduction: While I used to be an investment advisor, it goes without saying that all investments should be made to fit an individual's needs. Please do not take what I say here as the end all.

I am already on record as being bearish in the long term still for the market. I now feel the market is headed for a 10-15% correction over the next 120-180 days. Here's why.

Back when we were at about 6700 on the Dow, the market turned around starting with news that Citigroup had sent an internal email that said the bank was doing well in the first two months and were on their way to being profitable for the quarter.

To me, this was a peculiar piece of data to get excited about. On any given day, two to three pieces of economic data come out. For instance, today, the new unemployment filings were reveled and PPI numbers came out.

Since March, the market has been going up. That's not to say that all economic data were positive. In fact, they weren't. The market fixated on that data that was positive. Early in the move, I referred to this phenomenom as the market being oversold. This means that stocks were cheap and traders and investors were looking for good news. Since there is so much data, good news is easy to find if you look.

Since, we have seen the Dow go from 6700 to 8400 and S&P and NASDAQ have seen similar moves. Given that, I believe we are ready for a pull back and now the market is overbought. The first sign was the reaction yesterday to the consumer spending numbers for April. They were negative but for the first time in a while, the market reacted negatively. All indices were down at least 2% and that made two horrible days out of the last three.

Given where the market is, I believe that a pull back is set to begin. The market was exhibiting what Alan Greenspan referred to as "irrational exuberance". Every piece of economic data produced the narrative that "the worst was over". Suddenly, the consumer spending data put cold water on that narrative.

This, I believe, has less to do with the numbers yesterday and much more to do with where the market is at. After gains of nearly 30% in less than two months, the market is ready for a pull back.

The economy is still weak. There will be plenty of data to come out over the next weeks and months to support that. The market, I believe, will follow. Expect the Dow to test the low 7000's and the S&P to fall below 800.

I am however bullish on technology. That seems to be a sector that's been doing well.

Now then, how can you take advantage? In the short term, you could either buy S&P put options going six months out, or you can short sell Spiders (trading under the symbol SPDR). Both of these strategies allow you to buy a basket index and they allow to play a bearish position for the relative short term.

President Obama's Devious Universal Health Care Framing

Throughout the campaign, and during his presidency, President Obama has tried to present himself as the moderate on health care. On one side, were the so called free market extremists (like myself) who believed that health insurance and care should be left to the free market. On the other side was the original plan proposed by Hillary Clinton in 1993 which proposed a single payer plan. Instead, President Obama proposed a plan in which a government plan would "compete" with free market alternatives. By doing so, President Obama made his plan seem as though it was the moderate. Make no mistake, his plan is an extreme one pretending to be moderate.

That's because any plan in which a government run plan competes with private plans eventually winds up being one in which the government run plan takes over. That's because the government need not worry about such "trivial things like profit. The government has the advantage of unlimited borrowing, unlimited access to the money printing press, and the ability to tax the citizenry.

Here is how Senator Roy Blunt viewed the fear.

"I'm concerned that if the government steps in, it will eventually push out the private health care plans millions of Americans enjoy today," Republican Rep. Roy Blunt said in the Republican weekly radio address.

Blunt, who will play a leading role in the debate, warned: "This could cause your employer to simply stop offering coverage, hoping the government will pick up the slack."

The proposal he referred to would, for the first time, offer government-sponsored coverage to middle-class families, as an alternative to private health plans. By some estimates, it could reduce premiums by 20 percent or more -- making it much more affordable to cover the estimated 48 million people who don't have health coverage.

Here is how Charles Krauthammer describes the deception.

1) Obama wants to be to universal health care what Lyndon Johnson was to Medicare. Obama has publicly abandoned his once-stated preference for a single-payer system as in Canada and Britain. But that is for practical reasons. In America, you can't get there from here directly.

Instead, Obama will create the middle step that will lead ultimately and inevitably to single-payer. The way to do it is to establish a reformed system that retains a private health-insurance sector but offers a new government-run plan (based on benefits open to members of Congress) so relatively attractive that people voluntarily move out of the private sector, thereby starving it. The ultimate result is a system of fully socialized medicine. This will probably not happen until long after Obama leaves office. But he will be rightly recognized as its father.

President Obama wants the government to "compete" with two models. The first model is the one that provides health insurance to the legislators themselves. The second model is Medicare and Medicaid. Think about what that means. The plan that Congress gets loses money. It is the Rolls Royce of health insurance and that's because legislators take care of themselves. Furthermore, the government can handle losing money in covering 500 some people. If everyone if offered this same plan though, it will mean serious losses. Of course, that's no problem since the President has already proclaimed that we wil pay for it by raising taxes on the wealthy. What it does mean though is that the government will have a plan that the private market won't compete with. Soon, everyone will want what the legislators currently have. Soon all private plans will be out of business.

The second model is the Medicare/Medicaid. Well, there is a reason why both of those are bankrupting the country. That's because they aren't profitable. So, how does a private plan compete with a plan that isn't profitable? It doesn't. The government can continue to fund an unprofitable plan indefinitely while the private market will run out of money eventually.

This sort of slick marketing has devious intentions. As Krauthammer points out, we can't go from free market to single payer overnight. Instead, we offer a "moderate" plan in which the government competes with the private market. Of course, this is no competition. It is rigged to eventually drive the private market out, and soon enough we have single payer government run health care.

The Financial Crisis White Paper

Introduction: For long term readers, you may find that this is a recap of many other things I wrote, however here is an in depth report of the crisis and the solutions.

Before beginning, I want to quote from this Wall Street Journal article last fall.

Is a housing bailout the solution for clogged-up credit markets and a faltering economy? What the Fed has been doing and did again yesterday hasn't really worked, notwithstanding the pops it produces in the stock market every time it shovels liquidity into the system. The Fed's latest move provides financial institutions another $200 billion in direct short-term lending against their unsaleable housing collateral. The Dow Jones jumped 416 points. But it won't restart markets for the underlying collateral.

Where are the speculators, vultures and hedge funds? Where are the big money players willing to buy the exotic but still substantial mortgage-backed securities for which markets have ceased? The Fed's liquidity rush seems only to have convinced them the time is ripe for staying on the sidelines.

To get to a real solution, speculators and investors need to believe that home prices are hitting bottom, that any mortgage debt they might buy today for 80 cents on the dollar today won't be worth 30 cents tomorrow. Then the vultures will pile in: The transfer of wealth from the overleveraged banks and hedge funds to those who kept cash handy will be shocking, ugly and cathartic -- but it will also be relatively quick. Credit markets will begin to function again. The economy will grow.”

To try and understand the current crisis, we first need to understand how we got here. First, we must go all the way back to the end of 1999. That’s when Alan Greenspan, then head of the Federal Reserve, first began raising the Prime Interest Rate. This move surprised most everyone, and Wall Street included. This led directly to the popping of the so called Internet bubble. This bubble popping cost roughly $3 trillion in paper losses in stocks between March and December of 2000. This led directly to the recession that awaited George Bush when he entered office in January of 2001.

The economic malaise that was materializing in late 2000 was only exacerbated by two other events, 9/11 and the revelations of Enron et al. As such, by the end of 2001, we were in a full blown recession. While President Bush was enacting tax cuts, Alan Greenspan was furiously reducing interest rates just as quickly as he raised them in 1999-2000.

By the end of 2002, Greenspan had lowered interest rates so aggressively that the Fed Funds Rate, the rate that banks borrow from each other at, stood at .75%. The Fed Funds Rate is an overnight rate. This is important to understand because there are only two reasons why a bank would borrow overnight 1) they’d done something reckless and needed the money or 2) they were about to do something reckless and need the money. Greenspan lowered the Fed Funds Rate below 1% for well over a year and kept it there.

What this did was create so called loose money. Banks had access to far too much easily available cash. The recession had depressed almost all industries at the time except one, real estate. That’s because the recession had also led directly to record low mortgage rates. We were at the time in the middle of what was dubbed the refinancing boom. Because interest rates work in relation to relative inflation, the recession was great for rates because at the time the only fear was deflation. The record low rates didn’t only create a lot of refinancing but also led to more buying. At the time, we were just seeing the beginning of the real estate boom.

Because real estate was the only good sector, all this extra available bank capital went into one place, mortgages. The ‘problem” if you will at the time was that banks had more money than available loans. The solution was the birth of the sub prime explosion. Because folks with good credit (prime borrowers) were limited, banks began looking to more non traditional places for their money.

Mortgage Backed Securities, which bundled these sub prime loans and turned them into bonds, were the brainchild originally of Lew Ranieri at Lehman Brothers in the 1980’s. The financial vehicle had its glory days in the late 1980’s and early 1990’s, but since then the vehicle had lost some favor. It was, however, ready for a resurgence. Banks came to hedge funds, insurance companies, private equity firms and other financial conglomerates with ideas for new and aggressive loans. Because real estate was starting to move, these securitizers (those that package these loans together and turn them into bond) were all too willing to create new Mortgage Backed Securities out of these more aggressive ideas.

For the first couple years, the industry moved aggressively to loosen guidelines, but these moves were still relatively tempered. That all changed in 2005 when a new sub prime player entered the market. That player was Argent Mortgage, the sister company of Ameriquest. Argent would be able to walk into just about any mortgage company and offer more aggressive loans than anyone else. This caused panic and frustration in all their competitors as they saw their market share rapidly deteriorate. In response, the entire competitive landscape was trying to one up each other. So, what was a meticulous loosening of guidelines, turned into a free for all. Banks were in a constant war with each other to offer new and more aggressive programs.

What was lost was any semblance of reason. Whereas at the beginning, even sub prime frowned on such things as prior bankruptcies, foreclosures, and mortgage lates, by the end, nearly everything was dismissed. Furthermore, the revolution of so called “stated loans” became the fruit of future disaster. Stated started out only for borrowers with uneven or sophisticated incomes: commissioned borrowers, self employed borrowers, or borrowers with multiple investment properties. By 2005, nearly everyone could get a stated loan. As such, folks on salary like teachers, secretaries, and even janitors could get a loan by stating their income without actually providing any income documentation.

By the end of 2006, the industry’s recklessness had reached its limit. The industry had standardized the so called 620 stated/stated no money down loan. This was a loan for a borrower with a credit score of 620 (which is in the bottom third of all credit scores) and this borrower could state but not verify their income, their liquid assets (meaning how much they had in the bank) and do all of this with no money down.

Meanwhile, several things were happening on the securitization side of the business. In 1999, Congress and then President Bill Clinton passed landmark deregulation legislation of banks and financial services companies. What this bill allowed was for investment banks and commercial banks to perform each other’s functions. This had many different effects. For instance, brokerage firms like Merrill Lynch could offer checking accounts, and banks could offer investments. More pertinent to this discussion, it allowed more financial services firms to both package loans together and turn them into bonds, and to buy the buyers of said bonds. So, as the real estate market got hotter and hotter, more and more financial services firms began taking bigger positions in these bonds. Even more troubling was the availability of leverage to buy these bonds. Financial services firms were using margin, and very leveraged margin, to take massive positions in these bonds.

At the beginning of 2007, with no more new loans to create, the real estate market finally took a breather. With the real estate market taking a breather, all of the excesses that were masked by the hot market began to come to light. The entire industry was now discovering that billions of dollars worth of financial vehicles were being held with underlying borrowers with no ability to pay for their mortgage. These excesses were masked by the hot real estate market in several ways. Often these borrowers were able to refinance out of their loans before they got into trouble. Other times, these borrowers were even able to sell and buy new properties. Now that neither option was possible, the industry discovered that billions of dollars worth of assets were attached to “toxic borrowers”. This of course lead to toxic assets. The beginning of 2007 was the end of sub prime.

In the first part of 2007, it looked as though the toxicity would be limited to sub prime. By August, the industry realized that toxicity was wide spread. The next domino to fall was so called Alt A. This is the sub set of loans between prime and sub prime. At about this time, both Fannie and Freddie both asked for massive bailouts as well. These two giants both got themselves far too involved in aggressive loans. When these loans were money makers, they piled on to take massive positions. Now that they went bad, both held billions of worthless assets.

The next major event was in September of 2007 when FASB rule 157, mark to market, took effect. This forced banks to put a current market value on all assets, including billions worth of MBS’. While this rule may seem reasonable, what it did was force a so called write down of billions worth illiquid MBS. Because the market for Mortgage Backed Securities was no longer liquid, these banks couldn’t sell their assets, and each month their balance sheets got progressively worse as they had to apply ever lessening values on their MBS holdings. With shrinking assets, banks needed to raise capital in other places just to meet minimum capital requirements.

The next major event was the near downfall of Bear Stearns. In one weekend, the Federal Reserve orchestrated a multi-billion dollar buyout and essentially brokered a merger between JP Morgan/Chase and Bear Stearns. Of course, this consolidation of power was met with controversy and skepticism, but we were all told that it was necessary to avoid a financial meltdown. As it turns out, it only masked this meltdown for another six months. The meltdown came when the Fed couldn’t do the same for Lehman Brothers that it did for Bear Stearns in September of 2008. Since, we have seen a quick deterioration of wealth, jobs, and gross domestic product. We have been told that there is a credit freeze while financial institutions clean their balance sheets of these so called “toxic assets”.

Worse than this, the tax payers are on the hook for hundreds of billions of tax payer dollars in order to prop up companies like AIG, Citigroup, and the entire banking sector, which the government deems “too big to fail”. Meanwhile, all property owners are seeing the value of their properties disintegrate as rising foreclosures, as well as tightening credit, have seen the housing market shrink.

We are now at a financial cross roads, and all the answers seem to be less than desirable. It is, however, the belief of this white paper that the solutions lie mostly in the free markets. Currently, the administration believes that government interference is the only way to solve the crisis. That’s why the federal government has implemented a mortgage bailout program to modify loans. It’s also why the federal government has spent $750 billion to fund banks. This is the wrong course.

To understand why this course is so corrosive, look back to the original Journal article. What is needed now is a bottom to this economic cycle. At the bottom is when the financial “vultures” will come out looking for deals. The government believes that modifying troubled loans will stabilize housing. Yet, the problem with housing was the availability of loans to borrowers not qualified to own. In order to truly stabilize housing, these borrowers must be removed from the market entirely, not propped up with loans they don’t deserve. Furthermore, millions of borrowers are sitting on the sidelines waiting for prices to fall further. They are the housing vultures. By stabilizing housing artificially, all that will happen is that millions of qualified borrowers will be kept from buying. Furthermore, many of these troubled borrowers will ultimately be foreclosed on. The buyers of these foreclosed properties will also be vultures. Propping up current borrowers will also keep these vultures from taking advantage.

Then, there is the issue of the banking system. The government believes that the proper course of action is to prop up dozens of poorly run banks because their financial ruin would mean the whole system would meltdown. It’s impossible to prove a hypothetical, but one should ask what exactly are we in the middle of now. Far from a meltdown, what letting the free market work would do is create a restructuring. The troubled institutions would do what all troubled institutions do, go through the banking version of bankruptcy. This way their debts would be restructured. It’s also an exaggeration to say the entire banking system would meltdown. Financial institutions like Northern Trust, ABN Amro, and HSBC largely stayed out of sub prime and would survive any so called meltdown. Local and regional banks were also far too conservative to taken sub prime. Far from melting down, all these institutions would be in a position to take advantage of the downfall of many other institutions. In other words, they would all be the vultures swooping in to take advantage. Troubled institutions would also be forced to sell their parts at deep discounts. The prize jewel at Citigroup, for instance, is Smith Barney. If Citigroup were forced to restructure, they would likely have to sell off most of the company, and whoever bought Smith Barney would buy it at a deep discount. They would also be vultures.

Again, it’s impossible to say how deep or how long the meltdown would last if the free market took effect, but again, we should also ask how things are going now. By propping up the entire industry, the government is also giving a disincentive for any “financial vulture” to step in. Without these vultures we never see a bottom.

There are also plenty of places where much needed reform must take place. First, we must immediately suspend mark to market. All this rule does is pervert companies both during times of boom and downturn. Financial institutions hold much of their assets for the long term and so giving each a real time value is itself a perversion of reality. Without mark to market, financial institutions can simply put away many of their so called “toxic” Mortgage Backed Securities without worrying what they will do to their balance sheets.

Second, we must all use this opportunity once and for all for much needed reform to both Fannie Mae and Freddie Mac. To truly understand both is to truly understand the concept of “too big to fail”. Both were creations of the federal government, and are what is called Government Sponsored Entities. They are private companies that also receive federal perks (like treasury credit lines) that other companies do not. Because both securitize loans, they make all the rules. Banks are looking to fund a loan and sell it immediately. As such, they must play by the rules of the securitizers, Fannie/Freddie. Both currently hold about half of all mortgages. That means they literally run the entire industry.

Reforming them is rather simple. They have two structural problems. First, since there are only two of them, they are essentially a monopoly (or technically a duopoly). Second, since they are extensions of the government, they are essentially nationalized companies. Reform means fixing both. As such, they must be broken up into four to eight companies, and they must become fully privatized with no more government perks.

Also, there must be new limits set on just how much margin banks and other financial institutions are allowed to get when they borrow and invest. Many of the problems were caused because banks were leveraged in obscene ways when making investments into MBS. They were leveraged as heavy as five percent. This means that they only put of up five percent of the money they invested. The stock market crash happened in large part because people were allowed to margin as low as ten percent. It should be no surprise that massive margins caused this current crisis. Banks must be forced to come up with much more than five percent of any margin ed investment going forward.

Next, we must also reform the credit default swaps market. This is the field that has caused so many problems to AIG. Credit default is a way to make bets on whether a bundle of assets will default. As such, they are derivatives (a financial vehicle that derives its value from another vehicle). They are a way for the holder of said asset to hedge against failure. In that way, they are sort of like insurance. Yet, this massive market is neither and it is totally deregulated. The main difference is this. Anyone can make a bet in the credit default swaps market on the future default of any asset. As such, any number of bets can be made on the same asset. As such, trillions of dollars worth of bets can be made on billions of dollars worth of assets. There is absolutely no limit to the bets and each bettor need not be tied directly to the asset. No other insurance or derivative works like this. AIG is in such trouble because they took trillions of dollars worth of bets on billions of dollars worth of assets. This must end.

Our country can no longer be held hostage to any company that is deemed “too big to fail”. Whether we need an update to the Sherman Anti Trust Act, or we simply need regulators more aware of the implications of “too big to fail”, we must never again allow any company to become “too big to fail”. The tax payer can no longer be held hostage to corrupt and incompetent companies like AIG that hold everyone hostage for hundreds of billions of dollars because the implication of their collapse is something we simply cannot afford.

Companies that are too big to fail are the antithesis of free markets and capitalism. They operate in neither. They enjoy advantages that others do not. They take risks that others do not. Finally, their risks are paid by the tax payer, and that can no longer go on. Sherman Anti Trust was created to promote competition and free markets, and that’s what it must do. No longer can we allow companies to become too big to fail. They must be broken up prior to this happening.

Finally, we need to take this crisis as an opportunity for serious reform of the Federal Reserve. This crisis and much of the economic instability over the last decade were largely created by the Fed. We simply cannot have a growing economy when our money supply is moved in a pschzophrenic manner. No less than three times over the last decade, the Federal Reserve raised or lowered rates furiously only to have to reverse course within the next two years. How can you possibly have any economic stability when interest rates are so unstable? The Federal Reserve Chairman controls the money supply of the United States. There is no doubt that this is the most powerful position in the world, and yet this individual is not elected. Furthermore, they are rarely even questioned. They are treated as oracles and wizards. The Federal Reserve must come under greater scrutiny, with greater checks, or we will face further economic instability.

The Only Thing That Will Save Us Now is the Free Market

Of course, this won't happen, but it should be on the record for posterity at least...

First, I want to introduce this quote from a Wall Street Journal article last fall.

Is a housing bailout the solution for clogged-up credit markets and a faltering economy? What the Fed has been doing and did again yesterday hasn't really worked, notwithstanding the pops it produces in the stock market every time it shovels liquidity into the system. The Fed's latest move provides financial institutions another $200 billion in direct short-term lending against their unsaleable housing collateral. The Dow Jones jumped 416 points. But it won't restart markets for the underlying collateral.

Where are the speculators, vultures and hedge funds? Where are the big money players willing to buy the exotic but still substantial mortgage-backed securities for which markets have ceased? The Fed's liquidity rush seems only to have convinced them the time is ripe for staying on the sidelines.

To get to a real solution, speculators and investors need to believe that home prices are hitting bottom, that any mortgage debt they might buy today for 80 cents on the dollar today won't be worth 30 cents tomorrow. Then the vultures will pile in: The transfer of wealth from the overleveraged banks and hedge funds to those who kept cash handy will be shocking, ugly and cathartic -- but it will also be relatively quick. Credit markets will begin to function again. The economy will grow.

I will refer to this piece throughout as I think it speaks to a fundamental point of economic cycles and especially downturns.

First, let me give a brief recap of how we got here. (for the full summary read the link) In late 1999, Alan Greenspan began raising the prime rate and this action lead directly to popping the internet bubble. That lead directly to the recession that awaited George Bush when he took office. 9/11 as well as the Enron et al scandals only perpetuated the recession and soon Greenspan was just as furiously lowering prime rate as he was raising it only a couple years earlier.

Eventually, he lowered the prime rate so much that the fed funds rate (usually three percent below prime) got to .75%. This created very loose money within the banking system. That's because it became far too easy for the banks to borrow. At the time, only real estate was thriving as an industry and so banks naturally moved all this loose money into real estate. Because there was more money then loans, eventually they created new loans and the sub prime explosion began.

Throughout the next four years, the real estate market became more and more speculative. Meanwhile, sub prime loans became more and more irresponsible. Finally, folks needed little more than a heartbeat to get a loan.

When the real estate boom finally subsided at the end of 2006, it also exposed loan portfolios that made up Mortgage Backed Securities that had an obscene amount of loans that weren't being paid back. Because these MBS' were making obscene amounts of money throughout the boom, these banks all got far too into these investments. Furthermore, much of this investment was done on margin. The crisis was exacerbated by the fact that FASB rule 157 forced these banks to apply current market prices to this paper. As the paper fell in price, the banks had to write them down on their balance sheets. Because much of this paper was used to meet minimum capital requirements, banks struggled to stay capitalized and lending dried up.

Finally, the whole crisis has become intertwined. The banks all owe each other so the failure of one could lead to the failure of most or of all. Furthermore, real estate values deteriorating puts further downward pressure on the MBS' they all are holding. As such, there has become a belief among many that many of these banks need to be propped up so that obligations are met and a domino effect is not created. Furthermore, there is a similar belief that we need to stabilize housing values to make sure that the value of these assets are stabilized as well.

I believe that both of these beliefs are foolhearty and implementing policy in order to create this is exactly the wrong thing to do. Of course, we'll never know what would have happened had TARP not been passed, but all those that were screaming about a crisis without it, should be asked what exactly is happening now. Without TARP, many of these institutions would have filed for Chapter 11 protection. Much of their debt would have been forgiven or restructured. As such, many of their debtors might have wound up in a similar position. Would this have meant that a lot of big institutions would have failed? Absolutely, it would. Would this have lead to more institutions failing. Absolutely, it would. Would it have meant that entire banking system would have collapsed? Absolutely, not. There would still be plenty of banks that would not only survive but in fact thrive. For instance, both Northern Trust, ABN AMRO, and HSBC have largely stayed out of sub prime. Those banks would make it through any crisis. They would likely be serious buyers in any garage sale of all these assets. (the vultures) Furthermore, most regional and local banks are far too conservative to ever get involved in sub prime. All of those banks would not only survive, but the innovative ones would grow. What we would see is a restructuring of the banking system with far fewer multi national powers and far more local and regional powers. We would also likely see non banking financial institutions like the Hartford enter the banking market because of the hole left by all of these collapsing powers.

Beyond this, many of these entities would then have been sold off for "spare parts". In other words, divisions like Smith Barney and AIG's homeowner's insurance would have been sold in the market. Not only would they have been sold, but the buyer would have gotten quite a deal. These buyers would have acted much like financial VULTURES. Of course, that's exactly what the WSJ article said was necessary for a bottom. Whoever would have bought Smith Barney would have received a deep discount on it. In fact, most of AIG, Citigroup, et al's divisions would be broken up and the buyer's would buy them at well below market value. All of the players left standing would wind up vultures and the bottoming process would occur and we would begin the recovery.


As for housing, it is equally foolhearty to think that housing needs to be stabilized. All of these folks that got these extreme sub prime loans should never have been in the real estate market to begin with. In order to stabilize the market, they need to be removed from it as soon as possible. Furthermore, isn't what we need now more buying? What creates more buying than low prices? Don't we want to encourage as many real estate vultures as possible? The only way to do that is to allow the real estate market to fall as much the free market will allow. Also, there are those taking advantage of the market by buying up these foreclosed properties. These are also vultures. By artificially stabilizing housing, what we are really doing is not allowing vultures to come in. Yet, it is the vultures that are necessary for any bottom and recovery.

The argument against allowing market forces to take hold is that such action would mean significant pain. Yet, I ask isn't that what we are going through now. For all those that say allowing these banks to fail would create a credit freeze, what exactly are we going through now? How much longer should the economy go through incremental pain before we all realize that we are all merely prolonging the pain. Propping up bad banks so that they can struggle to meet their own obligations with no hope of viability is not a sound strategy for any long term healthy economy. Propping up bad borrowers so that real estate prices can stabilize temporarily is not a sound policy for any long term healthy economy.

What this economy needs is a cleansing. It needs to be cleansed from all the waste and the excess. The only force that can create that cleansing is the free market. Once the economy is cleansed the next natural step is for the vultures to swarm in on cheap assets and take advantage. The only thing that can create that is to allow the free market to run its course. Such a strategy is painful, scary, and not very politically appealing. Yet, what are we going through now if not the same thing?

Is It Time To Update Sherman Anti Trust?

One of the terms that I want to never hear again after this crisis is over is "too big to fail". If there is one thing that I want the American economy to never again face is any company that is viewed as "too big to fail". Our country has created all sorts of entities that are now too big to fail. Both Fannie/Freddie were created by the government, and it was the government that allowed them to dominate mortgage securitization and thus became too big to fail. Banking deregulation allowed financial institutions to be able to sell a major variety of financial products. It also lead to a period of consolidation and mergers. As such, we created a series of financial institutions, and with it a whole financial system, that was too big to fail. Finally, the auto industry it self is to vital to fail and so, with only three American players, all its players are too big to fail.

In the future, the country must do everything that it can to prevent ever again being held hostage to any company that can demand a handout by proclaiming that they are too big to fail. Never again should the country be held hostage to the corruption and incompetence of AIG and Citigroup. From now on, our economy must rid itself forever of any company that is too big to fail. I am not only a capitalist at heart but a true believer in free markets. Nothing is less capitalistic or free market than a company that is too big to fail. Such companies enjoy advantages that other companies don't. Furthermore, they have an inherent moral hazard as each of these companies expect to be bailed out if they fail because they are too big to fail.

In my opinion, the Sherman Anti Trust Act is one of the most important laws in the history of our nation. It is one of the greatest protectors of the free market. That's because it keeps companies from getting so big that they stifle competition. Some companies that fell under the discretion of Sherman include Standard Oil and AT&T.

Yet, the Sherman Act also put a lot of power and discretion into the hands of the government. In its idealistic it protects competition, but in reality it is open to abuse by any out of control government. So, Sherman could be updated to include any company that is too big to fail, but that update would also be open to abuse.

Such a law would be in many ways the anti thesis of everything I believe in. To update Sherman to include companies that are too big to fail would consolidate an obscene amount of new power in the hands of the government. As such, a new law would have to be narrowly defined to determine just how it would be determined that a company is truly to big too fail.

In fact, Sherman wouldn't even necessarily need to even be updated. Regulators already have to give green lights to mergers, however, these regulators allowed companies like Citigroup to grow so big that they became to big too fail. I believe there is room here for constructive legislation that can also be crafted so that power doesn't spin out of control. I do know for sure that to big too fail must be a thing of the past. Whether that is through new legislation or through a more refined regulatory attitude, our government must be committed to ending such companies.

President Obama Vs. the Stock Market III...Or Dow 5000

I have written two analyzing the effects of President Obama's policies on the stock market. The first I wrote in the summer time in which I predicted how his policies would have an adverse effect on the stock market. The second I wrote just the other day analyzing why the stock market has been hit so hard since he took over. I have written two because things have changed so much since the summer that it needed an update. Well, it appears that there is another update necessary.

It appears that soon my worst fears from the summer and my worst current fears will be combined and as such, I am predicting Dow 5000.

In the summer, I worried about three things more than anything regarding then candidate Obama's policies as the affected the stock market. The three policies were raising the top marginal tax rate, raising the capital gains tax, and creating a new "regulatory framework". Raising the top marginal tax rate, on those making $250,000 and more, would have a very serious and adverse effect on the stock market. That's because folks almost always use some or all of their discretionary money to invest. That means that they use all or some of the money left after necessary expenses to invest. Of course, raising taxes on the hyper wealthy means that much of the money levied in extra taxes would be removed directly from the stock market. Capital gains taxes punish long term investment in such things as the stock market. Finally, hyper regulations create an environment that is very unfriendly to business.

More recently, I pointed out that President Obama's talking down of the economy, Secretary Geithner's terrible performance, as well as the President's government intervention policies have all lead to the downturn in the stock market. These dynamics appear to be in place. We can only hope that Secretary Geithner performs better going forward, however, the President seems determined to talk down the economy. Also, he is determined to create a quasi socialist state.

So, here is the score. Without implementing any of the things that I feared this summer, President Obama has already lead the market down nearly 10% since inauguration. Now, we have this bit of news.

To get there, Obama proposes to cut spending and raise taxes. The savings would come primarily from "winding down the war" in Iraq, a senior administration official said. The budget assumes continued spending on "overseas military contingency operations" throughout Obama's presidency, the official said, but that number is lower than the nearly $190 billion budgeted for Iraq and Afghanistan last year.

Obama also seeks to increase tax collections, mainly by making good on his promise to eliminate some of the temporary tax cuts enacted in 2001 and 2003. While the budget would keep the breaks that benefit middle-income families, it would eliminate them for wealthy taxpayers, defined as families earning more than $250,000 a year. Those tax breaks would be permitted to expire on schedule in 2011. That means the top tax rate would rise from 35 percent to 39.6 percent, the tax on capital gains would jump to 20 percent from 15 percent for wealthy filers and the tax on estates worth more than $3.5 million would be maintained at the current rate of 45 percent.

As such, President Obama plans on raising taxes on the top income earners and he plans on raising capital gains taxes. As if his current policies haven't crushed the stock market enough, he is about to implement another set of policies that will be sure to crush the market even more. Make no mistake, hyper regulation is coming soon as well, at least in financial services and in energy.

It's absolutely stunning that the President has decided on this course. The current environment is corrosive on its own for the stock market. It will have a rough ride even under the most market friendly policies. Yet, the President has insisted on the most market unfriendly policies to combine with a very bad economic environment. Given what the President has proposed and will propose, I predict Dow 5000 prior to November 2010.

The Internet, Global Warming, and the Power of Free Markets

Back when I was in school one of the most talked about environmental threats to the world's trees from usage of paper. We were warned that our use of paper would soon deplete the world's supply of trees. Such threats to the world's trees are no longer talked about much. That's because the power of the internet means we are near a totally paperless society. Already, most everyone can see that the future of news will be paperless. Frankly, the internet allows for just about everything to be done without paper. As such, the threat to our trees from all the usage of paper is a problem of the past.

It's not only remarkable but instructive just how the internet solved a problem once at the top of every environmentalists lists of threats to the environment. That's because the internet was NOT created in order to save trees. Its ability to transform our society into a paperless one is merely a great side effect that no one involved in its creation likely ever even thought of. The internet was also the creation largely (though not exclusively) of entrepeneurs. Its roots are held in the tax cuts of Ronald Reagan of the 1980's. Reagan's tax cuts exploded the power of the entrepeneur and those entrepeneurs came up with many of the ideas that now form the bed rock of the internet.

Furthermore, the government made sure to stay away from regulating, taxing, or other wise controlling the internet. The lack of government involvement allowed the entrepeneurs free reign to innovate and expand its reach. Great ideas, like the internet, have all sorts of benefits on society and many of them are unintended. That the internet is moving our society into a paperless world is just one example of this.

We could use the same approach to solving the problem of global warming and other environmental issues. The government could stay out of the way and give entrepeneurs all the motivation they need to solve it themselves. Through a similar set of tax cuts the government could unleash the power of the entrepeneur to solve all our environmental challenges. Instead, the government feels it is a problem they must solve on their own. The government is determined to spend and to develop diplomacy toward a solution for global warming.

The government spent billions in research for decades in trying to solve the problem to the tree population by all the usage of paper. Internet entrepeneurs spent absolutely nothing on such research. They created an idea that they likely never dreamed would even solve the problem. Yet it did, and maybe that should be a lesson to all those that demand a plethora of government action to solve global warming and other environmental problems.

The Demonization of Free Markets

Among many things that 2008 will be remembered for, one of them will be that free markets began to fall out of favor. Now, those with an economically liberal agenda are using this opportunity to beat free markets when they are down. Free markets are now associated with unfettered greed and out of control behavior. Arianna Huffington took her turn demonizing free markets, and now, so has Thomas Frank.

But something went wrong on the road to privatopia. If everything is for sale, why shouldn't the guardians put themselves on the block as well? Now we find that the profit motive, unleashed to work its magic within the credit-rating agencies, apparently exposed them to pressure from debt issuers and led them to give high ratings to the mortgage-backed securities that eventually blew the economy to pieces.

And so it has gone with many other shibboleths of the free-market consensus in this tragic year.For example, it was only a short while ago that simply everyone knew deregulation to be the path to prosperity as well as the distilled essence of human freedom. Today, though, it seems this folly permitted a 100-year flood of fraud. Consider the Office of Thrift Supervision (OTS), the subject of a withering examination in the Washington Post last month. As part of what the Post called the "aggressively deregulatory stance" the OTS adopted toward the savings and loan industry in the years of George W. Bush, it slashed staff, rolled back enforcement, and came to regard the industry it was supposed to oversee as its "customers." Maybe it's only a coincidence that some of the biggest banks -- Washington Mutual and IndyMac -- ever to fail were regulated by that agency, but I doubt it.

Or consider the theory, once possible to proffer with a straight face, that lavishing princely bonuses and stock options on top management was a good idea since they drew executives' interests into happy alignment with those of the shareholders. Instead, CEOs were only too happy to gorge themselves and turn shareholders into bag holders. In the subprime mortgage industry, bankers handed out iffy loans like candy at a parade because such loans meant revenue and, hence, bonuses for executives in the here-and-now. The consequences would be borne down the line by the suckers who bought mortgage-backed securities. And, of course, by the shareholders.

Blaming free markets for the crisis is as simplistic as blaming deregulation, George Bush, Barney Frank, Fannie Mae, the Community Reinvestment Act, or any other of a number of villains that partisans on all sides have isolated and demonized for this crisis. This crisis didn't happen merely because the markets were too free. That is patently ridiculous. Beyond the scope of the unfettered greed that economic liberals like to look at, there was also a great deal of intervention in the free markets that perpetuated the problem. In fact, one could make the case that the pysczophrenic policy of the Federal Reserve over the last ten years has by far played the biggest role in setting up the crisis. All those bashing free markets seem to totally dismiss that the Federal Reserve has manipulated interests rates up and down no less than four times in nine years. Maybe just maybe, had the Federal Reserve not been so eager to interfere with the free market, then maybe just maybe, the free market wouldn't have responded so absurdly.

All those bashing free markets dismiss several other things as well. First, mortgages are one of the most hyper regulated industries we have. Every time a loan is closed no less than one hundred documents are signed. Those are signed in response to one regulation or another. Second, this crisis largely occurred in response to massive fraud on the part of borrowers, mortgage brokers, appraisers, and banks which all lied regarding income, assets, occupancy, and value. No market, free or otherwise, can withstand wholesale fraud. Finally, free market bashers dismiss the role of such regulations as FASB 157 in perpetuating this crisis.

Finally, what is the alternative? Should we have government control like in Cuba and Venezuela? Maybe we should have the quasi socialist systems of Europe where the economies have been largely stagnant for the better part of two decades. All those now clammoring for a plethora of new regulations to reign in this greed seem to dismiss the utter disaster of prior regulations like Sarbanes Oxley. Furthermore, those that demonize the free markets dismiss how the free market responded to this crisis. While pols all over the place debated what sort of new regulations we should have in mortgages, it was the free market itself that immediately eliminated all the trouble loans: stated, no money down, etc.

So, they can demonize the free market if they like. All it will really show is that they are partisan economic liberals with absolutely nothing more than a rudimentary understanding of how all of this came about. No one is saying that free markets are perfect. Some of us just realize that given any alternative, free markets are the best, and frankly, it isn't even close.

Lunch With HUD Secretary Steve Preston

Today, I attended a lunch sponsored by the Illinois Chamber of Commerce with current HUD Secretary Steve Preston. Preston is a native of Chicago and so this lunch, downtown, was a sort of homecoming.

During Preston's remarks, he first mentioned that he believes in limited government. He then proceeded to rattle off a laundry list of things that HUD has done both in the community and to help struggling homeowners. He mentioned that HUD has backed about 400,000 loans for borrowers currently struggling to repay their mortgages. He mentioned that HUD helps in providing loan modifications. At one point, he even mentioned that about 90% of all new mortgages are currently being backed by the federal government. This, I read, he thought was a good thing. His conclusion was then that the government was a force for stabilization in real estate. I found his supposition that he is a small government to run counter to the body of his speech. That prompted me to ask this rather provocative question. (I will relay it as close to word for word as I can remember)

...

I have been in mortgages since 2002. For about three years, mortgages were given to just about anyone with a heartbeat. Now, all those folks are in a position where they can no longer pay them back. You say that you are in favor of smaller government but you also say that government backs 90% of all mortgages. I don't think that's a good thing. That socializes mortgages. There's a mechanism for people that can't pay their mortgage back and its foreclosures. Why are mass foreclosures worse than the government intervention you are proposing?

...

Now, I felt that Secretary Preston danced around the question a bit. His basic point is not a new one. He said that without the massive government intervention we have seen our economy would really be in free fall. This is the standard answer that any normally small government conservative gives when they are asked to defend the massive government intervention they now back, like the bailout. It's one of those things that is impossible to prove one way or the other. First, I haven't seen the data that I assume he has. Second, we'll never know what would have happened without the bailout. I continue to be skeptical of such an answer. I understand that banks are holding onto much of the money, making acquisitions with much more, and some of it is winding up overseas.

When I first started blogging I talked about folks I called fair weather capitalists. That's how I would classify Secretary Preston. I'm sure he would say that he is a pragmatist. That said, I believe in free markets always. It's not enough to believe in free markets when things are going great. It's exactly when things begin to fall apart that real free market believers believe in free markets. I believe the free market is always the best arbitrator of moving our economy. Secretary Preston would say that this crisis was far too reaching to allow the free market to decide.

For me, free markets always guide us out of the wilderness. Secretary Preston talked about many large corporations that would have failed had we not stepped in. I would say it isn't the government's job to save them. For every corporate failure there is a corporate shark to step in to grab a great merger and/or acquisition deal. That's what the likes of Bank of America have done with many failed banks. When the government props up failure, it also effectively allows the weak to survive when they should be removed.

This debate that I created with my question is one of the central debates in our economy. What is the role of the government in the current crisis? Folks like me can be found on Wall Street, Main Street, and in many business media, but they are scant in the places that matter, within our government. As such, while I made Secretary Preston a bit uncomfortable with the question, ultimately, it is a debate my side will lose.

I also found that Secretary Preston is an example of how it is much easier to be a real small government person when you are given power. Had Preston governed over HUD as a small government conservative, his speech would have been full of examples of how he shrank HUD and made it more efficient. Instead, it was full of the things that HUD did for people. Once in power, small government principles are difficult to implement because it also means weakening your own power and reach.

Finally, I felt as though at the end of his answer to me Secretary Preston did a little pandering. After explaining that we need massive intervention to stop the massive collapse that would have happened without it, he also told me that soon we need to develop the private markets so they can function independently. Where I differ from Secretary Preston is in the idea that we can achieve free market bliss through massive government intervention. I would say such measures are counter productive.

Some Context on Stimulus, Inflation and Speculative Markets

Today, John Stossel has a very good piece about the potential ramifications of all of this stimulus that the government intends on applying.

In a free market, prices do more than tell us what we have to pay for things. They are messages emitted by an intricate communications system that inform us of the relative scarcity of resources, labor and consumer goods, and the relative intensity of consumer demand. Thanks to prices, we can tell producers how we rank our preferences, and they in turn can arrange production according to our priorities. Without prices, economic coordination is impossible, which is why attempts at state planning produce, in Ludwig von Mises's words, "planned chaos".

We associate inflation with a rising price level, but equally important, relative prices change when new money is created. That garbles the messages. As Mises writes, "The additional quantity of money does not find its way at first into the pockets of all individuals; ... [P]rice changes which are the result of inflation start with some commodities and services only. ... [T]here is a shift of wealth and income between different social groups."

The Fed gives money to AIG or Citicorp, but not to Lehman Brothers, or you and me. The new bank reserves also push interest rates below what the market would have set, further distorting production by encouraging investment plans to be made on the basis of artificially low rates.How can the economy straighten itself out if it is being systematically skewed by government inference with prices?

Stossel makes two very intuitive points. First, all of this stimulus is inflationary. Second of all, it is skewed inflationary toward one group at the expense of other groups.

These two points should be viewed in the context of the last time the government provided so much stimulus, 2002-2003. At that time, I believe that the Fed provided far too much artificial stimulus when it lowered the Fed Funds Rate below 1%. This artificial stimulus caused banks to borrow far more money than a natural market would have wanted, and this created, in my opinion, the speculative market that lead to the mortgage crisis. Sometimes, we don't recognize just how inflationary a stimulus is exactly because the inflation becomes isolated in or a few sectors. That's exactly what happened with the Federal Reserve's stimulus. From 2003-2006, we saw an explosion in real estate prices. Things varied but on average prices went up about 50% in that time period. Most folks didn't see this as inflation though in fact that's exactly what it was and the inflation was mostly isolated in the value of real estate.

This massive inflation in real estate was part and parcel wrapped up in the speculative nature of the market for real estate. All of this was created by the artificial stimulus of the interest rate cuts. In that event, those that happened to buy into real estate were the winners of this inflation but everyone else that didn't take advantage lost out. During that four year period, many people became priced out of real estate.

Of course, currently we are looking at even more inflationary stimulus and once again the stimulus is isolated. Stossel very intuitively points out that folks like AIG, Citigroup, and the autos will be the beneficiaries of the bailout. So, where all of these folks that are the recipients of the stimulus put that money that will be the market that will see inflation. Furthermore, and much more importantly, because this stimulus is so massive it is likely to cause whatever market is the beneficiary to invariably become speculative. Too much stimulus almost invariably leads to a speculative market wherever that is applied.

What all of this stimulus will eventually do is create disequilibrium in some niche or market. That market will show signs significant potential income and every quick buck artist will begin putting their money there, and we are on a path for another catastrophe created by another speculative market.

Make no mistake the sort of stimulus the government has and will create is unprecedented. We are about to drop about $700 billion into one sector. The kind of stimulus that financial services is about to receive is unprecedented. Furthermore, the Fed Funds Rate currently is 1% and most expect it to go lower and possibly all the way to zero. As such, not only will financial services be flushed with all sorts of cash but they will have access to very loose credit. This is in fact exactly what stimulated the speculative market that caused this mess only the last stimulation was minuscule compared to what we are about to see. By every indication, we are now creating another speculative market to blow up in the next five years.

The Market's Three Competing Forces

Are you one of those that watches the market everyday and is first dismayed by the equity you are losing and second stunned by the enormous volatility? Do you wonder how it can be that the market can continue to rise and fall as much as ten percent daily? The reason that this market continues to show this much volatility is because it continues to be driven by three competing factors each vying for leadership in moving the market. On any given day, the market can be moved by one, two or all three of them. As such, not only does the market show incredible volatility but unpredictability.

1) The economic malaise

That we are in an economic malaise is neither a shock nor in and of itself a stimulus one way or another on the market. The real problem is that we live in a world overwhelmed with economic data. As such, with each passing day there is another economic number that tells us we are in the middle of an economic malaise. Today that number was October's retail sales. The problem is that there are all sorts of numbers. There are weekly numbers, monthly numbers, and quarterly numbers. You can count that nearly every single day there will be a new economic number, and you can count on that number being bad. It's sort of like having a big zit on your nose. You just can't get away from it. That's what it's like to have a really bad economy and an endless stream of economic data. Each and every number is bad and it's a constant reminder that our economy is on the brink of disaster.

2) Government action

While you can count on constant reminders of just how bad the economy is, you can also count on governments all over the world to step in for aggressive action. Sometimes its the Fed, or its equivalents in Europe and beyond, cutting rates. Other times it's the Treasury, or its equivalents, calling a massive stimulus package. Earlier in the week, it was the Chinese government that announced a stimulus package worth roughly $600 billion. It is hard to know if it is merely wishful thinking or confidence, but more times than not the markets respond positively to stimulus, bailouts, and rate cuts. Because there are lots of governments around the world, and even more departments within each government, you can also count on some government somewhere announcing something stimulating that would have a positive effect on the market.

3) Speculation

The main reason that there is so much volatility is because there is now all sorts of speculation in the market. No matter what sort of economic news or action there is in a given day, markets don't move ten percent daily naturally. When we see rapid movements on the level we normally have, that is driven almost entirely by speculators. Speculators come in several different forms. Often times, they are the big money behind things like hedge funds and private equity. Other times, they are simply individuals sitting in front of a computer screen in some bedroom somewhere around the world. The biggest problem with speculators is that they don't respond to any economic data or government action. Their movements are calculated entirely based on technical movements of equities and debts. This is the sort of sophisticated analysis of charts that attempts to predict short term momentum, and frankly, even those that practice in it don't fully understand it themselves. As such, their effect on the market is even more difficult to predict except to say that they will definitely continue to provide volatility. (which is another reason why I continue to back a volatility play)

So, there you have it. On any given day anyone of these three forces will be vying for a leadership role in moving the market. Which one will emerge is anyone's guess, but for the time being they have created quite the roller coaster ride.