President Elect Obama is in Need of a History and Math Lesson

President Elect Obama unveiled most of his economic team today as well as the blue print for his economic recovery package.

President-elect Barack Obama unveiled key elements of his blueprint for turning around the economy -- and the team tasked with making it work -- including a massive stimulus package and tax cuts for a "vast majority" of Americans paid for by the nation's "wealthiest."

Against a backdrop of increasing calls for him to establish a viable economic rescue plan well before he takes office on Jan. 20, Obama said reforms in Washington will be needed to create a "sustainable economy," including larger contributions from taxpayers earning more than $250,000 per year.

"We've got to restore some balance to our tax code and the Bush tax cuts were disproportionately targeted to the very wealthiest Americans -- those who were making more than a quarter million dollars a year can afford to pay a little more," the president-elect said.

"And it is important if we're going to help pay for some of these expenditures that are absolutely necessary to get our economy back on track that those who are in a position to pay a little more do so. Whether that's done through repeal or whether that's done because the Bush tax cuts are not renewed is something that my economic team will be providing me a recommendation on," he said.

Saying his priority is to create 2.5 million jobs and sustain economic growth over the long term are his priorities, Obama on Monday named Timothy Geithner as his choice for Treasury secretary and Lawrence Summers as head of the National Economic Council.

This economic recovery proposal has both a math problem and a history problem. The proposal will cost somewhere between $500 billion and $700 billion. Yet, President Elect Obama says he will pay for it by raising taxes on the wealthiest 5%. This is an absurd distortion of basic math. Raising taxes on the wealthiest Americans will likely net no more than $75 billion in extra receipts and that assumes that most of this won't be eaten away as a result of the weakened economy. That leaves somewhere between $400 and $600 billion unaccounted for. In other words, this is NOT paid for. Rather, we are going to needlessly raise tax on the job creators in order to slightly reduce the massive addition to our budget deficit that his proposal will create.

Obama's second problem is even more troubling. His proposal total dismisses all economic lessons of history. FDR also raised taxes while increasing government spending exponentially during the Depression, and this policy caused our economy to still be in a Depression when he campaigned for President in 1940. That's because the stimulus of increased government spending was combined with the contraction of taking money away from those that create jobs in the private sector.

President Elect Obama continues to cling to the very destructive and faulty notion that if someone can afford higher taxes that this means there are no consequences with making them pay higher taxes.

Just because the wealthy will still be wealthy even while they pay more taxes, doesn't mean this extra tax burden won't contract the economy. The money that Obama is taking from these folks could be used to buy a second home, an investment property, a building, a business, a mutual fund, a stock, or even just simply be deposited into their bank. We no longer live in a world where money is kept in a mattress, and that means any extra tax is money taken out of the economy. The disaster of such a policy in the Great Depression is all the history lesson we need to see where such a policy will take us.

It appears that President Elect Obama is determined to impose income redistribution on our economy in the middle of a serious recession. This sort of social engineering is problematic enough during relatively good times. It is a total and unmitigated disaster during the current economic period.

Will Dodd/Frank Now Rear Its Ugly Head

This past summer I wrote often about mortgage bailout of troubled borrowers championed by Chris Dodd. The bill that passed this past July was in my opinion one of the most corrupt pieces of legislation that I had ever seen. Here is a quick summary of the corruption as I saw it. Chris Dodd received two sweetheart loans from Countrywide. For about a year and a half, Dodd received campaign contributions from Bank of America that averaged to about a $1000 weekly. In the winter last year, Bank of America bought Countrywide. The deal was a potential boondoggle for Bank of America however they also bought all of Countrywide's toxic mortgage debt. Then, we find out that Bank of America helped write this bill, which would transfer most of this toxic debt to mortgages that would now be guaranteed by the federal government. Such a bill would help remove much of this debt from the books of the newly minted company and as such, it would also make the merger a financial boondoggle for Bank of America.

So far, the newly minted bill has been an abject failure.

Since October 1st, HUD reports barely 150 applications from lenders. Yep, that’s just applications. Apparently the lenders weren’t too keen on that principal write-down. So HUD announced new regulations, telling lenders that they only have to write down to 96.5 percent of the current value, and homeowners would not have to spend more than 31 percent of their monthly incomes on the mortgage. The loan could be extended to 40 years.

The reason that the bill has failed to produce much activity is that it has asked banks to take far too large a markdown on their loans. What this means is that banks would be asked to reduce the balance on loans to a balance far lower than the value of the home. In other words, if a troubled borrower owed $250k, the feds would buy the loan but only if the balance were say $200k. In the summer, I didn't see this as a problem for the banks because they would likely get a lot less on their money in the open market than what the feds would offer. At the time the bill passed, Merrill Lynch had just accepted 22 cents on the Dollar for billions in toxic mortgage debt. If banks had to only write down to 60-65%, I thought they would see this as a boon.

Apparently, I was wrong. Banks, so far, have seen the write down stipulations as far too much. As such, the feds are now requiring that loans only be marked down to just under 97% of the value of the property.

The problem with this program is that the more successful it is initially, the more destructive it will be eventually. 97% is the maximum allowed on an FHA loan, the government program that will underwrite these new loans. Furthermore, FHA has strict requirements about prior mortgage history. Most borrowers with any prior mortgage lates are immediately rejected by FHA. This new program will forgive a massive amount of mortgage lates. They will do this because they will also require borrowers to stay within strict debt to income limits of 38%. Strict debt to income limits is another bedrock underwriting guideline of FHA.

The problem is that folks that have been late in the past are significantly more likely to be late in the future. That's why it is one of the standard underwriting guidelines. Furthermore, these borrowers, with mass mortgage lates, are being given loans where the loan to value is maximized. This makes such loans far riskier than FHA ever intended them to be. The math on this isn't very difficult to figure. This means that loans under this program will have far higher default rates than anything that FHA ever intended. There is no other outcome when basic underwriting guidelines are ignored. That's how we got into this mess.

The biggest problem is of course that the federal government will now be the debtor on these new loans. When these loans finally begin to default at ratios far more than what is allowed to make the program viable, it will ultimately be the tax payer, not the banks, that will foot that bill. That's because under this program the Federal government, or the tax payers, will guarantee any loans that will go into default. By moving the risk from the banks themselves to the Federal government, they are inviting exactly the sort of irresponsible behavior that lead us here.

I have felt from the beginning that this bill would eventually take our economic malaise to a place no one can imagine. So far, the banks have resisted allowing my theory to be tested. The government appears determined to make the terms attractive enough so that soon enough we will all see if I am right.

The Citigroup Bailout: The Scam Continues

To no one's great surprise, the Treasury is going to help bailout Citigroup as announced today.

President Bush said he and Treasury Secretary Henry Paulson share concerns with citizens about jobs and savings, and safeguarding financial systems -- like giant banker Citigroup -- is the best way for the economy to recover.

Bush said he spoke with Paulson while flying back from Latin America and agreed that a bailout of Citigroup was necessary.

"We've made these kind of decisions in the past, we made one last night and if need be, we're going to make these kind of decisions to safeguard our financial systems in the future," he said. Overnight, the Treasury Department announced an emergency bailout of Citigroup, which is getting $306 billion in loans and securities of its residential and commercial real estate and other assets in exchange for preferred shares of its stock being submitted to the Treasury and Federal Deposit Insurance Corporation.

In addition, the Treasury announced it is investing $20 billion in Citigroup from the Troubled Asset Relief Program in exchange for preferred stock. Citigroup will restrict enhanced executive compensation and implement the FDIC's mortgage modification program.

What should be stunning and scandalous is that much of this particular bailout will come outside the scope of the $700 billion bailout ratified last month for financial services companies. That the Treasury is planning on finding new funds to bailout Citigroup has enormous ramifications for the bailout and our financial system as a whole.

In fact, the massive bailout was supposed to avert exactly what is happening right now to Citigroup. That it didn't speaks volumes for just how impotent it is turning out to be. Second, if much of the money going to Citigroup is coming outside the initial bailout, where exactly is the bailout money going to? Is all of the bailout really going to something more urgent than saving Citigroup? Keep in mind, the Hartford, currently perfectly viable, is one of the companies currently applying for the bailout.

The scandal of what has occurred is unspeakable. Are the Feds really saying that a major bank suddenly on the brink of going under was something unforeseen a month ago when they asked for the initial bailout? Are the Feds really saying there is absolutely nothing available in the $700 billion to keep Citigroup viable while it restructures? Where has it all gone? If bailing out a major bank so that it doesn't collapse wasn't the intention of the $700 billion bailout, what was? Furthermore, the Feds are even saying that further bailouts maybe necessary and presumably these companies will also get money outside the scope of the initial bailout. So, where did it go and how did it happen that a $700 billion bailout has become woefully short? Why is no one out there explaining how all of this happened?

The tax payers have been scammed in a $700 billion boondoggle. It's clear that the $700 billion is NOT being spent in any productive, constructive, or efficient manner. It appears that a perfectly viable company like the Hartford can apply for funds while a company on the brink like Citigroup needs funds outside the scope of the $700 billion bailout. Does anyone believe the money is being spent efficiently? The taypayers were sold a bill of goods. They were told that troubled assets were going to be bought and possibly sold later at a profit. They were told that this was necessary to stop a disaster. They were told that the whole financial system would collapse without it. None of that is true.

Bailouts, Spending, the Deficit, and the House of Cards of U.S. Treasury Bonds

In the last seventy two hours or so, the government, both current and incoming, has announced plans for massive new spending. The current administration has just announced plans to extend help to Citigroup. Leaders of the incoming Congress plan to introduce a stimulus package that may cost as much as $700 billion.

Sen. Charles Schumer, D-N.Y., said Sunday that he thinks the economic stimulus package should be between $500 billion and $700 billion.

In an interview with ABC's "This Week," Schumer said, "I believe we need a pretty big package here." He added that Congress is working on getting the economic package to President-elect Barack Obama by Inauguration Day. "I think it has to be deep. In my view, it has to be between $500 and $700 billion, and that's because our economy is in serious, serious trouble."

"It's a little like having a new New Deal, but you have to do it before the Depression. Not after," Schumer added.

All of this spending will inevitably be combined with a bailout of the autos that at some point the Congress will give into. Furthermore, this is all on top of the $700 billion rescue package of the financial industry. By the time we are done, we maybe adding about $2 trillion onto our national deficit.

So, some might ask where does the U.S. government find all of this money. Much like any other powerful organization the U.S. government finds money by issuing debt in the form of bonds, U.S. treasury bonds. Just as corporations issue Corporate bonds when they want to borrow, the U.S. Treasury issues U.S. Treasury bonds.

U.S. Treasury bonds are the safest investment in the world. We've never had one default even though we've issued trillions of Dollars worth of bonds. How did this happen though? The way that the U.S. Treasury pays for debt is actually by issuing new debt. The U.S. Treasury bond market is so robust that the Treasury is able to continue to stay in debt indefinitely. That's because no matter how much debt it issues, through bonds, there is always plenty of buyers for their bonds. Debt is always paid back on time because there is always someone, plenty of someones, willing to take on new debt.

This comes from the perception that our economy and country are vibrant. Furthermore, it comes from the reputation that has been built up from decades of having perfect history of paying this debt back. If the U.S. Treasury ever issued new debt and no one bought it though, the proverbial house of cards would fall.

That is something to think about as our government continues to dig deeper into debt. At some point the market for our debt will say enough is enough. I don't know where that number is and it's almost certain to be a lot higher than our current plans for new expenditures. As we fall deeper and deeper into debt, some think the money just magically appears. It doesn't magically appear, but rather it is created through the issuance of new debt. Furthermore, our entire system of deficit spending is predicated on the assumption that there will always be buyers for new debt. We are entering an entirely new phase of the global economy. It's difficult to know just how much desire there will be in the future for U.S. Treasuries.

Furthermore, the nightmare scenario is not the only one that can cause the United States all sorts of problems. Even if there continues to be enough of a market, all of this newly issued debt will likely cause an imbalance between buyers and sellers. Because the market will need to find buyers for the newly issued debt, there will be less of them in the aftermarket. This will likely, eventually, cause Treasury bond rates to go up. Right now, the U.S. Treasury has to pay little for its debt, just over 3% for the 10 year bond and just under 4% for the 30 year. If rates go up, the U.S. Treasury will have to use more and more of each borrowed Dollar for owed interest. That will of course cause the Treasury to borrow even more. Furthermore, it will cause our borrowing to be much less efficient since much more of it will go to paying interest. All of this borrowing has a vicious cycle effect eventually. It's difficult if not impossible to know at what level it gets triggered, and let's all hope the current rate of borrowing won't get us there.

Citigroup, the Bailout, and the Wrath of Moral Hazards

(H/T to Michelle Malkin) To no one's surprise, negotiations are already under way between the Feds and Citigroup for yet another bailout.

Citigroup Inc. will probably get rescued by the U.S. government after a crisis in confidence erased half its stock-market value in three days, investors and analysts said.

Citigroup has more than $2 trillion of assets, dwarfing companies such as American International Group Inc. that got U.S. support this year. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke may favor a rescue to avoid the chaotic aftermath of Lehman Brothers Holdings Inc.’s bankruptcy in September.

“There is no question that Citi is in the category of ‘too big to fail,’” said Michael Holland, chairman and founder of Holland & Co. in New York, which oversees $4 billion. “There is a commitment from this administration and the next to do what it takes to save Citi.”

…Including a $25 billion capital injection from the U.S. Treasury under the $700 billion Troubled Asset Relief Program, the company has at least $50 billion of capital above the amount required by regulators to qualify as “well capitalized.” Capital is the cushion banks must keep to absorb losses and protect depositors.

Deutsche Bank AG analyst Mike Mayo wrote in a report today that the bank’s $25 billion of reserves, when combined with other resources, “should be enough to cover estimated cumulative losses of $50 billion on loans.’” Mayo rates the stock “hold” and has a $9 price target.“With Citi being as big as they are, the government will make a special case and step in and find another reason to dispose of more TARP funds,” said Matt McCormick, a portfolio manager and banking analyst at Bahl & Gaynor Investment Counsel in Cincinnati, which manages about $2.9 billion and doesn’t own Citigroup stock or debt.

According to the Wall Street Journal, Citigroup is looking at a number of options including selling off assets and breaking up the company. Furthermore, the CEO, Vikram Pandit, characterized Citigroup's business model as excellent and blamed their problems on fear mongering by their competitors. Frankly, if he is characterizing things correctly, Citigroup shouldn't be in need of a bailout.

The problem here, as I see it, is that a government bailout became a part of the company's myriad of options immediately. When a company is struggling there are many options, and none of them are pleasant. Companies can downsize, sell assets, borrow (if someone will lend), or issue more stock. The first two will make the company less powerful. The fourth will make each shareholder's shares less valuable. That's the way it is supposed to be. When your company gets in trouble, you do unpleasant things to get it out of trouble. This painful process is all part of vibrant capitalistic system. That's because the pain associated with turning around a company that is upside down like Citigroup keeps the players from making that are too risky or face winding up in such a situation.

The moment that the system takes away the pain, we have what is known as moral hazard, a concept I have written about often.

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. Moral hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions. For example, an individual with insurance against automobile theft may be less vigilant about locking his or her car, because the negative consequences of automobile theft are (partially) borne by the insurance company.

Going to Capitol Hill, eating crow, and then begging for tax payer money is a lot less painful than having to watch the company you rule over get halved, or worse having the same thing happen with your investment. (as in when a company issues a lot more shares)

What this nonstop bailout palooza has created is an environment where a bailout is now one of several legitimate options for any company in trouble. What sorts of behaviors will this create? First, companies will put off making tough decisions since they know that if all else fails they will get a bailout. They will pay less attention to their leverage. They will take more risks. They will do all those things that everyone does when the pain associated with failure is minimized. Moral hazard is not merely a concept to be learned in advanced economics. It is a state of mind that breeds the worst kind of behavior from the players in our capitalistic system. It's exactly the environment that we now have with bailout palooza.

Sarah Palin's Path to the White House 2012

I have been hesitant to comment or speculate on 2012 because it's foolish and in many ways useless. Furthermore, we just finished up a long and tumultuous election, and so we may need a break from speculating on elections. It's a point of debate, of great debate to some, whether or not she is fit to be President. What is, in my opinion, beyond debate is that her path to the White House is as clear as anyone short of the President elect. Here is the blue print.

2009-2011, January

For the next two years plus, Palin has a job and if she has any further ambitions, all she should focus on now is being Governor of Alaska. As most know, she entered the Presidential race with about 80% approval ratings. That's likely to dip some if not a lot for a myriad of reasons. Her national combative profile likely turned off a lot of people in Alaska which likely didn't have such an image of her. An approval rating that high is always going to fall. Just ask President Bush, he had an even higher ratings in the early part of 2002. Finally, with oil prices dipping, the economic outlook of Alaska becomes a lot more unclear.

Here is the reality. Palin has done a remarkable job as Governor. She re negotiated a corrupt contract with the oil companies. She passed landmark legislation on ethics reform. She cut taxes and she even sent each and every citizen a check. While her job performance has been excellent, it has also been in a very favorable environment.

Now, the economy will become a much bigger burden. Her opponents will feel emboldened after her higher profile, and the glare of the media spotlight will be on her. Now is when she, as they say, will really earn her paycheck. The next two years will likely be nowhere near as successful as the prior two, and frankly they don't have to be. If Palin maintains approval ratings above 55% when she leaves office, she will be in perfect position to run for President in 2012. She should wait as long as possible, but I wouldn't seek another term beyond the current one. Running for President takes almost two years. It will take up most of her time. She shouldn't run for re election unless she is committed to serve. She wants to wait as long as possible so that the legislature doesn't have an opportunity to consider her a lame duck.

One thing that is not up for debate is that Palin is now a star. That's why the next two years should be spent governing effectively. She will get plenty of publicity in a manner that a governor and certainly one from Alaska has never received. However she governs, her record will be on display for a national audience, and that's why it's vital that she govern effectively.

2011 February on

I would wait weeks not months following the inauguration of the next Congress to announce an exploratory committee. Announcing early, early than most, gives her a few vital advantages. First, she can immediately set up geographically within the continental United States. Her ability to navigate a Presidential campaign from Alaska is limited. She needs to immerse herself inside the continental U.S. and the sooner the better. Second, it immediately allows her to fundraise. You think that Obama's fundraising prowess is impressive, wait until Palin runs her own national campaign.

By fundraising early, Palin can knock out a lot of opponents because they will see just how much she has raised and realize they simply can't compete.

Then, she immediately does the formal rounds. CPAC is normally held in late February or early March. It is the single biggest and most important gathering of Conservatives in any given year. Talk about a target rich environment. There is no more audience more favorable to Palin than this one. It's also the perfect opportunity to formally throw her hat in the Presidential ring. If she did that, the announcement would be the talk of the conference. It would take the oxygen from any other potential opponent as well. As such, while we would still be a year out, just by maneuvering correctly she would immediately have an early commanding lead.

Palin will then need to make the rounds to other hallmark events like the Iowa County Fair. Palin will have an opportunity to develop a very unique campaign theme. First, she will be the first truly consistent conservative to be a serious Presidential candidate since the standard bearer, Ronald Reagan. Republicans have been itching for the next generation of a consistent conservative and now they will have their chance. She can combine this with a uniquel populist theme. She needs to develop the populist theme by highlighting those portions of her record. Her record as a whistle blower, taking on her own party, and taking on the oil companies. Those are the sorts of things that are likely to be very appealing to moderates and independents if framed correctly. Finally, when this is combined with the historic nature of her campaign, she has a chance to develop a very formidabel coalition.

2012 will either be very ripe for Palin or it will be an uphill battle for any Republican. If we are still facing an economic malaise, unemployment north of 6.5% for instance, it will give her a perfect opportunity to make the campaign a referendum on Obama's first term. Furthermore, it's clear that Obama and the Democrats are ready to spend in an unprecedented manner and so deficits will likely be at unprecedented levels by 2012. This will give her another opportunity to make the comparison between Obama's government expansionist policies and her own record in making government efficient.

If Palin is shrewd, she will make the case that the country lost its way as soon as the government got away from conservative principles. The last time we had a truly economic conservative President was Reagan. His record of deregulation, tax cuts, and deregulation unleashed the power of our economy that only stopped a couple months ago. The country will be reintroduced to the corrosive effect of regulations following Obama's "new regulatory framework" (whatever that maybe), and so the environment will be ripe for a renewed deregulatory spirit. Politics is very cyclical. Tax cuts, free markets and small government are concepts largely out of favor. We will have four years of the exact opposite. There's nothing like exposure to the opposite to make people appreciate such concepts again. These will all be themes ripe to run on in 2012, and they are all concepts that Palin not only believes in but has a record of accomplishing.

She will have to get past people's fears that she is a novice on foreign policy. The best way to do this is to get out in front of tough interviews and answer difficult foreign policy questions. Hopefully, she learns from the mistakes of the McCain campaign and she allows herself to be the most media accessible and non discriminatory candidate we have had. The more foreign policy questions she answers with confidence, clarity and detail, the more she will get over this hurdle. She will have the next two years to observe, process, and develop her own foreign policy philosophy. If she uses it wisely, she will be ready for these questions come 2012. Finally, she must emphasize competence. She must emphasis a history of accomplishment. It was the total lack of competence that defined the Republicans from 2002-2008, and to make a clean break, Palin must run on a record of competence. (which is another reason why all of this is predicated on having two more successful years as governor. It's hard to run on competence with a record of incompetence)

All right, it's four years out, but this is about as detailed a path to the Presidency as you will find.

Michael Vick's Very Troubling Profile

Earlier this week, Michael Vick was back in court to face a series of state charges.

Vick is serving a 23-month sentence in a minimum-security federal prison camp in Leavenworth, Kan., on a conspiracy charge relating to the interstate dogfighting operation he helped run on a property he owned in Surry County, Va. Vick is scheduled to be released on July 20, 2009.

Vick is currently being held in protective custody at Riverside Regional Jail in Hopewell, Va., until his hearing on Tuesday in Surry County Circuit Court to plead guilty to two state charges related to dogfighting.

The state charges -- one count of torturing and killing dogs and one count of promoting dogfighting -- each carry a maximum prison term of five years. But under the terms of his plea agreement, Vick is expected to receive a three-year suspended prison term and a $2,500 fine (which would be suspended if he pays court costs and maintains good behavior for four years).

By resolving the pending state charges, Vick would qualify to participate in the Federal Bureau of Prisons re-entry program, which could enable him to serve part of the
remainder of his federal sentence in a halfway house.

I for one hope that Vick gets his life back on track and I am willing to forgive him if he genuinely looks for forgiveness. That said, the nature of the crimes has admitted to along with his profile lead to a very troubling combination.

First, his participation in dog fighting has all the hallmarks of a sociopath, an individual devoid of a conscience. That's frankly the only way he could justify such a brutal act on a defenseless animal. He justified it because in his mind there was nothing to justify. A sociopath is so selfish that anyone else's feelings or thoughts never enter to the equation in their decision making process. Michael Vick justified being the ringleader in this dog fighting operation because the brutality that this would do to the dogs never even crossed his mind when he made the decision.

Second, to find the brutal sport of dog fighting enjoyable an individual must be afflicted with an enormous amount of sadism. Vick enjoys the sight of pain in a way that would make must people squirm. Rather than squirming, Vick gets a rush out of watching others inflict pain on each other.

pitbulls

Someone with this much sadistic tendencies is exposed to all sorts of criminal tendencies far beyond dog fighting, and when those tendencies are combined with sociopathy.

Finally, prior to being jailed, Michael Vick was in the middle of a contract worth well in excess of $100 million. This not only likely gives Vick an enormous sense of entitlement but power. It gives Vick the resources to do a nearly unlimited amount of damage but also the sense of entitlement for the worst kind of reckless behavior.

It's frankly not a very long road from animal torture to crimes much worse than that. In fact, serial killers like Jeffrey Dahmer started their evil with animal torture. The sort of behavior traits that it takes in order to engage in such a vicious behavior is exactly the sort of behavior that creates criminals and other sociopaths that spend their lives being a cancer to every situation they come into contact with. I hope that Michael Vick has taken his time in jail to try and conquer his demons, but if he hasn't, he has a very troubling profile. It's a profile of an individual that will go on to do things much worse than orchestrating a dog fighting ring.