The Federal Reserve released new data on the financial condition of the household sector of the United States. Like other sectors of the economy, the financial condition of this sector has deteriorated over the past year.
The value of household assets dropped about 15% falling from $77.3 trillion to around $65.7 trillion. Most of the decline came from the fall in housing values and in their stock market portfolios.
In terms of household holdings of stocks, the value of the stocks households owned, mutual funds that were held and funds in retirement plans, the loss was $8.5 trillion. That is, the value of stock holdings fell from $20.6 trillion to $12.1 trillion.
Although mortgage credit fell during the year, total household liabilities stayed roughly the same at about $14.2 trillion. This means that debt as a percentage of assets rose from around 18% to 22% during the year (or net worth as a percentage of assets dropped from 82% to 78%).
Mortgage credit at the end of 2008 was $10.5 trillion so that other household liabilities totaled around $3.7 trillion, with consumer credit making up $2.6 trillion of this latter number. Mortgage credit fell during the year, but not because the household sector was trying to get out of mortgage debt. The primary reason for the decline was foreclosures and the reduction in the willingness of financial institutions to lend.
What this means is that households took on increased leverage during the year, not because they wanted to in order to grow their balance sheets, but because of the decrease in the value of their assets and because of the need to borrow due to lower incomes. The increased leverage was a result of the collapse of the mortgage market, in particular, and the economy, in general. The increased leverage just happened—it was not planned.
In order to protect themselves in the face of these changes, households moved assets into cash and cash equivalent accounts. Banks deposits held by households were at about $7.7 trillion at year end.
This is important information for understanding the state of the economy and the contribution the household sector might make toward turning the economy around. The household sector was in free fall in 2008 and was reacting to events, not leading them.
Households took three major shocks last year: first was the decline in housing prices; the second was the rise in unemployment; and the third was the fall in the stock market. Not only was their cash flow significantly hurt, but the value of their assets fell precipitously. They borrowed in an effort to hold on and they became more liquid so as to be prepared for that “rainy day.”
The year 2009 does not look any better than 2008. Housing prices continue to plummet. The stock market has dropped since the first of the year. And, unemployment has ratcheted up. That is, one can assume that the direction observed in the balance sheets of American household in 2008 will continue to be followed this year. Even if the stock market were to stabilize or rise through the rest of the year consumer spending, I believe, will continue to be weak. Even if housing prices stabilize. Even with the implementation of the Obama stimulus plan.
According to the best information we have there are three further shocks looming on the horizon. The first two have to do with the mortgage market: over the next 18 a large amount of Alt-A and Options mortgages are supposed to re-price. Given the weakness in employment that is expected to continue and the lower household incomes, this event could be devastating. And, on top of that credit card delinquencies are rising and these are expected to grow given the financial condition of the household sector.
Consumers will continue to withdraw from the marketplace as they add debt where they can in order to maintain at least a part of their former living standards. Also, consumers will continue to try and become more liquid so that they can be prepared should they need to need cash to tide them over a rough time. Any improvement in the stock market will be met with households selling more stock so as to move the funds into more liquid assets, the rise in the market making it easier for them to get rid of stocks—even at a loss.
And where are the funds going to go that come to households from the Obama recovery plan? My guess is that a good portion of them will go into liquid assets, or into paying down debt. Households are scared right now. They are going to use whatever they have as conservatively as possible. This even goes for those that have some security in their employment condition.
The data that are coming out confirm the strength of the problem that the policy makers face. The United States has a tremendous debt overhang. This debt problem is going to have to be worked off. Economists talk about “the paradox of thrift”, the problem that consumers are not spending at this time and probably will not spend much in the near future, even though if everyone opened up their pocketbooks and spent, everyone would be better off.
This situation is like a “Prisoner’s Dilemma” game. If everyone else increases their spending reducing their savings and, willingly, increasing their debt and I don’t follow their lead, then I will be a lot better off that all these other people. But, if everyone else believes as I do and doesn’t reduce their savings and doesn’t increase their debt, then I end up losing big to everyone else. So, as in the “Prisoner’s Dilemma” everyone defaults to the decision to save more where they can and to pay off their debt. The consequence of this will be that consumer spending will remain weak and much effort will be extended, where possible, to work themselves out of debt.
The overall problem is that there is too much debt outstanding. The policy makers are focusing upon stimulating the economy by increasing spending. If the debt overhang is truly too great, then the stimulus package will only have a small multiplier effect on the economy as households try and get their balance sheets back in some kind of order.
Such behavior will not have much affect on the economy, and it will also not have much affect on the stock market. Government policy makers must direct more attention to resolving this debt problem. It seems to me that this is what the financial markets are trying to tell them. As Citigroup and Bank of America claim they are showing some signs of profitability. As General Electric survives a reduction in its credit rating, meaning that GE Capital has more of a chance to re-structure itself. As General Motors indicates that it has reduced costs sufficiently to rescind the request for another $2 billion from the government in March. And, as other financial institutions seek to repay to TARP money they had received last fall, the stock market rebounds.
It is the debt problem that is the big concern of the financial markets. In my opinion, as long as the government policy makers put their primary focus on stimulating spending, the financial markets—and the economy—will continue to flounder. When they refocus on the more crucial problem they will find that the financial markets will be more supportive of what they are doing.
Showing posts with label Obama Stimulus Plan. Show all posts
Showing posts with label Obama Stimulus Plan. Show all posts
Thursday, March 12, 2009
Tuesday, March 3, 2009
A Case Study in Unknown Asset Values: A. I. G.
My blog of March 1, 2009, “Uncertain Asset Values and the Stock Market” (http://maseportfolio.blogspot.com/), was written before the most recent news surfaced about the continuing bailout of A. I. G. I believe that the example of A. I. G. represents a perfect ‘test case’ for what was presented in that post.
The March 1 blog contended that the major uncertainty facing the investment community…and the Federal Government…is the value of assets on the books of many of the nations businesses…especially many large and important firms that are “too big to fail.” The argument is that this uncertainty has to be cleared up as much as possible before the economy is really going to have a chance to regain its health.
The problem now is that not only are companies withholding information from the investing public…but the government is also withholding information from the investing public. Specifically, companies…and the government…are afraid to release information on who they are dealing with…the “web of counterparties”…because of their concern that the release of these names would cause a panic leading to deposit withdrawals or the cashing in of insurance policies and so forth.
This is the old “after-the-fact” problem. I used to be a part of “information sessions” for journalists to help them understand banking and the issues that surrounded the banking industry. One of the concerns that always came up at these sessions was about what responsibilities “the press” had in reporting on troubled banks. That is, if a journalist “knew” that a bank was in trouble…what responsibility did that person have to report that the bank was having problems…and thus, perhaps, cause a “run” on the bank.
This is an “after-the-fact” problem. The bank is already a troubled bank…now what do I do?
One of the arguments I made was that journalists should keep up closely enough with banks to report when banks were starting to experience difficulties. By making this information public, the press could help prevent the bank getting too far into a mess because it would want to avoid the bad publicity and work to rectify the difficulties before they got “out-of-hand.”
This, of course, was very difficult because of the insufficient reporting requirements applied to banks and the secrecy surrounding the regulatory examinations. And, if banks knew that they were being scrutinized that closely by “the press” they would certainty make it just that much more difficult for the “outsiders” to obtain information.
So, investors and communities had little information on financial institutions that were important to them and had to “trust” the regulatory agencies to apply the appropriate oversight to the banking system. Of course, the regulatory agencies did not always have “full information”, especially as the financial conglomerates began transacting in very sophisticated derivative securities and taking many assets “off balance sheet.”
I believe that the company A. I. G. is a striking picture of how this scenario played out. A. I. G. is a holding company that began as an insurance company and then diversified itself into a financial conglomerate that included a hedge fund and other “black box” investment vehicles. Their primary regulators were the state insurance regulators (and some international regulatory requirements) and the state laws caused the subsidiaries to be highly segregated so as to ensure the safety of those the insurance subsidiary had insured.
The rest of the company was not regulated to any degree. As a consequence, A. I. G. was able to build up a huge financial conglomerate that could engage in untold transactions that were both un-regulated…and un-disclosed! The accounting and reporting rules were such that investors…and the public…and the government…and even other areas within the company did not have any idea about the risk exposure of the holding company or the “spider-web” of relationships that made it a potential “carrier of contagion.”
And, we…and the government…still don’t know what the potential damage could be from this dismal situation!
As a consequence, the probability of a fifth (this last bailout was the fourth return to A. I. G.) is a lot higher than we would like it to be. And a sixth? And a seventh?
With the government owning almost 80% of the company it would seem like any additional funds would be relatively small.
But, that is the problem…we don’t know! No one seems to have a handle on the value of the A. I. G. assets!
And, as I argued in “Uncertain Asset Values and the Stock Market”, this problem exists throughout the economy. What about the assets of Citigroup? What about the assets of Bank of America? Again, to quote the earlier blog, “It is not altogether clear that even the people running a large part of this economy have any idea about the value of their own assets.” Again, I take A. I. G. as the example.
And, then we have General Electric…and the problems of GE Capital. Again…we have another conglomerate with few pieces that go together. For years, GE Capital carried the rest of General Electric. And, what happens if you have one subsidiary making up for the “not-so-good” performance of other subsidiaries? You put more and more pressure on the performing subsidiary to produce exceptional results. And, how do you do that? You take riskier assets into your portfolio and you increase leverage. Simple!
Now, GE Capital is suffering along with other financial companies that attempted to extend “exceptional” returns. And, with GE Capital failing to perform…the spotlight is being focused on all the other subsidiaries that were only mediocre performers. Consequently, General Electric must face the value of ALL of its companies and determine what are the asset values under its umbrella.
This, to me, is the picture that is unfolding…and the problems we face are not going to be resolved until we get a better grasp on asset values. But, we need to do this quickly because…and this is the problem of bad assets…the value keeps dropping if the difficulties are not resolved. This is true of bad assets in an individual institution…I saw this over and over again in the banks I helped turnaround…and it is true with the financial and economic system. In fact, that is the problem with a contagion…bad assets tend to play off of bad assets…and the difficulties cumulate. This is all the more reason for attempting to get a handle on asset values as soon as possible.
A $787 billion economic recovery plan is insufficient to overcome the possibilities of a multi-trillion dollar write-down of assets!
The March 1 blog contended that the major uncertainty facing the investment community…and the Federal Government…is the value of assets on the books of many of the nations businesses…especially many large and important firms that are “too big to fail.” The argument is that this uncertainty has to be cleared up as much as possible before the economy is really going to have a chance to regain its health.
The problem now is that not only are companies withholding information from the investing public…but the government is also withholding information from the investing public. Specifically, companies…and the government…are afraid to release information on who they are dealing with…the “web of counterparties”…because of their concern that the release of these names would cause a panic leading to deposit withdrawals or the cashing in of insurance policies and so forth.
This is the old “after-the-fact” problem. I used to be a part of “information sessions” for journalists to help them understand banking and the issues that surrounded the banking industry. One of the concerns that always came up at these sessions was about what responsibilities “the press” had in reporting on troubled banks. That is, if a journalist “knew” that a bank was in trouble…what responsibility did that person have to report that the bank was having problems…and thus, perhaps, cause a “run” on the bank.
This is an “after-the-fact” problem. The bank is already a troubled bank…now what do I do?
One of the arguments I made was that journalists should keep up closely enough with banks to report when banks were starting to experience difficulties. By making this information public, the press could help prevent the bank getting too far into a mess because it would want to avoid the bad publicity and work to rectify the difficulties before they got “out-of-hand.”
This, of course, was very difficult because of the insufficient reporting requirements applied to banks and the secrecy surrounding the regulatory examinations. And, if banks knew that they were being scrutinized that closely by “the press” they would certainty make it just that much more difficult for the “outsiders” to obtain information.
So, investors and communities had little information on financial institutions that were important to them and had to “trust” the regulatory agencies to apply the appropriate oversight to the banking system. Of course, the regulatory agencies did not always have “full information”, especially as the financial conglomerates began transacting in very sophisticated derivative securities and taking many assets “off balance sheet.”
I believe that the company A. I. G. is a striking picture of how this scenario played out. A. I. G. is a holding company that began as an insurance company and then diversified itself into a financial conglomerate that included a hedge fund and other “black box” investment vehicles. Their primary regulators were the state insurance regulators (and some international regulatory requirements) and the state laws caused the subsidiaries to be highly segregated so as to ensure the safety of those the insurance subsidiary had insured.
The rest of the company was not regulated to any degree. As a consequence, A. I. G. was able to build up a huge financial conglomerate that could engage in untold transactions that were both un-regulated…and un-disclosed! The accounting and reporting rules were such that investors…and the public…and the government…and even other areas within the company did not have any idea about the risk exposure of the holding company or the “spider-web” of relationships that made it a potential “carrier of contagion.”
And, we…and the government…still don’t know what the potential damage could be from this dismal situation!
As a consequence, the probability of a fifth (this last bailout was the fourth return to A. I. G.) is a lot higher than we would like it to be. And a sixth? And a seventh?
With the government owning almost 80% of the company it would seem like any additional funds would be relatively small.
But, that is the problem…we don’t know! No one seems to have a handle on the value of the A. I. G. assets!
And, as I argued in “Uncertain Asset Values and the Stock Market”, this problem exists throughout the economy. What about the assets of Citigroup? What about the assets of Bank of America? Again, to quote the earlier blog, “It is not altogether clear that even the people running a large part of this economy have any idea about the value of their own assets.” Again, I take A. I. G. as the example.
And, then we have General Electric…and the problems of GE Capital. Again…we have another conglomerate with few pieces that go together. For years, GE Capital carried the rest of General Electric. And, what happens if you have one subsidiary making up for the “not-so-good” performance of other subsidiaries? You put more and more pressure on the performing subsidiary to produce exceptional results. And, how do you do that? You take riskier assets into your portfolio and you increase leverage. Simple!
Now, GE Capital is suffering along with other financial companies that attempted to extend “exceptional” returns. And, with GE Capital failing to perform…the spotlight is being focused on all the other subsidiaries that were only mediocre performers. Consequently, General Electric must face the value of ALL of its companies and determine what are the asset values under its umbrella.
This, to me, is the picture that is unfolding…and the problems we face are not going to be resolved until we get a better grasp on asset values. But, we need to do this quickly because…and this is the problem of bad assets…the value keeps dropping if the difficulties are not resolved. This is true of bad assets in an individual institution…I saw this over and over again in the banks I helped turnaround…and it is true with the financial and economic system. In fact, that is the problem with a contagion…bad assets tend to play off of bad assets…and the difficulties cumulate. This is all the more reason for attempting to get a handle on asset values as soon as possible.
A $787 billion economic recovery plan is insufficient to overcome the possibilities of a multi-trillion dollar write-down of assets!
Wednesday, February 25, 2009
The Obama Speech: The Day After
The Obama speech to the Congress on Tuesday night was “well given” and, basically, “well received”. It has been criticized for, among other things, not being specific enough. But, this was not the purpose of the speech. The speech was the first effort of the new President to lay out a vision for the near term and the future.
It was about the “vision” thing. A leader is, first and foremost, supposed to give us the “big picture” and not the details. The leader is supposed to provide us with something we can hold onto because we like the worldview it represents…or, provide us with something to disagree with because it does not conform to our worldview. I think that President Obama did that.
In terms of the crises in the economy and the financial markets, the thing that does not seem to come through in the “big picture”, however, is that there are two categories of problems we face. These two sets of problems can be put into boxes that are labeled…the problems of the past…and the problems of the future.
These are different issues and must receive different attention if they are to be resolved. Too often we lump them together for a bastard “Keynesian” solution.
The first set of problems has to do with debt…too much of it…and inappropriately assumed. This is the box of problems from the past…the box labeled “Insolvency Crisis”.
Too much debt, inappropriately assumed is a burden…it can cause finance and commerce to slow down or stop…and this can lead to a cumulative result in which the burden of the debt gets heavier and heavier. This burden is exacerbated as insolvencies grow and deflation becomes the problem (not inflation).
It has been argued that the only thing government can do to counter this problem is to reflate (Irving Fisher) or inflate (Keynes). That is, the only way government can lessen the burden of this excessive load of debt is to reduce the “real” value of the debt by causing prices to rise rapidly. But, this only recreates the environment in which the excessive debt was created! And, the consequence of this is just more and more leverage…which, in the longer run only makes the situation that much worse.
The excessive debt was created within the asset bubble world of the last decade or so. This world of asset price inflation resulted in a greater assumption of riskier assets and an overly aggressive assumption of leverage.
Financial and economic positions were taken than could only be justified within the rarefied world of the bubble!
The valuations from that time cannot stand up…outside the bubble!
In the case of the “Insolvency Crisis”, I believe that the only three choices are:
1. let the economy adjust to more realistic valuations by itself and just accept that we have to bear the burden of this adjustment;
2. help to smooth out the adjustment to more realistic valuations;
3. inflate our way out of the crisis…which, of course, would mean that we were just postponing the resolution of the foundation of the crisis.
The third of these choices is often attributed to Keynes and it is, I believe, an inappropriate application of Keynesian thinking…because it does not really resolve the situation.
President Obama is opting for choice number two…a choice I think most of us agree with. He is saying that choice number one is just too painful for the country and it’s people to go through. Hence, government must play a role in helping people and institutions work through the “debt problem” and that is going to cost…how much, we just don’t know.
That is the vision…the devil is in the details. And, that, I believe, is the problem right now. Most of us can agree with the vision…we just haven’t received sufficient information on how this is going to be done and how much it might cost. And, without greater certainty…markets will drop!
The second set of problems has to do with the future…and the box containing this set of problems is labeled “What We Want To Be.” President Obama stated in his speech Tuesday evening that in his vision of the future, he sees America as energy independent…he sees Americans protected with some form of universal healthcare…he sees Americans as among the best educated in the world. President Obama sees an America that is energetic and innovative…a continuation of what America has been in the past.
This, to me, is the stimulative part of the President’s program…the part of the program that is not focused on the consolidation of past ills, as is the part of the program discussed above. This part of the program is an effort to provide incentives to create the next era and not “bailout” the old.
That is the vision…the devil is in the details. A first look at some of the specifics came in the stimulus package recently passed. More will be coming in the near future. Again, more details will help us get over the grey areas of uncertainty that constrain our willingness to commit.
We need to keep these two sets of problems separate as we go forward. The first set of problems is going to take time…and not everything that is done to resolve these issues is going to be “fair”. As I have said before, once one has created this set of problems, one finds that all the choices available for solving the problems are not happy ones. But, “inflating” our way out of these problems is not the solution…it can only, ultimately, make more pain for the future.
The second set of problems must be looked upon in terms of the opportunities that are available to us. In my view, no serious economic crisis has ever been resolved without the creation of new innovations and new technological platforms. In the Great Depression, the innovations and the new technologies did really come about until the end of the 1930s and into the 1940s and were related to war. Earlier stimulus efforts in the 1930s tended to support what existed in the past.
We don’t want government providing stimulus to the economy that will just result in the old world being “re-created”…we do not want the “old” products or the “old” managements renewed and rewarded! We must move on to the future.
By providing his “vision” of this future, President Obama has changed the field of engagement. President Obama is not just talking “stimulus”…he is talking about the world we want to live in. We may not agree with him on everything. We may not agree with him on most things. But, we must accept the challenge, and…while we are attempting to resolve the debt problems from the past…we must enter the dialogue and debate about what the shape of the future will be.
In this sense, what President Obama has put forth is a stimulus plan…but with more than just one meaning of the word stimulus.
It was about the “vision” thing. A leader is, first and foremost, supposed to give us the “big picture” and not the details. The leader is supposed to provide us with something we can hold onto because we like the worldview it represents…or, provide us with something to disagree with because it does not conform to our worldview. I think that President Obama did that.
In terms of the crises in the economy and the financial markets, the thing that does not seem to come through in the “big picture”, however, is that there are two categories of problems we face. These two sets of problems can be put into boxes that are labeled…the problems of the past…and the problems of the future.
These are different issues and must receive different attention if they are to be resolved. Too often we lump them together for a bastard “Keynesian” solution.
The first set of problems has to do with debt…too much of it…and inappropriately assumed. This is the box of problems from the past…the box labeled “Insolvency Crisis”.
Too much debt, inappropriately assumed is a burden…it can cause finance and commerce to slow down or stop…and this can lead to a cumulative result in which the burden of the debt gets heavier and heavier. This burden is exacerbated as insolvencies grow and deflation becomes the problem (not inflation).
It has been argued that the only thing government can do to counter this problem is to reflate (Irving Fisher) or inflate (Keynes). That is, the only way government can lessen the burden of this excessive load of debt is to reduce the “real” value of the debt by causing prices to rise rapidly. But, this only recreates the environment in which the excessive debt was created! And, the consequence of this is just more and more leverage…which, in the longer run only makes the situation that much worse.
The excessive debt was created within the asset bubble world of the last decade or so. This world of asset price inflation resulted in a greater assumption of riskier assets and an overly aggressive assumption of leverage.
Financial and economic positions were taken than could only be justified within the rarefied world of the bubble!
The valuations from that time cannot stand up…outside the bubble!
In the case of the “Insolvency Crisis”, I believe that the only three choices are:
1. let the economy adjust to more realistic valuations by itself and just accept that we have to bear the burden of this adjustment;
2. help to smooth out the adjustment to more realistic valuations;
3. inflate our way out of the crisis…which, of course, would mean that we were just postponing the resolution of the foundation of the crisis.
The third of these choices is often attributed to Keynes and it is, I believe, an inappropriate application of Keynesian thinking…because it does not really resolve the situation.
President Obama is opting for choice number two…a choice I think most of us agree with. He is saying that choice number one is just too painful for the country and it’s people to go through. Hence, government must play a role in helping people and institutions work through the “debt problem” and that is going to cost…how much, we just don’t know.
That is the vision…the devil is in the details. And, that, I believe, is the problem right now. Most of us can agree with the vision…we just haven’t received sufficient information on how this is going to be done and how much it might cost. And, without greater certainty…markets will drop!
The second set of problems has to do with the future…and the box containing this set of problems is labeled “What We Want To Be.” President Obama stated in his speech Tuesday evening that in his vision of the future, he sees America as energy independent…he sees Americans protected with some form of universal healthcare…he sees Americans as among the best educated in the world. President Obama sees an America that is energetic and innovative…a continuation of what America has been in the past.
This, to me, is the stimulative part of the President’s program…the part of the program that is not focused on the consolidation of past ills, as is the part of the program discussed above. This part of the program is an effort to provide incentives to create the next era and not “bailout” the old.
That is the vision…the devil is in the details. A first look at some of the specifics came in the stimulus package recently passed. More will be coming in the near future. Again, more details will help us get over the grey areas of uncertainty that constrain our willingness to commit.
We need to keep these two sets of problems separate as we go forward. The first set of problems is going to take time…and not everything that is done to resolve these issues is going to be “fair”. As I have said before, once one has created this set of problems, one finds that all the choices available for solving the problems are not happy ones. But, “inflating” our way out of these problems is not the solution…it can only, ultimately, make more pain for the future.
The second set of problems must be looked upon in terms of the opportunities that are available to us. In my view, no serious economic crisis has ever been resolved without the creation of new innovations and new technological platforms. In the Great Depression, the innovations and the new technologies did really come about until the end of the 1930s and into the 1940s and were related to war. Earlier stimulus efforts in the 1930s tended to support what existed in the past.
We don’t want government providing stimulus to the economy that will just result in the old world being “re-created”…we do not want the “old” products or the “old” managements renewed and rewarded! We must move on to the future.
By providing his “vision” of this future, President Obama has changed the field of engagement. President Obama is not just talking “stimulus”…he is talking about the world we want to live in. We may not agree with him on everything. We may not agree with him on most things. But, we must accept the challenge, and…while we are attempting to resolve the debt problems from the past…we must enter the dialogue and debate about what the shape of the future will be.
In this sense, what President Obama has put forth is a stimulus plan…but with more than just one meaning of the word stimulus.
Monday, February 23, 2009
It's All A Matter Of Incentives
Cerberus Capital Management has asked for a bailout! Who would have thought that a private equity fund would be seeking the help of the Federal Government to provide it with bailout funds?
The United States government is the largest creator of incentives in the world. Whatever it does it sets up incentives that people respond to in order to gain whatever edge they can obtain. And, the competition can sometimes become extremely fierce.
Incentives can either be positive or negative. They can either encourage us to do something…like pursue an education…or they can discourage us from doing something…like quitting smoking. They can work to make the society better…like improving the environment…or they can cause criminal behavior…like prohibition resulted in an underground business boom.
Whatever it is that the government does…it sets up incentives that people respond to. And, making lots and lots of funds available to people creates a huge incentive for those individuals to line up…with their hands out.
We saw this earlier with TARP. I thought that this effort supposedly had something to do with the “toxic assets” that were on the balance sheets of banks. But, as soon as it was passed…all of a sudden mayors and governors had their hands out for some of the money. Somewhere I missed their inclusion in the bill passed by Congress.
The major criteria now for getting money from the Obama stimulus plan just passed by Congress is “shovel ready.” Wow…I didn’t know that so many governmental bodies in the United States had so many proposals ready to begin putting the shovel into the ground next Monday!
Most incentives in an economy evolve out of the workings of the economic and social system that exists within a country. One could say these incentives are “endogenous” to the system…that is, they are created through the normal functioning of daily life. One could say that these incentives arise naturally.
Governments and some large organizations can create incentives “exogenously”…that is, they can impose incentives on a society from outside the system…say, because they think that certain incentives create “right” behavior. A church, for example, is one such system. A government can create incentives that will raise the nation to fight a war…and the incentives must be strong enough to get the nation to pay for that war by paying taxes to support the war.
One of the problems with these “exogenous” incentives is that they may ultimately be harmful to the people that they were trying to help. This problem is observed quite often in economics because most changes in incentives take a substantial time period to work themselves out. Consequently it is difficult to attach the “consequence” of a government policy with the underlying “cause” of the result. Especially since modern society and its sources of information…television, newspapers, and radio…tend to focus on the current and the dramatic “consequences” without any recognition of what might have started off the whole chain of events leading to this end.
This leaves us with an uncomfortable situation in which we must deal with the existing problem and with the emotions and psychology of current events isolated from what got us into the mess we are in.
Last Friday, we saw an announcer on public television ranting and raving about how the people that have followed the rules and responsibly sheparded their resources now have to dig into their pockets and cover those that have not behaved in such a sensible manner and now are experiencing financial and economic difficulties. And, this tirade has gained national attention by both sides of the argument.
The auto industry “big-guys” are down on their knees begging for some “bread and water” so as to keep their positions of power and control. Yet, these are the people that have been protected for years by the same state and national politicians they are now seeking mercy from.
And, the bankers…what a bad lot they are…those greedy “b……s”! Of course, bankers are always an easy bunch to pick on…and this picking goes back centuries. The auto-guys are just wimps in comparison to bankers when it comes to taking criticism.
The question that goes unanswered is “What was the environment created by government that set up the incentives that resulted in the results just described?” I have already answered this for the auto industry. But, who wouldn’t go to the government and get protection of their industry when it was so possible to do so?
Who wouldn’t support the Federal Reserve keeping interest rates so low for an extended period of time…of course, real interest costs were negative…so that business could be continued at a furious pace? Who wouldn’t be in favor of substantial tax cuts for the wealthy…especially if you happen to be wealthy? Who wouldn’t support going after that bad dictator who had those…what was it now? Oh, yes…weapons of mass destruction.
The obvious point to this discussion is that government got us into the mess we are in through the incentives it created eight or so years ago…and now we are faced with a situation in which it appears that government must set up a new set of incentives in order to make up for the mess that resulted from the incentives set up from an earlier time.
Yes, we have to take some money from those that did not over play their fiscal hand and transfer it to some that did. Yes, we have to help those financial institutions that responded in too extreme a form to the perceived opportunities that existed for them. Yes, we may need to do more for the auto industry…and for other industries.
But, where does it stop? Is everyone entitled to a bailout? (Well, as a matter of fact…I think I need a billion or two to get me through the next several years! I’m sure you are deserving of a bailout as well!) And, what are the consequences down-the-road a piece for the people and the society that are getting the bailouts?
Does Cerberus Capital Management really deserve a bailout? I thought private equity firms were risk takers and that is why they got the big bucks? Maybe Cerberus should face a "stress test" like the commercial banks.
What kind of a society are we creating through the incentives that are being developed today? What mess is the government going to have to bail us out of in two or three, or, five or six years from now…the mess that we are now creating…but we don’t know what mess that will be?
Of course, the final question is…how are you going to respond to the incentives now being created? Is it wise for certain Republican governors to turn down the bailout money because of…what was that…because of their principles?
The United States government is the largest creator of incentives in the world. Whatever it does it sets up incentives that people respond to in order to gain whatever edge they can obtain. And, the competition can sometimes become extremely fierce.
Incentives can either be positive or negative. They can either encourage us to do something…like pursue an education…or they can discourage us from doing something…like quitting smoking. They can work to make the society better…like improving the environment…or they can cause criminal behavior…like prohibition resulted in an underground business boom.
Whatever it is that the government does…it sets up incentives that people respond to. And, making lots and lots of funds available to people creates a huge incentive for those individuals to line up…with their hands out.
We saw this earlier with TARP. I thought that this effort supposedly had something to do with the “toxic assets” that were on the balance sheets of banks. But, as soon as it was passed…all of a sudden mayors and governors had their hands out for some of the money. Somewhere I missed their inclusion in the bill passed by Congress.
The major criteria now for getting money from the Obama stimulus plan just passed by Congress is “shovel ready.” Wow…I didn’t know that so many governmental bodies in the United States had so many proposals ready to begin putting the shovel into the ground next Monday!
Most incentives in an economy evolve out of the workings of the economic and social system that exists within a country. One could say these incentives are “endogenous” to the system…that is, they are created through the normal functioning of daily life. One could say that these incentives arise naturally.
Governments and some large organizations can create incentives “exogenously”…that is, they can impose incentives on a society from outside the system…say, because they think that certain incentives create “right” behavior. A church, for example, is one such system. A government can create incentives that will raise the nation to fight a war…and the incentives must be strong enough to get the nation to pay for that war by paying taxes to support the war.
One of the problems with these “exogenous” incentives is that they may ultimately be harmful to the people that they were trying to help. This problem is observed quite often in economics because most changes in incentives take a substantial time period to work themselves out. Consequently it is difficult to attach the “consequence” of a government policy with the underlying “cause” of the result. Especially since modern society and its sources of information…television, newspapers, and radio…tend to focus on the current and the dramatic “consequences” without any recognition of what might have started off the whole chain of events leading to this end.
This leaves us with an uncomfortable situation in which we must deal with the existing problem and with the emotions and psychology of current events isolated from what got us into the mess we are in.
Last Friday, we saw an announcer on public television ranting and raving about how the people that have followed the rules and responsibly sheparded their resources now have to dig into their pockets and cover those that have not behaved in such a sensible manner and now are experiencing financial and economic difficulties. And, this tirade has gained national attention by both sides of the argument.
The auto industry “big-guys” are down on their knees begging for some “bread and water” so as to keep their positions of power and control. Yet, these are the people that have been protected for years by the same state and national politicians they are now seeking mercy from.
And, the bankers…what a bad lot they are…those greedy “b……s”! Of course, bankers are always an easy bunch to pick on…and this picking goes back centuries. The auto-guys are just wimps in comparison to bankers when it comes to taking criticism.
The question that goes unanswered is “What was the environment created by government that set up the incentives that resulted in the results just described?” I have already answered this for the auto industry. But, who wouldn’t go to the government and get protection of their industry when it was so possible to do so?
Who wouldn’t support the Federal Reserve keeping interest rates so low for an extended period of time…of course, real interest costs were negative…so that business could be continued at a furious pace? Who wouldn’t be in favor of substantial tax cuts for the wealthy…especially if you happen to be wealthy? Who wouldn’t support going after that bad dictator who had those…what was it now? Oh, yes…weapons of mass destruction.
The obvious point to this discussion is that government got us into the mess we are in through the incentives it created eight or so years ago…and now we are faced with a situation in which it appears that government must set up a new set of incentives in order to make up for the mess that resulted from the incentives set up from an earlier time.
Yes, we have to take some money from those that did not over play their fiscal hand and transfer it to some that did. Yes, we have to help those financial institutions that responded in too extreme a form to the perceived opportunities that existed for them. Yes, we may need to do more for the auto industry…and for other industries.
But, where does it stop? Is everyone entitled to a bailout? (Well, as a matter of fact…I think I need a billion or two to get me through the next several years! I’m sure you are deserving of a bailout as well!) And, what are the consequences down-the-road a piece for the people and the society that are getting the bailouts?
Does Cerberus Capital Management really deserve a bailout? I thought private equity firms were risk takers and that is why they got the big bucks? Maybe Cerberus should face a "stress test" like the commercial banks.
What kind of a society are we creating through the incentives that are being developed today? What mess is the government going to have to bail us out of in two or three, or, five or six years from now…the mess that we are now creating…but we don’t know what mess that will be?
Of course, the final question is…how are you going to respond to the incentives now being created? Is it wise for certain Republican governors to turn down the bailout money because of…what was that…because of their principles?
Wednesday, February 11, 2009
The Three Problems We Face: Debt, Debt, and Debt!
The focus is wrong. The focus is on the demand side of the economy. As John Maynard Keynes argued, “most practical men are indeed in thrall to the ideas of some long dead economist”…and that long dead economist is John Maynard Keynes. Niall Ferguson refers to the policy makers of today as “born again Keynesians”! And, so the focus remains on stimulating demand.
As a consequence there seems to be a disconnect between what the policy makers are producing in terms of stimulus and bailout and what others, financial markets and individual consumers and families, are experiencing. The debt overhang is stifling everything and this must be corrected before the contraction can be stopped.
This makes the problem in the economy a “supply” problem and not a problem of demand. It is a supply problem because the response to excessive amounts of debt is to save and to reduce leverage. And, this delevering is a cumulative process and either must be overcome by massive inflation…or, it must work itself out.
The explosion of credit is like a house of cards…with the underlying danger being that once the house begins to collapse…the whole house is affected. Given the incentives created by Bush43, the credit pyramid grew. The increases in government debt and the excessively low interest rates maintained by the Greenspan Fed set the standard for the day. And, the private sector followed…the private sector took on more and more risk…and financed their riskier positions with more and more leverage. The whole credit structure became shakier and shakier.
The problem with a house of cards is that once one of the cards on a lower level is removed…the whole house can come down. Experience teaches us that some portions of the house may not collapse…but, if the card removed is at the base of the house…it will likely be the case that a large amount of the house will fall…
The card that was pulled out of the house of cards this time was housing finance. As we know now the subprime market can be identified as the place where the collapse began. But, this level of finance supported a large component of the house of credit in the form of mortgage-backed securities and then other derivative securities and tools that used this base of mortgages as the foundation of the structure. And, the house began to fall.
Of course, we are waiting for other parts of the mortgage house to fall…those connected with the next wave of interest rate re-pricings connected with Alt-A mortgages and options mortgages that will be taking place over the next 18 months or so. And, this does not include other consumer debt like equity lines, credit cards, car loans and so forth. It also does not include the collapse of the banking system and other components of the finance industry.
As we have seen the collapse in the housing market has spread to other areas of the financial market. Contagion is the word to describe this spread. And, the problem has become a world wide problem with problems in financial institutions and beyond throughout the developed world and into the emerging nations.
What is the response to the existence of too much debt?
Well, there are two. The first response is to create inflation. Pour money into the system and artificially create spending so that resources are put back to work…eventually creating sufficient demand so that prices begin rising again. This is the Keynesian way…reduce the real value of the debt outstanding. And, the only way to do this is by “printing money.” If the banking system seems to be clogged up…why then let the Federal government begin to spend…finance the spending by selling Treasury securities…but sell the debt directly to the Federal Reserve where the central bank will just give the Treasury Department a demand deposit at some commercial bank. That is the demand side response.
The other response to the fact that there is too much debt is for people to pull back their expenditures…withdraw from the spending stream…and pay down debt in whatever way they can. This is what is happening now and this has been called historically a debt/deflation. It is basically the process of delevering the economy so that economic units can return to reasonable debt levels on their balance sheet.
Unless people come to believe that the government is going to create a substantial enough inflation to reduce the “real” value of their debt to reasonable levels…they will not stop their attempt to get their lives back in order with a reduced amount of debt on their balance sheets. This is why this process is a cumulative one…a process that eventually must work itself out before the economy bottoms out and a return to growth can occur.
One of solution to this overhang is to write down the debt. I dealt with this issue in my post of February 4, 2009, “Two Painful Proposals to Reduce Our Excess Debt,” http://seekingalpha.com/article/118475-two-painful-proposals-to-reduce-our-excess-debt, so I won’t go into it further here. A plan like this is politically difficult because writing down the debt of those that over-extended themselves looks like we are bailing out the undisciplined or the scoundrels at the expense of the prudent and honest. Such an appearance carries with it severe political risks.
However, if the debt levels have to be reduced at some time…this overhang of excessive debt is going to have to be worked out one way or another. Half-way plans are not going to work. (See my post of February 9, 2009, “Obama Stimulus Plan: Bailout or Wimp Out?”, http://seekingalpha.com/article/119347-obama-stimulus-plan-bailout-or-wimp-out.) The government in Washington, D. C. is going to have to bite-the-bullet sometime…the question is just whether they are going to do it now…or do it later when things get worse.
And, let me just re-enforce my argument of above. Ultimately, this is a supply side problem…not a demand side problem. The attempt to pull off a demand side victory hangs on the balance of when inflation can be restarted and how much inflation can be generated to significantly reduce the “real” value of the debt.
The problem with this effort, however, is that an inflationary environment is one in which the incentive is to add on more debt…just what we are trying to get away from. Hasn’t the experience of the 2000s convinced us that this is not what we want to do?
The problem with supply side solutions is that they take time and are not as showing as are demand side “stimulus plans.” Also, they tend to be directed toward those individuals and organizations that are under a dark cloud these days. For example, there is the proposal put forward by Bob Barro to eliminate the corporate income tax. (See “Government Spending is No Free Lunch,” http://online.wsj.com/article/SB123258618204604599.html?mod=todays_us_opinion.)
The stock market did not respond well to the initial showing of the Obama Bank Bailout plan presented by Tim Geithner yesterday. To me this plan is sending mixed signals…mainly because it is on the tepid side. We have a demand side plan…the Obama Stimulus Plan…and we have a plan to cushion the problem of excessive debt…the Obama Bank Bailout Plan. The two plans don’t seem to mesh and give off the signal that the administration has not yet got its act together. The question then becomes…will it get its act together?
The debt issue must be dealt with…and firmly. At this time…firmly is not a word I would use.
As a consequence there seems to be a disconnect between what the policy makers are producing in terms of stimulus and bailout and what others, financial markets and individual consumers and families, are experiencing. The debt overhang is stifling everything and this must be corrected before the contraction can be stopped.
This makes the problem in the economy a “supply” problem and not a problem of demand. It is a supply problem because the response to excessive amounts of debt is to save and to reduce leverage. And, this delevering is a cumulative process and either must be overcome by massive inflation…or, it must work itself out.
The explosion of credit is like a house of cards…with the underlying danger being that once the house begins to collapse…the whole house is affected. Given the incentives created by Bush43, the credit pyramid grew. The increases in government debt and the excessively low interest rates maintained by the Greenspan Fed set the standard for the day. And, the private sector followed…the private sector took on more and more risk…and financed their riskier positions with more and more leverage. The whole credit structure became shakier and shakier.
The problem with a house of cards is that once one of the cards on a lower level is removed…the whole house can come down. Experience teaches us that some portions of the house may not collapse…but, if the card removed is at the base of the house…it will likely be the case that a large amount of the house will fall…
The card that was pulled out of the house of cards this time was housing finance. As we know now the subprime market can be identified as the place where the collapse began. But, this level of finance supported a large component of the house of credit in the form of mortgage-backed securities and then other derivative securities and tools that used this base of mortgages as the foundation of the structure. And, the house began to fall.
Of course, we are waiting for other parts of the mortgage house to fall…those connected with the next wave of interest rate re-pricings connected with Alt-A mortgages and options mortgages that will be taking place over the next 18 months or so. And, this does not include other consumer debt like equity lines, credit cards, car loans and so forth. It also does not include the collapse of the banking system and other components of the finance industry.
As we have seen the collapse in the housing market has spread to other areas of the financial market. Contagion is the word to describe this spread. And, the problem has become a world wide problem with problems in financial institutions and beyond throughout the developed world and into the emerging nations.
What is the response to the existence of too much debt?
Well, there are two. The first response is to create inflation. Pour money into the system and artificially create spending so that resources are put back to work…eventually creating sufficient demand so that prices begin rising again. This is the Keynesian way…reduce the real value of the debt outstanding. And, the only way to do this is by “printing money.” If the banking system seems to be clogged up…why then let the Federal government begin to spend…finance the spending by selling Treasury securities…but sell the debt directly to the Federal Reserve where the central bank will just give the Treasury Department a demand deposit at some commercial bank. That is the demand side response.
The other response to the fact that there is too much debt is for people to pull back their expenditures…withdraw from the spending stream…and pay down debt in whatever way they can. This is what is happening now and this has been called historically a debt/deflation. It is basically the process of delevering the economy so that economic units can return to reasonable debt levels on their balance sheet.
Unless people come to believe that the government is going to create a substantial enough inflation to reduce the “real” value of their debt to reasonable levels…they will not stop their attempt to get their lives back in order with a reduced amount of debt on their balance sheets. This is why this process is a cumulative one…a process that eventually must work itself out before the economy bottoms out and a return to growth can occur.
One of solution to this overhang is to write down the debt. I dealt with this issue in my post of February 4, 2009, “Two Painful Proposals to Reduce Our Excess Debt,” http://seekingalpha.com/article/118475-two-painful-proposals-to-reduce-our-excess-debt, so I won’t go into it further here. A plan like this is politically difficult because writing down the debt of those that over-extended themselves looks like we are bailing out the undisciplined or the scoundrels at the expense of the prudent and honest. Such an appearance carries with it severe political risks.
However, if the debt levels have to be reduced at some time…this overhang of excessive debt is going to have to be worked out one way or another. Half-way plans are not going to work. (See my post of February 9, 2009, “Obama Stimulus Plan: Bailout or Wimp Out?”, http://seekingalpha.com/article/119347-obama-stimulus-plan-bailout-or-wimp-out.) The government in Washington, D. C. is going to have to bite-the-bullet sometime…the question is just whether they are going to do it now…or do it later when things get worse.
And, let me just re-enforce my argument of above. Ultimately, this is a supply side problem…not a demand side problem. The attempt to pull off a demand side victory hangs on the balance of when inflation can be restarted and how much inflation can be generated to significantly reduce the “real” value of the debt.
The problem with this effort, however, is that an inflationary environment is one in which the incentive is to add on more debt…just what we are trying to get away from. Hasn’t the experience of the 2000s convinced us that this is not what we want to do?
The problem with supply side solutions is that they take time and are not as showing as are demand side “stimulus plans.” Also, they tend to be directed toward those individuals and organizations that are under a dark cloud these days. For example, there is the proposal put forward by Bob Barro to eliminate the corporate income tax. (See “Government Spending is No Free Lunch,” http://online.wsj.com/article/SB123258618204604599.html?mod=todays_us_opinion.)
The stock market did not respond well to the initial showing of the Obama Bank Bailout plan presented by Tim Geithner yesterday. To me this plan is sending mixed signals…mainly because it is on the tepid side. We have a demand side plan…the Obama Stimulus Plan…and we have a plan to cushion the problem of excessive debt…the Obama Bank Bailout Plan. The two plans don’t seem to mesh and give off the signal that the administration has not yet got its act together. The question then becomes…will it get its act together?
The debt issue must be dealt with…and firmly. At this time…firmly is not a word I would use.
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