Alan Greenspan blames Irrational Risk-Taking and not his Keynesian Policies for the Subprime Mortgage Crisis

Posted by PITHOCRATES - October 26th, 2013

Week in Review

Since the Keynesians took over monetary policy we’ve had the Great Depression, the inflation racked Seventies, the dot-com bubble/recession of the late 1990s/early 2000s and the subprime mortgage crisis.  It’s also given Japan their Lost Decade, a deflationary spiral that started in the late Eighties that they are still fighting today.  As well as the sovereign debt crisis still ongoing in Europe.  So Keynesian economics has a record of failure.  Yet governments everywhere embrace it.  Why?  Because they love having the power to create money.  Especially when it’s ostensibly for helping the economy.  Which it never does.  As efforts to do so resulted in the carnage noted above.  But it always gives a good excuse for another surge in government spending.  And Keynesians love government spending.

Why does Keynesian economics fail?  Alan Greenspan, former chairman of the Federal Reserve whose policies helped create some of this carnage (dot-com bubble and subprime mortgage crisis), explains (see Greenspan ponders the roots of a financial crisis he failed to foresee by Martin Crutsinger, The Associated Press, posted 10/21/2013 on The Star).

Now, Alan Greenspan has struck back at any notion that he — or anyone — could have known how or when to defuse the threats that triggered the crisis. He argues in a new book, The Map and the Territory, that traditional economic forecasting is no match for the irrational risk-taking that can inflate catastrophic price bubbles in assets like homes or tech stocks.

This is why the Soviet Union lost the Cold War.  Because their managed economy failed.  As all managed economies fail.  Because it is impossible to know the decisions of hundreds of million people in the market.  These people making decisions for themselves result in economic activity.  But when governments try to decide for them you get Great Depressions, debilitating inflation, bubbles and nasty recessions.  As well as the collapse of the Soviet Union.

People only took irrational risks when the Federal Reserve (the Fed)/government interfered with market forces.  The dot-com bubble grew because the Fed kept interest rates artificially low.  So was it irrational for people to take advantage of those artificially low interest rates and make risky investments they otherwise wouldn’t have made?  Yes.  But if the Fed didn’t keep them artificially low in the first place there would have been no dot-com bubble in the second place.

Was it irrational for people to buy houses they couldn’t afford when the Clinton administration forced lenders to qualify the unqualified for mortgages they couldn’t afford?  Was it irrational behavior for people to buy houses they couldn’t afford because of artificially low interest rates, ‘cheap’ adjustable rate mortgages, zero-down mortgages, interest only mortgages and no-documentation mortgages?  Yes.  But if the Fed/government did not interfere with market forces in the first place to increase home ownership (especially among those who couldn’t qualify for a conventional mortgage) there would have been no subprime housing bubble in the second place.

The problem with Keynesians is they call anyone who doesn’t behave as they hope to make people behave with their policies irrational.  That is, people are irrational if they don’t think like a Keynesian and therefore cause Keynesian policies to fail.  But before there could be irrational exuberance there has to be a climate that encourages irrational exuberance first.  For if we went back to the banking system where our savings rate determined our interest rates as well as the investment capital available there would be no bubbles.  And no irrational exuberance.  What kind of a banking system would that be?  The kind that vaulted the United States from their Founding to the number one economic power in the world in about one hundred years.  And they did that without making money.  Unlike today.

Q: The size of the Federal Reserve’s balance sheet stands at a record $3.7 trillion, reflecting all the Treasurys and mortgage-backed securities the Fed has bought to push long-term interest rates down. You have expressed concerns about this size, which is more than four times where the balance sheet stood before the start of the financial crisis. What are your worries?

A: My basic concern is that we have to rein this thing in well before the demand for funds picks up and makes it very difficult to rein in. (Inflation) is not immediate. It is down the road. But historically, there are no cases where central banks blow up their balance sheets or where countries print money which doesn’t hit (with higher inflation).

The balance sheet is four times what it was before the Great Recession?  That’s an enormous amount of new money created to stimulate the economy.  And yet we’re still wallowing in the worst economic recovery since that following the Great Depression.  I don’t know how much more you can prove the failure of Keynesian economics than this.  About five years of priming the economic pump with stimulus stimulated little.  Other than rich Wall Street investors who are using this easy money to make more money.  While the median household income falls.

Keynesian economics attacks the middle class.  While enriching the ruling class.  And their crony friends on Wall Street.  These policies further the divide between the rich and everyone else.  Yet they continually say these same policies are the only way to reduce the divide between the rich and everyone else.  The historical record doesn’t prove this.  And those familiar with the historical record know this.  Which is why the left controls public education.  So people don’t learn the historical record.  Because once they do it becomes harder to win elections when you’re constantly lying to the American people.

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Working Capital

Posted by PITHOCRATES - December 3rd, 2012

Economics 101

A Business Owner uses Start-Up Capital to Pay the Bills until the Business starts Making Money to Pay the Bills

Few people understand how business works.  Some think it’s a mystical entity that has an endless supply of money for the taking.  To be taken by the government.  The unions.  And their employees.  While some believe business is some evil entity that acquired its wealth by taking it from poor people.  Poor people that had no wealth to give.  Because they’re poor.  Who we define as being poor because they have no wealth.

But businesses aren’t mystical or evil.  They’re run by ordinary people.  Often doing extraordinary things.  In a constant battle to survive.  They start off by risking everything they’ve ever earned and saved.  Perhaps persuading family to invest in them and their idea.  Or mortgaging their house to the hilt.  Just to get the money to start their business.  Short term financing to pay the bills until the business starts making money to pay the bills.  If the business ever starts making money to pay the bills.

One of the most misunderstood things about business is that their prices are pure profit.  When you buy a $4.50 cup of coffee from Starbucks people think that’s $4.50 of profit.  But it’s not.  That price has to pay for the coffee beans.  The water.  The regular milk.  The low-fat milk.  The flavored syrup.  The cup.  The cup sleeve so you can hold it without burning you hand.  The lid.  The plastic stick that plugs the drinking hole in the lid.  The baristas working there.  The equipment to grind the coffee beans.  To make coffee.  To make espresso.  To make steam to heat the milk.  The point-of-sale cash registers.  The lights.  The heat.  The air conditioning.  The Internet access provided free to their customers.  The soap and toilet paper in the restrooms.  Garbage bags.  Cream.  Sugar.  Sugar substitute.  Coffee stirrers.  The rent.  The telephone bill.  Marketing.  Etc.  They have to recover all of these costs in the sales price of their coffee.  With enough left over to pay for growth.

For a Business to be able to Pay their Bills their Current Assets must be Greater than their Current Liabilities

Bills.  Everyone has them.  And business owners have more than most.  Because it takes money to make money.  A business owner has to spend a lot of money to make something to sell.  Like a cup of coffee.  So they incur a lot of costs.  Costs that their revenues have to pay.  For a business like Starbucks that’s mostly cash and credit card sales.  For other businesses that could be sales on account.  Or accounts receivable.  Sales that don’t result in cash.  But a promise to pay cash later.  Like a lot of those bills Starbucks has to pay.  Things they bought on account.  With the promise to pay cash later.

Businesses have current liabilities.  Which include the bills they owe.  Accrued payroll.  Accrued payroll taxes.  And everything else that they have to pay within one year.  All of which they have to pay with current assets.  Such as cash.  Or short-term assets they can convert into cash within one year.  Like accounts receivable.  Or things that conserve cash.  Like prepaid expenses.  For a business to be able to pay their bills their current assets must be greater than their current liabilities.  If their current liabilities are greater than their current assets, though, they will have some problems paying their bills.

The relationship between current assets and current liabilities is important.  If we divide current assets by current liabilities we get the current ratio.  If this is greater than one then a business will find it easier to pay their bills.  If it’s less than one then a business will struggle to pay their bills.  And may not be able to pay their bills.  If they can’t they are insolvent.  Meaning that they are not selling at high enough prices.  They’re not selling enough.  Or their costs are just too great at the prevailing market prices.  And if any of the above is true they may have no choice but to file for bankruptcy protection.  Because they simply cannot pay their bills.

If a Business can’t Generate Cash (Working Capital) Borrowing Money will only Delay the Inevitable—Bankruptcy

Cash is king.  A business has to have it.  And if they’re business can’t generate it they have to get it someplace else.  Either by borrowing it from the bank.  From family.  Or taking out another mortgage on their home.  All of which are short-term solutions to a much bigger problem.  For if their business can’t generate cash borrowing money will only delay the inevitable.  Bankruptcy.  Which means they either have to raise their sales volume.  Raise their prices.  Or cut their costs.  To get their current ratio above one.  Making them solvent again.

When you subtract current liabilities from current assets you get a business’ working capital.  The greater a business’ working capital is the easier it is for them to pay their bills.  And the easier it is to grow their business.  Or to offer raises, bonuses, more generous benefits, etc.  For to do any of these things a business first has to be able to pay their bills.  If they can keep paying their bills and maintain a current ratio above one for a few consecutive accounting periods they will find themselves with a surplus of cash.  Or working capital.  Useable cash to expand business operations.  Or to better pay their employees.

Of course if a business is too generous with their employees it will dry up that working capital and make it harder to pay their other bills.  For example, when generous union contracts impose heavy costs on a business while the prevailing market prices prevents them from charging enough to be able to afford those generous union contracts a business will soon find itself in financial difficulties.  Leading to a possible bankruptcy.  Where a bankruptcy court allows them to renegotiate their union contracts.  So their sales at prevailing market prices can afford them.  As well as their other bills.  While leaving enough working capital left over to grow their business.  Replace some worn out equipment.  Or repay a loan.

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FT128: “Democrats use class warfare to attack and tax the rich while taking money from the working poor by selling them lottery tickets.” -Old Pithy

Posted by PITHOCRATES - July 27th, 2012

Fundamental Truth

The Inherent Contradiction of Class Warfare is that you can’t Hate the Rich while wanting to be Rich

You hear it in the news.  You can hear it in the streets.  You can feel it in the air.  It’s another election season.  And the Democrats are ramping up their class warfare to assail anyone who did what everyone in the country wants to do.  Make money and live well.  President Obama even told successful small business owners the reason for their success.  Not the 80+ hours a week they put into their business.  But because their previous taxes built roads and bridges.  Which is a puzzler.  Because there are a lot of roads and bridges across America.  So you’d think there would be no business failures.  But there are.  A lot of them.  Despite all those roads and bridges.  Like I said, it’s a puzzler.

I guess the sad truth is that it’s not only rich people who hate the poor.  But it would appear our roads and bridges hate the poor, too.  Otherwise everyone would be making money and living well.  Not just those lucky few the roads and bridges favor.  Damn roads and bridges and their hateful ways.  Then again, roads and bridges are inanimate objects.  And can’t pick winners and losers.  So perhaps it’s the government that taxes us to pay for those roads and bridges that have hateful ways.  Perhaps they’re not building them special enough to spread their magic of success to those they come into contact with.  Perhaps our government officials don’t like poor people either.  That is to say, poor people who don’t remain poor.

But that’s neither here nor there.  It’s more around the corner and down the stairs.  No, what’s at issue here is the inherent contradiction of the Democrats’ class warfare.  Namely, if having more money than others is so evil why is it that everyone wants to have more money than others?  Isn’t that the whole point of unions?  To give their members more money and better benefits than those outside their membership?  It’s why the teachers go on strike.  For more money.  And more benefits.  Including health care and pension benefits that few teachers have ever contributed to.  Which is a lot better than most poor and middle class workers.  So here is a large group of people who have more money than others and yet the president never tells the teachers that they didn’t earn their pay and benefits.  So it’s okay to elevate some people above others even though we all use the same roads and bridges.  Odd.  For that seems like the definition of class warfare.  Granting special privilege to some so they can have more money than others.

Thanks to Roads and Bridges Movie Stars and Musicians make Obscene amounts of Money

To further see the inherent contradiction in class warfare consider Hollywood.  And the young and aspiring actors who go to Hollywood.  Why do they go there?  To become rich and famous.  To have more money than other people.  So they can live in their Hollywood mansions.  And in other mansions around the world where the rich and famous like to call home.  For a few weeks out of the year at least.  Those who make it became obscenely wealthy.  And make far more in a day than regular working people earn in a lifetime.  Not only do they want more money than others.  They have more money than others.  Yet the president doesn’t tell them that they didn’t make that happen.  Or that their success was due not to talent but those roads and bridges.

Consider, too, those who enter the music industry.  Rock, pop, hip hop and rap stars.  Why do these people enter the music industry?  To become rich and famous.  To have more money than other people.  Like the Hollywood stars they, too, want mansions.  Private jets.  Boats.  And all the other toys that money can buy.  They want to eat in the finest restaurants.  And party with famous celebrities from around the world.  These musicians don’t make music for the greater good.  For the poor.  For sick children.  No.  They make music to make as much money as they possibly can.  Some even begin legal action to protect what’s theirs in the digital age.  Fighting piracy abroad and illegal downloads at home.  Because they may have a lot of money.  But more money is better.  So they sue.  Yet the president doesn’t single these people out, telling them that they didn’t make their success.  It was those roads and bridges.  And that their illegally downloaded music is due to the people downloading it.  Who paid for those roads and bridges that made their talent possible.

How about lawyers?  They’re some of the richest people in the world.  And how do they make their money?  By taking it away from others who earn it.  By suing these wealth creators.  Or insurance companies.  Especially medical malpractice attorneys.  Who earned the unflattering moniker ‘ambulance chaser’.  Because they are willing to sue anyone to make a buck.  To have more money than others.  Lawyers are in part responsible for the high cost of health care because of their fraudulent lawsuits raising the cost of medical malpractice insurance.  And the class action lawsuit raises the cost of businesses (and the price of everything we buy) while bringing in obscene amounts of money for them.  While the people they represent make a fraction of what they collect.  But the president doesn’t tell these people that they owe their success to roads and bridges.  No.  He never says a word about lawyers.  Probably because he is a lawyer.  So rich lawyers get a pass.

Being Rich can’t be Bad when the Poor Spend so Much on Lottery Tickets trying to become Rich

The Democrats use class warfare to take more money away from those who they think don’t deserve it.  Those who have more money than others.  Other than teachers, movie stars, music stars, lawyers and anyone else with more money than others who typically vote Democrat.  Which seems to make it okay to have more money than other people.  If you vote Democrat you can have as much money as the roads and bridges can make for you.  But if you’re a small business owner trying to navigate the labyrinth of regulations just so you can pay a high tax rate, well, then it’s a different story.  Because these small business owners may vote Republican.  So whatever they make they were just lucky to make.  Even undeserving.  Because they didn’t build their business.  They weren’t smarter than anyone else.  They just used our roads and bridges to an unfair advantage.  So these leeches now owe us.  The people.  And should pay a higher tax rate.  And when they try to use legal tax shelters we should change the law so they can’t.  While turning a blind eye whenever those who vote Democrat hide their income to avoid paying those high tax rates.

So they attack the successful. To help those who have less than them.  But do they really care for those who make less?  The good, decent, poor people?  Or do they try to take their money, too?  Well, it turns out they don’t.  Care for the good, decent, poor people.  And they try to take back whatever they give them.  By encouraging them to spend as much of their disposable income on lottery tickets as possible.  So the poor can be, wait for it, rich.  That’s why governments sell lottery tickets.  To give people the chance to be rich.  So they, too, can have more money than others.  So they can live well.  Even though they have a better chance of getting struck by lightning than winning a big jackpot.  Because when it comes to the lottery it’s little different than it is in Las Vegas.  The house ultimately wins.  As does the government.

Who’s buying the majority of lottery tickets?  The working poor.  So they can become what the Democrats hate.  People who have more than others.  So they can live well.  Again showing the inherent defect in class warfare.  Having more money than others can’t be bad.  Being rich can’t be bad.  Because if being rich and having more money than others was bad everyone wouldn’t be trying to be rich.  For teachers, movie stars, music stars, lawyers and anyone else with more money than others know that having money is good.  But having more money is better.  Especially when you have more than others.  And you can live a comfortable life away from those who have less than you.  While enjoying a disproportionally large share of that wealth created by all those roads and bridges.

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FUNDAMENTAL TRUTH #48: “Government benefits aren’t from the government. They’re from the taxpayers.” -Old Pithy

Posted by PITHOCRATES - January 11th, 2011

The Concept of Other People’s Money

A lot of people don’t understand how a bank works.  Or government.  In fact, banks and government are similar in one respect.  They both ‘give’ things away.  Banks loan money.  Government gives out benefits.  But before either gives anything away, they have to take from other people first.  Banks take money from depositors.  And government takes money from taxpayers.  That’s how they get the money that they give away (bank loans and government benefits).

You see, banks and government have no money of their own.  They work with other people’s money.  Yes, they can make money.  Banks via fractional reserve banking.  And government via monetary policy (lowering the discount rate, selling bonds and treasuries or simply printing money – we call this fiat money).  But there’s a danger when they do.  If they make too much money, we get inflation.  And a lot of bad things follow inflation.  Higher interest rates.  Higher prices.  And an overheated economy that eventually crashes into recession.  Which causes higher unemployment.  So they have to be careful when they’re making money.

If inflation is such a bad thing, then why do they even make money in the first place?  That’s a bit complicated.  To get a simplified understanding, think of a bank.  Businesses borrow from banks to expand their business.  When they expand they create jobs.  Everybody likes this.  Jobs.  So we try to help them get the money they need to expand their businesses.  But banks often don’t have enough money from their depositors to loan to all these businesses.  Fractional reserve banking solves that problem.  This allows the banks to lend more money than they have in their vaults from their depositors.  Creating more money allows more economic activity.  And that’s why we make money.  But we have to be careful not to make too much.

Money is only as Good as our Faith in It

More economic activity means more jobs.  And more taxes for the government.  This is why the government likes a little inflation.  A little bit allows economic activity.  And what is economic activity?  People trading with each other.  A worker trades his or her skills for groceries.  Of course, an office worker in midtown Manhattan can’t easily trader his or her office skills for a dairy farmer’s milk and cheese in Wisconsin.   But that’s okay.  Because we have a medium of exchange to make trading easier.  Our money.

You see, it’s things or services we want.  Not the money.  Money just lets us trade what we do with what others do.  We’ve used different types of money throughout history.  Specie (like gold and silver coins).  And commodities (tobacco, food, whiskey, etc.).  Specie and commodities have intrinsic value.  They’re worth something besides their value as money.  And because of this, it is not easy to make more of it.  Because a printing press can’t print gold, silver, tobacco, food, whiskey, etc.  So you can’t ‘stimulate’ the economy like you can with fiat money.  Of course, this can be a good thing.  Because you can’t over-stimulate the economy like you can with fiat money.  There are pros and cons of each type of money.  And there’s been a lot of debate between competing types of money (such as the gold standard versus fiat money). 

Money is only as good as our faith in it, though.  Because specie and commodity have intrinsic value, it’s easy to have faith in it.  It’s pretty hard to make this kind of money worthless.  But it’s easy to make fiat money worthless.  All you have to do is print too much of it.  You do that and people won’t want to use it.  Because they will have little faith that it will hold its value.

Inflation Reduces your Purchasing Power

How bad can it get?  Let’s illustrate with an example.  Let’s say you dug down about 30 feet in your back yard and discovered gold.  And you worked your butt off to bring it up to the surface, smelt it and pour it into gold bars.  Now you want to trade that gold for a new car, a 60″ plasma television, a state of the art home theater sound system, an in-the-ground swimming pool, some property on an island in the Caribbean and a few other extravagances.  You see all of these things for sale.  But the sale prices are all in dollars, not weights of gold.  Not a problem.  Because you can sell your gold for dollars. 

Think of a scale.  Put your gold on one side of the scale.  And put dollars on the other side.  When the scale balances (when both sides equal the same value, not weights), you have the value of your gold in dollars.   Let’s say your gold equals $1 million.  Lucky for you because that’s the total price of everything you want to buy. 

A week later you have all the details worked out.  You’re ready to write your checks.  But the day before, the government printed more money and doubled the number of dollars in circulation.  When you increase the number of dollars, you decrease the value of each dollar.  In this case, they doubled the amount of money so money is now only worth half of what it used to be worth.  This makes you furious.  Because if you had waited only one more week, you would have gotten $2 million for your gold instead of $1 million (same amount of gold on one side of the scale but twice the amount of dollars on the other).  Worse, not only did the price of your gold go up (after you had already sold it at the old price), but prices everywhere went up.  The stuff you were about to buy for $1 million now costs $2 million.  Now you can only buy half of what you want.  Because doubling the amount of dollars in circulation cut your purchasing power in half.

Other People’s Things

This is the time value of money.  Money decreases in value over time because of inflation.  The greater the inflation rate, the quicker the money in your wallet loses value.  During times of high inflation, people will not want to hold onto their money for a long time.  They’ll want to spend it fast.  Because they’ll be able to buy more with it sooner than they will be able to later.  And it’s the things they want to buy that have real value to them.  Not the money.

Things, not money.  That’s what people want.  And that’s what government benefits are.  Things.  Other people’s things.  You can’t just print money and give it away.  Because you need things to buy with that money.  So not only do you need taxpayers to pay taxes.  But you need them to make the things (and services) people want to buy. 

The greater amount of benefits the government hands out, the more of other people’s stuff they have to take.  That’s why there is a limit on the amount of benefits that government can hand out.  The things the government does to pay for those benefits reduces economic activity.  And increases unemployment.  Unemployed people can’t make stuff or perform services.  And they have less stuff to take.   No matter how much fiat money the government prints.

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