The Opportunity Cost of Debt

Posted by PITHOCRATES - September 16th, 2013

Economics 101

Housing Sales drive the Economy because almost Everything for Sale is for the Household

Once upon a time the rule of thumb was to buy the most expensive house we could possibly afford.  We saved 20% for a down payment on a conventional mortgage.  We lived on a shoestring budget and paid our mortgage no matter what.  Even if we had to live on meatloaf and macaroni and cheese for the next five years.  Or longer.  We did this because we would be paying that mortgage payment for 30 years.  And though tough at first during those 30 years we advanced in our careers.  And made more money along the way.  Making that mortgage payment easier to pay as time went by.

So that was the way it used to be.  And it was that way for a long time.  Until the Federal Reserve started playing with interest rates to stimulate economic activity.  Altering the banking system forever.  Instead of encouraging people to save their money so banks could loan money to homebuyers they printed money.  Flooded the market with it.  Ignited inflation.  And caused housing bubbles.  Then the government took it up a notch.

Housing sales drive the economy.  Almost everything for sale is for the household.  Furniture and appliances.  Beds and ceiling fans.  Tile and paint.  Cleaning supplies and groceries.  Dishes and cutlery.  Pots and pans.  Towels and linen.  Lawnmowers and weed-whackers.  Decks and patio furniture.  When people buy a house they start buying all of these things.  And more.  Creating a lot of economic activity with every house sold.  So the government did everything they could to encourage home ownership.  And few governments did more than the Clinton administration.  By applying pressure on lenders to qualify the unqualified for mortgages.  Which gave us the subprime mortgage crisis.

Lenders used Subprime Lending to Qualify the Unqualified to Comply with the Clinton Administration

People in poor neighbors tended to be poor.  And unable to qualify for a mortgage because they couldn’t afford the house payments.  When these poor people happened to be black the Clinton administration said the banks were racist.  They were redlining.  And advised these lenders that if they don’t start qualifying these people who couldn’t afford a house that the full weight of the government will make things difficult for them to remain in the lending business.  So they complied with the Clinton administration.  Using subprime lending to put people into homes they couldn’t afford.

The main reason why people can’t afford to buy a house is the size of the mortgage payment.  Which can be pretty high if they can’t afford much of a down payment.  So these lenders used special mortgages to bring that monthly payment down.  The adjustable rate mortgage (ARM).  Which had a lower interest rate than conventional mortgages.  Because they could raise it later if interest rates rose.  Zero-down mortgages.  Which eliminated the need for a down payment.  Coupled with an ARM when interest rates were low could put a poor person into a good sized house.  No-documentation loans.  Which removed the trouble of having to document your earnings to prove you will be able to make your house payment.  Making it easier to approve applicants when you don’t have to question what they write on their application.  Interest-only loans where you only had to pay the interest for, say, 5 years.  Greatly reducing the size of the monthly payment.  But after those 5 years you had to pay that loan back in full with a new mortgage for the full value of the house.  Which may be more costly in 5 years.

So these lenders were able to meet the Clinton administration directive.  They were putting people into homes they couldn’t afford.  Just barely.  These people had house payments they could just barely afford.  Thanks to the low interest rate of their ARM.  But then interest rates rose.  Making those mortgage payments unaffordable.  With zero-down they had little to lose by walking away.  And a lot of them did.

The Interest on the Debt is so large we have to Borrow Money to Pay for the Cost of Borrowing Money

Buying a house is a huge investment.  One that we finance.  That is, we borrow money.  Sometimes a lot of it.  Because we don’t want to wait and save money for a down payment.  And because we want so much right now we buy as much as we can with those borrowings.  Doing whatever we can to lower the monthly payment.  With little regard to long-term costs.  For example, assume a fixed 30-year interest rate of 4.5%.  And we finance a $150,000 house with zero down.  Because we have saved nothing.  The monthly payment will be $790.03.  But if we waited until we saved enough for a 10% down payment that monthly payment will only be $684.03.  And if we saved enough for 20% down the monthly payment will only be $608.02.  That’s $182.01 less each month.  The total interest paid over the life of this mortgage for zero down, 10% down and 20% down is $123,610.07, $111,249.06 and $98,888.05, respectively.  Adding that to the price of the house brings the total cost for that house to $273,010.07, $246,249.06 and $218,888.05, respectively.  So if we wait until we save a 20% down payment we will be able to buy a $150,000 house and $54,723.02 of other stuff during those 30 years.  This is the opportunity cost of debt.

We are better off the less we finance.  Because long-term debts are with us for a long time.  And they don’t go away if we lose our job.  Or if interest rates go up.  Like with an ARM.  A large driver of the subprime mortgage crisis.  Let’s see what was happening before the housing bubble burst.  Let’s say we could buy that $150,000 house with a zero down mortgage with an adjustable interest rate of 2%.  Giving us a monthly payment of $554.43.  Very affordable.  Which helped get a lot of people into houses they couldn’t afford.  But then the interest rate went up.  And what did that do to someone who could just barely pay their house payment when it was $554.43?  Well, if it reset to 4% that payment increased to $716.12 ($161.69 more per month).  If it reset to 6% that payment increased to $899.33 ($344.90 more per month).  Bringing the total cost of the house to $323,757.28 ($150,000 principle + 173,757.28 interest).  Which is why a lot of these people walked away from these houses.  There was just no way they could afford them at these higher interest rates.

Interest payments on long-term debt at high interest rates can overwhelm a borrower.  Making the Clinton administration’s Policy Statement on Discrimination in Lending insidious.  It destroyed people’s lives.  Putting them into houses they couldn’t afford with subprime lending.  But if you think that’s bad consider the national debt.  These are long-term obligations just like mortgages.  And currently we owe $16,738,533,025,135.63 (as of 9/13/2013).  At an interest rate of 3.9% the annual interest we must pay on this debt comes to $652,802,787,980.29.  That’s $652.8 billion.  Which is more than we spend on welfare ($430.4 billion).  Almost what we spend on Social Security ($866.3 billion).  And more than half of the federal deficit ($972.9 billion).  This is the opportunity cost of debt.  It limits what we can spend elsewhere.  On welfare.  Social Security.  Etc.  The interest on the debt has grown so large that we even have to borrow money to pay for the cost of borrowing money.  And there is only one way this can end.  Just like the subprime mortgage crisis.  Only worse.


Tags: , , , , , , , , , , , , , , , , , , , , ,

Housing Boom, Bubble and Bust

Posted by PITHOCRATES - April 15th, 2013

Economics 101

Building and Furnishing Houses creates Great Economic Activity

Central to any booming economy are healthy home sales.  For home sales unleash great economic activity.  From the first surveys of a new subdivision.  To the new sewers and water systems.  Gas and telephone.  Cable television and broadband Internet.  Concrete for basements, driveways and sidewalks.  Structural steel (that beam in the basement and steel poles holding up the house).  Rough carpentry.  Electrical work and plumbing.  Drywall, windows and roofing.  Painting, flooring, doors and hardware.  Heating and air conditioning.  Lighting and plumbing fixtures.  Brick, siding and landscaping.  Etc.

All of this takes manufacturing to make these construction products.  All these manufacturers need raw materials.  And raw material extraction needs heavy equipment and energy.  At all of these stages of production are jobs.  Extracting raw materials.  Processing raw materials.  Manufacturing products out of these raw materials.  Building this production equipment.  Interconnecting these stages of production is every form of transportation.  Rail, Great Lake freighter, river barge and truck.  Requiring even more jobs to build locomotives, rolling stock, ships and trucks.  And jobs to operate and maintain them.  And build their infrastructure.  Filling all of these jobs are people.  Earning a paycheck that will let them buy a house one day.

Then even more economic activity follows.  As people buy these homes and furnish them.  Washers and dryers.  Refrigerators, stoves, microwaves, food processors and coffee makers.  Furniture and beds.  Light fixtures and ceiling fans.  Rugs, carpeting and vacuum cleaners.  Telephones, televisions, music systems, modems and computers.  Curtains, drapes, blinds and shades.  Shower curtains, bath mats, towels and clothes hampers.  Mops, buckets, cleaning supplies and waste baskets.  Lawnmowers, fertilizers, hoses and sprinklers.  Snow shovels and snow blowers.  Cribs, highchairs, diapers and baby food.  Etc.  All of these require manufacturers.  And all of these manufacturers require raw materials.  As well as transportation to move material and product between the stages of production.  And to our wholesalers and retailers.  More jobs.  More people earning a paycheck.  Who will one day buy their own home.  And create even more economic activity.

Bill Clinton pressured Lenders to Lower their Requirements and Subprime Lending took Off

This is why governments love housing.  And try to do everything within their power to increase home ownership.  Which is why they changed the path to home ownership.  After World War II when the building of subdivisions took off there was the 3-6-3 savings and loan.  Where savings and loan paid 3% interest on savings accounts.  Loaned money to home buyers at 6%.  And were on the golf course by 3 PM.  And the mortgage was the 30-year conventional mortgage with a 20% down payment.

The conventional mortgage was the mortgage of our parents.  Who had no problem putting off their wants to save money for that 20% down payment.  They prioritized.  And planned for the future.  But the conventional mortgage has an obvious drawback.  It limits home ownership to those who can save up a 20% down payment.  Pushing home ownership further out for some.  Or just taking that option away from a large percentage of the population.  So the government stepped in.  To help those who couldn’t save 20% of the house’s price.

Mortgage Qualification Decreasing Down Payment

As we lowered the down payment amount it allowed lower-income people the opportunity of home ownership.  But it didn’t get them a lot of house.  That is, those who could afford a 20% down payment could buy more house for the same monthly payment than those who couldn’t afford it.  And a house in a better neighborhood.  Which some said was unfair.  Some in government even called it discriminatory.  As Bill Clinton did.  Who pressured lenders to lower their lending requirements to qualify the unqualified.  His Policy Statement on Discrimination in Lending helped to fix that alleged problem.  And kicked off subprime lending in earnest.  Leading to the subprime mortgage crisis.  And the Great Recession.

Conventional Wisdom was to Pay the Most you could Possibly Afford when Buying a House

But lowering the down payment wasn’t enough.  Even eliminating it all together.  The people needed something else to help them into home ownership. And to generate all of that economic activity.  And this was something the government could fix, too.  By printing a lot of money.  So banks had a lot of it to lend.  Thus keeping interest rates artificially low.  And we can see the effect this had on home ownership combined with a zero down payment.  It allowed people to buy more house for the same given monthly payment.  Even more than those buying with the 3-6-3 conventional mortgage.

Mortgage Qualification Decreasing Mortgage Rate

Falling interest rates bring in a lot more people into the housing market.  Which is good for sellers.  And good for the economy.  A lot more people than just those who could afford a 20% down payment can now buy your house.  As people bid against each other to buy your house they bid up your price.  Raising home prices everywhere.  Increasing the demand for new housing.  Which builders responded to.  Creating a housing boom.  As builders flood the market with more houses.  At higher prices.  That new homeowners move into.  And max out their credit cards to furnish.  Creating a lot of debt people are servicing at these artificially low interest rates.  But then the economy begins to overheat.  And other prices begin to rise.  Leaving people with less disposable income.  The housing boom turns into a housing bubble.  House prices are overvalued.  Those artificially low interest rates created a lot of artificial demand.  Bringing people into the market who weren’t planning on buying a house.  But decided to buy only to take advantage of those low interest rates.

Conventional wisdom was to pay the most you could possibly afford when buying a house.  For all houses gained value.  You may struggle in the beginning and have to make some sacrifices.  Say cut out steak night each week.  But in time you will earn more money.  That house payment will become more affordable.  And your house will become more valuable.  Which will let you sell it for more at a later date letting you buy an even bigger house in an even nicer neighborhood.  But when it’s cheap interest rates driving all of this activity there is another problem.  For printing money creates inflation.  And inflation raises prices.  Gasoline is more expensive.  Groceries are more expensive.  As prices rise households have less disposable income.  And have to cut out things like vacations.  And any discretionary spending on things they like but don’t need.  Which destroys a lot of economic activity.  The very thing the government was trying to create more of by printing money.  So there is a limit to the good economic times you create by printing money.  And when the bad consequences of printing money start filtering through the rest of economy the government has no choice but to contract the money supply to limit the economic damage.  And steer the economy into what they call a soft landing.  Which means a recession that isn’t that painful or long.

The Price of Artificially Low Interest Rates is Inflationary Booms, Bubbles and Great Recessions

As interest rates rise home buying falls.  Leaving a lot of newly built homes unsold on the market.  And that housing bubble bursts.  Causing home values to fall back down from the stratosphere.  Leaving a lot of people owing more on their mortgage than their houses are now worth.  What we call being ‘underwater’.  And as interest rates rise so do the APRs on their credit cards.  As well as their monthly payments.  And those people who paid the most they could possible afford for a house with an adjustable rate mortgage saw their mortgage interest rates rise.  As well as their monthly payment.  By a lot.  So much that these people could no longer afford to pay their mortgage payment anymore.  As a half-point increase could raise a mortgage payment by about $50.  A full-point could raise it close to $100.  And so on.

Increasing Monthly Payment dur to Increasing Mortgage Rate

With the fall in economic activity unemployment rises.  So a lot of people who have crushing credit card debt and a house payment they can no longer afford lost their job as well.  Causing a rash of mortgage foreclosures.  And the subprime mortgage crisis.  As well as a great many personal bankruptcies.  Causing the banking system to struggle under the weight of all this bad debt.  Add all of this together and you get the Great Recession.

This is the price of artificially low interest rates.  You get inflationary booms.  And bubbles.  That burst into recessions.  That are often deep and long.  Something that didn’t happen during the days of 3-6-3 mortgage lending.  And the primary reason for that was that the U.S. was still on a quasi gold standard.  Which prevented the government from printing money at will.  The inflationary booms and busts that come with printing money.  And Great Recessions.


Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

Civilian Labor Force Participation Rate and Recessions 1950-Present

Posted by PITHOCRATES - April 9th, 2013

History 101

LBJ was able to pass JFK’s Tax Cuts resulting in a Long Period of Economic Growth

The official unemployment rate is stuck around 8%.  But if you count all the people who can’t find a full-time job the actual unemployment rate is closer to 14%.  With every jobs report we hear the positive spin from the government about another down tic in the official unemployment rate.  And the hundreds of thousands of new jobs created.  But after three years or so of hearing these reports people start questioning the numbers.  And the rosy spin.  Because despite all the good news they tell us people are disappearing from the civilian labor force.  Which is the only reason why the official unemployment rate is falling.  Because they’re not counting a lot of unemployed people.  So looking at the civilian labor force may be a better indicator of the health of the economy.  Or better yet, the civilian labor force participation rate (CLFPR).  Which is basically the percent of those who can work that are working.  So let’s do that.  Starting with the Fifties.

Labor Force Participation Rate and Recessions 1950 to 1959

After World War II veterans went to college on the G.I. Bill.  These new college graduates with degrees in science, engineering and business management entered the workforce in the Fifties.  Helping the United States to develop new technologies.  New industries.  And a lot of new jobs.  American wells were busy pumping domestic oil.  Keeping gasoline cheap.  Having escaped the damage of war the American economy exported to those countries that didn’t.  And consumer spending took off.  Thanks to the new advertising industry telling Americans about all the great things to buy.  They bought houses and cars with borrowed money.  And used the new credit card to spend even more money they didn’t have.  Changing the American economy into a consumer-based economy.  Making the Fifties one of the most prosperous times in U.S. history.  Despite the Korean War.  And the Cold War.  Which was getting underway in a big way.  There was a burst of inflation to help pay for the Korean War.  When it ended they contracted the money supply to get rid of that inflation sending the economy into recession.  But once the recession ended the economy took off with all that consumerism.  Shown by the sharp rise in the CLFPR.  To correspond with the very good economic times of the Fifties.  Another monetary contraction happened in 1957 to tamp out some price inflation.  With a corresponding fall in the CLFPR.

Labor Force Participation Rate and Recessions 1960 to 1969

The Sixties started with another recession.  After it ended, though, the CLFPR continued to fall.  The recession was officially over but the economy was not doing well.  The CLFPR fell for almost three years following the recession.  Things were different from the Fifties.  For one, a lot of those war-torn economies were up and running again.  Providing some competition.  Especially a little island nation by the name of Japan.  Which one day would build all the televisions sold in America.  It was because of this fall in economic activity that JFK started talking about tax cuts in 1963.  Congress blocked his attempt to cut tax rates.  But after his assassination LBJ was able to pass the Revenue Act of 1964.  This lowered the top marginal tax rate from 91% to 70%.  And lowered the corporate income tax from 52% to 48%.  Among other favorable business measures.  Resulting in a long period of economic growth.  And a long upward trend in the CLFPR.

The Tax Cuts and Deregulation of the Eighties created one of the Longest Periods of Economic Growth

But following the Revenue Act of 1964 came the Great Society.  The Vietnam War.  And the Apollo moon program.  All paid for with a huge surge in federal spending.  Deficits began to grow.   As the government struggled to pay for everything.  And were unwilling to cut anything.

Labor Force Participation Rate and Recessions 1969 to 1979

The economy fell into a mild recession in 1970.  The CLFPR remained relatively flat.  To meet their spending needs they started printing money.  Devaluing the dollar.  Still part of Bretton Woods the dollar was still pegged to gold at $35/ounce.  That is, the U.S. agreed to exchange gold for dollars at $35/ounce.  But as they devalued the dollar our trading partners no longer wanted to hold dollars.  Because they were losing their purchasing power.  They wanted the gold instead.  So they began exchanging their dollars for gold.  Causing a great outflow of gold from the U.S.  Causing a problem for President Nixon.  He didn’t want the U.S. to lose all of their gold reserves.  But he didn’t want to cut any spending.  Which meant he didn’t want to stop printing money.  In fact, he wanted to print more money.  And the easy way out of his dilemma was by doing the most irresponsible thing.  He slammed the gold window shut in 1971.  And refused to exchange gold for dollars anymore.  And when he did there was no restriction to the amount of money they could print.  And they printed it.  A lot.  Creating double-digit inflation before the Seventies were over.  The inflation caused prices to rise.  Which Nixon tried to prevent with wage and price controls.  Causing a shortage of available rental property as people converted them into condos to get away from the rent control.  Gasoline stations ran out of gas as people filled their tanks with below-market priced gas.  And meat disappeared from grocery stores.  Wage controls kept wages from keeping pace with inflation.  So even though people had jobs they lost more and more purchasing power.  Or simply found there was nothing to purchase.  Throwing the economy into recession in 1973.  After the recession the CLFPR grew throughout the remainder of the Seventies.  But it wasn’t good growth.  It was growth sustained with double-digit inflation.  A bubble of artificial economic activity.  That would have to crash.  As all inflationary periods must crash.

Labor Force Participation Rate and Recessions 1979 to 1989

In the Eighties Paul Volcker, Federal Reserve Chairman, raised interest rates to double digits to wring out the double-digit inflation from the economy.  To restore people’s purchasing power.  And return the nation to real economic growth.  The tax cuts and deregulation of the Eighties created one of the longest sustained periods of economic growth in U.S. history.  With one of the longest upward trends in the CLFPR ever.  Indicating a growing economy.  With more and more people who could work finding work.  Proving that Reaganomics worked.  And worked very well.

If JFK or Ronald Reagan were President Today we wouldn’t be seeing a Freefall of the CLFPR

But it wouldn’t last.  Thanks to the government’s interference into the banking industry.  They had set a maximum limit on interest rates S&Ls (and banks) could offer.  When inflation took off people pulled their money from their savings accounts.  Putting it in higher earning instruments.  So they didn’t lose their savings to inflation.   This bad banking policy begat more bad banking policy.  They deregulated the S&Ls and banks.  So they could do other things to make up for their lost savings business.  And that other thing was primarily real estate.  They borrowed short-term money to make long-term loans.  Helping to create a housing bubble.  And when they began to wring that inflation out of the economy interest rates rose.  When those short-term loans came due they had to refinance them at higher interest rates.  While the interest they were earning on those long-term loans remained the same.  So their interest expense soon exceeded their interest income.  Creating the savings and loan crisis.  And a severe recession that ended the economic expansion of the Eighties.  With a corresponding fall in the CLFPR.

Labor Force Participation Rate and Recessions 1990 to 2000

Once the recession ended the CLFPR resumed a general upward growth.  But not as good as it was in the Eighties.  Also, it would turn out that much of the growth in the Nineties was artificial.  Bill Clinton’s Policy Statement on Discrimination in Lending forced lenders to lower their lending requirements.  And to qualify the unqualified.  Which created a surge in subprime lending.  And the beginning of a housing bubble.  The Internet entered the economy in the Nineties.  Just as the personal computer entered the economy in the Eighties.  Making Bill Gates a very rich man.  Investors were anxious to find the next Bill Gates.  Taking advantage of those low interest rates creating that housing bubble. And poured money into dot-com start-ups.  Companies that had no revenues.  Or products to sell.  Creating a dot-com bubble.  And a surge in computer programming jobs.  Also, as the century came to a close there was the Y2K scare.  Creating another surge in computer programming jobs.  To rewrite computer code.  Changing 2-digit date codes (i.e., ’78) to 4-digit codes (i.e., 1978).

Labor Force Participation Rate and Recessions 2000 to 2013

The Y2K scare proved to be greatly overblown.  Which put a lot of computer programmers out of a job in January of 2000.  And they wouldn’t find a dot-com job for the dot-com bubble burst in the same year they lost their Y2K job.  Throwing the economy into recession in 2001.  And then making everything worse came the terrorist attacks on 9/11.  Prolonging the recession.  As can be seen by the long decline in the CLFPR.  Which leveled out after the Bush tax cuts.  But then that housing bubble peaked in 2006.  And burst in 2007 into the subprime mortgage crisis.  Thanks to all those toxic mortgages Bill Clinton’s Policy Statement on Discrimination in Lending forced lenders to make.  And because Fannie Mae and Freddie Mac bought these toxic mortgages and had Wall Street package them into collateralized debt obligations this crisis spread worldwide.  Selling what they told unsuspecting investors were high yield, low risk investments.  Because they were backed by the safest of all loans.  Mortgages.  What they failed to tell these investors was that these mortgages were not safe 30-year conventional mortgages.  But highly risky subprime mortgages.  In particular adjustable rate mortgages.  Where the monthly payment would increase with an increase in interest rates.  And that is what happened.  And when it happened the unqualified could not afford the new monthly payment.  And defaulted.  Kicking off the Great Recession.  And because President Obama was more interested in national health care than ending the Great Recession he didn’t cut taxes.  Or cut regulations.  Instead, he increased taxes and regulations.  Making the current recovery one of the worst in U.S. history.  As can be seen in the greatest decline in the CLFPR since the Great Depression.  If you look at a continuous graph from 1950 to the present you can see just how bad the Obama economic policies are.

Labor Force Participation Rate and Recessions 1950 to Present

The JFK and Reagan tax cuts caused the greatest economic expansions.  And the greatest rise in the CLFPR.  Also, after most recessions there was a return to a growing CLFPR.  Interestingly, the two times that didn’t happen are tied to Bill Clinton.  Who created two of the greatest bubbles.  The dot-com bubble in the Nineties.  And the subprime mortgage bubble that was built in the Nineties and the 2000s.  The growth was so artificial in building these bubbles that the CLFPR did not recover following the bursting of these bubbles.  It might have following the dot-com bubble if the subprime mortgage crisis didn’t follow so soon after.  The current recovery is so bad that it has taken the CLFPR back to levels we haven’t seen since the Seventies.  Making the current recovery far worse than the official unemployment rate suggests.  And far worse than the government is telling us.  So why are they not telling us the truth about the economy?  Because the government wants to raise taxes.  And if the economy is improving there is no need for recession-ending tax cuts.  So they say the economy is improving.  As they hate tax cuts that much.  Unlike Ronald Reagan.  Or JFK.  And if either of them were president today we wouldn’t be seeing a freefall of the CLFPR.


Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

Banking, Lending Standards, Dot-Com, Subprime Mortgage and Bill Clinton’s Recessions

Posted by PITHOCRATES - March 19th, 2013

History 101

Lending more made Banks more Profitable as long as they Maintained Good Lending Standards

Money is a commodity.  And like any commodity the laws of supply and demand affect it.  If a lot of people want to borrow money interest rates rise.  This helps to make sure the people who want to borrow money the most can.  As they are willing to pay the higher interest rates.  While those who don’t want the money bad enough to pay the higher interest rates will let someone else borrow that money.  If few people want to borrow money interest rates fall.  To entice those people back into the credit markets who had decided not to borrow money when interest rates were higher.

Okay, but who is out there who wants people to borrow their money?  And why do they want this?  The key to any advanced civilization and the path to a higher standard of living is a good banking system.  Because if ordinary people can borrow money ordinary people can buy a house.  Or start a business.  Not just the rich.  For a good banking system allows a thriving middle class.  As people earn money they pay their bills.  And put a little away in the bank.  When a lot of people do this all of those little amounts add up to a large sum.  Which converts small change into capital.  Allowing us to build factories, automobiles, airplanes, cell towers, etc.  Giving us the modern world.  As banks are the intermediary between left over disposable cash and investment capital.

Banks are businesses.  They provide a service for a fee.  And they make their money by loaning money to people who want to borrow it.  The more money they lend the more money they make.  They pay people to use their deposits.  By paying interest to people who deposit their money with them.  They then loan this money at a higher interest rate.  The difference between what they pay to depositors and what they collect from borrowers pays their bills.  Covers bad loans.  And gives them a little profit.   Which can be a lot of profit if they do a lot of lending.  However, the more they lend the more loans can go bad.  So they have to be very careful in qualifying those they lend money to.  Making sure they will have the ability to pay their interest payments.  And repay the loan.

With the Federal Reserve keeping Interest Rates low Investors Borrowed Money and Poured it into the Dot-Coms

Just as a good banking system is necessary for an advanced civilization, a higher standard of living and a thriving middle class so is good lending standards necessary for a good banking system.  And when banks follow good lending standards economic growth is more real and less of a bubble.  For when money is too easy to borrow some people may borrow it to make unwise investments.  Or malinvestments as those in the Austrian school of economics call it.  Like buying an expensive car they don’t need.  A house bigger than their needs.  Building more houses than there are people to buy them.  Or investing in an unproven business in the hopes that it will be the next Microsoft.

America became the number one economic power in the world because of a good banking system that maintained good lending standards.  Which provided investment capital for wise and prudent investments.  Then the Keynesians in government changed that.  By giving us the Federal Reserve System.  America’s central bank.  And bad monetary policy.  The Keynesians believe in an active government intervening in the private economy.  That can manipulate interest rates to create artificial economic activity.  By keeping interest rates artificially low.  To make it easier for anyone to borrow money.  No matter their ability to repay it.  Or how poor the investment they plan to make.

The Internet entered our lives in the Nineties.  Shortly after Bill Gates became a billionaire with his Microsoft.  And investors were looking for the next tech geek billionaire.  Hoping to get in on the next Microsoft.  So they poured money into dot-com companies.  Companies that had no profits.  And nothing to sell.  And with the Federal Reserve keeping interest rates artificially low investors borrowed money and poured even more into these dot-coms.  Classic malinvestments.  The stock prices for these companies that had no profits or anything to sell soared.  As investors everywhere were betting that they had found the next Microsoft.  The surging stock market made the Federal Reserve chief, Alan Greenspan, nervous.  Such overvalued stocks were likely to fall.  And fall hard.  It wasn’t so much a question of ‘if’ but of ‘when’.  He tried to warn investors to cool their profit lust.  Warning them of their irrational exuberance.  But they didn’t listen.  And once that investment capital ran out the dot-com bubble burst.  Putting all those newly graduated computer programmers out of a job.  And everyone else in all of those dot-com businesses.  Causing a painful recession in 2000.

Based on the Labor Force Participation Rate we are in one of the Worse and Longest Recession in U.S. History

Encouraging malinvestments in dot-coms was not the only mismanagement Bill Clinton did in the Nineties.  For he also destroyed the banking system.  With his Policy Statement on Discrimination in Lending.  Where he fixed nonexistent discriminatory lending practices by forcing banks to abandon good lending standards.  And to qualify the unqualified.  Putting a lot of people into houses they could not afford.  Their weapon of choice for the destruction of good lending practices?  Subprime lending.  And pressure from the Clinton Justice Department.  Warning banks to approve more loans in poor areas or else.  So if they wanted to stay in business they had to start making risky loans.  But the government helped them.  By having Fannie Mae and Freddie Mac buying those risky, toxic loans from those banks.  Getting them off the banks’ balance sheets so they would make more toxic subprime loans.  And as they did Fannie Mae and Freddie Mac passed these mortgages on to Wall Street.  Who chopped and diced them into new investment vehicles.  The collateralized debt obligation (CDO).  High-yield but low-risk investments.  Because they were backed by the safest investment in the world.  A stream of mortgage payments.  Of course what they failed to tell investors was that these were not conventional mortgages with 20% down payments.  But toxic subprime mortgages where the borrowers put little if anything down.  Making it easy for them to walk away from these mortgages.  Which they did.  Giving us the subprime mortgage crisis.  And the Great Recession.

So Bill Clinton and his Keynesian cohorts caused some of the greatest economic damage this nation had ever seen.  For Keynesian policies don’t create real economic activity.  They only create bubbles.  And bubbles eventually burst.  As those highly inflated asset prices (stocks, houses, etc.) have to come back down from the stratosphere.  The higher they rise the farther they fall.   And the more painful the recession.  For this government intrusion into the private economy caused a lot of malinvestments.  A tragic misuse of investment capital.  Directing it into investments it wouldn’t have gone into had it not been for the government’s interference with market forces.  And when the bubble can no longer be kept aloft market forces reenter the picture and begin clearing away the damage of those malinvestments.  Getting rid of the irrational exuberance.  Resetting asset prices to their true market value.  And in the process eliminating hundreds of thousands of jobs.  Jobs the market would have created elsewhere had it not been for the Keynesian interference.  We can see the extent of the damage of these two Clinton recessions if we graph the growth of gross domestic product (GDP) along with the labor force participation rate (the percentage of those who are able to work who are actually working).  As can be seen here (see Percent change from preceding period and Employment Situation Archived News Releases):

Labor Force Participation Rate and GDP Growth

The first Clinton recession caused a decline in the labor force participation rate (LFPR) that didn’t level out until after 2004.  Even though there were not two consecutive quarters of negative GDP growth during this time.  Usually what it takes to call an economic slump a recession.  But the falling LFPR clearly showed very bad economic times.  That began with the dot-com bubble bursting.  And was made worse after the terrorist attacks on 9/11.  Eventually George W. Bush pulled us out of that recession with tax cuts.  The much maligned Bush tax cuts.  Which not only caused a return to positive GDP growth.  But it arrested the decline of the LFPR.  But the good times did not last.  For the second Clinton recession was just around the corner.  The subprime mortgage crisis.  Created with President Clinton’s Policy Statement on Discrimination in Lending.  That unleashed real economic woe.  Woe so bad we call it the Great Recession.  The little brother of the Great Depression.

This recession not only had two consecutive quarters of negative GDP growth but five of six consecutive quarters showed negative growth.  And one of those quarters nearly reached a negative ten percent.  Which is when a recession becomes a depression.  This recession was so long and so painful because those artificially low interest rates and the pressure on bankers to lower their lending standards created a huge housing bubble.  Pushing housing prices so high that when the housing bubble burst those prices had a very long way to fall.  Worse, President Obama kept to the Keynesian policies that caused the recession.  Trying to spend the economy out of recession.  Instead of cutting taxes.  Like George W. Bush did to pull the economy out of the first Clinton recession.  Worse, anti-business policies and regulations stifled any recovery.  And then there was Obamacare.  The great job killer.  Which he helped pass into law instead of trying to end the Great Recession.  GDP growth eventually returned to positive growth.  And the official unemployment fell.  A little.  But the president’s policies did nothing to reverse one of the greatest declines in the LFPR.  More people than ever have disappeared from the labor force.  That will take a lot of time and a lot of new, real economic activity to bring them back into the labor force.  And no matter what the current GDP growth rate or the official unemployment rate are it doesn’t change the reality of the economy.  Based on the LFPR it is in one of the worse and longest recession in U.S. history.  And the worse recovery since the Great Depression.  Because of President Obama’s embrace of Keynesian policies.  Which do more to increase the size of government than help the economy.


Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

Without a Bill Clinton the Bursting of the Canadian Housing Bubble will be less Painful than in the US

Posted by PITHOCRATES - November 10th, 2012

Week in Review

The subprime mortgage crisis caused the Great Recession.  And bad government policy caused the subprime mortgage policy.  First with artificially low interest rates to encourage everyone to borrow money and take on enormous amounts of debt.  Then the Clinton administration took it up a notch.  By charging lenders with discrimination in their lending practices.  And if they didn’t find a away to qualify the unqualified for mortgages they would soon find themselves out of the mortgage business.  So they came up with subprime lending.  Adjustable rate mortgages (ARM).  No documentation mortgages.  Anything to get the government off of their backs.  And the government was so pleased with what they saw they started to buy (and/or guarantee) those toxic mortgages with their Government Sponsored Enterprises Fannie Mae and Freddie Mac.  Clearing those toxic mortgages from the lenders balance sheet by unloading them onto unsuspecting investors.  Clearing the way for even more toxic subprime lending.  The government was pleased.  And the bankers were making money with bad lending practices.  Something they normally would have avoided because it is very risky.  But when the government was transferring that risk to the taxpayer what did they have to lose?

Governments like a hot real estate market.  Because housing sales drives so much economic activity.  Because people put a lot of stuff into those houses.  Which is why governments are always quick to use their monetary authority to lower interest rates.  Which is what they did in the US.  Cheap money to borrow.  Lax lending practices thanks to the Clinton administration.  Creating a housing boom.  And a housing bubble.  It was a perfect storm brewing.  The only thing that it needed was a raise in the interest rates.  Which came.  Causing the subprime mortgage crisis as those ARMS reset at higher interest rates.  Leading to a wave of subprime mortgage defaults.  And the Great Recession.  Which raced around the world thanks to those toxic mortgages Fannie Mae and Freddie Mac unloaded on unsuspecting investors.

Canada did not suffer as much from the Great Recession.  Because they did not pressure their lenders to qualify the unqualified like Bill Clinton did in the US.  But they still used their monetary authority to keep interest rates artificially low.  So while they escaped the great damage the Americans suffered in their subprime mortgage they still have a housing bubble.  And it looks like it may be time for it to burst (see Analysis: Canada braces as housing slowdown takes hold by Andrea Hopkins posted 11/10/2012 on Reuters).

Long convinced the country’s housing boom would never end in a crash, Canadians have watched this autumn as a sharp slowdown in real estate spreads across the country, leaving would-be home buyers hopeful and sellers scared…

Signs are everywhere that Canada’s long run-up in house prices is over, hit by a combination of tighter mortgage lending rules and growing consumer reluctance to take on more debt. Sales of existing homes are down steeply, with condo sales hit especially hard, and some long-booming prices have started to fall…

Canadian households hold more debt than American families did before the U.S. housing bubble burst, which has led the government to tighten mortgage lending rules four times in four years…

Tal believes slower sales activity will be followed by falling prices in many cities. But he says Canadian lending standards have been higher, and borrowers more cautious, than in the United States before its crash, which will prevent large-scale mortgage defaults and plunging prices.

Mindful of what happened in the United States, the Canadian government has tightened mortgage rules to prevent home buyers from taking on too much debt. While interest rates are low and expected to stay low into 2013, the fear is that eventual rate hikes will drive borrowers out of their homes or into bankruptcy…

The last round of mortgage rule changes took effect in July, forcing home buyers to cut back on their budget and pushing many prospective first-time buyers out of the market entirely.

The Canadians may escape the damage the US suffered as Bill Clinton was an American and not a Canadian.  So they only have to suffer the effects of bad monetary policy.  Not the effects of government enforced bad lending practices.  So housing prices will fall in Canada.  And there will probably be a recession to correct those inflated real estate prices.  But housing prices probably will not fall as far as they did in the US.  For the Canadians were more responsible with their irresponsible monetary policy than the Americans were.

The lesson here is that when markets determine interest rates housing bubbles are smaller and recessions are less painful.  If you don’t believe that just ask an American with an underwater mortgage.


Tags: , , , , , , , , , , , , , , , , , , , , ,

Subprime Lending, Housing Bubble, Dot-Com Bubble, Enron, WorldCom and Obamacare

Posted by PITHOCRATES - August 14th, 2012

History 101

Dot-Com Companies used Venture Capital and Proceeds from their IPOs to pay their Expenses as they had no Revenue

The economy in the Nineties boomed.  President Bill Clinton and the Democrats say it was their policies of higher taxes on the rich that made it all happen.  At least that’s the argument you hear today in their arguments for returning to the Clinton era taxes on the wealthy.  Because it gave us the incredible economic explosion of the Nineties.  And balanced the federal budget.  But was the economy really that good?  No.  It wasn’t.  A lot of bad things happened in the Nineties.  Including something we’re still suffering from today.  The Subprime Mortgage Crisis.  Which gave us the Great Recession.

The Clinton administration told lenders to approve more mortgages for poor and minority applicants or face action from his justice department.  Lenders were not approving these applicants for reasons like lack of income and a poor credit history.  Common of people who lived in poorer sections of town because they didn’t have the income and credit history to move to a less poor section of town.  To avoid action from Clinton’s justice department lenders turned to subprime lending to qualify the unqualified.  To help these lenders unload these toxic mortgages off of their balance sheets the federal government’s GSEs Fannie Mae and Freddie Mac bought them and resold them to unsuspecting investors.  And we all know how well that turned out.  A great housing bubble blowing up.  Subprime Mortgage Crisis.  And the Great Recession.

The Nineties also gave us the dot-com bubble.  A lot of Internet start-up companies with soaring stock prices for products they never sold.  They had no revenues.  But speculators were so anxious to get in on the next Microsoft that they ran up these stock prices into the stratosphere.  And with nothing to sell these dot-coms used venture capital and proceeds from their initial public offerings (IPOs) to pay their expenses.  Giving away what they had for free.  Hoping to build brand awareness.  And to figure out a way to actually make money on the Internet.  Even cities joined in the speculation.  Spending tax dollars to build high-tech infrastructure to attract the dot-coms to their cities.  And businesses came to their cities.  Built buildings.  Filled them with employees earning good money.  It was the dawn of the new high-tech, Internet-based world.  But when all of the investor money ran out they still didn’t have anything to sell to pay their bills.  The bubble burst.  People lost their jobs en masse.  And all those new buildings sat empty in cities burdened with debt and a shrunken tax base.  While students who went to college to get degrees to let them join the dot-com world found no one was hiring when they graduated.  As few were hiring during the ‘dot-com’ stock market crash and recession of 2000-2002.

Enron Cooked their Books to Overstate Sales and Assets and Underreport Liabilities

Enron came of age in the Nineties.  They were in the electricity and natural gas business.  In both distribution and generation.  They were also into other businesses.  Too many to list.  But the energy business took off in the Nineties thanks to deregulation.  And Enron became a darling of the stock market.  With its stock price rising about 300% during the Nineties.  The value of its stock was worth about 70 times earnings.  Meaning that investors saw nothing but further growth in Enron.  Why?  Because the Clinton administration was taxing the rich at higher tax rates?  Not quite.  It’s because they cooked their books.

Investors like to see strong earnings.  Lots of assets on the balance sheet.  With not so much debt (i.e., liabilities).  So Enron strived to give investors what they wanted.  By the aforementioned cooking of their books.  Using mark-to-market accounting.  As opposed to historical cost accounting.  Where you buy an asset.  You post it to the balance sheet for the value you paid for it.  Then forget about it.  Mark-to-market, on the other hand, notes the ‘fair value’ of those assets.  If an asset grows in value a company adjusts it books to reflect the current, higher value.  Making their books more attractive to investors.  To look better on the liability side they created a lot of shell companies and special purpose entities.  Posting liabilities on these off-balance-sheet companies instead of their own books.  The combination of higher asset values and underreporting of liabilities made Enron look very strong financially.  And strong revenue growth just made investors drool.

Enron traded.  They bought and sold products and services.  Providing risk management for its clients.  Think of an airline buying a contract for jet fuel for one year to lock in low prices.  How you record this transaction on your books depends on what you’re buying and selling.  If you’re a stock broker you record only your fees as revenue.  Not the value of the stock.  If you’re a retailer you record the value of what you sell as revenue.  Enron recorded their trading like a retailer would.  Which greatly increased their revenues from these trades.  They also used mark-to-market accounting on future revenue streams.  Instead of using the retailer method of recording sales and costs for a period they would calculate the value of a contract for future sales and record them as current revenue.  Pulling future revenues into the current accounting period.  This sent revenues soaring.  Increasing some 700-800% during the Nineties.  Much of which was a house of cards built upon shady accounting practices.  Long story short, they couldn’t keep cooking the books.  And the house of cards collapsed.  The stock price fell back to earth.  And landed with a thud.  Becoming worthless.  People went to prison.  Workers lost their jobs.  And their pensions.  Valued at some $2 billion (though they got a little of that back).  Shareholders lost some $74 billion.  Their accountant, Arthur Andersen, went out of business for their involvement.  And Enron went bankrupt.  The biggest bankruptcy ever.  Until WorldCom.

The Obama Administration borrowed Accounting Practices from Enron and WorldCom to Score Obamacare

WorldCom became a telecommunications titan by buying other companies.  And then with the largest merger in U.S. history when it merged with MCI Communications in 1997.  It was huge.  And it posted huge sales.  Accordingly, its stock price rose.  As the dot-com bubble burst WorldCom’s stock price fell.  As did a lot of telecoms.  To prop up their falling stock price they, too, turned to shady accounting practices.  Inflating both revenues and assets.  And like Enron they couldn’t keep up the scam.  And the fallout was similar to Enron.  Only bigger.  Interestingly, they even had the same accountant.

But it’s just not corporations playing with their accounting practices.  Even the government gets into the action.  Case in point Obamacare.  The magic number for the cost of Obamacare over 10 years was a trillion dollars.  The same cost of the Iraq War and the War in Afghanistan.  As the wars end Obamacare takes over that spending.  Making it ‘revenue neutral’.  Well, health care for everyone without adding any new government spending would be hard to say ‘no’ to.  So how do you keep it below the cost of these wars?  You borrow accounting practices from Enron and WorldCom.

The original CBO scoring of Obamacare came in at $940 billion.  They based this on the data the Obama administration gave them.  Which included 10 years of new taxes (or spending transferred from war spending to Obamacare spending).  But only 6 years of benefits.  So that $940 billion only covered 6 years of Obamacare in that 10 year period.  Greatly underreporting the costs of the program.  No one knew it at the time.  Because they fast-tracked this bill through Congress before anyone had a chance to read its two thousand pages.  So they had their CBO scoring below a trillion.  And with some shady backroom deals, voila.  Obamacare became law.  CBO has since revised their number to $1.76 trillion that includes 9 years of benefits.  Bringing it to about $2 trillion if you cover all ten years.  And closer to $3 trillion if you put back the $741 billion or so taken from Medicare.  So the government cooked the books to conceal the true costs of Obamacare.  With the true cost being approximately 300% more than they promised the American people it would cost.  This $2 trillion scam is greater than the Enron and WorldCom scams.  But the government suffers no fallout for their gross misrepresentation like Enron and WorldCom did.  Because when they do it it’s just politics.


Tags: , , , , , , , , , , , , , , , , , , , , , , , ,

Housing Boom, Subprime Lending, ARMs, Housing Bubble, CDOs, Subprime Mortgage Crisis, Housing Inventories & Sales and Great Recession

Posted by PITHOCRATES - July 24th, 2012

History 101

Artificially Low Interest Rates and Federal Pressure to Qualify the Unqualified created a Housing Bubble

The federal government loves home sales.  Because they generate a lot of economic activity.  From the washing machines and refrigerators new homeowners buy to furnish them.  To the raw materials extracted from nature to make the concrete, bricks, wood, pipes, wires, shingles, glass, plastic, paints, carpeting, insulation, etc., to build them.  Enormous amounts of economic activity at every level throughout the stages of production.  It reduces down to a simple formula.  Make it easy for people to buy houses.  Enjoy a booming economy.  And how best to do that?  Make mortgages cheap.  By keeping interest rates cheap.  Artificially low.  To stimulate a housing boom.

This is Keynesian economics.  Government intervention into the private market.  By having the Federal Reserve keep interest rates lower than the market would have them.  To encourage more people to buy houses.  Then the Clinton administration took it up a notch with their Policy Statement on Discrimination in Lending.  Investor’s Business Daily reported (see Smoking-Gun Document Ties Policy To Housing Crisis by PAUL SPERRY posted 10/31/2011 on that this policy statement forced lenders basically to qualify the unqualified.

At President Clinton’s direction, no fewer than 10 federal agencies issued a chilling ultimatum to banks and mortgage lenders to ease credit for lower-income minorities or face investigations for lending discrimination and suffer the related adverse publicity. They also were threatened with denial of access to the all-important secondary mortgage market and stiff fines, along with other penalties…

“The agencies will not tolerate lending discrimination in any form,” the document warned financial institutions.

The unusual full-court press was predicated on a Boston Fed study showing mortgage lenders rejecting blacks and Hispanics in greater proportion than whites. The author of the 1992 study, hired by the Clinton White House, claimed it was racial “discrimination.” But it was simply good underwriting.

There was no racial discrimination.  Just people who couldn’t qualify for a mortgage.  But that didn’t stop the Clinton administration.  So there were artificially low interest rates.  And federal pressure to qualify the unqualified.  To let those who can’t afford to buy a house buy a house.  Enter subprime lending.  A way lenders could approve the unqualified for a mortgage.  With adjustable rate mortgages (ARMs).  Interest only mortgages.  Zero down mortgages.  No documentation loans (say you earn whatever you want and we’ll enter it into the application without documenting it).  Anyone who wanted to have a house could have a house.  And a lot of people bought houses.  Even those with insufficient incomes to pay their mortgage payment if interest rates ever rose.

When the Housing Bubble Burst it Destroyed a lot of Economic Activity and a lot of Jobs

The economy was heating up.  There was a housing boom.  The boom turned into a housing bubble.  Housing prices soared demand was so high.  Builders couldn’t build them fast enough.  And people couldn’t buy a house big enough.  McMansions entered the lexicon.  Houses in excess of 3,000 square feet.  For a family of four.  Or smaller.  But then these artificially low interest rates began to heat up inflation.  And it was the Federal Reserve’s responsibility to keep that from happening.  So they raised interest rates.  Causing the interest rates on those ARMs to reset at a higher rate.  Making a lot of those monthly payments beyond the homeowners’ ability to pay.  Homeowners defaulted in droves.  Causing the subprime mortgage crisis.  And the Great Recession.

Facilitating this economic carnage was the secondary mortgage market.  Fannie Mae and Freddie Mac.  Who bought those very risky mortgages from the lenders.  Repackaged them into collateralized debt obligations (CDOs).  And sold them to unsuspecting investors.  Who thought they were buying high-yield safe investments.  Because they were backed by historically the safest investment.  A mortgage.  But that was before subprime lending.  For these subprime mortgages weren’t your father’s mortgage.  These mortgages were toxic.

So when the housing bubble burst it not only destroyed a lot of economic activity, and a lot of jobs, it wreaked financial destruction in people’s investment portfolios.  All because of a formula.  Make it easy for people to buy houses.  But when you play with the economy too much you don’t create economic growth.  You created bubbles.  And the bigger the bubble the longer and the more painful the recession will be when that bubble bursts.  As those artificially high house prices fall out of the stratosphere back to real market levels.

The Current Gulf between Housing Inventories and Sales is what made this Recession the Great Recession

If you look at the housing inventories and housing sales for the decade from 2001 to 2011 you can see how bad the recession was.  And will continue to be.  We took housing data from the United States Census Bureau.   Housing inventories from Table 7A.  And housing sales from Houses Sold.  The data shows housing units in inventory and sold.  We used 2001 as a base year, dividing each number by the 2001 base numbers.  Graphing the results shows how inventories and sales trended for this decade.

From 2001 to 2005 housing sales were rising at a greater rate than inventories.  Indicating demand for houses was greater than the supply of houses.  Causing house prices to rise.  Encouraging builders to build more houses.  Heating up the housing market.  Sending prices higher.  Creating the great housing bubble.  Then around 2005 the Federal Reserve began to raise interest rates to tamp out inflation.  And those ARMs began to reset at higher rates.  Causing housing sales to fall.  From about 2005 to 2008 inventories continued to rise while sales collapsed.  Leaving the available housing supply far outstripping demand.  Causing house prices to collapse.  Leaving people underwater in their mortgage (owing more than their house is worth).  Or living in paid-off houses that lost up to half their value.  Or more.

The gulf between inventories and sales is what made this recession the Great Recession.  And is why the Great Recession lingers on.  There are just so many more houses than people want to buy.  Killing new housing starts.  And all that economic activity that building a house generates.


Tags: , , , , , , , , , , , , , , , , , , , , ,

Keynesian Policies gave us the Subprime Mortgage Crisis, Solyndra and Inflation while the Free Market gives us Jobs

Posted by PITHOCRATES - September 30th, 2011

The Problem with Washington is that there are too many Elitists who Think they are Smarter than Us

Now we know why we have slow economic growth.  Apparently it’s par for the course after a financial crisis (see Phony Fear Factor by Paul Krugman, Keynesian Economist, posted 9/29/2011 on The New York Times).

We might add that major financial crises are almost always followed by a period of slow growth, and U.S. experience is more or less what you should have expected given the severity of the 2008 shock.

So why do any spending?  Why have any stimulus to stimulate growth that won’t come.  Because “major financial crises are almost always followed by a period of slow growth…”  If true then we could have gotten here without that $800 billion stimulus bill.  And we could have avoided that debt ceiling debate.  And the subsequent downgrading of U.S. sovereign debt.  All because we were spending money trying to alter slow growth that was going to happen anyway.

But the Keynesian will say, “Just think how bad things would have been if we didn’t spend that $800 billion.  And how better things would be if we had just spent more.”  How do you argue with that?  When spending fails it’s because we didn’t spend enough.    By this logic, then, spending as a policy can never fail.  Even when it fails.

If slow growth is more or less what you get were they then lying?  When they said they would keep the unemployment rate below 8%?  If Congress passed the stimulus bill?  Or did they just not understand how bad things were?  Because their understanding of economics is that bad?  Or was George W. Bush so much smarter than them that he was able to hide how bad things were?

And it also, of course, reflects the political need of the right to make everything bad in America President Obama’s fault. Never mind the fact that the housing bubble, the debt explosion and the financial crisis took place on the watch of a conservative, free-market-praising president; it’s that Democrat in the White House now who gets the blame.

But good politics can be very bad policy. The truth is that we’re in this mess because we had too little regulation, not too much. And now one of our two major parties is determined to double down on the mistakes that caused the disaster.

Who was it that pushed subprime lending to get people who couldn’t afford a house into a house?  Whose policies were those that made home ownership available to everyone, not just those with good-paying jobs that could pay their mortgage payments?  Who was it that brought suits and protests against lenders for ‘redlining’ poor and minority communities by not approving mortgages for those who could not qualify for a mortgage?  The Republicans?  The so-called servants of the wealthy?  Or the Democrats?  The so-called champion of the poor and disenfranchised?

Buying risky mortgages from banks allowed banks to make risky loans.  And who was buying those risky mortgages?  Fannie Mae and Freddie Mac.  That was government policy.  Keynesian policy.  Keeping interest rates low and removing risks from the normal risk takers in the mortgage industry.  There could not have been a Subprime Mortgage Crisis without these Keynesian government policies in place.  And we know that conservative Republicans aren’t Keynesians.  That’s why Keynesians hate conservative Republicans.  Especially when they hold up further stimulus spending in Congress.

The problem with Washington is that there are too many elitists who think they are smarter than us.  And these elitists want to double down on the mistakes that caused this crisis.  Already the Obama administration has been talking about boosting subprime lending.  Incredible.  This after that very same policy caused the worst recession since the Great Depression.

After the Benefit of a Cheap Euro runs its Course the Depreciated Euro turns into a Liability

The Keynesian’s answer to everything is more spending.  And when someone warns about igniting inflation with all of their easy monetary policy they call those people misinformed.  Monetary policy doesn’t cause inflation.  Greedy business people do.  By raising prices.  And supply shocks.  Like the OPEC oil embargo of the Seventies.  They point to the Eurozone and say, “See?  Their central banks have been keeping rates low to stimulate spending.  And where is the inflation?”  Here, apparently (see Euro-Zone Inflation Surges by Paul Hannon, Dow Jones Newswires, posted 9/30/2011 on NASDAQ).

The annual rate of inflation in the 17 countries that share the euro surged to its highest level in almost three years in September, while the number of people without work fell slightly.

The European Union’s official statistics agency Eurostat Friday said consumer prices rose 3% in the 12 months to September, up from 2.5% in August and was well above the European Central Bank’s target of just below 2%.

Prices rose faster than at any time since October 2008, and more rapidly than economists had expected. Those surveyed last week by Dow Jones Newswires had estimated that prices rose 2.5%. The last rise in the annual rate from one month to the next that was of a similar scale was in March 2010, when it picked up to 1.6% from 0.8%.

With a depressed economy businesses haven’t been able to raise their prices.  But what they couldn’t do their central bank has.  Put so much cheap money into the economy that they depreciated the Euro.  Which is another way to cause inflation.  Eventually.  After the benefits of a cheap Euro (making cheap exports) run its course.  And the depreciated Euro turns into a liability (higher input prices in the manufacturing process).

This always happens in Keynesian economics.  Yet the Keynesian ignores this reality and doubles down on the failed policies of the past.

Government Policies Favor Green Energy over Oil and Gas because Government Elitists are in Control

Keynesian economic thought is the prevailing though in most governments.  For a reason.  They’re expansionary policies.  And put government in control of that expansion.  Government officials don’t care if they work.  They just like the power it gives them.  The control over the economy.  And an open checkbook to buy votes.  So governments everywhere put Keynesians into their administrations.  Which give the Keynesians legitimacy.  People accept what they say.  Because if government adopts what they say they must know what they’re saying.

But Keynesian thought is wrong.  History has shown this.  The Austrian School of economics has a far better track record of success.  But that is not a popular school among expansionists.  Because it leaves the economy to the free market.  Not to elitists in government.  Who think they know better than the free market.

An example of this elitist intervention into the free market is government’s choice of green energy as the smart investment of the future.  Which has been failing even with heavy subsidies.  While the hated oil and gas industry, on the other hand, is creating jobs (see Gassing Up: Why America’s Future Job Growth Lies In Traditional Energy Industries by Joel Kotkin posted 9/27/2011 on Forbes).

But the biggest growth by far has taken place in the mining, oil and natural gas industries, where jobs expanded by 60%, creating a total of 500,000 new jobs…

Nor is this expansion showing signs of slowing down. Contrary to expectations pushed by “peak oil” enthusiasts, overall U.S. oil production has grown by 10% since 2008; the import share of U.S. oil consumption has dropped to 47% from 60% in 2005.  Over the next year, according to one recent industry-funded study, oil and gas could create an additional 1.5 million new jobs.

What makes this growth even more remarkable is that the month of August posted zero new jobs.  So if there were no new jobs while oil and gas was creating hundreds of thousands of jobs, hundreds of thousands of jobs in other industries must have been disappearing.  Such as in that government-backed green energy sector.

How about those “green jobs” so widely touted as the way to recover the lost blue-collar positions from the recession? Since 2006, the critical waste management and remediation sector — a critical portion of the “green” economy — actually lost over 480,000 jobs, 4% of its total employment…

The future of the rest of the “green” sector seems dimmer than widely anticipated. One big problem lies in cost per kilowatt, where wind is roughly twice as expensive and solar at least three times as expensive as electricity produced with natural gas. Given the Solyndra  bankruptcy  and their inevitable impact on the renewables industry, it’s also pretty certain that the U.S., at least in the near term, will not be powered by windmills and solar panels.

Natural gas is a clean burning fuel.  It’s so clean we use it in our homes.  In our stoves.  And our furnaces.  It’s cheap.  And it’s plentiful.  We’re getting it out of American ground that can put hundreds of thousands of Americans to work.  Without loan guarantees.  And they can bring it to market at market prices.  Without any subsidies.  It’s the hanging softball of energy policy.  But what are we pursuing?  Green energy.  A sector that is bleeding jobs.

The relative strength of the energy sector can be seen in changes in income by region over the past decade. For the most part, the largest gains have been heavily concentrated in the energy belt between the Dakotas and the Gulf of Mexico. Energy-oriented metropolitan economies such as Houston, Dallas, Bismarck and Oklahoma City have also fared relatively well. In energy-rich North Dakota there’s actually a huge labor shortage, reaching over 17,000 — one likely to get worse if production expands, as now proposed, from 6000 to over 30,000 wells over the next decade.

Why are we subsidizing green startups when we have an energy belt almost the size of the Louisiana Territory?  A labor shortage of 17,000?  And a plan to increase wells from 6,000 to 30,000 (an increase of 400%) in one state?  This is real economic growth.  Created with no government help.  I mean, if there is one thing the Obama administration isn’t known for it’s being a friend to the oil and gas industry.

So this is an industry government doesn’t help.  If anything government hinders it with heavy regulation.  And yet the gas and oil industry is blowing government-subsidized green energy away.  There’s a lesson here.  Free market works.  And when government intervenes into the market you can bet on them picking a loser.

Industry experts say that the shift in energy exploration is moving from the Middle East to the Americas, with rich deposits of oil and gas uncovered from Brazil to the Canadian oil sands.

Much of the new action is on the U.S. mainland, including the Dakotas, Montana and Wyoming. Increasingly, there’s excitement about finds in long-challenged sections of the Midwest such as Ohio. The Utica shale formation, according to an estimate by Chesapeake Energy, could be worth roughly a half trillion dollars and be, in the words of CEO Aubrey McClendon, “the biggest to hit Ohio, since maybe the plow.”

Ohio now has over 64,000 wells, with five hundred drilled just year. Recent and potential finds, particularly in the Appalachian basin, could transform the Buckeye State into something of a Midwest Abu Dhabi, creating more than 200,000 jobs over the next decade.

A Midwest Abu Dhabi?  Creating 200,000 new jobs?  And that’s just in the oil and gas business.

The energy boom also has sparked a spate of new factory expansions, including a $650 million new steel mill to make pipes for gas pipelines. Other local firms are gearing up to make up specialized equipment like compressors.

This is real economic growth.  Created and sustained by the private sector.  Without any stimulus funding or subsidies.  The way of the Austrian School of economics.  But is anathema to expansionist Keynesians.  That’s why government policies favor green energy.  Like they favored subprime lending.  Because government elitists are in control.  Not the free market.

The Genius Elite have given us the Subprime Mortgage Crisis, Solyndra and Inflation in the Eurozone

The government bet wrong on green energy.  As smart as they are.  And as smart as their Keynesian advisers are.  Is there a lesson here?  Yes.  They are not that smart.

The oil and gas industry is booming.  Why?  Because there is enormous demand for oil and gas.  For all the Keynesians’ lament over the lack of demand you’d think they’d jump on this.  But no.  They ignore it.  Instead they impose oppressive regulations.  Impose moratoriums on Gulf drilling.  And do more to impede this industry than to help it.  To please the environmentalists.  And their friends in green energy.

The genius elite have given us the Subprime Mortgage Crisis, Solyndra and inflation in the Eurozone.  The Keynesian way.  Whereas the free market is finding domestic sources of real energy and creating jobs.  The Austrian School way.  Which was also the American way.  Once upon a time.  And it can be again.  If we listen more to the market.  And less to the Keynesian elites.


Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,