“When Wall Street talks about the “failure” of a bank or other financial institution it means the failure of the company to pay off its own bondholders. It does not mean that depositors, counterparties or other bank customers lose money. A bank is essentially a big portfolio of assets, about 70% which are typically financed by depositors, customers and other liabilities, about 20% by the bank’s own bondholders, and about 10% with the capital of the bank’s stockholders. In a typical bank “failure,” the bank is taken into receivership by regulators, the liabilities to stockholders and bondholders are cut away, the remaining package of assets and liabilities is sold as a single entity to some other firm, the old bondholders get the proceeds of that sale, and the stockholders are wiped out. When investors willingly take a risk, and buy the stocks and bonds issued by an institution that goes on to mismanage its business, this is the appropriate outcome. Depositors and customers typically don’t lose a penny”

“If public funds are provided during a financial crisis, and it cannot be clearly demonstrated that the institution is solvent, the funds should be provided post-failure, as senior loans to a restructured institution where shareholders and existing bondholders have already been subject to losses. The interest rate should be relatively high, to encourage replacement of public funds with private ones. With few exceptions, when public funds are used to avoid major restructuring and shield private investors from losses, the result is almost inevitably a larger, less transparent, and more recklessly managed institution.”

“The same is true for government or “sovereign” debt. When Wall Street talks about “failure” of Greece, for example, it means failure of Greece to pay off its own bondholders. In trying to avoid this failure, Greece is instead forced to impose extreme austerity and depression on its citizens. From the standpoint of those citizens, Greece has already failed them painfully. Those are the choices – let bad debt “fail” or force depression on innocent citizens.”

“In 2008, the Federal Reserve created a set of off-balance sheet shell companies called “Maiden Lane” to buy undesirable long-term assets of Bear Stearns and other financial companies, justifying the purchases by appealing to Section 13.3 of the Federal Reserve Act. But if you actually read Section 13, it is clear that under the law, “discounting” means (as it has always meant) providing short-term liquidity by essentially providing a check-cashing service for obligations that are short-dated, well-collateralized, and promptly collectible. The Fed’s creation of the Maiden Lane companies to purchase bad assets was, and remains, illegal under the language and intent of the Federal Reserve Act.”

50% Contraction in the Fed’s Balance Sheet This is a great article on the Federal Reserve and it’s actions regarding interest rates and Treasuries. It’s a bit of a tough read, but if you can get through it and understand it, I think you will gain tremendous understanding of our current economic regulatory motivations and hurdles.

Handicapping QE3 This one has an in depth look at the results of the previous rounds of Quantitative Easing, and the likely timing and effects of a third round.

For the rest of his analysis, check out the full list of Weekly Market Comments here.

Got it?

OK, now let’s remove 8 zeros and pretend it’s a household budget:

• Annual family income: $21,700 • Money family spent: $38,200 • New debt on credit card: $16,500 • Outstanding balance on credit card: $142,710 • Total budget cuts: $385

I’ve seen the above posted on a number of sites recently. The oldest source I saw for it was here. I think it’s valid to think of the budget in these terms. Sure, there are differences, such as our government’s ability to legally launder money, but the basic principles of home finance do relate, and taking eight zeroes off helps make things imaginable. Considering that there are approximately 300,000,000 Americans, around half of whom don’t pay income taxes, it isn’t even too far off for figuring your own percentage of the debt. Gimmicks aren’t going to change this chart. You can tax the people to give out loans (more debt) to small businesses, but that is mostly zero-sum. You can tax the people to pay for unemployment to encourage the unemployed to spend money to stimulate demand for products and thus create jobs, but that is like buying your employer’s product on your credit card in order to keep them paying your paycheck; It gets you nowhere or worse. You can tax the rich dry and barely make a dent in that number. Just like in your personal finance, if you want to gain wealth, you need to provide something that someone else needs. If we aren’t selling more to foreign nations than we are buying, we are losing. This isn’t so much a supply or demand problem as it is a relative value problem. If we are going to be on the losing side of this equation, we need to be printing money rather than borrowing it. This may not be fair to the savers, but they will fail right along with the rest of us on the current course. Printing money eventually devalues it. A devalued currency will make imports more expensive and exports more affordable, putting us to our rightful place in the market again. I would also support an eye-for-an-eye tariff policy to prevent socialist nations from taking advantage of us. Until one or both of these things are instituted, our economy will continue to decline. Even with those changes, we also need to reduce our spending on the military, foreign aid, micromanaging regulations, incarceration, social programs for non-citizens, and benefits for public employees.

With the advent of the internet, knowledge in many fields is at your fingertips. Unless you want to be a doctor or something similarly carefully regulated, chances are you can learn most of what you need online and at your own pace, and nearly free.

Contrast that with the current college system. Colleges are putting professors on furlough and reducing the amount of education they produce each semester. Meanwhile tuition is going up far faster than the rate of inflation. College loans have increased over 500% since 1999.

Why? What is it in the system that is justifying tuition going up while quality of education is dropping? In this case I believe it is actually a self-defeating government subsidy. Credit is tight right now. If you want a loan for most things, you have to first prove that you don’t need it. This credit crunch has hit every sector but education, in which government loans are still easily available and low interest. Combine this with the lack of work, and people are going back to school and living off loans. The natural result of this is that colleges raise tuition, since the students can afford it.

Looking back a decade, government-sponsored enterprises gave out adjustable rate mortgages to the poor, and once they had them on the hook, raised the rates. What they didn’t take into account is what would happen when they took it too far and people just defaulted and walked away. This time around, they are ensuring that it doesn’t happen again. Federal student loans follow you till you die. Bankruptcy doesn’t help. What will happen when all of this debt comes due? Will people spend the rest of their lives trying to get above water? Will the government forgive the debt on the backs of the taxpayer? Will the next credit bubble use your children as collateral? When will they stop trying to hide the debt and start working to correct it?

What still doesn’t make sense is the furloughs. If tuition is up, and full time attendance is up, and professor salaries aren’t skyrocketing, then why the furloughs? It’s because we are becoming a nation of administrators. Less than a third of your tuition goes into educating you, and the percentage of funds going to college  administrative costs is going up at a truly unreasonable rate. I’m not even saying anyone is getting fat here, just that as a society, we are spending far more on administrating producers than we are on actually producing anything.

What we need now is some transparency. Unfortunately, creating the Office of  Administrative Overview Regulation or some such won’t help. What we need is simple disclosure. Let the resulting outrage do the rest.

Here we have a man, Dennis Kucinich, who is a contender for being the farthest left of center in our government, speaking out against the legitimacy of that government, its monetary policies, and the two party system. What surer sign can we have that the system is broken?

I’ve spoken of Dennis Kucinich before. I don’t always agree with him, but he has my support for one simple reason.  He’s one of the few honest politicians we have left who are willing to speak out against their own party, their own president, even be the only dissenting vote in the house, to set things right. Look at recent legislation, if you are in Congress and you haven’t voted against your party lately, then you have no ethics and no credibility with me.

It seems that these days, Congress takes a few breaks each year from legislating on important topics like who can marry who and baseball to bicker over some massive piece of legislation. This legislation is always claimed to be crucial to the continuation of society as we know it (sometimes it really is!), and has a deadline for doom avoidance. For months we see news anchors biting their nails over which side is going to win and whether it will pass in time to avert disaster.

The answer is always the same: It will pass. It will pass because if it doesn’t, the legislators will lose money like the rest of us, their constituents will abandon them, and the populace will make what remains of their now final term really unpleasant.  Sure, some will vote the other way, but all they need is a majority.

Why do they wait? Why not just make a deal early on and be done with it? Because somebody has to lose, in fact, most of us have to lose.

Our problems are too big to solve in a way that makes everyone happy.  Take the budget for example. Taxing the rich isn’t nearly enough (and it makes them not rich), reducing the military is slow and more expensive in the short term than leaving it alone, and the problem needs to be solved now. Raising taxes on the middle class just shifts the overwhelming burden to another group who can’t bear it, without fixing the core problem of a lack of national wealth, and the middle class are the majority of the voters. Stimulus is not much more than smoke and mirrors, and costs money we don’t have. Spending cuts cause outrage among those who are being cut and their sympathizers.

So what’s a politician to do? It’s pretty simple really. Put on a good show. Bang your fist on the podium, cry, point the finger at the other guys, all the while drilling home the point that the deadline of doom is approaching. The most important part is that you don’t make a deal until the clock has nearly run out. If you wait until the very end, you can vote something in that appears to address the problem and helps out your biggest donors (you know, the insurance companies, the unions, and the military industrial complex). Then you go to the American people and you tell them that the other guys put the bad stuff in there, but you had to pass it to avert catastrophe because the deadline was up. If you make the deal early, they will claim you should have kept fighting, and that you sold out.

How do we fix the system?

• Take on problems in smaller bites. Deadlines should be staggered rather than overwhelming. Bills should be mandated to be short and legible.
• Transparency. These people are public servants and we should be allowed to hear what they say on our behalf. All discussions should be on public record.
• Our taxes are a percentage of our earnings, so funding should be percentage based as well. That way, when revenue goes down, spending automatically matches it without the need for an emergency vote.
• Stop taxing the trade of Dollars for gold and silver. It’s Constitutional and allows people to shield themselves from the toxic inflationary effects of Congressional irresponsibility.
• If you want the money out of politics, take away the power from politicians to choose winners and losers. Take away the mandated insurance, the mandated union memberships, the private military contractors, and the corporate bailouts, and the money will take itself out of politics.

“Son, if you can’t take their money, drink their whiskey, screw their women, and then vote against ‘em, you don’t deserve to be here.” – Sam Rayburn, longst serving Speaker of the House

I haven’t spoken much about WikiLeaks, but I’m glad that such organizations exist to shine some sunlight on the back-room dealing of those in power. It’s a sad day when the truth is a crime.

Our secrets are a weakness, not our power. Who can be blackmailed, if they have no secrets? Who embezzles money in the light of day? If torture is humane and effective, then why don’t we do it publicly? What investor invests in a market they know is overvalued?

If the state of our Union is strong, don’t tell us it is strong, show us it is strong. Open the books. Knowing that the data they see is the truth will brink confidence in our Dollar and our nation, not chase it away. Besides, if you don’t open the books, Assange will do it for you.

California’s latest budget deal continues their now-familiar trend of chasing small business out of the state. In a desperate and unconstitutional powergrab, they are saying that any business that is even affiliated with anyone in California has to pay sales tax on everything sent to customers in the state.

I’m most often complaining about Congress overstepping their bounds in controlling the states, but this is a rare case (Like Arizona’s recent immigration laws) where the opposite is true. Interstate commerce is squarely under the jurisdiction of Congress. Let’s say that a product is manufactured in Texas, sent to Colorado to an Amazon distributor, and then shipped to a customer in California; what’s to stop Texas from saying they can charge sales tax on the item because they made it? Or Colorado to charge it because they are where the sale was shipped from, or every state in between because it passed on through? The Federal government is there primarily for two purposes, foreign policy, and making sure states don’t enact anti-competitive laws that interfere with the commerce between the states, thus, states were only allowed to regulate transactions from those companies which they have jurisdiction over because of a physical presence in the state.

California is now claiming that I, along with ten thousand others are ‘sister companies’ of Amazon, because we are paid to advertise for them. I’m nobody’s ‘sister company’. I have no Obligations to Amazon, they don’t tell me what to do, we don’t have any claim over each other’s assets, I just post a link to Amazon on my page, and Amazon reimburses me for doing so when paying customers arrive there through my sites. I’m no more connected with Amazon than television networks who advertise for them, UPS who carries their products, or Visa, who handles their transactions.

Living in an extremely liberal town, I hear a lot of people cheering this bill as somehow sticking it to the evil corporations and finally making them pay their fair share, but that isn’t what is going to happen out of this. Amazon has already announced that they will end their business dealings with everyone in California, which means not only are ten thousand more Californians now very suddenly out of work, but California won’t see a cent of it, since the companies won’t actually be taxed after cutting ties, and California will be out the revenue from those people and quite possibly paying to add them to its welfare rolls. Also, it isn’t legally Amazon’s responsibility to pay sales tax on your purchases, it’s yours, so if you aren’t paying taxes on your online purchases, then point the finger at yourself first.

I wish I’d seen that this ship was sinking before I bought a home here. If it were any easier to leave, I would.

This was our Nobel for Economics winner of 2008. More proof that our economic situation wan’t an accident, wasn’t the result of insufficient regulation, but was engineered by those very regulators.

“To fight the recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley or Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.” -Paul Krugman, 2002

(via FalkenBlog)

• Individuals acting in their own best interests.
• Religions representing different moral ideologies.
• Corporations representing the interests of their investors.
• The actions of the government itself, in seeking to maintain and expand its own control. This includes influential political parties.

All of these actors are working within environmental constraints, responding to the actions of others, and are most often comprised of individuals acting upon several of these influences in concert. Clearly, sustainability under the force of these tides is a near impossibility.

Our empire is in decline. There are many reasons for this. We were the only superpower left standing after WWII, there was a time not long ago when China and India barely even registered on our economic radar, and the scale of military, government, insurance, regulation, and debts both private and public have grown to the point where they consume the fruits of our labor and leave us the pits.

Some of these problems are beyond our control, and indeed shouldn’t even be considered problems. In the spirit of embracing the advance of humanity over that of nationalism, we should welcome China and India to the stage. There is no reason they need to fail in order for us to succeed, and we’ve proven many times in the past and present that suppressing nations only leads to military dictatorship.

Those interested in sustaining the status quo have been pulling the puppet strings of politics in order to convince us that what we need to do to save ourselves is to feed them. They’ve convinced us that by giving large amounts of taxpayer money to the largest and most inept banks, so that they may loan it back to us at interest, we will save ourselves money. They’ve convinced us that by getting rid of people’s old cars, we get them to buy new cars, thus providing jobs. This is the classic broken window fallacy, that in order to save the economy, we should all go out and throw a rock through our neighbor’s  window. Think of all the people we could employ making new windows! Now they want us to believe that the best way to save small business is to make small business loans more available, as if more debt is what small business needs to succeed.

There are times when the best ideas are the ones that sound the worst on the surface, A friend sent me this video from The Renegade Economist the other day, and I must admit I’m fascinated by the concept:

As horrible and unfair an idea as it may seem to reward those who have gotten into excess debt by cancelling their debts, I think the fallout from such a plan could very well leave us in a much more sustainable society. The first round of this is the toughest, both from the perspective of fairness, and in coming up with the money. Lets assume that the government simply prints money and pays off all debts acquired before the passing of the bill. This would create a massive devaluation of the dollar, which would be bad, right?

Can we agree that the recent success of Chinese industry can be attributed to their pegging of their currency below the dollar in order to get us to buy their goods and outsource to their industry? If we can say that their success is due to them devaluing their currency, then why do we insist that doing the same would ruin ours? It would level the playing field and herald the return of manufacturing.

If everyone knew their debts would disappear every four years, wouldn’t they just rack up uncontrollable debt again? Assume now that the government says up front that they won’t be paying the debts in the future, just cancelling them, why would the credit industry loan anyone money in the first place? They would cease to exist, and give up their jobs breaking windows in favor of something more useful. There would be no more housing booms or busts, as housing prices would never adjust beyond people’s ability to buy them outright. This would also serve to remove the divide we are currently seeing between tangible assets and fiat wealth.

I’m not at all certain I support this action, and I have no illusions about the likelihood of it even making it to vote, but I’d be interested in your thoughts.

It could be argued that politicians talked up the economy. It isn’t so much that they talked it up or down, but that they did them backwards. If they had tightened lending during the boom, we never would have been in the position to bust. Talking up the bust and down the boom makes me wonder if they wanted us to crash in order to boost U.S. manufacturing (see my conspiracy theory post), or if it was just straight corruption at the point where regulators choose who gets the money.

Our government is comprised almost entirely of investor-class elected officials. When times are good, they want to use their power to fuel growth and for their own profits and popularity. When times are bad, they feel the ire of the populace threatening their re-election and seek someone to blame in order to appear to be cracking down on the problem. We can see an example of this in the housing market boom and subsequent crash:

• In 1977 Jimmy Carter signed the Community Reinvestment Act, which went a long way towards giving government the right to force the banking system to lend to high risk borrowers.
• In 1982, Congress (with a Democratic majority) passed the Alternative Mortgage Transactions Parity Act, which allowed non-federally chartered housing creditors to write adjustable-rate mortgages.
• Clinton put pressure on “Government Sponsored Entity” Fannie May to relax credit requirements in order to try to boost lending to low income buyers. HUD wanted them to keep 50% of their portfolios in loans to low income people.
• Clinton threatened to essentially audit lenders and air their dirty laundry if they didn’t comply. Here is what realtytimes was saying back in the beginning of ’03: “Government policies encouraged riskier lending. They did this ‘encouraging’ with threats to step in with GSE reform legislation in response to accounting scandals, and other such methods.” There is clear evidence of both carrots and sticks being used by the government.
• Bush continued and expanded these policies. In 2008, Government Sponsored Entities had extended over five trillion in loans, with a mere hundred million in total assets. They were able to do this via Fractional Reserve Lending, which is an outdated concept from back when banks didn’t want to have to hold on to large amounts of gold, and more recently is used as a way for central banks to regulate the money supply.
• Investors would flee if they saw the banks making such high risk loans, so the banks started bundling risky loans and selling them at bargain prices in order to keep profits up for investors.
• People saw great profit in real estate and started taking out as much debt as they could, figuring they could always just sell some if things got tight.
• A hiccup in the housing prices started a cascade. Housing prices began to drop, and people started to default on homes that were no longer worth as much as the loan.
• As the problem gained media attention, the politicians deflected the blame, blaming the banks for the government-pushed subprime loans. They assured us that they would fix the problem by regulating these wicked banks and doing away with their subprime lending.
• The inability of people to get loans or refinance demolished the housing market, making it even harder for those in trouble to sell, even at a loss. Foreclosures cascaded further. This tanked the housing prices and caused the very foreclosures they were intended to prevent. People who would have gladly sold their homes or refinanced were foreclosed on instead. The banks were nothing but a Ponzi scheme.
• Bush realized his legacy was threatened, and that the collapse of the American banking system would be put at his feet. He abandoned any pretense of free market and crafted the largest corporate bailouts in history.

To unravel the above mess, you have to realize that government financial regulation is an illusion. It creates waste and assures that the booms and busts are larger, last longer, and affect everyone. The bottom line is that we had people borrowing fake money from the central bank, money which was backed up by the government, which is backed up by the people – people borrowed fake money from themselves to buy houses they couldn’t afford, and subsequently lost them. The free market won out and balanced itself, despite the government meddling, but with a loss of productivity caused by the waste of effort. Without government regulation, fractional reserve lending wouldn’t exist on a national scale, nor would subprime loans, and neither would the problem.

From the wiki: “fractional reserve banking benefits the economy by providing regulators with powerful tools for manipulating the money supply, interest rates, and government debt creation. From a Keynesian point of view this debt creation provides governments with much greater latitude to stimulate the economy through government spending.”

On the Federal Reserve: According to the wiki,  “The Federal Reserve System is subject to the Administrative Procedure Act. It is not “owned” by anyone and is “not a private, profit-making institution”. It describes itself as “an independent entity within the government, having both public purposes and private aspects”". The Federal Reserve was created in 1913, by a Democratic Congress and approved by Woodrow Wilson. The Chairman and Vice Chairman of the Federal Reserve are both appointed by the U.S. President.

The very creation of the Federal Reserve gave regulators both the power and the inclination to lengthen booms and then plunder private sector savings (monetize) to ‘stimulate’ our way out of the ensuing and ever larger busts.

Lack of oversight? There is a difference between no oversight and bad oversight. The government controls everything from taxes, to laws, trade treaties, tariffs, lending practices. If the regulators were pushing subprimes and Fractional Reserve Lending, then how would additional regulating been helpful? The only idea I’ve heard out of Washington lately is that we should borrow money to make a product we don’t want and then go buy it. We have a sinking boat with one party wanting to bail water out of the front of the boat into the back, and the other party wanting to bail water from the back of the boat into the front. It doesn’t help to shuffle the money around if you don’t make it in the first place.

It isn’t so much the fault of the market or government, but at the point at which the two meld, where government decisions affect the flow of large amounts of money in the private sector, here corruption is inevitable. The banking sector is a tough issue. The way I see it there are three main ways we can deal with this:

1. We can nationalize the banks. It wouldn’t be the first time. Obviously, the government has its own problems with inefficiency and corruption, and this essentially gives a competitive advantage to those banks which are subsidized by the government (as does our current meddling in which we have seen bailed out failures buy up successful competitors).
2. We can do nothing. This is high risk in the sense that if the banks fail, the government is obligated to pay for most of what the banks lose (FDIC guarantee of 250k per account), so if they fall, we pay anyway. As for if they will fail; deflation causes defaults, which causes bank failure; inflation higher than interest rates makes the banks lose money on all of their loans. Due to fractional reserve lending, this means they will fail if the economy is at all unstable. Seeing how we just doubled our money supply last year, this is pretty much going to happen. A failure of the banking industry impacts lending, which is central to the Ponzi schemes that are most modern businesses, and to the housing market. If everyone has to buy their houses with cash, the price is either going to fall a lot farther, or they are going to be bought by China.
3. We can do what we are doing now, which is leave them private and give them money, which they will abuse, both due to human nature and greed, and due to it being in the bank’s best interest to hold the money as long as the dollar is gaining value (which it has been until very recently), because using it causes inflation (if the dollar drops much longer, expect dramatic inflationary action by banks trying to drop dollars which are losing value). This is just meddling, and isn’t healthy for anyone.

The problem is that we are so deep in this Keynesian lunacy, that switching systems guarantees a crash. What are we to do?

I think this highlights a serious flaw in human nature. People have this unshakable feeling that there is a benevolent deity looking out for them, that everything will turn out fine in the end, and that there is a good solution to every problem, that when life gives you lemons, you get lemonade.

Sometimes every solution comes with pain and sacrifice. Sometimes the government can’t fix it, people die, wars are lost, retreat is the best you can do. Sometimes you just have to eat your damn lemons.

The longer you fight the tough decision, the worse the consequences get. We need to deal with the core issue, which is that every day we pay more regulators more money to regulate a shrinking industrial base. It’s time we let go of the micromanaging and let our good citizens keep the fruits of their labor so that they might afford to keep doing it.