USA - the socialist's paradise

The Conservative Party has just won re-election in Canada, actually adding seats to strengthen the position of Prime Minister Stephen Harper. While nobody's going to mistake him for Ronald Reagan, Harper is seen as a tax-cutter and a friend of the private sector. Actually, in each of the G-7 countries, politics has drifted to the "right" in the past few years - leading to the election of Nicolas Sarkozy in France, and Angela Merkel in Germany. Well, I should say, each of the G-7 countries save one - the United States. We're either going to elect a gang of enthusiastic progressives led by a Cult of Personality, or a tired old Senate hack who never misses a chance to trash the free market and kick small-government advocates in the hoo-hahs. Again, no matter who wins, it's quite possible that by this time next year, the United States will have the highest corporate tax burden in the Western world - and one of the highest personal tax burdens too (heck, even Sweden is cutting taxes these days). Didn't somebody stage a Tea Party in Boston once, because of something like this?

Isn't this what started this mess in the first place?

The markets enjoy their biggest one-day rally in history! Panic selling is replaced by panic buying! And what's the source of this sudden enthusiasm? A hastily slapped-together mega-plan, concocted over the weekend by the G-20 leaders, to drastically increase the role of government in every part of the world financial system. I'm still trying to sift through the details, but it seems like - at least in the short term - the government is going to "invest" $250 billion in tax money (*your* tax money - hey, where do you think it comes from?) into the financial system. And you can be sure this money will come with strings attached. No doubt the government will become intimately involved in everyday banking and business transactions to bring "stability" and "confidence" to the system. And yet everybody seems to love it. Why not? The government has just promised banks and businesses that it will magically prevent any of them from ever losing money on bad loans again. What a sweet deal! The whole concept of "risk" is so passe. Now the banks can just toss out that $250 billion in new loans to get the economy moving again. Oh, and I'm sure there won't be any political influence on who gets those loans. No, that would never happen. I think, in thirty years or so, our kids will look back at the past two weeks (provided they still teach history in 2038) and describe it as a Takeover, or even a Coup, of the world's free markets.

Oh, well, free enterprise was nice while it lasted. Embrace the future, Comrades. And by the way, with this recent spending orgy, the national debt has just added an extra digit, racing past $10 trillion with its foot on the accelerator. And that's not counting the impending nightmare of entitlement promises - those Boomers are just starting to cash their Social Security checks. As I said before, it's all well and good to raise a pint as we gather for Capitalism's wake - but I hope to also come up with strategies for the future. One thing I plan to do is research various western European economic systems, especially Britain, France, and Germany. They're further along the decaying spiral of cradle-to-grave Welfare Statism, and I think they'll give us clues as to what to expect in America in ten to fifteen years. Here's an easy call: no matter what Obama - or for that matter, McCain - is saying in their campaign ads, your taxes are going UP next year. That's simple math. The government needs a LOT more money now. A LOT more.

Misery Loves Company

Well, I've been generously invited by the illustrious owner to be a guest poster here at Conspicuous Musings. I'm certainly not an Economist, nor do I play one on TV, but I am an amateur student of history. And, unfortunately folks, we are living in interesting times, and not in the good "First-Moon-Landing" kind of interesting. The economic crisis that is currently unfolding - which should not be coming as a surprise, to anyone who's been paying attention since last August's liquidity shock - is going to drastically alter the role that government plays in our lives. And, since my political philosophy can be summed up by "leave me alone and stop stealing my money", you can imagine that I do not expect the government to make things better.

Now, while I am no lover of the Democratic Party, the truth is that the Republicans are shared authors of this mess. For every Barney Frank, there's a Ted Stevens. Right now, this is no party of fiscal responsibility in Washington - just two candidates promising to buy us all a pony, paid for with somebody else's money. Asking me "who do you want to win the election" is a little like asking me "would you rather get beat over the head with a pipe wrench, or a nail-studded 2x4?" In fact, since the last thing that the Internet needs is another partisan pie-throwing website, I intend to take the stance that party affiliation is becoming increasingly irrelevant. It's foolish (and a little sickening) to listen to Obama and McCain boasting about steps they're going to take to "fix" the economy, as if it's a malfunctioning water heater in the basement of the White House that Bush is too lazy to fix. The economy is an extremly complex, global network of interactions, with millions of variables, billions of actors, and trillions of transactions, each piece affecting the whole in a non-linear manner. Voting for a politician because he says he can fix the economy is like picking a prom date because he says he's going to make it sunny and 75 degrees on Saturday.

So hopefully, I'll add something of value here, and hopefully in a way that'll make you laugh (and roll your eyes). I'll also try to post useful advice for the future, because that's something I'm trying to find out for myself. Yes, the economy, and our freedoms, are likely to degrade over the next ten to twenty years. But that doesn't mean we should all just passively sulk in our couches and accept the end of Western Civilization. If history is any guide (and I believe it is), a prepared individual will not only survive, but will thrive, in times of crisis. It's the poor saps with their hands in their pockets, waiting for the Government to save them, who are going to get flattened. Remember, in the worst year of the Great Depression, the unemployment rate reached 25%. Which is another way of saying, three out of every four people still had a job.

Plunging of the Baltic Dry Index

I am not the first to notice this as a quick Google search will confirm, but declining consumer demand is probably not causing the plunge in the Baltic Dry Index (BDI). It may be much worse, though the demand reduction is certainly accelerating.

The credit lines cargo carriers use to purchase fuel and the Letters of Credit buyers/sellers of that cargo use to verify their financial worthiness could be hindered by the credit contraction. If Letters of Credit or short-term loans cannot be secured, then shipping does not happen. This could be more a symptom of supply disruptions then of demand destruction.

Let us hope the credit markets for non-financials don't come unglued.

Steps to a Depression

Well, according to Bloomberg the federal government is going to force the purchase of bad mortgages by Fannie Mae and Fredie mac. Where are the fiscally responsible in government? Certainly there will be pressure to not just buy the bad debt but to perform more social engineering. Wait until Congress suspends or slows foreclosures. Non-performing loans will skyrocket.

The shallow (feel good) analysis is this will support the institutions with bad mortgages, help borrowers, and prop up the housing industry. Sounds good but it won't work. It will certainly appear to work. The unintended consequences will be people who have financial problems will support unsecured loans (car, credit card) and not pay the mortgage. This also makes homeowners upside down. If there is equity sharing, then at sales time the non-supported (responsible) borrower will build wealth substantially faster. Supported homeowners will also be less mobile since they will have covenants attached to there equity (if any). At least some of these borrowers will be very house poor even after discounting. The worst incentive to all this is that the prudent borrower (and taxpayer) supports the imprudent. Schemes like this have serious long term negative implications.

Let the loans fail. This is how the economy clears the excess and will start allocating resources away from bad and toward the good institutions. This policy distorts (capital) resource allocation into the poor performing and away from the (potentially) well performing.

Propping lenders and borrowers with taxpayer money is foolish. We tried this in the 1929 recession, did that turn out well? Nope, bad policy exacerbated the depression. Maybe we could look at Japan? Nope, zombie banks, zombie companies, and a lost decade. Ben Bernanke (Chairman of the Board of Governors of the U.S. Federal Reserve ) is a student of the depression yet we are heading down the path towards one.

Unintended Consequences

Unfortunately, the free market is going to take the blame for this economic fiasco when interventionist government policies and lax regulation were significant contributors. The federal and state governments have been trumpeting their success in recent years of record high home ownership rates. This was a government fix and certainly at least part of the cause of our current situation.

Regardless, the government is under tremendous pressure to "fix" the deleveraging that the economy is experiencing. Nearly all government fixes, well intentioned or not, have less than desirable outcomes.

We'll look at just one policies I found reading Housing Wire.com. The policy is basically a foreclosure tax in New Jersey I ran across.

New Jersey Looks to Charge Lenders $2K Per Foreclosure

New Jersey is going to suffer in several ways, first, like nearly all "taxes" this one will ultimately be passed through to home buyers, particularly below prime. For the lenders clawing for survival, this could be the push off to bankruptcy resulting in the destruction of weak businesses at the margin. In Addition, Lenders will substantially tighten lending standards, avoiding the risk of default from home buyers buy requiring higher down payments, more fees and higher rates.

Fewer of the people this is designed to help will have access to mortgage credit. In the longer team, once this financial disaster unwinds some lenders will not expand or open in New Jersey. So, the unintended consequences are reduced number of servicers in the long run, tighter lender standards, higher down payments, higher interest rates and higher fees.

To many this seems obvious, but to many this isn't. New Jersey residents will never see the servicer that didn't open shop and they won't necessarily notice the higher costs for mortgages in there state since all lenders will pass this on. For the servicer's that don't survive some will even cheer. Over time mortgages will be a little more expensive in New Jersey.

Bailout Approval Coming

The massive taxpayer funded wealth transfer will be approved sometime this week. Why am I so prescient? First congress was expected to adjourn this week. Second, this is an election year, many congressional office holders feel the necessity of campaigning for their job. Thinking through such a massive proposal seems to be, at best, secondary.

I hope to be proven a bad predictor of congressional action.