Things That Shouldn't Happen

Perusing the news I came across this gem. This article, about a girl poking fun at school staff on MySpace, is certainly scary:

Less than a minute into the hearing the gavel came down. "Adjudicated delinquent!" the judge proclaimed, and sentenced her to three months in a juvenile detention centre. Hillary, who hadn't even presented her side of the story, was handcuffed and led away.

The state has the legal authority to enforce its rules forcefully through violence and incarceration. This is a power that no private corporation or individual can legally do and must be monitored vigorously.

Judge Ciavarella plead guilty to the charges of bribery but this went on for seven years.

Last month the judge involved, Mark Ciavarella, and the presiding judge of the juvenile court, Michael Conahan, pleaded guilty to having accepted $2.6m (£1.8m) from the co-owner and builder of a private detention centre where children aged from 10 to 17 were locked up.The cases of up to 2,000 children put into custody by Ciavarella over the past seven years...

This dovetails in the risks the proposed government spending bring. The stakes are high for people to get there piece of the action. We have to count on our government officials to dole out unimaginable sums of money fairly and without favoritism or worse, outright bribery.

Who is going to regulate the regulators?

Today in Bloomberg I saw what was a ridiculous statement from the Obama Administration regarding the plight of the auto industry.

White House Chief of Staff Rahm Emanuel said GM’s plight of is “a wakeup call to America” that signals the need to increase energy independence and overhaul the nation’s health care system.

Yes, that is it - he recognized that a recessionary economy simply needs energy independence and and health care. The economic team can go home we have "The Brilliance of Rahm"®

More disappointing comments to go with some seriously disappointing actions by the new administration.

Paradox of Spending

The King Report has a great analogy of Keynes' Paradox of Thrift:

“The Paradox of Thrift (or saving) is a reductio ad absurdum by John Maynard Keynes that avers that if everyone saves, aggregate demand will decline, and this will imperil the economy. We’d like to contribute the ‘Paradox of Spending’ to Econ 101. This maxim holds that if everyone spends, there are no savings; debt surges and the implosion of that debt collapses an economy.”

Stimulus for the Employed

Considering the richest counties 5 of the countries 10 wealthiest counties are around Washington, D.C., stimulus for this area should not be needed. And after the stimulus passes the wealth in these counties is sure to improve, regardless of "efficiency" and intent of the stimulus.

1	Loudoun County, Virginia	$107,207
2	Fairfax County, Virginia	$105,241
3	Howard County, Maryland	$101,672
4	Somerset County, New Jersey	$97,658
5	Morris County, New Jersey	$94,684
6	Douglas County, Colorado	$92,824
7	Montgomery County, Maryland	$91,835
8	Nassau County, New York	$89,782
9	Prince William County, Virginia	$87,243
10	Santa Clara County, California	$84,360

For a refresher on the horrible rate of unemployment for government and health and education workers in the Wall Street Journal by Allen Reynolds

Most of the spending is unlikely to be timely or temporary. Strangely, most of it is targeted toward sectors of the economy where unemployment is the lowest.

The December unemployment rate was only 2.3% for government workers and 3.8% in education and health. Unemployment rates in manufacturing and construction, by contrast, were 8.3% and 15.2% respectively. Yet 39% of the $550 billion in the bill would go to state and local governments. Another 17.3% would go to health and education...

Next, look at the supposed multiplier effect of government spending. The consensus seems to be around 1.57 - which, taken simplistically, results in $1.57 spent for every $1 of stimulus. Based on this we should borrow say $2T or $3T until this supposed multiplier gets just above 1. I say this in jest because the multiplier is not 1.57 and we will not grow our economy because of the stimulus. The government can always create jobs, but what it can't create is real wealth or improved living standard in the aggregate. North Korea is an example of government created wealth.

Finally, what are we going to do for an encore in two years when the money has been spent. Stimulate ourselves another $900,000,000,000? This is simply a massive shift of wealth from the prudent to the less prudent and a substantial growth in the power and reach of government. We should be reducing the cost of government not increasing it. We cannot stimulate our way out of credit contraction - the system needs to cleanse itself.

The Future Drag

As noted in today's Wall Street Journal:

The federal government's budget deficit will widen to $1.186 trillion for the current fiscal year, an unprecedented number that will likely only get bigger after Obama's economic package.

Since debt is a "pull forward" of future consumption and investment it means a drag on future economic growth. This is important because the substantial "economic stimulus" is going to have hazardous long term implications for our economy. The effect of debt is particularly gruesome since interest paid is an exponential function.

This adds about $8500 per taxpayer in new obligations. This number is arrived at by the fact there are about 138 million people are in the labor force. It gets a lot uglier when you consider the top 50% of taxpayers pay approximately 97% of all income taxes collected. The fact half the labor force pays less than 3% of the income tax simply doubles the obligation on the "real" taxpayers. The disappointing thing is that the incoming Obama administration is warning of trillion dollar deficits for years to come. Extraordinary borrowing to fix our current problem, which was excessive borrowing, is not a path to affluence for the U.S. economy.

No good will come from this.

Taxpayer Losses are GMAC's Gain

The GMAC bailout really is bothering me. Under TARP the government loaned GMAC $5,000,000,000 which, ironically, also allowed it to qualify as a bank. In lending, the Treasury received 8% dividend paying preferred shares. GMAC immediately began loaning out the money to consumers. On the surface this sounds good but this was a horrible deal - for the taxpayer. This isn't even a normal government policy that is not well thought out. It is downright wealth transfer. A sneaky end-run to subsidize the "American" auto industry.

I want to explain in simple terms what the government did. Say you borrow $100 from your mom and then loan a $1 to each of your 95 friends for 5 years, keeping $5 for yourself since it will take time to track who you loaned the money to. Great deal until you have to pay your 8% interest to mom since those were the terms on her preferred shares. And that 8% comes due every year. Your friends on the other hand got 5 year, 0% loans. And don't forget to factor in the friends who will never pay you back - say 3% - very modest considering you lowered your standards substantially almost ensuring your loan loss will be much higher than 3%.

Based on the above business model you would need to make at least 16% (5% yourself, 3% loss, 8% interest due) on those loans to break even. Not only is that not likely, that is not mathematically possible. So this means the government loaned an organization money that is guaranteed to produce a loss on the loans given. A loss exceeding $800,000,000 the first year if your origination costs are 5%. Even if GMAC paid itself nothing it still loses $550,000,000 in the first year alone.

It Gets Worse
Well, once GMAC loans out there initial $5,000,000,000 they are out of money. Unless, since they are now a bank, they can package those loans up and sell them. Guess who is buying consumer debt at low rates? It is not private investors, so that leaves the Federal Researve and the U.S. Treasury. GMAC will use the bundled loans to give as collateral to the Fed/Treasury who will value them at face value and allow another round of auto loan securitization. Once in the hands of the Treasury (taxpayers) any losses fall to them not GMAC, the loan originator. That would be you and I. This is just an ugly misuse of taxpayer money to ultimately subsidize GM.

Please consider joining the "DO NOT BUY AMERICAN" (GM at least) crowd. I can't imagine buying a car with 36 month warranty from a company with a 3 month lifeline anyhow. I might recommend Ford or one of the many other auto manufacturers. Many of which are build in America.

CRE Has Their Hand Out

According to the WSJ this morning we find that commercial real estate now needs free money.

Big property developers are asking to be included in a new $200 billion loan program as a surge in commercial mortgages comes due.

These firms managed to leverage up too much and now are in a world of hurt. For some property developers extensive use of leverage was the business model. The (poor) choices by the management needs to run its course. Bankruptcy moves the underlying assets to the hands of people who are more competent business managers. If bailouts are given then we, as taxpayers, are allowing profits to flow to the owners in the good times while the loses flow to the taxpayers.

This is not capitalism.

The tacit moves towards the nationalization of so many industries is making me apprehensive. This is the sure way to establish more government intervention and inefficiency. An extreme example is North Korea of what happens when the government manages resource allocation (I don't expect that for us). What this means is in the years ahead we can expect much weaker economic growth as resources are allocated poorly. The problem with this outcome, lower growth, is that you can't see the growth we didn't get.

Also expect to see substantial increases in both interest rates and inflation in the years ahead especially as more bailouts (money printing) comes. This could have a serious cost to our currency as the world's reserve currency. The temptation to print away all this borrowing by the Fed is going to be strong.

The more the government bails the more drag that puts on future growth. Keep in mind that the government cannot create jobs the way private business does. The simplified explanation is that any money the government spends must come from any of three sources which means a decline in assets for investment elsewhere. If they tax income, it comes from the productive class (aka the entrepreneurs) and results in more asset hiding and less business creation/investment. Borrowing by the Treasury takes money from what may have gone into other investments, say corporate bonds, which may have expanded plants and equipment. The last possibility is "printing" money or credit which causes inflation. High inflation is a tax on everyone but particularly those with least access to money and credit. This is much to simple an explanation of the impact but hopefully your further research will help the understanding of the bailout cycle and it's effects, intended and unintended.