Wednesday, January 27, 2010

Bernanke's Confirmation: No! Err... Well....Okay

Ben S. Bernanke, the Chairman of the Federal Reserve Board, is facing some opposition in winning a confirmation for his second term as Chair. As a man who is nearly universally proclaimed as the savior of the American economy from a deep depression, it seems amazing. The mainstream press has been a cheerleader and books have been written extolling his heroics. What is happening?

My own view of the man is spread throughout this blog, especially in my comments on his speech on January 2nd. He practices a science that is tailor made to not learn of causal relationships. He gives the impression of being non-political. He appears to be the ultimate academic bureaucrat.

Bernanke always appears poised and rock solid in his pronouncements and prognostications. This is his view of how a Fed Chair should be. Unfortunately, he appears rock solid regardless of the veracity or wisdom of his statements. Here are some examples: He appeared poised and rock solid when he said that there was no problem with the rise in housing prices a couple years ago. He appeared the same when he said that the problems with foreclosures would have no impact on the economy. He appeared the same when he said that Fannie Mae and Freddy Mac were in excellent financial health. He appeared the same when he and the Treasury nationalized the failing Fannie Mae and Freddy Mac a few days later. He appeared the same when he began nationalizing banks and put a couple trillion dollars into the economy. He appeared the same when he said that events that coincided with injections of money were coincidences. He appeared the same when he said that the probable cause of the foreclosure problem was the use of risky mortgages offered to substandard credit borrowers, even though he knew that the Fed had pushed with the rest of the Federal government for lowering credit standards for mortgages for years. The guy has an appearance that does not connect to the real world.

I also think that any man who accepts the chair of the Fed has to be regarded as having a questionable psychology. This is one of the most powerful, political positions in the world. Anyone willing to accept that much power over his fellow man has problems.

At this point, there is very little suggestion in the mainstream press that the Fed is responsible for the house price bubble. As I mentioned, there is nearly universal acclaim for his leadership in keeping the U.S. economy from depression. Why then is his confirmation being opposed by several Democrats?

The good news is that several democrats are criticizing Bernanke for the bailouts. The bad news is that they are criticizing the bailouts primarily because these politicians think the companies bailed out are unpopular. It is a play of the class warfare card.

It is okay, they think for the Fed to have pumped a trillion or two into the economy. It is okay for him to have wielded the power he has, along with the Treasury.

One set of criticisms of Bernanke is that he gave too much money to AIG and did not add conditions. These criticisms aren’t that Bernanke bailed out AIG, but that he didn’t do it in a certain fashion. Somehow, in his headlong dash to dole out all the money he could create, Bernanke was suppose to make sure that the money wasn’t suppose to be used for AIG’s actual business, which, in this case, was to insure certain investments tied to mortgage backed securities. If AIG failed to meet its contractual obligations, those companies would suffer sever difficulties and many would fail. What was AIG suppose to do with the money? These congressional critics are all for the use of government money as a means of manipulating the economy, confiscate assets, and generally extend the government’s reach, but they are outraged that the money was used for contracted, normal business activities. It is just another example of the attitude of the political climate that the importance of contract is ignored and denied. The worthiness of attacking a person because their actions inadvertently helped a company that can be attacked for political gain.

One criticism that I have heard only a little is that he has lied at several stages of the bail-out. He lied to BoA on the financial health of Merrill Lynch, and then when they found out the depth of the problem he threatened the Bank’s leadership and implied that he would put someone in their place who would do what he, Bernanke, wanted. The man feels as though he may do as he pleases with his power. He lied about the AIG deal and his representatives at the New York Fed told AIG to keep quite (for which the AIG officials are blamed with the suggestion that AIG instigated the deceit, when it was obviously the Fed). He has lied about the role of the Fed in the lowering of credit standards for sub-prime mortgages, implying that it was the nefarious and evil mortgage brokers, who had only their jobs and businesses to loose. The man apparently feels that any statement he makes is acceptable because he is “saving” the country from depression. He must “do all it takes”, which means forcing people to do what is not in their best interest. At best, Bernanke believes in sacrificing others for the sake of “the greater good”. Not to psychologize, but it is just as possible that he just likes the power.

I have seen that many people are happy that Bernanke may be rejected. They are joining the chorus, albeit a small one at the moment, in calling for his confirmation to fail. Bernanke should be fired, at the very least. He should not continue in a post that he doesn’t understand and mishandled so badly. I cannot deny that I too would feel good about the Senate sending him home. But. But! BUT! There is a small, okay, a big problem.

If Bernanke, the lying, self-deluded, power craving, freedom destroying, bureaucrat loses his job on Sunday. What happens? Obama gets to appoint a new Fed Chairman. Obama. Obama gets to appoint the person who is quite possibly the most powerful person in the world economy. Obama.

I am afraid. The prospect of Obama placing a person in the Fed Chair frightens me more than Bernanke does.

I have not kept track of Obama’s appointments. But from what I can tell, his people are radical, anti-freedom socialists and fascists. I am not aware of a single competent person. The guy at the Treasury is the one who forced through much of the current economic plan as head of the New York Fed. He came to the government from Goldman Sacks, and he turns out to be a pragmatist of the first order, willing to use government power to control and manipulate. He is not a capitalist. If there are people in Obama’s administration who do not want to actively expand government power, they haven’t made an impact.

So, what can we expect from an Obama appointment that could get through the Senate confirmation process? Anyone who has paid their taxes, including their nannies taxes, who will use the Fed as the means to further corrupt, undermine, and destroy what little remains of our freedom and capitalistic system. Is that better than Bernanke? Bernanke’s one little bitty redeeming piece of character is that he is an academic, as corrupt and pragmatic as that is. He is not overtly political. He is certainly not a supporter of capitalism, and he has shown no willingness to oppose any of Obama’s drive to fascism. Nor will his policies help stabilize and strengthen the economy. But, he is not going to act as Obama’s pawn or tool in the manner that Obama’s own selection would. It is a small difference, but sufficient that I am willing to argue for Bernanke’s return for another term.

If you want to argue that putting Obama’s person into the Fed will make our current situation much worse and that people will rebel against Obama and the destruction of our freedom I am willing to listen. But, I think that it is too early for us to do that. People don’t know any more about freedom and capitalism than they did three years ago. It is still too soon. I think that we can use more time in a slowly deteriorating situation to further our efforts to save our freedom and the United States of America. I want more time.

Wednesday, January 20, 2010

Social Security and Medicare: "Trust Funds"

A few months ago John Lewis published a “dire warning” about the future of the economy. [] This article concerns the near future proportional increase in retirees, the Baby Boomers, and their impact on the costs of Medicare and Social Security. To say the least, it will make all of today’s arguments regarding the budget superfluous. All of the facts and figures are in the material that Dr. Lewis references. I will not include them here. This post is meant to talk through the things that are going to happen, especially the impact of the “Trust Funds” of Social Security and Medicare.

You will hear some politicians argue quite loudly that, even if there may be a problem down the road, it is not now because both programs have trust funds that will provide money for several years. The date that the government has to begin adding funding to both programs is, thus, some time in the future and they don’t worry about it now.

Well, yes, both programs have “Trust Funds”. That is, both programs have had more money paid into them over the years by taxpayers than the programs have paid out. This “surplus” has been put into a trust fund. Each trust fund has securities in it that may be exchanged for cash as needed, and the cash is then paid out in benefits. So, these politicians are correct, right?

The recent annual report of the Medicare Trust Fund revealed that this program is already spending more than the Medicare Tax is bringing in. The short fall began in 2008. Medicare has begun redeeming “Trust Fund Assets”. Because of the recent short fall, they now expect the “Trust Fund” to be exhausted in 2017.

The Social Security Trust Fund is still taking in more money than it is spending, but the recent troubles in the economy have, no doubt, changed the “projected” dates as well.

When the Medicare Administration projects that they will fall short of Medicare claims they will not cover 19% of the annual cost of the program. As these claims are “entitlements”, the shortfall would have to be made up by general Federal Government revenue, or taxes and the proceeds of bond sales. So, according to our politicians, we have 8 years to solve this problem, right? We have even more years to solve the Social Security problem.

Ahhh. Let’s take a look at those “Trust Funds”. That money is invested in securities, right? Well, depends upon your definition. What the administrators were allowed by law to buy with their “surplus” is a special class of Treasury Bonds. These bonds pay interest, which are probably close to market, so they are accumulating assets, right? Okay, we are at the crux of the issue now. The Treasury of the United States sells these special bonds to the “Trust Funds”, and guess what the Treasury did with the money? They put the money into the General Fund, and spent it as they did with all the other tax money and the proceeds from bond sales. And the accounting, you ask? The money from the “Trust Funds” reduced the annual deficit of the Federal Government. The Treasury had to sell fewer bonds.

Administration after administration has been spending the Social Security and Medicare surpluses and pretending that it was general revenue, not some future debt. In many cases the administration crowed about the way it was decreasing the Federal Deficit.

In this case, however, it isn’t like the standard Treasury Bond that no politician expects to ever pay back. These special “Trust Fund” bonds have to be paid back as the two entitlement programs fall short of meeting their required payments from the FICA taxes. In practice, it means that the Treasury will have to sell more standard bonds. Did anyone say Ponzi?

I ask you, what is the difference between taking money from taxes and the proceeds of bond sales and redeeming special bonds for covering Medicare expenditures, and giving the money directly to Medicare after the “Trust Fund” Bonds are depleted? The Trust Funds are a standard government fiction, which allows some (many, most?) politicians to duck the issue.

Social Security is “projected” to need to dip into its “Trust Fund” in the middle of the next decade. Like any government projections, the government planners have foretold of wonderful years of tax collection because the economy will be booming and employment will be below 5%. Even if you count all of the non-employed as tax payers, there are far more than 5% unemployed, and current prognoses, even from the most optimistic government hack is that the employment part of the recovery will be slow. The number of retirees is growing, maybe even faster than expected (for Social Security), thus the outflow is growing at least as fast as expected, but the income is less, probably a lot less. That means that Social Security will begin drawing on its “Trust Fund” sooner, and more Treasury Bonds will need to be sold, more money will be taken from the economy, which means either less capital for investment and slower growth (if any) or more made-up money, i.e., inflation.

All of this will be on top of whatever programs our beloved leader can manage to get passed.

Some of you are eager for the end of the year when the Democratic strangle hold on our government will hopefully be reduced. I tend to think that a mix of Dems and Republicans is a nice safe government. But it won’t help this situation, because it will require a direct look at reality and the willingness and ability to tell the American citizen, especially the older American citizen, that the cupboard is pretty skimpy. The Republicans, who are after all, working to “conserve” the New Deal, have shown just as much willingness to ignore reality as the Dems.

In the meantime we can watch the drama being played out in Japan. Their problems with the same issue are more immediate and proportionally larger than ours. More than half of their population is dependent upon the government pension. Their elderly tends to depend upon their children, but that percentage is declining. The aging of the Japanese population is more rapid than other industrial countries. At the same time the population is shrinking.

The government has been steadily pushing up the retirement age and the age that government pensions begin. Japanese use to retire at age 50, now it is 60. The government pension begins at age 65, up from age 55. So a Japanese has a 5-year period that has to be filled in somehow.

But, get this, the taxes to support the retirees is a combined 30%, down from 40%. Part is paid by the employee and part by the employer. In the U.S. the combined tax is 15.3%.

Where are they going to get the income to support their elderly? The same place we will? We may be seeing real tragedies both at home and abroad. The European countries are heading for the same problem at various speeds, most of them will begin to see major problems before we do.

When we get done with the health insurance thing, whichever way it goes, we need to begin beating upon these people about this coming storm.

Friday, January 15, 2010

Notes on the Jobs Data

Someone noticed that the employment figure released recently by the Federal government was actually slightly less than the number they released ten years ago. I have looked for this comparison on the web, with no luck. I heard this report on PJTV, in the weekly discussion with Yaron Brook.

It is disturbing that employment is nearly the same as ten years ago. We are not talking about percentages here. It is the actual number of people employed. It means that the steady inflation that is suppose to make us prosperous didn’t work. Bernanke’s solution to all our problems hasn’t been a solution.

But two things come to mind, mine, anyway. One thought moderates the news, the other makes it worse.

The first thing that needs to be noticed is that an exactly ten-year comparison doesn’t really give you an honest read on what the figures mean. Given that we have been forced to live through two business cycles during that time, it would be a better comparison to go from peak to peak, or trough to trough. In this case the lowest employment during the earlier period of time as a basis of comparison to today. It might not look as bad. Of course, you might still argue that the growth in the population over the same period would tend to mean that the number of people employed today should still be higher today, even if this is a trough and the earlier number was mid-lower cycle. Okay, that’s true. (Note that this is the employment number, not the unemployment number, which has other problems.)

On the other hand, today’s number is bogus, and make the comparison to the earlier, ten-year old number, much worse. This is especially true if the government included in today’s figure any of the Obama, make-work “jobs”, that just soak up money.  There are more government "jobs".  There are also a lot of jobs in private enterprise that consist of doing stuff the government requires but don’t actually produce anything. These “jobs” don’t actually add anything to the economy either. All of these new jobs combined, new government jobs, Obama make-work jobs, and jobs created outside of government just to take care of government required reporting or compliance, mean that the actual number of productive jobs today are much fewer than ten years ago!

So, if you want to look at the level of prosperity-producing employment of today vs. 10 years ago, given the misleading, arbitrary choice of dates, you would have to conclude that the economy has lost a lot of jobs and that we are experiencing as prolonged decline in our living standards.

The resource that is most scarce in any economy is people. The more people you have, the more productive you can be (another point lost on the anti-immigration folks). We actually have lots of people but our government insists on forcing us to employ them in ways that tend to be less and less productive, or not employ them at all.  When will they notice that their whole thing is not working?  Do they care?  No, they don't.

Wednesday, January 13, 2010

Inflation Watch: Early 2010

It is kind of interesting now. Aside from the very important fight to prevent the federal government from expanding their control over medicine, not much is happening. It is a lull. It is the eye of the storm. It is waiting for the other shoe to drop (and it could be a big shoe). It is the calm before…..well you get it.

If this were nearly any other time after WW2, we would be seeing business activity picking up, profits being made, people being hired. Instead, people are waiting. Sure the equity markets have moved up some. Obama has spent a lot, okay, he has spent a lot of a lot. He is going to be spending even more, even if the healthcare bill fails. But, banks are still not making loans. The last report on consumer credit showed a decline. The money supply quantity has been level for a while – it is a reverse hockey stick. The dollar, the price of gold, oil prices, and house prices are staying in a pretty narrow range. Of course, when the supports of house prices disappear, we may see something different. The Fed keeps talking about having to soak up all of the excess reserves they created, but a lot of people don’t think that they have the backbone, let alone the ability, to do it. What we are all doing is waiting. Waiting for the shoe to drop. We’re afraid that it will hit us on the head, hard.

There is some talk about production beginning to come back on line, about corporate profits growing and banks regaining their strength. Then, following FDR’s example, Obama says something that scares everyone (like the tax on banks to “recover” the TARP junk money), except his loyal followers, and decision makers, the wise ones, sit on their hands again. So, this period is one of uncertainty and pause.
We can be certain that everything that Obama has done and wants to do and what the Fed has done and will probably do are bad for us. The corrections that are needed because of the house price bubble have only partially occurred, at best. There is still a lot that could happen besides a house price decline. We could easily see more unemployment, and certainly see more non-employment, as Obama continues to take money out of the economy to fund non-productive, make-work jobs. It would take a lot of study to determine which was worse, unemployment insurance or Obama make work jobs. Not only are these people not producing which would move our economy toward prosperity, but money is being taken out of the economy to pay the unemployed not to produce. At least with unemployment insurance there is no pretense.

Even though the money supply numbers are coming up flat for the last several months, since production has fallen off, but prices have not, we are experiencing price inflation, at least enough to maintain prices. There may be some asset boom in the price level of stocks and gold, but not a lot. There is a lot of money sitting on the sidelines. There is talk of the “carry trade” in international asset markets. I am sure that there is something happening there. How big it is I don’t think anyone knows.
Since banks aren’t lending, added money is coming from direct government spending. Obama’s spending feeds directly into the consumer markets, therefore, to the extent that the money is being pumped, we will see pressure on prices. The direct spending is coming through the increased government payroll and things like non-employment programs and mortgage support. This spending is money that winds up in individual’s pockets and does not impact any specific set of prices. As general government spending continues to ramp up, the result will be more like “stagflation”, much like the 70’s where we had a stalled economy and rising prices. This will confound the “economists”, especially the Fed’s people. They are depending upon businesses being able to ramp up their production to meet the levels of money wondering around the economy. Businesses aren’t ramping. Banks aren’t lending, which is a really reasonable, business wise, good decision.

The Fed will be amazed that their magic wand, really low interest rates, doesn’t provide the wonderful result their models predict. We will be back in 30’s, or the 70’s take your unhappy pick.  (When you hear "low interest rates" from the Fed, always think: creating made-up money.)
The money for the government spending is coming from some U.S. “investors” who are frightened and think that federal bonds are safe. A lot is coming from foreigners, mainly central banks, who have trillions of dollars sitting there with nowhere to go except U.S. government debt. If the Fed does start mopping up money out of bank reserves, we will see short-term interest rates rise, which may affect the long-term bond rates. It depends on the conclusions reached by investors. If they think that the Fed is acting with some determination and will finish the task of taking nearly a $ T out of member bank deposits (this is the money that banks are forced to have on deposit with the Fed;  in government speak, it is called a reserve, but it isn't), then long-term bond rates may stay fairly flat, with the inflation premium pretty small. If investors think that the Fed is not serious or lacks the will to do the job, long-term rates will rise, and today’s buyers will suffer.

Maybe it would be worthwhile to talk about what makes up interest rates. As von Mises would say, the basic decision a person has to make is his preference for current consumption or future consumption, today’s goods vs. future goods. What does it take to get you to put off consumption? The classical answer that I have seen is something like 1 ½ to 2 %, that is, you would want an interest rate of return of say 2% a year to put off consumption, all things being equal. That is a wonderful saying by economists, isn’t it? “All things being equal”, because all things aren’t equal in a mixed economy. There are two added factors: inflation and taxes. (This is why government bonds have always been a bad deal, because after inflation and taxes they generate a net loss, guaranteed.)

What is your expectation for inflation? Up until 2007, the average for 10 to 15 years had been around 2%, using the CPI (don’t shout at me, this is only an example). Let’s say that your tax rate (federal only) is 33%. Using the basic, “natural” interest rate of 2%, you would want a nominal rate of return of 6% on your bond, i.e., after the tax of 33%, you had 4%, then minus the rate of inflation, you had 2% left. Today the 10-year bond is under 4%. In 2008, the social security people decided seniors should get an indexed increase of 5.6%. That tells you where things were headed, doesn’t it.

What is your inflation expectation of 2011 and beyond? More than 2%? Mine is. Taxes aren’t going down either (I will pause while you laugh.)………

If long-term bond prices go up, BO will have to spend more money financing his spending (doesn’t that make sense?), and he won’t be happy. He will point his finger at the Fed. Our hero, Bernanke, will…. And the story continues.

Back to my inflation watch, I am trying to avoid guessing or jumping to conclusions, here. I don’t see much hope. I think the question is how severe will things get. If they get more severe, will people demand that the government and the Fed do something different, like get there hands off the economy and also stop making money? We shall see.

To let you know that I am keeping my eyes as open as possible, I want to report that one of the standard indicators of the 20C suggests that we will not see more downturn. Hemlines have pretty much stayed where they were. Yes, for most of the 20C, when recession or depression hit, hemlines went down, adding to the personal sense of depression. However, either this indicator has lost its connection to the economy, or things will be fine, or at least the level of depression in the population will be a little lighter.

(Please give me some feedback if any part of this was not as clear as you want. I want to be sure that I am deciding to publish what an intelligent person will understand. Thank you. C.W.)

Friday, January 8, 2010

Their Plans for You

Courtesy of Lisa Doby, on Facebook, where she referred to this article. 

The government has plans for you, your money, your retirement plan.  You know that Obama and his gang are looking out for you, don't you?  So everything will be okay, right? 

Seriously, keep your eyes open, and be prepared to act.

Wednesday, January 6, 2010

Speech by Ben S. Bernanke, Commentary

Monetary Policy and the Housing Bubble
At the Annual Meeting of the American Economic Association

January 2, 2010

This is a speech in front of an association of economists, and, consequently, Bernanke can talk freely in his “native language”. He can use the reasoning and terms with which he is most comfortable, keeping in mind that it is in public and the speech will be reported. This speech is his personal, professional statement of what he considers to be the consequences of his actions as a government official.

First, Bernanke’s comments make clear that in his opinion, the range of options that he faced or would not consider appropriate do not extend to letting interest rates rise to the market level. Those who argue the rates were too low, he says, meant that he should have done something different, not leave his hands off. As he was reported to have said in the book In Fed We Trust (p. 21), he was unpersuaded by arguments that the market can be effective by itself. In addition, he says that he was afraid of an unwelcomed decline in inflation. He was afraid of deflation, referring to Japan as an example of what can happen if prices fall.

“…the FOMC’s policy response also reflected concerns about a possible unwelcome decline in inflation. Taking note of the painful experience of Japan, policymakers worried that the United States might sink into deflation and that, as one consequence, the FOMC’s target interest rate might hit its zero lower bound, limiting the scope for further monetary accommodation.”

That he has no evidence that deflation in the U.S. was happening, or that it would have been bad is not considered. What he is actually saying is that falling prices is a bad thing for any economy. Falling prices are to be avoided at all costs. Falling prices, plus the potential for large scale problems in the financial sector world wide meant probable depression.

Bernanke has established himself as an expert on the Great Depression. His take on the depression is that it could have been avoided if the Fed had flooded the market with money in 1931 and 1932. This is his perspective. If something goes wrong in the economy, lower the interest rates.

Bernanke’s speech begins with discussion of the level of the overnight federal funds interest rate between 2002 and 2006. The question is whether it was appropriate in the face of the critics. He thus says that he will begin with a discussion of “simple rules” that have been offered to determine the proper rate, and talks about one, only one. And with the conclusion of this discussion, he simply dismisses the issue of the interest rate levels by saying that it appears that the Fed followed the correct policy.

The “simple rule” is a formula suggested by an academic that includes the actual rate of inflation, the desired rate of inflation, and the deviation from the optimum level of production. Bernanke quibbles about some of these terms, and ends by declaring that, even if the final result, after he has tinkered with the terms, is close to what the short-term interest rate goals that the Fed actually achieved, it is still too restrictive to be used. Sound strange? It is. I don’t recommend reading that section (or any of them, really; what’s that fun saying that some media types are using, “I read it so that you don’t have to”). (I am sorry. This section of the speech, about 25% of the text, is just not easily translated.)

He also uses only the level of prices, consumer prices as the subject matter of inflation. If prices rise there is inflation. If prices fall there is deflation. He is not willing to suggest that there is any other set of issues. Money supply is not an issue. It is not mentioned during the speech. Other causes for price rises, such as restrictions on oil production and thus higher oil prices, which tend to make other prices are not considered, at least in this speech. (He would probably like this suggestion, since it would be yet another explanation of “inflation” in which the central bank played no part.)

As you would expect, the concrete-bound detail and triviality of his remarks make this extremely tedious to read, as, I am sure, to hear by his listeners. Of course, they were mostly mainstream economists and government people and are used to hearing this kind of speech.

He then asks “can monetary policy have made an impact on housing prices?”

“With respect to the magnitude of house-price increases: Economists who have investigated the issue have generally found that, based on historical relationships, only a small portion of the increase in house prices earlier this decade can be attributed to the stance of U.S. monetary policy. This conclusion has been reached using both econometric models and purely statistical analyses that make no use of economic theory.”

Bernanke’s answer is founded in statistical analysis. He doesn’t use cause and effect, but looks for correlations. These techniques also depends upon focusing on the interest rate at the time and price inflation. What they ignore entirely is how low interest rates are achieved. He pretends that the fed declares low interest rates and they come about. But what happens is that to keep interest rates low, even the short-term rates, the Fed must supply funds. It must make up money. It must keep making money (this is electronic money) as long as it wants to keep the interest rates below what the market would set. Every time there is a move upward, the Fed makes up more money. Where does this money go? In the period in question, much of it went into mortgages. But Bernanke does not think that looking at this money makes any sense. He ignores it as if it doesn’t exist. But it does, or did until the liquidation of mortgage-backed securities became necessary because of so many defaults, which was the liquidation of the mortgages.

His entire speech demonstrates that the epistemological methods used in today’s mainstream economics is designed to avoid looking at reality and to obfuscate cause and effect.

He slips in the suggestion that the availability of ARMs and other special mortgage types is a “key” explanation of the rise in house prices.

“Clearly, for lenders and borrowers focused on minimizing the initial payment, the choice of mortgage type was far more important than the level of short- term interest rates. The availability of these alternative mortgage products proved to be quite important and, as many have recognized, is likely a key explanation of the housing bubble.”

At this point the level of evasion of responsibility becomes obvious, since the Fed, as well as every other imaginable government agency had pushed home ownership and the lowering of credit standards for years. (see Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse by Thomas Woods, p. 15ff)

“As you can see, the use of these nonstandard features increased rapidly from early in the decade through 2005 or 2006. Because such features are presumably not appropriate for many borrowers, Slide 8 is evidence of a protracted deterioration in mortgage underwriting standards, which was further exacerbated by practices such as the use of no-documentation loans. The picture that emerges is consistent with many accounts of the period: At some point, both lenders and borrowers became convinced that house prices would only go up. Borrowers chose, and were extended, mortgages that they could not be expected to service in the longer term. They were provided these loans on the expectation that accumulating home equity would soon allow refinancing into more sustainable mortgages. For a time, rising house prices became a self-fulfilling prophecy, but ultimately, further appreciation could not be sustained and house prices collapsed.”

To further support his position that the Fed is blameless, he considers the rise of house prices internationally. Bernanke uses the same statistical method of comparing monetary policy, as represented by a statistical analysis of the central bank short-term rates compared to the rise of house prices in separate countries. He finds no correlation. So the central bank of the U.S., the Fed, did not cause the rise in house prices. QED! The guy is a wizard! And, it is entirely nonsense. He has no concept of the role of cause and effect in economics. That is where we are, and why he and his brothers are completely mystified as to why people want to shut them down.

So what explains it, in Bernanke’s opinion: savings glut, especially in developing countries. It seems that the people who feed off of money loaned or “invested” in developing countries turn around and put the money in the U.S. Since this money is usually dollars and it isn’t actually U.S. savings, but made-up money, it is U.S. inflation anyway. But that is far too long of a chain for Bernanke to accept or even consider. Yet, here we are, foreign savings sent to the U.S. has driven up American house prices.

Step back and consider our house prices dependency on foreign money for a second. With Bernanke is keeping American interest rates low, why would anyone send us money. Well maybe, if your own country’s currency is even less stable, the U.S. is a fine place to put your money, or maybe you have so many dollars you need someplace to put them.

Somehow Bernanke can keep track of the money coming into the U.S., he says (actually, he is suggesting it, cause and effect is something that he is avoiding), but he can’t or won’t consider what is being done with the money the Fed is creating to keep the interest rates low in the first place. There is a parallel, Bernanke admitted in front of Congress that he doesn’t know what happened to the money that he loaned/gave to foreign central banks as part of the stabilization after September, 2008. He doesn’t watch it, except for that money that came from developing countries that drove up house prices in the U.S.

“In previous remarks I have pointed out that capital inflows from emerging markets to industrial countries can help to explain asset price appreciation and low long-term real interest rates in the countries receiving the funds -- the so-called global savings glut hypothesis (Bernanke, 2005, 2007).”

In his argument that central bank short-term interest rate policies are not responsible for the increase in house prices, Bernanke’s approach shows that there is a very significant methodological issue here. Bernanke felt that all he needed to do was create charts comparing the central bank interest rates with the house prices. He didn’t feel it was important to consider the actual money market in each country, or credit standards, if credit is used, type of mortgages, income levels of house purchasers, laws, or any feature that might or might not make each county a relevant candidate for comparison with the U.S. situation. No, all that is needed in Bernanke’s world is a look for the correlation. I have watched reactions to Bernanke’s speech and I have seen no reaction at all to his analytical methods. I suspect that the standard journalist is intimidated by what passes as Bernanke’s science. I saw one comment on a critic’s article saying that he thought Bernanke was smarter than the author of the article and so would continue to believe Bernanke. That is part of the problem, a lack of understanding of simple methodology.

And, therefore, after his analysis of the appropriateness of his low short-term interest rate policy and the possibility of Fed responsibility for the rise in house prices, both of which Bernanke resolved in his own favor, the cash payout, the conclusion, the recommendation is, wait for it, what do you think, you get three answers and the first two don’t count, what do you think it could be….(consider this all said in a high voice with a drum roll)…… it is, to da, MORE REGULATON!!!! SURPRISE!!!

Sorry, I couldn’t resist.

“What policy implications should we draw? I noted earlier that the most important source of lower initial monthly payments, which allowed more people to enter the housing market and bid for properties, was not the general level of short-term interest rates, but the increasing use of more exotic types of mortgages and the associated decline of underwriting standards. That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary. Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates. Moreover, regulators, supervisors, and the private sector could have more effectively addressed building risk concentrations and inadequate risk- management practices without necessarily having had to make a judgment about the sustainability of house price increases.

“The Federal Reserve and other agencies did make efforts to address poor mortgage underwriting practices. In 2005, we worked with other banking regulators to develop guidance for banks on nontraditional mortgages, notably interest-only and option-ARM products. In March 2007, we issued interagency guidance on subprime lending, which was finalized in June. After a series of hearings that began in June 2006, we used authority granted us under the Truth in Lending Act to issue rules that apply to all high-cost mortgage lenders, not just banks. However, these efforts came too late or were insufficient to stop the decline in underwriting standards and effectively constrain the housing bubble.

“The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter. The Federal Reserve is working not only to improve our ability to identify and correct problems in financial institutions, but also to move from an institution-by- institution supervisory approach to one that is attentive to the stability of the financial system as a whole. Toward that end, we are supplementing reviews of individual firms with comparative evaluations across firms and with analyses of the interactions among firms and markets. We have further strengthened our commitment to consumer protection. And we have strongly advocated financial regulatory reforms, such as the creation of a systemic risk council, that will reorient the country’s overall regulatory structure toward a more systemic approach. The crisis has shown us that indicators such as leverage and liquidity must be evaluated from a systemwide perspective as well as at the level of individual firms.”

The nicest thing that can be said is the he must be well insulated. The push to expand home ownership and lower credit standards by the government was a very big effort. To ignore that takes a heap of mental effort. The other problems I have touched upon.

But, the basic modus operandi of a government regulator is well established by excellent writers, Ayn Rand, Ludwig von Mises, and many more. When something goes wrong in the economy you are regulating always blame it on free enterprise and never yourself. And demand, loudly and often, more controls and power and less freedom.

(Bernanke's speech

Saturday, January 2, 2010

Meltdown by Thomas Woods, Review

Over the last two years or so, we, the citizens of the civilized world, have gone through a horrendous period in our economy. We have seen a towering boom in residential real estate turn into a collapse in that area followed by a collapse in the financial industry accompanied by a collapse in the stock market, with high unemployment, high foreclosures of homes, business failures, and amazingly high government spending, debt, money creation, and rhetoric.

What happened? The government talks about greed and risk-taking. They, the Fed and the Treasury, are the heroes.

But if you really want to know what happened and what the consequences of the current “recovery” actions are, read Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse by Thomas Woods..

As opposed to most discussions of the meltdown, this one begins years ahead of the September, 2008 Lehman Brothers bankruptcy. The roots of the bust are in the boom. In fact, as Woods explains, the damage to our economy is done during the boom. The damage starts with the Federal Reserve Board and its policy of low interest rates.

This specific cycle also is rooted in the appeal of home ownership for all. The liberals take this goal as a government policy, without regard to the economic consequences to the country or the individual buyers. Woods recounts the many and varied steps the government took to push home ownership without regard and in spite of the credit worthiness or ability to repay a loan.

Very important to anyone interested in how our economy works is Woods’ discussion of the Fed’s policy of low interest rates and credit expansion and the consequences in the 2008 panic. Woods points out that these activities have consequences, and not the ones that the Fed or either the Democrats or Republicans think. The consequences turn out to be the bust. The Fed’s policies create misallocations of savings and resources into investments that the economy can’t support. When he says “the economy” he means people who have produced and earned income and want to spend their income on their values. The Fed’s policies divert savings from what consumers want. Misallocated resources need to be put to productive uses, and that reallocation occurs during the bust. You get the fake boom and then you get to pay for it in the bust.

But for the bust to work, the assets have to be reallocated, which happens through business failures, lower prices, and movement of employees from bad investments to good ones, i.e., unemployment. These are all viewed as bad by the government and the Fed and they try hard (i.e., they spend money and make regulations) to keep businesses from failing, prices from lowering, and unemployment from rising. The things that need to happen to return the economy to productivity and prosperity are stopped, or at least they try to stop it. Woods points out that the result of stopping the process of reallocation can only be continued recession, as we are seeing, and will probably continue to see.

If you have read my recent blog post you know that I want to encourage people to learn how capitalism works. Reading this book would be a good beginning. It will also give you a good idea as to why government intervention and money manipulation is bad for us. It will help with your understanding of inflation. It will help you understand your own predicament.

Having said that, I must, unfortunately voice my one significant complaint about the book. As clear as he is about the causes of our economy’s current mess and the wrong headedness of the government’s actions today, Woods falls down on his explanation of the Fed’s creation of money and inflation. It isn’t that he is wrong so much as he leaves it muddled. You may come away with a confusion regarding inflation, price inflation, credit expansion, and how it all fits together. He talks about the expansion of credit to business being important in the boom/bust cycles, and then talks entirely about price inflation when explaining the Fed’s manipulation of the money supply. I hope that you can make the connection. [If not you can always ask me. I think that I can show the connections clearly enough for you. (Some of my earlier blog posts may help.)]
I found this book because a friend mentioned that Yaron Brook of The Ayn Rand Institute had recommended it. It was a good suggestion. Allow me to add my modest recommendation. In fact, please allow me to say that if you want to understand the economic world you live in, you will read it.