Bailing into the lifeboat

 economy, politics  Comments Off on Bailing into the lifeboat
Sep 232008
A few weeks back, when I posted about the necessity of raising taxes and cutting spending in order to reign in the national debt, I did not anticipate that the market would force us to take such an enormous step towards insolvency. The bailout proposed by the Bush administration would cost us $700 billion, but many predict that its actual cost, after Congress adds its own trimmings and attempts to include some relief for homeowners in danger of default, will reach $1 trillion or more of money that we don’t have. The irony of paying for bad debt with more debt might inspire a grim sort of humor if we weren’t in such a big hole already. The plan as initially proposed is completely outrageous, but I have little doubt that Congress will find some way to make it worse.

The fundamental problem is that a mortgage-backed security is not a mortgage. The holder of a mortgage has the right to foreclose on the property (thus recovering real assets) if the loan is not repaid, but the holder of a MBS does not appear to necessarily have this right. The security spreads the risk from a pool of mortgages among a pool of investors; as such, no single investor can be said to “own” a particular mortgage (except in the case that he owns all the securities from a given pool). It’s not clear whether the owners of MBS own anything other than debt; it is possible that they do not own the underlying loans. And these are the simplest vehicles assembled from residential mortgages… the real value of more exotic derivatives may be impossible to assess. This has serious implications for the proposed bailout, because there is a very real chance that we taxpayers will end up paying billions of dollars for smoke and mirrors. Before we release one penny from the Treasury for this rescue effort we must ensure that what we purchase with our money will give us a right to the underlying property, as well as the authority to modify the mortgages so as to diminish the default rate. We must not be left holding a bag of air.

The uncertain relationship between the securities and the actual mortgages underscores the unseemly nature of the whole affair. People who did not have the wherewithal to own homes got mortages from unscrupulous lenders who should never have given them out. These mortgages were packaged into vehicles that were treated like gold by credit raters, and then purchased by investors who probably should have known better. Only a fool could have imagined that the housing boom would continue indefinitely. The push by credit providers to make bankruptcy declarations more difficult for individuals had the unexpected side effect of increasing defaults. Holding negative equity on their homes in a plunging market, homeowners simply turned off the lights and walked out. The invisible hand failed to reign in the cascade of short-sightedness, stupidity, and outright malfeasance, and the credit market landed on its head with an audible crunch.

This would be bad enough on its own, but it set off a chain reaction leading to ever more violent flailing on the part of the Treasury department and the market players themselves. Because the securities had been insured, AIG took a hit and needed billions of dollars of government money just to die quietly. The failure of Lehman Brothers left money market funds holding worthless paper; the Reserve Primary Fund broke the buck and skittish investors started to flee. With all business in danger of grinding to a halt because of the shortage, the Treasury insured these investments with the Exchange Stabilization Fund. Because this insurance is not capped, small banks are now worried that panicked customers may move all assets in excess of $100,000 into the money market, leaving them short on cash.

Keating Five member John McCain, long a friend to unscrupulous financiers and enemy to the kinds of regulatory oversight that might have prevented this crisis, has been difficult to pin down on this issue, in large part because his position changes every time the sun comes up. His initial position, that we should stop bailing out financial giants, is understandable and at least has the virtue of being consistent with his free-market philosophy. His later attitude, an acceptance of the reality that these companies must be bailed out in order to protect the investors who acted in good faith, was more realistic. Exposure to the toxic mortgage-based securities put the other assets of these companies at risk, and it would be unconscionable to destroy the investments of good actors as punishment for the deeds of bad actors who had already escaped on golden parachutes.

(In McCain’s defense, at least he said something, even if it was insane, and Joe Biden’s response tracked a similar trajectory. As for the other presidential candidate, Barack Obama couldn’t manage anything better than “I’ll get back to you on that.” Who will you choose in November: the madman or the slacker?)

Bailing out rich people stinks, but it stinks more when we don’t really have any money to do it with. Section 10 of the proposed legislation increases our national debt limit for the fiscal year to $11,315,000,000,000. Given the authority to hit that ceiling, I have no doubt that the Treasury department will do so, meaning that our interest outlay in the next budget will be even higher than previously anticipated. Every new program you’ve heard politicians mention during this election cycle has just evaporated. The cost of a bailout is a credit crunch on the government, at the worst possible time. I’ve already proposed the solution to the problem: we must increase income and cut outlays. Otherwise, we’re just bailing water from the yacht into the lifeboat. Specifically, the wealthiest Americans must be willing to pay higher taxes, because it is they that benefit most from the financial institutions the rest of us will be breaking the bank to rescue, and it was their exploitation of those markets that got us into this mess.

Of course, I haven’t yet gotten to the most malodorous part of the whole proposal. It’s bad that we don’t know whether what we’re buying will be worth anything, and it’s worse that we’ll significantly increase the national debt to do so. But the really despicable part of the legislation is this:

Sec. 8. Review.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

You know, at least with the absurdly-named Patriot Act these Republican pricks had some kind of flimsy excuse for their totalitarian actions. This is sticking a thumb in the eye of Democracy just to show you can. It was a lack of transparency and honesty that got us into this whole mess; we cannot get out of it by spending $700,000,000,000 at the sole discretion of faceless bureaucrats from an abominably opaque and secretive administration. The estimated cost of the Iraq War to date is around $582 billion, a massive number but still less than the amount proposed in this legislation. It defies reason and sense to insulate the choices made with this massive amount of money from oversight and accountability. The very request for opacity suggests that the whole operation is being undertaken in bad faith.

Bernanke and Paulson continue to insist that Congress must act immediately. Nothing in their past behavior, however, suggests that they possess the competence to make this analysis, or the honesty to accurately convey their analysis to the media or to the legislature. Clearly, something must be done, but handing out $700 billion to the same nitwits that got us into this mess, without anything even resembling appropriate oversight, is more likely to bring economic disaster than salvation.

Sep 102008

As a very important source of strength and security, cherish public credit. One method of preserving it is, to use it as sparingly as possible; avoiding occasions of expense by cultivating peace, but remembering also that timely disbursements to prepare for danger frequently prevent much greater disbursements to repel it; avoiding likewise the accumulation of debt, not only by shunning occasions of expense, but by vigorous exertions in time of peace to discharge the debts, which unavoidable wars may have occasioned, not ungenerously throwing upon posterity the burthen, which we ourselves ought to bear. The execution of these maxims belongs to your representatives, but it is necessary that public opinion should cooperate. To facilitate to them the performance of their duty, it is essential that you should practically bear in mind, that towards the payment of debts there must be Revenue; that to have Revenue there must be taxes; that no taxes can be devised, which are not more or less inconvenient and unpleasant; that the intrinsic embarrassment, inseparable from the selection of the proper objects (which is always a choice of difficulties), ought to be a decisive motive for a candid construction of the conduct of the government in making it, and for a spirit of acquiescence in the measures for obtaining revenue, which the public exigencies may at any time dictate.

—George Washington, Farewell Address

The next President and Congress of the United States must raise taxes and cut spending.

The last time I checked, the national debt was about $9.6 trillion, but it’s probably higher now. The interest on this debt presently amounts to nearly 10% of the federal budget, which admittedly is less than half of we spend on defense, but still easily exceeds $200,000,000,000. According to the Congressional Budget Office, the interest outlay in 2007 could have covered the entire federal expenditure on supplemental security income, child tax credits, unemployment, food stamps, family support, child nutrition, and foster care, with almost enough left over to pay for veteran’s benefits. Of course, the magnitude of the debt (and the associated interest payments) will only increase when Medicare and Social Security payments start to exceed revenues. The federal government has run a deficit every year since 2001, and none of the people running for office now have done enough to stop it. Nor do they propose to do enough to stop it.

Instead, our candidates propose hosts of new projects, proposing no financing beyond the sunshine and rainbows that adorn their professionally-coiffed speeches. They shoo away the petty earmarks while the great consumers — Medicare, Social Security, Defense — gnaw the budget to the bone, unmolested in their gluttony. Most candidates who are willing to tax are unwilling to stop spending; most candidates who are willing to cut expenditures also want to lower taxes. Either way is insane, but many candidates want the whole pie: more spending, less taxes, damn the torpedoes, full speed ahead!

It has become almost obligatory, especially among those seeking office for the first time, to blame the present excesses on fat cats in the capital, but simply pointing the finger at Washington doesn’t cut it. Irresponsible big spenders do not reach office by magic; they get there because we elect them. This is not a problem of other people in other districts who have bad judgment and choose lousy representatives. This is your problem in your district, and it is a problem because we have failed to do as George Washington asked. A man who tells you that our budget problems can be solved without any pain is either a fool, or a liar who thinks that you are a fool. But when a candidate gets up and acknowledges that taxes must be raised, that favored spending must be restrained, he is hated by an electorate that ought to applaud him for his honesty.

So the politicians lie. They cut taxes and spend more. They raise taxes and outspend that. And all along we grumble and complain about “Washington insiders” and “Beltway bandits”. Well, throw the bums out! That’s in your power, isn’t it? If you’re reading this post you have access to the internet. Find out how your congressman voted during his term. Read the text of the bills he voted on. Find out what questions he asked in committee and what speeches he made on the floor. Dig up the things that interest you, no matter how obscure. The behavior of state legislators and other officials is often more difficult to track, but these records exist. You as a voter have a duty to find and evaluate them, because terribly few politicians are honest about their record or intentions. Even if they are inclined to tell the truth, they dare not speak it because we voters are all too happy to punish harsh truths and reward pleasant lies.

Paying down the national debt is a personal obligation. We owe it to our children and grandchildren, our nieces and nephews, not to leave them a country upside down on its loans. More than that, however, it is a patriotic obligation. We owe it to our parents and grandparents, our soldiers and our founders, not to let the country they worked so diligently to build and preserve crumble due to debt and dissipation.

The next President and Congress of the United States must raise taxes and cut spending. Any candidate for any national office who refuses to acknowledge this truth does not deserve your vote.

Feb 242008
Virgin Atlantic pulled off an interesting little stunt the other day. They flew a Boeing 747 across the Atlantic. Well, that’s not so interesting. What’s interesting is that one of its four engines was fueled by biodiesel—in this case a mixture of oils from babassu nuts and coconuts. Ultimately, this act barely addresses any of the questions surrounding the future of our transportation system. But even though it’s just a stunt, I don’t disapprove, because I think it’s important to raise people’s awareness of the monumental challenge we are going to face in this century, one that has profound implications for our ongoing prosperity and the global economy.

Like I said, the trip itself accomplished little. As a practical matter it established that at least some biofuel blends remain liquid enough to use as fuel at temperatures and pressures experienced by airplanes. The concern in this case isn’t just that the biofuel will turn into a solid or a gel; it’s also a possibility that a biofuel could remain liquid but become too viscous for efficient jet engine operation. Fortunately, that didn’t happen (the other three engines had conventional jet fuel in case it did).

However, that’s about it. We have no particular reason to believe that the existing tracts of babassu and coconut will provide sufficient fuel to replace the hydrocarbon uses of airplanes. The current batch was produced in such a way that it didn’t interfere with food production, but hey, it only powered a quarter of a single transatlantic flight. Does the world produce enough babassu nuts and coconuts in a year to supply fuel for a single day’s worth of flights? This is a pervasive problem with the biofuels approach. The most optimistic estimates about switchgrass ethanol suggest that it would replace no more than 30% of current petroleum use. That means we are going to have a serious problem.

The increasingly global nature of the economy means that many goods travel a very long way. The raw materials must be shipped, often to a factory in a different country. Once assembled, the manufactured goods must be shipped to the US, often overseas. Once they reach the US, they must be distributed, a process that sometimes involves rail but always involves an 18-wheeler or panel truck at some point. This is a lot of shipping, and the feasibility of biofuels to replace the energy source at any point is completely unproven. I don’t think anyone doubts that biodiesel can power a ship if you have enough, but there’s no evidence that we can produce enough. Even if we manage to produce sufficient yields of biofuels they may be significantly more expensive than the present plentiful oil. Of course, they will eventually become more economical than oil, but this will not be through any virtue of their own.

Supplies of oil will become increasingly tight. In the past, spikes in oil prices were driven by speculation or market interference by OPEC. But within the next few decades we will start to see oil prices rising because of supply scarcity. And because the resource is not renewable, once those prices start going up they will never go down until demand collapses. What this means is endless inflation. Oil permeates our economy. It provides the raw materials for our goods from drugs to sneakers, and the for the plastic in which those goods are encased and protected. It provides the energy and lubrication for the machines that transport those goods to our markets, and for the machines that carry us from our widely distributed homes to those markets and back. Parts of the markets themselves are constructed from materials made from oil and they were built by machines that ran on petroleum. The effective price of goods will be inflated at every single one of those steps.

This will murder the economies of developing countries. The only way to keep prices down at US destinations will be to either re-industrialize America or treat already underpaid workers in foreign countries even more terribly than they already are. Neither bodes well for these developing countries. Stagnant economies will only add to the damage likely to result from global warming, resulting in enormous instability. Stagflation on a global scale will pound the last nail into the coffin of the already-tenuous pax Americana unless we do something.

The Virgin flight is valuable because it emphasizes the need to plan for petroleum scarcity now. Scrambling to replace oil once we’re past peak production is a fool’s game. Biofuels such as those used in this stunt will probably not be the answer, but we cannot even know that without further research. Research money from DoD, USDA, and DoE should be funneled into this field now to establish the most viable means of replacing petroleum and mitigating demand. Otherwise the global economy will run aground when the great oil tide recedes, with all hands lost.