Bold and Fresh

POLITICAL THEATER

Barack Obama has apparently set a record for the number of press conferences held by a president in waiting---Obama beats record for press conferences.... This is the kind of information that passes for news today. This is a story by the conservative newspaper the Washington Times no less. The media is just beginning to wrap its arms around the idea that Obama may be the empty vessel which he said he was in one of his autobiographies. We have no idea what he really thinks or believes. The Left still is hanging onto his promises made during the primary season so many moons ago. And who would have thought the Right would start to breathe a sigh of relief for the return of the Clinton Administration?

I realize it is political theater, but the cliche driven oratory of Obama is really grating. So much about Obama's delivery and tone is designed to emphasize the specialness of his place in history. At his latest news conference he announced the formation of a new something or other called the Economic Recovery Advisory Board. He says he needed this board to seek advice from outside the Government. Normally we would call those people lobbyists. But at this "defining moment in history" the "old way" of thinking just won't do. We need "fresh" ways of thinking and "bold" new ideas. It sounds like what this country needs is a great new laundry detergent.

THE DECADE OF GREED

So to put forth these bold new ideas he announces that 81 year old Paul Volcker will head this committee. I guess we are starting to run out of Clinton appointees. Obama is now reaching back to name a Carter appointee to drive forward these bold and fresh new ways of thinking. Volcker is properly credited with helping stem the massive inflationary tide of the 70s. He did this by radically raising interest rates which did push the nation into a recession. But these anti-inflationary tactics did stop inflation and helped stage the economic recovery and record economic growth of the 80s. Of course, since a Republican was president during the 80s, it was not known for being the decade of growth but the "Decade of Greed" and the "Big Lie" (Decade of Greed). But we already know that.

So Obama seeks fresh and bold new ideas and reprises one of the architects of the Decade of Greed. But I think bold and fresh ideas are the last thing we need right now. How about some basic economics 101 and some old tried and true, dreary and boring ideas? Of course in politics, just breathing normally can be heralded as bold and fresh, so perhaps I shouldn't take the oratory so literally. Not to get all nostalgic and so yesterday, but that is one of the things I like about Sarah Palin (or "Sarah the Turkey Impaler"). At least she actually tries to say what she means.

What passes for political genius, at least when a favored Democrat is in charge, is when it is really difficult to figure out what policies a candidate or president elect is actually in favor of. The Obama supporting media seem awestruck over his every move. First, he is like the baby in the manger (Time Magazine), then Lincoln (Newsweek), then FDR (Time again). How more absurd can media blindness get than when Obama chooses to keep Bush's Secretary of Defense, promote a Bush appointee for Secretary of Treasury and there is not any recognition of the political ridiculousness of it all? Then to top it off we get Hillary. It is as if he is pulling every one's chain. But the media supporters just see a Lincolnesque Team of Rivals. So much for the "failed policies of the Bush administration". Well, maybe this is "bold and fresh" after all.

THE PAULSON CONFUSION

My belief is that Bush/Paulson/Bernanke are trying to do too much to "fix" the current economic problems. Obama is also giving every sign that he wants to significantly increase Governmnet's involvement. The first problem is trying to understand what the current policy of the Government actually is. I cannot determine it. In an unbelievable admission of historic proportions, Henry Paulson told Congress that by the time it had passed the original $700 billion "bailout" bill (now ridiculously known as TARP) he already had changed his mind on what to do. Oddly, the Government has not yet done all that much, at least relative to what they are threatening. The most significant thing that Bush and Obama have done is tell us what they are going to do.

Meanwhile, as they speak, the equity markets provides feedback by going down. The credit markets provide feedback by not lending. Investors are obviously confused about Government's intentions. When the Government has acted it has been very intrusive. Paulson forced banks to sell the Government equity even if they did not want to. When Wells Fargo and Citigroup were competing over the purchase of Wachovia the Government was almost forcing Wells Fargo to take its guarantees, which they rejected. This has to be an unprecedented intrusion.

Currently, we have a credit crisis, although if short term interest rates are any indication, it is not as severe as it was 1 month ago. A credit crisis is just a confusing term which means that banks either cannot or will not engage in lending at a rate that can sustain economic growth. It does not mean, as some headlines would have you believe, that there is no lending happening. There is just not enough of it to achieve growth. It also means that other lenders, such as State and Corporate Pension Funds, Mutual Funds, and Insurance companies will also not lend or invest money long term at levels required to fund growth. Individuals (all these institutions of course just invest the savings of individuals) who manage their own money are also conservative.

The reason this is happening at one level is pretty straight forward. Significant losses were taken in the real estate market and then the stock market. It is human nature that caution will follow a period where such losses are taken. This always happens toward the end of business cycles. This time, however, the pull back in risk taking is more severe than usual. From what I can tell, no one seems to understand why this is the case. Nor does there seem to be any inherent reason why this should be the case.

OBJECTIVE VERSUS SUBJECTIVE

But if everyone "subjectively" believes that economic activity will be more risky than usual, thus leading to less lending and investing, that belief alone can become "self fulfilling". This does not mean there cannot be "objective" reasons for concerns that justify such fear of lending and investing. What if we discovered that everything that was manufactured in the last 5 years was made of some mysterious disappearing material and just disintegrated over night? That would be an extreme example of an "objective" reason for fearing future investment. Or more realistically perhaps, what if we discovered that we just built 30 million cars but the world only wants to buy 25 million at the current price of producing those cars? Or even more realistically, what if we discovered that we built too many houses at the peak of the housing market?

My first example would be the worst case scenario, because everything built in the last 5 years would now be worth zero. There is no solution to that problem except discovering what caused the material to disappear in the first place to prevent future occurrences. Losses would be so extensive that we truly would have a financial disaster. The equivalent of this example is something like WWII in Europe.

But the next 2 examples should get solved by price adjustments in the free market and, while creating financial losses, need not create total fear and uncertainty. We are seeing this happen now, below the headlines for some reason, in the worst real estate market of all, California. The number of homes being sold is much higher than a year ago and in some large areas are actually at record levels.

Houses in California (and Phoenix, Las Vegas, and much of Florida) are being sold at significantly lower prices than the peak (down as much as 60-70%), but still 50% higher than in 2000. But number of sales have meaningfully increased. This appears to be a great example of a market adjusting to a "bursting of a bubble". Just as I have been mystified by the lack of interest in how (and even just the fact itself) the California and other "boom" housing markets became large and disproportional contributors to this crisis, I am equally mystified by the lack of interest in these markets' apparent market based adjustments to this same crisis. This is occurring without Government intervention and without noisy headlines. These stories just do not make the headlines because it counters the current narrative of the day, which is all about financial Armageddon.

My point point is that while there can be "objective" reasons for the current perceived severity of the problem, I do not believe there are, or at least I have not seen anything I find persuasive. The total housing losses are simply not big enough. I think our political and media leaders for a variety of reasons, some self serving and some not, have encouraged the Armageddon narrative. By doing so I believe they are increasing the probability of its actual occurrence. The reason I don't believe in what I call "objective reasons" for the severity of the crisis is that no one is able to say definitively what these could be.

To compound the confusion, we really do not know the actual severity of the problem. We know how much the equity markets and real estate markets have declined. But we do not yet know, of course, what the real economic impact will be in the next 12-24 months. 3rd Quarter GDP was flat, far from a disaster. The 4th Quarter is projected to be down 1.25% (or 5% on an annual basis). If the 5% rate of decline continued, that would be significant. But this brings us back to the whole issue of what is causing the decline to begin with. We do know there is great fear and concern, but that is a different thing than reality itself. I maintain, at least at this time, that it is, for lack of a better term, the "public narrative" itself which is the number one cause of the perceived problem.

THE "FIX"

In part because this has been a presidential election year, politicians and bureaucrats have been more inclined to get "involved" than even in normal times of economic weakness. When you subsidize something you get more of it. We taxpayers subsidize state, local and federal Government at about 30% of our total economic output. When we have a true economic problem (like building too many houses) the Government tries to give the people something for its money, which in this case is "fixing" the problem of having built too many houses. This becomes dramatically exaggerated in an election cycle as politicians and bureaucrats struggle to get or keep their jobs.

But inherently Government cannot "fix" a problem such as having built too many houses at too high a price. Only price adjustment and time can fix that problem. But the Government cannot tell the people that. Since they are quick to take credit for good things that happen, they need to find "reasons" and "solutions" for when bad things happen. Why? I think if they did not, we would realize that we do not need them to the magnitude that we pay for their services. It is amazing to me how we simply take it for granted that Government can be so large yet not have a negative impact. The average mindset really is to look for Government to solve our problems. I think this is the equivalent of believing in phantoms. Nobel economist Milton Friedman used to sardonically say he would prefer the Government just take his money and randomly give it to other citizens rather than use it to "fix" any problem. While the former is bad the latter is worse.

Obama is promising the biggest "fix" in the history of the United States. The political economists of the moment seem to agree on a few basic things. First, they do not know what is happening and why. Second, we need to try anything we can think of (which really just boils down to huge deficit spending on Government chosen projects and providing massive unprecedented financial "guarantees" to favored parties). Third, we need to do this in as big a way as possible (or as Harvard economist and Obama appointee Larry Summers says, we need to "over react"). And fourth, we do not know if it will work.

It is difficult to conceive of more unusual admissions. They cannot see the "ghost"; don't even know if it exists; have decided to burn down the house it could be in if it does exist; do not know if fires even kill ghosts; but the fire needs to be as big as possible. If Barack Obama really is a follower of Saul Alinsky, then we are about to move toward being an even more Government centric nation (Saul Alinsky - Wikipedia, the free encyclopedia). The spending programs and Government involvement potentially being put forth by the Democrats is unprecedented. All in the name of Economic Recovery.

The apparent Obama plans are unfortunately being conflated with the merely confused and misguided policies of the Bush administration, thus creating an illusion of continuity. Bernanke and Paulson seem to be unwittingly preventing price discovery from occurring in the "credit markets". Just as in California, where the real estate market needed to adjust its prices down before increased economic risk taking could begin again, the Government also needs to let the financial markets adjust the price of lending down (i.e., interest rates up) so increased economic risk taking can begin again.

This can be consistent with something like the TARP program. But we need to Keep It Simple Stupid ("KISS"). Instead, the Fed and Treasury insist on ad hoc intermediation in the financial markets. Daily, it seems, some new program is being announced by the duel headed ObamaBush even if not yet implemented. This is preventing real buyers from taking real risks. In doing this, the Bush administration is simply delaying the ultimate solution from naturally happening. Granted, my suggestion would likely cause a recession, but as Volcker proved in his tenure as head of the Fed, that is what is sometimes required and can end up much better in the medium and long run.

The irony of the Volcker appointment is that in his time and place he understood that the Government had caused the inflation problem and therefore he had to reverse course. Today, the Government is contributing to the current marketplace's "risk taking" phobia and we need to now reverse course. But this does not seem to be the solution of the day. The economic legacy of the Bush Administration may be that it set the stage for the "bold and fresh new idea" of the largest Government intervention and deficit spending spree in the history of the American economy.

(TO BE CONTINUED)