Mortgages a Bellweather on Property Rights?

Businessweek recently ran an opening article on the recent foreclosure debacle. The center piece of the article was focused on how the mortgage industry has been unable to effectively upgrade title record systems out of paper and into a more modern system. This was one of the major contributors to the foreclosure debacle. Another point the author comments on is how the ability to enforce and rely on property rights is critical to successful, developed, capitalistic systems.

I think the author is completely right in arguing that the current mess in mortgage re-sale and packaging has weakened the sanctity of property rights. These things changed hands so often and were so poorly documented that in some cases no one can figure out who ultimately owns what and even if they can they don't have documents proving that ownership that are acceptable to the courts.

Our government has taken steps into the private system that have only served to cloud the issue of property rights. They have weakened our rights to own and benefit from the use of property in the form of regulation, taxation, and bailouts. While some of these actions can arguably be justified (more or less) by the extraordinary circumstances of the recent financial crisis - the question we need to be asking ourselves is have we undermined the very system that made our nation great?

Strong and clear property rights, along with the courts' respect for contracts, are probably the two single most important facets of our economy and legal system and they have allowed us to grow as we have. We shouldn't be messing with them unless we have very carefully thought through the consequences...which I don't believe we have done.

Obama Toys With More Stimulus

The President is "warming" to the idea of another round of stimulus to help create jobs. President Obama promised to create new jobs with the enormous $787 billion stimulus. Unfortunately that didn't work to well as the unemployment rate continued to climb. Now democrats are yearning for more spending and more deficits to create jobs. The catch here is that most of the $787 billion won't be spent until next year or the year after, so this package alone may hit the economy at a time when we no longer need it and could overheat or otherwise distort the economy.

The current administration's idea here seems to be that if at first you don't succeed just spend more! I feel sorry for my grandchildren already.

CIT Files Bankruptcy, and Retailers Get Nervous

CIT's recent bankruptcy filing represents the 5th largest bankruptcy in US history with $71 billion in total assets on the books. CIT is a critical lender to retailers for inventory - especially around the holidays. Since CIT was only slightly smaller than GM and was larger than Chrysler it makes you wonder why it didn't warrant an Obama bailout...maybe because there are no unions working at CIT. You decide....

CIT Files Bankruptcy, and Retailers Get Nervous - Local News | News Articles | National News | US News - FOXNews.com

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The Unemployment Paradox

The unemployment rate dropped in July, from 9.5% in June to 9.4% in July. Many people have found the drop to be odd given that the economy wasn't really doing any better. Even more perplexing is that now that we seem to on our way out of this mess economists are warning that unemployment is still likely to rise to 10% and remain high through 2010. These same economists are projecting economic growth in 2010 and the second half of this year. How does this add up?

The unemployment rate is calculated by the Bureau of Labor Statistics (BLS) on a monthly basis. The formula is very straightforward: Unemployed/Labor Force. The catch is in the definition of labor force. The BLS defines the labor force as those currently working or actively seeking work. Unemployment is then those that are in the labor force but not currently employed. What happens is that when workers become discouraged and stop looking for work they are magically no longer unemployed because they are not a part of the labor force. The drop from 9.5% to 9.4% was primarily due to people stopping their search for work. Since those that fall out are 100% unemployed (by definition) when a large number of people give up the search the unemployment rate can drop or fail to rise month on month even as the economy sinks.

In fact there are some estimates that put the unemployment rate at closer to 15% if the so called "discouraged job seekers" were still included. This is the key to understanding how the economy can improve and unemployment rise slightly or stay high. As more jobs become available and companies start to hire, the "discouraged workers" suddenly start looking for jobs again. That adds more unemployed people to the labor force thus increasing the proportion of unemployed in the labor force - unemployment rate rises. Eventually the number of people becoming undiscouraged drops and the unemployment rates starts to stagnate and then slowly drop. This all occurs well after the economy is in recovery. This effect will likely be magnified this time since the recovery is not expected to be swift.

This is just one example of how the government, and some economists, can lie with statistics. Now you know!

Reason from on High?

The Supreme Court issued a temporary injunction blocking the sale of Chrysler to Fiat. Could the high court be about to inject reason into this debacle? I would not count on it, but one can only hope that the court will end Obama's experiment in central planning. Keep a watch on this one....

The Economy and You

The current recession is the worst since the great depression, and what really makes this recession scary is not so much how far we have to fall, but what will happen as we start heading back up. Two recent Business Week articles touch on two of the biggest challenges to a successful recovery.

The first article discusses the inflation risk inherent in any recovery. This recession was caused by a financial crisis, which severely restricted credit and impaired the functioning of our financial system. In order to prevent another depression (and stave off deflation) the Fed and the Federal Government have pumped enormous sums of money into the economy. Washington has pumped money in through tax credit, tax cuts, and good old fashion fiscal stimulus on an unprecedented scale. The Fed has lowered its target rate to almost 0% while at the same time turning loose a tsunami of government backed credit. In an ordinary recession these two actions would have produced a huge expansion of the money supply and would have caused levels of inflation that could bring an economy to its knees. What was different this time?

The credit crisis cut off the normal flow of funds to businesses and households. This dulled the effects of the economic stimulus, particularly those from the Federal Reserve (in economic-speak the money multiplier was significantly lower than in previous decades). The unique nature of this recession has required such extraordinary steps to prevent a depression because of the reduced flow of credit. The danger now is that the financial system is literally awash in money and as the economy begins to recover the blockages in the system will clear and a flood of money and credit will hit the economy. If this happens the recovery will be swift, but will likely yield another bubble and extremely high inflation. The trick is for the Fed to slowly siphon off the excess money and raise interest rates to prevent the flood of credit from hitting the system like a shot of adrenaline without choking the life out of the recovery. This is a very daunting task that historically has not been performed with precision.

The second article discusses the other side of the recovery equation: unemployment. The article points out that amid the highest unemployment rates in decades there are over 3 million unfilled jobs in the US. How can this be? The answer - structural unemployment.

To economists, not all unemployment is equal; in fact, there are four kinds: seasonal, frictional, structural, and cyclical. Seasonal unemployment is straightforward enough: some industries have seasonal ups and downs. Frictional unemployment represents typical job and labor mobility cycles and is generally very short-term unemployment. Structural unemployment represents unemployment caused by changing economic realities such as the rise and fall of industries and sectors of employment. Seasonal, frictional, and structural unemployment are always a part of any economy and comprise in varied proportions the natural level of unemployment. Cyclical unemployment occurs during the course of business cycles and is caused by recessions. This type of unemployment can be very long lived. A lot of the 8.9% unemployment right now is cyclical.

Now back to the original point, 3 million jobs remain open when unemployment is at nearly 9% reflects the fact that the landscape of our economy is changing with this recession. Too many professionals existed in fields such as construction and finance and they are now unemployed and will remain so for some time. At the same time fields like education and health care are still growing and they cannot fill all the jobs. This occurs because these are professional fields that require years of training and the newly unemployed financiers and contractors simply don't have the skills to fill these positions. The process itself is actually healthy for the economy in the long-run. We are matching employment to economic reality. The effect of this will be to prolong the high unemployment rate as the displaced workers get retrained. It is very likely that the natural rate of unemployment (NAIRU for all you economics students out there) is going to be reset to a higher level for a least a while.

What do these two factors mean for you? First and foremost, expect unemployment to continue to climb even as the economy bottoms out and then to fall slowly as workers are retrained. (If you have a child in college suggest a degree in education, medicine, engineering, or chemistry over finance.) Second, expect the recovery itself to be extremely slow. The Fed is likely to start pulling credit out of the system sooner rather than later keeping the recovery slow to avert disaster. The pain is likely to stop getting worse soon, but it's going to ache for a while!

GM a Division of the U.S. Treasury - Part II

This week's Monday Must Read mentions "Inside GM, With the G-Men in Charge," from Business Week. The article looks at how deeply the government has involved itself in GM's day-to-day operations. Interestingly, the Obama administration initially stated it had no interest in running GM's day-to-day operations. The government has done everything from pressuring bondholders to take losses to deciding which brands live or die. The changes are certain to improve GM's short-term financial position by ensuring a steady stream of goverment money, but will likely do nothing to improve the long-term viability of the firm.

The government has shown a willingness to pressure anyone that gets in their way. Bondholders will be all but wiped out by the current restructuring plan and the administration is pressuring them take these losses willingly rather than go for bankruptcy. The insane thing is that many of these bond holders are institutional investors that represent teachers' or firefighters' pension trust funds. They are asking the managers to take huge losses on securities bought with the hard earned retirement funds of middle class Americans. So much for helping out the little guy. Simultaneously, the Obama administration has called for tighter regulation of the financial industry including stronger requirements to act in shareholder interests while at the same time pressuring these funds to volunteer to take huge losses. Something smells foul to me.

The government has had a big impact on which brands will survive. While dropping brands like Saab, Saturn, and Pontiac is probably good for GM, the government pressured them to drop GMC and Buick despite the fact that these are the two most profitable business lines. Buick is a big seller in growing markets like China. Why would the government make such requests? GMC is primarily large trucks, which don't fit with Obama's green thumb. In the middle of trying to help make GM viable the government tried to kill it's most profitable business segment because of political goals. I doubt this ends well. Luckily management held its ground and kept GMC and Buick - though I wonder how long that will last with the ousting of CEO Waggoner.

Actually all Obama has to do is wait if he wants the authority to run GM into the ground. Under the current plans for a post-bankruptcy/work-out GM the government would own 50% of the firm and the UAW as much as 39%. I find it very odd that the government would want to give 89% ownership of GM to the two groups with the worst competitive record in America.

GM might have failed on its own and the result would have been well deserved, but under a combined Obama/UAW ownership GM may indeed live on. The only catch is that it will always be on tax payer life-support, just another federal budget leech.

This all started with a "small" government loan and will end up with nationalization, piece-by-piece. You know what else starts out small and grows steadily worse - a virus.

Chrysler R.I.P.

Well it has happened: a U.S. automaker is likely headed into bankruptcy. The fact that Chrysler or even G.M. for that matter would end up bankrupt is not really all that surprising. The U.S. auto industry has been hurting since the late 70s and has never really managed to forge a lasting turnaround. The reasons are plentiful: failure to adapt to changing customer demands, slow response time, lack of innovation where it matters, poor quality, inefficient manufacturing, failure to adopt new technologies rapidly, competitive issues from U.S. taxes and regulation, poor financial management, poor strategic leadership, and the UAW.

The major culprit here is in fact the UAW. The complexity of union labor rules and sheer cost of all the benefits and concessions mean that the average UAW worker is paid well above the market wage - bleeding the automakers dry. The fact of the matter is that the price American consumers are willing to pay for a new vehicle simply cannot sustain such lavish pay and benefits. If the UAW does not learn this lesson soon G.M. and maybe Ford (though it is in a much better position) will fare the same.

Honestly, I think bankruptcy is probably the only way G.M. or Chrysler will ever survive in the long term (though for Chrysler it will probably not be as an independent company). Only under court protection can they clear off some of the toxic and crushing liabilities they are carrying. Even after bankruptcy the automakers would face a long and difficult road. If they cannot change their culture and persuade the union to be a team player any gains will be short lived.

The thing that really irritates me is that if we were going to let Chrysler and G.M. end up in bankruptcy court anyway couldn't we have let it happen before giving them billions of dollars in taxpayer loans? I mean seriously how did they go from too big to fail a few months back to dead meat today? It seems to me that the current administration doesn't so much have a plan as a motto: "Just throw billions of dollars at the problem and if that doesn't work then walk away and let them fight it out in court, all the while saying 'We told you so'." There is a nice little video showing all the politicians vow not to let the automakers fail on "The Lonely Conservative."

I think part of the problem is that at his fundamental core President Obama is a socialist and he despises capitalism (which, by the way is, what made America great). His goals during this recession seem more about promoting his agenda and lending money to every business enterprise he can find so that later he can gag them when he rams universal health care and tax hikes down our throats (just ask the CEO of BofA, if only he could tell you).

Check out this brief article too.

And as a parting thought think about this - Is America still free and are companies "private" if we all owe the government for our houses, jobs, and cars?

The Economic Outlook

The American economy as we have known it since the mid-1980s is quickly and not so quietly coming to an end. The question on everyone's mind is, when will it be over? It is fairly clear what must happen for the economy to recover - the difficult part is determining when it will happen. Recently there have been some small bright spots of economic news. Citigroup, Goldman Sacs, and a few other companies are posting stronger earnings and banks are making headway into clearing out bad loans. Many economists now believe the pace of economic decline will slow for the second quarter and perhaps reverse by year's end. That's the good news, here is the bad: We are entering the most dangerous and difficult part of the business cycle - the bottom.

The current recession has taken an enormous toll on jobs, profits, economic growth, inflation, credit markets, and stock markets (didn't think I'd forget that one did you!) because it is at its core a painful deleveraging process. Our economy has been running overloaded with debt and now we have to shed that excess debt, which is a very slow and painful process. Where do we go from here? There are really two major paths that I see the economy taking and a lot of gray area in between. Here are my two cents on the economy - no guarantee included!

The first road is the more pleasant of the two. In the remainder of this year some hard choices will have to be made by the Federal Reserve and the Obama administration. Much of the current improvement is the result of temporary boosts to consumer income from stimulus efforts that will fade by the end of the second quarter. If the recovery is to start by that time the government will need to engineer a rapid completion to the deleveraging. If they get it right we might expect the economy to bottom out at the end of the second quarter and then stay relatively sluggish through the rest of the year. Unemployment is all but certain to rise through most of the rest of the year. We will be lucky to avoid hitting 10%. Mild deflation is also probable through the end of the year, though I would not expect anything severe. The credit markets will recover slowly as banks get better capitalized and more certain of borrowers' credit, but don't look for major recovery until the job market improves (think Q2 2010). It will likely be several years before the economy is at full employment again (unemployment of ~5%). The stock market is probably already near a bottom and if the economy bottoms this quarter should make a strong showing through year's end, but then who can really predict the stock market anyway! That doesn't sound so bad right. The trick is what is required to get us there.

In order for the economy to start a sustainable, long-term recovery like the one described above a lot of things needs to happen simultaneously. First, the Federal Government needs to do three major tasks and has to get them right. 1. Taxes must remain relatively low and not unduly burden businesses or individuals (this means all taxes - even on "the rich"). 2. The $700 billion bankruptcy, excuse me stimulus, package must be spent wisely. This means spending on infrastructure, education, and investment: the three things that drive truly sustainable, long-term growth. 3. Regulation must be reasonable, clear, and as minimal as possible. Second, the Federal Reserve has to engineer a very soft landing and very, very careful recovery. This means the Fed must be prepared to soak up liquidity and raise interest rates to prevent another unsustainable bubble or sky high inflation (which is a real risk), without grinding the recovery to a halt. This is NOT a small feat! Third, financial firms must clean up the junk and stand ready to lend. This is probably something the market will take care of, but we should watch it closely.

And now for the second path I spoke of earlier...If the government and business fail to do those three things effectively and with perfect timing we will see at best sky high inflation from too much liquidity and rapid growth or a deep depression the likes of which the world has never seen.

Which outcome is more likely? The government's track record on these delicate issues is not very encouraging. I would hope that collectively we would have learned from history, but the election of the most liberal President in American history suggests otherwise. Some of the things Obama, Bernanke, and company are doing are good and I can almost see light on the other side except for the mountain of debt that is rising from Capital Hill. My best advice is to hope for the best and plan for the worst. Let your representatives know how you feel and that you care. Guard your retirement savings from inflation. And most of all...pray.

General Motors (A Division of the U.S. Treasury)

Ok, seriously I don't even know where to begin to explain what went wrong here. The major U.S. car makers have been getting their butts kicked by foreign manufacturers for years. Basically everybody involved with these companies was to blame. Until recently these problems were left to GM to solve since they are, after all, GM's problems. This is one of the hallmarks of the American economic system, and one of our greatest strengths. The creativity and rapid advancement that stems from such individual economic freedoms is what made America great. The flip side of this is that every once in a while our economy will stumble, and the current deleveraging was a long time coming. What really makes this recession unique is the willingness on the part of Americans to tolerate such huge changes in the scope of government involvement in our lives and economy.

A case in point is that the government went from basically making loans to GM and Chrysler to forcing the resignation of GM's CEO in very short order. It is shocking that such a thing could happen in the U.S. without huge public debate or outrage, but it did and with barely a whisper of protest. Don't worry, it gets even worse - the article linked to in this post's title details the horrors of government intrusion. Barely had 24 hours passed on Obama forcing Waggoner out and now there is talk of dictating who can serve on the board of directors. It's now official folks: General Motors is a de facto state owned and operated company! The really incredible part of all this is that by replacing Waggoner Obama is implying that he believes that his administration is better suited to pick leaders to run companies than shareholders. I doubt very much that Obama has the industry knowledge possessed by, oh I don't know, Waggoner! Not to mention the fact that the President's track record of nominating leaders is not very good - just look at his nominations for cabinet positions. This is just one more brick in what is turning out to be a fairly short road to socialism and this administration is barely 60 days old.



The precedents set with GM and the current economic stimulus and bailout plans will have long reaching and I fear disastrous consequences for the long-term vitality of our economy.