Inequality, Leverage and Crises

That's the title of an interesting paper by Michael Kumhof and Romain Ranciere for the IMF. (Full text of the paper available here)

Although the details of their actual model will require some knowledge of economics to follow, the paper contains some lengthy non-technical sections, including one showing how the 1920's run-up to the Great Depression was similar to the 2000's runup to the Great Recession and one explaining the mechanism by which their model works.

Basically, they posit a shift in bargaining power (think decline in unionization rates, offshoring of jobs, etc.) from a working class (95% of the population that earns its money from wages) to an investor class (5% of the population that owns most of the capital) and then assume that the extra revenue coming to the investor class as a result of their improved bargaining power is lent back to the workers. This allows the workers to maintain their relative share of consumption, and provides an additional source of income for the investor class.

Over time, the debt level of the working class increases and the vulnerability of the system to a debt crisis increases along with it.

The authors find that widespread defaults during a crisis will help by reducing debt levels of the workers, but because the underlying cause is left unaddressed (the lack of bargaining power for the workers), this is a weak and short-lived solution, with crises repeating regularly. The quicker, more sustainable solution is measures to restore the bargaining power of the workers so that the incentive for workers to borrow and investors to lend is removed or at least reduced.

Anyway, it's just a model, but it's one of the few that actually seems to present a plausible theory of how (certain types of) debt crises happen that seems to mostly fit the facts of what we've observed in the Great Depression and our current Great Recession.

That's What Keeps the Rent Down, Baby**

I've been (very slowly) going through my blog archives and adding tags to all the old posts. I ran across one from 2005 where I wrote, tongue in cheek,

"What's the difference between China and Canada? China keeps its currency down vs. the American dollar by legislative fiat, while Canada does it by making the markets nervous with endless political shenanigans."

It struck me* that maybe the same thing is happening now, only more deliberately, in Europe, where The Germans are allowing Greece to twist in the wind which is helping keep the Euro down (from 1.5USD a few months ago to about 1.3USD now), which helps German exports.

With Bank of Canada governor Mark Carney caught between a high Canadian dollar, rising prices and a housing bubble, maybe a little domestic crisis would be just what the doctor ordered...

---
* Hmm, looking around the interwebs, I see I'm not the only person this thought has occurred to, oh well.

---
** Post title reference

Easy Does It?

Here's a chart from the U.S. federal reserve that Paul Krugman mentioned the other day.



The Fed included the chart as evidence that monetary policy wasn't the cause of a U.S. housing bubble. Krugman was pointing out in response that you can't use a national average change in housing prices all that meaningfully for a country like the U.S. since, unlike other countries that had bigger national changes, the U.S. had a mix of high-growth bubbly areas and small-growth no-bubble areas.

As a Canadian, I noted that the growth in housing prices was higher in Canada than the U.S. over the period covered, and that the same logic regarding only part of the country having the big house price changes applied here as well.

But what worried me was something else.

The x axis on the chart is the Taylor Rule residual, or how interest rates, as set by the central bank, varied vs. what a rule-of-thumb known as the Taylor rule would suggest they should be. I'm not going to get into the technical elements of how the Taylor Rule works, the point is that the U.S. Fed used this metric in the chart as a rough measure of how 'easy' monetary policy was over the period. One concern with 'easy' policy is that by keeping interest rates below what they 'should' be, the Central bank might foster an unsustainable credit/asset price bubble that would be followed by a crash.

So starting from the left let's consider the countries that had the 'easiest' policy:

Greece: "Moody's cut Greece's debt to A2 from A1 on Tuesday over soaring deficits, becoming the third major rating agency to downgrade the highly-indebted country's rating this month."

Spain: "The weaker euro economies such as Spain and Greece have been terribly hit by the crisis, and experts blame the euro, at least in part, as European Monetary Union (EMU) members cannot use national monetary policy as a crisis-fighting tool."

Ireland: "How close is Ireland to crisis? Close enough that prominent people are raising the spectre of capital account flight already underway."

"The United States: Aughts were a lost decade for U.S. economy, workers"

So who's in fifth place, behind arguably the 4 countries hardest hit by the global financial crisis? Canada.

But don't worry, it's different here - I hope.

Stay Calm

From the entry for 'Calm' in John Ralston Saul's Dictionary of Aggressive Common Sense,

"CALM - A state of emotion which is overrated except in religious retreats. It is used principally to control people who are dissatisfied with the way those in authority are doing their jobs. When individuals show annoyance, the person in power or with privileged information or expertise will make them feel they are not calm enough to deal with the situation rationally. A lack of calm suggests a lack of courage, intelligence or professionalism.

...

The Captain of the Titanic was no doubt pleased that his male passengers in first class remained calm as they waited to drown. Had they been less controlled, they might have found some small satisfaction in passing their time by throwing him overboard"

If you follow the financial news, you'll have heard that the largest investment bank in the U.S., Goldman Sachs, has reported a profit of $3.44 billion dollars for the quarter, and said it had set aside $6.65 billion for pay and bonuses in the quarter ($226,000 per employee, on average).

In a different era, just the 'mere' fact alone of a company paying its employees a quarter of million each for 3 months of work while the rest of the country faces the highest levels of unemployment and wage cuts in living memory might be enough to stir outrage.

These days however, it takes this profit coming on the heels of a series of government bailouts of Goldman Sachs, as well as a series of unseemly regulatory changes favouring Goldman Sachs, combined with the fact that seemingly all of the important political players who created the bailouts for Goldman Sachs and changed the regulatory rules to suit them are themselves former Goldman Sachs employees, finally combined further with the products that Goldman sells being a prime cause of the current economic crisis all put together with sky high profits and bonusses, to generate some outrage, some lack of calm from the passengers on the economic ship.

So on the Goldman front, we have a long article from Matt Taibbi in Rolling Stone, which starts by referring to Goldman Sachs (known as 'Government Sachs due to the fact that everyone important in financial matters in the U.S. government used to work for them) as "is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money."

Then a youtube clip from a French network business TV show with Max Keiser repeatedly referring to Goldman Sachs as 'scum' who should be 'in the Hague'.



Even Paul Krugman gets shrill enough to say that,

"The American economy remains in dire straits, with one worker in six unemployed or underemployed. Yet Goldman Sachs just reported record quarterly profits — and it’s preparing to hand out huge bonuses, comparable to what it was paying before the crisis. What does this contrast tell us?

First, it tells us that Goldman is very good at what it does. Unfortunately, what it does is bad for America.

Second, it shows that Wall Street’s bad habits — above all, the system of compensation that helped cause the financial crisis — have not gone away."

The Krugman comments were the final straw that sent The Economist to the fainting couch. In a column entitled, 'Goldman Madness Spreads' they admonish us as follows,

"Paul Krugman writes today that:

...what [Goldman Sachs] does is bad for America.

What it does is bad for America. Not "some of what it does is bad for America". Not "the legal, profit-seeking behaviour of large investment banks may have some negative externalities that should be addressed by government regulators, in the following ways".

This is no way to have a policy discussion."

Let me repeat part of the quote from John Ralston Saul that I started with, "the person in power or with privileged information or expertise will make them feel they are not calm enough to deal with the situation rationally."

Which, at length, brings to this post by Mike at Rortybomb which triggerred my post. Says Mike,

"Is there room for outrage? I always find this frustrating in economic technocratic talk, where outrage/disgust/shaming is dampened by having to focus in terms of 'bad incentives.' There’s a schizophrenia in the way we talk about this, that capitalism on one hand is a benevolent invisible hand guiding us all together, and also amoral tiger who of course was going to rip your throat out if you don’t lock its cage properly.

Getting a little hyperbolic, it’s like someone has broken into our house and is looting everything in sight. How do we 'set up his incentives' so that he leaves without the treasury in tow? Setting up the terms for discourse in economic rationality speak is only going to allow us to answer the question of 'why didn’t we lock the door?' Good question, of course. But we have problems right now that rightfully deserve shock and anger."

In case it's not obvious, I agree. I often find myself resigned when thinking about the dominance of our politics and economics by a wealth-serving ideology that hides under a cover of technocratic 'rationality', but the appropriate, and more effective response is often anger, not resignation.

Debt, Redux

"Your servant here, he has been told
to say it clear, to say it cold:
It's over, it ain't going
any further"

I keep writing this same post about the role of debt in the economy and the economic cycle, but I think the reason why I keep coming back to it from slightly different angles is that I am wary of being in disagreement with the majority of experts on a complicated topic about which I am not an expert. It seems as though adherents of the notion that our troubles stem from too much debt and will be cured by eliminating the debt come from the fringes on either the left or right, with few mainstream or 'establishment' figures supporting this notion.

At any rate, here goes.


Consider the game of Reversi, aka Othello. The fun in the game derives from the placement of pieces on the board – deciding which spot to occupy and when to occupy it is what the game is about. At the start of the game, the board is wide open and filled with possibilities. The game ends when the board is full, when there is nowhere left to place stones. At that point the only way to continue to enjoy playing Reversi is to clear the stones off the board and start over.

Now, consider the economy. Economic growth occurs as people invest money into producing goods and services. Generally, investment to support production involves taking on debt. Either people simply don't have enough money available to use as equity to start/expand production, or they figure that if the venture works out, higher leverage (more debt) will increase the return on their equity and if the venture doesn't work out (goes bust) then at least some of the money lost will be someone else's as opposed to their own.

Not everyone has the inclination or ability to go into debt to produce goods and services. In any society there is a mix of people who will and people who wont. For this post, let's call the people who will, entrepreneurs, and the people who won't, bankers (since the people who have savings place them in the bank, and the bank then lends those savings out – effectively anyone with savings is a banker).

To start with, imagine an economy with no debt* – it is like the Reversi board at the start of the game, filled with possibilities. All of the society's entrepreneurial types have no leverage (no debt) and the greatest ability to borrow (for a given level of equity) that they will ever have.

Then you set the economy in motion. As the entrepreneurs borrow and invest, the economy expands. This is equivalent to the placing of the stones on the Reversi board.

The problem is that, although individual entrepreneurs can and will succeed, as a whole they seem doomed to eventually fail. Over time, as the economy expands, both the entrepreneurs and the bankers grow more confident and the level of the entrepreneur's debt relative to their equity increases. i.e. Debt expands faster than the rate of economic growth. True, some entrepreneurs will go bankrupt, eliminating their debts, but there is a strong correlation between the individual entrepreneurs success or failure, so during the up part of the cycle when times are good, bankruptcies will be relatively rare.

Every now and then there is a breakthrough of some sort that allows higher than normal growth rates in a particular area. The invention of the steam engine and the railroad for example, or the development of the internet. These cases lead to an understandable gold rush where a mass of entrepreneurs piles in with their investments until they eventually blow a big bubble which collapses at some point once people realize that the investments have swamped the productive capacity of the new phenomenon (e.g. Once AOL's stock is so high that it can 'buy' Time Warner in a stock swap).

Sooner or later, whether due to a speculative mania or just a steady accumulation of good times and increasing risk tolerance, society reaches a point where the class of entrepreneurs has so much debt that they simply can't or won't take on any more. i.e. The Reversi board becomes full.

When the board is full, you have to clear the stones and start over, much like Solon did in Greece, back in the day. In economic terms, the debts must be eliminated or at least reduced.

Note that although it's certainly not very stable, and people do get hurt, especially in the cleaning stones off the board phase, there's nothing unsustainable about this cycle and the net result is positive (wiping out the debts doesn't wipe out the productive investments that the entrepreneurs have made). In every game the entrepreneurs take the risks and do the investing that builds up our wealth but eventually they lose and they can't play any more stones (take on any more debt) and they have to declare bankruptcy. For example, the Reichmans went bankrupt building Canary Wharf, but Canary Wharf is still there and the Reichmans were able to rebuild their fortune in the next cycle.

The role of the bankers is twofold:

While the stones are being played, they must try to direct the money they lend to the entrepreneurs with the best chance of making good investments with the money. This allows the entrepreneurs to do as much productive work as possible before they eventually lose out. In a sense, the role of the bankers is to try and expand the debt as much as possible while at the same time promoting as much growth as possible in order to sustain more and more debt.

The second role of the bankers in the cycle is to win gracefully. That is, when the game is over they must allow the stones to be cleared off the board so that the game can be replayed. Of course, clearing the stones off the board means wiping out all the accumulated money that the bankers are owed so this can be difficult. Deposit insurance was a progressive innovation designed to prevent small scale bankers (savers) from being wiped out in the process of stone removal so that the costs would fall heaviest upon the large scale bankers who would no doubt feel aggrieved but would still be handily able to clothe, feed and shelter themselves after having their stones removed.

In a sense, both sides are propelled forward by a certain perverse competitive behaviour. The entrepreneurs know that as a class they will eventually get in over their heads and fail, but each one believes that they will be one of the ones that succeeds. The bankers know that they can't accumulate claims against the entrepreneurs forever and that eventually most of the claims will have to be eliminated, but each one believes that they will lend to the entrepreneurs that succeed and that their claims will be preserved.

Besides, in the long run we are all dead, and both entrepreneurs and banks might as well enjoy the upside of the cycle while it lasts.


The question of the moment is what happens when the bankers refuse to win gracefully. What happens when, instead of allowing the stones to be removed from the board, they try to get blood from them instead?

Bankers can use the power of the government** to try and extend the game (or at least prevent it from being restarted) in a number of ways.

1) By lowering interest rates, they can reduce the burden of a given level of debt (sort of like shrinking the stones on the Reversi board so you can have more squares on the same board). The limiting case here is when government set interest rates reach 0.

2) You can substitute household borrowing for business borrowing. So when entrepreneurs can't or won't borrow any more, you encourage their customers to borrow instead (do not pay until 2017!). The resulting increased demand for their products will allow the entrepreneur to expand some more.

Eventually, however, the customers will in turn reach their limit with respect to capacity / willingness to borrow, and again, this can be extended by reducing rates, with a limiting case of 0 rates. (Note that this approach will direct investment towards the priorities of impatient consumers instead of towards whatever entrepreneurs see at the greatest unmet needs of people in general (in proportion to how much money they have, of course) – this may not be for the best).

3) By inflating asset prices, the perception (on both sides) of people's capacity to borrow can be increased, because the collateral is perceived to be worth more. Of course once asset prices get too high, they are vulnerable to a sudden loss of confidence followed by a crash. Where the limits are here is not known precisely and is a matter of psychology, but that they exist is certain.

4) Finally, when all else fails, the government itself can step into the shoes of the entrepreneurs and consumers and borrow for itself – up until the government also reaches its limit. This borrowing can either be done directly via government deficits or indirectly by either bribing or forcing entrepreneurs and consumers to borrow more. For example, if consumers have reached the limits of their willingness to take on mortgage debt, the government can guarantee their mortgage in order to tempt them with lower interest rates, and if the sweet, sweet offer of low interest rates is not enough to make them jump, then government can outright offer people an $8,000 bribe to buy a house. And if that doesn't work, try $15,000. Of course encouraging people to take on mortgage debt is a 2 for 1 deal in terms of expanding debt, since it expands household debt directly and also supports asset prices.


You can see that we have plowed our way through phases 1,2 and 3 and have reached the 4th and final option. Unwilling to allow any stones to be removed from the board (this would hurt the bankerseconomy!) the government (acting on behalf of the bankers) intends to put at least one stone of its own down for every stone that the private sector tries to remove. But sooner or later, the stones have to come off the board if we want to play again.

As I described above, we reach this final stage when entrepreneurs and their surrogates (consumers) have reached a point where they can't or won't borrow any more. The flip side of this, of course, is that it means bankers and their suppliers (people who save/lend money) have accumulated a massive amount of claims on the economy.

This relationship clarifies why we see such a strong historical relationship between inequality and debt crises. Also note that, if the government were to intervene on behalf of the entrepreneurs instead of on behalf of the bankers (e.g. by taking money from creditors and giving it to debtors), this would help to solve rather than aggravate the problem. Again, this clarifies why the period from the end of WW2 to the 70’s which had strongly progressive taxation was marked by unprecedented economic stability and the subsequent removal of this progressive taxation has brought us back to crisis. To put it simply, when the problem is that the bankers have all the money/claims on the economy, the only solution is to change this distribution.

As a society, we need to say to the bankers, ‘look, you win, let’s play again’. Either we wipe out the debts via bankruptcy or we inflate them away via bankruptcy or we redistribute income from bankers to entrepreneurs or we find some other way to reset the board. Naturally, this is not fair (Personally, I am a banker, not an entrepreneur – remember that we are including anyone who has net savings in the bank as a banker!), but fairness is beside the point – what must happen, will, and putting it off doesn't help. Of course, the bankers/savers will do almost anything to prevent this outcome, and they will try to convince us that we can grow our way out of the debts that we grew ourselves into (which we could if they were willing to accept interest rates below the rate of economic growth, but I'm not optimistic on this point, and even then it would take a long, long time).

The banker's incentive is to say that if entrepreneurs won't put any more stones on the board, then consumers will. If consumers won't do it then government will continue the game for them. Government will bribe people with low interests and cash payments for borrowing. If that doesn't work, the upper class bankers will direct the government to take the savings of the lower/middle class bankers via taxes and use that to support more government borrowing. But in the end, even holding all the political power, and controlling all the media, all the banker's kings will prove unable to keep Humpty Dumpty from falling off his wall.

The current game of 'run-up the debt' has been underway for decades. Maybe it can continue to be played, or at least held in stasis, for another year, or another decade, or even a couple of decades, I don't know. But someday, and the day is not too far off I fear/hope, we’ll hit that final, global, Minsky Moment when it’s over / it ain’t going any further.








* i.e. All money has zero maturity or pays no interest, like a $20 bill – holding it doesn’t require you to pay interest to anyone.

** I'm taking a break from the ethics series with this post, but note that the interference of bankers in government is exactly the sort of 'syndrome mixing' that Jane Jacobs identified as systemic corruption in 'Systems of Survival'.

Deja Vu

All of this has happened before
All of this will happen again...

Here's a quote that seems relevant to the current financial situation,

"Another way of defining moral hazard is that it is what results from the combination of privatized profit an socialized loss. In the words of Kenneth A. Guenther, executive vice president of the Independent Bankers Association of America, "The combination of interest rate deregulation with 100% deposit insurance is like the invention of gunpowder - sooner or later it was bound to explode" But deregulation of banking and finance was all the rage ... and the banking sector wanted "the government off its back." Nowadays the last thing it wants is for the government to leave the scene of the train wreck. Ironically, the degree of government involvement in the financial sector ... is proving much greater than before. ... Those deemed 'too big to be allowed to fail' are of course especially favoured, further encouraging bigness.

...

To analyze or even recount the recent and unfinished consequences of the financial deregulation disaster in the United States, or the international debt crisis, is far beyond our scope. We are sure that the consequences will eventually have to include a large dose of reregulation in the public interest."

That's Herman Daly and John Cobb from the 2nd edition of 'For the Common Good', published in 1994. I wouldn't be too optimistic about that reregulation bit, we're just going to go from crisis to crisis without anything changing if the last few decades are anything to go by...

Medical Costs and Financial Regulation

One of the best places on the web to find links to interesting material on ethics and economics with interesting discussion thereof, is Mark Thoma's Economist's View blog.

A couple of recent links from there that are worth noting here on the blog:

1) The Cost Conundrum, links to this excellent piece of journalism by Atul Gawande in the New Yorker, tracking down the source of high costs in the U.S. medical industry. I may come back to this piece further down the line in my series of posts on ethics.

A couple of quotes from the article that I want to remind myself of when I come back to this later,

"The primary cause of McAllen’s extreme costs was, very simply, the across-the-board overuse of medicine.

This is a disturbing and perhaps surprising diagnosis. Americans like to believe that, with most things, more is better. But research suggests that where medicine is concerned it may actually be worse."

...

"There was no sign, however, that McAllen’s doctors as a group were trained any differently from El Paso’s. One morning, I met with a hospital administrator who had extensive experience managing for-profit hospitals along the border. He offered a different possible explanation: the culture of money.

"In El Paso, if you took a random doctor and looked at his tax returns eighty-five per cent of his income would come from the usual practice of medicine," he said. But in McAllen, the administrator thought, that percentage would be a lot less.

He knew of doctors who owned strip malls, orange groves, apartment complexes—or imaging centers, surgery centers, or another part of the hospital they directed patients to. They had “entrepreneurial spirit,” he said. They were innovative and aggressive in finding ways to increase revenues from patient care. “There’s no lack of work ethic,” he said. But he had often seen financial considerations drive the decisions doctors made for patients—the tests they ordered, the doctors and hospitals they recommended—and it bothered him. Several doctors who were unhappy about the direction medicine had taken in McAllen told me the same thing. “It’s a machine, my friend,” one surgeon explained."

...

"I spoke to a marketing rep for a McAllen home-health agency who told me of a process uncannily similar to what Powell found in biotech. Her job is to persuade doctors to use her agency rather than others. The competition is fierce. I opened the phone book and found seventeen pages of listings for home-health agencies—two hundred and sixty in all. A patient typically brings in between twelve hundred and fifteen hundred dollars, and double that amount for specialized care. She described how, a decade or so ago, a few early agencies began rewarding doctors who ordered home visits with more than trinkets: they provided tickets to professional sporting events, jewelry, and other gifts. That set the tone."

...

"We took a wrong turn when doctors stopped being doctors and became businessmen,” he said."

...

A cardiologist tells an elderly woman that she needs bypass surgery and has Dr. Dyke see her. They discuss the blockages in her heart, the operation, the risks. And now they’re supposed to haggle over the price as if he were selling a rug in a souk? “I’ll do three vessels for thirty thousand, but if you take four I’ll throw in an extra night in the I.C.U.”—that sort of thing? Dyke shook his head. “Who comes up with this stuff?” he asked. “Any plan that relies on the sheep to negotiate with the wolves is doomed to failure.”

2) Credit Crisis Cassandra links to another hoocoodanode story, this one by Manuel Roig-Franzia in the Washington post telling the the story of Brooksley Born - an American regulator, head of the Commodity Futures Trading Commission in the late 1990's, who went head to head with folks like Alan Greenspan, Robert Rubin and Larry Summers as they stymied her attempts to bring greater oversight and regulation to the derivatives market in an attempt to prevent the sort of financial debacle we are currently being subjected to.

A couple of quotes,

"Greenspan had an unusual take on market fraud, Born recounted: "He explained there wasn't a need for a law against fraud because if a floor broker was committing fraud, the customer would figure it out and stop doing business with him."

(Rumour has it Greenspan was up for baseball commissioner until word got out he was going to fire all the umpires since what team would play against another team that was known to cheat on calls...ok, I'm kidding, that's a joke - I hope)

"In one call, Summers said, "I have 13 bankers in my office and they say if you go forward with this you will cause the worst financial crisis since World War II," recounted Greenberger, a University of Maryland law school professor who was Born's director of the Division of Trading and Markets. Summers declined to comment for this article.

The discordant notes crescendoed in April 1998 during a tension-filled meeting of the President's Working Group, a gathering of top financial regulators that periodically met behind closed doors at the Treasury Department. At that meeting, Greenspan and Rubin forcefully opposed Born's plans, Waldman said.

"Greenspan was saying we shouldn't do it," Waldman recalled. "Rubin was saying we couldn't do it."

The next month, Born released her concept paper anyway.

Within weeks, she was under attack. Lauch Faircloth, then a Republican senator from North Carolina, took to the Senate floor to call her "a rogue regulator." A Boston Herald column accused her of a "power grab. . . . She reached for that brass ring and in doing so cast a pall of legal uncertainty." Greenspan, Rubin and Levitt jointly urged Congress to pass a moratorium on the CFTC regulating over-the-counter derivatives. "

...

But then, in September 1998, a huge hedge fund that had bet heavily on derivatives -- Long-Term Capital Management -- nearly failed and had to be bailed out by a group of banks. Here was a living example of Born's prophecy. Even Leach, who supported the moratorium on CFTC regulatory action, introduced Born at a hearing by saying, "You're welcome to claim some vindication, if you want."

Born responded: "I certainly will not do so." But she went on to tell the committee that the Long-Term Capital debacle "should serve as a wake-up call about the unknown risks in the over-the-counter derivatives market."

No one woke up. That same month, Congress passed the moratorium. Born says they were "muzzling an independent agency."

The Home Ownership Scam

Worth repeating, Willem Buiter on the social benefits of home ownership:

Home Loans in the U.S. the Biggest Racket Since Al Capone:

...Why do politicians of all political colours and parties get their knickers so twisted about people losing their homes? In the case of the Tories in the UK and the Republicans in the US, the answer is obvious. Both parties believe that home owners are conservative. Not it the sense that people who are inherently conservative are more likely to become homeowners (although they may believe that as well). This is not a selection story but an osmosis story. Home ownership makes people more conservative. So both Tories and Republicans do everything they can to encourage home ownership. But so do (New) Labour in the UK and the Democrats in the US, so it’s no longer a left-right thing.

The one argument for encouraging home ownership that makes sense is that owner-occupiers look better after their property and its immediate surroundings than would a tenant. This is a simple principal-agent story where it is costly for the principal (the owner) to monitor the care and attention the agent (the tenant) bestows on his property. Add some neighbourhood externalities (I don’t want to live next door to a place where they don’t mow the lawn or paint the exterior of the house), and you have an argument for encouraging owner-occupancy, say by subsidising it.

But a subsidy for owner-occupancy is something completely different from subsidising borrowing using residential real estate as collateral. If they exist, the benefits from owner-occupancy are there regardless of whether the owner-occupier has a mortgage or not. It doesn’t matter whether she borrowed to buy the house, paid in cash, stole it, inherited it from her parents, or built it with sweat equity on land won in a raffle. The US does not encourage owner-occupancy directly, say by paying each head of household who is an owner-occupier, a given amount of cash each year. Instead it encourages and subsidises a particular form of borrowing, regardless of what that borrowing is spent on. Funds, after all, are fungible. I can withdraw equity from my house by taking out a first or second mortgage against it, or by increasing the size of an existing mortgage, and spend the proceeds on Cuban cigars.

All this is rather insane. Through the deductibility of mortgage interest from taxable income, the US tax payer gives vast subsidies to borrowing secured against a particular type of collateral - residential real estate. What so special about this borrowing and this collateral? Fortunately, the UK has abolished this boondoggle. In the US, other forms of preferential treatment for home ownership are piled on top of the mortgage interest-deductibility. Over half the stock of home loans, and virtually all new home lending in the US are heavily subsidized by the lending and guarantees of Fannie Mae, Freddie Mac, Ginnie Mae and assorted smaller smaller government agencies. The direct interventions of the Fed and the Treasury in the market for residential mortgage-backed securities, announced as part of the credit-easing policies of the Fed represent further quasi-fiscal subsidies to housing finance.

This is on top of the creation by the Fed of at least a dozen facilities that accept RMBS as collateral for Fed loans in the earlier stages of the financial crisis. All these quasi-fiscal interventions by the GSEs and the Fed are deeply non-transparent as regards the magnitude of the subsidies involved. They also evade the normal scrutiny and accountability to Congress that is associated with explicit subsidies by the Treasury. The only priviliged treatment of residential housing that makes a modicum of sense from the perspective of encouraging owner-occupancy (as opposed to borrowing to fund whatever expenditures using residential housing as collateral), is the ability to postpone capital gains taxation on the sale of one’s principal residence, and to have one capital-gains-tax-free realisation during one’s lifetime (taken generally when people size down on retirement or when the kids have flown from the nest).

The extreme fiscal largesse bestowed on residential housing, directly and indirectly through mortgage interest deductibility, has led to a massive misallocation of investment in the US. There has been overinvestment in the private residential housing stock and underinvestment in just about every other form of fixed capital: infrastructure, public amenities of all kinds (sports facilities, public recreational facilities, parks etc.), commercial structures, plant and equipment. It is time to correct the distorted incentives that are at the root of this misallocation. The easiest way to do this, in the current tax system, is to end the deductibility of mortgage interest in the personal income tax, close down Fannie and Freddie and end the role of the US government in the provision of residential mortgages. A focused social housing program is of course a legitimate activity of the Federal government. It should be on-budget, that is, fiscal rather than quasi-fiscal.

...

But really, you should read the whole thing...

Buiter does a great job exposing the madness behind out-of-hand government promotion of home ownership, but he doesn't really get into the question of why governments act this way.

And it's not just the U.S. - Canada has gone down the same road with CMHC and a host of other incentives.

And over here, Steve Keen catalogues the extensive list of government interventions in Australia and again has little explanation for the magnitude of the government intervention in this particular area.

I do have a theory on why governments find this area particularly irresistible, but I'll have to save it for a few weeks until I've developed the appropriate background material first.

Thoughts on the economic crisis

I thought I’d post some updated thoughts on my views on the current global economic crisis. To be honest not much has changed since I wrote this post a couple of months ago, other than my confidence in my conclusions has increased.

Note that if you haven't already read Stoneleigh's must-read summary of the financial crisis (written almost a year and a half ago, now) you should read that rather than reading this post. (abridged version here)

Some other posts you'd be better off reading before reading my thoughts are as follows:

Steve Keen's Roving Cavaliers of Credit

Martin Wolf, Why Dealing with the Huge Debt Overhang is so Hard

Naked Capitalism, Irving Fisher's Debt Deflation Theory (and read the comments, too)

Mish, Wealth Does not pass three generations

Update: Another good post, 'Recession? No, it's a D-process, and it will be long', from an interview with Ray Dalio in Barron's (via Automatic Earth)
Before I begin it's worth noting the ideologically (from a left vs. right point of view) scattered nature of the people linked above, a group united more in its outsider status vs. the establishment status quo than in any left vs. right political views.
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Here are 5 culprits in the crisis, moving from ultimate towards proximate causes:

Human Nature
Bad Regulation (fractional reserve banking, monetary policy to lower interest rates, etc.)
Inequality
Financial System Leverage
Debt

Basically what we have seen is a debt/credit bubble. There are two forces that drive the creation and then destruction of the credit bubble:

1) Increasing financial system leverage along with an increasing ratio of credit money to fiat/currency/non-debt bearing money
2) Increasing inequality as debtors enrich creditors via exponentially rising interest payments.


In more detail:

1) We start with a healthy economy.
2) This healthy economy is growing due to improved productivity, population growth, etc., or maybe because interest rates have fallen.
3) Optimistic and impatient people take on debt believing either that they can earn a great enough return on the borrowed money to repay with interest or that consuming now instead of later is worth the interest payments.
4) Borrowing expands the supply of credit money in the system and this expansion is self-reinforcing in that the optimistic expansion of borrowing creates the money needed to pay back the original loans
5) The self reinforcing dynamic keeps the default rate on loans low.
6) Some of the newly created money starts to go into speculation on asset prices
7) This is again self-reinforcing as rising asset prices collateralize greater lending (think ‘taking equity out of your house’ and prevent losses on defaults (rather than default on your house, sell your house and pocket the profits due to appreciation)
8) The good times allow people to repay their loans which leads to greater inequality, since the rich lend to the poor, if loans are repaid with interest the rich get richer vs. the poor (except in cases where the return on borrowed money above the interest rate exceeds the rate of interest, but this is the exception rather than the rule)
9) The rising asset prices also increase inequality since the wealthy own more assets than the poor.
10) The proportion of the economy devoted to the financial sector grows as the volume of credit expands relative to the size of the economy.

There are four things which can limit this self-reinforcing credit bubble dynamic:
1) People choose to stop borrowing money out of a moral aversion to taking on more debt
2) Regulation prevents further lending (via reserve requirements, capital requirements, leverage constraints, or other restrictions)
3) Lenders choose not to lend any more money due to the increased risk
4) People’s debt to income ratios rise so high (due to the expansion of debt and the rising inequality) that they simply can’t afford to borrow any more money but they do it anyway and begin to default.

If 1,2 and 3 fail, as they have failed us in this latest crisis, then sooner or later 4 will take hold.

There is one way to forestall point 4) and that is to have the government lower interest rates. Since the early 1980’s when interest rates hit 20%, interest rates have fallen. Lower interest rates support higher asset prices (you can buy more house if the mortgage rate is lower) and they lower the burden of accumulated debt levels by reducing the interest payments. In 2001 when it looked like the expansion of the credit/debt bubble was at risk, central banks dramatically lowered interest rates and succeeded in triggering another 5-6 years of credit/debt bubble expansion along the lines described above.

What happens if point 4) happens and interest rates are already pretty much at 0% you ask? You reach our present situation.

What we see now is that (almost) everything that happened on the way up goes into reverse.

A) Without new credit expansion to support rising asset prices, asset prices begin to fall
B) Once people default on loans that are no longer fully collateralized due to falling asset prices, banks start to take losses.
C) Once speculators realize the game is up, they start trying to pull their money out of their speculative investments, aggravating the decline.
D) The bank losses quickly wipe out the capital of over-leveraged financial institutions making it impossible for them to lend money, further accelerating the destruction of the credit/debt bubble
E) Even if you give the banks money to lend, they won’t do it, because without the promise of the ever expanding credit/debt bubble, nobody is credit-worthy since they either have too much debt or they just defaulted on their debt.
F) Even if the banks want to lend, few people want to borrow because they are afraid of deflation making their debts harder to pay because…
G) Deflation means that real interest rates are high even though nominal interest rates are 0 because…
H) The one thing that isn’t shrinking is the size of the debts owing since your mortgage doesn’t shrink just because you got a 10% pay cut. So the deflation makes it impossible even for those people who originally borrowed at reasonable levels to repay their now massive and growing debts. This further aggravates the downward spiral.
I) As people default on their debts, the balance between rich and poor is restored as rich creditors lose money to poor debtors. Falling asset prices have the same effect.
J) Only when enough of the debt has been defaulted upon so that the ratio of debt/credit money in the economy to actual debt-free currency is restored to a low enough value and the debtors are no longer being crushed under the weight of their debts can people once again start lending and rebuilding the economy.

So 2 questions arise:

1)How do we get out of the current mess?
2)How do we avoid getting into this mess in the future?


1)How do we get out of the current mess?

We can’t get out by repaying the loans since repayment of the loans will just make poor debtors even poorer. Also, deflation will make repayment extremely difficult.

One way out is through inflation. However, it is unclear that central banks have the will to print the truly massive amounts of money that would be needed to cause inflation in the midst of deflation of a credit/debt bubble. History suggests they don’t as far as I know (although I’m open to corrections, aside from the Weimar Republic which I know about).

Also, using inflation is a bit like stopping a free fall by using rocket thrusters. It will work but you have to be extremely careful not to apply so much force that you fly off into space (hyperinflation).

The best way out, to my mind, is to wipe out the debts in as orderly a fashion as possible. I don’t say this lightly since I have no debts and I would find it galling to see all the people who irresponsibly piled up debts and enjoyed themselves with this spending spree now getting bailed out because collectively all the debtors were too big to fail but I’ll settle for getting screwed over to having a depression which won’t be any barrel of laughs either. Society’s preferred method for discharging debt is via bankruptcy and I believe the government should be trying to encourage a widespread outbreak of bankruptcy to reduce the overall debt levels.

In a nutshell we need to rebalance the amount of currency (money not created as debt) with the amount of debt/credit. We can attack this from two sides, both by printing more currency and by encouraging/allowing defaults on the debt. Once this balance is restored things can start growing again, but we are so far, far from being in balance that it is inevitably going to be painful getting from here to there.

Measures to try and preserve the existing ratio (e.g. forcing banks to lend at gunpoint, negative real interest rates that punish savers and reward borrowers) will either cause another run-up in the bubble leading to even greater pain next time the bubble pops (as happened from 2001-2007, but I suspect we are too far gone to have happen again), or freeze things in place allowing us to limp along Japan style for year after year without ever really getting out of stagnation.

Having government take on debts as private sector debt collapses will help, but only in the sense that raising the flaps helps you land a plane that has run out of gas. It acts as a brake on the collapse in credit money but can only slow it down since moving risk from one holder to another doesn't really change the underlying dynamics.

2)How do we avoid getting into this mess in the future?

If the great depression only scared us straight for a couple of generations (see the post by Mish linked above), it seems unlikely that we can make any permanent fixes here either. Still, I have a few suggestions:

1) 100% reserve requirements for financial institutions – Preventing lenders and central bankers from working together to supply an infinite amount of credit at zero cost will mean that in future, if people want to borrow, they have to find someone willing to lend their actual money, not just give them made up money. In this scenario, although the central bank may want to lower interest rates, doing so will be constrained by the limited supply of people willing to lend out their money at these low interest rates. 100% reserve requirements won’t prevent credit bubbles, because they won’t change human nature (the enduring belief that it’s different this time, it’s different here, the fundamentals don’t matter, etc.), but it will remove one enabling element that supports the growth of credit bubbles, and that’s a start.

2) Fixed and conservative margin requirements for asset purchases (say, a minimum 25% down payment for a residential mortgage, 50% for stocks and maybe a few other asset classes, and 100% for everything else, including cars and sofas). This will help prevent the self-reinforcing cycle of rising asset prices and expanded credit from getting out of hand.

This list from Karl Denninger wouldn’t be a bad way to start either:

I picked out a few of his suggestions that I liked the best, but they almost all make sense in the American context (the Canadian banking picture is a little different than the U.S. one, in particular we have the appropriate history and culture to manage a more concentrated banking sector than the Americans do).

3. Repeal the "Bankruptcy Reform" law. Consumers must have the same right to go bankrupt and discharge debts that corporations have. Banks and others who grant loans must have this Sword of Damocles over their head - you make a bad loan and the borrower can file Chapter 7 and stick you with it, without exception. This will immediately collapse the outrageously overpriced bubbles that remain and are credit-driven, including post-secondary education.

[Ed: We didn't have this 'reform' in Canada, but in general loosening our bankruptcy laws to match the more debtor friendly American laws would help]

4. Remove the obscure little change made in the EESA/TARP legislation that allows Bernanke to set the reserve ratio to ZERO for banks, and set it statutorily to 8%. Enhance the law by declaring that ALL funds taken in by a bank irrespective of their source are subject to the 8% reserve requirement (thereby removing the "sweeps" exemption that started this mess.) This will force leverage in the regulated banking system to no more than approximately 12:1.

[Canada has no official reserve rates. Leverage is constrained instead by regulatory capital requirements but the principle remains the same, constrain financial industry leverage to a set ratio - and *enforce* this limit.

5. Set the lawful leverage limit to 12:1 for all investment banks and other entities including hedge funds. Any firm that wishes to be domiciled or operate in the United States must comply. Period. I know what the counter-argument is - "they'll go somewhere else." Fine! Go blow up some other nation's economy. We've had enough of it.

6. Said 12:1 leverage limits must apply to all assets. Yes, even US Treasuries. If you hold it at most (for the safest assets) you can gear it at 12:1. Period.

7. Ban all off-balance-sheet vehicles; no exceptions of any sort. If you have control of it or are responsible for it in any form or fashion you must consolidate it on your balance sheet. "Shell corporations" set up to evade this requirement that have no capital or assets of their own are deemed a fraudulent shell company. Close the SIV loopholes.

9. Bar the trading of derivatives contracts by commercial banks except where those contracts are backed by or insure a hard asset (e.g. a CDS on an actual bond or mortgage) and they are exchange-traded with a central clearing counterparty and thus guaranteed "good". If some Hedge Fund wishes to write or hold naked CDS and immolate themselves that's fine, but they cannot blow regulated financial firms (including insurance companies) to pieces nor can they distort share and debt-pricing mechanisms in the public, regulated markets.

11. All derivatives traded by regulated financial entities must be cleared and traded through a public exchange with a central counterparty, nightly margin supervision and published bid/ask/open interest.

12. Extend bank fraud statutes to explicitly cover actions taken by The Fed or any banking or financial institution in violation of statutory limits and name the members of the board of any such institution as personally responsible for violations. This stops the game-playing where institutions feel free to be "fast and loose" because all they will get is a slap on the wrist by FINRA or the SEC. With these offenses being federal criminal offenses the calculus changes immediately on what someone will and will not attempt.

14. Stop trying to prop up asset (especially house!) prices. Instead, preach the truth - affordable housing means no more than 28% of your income goes toward all housing expenses, you should put 20% down, and you should not take anything more aggressive than a 30 year fixed-rate loan. For many areas this means median home prices must still contract. A house is shelter, not a speculative vehicle.

Elephant in the Room

The head of the Bank of Canada, Mark Carney, gave a speech on the economy today in the House of Commons. The word 'debt' did not appear in his speech, although he did note that current Bank policy is to pay people to borrow money and take money from those who save.

A Long Time Coming

I was reading something recently that did a good job describing the sources of our current economic troubles. Here are a few quotes I pulled out...

"Just as our structures and elites prefer corporate manipulation to real production, so financial manipulation comes more naturally to them than the creation of new capital"

"We run virtually uncontrolled money markets within our own borders. We permit highly leveraged buyouts. We allow takeovers to be financed by the privately initiated printing of money against the value of the target company's assets. We allow the uncontrolled printing of money through such devices as credit cards."

"Consciously or unconsciously, we began to lift restrictions and to lower standards throughout the financial sector, thus freeing the profound forces of inflation. Of course, no one was permitted to play directly with the traditional governmental inflationary tool - money supply. This and the area of wage and price increases were roped off, so to speak, and kept under obsessive public scrutiny ...
Meanwhile, every other potential inflationary area was gradually opened up to marketplace manipulation. General economic activity was drawn towards the financial sector by this explosion in ever-less regulated activities. Inventiveness concentrated itself on the creation of new, immeasurable financial abstractions - abstractions built upon abstractions - forms and levels of leverage which made the standards of 1929 seem tame by comparison"

"In this context, the traditional definitions of bank leverage no longer mean very much. ... the American merchant bank Lehman Brothers had a capital base of $270 million. It had a daily exposure of $10 billion."

"The whole process was fed by minor finance companies, which under stricter regulations would be considered marginal, if not criminal. With deregulation they became banks. And the large deposit banks, seeing the enormous paper profits made by these little speculators, leaped down into the gutter to play the same game. The overall picture is what Keynes would have called a Casino society."

"Contemporary monetarism, despite its narrow obsession with money supply and classic inflation, has produced the greatest debt levels of modern history, accompanied by onerous or impossible burdens of interest. Odder still, while the monetarists remain obsessed with the state's indebtedness, they are indifferent to unprecedented corporate and personal debt levels."

"One indication of how far things have gone is the desire of business to see government intervene each time the situation gets out of hand. The willingness of governments to do so, despite a supposed devotion to market forces, shows that they realize how dangerous the current system is. The irony of deregulation is that the more freedom business is given, the more dependent it becomes upon government as the saviour of last resort.
Financial marketplaces have never been capable of self-regulation except through catastrophe. One of our accomplishments was to regulate most of these explosions out of existence. Financial deregulation has reintroduced them."

"The current situation, in which government stands as the saviours of last resort - having abandoned many of their intermediate powers of guidance - actually breed irresponsibility. And while government intervention late in the day prevents general calamities, it also maintains the fiction that the system is healthy."

All the above quotes are from chapter 17, 'The Miracle of the Loaves' in John Ralston Saul's 'Voltaire's Bastards' - written in 1992.

But yeah, no doubt our current problems are all due to 'excess' saving by peasants in China...

I don't know about you, but I find it pretty damn depressing to realize how clearly Saul laid it all out, almost two decades ago, and here we are as clueless as ever.

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Re-reading that chapter by Saul (prompted by my frustrations with the narrow technocratic mindset exhibited by all the powers that be in the face of the current situation) reminded me also that it was also the source for my recollection of Solon's reforms in clearing away the debt burden that was plaguing Athens prior to his rule.

2009, You Should Have Taken the Blue Pill

Year end is always a good time, I figure, to step back and look at the bigger picture and see how things are going. To begin with, I want to review something I've covered before, but is worth repeating at least once more: the exponential function. No don't skip ahead, this is not complicated, and it's important.

If something grows exponentially, all that really means is that the bigger it is, the faster it grows. You can understand how this is a process that could accelerate over time, and eventually get quite out of hand. Get bigger, grow faster, which makes you bigger, which makes you grow faster, which makes you bigger, and so on.

The thing about exponential growth patterns is that they can have a long period of what looks like stability, but that the growth cycle gets out of hand and there is a sudden unsustainable burst followed by, in most cases, a crash.

This initial long period of relative stability can create the illusion of sustainability. The example that made this clearest to me is the example of a water lily which doubles in size every day. Eventually, the lily will occupy the whole pond and smother it, killing all other life in the pond. But how much of the pond will the lily occupy just one day before the whole pond is covered? Only half. And the day before, only a quarter. The end will come suddenly, after a long period where it seemed everything would be all right.

Exponential growth can not be sustained and the only way out is to lower the rate of growth somehow.

Consider the following chart of global population over the last few hundred years.



Image from here

You can see the pattern of exponential growth, the line getting ever steeper and steeper as growth feeds size which feeds growth and so on. And keep in mind that on top of this growth in population, our economy is premised on exponential growth in wealth per person. So we have an exponential growth piled on top of an exponential growth.

Clearly, a continuation of this level of growth was not possible, and thankfully, reductions in global birth rates (especially in China) have ended this exponential growth pattern in enough of the world so that global population is levelling out and may even decline at some point in the next century.


However, global population has so far been able to rise to about 7 billion and counting, without being brought down by famine, pestilence or some other limiting factor. In order to understand if we can maintain this record, we need to understand what has allowed us to continue feeding (almost) everybody and advancing civilization, in the face of such huge numbers of people on a finite planet.

Some would say it is simply the expansion and application of human ingenuity, an infinite resource, and that we therefore have nothing to worry about, and could handle a global population of 20 billion or 50 billion or 100 billion.

Although I agree that human ingenuity is important, I offer two caveats (with a third implicit caveat being that there probably should be more caveats, I just haven't thought of them).

1) As much as ingenuity is important, if that ingenuity can’t come up with a replacement energy source for oil we have big problems. With enough energy you can solve almost any problem. Short on fresh water? Pipe it over mountain ranges, extract it from the oceans, build massive dams and reservoirs and irrigation systems. Short on food? Use natural gas to manufacture fertilizer, scour the earth for potash, irrigate the deserts. You get the picture. But without a big surplus of cheap energy, none of these methods for expanding nature's bounty are all that feasible.

Even all the efforts to reduce our dependence on oil (metal wind turbines shipped halfway around the world, massive concrete dams with 1000's of miles of transmission towers, etc.) depend on significant amount of cheap energy to build and maintain.

Will we inevitably find a better replacement for oil as supplies run low? Can we maintain a global population this large and the current Canadian lifestyle with dwindling supplies of easily accessed oil and gas? These are questions we don't have an answer for yet.

2) At a certain point, ingenuity is overwhelmed. Even the most optimistic cornucopian would admit that an earth which has one person per square foot of land wouldn't be a pleasant or sustainable place to live. The question is, is the current 8 billion and counting already past that point? Lately the global problems suggested we've overshot our carrying capacity seem to be piling up faster than we can solve them and few think that the world could sustain everybody living the way people in Canada currently do.

We’ve seen the problems from acid rain, we've had (and have ) the depletion of ozone in the atmosphere. The steady collapse of fisheries around the globe as we move further and further down the food chain. Dead zones in the sea due to agricultural runoff. Climate change(pdf) due to greenhouse gas emission. Deforestation. Loss of biodiversity. Acidification of the oceans. Etc.

Of course we will take action to try and mitigate these problems but each one will be a battle that will absorb resources, and many of them can only be partially mitigated, some hardly at all, and as long as we try to maintain global population and consumption at ever increasing levels, or even maintaining the current levels, these problems are just going to come harder and faster. At what point are we spending most of our resources just mitigating the negative effects of our existence, and few trying to improve it. At what point does even devoting all of our resources just trying to preserve the status quo prove inadequate? Are we past that point already? Again questions we don’t know the answer to.


So, 2009. The environmental problems will continue to harry us, but it’s still early days on that front (I hope!). After helping to blow up the global economy in 2008, oil prices and commodity prices are a big question mark for 2009. Absent some of that old human ingenuity, we currently seem stuck alternating between growth that drives up commodity prices because we don’t know how to get them cheaply any more or high commodity prices that kill growth because the inputs to everything get too expensive. I suspect that they will generally stay low for most of the year as the economic news gets grimmer and grimmer.

And on the financial front, while I predicted that financial problems would be the primary unpleasantness in 2008, even a pessimist like me underestimated just how bad things would be for the financial world last year. It will be more of the same in 2009, I suspect, namely trillions of dollars in government money given to banks to try and preserve the unpreservable status quo of a high leverage high debt economy.

There is no shortage of question marks surrounding the fate of the financial world in 2009, with seemingly plenty of smart people on both sides of every one. One of the questions I see asked most often is whether we will have deflation or inflation (likely deflation in 2009, followed by inflation at some point in the future). Another is will the U.S. dollar serve as a refuge as part of a flight to safety, or will people lose faith in the future value of U.S. dollars leading to a sudden, rapid plunge in the value of the U.S. dollar (beats me, either seems very possible - but sooner or later the bubble in U.S. debt will pop).

As for Canada, in 2008, the commodity boom that marked the end of the last debt fuelled boom, combined with the delayed collapse of our housing markets relative to the rest of the world helped cushion Canada from the economic troubles affecting the rest of the world. Now its 2009 and our housing market is falling and commodity prices are fallen and the last bits of Canadian smugness that suggest that, even if its not different this time, its different here will be wiped away by year's end.

Still in a world of 8 plus billion people, where resources of all kinds are likely to be in short supply, a place like Canada with a (relatively) sound financial system, a (relatively) stable political system, a placid population and a high ratio of useful stuff to people should be able to do better than most places over the medium haul. Sadly, doing better than most places in 2009 is likely to be a very low bar.

A friend who's been through a few recessions in his day suggested in a recent email that this might be a good time to 'keep your job, save some money for a pinch and ride out the impending hard times.'

Sounds like good advice to me.

The Economy in 2009, Becuase We Don't Get Nine Lives, Nor Do We Always Land on Our Feet

A summary for the entire dogalogue of problems we are likely to see this year:

* The dogalyst of our financial problems: Too much debt backed by too little actual currency.
* A more indirect dogalyst of our troubles: Inability of our society to enforce the dogegorical imperative.
* Best description for the economy in 2009: A dogastrophe
* Next best description: Dogaclysmic
* Likely state of investors by end of 2009: dogatonic
* Sound made by any non-dogatonic investors: dogerwauling

Asset Sales

One of the many bad ideas in the recent fiscal update proposed by Jim Flaherty and the Conservatives, that I've been meaning to get back to was the idea of asset sales. To appreciate why I consider asset sales a bad idea at this time, consider the following:

Let's say that you think the current economic fears are overblown and that things will be back to good times and growth soon enough. If that is what you believe, then you might suggest, as Stephen Harper did during the election campaign, that this was a good time to buy assets while prices are low. But if Harper really believed it was a good time to buy assets in October, surely it is an even better time to buy them now that asset prices have fallen so much further since he made his initial comments.

But naturally, if buying assets is such a good idea, then surely selling them is a bad idea, no?

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Fair enough, let's say that Harper and Flaherty have admitted they were wrong and that they now think the financial crisis really is serious. Well, in that case, with interest rates already approaching zero, if you think a serious financial crisis is coming, then you must be worried about deflation and a possible liquidity trap, wherein the economy remains depressed because there's just not enough money circulating to get it going again.

Given this scenario, it is imperative that government introduce a stimulus package to increase the amount of money circulating in the economy. And indeed, in the countries where people believe this is what is happening, governments are doing just that. Of course, one the primary ways that governments can stimulate the economy is by buying assets. For example, see this story of the U.S. purchasing $600 billion in mortgage backed assets.

So the consensus is that, if the crisis is serious, then government should be out there buying assets, which in turn suggests that the last thing government should be doing at this time is selling assets.

Finally, consider Flaherty's time as part of the failed Mike Harris government, when he tried to hide a deficit by selling assets, including the misguided sale of unlimited tolling rights on a freeway across the busiest corridor in Canada for 99 years, a mistake that will be with the people of Ontario long after you and I are both dead. Is this the person we want selling our assets, given his record?

So, while various establishment pundits spent the last couple of weeks hyperventilating about the damage to our economy that would surely be done to our economy if the NDP were allowed to have a few cabinet seats for a while (without really explaining what damage might actually occur), few have commented on the near certain damage that would occur simply by letting the Conservatives carry out their proposed fiscal plan. I mean, if Flaherty could only get 50% of the estimated value of the 407 when he sold it in 1999 during an economic boom, imagine how much we will get shortchanged if we let him sell off a bunch of assets during a global crash.

No Wait, Please Do Quit

Speaking of bad financial advice, since Stephen Harper's suggestion on, if I recall correctly, October 8, that it was a good time to buy stocks, the TSX has gone from 10,055 to 8,117 - a drop of almost 20% - ouch! Normally, I'd say don't quit your day job, but in this case....


Meanwhile, I keep writing posts about our current media and political and economic problems, but as I dig around for links to stories, I keep seeing reminders that there are other stocks that are more important, and in even more trouble.