Monthly Archives: August 2014

Strictly Fishwrap

fish-and-chips-in-newspaperSomething fishy is going on at The Economist. The rest of the magazine still features economics, but the United States section increasingly reads like talking points from the White House. Policies for which they ridicule President Hollande in the Europe section magically make sense in America. We suspect that “Lexington” is actually James Carville.

Pearson has billions of dollars in long-term contracts with education departments in a number of states and municipalities

Last week, the magazine featured a faulty analysis of economic growth having something to do with which president is in office. To be useful, such an analysis must identify whether the economy is responding to a policy at all, and then whether (some) president is responsible for the policy.

Even if you wanted to draw simple minded generalizations about presidents and the economy – Jeremiah doesn’t – you would have to add lag time for the policies to take effect.

The same issue featured an equally idiotic assertion that our economy must be good because the stock market is up. Seriously? In a magazine called The Economist? We are not even going to dignify that one with a rebuttal.

Something fishy is definitely going on. We suspect it has something to do with Pearson’s lucrative no-bid deal to provide Common Core materials. We will continue to read the finance and economics sections, but the United States? Forget about it. You might as well read Huffington Post.


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Blame Canada

We did a double take when we read about Burger King’s tax inversion to Canada. Canada? Burger King is majority owned by Brazilian private equity, so they’re not exactly “corporate deserters,” to use the president’s phrase. They will also enjoy revenue synergy with Tim Horton. Plenty of financial analysis is on FT, as here. So, when did Canada become a tax haven?

Jeremiah is always coaching you to find the truth behind the news, and this is a great example. America has the world’s highest corporate tax rate, at 35%. If you know this, you also know the headline figure is contested. Many pundits say that, once you back out various credits and deductions, the rate is closer to 23%. If this were true, companies would not be leaving the country. See chart from Bloomberg, below.


The Brazilian capitalists will have done their own tax planning. KPMG reckons that the total tax rate in America is 40%, versus 26% in Canada. To be fair, the tax apologists may be right about certain companies which are able to enjoy the gamut of preferential tax breaks. GE famously paid no tax at all in 2010.

Over the last decade, G.E. has spent tens of millions of dollars to push for changes in tax law, from more generous depreciation schedules on jet engines to “green energy” credits for its wind turbines.

The point is that if you “follow the money,” you can determine which pundits are liars, and which corporations have Washington skills.


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Keynesian Blather

YellenPolitical bloggers were not kind to Chairman Yellen’s keynote speech at Jackson Hole. David Stockman called it “Keynesian blather.” Someone else called it an insult to America’s intelligence.

The Fed Chairman makes an easy target, especially if you don’t understand the technical terms. After all, who cares if you’re unemployed for cyclical reasons or structural ones?

Jeremiah prefers to assume people are generally competent for their jobs. We downloaded the speech here. Remember that this is a keynote speech, kicking off a symposium on the labor market. So, when Yellen refers to the unsolved mysteries of employment, that doesn’t mean she’s confused – she is introducing the topics.

Jeremiah was pleased to see that Yellen does not take the headline unemployment figure at face value. She acknowledged the growth in part time employment and the drop in labor force participation. Here are a few of the topics:

  • Is labor force participation off because people have retired, or are they coming back? If people come back en masse, that will drive wages down.
  • Is there “pent up wage deflation?” If so, wages may jump once it has run its course.
  • Have the midlevel jobs gone, to Asia and automation, never to return?

You can see that these are all relevant to ordinary Americans, and relevant to Fed policy. The Fed needs to know whether there is still slack in the labor market, or if our current wretched economy is the new normal. The dual mandate requires the Fed to keep credit conditions easy as long as there is any chance it will help someone find work. This brings us to the Keynesian part.

Keynes reckoned that inflation could reduce unemployment, and this is why the Fed has a dual mandate instead of simply maintaining price stability. In fact, Keynes’ definition of full employment is the level at which inflation can’t help one more guy find work.

Men are involuntarily unemployed if, in the event of a small rise in [inflation], both the aggregate supply of labor willing to work for the current nominal wage and the aggregate demand for it at that wage would be greater than the existing volume of employment.

Lower wages will put more people to work – basic supply and demand – and the role of inflation is to give everyone a pay cut, by reducing the value of their nominal wage. This is a pretty incompetent way to create jobs, and it’s not even a good definition.

There is no magic formula for full employment, any more than there is a magic diet pill. Keynes didn’t have it and, when the symposium is over, Janet Yellen won’t have it either.

Labor is employed when entrepreneurs have profitable projects, capital to invest, and a stable political environment. As public policy, this means the rule of law and – a predictable tax and regulatory regime. Various surveys, including the Fed’s own Beige Book, have indicated this is what’s holding back the job market.

Keynes wrote a system of equilibrium equations, like the ideal gas law. In such a system, aggregate demand for goods cannot be more or less important, as a policy objective, than the aggregate demand for labor.

When companies are starved for workers, they compete by offering higher wages. You guessed it – full employment causes inflation.

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Taxation without Representation

Prior to the Revenue Act of 1913, the federal government was supported pro rata by the states. States are apportioned seats in the House of Representatives according to population, and this was also their share of the federal budget. Congress could levy direct taxes only in proportion to population. It’s easy to see the wisdom in this approach, plus it didn’t require a huge federal agency.

Tax by StateRepresentation was linked to cost sharing. Without this link, there would be a risk that populous states could pass laws shifting the federal tax burden to small, rich ones.

We wanted to see what the House would look like if the original rule were still in effect, so we downloaded the IRS data book and reallocated the seats according to each state’s tax payments.

Federal tax collection, all types, net of refunds, was roughly $2 trillion for 2012. The table shows the current allocation of 435 seats, by population, and our reallocation by net tax.

The third column shows the number of seats by which each state is over (or under) represented relative to the old rule. Another way to think of under-representation is to say that the state is overtaxed relative to its voting power.

Sure enough, richer (though not necessarily smaller) states are underrepresented and poorer ones are overrepresented. Could this result in a legislative bias? Almost certainly.

The top twenty-three states in this list enjoy a voting majority in the House. They have an incentive always to vote for higher income taxes – because the burden will fall disproportionately on other states.

See also: Easy Constitution

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Cash Cows and Scapegoats

Now that Bank of America has settled with DOJ for an unprecedented $16 billion, it is time to reflect on the pervasive corruption that led to the housing bubble. The settlement is for sins committed by Countrywide Financial and Merril Lynch, which BofA bought after the crash, under pressure from the government.

The majority of the mortgage securities at the heart of the Justice investigation are the product of Countrywide and Merrill Lynch.

BofA now tops the list of settlements sans verdicts or, as The Economist calls them, “an extortion racket.”  If you are one of those who blame the banks for the housing bubble, you might wonder why the DOJ never insists on a trial.

Bank Fines

American housing policy was insane to begin with, and still is. Mortgage interest is tax deductible, encouraging home buyers to overextend themselves. On the other side of the transaction, lenders are backed up by Fannie Mae, encouraging them to overextend as well. This means that our mortgage market is, at all times, bigger and riskier than it would be without policy intervention.

Starting in the Clinton administration, we added 1) the Community Reinvestment Act and 2) regulatory pressure for lending to underprivileged buyers, plus 3) the repeal of Glass Steagall, and 4) a suppressed Fed funds rate. These policies caused mortgage risk to be further underpriced, and directly resulted in the housing bubble.

Anyone with any knowledge of economics saw it coming. Offhand, we can recall Taleb, Schiller, Rajan, and that guy from Goldman Sachs. Look up “predicted the housing crisis,” and investigate some of the claims. Here is an article from City Journal, warning about the impending crisis – in 2000. All the participants knew exactly what would happen, and how they would profit from it.

The cash cow was the government backed mortgage agency, Fannie Mae. When the housing bubble burst, the taxpayers were left holding most of the bad debt – and the guy running Fannie Mae got a fat bonus.

Johnson spotted a golden opportunity to use a popular cause—increasing home ownership—as a means of building Fannie’s power in Washington, and also feather his and his fellow executives’ nests along the way.

Fannie Mae CEO James Johnson had a lead role in the policies that created the bubble. He organized various advocacy groups to push for the failed policies, and bribed Congress with campaign donations. If you really want to raise your blood pressure, read the New York Times account of this scam – or the book, Reckless Endangerment.

Fannie Mae co-opted relevant activist groups, handing out money to Acorn, the Congressional Black Caucus, the Congressional Hispanic Caucus and other groups that it might need on its side.

There was something in it for everyone. The politicians would look good because there would be a temporary boom, led by housing activity. Underprivileged buyers would finally get homes. The boom might run for years, and the bust would be on someone else’s watch. Meantime, everybody would get rich. The bankers just needed to get the bad loans off their books before the music stopped.

Securitizing mortgage loans was not new. Banks had been routinely packaging loans and reselling them, to Fannie and to each other. The innovation was bundling loans of varying risk classes into inscrutable “collateralized debt obligations.” These were inscrutable in the sense that, when the bubble popped, no one knew who was holding the bad mortgages. Banks stopped lending to each other, and the financial system locked up.

This brings us to the various interventions of Sec. Paulsen and Chairman Bernanke, and brings our story back to Bank of America. Paulsen prevailed upon BofA to buy the assets of Countrywide and Merrill Lynch. The CEO, Ken Lewis, knew this was a bad deal, but gave in to pressure from Paulsen. They made a handshake deal that BofA would be protected from liability.

Wall Street was crumbling and BofA faced intense government pressure to buy Merrill to keep the crisis from spreading.

Countrywide had escaped scrutiny by giving generous mortgage deals to members of Congress. One beneficiary was Sen. Chris Dodd. That’s right – he of the Dodd-Frank “Wall Street Reform Act.” Rep. Barney Frank (you have to ask) was in a relationship with a Fannie Mae employee.

Countrywide … bought influence on Capitol Hill by issuing hundreds of sweetheart loans for members of Congress, their staffs and other government employees

So, the Clinton administration made political hay by inflating a housing bubble, the Bush administration ordered BofA to take a share of the fallout, and now the Obama administration turns around and prosecutes them for it. Along the way, lots of people got rich. James Johnson’s haul is estimated at $100 million. This revolving corruption and scapegoating is so flagrant it’s comical, and the really funny part is –it’s called Bank of America.

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Thank You, Mr. Lee

Saturday was Singapore’s national holiday, and we reread Michael Barr’s wonderful paper on Lee Kuan Yew. This is a thoughtful, well researched inquiry into the question of Mr. Lee’s professed socialism. Looking at Lee’s policies, and modern Singapore, you would never guess that the old man was a socialist.


The author makes a strong effort to solve this riddle but, at bottom, it is just semantics. We have warned you before about reasoning from labels. Barr starts with the western definition of socialism, and Jeremiah’s essay on socialism uses some of the same examples.

Rather than seeing Lee’s socialism as a gutted version of British socialism, it should perhaps be viewed as a less ruthless version of Chinese communism.

Academic socialists are unhappy with Lee, because they are working from a textbook and he was working with a real economy.   Lee has said, for example, that a welfare state is only possible where the economy is already affluent, as in the West. For tiny Singapore, capital formation was a priority.

The party had called for a social insurance scheme, like our Social Security, but Lee needed the funds for investment. Today, Social Security is bankrupt, while Singapore’s investment fund is one of the world’s strongest. Investment in housing meant homes for workers, plus the economic benefits of home building.

People are not interested in “isms”: Capitalism, Socialism, Fascism, or Communism. They are only interested in seeing that their ordinary lives improve.

Lee believes in state control, but not a welfare state. His model looks a lot like China’s, but he was ahead of Deng and Xi in reform and opening up. Great leaders know they will be judged by results, not dogma – and Lee’s results speak for themselves.

The welfare states of the West are now in obvious decline, just as Lee foretold. Carping about who is a proper socialist is just another example of western arrogance. Socialists in England, France, and America should use this occasion to reconsider their own ideas.

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Mind the Wealth Gap

Bubble MachineStandard & Poor’s, God bless ‘em, have figured out that America’s rising wealth gap is responsible for our boom and bust economy. Obviously, blaming anything on a “rising wealth gap” will have a certain political appeal, but – this is to mistake cause and effect.

What Raghuram Rajan and (separately) Larry Summers have said is that the advanced economies ran out of gas in the late twentieth century, leaving us not only in secular stagnation, but with unsustainable social commitments. Since Chairman Greenspan, Fed policy has been to “jump start” the economy with cheap funds, making available – on credit – a lifestyle we can no longer afford.

Those to whom the system brings windfalls … become ‘profiteers’, who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat.

So, we had an economic boom and the tech bubble in the 1990s, and then a bust. Next, federal policy joined cheap Fed funds to produce the housing bubble, and – now we are on the third bubble in recent memory.

The “rising wealth gap” is responsible for this? Quite the contrary. Our monetary policy is a trillion dollar bubble machine. Whoever is nearest the spigot is going to get rich fast even if – as Keynes observed – he’s not trying. There’s your rising wealth gap. It is an effect, not the cause, of our boom and bust economy.


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