Easy Opinions: October 2008

Oct 31, 2008

Otto the octopus wreaks havoc

10/31/08 - Telegraph UK --> Source

What if you are the most intelligent creature in the ~~tank~~ room?

Don't Just Do Something. Stand There

10/31/08 - WSJ.com by Russell Roberts --> Source

The current financial crisis is similar to the government panic of 1932. The economy was weakening, and Herbert Hoover was doing everything and anything to change the situation, with disastrous results. What should the government do today?

Don't want Higher Taxes? Barack Obama thinks you're selfish

10/31/08 at JimTreacher.com --> Source

Oct 30, 2008

Government Action Delays Recovery

Credit Panic: Stages of Grief
10/27/08 - WSJ.com Opinion

The power of government delays recovery. Enacting one arbitrary policy after another, moving this way and that, "solving" problems by directives, keeps private investment and productivity from making things better.

[edited] Uncertainty about Washington will slow the recovery.
Economist Robert Higgs says that economic recovery from the Great Depression was postponed for years by a "regime of uncertainty." He blames the uncertainties caused by extreme government economic intervention in the 1930s, by laws, regulations, and confiscatory tax rates. He writes that businesspeople were uncertain about government, afraid that their property rights, capital, and derived income would be decreased by government action.
Amity Shlaes wrote "The Forgotten Man", the recent best seller about the causes of the Great Depression. She agrees, and says our current economy is in a "recession of uncertainty." Markets will not be confident about the rules of the road until Washington accepts responsibility for politicizing banking over the past several years. [An unrepentant, ignorant Washington will probably repeat its mistakes and make new ones.]

Government intervention caused the current financial disaster (see We Guarantee It). Government intervention will delay any recovery. Don't trust your economic fate to politicians. Their motto is "If we don't know what to do, let's all agree to do something big. With other people's money."

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Don't Just Do Something. Stand There.
10/31/09 - WSJ.com by Russell Roberts

[edited] A recession is coming (or has already arrived) no matter what happens in Washington. The attempt to forestall it may make it worse and turn it into another Great Depression.
Just as in the 1930s, there is no evidence that the policy makers have any understanding of what they are doing. They need to make way for the natural forces of repair. They need to let housing prices fall, let the imprudent firms go bankrupt, and let the healthy firms thrive and buy the sick firms as bargains.
Politicians have destroyed the rules of the game by acting without rhyme or reason. There is no reason to invest, to take risks, to be prudent, or to look for buyers if your firm is failing. Everything is up in the air. So, the only prudent policy is to wait and see what the government will do next. The frenetic efforts of FDR had the same impact: Net investment was negative through much of the 1930s.
The next administration is unlikely to do any better. Mr. Bernanke is chairman of the Federal Reserve. He is perhaps the greatest living authority on the Great Depression, yet he has failed to stem the damage. Messrs. Paulson and Bernanke are confronted with a sick patient. They have antibiotics. They have a scalpel. I see no evidence from the last seven months that they understand the underlying cause of the illness, or how to cure it.
Worst of all are the political incentives that are unleashed when Washington promises to spend a trillion dollars and more. ($1 trillion is $1 million million dollars.) No one can spend such money wisely. The information about who needs to be bailed out and who needs to fail is too complicated. Inevitably, such decisions will be more about politics than economics.

In my view, the government does not know what to do. No individual does, and no group does. No group can have a meeting and decide what is best. The government should only set simple, fair rules and get out of the way.

The productivity of an economy is built out of a complex fabric of millions of judgments, decisions, and risks. The government created a huge distortion and loss by guaranteeing home loans that could not be repaid, and by lending its authority to credit rating agencies that went along with approving strange mortgage bonds as AAA. There are now unexpected consequences that have gone far beyond the absolute loss.

The government has to stop using the money and credit of the population. We should let investors throw out the managements that were stupid and greedy, and support or create managements that are cautious and respectful of real values, untrusting of government labels and political decrees.

McCain's Health Proposal is Misunderstood

The $5,000 Tax Credit Pays the Extra Tax

People have written:

I hate McCain's health plan. My family coverage provided by my employer is worth $13,000 per year, and McCain wants to fool me by giving me a tax credit of only $5,000 to go out and replace my insurance. That is an idiotic deal.

The reality:

McCain's plan does not require or encourage employers to drop their health coverage for workers. It offers a $5,000 refundable tax credit for families ($2,500 for individuals), to encourage the development of privately offered, competitive, health insurance. This would also encourage less expensive company insurance plans.

The $5,000 refundable tax credit more than covers the tax on your $13,000 company benefit. The only change for you is that you will see $13,000 more income on your W2, causing additional tax, offset by the $5,000 tax credit. Your employer has no stake in this. It doesn't change your employer's decision to offer health insurance.

The extra tax on $13,000 is $3,250 (25% rate) for a family earning $44,000. The tax is less for lower incomes. McCain's plan would provide $1,750 more than the extra tax.

Your biggest risk under any corporate health insurance is losing your job and not finding coverage. By making health insurance tax-neutral, private coverage will be encouraged to compete at lower costs.

Even better, this could be the first step toward separating health insurance from employment. Then, the coverage would belong to you, and wouldn't terminate because of changing jobs. Employers could offer you a choice: sign up for the company insurance, or take an additional $13,000 in salary. It would no longer matter to you or the employer as far as taxes are concerned. You could use the extra money to buy or continue your own health insurance, regardless of employer.

McCains's proposal is mostly tax neutral. Currently, your employer provided health insurance is not taxable to you. McCain's proposal makes it taxable to you, but gives you a credit to cover more than that tax, unless the medical plan is very expensive and you are in a high tax bracket.

Frankly, I don't support the refundable part of this. McCain actually wants to give out money if $5,000 is greater than the extra tax, which is the usual situation.

Oct 29, 2008

Credit Rating Agencies Misled Investors

10/29/08 - Banks bought AAA rated (rock-solid) mortgage securities. The ratings were given by government-approved agencies. The actual risk was possibly 10 times higher.

A part of We Guarantee It

What Caused The Mortgage Crisis

10/29/08 - Investors Business Daily By M. Jay Wells --> Source

An outline review of US economic history and the mortgage crisis.

[edited] For Obama, increased federal revenue be damned, tax increases are nonetheless necessary for redistributionist "fairness." He said as much at an April debate where he described his plan to "look at raising the capital gains tax for purposes of fairness", after having just admitted that raising the tax rate would reduce revenues.
Contrary to the Obama narrative, free-market capitalism is not the cause of the current mortgage industry crisis; the cause is the very socialism he hawks. The historical record makes this fact unmistakably clear.

Oct 28, 2008

The Tax Cut You May Have to Send Back

34% Effective Rates Are No Longer Just for the Rich

Barack Obama has promised a "tax cut" for everyone, except for the 5% of taxpayers who have large incomes and are supposed to pay more. The tax cuts are refundable, meaning that people can apply for a check up to $500 per taxpayer (or $1000 per family) if the "cut" is greater than the taxes paid. Even if no tax was originally paid. Additional refunds are promised for expenses such as college tuition.

This is not a tax cut in the usual sense. People with more income will pay people with less income, and will pay for most of government in addition. Payments from the rich to the poor are usually called "welfare".

I said "people can apply for", because the taxpayer (or non-taxpayer) does not get the money automatically. He needs to document the expenses that are favored for a tax rebate, and file a more complicated tax return.

This is like the $20 off coupons that retailers hand out. Just collect all the paperwork, clip the coupons, do the math, send it in, and get the refund. Your tax preparer will charge a bit more for the service, or you can study the tax booklets yourself.

Some people will lie about eligibility, just as they currently lie about extra dependents to get current tax deductions. The temptation to lie is greater, because they can walk away with a check, not just a reduction in the tax owed. The government will spend even more money trying to catch them, or checking up on you. There is an incentive to file under a false social security number, get the check, and disappear.

Taxes will be made more horribly complicated. Obama proposes phase-outs and rate changes along with the cuts. The cut you get this year may be ~~reclaimed~~ reduced in following years by inflation and any increasing family income.

The chart below is from American.com: The Folly of Obama’s Tax Plan. It shows the Marginal Tax Rate for our current tax law and under Obama's plan. Marginal Rate means how much income the government takes out the next $1000 for each income level.

Obama says he will give you $1000 plus other amounts. The downside is that these benefits "phase out" (reduce gradually) as income increases. So, either you don't get the full benefit at your income, or the benefit disappears if you earn more in the next year. If you lose $500 in benefit, it feels the same as paying $500 more in tax.

From the graphic, say you get a raise from $30,000 to $35,000. Current law takes $1000 of that $5000, a marginal tax rate of 20%. Obama's proposal takes $1700. You give back an extra $700 of whatever benefit was originally granted to you, because something is being "phased out", for a marginal tax rate of 34%.

The very high marginal rate shown in the graphic (the red line and pink area) drops back steeply at $45,000. This means that most of the tax "cuts" have been reclaimed at that income. Much of the rest disappear at an income of about $83,000. This is for a family with two children (see the original article).

The original tax gift feels great. The phase out is a gotcha. Just when you are happy to make more money, you will find out that you owe much more tax. Just hope you didn't spend it already. I'm not happy with Obama's plan or with the current tax law. We should have simpler, understandable tax laws, not a grab-bag that hides who is paying what.

Obama has put forward a complex proposal. He talks about tax "cuts", but they are really gifts that are reduced according to income. He gives no public idea of the social evaluations that he is using to decide how these benefits phase out. It seems detailed and arbitrary. There is no general philosophy to refer to if he is elected and wants to change things around.

Everyone should pay less tax and know what they will keep if they work hard and earn more. You should not need a tax accountant for a $35,000 income. On the plus side (smile) you may have a chance to feel like that rich person, who pays 34% ($340) out of each additional $1000 he earns.

Oct 26, 2008

GMIP Regulation of Fannie and Freddie

Great Moments in Politics
(Fictional, but seems right to me.)

Jim: We're pressuring the banks to make more housing loans.

Bob: Right. Are they printing "Brought to you by Democrats" at the bottom of the loan documents?

Jim: They say there are programming glitches.
We're working on it.

Bob: Still, they aren't making enough loans to our voters.

Jim: The banks complain that it is too risky.
We have to help them.

Bob: Tell Fannie Mae and Freddie Mac to buy those loans, whatever it takes.

Jim: What about the regulator, OFHEO?

Bob: We own OFHEO. They won't complain too much. Who understands what they say? They report to us, and we don't care.

Jim: If the loans go bad?

Bob: We'll have to give Fannie and Freddie some money. We'll raise taxes on the fat cat Republicans. That can't be bad. We always wanted the rich to buy houses for the poor, and now we can do it.

Jim: Won't anyone notice?

Bob: They haven't complained so far. But, just in case, lets print "Brought to you by caring members of Congress, mostly Democrats" at the bottom of the loans.

Oct 25, 2008

Pennsylvania Is Driving Its Doctors Away

10/25/08 - WSJ.com by Dr. Frederic Jarrett --> Source

Jarrett is a vascular and general surgeon, and Clinical Professor of Surgery at the University of Pittsburgh.

[edited] High malpractice premiums were (and still are) driving doctors out of Pennsylvania. So Pennsylvania created M-Care insurance to pay extra-high malpractice awards, and made doctors pay only part of the cost. The money came from a $500 million fund from cigarette taxes. Previously, malpractice premiums were sometimes 55% of specialist income.

See more as part of ER Medicine and Bureaucracy

Oct 24, 2008

My Book List

I Am What I Read

These are books that helped form my view of the world. I remember them fondly, some after 25 years. I don't remember all of the details, but their advice has affected how I analyze situations. They are all interesting, clearly written, easy to read, and worth talking about over dinner.

They are not expensive. A friend told me that most books are free. They make back more than their cost if you learned something that improved your happiness, understanding, or productivity. These books did that for me.

It is an amazing world, where almost everything has been tried, investigated, and explained. If I want to do something new, I find a few books on the subject or a similar subject. Before reinventing the wheel, read about how past wheels were built. In school, I thought that three books on a subject were better than taking the course.

An untruthful book is easier to detect than an untruthful speaker, because the organization of a book reveals fuzzy thinking. They don't have the lecturer's excuse for making mistakes.

Don't you wish that the last person to interview you for a job had first read a book about doing interviews?

Knowledge

See How to Lie With Statistics
See Knowledge and Decisions
See Surely You're Joking, Mr. Feynman!
See What Do You Care What Other People Think?
See How to Solve It
See Economics in One Lesson

Relationships

See Why Marriages Succeed or Fail
See Raising an Emotionally Intelligent Child
See Too Good to Leave, Too Bad to Stay

See Stop Walking on Eggshells - Borderline Personality

Business

See The Elements of Style - Writing
See Parkinson's Law - Management
See A Random Walk Down Wall Street
See The Effective Executive
See The Organization Man - Big Companies

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How to Lie With Statistics

by Darrell Huff, 1954 Amazon Reviews

Statistics have undeserved respect because they are supposed to be the result of smart, mathematical people. So wrong. People often lie with numbers, or just pass along bad results because they serve a political or commercial purpose. There are standard statistical packages available for evaluating study results. It is easy to come up with automated conclusions, without having a clue about the automated errors.

Example. A study might report that smoking increases the risk of a particular cancer by 20%. Scary. But, you learn that the incidence goes from 2 up to 2.4 per 1000 population. This small difference is not so scary. If 5000 people were studied, 2/1000 is 10 cases, and 2.4/1000 is 12 cases. So, 2 extra cases of the studied cancer produced the headline. Is this significant or a random variation? A good question.

Example. Bias means getting an incorrect result because a study did not choose a random sample. "Survivor Bias" shows up (directly) when people are asked at their 100th birthday about what they did to live so long. Was it really the daily drink of Scotch or the teaspoon of vinegar? You can't tell unless you find out about all of the other (dead) people who did those things.

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Knowledge and Decisions

by Thomas Sowell, 1980 Amazon Reviews Overview

What do you know and how do you know it? Is government using good information to manage our lives? Should you believe what you are told? Is society transforming to use knowledge in a better way, or to ignore what has been learned? Don't believe everything you read in the newspaper.

This is not a mysterious book of philosophy. It discusses real problems about acting in groups and dealing with others. Life is complex, and it is much better to understand why it is so.

I read another of Sowell's books (which I can't find) about how racial and social discrimination affects success. His current books on this should be just as good.

Sowell asks and answers an interesting question. We can assume that bigots are not delicate about who they hate. For example, they shouldn't care much if they are hurting people of northern Vietnamese vs southern Vietnamese origins. So, why have these two groups done so differently in an American society that has elements of discrimination?

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Surely You're Joking, Mr. Feynman!

Richard P. Feynman, 1918-88 Amazon Reviews

Feynman had one of the best minds in physics, combined with a direct and playful personality. He brought a fresh, analytic, and inquiring view to everything. This book collects stories about science and his life.

When Feynman was at Los Alamos labs, working on the atomic bomb, he questioned the security of the research documents. When the directors ignored his concerns, he left notes like "I was here" in the files, to show that they were insecure. The security officers corrected the problem by issuing a memo "Don't let Feynman near the files".

The lesson of this book is to look at things skeptically. Don't take what others say without examination. People who know what they are doing and tell the truth do not mind answering questions or explaining their results. Others are afraid of being caught.

This book is important to the non-scientist, to understand how a great scientist looks at science and what good science is like. It is fun training in how to be skeptical about authority, especially when cloaked as science.

From the review by Subornator:

Feynman's book, subtitled "Adventures of a Curious Character", is his memoir - not written down, but narrated in conversations with a close friend. It is very clear that nothing surpassed his ardent passion for physics. When Feynman spoke about his subject, he rejected all notions of etiquette and subordination; Nils Bohr and Einstein could discuss their new ideas only with him - other colleagues just gaped in awe at any dictum of theirs. Feynman writes about the very *process* of discovery - this is probably the only sincere and authentic description of scientific creativity of such scale in literature. In the closing chapter, Feynman speaks about the scientist's responsibility - not to society or colleagues, but rather to himself and his science; all his recollections, serious and jocular, clearly demonstrate how serious it was to him.

From the review by Lance Mitchel:

There are some great stories in this book and they will make you laugh out loud. Feynman was always so full of life and he was curious about absolutely everything from a very early age. He would always want to know, "How does that work?" or "Why is that the way it is?" or "Is there another way to do that?" He would also latch onto something and decide that he wanted to do it, and to do it really well. For example, witnessing the bongo-playing in Brazil inspired him to learn to play like that and not like some studio-taught purist. He achieved it through dedication to his objective and sheer passion.

What made Feynman a genius? Well, there were lots of factors that contributed to his status, many of them discussed in other reviews of this book, but, my reason for putting him into that classification was that he was capable of explaining the most complex of matters to a five-year-old. That is TRUE genius. I have read this book many times. It is a short book and will remain amongst my collection until the day that I die. If you haven't read it already, you should. You really need to read this book. I can guarantee that it will change at least one aspect of your life!

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What Do You Care What Other People Think?

Richard P. Feynman, 1918-88 Amazon Reviews

From the review by D. Roberts [edited]:

One quarter of this book fits the tone and humor of Feynman's prior book "Surely You're Joking". The rest is more serious. One section details Feynman's love for his first wife as well as her untimely terminal illness. The other section reports his work on the commission to examine the technical problems leading to the explosion of the Space Shuttle CHALLENGER in 1986.

The chapter on his wife's suffering is especially poignant and touched me very deeply. Feynman was a man whose love and compassion matched his intellect. I felt empathy and admiration for the way he took care of his bride, knowing all along that she would not live long. His decision to be straight with her about her condition, instead of feeding her some fairy-tale story about how she had a good chance of recovery, was both painful and edifying to read.

The section on the CHALLENGER goes into great detail on everything that went wrong that fateful day in '86 as the nation watched the disaster on TV.

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How to Solve It

G. Polya, 1957 Amazon Reviews

I was always interested in mathematics. I owe much of my success to reading this book when I was 18. It uses some mathematics in a simple way. The lessons work for all types of problem solving. They are things that you say "I knew that" after you see them, and it gives you an overview in an organized way.

This review by Philip Hamilton describes the essence of the book.

Polya provides a systematic way to creatively solve problems. This volume has withstood the test of time for nearly 50 years. I recommend it highly.

What is the unknown? What is the data? What conditions does the solution need to satisfy?
Do you know a related problem? Look at the unknown and try to think of a familiar problem having the same or a similar unknown.
Can you restate the problem? Can you solve a part of the problem.
Can you think of other data appropriate to determine the unknown?
Can you check the result?
Can you look back and use the result or the method for some other problem?

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Economics in One Lesson

Henry Hazlitt, 1946, 1978 On Line Reviews

From the review by Aaron Jordan [edited]:

The one lesson is simply this: economic planning should take into account the effects of economic policies on all groups, not just some groups, and what those effects will be in the long run, not just the short run. That's it. That's the lesson.

Hazlitt examines the many variations of fallacious economic policies that benefit one group at the expense of others, or give short-term benefits at the expense of long-term costs.

I should have studied economics. Hazlitt's book is remarkably readable, coherent, and logical. It confirms that truth is understandable, whereas complicated obfuscation is usually the alarm bell that tips you off when people are trying to shaft you. This guy really knows his stuff.

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Why Marriages Succeed or Fail, and
How You Can Make Yours Last

John Gottman, 1995 Amazon Reviews Gottman Institute

Gottman learned in school many reasons why couples bonded or separated and decided to check it out. He couldn't verify anything, and decided that the conventional wisdom was only a guess. Gottman now bases his recommendations on his direct observation of couples in his lab, where they spend 3 days being videotaped (but not in the bathroom or bed).

He was able to make a 90% correct prediction of which couples would break up within the next 3 years, based on how attentive the couples were to each other, how many "bids" for attention or help were received rather than ignored by their partner. The rule seems to be that the couple will break up if they ignore more than 1 out of 7 requests for attention, or if they demean or criticize. Other things were less important.

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Raising an Emotionally Intelligent Child

John Gottman, 1998 Amazon Reviews Gottman Institute

How to be responsive and informative to your child so he will understand his emotions in life. See your child's behavior as a way of communicating. Send the right signals yourself. Don't take a hard stand, or a soft stand. Learn what is going on. Give help and criticism without blaming your child.

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Too Good to Leave, Too Bad to Stay: A Step-By-Step Guide to Helping You Decide Whether to Stay in or Get Out of Your Relationship

Mira Kirshenbaum, 1997 Amazon Reviews

Analyzes the types of conflicts that lead people to break up. It presents whether most people later confirmed or regretted the decision to leave. How to think about what you will gain or lose by breaking up or staying.

Example: Leave if he throws one ashtray that hits you, or two that miss. Don't sacrifice your personal development to affection. It may be over if he loves the city and she loves the country, or if he loves public affection and she hates it.

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Stop Walking on Eggshells
Borderline Personality Disorder

Paul Mason, Randi Kreger, 1998 Amazon Reviews Review

Everyone needs this book about Borderline Personality Disorder, to deal with a Borderline personality or to avoid the heartache of associating with one by mistake.

The Borderline does not fit into the usual categories of Depressed, Manic, or Psychotic. They are "borderline" to all of the categories. The danger of the Borderline is that she (or he) is hard to identify and often is "high functioning", intelligent, fun, friendly, interesting, spontaneous, and adoring.

The Borderline woman sees the world completely "in the moment", and may be the most vivacious person you have met. She is expert at responding to people in her life in the ways they desire, and may show love at first sight. She can love completely and with devotion, but seemingly small things eventually cause her to change her mind.

The borderline has wild swings of emotion. She begins with intense feelings that you are "the one", better than anyone else could be. As newness fades and she discovers some things that she doesn't like (possibly after many years), she discards memories of what was good. She yearns for a change and to find the next person who is perfect for her.

Typically, the vibrant, outgoing, spontaneous, wonderful woman who was so much in love announces that you just aren't right for her, and it would be too complicated to explain how this could be true. This announcement may be sudden or come after a few instances of feeling emotionally upset or distant, each time seeming to recover.

Borderlines do not integrate their prior experiences and memories into the present in the usual way. They rewrite history to fit their current emotion, and they eventually become bored with everything. You remember the great times together; she wonders why she ever liked you. If you hold any assets in common, she will fight for them as if you are an enemy who tried to fool her.

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The Elements of Style

William Strunk, Jr., 1918 Amazon Reviews Excerpt

Write clearly and simply. Punctuate clearly. Throw away all of the useless stuff and get to the point. This book can revolutionize your writing, and you will never be able to read a corporate memo again without laughing. It is written itself in a spare, direct style.

I was a poor writer in school until I found this book in college. I was in despair that I would never write with style, so I read this book, eliminated every stylish thing, and settled for effective writing. Amazingly, that was a style in itself. You be the judge.

Coding is Just Writing
11/08/08 - Jeff Atwood at CodingHorror says this book is a great guide to technical writing and programming.

There is perhaps no greater single reference on the topic of writing than Strunk and White's The Elements of Style. It's one of those essential books you discover in high school or college, and then spend the rest of your life wondering why other textbooks waste your time with all those unnecessary words to get their point across. Like all truly great books, it permanently changes the way you view the world, just a little.
Donald Knuth was getting at this with his concept of Literate Programming (pdf).

Let us change our traditional attitude to the construction of programs: Instead of imagining that our main task is to instruct a computer what to do, let us concentrate rather on explaining to human beings what we want a computer to do.
The practitioner of literate programming can be regarded as an essayist, whose main concern is with exposition and excellence of style. Such an author, with thesaurus in hand, chooses the names of variables carefully and explains what each variable means. He or she strives for a program that is comprehensible because its concepts have been introduced in an order that is best for human understanding, using a mixture of formal and informal methods that reinforce each other.

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Parkinson's Law, and
Other Studies in Administration

C. Northcote Parkinson, 1957 Amazon Reviews

This is a wonderful and funny book that changed my view of government and business, or confirms what I may have suspected. For example, why will a corporate board of directors spend five minutes approving a $100 million corporate plan, but require an hour to decide on what brand of coffee to serve at the next meeting. Answer: They know something about coffee.

Doug Vaughn's review:

Parkinson's Law is "Work expands to fill the time available for its completion." If it doesn't seem that an entire book could be written about this thesis then you haven't encountered the imaginative genius and the stinging comic wit of C. Northcote Parkinson.

He uses this insight as an analytic tool to expose much of what is wrong with organizations and why much in both business and government seems at odds with common sense.

For example, why the British Colonial Office has grown in number of employees as the actual number of colonies declined - so that it employed more people when the number of colonies had been reduced to zero than when they were at their highest number.

Witty, brilliant and always right on the money, Parkinson can make what should be deadly dull - a description of bureaucracy - into a delightful excursion through the halls of pompous human folly. Really great stuff. This book is a classic and can be read and reread with great pleasure.

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A Random Walk Down Wall Street

Burton G. Malkiel, 2003 Amazon Reviews

The basic facts that you should know about investing.

From the review by The Finance Buff:

The book begins with two basic stock valuation models -- Firm Foundations and Castles in the Air. It goes on with a review of bubbles and manias: the Tulip Craze in the Netherlands, the South Sea Bubble in England, the 1929 Great Crash in the U.S., the stock market anomalies from the 1960's and 1970's, and the late 1990's Dot Com Bubble.

The book describes two types of stock valuation: Technical Analysis and Fundamental Analysis. It shows how both fail to identify outstanding investment opportunities better than an efficient market already provides. You can make money with Technical Analysis and/or Fundamental Analysis, but you can't make more money than you already can by investing in a market index fund.

The chapter on behavioral finance is new for the 9th edition. It reviews how investors often become their own worst enemy when it comes to investing.

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The Effective Executive

Peter F. Drucker, 1966 Amazon Reviews

Clear advice for managing a business or any activity. No buzz words or strange methods. Useful as an employee wondering about who to work for, or how to have an influence in your organization.

This is an important point that I hope is in this book and not one of his other ones. The job of a manager is to organize the work so that the available people can do it. You have to get it done now, so how are you going to do it with the people and skills that you have. Maybe, by limiting your objectives about what can be done.

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The Organization Man

William H. Whyte, 1957 Amazon Reviews

Whyte talks about the mindset of people who have to operate with little independence in a big group. A cautionary tale of his own experience working as a bright, independent thinker within an organization of random beliefs.

He describes how "scientific" management took over from common sense. Corporations wanted to measure the people who they hired and managed. Who would be good for promotion? They accepted "Personality Tests" that were borrowed from psychology, previously used to screen for pathological behavior. Now you know why some employment tests still ask "Are you bothered by frightening thoughts?"

Worse, those tests valued being happy and ordinary, and penalized being unusual and unlike the group mean value.

Whyte found that he could beat those tests. His three thoughts to keep in mind while answering (lying) on a corporate personality test:

I love my family, but my job comes first.
I don't much like classical art or music.
I would rather watch baseball.
Thing are pretty good just the way they are.

His manager responded to Whyte's test results. "Bill, I had my doubts about you, being a "thinker" and not fitting in. But, these tests show that you are really an OK guy." Whyte was promoted.

The 1950's and group thinking are still with us. This is a must-read. Know the enemy.

From the review by Christopher Hefele [edited]:

Whyte argues in this 1956 bestseller that some people not only worked for an organization, but sold their psyches to them. These "organization men" willingly subordinated their personal goals and desires to conform to the demands of corporations, hoping to gain loyalty and security. The organization is a friend, not a foe; it should be co-operated with, not questioned.

Whyte discusses the social ethic of the organization. Its core beliefs are that the group is superior to the individual, and individuals lack meaning and purpose outside of that group. The ultimate emotional need of the individual is to belong. To achieve it, society should not hesitate to use a bit of social engineering. The result is an ethos of conformity at any price.

Whyte looked around the world in the mid-1950's and saw the ethos of the Organization Man everywhere.

College graduates joined big corporations, pledging their loyalty with visions of a safe stable life.
Corporate executives pulled up roots every time the company wanted to transfer them.
Educators taught kids social skills to "get along" rather than teaching academic subjects that forced them to think for themselves.
Engineering companies that said there were "no geniuses here; just average Americans working together" (although studies show that innovative engineers and scientists are fiercely independent, thus the direct antithesis of the company-oriented man).

More medical "never event" absurdity

10/24/08 - Buckeye Surgeon --> Source

The NY Times and National Review are talking about medical "never events" without knowing the facts. A "never event" is supposed to be a medical problem that always occurs by medical neglect or avoidable error. But, this label is applied to such events as falls and surgical infections. Will bad policy become conventional wisdom?

Oct 22, 2008

Obama and the Tax Tipping Point

10/22/08 - WSJ.com By Adam Lerrick --> Source

[edited] How far can society's top earners be pushed before they stop (or cut back on) producing? The incentives are easy to see. Voters who benefit from government programs will push for higher tax rates on high earners -- at least until those who create jobs and wealth stop working, stop investing, or move out of the country.

Other nations have tried the ideology of fairness and found that reward without work brings decline. In the late 1970s and throughout the 1980s, Margaret Thatcher took on the unions and slashed taxes to restore growth and jobs in Great Britain. In Germany a few years ago, Social Democrat Gerhard Schroeder defied his party's dogma and loosened labor's grip on the economy to end stagnation. Recently in France, Nicolas Sarkozy was swept to power on a platform of restoring flexibility to the economy.
The sequence is always the same.

High-tax, big-spending policies force the economy to lose momentum.
Growth in government spending outstrips revenues.
Fiscal and trade deficits soar.
Public debt, excessive taxation, and unemployment follow.
The central bank tries to solve the problem by printing money.
International competitiveness is lost and the currency depreciates.
The system stagnates.
Then, a frightened electorate returns conservatives to power.

Oct 16, 2008

The Best Promises Win

Make Them Explain the Bid
Obama's Tax Proposal

Long ago, I planned to renovate part of a two-family house. I would live in the second and attic floors and rent out the first floor. I found an architect to create the plans. I needed a contractor.

My architect asked three contractors, and I reviewed the bids. The high bid was twice the low bid. How would I choose between them? My architect said that they all were OK as far as he knew. Since I had no other information, I took the low bid. My architect would supervise, so why not the low bidder?

I reasoned like this. I had equally poor information about each bidder, only the price was different. If I made a mistake, at least I would spend less money, and I could fix things up later if I needed to.

It was a mistake. This contractor cut a few corners. Some were visible along the way, and some only showed up years later when some pipes froze. He misread the plans, didn't run the pipes in the space allowed for them (insulated), but did run them in the wall (uninsulated). Maybe the middle bid would have worked out better. I'll never know.

The lesson for me is to find out the evaluations and why the bids are different. I would investigate a lot more if I did it today. I wouldn't go for the low bid, or any bid, until I understood how they came to their number. Just talking to them helps a lot. If they won't talk, I won't buy -- low bid, high bid, or whatever.

House Painter

Another time, I was talking to exterior house painters. One guy was very friendly and seemed knowledgeable. He looked around my house and gave a price, and I asked how he computed it. He said that he just knew. He painted a lot of houses, and this seemed like x men for y days.

I pressed on, because sometimes paint jobs run into problems, and I wanted some structure ahead of time to value and negotiate any changes that might be needed. In particular, was this the price for two coats? He said that the house needed two coats on the sunny sides, but just one coat on the shaded sides. He assured me that when they were painting, he would do two coats if the house needed it, for the original price. So, I could get a low bid and a second coat for free if needed.

I thanked him for the estimate, and I dropped him from consideration. First, he didn't answer my plain question about how he got to his price. "He just knew". Worse, he was willing to "throw in" a second coat on part of the house if needed.

No one cuts his profit by "throwing in" a major item. When a contractor treats an additional cost as a gift, "no problem", then it is because he isn't serious about it. He could promise anything he wanted to, because he wasn't going to do it anyway.

Election Promises

An election invites promises from the candidates. Herbert Hoover in the 1928 Presidential Campaign used the immortal slogan "A chicken in every pot and a car in every garage". He won the election. The promise was broken, as the Great Depression started 10 months later.

President George H.W. Bush, the father of our current President, said "Read my lips, no new taxes" as he accepted the nomination for President at the 1988 Republican Convention. It helped him win election. From Wikipedia:

[edited] As President, the elder Bush made no progress dealing with a House and Senate controlled by Democrats. Bush compromised to raise several tax rates as part of a 1990 budget agreement to reduce the national budget deficit. This reversal caused great controversy, especially among conservative Republicans. Technically there were no new tax items in this agreement, only rate increases.

It seems that politicians are deep thinking philosophers. When they break their promises, they explain that there are subtle problems in understanding their language. You can only determine what they meant earlier after they explain it to you later. Honest men, misunderstood.

All politicians promise to give something to you. Just one problem; they don't do the giving. When they have a choice of granting government favors to their corporate supporters, or giving the money to the "little guy", the little guy loses out.

A worse problem is that raising taxes reduces economic production and government revenue. Politicians want more money, and people want more jobs. Raising tax rates kills both. That has been the interesting lesson of the past 25 years. If politicians want to distribute more money, they have to spend less on political pork, and they won't.

McCain Should Admit It

Obama is promising gifts before an election. He says he is going to give that money to you, and spread the wealth around. These promises probably have worked for all of his career as a Chicago and Senate politician. He has made a bunch of promises: checks in the mail, money for college, mortgage payments, health care, and an expansion of government to give more to everyone (except the 5% who are supposed to pay for it all).

Ironically, a politician is at a disadvantage when he has some vision and scruples. McCain is a rare politician who seems to have a conscience. His military career probably had that effect - Country, Honor, Duty. I think it is hard for him to lie, although he sometimes does, and he has apologized for some past mistakes, a rarity. He does make promises like all politicians, but he seems constrained.

McCain just can't match Obama's promises. He looks at the situation, and tries to explain that lower taxes will bring in more government revenue, and that a smaller government will free up resources for more satisfying jobs.

It may seem like a deal with the Devil, but leaving more resources in the hands of productive citizens is going to produce more production, lower prices, and more jobs than handing out walking-around money. McCain is not giving the well-off more money. He is letting them keep more of what they have earned. They do better investing that extra money than the Government does. The society gets more jobs and higher wages, than if the government hires more office workers.

Obama says he will give you everything. This is all a smiling promise with no downside. He will make the rich give you the money. This will be the first time in history that any government will take from the rich, rather than be manipulated by them.

I think Obama can promise everything because he isn't serious. It will all work out, or maybe it won't, but he will be President, and he can worry about it then.

McCain should admit that he can't compete in the giveaways. His sense of reality prevents him from promising everything. Obama clearly makes the bigger promises.

Tax Complications

Barack Obama has promised a "tax cut" for everyone, except for the 5% of taxpayers who have large incomes and are supposed to pay more. The tax "cuts" are refundable, meaning that the government will send a check up to $500 per taxpayer (or $1000 per family) if the "cut" is greater than the taxes paid. Even if no tax was originally paid.

This is not a tax cut in the usual sense. People with more income will pay people with less income, and will pay for most of government in addition.

Taxes will be made more horribly complicated. Obama proposes phase-outs and rate changes along with the cuts. The cut you get this year may be reclaimed in following years by inflation and any increasing family income.

The chart below is from American.com: The Folly of Obama’s Tax Plan. It shows the Marginal Tax Rate for our current tax law and under Obama's plan. Marginal Rate means how much income you get to keep out the next $1000 for each income level.

Obama says he will give you $1000 plus other amounts. The downside is that these benefits "phase out" (reduce gradually) as income increases. So, either you don't get the full benefit, or the benefit disappears if you earn more in the next year. If you lose $500 in benefit, it feels the same as paying $500 more in tax.

From the graphic, for example, say you get a raise from $30,000 to $35,000. Current law takes $1000 of that $5000, a marginal tax rate of 20%. Obama's proposal takes $1750. You give back an extra $750 of whatever benefit was originally granted to you, because something is being "phased out", for a marginal tax rate of 35%.

The original tax gift feels great. The high marginal rate is a gotcha. Just when you are happy to make more money, you will find out that you owe more tax. Just hope you didn't spend it already. I'm not happy with Obama's plan or with the current tax law. We should have simpler, understandable tax laws, not a grab-bag that hides who is paying what. Everyone should pay less tax and know what they will keep if they work hard to earn more money. You shouldn't need a tax accountant for a $35,000 income.

- -
A Few Words About Policy
July 2009 - Easy Opinions

Where are the policy papers, Obama's/Congress's research on healthcare reform and other vast programs?

Where are the plans that Obama supports, in writing so that they may be analyzed and criticized in a reasonable manner? Hiding the details as a political tactic is fraud on the public.

Or, are Obama and the Democrats putting down all of the odd thoughts and biases that they picked up over the years.

We should ask loudly, how do our representatives know that their legislation will help, or solve anything? The legislative language is less important than the research that should show that the legislation will be of good effect.

Further, people are writing bills, in detail. Where are the research papers that support the writing of the bills? This research has to be there. We need to see it.

The Congress and Obama should proudly present the careful research that supports their proposed rearrangements of our country. Obama is a Harvard trained law professor. He should be up to the task.

Oct 15, 2008

Never Talk to the Police

Never Talk to the Police
2008 - YouTube (48:40)

• Prof. James Duane of the Regent University School of Law
• Officer George Bruch of the Virginia Beach Police Department

Prof. Duane explains why he is proud of the 5th Amendment, will never, ever talk to the police without a lawyer, and you shouldn't either. Don't take his word for it; he cites the advice of Nuremberg Trial Chief Prosecutor Robert Jackson and the U.S. Supreme Court. Prof. Duane is animated and interesting. This lecture is an eye-opener and goes by quickly.

Officer George Bruch candidly agrees in the second half.

Talking is dangerous because there are so many laws that you break every day. You are usually protected by invisibility. The police need to see "probable cause" to examine you further. You are clearly visible when they are asking questions, so watch out.

The power of government, the expansion of law, and the intricate rules governing your life make you the servant of government.

Don't Take Take A Breathalyzer Test
(Undated) - Darryl Genis (Video 3:12)
Via Schneier on Security

This defense attorney demonstrates how breathalyzers can be mishandled to report alcohol levels that are twice the actual level, the difference between freedom and jail.

The Supply Side Robin Hood

You Can Steal From the Rich Until They Wise Up

The American Legislative Exchange Council (ALEC) promotes free markets, low taxes, and limited government. Their policy recommendations are based on fact filled research.

Rich States/Poor States on their website provides a long study measuring state wealth and success, related to factors like tax rates and regulation. The ALEC-Laffer Economic Competitiveness Index is a downloadable PDF of the study. I have read only a few sections. The following is an excerpt from page 31, edited for flow and clarity.

-----------------
The highly progressive tax structures in California or New York do not help the poor, minorities, or the politically weak. Intuition tells us that when government taxes people who work, there are fewer of them. When government pays people who don’t work, there are more of them.

Most of us want to help the people who have difficulty helping themselves. The problem is how to do it.

If the rich are taxed and the money is given to the poor, do not be surprised if the number of poor persons increases and the number of rich persons decreases. People respond to incentives. If you tax an activity, people do less of it. If you subsidize an activity, people do more of it.

Supply-Side Economics is the view that all people are better off, including the poor, when production is encouraged through lower tax rates. The opposite view is that tax rates should be high to pay for programs which aid the poor.

The Supply-Side Version of Robin Hood

Robin Hood and his band of merry men start their days hiding among the trees in the Sherwood Forest waiting for hapless travelers on the trans-forest throughway.

If a rich merchant comes by, Robin Hood strips him of all his belongings. Before you feel sorry for him, remember he is so rich that there will be an abundance of jewels and wealth waiting for him when he gets back to his castle.

If a prosperous merchant comes by, Robin Hood takes almost everything. He seizes a moderate chunk of an everyday businessman’s belongings. He takes only a little token from a poor merchant who barely makes a living.

In the language of our modern society, Robin Hood has a progressive stealing structure. This is similar to the California government or other tax systems used in this country.

At the end of the day, Robin Hood and his men take their contraband back to Nottingham to help the poor. They distribute their treasures to citizens based on their poverty. The more a person makes, the less Robin Hood gives him, and the less a person has, the more he receives. Robin Hood robs from the rich and gives to the poor.

Now, put on your supply-side economics hat and imagine that you are a merchant back in Nottingham. How long would it take you to learn not to go through the forest? Those merchants who couldn’t afford armed guards would have to go around the forest in order to trade with the neighboring villages.

Of course, the route around the forest is longer, more treacherous, and more costly. Those merchants who could afford armed guards (today’s equivalent of lawyers, accountants, and lobbyists) would go through the forest and Robin Hood couldn’t rob them. As a result, Robin Hood had nothing to give to the poor. All he had succeeded in doing was drive up the cost of doing business, which meant the poor had to pay higher prices. By stealing from the rich and giving to the poor, Robin Hood made the poor worse off.

And so it is in high-tax states. The poor, who rely on the state for their sustenance, are having their benefits cut to the bone. Because of some states’ unfriendly business policies, unemployment rates rise. We could go on, but the point is simple enough. Progressive tax structures do not benefit the truly needy.

Government never succeeds in its attempts to redistribute income. Taxes do not change the distribution of income, but taxes can and do lower the volume of income. As we look across the world at the progressive tax structure of California and other economies, it is amazing how the distribution of income, if anything, is made worse.

ALEC ranked states by employment, income per-person, and growth in population. From 1996-2006, the low-tax states Texas, Florida and Arizona were the most successful. The high-tax states Illinois, Ohio and Michigan were the least successful.

Oct 13, 2008

Obama's 95% Depends On the Meaning of Tax Cut

10/13/08 - WSJ Opinion --> Source

For the Obama Democrats, a tax cut is no longer letting you keep more of what you earn. In their lexicon, a tax cut includes tens of billions of dollars in government handouts that are disguised by the phrase "tax credit." Mr. Obama is proposing to create or expand at least seven such credits for individuals.
Mr. Obama's tax credits are phased out as incomes rise. So, they impose a huge "marginal" tax rate increase on low-income workers. The marginal tax rate refers to the rate on the next dollar of income earned. As the nearby chart illustrates, the marginal rate for millions of low- and middle-income workers would spike as they earn more income.
Some families with an income of $40,000 could lose up to 40 cents in vanishing credits for every additional dollar earned from working overtime or taking a new job. As public policy, this is contradictory. The tax credits are sold in the name of "making work pay," but in practice they can be a disincentive to working harder, especially if you're a lower-income couple getting raises of $1,000 or $2,000 a year.

Oct 10, 2008

Tell Me About The Past

Leadership For the Future Is About Past Success

I don't want to hear politicians or businessmen saying:

I have a plan for the future.
I'm going to work for you.
We need to improve life for all Americans.
We need to help the little guy.
We need better/cheaper/faster/more effective healthcare.
You are unhappy. You will be happier after I do things differently.
We need happier more productive lives with more vacations.
We need safe investments with guaranteed returns.
You should be able to work less, and earn more.
I want you to benefit.
I feel your pain. I grew up in a poor family.
Together we will go on to victory!

I don't want to hear these statements, because they tell me nothing. It is easy to be in favor of happiness and against sickness. OK, the politician says he isn't heartless, but what about his head? I want, you need, you should, I feel. This is pure emotion and wishful thinking, just words, feeling good, and using up time.

The politician doesn't go all the way to "I wish/dream/pray for a better future" because the crowd might wake up and laugh. Laughter isn't the desired response to a stirring speech. We would all be better off if we laughed at these statements rather than cheering. Let's say "Wow. A politician who wants things to be better, cheaper, and easier. Ha Ha."

The Football Coach

Movies show "The Coach" at half-time, pumping up the spirits of his losing team. He talks about strength, character, trying harder, and not letting down parents and the school. I didn't play football, but he seems like a bad coach to me.

An effective coach doesn't waste time insulting his team. "Try harder" tells the team that they weren't trying their best. A great coach tells his players about their individual mistakes and how to correct them. He has a plan that has worked in the past. His team has practiced to that plan, and he tells them how to cooperate to carry it out. Trying hard with a bad plan doesn't work. Making up a new plan on the spot doesn't work. Telling them that he is working on a plan doesn't work.

Action, Not Experience

I want a politician to tell me about the past. What has he done, what has already worked well, and why? Maybe he didn't do it himself, but he has seen something that worked, and he wants to apply it and describe it. In a world with websites, he can report all of his ideas in detail, and link to the plan that worked, in detail. He can hire the people who implemented the plan that worked. He can make his plan subject to review and criticism. Before election.

I don't care about his "experience" belonging to some group, sitting in some chair, or "being" a Governor, Senator, Ambassador, or President. What were the past situations, what did he do, and what worked? What were his beliefs, goals, actions, and accomplishments or failures? Past tense. Not promises about what will work in the future based on his good will and doing his best.

Of course, a politician will face new situations in office for which there is no current plan. That is exactly why we need to elect people who have solved problems (past tense) and have shown their ability to look at the world for solutions that have already worked and can be adapted.

References

My concerns are the same for hiring a painter or a President. I want references. I want to see good work in the past. I don't want him learning on my job.

I am a software designer. You are probably too aware that it is hard to design software that does what you want, with reasonable convenience and reliability. Even simple sounding tasks can have surprising complexity.

Many complex projects have been started and never finished because they couldn't get the software to provide the needed services, or even to work at all. The same warnings apply to political projects that are supposed to rearrange society. Most of those projects turn out to be costly, inefficient, and annoying. We need good political designers with proven records.

The greatest failure in software and politics is to look too narrowly at the problem. Voting machines seem like a good idea, until you go one step further to ask how the vote can be verified, looking back. Asking doctors to meet quality standards seems good, until the system spirals into requiring three hours of paperwork for every 5 hours of practice. Social Security seems good, and could be, until promises bankrupt the system (coming soon), making everyone worse off than they would have been.

Actual life is complex, and it routinely shreds seemingly good goals that are written on cocktail napkins and given in political speeches. We can only know what really works, works in reality and not merely on paper, by looking for similar situations that are already working. Or, we can implement small-scale or partial policies and find out what problems result, especially when the plan involves people, who have individual desires, standards for happiness, and demands for personal dignity.

Otherwise, it is like hiring a friendly painter with no references to paint your house. Scary, with peeling paint one year later.

----------
For a laugh, look at this story about a computer project to make data collection easier for water quality engineers. It cost a lot of money to eventually do the job the old way, but with a flashy computer system in the middle. This was done by government, to make a "well understood" process work better.

The water engineers already used available technology to form a pretty good, "unplanned" (ad-hoc, free market, innovative) system. Producing the final report was the part that seemed inefficient. That was the only part of the system that affected the planners; it was work for them. The planners fouled up the engineer's work trying to make their own small part of the system easier.

The "free market", allowing people to arrange informal systems that work, is usually better than the "planned solution", which can almost never incorporate the knowledge and detail of the informal system. Computer projects can work, if the planners humbly study the whole problem, find out what is really going on, in detail, and test pilot projects. This doesn't happen often.

Don't easily accept the dreams of planners. They don't have enough respect for the complexities of life. Don't accept politician's promises about the future. Make them use proven policies and systems, tested in the past.

--------
The Best Promises Win

So, it is meaningless to pick the politician with the best promises. Instead, he must explain the best programs that have worked before, in detail.

Oct 8, 2008

We Guarantee It

A Government Guarantee Is a Blank Check Written On Your Account

When you guarantee something, you have all of the downside risk of ownership, often without any upside hope of profit. A guarantee is the most dangerous financial action you can take. Ironically, the more that you can pay, the greater is the danger. A guarantee should be specific, limited, and closely watched. All of Wall Street and Main Street know this. Politicians know it too; they pretend that they don't.

The center of the current financial disaster is a runaway government guarantee placed in service of government affilliated corporations Fannie Mae and Freddie Mac, under the direction of Barney Frank, and the cooperation of most of Congress.

A mistake in oversight can cost you plenty.

Credit Parable

(Stage lights brighten from black)

Son: Hi Dad. I need a credit card for college. I can get a card with a $3,000 limit at 18% interest, and I'll pay off any balance from my part-time work. I expect to occasionally run a $2,000 balance. I figure this will cost me about $150 per year. At $12/month I think the convenience is worth it.

Dad: You have done your research, and I think this makes sense.

Son: I want to mention that they will cut the rate to 10% and raise the limit to $5,000 if you will guarantee the card. I'll have all the credit I need in an emergency, and I'll save $67 per year, just for getting your signature. It's free money.

Dad: OK, I trust you. I'll just sign here ...

(A year later)

Son: I have a problem. You know that credit card I got a year ago? I owe them $18,000. They are going to make you pay them.

Dad: What? How can that be? What did you do?

Son: A few months after I got the card, they raised my credit limit to $20,000. I think they were impressed by your credit rating. They offered me 0% interest for a year, so I moved to an off-campus apartment and bought some furniture. I could not resist taking a spring break to Cancun. Did you know that you can gamble at age 18 in Cancun?

I met a beautiful girl. She is from a wealthy Nigerian family, but needed a loan to complete her first year. Bad luck, she had to leave college and go home. Unfortunately, the college says they didn't get the tuition she owed them, but they do have my credit card number and my signature. Her phone number in Nigeria is not working.

They raised the interest rate to 29% when I was late with a minimum payment, and there were some extra credit fees. With late fees and some stupid stuff with their attorneys, they say I owe them $17,893, and that you have to pay if I don't. Of course, I can't pay them.

I'm sorry Dad, I thought I could clear this all up, and I really didn't know what to do. So, there it is.

Dad: This is impossible. I only guaranteed a $5,000 limit, and you were going to be careful. They aren't getting more than $5,000 from me, and you are going to work that off.

Son: They told me that raising the $5,000 limit was just an extension of the contract terms, and that I had 60 days to object, but I didn't see the harm. Also, it seems that you guaranteed "the card" and not "the limit". Anyway, it might take a lawyer to fight their claim. They said that we would have to pay more of their attorney's fees if we fight and lose. Your credit rating is also at stake.

Dad: (Head in hands, wheezing sounds) What a disaster.

(Lights fade to black)

Created by Congress

The parable suggests what the Congress did with Fannie Mae and Freddie Mac, the government Sponsored Enterprises (GSE's) that Congress set up to encourage lending for home ownership.

Congress maintained close oversight of what Fannie and Freddie (FanFred) were doing, and approved of it. Congress created OFHEO (The Office of Federal Housing Enterprise Oversight) especially to regulate FanFred. The much larger and more visible SEC (Securities and Exchange Commission) was available, but Congress wanted its own regulator.

OFHEO knew month by month that by December 2007 FanFred had bought and held 18% ($219 billion) of all subprime mortgage bonds (the most risky) created in 2006 and 2007. By June 2008, Fannie owned in addition $307 billion of questionable Alt-A mortages, 11.5% of its total of $2,670 billion of mortgages owned.

FanFred borrowed money from private institutions in order to buy and hold this "subprime paper" and more usual mortgages. Fannie and Freddie together owned and guaranteed mortgage bonds representing $5,400 billion in home mortages ($5.4 trillion). In comparison, the borrowed debt of the US is separately $5.5 trillion. Institutions loaned to FanFred whatever it wanted, because FanFred had the implied guarantee of the US Government.

Risky Lending

An Alt-A mortgage is rated as an intermediate risk, between standard prime "A" mortgages and "subprime" mortgages. It may be granted to someone with low credit scores and serious late payments, without recent defaults or bankruptcy. Compared to a prime loan, it allows for no verification of stated income and assets ("no-doc loan"), higher debt for the stated income (payments at a higher fraction of income), less money down ("high LTV Loan to Value ratio"), and for less desireable properties.

A "subprime" mortgage is rated as high risk. It is granted to someone who cannot qualify for Alt-A, maybe to someone with recent defaults and bankruptcy.

The small market for Alt-A loans increased hugely because FanFred became a buyer. The subprime mortgage was created by government mandates on banks through the the CRA housing bill, and the volume of subprime loans expanded mostly because FanFred became a buyer, as dictated by Congress. FanFred did not buy all of the risky loans, but it supported the market for such loans and made them acceptable over time to other institutions. So, mortgage losses have not been limited to FanFred.

FanFred set the standards for the mortgage market. Mortgage lenders made risky loans to people with poor credit ratings, according to the standards for the loans FanFred would buy. FanFred's decreasing credit standards of course produced decreasing credit standards by retail mortgage lenders. FanFred knowingly took on all of the risk when they bought these loans.

Don't Stop

No one stopped FanFred from making these bad investments. The Congress (House and Senate) intentionally ignored clear warnings over many years. The House Financial Services Committee (overseeing banking and financial services) did not object, and actually encouraged more lending to subprime borrowers. Barney Frank (D. MA) has served as ranking (most senior) Democratic member on this committee since at least 1991 Called the House Banking Committee in 1991, it had oversight over Fannie Mae.
Events in 1991: Frank pushed the Banking Committee to loosen regulations on mortgages for two- and three-family homes.
Fannie hired Herb Moses as Assistant Director for Product Initiatives where he helped develop many of Fannie Mae’s lending programs for affordable housing and home improvement.
Moses had lived with the openly gay Frank since 1987. , and has chaired the committee since 2007 in the Democratic majority.

Barney Frank was Fannie Mae's Patron Saint, blocking attempts at limiting and reforming FanFred at least since 1992, denying that there were any problems, and even today demanding that any restructured company continue buying subprime loans.

FanFred's management was corrupt. In May 2006, OFHEO levied a $400 million fine against Fannie (as a corporation) for intentionally reporting $10.6 billion in false profits. According to USA Today "OFHEO holds Fannie Mae CEO Franklin Raines and former CFO Timothy Howard as principally responsible for manipulating the company's earnings from 1998-2004 while reaping tens of millions of dollars in pay and bonuses."

In April 2008, the NY Times reported that Raines and two other top executives would together pay $31.4 million in fines for their actions in 1998-2004. There is no mention of anyone going to jail.

Republicans did nothing for 12 years as the majority party. Democrats have done nothing in the past two years as the majority. There was never a majority of legislators, of whatever political party, in favor of stopping FanFred from using its guarantee to recklessly borrow money and buy risky loans.

Plausible Deniability

Politicians benefitted from FanFred in many ways. Their voters received loans, they received votes, FanFred made campaign contributions, and many of the political elite worked for FanFred at high salaries.

Most Democrats, in particular Rep. Barney Frank, said that FanFred aided poorer voters as part of enlightened social policy. Most Republicans did the same, and many did not criticise FanFred, afraid of being labeled heartless penny-pinchers who didn't want to help the poor. FanFred bought political support by contributing $200 million in the last 10 years toward lobbying and political contributions.

A long list of politically connected, mostly Democratic directors, senior management, and consultants made FanFred a vehicle for political patronage and personal profit. See Slate.com - Sep 2008 Fannie Mae and the Vast Bipartisan Conspiracy: A list of villains in boldface.

It is amazing that the government offered no written, legal guarantee of FanFred's mortgage bonds and debt. Large institutions relied on an implicit government guarantee Fannie Mae’s awfully big advantages
At the link [edited]: Fannie Mae is a government-sponsored enterprise. The financial markets concluded that the government will provide full faith and credit for Fannie’s debt. So, Fannie Mae maintains a AAA credit rating.
The government has never said it would guarantee Fannie and Freddie’s portfolios, and Fannie denies any guarantee in its offerings. But everybody, and I mean everybody, believes that the government would support Fannie and Freddie, and they don't press the government to say anything.
AMG: See also the other advantages that Fannie and Freddie had over any private company., and they were proved right by recent bailouts.

Institutions and credit rating companies such as Standard & Poor's (S&P) see almost no risk of default by FanFred and other GSE's, because GSE's are created by Congress, promote public policy (what politicians want), and are huge enterprises. This view has been supported by at least 30 years of government intervention to give government agencies and GSE's a guarantee in fact, if not in law.

Strangely, the GSE's and the government emphasize that there is no legal obligation for the government to pay their debts if the GSE's or agencies default.

Here is Barney Frank at a hearing in September 2003 about a Republican (George Bush) administration proposal to increase the regulation of FanFred and other GSEs:

[edited] I will consider the legislation, but the GSE's Fannie Mae and Freddie Mac are not in any kind of a crisis. An accounting problem has led appropriately to people being dismissed. At this point there is no threat to the Treasury.
This is an example of self-fulfilling prophecy. Some critics see a problem, that the Federal government must bail out people who might lose money. But, I do not believe that we have any such obligation.
I support the role that Fannie Mae and Freddie Mac play in housing, but investors should not look to me or the Federal Government for a nickel. If investors take some comfort and want to lend them a little money at lower interest rates, because they like their affiliations, then housing will benefit. But there is no guarantee, there is no explicit guarantee, there is no implicit guarantee, there is no wink-and-nod guarantee. Invest, and you are on your own.
We have a system that has worked very well to help housing. The high cost of housing is one of the great social bombs of this country. I would rank it second to the inadequacy of our health delivery system as a problem.
Fannie Mae and Freddie Mac have helped make housing more affordable, both through leveraging the mortgage market, and their mission to focus on affordable housing. In return, this Congress has given them some of the arrangements which are of some benefit to them.
I believe that we (the Federal Government) have probably done too little to push them to meet the goals of affordable housing and to set reasonable goals.
I worry frankly that there is a tension here. The more people exaggerate a threat of safety and soundness, the more people conjure up the possibility of serious financial losses to the Treasury, which I do not see.
We see entities that are fundamentally sound financially and will withstand some of the disastrous scenarios. And even if there were a problem, the Federal Government doesn't bail them out. But the more pressure there is, then the less I think we see in terms of affordable housing.

The Congress approved $200 billion ($200,000 million) to pay off FanFred's losses, and it may cost $300 billion. This was before, and in addition to, last week's $850 billion "bailout" bill recently enacted ($700 billion plus $150 billion added on by the Senate for pet projects and earmarks). When the government pays, this actually means taxpayers will pay, both in direct dollars and in even larger losses in opportunity and jobs. For 110 million households, the spending or loss of $500 billion is $4,500 each.

In my view, this is a giant case of Plausible Deniability. That is the tactic of benefitting from a situation, but claiming that you didn't know, weren't responsible, or even spoke against it. The attitude is "You can't prove that I knew". It is politics as usual.

Barney Frank has not repeated his position in the current crisis, that the government will not and should not pay off the debts of FanFred.

He wants FanFred to continue in its mission. He and Sen. Chris Dodd among others support restoring FanFred to health and then returning them to the way they were before they went into conservatorship, but with safeguards to prevent another crisis.

The Bush admistration favors the breakup of FanFred after this crisis has passed. New, private companies would compete in the market for loans, and they would not have the support of the government.

FanFred was in some ways a hidden project. There were no budget items. Politicians claimed that there was no guarantee, no cost to the government, and nothing extra to legislate. There was no need to publicly examine what would happen if FanFred lost money and defaulted. OFHEO warned the House Financial Services Committee about growing risk. Chairman Barney Frank dismissed this as a matter of opinion.

In the language of Washington, FanFred was "off budget", until it exploded onto the taxpayer's budget with massive losses and a disruption of the US and world financial system.

More Rules

Now, the losses are discovered, and the cry goes out by Democrats that the fault was a lack of regulation by the Republican President George Bush.

In my view, the majority of Congress knew the risks in FanFred and willfully ignored those risks, while whispering "so far, so good". Most politicians saw the problems, and accepted possible losses as the cost of doing business, eventually to be paid for by "rich" people through progressive tax increases. No harm done according to their philosophy. Other politicians did not want to be labeled "unfeeling" or "anti-poor", and couldn't point to losses until they occurred.

The economist Thomas Sowell has written that almost nothing in life can be reduced to a set of rules. The beauty of a free market is that people can use their full abilities, knowledge, and experience as needed to produce a productive result or avoid loss, while risking only their own money. This is called good judgment, and it can't be completely expressed as a set of rules.

The fatal weakness of government and bureaucracy is that it is limited to a set of rules. When the rules don't work and loss results, a bureaucracy blames lack of regulation, and wants even more rules and more money. There is no public solution. We can't risk having a government that is not bound by rules.

The failure and huge cost of FanFred goes beyond inadequate rules. Politicians actively suppressed regulation of a business that they created, supervised, and grew into a monster using government connections. These same politicians are now blaming the lack of regulation in a "free market".

Congress guaranteed the debt of FanFred so that it could borrow unlimited funds from lending instutions, without review by those instutions, and without the borrowings appearing on-budget as an obligation of the Government.

Congress ran FanFred into the ground, plucking presents along the way. Congress set up FanFred, took full responsibility by unofficially guaranteeing repayment of its debts, removed it from private market discipline, funded it through massive private borrowing outside of Government budget accounts, commanded it to do risky business outside usual standards, restricted its regulation to a special office set up by Congress (OFHEO), and then ignored that regulator.

This scheme continued until the losses were enormous and had to be accepted publicly. Congressmen and Senators now complain that it was greed and lack of regulation by all of those other people that caused massive losses, especially the other people in the other political party.

If Fannie and Freddie were truly private companies in the free market, no one would have lent them enough money to damage the US and world economies. The mortgage loans were too risky, and no one would have trusted them.

New Guarantees

The Price of 12 House Votes
10/03/08 - WSJ.com Editorial

[edited] The White House and Congress are raising bank deposit insurance to $250,000 per account (up from $100,000) to pick up 12 House votes in favor of the $850 billion emergency credit legislation. The political bet is that this will please the community bank lobby, which in turn will persuade a dozen House Members to change their vote to Yes.
[ Note that this guarantee and subsidy is a political payoff to banks, so that they will throw support and money at congressmen, to convince them to support the credit legislation (or bailout bill). It seems that the minority is arguing with money rather than principle. As usual, it worked. ]
Apparently, the way to persuade Members who claim to oppose a "bailout" is to increase the cost of that bailout. The same Members who denounce bankers taking reckless risks are delighted about a measure that will encourage bankers to take more such risks. Your Congress at work.
The long-term danger is more risky lending. We've seen it before. In March 1980, Congress increased deposit insurance from $40,000 up to $100,000. This encouraged struggling Savings and Loan banks [Government licensed, inspected, and insured local and regional banks] to pay higher rates to attract more deposits, and use them to make risky loans.
Those loans went bust a decade later, and taxpayers had to pay $150 billion [$235 billion in 2007 dollars] to cover the losses and repay the deposits. That hard lesson is one reason the $100,000 limit hasn't been increased until now.

Maybe by coincidence, $40,000 in 1980 was worth about $100,000 today, and so $100,000 back then was worth $250,000 today. Congress has made the same adjustment to deposit insurance today that it did in 1980, inviting the same behavior, risk, and result.

Deposit insurance is a government guarantee of private banks. Our politicians think that such guarantees are worth it and have little cost or risk, or they just don't care. The FDIC (Federal Deposit Insurance Corporation) is supposed to act like an insurance company, but it is out of money, as reported at Seeking Alpha.

[edited] 11/26/10 - The FDIC insures total deposits of $5,400 billion [calc] Calculated as $379 B /.07 from the link. in 7,830 banks and savings associations, up to $250,000 per account.
As of 09/30/2010, the FDIC had a negative balance of $8 billion [borrowed from the Treasury], despite adding $7.2 billion during the quarter. In the next 4 years, the FDIC expects to pay out $52 billion for hundreds of bank failures due to losses on commercial real estate.

The FDIC is supposed to collect fees from insured banks to pay for any losses (to pay back the depositors) if this or that bank fails. The FDIC has not collected enough to cover current bank failures, and looks forward to needing at least $52 billion more.

Raising the insured limit to $250,000 has made things worse, because depositors are encouraged to put more money into bank deposits, at the higher interest rates the banks are likely to offer. They will not care about how much risk the bank has acquired as an investment institution.

Like Fannie and Freddie, like Savings and Loans in 1980, this increased government guarantee is a subsidy to the banks. It provides the banks with more money to lend, supplied by depositors who "don't have to worry". It poses "systemic risk", the risk that the worst banks will offer the highest interest, acquire large deposits, and lose their bets on risky loans.

Regulation

Starting with a government guarantee, only government regulation stands in the way of disaster. This is the same regulation that has failed in the past and present, regulation based on rules and modified by powerful politicians, lobbying, and campaign contributions. Depositors have less risk to their deposits, but a greater hidden risk to their 401K accounts and the availability of jobs, when the next bubble bursts and is bailed out by the government (by the taxpayers).

Government guarantees have great value and invite unlimited risk. The guarantee is made by government on behalf of taxpayers. The cost of these guarantees is not limited to the amount that government spends or borrows, it is as great as all of the promises that politicians make or allow their Fannie's and Freddie's to make. The guarantee will be paid by you, in taxes or lost jobs, when the bill is due.

Many politicians make unlimited promises. They need to be regulated by being fired, before a declining economy fires you and takes your investments and retirement account.

Links

McCain Talks to the Senate
On 5/25/05 Sen. John McCain spoke to the Senate about his bill, The Federal Housing Enterprise Regulatory Reform Act of Jan 2005.

[edited] Fannie Mae reported quarterly profit growth over the past few years. OFHEO regulates Fannie Mae and reported that this growth was an “illusion deliberately and systematically created” by the company’s senior management, resulting in a $10.6 billion accounting scandal.
Fannie Mae employees intentionally manipulated earnings targets to generate bonuses for senior executives. Franklin Raines was Fannie Mae’s chief executive officer. Over half of his compensation during 1998-2003 came from meeting these targets. This echoes the deeply troubling $5 billion profit restatement at Freddie Mac.
Fannie Mae lobbied Congress in an attempt to interfere with the regulator's examination of the company's accounting problems. The OFHEO report comes some weeks after Freddie Mac paid a record $3.8 million fine to the Federal Election Commission, and restated lobbying disclosure reports from 2004-2005.
This report confirms that the GSEs need to be reformed without delay. If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Faannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole.

McCain's letter about Fannie and Freddie

On 05/05/06, Sen. John McCain wrote a letter to Senate Majority Leader William H. Frist and Chairman of the Senate Banking Committee Richard C. Shelby. Nineteen Republican senators co-signed. No Democratic senator signed. Sen. Obama did not sign.

Republicans held a majority in both the House and Senate, and George W. Bush was president. McCain wanted to resrict Fannie and Freddie, but there was no majority for stopping them.

(Democrats would win majorities in both the House and Senate in the Nov 2006 elections.)

McCain [edited excerpts]: We are concerned that that Fannie Mae and Freddie Mac pose an enormous risk to the housing market, the overall financial system, and the economy as a whole. We want effective regulatory legislation this year for the Government Sponsored Enterprises (GSEs) in housing finance. If not enacted this year, American taxpayers will continue to be exposed.
Therefore, we offer to you our support in bringing the Federal Housing Enterprise Regulatory Reform Act (S. 190) to the floor and allowing the Senate to debate the merits of this bill. It has passed the Senate Banking Committee.
These GSE's are mammoth financial institutions with almost $1.5 Trillion of debt outstanding. Deficits, entitlements, pensions, and flood insurance are fiscal challenges facing us today. Congress must ask itself who would actually pay this debt if Fannie or Freddie could not?

Fannie, Freddie Subprime Spree May Add to Bailout (Update 2)
09/22/08 - By Jody Shenn via Bloomberg

[edited] Freddie Mac had been gorging on subprime and Alt-A debt, buying the safest classes of the [riskiest] mortgage loan pools. Freddie bought 13% ($158 billion), and Fannie bought 5% [$61 billion] of all these securities created in 2006 and 2007, according to its regulator and the newsletter "Inside MBS & ABS".
These purchases supported the boom in lending that led to frozen credit markets, more than $514 billion in bank losses, and the collapse of two of the biggest securities firms. The amount of subprime losses may determine whether the $200 billion authorized to U.S. Treasury Secretary Henry Paulson is enough. William Poole said that Paulson may have to spend $300 billion. Mr. Poole is a former president of the Federal Reserve Bank of St. Louis.
[ Fannie and Freddie have guaranteed payments on $5.4 trillion ($5,400 billion, $5,400 thousand million dollars) in mortgage bonds and its own corporate debt. ]

How the Democrats Created the Financial Crisis
09/23/08 - at Bloomberg by Kevin Hassett

[edited] Alan Greenspan told Congress in 2005 that it was urgent to act: if Fannie and Freddie "continue to grow, to have low capital, and to engage in the dynamic hedging of their portfolios (to avoid the risk in changing interest rates), they potentially create growing systemic risk. We are placing the total financial system of the future at a substantial risk."
For the first time, the Senate Banking Committee passed a serious reform bill. The bill gave a regulator power to require Fannie and Freddie to eliminate their investments in risky assets. [The bill went from the committee to consideration by the Senate.]
The market for risky mortgage bonds would likely not have existed without Fannie and Freddie keeping the market liquid by buying up excess supply. These subprime bonds buried many of our oldest institutions in losses [when Fannie and Freddie stopped buying them].
The bill did not become law. Democrats opposed it on a party-line vote in the committee, making this a partisan issue. Republicans were tied in knots by the tight Democratic opposition, and couldn't get the Senate to vote on the matter.

How Government Stoked the Mania
10/03/08 - WSJ by Russell Roberts (via EconLog)

[edited] Housing prices would never have risen so high without multiple Washington mistakes.
Congress designed Fannie and Freddie to serve both investors and the political class. Congress and the White House subsidized low-income housing by demanding that Fannie, Freddie, and local banks do more to increase home ownership among poor people. It was a political free lunch, avoiding an allocation of budget dollars.
The Department of Housing and Urban Development (HUD) told Fannie and Freddie that 42% of their mortgage financing in 1996 had to go to borrowers in their area with below median income. The target was 50% in 2000, and 52% in 2005.
The Community Reinvestment Act of 1977 (CRA) did the same thing with traditional banks. It encouraged banks to serve two masters, their own profit and the so-called common good. The CRA was "strengthened" in 1995, causing an increase of 80% in the number of bank loans going to low- and moderate-income families.
Fannie and Freddie were part of the CRA story. Bear Stearns did the first securitization of CRA loans in 1997, a $384 million offering guaranteed by Freddie. Bear Stearns issued $1.9 billion of CRA mortgage bonds backed by Fannie or Freddie in the next 10 months. Fannie Mae securitized $394 billion in CRA loans in 2000-2002, with $20 billion going to buy mortgage bonds from others.
[ "Securitized" means collecting mortgages together into "pools" and selling "mortgage bonds" that pay principal and interest according to what the homeowners pay on their mortgages. ]
Politicians pressured banks to serve poor borrowers and poor regions of the country despite risk. They could push for increases in home ownership and urban development without having to commit budget dollars. Another political free lunch.

Fannie Mae's Patron Saint
09/09/08 - WSJ.com Editorial

[edited] Taxpayers are now on the hook for as much as $200 billion to rescue Fannie Mae and Freddie Mac. To know why, look no further than House baron Barney Frank's rapid response to this bailout. The Treasury wanted the companies to reduce their ownership of high-risk mortgage-backed securities (MBS) starting in 2010. Mr. Frank said "Good luck on that," and that it would never happen.
That is the Fannie Mae problem in profile. Mr. Frank wants you to pick up the tab for its failures, while he vows to block a reform that might prevent the disaster from happening again. At least he is consistent. His record is close to perfect as a stalwart opponent of reforming the two companies, going as far back as 1992.
In January 2007, Mr. Frank noted one reason he liked Fannie and Freddie; they were subject to his political direction. He contrasted Fan and Fred to private-sector mortgage financers. "I can ask Fannie Mae and Freddie Mac to show forbearance" in a housing crisis. Mr. Frank believed they would do his bidding because Fannie and Freddie are political creatures.
Mr. Frank attempted to prove exactly this when housing prices began to decline. He encouraged the companies to guarantee more "affordable" mortgages, thus encouraging their disastrous purchases of subprime and Alt-A loans. He increased the conforming-loan limits, to allow buying larger mortgages. And he pressured regulators to reduce capital requirements [money in reserve]. The larger losses are being paid by taxpayers.
The biggest payoff for Mr. Frank is the "affordable housing" trust fund he required as one political price for supporting the recent Fannie reform bill. This fund siphons off up to $500 million per year of Fannie's and Freddie's profits, which he and other politicians can direct to their favorite interests.
This is why Mr. Frank won't tolerate cutting the companies' MBS holdings. Those portfolios were a main source of profits before the housing crash, and he figures they will be again after this crisis. This time, his fund will get part of the loot.

Shouting Fannie! in a Crowded Congress:
Advice from the man who foresaw the GSE collapse.
10/14/08 - WSJ by William McGurn

[edited] Richard Baker is the Louisiana Republican who spent nearly a decade in Congress crying out that Fannie Mae and Freddie Mac were ticking bombs. He is now CEO of a lobbying firm for the hedge fund industry. He is somewhat bemused to hear people say they are shocked, shocked to learn that someone had predicted it all. Mr. Baker said "Everyone writes as though there were just one hearing or one piece of legislation. I think I must have had eight bills and maybe 40 hearings going back to 1996."
Fannie Mae and Freddie Mac had the worst of both public and private accountability. They lacked the congressional oversight that would have come from an explicit and acknowledged taxpayer guarantee. And, the privileged position given by the implicit guarantee removed market discipline that applies to other private enterprises.
Mr. Baker said that it wasn't the unregulated part of the financial markets that got us here. It was the regulated part.
For example, the lack of a government guarantee in the hedge fund industry means folks do a lot more investigation before they part with their money.
Today this sounds wise and obvious; but back then he was opposed. Fan and Fred's executives threatened to sue him when he made public their outrageous compensation. A fellow congressman accused him of a "lynching" when he questioned Franklin Raines, the now disgraced former head of Fannie Mae. He was dismissed as a crank when he suggested Fan and Fred's [mortgage bonds] were not solid. He couldn't find a single co-sponsor on one of his early reform proposals.

The Very Poor Pelosi-Obama-Reid Economy
10/18/08 - Pajamas Media Blog by Tom Blumer
(via Instapundit) [edited]

Barack Obama and others have an equal-results-regardless-of-merit mindset.
You see, thanks to blockbuster research done by Ragnar Danneskjold at the Jawa Report, we know that Obama was a plaintiff in a lawsuit against banking behemoth Citibank in 1994, ultimately settled out of court in 1998. In essence, the suit demanded that the bank approve an equal percentage of minority and non-minority mortgage loan applicants. Danneskjold writes: “The net result of this sort of litigation was, of course, that banks like Citibank started approving more subprime loans in the 1990s.”

Lawsuits like this fueled the explosive growth of these high-risk loans to minority borrowers who could not qualify for conventional mortgage financing. Government-sponsored enterprises Fannie Mae and Freddie Mac (a.k.a. Fanron and Fredron) also responded to these legal pressures by lowering credit score thresholds for subprime and conventional loan approvals.

The high default and foreclosure rates that followed ultimately led to the crackups at Fan and Fred. Those failures in turn contributed to liquidity problems in the banking system that were apparently so serious that Congress rammed through a $700 billion bank “bailout” package. Despite such supposedly corrective measures, equity markets have steeply dived.

All of this likely makes Barack Obama the first U.S. presidential candidate in history to cause an economic downturn even before the general election has been held.

After experiencing barely one quarter of the Pelosi-Obama-Reid Economy, can it really be that the American people want four more years of this?

Credit Rating Agencies Misled Investors

Barack Wrote a Letter About Fannie and Freddie
10/29/08 - WSJ Opinion

The main topic is that politicians write vague letters complaining about things, then later point to those as proof that they were early in predicting any crisis. But, letters are nothing. Public statements, action, and votes are everything.

Part of this article explains a piece of the financial meltdown puzzle. A "Credit Default Swap" is an insurance policy that pays if a company can't make payments on its debts. It is the industrial version of mortgage insurance, which pays back your bank if you can't make the payments on your home loan. A financial institution guarantees a repayment when it sells a Swap.

For example, a Bank has some doubts about loaning money to X-Corp. The Bank wants Hedge to pay back the loan if X-Corp fails. So, the Bank loans the money to X-Corp at 12% interest, and pays 6% interest to Hedge to buy a Swap. The Bank keeps 6% interest as a result, and feels safer knowing that either X-Corp or Hedge will pay back the loan. The Bank pays Hedge to take most of the risk.

[edited] Many sellers of Swaps (insurers of corporate credit) made horrendous judgments in assessing the likelihood of defaults. They were encouraged to make these poor judgments by government-approved credit-rating agencies, who evaluated and approved mortgage-backed securities (bundles of home loans).
Banks bought AAA rated (rock-solid) mortgage securities. The ratings were given by government-approved agencies. Other institutions (say insurers like AIG) relied on those AAA ratings, and insured those banks by selling Swaps, which seemed to be a safe, conservative risk. The actual risk of those mortgage securities was far higher.
Much of the subprime disaster could have been avoided if the credit rating agencies had never agreed to put a AAA rating on collateralized debt obligations - CDO's.
CDO's are constructed from pieces of other mortgage bonds, in complex ways that almost no one understood. Most investors around the world had never heard of a CDO before the housing boom, but they knew what AAA meant. They relied on the credit rating agencies to understand CDO's and tell them that they were safe. The government's chosen credit raters had said for years that this label applied to conservative investments that were highly unlikely to default.

Conflicts and the Credit Crunch
09/07/07 - WSJ.com Opinion by Arthur Levitt Jr., former chairman of the US Securities and Exchange Commission

The credit rating agencies such as Standard & Poors, Moody, and Fitch are specially authorized by government regulators to give their opinions about the riskiness of bonds and debt. This gives these few companies almost all of the credit rating business, excluding healthy competition that might challenge their judgment and practices.

[edited] Originally, investors bought a subscription from credit rating agencies to get information to support investment decisions. This business model changed in the 1970's. The issuers of securities paid the agencies for assigning ratings.
This conflict of interest deepened with the rise of complex structured financial products. The credit ratings agencies offered the issuer (the company selling the bonds) help in constructing the product to obtain a high rating, and then went on to assign that rating.
This has become a lucrative business for the ratings agencies in the past few years. Structured finance deals accounted for 40% of Moody's total revenue last year. This raises doubts about the objectivity of ratings that are critical to the proper functioning of the market.

The Moody's Blues
02/15/08 - WSJ.com Opinion

[edited] Investors struggled to understand complex new securities during the credit boom. So, they relied on the credit-rating agencies, mainly Standard & Poor's, Moody's, and Fitch. These firms labeled the new securities with the ratings already applied to corporate bonds.
But, the new securities had almost nothing in common with corporate bonds. Joseph Mason is a professor of finance at Drexel University. He examined Collateralized Debt Obligations (CDOs) having a Baa (medium risk) rating from Moody's. He found they were more than 10 times as likely to default (10 times the risk) as corporate bonds of the same rating. Moody's argues that the figure is closer to eight times, but you get the idea.
Are the ratings agencies always the last to know, or just the last to acknowledge a problem? The agencies say that they rely on facts presented by issuers, and that they are not responsible for conducting their own factual review. When S&P and Moody's rate a pool of mortgage loans, they don't examine any of the individual mortgages. S&P said "We are not auditors; we are not accounting firms."
So, the information about the assets underlying these bonds comes from the company selling the bonds, and the credit rating agency never verifies any of it. Investors might wonder what exactly does the rating agency provide? An opinion.

Write the Rating Agencies Out of Our Law
01/02/09 - Online.WSJ by Robert Rosenkranz

[edited] [ There are only a few government certified rating agencies, including S&P, Standard & Poors, and Fitch. ] Their ratings on bonds determine the amount of money (capital) that a bank needs to set aside by regulation for expected losses.
Ratings have a profound influence on how financial institutions invest their assets. Regulations make the rating agencies the de facto allocators of capital. Every participant in the financial system has a strong incentive to group assets in ways that maximize their rating, not their fundamental soundness.
[ Large capital requirements (more money set aside) means owning fewer bonds and making less money on the coupon payments. ]
The $6 trillion structured finance business serves mostly to improve ratings. Subprime mortgages and all manner of other risky loans would deserve a "junk" rating if taken alone, and require high capital reserves.
The structured finance people bundled these assets and sliced the bundles into "tranches" [groups according to order of repayment]. The rating agencies gave AAA ratings to 85% of the tranches by value, and gave "investment grade" to another 14%, thus turning lead into gold through ratings alchemy.
This created enormous demand for risky mortgages packaged into bonds. Mortgages were given to countless house purchasers of poor credit risk, which in turn drove dramatic increases in prices. The housing bubble has now burst, and average house prices in America are down 20% to 25% from the peak. This led to the current financial crisis, based on huge losses from the "rock solid" bonds.

A "tranche" is similar to a first and second mortgage on a home. The first mortgage has priority, and is repaid first in any default. Any remaining money goes to repay the second mortgage.

Tranches (French for "slices") are obligations created from a bundle of home mortgages or other loans. All of the mortgage payments collected from the bundle are allocated to repay the first tranche as required, then the second and remaining tranches until the money runs out.

The first tranche is likely to be repaid even if many loans default. The last tranche is likely to be worthless if more than a few loans default. Many risky tranches were given AAA or "investment grade" ratings, far above the actual risk as now understood.

+ + +
A comment about the above article
by Craig Bardo - 01/02/09 at EconLog.EconLib
--> Capital Requirements and Bond Ratings

[edited, restated] The failure of the ratings agencies has had consequences that are out of proportion. It should not be dismissed as a simple regulatory mistake.
I represented bond issuers and designed entire programs based on getting better ratings as well as better tax treatment for non profit issuers. Why did the ratings agencies get the mortgage securities so wrong and not the debt of hospitals, colleges, and universities I represented? Why did purchasers do better buying lower-rated health and university bonds than the higher-rated mortgage bonds?
The answer lies in political pressure. My issuers had very little power over the rating agencies. But, the federal government effectively provided the charter for the ratings agency, and the federal government tacitly backed the bonds being rated. Even the most seasoned, hardened analyst working for the ratings agency would have a hard time stating that those bonds were not worth the paper used to print the offering document.
The ratings agencies obviously treated the federal government involvement as a credit enhancement. They looked past the credit worthiness of Fannie Mae and Freddie Mac, and treated their securities as a full faith and credit obligation of the federal government.
Investors would make better decisions if we didn't have the current ratings and regulatory schemes. The government was a direct participant in the current crisis.

Craig Bardo's comment illuminates an important question. The financial crisis is world-wide. Banks bought housing bonds from Fannie Mae and Freddie Mac that were implicitly guaranteed by the U.S. government. The failure of those bonds has caused losses to the federal government, but not to those bond holders, because the government is meeting that guarantee. The larger banking crisis is not about the losses on Fannie Mae and Freddie Mac bonds. (Of course, we should still be unhappy about those losses to the U.S. government and our society.)

The world-wide problem is that banks and other institutions bought huge amounts of mortgage bonds that were issued independently of Fannie and Freddie and not guaranteed in any way by the U.S. Government. Those banks are failing because of the huge losses on those bonds.

Maybe this is what happened:

The ratings agencies gave AAA and investment-grade ratings to MBS bonds (Mortgage Backed Securities) issued by Fannie and Freddie. The bonds were risky, but the implicit guarantee of the government made up for that. The implicit guarantee was a sophisticated (and correct) prediction by most analysts.

There was political pressure to bless the subprime credit expansion, the government policy to expand home ownership. The ratings agencies found a rationale for blessing the bonds independently of any government guarantee. After all, the government said there was no guarantee.

Subprime MBS bonds issued by investment banks received the same AAA ratings as the bonds issued by Fannie and Freddie. Subprime MBS bonds were built on similar categories of subprime mortgages. The ratings agencies couldn't say that Fannie's bonds were AAA, but that similar bonds issued by others were risky "junk".

Bond buyers came to believe the AAA classification given by the ratings agencies. These agencies had been reliable analysts of the other bonds on the market.

Bond trading departments were making money. They wanted to believe the AAA ratings. They would collect their bonuses long before any problems with the bonds, so they kept any doubt to themselves.

The risk control departments of banks had no formal or regulatory reason to limit trading or ownership of AAA rated bonds.

The government was indeed a direct participant in the current crisis.

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The Housing/Financial Crisis - Their Own Words
Our leaders talk about the good and safe purposes of Fannie and Freddie.

Democrats Were Warned of Financial Crisis and Did Nothing.
(YouTube 3:32) A review of actions about Fannie and Freddie.
Watch the whole thing. Barney Frank says Fannie and Freddie are solid. (1:40 - 2:05)

Don't Regulate Fannie and Freddie
(YouTube 8:30) Late 2004 - Democrats fight greater regulation of Fannie Mae and Freddie Mac. "Excerpts from a hearing to investigate Fannie and Freddie's illegal bookkeeping"

Barney Frank - Lack of Regulation by Republicans
(YouTube 1:49) 09/18/08 - Barney Frank speaks on the lack of financial regulation by the Bush administration (:35 - 1:40).

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Sponsoring Recklessness at Fannie Mae
11/13/08 - (07/28/08) The New Yorker by James Surowiecki
(Via Greg Mankiw) [edited]

Fannie Mae and Freddie Mac have long been required to tell investors that their securities are not guaranteed by the federal government. But, the financial markets have always believed that this demurral was window-dressing, and everyone was right. The Federal Reserve rescued them last week when fears of their collapse threatened a financial crisis. The implicit guarantee became an explicit one.
There is no obvious reason for these Government Sponsored Enterprises (GSE's) to exist in the form they do. The government could directly do Fannie and Freddie's jobs. They were set up to buy and sell mortgages to promote home ownership. Fannie Mae started in 1938 as a government agency with authority to buy mortgages, in the hope that this would expand the supply of credit to homeowners.
Fannie was privatized in 1968. Freddie was created two years later, private from the start. Accounting was the main reason for the change. Lyndon Johnson was concerned about the large debt of the Vietnam War on the federal budget. Making Fannie Mae private moved its liabilities off the government’s books, without removing the obvious, real liability. It was like what Enron did thirty years later, when it used “special-purpose entities” to move liabilities off its balance sheet.
The implicit guarantee of the government empowered Fannie and Freddie to borrow money more cheaply than their competitors. They used this cheap financing to buy increasing numbers of mortgages [and make outsized profits].
They were able to grow extravagantly because neither the market nor the state checked their growth. Had Fannie and Freddie been ordinary private companies, there would have been a natural limit. Companies with more debt are usually seen as riskier, and that makes investors less willing to invest. On the other hand, had Fannie and Freddie been government agencies, visible budget constraints would have limited the size of their operations.
Congress failed to give regulators sufficient power to rein them in, thanks in part to ardent lobbying [and political contributions] by Fannie and Freddie.

The Bank's Mistake was Trusting the Government
03/13/09 - ChicagoBoyz by Shannon Love

[edited] For leftists, OneUnited should represent the perfect small, minority owned bank. The “socially responsible” Maxine Waters invested in the bank and sat on its board. There is no evidence that it made predatory loans. Yet, it failed.
It failed not due to any short-sighted greedy decisions of the bank’s management, but because the bank’s management and board members, like Waters, trusted that the mortgage-backed securities issued by the government sponsored enterprises (GSEs) Fanny Mae and Freddie Mac were worth the paper they were written on.
OneUnited is a microcosm of the entire financial collapse. Over the past 40 years the GSEs have piled up a vast store of toxic assets created by the attempt to get something for nothing by fooling the market about the risk of residential mortgages. Ratings firms gave the GSEs top ratings because of their implied government guarantee and oversight. Banks like OneUnited bought into the political myth and now they and everyone else are paying for it.

Whitewashing Fannie Mae
12/11/08 - WSJ.com Review and Outlook

[edited] Documents from a recent congressional hearing prove that Fannie Mae and Freddie Mac turbocharged the housing mania with a taxpayer-backed, Congressionally protected business model that has cost America dearly.
Fannie Mae and Freddie Mac have long maintained they were quietly buying 80% fixed-rate 30-year mortgages when they were blindsided by the greedy excesses of subprime lenders.
Memos and emails from 2004-2005 by top management show they took increasing risks to maintain their market share [fraction of all loans they would buy] and meet affordable-housing goals set by HUD, by purchasing risky loans including option-ARMs and interest-only mortgages.
In April 2004, Head of risk management David Andrukonis wrote to his colleagues about "stated income, stated assets" (Liar's) mortgages, "This is not an affordable product, but a product necessary to recapture market share. In 1990 we called this product 'dangerous' and eliminated it from the marketplace."
One Fannie Mae document from March 2005 notes dryly, "We invest almost exclusively in AAA rated securities, but the rating agencies may not be properly assessing the risk." Fannie and Freddie bought them anyway, to maintain their market share and to show people like Democrat Barney Frank that they were promoting affordable housing.
By mid 2008, Fannie and Freddie had bought or guaranteed $1.6 trillion [$1,600 billion] worth of subprime loans. They were central players creating the housing boom and the credit bust. They bought private-label subprime and Alt-A MBS (Mortgage Backed Securities) They helped legitimize and provide liquidity (be willing to buy and sell) for products that they now claim others irresponsibly sold.
Mr. Raines (former CEO of Fannie) testified "It is remarkable that during the period that Fannie Mae substantially increased its exposure to credit risk, its regulator made no visible effort to enforce any limits."
He failed to mention that Fannie and Freddie spent millions on lobbying to ensure that regulators did not get in their way. Freddie spent $11.7 million lobbying in 2006 alone. Fannie and Freddie tried to buy everybody in town, from both political parties, and made themselves immune from regulatory scrutiny.

Stop Covering Up - Kill The CRA
11/28/08 - Investor's Business Daily Editorial
(Via InstaPundit)

[edited] The Community Reinvestment Act is to blame for the financial crisis. It so powerfully serves Democrats' interests that they will do anything to protect it, including revising history.
The CRA coerces banks to make politically correct loans to people who can't afford them. Clinton beefed up the CRA in 1994 and forced banks to subsidize poor communities with close to $1 trillion in high-risk loans and commitments that ignored prudent lending rules. Clinton ordered HUD to set quotas for "affirmative action" lending at the Government Sponsored Enterprises Fannie Mae and Freddie Mac, creating the secondary market [buyers] for subprime loans.
This destroyed credit standards and created the subprime market. Minority home ownership rates had been flat, but began a steep rise in 1995. Home prices soon followed, stoked by easier lending. This promoted the housing bubble that has now burst, causing the worst housing and banking crises since the Great Depression.
Many bank officials complain that they still feel pressured by CRA regulators to make inner-city loans they know are at great risk of default.

Myth: The CRA could not be at fault, because the overwhelming share of subprime mortgages came from non-bank lenders that were not regulated by the CRA.
Fact: Nearly 40% of subprime loans in 2004-2007 were made by CRA-covered banks such as Washington Mutual and IndyMac. This doesn't include loans by bank-owned subprime lenders which were in effect covered by the CRA.

Myth: The CRA did not force anyone to do subprime loans or take excessive risks.
Fact: Banks made subprime loans to comply with the CRA, encouraged by Clinton's regulators. Subprime loans were rare before Clinton took office. They were more than 9% of mortgage originations when Clinton left office, and are 20% today. Clinton pushed banks to grant mortgages to minorities with poor credit, or risk being branded racist. Rules were weakened to accept welfare and unemployment checks as qualifying income.

Myth: Greedy investment bankers securitized and sold subprime mortgage bonds. They produced the credit crisis, not government.
Fact: Clinton's CRA amendments created the subprime market. Wall Street got involved in a big way only after Clinton pressured Fannie and Freddie to assume the risk and guarantee the profit from subprime loans.
Regulations had almost everything to do with this mess. We should be abolishing these regulations, instead of strengthening them to atone for the alleged "sins of capitalism".

FDR and the FDIC
12/02/08 - Cafe Hayek by Russ Roberts

President Franklin D. Roosevelt recognized the danger of a government guarantee in the 1932 proposal for the FDIC, Federal Deposit Insurance on bank accounts. He opposed the bill, but accepted credit for the program after congress passed it.

[edited] Roosevelt: It would lead to laxity in bank management and carelessness on the part of both banker and depositor. I believe that it would be an impossible drain on the Federal Treasury to make good any such guarantee. For a number of reasons of sound government finance, such plan would be quite dangerous.

Federal Deposit Insurance: A Banking System Built on Sand
June 2010 - The Freeman by Warren C. Gibson

Many aspects of the FDIC and banking.

[edited excerpts]: Rep. Henry Steagall vigorously pushed deposit insurance. Franklin Roosevelt opposed him.
Roosevelt in March 1933: The underlying thought behind the word ‘guarantee’ for bank deposits is that you guarantee bad banks as well as good banks. The minute the Government does that, there will be a probable loss. We do not wish to make the United States Government liable for the mistakes of individual banks, and put a premium on unsound banking in the future.

FDR was right. Deposit insurance creates a moral hazard, an incentive to be reckless when misdeeds are covered by someone else. Bank managers tend to make riskier loans than they would without insurance, and depositors don’t worry about the lending practices of the banks they use.
Many people, including me, buy bank certificates of deposit through online brokers, perhaps not learning the name of the bank that received the money. The magic letters FDIC are all we look for.
Though the FDIC lacks market incentives, it is awash in political incentives. Congress voted in 2008 to increase deposit coverage from $100,000 to $250,000 with little or no discussion of the costs. This “temporary” increase will likely become permanent.
Members of Congress are motivated by the campaign contributions of bankers and others. They may not know or care about the long-term consequences.

----------
Deadweight Loss of Taxes

It isn't common knowledge just how much wealthy people already pay, and how much tax is wasted by increased spending on everything. Ironically, raising taxes on anyone will lower the production of the US, and so will lower the number of jobs.

There are two myths that make people eager to raise taxes, if it doesn't affect them personally.

Taxes are a nice transfer. $1 from him means $1 for me or my friends.
Government spending stimulates jobs. Good for the economy.

From Tax Avoidance And The Deadweight Loss Of The Income Tax
2000 by Martin S. Feldstein, the George F. Baker Professor of Economics at Harvard University and former President of the US National Bureau of Economic Research.

[edited] Traditional analyses of the income tax greatly underestimate deadweight losses by ignoring its effect on compensation and consumption [jobs]. The full deadweight loss is easily calculated. Estimates imply a deadweight loss of as much as 30% of revenue. The deadweight loss caused by increasing tax rates may exceed $2 per $1 of revenue increase.

I will restate this. Government activities and transfer payments had better be useful to the society, because economic output has already been lowered by 30% of the taxes currently collected. Output will be further lowered by $2 for each $1 of any additional taxes collected. This means that $2 worth of production (jobs) will be destroyed for every additional $1 collected through increased taxes.

This is a severe loss, because there is no "stimulus" from that "extra" $1 in government spending. That $1 would have been invested or spent anyway. Taxes only move goods around from some people to other people, at great expense.

To transfer $1 to a needy voter, or bail out a public loss, the government will take $1 from a richer person, eliminating $2 in production of goods and services, also called jobs. By the same analysis, $1 of decreased tax results in $2 in new production and jobs. This effect is not "trickle down" from spending. The $1 in reduced tax supports some amount of increased investment that in turn supports $2 in new jobs.

At The Myth of the Economic Multiplier I consider why it seems there should be a stimulus that goes beyond each dollar of spending, and why this is wrong. Government spending is a banquet, not a stimulus.

Also see my post Public Tax Meeting about proposed tax policy, to raise taxes on the wealthy 5% and give a rebate check to the 95%.

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