Melding finance and politics

William A. Ackman, the activist hedge fund manager who had bet a billion dollars on the collapse of the nutritional supplement company Herbalife, offered his latest evidence to a handful of other hedge fund managers about why the company’s stock could soon plummet. He also spreads the word in Congress and regulatory agencies, hoping the bad publicity will ruin Herbalife and cause its stock price to fall to benefit his short position.  (see NYT 10 March)
    Small time crooks who steal a purse or have an ounce of pot go to jail for long periods.   But if you steal a billion, you probably are featured in the Wall Street Journal.

Jobs

Johnny Cash sings a song in which he says “St. Peter don’t you call me, ‘cause I can’t go, I owe my soul to the company store.”  This thought now dominates popular thinking .  But why is it that jobs depend on capitalists any more than returns to capital depend on labor?  Did you ever try to build something with only dollar bills?  Confusion on this point leads to local governments subsidizing companies to locate in their jurisdictions to the extent that taxpayers give back much of their wages in taxes. And then they bitch about taxes.

It leads to Congressional representatives objecting to reduced military spending and base closing because it reduces local employment.  But the money would be spent for other goods providing equal employment.  Instead of subsidizing military production, we should help employers and employees by sharing the costs of transition.  Contrary to much economic thinking, reallocation of labor and capital is not costless and if it is not shared, political action freezes assets in old lines of production.

Capitalism

Capitalism is commonly described as the system of private ownership (often rarefied as individualistic, though in fact it is corporate and collective). Its primary character is a system wherein selected corporations are given totemic symbols in their accounts (no printing press necessary) enabling them to order people and resources around. The primary creation of these symbols by commercial banks is the essence of capitalism. It requires collective action and legitimation far beyond the individual. This is far from just an assortment of individuals buying cheap and selling high. Markets are only a handmaiden of the essentially collective monetary system—collective, planned and centralized.

The private ownership of capital begs the question of where capital comes from in the first place. No individual Robin Crusoe ever created a unit of credit that can be subsequently traded for labor or iron. The very word capitalism suggests its essence is capital, a collective institution, not individualism. The common dichotomy of capitalism vs. socialism misses the point.

Coffee Prices at Mercy of Speculators

Hedge funds and other speculators are drving up the price of coffee (as they have done with gasoline) much more than warranted by fundamentals of supply and demand. The government should prohibit futures markets and let the gamblers play at the casino where they can't harm the rest of us.
Futures markets are a means by which coffee processors can lock in the price of future deliveries, but this benefit is not worth its cost. Lots of businesses live with uncertainty--sometimes the acutal price in the future is more than the expected price and sometimes less. A prudent company can survive these fluctuations and thrive on the averages.

The Big Casino

If you are looking for evidence that the stock market is one big casino, note the yo-yo pattern of the markets this week. Up 600 points, down 600, and repeat. If this casino were isolated from the real economy, no one would care, but it is not. To reduce this problem, four European countries have banned negative bets against financial stocks--selling securities that you do not own in hope of buying them back later for less. This is a pure gamble not unlike betting on the horses.
Another casino dealing in petroleum futures accounts for a similar yo-yo pattern in gas prices at the pump. Our lives seem to be at the mercy of gamblers' whims.

DEBT!

Debt has become a scare word meant to paralyze thinking and to create a search for how to reduce it and by how much rather than to examine its assumptions. Here are some facts.
1. All money is debt, there is no other kind.
2. When a bank makes a loan to a business, it creates money.
Policy suggestion:
If a bank can create money for business, why can't the Federal Reserve (the nation's own bank) create money for the Treasury to keep our schools going and the police and fire fighters employed?

Underwater Mortgages

The number of Amricans who owe more on their household mortgages than their house is worth now exceeds 11 million (23% of all mortgaged homes).
One of the marvelous things about capitalism is that a peoples' wealth can increase without any effort on their part as prices increase. The reverse is also true. Through no action on the part of the asset holder, wealth can decrease--occasionally dramatically as in 2008 when housing prices plummeted 20 to 30 percent. Such a big swing in value can make old contracts impossible to honor.

Of course, this was a paper phenomenon, not a tornado that made people homeless, though the physical result was similar. The banks are resisting reducing their mortgages because then they would have to admit they are bankrupt under current banking rules. The government could have changed the rules one-time to allow banks to write-off say 20% of their mortgages' value without it being a charge against their capital in exchange for a similar reduction in what home owners owe.
We celebrate the glory of capitalism, but don't have institutions that acknowledge its inherent volatility.

Tidbits & Outrages

Profits Soar, Employment lags
(items gleaned from the New York Times)
The nation’s workers may be struggling, but American companies just had their best quarter ever.
American businesses earned profits at an annual rate of $1.659 trillion in the third quarter, according to a Commerce Department report released Tuesday. That is the highest figure recorded since the government began keeping track over 60 years ago, at least in nominal or noninflation-adjusted terms.

Return of Conspicuous Consumption
But when it comes to personal indulgences, there are signs that the wallets are beginning to open up. Traders and executives say that jobs seem much more secure. Businesses whose fortunes ebb and flow with the financial markets are thriving again.
“Wall Street is back spending as much if not more than before,” said the New York cosmetic surgeon Dr. Francesca J. Fusco, whose business is booming again after a difficult few years.
Christie’s auction house says investors from the financial world who fell out of the bidding market during the 2008 credit crisis are “pouring” back in.
Expensive restaurants report a pickup in bookings. At the Porter House restaurant in the Time Warner Center across from Central Park, the head chef, Michael Lomonaco, says business is up about 10 percent over a year ago and “people are starting to shake off what happened.” The restaurant is a favorite of A-list Wall Street executives, including Goldman Sachs’s chief executive, Lloyd C. Blankfein.
Real estate agents say Wall Street executives have already begun lining up rentals in the Hamptons for next summer. Dolly Lenz of Prudential Douglas Elliman said the bidding this year was “hotter and heavier” than previous years. “There is a passion now in the market I haven’t seen in a while,” she said.
She said her clients, almost exclusively from Wall Street, were afraid to lose out. Just recently, Ms. Lenz said, she had three people bidding more than $400,000 for a summer rental in Southampton.
And the new Congress wants to extend tax cuts of these people!

Burst Bubble policy

What To Do When Big Bubbles Burst?

Capitalism is beautiful. It is a system whereby owners of appreciating assets can sit on their hands and still increase their wealth. For example, for more than a decade, people could buy a house, and with real estate prices increasing faster than incomes in general, the house was worth more that they paid for it. Their wealth increased without any labor. Anticipation of still further increases in asset values fueled still more increases in real estate prices. This is the stuff of bubbles that the world has seen in its history ranging from the South Seas Bubble, Mississippi Land Bubble, the Tulip Bubble, and more recently, the Japanese real estate bubble in the 1990's.
But, what happens when the bubble inevitably bursts, as it did in 2007-8? It does not take much. Just a little slackening in the rate of increase is enough to begin the reverse movement. Investors head for the exit, but the exits will always be overcrowded. Holders of assets find their wealth decreasing, again without any particular action on their part. Across the country, real estate has fallen by 20 percent, and in the hottest markets such as Florida, Arizona, California, and Nevada, the decline was 30 percent. Few can survive this kind of decline, neither home owners nor mortgage holders. Worst off are homeowners and investment firms that bought with immense leverage. When the market was going up, they profited hugely with very little money down, and when the market headed down, they suffered losses that few had the capital reserves to weather.
What can be done? Some don’t want to even think about it—people and businesses must pay for their sins and excesses, even if it brings the whole economy to ruin, the foolish and the cautious as well. However, the Republican government decided it could not live with big banks going bankrupt and further loans and credit going to zero. So, they rescued the banks by buying some of their mortgages and by adding to the bank reserve accounts kept at the Federal Reserve. The result was that most of the big banks survived, but the little guys with mortgages on their houses greater than the present worth of their homes, suffered. Suffered enough to lash out at the party now in power, voting them out of office and putting in the very party that helped created the bubble in the first place.
What could have been done differently? When a commercial bank makes a loan such as to an individual wanting to buy a house, it creates money. Out of thin air, if you prefer colorful language. When the loan becomes non-performing, money is destroyed, again out of thin air. By law, a non-performing loan becomes a charge against the bank’s own capital—its reserves, its building, etc. As already noted, to prevent the bank from bankruptcy and credit freeze, the Fed gave it reserves. There is another alternative that was never discussed. If declines in home values and broken mortgages is ultimately the result of a law, then the law could be changed.
The rule now causing such chaos serves a good purpose in normal times. It makes the banks consider extending credit without good assurance of repayment. It did not work. In the hubris of get rich quick, banks (and their customers) threw caution to the wind. In crisis times, sticking to the rule adds to the chaos. The law could be changed one time to get the economy out of its morass. If loans created money out of thin air, then the financial contracts can be voided in the same way (or at least greatly reduced) and the banks could start over doing what they normally do. This would have been an alternative to the Fed injecting huge amounts of cash into bank reserves. Moral hazard would be created in any case—the banks may act irresponsibly again if they believe that they are will be bailed out—whether bailed out by the Fed or by a change in the rule of non-performing loans being a charge against their capital. This is a problem we have to live with.
The average person does not understand what drove Bush’s Republican Treasury Secretary, Paulson, to bail out the banks, so they are not grateful for something they can’t understand. All they know is that a lot of money was thrown around and they did not see any of it. None of it helped them with their mortgage payments where the mortgage was larger than the depreciated value of their homes. So they are angry with the Democrats who happen to be in power when the pain peaked. When people are angry, they lash out at whatever they can see.
If the Treasury and the Fed had created money for a larger stimulus and mortgage relief, instead of bailing out the banks (when there was a better way to save them by a rule change), people and the economy would be a lot happier today. We are not the first society to destroy itself by clinging to obsolete institutions. The barriers to full employment are symbolic (in the air, if you will), but few economists or politicians are helping the public understand its options. Treating the problem as if it were a moral failure, as Paul Krugman has pointed out, may doom us to the Japanese experience of over a decade of negative and zero growth after a real estate boom so large it can’t be accommodated with old thinking. Capitalism with its inevitable booms and busts can be saved without so much pain, but it will take bold rethinking of our institutions.

Fannie & Fredie

The Secretary of the Treasury is advocating Federal loans at low interest rates to the mortgage firms known as Fannie and Freddie. This proposal while laudable in purpose further increases the Federal debt. Why do we do it that way? Is money in short supply such that there is a real opportunity costs if diverted? I do not think so. There is plenty of unused capacity in the real economy. There is no reason for taxpayers to consume less so that these mortgages can be extended. Why does not the Federal Reserve and the Treasury simply write a check to Fannie and Freddie? We do it the old way only because we are locked in to old customs and obsolete institutions. It is time for modernization of fiscal policy. I call it zero interest public debt.

Disaster Capitalism

In the 19 months following Hurricane Katrina, New Orleans’ public schools had been replaced with privately run charter schools paid for with public vouchers. The union contracts of teachers were canceled. In her book entitled, Shock Doctrine, Naomi Klein details the “orchestrated raids on the public sphere in the wake of catastrophic events,” thus her term “disaster capitalism.” She sees a pattern in how the Bush administration used 9/11 as an excuse to bomb Iraq. She might have added the attempt to create an impression of a crisis of the Social Security system to replace it with a private alternative, and the weak economy to promote extension of tax cuts for the rich. These people can no longer be called “conservatives,” they are radicals.