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Jun 23 2012

Principles or People

C.M. Phippen

I happened to notice the other day someone blaming President Reagan for the recent recession. Back in 2009, this was a somewhat common liberal refrain, and Paul Krugman repeatedly exclaimed that Reagan was responsible for the economic crisis because he was behind legislation (co-sponsored and passed by many Democrats as well as Republicans) that allowed for home purchases without large down-payments and that freed up the consumer credit market.

Here is no better example as to why we must discuss and focus on principles rather than people. I’ve never met a Democrat who didn’t support affordable housing policies or legislation that would make credit more available for those whose behavior doesn’t merit it. Funny how when the other guy agrees with you and things go wrong, it’s the other guy who was wrong.

Here is a list of statements or actions of individuals from both sides of the aisle regarding housing policies prior to the bubble bursting; see if you can figure out who said or did what.

1.”The White House doesn’t think those who can afford the monthly payment but have been unable to save for a down payment should be deprived from owning a home.”

2. “Fannie Mae has expanded home ownership for millions of families in the 1990s by reducing down payment requirements. Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.”

3. “In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders . . . Fannie Mae . . . has been under increasing pressure from the X Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.”

4. There exists deep concern “about increased mortgage market fragility, which, combined with growing bank portfolios in high-risk products, pose serious potential problems that could occur with dramatic suddenness.” And failure to adjust bank underwriting, reserves and capital to account for this growing risk “means that downturns from credit and/or interest rate events – let alone shocks – will be far more severe than” if precautions are taken. What is “disturbing to us is the fact that recent trends could lead to sudden increases in foreclosures.”

5. “Fannie Mae and Freddie Mac have played a very useful role in helping make housing more affordable.” Critics “exaggerate a threat of safety” and “conjure up the possibility of serious financial losses to the Treasury, which I do not see.”

6. Congress should, “enact legislation to create a new Federal agency to regulate and supervise” Fannie and Freddie because of the risks they were taking. “The concern is, if something unravels, it could cause systemic risk to the whole financial system.”

7. If Congress doesn’t reign in Fannie and Freddie, “there will be a massive default with huge losses to the taxpayers and systemic effects on the economy.”

8. “Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately.”

9. “President X issued America’s Homeownership Challenge to the real estate and mortgage finance industries to encourage them to join the effort to close the gap that exists between the homeownership rates of minorities and non-minorities. The President also announced the goal of increasing the number of minority homeowners by at least 5.5 million families before the end of the decade.”

10. “Back in 2005 and 2006, I argued as forcefully as I could . . . that the mortgage market would melt down in the second half of 2007, causing substantial damage to the economy.”

11. “[W]e do not have a crisis at Freddie Mac, and in particular at Fannie Mae . . . What we need to do today is to focus on the regulator, and this must be done in a manner so as not to impede their affordable housing mission, a mission that has seen innovation flourish from desktop underwriting to 100 percent loans. . . . These GSEs have more than adequate capital for the business they are in: providing affordable housing. . . . we should not be making radical or fundamental change.”

While conservatives and liberals were both supporting the expansion of affordable housing programs which not only made housing less affordable but put those least able to afford homes into them, the voices of warning were mainly coming from those outside of government. Private businesses that knew the bursting of the housing bubble could destroy them or who could profit from it, were able to see and acknowledge the downside of decades of feel-good government giveaways. Those in government were possibly too invested in the sham to see its risks, or too inexperienced in economics to understand.

Will the next bubble look any different and will the blame game remain the same? Let’s not wait to have this discussion in another decade, after the bursting of the student loan bubble, driven by the astronomical rise in college tuition due to government intervention and subsidies. Are we listening to those trying to warn us this time?

1. John Weicher, Federal Housing Commissioner (2004)
2. Franklin D. Raines, Fannie Mae chairman and CEO, Bill Clinton supporter
3. The New York Times (1999) talking about the Clinton administration
4. Suzanne Hutchinson, executive at Mortgage Insurance Companies of America (2005); http://www.foxbusiness.com/markets/2010/02/02/housing-red-flags-ignored/#ixzz1yb1vJQiv
5. Congressman Barney Frank (2003)
6. US Secretary of the Treasury John W. Snow (2003 & 2005)
7. Peter J. Wallison, scholar at American Enterprise Institute, (2005)
8. Federal Reserve Chairman Alan Greenspan (2005); http://www.nytimes.com/2010/04/04/opinion/04burry.html?pagewanted=all
9. Bush administration (2002); http://www.dailykos.com/story/2008/09/23/607383/-George-Bush-proud-parent-of-the-mortgage-crisis
10. Michael J. Burry, investment advisor at Scion Capital (2010); http://www.nytimes.com/2010/04/04/opinion/04burry.html?pagewanted=all
11. Maxine Waters, Congressional Representative from CA (2003); http://www.discoverthenetworks.org/Articles/The%20Secondary%20Mortgage%20Market.html

Quotes without a weblink were taken from the Thomas Sowell book, The Housing Boom and Bust, New York: Basic Books, 2009.


Jun 2 2012

Get the Job Done or Get Out

C.M. Phippen

Last week I wrote about the fact that President Obama seems to want to make excuses for everything that he deems as getting in the way of him delivering his promised hope and change. Nothing works out quite like he believes it will, and yet he behaves as though there are no other options.

It was interesting then, to hear him criticizing Romney’s experience with Bain Capital. While Romney has a proven track record of turning around companies that are suffering from adverse circumstances brought on by world events, prior poor management, bad luck, structural changes in the economy, etc. Obama looks at these very same types of challenges, throws up his hands and says he can’t.

A friend recently shared with me her husband’s experience working for Bain & Co. many years ago. His job was to turn around companies and make them profitable in under six months, to take them from losing money to earning profits. Of course, as we all know, companies making money tend to hire and/or retain workers; companies losing money tend to lay off workers. And mind you, in under six months.

Admittedly, the US economy is a much larger, more complicated beast, but the principles for success and sustainability are still the same. “If I don’t have this done [the economy fixed] in three years, then this is going to be a one-term proposition.” Apparently, he felt that giving him 500 percent more time than a business consultant would get was adequate to prove the effectiveness of his strategies.

Not only did Bain Capital (the investment firm), under Romney, have a 78 percent save rate with regard to companies that were headed toward bankruptcy before Bain stepped in, but when Bain & Co. (the consulting firm) itself was headed for trouble in the early 90s, Mitt Romney was the person called in to turn around that company. Within a year under Romney’s leadership, Bain & Co. was again profitable and able to grow throughout the 90s at a rate of 25 percent per year, more than doubling the number of offices and increasing the number of employees.

On the other hand, the Obama administration handed out large amounts of money to various failing companies that have continued to fail even after receiving grants and loan guarantees from us, the taxpayers. Marc A. Thiessen had a piece in the Washington Post that outlined Obama’s record of public equity failures. These included:

Abound Solar, Inc. received a $400 million guarantee, drew on $70 million before halting production and laying off 180 workers.

Beacon Power received a $43 million taxpayer loan guarantee and filed for bankruptcy in fall 2011. We can assume loss of jobs for 100% of the workforce.

ECOtality received $126.2 million in taxpayer money. The company has sustained $45 million in losses and claim to have no foreseeable profits anywhere in the future.

First Solar received $3 billion in loan guarantees, yet the company’s trading price fell to record lows this month due to “$401 million in restructuring costs tied to firing 30 percent of its workforce.”

Nevada Geothermal Power (NGP) was given a $98.5 million loan guarantee in 2010. As of October 2011, its own auditor concluded that there was “significant doubt about the company’s ability to continue as a going concern.”

Raser Technologies was given a $33 million grant and filed for bankruptcy protection this year. The plant for which the money was used has fewer than 10 employees and owes $1.5 million in back taxes.

SunPower received a $1.2 billion loan guarantee and now owes more than it’s worth.

Many of the companies this administration chose to invest in were rated as junk bonds. Maybe that’s because “71 percent of the Obama Energy Department’s grants and loans went to ‘individuals who were bundlers, members of Obama’s National Finance Committee, or large donors to the Democratic Party.’” And maybe that’s why over 100 investigations have been launched relating to the Department of Energy’s green energy programs.

If this is what Obama calls capitalism, no wonder he thinks it doesn’t work.

The very things Romney was able to overcome at Bain are the very things Obama claims are outside of his control. Could it be that our president is right, that he just isn’t capable of working through the roadblocks in his way? If so, then I guess it’s time to elect someone who is.


May 26 2012

What Is It that Our President Actually Does Know?

C.M. Phippen

The greatest economy the world has ever seen, the one responsible for the majority of the medical and technological innovation of the past century and for leading the way in eradicating 80 percent of the world’s worst poverty in the past 40 years, is being run by a man who claims himself a victim at every turn.

With each succeeding policy failure, President Obama can’t help but claim he just didn’t understand or for some reason he just had no power to overcome the obstacles in his way.

While holding the most powerful office in the world, he is paralyzed by events outside of his control. He blames Pres. Bush, natural disasters, Pres. Bush, Arab Spring, Pres. Bush, bad luck, Pres. Bush. In one of his most astounding excuses yet, he blamed a lack of job creation on greater efficiency (“structural issues”) in the economy.

The difficulties faced by our president are simply a part of the realities of life. Does Obama truly believe that no man before him has ever dealt with a financial crisis, a predecessor whose policies he didn’t agree with, bad luck, a shifting labor market or natural disasters? What if every man before him chose to make the same excuses or to walk away from the real solutions because they weren’t a part of his political strategy?

In every past recession over the previous 100 years, entrepreneurship has led us out and placed us back on the path to greater prosperity. For the first time ever, this is not occurring. Does President Obama even stop to ask why?

Over 4,000 new federal regulations are in the pipeline and “pending major regulations – those costing the economy $100 million or more – have increased 60 percent since 2005.” Recently, “20 percent of small-business owners said ‘government regulations and red tape’ was the single most important problem facing their business,” ranking ahead of anything else, including poor sales.

According to President Obama, because of these structural changes, “. . . what we have to do now . . . is identify[ing] where the jobs for the future are going to be; how do we make sure that there’s a match between what people are getting trained for and the jobs that exist; how do we make sure that capital is flowing into those places with the greatest opportunity.”

Entrepreneurs just figure those things out on their own. They don’t need a government program so that a bureaucrat who’s never run a company, met a payroll or put his life’s savings on the line to start a company can make decisions as to the proper allocation of resources within the economy; let alone rely on that individual to determine where those resources will be most needed at some point in the future. In a dynamic economy, where growth is encouraged, someone will always step up and take a risk as long as that risk has the potential for a commensurate reward in the end.

When has a centrally planned economy, or any variation of it, actually worked?

Here’s a guy who’s admitted that when he entered office his administration had no idea how bad this downturn was, despite the fact that he claimed it was the worst economic crisis since the Great Depression and called it a crisis of historic proportions. Yet he wants us to trust that he and his administration have the expertise to know how to allocate the various resources administered through the federal government in order to adequately train the unemployed to be prepared for the jobs of the future? He doesn’t even understand what the jobs and businesses of the future are.

This is the guy who told us that Solyndra was a model for economic growth, one of those companies of the future. As I wrote in an earlier post, while Obama was touting the “ingenuity and dynamism” of Solyndra, T.J. Rodgers, founder of Cypress Semiconductor, former Chairman of Sunpower and a man who apparently knows what real ingenuity and job creation look like, had a very different take. He has said that on the day of President Obama’s visit to Solyndra in 2010 a secretary asked him what it meant that the President was there, visiting their competitor. His response apparently was, “Set your watch. That company will be out of business in one year.” So much for Obama’s ability to judge the future.

This is the same guy who told us that if his massive stimulus of nearly $1 trillion were passed, we wouldn’t see unemployment rise above 8 percent. What we haven’t seen is it actually come down below 8 percent at any point since.

This is the man who told us that recovery summer was two years ago. Most of us are still waiting, as are the many businesses that are choosing to sit on the sidelines with record amounts of cash and not hire new workers in such an uncertain environment. Those threats to tax the rich and blame corporations may actually have a downside.

This is the same guy who said that the healthcare bill “will help reduce our deficit by as much as $1.3 trillion in the coming decades, making it the largest deficit-reduction plan in over a decade.” Updated CBO estimates now project cost increases over 10 years from $938 billion to $1.76 trillion, and that’s before we’ve had to actually start paying. If history is any indication, the cost is likely to be many times greater than even the new estimates.

Yes, still the same guy, the one who said that with his new healthcare bill, “Families will save on their premiums.” Unfortunately, though the CBO initially projected per family premium savings of over $2,500, more recent studies show increases of over $1,500 above what premiums would have been without the legislation.

Exactly what is it this guy actually does know? Maybe this, “We can’t doom another generation of Americans to soaring costs . . . and exploding deficits.” Yep, same guy.


Aug 20 2010

Financial Crisis and Unintended Consequences

C.M. Phippen

During most of this past decade, the housing market rose at an unprecedented rate (12.5% in one year alone), only to come crashing down in 2008 to such a degree that $4.5 trillion in US wealth was lost. What were the circumstances that converged to cause the rate of mortgage securitization to increase over seven-fold from 2001 to 2006, allowing the underwriting of high-risk loans without fear of having to hold those loans? The answer, surely, is a complicated one, but simply chalking it up to the greed of Wall Street while refusing to look below the surface is a bit too simplistic for me.

The banking crisis which stemmed from the bursting of the housing bubble was concentrated in commercial banks, but contrary to popular belief and the myth of “lack of regulation,” the commercial banks were more heavily regulated than were the investment banks. While the investment banks were caught holding large inventories of MBS’s they hadn’t yet sold off and mortgage loans that hadn’t yet been securitized, commercial banks held large numbers of mortgage-backed securities that became essentially worthless and put many at substantial risk of failure, all while being heavily regulated.

In 2001, the Federal Reserve, along with the FDIC, Comptroller of the Currency, and the Office of Thrift Supervision instituted what is known as the recourse rule. This rule was meant to steer the funds of banks into “safe” assets and make it attractive to buy MBS’s as opposed to actually lending out their own money. (In 2006, a similar rule was instituted for non-US banks, exposing them to the same types of risk just before the housing meltdown in 2008.)

[U]nder the recourse rule, “well-capitalized” American commercial banks were required to spend 80 percent more capital on commercial loans, 80 percent more capital on corporate bonds, and 60 percent more capital on individual mortgages than they had to spend on asset-backed securities, including mortgage-backed bonds, as long as these bonds were rated AA or AAA or were issued by a government-sponsored enterprise (GSE), such as Fannie or Freddie. Specifically, $2 in capital was required for every $100 in mortgage-backed bonds, compared to $5 for the same amount in mortgage loans and $10 for the same amount in commercial loans.

As the demand for MBS’s increased, so did the supply from Wall Street and the GSE’s. This timing coincided nicely with the fact that major pressure had been put on banks during the 1990s to make loans to individuals who wouldn’t qualify under traditional guidelines. The banks, of course, weren’t willing to hold on to those loans – they simply sold them off to Wall Street and bought back highly rated bonds that offered them a huge tax advantage.

As I’ve written in a previous post,

According to economist Milton Friedman, the use of political channels, as opposed to the market, for the provision of resources leads to the straining of social cohesion. The reason for this is that markets allow diversity, while government policies require conformity. In Capitalism and Freedom, he states that the more extensive the range of issues we attempt to solve through political means, the greater the strain on the “delicate threads that hold society together.”

The problems found in the issue of lack of diversity v. conformity apply when dealing with economic issues, as with other public policy issues. Regulations have the express purpose of homogenizing behavior, and in a capitalist system where competition reigns supreme, the natural state is one of diverse behavior, ideas, and experimentation.

If capitalists stop acting heterogeneously–if they compete through imitation, rather than innovation–the risk of systemic failure increases . . . Regulations are like mandatory instructions for herd behavior, automatically increasing systemic risk.

The more we expect the government to regulate, the more we can expect risk to increase throughout society and have a greater and greater negative impact on ever-larger numbers of people. Is there another way?


Jul 29 2010

70/30 Nation

C.M. Phippen

So, 36% of the American public thinks Obama is doing a good job on the deficit. In fact, 23% didn’t think the stimulus package added to the deficit at all. That level of miseducation is astounding to anyone even the slightest bit economically informed. The federal deficit for the 2010 budget is projected to be 10.6% of GDP, with an expected increase even higher next year. This, even though according to our President, we’re in the middle of recovery.

Federal discretionary spending increased over 80% from 2008 to 2010, thus resetting the baseline at an extraordinarily high level. Every new budget going forward starts at that point and goes upward from there; any reductions are considered cuts – something that almost never happens in Washington. What does tend to happen is that spending will increase each year, thus ensuring greater and greater deficits, and an exploding national debt as far as the eye can see.

Deficits under George W. Bush were in the 1-3.5% range until 2009, for which President Bush and President Obama were both responsible. Most of us believed spending was out of control under Bush, only exacerbated by the $800 billion (ten year) price tag on Medicare Part D.

President Clinton was elected to his first term in office with a minority of the popular vote, which had been split by Ross Perot with 19%. What was the issue that so divided fiscal conservatives and was the basis of Perot’s campaign? Concern over a deficit of approximately 4% of GDP.

A quick review of articles written during the Bush administration attests to the fact that liberals have been consistently concerned with out-of-control deficits during periods of time when they’ve been a fraction of what they currently are. I certainly hope this concern is genuine rather than political and we’ll soon see wide-ranging support for massive spending cuts in order to meet the historically consistent level of spending at 18-20% of GDP.

Politicians from both parties have been selling out the future of our country in order to buy votes in the here and now, and the rest of us just can’t afford this party any more.

In The Battle, Arthur C. Brooks outlines a consistent 70/30 split among the American population. That is pretty much what we see in this support for current policies dealing with budget and spending issues.

Nearly 70% of Americans agree that they’re better off in a free market economy than not, “despite its severe ups and downs.” Fifty-six percent of Americans believe their income taxes are too high, while 33% believe they’re just right. Astoundingly, while many Americans believe that the rich should pay more taxes, 69% believe that the top tax rate should be 20% or lower! Seventy-six percent believe the strength of America is based on the success of American business and 66% believe that when “big business” earns a profit it helps the economy; alternately, 18% believe it hurts (where did they go to school?) When asked if they would prefer larger government with more services and higher taxes or smaller government with fewer services and lower taxes, only 21% of Americans chose larger, more expensive government while 69% preferred smaller.*

There is a minority of the population, the 30%, who will, due to lack of understanding or pure ideological drive, charge ahead in attempts to completely redefine and transform this nation of freedom and wealth which was unimaginable in the world just a few centuries ago. It is the rest of us, the 70%, the mainstream of America, who stand in their way. It’s time for the politicians to represent us.

(Polling data excerpted from The Battle by Arthur C. Brooks, Basic Books, 2010, pp. 3-12)


Mar 15 2010

Accounting Fraud and Short Sellers

C.M. Phippen

Fascinating discussion Friday on CNBC about the falsification of Lehman Bros. balance sheets prior to their collapse. The fraud was completely missed by regulatory agencies despite extensive government oversight by the SEC and the NY Federal Reserve, who had regulators inside Lehman after the Bear Stearns meltdown. Sarbanes-Oxley, put into place after the Enron scandal to ensure that such a thing never happened again, failed to keep Lehman honest, and numerous other rules and regulations had no effect either. Even Ernst and Young, Lehman’s accounting firm, still stands by Lehman’s practices which apparently amount to outright fraud.

Who investigated and discovered the problems? Short sellers. Could it be that those with an economic interest are in many ways more effective regulators than the government? (Not to say we don’t need some government regulation, to be sure, so don’t even go there.)

Watch the video, and tell me what you think.