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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 15 2012

Austerity: A Balanced Approach?

C.M. Phippen

Concerns are spreading that Germany is on the verge of losing its safe-haven status for investors. According to Bill Blain, co-head of the special situations group at Newedge Group Ltd, “[Germany] isn’t a pure safe haven anymore.” As it finds itself potentially on the hook for an additional 100 billion euros ($125 billion) after the EU bailout of Spanish banks earlier this month, investors are starting to see the cracks in the foundation of what has been a star in the EU economies.

Not only does the most recent bailout scare off private investors from Spain, who know they will be the last in line if the country does eventually default, but most analysts fear this bailout is only one of many. Estimates of future liquidity injections in Spain alone are as high as 700 billion euros, which would decimate the EU rescue funds.

Despite German fiscal restraint, high worker productivity and relatively low levels of unemployment, apparently a system where a minority put in the serious work and everybody else lives off of their largess while sipping margaritas, is an unsustainable system.

As Angela Merkel recently stated, “Germany’s powers are not unlimited,” and “All the (aid) packages will ring hollow if you overestimate Germany’s strength.” Even the German economy can be dragged down by too many dependents pulling at it for too long.

It’s time for the rest of the European countries to start playing by the rules of success, the rules of true austerity.

In Britain, promises to reform social programs and cut taxes and spending were made by Gordon Brown just before leaving office, but instead he increased the top marginal income tax rate. In 2011-2012, spending increased, the public pension system is still not reformed and “the government increased the capital gains tax, national insurance tax and value-added tax along with other fees and duties.”

In Spain, while the retirement age was increased from 65 to 67, no structural reforms have been made to entitlements. Additionally, myriad tax rates have been increased, from income and property taxes to tobacco taxes (up 28 percent). While the current budget calls for spending cuts as well as tax increases, there is little chance that the tax increases will bring in the expected revenue because of a lack of economic growth. With entitlement spending unchecked, deficits are projected to continue rising.

France’s spending increased $33.4 billion between 2009 and 2010, and $29.5 billion in 2011. The Socialist government there also plans to implement a new 75% top marginal income tax rate for anyone earning over $1.3 million, in addition to an increase in the corporate income tax rate. At the same time, they are promising significant public sector hiring, a decrease in the retirement age and an increase in the minimum wage, which has been shown to price the least skilled workers out of the labor market.

According to recent research, a “balanced approach” to austerity (isn’t that the new progressive catch phrase?) doesn’t end well. An austerity program that involves both tax increases and spending cuts does not successfully stabilize debt and leads to economic contractions in the marketplace.

Harvard economists Alberto Alesina and Silvia Ardagna looked at 107 examples of austerity in developed countries over a period of 30 years and found that spending cuts without tax increases were the key to significant debt to GDP ratio reductions. They also discovered that when those spending cuts were accompanied by structural reforms, easy monetary policy and a liberalization of markets, economic expansion was most often the result.

Across the ocean here at home, the story is, unfortunately, much the same. While we could continue down our current path of demonizing the rich and blaming them for not paying their fair share (who can possibly believe that the top 5 percent paying 59 percent of federal income taxes while earning only 35 percent of total national income is somehow not their “fair share”?!), all the while threatening onerous taxes and regulations, we wonder why corporations are sitting on massive amounts of cash and refusing to hire new workers.

President Obama’s claim that his policies would “have this done” (fixing the economy) within three years and Clinton’s encouragement in 2010 to “vote ‘em out” if the economy weren’t fixed in two years lead me to think that this administration is honestly and genuinely surprised that their understanding of the economy just isn’t reality.

Welcome to the world the rest of us live in . . .


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.