The Skeptical Optimist

Two ways to learn something new

In my experience, there are usually two ways to learn any given lesson: the easy way (through advice), and the hard way (through experience).

More specifically, here are the two ways to learn that a main-street credit freeze can turn into a severe recession, or worse:

Method 1: Listen to those who already know what happens and how to prevent the consequences, add that to one's knowledge base, then act on their advice to prevent the consequences;

        OR
   
Method 2: Play political chicken with the economy, refuse to relieve the credit freeze, experience the subsequent consequences, then add that experience to one's knowledge base.

Our esteemed House of Representatives has chosen Method 2 for learning what happens. Today (Monday) we needed Kumbaya around the campfire, but instead we got the same old partisan rants and venom -- the same old win/lose game, instead of win/win leadership.

I wish I could say I am surprised. But I'm not.

Get ready for what could turn out to be a lengthy educational experience, thanks to our expert politicians: Nancy Pelosi, John Boehner, Newt Gingrich, Barney Frank, and a host of others in and around the House of Representatives.

It's not funded by taxpayers

[Now that Capitol Hill has agreed on a package, I hope we can all take a breath. My last article was titled "It's not a bailout; it's the dollar's credibility"; this is a follow-up.]

Seems to me the main sticking point that almost prevented an agreement on the falsely-named "bailout" package was the false impression that we taxpayers will have to reach into our pockets and somehow come up with seven hundred billion dollars on short notice. And I think that false impression resulted largely from the answer Jim Bunning got when he pressed Secretary Paulson for an answer to his question, "Where will the money come from?" Paulson, I think, answered too quickly; "The taxpayers" was his answer.

I wish he had said "bond buyers" instead of "taxpayers," because that's how it will really be funded. But he didn't. He said "taxpayers" -- and, unsurprisingly, that scared a lot of taxpayers.

I checked the wording of the not-a-bailout plan, and it clearly refers to Title 31 of the US Code as one of the main levers the Treasury will use to execute the plan: it will issue treasury bonds, bills, or notes as necessary.

When the Treasury sells T-bonds to willing buyers in the bond market, the transaction does not involve unwilling taxpayers. (Does Jim Bunning know that? How about Ron Paul? I'm not so sure.) In any case, I decided to build an eight-picture series of the "asset swap" to show why taxpayers need not be involved at any point in the swap.

Diagram 1:

The emergency situation as of last Friday. It would remain like this, or get worse, if Congress had not come together over the weekend.

Diagram 2:

Approval of the plan enables the Treasury to go to the bond market -- repeat, the BOND market, NOT the taxpayers -- to obtain funds.

Uh-oh, those new T-bonds indicate that the national debt increased, right? Yes, but please don't have a heart attack yet; keep going.

Diagram 3:

Proceeds obtained from the bond buyers are used to buy up the questionable mortgage paper from the financial sector.

Diagram 4:

Liquidity in the banking sector is restored; banks once again start lending small, medium, and large businesses the money they need to meet their payrolls. The danger of a severe recession or a deflationary depression has been averted. At the same time, the Treasury's rescue process, highly transparent to the public, starts sorting out the good paper from the bad paper. (Let's call this a "cleansing" of the paper.)

Diagram 5:

The Treasury, having made it easier to judge the value of mortgage paper, auctions the paper off. The highest-bidding banks and financial firms buy the paper back from the Treasury.

Diagram 6:

Now the Treasury has money to repurchase T-bonds from willing sellers in the open bond market.

Diagram 7:

If the Treasury's cleansing process reveals enough high-quality paper, auctioning it off could yield a breakeven -- or even a profit -- for the Treasury.

And even if the process yielded a loss, it would mean recovering the difference from the financial sector, or at worst, not buying back quite all of those T-bonds.

Diagram 8:

Can you spot the only difference between this and Diagram 1? Hint: The taxpayers' funds didn't get affected by the process.

Conclusion:
One of the most unfortunate aspects of the last seven days' dialogue, in my judgment, was the mistaken impression that "taxpayers" would somehow have to come up with "seven hundred billion dollars" on very short notice -- and hand it over to Wall Street CEOs. No wonder everybody was angry; clueless talking heads were on every channel, egging us on. I was walking past a TV from which the dangerous renegade Lou Dobbs was sarcastically perpetuating his version of that false characterization, but I didn't get to hear more than a few sentences of Dobbs's uninformed tirade. Reason: his voice always triggers the involuntary reflex of getting myself away from that TV quickly as possible.

Obviously, there are all sorts of details that need to be worked out regarding the cleansing and auction processes -- and there are all sorts of good ideas being floated for those, too. The credit markets have yet to speak today (Monday), but I'm glad Capitol Hill came through with a plan that has only a few ugly ornaments hanging on the basic Paulson/Bernanke package. This should be good news to the markets.

It should also be good news to the taxpayers, to Jim Bunning, and to Ron Paul, don't you think? (I doubt it will do Lou Dobbs any good; he's hopelessly locked into his schtick -- and in any case, I don't care.)

It's not a bailout; it's the dollar's credibility

Today (Friday, 9/26/08) will be an important day in American history. The credibility of the US dollar is at stake, which in turn depends on worldwide confidence in the US economy's future. [Note to gold bugs: see the end note.]

Almost everything I've written about at this blog for the last four years (regarding how bright the future just might be) depends on one huge but intangible asset on the balance sheet: worldwide confidence in the dollar.  Accountants would liken it to an asset called "goodwill"; I roughly estimate the brand name "US dollar" to be worth around fifty to a hundred trillion dollars in present value. If we destroyed that asset, it would be like destroying the most powerful brand name in economic history. 

I hope the Republican holdouts do understand that -- but some of the things I've heard about those who are blocking the rescue package are making me doubtful. If the Newt Gingrich faction "succeeds" in stopping the rescue package, they have a good chance of wiping that hundred trillion dollar asset off the balance sheet in one short weekend.

Frankly, I'm starting to think Gingrich learned nothing at all from his failed 1995 attempt to embarrass Clinton by shutting down the government (...by playing Russian roulette with the meaningless "debt ceiling"). Now it sounds like Russian roulette with the US dollar's future.

I guess we'll know by Sunday evening. Look for a change in tone here if the Republican holdouts put a bullet in our economy's brain. 

===========
By the way, the rescue package is not a "bailout"; it's an asset swap, to be followed by a subsequent swap to get the dollars back -- and it might not end up costing taxpayers a dime. It is beyond me why so many who should know that apparently don't know that.

===========
Final note, for Ron Paul fans, gold bugs, and monetarists:

In the equation of exchange (MV=PQ), the math gets a lot easier when you folks simply assume that V, the velocity of money, is a constant -- which in turn makes it easier for you to argue that any increase in M, the money supply, is "inflationary."

Please remember the old cliche, however, that "assume" makes an ass out of u and me.

How much evidence do you need that the velocity of money can in fact drop to near zero?  That's what is meant by "freeze up," "liquidity crisis," and "cash crunch." How much more evidence do you need that the velocity of money can drop, and when it does, the Fed needs to inject more money just so the economy breaks even instead of going into a tailspin that could very well end up in a deflationary depression?

Please, I'm serious: Just how much more evidence do you really need? (Or do deflationary depressions not bother you, for some reason?)

What shall we do about the board of directors?

The banking upheaval, still in progress, is creating a wave of hindsight scapegoating. Yesterday's Wall Street Journal (9/22/08) was chock full of fingerpointing. But the most concise statement I've heard as to the root cause of the whole mess came from Robert Shiller, when he was interviewed last week by Russ Roberts (listen to it at this page). Shiller's summary: It crossed almost nobody's mind that housing prices might stop climbing. Not buyers, not sellers, not intermediaries, not those who securitized the paper, not those who insured against defaults, not Congress, not the president, not the foreign banks, not you, not me. Almost nobody in the loop thought to include that possibility in their risk/return equations. (One exception: Warren Buffet, who called the risky debt instruments a "time bomb" a few years ago, just before he distanced Berkshire Hathaway from the threat.)

In any case, while I was thinking of all the shareholders (owners) who suffered the Black Swan events of the last few weeks—namely, the sudden surprise of an Enron-style fall in the value of their ownership stakes—I wondered how differently things might have turned out for them if their representatives inside the companies had asked, and obtained acceptable answers to, the above what-if question Shiller says everyone ignored.

So I dusted off a book I read a quarter century ago (see the end note below). Then I read Chapter 12 for the umpteenth time since 1984. The book was written by the retired CEO of ITT Corp; the chapter was about how poorly the owners of the top 500 corporations were being served by their elected representatives (the board of directors); and the recommended solution was still dramatic and thought-provoking, after all these years.

A few excerpts:

Above the exalted chief executive, if you look closely, is a large, amorphous mass, representing the owners of the corporation, the stockholders, who more often than not far outnumber all the employees. And if you look even more closely, you will see that the mass of owners is connected to the corporate pyramid by an archaic, creaking contraption at the top call the board of directors.
       . . .
The board was elected to act in the place of the owners. The board’s responsibility is to sit in judgment on the management, especially on the performance of the chief executive, and to reward, punish, or replace the management as the board, in its wisdom, sees fit. That is what is supposed to happen. That is what may appear to happen. But it doesn’t.
       . . .
Under present conditions, shareholders, whether individuals or institutions, have virtually no way of knowing whether or not they are getting their money’s worth from the [people] hired to manage their company... Over the years [boards] have grown so soft and so ineffectual that most often they are a captive of management, rather than effective representatives of the company owners.

The dramatic solution: Ban corporate employees, including the CEO, from membership on their company's board of directors. In the author's words:

...we would have to make boards of directors genuinely independent of the managements they are there to judge ... The board should represent the owners and only the owners, even as they support valid positions of the management to the stockholders.

The author concludes the chapter as follows:

The impact of a free and independent board of directors upon a company’s management would be profound. Its ultimate effect upon the productivity of this country would be enormous.

Open question:
Republicans and others are fond of saying that America is being transformed into an "ownership" society. Well then, is it time to give all those owners a little more power over the companies they own and the CEOs they've hired?

Feel free to comment; I don't have the answer yet—just the quarter-century-old question. [But after watching this segment of CNBC's Fast Money, I decided that Carl Icahn would smile favorably on the above proposal.]

===============

The book: Managing, by Harold Geneen. You can buy the book for one penny (plus shipping) from Amazon's used book market, at this link. Chapter 12 all by itself is a good whack on the side of the head.

Glenn Beck falls for the fiscal doomsday message...

...without challenging much of anything.  [Link to Beck's videos]

That's really too bad.  The peddlers of the fiscal doomsday message have found a lapdog. Beck's interviews reminded me of the way Olberman interviewed Obama, or the way Hannity interviewed Palin. Hard-nosed journalism is supposed to ferret out the truth, but what I'm seeing these days looks more like slow-pitch softball.

Is it possible that Glenn Beck simply does not know the questions he should be asking?  If ignorance is the problem, that's good news to me — because ignorance is fixable. 

I've written many times here about what's missing from the debate: GDP growth.  Without enough of it, doomsday is our destiny; with enough, easy street is possible; somewhere in between is probably more likely.  But all we ever hear about is doomsday — and Glenn Beck has bought it, hook, line, and sinker, no questions asked.

So, instead of another lengthy explanation of why doomsday might not be inevitable, I'll simply attempt to spoon feed five yes-no questions for the Glenn Becks in the media to pass along to the doomsday crowd.  In my mind's eye, I'm picturing the (highly unlikely) scenario of Glenn Beck asking ex-Comptroller General David Walker to answer each of the following five questions with a simple yes or no, followed by any elaboration he deemed necessary:

Question 1

Mr. Walker, you talk repeatedly of the $53 trillion shortfall in assets versus liabilities on America's balance sheet. But with regard to our nation's assets, is the following statement still accurate? It's by former Treasury Secretary Robert Rubin, excerpted from page 8 of the 1998 Financial Report of the US Government, signed by both you and Secretary Rubin:

The assets presented on the Balance Sheet are not a comprehensive list of Federal resources. For example, the U.S. Government's most important financial resource, its ability to tax and regulate commerce, cannot be quantified and is not reflected. [And that's not the only asset left out...]
—Secretary Robert Rubin, 1998 FRUSG

Question 2

On page 8 of that same report, Secretary Rubin also said this:

The expanding economy [i.e., growing GDP] over the course of the year brought a surge in tax revenue in 1998...

Mr. Walker, do you agree that, as in 1998, a faster-expanding economy would cause future tax receipts to rise faster, even if tax rates remain unchanged?

Question 3

Mr. Walker, you've said we won't "grow our way out of the problem." But given the overwhelming effect that GDP growth has had on tax receipts in the past, do you honestly think economic growth deserves only a terse dismissal — instead of a more detailed explanation? 

Question 4

Mr. Walker, below is an important chart from page 16 of the 2003 Financial Report of the US Government, signed by you. The chart is important because GDP growth rates drive tax receipts, as Secretary Rubin explained above.

Would you please furnish us with an update of this same chart, extended out 75 years into the future? That would allow us to compare the GDP growth we have experienced in the recent past with growth assumptions you are using in your widely publicized forecasts for the long term future.

Question 5

Mr. Walker, you projected that we will eventually run our debt/GDP ratio far beyond our post WW2 high of 100+ percent. Would you agree that keeping the ratio of debt to GDP at approximately today's level (64%) would require an economy that grows at the same rate as the debt, but would not require a balanced budget — and would you therefore be willing to define the much ballyhooed term "fiscal responsibility" as "the condition achieved when the debt grows no faster than the economy"?

Try to picture Glenn Beck asking those questions. I know, it's bizarre; but I keep trying to picture it anyway.

YouTube: Food for thought about the national debt

Eureka. This guy thinks a lot like I do, and just might get a few others thinking a little harder during this campaign season.

It's mostly facts, plus one hypothetical to illustrate the point. (The hypothetical: "What if we saved up $6 trillion cash out of our disposable incomes in order to retire all the debt?").

Next time, this guy should use a brighter light and larger fonts, but that's just a nitpick. 

Here it is:
National debt food for thought.


ps- Looks like you have to watch it in "high quality" -- I couldn't get it to come up in "standard quality."  Also, be sure "annotations" are turned on. (Thanks for the heads up, Andy.)