paulbissett.com

The problem with public-service “unions” (and any industry that gets public subsidies) is that they are not truly negotiating with their managers (the elected representative) in an arms-length transaction.

In an arm-length transaction the unions would negotiate with management for a share of the corporate profits.  If the company pays too much of its resources to shareholders, management, or union, then the company goes out of business. There is an inherent requirement in union negotiations that they do not try to take an excess share of profits because in doing so, they will eventually destroy the company and themselves.

Governments have no profits; they just have tax- and fee-based revenues. The control and use of the taxing authority of the government resides in the elected officials. An elected official that is beholden to a public-service union (or any other subsidy receiving industry) is not dealing in an arms-length transaction in negotiating with the unions for their pay and benefits.

In a polarized political environment, this “corrupt” situation is exacerbated because both the unions and the elected official are fighting for their paychecks. If the elected official loses their elected position, they lose their paycheck, power, and podium for advancement. There is a direct benefit for the union-leaning politician to give more pay to the unions so the unions can give more direct campaign contributions, as well as support the politician through volunteer efforts. This effect more tightly weds the favored politician to the union because each are fighting for their preservation against those tax-payers who would direct the available tax revenues to other uses.

This is not a theoretical possibility, but in fact the reality of today’s political environment. Public service unions were the largest single supplier of election funds in the 2008 elections outside of the political parties themselves. These funds were given almost completely to the Democrats, who promised to continue to support their pay and benefits.

This is a “corrupt” system, where corrupt is defined as being unsupportable in the long-run because eventually the tax revenues can not support the system and the system collapses upon itself. See Greece’s current economic conditions for an example of what happens in the long-run if this system is allowed to become entrenched.

The same problem extents to any industrial group seeking subsidies or other transfer payments from the government, whether it is the oil & gas industry, the farming industry, etc.  If those payments are used to lobby or elect political representation, it is bad for democracy, it is bad for the economy, and most importantly it is very bad for tax paying citizens.

It is very bad for citizens because this is a corruption of the democratic system required to maintain economic balance and longevity to any civil society.

Updated March 14, 2011:
In Wisconsin, police and firefighting unions are threatening to boycott businesses that do not support their efforts to over-turn the recent Wisconsin laws.

The subtle long-term threat about which I wrote has moved into direct threats against citizens from the civil servants responsible for protecting those citizens.

Free association is a guaranteed right in this country. No one has suggested otherwise in any of the reasonable debates about public service unions.

The police and firefighter unions were explicitly excluded from the new Wisconsin laws. Yet, the police and firefighter unions are leading the threats against businesses if they do not sign a petition to rescind these laws.

“Corruption” has taken on a new definition with respect to the impact of public service lobbying on democracy.

The world-wide bailout of Greece would be funny were it not so indicative of attitudes by some that you can take more from an economic system than can be created by its participants.

The Greek problem is in a large part the result of the inadvertent corruption of democracy when those who want to use the productive capabilities of others are given unfettered power to do so. This power can accrete slowly, sometimes over decades, but when it starts, it is very hard to stop.

In this case, the Greek bureaucracy began to exert control over the taxing and spending powers of the government by (legal and illegal) contributions to elected officials who supported their desire for more money and benefits. These contributions were collected from their members’ salaries; salaries that were paid for by tax and bond revenues assessed by the elected officials. Union members naturally supported the increase in their salaries and benefits packages. This, of course, also led to the collection of greater union dues, which in turn led to greater contributions to elected officials who would raise tax and bond revenues to pay union members.

This corruption of the control of resources within the Greek society created a positive feedback loop for tax increases and bureaucratic expenses that drained their economic resources. The situation of allowing people who directly depend on tax and bond receipts to elect the officials responsible for determining the assessment of taxes and the selling of bonds is analogous to “putting the kids in charge of the cookie jar”.

George Will has a great article on the recent mess.  In it he states -

Greece represents a perverse aspiration — a society with (in the words of Wisconsin Republican Rep. Paul Ryan) “more takers than makers,” more people taking benefits from government than there are people making goods and services that produce the social surplus that funds government. By socializing the consequences of Greece’s misgovernment, Europe has become the world’s leading producer of a toxic product — moral hazard. The dishonesty and indiscipline of a nation with 2.6 percent of the eurozone’s economic product have moved nations with the other 97.4 percent — and the United States and the International Monetary Fund — to say, essentially: The consequences of such vices cannot be quarantined, so we are all hostages to one another and hence no nation will be allowed to sink beneath the weight of its recklessness.

Recklessness will proliferate.

Those with kids understand that the risk of putting the kids in charge of the cookie jar is not that they will eat all the cookies. Instead the greater risk is that their lack of self-control will make them sick, and in turn, may cause greater problems for those around them.

It is not the child’s fault for eating all the cookies when we put them in charge of the cookie jar; rather it is the adult-in-charge’s fault for enabling them with the opportunity to do so.

In Greece, the “children” have taken to the streets to murder private sector employees because they were told they could no longer have everything they wanted. Whose fault is this? The children or their enablers.

Adults in our society need to learn the word, “No.” and we need to use it.

Could this happen here? The answer is it already has in California. The following is from a Wall Street Journal Op-Ed by David Crane -

In 1999 then California Governor Gray Davis signed into law a bill that represented the largest issuance of non-voter-approved debt in the state’s history. The bill SB 400 granted billions of dollars in retroactive pension boosts to state employees, allowing retirements as young as age 50 with lifetime pensions of up to 90% of final year salaries. The California Public Employees’ Retirement System sold the pension boost to the state legislature by promising that “no increase over current employer contributions is needed for these benefit improvements” and that Calpers would “remain fully funded.” They also claimed that enhanced pensions would not cost taxpayers “a dime” because investment bets would cover the expense.

What Calpers failed to disclose, however, was that (1) the state budget was on the hook for shortfalls should actual investment returns fall short of assumed investment returns, (2) those assumed investment returns implicitly projected the Dow Jones would reach roughly 25,000 by 2009 and 28,000,000 by 2099, unrealistic to say the least (3) shortfalls could turn out to be hundreds of billions of dollars, (4) Calpers’s own employees would benefit from the pension increases and (5) members of Calpers’s board had received contributions from the public employee unions who would benefit from the legislation. Had such a flagrant case of non-disclosure occurred in the private sector, even a sleepy SEC and US Attorney would have noticed.

Let me repeat here. We need to learn the word, “No.” And we need to learn to use it.

The juxtaposition of several articles hit me all at once today.  The first was a great article by T. Friedman in the New York Times on the exaggeration of the “decline” of the United States.  It was a solid article on the ingenuity of the American people, as well as the advantages in US immigration and population demographics.  The economic possibilities afforded to the US by these advantages should lead to increasing economic growth in the coming decades.

This was balanced by the two articles in the Wall Street Journal that discuss youth unemployment and the current discussion in Washington, DC of a federal Value Added Tax.

Here’s the gist -

From Daniel Henninger’s article -

The U.S. unemployment rate for workers under 25 years old is about 20%.

This is similar to the perpetual unemployment rate for youth in old Western European nations.

These are the Western European nations that spent the postwar period free of Soviet domination. With that freedom they designed what came to be called the “social-market economy,” a kind of Utopia where a job exists to be protected and the private sector exists mainly to pay for the state’s welfare plans. … In the final month of 2009, these were European unemployment rates for people under 25: Belgium, 22.6; Spain, 44.5; France, 25.2; Italy, 26.2; the U.K., 19; Sweden, 26.9; Finland, 23.5.

Couple these unemployment statistics for youth with this tidbit from the WSJ Editorial Board -

“Answering a question at the New York Historical Society on Tuesday, Mr. Volcker said that a VAT—a consumption tax levied along stages of production—”was not as toxic an idea” as it has been, and that both a VAT and some kind of tax on energy need to be on the table. “If at the end of the day we need to raise taxes, we should raise taxes,” he said.

The VAT has been a staple of European taxation policies for decades, and high rates of taxation is one of the causal mechanisms of slow economic growth in the countries.

In the middle of the worst economic situation in nearly a century, we are building the economic policies that replicate the social welfare state of old Western Europe.  These policies have led to perpetual under-employment (particularly of youth and immigrants), low economic growth rates, and stratification of the economic classes (i.e. limited upward mobility amongst the economic classes).  Is this the future model of the US economic system?  I hope not.

Long-term economic survival requires a successful risk/reward system that provides opportunities for great success, and great failures.  Why?  Because without a risk/reward system (with both the highs and lows) you get a steady state society that eventually leads to stagnation.  And stagnation of an economic system will eventually lead to its demise.

In short, you can not (over) tax the system to reduce economic disparities; nor can you (over) regulate the economy, and the people, to keep bad things from happening them.  If you do, the system stops working.

Economic policies can be compared to forestry management policies.  Bad forestry management (as practiced in the middle to end of the last century) tries to put out all fires – everywhere – all the time.  The result is that when a fire eventually happens, the dead wood and scrub brush fuel load is so high that the fire burns too intensely hot and destroys the forest.  Good forestry management requires an occasional (small) fire to reduce the fuel load.

Adequate risks and rewards serve this same purpose in the economy.  You cannot reduce the risk of failure (or any other personal catastrophe) to zero.  If you do, the accumulation of bad (dead) wood will burn your (economic) house down.  In addition, a vibrant growing economy, like a forest, needs clear access to resources (like capital) without the choking over-growth of underbrush, deadwood, and over-regulation.

I have been meaning to write about what I expect mortgage rates to do once the Federal Reserve ends its purchases of Government Sponsored Enterprise (GSE)-backed mortgage bonds (i.e. Freddie Mac, Fannie Mae, and Ginnie Mae). The Fed stepped into the market to support liquidity in the housing industry, and is expected to complete its $1.25 T in the next month. The big question has been, “What will happen to mortgage rates?” when the Fed stops buying.

There are some who would argue for an expected increase of 50 basis points in spread widening between treasuries and Mortgage-Backed Securities (MBS). (By the way, Calculating Risk is becoming one of my favorite financial blogs.)

It certainly makes sense to suggest that the price for MBS will fall (and hence yields will rise) once the major buyer of these securities stops buying. However, I don’t think that this will happen, and its a perfect example of why statistics can bite you in the rear when analyzing market trends.

This graph from Politico.com shows the history of 30 yr mortgage rates in relation to 10 yr treasury bonds.

The problem is that it is in the past, and does not reflect the fact that today the GSE’s are wholly-owed subsidiaries of the US Government. The current private market buyers of MBS now consider these bonds to essentially be the same as treasuries (and so does the Congressional Budget Office). Until this changes, the MBS will continue to trade at historically compressed levels compared to treasury bonds, and mortgage rates will continue to remain low.

One could also argue that the recent troubles in the EU may actually cause money to flow into the US fixed income markets, further compressing spreads as foreign buyers of these fixed income securities seek greater yields than are offered on treasuries.

For mortgage rates to significantly change, the following needs to happen – (1) inflation begins to be priced into the market and 10 yr treasury yields go up (maybe), and/or (2) the US Government stops backing the GSEs (unlikely), and/or (3) the Fed starts selling its $1.25 trillion holdings of MBS (again unlikely).

A new study from New Jersey suggests that wealth leaves when tax rates increase. New Jersey’s Chamber Chairman Dennis Bone says it is

crystal clear that the state’s tax policies are resulting in a significant decline in the state’s wealth.

A more insidious effect is that the study found a

less-robust “in-migration,” the study finds that people who are moving to New Jersey aren’t as wealthy as those leaving.

So why would one care about those wealthy people who want to “escape” paying their “fair share”.

Well for one thing, class warfare is bad. Nobody likes to be called a villain, particularly those who are working hard to be successful for their families, their co-workers, and their communities. Making people feel guilty for being successful is not conducive for a healthy community.

For another, you need a concentration of “excess” wealth to feedback into the local investment of new technology and jobs. Governments do not do this; they redistribute wealth. Individuals and corporations operating in their own self-interest invest in opportunities that create wealth, which as a by-product create additional goods, services, and jobs.

I am not suggesting that we “starve” schools. What I am suggesting is that if you chase out (or otherwise make the community unattractive for those who wish to immigrate into that community) those who are at the head of the bell curve in terms of success, the community will eventually suffer. All one has to do is look at the problems seen in New York, California, and New Jersey.

“It is to me a new and consolatory proof that wherever the people are well-informed they can be trusted with their own government; that whenever things get so far wrong as to attract their notice, they may be relied on to set them to rights.”

—Thomas Jefferson to Richard Price, January 8, 1789.

This article in the Wall Street Journal by Edward Pinto describes the fuse that was lit by the 1992 GSE Act. Mr. Pinto chief credit officer at Fannie Mae from 1987 to 1989, so has some knowledge of this act and its impacts on the underwriting process of loans securitized by Freddie Mac and Fannie Mae.

Groups like ACORN were invited by House Banking Committee Henry Gonzalez to -

draft statutory language setting the law’s affordable-housing mandates. Interim goals were set at 30% of the single-family mortgages purchased by Fannie and Freddie, and the Department of Housing and Urban Development has increased that percentage over time.

This eventually led to zero percent down mortgages, the (continued) bailout of Freddie Mae and Fannie Mac, and our current credit difficulties. Make no mistakes about it. The economic problems that we suffered over the last 18 months, and continue with today, have their roots in Congressionally-mandated actions to rewrite the standards for credit-worthiness to help facilitate home ownership.

While these were (are) admirable goals, the road to economic hell is paved with good intentions.

I read Paul Krugman’s columns on a regular basis. A frequent topic of his columns is his perceived need to pursue Keynesian solutions to our current economics problems. Keynsesian solutions propose that government should spend liberally during times of economic troubles in order keep the economy operating efficiently until such time that private segment spending and investment can “get back in the game.” Public spending should act as a governor to business cycles, spending more in times of recession, and spending less during economic booms. This article (and this one and this one) suggests that the Obama administration erred in not being more aggressive in their stimulus efforts, and that the economy will suffer without more deficit spending by the government.

It may be an extreme act of hubris to critically comment on the rhetoric of a Nobel Prize winner in Economics. However, he seems to ignores the fact that public stimulus can come in two forms, one through direct government spending (e.g. spending on infrastructure) and transfer payments (e.g. unemployment benefits), and the other through the monetary policy of the federal reserve.

There are several problems with direct governmental spending to support Keynesian goals. First, is that it takes a long-time to get bills through Congress, so by the time the money actually starts flowing, the economy has typically worked through its issues. Second, Congressional priorities are typically not the same as those priorities required to get the economy back on its feet. Thus, the money is inefficiently spent with respect to helping the economy. Third, a true Keynesian spending program would be reduced when the economy is doing well. However, Congress has yet to reduce real spending during any period since 1960 (see chart.)

A much better approach to stimulate the economy is through the monetary operations of he Federal Reserve. As this previous post suggests, the Federal Reserve has made a huge bet on monetary stimulus, to the tune of $13 trillion, far in excess of that requested by Mr. Krugman. This stimulus continues today, and is not just through low interest rates (which may be leading to asset inflation in other countries through the dollar carry-trade), but also through direct purchases of mortgages from Freddie Mae and Fannie Mac (and here). This stimulus is huge. In addition to the direct Federal Reserve purchases for these bonds, the government guaranteed 98% of the residential mortgages in the third quarter, providing an “off-the-balance sheet” stimulus that is not included in any of the accounting for governmental or federal reserve actions.

Mr. Krugman obviously knows the importance of the continued easy money policy of the Federal Reserve. However, it is not clear to me why Mr. Krugman continues to write on the importance of another direct stimulus effort from the government, which would only be a small fraction of what the Federal Reserve and off-the-balance-sheet efforts have already committed to the economy. An expansion of direct spending seems to be more of a political desire for increased top-down control of the economy, than any true desire for more economic stimulus.

General Electric closed today (3/5/2009) at 6.66. An apocalyptic number? Odd, isn’t it. What is the market telling us?

I don’t think it is saying capitulation. The volume is not there. There is something different about this market. This is not a dramatic catharsis that like the proverbial phoenix gives rise to a beautiful new bird that flies again. This is the grind, the mashing of metal against metal that suggests something is seriously wrong with the machine.

Since Election Day the DJIA has dropped from 9,625 (11/4/2009) to 6,594 (3/5/2009), down 31%. This in a market that was already down 32% from an all time high of 14,093 in October 2007. Its not supposed to happen like this. And I don’t think the administration is listening. Or if they are, maybe they are hearing something different.

Federal Reserve Balance Sheet - Wall Street Journal

Between the 1929 and 1932, the DIJA fell nearly 90%; and by 1933 GDP had fallen by 45%. There were a lot of bad policy mistakes that were made during that time that contributed to the continued decline in economic activity. The current Federal Reserve appears willing to add trillion of dollars of debt on its balance sheets to avoid the monetary mistakes of the past. However, Congress and the White House seem to have taken a different message from the previous crash and the current one, and seem bent on trying to antagonize capital holders and businesses in ways that have not been seen since Roosevelt.

However, when you consider the market is down 51% from its high, half of which is during the time since a new administration was elected, it would appear that there is a new vote happening. This vote is in the markets and business investment and it is going in a direction that is opposite the one expected by our political leaders. Can they hear it?

I like visiting Europe. The continent has a different flow and feel to life. Life seems to move a bit slower, and people tend to have lower expectations about the “stuff” in their lives.

On the flip side, it seems to be more expensive to live, which maybe feeds into the lower expectations on the stuff. Economic classes also seem to be more rigid, and upward mobility seems to be a far away dream for millions of inhabitants. Look a bit deeper and services like health care and education, while free, tends to be rationed fairly extensively.

So I like visiting Europe, but would I want to live there?

A read of the opinion pages across the political spectrum seem to converge on a similar theme with the current administrations budget plans. Krauthammer, Brooks, Krugman all seem to point to grand plans by the administration to address social engineering on a scale not seen since Roosevelt or Johnson. Others see similar impacts through the nationalization of the banking industry.

If you look at the current federal deficit as a percentage of GDP as well as the total federal outlays as a function of GDP, we seem to be approaching a federal budgetary perspective of Western Europe. In the last 10 years, US government expenditures has increased from 34% to 40% of GDP, rapidly approaching that of the European Union at 47%. As the fraction of direct government expenditures to GDP increases, more of the total services provided for everyday life will be directly supplied by the federal government. This will have dramatic consequences for future expectations of governmental services. In short, the more people that become dependent on government for services, the more they will expect and demand that those services continue, until the service itself becomes a right.

The current crisis certainly calls into question the rhetoric of smaller government. But we should not confuse the rhetoric with the facts of increasing governmental expenditures over the past decade. The growth in federal services over the last administration does not suggest that the Bush years were built on pinching pennies. Real (inflation-adjusted) governmental expenditures increased more than 24% from 2000 to 2008 (probably higher because I am not sure if the this Census Bureau has updated their figures for the TARP program). It has been suggested that California is our first looks at the results of continually growing government expenditures at the expense of a sane fiscal policy. One has only to review California’s 10.1% unemployment and $41 billion deficit to get a sense of what a “European-azation” of our federal budgetary policy may accomplish for the rest of the US.

Does this mean that we will drift towards a more European America? I hope not. When I think of Western Europe economies, I think of slow growth, high unemployment, and strongly regulated industries. This is not consistent with the ideals and work ethics of many Americans.

I want the ability to create a future for my family based on how hard I work and how well I make my choices. I would probably accept some restrictions and regulations for public safety and the infrastructure investments necessary for greater economic gains, i.e. a rising tide will raise all ships of opportunity. However, limit my abilities to generate a future for my family based upon my work ethic and intelligent choices, and I will have serious issues with the people in charge.

Such limitations can come from tax policy, regulation, or even energy regulation via a cap and trade system, for this is a hidden tax on economic activity (an expected $646 billion). Given the current leanings of the Congress and the Executive branch, some limitations will probably happen. If the net result of these new policies leads to anemic growth (~1-2%), persistent high unemployment (~8-10%) and high inflation (~3-5%), then our journey to a European America will be nearly complete.