Thursday, September 25, 2008

What Went Wrong? – The Only Explanation You’ll Ever Need To Read

Fast Money on CNBC ran a good explanation, with video, on how we got into our current financial crises. Essentially in 2004 five financial institutions: Morgan Stanley, Goldman Sachs, Bear Stearns , Lehman Brothers, and Merrill Lynch, in a cooperative effort, went before the Securities Exchange Commission to change their leverage requirement from 12:1 to 40:1. Additionally interests rates were low, the firms were given access to cheap money, and instituted lax lending standards.

It was not "regulation" that caused this problem. These companies went to the government for less regulation and were given less regulation. They abused their freedom. Regulations did not force these corporate leaders to "innovate" financial instruments that were toxic. It was the willful actions of the corporate leaders that created this financial mess. Unfortunately, I doubt that any of the corporate leaders who created this financial mess will acknowledge responsibility, will offer an apology, and will refund their excessive pay packages. One could conclude that "responsibility" for ones action is no longer fashionable in the United States.


Here is a YouTube video (9/23/2008) between Larry Kudlow and Senator Bernie Sanders of Vermont. Bernie humorously points out the amazing overnight "conversion" of Larry Kudlow (a free market advocate) to "socialism" now that the free market has failed and these companies need to be bailed out. Enjoy.

9/29/2008 (Update)
Good article at TechDirt: "Take a Deep Breath: Some Perspective on The Financial Crisis".

10/03/2008 (Updated)
New York Times Article: "Agency’s ’04 Rule Let Banks Pile Up New Debt, and Risk"

In "The Borrowers" Ms. McLean writes: "Step back. The securities that are poisoning the financial system are made up of mortgages and home equity lines that are going sour. They may soon consist of sick credit card and automobile debt as well. “Innovation” on Wall Street meant that the institution that made the loans could sell them off, and bankers could carve up those loans into new instruments, which they in turn sold to investors around the globe, with the result being that no one felt responsible for ensuring that the person who got the mortgage or the credit card or the home equity loan could actually pay for it." (Emphasis added)

Monday, September 22, 2008

The Gold Standard

As part of writing my prior post, I read Steve Forbes article How to Cure This Sick System". In that article Steve recommends that "The Fed should declare that its goal for gold is around $500 to $550. That would stabilize the buck ...". I have never approved of the gold standard, but Steve does have an extremely valuable point.

If one looks at the recent rise in commodity prices (such as gold and oil) the question naturally arises as to why these commodities are going up in value? In actuality they are NOT going up, the dollar is going down in value. (My perception, not based on research)

This can also be extrapolated to house values (a type of asset) going up. The value of housing, in very very simplistic terms, has NOT being going up. The value of the dollar has been going down.
(My perception, not based on research)

T. Boone Pickens for example has been pointing out through TV commercials that we export some of out wealth every time we buy a barrel of oil from a foreign source.

Steve writes in his article "
What enabled their taking on so much debt and so many questionable assets was, primarily, the easy-money policy of the Federal Reserve." The availability of cheap credit also allowed many home buyers to pay more for houses that they otherwise could not have afforded.

Additionally, the Federal government is running a budget deficit. Spending money that we have not yet earned and that we currently do not posses promotes inflation.

In essence through the creation of cheap credit, running a budget deficit, and exporting our wealth overseas we are devaluing our currency. This devaluation, since we have a world wide economy, is reflected in perceived increases in the prices of real assets such as houses, gold, and oil. (Of course some increases/decreases in commodity prices can be attributed to global demand)

As a nation we may be rich now. We won't go broke immediately, but if this trend continues we will end up in the poor house when the foreign holders of our debt decide to foreclose.

The Free Market and Responsiblity II

One of the fundamental mantra's of many professed "free market" advocates is "less regulation means growth" The financial institutions were given greater regulatory freedom and they abused this liberty. What is truly amazing is that some of those who chant the mantra of less regulation are now attempting to blame the collapse of our financial institutions on regulation!

Missing from this anti-regulatory chant is an acknowledgment that the freedom to succeeded is also a freedom to fail. If one has freedom, they misuse that freedom, and they consequently fail; they should accept the responsibility of their failure. No one forced the financial institution to make risky bets. They did it to themselves.

Over at the The Technology Liberation Front Hance Haney wrote "But as Steve Forbes points out, the “easy-money” policy of the Federal Reserve helped financial institutions pile up debt and bad assets."

So here we have the Federal reserve opening up the candy store to satiate the corporate demand for cheap money to promote economic growth. Now the financial institutions have a bellyache because they overate. Rather than acknowledge that the "free market", in this situation failed because they lacked self control, apologists are attempting by slight of hand to place the blame on regulation.

This seems to be a very contrary to Libertarian principles. Actually, it sounds like something the Democrats would promote. The Democrats advocate how we have a moral obligation to save the the poor unfortunate homeowners, while failing to acknowledge that the homeowners bought houses they could not afford. It does not make a difference, in term of responsibility, whether it is a corporation or a house. The simple fact is, we have had some irresponsible behavior and everyone is asking for a hand-out. In today's America no one is to blame and we are all entitled to the state saving us. I guess we are on the road to a welfare state.

Monday, September 15, 2008

The Free Market and Responsiblity

Today was a tough day. The meltdown in the financial stocks continued. The stock market fell 504 points. Lehman Brothers and Merrill Lynch went out of business. Previously Bear Sterns and Countrywide also went out of business. These companies went out of business because they were managed irresponsibly.

I am using the word "irresponsibly" because a small segment people who profess to be free market advocates refuse to acknowledge that corporations, if they wish to operate in a regulatory free environment, must behave responsibly. Besides, I don't want to get into the other inflammatory issues such as unrestrained greed.

According to some free market advocates the onus for uncovering corporate misconduct belongs to the consumer and that a magical black box, in the form of "market forces" will somehow cause the offending corporation to mend their ways. This is a simplistic argument for few of us have the expertise and time to fully investigate corporate operations. Even the experts, who are paid full time to monitor companies were unable to detect the severity of the problem. Regretfully, the invisible corrective hand of "market forces" failed the financial sector since these companies did not mend their ways before it was too late. In a real absolutist sense the free market has worked, these companies have gone out of business due to mismanagement. A fairly draconian solution. Now, we as nation have been left to clean up this mess.

An issue currently under debate is Network Neutrality. The uncompromising free market advocates claim that regulations requiring that internet providers deliver the packets in their trust in a neutral manner to the packet's destination will destroy the internet since it will squelch innovation and hinder investment. They assert that internet service providers must have the "flexibility" to manage the flow packets as they see fit. On the other hand, those in favor of Network Neutrality want to be guaranteed that the internet service providers will deliver the packets to their destination in a fair and neutral manner.

My concern with the Net Neutrality Debate is that the word "flexibility" in the corporate environment has degenerated to mean that we (as a corporation) can do whatever we want. The financial institutions are in deep trouble because of their misuse of "flexibility". In terms of the Net Neutrality debate, we are seeing that some companies are abusing their "flexibility". Comcast and AT&T , for example, have already demonstrated, in some cases, that they cannot be trusted. Of particular concern is that in the absence of Network Neutrality guarantees the consumer will have no rights concerning how their packets are delivered. My observation in following the Net Neutrality debate, there are regretfully few calls by commentators for offending corporations to modify deplorable behavior when it is uncovered.

My intent is not to advocate for more regulation. Corporate managers can take steps to avoid regulatory oversight by accepting responsibility to operate their companies in a clear transparent manner. One means of accomplishing this would be the creation of a professional code of conduct. Self regulation, if done properly would avoid the necessity of regulation and would represent a commitment to operate responsibly for the benefit of both the corporation and its customers. The ability to act freely should also mean that one is responsible. The freedom to act "flexibility" in a whimsically self serving manner ultimately leads to failure.

If companies fail to operate ethically, they deserve to be regulated. Unfortunately, the meltdown of our financial institutions is not a positive indicator that corporations, especially on the issue of Network Neutrality, will act ethically .

Revised: September 16, 2008.

Wednesday, September 3, 2008

Quote of the Day

Thanks to William Stepp at Against Monopoly for finding the quote below from John Perry Barlow. This quote was written in 1994!

"The greatest constraint on your future liberties may come not from government but from corporate legal departments laboring to protect by force what can no longer be protected by practical efficiency or general social consent."

John Perry Barlow, "The Economy of Ideas: A Framework for Patents and Copyrights in the Digital Age (Everything You Know About Intellectual Property Is Wrong)," Wired 2.03 (March 1994). This document can be accessed at:

Tuesday, September 2, 2008

Idle Observations on Election Year Tax Rhetoric

Tonight on Kudlow's Money Politic$ Larry had on his show Jason Furman and Steve Forbes. Jason was representing Obama’s proposed tax plan and Steve was representing McKain’s proposed tax plan. Both Jason and Steve Forbes claimed that their proposed tax cuts would help the economy.

Missing from the discussion is the obvious question, how will we balance our National budget? Both parties seem to avoid discussing the “hard” decisions that politicians are supposed to be making to balance the budget. Seems that both Obama and McKain are offering us free circus acts in the hopes that we won't notice that we are spending ourselves into bankruptcy. Fiscal responsibility is an "inconvenient truth".

Another issue discussed, who should pay the taxes? Needless to say Larry and Steve demanded with much empty rhetoric that corporate tax rates be reduced to “foster economic growth”. While this line of reasoning has emotional appeal, this point of view fails the smell test. Assuming a balanced budget, a low corporate tax rate will not foster economic growth as explained below.

Supply side supporters such as Larry and Steve promote the concept that if corporations don’t pay taxes it will foster economic growth since corporations will be able to sell their products at a lower price thereby generating consumer demand. But wait! The supply side supporters are overlooking the critical concept that the consumer would now be forced to pay more in taxes since the corporations aren’t. Logically, if you as a consumer must pay more in taxes you will have less money to spend on products. Therefore the consumer would have less incentive to buy. In reality, with a balanced budget, it does not matter who actually pays the taxes.

Nevertheless, I would advocate that taxes should be paid by the corporation and not by the consumer. Why? Under the capitalistic system corporations are, in theory, competing for your dollars when selling their products. If the consumer is “freed” of the tax burden, the consumer may more appropriately allocate their scarce resource (money) for the products they want.

As a follow-up to the concept of “the products consumers want”, tax policy should not be made on “fostering business” since corporations may be distorting the free market by making products that are profitable for tax reasons rather than economic reasons. (Of course this assumes that corporations will be paying a fair tax and not playing accounting tricks with taxes.) If business can’t compete without a tax crutch (corporate welfare), they have no business being in business.