Thursday, January 29, 2009

Sounds Like Such a Good Idea

Today, President Obama signed into law the "Lilly Ledbetter" Fair Play Act. What the Act does is eliminate the existing statute of limitations on an employee's right to sue their employer for violations of the equal pay laws. Lilly Ledbetter worked in a tire factory for 19 years and, after retiring, sued her employer for 19 years for "pay discrimination." The Supreme Court held that Ms. Ledbetter had waited past the time allowed under the law. The legislation signed by the President today eliminates the time limit. Now, you can sue whenever you want. Even if you are dead, your heirs can sue.

What will be the effect of this law? It applies, by the way, mainly to blacks and hispanics, females and anyone over the age of 50, since these group are the main groups "protected" by existing legislation. The first impact is that anyone thinking about hiring anyone in the "protected" categories will have second thoughts. Why not hire someone not in the "protected" categories? Then there will be no lawsuits. Second, the Act itself is an additional cost for all employers no matter who they hire. It therefore makes employees less attractive. If the employer was thinking about outsourcing to India, then this will made that decision much easier, since employees in India are not covered by this legislation.

For companies that already have been public spirited enough to hire folks in the "protected" categories, they will be subject to a new source of lawsuits. While they may have treated an employee well, the employee's heirs may not agree and can sue even if the deceased employee would never have thought about suing! So, folks trying to do the right thing in the past will learn not to hire the "protected" category in the future.

The moral: if you provide a benefit to an employee, that becomes a cost to the employer and makes the employer less likely to hire that particular employee...simple economics. If you want to hurt a particular demographic's life chances, then "protect" them with this kind of legislation.

Another recent example of the law of unintended consequences is the bailout of AIG and GE. Both firms have received FDIC guarantees for their debt offerings. If, unlike AIG and GE, you were an insurance company that did not get into trouble with exotic derivatives, kept a clean balance sheet, and did not require a government bailout....too bad. Your debt is not selling. Buyers would rather buy the government guaranteed debt of AIG and GE. After all, if you did the right thing, you didn't need the government guarantee. Now, you can't sell debt. All of these guarantees direct capital to the worst examples of excess and mismanagement and away from sound management and sound finances. What a policy!

Saturday, January 24, 2009

Bailouts and the Aftermath

George Bush initiated the largest taxpayer bailout of private businesses that the world has ever known. Obama seems determined to set his own record. His stimulus bill will waste more resouces in one single legislative action than any in world history.

Bush's bailouts have done no good. The financial sector is in worse shape than last Fall when all of the political hype began. The economy has been talked into a recession. Eventually, it will tire of the talk and work its way out. The bailouts and stimulus package will simply be very, very expensive impediments to future economic growth.

Some countries have taken the bailout/stimulus policies much further. Great Britain comes to mind. It is highly likely that Britain will be forced to default on its external debt within the next twelve months. Britain won't be alone.

No one seems to think that those who bet wrong should have to pay for their wrong bet. The stock and bondholders of Bear Stearns, Lehman Brothers, AIG, Fannie Mae, Freddie Mac, Merrill Lynch, Citigroup, Bank of America should pick up the tab....not the US taxpayer. All of these investors knew they were taking risk. It didn't work out. So, they should lose. Not the taxpayer.

Everyone always thinks that if their industry goes belly up, the whole world will come to an end. The financial industry thought so last fall, the auto industry thought so in December, and more and more will step forward to ask the average taxpayer to pay for mistakes that taxpayers did not make. Aside from the very, very foolish economics of the bailouts and stimulus packages, the specter of rewarding those who made bad decisions and punishing those who made good decisions is appalling.

The proper response is to let the chips fall where they may. If you want to stimulate the economy, lower tax rates and expand the monetary base. These policies have proven records. They work. Bailouts don't work. They never have worked and they never will work. Bush and Obama should have taken an economics course along the way.

Sunday, January 18, 2009

Corporate Governance Loses Out to Big Government

On the 5th of December, Bank of America shareholders voted to approve the big bank's acquisition of Merrill Lynch. Existing securities law requires that BofA (and Merrill Lynch) inform voting shareholders of "all material facts" regarding the acquisition before the vote. The law also stipulates that "no material fact" may be "omitted." Were the voting shareholders of BofA provided the required information? Clearly not. BofA senior management approached treasury officials before the vote and warned them that BofA was considering pulling out of the acquisition because of "material adverse change" in conditions. BofA management knew that Merrill Lynch was bleeding and wanted out. Treasury pushed BofA management to go forward and, implicitly, to mislead the shareholders of BofA who, days later, would unwittingly vote to acquire a company that had, at a minimum, $ 15 billion in undisclosed losses on their balance sheet.

After the acquisition, BofA went back to the Treasury to get additional funds to support the ML acquisition claiming that the Treasury had promised this support as a quid pro quo for BofA's proceeding with the Merrill acquisition. But what of the poor BofA shareholders?

On December 5th BofA stock was trading at $ 15 per share. With no knowledge of the problems at Merrill, shareholders voted to approve the acquisition. Now the market knows and so do the poor hapless BofA shareholders. Now, BofA trades at $ 7 per share, just one month later. The loss to BofA shareholders was nearly $ 40 billion.

What should have happened? The law should have been followed. BofA shareholders should have been apprised of the situation at Merrill before the vote. The loss to BofA shareholders is nearly $ 40 billion. This number is in Madoff territory and the crime is similar.

Securities law was simply tossed out the window by BofA management and the Treasury for, what in their eyes, is the "greater good." In the name of protecting the economy, BofA shareholders were blindsided in true Madoff fashion. Only this time the government itself is the perpetrator. Hopefully, there will be redress for BofA shareholders in the courts and those who conspired to defraud BofA shareholders will be prosecuted to the full extent of the law.

One wonders whether the rule of law will survive the new crisis management government that we have had imposed upon us.

Sunday, January 11, 2009

The Stimulus Package

Will massive government spending on "green" projects and infrastructure pull us out of our, so far mild, economic slump? Simple Keynesian theory drilled into the heads of countless Economics 101 students worldwide says "yes," but common sense suggests otherwise. Not that the US economy won't recover. It will. And that process should be well underway long before the so-called stimulus ever really gets started.

The bulk of the proposed stimulus would not be spent until 2010 or 2011, long after economic recovery has begun. The only thing that the stimulus package will do is create distortions in the economy (and possibly provide for the largest incentive for corruption in politics in the nation's history). (We will be looking for places to store unused wind turbines and inefficient solar panels for the next few decades.) The cut in the payroll tax, if it survives, does not have these drawbacks, but it looks like Congress isn't interested in cutting the payroll tax as much as getting their hands on increased spending for their favorite pet projects.

The reason the simple Keynesian paradigm is fallacious is that the simple Keynesian model is a timeless story. When you increase spending in that simple model (or cut taxes), the effect is instantaneous. Hence the result is stimulative at exactly the right time. In the real world spending and tax plans take time to implement, even after accounting for the delay in realizing that you actually need to do something. (Remember it was in December of 2008 that the NBER officially declared that the "recession" had begun in December of 2007). So, you end up with a one year lag in recognition, then a one year lag in implementation -- not quite instantaneous like the simple world of Economics 101.

{If you want to believe that the stimulus is a great idea, but just not grandiose enough, then check out Paul Krugman's articles in the NY Times. He thinks $ 1 trillion just isn't near enough!!! And he just won the Nobel Prize in Economics!}

So what will happen except a lot of wasted taxpayer money? By the time the spending hits, the economy will be recovering and plagued with a dramatically declining dollar and growing inflation. Both of these trends can be helpful. The declining dollar boost exports and the decline in the dollar and increase in inflation reduces the real value of our humongous national debt. (The escalating tbill and tbond rates will offset this rosy scenario for treasury debt financing). But, then what? With Paul Volcker on board, presumably Obama could recruit him to, once again, break the back of inflation. It would be the 30th anniversary of the date he took on this task at the request of Jimmy Carter, back in 1979.

When the smoke clears, most Americans will probably begin to start saving as their trust in government programs is gradually undermined by what they see going on with social security, medicare, medicaid, and whatever bureaucratic nightmare becomes the new "health care solution" imposed by an overwhelmingly Democratic Congress.

The good news is that Americans need to save more and trust their government less anyway. Government is really not able to do what it says it will do. If squirrels need acorns in the winter, some of the squirrels must gather and save the acorns. There are no squirrels doing this now, so there are no acorns set aside for winter. That will change as people realize they must save and protect themselves against the vagaries of their government.

There is reason for optimism, though. Obama seems much more sensible than his former compatriots in the US Senate. Larry Summers, his Treasury Secretary designate, was roughed up last week in a meeting with a group of prominent Democratic Senators. That's good news not bad news. It shows Obama is prepared to do battle with some of the crazies in his own party. Clinton had to do much the same. Who knows -- maybe Obama actually likes free trade (contrary to his campaign comments)? Hope springs eternal!

Thursday, January 1, 2009

New Years Resolutions & Predictions

Hooray!! 2009 is here and we have finally pulled the curtain on 2008 -- the single worst financial year in American history (measured by losses in stocks, bonds, and real assets).

Think of all the surprises that we witnessed in 2008: The collapse of oil prices after a rally of historic proportions. Oil climbed to 155 in July and finished the year at 45. Stocks reached an October 9, 2007 high of 14,160, began 2008 slightly above 13,000, rallied to finish 2008 at 8,776 down 34 percent for the calendar year. Most other indices were far worse, especially in non-US markets. Barrack Obama, a minor candidate with no hope of defeating the Hillary machine, is now the President-elect. Elliot Spitzer's dark horse chances to win the Democratic nomination for President took a walk on the wild side. Bernie Madoff's absolute return strategy proved once again that the risk free rate is not 8 to 12 percent as the hedge funds would have us believe. A Republican Administration spent $ 350 billion bailing out Wall Street firms and GM and Chrysler. A conservative Republican chief of the Federal Reserve expanded the Fed balance sheet to historic proportions, opened the discount window to virtually anyone and everyone, and finished the year with a an open ended plan to buy mortgages directly from the market. The big five investment banks either became commercial banks (Goldman, Morgan Stanley) or got sold to commercial banks (Bear Stearns, Merrill) or went bankrupt (Lehman).

Think of the surprises that we didn't see: 1) Unemployment never reached seven percent; 2) The foreclosure rate did not reach one percent of American homes; 3) Inflation did not reach three percent or fall below zero percent; 4) Iraq did not descend into chaos; 5) Hugo Chavez did not win his mandate to perpetuate his rule in Venezuela.

So, be of good cheer!!

New Year's Resolutions:

1) Finish book about the financial crisis
2) Gain zero pounds
3) Spend less money
4) Figure out what happened to the stock market(s) in October and November of 2008
5) Enjoy life


1) Big stock market rally in January and February
2) Home prices hit bottom in Spring of 2009
3) Unemployment hits high of 8.5 percent in April of 2008
4) Credit markets improve dramatically in the Fall of 2009
5) Endowment losses much heavier than earlier reported; colleges and universities under major fiscal pressures
6) Card check fails in the Congress
7) Hillary and Obama at odds before year ends.
8) Chavez overthrown in Venezuela, Iran and US reach rapprochement, US and Cuba normalize relations
9) Obama maintains popularity during first year in office
10) Prof Burton reaches quarterfinals of US Nationals in his age group (not telling)

So, there you have it...enjoy!!