New American Paradigm

Geithner’s Requiem

Last month Treasury Secretary Timothy Geithner went to Capitol Hill in an attempt to calm the fears of Congress, investors, and banks. His mission… to give a broad outline of his plan so that an impatient audience would understand that a plan was forthcoming. Normally we would excuse a career finance geek who's used to operating behind the veil of secrecy of the Federal Reserve System for not being the most impressive of public speakers. Nor did anyone expect details of the plan given he had not yet begun to the skeleton crew left at the Treasury. But unfortunately his performance was so poor; his inability to answer questions so frustrating, and the plan so vague that it had the opposite effect. Not that I will ever have a chance to be Treasury Secretary, but I'm also confident that I'll ever be so bad at my job that I cause a small stock market crash.

A month later we are now starting to see details of the plan leak out and there are some things I and others find troubling. Here's the plan:

1. FDIC will set up partnerships with private investors to supply enough capital that it removes the risk from purchasing $2 Trillion or so in "toxic assets" that are weighing down banks. The theory here is that nobody will buy them because they can't figure out what they're worth. Once they are initially cleared this will then have the effect of restarting a market which is desperately needed to make this work. Even a dangerous investment has some terminal value, but it won't unless the investor is sure they can unload it later on.
2. Firms that invest in these assets will then be hired to manage them creating a secondary incentive to climb into the "bad asset" business.
3. Expansion of the TALF program which I'd call the "rest of us" part of the plan. Essentially it backs asset-backed securities (ABS) like student, auto, credit card and other consumer loans.

So what's the beef? Geithner was bashed mostly for his inability to explain how a fair market value would be determined that is fair to taxpayers but still is enough to have a positive effect on the banks. In addition, there was no indication how risk and profit would be distributed in this public/private partnership. Now we're seeing the reason he was reluctant to say, it appears the downside is all on the government side of the ledger and the upside to the investors.

To me and others the most troubling aspect of this plan is that it presumes that the assets are as Tim Duy puts it "there are no bad assets.  Only misunderstood assets." They seem to be convinced that the market is wrong and that these assets have some intrinsic value higher than where they are. There's a problem with that theory… it's wrong. Homes are only worth what people can afford, no more, and typically no less. The problem with the last decade or so is that creative dishonest lending practices inflated buying power by 40% in some cases. Take away the interest only, no money down, hybrid adjustable rate mortgages and that phony buying power disappears. It doesn't take an economist to figure out what happens when the buying power of potential homeowners is dramatically reduced.

So apparently our grand plan is to close our eyes and pretend that these assets are still worth more than they are, a nod to a philosophy Republicans have been falling all over themselves to end known as Mark to Market or Fair Value accounting. It used to be that if an asset appreciated or depreciated, the bank simply held it at the same value until the gain or loss was realized… reality be damned. You'd think that they would value honesty and integrity in financial reporting. By the way, I would not suggest trying this strategy at home. It could have disastrous consequences.

Husband: "Honey how much is in the bank account?"

Wife: "Let's say… A MILLION!"

Husband: "Ok I'm buying a boat."

Needless to say this story ends in a messy divorce. The problem being that when the government tries the same thing there is no court we can run to try to dump our spouse and boat on. I suppose if there are no more losses to book on these assets it won't be a problem and we'll in fact see a gain. But if there were no more losses, why would we need the government inducing investment?

End of Sprawl? Part I

Since it's not the sexiest of issues, land use is never covered by the media like taxation, global warming, or the financial meltdown. Perhaps it should given inextricable link to all of those issues and quite possibly their leading cause. In fact land use policy has a great effect on our lives than virtually any other government policy. Why is it important? Urban sprawl.

When President Obama said last month that "The days where we're just building sprawl forever, those days are over," most people shrugged their shoulders and went back to soaking their 401k statement with tears. In fact this was a profound statement of not only the direction his policies would head, but an acknowledgement of where we are as a country. Obama understands intuitively what builders and homeowners across the country are finding out the hard way, those development patterns are unsustainable and probably a thing of the past.

Urban sprawl can be defined as ""dispersed development outside of compact urban and village centers along highways and in rural countryside." You know it when see it. It's soulless strip malls and large lot/large home development outside of cities. Its cause is simple… lax land use policy that allows urban development on cheap land in rural areas. Unlike normal urban development patterns, urban sprawl is dominated by the car with everything from large parking lots to wide multi-lane roads being designed to accommodate while pedestrian mobility is limited and often conflicts with the design of the development.

Although it occurs in Canada and Europe to a degree, the US fell head over heels for sprawl years ago and the affair only grew more passionate with time. Since most of the country developed after the advent of the car, development geared to this absurdly cheap form of transportation was the norm. In Europe, which mostly built up prior to the automobile, cities are densely packed since foot travel was the most common form of getting around. Everyone had to live within walking distance of everything they needed, their job, the market, a doctor, etc. As a result, travel by car wasn't necessary within town making it more expensive than trains for inter-city travel.

It's a strange phenomenon in that the demand is created by people wanting to get their piece of paradise, killing it in the process. Rather than sharing communal greens in urban parks and, people crave their own private park in a large yard. The result is the destruction of rural areas across the country. Wanting a big home but unable to afford it people turn to large homes built in cheap rural areas commuting further and further to work clogging roads along the way. The population of these areas then demands services but don't have the population in their neighborhood to support them so strip malls are built and designed to accommodate vast amounts of cars.

One of the phenomena contributing to this problem is the "Not in My Back Yard" mentally, otherwise known as NIMBY. As noted before local government tends to fly under the radar despite its impact on our lives. Chances are your local Mayor has made a much greater impact on your life than the President or Congress yet most people can't even name someone from their City or County Council. For the last 12 years I've been one such faceless City Councilmember so I understand all too well how to introduce myself to people; approve a new development or change in zone standards near their home. Suddenly people that haven't paid the least bit of attention to months and months public process, meetings, design charrettes, and outreach are in your face telling you what an idiot you are for destroying the "character" of the community. Oddly, they may live in old small lot homes in a historic part of town and demand large lot homes to "preserve" character. In isolation, this isn't all that big of a deal. But repeated millions of times across the country and the path of least resistance for locally elected officials becomes land use controls that resemble sprawl more than good planning. In incorporated areas outside of cities the problem is reversed, in this case properties are larger and owners typically want to preserve the development potential as it makes their property worth more. Combined with the moneyed interests of developers, rural areas tend to support lax controls and therefore encourage development inappropriate for the area.

Over the next few weeks we'll take a look at sprawl's connection to the subprime meltdown, its effect on tax policy and local government resources, how it impacts climate change, and generally decreases our quality of life. Obama may think that its day has come and gone, but without smart policy that may not be the case. Ultimately it will take a different way of looking at how we live our lives. If we continue to look at a big house/big yard in the suburbs as the way to the good life, we'll actually further erode our quality of life.

Debt and Foreign Policy

Last week the big news in Sino-US relations was the harassment of a US spy ship near a Chinese nuclear submarine base by the Chinese Navy. I use the term harassment a bit tongue in cheek since it consisted of mooning the American sailors rather than the sort of menacing behavior we might normally expect.

Anyway it should sound familiar to those of us at least old enough to remember when Nirvana was still recording because China through a similar hissy-fit over a US spy plane in the first few months of the Bush administration. That incident turn more serious since our people were essentially held hostage for a week and a half, but ultimately cooler heads prevailed and we went back to patriotically buying shoes made by Chinese slaves. I should point out that in both cases our spying was on the up and up since they were in international airspace or waters, however imagine how nervous we would be with Russian ships cruising around 30 miles off the Pacific coast.

That said, the incident drowned out coverage of a much more disturbing and potentially dangerous bit of diplomatic saber rattling coming out of Beijing. Premier Wen Jiabao demanded that the US "guarantee the safety" of China's $1 Trillion in US debt.

"We have lent a huge amount of money to the U.S. Of course we are concerned about the safety of our assets… To be honest, I am definitely a little worried."

Make no mistake; this is a direct shot across the bow. Combined with the spy ship incident it's clear they are testing President Obama's resolve and demonstrating their position of strength. With Secretary of State Clinton just back from her Friendship "Please please please keep buying our debt and we'll stop talking about human rights" tour, the intent couldn't be more clear.

So how did they end up with so much of our debt in the first place? It's actually a strategy China has employed to keep their currency deflated compared to the US. Since we have a trade deficit with China they end up with extra US dollars. Most countries would use this to build up their economies, make new investments, and raise the standard of living for their people. However, that would mean their currency would rise relative to the US making Chinese manufacturers less cheap. And let's face it, cheap is the only attractive thing about dealing with the Chinese government. Not being concerned in the least for the average Chinese worker gives their government an opportunity to pursue a strategy most other nations would never think of employing. So to keep their currency from rising they buy US Treasuries by the boatload. This keeps their currency rising and falling with our own. It also helps out the US because an eager buyer for our debt means interest rates remain low and cheap debt helped fuel our consumer driven economy.

However, this also gives China enormous leverage over the US. How? China can wreck what's left of our economy by selling off all their Treasuries at once, sending the dollar into a freefall. There's actually precedent for this sort of behavior. During the Suez Canal Crisis in the 50's the US was demanding that the United Kingdom cease hostilities (isn't it cute that we used to try to keep the Brits from going to war?) Upon their refusal President Eisenhower announced that he would sell US reserves of the Pound as well as their debt. The threat had immediate effect and the crisis ended. How could we respond to some action by China if they threatened to sell off our debt crashing our economy? Is Taiwan's independence more or less important to us than another Great Depression?

In this regard our political leadership, Democrat and Republican, undermines US foreign policy and security by refusing to bring spending and taxation into balance. They do so at the behest of unrealistic voters who alternately want cut taxes from Republicans and increased spending from Democrats. Perhaps our current situation is a good time to reevaluate those conflicting demands.

Buffett Speaks, Everyone Listens

The Oracle of Omaha, Warren Buffett, had something interesting to say the other day.  And by “interesting” I mean it scared the daylights out of me and anyone else within earshot.  Speaking on the state of the economy, Buffett told CNBC:

“It’s fallen off a cliff…. Not only has the economy slowed down a lot, but people have really changed their habits like I haven’t seen.”

When the man widely considered to be the greatest investor in the world says things like this, it has a tendency to be move markets, cause panic, shift tides, etc.  But what does he mean?  Have the fundamentals of our economy really changed all that much in just a year?  Are people stocking up on canned food and ammunition?  Not quite.  We’re just making more frequent contributions to the piggy bank. 

Remember the rule your father taught you about socking away 10% of your paycheck?  Historically Americans have actually done that or been pretty close.  But something strange happened starting in the 90’s and accelerated in the last 8 years.  According to the Department of Commerce, the average personal savings rate dropped down to around 1%  In some cases it actually dropped into negative territory meaning the average American worker was spending more than they were earning.  Raise your hand if you think that’s sustainable? 

Ok, silver lining time now.  The changing habits Buffett refers to is the reversal of this trend.  Americans are scared and scared people squirrel away cash.  People are now saving 5% of their income, not exactly miser territory, but still that’s a significant change in spending in a short time span.  The result is a retail sector that has to adjust to dramatically less consumer spending.

Because it is happening suddenly, businesses are having a hard time adjusting.  Were it a gradual process this kind of increase in personal savings would simply be absorbed into natural growth patterns.  Sudden change means drastic steps.  Retailers close stores, adjust product lines, and layoff workers.  On the other hand, it had to happen didn’t it?  Not everyone should be able to buy a flat-screen TV.  No matter how cool they are, it doesn’t change the fact that it’s not really necessary; especially when you have to go into debt to buy it.  In short, our troubles are forcing people to shift their attitudes towards consumerism that is unfortunately the current foundation of our economy.

It’s important that we answer the question of how this thinking crept into American culture because its effects echo throughout our society.  The drive for cheaper products has killed our manufacturing base by sending it overseas where sweatshops and non-existent environmental regulation mean cost savings.  In some cases the cost savings is the result of outright slavery.  Think about that the next time you crave a new pair of shoes before the old ones have been used up.  Back in the day other nations respected and even feared the US due to our enormous capacity for manufacturing.  Now we don’t seem to make much other than guns and methamphetamines (no offense to gun loving tweakers intended.) 

How did we get here?  I blame Ronald McDonald.  Seriously.  From the time we are born TV is a parental replacement; and not a very good one.  Children are exposed to consumerism early on by teaching them that buying things will make them happy.  Attention from adult role models is replaced with a smiling clown that tells you one of his meals will make you happy.  With critical thinking underdeveloped, kids make decisions based mostly on emotion, and those emotions are easily manipulated by that damned clown.  Obviously our tastes refine later in life, but the clown just becomes someone else telling us how to buy our happiness.

I’m not suggesting that the foundations of capitalism need to be challenged, but that this mass hallucination that created the now collapsing asset bubble has to make us reevaluate what is important to our society.  If it’s big houses with the latest kitchen gadgets, we’re doomed to repeat our mistakes. 

Introduction

I've started this blog in the midst of political and economic chaos.  The world as we knew it is already gone and continuing to change rapidly before our eyes.  Whether it's the wars, national debt, environment, or crumbling economic infrastructure, something transformative is occurring in our society; perhaps not for the better, but changing nevertheless.  The critical question is “Into what?”

The election of President Obama has particularly piqued my interest.  Though I'm as passionate of an Obamaniac as any, I can't help but feel that much of the fascination with the man is his difference, rather than his views.  He was the physical manifestation of this feeling I have, that something has to be different about this election in this time.  We simply cannot continue traveling down the road we're on.  It will mean departures from our accustomed way of life.  It will mean sacrifice.  It will mean thinking about life and government in very different ways.  It’s neither conservative nor liberal.  It’s a fundamental shift in the way we think.  That’s why I refer to the blog as the New American Paradigm.

Paradigm Shift:  A radical change in thinking from an accepted point of view to a new belief.

Which brings us back to the question:

“Into what?”

That will be the purpose of this blog, trying to answer those questions for myself and perhaps a few others.  My hope is that it's mostly post-partisan, occasionally funny, and somewhat enlightening.  It may not even be fully formed ideas, but it’ll be something…