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    Re-Privatizing Fannie and Freddie: It’s Déjà Vu All Over Again

    Posted by Kevin Villani on 19th July 2019 (All posts by )

    Privatization reform of Fannie Mae and Freddie Mac, a hot topic on and off since their founding eight and five decades ago respectively, is heating up once again after more than a decade of temporary conservatorship. All past reform efforts have failed. What should we have learned?

    • Private markets operate on one set of incentives and accountability, government on an entirely different set. Each has its problems and imperfect solutions.
    • Private markets may inappropriately discriminate against qualified borrowers, for example, whereas public programs may fail to adequately discriminate.
    • Public enterprises created to jump-start or complement private markets often miss the mark, with unintended consequences.
    • Politicians much prefer to deliver subsidies through taxes (in this case tax exempt debt substituting for taxable equity) rather than expenditures – especially since the Budget Control Act of 1974 – and implicit off-budget credit guarantees that delay the reckoning.
    • In spite of good intentions and design to get the best of both, privatized hybrid public-private systems inevitably embody the worst: public risk for private profit. Lacking both market and public discipline, they cause systemic failure that “nobody could have seen coming.”
    • Political reform reflexively blames private market failure, doubling down on unaccountable and ineffective bureaucratic methods while providing opaque bailouts through greater tax and credit subsidies.
    • Political reform starts with what is, not what should be, repeating the cycle.

    U.S. secondary markets evolved entirely in response to anachronistic political forces. FHA was created in 1936 to stimulate new construction jobs subsequent to a huge housing construction boom. Fannie Mae was created two years later to prop up flagging demand for FHA mortgages. Ginnie Mae was created in 1968 to liquidate Fannie Mae after prior privatization attempts failed to reduce official government debt, but the residual $1 billion secondary market facility with minimal shares outstanding as a result of a mandatory user purchase program was instead privatized. When that entity turned down tax exempt pass-through securitization to circumvent the myriad laws and regulations preventing the development of a national securities market, Ginnie Mae stepped in. Rather than liquidate, the privatized Fannie turned to funding conventional mortgages for their mortgage banker clients. To protect their turf, portfolio lending savings and loans then demanded their own secondary market facility, Freddie Mac. It later privatized mainly to provide management incentives comparable to Fannie, particularly stock options.

    They then morphed into massive public directed credit institutions, with profits from government subsidies privatized but otherwise lacking the benefits of market efficiency and discipline. About half of F&F subsidies were captured by shareholders, managers and politicians (my estimates), an invitation to affordable housing proponents to share in this booty. Several 2018 Democratic presidential candidates have proposed upping these goals.

    U.S. mortgage markets were characterized by cut-throat competition decades before the advent of government sponsored enterprises (GSEs): the indiscriminant lending and private market securitization during the sub-prime lending bubble of 2004 to 2007 suggests that is still the case.

    What the private market can’t deliver are the tax and credit subsidies – worth tens of billions annually – that result from federal backing to support fixed rate mortgage interest rate and affordable housing credit risks. Any re-privatized hybrid system that promises to mimic the market, e.g., by requiring that it actuarially price a government credit guarantee as the market oriented Milken Institute and others recommend and to impose market capital requirements and risk regulations directly conflicts with these goals and is doomed to failure. Regulatory restrictions will remain malleable because politics has and will continue to trump bureaucracy. Nor will the market discipline this regulated too-big-to-fail public mission duopoly, having correctly inferred an implicit guarantee in the past for the GSEs, disclosures, regulations and legislation notwithstanding.

    There is a better “public/private” policy option to deliver these subsidies. Long term fixed rate FHA insured mortgage loans have since 1970 been funded almost exclusively with Ginnie Mae securities. Investors take the interest rate risk, HUD takes the credit risks and all ancillary functions are delegated to a competitive private marketplace. FHA, a government sponsored mutual insurance fund with de facto public backing since incorporated into and regulated by HUD insures each mortgage. The un-capitalized Ginnie Mae de jure security guarantee covers only timeliness of FHA payments, but de facto acts as a guarantor of FHA mortgage securities.

    While FHA has failed actuarially – in part due to overly ambitious political goals and its focus on borrowers who may not have qualified for a conventional loan – bailouts have been opaque with minimal or no budget transfers, investor losses or market disruption. It survived the sub-prime lending debacle relatively unscathed. This system hasn’t failed systemically because it separates the private and public functions into different entities, minimizing public risk for private profit incentive conflicts.

    A federal guarantor for conventional mortgage securities modeled after Ginnie Mae (something Ginnie Mae proposed in the late 1970s but I opposed on grounds that it would displace the private savings and loan system of the time) should replace F&F, with the existing infrastructure auctioned to the highest bidder .

    Properly designed, a federal guarantor wouldn’t experience any loss except in catastrophic circumstances. The original Fannie Mae and particularly Freddie Mac secondary market system that left credit risk primarily with multiple state regulated private mortgage insurer’s (pmi’s), experienced negligible credit losses until the market collapse of 2008, after which F&F credit losses of about $300 billion were ten times total pmi industry losses, due to loss severity far exceeding insurance limits. A federal guarantor should be limited to pools of fixed rate mortgages with deeper pmi coverage to reduce exposure, and ideally partially re-insured with private mortgage pool insurers to further capitalize and diversify risk.

    The tax and credit subsidies all go to uniformly lower rates. Deeper affordability subsidies in pursuit of federal home ownership affordability goals were previously provided by HUD’s Section 235 homeowner program targeted to individual FHA mortgage borrower needs, the right approach for achieving this goal. But after years of default losses, Congress shut it down in 1989 rather than increase the budget to reflect the true cost. Following the law of unintended consequences, the affordable housing goals were then dramatically expanded in the Federal Housing Enterprises Regulatory Reform Act of 1992, a precursor to their subsequent failure.

    The debate over the desirability and magnitude of homeownership subsidies remains unresolved. This proposal shifts it to the political arena.

    Kevin Villani

    —-

    Kevin Villani, chief economist of HUD during the Carter and Reagan Administrations and Freddie Mac from 1982 to 1985, is the author of Occupy Pennsylvania Avenue on the political origins of the sub-prime lending bubble and aftermath.

    Posted in Big Government, Business, Economics & Finance, Politics, Public Finance | 3 Comments »

    America, the Land of the Free Lunch and the Home of the Brave Easily Traumatized

    Posted by Kevin Villani on 3rd May 2019 (All posts by )

    As a Boston area baby boomer, I belted out the National Anthem in my youth with conviction at sporting events. Massachusetts educators emphasized its role as the birthplace of the American Revolution from distant unaccountable politicians (leaving out the crucial role of fake news written and published by the infamous brewer’s son Sam Adams) and the motivating principles, summed up by Virginian Patrick Henry’s immortal phrase: “give me liberty or give me death.”

    In the 1970s Boston’s U.S. Congressman Speaker of the House Tip O’Neill quipped “all politics is local.” Now the progressive daily prayer on Twitter begins “Our father, who art in Washington D.C. give us money – a guaranteed minimum income, reparations, welfare, entitlements, etc. and other free stuff – food, housing, medical care, a college education.”

    Bostonian President Kennedy’s appeal to voters’ patriotism in the 1960’s to “Ask not what your country can do for you. Ask what you can do for your country” is reversed today. Patriotism is as out of favor with many millenials (who proudly display their participatory soccer trophies) as are the Boston (now New England) Patriots for hogging the Super Bowl Trophy this century, stigmatizing other teams as “losers.”

    Competing Foreign Ideologies

    Traumatized by competing ideas, many millenials would trade U.S. competitive capitalism and individual freedom for a free lunch. “History doesn’t repeat itself but it rhymes” according to Mark Twain. The core contemporary national political issue is whether America’s popular progressive ”social democracy” ideology rhymes with its founding principles and historical values or foreign ideologies that threaten the body politic?

    The Communism Threat

    The Bolshevik Revolution ended an anachronistic Imperial dynasty in a country with no prior democratic traditions. Communist intellectual Leon Trotsky promised a utopian Marxist socialism, international brotherhood and the end of nation-state competition for resources as the state would wither away. Communist atrocities under Stalin, murders and deaths measured in the tens and hundreds of millions, predated the WW II Western Alliance in a desperate attempt to industrialize a backward agrarian society.

    Stalin promoted opaque Russian Imperialism under the banner of brotherhood. Soviet skullduggery in post War elections in Europe and around the globe – and CIA involvement to counter it (or visa-versa) – was widespread. The post WW I & II “Red Scare” of communist infiltration of state institutions in the U.S. was somewhat over-blown, but the belief that communists could be elected in a democracy based on false promises then turn dictatorial and refuse to relinquish power as has occurred most recently in Venezuela, was well founded. Fearing such a cancer on the body politic, the Communist Control Act of 1954 outlawing the Communist Party in the United States suppressing free speech passed with the full support of progressive Democrats who wanted to distance themselves from ”Uncle Joe” Stalin (and later, many others, including Mao).

    Fascism, Communism’s Cousin and Bitter Political Rival

    Hitler came to power in democratic Germany promising economic prosperity, understandably as wartime consumer deprivation far exceeded that of France and Britain (where communist sympathies were widespread), and post war reparations inhibited a consumer recovery. Although Mussolini, the founder of European fascism, once headed the Communist Party in Italy, and Hitler founded the National Socialist Party, neither implemented socialism domestically. By national, they meant a return to Germany’s pre-War greatness: consumers initially benefitted from a massive boom in defense spending before once again suffering wartime deprivations.

    The nationalist agenda was less imperial than traditional. European history since 1453 is largely related to border wars as Germany is caught in the middle between the British and French empires to the west and Russian empire to the east: only the scale of Nazi eastward border expansion represented a radical departure. In Hitler’s view this rhymed with American westward expansion and genocide of the indigenous populations. He persecuted the Jews, even ethnic Germans, based on Nazi perception of Jewish financing of German enemies on the WW I battlefield and in the labor movement fomenting unrest on the home front and their perceived outsized influence in the Bolshevik communist movement (Trotsky was Jewish).

    Hitler inherited a failing German economy. He was aware that the economic potential of the western capitalist powers were orders of magnitude greater and growing faster, causing him to knowingly take enormous risks to address what he believed was an existential threat. Even as he acquired new territories he was playing catch up. Unlike Stalin, he was not driven by an anti-capitalist economic ideology, but intervention in the German economy increased as the Wehrmacht consumed an ever increasing share of GDP – over half at the peak – relying on private enterprise and the profit and price mechanism to the extent feasible (and arguably more than FDR) relative to the size of the war effort. Dictatorial power and crony capitalist corruption – favoritism of the political elite – was an inevitable result of a rising government share of the economy.

    Racist ideology contributed to his miscalculation of the military industrial ability of the Soviet Union, where his early luck inevitably ran out, after which a war of attrition would exploit Germany’s relative economic weakness. Economic desperation determined the magnitude of Nazi atrocities, less in scope and subsequent to those of the communists in the Soviet Union, but driven by racism.

    In 1977 the U.S. Supreme Court extended freedom of speech protection to the National Socialist Party of America, a racist fringe rather than socialist party.

    European Social Democracy

    In the wake of WW II deprivation and devastation in Europe, “social democracy” – a greater role of the state in providing household necessities – was viewed as a more benign alternative to communism. Britain, particularly Scotland, experimented primarily with socialized housing and medical care until the late 1970s when, as British Prime Minister Margret Thatcher put it, they were running out of “other peoples’ money.”It was also tried in the small relatively homogeneous Nordic countries, running out of money in Sweden in the 1990s and Finland more recently. These experiments were not democratic socialism or the fascist prone democratic capitalism, as all were financed by taxing capitalist-created income and resulted in retrenchment rather than socio-political collapse when they went to far.

    American Progressivism Rhymes with Fascism and Communism, not European Social Democracy

    But for democrat skullduggery, Socialist Bernie Sanders might well have been the 2016 Democratic candidate and also won the election. Most of his younger Democrat competitors for 2020 support the Green New Deal, the latest utopian vision. Their success hinges on rhyming this vision with small-state European social democracy, but the American progressive movement has always focused on the entire nation. When a failed ideology is adopted by a large too-big-to-fail nation-state like Germany or the Soviet Union in the past or the U.S. at present, unaccountable politicians cover-up and double down on failure until it is systemic and seismic like the 2008 financial crisis.

    Progressivism’s historical nationalism and racism and current methods of intervention in a capitalist market economy rhyme with fascism: its premise that economic progress is attributable to politics and its utopian goal of social justice without regard to national borders both rhyme with communism: the inherent dictatorial lack of political or fiscal accountability rhymes with both.

    American Nationalism

    Federal power ballooned during the wars of progressive presidents TR, Wilson, FDR and LBJ. That American patriotism is excessively nationalistic has been an issue since the Monroe Doctrine and subsequent Manifest Destiny. America’s support of free trade post WW II supported by American hegemony over trade routes worked well, as it did under British hegemony leading up to WW I. But the post WW II order is once again breaking down as a consequence of increasing nation-state rivalry over resources and trade routes. President Trump’s “Make America Great Again” is daily attacked not as patriotism but Nazi racist nationalism. The future of American Hegemony should be the central issue in the next presidential election.

    Racism and Sexism

    In a competitive free market economy those who would inappropriately discriminate by race or sex always lose out, always: racism requires political protection from competition. Socialism is inherently discriminatory; the state determines who gets what and who pays. The Democratic Party was the party of slavery, Jim Crow and voter discrimination; it remains the party of restrictive working laws and regulations (with a “disparate impact” on black youth employment) e.g., with well above market “living” minimum wages, credentialing and anti-immigrant worker prohibitions, and admission quotas. Winners beget losers: progressives once again discriminate against Asians.

    The progressive party founded the eugenics movement targeted to limit the black population from which Hitler borrowed ideology. Roe versus Wade represents a eugenic success story, as abortion for the white population at the time required no more than a bus ticket to the next state. Now about half of black pregnancies are terminated.

    The Road to Serfdom

    The promise of “free stuff” to those mostly not yet paying taxes and of cancelling their debt likely explains college students’ preference for socialism over capitalism, and the myth of socialist environmentalism the Green New Deal environmental goals.

    Income inequality and Social Justice in a Democracy

    America’s social welfare system while not as generous as the Nordic countries generally provides a standard of living sufficient by international comparison and luxurious compared to the deprivations suffered when fascism and communism incubated. Competitive market capitalism produces unequal incomes, the source of its ability to raise the living standards of all through increased productivity. Progressive policies that cross the constitutional threshold of equality of opportunity to demand equality of economic outcomes by broadening the base of the politically favored are a subset of crony capitalism that favors the political elite at the expense of society generally, a failed ideology. Socialism fails every time because incentives matter.

    The Green New Deal: a Fentanyl induced Utopian High

    Concern for the environment and the human impact on it is warranted, but what to do about it is a difficult question primarily for foreign diplomats. The Green New Deal adopted by only the U.S. would provide negligible environmental benefit. But as virtually all past environmental initiatives, it would be a bonanza for the crony capitalists and their political patrons. Whether or not the Green New Deal cost $100 trillion or only $10 trillion, it is a road to serfdom for millenials, with no exit provided by the archaic modern monetary theory.

    Democrats Cross the Rubicon

    “The founders of the Roman Republic, like the American founding fathers, placed checks and balances on the power of their leaders. The Romans, however, came up with a way to sidestep these checks and balances when strong leadership was needed, such as a time of crisis.” 

    Communism, fascism, the New Deal and social democracy were all implemented in response to an existential crisis. It is no accident that progressives exploited the “environmental crisis” to push their social justice agenda: these faux crises don’t justify national socialism, an existential threat to the body politic.

    The majority of American voters – positively correlated to age – still properly associate socialism with the totalitarian communist and Nazi regimes rather than European democratic socialism as socialist Sanders’ argues, undercut by his Moscow honeymoon. The two big progressive myths are that European social democracies never run out of money and that “other peoples’ money” i.e., the other party’s voters, will somehow finance the socialist agenda. Green New Deal proponents refused to vote for it to avoid voter accountability for the costs. National socialism and the virtual one party rule necessary to achieve it provides the best explanation for the rest of the 2020 “democratic” agenda.

    Progressive Social Democracy isn’t Nordic

    The population of California is four times that of the largest Nordic country Sweden. It, like all the progressive states is over taxed and over indebted. Obamacare impregnated promiscuous states with these twin fiscal burdens with a whispered promise of a subsequent opaque federal bailout when they matured, making states subservient to D.C. like Soviet Oblasts to Moscow.

    Suppression of Free Speech

    The free speech amendment is listed first as the foremost safeguard against infringement of individual freedom and equality under the law. The Communist Party remains illegal in U.S. due to its meretricious promises, now virtually indistinguishable from those of progressives. Conservative speech to expose the fallacies of progressive ideology and the threat to the Republic is suppressed by the democratic state apparatus. Free speech invites propaganda, including Russian translations, think tank and academic “research” but should be protected, even for communists and neo-Nazis.

    From Republicanism to Democratic Totalitarianism and One Party Rule

    The American experiment with a limited government republic has been undergoing constant change since the “peoples” candidate Andrew Jackson, founder of the Democratic Party and seventh President, while winning the popular vote in the post-universal male suffrage election of 1824 lost in the Electoral College, which he then proposed to abolish. Subsequent progressive constitutional amendments extended voting rights to former slaves and their decedents (15th), women (19th) and the direct election of Senators (17th).

    Even with control of the House, Senate and Presidency, this wasn’t enough to pass Obamacare, arguably the stealth stepping stone to single payer Medicare for all. Unprecedented political maneuvering and prosecutorial and administrative abuse by then FBI Director Robert Mueller was employed. Then a lone opinion of Chief Justice Roberts relied on another progressive amendment, the 16th enabling unlimited power to tax, to save it.

    Socialism in a large diverse nation like the U.S. requires permanent dictatorial powers of enforcement, as highlighted by the requirements of Obamacare and the controversy over the individual mandate. This explains the progressive platform on: voting rights; opposing voter registration, supporting immigration of dependents with voting rights rather than working rights, eliminating the Electoral College, reducing the voting age to 16 years old, registering prisoners, and drive-by voter registration: the Supreme Court; nominating liberal (i.e., anti-Constitutional) Supreme Court Justices, packing the Supreme Court (again), and: the apparent attempt by the Obama Administration to implement PRI style hereditary presidential selection. This rhymes with Mao’s “people’s democratic dictatorship” not the individual liberty of the American Lion.

    To quote America’s greatest economist Milton Friedman:  “A society that puts equality before freedom will get neither. A society that puts freedom before equality will get a high degree of both.”

    Kevin Villani

     
     
    —-

    Kevin Villani, chief economist at Freddie Mac from 1982 to 1985, is a principal of University Financial Associates. He has held senior government positions, has been affiliated with nine universities, and served as CFO and director of several companies. He recently published Occupy Pennsylvania Avenue on the political origins of the sub-prime lending bubble and aftermath.

    Posted in Big Government, Book Notes, Conservatism, Crony Capitalism, Culture, Economics & Finance, Elections, History, Leftism, Libertarianism, Obama, Political Philosophy, Politics, Public Finance, Taxes, Tea Party, Tradeoffs, Trump, USA | 6 Comments »

    Draining the Swamp: Progressive Politics – the Road to Crony Capitalist Perdition

    Posted by Kevin Villani on 17th June 2018 (All posts by )

    From A Libertarian Republic to Majoritarian-Totalitarian Democracy: a Summary

    The 2016 American Presidential Election

    Trust in government fell by almost 80% from the end of the Eisenhower Administration to the end of the Obama Administration. Then Americans endured one of the most divisive and longest two year election campaigns leading up to the 2016 election. Former Democrat turned Republican Donald Trump defeated a field of 17 traditional center-right Republicans to run against traditionally center–left Democratic candidate Hillary Clinton who turned left to defeat her socialist competitor Bernie Sanders in the primary. Sanders correctly argued that the U.S. political system is rigged – more than he knew at the time – but responded by promising his generally young supporters socialism without totalitarianism. The public has endured another two years of divisiveness as the losing party tries to undermine and some would impeach the winner.

    Republican nominee and arguably crony capitalist businessman Donald Trump, the son of a crony capitalist housing developer, ran on the paradoxical promise to “drain the swamp.” The faux democratic election of crony capitalist supremo Vladimir Putin in 2011 drew the public reprobation of then U.S. Secretary of State Hillary Clinton, the subsequent Democratic Party nominee. Putin responded with a campaign of not so fake news not to elect Trump – they had the same polls as everybody else – but to expose Clinton as a crony capitalist who also engaged in election-rigging. He hit pay dirt. The faux Russian collusion scandal has since been used to undermine the legitimacy of the Trump Administration.

    On the issue of trade there was no difference between the three main candidates – all opposed the new TTP trade agreement. The U.S. trade deficit has been about $500 billion a year during this century, consumption financed mostly with additional debt. Candidate Clinton, who supported China’s entry into the WTO during the Clinton Administration agreed she would if elected renegotiate NAFTA, the trade bill passed at her husband’s initiative. On the related issue of immigration, candidate Clinton voted for the bipartisan Secure Fence Act of 2006, as did then Senators Obama and Schumer.

    The Obama Administration had doubled the federal debt outstanding to over $20 trillion – and the unfunded liability is approximately ten times that. President Obama’s Chairman of the Joint Chiefs of Staff publically warned as early as 2010 that the debt was a threat to national security. Candidate Clinton promised she wouldn’t add a penny to the national debt, but her platform had an imbedded $10 trillion increase, less than Sanders to be sure. Candidate Trump promised to eliminate the debt in eight years by increasing economic growth. Clinton’s was a political lie, Trump’s an outlandish campaign promise since going unfulfilled: his appropriations bill contained a $200 billion increase in spending, a Democratic victory for domestic spending in return for Republican defense spending.

    Candidate Trump ran against the “deep state” wars and military interventions that candidate Clinton had voted for. But as President, Trump embraced it with overwhelming Democratic support to punish Russia.

    Progressivism’s Administrative State

    The Democrats’ agenda has arguably fared much better under Trump than Republicans did under Obama. Given these similarities in proposed and actual policies, the subsequent animosity might appear puzzling. But the biggest difference among the candidates relates to the relative roles of the public and private sectors. The U.S. is now governed by an unaccountable patria administrative state: judicial and legislative subsumed in the executive branch and sometimes independent even of that – judge, jury and executioner. The new religion is “science” requiring a faux consensus and leadership by the “experts” as proposed by John Kenneth Galbraith in the New Industrial State (1967) over a half century ago.

    Washington, D.C. is a place where self interested deals are made in hotel lobbies and K street offices, but the entire federal bureaucracy sits on a former swamp. Most federal politicians are political swamp people having worked their way up in local and state politics by making political deals for budget and/or tax subsidies and/or regulatory discretion – legal extortion. Candidate Clinton is a self described progressive and candidate Sanders a socialist, the former supports state control of business, the later favors more direct state ownership.

    The Berlin Wall fell in 1989, followed by the Soviet Union two years later. In 1995 U.S. President Bill Clinton declared “The era of big government is over.” Britain’s Prime Minister Tony Blair, publishing in a Fabian pamphlet in 1998 argued: “Liberals (classical, i.e., American conservatives) asserted the primacy of individual liberty in the market economy; social democrats promoted social justice with the state as its main agent. There is no necessary conflict between the two, accepting as we now do that state power is one means to achieve our goals, but not the only one and emphatically not an end in itself.” But “the values which have guided progressive politics for more than a century – democracy, liberty, justice, mutual obligation and internationalism” have lead in practice to “state control, high taxation and producer interests (crony capitalism).” By the end of the century a few years after Blair spoke, the market had reached The Commanding Heights of the economy. But a decade later the Obama Administration had put the state back on top, seeking to control not just health care but finance and energy.

    Progressivism – like fascism and communism – started with the best of intentions, in opposition to crony capitalism. Social welfare programs were implemented to spread the wealth and provide a safety net, but during the progressive Obama Administration economic growth per capita stagnated. Candidate Trump believed that rolling back the administrative state regulations and the tax on savings and investment as suggested by Blair would restore real private economic growth, the key to managing the public deficit. His Democratic opponents both favored a vast expansion of the administrative state and increases in the tax on capital.

    Progressive Internationalism and the New World Order

    Progressives supported freer trade even if not reciprocal in the post WW II era because America could still enjoy a balance of trade surplus that could be used to fund investments abroad and a “new world order” of American dominance in a bi-polar world with the Soviet Union and its satellites. The European Union evolved as a mechanism to end European – especially German – “nationalism” in favor of this plan. Two events undercut this agenda of international control through capital flows: the 1960s wars on poverty and Vietnam turned American surpluses into deficits, and the common European currency created a German economic hegemony over Europe. The U.S. today is to China what Greece, Italy, Spain, Portugal and Ireland are to Germany, and that’s not a compliment. Both China and Germany – whose exports equal China’s with only 6% of the population – are mercantilist countries pursuing low wages and consumption domestically so that future generations can live off the debt that finances their over-consuming customers.

    Germany understands perhaps better than any country the problem of using foreign debt to finance current consumption as it did to feed a starving population during the interwar years. The excessive debt undermined the fledgling Weimar Republic, giving rise to Hitler. Trumps trade policy appears incoherent, as is much of the criticism. Progressives still argue for globalism and internationalism while conservatives and libertarians are hung up on Ricardian theory of comparative advantage in international trade and the accounting identity of the trade and capital balance.

    The problem isn’t global trade per se, but progressive policies that repress national saving and domestic labor and capital productivity while growing the administrative state. National boundaries still matter. In the EU the single currency zone has destabilized previously relatively stable prosperous countries, threatening political and economic collapse. The relationship between the U.S. and China reflects a similar dynamic: the willingness to accept American debt has kept the dollar from falling and trade adjusting. China holds over trillion dollars of debt backed by taxpayers, and was the biggest foreign funder of Fannie Mae and Freddie Mac during the sub-prime lending bubble. Progressives argued that we would grow out of this debt, but simultaneously and inconsistently deny that the failure to grow during the Obama Administration reflected economic repression but “secular stagnation” – that capitalist innovation has run its course. If so, we are doomed when countries attempt to collect.

    Thus far the main part of the Trump agenda, the tax reform and regulatory roll back – against universal Democratic opposition and condemnation – appears to be working. Economic growth per capita has picked up, unemployment is the lowest since the turn of the century, and business investment net of depreciation is rising from historic lows. But it is way too early to declare success. China entered the WTO without meeting the minimum requirements for intellectual property protection or reciprocity, a Clinton Administration oversight. Fixing the former should be uncontroversial. Reciprocity insures that the most competitive – not the most subsidized – win. Subsidies may benefit American consumers temporarily, but the dislocations are costly and overconsumption dangerous, the debt leading to contemporary “gunboat diplomacy” to settle debts. A reciprocal tariff is a consumption tax, not irrational to consider under those circumstances.

    Progressive efforts to Impeach President Trump: the Totalitarian Administrative State Strikes Back

    Yet since the election, some progressive Democrats have been pushing for impeachment on grounds of Russian collusion and obstruction of justice, although no evidence has yet been produced of that after two years of investigation.

    One thoughtful progressive commentator dismisses these grounds, arguing that the real grounds for impeachment are the “threats Trumpism poses to democracy and rule of law.” If true, those would indeed be grounds for impeachment but he doesn’t define Trumpism or provide evidence. The many articles in the progressive media can be summarized thus: Trump is tweeting against the administrative state agents that are out to get him.

    Libertarians and Republican conservatives have argued that progressives have been undermining liberty and the rule of law for over a century to create the administrative state, obfuscating their agenda by manipulating words to mean the opposite of their historical meaning. Trump’s Court appointments are intended to reverse that trend. Statism is usually associated with one-party faux democracy to prevent state power from turning against the entrenched interests with a change of government. Trump ran against the progressive new world order, arguing to “put America first.” The Democrats didn’t think Trump had any chance to win. This seems the more compelling reason for their impeachment efforts. The anti-Trump organized hysteria bears a marked resemblance to the largely Soros funded Republican and Democratic efforts to ignite the democratic color revolutions in the former Soviet states described by F.William Engdahl in Full Spectrum Dominance: Totalitarian Democracy in the New World Order (2009).

    This isn’t about Trump tweets. It’s a battle for the commanding heights.
    Read the rest of this entry »

    Posted in Big Government, Capitalism, Civil Liberties, Civil Society, Conservatism, Crony Capitalism, Economics & Finance, History, Leftism, Libertarianism, Political Philosophy, Politics, Public Finance, Taxes, Tradeoffs, USA | 11 Comments »

    Our Quasi-Soviet Fiscal Policy

    Posted by Kevin Villani on 5th April 2017 (All posts by )

    “It’s like deja vu all over again.”

    Do Yogi Berra‘s words of wisdom apply to the “new” trillion dollar “public infrastructure” program? The last program, still unpaid, focused on “shovel-ready” projects but somehow missed most potholes. Meanwhile, private companies are prepared to spend $100’s of billions on a new fiber optic internet super highway.

    Is the current proposed public spending program more likely to pay off for taxpayers than the last one?

    Historical Precedent

    When the hammer and sickle flag was lowered for the last time in Moscow on December 25, 1991, the international finance agencies created in Bretton Woods in 1944, led by British economist John Maynard Keynes and the Undersecretary of the U.S. Treasury Harry Dexter White, found a new mission.

    The International Monetary Fund (IMF), which is a “bank” according to Keynes, provided the financial infrastructure for international trade. The World Bank (WB), or a “fund” according to Keynes, was promoted by, known communist and accused Russian spy, Undersecretary White to help reconstruct European infrastructure, but primarily Russia’s infrastructure, in the wake of WW II destruction.

    The IMF lost its raison d’être in 1971 after President Nixon eliminated dollar convertibility into gold, ending the Bretton Woods function. Russia turned down World Bank membership, so the Bank turned to lending for infrastructure projects in the “underdeveloped” nations, which by 1991 faced overwhelming political obstacles.

    Assisting in the conversion of formerly centrally planned economies into capitalist market economies became the finance agencies’ new post-Soviet mission. However, few people had much of an idea of how to accomplish this. It had never been done before, and the IMF and WB were particularly ill-equipped as their charter limited them to lending only to governments. They were essentially statist organizations with little experience with (or sympathy for) competitive private markets (which helps explain why they remain chronically underdeveloped).

    Read the rest of this entry »

    Posted in Big Government, Economics & Finance, Organizational Analysis, Politics, Public Finance, Russia, Trump | 3 Comments »

    Free Trade with a Hostile Mercantilist Empire?

    Posted by Kevin Villani on 14th March 2017 (All posts by )

    2017 marks the 200 year anniversary of David Ricardo’s publication on the theory of comparative advantage that underlies the economic case for free trade. Several years later Frederic Bastiat wrote the satirical Candle Maker’s Petition debunking the arguments in favor of protectionism. This was an ironic choice, as candle makers were politically protected by the Founding Fathers as necessary for the Revolutionary War. These protections lasted several centuries, and in 2016 Senator Chuck Schumer sought it re-instated on grounds of unfair competition from China.

    President Trump’s trade representative economist Peter Navarro is making both the political and economic case against free trade with China, which he considers a mercantilist trader with military ambitions hostile to the U.S.

    Navarro’s political case is an update of that faced by the Founders regarding candle making. China is viewed as pursuing a trading strategy to accumulate wealth and technical know-how to challenge the U.S. militarily in the South China Sea and globally. China’s mercantilist trade practices result in huge export surpluses with the U.S. He argues that China uses this advantage to weaken America’s industrial base and future defensive capability.

    While economists can’t reject this political concern out of hand, it does seem several decades premature given the relative size of the two countries’ navies. At present the US could quickly secure sources of supply for military purposes, and protectionism tends to linger for decades or even centuries.

    The second case against free trade with a mercantilist trader relates mostly to the loss of jobs due to “unfair” competition, i.e., not due to inherent comparative economic advantages as much as political subsidies, in China’s case a purportedly cheapened currency and weak labor and environmental protections. The standard argument is that such trade generally benefits consumers at the expense of high cost producers, resulting in a less political more fair distribution of consumption as well as a higher overall level. Read the rest of this entry »

    Posted in Big Government, Business, China, Economics & Finance, International Affairs, Japan, Markets and Trading, Politics, Public Finance, Trump | 11 Comments »

    Dodd-Frank, Obamacare grew out of same faulty reasoning

    Posted by Kevin Villani on 6th March 2017 (All posts by )

    The current partisan war over the Dodd-Frank Act is just one dispute in a broader ideological divide about the government’s role in industry. This dispute, which has deep historical roots, includes a similar battle over Obamacare. The common disagreement at issue with both laws — now in the cross hairs of a GOP-controlled Washington — is the extent to which politicians should subsidize their constituents indirectly through regulation of private companies.

    The Affordable Care Act governing health insurers was about 1,000 pages, and Dodd-Frank governing most other financial institutions was more than twice that. Both stopped short of nationalizing their respective industry, instead generating more than 10 pages of regulation for every one page of legislation, although many view nationalization as an eventual but inevitable consequence, particularly for health care.

    The distinction between public control and public ownership is the primary distinction between the competing mid-20th-century ideologies of fascism and communism. In contemporary terminology, this distinction is between crony capitalism and nationalization, neither of which can be reconciled with competition and freedom of choice.
    Read the rest of this entry »

    Posted in Big Government, Business, Capitalism, Crony Capitalism, Economics & Finance, Health Care, Obama, Political Philosophy, Public Finance, Systems Analysis | 10 Comments »

    Some Thoughts on Trump, Free Trade, and Horses

    Posted by Lexington Green on 28th February 2017 (All posts by )

    A friend sent a link to a leaked, recorded conversation between Trump and Wilbur Ross, his nominee for Commerce Secretary. There is nothing particularly troubling in the conversation. Trump is talking like Trump. He is the same person in public and in private, which is nice.

    I responded:

    Sounds good to me.  A tariff is a consumption tax collected at the port of entry.  The American founders expected to fund the operations of the national government with revenue from a tariff, and it worked.  He is also right that the Japanese and other countries use safety regulations as non-tariff import barriers.  There is nothing bad on here at all.  

    Read the rest of this entry »

    Posted in Culture, Economics & Finance, History, Politics, Public Finance, Taxes, Trump | 20 Comments »

    The Boom/Bust Cycle Isn’t about Emotion

    Posted by Kevin Villani on 27th February 2017 (All posts by )

    My first experience with manias was in the 1950’s. As a pre-schooler, I was dragged along to the Filene’s Basement annual designer dress sale. Thousands of women of all types and sizes pressed against the glass doors opening into the subway station. Within minutes of the doors opening, these “maniacs” cleared all the racks and, holding armfuls of dresses, began stripping to their slips. That’s when I panicked.

    Looking back, those women acted rationally. There was a limited supply of deeply discounted dresses available on a first come basis. They traded among themselves to get the right size and their most desired dress. Buyer’s remorse was cushioned by Filene’s liberal return policy.

    The premise of U.S. financial regulation is that actors within private markets are irrational, but the evidence shows that it’s not maniacal, illogical behavior that sends markets into freefall.

    Great Depression and Recession

    Now in its seventh edition, Manias, Panics and Crashes: A History of Financial Crises, Charles Kindleberger’s seminal work provides the narrative that underlies virtually all public financial protection and regulation: First, the irrational exuberance of individuals transforms into “mob psychology” and fuels an asset bubble. Then, when the exuberance of a few turns to fear, the mob panics and overreacts, causing a crash that brings down both solvent and insolvent financial institutions.

    In his memoir, the former Federal Reserve Bank President and Treasury Secretary Timothy Geithner, who was at the epicenter of the last crisis, concluded, “It began with a mania — the widespread belief that devastating financial crises were a thing of the past, that future recessions would be mild, that gravity-defying home prices would never crash to earth.”  

    Most U.S. federal financial regulation originates from the Great Depression and the subsequent introduction of federal deposit insurance provided by the Federal Deposit Insurance Corporation (FDIC), which was established in 1933 to protect “small” savers. All prior state attempts to provide insurance failed. Because there were no effective, non-politicized regulations that could prevent the moral hazard of insured banks and savings institutions taking on excessive risks, an extensive regulatory infrastructure was put in place.

    Rational Actors

    Now, the U.S. has about 100 financial regulators, including those in the U.S. Treasury and the Securities and Exchange Commission (SEC), the FDIC, and the Fed. With near-universal deposit insurance, bank runs have become a rarity, but systemic crises have occurred more frequently. It is incontestable that big bubbles eventually burst, asset prices crash, and financial crises ensue. What causes the bubbles to inflate to systemic proportions, and to ultimately burst, is more contentious.

    At the time of Kindleberger’s analysis, individuals were assumed to be rational. The latest edition of his book, written after the 2008 financial crisis, postulates numerous theories about mob psychology (mania) that could lead rational individuals to produce irrational markets, but these ideas are all rather lame.

    Read the rest of this entry »

    Posted in Big Government, Business, Capitalism, Economics & Finance, Human Behavior, Markets and Trading, Public Finance, Real Estate, Systems Analysis, Tradeoffs | 9 Comments »

    There Is No Possible Reform for HUD

    Posted by Kevin Villani on 17th December 2016 (All posts by )

    “The Department of] Housing and Urban Development has done an enormous amount of harm. My god, if you think of the way in which they have destroyed parts of cities under the rubric of eliminating slums … there have been many more dwelling units torn down in the name of public housing than have been built.” ~ Milton Friedman, Interview, Hoover Institution, February 10, 1999

    President-elect Trump’s appointment of Dr. Ben Carson as Secretary of Housing and Urban Development is being criticized on the grounds that he lacks the requisite administrative experience. More likely, Carson’s affront was to question why HUD exists.

    Republican presidents have been ambivalent. Having bigger fish to fry, President Reagan appointed Sam Pierce HUD Secretary so that he could ignore it. George H.W. Bush repaid Jack Kemp’s political opposition by first making him HUD Secretary and then frustrating his attempts to eliminate the Department. HUD Secretary Alphonso Jackson, appointed by George W., was allegedly focused on participating in the traditional kickback schemes while his Assistant Secretary for Housing pursued homeownership policies that contributed mightily to the financial crisis of 2008.

    Democratic presidents have used it as a platform to pursue other agendas. Jimmy Carter’s HUD Secretary Patricia Harris introduced Fannie Mae housing goals – quotas – as punishment for not appointing a woman to the Board of Directors. Between scandals, Clinton’s HUD Secretary Henry Cisneros promoted the homeownership goals that left both the financial system and the new mortgage borrowers bankrupt.

    HUD’s budget is relatively small as compared to other federal departments, but it has always punched far above its budget weight in destructive power. To put HUD’s annual budget of about $50 billion in perspective, the cost of the homeowner mortgage interest tax deduction is two to three times greater, but HUD’s “mission regulation” of financial institutions has given it influence or control over trillions more.

    The initial political interest in housing during the Great Depression was entirely Keynesian, i.e., related to the short-term potential to create jobs and relieve cyclical unemployment – the “infrastructure investments” of that era. The Democrat’s approach to construction, management, and allocation of public housing was generally implemented to benefit builders and rife with corruption. FHA and Fannie Mae were chartered mostly as off-balance sheet financial institutions to stimulate housing production on the cheap.

    The problem of urban development, as many politicians and urban analysts saw it in the 1960s, stemmed from the 1956 Eisenhower initiative to build highways financed by the National Interstate and Defense Highways Act, a byproduct of which was that more affluent people commuted from the suburbs while leaving poorer families behind. The pursuit of the American Dream of homeownership left city administrations accustomed to cross-subsidizing municipal services in fiscal distress, creating a vicious cycle: as services declined, more affluent households moved out.

    The Housing and Urban Development Act in 1965 established HUD as a separate cabinet department as part of LBJ’s Great Society to give a greater priority to housing and urban issues. HUD inherited a mishmash of various New Deal federal programs, ranging from public rental housing to urban renewal, as well as financial oversight of FHA and Fannie Mae.

    Faced with steep “guns and butter” budget deficits, LBJ focused on ways to further encourage off-balance-sheet financing of housing construction through “public-private partnerships.” Republicans, led by Senator Edward Brooke of Massachusetts, convinced by academic studies that the urban riots of the 1960s were the direct result of poor quality housing and the urban environment and by lobbyists for housing producers, supported the Housing and Urban Development Act of 1968. The “goal of a decent home and a suitable living environment for every American family” was first introduced in the 1949 Housing Act. Title XVI of the 1968 Act “Housing Goals and Annual Housing Report” introduced central planning without specifying the goals, a timetable for implementation, or a budget.

    In the late 1960s, the Weyerhaeuser Corporation produced a forecast of single-family housing production in the coming decade to assist with tree planting. Congressional math wizards divided the total forecast by 10 to produce HUD’s annual housing production goals for the nation. For the next decade, HUD Secretaries were annually paraded before their Senate oversight Committee on Banking, Housing, and Urban Affairs to explain why they did or did not meet these production goals.

    Republicans have historically supported rental housing vouchers for existing private rental units for privately built housing to minimize market distortions. Republican HUD Secretary Carla Hills in the Ford Administration pushed HUD’s Section 8 subsidies for existing housing – something arguably better administered as a negative income tax – as a political alternative to the Democrats’ push for a return to public housing construction. But as a further political compromise, the largely autonomous local public housing authorities would administer these vouchers, leading to the same concentration of crime and urban decay as public housing. To borrow a phrase from former House Speaker Newt Gingrich, “Republican social engineering” isn’t necessarily better than “Democratic social engineering.”

    The economic goals of “affordable” housing have generally been in direct conflict with urban development. When I proposed demolishing the worst public housing projects and redeveloping the land, using the proceeds to fund subsidies for existing private market housing (something partially achieved during the Reagan Administration), Clinton Administration officials scoffed at the idea.

    HUD combines socialist goals and fascist methods that seriously distort and undermine markets. There is neither market nor political discipline on the enormous scope of its activities. HUD met unfunded goals through financial coercion, undermining both Fannie Mae and Freddie Mac, and their commercial banking competitors, with the collusion of the Senate Committee responsible for both financial and housing oversight, leading to the sub-prime lending debacle of 2008.

    There is no economic rationale for a federal role in housing or urban affairs in a market economy. HUD represents a continuing systemic threat for which there is no cure. May it RIP.

    Kevin Villani


    Kevin Villani

    Kevin Villani, chief economist at Freddie Mac from 1982 to 1985, is a principal of University Financial Associates. He has held senior government positions, been affiliated with nine universities, and served as CFO and director of several companies. He recently published Occupy Pennsylvania Avenue on the political origins of the sub-prime lending bubble and aftermath.

    This article was originally published on FEE.org. Read the original article.

    Posted in Big Government, Economics & Finance, Politics, Public Finance, Real Estate, Urban Issues | 4 Comments »

    Can Donald Trump Prevent the Economy from Falling Into a Black Hole?

    Posted by Kevin Villani on 13th December 2016 (All posts by )

    Interest rates will eventually rise without an even more devastating policy of financial repression. When they do, rising interest costs will produce a vicious cycle of ever more borrowing. We are already approaching the “event horizon” of spinning into this black hole of an inflationary spiral and economic collapse from which few countries historically have escaped. A substantially higher rate of growth is the only way to break free.

    National economic growth is typically measured by the growth of GDP, and citizen well being by the growth of per-capita GDP. The long run trend of GDP growth reflects labor force participation, hours worked and productivity as well as the rate of national saving and the productivity of investments, all of which have been trending down.

    The population grows at about 1% annually and actual GDP growth averaged 2% overall for 2010-2016 (using the new World Bank and IMF forecast of US GDP at 1.6% for 2016), hence per capita GDP grew at only 1%. Moreover the income from that 1% growth went primarily to the top one percent while 99% stagnated and minorities fell backwards.

    Why we are approaching the Event Horizon
    The Obama Administration annually predicted a more historically typical 2.6% per capita growth rate, consistent with the historical growth in non-farm labor productivity. How could their forecasts be so far off?

    The Obama Administration pursued the most massive Keynesian fiscal and monetary stimulus ever undertaken. Such a policy generally at least gives the appearance of a rise in well being in the near term, as the government GDP statistic (repetitive, as the word “statistic derives from the Greek word for “state” ) reflects final expenditures, thereby imputing equal value to what governments “spend” as to the discretionary spending of private households and businesses in competitive markets. But labor productivity gains stagnated at only about 1%, most likely reflecting the cost and uncertainty of anti-business regulatory and legislative policies that dampened investment, something the Administration denied, trumping even a short term boost to GDP.

    As a result the national debt approximately doubled from $10 trillion to $20 trillion, with contingent liabilities variously estimated from $100 to $200 trillion, putting the economy ever closer to the event horizon. Breaking free will require reversing the highly negative trends by reversing the policies that caused them.

    Technology alone isn’t sufficient
    Obama Administration apologists argued that stagnation is “the new normal” citing leading productivity experts such as Robert Gordon who dismissed the potential of new technologies. Many disagree, but Gordon’s findings imply even greater reliance on conventional reform.

    Fiscal policy won’t be sufficient
    Raising taxes may reduce short term deficits but slows growth. Cutting wasteful spending works better but is more difficult.

    The list of needed public infrastructure investments has grown since the last one trillion dollar “stimulus” of politically allocated and mostly wasteful pork that contributed to the stagnation of the last eight years. Debt financed public infrastructure investment contributes to growth only if highly productive investments are chosen over political white elephants like California’s bullet train, always problematic.

    Major cuts in defense spending are wishful thinking as most geopolitical experts view the world today as a riskier place than at any prior time of the past century, with many parallels to the inter-war period 1919-1939.

    The major entitlement programs Social Security and Medicare for the elderly need reform. But for those in or near retirement the potential for savings is slight. Is Medicare really going to be withheld by death squads? Are benefits for those dependent on social security going to be cut significantly, forcing the elderly back into the labor force? Cutting Medicare or SS benefits for those with significant wealth – the equivalent of a wealth tax – won’t affect their consumption, hence offsetting the fall in government deficits with an equal and offsetting liquidation of private wealth. Prospective changes for those 55 years of age or younger should stimulate savings and defer retirement, improving finances only in the long run.

    The remaining bureaucracies are in need of major pruning and in numerous cases elimination but they evaded even budget scold David Stockman’s ax during the Reagan Administration.

    Americans will have to work more and consume less
    That is the typical progressive economic legacy of excessive borrowing from the future.

    The first Clinton Administration created the crony capitalist coalition of the political elite and the politically favored, e.g., public sector employees and retirees, subsidy recipients and low income home loan borrowers. The recent Clinton campaign promised to broaden this coalition, which would have accelerated the trip over the event horizon.

    Reform that taxes consumption in favor of savings and a return to historical real interest rates could reverse the dramatic decline of the savings rate. Regulations redirecting savings to politically popular housing or environmental causes need to be curtailed in favor of market allocation to productive business investment.

    Repeal and replace of Obama Care could reverse the trend to part time employment. Unwinding the approximate doubling of SS Disability payments and temporary unemployment benefits could reverse the decline in labor force participation.

    Service sector labor productivity has been falling since 1987, the more politically favored the faster the decline. Legal services are at the bottom, partly reflecting political power of rent-seeking trial lawyers, followed by unionized health and then educational services. Union favoritism through, e.g., Davis Bacon wage requirements and “card check” increases rent seeking, particularly rampant in the unionized public sector.

    Competition, of which free but reciprocal trade has historically been a major component, has traditionally provided the largest boost to well being by realizing the benefits of foreign productivity in a lower cost of goods while channeling American labor into employment where their relative productivity is highest. The transition is often painful, but paying people not to work long term is counterproductive. Immigration of both highly skilled and low cost labor (but not dependent family) generally contributes to per capita labor productivity in the same way as free trade.

    None of this will be easy. The alternative is Greece without the Mediterranean climate or a sufficiently rich benefactor.

    —-

    Kevin Villani, chief economist at Freddie Mac from 1982 to 1985, is a principal of University Financial Associates. He has held senior government positions, been affiliated with nine universities, and served as CFO and director of several companies. He recently published Occupy Pennsylvania Avenue on the political origins of the sub-prime lending bubble and aftermath.

    Posted in Big Government, Current Events, Economics & Finance, Politics, Predictions, Public Finance, Trump | 13 Comments »

    A Really Big Short Still Awaits

    Posted by Kevin Villani on 24th September 2016 (All posts by )

    When testifying in 2010 before the Financial Crisis Inquiry Commission into the financial crash, then Federal Reserve Board Chairman Ben Bernanke recommended only one reference, Lords of Finance: The Bankers Who Broke the World (2009), presumably for the narrative that insufficient money printing in the aftermath of the Great War lead to the next one. Right idea, wrong narrative!

    The US homeownership rate peaked at a rate well above the current level almost a half century ago mostly funded by a system of private mutual savings banks and savings and loans. The historical justification for federal “secondary market” agencies was political expediency – exemption from now obsolete federal, state and local laws and regulations inhibiting a national banking and mortgage market. Now government-run enterprises account for about 90% of all mortgages, with the Fed their primary funding mechanism, what the Economist recently labeled a de facto nationalization.

    The Historical Evolution

    How did the private US housing finance system repeatedly go bankrupt? To quote Hemingway: Gradually, then suddenly. The two competing political narratives of the cause of financial market crises remain at the extremes – either a private market or public political failure – with diametrically opposite policy prescriptions. The politician-exonerating market failure narrative has not surprisingly dominated policy, with past compromises contributing to the systemic financial system failure, the global recession of 2008 and subsequent nationalization.

    The Great Depression stressed the S&L system, but the industry’s vigorous opposition to both federal deposit insurance and the Fannie Mae secondary market proved prescient as the federally chartered savings and loan industry eventually succumbed by 1980 to the federal deposit insurer’s perverse politically imposed mandate of funding fixed rate mortgages with short term deposits and competition from the government sponsored enterprises.

    The S&Ls were largely replaced by the commercial banks. To make banks competitive with Fannie and Freddie, politicians and regulators allowed virtually the same extreme leverage, in return for a comparable low-income lending mandate – CRA requirements leading to a market dominating $4 trillion in commitments to community groups to whom the Clinton Administration had granted virtual veto power over new branch and merger authority.

    The Financial Crisis of 2008 and the aftermath

    The Big Short by Michael Lewis and more recent movie portrayed not just banker greed but the extreme frustration of those shorting the US mortgage market stymied by a housing price bubble many times greater than any in recorded US history that refused to burst. The reasons: 1. the Fed kept rates low and money plentiful, and 2. whereas banks would have run out of funding capacity, the ability of Fannie and Freddie to continuously borrow at the Treasury’s cost of funds regardless of risk and their HUD Mission Regulator requirement to maintain a 50% market share kept the bubble inflating to systemic proportions.

    The Obama Administration fully embraced the alternative private market failure narrative in Fed policy, regulation and legislation:

    • To partially ameliorate the effects on the real economy of disruption to the global payments mechanism the Fed had to bail out the banking system. QE1/2/3/4 and ZIRP (zero rates), now NIRP, did this by re-inflating the house diazepamhome price bubble, postponing defaults while allowing banks risk-free profits. The Fed – and taxpayers – would lose more than the entire S&L industry did should rates rise by a comparable amount if it marked its balance sheet to market.
    • Regulators had to appear to punish the banks. In response to paying hundreds of billions of dollars in what the Economist labeled “extortion” – some of which ironically went to populist political action groups – and the subsequent oppressive regulatory regime, U.S. commercial banks are exiting the US mortgage market in spite of ongoing profits enabled by extreme leverage.
    • One legislative centerpiece, the Dodd Frank Act passed in July 2010 in direct response to the financial crisis, doubled down on political control of financial markets without addressing the future of Fannie and Freddie. The other, Obamacare, enacted four months earlier, was similarly premised on regulating private health insurers to make health insurance simultaneously cheaper and more widely available.

    The Long Term Consequences

    Bernanke’s focus on choosing the narrative was useful, but the political choice of the market failure narrative appears to reflect convenience rather than conviction. The direct taxpayer costs of implicit or explicit public insurance and guarantees come with both a whimper – tax savings amounting to tens of billions annually due to the deductibility of interest costs – and a bang – future taxpayer bailouts generally delivered off-budget.

    Fannie and Freddie conservatorship deftly avoided debt consolidation while dividends reduced reported federal deficits. The student loan market has also been de facto nationalized, with potential unbudgeted losses totaling hundreds of billions. Obamacare was similarly premised on regulating private health insurers to make health insurance simultaneously cheaper and more widely available, but under-budgeted health insurance subsidies predictable caused massive losses and health insurers are now withdrawing from the market.

    Monetary policies caused household savings to stagnate as returns to retirement savings evaporated. Defined obligation public pension funds were all rendered technically insolvent when funding is valued at current market returns rather than the assumed rate as much as ten times that. The failure of the economy to grow per capita was explained as the “new normal”. But politicians made no attempt to reflect the implied technically insolvency of public pensions or Social Security and Medicare.

    Private firms fail, but private markets rarely do. Public protection and regulation makes firms “too big to fail” until markets fail systemically. The current and projected future public debt bubble is unsustainable, and financial markets will eventually ignore the accounting deceptions and pop it. The relative weakness of other sovereign debt is delaying the inevitably, making The Really Big Short a good title for a Michael Lewis’s sequel. Politicians and central bankers will again say “nobody saw this coming”. What then?

    ====
    Kevin Villani, chief economist at Freddie Mac from 1982 to 1985, is a principal of University Financial Associates. He has held senior government positions, been affiliated with nine universities, and served as CFO and director of several companies. He recently published Occupy Pennsylvania Avenue on the political origins of the sub-prime lending bubble and aftermath. This article was originally published at FFE.org

    Posted in Big Government, Economics & Finance, Markets and Trading, Predictions, Public Finance, Real Estate, Systems Analysis | 21 Comments »

    What has happened to Venezuela?

    Posted by Michael Kennedy on 21st May 2016 (All posts by )

    venzuela

    Venezuela is in the news as the country cannot even buy paper to print money.

    This all goes back to 1998 when Chavez was elected by the people.

    He was an army officer and had previously attempted to overthrow the government, a coup that failed.

    in the early 1980s. Chávez led the MBR-200 in an unsuccessful coup d’état against the Democratic Action government of President Carlos Andrés Pérez in 1992, for which he was imprisoned. Released from prison after two years, he founded a political party known as the Fifth Republic Movement and was elected president of Venezuela in 1998.

    Venezuela is an example of The Curse of Natural Resources.

    The idea that resources might be more of an economic curse than a blessing began to emerge in debates in the 1950s and 1960s about the economic problems of low and middle-income countries.[3] The term resource curse was first used by Richard Auty in 1993 to describe how countries rich in mineral resources were unable to use that wealth to boost their economies and how, counter-intuitively, these countries had lower economic growth than countries without an abundance of natural resources. An influential study by Jeffrey Sachs and Andrew Warner found a strong correlation between natural resource abundance and poor economic growth.

    Venezuela is only the latest and worst example. The history is depressingly familiar.

    Read the rest of this entry »

    Posted in Big Government, Civil Liberties, Civil Society, International Affairs, Leftism, Public Finance | 55 Comments »

    “THE 30-SECOND GUIDE TO GOVERNMENT SPENDING”

    Posted by Jonathan on 9th May 2016 (All posts by )

    View post on imgur.com

    (Via Dan Mitchell: Milton Friedman, Adam Smith, and Other People’s Money – well worth reading.)

    Posted in Big Government, Economics & Finance, Political Philosophy, Public Finance | 3 Comments »

    Government, the things we do together.

    Posted by Michael Kennedy on 6th April 2016 (All posts by )

    cal

    Barack Obama is fond of describing government this way.

    As President Obama said the other day, those who start businesses succeed because of their individual initiative – their drive, hard work, and creativity. But there are critical actions we must take to support businesses and encourage new ones – that means we need the best infrastructure, a good education system, and affordable, domestic sources of clean energy. Those are investments we make not as individuals, but as Americans, and our nation benefits from them.

    That was a reaction to Romney’s criticism of his silly comment.

    I prefer the quote attributed to Washington.

    “Government is not reason, it is not eloquence,—it is force! Like fire, it is a dangerous servant, and a fearful master; never for a moment should it be left to irresponsible action.”

    Now, we see a new imposition.

    The Department of Labor says its so-called fiduciary rule will make financial advisers act in the best interests of clients. What Labor doesn’t say is that the rule carries such enormous potential legal liability and demands such a high standard of care that many advisers will shun non-affluent accounts. Middle-income investors may be forced to look elsewhere for financial advice even as Team Obama is enabling a raft of new government-run competitors for retirement savings. This is no coincidence.

    Labor’s new rule will start biting in January as the President is leaving office. Under the rule, financial firms advising workers moving money out of company 401(k) plans into Individual Retirement Accounts will have to follow the new higher standards. But Labor has already proposed waivers from the federal Erisa law so new state-run retirement plans don’t have the same regulatory burden as private employers do.

    Read the rest of this entry »

    Posted in Big Government, Capitalism, Economics & Finance, Public Finance | 7 Comments »

    Who’s More Fascist: Presidential Candidate Donald Trump or Former Federal Reserve Chairman Ben Bernanke?

    Posted by Kevin Villani on 19th March 2016 (All posts by )

    How Economists Facilitated the Transition of Erstwhile “Market” Economies to Fascism

    The Left calls Donald Trump a fascist invoking the memory of Hitler and Mussolini, to which Trump might reply: “they were losers; I’m no loser.” Fascism is in essence the political control of the private economy, historically justified by democratically elected leaders to defend against perceived or orchestrated external threats. Progressive war politicians from Presidents Wilson and FDR to Johnson and Obama and now candidate Clinton have pursued this same goal in the US as has the social democratic European Union.

    At the recent meeting of the G20 leaders and central bankers political responsibility for and control over their respective economies was assumed, but their Alfred E. Newman “what, me worry” smiling faces belie the fragility of the current global economy. The political distortions to both the financial and real economy have arguably never been greater, to which politicians and their economist enablers prescribe more of the same mostly wasteful public spending financed by money printing, a cure reminiscent of medieval bloodletting.

    Having never been of much use to business, economists mostly followed “Say’s Law” that supply creates its own demand (for academic economists). They got their first pervasive shot at political power when President Wilson – an academic who chafed at constitutional constraints – created the Federal Reserve which helped US bankers fund the Allies until he could mobilize a war economy, making the first WW “Great.” The unprecedented death and destruction of the Great War knocked the global economy off kilter and the massive international war debts made stabilization politically difficult. As the creditor and least damaged victor, the US economy boomed in the roaring ’20s, followed by a bust.

    Purveyors of the “dismal science” had previously counseled that politicians had to own up to the cost of war until the private economy recovered. While the “arts” of manipulating the value of currency and public spending financed by coercive taxes and often uncollectable debt as well as coercive regulation were as old as politics and war itself, post WW I economists became noticeably less “dismal” and purportedly more “scientific,” believing that such “macroeconomic” interventions could be calibrated to “tame business cycles” in part by transferring or defaulting on war debts. This was complemented by “microeconomic science,” the recent objective of which has been to prove that individuals aren’t always perfectly rational (and by inference in need of paternalistic political protection and direction). Macroeconomists contend that this psychological defect is contagious, conjuring irrational mobs running on banks (or attending Trump rallies).

    Read the rest of this entry »

    Posted in Big Government, Crony Capitalism, Economics & Finance, Public Finance, Trump | 5 Comments »

    In Defense of Wall Street A**holes

    Posted by Kevin Villani on 11th February 2016 (All posts by )

    Long time Democrat turned Republican Donald Trump, who as a business titan relied more than any of his opponents on “Wall Street” funding, decisively won the Republican primary. In sharp contrast, socialist Bernie Sanders decisively won the New Hampshire Democrat primary by attacking his opponent’s Wall Street ties. Trump supporters apparently believe that the way to deal with Wall Street a**holes is a bigger a**hole who will negotiate much better deals, whereas Sanders supporters believe that “Wall Street (a synonym for the entire US financial system) is a fraud” requiring major extractive surgery.

    Most people within the NY financial community including the numerous mid-town asset management firms agree that many Wall Street players were a**holes during the sub-prime lending debacle leading to the 2008 financial crisis, but surely the Sanders pitchfork brigade wouldn’t travel uptown. This may explain why among the thousands of books and articles written in the aftermath of the financial crisis and the Occupy Wall Street movement, Wall Street hasn’t defended itself and has found few defenders willing to go public.

    Truth be told, Wall Street has always attracted more than its share of greedy a**holes. But historically they discriminated against the less profitable investments in favor of those that had the highest return potential relative to risk. This represented the brains of a heartless US capitalist system. Defenders of capitalism correctly argue that it is the only economic system at the base of all human economic progress, however unequally distributed. Progressive critics argue for greater equality, the poor made poorer so long as the better off are equally so (although this is not the way it is typically represented).

    Read the rest of this entry »

    Posted in Business, Crony Capitalism, Economics & Finance, Human Behavior, Markets and Trading, Politics, Predictions, Public Finance, Trump | 6 Comments »

    The Most Important Story No One Is Talking About – Puerto Rican Debt

    Posted by Carl from Chicago on 15th October 2015 (All posts by )

    Dan and I go back and forth on the relatively arcane topic of municipal debt. As we all know, the state of Illinois is awash in debt. The situation is so bad that:


    1. The State of Illinois is operating without a budget

    2. The city of Chicago is proposing a massive property tax increase

    3. Cook County just raised our sales tax (one of the highest rates in the country, already) and is proposing additional fees

    4. Chicago Public Schools face a major deficit and without some sort of massive state tax relief is likely going to face significant layoffs and a likely teachers strike

    5. Note that we are one of the few states and cities to be in such dire straits that we issue TAXABLE debt instead of MUNICIPAL debt which is generally exempt from Federal taxes and some state taxes. This is due to the fact that you generally cannot issue muni bonds to pay off operating expenses (like payroll and legal settlements)

    The long term most indebted players have been Detroit, Puerto Rico, and the State of Illinois / City of Chicago. We saw how the Detroit bankruptcy occurred, with bondholders generally taking it on the chin and unsecured pension holders in fact emerging in a relatively better situation.

    Now Puerto Rico is up to bat. They have massive, unpayable debts of many varieties (some secured by full faith and credit, some secured with revenues, some bank loans, etc…) and their governor basically said so out loud. All of this is inevitable as their island’s best talent has fled to the mainland USA and the remaining population is more and more reliant on government aid to survive. They also have failed to modernize their power infrastructure and / or build new industries outside of tourism which erodes their ability to compete against the mainland USA that in turn has much higher productivity.

    The real issue – long term – is whether or not the Federal government will back up the states. This is essentially the “long game” of the State of Illinois and the city of Chicago – waiting to see whether or not the Federal government is really going to stand by and let us go bankrupt or not. If the government is ultimately going to pick up our debts, it is “business as usual”, and the corruption, back-scratching, and non-competitive behavior can just continue indefinitely, with taxpayers across the nation picking up the debris rather than forcing the citizens of Illinois to clean up our act.

    Today Puerto Rico and the treasury announced that they are working to backstop the Puerto Rican debt with some sort of Federal umbrella per this article.

    Puerto Rico and U.S. officials are discussing the issuance of a “superbond” administered by the U.S. Treasury Department that would help restructure the commonwealth’s $72 billion of debt, people familiar with the plan said.

    And what a great name! A “superbond” means that all the US citizens will pick up the “super” obligations of our corrupt, crony-laden, inefficient city and state. That’s super!

    This is the path out for Illinois and the city of Chicago. Play brinksmanship with Federal government and receive a backstop. Puerto Rico leads the way!

    Cross posted at LITGM

    Posted in Big Government, Chicagoania, Economics & Finance, Politics, Public Finance, Taxes | 15 Comments »

    Risk: An Allegory

    Posted by Jonathan on 26th August 2015 (All posts by )

    Here’s an interesting article on CNBC’s website: Katrina anniversary: Will New Orleans levees hold next time?

    The 100-year threshold is also a statistical guess based on data on past storms and assessments of whether they’ll occur in the future. That means the models change every time a new hurricane strikes. The numbers being used as guidelines for construction are changing as time passes.
     
    The standard also does not mean—can’t possibly mean—that a 100-year storm will occur only once per century. It means that such a storm has a 1 percent chance of happening in any given year. So for example, it’s technically possible for several 100-year floods to occur in just a few years, although it’s highly unlikely.

    One way to look at it is that the engineers need to estimate how high a wall New Orleans needs to protect itself against a reasonably unlikely flood — say, a 1-in-1000-year event. This is the line of discussion pursued in the CNBC article.

    Another way to look at it is to observe that the odds of another Katrina, or worse, within a specified period are highly uncertain. In this case a radical course of action might be called for. You do something like: take the best estimate for the wall height needed to protect against a 1000-year flood and then double it. Building such a levee would probably be extremely expensive but at least the costs would be out in the open. Or you might decide that it’s not the best idea to have a coastal city that’s below sea level, and so you would discourage people from moving back to New Orleans, rather than encourage them by subsidizing a new and stronger system of walls.

    In this kind of situation the political incentives are usually going to encourage public decisionmakers to ignore radical solutions with high obvious costs, in favor of the minimum acceptable incremental solution with hidden costs: probably subsidies to rebuild the levees to, or perhaps a bit beyond, the standard needed to protect the city in the event of another Katrina. And it’s unlikely that any local pol is going to advise residents to move out and depopulate his constituency. Thus, eventually, a worst case will probably happen again.

    Posted in Deep Thoughts, Economics & Finance, Environment, Human Behavior, Markets and Trading, New Orleans Tragedy, Predictions, Public Finance, Statistics, Systems Analysis, Tradeoffs | 14 Comments »

    Greece is going aglimmering.

    Posted by Michael Kennedy on 5th July 2015 (All posts by )

    Greeks

    I’ve been planning trip to Greece for months. Back in January, I decided to wait until the Greek monetary crisis was closer to resolution. Finally in May, I made reservations for September. I even posted my plans here.

    Well, today it may be all going glimmering. The Greeks have apparently voted NO to the EU deal.

    Greece has overwhelmingly rejected Europe’s latest bailout package, plunging the country’s future in the Eurozone into jeopardy.

    With most of the votes counted in a referendum that will shape the future of the continent, the ‘No’ campaign has a staggering 61 per cent of the vote – 22 points ahead.
    German Chancellor Angela Merkel and French President Francois Hollande called for an EU crisis summit to find a ‘solution’ for Greece, with leaders set to meet in Brussels on Tuesday.
    Thousands of anti-austerity voters took to the streets in celebration as the leader of the pro-EU ‘Yes’ campaign resigned, with an official announcement of the final result imminent.
    But German politicians warned of ‘disaster’ as they accused Greek Prime Minister Alexis Tsipras of ‘tearing down bridges’ between Greece and Europe.

    Now what ?

    Read the rest of this entry »

    Posted in Big Government, Current Events, Europe, Leftism, Public Finance | 32 Comments »

    Random Thought

    Posted by Jonathan on 27th June 2015 (All posts by )

    The Supreme Court and Federal Reserve are corrupt in the same way. Both institutions defer excessively to legislative and regulatory agendas instead of sticking to their respective mandates.

    (Re: Judicial Restraint.)

    Posted in Current Events, Deep Thoughts, Law, Organizational Analysis, Political Philosophy, Politics, Public Finance, Tea Party | 6 Comments »

    Economic and Political Turmoil a Century after the Great War: Is it Deja Vu All Over Again?

    Posted by Kevin Villani on 17th October 2014 (All posts by )

    This year marks a century since the outbreak of WW I and coincidently the initiation of US Federal Reserve System operations. Prior to these events, politics were democratizing, economic growth was booming, economies were liberalizing and global trade and finance were growing, all at a pace not seen again for almost another century. Recognizing that achieving these mutual benefits required an externally imposed political discipline, all of the countries participating in this happy situation voluntarily followed a set of rules governing domestic and international trade and finance for automatic and continuous adjustment to changing economic reality, then provided by the gold standard.

    It was during this enlightened period that philosopher George Santayana wrote: “those who cannot remember the past are condemned to repeat it.” Hedge fund manager and Brookings Director Liaquat Ahamed set out to remind us why countries failed to recapture this economic dynamism after the Great War with the publication of the Pulitzer Prize winning Lords of Finance: The Bankers Who Broke the World in 2009. This book took on greater significance when in 2010 Federal Reserve Board Chairman Ben Bernanke recommended only this historical account in response to the Financial Crisis Inquiry Commission’s request for a book reference explaining the 2008 financial crisis. What history had this most recent financial crisis already repeated and what was Chairman Bernanke determined to avoid repeating in the aftermath?

    Read the rest of this entry »

    Posted in Book Notes, Current Events, Economics & Finance, History, Public Finance, Systems Analysis | 6 Comments »

    Incentives and Economics

    Posted by Carl from Chicago on 14th July 2014 (All posts by )

    A few years ago I went to Norway and had a great time. In this post I described how expensive everything was in Norway due to their highly valued currency (tied to oil riches) combined with the relentless decline of the US dollar (tied to ZIRP and other dubious economic moves). In the simplest terms, a fast food meal or a beer in Norway cost over $20 USD which is complete madness.

    Business Insider discussed the Scandinavian economic experiment, where high taxes are applied to goods and services in order to fund a vast social safety net. From the article:

    In Norway, a burger and fries at a fast food joint will set you back $23. A six-pack of warm grocery-store beer is nearly $30.
    These hefty price tags are due, in part, to high wages for low-skilled service jobs. But high taxes play a role too.
    Most products have a 25 percent value-added tax, which means that $5.50 of the cost of that burger goes to fund Norway’s generous social programs.
    As a visitor, you get little for the added price. But, as a resident, your daily spending helps to fund an expansive package of benefits, including health care, child care, high-quality education, pensions, and unemployment insurance.

    Some are now proposing this high-cost method, with large taxes embedded in everyday prices, as a solution to the inequity in incomes and wealth that is discussed widely in politics and economics today.

    From the perspective of someone who is highly interested in economics and tax policy, my two rules of thumb are:
    1) that the tax policy raise the money that it intends to raise
    2) that the tax policy not significantly distort economic activity

    Any society that implements high taxes such as Norway needs a comprehensive surveillance model in order to collect these taxes. It is difficult to avoid taxes that are broadly assessed on fast food, for instance, because each corporate location will set up cash registers and controls to remit these taxes onto the state. The same types of processes can be installed in liquor stores, formal bars and nightclubs, grocery stores, and restaurants.

    In a less-homogeneous society such as the USA, we already have major problems with tax evasion on cigarettes and likely liquor, and these are in responses to our sales taxes. The problems would be compounded if we placed value added taxes on all goods at a higher level and on services such as restaurants, hair care, etc… Smuggling would become rampant and informal or barter methodologies would increase in size and scope. These sorts of costs would have to be applied across the USA or some areas would become uncompetitive and see an out-migration of economic activity, starting with incremental additions (no one has opened a new manufacturing plant in Illinois in years, for instance) and eventually leading to the lock, stock and barrel out migration of existing industries (such as the exodus of car manufacturing out of the Midwest and California to the American South).

    Read the rest of this entry »

    Posted in Big Government, Economics & Finance, Public Finance, Taxes | 33 Comments »

    Emmanuel Todd, Speaking in English, on Why the Euro is a Failure

    Posted by Lexington Green on 9th July 2014 (All posts by )

    Todd applies his family structure analytic model to explain why the Euro is doomed to fail. He notes that the French and the Germans, for example, have little in common. He expressly says that the French individualism is much closer to the Anglo-American individualistic culture, distinct from the German authoritarian style. He says that the French elite caused the problem and they cannot admit their mistake or the entire foundation of the French political structure would collapse.

    The European idea of a union of free and equal states has been destroyed by the Euro, and it is now an economic hierarchy, with the Germans at the top. Further, democracy itself is incompatible with the Euro.

    Todd notes that the very low birth rates in Europe have a positive benefit: There will be no open or violent conflict to resolve the current political conflicts. Rather, contentious issues are kicked up to the “European level” — which means nothing whatsoever will happen.

    He sympathizes with the British position. Britain is dependent on a dying content, Europe. “It is committing suicide under German leadership.” But Britain is part of a much larger Anglo-American world, which in ten years, on current trends, will have more people than all of Europe.

    Of course, America 3.0 is based in large part on a “Toddean” understanding of American culture, and this talk is consistent with our understanding.

    A fascinating talk.

    H/t Brian Micklethwait

    Posted in America 3.0, Anglosphere, Economics & Finance, Europe, France, Public Finance, Video | 3 Comments »

    Posted by Jonathan on 19th June 2014 (All posts by )

    canned gold

    After Janet Yellen’s latest press conference Chicagoboyz plunge heavily in canned kipper snacks and other hard assets.

    Posted in Photos, Public Finance, That's NOT Funny | 6 Comments »

    Picketty’s Introduction

    Posted by TM Lutas on 9th June 2014 (All posts by )

    Thomas Piketty has written a monster of a book, Capital in the Twenty-First Century. I find myself in strange agreement with Brad DeLong, that the collective conservative response is weak. I had a patch of time that left me twiddling my thumbs waiting for some pretty long database operations to finish over the past four days. So I went and decided to fisk the book. I just finished the introduction. It took four posts, Part I, Part II, Part III, Part IV and overran the spare time I had available from a database import and indexing task by about 12 hours.

    Now I know why the criticism is so weak. Piketty is a target rich environment and doing a line by line analysis is simply exhausting. But it’s the only way to be sure.

    Posted in Book Notes, Business, Economics & Finance, Public Finance, Society, Taxes, USA | 18 Comments »