Bernie Madoff's Victims

I’ve been reading a lot about Bernie Madoff in the news recently. Bernie is the Wall Street financier who has owned a securities trading firm for four decades. He was one of the pioneers of electronic trading, and was actually president of the NASDAQ organization for a couple of years. As a market maker, he was one of the most respected members of the Wall Street finance community.

He also ran a money management firm, noted for taking cash from wealthy individuals and other money management firms and producing consistent, steady returns of 1% to 2% a month.

Except that it now appears that Bernie wasn’t actually investing the money he was given. He was making up the posted gains, and using the money new investors gave him to pay cash distributions to older investors. A Ponzi scheme. The biggest, longest lasting Ponzi scheme in history.

So now I am reading stories from people who lost everything from a couple of hundred thousand dollars to a couple of million dollars up to institutions that have lost billions of dollars. Estimates of total losses have run as high as $50 billion dollars.

But here’s what I want to know: Can you truly lose money that you never had? For example, I read one account of an investor who put $25,000 into a fund that invested with Madoff in 1992. Even though the investor pulled out cash distributions every year, his investment had grown to $150,000. In his account, the investor said he had lost all $150,000.

The thing is, the investor never had $150,000. He only thought he had that much because Madoff told him he had that much. The most he ever had at risk was the original $25,000, and he had probably gotten most of that back in distributions over the years. So what is the true loss?

A Ponzi scheme is essentially a zero sum game. A zero sum game is one where the winnings of some of the players are offset by the losses of the other players. The individual running the scheme, in this case, Bernie Madoff, takes a cut off the top. Madoff’s skim, however, appears to be miniscule compared with the sums invested. I mean, the guy lived well, but not that well.

When all the forensic accounting is completed, the losses of later investors are going to be balanced with the gains of the earlier investors. And once that accounting is done, the losers are going to hire lawyers and try and get their money back from the winners.

Thousands of plaintiffs and defendants, all using lawyers to fight over money. Now that’s not a zero sum game. That’s a negative sum game.

Except for the lawyers.

Happy New Year, Part II

In my last post I discussed the theme of deleveraging for 2009. By deleveraging, I mean reducing the ratio of debt to equity on both household and corporate balance sheets.

There are a number of ways an individual household can reduce leverage. Probably the most painful is to have your house foreclosed on. Since a home mortgage is typically the largest source of debt for a family, losing your home means losing most of your debt all at once. Not recommended, but if your mortgage payment is greater than market rent, moving into a rental will free up your cash flow.

A bankruptcy is less effective at reducing leverage than foreclosure. Most states protect your home equity during a bankruptcy filing. You can drop most of your credit card payments, but you still have the debt associated with your mortgage. Foreclosure and bankruptcy have got to be the two most painful ways of deleveraging.

The least painful way to reduce debt is to reduce current consumption and divert more of your cash flow into paying off debt. Whether paying off credit cards or making extra equity payments on a mortgage, either way you are reducing household debt.

Actually, it may be even less painful to increase income and put that extra money into debt retirement. Start up a sideline business or get a part-time second job. But in today’s market, those options may not be as readily available as they were even a year ago.

In the struggle to pay off debt, there are two schools of thought on which debts to pay of first. One school holds that the best idea is to focus most of your effort into paying down the debts with the highest interest rates. That way you lower the burden of finance charges faster. The other school of thought is to pay down the smallest debts first. This technique gives you small victories as you eliminate one debt after another.

Whichever technique you use, I’m more interested in the timing of the payoffs. Unless you are paying truly outrageous interest rates, the best response to an uncertain employment outlook is to build your cash position with additional savings.

Consider: both foreclosure and bankruptcy are not a function of the amount of debt carried. They are a function of cash flow. If you do not have enough cash to make all of your payments every month, you start to fall behind. It is the inability to make payments that drives people into bankruptcy. Exacerbating this is that most lenders pile on late fees and higher finance charges once you have late or missing payments.

Let’s say you are doubling up on the equity payment on your mortgage, and have been for years. The extra equity payments have shortened the term of the mortgage. You will pay it off in 15 years instead of 30. In the meantime, however, you have to keep making your payment every month.

Now you lose your job. If all your extra cash went towards paying down the mortgage, and you don’t have a substantial cushion, you are one month away from being delinquent on your mortgage. The fact that you made all those extra payments won’t cut any ice with the bank. They still want their payment every month.

So my plan is to continue making all my payments every month while I increase my cash reserve. Once I have enough extra money put away to extinguish a debt like a car loan, then I’ll pay it off all at once. It will require more discipline to hold onto the cash, rather than funneling the money directly to the lenders on a month by month basis. I may have to pay more in finance charges. But I’ll sleep better at night knowing I have the ability to ride out any unforeseen financial storms.

In a world of rising unemployment and falling real estate values, cash really is king.

Happy New Year!

At the beginning of the New Year, I like many others, make resolutions for the coming twelve months. Sometimes these resolutions actually come to fruition (2008: start a blog), sometimes the hard realities of December bear no resemblance to the wishful thinking of January (2008: increase the value of my portfolio by 15%). Nonetheless, I find value in the exercise of goal setting. It helps define my priorities for the coming year.

Sometimes as you take stock at the end of one year, and you review progress against your goals, it becomes an exercise in shoulda, woulda, coulda. For example, I sure wish I'd gotten 100% into cash in the first half of 2008. Ah well. I'll just keep telling myself that I'm investing for the long haul. That makes it feel okay. Really, it does.

Anyway, I've decided that my financial theme for 2009 is deleverageing. My spell check doesn't like the term, so maybe deleverageing isn't in the dictionary yet. By the term the current financial crisis is in the history books, it will be.

In financial terms, leverage is a way of expressing the ratio of debt to equity. For example, if you buy a house with a 20% down payment, and take out a mortgage for the other 80%, you have leveraged your equity four to one. As you make your mortgage payments, your reduce the leverage as you build equity. This happens very slowly in the first years of the mortgage, than picks up speed as a larger and larger percentage of your mortgage payment is focused on paying down the principle balance.

The current crisis in the financial markets was brought on by excessive leverage during the housing bubble, both by consumers and institutions. Consumers bought houses with no money down (essentially infinite leverage), or they extracted all of the equity from their houses through home equity lines of credit. After all, if the value of housing had kept going up, they would have created equity out of thin air. Why not borrow against that? It seemed like a good idea at the time.

On the institutional side, banks were dumb enough to make those loans. The investment banks on Wall Street were dumb enough to repackage those loans and resell them, and institutional investors like insurance companies and pension funds were dumb enough to buy them. After all, if the home owners stopped paying their mortgages, the collateral (the houses) would be worth more than the original loans. Why not loan against that? It seemed like a good idea at the time.

It seemed like such a good idea that the Wall Street investment banks borrowed hundreds of billions of dollars to amplify the returns on the firm's capital. After all, bonuses were paid based on returns on capital. These guys were capitalists, says so right on the brochure. So when the housing market started to turn downward, a lot of the banks and investment banks were highly leveraged, 20 to 1 or even 30 to 1.

The upside of leverage is that when you are making gains, those gains are amplified by the amount of leverage. The downside of leverage is that when you are taking losses, the losses hit your capital by the same degree that gains boost it. So if you are leveraged 20 to 1, that means you have 20 dollars of debt for every dollar of equity. A 5% loss on the value of your assets is enough wipe out your equity.

Picture a bank holding most of it's assets in residential mortages. Foreclosure rates have more than doubled since 2007, and housing prices have dropped an average of 18% in the last year. Banks are taking losses of way more than 5% on their loan portfolios. When your debt is greater than the combination of your assets and your equity, that is the technical definition of insolvency, also known as bankruptcy. Ouch.

Financial institutions have spent the last year trying to raise capital, either by selling shares of preferred stock or by selling assets or by raising cash by cutting expenses like dividend payments. If leverage is the ratio of debt to equity, having more capital lowers leverage. For consumers, leverage is also being reduced. When you mail the keys to your house back to the bank, and move into a rental, you have reduced your personal leverage by the amount of your mortgage loan.

The bottom line is that when you reduce debt, you deleverage your financial position. So the process of reducing debt is deleverageing, however you spell it.

The thing about deleverageing is that it is a lot less painful when you do it willingly, before circumstances force you into it. It is a lot easier to tighten one's belt and build your rainy day fund, than it is to deal with foreclosure, or even escalating late payments because you missed a credit card payment.

Having established the theme of deleverageing for 2009, the next question is whether it is better to pay down debt or build up cash. I'll take up that issue in another post.

The Joy of Christmas Past

You don’t have to be much of a curmudgeon to appreciate the pleasures that come with the end of the Christmas season on December 26. The palpable slowing down of pace after the last minute frenzy of gift buying, wrapping, and delivering. The slackening of traffic on the roads, combined with the ability to get a parking spot at the mall. The chance to rest up after the round of Christmas festivities, and gather strength for the onslaught of New Year’s Eve. But for me, this year, there is one special blessing, post holiday.

They’ve stopped playing “Christmas Shoes” on the radio.

You know the song. It’s the one about the guy who’s in the store when he sees a little kid who needs money to buy a pair of shoes for his dying mother. The poor sap rediscovers the true meaning of Christmas when he forks over the dough for the kid to get the shoes. Just in case you forgot, here are the lyrics to the refrain.

“Sir I wanna buy these shoes for my Momma please
It's Christmas Eve and these shoes are just her size
Could you hurry Sir?
Daddy says there's not much time
You see, she's been sick for quite a while
And I know these shoes will make her smile
And I want her to look beautiful
If Momma meets Jesus, tonight.”

What a batch of hooey! What a load of hogwash! The pathetic absurdities of this song beggar the imagination. Consider the baloney you’re being asked to accept when you listen to this load of rubbish.

First, the kid knows his mother’s shoe size. What? I don’t know my mother’s shoe size, and I’ll bet you don’t either. Hellfire, I was well into my twenties before I could have reliably stated that my mom had feet. It just never entered my consciousness.

Second, what kind of shoes are these? Jimmy Choo’s? Manolo Blahnik’s? I mean, seriously, what kind of little kid pays attention to shoe fashion? The only reason I know those names is from watching “Sex and the City” reruns on cable, and I had to Google the names to get the spelling right.

Third, the song posits that what a dying woman wants most before she passes away is a new pair of shoes. Now, you usually can’t go wrong betting on the shallowness and materialism of the American consumer, but the woman is going to die, for cripe’s sake! If I was dying, that sure wouldn’t be the top of my Christmas list. A miracle cure, that’s what I want Santa to drop down my chimney. Or maybe just more morphine to keep the pain pump fully stocked up. But shoes?

What kind of store is this, anyway? Probably a department store, because the narrator isn’t there to buy shoes, he is just there to “pick up a few things.” That raises another question. The kid is described as “dirty from head to toe.” In most upscale stores, the staff wouldn’t let a dirty street urchin wander around, pawing through the merchandise and panhandling from the customers to pay for shoes. The staff would call security, assuming they didn’t just give the kid the bum’s rush on their own. I can picture the response when the kid first walked into the store: “Hey, kid, keep your grubby hands off. That’s cashmere!”

Here’s my theory: the kid and the salesclerk are running a scam. The store overstocked on cheap Chinese knockoffs of designer shoes. The kid spots a mark, turns on the waterworks, and the sucker pays for them. The suddenly overjoyed scamster goes out the front door, and comes around and in through the back door, ready to resell the same pair of shoes with the next mark to walk in. Meanwhile, the clerk cleans up on commissions. Hellfire, the clerk is probably the kid’s real mother! They probably share a good horse laugh over the suckers they rooked when they get home.

Cheating sentimental saps, all in the service of pure commercialism. There’s a Christmas anthem for you. At least we’re all done with that now. That song is off the playlists.

At least until next year.

Closing Down

Chrysler has announced that starting tomorrow, they are closing all thirty of their manufacturing sites for a month. This is being billed as a cash conserving move on their part. This is being treated as a major news story, getting coverage on the networks and all the major newspapers. Of course, I have a reaction to this story. Ready? Wait for it.

Big, fat, hairy deal. Do they want us to think that this is a last ditch effort to save the company, because they didn't get their Federal bailout check?

My company shut down operations for the entire week of Thanksgiving. We came back to work on December 1, worked production until December 9, then closed up and sent the production associates home until January 5. Our maintenance crews are going home at the end of this week, and they'll be off for two weeks. So between November and December, we've taken four weeks off, just like Chrysler. We're doing this because orders are down, and you cannot keep building product when your customers aren't buying, just like Chrysler.

The difference is that we didn't issue a press release just because we are closing down for inventory reduction at the end of the year. We would rather be running production, but in today's environment, it is just a sound business decision, to cut production to balance inventories. You don't see us threatening the economy of Tennesse with collapse if we don't get a bailout.

In their campaign to get hold of Federal bailout money, the domestic car companies and the UAW have consistently presented the worst case scenario to support their claim on Federal money. "If you don't give us $30 billion, RIGHT NOW, we are going bankrupt, one out of every five Americans will be unemployed, and a new Great Depression will sweep the country."

It is the industrial equivalent of extortion. And it's getting old.

Investment Scam of the Year

The latest shock to come out of the financial industry on Wall Street is the Bernie Madoff scandal. Mr. Madoff has been involved in Wall Street business for almost fifty years. He was the head of NASDAQ for several years, and his securities firm occupies three floors of a downtown skyscraper.

The primary business of his firm was to act as a market maker, taking orders to buy and sell a number of stocks. However, he also ran an investment advisory firm, taking in money and investing it for people and institutions. At the beginning of the year this arm of his business reported holding $17 billion in other people’s money.

It now appears that the investment advisory part of his business was actually running like a giant Ponzi scheme, where the money that new investors put in was used to pay dividends to older investors. Hit by requests for $7 billion in redemptions by investors this quarter, the house of cards came tumbling down. Mr. Madoff’s own estimate of total losses to investors was $50 billion.

This is an amazing story, and it is only starting to unfold. From what little has been revealed so far, several aspects of the situation boggle the mind.

First, how did one guy pull this off? From all reports, only a couple of dozen people worked on the floor of the building where the investment firm was located. Most of the employees were on the two floors where the legitimate business was located. How did Mr. Madoff handle the mundane details like keeping everyone’s theoretical balance straight, or mailing out statements and dividend checks? Normally, managing billions of dollars takes hundreds of people. Of course, it is a lot easier when you aren’t actually managing the money. Still, the logistical details of a fraud this size must be daunting.

How do we know that Mr. Madoff was acting alone? Because he says so. At this point, if Bernie Madoff said the sun came up this morning, I would have to look out the window to check. I suspect this morality play has more villains than just Mr. Madoff.

The other astonishing part of this story is the victims of the scam. Some of the investors were relatively wealthy individuals who were taken in, and are now ruined. Mr. Madoff’s reputation and longevity, as well as his charm, had to help in duping his victims. But the big money came from other Wall Street investment firms, as well as a slew of international banks. How did these guys fall asleep at the switch?

It apparently never crossed their collective mind that Madoff was scamming them. I can just picture the due diligence meeting. “Bernie? Bernie Madoff? I’ve known the guy for years. We take steam together down at the club. Twice a week, regular as clockwork. He says he needs another billion? So send him a check. Electronic transfer would be even better.”

Then again, these were some of the same sharp guys who were buying subprime mortgages up until a year ago, so I guess we shouldn’t be too surprised that they got taken.

I’m sure that the “Law and Order” screenwriters are already working on a “ripped from the headlines” story.

The 5% Solution

As part of the news coverage concerning the Federal bailout of the Big 3 domestic automakers, I have seen stories about how the president of the United Auto Workers, Ron Gettelfinger, has been meeting with other leaders of the union to discuss how labor is going to have to put some cost saving ideas on the table to help the Big 3 avoid bankruptcy. Obviously, it is the union's interest to avoid a Chapter 11 filing, because a bankruptcy trustee could unilaterally make changes to union contracts to preserve the value of the business for the creditors. It's better to volunteer givebacks before they are imposed upon you.

First and foremost should be the Jobs Bank. That is the part of the contract that says laid off UAW workers get to receive 95% of their hourly pay and full benefits while waiting for another job position to open up. Since the domestic manufacturers have been cutting headcount for years, the new job positions never do open up. The UAW members merely collect full wages and benefits, while doing no work for the company. The Jobs Bank has been bleeding the car companies for years now. The union says that the Jobs Bank is not that much of a problem, since there are only about 3500 employees currently in the program.

Only 3500! Wages and benefits for the average Big 3 autoworker are $75 per hour (compared to $45 per hour for Japanese transplants like Toyota and Honda). Simple math tells us that $75/hour times 1800 hours/year time 3500 equals $472 million dollars a year in potential savings. Now I've gotten kind of numb from listening to all the big numbers thrown from all of the different Federal bailouts so far this year, but $472 million sounds like a lot of money to me.

But I've got another idea for changing the UAW contract with the domestic automakers. This won't help stave off bankruptcy in the short term, but in the long run could help them regain some of their lost competitiveness. I call it the 5% solution.

The concept is simple, change the contract to allow management to fire up to 5% of the UAW workers every year, no questions asked. That means no seniority, no grievances filed, no arbitration. Management would have to follow Federal law, which prevents firing people based on their membership in a protected class (race, gender, age, etc.). Other than that, pull whoever you want and give them the boot. Management would not be required to exercise this right, they would merely have the option.

In Right to Work states, employment law features a doctrine known as employment at will. Employment at will assumes that the work relationship is mutually agreed upon, and that either party has reciprical rights to terminate that relationship at any time. Simply put, you can tell the boss to take this job and shove it. The boss can give you the boot. All I'm proposing is to apply this doctrine to the UAW contracts, subject to a limit of 5%.

Consider the effect this change would have. As things stand now, to terminate a union worker requires cause, and proving cause requires evidence that will stand up in a legal proceeding. Being lazy and inefficient doesn't qualify as just cause. But if you could fire 5% without having to show cause, think about the impact that would have on the organization.

You could let the maintenance worker go who has a lot of seniority but can't fix equipment, and keep the newer guy who can actually keep the machines running. Or how about the stock handler who has spent his years finding the best places to hide, and always shows up five minutes after he has been paged. Or the assembler who sends parts with a quality problem down the line instead of raising the flag about the issue. "Not my problem" the assembler says. Think about what it would do to efficiency to get rid of the shirkers and malingerers who drag down the whole team.

Management would not even have to use the option for it to have a salutary effect on the organization. Whe they know they can be fired, almost everyone will hustle harder to impress hte boss. The worst will pick up the pace significantly, and even the best will put out a little extra effort. When they see the bar being raised, employees will be more focused throughout the organization.

Some will complain that my idea will mean the end of job security, and will shift the balance of power away from labor and deciviely towards management. Well, right now the industrial workers with the most contractual rights on job security are the UAW workers. That's what the Jobs Bank was all about. But you have to ask yourself: How much job security do you have if your employer is on the brink of bankruptcy?

The only real job security is when the company is winning in the marketplace. It's time for a change in how the unions do business.

The gurus have spoken!

Well, it's official.

The National Bureau of Economic Research came out Monday and announced that the US economy was in a recession. Their statement said that the economy had been contracting since December 2007. That means this recession has already gone longer than the post World War II average, which is ten months.

Yup, it's official: the economy has been contracting for a whole year now. This makes me want to channel the late, great "screamer" comedian, Sam Kinnison:

WELL, WHAT WAS YOUR FIRST CLUE?! WAS IT THE 50% COLLAPSE IN HOUSING STARTS? THE TRIPLING IN THE FORECLOSURE RATE? MAYBE IT WAS FACT THAT THE BIG THREE DOMESTIC CARMAKERS ARE ON THE VERGE OF BANKRUPTCY? OR COULD IT BE THE COMBINATION OF HUNDREDS OF BILLIONS IN BANK LOSSES, THE FAILURE OR FORCED MERGER OF MAJOR INVESTMENT BANKS, AND THE TOTAL FREEZE UP IN THE CREDIT MARKETS?

The business I work in has been hunkered down in survival mode all year, but the official announcement is just now being made. It hardly seems worth calling a news conference to announce the finding. What great finding will be announced next? Water is wet? Gravity pulls you down? Oh, I know: The Earth revolves around the Sun!

Now, if somebody knew when the recession would end, and the economy start growing again, that would be news you could use.

Throw the bums out. Just not yet.

In my last post I mentioned that Gail Collins, a New York Times columnist, had advocated George Bush resign the Presidency so that Barack Obama could start his term early. Today, Thomas Friedman, the Times' foreign affairs correspondent seconded that desire. I just found out that Lou Dobbs, the CNN anchor, had made the same suggestion, that George Bush resign.

These are supposed to be thoughtful, intelligent, well-educated people. What possesses them to say such silly things?

One of the great things about the American political system is the peaceful transfer of power. On the appointed day, the outgoing guy packs up his momentos and rides off into the sunset. No riots in the street. No power sharing deals. No cabals of senior military officers throwing their support behind one candidate or another. No flight into exile, financed by a secret Swiss bank account. On Inauguration Day, the ex-President and his team leave quietly, and the new President and his team move into the White House.

What the pundits listed above have proposed is to interfere with that process. There is a crisis, so throw the rulebook out the window. No one's in charge, and we need a strong hand at the helm to steer us through this storm!

This just another version of the end justifies the means. If, by some miricle, they did manage to hound Bush out of office prematurely, do they not realize that would set a precedent? A precedent that can cut both ways. Suppose Bush was to announce that due to the crisis in the financial markets, he was going to have to stay in office until the crisis was resolved. That would create a constitutional crisis, but no more so than trying to install Obama before Bushes term in office is over.

Once you start playing games like that, you are starting to erode away one of the supports of our democracy.

Whether they like it or not, Obama is just going to have to wait his turn.

Be Calm

From all indications, the US economy is in bad shape. Unemployment is rising, as more companies announce layoffs. The fall in stock prices has gotten to the level that many of us have stopped looking at our 401K balances. The credit markets are still largely frozen up, making it difficult for even profitable companies to get financing for their operations. It is clear that we are in a recession, and by all indications it will be a bad one.

In the face of all this bad news, the cries for a new stimulus package from Washington have become louder and more insistent. Paul Krugman, the Nobel winning economist and New York Times columnist, is calling for an immediate fiscal stimulus of $300 to $600 billion. Gail Collins, another New York Times columnist, is calling on President Bush to resign as the only way to save the country. "Orderly transfer of power be damned! Save us, Obama, save us!" Any impediment to handing out the fat envelopes of government cash, such as the Constitution, is considered as perilous in this time of crisis.

Two things are being missed in the panicked rush to increase the national debt in the name of keeping the economy going.

First, it's not that bad out there. The unemployment rate has risen, that's true. But 93% of us still have jobs. Banks have had to write off hundreds of billions of dollars worth of bad mortgages, and a number of banks have failed, that's true. But not a single depositor has lost his savings. Credit has gotten scarcer and more expensive, that's true. But my credit card still works and I expect it to keep working, as long as I keep paying off the bill. Standards may be a bit higher, but banks are still making loans to individuals with good credit ratings. Corporate profits are down, but aside from financial services and the domestic auto makers, companies in most sectors are not losing money.

Perform a little thought experiment: when you drive past Wal-Mart, is the parking lot still full of cars? If you go out to eat at a restaurant, is the place half empty, or do you have to wait for a table? My experience has been that the economy is still functioning. It may be harder to make a buck, but rumors of a new Great Depression are greatly exaggerated.

The other factor that has been missed by the pundits is that gas prices have dropped in half over the last couple of months. Gasoline that was at $4 a gallon over the summer now costs under $2 at the pump. For the average household, this frees up between $50 and $100 a week. Between now and the end of the year that could be worth up to $500, with another chunk of budgetary relief in January. And another in February, and so on. Over the next few months, lower gas prices will but as much money back into the economy as any proposed stimulus package.

Money that isn't literally burned is availible for keeping mortgages current, and paying down credit card debt, and shopping for Christmas presents. All activities that will reduce the level of financial panic. We just have to be patient.

Buzzing with Excitement

Since Congress passed the $700 billion bailout authorization called TARP (Troubled Asset Relief Program) in October, the predictable rush to the trough has occurred. What I didn't anticipate, however, was how fast other players than banks would get their hands out for a share of Federal largesse.

Originally sold as a plan to buy up illiquid mortgages and mortgage backed securities, TARP quickly morphed into direct equity injections into major banks. Seeing how easy it was, insurance company AIG bellied up to the bar for a second round, having already received an $80 billion Federal loan.

Not to be outdone, the cities of Philidelphia, Atlanta, and Phoenix sent a letter to Treasury Secretary Paulson, asserting their rightful claim to a Federal handout. San Jose, the home of Silicon Valley, is waiting to see how that is handled before submitting their request for $15 billion.

This was closely followed by the domestic automotive manufacturers. Not satisfied with the first $25 billion in loan guarantees they got as a separate line item in the TARP authorization, Ford, Chysler, GM are threatening economic armageddon if they do not get at least another $25 billion.

This morning a group of automotive supplier companies applied for their fair share of the bailout money. In a strange way, this latest request almost makes sense. The big 3 car companies are threatening to take their supplier base down with them if they have to declare bankruptcy. The auto suppliers are just trying to cut out the middleman, getting the money directly from the Treasury instead of getting it from the car companies.

I guess I shouldn't be surprised with how fast players far removed from the financial industry are rushing in to get a chunk of the $700 billion TARP bailout fund. When you've got that big a honeypot, you're going to pull in a lot of flies.

Bailout Nation

Ford and General Motors are looking for $50 billion in loans from the Federal government to keep their operations going. I should say another $50 billion, because they already got $25 billion earmarked for them when the $700 billion financial bailout package passed.

Speaker of the House Nancy Pelosi and Senate Majority leader Harry Reid issued a joint statement last week in favor of handing more taxpayer cash to the domestic carmakers. Rahm Emmanuel, chief of staff designee for President-elect Barack Obama, weighed in on the side of the increased bailout this weekend. I guess that this means the fix is in.

Still, I’m not convinced that a good case has been made for bailing out the domestic car companies. Not that I do not believe that bankruptcy is a real possibility for the car companies. GM alone burned through $6 billion in cash during the last three months. If they continue at that rate, they will run out of cash sometime next year.

But bankruptcy isn’t the end of the road. They can use Chapter 11 of the bankruptcy code to continue to operate while they reorganize. This is what all of the major airlines except Southwest and American have done, and they all managed to stay in the air while going through the process. If the airlines can do it, why can’t the auto makers?

A Chapter 11 filing would give them a chance to get out from under their UAW contracts. These are the contracts that require the car companies to pay laid off workers 95% of their base wage (and 100% of their benefits), even though those workers and actually doing any work.

My concern is that, even with the government loans they are seeking, GM and Ford are only staving off the inevitable. Without structural changes to how they do business, like dropping the UAW contracts, what’s to keep them from coming back to the taxpayers in another year or two, asking for good money to be thrown after bad?

Where is the Center?

As Team Obama shifts from the campaign to the transition team, the analysis coming out of the media has also shifted. Some have suggested that the Obama administration will shift to the right once in office, attempting to find centrist positions to the tough issues. Looking at Obama's policy positions, I'm not holding out a lot of hope.

Governing from the center is raising taxes to pay for infrastructure spending. Governing from the left is raising taxes on some people to give transfer payments (excuse me, tax credits) to others.

Governing from the center is making an argument for expediting new nuclear power plants, to replace carbon dioxide emitting coal fired power plants. Governing from the left is placing a massive tax on energy (excuse me, a cap and trade system), while telling people that wind mills will replace the industries that you bankrupt.

Governing from the center is announcing that you will put your administration's political capital into redefining Federal law to recognize gay marriage. Governing from the left is declaring you will appoint judges who will rule based on their compassion for the downtrodden.

Governing from the center is coming out in favor of unionization, staffing the NLRB with pro-union partisans, and ramping up Justice Department investigations of companies accused of illegal antiunion activities. Governing from the left is tossing out 70 years of law backing secret ballot elections, and replacing it with card check legislation allowing for covert intimidation and coercion to determine the nature of the workplace.

Governing from the center is to propose raising the minimum wage to $9.25/ hour. Governing from the left is to propose raising the minimum wage to $9.25/hour, extend the FMLA in terms of employers affected, reasons for claiming leave, and amount of leave, and require employers to give employees 5 days of paid leave.

Governing from the center is to require health insurance plans to provide unlimited mental health benefits. Governing from the left is to require health insurance plans to provide unlimited mental health benefits, and then go on to require employers to health insurance to all employees as a mandatory benefit.

The Obama administration has the potential to make conservatives nostalgic for traditional tax and spend liberalism. Between unfunded mandates on business and tax and give policies, I'm gearing up for four years in loyal opposition.

How to Create Jobs, Not!

Part of an interview Barack Obama gave in San Francisco last January came to light over the weekend. In the interview with the San Francisco Chronicle, President-elect Obama made the following comments regarding coal-fired power plants:

“If somebody wants to build a coal plant, they can — it’s just that it will bankrupt them, because they are going to be charged a huge sum for all that greenhouse gas that’s being emitted.”

This comment was made in the context of explaining a cap and trade system for reducing greenhouse gas emissions. Since coal burning power plants emit more carbon per kilowatt than any other type of electrical generation, the penalties on those plants will be higher. The idea behind a cap and trade system is that, over time, the penalties for emitting carbon increase, until they become ruinous, and the carbon emitting power plants are shut down.

The goal of a cap and trade system is to drive carbon emitters out of business, while rewarding businesses that produce the same products in a carbon neutral way. In the context of power generation, coal-fired power plants are bad, solar and wind farms are good.

I bring this up by way of introducing the topic I really want to write about: the myth of the “green job.” The way this myth is presented is that by developing nonpolluting energy sources, all kinds of jobs with high pay and great benefits will be created. Since entirely new industries will be created in the field of clean energy, lots and lots of new “green jobs” will be added to the economy.

Yesirree, plenty of demand for windmill mechanics out there on the horizon. Sky’s the limit. Speaking of the sky, we’ll also need a bunch of solar mirror focusers. Step right up and get your job application here.

Now the problem I have with this line of argument is that job creation is being sold as one of the benefits of changing our energy infrastructure over to a less carbon intensive model. Try telling that to the guy who works in the coal-fired power plant that’s going to be taxed out of existence to pay for all those shiny new windmills. That poor schmoe is going to lose his job. So will the coal miners supplying him with fuel.

As I see it, employment in the energy industry is at best a zero sum game. For every job you create building or servicing windmills, or installing solar panels, you lose a job building mining equipment or transporting coal. There are going to be winners in new energy technologies, but there will be just as many losers in the old, reliable, proven technologies.

If we have to make this transition, if the survival of civilization requires it, than so be it. But don’t try and pitch it as a good way to create jobs.

We should pay more respect to the people who are going to lose their livelihoods after the companies they work for are bankrupted.

Hail to the King!

I don’t know if this is a function of the media coverage or a real phenomena, but it looks like a lot of the people at risk for losing their houses in the next wave of foreclosures will be the newly unemployed. Whenever I read an article about foreclosures, the stories feature people who just lost their job.

Now, as far as recessions go, this is not my first rodeo. We had spikes in the unemployment rate in 2001 and in 1991 when the economy contracted. But from my admittedly foggy recollection of news coverage from those days, I do not remember a lot of foreclosures being associated with the downturn.

To the extent that this is a real phenomena, I wonder if this is a function of increasing household leverage. During previous recessions, did folks have more savings that could tide them over a rough patch? Or is it that these days, the mortgages are so large that making the payments exhausts one’s savings more rapidly than in years past?

In an uncertain environment, you want to have more stored fat to carry you through the lean times. Whether because we’re leaner (financially, not physically) or because our burdens are heavier, it seems like people who lose their jobs in this recession are at much higher risk of a financial upset turning catastrophic.

I wonder if some people thought they were “storing fat” though their home equity. Either by making extra equity payments, or rising housing prices, maybe some thought they were storing up equity. The simultaneous drops in housing prices and credit availability have given the lie to that theory.

Cash is king right now, and cash is the only truly liquid investment. Times like these demonstrate the critical importance of keeping an emergency fund available.

Give the guy a break!

Sometimes the media coverage amazes me.

Take Joe the Plumber. The guy questions Barack Obama's tax plans at a campaign stop in Ohio. Based on Obama's answer to his question, the interaction gets posted to the internet, and is picked up by the McCain campaign, who used it in the last debate between McCain and Obama.

So apparently editors around the country start asking who is this Joe the Plumber, and what is his story. What seems like a hundred reporters sift through every public record on this guy, and report the following scoops:

His name isn't really Joe.
He doesn't hold a plumbing license.
At one point he was in arrears on his taxes.
The business he works for probably doesn't generate over $250,000 in earnings for the owner.

Who gives a crap.

What made the exchange newsworthy wasn't the question, or the questioner. It was the candidate's response. Barack Obama said "I think things go better when you share the wealth." What he meant was "I think things go better when I share your wealth." Barack Obama's tax plan proposes to use the government as the intermediary to transfer money from people who have it to people who don't.

Take from the rich and give to the poor.

As I have said before, Barack Obama will be the Robin Hood President.

And focusing on Joe, or Sam, or whatever his name is, distracts us from focusing on the candidate's proposals, and the implications of those proposals.

Tax Cut Semantics

When is a tax cut not a tax cut? Barack Obama claims that his economic proposals include tax cuts for 95% of Americans. But to do so would require redefining what it means to cut someone’s taxes. To understand what I mean, it’s necessary to illustrate the differences between tax deductions, nonrefundable tax credits, and refundable tax credits.

The basic concept behind income taxation is pretty simple. You take your income and subtract out deductions to come up with adjusted gross income (AGI). Then you multiply AGI by a percentage to figure how much tax you have to pay. The US tax is progressive. That is, the more money you make, the bigger the percentage you hand over to the Federal government.

Tax deductions are things like paying home mortgage interest, or saving for retirement by putting money into an IRA. You deduct the money you put into those things from your income. So if you are in a 15% tax bracket, for every dollar you put toward your IRA, your taxes are reduced by fifteen cents.

Your deductions can only drop your income down to zero. You can’t have negative income and get any kind of rebate from the IRS.

Then there are the tax credits, nonrefundable and refundable. After calculating how much tax you owe, based on your adjusted income, tax credits reduce the final sum of taxes paid. For every dollar of tax credit, your taxes are reduced by a dollar. For nonrefundable credits, you can reduce your tax liability down to zero, but then the game stops. With nonrefundable credits, you can’t have a negative liability and get any kind of a rebate from the IRS.

This brings us to refundable tax credits. With this type of tax credit, after your tax liability is reduced to zero, any credit left over is yours to keep. Which means the government sends you a check.

Tax deductions, nonrefundable tax credits, and refundable tax credits: guess which type the Barack Obama plan calls for when he says he’ll cut taxes for 95% of Americans? Now here’s the thing about this tax “cut.” After deductions from income, and existing tax credits, about 40% of American households don’t pay any income tax. But under the Obama plan, they would be getting money from the government.

So, getting back to our original question, when is a tax cut not a tax cut? When it’s welfare.

New Ideas for Spending Money

Where do they come up with this stuff?

In the face of a plunging stock market and moribund credit markets, both Presidential candidates are reaching deeper into their goodie bags to come up with new bribes, er, enticements to try and stimulate the economy. Sure, because $700 billion to buy up banks and mortgages wasn’t enough.

Last week John McCain fired off a salvo. He proposed rescinding the requirement that owners of IRA’s and 401K’s have to start taking withdrawals from retirement accounts starting at age 70 ½. Why force people to sell assets into a down market, when that just increases the downward pressure on stock values? Actually, I think this is a pretty good idea, but then again, I’ve never heard a good argument for why mandatory withdrawals from retirement accounts were necessary in the first place.

After meeting with his economic advisors over the weekend, McCain apparently felt that anything else they proposed was too gimmicky, so he hasn’t come out with anything new this week. Of course, there is one more presidential debate coming up, so maybe he’s saving up for that.

In the meantime, Barack Obama came out with multiple gimmicks, er, policy proposals this week. First, he wants to mail out a $1000 check to everyone whose household income was less than $150,000. He also wants to extend unemployment benefits for another 13 weeks. This looks like a straightforward increase in welfare to me, pure and simple.

Senator Obama wants to impose a three month moratorium on foreclosures for any bank that accepts the Federal bailout money. You have to wonder what the economic point of this is. Does he anticipate that people will start paying their mortgages again after a three month grace period? Wouldn’t an increase in the number of foreclosures in process (loans go delinquent, but none ever get resolved) put even more stress on the banks that taxpayer money is going to bail out? The political point is a little more self evident: “Vote for me, folks, and I’ll give you three months free rent!”

Then there is the idea of removing penalties for 401K withdrawals. This allows you to get the tax break for contributing to a retirement plan, without actually having to forego the immediate consumption. Americans don’t save enough for retirement now, so let’s make it easier to consume instead of invest. This is the triumph of short term gratification over long term planning. Times may be tough now, but they will be even tougher when you are too old to continue working.

My personal favorite among Senator Obama’s new proposals is the tax credit for adding employees to the payroll. He has proposed a $3000 tax credit be given to businesses for every person they hire. This is basically offering a bribe to go out and hire people, but it is not even an effective bribe. In my hiring and firing, if I need to hire people, I hire them, and $3000 from the government isn’t nearly enough to sway my opinion. A new employee costs at least $20,000 a year. Unless you have enough business to justify that expense, a $3000 dollar subsidy doesn’t begin to cover that cost.

As a conservative, I long for the days when every problem didn’t automatically become the concern of the US government. Both parties seem to be caught up in the game of seeing who can offer more tax revenue to the citizenry. I’ll be happy in three weeks when the Pander fest known as the general election campaign is over.

If at first you don't succeed...leave it alone.

The crisis in the nation’s, and the world’s, credit markets continues to persist. From reading news reports, I hear that credit is “frozen,” and that “banks are afraid to lend to one another.” The standard line being used is that without access to credit, businesses cannot buy inventory or payroll, consumers cannot buy cars or houses, and the entire economy is in danger of grinding to a halt.

In the face of the credit market freeze, the Federal Reserve and the Treasury are announcing new actions almost every day to try and get the buyers of securities off the sidelines (there is no shortage of people wanting to sell IOU’s, just not a lot of people buying them these days).

In the last week the Fed has taken the following actions:
-It has started buying unsecured commercial paper. These are basically short-term loans made to individual companies for funding operations. They are usually not backed by any collateral.
-Fed Chairman Ben Bernanke promised to cut interest rates in a speech on Tuesday. That’s usually good for cheering up the markets.
-This morning, the Fed did cut interest rates, along with six other central banks around the world, in a coordinated action. Okay, now we know all of the central bankers are serious about restarting the stalled credit markets.
-The latest proposal that has been floated is a plan for the Fed to buy ownership stakes in banks.

All of this of course, is on top of the $700 billion Treasury bailout that passed Congress last week, also known as the mother of all interventions.

The first thing that strikes me about all of this is the emphasis on making loans and borrowing money as the engine of the economy. Wasn’t it too much borrowing, and lending to people who couldn’t pay the money back that got us into this mess?

The other thing that strikes me is the frenetic nature of the government’s actions. They want an immediate reaction, and when the market doesn’t oblige, they cough up another plan to see if that will give them an immediate reaction.

In the manufacturing arena, one reaction to problems is called "overadjusting the process." You take a part coming off the machine, measure it, and then tweak the machine. Then you do it again, and again, and again. The problem with that is that you never let the process stabilize to normal capability. Sometimes you have to resist the temptation to keep pulling on the levers and knobs, and just let the machine run for a while to determine your true process capability.

It feels like governments are trying to do the same thing. Every day a new program or intervention is announced, without giving the markets time to settle down and get used to the last adjustment. It probably doesn't help that it is an election year. My favorite metaphor for this is “pulling the plant out of the soil to check on the growth of the roots.”

There are a lot of people who work in the credit markets. Leave 'em alone to do their jobs, and eventually they will figure out how to muddle through. Interest rates will spike higher for awhile, even for ultrasafe borrowers like the state of California and AT&T. But as investors figure out that California is not going to default, trading volume will go up, and rates will come back down.

I have a lot of faith in letting people muddle through. It is not always efficient, and it is almost never pretty, but in my experience, letting people do their jobs seems to work.

A Tale of Two Deals

A little less than two weeks ago, Citibank agreed to take over the banking operations of Wachovia Bank. This was a deal engineered by the Treasury Department to protect depositors of Wachovia. Although Wachovia did not technically fail, this was certainly a shotgun wedding arranged by the regulators. Citibank agreed to pay $2 billion for Wachovia.

Interestingly, Citibank agreed to pay for the first $41 billion of losses on Wachovia’s loan portfolio. After that, the Treasury (meaning we the people) agreed to indemnify the folks at Citibank for any additional losses. In other deals of this type, the government has taken the losses up front, as a sweetener to get the acquiring party to do the deal.

For example, when Bear Stearns was acquired by JP Morgan Chase earlier this year, the Federal Reserve took $30 billion of bad assets off Bear Stearns’ books before the sale went through. Since the Wachovia deal is structured the other way around, Citibank has powerful incentives to keep the losses as low as possible. This tells me that nobody, and I mean nobody, really knows which loans are going to default, and what the recovery on the collateral will be when all the foreclosures are done and the houses resold. But I digress.

So anyway, the Treasury pushes through a crash sale of Wachovia to Citibank. Three days later Wells Fargo offers $15 billion to buy Wachovia in a separate deal. The CEO of Wachovia, using the keen business acumen honed by decades of experience in high finance, quickly realizes the Wells Fargo offer is about 750% better than the Citibank offer. Wow, maybe the guy is worth the $19 million in signing bonus and severance pay he’s going to get for six months worth of work.

Wachovia’s Board of Directors quickly approves the sale to Wells Fargo. Citibank, spurned at the altar as Wachovia elopes with Wells Fargo, cries foul. All three banks hire $400 an hour lawyers and go searching for judges who will rule in their favor. The corporate equivalent of a barroom brawl erupts. Or maybe a mud wrestling match.

The latest news is that the banks have called off their attack dogs, and some kind of compromise deal is in the works. All very entertaining, but what does it have to do with us.

Just this: the guys at Treasury put together the Citigroup-Wachovia deal, and less than a week later somebody else offers 750% more for the same assets. And let’s not forget that there is no risk to the taxpayers in the Wells Fargo offer. Thirteen billion dollars is a lot of money to leave on the table in a negotiation. I mean, it’s not exactly a rounding error.

I can’t really fault the T-men either. Their priority was to protect the depositors, and get the deal done as smoothly as possible, with minimal disruption to the financial markets. Getting the best deal possible was never even on their radar screen. For the Citigroup team, getting the best deal possible is always their primary consideration, and those boys have sharp elbows. For that matter, the same could be said for Wells Fargo.

But here’s the thing. Didn’t Congress just pass legislation allocating $700 billion of the government’s money (meaning we the people) to buy up financial assets? Didn’t the money get allocated to the Treasury Department? And aren’t the T-men going to buy those financial assets from banks like Citigroup and Wells Fargo? Using our money? Forgive me if I’m wrong, but isn’t the Treasury’s primary goal to support the banks, and not to get the best deal possible?

We the people are going to get rolled like a drunk on New Year’s morning.

It's been a wild ride so far!

The last month has been an amazing time to watch the financial markets. More and bigger changes have occurred among the major players in the US financial system than in the previous generation.

A quick recap:
The Federal government took over Fannie Mae and Freddie Mac, effectively nationalizing the US mortgage market.
Lehman Brothers goes bankrupt.
The US government buys 80% of one of the largest insurance companies, AIG, in exchange for an $85 billion loan.
Bank of America acquires Merrill Lynch.
After a run on deposits, Washington Mutual is taken over by Federal regulators and is sold to JP Morgan Chase. This is the largest bank failure in US history.
Just prior to failing, Federal regulators engineer a deal for Citibank to take over the banking operations of Wachovia bank.

While all that was happening, the last two major independent investment banks, Morgan Stanley and Goldman Sachs, decide to rewrite their charters to change to more ordinary commercial banks. This move will require them to continue the process of deleveraging that has been going on all year, and will also require them to accept a much higher level of regulation than they have previously had to deal with.

What else happened last week? Oh yeah, after the House rejected a $700 bailout of the financial markets, the Senate passed a sweetened bill, and the House accepted that. So now the Treasury is going to directly own $700 billion in mortgage packed securities. Since these will be distressed assets (otherwise why sell them to the bailout fund), it is likely the government will own mortgages with a face value of well over a trillion dollars.

So, while competition in the banking sector is being dramatically reduced, and the investment banking industry is essentially eliminated, the Federal government becomes the largest player in the mortgage market.

I thought we were supposed to be the guys who believed in free markets.

Financial Market Bailout, Take II

If at first you don’t succeed…

The government’s bailout plan for the credit markets passed in the US Senate last night, after failing in the House of Representatives on Monday. The revised legislation will probably come up for another vote in the House on Friday.

In the first stampeded rush to judgement, the unpopular bill failed, in part because of the very size of the package, and the unprecedented leeway the Treasury secretary was given in handing out $700 billion of the taxpayer’s money. Also disturbing many lawmakers, of both parties, was how quickly the message of the administration changed from “the system is stressed, but still working,” over to “if you don’t give us this authority, your ATM will stop working.”

In order to get more votes for the proposal (note I did not say “make the proposal more popular”) the Senate followed the time honored tradition of packing more lard into the pork barrel. The revised plan now includes an increase in insurance on bank deposits, up from $100,000 to $250,000. It now also includes a grab bag of tax breaks estimated to cost another $100 billion.

Great! Spending $700 billion in one fell swoop isn’t enough. Let’s plug another $100 billion on top of that. I thought this plan was half baked before. The Senate version looks like they pulled the cake out of the oven, saw it was half baked, and decided the answer was to add a bunch more ingredients to the mix.

I’ve heard of smearing lipstick on a pig, but who knew they had invented lipstick body wash?

Adding to the hysteria has been the behavior of the stock market. The House fails the bill, and the market drops 700 points! The bailout is resurrected in the Senate, and the market leaps 500 points! The market opens quiet, waiting to see if the revised bailout passes the House!

I’m put in mind of the two year old who throws a tantrum in the aisle of the grocery store until the parent buys them the candy they want.

Try this on for size: leave the markets alone. If the credit market starts to seize up, let it. In the short run, interest rates will go up, and it will be harder to get loans. But after a while, the boys and girls on Wall Street will figure out that if they don’t play nice, their jobs will go away, and the markets will start functioning again.

At least, that’s my theory. I call it “Free Market Economics.” It’s too bad that we’re not going to see that theory tried out.

No Skin in the Game

Congress and the Bush administration have agreed to terms on a $700 billion bailout package for Wall Street. Under the plan, the Treasury will purchase mortgage-backed securities that no one else wants to buy from banks. This infusion of cash will recapitalize the banks and hopefully stimulate inter-bank trading to resume at something close to normal levels.

For the taxpayer’s $700 billion, we get several things. First, the government gets the securities, which will hopefully be worth something. The idea is that the Treasury can get a better deal by waiting for the right buyer to come along. Right now, panic selling has these securities worth pennies on the dollar. By driving panic out of the market, the prices of these mortgage-backed assets will recover some of even most of their value. If they don’t recover in value, the taxpayer will eat the loss.

In addition to the bonds themselves, the government will get warrants that give the Treasury an equity stake in the companies that participate in the plan. So if the stocks of the banks go up, post rescue, the government (i.e., the taxpayers) will recover some value. Finally, there are some limits on senior executive compensation that go along with accepting the government’s largesse.

We have been assured that this bailout was necessary to prevent total collapse in the banking system. The end was near! If that had happened, consumers would have been unable to get mortgages or car loans, and businesses would have been cut off from lines of credit necessary to continue operations. If you accept that, congress and the administration had no choice but to act. The problem is, I’m not buying it.

I understand that the rates banks charge each other for short term loans have spiked in he last two weeks, and that trading in the credit markets has been at much lower volumes that usual. But nobody has connected the dots to show why the credit markets wouldn’t calm themselves without the largest government intervention in history. Nor has anyone made the case for why credit worthy borrowers would not have been able to get loans, even if the interest rate was higher than it would otherwise be.

Nobody in the banking industry has come forward to say: “I’ll take the hit. Passing this legislation is so important that I will forego salary and bonus for 2008.” Kenneth Lewis, the CEO of Bank of America, which just acquired Merrill Lynch, wrote an editorial in Friday’s Wall Street Journal urging passage of a bailout plan. But since Bank of America is in such good shape that they don’t need the help, I guess ol’ Ken doesn’t feel the need to sacrifice any of his hard earned compensation to convince Main Street voters that the crisis is as dire as portrayed.

When Lee Iacocca was brought in to turn around Chrysler in the early eighties, he asked congress for loan guarantees to help him raise money for the turnaround plan. In order to build credibility for the effort, he agreed to forego salary and bonus until the company returned to profitability. I sure would like to see some of the Wall Streeters volunteering to do something similar.

If the situation is as serious as it is reputed to be, that is the least that they could do. Of course, maybe the end wasn’t so near. Maybe the taxpayers just got played.

Would you buy a used car from these men?

I watched a little of the C-SPAN coverage of the Paulson/Bearnke show last night. This was the Senate hearing where the Treasury Secretary and the Federal Reserve Chairman were pitching their plan to use $700 billion to buy up mortgage bonds and rescue the financial markets. As I understand it, their contention is that unless the government buys up all of these assets, the banks will not trade with each other, leading to other businesses and consumers being unable to get credit to run or expand their operations.

The august personages that sit on the Senate Banking Committee were, not surprisingly, reluctant to hand over an amount greater than the entire defense budget to two bald guys sitting at a folding table saying “yup, we really do need that much money.”

Based on the short section of the hearing that I watched, I felt like this was the gist of things:
Q: What assets will are you buying?
A: We don’t know yet. No point in thinking about that until you know you’ve got the money in hand.

Q; How will you price the assets you are buying?
A: We think we’ll use a reverse auction, but we’re not sure yet. The method of making purchases will vary based on the type of asset we are buying. Can we have the money now?

Q: How will you know if the prices you pay are fair prices?
A: Well, at this point we don’t know. We plan to hire some really smart guys to figure that out, just as soon as you give us statutory authority to spend enough money to buy Switzerland.

Q: What will you do if the taxpayers buy all of the crummy assets from Wall Street, and those guys turn around and award themselves multi-million dollar bonuses as a result?
A: We agree that would make the taxpayers feel cheated. But what is important here is that if you don’t hand over the money, the Wall Street boys will throw a tantrum and push us into a recession.

Q: Secretary Paulson, what kind of government oversight is included in your plan?
A: I never needed government oversight when I was running Goldman Sachs and awarding myself multi-million dollar bonuses, but there is this tweedy looking nerdy guy next to me. Would he count? On second thought, I welcome additional government oversight, just as long as they don’t get in the way while I’m writing checks.

Can you spell “half baked?” I wouldn’t give these guys any (more) money either.

It's the Leverage, Stupid!

It has been an amazing couple of weeks in the financial markets. Fannie Mae and Freddie Mac: nationalized. Lehman Brothers: bankrupt. Merrill Lynch: acquired by Bank of America. Insurance company AIG: 80% owned by the Federal government. Last week’s news is that commercial bank Washington Mutual and investment bank Morgan Stanley are both searching for buyers to acquire them before they go the way of Lehman Brothers. This week’s news is that the Federal government is engineering a $700 billion plan to acquire troubled mortgage assets from Wall Street companies.

And all of this is on top of the collapse of Bear Stearns and IndyMac Bank earlier this year, not to mention the massive multibillion write offs that have hammered almost every large financial institution in the country.

The root of this turmoil is the collapse of the housing bubble. Houses that used to sell for $500,000 are now selling for $350,000. Houses that were selling for 250,000 are now selling for $175,000. More declines in housing prices are forecast for next year. People who purchased houses with 100% loan to value mortgages, or who pulled all of the equity out of their house with home equity lines of credit (HELOC, in banking jargon), are being foreclosed upon in record numbers, leaving their bank with collateral that is now worth less than the balance owed on the loans.

But there have always been foreclosures, big bankruptcies have occurred before. What makes the impact of current conditions so severe? In a word: leverage.

One of the reasons the stock market crash of 1929 led directly to the Great Depression was leverage on the part of individual investors. During the stock market boom of the twenties, investors could buy 5 shares of stock while putting in the cash for only one share. The rest of the money was borrowed. The practice of buying stock with borrowed money is called buying on margin.

When the market crashed in 1929, stock values dropped low enough that the cash the investors had put in was wiped out. The brokerage that had loaned them the money then turned around and required the investors to come up with more cash. This is known as a margin call. In 1929, the margin calls set up a feedback loop. To raise cash, investors sold more stock. The increased selling lowered prices further, which led to more margin calls. More margin calls, more selling, lower prices, more margin calls. Rinse, repeat.

The problem was set off because investors had borrowed too much money compared to the equity they put into their portfolios. They did it because the more shares they controlled with borrowed money, the bigger the return on the equity they had put in. At least, that was true as long as stock prices were going up.

Borrowing money, or leverage, amps up returns when assets prices are rising, but it has the reverse effect when asset prices are falling. Falling like they are these days.

Leverage is everywhere in today’s economy. Let’s say you buy a new car that costs $25,000. You trade in your old car for $5000, and finance the rest. In this instance, you have leveraged your equity (the value of your trade-in) by a factor of four. If you buy a house with a standard 20% down payment, you are leveraged four to one.

Industrial companies use leverage as well. They finance their operations through a combination of stockholders equity (capital) and debt instruments like corporate bonds. Usually the ratio is less than one to one. That is, they have more capital than debt. The thing about debt is that you always have to make the interest payments. With equity, you can always cancel your dividend when you hit a rough patch.

In the last few years, Wall Street firms have piled on an astonishing amount of leverage. The investment bank Goldman Sachs has leverage of 22 to 1 currently. Before it collapsed, Lehman Brothers had leverage ratios of over 30 to 1. That means it only took a 3% loss to wipe out the equity in the firm.

But despite the media coverage, we can’t blame all of the current financial crisis on greedy Wall Street financiers. There is plenty of mud to throw at Main Street folks as well.

Consider a homeowner who buys a $200,000 house and takes out a $160,000 mortgage. That guy is leveraged 4 to 1, right? Now watch the homeowner take out a $30,000 HELOC a year later. Now the homeowner is leveraged 19 to 1. That’s getting up into Wall Street territory. During the bubble inflation years, it was possible for subprime borrowers to take out 100% loan to value mortgages. The banks went to people who had a history of not paying off their debts, and let them take on leverage ratios of over 100 to 1. That’s like giving a six year old a can of gasoline and a book of matches, and then telling the kid to go out and play.

Now our financial system is burning down around us.

Debt is a good servant, but a bad master.

The Fundamentals of the Economy

John McCain gave a speech yesterday where he said "The fundamentals of the economy are strong." He was immediately excoriated for that remark.

"How out of touch is that guy? Wall Street is collapsing! People are losing their homes to foreclosure! Gas prices are up! I found a double yolked egg when I went to make breakfast this morning! Damn Bush and those neocons!"

You know what? All of those things may be true (except for the double yolk egg part. I usually eat cereal for breakfast). But I happen to agree: the fundamentals of the economy are strong.

This is not to say that things are booming, because they're not. I work for a company that makes subassemblies for the major appliance market. We've taken a big hit this year, both in sales that are off because of the slowdown in the housing market, and in our costs, because commodity and energy prices are up so much this year. I've had to conduct several rounds of layoffs to get our company's workforce down to the right size for our current volume of business.

But we're still selling product, still meeting payroll, still investing for the future in both people and equipment. Just as you can have slow sales, but a fundamentally sound business, so too can you have a recession, even a severe recession, and still have a fundamentally sound economy.

I don't want to make light of the real suffering going on out there right now. People are losing their jobs and their houses, and that has just got to suck. High gas and food prices are taking a bite out of my income just like everyone else's. But I went out jogging the other day, and I noticed a funny thing: there was no blood in the streets. I would have noticed too, becuase it hadn't rained for several days.

Layoffs are up, but 94% of us still have a job. Foreclosures are up, but over 97% of homeowners are still making their mortgage payments. The stock market is down, but it is not shut down. You can still buy and sell stocks. At a personal level, it easier to get a table at the local Outback Steakhouse, but only after 8:00 at night. The dollar doesn't go too far if you're in France for vacation, but it still spends just fine in Wal Mart or Target.

At least, I think it still spends fine in Wal Mart or Target. I haven't bought anything at either store in months. Gas prices are up, so I compensated by cutting back on the amount of Chinese made crap I buy.

My point, however, is that the economy is still functioning. People are adapting and adjusting to tough times, and when this deleveraging process we're going through runs it's course, we are going to get back to growing and creating businesses. We're going to do this without a lot of help from the government, by the way.

The people who work for my company are coping with the current economic environment in a variety of ways. Some are carpooling to work to save gas. Some are finding second jobs to replace the overtime they've lost. Some are cutting back vacation plans. One thing they are not doing is cutting back on helping each other. When a coworker or family member hits a rough spot, they chip in to help to the same extent as in better times. At a fundamental level, they are muddling through this rough patch. So, yeah, I think John McCain is right when he says that the fundamentals of our economy are strong.

Tough times never last, but tough people do. At the core, Americans are tough people.

Little Houses on the Prairie

Have you heard about the Tiny House movement? This is a very loose grouping of individuals, foundations and companies that are championing the concept of living in very small houses. As in a house of about 100 square feet, on the extreme end. I had a friend with a bigger tree house than that when I was a kid.

The New York Times had a front page article on the subject this week. You can read about it http://www.nytimes.com/2008/09/11/garden/11tiny.html

The people who espouse the cause of tiny houses seem to fit into two categories. Some of them talk about the desire to simplify their lives, break free from materialistic consumer culture, ala Thoreau when he moved to Walden Pond. Others appear to be motivated by Green movement considerations. They talk about reducing their footprint, carbon and otherwise.

The companies that identify themselves as Tiny House companies both build these houses and sell plans. Most of these tiny houses are built on a trailer chassis, so the builder can make the house and then have it towed to the home site. Since the companies profiled in the Times article sold only a few hundred sets of plans combined last year, I think KB Homes and Toll Brothers are safe for the time being.

Now, I have to admit that the thought of reducing my maintenance and utility expenses can be mighty attractive at times. My wife and I live in a 3000 sq. ft. house. I think it’s ridiculous to have only two people in a house that size. She thinks that if she had more closet space, she could go out and buy more clothes, and if she had a larger attic, she could store more of her collection of Santas to bring out at Christmas (150 at last count). We continue to live in a 3000 square foot house, so I don't think aI need to tell you who wins the argument.

There does seem to be a holier than thou element to this whole business. “Look at me, I only need 500 square feet.” “That’s nuthin’. I’m down to 250 square feet. That’ll really save the planet.” If you really want to save money and simplify your life, you don’t need a specially built house.

A small living space built on a trailer chassis? Here in Red State country, we call that a single-wide mobile home.

Sarah Palin, Take Two

One of the things that annoyed me about the press coverage on Governor Sarah Palin over the Labor Day weekend was the question posed by several news outlets, including the New York Times and Newsweek. Along with the stories about her daughter’s pregnancy and her husband’s twenty year old DUI, this question kept popping up: Was Sarah Palin properly vetted? This is kind of like asking someone if he’s stopped beating his wife yet.

The subtext of this question seems clear to me. When someone asks “Was she properly vetted,” what they really mean is “How could you have picked her without getting our seal of approval first?”

The arrogance this reveals on the part of the national media, those based in New York and Washington, is appalling.

Sarah Palin is a state governor, which is a pretty small club. She was elected after her second statewide political race, having unsuccessfully run for lieutenant governor in 2002.

She has been governor of Alaska for the last twenty months. During that time, she has been continuously vetted by her constituents, the citizens of Alaska. And they must like what they see, because Sarah Palin has an 80% approval rating.

This is the highest approval rating for any governor. It may be hard to believe, but you can have good sense, even if you don't live in Washington or New York.

Sarah Palin, Take One

As the whole world knows by now, last week John McCain announced that he had selected Alaskan governor Sarah Palin as his Vice presidential pick. Like everyone else outside of Alaska, my first thought was: Who?

After several days of 24 hour news coverage, a number of negatives, and potential negatives have come to light regarding Governor Palin. Some of the fodder for attacks against her was apparent immediately. Before being elected governor of Alaska in 2006, her total experience as an elected official was as city councilwoman and mayor of Wassila, Alaska, a small town of about 10,000.

Some of the other issues surrounding Palin are that her 17 year old daughter is pregnant, as mayor of Wassila she hired a lobbyist to get earmarked money (a practice she now opposes), and she has been accused of firing a member of her cabinet because he would not fire her ex-brother-in-law as a state trooper. Oh, yes, her husband had a DUI twenty years ago.

The fact that Sarah Palin was a relative unknown, new to the national media spotlight, combined with these revelations about her past, have made many in the media speculate that she was insufficiently vetted for the VP slot.

In spite of these concerns, I think that John McCain made a brilliant political move with this pick.

Both campaigns selected VP candidates to combat perceived weaknesses of the presidential candidate. Barack Obama picked Joe Biden to shore up the tickets foreign policy credentials. John McCain picked Sarah Palin. What does she bring to the party?
-As a pro-life, NRA lifetime member, she energizes the Republican base of social conservatives, who have never been excited about McCain.
-At 44 years old, she counterbalances the 72 year old McCain, bringing a sense of youth to the ticket.
-As a governor, she has more executive experience than the rest of both tickets combined. She is also a politician who is a complete Washington outsider. You could not get farther from Washington and stay in the continental US. This co-opts Obama’s theme of change, and reinforces McCain’s reputation as a maverick, independent of the current administration.
-Did I mention that she’s a woman? Both tickets now offer a chance to make a historic choice.

Sarah Palin also brings a stealth weapon to the campaign: her husband, Todd Palin. A large part of why Hillary Clinton was able to stay in the primary race for so long was because Barack Obama could not “close the deal” with a key demographic in big industrial states: white, blue collar men. Todd Palin is the epitome of that demographic. He works as a production operator in the oil industry, when he’s not working as a commercial salmon fisherman. In his off time, he wins long distance endurance snowmobile races. The “First Dude” of Alaska is clearly a man’s man.

Reformer, fiscal and social conservative, telegenic hockey mom with five kids. Sarah Palin is the red state answer to Carla Bruni Sarkozy.

Taxes and Fairness

When people talk about everyone paying their fair share of taxes, what they usually mean is that someone else is going to pay more. But that raises the question: how much is the fair amount to ask people to pay, and how much more than that is unfair?

There are two ways of looking at that question. The conventional way is to look at someone who pays, oh say 20%, and determine that they could afford to pay more. So for this example, we could decide that 25% is that person’s fair share. After all, we're only asking that person to give up another 5% of their income. They can afford it, right?

To look at this from another perspective, let us examine a hypothetical economy. In our small scale imaginary model, there are only 25 income earners. The distribution of income among these households is as follows:
1 @ $1,000,000
14 @ $100,000
10 @ $10,000
So the top 4% of households earn 40$ of total income.

Let us further assume the following tax policy: the first $10,000 of income is exempt from tax. After that, up to $100,000 is taxable at 10%. Income above $100,000 is taxed at 20%.

Under this scenario, tax payments break down as follows:
$1,000,000 household: $189,000 (10,000*0%+90,000*10%+900,000*20%)
$100,000 households: $126,000 (14*(10,000*0%+90,000*10%))
$10,000 households: $0
Total taxes: $315,000

What this means is that 4% of the taxpayers are covering 60% of the total tax payments. Meanwhile, the bottom 40% of households are paying…nothing. Somehow that doesn’t strike me as fair play.

Of course, the example shown above is a completely imaginary, highly simplified economy. Let’s see what the numbers are for a real world economy, like, for instance, the United States.

According to the Heritage Institute, in 2004 the top 5% of taxpayers had 29% of the reported income, but paid 58% of the taxes. Expand that group to the top 10% of income, and the numbers climb to 39% of the total income and 71% of the taxes paid. Meanwhile, the bottom 50% of income earners paid less than 3% of the total taxes.

Maybe my example wasn’t so far fetched after all.

My policy point is this: if, as a society, we have decided that we have cut government spending as much as we can, and we need more tax revenue, let’s raise everyone’s taxes. We can have a debate about making the system more progressive, or less progressive. But if we are going to hit the high income folks up for more money, the low income folks should have to pay something in as well.

And maybe, if everybody has to kick into the pot, we’ll discover as a society that maybe we can do without some government spending after all.

A Simple Plan

We have a host of economic problems facings us these days. If not already in one, we seem to be sliding into a recession. Although the unemployment rate is low, a lot of people are underemployed, wither working part time or in jobs for which they are overqualified. Americans undersave, risking an insecure retirement down the line. The weak dollar is contributing to the rise in oil prices, generating inflation.

I have a cure for all of that. Buy American.

I have to confess, I have been a Galactic-class pain in the rear on this subject for at least twenty years. For a long time, Christmas morning conversations went like this:
“Gee mom, thanks for the tie, let me just check the label. Oops, says here Made in Italy. You’ll just have to return it.”
“But dear, all of the silk ties were Italian.”
“It would have been okay if you had just gotten me postage stamps as a gift. Like I asked you to.”
This issue was finally resolved with the advent of restaurant gift cards.

Still, hear me out on this one. When you buy Chinese made products, you put a bunch of Chinese to work, plus one retail sales clerk. When you purchase American made goods and services, you put more Americans back to work. Basically, your dollars have a multiplier effect, creating jobs for more of your countrymen than when you imported products.

It’s not just patriotic, either. When you buy American, you are putting your money into the pockets of potential customers. Think about it, how many of your customers live outside the United States? Unless you work for Boeing or Hollywood, probably not too many.

I can hear someone whining now: “Nothing’s made in this country anymore!” Since I have worked for manufacturing companies for the last twenty years, this is one of my personal pet peeves (#3994, to be exact). However, I do concede that it can be difficult to find US made products sometimes. My advice in that regard is to do without. I mean, do you really need another picture frame/stuffed animal/baseball cap/kitchen gadget? Our homes are filled to overflowing with possessions now. Why keep spending your money on more stuff? Stop the insanity! Just say no!

If you stop buying offshore stuff, you’ll have more money for other things, like saving for retirement. Also, since we as a country currently buy so much more than we sell, we’ve reached a point where our dollars are worth less and less every year. If we stop buying stuff we don’t need, it will strengthen the dollar, making it cheaper to buy the things we do need, like imported oil.

I’m not advocating that we be slavish about this. We all have some things we just aren’t going to do without. For me, it’s coffee.

Bad Timing Award, 2008 Edition

Kia Motors, the Korean car company, has just launched an ad campaign to tout their newest model, a V-8 powered SUV called the Borrenga. The tagline of the ads are that you’re not surprised when a luxury SUV is advertised with various clichés (show the car going off-road, show a symphony orchestra to suggest the harmony of the ride, etc.), but you will be surprised when you see the Kia name badge on the front grille. This is Kia’s attempt to move into the luxury segment of the car market.

Car companies don’t make the decision to do this kind of platform launch lightly. It takes years to develop these vehicles. Hundreds of millions of dollars are spent to build the tooling and production processes involved in a totally new car. Just the budget for the TV advertising alone can run upwards of $20 million.

It’s just a shame that they have come to the culmination of this process just in time to watch the market for big SUV’s crash and burn. Too bad, so sad, sucks to be Kia Motors.

I bring this up by way of pointing out that the domestic automotive manufacturers were not alone in their plans to continue selling large numbers of big cars in the North American market. The American car companies have gotten a lot of bad press because of their overreliance on pickup trucks and SUV’s. But for fifteen years the best selling vehicle in America was the Ford F-150 pickup. What would you expect Ford to do, stop making them?

Even Toyota, probably the best car company in the world, got hammered by the shift in the market. They built the brand new San Antonio assembly plant in 2006 to build the Tundra full size truck. Because sales fell off so much, Toyota has closed the plant for three months this summer while they work off inventories. They were building another plant in Tupelo, Mississippi to build trucks. It now looks like that plant will be retooled to build hybrid Priuses.

A number of commentators have written about how the government should have forced the manufacturers to raise the average mileage on the cars they sell. As if it should be illegal to sell a car that gets less than 30 miles to the gallon.

It’s not like the car companies didn’t offer fuel efficient vehicles for sale, because they all do. Even Ford, GM, and Chrysler. But they kept making full size vehicles because that’s what we wanted. That is why all of the car companies kept developing full size cars and trucks, including Kia.

Being able to buy what we want, and being able to make what people want to buy. It’s a little concept that I like to call freedom.

Take from the rich...

Last spring, John McCain floated a proposal to suspend Federal gasoline taxes for the summer driving season. This was a bad idea, widely criticized. It would have taken millions out of the Federal highway fund those taxes go into, leading to shortages of money to keep roads and bridges in repair. It would have led to increased gasoline demand, keeping prices elevated. Finally, it would have saved the average family only about $3 a week.

Barack Obama opposed the gas tax holiday proposal, for all of these reasons. He got a lot of favorable press at the time for being wiling to take an unpopular stand and tell people the truth.

Now Obama has come out with some ideas of his own. He has proposed selling oil out of the Strategic Petroleum Reserve. He also wants to place a windfall profits tax on large oil companies, and then provide a $1000 rebate to every American family out of that tax.

His campaign released a statement that actually said “Barack Obama will require oil companies to take a reasonable share of their record-breaking windfall profits and use it to provide direct relief worth $500 for an individual and $1,000 for a married couple.”

He might as well have said: “Vote for me, folks, and I’ll give you $500 in exchange for providing me the privilege of riding on Air Force One.”

His response to two different proposals reveals a mindset that taxes are good, and should not be lowered. Profits are bad, and should be taxed.

George W. Bush is often metaphorically referred to as a cowboy. This has both good and bad connotations. The cowboy is an icon for strength and self-reliance, admirable qualities. In the pejorative sense, calling someone a cowboy implies a lack of control and finesse. The European press has this in mind when they disparage President Bush as a cowboy.

Based on this part of his energy policy, a different mythic figure springs to mind with regard to Barack Obama. While the cowboy is an iconic American image, Obama is associated with a European figure. This is only fitting, given his wild popularity on the other side of the Atlantic.

He’s Robin Hood.

Let the Games Begin

There is breaking news on this summer’s salmonella outbreak. At first the Centers for Disease Control thought the bacteria was coming in on tomatoes, so stores and restaurants pulled tomatoes from the shelf. Then after ruining this year’s tomato crop for farmers, the CDC announced that no, it wasn’t tomatoes, it was actually Serrano peppers from Mexico that were to blame.

Me, I kept eating salsa. Over 1300 people came down with salmonella poisoning during this outbreak. But I would guesstimate that over 130 million people ate some combination of tomatoes and/or peppers during the time period between the start of the outbreak and the location of the source of contamination. So the odds of getting salmonella were about the same as the risk of being stung to death by killer bees, and only a little riskier than being ripped to pieces by a pack of dogs. Most of us don’t build our lives around avoiding bee stings and dog bites.

I don’t want to make light of salmonella. One of my coworkers got it a couple of years ago, and he said he remained curled around the toilet for three days, because there was no point in going anywhere else. He wouldn’t wish it on his worst enemy. About one in five of the people who came down with the stpaul strain involved with this outbreak were hospitalized.

Well, one of the hospitalized people has hired an attorney. And who has the attorney sued? Not the CDC, for missing the source during the initial investigation. Not the farmer, who was the actual source of contaminated produce (how much money could a Mexican pepper farmer have, anyway?). No, no, the attorney has sued Wal-Mart. Wal-Mart sold this guy the peppers that made him sick.

This attorney actually has a practice dedicated to suing companies based on food borne illnesses. According to the press release, his position is that Wal-Mart should have known that the peppers had salmonella and prevented them from being sold. I guess that Wal-Mart is supposed to check every box of produce from every source for every possible contaminant and pathogen.

I fell for the guy who got sick, but suing the supermarket is not the answer. If this suit is successful, what’s next? Suing the supermarket for selling honey and dog food?

Food Police

Last week the Los Angeles City Council passed what has to be a candidate for the worst new law of 2008. In the district of South Central Los Angeles, a thirty-two square mile area with over 500,000 residents, the new ordinance places a one year moratorium on building new fast food restaurants.

This part of LA has the highest percentage of obesity in the city. Fully 30% of the adults are obese. So the rationale behind this law is that the rate of obesity is connected with the prevalence of fast food restaurants in this area. By blocking new McDonald’s or KFC’s for a year, the goal is that planning for healthier food choices can be accomplished.

This plan is so ludicrous that one scarcely knows where to begin attacking it. Let’s start by pointing out how hard it is to define what a fast food restaurant is. I have not read the ordinance itself, but it apparently contains language about restaurants with limited menus. Well hello, but I’ve eaten in bistros where the night’s offerings were the five or six items chalked up on the menu board at the entrance. By a limited menu definition, the bistro would be fast food. Of course, the bistro chef could counter that he had been cooking all day, so the food wasn’t exactly fast.

Maybe by fast food they mean a lack of table service. By that definition, a salad bar restaurant would be excluded, even though we can all agree that a salad bar could provide healthy food. Although, after loading up on the cheese and creamy dressing, you could debate that point.

What if you opened a new supermarket in South Central LA. Would the deli be able to sell rotisserie chicken? Would the market be able to put in a salad bar? I’m sure the planning department bureaucrats will be able to provide the answers to these kinds of questions. Eventually.

If you’re in a hurry for those answers, well, that’s just too bad. It’s your own fault for not getting a safe city job.

Even assuming we have a common definition of fast food, I don’t quite understand the theory that preventing fast food outlets will spur the development of other types of restaurant. Somehow I can’t envision Wolfgang Puck announcing plans to open “Spago in the ‘Hood.” When Emeril Lagasse is siting his next place, I’ll bet he doesn’t count the number of Wendy’s in the area.

Aside from the practical difficulties of helping Angelinos lose weight by using the blunt instrument of restricting their eating choices, it is troubling to consider the worldview that informs this experiment in social policy.

To wit: the residents of South Central Los Angeles are children, incapable of making decisions that affect their own lives without the wiser heads of the LA City Council stepping in to protect them from their poor decision making.

As a political conservative, I believe that we institute governments among ourselves for the primary purpose of protecting our freedoms. That includes the freedom to make dumb choices. Now, government is restricting freedom in the name of helping the citizens. “It’s for your own good.”

A lot of the rationale for this new law is to control Medicaid costs. After all, obese people have higher rates of diabetes, heart disease, and high blood pressure. A few years ago, the states’ Attorneys General piled on to attack the tobacco companies. The legal reasoning was that because states paid for half of Medicare expenses, they had the right to appropriate the profits of the tobacco industry. A variation of this argument is now being extended to cover what we eat. “If we are going to pay for your health care, than we have the right to regulate your choices that affect your health.”

The scary part of this argument is that almost every activity involves choices that have the potential to adversely impact our health. If we buy into the argument paying for health care gives government the right to regulate your activities, where do we stop?

“Our studies show that the citizens are not getting enough exercise. Therefore we have banned elevators in high obesity areas. Enjoy your climb, sir!”

The scariest part of this whole story: the LA City Council passed this moratorium unanimously.

Be afraid. Be very afraid.