Everyone Guessed Wrong

On NBC's Meet the Press, VP Joe Biden was asked why job losses have continued despite passage of $787 billion in economic stimulus legislation in February.


Joe said, Everyone guessed wrong at the time the estimate was made about what the state of the economy was at the moment it was passed.

He was speaking to the following chart--which shows unemployment running much higher than presented to us earlier this year. This was not to happen after the economic stimulus plan was passed.


Well, not everyone guessed wrong. Those with a contrary point of view were just ignored by the Obama administration. Consider:

• On February 18, Investors Business Daily opined, The (stimulus) bill Congress hurried to pass last last week without anyone having read the entire 1,434 pages will in fact not stimulate much of anything.

• Respected scholars, including three Nobel prize recipients, some 330 economists in all signed a statement saying that President Obama's claim that "there is no disagreement that we need action by our government, a recovery plan that will help to jump-start the economy" simply is not true.

• The non-partisan Congressional Budget Office (CBO) presented their analytical estimate which said in the long run, the legislation would result in a slight decrease in gross domestic product compared with CBO's baseline economic forecast.
  

Now in part, all of this should not come as a surprise. Much of the $787 billion in stimulus money is not scheduled for distribution until later, much later into 2010 and beyond.



Through June 15, Recovery.gov reports that $141 billion has been allocated and $44.4 billion has been paid out. The difference represents the lag between authorization and "shovel ready" projects, ready to accept the government funding.

"Shovel ready" is one of the big challenges to an impactful stimulus plan. Senator Tom Coburn released a research report, 100 Stimulus Projects: A Second Opinion.

He says this report provides a closer examination of 100 projects, programs and missteps – worth $5.5 billion – some even in my own home state of Oklahoma, that are likely to fail the expectation of out of work Americans who were hoping this bill would create good jobs that they are desperately seeking so that they can provide for their families once again.


By offering 100 examples of questionable stimulus projects, worth $5.5 billion, this report does not attempt to prove that the stimulus is not working. Rather, the intent is to educate taxpayers, policymakers and the media on lessons that can be learned from some of the early missteps and prevent other questionable projects from moving forward.

A new Rasmussen poll released on June 10 shows that 45 percent of taxpayers want to halt all of the remaining unspent stimulus funds, while only 36 percent want to continue.

I suspect there are several reasons for this, such as:

• Americans are tired of bailouts.

• We are seeing "green shoots" of economic recovery without any help from the $787 billion stimulus package.

• People are worried about the current federal deficit explosion, enormous future US debt, potential high inflation in the future and passing these costs along to our children & grandchildren.

• Some may just be suspicious because of projects reported by Senator Coburn and others.

Here is an illustration of the Coburn report from my own state of Wisconsin.

Wisconsin has 1,256 structurally deficient bridges, which is more than the number in Florida, Colorado, Arizona and Alaska – combined. Instead of repairing these bridges, $15.8 million in transportation stimulus money will be used to repair 37 rural bridges that hardly anyone uses.

On average, the 37 rural bridges carry little more than 500 vehicles apiece each day, with several that typically see fewer than 100.

Puzzled residents are wondering why these bridges will receive the state’s first wave of stimulus money when other more pressing needs are getting nothing.

The answer is that many repair projects for the worst off bridges cannot begin quickly, and so are not considered “shovel-ready.”

Shovel-ready projects were pushed to the front of the line, whether they were high priorities or not, and as a result, the only projects available for immediate repairs in Wisconsin were those that almost nobody uses.


One small bridge is receiving $840,000, though it only carries 260 vehicles a day on average. It primarily provides access to a golf course and Rusty’s Backwater Saloon in Stevens Point, WI, which boasts pontoon rentals and a Steak-A-Rooni for just $5.25.

In contrast, the Journal-Sentinal found that half of all Milwaukee streets have not been repaved for forty years and 20 percent of them are past their intended lifespan.

How Did You Spend Your Rebate Check?

Members of Congress and Presidents love to get involved when the US experiences economic recessions. There is ongoing debate as to whether it's more effective to give citizens money to spend (the rebate check) or for Washington to spend money (for supposed infrastructure projects and welfare benefits).


These activities are known as fiscal policies. That's in contrast to monetary policies that are conducted by the Feds, such as efforts by current Fed Chairman Ben Bernanke.

In this long running fiscal debate, Republicans tend to favor rebate checks. Democrats are disposed to having the government spend money to stimulate the economy.

Recently the Congressional Budget Office (CBO) examined whether the 2008 tax rebates stimulated short-term growth.

President Bush signed a stimulus package called the Economic Stimulus Act. It contained roughly $95 billion in tax rebates that went out last spring.

The CBO estimated that 40% of these tax rebates would be spent within six months––raising the growth of consumption in the second and third quarters of 2008 by 2.3 percent and 0.2 percent, respectively.

The CBO analyzed this question in various ways. It's difficult to find any meaningful impact from this tax rebate program.


This chart reveals the increase in income from such rebate checks. However, consumer consumption was barely affected. Hence, this form of stimulus appears to have failed to stimulate the economy!

Instead, most Americans saved their rebate checks or used the money to pay down credit cards and other forms of personal debt.


The New York Times reports, The economic downturn is forcing a return to a culture of thrift that many economists say could last well beyond the inevitable recovery. This is not because Americans have suddenly become more financially virtuous or have learned the error of their free-spending ways. Instead, these experts say, Americans may have no choice but to continue pinching pennies.

This shift back to thrift may seem to be a healthy change for a consumer class known for spending more than it earns, but there is a downside: American businesses have become so dependent on consumer spending that any pullback sends ripples through the economy.

You will discover that economists are divided about the effectiveness of tax rebates for stimulating short-term growth.

1. Some argue that the temporary nature of rebates leads households to save, not spend, virtually all of the additional income. If so, rebates do not add much to short-term growth.

2. Others argue that even temporary tax cuts will encourage spending, particularly if they are directed toward low-income households or those with few liquid assets. Such households, those analysts maintain, are more prone to spend any additional income.

I have doubts about using government money to stimulate spending and help the US economy improve its growth. I just don't think this is a very effective means of curing a recession. I believe this study provides support for this. It didn't work last year--and the OMB study also indicated that the $35 billion distributed in 2001 (represented then as advance tax refunds) didn't work either.

Likewise, I would suggest that the rebates within President Obama's stimulus package will also fail to provide any meaningful economic stimulus.

Just today we received another report that supports by hypothesis. In an Associated Press report, Households pushed their savings rate to the highest level in more than 15 years in May as a big boost in incomes from the government's stimulus program was devoted more to bolstering nest eggs than increased spending. The savings rate, which was hovering near zero in early 2008, surged to 6.9 percent, the highest level since December 1993.

The stimulus provided for one-time payments of $250 to people receiving Social Security, supplemental security income and other benefits. Wages earners will receive small credits each paycheck.

Walmart Growth

From its humble beginnings, Sam Walton created and nurtured Walmart from its small town headquarters in Rogers, Arkansas in 1962 to the mutli-national behemoth today--employing over 2 million people.


Walmart brought low prices to small cities, but its creator also changed the way Big Business is run.

Though it's hard to believe today, discount retailing was a controversial concept when it began to gain ground in the '50s.


Traditional retailers hated it, and so did manufacturers; it threatened their control of the marketplace. Most states had restrictions on the practice.

Once committed to discounting, Walton began a crusade that lasted the rest of his life: to drive costs out of the merchandising system wherever they lay — in the stores, in the manufacturers' profit margins and with the middleman — all in the service of driving prices down, down, down.

The formula was highly successful. Today we find Walmart's in nearly every corner of America.

Walmart has its many benefits:

• Lower costs--making it easier for lower income Americans to live
• Employment opportunities--today during this recession Walmart is actively hiring throughout America
• Much broader selection
• Fresher produce, meats and other grocery goods
  

I recently spent 2 weeks in my hometown in Nebraska. Things have changed remarkably in the last 40 years--and it seems to have passed rather quickly. The Walmarts of this world had a hand in this.


It started with the loss of our local K-12 school. Still this town of 440 people had two groceries, two cafes and two gasoline stations.

No more. The food in the groceries gets stale sitting on the shelf. It's costly to transport fuel to the filling stations. There is still one cafe trying to make a go of it.

Such is the pace of "progress" in our small village.

This is happening all across the US. Some people rue this "progress," still most consumers vote with their feet--and travel, for example, to the larger cities of Seward or York, NE to do most of their shopping.

I'd recommend a characterization of this in film; Watch the movie, What's Eating Gilbert Grape. It stars Johnny Depp, Leonardo DiCaprio and John C. Reilly. This takes place in Endora, IA.

Not only does this depict the demise of a local grocery--due to competition from the town's new supermarket, but it is a human interest tale, and a sad one indeed, about Gilbert, his mentally disabled brother and their 500 pound mother.

Sometimes about all that is left after "progress" sweeps in is some dilapidated buildings. Such is the scene in Tamora, NE. This is one of the better looking buildings that still remains standing today.

In Defense of the V

My favorite economist, Brian Wesbury, recently published an article, saying he has never seen as much emotion in economic debate as we have in recent years.


He says that people question his sanity or integrity for predicting an economic recovery. The responses fall into three groups.

1. Those who think debt drove the wealth creation of recent decades and until this debt unwinds nothing will be normal again. These commentators expect more shoes to fall.

2. Those who just can’t see a recovery if people are losing their jobs.

3. Those who look at all the government spending and money printing and think this will undermine growth and boost inflation to painful levels very soon.
   

In response, Wesbury admits that he failed to forecast the recession last year.

What we missed was how badly the government would mishandle otherwise manageable problems: a combination of mark-to-market accounting and ad hoc remedies, finally allowing Lehman Brothers to fail in September 2008. This set off a rare financial panic, the velocity of money plummeted, and economic activity collapsed.

Wesbury maintains that capitalism did not fail, it was government that failed. The government perhaps never better lived up to Groucho Marx’s maxim: “Politics is the art of looking for trouble, finding it, misdiagnosing it, and then misapplying the wrong remedies.”

Still you are never going to get Rep. Barney Frank, or other politicians who were overseeing the US banking system, to admit any guilt!!

Wesbury goes on to write, We expect the economy to rebound from the panic and make up for the loss of growth relatively quickly. This is hard for some people to comprehend because if you listen to the business news or read the popular press, the economy has basically stopped – had a heart attack – crashed – shut down.

But the system never shuts down. It may slow down, but as long as freedom exists, the system remains dynamic.

For example, in the past 26 weeks, roughly 16 million people filed initial claims for unemployment insurance. But, as of two weeks ago, there were only 6.816 million people continuing to receive claims. In other words, possibly as many as nine million people who might still be receiving benefits are not because they found gainful employment.

For all the blog articles I read every day (about 250 articles from 30 economic blogs), I do not recall anyone pointing out that we have had to have millions of people return to work after filing initial unemployment claims. All I see to read is the doom & gloom surrounding job loss.

Yes, it is true that the government has grown almost exponentially, and the Fed is super easy, too. But the problems with all of this are long-term in nature and probably not as bad as the most vocal critics believe.

We will pay a price for government growth, but that price is still at least a year or more away.

For now, a recovery is coming and it will be stronger than the conventional wisdom believes, partly because the Fed is so easy.

Fed Chairman Bernanke on 60 Minutes

In case you missed it, 60 Minutes conducted an historic interview with Fed Chairman Ben Bernanke. Bernanke is the chairman of the Board of Governors of the Federal Reserve System, better known as the Fed.

The words of any Fed chairman cause fortunes to rise and fall and so, by tradition, chairmen of the Fed do not do interviews - that is until now.

Bernanke's comments have had more soothing impact on Americans than any other government representative. At the time of this interview on March 14, the US had experienced another devastating 2 months in the stock market--and many commentators were prepared to declare The Great Depression II death knell.

A couple days later in US News & World Report they opined, It takes an extraordinary set of circumstances to get a sitting Fed chief into the interview chair, but these are extraordinary times.

Ben Bernanke's appearance on "60 Minutes" Sunday night was a great public relations move.

Calling a lack of "political will" in stabilizing the banking system the "biggest risk" facing the economy, Bernanke is putting added pressure on an increasingly testy Congress.

I have captured this two-part interview for posterity--and for your viewing.





Here is part two.

Subprime Warnings

In a recent post I shared excerpts from a 1999 New York Times article which warned of a financial crisis that could stem from sub-prime mortgage lending.

That wasn't our only warning. Here is an excellent news story, complete with clips, from Fox News that illustrates the debate most people ignored over the past several years.

This is a good summary of how the politics of protectionism from Congress shielded these at-risk banks from close scrutiny until they could no longer withstand the pressures that resulted last year in the sub-prime crisis.

Subprime Prediction

Many of the current economic woes can be traced to the sub-prime mortgage mess--and like many catastrophes, this one had a tiny start with the Community Reinvestment Act (CRA). Our own Senator William Proxmire had a hand in the CRA's development in the 1970s.


But like a little snowball the CRA didn't amount to much until the 1990s. A decade ago there was pressure to increase home ownership among minorities and low-income consumers.

A September, 1999 New York Times article by Steven Holmes was prophetic. Here is an excerpt.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.''


In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times.

But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison, a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''


Fannie Mae, the nation's biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary market. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings.

It took more than the CRA, the Clinton administration push and the greed of Fannie Mae to get us in this mess. There is considerable documentation surrounding the players (including mortgage lenders, Fannie Mae, Congressional influence peddling, Federal Reserve interest stimulus, shoddy rating agency work, inadequate regulatory supervision, ignorant or greedy consumers and more)--yet, isn't it quite prophetic that Peter Wallison so aptly foreshadowed this coming crisis?

Were We Forewarned??

Nassim Taleb studies randomness and the role of uncertainty in science and society, with particular emphasis on the philosophy of history and the role of fortunate or unfortunate high-impact random events, which he calls "black swans", in determining the course of history.



He wrote a highly popular book, called the Black Swan. As he writes, A Black Swan is a surprise event - like the discovery of the black bird in Australia, which was unpredictable because swans in the Old World were all white. But unlike the bird, my Black Swan carries large consequences.


He summarizes that a Black Swan event is:

• Highly improbable and unpredictable
• It will have massive consequences
• Afterwards, experts will invent reasons why it was predictable, and not random

Recently, staff of The Audit, the business-press section of the Columbia Journalism Review, prepared the List. The List is a comprehensive catalog of relevant stories about the lending industry during the run-up to the mortgage crisis.

They scoured over 1/2 million news articles from 2000-2007, and uncovered just 727 significant stories.

The Audit looked for the best pre-crisis stories during this critical period, after which it was too late for warnings. They found work that falls into three categories, ranging from investigative to non-investigative but otherwise useful service pieces to, for context, non-warnings.

These news articles came from such leading papers as the the Wall Street Journal, New York Times, Washington Post, Financial Times, Bloomberg, Forbes, Fortune and Business Week.

They explored the question of whether the business press provided the public with adequate warnings of the looming calamity—and The Audit concluded that NO, we were not adequately forewarned.

To the extent there were warnings, here are a few notable examples from The Audit's research files:

New York Times, 3/15/2000: A landmark probe of the Lehman Brothers subprime connection. A predatory lending firm closed shortly afterwards. Nothing like this appeared again for seven years.

New York Times, 10/22/2000: Along With a Lender, Is Citigroup Buying Trouble? An investigation of a notorious subprime outfit.

Wall Street Journal, 12/7/2001: How Big Lenders Sell A Pricier Refinancing To Poor Homeowners--People Give Up Low Rates To Pay Off Other Debts.

Forbes, 9/2/2002: Household International succeeds at lending to bad credit risks by managing smarter. People suckered into mortgages by lies and deceit.

Wall Street Journal, 11/10/2002: Friendly Watchdog: Federal Regulator Often Helps Banks Fighting Consumers--Dependent on Lenders' Fees, OCC Takes Their Side Against Local, State Laws.

Bloomberg, 6/26/2003: Credit Swaps, Some Toxic May Soar to $4.8 Trillion.

Washington Post, 11/22/04: Dozens of current and former rating officials, financial advisers and Wall Street traders and investors interviewed by The Washington Post say the rating system has proved vulnerable to subjective judgment, manipulation and pressure from borrowers. They say the big three are so dominant they can keep their rating processes secret, force clients to pay higher fees and fend off complaints about their mistakes.

Los Angeles Times, 3/28/2005: The three plaintiffs contend in court papers that Ameriquest had an art department in a Tampa office where loan documents were altered. In interviews with The Times, they've shown stacks of what they say are internal Ameriquest files proving their allegation. After the crash, such practices are found at Countrywide, WaMu, New Century and lenders across the board.

Los Angeles Times, 10/24/2005: Freddie Mac, the government-sponsored mortgage finance giant, estimates that more than 20% of people who get these so-called sub- prime loans could have qualified for more-conventional prime loans.

Bloomberg, 5/11/2007: Bear Stearns Funds Own 67 Percent Stake in Everquest. Important because the Bear funds were trying to offload their risk on to the stock market. When that failed, the funds went kablooey.

Bloomberg, 5/31/2007: CDO Boom Masks Subprime Losses, Abetted by S&P, Moody's, Fitch.

Bloomberg, 6/1/2007: Banks Sell 'Toxic Waste' CDOs to Calpers, Texas Teachers Fund. This is a good look at Wall St. dumping on clients.

Wall Street Journal, 6/27/2007: Debt Bomb--Lending a Hand: How Wall Street Stoked The Mortgage Meltdown --- Lehman and Others Transformed the Market For Riskiest Borrowers. This is an exemplary examination of the subprime/Wall Street connection. Interestingly, it cites documents from the same case that underpinned the NYT's fine story on 3/15/00.

Crisis of Credit

Jonathan Jarvis is a designer based in Los Angeles. He practices in the Graduate Media Design Program at the Art Center College of Design.

He has created an excellent video regarding the credit crisis that we are experiencing.

This video takes the complex situation about the credit crisis and distills it for those unfamiliar and uninitiated.