Upholding the Illusion

Upholding the illusion that America’s financial system is simply going through a crisis which can be resolved is becoming increasingly more difficult for the U.S. government. After an enormous bailout package, a stimulus package worth about 6% of GDP and guarantees of bad assets worth much more than that, the government has nothing to show in terms of recovery.


It is also an illusion that many U.S. financial institutions are not already nationalized. AIG has received $150 Billion from taxpayers. The company has far more in losses, and it will report what is expected to be the biggest losses in U.S. financial history on Wednesday.


AIG has now asked for more taxpayer money, although the government already owns 80% of the company.


Citigroup has received $45 Billion from taxpayers, and is now asking for much more. Citigroup is only worth about a fourth of that, around $10 Billion, so why the hell are there any shareholders left other than the U.S. government?


The U.S. government’s ideological opposition to nationalization has wound up costing American taxpayers 4 or 5 times more than what a nationalization would have cost.


Citigroup’s shares are as I just mentioned worth $10 Billion, yet taxpayers have paid the company $45 Billion just so that the shareholders won’t lose their investments (of which there is only 10% left since Citigroup’s stock lost 90% of its value), and so that the executives won’t have to be fired.


It would have been a lot cheaper to simply buy all the stock. Cheaper yet would have been the only morally sound thing to do: wipe out shareholders and nationalize the bank.


Furthermore, banks are failing across the United States every week now, and the FDIC (which nationalizes such banks every week so that they can be liquidated and/or sold off) has had to hire more staff, and is currently bringing people back from retirement.


The U.S. government also has a secret list of which banks are in serious trouble, and are in imminent danger of failing. Many have called for this list to be made public, but the government refuses.


In addition to all this, the U.S. government is engaging in the sort of “creative accounting’ that played a large role in creating this crisis. It is trying to sweep all the losses of big institutions under the rug by “not estimating assets too conservatively” as Geithner has stated.


What that means is that when the government has given taxpayer money to big banks and other institutions, it has valued their assets much higher than the market (which values them at zero), creating the illusion that these institutions are much better off than they really are.


Also, the government has helped institutions like AIG to set up “special purpose entities” where the company can hide bad assets away from the balance sheet, again creating the illusion that things are much better than they really are. This is what Enron did, and a lot of people went to jail after that…


All these efforts are obviously counterproductive and ultimately detrimental. The government is lying about many things relating to the financial crisis, but most people don’t realize it. Why is the government doing this? Well, I think it feels that it MUST uphold the illusion that the system can indeed go on as it has before. If it cannot, what is the alternative?


They know what the alternative is: a European-style regulated society where citizens are guaranteed a standard of living rather than being left to hope for that standard amidst cycles of boom and bust. In a country where all politicians are either right or right-wing, this is a terrifying prospect.


I recently realized that the upholding of illusions is exactly what Keynes based his theories of spending and crisis management on, and that’s why it makes perfect sense for Keynes’ theories to be back in the spotlight.


It is widely believed that Keynes developed his theories in response to the Versailles Treaty after World War I, and the treatment of Germany in economic terms.


The Versailles Treaty made it so that Germans’ standard of living went lower and lower each year after it was enacted. This, according to Keynes, destroyed confidence among Germans, and the economic crisis started feeding off itself (which is something that was echoed by Ben Bernanke in a speech before Congress today).


So, after the war, Germans were obviously bankrupt. Even so, thought Keynes, they should keep spending, and if they could not, the government should enable them to do so. Even if you don’t have money to spend, you must uphold the illusion that you do, by borrowing money to spend, otherwise the economic crisis will get worse. That is in essence what Keynes thought.


Expressed in that way, Keynesian economics sounds like a really bad case of “keeping up appearances”, don’t you think? Upholding the illusion is what it is all about.






Moreover, I advise that the winner-takes-all voting system should be destroyed.

A Better Stimulus Package - Research and Education

Obama’s recent stimulus package will help to plug a lot of holes in state budgets across the country. It will also marginally improve the infrastructure situation. However, 40% of the package is made up of tax cuts, and for that and other reasons, I believe that it will be very unsuccessful in actually helping the economy recover.


I believe that the road to economic recovery for the United States is not one of tax cuts or stimulus packages, but one which made this country great in the first place: massive spending on scientific research and education.


I do not believe in trickle-down economics, like the Reagan/Bush/Clinton policies, because that theory is based on a belief that excess money, spent by wealthy individuals, floating around in society, will somehow create wealth for all citizens.


I also do not believe in Keynesian economics, like the stimulus package, because that theory is based on a belief that excess money, spent by the government, floating around in society, will somehow create wealth for all citizens.


You can probably tell where I’m going with this: the basic flaw of both trickle-down and Keynesian economics is that the money that the government spends and/or controls in other ways has no direction or purpose.


I’m not saying that the government should tell people what to spend money on, or that there isn’t a large role for the so-called “invisible hand” for people in society. I’m saying that when the government spends money, it must do so with a specific purpose, and do it well.


There are two important issues to consider when delving deeper into this: economic growth and job creation. These are favorite expressions of politicians, but most politicians have only a vague idea of what they actually mean.


Economic growth occurs when something is added to society. If someone gets up off the couch and starts growing potatoes, he or she has contributed to economic growth. Economic growth does not occur if the government gives someone a tax cut or chooses to spend tax money on road maintenance.


Job creation occurs when someone hires an unemployed person and pays that person’s salary with the revenue from increased production. When the PC was invented and Silicon Valley hired thousands of people, that was a perfect example of actual job creation.


Job creation does not occur when the government hires someone to work on road maintenance or when a company hires someone and pays the salary out of money left over from a recent tax cut. (the government could create jobs by actually starting their own business enterprises, but that is rather unusual).


Hence, both trickle-down and Keynesian economic policies are ineffective for economic growth and job creation, especially in times of crisis. In order to actually spur job creation and economic growth, you need something specific, something new, and American history provides excellent examples.


After World War II, The United States started spending massive amounts of money on higher education and scientific research. Young people were able to go to college for free, and scientific researchers were making strides like never before. This enabled the U.S. to go to the moon, invent vaccines and computers, and become the most industrially and economically powerful country in the history of the world.


In sector after sector, The United States became the world leader with the help of education and research, and this laid the foundation for the immense prosperity that the country still enjoys today. Unfortunately, since Nixon, all that prosperity which was originally created by everyone in society, has been funneled only to the top.


It would be very difficult to make the case that these industrial advances came about as a result of trickle-down, low tax economics. Nor could it be argued that Keynesian economics was behind it, because it was not used.


It is crystal clear that America’s prosperity mainly came about as a result of massive government spending on research and education, and it is to this that we must return.


In order to actually create jobs, and to achieve actual economic growth, the U.S. government should:


- make college education much cheaper, and free for as many people as possible


- fund research into as many areas as possible and help industries with the practical application of research results


- create national standards in the most important school subjects, such as the natural sciences and English


- end the system where local schools depend on local real estate taxes, and centralize funding for schools


These are only a few ideas for a new stimulus package with a real potential to help the American economy, and there are myriads of other things that could be done quite easily. A stimulus package full of tax cuts will do nothing to help the American economy recover, but research and education will.






Moreover, I advise that the winner-takes-all voting system should be destroyed.

Government Incompetence and the Creation of the Crisis

The vast majority of severe economic crises start with an unexpected bursting of a speculative bubble. These speculative bubbles are usually very complex, and are made more potent by complex financial instruments that only the people who created them can understand. This is also the idea behind these complex instruments; it will make them seem worth more than they are because people don’t realize what they are made up of.


During crises in the past, governments have always been unable, or in the case of the U.S., unwilling, to keep up with the ever increasing complexity of the financial instruments. In the end, that leads to a situation where nobody knows what anything is worth, so prices can only go down.


In the panic of 1873, which led to the “Long Depression”, speculation in complex bonds relating to railroad construction was a large contributing factor. Before the “Great Depression”, traders were mailing complex trades across state borders in order to evade any financial regulation (which only existed as local law at the time).


In the crises in Sweden and Japan in the 90s, complex financial products related to real estate speculation were almost fully responsible for the crisis, as they are in the crisis in The United States today.


As I mentioned above, governments are usually unable to keep up with financial markets when complex financial products are being created. This is mainly a result of the lack of competence within the government, and a lack of understanding of the financial markets on behalf of its staff. George W. Bush was famous for having repeatedly mixed up inflation and deflation. More importantly, however, the SEC has been largely absent in recent years.


Many traders that I have talked to here in New York, as well as traders in the media, say that they have never once been contacted by the SEC in any capacity over the last decade. This is especially true for the most complex trading, including trading with mortgage-backed securities and CDOs “squared” (don’t ask). Similarly, the ratings agencies were left alone to prosper as they saw fit.


The long-term commitment to self-regulation has obviously contributed a lot to the current situation. And U.S. politicians have failed the country in more ways than one in the creation of this crisis. Self-regulation becomes a vicious cycle in the following way: when the government does not engage in regulating, it loses the capacity and competence to do so.


Hence, after two decades of self-regulation, the U.S. government has no idea what’s going on in the financial markets because they haven’t touched them, studied them or regulated them. The SEC has under 4,000 employees, which I’m guessing is less than the amount of shoe shiners in New York City. Needless to say, this lack of competence is very problematic in trying to deal with this crisis.


An unfortunate “solution” to the problem of not being able to deal with a complex financial crisis has been to bring in the people who created the crisis in order to solve it. Of course, these people have their own agendas, and are easily able to enrich themselves as taxpayers pay money to resolve the crisis. This is the “solution” currently being pursued by Obama and Geithner, which has already turned out to be very detrimental, as taxpayer money has been thrown into a black hole, only to enrich individuals on Wall Street.


The much talked about Swedish solution to the crisis also dealt with this problem. In Sweden, executives were fired, and representatives from the financial industry were not made a part of the team that would clean up the mess, or at least they were included to the smallest extent possible. The Swedish government had to create competence within its agencies in order to deal with the problem and get the best deal for taxpayers. It did so mainly with the help of academia.


The belief that the government can never be competent enough to engage in issues such as these is misguided. When it comes to the IRS, the U.S. government is very competent. The IRS has vast, in-depth knowledge of anything that pertains to taxes, domestically and abroad, and in immensely complex arrangements. I’m not saying that the IRS is perfect, but that the SEC MUST become more like it. The IRS has over 86,000 employees, which is more than 20 times as many as the SEC.


The SEC is, at present, completely incompetent. The people that are advising Obama and Geithner are nothing but self-serving Wall Street insiders, as the people who advised Bush and Paulson also were. The Obama administration and the Treasury need to turn to international and domestic academia (except for those who used to work on Wall Street) and to Sweden, Japan, The IMF and The World Bank for help in resolving this crisis. By gradually building competence, the U.S. can hope to avoid some of these problems in the future.






Moreover, I advise that the winner-takes-all voting system should be destroyed.

Taxpayer Bonuses to Failed Bankers... Is Obama Serious??

Chris Dodd is s sneaky fellow. Towards the end of the stimulus package negotiations, he snuck a provision in, severely limiting bonuses for executives receiving taxpayer money through the TARP or in other ways.


Tim Geithner has filled his cabinet with ex-Wall Streeters, so he and the Treasury have been fighting, tooth and nail, against limits on executive pay, just like Paulson did. Dodd’s provision was meant to counter the Treasury.


Now Obama has sided with the Treasury, and is trying to come up with ways for taxpayer money to be paid to these executives.


On Fox News on Sunday, senior Obama adviser David Axelrod said that the administration will: “seek changes in the government's approach to executive compensation”. That can only mean one thing: Obama will refuse to implement to provisions that he will sign into law on Tuesday.


Obama is prepared to break the law in order to give failed bankers million dollar bonuses paid by taxpayers! As someone who supported Obama fully, I am now left speechless, only able to say: are you serious Obama!!??


If a corporation feels like its executives deserve multi-million dollar bonuses and is willing to pay that, I have no problem with that. And if that corporation keeps paying the bonuses even in the face of multi-billion dollar losses, that is also fine with me. It’s just stupid, and I don’t understand why the shareholders accept that.


However, when the corporation receives taxpayer money, it is very much my problem how that money is being spent.


This is a really, really serious crisis. In Florida, there are actual bread lines. In Nevada and California, local governments have designated and fenced in land for people who live in their cars, reminiscent of the “Hoovervilles” of the Great Depression. Food banks are out of food in the Northeast, and the beggars in New York City are no longer mostly made up of addicts.


The President of The United States is currently weighing these problems against the need for multi-million dollar bonuses to failed bank executives. You have to ask yourself if he has lost his mind.


The heat is turning up in the battle for taxpayer money and the continued roll of Wall Street in the American economy. On outlets for Wall Street employees like CNBC and Fox News, the rhetoric is really changing dramatically.


The financial sector seems united in a battle against taxpayers, eerily reminiscent of crises in countries with financial oligarchies and mafia control like South Korea and Russia. The gloves have come off, and the financial oligarchs seem to be winning. People on these networks, such as Larry Kudlow and Charlie Gasparino, are absolutely mocking efforts to use taxpayer money to help taxpayers, as opposed to giving it to individuals on Wall Street.


For decades, The United States has been dictating what countries receiving aid from the IMF should do during bank crises. The advice has always been the same when corrupt countries have been receiving aid: fire bank executives, nationalize banks, and under no circumstances give the banks money with no strings attached.


Now, The United States is going down the very road it has warned against so many times, and the results have already proven to be disastrous. Bankers and other Wall Street executives are demanding taxpayer money while hiding even the slightest hint of the extent of their losses. They have insiders from Goldman Sachs, Citigroup and many other firms in the Treasury, and they are even using TARP money to lobby for these things.


I don’t know what Obama is thinking at this time. What he’s actually doing, though, is taking food from the mouths of starving Americans and putting the money in the pockets of bank executives who have brought down the American financial system.





Moreover, I advise that the winner-takes-all voting system should be destroyed.

The Road to Sweden, or the Road to Japan

As I have mention before, this crisis is NOT unprecedented, which the U.S. government keeps claiming. The reason that they’re claiming this is partly that they don’t understand it, and partly that they won’t admit how much trouble the banks are in. I can understand the latter to some extent; admitting this would probably create a panic.


The two crises in Sweden and Japan in the 90s had the following attributes:


1. The banks became insolvent because of bad assets


2. The bad assets were hidden off their balance sheets, meaning that they could not be seen by the public or the government


3. The bad assets were made up of complicated financial products related to real estate speculation


Sound familiar? We have here three almost identical crises, and two different approaches in dealing with them: the Japanese way or the Swedish way.


The Japanese way resulted in “Japan’s lost decade”, with huge job losses, capital destruction and an immense waste of taxpayer money. A sustained weakening of the Japanese economy occurred, which harmed Japanese competitiveness greatly.


The Swedish way certainly created short term pain for the country, but the net result of the crisis was an actual profit for the taxpayers, a sustained budget surplus and an eventual lowering of the national debt. In short, the country came out of the crisis stronger than before.


Another thing that, by now, may sound very familiar to Americans, is how the Japanese dealt with their crisis. They did the following: gave the banks hoards of money with no strings attached, bought bad assets, attempted to have a public/private partnership in buying up bad assets (which Geithner just recently suggested), passed multiple stimulus packages and lowered interest rates to zero.


Japan did all this, and everyone now agrees that none of it worked, otherwise they would not have had a “lost decade”…. The country’s crisis was not resolved until they did what Sweden instead did. The Swedish government did the following:


- Ruthlessly combed through the books of the banks to weed out which banks could be saved, and which could not be


- Nationalized the ones that were deemed to be able to survive, and let the weak ones fail


- Wiped out all shareholder value and fired bank management


- The government had to actually learn all there is to know about the assets, so that they could be sold at the highest price. They did not simply let stock market “experts” dole out money to their buddies.


Prior to the rescue, the Swedish Parliament had passed a law giving it the right to do all these things if a bank’s equity in relation to its debts fell below 2%. Many U.S. banks are far below that threshold now.


So, the U.S. government has two very clear alternatives: one that has been proven to work, and one that has been proven to be disastrous. It doesn’t get much clearer than that.


The U.S. government is currently furiously pursuing the disastrous course.






Moreover, I advise that the winner-takes-all voting system should be destroyed.

The Geithner Proposal - On Second Thought

Initially, I thought the Geithner plan seemed pretty stupid and unfinished. I still believe it is both of those things, in its essence, but I have come to realize that it actually has some merit, albeit through unintended consequences. Bear with me and I will explain.


First of all, the Geithner plan is a direct descendant of the Paulson plan, which makes it fundamentally misguided and immoral in nature. Also, the most counterintuitive of arguments is its main premise: that private investors will want to buy toxic assets that are worthless because the same investors turned their backs on them.


Now, the important thing to remember is that there are different kinds of so-called toxic assets. I’m not sure who came up with the term, but it seems to mean that nobody wants to buy the assets, that they have somehow become “contaminated”.


In most cases, they are contaminated for a reason, such as that they are made up of mortgages for houses that have actually been torn down or have lost more than half of their values. In other cases, however, the assets are sort of guilty by association.


In the eyes of a capitalist economy, whether or not an asset is actually destroyed or just guilty by association does not matter; an asset is only worth what someone is willing to pay for it.


If Geithner’s plan can help to separate out the two kinds of assets and entice investors to buy the ones that are not as bad, then the plan will have achieved something. An asset like this would have to be something rather special though. It would have to be:


- unrelated to the housing market


- unrelated to the continued existence of firms that are very near bankruptcy, which includes many banks


Also, the buyer would have to have a long-term strategy, because there is simply no way that the stock market will achieve any stability, probably for years to come. I have no idea how many assets that fit all these criteria there are at this time, and I don’t think anyone has.


Circling back to what I said in the beginning about unintended consequences, what I have just described is not what the plan meant to do. Geithner wanted investors to buy the assets that in fact have been destroyed, and that will happen when hell freezes over.


Another important point that I’d like to mention, and one that I will come back to soon, is the reason for this confused and unfinished plan. What most people don’t realize is that politicians have no idea what’s going on. They don’t know what these assets are, how they came to be, or how to solve the problem of them being worthless.


I happen to work in a large office building in midtown Manhattan, and ever since Bear Sterns failed, I have seen officials from the government running around in my office building and other buildings, talking to experts in financial trades, banking regulation and more, trying to understand what is going on.


Long story short: it’s not something you learn over a few doughnuts.






Moreover, I advise that the winner-takes-all voting system should be destroyed.

There ARE Solutions to the Banking Crisis

Treasury Secretary Geithner presented his new financial rescue plan on Tuesday, which impressed no one. The plan was confused, unfinished and intellectually contrafactual. In this posting, I will expand on my solution to the banking crisis, which involves a system of what are called “covered bonds” along with the creation of new banks.


After the plan was introduced and poorly received, Geithner defended himself by saying that there was “no historical precedent” to this crisis. Nothing could be further from the truth. Simply giving the banks taxpayer money to spend as they please, a.k.a. the “Bush/Paulson/Geithner solution” is what lacks a historical precedent, simply because it’s so infinitely stupid.


Geithner, along with what seems to be the entire American political and economic establishment seems to be completely in the dark in terms of economic research and economic history. I’m saying that there are many precedents to this crisis, and that there are many precedents on how to solve it.


There are 2 main, related problems that must be solved as soon as possible:


1. the banks are insolvent, and


2. the mortgage securitization market is dead


The banks are insolvent because they own worthless assets that nobody wants to buy. Geithner’s plan involves trying to convince private investors to buy these worthless assets, but the reason they’re worthless is that these same investors didn’t want to have anything to do with them in the first place.


The assets are like rotten apples in a fruit stand, and however much such apples are promoted, I think it’s pretty safe to say that few people will ever by them.


The mortgage securitization market is the market where banks sell off mortgages to private investors in the form of mortgage-backed securities, which is the same thing as the assets I mentioned above.


Nobody wants to participate in the mortgage securitization market anymore because housing prices have imploded, so the market is dead with little chance of being revived any time soon. In other words, if housing prices don’t go up, the mortgage securitization market will continue to be dead.


Now to my suggestions of solutions to these problems. In a catastrophic banking crisis, the solution has in the past been either nationalization or the creation of new banks.


Nationalization is the more common solution, but if a bank’s debts are five times its market value, what is the point of rescuing it by nationalizing it? Spending five dollars to make one dollar doesn’t make a lot of sense… In light of the banks’ situation, nationalization would be the least severe destiny awaiting them. It would, however, be extremely expensive for the taxpayer.


Because the U.S. Government is ideologically opposed to nationalization, my bet would be that Bank of America and Citigroup (along with many smaller banks) will have the same fate as Lehman Brothers.


Instead, I believe that the creation of new banks is the appropriate solution. This was done in the 1800s in the United States during a catastrophic banking crisis. Under this plan, the government would simply set up a new bank, inject it with money for lending and write strict rules on how it can operate. That would instantly create a stable, prudent and dependable bank.


The government would then sell off 49% of the shares to private investors and keep running the bank according to prudent standards until the crisis is over. At that point, the bank can be sold off completely.


Instituting a system of covered bonds would be a good solution for the mortgage market. This is a very stable system that has been used for hundreds of years in Europe. Basically, all the banks would get together and put all their mortgages in a giant pool.

As soon as one mortgage defaults, it is immediately taken out of the pool, and the loss is shared by all the banks at once. All the mortgages, meaning the investments that the banks have made, are hence “covered” by all the participants in the system.


Under this system, the mortgages remain on the banks’ balance sheets. It is a collaborative effort, as well as being a system where each bank has to take responsibility for its own lending practices. This system encourages prudent lending standards by all participants, stabilizes the housing market in general, and improves the trust in the financial system.


We need to think in new ways about the crisis, which Geithner acknowledged in his speech, but he is so ignorant that he does not know of any solutions like the ones I just described.






Moreover, I advise that the winner-takes-all voting system should be destroyed.

What to do with the Banks?

Allow me to explain, in plain language, what the whole discussion about the troubled banks is about. A lot of the banks, most notably Bank of America and Citigroup, are already insolvent. The only reason that they haven’t had to file for bankruptcy is that they’re claiming that their assets are worth much more than they actually are.


The banks are saying: our assets are worth a lot, but nobody is willing to pay anything for them now, but the value of them will go up in the future, so give us money now.


The very foundation of a capitalist economy is that any asset, whether it’s a house, a painting or a complex financial product is only worth what someone is willing to pay for it. In a communist economy, the government decides what assets are worth, but that is not, as we all know, how things are done in the U.S..


The assets that the banks are claiming to be worth so much money are actually completely worthless, because nobody is willing to pay anything for them. They’re like houses in a ghost town.


According to financial regulation you have to “mark assets to market”, which means that you have to value them according to what people are willing to pay for them, which is in line with the capitalist economy. However, the banks are hiding all these assets away from sight of regulators, investors and the public, so that they can get away with not doing this.


They do this by putting worthless assets in what they call “special purpose entities”, which do not appear on the balance sheet. It’s as if someone were to have a secret credit card with a huge balance that they have hidden away from their spouse, while telling that spouse that they have no debts.


Currently, the U.S. government is trying to figure out how they can relieve the banks of these assets (of which the government actually has no idea how much there are, or of what they are made up). Tim Geithner will present a plan tomorrow at 11 a.m., and the most important factor in this plan is that the government will try to buy these worthless assets from the banks.


What they have to do, in actual fact, is to decide a price of the assets, just like communist governments used to do. It is strange for the government to engage in communist economic policies in order to save capitalism. The taxpayers will pay for the assets, but whatever price is above zero is too high, so the American taxpayer is without question being ripped off big time… again.


The money which is available for use in this plan is $350 Billion. That is nowhere close to being enough for the banks so that they can avoid bankruptcy. The only thing this does is to buy time. It buys time for these worthless assets to go up in value again, and that is the only way that the banks can remain in their current forms.


Will the assets recover the value that they used to have? Absolutely not. Using the analogy of the house in the ghost town again, the ghost town would have to turn into a boom town in just a few months. I’m not aware that something like that has ever happened.


To simplify things quite a bit, you could say that one of these bank assets is made up of 1,000 houses in a low-income area of Cleveland (where the sub prime crisis is extremely severe).


By now, all of them will have lost at least 50% of their value, 200 of them will have been torn down, and 500 of them are empty (and the empty ones have lost 80% of their value due to looting and other things).


If each house were worth $20,000 in the beginning, the bank asset would have been worth $20 million. After the value destruction that I outlined above, the face value of the asset would be only $5 million. In addition to that, such an asset is priced based on the future expectations of it, which I need hardly mention are not good. Hence, nobody wants to buy it, and it is in fact worthless.


This decrease in value from $20 million to $5 million in a short time is the essence of the banks’ problems. In many cases, the situation is far worse than what I have described above, but I’ll try to keep it simple for now.


Hence, this bailout, like the other ones, is totally misguided and has no prospects of working. Why are they doing this anyway? Because the prospect of nationalization is too ideologically offensive to American politicians. Nationalization would lead to all the shareholders losing their money, and the bank executives would be fired.


Several banks will have to be nationalized sooner rather than later anyway, regardless of further bailout attempts. As I said, the reason for this is simple: the value of the bank assets will not go back up. I don’t favor nationalization because I think that would be too wasteful and expensive, but instead, I favor the creation of new banks, as I wrote in January.






Moreover, I advise that the winner-takes-all voting system should be destroyed.

Proportional Representation - The Iraq Example

George W. Bush claims to have created a new democracy in the Middle East: Iraq. One of the most interesting things about this is how it was done, and how the government and the voting system was set up. Surely, if a democratic “liberator” country topples a regime in the name of democracy, it would want to create a new democracy in the country as a mirror image of itself. In the case of Iraq, however, this was not done.


Proportional Representation has become the system of choice for virtually all developed countries in the world, except in the Anglo-Saxon countries. When the United States toppled the Iraqi regime and installed a new political system, the American model of government was not chosen. Instead, Proportional Representation was chosen.


All that Proportional Representation is, is a system that counts every vote and awards seats in Congress based on how many votes a certain party gets. Can it get any simpler than that? If you get 40% of the vote, you get 40% of the seats. End of story. In The United States today, however, if you get 40% of the vote, you may get 0% of the seats. The American voting system inevitably leads to the following outcomes:


1. Only two parties can ever take part in the political process, even if those two parties are not even close to enjoying support from a majority of the population.


2. Politics is not driven by issues, such as whether or not to provide national healthcare. Instead, the personality of politicians and the amount of money a politician has are without question the two most important factors.


3. Co-operation between the parties (a.k.a. bipartisanship) occurs, so that neither of the parties can ever be challenged by a new party. This can also be described as a political cartel. For a new party to come onto the political stage, one of the old ones would have to disappear.


If the United States government had suggested the American voting system for Iraq (also known as the winner-takes-all voting system), there would have been a nationwide outrage and eventually, very likely, a civil war. The reason for this is that, inevitably, only two parties would have made it into the Iraqi parliament, one of which would have ruled everything.

Clearly, there would have been one Shia Nationalist Party and one Sunni Nationalist Party. The Shia Nationalist Party would have won the majority and ruled completely. The Kurds would not have been represented at all, nor would any other minority, like the Christians.


In a deeply divided and diverse country like Iraq, it would have been disastrous to have only one ethnic group rule the whole country, which is what would have happened under the winner-takes-all voting system. The other groups would most likely have been repressed to a point where rebellions started occurring. The Kurds would have rebelled against the usage of oil money, the Sunni would have rebelled against religious intolerance, and so on.


By giving the Iraqi people Proportional Representation, The United States ensured that every Iraqi was given a voice, regardless of ethnicity, region or income. This made the likelihood of civil war infinitely smaller, and gave the new country a chance to work its problems out. It remains to be seen whether that is possible, however, but a fair voting system is obviously of the utmost importance.


The United States is also a deeply divided country because of geography, ethnicity and old divisions going back to the civil war. There is an incredibly strong anti-government sentiment in this country that is unmatched in the rest of the world, leading to a situation that many foreigners would describe as semi-anarchistic. The American people do not want to work together, and they do not share the same goals.


I believe that the reason for this is that the American people cannot be represented proportionally because of the winner-takes-all voting system, as Iraqis can. As a result of this, doing nothing seems like a better option than having one group rule over all the others. In the United States, an unfair voting system has gradually led to a governmental paralysis.


For all those groups of voters whose interests are not shared by the political elite, there is no way to gain a political voice, because their party would have to be big enough to eradicate either The Republicans or The Democrats from the political scene, which is obviously easier said than done.


The only rational thing these people can do is to be critical of government action in general, which is what they have done for over 200 years now…



The main reason that I write this blog is that I consider the American (as well as the Canadian and British) system of government to be undemocratic. Even George W. Bush knows that the American voting system is undemocratic, otherwise he would have seen to it that Iraq was given this system too.


The biggest problem, however, is that the American people are not aware of what consequences the current voting system has, or that there is something called Proportional Representation, and that is why I’m writing all this.






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The Shimon Peres Proposal

The New York Times reported yesterday that the President of Israel, Shimon Peres, had come up with a suggestion for dealing with fraud and other abuses on Wall Street. During a Sabbath dinner last week, Peres reportedly proposed that, instead of giving huge bonuses to executives of failed banks and Wall Street firms, large bonuses should be given to federal employees who sniff out the next Bernie Madoff or expose the next financial derivatives scheme à la Lehman Brothers.


The proposal is a very good one, and it goes deeper than what it seems like on the surface. It is not the most sophisticated of political tools, but it is one that most people can understand and embrace. It may not be fair to other federal employees, but desperate times call for desperate measures.


The core of the problem is bad governance. For decades, people who have worked as federal regulators have only done so long enough to make their next career move: to work on Wall Street with ten times the salary. This makes regulators unmotivated and decreases the skill of the regulatory institutions in general because of poor staff retention numbers.


Also, financial regulation is simply a game of cat and mouse, where regulators try to keep up with Wall Street’s innovations, but always lose. The reason: Wall Street employs ex-regulators who know how to structure everything relating to financial transactions so that they will be kept under the radar.


The situation for federal regulators is very similar to that of Mexican policemen who can’t feed their families on their salaries and turn to the drug trade to make much needed money. I don’t think the families of regulators are starving, but when prosperity is put into a relative context, as it always is, they might as well be. The incentive to move to Wall Street is simply far too great.


People who work for the United States government are actually not that poorly paid from a comparative perspective. They get a fair salary and pension, a good amount of vacation time, good work hours and are allowed time with their families. In most respects, working for the U.S. government closely resembles working in a middle-class job in the EU, where all jobs, whether private or government paid, come with such benefits.


So, theoretically, I disagree with the fact that financial regulators should be paid much more than other federal employees. However, this is a crisis if gigantic proportions, and because Wall Street is the biggest part of people’s financial well-being, problems with fraud and schemes can rock the foundations of society.


I hereby suggest a few more details to the Shimon Peres proposal:


- give regulators who expose fraud and schemes a share of the fines in the eventual court settlement


- increase incentives for the already enacted whistle-blower compensation with respect to Wall Street firms


- consolidate all financial regulatory agencies into one huge agency


- consolidate all financial regulation into clear, simple, federal legislation (this is definitely easier said than done)






Moreover, I advise that the winner-takes-all voting system should be destroyed.

Turning Prime Into Subprime - For Taxpayers

A disturbing new trend is slowly emerging as banks are responding to the crisis and the political climate. Banks and Wall Street firms have obviously made billions from the bailouts because of taxpayer donations, but it has taken them a while to figure out how to benefit from the crisis and rip off taxpayers with a new business model. Now they seem to have figured that out.


Politicians have been angry with the banks for not lending more money to the public. Since the banks got the bailout money, they have been sitting on it and only been spending money on “essentials” such as bonuses and dividends.


What is happening now is that they actually are starting to lend. They are giving 30-year fixed rate mortgages with very low interest rates. This is also the centerpiece in a new recovery plan put forth by the Republicans. Making these loans seems like something a very healthy bank would do, so in light of the fact that most of the major banks are effectively insolvent, how are they doing that?


Recently, it has come out that Wells Fargo is giving 30-year fixed rate home mortgages in Portland, Oregon, with an interest rate of only 3.875%. Considering that interest rates everywhere else are much higher, these loans are completely unrealistic from a business perspective. In addition, Oregon’s real estate market is not exactly booming, so the loans are quite likely to go into default.


Today, Citigroup announced that it was going to use $36.5 billion in bailout money to provide home loans for the public. $10 billion of that will be backed by the government entity Fannie Mae. Citigroup has not announced interest rates or other details as far as I’m aware, but the important thing to remember is the combination of using bailout money and government-backed entities to guarantee the loans.


I believe that Wells Fargo and Citigroup are doing the same thing: making loans that are likely to go into default using taxpayer money while taxpayers guarantee the loans if the default.


This is very similar to how the subprime loans were created. When making those loans, the banks didn’t care at all whether the loans would go into default; they just took the fees for making them, and then sold off the loans.


This is the same thing, and from a taxpayer perspective. This amounts to a triple or quadruple whammy.


First, taxpayers pay for the unbelievable mistakes the banks made, then they pay CEO bonuses, then they pay to start up the subprime scourge again, and finally get sent the bill from Fannie Mae and Freddie Mac. When will we stop digging a deeper hole for ourselves???






Moreover, I advise that the winner-takes-all voting system should be destroyed.

Response to Crisis - Kleptocracy

Obama has certainly done many good things since he took office. However, as I feared last year, his appointments in the economic field are proving disastrous. Timothy Geithner and Larry Summers were two terrible choices that represent a direct continuation of the utterly failed policies of Greenspan and Paulson.


A kleptocracy is a political system run by thieves. The only beneficiaries in the system are the thieves themselves, and the public is left robbed. At this point in American history, Wall Street appears to have taken over democracy completely, and is somehow able to dictate the terms no matter who is in the White House or in Congress.


A kleptocracy usually includes large elements of bribes, corruption and extortion, without which the government cannot function. Around the world it is often said that The United States has the “best politicians money can buy”. Indeed, that is how it is, and Wall Street has bought these politicians over many years now. Politicians cannot run their campaigns without these donations, so the relationship is unavoidably symbiotic.

Kleptocratic regimes are usually associated with countries such as Uganda and Congo, so why is the U.S. a kleptocracy? Because Wall Street controls the agenda and gets all the benefits.

We are now approaching the third or fourth bailout attempt with the exact same theme: outright taxpayer donations to failed Wall Street firms and banks and their stockholders.


Everybody can see that it’s not working, so why is the Obama administration suggesting another one of these bailouts: the bad bank solution!!?? The bad bank solution entails simply giving banks taxpayer money to cover their losses, with no strings attached. And believe me, that money will never be seen again. It’s going to go into a black hole of losses, built up by fictitious profits, but now exposed and imploded.


To engage in something so morally offensive and intellectually misguided as the bad bank solution only has one explanation: the system is totally corrupt. Why else would the government embark on a bailout that everyone knows won’t work?


I blame Timothy Geithner and Larry Summers for continuing the kleptocratic system. Their only concern seems to be the continuation of the supreme rule of Wall Street in American democracy. Geithner specifically said today that the current financial system must be preserved.

If they are going to rob the taxpayers, it would actually be better if they robbed the money and spent it on luxury goods. That would at least provide some jobs for people, or prevent luxury goods companies from having to lay people off. Maybe a “Thain renovation” would be appropriate?






Moreover, I advise that the winner-takes-all voting system should be destroyed.

Is the Stock Market Working?

The heading of this post may seem like a strange question, but I think at times like these we need to ask ourselves more fundamental questions. The American people are deeply invested in the stock market in a myriad of ways, and now that stocks have lost almost half of their value, I think it’s time to re-evaluate the very model of our economy, and in particular, the role of the stock market. A majority of Americans are to a great extent dependent on the stock market doing well for their fundamental well-being. What I’m asking is: should that really be so?


The stock market is supposed to fill an essential function in an advanced society: to provide money for ventures that otherwise would have been far too expensive to embark on. The invention of the stock corporation was an ingenious one, in that it allowed many people, not just kings and despots, to invest in large and expensive projects such as factories, mines, and much more. This adds a whole new layer to society and enables immense progress, innovation and price reductions.


To determine whether or not the stock market is “working” from the perspective of society at large, one must try to determine the reason why investors buy stocks of different companies. If investors truly believe that a company has a good plan and structure for growth and profit, and invest in that company as a result, then that is a good example of how the stock market can help society progress and prosper. If, however, an investor invests in a company for other reasons, the role of the stock market in society becomes much more questionable.


The way you can tell whether or not investors are buying stock because they believe in companies or for other reasons is by looking at how the stock market moves. If the whole stock market as one, regardless of the industry that the companies are in, then something is up. Of course there will always be a connection to the economy as a whole, but different industries will always be affected differently. When the stock market moves up and down as one, as the American stock market has for a long time, then there is unquestionably something that is not working.


What is causing this is speculation without a motive. Investors buy stocks not because they think that the companies are going to do well, but because they think that other people will buy the stocks too, so that the price will go up. When they do that with borrowed money, a huge bubble is created, which will eventually pop and create a recession or a depression. This creates an outcome that is completely contrary to what the stock market is meant to do, in that companies that do well can get punished, and companies that do poorly can get a hugely inflated stock price. This sort of behavior removes the good dynamics of capitalism.


U.S. politicians have over the last 30 years allowed the stock market to become almost a state within the state. If the stock market does not get what it wants in terms of de-regulation and bailouts, it brings stock indexes down until politicians cave in. This is what happened when the first TARP-plan was voted down. Remember, stock brokers don’t get paid a percentage of the profit they make for their clients, they get paid based on the volume of what they trade. Hence, it does not matter to them if they win or lose, they just have to play. They need people to believe that the stock market is a good place to invest money in, and that is why you hear endless optimism everywhere in the media with regard to the stock market. When it seems like the whole financial world is coming to an end, stock brokers will try to tell people that it’s a great time to buy stocks based on some economic report that says that the situation isn’t quite as bad as everyone thought. It’s simply absurd.


Because almost all Americans own stocks in one form or another, Wall Street can hold everyone’s money hostage at the same time. This situation is undemocratic, inefficient and immoral.


The American people and the American economy must de-couple itself from the stock market. The stock market has become a place of pure gambling and blackmailing, without regard to what a stock market is actually supposed to do.






Moreover, I advise that the winner-takes-all voting system should be destroyed.

Good Versus Bad Protectionism

For the longest time, The United States had a firm commitment to protectionism. Protectionism is a policy under which a country limits imports by different means so that the country consumes primarily its own goods. In the early 20th century, America’s commitment to protectionism was ended, and a commitment to free trade was started instead. Of course, protectionism has its clear advantages. It is clearly better for the U.S. economy on the whole if Americans buy Fords instead of Toyotas, because the money would stay in the U.S. instead of being transferred to Japan. The story, however, is much more complicated than that.


During times of a severe crisis when job losses mount and industries shut their doors, calls for protectionism usually grow louder. That happened during the Great Depression, and it is happening now. Much of Barack Obama’s campaign rhetoric was centered on domestic industry and a return to consumption of domestic goods, and more recently, Timothy Geithner has repeatedly alluded to the fact that China is manipulating its currency to stimulate exports. What Geithner is effectively saying is that China should raise the value of its currency, so that Chinese goods will become more expensive in the U.S., so that Americans will buy American goods instead. So, what are the benefits of free trade, and is there such a thing as “good protectionism”?


Free trade has many advantages. Most importantly, it lowers the price of goods dramatically, and makes goods available everywhere. 20 years ago, the prices of food, furniture, clothes, electronics, appliances and much more were considerably higher than they are today. The globalization of free trade have made these goods much cheaper in the West and provided jobs in the Third World. Today, most types of trade is global, and many countries even import the same goods that they export (this is also called “counter trade”). Globalization has, in short, put millions of people to work, and brought cheaper goods and greater prosperity to everyone.


During a crisis, globalization and free trade do little good. The enormous forces of the global economy cannot be controlled or steered towards a certain goal, such as job creation in the U.S.. Protectionism can do that, but at a cost to the global economy, and global growth. An increased amount of protectionism would likely cause some problems in trade relations around the world, but those problems may not be as large as those that would occur if the unemployment rate were to go up to 15-20%. There are definitely some excesses in global trade that could be addressed, while local goals could be achieved.


Not every country can produce everything, and it would make little sense for advanced, industrialized countries to start producing basic goods again just to create jobs. For the government to sponsor a pencil factory next to a bio-tech lab would be stupid. That would be an example of bad protectionism. We need trade to a large extent, but we don’t need trade for everything, and in some cases, trade can be a liability.


There are certain goods that are not suited for global trade, for various reasons. I’m thinking primarily of food, defense and government contracts. If a country does not have its own food production, it becomes very vulnerable to political insecurity in the world. If a food exporting country has a choice between feeding its starving citizens, or breaking a deal with a food importing country, the former will obviously be chosen.


A country that is dependent on imports for its defense is also very vulnerable to insecurity. Again, if a weapons exporting country is faced with a choice of defending itself or breaking a deal with another country that wants to buy weapons, the former will be chosen.


With respect to government spending in general, it makes little sense not to buy domestically when buying police cars, fire trucks, steel for bridges, energy, and so on. To directly take taxpayer money and transfer it to foreign taxpayers through government imports results in a dramatic hemorrhaging of money for the country’s finances.


The conclusion one can draw from these examples is that there is such a thing as “good protectionism”. If the American government wants to create jobs at home, it should primarily focus on supporting domestic production in food, defense and whatever goods the government purchases. Good protectionism is protectionism that makes economic and philosophical sense.


No country can be legitimately blamed for implementing such policies, so the impact on global trade is minimized using this approach. Focusing on good protectionism can also lower the trade imbalance and strengthen the dollar. When it comes to free trade, the story is very similar to that of public goods and public utilities: there are times when the free market is unmatched in providing what is needed, but there are other times when the free market is completely unsuited to the task at hand.

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The Good Bank Solution

One solution to the financial crisis that is currently being discussed is the so-called “bad bank solution”. What this means is that the government would set up an entity, and gather all the toxic assets that the banks have, so that the bank system can be freed of the bad stuff and move on. Sounds good, but where do the losses go? The answer is: to the American people.


This solution is no different from the original TARP plan, in that the American taxpayer simply gives banks money to cover all the mistakes those banks made, with no strings attached. I believe that the losses in the banking system are too great for a bailout like this one to have the potential to work, regardless of the moral implications. That is why we need a different solution.


First, a reality check to illustrate my point. Bank of America and Citigroup are the two large banks that are in the worst shape. Consider their market value in 2007 compared to today:


Bank of America’s market value in the second quarter of 2007: $228 Billion


Bank of America’s market value in January 2009: $33 Billion


Citigroup’s market value in the second quarter of 2007: $255 Billion


Citigroup’s market value in January 2009: $15 Billion


In addition to this, these banks have several times their market value in toxic assets, which means that they are effectively insolvent already. Consider also what Bank of America did after it received bailout money: it went and bought MORE mortgage-backed securities, creating even greater losses. When the bank found out that it was going to get a bailout, it started paying huge bonuses to its executives, in reality using TARP money for that. It’s definitely time to stop betting on the losing horses. It doesn’t matter how much money we spend on these banks, they’re not going to be able to continue in their current forms. The bad bank solution is nothing more than a bad solution.


I am instead proposing a Good Bank Solution, under which the government sponsors entirely new banks, completely untainted by the crisis and the toxic assets. Instead of trying to repair a complete wreck of a bank, a new one is constructed from scratch. The public could then safely put its money into those banks, investors could invest money in them, and the banks could immediately start lending with prudent standards. More specifically, the plan would consist of the following steps:


1. The government drafts a bank charter (the rules for the bank), and includes very stringent standards on lending, how much capital the bank must have, how the bank can invest, how much money the bank must lend, and so on.


2. The government puts money into the bank. We’re talking about billions of dollars, not billions in losses, but in investments in a new banking system with a clear potential for profit. The government owns 100% of the bank.


3. The bank opens for business, takes customer deposits and starts lending immediately. Investors will be able to buy 49% of the stock, but the government must remain the majority shareholder for a few years until the financial crisis has been resolved. By selling stock, the government may already have recouped half of the investment at this stage, potentially at a profit.


The government can create many of these banks, and in one fell swoop bring confidence and lending back. It is important to note that this is just a temporary solution. Once the crisis has passed, these entities can be sold completely, so that the government does not have to act as a banker.


Before that happens, the government will also have been given time to legislate the new financial regulation that is so direly needed. The “good banks” don’t need regulation, because they will have that written into their charters. This would be a big operation for sure, but it must be done, because the current system is broken.






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The Six Stages of the Credit Crisis

Recently, the idea of the nationalization of major banks has been gaining ground in the U.K. and the U.S.. I am against the idea, simply because I think it will cost too much in the end. It was the right thing to do in the 1980:s in the U.S., it was the right thing to do in Sweden in the 1990:s, but this time the scale of the problem is so different that nationalization could be very dangerous.


I’d like to talk about the current crisis on a larger scale, because there are some definite patterns that have shown up in recent years in several countries that now seem to be imploding. I’m thinking of the U.S., the U.K., Ireland and Iceland. The common denominator for the last 20 years of financial history is crystal clear:


All four countries decided about 20 years ago that they would promote and expand the financial industry through deregulation, tax incentives and lower interest rates.


Of course, the U.S. was already the financial hub of the world, but it nevertheless embarked on the same strategy as the other three countries. In all four countries, the financial industry’s share of GDP grew steadily and even explosively as a result of the respective governments’ efforts. This was a very attractive development for politicians, because only by de-regulating, they could hold off on raising taxes, grow GDP and increase the standard of living. It seemed to be a win-win situation, if it hadn’t been for the familiar problem of credit.


Debt fueled both speculation and consumption, so that debt levels have now risen to astronomical levels in all four countries. Private debt is now several times larger than the GDP in each of these countries. By borrowing money to speculate and consume, companies and individuals have set in motion a huge credit expansion and created the enormous credit bubble that we have today. As I wrote here ,whenever such a system is shaken, everything falls apart, because real debts stemming from fantasy money must be paid back with real money.


A pattern seems to be emerging with respect to how a country develops after the huge credit bubble is popped. The smaller you are, the sooner you will go down. The more debt you have, the less likely rescue attempts are to work. There seems to be six stages to the further development of this crisis, and the following scenario may play out in all four of these debt-laden countries:


1. Real estate prices go down


2. The stock market collapses


3. Bailout attempts fail


4. The currency gets attacked and loses much of its value (which greatly increases the country’s foreign debt)


5. The banking system becomes nationalized


6. The country becomes insolvent


Iceland has already gone through all the stages. The U.K. is in stage number 4. Ireland is in stage number 3, where the U.S. also currently finds itself. Will all the four countries go through the six stages? That doesn’t have to happen if you do the right thing. We must stop throwing good money after bad, and only invest minimal amounts in the current financial system, while we build a new one at the same time. I believe we must move very quickly with a new plan, the creation of completely new banks, which I will elaborate further on in my next post.


P.S.
To those who say that nationalization is “socialism”, I’d like to say that it actually amounts to the opposite of socialism: it is meant to save the capitalist system. If the system is not saved, you may very well experience actual socialism.






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Crowd Them Out!

President Obama and his administration is currently working on a new stimulus package that includes large amounts of spending on public goods, such as infrastructure, health care and the environment. Traditionally, a public good is something that is available to all citizens of a country at little or no cost, to the benefit of everyone. However, in The United States, goods that are considered “public” in most other countries, are considered “private”. For example, health care is considered a right (by extension a public good) in the EU, whereas it is considered a privilege (a private good) in The United States. Such thinking is the reason why a lot of commentators are voicing opposition to Obama’s stimulus package at the moment.


The free market philosophy is deeply ingrained in American culture, and stretches back hundreds of years. A lot of Republicans and other free market proponents are now criticizing Obama’s plan, saying that it would “crowd out” the private sector from the provision of certain goods and services. “Crowding out” is a phrase that is used to describe a situation where the government provides a service that could have been provided by the private sector. For instance: if the government were to provide free health care for U.S. citizens that was as good as private health care, why would anyone pay for health care? As a result, private health care companies would be “crowded out”.


It is important to remember that Obama’s stimulus plan is concerned almost exclusively with public goods, or at least what the administration considers to be public goods. Obama is not suggesting that the government should start producing toaster ovens to sell for a profit. He is proposing to use public money for public goods. Very few people would argue that the government would be better at producing toaster ovens than the private sector. They tried this in the Soviet Union, but wound up with toaster ovens that could barely toast one piece of bread, as well as a mountain of them that was never sold. As I eluded to earlier, the Republicans don’t consider health care to be a right. The current debate is hence a highly ideological one. The real question here is: can the private sector provide the goods in Obama’s plan 1. affordably and 2. reliably?


Let’s go through a few examples. The most important sectors that this plan is concerned with are electricity, roads and health care.


Electricity - does anyone remember the Enron scandal? If not, this company pioneered a new approach to the provision of electricity and natural gas. Before Enron, electricity was considered as something that should be provided to citizens at the lowest cost possible. There was literally a direct link between the government’s not-for-profit production and distribution of electricity and the citizen’s outlet. Unbeknownst to citizens, Enron convinced politicians that that should no longer be so.


By introducing itself as an intermediary between the energy source and the electrical outlet, Enron was able to charge customers vast sums of money, while making electricity much more expensive. Enron bought up power grids (which were built up with taxpayer money) and charged more. It bought power plants, and charged more. It intentionally choked the supply of energy, and charged more. In the ground zero of free market philosophy, Texas, electricity prices rose by 800%, and are still at that level today even though Enron is gone. California experienced countless blackouts when Enron was in charge of electricity provision in that state. These blackouts were partly intentional to choke the supply, and partly due to incompetence. So, the result was blackouts and price increases of 800%... - guilty on both counts.


Roads - Americans are always screaming about high gas prices, but I never hear anyone screaming about road tolls. In the New York area, a trip to the shopping mall can easily wind up costing $40 in tolls. It’s important to remember that almost all roads in the country have been built with taxpayer money at some point in the past. As such, they are the property of taxpayers, as much as the White House itself is. Local governments all over the country have been selling roads to private companies since the 1980:s, in the same way that electricity grids were sold to Enron. Road tolls inhibit citizens from driving on roads that they themselves paid for, and in many cases, the money goes to private companies. These private companies have no incentive to make the roads as good as possible, their only incentive is, and should be as a corporation, profit. Hence, it makes no sense to sell a road to a private company to run it for profit, when the government can run it without a profit motive. It’s a question of good governance.


The very reason that the country’s roads are crumbling is the outsourcing of roads to private companies. By doing this, The United States now has a more expensive, and lower quality transportation system. Guilty on both counts.


Health care - need I even mention the 50 million Americans who do not have access to health care? That number is growing as the economic crisis gets worse. The United States ranks very low on measures of population health, far behind all other Western countries, and even behind Cuba. Also, I never understood why employers should be saddled with health care costs. The duty of an employer is first and foremost to pay a salary and adhere to labor laws.


A little known fact is that The United States spends around twice as much tax money per capita on health care compared to the countries in the EU that provide the most comprehensive free health coverage, such as Germany, France and Sweden. In The U.S. you are covered for nothing, and in the EU you are covered for everything, at half the cost! What does that tell you about the efficiency of the market in the provision of health care for citizens?


So, what we have is truly second-rate health of the population and non-existent coverage at astronomical prices. Guilty on both counts.


The private sector absolutely cannot provide these things affordably or reliably. In an economy, there are certain things that are suited to be provided by the market, and others that are definitely not. The motive of a health care organization should be to keep citizens healthy at the lowest cost possible. Anything other than that reflects a medieval state of mind. Profit cannot be a part of the equation, because dead patients are more profitable than surviving ones. The motive of an electricity infrastructure is to keep citizens warm and able to feed themselves. Anything other than that severely threatens the security of citizens. The motive behind a national infrastructure is for citizens to be able to move around and for goods to be able to travel. Anything other than that amounts to a country giving up sovereignty over its land.


Selling out public goods to private companies is highly detrimental to a country, and indeed immoral. Obama’s plan would crowd these companies out. The plan will not bring the short-term boost that Wall Street is praying for, and will actually do the opposite of what Wall Street wants in terms of the policy on public goods. However, people on Wall Street are too stupid to figure that out.


The selling of America’s resources must be stopped and reversed. Therefore I say: crowd them out!

The Hope For A New Financial Order

On this day that Barack Obama is inaugurated, I would like to talk about the need for big ideas for the world’s financial future. As the U.S. and the world is in a state of hope for a better future, now is the time to think big, and to think fundamentally about how we can move forward. What we need is a truly global effort to change our financial system for a sustainable future.


The financial crisis is getting worse every day, and there are some very good reasons for this. As a result of the developments of the last 20-30 years, the world’s financial state is worse than most people realize. I usually don’t list a heap of numbers on this blog, but this time, a bit of a reality check is called for. The current crisis actually has a pretty straight-forward cause, which is a rather simple question of plus and minus. Consider the following facts:


The GDP for the entire world in 2007 was around $54 Trillion.


The outstanding value of financial derivatives is currently over $200 Trillion


At least $100 Trillion of these financial derivatives are estimated to be so-called toxic assets, by several independent estimates. In essence, these assets are worthless, but someone has to take the hit…


So there is a slightly delicate question of $50 Trillion that needs to be resolved. I recently had a conversation with a plumber about the economic crisis. He was, understandably, confused about the crisis. He couldn’t understand how there could be more debts than there was money in the world. Though he was more familiar with plumbing than the world of high finance, his reasoning about the economy was positively more profound than that of any Wall Street trader.


The answer to the plumber’s question has to do with what is known as credit expansion. In essence, when speculators borrow money to bet on all sorts of different things, a bubble is created that will make it seem as if there is more money than there actually is. A speculator can hence own lots of “fantasy money”. However, the catch is that, if things go bad as they have now, the speculator cannot pay his debts back with fantasy money; he has to pay them back with real money (because the fantasy money is now worthless). Since there is considerably less real money than there is fantasy money, something’s got to give. That is why Lehman Brothers, Bear Sterns and all the other institutional speculators no longer exist, and that is why we are in a global financial crisis right now.


So, how do we deal with this problem? In society there are many rules. If rules were gotten rid of, does anyone really believe that everyone would behave responsibly anyway? If we took down all the road signs and got rid of all the traffic rules, would everyone drive safely down the road at an appropriate speed? I don’t think so, and the same is true for high finance.


Commerce is truly global again today, which it was not 30 years ago, and hence the same regulations as those that were gotten rid of in the 1980:s (which led to the crisis) cannot be applied today. The new legislation doesn’t necessarily need to be more draconian, but it needs to be comprehensive, simple, uniform as well as prohibitive.


I think it’s time for the U.N. to get involved in financial regulation. We need an International Treaty of World Commerce. We need clear and well thought out rules that will prevent a global meltdown like the one that we are seeing today. Here are some suggestions of what should be included in an International Treaty on World Commerce:


Prohibition on overly leveraged speculation - in other words, a prohibition on borrowing 20-30 times more than you own, in order to make financial bets. Leveraged speculation is what leads to credit expansion and asset bubbles, the cause of this crisis. In many countries, it is illegal to buy lottery tickets or place bets with a credit card (borrowed money). This law would be in the same spirit.


Tax on stock market investments - this would discourage small-scale investing by vulnerable individuals and also breed prudent investment strategies among institutions. Less volatility and less vulnerability would be the outcome. The tax money could go to a reserve fund of the IMF to fight economic crises wherever they occur.


Uniform accounting standards - these standards would be constructed so that hiding assets away from, or within a corporation’s balance sheet, would be next to impossible. The tactic of hiding bad assets or large liabilities, pioneered by Enron and perfected on Wall Street, is also an important cause of the crisis.


Prohibition on complicated derivatives - most financial derivatives were intentionally constructed in such a complicated way that the buyers were not meant to be able to understand what was in them or how they worked. The food industry could serve as inspiration for more transparency, and any financial product would have to have a strict declaration of its “ingredients” as well as the exact plan for growth and how that makes sense.


There are many more things that could be added. Readers are encouraged to add their own suggestions in the comment section.

Oligocracy

OK, Oligocracy isn’t really a word, but I hope it will become one as time goes by. Oligarchy (which is a real word) means the rule by the few, or a sustained political elite. Oligarchy tends to develop over time, as certain segments of the population, such as powerful families, accumulate more wealth and influence and become oligarchs. My version of the word, Oligocracy, is meant to describe a system that is intentionally set up from the beginning to be the rule of the few.


It comes without saying that a rule of the few, as opposed to the rule of the many, is inherently less democratic, and, indeed, undemocratic. The phrase, “the rule of the many” is not primarily meant to refer to a government that has, for instance, a lot of politicians, or a lot of public referenda. Instead, it is meant to refer to the inclusion of as many of the citizens as possible in the shaping and outcome of the political process. An oligocracy is meant to do the opposite.


There are several reasons why the founder or founders of a political system would want to limit the influence of citizens in the country when drafting a constitution. The United States constitution is by far the oldest constitution that is still in use in the world. Many other industrialized countries have had to write new constitutions because of wars, or chosen to significantly re-write them as they have become seen as obsolete. The older and less amended a constitution is, the more likely it is that values that are unfamiliar to us today will appear in it. Values tend to go through an evolution as societies evolve. For instance, we would be very unlikely to see a new constitution in an industrialized country that would prohibit black people from voting.


When The United States Constitution was drafted and consequently adopted, a few important values that are unfamiliar, and even reprehensible, to us today, were commonplace and seen as normal. A few of these values, which were expressed in law in The Constitution, were:


- the belief that black people should not be allowed to vote


- the belief that women should not be allowed to vote


- the belief that people who do not own property should not be allowed to vote


These beliefs express clearly, more than anything else, the belief that only a small segment of the population should be allowed to have an influence in the political system. Although all three of the abovementioned rules have been gotten rid of, the spirit of them most certainly remains in the constitution, because that constitution is so old and relatively unchanged. The U.S. Constitution, as well as other federal and state-level law, retains a very large number of provisions that are meant to limit the influence of currently disenfranchised citizens and political actors. The United States is a clear example of an Oligocracy.


In the current U.S. system, there are mainly three factors that perpetuate the U.S. oligocracy:


1. Winner-takes-all voting system. In this system, the party that gets the most votes in a given district gets all the seats in that district. The U.S. and British systems are examples of this, and this system invariably creates a two-party system. Only two parties have actual influence on national politics, and all other parties are, in practice, excluded. The alternative, which is used in a majority of advanced democracies, is proportional representation. Proportional representation awards seats in proportion to how many votes a party received. Hence: 25% of votes = 25% of seats.


2. Bipartisanship. In a two-party system, the two parties will benefit from working together, so that no other party can be successful in elections. This creates a type of political cartel, much like an economic cartel, where supposedly competing companies agree to set high prices for the customer instead of competing with each other. The voter will inevitably be short-changed in a system of bipartisanship.


3. Limiting voting rights and voting access. The U.S. still legally restricts voters who have been convicted of crimes, and to some extent, university students who study in a state other than their home state. In The U.S., voting is a much more complex affair than anywhere else, where complicated registration and voting procedures are clear and intentional deterrents to voting. Illegal voter suppression is also more common than anywhere else.


An oligocratic system is an undemocratic system that excludes large segments of the population. It comes as no surprise that The United States has, by far, the lowest voter participation in the entire industrialized world.

Why Didn't They Listen?

It has been announced today that Obama, by way of President Bush, has asked for Congress to release the second half of the TARP fund. The institution of this requirement may have been the only sensible thing to come out of the TARP plan. If it had not been instituted, all the 700 billion would have already been given away to Wall Street institutions and banks, never to be seen by taxpayers again.

The Democrats now say that they have a plan to use this money to help Main Street instead of Wall Street because the original TARP plan produced so much “unhappiness”, according to Barney Frank (who, by the way, has received millions in donations from Wall Street firms over the years). The question then becomes, in light of the hundreds of thousands of emails, letters and phone calls from voters telling politicians not to vote for the TARP plan: why didn’t they listen?


Economics is not as difficult an issue as some make it seem. Most of what it’s about is pluses and minuses. The public rightly understood that the original TARP plan was a huge cry for help by Wall Street firms that were about to go under. Simply giving them money without strings attached would not achieve anything. The public understood this too. What the public did not understand was the concept of “Voodoo economics”, where money magically appears if you leave financial markets alone. The reason that the public didn’t understand this was that it makes no sense. It makes no sense because it doesn’t work. End of story.


Politicians, however, strongly believed that they had mastered the art of Voodoo economics. They listened to who they referred to as “the smartest people in the room” (Wall Street executives), in addition to taking millions in donations from those same people. “The smartest people in the room” had for years told them that the free market can provide all the security Americans need, so taxes could be kept low and the government would not have to take responsibility for the well-being of Americans. It’s a pretty sweet deal if you think about it: in your job you get to:


1. have less responsibility (by not insuring pensions, wages, affordable education and more)


2. get millions in donations


3. not have to take any tough decisions that will anger and disappoint people (raising taxes)


The politicians were able to outsource their own jobs, while also keeping them and receiving millions of dollars in donations from the ones they outsourced to. Sweet deal! That is why they didn’t listen.

Question: what possible upside could there be to allowing large-scale campaign donations, for instance by Wall Street firms? The argument that it is essential for freedom of speech is a pretty weak one...

Protecting Your Investments With Foreign Securities

Let’s say that the economic crisis really does turn in to a full-blown depression, currency crisis, inflation or deflation spiral and obviously further deterioration in the stock market. What can you do to protect your investments? Not a whole lot, but there are a few alternatives that should be considered. What I’m about to suggest is not an easy thing to do, because it requires knowledge far beyond traditional investing and hedging in The United States.


The premise on which this analysis is based is that the U.S. economy as a whole, including the financial economy, the government, the local governments and U.S. corporations are all in very bad shape, and hence cannot be trusted as investment vehicles. Furthermore, if the U.S. government is in bad economic shape, that fact has word-wide implications on most investments.


The real core of any investment is what’s actually behind it. In the end it comes down to what someone else is willing to pay for that investment, and that in turn has everything to do with the environment in which the investment is situated. If the U.S. economy is sinking, then U.S. corporations will suffer, and U.S. stocks will sink too. (also, in case someone forgot, the U.S. stock market was and is a house of cards…)


If the U.S. government is doing poorly, and is at the same time drastically lowering interest rates, not only does one not get a good return on U.S. Treasuries, the government may actually default on the Treasuries, or inflation will make the principal worth much less. In the end, all this has to do with the way a country is run in the long term. Keeping your money inside a country that is poorly run will deteriorate all your assets domestically and internationally. The key to protecting yourself during a catastrophic crisis could then be to find a different, well-run country, from which to buy Treasuries.


If you can find a “well-run” country, you can then invest in that country’s Treasuries, or government debt. The taxpayers of that country will stand behind the debt and guarantee its value. That, in turn, means that for your investment to be safe, those taxpayers must have jobs and overall security, and the government of the country must have responsible long-term policies. Otherwise you run the same risk that you run in buying U.S. Treasuries. In order to analyze what country might be a good one to invest in, one must know about mainly the political and fiscal situations in that country. A well-run country has:


- a persistent budget surplus


- a diversified economy


- a sufficiently regulated financial sector


- a long-term political commitment to fiscal responsibility regardless of ideology


- an independent national (or supra-national) bank committed only to fighting inflation


Being able to identify countries according to all these conditions is certainly not easy, and one must know a lot about international comparative politics, history, law, government studies, institutional studies, economics and much more. However, I would like to suggest two countries that fit these descriptions: The Netherlands and Sweden.


The Netherlands has for centuries been involved in trade and business in a prudent way. The commitment to sound fiscal policies is very strong, and just like Sweden, this country consistently supports the heavy spending of the EU while getting less money back in return. The country responded well to the economic crisis and took pre-emptive steps to protect its prudent, venerated banking sector.


Sweden has a more inconsistent history of financial prudence, but has more recently gone through crises that has made the commitment to sound economic dealings very strong. Sweden is most of all famous for its efficient government institutions. When the economic crisis started in the U.S., the former Swedish minister of finance, Bo Lundgren, offered to testify before Congress on how to deal with the crisis, which is very, very similar to the Swedish crisis of the early 90s. The Bank of Sweden recently had to suspend its sales of Treasuries because demand from abroad was too high. Obviously there were some investors who were thinking in a similar way to what I am describing in this post.




Addendum - What’s wrong with the traditional hedging strategies?


U.S. stocks: Traditionally, stocks are supposed to at least keep pace with inflation and pay dividends, so that they make for good investments in the long run. We now know that the stock market was a house of cards, and there is no imaginable reason why the stock market should be a good investment anytime soon.


Foreign stocks: Before the crisis, a lot of people were talking about the idea of de-coupling. that meant that it was thought that other economies were operating independently of the U.S. economy. We now know that that idea was completely misguided. Hence, foreign stocks more or less equal U.S. stocks, and as such don’t constitute good investments.


Cash: In 2008, the Federal Reserve increased the money supply enormously. That creates a huge potential for massive inflation in the future.


U.S. treasuries: Danger of default and massive inflation, in addition to non-existent returns.


Treasury Inflation Protected Securities (TIPS): Danger of default and even lower returns. Danger of deflation.


Municipal bonds: Clear danger of default. Local and state governments have not been able to sell bonds lately because confidence has already evaporated to some extent. This is because a lot of construction projects have fallen through because of the credit crisis. Many states are in a state of fiscal emergency. If all this weren’t enough, rampant fraud with respect to these assets are beginning to come to the surface. that is why Bill Richardson had to withdraw from his attempt to join the Obama administration.


Savings account: Danger that the FDIC will run out of money. In a catastrophic crisis, this is not at all a distant possibility.


Gold: Subject to much speculation and danger of loss of value. Still, by owning a commodity, you will probably be better off than with the abovementioned assets.

Obama Knows

I have recently been quite disturbed by the appointments that Obama has made, especially with respect to his economic team. Yesterday, my wife tried to console me by saying: “he has a plan”. By that she meant that the appointments don’t necessarily translate into the policy favored by the people Obama has chosen, who largely constitute a restoration of the Clinton economic team. I put a lot of blame on Clinton for the situation we are in today, and I also blame Reagan and Bush Jr., but I don’t blame Bush Sr.


In a speech at George Mason University, Obama spoke in very serious terms about the economic state, and he, I believe, correctly identified many of the upcoming challenges. What Obama realizes is that the challenges we face are not limited to the restoration of confidence in the financial markets. This is not about even about the financial markets anymore. We are unavoidably facing a paradigm shift in the way that this country functions.


To put this in perspective, we seem to be facing a budget deficit of around 2 Trillion dollars with the Obama plan. The current estimated value of “toxic” financial assets is now around 8 Trillion dollars. If it would take 8 Trillion dollars to clean up the financial markets so that those markets can again provide America with across-the-board prosperity (which they can’t), but 1 Trillion dollars to provide direct relief according to the Obama plan, then the choice seems easy. Obama suggests something pretty simple: to funnel taxpayer money directly back to the taxpayers who need it, instead of giving it away to financial institutions in the hopes that, some day, that money will trickle back to the taxpayers. The latter was the Paulson plan.


I am definitely not a fan of deficit spending, even in a crisis. Normally, I would have argued that fiscal restraint, followed by a time of a baptism of fire would be called for. However, since the people of The United States have essentially no societal protection with respect to incomes, pensions and healthcare, such a harsh experience would probably be too devastating. To set the record straight, what we really should be talking about now are things like the following:


real dangers to future American competitiveness, a deterioration of the fabric of society, hunger, poverty, crime and the like.


Obama makes the case that the only way to deal with the situation is to mortgage our economic future. I reluctantly agree.


Here’s an important quote from Obama’s speech:


“We could lose a generation of potential and promise, as more young Americans are forced to forego dreams of college or the chance to train for the jobs of the future, and our nation could lose the competitive edge that has served as a foundation for our strength and standing in the world. In short, a bad situation could become dramatically worse.”


We cannot move forward thinking that the financial markets are going to provide prosperity and security for Americans, we must provide that among ourselves. That is the only way.