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Preparing for the Next Banking Crisis

Since we bailed out the investment banks, we've done almost everything possible to assure that we have another banking crisis and another bailout opportunity.

  1. The banks that were too big to fail before have gotten even bigger as weak banks were merged into their less weak brethren. TARP money was used to finance the consolidation.
  2. Nothing effective has been done to limit the speculation banks can do with federally insured deposits. The Barney-Frank bill is as ineffectual as you would expect it would be, since it was written by the foxes who guard the henhouse.
  3. Even the compensation of bailed-out bankers is still rising beyond the stratosphere. This isn't the reason why the Occupiers have to repay their student loans; but it is outrageous. During the bubble bank presidents were supposedly being compensated – like football players – for success; apparently failure demands an even higher reward. We wouldn't want to damage their self-esteem.
  4. The real estate price plummet has been prolonged by regulatory forbearance. Banks have not been forced to write their mortgage portfolios down to their true declining values on the assumption that home owners, unlike Donald Trump or almost any other holder of a commercial loan, will keep paying instead of just walking away even though their mortgages are underwater. That makes the banks reluctant – to say the least – to agree to reduce principal amounts on residential mortgages as they would have done rather than have a commercial loan fail. Reducing the principal forces the bank to recognize its loss. It now looks more and more like the "correct" price for real estate is closer to what it sells for today than it what it could command during the bubble. So there are more foreclosures than there would have been had banks had an incentive to be reasonable, and there are still significant unrealized losses in bank portfolios.
  5. The euro-contagion is sure to spread here. Our banks lend to and invest in European banks. These banks will have a hard time raising capital to compensate for the 50% haircut they've agreed to take on Greek debt. They have not marked their Italian or Spanish debt down to its real value. The willingness and capacity of Germans to bailout other country's banks is limited.


How did we get in this dilemma? Tom Friedman describes a big part of the problem:


"Our Congress today is a forum for legalized bribery. One consumer group using information from Opensecrets.org calculates that the financial services industry, including real estate, spent $2.3 billion on federal campaign contributions from 1990 to 2010, which was more than the health care, energy, defense, agriculture and transportation industries combined. Why are there 61 members on the House Committee on Financial Services? So many congressmen want to be in a position to sell votes to Wall Street."

Protecting the financial services industry is almost the only bipartisan action that's been taken lately.

Friedman has some good suggestions for avoiding the next crisis:

"1) If a bank is too big to fail, it is too big and needs to be broken up. We can't risk another trillion-dollar bailout. 2) If your bank's deposits are federally insured by U.S. taxpayers, you can't do any proprietary trading with those deposits — period. 3) Derivatives have to be traded on transparent exchanges where we can see if another A.I.G. is building up enormous risk. 4) Finally, an idea from the blogosphere: U.S. congressmen should have to dress like Nascar drivers and wear the logos of all the banks, investment banks, insurance companies and real estate firms that they're taking money from. The public needs to know."

I don't know if #3 is needed if we have #2 but I sure like #4. Probably should apply to Presidential candidates as well.

In some ways we are better prepared to play hardball with the investment banks now than we were a few years ago, if we (and our congresspeople) are ready to do so. Consumers have reduced their appetite for debt; large corporations have stopped playing the financial markets with their working capital and have plenty of cash on hand to pay expenses without new bank loans; small business is getting very little from the money center banks. We're not earning any interest to speak of on our savings. Innovative new services like PayPal or cellphone payments can be done without traditional banks.

If we are not going to break the biggest banks ups now (my first choice) then the best way to avoid another bailout crisis is to make the bailout rules clear now:

  1. No executive of a bailed-out bank will be paid more than the President of the US.
  2. Bailout is a form of bankruptcy and invalidates all promises of future payments to employees as well as recovery of payments made in contemplation of bail out.
  3. Bailed-out banks will promptly be broken up and their deposits distributed among much smaller competitors.

Once they know the rules, the banks may figure out how to avoid another crisis. Right now they have no incentive to do so. None of this'll happen, though, unless we implement some form of Friedman's rule 4 "U.S. congressmen should have to dress like Nascar drivers and wear the logos of all the banks, investment banks, insurance companies and real estate firms that they're taking money from".

Related posts:

The World is Overbanked

The Occupiers and Tea Partiers Are Both Right

We've Been T*RPed

Election Analysis: It Was TARP that Boiled the Tea

Green Mountain Power Sets Good Precedent on “Bad” Project

Green Mountain Power says that it will try to collect damages from those who obstruct its already-permitted and approved Lowell Mountain wind project. It would be a wonderful precedent for Vermont if the cost of post-permitting delays were born by those who cause the delays. There's no good reason why Vermont ratepayers should be saddled with both the extra cost of wind power and the extra-extra cost of harassing delay tactics by project opponents. If we establish the principle of delayer pays once a project has been approved, we will be able both to protect the environment with tough standards and attract good projects, whose sponsors will appreciate the certainty once approval has been achieved.

I actually don't think the 21 turbine Lowell project is a good idea. It will supply a negligible amount of amount of not-very-dependable power at a high price even after various subsidies. We can literally get hundreds of times more carbon-free kilowatt hours reliably at 20% of the price with no further subsidies just by keeping Vermont Yankee open. But I – and other opponents – had the opportunity to make our case before the Public Service Board and failed to do so. We didn't succeed in convincing the Vermont legislature to be responsible about Yankee or to be realistic about the cost of "green" electricity. The town of Lowell voted overwhelmingly in favor of the project, despite the fact that they'll be able to see the turbines on the ridge. We opponents lost; we don't have a right to impose penalty costs on the project now that it's been approved – although we can catalog the actual costs and try to block similar projects from being approved in the future.

Every project of any consequence is in someone's backyard. Every project will have opponents. Some projects shouldn't get approvals for environmental or other reasons. Opposing a project during the hearing and approval process is both legitimate and necessary if you think the project is harmful. Projects like Lowell Wind, which impose extra costs on ratepayers in return for dubious benefits, merit opposition. But, once a project has won approval and assuming it complies with the conditions of approval, we don't have a right to impose penalty costs and delay on the developer.

Related posts:

America's Industrial Revival

Google Finds Nothing is Shovel Ready, Not Even for Free Fiber Build

Irene Lesson #2: Nothing in America is Shovel Ready – Until It Has to Be

Scale Matters

Thanks to The Young Man from Misurata

You are a young man from Misurata. Standing in front of you is the man who ordered the relentless shelling that destroyed your hometown and killed your family and friends. "You're sinning," he says.

You are a young man from Misurata. Everything you know about soldiering you learned on the battlefield over the last few brutal months. Your comrades have been killed and maimed as you pursued this man inch by bitter inch. "You're sinning," he says, perhaps directly to you.

You are a young man from Misurata. If you were a young man from Auschwitz, he would be your Hitler. If you are from the Gulag, he is your Stalin.

You are a young man from Misurata. Standing in front of you is the man whose underlings have terrified your family as long as you can remember. "You're sinning," he sneers.

You are a young man from Misurata. The sounds of battle are all around you; it's not quite over yet, maybe it won't be for a long time. Someone might still try to rescue the monster who is your prisoner. He has been all-powerful for almost all of your life. You have a loaded gun in your hand.

You are a young man from Misurata. You shoot Col. Muammar el-Qaddafi in the head. I think I would've done the same if I were brave enough to fight my way to the culvert where you found him hiding.

Somewhere in the safety of a UN Secretariat someone thinks it's vitally important to investigate what the young men from Misurata may or may not have done to Qaddafi. There is outrage that he wasn't captured so he could live out his natural life sparring civilly with bewigged judges in The Hague like some of his fellow mass murders. Even the US says "the facts must be determined." After we're done determining these facts, we should make sure that the Wicked Witch wasn't actually already captured by Toto before Dorothy doused her.

On the same day, according to press reports, a score or more of protesters were killed in Syria by another brutal despot. It's much more important that the world investigate what's happening to them than determine the exact circumstances of Qaddafi's last minutes. Aren't their lives as valuable as that of a dictator? We don't have to worry about Qaddafi being shot again tomorrow; on the other hand, we know that protestors will die in Syria tomorrow and tomorrow and tomorrow. We should direct our outrage at Qaddafi's fellow dictators, not at the young man from Misurata.

There is a danger of endless vengeance and repercussions in Libya. There will need to be fair and hopefully swift trials of those who followed Qaddafi's orders to shell civilians and those who profited from his regime. There will have to be trials, too, of those who used the cover of revolution to loot or to kill their traditional enemies. There will, we all hope, be a civil society in Libya. The country will need a disciplined and professional police force and an army. It needs a government.

Today, though, is a day from thanking the young men of Misurata and the rest of Libya who fought so hard and at such cost (and with help from NATO) to take Qaddafi off the world stage. Tomorrow is the day for reflecting on the increasing futility of the UN and its absurd priorities. And for many days after that the world needs be outraged by Assad in Syria and to help the young people of Libya build their young democracy (we hope).

You are a young man from Misurata. We wish you a bright future.

Open Negotiation is an Oxymoron

"…greater openness by the panel, officially known as the Joint Select Committee on Deficit Reduction, would actually be harmful to the public interest. Private meetings are essential to give the committee's six Republicans and six Democrats the freedom to step away from party orthodoxies, conduct serious negotiations and search for common ground, rather than engage in political posturing." Op Ed by Jordan Tama in the New York Times 10/19/11.

The Super Committee has an almost impossible job to do; and we are all dependent on it accomplishing that job in order to avoid mindless automatic budget cuts which'll happen if it fails. So shouldn't we all get a ringside seat for these critical deliberations? Absolutely not if we want them to succeed. Meaningful negotiations can only happen in private. "Transparency" is not always the right answer. Of course, we should know how each member of the committee votes on its final report and, of course, committee members should have to report campaign contributions (as they are already required to do). But they should be able to think, make stupid suggestions, think them through, compromise, and negotiate in private.

Why in private? Because they won't succeed if advocates can jump on and squelch any move towards compromise before it can be met by a counter-offer and before any progress can be made. The final agreement, should we be lucky enough to have one, will contain plenty for everyone to hate. Hopefully, for most of us, the overall result will be acceptable and constructive despite the individual elements we don't like. That's the way deals work. But these deals have to be put together a plank at a time. If we all have a veto over each plank out of the context of the whole structure, no deal will ever emerge. Advocates who would prefer no deal are very well aware of this dynamic. Further from the article:

"…For Democrats on the committee, political danger lurks if they back any cuts to entitlement programs, whereas for Republicans, support for any tax increases is even more perilous.

"The attacks on the committee for meeting in private are probably motivated as much (or more) by fear of the committee's succeeding as by a commitment to open government. Those calling for greater committee transparency are largely staunch conservatives, like Senator Marco Rubio, Republican of Florida, or staunch liberals, like Representative Jan Schakowsky, Democrat of Illinois, who have opposed a grand bargain that includes significant tax increases and entitlement cuts. They surely know that it will be harder to reach agreement if the panel cannot meet privately."

A year and a half ago I was point man for Governor Jim Douglas'(R-VT) Administration on a bipartisan initiative originally proposed by the very Democratic legislature called Challenges for Change. One of the challenges set by the legislature was to make education more effective at less cost. In other words, we were supposed to put together a plan which would get better educational outcomes while spending less money. The task was hard but not impossible. All money spent on "education" does not really improve educational results. Vermont has the highest staff to student ratio in the country. We have IMHO way too many school districts and consequently too much educational bureaucracy for our population. Many of our schools are too small to offer the range of courses students should have. Teachers are not compensated for excellence or dinged for inattention or incompetence. Point is that we really did have lots of levers to work with – as well as lots of interest groups opposed to any change which would affect their members.

The Commissioner of Education put together an excellent group to propose changes to the legislature. The group, which had no power except to make a recommendation, included school administrators, teachers, school board members, even the head of the Vermont Red Cross which had recently gone through a wrenching consolidation. I insisted that we meet in private. There was immediate protest.

"Tom Evslin, the state's Chief Technology Officer, who is also overseeing the education design team and the 10 others like it across state departments, says the meetings are behind closed doors so they will spark more creative thinking.

""If from the very beginning you're saying, 'Boy am I going to sound like an idiot if I make that suggestion?' then you can't really think, and so it's an opportunity perhaps for people to have dumb ideas, for people to fight about ideas,"'says Evslin.

"…The design team has to submit its ideas to lawmakers in two weeks and that is when Evslin says the public will have its chance to weigh in on the proposals.

"'It's not that they're being shut out of the process,' he says."- Interview on WCAX 3/8/10

The first two meeting were held in private. We were, I think, making great progress because people were willing to put aside their affiliations and think creatively. There was an extremely healthy back-and-forth and real dedication to achieving high quality education at a sustainable price. But interest groups were furious at being shut out… and likely afraid of what might emerge. The press (as is their job) wanted in. The pressure was too much; over my objections but with my understanding, the Education Commissioner decided that the meeting would be open.

The real public doesn't come to open meetings, of course; but the advocates came and sat there steely-eyed. No longer could a teacher speculate about how to get better performance from his or her colleagues nor could a superintendent talk about consolidation of function. We made no more progress. We made no meaningful recommendation to the legislature other than to count savings that had already occurred. The legislature gave "education" a hall pass on change and left the problem to grow and be addressed another day (which is rapidly coming).

Greater transparency in government is usually a good idea, but not always. One can argue with some evidence that the age of openness is also an age when art of political compromise seems to have been lost. Open negotiation is an oxymoron. No one can afford to propose the first concession in public; no one can risk going out on a limb in search of agreement in the glare of television lights.

Legislatures appoint special committees when they are afraid of the political price for confronting the need for change. Sometimes these committees really can cobble together something workable, a better than zero sum solution. But these committees can only function if they can formulate a plan in private for later public review. If we want a reasonable budget plan, we have to make sure that those who don't really want any plan or are against all compromise can't kill thought and negotiation with calls for premature "openness".

The Occupiers and Tea Partiers Are Both Right

Is the federal government at fault for the current lousy economy? Absolutely.

Are we still suffering from the excesses of Wall Street? Yup.

In fact Wall Street (and its foreign compatriots) and Washington (and other capitols) were co-conspirators in tanking the economies of much of the developed world. Thanks to this not-so-grand alliance, bankers got to kill the goose and keep the golden egg – subject, of course, to continued campaign contributions.

The Occupiers of almost anything and the Tea Partiers should be listening to each other. As the brilliant Venn diagram below from a post by James Sinclair shows, the two groups are looking at different views of the same monster: a hybrid of giant corporations and giant government supporting each other's aggrandizement at our expense. (hat tip to Art Woolf writing on VermontTiger for posting this).

It may be that the people on the extremes of both of these movements will never recognize that they are looking at two aspects of the same problem. But the 99.999% of us who are not on either extreme can learn by seeing the problem is really right in the middle of the Venn diagram above. The problem isn't solved by giving more power to a government (and Federal Reserve) which will use that power to entrench those who are "too big to fail." The problem isn't solved by holding investment banks harmless from their own reckless behavior and allowing them to continue to shower riches on leaders who led them to disaster (so long as they continue their campaign contributions). Much of our problem CAN be solved by teasing apart the too cozy relationship between big government and big corporations – particularly big financial corporations – and putting both corporations and government back in their proper role.

Unfortunately, at the moment, all leading candidates for President of the United States from both parties are actually advocates for extending the status quo. They justify their positions – and placate their followers – by adopting the language of either the Tea Party or the Occupiers, which conveniently allows them to ignore the problem right in the middle of the diagram. Both Republicans and Democrats talk the talk of reform and change; neither Democrats nor Republicans walk the walk. No wonder people are mad.

Take the Republican candidates in the last debate: they talk the talk of free enterprise. To a man (and a woman) they all insisted that Washington alone was responsible for the housing boom and collapse and the lingering malaise that has followed. Strangely for supposed free market adherents, they don't think that investment banks bear any responsibility for reckless securitization of worthless mortgages or looting the investment pool with absurd executive compensation. Most of them supported TARP as necessary without making the obvious point that institutions which are bailed out with public money have lost their claim to immunity from public scrutiny and regulation. The poor banks were victims, according to the candidates, of bad examples from Fannie Mae and Freddie Mac (it's all the fault of the neighborhood) and the poorly thought out quotas of the Community Reinvestment Act (it's all the fault of their upbringing). Gimme a break.

Take President Obama: he talks the talk of economic equality. But he eagerly pursued the Bush-administration's policy of using public money to protect the accumulated wealth of investment bankers from a well-deserved correction, which would have dissolved (and effectively redistributed) much of it. He appointed TARP-architect Timothy Geithner Treasury Secretary and embraced the bank-protecting policies of Bailout Ben Bernanke. Geithner is still traveling to Europe – on our behalf – and urging European governments to protect their banks from the consequences of lending money to profligate governments (at very attractive rates). The Head of Obama's Jobs Council is Jeffrey Immelt, Chairman and CEO of GE, a company which got bailed out because of its banking activities, manages to pay no federal taxes on huge net income, and whines that it can't compete in manufacturing because it doesn't get enough subsidies. The too-big-to-fail banks have gotten bigger on Obama's watch and the bank reform bill he signed effectively enshrines their special status (and strengthens the alliance between big government and big banks). Gimme a break.

No wonder people are mad. But, unlike the brave participants in the Arab Spring, we have a vote. We have a right to protest, of course, and protest we will when not listened to (and we don't have to risk our lives to do so). But we have a responsibility to vote – especially in primaries. The Tea Party, whether you agree with its goals or not, has set a good example – which Occupiers would do well to heed – of how to make change in a democracy. The Occupiers have done a good job of reemphasizing the absurdity and essential unfairness of bailing out the very rich in the name of free enterprise.

James Sinclair has a new post today, "Bringing America Together, One Venn Diagram at a Time" in which he justly boasts of the attention his Venn diagram has gotten from all over the political spectrum. That's a very good sign; now we need some candidates who both talk the talk and walk the walk and understand that a successful free enterprise system requires solving the problem at the middle of the Venn diagram rather than railing at the symptoms from the left or the right.

Related Posts:

We've Been T*RPed

Election Analysis: It Was TARP that Boiled the Tea »





Jobs Coming Back from China

Automation means low labor wages are less of an advantage than they used to be. If you only use a few workers to achieve high output, you are less sensitive to what you pay them and more sensitive to their individual skills since each worker is responsible for an increased amount of output. As Chinese wages go up and the labor content of manufactured goods go does down, China has less of a manufacturing advantage over American rivals – so long as those rivals aren't hampered by obsolete factories or labor-increasing work rules.

There's an example from an article in The Wall Street Journal:

"Bruce Cochrane is emblematic of the incipient shift [of jobs to the US]. He's opening a furniture factory in Lincolnton, N.C., a rare event in a region and industry that have been walloped by outsourcing. Employment in U.S. furniture factories fell by 60% over the last decade.

"Mr. Cochrane says furniture made in China and sold in the U.S. previously had a price advantage of up to 50%. That's often down to 10% to 15% now, in part because wages in China are soaring—up 15% or more a year in some locales. Shipping costs, he says, have doubled from a few years ago."

Proximity to markets counts, too. It's unlikely that Cochrane will make furniture for the Chinese market in North Carolina anytime soon. But he can deliver furniture to US markets for less than it costs including freight to get it here from China. The article doesn't mention it but furniture-quality wood is in better supply in the US than in China. We don't need to import the raw materials for furniture making.

The article continues:

"…he's buying state-of-the-art saws, routers and other machinery for his facility, exemplifying why productivity is robust in the U.S.

"The flip side, though, is employment. When North Carolina's newest furniture factory is up and running, Mr. Cochrane expects to accomplish with 135 employees what it took 250 to do in the past."

Do you count this as gaining 135 jobs or losing 115? That's really an academic question. If we want manufacturing jobs in the US – and I believe we do – then we must be as automated and efficient as any rival - preferably more so.

It's not only expensive-to-ship goods whose manufacture is coming home; quality counts, too. The WSJ article tells another story:

"'We're in the process of bringing everything back from China,'" says David Gil, marketing director for Sleek Audio, which makes high-end tunable earphones. Along with rising costs in China, quality control proved a headache.

"The company sells its SA Six earphones for $250, and the price won't change when production moves to Palmetto, Fla., though costs will rise about 20%. Mark Krywko, the chief executive, says better quality control and less lost inventory will offset those increases. 'Profits will go up,' he says."

Long supply chains mean increased vulnerabilities to foreign disasters as well as our own. Currently, according to my friends in telecom, fiber optic cable is in such short supply in the US that there is a danger some broadband projects won't meet their stimulus deadlines. Turns out that raw fiber is made mainly in the areas of Japan affected by the tsunami. Smart manufacturers want diversity of supply – so long as costs are reasonably close.

It was heartening to hear most of the GOP presidential candidates last night agree that the US can survive and flourish in economic competition with China. Winning means supplying much (but not all) of the needs of our own markets for many (but not all) goods and achieving a large secondary position to foreign manufacturers in meeting the needs of their domestic markets. It doesn't hurt us at all if a US furniture manufacturer becomes stronger by building a Chinese factory to meet the rapidly-growing needs of the Chinese market; it only hurts when the US market is served by that factory instead of one here with no offsetting reciprocal trade in other products.

We have the huge advantage of being near our own market and bountiful supplies of raw material including rare earths. If we will let ourselves, we can have a huge advantage in energy price and supply. Our engineering schools still train the world's top engineers; we just need to make sure that they can flourish here and don't all leave for places where projects can be built without twenty years of regulatory delay. Rising wages in China and India not only level the playing field but also increase global demand – we can benefit from both.

Related posts:

The Inconvenient Good News in the Employment Report

Jobs Go Awaiting… Or to China

Google Finds Nothing is Shovel Ready, Not Even for Free Fiber Build

America's Industrial Revival

The Inconvenient Good News in the Employment Report

Both Democrats and Republicans were quick to leap on the superficially tepid jobs report Friday to prove their partisan points. Both sides studiously ignored the good news hidden in the details: the private sector added enough jobs in September (137,000) to lower the unemployment rate if all things were equal. All things aren't equal, however; the public sector is still shedding jobs (34,000), and so NET job creation (103,000) was slightly below the level needed to keep pace with population growth. The overall unemployment rate stayed at a very high 9.1% as some formerly discouraged workers began looking for jobs again. The shift from public sector employment to the private sector is healthy and, to use an overused word, sustainable. As the public sector burden imposed on each private sector job decreases, it gets easier and more attractive to create private sector jobs – a virtuous circle.

The fear had been that public sector layoffs would subtract so much demand from the economy that the private sector would shrink as well - a fate that may well await Greece, for example. If the private sector continues to grow, we will reach a point at which it can support the level of public services we want (which is probably still lower than the level of public sector employment we have today). At that point the public sector stabilizes; total employment is not struggling to grow despite the loss of public sector jobs and buying power; and the economy accelerates the way we all hope it will except, apparently, highly-partisan Democrats AND Republicans.

Both average hours worked and the average hourly wage inched up slightly. Employment in finance was down slightly; like public sector employment, a lower ratio of these jobs to goods-producing jobs is a good thing for the competitiveness of the economy as a whole. That isn't to say that we don't need government or banking, just that we don't need as much of either one as we've got. Manufacturing jobs were very slightly down, though; the best news was a reasonably large increase (26,000) in construction, which the Bureau of Labor Statistics analyzes as driven by non-residential construction. Non-residential construction means we are investing in infrastructure and in new places for people to work.

Partisans of both parties, however, studiously ignored any possibility of good news – it doesn't fit their message. Republicans say that the low numbers are one more bit of evidence that President Obama and the rest of the Democrats need to be replaced by Republicans whose pro-business policies will make employment skyrocket. Democrats say the low numbers make it clear that Stimulus II needs to be passed right away and that Republicans are standing in the path of its job-creating potential. Republicans are also ignoring that the recession began with a Republican in the oval office and Democrats are ignoring the failure of Stimulus I to keep employment below 8% as promised.

Countries with governments ranging from the fiscal left to the right all partook in the great recession. What if government policies don't have much to do with the short-term direction of the economy? What if politicians really can't create jobs? It's at least arguably possible that we would have recovered faster if TARP hadn't merged zombie banks into even more too-big-to fail entities which don't lend money to small businesses anyway. Housing may have bottomed out by now if banks hadn't been encouraged to paper over their book-value losses from underwater mortgages and instead had to deal with their customers to restructure loans in both their interests. We might have more jobs today if we hadn't attempted an ill-planned stimulus which actively discouraged states from dealing with program bloat and which didn't build needed infrastructure but did help dig a deeper budget ditch and encouraged companies to chase grant dollars rather than customer value.

But this campaign is all about jobs! Both sides have to use the fear of what the other side will do to us to get us to vote the rascals out (and the new rascals in). With the country's opinion of politicians at an all-time low (at least since there's been polling), we're much more likely to vote against than vote for. Isn't that what "change" was all about? So neither side wants to see an economy which is actually starting to heal despite the ill-designed treatments they forced it to undergo. Neither side wants to see the shoots of economic spring. What if tax revenues were to increase because of prosperity? Then we wouldn't have to raise taxes as the Democrats want or cut government services as much as the Republicans want. Neither side wants to campaign on boring issues of how government ought to do its job while we do our best to create jobs for ourselves and our neighbors.

Caution: I'm deliberately being a Pollyanna to make the point that politicians will be the last to see a recovery. One shouldn't judge the direction of an economy from a single monthly report which is, itself, statistically derived and routinely corrected. That's as dumb as judging climate from a single year's weather.

Related posts:

Jobs Go Awaiting… Or to China

Confessions of a Stimulator

We've Been T*RPed

Where Did All the Tax Revenue Go?

Ben Bernanke's Blunder: How NOT to Solve the Mortgage Crisis




Jobs Go Awaiting… Or to China

"China, which currently mines most of the world's rare earths of both types [light and heavy], has a chokehold on heavy rare earths, producing 99 percent of the global supply.

"In its report last December, the Energy Department said it could take up to 15 years [emphasis decidedly mine] for the United States to break dependence on China, based on how long it might take to obtain federal permission to open new mines and processing plants…" NYTimes story by Keith Bradsher.

China, as you may remember, has choked back exports of rare earths in order to force high-tech factories which need these materials to locate in that country. Turns out that most rare earths can also be found somewhere in our huge country. It would be nice to have those factories – and working mines and processing plants - here rather than in China.

It's likely that the companies building the factories want some geographic and supply diversification and want to avoid absolute dependence on China, which is also forcing companies which locate there to turn over intellectual property to Chinese joint venture partners. Moreover, Chinese wages are going up along with the standard of living and China has an energy problem. The US is a huge market. There are lots of reasons we could be a competitive place – especially if we had an active supply of rare earths.

Of course we can't do away with all regulation of extraction; there ought to be environmental approval of new projects and enforcement of the conditions of any such approval with harsh penalties for violation. But we've tied ourselves in handcuffs; fifteen years is absurd! What are we going to learn about a project in fifteen years that we can't learn in two? Conditions may actually change in fifteen years. Market conditions may change as well so who wants to start a project now for a market that may or may not exist in fifteen years?

Now imagine a two-year review process (up or down) and, should approval be granted, no delay through injunction or appeal unless the appellant posts a bond for the damages that delay will cause. Imagine the flood of private investment which could go first into rare earth extraction, then into processing, and finally into the industries which are dependent on rare earths and all the supporting businesses. Imagine the jobs that would be created, the economic growth, even the taxes collectible.

BTW, this particular story has good news in it: Molycorp has discovered that it has a source of heavy rare earths in an area of the US where it already has permits. They say they can begin extracting in a little more than a year – that's more like it. They are already building a processing plant for both heavy and light rare earths. We need to see this story replicated a hundred times over. And it can be… if we take off the handcuffs.

BTW # 2, in the same edition of the Times there is an article by economist Bruce Bartlett saying "Academic research has also failed to find evidence that regulation is a significant factor in unemployment." Maybe Bartlett and the academicians ought to read the newspapers. How much more evidence of glacially-paced regulatory approval costing jobs do we need beyond the fact that China will have a virtual monopoly on a key industrial ingredient for fifteen years because that's how long it takes to get the feds to say yes to mining in the US?

Related posts:

Google Finds Nothing is Shovel Ready, Not Even for Free Fiber Build

Irene Lesson #2: Nothing in America is Shovel Ready – Until It Has to Be

America's Industrial Revival

Where Did All the Tax Revenue Go?

Don't read this post unless you like numbers.

In fiscal year 2000 the federal budget was actually in surplus. Revenues were higher than expenditures and the national debt was reduced a small amount. Economists hadn't predicted that strange occurrence; it was certainly a consequence of soaring tax revenues from profits on bubble IPOs and a robust economy. On the expenditure side, the trajectory of welfare payments had been reduced by reform supported by Bill Clinton and Republicans; and we weren't fighting any wars. By fy2001, revenues were declining and expenses were still climbing. Post 9/11 in fy2002, we were back to running an annual deficit and we haven't recovered yet – the fy2009 deficit was an astonishing $1.413 trillion dollars, 10% of our gross domestic product (GDP). My former colleague in state government Tom Pelham describes this well in a Vermont Tiger post.

What went wrong? On the expenditure side, the answer is simple: government spending went from $1.789 (18% of GDP) in 2000 to $2.983 trillion (21% of GDP) in fy2008 to $3.517 trillion (25% of GDP) in 2009. Spending ratcheted up during the Bush years; then soared with stimulus spending as well as increased demand for government services like unemployment insurance and welfare in the first full year of recession and the Obama presidency. Federal spending has not been this high as percentage of GDP since WWII. The closest was 23% of GDP in fy1982. We can't sustain this level of spending and still be the same kind of county we've been. Some people think we should be a different kind of country, more like the welfare states of Europe where the percentage of government expenditure is even higher; I'll leave that argument for another day.

But what happened to revenue? Did the Bush tax cuts do us in? Have the rich somehow managed to escape their fair share? In fy2000 the feds took in $2.025 trillion (20% of GDP); in fy2008, after the tax cuts, revenue was UP to $2.524 trillion (but only 18% of GDP); in 2009 revenue was DOWN to $2.105 trillion (15% of GDP). The last time federal revenue was this low as a percentage of GDP was in 1943! It would NOT change the nature of the country to have federal revenues work their way back up to the 17% or 18% of GDP which they have historically been in modern times. Put another way, we WILL be changing the nature of the country – perhaps for the better, perhaps not – if we keep federal revenues at such a low percentage of the GDP. We will certainly roll back the role of government to what it was before WWII in peacetime with no standing army and much smaller social commitments. I'll leave that argument for another day, as well.

Assuming we want to get government revenues backup to their modern norm, how do we do that? First we have to understand why revenue declined.

After the Bush tax cuts, federal revenues did decline for a couple of years; partly because of the tax cuts and partly because of the lingering effects of the dotcom crash and 9/11. By fy2005 federal revenues were back at record highs in nominal dollars and continued to climb strongly for a few more years. The revenue loss from fy2007 to fy2009 came from recession and wiped out all these gains and more. Because taxable income declined by almost a trillion dollars, personal income tax receipts declined from $1.163 trillion to $0.915 trillion while the corporate income tax was off an even greater percentage, shrinking from $0.370 trillion to $0.138 trillion. Together that's over $400 billion/year of lost revenue which had nothing to do with the Bush tax cuts; in fact, if tax rates had been higher, the declines in revenue would have been even greater. Almost all of the decline in personal tax revenue is from those with adjusted gross income above $200,000 both because they paid 52% of the income tax and had 40% of modified taxable income in 2007 and because their modified taxable income was down 34% over those two years.

So the well-to-do – who have more income to lose – lose a greater percentage of that income during a recession than everyone else. That's no consolation, of course, to someone who has lost his or her job and all of the income that went with it; but it does explain why an income tax system which gets the majority of its revenue from the wealthy has lots of downside during a recession. According to the IRS, in fy2008 the top 1% of taxpayers paid 23% of all income tax and the top 0.1% paid over 12%. When the big bucks don't roll in for the rich, they don't roll in for the federal government as a whole. It's not an exaggeration to say that our tax system was playing the stock market and the housing market. When those markets tanked, revenue went with them. That's easy to understand.

Harder to understand is why, even though GDP was higher in FY2009 than FY2007, both corporate and personal taxable income were still much lower in the latter year. Part of the answer, indubitably, is that people didn't have many assets to sell off at big gains as the country came slowly out of a recession. There were almost no IPOs with big payoffs nor as many lucrative buyouts – that 0.1% who pay 12% of our taxes aren't all the same people very year; they're just the ones that scored big. Corporate profits are up but the tax law permits tax loss carry forwards. So it takes a few good years in a row before corporate income taxes can recover to pre-recession levels.

Possible good news in all this is, if we don't dip back into recession, tax receipts should start a strong recovery on their own without any need to increase rates. The Congressional Budget Office estimates fy2012 GDP at just over $15 trillion. If federal revenues were to recover to the 18% of GDP that they were in fy2007 (still less than the 20% it was in 2000), we would take in $2.7 trillion – just about enough money to balance the budget if we could get spending in dollars down to where it was in fy2007 (not allowing for inflation).

This particular scenario is a pipedream; spending won't come down that fast; the recovery is slow. But the lesson is still correct. We can reverse our revenue shortfall if we can get our economy chugging again.

President Obama has proposed rolling back the Bush tax cuts for people earning more than $250,000 per year. However the Bush cuts lowered taxes for everyone who pays them – especially those in the lower brackets. Repealing the cuts just for these "millionaires" would raise something over $0.1 trillion/year even assuming they didn't just find new tax shelters and keep their income down; so all of our taxes have to go up if increased tax rates are the answer. In order to increase revenue from 14% to 20% of GDP just through increased taxes, we would have to raise taxes on the average by close to 50%. And we'd still have to bring government spending down a huge amount to live within these new revenues.

We need a booming economy! More government spending won't get us there and government has nothing left to spend anyway. So how do we get there?

  1. Tap America's abundant energy resources now, especially abundant natural gas. The payoff will be a rebirth of manufacturing - and lots of middleclass jobs – based on low energy costs compared to our competitors.
  2. Reform permitting drastically so that corporations like Google and Amazon can spend the huge amounts of earnings they have in their coffers to boost their worldwide presence from their American base and so that the 20 year backlog of public and private infrastructure projects awaiting approval and fighting off nuisance lawsuits can be done in the next five years.
  3. Reform the tax code to eliminate loopholes and reduce the nominal rates dramatically. Actually this will increase the share of taxes paid by the rich (because they use loopholes more). It will also make America a competitive place to invest corporate cash (see #1 and #2 above).
  4. Don't bail out anymore banks.
  5. Reduce federal spending to less than 20% of GDP.
  6. Through all of the above, increase the relative wealth of the middle class so that our government revenues are not so much at risk in years when top earners are not earning top dollar.

The sources for all these numbers are directly or indirectly the IRS, the Census Bureau, and the Congressional Budget Office. The Tax Foundation, usgovernmentspending.com, and usgovernmentrevenue.com do a particularly good job at aggregating.

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