Defenestrating Thoughts from the Bivouac

With unemployment shooting up (last month we had 12.5% unemployment), with stocks dropping like a rock, and with a depression looming, Congress has given themselves a raise.

After all, they deserve it. It’s really hard to spend $350 billion and not know where it went:

But a month after the money was doled out, the chair of the congressional oversight panel told reporters she didn’t yet know where the money was.

“I only got this job 14 days ago,” Elizabeth Warren, who chairs the congressional oversight panel, said last week on MSNBC. “We don’t have a fax machine. We don’t have, you know, a phone yet.”

They have phones now, and “we’re up to a staff of five,” Warren said.

Five people watching $350 billion? So each guy has to track just $70 billion? I think someone needs to rethink this.

In most jobs your raise is dependent on your performance, and right now Congress has a 9% approval rating. But if you’re a Congressman, you don’t need to worry about performance, you can just give yourself a raise!

Forget working for Detroit, Wall Street, becoming a gradual student, or setting up my own $120,000 course on how to identify a gold-digger, I need to become a Congressman. That’s where the easy money is.

Today the Fed cut the target interest rate to 0%. This officially brings us to Zero Interest Rate Policy (ZIRP):

Under ZIRP, the central bank maintains a 0% nominal interest rate. The effect of a ZIRP is to encourage investment throughout the economy by making capital purchases more financially attractive. Whether ZIRP succeeds in achieving this goal is a matter of much debate (Wikipedia).

Whether ZIRP works is “a matter of much debate”. The folks that say it does work are the Keynesians who didn’t see this recession coming. The folks who saw this coming, the Austrians, say it won’t.

Who do you trust?

History also says ZIRP doesn’t work. Japan has lost two decades of economic productivity due to following ZIRP:

The Japanese asset price bubble was an economic bubble in Japan from 1986 to 1990, in which real estate and stock prices greatly inflated. The bubble’s collapse lasted for more than a decade with stock prices bottoming in 2003.

…

Correcting the credit problem became even more difficult as the government began to subsidize failing banks and businesses, creating many so-called “zombie businesses” (Wikipedia).

Real estate and stock prices greatly inflated? That’s what we had.

Subsidizing failing banks and business? That’s what we’re doing.

20 years of recession? That’s where these policies are taking us.

Common sense (which is increasingly uncommon in Washington) tells us that ZIRP will fail as well. We are in this mess because the Fed created excess credit and more credit can’t fix it. You wouldn’t give an alcoholic more alcohol. This isn’t any different.

Now that the interest rate is zero, the Fed’s only tool is to print money.

And as we know, no one gets rich going into debt. And no one gets rich by printing money. If we continue down this path, this recession is going to be really bad.

Actually it’s much colder than freezing. Yesterday afternoon it was minus 4 degrees Fahrenheit. And last night it was minus 18!

When it’s cold you have to suffer through annoying things like your nostrils freezing.

But when it’s this cold lots of things are different. While I was shoveling the snow off the driveway yesterday, as soon as I removed the snow, the residual water froze immediately leaving me with a very slippery driveway.

And all the outdoor light bulbs stopped working.

And we had frost on the inside of the windows.

The strangest was tonight while driving home; it was so cold that the LED display in my car didn’t work properly. The display took a few seconds to update; it was really weird. I wish I could have played with it more, but I had to pay attention to the skating rink of a road.

Every politician and Keynesian has been telling us over and over, “The credit markets are frozen! No one can get a loan!”

Turns out that this is not true at all.

First of all, you can get a loan if you want, assuming you’re loan-worthy. The days of minimum wage workers buying half million homes are over. And that’s a good thing. We absolutely don’t want to go back to lending anyone whatever they want.

The same applies to businesses too:

[G]overnments are pumping masses of public money into the economy across the world because of the difficulties of a few big, vocal banks and industries such as car manufacturing, which would be in difficulty anyway, according to the report published by Celent, a financial services consultancy (source).

So the bottom line is companies that are not creditworthy can’t get loans. That seems like a good thing to me. If a prudent bank manager won’t lend them money, there’s probably a good reason.

From the study:

• Overall U.S. bank lending is at its highest level ever and has grown during the current financial crisis.
• U.S. commercial bank lending is at record highs and growing particularly fast since May 2007.
• Corporate bond issuance has declined but increased commercial lending has compensated for this.

So the trillions spent in the bailout are very much a giant waste of money and likely to make things worse:

All of which drove the Celent report to conclude that the U.S. and other governments may be throwing good money after bad for want of a better idea of what is really happening.

“Just like a doctor contemplating an obviously sick and suffering patient, a massive surgical intervention based on a misdiagnosis can only worsen the patient’s condition.”

Crissy’s been hard at work making her jewelry business a reality and has made a ton of progress. So far, she has:

• Etsy Store (buy your Christmas presents today!)
• Design Gallery for people to get ideas for custom orders
• Merchandise in two stores: Art Mart (on Pearl Street Mall in Boulder) and the Lafayette Library.

If you are interested in buying something, you can order right now at our Etsy Store. Or you contact either of us to order directly or for custom orders.

I’m also working on getting our own web store up and running. Hopefully it will open soon. Crissy’s whole product line will be available on that site.

And no, this isn’t one of the businesses that I mentioned I was starting in my Birthday resolutions. One of those will hopefully launch in mid-January. Currently we’re working on the setting up the domain, designing the landing pages, filing the corporation paperwork, and opening a business bank account.

It’s all very exciting! :-)

I came across this great writeup about the 10 Immutable Laws of Money. It’s worth reading the whole thing, but really there are just two simple rules that really matter.

Spend Less Than You Make

Whether you say, “Live within your means” or “Pay yourself first” (i.e. savings first), the meaning is the same: you need to spend less than you make. No one got rich by going into debt. You get rich by saving and investing wisely.

Wants Always Exceed Needs

Understanding that wants always exceed needs is the key to get spending under control. There’s very little that you need; you need food, shelter, and water.

Beyond that you get into the wants. You don’t really need a BMW, you want one. You don’t need a week long vacation in Europe, you want one.

Another trap here is tying “material goods” into self-esteem. Lots of people will say, “I need to buy this (big TV, big car, etc) so that my friends don’t think I’m poor.” I think in this case what you need is new friends!

The rest of rules are just rephrasing these two core tools. For example, when you buy a house, conventional wisdom says, “You should buy the biggest house you can afford.” That’s patently untrue.

Homes aren’t investments, they are places for you to live. Historically home prices track inflation, so any appreciation you have in your home is not real in terms of spending power. You’d be better off buying the house you need and investing the leftover money in assets that appreciate faster than inflation.

I’m a regular reader of Karl “Ticker Guy” Denninger’s blog. If you aren’t familiar with Ticker Guy, he’s a very outspoken, very angry, fairly vulgar, but shocking accurate guy that writes about the economy. I learned more from spending 15 minutes reading Karl’s blog than I did from two semesters of college economics.

Because of his and other blogs, I was able to avoid any major investment losses from this recent downturn. Needless to say, I’m a big fan. :-)

I’d been doing research and taking notes on the causes of our current recession. Yesterday, Ticker Guy posted his list and findings. His list is a superset of mine and reached the same conclusions.

Fundamentally, the government caused this recession. Here’s how:

1) Gramm-Leach-Bliley Act

The Gramm-Leach-Bliley Act repealed part of the Glass-Steagall Act of 1933. Glass-Steagall enforced a separation of investment and commercial banking in order to prevent the over leveraging that led to the Great Depression.

Given that we have a fiat monetary system and fractional reserve banking, this was basically corporate welfare: investment banks could use fractional reserve banking to create money which they used in leveraged investing.

2) Removal of Leverage Limits

Leverage is a financial mechanism that encourages investment banks to borrow money, invest it, and pocket the spread. The spread is the difference between what the investments earn and what the bank owes. So the investment bank borrows (sells bonds) at 4% and then invests the money to earn 10%. The investment bank pays the lender 4% and keeps the difference of 6%.

It used to be that 12:1 was the limit of leverage a company could have (it owes no more than 12 times its worth).

But in 2004, the Bush adminstration’s SEC removed the limits due to strong lobbying by Henry Paulson. This let companies over-leverage. And unsurprisingly each company that failed was leverage at more than twice the previous limit. Freddie and Fannie were running at roughly 80:1 when they failed.

3) Bankruptcy Reform
Normally if a bank loans money to someone that can’t pay it, the bank has to eat the loss. There’s a clear incentive for the bank not to make stupid loans.

Recent bankrupcy “reform” prevents people from discharging their debt through bankruptcy and makes it easy for the banks to get money through mechanisms like wage garnishing. So now even if you go into bankrupcy, you have a limited ability to recover. Those home loans and student loans will be with you forever.

With the drastically reduced disincentive against making bad loans, it’s actually profitable for the banks to lend money to people that can’t back their loans!

In summary, government actions encouraged banks to create money (fractional reserve banking with no leverage limits) and lend it to people that can’t afford it (bankruptcy “reform”).

Which, of course, is the root cause of the mess we’re in.

The news is all abuzz about Illinois Governor Rod Blagojevich’s attempt to sell the open Illinois Senate seat to the highest bidder.

This is obviously illegal and unethical, but it’s shocking how surprised some people are. Didn’t we learn from Watergate that to understand how things work, you just need to “follow the money”?

Just glancing at the news today we learn that Washington is going to send $14 billion to the Big 3 automakers. The automakers gave over $50 million in bribes to Washington this year. Perhaps these are related?

And what about all the no-bid contracts for Iraq going to friends of the administration?

Or how about the fact that politicians get votes and support in exchange for giving money or granting favors to special interests?

At some level, all that separates Governor Blagojevich from the rest is that he was honest about it.

Look at Chrysler’s website today (click to see full image):

This is clearly a bailout. If it were just a “loan to help us succeed”, then they would be able to get private financing.

Today if Chrysler were to offer bonds and stock to raise the amount of money they need to “help them succeed”, no one would give them the money. Why? Because it would be a bad investment and you’d likely lose all your money.

If it were a good investment, you’d see mutual fund directors, Bill Gates, Warren Buffet, and many, many others lining up to invest in Chrysler.

But the reality is that Chrysler is a bad and failing company that no one wants to invest their own money in.

So if no one is willing to put their own money into these companies, why is Washington putting taxpayer money into these companies? Because these companies bribed Washington. They gave Washington over $50 million dollars this year so that Washington would give them billions of taxpayer money.

Just follow the money. The car companies and Washington get lots of money while the taxpayer gets the bill.

And I love the use of green in the website. It’s great subliminal messaging, “Look at us, we’re green and responsible”. Maybe instead of lobbying Congress, lying, and spending so much time on marketing, Chrysler should build a car that people want.

Competition is good. It forces people to improve their product (quality, price, etc) or risk losing their business to someone else. As a result, the existence of competition is a major driver of progress.

On the other hand, lack of competition is a detriment to progress. In the past few weeks, I’ve said the following numerous times:

Do you really want the same folks that run the DMV, Post Office, TSA and the IRS to run things (e.g. hospitals, car companies)?

That statement resonates with people. And fundamentally when we think about it, we realize that the DMV, TSA, and IRS have no incentive to improve quality. Where else are you going to go to get a driver’s license or get on a commercial flight? And for the IRS, they have guys with guns to make sure you do business with them.

In the few cases when they do improve things, it’s because they need to cut costs or add a new technology mandated by Congress. This, however, is a much smaller impetus compared to losing all your customers to a competitor and going out of business.

So how does this apply to schools and vouchers?

Let’s start by looking at some startling data. We’ve all heard that public school teachers send their kids to private school at a much higher rate than the general public. But how much? Here are some numbers:

• Overall:
  • General Public – 10%
  • Public School teachers – 22%
• In Chicago
  • General Public – 22.6%
  • Public School teachers – 38.7%
• In Washington DC
  • General Public – 19.8%
  • Public School teachers – 26.8%

Now let’s put these numbers in perspective, suppose I told you the following (borrowed from Carpe Diem and modified):

Employees at Company X make around $35,000 year. They are offered free Company X products for their children. However, 22% of the employees spend $10,000 to $20,000 of dollars to buy competitors products for their children and pass up on the free products.

When you say it that way, it’s pretty clear. Teachers know what quality of education public schools offer and don’t want their kids to suffer it.

Now it gets interesting. Obama will be sending his daughters to a very prestigious private school, Sidwell Friends, for an annual cost of about $29,000 per year.

But if we do the research we learn that Washington DC public schools spend about $25,000 per student per year.

So why don’t DC public schools have the same quality as Sidwell Friends? After all, they have the same budget.

If Sidwell had the same horrible quality as DC public schools, no parents will send their kids there, and Sidwell will go out of business.

DC public schools, though, get their money regardless of quality. So there is no incentive to provide a quality product. Their customers are not allowed to take their money and leave. There is no consequence for their horrible quality, so there is no incentive to fix it. Just like the DMV, TSA, and IRS.

Here’s where vouchers come in. Instead of the government running failed schools, they could give each kid a $25,000 voucher to go to the school of their choice! Even Sidwell!

Suddenly, parents can pick where to send their kids to school and have the same advantages of the super-rich and connected when it comes to education. Parents and kids have choice and this leads to competition.

By fixing the incentive model, we create an ecosystem of schools competing to provide the highest quality service. And since we have vouchers, each kid has the opportunity to get a quality education.

I think you’d be amazed at how quickly new quality schools would be created if we went to a voucher system. There are literally thousands of amazing teachers toiling in the horrible bureaucracy of government schools, we need to have a system to set them free.

Personally, I want to start, run, and teach at my own charter school one day. I know that today I could quickly find quality teachers and get lots of interested parents. The main thing blocking me is money; I need a big pile of money to finance this and offer scholarships.

Suppose that starting tomorrow parents were allowed to choose where the $25,000 for their kids education was spent. If that happened I bet I could have my school up and running by the start of next school year.