2 posts tagged “economics”
A lot of banks are pleading for aid from Washington, claiming that they are “too big to fail” and that they need funds right away [1]. And they are asking for aid to the tune of $700,000,000,000 – in addition to the $85,000,000,000 already granted to AIG, the $30,000,000,000 given to Bear Stearns, and the $25,000,000,000 thrown to Freddie Mac and Fannie Mae [2]. They claim this is necessary to prevent the collapse of the financial markets (though some economists disagree).
If this sounds familiar, it is because we’ve been here before. Back in the 1980’s, five congresscritters (Cranston, DeConcini, Riegle, McCain and Glenn [3]) worked to loosen the regulations on savings and loans, which had been community-based banks up until that time with tight limits on permissible investments. Following their changes, S&Ls could invest in anything – and did. As a result, 747 of them went broke, to the tune of $124.6 billion [4]. It was the most expensive financial crisis in the history of the US – until now. And fixing the problem included more regulation as well as cleaning up the mess and investigating the senators [5].
As someone who enjoys the occasional arm-chair economic quarterbacking as much as the next boffin [6], I’d like to offer my conditions on the bailout. Were I in charge, what would happen?
- The assets would be bought at reverse auction. We would offer ten cents on the dollar for the distressed assets [7]; banks would then trot out the assets that they felt were worth no more than that. We would buy up all of those and then offer fifteen cents on the dollar, and continue until the $700 billion was gone or all of the distressed assets had been sold. This has the advantage of taking care of the worst cases first, which should keep those banks in the most trouble from failing (which is the whole point of this exercise). It also puts a limit on what we will do.
- Loans for primary residences would be treated differently than loans for other purposes. As an unabashed fan of Keynesian economics [8], I support building a strong middle class. Home ownership is a key part of that [9]. Thus, loans for primary residences should go through a special process to help them keep their homes. Not everyone will be able to do so; there will be some losses. But these should be minimized. As for loans for secondary houses and other uses, they should get no special treatment. If you bought too many homes or speculated in the wrong market, that’s your tough luck, bub!
- The assets would be held by the US for a minimum of one year. This keeps the market from being flooded with bad loans (the cause of the current problem) and gives the borrowers an opportunity to become more solvent.
- The assets would be sold in auction format, with reserves set before the auction but not announced. This is similar to the way in which leases for oil and gas are sold in the US. Companies know what they’ll be getting, but not how much other folks will pay for them nor what the minimum needed to buy is. This tends to encourage aggressive bidding, which makes it likely that we’ll get more of our money back. Any loans that don’t sell at the end of the first auction can go back up for auction six months later; we simply repeat the cycle until all of the loans are sold, have been paid back, or have gone under.
- The CEOs, Vice presidents, and members of the Boards of Directors [10] from any company that takes part in the program are fired with no “golden parachute” [11]. They made the mess; it is only fair that they feel some of the pain.
- Members of the BoD are prohibited from serving on any other BoD for five years. Again, this is a penalty for dereliction of duty. If they had been keeping the managers in check, then the bank wouldn’t need the bailout.
Some of these rules might seem draconian [12], especially if you are one of those who will lose his job because your company is going broke [13]. But that’s the point. This bailout needs to have teeth in it to prevent other banks from assuming risk and then counting on the government to take it on when it turns bad.
So there are my rules. What are yours? What would you do if you had control of this problem?
John
PS - Late addition: Timmy has this on his blog. It is worth listening to!
[1] Amusing, isn’t it? Two years ago, they were all for letting laissez-faire market forces have their way and asking for more deregulation. Now that their mistakes have caught up with them, they’ve decided that Smith had his points as well [a].
[2] For comparison, the amount already given ($140 billion) is nearly the same amount as that requested for the war in Iraq ($145 billion). It is equal to 2 Departments of Education, 5 Departments of Energy, 7 NASAs, 15 Social Security Administrations, 17 Environmental Protection Agencies, or 240 Small Business Administrations. Including the $700 billion in new funding makes it nearly equal to all the discretionary spending in this year’s budget.
[3] If Obama isn’t an idiot, he’ll find a way to remind voters that McCain was partially responsible for the S&L mess and to link it to the current problem. Any bets on him not being an idiot?
[4] Or about $200 billion in constant dollars.
[5] One reprimand, two severe criticisms, and two minor criticisms. Who says politicians can’t be trusted to clean their own house?
[6] For the record, the pecking order [b] goes: rube, peon, plebe, student, boffin, scholar, geek [c], uber-geek, king of the world [d], evil overlord of the universe [e].
[7] Actually, the assets are making the bankers distressed. Or perhaps distraught. Do we help women in distraught? [e]
[8] This is why I support a progressive tax code to a flat or regressive one; progressive taxes tend to build a nation’s wealth by increasing the size of the middle class. This is a good thing, IMHO. And it is why I am against a national debt, except in the short term; because it takes money away from the middle class and gives it to corporations and foreign governments.
[9] Yes, you can be middle class without owning your own home; millions of people in New York City do it. But it is much easier to have a stable middle class if they have a place that they can call their own.
[10] Why members of the BoD? Because it was their job to prevent this from happening. A BoD is the mechanism whereby the stockholder’s interests are protected. Without them, there is nothing to prevent the managers from running the company for their own profit.
[11] There is actually some precedent for this one: Fannie Mae and Freddie Mac CEO’s recieved no golden parachutes after the Federal takeover.
[12] From the Athenian scribe Draco, who promoted harsh penalties for minor infractions. These laws were actually more liberal than the ones that had preceded them, in that they were written down and posted publicly instead of being part of a semi-private oral tradition. Thus, every citizen knew exactly what the laws were and could appeal decisions – a revolutionary concept in 621 BCE!
[13] Then again, they probably seem too lenient to those who did lose their jobs because of management screw-ups.
[a] Further amusement can be had at the expense of those who confuse Le Gendre and Smith. Le Gendre was for getting the government out of the markets almost entirely (to ensure the free flow of commerce). Smith was for careful government oversight (to ensure a level playing field).
[b] And level of education in the field.
[c] Just because I know you’ll ask: geeks differ from nerds primarily in that geeks get laid.
[d] This is a gender-neutral term, as is the following one. Many women have become evil overlords of the universe.
[e] Geek points for the reference!
A friend sent me an email with the treatise below in it. As this is the fourth time this particular missive has come to me, I'm tackling it once and for all here and now. The body of the email goes like this:
This piece is variously placed in a bar, a restaurant, and a golf course; the authorship is similarly suspect. But what about the economics? Is that sound?Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:
So, that's what they decided to do. The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. "Since you are all such good customers," he said, "I'm going to reduce the cost of your daily beer by $20." Drinks for the ten now cost just $80.The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men, the paying customers? How could they divide the $20 windfall so that everyone would get his fair share?
They realized that $20 divided by six is $3.33. But if they subtracted that from everybody's share, then the fifth man and the sixth man would each end up being paid to drink his beer.
So, the bar owner suggested that it would be fair to reduce each man's bill by roughly the same amount, and he proceeded to work out the amounts each should pay.
And so:
Each of the six was better off than before. And the first four continued to drink for free. But once outside the bar, the men began to compare their savings.The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33% savings).
The seventh now pay $5 instead of $7 (28% savings).
The eighth now paid $9 instead of $12 (25% savings).
The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings)."I only got a dollar out of the $20," declared the sixth man. He pointed to the tenth man, "But he got $10!"
"Yeah, that's right," exclaimed the fifth man. "I only saved a dollar, too. It's unfair that he got ten times more than I did!"
"That's true!" shouted the seventh man. "Why should he get $10 back when I got only two? The wealthy get all the breaks!"
"Wait a minute," yelled the first four men in unison, "we didn't get anything at all. The system exploits the poor!"
The nine men surrounded the tenth and beat him up. The next night the tenth man didn't show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn't have enough money between all of them for even half of the bill!
And that, ladies and gentlemen, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up any more. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.
Not really. You see, what this piece ignores is the purpose of the tax code. If you are like most people, you probably think that the idea behind taxes is to pay the government's bills [1]. But, in the words of my structural geology professor, that answer is correct but not complete because taxes do more than pay bills. They also shape our society.
The way the American tax code is structured (progressive, income-based) is intended to increase the number of times that money changes hands, thus creating wealth and increasing the size and prosperity of the middle class. Thus, by taxing those who would use the money to concentrate wealth as opposed to those who would use it to create wealth, the tax code creates a stronger America. This can be seen in many places from unemployment to the size of the deficit [2].
Here's a quick check on the statement. During Clinton's terms, the tax rate was higher on those earning more than $200,000/year than it is now. During Clinton's terms, the deficit became a surplus and the national debt was paid down. During Bush's terms, the tax rate was reduced, most dramatically for those earning over $200,000/year. During the same time period, the surplus became the largest deficits in history, and the national debt doubled. Which of these two eras do you think did the most to strengthen America? Which did the most to strengthen the middle class? Are you better off now than you were ten years ago? If you are like the average American, then your answer to that is probably a resounding "No!". Similarly, during Reagan's tax cut and spend era, the USA changed from the world's largest creditor nation to the world's largest debtor nation. Thus, we can say that lower taxes in and of themselves do not create wealth or a more stable society [3].
There are undeniable problems with the current tax code. It is too complex and incomprehensible [4]. It has too many loopholes for special interests [5]. It treats different types of income vastly differently [6,7]. And, most importantly, it doesn't completely fund the government [8]. Other tax codes have been proposed, but they are usually either impractical or worse for the middle and lower classes than the current code.
The most popular of these is the soi disant "flat tax". Its chief virtue is its simplicity [9]; everyone, from the poorest banker to the richest farmer, would pay at the same rate. This would either be done as a simple tax on income or as a more abstract tax on consumer goods. However, in any variation the flat tax has several problems.
The first and foremost of this is the tax rate that would be needed. Let us assume that we replace the current structure with a flat tax that is "revenue neutral"; that is, one that does not increase the deficit. The proposed 2008 US budget is $2,758,000,000,000 and the mean US income in 2006 was $66,570 for the 116,011,000 households reporting income. That makes a total income of $7,722,852,270 (ignoring corporate income taxes, licensing costs, fines, fees, and so forth). In order to generate the needed amount using a flat tax, we would have to tax everyone at a flat rate of 36%. If we assume that corporations also pay income tax at the flat rate, then that brings the flat rate down to about 28%. In effect, a flat tax is a tax hike for all but the wealthiest.
As a sales tax, the problem is even worse. That's because sales taxes are inherently regressive; that is, they cost more if you are poor than if you are rich, both in absolute terms (as total dollars spent) and relative terms (as a proportion of the household income). Sales taxes are easier on those with abundant resources in absolute terms because they can easily commute to where resources cost less and because they can buy in bulk, allowing them to wait for market prices to decrease. If I have to pay $2 for a 5 lb bag of sugar, and you pay just $8 for a 50 lb bag, my tax rate would be higher than yours. Sales taxes are easier on those with abundant resources in relative terms because the proportion of income used just to survive is lower; if I earn $10,000/year and have to spend $7,000 on my rent, car, and food, but you earn $50,000/year and spend just $14,000 on your rent, car, and food, at a nominal tax rate of 30% on sales, my effective tax rate would be ($8000*.3/$10000=) 24% and yours would be ($16000*.3/$50000=) 9.6%. The situation would lead to concentration of wealth [10], because at the end of the year, I would have but $900 to invest, whereas you would have $31,800.
So where does this leave our mythical rich man drinking with his poorer buddies? Pretty much where they were in the first place. If we assume that the primary purpose of taxation is to fund the government (which protects rich as well as poor) and that the secondary purpose is to encourage the creation of wealth, then here's the way the piece should have been written:
JohnSuppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:
So, that's what they decided to do. The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. "Since you are all such good customers," he said, "I'm going to reduce the cost of your daily beer by $20." Drinks for the ten now cost just $80.The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men"”the paying customers? How could they divide the $20 windfall so that everyone would get his fair share?
They decided that "fair share" meant changing the amount so that most of them had the chance to save up more and become rich. So, the bar owner came up with the new payment plan. And so:
Each of the six was better off than before. And the first four continued to drink for free. Once outside the bar, the men began to compare their savings.The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $1 instead of $3 (67% savings).
The seventh now pay $3 instead of $7 (57% savings).
The eighth now paid $7 instead of $12 (42% savings).
The ninth now paid $15 instead of $18 (17% savings).
The tenth now paid $54 instead of $59 (8% savings)."What should I do with my extra money?" asked the sixth man.
"Yeah, that's a good question!" exclaimed the fifth man. "I've got an extra couple of bucks "“ what should I do?"
"Save it" advised the tenth man. So they all saved their extra money for a month, then went and spent it on another round of beer. As a result, the bar tender was able to make more profit, which allowed him to lower his prices further. And the men were able to drink more often for less money. And that made everyone very happy indeed.
[2] Many people confuse the deficit (how much the annual budget lacks) with the national debt (the total of all deficits and surpluses over time). They claim that because a deficit can have good effects, such as stimulating the economy through increased government spending as the New Deal did, a debt must also be good. What they miss is that a series of deficits can create a debt so large that no country can get out of it [a], crippling the very stimulus that it created in the first place.
[3] If you are truly interested in the questions of the economics of taxes, there is abundant literature in the field on the topic. Happy reading!
[4] You may be aware of the annual "tax challenge" where trained tax preparers, people who fill out these forms for a living, are asked to fill out the taxes for a hypothetical family. These agents typically have results that can vary by as much as $2000. If even the professional players can't figure out the rules of the game, isn't it time to simplify it?
[5] Should we subsidize hybrid cars? What about hummers? Or charities? These special deductions are where the society shaping aspect of taxes becomes most obvious.
[6] If you earn $100,000 at your job, it is taxed at 28%. If you get $100,000 in dividends, it is taxed at 15%. If you get $100,000 in capital gains, it is taxed at 15% unless it is from the sale of property (25%), the sale of small business stock (28%), or the sale of collectibles (28%). Are you confused yet?
[7] The original rationale for this was to encourage people to invest in long-term projects. Now it encourages businesses to churn their stock so that they can take the 15% tax rate instead of the 28%.
[8] Yes, the other side is that government spending should decrease so that there is no annual deficit except in economic emergencies. But, given the way that Congress is set up, there is no way that will ever happen "“ pork is too much fun and too good a way of ensuring re-election for it to ever end.
[9] Though if anyone expects that simplicity to last beyond the first session of Congress, they should put down their joint right now.
[10] Concentration of wealth is generally considered to be a bad thing economically speaking because it reduces the opportunities to generate new wealth. Socially, it is a bad thing as it creates a more rigid class system (think Irish farmers and English landlords, or Southern sharecroppers and landowners), which stifles innovation and invention.
[a] Countries cannot declare bankruptcy under modern international law. Nor can they claim that they are not responsible for the acts of previous rulers, even if the previous ruler was a dictator thrown out by a popular uprising. The bankers want their money and they don't care who pays.
