Thursday, March 5, 2009

Obama Muddles While Rome Burns

The broad markets have now lost a full sixty percent of their peak values. This is as bad as it should get. The vulnerable will be swept away. The housing market has put all mortgages issued since 2003 underwater to some degree or the other. It faces an overhang of inventory held by folks suddenly unqualified to borrow the sums they have contracted for.

This wall of inventory is strangling the majority of American consumers and if allowed to continue, it will succeed in destroying all credit and all financial institutions. The reason for this is that the ultimate strike price for buildings is the depreciated cost of the build out and the ultimate strike price for all land is the cost of providing services. All else is an intangible value created by property attractiveness.

With an overhang as we now face, everyone with free capital now owns all the properties they want while their capacity to borrow has disappeared. In short actual demand has collapsed far more than anyone understands and the banks now have to attempt to match the two together to get out from the position they are in and from there to rebuild their balance sheets.

Most consumers also have to rebuild their personal balance sheets. Without been reckless at all, a person with a good job had a mortgage on a property with a hundred thousand in free equity available and a credit card line that totaled $40,000. Now he has a negative equity of $50,000 and his credit card company is no longer revolving his card and is now charging usurious rates of interest for the slightest provocation.

He is highly motivated to force his credit card company into a settlement arrangement and to look carefully at the cost benefit arrangement regarding the house.

The problem is the mortgage portfolio and it must be fixed properly now. This is an emergency. Doing nothing is toying with the economic engine that has driven the world.

This is not a problem that the banks can solve by themselves. All they can do is ask for more money to shore up their balance sheets until the price of all underlying land approaches zero, so that trade becomes impossible. All the banks can do by law and the rules that guide them is to chase the price of property downward.

I have already explained what should be done and what will be done will approach that, but likely in a much more ugly fashion. After all it will be managed by folks driven by greed and stupidity.

President Obama is approaching his Herbert Hoover moment and the signs are not positive. Every investor understands that if his friends are losing their homes that his investments will start losing money.

The other shoe that has not dropped fully yet and it will be crushing, is the pending collapse in all government revenues. We are not talking about a few percentage points. We are talking of a massive revenue shortfall that no tinkering will escape. It also cannot be solved by raising taxes. Hoover tried and it suppressed the economy further.

Quite simply, each day that we fail to act will add several days of pain on the road back. Otherwise, our hope is, and that is a lousy way to run an economy, that there is enough liquidity in hard cash to suck up enough of the inventory to begin the recovery cycle. Once that happens the overhang can disappear quickly.

The last article is a timely reminder of how attempted intervention in the thirties was less than helpful. It also provides background to help understand current government thinking.

Poll: Voters Skeptical About Obama's Recovery Plan

WASHINGTON - Americans are skeptical that President Barack Obama will solve the economic crisis within two years but still overwhelmingly approve his job performance, a new poll found Wednesday.

Most voters also support Obama's mortgage rescue plan unveiled last month in a bid to quell a rising tide of home foreclosures, but they think it is unfair to people who played by the rules and met all their payments.

The large snapshot of more than 2,500 voters reveals deep pessimism among U.S. voters about the state of the economy and prospects for a recovery, according to the Quinnipiac University Polling Institute.

Half of the survey sample was asked whether they believed that the federal government could fix the economic crisis within two years and answered no by a margin of 68 to 26 percent.

The other slice of the survey group was asked whether Obama alone would be able to lead the country out of the economic mire within the same time period, and answered no by a 64 to 28 percent margin.

Yet Obama's approval rating, so far at least, seems immune to the impact of the worst economic crisis in decades: 59 percent of those polled said they approved of the job their new president is doing, compared with 25 percent who did not.

Overall, voters approve of Obama's handling of the economy 57 to 33 percent, and significantly give him much higher marks on the issue - 56 to 26 percent - than Republicans.

"President Barack Obama's approval rating is solid, compared to the historical record of new presidents," said Peter Brown, assistant director of the institute.

"But the lofty numbers he enjoyed after his election are leveling off, largely because of declining support among Republicans," Brown said.

There is also more good news than bad for Obama on three of his key domestic policy priorities, which he has been highlighting in the last two weeks.

By a 55 to 39 percent margin voters believe that he will get healthcare reform, an issue that has bedeviled past Democratic presidents, through the Congress this year.

By a 61 to 35 percent breakdown they also say they believe Obama when he promises not to raise taxes on anyone with a family income under 250,000 dollars a year.

But the president's vow, made last week to cut the ballooning budget deficit in half by the end of his term in 2013, draws more cynicism.

Fifty-five percent of Americans do not believe he can do it, compared to 38 percent who do.

The survey was conducted between February 25 and March 2 among 2,573 voters with a margin of error of plus or minus 1.9 percentage points.

The Government and the Great Depression

by Chris Edwards, Director of Tax Policy, Cato Institute

The economic policies of the 1930s are a continuing source of myth and confusion. Many people believe that capitalism caused the Great Depression and that President Franklin Roosevelt helped to end it. A recent History Channel special on Roosevelt said that his New Deal resulted in “recovery and reform” while creating “millions of jobs.”

1 Such often-stated claims are incorrect. Misguided federal policies caused the downturn that began in 1929, and they prevented the economy from fully recovering for a decade. Policy blunders by the Federal Reserve, Congress, and Presidents Herbert Hoover and Roosevelt battered the economy on many fronts. The events of the 1930s influence economic policymaking today. Many people think that we need a big government to prevent, or to reverse, recessions. But the 1930s illustrate that activist policies increase, not decrease, economic instability. Government interventions reduce the flexibility that markets need to adjust to shocks and return to growth. This bulletin looks at the 1930s economy and highlights the worst policy failures.

2 Policy Failures Lead to a Long and Deep Downturn

The Depression was a uniquely severe contraction. Real gross domestic product fell for four years before finally beginning to recover.

3 Real output only regained its 1929 level in 1936, but then output plunged again in 1938. The unemployment rate stayed persistently high at more than 14 percent for 10 years (1931 to 1940).

4 By contrast, the economy recovered rapidly after a sharp contraction in 1921. Real output fell 9 percent in 1921 and unemployment rose to 11.7 percent.

5 But the economy bounced back with output recovering all its lost ground in 1922. Unemployment fell to 6.7 percent in 1922 and 2.4 percent in 1923. The secret to the quick recovery was that the government generally stood aside and let the market recover by itself—wages and prices adjusted, resources shifted to new areas of growth, profits recovered, business optimism returned, and investment rose. By contrast, government policies in the 1930s prevented the U.S. economy from recovering. The following are some of the key policy mistakes:

6 Monetary Contraction. The Depression was precipitated by a one-third drop in the money supply from 1929 to 1933, which was mainly the fault of the Federal Reserve. The Fed made further errors that helped put the economy back into recession in 1938. Meanwhile, a flood of bank failures in the early 1930s compounded the money supply shrinkage and heightened economic fears. A key problem was that most states restricted bank branching, which prevented banks from diversifying their portfolios across jurisdictions. By contrast, Canada allowed nationwide branching and did not suffer a single bank failure during the Depression.

Tax Hikes. In the early 1920s, Treasury Secretary Andrew Mellon ushered in an economic boom by championing income tax cuts that reduced the top individual rate from 73 to 25 percent. But the lessons of these successful tax cuts were forgotten as the economy headed downwards after 1929. President Hoover signed into law the Revenue Act of 1932, which was the largest peacetime tax increase in U.S. history. The act increased the top individual tax rate from 25 to 63 percent. After his election in 1932, Roosevelt imposed further individual and corporate tax increases. The highest individual rate was increased to 79 percent. State and local governments also increased taxes during the 1930s, with many imposing individual income taxes for the first time. All these tax increases killed incentives for work, investment, and entrepreneurship at a time when they were sorely needed.

International Trade Restrictions. In 1930, President Hoover signed into law the infamous Smoot-Hawley trade act, which raised import tariffs to an average of 59 percent on more than 25,000 products. More than 60 countries retaliated by slapping new restrictions on imports of U.S. products. As new trade restrictions were imposed around the world, trade plummeted. By 1933, world trade was down to just one-third of the 1929 level.

Keeping Prices High. The centerpiece of the New Deal was the National Industrial Recovery Act of 1933. It created “codes” or cartels in more than 500 industries in order to limit competition. Businesses were told to cut output and maintain high prices and wages. Businessmen who cut prices were cajoled, fined, and sometimes arrested. Fortunately, NIRA was struck down by the Supreme Court in 1935. The Agricultural Adjustment Act of 1933 similarly restricted production to keep prices high. “Excess” output was destroyed or dumped abroad. While millions of Americans were going hungry, the government plowed under 10 million acres of crops, slaughtered 6 million pigs, and left fruit to rot. Production of milk, fruits, and other products was cartelized to boost prices under “marketing orders” begun in 1937. These policies reduced employment and burdened families with higher prices. At a May 1935 press conference, Roosevelt read letters from businessmen thanking him for keeping prices high.

7 With millions out of work and short of money, Roosevelt thought that his job was to shield high-cost producers from entrepreneurs wanting to offer lower prices to hard-pressed families.

Keeping Employment Costs High. Many New Deal policies raised employer costs, contributing to the extraordinarily high unemployment of the 1930s. NIRA industry codes required high wages. The new Social Security tax increased compensation costs. New minimum wage rules reduced demand for low-skilled workers. The Davis-Bacon Act required the payment of excessively high wages on federal contracts. Compulsory unionism and militant union tactics were encouraged under a series of laws. One result was that U.S. work stoppages soared from an average 980 annually between 1922 and 1932 to a peak of 4,740 in 1937.

8 While “millions of jobs” were created in the government during the 1930s, private-sector jobs were destroyed. Total U.S. private employment was lower in 1940 than it had been in 1929.

9 Harassment of Businesses. Investment stagnated in the 1930s as a result of uncertainties in the economy and the new risks of adverse federal actions.

10 Roosevelt and members of his administration demonized business leaders and investors in their speeches. FDR called them “economic royalists” and “privileged princes” seeking a “new despotism” and “industrial dictatorship.” Laws and regulations poured forth from Washington like never before. Roosevelt issued more executive orders than all presidents from Harry Truman through Bill Clinton combined. Presidents typically issue just a few hundred executive orders, but Roosevelt issued 3,723.

11 Roosevelt’s antitrust crusade was typical of his antimarket approach. The Justice Department hired hundreds of new attorneys and began a lawsuit blitzkrieg in 1938 against dozens of industries for conspiring to keep prices high. The irony was that Roosevelt had spent his first term encouraging cartels, monopoly unionism, and other policies designed to boost prices and production costs.


New Deal interventions were not only bad for the economy, but favored fat cats over average families. Most farm subsidies went to major land owners, not small-time farmers. Required reductions in farm acreage devastated poor sharecroppers. Efforts to keep farm prices high led to the destruction of food while millions of families went hungry. Compulsory unionism led to discrimination against blacks because it gave monopoly power to union bosses who often didn’t want them hired. NIRA cartels prevented entrepreneurs from cutting prices for consumers. Roosevelt’s strategies of handouts, federal jobs, subsidized loans, demonizing businesses, and public works projects in swing states worked well politically. But economically, Roosevelt and his “brains trust” had no idea what they were doing. They attempted one failed intervention after another. The Great Depression was a disaster, and sadly an avoidable one.

1 The History Channel, “America’s Man of Steel,” advertisement, Washington Post, April 17, 2005, p. R2.

2 See Chris Edwards, Downsizing the Federal Government (Washington: Cato Institute, November 2005), Appendix 1.

3 U.S. Bureau of Economic Analysis, Survey of Current Business, April 2000, p. 15.

4 U.S. Bureau of the Census, Historical Statistics of the United States, 1975, Part 1, p. 135.

5 For the change in output during the 1920s, see U.S. Bureau of the Census, Part 1, p. 224. For unemployment, see p. 135.

6 Most facts are from Jim Powell, FDR’s Folly: How Roosevelt and His New Deal Prolonged the Great Depression (New York: Crown Forum, 2003). See also Alan Reynolds, “What Do We Know About the Great Crash,” National Review, November 9, 1979.


8 Powell, p. 204. Powell cites data from Morgan O. Reynolds.

9 See Table 6.4A.

10 Real gross private domestic investment did not recover to its 1929 level until 1936. Investment fell again in 1938. U.S. Bureau of Economic Analysis, p. 15.

11 William J. Olson and Alan Woll, “Executive Orders and National Emergencies: How Presidents Have Come to ‘Run the Country’ by Usurping Legislative Power,” Cato Policy Analysis no. 358, October 28, 1999, p. 13

1 comment:

Robin said...

Chris Edwards cites a fact-filled 1979 article on the Great Depression by Alan Reynolds. It is available online.