Sunday, January 18, 2009

Thoughts On Sheila Bair's Bad Bank Solution

Does FDIC's Sheila Bair's idea of using government funds to buy bad, toxic assets at banks at a 'fair value' price that is above current prices make economic sense?

If you believe that markets price assets at or close to fair value all or most of the time, then the only solution is for the government to overpay for the banks' assets. Having this idea is to align oneself with efficient, rational markets theorists.

If you believe markets can misprice assets and under or over value them for a sustained period and that the market will eventually correct itself, then purchasing the assets from banks above current prices will be the correct action. In this scenario, one sees the banks as unfairly penalized for market disruptions that are beyond their control.

If you believe that market prices are mostly right, then it is inconsistent to believe that there was a housing bubble. Then, the recent decline in house prices is a rational response to expected economic forces as yet not fully disclosed.

Bair, other government officials, many politicians, and more than a few economists believe there was a housing bubble and that house prices were not rational. Going from believing in mispriced house prices to mispriced mortgage and other bank assets is a tiny step.

Sunday, January 11, 2009

What Are The Expected Values Of the Stimulus Plans?

Every government stimulus spending or tax reduction plan has its own risks associated with it and probabilities that measure that risk. There is obviously a political risk as to whether Congress will pass the plan, will substantially modify it, or will fail to pass it. Likewise, there is an implementation risk as to whether the plan can be and will be set up as envisioned. Lastly, there is also obviously a results risk as to whether the plan will achieve its intended effect with the expected impact without negative unintended economic consequences. For example, a plan double the size of that proposed may have no additional impact on the economy in a reasonable time because the government will be unable to spend the extra funds sufficiently quickly to have a positive economic result. Additionally, there can be other economic risks to the proposed plan not discussed here, such as geopolitical risks from trade effects, military budget effects, etc.

Evaluation of different stimulus packages just by the final modeled effect on the economy, GDP and unemployment is misleading because it does not incorporate the chance of the success or failure of the different proposed plans. It would be like playing poker and assuming the odds of getting two of a kind are the same as getting four of a kind.

A much more meaningful and relevant discussion of the comparison of different stimulus packages, whether the packages are government spending, tax reduction or a blend, is to compute the expected value of each plan based on each plan's risk profile. Under economic theory, the plan with the highest expected value is the one to choose for the greatest economic impact. Without a computed expected value for the different plans, the discussions about the various economic plans in news articles, or in blogs shed no real light on what plan to choose.

Wednesday, January 7, 2009

Will Private Investment Follow Government Stimulus Spending

When the two years of government stimulus spending ends, what will there be to replace it unless we have concurrent private investment? The government does not have an obvious answer as to what will be a sustained replacement for the decline in the US housing component (construction, sales, etc.) of the last decade's GDP. Obama's plan to fix roads, bridges, build modern schools, pay teachers higher salaries, make government buildings energy efficient and green America will not provide the necessary historical and consistent long-term per capita US GDP growth that has given the US its high standard of living and has been the envy and despise of the world.

Sustainable high productivity is a sure long-term path to a better standard of living for a country's people and is the result of the technological innovations of private investment and fierce competition. US workers have the highest productivity in the world for many reasons: Ease of bankruptcy, low government share of GDP, low government ownership rate of business, low unionization rate, entrepreneurial wealth incentives, ability to amass wealth through hard work, accessibility to capital, ease of business start-ups, tough competition, lack of price controls, etc.

Recent government efforts to help the financial, automotive and other US industries are doing much to undermine the prospects for future US economic growth for the sake of appearing to help the voting worker, a lesson learned during the Franklin Roosevelt era and forgotten by our current politicians. It took until 1940 for the US economy to return to the height of its 1928-29 production levels and much of that was due to helping the war effort in Europe. Over the next two years, the US employable workforce is expected to grow at 1.1 percent a year, and the US needs to create 3.3 million new jobs in addition to replacing the 2.6 million jobs lost in 2008 and the yet unknown jobs lost in 2009 to have unemployment levels return to pre-recession levels. The US needs to create at least double the number of jobs promised by the new president. Obama's US employment rhetoric and goals of 3 million jobs falls far short of the needs of the US economy for the next two years.

Unfortunately, our politicians see the Roosevelt era through rose-colored glasses. While we call the 1930s, the period of the Great Depression, the slowdown in Europe was not called a Great Depression because it was not as severe and it was shorter lived. In England, it was much milder than in the US and their Great Depression occurred in 1907.

Predicting the future success of new businesses and of new technological innovation is impossible. The US needs a new commitment to fund basic scientific and technological research, a commitment to facilitate business start-ups and business growth and the least obvious, a commitment to allow businesses of all sizes in all industries to fail. Unfortunately, nothing in Obama's plans deal with helping the long-term per capita GDP growth of the US. His instincts, rhetoric and plans are more of the nature of a political animal already planning his reelection than of an economic man who will steer the US economy to long-term prosperity.