Causes of the Bust

Causes of the Bust

December 14, 2008


I don’t usually comment on other people’s stuff, but this was so tempting I couldn’t resist. Joe Stiglitz, who won a Nobel Prize, if you can believe that (he helped blow up Russia but said he was sorry afterwards) comes up with his Five Points. I find this list to be pretty disappointing. It is a list that could be made by a journalist, like Suze Orman if she had the poor judgement to tread where she doesn’t belong. For a “serious” economist to come up with such weak and blatantly political arguments is surprisingly mediocre even compared to my many-times-lowered expectations. On the other hand, maybe he is pledging his eternal hackdom to the now-ascendant Democratic Party. Even a Joe Stiglitz needs to pay the bills, and, hey, it works for Paul Krugman!

Maybe some people are wondering what I mean by a “hack.” Being a hack doesn’t mean that you’re incompetent. Many hacks are fabulously talented hacks. It means that you volunteer to be a political spear-carrier. I liken it to the Roman Catholic Church, or really any academic department. The Roman Catholic Church, first and foremost, is an organization. If you decide to hack for the Roman Catholic Church, at the basic parish level or as an archbishop, you have to go along with the Roman Catholic program. You can’t say “I think St. Augustine was wrong about that one. The Buddha’s approach is much better.” For your hackdom, you get a paid position, and all the various perks and influence. The Roman Catholic Church may have useful and correct attributes — maybe that is what attracted you in the first place. Or, maybe it is just the dominant organization. Who wants to be a Sufi in Rome? But, if the Roman Catholic Church declares that the sun revolves around the earth, then that is what you must preach. Ultimately, that is what you must think as well, because if there is too much dissonance between what you are thinking and preaching, problems ensue. Thus, hacks are usually True Believers.

My comments are in red.

Vanity Fair
The Economic Crisis:
Capitalist Fools
by Joseph E. Stiglitz
January 2009
Behind the debate over remaking U.S. financial policy will be a debate over who’s to blame. It’s crucial to get the history right, writes a Nobel-laureate economist, identifying five key mistakes—under Reagan, Clinton, and Bush II—and one national delusion.

There will come a moment when the most urgent threats posed by the credit crisis have eased and the larger task before us will be to chart a direction for the economic steps ahead. This will be a dangerous moment. Behind the debates over future policy is a debate over history—a debate over the causes of our current situation. The battle for the past will determine the battle for the present. So it’s crucial to get the history straight.

What were the critical decisions that led to the crisis? Mistakes were made at every fork in the road—we had what engineers call a “system failure,” when not a single decision but a cascade of decisions produce a tragic result. Let’s look at five key moments.

No. 1: Firing the Chairman
In 1987 the Reagan administration decided to remove Paul Volcker as chairman of the Federal Reserve Board and appoint Alan Greenspan in his place. Volcker had done what central bankers are supposed to do. On his watch, inflation had been brought down from more than 11 percent to under 4 percent. In the world of central banking, that should have earned him a grade of A+++ and assured his re-appointment. But Volcker also understood that financial markets need to be regulated. Reagan wanted someone who did not believe any such thing, and he found him in a devotee of the objectivist philosopher and free-market zealot Ayn Rand.

I always thought Volcker was sort of a conservative hero. He put an end to the cheap-money policies favored by Democrats since the 1890s. Since when was he a champion for regulation? The Volcker years during the 1980s stopped the 1970s trend of currency devaluation, but they were very rocky and volatile. Greenspan did a better job of smoothing things out — just look at the dollar compared to gold in the 1990s — which did a lot to help the economy under … Bill Clinton! Clinton and Greenspan were always good buddies. Didn’t Clinton reappoint Greenspan? Oh yeah. But, now Volcker is head of Obama’s new economic advisory board! So all the hacks have new marching orders. I like Volcker myself. Right or wrong, he is willing to speak his mind. This article from (the lefty) San Francisco Chronicle gives a little more realistic version of how Volcker was viewed in the 1980s.

Paul Volcker was reviled before he was revered.

President-elect Barack Obama named the 81-year-old Volcker to head a new economic advisory panel Wednesday, citing “his sound and independent judgment.” But nearly three decades ago – when Obama was still a college student – the towering 6-foot-7 Volcker was one of the most disliked public figures in the United States.

As Federal Reserve chairman, he took an uncompromising stance against inflation, jacking up interest rates as high as 20.5 percent. Unemployment soared to 11 percent in the most painful recession since the Great Depression. Volcker had been appointed by President Jimmy Carter in 1979, but his tough medicine likely contributed to the Democrat’s failure to win re-election in 1980.

According to Joseph Treaster’s 2004 biography “Paul Volcker: The Making of a Financial Legend,” angry workers who had lost their jobs flooded Volcker’s office with mementos of their plight – two-by-fours from carpenters unable to build houses; bags filled with ignition keys from car dealers stuck with unsold cars.

One leading Democrat, Rep. Henry Gonzalez, D-Texas, called for Volcker’s impeachment. Another, Rep. Frank Annunzio, D-Ill., sputtered at Volcker during a hearing: “Your course of action is wrong. It must be wrong. There isn’t anyone who says you are right.”

Republicans were no happier during Volcker’s eight-year chairmanship. While Ronald Reagan remained silent as Volcker’s policies sent his approval ratings tumbling, Reagan’s aides were eager to remove him. He finally stepped down in 1987, to be replaced by Alan Greenspan.

Ummm, oh yeah. Kinda forgot about that, eh Joe?

Greenspan played a double role. The Fed controls the money spigot, and in the early years of this decade, he turned it on full force. But the Fed is also a regulator. If you appoint an anti-regulator as your enforcer, you know what kind of enforcement you’ll get. A flood of liquidity combined with the failed levees of regulation proved disastrous.

Greenspan presided over not one but two financial bubbles. After the high-tech bubble popped, in 2000–2001, he helped inflate the housing bubble. The first responsibility of a central bank should be to maintain the stability of the financial system. If banks lend on the basis of artificially high asset prices, the result can be a meltdown—as we are seeing now, and as Greenspan should have known. He had many of the tools he needed to cope with the situation. To deal with the high-tech bubble, he could have increased margin requirements (the amount of cash people need to put down to buy stock). To deflate the housing bubble, he could have curbed predatory lending to low-income households and prohibited other insidious practices (the no-documentation—or “liar”—loans, the interest-only loans, and so on). This would have gone a long way toward protecting us. If he didn’t have the tools, he could have gone to Congress and asked for them.

Of course, the current problems with our financial system are not solely the result of bad lending. The banks have made mega-bets with one another through complicated instruments such as derivatives, credit-default swaps, and so forth. With these, one party pays another if certain events happen—for instance, if Bear Stearns goes bankrupt, or if the dollar soars. These instruments were originally created to help manage risk—but they can also be used to gamble. Thus, if you felt confident that the dollar was going to fall, you could make a big bet accordingly, and if the dollar indeed fell, your profits would soar. The problem is that, with this complicated intertwining of bets of great magnitude, no one could be sure of the financial position of anyone else—or even of one’s own position. Not surprisingly, the credit markets froze.

Here too Greenspan played a role. When I was chairman of the Council of Economic Advisers, during the Clinton administration, I served on a committee of all the major federal financial regulators, a group that included Greenspan and Treasury Secretary Robert Rubin. Even then, it was clear that derivatives posed a danger. We didn’t put it as memorably as Warren Buffett—who saw derivatives as “financial weapons of mass destruction”—but we took his point. And yet, for all the risk, the deregulators in charge of the financial system—at the Fed, at the Securities and Exchange Commission, and elsewhere—decided to do nothing, worried that any action might interfere with “innovation” in the financial system. But innovation, like “change,” has no inherent value. It can be bad (the “liar” loans are a good example) as well as good.

OK, Stiglitz was head of the CEA during Clinton. He was in meetings with Greenspan. What did he do during these meetings? “We didn’t put it as memorably as Warren Buffett … but we took his point.” Hmmmm. You “took his point.” That means … you weren’t asleep? Congratulations for not being asleep. Probably Greenspan thought of his role as making the Fed’s interest rate target go up and down, and blabbing incoherently to Congressmen when they wanted to get him to say something that could be politically useful. Regulation was for Congress, the SEC, etc. Greenspan probably didn’t think he had anything more to do with the process than Stiglitz. Certainly the target-rate-up-and-down guy has other things on his agenda than wondering if a certain bank’s derivatives book is properly priced, or if Fannie has too much leverage. Only the real oddballs, like Buffett, would see the danger of derivatives and actually do something about it, as Buffett did when he wound up the derivatives arm of Gen Re Securities (at huge expense). But then, it was his own money on the line, more or less. Which makes him rather exceptional, I figure.

No. 2: Tearing Down the Walls
The deregulation philosophy would pay unwelcome dividends for years to come. In November 1999, Congress repealed the Glass-Steagall Act—the culmination of a $300 million lobbying effort by the banking and financial-services industries, and spearheaded in Congress by Senator Phil Gramm. Glass-Steagall had long separated commercial banks (which lend money) and investment banks (which organize the sale of bonds and equities); it had been enacted in the aftermath of the Great Depression and was meant to curb the excesses of that era, including grave conflicts of interest. For instance, without separation, if a company whose shares had been issued by an investment bank, with its strong endorsement, got into trouble, wouldn’t its commercial arm, if it had one, feel pressure to lend it money, perhaps unwisely? An ensuing spiral of bad judgment is not hard to foresee. I had opposed repeal of Glass-Steagall. The proponents said, in effect, Trust us: we will create Chinese walls to make sure that the problems of the past do not recur. As an economist, I certainly possessed a healthy degree of trust, trust in the power of economic incentives to bend human behavior toward self-interest—toward short-term self-interest, at any rate, rather than Tocqueville’s “self interest rightly understood.”

The most important consequence of the repeal of Glass-Steagall was indirect—it lay in the way repeal changed an entire culture. Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people’s money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people’s money—people who can take bigger risks in order to get bigger returns. When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top. There was a demand for the kind of high returns that could be obtained only through high leverage and big risktaking.

There were other important steps down the deregulatory path. One was the decision in April 2004 by the Securities and Exchange Commission, at a meeting attended by virtually no one and largely overlooked at the time, to allow big investment banks to increase their debt-to-capital ratio (from 12:1 to 30:1, or higher) so that they could buy more mortgage-backed securities, inflating the housing bubble in the process. In agreeing to this measure, the S.E.C. argued for the virtues of self-regulation: the peculiar notion that banks can effectively police themselves. Self-regulation is preposterous, as even Alan Greenspan now concedes, and as a practical matter it can’t, in any case, identify systemic risks—the kinds of risks that arise when, for instance, the models used by each of the banks to manage their portfolios tell all the banks to sell some security all at once.

As we stripped back the old regulations, we did nothing to address the new challenges posed by 21st-century markets. The most important challenge was that posed by derivatives. In 1998 the head of the Commodity Futures Trading Commission, Brooksley Born, had called for such regulation—a concern that took on urgency after the Fed, in that same year, engineered the bailout of Long-Term Capital Management, a hedge fund whose trillion-dollar-plus failure threatened global financial markets. But Secretary of the Treasury Robert Rubin, his deputy, Larry Summers, and Greenspan were adamant—and successful—in their opposition. Nothing was done.

LTCM mostly went bust on big leverage, not derivatives. I do think the removal of the Depression-era regulations was a significant step. It didn’t “cause” the present situation to happen — when people want to be stupid, there is hardly anything that will prevent them from being stupid — but it allowed the situation to get more out of hand than it would have otherwise. The 2004 SEC ruling on brokerage house leverage was also important.

No. 3: Applying the Leeches
Then along came the Bush tax cuts, enacted first on June 7, 2001, with a follow-on installment two years later. The president and his advisers seemed to believe that tax cuts, especially for upper-income Americans and corporations, were a cure-all for any economic disease—the modern-day equivalent of leeches. The tax cuts played a pivotal role in shaping the background conditions of the current crisis. Because they did very little to stimulate the economy, real stimulation was left to the Fed, which took up the task with unprecedented low-interest rates and liquidity. The war in Iraq made matters worse, because it led to soaring oil prices. With America so dependent on oil imports, we had to spend several hundred billion more to purchase oil—money that otherwise would have been spent on American goods. Normally this would have led to an economic slowdown, as it had in the 1970s. But the Fed met the challenge in the most myopic way imaginable. The flood of liquidity made money readily available in mortgage markets, even to those who would normally not be able to borrow. And, yes, this succeeded in forestalling an economic downturn; America’s household saving rate plummeted to zero. But it should have been clear that we were living on borrowed money and borrowed time.

The cut in the tax rate on capital gains contributed to the crisis in another way. It was a decision that turned on values: those who speculated (read: gambled) and won were taxed more lightly than wage earners who simply worked hard. But more than that, the decision encouraged leveraging, because interest was tax-deductible. If, for instance, you borrowed a million to buy a home or took a $100,000 home-equity loan to buy stock, the interest would be fully deductible every year. Any capital gains you made were taxed lightly—and at some possibly remote day in the future. The Bush administration was providing an open invitation to excessive borrowing and lending—not that American consumers needed any more encouragement.

Germany doesn’t tax capital gains on equities at all. Nor does Singapore or Hong Kong. Japan effectively didn’t until very recently. Claiming an “upper income tax cut” that moved the top income tax rate from 39.6% to 35% caused some sort of bubble is not only plain wrong, it is bizarre. Obviously a political ploy — something you’d expect to hear from a Michael Moore lefty. Does someone want to claim that capitalism doesn’t work if taxes are too low? Now, it is true that the rich got richer and the poor mostly got poorer under Bush. That’s a problem, if you ask me. Certainly, some of those rich got richer basically by stealing. They’re still doing it right now, aided by their Man At The Treasury. Oligarchs were a big winner during the Bush years. But, that wasn’t because they paid a 35% tax rate instead of a 39.4% one. Republicans also led a significant capital gains tax cut in 1997. This introduced the Roth IRA and made the first $500,000 of home value free of capital gains taxes. Seriously rich people don’t give a damn about Roth IRAs and a $500,000 deduction. It’s irrelevant. You would expect this sort of mishmash from a labor-oriented Democrat with no real background in economics. It is supposed to be the role of a Nobel Prize winner and former CEA head to straighten this stuff out.

Although I’m generally a low-taxes fan, nevertheless I think there may be a role for taxes on higher incomes. The fact of the matter is, 19th century capitalism was pretty ugly in many ways. This is part of what led to the rise of socialism, unions and the urge to “tax the rich” around the 1880s-1940s period. 1950s capitalism — with unions, and rather high tax rates on high incomes — was not all that bad. I tend to think something like essentially no income taxes for the great majority of people, but a 20% – 30% or so tax on high incomes, might be a good compromise. By “high incomes” I mean really high incomes. So, something like the first $100,000 is tax free, and the 25% rate hits around $1 million. Capital gains could be tax free up to $1 million or so a year, at which point they are taxed as regular income (with a 25% top rate).

No. 4: Faking the Numbers
Meanwhile, on July 30, 2002, in the wake of a series of major scandals—notably the collapse of WorldCom and Enron—Congress passed the Sarbanes-Oxley Act. The scandals had involved every major American accounting firm, most of our banks, and some of our premier companies, and made it clear that we had serious problems with our accounting system. Accounting is a sleep-inducing topic for most people, but if you can’t have faith in a company’s numbers, then you can’t have faith in anything about a company at all. Unfortunately, in the negotiations over what became Sarbanes-Oxley a decision was made not to deal with what many, including the respected former head of the S.E.C. Arthur Levitt, believed to be a fundamental underlying problem: stock options. Stock options have been defended as providing healthy incentives toward good management, but in fact they are “incentive pay” in name only. If a company does well, the C.E.O. gets great rewards in the form of stock options; if a company does poorly, the compensation is almost as substantial but is bestowed in other ways. This is bad enough. But a collateral problem with stock options is that they provide incentives for bad accounting: top management has every incentive to provide distorted information in order to pump up share prices.

The incentive structure of the rating agencies also proved perverse. Agencies such as Moody’s and Standard & Poor’s are paid by the very people they are supposed to grade. As a result, they’ve had every reason to give companies high ratings, in a financial version of what college professors know as grade inflation. The rating agencies, like the investment banks that were paying them, believed in financial alchemy—that F-rated toxic mortgages could be converted into products that were safe enough to be held by commercial banks and pension funds. We had seen this same failure of the rating agencies during the East Asia crisis of the 1990s: high ratings facilitated a rush of money into the region, and then a sudden reversal in the ratings brought devastation. But the financial overseers paid no attention.

Kind of a shotgun approach to “corporate malfeasance” in general. Certainly, corporate malfeasance has been pegging the meter in the last few years. The guys at the top really do jigger the numbers to stuff their pockets, with little regard to the consequences to their companies or shareholders or the economy in general. The rating agencies are whores. But, didn’t we always know that? I mean, who was actually buying a synthetic CDO-squared? Or a CPDO? Crazy people, basically. We have seen the Stupid People, and it is us!

No. 5: Letting It Bleed
The final turning point came with the passage of a bailout package on October 3, 2008—that is, with the administration’s response to the crisis itself. We will be feeling the consequences for years to come. Both the administration and the Fed had long been driven by wishful thinking, hoping that the bad news was just a blip, and that a return to growth was just around the corner. As America’s banks faced collapse, the administration veered from one course of action to another. Some institutions (Bear Stearns, A.I.G., Fannie Mae, Freddie Mac) were bailed out. Lehman Brothers was not. Some shareholders got something back. Others did not.

The original proposal by Treasury Secretary Henry Paulson, a three-page document that would have provided $700 billion for the secretary to spend at his sole discretion, without oversight or judicial review, was an act of extraordinary arrogance. He sold the program as necessary to restore confidence. But it didn’t address the underlying reasons for the loss of confidence. The banks had made too many bad loans. There were big holes in their balance sheets. No one knew what was truth and what was fiction. The bailout package was like a massive transfusion to a patient suffering from internal bleeding—and nothing was being done about the source of the problem, namely all those foreclosures. Valuable time was wasted as Paulson pushed his own plan, “cash for trash,” buying up the bad assets and putting the risk onto American taxpayers. When he finally abandoned it, providing banks with money they needed, he did it in a way that not only cheated America’s taxpayers but failed to ensure that the banks would use the money to re-start lending. He even allowed the banks to pour out money to their shareholders as taxpayers were pouring money into the banks.

The other problem not addressed involved the looming weaknesses in the economy. The economy had been sustained by excessive borrowing. That game was up. As consumption contracted, exports kept the economy going, but with the dollar strengthening and Europe and the rest of the world declining, it was hard to see how that could continue. Meanwhile, states faced massive drop-offs in revenues—they would have to cut back on expenditures. Without quick action by government, the economy faced a downturn. And even if banks had lent wisely—which they hadn’t—the downturn was sure to mean an increase in bad debts, further weakening the struggling financial sector.

The administration talked about confidence building, but what it delivered was actually a confidence trick. If the administration had really wanted to restore confidence in the financial system, it would have begun by addressing the underlying problems—the flawed incentive structures and the inadequate regulatory system.

That TARP was always a channel by which bankers could steal from the U.S. Treasury to fill in their gaping losses — and pay themselves some nice bonuses. This was obvious to a great many people, which is why it was opposed (mostly by Republicans). The Democrats passed it largely because they didn’t want to get blame for whatever happened afterwards if it was not passed. Nobody gets blamed for “Doing Something that Didn’t Work.” Plus, after passing it, the Dems get a nice chance for criticizing TARP for being what it always was from square one. The Dems could have just put together their own bill, three pages if necessary, that undertook bank recapitalization (or whatever their alternative was) under the aegis of someone other than the bankers’ Scammer in Chief Hank Paulson. They had that option. But, that would require real leadership and understanding. Instead, it was a lot easier to just pad out the bankers’ present to themselves with another $150 billion of handouts. Since it’s Christmas and all. Thus far, the TARP hasn’t caused any problems, although the pattern of these giant mystery bailouts will eventually have consequences I think. Incentives and regulation don’t solve the present problem, they prevent it from happening again, some generations hence.

Was there any single decision which, had it been reversed, would have changed the course of history? Every decision—including decisions not to do something, as many of our bad economic decisions have been—is a consequence of prior decisions, an interlinked web stretching from the distant past into the future. You’ll hear some on the right point to certain actions by the government itself—such as the Community Reinvestment Act, which requires banks to make mortgage money available in low-income neighborhoods. (Defaults on C.R.A. lending were actually much lower than on other lending.) There has been much finger-pointing at Fannie Mae and Freddie Mac, the two huge mortgage lenders, which were originally government-owned. But in fact they came late to the subprime game, and their problem was similar to that of the private sector: their C.E.O.’s had the same perverse incentive to indulge in gambling.

The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal. Looking back at that belief during hearings this fall on Capitol Hill, Alan Greenspan said out loud, “I have found a flaw.” Congressman Henry Waxman pushed him, responding, “In other words, you found that your view of the world, your ideology, was not right; it was not working.” “Absolutely, precisely,” Greenspan said. The embrace by America—and much of the rest of the world—of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today.

So much of what has happened strikes me as a reflection of a Baby Boomer mentality — the thinking of people who grew up in the wealthiest society the world has ever seen (certainly wealthier than the U.S. today), with an invincible sense of entitlement, and who spent their youth doing lots of drugs with apparently no consequences. Debt was their new drug, at the individual and institutional level. Some of the institutions are learning this has consequences, but the government hasn’t yet. To this we add another mentality, that it is right and proper to take as much as you can, by any means possible, the more legal the better. These days I often think that outcomes happen largely because people think they should be so. That, for example, there was a broadening middle class in the U.S. 1950s or 1960s in part because corporate leaders felt that it was good and proper that all employees should benefit along with the growth and prosperity of a company, rather than having top management benefit from griding down the employees as far as possible. Not necessarily because of this tax rate or that regulation, although those also reflect the thinking of the time. The Soviet system was just as effective as the 19th century Capitalist system at producing a class of entrenched elites above a sea of peons. Heck, 18th century French feudalism produced the same outcome. This has arisen in no small part due to the expectations of the peon class itself, which really is most comfortable in the “I’ll do what you say if you feed me” feudal format that has characterized European culture since waaaay back. Domesticated animals can no longer live in the wild, or at least they think they can’t.

What we have seen is mass stupidity — or cravenness, if you consider that the top financial guys are still paying themselves bonuses. I’m not sure that is an “economic philosophy.” The outcome of mass stupidity (or cravenness) is what it is. Simple cause and effect. We might look back and see the present Democrat-led policy process as equally stupid and craven. It sort of has the same flavor as I remember when I was first getting my head around the housing and credit bubble in early 2004 or so. “This sure looks like it is going to blow, and the outcome would probably be messy. However, I’m not sure, because I’ve never seen one of these blow before, and I’ve never seen the kind of outcome that I think could happen if this did blow. And, everyone who thought this was going to blow in 1989/1996/2001 were wrong. Besides, everyone else seems to think it’s OK.” Remember that feeling? Is this really going to do what I think it could do? Or am I just hallucinating? When I look at these mega bailouts, the government market manipulation, and the Fed’s money printing games (apparently they really did go in and buy some GSE debt using the printing press last week), I get that feeling.

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Archangel Metatron has released his second installment in the Soul Journey of Jeshua. It is available here:

Archangel Metatron is channeled by Carolyn Evers.

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Famine Watch: Seed shortage coming? I didn’t really think this was going to be a weekly item. But, hey, let’s go with it!

Yesterday afternoon, my Fedco Seed Catalog arrived – always my personal favorite. And on page 6, what should I see but this, in founder CR Lawn’s description of their situation:

And now seed prices. I’ve ben 30 years in this business and these are the highest increases to us I’ve ever seen. The ethanol boom diverting land to corn production has ahd a tremendous impocat on farm commodity prices, including vegetable seeds. Wholesale prices for pea and bean seed are up 30-50%, for corn and squash, 20% or more. Even so, wholesalers could not find growers for all crops so several varieties are missing from our catalog. Horrible growing weather this summer has exacerbated the shortage.

Remember, I suggested that if people decide they need to grow their own food — because it isn’t coming from Argentina anymore perhaps — then they will need seeds. And, if they need it, they are going to really, really need it. And, if everyone needs it at once, it isn’t going to be available. Apparently, most of the seeds found in packets at your garden store are crap. To get the good stuff, you have to mail order, and, if you want to grow meaningful quantities, you have to get size. The link above has lots of good details.

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UAW: Good for you! Apparently the auto bailout deal stumbled because Republican senators demanded big wage concessions by the UAW, and the UAW said “no way.” That makes perfect sense to me. Employees are at the TOP of the BK food chain. They are senior even to banks and suppliers. Why should they take the hit first? They’re supposed to take the hit LAST. First, the equity goes bye bye. Then, the bonds get marked down. Then, the banks get marked down. Then, the suppliers get paid back. Then, and only then, the employees make a deal. Actually, the employees will deal before then, because they don’t want to see the whole thing be liquidated. However, I totally agree that it is time for the bondholders to take a bath. That is why I suggested a prepack BK upfront. Makes sense. Realistically, GM isn’t going to be viable until the labor problems are worked out, which would allow them to downsize meaningfully. (Update: apparently the UAW was willing to deal, and the Republican senators come from states where there are factories of foreign carmakers. Still, I think the bond guys should get whacked before the UAW.)

I was joking to a friend of mine: “Why is it that AIG gets $150 billion no-questions-asked, when the auto guys have to beg for $15 billion? I figure it’s because Goldman has CDS on GM, and AIG is the counterparty.” My friend said: “Yeah, that’s exactly the reason!” I’m just making this up, but sometimes it really is that simple.

Hint to the UAW: You might think of getting benefits in terms of things rather than money. For example, GM could run some company hospitals and clinics, instead of going through the healthcare/insurance system, which is a mega scam. Or, instead of a pension per se, GM could provide company housing in certain retirement locales, maybe even with some food provided in some way. I suppose that after Americans’ bad experience with the welfare housing projects of the 1960s, this doesn’t sound like such a good idea. However, other countries (especially Asian) have worker housing and even food, and it is fine. I personally have eaten in corporate cafeterias regularly and vactioned at corporate vacation resorts (both very cheap), and I have friends working in high-level professional jobs for Mitsubishi-UFJ Financial Group, Toyota Motors, Toshiba and Mitsubishi Heavy Industries that have lived in company housing. (A lot of Japanese company housing was built in the 1950s and 1960s, and is rather dingy today. They should upgrade it.) In an economic situation, it is far better to have a thing like an apartment rather than a bunch of financial promises. Economies collapse, pension funds collapse, governments collapse, currencies collapse, but apartments stay standing. This is a solicited contribution by doomer Dimitri Orlov to the Harvard Business Review for their list of “breakthrough ideas.” HBR took it, and said that they would have liked to give it more space. And for GM? You’ve got unused real estate aplenty, conveniently located near the factories and offices. Construction workers are working cheap. It’s tax deductible.

When All Your Best Employees Are Going Broke

The combination of skyrocketing food and energy costs, rising medical costs, falling real estate values and stagnant wages is putting increasing numbers of workers in financial distress. A distressed workforce can hardly be a productive workforce, and companies must do whatever it takes to make it physically possible for their employees to function. What can companies do to remedy this situation? The obvious step of increasing wages not only puts additional pressure on the bottom line, but can also fuel wage inflation. Also, It may not be the most effective approach.

A better approach is to treat the company and its employees as an economic unit: a single household, with a common set of costs. These costs can be cut very effectively by trading off slightly higher company costs against significantly lower employee costs. Each additional dollar paid out in wages is taxed as income, trimming it by about a third. It is then spent in the retail chain, generating profits for retailers and service providers, trimming it by another half or more. This same dollar can be stretched much further if the company uses it to buy products wholesale and makes them available to its employees either free of charge or for a nominal fee.

Many families are struggling with rising food costs. To help them, the company commissary can provide not just breakfast and lunch, but take-home dinners for the entire family. Periodically, it can provide other take-home items such as frozen chickens purchased in bulk, fresh organic vegetables from local CSA (Community-Supported Agriculture) farms, or a basket of popular foodstuffs purchased wholesale and assembled in-house.

Many employees are finding that their daily commute is eating ever deeper into their budgets because of the increasing price of fuel. In many cases, their ability to relocate closer to work is complicated by the stagnant real estate market and the higher price of housing closer to population centers. Telecommuting can help, but is only feasible for certain types of work. Here, the company can help by providing dormitories close by, which would allow employees to commute every other day, or even just once a week. For the younger, single employees, this may allow them to avoid spending money on housing altogether.

There are numerous other ways that a company can use its vastly greater negotiating power to effect significant savings for its employees while incurring a comparatively small additional cost. Examples run from directly providing family medical care through a company clinic to providing vacation packages at cost by renting out an entire vacation resort at a lower, negotiated group rate.

But perhaps the greatest opportunities for cost reduction lie in areas where employees’ own efforts can replace services or products they would otherwise be forced to purchase, be it taking care of their elderly relatives instead of putting them in assisted living, or spending time with their children instead of paying for day care, or growing their own food in a community garden instead of shopping at a supermarket. Here, the company has to be willing to accommodate shorter working hours, trading off the slightly lower efficiency of having more part-time employees against the resulting vastly greater efficiency of the company community when it is viewed as a single household.

There is no need to couch such initiatives in purely negative terms of cost containment. Here is how Eric Schmidt, CEO of Google, sees it: “The goal is to strip away everything that gets in our employees’ way. We provide a standard package of fringe benefits, but on top of that are first-class dining facilities, gyms, laundry rooms, massage rooms, haircuts, car washes, dry cleaning, commuting buses – just about anything a hardworking employee engineer might want.”

If you feel that such special treatment may be required for the pampered software artists at prosperous Google, but not for your own employees, then take a look at the long list of benefits enjoyed by the enlisted men and women of the US Air Force, which includes 30 days a year of paid vacation and unlimited free air travel. This is a fine example of making the best use of what you have to make a difference for your employees: if what you have is plenty of jets, then why not let your employees travel as much as they want?

Although the results of such efforts may at first be difficult to quantify, should they succeed, the resulting competitive advantage is likely to become obvious. Let your hard-nosed competitors try to run their businesses with distressed, disgruntled, overworked employees, while you reap the benefits of loyalty, solidarity and ésprit de corps. In due course, this should make your competitors attractive as acquisition targets.

One ready objection that this proposal normally encounters runs along the lines of “If everybody did this, the economy would collapse.” If it were implemented across the board, this would cut retailers and the government out of their share of your earnings, reduce both corporate profits and government expenditures, shrink the overall size of the economy, making it unable to sustain a large and growing national debt, and hasten economic collapse and national bankruptcy.

But it is clearly a mistake to consider it likely that this proposal would be implemented by more than a handful of companies. Overwhelming numbers of corporate executives would regard it as professional suicide, because financial markets punish companies that put the interests of their employees ahead of those of their investors. And it seems equally outlandish to think that the actions of a few mavericks could significantly hasten economic collapse and national bankruptcy. In short, the macroeconomic effects of this proposal are not interesting. It is far more interesting to consider the notion that it is possible to safeguard a company and its employees against a continuously worsening economic environment, even onto complete economic and political collapse. The steps proposed in this article can be regarded as baby steps in that direction. The remaining steps are varied and far more difficult, and are beyond the scope of this article.

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A short history of the Brazilian real/cruzero/cruzado:

A shorter version: 21 zeros in sixty years.

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Why ETFs aren’t gold: a few details here:

It doesn’t matter until it matters, and then it’s the only thing that matters.