But Then What - Where Business, Economics and Politics are, and where they're going

The Tax Con

Posted by Tom Lindmark on July 25th, 2010

Tim Geithner seemed to make it pretty clear today that the administration plans to let the Bush tax cuts for individuals making more than $200,000 and families earning more than $250,000 expire. Here is the rationale for increasing taxes:

“We think that’s the responsible thing to do because we need to make sure we can show the world that (we’re) willing as a country now to start to make some progress bringing down our long-term deficits,” he said on ABC’s “This Week” program.

Notice that he’s justifying the increase as a fiscally responsible policy move. This fits with the larger theme that the administration, much of the MSM and a lot of Democrats are advancing that it is time for Americans to understand that the government has no choice but to pay its ever growing portfolio by claiming a larger share of the nation’s output.

The talk is that 2011 will be the year of major tax overhaul. Supposedly a top to bottom review of the tax code that entails some serious review and reform of embedded subsidies will be paired with the work of increasing the feds take. On the table as well is likely to be the introduction of a value added tax to the menu. It’s all being billed as the inevitable solution to spending commitments arising from entitlement programs.

Let’s step back for a second and consider a couple of things.

First, take a look at this chart from Don Marron :

This actually comes from the CBO and was part of their recently released long-term budget outlook. The blue bars represent tax receipts as a percentage of GDP under current tax law without Congressional meddling while the pink bars assume Congress doesn’t change its stripes and continues to “fix” things like the AMT. Note that the historical tax take has been around 18.2%.

Here are the reasons per Marron that taxes should exceed their historical norm:

That rapid growth reflects six factors. First, the economy will recover, lifting revenues from currently depressed levels. Second, the 2001 and 2003 tax cuts will expire, as will tax cuts enacted in the 2009 stimulus. Third, the Alternative Minimum Tax, which is not indexed for inflation, will boost taxes for millions more taxpayers. Fourth, the new taxes that helped pay for the recent health legislation will go into effect. Fifth, retiring baby boomers will make more taxable withdrawals from tax-deferred retirement accounts. Finally, in a phenomenon known as bracket creep, growing incomes will push taxpayers into higher brackets and reduce their eligibility for various credits.

So assuming that we just hold to our present course, federal revenues should grow to levels substantially above historical norms. If spending were to remain somewhere in the historical range of 21% of GDP then we would clearly be running surpluses or at least balancing the budget. We are assured, however, that cannot happen because Social Security and Medicare payments are going to explode and eat up every single tax dollar in sight. Therefore, the only solution is to raise taxes.

Therein lies the con. There is nothing that suggests that both cannot be put on a more sustainable basis but that discussion is excluded from the debate.

Social Security is particularly susceptible to reform. Tweaking the retirement age, fiddling with COLA formulas and some minor means testing will put the program on solid footing. Most of the fixes are politically doable since they can be phased in over a number of years and won’t involve unbearable pain among the electorate.

Medicare and more broadly health care already has its fix in place. It’s Obamacare. While the program doesn’t involve much cost control in its present form, what it does do is make the inevitable “bending of the cost curve” politically easy. Benefits are being bestowed prior to the inevitable austerity that must follow not just to make the program financially feasible but to bring down the share of GDP that health care currently claims. The heavy lifting of rationing and ratcheting down the profit of the health care industry will be at the worst grudgingly accepted as the price that has to be paid to maintain the new benefits (I recommend you read this blog post by Bronte Capital concerning the likely path of cost control). Moreover, Congress has in its unique way created a system that will boot to the bureaucracy the unpleasant job of cutting the cost of health care.

So, we are being marketed a line that suggests the only path to fiscal responsibility is to raise taxes as future expenditures are baked into the cake. In fact, we should be having a discussion that includes increasing revenues, reforming and reducing the impact of entitlements and the desired level of government expenditures overall.

Deficits are wonderful tools for forcing the political class to focus on the bigger picture. Take the pressure off with new revenues and you’re going to give them the out they perpetually seek. Entitlement reform should be a prerequisite for any further discussion much less action with respect to new taxes. Once accomplished then we can move onto a reasoned compromise with regard to the size of the bite the government is going to take from the economy and the uses of those funds.

The one-sided argument that looks to tax increases as the only solution is a confidence game. It’s proponents want to establish a larger, permanent pool of money with which to finance expanded government. Whether that is in the country’s best interests and possible alternatives should be the subject of the debate.

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JournoList: Overblown Scandal And Sad Commentary

Posted by Tom Lindmark on July 24th, 2010

Still nursing a very sore right paw (hand), so blogging has been pretty close to impossible. Some new meds appear to be working, thus I’ll take a chance I can bang out a few posts without doing further damage.

Let’s start with the now infamous JournoList tempest.

If you’ve missed this one, it’s about a Progressive e-mail group that traded ideas related to the great and not so great issues of the day. A Washington Post writer was fired after it was disclosed that he had exhibited Progressive tendencies as a member of the group even though he was one of the Post’s designated conservative bloggers. The proverbial wolf in sheep’s clothing as it were.

Anyway, the archives fell into unfriendly hands and the group has been outed as it were. The founder of the email cabal, Ezra Klein, a blogger for the Washington Post of more than a little note closed down the site post-haste. That might have been a futile effort as it appears that the archives, or at least a big part of them, have been captured and the more damaging and/or embarrassing items are showing up on the Web.

The source of most of the disclosure is The Daily Caller, a conservative blog. They’re playing it for all its worth, so click on over if you want to really dive into this thing.

The rather unsurprising facts of the matter are that a bunch of Progressives were emailing each other their standard party line. They talked about the Conservative figures they loathed and discussed ways and means to advance their ideology. Some of that discussion involved suggestions about how to color or slant certain events to achieve their desired outcome.

For the most part, I tend to agree with Clive Crook who thinks that all of this is pretty unremarkable. If you set up a group of like-minded people to exchange views, they are generally going to do little more than reinforce a sort of group think. With 400 participants you’re going to get more than a couple of idiots who will pen the sort of nonsensical stuff that lends an aura of smarminess to the endeavor.

Having said that, there have been several writers who felt that the suggestions in the emails as to how to portray certain events in order to achieve Progressives’ desired outcomes were at best discomforting. James DeLong and Dave Schuler both feel that the members of the group, many of which are reputedly unbiased reporters, were actively engaged in constructing propaganda campaigns to be used on the pages of their employers’ media to advance their personal causes.

Through all of this, the members of the email group have attempted to portray their critics as at best shrill. Their defense is that the group amounted to nothing more than a club which exchanged thoughts and bounced ideas off one and other. That may be true but the speed with which Ezra Klein shut down the site suggests that there was probably more there than he or others would like to see the light of day. He also saw fit yesterday to write not one but two posts on the subject, each claiming to be his final discussion of the project. In essence protesting innocence too much.

JournoList was an egotistical and partisan endeavor that would at best been never undertaken. No laws were broken and though ethics might have been bent, they weren’t broken. It, however, has a smell that will cling to the participants for some time as well as diminish their credibility among those outside of their chosen circle.

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One Case For Bricks And Mortar

Posted by Tom Lindmark on July 18th, 2010

Wonder why investors have been snapping up single family homes? This graph from Mike Mandel might explain a little.

It’s probably worth noting that the gains from home ownership reflect only prices here, not the favorable tax advantages or, if you were an investor and bought wisely positive cash flow.

I tend to think that today’s investors in single family homes are going to have to sit for a long time before they recognize any sizable price appreciation. On the other hand, unless they’re brain dead, they have probably been able to pick up homes which generate pretty nice cash.

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Will Obama Stop Iran’s Nuclear March?

Posted by Tom Lindmark on July 18th, 2010

The World has been rightly focused on economics for much of the past two years, so much so that geopolitical issues, though raised often enough, have a tendency to be pushed back into the mists as we confront what we perceive to be the immediate threat.

Well, Walter Russell Mead has come along with a good post that reminds us that Iran, nuclear weapons and war are very real things that will most likely intrude on our singular focus.

Make no mistake about it. If Iran gets nuclear weapons on his watch, the dream of non-proliferation comes to an end and Barack Obama will go down in history as the president who lost the fight to stop nukes.

It won’t just be Iran: if Iran defies western pressure to get nukes, every self-respecting country in the Middle East will want and need nukes. Saudi Arabia, Turkey, Egypt and even some of the smaller fry will have to make their moves. They won’t all get the bomb but enough of them will. This will have a disastrous impact on America’s ability to carry out one of its principle global tasks and ensure the steady and uninterrupted flow of oil to the great industrial and commercial centers of the world — but that isn’t all. The decisive failure of the nonproliferation agenda in the Middle East undermine nonproliferation everywhere, not only because the Bomb will become even more of a coveted symbol of first class international status than it already is, but because with all those proliferating states buying and selling the technology, it will be harder to stop countries from moving ahead. The global black market in nuclear tech will spread like kudzu; there will be so many sources and so many destinations that the traffic will be harder than ever to stop.

Mead makes a thorough and reasonable case for the philosophies as well as realities that would drive Obama towards the war alternative. Nevertheless, personally at least, I have a hard time looking at the President and concluding that he would opt for that solution. I guess I just see an individual of great caution, to be charitable, when I look at Obama. Events, of course, have a way of trumping natural tendencies, so how he might react to the imminent nuclear arming of Iran is always going to be guess work to some extent.

Perhaps the more immediate implication is that the acquisition of the bomb by Iran is looking more and more like an event that will not only transpire but do so in the relatively near term. Even if it occurs without America or other countries resorting to military intervention, the reality when it occurs is going to have repercussions of seismic proportions.

Leaving aside the implications that Mead lists, the mere fact that the world balance of power, and particularly the balance that exists in the Middle East right now, will radically shift is going to land like a meteor in the middle of the global economy. Oil supplies which are stretched now are going to be subject to new laws of availability or at least perceived to be so constrained, probably resulting in a spasm of reaction which will rock the developed economies.

So worry away about double dips, austerity versus stimulus and sovereign defaults. Hopefully, all of that will be old news by the time we have to deal with a nuclear Iran or measures to prevent that from happening. Rest assured, however, that what we have seen for the past few years may be fondly remembered as the good old days if things go badly because of nukes.

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Small Banks And TARP: A Train Wreck

Posted by Tom Lindmark on July 14th, 2010

In the scheme of things it’s a bit trifling but this month’s report from the Congressional Oversight Committee charged with reviewing the execution of TARP and other facets of the financial services rescue is an object lesson in what can and may have gone wrong with the program. It deals with the plight of small banks that received TARP funds.

First, the numbers:

$205 billion was disbursed under the program to 707 banks.
Seventeen of 19 banks with assets greater than $100 billion received 81% of those funds.
Six hundred ninety banks with assets less than $100 billion received the rest of the money.
All of the 17 large banks have repaid their TARP investments while less than 10% of the smaller banks have done so.
One in seven small banks have missed a payment.
There is currently $24.9 billion outstanding to the small bank contingent.

The report goes into a lengthy discussion about the reasons for the disparate performance of the small banks relative to the large banks. Suffice it to say that the economy and the inability of the smaller banks to tap the equity markets are the principal reasons for the desultory performance. Significantly, the report notes that the situation might well worsen as more banks fail to maintain their dividend payments.

All of this is raising once again the question of why we included small banks in the program in the first place. After all, their failure or survival had little to do with the very real risks that the financial system was facing at the time the program was implemented. Here is the relevant discussion from the Commission:

It is also unclear whether the participation of small banks in the CPP has advanced Treasury’s broader aims for the program. Treasury’s main stated goal was to restore stability to the financial system, but the participation of small banks likely did not advance this cause. Even in the aggregate, by themselves the smaller CPP banks comprise too small a share of the banking sector to be systemically significant. Treasury’s other initial goal was to increase credit availability, but as the Panel explored in depth in its May 2010 report, there is very little evidence to suggest that the CPP led small banks to increase lending.

More recently, Treasury has articulated a different reason for opening the CPP to small institutions: fairness. In this view, Treasury had an obligation to provide smaller banks with the same access to capital as larger banks so as to avoid tilting the playing field in favor of larger institutions. Yet the ideal of fairness will be poorly served if the CPP has the effect of stabilizing large institutions while smaller institutions continue to struggle with growing losses and no capacity to repay their obligations to the taxpayers. Indeed, one of the most lasting and troubling effects of the CPP may be to increase concentration in the banking sector. In its earliest days the CPP provided a capital cushion that helped large banks weather the financial crisis and, in some cases, purchase smaller banks. Now small banks continue to struggle and the TARP provides little relief.

It’s usually wise to be especially alert when the government uses the fairness word. That’s often a sign that they are about to give money away. You won’t be surprised to learn that indeed forgiveness of some or all of TARP indebtedness is on the table or at least near the table. The Commission itself lets slip the concept in its report:

Treasury may remain invested in smaller banks through the CPP for years to come, which could destabilize the sector. The CPP was designed to provide Tier 1 capital to banks, so under the terms of the program, Treasury cannot call the investments; Treasury must remain invested in the CPP recipient until such time as the relevant regulator and the bank determine that the bank is able to pay off the CPP Preferred. While the dividend increase in 2013 may create an incentive for banks to repay, whether those repayments will be possible will depend on a variety of concerns particular to each individual bank, and a bank’s inability to repay after the dividend increase may signal weakness and increase stigma. Meanwhile, 9 percent may prove a costly dividend, and indeed some, or many, smaller CPP recipients may be forced to downsize or merge in order to pay off their investments. Treasury’s long time frame increases uncertainty, and subjects the investments to future financial shocks, management stresses, and other contingencies. In the face of these concerns, and in view of the relatively small sums involved, Treasury could consider writing off the investments. A write-off, however, would not only increase moral hazard, but might also contradict EESA’s mandate.

There never was a logical reason to extend TARP to the contingent of smaller banks that received funds. In reality, many were saved from extinction because of political connections, not for any rational economic reason. Having been the beneficiaries of an extended lease on life, it doesn’t seem unreasonable to ask them to pay back the money over the next three years or to suffer the consequences.

If the Treasury is going to fall back on a fairness argument for having included them in the first place, then it needs to hew to that line of reasoning. Fairness would also dictate that they suffer the consequences of a failure to live up to the terms of their contracts and that the taxpayer gets back the money that was advanced to them.

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Strategic Defaults, The Rich And Non-Recourse Loans

Posted by Tom Lindmark on July 9th, 2010

The topic du jour is David Streitfeld’s article in the NYT about the rich opting for strategic defaults. If you missed it, he uses some data from Core Logic and anecdotal tales to argue that the rich are defaulting at a rate in excess of the general population.

Streitfeld points out the concern that strategic defaults cause in the lending community:

Lenders are fearful that many of the 11 million or so homeowners who owe more than their house is worth will walk away from them, especially if the real estate market begins to weaken again. The so-called strategic defaults have become a matter of intense debate in recent months.

Fannie Mae and Freddie Mac, the two quasi-governmental mortgage finance companies that own most of the mortgages in America with a value of less than $500,000, are alternately pleading with distressed homeowners not to be bad citizens and brandishing a stick at them.

In a recent column on Freddie Mac’s Web site, the company’s executive vice president, Don Bisenius, acknowledged that walking away “might well be a good decision for certain borrowers” but argues that those who do it are trashing their communities.

Felix Salmon succinctly sums up his thoughts on whether or not people ought to walk away from their mortgages:

Well, sure, it’s not good social policy to strategically default. Fine. That doesn’t stop the rich, and it shouldn’t stop the rest of us either. I think it’s pretty clear which direction we’re headed in, and moralistic exhortations aren’t going to turn the tide.

I can’t disagree with Felix. If the rich or anyone else for that matter find themselves underwater on their homes and are astute or lucky enough to live in a non-recourse state then it’s folly all else being equal not to bolt. The situation, however, does raise a couple of questions.

One, should we eliminate non-recourse mortgages? Before you respond that they’re a product of state law and changing those laws is well nigh impossible, consider what would happen if Fannie, Freddie and FHA simply changed their standards and henceforth refused to purchase any loan that didn’t provide full recourse to the borrower. After the ritual political outrage, most state legislators would grudgingly amend their statutes in order to allow their local real estate markets to resume functioning.

And don’t think that this would now have an effect on the non-conventional mortgages. Fannie and Freddie still set the standards for underwriting and most jumbo lenders would not only jump on board, they would do so with glee.

Second, didn’t the Congress to an extent create this situation? Once they decided to suspend the tax liability for forgiven debt associated with home mortgages they eliminated a major barrier to strategic defaults. Maybe they need to revisit this. The tax code is already full of measures that discriminate against those with large mortgages so a tweak that, say, reimposes the penalty for non-conforming mortgages would not be inconsistent, nor would it be politically difficult.

If, and it’s a really big if, reform does come to residential mortgage finance that incorporates market disciplines, one would expect that homebuyers who live in non-recourse states would be socked with higher rates to compensate the lender for accepting that risk. Given that probability why shouldn’t we get a jump on it and get rid of non-recourse home loans now rather than later?

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Here’s How Spending Has Been Maintained

Posted by Tom Lindmark on July 9th, 2010

Sometimes the answers are pretty simple. This chart from EconomPicData.com pretty much tells you all you need to know about the state of the recovery, why businesses small and large are hoarding their cash and not hiring and probably why the Democrats get pasted in November.

Chart