The credit squeeze for growers

Click here for a brief conversation I had with Greenhouse Grower's Online Editor Sara Tambascio recently about what role suppliers and distributors play in the credit situation in floriculture and how growers can weather these volatile times.

Retail Holiday Outlook

Two independent surveys project the troublesome holiday outlook for retailers:

1. According to the National Retail Federation's (NRF) 2008 Holiday Consumer Intentions and Actions Survey, conducted by BIGresearch, U.S. consumers plan to spend an average of $832.36 on holiday-related shopping, up a paltry 1.9 percent over last year’s $816.69. This represents the lowest increase in planned consumer spending since the survey began in 2002.
   
   
2. A Deloitte survey released Wednesday was a bit more bleak in its findings. Almost six in 10 consumers said they would reduce spending this holiday season. Shoppers plan to spend about $532 on gifts, down 6.5 percent from last year, and buy fewer items. Nearly seven in 10 consumers said they would wait for store sales, cut back on shopping trips to save gasoline and use more store coupons.

From an earlier post, I quoted BusinessWeek.com saying:

"Call it a customer service Christmas. Consumers are expected to rein in spending this year, and the retail climate favors big-box stores that can offer bargains. But because small retailers can't win price wars, experts say independents need to leverage their biggest advantage over the chains: personal relationships with customers and the ability to deliver superior service. With some economists predicting one of the weakest Decembers since 1991, retailers that falter could face a cold winter." For the entire story, click here.

Another good quote I came across today:

“In the current economic environment, consumers are looking for value,” said Stacy Janiak, Deloitte’s U.S. Retail leader. “Heading into the holiday season, retailers will be well-positioned by emphasizing their unique value propositions, whether that means price, customer service, loyalty programs, or some other metric important to their customer base. In addition, given the current credit situation, retailers should take a close look at their financing options and conduct scenario planning, particularly with respect to liquidity issues.”

Since retail firms in the Green Industry should NEVER compete solely on price, they MUST differentiate their product and service offerings. Refer back to previous posts on differentiation strategies (click on the differentiation link on the right-hand side of this page) as a reminder of why this is so important!

The psychology recession

From the SAF Floral Trend Tracker newsletter:

It ís too early to show up on the official gauges, but we're surely in a recession now. The economy was actually holding up through most of the summer, but the news since August has been dreary, and one-sided.

The credit turmoil, the bank failures and restructuring, and the stock market volatility has been bad enough, and the bipartisan drumbeat of "This bailout bill has to be passed now!" has to concern the most financially secure, while increasing the anxiety of the rest of us. The desperation of the nation's political leaders warning us about being on the edge of financial collapse has exacerbated the problem.

Strong Engines. The economic engine of growth remains strong — productivity growth has been vibrant, and exports have been soaring. That allows businesses to absorb higher prices on their inputs without raising the price on their output and helps maintain profit levels. If productivity growth were limping along, or declining, then firms would find business expansion much more difficult.

Moreover, a broad measure of economic activity known as real (or inflation-adjusted) final sales jumped a very healthy 4.4% during the second quarter, up from just 0.9% during the first quarter. The fact that it was so much higher than real GDP's 2.8% increase means that households and businesses bought a lot out of business inventories during the quarter (GDP equals final sales plus the change in business inventories). A big drop in inventories, as we just experienced, foretells increased production activity as businesses respond to strong demand and rebuild inventory to desired levels.

Sticky Wheels. But now credit, the oil lubricating the engine, has turned to sludge. That's meant that lots of companies, large and small, are facing problems financing their regular operations, much less their business expansions. This troubling development will cause and prolong our downturn. Without the credit market problems, the housing market workout and the oil price shock were being handled without driving the economy into a recession. The recently passed financial bailout doesn't solve the problem, but it will help as it removes many of the toxic mortgage securities off corporate balance sheets.

We are getting a break in oil prices, and the price of gas has dropped by 20% or so since the summer. Sure, that's after a big run-up, and itís tough to know if the price decline will prove to be a brief respite or a long-lasting correction. But the lower prices are giving household and corporate budgets more breathing room.

The economy will recover when confidence replaces fear in the credit markets, as it will (it always has). We'll still be reassessing value in many housing markets, and the recovery may be subdued as consumers avoid over-leveraging themselves with the purchase of big-ticket items. But then sticking to a low-debt diet will be a good thing, as we've learned.

Author Robert Barr is an economist in Northern Virginia

How will the candidates' tax plans affect Joe the Grower, Joe the Landscaper, and Joe the Retailer?

According to a new analysis by the Tax Policy Center, a joint project of the Urban Institute and the Brookings Institution, Democrat Barack Obama and Republican John McCain are both proposing tax plans that would result in cuts for most American families. Obama's plan gives the biggest cuts to those who make the least, while McCain would give the largest cuts to the very wealthy. For the approximately 147,000 families that make up the top 0.1 percent of the income scale, the difference between the two plans is stark. While McCain offers a $269,364 tax cut, Obama would raise their taxes, on average, by $701,885 - a difference of nearly $1 million.

Poor Joe the Plumber has become a political metaphor: something no one ever wants to be. As we all know by now, based on his actual (rather than aspirational) income of $40,000, Joe would get a slightly bigger tax cut under President Obama than President McCain.

But in one sense, even though the real Joe doesn’t own a business, most small business owners, like Joe, also have very modest incomes. Based on a sample of individual income tax returns, TPC finds that among tax units that receive most of their income from their own business, a partnership or a farm (reported on schedules C, E, or F), more than half have income below $30,000 and 80 percent make less than $100,000. (Table T07-0206)

The vast majority of small businesses would not be affected by Obama’s income tax increases. Among those that receive at least half of their income from a business or farm, 335,000 (2.7 percent) are in the top two tax brackets that are targeted for Obama’s tax increases. (Table T08-0164) Among tax units with any income from a business, 663,000 (1.9 percent) are in those tax brackets. Clearly, most business owners are safe from Obama’s individual income tax increases.

The individual income tax return data do not provide a precise picture of how taxes affect “true” small business owners. Some people who report business income on their tax returns are not really self-employed and some small businesses are “C” corporations that pay corporate instead of individual income tax on their business profits.

Many people report some business income from freelance activities while they are full-time employees. Members of corporate boards, for example, report their compensation for that service on schedule C of their individual tax return. Partners in many law firms, accounting firms, medical practices, and Wall Street hedge funds also report business income rather than wages, as do people who receive rents or royalties from investments in real estate and oil and gas partnerships.

All of these factors overstate counts of small business owners based on individual income tax return data. On the other hand, some small businesses are organized as taxable corporations (C corporations) and pay out all or most of their income as compensation to their owners to minimize corporate tax.

Despite these caveats, it seems likely that relatively few taxpayers who are small business owners (including Joe the Grower; Joe the Landscaper; and Joe the Retailer) will be affected by increases in the top two individual income tax rates.

Sources: Washington Post, 10/20/08; Tax Policy Center TaxVox blog, 10/14/08

Comparison of subprime devastation and S&L collapse

Interesting graphic (click to enlarge) from Bloomberg, comparing the present Subprime debacle versus the S&L crisis. Here is an excerpt:

The $700 billion bailout of Wall Street's subprime-tainted securities harkens back to the real- estate bets that sparked the savings and loan crisis in the 1980s. The geography's the same, too.

Then, as now, the government created a taxpayer-funded enterprise to absorb the fallout from bad real-estate investments. A Bloomberg map of the hardest-hit areas shows that, with the exception of Nevada, regions with the highest foreclosure rates also had the most savings-and-loan failures, according to the Federal Deposit Insurance Corp.

The overlap shows that the aggressive lending and speculation that ignited the savings-and-loan meltdown persisted, at least in those areas, according to Paul E. Johnson, who was mayor of Phoenix from 1990 to 1994.

Source:
Subprime Devastation Retraces Path of S&L Crisis in U.S. States
Jonathan Keehner and Bob Ivry, Bloomberg, Oct. 8 2008

Better than the debates

At the 63rd annual Alfred E. Smith Memorial Foundation Dinner, John McCain and Barack Obama exchanged comedic jabs. The Al Smith dinner is a charity event organized by the Catholic Archdiocese of New York for the benefit of needy children. An estimated $4 million was raised. The event often draws politicians as speakers and, by long tradition, presidential candidates appear as headliners every four years. In this case, the evening of humor came one night after an intense final debate of the presidential campaign.

Falling gas prices act almost like a tax cut

According to the most recent data from the Federal Highway Administration, the total traffic volume over the most recent 12-month period (through July 2008) was 2.944 trillion miles. According to data from the EIA, the average fuel efficiency for all vehicles in 2006 (most recent year reported) was 17.2 miles per gallon. That means that the amount of gasoline required for the traffic volume over the most recent 12-month period was 171,216,860,465 gallons (2.944 trillion miles driven divided by 17.2 miles per gallon).

Therefore, every penny decrease in the price of a gallon of gas would equal more than $1.71 billion in consumer savings over a year (171.216 billions of gallons X $0.01). In that case, the $1.10 per gallon decrease in gas prices from $4.12 in July to $3.02 this week (data here), would represent annual consumer savings of $188 billion from the fall in gas prices just so far over the last three months (compared to a scenario where gas stayed at $4.12 per gallon).

An alternative calculation is to use the EIA estimate of 390 million gallons consumed per day in the U.S. times 365 days per year, or 142,350,000,000 gallons annually. For each penny decrease in the price of gasoline, consumers would save $1.4235 billion annually according to this approach, and will save $156.6 billion over the next year from the $1.10 per gallon decrease in gas prices since July.

If gas prices continue to fall over the next month (which seems likely), it could be like a $200-$300 billion tax cut for the economy.

Of course, it does beg the question of why have we not invested more in fuel efficiency of our vehicles? 17.2 miles per gallon seems ridiculously low.

Who will economists vote for?

The title reflects a question that I have been asked several times by friends lately. I was surprised that anyone cared, but nonetheless, here is the answer -- it depends. OK, I know what you're thinking. That is the typical retort you might expect from an economist, but hear me out.

Much ado has been made of various lists of economists supporting Obama (click here) and those supporting McCain (click here). But a recent survey (click here) of over 500 economists drawn from a subset of members of the American Economic Association, indicated that "Not surprisingly, 88 percent of Democratic economists think Democratic Sen. Barack Obama would be best, while 80 percent of Republican economists pick Republican Sen. John McCain." So obviously, there is a strong correlation between favored economic policies and political pursausion.

Why does this matter? Well, for the most part, we need to understand where folks are coming from when we read or listen to them. To me, it is important to know enough to know the difference.

For example, among the plethora of resources I consult each day, I regularly read the column in the NY Times of recent Nobel prize winner Paul Krugman (a very good Princeton economist) who has made no secret of his Democratic leanings. But I also read stuff from Martin Feldstein (another very good economist) who is a professor of economics at Harvard and President Emeritus of the National Bureau for Economic Research. Martin also happened to be Chairman of President Ronald Reagan’s Council of Economic Advisors, so obviously he has a Republican slant.

So when I read comments from these guys [and others], I can better understand WHY they they hold certain positions because I know from "whence they came," so to speak. The same holds true with mainstream media pundits as well. Unbiased commentary is a rarity, so it behooves us to, again, know enough to know the difference.

A mind is a terrible thing to waste! So read, listen, debate, evaluate, discern -- use your gray matter -- to decide where you stand. Because as the saying goes: "if you don't stand for something, you'll fall for anything!"

More market commentary...

Putting "Panic" into Perspective -- click here

We're Laying the Groundwork for Recovery (Bernanke in today's WSJ) -- click here

Dow Jumps 938 Points after Historic Weekend!

The eight-day losing streak ends Monday after central banks and governments announced measures to bolster the global financial system. Click here.

See the Forest, not Just the Trees

"We are not going to have a depression, and we have survived financial crises before. A century of investing experience, as well as insights from the field of behavioral finance, suggest that investors who bail out of equities during times like these are almost always making the wrong decision.

Look at history: The market eventually bounded back from the damaging stagflation of the 1970s and the savings-and-loan crisis of the early 1990s, when a whole industry had to be rescued. Stocks also recovered from the Asian crisis of the late 1990s. Similarly, investors who held on after the more than 20% one-day stock-market decline in 1987 were eventually well rewarded.

Don't forget that the U.S. economy is still the most flexible in the world and our "innovation machine" is alive and well.

No one has consistently made money by selling America short, and I am confident the same lesson is true today."

~Burton Malkiel in today's WSJ (click here)

Interesting commentary

Some pretty good commentary from Kasey Gahler regarding:

1. A Look Back at the past 18 Elections - See What Elections Have Meant to the Economy Over the Past 72 Years (click here)

2. Past Market Rebounds - How Long Will it Take to Turn this Around? (click here)

3. What To Do During Turbulent Times - Some Tangible "To-Do's" (click here)

Financial wisdom???

If you had purchased $1,000 of Delta Air Lines stock one year ago, you would have $49 left.

With Fannie Mae, you would have $2.50 left of the original $1,000.

With AIG, you would have less than $15 left.

But, if you had purchased $1,000 worth of beer one year ago, drunk all of the beer, then turned in the cans for the aluminum recycling REFUND, you would have $214 cash.

Based on the above, the best current investment advice would be...

The other side of the coin

With the news full of failing banks, dried-up credit and falling stock markets, it’s no shock that people are afraid about what’s ahead, entrepreneurs included. And yet even in the midst of all this, the opportunities ahead are bright for green businesses providing renewable energy.

In a recent post, I outlined the non-financial sections of the “Emergency Economic Stabilization Act of 2008” fully expressing my frustrations. But there are always two sides of every coin. Perhaps the silver lining in the "bailout cloud" was an extension and expansion of tax credits for renewable energy. The impact of the $700 billion bailout remains uncertain as this point, but the impact of these incentives for renewable energy is likely to be huge, helping to solve our financial problems, our climate problem, and our energy problems at the same time.

The bill provides for an eight-year extension of renewable energy investment tax credits covering up to 30% of the cost of solar power projects for homes or commercial sites. The short time frame of these tax credits in the past, and their frequent expiration from year to year have created enough uncertainty to dampen long-term growth. Eight years is long enough to allow for long-term planning, and encourage long term growth.

Along with the extension of the credits, the $2000 cap on the tax credit for residential systems has been removed. With a residential system of $30,000, the tax credit will be $9000 in 2009 rather than being limited to $2000 as before. While a large percentage of the solar market has been limited to states like California that have provided the most generous state-level subsidies, removing the cap will greatly expand the market for solar power across the country.

Distributors and installers will see opportunities expand nationwide. A recent study by Navigant Consulting found that extending these credits will create 440,000 jobs, contributing to the growth of green collar jobs, and these numbers did not include the removal of the cap.

Other renewable energy technologies will also benefit from the measures in the bill, including small wind, geothermal, fuel cells, and ocean (wave/tidal) energy. The measure allows utilities to take advantage of the investment tax credit as well, removing another restriction, and allows clean energy bonds to be created to support the creation of renewable energy production.

As renewable energy continues to grow and its costs fall, it’s becoming increasingly competitive with power from other sources like coal. These tax credits will help to get us there. We're not out of the woods yet by a long shot, but these moves to a greener economy may help us dig our way out.

Survey indicates slowdown impacting landscape architects

Less than half of landscape architecture offices responding were busier than usual last quarter, and only a quarter of firms plan to hire in the short term as the economic turmoil begins to be felt across the profession, according to the latest Business Quarterly survey by the American Society of Landscape Architects (ASLA).

Only 44 percent of the 267 responding landscape architecture offices reported average or above billable hours in third quarter 2008, (July 1 – Sept. 30), and just under 43 percent reported average or above inquiries during the same period—12 and 7 percentage-point reductions, respectively, from the previous quarter. Additionally, just over 25 percent plan to hire in the upcoming quarter, down from 29 percent in the second quarter.

“The reduced demand for landscape architecture work comes as no surprise considering the current problems with the economy,” said Nancy Somerville, executive vice president and CEO of ASLA. “International projects, particularly in the Middle East and Pacific Rim, are a strong and expanding source of work for many firms. Domestically, the public sector remains the most robust source of projects.”

Becoming a what?

Source: http://www.gocomics.com/adamathome/

Gas prices fall below $3.00 in Midwest

Lowest reported gas prices today in: Texas: $2.68; Oklahoma: $2.80; Missouri: $2.79; Kansas: $2.87; Iowa: $2.87; and Minnesota: $2.94.

Regional economic contractions vs growth

Nice depiction of where the pain is being felt most:
click for ginormous version

This is obviously having a political effect:
click for ginormous version

Sources:

For Most Cities, Recession Has Arrived
BILL MARSH
NYT, October 4, 2008
http://www.nytimes.com/2008/10/05/weekinreview/05marsh.html

Economic Unrest Shifts Electoral Battlegrounds
ADAM NAGOURNEY and JEFF ZELENY
NYT, October 4, 2008
http://www.nytimes.com/2008/10/05/us/politics/05map.html

What got us here in the first place?

After having time to think more about the current financial industry crisis, I think the reason it is confusing is that it is the result of two parallel but largely independent causes that worked together to create this mess. Conservatives will see government intervention as the problem; liberals will see greed and deregulation.

What makes this situation particularly confusing is that of the two causes I believe led to the crisis, each has been embraced by one of the two parties as the only cause. It's a case where everyone is half right, but the other half is important too. It's a two part recipe, with neither active ingredient causing much of an explosion until mixed with the other.

Cause 1: Creating the Asset Bubble

The first thing that had to happen for the crisis was the creation of an asset bubble. There had to have been some type of over-valued asset whose prices crash to earth to spark the crisis. So we begin with housing.

Home prices have gone through boom-bust cycles for years, just as have many commodities. There is a whole body of literature on such cycles, so we will leave that aside and accept their existence as a feature of markets and human behavior.

But this housing bubble had a strong accelerant, in the form of the Federal government. For years, this nation has made increasing home ownership a national goal and many laws and tax policies have been aimed at this goal. The mortgage interest deduction on personal income taxes is just one example.

Starting in 1992, Fannie Mae and Freddie Mac, which were strange quasi-public / quasi-private entities, came under pressure from the Congress (e.g. Barney Frank) and the Clinton administration to add increasing home ownership to poorer people part of their missions.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has.

The results were astonishing:

Beginning in 1992, Congress pushed Fannie Mae and Freddie Mac to increase their purchases of mortgages going to low and moderate income borrowers. For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target — 42% of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50% in 2000 and 52% in 2005.

For 1996, HUD required that 12% of all mortgage purchases by Fannie and Freddie be "special affordable" loans, typically to borrowers with income less than 60% of their area’s median income. That number was increased to 20% in 2000 and 22% in 2005. The 2008 goal was to be 28%. Between 2000 and 2005, Fannie and Freddie met those goals every year, funding hundreds of billions of dollars worth of loans, many of them subprime and adjustable-rate loans, and made to borrowers who bought houses with less than 10% down.

Fannie and Freddie also purchased hundreds of billions of subprime securities for their own portfolios to make money and to help satisfy HUD affordable housing goals. Fannie and Freddie were important contributors to the demand for subprime securities.

Simultaneously, the 1977 Community Reinvestment Act was pushing private banks to make more loans to less qualified borrowers:

The Community Reinvestment Act (CRA) did the same thing with traditional banks. It encouraged banks to serve two masters — their bottom line and the so-called common good. First passed in 1977, the CRA was "strengthened" in 1995, causing an increase of 80% in the number of bank loans going to low- and moderate-income families.

These actions had a double whammy on the current crisis. First, by pushing up housing demand, they inflated the housing pricing bubble. Second, it meant that these inflated-price homes were being bought with lower and lower down payments. In effect, individuals were taking on much more leverage (leverage is a term that I will use to mean the percentage of debt used to finance a set of assets -- more leverage means more debt and less equity. The term comes from the physics of a mechanical lever, in that more debt, like a lever, can magnify force. Profits from assets are multiplied by leverage, but, alas, so are losses.)

When the economy softened and the housing bubble started to burst, these new mortgage customers [that the government went out of its way to bring into the system] did not have any resources to handle the changes -- they did not have the down payment to cushion them (or the banks) against falls in asset value and did not have the cash flow to cushion them against falling income in the recession and/or rising interest rates.

The result: Huge portfolios of failing loans with rapidly falling collateral values.

Cause 2: Over-leverage of Risky Assets and Related De-regulation of Capital Requirements

Needless to say, the word "greed" was used a LOT during the Vice-Presidential debate. But what does it mean in this context? After all, we are all greedy in one way or another, if one equates greed with looking after one's self-interest.

So I will translate "greed" for you: When you hear "greed on Wall Street", think leverage. Remember, we said above that as long as the underlying asset values are going up, leverage (ie more debt) multiplies profitability. [Quick example: Assume a stock that goes from $100 to $110 in a year. Assume you pay 5% interest on money. No leverage, you make $10 on a $100 investment. With 95% leverage -- ie buying $2000 worth of the stock with $100 equity and $1900 debt -- you would make $105 on the same $100 equity investment. Leverage multiplied your returns by more than a factor of 10]

Remember that around the year 2000 we had the Internet bubble burst in a big way. A lot of companies not only dropped, but went to $0 in value. This was painful, but we did not have a cascading problem. Why? In part because most of the folks who invested in Internet companies did not do so in a highly leveraged way. The loss was the loss, time to move on. Similarly, in this case, if these mortgage packages had been held merely as a piece of a un-leveraged portfolio, like a pension fund or an annuity, the loss would not have been fun to write off, but it would not have cascaded as it has. The government would have had to bail out Fannie and Freddie, a few banks would have failed, but the disaster would have been limited.

One reason this problem has cascaded (forgetting for the moment Henry Paulson's chicken-little proclamations of doom to the world) is that many of these mortgage packages or securities got stuck in to highly leveraged portfolios. The insurance contracts that brought down AIG were structured differently but in the end were also highly leveraged bets on the values of mortgage securities in that small changes in values could result in huge losses or gains for the contracts.

If this all sounds a bit like cause #1 above, e.g. buying inflated assets with more and more debt, then you are right. There is an interesting parallel that no one wants to delve into between the incentives of home buyers trying to jump into hot housing markets with interest-only loans and Wall Street bankers putting risky securities into highly leveraged portfolios. Leverage is really the key theme here. In a sense, houses were double-leveraged, bought the first time around with smaller and smaller down payments, and then leveraged again as these mortgages were tossed into highly-leveraged portfolios. Sometimes they were leveraged even further via oddball derivatives and insurance contracts whose exact operation are still opaque to many.

Personally, I would have let the market forces play out without any government intervention. You probably gathered that from the tone of previous posts. Wall Street has been living high on the extra profits from this leverage during "the good times." They knew perfectly well that leverage is a two-edged sword, and that it would magnify their losses in a bad time. But their hubris pushed them into doing crazy things for more profit, and I am all for a Greek-tragedy-like downfall for their hubris [as long as Main Street is not taken down in the process]. The sub-prime, first-time home buyer can claim ignorance or unsophistication, but not these guys.

During the Bush Administration, these bankers came to the SEC trumpeting their own brilliance, and begged to be allowed to leverage themselves even more via a relaxation of capital requirement rules. And, in 2004, without too much discussion or scrutiny, the SEC gave them what they wanted:

Many events in Washington, on Wall Street and elsewhere around the country have led to what has been called the most serious financial crisis since the 1930s. But decisions made at a brief meeting on April 28, 2004, explain why the problems could spin out of control. The agency’s failure to follow through on those decisions also explains why Washington regulators did not see what was coming.

On that bright spring afternoon, the five members of the Securities and Exchange Commission met in a basement hearing room to consider an urgent plea by the big investment banks.

They wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments.

In part they traded capital requirements for computer models, a very dubious decision in the first place, made worse by the fact that most of the banks were gaming the models to reduce the apparent risk. The crazy thing is that, in gaming the models, they really weren't trying to fool regulators, who pretty much were not watching anyway, but they were fooling themselves! Certainly I would not expect government regulators to do a better job of risk assessment in this environment, which argues for a return to the old bright-line capital requirements that are fairly simple to monitor. Investment banks played a game of Russian Roulette, and eventually lost. Which begs the question of whether the government's job is to protect consumers at large or to protect financial institutions from themselves.

“We foolishly believed that the firms had a strong culture of self-preservation and responsibility and would have the discipline not to be excessively borrowing,” said Professor James D. Cox, an expert on securities law and accounting at Duke School of Law.

The Ratings Agencies Didn't Do Their Job Either

Clearly, ratings agencies have really failed in their mission during this fiasco. Right up to the last minute, they were giving top ratings to highly risky securities. But I think folks who want to lay primary blame on the rating agencies go too far. Ratings agencies are for individuals and state pension funds and the like -- I have a hard time imagining companies such as Goldman or Lehman depending on them (ratings agencies) for risk assessment. Its a nice excuse, and we may well have very different companies rating securities five years form now, but its just a small contributor.

So What is The Fix?

So you see what is going on. Republicans are running around saying "the government caused it with the CRA" and Democrats are saying "it was greed and deregulation." Incredibly, both parties seem to come to the conclusion that sickly mortgage securities need to be pulled out of the hands of the folks who created and bought them and put in ... OUR hands.

As I said before, I personally would have let the whole thing sort itself out, and lived with the consequences. My hypothesis is that much of the current credit squeeze in the money markets is due to Henry Paulson's clumsy public statements and the Fed's busting open the door to overnight borrowing. Everyone is frozen not by the crisis, but by the prospect of some sort of incalculable government action. Short term borrowers and lenders are doing their business with the Fed, while the government crowds out the private short-term markets and causes the very problem it is trying to prevent.

Without the government bending over backwards to take in short-term money from lenders, private firms would be forced to find private options. Lenders have to lend to stay alive financially, just as much as borrowers have to borrow. Money may go into the mattresses for a week or two or three, but it can't stay there forever.

What was once a three-page plan from Henry Paulson became 110 pages long when considered by the House and it is now a 451-page monster. The Emergency Economic Stabilization Act of 2008 now also includes the Energy Improvement and Extension Act of 2008 and a smorgasbord of other add-ons. MUCH has been written about why we need such a monumental intervention, but I find it VERY interesting that, amid discussions of eliminating pork and earmarks, this bill is laden with them.

For example, someone explain to me how "fixing" our ailing financial system includes the following:

Sec. 101. Renewable energy credit.
Sec. 102. Production credit for electricity produced from marine renewables.
Sec. 103. Energy credit.
Sec. 104. Energy credit for small wind property.
Sec. 105. Energy credit for geothermal heat pump systems.
Sec. 106. Credit for residential energy efficient property.
Sec. 107. New clean renewable energy bonds.
Sec. 108. Credit for steel industry fuel.
Sec. 109. Special rule to implement FERC and State electric restructuring policy.
Sec. 111. Expansion and modification of advanced coal project investment credit.
Sec. 112. Expansion and modification of coal gasification investment credit.
Sec. 113. Temporary increase in coal excise tax; funding of Black Lung Disability
Trust Fund.
Sec. 114. Special rules for refund of the coal excise tax to certain coal producers
and exporters.
Sec. 115. Tax credit for carbon dioxide sequestration.
Sec. 116. Certain income and gains relating to industrial source carbon dioxide treated as qualifying income for publicly traded partnerships.
Sec. 117. Carbon audit of the tax code.
Sec. 111. Expansion and modification of advanced coal project investment credit.
Sec. 113. Temporary increase in coal excise tax; funding of Black Lung Disability Trust Fund.
Sec. 115. Tax credit for carbon dioxide sequestration.
Sec. 205. Credit for new qualified plug-in electric drive motor vehicles.
Sec. 405. Increase and extension of Oil Spill Liability Trust Fund tax.Sec. 306. Accelerated recovery period for depreciation of smart meters and smart grid systems.
Sec. 309. Extension of economic development credit for American Samoa.
Sec. 317. Seven-year cost recovery period for motorsports racing track facility.
Sec. 501. $8,500 income threshold used to calculate refundable portion of child tax credit.

And, of course, the big one:

Sec. 503 Exemption from excise tax for certain wooden arrows designed for use by children.

All of these, however, are part of the bailout bill approved by the Senate. Sources here and here. Anyone else frustrated???

Read my lips...

Here at the conclusions of a study released yesterday by the Tax Policy Center:

The tax proposals of both presidential candidates would alter effective marginal tax rates in complicated ways. Senator McCain’s plan would—among other things—reduce statutory rates, increase the dependent exemption, and raise the AMT exemption level. In addition to also changing statutory rates and raising the AMT exemption, Senator Obama would modify existing deductions and tax credits and introduce several new ones. The numerous phase-ins and phaseouts that these credits entail would affect marginal rates, lowering them for some taxpayers and raising them for others.

Overall, the Obama plan would lower effective marginal tax rates for the majority of households. In 2009, only about 1 in 7 households would see an increase in their marginal rate. Only at the top of the income distribution—households making at least $500,000 a year—would a majority of taxpayers face higher rates. Obama’s plan would leave the average marginal rate on wages and salaries for the economy as a whole unchanged at 24 percent in 2009. In that same year, close to 80 percent of the population would see no change in their marginal rates under Senator McCain’s plan and most other tax units would face lower rates; only about 1 percent of households would experience a marginal rate increase under the fully phased in McCain plan. Overall, Senator McCain’s plan would reduce the average marginal tax rate on wages and salaries by about 1 percentage point, to 23 percent in 2009.

Senator Obama’s proposal would result in an average marginal tax rate of 25 percent on wages and salaries in 2012, lower than under current law but higher than if the tax cuts are extended. Because Obama would leave the top two statutory rates at 36 and 39.6 percent and reinstate PEP and Pease, taxpayers with more than $1 million in income would face an average marginal rate of 40 percent, 6 percentage points higher than under the McCain plan. Overall, because it would extend all of the individual income tax components of the 2001–06 cuts and increase the dependent exemption, the McCain plan would lower the average EMTR for all households slightly relative to a tax cuts extended baseline and significantly compared with current law.

For the full report, click here.