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Two percent inflation is essential to the illusion

Jared Bernstein in WaPo recently said, “Why is 2 percent the Federal Reserve’s inflation target? Because it is.” The idea being that the world’s central bankers and economists and money men pulled this number out of their left ears because they didn’t know what else to say.

But Martin Wolf actually gave a real answer to that question, which had been bothering me for years.

[E]xperience shows that the low inflation targets to which policy makers are committed are not high enough to ensure short-term interest rates can remain above zero in all circumstances….

His article is on another topic — the need for financial reform — but that sentence gave me an Aha! moment.

Interest rates have to be high enough so that people with money feel they’re getting something for it, even if in reality they aren’t.

If, in reality, they’re not getting anything then the honest interest rate would be zero percent. But who wants that? You might as well have kept your money in your mattress and saved yourself the fifteen cents of gas getting to the bank to open an account. Then, of course, nobody could use your money to make money. The powers-that-be are terrified of people deciding to keep their money in mattresses.

So it’s vital to give people the illusion that they’re getting something for their money. Obviously, if the best you can do is zero, a 10% interest rate (and 10% inflation) is a much more exciting illusion than 2%. But the problem with high inflation is it starts running away with itself and the whole economy lands in the shredder. Two percent, on the other hand, seems to be about the lowest return that still motivates people to buy bonds. (Wolf’s point is that 2% isn’t working. The illusion needs to be set higher, at 4% perhaps.) The fact that it’s fictional if there’s matching inflation doesn’t matter. Even professionals buy the things so long as there’s at least a small positive number attached. (They report their year-end results in ordinary numbers, not inflation-adjusted ones.)

It’s a shell game, in which you provide money in the hope of gain. By the time you find out it was all fairy money, it’s too late to do anything about it.

And that’s why there’s a 2% target for inflation.

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Hah. I’m way ahead of Carlos Slim.

He’s making the news because he’s a gazillionaire and he thinks people shouldn’t work so much.

All right. I mean, really now, isn’t it obvious? If we spread time and money around a bit we could all be working less and enjoying it more.

I made that point years ago. But, not being a gazillionaire, I’m one of those people who’s actually done overlong work weeks, so what do I know?

The only thing he does wrong is not take it far enough.

He’s talking about a three-day work week of 11-hour days. (Financial Times but with stupid login restrictions. The gist also here.) So it’s not really a big change from the civilized world with its current 35-hour week. And there’s research (I’ll come back with the link as soon as I dig it up) that people’s productivity slopes off toward the end of even an 8-hour day. It’s d.u.m.b to use people as placeholders to fill up traditional and counterproductive time.

What we need is 24-hour work weeks. Yes, twenty four hours. It seems like a huge departure, but once upon a time a work week was on the order of 70 hours. Halving that to 35 to 40 has helped, not hurt, economies.

The same would happen with 24-hour weeks. If people were paid real living wages for those hours, it would mean significantly more even distribution of wealth. As I think we’ve all figured out by now, that would be a good thing. Rich people would be making twenty or forty times as much as ordinary people. Not hundreds or even thousands of times more. Economies have plenty of resources to provide for (normally) rich people and lots of ordinary people able to live on their 24 hours per week of work. Really. Read that first link up there. I go through the numbers.

And it would solve other problems, too. With 24-hour weeks, there’d be many ways to slice up shifts. Work could be four hours a day for six days, or eight for three, and so on. Within a day, shifts could start every four, six, eight, or, hell, even twelve hours if that works in some cases. The flexibility would be good for everyone: students, people with errands to run, creatives, you name it. Employers could, by law, accommodate caregivers with different shifts. Child care or elder care could become much simpler to arrange.

Honestly. It’s time. The wealth produced by our technologically advanced economies is festering because it’s all piled up in a tiny space and doesn’t get air.

A wage you can live on for a week you can live in.

Happy elderly Siberian couple, photographer unknown

Real wealth

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Why austerity was cool


The idea that austerity could help economies by ending profligacy and wastefulness has been proved wrong again. It’s been wrong based on the evidence since the 1930s. For a while, everybody knew that. Then “everybody” forgot it, it became all the rage in policy circles, and now it’s failing again as badly as fantasies do.

So why was it listened to? Gradually, I see more and more people noting the obvious answer. “Because it’s what the Powers That Be wanted to hear.” [You’ll notice most of the links point to Krugman. Yes, I get large chunks of my econ news from him.]

That’s important because even the most perfect spreadsheet can’t fix it. (Background if you’d like it: Konczal’s article on Herndon’s Reinhart-Rogoff criticism.) If the problem is denial of facts and not the lack of facts, then clearer and louder facts won’t help. When people want to hear something, they hear it. If the Powers That Be want to hear that austerity is the answer, and all the economists refuse to tell them so, they’ll simply start getting their answers from physicists or CEOs. Consider the unanimity among climate scientists that humans are causing global warming, and the total lack of those scientists when politicians find “authorities” to deny anthropogenic climate change.

The first question becomes why the austerity message was so captivating. I’ve seen it explained as the desire for the neatness of a morality play. (“Spending? Bad! You must pay for your sins!”) But that idea makes no sense. If the Powers That Be were that interested in morality, I can think of many things ripe for punishment. Yet somehow the only programs in need of scourging hit people poorer than the PTB.

I also don’t think that the unwillingness to admit being wrong explains everything. It can explain a lot. But it doesn’t explain why they fell for such a thoroughly debunked fallacy in the first place. These are all intelligent people with a lot of training in reading comprehension. They don’t make such floaters unless they want to.

The simplest place to start when probing motives is to follow the methods of the experts, homicide detectives, and ask, “Who benefits?”

Money should be taken from the poor, the sick, the elderly, because … because what? There’s nowhere else to get it? I can think of two other large pots of money in the USA. One is the spending on expensive military hardware. Two is the absurdly low tax rates paid by corporations and wealthy individuals, the “one percenters.”

Could it be that by directing attention to the weakest members of society they’re hoping nobody notices that their money could solve any shortfalls better, (socially) cheaper, and faster?

Why, yes. Yes, I think it could. This is a classic example of “don’t tax him, don’t tax me, tax the fellow behind the tree.” It’s understandable. We all feel that way. But that doesn’t make it right or intelligent or likely to deliver the greatest good to the greatest number.

Diagnosis accomplished in two easy steps and the only training needed is an appropriately suspicious nature. That means it can easily be applied in real time.

That diagnosis also makes the solution painfully evident. Everybody’s seen it who isn’t hypnotized by wealth. Money from the rich has to be a factor. It’s not off the table, inconceivable, crazy talk. Because the solution is so obvious, it could even be applied before we have a problem, which is the nicest time to apply solutions.

And that’s why austerity was so cool for so long. It’s allowed the Powers That Be to say for years, “Look! Over there. Poor people getting money!” while keeping their piles of tax-sheltered wealth right out of the discussion.

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Why Austerity is Necessary: short version


US White House state dining room during Bush PresidencyDoes anyone honestly think austerity is important to the restoration of fiscal balance because discipline and frugality lead to wealth? The people promoting austerity are invited to dinner in places like the room to the right. They’re doing well and not practicing austerity, so the answer must lie elsewhere.

And, really, it’s not that hard to figure out if you remember not to listen to a word they say.

  • 1) For whatever reason (the crash in this case) there’s not enough money to go around.
    • 1a) It is necessary to get the money from somewhere.
  • 2) You could get it from rich people.
    • 2a) If you do this by making them take the loss (= no taxpayer-funded bailout), they will threaten to take their ball and go home. (For instance, “I won’t buy your treasury bonds. I’ll buy somebody else’s.” Government goes into cold sweat worrying about finding money and has a crisis of confidence. This is the real “confidence fairy.”)
    • 2b) Assuming you must bail out the rich, the government could cover the cost by taxing the rich. But the wealthy own the media, plus they can defund re-election campaigns, so the actual people in government would be out of a job. This, too, leads to cold sweat, but it does not yet have a catchy name. (The “keep-my-job fairy”?)

  • 3) You could get it from everybody else.
    • 3a) Everybody else objects because they didn’t cause the problem, so why should they pay for it?

Because austerity! It sounds so much better than,

“You pay for it. I don’t want to.” And way better than,

“I don’t need you for anything, Bub. Pay up.”


Full disclosure: I am (obviously) not an economist.

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Free markets are for losers


You don’t have to believe me. The S&P says so. At the very heart of the supposedly free market, right there on Wall St., they’ve got no use for it. Standard & Poors announced a mass of ratings cuts for the biggest names in banking.

Bank of America and Goldman Sachs, … Barclays, HSBC, … Citigroup, … Morgan Stanley, Commerzbank, and UBS, [all] had ratings cut by one notch. …

But. But, but, but, and however,

it upgraded ratings on two Chinese banks, Bank of China Ltd. and China Construction Bank Corp. …

The upgrade for the Chinese banks has come at a time when there have been increased concerns about the health of the country’s banking sector. …

Analysts said while the Chinese banks were prone to the risk of accumulating bad debt, they still remain a safe bet.

“The key factor is that they are largely government owned, that means the risk to shareholders of these banks is quite low.”

Too funny. The joke is on me, thinking they believed all that free market eyewash.

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Taxes are the solution, not the problem


As far as I can tell, if corporations and the top 1% paid anything like a fair share of taxes, budget problems would melt away.

I feel a bit like the recent physicists who seemed to find faster-than-light neutrinos in their data. (There’s the big difference that I’m an amateur at taxes, and they’re anything but amateurs at physics.) But, like them, I’m so boggled by the results that I want to throw it out there for people to pick apart.

Let’s begin at the beginning. The current US deficit is around $1.5 trillion per year. Current US GDP is around $14 trillion per year. Current yearly tax revenues are near $1.1 trillion (IRS pdf, 2008 numbers). In better years revenue is higher, deficits are lower.

An aside: Those numbers are smaller than the multiple trillions of cuts the Super Committee throws around. That’s because they say they need to come up with money for ballooning future costs of social insurance. (The powers-that-be didn’t seem to be worried about the future when tax cuts were implemented.) I don’t consider those future costs a real issue. Social Security doesn’t have any real problems. National health care costs could be cut in half with Medicare for All, based on the evidence from all the industrialized countries that do have national health care systems. (Link is to Congressional Research Service, 2004, pdf. See e.g. Table 1, Fig. 1, Fig. 2.) So Medicare for All is the place to start for anyone who is actually concerned about future costs, and not some other agenda.

Further, a healthy deficit level is said to be around 2% of yearly GDP. In addition to other considerations, the ability to buy US Treasury bonds and bills is an important factor in global finance. Zero deficit means the end of that whole asset class, which is not a Good Thing. One wants a sustainable and easily carryable deficit, and 2% is a conservative estimate of that level. Two percent of $14 trillion is $280 billion. (I saw this most clearly expressed somewhere in Krugman’s writing, but all I can find right now is a passing reference here.)

So the yearly shortfall, in round numbers, is $1.2 trillion ($1.5T deficit – 0.280T healthy deficit).

If Fortune 500 corporations actually paid tax on their corporate profits, there’d be much less freeloading from that end. When even Marketwatch headlines “Big Profits, Zero Taxes” you know it’s not a small issue. It’s hard (for me) to find unequivocal numbers on how much difference that would make to revenue, but there are fairly clear data on corporate tax payments as a share of GDP. It’s now at a recent all-time low of 1% of GDP. Moving that back to 4%, about where it was in the 1960s would bring in an extra $480 billion (1% of GDP = $160B, 3% = 480B).

That would entail ending all the corporate loopholes, such as income-shifting in transnationals to whichever tax haven suits them that year, as well as ending special tax breaks for wildly profitable industries such as oil and finance. It would involve adding necessary new taxes, such as a financial transaction tax that would have other beneficial social consequences by slowing down market trading velocity. And it would involve raising rates on large corporations.

Then, the other task is to raise taxes on the top 1%. According to the IRS (pdf), in 2008 the top 1% was composed of households making an average of $1.2 million per year. Their effective tax rate is 20% ±5% (CBO pdf, Table 3), and at that rate they contributed well over $350 billion in tax revenue. (For instance, in 2009 the top 1% contributed 36.7% of total income taxes. That proportion is typical during the last decade, plus or minus a few percent. Total income tax revenue in 2008, the last year for which I could find complete IRS data, was $1.081 trillion. 36% of 1.081T = $389 billion.) If their tax rates went to 60%, there would be an extra $700 billion revenue.

So, $700 billion plus $480 billion approaches $1.2 trillion, pretty much the entire yearly shortfall of $1.2 trillion.

That doesn’t pay down the debt. Nor does it provide funds for essential projects such as switching to clean, sustainable energy. But those are one-time charges, as it were, not permanent features of fiscal balance, which I gather is what the Super Committee is worrying about.

Raising taxes on the megarich is not the same as taxing the middle class. It’s not even taxing the upper middle class, such as the heart surgeons and mid-size successful business owners. It involves only having the massively wealthy corporations and households pay something vaguely like their fair share. What’s more, it wouldn’t make a bit of difference to their lifestyles. For an income of $1.2 million per year, that tax increase would drop them from living on $80,000 per month to living on $40,000 per month. They could still jet to Paris for the weekend. Anybody who feels deprived living on $40,000 per month needs therapy, not tax breaks.

All this is something to think about while the news covers the new super ways the Super Committee has found to shred the safety net. Nor is this just a classic “Don’t tax him, don’t tax me. Tax the fellow behind the tree.” The fellow behind the tree has been tax cheating for far too long, and it’s time to rebalance. If the megarich paid their fair share, we could have a future that was more than collapsing bridges and work on their plantations.

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What part of “Stop Stealing!” is hard to understand?


Bank of America has now jumped the shark, gone right over the top, past the frozen limit, and exposed themselves.

This ought to be unbelievable. It only makes sense if the bank robbers are running the bank. Bank of America has transferred assets it acquired during its takeover of the Merrill Lynch brokerage to its deposit-taking arm.

Let me unpack that a bit.

Banks, officially, put people’s savings into safe investments. The FDIC insures those savings in case the banks fail, but to prevent that outcome there are strict regulations about how banks can only put that money in safe investments.

Brokerages, officially, exist to broker any transactions on any market. Those can be the staidest of riskfree investments, like Treasury bonds, or interesting things like ultrashort inverse contracts derived from the SP 500 basket of stocks. “Derivatives” may be two, three, four, or even more meta levels above the real underlying things they represent, such as a stock or tanker load of oil. With some derivatives, you can make many times the amount of your own money that’s tied up in the trade, or, likewise, you can lose more than everything you own. That means (duh, right?) they’re risky. They have legitimate functions, such as hedging other risks or providing a way to bet on being right, but nobody ever pretends they’re safe.

Nor is there any universe in which it is up to the FDIC (=taxpayers) to make them safe by writing blank checks to cover them.

So what does BofA do? It takes bets made by Merrill Lynch — bets which were fine for a brokerage — and makes them part of the regular bank assets that are covered by the FDIC. By the magic of modern accounting, the taxpayer gets to cover wild stock market gambles that didn’t pan out.

There’s another wrinkle here. In the old high-flying days, financial institutions would sell derivatives to customers, e.g. one expecting price to go up, and then the institutions would, for their own account, buy the opposite derivative! There are two betrayals. It’s their fiduciary responsibility to tell their customers that the firm is itself investing in a fall in price. And it’s wrong to rake in money from customer commissions as well as customer losses on those same trades. It’s called a conflict of interest. It’s a big no-no.

After the crash, when it became clear that betting against the customer was fairly common in the financial industry, regulations were put in place against what’s called “proprietary trades.”

So what is BofA’s excuse for what it’s done?

Bank of America spokesman Jerry Dubrowski said the bank’s derivatives trades are subject to risk-management controls and are client-driven, not proprietary trades – meaning the bank is not betting with its own money.

In other words, it’s okay to stick taxpayers with the bill for somebody else’s failed stock market gamble because the gamble itself was not a criminal breach of ethics.

Hello? It’s the gambling that is not insured. We don’t really care who did it. And the fact that it wasn’t criminal gambling only makes it one of the few things for which BofA won’t need a lawyer.

The scariest part is that for all I know, the gross rip-off may be legal. Most of the laws for banks were written before they could turn themselves into FDIC-insured gamblers.

Bank of America posted a third quarter profit — i.e. just for the months of July, August, and September — of $5.9 billion.

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What’s right isn’t always what’s good


There’s something that bothers me about the current conversation (diatribe?) about the sins of the bankers.

The tone of a lot of the talk is as if they belong to some other species, as if they commit crimes nobody else does, but also as if they keep their heads when nobody else can.

Holding them to sub- or superhuman standards means it’s hard to understand why they do what they do. And that means it’s hard to make them do the right thing.

Let me explain what I mean.

After the crash, US banks were bailed out. People were outraged, and rightfully so. It’s just wrong for a thief to rob your house and then grab your savings when the jerk can’t make his rent.

But.

The time to worry about the thieving was before the crash. While it was going on. Then it would have been possible to stop it without crashing the economy.

It would have also stopped the wild ride, and — at the time — not many people wanted that. Plenty of people are just like bankers without a bank. There’s a big difference in impact, but the difference is one of degree. They’re no more subhuman than everyone else.

When the crash happens the sad fact is the thief lives in the same house you do. When he (the high-flying financial mavens were almost all “he”) can’t make his share of the rent, you both get evicted.

The thieves are literally in the same house. They’re in the same economy. The 99% and the bankers all depend on it. If the economy is destroyed, everybody is just as homeless. Your pension loses money. Your job is destroyed. The value of your house goes down. That’s been made rather clear by now.

There is no way — during the actual crash — to limit the damage to the people who caused it. There is no choice but to bail out the jerks who caused the problem. It’s not right. It’s maddening. But doing anything else means more damage for you. It’s not about punishing the guilty at that point. It’s about saving the innocent.

That’s why the bailout was the right thing to do. It wasn’t done well, or enough, or with any of the necessary rules attached to it, but it did avert a much bigger disaster. That’s all clear by now, and leads even compassionate economists to point out that economics is not a morality play.

The time for retribution is afterward. That is, now. But now the 1% are going scot-free and raking in more money than ever. That’s criminal laxity. Not the bailout.

However, bankers are just people with banks, so they’re now going through the same process of preferring moral outrage to emergency assistance.

Europe is having a similar problem with inability to repay debts. In their case it’s a country, not mixed salads of mortgages, but the problem is the same.

Unless Greece is convincingly bailed out, everybody with money in the market will be worried about how much they could lose if they don’t get out now. If everybody pulls their money out, economies freeze up, and we all go broke.

So what have the bankers been arguing about? How to create the funds for an adequate bailout? No, it’s about not wanting to bail out those profligate Greeks. It’s the same routine, but with more numbers and graphs: I was frugal. It’s not fair to make me pay some gambler’s debts. They should just suck it up.

These are people whose jobs are dealing with money. They, of all people, should know that economics is not a morality play. They, of all people, should know that when the sheriff is at the door with the eviction notice, it’s not the time to beat up the crackhead brother for squandering the rent. At that point, you just scrape together the rent. Later, you send the brother to rehab.

What’s funny, though, is how far the inability to recognize the common roots of feelings extends. Krugman is smarter than I am in practically every way, but even he is continually mystified by the non-rational adherence to austerity when austerity will cost the earth. (Read his blog. There are dozens of posts asking What were they thinking?.)

There’s nothing mysterious about it. It’s the same reaction everybody has. Don’t make me pay for someone else’s mistakes. It doesn’t matter whether you agree with the bankers’ definitions of mistakes. Nobody wants to pay for what they see as somebody else’s mistakes. And when something turns out to be a mistake, it’s amazing how fast it becomes somebody else’s.

The other unspoken, non-rational motivation is the equally simple one that austerity for thee but not for me is a great way for the rich to get richer. That, too, may be unmentionable, but it is not mysterious.

The point is this. Once the emotional roots of a non-rational stand are recognized, there’s a chance one could deal with it. It’s only a chance, but without that understanding, there’s none at all. Understanding allows us to start fighting the right battles instead of the distractions.

For instance, bankers are professionals, so they hang an economic story around their outrage. They come up with theoretical underpinnings for why austerity is such a good idea. None of those pins stays in place when examined, but they don’t care. And that is the hallmark of acting on feelings, just like an ordinary human being. They’re no more superhuman than everyone else.

I’m not suggesting that every argument one doesn’t like can be written off as “emotional.” All arguments have to be evaluated against the evidence, and evaluated several times to make sure the results are right. But once that’s done, if people keep clutching an anti-rational position, it is not insulting to figure out why they’re doing that. It’s essential.

And then when one argues with them, one needs to argue with their real reasons, not their stories.

So, in the present case, if the roots of the cries for austerity were faced squarely, we could clear the way for useful solutions. We could discount the more-for-me motivation as the bog-standard grabbiness we all have and decide to ignore it. And to the extent that the cries are rooted in a sense of unfairness, maybe we could get past it.

We could acknowledge the unfairness. We could resolve to deal with it after the crisis, instead of letting the rich and powerful off scot-free. And we could acknowledge that fairness is better served by helping millions of small people through the crisis, even if it also carries along some perps. That’s the good thing to do. Punishing the perps may feel right, but it’s stupid to let it cost us everything we have.


[Update Oct 27th: It remains to be seen whether today’s agreement in Europe to help Greece did enough or just did the minimum to keep the markets from panicking this very minute. Still, any prevention of panic is better than none.]

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It’s not about taxes

I live in California, and you may have heard that we’re having a bit of an argle-bargle about a budget in this state.

The history, for those who’d like it: Back in the 1970s, enough Californians felt their taxes were too high to limit property taxes by law. The limit is low, (1.5%, I thought, but wikipedia says 1%) and — this is the biggest deal — the assessed value of the property can’t increase more than 2% a year until it’s sold. The new assessed value is then based on that sale price. You’ve probably heard about property values in California. A house worth $60,000 in 1978 is worth $600,000 now, but it’s taxed at around $100,000. There’s something to be said for this in the case of retirees on fixed incomes, for instance. However, they forgot to limit it to people of limited means. It applies equally to movie stars. And to commercial real estate which can stay in the same hands forever, even when it’s sold, through the magic of shell corporations. That turns out to be a loophole big enough for the whole state to fall through.

Proposition 13, as it’s known, also said that any tax increase had to pass with a two-thirds supermajority. We have two, count ‘em, two, Republicans more than a one third minority. So that voting bloc, in its infinite intransigence, can stop any budget from passing. The situation is not helped by a Gropinator who vetoes legislation just to show off, as far as I can tell.

(Update: I should mention that the up-to-the-minute blog for all things political in California is calitics.com.)

On to the gnarly present. As Krugman wrote, California may once again be ahead of the curve in showing what happens when a bunch of Republicans decide to play politics with the future. This is not, at this point a faults-on-both-sides situation. This is a bunch of Republicans playing politics with the future. They have made the (apparently accurate) judgment that repeating NO NEW TAXES on an infinite loop will keep getting them re-elected till hell takes over.
Read more »

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Out of Africa: Financial Innovation

We’ve made the world a depressing place. Everywhere you look, all the good stuff is buried under a thick and powerful layer of crud. Sort of like an endless mall parking lot. Seedlings push through it every now and again. You can’t even see them from a distance and if you stepped on them, they’d be dead. But you know how it is with seedlings. In time they’re going to destroy the whole damn lot. What follows is one of those seedlings. Keep an eye on it.

Africa pioneers mobile bank push

Mobile financial services in the developing world could be worth $5bn by 2012, say analysts. . . . More than one billion people in the developing world have access to a mobile phone, but no bank account. . . . [CGAP] also expected more than one in five to use their mobile to access banking services, creating a market worth up to $5bn (£3.05bn). . . .

One of Africa’s first mobile banking system[s], M-Pesa, launched in Kenya in March 2007. A network of more than 7,000 agents – mostly shopkeepers – was set up to take deposits and issue cash, with users authorising payments on their mobile phone using a Pin code. That service has now expanded to include Tanzania and Afghanistan with plans to launch in India, Egypt and South Africa.

If we can keep this out of PayPal’s grubby monopolistic mitts, maybe some of this newfangled convenience could trickle all the way down to us. It should go without saying that we, and the rest of the world, will have to do some serious anti-spam and anti-fraud work as this gets more widespread. But you know what? That’s doable.

(Personal note: I’m back from vacation, hiatus, and general out-of-the-loopiness. Sort of. I may become loopy any time again so long as the weather is nice. And it’s always nice here in sunny Southern California.)

mobile banking, microfinance, Africa

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In which I disagree with Krugman (o_O)

This has never happened before. I’m shocked. However, I’ll try to pull myself together and explain.

In The Market Mystique, Krugman says:

Underlying the glamorous new world of finance was the process of securitization. Loans no longer stayed with the lender. Instead, they were sold on to others, who sliced, diced and puréed individual debts to synthesize new assets. Subprime mortgages, credit card debts, car loans — all went into the financial system’s juicer. Out the other end, supposedly, came sweet-tasting AAA investments. And financial wizards were lavishly rewarded for overseeing the process.

But the wizards were frauds, whether they knew it or not, and their magic turned out to be no more than a collection of cheap stage tricks. Above all, the key promise of securitization — that it would make the financial system more robust by spreading risk more widely — turned out to be a lie. Banks used securitization to increase their risk, not reduce it, and in the process they made the economy more, not less, vulnerable to financial disruption.

… I don’t think this is just a financial panic; I believe that it represents the failure of a whole model of banking[.]

Yes, it represents the failure of a model of banking, but I think Krugman is wrong in saying that securitization — the process of juicing and producing new investments — is at fault.

The reason the sweet-tasting AAA investments were sold as such was due to the estimate of risk they carried. Knowing the risk associated with an investment is central to pricing. If there’s a big risk that you’ll lose your money, you get a higher rate for its use. Supremely complex and secret models were used to assess the supremely complex risks of hundreds of mixed investments. (The secrecy, I think, is a big deal. If they hadn’t been secret, specialists outside the industry would have been able to review them and sound warnings.) The models found layers of the juice that were “sweeter” than other layers, assigned low risk to them, and pension funds snapped them up.

But since nobody (except maybe the quants who invented them) understood the models, nobody actually knew how much risk they were taking on. When it started to look like the risk assessments were wrong, all hell broke loose as everyone tried to dump investments that had nobody-knew-how-much loss mixed into them.

Had the securitization been done in an open and reviewable way (I know, laugh all you want), then that process by itself would not have created disaster. What created disaster was obscuring adequate risk assessment. We could get rid of securitization, and wind up in this exact same place when some genius came up with a new way to obfuscate risk.

Obfuscating risk is what needs to be stopped. Not the red herring of securitization. Or not just that red herring.

Keep your eye on the ball for us, Paul! We need you!

Tags: Krugman, financial, crisis, risk, quants, securitization

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To bail or not to bail

That is actually not the question. Not now.

The time to ask that question was four, five, six, and more years ago. The time to ask it was when the shadow banking system started growing. It was invented to avoid regulations. It made a lot of money doing it.

While the party was on, while yee-haa mortgages were driving up real estate prices and making everyone feel richer, while loans on that inflated home equity were keeping the economy afloat, nobody wanted to be the wet blanket on the house of cards.

That’s the real problem. No amount of new oversight bureaucracies will change the fact that when a party is on, nobody wants oversight. We had plenty of oversight in place. We just didn’t use it. The real solution to the current crisis would have been not to get drunk at the party in the first place. Anybody reading this blog already knows that. (So why am I saying it? I dunno. Just venting, I guess.)

But now what? Why should the innocent get stuck paying the bills of the guilty?

Because there’s no other choice. Not now.

The current bailout plan is estimated to cost about $2000 for every human being in the country. Leave aside the question of whether we may eventually recoup some or all of it. Say we don’t. Let’s also assume that’s an underestimate, which is probably a safe bet. Let’s say it’ll cost $4000. (I’m getting most of my information via Krugman and Calculated Risk. They have good analysis and lots of details. The $4000 figure is not from them. That’s just my pessimism.)

We don’t have a choice between spending $4000 or saving it for, say, a college education. At this point if there is no bailout, the global financial system literally would collapse. It was flirting with that on Wednesday last week. A financial collapse would shrink pension funds to shadows. You’d likely lose your job. Crime would skyrocket. That’s expensive for everybody, and beyond price for it’s victims. The list of ways a financial collapse would cost you goes on forever. It would cost you $4000 in the first week and then keep costing you for the rest of your life.

The choice is to spend $4000 or to spend hugely more than $4000. If we had a real government, it would be structured so that we got something back for our largesse. But we don’t. So even that’s not possible.

The only thing anybody could ever do about this situation is not succumb to smooth-talking politicians telling people what they want to hear.

Good luck with that.

Technorati Tags: economy, housing, crisis

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A Blast from the Past

I have birds. I use newspapers to line the bird cages. However, I haven’t bought a newspaper since November of 2004. It’s too depressing. So I’m getting to the bottom of the stack that was going to be recycled when I realized I better save it. Who knew when the world would be in a fit condition to provide not-sick-making bird cage liners?

So I bumped into these mortgage ads from my corner of Southern California in the heady days of 2003 . . .

[click on image for larger size]
mortgage lenders advertising free money (haha) in the good old days of the housing boom

The circled “No Tax Return” promises that this lender won’t want to see any real evidence of income. It translates to, “Please come and lie to us so that we can get loan origination fees off you! Puhleeeze!”

This wasn’t unusual. Au contraire. A couple more ads from the same page of Aug. 17, 2003 classified ads in the Real Estate section of the Ventura County Star:

even sleazier mortgage lending ads from 2003

Technorati Tags: housing, boom, 2003

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Globalization for me but not for thee

Globalization is good. Regions adept at making thingummies can use their natural advantages to produce them cheaper than anyone else, efficiently saving everyone money.

Globalization is bad. The regions outclassed in thingummy production lose their livelihoods, and factories can flit around the globe, escaping labor and environmental laws.

Neither of these problems is new. Only the scale is different. In the Middle Ages, a mass of fiefdoms ringed the Baltic and fought all the time, although nominally they were all part of the Holy Roman Empire. Meanwhile, traders among the independent cities of the area formed the Hanseatic League for profit and protection, and were actually more powerful than many of the area governments. Global corporations are different only in scale, and in their expectation that governments will provide protection.

Getting rich is conceptually simple. One buys low and sells high. The traders or corporations, by having more mobility than average citizens, are able to make money off of regional disparities in pricing. If you or I could hop over to Western China for a couple of dollars, we could buy the t-shirts Walmart makes there for the cheap local price and cut Walmart out of the process entirely. We can’t, so Walmart makes money by buying low and selling (relatively) high.

There is a technical term for making money from pricing disparities that really shouldn’t exist, according the economic theory. (In that particular fairyland, everybody has access to all goods and to the same information, so overpriced goods are immediately outcompeted.) In the real world, disparities always exist. The technical term for profiting by them is arbitrage, the idea being that you “arbitrate” or balance between the two unequal situations. Walmart arbitrages the cost of living in China versus that in the US.

According to economic theory, arbitrage is a good thing because it removes disparities, makes markets more efficient, and generally makes it easier to fit economic activity into a mathematical equation, which is (apparently) the point of the dismal science. Somewhere, there is someone with tenure who thinks that sweatshops in the Third World will increase local wealth to the point where everyone becomes middle class and the disparity ceases to exist.

If arbitrage is such a good thing, then why doesn’t everyone get to participate? Walmart can do it, but the Chinese woman in the company’s factory, who’s quite willing to arbitrage her modest wage demands against the higher expectations of workers in, say, New York, is not allowed to. It’s the exact same thing. The only difference is that it’s a poor person taking advantage of disparity rather than a rich person. Globally, workers are in the same position as medieval serfs, but on a different scale. They’re tied to their land and not allowed to move to better markets for their labor.

Obviously, if everyone willing to work for next-to-nothing were to flood into the high-wage West, it would be the end of life as we know it. However, if everyone were to turn themselves into Walmarts, that situation would also fall apart immediately. The benefit in these things depends on most people being unable to do them. It’s true of labor, but it’s equally true of the corporations. If it’s okay for them, it has to be okay for everyone. If it’s not okay for poor people to end life as we know it, then it’s not okay for the corporations either.

Labor isn’t the only thing whose globalization runs on different rules than that of corporations. Products people buy, rather than those businesses sell, are also not to be globalized. US citizens are not to take advantage of a better health care system in Canada and buy cheaper drugs there. You’d think the economists would be pleased at this free market pressure towards reform of the US system, but they’re oddly silent about the merits. US college students aren’t supposed to buy half-price textbooks in England. The list of anti-globalization measures for consumers could go on for pages, and it’s promulgated by the same outfits who insist that completely free markets are the only fair way to treat corporations.

It doesn’t take much for the pattern to show through. Globalization is used to mean “I want to make as much profit as possible.” Add in the consistency with which “globalization” is used to evade the most basic environmental and labor laws, and it is screamingly obvious that the term is a euphemism. Dishonest business practices are not exactly a new thing. The people protesting globalization at the trade talks aren’t really protesting globalization. They’re protesting greed. Let’s keep these things straight. Then we may have a snowball’s chance in a temperate zone of using globalization to provide wider markets for everyone. (Imagine what an African villager could do with a web connection and reasonable local transport). And we may do it without all becoming wage slaves living in cesspools.

Technorati tags: globalization, free markets, labor market, slave labor, environmental laws

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Free Markets Cost Too Much

It is a given in the United States that free markets can solve all problems. Bureaucratic inefficiency? Give the job to competing businesses and waste will disappear. World hunger? Nothing some free trade can’t cure. Global warming? If there’s a problem, free markets will let the best solution win. Unfortunately, despite the application of capitalism, the problems on the ground get worse, not better. However, that’s supposed to be because we still have too much regulatory baggage for the benefits of freedom to show through. The more problems there are, the more free trade we need.

That kind of thinking reminds me of the communist party line, which said that communism would solve all problems, and the only reason it hadn’t was that those miserable bourgeois were still gumming up the works. China’s Great Leap Forward was supposed to root out these remnants, and we all know how smoothly the communist economy functioned after that.

So I would like to cast a jaundiced eye on the free market, and explain why I think we can’t afford more of it than we actually need. My background is not in economics, which is ample qualification to discuss the subject. Economists, after all, are the ones who assume that decisions about buying and selling are based on rational thinking. Stop laughing for a second, and take stock of just how far away from the real world these people must live. Another thing economics teaches us is that supply and demand are always in balance in a free market. It’s impossible, for instance, for oil to run out because supply balances demand. Totally gaga, right? It took a translation from econospeak for me to make sense of this. To an economist, demand equals ability to pay, and not demand in the ordinary sense of the word. So, if there is only one shipload of oil left in the world, it will cost billions of dollars, and there will be few buyers bidding for the meager supply. And, they point out, you can always squeeze out another barrel or two, so the supply never actually runs out. These are the people managing the world’s economies.

(I should, perhaps, attach a humor alert to the previous paragraph. And even though economics deserves much much of its reputation for having no clothes, I would never have understood the little I do understand about it without the help of some very sharp economists willing to talk to the rest of us. E.g. Brad DeLong, Kash and others at Angry Bear, Paul Krugman, James Hamilton at Econbrowser, Mark Thoma, excellent articles in The Economist.)

The biggest recent failure of unreal economic theories was communism, but that doesn’t make capitalism right just because it’s the opposite. That is not good logic. It’s also more than a theoretical fallacy, since capitalism shows symptoms of the same problem of trying to fit human nature to economies, rather than the other way around.

Economic theory still seems to have a tenuous grip on how people work. It was born in the era of the Gas Laws, the subsequent invention of the steam engine, and its transformation of society. Everybody who was anybody wanted to be in on the game. Everything was viewed as a mass of gas, its little molecules bumping around frictionlessly, and if you could just figure out the laws governing the motions, as Boyle had done for gases, you’d have the whole system figured out. People in a market were like atoms, buyers bumping into sellers, bouncing off, with the force of the interaction dependent on as simple a set of parameters as any volume of hot air. Most people, of course, don’t make very good gas molecules, which is something economists eventually figured out and which made their equations increasingly complex. However, to this day, many of their ideas smack of the old simplicity and clarity, as if they’re not only studying gas, but have forgotten they live on a planet and need to take gravity into account.

The human equivalent of gravity is power, whether it’s social, military, or financial. Without taking into account how power tilts and warps any given situation, there isn’t a hope of providing the level playing field that is supposed to be the home of the free market. It is a fact of human nature that people holding the levers of power will try to tilt the field. (Just as it’s a fact that people will only live by half of the communist ideal, facetiously summarized as, “What’s yours is mine, and what’s mine is yours.”) Everybody knows that unrestrained freedom is just a way to hand the game to the biggest bully on the block. That’s why stock exchanges are among the most tightly regulated activities in the world.

However, the focused and continuous balancing needed to keep free markets on the level is generally obscured by the free marketeers themselves. Regulation is anathema to them, and yet when they lose in the market, they demand special treatment. There are endless examples of this, but look at just one particularly ironic one. The North American Free Trade Agreement allowed subsidized US corn to undersell that produced in Mexico. Thousands of poor farmers went out of business and whole communities are collapsing. The people, however, aren’t sitting on their butts waiting for handouts. They go where the work is, and since their own provinces are broke, that means going north. In the US, these people “taking jobs away” are unwanted, so US regulations prevent a free market in labor, and seal the borders against the poverty they created.

Considering the spotty adherence to free market principles, that philosophy looks less like an ideal and more like a con man’s attempt to distract attention from what his fingers are doing to your wallet. The only thing to be said for it is that the system, as applied, does work for the con man. On the other hand, true believers in unfettered capitalism actually subscribe to the principles of anarchism, which holds that social systems self-regulate if there is no interference. Anarchism hasn’t worked for anybody.

Regulation of markets is a fragile thing: too much, and there’s no free market; too little, and the result is the same. So let’s begin at the beginning and think about what a market actually is. It’s a place where things are bought and sold. Logically, anything that can be bought and sold, such as oranges or copper, belongs there. Equally logically, anything that cannot be traded does not belong there. That includes practically everything that really matters, such as life, liberty, happiness, hope, love, and God. A market trades things. It doesn’t try to provide the greatest good of the greatest number, or moral behavior, or knowledge, or anything we care about except a living. Free markets are good, within their limits, at divvying up livings.

The concept that free markets have limits is the important one. They’re not bad in and of themselves. They’re good at what they do, but they do not do everything. That used to be taken for granted, but lately it’s become a radical position, so the limits need to be examined.

The most obvious one is that human life should not be for sale. Slavetrading is a crime against humanity. However, other stark ways of putting a price on life are not much better. Policies that cause people to starve, sicken, or die, all these are also crimes. I realize that this has implications for everything from pollution to structural poverty in the Third World. I realize that it means medicine should not rightly be profit-driven. I know it means that whole sectors of the market would have to stop making a killing, and go back to making a living. Putting a price on life is a crime, whether our economic system is built on allowing it or not. If we don’t want to be criminals, the economic system has to be changed.

It’s common practice to forget that free markets are based on a series of assumptions, and that when these assumptions don’t hold, there can be no free market. In very general terms, free markets presuppose equality. Buyers and sellers have equal levels of choice of trading partners, as well as equal access to information. The famous self-correcting and self-regulating abilities of markets depend on the participants having other choices, so that bad deals evaporate when all they do is drive everyone elsewhere. When participants have too little choice, it’s the freedom of the market that evaporates.

Monopolies reduce choice, which is why they’re not supposed to exist without heavy regulation, and yet they’re so lucrative that it’s a constant struggle to beat them back. The latest trick is to pretend tiny companies provide enough choice so that the giants don’t need to be regulated. (Yes, I’m thinking of Microsoft.)

There is, however, a more insidious form of monopoly which isn’t recognized because it is new. In a technological age, the mental cost associated with learning to use new things can create its own kind of barriers. Once you’ve learned how to use the “qwerty” keyboard, for instance, you won’t use another kind even if it’s demonstrably cheaper, faster, and better. The same is true of anything bought with a learning curve as well as money, and if we’re to get the benefits of free markets for complex things, it’s very important to adapt copyright and patent law to be fair to the buyer’s time as well as the seller’s intellectual property.

Another kind of unfree market that does not receive enough attention is the labor market. The difference in power between employer and employed is huge, but discussions about labor proceed as if workers can quit jobs as easily as they can get them. In reality both carry enormous costs, and pretending otherwise is simply a way of tilting the playing field into something more like a slide that ends right in the employer’s hands. Convenient for employers, certainly, but not in any sense free.

The abuses that can be expected when buyer and seller aren’t equal happen without fail. Sometimes it’s a matter of paying starvation wages to people in countries without labor laws and then quietly pocketing the profit when the t-shirts, or whatever, are sold in countries where labor laws have created a population rich enough to pay more. Sometimes it’s a matter of socializing the costs of underpaid labor, such as medical care, while privatizing the profit. All of this has tremendous social consequences in terms of stress, disease, and crime, and yet we seem unable to stop the true perps from laughing all the way to the bank.

In addition to free choice, efficient markets depend on equal access to good information, but preventing that access is the quietest and most effective way to tilt any playing field. Controlling the flow of information doesn’t have to be done with hamhanded secrecy. For instance, regulations require lots of information about companies to be published, but nobody without a degree in accounting can understand it. This is not because that is the only way to present those facts.

Markets are supposed to summarize all the information about a sale in its price. Products made more efficiently provide more value for less cost and are supposed to win the competition. That would be great if it worked, but cost information is rigged and the system is failing so badly we may lose the planet in the process. The game starts in the very definition of what is a cost, long before it enters the realm of economics. The seller obviously wants costs to be as low as possible, since everything above that is profit. The honest way to do this is to keep costs low. The less honest way to do this is pretend costs don’t exist, thereby sticking someone else with the bill. Costs are defined as whatever the seller says they are, and all the other costs–social, environmental, or medical–belong to someone else. This is, in effect, a blank check to rip off the world. At this rate, so-called free markets cost way more than the whole planet can afford. What capitalism needs, if it’s not to fail even more spectacularly than communism, is reality-based accounting.

Even a glance as rapid as the one I’ve tried to give here is enough to show how far away from free markets we actually are. Examples of the discrepancies could be multiplied easily, but the solutions are difficult because every problem is caused by excess pressure on the levers of power, and counteracting the powerful is the most difficult social problem of all. I hope I’ve made it clear that I’m not opposed to free markets. Far from it. In their proper place, and operating under the conditions they need, I think they’d do a much better job of rewarding merit and distributing wealth than our current system of insisting, “What’s yours is mine, and what’s mine is mine.”

Technorati tags: free market, capitalism, socialism, globalization, social costs, environmental costs, economics,

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