The Doomsayers and the Retirees

How can opposite sides of a debate both be right?

Doomsayers insist that Social Security has no 'trust fund' and will run out of money sooner than 2037, the new date listed in this month's official new projections.

Optimists say Social Security is well-funded and can continue with little additional money, if any.

They're both correct, at least partially so.

The doomsayers have latched on to a concept few media outlets understand: we're spending the Social Security surplus, and that means there's no 'trust fund.' Currently, Social Security takes in more money than it spends; that will change as we get more retirees per worker. Most news sources then report that the extra money Social Security has taken in - including this year and last - can then be spent to cover the gap until 2037.

But since we're spending that money now, there isn't any 'saved.' The surplus money goes into the general fund, which is spent by Congress on defense, education, and the like (see 'Where do your Taxes Go?').

It's as if you give $100 to your best friend in exchange for an I.O.U. while he or she then spends that cash. When you turn in your I.O.U., your friend needs to get that new money from someplace, since it hasn't been saved.

For Social Security, the I.O.U.'s are notes from the Treasury Department (or technically, they're an accounting entry made in the ledger for Social Security). To pay them off, the government will either need to borrow more (by issuing Treasury Bonds), or raise the income through taxes. There just isn't any saved. Really.

Optimists say the Treasury Department never defaults on payments, and that's true, too. Next week, we'll see why they're right: even though there isn't money saved, Social Security is not in crisis.

Who Laughs at the Laffer Curve?

You've found me: the one and only person in America who believes in the Laffer curve.

Ever since Reagan championed the idea that the government can earn more from lower taxes, liberals have shunned the concept.

Oddly, conservatives have, too, though they love part of the idea. You can read some near-religious praise for part of the Laffer curve at FreeRepublic.com, a site whose crazy fervor used to tickle me until they kicked me off for suggesting there's a role for good government.

One poster says, 'its logic continues to elude the class-warfare lobby' and another insists, 'Laffer curve should be pasted on the ceiling above every child's bed.'

But they don't really want a Laffer curve. They want a Laffer bulge, a curve with no left side.

Look closely at that left side: at that point, government receipts fall with further tax cuts. That fits both our historical data and plain logic. If you cut taxes to 0%, we'll clearly have no government revenue.

So where are we on the curve?

For us to expect more revenue by cutting taxes to 10%, from 40%, we'd have to expect that people would work four times as many hours. That's simply not possible, and the tax change does not imply any leap in productivity to fill the gap.

Could people work twice as many hours to compensate for a cut to 20%? Since the average employed American works between 46 and 50 hours per week, doubling their time would be exceptionally hard. Remember, that's an average. Yes, some people already work 100 hours a week, but they can't double their time to 200.

Then here's where we are on the Laffer curve: we're close to the optimum level for receipts. We can't cut the top tax rate to 20% and expect people to double their work week, nor should we hike it to 60% while hoping it doesn't reduce hours. Neither is reasonable.

We can argue over whether we should shift 5% one way or another, but we're no longer at the punitive 80% top tax rate that existed when Reagan took office. The level now is close to where it needs to be.

So let's put away the Laffer bulge and call a spade a spade: lowering taxes now is liking taking medicine for last year's cold.

The Smartest Spending of All

So why not boost spending with $2000 gift card for each American?

Here are the most common objections and questions I've received about my article in this weekend's Washington Post:

  - Didn't spending get us into this mess? We need jobs, not cash!

We do need jobs, and the gift card helps us get there, during the months that job programs get underway. This week and next, there's only one thing that keeps businesses from folding, and that's consumer demand.

To help in the short-term, the Senate has proposed nothing but tax cuts, and that's disingenuous. While some other problems may be averted with appropriate breaks, like expanding exemptions from the Alternative Minimum Tax, we shouldn't confuse those with immediate stimulus.

When your house is on fire, there are things to do before choosing a new sprinkler system. The 600,000 jobs lost last month represent only one sixth of the the total losses since the start of the recession. We need relief soon, while all other plans take root.

The $2,000 gift card isn't a full solution, but it's a strong tool we can put in the hands of every American right now, this week.

   - What if I just save the money?

Fine. If people save every penny of it, the program carries no cost: $2,000 goes to you, then back to the government years later. Even the interest goes to you and back. The Treasuries used to finance our debt are sold overwhelmingly to Americans. Despite the huge foreign reserves of Japan and China, we borrow mainly from ourselves.

But while rebate checks were saved at too high a rate to help boost the economy, the American Gift Card can do better, as it never sits in a bank. In our house, grapes get eaten a lot faster when they're out on a plate than when they sit in the bottom drawer of the 'fridge.

   - Won't the money just go to China?

Amazing at it seems, given that half the things on my desk were made in China, well over 80% of dollars are spent on domestic goods and services. Even without restrictions on the card, it really will help Americans.

   - Why not $2 million, so we're all rich?

$2000 is a good figure: $200 is too little and $20,000 is excessive. It's also the right amount to replace the $275 billion in proposed corporate and other tax cuts, some of which have merit but none of which have a stimulus effect with the promised speed.

$2000 per taxpayer provides a solid short-term stimulus while other programs begin, even though the mere issuing of a card doesn't create wealth. It is indeed money we're borrowing from ourselves, and for these next few months, that's a good thing. While there may be benefits to a higher rate of saving in America over the long term, the sudden drop in spending is causing substantial pain.

We can start cheering about reduced consumption after people stop losing their jobs.

- Can't we keep the government from telling us what to do or giving handouts?

Unlike other spending projects, the Gift Card program doesn't rely on the government to decide which business or industry should receive the money. You do.

There's no handout. Stores still have to attract your business if they want a boost in their bottom line. The difference between this an industry bailout is that you get to decide where the money goes.

And that's the smartest spending of all.

Boost the Economy, Today

Thanks for the many positive notes about my article in today's Washington Post, suggesting a short-term stimulus through a $2000 federal Gift Card.

It's a short-term boost, not a fix for all the long-term problems with the economy, nor to replace useful infrastructure spending or appropriate financial regulation.

Tax cuts can help avoid some problems, particularly if we wisely expand exemptions from the misguided Alternative Minimum Tax,  but we shouldn't confuse tax breaks with immediate stimulus.

The store on the corner struggles when there is a fall in consumer demand. That's true whether taxes are high or low, whether subprime lenders are spinning their evil ways, or whether or not the financial markets need more regulation.

And so do the store employees. The 600,000 jobs lost last month are most remarkable in that they represent only one sixth of the the total losses since the start of the recession. We need relief now, while all other plans take root.

The $2,000 gift card isn't a full solution and isn't meant to be. It's a tool we can put in the hands of every American, right now, this month.


On Monday, I'll post answers to the most common questions about the idea, plus a response to some objections. Or you can read hundreds of differing opinions on the idea at several blogs including that of MadDogMedia, Reddit, Scott Loftesness, and The Washington Post comment board.

The Truth, Plus Distortion

There's no reason for news media to treat Americans like dunces.

This week's shameful partisan spat over the stimulus plan is shocking enough. “Not one person felt his or her district needed to have any of this assistance?” Representative Rosa DeLauro, Democrat of Connecticut, asked of Republicans. “That can’t be.”

Even papers that generally keep a high standard have played loose with the facts in their summaries of the stimulus bill.

It's misleading to overlook the huge scope of proposed tax cuts, which even if they were reduced by half would still be the largest portion of the package. See the previous blog for details). The only programs mentioned there are $50 million for the NEA, $335 million for family planning, $70 million for a supercomputer for a weather facility, and $75 million for smoking treatment.

Let's put that in proper perspective. Added together, all of those programs total less than one percent of the proposed package. In fact, they aren't even one-tenth of one percent of the proposed package. That's right: 99.95% of it passes without criticism.

There's simply no need to distort a bill to emphasize old grievances like funding for the National Endowment for the Arts. That money isn't even one-thousandth of one-percent of the proposal, so it deserves no greater proportion of our attention.

We Americans can handle the truth. Give us the facts in proper perspective and we'll make our own judgments. If a party, or a paper, can't win our approval without tricks, they don't deserve it.

The Bailouts Compared to the Cost of War

Figures in the hundreds of billions of dollars become mind-boggling and difficult to envision. How big are they really?

Here's a useful chart:

Item  Size ($ trillion)     % GDP

U.S. GDP  14.2   100

National debt   5.4   38

Annual gov’t spending   3   21

Revenue   2.5   18

Historical avg revenue   -   17 to 20

Bailout so far   1.6   11

Wars in Iraq and Afghanistan   0.8/yr   3 / yr.

What does this tell us?

First, America has a big economy. We produce nearly $15 trillion worth of goods and services each year. The national debt is big, too - more than the annual federal budget - but it doesn't need to be repaid all at once.

In one sense, the bailout is huge. It's more than half of what the government spends in a year. On the other hand, if people were really worried about debt, they'd be asking every day if we're getting our money's worth from the wars in Afghanistan and Iraq.

There are other ways to shrink the deficit. We could raise taxes slightly, since we're at the low end of the historical average, but that alone won't do it. Nor will cutting spending from the traditional budget, unless the cuts were huge - far deeper than is likely to be politically possible. A ten percent cut wouldn't do it, nor would twenty percent, if we include interest due on the bonds issued.

But there is a way. The gap between spending and revenue is about 3% of GDP, which is also the size of our spending on the wars in Iraq and Afghanistan. Without those, we're in far better shape, with many more financial tools to help our own economy.

We've spent nearly twice on those wars so far than on the entire financial bailout. Another way to think of that is to imagine how much economic stimulus we would have if we spent that money here at home, instead of wasting hundreds of billions on graft and poorly supervised projects abroad.

How you feel about the war is a political issue, of course. But if you care about national finances, it should be an economic one, too.

A Mighty Brief History of Bailouts

The forgotten bailout of my post of Sept 30th  is just the most recent in a long line of government interventions.

Here are the three largest bailouts of the past,  (financial figures from a related Wall Street Journal article), and it's easy to see a pattern: they work.

At least they do if done early, with substantial support. They don't seem to fail even when large - look at the incredible credit extended by the RTC - but they do need to happen quickly enough to restore confidence.

-       The S&L Crisis

It cost $124 billion, but an FDIC historian notes, “Perhaps a measure of the Resolution Trust Corporation’s success is that little more than a decade after it closed, this agency that provoked so much debate is now largely forgotten.” 

 

-       Mortgage defaults of the Great Depression

By 1933, a thousand Americans a day were losing their homes to the bank. Creation of the Home Owners’ Loan Corporation handled 1.9 million applicants, about half of whom had monthly incomes below $150.

 One in ten Americans eventually secured aid from the agency, and since there was no secondary market for securitized mortgages, the agency had to hold the loans for the full terms.

 When it closed in 1951, 80% of borrowers had paid off their loans on time or early, and it even earned a small profit.

 Economist Alan Blinder has cited it as a model to be considered today.

  

-       The Panic of 1792

When the federal government assumed obligations that states owed from the Revolutionary War, it added $18 million to a domestic debt of $65 million, held in debt securities attractive to speculators. 

One speculator in particular cornered the market on government 6% bonds, so-called Sixes, and then prompted a selling frenzy that led to a 25% drop in value. 

Working without a historical blueprint, Alexander Hamilton engineered an innovate response. The Treasury borrowed money from banks and used to buy the bonds, lifting the market price. He also told banks to accept the bonds as collateral for loans, with the government guaranteeing their worth.

 The financial system stabilized quickly, and not a single bank faired for fifteen years, a remarkable outcome for such an unproven strategy, says economic historian Robert Wright. He named his son Alexander Hamilton Was Wright.

 

the Bailout Congress Forgot

The shameful failure of Congress to pass the bailout hurts an awful lot of Americans, not just wealthy bankers.

Have a retirement account? Own a home? Need a business loan? Whether or not you made any mistakes at all this year, you're getting pummeled by a fractured market and a government that is failing to help.

No one needs a handout - not even failing banks - but we do need restoration of confidence. It needs to be prompt, clear, and sufficient.

Remember the Mexican bailout under the Clinton administration? Maybe not, since it turned out so well. When Mexico was facing financial ruin in a deepening spiral, the Treasury stepped up to offer $40 billion in credit. The amount was considered huge, but that was intentional: it was meant to reassure the markets that more than enough was being done.

It worked. Creditors relaxed, and Mexico was able to get more loans from other sources. It needed little of the money offered by the Treasury and paid back all that it took.

But Congress voted against it, days after promising support. Dissenting Republicans said we couldn't spend our money helping an irresponsible nation, and they yanked their votes.

At that time, the Treasury exercised a little-known option to bypass Congress, and all went well. But Congress later passed a law to close that approach, so now we need their support.

And they've failed to give it.

This isn't about 'principle' or 'voting your conscience,' as  Rep. Jay Inslee (D-WA) claims. How did that kind of reasoning work in the 2000 election?

Whether or not you think we need protection for homeowners and tighter regulation of credit default swaps (as both Inslee and I do),  we need swift action, even if the bailout package is imperfect.

The longer we delay, the more it costs us. Look at the effects of  allowing Lehman to fail, which then hurt AIG, which then weakened Merrill Lynch, which led to a run on Washington Mutual, which increased worry about Wachovia.

Compare that to the swift and comprehensive protection during the Mexican bailout. By acting decisively, the crisis passed quickly and at less cost.

I know that some people feel banks deserve to fail - see my 'moral hazard' blog from last week, and several of the comments after the Inslee link above (and this  thoughtful response from blogger Ken Smith) -  but this is a market crisis that affects all of us.

I'm not out to punish any bank, or hedge fund, or C.E.O.  I don't care about them. I do care about my family, and my friends, and my neighbor, and the rest of Americans hurt by the crisis.

And we deserve a Congress that does, too.

The Phantom Moral Hazard

There are a thousand theories about why American markets are in such turmoil, and ten times as many about what we need to do. Here's one of the craziest.

Some economists and many conservative pundits say we should let financial giants fail, because if we save them, future executives will feel safe with even more risky behavior.

This so-called 'moral hazard' is a principle of economics that applies in some cases, but it's awfully hard to see it here. Let's see what's happened to the wealth of these executives as their firms prepare for bailout.

Stock value for CEO's of rescued firms ($ millions)

CEO	Firm	2007 value	Last Friday
Greenberg	AIG	1,250	50
Fuld	Lehman	827	2
Cayne	Bear Stearns	1,060	61
Sullivan	AIG (ex-CEO)	3	0.1
O'Neal	Merrill (ex)	128	40
Mudd	Fannie Mae	26	0.4
Syron	Freddie Mac	11	0.1

Look at, say, James Cayne, former head of Bear Stearns. I'm not asking you to feel sorry for him - he's still got $61 million in stock there - but note that up until last year, he was worth nearly a billion dollars.

Can you imagine a CEO saying, after the bailout, "I know I should do more to manage risk, or I might lose 95% of my personal worth, my job, my title, control of the company, and the respect of my peers, but at least the government will keep things from getting too bad" ?

Sounds silly, doesn't it? So is the argument that the government is doing too much.

No one is removing the risk from the financial markets. We're just taking steps to ensure that when Wall Street stumbles, the rest of us lose less than, say, some CEO's.

Wall Street's Fall Guy

The market isn't the only thing in turmoil this week; so is honesty in politics.

As recently as two months ago, the head of the Securities and Exchange Commission was considered a top contender for the Republican vice presidential nomination. Christopher Cox has been long appreciated by conservatives, and he'd done a surprisingly good job of reassuring liberals, who feared he would be too passive in his post. 

Cox reinvigorated the S.E.C. and the conservative American Spectator called him "the best [VP] choice, bar none."

Now John McCain is saying Cox "has betrayed the public trust," and "If I were president today, I'd fire him."

What happened?

Nothing that Cox did, or didn't do. He moved actively to address market problems, and weeks ago, increased criticism of "naked" short sellers seeking to profit from a falling market... the very problem that prompted McCain's comments. Cox's fault here was being in the line of fire.

The McCain criticism is all the more disingenuous because Republicans have been clamoring for less market intervention, not more. It's hard to pick up a newspaper - before today, at least - without reading about conservatives moaning about 'moral hazard' (the presumption firms will assume even more risk if they believe the government will save them. See my next blog entry for more on this canard). 

It's even worse when you consider how Cox arrived at the S.E.C.. The first Bush appointee, Harvey Pitt, resigned under universal criticism of his passive approach (called a "patsy for accounting firms," even the Wall Street Journal called on him to step down.) His replacement, William Webster, wasn't much better. Remember that when President Bush spoke on Wall Street during the first market crisis of his administration, markets fell on news that he wanted to reduce regulation.

Today's Republicans (my apologies to anyone who, like me, believed in the values of Goldwater or the early Reagan years) believe that government action is always bad. But Wall Street does not. When things are going well, firms want the government to keep a safe distance, but in times of crisis, they want America's safety net to be a strong one.

Cox has been the most forward-thinking S.E.C. chairman in several years. He's no Arthur Levitt (Clinton's brilliant appointee), but he's a huge step ahead of his immediate predecessors and a market supervisor who has played a more active role than most Republicans have endorsed.

And now they're attacking him for doing too little?