AskDong

On Friday, Obama enacted a new tariff on Chinese made tires of up to 55%.  Obama had until this week to make a decision, but decided to act early.  This decision was a true test of Obama’s commitment to free trade.   Right now, I feel the same way as Greg Mankiw, disappointed.   I am a strong believer of Free Trade.  Protectionalism serves some people’s interests, but not everybody.

This is not to say there are not real problems with the U.S. economy and especially in the manufacturing sector, but restricting free trade is treating the symptoms rather than the causes.   The U.S. is like an unemployed teenager going crazy buying video games with his birthday money from his grandparents when he should be looking for a summer job.  Restricting free trade might stop him from buying video games, but it doesn’t help him get a job.

The more troubling aspect right now with regards with the tariffs is that China is looking to retaltiate with restrictions on Chicken and Auto Part imports.  If China were to retaliate, we would have few winners and plenty of losers.   A trade war is the last thing we need to see during what are still unertain economic times.

I recently finished reading When Genius Failed by Roger Lowenstein.   The book details the glorious rise and ignoble fall of Long Term Capital Management, a fund that boasted not one Nobel laureate but two.   I had been meaning to read the book for the last 4 years, but recently came to it indirectly.   The previous week, I had finished reading the Warren Buffet biography Snowball by Alice Schroeder.  The characters of LTCM, especially Jon Meriweather, play a prominent role during Buffet’s days at Salomon Brothers.  My curiosity was ignited to hear another tale of high finance.

Roger Lowenstein is great writer, and an even better financial writer.  He doesn’t just thrown down good prose, but understands the basic financial issues at hand.  I write here not the review the book, but dwell on one issue that epilogue raised - did the bailout of LTCM set the stage for the recent financial collapse and subsequent bailout?

Lowenstein writes prophetically, “If one looks at the Long-Term episode in isolation, one would tend to agree that the Fed was right to intervene, just as, if confronted with a suddenly mentally unstable patient, most doctors would willingly subscribe a tranquilizer.  The risks of breakdown are immediate; those of addiction are long term.”  In the case of LTCM, the Fed did not risk any public money - it merely orchestrated the meeting of the heads of the various Wall Street banks so they could privately fund a bailout.  In 2008 we had the Fed and the government take unprecedented steps to prevent a financial collapse, and this time the public did foot the bill.

I for one think it worked, but the spectre of long term addiction that already loomed since the days of LTCM rides much higher in the horizon.   Moral hazard is easy to recognize; if the government is willing to bailout financial firms that are “too large to fail”, the government is implicitly encouraging financial institutions to take on too much risk.  Moral hazard is easy to recognize and hard to avoid.   Purists will argue that we should have let AIG and brethren banks fail, and dealt with the consequences even if those consequences were another Great Depression.

I’m not a purist, but have to admit the precedent that we’ve set is a dangerous one.   Ultimately, it’s not just about  making sure that those who do misdeeds are punished.  At some point, as the stakes become greater and greater, there will be no recourse and the consequences even greater.   There are failures which cannot be bailed out.

The question is, can we pursue a course of action that is “correct” for the here and now while still setting the right precedent?  I like to believe there is.   Commonly, we make no distinction between Banks and Bankers, but there is a distinction to be made.   Institutions devoid of people should not susceptible to moral hazard.  So how can we bail out banks and not send the message to bankers to engage in ever riskier activity?

I think the “bailout” of LTCM spoke spades about how badly we deal with the guilty right now.  The managers/partners of LTCM received 250k salaries and 500k bonuses.  Yes, these amounts were trivial in comparison to the compensation these partners made in the good years, and admittedly many of the partners saw a majority own net worth vanish with that of their fund.  A few lost even more than they had as they borrowed money into invest in the fund.   Still why were they paid anything?  The twisted irony of failing in the financial world is that one is most needed when one has screwed up the most badly.  As a result financial sinners are able to hold their saviors hostage.  The worst part is that the same partners at LTCM took in more money from investors a little more than a year later in a new fund.   Should not there be repercussions?

Should we not hold some of those in the finance industry who nearly brought us brink of armageddon criminally liable?   I like to think there is some way, but here in lies the rub.   The banking crisis of the past year was widespread with no one party truly at the heart of the crisis.  The financial risks were truly institutional.   There was no one activity that was in itself too risky, but sets on interconnected activities that amplified risk.   How do you reform Wall Street?  It’s not arbitrary limits on pay going forward.   It’s a combination of good regulation that prevents systemic risk, and it’s also policies that let’s bankers know that they will not get away with risking the entire financial sector without repercussion.   Do you punish everyone who had a hand at all in the crisis which would be most of Wall Street, real estate agents, appraisers, home buyers, sellers, etc?  Individually each can claim their innocence, but collectively we are all guilty.

The Cash for Clunkers program has been getting quite a bit of press lately.  Will it be renewed or will it not?   It will.  Not suprisingly there’s been quite some debate about the merits of the program.  Is it an effective program?  If one were to judge by the good news coming out of Detroit, one would have to think that it must be.   However the numbers coming from the automakers are not the only criteria that the program should be judged upon.

Pros

The Cash for Clunkers program serves 2.5 primary purposes:

1. Improve the overall gas efficiency of the US auto fleet
2. Stimulus for the economy
3. Assistance to beleaguered automakers (similar to point 2)

Using those metrics only, it seems the Cash for Clunkers program has been success.  The program has been so successful that it’s run out of funds.  People have turned in cars averaging 15.7 for cars that average 25.4 MPG.   People are driving more effecient cars.

Cons

On the other hand, if you believe that Government has no place in choosing what industries deserve to be helped during an economic downturn, the Cash for Clunkers program is anathema to sound economic policy.   If the government must encourage spending, then a tax cut is surely the best way to do so.  Let people choose what they will spend money on.  In addition, it’s unclear that the Cash for Clunkers is truly benefiting the economy or the environment.

Some believe many of the people trading in clunkers would’ve have brought new cars anyways.  If this is true for the great majority of car buyers then program does nothing to stimulate the economy.  It serves only as subsidy from non car buyers to car buyers, and as a result does little to actually benefit the environment.  Additionally it can be argued that by encouraging people to buy new cars when they were able to make due with an older car has net detrimental effect on the environment because the construction of new car in itself is not good for the environment.   The cars being turned into the program will have their engines disabled, making them only useful for parts.   Ruining a perfectly good engine seems like a waste.  Though not to do so would curtail the effectiveness of making the car fleet more effecient as these cars would then make their way into the market.  As a stimulus program it’s not too much different from the age old example of hiring someone to dig a hole, and hiring someone else to fill it back up.

So is it a good program?

Not surprisingly how people feel about the program has broken down predictable partisan lines.  Equally not surprisingly, I’m a fan of the program.  I supported the original stimulus package because I believe the Economy needed it.   The cash for clunkers program is actually exactly the type of intervention that we need if you believe in Keynesian economic stimulus.  The money was delivered quickly and directly replace spending that was being curtailed (assuming that you believe that it actually encourages people who would otherwise not purchase cars).  Even if people moved up purchases, the program is still effective.   The goal of the stimulus package is not to encourage more consumption, but to encourage more consumption at this moment to prevent a spiral towards a depression like scenario.   While on the surface it might seem a tax cut would serve the same purpose given the prevailing mood, it was more likely a tax cut would’ve gone into savings - good in the long run, but bad in the short run which in turn puts the long run in jeopardy. 

One issue I am worried about is that we have encouraged people who should not be buying new cars into taking on more debt to purcahse new cars.  While such behavior may be good for the here and now, the long run consequences of burdensome consumer debt is not.

My postings have been even more meager than usual, and as much as i would like to blame the difficult economic times, I really can’t.   I don’t get paid to write this blog (except for the $50 I collect a year from advertising - a problogger I am not).   I’m getting paid as much as ever which is about nothing.  However, I do want to comment on the state of the job market.   The recent unemployment numbers have been encouraging, but I would probably tend to agree with Jeff Frankel that overall unemployment is ultimately less important than hours worked.

Anecedotally, I’ve seen many people I know who have either been furloughed or had others at their place of work furloughed.   I didn’t see this duing the last recession (2001), and don’t necessarily think it’s a such a bad thing.    On a human level, coworkers are often quite selfless.  They rather have their own wages cut rather than see friends layed off.   The other advantage of furloughs is that because people are keot on the payroll when good times come again, it’s much easier to pick up work.  I’m a fan of the flexible job market.  I think a well functioning society is dependent on both workers willing to move and change their work, and employers being able to change the parameters of work when circumstances force it.  As in baseball, long term employee contracts are an albatross around the neck - just as GM and Chrysler found with it’s legacy retiree benefits.

While I believe in the flexibile labor market, and encourages others to believe in one as well, American society as whole is not particularly well prepared for it.  We are a society of grasshoppers rather than ants.  We do not prepare for the winter, and most of us have not prepared for this winter.  Ideally we would have saved up the long days of summer for the coming winter.  If that were so then workers would be better able to deal temporarily reduced hours and pay.

If GM files bankruptcy as expected today,  Ford will be the only U.S.  carmaker left standing.  This is not to say Chrysler or GM will cease to exist.  They may both likely survive bankruptcy, or the shotgun marriage (in the case of Chrysler and Fiat), however Ford is the lone US automaker escape the current economic crisis relatively unscathed.

There is continuing debate on how much the Government should’ve been involved if at all with the bailing out the automakers.   Would it have been better that both Chrysler and GM collapsed on their own six months ago?  It’s always impossible to say.  Personally, I prefer an ordered transition to abrupt change as the economic impact is likely more favorable in an ordered transition. 

I’m not, however, particularly estatic at the notion of the Government owning 60% of GM after bankruptcy for any great length of time.   I’ve been supportive of bailouts (bank and auto) because I believe that Government has a role to ensure a smooth economic recovery.  I’m less supportive of the auto bailout both because a single manufacturing industry (even one as large as the Auto industry) has a smaller impact on the econmic system than widespread bank failures.  

The Government has entered a tricky position in having takenownership responsbility of what were private companies.  Only a quick return to private ownership can be ruled a success.  The worst possible outcome would be one such as Amtrak in which the Government effectively nationalized the passenger rail system.  That is not what I or anybody else should want.   I hope for the best and fear for the worst.