The Best Links of the Week That Was

From The Inoculated Investor blog:

Looks like the government piling up all that debt is a problem after all: Who would have thought that endlessly accumulating debt to finance current spending obligations could be a bad thing? Come to think of it, the reminders of the risks associated with excessive leverage are probably the central lessons that have emerged from the credit crisis. Even households are starting to understand that you can’t borrow and spend your way to sustainable prosperity and subsequently have been tightening their purse strings. Unfortunately, this intuition has clearly been lost on the US government. Specifically, the backdrop of the need to stimulate a depressed economy has given the powers that be in the US a remarkably convenient excuse to ignore these lessons and continue to borrow with reckless abandon. Aside from the usual risks like default, debt service as a percentage of total revenue increasing as rates rise and the destruction of the US dollar, authors Carmen Reinhart and Ken Rogoff now find that future growth may also be impacted by unsustainable debt levels:

In a new paper presented Monday at the annual meeting of the American Economic Association, Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard study the link between different levels of debt and countries’ economic growth over the last two centuries. One finding: Countries with a gross public debt exceeding about 90% of annual economic output tended to grow a lot more slowly. For advanced countries above the 90% threshold, average annual growth was about two percentage points lower than for countries with public debt of less than 30% of GDP.

The results are particularly relevant at a time when debt levels in the U.S. and other countries at the center of the financial crisis are rapidly approaching the 90% threshold. Gross government debt in the U.S., for example, stood at 85% of GDP in 2009 and will reach 108% of GDP by 2014, according to IMF projections. The U.K.’s gross government debt stood at 69% of GDP in 2009 and is expected to reach 98% of GDP by 2013.

“If history is any guide,” the rising government debt “is very troubling for the U.S. and other advanced economies,” says Ms. Reinhart.

Left unaddressed, it appears that the US’s debt to GDP ratio will cross the 90% point of no return threshold in the next few years and that event could dampen an already meager growth rate. I don’t think I have to point out that a lot of the budget projections that have come out over the last year have included some particularly rosy estimates of future GDP growth. If the debt and deficit collaborate to stunt that growth then suddenly the US has to borrow more than anticipated even though tax revenues are unlikely to increase without meaningful GDP growth. I don’t know what the technical definition of a debt spiral is, but this situation sure sounds like one.

Would a bonus deferral scheme help solve the compensation problem on Wall Street? James Kwak of The Baseline Scenario recently created an interesting post on the potential way to remedy the misaligned incentives issue that is the plague of the taxpayer and a windfall for Wall Street traders. At just about every firm bonuses are paid on a yearly basis even though it could take years for the success of certain trades to be ascertained. Recent trading “profits” stemming from RMBS and CMBS assets come to mind as those that have looked great for a while but then turned into crippling losses when the housing and commercial real estate markets started to implode. A trader who loaded his company’s balance sheet with MBS probably looked like, and was compensated like, a star when the prices of these securities were going up. But then when some of these securities could not be unloaded without taking gigantic losses a few years later, most firms reluctance to claw back past bonuses meant this trader got to keep his bonus even though his trades endangered the going concern status of the institution. Recently, this dynamic has meant heads the trader wins and tails the taxpayer loses as the government has been forced to bail out the firm in question when its balance sheet caught fire.

There has to be another way right? Let’s review what Kwak’s idea is:

Instead, what about making your 2009 year-end bonus based on your performance in 2006, 2007, and 2008? That is, by the end of 2009 you would have better information about whether the trades placed in those years had turned out well or badly. There are all sorts of variations possible: you could weight the years differently; you could include 2009 (with a low weight because it’s too early to tell); you could do it on a quarterly basis to smooth out the lumps; you could pay out on a quarterly basis; and so on. But the basic principle is that you don’t calculate the bonus until enough time has elapsed to ensure that the employee deserves it. If you wait long enough, you could even just pay it out in cash instead of restricted stock.

The first objection will be that new employees get screwed, since they will get lower bonuses until they have been with the company for a few years. There are a couple possible solutions to that. The one I like less is that for someone who joins on 1/1/2009, his 2009 bonus could have a full-size target and be based on 2009 performance; but his 2010 bonus would be based on two years of results, his 2011 bonus on three years of results, and his 2012 and later bonuses on four years of results.

My preferred solution, though, is that people simply get smaller bonuses (and maybe somewhat higher salaries to compensate) when they switch companies, and only get the big bonuses after they’ve been around a few years. (You can imagine a new equilibrium where bonuses for employees in their first years are lower than today, but bonuses for long-term employees are higher. I’m not saying in this post that total compensation has to go down; that’s a separate issue.) In the technology startup industry, employees get stock options that vest over four years (with a one-year cliff). If you leave after two years, you give up your last two years of options (and unless the company is already public, you have a difficult choice about whether or not to exercise your options). This increases the cost to the employee of switching companies, which is good on two levels. First, as far as the division of the pie is concerned, it benefits employers (shareholders) relative to employees, which would be a good thing for the banking industry (as opposed to, say, the fast food industry). Second, it makes the pie bigger, since companies are more productive if they have more stable workforces. For these reasons, banks should actually want to move to this type of bonus calculation.

Although the exact calculations of yearly weights or how many years to include when determining a bonus need to be worked out, this seems like an infinitely better scenario (for taxpayers) than what we have now. Currently, traders have the incentive to make as much money now as possible with little regard for the future consequences. But, if a big bonus after a particularly profitable year were deferred, a trader’s time horizon would be elongated in a way that reduced the possibility of a future blow up. This would actually be great for the bank and would protect taxpayers a lot better without capping or reducing compensation. I’m sure if such a scheme were ever forced upon members of Wall Street I would be able hear their cries from Los Angeles. But, if the goal is to create a more stable financial system in which individual participants are reluctant to take excessive short-term risks because their own compensation is one the line, then maybe Obama and Congress should ignore those ubiquitous financial lobbyists on this topic.

You don’t always have to use a bazooka: In 2008 former Treasury Secretary Paulson likened the threat to take over Fannie and Freddie to having a bazooka that he hoped not to use. In the end, he eventually did have to use the bazooka but the sentiment of his comment was interesting. He thought that the threat of nationalization or conservatorship would be enough to force Fannie and Freddie to reform their money losing ways. In retrospect, by the time he made that threat it was way too late as it had become abundantly clear that F&F had filled their balance sheets with such toxic waste that the HAZMAT team needed to be summoned.

The truth is that in the past sometimes all government officials or the Fed had to do was hint at taking action in order to change market sentiment or practice. Unfortunately, the financial crisis has diminished the credibility of such threats. When Tim Geithner talks about the US’s commitment to a strong dollar people laugh at him and the markets ignore him. However, the Fed does this type of thing all the time and it appears to still be working. Without any actual action, all the Fed has to do is say that rates will be held low for an “extended” period and the market gets the signal that interest rate hikes are not forthcoming immediately. We will see how long this continues but for now the Fed has the ability to pull out the bazooka but not actually fire.

In his most recent piece, Martin Hutchinson of The Prudent Bear goes through a list of potential actions the government could take to incrementally help solve our myriad problems without actually pulling out the big guns. Think of it as pulling out a pistol as opposed to a rocket launcher. It is now painfully obvious that Congress cannot pass single bills that address all of the issues that need attention and if they do, the bills are 20,000 pages long and contain so much pork that they would make pig farmers blush. That’s why I think it makes sense to take little steps like the ones suggested by Hutchinson. Unfortunately, as he details below, the government could also use its pistols in ways that do not tackle the long term conundrums facing the US and only kick the can down the road at the expensive of future taxpayers:

The Christmas Eve decision by the U.S. Treasury to extend unlimited support to Fannie Mae and Freddie Mac was such a policy, albeit one pointed in a pernicious direction. In reality, it makes very little difference; Fannie and Freddie have such massive political support that no kind of devastation in their home mortgage operations would cause the Obama administration to abandon them. However, the unlimited support line from the Treasury allows them to extend their pernicious operations aggressively, thus diverting yet more U.S. capital into the wasteful housing sector, and increasing the contingent liability on taxpayers still further.

Come the November midterm elections, the Democrats will be able to claim that house prices have recovered substantially on their watch. However, a market that is propped up artificially in this way has a tendency to extract its revenge by requiring still larger and larger subsidies in order to avoid collapsing to its true equilibrium level, perhaps still 15% below current levels. Thus the cost to taxpayers, homeowners who buy houses in 2010 and the U.S. economy in general from this particular "miracle" of Treasury sleight of hand will be substantial.

Turning in the opposite direction, to an action of no direct economic consequence that could cause a genuinely useful miracle, we can consider the effect of a modest increase in the federal funds target rate, perhaps to a trading range of 0.25% to 0.50% from its current 0% to 0.25%.

This would have no immediate economic effect. With inflation already running at 2% to 3% and heading higher, short-term rates would remain heavily negative, so monetary policy would remain hugely "stimulative" as Ben Bernanke and the political class wants it.

However, such a move would have a considerable effect on commodity and energy markets. Currently, the main near-term threat to continuing economic recovery arises from these markets, in which prices are continuing to rise and may at some point get to levels that threaten recovery, by draining purchasing power out of commodity-using Western economies and/or produce a confidence-sapping acceleration of inflation…

The United States could have a similar benign effect by agreeing to raise the eligibility age for Social Security and Medicare entitlement by one month each year from 2026, the year in which the Social Security retirement age reaches 67. Such a change would have no direct economic effect at all for the next 16 years but it would at a stroke eliminate the long-term deficit in the Social Security system and greatly reduce that in the Medicare system.

Further reductions in the Medicare system's deficit certainly require a year or two to allow the whole health-care question to be depoliticized after 2009's battles. Then, some cost-saving measures such as limiting damage awards for medical malpractice are themselves highly political.

However, there is one counterintuitive measure that could be taken which would hugely reduce costs in the system overall even though at first sight it would increase federal funding for health care. That would be for the federal government to fund properly the mandate it imposed on hospitals in 1986 to treat indigent patients in emergency rooms, without regard to their ability to pay. If the federal government reimbursed the costs of this mandate, hospitals would no longer have to load the losses onto the charges for insurance-covered patients or the even higher charges on individuals, nor would they have to employ a large staff chasing deadbeats. Since the unfunded cost of emergency room treatment is estimated at $80 billion annually, transferring that burden to government would save two or three times that amount from the costs to insurance companies and individuals of medical treatment, probably saving 1% of GDP from health-care costs by that reform alone.

Does the US have more criminals on a per person basis than the rest of the world or just laws that are too restrictive? It is hard for me to believe that the average person in the US is more likely to engage in criminal activities than someone in a third world country. But that’s what the data regarding the number of incarcerated Americans relative to the US’s percentage of total world population would seem to imply. In reality, without doing a lot of research on the subject I surmise that the reason for this is that the US just has much more developed policing practices, court systems and jail infrastructure. If another country does not have to resources to catch, prosecute and then incarcerate its criminals then of course it would have fewer people in jail on a relative basis.

The problem now is that our ability to house the criminals that we are so good at catching is diminishing fast. The cost of holding all of these people in jail has begun to cripple state budgets. So, we really need to figure out what to do before states literally are forced to raise taxes on the rest of us just to keep so many people locked up. Either we need to change the laws that define what a criminal is or shorten the time that certain types of lawbreakers are forced to stay in jail. In retrospect it may have been a poor decision to put people in jail for having a minimal amount of pot or when their third strike was jaywalking, for example. Thus, we need to assess the actual threat that nonviolent offenders pose on broader society. I have no problem keeping murders, rapists, child molesters, and drug traffickers in prison. There is no question that isolating those people from the rest of us is necessary to maintain some sort of civilized and functioning society.

I just think it makes sense to try to rehabilitate some people outside of jail by helping them gain skills that allow them to re-enter the workforce. My guess is that in just about any scenario the cost of job training or classes about how to properly function within the mainstream society would be a fraction of what we now spend feeding and monitoring these individuals in jail. Not surprisingly, as this NY Times editorial points out, there is some data that supports at least trying some of these alternative measures:

The United States, which has less than 5 percent of the world’s population, has about one-quarter of its prisoners. But the relentless rise in the nation’s prison population has suddenly slowed as many states discover that it is simply too expensive to overincarcerate.

Between 1987 and 2007 the prison population nearly tripled, from 585,000 to almost 1.6 million. Much of that increase occurred in states — many with falling crime rates — that had adopted overly harsh punishment policies, such as the “three strikes and you’re out” rule and drug laws requiring that nonviolent drug offenders be locked away.

These policies have been hugely costly. According to the Pew Center on the States, state spending from general funds on corrections increased from $10.6 billion in 1987 to more than $44 billion in 2007, a 127 percent increase in inflation-adjusted dollars. In the same period, adjusted spending on higher education increased only 21 percent…

One factor seems to be tight budgets as states decide to release nonviolent offenders early. This can not only save money. If done correctly, it can also be very sound social policy. Many nonviolent offenders can be dealt with more effectively and more cheaply through treatment and jobs programs.

Michigan, which has been hard hit by the recession, has done a particularly good job of releasing people who do not need to be in prison. As the American Civil Liberties Union’s National Prison Project details in a new report, Michigan reduced its prison population by about 8 percent between March 2007 and November 2009 by taking smart steps, notably doing more to get nonviolent drug offenders out, while helping in their transition to a productive, and crime-free, life.

What we don’t know is whether crime also increased in Michigan after the prisoners were let go. A skeptic might argue, “once a criminal, always a criminal.” But it doesn’t appear that states have enough money to incarcerate all the people who they decided were criminals so at some point tough choices must be made. I don’t see the harm in implementing prison reduction programs on a trial basis in states that have the resources to monitor the released individuals and properly assess the ongoing risks they pose to society. You never know. We might be pleasantly surprised by the outcome.

Comments

[Anonymous]

US have more criminals that any other nation?

Nope, we just have the worst borders, and the best prison food.

I'm surprised all of the world's criminals haven't moved here, we're a "destination joint".

[Anonymous]

more accurately, why not just allow people to take a tax loss from their real estate equity position and be done with it ?

[Anonymous]

why not just let people write down the value of their real estate losses via income tax reduction?

*

[Gimp]

It is all a service economy, law enforcement, prison system is makes up a huge part of it. The Wild West had a better system, arm everyone and the crime rate drops significantly.

[Anonymous]

what's "debt"?

[Anonymous]

'...Debt is the money of slaves.'

If you're interested... the rest of it goes....

'Gold is the money of kings,
Silver is the money of gentlemen,
Barter is the money of peasants,
Debt is the money of slaves."

So there you have it. Glad to be of service

[Anonymous]

When you create/devalue the agreed-upon medium of exchange one used to buy things with it, and it isn't the part of net worth in (parentheses) that, if it's way more than the figures not in parentheses means you're broke, I guess it's just a joke.

Until the creditors decide to break your arm, or burn you out.

[Ripped Chunk]

On the Fed's balance sheet?

Nothing really.

[Anonymous]

it boils down to a philosophy @ who gets to capture future income and purchasing power -

[the grateful un...]

There is also Karl Denninger's "Hint To Other Nations: Here's the Bill:, http://www.321gold.com/editorials/denniger010610.html, in which he suggests countries can renege on their debts, if they feel they were deceived in accepting them. In Iceland 1/4 of the country turned out to demand these payments stop. "Just walk down any of your much-vaunted "streets" in "The City" and where you see a $5000 suit, apply a pair of handcuffs." We're just seeing this sort of populist outrage, and while refusing to pay your taxes, isn't the same as refusing to pay your debts, which on the international scale seems pretty self defeating. The global economy should probably be thrown into reverse, at least for a while, but allowed to function where the parties seem okay with it, (Brazil and China?) but bombing the central bankers into the stone age? Imagine US courts blocking home foreclosures because the MBS financial products we sold to China, and other sovereign wealth funds, do not constitute proof of ownership. Haha, the homeowner says, you suckers wrote me a fraudulent mortgage, and you can't do anything about it. Which is pretty much the way the system is working, as home owners walk away, making payment on their credit cards instead of their homes, because the CC debt is not forgiven in bankruptcy court, and you need that line of credit to live on. The Fed backstops the debt, but for how long. How much Treasury product is held by the Americans who man the protest lines at the teabagger rallies? Do they care if T-bonds default, and will those Congressional types who grill Bernanke over his policies, be whispering this is in ear. Go ahead Ben, and pull the plug.

Put this link on your list ahead of asteroids, tidal waves, and swine flu.

[cmalbatros]

"Does the US have more criminals on a per person basis than the rest of the world or just laws that are too restrictive?"

Over 50% of  inmates are "non violent" drug users. Private prison companies such as Wackenhut get $billions for doing this, watch "Americas Drug Wars" to enlighten ones selves.  Jobs For The Boys?

[A Nanny Moose]

indeed. It is utter nonsense to spend money combating plant ownership/us, when this money flow could be reversed completely.

The reasons, of course, are that one cannot patent a product of nature. Though it is being attempted.

[jeff montanye]

this is the crux of the matter: an argument over intoxicants.  certain politicians find it advantageous to use this as a wedge issue and other politicians are too cowardly to call them on it.  i also find it amusing that we are enforcing what amounts to the harrison narcotics act of the 1920's in afghanistan, enabling the taliban to fund their operations from the sale of opium at contraband prices, while importing alcohol into a nation of believers in a prophet who prohibited its use some thirteen centuries ago.

[Anonymous]

Yes, USA has more people in jails than in other countries. Yes, there are overly excessive punishments, but there are valid reasons why the ration will be higher here than countries:
A. The assumption in the USA is that cops for the most part are honest. So, more crimes are being reported than in other countries.
B. The resources in the hands of investigators are greater, so there are more convictions
C. There are more people in the USA who have something of value that can be taken, unlike in the poor countries.
D. People have grown to be complacent, they don't lock their cars, front doors, and don't pay attention. A few "bad apples" on the streets of suburbia can make the society explode.
E. Weapons. If you don't keep every potential offender out, too many of them will get shot or shoot others.

I do think that there should be a lot more white-collar prosecutions. I mean 10 times, 20 time, 50 times more! Insider trading, fraud, etc. But it's not happening.

Bottom line: most people still can go out at night outside of your own community, leave the car parked on the street, and not fortify your house with bullet-proof windows, solid steel double-doors, and barb-wire perimeter. It's quality of life issue. You can either put away as many perps as possible, or run a police state like N.Korea. The third choice is 3rd world where .1% live in fortified mansions with armed security 24/7, and 99.9% live in the barrios where an outsider (or even many locals) don't venture out at night at all.

[A Nanny Moose]

There are many absurd reasons as well. This is mostly due to the Gordian Knot of laws. The criminalization of ownership of plants for example. Additionally some federal, state, and municiapal laws are in direct conflict with each other creating Double Jeopardy.

B) To analyze largely circumstantial evidence. Witnesses are the key to locking the criminals away.

D) In some ways we are far more paranoid. As a kid I use to leave doors open, cars running, ride bike down the street, to school, etc. Walked to store. How many would let their kids do this today?

E) Weapons do not equal criminals. Like it or not, an armed society is a polite society. This is THE Key factor. By the time your non-corrupt cops arrive, the crime has already been committed. Also "Keep every potential offender out"...of where, and how?

[lawrence1]

The US is run by criminal syndicates from the top down beginning with the Federal Reserve, JP Morgan, Goldman Sachs and they dictate government policies. As Naomi Klein points out, the massive theft from the middle class is the largest financial crime in western history.  Virtually no regulation,  no prosecution. No different than if not worse

than any third world country and I live in one.  Here at least there is less surveillance of most individuals.  But the systematic descruction and destitution of the US middle class has no parrallel in history.  And, as Gregg Palast wrote, the war against the middle class was won without a shot being fired.

[Anonymous]

lawrence1 wrote:

" And, as Gregg Palast wrote, the war against the middle class was won without a shot being fired."

The middle class has yet begun to fight. You might want to try buy some ammunition if you want a leading indicator.

[sepmeier]

Here's another one for the compilation -- PIMCO CEO says 80% of Treasury debt in '09 bought by the Fed...

http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2010/Let%E2%8...

PIMCO's Bill Gross:  "Here’s the problem that the U.S. Fed’s “exit” poses in simple English: Our fiscal 2009 deficit totaled nearly 12% of GDP and required over $1.5 trillion of new debt to finance it. The Chinese bought a little ($100 billion) of that, other sovereign wealth funds bought some more, but as shown in Chart 2, foreign investors as a group bought only 20% of the total – perhaps $300 billion or so. The balance over the past 12 months was substantially purchased by the Federal Reserve. Of course they purchased more 30-year Agency mortgages than Treasuries, but PIMCO and others sold them those mortgages and bought – you guessed it – Treasuries with the proceeds. The conclusion of this fairytale is that the government got to run up a 1.5 trillion dollar deficit, didn’t have to sell much of it to private investors, and lived happily ever – ever – well, not ever after, but certainly in 2009."

[Ripped Chunk]

Is that you Bill?

Yes a grand ponzi scheme it is.