Daily Noise Reduction (3/31)

Anyone have any ideas on what type of symbol I can use for "independent"-leaning articles? The question marks seem pretty low rent. Respond in the comments if you have ideas.

Must Read:
This is Really Bad News Regarding Pensions

Recommended:
Thoma, On DeLong, On Kick Starting Employment (?)

The Economist on 'Bottom Fatigue'

Apparently, Obama Thinks Bankruptcy is Best Option for GM (?)

Yglesias Has a Good Look at When A Recovery May Come

An Analysis of Wall Street "Brain Power"

Daily Noise Reduction (3/30)

An absolute must read:

Inside the IMF (?)

Recommended:

The Press Coverage of Geithner Comes Full Circle 

Hilzoy on Write Downs of Mortgage Debt  

Random Horrible Advice Flashback

I was strolling through some Real Estate Investment Trust (REIT) related information this week and stumbled across this article from 2006 by John Waggoner:

REIT returns have been spectacular in the past five years. Real estate mutual funds, which invest mainly in REITs, have soared an average 139%, compared with 21% for the average stock fund and 10% for the Standard & Poor's 500-stock index.

All of which means that five years ago was a swell time to invest in real estate funds. But is it too late now?

Well, yes and no. If you're counting on booking a 139% gain in the next five years, REITs and real estate funds are likely to disappoint you. "Nothing is cheap," says Samuel Lieber, manager of the Alpine U.S. Real Estate fund.

But, why let data get in the way of a "good" investment:

"There's not a lot of upside here," says Alpine's Lieber. But there's not a lot of downside, either. REITs will probably raise their dividends in the next few years, making them slightly more attractive. Should the stock market turn down, those dividends will ease the pain.

Unless you plan to pick your own REITs, it's probably best to invest in a real estate fund. The top-performing real estate funds the past five years are in the chart. Right now, a $1,000 investment in a real estate fund will cost you less than a few days in a major city hotel.

Why not toss a mint on your pillow and invest the savings in a real estate fund? You'll get some decent income and save on aftershave, too.

If you had followed this advice and bought one of the funds listed in the article, you would have lost 50-70% on your investment to date. Oops.

The GOP Budget Proposal

The GOP released their "budget" this week and they probably didn't receive the response they had hoped. It was universally panned by both the right and left due to a complete lack of actual details.

As an illustration of just how weak the opposition party is right now, David Feddoso comments:

One cannot help but get the impression that Obama's challenge to present an alternative caught the Republicans unprepared. It's great that they're going to present an alternative budget, but it's a bit disappointing to be promised a budget and to get a general statement of policies instead.

Still, there is some information about the current GOP's vision to be gleamed from the proposal. The general objectives are:

1. Curb Spending
2. Create Jobs and Lower Taxes
3. Control the Debt

Who can disagree with those? Unfortunately, the solutions seem to have a common theme, see if you can pick it out. For example, on health care:

Republicans support leveling the playing field through policies that will provide tax incentives for millions more working families and small business owners to obtain access to coverage.

On creating jobs:

Instead of raising taxes on all Americans in the midst of a recession, Republicans seek to reduce the tax burden on working families and small businesses in order to create jobs and unlock private capital.

On energy:

Instead of taxing all energy users with a new energy tax that will cost up to $3,128 per household, Republicans want energy independence with increased exploration and the development of new renewable energy sources, such as wind and solar.

Cut taxes, cut taxes, cut taxes. There are some other solutions such as "ending bailouts" and "reducing the deficit" without any real details on how to do that. The plan does close with a counter proposal to the fed's loose monetary policy to help reduce the long term prospects of inflation. Probably the least comprehensible to the general public but it is worth hearing more about.

Apparently, the GOP will produce an actual budget this week, I'm on the edge of my seat.

Weekend Reading

Must Read:
The Economist Comments on the Geithner Regulation Plan

Recommended:
The New EU Head Doesn't Like Obama's Stimulus

The Economist Chimes in on Banks Buying Up Bad Assets

Calculated Risk Has a Nice Comparison of 4 Bear Markets (?)

Daily Noise Reduction (3/26)

Today's Must Read:
Nicholas Kristof on "Expertise"

Recommended:
Robert Reich Predicts the Recovery

Andrew Sullivan Summarizes Some "Bottom Hunters"

Daily Noise Reduction (3/25)

Slow news day today, the must read:
Ezra Follows Up on the One Bank We Did Nationalize

Recommended:
Some Details on the Senate Budget

An AIG Executive Resigns and Writes About It (?)

Drum Previews the Coming Financial Regulations

Another (If Obscure) Indicator of a Bottoming (?)

Drum Responds

Kevin Drum responds to my post on housing prices:

Mike suggests that lower mortgage rates and the upcoming stimulus tax credit will prop up prices a bit compared to past levels, and that's possible. But mortgage rates are only slightly lower today than in 2000, and the effect of the tax credit is hard to judge. I'm just guessing like everyone else (and since I have a house I'm trying to sell I'd be delighted to end up wrong about this) but I'd keep my money on a further 20% drop.

No real issues with his calculation, he was using the Composite-20 measure of the Case-Shiller Home Price Index, which looks at housing prices across 20 major cities.

I will only make a couple points (warning, this gets technical). First, the Case-Shiller numbers are delayed 2 months instead of 1 like the NAR numbers I was using, and January was a really bad month for housing prices, declining 8.3% (at least according to NAR). Also, they aren't national numbers so we weren't comparing apples to apples, if you use the national Case-Shiller numbers, the index was at 139 in December 2008. If we add in the same 8.3% January decline, the index becomes 127 and then adjusting with the GDP deflator (divide index number by GDP deflator of 123), we are at 103. That is exactly where you would expect the bottom to be, especially with all the incentives that buyers have right now.

I will hedge a little and say that you can't really "predict" anything in the current environment and it clearly depends what indexes and data you look at, the data I'm using supports a "national" bottom. Remember, this is national data, there are pockets that still have much further to fall and other areas that may be starting to recover. Finally, just because prices have plateaued, that doesn't mean they will immediately bounce back. If you look at the inventory numbers, we are still a long way away from working that off.

Your Daily Noise Reduction (3/24)

Must Read:
President Obama Comments on the Economic Crisis

Recommended:
The Curious Capitalist Questions the Krugman Worship (?)

Comparing the Geithner Plan to the FDIC

And if you are thinking of buying a home...
A Great FAQ on the $8,000 Housing Credit

A Housing Bottom?

In a post about the good housing news today, Kevin Drum says:

It's not clear what caused this, since home prices are almost certainly going to keep falling another 20% or so. In fact, this might even be bad news in a way, since the faster we hit bottom and get back to trend growth, the faster we're likely to see the end of the recession.

I'd like to know what he is basing a further 20% decline on, I don't see it. If you look at a number of indicators, we are at, or very near a housing bottom.

Housing affordability as of December 2008 was at a historic high:

Keep in mind, this affordability metric was based on a median existing home sales price of $180k in December 2008. As of the data released today (for the month of February), the median existing home sales price was down another 8.3% to $165k.

Adding in the stimulus tax credit for buying a home in 2009, we can reduce that median price another $8k and then factor in interest rates at 5%, the lowest in decades. Housing affordability has never been higher.

Now looking at historical home prices, the median existing home sales price is already very close to the historical, inflation adjusted average of $150k:


If prices were to fall another 20% to $132k as Drum suggests, or $124k when adjusted for the tax credit, we would be at the same inflation adjusted median price as the early 80s (when mortgage rates were a whopping 18.5%).

Update: Kevin responds here and I follow up here.

Your Daily Noise Reduction (3/23)

Must Read:
A Great Explanation of Geithner's Plan Using Cars (?)

Recommended:
Andrew Summarizes Brad DeLong on the Plan

And Geithner, In His Own Words

On Distractions

Anyone else find it humorous that the 3 biggest stories this past week were:

1) The AIG Bonuses - (0.000065% of 2008 US Tax Revenues)
2) President Obama "Wasting Time" on Leno - (0.00011% of Obama's time as President)
3) President Obama Taking On Too Many Things at Once

Has the press just completely given up?

Uh Oh - Initial Details of the Treasury's Toxic Assets Plan

The first details of the treasury plan have leaked, covered by the NYT here.

The Times does a nice job of explaining the objective of this plan:

Risk-taking institutional investors, like hedge funds and private equity funds, have refused to pay more than about 30 cents on the dollar for many bundles of mortgages, even if most of the borrowers are still current. But banks holding those mortgages, not wanting to book huge losses on their holdings, have often refused to sell for less than 60cents on the dollar.

The result has been a paralyzing impasse. Banks, unwilling to sell their loans at fire-sale prices, have had less capital available to make new loans. Mortgage investors, unable to leverage their investments with borrowed money, have been unwilling to pay more than fire-sale prices.

To break that impasse, the government’s crucial subsidy is meant to provide investors with the kind of low-cost financing that has been utterly unavailable in today’s credit markets.

A Friday evening leak, and if the initial reaction is any sign, this probably won't go over well. Although, the press has decided that Geithner can't do his job and is going to go after anything he puts out. I'm not going to defend Geithner, and I think he obviously needs some political/PR training, but people need to understand that there are no "good options" in the current crisis.

Krugman sums up the opposition to the plan, more below:

The Obama administration is now completely wedded to the idea that there’s nothing fundamentally wrong with the financial system — that what we’re facing is the equivalent of a run on an essentially sound bank. As Tim Duy put it, there are no bad assets, only misunderstood assets. And if we get investors to understand that toxic waste is really, truly worth much more than anyone is willing to pay for it, all our problems will be solved.

To this end the plan proposes to create funds in which private investors put in a small amount of their own money, and in return get large, non-recourse loans from the taxpayer, with which to buy bad — I mean misunderstood — assets. This is supposed to lead to fair prices because the funds will engage in competitive bidding.

Krugman's charge that the Obama administration thinks "there’s nothing fundamentally wrong with the financial system — that what we’re facing is the equivalent of a run on an essentially sound bank" is a leap. Unless I'm missing something, this plan means that they think the assets are worth more than 30 cents on the dollar but also that they are worth less than 60 cents on the dollar, far from "nothing fundamentally wrong" with the assets. In the links below, you can see that there are some gaps in the details released so far, people are just assuming the worst.

Everyone agrees that these toxic assets are choking the system, and the fact remains that if you don't do something like this, you either take over the banks and their bad assets (huge cost to the taxpayer among other complexities) or pay the 60 cents on the dollar for the bad assets that the banks are willing to sell for (again, huge cost and a bad investment). The key thing to watch is if the banks are allowed to set a reserve price at the auction of the assets, say at 60 cents on the dollar. If they can, then I agree that this plan is probably the wrong one.

There are some credible supporters of a plan like this, Lucian Bebchuk, an economist at Harvard is one.

However, there are many detractors, below is a roundup of respected economists who have panned the initial details:
Krugman is unhappy. Really unhappy.

Calculated Risk is not enthusiastic

Yves Smith at the Naked Capitalism Has a Detailed Rebuttal. And a follow up.

Are they right? Let's hope not.

Your Daily Noise Reduction (3/20)

Forgot to post these on Friday.

Must Read:
Brad DeLong Has a Great Idea for Exec Compensation

Recommended:
Is AIG Really "Too Big to Fail"? (?)

Obama Is No Socialist (?)

The TED Spread Stabalizes

I'm going to start monitoring some of the key economic indicators to help track where we are in the economic recovery process. The first that we will be looking at is the TED Spread.

In short, the spread is used to measure of the perceived risk of credit in the overall economy. It measures the difference between interest rate on US Treasury Bills (considered to be risk free) and the cost of inter-bank loans ("credit flow"). See the chart below:


The TED spread has stabilized to August 2007 levels, and with the FED taking some drastic action, I would expect the spread to trend down in the coming months. Yet another positive indicator that the crisis is beginning to find a bottom.

Your Daily Noise Reduction (3/18)

In light of the anger over the AIG bonus debacle, today's must read:

Who Is The Villain That Caused The Crisis? (?)

Recommended:
How Well Does America Respond To A Crisis

What the Fed Just Did

The Housing Surge

It isn't quite clear what to think of the surge in new housing starts:

Initial construction of U.S. homes unexpectedly surged in February, after falling for eight months, according to a government report released Tuesday.

Housing starts rose to a seasonally adjusted annual rate of 583,000 last month, up 22% from a revised 477,000 in January, according to the Commerce Department. It was the first time housing starts increased since June, when they rose 11%.

In the aggregate this is troubling, as Shepardson notes:

"With new home sales still falling and the months' supply at a record, there is no reason for homebuilding to rise," wrote Ian Sheperdson, chief U.S. economist at High Frequency Economics in a research note. "This is a temporary rebound, not a recovery."

However, looking at the data by region, in the areas with the most overbuilt markets (the west), housing starts declined by 25%. This is a positive sign that confidence is returning and builders have decided it is time to take advantage of the huge decline in the cost of building materials.

Policymakers must be vigilant as move forward though, we cannot risk starting yet another unsustainable boom in housing. Part of this collapse of the housing market is unavoidable and really will be a good thing for long term economic stability.

Your Daily Noise Reduction (3/17)

A catch up post, didn't have time to post these yesterday:

Must Read:
Larison Questions the Earmark Crusaders

Recommended:
China Isn't Happy About Obama's Budget

The Difference Between Economists and the General Public (?)

Artificially Inflating Housing Prices

I attempted to analyze this post by Henry Blodget and had some difficulty:

Here's the big problem with almost all the current rhetoric about the housing crisis: It presumes that the goal should be to get house prices rising again. The problem with that idea is that, even after a 25% decline, house prices are still way too high.

Even if there is a government mechanism that could stop house prices from plummeting and artificially pump them up again, therefore, it would just postpone the inevitable.

He uses the below chart to make his point:

Let's ignore the fact that Blodget's predictions have about as much credibility as the bible code, it's a scary picture. However, the data is horribly sourced and the calculations are not documented. There are many factors that roll into housing prices, especially mortgage rates (low rates increase buying power) that don't appear to be accounted for. As an example, mortgage rates were close to 8% on a 30 yr fixed mortgage in 1996, which was the start of the current boom. They are currently only 5.2%.

But back to Blodget's argument, the idea of the Obama foreclosure plan isn't to artificially inflate housing prices, it is to protect an all out collapse that would cause millions of families to lose their homes. The National Association of Realtors announced at the end of February that average existing home sales had fallen to $170k as of January from the $180k at the end of 2008. That is a complete collapse in housing prices. If foreclosures can be prevented, housing price declines will slow, and families who under normal circumstances can afford their homes, can keep them.

Your Daily Noise Reduction (3/16)

In honor of St. Pattys day (and my brother visiting), I took Friday off. To the news:

Must Read:
Real Capitalists Nationalize

Recommended:
Obama Unveils Small Business Plan (?)

Yglesias Makes a Good Point About Capacity Utilization

A Profile of Larry Summers

On Fire Today, Yglesias on the Lack of Eurostimulus

Your Daily Noise Reduction (3/12)

Must Read:
Tax Rates and "Class Warfare" (?)

Recommended:
A Bottom?

A Keynesian Debate, Long But a Good Read

Your Daily Noise Reduction

Must Read:
Greenspan Deflects Blame...But Teaches

Recommended:
Anyone Still Up for Privatizing Social Security?

An Analysis of Obama's Student Loan Proposal (?)

More on Nationalization and Krugman (?)

Can the President Really Fix Education?

Cramer Vs. Stewart - Round 2:

The Daily Show With Jon StewartM - Th 11p / 10c

Basic Cable Personality Clash Skirmish '09

Daily Show Full Episodes
Important Things With Demetri Martin

Political Humor
Economic Crisis

Happy Thoughts

Your Daily Noise Reduction

Must Read:
A Sobering Take on the Dangers of Debt

Recommended:
The Challenges Facing Geithner

Drum Has A Smart Post on Bernake's Comments Re: Leverage

Your Daily Noise Reduction

Busy day. Suggested reading below.

Must read:
Kevin Drum Asks, "Let Citi Fail?"

Recommended:
Laura Tyson Defends Obamanomics in the WSJ

The NYT Reports on the Appeal of the Dollar

And Warren Buffet predicts recovery in 5 years :

Manzi Responds

Jim responded to the taxes and entrepreneurship post in the comment section and then followed up with a post on the Corner:

The first of these at least attempts to make the argument from evidence. The author asserts that tax rates were higher under President Clinton than under President Bush, and there was a greater increase in net new businesses under President Clinton than under President Bush, so therefore my conclusion “just isn’t true.”

That oversimplifies my argument, but the data does show that if we have marginally higher taxes, they alone don't doom entrepreneurship in America as the article insinuates. That was my point. Continuing:

There are some problems with the analysis, but more fundamentally, with the logic.

First, the analytical problems. As the author notes, he is looking at “net increase in number of firms”, which is new formations less eliminations, so it does not actually capture new starts. I think that a much more direct analysis of this kind in regard to my assertion would be to compare government spending as a percentage of GDP (I referred in the article to current tax laws plus the rational expectation of future tax increases) to total dollars of new venture capital commitments (I described a venture-backed entrepreneur, and quoted the number of jobs created by venture-backed start-ups as evidence for the importance of the issue). I did this only as a response to some of these criticisms. You’ll find that there is a negative correlation with R-Squared of 0.28 between these two variables — that is, as government spending becomes a larger part of the economy, venture capital funding of businesses tends to drop.

Only that wasn't the only assertion he was making in the article. Edmund Phelps, who Manzi quotes, makes the argument that there is some correlation between an increase in government spending and a decrease in new venture funding. But Manzi quickly moves from that, to the effect of marginally higher taxes on an entrepreneur's willingness to make the leap. Furthermore, and Manzi admits this in his response, a 0.28 R-Squared is by no means conclusive (there are other lurking variables that explain the remaining 72% of variation).

He closes with:

I was carefully circumscribed about my claim:

Higher tax burdens raise the price of entrepreneurship. When you raise the price of something, then, all else held equal, you usually get less of it.

That is, I didn’t claim that we would have fewer new company formations in the next decade than we did in the last. I didn’t even claim that the net effect of the overall Obama political program would be positive or negative for entrepreneurs.

He certainly spent a lot of the article talking about how higher taxes would make someone less likely to start a business. And the title of the article is, "The Innovation Squelch: Obamanomics is bad news for American entrepreneurs", draw your own conclusions.

Responses to Taxes and Entrepreneurship

We had quite a large response to the taxes and entrepreneurship post today, which led to a lot of new visitors courtesy of Andrew Sullivan. Welcome, and I hope you continue to read and interact with the site.

There are some great comments in the comment section, and I want to highlight a couple:

It's interesting that you include 1992 as Clinton year, when he wasn't President, and 2000 as a Bush year, when he wasn't President. If you start with 1993 and 2001 respectively, and take the 5 Bush years which appear on your graph and the first 5 Clinton years, you will see substantially greater new business growth during the Bush years.

Actually I included the correct data from the correct years, but you pointed out something that wasn't exactly clear on the charts. Each X-axis label was the end of a year, not the beginning. So the space between 2000 and 2001 is actually end year 2000 to end year 2001. Thanks for pointing that out and I clarified the labels in the original post.

Another commenter:

I have started 3 and sold 2 software businesses. Current tax rates had zero impact on my decision making process. Far more important: Could the business succeed, did I have a realistic chance of selling our services/products, was I willing to make the commitment in time/effort/money to make it successful, was there an achievable endgame? A few percentage points of tax rate really only drove what I took home as profit - with the higher rate, I would, as a commenter said above, look to ways to reinvest in the business instead of taking home everything.

And finally, from another commenter:

Mark Cuban had a good post about this a while back, the line that jumps out at me:
"Entrepreneurs live to be entrepreneurs. I have never had a discussion with anyone about starting a business that included tax rates. Ever. If anyone that wanted an investment from me made a point of discussing tax rates as an impact on their business, I wouldn't invest in them. Ever."

The Effects of Taxation on Entreprenuership

This post by James Manzi about Obamanomics being bad news for innovation made the blogosphere rounds this week. While it got some people excited, specifically the "tax cuts solve all problems" crowd that I have previously addressed, the argument has some gaping holes in logic. It begins by citing Edmund Phelps as follows:

For an academic macroeconomist, Nobel laureate Edmund Phelps can sound shockingly in touch with the real world. In a recent interview, he described the possible implications of the large government-spending programs in President Obama’s stimulus package: “There’s . . . a chance that the perceived increase in the role of government of this sort will have some unanticipated effects on the animal spirits of entrepreneurs.”

Now, Phelps' statement clearly isn't definitive, and certainly doesn't mention taxes in any way. In some blogging jujitsu, Manzi uses the credibility of Phelps, who clearly wasn't making the same point, to support a diatribe about the Obama tax plans:

In fact, not only the stimulus package itself, but the higher taxes that it will require—both tax increases explicitly proposed in the president’s budget and the expectation of large future tax increases because we’re paying for all this spending with the national credit card—are likely to reduce the number of entrepreneurs in America.

What evidence does he supply for making such a dramatic leap? Just an abstract thought study, using an engineer who has an idea to start a business. His point being, the deciding factor for an entrepreneur taking the leap to start a business is a calculation based on the success rate of businesses and the expected payoff:

But consider the prospective entrepreneur’s incentives as they exist the moment before she makes the leap. She multiplies her potential payout by the odds of success. Tax increases influence this calculation directly by reducing the size of the payout. The capital-gains tax that hits her when she sells her company is just the first thing for her to consider. Second and more important are increasing tax rates on dividends, interest income, and (again) capital gains—since she will invest the proceeds she gets from selling her company in a portfolio of stocks, bonds, and so forth, and rising taxes will reduce the present value of the after-tax consumption that the portfolio will generate in perpetuity.

As an engineer, who has considered starting a couple different businesses, I will say this just isn't true. While the stakeholders providing the funding for a venture almost assuredly would factor in expected payoff, an entrepreneur is thinking very differently. First, they absolutely will not think 'their idea' has only a 20% chance of success, it's the "it can't happen to me" syndrome, although they will be aware that failure is a possibility. Second, how their life will change immediately after making the leap to being self-employed and what happens to them in the event of failure, is a much much larger consideration.

In other words, the ability of the entrepreneur to provide for the day to day needs of his household, and the ability to recover if the venture fails. Can they meet their household's monthly cash flow requirements? Will they have to forgo health care coverage? Can they afford college for their kids? How quickly can they find a job if the venture fails? These are examples of what an entrepreneur is thinking about immediately before they make the leap. The differences between an upper income bracket tax rate of 35% and 39% (or slightly higher) and how that would effect the entrepreneur in the event of success, probably isn't even in the way back of their mind.

However, don't take my word for it. Let's take a look at what the data tells us. The below graphs are from the US Census Bureau:

Disclaimer: This data does not include non-employers, which can be found here. It also only looks at the net increase in number of businesses, not the number started in any given year.

The census data only goes to 2006, so we can only compare the first 6 years of each presidency. After 6 years, Clinton and Bush had presided over a net increase of roughly the same amount of businesses (375K to 369K respectively). Clinton's final two years, coinciding with the height of the tech boom, included a huge jump to a final net increase in businesses of 557k under his presidency. Keep in mind the top tax rate under Clinton was exactly the same that Obama is proposing it return to.

Clearly, the data doesn't support Manzi's argument that a return to a 39% tax rate will negatively affect entrepreneurship and innovation. In fact, by addressing health care and college affordability as well as energy and infrastructure, the safety net Obama is creating for entrepreneurs could lead to an increase in new business starts. At the least, there isn't going to be some grand implosion of innovation due to a 4% increase in taxes as Manzi suggests.

Your Daily Noise Reduction

To help you understand what you are reading, I'm going to be marking the "Daily Noise Reduction" articles with a Republican or Democrat icon based on whether the commentator is liberal or conservative (when applicable). I know that liberal or conservative doesn't necessary translate to the political parties directly.

Must Read:
David Brooks Explains the Obama Budget

Suggested:
Paul Krugman Questions the Treasury's Bank Plan

NPR Questions the Benefits of a Strong Dollar
Robert Reich Takes on the "Blame Obama" Crowd

Your Daily Noise Reduction

Must Read:

An Explanation of What Happened to AIG

Leisure Reading:

Lexington Makes a Great Point About Talented Immigrants

GM May Not Make It

And this video was all over "the internets" today, but it hammers home the point that this blog will make many times in the future. You shouldn't get financial advice from cable news!

The Daily Show With Jon StewartM - Th 11p / 10c

CNBC Gives Financial Advice

Daily Show Full Episodes
Important Things With Demetri Martin

Political Humor
Joke of the Day

Your Daily Noise Reduction

I’m going to be posting a daily roundup of the most relevant, well thought out and understandable economic thoughts.

Today’s Must Read:

A Defense of Government Debt….For Right Now

Leisure Reading:

An Andrew Sullivan Reader Has an Optimistic Take on the Current Situation

ABC Blows It in an Article on Taxes for People Making Over 250K

What The Dems Are Doing...Well Maybe

Reaganomics vs. Obamanomics vs. Misinformation

A radio show I listen to had a conservative financial commentator on this morning, Jim Pethokoukis from US News. He was all worked up about the decisions President Obama was making, specifically running huge deficits, spending money on health care and raising taxes on the rich. After an over the top tirade, he was asked what we should do instead. His proposal was to invest a very small amount in infrastructure ("which is a problem") and then put the rest towards tax cuts, not mentioning how that will address the deficit he was previously so upset about. Backing up his argument, he referenced what Reagan did in 1981, which absolutely did stimulate the economy. If you want the basic argument, listen to the first radio show caller in this segment here. Anyways, this whole incident made me realize what a truly terrible job the press is doing in explaining the situation to the public. I decided that I could do better. Today I will explain why this argument is so off and then describe what the current President is attempting.

A quick history lesson is in order, the top tax rate in 1981 was 70% (yes, 70!), which Reagan’s cuts reduced to 50% (they were later reduced further under Reagan, and the top rate was 39% by the time President Clinton left office). In 2001, President Bush cut the top rate to 35%, an unprecidented tax cut during a time of war. As far as corporate tax rates go, they currently sit at the same 35%. You constantly hear they are the highest in the world, but there are so many loopholes in the tax code, that is a difficult factual argument to make (For example, look at Lockheed Martin’s actual 2007 tax rate of 30%). The corporate tax rate in 1981 was 46% and was also reduced reduced to 34% by Reagan's tax cuts.

So the Republican argument right now is that the deficit is out of control and we should stimulate the economy by cutting taxes across the board. Keep in mind that when you cut taxes while you are running a deficit, that IS spending. We will need to borrow the money from the Chinese to pay for them, just like we are going to do to pay for the stimulus bill. However, instead of the government deciding where to invest, they are just giving the money back to the public and businesses. That makes sense if the tax cuts go to people who will spend and invest that money wisely or when tax rates are so high that they stifle growth like in 1981. Yet after 8 years of doing exactly that (cutting taxes and running deficits), we have nothing to show for it: horribly inefficient healthcare, a deteriorating education system, volitle energy costs, and a dying infrastructure. This is because while running huge deficits, we were cutting aid to states for infrastructure, education, and healthcare programs. Clearly, the last 8 years have shown that there is a difference between a cut from 70% to 50% and cut from 39% to 35%. You should ask yourself why another cut from 35% to say 30% would change anything? Amazingly, the "conservative" leadership is literally saying, "Let’s do the same exact thing we’ve done since 2001" and all the commentators on CNBC are chirping right along. Hopefully the insanity of this clear, but it will become more so after the next paragraph.

Now the approach that President Obama is taking, is that our economy is fundamentally broken. I’m not just talking about the banking system, but the fact that business is being stifled, just like in 1981, but this time by skyrocketing healthcare costs and volitle energy prices. At the same time, looking to the future, the administration has recognized that our infrastructure and education systems are growing more and more inadequate every day. For example, our broadband availability is ranked 15^th in the world and our water systems and energy grid were built decades ago. This makes it difficult to compete with China and India to attact business investment when they offer cheaper labor and are building entire cities with brand new infrastructures. So the President, has chosen to put the majority of money right now towards those four things, two that will free up business (energy and healthcare) and 2 that will position us for long term growth (education and infrastructure). At the same time, this money will create jobs immediately, and make us the world leader in energy technologies, technologies that developing countries like China and India will want. This isn’t bad or irresponsible spending, it is smart and targeted, and if executed properly, exactly what we need to do.

Now there are two caveats to this, first the banking system needs to be fixed for anything to work. Secondly, the deficit must be drastically reduced once we have stable economy again to ensure the long term strength of our currency and borrowing power. I’ll touch on those in future posts.