Topic: Finance, Banking & Monetary Policy

American People to Government: Don’t Mess Up the Economy

The American people get it.  The government is likely to go too far in “fixing” the economy. 

Explains Rasmussen Reports:

Fifty-four percent (54%) of U.S. voters worry more that the federal government will try to do too much to fix the economy rather than not enough. That’s up three points from a month ago and the highest level of concern found on this question since Barack Obama was elected president.

A new Rasmussen Reports national telephone survey finds that just 37% are more worried that the federal government will not do enough in reacting to the nation’s current economic problems. That’s little changed from last month and down from a high of 44% in January.

Last October, as the meltdown of Wall Street dominated the front pages, 63% worried that the government would do too much. By the first week of November, that number had fallen to 46% and it stayed below the 50% level for several months.

Among the nation’s Political Class, (70%) worry that the government will not do enough. As for those who hold populist or Mainstream views, an identical percentage (70%) fear the government will do too much.

Notable is the contrary thinking of the political class.  The vast majority worries that the government won’t do enough.  Unfortunately, this group has far more influence over what government is likely to do than does the general public.

The Pay Czar at Work

Mark Calabria notes how the form of salary scheme at financial institutions played no apparent role in sparking the financial crisis.  But that hasn’t stopped the federal pay czar from boasting about his power, even to regulate compensation set before he took office.

Reports the Martha’s Vineyard Times:

Speaking to a packed house in West Tisbury Sunday night, Kenneth Feinberg rejected the title of “compensation czar,” but he also said said his broad and “binding” authority over executive compensation includes not only the ability to trim 2009 compensation for some top executives but to change pay plans for second tier executives as well.

In addition, Mr. Feinberg said he has the authority to “claw back” money already paid to executives in the seven companies whose pay plans he will review.

And, he said that if companies had signed valid contractual pay agreements before February 11 this year, the legislation creating his “special master” office allowed him to ask that those contracts be renegotiated. If such a request were not honored, Mr. Feinberg explained that he could adjust pay in subsequent years to recapture overpayments that were legally beyond his reach in 2009.

This isn’t the first time that federal money has come with onerous conditions, of course.  But it provides yet another illustration of the perniciousness of today’s bail-out economy.

Did Bank CEO Compensation Cause the Financial Crisis?

Earlier this summer, the House of Representatives approved legislation intended to, as Rep. Frank, put it, “rein in compensation practices that encourage excessive risk-taking at the expense of companies, shareholders, employees, and ultimately the American taxpayer.”

While there are real and legitimate concerns over CEOs using bailout funds to reward themselves and give their employees bonuses, Washington has operated on the premise that excessive risk-taking by bank CEOs, due to mis-aligned incentives, caused, or at least contributed to, the financial crisis.  But does this assertion stand up to close examination, or are we just seeing Congress trying to re-direct the public anger over bailouts away from itself and toward corporations?

As it turns out, a recent research paper by Professors Fahlenbrach (Ecole Polytechnique Federale de Lausanne) and Rene M. Stulz (Ohio State) conclude that “There is no evidence that banks with CEOs whose incentives were better aligned with the interests of their shareholders performed better during the crisis and some evidence that these banks actually performed worse…”

Professors Fahlenbrach and Stulz also find that “banks where CEOs had better incentives in terms of the dollar value of their stake in their bank performed significantly worse than banks where CEOs had poorer incentives.  Stock options had no adverse impact on bank performance during the crisis.”  While clearly many of the bank CEOs made bad bets that cost themselves and their shareholders, the data suggests that CEOs took these bets because they believed they would be profitable for the shareholders.

Of course what might be ex ante profitable for CEOs and bank shareholders might come at the expense of taxpayers.  The solution then is not to further align bank CEOs with the shareholders, since both appear all too happy to gamble at the public expense, but to limit the ability of government to bailout these banks when their bets don’t pay off.

What Recovery?

Despite the ballyhooed cash-for-clunkers program, retail sales dipped in July. Initial claims for unemployment also rose. Housing continues to be plagued by foreclosures. And many banks are still operating under the burden of toxic assets, which inhibits their ability to provide credit. These are not the recipe for an economic recovery. Yet the Federal Reserve is signalling it thinks a recovery is on the way. And President Obama is making happy talk on the economy.

A recovery may very well technically begin in the 3rd quarter of 2009, as signalled by rising GDP. But it is shaping up to be a jobless and joyless recovery. Firms are finding ever new ways of producing and earning some profits without hiring workers. The prospect of higher taxes for health care and to fund all the bailouts understandably makes businessmen cautious about taking on the liability of new workers.

The administration’s economic policy has been behind the curve. The idea of initiating new federal mandates, like health care and cap-and-trade with the attendant higher taxes, is a sure way to derail an economic recovery. What is needed is less spending and broad-based tax cuts. The administration’s economic policy is the real clunker and it is time to trade it in.

Measuring Policy Success

NPR reported this morning that “Cash for Clunkers” style programs in Germany and France are “popular and successful.” Successful by what standard? I see that the Wall Street Journal has reported that in Europe “’cash for clunker’ programs have breathed fresh life into a battered auto industry.”

Yes, by that standard, no doubt subsidies for buying cars are successful in encouraging the sale of cars. Certainly subsidies to homebuying encouraged the buying of homes. A “Cash for Computers” program would “breathe fresh life” into computer sales. Make it “Cash for Compaq” or “Cash for Windows,” and you could direct purchasers to particular companies.

But to declare a policy successful, shouldn’t you mean that it makes the country better off? And that means that the subsidies produced more economic growth or more overall consumer satisfaction than a policy of nonintervention would have. That’s a much harder standard to meet. Subsidies by definition divert consumer choices from their natural outcome. Economists generally agree that subsidies create deadweight losses for society. And sometimes, by distorting consumer decisions and encouraging decisions that don’t make real economic sense – as in the long effort to channel consumer resources into housing – subsidies eventually prove unsustainable and unstable.

Indeed, it seems likely that another part of the Wall Street Journal was correct when it described “Cash for Clunkers” as “crackpot economics.”

No Consensus on Stimulus

Following up on Chris Edwards’ comments, Alan Blinder of Princeton writes in the Washington Post that the stimulus is working and “we need to stay the course.”

But Casey Mulligan of the University of Chicago writes in the New York Post that 90 percent of the stimulus money hasn’t been spent yet, so we could still stop it before it does too much harm:

The best case scenario for the stimulus law gives us results that are miniscule compared with the costs. In the worst case scenario, we actually pay money to further harm an already struggling economy….

It would have been designed better if money had stayed with the taxpayers instead of funneling through dozens of federal agencies – an option that is still available. Otherwise, we are looking at heavy taxes – and further economic damage – down the road to pay for all the borrowing.

Mulligan wrote earlier in the New York Times that “The economy has gotten worse than the Obama administration had predicted it would be even if Congress had spent nothing on ‘fiscal stimulus.’” Mulligan provides more details at his blog stopthefiscalstimulus.com.

Meanwhile, Mario Rizzo of New York University asks

what is the mechanism by which about $70 billion in extra spending (this is the amount of the total stimulus package now spent) reduces the rate of increase in unemployment and reduces the rate of decrease in output in a $14 trillion economy? If my advanced arithmetic is correct this is ½ of 1 percent of the GDP. What kind of Super Multiplier is that?

He goes on to point out that unemployment is now higher than the administration predicted just a few months ago it would be if we didn’t pass the stimulus. So how can we believe today’s econometric claims about the good effects of the so-called stimulus?

Congress Passed TARP for What?

I thought it was to clear up so-called toxic assets.  But apparently no toxic assets have been cleared up.

Reports ABC News:

Signs abound that the worst of the recession is over: Stocks have been surging, the rate of job losses has slowed, so it seems that the economic apocalypse has been averted.

Government programs such as the $787 billion stimulus and last fall’s $700 billion Troubled Asset Relief Program have so far been successful, the Obama administration says.

Except, the Congressional Oversight Panel warns in its August report, TARP never actually bought any troubled assets.

“It is likely that an overwhelming portion of the troubled assets from last October remain on bank balance sheets today,” the panel’s report says.

Those bad assets are still there, rotting away on banks’ books, making banks reluctant to ratchet up lending, and maybe, the watchdog warns, paving the way for another financial meltdown.

Isn’t American government great?!  The executive branch stampedes Congress into authorizing the former to spend an enormous amount of money allegedly to save the nation from economic calamity.  The executive branch changes its mind and uses the money in other ways.  The original problem remains — while the taxpayers are  far poorer — presumably still threatening economic calamity.  Now what?

TARP II.  Don’t be surprised if the Obama administration eventually unveils a massive new program to clear up toxic assets.

The lesson?  Beware government officials promising to help you by seizing your money and distributing it to a gaggle of grasping individuals and companies.  Especially beware government officials demanding a second chance after wasting your money the first time!