Entries for March 2008

Economic conservatives have a special love for cutting capital gains taxes. Not only do they feel it is one of the most destructive taxes that exists, but it was the 1978 capital gains tax cut—along with Proposition 13 the same year in California—that really launched the supply-side tax revolution. Now Barack Obama says he wants to perhaps nearly double the capital gains tax rate. Here is what he told CNBC's Maria Bartiromo last week (boldface mine):

Well, you know, I haven't given a firm number. Here's my belief, that we can't go back to some of the, you know, confiscatory rates that existed in the past that distorted sound economics. And I certainly would not go above what existed under Bill Clinton, which was 28 percent. I would—and my guess would be it would be significantly lower than that. I think that we can have a capital gains rate that is higher than 15 percent. If it—and if it, you know—when I talk to people like Warren Buffett or others and I ask them, you know, what's—how much of a difference is it going to be if it's 20 or 25 percent, they say, look, if it's within that range, then it's not going to distort, I think, economic decision making.

Should Citigroup's executives start working on their résumés? This from the U.K.'s Daily Telegraph:

The US Federal Reserve is examining the Nordic bank nationalisations of the 1990s as a possible interim solution to the US financial crisis. The Fed has been criticised for its rescue of Bear Stearns, which critics say has degenerated into a taxpayer gift to rich bankers. A senior official at one of the Scandinavian central banks told The Daily Telegraph that Fed strategists had stepped up contacts to learn how Norway, Sweden and Finland managed their traumatic crisis from 1991 to 1993, which brought the region's economy to its knees.... Scandinavia's bank rescue proved successful and is now a model for central bankers, unlike Japan's drawn-out response, where ailing banks were propped up in a half-public limbo for years.... Norway ensured that shareholders of insolvent lenders received nothing and the senior management was entirely purged. Two of the country's top four banks—Christiania Bank and Fokus—were seized by force majeure.

JPMorgan economist Jim Glassman sums up the current state of play:

The US economy is stalled, barely growing. It's not in recession—not what we normally mean by that label—and probably will avoid one. The rest of the world is booming. The commodity (and farm) economies in the United States—from Texas and Oklahoma to the Northwest and across the Midwest—are soaring. The dollar is competitive. Most US companies enjoy high profit margins. And US macro policy is in full throttle, with policy makers aiming to do more if events dictate.

Is McCain campaign economic adviser Phil Gramm, the former U.S. senator from Texas, partially to blame for the subprime crisis engulfing Wall Street? Some Democrats and liberals have been trying to make that case. It was the Gramm-Leach-Bliley Act that in 1999 repealed the Depression-era Glass-Steagall Act and allowed banks, securities companies, and insurance companies to directly compete with one another and led to the creation of financial conglomerates like Citigroup. I was chatting this morning with Gramm by telephone for a separate economic story I am working on, and I took the opportunity to ask him about the accusation. Here is a bit from that fascinating interview, the rest of which I will post later:

What do you make of Treasury Secretary Henry Paulson's proposal this morning for changing how the financial industry is regulated?
I've looked at it. Senator McCain has a group of advisers looking at it. I better wait until a consensus is reached on that.

"We might be drifting into a Japanese-like situation," Hillary Clinton told the Wall Street Journal earlier this week. "I don't think we can work our way out of the problems we're in, in the broad-based economy, with monetary policy alone. I think the Japanese tried that and tried that and tried that.... I don't think we'll have the strong growing economy we need until we have the strong energy policy, for example."

In the 1990s, miracle turned into malaise for Japan. A 2006 study from the Dallas Fed documents the nation's economic troubles. In 1991, the Japanese economy was 80 percent the size of America's. By 2004, it was 71 percent. From 1996 to 2002, per capita gross domestic product in Japan inched forward by just 0.2 percent. From February 1991 to January 2002, Japan suffered 66 months of recession vs. 16 for America. In the 1990s, the country's unemployment rose by nearly 3 percentage points, while the U.S. rate fell by more than 2 percentage points.

There has been a lot of chatter about Barack Obama's recent interview with CNBC's Maria Bartiromo in which he called for a near doubling of capital gains taxes. But I also thought this part was interesting, where Obama talked about possible spending cuts:

Oh, you know, there are probably some weapons programs that I think are not serving our national security interests that need to be examined, and we've got to do an audit there. There are reforms that need to be made in our purchasing processes, where—simple things, you know. If we actually made sure that every government employee had a single, you know, debit card or credit card, then negotiated with large purchasers to get the discounts that any other large purchaser would get, we could lop off 10 percent of some of our major purchases by the federal government. Our travel allowances and expenses are a major problem. We could save several billion dollars just in how we set up government travel. So there are a whole bunch of areas where we can make some significant savings.

Just a quickie. Economist Robert Brusca sees a silver lining in today's personal income and consumer spending numbers: "Looks like we are still set for a small plus number for Q2 GDP growth. Remember Q4 GDP was weak but Q3 GDP was very strong. Nothing that looks like a recession is in the works based on GDP." Hey, it's something!

During his speech today on housing and financial market regulation, Barack Obama gave a little history lesson on the economic beliefs of two of the Founding Fathers, Alexander Hamilton and Thomas Jefferson:

Hamilton had a strong belief in the power of the market. But he balanced that belief with the conviction that human enterprise "may be beneficially stimulated by prudent aids and encouragements on the part of the government." Government, he believed, had an important role to play in advancing our common prosperity. So he nationalized the state Revolutionary War debts, weaving together the economies of the states and creating an American system of credit and capital markets. And he encouraged manufacturing and infrastructure, so products could be moved to market.

Wall Street has been supporting Democrats in greater numbers since the Clinton era. How to reconcile that with its professed belief in the wonder-working power of free markets? Maybe there is really nothing to reconcile when you have the top economist at one of the country's premier investment firms making recommendations like the one made by David Rosenberg of Merrill Lynch (boldface mine):

To alleviate credit market paralysis, the outright purchase of illiquid mortgage-backed securities (MBS) is probably required, and could employ government-backed fiscal action. So far, government-backed plans have relied on just voluntary actions by loan-servicers to modify existing mortgage loans, resulting in low participation. The Federal Reserve itself could buy some of these securities, but the Fed alone cannot unclog the congestion in the credit markets, in our opinion.

A recent Bob Novak column from a few days back echoes what I am hearing more and more from investors I chat with:

The central bank's bold new role relieves the pressure on American financiers who have committed serious errors but does not reassure investors around the world alarmed by what they perceive in the U.S. political process, where class warfare has gained traction. The populist prospect of a new Democratic administration and Democratic Congress that will impose higher taxes and trade protection contributes to what is seen as an international buyers strike by investors that feeds the financial crisis.

My take: Yet everyone on Wall Street wants a bailout, it seems. Let me again repeat: There are no libertarians during financial crises.

This is the most downbeat thing I read today. From the Wall Street Journal:

"We have to accept that this is no longer a nation of 4% real economic growth. This is a mature nation that no longer has a strong manufacturing base," says Steve Leuthold, chairman of Leuthold Weeden Research in Minneapolis.

You might think that the housing crisis and economic slowdown would force the presidential candidates to reshuffle some of their economic plans. Certainly, huge budget deficits might. This from Goldman Sachs:

We are raising our forecast for the fiscal 2008 federal budget deficit to $500 billion (3.6% of GDP) from $425 billion. Even with that increase, the risks are skewed to the high side.... Forecasters tend to underestimate the power and extent of a turn in direction when it occurs. So it is with the federal budget, which improved much more sharply than we anticipated from fiscal year (FY) 2004 to FY 2007 but now appears to be deteriorating more quickly than we estimated just a few weeks ago. With five months of the fiscal year now behind us, we are boosting our estimate of the FY federal deficit to $500 billion (bn) from the $425bn that we announced on February 8.

The blogosphere speaks!

1) John Tamny (RealClearMarkets) dispels some economic myths. This one is a print-and-save, folks.

2) Larry Kudlow sees an interesting connection between McCain's surge in the polls and the stabilization in the stock market.

3) Calculated Risk thinks the Fed's involvement in the JPMorgan Chase-Bear Stearns deal has created a dangerous precedent.

John McCain gave further insight into his economic views today. Along with his views that 1) a cap-and-trade system is the best way to deal with carbon emissions, 2) the 2001 and 2003 Bush tax cuts were tilted too far toward the rich, and 3) pharmaceutical companies are the "bad guys" in America's ongoing healthcare drama, you can add another view that McCain apparently shares with Democrats (and more and more Republicans in Congress): that homeowners need a taxpayer-funded bailout. Here is a key excerpt from his speech today on the housing crisis (boldface mine):

Let's start with some straight talk: I will not play election year politics with the housing crisis. I will evaluate everything in terms of whether it might be harmful or helpful to our effort to deal with the crisis we face now. I have always been committed to the principle that it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers. Government assistance to the banking system should be based solely on preventing systemic risk that would endanger the entire financial system and the economy. In our effort to help deserving homeowners, no assistance should be given to speculators. Any assistance for borrowers should be focused solely on homeowners, not people who bought houses for speculative purposes, to rent or as second homes. Any assistance must be temporary and must not reward people who were irresponsible at the expense of those who weren't. I will consider any and all proposals based on their cost and benefits. In this crisis, as in all I may face in the future, I will not allow dogma to override common sense. When we commit taxpayer dollars as assistance, it should be accompanied by reforms that ensure that we never face this problem again. Central to those reforms should be transparency and accountability.

"Maybe Bernanke can go to Capitol Hill and also tell Grassley how he just saved the stock market," is how one miffed Wall Street pro reacted to news that Charles Grassley, the top-ranking Republican on the Senate Finance Committee, wants his staff to look into the Federal Reserve-backed acquisition of Bear Stearns by JPMorgan Chase. Grassley said last week that he wanted to make sure top executives didn't profit at the expense of shareholders.

But even more irksome to some was this query by Grassley: "Is there any upside for taxpayers in the Bear Stearns deal?" Well, a repeat of Black Monday—a real possibility if the Fed had done nothing and the Bear deal had never happened—would have meant a nearly $3 trillion loss in market value. Just a guess here, but that probably isn't good news for taxpayers—or anybody else. So what is behind Grassley's actions? A couple of possibilities:

1) With markets convulsing and the Fed dancing as fast as it can, this was Grassley's way of reminding all involved that Congress still matters and has a big role to play as the housing crisis continues. Plus, as one Washington observer put it, "If there are five guys on Capitol Hill willing to make an issue of this, Grassley is one of them."

2) To some people, it might look as if Washington is scrambling to help Wall Street with all sorts of largess courtesy of the Fed but pretty much ignoring homeowners. Grassley's statement is a reminder that Washington isn't cutting checks with no strings attached.