Italy: Roubini Had it Right Five Years Ago

For about two years I have watched the performance of my (mostly American) stock portfolio gyrate, more or less in sync with the news about the PIIGS of Europe.  The latest scary news has been all about Italy: rising bond yields implying an imminent inability to roll over their debt, leading to a possible default.   What surprises me is that the gyrations have been similar in scale to what we saw recently when all the scary news was about Greece.  It strikes me as odd since Italy's economy (and debt) is somewhere on the order of five times the size of Greece's.  I guess you could say the market has been taking the Italian news in stride, or perhaps that the market always knew that the Italian bad news was somehow "baked into" the Greek bad news. Interesting though, that you don't hear much about Spain anymore.  Unemployment there is abysmal, but they seem to be making serious efforts to shore up their banking system, and of course their debt is only around 60% of GDP, as opposed to Italy's 120%.  (see my article and chart: What is Going On in the Eurozone?)

Meanwhile, browsing through Nobel laureate Paul Krugman's economics blog, I was pointed to this very interesting piece written in 2006 by Nouriel Roubini.  Please read it.  At an economic conference at Davos in 2006, Italian finance minister Giulio Tremonti tried to shout down Roubini when he gave an accurate and prescient analysis of the challenges which would be facing Italy if they did not make serious reforms to their economies; basically he compared Italy to Argentina, and said they were going down the same road.  

Of course Roubini turns out to be right, and the entire Berlusconi administration comes out looking like ineffective, corrupt children, who had been placed in charge of a $2 trillion economy.  Nice work, guys.

What Should Wall Street Do? Disappear!

The latest "Schumpeter" column in The Economist makes the case that large financial firms ("Wall Street") have not been doing enough to defend themselves against the onslaught of criticism coming out of the Occupy Wall Street movement. He says that banking is important to the economy: "....people still need loans and somewhere to park their savings.  Companies...need investment banking to help them manage their finances and grow."

Yes, but....For a long time, Wall Street has not been about maximizing social utility, and bank chiefs--who are by and large the same cast of characters that crashed the financial system to begin with-- have not been thinking about these things.  Instead they have been thinking about how to make a killing either by selling a new opaque, fee-laden product, or by taking advantage of some informational edge to make money trading in the market.

It is easy to make a case that the plain vanilla services that banks offer -- taking deposits, making loans (not repackaging them and selling them off right away), even helping companies issue stocks and bonds--are a public good.  The problem is, this is not how hot-shot Wall Street bankers got rich over the last 20 years.  They did it by trading, or through financial engineering.  And the only reason they were able to do this is because they were able to convince our public guardians to look the other way, and somehow convince the public that it was all part of a healthy, vigorous free-market system.

Paul Volcker has it right; banks should not be trading with government-insured deposits.  I believe they should  not resist putting derivatives onto exchanges where they would trade efficiently with the lowest spread possible. And probably credit default swaps should be regulated as insurance contracts, which would effectively make them illegal.

"Middle class Wall Street"--brokerage, custody, retail banking--has been shrinking for decades as a result of technology.  But Wall Street as a whole has been growing, as firms take advantage of deregulation to make money in ways that offer very little public benefit.  Can Jon Corzine make the case that by having his firm, MF Global, invest $6 billion in European bonds on a capital base of $500 million he was somehow benefiting society?  I would like to hear that.

Yes, modern society needs banks.  But it does not need super-sized institutions whose main source of profits is trading, it does not need opaque and gargantuan over-the-counter derivatives markets, and it does not need regulated institutions making leveraged bets and paying out 7-figure bonuses.

Technology should be making the banking industry shrink every year.  Profits should be shrinking, not just jobs.  Yes, this would be bad for places like New York in the short term.  But in the long term it will be good for society as a whole, as borrowers, lenders and investors are matched together at the lowest cost possible.  And New York has recovered from worse dislocations than this.

A truly free market should lead to less money for Wall Street middle men, not more, as their margins and fees are squeezed through competition.  Of course, if all profit is squeezed out, then banks will go under, which will hurt society.  So the case can be made for regulating banks as a public utility, allowing them to maintain a certain profit margin in exchange for submitting to price controls and strong regulatory oversight--like what is done with power plants and railroads.

If a Lloyd Blankfein or a Jamie Dimon wants to come out and make the argument for downsizing trading, profits and bonuses and returning banking to the conservative, risk-averse, highly regulated activity it once was, then I'm sure America will be most grateful, and protests may even calm down.  But we know how these guys made their money, and how they continue to make it.  There is no reason to expect them to change.  They will continue to keep their heads down, pay their lawyers and lobbyists, and keep raking it in for as long as it lasts.

Looking Good, Barack!

This has been a good couple of weeks for President Obama.

With just over a year to go to the election, any prediction I make now could well be dead wrong.  But for now, the President's prospects are looking good.

The big story, of course, is Thursday's killing of Muammar Qaddafi, Libyan strongman, "mad dog of the Middle East", and one of America's main bogey-men since the Reagan administration.  Does Obama get the credit for this?  Sure he does; his Administration's plan in Libya was brilliant in its "less-is-more" low-key simplicity-- the polar opposite of his predecessor's big spending, big talking and far less effective efforts in Iraq.  Obama spent around $1 billion in Libya (about 0.1% of the Iraq war), and let the allies do most of the heavy lifting and take most of the credit.  But does anyone seriously think this could have succeeded without U.S. technological and political backing?

Then, there is yesterday's news that we will be pulling all troops out of Iraq by the end of the year, finally cleaning up Bush's worst foreign-policy mess, just as Obama said he would.  Sure, critics warn of a resurgent and dangerous Iran, and the dangers it poses in the region.  But if this is the fear, Obama has rapidly proven that he is the best man to deal with the threat -- with his successful targeting of senior al-Qaeda figures (remember Osama Bin-Laden?)  and aggressive drone strikes in Pakistan and Yemen he has shown that he is no weakling, and Iran discounts him as an adversary at their own risk.

Whether polls show it or not, military and foreign policy is the most important job of any President, and Obama is now second to none on this front.  Who can challenge him when it comes to our security and vital interests: Romney? Perry? Cain?  Hah!

As far as the economy goes, most say that this will decide the election.  But this has been a good week for Obama as well, with the recent signing of free trade agreements with Korea, Colombia and Panama (in descending order of economic importance).  This won't turn the economy around on a dime, but will increase overall prosperity for years to come, and is an issue that has always had broad bipartisan centrist support.  And, as reported in today's Wall Street Journal, it has helped lead to a "thaw" in the Senate, which has allowed the confirmation of several judges and other officials that had been "held" for Senate approval for months.

Speaking of the economy, I think the nation is coming to realize that we are in the midst of a long slog, as Americans become more thrifty and save more, reducing consumption, and thus slowing economic growth (see today's WSJ, Spenders Become Savers, Hurting Recovery, by Jon Hilsenrath and Ruth Simon).   I believe this might be the beginning of a more sane, sustainable economy, one that is not based on living in a bigger house than you really need, having more (and bigger) cars and appliances than you can use, and financing them with debt.  Yes, commerce and dreaming big are American values, but so are modesty, simplicity, spirituality and sacrifice.  The idealist in me thinks that Americans can live happier and better lives without a high economic growth rate fueled by ever-increasing consumption.  But one of the keys has to be a more equitable distribution of wealth.

There is a national heritage that we are all part of, and which contributes in large part to our well-being as individuals.  In this I would include our roads, our national parks, our education system, our social security system, our system of medical care (which is now close to 50% publicly funded), not to mention our rich history and culture.  By concentrating on these things, we build wealth for the entire country that we can all share in, and that cannot be taken away from any American.  The days of a consumption-based economy, where the middle class buys more than they need, and the rich make a killing off their unnecessary purchases are over.

I hope that people are coming to realize that Republican policies that aim to take us back to this type of consumption-based economy are not appropriate in today's world.  I hope that the widespread public support for the "Occupy Wall Street" movement are a symptom of this realization.  So far, Obama is the only candidate who seems to get this, and offer something approaching a reasonable way forward.

High Frequency Trading: Have Transaction Costs Gotten Too Low?

Article: Wall Street Journal, A Call to Pull Reins on Rapid-Fire Trade, Scott Patterson

This article from today's paper is about Thomas Peterffy, chief executive of Interactive Brokers, and one of the inventors of high frequency trading.  Now he's turned against the practice which he helped invent, and says it's bad for the market.  (It also hurts his business.)  He blames high frequency trading for the flash crash of May 2010, when the market dropped by 1,000 (10%)  points before rebounding a few minutes later.

There is an orthodoxy that practices like high frequency trading make markets more efficient through an arbitrage mechanism.  As traders exploit inefficiencies to make a profit, they tend to squeeze those inefficiencies out of the market, thus making trading more efficient (cheaper) for everyone else.

But I wonder...

Transaction costs in the stock market have been dropping for decades.  Technology enables huge numbers of shares to be bought and sold with very little human intervention--cheaply.  Over the years this has caused the loss of lots of middle-class Wall Street  jobs.  But this has been the way of the world at least since the industrial revolution.

But at the same time, a small number of people have enriched themselves to an unprecedented degree by exploiting every informational and technological advantage they could find.  From big trading desks at companies like Goldman Sachs whose alumni staff the Fed and the Treasury Department, to hedge funds which somehow in an "efficient market" are able to charge many times more than what the average mutual fund manager charges --because their rich clients must believe they know something or someone that no one else does-- to high frequency traders, who somehow manage to turn a profit just by trading faster than anyone else.

It seems to me that if Wall Street is fatter than ever (in absolute terms, and as a percentage of GDP), then markets must be less efficient than ever--because after all, Wall Street is just a middle man between savers and borrowers.  The less money the middle man gets, the more efficient the market is, right?  Is "market efficiency" just a shibboleth that those who exploit an unfair advantage utter to defend their racket?

It's not really a mystery how high frequency traders make money.  They act as "market makers", taking the opposite side of the trade for all who are ready to buy or sell, as long as you're willing to accept their spread,  which is a market maker's legitimate source of profit.  Market makers provide a service; they are always there if you need to sell quickly to raise cash.  They earn a spread in return for taking the risk that they will get stuck with a toxic inventory of plummeting stock.

But in most markets, at least traditionally, market makers are regulated, and expected to step up as buyers of last resort in times of market stress.  As I read, high frequency traders are different because they stop trading and leave the market as soon as conditions get rocky.  So they really are not market makers in the traditional sense.  They make a market when it suits them, then step away when it doesn't.  This might be OK if they were small players, but high frequency trading is now over 50% of U.S. equity volume.  So they have an undue influence on the equity markets, and contribute nothing but this so-called "market efficiency" which mysteriously manages to produce more super wealthy individuals than ever before.

There are various ways to deal with this problem.  Thomas Peterffy proposes putting a 1/10 second delay on all exchange orders, which would eliminate the high-frequency houses' speed advantage, and stop their orders from getting in front of legitimate regulated market makers' orders (like Interactive Brokers).

Another solution that occurs to me is to raise transaction costs by imposing a modest tax on each trade.  Those off us who buy shares because we actually want to have them will hardly notice.  But those who churn the market for profit will have to slow down.  And the tax could be used for something good, like fighting off bank lobbyists and splitting up some of the big players, so they have less influence and pose less systemic risk.

But I think the best solution is for the SEC to simply do its job.  If you are pumping thousands of trades through the market each day, then you are a de facto market maker, and need to be regulated as such.  The SEC's mandate is to ensure fair and orderly markets.  If certain players are making profits through activities which destabilize markets and create more risk all around, then they need to be warned, and then banned from the markets if they continue.

To my loyal readers, I apologize for the 17 days that have passed since my last post.  After a wonderful, though truncated visit to the island of Shikoku, Japan, I am now gainfully employed which is interesting, but makes out-sized claims on my time.

Good News, Trade Pacts Moving Forward

Article: Wall Street Journal, Disputed Trade Pacts Advance, by Elizabeth Wilson

According to the WSJ, trade pacts with South Korea, Colombia and Panama could be passed by mid-October.  These pacts have been a source of political conflict for five years.  The main sticking point has been the extension of "Trade Adjusted Assistance" or TAA, a U.S. program which gives extended unemployment benefits to workers displaced by globalization.  The article says that the White House and Congress are near an agreement on a scaled-back version of TAA, and the President could send the three trade pacts to Congress early this week.

I believe this is good news for the United States, as well as Korea, Colombia and Panama.  Economists agree that free trade is a win-win, that increases overall wealth and prosperity, as each country is able to use its comparative advantage to produce those goods and services that it can make most efficiently, and trade them openly.  The article says that this pact could boost U.S. exports by $13 billion annually, with most of the gains ($11 billion) coming from Korea.

For Obama, this one is a no-brainer, and shows that he is serious about sound economic policy.  Better late than never, I say.  Now it's time for tax simplification....

from wsj.com

Let's Eliminate the Corporate Tax

Article: Wall Street Journal, A Short History of the Income Tax, John Steele Gordon

Lately there has been a lot of talk about corporations who do not pay their fair share of tax, big oil getting all matter of tax-based subsidies, General Electric  paying an effective tax rate of 0% last year, etc.

When Democrats go after millionaires and billionaires, corporate jet owners and the like, and ask them to pay their fair share, I'm all for it.  The gap between rich and poor in this country is greater than it's ever been, and rich folks have been making a sport out of hiring talented tax advisers to game our country's Byzantine tax code for decades.

But when it comes to bashing corporations, and asking them to pay more, I have mixed emotions.  Corporations are not people.  But they do hire people.  They pay wages, produce useful goods, add value and innovate.  And they are highly regulated--depending on the industry.

But the key fact is that corporations are owned by individuals, and individuals are taxed.  So why tax corporations as well as individuals?  In the interest of simplicity and fairness, lets' just stop taxing corporations.  Instead, let's impose a truly progressive tax on all individual earnings--including on the money that people earn from their corporate investments.    Then we could stop doing silly things like taxing capital gains and dividend income at a lower rate than ordinary income.   If we did this, Warren Buffet would be paying a higher tax rate than his secretary, and all would be right with the world.  And we would see a massive shrinkage in the the tax compliance industry--a wasteful drag on our nation's productivity.

Graphic from www.taxpolicycenter.org
Note the small portion of revenue that corporate tax actually comprises.....

Not only that, but we would see the U.S. become much more competitive as a location for corporate headquarters.  This could only be good for employment.

Mr. Steele's article notes that the Corporate Income Tax was instituted in the early 20th Century as a stop-gap measure.  Unfortunately, it was never phased out.  I hope that Mr. Obama will take up tax simplification, as he promised.  It is an issue with bi-partisan support, which can do the country a world of good.  And I hope he will give serious consideration to the simple but dramatic step of eliminating the corporate tax altogether.

More to Worry About: Russia Commits to Chernobyl-Style Reactors

Article: Wall Street Journal, Russia to Extend Life of Aging Reactors, by David Crawford and Rebecca Smith

To take my mind off the 400+ drop in the Dow Jones Industrial Average, I was thumbing through the international section of the paper, and found this article about nuclear reactors in Russia.

Despite Western pressure to shut them down, there are still 11 Chernobyl-style reactors, also known RMBK reactors, operating in Russia.  All of them are on the Western edge of Russia, near the cities of St. Petersburg (pop. 4.8 million), Smolensk (pop. 327,000) and Kursk (pop. 415,000).  These reactors originally had a life-span of 30 years; they have now been extended to 45 years.

from www.wsj.com

As per the article: "Many Western nuclear experts believe the RMBK reactors are among the world's most dangerous and still suffer from fundamental design shortcomings."  Such as:

• No containment structure to keep in radiation in case of an accident.  A containment structure is a standard feature on modern nuclear reactors.
• No central crucible to hold fuel rods.  Each fuel rod sits in its own tube, so engineers have to monitor and maintain 1,000 separate tubes, instead of one central crucible.

Although Russia is rich in natural gas, they are reluctant to replace their aging stock of Soviet-era nuclear reactors with natural gas plants, because they prefer to export their natural gas for profit.

I hope that Europe will become less reliant on Russian natural gas soon, and that this will change the equation.  In the meantime, let's all keep our fingers crossed.

The Human Cost of Greece's Debt Crisis

Article: Wall Street Journal, Greek Crisis Exacts Cruelest Toll, by Marcus Walker

This front page article in today's WSJ tells the tragic story of Vaggelis Petrakis, a hard-working family man from Crete who had a company that supplied vegetables to hotels and supermarkets. He was brought low by a “credit economy”, namely clients who paid him with 6-month postdated checks. I won’t paraphrase the story; you’re better off clicking on the link and reading the original.

The article quotes Constantine Michalos, president of the Athens Chamber of Commerce and Industry, who says that the practice of paying with post-dated checks exploded in Greece in the 1990's. "This was a para-banking system of enormous size. It is one of the main reasons for the crisis."

(There was also an interview with Michalos on CNBC today, where he says that about 80,000 small business have gone under in Greece over the last year)

Walker's article notes that the suicide rate in Greece has roughly doubled since the beginning of the crisis.

This morning on CNBC, I saw an interview with Mark Grant, Managing Director of Southwest Securities, who said that total Greek debt, including sovereign, corporate and municipal debt is around $1.1 trillion, roughly 3.5 times their annual GDP -- much larger than the sovereign debt alone, which was reported as $454 billion at the end of 2010 (143% of GDP).

Notwithstanding the outcome of the European debt crisis, it looks like Greece is in for a hell of a de-leveraging, which will weight down their economy for years to come.

What is Going on in the Eurozone?

Fiscal problems in the euro zone have been a primary cause for the gyrations in the U.S. stock market this year and last.  There is an element of panic that a default by one or more countries (ie, Greece) and/ or financial institutions (Societe Generale?) will cause a cascading "contagion" in the markets, similar to what happened with the bankruptcy of Lehman in 2008.  Whenever the euro zone countries step up to do something, often through the efforts of the European Central Bank, or ECB, the market goes up.  When they are seen as hanging back, markets go down.

This week, we have seen markets go up on what seems to be a concerted effort by the ECB along with other major central banks.  Today it was announced that 3-month USD loans will be made available to European banks who have been having problems placing their commercial paper, which has traditionally been an important source of US dollar funding for them (See AP Story, ECB to Provide Banks with Dollar Loans).  And in a CNBC interview yesterday, U.S. Treasury Secretary Tim Geithner was unambiguous in his statement that Europe would not allow its major financial institutions to default a la Lehman -- Europe is by and large less market oriented than the U.S., and not so concerned about "moral hazard".  (See No European Lehman-Like Collapse?)  

There seems to be a growing consensus that Greece will default and probably exit the euro--its bonds are now yielding 25%-- that this will not be the catastrophe some have been fearing, and that Germany will eventually face the inevitable choices that it has to make in order to save the euro experiment--more central planning of fiscal policy, including some kind of central euro treasury.    (See George Soros' article in The New York Review of Books, Does the Euro Have a Future?)

Nothing is decided yet, but markets have been moving up this week on these less-than apocalyptic assumptions.  As of this writing, the Dow is up over 100 points today (1%) and over 350 points since Wednesday (about 3%).

There will surely be more ups and downs on this roller coaster in the future, but as an investor, it is nice to see gains.  Hopefully they will last.

Is Wall Street Shrinking?

Articles:
Wall Street Journal, BofA Readies the Knife, by Dan Fitzpatrick
CNN Money, More Layoffs Looming on Wall Street, by Maureen Farrell

The Wall Street Journal reports that Bank of America is planning to cut $5 billion in costs by the end of 2013, including the elimination of about 30,000 jobs.  CNN reports that their major competitors will probably follow suit.

Is Wall Street shrinking?  Well, it depends how you measure it.  If you look at the number of people employed, yes it is.  Those of us who are producers and even consumers of financial products have seen great increases in efficiency over the years--everything from online brokerage, to ATM machines, to exchange traded funds, to decimalization have allowed Wall Street to service investors more cheaply than ever before.  As the below chart shows, the number of people dedicated to finance has barely budged since 1998 (the first year that the Bureau of Economic Analysis makes figures available), and is now trending downward.

To the extent that Wall Street is part of the "overhead" of our economy, and produces no real wealth, that is good news.   (Although this is little consolation if you are a BofA teller who gets laid off).

But look at the green line on the graph.  This is the percentage of GDP that is produced by the financial industry, which has been going nowhere but up for decades. Except for a few down years, GDP has been steadily increasing over those years, so we are seeing finance making up a steadily larger piece of a steadily growing pie, and doing it without employing more people.  In other words, some people are making a lot more money.  And who are these people?  Shareholders?  You wouldn't know it by me!  Tentatively (until someone proves me wrong) I think we are talking about individuals with out-sized compensations: hedge fund managers, traders, C-suite executives, lawyers.

And again, to the extent that financial services produce no real wealth, and are part of the overhead of our economy (which I believe is the case), this is done at an overall cost to our prosperity as a society.  How has this happened?  I guess that a big part of the answer is "financial innovation", which is a fancy word for getting more people to borrow more money at a higher cost than ever before.  For individuals this means things like new types of mortgages, home equity loans, and credit cards.  On the corporate side there are things like securitization, over the counter derivatives, credit default swaps, all generating hidden fees and spreads which over the years have greatly outpaced any efficiency gains coming from automation and downsizing of clerks.

I believe Wall Street needs to shrink more and become more efficient.  But I hope that the next arena for efficiency gains will be fees, spreads and six or seven figure bonuses, not just clerks' salaries.

Bashing President Obama and Pushing Dirty Energy

Article: Wall Street Journal, Canada's Oil Sands are a Jobs Gusher, by Mary O'Grady

I'm glad that in his speech on Thursday President Obama didn't say a word about green energy jobs.  As I said in a previous post, I'm fairly convinced that subsidies for forms of energy that are not yet economically viable (e.g., solar and wind) are a waste of taxpayer money.   (Research, on the other hand, is another story).

It seems like Ms. O'Grady, a columnist for the Wall Street Journal listened to a different speech than I did, or perhaps she didn't listen at all, just trotted out the old cliches one more time.  Here is the first paragraph of her article:
For all its soaring rhetoric, President Obama's "jobs speech" last week didn't demonstrate a lick of insight into why economies grow or how wealth is created. It was merely trademark Obamanomics: using government diktat to move money that's over here, over there.

What is she referring to, exactly?  Cutting payroll taxes?  I thought conservatives believed tax cuts were the key to prosperity.  Investing in infrastructure projects a la Eisenhower?  Investing in education?  Cutting government red tape and streamlining regulation?  Yes, these were the core elements in the President's speech.  

She mentions Alberta's oil sands as an example of the type of exploration that will lead to increased jobs, then blasts Obama for allowing regulators to slow down drilling on Federal lands.  My understanding is that the oil sands remained unexploited for years is because the oil that they contain is filthy, expensive to exploit and high in greenhouse gases and replete with negative environmental effects.  The only reason Canada has had success with this energy source in the last few years is that the cost of imported oil has gotten so high.  But what is the way forward for our energy future?  Clean natural gas from the U.S.?  Maybe.  Dirty tar from Canada?  Highly doubtful.

Ms. O'Grady also mentions that the market tanked 300 points the day after Obama's speech.  Come on!  Anyone following the market that day knows that this move was all about Europe, notably the highly scary resignation of German ECB official Jurgen Stark.  As I recall, the market was up on Friday morning (largely on Obama's well-received speech and plan) before this news hit.

Obama's plan is not the be-all end-all, but it is a practical, centrist step in the right direction, which may actually have a chance of passing.  Given budgetary constraints and a divided government, this may be the best we can hope for right now.  

If Mary O'Grady wants to criticize the speech, perhaps she should start by actually listening to it.  

The USA's Aging Energy Infrastructure

Articles:
Wall Street Journal, Nuclear Backlash Energizes Old Plants, by Rebecca Smith
Wall Street Journal, Gas Pipeline Operators Sweat Test, by Daniel Gilbert

Two articles in Thursday's WSJ about the USA's aging energy infrastructure.

The first points out that the anti-nuclear backlash caused by the Fukushima disaster in Japan is stalling construction of new nuclear reactors around the world, which will have the perverse effect of increasing our reliance on an aging stock of nuclear power plants.  The U.S. produces more nuclear power than any other country in the world, with 104 power plants.   Ground was broken on virtually all of these in the 1970s.  They were originally licensed for use for 40 years, but according to the article, over 70 of the plants have already received 20 year extensions.  Are 60-year-old nuclear reactors safe?  I hope so.  Meanwhile, regulators are conducting research to see if it would be feasible to operate a nuclear reactor for as much as 80 years.

from WSJ.com

The article also points out that the energy industry has been finding it more attractive to construct natural gas fired plants as an alternative to nuclear plants.  This sounds reasonable, except that over 60% of the U.S.'s natural gas pipelines were built before 1970--around 178,000 miles worth.  A large portion of these older pipelines were never subject to pressurized water tests for leaks.  The test became a requirement after 1970.  Now regulators are considering making the industry go back and perform this test on all of the old pipelines.  At between $125,000 and $500,000 per mile, the cost will be in the tens of billions.

I don't have the expertise to say how safe it is to continue using nuclear facilities and gas pipelines for 40, 50, 60 or more years.  But it's pretty surprising to learn how truly old our country's energy infrastructure is.

GOP Facing Reality on Immigration?

Article: Wall Street Journal, Farmers Press GOP on Hiring, by Miriam Jordan

I have already blogged about a couple of Miriam Jordan's articles on illegal immigration from Mexico.

This latest one says: "Recent Republican solidarity on illegal immigration is showing cracks under pressure from agricultural groups..."  It says that a bill to be introduced today by Texas Republican Lamar Smith will revise an existing guest worker provision, and allow for up to half a million foreign farm workers to work in the U.S.  The number may not be high enough, but it is a step in the right direction.

The article points out that "...concern is also rising for a wider swath of corporate America about the need for a more business-friendly rationalization of immigration policy."

My view is that politicians are simply facing reality.  Demagoguery from Presidential candidates aside, migration from the south to the north to work the seasonal harvest has been a feature of American life for centuries, since before there was a border.  The idea that the 2000-mile long border can be sealed is a silly impractical waste of money.  The sooner politicians recognize this, the better, for our budget and for the economy, among other things.  You can't fight nature, history and culture.

We share a continent with Mexico.   This is not only a geographical fact, it is also cultural and historical.  With an ongoing brutal drug war in Mexico, this may not be the right time for a wide open border, but it should be the ideal towards which we move.


Related posts:
Change to U.S. Immigration Policy, 8/19/11
Illegal Immigration and the Need for Reform, 8/15/11

FHA Sues Banks: Bad Timing?

Articles:
Wall Street Journal, U.S. Sues Big Banks Over Home Mortgages, Nick Timiraos, Robin Sidel, Ruth Simon
The Economist, Fannie Mae and Freddie Mac: Self Harm

The Economist notes that the two U.S. Government Sponsored entities, FNMA (Fannie Mae) and FHLMC (Freddie Mac) which have a mandate to encourage home ownership in the U.S., mainly by guaranteeing mortgages, have received around $140 billion from U.S. taxpayers.

Their regulator, the Federal Housing Finance Authority (FHFA) has said that they are legally required to conserve assets and protect taxpayers from further losses.  In this spirit, apparently, they have filed suit against 17 banks, for failing to adequately disclose the risks of $196 billion in mortgages which they sold to Fannie and Freddie during the housing bubble.

There may be some sense of justice here.  The banks made a lot of money during the boom (and paid out huge bonuses) by loosening credit standards and making all manner of risky loans.  Why should taxpayers have to shoulder losses when the banks are still around to pay out?

But the problem is, it's bad for the economy.  The banks are in bad shape now, especially Bank of America, which recently received $5 billion in capital from Warren Buffett.  The last thing they need now is a huge open-ended liability coming from the federal government.  The Bush and Obama administrations made a conscious decision that the best way forward out of the recession was to keep the banks alive, recapitalize them and prop them up.  Now the Obama administration is kicking them when they're down.   As a result, they can be expected to re-trench and cut back on risky lending, which will slow the economy further.

I'm not sure if the President approved these lawsuits because of populist political considerations, or if it is just an example of the left hand not knowing what the right hand is doing.  But if the goal is to strengthen the economy and create jobs, it sure looks counterproductive to me.

Its easy to criticize the decision to prop up the existing Wall Street system that was made a couple of years ago.  But that was the decision that was made, and we can't have it both ways.  Wall Street can't be the savior and the villain at the same time.

Here is the picture (again from The Economist) that tells 1,000 words:

Is Green Energy a Waste of Our Money?

Article: Wall Street Journal, 'Green Jobs' vs. Real Energy Jobs, by Stephen Moore

The author of the above article is a member of the Wall Street Journal's editorial board, which will give you some idea of his politics.  I am embarrassed to say that I am largely in agreement with much of what he says.  In the near future I may have to blog about a couple of New York Times editorials and perhaps an Atlantic Monthly piece to wash the bad taste from my mouth.

Moore argues that the administration has spent large amounts of stimulus money on green energy projects that basically could never work, while putting roadblocks before technologies like fracking for natural gas which have the potential to generate decades worth of (relatively) clean energy to our country and are already providing jobs.

I understand that fossil fuels are dirty, bad for our planet and bad for our health.  But natural gas is much cleaner than coal, and fossil fuels obtained locally are vastly preferable to petroleum imported from countries like Saudi Arabia.  I remember when President Obama was campaigning, he talked about three long-term priorities: education, health-care, and energy independence.  We shouldn't forget this last priority, which would have saved us all manner of economic and political headaches over the last 50 years.

I agree with many of the arguments made by Matt Ridley in his book "The Rational Optimist", that fossil fuels have largely been the basis for the last 200 years of remarkable human progress, and , that throughout history "renewable" energy has been a synonym for human, animal or wood power, which is another way of saying poverty, misery and back-breaking subsistence farming.  Not to mention that with a world population approaching 7 billion, the environmental impact of the above would be far more devastating than any coal, oil or gas-fired future.

Now obviously the ideal of something like solar power is to generate oodles of clean, cheap energy.  The problem is, it has been a pipe dream for the last 50 year and has not yet panned out.  It is not viable.  Can it be in the future?  Maybe, but not yet.  So why should the government pay me to put an inefficient solar panel on my roof, the pre-tax cost of which is greater than the cost of the energy I save?  Isn't that just throwing our money away?

I am all for research and development, and certainly the government should be funding renewable energy research projects in our nation's great research universities.  But until green energy is economically viable, I wonder is it really a good basis for economic stimulus?

As far as fossil fuels go, I don't believe in tax breaks for oil companies, but neither do I believe in distorting markets by imposing things like fuel economy standards by fiat.  Let's tax fossil fuels so that their price will include the full cost of the damage they inflict on human health and the environment.  Then it will be in everyone's interest to use less, conserve, and find cleaner alternatives.  I have read that this is politically impossible, but that doesn't stop it from being the right way to use energy wisely.

In the meantime, why turn our backs on the stated long-term goal of energy independence when it may be realistically in sight?

The Island of Hispaniola: Haiti and the Dominican Republic

Article: New York Times, Dominican Republic Grows Weary of Haitian Refugees, Randal C. Archibald

The title of the article says it all.  After the devastating earthquake hit Haiti in January, 2010, Dominicans rushed to help their island neighbors.  There was also an influx of refugees from Haiti (one of the poorest countries in the world) to the DR (a poor but upward-trending country).  Now, the DR is losing patience with the refugees and is deporting many, including through a program which offers Haitians $50 each to return to their home country.  This program has had many takers due to the desperate condition in which many Haitian refugees find themselves.

Although Haiti and the Dominican Republic both are third-world countries with populations around ten million, and they share the same island, the contrast between them is stark.  According the the CIA World Factbook (https://www.cia.gov/library/publications/the-world-factbook/index.html), the DR has a GDP of around $87 billion, or $8,900 per capita.  Haiti's GDP is $11.5 billion, or $1,200 per capita.  In Haiti, 80% of the population lives below the poverty line, and two-thirds of the workforce do not have formal jobs.

The reason for the disparity?  This is complicated, but in his book "Collapse", Jared Diamond points to Haiti as an example of a country that has ruined itself through deforestation and ensuing desertification, largely due to a history of ill-considered agricultural practices.  The Dominican Republic has historically been a better steward of its natural resources, especially its forests, which is at least partly responsible for its higher rainfall and more productive agriculture.  Diamond gives some of the responsibility for this to the much hated brutal dictator Rafael Trujillo, who ran the DR from 1930 to 1961.  Apparently, though he killed and tortured thousands, he had a soft spot for trees, forests and nature.

I visited the Dominican Republic in 2006, a few years before the Haitian earthquake.  It was a poor country, but even then, many Haitians had come across the border to do whatever work they could find, as they have throughout modern history.  During an unplanned detour through a sugar cane plantation, we saw many Haitian workers chopping cane, and loading it into railroad cars.  I asked the guide if he thought the DR and Haiti could ever unite as a single country, since they shared a single island.  He told me no, because there were too many cultural differences.  When I pressed him, he said that Dominicans were proud of their Spanish Catholic roots, and would never be comfortable with the "African" religious practices of the Haitians.

A sad situation, no matter how you look at it.

Can Germany Do Without Nuclear Power?

Article: New York Times, Germany Dims Nuclear Plants But Hopes to Keep Lights On, by Elisabeth Rosenthal

Germany's Biblis Nuclear Plant, from www.spiegel.de

An article in today's NY Times notes that Germany has already shut down 8 of its 17 nuclear reactors, and plans to close the rest by 2022.

This was a reaction to the Fukushima disaster in Japan.  That a mishap of this scope could take place in a developed country has really spooked Germans.

Germany has been aggressively pursuing green energy and today gets 17% of its electricity from renewable sources (wind, solar and bio fuels) although the first two are somewhat unpredictable as they are highly dependent on weather conditions.  Skeptics say that Germany's energy plan will lead to higher energy prices, higher emissions, and has already caused it to import more electricity from France and the Czech Republic--countries that use nuclear plants to generate much of their electricity.

The German plan estimates that electricity from renewable sources will double in the next ten years, but also calls for the construction of additional coal and gas-fired plants.

Japan is already backing off its initial pledges to completely phase out nuclear energy.  It will be interesting to see if Germany will follow through with theirs.

Japan: And the Winner Is...

The next Prime Minister of Japan will be the current Finance Minister, Yoshihiko Noda.

Yoshihiko Noda
from www.dpj.or.jp

Article: Wall Street Journal, Noda Next to Take Up Burden of Rebuilding, Toko Sekiguchi and George Nishiyama

Mr. Noda was elected in a run-off against Trade and Industry Minister Banri Kaieda by 215 to 175.  In a recent poll, Noda and Kaieda had public support of 12% and 9% respectively.  The candidate with the most public support, 48%, was Seiji Maehara, but he was knocked out in the first round of voting.

Politics in Japan

Here are some of the recent headlines coming out of Japan, none of which bode well for this economic giant.

On August 24, Moody's announced that it would downgrade Japan's sovereign credit rating from Aa2 to Aa3.  Here is the press release: Moody's lowers Japan's government rating to Aa3; outlook stable

Moody's cited Japan's huge national debt (around 200% of GDP) and projections that the budget deficits of at least 7% of GDP will continue until at least 2015.  They noted that Japan's recovery from the 2009 financial crisis had been delayed by the March 2011 earthquake and tsunami.

On August 26, Japan's Prime Minister Naoto Kan announced that he would resign, after just 15 months in office, making him the sixth Japanese PM to resign in 5 years.  His approval rating had dropped to the mid-teens, largely based on his handling of the March natural disaster.  Here is the New York Times article: Prime Minister’s Departure Underscores Japan’s Search for Leadership, by Martin Fackler.  Also in The Economist: Politics in Japan: Sixth Time Lucky?

Tomorrow, August 29, the ruling Democratic Party of Japan will have a "leadership vote" to determine Prime Minister Kan's successor.  (Wall Street Journal Article: Japan Race Narrows as DPJ Prepares for Vote, by George Nishiyama and Hiroyuki Cachi.)  Two favorites have emerged: Seiji Maehara, a former foreign minister, and Banri Kaieda, the trade minister.  Kaieda is favored by much-hated (but politically influential) DPJ king-maker Ochiro Ozawa, so may have a better chance of getting the job.   In Japan the view seems to be that most of these politicians are the same, and it does not really matter who gets picked.

The Nikkei 225 stock index is down to levels seen just after the earthquake.  But paradoxically the yen is stronger than ever, and Japan is able to borrow money for 10 years at just over 1%.  I don't pretend to understand it.

Latin America Overview: More Fun With Charts

While economic growth in the developed world is moderate at best, does the developing world hold more promise?  Today I am taking a look at the countries of Latin America.  The first chart below gives an overview of the countries in the region, which helped me to see the scale of the economies in the region.  By the way, both of these charts are made with data from the International Monetary Fund's World Economic Outlook Database, available on the web at http://www.imf.org/external/ns/cs.aspx?id=28

The second chart gives an idea of GDP growth rates in 2010 and 2011, which might possibly correlate to profitable investment opportunities.

We can see from the chart that the region bounced back vigorously from the 2008-2009 downturn (unlike its giant neighbor to the north), and growth in the major markets: Brazil, Mexico, Argentina, Colombia and Chile continues into 2011.

Peru, a poorer country, may be emerging as a regional success story.  It should be noted that Peru recently inaugurated a new left-wing President, Ollanta Humala.  According to the press, he is attempting to persuade investors that his administration will have more in common with Brazil's pro-growth, pro-labor former primer minister Lula, than with Venezuela's "Bolivarian revolutionary" Hugo Chavez, who among other things recently announced the nationalization of gold mining companies.

Paraguay's record growth rate of 15% in 2010 is interesting to see, but it is a tiny country (see first chart), and the IMF notes that its GDP growth is highly volatile, and largely dependent on agricultural factors.

There were several interesting stories on the region in last week's Economist, including:

• Politics in Brazil: Dilma Tries to Drain the Swamp, about the Brazilian Prime Minister's ongoing fight against government corruption.
• Argentina's President: In Her Prime, about a recent primary in Argentina,which all but guarantees President Cristina Fernandez's re-election in October.
• Mexico's Presidential Race: A Flash in the PAN, about the difficulty of finding a successor to outgoing President Felipe Calderon, and the strong possibility that the country will elect a leader from the left-ish PRI party next year, after many years of being led by the conservative PAN party.
• Venezuela's Economy: Medieval Policies, about attempts by Venezuela's Hugo Chavez to tame inflation by imposing price controls.  According to the article, the country now has the world's highest rate of inflation.

Why Does the SEC Care About Fracking?

Article: Wall Street Journal, SEC Drills Down on Fracking, Deborah Solomon

Interesting article today on page one of the WSJ's Marketplace section.  "Fracking" is short for hydraulic fracturing, the somewhat controversial practice by which shale-based natural gas is extracted by pumping water, chemicals and sand into deep underground wells (see earlier post Natural Gas: Fracking in Europe).

Many environmentalists, and groups living in areas where fracking is being carried out, have raised concerns that the practice pollutes groundwater, and that the chemicals used are not fully disclosed.  Now the U.S. Securities and Exchange Commission (SEC) is stepping in, asking for "detailed information about oil and gas companies' hydraulic fracturing operations, including environmental impacts."

Which raises the question: why the SEC?  The SEC's mission is to: "...protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation."  Wouldn't this be better left to the Environmental Protection Agency (EPA), whose mission is "..to protect human health and the environment"?

SEC Head Mary Schapiro

Perhaps so, but after reading the article I came to a better understanding of the SEC's concern here.  "Government officials said the SEC's interest in fracking is in ensuring investors are being told about risks a company may face related to its operations, such as lawsuits, compliance costs or other uncertainties."  I always wondered how much faith I should put in the part of the annual report where management discusses risks--how can an investor be sure that this discussion is honest and complete?  After all, if management wants the stock price to go up, they might feel a temptation to downplay risks and put a happy face on future prospects.

To the extent that the SEC causes management to be honest about risks, it's good for investors.  On the other hand, to the extent that they require companies to disclose similar information to multiple agencies, it is an inefficient regulatory compliance burden which costs money both for the company being regulated and for the taxpayers who fund the agencies doing the redundant work.

EPA Head Lisa Jackson

It's a tough call.  Oil and gas companies use toxic chemicals in their operations which are to a certain extent undisclosed, because they say the exact formula represents a "trade secret", like the top secret formula for Coca Cola syrup.  I would say the public has a pressing interest in knowing this information.  Ideally, information on practices with potential environmental effects should be disclosed to the EPA, these disclosures should be publicly available, and the SEC should make sure that management is not distorting or downplaying this information on their disclosures to the market.  But if the EPA --which is often accused of being a jobs killer and is funded from the vulnerable "discretionary" budget-- can't get the job done, then I applaud the SEC for stepping up and doing something that protects both investors and the general public.

Many people believe that shale-based oil and especially natural gas will be a resource of major importance to the United States in coming years.  The size of these unconventional reserves is compelling, and will be examined in future posts.  It is already a provider of jobs in some regions (see CNBC report Unemployed? Go to North Dakota).  But the risks to public health and the environment must be addressed.

Buffet Buys a Stake in Bank of America

Story: Yahoo News, Warren Buffet to Invest $5 Billion in Bank of America, Ben Berkowitz and Joe Rauch

One of the big stories of the day was the announcement by Warren Buffet that his company, Berkshire Hathaway would make a $5 billion investment in Bank of America.  Over the last several weeks we have watched shares of BofA go down to levels not seen since the financial crisis, due to its ongoing exposure to liability from bad mortgages from Countrywide Financial, which Bank of America bought in 2008.  There have also been rumors that BofA has large amounts of exposure to European banks.  Other financial institutions have followed BofA down, though to a lesser extent, with Citigroup in particular (which I hold in my portfolio) taking on the appearance of a "BofA lite".  (See below chart from Yahoo Finance: BofA is the blue line; Citi is green).

3 month chart from finance.yahoo.com

The announcement of the deal, which Buffet --now said to be the third richest man in the world with a net worth over $50 billion-- thought up while in the bathtub, caused BofA stocks to jump considerably, along with the other financials.

5 day chart from finance.yahoo.com

As of this writing, the Dow Jones Industrial average has followed the European markets downward, and is now off by about 130 points or just over 1% -- which used to be a lot, but could change in the blink of an eye  in these recent weeks of high volatility.  But the financials are a bright spot, at least today, with BofA up by over 10%, and Citi up by just under 5%.

OECD Announces Slower Growth in Second Quarter: 0.2%

OECD Press Release: http://www.oecd.org/dataoecd/42/9/48539187.pdf

Yesterday the Organisation for Economic Cooperation and Development, which represents 34 countries, announced that GDP growth among these more developed economies had slowed to 0.2% during the second quarter, down marginally from 0.3% during the first quarter -- a very anemic growth rate overall.

Although latest rates were not announced for all of the OECD countries, I made the following chart, with the countries sorted by GDP size, to get a picture of growth on a per-country basis.

data from www.oecd.org

According to this data, the following countries had negative economic growth:

• Japan
• Australia*
• Norway*
• Portugal*
• Denmark*

* Based on Q1 data

Details Revealed of $1.2 Trillion in Secret Loans

Articles:
Bloomberg.com, The Fed's Secret Liquidity Lifelines, Bradley Keoun, Phil Kuntz et al, graphic by David Yanofsky

Bloomberg.com, Wall Street Aristocracy Got $1.2 Trillion in Secret Fed Loans, Bradley Keoun and Phil Kuntz

The Atlantic Monthly (April, 2010), Inside Man, Joshua Green
Data: http://www.federalreserve.gov/newsevents/reform_transaction.htm

My favorite part of the Bloomberg report was the beautiful interactive Adobe Flash graphic, by David Yanofsky.  It gives a list of all the banks that participated in the lending program (407 of them!), with the peak lending amount and date.  If you click on an individual bank, you are taken to another graphic which gives you the bank's borrowing over time, as well as their market value, plus some additional description.  It also lets you graph multiple banks together in order to do a comparison.

Click on the image below to take a look.    

from Bloomberg.com -- click for original graphic

Where would we be without the Fed?

Among the Federal Reserve Bank's most important functions is serving as lender of last resort for the U.S. banking system.  In ordinary times this function is used sparingly, through the Discount Window.

New York Fed headquarters, from www.newyorkfed.org

But during the liquidity crisis of 2007-2009, a lot of financial institutions borrowed money from the Fed, under the guise of various lending programs with names like: Term Securities Lending Facility (TSLF), Primary Dealer Credit Facility (PDCF), Commercial Paper Funding Facility (CPFF), Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), etc.

Today, Bloomberg.com released a report giving many details of the lending programs, based on databases released by the Fed under the Dodd-Frank Act, as well as information obtained under the freedom of information act.  Some of this information can be seen on the Fed's website.

The lending reached a peak of $1.2 trillion in December 2008, a number which Bloomberg reporters note was:

• 3 times the size of that year's U.S. budget deficit
• 25 times the previous lending peak reached on September 12, 2001
• More than the total earnings of all federally insured banks from 2001 - 2010
• Enough to fill 539 Olympic-sized swimming pools if denominated in $1 bills (which it certainly was not)

It should be noted that these programs were not exactly bailouts.  All the loans were collateralized (though the quality of the collateral varied) and repaid for the most part.  Still, it gives a sobering picture of the extent to which the Fed, and by extension the U.S. government was propping up the banks at that time.

Why did we do it this way anyway?  I think Joshua Green's April 2010 Atlantic Monthly article gives a pretty good idea of the thinking at the time.  Basically, propping up (and reforming) the existing financial institutions was the cheapest option.  There would have been some justice in letting banks fail, and wiping out the bastards who played fast and loose with our trust and destroyed our economy.  But it would have been even more disruptive of the economy, and probably would have caused deficits to balloon even more than they did.  Basically, both administrations --Bush and Obama-- were taking a conservative, low-cost approach, provocative statements by Republican candidates and Fox News commentators notwithstanding.  But what a shame that they had to leave the same people who caused the mess in charge of Wall Street, and that those people proceeded to fight tooth and nail against any meaningful reform.

It is also interesting to note how much we depend on the Fed even today.  While our elected officials fight endlessly over fiscal matters, generating unprecedented volatility in the stock market, statements from the Fed that rates will remain low for the next two years and bond purchases by the European Central Bank seem to be the only thing that have made the markets feel any confidence lately.

U.S. Energy Sources and Uses

Here is a very interesting chart from the Lawrence Livermore National Laboratory, that gives a great panoramic view of how energy flows in the U.S (click on it to expand).  Note that a quad means 1 quadrillion Btu -- that's 1 with 15 zeros.

Bloomberg.com also has an interactive version of the same graphic, with links to additional information, created by John Tozzi and David Yanofsky --most interesting: U.S. Energy: Where It’s From, Where It Goes, and What’s Wasted

Fossil Fuel Production and Use: Lots of Fun With Charts

This chart is a combination of three that I posted previously which give an overview of which countries produce and consume the most coal, oil and natural gas.

To make the above chart, I had to convert the coal, oil and gas numbers--which were denominated in short tons, barrels per day, and cubic feet--into the common unit of BTUs (British Thermal Units).  Arriving at the conversion factors can be a fairly technical exercise, of which there is good discussion here: http://www.aps.org/policy/reports/popa-reports/energy/units.cfm

I used the following factors, which were suggested as averages:
Oil: 1 barrel = 5.8 MBtu
Coal: 1 short ton =  25.2 MBtu
Natural Gas: 1 cubic foot = 1000 Btu

Global Natural Gas Production and Consumption

Over the last couple of weeks I published charts based on data from the U.S. Energy Information Administration that showed various countries' production and consumption of coal and oil.  Today I turn to the third fossil fuel, one which is gradually growing in importance in the U.S.: Natural Gas.

Natural gas is a resource which is mainly used for heating homes, industrial uses, and electrical power generation.

The chart shows that the U.S. and Russia are the largest producers of natural gas.  Russia exports a great deal of natural gas, while the U.S. consumed slightly more than it produced in 2010, although this may change in coming years, as the U.S. taps its huge supply of unconventional shale-based natural gas.  China is a surprisingly modest consumer of natural gas, and instead has an over-sized reliance on coal.

Change to U.S. Immigration Policy

Article: Wall Street Journal, U.S. Alters Policy on Deporting Immigrants, Miriam Jordan

from www.texastribune.org

As if in response to my post from earlier this week, Illegal Immigration and the Need for Reform, the Wall Street Journal reported today that the Obama administration would review the cases of 300,000 illegal immigrants and might allow some of them to apply for work permits, and remain in the country while the applications are pending.

According to the article, the number of deportations has increased under the Obama administration, but this new stricter policy is overwhelming immigration courts, which now have a backlog of around one year.

Part of the justification for changing the policy may be political (Obama needs the Hispanic vote), but it is also practical.   A draconian crack-down on illegal immigration is expensive, and I guess the politicians who push for this approach are to some degree playing to the xenophobia of their electorate.  Our agricultural industry, especially, needs these workers.  Immigration reform that works is what is needed, not more cops, jails and courts.

Bland Message from Patty, Max & John

Article: Wall Street Journal, Together We Can Beat the Deficit, by Patty Murray, Max Baucus and John Kerry

Senator Patty Murray

Senator John Kerry

Senator Max Baucus

Today's Wall Street Journal contained a rather bland article by the 3 Democratic Senators who are on the Joint Select Committee on Deficit Reduction.  What they say in the article is: we can do this; we have done it in the past; we need to work together.

I suppose it is only appropriate to start with a cordial, hopeful message.  I do hope they are right.

The committee's mandate is to find $1.5 trillion in deficit reduction over the next ten years.  If not, there will be mandatory across-the-board spending cuts in defense and non-defense spending--but not entitlements like Social Security and Medicare spending, which are the real long-term threats to the budget.  The idea is that the automatic cuts will be so distasteful to both parties that they will be forced to reach a consensus and propose a more practical set of measures (cost cuts and revenue enhancements) to help reduce the debt.

Joint Select Committee on Deficit Reduction

	Democrats	Republicans
Senate members	Patty Murray, Washington, Co-Chair Max Baucus, Montana John Kerry, Massachusetts	Jon Kyl, Arizona Pat Toomey, Pennsylvania Rob Portman, Ohio
House members	Jim Clyburn, South Carolina Xavier Becerra, California Chris Van Hollen, Maryland	Jeb Hensarling, Texas, Co-Chair Dave Camp, Michigan Fred Upton, Michigan

(thanks, Wikipedia)

One major problem is that many Democrats have vowed to not touch entitlements, which is unrealistic and irresponsible, and many Republicans (all of the members of the committee, as I understand) have vowed not to raise taxes, which is unrealistic, irresponsible and unfair to boot.  Both of these stances may be largely based on political posturing, but my opinion is that the Republicans may be acting on a partial understanding that irresponsible actions on their part will hurt the economy and jobs, which will make it nearly impossible for President Obama to win the election in 2012.

The other problem, of course, is that economic growth is slowing, and massive ill-considered short-term cuts may be just the thing to tip the economy back into recession.  Of course, this is exactly what candidate Michele Bachmann is calling for when she says repeatedly that there is no need to raise the debt ceiling.  (Conservatives point out that Barack Obama said nearly the same thing when he was a junior Senator).  It's hard to know if Bachmann's statements are based on her own ignorance of economics, or if she knows better, and is simply pandering to a disgruntled electorate which is ignorant of economics.  I suppose it is the latter--she must know better.

I know better

Committees, aggressive time-frames, and automatic mechanisms aside, here is what is needed, and in this order:

Step 1 should be relatively easy: massive tax simplification and reform.  The Economist said that by one measure the tax compliance industry in the U.S. is 7 times the size of the automobile industry.  The government obviously needs to take our hard-earned money, but can't they do it in a simple straightforward way, which the average citizen can understand?  The first step to tax fairness is tax transparency and simplicity.  This is something both sides should be able to agree on, and it would go a long way to showing voters that government actually is capable of getting something right.  Obama should get behind this.  It will increase his credibility and will certainly be simpler to do than healthcare was.

Step 2 is harder: massive reform of entitlements, especially health care related entitlements like Medicare.  In his plan, Representative Paul Ryan noted that the average Medicare recipient puts just over $100 thousand into the system, and gets out somewhere around $300 thousand.  This is obviously unsustainable.   Fixing it will be difficult, and may have to be phased in over the long term.  I suspect it will have to entail a re-working of Obama-care, probably including the famous "public option" which may be the only way to have meaningful cost reductions.

Simple as that...