The Best Laid Plans Of Mice and Men

Los Tres Amigos: Obama, Geithner, Orzag

Los Tres Amigos: Obama, Geithner, Orzag

The Obama Administration just handed Congress a $3.6 trillion budget.  The budget is one of the best ways of seeing what a President lays out as priorities and can be linked to many campaign promises.  While it demonstrates a vision, what remains after congress hacks through it tends to be a more reliable gauge of the direction since compromise will shortly rule the day.  I’m going to outline some of the major points and point you to some media coverage.  We’ll have to watch over time what gets sold out and haggled away.  That will really show the priorities and not just the posturing.

The overall tone of the budget shows a more activist government in the areas of health and education mostly paid for by families making over $250,000 a year, singles making more than $200,000 and various  business interests. The WSJ has the numbers here.

As expected, tax increases will rise for singles earning $200,000 and couples earning $250,000, beginning in 2011 — for a total windfall of $656 billion over 10 years. Income tax hikes would raise $339 billion alone. Limits on personal exemptions and itemized deductions would bring in another $180 billion. Higher capital gains rates would bring in $118 billion. The estate tax, scheduled to be repealed next year, would instead be preserved forever, with the value of estates over $3.5 million — $7 million for couples — taxed at 45%.

Businesses would be hit, too. The budget envisions reaping $210 billion over the next decade by limiting the ability of U.S.-based multinational companies to shield overseas profits from taxation. Another $24 billion would come from hedge fund and private equity managers, whose income would be taxed at income tax rates, not capital gains rates. Oil and gas companies would be hit particularly hard, with the repeal of multiple tax credits and deductions.

There is a shift away from the oil and gas industry reliance as well as removal of some of their tax privileges.  One of the more ambitious plans is that of an emissions trading program.  Under this scheme, the government will set a cap on the allowable amount of green house gases and businesses will have to buy permits if they want to pollute above their allotment.

In one of the budget’s most ambitious proposals, the president plans to cap the emissions of greenhouse gases, forcing polluters to purchase permits for emissions that would be slowly brought down to 14%  below 2005 levels by 2020 and 83% below 2005 levels by 2050. The sale of those permits, beginning in 2012, would reap $646 billion through 2019.

One of the most interesting things is the percentage of federal debt in relation to GDP.  It’s at an historic high unlike anything seen for a long time.  This is especially interesting coming after a “Fiscal Responsibility” Summit.   The deficit estimates are based on pretty optimistic numbers  which makes that summit look like even more of a marketing event

hats off to bb for this one ... WHOA!!!

hats off to bb for this one ... WHOA!!!

from the land of Oz.

The president blamed the nation’s economic travails on the administration that preceded him and on a nation that lost its bearings. His budget plan projects a federal deficit of $1.75 trillion for 2009, or 12.3% of the gross domestic product, a level not seen since 1942 as the U.S. plunged into World War II.

I’m still wondering if we’re going to be able to float all that debt. Again, however, these are preliminary numbers and I’m certain Congress will bargain them down and around to other places.  What the Administration compromises on will tell its true agenda.  Republicans and business interests are not likely to go quietly into the night on any of this.

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Quantifying the Unquantifiable

I found this neat article on 13 tipping points by Market Watch’s Paul Farrell.  I managed to read it in between multi-napping and watching the Dow go down in response to the the State of the Union Address and bad  numbers coming out of housing.  Then, I watched the market return to a more neutral position following Ben Bernanke’s second day of congressional testimony .  I decided it might be a good idea to talk about how information comes into markets and how markets react to that information using his article.

The article is subtitled why “Obamanomics may backfire, triggering the next Great Depression”.  It’s actually less about Obamanomics than it is about the number of unquantifiable ‘shocks’ to the macroeconomy that may lurk out there and panic or entice Wall Street.  These shocks (called so because they shock the economy and frequently appear unforeseeable) represent a huge amount of risk but can’t be easily written into the mathematical models.  They wait out there like a cat ready to pounce on an unsuspecting mouse.  Farrell’s basic point is that we don’t know right now if the stimulus package will work because there is too much unquantifiable risk out there.  However, just because the mouse is unsuspecting, I always think that there must be ways of detecting that big old cat. Hence, I research.

Usually the chance of the shock can be added into a model using Bayesian ‘dummy’ variables.  They take on either a 1 or 0 value and are ‘weighted’ by the probability of realizing the event.  So, the 13 variables that Farrell lists could be used to cause a negative shock (using a negative one for the occurrence of the event) times its Bayesian probability (say something like a 20 % chance of occuring vs a 80% chance of not occuring).   Shocks can also positive impact by using a positive 1 for the occurrence of the event say like a technological advance that just suddenly happens.

Farrell identifies these 13 things that are possibilities that haven’t been “quantified” by most Wall Street Risk models because these models focus on getting at the risk and pricing of an asset using asset-related events, rather than macroeconomic-related events.  Here’s his list.  It’s a basic what’s what of tinfoil hat scenarios.

  1. Massive debt: government, private; Fed printing money, tax increases
  2. Population: exploding demand, resources depleting, conflict, rebellion
  3. Lobbyists: feeding frenzy, 40,000 run Washington, sabotaging democracy
  4. Derivatives: $683 trillion hiding in shaky global “shadow banking system”
  5. Petro czars: Exxon, Saudis, Chavez, Iran — all vulnerable, unstable, risk
  6. Universal health care: 46 million uninsured; costs inflating debt
  7. War on drugs: massive global failure: Afghan, Mexico, Latin America.
  8. Deflation? Inflation? Stagflation? 1970’s sideways market ahead?
  9. Entitlements: Social Security, Medicare, drug benefits may soon sink us
  10. Politics: “Grand Obstructionist Party” Or “New Contract with America?”
  11. Savings: sabotaging consumer spending, the engine driving the economy
  12. Climate change: Pentagon sees increasing tension, triggering new wars
  13. Socialism and nationalization: will free markets return, or sink us?

tippingpointUsing Malcom Gladwell’s idea from the Tipping Point (a book club selection that Readers of the Confluence will recognize,),  Farrell isn’t sure if any of these dicey situations will actually reach that critical place where the event impacts everything it touches.  Hence, becoming one of Gladwell’s Tipping points.

More significant, although invariably left out of Wall Street’s equations, true economic tipping points will grow to a “moment of critical mass, the threshold, the boiling point,” according to author Malcolm Gladwell, where “change” (whether positive or negative) is “unstoppable.” And although left out, these macroeconomic variables can account for over 90% of the risk in an economic equation or derivatives contract, as we’ve discovered so painfully this past year.

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It’s Mardi Gras: You know, the Party before Penitence?

dscn0382I’m sitting here watching the kids get their costumes together for the big day of celebration called Fat Tuesday.  That’s the day when you pull out all the stops because you know lean days (no meat, no alcohol, no fun) starts tomorrow.  I guess I must be in hyper-metaphorical mode because it’s really striking me this year as a good fable.  Tonight at midnight, the Krewe of Klean will take to the streets of the French Quarter to shovel all the leftovers into the dump trucks. The police will ride their horses down Bourbon street and announce that the Party’s over.  They arrest anyone who want the party to continue at that point.  You can either spend Ash Wednesday doing penitence in your bed or the Parish Prison.

When I first got out of graduate school I went to work at a small bank.  I was soon lured to the biggest Savings and Loan in the middle of the country.   I’d been working on loan pricing models and arranging bank income statements into an exercise called spread management and asset-liability matching.   Big time company working for a big time CEO!

I have to admit, the only person that I really knew that was a CEO was my dad and he was great.  His employees loved him.  He gave them wonderful benefits and when they had sick children or they were gravely ill,  he gave them time off with pay.  His office manager was openly gay.  His mechanics and body technicians were a diverse group for small town Iowa.  Most of them worked for my dad the entire 30 years and loved him as much as I did. From the time he bought it when I was one, until he retired when I was in my 30s, the entire employee base was my extended family.  So, I entered the business world thinking this was the model for management and boy, was I wrong.

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WTF? Pre-Determined Stress Tests?

I finally have a bit of time to catch up on reading.  I’m hosting 10 of my youngest daughter’s college friends for Mardi Gras in a very small house and it’s as wild as it sounds.  I read this on Naked Capitalism and just didn’t even know what to say.   So I’m going to throw it to you. Now mind you, this is an economics site and not a political one.

We have been skeptical that the pending Treasury stress tests on banks, designed to ascertain their state of health, were inadequately staffed and therefore could not do the job properly. Our big concerns were that they had too few bodies to e test financial data versus underlying documentation adequately (usually done on a sampling basis) and they lacked the expertise (and perhaps the mandate) to vet risk models (which we all know have performed impeccably over the last two years.

Is it a test if the results are pre-determined? Apparently Team Obama thinks so.

I’ve been wondering what exactly this stress test was going to be myself and how they were going to pull it off.    I’ve worked in commercial banks, savings and loans, and at the Fed as well as the educational background and I’ve been scratching my head since it was first announced. No wonder the Obama administration is sounding so firm on the no nationalization issue. They’ve planned what they’re going to get ahead of time.

bank_crisis_03 This report and picture from CNBC.

Said one high-level official, “I think the market is missing that the whole intent of this process is to show that the banks have enough capital for even worse outcomes than we currently envision and to show there’s a program in place to give banks access to that capital if they need it.”

Yes, read it again. The process is to show us that the banks are okay.  No wonder there’s no discussion of the Swedish or German approach to Banking crises.  We’re going to be ‘shown’ everything is okay even under the ‘worse’ outcomes.  Details on the worst scenarios are supposed to be out on Wednesday, but really, we’ve heard this before. Remember I mentioned in my last thread that much of the definitions had to do with what type of stock (common, preferred, some hybrid) winds up flowing from the Treasury to the target banks?  Here’s another on the money paraphrase from the CNBC story.

The key misunderstanding in markets, officials believe, is how the public-private partnership will work and the way that new government capital, in the form of mandatory convertible preferred shares will become common equity.

One official said the public-private partnership will be voluntary so there will not be no mandate that banks offload assets at a loss. The official added that additional government capital will go into the banks as mandatory convertible preferred. Those shares remain preferred until realized losses and capital needs trigger conversion to common. As a result, the official said, the government may end up with a large stake in a given bank over a period of time, but it wont’ happen overnight.

May I suggest some new Savings Vehicles for the Obama Years?


It Ain’t Over until the Eagle Grins

atlant-fed-eaglePaul Krugman’s column in yesterday’s NY Times talked about the economic outlook report released by the Federal Reserve’s monetary policy ‘deciders’, the Open Market Committee.  He’s been obsessing on one little sentence.

But my eye was caught by the following chilling passage (yes, things are so bad that the summarized musings of central bankers can keep you up at night): “All participants anticipated that unemployment would remain substantially above its longer-run sustainable rate at the end of 2011, even absent further economic shocks; a few indicated that more than five to six years would be needed for the economy to converge to a longer-run path characterized by sustainable rates of output growth and unemployment and by an appropriate rate of inflation.”

I used to participate every so often  in the gleaning of the data for the Atlanta Fed’s report back in my days which were back in Greenspan’s days at the Fed.  (Bill was President and all was well in the world, so completely different environment than now.)  It’s a rather interesting exercise that combines the sweat of wonky economists dropping numbers into black boxes and anecdotal evidence gathered by holding meetings with business folk out in meeting rooms to gauge what’s going on in reality-based USA.  The anecdotes  we try to catch are things like: Are you hiring?  Are you buying inventory?  Are you expanding your business?  What are your customers saying?  How happy is every one in your city?  You just basically chat them up after you’ve plied them with food and booze. We used to have the meetings at the Gulf Coast Casinos.  I’m not sure what the other Feds do, but I’m sure I’d love to be around for some of them as the ones down here could be pretty interesting.

Each of the Fed Banks print their assessment of the economy.  Some stick to their regions.  Some have particular interests.  For example, the St. Louis Fed is considered to be the center of the monetary policy wonks.  San Francisco Fed tends to focus on issues dealing with the Pacific Rim.  You can visit each of the sites and get a feeling for not only the country’s outlook, but the area where you live.

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