Anti-Semitism again

I see the world press is once again revealing its latent anti-Semitism. The news on the web from traditional news sources is reporting in gory detail the civilian casualties from Israel’s newest air strikes into Gaza, but saying little or nothing about the Hamas actions that provoked them.

Never mind that it was Hamas who decided to end the truce just before Christmas. Never mind that it was Hamas thugs who fired almost 70 rockets into Israel the next day, and who have fired over 3000 rockets into Israel over the past year when a truce was supposed to be in effect. Never mind that Hamas has been equipping a small army over the past year with illegally-supplied weapons (including rockets) from Syria and Iran. Never mind that while Israel targets Hamas facilities and fighters, Hamas rockets and suicide bombers deliberately target civilians.

I can imagine what would happen if thugs in Canada or Mexico fired 3000 rockets into the USA, or if neighbors fired rockets into England or France or Germany or China or Russia. The response would be swift and decisive.

The Arab world, of course, is outraged, but that is to be expected in the never-never land they seem to live in. What puzzles and dismays me is the one-sided response from the non-Arab world press, who ought to know better.

One might also note that far worse violence against civilians goes on every day in places like Africa without drawing any particular sustained interest or comment from the world press, so one can only assume there are racist overtones as well.

Obama and science

President-elect Obama’s recent appointments for Secretary of the Department of Energy (Steven Chu, a Nobel Prize winning physicist currently head of Lawrence Berkeley National Laboratory), director of the White House Office of Science and Technology Policy and chairman of the president's Council of Advisers on Science and Technology (John Holdren, currently Professor of Environmental Policy at Harvard’s Kennedy School of Government), and head of the National Oceanic and Atmospheric Administration (Jane Lubchenco, Professor of Marine Biology at, Oregon State University) suggest that FINALLY we have an administration once again that recognizes the importance of science to the nation, and will appoint people who know their fields to high positions, instead of just political hacks..

The current neocon-dominated administration has been remarkably blind to the importance of science, repeatedly ignoring or denying scientific evidence that didn’t agree with their ideology, or that might obstruct their business supporters, and even apparently ordering government scientific reports to be redacted to modify or eliminate results unfavorable to their policies.

One can hope that Obama’s choices reflect a change of course, and that this administration might even believe scientific evidence and act on it. Now if Obama will just focus as well on improving the quality of elementary and secondary school science education in the U.S., we might be on the way to a reasonable recovery of our nation’s historical preeminence in science, a preeminence currently being maintained mostly by foreign scientists and engineers coming to the US to study and work.

I visited Silicon Valley a few months ago for the first time in a decade and was amazed to find whole sections in which the store signs and even some of the street signs are in Korean or Chinese – this is a telling indication of how dependent we have become on foreign scientists and engineers to drive the technological part of our economy – not a good sign.

The union dilemma

The auto company bailout plan failed to pass in the Senate, and last-minute negotiations between the Republicans and the United Auto Workers to try and salvage the bill reached an impasse when the UAW refused to agree to a date certain when their members would accept a pay cut bringing their pay in line with the pay of U.S. workers in competing (and profitable) companies like Toyota and Honda. They were offered any day in 2009, but refused to make a date-certain commitment – meaning in effect they refused to accept the pay cut. No doubt the union leaders hope in the end the administration will blink and aid the auto companies without significant union concessions – and in fact they may win this game of chicken in the short run, though they will lose in the long run.

The union dilemma is that on the one hand collective bargaining gives individual workers some much-needed leverage in the eternal competition to divide a company’s profits between shareholders, managers, and the workers. On the other hand, the incentive for union leaders is to gain as much pay and benefits as possible for their membership in the short run, irrespective of the long-term consequences for the company. So now we have domestic auto companies whose labor costs are so high they cannot compete effectively in the market, and are on the verge of bankruptcy. As a consequence, instead of just taking a pay cut, tens of thousands of auto workers may soon be out of a job altogether.

The problems GM and Chrysler and Ford face are not altogether the fault of the unions – the company management has been remarkably inept, and these three companies have been losing market share for years, at least in the U.S. market. Nonetheless, the union demands, backed by occasional strikes, have finally driven the companies over the economic cliff. GM’s average labor costs, including pensions, was about $73.50 per hour, while Toyota’s was about $48 per hour. GM worker health car costs are about $1525 per vehicle, vs $201 per vehicle for Toyota. It is pretty hard for a company to stay in business when its costs are that far out of line with the competition’s costs.

This isn’t the first time this has happened. Union labor costs were one of the primary reasons why the domestic steel companies were driven out of business by foreign competition, leaving us with high rust belt unemployment.

What is needed is some new form of collective bargaining system in which the incentives for the union leadership are aligned with survival of the company, rather than just with short-term gains for the membership. In fact, much the same change is needed for management pay as well in many industries, so that CEO’s aren’t incentivized just to maximize their yearly bonuses.

The great unknowns

One of my granddaughters, just turning 14, is fascinated with the big questions in astronomy and cosmology, and admitted recently that she desperately hopes that the nature of dark matter won’t be determined before she gets old enough to work on the problem herself.

That led me to reassure her that there were lots of big problems still to work on, and if dark matter has been understood by the time she finishes graduate school (unlikely), there will be lots of other interesting problems to work. And that conversation in turn led me to think for while about what some of the other remaining “big unknowns” were.

• We know a great deal about the neuroanatomy of the brain, and even a good bit about the molecular processes going on in and between brain cells, but we still have no idea how all of these mechanical and chemical processes result in a self-aware, thinking mind.

• We understand in great detail the working of gravitational fields, and can predict with high accuracy the effect of gravity of satellites and spacecraft and planets, yet at a fundamental level we still really have no idea how mass distorts spacetime in its vicinity to cause a gravitational field.

• We understand in great detail how to create and control electromagnetic fields, and routinely use this knowledge to build such sophisticated things as directional radio antennas and containment fields for plasma jets, yet at a fundamental level we still have no idea why an ordinary magnet draws some materials to it and not others.

• We now understand that black holes exist (a wild, off-the-wall idea only a few decades ago), and even that black holes seem to be essential to the formation of galaxies, and seem to exist in the center of most if not all galaxies, including our own. Yet we understand almost nothing about what goes on in a black hole. Calculations based on standard physics go awry (give indeterminate answers or go to infinity) in the center of a black hole.

• We know life exists, because it exists here on this planet, but we as yet have no idea if life is common or rare in the universe, and if the basic structure of earth life (DNA-RNA based) is the only form it can take. Neither do we know if, where conditions allow enough time for it to evolve, intelligence is rare or common in the universe.

• We understand the pace at which radioactive materials decay, according to the half-life rule, but we have no idea what causes a particular radioactive atom to decide to decay at one moment rather than another. Nor do we understand the recently-discovered fact that the rate of decay of radioactive elements all across the earth apparently fluctuates minutely but synchronously.


It’s worth remembering that just because we have equations that can accurately describe and predict an effect does not mean that we truly understand the effect, just as fire was used practically for tens of thousands of years before anyone had the slightest idea what was going on in a fire.

Rest assured, dear granddaughter, that there will be plenty of big problems left to work on when you grow up.

A qualitative change

There has been a qualitative change in the world, and we need to learn how to adapt to it. The change didn’t occur on 9/11/2001. That’s just the date on which we began to wake up to the fact that the change had occurred. We still haven’t really grasped the magnitude of the change, or the magnitude of the effort we need to adapt to that change.

There are two things which have changed.

We have always had violent maniacs, deranged fanatics, thugs, and ambitious and unprincipled leaders among us. We have always had a reservoir of deluded and misguided souls whom those leaders could manipulate to their own ends. And we have never lacked for pathological beliefs, or real or imagined grievances that are used to justify the most inhuman and outrageous acts. But until recently the damage such people could do to society was limited. With swords and machetes and even firearms there are only so many people an individual or small group can maim or kill. Even truck bombs or commandeered airplanes can only bring down one or two buildings at a time.

Up until now, to really destroy a nation or a civilization, to level their cities and salt the earth they stood on, required the resources and armies of a nation, or coalition of nations.

The first thing that has changed is the advent of nuclear and biological weapons. With these a small group, even a talented individual, now has the capability to destroy cities, perhaps nations, perhaps all life. It still takes the resources of a nation to produce weapons grade uranium or plutonium, but it only takes a small group to buy or steal those materials and assemble them into a crude but effective weapon capable of wiping any major city from the map, and to deliver that weapon in a truck or car or boat to its target.

Biological weapons are even harder to control. The raw materials exist in nature all around us, the knowledge can be found in any good university, and the required equipment can be bought from supply houses or on Ebay or even homemade from materials from a local hardware store. And the potential damage from releasing a highly infectious lethal disease on the world is immense.

The second thing that has changed is that our society is now much more vulnerable to disruption than it used to be. Even 250 years ago most of our ancestors could, if they had to, make do with what they could grow or find in nature. Much of the world still can, but not our first world economies. First world economies abound in critical bottlenecks – places where a single failure would cause extensive disruption. And the many facets of our civilization are so tightly interdependent that a single failure in one place can cause havoc throughout.

For example, we are wholly dependent on our electric grid. These days, if the power went down for days or weeks, much of our food supply would spoil. Even oil-powered transportation would halt, because the electric pumps needed to move the fuel wouldn’t work. The average store couldn’t even ring up a sale because their checkout computers would be down. The average home would have no heat, because electricity drives the oil or gas furnace blowers. Almost all business and finance would come to a halt, because computers and machines wouldn’t work. And so on. Just look around and see what our lives would be with no electricity. And yet our electric grid – thousands of miles of high tension lines running unprotected across remote parts of the country – is a highly vulnerable target.

Spend a few minutes thinking about this and one can think of dozens of other similar vulnerabilities in our high-technology first world civilizations.

So what has changed in the past few decades, and what we are just now beginning to really notice, is that small groups or even individuals now have the capability to do us massive harm, even to destroy us as a civilization, even to destroy us as a species. And we will never lack for individuals who want to do us such harm.

There is no easy answer to how we adapt to these changes, but adapt we must, and soon. The sort of token cosmetic changes the government has been putting in place to date – like more screeners at airports – simply shows that the political structure doesn’t yet recognize either the magnitude or the seriousness of the threat.

Recommended – Your Government Failed You

Richard Clarke worked for thirty years in the Pentagon, the intelligence community, and the National Security Council, serving under three presidents. He has seen the transformation of the military from the inside, from the post-Vietnam reactions to the Iraqi invasions. He is dismayed, even outraged, at what the civilian leadership has done to the military, and at the failure of some senior military leaders to speak up and oppose the naïve and misguided directions of civilian leaders, and he has detailed his arguments in a new book Your Government Failed You: Breaking the Cycle of National Security Disasters. (see booklist on sidebar for details).

In 1984 Secretary of Defense Casper Weinberger put forth a list of six eminently reasonable guidelines for the use of American force, evolved as a consequence of the Vietnam War:

• U.S. vital interests must be at stake
• We must be committed to winning decisively
• The political and military objectives must be clear and obtainable
• The forces necessary to win decisively and achieve the goals should be made available and the appropriate force size should be regularly reviewed
• There should be reasonable grounds to suppose that the American people would support the operation
• Force should only be used as a last resort, after all other alternatives are exhausted or proven unworkable

Subsequently, General Colin Powell added four more principles:

• Have all the risks and costs been fully and frankly analyzed?
• Is there a plausible exit strategy to avoid endless entailment?
• Have the consequences of our action been fully considered?
• Do we have genuine and broad international support?

These guidelines were all available to President Bush, Secretary of Defense Rumsfeld, and the U.S. military leaders while they considered the Iraq invasion, and hardly any of the guidelines were met, or apparently even considered by the politicians. Generals who protested that the guidelines hadn’t been considered were reassigned, and replaced with more compliant generals. The result has been soldiers killed because of inadequate equipment, a loss of American support throughout the world, and a messy and expensive insurgency for which our armed forces were not prepared.

Warning: this book will make your blood boil!!

But who will buy.....??

The Detroit auto makers were before Congress today asking for about $25 billion in loans to tide them over for the next few months. Suppose they get those loans and manage to build more cars --- who is going to buy them in this economy? Fixing the car maker's immediate cash problems does nothing if Americans can't afford to buy their products. Perhaps Congress ought to give every American family $25,000 to be spent only on buying a new American car, so that there will be a market for all those cars they want to continue to build.

Seriously, though, I don't get the feeling that anyone in Washington has really thought this all through. Printing money and handing it around to big companies doesn't seem to me to do anything toward solving the underlying problems; it just serves as short-term life support. And the astronomical debt this approach is accumulating will certainly create some severe long-term problems for all of us.

I expect that what should happen is that these companies should go into Chapter 11 bankruptcy, get reorganized to offload some of their unsupportable debt and obligations, and clean out their incompetent management, and then perhaps re-emerge lean enough to compete successfully in the market again. That will be painful for shareholders and workers, but it will eliminate the inefficient producers and divert capital to more productive uses. This business of trying to keep inefficient producers in business just to save jobs is a dead-end street, as a good many other countries have already proven.

Recommended: Bailout to Nowhere

I recommend David Brook's November 14 New York Times Op Ed column, Bailout to Nowhere. It is indeed sorely tempting to politicians of both parties to try to save all those Detroit jobs (and votes), but in fact the government should not be in the business of saving inefficient and uncompetitive companies. The Detroit Big Three were in trouble long before the current recession pushed them to the wall, as their declining market share over the past decade proved. Pouring taxpayer money into them isn't going to solve their fundamental problems; it's just going to keep them on life-support longer.

Still, now that Congress has found that it can print money at will (eg: the first $700 billion bailout), I suppose they will be eager to buy votes everywhere they can, and no doubt the line of CEO's applying for Congressional welfare for their uncompetative companies will get quite long.

Does this really make sense?

Our “home theater” amplifier died recently, and I had to go buy a new one to replace it. There was nothing to do with the old one but throw it in the trash, from where it will eventually go into a landfill and no doubt delight some archaeologists in another thousand years.

Once upon a time, when a high fidelity amplifier died, we could take it to a nearby radio/TV repair shop and get it fixed and get another ten years of life out of it. I tried to do that with this amplifier. But I find that no one repairs amplifiers anymore, and in fact even e-bay has trouble finding replacement circuit boards. And in fact, if there were a repair shop, the labor and parts cost to troubleshoot it and repair it would exceed the price of a new amplifier (about $200 in this case), which is exactly why such shops no longer exist.

So I threw it out and bought a new one. But before I did that I took the cover off and satisfied my curiosity to see what was inside. What was inside, of course, was a series of circuit boards with innumerable tiny but very sophisticated circuit chips and microprocessors that would have amazed the scientists and engineers of twenty years ago. Yet they were all headed to the trash heap.

We buy all kinds of marvelous gadgets – MP3 players and flat-screen TVs and radios and home computers and IPods and boom-boxes and high tech automobiles with dozens of embedded computers – and five or ten years later when they quite working we just throw them away. I understand the economics of this, but somehow it just doesn’t seem right. Can a society survive for eons if it throws away as much as we throw away?

A primer on foreign policy

There are essentially three ”schools” of foreign policy in America, the realists, the isolationists and the liberal internationalists. Of course there are an infinite number of shadings between and within these positions, but in their purest forms these are the three main foreign policy positions in our nation today.

Realists see the world as a jumble of nations and groups each pursuing their own self-interests, each with their own differing agendas and cultural world views. Realists see the task of American foreign policy to be the advancement of American self-interest in this global competition by whatever pragmatic means are effective, even if it occasionally means working with or supporting unsavory regimes. Although this sounds heartless and Machiavellian, realists would argue that unrealistic idealism endangers our nation.

To see how foreign policy realists think, read the recent book American and the World by Zbigniew Brzezinski and Brent Scowcroft, or Henry Kissinger’s Does America Need a Foreign Policy: Toward a Diplomacy for the 21st Century or Kissinger’s seminal 1994 book Diplomacy. Han’s Morgenthau’s Politics Among Nations: The Struggle for Power and Peace (1974) is also a good introduction to this view.

Isolationists, sometimes called Jacksonians because they espouse principles enunciated by Andrew Jackson, believe that American should tend to its own business and not involve itself more than the minimum necessary with the affairs of other nations. George Washington’s admonition for the new United States to avoid “entangling alliances” fits this view. Isolationists are not in favor of American intervention abroad for any reason – humanitarian or political -- and pure isolationist tend to believe in protectionist trade policies – keeping jobs at home. Isolationists also tend to be suspicious of global institutions like the UN, and of any arrangement that involves America giving up any national sovereignty. The “America First” movement at the start of World War II was an expression of relatively pure isolationism, and many of the subsequent pacifist and anti-war movements are essentially isolationist in their outlook.

There probably aren’t too many pure isolationists, but there is a strong isolationist vein running through the American electorate, which showed itself in America’s reluctance to enter World War I, and then World War II until we ourselves were attacked, and has reappeared loudly every time America has contemplated a serious international intervention, from Korea to Iraq.

I have never found a book that gives a good argument for a pure isolationist foreign policy in today’s world, but some insight into the position can be gained from The Isolationist Impulse: Its Twentieth Century Reaction, by Selig Adler.

Liberal internationalists, sometimes called “Wilsonians” because they follow principles enunciated by Woodrow Wilson, believe that America has a moral obligation to actively spread liberal ideas, including democracy, to other nations around the globe. There are significant shadings between those at one end content to just lecture and scold non-liberal governments, and even perhaps impose sanctions, and those at the other end prepared to intervene militarily to overthrow non-liberal governments and forcibly replace them with democracies, but all feel obligated to evangelize for American liberal values. Liberal internationalists tend to place faith in the establishment of global institutions like the UN to promote liberal democracy and keep the peace, and tend often to be highly critical of cooperation with ”unsavory regimes”.

To see how current liberal internationalists think, read the recent book Heads in the Sand: How Republicans Screw Up Foreign Policy and Foreign Policy Screws Up Democrats by Matt Yglesias, or The Good Fight: Why Liberals—and Only Liberals—Can Win the War on Terror and Make America Great Again, by Peter Beinart. Also important would be Arthur Schlesinger, Jr.’s 1949 book The Vital Center. The historical roots of liberal internationalism can be found, among other places, in the works of Emmanuel Kant and John Stuart Mills.

At one time isolationism was a dominant feature of conservative Republicans, while liberal internationalism was associated primarily with liberal Democrats. However, in recent years these division have blurred beyond recognition, so that in fact the neoconservative Republican Bush administration has adopted the most extreme form of liberal internationalism as a fervent obligation, while some Democrats have argued fiercely for what is almost an isolationist view. These days all three schools can be found within both political parties, and among both liberals and conservatives, and in fact many people espouse a combination of two or even all three of these views simultaneously.

There are valid arguments for all three foreign policy schools. Back when I was a teacher (in another life), at this point students would demand to know which view was “right”, and were always frustrated when I told them that all were right, and all were wrong. Each has its advantages and disadvantages, and each might be appropriate in one situation and not another. But I personally lean toward the realist view.

George Washington’s isolationist admonition was probably appropriate for a newly-formed, still weak and largely self-sufficient nation protected by oceans from Europe, but it hardly fits today’s world where America depends upon resources and markets around the globe and can be struck by long-range missiles from thousands of miles away.

Liberal internationalism, it seems to me, is in general based on a narrow and parochial view of the world that assumes that everyone wants (a) peace and (b) democracy. There is nothing in my reading of world history or cross-cultural studies that supports those beliefs. In fact, it seems to me that history teaches that people are far more interested in (a) power, (b) stability, and (c) status, even dominance, for their own tribe, clan, ethnic group, nationality and/or religion. In this respect I think well-off American political elites, living in safe, isolated upper-class communities, are far more naive about human nature than the urban poor who witness the Hobbsian world of gang wars, crime, unequal distribution of wealth and urban violence every day, a world much more like the violent chaos of Africa or the Middle East these days.

Realist policies cannot be perfect because the world is an extremely complex place, and it is not always obvious what course will best advance our cause, or what unintended consequences will emerge. But on balance, it seems to me that the realist approach, not blinded or constrained by religious, political or philosophical ideologies, is more adaptable, quicker to recognize errors and correct them, quicker to adopt promising new ideas, and better grounded in real human nature.

That does not mean that realists have no interest at all in spreading liberal ideas. On the contrary, the wider our liberal democratic views are spread and the rule of law accepted, the safer America becomes, and so spreading liberal ideas where possible is a valid part of realist diplomacy, but for pragmatic reasons, not ideological or moral reasons.

It's pretty clear......

It’s pretty clear by now that a liberal resurgence has occurred in this election. I’m grateful for that, because America is healthiest when both parties are strong and vital, and the Democratic party has, until this election, appeared moribund for a couple of decades now (the Clinton years hardly count, because he was one of the best Republican presidents that the Democrats ever elected).

Perhaps the Republicans will be smart enough to go back to the drawing board and recover the original conservative Republican principles (smaller government, balanced budgets, pragmatic foreign policy) and dump the nutty right-wing religious and ideological baggage that has driven so many traditional Republicans from the party.

Of course, the Democrats have to show us something if they are to keep power – the Democratic-controlled Congress hasn’t been impressive over the past two years, and in fact has an even lower approval rating than President Bush. So President Obama needs to demonstrate that he can govern as eloquently as he speaks.

Recommended: Guess Who's Coming to Dinner

Now that we have (finally) reached election day, I recommend the recent New York Times Op Ed piece Guess Who's Coming to Dinner. The discussion of the liberal press' own racist biases is interesting.

Recommended – 12 Myths of 21st Century War

Ralph Peters, a retired United States Army Lieutenant Colonel who has written some 22 books and countless articles to date on military affairs, has summarized his view of the American government’s myths that get us embroiled in needless and endless wars and cost us needless military lives. I highly recommend his article 12 Myths of 21st Century War, originally published in the American Legion Magazine.

America’s ruling elite

I’ve read a number of books and articles and online papers recently detailing the many, many failures of our government in all manner of affairs – in economic policy, military policy, energy policy, global warming policy, and many others. Of course all the authors have their varying biases, and they tend to blame all sorts of people and institutions, so it is hard to get a clear picture of exactly who did what wrong and when they did it.

But what does come through clearly through all the conflicting opinions is that the “ruling elite” of our nation – the elected officials, the career government officials, the academic experts that advise them, the senior military commanders, and the corporate leaders – are (a) largely unequal to the problems that face them, and (b) primarily focused on advancing their own careers rather than advancing the interests of the nation.

Some part of the problem is that the people who rise to the American ruling elite (or are born into it, as many are) tend to have very strong egos, meaning that they are sure they are right, are sure they are smarter then everyone else, and are fairly intolerant of opposing opinions. This leads to government, military and corporate organizations in which strong, arrogant egos rule, in which people who might have alternate views are systematically weeded out, and in which people who will “go along” with the prevalent view are promoted. This leads these institutions to a very narrow, “politically correct” view of the world.

Some part of the problem is that the ruling elite, the “old boy network” that rules America, is bound by all manner of reciprocal favors. It is no accident that corporate leaders make hundreds of millions, and then rotate into government jobs and somehow their former companies end up with billions in contracts (think Chaney and Halliburton, for example). It’s no accident that senior military officers retire into lucrative senior corporate positions in defense companies they used to deal with. It’s no accident that when legislators lose their seats they have no trouble getting lucrative positions with lobbying firms right down the street from their old legislative offices. It’s no accident that people rotate regularly between academic or Wall Street jobs and government posts. When it’s time to find an appointee for a senior government post, or a corporate CEO, leaders naturally look among their friends, neighbors, and golfing buddies. That unfortunately limits the pool to a very small subset of insiders, most of whom share the similar narrow view of the world.

Some part of the problem is that the American electorate puts up with this state of affairs. Oh yes, we get mad at the more outrageous actions and mistakes, but then we go right on and blame the other party and vote the same incompetent people right back into office, because they offer us some token benefit to buy our votes, or make some attractive promise that we all know in our hearts they couldn’t keep even if they wanted to, or just because they run under the right political party label. We re-elect people who have made terrible policy mistakes, who have been exposed as untruthful or dishonest, even some who have been indicted.

Nor, despite the election rhetoric, is there any persuasive evidence that the election of either Senator Obama or Senator McCain will change these matters much. Both are themselves part of the insider group, and in any case, the problem is more than any single elected official could solve even if they wanted to.

Of course this isn’t unique to America. The ruling elites of other nations aren’t any better, and many are much worse.

I don’t know what it will take to break up this dysfunctional system, but historically it has taken either a political revolution (which more often than not has disastrous and unintended consequences) or the fall of an empire (which may be where we are now).

In their narrow, parochial outlook and self-serving approach our American ruling elites today look uncomfortably similar to the ruling aristocrats, the “mandarins of Whitehall”, of Britain just before their empire began to decline. These British counterparts, comfortable in their myths and unable or unwilling to see the world as it really was, managed to bumble into both World War I and World War II, and lose their empire in the process. Are we headed down the same path?

Joe the Plumber

“Joe the Plumber” featured a good bit in the last Presidential debate. And he was interviewed afterward. For those of you who haven’t been following this item, Joe was captured on camera at an Obama rally ( a few days before the debate) asking Barak Obama why he should be taxed at a higher rate just because he worked hard and became successful. Joe feels that if he managed to make $250,000 a year (which he doesn’t), he ought not to be taxed “extra” just because he has been successful.

I have to say that I think Joe has a good point. The general principle of “income redistribution” (called “progressive taxation” among economists) is to make those who have more pay a higher tax rate than those who have less. This is essentially the Robin Hood principle of taking from the rich to give to the poor, and of course it is naturally highly popular with the poor, and apparently with liberals.

But is it really fair? If Joe works hard and buys a plumbing business (which is what he was thinking of doing) and makes a success of it and manages to bring in $250,000 a year, should he be taxed at a higher rate than someone who doesn’t work as hard and doesn’t take the entrepreneur risks of a small business owner? If someone is willing to work his/her way through medical school and years of internships and become a highly-paid surgeon, should they be taxed at a higher rate than someone who chose not to work so hard?

Proponents of progressive taxation like to point to rich heiresses or CEOs making millions and ask why they shouldn’t be asked to share more of their wealth, but of course that is a red herring. Most of the truly rich (people and corporations) actually pay very low taxes – they can afford the expensive legal help to find ways of avoiding taxes. (for example, if your company provides you with a penthouse and a private plane and a private chef you don’t get taxed for their cost and your company can even write the cost off as expenses). These higher rates really fall mostly on successful professionals and small business owners who happen to be doing well.

I never have been philosophically happy with this liberal approach. Certainly everyone (including the very rich, who now largely escape taxes) ought to pay taxes, and perhaps the tax rate or amount ought somehow to be proportional to the services consumed (ie – if you drive more, you ought to have to pay more of the highway tax). And I can see an argument for making everyone pay the same proportional (“flat”) tax -- say 15% of your income, whether you make $10 or $10 million, but I have always been uncomfortable with the idea that you ought to have to pay a higher proportion than other people just because you worked harder, were willing to get more education, were willing to take on the substantial risks and problems of a small business owner, and were more successful.

Of course promising to tax the rich more always plays well with much of the liberal base, but it seems to me this gets the incentives wrong. We would like to encourage people to get more education, to develop skills more valuable to the society, to work harder, to innovate, to be entrepreneurs and create more jobs and produce more products and services. Why then should we penalize those who do with a higher tax rate? If anything, perhaps we ought to penalize the couch potatoes with a higher tax rate, since they contribute less to the society.

Our Dysfunctional Government

If anyone needs reminding these days about how dysfunctional our American government is, I suggest reading the article Insider’s Projects Drained Missile-Defense Millions in yesterdays New York Times. That a mid-level government employee could bilk the government of a million or two is probably unremarkable. But look at the number of well-known elected officials in Congress who were willing to aid and abet him in the interests of pumping tax dollars into their districts and thereby assuring their re-election. Clearly something is badly broken in Washington.

Keeping things in perspective

Just to keep things in perspective, here is the S&P 500 chart running from 1950. As you can see, there have been other bad times, but the market has always recovered, and the long-term trend line continues upward at about 8-10% per year.

I find it is never good to look at the 1-day, 1-month, or even 1-year charts – they can give you heart failure. Look at the long-term charts to see what is really happening.

Recommended - Nouriel Roubini's latest post

On this Friday morning when the already severe financial crisis is clearly becoming worse hour by hour (the US stock market just opened 700 points down in the first few minutes, though it has recovered most of that now), Nouriel Roubini's latest post The world is at severe risk of a global systemic financial meltdown and a severe global depression, posted yesterday afternoon, seems worth reading. He suggests the sort of dramatic steps that are now needed, since the day-by-day incremental steps taken by the Treasury Department and the Federal Reserve clearly aren't working yet.

Among his suggestion: insure ALL bank deposits of any size (to stem the continuing pullout of money from regional banks), immediate triage of the remaining banks, and temporary nationalization of those that are failing, an immediate freeze on all foreclosures, and a massive WPA-style stimulus package.

It looks to me like it is time for such drastic and dramatic steps.

Common sense – finally!

The original plan for the $700 billion bailout package (now renamed the “rescue package” to try to put lipstick on the pig) was to use it to buy bad assets from the banks and get them off the bank’s books. This was a terrible idea, unanimously opposed by economists of all persuasions. It put all the risk on the taxpayer. It bailed out the banks at no cost to themselves. To be effective, the government would have had to buy the suspect assets at more than they were probably worth. Congress only passed it, in the face of strenuous opposition, because they felt the need to be seen to be doing something. And it was probably one of the least effective approaches to solving the current problem.

Far better was the approach taken earlier with AIG – loan them money (at a high interest rate) and take back senior equity in the bank (“senior” meaning the government is first in line to get its money back) as collateral.

I see this morning that the government is finally coming to its senses and thinking about taking the loan-equity approach, perhaps spurred on by the British example (the British got it right the first time).

Meanwhile the second Obama-McCain debate made it clear that neither candidate has the slightest idea what is going on or how to solve it. They both used sound bites perhaps appropriate some months ago but completely disconnected from today’s reality. Whichever one gets elected, let’s hope they have the wit to quickly find some good advisers to deal with this matter.

Professor Nouriel Roubini

In all this mess, only a very few economists saw what was coming and warned about it months ago. One of the most prominent of these was Professor Nouriel Roubini, Professor of Economics and International Business at the Stern School of Business, New York University. In February of this year, before the first of the big bank failures took place, he published a paper entitled “The Risk of a Systemic Financial Meltdown: The 12 Steps to Financial Disaster” , which described with uncanny accuracy just the sort of crisis we find ourselves in. At the time his predictions were widely derided as excessively pessimistic by the "more knowledgeable" government and financial experts, who now look extremely foolish and naive.

It's worth following his continuing discussions as this crisis unfolds. They can be found, among other places, at http://www.rgemonitor.com/.

This afternoon he is arguing for dramatic government intervention (of the sort I suggested was needed in my post earlier today), including a WPA-type program to immediately spend $300 billon to jump-start the economy again (he suggests it be spent on infrastructure and green energy, which addresses other critical problems as well). One might want to read, for example, "Revisiting my February paper “The Risk of a Systemic Financial Meltdown: The 12 Steps to Financial Disaster”…And Some New Policy Recommendations to Avoid the Meltdown", and

"Global Money and Credit Markets Continue to Worsen Despite Coordinated Rate Cut: What Needs To Be Done?"

The Nature of Panic

Once again today, the world stock markets are in free-fall as the worldwide herd of investors stampede to the exits. Politicians have that “deer in the headlights” look, and central bankers keep pulling one lever after another hoping that something will work.

The problem, as I see it, is that those in charge may understand economics but they don’t understand human psychology. They are trying careful, rational actions in the hopes of controlling irrational behavior – but it doesn’t work that way.

Human groups en masse behave much like schools of small fish or large flocks of birds, moving as a unit. An economist named Lake LaBaron at Brandeis University has built a simulation of the stock market that can reproduce fairly accurately the sort of irrational herd behavior that often grips the markets, just as it is doing in the real markets today.

American hunters knew that to control a stampeding herd of buffalo it took dramatic actions – gunshots in the air, strategically-placed grass fires, or lines of hunters waving big buffalo skins – to get them to change course.

What governments and central bankers have to understand is that the small, conservative stepwise changes they have been trying day by day can’t control an irrational stampede. It takes big, impressive, dramatic steps to divert a stampede – a “slap in the face” of some sort. In 1933 Franklin Roosevelt declared a bank holiday to stop the run on the banks that he faced, and it worked. Today’s leaders need to try something similarly dramatic to halt the stampede and give spooked investors time to regain their composure and come to their senses.

Recommended: How Did It Happen

Another recommendation is yesterday's article How Did It Happen, by Megan McArdle from the Atlantic Monthly website. And unlike most such posts, many of the reader comments that follow it are not knee-jerk ideological rants but thoughtful and worth reading.

Recommended: The Age of Bloomberg

Fareed Zakaria always seems to cut to the core of a problem. I recommend his recent post The Age of Bloomberg. He argues that this crisis doesn't mean the end of capitalism in the world, but it may well mark the end of America's dominance of the capitalist world.

Recommended: America's Nervous Breakdown

I recommend Victor Davis Hanson's new commentary, America's Nervous Breakdown. As he points out, in the past our enemies have tended to take advantage of our preoccupation with other crises -- will it be any different this time?

Why Washington Can’t Think

Ralph Peters, himself a retired military man, is one of America’s brightest and most unorthodox military observers (see comments on two of his previous books, Beyond Terror and Fighting For The Future in my booklist). I just got from my local library his newest book, Wars of Blood and Faith: The Conflicts That Will Shape the Twenty-First Century. The foreword alone is as full of profound insights as many full-length academic tomes.

But in the present circumstances, with Congress grappling with a series of massive taxpayer bailouts of Wall Street to correct problems that were largely created by Congress itself, I was drawn to the following paragraph in the forward:

“We are led by vultures, not eagles”

“In the middle of the last century, a grand hullabaloo followed the publication of a critique of our educational system, Why Johnny Can’t Read. We are due for a companion volume, Why Washington Can’t Think. The advertising copy for such a book might note that, despite Washington’s status as the richest, most powerful capital city in history, where advanced degrees are ubiquitous, innovative thought not only doesn’t exist, but has become distinctly unwelcome. Washington is incestuous and elitist, as closed to outside ideas as a paranoid religious cult. No matter their party affiliation, insiders at work in government or the media arise from mini-dynasties, attend the same schools and universities, share a disdain for military service, play musical chairs with the same government positions, rotate through the same cluster of (wildly misnamed) think tanks, attend the same usual-suspects policy briefings, read the same books and newspapers, live in the same neighborhoods – and dread the embarrassment threatening anyone who challenges Washington’s dysfunctional, but comfortable, way of interpreting the world.”

I am reminded of the astonishment among members of Congress that there would be such an unexpected backlash against their bailing out Wall Street. Emails to members of Congress were reported to be running about 100-1 against the initial bailout plan. They could only have been astonished at this reaction if they were completely out of touch with the mood of the country.

I am reminded of the astonishment in Washington that we were not greeted in the streets as liberators in Iraq when we overthrew their government. Washington insiders could only have been astonished at this if they were completely ignorant of the long history of the Middle East.

I am reminded of the astonishment of Washington that Russia has reverted to a bellicose, expansionist, authoritarian form of government under Putin. They could only have been astonished at this evolution if they were completely ignorant of the Russian national psyche, humiliated at being demoted from a world power and with memories of German World War II aggression still fresh in their minds.

It seems to me that events in recent years support Peter’s assessment of our governing establishment as hopelessly out of touch with the real world, deluded by their comfortable ideologies (both liberal and conservative), and largely ignorant of history or the lessons history can teach.

Obama, Foreign Policy Realist

I have enormous respect for Fareed Zakaria, and have several of his excellent books listed in my booklist (see sidebar). I strongly recommend his recent article Obama, Foreign Policy Realist. There have been many claims that Senator Obama is a far-left, dewy-eyed idealist. Fareed disagrees, and makes the case that in fact he is a foreign policy realist in the mold of Henry Kissinger, Zbigniew Brzezinski and Brent Scowcroft.

The root of the problem

In all this panic about the markets and Wall Street there has been a lot of glib and partisan finger-pointing about whose’ fault it was that we got into this situation. A little quiet reflection, and some research, leads me to conclude that at root, the fundamental errors that probably got us into this situation include (not necessarily in priority order):

1. Failure by the SEC to enforce existing regulations. No doubt some will argue for a slew of new and more restrictive market regulations in the wake of this debacle, but it’s not clear to me that we need more regulations – just effective enforcement of the existing regulations. A reasonable summary of the SEC’s regulatory failures can be found at http://seekingalpha.com/article/96487-5-failures-of-sec-chairman-cox. To be fair to SEC Chairman Cox, Congress has kept the SEC’s funding almost flat throughout the recent years of Wall Street growth, and they are badly understaffed. And administrations from President Reagan through to the current administration, including President Clinton’s administration, have given clear instruction to regulatory agencies throughout the government (including the SEC) to interfere less, not more, with private markets.

2. Failure of the bond rating agencies such as Standard & Poors and Moody’s to do their jobs. Many of the debt instruments which are now almost worthless were rated AA or even AAA by these agencies. Some previous employees of these agencies are now admitting that in recent years they were ordered to simply accept the rating suggested by the investment banks that issued the bonds, rather than independently verifying the creditworthiness. No doubt the fact that the rating agencies depend on fees from the very investment banks they are assessing influences this behavior.

3. Failure of shareholders to demand better information and more accountability from the management of firms they invest in. Obscene executive pay is probably not a root cause of this mess, even though it has powerful political implications. But it probably is a symptom of the failure of shareholders to demand more of management. Some will argue that shareholders have little power to make such demands, but that is false. Investors have all the power – they can simply refuse to buy shares in a company whose management doesn’t act responsibly. Shareholders who don’t perform “due diligence” before buying shares in a company deserve whatever befalls them. I would bet that few individual investors even bother to read the prospectus of a company before buying shares, let alone demand management accountability.

4. Congressional pressure on Fanny Mae and Freddie Mac to increase financing of “affordable housing”. Part of the recent history of that effort is documented at http://online.wsj.com/article/SB122212948811465427.html. Briefly, Congress pressured these agencies to accept more sub-prime loans, and since Freddie Mac and Fannie May would buy them (as Congress ordered), that created a good market for them and encouraged banks to make more of them. Actually, subprime mortgages originated back in 1977 in the Carter Administration with the Community Reinvestment Act (CRA), an effort to help more people own their own homes. Yet another example of “good intentions” leading to bad policy.

Those partisans who are hell-bent on blaming the whole mess on the current administration ought to know that Republicans tried to get legislation enacted in 2003 to regulate Fannie Mae and Freddie Mac, but were fiercely opposed by Democrats who claimed we were “not facing any kind of financial crisis” (Rep. Barney Frank, D-MA, current Chairman of the House Financial Services Committee.).

5. The abysmal level of American public education. Behind the bad mortgages now choking the system are a slew of gullible American home buyers who, for one reason or another, took out a loan they were not in a position to pay back. Some fell for balloon mortgages or adjustable-rate mortgages without understanding the (rather simple) math behind them, or the (rather obvious) risks they entailed. Some “flipped” houses, trying to make a profit on a housing market they thought could never go down. Some were simply conned by their real estate agents and banks into buying a bigger house than they could afford. One wonders if this could have happened if American schools taught children even the most basic facts about real life or how to handle money.

6. The short-term focus of American society. Asian societies think in terms of decades, generations, even centuries. America thinks in terms of months, quarters, and occasionally a year or two. We suffer from national ADD (Attention Deficit Disorder). Far too often management, shareholders, and government leaders alike think short-term, with little or no attention to possible long-term consequences.

These are all fundamental structural problems with our government, our financial system and our society, and they are not going to be solved quickly or easily. Indeed, with our present government system, it’s hard to see how they will even be addressed, but address them we must if we are not to have a repeat of this sort of crisis, or indeed a total economic disaster.

Credit Default Swaps

While we all watch the Congressional drama over the "toxic mortgage" crisis, there is another, even larger boogyman in the background. Credit Default Swaps are privately-placed "bets" or insurance on the potential default of debt instruments. In essence, anyone can create such a swap, and even bet on the default of someone elses' debt -- sort of legalized gambling. Hedge Funds got onto this a decade ago and some have made billions on it, but it is totally unregulated, and there are now trillions of dollars of such bets out there, ready to collapse.

See The $55 Trillion Question for a good and quite readable discussion of this risk.

Second try a charm?

Well, the first attempt yesterday at bailing out Wall Street failed, largely because of the almost unanimous public opposition to it. Clearly the administration misjudged popular anger at Wall Street excesses, as they have misjudged so many other things in recent years. It supports my thesis that Washington political insiders, living in their own narrow, isolated and self-contained world, are pretty much out of touch with the average Americans they supposedly represent.

It doesn’t help that Secretary Paulson is himself from Wall Street and made over $600 million while CEO of Goldman Sachs. There is understandable popular suspicion that he is too Wall- Street-centric (to put it politely), or that he is out to help his buddies on Wall Street (to put it impolitely). As someone put it, it is like the fox guarding the chicken house complaining that he needs more chickens.

They will of course try again in a day or two. What will be interesting will be to see if they make any substantive changes to their basic approach of government intervention in the markets, or whether they just add a few toothless sops to give House members more political cover, and then strong-arm the votes.

I don’t think the administration yet understands that people are going to be furious at this bailout, whatever form it takes, if it seems that banks get whole again but the average person is still in economic distress.

The (purported) executive pay provision

Reading the text of the bailout bill voted on this morning, I see that the section on limiting executive compensation is essentially toothless, a sop put in there to appease the public if we are stupid enough to just trust sound bites from members of Congress without actually checking the language of the bill (which can be found, among other places, at http://www.washingtonwatch.com/blog/2008/09/28/bailout-text-tarp-taxpayers-are-really-payin/

Section 111 deals with executive compensation:

SEC. 111. EXECUTIVE COMPENSATION AND CORPORATE GOVERNANCE.

(a) APPLICABILITY.—Any financial institution that sells troubled assets to the Secretary under this Act shall be subject to the executive compensation requirements of subsections (b) and (c) and the provisions under the Internal Revenue Code of 1986, as provided under the amendment by section 302, as applicable.

(b) DIRECT PURCHASES.—

(1) IN GENERAL.—Where the Secretary determines that the purposes of this Act are best met through direct purchases of troubled assets from an individual financial institution where no bidding process or market prices are available, and the Secretary receives a meaningful equity or debt position in the financial institution as a result of the transaction, the Secretary shall require that the financial institution meet appropriate standards for executive compensation and corporate governance. The standards required under this subsection shall be effective for the duration of the period that the Secretary holds an equity or debt position in the financial institution.

(2) CRITERIA.—The standards required under this subsection shall include—

(A) limits on compensation that exclude incentives for executive officers of a financial institution to take unnecessary and excessive risks that threaten the value of the financial institution during the period that the Secretary holds an equity or debt position in the financial institution;

(B) a provision for the recovery by the financial institution of any bonus or incentive compensation paid to a senior executive officer based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate; and

(C) a prohibition on the financial institution making any golden parachute payment to its senior executive officer during the period that the Secretary holds an equity or debt position in the financial institution.

(3) DEFINITION.—For purposes of this section, the term “senior executive officer” means an individual who is one of the top 5 executives of a public company, whose compensated is required to be disclosed pursuant to the Securities Exchange Act of 1934, and any regulations issued thereunder, and non-public company counterparts.

(c) AUCTION PURCHASES.—Where the Secretary determines that the purposes of this Act are best met through auction purchases of troubled assets, and only where such purchases per financial institution, in the aggregate exceed $300,000,000 (including direct purchases), the Secretary shall prohibit, for such financial institution, any new employment contract with a senior executive officer that provides a golden parachute in the event of an involuntary termination, bankruptcy filing, insolvency, or receivership. The Secretary shall issue guidance to carry out this paragraph not later than 2 months after the date of enactment of this Act, and such guidance shall be effective upon issuance.

(d) SUNSET.—The provisions of subsection (c) shall apply only to arrangements entered into during the period during which the authorities under section 101(a) are in effect, as determined under section 120.

Perhaps you noticed the vague language (no dollar amount mentioned) and the fact that it applies only to the top 5 executives. Don’t you like the section 2(A) language: “exclude incentives for executive officers of a financial institution to take unnecessary and excessive risks”.

Congress has tried before to limit executive pay, with little or no success. For some of that history, see Attempts to limit CEO pay have yet to succeed. and Do Caps on Executive Compensation Really Work?

In fact, any CEO whose lawyers can’t get around this toothless provision ought to be fired. Looks to me like the Washington insiders are at it again – protecting the establishment.

Recommended: Cool It: The Skeptical Environmentalist’s Guide to Global Warming

Bjorg Lomborg’s two previous books, Global Crises, Global Solutions (see book list under 2004) and The Skeptical Environmentalist: Measuring the Real State of the World (see book list under 2001) have made the point that supporters for an issue have a tendency to exaggerate their issue into a crisis in order to draw attention to it and gain support and leverage, but that the public perception built on the exaggerated claims, hyped by the press, frequently lead to bad or ineffective policy. In this book he takes on the “Global Climate Crisis”, arguing that although global warming is certainly real, it is nowhere near the crisis that supporters claim for it, and that a clear-headed look at the data would suggest that there are lots of other issues we could spend money on that would have more drastic and more immediate effects in terms of saving lives and improving the quality of life for people around the world.

It’s not that he thinks global warming isn’t a problem; it’s that he thinks the billions we might spend to make a small dent in the CO2 level in 50 years could make a huge difference to billions of people tomorrow in better health, better nutrition, education, and the like, and that we ought to be more thoughtful in ordering our priorities and not get stampeded by exaggerated claims of crisis. As in his previous books, his arguments are solidly backed by facts from reputable sources, and deserve serious consideration.

Recommended: Brzezinski & Scowcraft: - America and the World

Zbigniew Brzezinski was President Carter’s National Security Advisor; Brent Scowcroft was the National Security Advisor to Gerald Ford and then the elder President Bush. Both are considered among the brightest minds in Washington. Early this year they sat down with noted journalist David Ignatius for a series of recorded private discussions about America’ place in the current world, and their views on what the next American president needs to do. This book is the result (transcript) of that discussion.

One is a democrat and one a republican, but both are foreign policy “realists”, and they are in remarkably close agreement about what needs to be done. We all ought to read this book, but one certainly hopes the next president, whomever that turns out to be, reads it.

Obscene Wall Street income?

Washington Mutual Bank failed last night, and was taken over by the Treasury and its assets sold off to J.P. Morgan. Its current CEO, Alan Fishman, took over that job just three weeks ago. Now of course he is out of a job, but to ease the pain he gets to keep his $7.5 million signing bonus and his $11 million severance payment. So he makes $18.5 million for three weeks work, or about $900,000 per day!!

I wonder how the average 20 year enlisted man or woman in the military, earning about $165 per day for risking their life and getting shot at, would feel about this?

No wonder so much of the country is in revolt against bailing out Wall Street.

The status of the bail-out proposal today

As of this moment (Friday noon), Secretary Paulson’s $700 billion dollar bailout plan is in deep trouble. That the revolt against it came from the House and not the Senate is probably not surprising – all the House members have to stand for re-election in a few weeks, while only a third of the Senators are up for re-election, and most of those have safe seats thanks to the years of partisan redistricting (we used to call it gerrymandering).

Public opinion, both Republican and Democratic, is running heavily against the plan. Opinion among economists of all persuasions is heavily against the plan. Opinion among rank-and-file professionals in the finance industry is running against the plan, even though their own jobs are at high risk.

Almost everyone sees this as a matter of Wall Street greed coming home to roost, and the bailout as government pandering to big Wall Street companies to save them with taxpayer money from the consequences of their own greed. Many people are suspicious that Secretary of the Treasury Paulson is showing excessive favoritism to Wall Street, since he was CEO of Goldman Sachs until 2006 (earning $34 million his last year as CEO). And almost everyone feels that the bailout plan does little or nothing for the average person trying to pay off their mortgage and keep their job. That may or may not be an accurate perception, but in politics, perception is reality,

So of course, with an election coming up in a few weeks, House members aren’t keen to be seen to be complicit in an unpopular “fat cat” bailout unless they have some political cover. Democrats desperately need lots of Republicans to support the legislation, so that they don’t look like they did this themselves. Conservative Republicans, of course, see this as exactly the worst sort of government meddling, and moreover in an area in which the government has never showed any competence. And they have a point. Other nations have tried variations of this approach in their fiscal crises and the results have been uniformly poor, as economists of all persuasions have been loudly arguing over the past few days.

Eventually some sort of agreement will emerge, probably committing a lot less than $700 billion in taxpayer dollars. Neither party can afford to be seen to be just ignoring the situation. And probably it will have little or no effect on the economy in the short term.

In fact, even while Congress debates, the right sort of free-market mechanisms are cleaning up the mess – badly-managed banks are failing and their assets are being bought up at fire-sale prices by competitors who were more prudent, as happened last night with the purchase of failing Washington Mutual by JP Morgan. This process will no doubt continue even without government intervention – more banks will fail (117 are on the danger list as of this morning) and their assets will be bought up by better-managed banks. Investors who were imprudent enough to invest heavily in poorly-backed securities will lose their money. They gambled on a high risk investment and lost.

Whether or not there is a big bail out in the end, the economy will no doubt be sluggish, unemployment rates higher, consumer spending lower, the stock market turbulent, and home prices and sales depressed for at least a year or two, and perhaps longer. That means that few if any of the big spending promises or tax cut promises that the two Presidential candidates have made will be possible unless they want to court rising inflation rates.

I’m inclined to think the process is operating as it should – the country is going through a long-overdue shakeout after a period of excessive speculation and borrowing, at the federal, corporate and personal level. The shakeout is certainly unpleasant, but delaying it with a massive bailout (even if it works, which it might not), probably just postpones the inevitable and makes it all the more painful when it finally does arrive. Short-term fixes hastily cobbled together for political gain are probably not what we really need – what we really need are some thoughtful, long-term adjustments in our economy.

I wish I thought either of the Presidential candidates, or either of the political parties, were capable of such dispassionate, non-partisan, non-political, thoughtful actions.

Recommended: Blame Fannie Mae and Congress For the Credit Mess

To get some insight into how this current fiscal mess came about, I recommend the online Wall Street Journal article Blame Fannie Mae and Congress For the Credit Mess, by Charlas Calomiris and Peter Wellison. The authors are, of course, from the right wing of the economic spectrum, but their argument deserves serious attention.

Minister of Treasury Paulson

Those of you who have seen the perennial Nigerian scam emails will recognize this spoof of it, now circulating widely in government circles:

--------------

REQUEST FOR URGENT CONFIDENTIAL BUSINESS RELATIONSHIP

Dear American:I need to ask you to support an urgent secret business relationship with a transfer of funds of great magnitude .I am Ministry of the Treasury of the Republic of America. My country has had crisis that has caused the need for large transfer of funds of 800 billion dollars US. If you would assist me in this transfer, it would be most profitable to you. I am working with Mr. Phil Gram, lobbyist for UBS, who will be my replacement as Ministry of the Treasury in January. You may know him as the leader of the American banking deregulation movement in the 1990s. This transaction is 100% safe.This is a matter of great urgency. We need a blank check. We need the funds as quickly as possible. We cannot directly transfer these funds in the names of our close friends because we are constantly under surveillance. My family lawyer advised me that I should look for a reliable and trustworthy person who will act as a next of kin so the funds can be transferred. Please reply with all of your bank account, IRA and college fund account numbers and those of your children and grandchildren to wallstreetbailout@treasury.gov so that we may transfer your commission for this transaction. After I receive that information, I will respond with detailed information about safeguards that will be used to protect the funds.
Yours Faithfully
Minister of Treasury Paulson

A "punative" bailout?

Yesterday in his testimony to the Senate Banking Committee Secretary Paulson is reported to have said that he didn’t want the bailout to “be punitive”, and that was why he opposed forcing bailed out firms to limit executive pay and give up a equity stake to the government.

Let me suggest that if Congress doesn’t make this bailout punitive – painful in the extreme to those forced to ask for help – they will have sold out to Wall Street. Any competitor who came in as a white knight to save a company would expect to clear out the incompetent executive management team and take a controlling interest in the company as the price of saving them. I expect Congress to do no less with my taxpayer money. Paulson had the right idea with the AIG bailout (10.5% interest and 80% equity in the company) and that sort of hard bargain ought to be the model for any future bailouts from Congress, whether of Wall Street firms or auto makers or whomever.

We pay the President of the United States $400,000 per year (and many of us in both parties think he was overpaid at that, considering his performance) – if the government has to save a Wall Street firm, I don’t see why anyone on the executive management team of that firm should get paid more than the CEO of the firm that saved them, the President of the U.S.

Amazing!!

Amazing!! There really are a few people on Wall Street with honor. The Wall Street Journal reports that former AIG CEO Robert Willumstad, replaced a week ago when the Federal Reserve bailed AIG out, has just rejected the $22 million bonus to which he is entitled under his contract. Lets see if anyone else in this debacle is as much of a mensch.

Recommended - Palin and Obama: What Really Is Wisdom?

Governor Palin has been getting a lot of sneering attacks from the East Coast elite and the Washington insiders and press corps ever since she was nominated. They complain that she is uneducated (no Harvard degree), inexperienced (hasn’t been part of the Senate “old boys” network), dishonest (apparently Alaskan earmarks are dishonest while those for other states are honest), and all manner of other things.

Now I’m unlikely to vote for the McCain-Palin ticket for reasons I laid out in my July 24 posting, but in fact I have been bothered a great deal by these attacks, far more than by the predictable partisan attacks on McCain or Obama, without quite being able to put my finger on why. Victor Davis Hanson’s article Palin and Obama: What Really Is Wisdom? (http://victorhanson.com/articles/hanson091908.html) has finally helped me see what it is I find so disturbing.

It is the underlying assertion, by the political and press “elites”, that in national politics only formal education and Washington experience counts. And indeed, I think that is much of what is wrong with Washington politics these days - the Washington “elites” of both parties are largely disconnected from and ignorant of the real-world day-to-day life of the voters they represent, the military men and women they command, and the workers their economy depends upon. Their enclosed world of Georgetown cocktail parties, power lunches at the Watergate, golf at Chevy Chase Country Club, and self-important press meetings has little to do with life in the nation as a whole.

I recommend this article – it made me think.

Recommended - How We Became the United States of France

On the same topic as the last two posts, I recommend the article How We Became the United States of France at http://www.time.com/time/nation/article/0,8599,1843168,00.html.

So here’s the key question….

Partisan political rhetoric aside, what has really happened in our nation over the past few years is that some banks have gotten greedy and lent more money to some people than they can pay back. Some of these borrowers were trying to make a quick buck on rising housing prices, some were sold a bill of goods by their lenders, and some were just ignorant about money matters. Under normal circumstances, banks would be expected to be careful not to loan money to people with poor credit or insufficient income. But bank executives got greedy – banks made lots of instant money from the fees associated with placing the loans and yet more money from the higher interest rates they charged for these loans, and that looked good on their balance sheets and justified big executive salaries.

Now the mess has come home to roost, requiring a massive government bailout that apparently will top a trillion dollars of taxpayer money by the time we are done with the Fanny Mae and Freddie Mac bailout, the AGI bailout, and now the 700 billion dollar proposal to buy up all those bad mortgages and loans.

So here is my question: if this bailout goes through, will any of the people who caused this mess in the first place be carrying any of the cost?

Are the highly-paid bank executives who pushed these loans paying anything? Are the investors who greedily bought up these higher-interest-rate loans as “securitized” packages paying anything? Are the borrowers who imprudently took on loans they couldn’t pay back paying anything? Are the Freddie Mac and Fannie May executives who bought up these loans paying anything? Are the SEC executives who allowed this to go on paying anything? Are the officials in the administration and Congress who allowed this mess to develop paying anything?

Is the president taking a pay cut in his $400,000 annual salary because of this? Are members of Congress taking a pay cut in their $169,300 salary because of this, or forgoing their annual increase (2.5% last year), or giving up any of their exceedingly generous benefits? Are either of the Presidential candidates (both members of the Congress that allowed this to happen) taking a pay cut because of this? Is SEC chairman Chris Cox taking a pay cut in his $191,300 annual salary? Is any bank executive giving back any of his/her massive salary and bonuses from recent years because of this? Freddie Mac CEO Richard Syron made nearly $19.8 million in salary and bonuses in 2007. Fannie May CEO Daniel Mudd made $8.4 million in 2007-- his predecessor Franklin Raines got $52 million in bonuses as he was fired in 2004. AIG CEO Martin Sullivan has an annual income of $2.1 million. Are any of them returning any of this? Are borrowers who imprudently borrowed more than they can afford being required to sacrifice anything?

Are any of these people even going to offer a public apology?

I thought not. We the taxpayers will be the only ones who pay, in higher taxes and less government services now or in the future. The old adage “the rich get richer and the poor get poorer” applies once again.

The government’s proper role

There is a real question about the government’s proper role in helping people recover from disasters. Two events in recent days bring this issue to mind: the devastation in Galveston, Texas and the devastation among investment banks on Wall Street.

In both cases government policy, some local and some federal, led people to do very unwise things. Galveston City actively encouraged people to build million-dollar homes right on the waterfront (it increased city tax revenues and provided a building boom). And on Wall Street a conservative administration resisted attempts to impose more regulation on the banks, who were chasing huge paper profits by lending money to poor credit risks and highly leveraged buyers (that’s what a ”subprime mortgage” is).

Now we are pouring hundreds of billions of taxpayer dollars into recovery efforts on both these disasters. It may seem heartless to say we ought to let people (and businesses) suffer the natural consequences of their own folly, especially if the government has been encouraging that folly. On the other hand, if the government will rescue everyone who takes an unwise risk and loses, then why should we not all take more big risks? If we win the profit is ours; if we lose the loss is the government’s (actually the taxpayer’s).

For places subject to natural disasters, like river flood plains and vulnerable seashores, forests subject to frequent fires, earthquake fault lines, etc., it seems to me people ought to build there at their own risk, and if they can’t find anyone willing to insure them, then they simply have to take the risk with their own money. For established communities in such a disaster, it might be appropriate for government to help them relocate their community or town to a safer place, like the bluffs well above the floodplain that floods every few years. But it certainly doesn’t make sense for government to shell out taxpayer money to help people build right back on the same unsafe spot. The billions being poured into New Orleans is probably largely wasted money – much of New Orleans is already below sea level and still sinking, and it doesn’t take a genius to see that there will be more devastating hurricanes over the coming decades and it will almost certainly flood again. The same is true of the vulnerable shoreline and islands in Galveston Bay.

For businesses that make unwise decisions, we risk creating a real moral hazard if everyone thinks the government will bail them out. The Federal Reserve seems to be (finally) realizing that, which is probably why they declined to offer Federal money to bail out Lehman Brothers last weekend. There were powerful arguments for saving AGI – its collapse would probably have sent markets all around the world plummeting. And the government drove a hard bargain (11.5% interest on the loan and 80% ownership of AGI) on the deal, which is probably proper, considering the risk they are assuming. Still, as a general principle, it is probably unwise for governments to save businesses from their own unwise decisions, however strong the political pressure is. Foreign countries that have done that in the past, such as Japan, have generally had much worse economies in the long run, because the market’s natural selection process hasn’t been allowed to prune out the less fit businesses and the unwise managers.

Now the administration proposes to spend about three quarters of a trillion dollars to buy bad loans from banks. If they drive a hard enough bargain (say buy the loans at 20-25% of their face value, this might turn out to be at least revenue-neutral. If they buy the loans at, say, 90% of their face value, they will have simply given the managers and stockholders of these banks a free gift – assuming the risk but leaving the profits to the banks. That certainly would create a moral hazard. In fact, one might be forgiven for the cynical suspicion that this arrangement is simply a way for well-paid bankers to recover from their poor judgment, and keep their high incomes, at the expense of the ordinary taxpayer who will pay the bill.

It’s a hard problem, and requires a delicate balancing act. But in general I think the government should not act to save people or businesses that have been unwise. It is appropriate beforehand for the government to give loud warnings, but if people or businesses ignore those warnings, they ought to assume the risk and the consequences.