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.

Recommended: The Post-America World

As in his previous book The Future of Freedom (see reading list under 2003), Fareed Zakaria gives a brilliant analysis of a difficult and complex subject, America’s place in the emerging 21st century world. He argues that, despite so many books to the contrary, America is not doing worse these days, it’s just that the rest of the word (or at least some of it) is doing better, and that requires that we adjust our policies to the new reality. Two detailed chapters discuss in particular the rising influence of China and India, and how we should relate to them. In general he feels that most American institutions are working well, better in fact than in most of the rest of the world. The one prominent exception is our do-nothing political system, mired in ideological trench warfare between the two parties, and frozen into inaction by myriad interest groups and well-funded private business agendas. Well worth reading. (see the reading list on the sidebar for ISBN number)

Recommended: The Nine: Inside the Secret World of the Supreme Court

Jeffrey Toobin, a staff writer for the New Yorker and CNN senior legal analyst, interviewed not only the justices themselves, but also some seventy five of their law clerks to build a comprehensive picture of the Supreme Court, how it operates, the issues it deals with, and the personalities of the justices themselves. The entire decades-long conservative battle to “capture” the court and turn it to the conservative agenda (first and foremost, to overturn Roe v. Wade) is documented in detail, along with a brilliant and fascinating analysis of why, despite all the supposedly conservative appointment to the court, Roe v. Wade has yet to be overturned. Also included is a detailed description of the Court’s participation in the disputed Bush vs Gore election. This might seem like an arcane subject, but once I started it, I couldn’t put this book down. (see the book list on the sidebar for the ISBN number)

The Emperor’s New Clothes and feedback loops

Yes, the title was supposed to intrigue you. What do the story of the Emperor’s New Clothes and feedback loops have to do with anything?

We are at an extremely critical and dangerous moment right now. The world’s financial system, in the end, depends on everyone believing that it is safe and stable and solvent. As long as everyone believes that, business can continue as usual. But like the Emperor in the story, when someone finally voices the obvious – that he has no clothes – the illusion disappears in an instant, and in the financial world that instant has come. Years of reckless borrowing and reckless lending practices have begun to come home to roost, and now major banks are failing, one after another, like dominos falling.

The feedback loop part of the story is that once confidence is shaken, people try to pull their money out, making things all that much worse. Yesterday there were literal “runs on the bank” in AGI offices in Asia. We now have all sorts of feedback loops making things worse. The stock market is in free fall, so stockholders are fleeing to bonds, and all those buyers who bought on margin are having to sell to meet margin calls, further depressing the market. Home prices have plummeted, so that mortgage holders no longer have the equity on their books that they used to have, weakening them more. And now it is getting harder to get loans, making it even more difficult to sell homes and further depressing the real estate market. And so on and so on.

There are more big shoes to drop – more banks will likely fail or have to be saved by the government or a buyout in the next few months. But there is a much bigger shoe that we ought to be worried about – all that federal bail-out money in the end comes largely from money that the government borrows on the world bond market. There is a very real danger that the world bond market will get spooked and stop buying our bonds, which cuts off that supply of bail-out money (and indeed the money that pays for most of the government these days). Since the treasury needs to sell many of these bonds just to roll over existing 30-, 60- or 90-day debt, if the world stops buying US bonds, we suddenly owe trillions of dollars to other nations that we can’t pay.

I would be happier if there were the slightest indication that our politicians had a clue what to do to get us out of this mess, but I have no such confidence. The Bush administration, a lame-duck administration in any case, seems to be mentally on vacation. Rhetoric and charisma aside, Obama and Palin are both untried newcomers to national politics, and McCain and Biden are both political insiders (personally attractive, but still insiders) from a Congress that has been remarkably inept and ineffective for years under the control of either party. The fact that in this crisis neither political party has been able to formulate more than trite partisan sound bites to address the problem says a lot about how bad our problem is.

One promising light is that the Federal Reserve at least seems to be thinking fast and doing what is necessary to keep the boat afloat for the moment. But it will take more than that to handle this crisis. It will take far-sighted bipartisan statesmanship and close cooperation with most of the other nations in the world to solve this problem.

The other promising light is that underneath it all, American productivity and innovation is essentially unaffected by all this turmoil. America still has the vast natural resources and the highly-skilled workforce and the great higher education system that it had before this crisis began, and in the end (but perhaps after some painful times) we will pull out of it, probably in better shape than most of the rest of the world.

But this crisis ought to remind us again that the world is a complex and demanding place, and we ought to require leaders and a government of higher quality than we have put up with in recent decades. Both presidential tickets have pledged to end partisan sniping, and then gone right on with the usual partisan sniping. Both have made politically popular but economically meaningless promises. Both political parties are enamored of their respective ideologies to the point that they have lost sight of the real world. And this fecklessness will go on unless and until the American electorate forces it to halt by refusing to support such candidates and such parties.

The Darwin effect

For years the annual Darwin Award has been circulated on the internet - the award for the annual really stupid action most likely to remove one or more people from the gene pool. (See http://www.darwinawards.com/ for some recent awards). The Darwin effect is the natural pruning from the gene pool of those less fit to survive.

Hurricane Ike roared ashore in Galveston, Texas yesterday. Galveston had been devastated by the storm surge in the 1900 hurricane, killing between 6000 and 12,000 people, This fact was widely advertised and discussed on the TV. The National Hurricane Center made the strongest possible statement about the danger of not evacuating - "Persons not heeding evacuation orders in single family one- or two-story homes will face certain death." It couldn’t have been clearer.

Yet, despite all this, and the drumbeat of new reports about the approaching storm, and the police passing through neighborhoods with loudspeakers ordering the evacuation, a vast number of people (estimates run as high as 140,000) simply ignored all that and stayed in place. Some were even shown on TV partying at a bar on the beachfront.

Now rescue crews are risking their lives and spending millions of dollars to find and rescue all those people who ignored all the warnings. And no doubt some will go on TV eventually, as they did in New Orleans, to bitch about why the rescuers were late and why the shelter food wasn’t better and why the government didn’t do more and why their insurance companies are reticent to pay them to rebuild in the exact same spot, etc, etc, etc.

I have a lot of sympathy for people devastated by an unexpected and unpredictable natural disaster like a tornado, an earthquake. a forest fire or a famine, but it’s much harder to feel as much sympathy for people who, from their own arrogance, stubbornness or stupidity, deliberately leave themselves in harms way despite extensive warnings and then expect other people to risk their lives to save them.

Or perhaps they have a death wish. And perhaps the Darwin effect should simply have been allowed to operate.

A little knowledge is a dangerous thing….

This week the European Large Hadron Collider (LHC) goes into operation. The Large Hadron Collider will become the world’s largest “atom smasher”, sending beams of protons at close to light speed both ways around a 27 km ring buried hundreds of meters under the French-Swiss boarder area before finally steering them into a head-on collision. The resulting collisions will, it is hoped, produce in miniature the conditions that existed just fractions of a second after the “big bang”, and perhaps even detect the elusive “Higg’s Boson”, a key sub-atomic particle predicted but not yet detected.

Now what I find interesting is that there is a small but very vocal fringe of people who have been spreading the story that the LHC may produce miniature “black holes” that will swallow the earth, and who have been spreading panic among some people. Of course these people aren’t physicists, or even scientists. But they have read just enough popular science to find a few out-on-context quotations that seem to support their position, and they are running (and even selling books) with this misinformation.

In fact cosmic rays hitting the earth’s atmosphere every day produce more energetic collisions than the LHC can manage, so if such collisions were going to produce earth-destroying black holes then they would have done so long ago. Non-scientists have a very poor grasp of how puny our human efforts are compared to what nature does all around us every day. Even the awesome power of a human-made nuclear weapon is dwarfed by the energy in a common thunderstorm (though the thunderstorm doesn’t release it all at once the way a bomb does).

There are real things to worry about – such as what food additives and the chemicals leaching from all our plastic containers are doing to us, or what global warming will eventually do to the world’s food supply – but earth-swallowing black holes from the LHC aren’t among them. It just goes to show how dangerous a little knowledge can be.

The minimum wage dilemma

A popular liberal cause over the years has been to get the minimum wage raised, reasoning that even minimum-wage people ought to be able to make a decent living wage. It’s certainly an appealing and politically potent position.

Business owners will always try to pay as little as possible for their means of production, including their labor, because that makes their products and services more competitive in the market and increases their profit margins. Labor will always try to get as high a pay rate as possible, because that increases their disposable income. Market pressures are what balance these two conflicting goals. Businesses pay what they have to in order attract the workers with the skills they need, and workers shop among businesses for the best pay levels that are available for the skills they can offer.

Now the underlying economic reality is that a laborer has to make more money for his/her employer that he/she costs the employer in wages and benefits. Otherwise the business is a losing proposition and will soon close. For some minimum wage jobs, the employee isn’t making much of a profit for the employer, and if the minimum wage forces the pay rate up, at some point it is simply no longer profitable to employ them. Then the company closes down, or the job is automated or outsourced or otherwise eliminated. Now instead of getting higher pay, the employee is unemployed.

So there is a difficult dilemma here. One would like to assure that workers get a living wage. On the other hand, forcing the minimum wage up will eventually result in workers losing their jobs altogether. The minimum wage dilemma parallels the union dilemma – unions, for perfectly reasonable motives, force wages and benefits up until eventually the resulting total labor costs make their companies uncompetitive and they close altogether. This has happened repeatedly in industries such as steel and automobile manufacturers.

There are no easy answers here. It is a complex issue. Trade barriers sometimes look like the answer (keep the lower cost foreign competition out of the country), but of course then our own export products are priced out of the world market and our own people pay higher prices for their goods and services, and all of that causes additional economic problems and company closings.

Underneath it all is the fundamental reality that workers have to produce more income for their employers than their pay and benefits cost the employer, or the company will eventually be out of business. So in fact the only viable long-term way for workers to increase their wages is for them to become more valuable to their employer by increasing their skills, and hence the income per hour that they earn for their employers. Then and only then are they worth higher pay.

Nevertheless, arguing to raise the minimum wage remains a potent political card, even when in the long run it produces more pain than benefits for workers.