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?"