Risk in a Free Society

Risk in life cannot be eliminated, but it can be managed. This is the nature of a dynamic universe undergoing constant unpredictable change. This article from City Journal explains well the role risk and uncertainty plays in our lives. [Comments in red italics.]

Propeller of Growth

Technology and globalization are changing the nature of work and commerce, displacing workers, and altering the way of life for many people. In response to this uncertain economic environment, policymakers from both parties have become preoccupied with reducing risk. But many of their risk-management proposals go too far, address the wrong sources of risk, and would undermine America’s economic leadership.

The general conception of risk management is that it serves to eliminate bad outcomes. On the plus side, risk propels economies and motivates entrepreneurs to innovate. Risk, for better and worse, is at the heart of economic growth, and successfully apportioning it—not avoiding it—is the key to prosperity. The purpose of markets is not only to match buyers and sellers and establish prices but also to allocate risk. In a functioning market, people who take the most risk can reap the biggest reward. Those who wish to avoid risk can reduce it by hedging or diversifying or by paying someone, in the form of insurance, to take on the downside risk for them.

Sometimes reducing risk is impossible because a market has distortions or is incomplete, leaving participants bearing more risk than they would like. For example, a worker may want to reduce the risk of losing his job by saving money or by pooling his risk with other workers. These options are difficult, though: he may not have enough money to save, and a market for private wage insurance doesn’t exist because it’s not profitable for insurance companies.

Government can fill this void, providing some protection, so that bad luck doesn’t leave people destitute. Unemployment insurance, for instance, pools risk for workers, a certain percentage of whom are out of work at any given time, while Social Security diversifies risk across generations. The government can foster functioning financial markets, enforce property rights, and maintain rule of law to create an environment where taking risks is rewarded. But too much intervention distorts choice by encouraging people to take the wrong risks or by eliminating risk-taking altogether.

Progressives, calling for greater government intervention, often cite the work of Yale political scientist Jacob Hacker, who argues that income has become unstable and retirement riskier. [Note: Hacker’s research is illuminating, but the reasons he cites for increased risk burdens are more related to financial policy that has increased the volatility in asset markets while increasing inequality between the asset-rich and asset-poor.] But economists, using Social Security earning records, found that income volatility (as represented by year-to-year income shocks) has actually decreased since the late 1970s, and that job stability has increased since the 1980s, with average job tenure longer now than it was then. [Note: And neither of these measures is measuring the inequality of asset markets.] It’s true that breadwinning has gotten riskier, especially for low-income workers, who face longer spells of unemployment during recessions and higher vulnerability to being replaced by technology. But progressive policymakers are addressing the wrong problems, focusing on solutions better suited to dealing with year-to-year wage volatility than with systemic risks associated with long-term economic change.

California recently enacted AB5, a law regulating freelance “gig work,” the growing popularity of which is often regarded as a signal of the American worker’s tenuous economic situation. But contrary to popular perception, gig work is usually supplementing traditional work, not replacing it. The number of workers who claim contract work as their primary job has fallen; what has gone up is the number of Americans who do gig work to smooth out income drops or periods of unemployment. The flexibility of freelance labor is what makes gig work a valuable risk-reduction strategy—it needn’t interfere with a primary job, job training, or a job search. California’s effort to standardize gig work, with regular hours and benefits, is thus counterproductive, and will result in fewer options for workers. [Yes.]

Counterproductive, too, are bigger policies targeted to the middle- and upper middle-income brackets. Both Bernie Sanders and Elizabeth Warren would like to eliminate risks associated with middle-class wealth by making college free, cancelling student debt, and expanding Social Security. But college-educated workers, even indebted ones, have lower rates of unemployment and experience joblessness for shorter periods. They are also better equipped to acquire new job skills years after they finish college. Given limited government resources, ameliorating risk for the college-educated should be a lower priority than helping less-educated workers in rural areas, who face higher risks of economic hardship.

Expanding Social Security doesn’t reduce the biggest risk in retirement, either. Americans have more income in retirement than ever before. Defined-contribution retirement plans like 401(k)s shift risk onto individuals, but they also cover many more people than defined-benefit pension plans ever did. The major risk that Americans face is the prospect of high long-term-care costs not covered by Medicare. Affordable long-term-care insurance is practically nonexistent because it’s unprofitable for insurance companies to provide. This creates a potentially huge financial and time burden for many families—one much worthier of government resources than expanding Social Security benefits. [The solutions to long-term care are health savings accounts promoting a higher level of national savings for end-of-life costs. Certainties in life must be paid for through savings, not insurance. Our entitlement programs discourage that saving.]

American health care is expensive and uncertain and suffers from coverage gaps. But nationalization of the multitrillion-dollar health-care industry will stifle innovation, as will Warren’s plans to pay for expanded health care, Social Security, and education programs by limiting returns on investment. She plans to increase capital gains and corporate taxes, set a 14.8 percent tax on income exceeding $250,000 (including investment income), and impose a constitutionally dubious wealth tax on fortunes greater than $50 million. The rewards from risk-taking are what motivate entrepreneurs to innovate despite high odds of failure. Punitive taxation on income and capital gains is a means of managing risk by capping the reward of taking it in the first place. But a growth-oriented economy demands that all participants in a risk-taking venture be rewarded, including investors and early hires. [Note: Most definitely. Assuming and managing risk-taking is the key to successful participation in a capitalist society. This is also the solution to the inequality problem over time.]

Some Republicans are also responding to the new economy by embracing more government intervention to reduce risk. President Donald Trump makes no secret of his desire for the Fed to lower interest rates in order to boost the stock market. But the Fed’s efforts to minimize risk by keeping rates artificially low in a growing economy create distortions and bubbles by making loans artificially cheap and encouraging leverage. This strategy may reduce short-term asset volatility but at the cost of more severe systemic risk.

Senator Marco Rubio, a former and perhaps future presidential contender, hopes to reduce the risk of American failure in global markets by advocating industrial policy that subsidizes particular industries. This puts the government in the role of picking winners—something it has shown little faculty for doing—and distorts risk-taking. As economic historian Joel Mokyr has argued, innovation is never predictable, especially in a transitioning economy. New technology often creates a market that no one could have predicted. Subsidizing pet industries slows and distorts the discovery process, funneling capital to the wrong places and putting entrepreneurs who want to take a chance at a fledging, not yet favored, industry at a disadvantage when it comes to raising capital. It’s true that industrial policies worked in some Asian economies, but these policies made use of already market-proven technology. Industrial policy is less effective for economies that hope to maintain a leadership role.

The U.S. economy gained supremacy by trusting markets to allocate risk, by letting people fail, and by rewarding those who thrived. Government has a role to play in reducing risk, but to do its job well it needs to be clear about what the most pressing risks are and how best to address them—while still rewarding risk-taking. 

 

A Fundamentalist Revival?

This is a fine essay by David French, noting the ideological rather than just the religious underpinnings of fundamentalist social movements.

In the US, the Left has embarked on a secular fundamentalist movement that is now reaching a fever pitch. It is a bit ironic that its proponents have strongly condemned conservative religious fundamentalism along the way while adopting the same social behavioral tactics. Fascism was/is a form of fundamentalism too, as well as communism and environmentalism. So is the more virulent form of right-wing Trumpism.

Fundamentalism comes with the territory when we all are expected to march in lockstep toward some abstract common good. Coercion is its necessary tool. But freedom and civic responsibility have always accomplished this task far better.

America Is in the Grips of a Fundamentalist Revival

But it’s not Christian.

 

“…yes, secular religion is breaking out across the land. That’s old news. Here’s what’s new—it’s growing so very dark. We don’t need to repeat all the recent excesses of cancel culture to know that many anti-racist progressives are in the midst of a hunt for ideological heretics, and even the oldest sins can’t be forgiven. Consider that on Friday a Boeing executive resigned after an employee complained about an article he wrote 33 years ago opposing women in combat.”

 

Cancel

Another interesting passage that ties belief systems to the uncertainty that is the nature of the universe:

To understand the distinction between fundamentalism and, say, evangelicalism or other forms of devotion, I want to go back to Ecclesiastes 3:11 and quote the entire verse: “He has made everything appropriate in its time. He has also put eternity in their hearts, but no one can discover the work God has done from beginning to end.”

Let me quote another verse, this one from the New Testament: “For now we see in a mirror dimly, but then face to face. Now I know in part; then I shall know fully, even as I have been fully known.”

Both of these passages speak to the existence of an immovable, irreducible amount of uncertainty in this world, including mysteries about God Himself.

Recall the end of the book of Job, when the righteous, suffering man demands an explanation for his plight from the God of the universe, and the God of the universe responds with an extended soliloquy that essentially declares, “I’m God, and you’re not.” And what is Job’s response? “Behold, I am of small account; what shall I answer you? I lay my hand on my mouth.”

As a consequence, while there are many, many things we can know about God—and many things we can learn—we must approach our faith and our world with a sense of existential humility.

Managing the uncertainties of our existence brings us back to social science, economics and the art of politics. It’s a deep well.

What’s Really Going On?

Reading the news each morning one might conclude that a significant part of our society has gone pretty much off the rails. A few recent article links are enough to make the point:

The Orwellian Nightmare

The Thought Police Are Coming

American Version of the French Revolution?

These trends are antithetical to a free society, so what is going on? It would be easy to point to one factor, like the police, as the cause of this meltdown but social science and history are usually a lot more complex than that. In fact, one might rightly suspect most of what we see on the television, read in the news or on social media is one major distraction from the true challenges we face. And one does not need to dismiss any contributing factors like the virus pandemic, the shutdowns, or racist conflict to make the case.

There is racism in this country – it exists, it’s real. But there is racism to different degrees in every society – the fear and persecution of the “other” is one of the stains on the human soul, one of our original sins. The question is how determinant race discrimination is in any particular society in determining the outcomes and fates of those so discriminated against. Posing that question demands an empirical analysis – it cannot rely solely on anecdotal, lived experiences. In other words, if I have suffered a racist action, that alone does not prove the entire society is racist, only that one case of racism has occurred. A pattern of anecdotal cases is also not enough, we must do an analysis with a much larger data sample. So, “systemic” racism must be addressed with scientific data analysis, not lived experience and media narratives. That work has been done elsewhere and is not the focus of this essay.

Instead, we will zoom out from the chaos to gain a more measured perspective. Police violence is the tip of the spear propelled by a complex web of social and political policy failures. I cite a few recent articles (and one video) that make the larger points surrounding our current social crisis:

The True Plight of Black Americans

[The] Depth of Black Americans’ Economic Struggle

America’s New Nihilism

The first article is written by Walter Williams, one of the most prominent scholars on the economic plight of blacks in America. He, along with Thomas Sowell, has examined the causes and effects of racism and their research, along with that of some sociologists, point to the more significant causes of urban poverty: the breakdown of the family due to welfare dependency, failures of public education, corrupt machine politics, drug culture, lack of economic opportunity, among others. These urban cities have been dominated by the post-60s liberal ideology of the Democratic Party. But we disassemble and allow these failed policies to continue, then expect the police to step in to control the chaos.

A simple graph of the plight of blacks in Minneapolis reinforces the case:

This is less a failure of black Americans to grasp the American Dream than it is of failed social, tax, and financial policy by the Federal and state governments under both party leaderships. The volcano we see erupting today has been boiling below the surface for the last 50 years. The biggest factor is financial policy, because, with the right financial policies, we can usually afford a lot of social policy failure.

The decoupling of monetary policy from the discipline of Bretton Woods pegged-dollar policy means the supply of money and credit is no longer constrained beyond the discretion of the monetary and political authorities. This happened in 1971 but it took a decade into the mid-80s before policymakers realized that they were no longer constrained by price inflation as well because of the explosion of global labor supply. The economic liberalization due to the failures of state planning in the USSR, China, India, Africa, and South America, opened up their labor forces to international trade and production. This kept wage push inflation off the table and allowed the Federal Reserve to pursue its massive credit creation and financial repression. The result has been a combination of cheap credit and low wages, leading to the massive leverage of existing productive assets.

That has driven wealth and income inequality that has impoverished those who do not own these appreciating assets. So, jobs have been created because they’re cheap in many respects, but everything one needs to buy – such as housing, education, medical care – has sky-rocketed in relative price. Most urban residents left behind on this train have dim prospects for wage incomes, decent educational opportunities, homeownership, or accessible healthcare. This is what has thrust the spear of police violence against the urban poor into the spotlight.

So one can understand how the Tea Party and Occupy Wall Street came to this. The solutions are obvious, we just choose to ignore them because of our treasured political ideologies and partisanship identity politics. Urban minorities must turn the tide against corrupt urban machine politics. Zooming in again, here is an article showing how one city reformed urban policing:

Camden, NJ, did police reform right

The key cited here, which many on the Left will find disconcerting, is to reform public-sector union contracts to break up the cozy relationship between city councils and those who fund their campaigns: public-sector unions. This applies to teachers’ unions, police unions, firefighter unions, and municipal employees’ unions. At the same time, we need more transparency concerning the relationships of politicians with the private sector, including real estate developers and the Bar Association.

Zooming back out. These urban political reforms can only succeed if we get our financial house in order. Free-wheeling monetary policy – like the one that quadrupled the price of a house in the past 20 years – must be reined in to support fundamental value creation. In other words, our economy must produce and distribute wealth according to real value creation that improves our quality of life, not through speculating on asset appreciation. When the hedge fund industry and lives of the financial elites are no longer in the headlines, we’ll know we’re on the right path. Unfortunately, with our descent into the distractions of anarchy and chaos over identity, I don’t have hopes of this happening any time soon.

 

 

Global Depression or Persistent Stagflation?

Dr. Doom and Gloom lays out the downside global economic scenario. Worth reading and factoring into our economic posturing…[Comments bracketed in red].

Published in NY Magazine

Why Our Economy May Be Headed for a Decade of Depression

Eric Levitz May 22, 2020

The worst is yet to come?

In September 2006, Nouriel Roubini told the International Monetary Fund what it didn’t want to hear. Standing before an audience of economists at the organization’s headquarters, the New York University professor warned that the U.S. housing market would soon collapse — and, quite possibly, bring the global financial system down with it. Real-estate values had been propped up by unsustainably shady lending practices, Roubini explained. Once those prices came back to earth, millions of underwater homeowners would default on their mortgages, trillions of dollars worth of mortgage-backed securities would unravel, and hedge funds, investment banks, and lenders like Fannie Mae and Freddie Mac could sink into insolvency.

At the time, the global economy had just recorded its fastest half-decade of growth in 30 years. And Nouriel Roubini was just some obscure academic. Thus, in the IMF’s cozy confines, his remarks roused less alarm over America’s housing bubble than concern for the professor’s psychological well-being.

Of course, the ensuing two years turned Roubini’s prophecy into history, and the little-known scholar of emerging markets into a Wall Street celebrity.

A decade later, “Dr. Doom” is a bear once again. While many investors bet on a “V-shaped recovery,” Roubini is staking his reputation on an L-shaped depression. The economist (and host of a biweekly economic news broadcastdoes expect things to get better before they get worse: He foresees a slow, lackluster (i.e., “U-shaped”) economic rebound in the pandemic’s immediate aftermath. But he insists that this recovery will quickly collapse beneath the weight of the global economy’s accumulated debts. Specifically, Roubini argues that the massive private debts accrued during both the 2008 crash and COVID-19 crisis will durably depress consumption and weaken the short-lived recovery. Meanwhile, the aging of populations across the West will further undermine growth while increasing the fiscal burdens of states already saddled with hazardous debt loads. Although deficit spending is necessary in the present crisis, and will appear benign at the onset of recovery, it is laying the kindling for an inflationary conflagration by mid-decade. As the deepening geopolitical rift between the United States and China triggers a wave of deglobalization, negative supply shocks akin those of the 1970s are going to raise the cost of real resources, even as hyperexploited workers suffer perpetual wage and benefit declines. Prices will rise, but growth will peter out, since ordinary people will be forced to pare back their consumption more and more. Stagflation will beget depression. And through it all, humanity will be beset by unnatural disasters, from extreme weather events wrought by man-made climate change to pandemics induced by our disruption of natural ecosystems.

Roubini allows that, after a decade of misery, we may get around to developing a “more inclusive, cooperative, and stable international order.” But, he hastens to add, “any happy ending assumes that we find a way to survive” the hard times to come.

Intelligencer recently spoke with Roubini about our impending doom.

You predict that the coronavirus recession will be followed by a lackluster recovery and global depression. The financial markets ostensibly see a much brighter future. What are they missing and why?

Well, first of all, my prediction is not for 2020. It’s a prediction that these ten major forces will, by the middle of the coming decade, lead us into a “Greater Depression.” Markets, of course, have a shorter horizon. In the short run, I expect a U-shaped recovery while the markets seem to be pricing in a V-shape recovery.

Of course the markets are going higher because there’s a massive monetary stimulus, there’s a massive fiscal stimulus. People expect that the news about the contagion will improve, and that there’s going to be a vaccine at some point down the line. And there is an element “FOMO” [fear of missing out]; there are millions of new online accounts — unemployed people sitting at home doing day-trading — and they’re essentially playing the market based on pure sentiment. My view is that there’s going to be a meaningful correction once people realize this is going to be a U-shaped recovery. If you listen carefully to what Fed officials are saying — or even what JPMorgan and Goldman Sachs are saying — initially they were all in the V camp, but now they’re all saying, well, maybe it’s going to be more of a U. The consensus is moving in a different direction.

Your prediction of a weak recovery seems predicated on there being a persistent shortfall in consumer demand due to income lost during the pandemic. A bullish investor might counter that the Cares Act has left the bulk of laid-off workers with as much — if not more — income than they had been earning at their former jobs. Meanwhile, white-collar workers who’ve remained employed are typically earning as much as they used to, but spending far less. Together, this might augur a surge in post-pandemic spending that powers a V-shaped recovery. What does the bullish story get wrong?

Yes, there are unemployment benefits. And some unemployed people may be making more money than when they were working. But those unemployment benefits are going to run out in July. The consensus says the unemployment rate is headed to 25 percent. Maybe we get lucky. Maybe there’s an early recovery, and it only goes to 16 percent. Either way, tons of people are going to lose unemployment benefits in July. And if they’re rehired, it’s not going to be like before — formal employment, full benefits. You want to come back to work at my restaurant? Tough luck. I can hire you only on an hourly basis with no benefits and a low wage. That’s what every business is going to be offering. Meanwhile, many, many people are going to be without jobs of any kind. It took us ten years — between 2009 and 2019 — to create 22 million jobs. And we’ve lost 30 million jobs in two months. [This begins to show why employment is the wrong focus for the Information Age.]

So when unemployment benefits expire, lots of people aren’t going to have any income. Those who do get jobs are going to work under more miserable conditions than before. And people, even middle-income people, given the shock that has just occurred — which could happen again in the summer, could happen again in the winter — you are going to want more precautionary savings. You are going to cut back on discretionary spending. Your credit score is going to be worse. Are you going to go buy a home? Are you gonna buy a car? Are you going to dine out? In Germany and China, they already reopened all the stores a month ago. You look at any survey, the restaurants are totally empty. Almost nobody’s buying anything. Everybody’s worried and cautious. And this is in Germany, where unemployment is up by only one percent. Forty percent of Americans have less than $400 in liquid cash saved for an emergency. [This is a major policy failure that citizens of other countries do not share. Our tax policies have discouraged savings but encouraged borrowing.] You think they are going to spend?

Graphic: Financial Times
Graphic: Financial Times

You’re going to start having food riots soon enough. [I don’t see that happening, at least not in the US. People on state welfare support are going to need more of it and the welfare roles will rise.] Look at the luxury stores in New York. They’ve either boarded them up or emptied their shelves,  because they’re worried people are going to steal the Chanel bags. [Yes, because luxury goods are a form of currency. Luxury stores are also a focus of resentment.] The few stores that are open, like my Whole Foods, have security guards both inside and outside. We are one step away from food riots. There are lines three miles long at food banks. [This not a riot, it’s an overload on govt provided welfare.] That’s what’s happening in America. You’re telling me everything’s going to become normal in three months? That’s lunacy.

Your projection of a “Greater Depression” is premised on deglobalization sparking negative supply shocks. And that prediction of deglobalization is itself rooted in the notion that the U.S. and China are locked in a so-called Thucydides trap, in which the geopolitical tensions between a dominant and rising power will overwhelm mutual financial self-interest. But given the deep interconnections between the American and Chinese economies — and warm relations between much of the U.S. and Chinese financial elite — isn’t it possible that class solidarity will take precedence over Great Power rivalry? In other words, don’t the most powerful people in both countries understand they have a lot to lose financially and economically from decoupling? And if so, why shouldn’t we see the uptick in jingoistic rhetoric on both sides as mere posturing for a domestic audience?

First of all, my argument for why inflation will eventually come back is not just based on U.S.-China relations. I actually have 14 separate arguments for why this will happen. That said, everybody agrees that there is the beginning of a Cold War between the U.S. and China. I was in Beijing in November of 2015, with a delegation that met with Xi Jinping in the Great Hall of the People. And he spent the first 15 minutes of his remarks speaking, unprompted, about why the U.S. and China will not get caught in a Thucydides trap, and why there will actually be a peaceful rise of China.

Since then, Trump got elected. Now, we have a full-scale trade war, technology war, financial war, monetary war, technology, information, data, investment, pretty much anything across the board. Look at tech — there is complete decoupling. They just decided Huawei isn’t going to have any access to U.S. semiconductors and technology. We’re imposing total restrictions on the transfer of technology from the U.S. to China and China to the U.S. And if the United States argues that 5G or Huawei is a backdoor to the Chinese government, the tech war will become a trade war. Because tomorrow, every piece of consumer electronics, even your lowly coffee machine or microwave or toaster, is going to have a 5G chip. That’s what the internet of things is about. If the Chinese can listen to you through your smartphone, they can listen to you through your toaster. Once we declare that 5G is going to allow China to listen to our communication, we will also have to ban all household electronics made in China. So, the decoupling is happening. We’re going to have a “splinternet.” It’s only a matter of how much and how fast.

And there is going to be a cold war between the U.S. and China. Even the foreign policy Establishment — Democrats and Republicans — that had been in favor of better relations with China has become skeptical in the last few years. They say, “You know, we thought that China was going to become more open if we let them into the WTO. We thought they’d become less authoritarian.” Instead, under Xi Jinping, China has become more state capitalist, more authoritarian, and instead of biding its time and hiding its strength, like Deng Xiaoping wanted it to do, it’s flexing its geopolitical muscle. And the U.S., rightly or wrongly, feels threatened. I’m not making a normative statement. I’m just saying, as a matter of fact, we are in a Thucydides trap. The only debate is about whether there will be a cold war or a hot one. Historically, these things have led to a hot war in 12 out of 16 episodes in 2,000 years of history. So we’ll be lucky if we just get a cold war.

Some Trumpian nationalists and labor-aligned progressives might see an upside in your prediction that America is going to bring manufacturing back “onshore.” But you insist that ordinary Americans will suffer from the downsides of reshoring (higher consumer prices) without enjoying the ostensible benefits (more job opportunities and higher wages). In your telling, onshoring won’t actually bring back jobs, only accelerate automation. And then, again with automation, you insist that Americans will suffer from the downside (unemployment, lower wages from competition with robots) but enjoy none of the upside from the productivity gains that robotization will ostensibly produce. So, what do you say to someone who looks at your forecast and decides that you are indeed “Dr. Doom” — not a realist, as you claim to be, but a pessimist, who ignores the bright side of every subject?

When you reshore, you are moving production from regions of the world like China, and other parts of Asia, that have low labor costs, to parts of the world like the U.S. and Europe that have higher labor costs. That is a fact. How is the corporate sector going respond to that? It’s going to respond by replacing labor with robots, automation, and AI.

I was recently in South Korea. I met the head of Hyundai, the third-largest automaker in the world. He told me that tomorrow, they could convert their factories to run with all robots and no workers. Why don’t they do it? Because they have unions that are powerful. In Korea, you cannot fire these workers, they have lifetime employment. [There is a serious cost to raising labor rates in a world with price competition. Raising input costs means pricing power rules and most producers lack that pricing power. If Hyundai cars become more expensive, then Hyundai loses sales and Hyundai requires state subsidies paid for by Korean taxpayers. If Hyundai reduces costs, Hyundai workers face dimmer income prospects and more state welfare. The only way out of this conundrum is to share the economic costs across all stakeholders. That’s best done through equity rights than through state directives. This is especially true in the US under the corporate legal structure.]

But suppose you take production from a labor-intensive factory in China — in any industry — and move it into a brand-new factory in the United States. You don’t have any legacy workers, any entrenched union. You are going to design that factory to use as few workers as you can. Any new factory in the U.S. is going to be capital-intensive and labor-saving. It’s been happening for the last ten years and it’s going to happen more when we reshore. So reshoring means increasing production in the United States but not increasing employment. Yes, there will be productivity increases. And the profits of those firms that relocate production may be slightly higher than they were in China (though that isn’t certain since automation requires a lot of expensive capital investment).

But you’re not going to get many jobs. The factory of the future is going to be one person manning 1,000 robots and a second person cleaning the floor. And eventually the guy cleaning the floor is going to be replaced by a Roomba because a Roomba doesn’t ask for benefits or bathroom breaks or get sick and can work 24-7. [I’ve written many times in the past, what matters is who owns and controls the robots.]

The fundamental problem today is that people think there is a correlation between what’s good for Wall Street and what’s good for Main Street. [Yes, but conceptually we can close this conflict of interest by turning more of Main St. into entrepreneurial risk takers through the sharing of diversified equity risks.] That wasn’t even true during the global financial crisis when we were saying, “We’ve got to bail out Wall Street because if we don’t, Main Street is going to collapse.” How did Wall Street react to the crisis? They fired workers. And when they rehired them, they were all gig workers, contractors, freelancers, and so on. That’s what happened last time. This time is going to be more of the same. Thirty-five to 40 million people have already been fired. When they start slowly rehiring some of them (not all of them), those workers are going to get part-time jobs, without benefits, without high wages. That’s the only way for the corporates to survive. Because they’re so highly leveraged today, they’re going to need to cut costs, and the first cost you cut is labor. But of course, your labor cost is my consumption. So in an equilibrium where everyone’s slashing labor costs, households are going to have less income. [Again, this is why using wage labor as the dominant distributional mechanism for the success of capitalism is no longer viable. It only was during the industrial age.] And they’re going to save more to protect themselves from another coronavirus crisis. And so consumption is going to be weak. That’s why you get the U-shaped recovery.

There’s a conflict between workers and capital. [Only in the short-run.] For a decade, workers have been screwed. Now, they’re going to be screwed more. There’s a conflict between small business and large business.

Millions of these small businesses are going to go bankrupt. Half of the restaurants in New York are never going to reopen. How can they survive? They have such tiny margins. Who’s going to survive? The big chains. Retailers. Fast food. The small businesses are going to disappear in the post-coronavirus economy. So there is a fundamental conflict between Wall Street (big banks and big firms) and Main Street (workers and small businesses). And Wall Street is going to win. [We all win by participating in the financing and risk sharing of capitalism. We all need to be invested in Wall St., and finance – both ownership and control – must be transparent. Someday we will have blockchain smart contracts distribute corporate profits to shareholders in a transparent manner under the shareholders’ control, reducing the agency costs and conflicts of interest.]

Clearly, you’re bearish on the potential of existing governments intervening in that conflict on Main Street’s behalf. But if we made you dictator of the United States tomorrow, what policies would you enact to strengthen labor, and avert (or at least mitigate) the Greater Depression? 

The market, as currently ordered, is going to make capital stronger and labor weaker. So, to change this, you need to invest in your workers. [Yes, but that does not mean wage or labor supply controls – intervention on the cost side of production will only backfire.] Give them education, a social safety net — so if they lose their jobs to an economic or technological shock, they get job training, unemployment benefits, social welfare, health care for free. [These policies all lead to productive investment in human capital, but it is not enough. Workers need financial capital that generates diversified streams of income.]  Otherwise, the trends of the market are going to imply more income and wealth inequality. [The Fed has been no help here.] There’s a lot we can do to rebalance it. But I don’t think it’s going to happen anytime soon. If Bernie Sanders had become president, maybe we could’ve had policies of that sort. [No, Bernie is completely focused on intervening into labor markets. Workers look like they’re gaining in the short-run and lose big time in the long-run.] Of course, Bernie Sanders is to the right of the CDU party in Germany. I mean, Angela Merkel is to the left of Bernie Sanders. Boris Johnson is to the left of Bernie Sanders, in terms of social democratic politics. Only by U.S. standards does Bernie Sanders look like a Bolshevik.

In Germany, the unemployment rate has gone up by one percent. In the U.S., the unemployment rate has gone from 4 percent to 20 percent (correctly measured) in two months. We lost 30 million jobs. Germany lost 200,000. Why is that the case? You have different economic institutions. Workers sit on the boards of German companies. So you share the costs of the shock between the workers, the firms, and the government. [Yes, this is how it should be, but in US society and business, equity is the cleanest way to achieve this representation. Stakeholders should have board representation through their equity ownership claims.]

In 2009, you argued that if deficit spending to combat high unemployment continued indefinitely, “it will fuel persistent, large budget deficits and lead to inflation.” You were right on the first count obviously. And yet, a decade of fiscal expansion not only failed to produce high inflation, but was insufficient to reach the Fed’s 2 percent inflation goal. Is it fair to say that you underestimated America’s fiscal capacity back then? And if you overestimated the harms of America’s large public debts in the past, what makes you confident you aren’t doing so in the present?

First of all, in 2009, I was in favor of a bigger stimulus than the one that we got. I was not in favor of fiscal consolidation. There’s a huge difference between the global financial crisis and the coronavirus crisis because the former was a crisis of aggregate demand, given the housing bust. And so monetary policy alone was insufficient and you needed fiscal stimulus. And the fiscal stimulus that Obama passed was smaller than justified. So stimulus was the right response, at least for a while. And then you do consolidation.

What I have argued this time around is that in the short run, this is both a supply shock and a demand shock. And, of course, in the short run, if you want to avoid a depression, you need to do monetary and fiscal stimulus. What I’m saying is that once you run a budget deficit of not 3, not 5, not 8, but 15 or 20 percent of GDP — and you’re going to fully monetize it (because that’s what the Fed has been doing) — you still won’t have inflation in the short run, not this year or next year, because you have slack in goods markets, slack in labor markets, slack in commodities markets, etc. But there will be inflation in the post-coronavirus world. [We will have asset price inflation in the immediate and longer-term – this greatly aggravates inequality.] This is because we’re going to see two big negative supply shocks. For the last decade, prices have been constrained by two positive supply shocks — globalization and technology. Well, globalization is going to become deglobalization thanks to decoupling, protectionism, fragmentation, and so on. So that’s going to be a negative supply shock. And technology is not going to be the same as before. The 5G of Erickson and Nokia costs 30 percent more than the one of Huawei, and is 20 percent less productive. So to install non-Chinese 5G networks, we’re going to pay 50 percent more. So technology is going to gradually become a negative supply shock. So you have two major forces that had been exerting downward pressure on prices moving in the opposite direction, and you have a massive monetization of fiscal deficits. Remember the 1970s? You had two negative supply shocks — ’73 and ’79, the Yom Kippur War and the Iranian Revolution. What did you get? Stagflation.

Now, I’m not talking about hyperinflation — not Zimbabwe or Argentina. I’m not even talking about 10 percent inflation. It’s enough for inflation to go from one to 4 percent. Then, ten-year Treasury bonds — which today have interest rates close to zero percent — will need to have an inflation premium. So, think about a ten-year Treasury, five years from now, going from one percent to 5 percent, while inflation goes from near zero to 4 percent. And ask yourself, what’s going to happen to the real economy? Well, in the fourth quarter of 2018, when the Federal Reserve tried to raise rates above 2 percent, the market couldn’t take it. So we don’t need hyperinflation to have a disaster. [So we seesaw between heeling one way or the other –  inflationary or deflationary pressures with volatile financial policy. Sounds like a great policy scenario.]

In other words, you’re saying that because of structural weaknesses in the economy, even modest inflation would be crisis-inducing because key economic actors are dependent on near-zero interest rates?

For the last decade, debt-to-GDP ratios in the U.S. and globally have been rising. And debts were rising for corporations and households as well. But we survived this, because, while debt ratios were high, debt-servicing ratios were low, since we had zero percent policy rates and long rates close to zero — or, in Europe and Japan, negative. But the second the Fed started to hike rates, there was panic.

In December 2018, Jay Powell said, “You know what. I’m at 2.5 percent. I’m going to go to 3.25. And I’m going to continue running down my balance sheet.” And the market totally crashed. And then, literally on January 2, 2019, Powell comes back and says, “Sorry, I was kidding. I’m not going to do quantitative tightening. I’m not going to raise rates.” So the economy couldn’t take a Fed funds rate of 2.5 percent. In the strongest economy in the world. There is so much debt, if long-term rates go from zero to 3 percent, the economy is going to crash.

You’ve written a lot about negative supply shocks from deglobalization. Another potential source of such shocks is climate change. Many scientists believe that rising temperatures threaten the supply of our most precious commodities — food and water. How does climate figure into your analysis?

I am not an expert on global climate change. But one of the ten forces that I believe will bring a Greater Depression is man-made disasters. And global climate change, which is producing more extreme weather phenomena — on one side, hurricanes, typhoons, and floods; on the other side, fires, desertification, and agricultural collapse — is not a natural disaster. The science says these extreme events are becoming more frequent, are coming farther inland, and are doing more damage. And they are doing this now, not 30 years from now. 

So there is climate change. And its economic costs are becoming quite extreme. In Indonesia, they’ve decided to move the capital out of Jakarta to somewhere inland because they know that their capital is going to be fully flooded. In New York, there are plans to build a wall all around Manhattan at the cost of $120 billion. And then they said, “Oh no, that wall is going to be so ugly, it’s going to feel like we’re in a prison.” So they want to do something near the Verrazzano Bridge that’s going to cost another $120 billion. And it’s not even going to work.

The Paris Accord said 1.5 degrees. Then they say two. Now, every scientist says, “Look, this is a voluntary agreement, we’ll be lucky if we get three — and more likely, it will be four — degree Celsius increases by the end of the century.” How are we going to live in a world where temperatures are four degrees higher? And we’re not doing anything about it. The Paris Accord is just a joke. And it’s not just the U.S. and Trump. China’s not doing anything. The Europeans aren’t doing anything. It’s only talk.

And then there’s the pandemics. These are also man-made disasters. You’re destroying the ecosystems of animals. You are putting them into cages — the bats and pangolins and all the other wildlife — and they interact and create viruses and then spread to humans. First, we had HIV. Then we had SARS. Then MERS, then swine flu, then Zika, then Ebola, now this one. And there’s a connection between global climate change and pandemics. Suppose the permafrost in Siberia melts. There are probably viruses that have been in there since the Stone Age. We don’t know what kind of nasty stuff is going to get out. We don’t even know what’s coming. [Climate change and environmental degradation need to be managed, probably in a decentralized manner using market signals to change behavior. But a society needs resilience, slack, and insurance to manage the vagaries and risks of uncertain change. We’ve reduced our ability to adapt through misguided policies for about 50 years now, greatly increasing systemic risk. That’s what man-made disasters are made of.]

Bubblenomics

Some people will read this and say, “No inflation, no problem.” But that completely misses the point of asset price volatility and distortions of resource allocations. People complain about inequality, but then ignore these policies that aggravate inequality while making unequal outcomes rather arbitrary. In the meantime we live in a far more volatile and precarious world.

The Federal Reserve’s everything bubble

Desmond Lachman, May 19, 2020

Good economic policymaking resembles good medical practice. In much the same way as a skilled doctor’s effective prescription for a disease rests on an accurate diagnosis of the illness, so too a wise economic policymaker’s effective crisis policy response depends on a comprehensive understanding of the crisis’s underlying causes.

One has to regret Federal Reserve Chairman Jerome Powell’s seemingly partial diagnosis of our present daunting economic challenge, especially considering his key role in defusing the crisis. In Powell’s view, our economic predicament has nothing to do with the possibility that years of ultra-easy U.S. monetary policy might have contributed to the creation of worldwide asset and credit market bubbles. Rather, he seems to believe that our economic challenge is solely the result of the supply side shock delivered to the economy by the coronavirus pandemic. 

Following the bursting of the U.S. housing and credit market bubble in 2008, it took the U.S. economy some six years to regain its pre-crisis employment level. Dismissing any notion that the coronavirus pandemic might now be bursting asset and credit market bubbles of the Fed’s creation, Powell believes that this time around we could have a quicker economic recovery than we did following the 2008-2009 Great Recession. 

Indeed, Powell believes that the U.S. economy could fully recover by the end of 2021, notwithstanding the very much deeper economic recession that we are now experiencing than in 2008-2009. 

Despite Mr. Powell’s assertions to the contrary, over the past decade the Fed, along with the world’s other major central banks, created a global asset and credit market bubble. They did so by buying a staggering cumulative $10 trillion in low-risk government and private sector bonds with the aim of forcing investors to take on more risk and to stretch for yield. The net result of that policy was the creation of a global equity and housing market boom as well as the major distortion of world credit markets.

One indication of the world equity price bubble was the very high valuation to which the U.S. equity market reached before its large coronavirus-induced correction earlier this year. Measured by the cyclically adjusted price-earnings ratio, before the pandemic’s onset U.S. equity valuations reached lofty levels experienced only three times in the past hundred years. Meanwhile, numerous housing markets around the world, including those in several large U.S. cities, had price-to-income ratios that exceeded those reached at the 2006 peak of the earlier housing market bubble.

More troubling yet, the world’s major central banks have distorted global credit markets in a major way, as investors were encouraged to take on excessive risk. One indication of such credit market excess was the more than doubling in the risky U.S. leveraged-loan market to its present level of around $1.3 trillion. Other indications were the approximate doubling over the past decade of lending to the emerging market economies and the very low interest rates at which highly indebted countries like Italy were able to finance themselves. 

A key point to which Powell is choosing to turn a blind eye is the great likelihood that the very depth of the current economic recession, which is almost certain to be the worst experienced in the past 90 years, will burst asset price bubbles around the globe and make it all the more difficult for debtors to service their loans. This will be particularly the case for the travel, hospitality and entertainment sectors of the world economy that are bound to be particularly hard hit, at least until a COVID-19 vaccine is made widely available. If a wave of debt defaults and bankruptcies were to occur, we could see real stress in the world financial system. [The only option the Fed has at this point is to ramp up ZIRP and QE4ever as well as underwrite US Treasury borrowing.]

Another key point that Powell seems to overlook is the likelihood that the global economic recession could trigger both another round of the European sovereign debt crisis and yet one more major emerging market economic crisis. In this respect, it is hardly encouraging that the European economic recession shows every sign of being deeper than that in the United States and that Europe is still struggling to fashion a united fiscal response to the recession. Nor is it encouraging that capital is being withdrawn from the emerging market economies at a record pace and that a number of emerging market currencies already appear to be in free fall.     

To his credit, Powell responded both boldly and promptly to the initial phases of the current economic crisis. Hopefully, he stands ready to do more of the same at the first signs of real stress in the global financial system. If not, we can be sure that our full economic recovery will be delayed until well after the end of 2021. 

[Not sure how writing more trillion$ blank checks really is a solution.]

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.


The problem we see here is that the world’s economies, made up of the world’s citizens, have been dangerously pushed out on the risk curve. Meltdowns of inflated asset values are sure to occur and each one means we are less able to respond to excess risk and loss. The USA is in an envious position because its control of the world currency means all those dollars come back to the US economy to buy real assets, so those who own those assets (Americans) are far more fortunate than those who want to buy them. But this only means more economic and political volatility across the globe.

Mortgage Housing Follies

 

Some of us have been sounding this alarm for about 18 years, since the time the Greenspan Fed inflated the housing markets across the board by keeping interest rates too low. Since the inevitable crash in 2008, financial housing policy has doubled and tripled down on this folly to the point where in many areas of the country most homeowners live in houses they could never afford if they had to buy them again.

Recovery in any housing market requires housing prices to find fundamental value by shoring markets up at the margin, helping people who can’t afford their house, and never could, to sell to those who do have the necessary resources. And that doesn’t mean reflating private equity portfolios to become the new landlords of residential housing. Nor does it mean buying up mortgages at full value and then selling them at a deep discount to investors. Bad investments require taking losses and if necessary, going bankrupt.

Widespread housing and land ownership are the foundation of the middle class, and we’re quickly destroying it. We are experiencing Einstein’s definition of insanity.

The Bailout Miscalculation That Could Crash the Economy

When Donald Trump signed the $2 trillion CARES Act rescue on March 27, there was immediate praise across the political spectrum for section 4022, concerning homeowners in distress. Under the rule, anyone with a federally-backed mortgage could now receive instant relief.

Forbearance, the law said:

…shall be granted for up to 180 days, and shall be extended for an additional period of up to 180 days at the request of the borrower.

Essentially, anyone with a federally-backed mortgage was now eligible for a six-month break from home payments. Really it was a year, given that a 180-day extension could be granted “at the request of the borrower.”

It made sense. The burden of having to continue to make home payments during the coronavirus crisis would be crushing for the millions of people put out of work.

If anything, the measure didn’t go far enough, only covering homeowners with federally-backed (a.k.a. “agency”) mortgages. Still, six months or a year of relief from mortgage payments was arguably the most valuable up-front benefit of the entire bailout for ordinary people.

Unfortunately, this portion of the CARES Act was conceived so badly that it birthed a potentially disastrous new issue that could have severe systemic ramifications. “Whoever wrote this bill didn’t have the faintest fucking clue how mortgages work,” is how one financial analyst put it to me.

When homeowners take out mortgages, loans are bundled into pools and turned into securities, which are then sold off to investors, often big institutional players like pension funds.

Once loans are pooled and sold off as securities, the job of collecting home payments from actual people and delivering them to investors in mortgage bonds goes to companies called mortgage servicers. Many of these firms are not banks, and have familiar names like Quicken Loans or Freedom Mortgage.

The mortgage servicing business is relatively uncomplicated – companies are collecting money from one group of people and handing it to another, for a fee – but these infamously sleazy firms still regularly manage to screw it up.

“An industry that is just… not very good,” is the generous description of Richard Cordray, former head of the Consumer Financial Protection Bureau.

Because margins in the mortgage service business are relatively small, these firms try to automate as much as possible. Many use outdated computers and have threadbare staffing policies.

Essentially, they make their money collecting in good economic times from the less complicated homeowner accounts, taking electronic payments and paying little personal attention to loan-holders with issues.

They rely on lines of short-term financing from banks and tend to be cash-poor and almost incompetent by design. If you’ve ever tried to call your servicer (if you even know who it is) and failed to get someone on the phone, that’s no accident — unless you’re paying, these firms don’t much want to hear from you, and they certainly don’t want to pay extra to do it.

Last year, the Financial Stability Oversight Council (FSOC), which includes the heads of the Treasury, the Commodity Futures Trading Commission, the Fed, the aforementioned CFPB and others issued a report claiming mortgage service firms were a systemic threat, because they “rely heavily on short-term funding sources and generally have relatively limited resources to absorb financial shocks.”

For Cordray, who has a book out called Watchdog that chronicles his time heading the CFPB, the worry about mortgage servicers was serious.

“Nonbanks are very thinly capitalized,” he says. “They haven’t been very responsible in building up capital buffers.”

Enter the coronavirus. Even if homeowners themselves weren’t required to make payments under the CARES Act, servicers like Quicken and Freedom still had to keep paying the bondholders every month.

It might be reasonable to expect a big bank like Wells Fargo or JP Morgan Chase to front six months’ worth of principal and interest payments for millions of borrowers. But these cardboard fly-by-night servicer firms – overgrown collection agencies – don’t have that kind of cash.

How did the worst of these firms react to being told they suddenly had to cover up to a year of home payments? About as you’d expect, by trying to bully homeowners.

Soon after the passage of the CARES Act, reporters like Lisa Epstein at Capitol Forum and David Dayen at the American Prospect started hearing stories that servicers were trying to trick customers into skipping the forbearance program. As David wrote a few weeks ago:

I started hearing from borrowers that they were being told that they could apply for three months forbearance (a deferment of their loan payment), but would have to pay all three months back at the end of the period…

It soon came out that many servicers were telling homeowners that even if they thought they were getting a bailout break, they would still have to make it all up in one balloon payment at the end of the deferral period. This was a straight-out lie, but the motivation was obvious. “They’re trying to get people to pay any way they can,” is how Cordray puts it.

Dayen cited Amerihome Mortgage and Wells Fargo, but other names also started to be associated with the practice. Social media began to fill up with stories from people claiming firms like Mr. CooperBank of America and others were telling them they had to be prepared to make big balloon payments.

Same with the CFPB’s complaint database, which began to be filled with comments like the following, about a firm called NewRez LLC:

If you have 4 months of mortgage payments laying around at the end of the COVID-19 pandemic you will be fine if not good buy [sic] to your house. I understand its a business and they will make a lot of money with I’m sure a government bailout and lots of foreclosures from not helping any american home buyers…

Suddenly regulators and politicians alike were faced with a double-edged dilemma. On the one hand, the poorly-designed CARES Act placed servicers in genuine peril, an issue that left unfixed might break the mortgage markets – not a fun experience for America, as we learned in 2008.

The obvious solution was to use some of the apparently limitless funding ammunition in the Federal Reserve to help servicers maintain their responsibilities. The problem was the firms that needed such help the most were openly swindling homeowners. If there’s such a thing as regulatory blackmail, this was it.

Should the Fed open its war chest and create a “liquidity facility” to help mortgage servicers? If so, how could this be done in a way that didn’t put homeowners at more risk of being burned in some other way?

“This is the script of a heist flick, where homeowners get screwed in the end while servicers get the money,” says Carter Dougherty of Americans for Financial Reform. “If you combine money for servicers with strong consumer protections and a vigorous regulator, then the film could have a happy ending. But I’m not holding my breath.”

In early April, a group of Senators led by Virginia’s Mark Warner sent a letter that pleaded with Treasury Secretary Steven Mnuchin to use some of the $455 billion economic stabilization fund to solve the problem. The letter included a passage that essentially says, “We know these companies suck, but there’s no choice but to bail them out”:

While we understand that some nonbank lenders may have adopted practices that made them particularly susceptible to constraints on their liquidity during a severe downturn, imposing a broad liquidity shock to the entire servicing sector is not the way to go about reform…

The Senators put the problem in perspective, noting that as much as $100 billion in payments might be forborne under the CARES Act. This was a major hit to an industry that last year “had total net profits of less than $10 billion.”

The CARES Act was written in March with such speed that it became law before anyone even had a chance to catch, say, a $90 billion-sized hole in the bailout’s reasoning. Still, when the forbearances began and it started to look like the servicers might fail, there was talk among regulators and members of congress alike of letting failures happen, to teach the idiots a lesson.

But ultimately the Senators on the letter (including also Tim Kaine, Bob Menendez and Jerry Moran) decided this would ultimately be counterproductive, i.e. letting the economy collapse might be an unacceptably high price for the sending of a message to a handful of dirtbag companies.

“The focus now should not be on longer-term reform, but on ensuring that the crisis now unfolding does as little damage to the economy as possible,” is how the letter put it.

Although the letter essentially urged the creation of a new Fed bailout facility to contain the mortgage-servicer ick, that didn’t happen, even after mortgage servicers stepped up lobbying campaigns. In mid-April, a string of news stories appeared in which servicers warned reporters of snowballing market terror – as the New York Times put it, the “strain is expected to intensify” – that would only be solved with a bailout.

No dice. In a repeat of the often-halting, often illogical responses to mushrooming crises of 2008, the first pass at a solution came in the form of a move by the Federal Housing Finance Agency (FHFA), the overseer of Fannie and Freddie.

On April 21, FHFA announced they were coming to the rescue: servicers would no longer need to come up with six months of payments. From now on, it would only be four:

Today’s instruction establishes a four-month advance obligation limit for Fannie Mae scheduled servicing for loans and servicers which is consistent with the current policy at Freddie Mac.

Which was fine, except for one thing: from the standpoint of most of these woefully undercapitalized servicing firms, having to cover four months of payments is not a whole lot easier than covering six. “It still might as well be ten years for these guys,” is how one analyst put it.

Absent an intervention from the Fed, a bunch of these servicing firms will go bust. There will be chaos if even a few disappear. As we found out in 2008, homeowners facing servicer disruptions can immediately be confronted with all sorts of problems, from taxes going unpaid to payments vanishing to incorrect foreclosure proceedings taking place. Such problems can take years to resolve. Service issues helped seriously prolong the last crisis, as I wrote about in 2010.

Also, if your servicer disappears, someone still has to do the grunt work of managing your loan. To make sure your home payments are collected and moved to the right place, some entity will have to acquire what are known as the Mortgage Servicing Rights (MSRs) to your loan.

But MSRs have almost no value in a battered economy, which means it’s likely no big company like a bank will be interested in acquiring them in the event of mass failures, absent some kind of inducement. “They’re not going to want that grief,” is how one hill staffer puts it.

A third problem is that if some of these nonbank servicers go kablooey, a likely scenario would involve their businesses being swallowed up by big banks, perhaps with the aid of incentives tossed in from yet another bailout package.

This would again mirror 2008, in that a regulatory response would worsen the hyper-concentration problem and make big, systemically dangerous banks bigger and more dangerous, again.

As Dougherty says, the simplest solution would be opening a Fed facility to contain the servicer disaster, coupling aid with new measures designed to a) force servicers to keep more money on hand for a rainy day and b) stop screwing homeowners.

But the more likely scenario is just a bailout for now, with a vague promise to reform later. This would lead either to an over-generous rescue of some of our worst companies, or an industry wipeout followed by another power grab by Too Big To Fail banks.

The whole episode is a classic example of how governmental ignorance married to corporate irresponsibility can lead to systemic FUBAR, though we still don’t know how this particular version will play out. As Cordray puts it, it’s not easy to predict where failures in the mortgage servicer industry might lead.

“What’s easy to predict, though,” he says, “is that it will be a mess.”


Yeah, no kidding.

Virus Killing Off Mom and Pop…

…stores, that is. This article in the Atlantic sounds the real alarm for a free, self-reliant society. I suppose the alternative is for everyone to line up in a queue several million long to get those few jobs at Amazon and Google. An uncompetitive, ‘managed’ economy is one run by oligarchs and served by serfs.

Ultimately, this means a less competitive American economy. New companies and small businesses drive net job growth in the U.S. They generate more productivity growth than bigger and established businesses. The great small-business die-off will fuel industry consolidation, which will both depress wages for workers and increase prices for consumers. More inequality, more sclerosis, and a smaller GDP: These are some of the legacies the coronavirus pandemic is leaving.

The Small-Business Die-Off Is Here

theatlantic.com/ideas/archive/2020/05/bridge-post-pandemic-world-already-collapsing/611089/

Annie Lowrey Staff writer at The Atlantic, May 4, 2020

Outside of Boston, a marketing company is struggling to figure out how to cover its bills. In Indiana, a dance studio is waiting on three emergency-loan applications. In Baltimore, a deli is closed and desperate for help.

The government is engaged in an unprecedented effort to save such companies as pandemic-related shutdowns stretch into the spring. But Washington’s policies are too complicated, too small, and too slow for many firms: Across the United States, millions of small businesses are struggling, and millions are failing. The great small-business die-off is here, and it will change the landscape of American commerce, auguring slower growth and less innovation in the future.

Small businesses went into this recession more fragile than their larger cousins: Before the crisis hit, half of them had less than two weeks’ worth of cash on hand, making it impossible to cover rent, insurance, utilities, and payroll through any kind of sustained downturn. And the coronavirus downturn has indeed been shocking and sustained: Data from credit-card processors suggest that roughly 30 percent of small businesses have shut down during the pandemic. Transaction volumes, a decent-enough proxy for sales, show even bigger dips: Travel agencies are down 98 percent, photography studios 88 percent, day-care centers 75 percent, and advertising agencies 60 percent.

This deep freeze has posed a singular policy challenge: The government has never before been tasked with figuring out how to put a majority of the country’s businesses on life support. “We know how to support the financial system. It goes all the way back to Walter Bagehot,” Satyam Khanna, of the Institute for Corporate Governance and Finance at NYU’s School of Law, told me, referring to the 19th-century British thinker. “There’s a playbook to follow. What we don’t know how to do, or had no idea how to do, is provide direct support to your local coffee shop at scale.”

Congress and the Trump administration came up with a $350 billion plan to provide forgivable loans to small businesses, now amplified by a second tranche of $320 billion. The Small Business Administration’s Economic Injury Disaster Loan initiative provides small grants to small firms; its Paycheck Protection Program has small firms apply to retail banks and credit unions for loans of up to $10 million, intended for expenses such as rent, insurance, utilities, and wages. The PPP loans become grants, provided that employers retain their employees and spend 75 percent of the money on payroll.

Since it went live in early April, this rescue effort has been beset with implementation problems. Banks were unclear on what information to collect and were overwhelmed with applications. Small businesses had difficulty figuring out where to put in their paperwork, and what was available to them to begin with. Millions of massage therapists and cupcake makers and furniture companies were left adrift. A survey by the National Federation of Independent Business showed that four in five applicants to the two emergency programs were unsure whether they would receive help when the first tranche of money ran out.

Even successful applicants describe the process as a mess. Jackie LaVana owns a marketing firm in the Boston area. “It’s small but mighty,” she told me. “Me at my kitchen table,” plus a team of subcontractors who help her create online advertising campaigns. “I was having my best year ever” before the coronavirus pandemic, she said. But her company has since taken a 25 percent hit to revenue, if not higher.

LaVana watched the congressional rescue process closely and spent hours on text and email threads, talking with friends in the accounting and legal trades and with other small-business owners. Everyone had questions. What version of the program did they need? Who would even let them apply? Did they qualify? Would they meet the requirements? “It was complete confusion,” LaVana told me.

The Village Bank in Wayland, Massachusetts, where LaVana’s company has an account, initially said it could process her application, then told her it could not help her, because her company did not have a commercial loan. Other financial institutions told her that she needed an account with them to apply, or did not respond to her queries. She had finally managed to move forward with a small bank in western Massachusetts, before her own bank got back to her and said it would, in fact, be able to help.

The money would be enough to “keep the lights on,” she told me. One of the worst facets of the crisis, she feels, is that so many small businesses in her community are ailing together, and so many have not received help: “This is spiraling,” she said. “My ability to run my business allows my home day-care [provider] to get paid, and they’re also seeking a disaster loan. I want to support the businesses that sustain me, but I feel like I need support to do that.”

The problems with the relief package run far deeper than a flubbed rollout. For one, banks have been prioritizing applications from bigger clients; some have even developed “concierge treatment” options for wealthy firms. Even after some congressional fixes, the small-business plan, in that way, has helped big small businesses over small small businesses, and established small businesses over new small businesses, as the approval of loans to brand-name companies such as Shake Shack, Ruth’s Chris, the Los Angeles Lakers, Potbelly, and others has demonstrated. (Under public pressure, these companies have returned the funding.) Much of the help has gone to the companies that need it the least, among them firms with employee counts just under the SBA caps, franchises of major chains, and publicly traded firms, which are by definition able to raise money from investors. As structured by the federal government, “it was inherently regressive,” Khanna said.

Indeed, loans of $1 million or more soaked up half of the initial $350 billion allocated by Congress. Whiter, less populated states got more loan money per capita, with Vermont, North Dakota, and Minnesota overrepresented and Nevada, Florida, and California underrepresented. Researchers found no evidence that money went to the places and industries hit hardest, as measured by business closures and declines in hours worked. The accommodation- and food-services sector accounted for two in three jobs lost, but received just 9 percent of federal aid dollars.   

The program is generating inequality in other ways too. One of the businesses that has applied but not yet received aid belongs to Jessica Yang’s parents, who sell sandwiches and groceries at a deli in Baltimore. The shop has closed, unable to make a takeout-and-delivery model work with no notice: The deli had no online presence before the shutdown, and services such as DoorDash and Uber Eats charge such large commissions that it would “never break even on an order,” Yang told me. The SBA was its only hope. “I heard that we would hear back in three to five days,” she said. “My parents keep calling me and asking if I’d heard anything. Then we read in the news that the program reached its limit. I wonder if that has anything to do with it. Maybe there’s just no money to go around.”

Yang said that her parents’ ages and backgrounds complicated the application process: Her father is in his 60s; her mother is in her 50s and does not speak English fluently. “For first-generation Koreans, how are they getting accurate information?” Yang asked. “I don’t want people like my parents to miss out on these opportunities because the process of applying is complicated.”

They are, and it is. Although the government is not collecting or releasing data on the racial makeup of SBA-aid recipients—leaving think tanks and advocacy groups to fill in the gaps—the Center for Responsible Lending has estimated that 95 percent of black-owned businesses, 91 percent of Latino-owned businesses, 91 percent of businesses owned by Native Hawaiians or Pacific Islanders, and 75 percent of Asian-owned businesses have “close to no chance” of getting an emergency loan through a mainstream financial institution. Even with congressional tweaks, the program is amplifying existing racial disparities.

In other ways, the SBA programs are too little, too late. John Lettieri of the Economic Innovation Group, a Washington, D.C.–based research and advocacy organization, explained to me, “If you have a short-duration crisis that causes a lack of liquidity across small businesses, followed by a quick return to normal, PPP is going to help a lot of businesses. But does that sound like what we’re facing? Not to me.”

Among the issues that EIG and other advocates are pointing to: The program is not big enough, because businesses likely require an estimated $1 trillion in relief. The maximum loan size, at $10 million, is too small for many firms to cover payroll and other expenses. The program disadvantages companies with high overhead costs, such as businesses that need to pay rent in expensive cities. It requires employers to keep workers on the books, when many would financially benefit from being laid off and receiving enhanced unemployment-insurance payments. Finally, its timetable is far too short, given that formal shelter-in-place orders are expected to last for months, and the consumer economy is expected to remain weak for a year at minimum.

Facing mounting bills and absent revenue, many businesses are closing permanently, rather than drifting further and further into insolvency. “When responding to something like this, you’re not just dealing with dollars and cents. You’re dealing with toxic and pervasive fear and uncertainty,” Lettieri told me. “I can’t take for granted that Congress will extend this program, and that I’ll have a business worth running in three months. I’m going to burn through the cash I have in pocket, so why not cut losses now?” Surveys indicate that one in four small businesses does not expect to survive; an additional one-third are uncertain of their potential to withstand the cataclysm.

The short-term effects of this disaster are clear: When businesses liquidate, they lay off workers, who spend less in their local economies, making other businesses weaker, necessitating further layoffs. Business failures thus act as an accelerant in a downturn, making temporary damage permanent. This is a central reason why many economists do not expect a sharp, V-shaped rebound to the current recession, but a long, slow, U-shaped recovery.

But the decimation of American small businesses will inflict more insidious, long-lasting harm too. “We are seeing a complete wipeout of a cohort of entrepreneurs and young firms,” Lettieri said. “And there’s nothing coming up behind them.” The pandemic will mean the triumph of franchise chains over mom-and-pop shops, of C-suite executives over entrepreneurs working in their basements. It will mean town centers filled with banks and 24-hour pharmacies rather than bookstores and nail salons and takeout counters. It will also mean fewer start-ups competing with incumbents.

Ultimately, this means a less competitive American economy. New companies and small businesses drive net job growth in the U.S. They generate more productivity growth than bigger and established businesses. The great small-business die-off will fuel industry consolidation, which will both depress wages for workers and increase prices for consumers. More inequality, more sclerosis, and a smaller GDP: These are some of the legacies the coronavirus pandemic is leaving.

Viral (or Vile) Media

I start my morning reviewing the headlines of the major news media on RealClearPolitics to see if there is anything worth reading. Of course, RCP now juxtaposes the ying with the yang on every issue in order to drive engagement and traffic. Today I came across these two articles and was struck on how they captured the manufactured controversy over ending or maintaining virus lockdowns. Give them a read and see if you can perceive the difference.

How to reopen the economy with a reality-based approach

https://www.washingtonexaminer.com/opinion/how-to-reopen-the-economy-with-a-reality-based-approach

The first, published in the esteemed (sic) NYT, is written by a professor of pediatrics. I read it through, hoping to gain some insights. Sadly, incredibly obtuse, he makes assertions about epidemiology and public opinion and dismisses experts from the fields of psychiatry, politics, economics, and social behavior with a fairly baseless argument that only the medical experts know. We must follow their advice without question (okay, let’s ignore the fact that every medical projection has been off by a country mile). Then he adds that public opinion agrees. Okay, a public survey poll is an obvious contradiction of expertise: if 60% of the lemmings say we need to go over the cliff, the other 40% better follow?

He tried to obscure this error with a survey of economists. As a trained economist I happen to know the profession is one of the most risk-averse in academia (note the quoted economist who doesn’t want to be a restaurant guinea pig). Why? Because we are painfully aware of how much we don’t know (and make sure to maintain plausible deniability for those bad forecasts – Paul Krugman take note). There is no actionable intelligence in this opinion piece, as that’s what it is, unqualified opinion.

The second piece is published by the less esteemed (?) Washington Examiner (hmm, presenting a perfect opportunity to shoot the messenger and kill the message?), written by an MD and JD trained in economics. This writer offers a nuanced strategy with actionable intelligence for opening up parts of society while maintaining certain social behavior protocols to manage the risks. Okay, not bad.

My advice: trash the NYT piece and don’t take the WE piece as gospel, as that is not how it is intended, but give it careful consideration. There’s no equivalence here. Our media seems committed to misguiding at least half the country’s citizens. Ugh!

Donut Holes?

Watched a TED video by the woman who developed this idea of doughnut economics (see book). Seems to be all the rage among the save the planet crowd.

TED Talk Kate Raworth

Interesting, but I think she’s tilting at a straw man. This is a measurement problem, not a mechanistic problem. First, GDP is a very blunt instrument for measuring improvements to the human condition, but it’s the only yardstick the politicians and policymakers have and they are judged based on these metrics. Same with U6 and CPI and PPI and poverty, etc. We get GPD numbers every week of the year and our information channels repeat them as grade reports.

Second, Ms. Raworth uses the word growth as a proxy for measuring change and consuming energy resources. Not all growth or GDP measurement is expansion of goods and services. Recycling is a measure of growth; developing alternative sources of energy is a measure of growth. What we are truly dealing with is how to manage positive CHANGE. When we mismanage change, we get negative GDP growth rates. When we manage it productively, we get positive changes in GDP, among other measurements of life quality, like leisure time and cultural and technological innovation.

Economics is the fine art of managing change through exchange. So we need better measurements that include those subjective values that are not so easy to measure.
Everything else here is fantastic hyperbole, saving the planet and all that…dollars to donuts?

Social Behavior and the Coronavirus Pandemic

If you’re like me and follow the mainstream as well as social media, you’ve likely been inundated with information about the coronavirus pandemic, with many different data interpretations and conflicting claims based on these interpretations. The simple graphic below, called “flattening the curve,” seems to be the dominant visual for explaining the current public healthcare issues and provides a good starting point.

Flattening the curve.

The graph was created by disease specialists at the CDC and has been spread widely by medical professionals, government officials, and non-government agencies. It visually represents the logic behind the political response to the crisis and the strategy to slow the spread of the virus. This is critical to managing the capacity limitations of healthcare resources like hospitals, drug therapies, and healthcare personnel. However, it is a theoretical model based on exponential pandemic dynamics; it is not a graph of actual empirical data. It is meant to educate, not report.

Unfortunately, the graph has been adopted by public media as a projection of “likely” real-time scenarios under various assumptions, focusing completely on the rose-colored part of the graph. According to this worst-case scenario, without strict adherence to isolation protocols the coronavirus is projected to spread exponentially through the population, placing an impossible burden on healthcare resources. The problem is that the empirical data so far does not seem to be supporting this worst-case scenario.

Let’s not get derailed here: the virus outbreak is a serious public health threat and a deadly threat to the elderly and immune-compromised. Our policies should foremost target the security of these groups. In this respect, the model is valuable and instructive, but not so much for actual health outcomes to the majority of the population. From the macro point of view, we have little idea how many of those people infected will require medical intervention and how extensive that intervention might be. In other words, infection rates may not impact health care capacity as depicted here. We also have little feel for how high or low that spike might be, or the magnitude of the y-axis – is it thousands, millions, or billions? 20%, 50% or 90%? Many media interpretations of existing data choose a scale that looks like we’re shooting up to the top of that rosy peak when we are really barely past the initial stage way, way down near the floor of the x-axis (see next graph). The projections repeatedly fail to project for interventions and behavior changes.

Where are we?

Also, as we discover more and more people have contracted the virus yet show no serious symptoms, we are missing any projection of herd immunity. Immunity gradually reduces the ability of the virus to find new hosts within the existing population so it gradually dies out.

What is valuable about the meme is the implication for how the public should adapt social behavior now to reduce the transmission rate of the contagion. Physical or social distancing is at this time imperative. Essentially this is less about biology and more about social behavior informed by biology. It strikes me that most of our media information is overly focused on very uncertain medical data given credibility by concerned medical experts. The problem is that the experts are shrouded in uncertainty and thus must err on the side of extreme caution. In hindsight most of this speculation will likely turn out to be fictional. But the effect will be real, and this takes us back to social behavior.

Some reports opine that this coronavirus is just a bad flu. If one is looking at medical data, I would tend to agree. But looking at social behavior, I would obviously disagree. What is driving social behavior, which will be measured in political policies and economic results, relates to the nature of this pandemic, not the pathogen itself. The coronavirus strikes at the heart of our instinctual behavior in the face of existential threats.

The real problem we face is that 1) the threat is invisible, 2) seems to be highly transmissible and somewhat random, 3) offers no preventive therapy (vaccine) or 4) sure treatment options or cures. Thus, 5) we feel little sense of control over what might be a serious existential threat. What this combination of characteristics does is incite a strong psychological reaction to uncertainty, risk, and potential loss, leading to exaggerated reactions to very low probabilities.

We know from behavioral science that the survival instinct causes behavior to respond to these contextual parameters. Humans, like all sentient beings, are risk and loss averse. Loss pertains to the nature of the threat, such as will I lose my job, or my savings and pension, or the ultimate existential threat: will I get sick and die? Risk is a probability function of the uncertainty of that loss. As the threat level rises (reported death counts and mortality rates) people become more fearful. Then, as uncertainty blankets us like a fog, the anxiety level rises. This survival response is perfectly rational for any organism trying to stay alive.

The important thing to note is that when the probability of loss increases and the consequence becomes more serious, people tend to become risk-seeking. In other words, faced with a likely existential threat, people take more behavioral risks than would be rational in the absence of that threat. We see this in those apocalyptic movies, when widespread hysteria and panic leads to chaos and deadly conflict, where more people die from the chaos than from the threat.

Individual behavior is compounded by irrational social behavior. An example is the panic buying of paper products, where some people, pressed to explain their behavior, have only offered the justification that everybody else was hoarding paper, so they were too. This suggests that what may not be categorically much different than a bad flu medically has the potential to turn into a global social and economic crisis.

So why is this reaction to coronavirus different than the Asian bird flu, Ebola, SARS, MERS or H1N1? The coronavirus seems to have a much higher and faster transmission rate than these previous pathogens and thus it has spread world-wide much faster. This is likely because it is highly asymptomatic while it is contagious and spreading. It also may be far more benign. But we don’t know why it is asymptomatic in some people and severely life-threatening for others. This uncertainty and randomness heighten our fear of the threat.  

There is something else going on with the present pandemic that is aggravating the crisis. Because the virus has easily spread rather quickly, our global information media has gone into overdrive, especially social media. We know that social media is mostly driven by emotional reactions to uncertain facts, what we now call fake news. The sad reality is that the traditional print and broadcast media have also had to succumb to sensationalism and emotions in order to stay in business. Remember the editor’s dictum: If it bleeds, it leads. This presents the danger of reporting one random healthy young person who dies of COVID-19 complications instead of the thousands of others who contract the virus and seem unaffected. Our media, willingly or unwillingly, by focusing on infection and death counts taken out of context may be contributing to the social psychological effects driving this pandemic crisis. Worst-case scenarios painted by the medical experts and spread by the media are doing the same.

I suspect officials may sincerely believe projecting the worst-case scenario is necessary to “scare people straight” to get them to change behavior. But social behavior indicates that fear can become more viral than the virus, increasing the threats to social stability, safety, and security.

If one doubts this, imagine what would happen if a vaccine or cure were discovered tomorrow. Most of the world would return to normal the next day, not because the pathogen was eradicated any more than the seasonal flu, but because our fear would disappear.