Public Investment? Or: How the Government Spends Your Money



Is this to be the endless folly of those who believe free markets don’t work?

How the Wheels Came Off for Fisker

Untested Electric-Car Firm Was Ripe for the Times; U.S. Loans Saddled It With Factory Never Used


For a few months in 2012, Bruce Simon, the chief executive of gourmet food retailer Omaha Steaks International Inc., drove a $100,000 plug-in hybrid electric car known as the Fisker Karma. No longer.

Mr. Simon says his car broke down four times over the span of a few months. Each time, Fisker Automotive Inc. picked it up and sent it by trailer from his home in Omaha, Neb., to a dealer in Minneapolis.

The Karma was “so vulnerable to software errors, and the parts used were of such poor quality that eventually I insisted they take the car back and return my purchase price, which they did,” he says. “It’s a real shame, the car itself was beautiful.”

The near collapse of the Anaheim, Calif., company—it missed a loan payment on Monday, earlier dismissed most of its staff and has hired bankruptcy advisors—comes as affluent buyers like Mr. Simon have turned away from the once promising startup and falling gasoline prices have chipped away at demand for electric cars.

Barring a last-minute rescue, Fisker is poised to become another DeLorean Motor Co. or Tucker Corp., a symbol of the difficulties of creating entirely new car companies. Unlike those others, it also represents one of the most prominent failures of the government’s use of public funds to wean American industry from fossil fuels—and of how that government interest pushed Fisker to reach too far.

Originally, Fisker wanted to start small. But, says investor David Anderson, the U.S. asked it to think big. ‘”We can’t loan you money to make a low volume car [in Finland],'” he said the U.S. argued. ‘”But if you wanted to bring forward in time your idea of the small car to be produced here in the U.S.,’ then, they’d say ‘OK,'” Mr. Anderson said.

A spokesperson for the Department of Energy declined to comment.

At its peak, tiny Fisker was one of the largest U.S. venture capital backed companies ever. Its founders raised more than $1 billion from highly regarded Silicon Valley venture funds including Kleiner Perkins Caufield & Byers. It also recruited a roster of prominent backers including former Vice President Al Gore and former Oracle Corp. president Ray Lane.

Its biggest single investor was the U.S. In 2009, the Obama administration’s interest in cultivating electric cars got the untested Fisker loans totalling $529 million, more than the company had initially requested, and an amount that encouraged private backers to chip in more funds. At one point, backers valued the company at $1.8 billion.

The company had applied in 2009 for a $169 million loan from a $25 billion program set up in the wake of the financial crisis to boost alternative-energy vehicles. Energy Department officials recommended that if Fisker was willing to build in the U.S., the agency would fund the development of the Karma and the company’s proposed second, less expensive model, according to people familiar with the matter.

Fisker executives agreed to acquire a shuttered General Motors Co. assembly plant in Wilmington, Del., where it hoped to build a $60,000 sedan.

Today, Fisker looks headed toward a bankruptcy restructuring. The U.S. could wind up owning all or part of the company’s assets because its loans were backed by Fisker assets. So precarious is the company that the U.S. seized $21 million this month from Fisker in anticipation of a default.

How did the wheels come off so quickly? Fisker got its start in 2007, a year before U.S. gasoline prices hit $4.11 a gallon and seemed headed to $5 a gallon. The fuel spike and global cash crunch helped put General Motors and Chrysler Group in government-led bankruptcies. Its co-founder, Henrik Fisker, was a highly regarded designer for luxury brands Aston Martin and BMW and armed with an idea ripe for the times.

He lured investors with a hand-sculpted clay model of his dream car and the promise of an high-tech answer to what then was seen as an inexorable rise in fuel prices. Fisker and its promising Karma luxury plug-in appeared as the opposite of Detroit’s plodding big car makers.

In September 2009, the Energy Department gave preliminary approval to a $529 million in loans for the company. The amount was more than the $465 million it had earlier agreed to loan to rival electric-car startup Tesla Motors Inc. The DOE also awarded Ford Motor Co. and Nissan Motor Co. $5.9 billion and $1.4 billion, respectively, to fund their electric and hybrid vehicle programs. The DOE’s decision to increase the Fisker loan will be a topic of a hearing scheduled on Wednesday before a House committee.

Even with its wealthy backers, Fisker had plenty of problems. Troubles with suppliers and regulatory requirements added months to the Karma’s release. Its engineers expressed concerns that the software that ran the Karma’s display screens and phone connections wasn’t ready, people familiar with the situation say. Still, the Karma went out to customers. The company said that its problems were expected of any new model.

In May 2011, the Obama administration, under pressure from critics of its alternative energy spending and after the high-profile failure of U.S.-backed solar panel maker solar panel makerSolyndra LLC, froze disbursements to Fisker citing delays in the Karma’s rollout.

Nonetheless, Fisker kept ordering parts to build Karmas, piling up costs even as the company struggled to fix software and other problems that prompted complaints from early buyers, and led to critical reviews in auto publications.

In the fall of 2011, Fisker’s battery supplier, A123 Systems Inc., was informed Fisker had run out of cash and wouldn’t be able to take more deliveries.

A123, which also received a government grant to finance U.S. factories, had shipped about 3,000 battery packs to the company. The Waltham, Mass., company was ready to ramp production to 15,000 packs annually for its top customer. Its own market miscalculations and quality problems led A123 to seek bankruptcy protection last fall.

Fisker stopped production of the Karma at a factory in Finland in July 2012 in an attempt to negotiate a cost-saving contract. The following month, Fisker recalled its cars for a second time to fix a cooling system flaw that was linked to battery fires.

It hasn’t built a car since.

Traveling The Road to Serfdom


This, too, is an illusion.

This post borrows from the famously titled book by Friedrich Hayek, The Road to Serfdom. In his landmark critique, Hayek laid out the reasons why government-directed socialism would lead to the impoverishment of society. Maybe more of us should be reading such books these days instead of watching American Idol.

A couple of weeks ago I also posted an article here on the “feudalization” of capitalism. In that article I explained how feudalism was based on the narrow ownership and control of land, while feudal capitalism would be based on the concentrated ownership and control of financial capital. But, of course, financial capital is only good for the economic power it provides over real resources, and now we are seeing that applied rather transparently. From a recent news report:

After quite a bit of bingeing — and more than a little purging — the private equity real estate market appears to be finding a bit of equilibrium, even after poor performance and regulatory changes have thinned the ranks of dealmakers in the sector.

This month’s issue of Private Equity Analyst takes a look at how a number of buyout firms, some with dedicated real estate funds and some without, are positioning themselves to profit from a nascent real estate recovery, even as fundraising for real estate funds remained well off its 2008 high of $139.9 billion.

Private equity real estate funds raised an aggregate $54.9 billion last year, and a further 451 funds are currently on the road chasing $148 billion According to data provider Preqin.

Leading the charge of successful fund raises in 2012 was the Blackstone Group, which held a final close on $13.3 billion for Blackstone Real Estate Partners VII LP in the fourth quarter of 2012. The fund’s predecessors, including the $11 billion Blackstone Real Estate Fund VI LP raised in 2007, were top performers in the portfolio of the New Jersey Division of Investment.

The changing investment landscape has led Blackstone to shift Fund VII into some previously-untapped territory, namely, the single-family housing market. The firm created a company called Invitation Homes to buy foreclosed homes, fix them up and rent them to families.  So far it has put about $2.6 billion to work in that space, amassing a portfolio of 16,000 homes.

The housing/financial bubble, bust, and nascent recovery is transferring the ownership of housing and land to an ever-narrower group of financial plutocrats – those the popular press refer to as the 1%. If you think Democrats (Obama or anyone else) or Republicans in Washington are doing anything to prevent this, you’re fooling yourself. They are all, through the Federal Reserve, promoting it.

Can’t afford your house because of the massive credit bubble we engineered? Okay, we’ll let Blackstone partners buy it out from under you with the cheap credit we’ve provided them and then they’ll rent it back to you! Problem solved. When the day comes when the real value of these assets results in much higher prices, Blackstone will sell it back to you or somebody else for a tidy profit. In the meantime, the steady devaluation of the dollar will make us one-percenters much richer and you serfs much poorer. Neat trick, eh?

This tragic state of affairs all resulted from an historic scam to turn homes into speculative trading assets. It would be wrong to blame just the 1%. Everyone who thought flipping houses was a great way to get rich (and they’re coming back in force) is complicit in this scam. As are the politicians and housing industry lobbyists who promote housing tax subsidies. If house prices were stable and based on fundamental economic relationships to incomes and rents, there would be no profit to be had by trading them and we might all live easier with a lot more financial security.

Instead, we are surely truly traveling down Hayek’s Road to Serfdom.

Stockman Again









This time he makes a bit of sense…excerpted from a book review in the WSJ:

“The Great Deformation” is more than a polemic aimed at government check-writing. Mr. Stockman, who has been mostly unhappy with both Democratic and Republican policies for three decades, is appalled by the ruling class’s belief that economic prosperity flows from “macromanagement by the state, rather than from free market interaction.” Everywhere he sees sweetheart deals between government and industry, often engineered by lobbyists. The energy sector in particular he views as a sewer of subsidy and false “green” promises. Meanwhile, corporate America enters into reckless deals in part because borrowing is much too cheap, thanks to skewed tax and monetary policies.

As for the real-estate and banking crash of 2008, Mr. Stockman makes the case that nearly every policy response made things worse. He derides the interventions by Henry Paulson, Mr. Bush’s Treasury secretary, as “a de facto coup d’etat by Wall Street, resulting in Washington’s embrace of any expedient necessary to keep the financial bubble going—and no matter how offensive it was to every historic principle of free markets, sound money, and fiscal rectitude.” The too-big-to-fail doctrine, he believes, allows bad actors to thrive at taxpayer expense. The auto industry didn’t need $20 billion in federal money, Mr. Stockman says; it needed “a cold bath of free-market house cleaning.” As for the Federal Reserve, he claims that in 2008 it was guilty of “spraying an alphabet soup of liquidity injections in every direction”—a cheap-money strategy that Ben Bernanke is still employing five years later to prop up stock-market valuations.

There is something tonic about all this angry complaint, and “The Great Deformation”—though about twice as long as it needs to be—is a welcome thrashing of the ruling classes in both parties. Economic elites in Washington and on Wall Street routinely pat themselves on the back and tell us that, five years after the meltdown, their “quick and decisive” interventions prevented a 1929-style collapse. Mr. Stockman isn’t buying it. “The Main Street banking system was never in serious jeopardy, ATMs were not going dark, the money market industry was not imploding,” he writes. The smaller banks in 2008, he notes, had more than $2 trillion in safe assets on their books.

It may well be that the danger of a return to 1929 was grossly exaggerated. Whether policy makers should have assumed it was—in the midst of a panic—is an open question. The challenge for Mr. Stockman, and for free marketers in general, is to make the case that the American economy would be in better shape today if we hadn’t borrowed $5 trillion and bailed out Wall Street investment banks, the insurer AIG and General Motors—let alone home buyers with toxic mortgages. But even if a modest bailout was justified to rescue the soundness of the financial system, Mr. Stockman’s essential critique is accurate: that Fed and federal officials sheltered malefactors from gargantuan losses and made current taxpayers—and future ones—pick up the tab.

What is true is that today we have a kind of “deformed” capitalism, with private gains and socialized losses. Mr. Stockman says that it is too late to change things and that a crash is unavoidable. He has been wrong before. We can only hope that he is wrong again.

Criminal Intent







From the WSJ:

How Congress Puts Itself Above the Law

The only way to finally end the sorry tradition of congressional exemptions is with a 28th Amendment.


For years, some have argued that we need a 28th Amendment to the Constitution providing that all members of Congress have to comply with all laws that other citizens have to obey. “Congress shall make no law,” the amendment might read, “that applies to the citizens of the United States that does not apply equally to the senators and/or representatives; and, Congress shall make no law that applies to the senators and/or representatives that does not apply equally to the citizens of the United States.”

Others apparently have faith in the high moral character of their elected officials and argue that we shouldn’t have to enact a constitutional amendment to make sure Congress follows the same laws all Americans do.

Yet history shows that is definitely not the case. Over the decades, Congress has passed innumerable statutes that regulate every aspect of life in the American workplace, then quickly exempted themselves.

In 1938, when the Fair Labor Standards Act established the minimum wage, the 40-hour workweek, and time and a half for overtime, Congress exempted itself from coverage of the law. As a result, for decades congressional employees were left without the protections afforded the rest of Americans working in private industry.

In 1964, with great fanfare, President Johnson signed the landmark Civil Rights Act, including Title VII, which for the first time protected all Americans from employment discrimination on the basis of race, color, religion, sex or national origin. But the law exempted Congress from its coverage, so thousands of staffers and other employees on the Hill were left with no equal-opportunity protection. Staffers could be discriminated against or sexually harassed with legal impunity.

Some will remember Bob Packwood, the former senator from Oregon who resigned his seat in 1995 under threat of expulsion for alleged serial harassment of female staffers and lobbyists. The women who alleged they had been repeatedly victimized by the senator had no legal recourse under federal law. Had Mr. Packwood been a corporate executive instead of a lawmaker, he likely would have been sued for millions.

The same blanket congressional exemption found in Title VII was contained in a total of 10 other federal statutes regulating the American workplace, including protections from age and disability discrimination, occupational safety and health rules, family and medical leave, and many other issues that Congress felt important enough to impose on American industry. These federal laws apply to all civilian employees in the U.S., except those working on the Hill.

Critics advanced the rather sensible and straightforward proposition that U.S. lawmakers should live by the same laws they impose on private employers and state and local elected officials.

Nonetheless, when the comprehensive reform of the Civil Rights Act of 1991 was passed, efforts to eliminate the exemption failed. The immunity of members of Congress from lawsuits for compensatory and punitive damages in cases of employment discrimination continued.

Instead, the federal lawmakers enacted a toothless, self-policing system whereby Congress investigated and enforced its own compliance with civil-rights laws.

Given the choice, private employers no doubt would welcome the opportunity to police themselves on matters of equal-employment opportunity. Who wouldn’t prefer self-regulation over dealing with government enforcement agencies and federal court juries considering punitive damages? However, unlike the Congress, private employers don’t have the option of self-regulation.

Pressure on Congress mounted and finally, in 1995, with Republicans in control of the House and Senate, the Congressional Accountability Act was passed, eliminating the congressional exemption for all workplace laws and regulations. Some thought passage of the law marked the end of congressional exceptionalism through exemption. They were mistaken.

Insider trading (the buying and selling of stocks based on insider information not available to the general public) has been a violation of federal securities laws for almost 80 years. Yet it was never illegal for members of Congress. Not, that is, until a November 2011 report by CBS’s “60 Minutes” shamed Congress into changing the law to prohibit members of Congress and their staffs from trading on inside information. The report was largely based on research conducted by the Hoover Institution’s Peter Schweizer for his book, “Throw Them All Out,” published that same month. Speaking about the legislators capitalizing on their positions, Mr. Schweizer told Steve Kroft on the program: “This is a venture opportunity. This is an opportunity to leverage your position in public service and use that position to enrich yourself, your friends and your family.”

Six months after the “60 Minutes” segment with Mr. Schweizer aired, Congress passed and the president signed the Stop Trading on Congressional Knowledge Act of 2012, which bans insider trading by lawmakers and their staffs. But just last week, while voters were focused on emotional issues such as immigration and gun control, House and Senate members voted to repeal a key provision of the so-called Stock Act—the one that required online posting of their financial transactions.

It’s not yet clear whether the president will sign the repeal, but it shouldn’t be necessary to take a piecemeal approach to rolling back congressional exemptions, ending them—as with the ones for workplace rules and insider trading—only when they become embarrassing. Nor will blocking exemptions here and there prevent members of Congress, particularly those who serve numerous terms, from developing a sense of privilege that makes them think they’re above the law.

America shouldn’t need to amend the Constitution to ensure that elected leaders comply with the laws of the land. But given the sorry history of congressional leadership by exemption rather than by example, a 28th Amendment doing precisely that makes sense.

Review of Who Stole the American Dream by Hedrick Smith


Posted at Amazon:

I wanted to give this book at least 2 stars in respect for Mr. Smith’s journalistic skills and his previous fine work with The Russians. However, this exposition is so flawed and wrong in its diagnosis of the problems and prescriptions that I can barely give it one star. It also saddens me to see 109 five-star reviews – after reading a few I’m left wondering how readers can be so easily led by just-so stories by our media elites. Or is this analysis so ideological that readers just choose to believe what they want to believe and disregard any counter-factual evidence? That is truly a lost, if not stolen, American dream.

First, Smith gives a good journalistic rundown of select history, as we would expect. His selected comparison is the post-war period referred to as the Great Compression. But he fails to see that this virtuous moment in our history was more a product of historical events than public policy. The US was the sole developed nation with an intact industrial base, while all of Europe, Russia and Asia lay in ruins. So, employable skilled labor was in short supply and American workers commanded a greater share of the returns relative to capital. The world was forced to buy our goods, even if we had to extend them the credit. This would not last and came undone in the late 60s. The 1970s was a period of stagnation when wages and corporate profits were similarly depressed by energy spikes and misguided economic policies.

Smith finds his villain in Justice Lewis Powell, who motivated a cabal of rapacious corporate raiders and turn-around artists like Chainsaw Al Dunlap and Neutron Jack Welch to take over American business. Please. The battle for corporate control was a response to ineffectual management that fed fat cat perks in the corporate boardroom while depriving other stakeholders of value. Stagnating stock prices reflected this and provided the opportunity for people like Dunlap and Welch to create value. Yes, and sometimes this depressed value was due to the mismanagement of labor inputs, so the remedy was to increase profits by reducing costs. This is how competitive business becomes efficient. If it hadn’t been Al and Jack, it would have been someone else. The business of America is wealth creation, not job creation. If we want to deal with the problems of winner-take-all globalization, we’d better understand that first.

Thus, Mr. Smith’s basic premise is not only flawed, it’s wrong. What caused the shift in power between capital and labor was the 30-year credit bubble (accommodated by a fiat dollar) that drove down interest on debt (with its tax subsidy), permitting the over-leveraging of capital ownership shares. Combined with the liberalization of developing nations in East, Southeast and South Asia, the world supply of labor exploded, driving down wage incomes across the board. Globalization powered by technology, transportation and communications, has delivered a new world that is so different from the post-war America Mr. Smith craves as to make the comparison ludicrous. We’re not going back to Kansas, Dorothy, no matter what the Wizards promise us.

Mr. Smith’s remedies are equally ill conceived, as we might expect from false premises. He’d like us to imitate Germany’s corporatist industrial policies, and in this he seems to share the same delusions as our current Democratic administration. Corporatism is a form of economic feudalism where control over economics and politics gravitates up to the national level with grand compromises made among peak labor unions, business roundtables, and government bureaucrats. Guess who wins and who loses? Elites win big while average Joe is told to be satisfied with a promised job, retirement, healthcare and three squares a day. This works currently in Germany because of several factors specific to Germany: a homogenous culture and labor force, an export-dependent economy, and a population of 80 million – none of which apply to the U.S. The long-term results of this policy are also less sanguine: the fertility rate of Germany is 1.36, well below the replacement rate of 2.1. There are more deaths than births and immigration does not make up the difference. In other words, like its European neighbors, the nation of Germany is dying a slow death. Hardly a model we would wish to follow. One must ask why, if life is so good, Europeans refuse to invest in the future by having children? Obviously, the developing nations that are liberating their societies see a much brighter future.

One more point that piqued my attention was Smith’s focus on public-private partnerships to recreate a past that he only imagines. This idea is a real buzzword for people who want to believe in the myth of a third way between socialism and capitalism. But does anybody really understand what the terms of these partnerships yield? Private interests use their connections in government to receive taxpayer subsidies to make investments in which they capture the excess returns. The risks of loss are borne by taxpayers, but these taxpayers never receive any direct return from success. This is a pure form of “heads we win, tails you lose” cronyism perpetrated by the elites in business and government. If taxpayers underwrite the risks, why don’t they have residual claimancy on any success? At heart, private-public partnerships are immoral because they violate the golden rule of moral capitalism: she who takes the risk, receives the gain or suffers the loss. (If you wonder about the morality of this rule, consult the Bible or the philosophy of law that defends the innocent from the transgressions of the powerful.)

This gets to the issue of true prescriptions to correct the failures of crony (not free market) capitalism that pervades our world. A world that advances freedom, and that includes the freedom to trade, must promote and defend the basic rights of ownership that undergird not only capitalism, but human nature itself. A worker is little more than an input cost, but ownership represents the residual claimancy on productive effort after all input costs have been paid. The success of capitalist society is measured by the creation of excess wealth associated with productive activities, in other words, profits. The problem is that 20th century industrial policy has associated the distribution of economic success through employment alone. In other words, most citizens only participate in the system as a labor cost. Thinking outside this “job creation” box calls for a wider distribution of the risks and returns to the ownership of the resources used in economic production, not least of which is financial capital. How does Mr. Smith really think all those CEOs got so rich? They all had stock options! Was there theft? Yes, from other stakeholders, principally shareholders. Unions should become the agents representing diversified ownership in American business for workers, and by association for all Americans. That’s a job that would get them on the right side of history.

The way Mr. Smith (and others of his persuasion) would lead us would be the ruin of the greatest experiment in freedom the world has ever known. That’s sounds more like a nightmare than a dream. Please folks, wake up. Do it for the children.

A Policy of Insanity

Einstein said the definition of insanity was doing the same thing over and over again and expecting a different result. It’s seems our politicians and policymakers are perfecting the art of insanity, at our expense. The ultimate result of over-investment in housing is to become a financial prisoner in your home.


Did he really say “my” money? I think he means “your” money.

From the WSJ:

Can We Afford Another Housing Boom?

With prices rising, now is the time to prevent over-investment.

Fannie Mae put an exclamation point on the housing rally with last week’s announcement of its largest-ever annual profit. The news comes soon after Fannie’s cousin, Freddie Mac, announced its own record high. These results may seem like cause for celebration after years of losses at the two taxpayer-backed mortgage giants. But they also underscore the urgent need for reform to ensure that the next real estate boom doesn’t end as badly as the last one.


It’s certainly good news that the very long housing recession is finally over, and that prices in most of the country are rising again. For the 12 months through January, the S&P/Case-Shiller index of 20 U.S. cities shows an annual increase in home prices averaging 8.1%. Prices in Miami were up almost 11% on the year, the Las Vegas market enjoyed a pop of more than 15%, and in Phoenix prices jumped more than 23%. Not a single one of the 20 metropolitan areas in the index suffered an annual price decline.

The healthy part of this revival is the normal adjustment of supply and demand after a painful recession. Foreclosures have been slowly working their way through the system, and the long dry spell in building means there are fewer new homes to buy.

But there’s a less desirable side to this new boom: It is fueled by the same kind of government super-subsidy for housing that drove the boom and bust a decade ago. Through Fannie, Freddie and the Federal Housing Administration (FHA), the feds now underwrite some 90% of all mortgages.

Meanwhile, the Fed’s rock-bottom interest rates and its QE policies are both intended to reflate the housing market. The Fed is buying $40 billion a month in mortgage securities, despite the housing rebound, plus an additional $45 billion in long-term Treasurys to keep mortgage rates low. This makes it cheaper for families to borrow to buy a home. But the Fed’s goal is also to keep rates so low that investors will dive back into real estate in a search for yield they can’t get from savings accounts or financial investments.

And sure enough, from Georgia to California, investors have been scooping up residential properties, often in foreclosure auctions. As the Journal has reported, large private-equity firms such as Blackstone Group and Colony Capital have spent billions of dollars over the last year buying single-family homes.

Mom and Pop are also back buying property for investment returns, rather than for shelter. A software engineer looking to buy a house in California’s Orange County as an investment property recently told the Journal, “Right now, it just seems like real estate is a good place to put cash.”

It’s true that many of today’s investors are planning to be landlords collecting regular rent, not speculators betting on their ability to execute a quick flip. But the hard part is knowing how much an asset-price rally is rooted in genuinely rising prosperity and how much in government policies that can’t last. One danger sign now is that prices are rising much faster than the economy, which isn’t sustainable over time.

It’s also worth keeping in mind that housing is not the secret sauce of economic prosperity. The anemic 0.4% GDP growth in the fourth quarter of 2012 would have been even worse without a 17.6% surge in real residential fixed investment. But even though the government calls it investment in GDP calculations, housing is substantially a form of consumption. A large home (assuming the occupant can afford it) is a manifestation of wealth, not a creator of it.

Every dollar of capital that policy makers drive into housing is a dollar that won’t be spent creating the next great innovation in software or medicine or something else. Over the long haul, the economy grows when people invest in things other than housing—specifically in technologies that enhance productivity and allow all of us to achieve higher living standards. Housing does fine when people are employed and wages are rising. In other words, sustainable growth in real-estate values is a symptom of a vibrant economy, not a cause.

In the 2000s, America tried to use a debt-fueled real-estate boom as a substitute for real wealth creation. The Fed’s loose money, government endorsement of private credit-ratings agencies and reckless promotion of homeownership created a housing bubble. The bursting of this bubble created a financial crisis. We do not want to repeat the experience.


Yet there are signs that the politicians have failed to learn that lesson. Beyond the Fed, the Washington Post reported last week that “the Obama administration is engaged in a broad push to make more home loans available to people with weaker credit.” The government is pressing banks to press borrowers to take advantage of FHA guarantees and other federal subsidies. That’s the same thinking that gave us the Fannie Mae-Countrywide Financial subprime loan machine, the subprime bust and the $187.5 billion failure of Fannie and Freddie.

With prices rising again, now is precisely the time to begin reducing the federal subsidies that encourage over-investment in housing. In some areas of the country Fan and Fred still back mortgages of more than $600,000, while the FHA backs loans of more than $700,000. Reform-minded lawmakers may not be able to stop Fed Chairman Ben Bernanke from dropping money from helicopters, but they can begin reducing the conforming loan limits at Fan, Fred and FHA to put some guardrails around Washington’s reckless credit policies.

Blowing Bubbles

Fool me once, shame on you. Fool me twice, shame on me.


Is the Fed Blowing a New Housing Bubble?

Stagnant real incomes suggest that rising home prices reflect artificially low interest rates.


Over the past year, the Federal Reserve has ramped up its policy of quantitative easing, with the result being new stock market highs and surging bond prices. Moreover, housing prices jumped 8%, the biggest annual gain since 2006.

The result is that more than a trillion dollars have been added to the market value of single-family homes. Homeowners are now wealthier and according to what economists call the “wealth effect,” they should be willing to spend more, helping the economy.

But there is another, less sanguine view of the housing recovery. Recent data released by the Federal Housing Finance Agency (FHFA) suggest that the increase in house prices is not being driven by a broad-based improvement in the economy’s fundamentals. Instead, the Fed’s lower rates are simply being capitalized into higher home prices. This does not bode well for the future.

A comparison of FHFA’s conventional home-financing data for February 2012 and February 2013 shows that borrowers bought newly built and existing homes in 2013 for 9% and 15% more respectively than in the previous year. Increases of this magnitude cannot be attributed to higher incomes, as these rose a mere 2% over the last year, just keeping up with inflation. It appears that home prices are being levitated by quantitative easing. Because interest rates were .625% and .90% lower on new and existing homes respectively this year compared with last year, the monthly finance cost to purchase a new home remained the same and went up only 3% for an existing home.

While a housing recovery of sorts has developed, it is by no means a normal one. The government continues to go to extraordinary lengths to prop up sales by guaranteeing nearly 90% of new mortgage debt, financing half of all home purchase mortgages to buyers with zero equity at closing, driving mortgage interest rates to the lowest level in 100 years, and turning the Fed into the world’s largest buyer of new mortgage debt.

Thus, with real incomes essentially stagnant, this is a market recovery largely driven by low interest rates and plentiful government financing. This is eerily familiar to the previous government policy-induced boom that went bust in 2006, and from which the country is still struggling to recover. Creating over a trillion dollars in additional home value out of thin air does sound like a variant of dropping money out of helicopters.

Will history repeat? When it comes to interest rates, whatever goes down must go up.

The average mortgage rate during the first nine years of the 2000s was 6.3% compared with today’s rate of less than 3.5%. If mortgage rates were to increase to a moderate 6% in three years, say, some combination of three things would have to happen to keep the same level of homeownership affordability. Incomes would need to increase by a third, house prices would need to decline by a quarter, or lending standards would need to be loosened even further.

The National Association of Realtors and the rest of the government mortgage complex can be relied on to push for looser lending. The Consumer Financial Protection Bureau recently came out with new rules that would grease the skids for relaxed lending standards, compliments of Fannie Mae, Freddie Mac and the Federal Housing Administration.

Given the continued subpar economic recovery and our past experience with the disastrous impact of loose lending encouraged by federal policies, homeowners would best be cautious about spending their new found “wealth.” Americans have seen this movie before and know how it ends.

Managing and Mismanaging Risk

riskThis is the kind of issue that makes readers’ eyes glaze over, but it’s crucially important to understanding our financial situation today and for the future. The political management of risk through guaranteed benefits means that uncertainty risks and losses are borne by third party taxpayers. This is a highly inefficient strategy to manage risk because future outcomes are a function of present behavior. When people see there is no consequence to their present behavior, they do things that blow up the assumptions about the future. This is a form of moral hazard that renders insurance pooling ineffective and unworkable.

Social Security is a form of defined benefit plan that relies on uncertain assumptions about future growth. If we mismanage that growth, the assumptions will fall seriously short of expectations. Our Medicare entitlements follow the same logic and it’s no wonder that we see enormous moral hazard costs in the form of unsustainable deficits. The idea that raising taxes can meet this need is fallacious in its basic premises. If we mismanage risk in this way the hole we dig will only get deeper and deeper. This is the most consequential statement of fact to take from the following analysis: In the long run, defined-contribution plans that most corporations have embraced will also be adopted by local and state governments.

From the WSJ:

The Pension Rate-of-Return Fantasy

Counting on 7.5% when Treasury bonds are paying 1.74%? That’s going to cost taxpayers billions.


It has been said that an actuary is someone who really wanted to be an accountant but didn’t have the personality for it. See who’s laughing now. Things are starting to get very interesting, actuarially-speaking.

Federal bankruptcy judge Christopher Klein ruled on April 1 that Stockton, Calif., can file for bankruptcy via Chapter 9 (Chapter 11’s ugly cousin). The ruling may start the actuarial dominoes falling across the country, because Stockton’s predicament stems from financial assumptions that are hardly restricted to one improvident California municipality.

Stockton may expose the little-known but biggest lie in global finance: pension funds’ expected rate of return. It turns out that the California Public Employees’ Retirement System, or Calpers, is Stockton’s largest creditor and is owed some $900 million. But in the likelihood that U.S. bankruptcy law trumps California pension law, Calpers might not ever be fully repaid.

So what? Calpers has $255 billion in assets to cover present and future pension obligations for its 1.6 million members. Yes, but . . . in March, Calpers Chief Actuary Alan Milligan published a report suggesting that various state employee and school pension funds are only 62%-68% funded 10 years out and only 79%-86% funded 30 years out. Mr. Milligan then proposed—and Calpers approved—raising state employer contributions to the pension fund by 50% over the next six years to return to full funding. That is money these towns and school systems don’t really have. Even with the fee raise, the goal of being fully funded is wishful thinking.

Pension math is more art than science. Actuaries guess, er, compute how much money is needed today based on life expectancies of retirees as well as the expected investment return on the pension portfolio. Shortfalls, or “underfunded pension liabilities,” need to be made up by employers or, in the case of California, taxpayers.

In June of 2012, Calpers lowered the expected rate of return on its portfolio to 7.5% from 7.75%. Mr. Milligan suggested 7.25%. Calpers had last dropped the rate in 2004, from 8.25%. But even the 7.5% return is fiction. Wall Street would laugh if the matter weren’t so serious.

And the trouble is not just in California. Public-pension funds in Illinois use an average of 8.18% expected returns. According to the actuarial firm Millman, the 100 top U.S. public companies with defined benefit pension assets of $1.3 trillion have an average expected rate of return of 7.5%. Three of them are over 9%. (Since 2000, these assets have returned 5.6%.)

Who wouldn’t want 7.5%-8% returns these days? Ten-year U.S. Treasury bonds are paying 1.74%. There is almost zero probability that Calpers will earn 7.5% on its $255 billion anytime soon.

The right number is probably 3%. Fixed income has negative real rates right now and will be a drag on returns. The math is not this easy, but in general, the expected return for equities is the inflation rate plus productivity improvements plus the expansion of the price/earnings multiple. For the past 30 years, an 8.5% expected return was reasonable, given +3%-4% inflation, +2% productivity, and +3% multiple expansion as interest rates plummeted. But in our new environment, inflation is +2%, productivity is +2% and given that interest rates are zero, multiple expansion should be, and I’m being generous, -1%.

So what to do? I recall a conversation from 20 years ago. I was hoping to get into the money-management business at Morgan Stanley. I wanted to ramp up its venture-capital investing in Silicon Valley, but I was waved away. It was explained to me that investors wanted instead to put billions into private equity.

One of the firm’s big clients, General Motors, had a huge problem. Its pension shortfall rose from $14 billion in 1992 to $22.4 billion in 1993. The company had to put up assets. Instead, Morgan Stanley suggested that it only had an actuarial problem. Pension money invested for an 8% return, the going expected rate at the time, would grow 10 times over the next 30 years. But money invested in “alternative assets” like private equity (and venture capital) would see expected returns of 14%-16%. At 16%, capital would grow 85 times over 30 years. Woo-hoo: problem solved. With the stroke of a pen and no new money from corporate, the GM pension could be fully funded—actuarially anyway.

Things didn’t go as planned. The fund put up $170 million in equity and borrowed another $505 million and invested in—I’m not kidding—a northern Missouri farm raising genetically engineered pigs. Meatier pork chops for all! Everything went wrong. In May 1996, the pigs defaulted on $412 million in junk debt. In a perhaps related event, General Motors entered 2012 with its global pension plans underfunded by $25.4 billion.

In other words, you can’t wish this stuff away. Over time, returns are going to be subpar and the contributions demanded from cities across California and companies across America are going to go up and more dominoes are going to fall. San Bernardino and seven other California cities may also be headed to Chapter 9. The more Chapter 9 filings, the less money Calpers receives, and the more strain on the fictional expected rate of return until the boiler bursts.

In the long run, defined-contribution plans that most corporations have embraced will also be adopted by local and state governments. Meanwhile, though, all the knobs and levers that can be pulled to delay Armageddon have already been used. California, through Prop 30, has tapped the top 1% of taxpayers. State employers are facing 50% contribution increases. Private equity has shuffled all the mattress and rental-car companies it can. Buying out Dell is the most exciting thing they can come up with. Expected rates of return on pension portfolios are going down, not up. Even Facebook millionaires won’t make up the shortfall.

Sadly, the only thing left is to cut retiree payouts, something Judge Klein has left open. There are 12,338 retired California government workers receiving $100,000 or more in pension payments from Calpers. Michael D. Johnson, a retiree from the County of Solano, pulls in $30,920.24 per month. As more municipalities file Chapter 9, the more these kinds of retirement deals will be broken. When Wisconsin public employees protested the state government’s move to rein in pensions in 2011, the demonstrations got ugly—but that was just a hint of the torches and pitchforks likely to come.

Meanwhile, it’s business as usual. California Gov. Jerry Brown released a state budget suggesting a $29 million surplus for the fiscal year ending June 2013 and $1 billion in the next fiscal year. Actuarially anyway.

Or as Utah Rep. Jason Chaffetz told Vermont Gov. Peter Shumlin, upon learning at a 2011 House hearing about that state’s unrealistic pension assumptions: “If someone told me they expected to get an 8% to 8.5% return, I’d say they were probably smoking those maple leaves.”

Margaret Thatcher, R.I.P.


Great address delivered by Lady Thatcher at Hillsdale College in 1994. We ignore such historical wisdoms these days.

The Moral Foundations of the American Founding

History has taught us that freedom cannot long survive unless it is based on moral foundations. The American founding bears ample witness to this fact. America has become the most powerful nation in history, yet she uses her power not for territorial expansion but to perpetuate freedom and justice throughout the world.

For over two centuries, Americans have held fast to their belief in freedom for all men—a belief that springs from their spiritual heritage. John Adams, second president of the United States, wrote in 1789, “Our Constitution was designed only for a moral and religious people. It is wholly inadequate for the government of any other.” That was an astonishing thing to say, but it was true.

What kind of people built America and thus prompted Adams to make such a statement? Sadly, too many people, especially young people, have a hard time answering that question. They know little of their own history (This is also true in Great Britain.) But America’s is a very distinguished history, nonetheless, and it has important lessons to teach us regarding the necessity of moral foundations.

John Winthrop, who led the Great Migration to America in the early 17th century and who helped found the Massachusetts Bay Colony, declared, “We shall be as a City upon a Hill.” On the voyage to the New World, he told the members of his company that they must rise to their responsibilities and learn to live as God intended men should live: in charity, love, and cooperation with one another. Most of the early founders affirmed the colonists were infused with the same spirit, and they tried to live in accord with a Biblical ethic. They felt they weren’t able to do so in Great Britain or elsewhere in Europe. Some of them were Protestant, and some were Catholic; it didn’t matter. What mattered was that they did not feel they had the liberty to worship freely and, therefore, to live freely, at home. With enormous courage, the first American colonists set out on a perilous journey to an unknown land—without government subsidies and not in order to amass fortunes but to fulfill their faith.

Christianity is based on the belief in a single God as evolved from Judaism. Most important of all, the faith of America’s founders affirmed the sanctity of each individual. Every human life—man or woman, child or adult, commoner or aristocrat, rich or poor—was equal in the eyes of the Lord. It also affirmed the responsibility of each individual.

This was not a faith that allowed people to do whatever they wished, regardless of the consequences. The Ten Commandments, the injunction of Moses (“Look after your neighbor as yourself”), the Sermon on the Mount, and the Golden Rule made Americans feel precious—and also accountable—for the way in which they used their God-given talents. Thus they shared a deep sense of obligation to one another. And, as the years passed, they not only formed strong communities but devised laws that would protect individual freedom—laws that would eventually be enshrined in the Declaration of Independence and the U.S. Constitution.

Freedom with Responsibility

Great Britain, which shares much of her history in common with America, has also derived strength from its moral foundations, especially since the 18th century when freedom gradually began to spread throughout her society. Many people were greatly influenced by the sermons of John Wesley (1703-1791), who took the Biblical ethic to the people in a way which the institutional church itself had not done previously.

But we in the West must also recognize our debt to other cultures. In the pre-Christian era, for example, the ancient philosophers like Plato and Aristotle had much to contribute to our understanding of such concepts as truth, goodness, and virtue. They knew full well that responsibility was the price of freedom. Yet it is doubtful whether truth, goodness, and virtue founded on reason alone would have endured in the same way as they did in the West, where they were based upon a Biblical ethic.

Sir Edward Gibbon (1737-1794), author of The Decline and Fall of the Roman Empire, wrote tellingly of the collapse of Athens, which was the birthplace of democracy. He judged that, in the end, more than they wanted freedom, the Athenians wanted security. Yet they lost everything—security, comfort, and freedom. This was because they wanted not to give to society, but for society to give to them. The freedom they were seeking was freedom from responsibility. It is no wonder, then, that they ceased to be free. In the modern world, we should recall the Athenians’ dire fate whenever we confront demands for increased state paternalism.

To cite a more recent lesson in the importance of moral foundations, we should listen to Czech President Vaclav Havel, who suffered grievously for speaking up for freedom when his nation was still under the thumb of communism. He has observed, “In everyone there is some longing for humanity’s rightful dignity, for moral integrity, and for a sense that transcends the world of existence.” His words suggest that in spite of all the dread terrors of communism, it could not crush the religious fervor of the peoples of Eastern Europe and the Soviet Union.

So long as freedom, that is, freedom with responsibility, is grounded in morality and religion, it will last far longer than the kind that is grounded only in abstract, philosophical notions. Of course, many foes of morality and religion have attempted to argue that new scientific discoveries make belief in God obsolete, but what they actually demonstrate is the remarkable and unique nature of man and the universe. It is hard not to believe that these gifts were given by a divine Creator, who alone can unlock the secrets of existence.

Societies Without Moral Foundations

The most important problems we have to tackle today are problems, ultimately, having to do with the moral foundations of society. There are people who eagerly accept their own freedom but do not respect the freedom of others—they, like the Athenians, want freedom from responsibility. But if they accept freedom for themselves, they must respect the freedom of others. If they expect to go about their business unhindered and to be protected from violence, they must not hinder the business of or do violence to others.

They would do well to look at what has happened in societies without moral foundations. Accepting no laws but the laws of force, these societies have been ruled by totalitarian ideologies like Nazism, fascism, and communism, which do not spring from the general populace, but are imposed on it by intellectual elites.

It was two members of such an elite, Marx and Lenin, who conceived of “dialectical materialism,” the basic doctrine of communism. It robs people of all freedom—from freedom of worship to freedom of ownership. Marx and Lenin desired to substitute their will not only for all individual will but for God’s will. They wanted to plan everything; in short, they wanted to become gods. Theirs was a breathtakingly arrogant creed, and it denied above all else the sanctity of human life.

The 19th century French economist and philosopher Frederic Bastiat once warned against this creed. He questioned those who, “though they are made of the same human clay as the rest of us, think they can take away all our freedoms and exercise them on our behalf.” He would have been appalled but not surprised that the communists of the 20th century took away the freedom of millions of individuals, starting with the freedom to worship. The communists viewed religion as “the opiate of the people.” They seized Bibles as well as all other private property at gun point and murdered at least 10 million souls in the process.

Thus 20th century Russia entered into the greatest experiment in government and atheism the world had ever seen, just as America several centuries earlier had entered into the world’s greatest experiment in freedom and faith.

Communism denied all that the Judeo-Christian tradition taught about individual worth, human dignity, and moral responsibility. It was not surprising that it collapsed after a relatively brief existence. It could not survive more than a few generations because it denied human nature, which is fundamentally moral and spiritual. (It is true that no one predicted the collapse would come so quickly and so easily. In retrospect, we know that this was due in large measure to the firmness of President Ronald Reagan who said, in effect, to Soviet leader Mikhail Gorbachev, “Do not try to beat us militarily, and do not think that you can extend your creed to the rest of the world by force.”)

The West began to fight the moral battle against communism in earnest in the 1980s, and it was our resolve—combined with the spiritual strength of the people suffering under the system who finally said, “Enough!”—that helped restore freedom in Eastern Europe and the Soviet Union—the freedom to worship, speak, associate, vote, establish political parties, start businesses, own property, and much more. If communism had been a creed with moral foundations, it might have survived, but it was not, and it simply could not sustain itself in a world that had such shining examples of freedom, namely, America and Great Britain.

The Moral Foundations of Capitalism

It is important to understand that the moral foundations of a society do not extend only to its political system; they must extend to its economic system as well. America’s commitment to capitalism is unquestionably the best example of this principle. Capitalism is not, contrary to what those on the Left have tried to argue, an amoral system based on selfishness, greed, and exploitation. It is a moral system based on a Biblical ethic. There is no other comparable system that has raised the standard of living of millions of people, created vast new wealth and resources, or inspired so many beneficial innovations and technologies.

The wonderful thing about capitalism is that it does not discriminate against the poor, as has been so often charged; indeed, it is the only economic system that raises the poor out of poverty. Capitalism also allows nations that are not rich in natural resources to prosper. If resources were the key to wealth, the richest country in the world would be Russia, because it has abundant supplies of everything from oil, gas, platinum, gold, silver, aluminum, and copper to timber, water, wildlife, and fertile soil.

Why isn’t Russia the wealthiest country in the world? Why aren’t other resource-rich countries in the Third World at the top of the list? It is because their governments deny citizens the liberty to use their God-given talents. Man’s greatest resource is himself, but he must be free to use that resource.

In his recent encyclical, Centesimus Annus, Pope John Paul I1 addressed this issue. He wrote that the collapse of communism is not merely to be considered as a “technical problem.” It is a consequence of the violation of human rights. He specifically referred to such human rights as the right to private initiative, to own property, and to act in the marketplace. Remember the “Parable of the Talents” in the New Testament? Christ exhorts us to be the best we can be by developing our skills and abilities, by succeeding in all our tasks and endeavors. What better description can there be of capitalism? In creating new products, new services, and new jobs, we create a vibrant community of work. And that community of work serves as the basis of peace and good will among all men.

The Pope also acknowledged that capitalism encourages important virtues, like diligence, industriousness, prudence, reliability, fidelity, conscientiousness, and a tendency to save in order to invest in the future. It is not material goods but all of these great virtues, exhibited by individuals working together, that constitute what we call the “marketplace.”

The Moral Foundations of the Law

Freedom, whether it is the freedom of the marketplace or any other kind, must exist within the framework of law. 0thenvise it means only freedom for the strong to oppress the weak. Whenever I visit the former Soviet Union, I stress this point with students, scholars, politicians, and businessmen—in short, with everyone I meet. Over and over again, I repeat: Freedom must be informed by the principle of justice in order to make it work between people. A system of laws based on solid moral foundations must regulate the entire life of a nation.

But this is an extremely difficult point to get across to people with little or no experience with laws except those based on force. The concept of justice is entirely foreign to communism. So, too, is the concept of equality. For over seventy years, Eastern Europe and the Soviet Union had no system of common law. There were only the arbitrary and often contradictory dictates of the Communist Party. There was no independent judiciary. There was no such thing as truth in the communist system.

And what is freedom without truth? I have been a scientist, a lawyer, and a politician, and from my own experience I can testify that it is nothing. The third century Roman jurist Julius Paulus said, “What is right is not derived from the rule, but the rule arises from our knowledge of what is right.” In other words, the law is founded on what we believe to be true and just. It has moral foundations. Once again, it is important to note that the free societies of America and Great Britain derive such foundations from a Biblical ethic.

The Moral Foundations of Democracy

Democracy is never mentioned in the Bible. When people are gathered together, whether as families, communities or nations, their purpose is not to ascertain the will of the majority, but the will of the Holy Spirit. Nevertheless, I am an enthusiast of democracy because it is about more than the will of the majority. If it were only about the will of the majority, it would be the right of the majority to oppress the minority. The American Declaration of Independence and Constitution make it clear that this is not the case. There are certain rights which are human rights and which no government can displace. And when it comes to how you Americans exercise your rights under democracy, your hearts seem to be touched by something greater than yourselves. Your role in democracy does not end when you cast your vote in an election. It applies daily; the standards and values that are the moral foundations of society are also the foundations of your lives.

Democracy is essential to preserving freedom. As Lord Acton reminded us, “Power tends to corrupt, and absolute power corrupts absolutely.” If no individual can be trusted with power indefinitely, it is even more true that no government can be. It has to be checked, and the best way of doing so is through the will of the majority, bearing in mind that this will can never be a substitute for individual human rights.

I am often asked whether I think there will be a single international democracy, known as a “new world order.” Though many of us may yearn for one, I do not believe it will ever arrive. We are misleading ourselves about human nature when we say, “Surely we’re too civilized, too reasonable, ever to go to war again,” or, “We can rely on our governments to get together and reconcile our differences.” Tyrants are not moved by idealism. They are moved by naked ambition. Idealism did not stop Hitler; it did not stop Stalin. Our best hope as sovereign nations is to maintain strong defenses. Indeed, that has been one of the most important moral as well as geopolitical lessons of the 20th century. Dictators are encouraged by weakness; they are stopped by strength. By strength, of course, I do not merely mean military might but the resolve to use that might against evil.

The West did show sufficient resolve against Iraq during the Persian Gulf War. But we failed bitterly in Bosnia. In this case, instead of showing resolve, we preferred “diplomacy” and “consensus.” As a result, a quarter of a million people were massacred. This was a horror that I, for one, never expected to see again in my lifetime. But it happened. Who knows what tragedies the future holds if we do not learn from the repeated lessons of history? The price of freedom is still, and always will be, eternal vigilance.

Free societies demand more care and devotion than any others. They are, moreover, the only societies with moral foundations, and those foundations are evident in their political, economic, legal, cultural, and, most importantly, spiritual life.

We who are living in the West today are fortunate. Freedom has been bequeathed to us. We have not had to carve it out of nothing; we have not had to pay for it with our lives. Others before us have done so. But it would be a grave mistake to think that freedom requires nothing of us. Each of us has to earn freedom anew in order to possess it. We do so not just for our own sake, but for the sake of our children, so that they may build a better future that will sustain over the wider world the responsibilities and blessings of freedom.