Getting It Exactly Backwards

The mechanism for this recession seems pretty clear:  A bursting asset bubble has left both lenders and consumers over-leveraged, so everyone is trying to reduce their debt.  This means less consumer spending for a while, as well as tighter lending.

Running a small business over the last few months, I have found that the credit we need to expand is not unavailable, but is harder to get.  Banks and individual investors are asking for tougher terms, more collateral, and are being pickier about what they will fund.  All totally normal and unsurprising (though stressful if you are in the middle of it).

The one thing small borrowers like myself have in our favor:  Eventually, lenders have to lend and investors have to invest.  They simply cannot just put all their money in the vault or the mattress.  The money they hold, in deposits and CD's and whatever else, has a cost, as do their operations staff.  These costs have to be covered.  The only way they have of doing so (short of switching businesses) is to put their free cash to work.  They have to lend it and invest it.  It's  a useful thing to remember in this world dominated by the cult of victimization and helplessness  -- that even as a borrower, you have power.  Banks need you as much as you need them.

So, what does the government do now?  Well, very soon, the Obama administration is going to be marketing to banks and investors an additional trillion dollars of government bonds backed by the full faith and credit of the US taxpayer as an alternative investment to funding my business.  Uh, yeah, that's sure going to help.  On Thursday, I had some power with investors.  Given time, they were going to have to consider my business as a place to put their money to work.  Now, however, everyone can run out and park their money in a trillion dollars of new government securities that have features attached I can never match (e.g. the ability to print money or grab it at gunpoint to repay the loans).

But don't worry about me, I will figure it all out.  I just will not grow the business or hire as many people as I thought I could given new investment capital.  But everything will be fine for the country as a whole as long as you believe that Nancy Pelosi and Barack Obama, with their vast business experience, will invest this trillion dollars more productively than I, and other like me, would have.

  • Link

    Unless our banks totally melt down, we'll likely see some kind of recovery in 2010. But we have longer-term problems. I fear the following will happen:

    Federal revenues are consistently about 19% of GDP, no matter the tax rates that are used. But federal spending has been going up and is about to explode.

    We recently passed two cross-over points. Outflows for federal entitlements are now higher than payroll tax inflows. Also, the federal government now spends more per retiree on Medicare than it does on Social Security ... these trends will continue.

    The federal government has masked this to an extent by pushing Medicare costs onto the states, which is a contributing factor as to why many states can't make budget. Part of the Stimulus Bill is to bail out these states, and in effect take these costs back onto the federal budget where they will be covered by increased federal borrowing.

    This can only be a temporary solution, as it's not sustainable. Over the next year or two or three, we'll see federal spending be significantly higher than 19% of GDP. We won't be able to maintain the fiction that this is a temporary crisis that justifies enormous deficits. We'll either have to cut spending sharply or raise taxes sharply.

    This is why the Stimulus Bill is so bad. It isn't about one-time infrastructure projects -- where you can point to a bridge or a train line as an outcome -- as much as it is a big patch on government deficits at all levels ... and, shockingly, a commitment to fund more government programs.

    My fear is that Obama is a closet socialist who will see this as an opportunity to jack taxes on the "rich" in order to level society.

    Am I wrong?

  • Zach

    I blame DuckTales. People think that the rich hide all their money in a vault, and go swimming in all that money on a regular basis (often with their 3 nephews).

  • Michael Miller

    "My fear is that Obama is a closet socialist who will see this as an opportunity to jack taxes on the “rich” in order to level society.
    Am I wrong?"

    No, not at all. Obama has publicly admitted to favoring redistribution. Robert Reich is a key advisor to Obama, and Reich is quoted in his bio on the wikipedia as follows: -In response to a question as to what to recommend to the incoming president regarding a fair and sustainable income and wealth distribution, Reich said, "Expand the Earned Income Tax Credit — a wage supplement for lower-income people, and finance it with a higher marginal income tax on the top five percent. For the longer term, invest in education for lower income communities, starting with early-childhood education and extending all the way up to better access to post-secondary education."

    Stay tuned. They have a big plans.

  • Link

    Axelrod is a red diaper baby, and I suspect Obama is too.

    If so, bigger deficits aren't a problem in their eyes ... but an opportunity to raise rates as a means to level society. I expect that they plan to eliminate caps on payroll taxes, and to raise rates, so that marginal federal rates will go well over 50%. "Rich" will be defined down to $150,000 or $100,000. Future deficits might even bring this lower. So long as the majority of Americans make less, and have been trained to see that they're not paying, Obama & Co will believe they can sell this politically.

    People often forget ... but IRA distributions are subject to tax on the way out.

    We're on a path where we will soon have to either raise taxes a lot, or cut spending a lot. Which way do you think Obama & Co will go?

    Such a program will kill growth, and lead to higher unemployment ... but Obama & Co wouldn't admit that.

    Such a program won't hurt the truly wealthy ... who own things and are good at hiding income.

    It'll lead to a two class society ... not socialism ... it's very Latin American.

  • boqueronman

    Cries and lamentations are all over the internet regarding the "socialism" of the Obama regime. Certainly a frightening prospect, but frankly it doesn't seem they are smart enough for that. My question in response would be, is the Chicago city machine socialist? I don't think so but I firmly believe that's where one must look for a pattern, if there is one, to Obama's governing style. For me, the "stimulus" bill should be retitled as the "Democrat Federal Patronage Bill." It is all about rewarding Democrat constituencies - trial lawyers, labor unions, the education establishment, racial "grievers," social and environmental non-profits, and selected business high rollers - to ensure loyalty, with the resulting campaign contributions and voting patterns, and punishing their political opponents - small and medium businesses, non-union employees, the military, the religious community, and, eventually I'm sure, the South. News is already leaking about the Fairness Doctrine, the call for so-called "national service" by BHO during half-time at the BB All-Star game, and, issuance (on 1/23/09) of a revised DoD directive about its Civilian Expeditionary Workforce (in other words, NOT uniformed personnel) which strikes all references to overseas and adds options for its use to include "restore order" and conduct "stability operations." No, there is much to be troubled by. Venezuela's Hugo Chavez had a referendum to approve unlimited reelection. We may not get that chance. A total of 34 state legislatures is sufficient to invoke a Constitutional Convention, which then can, as its first act, rescind our present Constitution. So far, 32 states have voted in favor of such a convention. Unified action - economic, political, and, as a last resort, military - may be required before this is all over.

  • Link

    Obama & Co scared us into adopting the Stimulus Bill, and misrepresented its details. I wished it had included more "bridges to nowhere" as they're only one-off items and not a down payment on open-ended commitments for new spending ... which is waht we got. Boqueronman, you called it ... it's the "Democrat Federal Patronage Bill."

    So I suspect the motives of Obama & Co in scaring us into this, especially as this was done in the midst of what Obama says is our "greatest economic challenge in generations."

    I believe we'd agree that Obama has all the deviousness of a Chicago alderman, and that the Stimulus Bill is the work of a profligate big city mayor, writ large. But I fear it goes beyond that. Obama has the ego to want to leave a huge personal stamp on America. So if he and his inner circle are looking ahead ... and are pretty smart ... they have to see that spending and tax revenue will be unsustainably out of balance, so we'll be faced with the need to either sharply cut spending or to sharply raise taxes.

    Obama has admitted to wanting to use the tax system to redistribute income. During the campaign, he cleverly came up with his 95% / 5% plan as a way to buy votes. So it's not that much of a stretch to see that he'll cover deficits with big taxes on the "rich." No plumber or doctor or honest small businessman will be able to take home more than $100,000.

    Here's the kicker: Obama and Axelrod probably see this not as an unfortunate but necessary outcome ... but as a desirable end in itself.

  • http://wordpress.pocosin.com Counsel

    Pretentiousness. Politicians, I think, are intimately comfortable with it...

    Washington DC (and much of the USA public) chastise CEOs for flying public jets to Washington DC to speak to Congress. Yet, Congress says nothing when Obama and the complete retinue fly to Colorado to sign the Stimulus package when he could have done so in Washington DC?

    Was the trip to Colorado part of the Stimulus Plan? If so, how is that different from what the CEOs did?

    We should be cutting social security taxes. This gives a 6.2% "raise" to every taxpaying employee. It gives that value from each employee's 6.2% as a profit to the company.

    Social Security is already broken, and this could be the time to fix it and give a real stimulus to the economy.

    We could make social security contributions pay for ... social security only (gasp) rather than funding the federal budget. Congress always tells the CEOs they should change their spending and salaries if their business model can't support the costs.

    Funny how Congress just raises taxes or goes into debt to fund theirs...

    "Do as I say not as I do" appears to be the modus operandi in Washington...

  • David

    I find so many of your articles insightful, thought provoking, and educational. In this case, I disagree with your assessment of the cause of the recession, the rest of your post is spot on (as usual).

    Out here in the midwest, we knew it was happening last spring, before any of the economists or the media had any clue. While the cost of living is much more reasonable here, incomes are lower as well. The sub-prime mortage/bursting housing bubble problems hadn't really picked up steam yet, but the hurt had already started.

    When gas hit $4.62/gal, everyone's budget took a beating. Take the median income, translate this to weekly net take home, then compare to the increase in the fuel expense. For example, $40,000/yr is about $30,000 net annually or ~$575/wk, 20 gal/wk X $2.76 increase per/gal = about 10% of net income. Anytime consumers lose 10% of their purchasing power, the pain is going to spread throughout the economy. My wife and I didn't take our normal number of camping trips, perhaps we weren't the only ones who didn't, and it was a trend you were aware of.

    I maintain that the recession was caused by the fuel price spike, the housing problem was just waiting for a downturn to trigger it. Fuel prices came back down, but the damage was done. It doesn't seem likely to me that we would be projecting a recovery in late '09, if fuel prices had remained high.

    I think that it is important to understand what the effects of high energy costs are, and to get the info out there. Our new President has an agenda that will cause energy prices to go through the roof, and the result won't be pleasant. I don't think that the MSM will educate everyone about this, but it's the libs who prevented us from having a meaning energy policy, and of course there's always AGW to worry about.