Coyote Blog

Kevin Drum doesn’t buy the regime uncertainty argument as a partial explanation of the slow recovery.

Here’s what’s remarkable: Carter, a law professor at Yale, apparently never once bothered to ask this guy just what regulations he’s talking about. Is he concerned with general stuff like the healthcare law? Or something highly specific to his industry? Or what?

Regardless, I’ve heard this kind of blowhard conversation too often to take it seriously. Sure, it’s possible this guy manufactures canisters for nuclear waste or something, and there’s a big regulatory change for nuclear waste storage that’s been in the works for years and has been causing everyone in the industry heartburn for as long as they can remember. But the simple fact is that regulatory uncertainty is no greater today than it’s ever been. Financialuncertainty is high, but the Obama adminstration just hasn’t been overhauling regs that affect the cost of new workers any more than usual. The only substantial exception is the new healthcare law, and if you oppose it that’s fine. But it was passed over a year ago and its effects are pretty easy to project.

First, the costs of the health care law are NOT easy to project, and are made even harder when your company might or might not get waivers from certain provisions.    Second, he seems to forget cap and trade, first by law and then by executive fiat; the NLRB’s new veto power over corporate relocations it exercised with Boeing; the absurdly turbulent tax/regulatory/permitting regime in the energy field, and particularly oil and gas.  How about trillion dollar stimulus projects, that until very recently Obama was still talking about replicating (and Krugman begs for to this day).  I could go on and on.  This is spoke just like a person who never had to run a business.

Further, I wrote this in the comments section:

I think you are both right and wrong.  I am sure the discussion about this is to some extent overblown.  But you are thinking about business and hiring much too narrowly.

You seem to have a mental model of business showing up at the door, and someone turning that business down because they don’t want to hire an employee to serve it (or out of sheer petulance because Fox News told them to sit on their hands, lol).  You find it unlikely anyone would refuse the business, and so do I.

But I run a small to medium size business, and a lot of hiring decisions don’t work that way.    I do have some situations that fit your model – I have a campground that is really busy this year, so we hired more people to serve the volume.   No problem.

But most of my hiring decisions are effectively investments.  I am going to create a new position, pay money to train that person, and pay their wage for a while in advance of demand.  Or I am going to open a new site or department or location and make a lot of investment, and the return on investment may be very sensitive to small changes in labor or regulatory costs.

For our business, with labor costs over 50% of costs, the issue is definitely labor costs.  Our pre-tax margins are in the 6-7% range.  So if labor costs are 60% of revenues, then a 10% change in labor costs might wipe out the margin entirely, and a much smaller change in costs might flip the investment from making sense to not making sense.

We run a seasonal business with part-time workers who are older and on Medicare.  Regulations about exactly how much we will have to pay under Obamacare have not been written, so we have no idea how much our employment costs will go up in 2014, so we sit and wait.  I have cancelled two planned campground construction projects in the last 6 months because we have no freaking idea if they will make money.

If I am having trouble with just this one law figuring out whether to make investments, what are, say, oil companies doing in evaluating investments when they have absolutely no idea what their taxes will be, whether they will be permitted or not to drill, or whether they will be subject to cap and trade?

One other thought, it strikes me that there is a lot of good scholarship that suggests that the Great Depression was extended by just this kind of regime uncertainty.  Now, of course, the proposed structural changes to the economy being proposed at the time were more radical than anything on the table today.  The National Industrial Recovery Act was essentially an experiment in Mussolini-style economic corporatism, until most of it was struck down by the Supreme Court.   Nothing so radical is being proposed (unless you work in health care).

Look, I know the Left has convinced itself that only consumer demand matters in an economy, but business investment has simply got to matter in a recovery.   If the returns on future investments are harder to predict, and therefore riskier, businesses are going to apply a higher hurdle rate to new investments, meaning they don’t stop entirely, but do invest less.

One interesting may to confirm this some day would be to look back and see if larger corporations with political access invested more than smaller ones or ones with less access.  Did GE, who clearly can get whatever it wants right now from the government, invest more than a small company or even than Exxon, which is on the political outs?  If so, this in my mind would confirm the regime uncertainty hypothesis, because it means that the companies doing most of the investing were the ones confident that they could shape the mandates coming out of the government in their favor.

Beyond regime uncertainty, if you want to talk about Obama and the recovery, you have to mention that a trillion dollars was diverted from private hands to public hands.  Does anyone believe that taking a trillion dollars out of whatever investments private actors would have used the money for and diverting most of it to help maintain government payrolls is really the way to increase the strength and productivity of the economy?

From Fox Business

U.S. Treasury Secretary Timothy Geithner told Congress he would start tapping into federal pension funds on Monday to free up borrowing capacity as the nation hits the $14.294 trillion legal limit on its debt.

The U.S. Treasury will issue $72 billion in bonds and notes on Monday, pushing the nation right up against its borrowing cap at some point during the day, according to a Treasury official.

Geithner said he would suspend investments in two government retirement funds, which will give the U.S. Treasury $147 billion in additional borrowing capacity.

“I will be unable to invest fully” in the civil service retirement and disability fund and the government securities investment fund, he said in a letter to congressional leaders

Why does this surprise anyone?  Up to this point, government workers have enjoyed a special privilege.  All other Americans have had their retirement accounts in the Social Security system raided and replaced with IOU’s, such that $0 actually still exists in these accounts.  All this does is subject government worker’s pensions to the same treatment.  It is in fact telling that government employees have been a protected class on this dimension for so long.

I am sure these funds will be quickly replaced.  No such luck for folks counting on Social Security for their retirement.

Hey, why make expensive investments when the government will just give you access to your competitor’s infrastructure?

Federal Communications Commission has decided to mandate data roaming by a 3-2 vote. Simply put, major carriers like AT&T and Verizon will be required to let you check your email and perform VoIP calls over their federally-licensed airwaves even if you’re actually paying a regional carrier for your cellular coverage instead — just as they’ve been required to do for voice and messaging since 2007. As you can imagine, Big Red and Ma Bell aren’t exactly jumping for joy at the news, with both threatening to slow expansion into niche markets if they’ll be forced to share their infrastructure. The victorious members of the FCC claim that this doesn’t constitute common carriage because the big boys still get to negotiate “commercially reasonable” rates. Considering that two dissenting commissioners say that it is, indeed, common carriage, though, and thus beyond the powers granted to the FCC, we imagine we haven’t heard the last of this debate.

By the way,  the commercially reasonable rate piece is so much BS.  I can say from experience that there is no such thing as a true price negotiation when one party is forced to make a deal.  In one of my great moments in not reading the fine print, I signed a commercial lease with the National Park Service in which the fine print demanded that I buy the personal property used in that operation from the former tenant.

Well, you can imagine what happened.  The contract said I had to buy it at a reasonable market price, but at the end of the day, if they guy insisted on selling me a pile of useless junk for $100,000, my negotiation options were limited because I could not just walk away.  Just to really hammer the lesson home to me about being careful in such deals in the future, the former tenant really went the extra mile in taking advantage of the provision.  He stripped out every good asset from the operation and shipped in every non-working piece of junk equipment he could find in his other operations — after all, I seem to have given him an open-ended “put”.  Only his, shall we say, excessive creativity in the latter eventually saved me, as trying to sell property from other operations (there was even some old couches from someone’s house sitting in the boat repair shed) was considered by the NPS to be a violation of the rules and they eventually released me from the requirement.

Most of the time when folks lament about the US’s trade deficit, I just yawn.  That is because to a large extent the trade deficit is simply an artifact of an arbitrary accounting definition.  Basically, we define a certain fairly arbitrary subset of total commerce and commercial activity between two countries, and then throw tantrums when that arbitrary account is unbalanced.  At the end of the day, the payments loop has to close – the dollars come back to the US somehow.  Historically, most money from such trade deficits have come back to the US as foreign investments in US assets (think, for the example, Japanese investments in the late 80′s in US real estate and high profile companies).

It is amazing that we would complain about such a situation.  First, we should be thrilled that foreigners choose to invest in our productive assets rather than just our manufactured goods.  Second, think about it this way — if we export a product, we get the foreign money but the product goes overseas.  When foreigners invest in our fixed assets, we get the money and the assets remain here.  It is the outsized political influence of shareholders and workers in a few export-oriented industries  rather than economic rationality that keeps the US Congress so fixated on the “trade deficit.”

The one issue I have with the trade deficit is it is in large part tied closely to the budget deficits run by the Feds.   Think about it this way — let’s take the definition of the balance of trade and keep it intact, adding just one single additional export product to the calculation:  US Government debt securities.   Certainly these are products we export, and there is nothing wrong with thinking about them as an alternative way for foreigners to spend dollars vs. buying US exports  (just as we all face the choice of investing for savings or buying consumer goods with our own incremental income).

Last year the US trade deficit was between $400 and $500 billion per year.  In 2009 the US government deficit was something like $1.4 trillion.  Assuming they issued debt securities to fund this deficit (ignore QE for now) and assuming foreigner bought 40-50% of these bods, then we exported as much as $700 billion in US government bonds to foreign buyers.  Now, suddenly, when we consider this one additional export product in the mix, we are running a trade surplus.  This is why currencies like the yuan are not necessarily as undervalued as people (including President Obama) may assume — the issuance of government bonds creates a huge demand for the dollar, and keeps the value high.  If exporters are truly pissed off about the high value of the dollar vs. the yuan, they should not complain to the Chinese, they should complain to Obama and the US Congress for competing with them in foreign markets.  Though we tend to go through phases where we forget it, saving is a competitive product to consumer goods.

Update: Scott Grannis via Carpe Diem

“The Chinese sell us mountains of cheap goods, then turn around and invest most of the proceeds (equivalent to our trade deficit with China) in U.S. Treasury securities. We get the goods, and we get to keep the money. Then we devalue the dollar, and they lose on their investment. Why we would want them to stop doing this is beyond me, though if I were a Chinese citizen, I would be furious with my government for directing such massive quantities of my country’s export earnings to Treasuries.

A while back another entrepreneur/blogger wrote and asked me about investment choices for retirement.  My philosophy on retirement seems to be a lot different than that of others, and I think owning one’s own company changes some of the dynamics of retirement investing.   Note that this advice is not right for everyone, and maybe no one, so read at your own risk.  I publish it because the person I wrote suggested I do so, and after weeks of crazy intense work schedules I finally have the time.

A blogger wrote me about his despair at finding appropriate investment vehicles for his retirement savings.   With relatively equal chances of 1) a long period of Japan-like slow growth or 2) a high inflationary period triggered by trying to avoid #1, both bonds and equities looked bad, and while real estate may have some value plays when things finally bottom out, neither of us has the time to pursue that.  [since our emails, International equities are something I have moved money into, both as a diversification play as well as a way to short the dollar].

As I wrote him in one email

There is still a good chance of returning to normal growth in the middle somewhere, but both those bookends [inflation and stagnation] loom much larger than they might have, say, in my calculations five years ago.  I have trouble figuring out what to invest in when both are possibilities.  Equities?  Great for hedging inflation but suck if there is a lost decade.  Bonds would make sense in that case, but their interest will be low and they will be awful if inflation ramps up.  If I really knew we would get inflation and devaluation, I would be leveraging like crazy because inflation transfers wealth from creditors to debtors.

As a result, I said that my main investment for my free capital was debt reduction and de-leveraging of my own business.  Paying down debt has the advantage of having an absolutely predictable return and it reduces risk.   This makes double sense for me as I have put new expansion investments in my business on hold until a variety of government issues from health care to tax rates become clearer.  (For example, in health care, because my company is an oddity, with seasonal part time workers mostly on Medicare already, no one can yet tell me what my future costs will be.  Estimates range from +0 to +20% of revenues!)

The key to my business, which may be very different from others, is that I make big investments to gain long-term contracts, but once captured, these contracts give my business a fair amount of stability and predictability.  Further, in the latest recession, my business has proved to be either counter-cyclical or at least recession-proof to some extent, as 2009 was actually a blow-out record year for us.  Given these facts, I am able to put a higher percentage of my net worth into my own business as an investment, without having to diversify as much in case of business trauma.  And I prefer this.  Given the choice of investing in a company I barely know on the NYSE or mine, which I understand and control, I prefer the latter.  Also, returns on capital from buying or investing in private small businesses can be much higher (with higher risk of course) than in traditional equities – see my whole series on buying a small business.

But here is where I really differ from most people: I take a very different view of retirement.   When I worked in grinding corporate jobs (e.g. up until I was about 40) I was very focused on retirement.  Now that I am doing something that is not brutally stressful,  I hardly think about retirement.   The whole concept of retirement now seems weird.  I have, after a lot of hard work, gotten my business to the point where I can generally work as hard as I want to — if I don’t work hard, the business does not grow but I have good people such that it doesn’t fall apart either.  I compete with people who are running businesses in their late 70′s who are still having a good time.  I can take nice trips when I want to, take the day off if I need to, or whatever.  My business actually has an off-season so I can be more relaxed part of the year.

My advice to this particular entrepreneur was to maybe reconsider the paradigm of “retirement.”  After all, the the long history of the world, retirement is a new concept that is barely 100 years old.

Are you the shuffleboard and golf type?  What do you imagine yourself doing after retirement?  I think you need some protection against becoming infirm or senile, but if you are healthy and vigorous, are you the type to get bored fast?  As an example, nearly all of my 400 employees are retired, but they all got bored and wanted something to do.

Here is an alternative, entrepreneur’s way to think about planning for retirement:  How do I work really hard building a business that in 10 years will have a position such that it spits out some level of cash without effort on my part and can still grow if I want to spend time on it.  I am surrounded in Scottsdale by people who have done exactly this after giving up a corporate job.  At some point they took their savings from their 30s and 40s and dumped it into a business where they could still have the lifestyle they wanted.  Buying or building the right company is sort of like buying a bond with an attached warrant whose value is related to how hard you want to work.

As I implied earlier, this is not an appropriate approach for every small business.   The problem with technology businesses, for example, is that they never seem to mature into that latter predictable-cash-flow-stable-market-share phase.  One is always running in place.  One lesson I never forgot from my corporate years:  In the industrial sector, I often saw people making loads of money selling bushings or some such whose design hadn’t changed since 1920.  It led me to this strategy:  Find a market with barriers to entry, which may well not be very sexy, and spend ten years battering you way in, and then relax behind those walls.  (As to sexy, the very first two classes of the first year Harvard Business School strategy course were a sexy cool software business and a boring stable industrial product business.  Of course,the boring stable water meters made a fortune, while the software business never made a good return on capital.  Beware of sexy businesses — see: Airlines).

One other paradigm I would challenge is the notion everything you do as an entrepeneur has to be started from scratch.  Many entrepreneurs have fun doing this but the prospect of doing a bootstrap startup when you are 70 years old is exhausting.   Such entrepreneurs who have had a life of serial startups might consider a new phase in their business career as they get older, when they have saved enough assets to perhaps buy into an existing business rather than starting from scratch.  I cannot tell you how many interesting small businesses there are that come up for sale with a guy who has an interesting product and has made some progress but can’t manage his way out of a paper bag and thus hits some growth ceiling.  I bought just such a core to my current business 8 years ago.  These businesses require a lot of due diligence, because they are a real mixed bag, but I bought mine in an asset sale for 3.5 times EBITDA (which is an entirely typical price).  Try buying Wall Street equities for 3.5 times EBITDA!  If you pick the right business, and you are a good manager, there is not a better investment out there.  Again,  see my whole series on buying a small business.

Of course this investing-for-retirement is higher risk, because one bets a substantial portion of his net worth on his own business.  But for those with confidence in their own ability, I find it a lot more compelling to bet my capital on myself rather than on guys I don’t know running the Fortune 500.

I thought this was an interesting irony of our growing corporate state:

In my post “Attention Gov’t: This Is How Businesses Are Created” I brought up the point that government regulations keep the average American from investing in ground floor business opportunities with rules specifying how much money someone must have before they can invest in start-ups (unless the start-up is being done by a friend or family member).  Government regulations also prevent start-ups from advertising their investment opportunity.  If you need ground-floor investment (as opposed to loans) to bring your business to the proverbial next level, there is a wall of regulation that keeps you from asking for it from the general public and specifies what “sophisticated investors” (the already rich) you can approach and how.

Those rules are there to protect us middle class rubes from being taken in by crafty and ill-intentioned businessmen.

I contrasted this protection the government so thoughtfully provides us–keeping us from making possible bad investments–with it’s promotion of lotteries and acceptance of casino gambling.

Now these people who will not allow an entrepreneur to advertise or promote his start-up in order to get voluntary investment money from people willing to take a risk on the business idea or invention are looking at legalization of online gambling in the USA.

Via a reader, the cost of a few politicians deciding that there absolutely had to be an Australian-assembled hybrid.

“My wife was looking for an Australian-made hybrid car,” Rudd told John Laws in March, 2007, “and I’m sure some of your listeners would have found this out – you can’t find one.

“So, that started me thinking about why don’t we have one in this country.”

There are certain people from whom the phrase “that started me thinking” serves as a 150-decibel alarm. We weren’t to know it at the time, but Kevin Rudd turned out to be one such bloke. Instead of settling on a nice secondhand Prius, Rudd’s simple quest to find some wheels for the missus quickly led, once he was elected, to the $500 million Green Car Fund.

Why couldn’t Ms Rein have been interested in something less expensive, like knitting? No, scratch that – once her husband “started thinking”, we’d have been stuck with a $2 billion National Crochet Initiative.

Subsidies appear to amount to about $(AU)100,000 per private car sale.  This is a sort of new brand of left-progressive triumphalism that reminds me of an essay Ayn Rand wrote decades ago on statism and prestige.  These are the modern Green equivalents of the Brandenburg Gate — they cost a lot of money, they don’t really do anything useful, but everyone can point at them and marvel.

And speaking of which, our current Administration in the US in by no means immune

U.S. President Barack Obama will attend a groundbreaking ceremony on Thursday for an LG Chem plant in Holland, Michigan, the company said Sunday. It is very unusual for an incumbent U.S. president to appear at such an event for a foreign company, and it is the first time for a Korean firm.

LG is investing US$300 million to build the plant which will produce batteries for electric vehicles. First-phase commercial production is scheduled to begin in the first half of 2012, and once completed in 2013 the plant will churn out lithium ion cells for 200,000 hybrid cars annually.

Ah, there Coyote goes exaggerating — because the article explicitly says that a private company will be investing the money, so this isn’t really a government project.   Ah, but read to the last paragraph

As part of efforts to revive the auto industry by bringing more green vehicles to the road, the U.S. government has lent considerable support to LG’s Holland plant, including $151 million from a federal stimulus program. The Michigan state government also offered tax cuts worth $130 million, which together with the stimulus funds will almost offset LG’s entire construction costs. The plant will help ease unemployment in the state by creating some 400 jobs, U.S. media reported.

So $281 million of the $300 million LG is investing is actually taxpayer money.  More brave capitalists! But fortunately we will have lots more batteries so rather than burn gasoline, electric vehicles can charge themselves from coal plants.

PS- Don’t forget the jobs, though, created for the low low taxpayer cost of $702,500 each!

PS #2 – I had not noticed before I wrote it, but both of these articles also share in common the government subsidizing foreign companies to manufacture in their country, rather than producing these goods elsewhere and importing them.  This reduces the benefit of these investments even further – its pretty clear that both batteries and Prius’s would have been made somewhere in the world, so they would have been available to consumers (probably at lower prices), but these investments merely were to shift production across some line on a map.

Update: John Stossel discusses another form of modern statist triumphalism — the government-funded sports stadium

South Africa’s ability to pull it all together for six weeks doesn’t mean the World Cup will be a net benefit to the country in the long term. As the ESPN video below explains, South Africa’s government spent $6 billion on the tournament. Tournament-related revenues are expected to fall well short of that figure. Some of the hundred million dollar stadiums built for the tournament won’t get much use now that the games are over. The video points to one stadium built for the tournament which will likely remain vacant—it sits over over slums that lack running water.

Fond memories of the month South Africa performed marvelously on the world stage are nice. But $6 billion is a lot to pay for a memory. These spectacles—the World Cup and the Olympics—are nearly always money losers. They’re a lousy investment in wealthy countries. They’re particularly garrish in countries that aren’t as affluent.

Remember that Greece got the same kudos for not screwing up the Olympics, but years later it sure seems like the $15 billion that was sunk into those games by the Greek government has contributed to its financial crisis.

The Free Market Project wonders why the government wants to make it harder for entrepreneurs to attract investment capital.

This is the same government that has no problem with the poorest people in our society, or anyone else, playing the lottery every week, or heading to an Indian casino or Las Vegas.  For certain, they don’t have an income limit on who can contribute to a political campaign, despite the fact that there is generally no pay-off for that unless you’re able to contribute thousands or bundle tens or hundreds of thousands in campaign donations….

My question is this: With the transparency possible using the Internet, why aren’t average citizens able to spend small amounts of money (like, lottery ticket money) on seed-money investments?  With proper transparency and protections in place, why aren’t entrepreneurs allowed to put their idea online so that the average Joe (or anyone) can look at what they’re doing and invest in it if they like the idea?

Government bureaucracies do not exercise power by allowing activities to occur – they only have power, and thus have reason to justify their continued funding and jobs, when they say no.   Every incentive that they have is to say no.  When a government agency allows progress to proceed smoothly, it is doing so because some person or small group is fighting against the very nature of the organization.  Anyone who believes otherwise about government agencies is challenged to go build and open a new restaurant in Ventura County, California.  Here is the latest example:

The [weatherizing] program was a hallmark of the American Recovery and Reinvestment Act, a way to shore up the economy while encouraging people to conserve energy at home. But government rules about how to run what was deemed to be a ”shovel-ready” project, including how much to pay contractors and how to protect historic homes during renovations, have thwarted chances at early success, according to an Associated Press review of the program.

”It seems like every day there is a new wrench in the works that keeps us from moving ahead,” said program manager Joanne Chappell-Theunissen. She has spent the past several months mailing in photographs of old houses in rural Michigan to meet federal historic preservation rules. ”We keep playing catch-up.”

And of course, even in a skeptical article about a “stimulus” project, no one ever mentioned what productive activities the $5 billion was being used for by private individuals before the government yanked it away for this little catastrophe.

By the way, the overblown rhetoric award has to go to this:

”This is the beginning of the next industrial revolution with the explosion of clean energy investments,” said assistant U.S. Energy Secretary Cathy Zoi. ”These are good jobs that are here to stay.”

Given that the first one was about steel mills and railroads and oil and electricity, if this new industrial revolution is all about caulking, I think I am getting nostalgic for the first one.

From the SEC web site (via frequent contributor LK)

The Securities and Exchange Commission today voted to provide public companies with interpretive guidance on existing SEC disclosure requirements as they apply to business or legal developments relating to the issue of climate change.

I haven’t seen anyone explain the reason for this requirement, so I thought I would do so.  Companies know that no real investor is going to pay any attention to these climate disclosures, so to avoid any future action accusing them of not being forthcoming enough, companies are going to go overboard outlining potential risks far beyond what they think is likely.  These exaggerations will protect them from the SEC while at the same time having no effect on their stock price.  Then, alarmists will collate all of these and use them as evidence of the high cost of climate change, saying “see, look at what all these public companies are saying climte change will do to them.”  Lacking any evidence of harmful climate change in the actual climate or economy, this is one way to manufacture fake evidence.

By the way, here is the diclosure every oil company should put in their reports:

Notice:  Poplist politicians are very likely to demagogue this company for a wide-range of imagined crimes in an attempt to get re-elected, including crimes against the climate in various forms.   Politicians will attempt to preferentially saddle this company with new taxes and regulations given that this company is not liked by many voters (despite the fact that many of these voters freelydo business with this company).  Politicians will likely continue to try to sieze portions of this company’s earnings, despite the fact that those earnings are relatively low given the magnitude of the our investments and the amount of value we add.

Tampa Rail writes (hat tip to a reader):

The new Phoenix light rail system is emerging as one of the most successful new systems in the country.  This is especially poignant for Tampa because in scale, project scope, and demographics, Phoenix represents the apogee of operating examples.

Over the course of its first year the system has received high marks in community integration, stunning ridership figures, and respectful financial constraint (making tough decisions on long-term planning that do not inhibit the value of its starter-line status today).  This is exactly what Hillsborough County is shooting for in its own implementation.  A perfect balance of conservative control and benchmarking combined with progressive action and democratic freedom, the latter which may finally come to Hillsborough County in the form of a referendum.  That all good stuff was achieved by such a strikingly similar auto-depenent culture is a great omen.  A starter light rail system can be championed by civic conservatives (Mark Sharpe), and civic progressives (Ed Turanchik) to great outcome….

Both pieces I link to here embarass anti-rail or anti-tax groups who are, as the Phoenix article notes, “muted” if not definetively silenced.  Their arguments against community investement were loud, often intelligent (once one bought into the ideological premise that rail systems must ‘pay for themselves’ and that community investement is somehow inherently evil – points not firmly established by any means among rationale individuals), and grossly atypical.  I will forever hype on how mechanical, unchanging, and how pre-web these attacks were formulated.

Ooh, how can I overcome my embarrassment?  Look, I don’t think I have ever argued that Phoenix Light Rail was run poorly or didn’t have pretty trains.   And I don’t know if moving 18,000 round trip riders a day in a metropolitan area of 4.3 million people is a lot or a little (though 0.4% looks small to me, that is probably just my “pre-web” thinking, whatever the hell that is).

The problem is that it is freaking expensive, so it is a beautiful toy as long as one is not paying for it.  Specifically, it’s capital costs are $75,000 per daily round trip rider, and every proposed addition is slated to be worse on this metric (meaning the law of diminishing returns dominates network effects, which is not surprising in this least dense of all American cities).

Already, like in Portland and San Francisco, the inflexibility of servicing this capital cost (it never goes away, even in recessions) is causing the city to give up bus service, the exact effect that caused rail to reduce rather than increase transit’s total share of commuters in that wet dream of all rail planners, Portland.  Soon, we will have figures for net operating loss and energy use, but expect them to be disappointing, as they have in every other city (and early returns were that fares were covering less than 25% of operating costs).

PS- I get a lot of comments that I have some weird anti-train bias.  Actually, I have an n-scale model railroad in one room of my house, and spent a lot of my teenage years traveling along rural rail lines and photographing trains.  I love trains.  I just don’t like stupid investments.

PPS- I was just thinking, on the basis the Tampa writer declares the building of Phoenix Light Rail a raving success, I could say the same thing about buying a super-size 100″ flat screen TV for $50,000.  It is beautiful.  Everyone who sees it will love it.  It works flawlessly.  Lots of people will be able to enjoy it at one time.  In fact, it is the greatest, most sensible and successful purchase of all time as long as you never mention the cost.  Which is, by the way, why only one person I have ever met has one (I happened to be at a Reason reception the other night and the homeowner had such a beauty on his living room wall).

Update: I try to anticipate every argument in these posts.  The one other argument is that rails takes congestion off roads.  But for most of its length, Phoenix light rail displaced one lane of road in each direction.  These lanes had a capacity as large or larger than what Phoenix light rail carries.  The were also much cheaper to build.  I must say I liked my quote from that post

If running trains requires, as you suggest, draining resources from millions of people just to move thousands, how is it sustainable?

If Obama really wanted to get small businesses to start investing again, he could announce that both cap-and-trade and the health care bill are dead-dead and will not be disinterred this year.   These two bills affect nearly 2/3 of our company’s cost structure.  Since we have single digit margins, small changes in the wage and fuel cost lines can completely wipe out our profits.  Not knowing what 2/3 of our costs were going to look like into the future, we have been sitting on our hands.

Unfortunately, this may not be enough.  The third leg of the uncertainty stool is income taxes, and its seems likely that some huge increase almost has to be forthcoming given Congress’s predilection for taxes and marked unwillingness to cut spending in any meaningful way.

Here is a very specific example.  We have an opportunity to invest about a half million dollars in a new operation in Texas.  Financing is available.  But in my evaluation spreadsheet, small changes in income tax rates combine with a potential 8% health care tax on wages and an unknown fuel tax increase to move the net present value by enormous amounts.  I am not going to risk a half million dollars on a 20-year investment when the government is considering so much legislation that will arbitrarily move the value of this investment.

This is why Obama’s offer of small business financing is meaningless.   In the last decade, government sponsored cheap money lured people into housing “investments” that eventually went upside down.   Are they now luring small businesses into a new trap, encouraging them to take on debt, only to slam the door on them with future increases to their operating costs and taxes?

Consider the incentives for a bank trying to set the risk profile of its investments.  Should it go for higher returns at higher risk, or dial back the risk at a cost to near-term profits?  Now consider this decision in the context of two actions from the past year:

• Large banks that took on too much risk are bailed out and management mostly preserved
• Banks that eschewed higher profits by avoiding bad risks are now forced to pay for the bailout of those that went wild:

Obama administration officials and lawmakers are scrambling to find a way to funnel some of the financial industry’s record earnings back to the taxpayers who helped rescue the industry from looming disaster.The White House is considering a fee on banks and other financial companies

as one approach, with revenues earmarked to help recoup any losses from the government’s $700 billion bailout fund, a senior administration official said.

Some in Congress want to add a new tax on bonuses or assess a small fee on all stock transactions, which would hit large banking companies the hardest.

Note that there is no attempt here to only charge banks who received bailout money, but all banks will be charged equally.  To each according to his need, from each according to his ability.  This is moral hazard in spades.

Ever get that feeling like the Obama White House doesn’t have a clue as to what it takes to actually run a business, make investments, hire people, sell a product, etc?  There is a reason for that:

It has been fascinating to watch George McGovern change his tune about much of the regulatory state over the last 10 years as he has actually tried to run a business.

On any number of occasions from October through February, I predicted that this recession would top out at perhaps 9% unemployment at the most, and would probably not be as bad as the recession of the early 1980′s.  My logic was that we had a mortgage-driven banking crisis, but that the crisis was perhaps not as bad as that of the late 1980′s and that many fundamentals (e.g. interest rates) were looking way better in this recession than in the early 1980′s.  I honestly thought that Bush and Obama Treasury and Fed officials were declaring the sky was falling more from the danger to their beloved former employers on Wall Street than due to any economic fundamentals.

Well, obviously I was wrong.  Unemployment has topped 10% and could be headed higher.

So the question is, do I accept that others saw something I did not, or do I crack open the self-serving excuses.  Well, at the danger that this will fall into the latter category (I will leave that to readers to decide) I do think some things have changed since late last year that have contributed to worsening the economy.

Businesses are reluctant to invest when the returns on their investment are wildly unpredictable, particularly when future income changes are more driven by changing acts of Congress rather than fluctuations in the market.   Over the last year the Congress and Administration have:

• Printed trillions of dollars of new money, raising the risk of future inflation
• Borrowed trillions of dollars, sucking capital out of private lending markets
• Run up deficits that pretty much guarantee future tax increases
• Toyed with health care bills that will substantially increase the cost of labor
• Toyed with climate bills that will substantially increase the cost of fuel and electricity
• Demagogued industries with average to below-average profitability for making obscene profits that must be reduced (e.g. health insurance companies who make 3-4% of sales)
• Taken over whole industries (autos, banks) and run them to the benefit of favored political constituencies, even when it violates the law (e.g. trashing for secured creditors of auto companies in favor of the UAW).
• Demonstrated a disdain for money-making by imposing populist compensation limits on executives of out-of-favor companies and industries.
• Spent money in the stimulus mainly to add government jobs, every one of which is generally focused on making my life running a business harder.  If you do not understand or believe this, you have not run a business that employs people.
• Shown a general philosophic hostility towards markets and capitalism

I am sure this is just a subset (Louis Woodhill has more in this vein here), but these all have negative effects on investment.  My company for one has backed out of several planned expansions this winter for four reasons:

1. Half of my costs are labor, and I don’t know how much Congress is going to increase my labor costs.  Current health care bills will increase it at least 8% — given that my typical margin in 5-8% of sales, a government action that increases half my costs by 8% is worrisome.  Worse, my smaller competitors will not bear this expense under certain versions of the legislation.
2. My second highest expense is fuel and electricity.  I have no idea right now how much Congress may raise these expenses.
3. Capital for small businesses is gone.  I can get secured equipment financing, but that is it.
4. Assuming I make any money from these investments, I have no idea how much I will be able to keep.  I would not be surprised at all if Obama pushes my marginal rates over 50% — and investments in my business are just too much work and risk to keep less than half if I make any money.

I used to work as for several years in St. Louis as VP of Planning for Emerson Electric.  I worked for a guy named Chuck Knight, who could be a real pain in the *ss to work for, but was a) brilliant and b) always willing to speak his mind without the typical filters a lot of other executives apply.  It appears that his successor Dave Farr, who I also knew at Emerson, is following in this tradition:

Emerson Electric Co. Chief Executive Officer David Farr said the U.S. government is hurting manufacturers with regulation and taxes and his company will continue to focus on growth overseas.“Washington is doing everything in their manpower, capability, to destroy U.S. manufacturing,” Farr said today in Chicago at a Baird Industrial Outlook conference. “Cap and trade, medical reform, labor rules.”…

Companies will create jobs in India and China, “places where people want the products and where the governments welcome you to actually do something,” Farr said.

The unemployment rate in the U.S. jumped to 10.2 percent in October, the highest level since 1983. Emerson, which Farr said employs about 125,000 people worldwide, has eliminated more than 20,000 jobs since the end of 2008 to lower expenses.

“What do you think I am going to do?” Farr asked. “I’m not going to hire anybody in the United States. I’m moving. They are doing everything possible to destroy jobs.”

Politicians in both parties are generally clueless about this kind of thing, because very few of them have ever run a business or even even been in a real business position other than as lawyer or lobbyist.  Just look at how George McGovern feels now that he has run a business.

But the Obama administration is almost scary clueless.  In defending their promotion of a good business environment, they cite the most hostile item on their agenda:

“This administration has made a significant commitment to U.S. manufacturing, including reforming the country’s health insurance system to bring down costs and make American companies more competitive globally,” Griffis said.

Not. One. Single. Clue.

Actually, I think the Obama administration may believe this, which just accentuates their preference for a corporate state wherein “business friendly” means support for the top 20-30 corporations in the country.   In the context of a few old-line corporations with politically powerful unions, health care reform is helpful in that it dumps a bunch of the corporation’s commitments to present and past workers onto the taxpayers.  But these are not the companies that grow the economy — they are just the ones with out-sized power in political elections.

Tyler Cowen links to a good article that gets at the fallacy that suddenly obsoleting our energy infrastructure and having to rebuild it will be of net economic benefit.

Optimistically treating European Commission partially funded data, we find that for every renewable energy job that the State manages to finance, Spain’s experience cited by President Obama as a model reveals with high confidence, by two different methods, that the U.S. should expect a loss of at least 2.2 jobs on average, or about 9 jobs lost for every 4 created, to which we have to add those jobs that non-subsidized investments with the same resources would have created

Includes 1 million euros in government subsidies per wind job created.

In my mind, the green jobs mantra is a result of the CO2 abatement case becoming fatally weak, with supporters of legislation casting about for other justificaitons.  From the very beginning, many of the most passionate folks are on the AGW bandwagon not because they really understand the science, but because the theory provided justification for a range of government actions (reduced growth, limited technology, reduced energy use, reduction in global trade — even vegetarianism) that they supported long before AGW made the news.

Update: A quick note on a theme I harp on a lot – nameplate capacity for wind and solar is really, really misleading.  In Spain in the study cited, wind operates at 19% of nameplate over the course of a year and solar operates at 8% (figure 3).  The actual CO2 reduction is even worse, because, particularly for wind, fossil-fuel fired turbines have to be spinning on hot backup for when wind suddenly dies.  Germany, the largest wind user in the word, found only 1,000MW of reduced fossil fuel plant needs from every 24,000 MW of wind capacity.

This year has been a frustrating year for my business.  As many of you know, I am in the business of privatizing public recreation.  We take over the management of public recreation facilities, and are generally able to run them to the same or better standards as the government for less money.  Whereas before we take over, the government typically loses money on a park, we often can run it at a profit AND pay the government rent for the concession rights.

This year, numerous state parks have been threatened with closure in states all across the country.  In many of these states, I have communicated with everyone I could think of, from the governor to state parks leaders, trying to say that companies like ours could probably keep many of these parks open. I told them I wasn’t looking for a sweetheart deal – we weren’t afraid to bid against other companies, but it was crazy to close parks that could easily remain open.   We have been told any number of times by numerous state leaders that they would prefer to close the park rather than put it under private concession management.

To some extent, this is due to the pressure of public employees unions, who have every incentive to play brinkmanship and force closure of parks rather than set the precedent of having them managed by a non-union private company.  This is unsurprising.

I also understand that there is a fear of private management of public recreation facilities.  I swear the first think I hear almost every time I present on what we do  is that they fear we would put a billboard or a McDonalds in front of Old Faithful.  I kid you not, this charge is as regular as clockwork.  Fortunately, we manage about 175 public recreation facilities to a pretty high standard, and not one billboard or McDonalds can be found at any of them.  A large part of the bid process for any facility management contract is not just the rate or the rent but also the detailed operating standards to which it will be managed.  So this is a normal, but surmountable hurdle.

But even taking into account these usual sources of resistance, I am always just amazed at how vociferous the opposition is to even experimenting with private management.  States like California are simply hell-bent on closing parks a company like ours could easily keep open for the public (to be fair, Ruth Coleman, head of California State Parks, is very open to new models but she gets absolutely no support either within her organization or in the legislature for such new ideas).

But I think I understand this phenomenon better now after reading Kevin Drum today. This is what Drum wrote in response to the DNC ad, which clearly stretched the truth, claiming that Republicans voted to end Medicare:

Why not just tell the truth: Republicans essentially voted in favor of turning Medicare over to private industry.  With only a few words of explanation, this could easily be more effective than the ad that actually ran.  Like so:

Republicans voted to turn Medicare over to private insurance companies!  You heard right: they want to hand Medicare over to the same companies that [insert two or three insurance company outrages here, maybe a Wall Street reference, something about profits over people, etc.].  Democrats will never do that.  Blah blah blah.

Would that really be any less scary than the ad that actually ran?

So for Drum, and I presume for much of the Left, the suggestion that a government service be managed privately is just as bad as the suggestion that the service be ended. In essence, Drum is saying he would almost rather have no Medicare than Medicare provided privately.

It certainly explains a lot, and puts the phenomenon I see in public recreation into a larger context.

Update: A couple of the comments hpothesize the problem is that many in government and on the left just hate profits and the profit motive in general.  One related story — I was in a meeting with a large state parks organization where a senior person raised the idea of private park management.  Well, everyone hated the idea, but when it looked as if the leadership might still seriously consider the private option, one person in the room said “well could we at least mandate that they can’t make a profit.”  There was a lot of head nodding at this.

I didn’t go off on this and kept a smile on my face.  But I did lose it in an earlier meeting with the head of some government parks we actually did run.  We were discussing park fee increases for the next year (the state had just raised minimum wages about 30% and we were scrambling to make ends meet).  He said he was uncomfortable with the level of profits we made.  I asked him, “Jim (not his real name) does this state pay you more than $25,000 a year to run this park?”  He nodded.  I said, “then you make more profit in this park than I do, and what is more, you didn’t have to invest $100,000 in equipment to get your job, nor do you have to rebid for your job every 5 years, nor does you salary go down if for some reason park visitation decreases.”

Sometimes I wish I had stood up in that state meeting and said something similar, as in “Why is the money I make in a park somehow tainted because it is the difference between my revenues and expenses and the result of substantial investments and subject to extraordinary risks, while the virtually guaranteed-for-life salary you make, paid for by the same visitors, is somehow pristine?”

Two excerpts from Obama’s speech:

That’s why under my plan, individuals will be required to carry basic health insurance – just as most states require you to carry auto insurance.

Oh, jeez, I sure wish that were true.  Auto insurance covers only catastrophic damages, such as totaling your car or incurring serious liability by hurting someone.   It does not cover regular repairs, preventative maintenance, etc.  Also, state-mandated auto insurance has a range of coverage caps — if you want a higher cap, you can pay for it.  No one expects their company to pay their auto insurance, and if a company were to provide it it would be considered a taxable benefit.  Compared to our current health insurance system, auto insurance-like health insurance would be a brilliant improvement.  Despite his making this analogy, this is absolutely NOT what he is suggesting.  Also from his speech:

Under this plan, it will be against the law for insurance companies to deny you coverage because of a pre-existing condition. As soon as I sign this bill, it will be against the law for insurance companies to drop your coverage when you get sick or water it down when you need it most. They will no longer be able to place some arbitrary cap on the amount of coverage you can receive in a given year or a lifetime. We will place a limit on how much you can be charged for out-of-pocket expenses, because in the United States of America, no one should go broke because they get sick. And insurance companies will be required to cover, with no extra charge, routine checkups and preventive care, like mammograms and colonoscopies

Update: OK, here is another good pairing, from the same source — first, he says that a public option will not be subsidized:

They argue that these private companies can’t fairly compete with the government. And they’d be right if taxpayers were subsidizing this public insurance option. But they won’t be. I have insisted that like any private insurance company, the public insurance option would have to be self-sufficient and rely on the premiums it collects.

But then he makes this comparison:

It would also keep pressure on private insurers to keep their policies affordable and treat their customers better, the same way public colleges and universities provide additional choice and competition to students without in any way inhibiting a vibrant system of private colleges and universities.

See?  The public option will not be subsidized and will work just like public universities which are highly subsidized.

By the way, it is almost impossible for government NOT to subsidize such an entity, in part because of the way government accounting differs from private accounting.  Government accounting is on a cash basis, so large up front investments show as a first year loss with no future expense implications.  In operation, it means capital spending is pretty much free.  And numerous charges that private firms take on, such as liability insurance, are not charged for on government books.   I compete with the government a lot, and have investigated this dynamic in depth.  Even why my costs are lower, the government, because of the way it accounts for things, often thinks its costs are much lower than mine and they under-price us.

I have seen several folks of late testing out a meme that opposition to health care reform is mostly about churlish unwillingness to help people.  My sense is that this is dead wrong.

As a strong libertarian, that may well be my motivation.  But the vast majority of Americans accept and support the government safety net and generally will support reasonable expansions of it to address true need.   I think most Americans would be willing to help people who honestly need financial aid to pay the health care bills.  This is particularly true for children — you don’t remember people going ballistic over SCHIP, do you?

I am not representative.  The vast center of this country is willing to accept, even embrace, increased government interventions in the right cause.  I forgot to blog on it, but remember that poll a few weeks ago that a majority of Americans think the government should required that women take their husbands last name after marriage?  I think the notion that there is any kind of sizable block of small government libertarian type folks out there is simply a myth.

So health care intervention and spending can be sold – again remember SCHIP but also the prescription drug bill.  I think the Administration is having trouble selling it in this case for two reasons:

• They are having difficulty showing people who truly are not getting care.  Sure there are a lot of people who are uninsured, but I think that meme has been around enough for people to deconstruct.  Who isn’t getting care?   Sure, for some folks getting care is a real hassle, but there are arguments to be made that accepting charity should not be that easy (remember the old Welfare?)  And sure, some folks have financial straights and can even face bankruptcy over health care bills, but our bankruptcy laws are incredibly generous and when tens of thousands are facing bankruptcy because they bought too many TV’s on their credit cards, it almost seems honorable to face bankruptcy over your wife’s cancer treatment.
• The second problem is what I call the public housing problem.  In the late 1960s, Americans were concerned about the poor and homeless and spent billions to build housing projects for them.  It turns out that this doesn’t work out so well, but that is not my point.  My point is that Americans could be convinced to spend money to build poor people government homes.  BUT their position would have been very different if investments in public housing required the rich and middle class who were paying for the program to move out of their homes and into public housing as well.That is the fear that I think much of America has today.  If asked, they would likely pay to provide government health care in an instance where it was demonstrated that health care was entirely lacking.  They would likely suspect that such care, like much of public housing, would suck, but as it was being offered to someone who supposedly had nothing, it would represent a net improvement.  But they don’t want to move into the projects themselves, and frankly don’t understand why agreeing to help poor people afford more health care also means they have to move into the government system themselves.

I just finished “The Box,” which is a history of container shipping.  Never has any book I have read elicited so many laughs from my family.  Nothing says “geek” like reading a book about shipping containers.

But, for those of you who might similarly be turned off by the subject matter as unpromising, I can say this is easily one of the most interesting business books I have ever read.    It is fascinating to see how the entire economics of an industry can be changed not by some arcane advance in silicon, but by a metal box.  In a period of about 20 years, the entire merchandise shipping business, which had remained virtually unchanged for thousands of years, was completely reinvented.  Every ship and every port had to be replaced.  Moreover, these changes resonated far beyond shipping, as they enabled much of the global manufacturing revolution of the last generation.

Because pre-container shipping and transport were so highly regulated, the book provides a great window on how regulation affects innovation, and vice versa.  It also focuses quite a bit on how unions and in particular union work rules affected industry economics, and how these unions reacted to change in the industry.

And of course, the book allows us to look at any number of interesting business strategy issues:

• Is being a first mover an advantage, or a disadvantage?  Sea-Land reaped a number of first mover advantages, but it also got hurt badly when a number of the earlier investment choices they made turned out to be wrong.  Several late movers, who invested after ship designs had been through two or three generations, did quite well.  Others did not.
• Who makes money investing into this kind of change?  A few early SeaLand investors made out well, the equivalent of angel investors, but later investors did poorly.  And it is not at all clear that anyone making massive, billion dollar investments ever really made great returns.  Like the airline industry, the industry quickly hit over-capacity and prices dropped.  It is clear shippers won big, but did it really make sense for anyone to invest in this business?  The best strategy I can come up with was followed by Maersk, which basically sat out until late and then bought up assets on the cheap out of bankruptcy from early participants.

This situation was reminiscent of a business case I had at HBS about the beginnings of the high fructose corn syrup (HFCS) market.  It was run as a computer simulation among teams.  Basically, almost not matter what everyone did, the industry ended up in over-capacity and everyone lost money.  The only successful strategy was the Wargames approach (“the only winning move is not to play’).

I don’t generally give investment advice, because I am not really qualified to do so and I make enough mistakes with my own investments that it seems silly to give other people advice.

But these are extraordinary times, and I do want to pass on one general piece of advice: Be ready for inflation.  If you are under forty, you probably don’t even remember any real inflation, so you may need to seek advice as to how to handle it.

I just do not see how there is going to be any way to avoid a substantial uptick in inflation over the next couple of years. Crazy-large deficit spending, huge inflation of the money supply, absurdly low interest rates, massive government money-printing efforts, and government-mandated tilts in the balance of power between labor and management towards the unions can only add up to inflation,

Now, if we were really in the next Great Depression, as the Obama administration tried to tell us in its early weeks (mainly in order to pass pet legislation in a mood of total panic), then we might not see much immediate inflationary pressure. But I think most of us are realizing that the whole depression thing was over-sold. We are likely already on the first steps towards a recovery (if the Administration does not keep doing stupid stuff to kill it) and this recovery will become obvious by the third quarter (for their budget, the Obama administration is forecasting this now to be a milder-than-average recession). When the recovery starts, inflation is going to slam home hard and fast.

The smart money already knows this. That is why the government (as is the UK government) is having a hard time finding takers for long-term government bonds fixed at 4 or 5 percent. Such low rates could easily be under water after inflation.

So, find ways to hedge inflation.  Here are some general ideas:

• If you need to borrow money, now is a great time if you can borrow long and fixed (as with 30-year mortgages).  With high inflation, the amount you owe effectively goes down every year.  Borrowers love inflation!
• Avoid buying long-term bonds at fixed rates like the plague.  Again, you want to be issuing such bonds, not buying them.
• Consider various US government inflation-adjusted bonds, or shorter maturities on traditional bonds
• Equities tend to be a good inflation hedge.  Revenues and earnings go up with inflation, so equity prices and dividends tend to as well.  There will be, though, certain industries and companies that will not manage well in this environment.
• Gold is OK, but I have always thought of gold as dead value.  Sure, it can hedge inflation, but it gives no real return.  Commodity producer stocks (e.g. oil companies) may be a better bet.
• International stocks are really dicey in this kind of environment.  Added to the underlying risk of investing in less developed markets is the currency question, which basically boils down to — we know the US is screwing up its currency, but will other countries screw theirs up worse?  If you think there is a country out there who is less likely to inflate their currency, by all means consider equities and bonds denominated in that currency.  You get the underlying return plus an exchange rate boost   (all things being equal, if the US has a lot of inflation and others don’t, the value of the dollar will fall.  Thus investment returns in, say, Euros will return more dollars in the future.)

These are just some ideas, and I am not positive they are all good ones.  Talk to someone more knowledgeable than me, but whatever you do, I think you need to be planning for inflation.

This is taken from and expanded from the end of this post.

Everyone involved in the bailout plan says, at least publicly, that they are not trying to bail out a bunch of Wall Street folks who lived high off the risk premium of these investments but now want to avoid the costs when the actual risks become clear.  They claim to be bailing out Wall Street and various large banks because they fear that a financial meltdown and liquidity crisis will starve main street businesses of cash, and create a deep economic slowdown.

OK, if this is the real policy goal — to maintain the ability of main street businesses to borrow — then here is my alternative proposal:

1. Immediately increase the SBA loan gaurantee authority by $100 billion dollars.  That is enough for a million new small business loans of $100,000 each.
2. Authorize treasury to spend up to X hundred billion to buy rated new issues of bonds and commercial paper of US non-financial companies.  Some limits should be applied – such as the feds cannot buy any more than 30% of a single issue and/or more than 10% of the entire outstanding debt of one company.

That’s the plan.  Here are the advantages:

• The government is addressing the actual policy goal of keeping liquidity in main street business directly
• The government is investing in success, in main street companies trying to grow, and not in failed banks and financial institutions
• Moral hazard issues are avoided with financial institutions. 
• The SBA loan guarantees cost nothing today.  In fact, they are cash positive in the short term due to loan guarantee payments by borrowers.  Of course, they risk future losses,  but such losses in the future are in part covered by the guarantee payments, and a future loss is cheaper than a loss today.
• Investments in corporate bond issues are much easier to value, and are far less risky, than investments in illiquid mortgage securities.  The taxpayer is far less likely to take a beating on these purchases.
• Banks may still fail, but the FDIC has an infrastructure and experience for handling this.  If necessary to calm people, the FDIC could make a public commitment to assisted mergers to maintain all depositors.
• If there is some big financial meltdown, which I still doubt, there might be a need to inject some mortgage liquidity, but since the Feds now own Fannie and Freddie, the vehicle for doing so is easily available.

Update:  I was not clear — this is actually an alternative to by alternative.  My first, preferred alternative plan is "do nothing."

Been smugly thinking that you were smart enough not to take out an interest only mortgage to finance a house at the peak of the market?  Or savvy enough not to invest your savings in a mortgage portfolio or some sort of interest rate swap?

Sorry, think again.  Because GWB and the US Congress have decided to force you to be an investor in crappy, devalued investments.  To the tune of at least $700 billion.

Four years ago, privatization of Social Security was scuttled in large part because Congress thought it unfair to toss the average taxpayer into the volatile marketplace with his/her retirement savings.  Now, the government is forcing us all to participate in the financial markets, but only allowing us to invest in the worst assets.  Just great.

Saul Hansell at the NY Times has an interesting article about why risk assessment programs in investment banks were not sounding the alarm coming into the recent turmoil.  The article contains this gem:

Ms. Rahl said that it was now clear that the computers needed to
assume extra risk in owning a newfangled security that had never been
seen before.

“New products, by definition, carry more risk,” she said. The models
should penalize investments that are complex, hard to understand and
infrequently traded, she said. They didn’t.

I continue to see parallels between recent problems and the meltdown at Enron.  In fact, in many ways events in the natural gas trading market were a dry run for events in the mortgage market.   One filmmaker coined the phrase "Smartest Guys in the Room" to describe the hubris of the guys who ran Enron.  To some extent the phrase was absolutely true – I knew Jeff Skilling at McKinsey and he was indeed the smartest guy in the room.  But everyone can be wrong, and sometimes the smartest guys can be spectacularly wrong as they overestimate their ability to predict and control complex events.  I think this is a fair description of what went on in Wall Street over the past several years.

I know that most non-financial folks, including myself, have their head spinning after this past few weeks’ doings on Wall Street.  Doug Diamond and Anil Kashyap have a pretty good layman’s roundup on Fannie/Freddie, Lehman, and AIG.  My sense is that their Lehman explanation also applies to Bear Stearns as well.  Here is just one small piece of a much longer article:

The Fannie and Freddie situation was a result of their unique roles
in the economy. They had been set up to support the housing market.
They helped guarantee mortgages (provided they met certain standards),
and were able to fund these guarantees by issuing their own debt, which
was in turn tacitly backed by the government. The government guarantees
allowed Fannie and Freddie to take on far more debt than a normal
company. In principle, they were also supposed to use the government
guarantee to reduce the mortgage cost to the homeowners, but the Fed
and others have argued that this hardly occurred. Instead, they appear to have used the funding advantage to rack up huge profits
and squeeze the private sector out of the “conforming” mortgage market.
Regardless, many firms and foreign governments considered the debt of
Fannie and Freddie as a substitute for U.S. Treasury securities and snapped it up eagerly. 

Fannie and Freddie were weakly supervised and strayed from the core
mission. They began using their subsidized financing to buy
mortgage-backed securities which were backed by pools of mortgages that
did not meet their usual standards. Over the last year, it became clear
that their thin capital was not enough to cover the losses on these subprime
mortgages. The massive amount of diffusely held debt would have caused
collapses everywhere if it was defaulted upon; so the Treasury
announced that it would explicitly guarantee the debt.

But once the debt was guaranteed to be secure (and the government
would wipe out shareholders if it carried through with the guarantee),
no self-interested investor was willing to supply more equity to help
buffer the losses. Hence, the Treasury ended up taking them over.

Lehman’s demise came when it could not even keep borrowing. Lehman
was rolling over at least $100 billion a month to finance its
investments in real estate, bonds, stocks, and financial assets. When
it is hard for lenders to monitor their investments and borrowers can
rapidly change the risk on their balance sheets, lenders opt for short-term lending. Compared to legal or other channels, their threat to refuse to roll over funding is the most effective option to keep the borrower in line.

This was especially relevant for Lehman, because as an investment
bank, it could transform its risk characteristics very easily by using
derivatives and by churning its trading portfolio. So for Lehman (and
all investment banks), the short-term financing is not an accident; it
is inevitable.

Why did the financing dry up? For months, short-sellers were
convinced that Lehman’s real-estate losses were bigger than it had
acknowledged. As more bad news about the real estate market emerged,
including the losses at Freddie Mac and Fannie Mae, this view spread.

Lehman’s costs of borrowing rose and its share price fell. With an
impending downgrade to its credit rating looming, legal restrictions
were going to prevent certain firms from continuing to lend to Lehman.
Other counterparties
that might have been able to lend, even if Lehman’s credit rating was
impaired, simply decided that the chance of default in the near future
was too high, partly because they feared that future credit conditions
would get even tighter and force Lehman and others to default at that
time.

A.I.G. had to raise money because it had written $57 billion of insurance contracts whose payouts depended on the losses incurred on subprime real-estate related investments.
While its core insurance businesses and other subsidiaries (such as its
large aircraft-leasing operation) were doing fine, these contracts,
called credit default swaps (C.D.S.’s), were hemorrhaging.   

Furthermore, the possibility of further losses loomed if the housing
market continued to deteriorate. The credit-rating agencies looking at
the potential losses downgraded A.I.G.’s debt on Monday. With its lower
credit ratings, A.I.G.’s insurance contracts required A.I.G. to
demonstrate that it had collateral to service the contracts; estimates
suggested that it needed roughly $15 billion in immediate collateral.

A second problem A.I.G. faced is that if it failed to post the
collateral, it would be considered to have defaulted on the C.D.S.’s.
Were A.I.G. to default on C.D.S.’s, some other A.I.G. contracts (tied
to losses on other financial securities) contain clauses saying that
its other contractual partners could insist on prepayment of their
claims. These cross-default clauses are present so that resources from
one part of the business do not get diverted to plug a hole in another
part. A.I.G. had another $380 billion of these other insurance
contracts outstanding. No private investors were willing to step into
this situation and loan A.I.G. the money it needed to post the
collateral.

In the scramble to make good on the C.D.S.’s, A.I.G.’s ability to
service its own debt would come into question. A.I.G. had $160 billion
in bonds that were held all over the world: nowhere near as widely as
the Fannie and Freddie bonds, but still dispersed widely.

In addition, other large financial firms — including Pacific
Investment Management Company (Pimco), the largest bond-investment fund
in the world — had guaranteed A.I.G.’s bonds by writing C.D.S.
contracts.

Given the huge size of the contracts and the number of parties
intertwined, the Federal Reserve decided that a default by A.I.G. would
wreak havoc on the financial system and cause contagious failures.
There was an immediate need to get A.I.G. the collateral to honor its
contracts, so the Fed loaned A.I.G. $85 billion.

Update:  Travis has an awesome post with his own FAQ about what is going on.  Here is a taste:

Lots of financially naive folks think that we can remove all risk,
inflation, etc. by only ever trading apples for chickens on the barrel
head, and doing away with paper money (so that all money is gold) and
doing away fractional reserve banking, so that when I deposit one gold
coin in the bank, the bank can then take that actual physical gold coin
and loan it to someone else. It turns out that the friction involved in
doing things this way is so huge that the effect would make The Road
Warrior look like a children’s bedtime story. You want to borrow money
to buy a car? The bank can’t just loan money that’s been deposited in
someone else’s checking account – the bank has to get that person to
sign a note saying “yes, I understand that this money is on deposit
until that dude buying the card pays the bank back IN FULL”. And the
lender, if he wants his money out ahead of time, is SOL. And even then,
there can be a flood, and your car gets totaled, and you get
Legionaire’s disease, and you can’t make the payments.

or this:

Now, for the next complication, let’s also imagine that there are
300 million other people watching all of this, thinking “How bad is
this? Should I go down to the gun store, stock up on .223 and 12 gauge
shells, then stop by the veterinarians to see how much antibiotics I
can cadge before heading to the hills” ?

And the Feds really don’t want 300 million armed folks heading
for the national forests, so they first try to tell everyone who owns a
bicycle “Hey, the value of your bike didn’t really drop! It’s still
worth $9!”.

But no one wants to believe that.

So then they go to the guy who’s writing insurance policies on
the value of bikes and they say “if you got $100 million, would that
calm things down a bit?”.