'We Have a Lot of Work to Do'

Punitive Damage

Congress is in a lynching mood over bailouts and bonuses

Steve Chapman

The financial crisis has been widely interpreted as proof of the need for extensive government regulation of banks, insurance companies, and other capitalist institutions. The antics of politicians now that they have a greater role, however, are a vivid reminder of why they can't be trusted with such power.

These days, every politician assumes that because he has a driver's license and an ATM card, he must have all the necessary skills to run an automaker and operate a bank. House Speaker Nancy Pelosi and Senate Democratic Leader Harry Reid, for example, said Detroit should use its bailout money to become "a global, competitive leader in fuel efficiency."

Never mind that if we know anything from recent automotive history, it's that the Big Three's competitive advantage is in trucks and SUVs. If they had spurned that segment during the decades of cheap gas, things would have been very different: They would have reached the brink of bankruptcy long before now. But Congress' idea of a sound business plan is to build cars that suit its grand ambitions rather than, say, the tastes of consumers.

Banks getting federal money have likewise been subjected to a frenzy of finger-wagging. Politicians were shocked when Northern Trust hosted a client event featuring the band Earth, Wind and Fire. House Banking Committee Chairman Barney Frank and 17 other Democrats demanded that it "immediately return to the federal government the equivalent of what Northern Trust frittered away on these lavish events."

But Northern Trust didn't ask for federal help—it was conscripted into the bailout. It happens to be managing its money well enough to be making a profit and repaying the taxpayers.

And did anyone notice that after Earth, Wind and Fire did the Northern Trust gig, it performed at a White House dinner? Why is it OK for President Obama to host "lavish events" that are financed by taxpayers but outrageous for a bank to use mostly private funds to entertain valued customers?

Then there is the insurance giant American International Group, which unleashed bubbling torrents of outrage when it paid large bonuses to hundreds of employees. Angry lawmakers have no idea what these workers should be paid, except that it should be a lot less.

Of course, some taxpayers feel that members of Congress should forfeit their salaries in years when they fail to balance the budget. But our leaders' contempt for failure applies only to the private sector.

They demand that the bonuses be rescinded and, failing that, threaten to tax them away, at proposed rates as high as 100 percent. "Let the recipients of these large and unseemly bonuses be warned—if you don't return it on your own, we'll do it for you," thundered Sen. Charles Schumer (D-N.Y.).

No one in the lynch mob wants to admit that the amount is piddling from the point of view of taxpayers. It adds up to less than 1 percent of the $170 billion the government has poured into AIG. The prevailing reaction amounts to swallowing a camel and straining at a gnat.

AIG could have refused to make the payments, but only by violating contracts it had made with employees. Officials at the Federal Reserve Bank of New York entertained this option, reports The Washington Post, only to realize that the spurned staffers would have sued and gotten not only the payments but "punitive damages that would make the ultimate cost perhaps two or three times as high as the bonuses themselves."

Refusing to pay would also have driven away any top employees with alternatives—which would tend to be the better people, who might just be useful in restoring the company to health. Congress's approach brings to mind the sardonic workplace sign: "The floggings will continue until morale improves."

Expropriating property from people who did nothing more than accept money they were legally due sounds uncannily like a bill of attainder—a legislative measure declaring someone guilty of a crime, and imposing punishment, without trial. This weapon was expressly forbidden by the framers of the Constitution because it is fundamentally unfair, at odds with the rule of law, and driven by mass hysteria rather than dispassionate fact-finding.

'We Have a Lot of Work to Do'

'We Have a Lot of Work to Do'

ABC's John Stossel on defending the market from within the liberal media

Ted Balaker |

John Stossel is the best-known libertarian in the news media. As the co-anchor of the long-running and immensely popular ABC News program 20/20, auteur of a continuing series of specials on topics ranging from corporate welfare to educational waste to laws criminalizing consensual adult behavior, and author of best-selling books such as Myths, Lies, and Downright Stupidity, Stossel brings a consistent message of liberty to millions of viewers on a weekly basis.

It wasn’t always this way. Born in 1947, Stossel started out as a standard-issue consumer reporter, working in Oregon and New York before joining the staff of Good Morning America and, later, 20/20. He did scare stories about everything from pharmaceutical rip-offs to exploding coffee pots. Then, in the 1980s, he encountered reason, which radically changed his thinking about the benefits of laissez faire in economics and personal lifestyles.

“It was a revelation,” he writes in his 2004 memoir, Give Me a Break. “Here were writers who analyzed the benefits of free markets that I witnessed as a reporter. They called themselves libertarians, and their slogan was ‘Free Minds and Free Markets.’ I wasn’t exactly sure what that meant, but what they wrote sure made sense.”

reason caught up with Stossel in January in Los Angeles, where he was filming a special episode of 20/20 based on six reason.tv documentaries featuring Drew Carey. Among the topics: the desirability of open borders, the need to reform the nation’s drug laws, and the case against universal preschool. Ted Balaker, a reason.tv producer, talked with Stossel about bailouts, his hopes for the Obama years, and his attempt to educate a generation of school kids with a video series called Stossel in the Classroom.

Audio and video of the interview is available online at reason.tv/stossel.

reason: What do you think of the bailout mania that’s sweeping the country?

John Stossel: I think it’s disgusting. They keep saying everybody agrees that we have to bail these people out and the feds have to spend trillions of your tax dollars guaranteeing this and that. It’s just so irresponsible. We’ve got a $35 trillion Medicare liability already that they’re not facing. Now they’re going to throw more trillions of dollars to stop this recession, like we’re not allowed to experience any pain in America. There are recessions. There are booms and busts. Bubbles have to pop.

In this case, there are smart people, like [former Treasury Secretary and Goldman Sachs chief] Hank Paulson, making the argument that this is different: You’ve got the credit lock; the whole system is at stake. That is possible, but what I’ve learned over 30 years of consumer reporting is that the people closest to the problem panic. And when they panic, that is an invitation for government to get bigger. It’s not only war that is the friend of the state. Any crisis is the friend of the state.

The mad cow disease doctors were convinced we were all going to have holes in our brains and anybody who ate meat was at risk of these horrible diseases. The Y2K technicians were convinced all the planes were going to crash. Now it’s the Wall Street investment bankers, who unfortunately are allowed to spend trillions of our dollars in their panic.

reason: Let’s take a quick look back at the Bush years. Spending has exploded to historic proportions. Regulations exploded too. Yet people look back on the Bush years and say it’s a failure of free market policies. What do you say to that?

Stossel: I say bullshit. There was no deregulation under Bush. People don’t know that, yet everybody says, “See, your libertarian ideas, they’re wrong and this proves it.” First of all, there was no real deregulation. [The repeal of the Depression-era banking regulation] Glass-Steagall was done under Clinton, and he rightly defends that. Banks that had more options after Glass-Steagall were not the ones that got into trouble. Under Bush, the regulators have added more pages of rules than any administration ever. The cost of regulation has gone up more under Bush than any president before. And yet, because of the bad media coverage and assumptions about Republicans, people think it as
laissez-faire.

I’m sure there are some people at regulatory agencies—at least I hope there were—who said, “You know, a lot of these rules are bad and we’re going to be less aggressive about them under Bush.” But that’s not what caused this bubble. The bubble was the government saying: “Lend more, lend more. You’re discriminating against poor people; you’re racist. Lend to more people.” That’s not deregulation.

reason: What are your hopes and fears for the Obama years?

Stossel: My fear is that they’ll spend us all into bankruptcy and we’ll be like the people in the Weimar Republic, running around with wheelbarrows full of cash because inflation is so bad. We’re trillions of dollars in the hole for just Social Security and Medicare. They won’t have the guts to raise taxes. Well, maybe they will, but they won’t be able to raise taxes enough to pay for Social Security and Medicare because you’d have to take just about all people make, and that would totally destroy the economy. They won’t cut the programs because we older people want the best of medical care, and we’re going to demand it, and the politicians can’t say no to anybody.

reason: And your hope?

Stossel: Hey, Nixon went to China. Maybe Obama will be financially responsible. And maybe he’ll do the things that reason thinks should be done, like legalizing drugs and prostitution and ending the criminalization of behavior between consenting adults.

Hayek called it a fatal conceit to think you can plan an economy. I think it’s also a fatal conceit to predict what these politicians will do.

reason: Talk about your collaboration with reason.tv and Drew Carey and how it came about.

Stossel: reason magazine has always meant a lot to me. I was lost in the political wilderness and politically naive. Conservatives didn’t make sense to me in the magazines I was reading, and the liberals who controlled the media where I am always said government will fix it and we just have to spend more. That made no sense to me either. Discovering reason was just wonderful. I could see that, wow, there was another way to think about these things. I’ve always read the magazine. [Former Editor] Virginia Postrel was my teacher originally, and when you guys started doing television, I thought, “Great, let’s take the best of it and get it out to a wider audience.”

reason: Is the mainstream media biased?

Stossel: Yes.

reason: Is it because liberty just isn’t TV-friendly? You can pass a minimum wage law and go interview the happy employee at Burger King who just had her wage boosted, but you can’t interview the person who doesn’t know she got squeezed out of a job.

Stossel: That’s part of it. It’s certainly hard to show the people who arehurt by a government program that takes two cents from everyone or prevents a job from being created. You can’t take a picture of that. I think liberty intuitively is hard to get. Intuitively, the minimum wage makes sense. We want to help poor people, so raise the minimum wage. It’s hard for people to understand how that hurts people.

Plus, there is just the basic political bias. The people with whom I work read The New York Times and The Washington Post, and that’s their world. Everybody around them agrees with them. They all lean left, and they think that’s the middle.

The Internet has shown people that there was a liberal media. Now the public at least knows that ABC, NBC, CBS lean left. CNN, especially. MSNBC gets talked about a lot on the Internet. Thanks finally to the Internet and cable deregulation and Fox TV, people have an alternative from the days when government monopoly limited the number of TV stations. The broadcast networks lobbied Congress to say if you allow cable to come in everywhere, then poor people who can’t afford cable will be deprived of free TV. So there were five channels. That helped me make more money, but it certainly wasn’t fair. It’s far better that we have 150 channels now. It’s right for people that they should have more choices.

reason: What sort of new media gets your attention?

Stossel: I’m embarrassed to say that I still read magazines. I’m still reading reason in its print form, and The American Prospect and The New Republic and National Review. It’s the traditional publications of the left and the right. I’d like to say I check Google all the time, but I don’t.

reason: Do you think the libertarian worldview is gaining influence?

Stossel: I don’t know. It’s easier for me now because there are more points of view on TV. That makes me think at least now people know these ideas deserve a place at the table. It’s why ABC lets me do my specials, but are we winning?

This move toward more spending makes me think not. On the other hand, as [Cato Institute Executive Vice President] David Boaz often points out, if you are gay or black or a woman, we forget how America has changed, how much more freedom there is. It’s a mixed bag.

Government’s much bigger, but in many personal ways we are freer. The fall of the Soviet Union in some ways is a danger because we used to have role models of failure. Now you have the left saying, “Ah, we just have to do it right, be more a middle way between government and capitalism, like Europe.” We have models of failure in Cuba and North Korea and the post office and the motor vehicles department, but they are relatively few. People still say, “When I’m scared, government must step in.”

reason: What are some of the things you regret about your career?

Stossel: Now that I’ve wised up to the benefits of economic freedom, I regret much of my first 20 years of bashing business, of calling for more regulation. That’s the intuitive reaction. You send the TV out to 15 repair shops. Some people cheat you. Politicians call me up and say, “Oh, great piece, we’re going to establish a department of consumer affairs and license TV repair shops and car repair shops.” If you haven’t read reason, it sounds good, because you like licensing. We license dogs and drivers. It sounds like the right thing to do.

I encouraged that sort of thing for many years. Just scare stories: “Danger in the Grass,” things about lawn chemicals that were over the top.

reason: I was worried about exploding coffee pots during my whole childhood because of you.

Stossel: I did a story on somebody who died because their house caught fire after their coffee pot blew up. These things do happen, but it’s a big country. There’s a lot of nasty stuff happening to people. You’ve got 50 people who die every year from plastic bags.

reason: What about the flip side, the things that you look back on and you’re truly proud of what you’ve done?

Stossel: My first special was this show called Are We Scaring Ourselves to Death? That’s when I finally said, “We’re scaring people about everything. We ought to put this into perspective.” I read Searching for Safety by [political scientist] Aaron Wildavsky, which really opened my brain. I tried to put risks in perspective. It was tough to get on the air. Two freelance producers quit rather than work on that show. They said I wasn’t objective, that it was conservative dogma to say that regulation itself might hurt people. To ABC’s credit, a producer said, We don’t agree with you, but this is an argument that deserves to be heard.

More recently, we did a special called Stupid in America, which was about education. I worried that the show wouldn’t be well received because education isn’t good TV. It’s just people, kids sitting at a desk. But the ratings—we get minute-by-minute ratings now—went straight up. It was the highest-watched show that night, as was the repeat. It argued pretty forcefully that choice and competition might make a big difference. There’s this argument that the reason public education is failing is that we’re not spending enough money. We’re spending $11,000 per student. If you do the math, that’s more than $200,000 per classroom. Think what you would do with that money.

reason: Drive the kids up in limos?

Stossel: Hire four excellent teachers. It just shows that government monopolies waste money. That special stirred the pot some. I’m happy with that show.

reason: If you look at the positions you’ve taken over the years, there’s a lot for conservatives to dislike about you and a lot for liberals to love. You’ve spoken out against corporate welfare, against greedy peddlers of junk science and medicine ripping people off, in favor of legalizing drugs, gay rights, and free speech. Yet it seems almost always that you’re widely adored by conservatives and widely scorned by liberals. Why is that?

Stossel: I’m not sure, but you’re absolutely right. Somebody came up to me in New York and said, “Are you John Stossel?…I hope you die soon.” He was a legal aid lawyer. There is this real hatred on the left because I’m a consumer reporter defending business, and they just so hate business.

I don’t know. I mean, I’m prochoice. I was against the war in Iraq. I think homosexuality is just fine. I want drugs legal and prostitution legal. Yet conservatives invite me to their conferences and give me standing ovations. Sometimes. Not always, but they generally like what I have to say. I even mention some of that, and it shows how pathetic it is for conservatives in the mainstream media that I, a libertarian, am the closest thing that they have to invite to a conference.

This hatred of business—I’m not sure what that’s about. I used to think it was envy, that the college professor is angry that his slightly stupider roommate is making more money than he is because he’s in business. Then you think about the kings and queens of Europe. People didn’t hate them for all their wealth, and their wealth proportionately was vastly greater than now, but they hated the bourgeoisie. They gave them that nasty name. They hated the very people who sold them the things that they needed to make their lives better. What’s that about?

My best guess is that it’s the intuitive reaction that the world is a zero-sum game, that if he makes profit off you, you must’ve lost something. If you don’t study economics, that is how people think. I see why politicians think that way, because that’s how their world works. One wins. Somebody else has to lose. We have a lot of work to do to explain that free commerce doesn’t work that way, that everybody gains.

reason: Talk about Stossel in the Classroom. What is it, and what do you hope to accomplish through it?

Stossel: I’m very invested in that now. We do these shows, and they cost ABC almost half a million bucks, and then they air and they’re gone. Teachers sometimes wrote in saying, “I wish I’d taped that because I wanted to show it in class.” Or, “We did tape it and I showed it in class, and the kids, quiet kids who’ve never spoken all year, suddenly they were up arguing. We had a great discussion. Can we get more of these things to use in the classroom?”

I had some shows like Greed or Is America No. 1?, which discussed why America is prosperous. You ask kids, and they say it’s because we have democracy and we have natural resources. I point out, well, India has democracy and natural resources, but India’s poor. They’d say, India’s overpopulated. Actually the population density of India is the same as that of New Jersey, and New Jersey’s doing OK. And Hong Kong has no natural resources and 20 times as many people per square foot as India, and Hong Kong got rich. In 50 years it went from the Third World to First World because, as Milton Friedman points out, economic freedom is the answer to why a country’s prosperous. The British rulers in Hong Kong enforced the rule of law, kept people and property safe, and then they sat around and drank tea. They left people alone. To me, that’s such a valuable lesson for kids.

Weirdly, more public school teachers are asking for these. Now I have a nonprofit that raises money to buy them from ABC. Any teacher can go to stosselintheclassroom.org to get a DVD with teacher’s guides and suggestions for how it meets the curriculum.

reason: What are the stories that you’re still itching to do?

Stossel: I would love to do more on Medicare. We did a show called Sick in America, which touched on the success of free market medicine and the times and places where it’s been allowed to flourish. As we criticize Bernie Madoff, I’d like to point out that the government’s running a bigger Ponzi scheme in Social Security and Medicare.

We are working on a show that asks why, if you’re an owner of a business, can’t you hire and fire who you want? Why can’t you refuse to hire older people if you want because they cost more? Or refuse to hire pregnant women because they’re probably going to leave, or they’re certainly going to take time off? Who gets to make these decisions? You or the state?

As reason readers know, companies that were racist and homophobic would bid up the price of whites and straights, and a business then that hired only gay men or women would clean their clock because they’d have better workers they could hire more effectively. The market sorts these things out. But again, that’s an education job to explain to people.

Can Congress Write Any Laws It Wants?

Can Congress Write Any Laws It Wants?

by Andrew P. Napolitano

"Some men think the Earth is round, others think it flat… But, if it is flat, will the King’s command make it round? And if it is round, will the King’s command flatten it? … NO."

When Robert Bolt wrote that truism in his play A Man For All Seasons, his protagonist, Thomas More, was attempting to persuade the jury at his trial for high treason that all governments have limitations, and that the statute he was accused of violating was beyond Parliament’s lawful authority to enact. Sir Thomas was there appealing to the natural law as well as to the common sense of his jurors: The government can’t change the laws of nature. As we know, he fared no better than those who today argue that Congress is not omnipotent, has natural, moral, and constitutional limitations on its power, and every day fails to abide them.

Jefferson wedded the natural law to American law in the Declaration of Independence when he wrote that our rights are "inalienable" and come to us from "Our Creator." Not only does federal law recognize that, but the whole American experience recognizes the natural law as the ultimate source of our freedoms and as a restraint on the government. Thus, the traditional panoply of American rights is ours by birthright and cannot be interfered with by an act of Congress or order of the president, but only after due process.

Two of those rights are speech and contract. A law enacted by Congress punishing speech (such as the Patriot Act provision that declares to be felonious speaking about the receipt of certain search warrants) is no law at all, since the law itself violates the natural right to speak freely, which is expressly protected in the Constitution. The Framers fully understood this as they wrote in the First Amendment: "Congress shall make no laws … abridging the freedom of speech." I have italicized the word the to make my point. The framers accepted the natural law premise that freedoms come with and from our humanity. The freedom of speech obviously preexisted the constitutional amendment insulating it from government abridgement, and the Framers’ use of the article the reflects their unmistakable acceptance of that truism.

Similarly, a law changing the terms of a private contract is no law since it violates the natural right to make binding agreements. The Framers knew that as well. The Constitution specifically forbids the states and, by requiring due process and expressly forbidding taking property without just compensation, the federal government, from "impairing the Obligation of Contracts." This, too, is a personal natural right that pre-existed the constitutional clauses that bar the government from interfering with it.

The Constitution sets forth just 17 discrete delegated powers on matters like currency, interstate commerce, the post office, the judiciary, and national defense. The Constitution also interposed two precise brakes on all federal powers: The Ninth and Tenth Amendments together state that the powers not enumerated in the Constitution as given to the federal government are retained by the people and the States.

The whole purpose of the Constitution is, was, and has been to define the government, to impose restraints on the government, and to guarantee personal freedoms. It specifically diffused power between the States and the central government and, within the federal government itself, it separated powers among the three branches.

It is elementary to state that the Constitution mandates that Congress writes the laws and decides how to spend tax dollars, the president enforces the laws as Congress has written them, and the courts interpret the laws as they have been written and enforced to assure their compliance with the Supreme Law of the Land.

As elemental as this sounds, it is hardly recognizable today. After 230 years, we have come to a point where a president declines to enforce laws he has himself signed, directs his Treasury Secretary to make laws interfering with private contracts, and signs executive orders that invade privacy, restrict speech, and appropriate property. Today, we have a Congress that delegates to the president its power to spend taxpayer dollars and money borrowed in the taxpayers’ names, has written laws regulating the air you breath, the water you drink, the words you speak, and relieving the persons with whom you have contracted or to whom you have loaned money from complying with their agreements. And our courts from time to time have raised taxes, run prisons, re-cast the boundaries of school districts, and declined to right obvious constitutional wrongs committed by the other branches.

The oath to uphold the Constitution that everyone in government takes, though solemnly delivered and publicly sworn to, like an oath to tell the truth in Court, is simply not taken seriously. Notwithstanding the plain language of specific grants and general restraints, notwithstanding a careful compromise between the Hamiltonians who wanted all power to be in the federal government and the Jeffersonians who wanted all power in the States, and notwithstanding our inalienable rights from our Creator, the federal government today simply recognizes no limits on its power.

But the Constitution is the Supreme Law of the Land. We will have chaos if those in whose hands we repose it for safekeeping intentionally violate it with impunity. A government that violates its supreme law becomes arbitrary, and arbitrary rule becomes authoritarian, and authoritarian rule will trample our freedoms. Just six weeks into its four-year term, the Obama administration and its allies in Congress, just like the Bush administration and its allies, have acted like they never heard of the Constitution. They have attempted to control salaries of private banks, change the terms of private mortgages, enter the marketplace by nationalizing banks and the world’s largest insurer, and investing taxpayer dollars in companies whose products consumers reject and investors eschew. This is theft of liberty and theft of taxpayer property.

Is freedom a reality or a myth? Are the rights guaranteed in the Constitution real or just a pretense? Isn’t the whole purpose of government in a free society to uphold rights rather than interfere with them? If the answers to these questions are no longer obvious, it is because we have a central government whose only self-acknowledged limitation is whatever it can get away with.

March 19, 2009

Andrew P. Napolitano [send him mail], who was on the bench of the Superior Court of New Jersey between 1987 and 1995, is the senior judicial analyst at the Fox News Channel. His newest book, coming in April, is Dred Scott’s Revenge: A Legal History of Race and Freedom in America, (Nelson, 2009) His previous books are A Nation of Sheep, The Constitution in Exile and Constitutional Chaos: What Happens When the Government Breaks Its Own Laws.

Management Theory Is Not to Blame

Management Theory Is Not to Blame

by Nicolai J. Foss and Peter G. Klein

Is management theory to blame for the current crisis in the world economy? Some commentators think that business schools' focus on shareholder wealth maximization, performance-based pay, and the virtue of self-interest have led banks, corporations, and governments astray. Hefty bonuses promoted excessive risk-taking, and the free-market philosophy taught in business schools removed the final ethical checks and balances on such behavior. "It is the type of thinking," worry Raymond Fisman and Rakesh Khurana in Forbes (December 12, 2008), "that is now bringing capitalism to its knees."

The populist crackdown on executive pay is linked to such thinking. The late Sumantra Ghoshal of the London Business School, widely hailed as one of the world's foremost management gurus, was a forceful critic of performance pay and its allegedly destructive consequences. More generally, Ghoshal thought that management theory was "bad for practice" financially, ethically, and politically.

We think, however, that management theory has much to offer policymakers, practitioners, and analysts seeking to understand the current crisis. Take, for example, the notion of heterogeneity. The idea that resources, firms, and industries are different from each other — that capital and labor are specialized for particular projects and activities, that people are distinct — is ubiquitous in the theory and practice of management. What strategists call competitive advantage arises from heterogeneity, from doing something differently from the competition. Human-resource managers deal with an increasingly diverse workforce and people with highly specialized talents. Firms that expand internationally learn the lessons of market, cultural, and institutional heterogeneity. And so on.

As a consequence, management scholars think of firms as bundles of heterogeneous resources or assets. Assets can be specific to certain firms. Assets may be "co-specialized" with other assets, such that they generate value only in certain combinations. And as any accountant knows, assets have different (economic) life expectancies. Such unique and specialized assets can also be intangible, such as worker-specific knowledge or firm-specific capabilities.

To the uninitiated this may sound trite. But look at economics. Here homogeneity, not heterogeneity, rules the roost. Economic models of industries and economies typically start with "representative firms," implying that all firms in an industry are alike. This may be a handy starting point if one is interested in the industry per se rather than in individual firms but can be seriously misleading if one is interested in the relative performance of firms or industries.

And, here, macroeconomists are the worst transgressors. Their models of an entire economy treat factors of production as homogeneous within categories. Thus, "labor" means homogeneous labor inputs. "Capital" has the same interpretation. Nobel Laureate Robert Solow adopted the notion of "shmoo" from the comic Lil' Abner — shmoos are identical creatures shaped like bowling pins with legs — to capture this kind of homogeneity.

This style of reasoning originated with David Ricardo, who found it a useful simplification. And it can be. But sometimes economists' assumption of homogeneity leads them into trouble, as is the case with the current crisis.

The macroeconomic problem, we are told, is that "banks" made unwise investments, and now aren't "lending" enough. "Businesses" and "consumers" can't get "loans." "Firms" have too many "bad assets" on their books.

The key question, though, is which ones?

Which banks aren't lending to which customers? Which firms have made poor investments? A loan isn't a loan isn't a loan. The relevant question, in analyzing the credit mess, is which loans aren't being made, to whom, and why? The critical issues are the composition of lending, not the amount. Total lending, total liquidity, average equity prices, and the like obscure the key questions about how resources are being allocated across sectors, firms, and individuals, whether bad investments are being liquidated, and so on. Such aggregate notions homogenize — and in doing so, suppress critical information about relative prices. The main function of capital markets, after all, is not to moderate the total amount of financial capital, but to allocate capital across activities.

The US stimulus package, and similar proposals around the world, are likewise stymied by their crude, Keynesian-style reliance on macroeconomic aggregates. According to the common wisdom, the bank crisis led to a collapse of effective aggregate demand, and only massive increases in government expenditure (and government debt) can kick-start the economy. Expenditures — on what? It doesn't matter: just spend. The only criterion is whether the projects are "shovel-ready."

But a shovel isn't a shovel isn't a shovel.

As F.A. Hayek — Keynes's most important intellectual opponent — argued in the 1930s and 1940s, the economy's capital structure is a complex and delicate structure, one that cannot be mashed and pushed like putty. Resources cannot be shifted costlessly from one activity to another, particularly in a modern economy in which much of those resources are embodied in industry-specific, firm-specific, and worker-specific capabilities. Even idle resources can be misallocated — what Hayek and his teacher Ludwig von Mises called "malinvestment" — if invested in activities that don't produce the goods and services the economy needs.

Every manager knows that directing specialized resources to the wrong projects is a bad bet, even if it leads to a slight boost in short-term earnings. In the same way, the path to economic recovery is to allow markets to channel specialized resources to their highest-valued uses, not to dump taxpayer funds on whatever firms and industries happen to be ready for them — or politically connected. In an important sense, banks' failure to distinguish among heterogeneous borrowers got us into this mess. A mistaken focus on homogeneity, in pursuit of a quick fix, will only bring more of the same.

The Fed Did It, and Greenspan Should Admit It

The Fed Did It, and Greenspan Should Admit It

by Frank Shostak

In his Wall Street Journal article from March 11, 2009, former Fed chairman Alan Greenspan rejects the idea that the Fed's low-interest-rate policy between December 2000 and June 2004 fueled the housing bubble, which in turn laid the foundation for the current economic crisis.

(The federal funds rate was lowered from 6.5% in December 2000 to 1% by June 2003. It was kept at 1% until June 2004 when the rate was raised by 0.25%.)

Greenspan holds that what matters for the housing market is long-term and not short-term interest rates. The Fed, however, doesn't control long-term rates, argues the former Fed chairman.

According to Greenspan, the decline in long-term rates and mortgage rates took place while the Fed had been tightening its interest-rate stance. The federal-funds-rate target was raised from 1% in June 2004 to 4.25% in December 2005.

Yet in June 2005 the yield on the 10-year Treasury note fell to 3.92% from 4.58% in June 2004. The 30-year fixed-mortgage rate closed at 5.58% in June 2005 against 6.29% in June 2004.

How in the world, asks Greenspan, can the Fed be blamed for the housing bubble and the current economic crisis?

Who, then, is to blame for this fall in long-term interest rates and for the present economic crisis?

According to Greenspan, the culprit is the savings glut from emerging economies, such as China. This glut of savings was channeled to long-term US Treasuries and other US financial assets thereby depressing their yields, argues the former Fed chairman.

Ben Bernanke concurs. In his speech at the Council on Foreign Relations on March 10, 2009 he said,

Like water seeking its level, saving flowed from where it was abundant to where it was deficient, with the result that the United States and some other advanced countries experienced large capital inflows…

What Greenspan and Bernanke call "savings" is nothing more than the amount of US dollars that emerging economies accumulated.

The accumulation of these dollars by emerging economies cannot increase the pool of dollars. The accumulated dollars are part of the existing pool of US money.

When a Chinese exporter sells goods to an American importer, he is paid with dollars. This means that the ownership of dollars is changed here, not their quantity.

With all other things being equal, a sustained decline in long-term yields requires an increase in the pool of dollars. The increase in the pool of dollars means that more American dollars will be employed as the medium of exchange. As a result, the prices of goods and assets move higher, while yields on assets are pushed lower.

However, if the accumulated dollars of emerging economies are only invested in US Treasuries, then it is tempting to suggest that a sustained fall in long-term rates without an expansion in the pool of dollars is possible.

We suggest that this is highly unlikely. If the pool of dollars remains unchanged while the quantity of goods and assets continues to expand, then this will lead to the fall in the average price. (Remember, a price is the number of dollars per unit of a good or asset.)

This means that explicit and implicit yields will come under upward pressure. (As a result, investors from emerging markets are likely to shift their funds from less-yielding Treasuries to a higher-yielding asset if the pool of dollars remains fixed, thus pushing yields on Treasuries higher.)

It is only the monetary policy of the Fed — and not the accumulation of dollars by emerging economies — that can set in motion changes in the pool of dollars. Hence, the fall in long-term interest rates and mortgage rates has to be the result of the Fed's loose monetary stance.

If what we are saying is valid, then how are we to reconcile the fact that in 2005 long-term rates had been falling while the Fed was tightening its stance?

Historically, the 30-year fixed-mortgage rate and the federal funds rate have had a tendency to display a very good visual correlation. This doesn't mean that the correlation is perfect — a discrepancy in the movements between the federal funds rate and long-term rates can occur.

The emergence of a discrepancy doesn't imply that suddenly the Fed's policies have nothing to do with the housing bubble or boom-bust cycles.

(Recall that, because of a discrepancy during June 2004 and June 2005 between the federal funds rate and long-term rates, Greenspan has concluded that his loose monetary policy between December 2000 and June 2004 had nothing to do with the housing bubble.)

Various discrepancies between the movement in the federal funds rate and the mortgage rate are the result of a variable time-lag effect from changes in monetary policy on various markets.

Because of the variable time lag, a situation can emerge where long-term rates may ease despite the central bank's tighter interest-rate stance.

Despite a tighter-interest-rate stance, the previous loose-interest-rate stance may still dominate economic activity. Consequently, in order to maintain a given interest-rate target in the midst of still strong economic activity, the Fed may be forced to push more money into the economy to prevent the federal funds rate from overshooting the target. (For instance, an increase in the federal funds rate from 1% to 2% is a tighter stance, yet the 2% rate can still be too low — strong economic activity pushes the federal funds rate above the target.)

As a result, more money becomes available for financial markets, which puts downward pressure on long-term rates, all other things being equal.

In November 2004, the yearly rate of growth of the Fed's balance sheet jumped to 6.9% from 4.3% in June 2004. Note that this increase in the pace of monetary pumping took place while the federal-funds-rate target was lifted from 1% in June to 2% in November.

Also note that between December 2004 and June 2005 the average yearly rate of growth of Fed assets stood at a still-elevated 6%.

Contrary to Greenspan and other commentators, we suggest that what sets in motion a boom-bust cycle is not a boom in a particular market such as the housing market but the increase in money supply out of "thin air."

Now let us say that the dollars accumulated by emerging economies were to be invested solely in Treasuries. while this might push long-term interest rates temporarily lower, all other things being equal, it is not going to set in motion a boom-bust cycle as long as the pool of US dollars remains unchanged.

If, as a result of lower interest rates, too many dollars are invested in the housing market, it means that fewer dollars are invested in other goods. As a result, the housing market will become overvalued while other goods will become undervalued. This will set in motion an outflow of money from the housing market to other markets.

If, as a result of lower interest rates, too many dollars are invested in the housing market, it means that fewer dollars are invested in other goods.

In our writings we have shown that the main source of boom-bust cycles is the Fed itself. Thus, by aggressively lowering interest rates between December 2000 and June 2004 — and accompanying this with monetary pumping — the Fed set in motion an economic boom.

The boom gave rise to various nonproductive (bubble) activities that emerged on the back of the loose monetary stance of the Fed. The increase in money supply led to the diversion of real funding from wealth-generating activities toward various nonproductive activities.

(Note that these activities cannot stand on their own — they cannot fund themselves. They are funded by diverting — by means of new money created "out of thin air" — real savings from wealth-generating activities.)

From June 2004 through September 2007, the Fed adopted a tighter stance, which slowed the diversion of real funding to nonproductive activities.

As a result of this, various nonproductive activities came under pressure. (Without real funding, these activities are forced to go under.)

Now, when money is injected, it doesn't instantly affect all the activities in an economy. The money starts with the first recipients and then moves to other recipients. It moves from one market to another market — there is a time lag.

This means that various nonproductive (bubble) activities are spread across all the markets — the boom is everywhere. Once the Fed tightens its stance it starts a bust, and this weakens various nonproductive activities across all the markets. The severity of the bust is dictated by the size of the boom.

(The percentage of nonproductive activities — the product of the boom — determines the severity of an economic bust in a particular sector of the economy.)

It follows, then, that a bubble in a particular market cannot emerge without the preceding increases in money supply. This in turn means that a bubble cannot emerge without a preceding loosening of monetary policy, which means it cannot occur without money pumping by the Fed. Hence, what matters for the economic boom, i.e., the emergence of bubbles, is the creation of money "out of thin air" and not the level of long-term interest rates.

Contrary to Greenspan, we can conclude that it is not long-term rates as such that fueled the bubble but the loose monetary policy of the Fed.

We can also conclude that the so-called savings glut in emerging economies had nothing to do with the last economic boom or the current economic crisis.

The only institution that can set in motion the expansion of money and a false boom is the Fed.

A test of will

The Fed

A test of will

The Fed finds innovative ways to pump hundreds of billions of additional dollars into the economy

A FEW days ago Ben Bernanke, chairman of the Federal Reserve, was asked to identify the biggest obstacle to economic recovery. That “we don’t have the political will,” he replied.

Mr Bernanke showed his own will on Wednesday March 18th, when the Fed’s policy panel said it would purchase $300 billion in Treasury debt, mostly maturing in two to ten years, starting next week. It will also boost its purchases of mortgage-backed securities to a total of $1.25 trillion from a previously announced $500 billion, and its purchases of debt issued by Fannie Mae and Freddie Mac, the mortgage agencies, to a total of $200 billion from $100 billion.

The Fed had already said it was considering Treasury purchases, but expectations had waned in recent weeks. The announcement electrified investors, sending the Dow Jones Industrial Average up by 91 points, or 1.2%, and the ten-year Treasury bond yield down a stunning 50 basis points to 2.51%.

The plans are awe inspiring in their scale, but they are different only in degree rather than kind from the steps the Fed has already taken. In December, it exhausted its supply of conventional monetary ammunition when it lowered its short term-interest rate to between zero and 0.25%. At that time it had already started unconventional operations: expanding loans to banks and other financial institutions; buying private commercial paper; making enormous and controversial loans and loan guarantees to AIG, Bear Stearns, Citigroup and Bank of America; and setting up a facility, capitalised by the Treasury, to buy securities backed by car, student and small-business loans, and mortgages. By the time its new steps are done, the Fed’s balance sheet will reach $4.5 trillion, or about a third of GDP, up from less than $1 trillion a year ago, Capital Economics estimates.

All these steps were aimed at reducing credit spreads on private loans and increasing the supply of private credit, currently constrained by fear of counterparty default, illiquidity and banks’ depleted capital. They have worked to some extent, as spreads on private debt have come down, though they remain well above pre-crisis levels.

Taking the added step of buying Treasuries made some inside the Fed uncomfortable. It amounts to monetising government debt—in essence, allowing the government to finance its spending with newly printed money rather than by borrowing or through higher taxes. That raises two fears: that it would eventually lead to inflation, or even hyperinflation, and that it would compromise the Fed’s independence.

The fear of inflation is exaggerated. Inflation was just 0.2% year-on-year in February, the government said on Wednesday. While core inflation, which strips out food and energy, was a more normal 1.8%, that is probably headed lower as high unemployment and unused capacity put downward pressure on wages and prices. The Fed repeated in its announcement that it “sees some risk that inflation could persist for a time below [its preferred rate]”.

As for the Fed’s independence, Mr Bernanke has previously argued that should be more of a consideration in times of inflation, rather than deflation. In any case, the Federal Open Market Committee, which approved the decision unanimously, appears to agree such risks were an acceptable price for more forceful action against the recession.

Following a similar announcement by the Bank of England, the Fed’s action understandably suggests central banks, having approached the limits of conventional monetary easing, are now experimenting with more monetarist solutions. And the monetary base (currency plus commercial bank reserves) has grown sharply in America, Britain and the euro zone. The Bank of England describes its actions in monetary terms: by expanding the amount of money in the hands of the public, some people will shift to riskier assets such as stocks and bonds, raising wealth and spurring investment. Banks may use the reserves to make higher-returning loans.

But an expanding monetary base will not create inflation if the money is not lent out. The Bank of Japan engaged in quantitative easing earlier this decade, buying government debt and raising commercial bank reserves. Banks did not expand their loans because their capital was constrained and loan demand was weak.

The Fed has explicitly described its goals as lowering the cost and improving the supply of private-sector credit; that this results in an expanded monetary base is secondary. Even Treasury purchases are meant to “improve conditions in private credit markets.”

In the short term at least, the Fed’s actions raise the odds that the economy, in recession since the end of 2007, will pull out by the end of this year. There have been signs the housing market has stabilised, albeit at deeply depressed levels, and lower mortgage rates will bolster demand. If share and home prices stabilise, that will mitigate the astonishing loss of wealth that is depressing consumer spending.

But the Fed cannot do the job by itself. For one thing, many borrowers are unable to take advantage of lower mortgage rates because of stiffer underwriting requirements. Many corporations are either unable to borrow because lenders are more skittish or unwilling to borrow because the business outlook is so weak. Barack Obama’s administration has tackled the first problem with plans to help homeowners refinance and avoid foreclosure. It is to announce within days how it will remove toxic assets from bank balance sheets and regulatory tests should soon disclose how much more capital the government must inject into the banks.

The problem is that the administration’s ability to get the extra funds needed for these schemes has been significantly injured by the outrage among voters and Congress over bonuses paid to recipients of bail-out money. That thirst for retribution could also deter banks, investors and others from participating in the schemes. “I don't want to quell anger, what I want us to do…is channel our anger in a constructive way,” Mr Obama said on Wednesday. That will take political will from him and Congress. For now, Mr Bernanke has done his part.

The AIG Tax

French Supply-Side Lessons

French Supply-Side Lessons

THE WALL STREET JOURNAL EUROPE

Just as President Barack Obama is trying to tax the U.S. into an American version of France, that country's leader is resisting pressure to "spread the wealth around."

French unions are planning nationwide strikes and demonstrations today to protest Nicolas Sarkozy's economic policies. Unions and left-wing parties hope that more than one million workers will flock to the streets to push the government to boost the minimum wage, scrap plans for shrinking the public sector and reverse tax cuts for high-income earners.

Nicolas Sarkozy

Particularly on the last point, Mr. Sarkozy seems to have found his inner Gipper -- at least for now. "I was not elected to increase taxes," he said Tuesday, speaking to workers at a factory no less. "My goal is to convince people who have money to come to France and invest in our factories and companies, not to push them out."

Just a few months after coming into office in 2007, Mr. Sarkozy lowered the so-called fiscal shield to 50% from 60%; taxpayers could apply for reimbursement if their tax bill was more than 50% of their income. Making sure taxpayers wouldn't have to pay more than half of their income to the state hardly turned France into a tax paradise. But this measure, together with more exemptions for France's wealth tax -- levied on a person's net wealth, such as savings and real estate -- at least introduced some balance into the tax system.

French suspicion of the rich -- "Behind every great fortune lies a great crime," Honoré de Balzac quipped -- and France's punitive taxes had pushed many of those wealthy suspects to friendlier shores. About 200,000 French live in Switzerland alone. According to a 2007 study by the Economic Analysis Council, which advises the government, about 10,000 business directors left France in the preceding 15 years, taking with them €70 billion to €100 billion of capital.

There appear to be no studies out yet on how lowering the French tax shield to 50% may have helped boost tax revenues by encouraging investments and work. But the number of people subject to the wealth tax who are leaving the country dropped to 719 in 2007 -- the year of President Sarkozy's reforms -- from 843 in 2006.

The pressure on the French President to reverse course will only increase. The economy is expected to contract by as much as 2% this year while unemployment will likely approach 10%. Recent polls suggest that almost 80% of the population support today's rallies, the second such protest after union action on January 29 brought up to 2.5 million people onto the streets.

Even lawmakers in the President's own center-right coalition support tax hikes for high-income earners. Mr. Sarkozy's assessment of his colleagues who are forging common ground with the unions was swift: "They lack spine," he told his worker audience Tuesday.

Mr. Sarkozy will need a strong backbone to stand his ground. His reforms so far have not been as far-reaching as many hoped and his policy ideas can quickly switch from free-market to protectionist -- sometimes within the same sentence. But as supply-side theory is being buried in the country of its birth, some of its principles may yet help create wealth in an unlikely place called France.

FDR's Conservative 100 Days

FDR's Conservative 100 Days

GEORGE BITTLINGMAYER THOMAS W. HAZLETT

The Obama administration's opening policy sprint -- massive deficits and bailouts, with sweeping health-care and education reform, plus cap and trade to come -- has been likened by the president himself to Franklin D. Roosevelt's famous first 100 days.

But FDR did not launch his New Deal with a program that roiled financial markets. On the contrary, his first step was to stem the banking panic with a national bank holiday (many states had already imposed their own). He closed troubled institutions, injected capital into the healthy ones, and reassured Americans that their deposits would be safe.

His approach met with quick success. The New York Stock Exchange, closed during the bank holiday, opened up 15% on March 15. By July 3, the Dow Jones Industrial Average was 93% above its close on March 3, the day before Inauguration Day in 1933. FDR's fast start, embraced by Wall Street, provided him with early, and crucial, political capital when his agenda later veered left.

As Raymond Moley, an FDR adviser intimately involved in crafting the bank holiday and other 100 days policies, wrote in his book, "After Seven Years," "It cannot be emphasized too strongly that the policies which vanquished the bank crisis were thoroughly conservative . . . Those who conceived and executed them were intent upon rallying the confidence, first, of the conservative business and banking leaders of the country and, then, through them, of the public generally."

Moley stressed that the policy relied on "conventional banking methods" and eschewed "any unusual or highly controversial measures." As FDR said in his first fireside chat, "I hope you can see from this elemental recital of what your government is doing that there is nothing complex, or radical in the process."

Roosevelt initially tacked right on fiscal issues. On March 10, he asked Congress to slash the salaries of federal government employees by $100 million, with an additional $400 million sliced from veterans' pensions. This stunning cut -- total annual federal expenditures then running at $4.6 billion -- came in a measure called "A Bill to Maintain the Credit of the United States Government."

Moley said the "psychological effect was electric. The bill [was] greeted with loud shouts of approval by all articulate conservatives. But I am confident that deep down in the consciousness of the average people of the country it found a similar response. Somehow or other . . . Hoover had always seemed to be an expensive President."

As, so recently, George W. Bush seemed to be. Yet fiscal conservatives, Democrats and Republicans, are now wondering what happened to the good old days of Mr. Bush's $400 billion deficits. (The fiscal 2009 deficit is now pegged at $1.75 trillion.) Plans to shore up bank solvency and bring clarity to the toxic asset crisis have given way to false starts at Treasury.

Worse, investors grappling with the collapse of global markets have to cope with higher future tax rates, one policy clearly enunciated by the new Obama administration, and with threats posed by government shareholders leveraging bailout funds for political purposes.

Limiting corporate jets and CEO salaries may play well to the crowd. But every rational shareholder knows that jets make sense if (and only if) they help increase profits, and that arbitrary pay limits don't protect company assets or owners. Instead, failed managers need to be replaced, at competitive wages, by superior ones. New shareholder protections that made that easier would attract bipartisan support and be cheered by investors.

Even with the recent signs of life in share prices -- triggered by an improved picture on bank holdings -- equity values have plummeted 10% since the inauguration. This is on track to be the worst opening performance for any president's stock market in the past century.

For a president who seeks to emulate Roosevelt, it is proving a very cloudy 100 days. Whatever is to come, an Obama administration reset that focused on investment incentives could stimulate confidence and give our economy a fighting chance to recover. That is the message being conveyed by pro-Obama business champions such as Warren Buffett -- and it was in fact the strategy executed by FDR.

Mr. Bittlingmayer is professor of finance at the University of Kansas. Mr. Hazlett is professor of law and economics at George Mason University.

Is Inflation Baked Into the Budget Plan?

Is Inflation Baked Into the Budget Plan?

JUDY SHELTON

Trust, honesty, accountability -- these are the watchwords of President Barack Obama's administration. In his inaugural speech, Mr. Obama made it clear that these principles are especially applicable to fiscal and budgetary matters. "Those of us who manage the public's dollars will be held to account -- to spend wisely, reform bad habits, and do our business in the light of day -- because only then can we restore the vital trust between a people and their government."

Fiscal accountability is imperative because when government spends more than its citizens can afford, it hollows out the productive capabilities of the nation. Resources that should be used to create new wealth are allocated to pay interest on accumulated debt; instead of investing in tomorrow, people must labor to pay yesterday's bills. When deficit spending is accommodated by loose monetary policy, it leads to internal bankruptcy -- indeed, whole nations have foundered on this path.

Which is why the Obama administration should be asked to provide assurances it won't compromise the integrity of our money as it strives to implement its $3.9 trillion budget and simultaneously reduce the deficit. We cannot balance the budget by resorting to the dodge of inflation. Fiscal honesty demands a meaningful measure of value, an honest dollar.

Therefore, it is crucial that as Mr. Obama talks up his blueprint for reducing the deficit from 12.3% of GDP to a mere 3% within the next four years, the underlying economic assumptions that drive his projections are subjected to close scrutiny. One factor that tends to get overlooked is that the year-to-year growth in projected GDP is a function of two estimates: real growth and inflation. It is the combination of these two estimates that provides the budget number that serves as the denominator for calculating the deficit as a percentage of GDP.

Here's an example of some fuzzy math: The Obama budget shows GDP at $14.240 trillion in 2009 and projects it at $17.498 trillion in 2013. In other words, it projects that the total value of U.S. economic output will increase by 23% over the next four years, i.e., it will be nearly one-quarter larger. The projected deficit for 2013 is $533 billion in the Obama budget; hence, $533 billion divided by $17.498 trillion is 3% -- voila! the impressive deficit-at-3%-of-GDP claim four years out.

The trick lies in getting a big number for GDP growth, and the fudge factor arises from assigning relative weights for real growth versus inflationary growth. The Obama budget assumes 70% of the increase can be attributed to real growth, 30% from inflation.

The fact that the mainstream summary of private economic forecasts known as the Blue Chip Consensus predicts nominal GDP in 2013 will be $730 billion lower than does the Obama budget -- and also assumes lower real growth and higher inflation across the same four-year period -- was dismissed not long ago by Christina Romer, chair of Mr. Obama's Council of Economic Advisers. "We are economists and not soothsayers," she quipped.

Economists are notorious for disagreeing with each other, true. If you were to poll economists right now whether the bigger threat on the horizon is deflation or inflation -- you would receive a continuum of opinions.

But what most Americans are concerned about, it's safe to say, is not so much the possibility of declining prices -- after all, lower prices can serve as a stimulus to start buying -- but rather the likelihood that the purchasing power of their wages and savings will be eroded through inflation. It's small comfort to have more dollars rounding out the economy these next few years if those dollars are worth less. So it very much matters how much of the projected growth touted in the Obama budget will turn out to be real, and how much is apt to be achieved through money illusion.

Economists may not be soothsayers, but they should strive to be truth tellers. It's one thing to claim that the dollar value U.S. economic output will be one-quarter higher in four years; it's quite another to suggest that the U.S. GDP in 2013 will be worth one-quarter more.

Can the president's economic team definitively state that inflation is not baked into the plan? Would Mr. Obama be willing to guarantee the stable purchasing power of the dollar?

The notion that monetary policy might be in cahoots with fiscal policy is sure to elicit howls of protest all the way from the Treasury to the Federal Reserve -- about a mile's distance. But no one can seriously suggest that the Fed has not been politicized beyond all pretenses toward independence. The Fed has become a key player in the government's efforts to deal with the credit crisis, purchasing hundreds of billions in mortgage-backed securities guaranteed by federal agencies and taking them onto its own balance sheet. Last month the Fed issued a joint statement with Treasury that they stood ready to inject more capital into banks "to provide a cushion against larger-than-expected future losses." And according to yesterday's surprise announcement, the Fed now plans to buy up long-term Treasury bonds -- an act of fiscal incest -- while taking another $1 trillion or so onto its balance sheet to boost consumer spending.

So the Fed is involved up to its neck in this blueprint for the future. Does anyone doubt that former Treasury Secretary Larry Summers, who heads the White House's Economic Council, is slated to be the next Fed chairman?

All of which brings into urgent focus the need to put down a marker for sound money. How can capitalism find its footing when the monetary foundation is shifting with each new government bailout -- each new infusion of deficit-financed government expenditure? American families deserve better than to be punished by wasteful public spending and ruinous inflation.

We must require the Obama administration to abide by its professed willingness to be held to account. We should demand a new form of savings bond from the government aimed at safeguarding the purchasing power of the currency. "Make the dollar, once again, an honest dollar," Jack Kemp urged as a Republican candidate for president in 1988. "The dollar should be so trustworthy, so predictable, so lasting in value, that it's as good as gold." Thirty years later, gold remains a surrogate for long-term confidence in U.S. fiscal policies. Judging from the steep rise in the dollar price of gold -- and runaway sales of gold coins -- the verdict is not positive.

It is time to take a stand. Honest money is essential to an honest budget; we need to safeguard the integrity of America's currency. As Republicans put forward an alternative blueprint for America's future based on pro-growth tax policies and entitlement reform, they should also seek to pass legislation authorizing the issuance of gold-backed Treasury bonds -- payable at maturity in dollars or ounces of gold, at the option of the holder.

A limited issuance of gold-backed Treasury bonds would serve as a sign to U.S. citizens that the dollar will not be the default mechanism for governmental excesses. "The Honest Dollar Act" will function as a barometer measuring the fiscal rectitude of the Obama administration. If the promised deficit reduction has been sufficiently accomplished to stem inflationary fears, holders of gold-backed Treasury obligations are unlikely to redeem in gold; after all, gold pays no interest and normally engenders warehousing costs. Unless the utter lack of progress toward fiscally conservative goals has unleashed even more egregious levels of deficit spending, repayment in dollars will be preferred. But the right to convert the face value of the note for gold at a fixed rate -- say, $1,000 per troy ounce -- conveys a trust-but-verify provision that marks the first solid step toward sound money.

As we strive to turn the U.S. economy around, let us not forget that money is a moral contract between government and citizens -- a key aspect of that "vital trust" between a people and their government to which Mr. Obama so powerfully subscribes. And which we must uphold.

Ms. Shelton, an economist, is author of "The Coming Soviet Crash" (Free Press, 1989) and "Money Meltdown" (Free Press, 1994).

Wonder Land: The Earmark Shopping Channel?

Earmark Madness

Earmark Madness

• By DANIEL HENNINGER

Barack Obama was so fed up hearing about the evil earmarks in the $410 billion omnibus spending bill that the president signed it in private. "Some things are signed in public," said irrepressible White House humorist Robert Gibbs, "and some aren't."

What's to be embarrassed about?

If the first major act of one's presidency was to sign a stimulus bill whose goal was to spend $787 billion, how is it possible to blush while signing your John Hancock to $14.3 billion in earmarks?

There is a 78-year-old theory behind the stimulus bill called the "Keynesian multiplier." It holds that in times of negative growth it's the government's job to "inject" cash into the economy, like a giant hypodermic needle, to jack up aggregate demand.

Seen this way, pork may be nature's purest form of stimulus spending. Shovel-ready? Most of these earmark projects have been shovel-ready for so long the shovels are rusting. Instead of hiding, President Obama should have signed all 8,000 earmarks on the White House lawn.

Wonder Land Columnist Daniel Henninger appreciates the entertainment value of federal spending.

If with the White House you believe in the magic of spending to make an economy grow, how can you not want to put into motion a $2 million earmark for the Steptoe Street Extension in Kennewick, Washington? Or $2.8 million for the Cesar Chavez/Calexico-West Port of Entry Congestion Improvements in California? A hundred dollars says Bobby Byrd's $4 million earmark for West Virginia's Coalfields Expressway has new workers spending the multiplier at Wal-Mart long before Mr. Obama's fiber-cable project is creating jobs in the North Dakota outback.

Mr. Obama isn't the only Washingtonian having an argument with himself over the social status of earmarks. Rep. Ron Paul, the famous GOP presidential primary candidate, had an amazing conversation about earmarks recently with Neil Cavuto of Fox Business News.

Cavuto: "That's a lot of pork -- $73 million went to your district, is that true?"

Paul: "Well it might be. But I think you're missing the whole point. I have never voted for an earmark. I voted against all appropriation bills. So, this whole thing about earmarks is totally misunderstood . . ."

Cavuto: "Well, then, how does that even get in there."

Paul: "I have no idea. But the most important thing is to have transparency."

Earmark angst has turned poor Ron Paul into the Prof. Irwin Corey of Congress. It doesn't have to be this way. Joy in public life is hard to find these days, so I exhort conservatives to get over their anti-earmark mania and view the pork spectacle as (relatively) cheap entertainment.

Think of those 8,570 earmarks as the master to-do list of the burbling swamp of American politics. This is what the swamp has sent to the surface. It only adds up to $14 billion, not even 2% of the $787 billion stimulus bill.

In any fiscal year, earmarks are a virtual Mobil Travel Guide of the American experience. The spending projects often have beautiful American names: the Codorus Creek Watershed Restoration, Dog Island Shoals, Blue River, the Emiquon Preserve, Winnapaug Pond, Shortcut Canal and the most irresistible earmark of all, Pleasure Island (that's in Maryland).

Earmarks get a bad rep because so many of them sound disreputable: things called Integrated Predated Management Activities, the Lake Worth Sand Transfer Plant or the sketchy-sounding Vermont Farm Viability Program.

Some Washington experts say that to come out from the shadows and join respectable society, this distasteful Congressional habit just needs to be reformed. I agree. Reform's watchword is "transparency."

Let's not be shy about this. Given its past sins, the earmark pork barrel must migrate to America's most transparent medium -- television.

An Earmark Shopping Network comes to mind. But that sounds corrupt. Instead, let the FCC mandate that major TV stations in each state launch a new series -- "American Earmark." The earmark competitor pool is bottomless. This year's 8,500 earmarks works out to an average of nearly 16 per Member of Congress.

On the "American Earmark" show, Senators and Representatives would have to do a song and dance about each of their projects. Sen. Jon Tester could sing out for $682,000 for Sustainable Beef Supply in Montana. Olympia Snowe and Susan Collins could do a lovely duet for the $3.45 million Machias River project. Frank Luntz, the pollster, would assemble focus groups of local citizens who'd use those little post-debate machines to vote thumbs up or down on the competing pork.

These sectionals could be escalated to a televised national finals of earmark madness. Taxpayers for the first time would see some of earmarking's legendary professionals compete in public: John Murtha, Bobby Byrd, Dan Inouye ($238,000 this year for the Polynesian Voyaging Society), Virginia's Jim Moran.

Hey, it used to be your money. Why not enjoy it?

Obama Gives the GOP an Opening

Obama Gives the GOP an Opening

KARL ROVE

President Barack Obama and his West Wing lieutenants are playing on the world's largest stage, yet act as if no one is watching them when they contradict their campaign promises. That behavior is unwittingly giving the Republicans an opening.

For example, Team Obama thinks the president, having spent a good portion of the campaign decrying the $2.9 trillion in deficits during the Bush years, can now double the national debt held by the public in 10 years. Having condemned earmarks during the campaign, the Obama administration now believes it can wave through 8,500 of them in the omnibus-spending bill, part of the biggest spending increase since World War II.

Associated Press

Wisconsin Rep. Paul Ryan.

With the Dow at 7,486 and unemployment at 8.1%, Mr. Obama says the economy is fundamentally sound. Does he suppose the nation won't recall him attacking John McCain last September for saying the same thing -- when the Dow was at 11,000 and unemployment at 6.2%?

Candidate Obama vowed to end "the same partisanship and pettiness and immaturity that has poisoned our politics." Yet his administration geared up MoveOn.org to lead a left-wing coalition to pressure Republicans and centrist Democrats, organized a daily conference call to coordinate liberal attack dogs, and strategized with Americans United for Change on ads depicting the GOP as the party of "no."

About Karl Rove

Karl Rove served as Senior Advisor to President George W. Bush from 2000–2007 and Deputy Chief of Staff from 2004–2007. At the White House he oversaw the Offices of Strategic Initiatives, Political Affairs, Public Liaison, and Intergovernmental Affairs and was Deputy Chief of Staff for Policy, coordinating the White House policy making process.

Before Karl became known as "The Architect" of President Bush's 2000 and 2004 campaigns, he was president of Karl Rove + Company, an Austin-based public affairs firm that worked for Republican candidates, nonpartisan causes, and nonprofit groups. His clients included over 75 Republican U.S. Senate, Congressional and gubernatorial candidates in 24 states, as well as the Moderate Party of Sweden.

Karl writes a weekly op-ed for The Wall Street Journal, is a Newsweek columnist and is now writing a book to be published by Simon & Schuster. Email the author at Karl@Rove.com or visit him on the web at Rove.com.

Or, you can send him a Tweet @karlrove.

Rather than working with Republicans on the budget, the administration attacked them as mindless obstructionists. Yet the administration's policies are not nearly as popular as one might suppose.

For example, the liberal Center for American Progress recently found that 61% of Americans say government spending is almost always wasteful and inefficient, and 57% think free market solutions are better than government at creating jobs and economic growth. A late February poll by NBC News/Wall Street Journal found that 61% were concerned "the federal government will spend too much money" and "drive up the budget deficit" versus 29% concerned the government "will spend too little."

These general attitudes translate into opposition to specific policy initiatives. For example, CBS found support for the stimulus bill falling to 51% in February from 63% in January. Meanwhile, opposition to more money to bail out banks rose to 53% in March from 44% in February.

This, in turn, is affecting Mr. Obama's job approval ratings, already just average for a new president. Last week's Pew poll showed Mr. Obama's approval at 59% with 26% disapproval, down from February's 64% approval and 17% disapproval. His standing on the economy is also falling: Newsweek found in January that 71% were confident Mr. Obama would be able to turn around the economy, while 26% were not. By March, his ratings had fallen to 65% confident, 33% not.

Republicans sense the opportunity. The House GOP leadership deputized the top Budget Committee Republican, Paul Ryan of Wisconsin, to prepare an alternative budget. The GOP budget won't raise taxes, gets spending and debt under control, and will result in a stronger economy with more jobs. House Republicans plan a major selling effort back home during the coming recess. Minority Leader John Boehner is already up on YouTube extolling the plan.

Senate Republicans will not prepare a complete alternative, but they will offer a robust package of amendments, with a wave of proposals for each of the three weeks the upper chamber will devote to the budget. Senate Minority Leader Mitch McConnell and Republican Conference Chairman Lamar Alexander foreshadowed the GOP's theme by saying the Democratic budget taxes, spends and borrows too much.

Sen. Alexander is also working with Sen. Judd Gregg, the ranking Budget Committee Republican, on a statement of budget principles that sharpens the contrast between the two parties' approaches to America's economic future.

The GOP's challenge is winning attention for its vision. True, its megaphone isn't nearly as big as those of the White House and the Congressional Democratic majorities, and Mr. Obama still has the upper hand. Yet by discarding so much of what people found appealing in him, Mr. Obama may change that.

Every president eventually depletes his political capital. Some have done so advancing great, difficult causes. Others squander it because of missteps, and what the public views as breaches of faith. Having been president for all of eight weeks, Mr. Obama retains much residual goodwill and could still change course on the budget to reach across the aisle. But his current strategy has made him weaker than he was and weaker than he needs to be. It's turning into a costly two months for America's 44th president.

Mr. Rove is the former senior adviser and deputy chief of staff to President George W. Bush.

Wednesday, March 18, 2009

Washington Has Always Demonized Wall Street

Washington Has Always Demonized Wall Street

ZACHARY KARABELL

'Wall Street, as we knew it, is dead. The system that allowed the U.S. economy to be a dynamic innovator has been fundamentally broken and the implications of these structural changes have yet to be fully felt."

It's now commonly accepted that the economic meltdown has forever changed the nature of the financial industry. But the words above weren't written in the past weeks. They were penned by financial analyst Richard Wayman in 2003, after investigations by then New York Attorney General Eliot Spitzer led to a structural shift in the relationship between research and investment banking following the stock-market collapse of 2001-02.

Martin Kozlowski

Among the many remarkable aspects of our present crisis is the speed with which we have collectively forgotten past crises, even ones that happened recently. The current meltdown is substantial, dramatic, and systemically dangerous -- but it is hardly the first to merit that description. And each crisis, without fail, results in unequivocal pronouncements that such excesses will never again be allowed.

When President Barack Obama lambastes Wall Street bonuses as "shameful," he is keeping up with the American tradition of vilifying Wall Street. Almost since the founding of the country, the U.S. has oscillated between admiration and condemnation of money men. When the first Bank of the United States was established in Philadelphia in 1791, it was amid fears that it would allow merchants and speculators to subvert the new republic for their own gain. Decades later, Andrew Jackson's presidency was bolstered by his staunch opposition to the Second Bank of the United States. He positioned himself as the defender of the common man against supporters of the bank who used their money to obtain influence.

From the 19th century to the present day, denunciation of financiers has gone hand in hand with each recession, speculative bust and depression. Each time the economy falls, the chattering classes announce that the old ways have brought the country to the brink of ruin and that the riches of society will no longer remain in the hands of the greedy few.

Little recalled now is "The Long Depression" of the 1870s that began with the Panic of 1873. The Panic was triggered by the collapse of the Jay Cooke and Company Bank, which came on the heels of Jay Gould's infamous attempt to corner the national gold market in 1869 and the speculative boom in railroad building. During the 1870s, as much as 50% of the U.S. labor force was out of work at one time or another, making it by far the worst economic collapse in the country's history. In the agrarian heartland of the country, early stirrings of populism led to attacks on eastern barons for robbing Americans of their birthright.

From then on, busts followed almost like clockwork every 20 years, with the panics of 1873 and 1877 followed by the panic of 1893 and then the "Bankers' Panic" of 1907, when J.P. Morgan orchestrated the recapitalization of the financial system from his mansion in Manhattan. It was the TARP, the "bad bank," and the stimulus of its day, and it earned Morgan the gratitude of a nation and the applause of President Theodore Roosevelt.

Having lionized Morgan, a few years later the country turned on him and his ilk with a vengeance. In 1913, a populist congressman from Louisiana, Arsène Pujo, launched an investigation of the so-called "Money Trust" that he claimed was exerting undue and deleterious influence on the body politic. Exhibit No. 1 was none other than one-time savior Morgan, who was interrogated by the committee as if he had committed a heinous crime. One member of the committee said Morgan represented "a moneyed oligarchy more despotic and dangerous to industrial freedom than anything civilization has ever known." Strict regulations followed -- as they always have on the heels of such crises.

Yet 20 years later, the market imploded with the crash of 1929. The ranks of the unemployed swelled to at least 25%, and the country was plunged into the Great Depression. Franklin Delano Roosevelt famously indicted the "money changers" in his 1933 inaugural address, but he was even more caustic in private, vowing to end forever "speculation with other people's money." The raft of modern regulatory institutions, from the Securities and Exchange Commission to the Federal Deposit Insurance Corporation, was one result. Wall Street was tamed and quiet for a while.

Later on, the "Go-Go" years of Wall Street in the late 1960s quickly gave way to the bust of the so-called "Nifty-Fifty," the 50 largest blue-chip companies. Then came inflation, severe unemployment, and the stock market collapse of 1973-74. Between 1964 and 1982, the major stock indices went nowhere fast -- the Dow began that period at about 800 and ended at the same. Wall Street in those years was more of a cottage industry, one that few suspected would again return to its prominent and controversial position at the apex of American society.

The booming 1980s -- mergers and acquisitions and arbitrage -- were capped by the highly publicized trials of Ivan Boesky and Michael Milken, who were pursued by the Eliot Spitzer of his day, Rudy Giuliani. Combined with the market crash of 1987, the subsequent Savings and Loan debacle (which had little to do with Wall Street per se, but was wrapped up with the same crowd in public imagining), and the recession of 1991-92, Wall Street was once again pronounced immoral and in need of tight reins. Yet within a few years, the Nasdaq was soaring, animal spirits were in control, and the Internet bubble was in full bloom.

Wall Street's obituary has been written many times. Yet what is striking today is that cycles that used to take a few decades now take a few years. And our cultural amnesia has gotten worse. The rapid sequence of the dot-com bubble of the 1990s, the recession of 2001, and the 2002 collapse of Enron combined with major fines levied against investment banks, all became a distant echo in a surprisingly short amount of time. At the rate we've been going, we're due for a new boom with obscene profits for the financial industry -- albeit with different names and different companies -- before Mr. Obama runs for re-election.

The fact that we have been in similar places in the past doesn't make the specific problems we face any less pressing. New regulations may prevent an exact recurrence of yesterday's crises, but our relentless capacity for reinvention means that we will produce innovations that will in turn create new problems.

Recognizing that our present is not quite so breathlessly unprecedented doesn't make the challenges less critical, but it could lead to a more level approach. That can begin with steady leadership from President Obama. Wall Street has been humbled and will change, but capital will continue to flow. That much, at least, is certain.

Mr. Karabell is president of River Twice Research. His new book, "In the Red: How China and America Became One Superpower Economy," will be published by Simon & Schuster in October.

Obama's AIG Panic

Obama's AIG Panic

The AIG Beltway bonfire continued yesterday with the spectacle of Ed Liddy, AIG's government-appointed CEO, enduring the wrath of Congress for embarrassing the Members with post-bailout bonuses. What we now have is a full-blown political panic ignited by no less than President Obama himself that is threatening to engulf his attempts to revive the financial system, and is undermining confidence in his leadership. This is no way to promote an economic recovery.

As recently as Sunday morning, White House economist Larry Summers was saying the bonuses were regrettable but there wasn't much that could be done to stop them. "We are a country of law. There are contracts. The government cannot just abrogate contracts," he said, with great good sense. Assorted Congressmen then did what comes naturally, which is declare their mock outrage. Rather than keep his legendary cool, Mr. Obama and the White House panicked as well and joined the braying pack.

Speaking on Monday of the $165 million paid to members of AIG's Financial Products division, the President asked, "How do they justify this outrage to the taxpayers who are keeping this company afloat?" Treasury Secretary Tim Geithner, who had known about the bonuses, was also trotted out to express his "outrage" and declare that Treasury would somehow try to claw back the bonuses. By shouting "greed" in a crowded and panicky Washington, our supposed financial stewards thus gave license to everyone in the media and Capitol Hill to see who could claim to be most shocked and appalled at AIG.

We've now got a full-fledged mob on our hands, with Congress looking to string up bankers in whatever bunker they can be found. Senators Chuck Grassley and Max Baucus want to double the current income tax on these bonuses, to 70% from 35%, and that's one of the more reasonable proposals. Congresswoman Carolyn Maloney, the Democrat from silk-stocking Manhattan, wants to tax it all -- at 100%.

Senator Chris Dodd, down in the 2010 election polls after his sweetheart Countrywide mortgages, is busy rewriting the TARP compensation limits he only recently stuck in the stimulus bill. His last-minute measure explicitly exempted from compensation limits bonuses agreed to prior to the passage of the stimulus bill: "The prohibition required under clause (i) shall not be construed to prohibit any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009 . . ." So Senator Hedge Fund is suddenly morphing into Huey Long to save his career.

This is all too much even for Rep. Charlie Rangel, the House's chief tax writer, who says the tax code shouldn't be deployed as a "political weapon." He's right. AIG's managers may be this week's political target of choice, but the message to every banker in America, indeed every business in America, is that you could be next. At least we haven't yet seen the resolution that was proposed in the English parliament, in 1720 in the aftermath of the South Sea bubble, that bankers be tied in sacks filled with snakes and tipped into the Thames. But it's still early days.

One consequence will be that every bank executive in America will try to repay his Troubled Asset Relief Program, or TARP, money as rapidly as possible. The political punishment for accepting public money is becoming higher than the benefits of the extra capital cushion. According to Wells Fargo Chairman Richard Kovacevich, "If we were not forced to take the TARP money, we would have been able to raise private capital." On Tuesday, Bank of America CEO Ken Lewis joined the rush for the TARP exits, saying he hoped to pay back the $45 billion BofA has received by 2010 if not sooner. It's hard to argue with the sentiment.

For the larger banking system, however, this is exactly the wrong time to be shedding capital. The main point of the TARP was to backstop the financial system against systemic failure. Treasury botched the roll out and the execution, but with the economy still in recession and housing prices still falling, banking losses will surely grow. Mr. Geithner has projected the need for more than $1 trillion more in public capital, and the FDIC has asked Congress to increase its credit line to as much as $500 billion.

If we're lucky, the banks will be able to use today's steep yield curve to earn their way out of this mess, but no one can be sure and before this is over the FDIC and Treasury are going to need more public capital to protect depositors of failed institutions. The last thing we need is for this year's political panic to recreate the circumstances for another financial panic like the one we had last fall.

The Beltway's banker baiting seems to increase in direct proportion to the government's incompetence in nurturing a financial recovery. Anger rises when Americans learn after three bailout revisions that they haven't been told the truth that the AIG nationalization was a conduit to save counterparties, and even hedge funds, that gambled on housing. Only two weeks ago, Federal Reserve Vice Chairman Donald Kohn told Congress he couldn't disclose who AIG's counterparties were. Americans also wonder why taxpayer guarantees should be provided to Citigroup, a three-time loser, but with little accountability for the board and managers who brought the company low.

Reviving a financial system is a long process that requires a combination of capital support, workout ability and discipline for mistakes. The public has to believe the end result will be a better, sturdier system in return for taxpayer support, while at the same time being assured that gamblers aren't saved from their own mistakes.

If this balance is beyond the ability of Mr. Obama's current economic team, he needs a better team. The worst mistake he can make is to deflect attention away from government's mistakes by joining the attack on the very bankers he needs to lead an economic recovery. That's how a deep recession becomes a Depression.