Dr. Sherry Jarrell

The Farcical Freeze

President Obama's proposal to freeze parts of federal government spending over the next three years is a lot like a smoker buying a truckload of cigarettes today, then promising to "freeze spending" on cigarettes tomorrow.  He can keep smoking for years to come without spending another dime.

Federal government spending has increased so much over the last year -- by some estimates at a rate of 34% (http://www.usgovernmentspending.com/year2009_0.html#usgs302 -- that in December of 2009 the debt limit had to be raised to $12.4 trillion to help absorb a record-shattering $1.4 trillion deficit (http://www.washingtontimes.com/news/2009/dec/25/senate-oks-rise-in-debt-limit-to-124-trillion/).

The promise to freeze spending is actually a guarantee that spending will remain at record high levels for the next three years.  It effectively prevents a reduction in federal spending. 

How disingenuous of our President.  

 

The Fed sets up Unit to Police Itself

I'm not quite sure how I feel about this yet.  The Fed has just announced that it has appointed a long-time staffer with the New York Fed to head a newly created branch to oversee the the parts of its balance sheet acquired in efforts to bail out firms like AIG.http://blogs.wsj.com/economics/2010/01/21/new-york-fed-sets-up-unit-to-handle-bailout-balance-sheet/?mod=rss_WSJBlog   

These massive asset purchases, orchestrated by Timothy Geithner, the current Treasury Secretary and former New York Fed official, ballooned the Fed's balance sheet from $800 billion in primarily government bonds to $2.3 trillion in toxic assets.   

Now the New York Fed is overseeing the assets brought into the Fed by the Treasury Secretary as he moved from the New York Fed to the Treasury.  All while the Treasury functions are supposed to be isolated from the Federal Reserve's role in its implementation of monetary policy.
 

Smacks of the fox watching the hen house....

Actual Unemployment is Worse

Keep in mind, even as the number of first-time claims for unemployment insurance rose again this week, that the 10% U.S. unemployment figure understates the actual number of unemployed. Even the 17% underemployment figure, which includes those who are either unemployed or who are working part-time but would like to work full-time, fails to include many of those who have lost their jobs but, because they fail to qualify for unemployment, are not being tracked.  I know several such people personally; one has been unemployed for over a year. 

My point?  Structural unemployment is a serious economic issue.  But the solution is not to funnel more unemployment benefits to the unemployed.  The best thing the government can do is to reduce the barriers it has erected to a vibrant economy, including oppressive taxes, fees, paperwork, bureaucracy, and regulations that repress business productivity and raise prices.  By reducing these explicit and implicit costs, there is absolutely no doubt that the private economy will be able to employ more workers as it produces more output at lower prices. 

The best thing we can do as private citizens and neighbors is to treat each other right.  Keep the economy moving.  Put in a good day's work.  Volunteer or learn a new skill if you can't find a job.  Fill a need.  Buy smart.  And, finally, elect business-friendly local and national politicians.  It matters. 

Capitalism and the Daimler-Chrysler Saga (Part 3 of 3)

This is part 3 of a 3 part post on the saga of the ill-fated 1998 merger between Daimler and Chrysler.

The Daimler-Chrysler merger was troubled from the beginning. Investors sued over whether the transaction was a 'merger of equals' or a Daimler-Benz takeover of Chrysler. A class action lawsuit was settled in August 2003 for $300 million. A lawsuit by activist investor Kirk Kerkorian was dismissed in April 2005, but claimed the job of the merger’s architect, Chairman Jürgen E. Schrempp, who resigned in response to the fall of the merged company's share price. The merger was also the subject of a book Taken for a Ride: How Daimler-Benz Drove Off With Chrysler, (2000) by Bill Vlasic and Bradley A. Stertz.

It is questionable whether the merger ever delivered promised synergies or ever successfully integrated the two businesses. As late as 2002, DaimlerChrysler appeared to run as two still-independent companies.  In 2006, Chrysler reported losses of $1.5 billion.  In 2007, it announced plans to lay off 13,000 employees, close a major assembly plant, and reduce production at other plants in order to try to restore profitability.

It was all for naught.  In May of 2007, DaimlerChrysler announced that it would sell 80.1% of Chrysler to Cerberus Capital Management of New York, a private equity firm specializing in troubled companies. Daimler continued to hold a 19.9% stake. Daimler paid Cerberus $650 million to take Chrysler and associated liabilities off its hands, an amazing development given the $36 billion Daimler paid to initially acquire Chrysler. Of the $7.4 billion purchase price, Cerberus invested $5 billion in Chrysler Holdings and $1.05 billion in Chrysler’s financial unit. The de-merged Daimler AG received $1.35 billion directly from Cerberus but invested $2 billion in Chrysler LLC itself.

On April 27, 2009, Daimler AG agreed to give up its remaining 19.9% stake in Chrysler LLC to Cerberus and pay as much as $600 million into the automaker's pension fund.  On April 30, 2009, Chrysler LLC filed for Chapter 11 bankruptcy protection and announced a plan for a partnership with Italian automaker Fiat. On June 1, Chrysler LLC stated they were selling some assets and operations to the newly formed company Chrysler Group LLC, with Fiat retaining a 20% stake in the new company.

On June 10, 2009, the sale of most of Chrysler assets to "New Chrysler," formally known as Chrysler Group LLC, was completed. The federal government financed the deal with $6.6 billion in financing, paid to the "Old Chrysler.” The transfer does not include eight manufacturing locations, nor many parcels of real estate, nor equipment leases. Contracts with the 789 U.S. auto dealerships who are being dropped were not transferred.  Not a hint of the disastrous Daimler-Chrysler merger remains.

Capitalism and the Daimler-Chrysler Saga (Part 2 of 3)

Yesterday, I posted part 1 of 3 parts on the saga of the 1998 Daimler purchase of Chrysler in which I set up the question:  would the Daimler Chrysler merger, with its internationally traded share and U.S. disclosure rules, be enough to offset the secrecy of the German corporate governance standards at the time of the merger? In today's post, I provide the answer:

When DaimlerChrysler (DCX)  incorporated it adopted German corporate governance standards.  U.S. institutional ownership in Chrysler was largely replaced by European banks that not only directly monitor the working capital financing of DCX but also may sit on its Management and Supervisory Boards.  Such superior access and corporate control created distinct advantages for large German institutional owners relative to minority owners; foreign shareholders in the U.S. found themselves among this minority group.  These advantages included the ability to: expropriate the private benefits of control from minority shareholders; share these benefits with management, effectively creating a collusion, and; profit from trading DCX shares with superior information.  As a result, minority owners priced their shares less aggressively – i.e., the bid-ask spread widened -- to minimize their losses from transacting with controlling shareholders.  As their spread increased, U.S. minority shareholders’ trading costs rose and U.S. trading volume fell as it migrated to Germany, the relatively cheaper trading venue.

The merger between Chrysler and Daimler and consequent changes in corporate governance create an ideal clinical study for isolating our hypothesis about the failure of the enhanced disclosure requirements to effectively compensate for lax corporate governance standards in protecting minority shareholders.  To test this hypothesis, we explored changes in the bid-ask spread that are associated with the change in corporate governance and the control over the flow of information about the Chrysler assets.  We look “inside” the trading mechanism that creates the observed transacted stock price, namely the bid-ask spread, to generate evidence on shifts in the quality and quantity of information available to minority versus controlling shareholders.  The bid-ask spread should grow as minority shareholders learn that traders on the other side of the spread possess superior information about the company, information which is linked to their majority control of the firm and its senior management compensation, asset disposition, and financing and risk-taking strategies.

We found that the decision to merge and become a German stock corporation significantly weakened the protection of minority shareholders, particularly prior owners of Chrysler assets, and led to their expropriation by controlling shareholders and principal creditors of the consolidated firm.  The answer lies in the lack of protection afforded minority shareholders by the German corporate governance structure of the newly combined DCX entity.

Capitalism and the Daimler-Chrysler Saga (Part 1 of 3)

In a paper co-authored with Rick Harris, Tom McInish and Bob Wood, we explored the Daimler-Chrysler merger of 1998 to examine the interplay between disclosure rules in the U.S. and corporate governance standards in Germany.  Here is an overview of what we found.

Large shareholders typically control European and Asian industrial giants, leaving minority shareholders less than well protected.  In several studies of the legal protection afforded minority shareholders across 27 countries, German shareholder protection ranked among the very worst. In the early 1990s, Daimler-Benz, one of the largest firms in Germany, was no exception.  In 1993, with Deutsche Bank owning 24% of the equity, Mercedes AG Holding 25%, and the Emirate of Kuwait 14%, its controlling shareholders decided to cross-list Daimler-Benz on the New York Stock Exchange (NYSE).

All foreign firms that cross-list [list their shares for sale in more than one country] in the U.S. subject themselves to stricter disclosure standards.    In addition to listing on a major U.S. stock exchange, Daimler was required to file financial statements with the SEC and report any material non-financial information as well.   Cross-listed firms are also followed more closely by U.S. stock analysts and the business press.  These legal disclosure requirements and additional scrutiny by the investing community improved both the quantity and quality of information available to all shareholders about Daimler.

By early 1998, the cross-listed Daimler shares were widely held and actively traded worldwide, including significant volume originating in the United States. In September of 1998, Daimler and Chrysler shareholders, majority and minority owners alike, overwhelmingly approved a merger creating DaimlerChrysler AG (DCX) through an exchange of the cross-listed share for the first “global registered share” (GRS).  The so-called “merger of equals” was widely expected to realize both operating efficiencies and, via the informational transparency of the GRS, improved access to international capital markets.

Part 2 tomorrow.

Engine of Economic Growth is Sputtering

The engine of world economic growth is sputtering.  The most clearevidence of this is the lack of new business formation in developed nations across the globe.  Over the last year, the number of entrepreneurs starting new businesses in the wealthiest of nations dropped 10% from the 2006-07 level; in the U.S., that number fell by 24%. http://www3.babson.edu/Newsroom/Releases/globalgem2009.cfm

The contaminants in the fuel line are oppressive government policies that increase the cost of doing business, increase unemployment, and raise the risks to the current labor force of quitting their jobs to try to start new businesses.  

At a time when government should be encouraging venture capitalists and the formation of new business, it is instead putting on the brakes to this source of economic growth in the form of cap and trade, compensation regulations, fees on banks, and myriad other explicit and implicit new taxes.  In 2009, nearly half of U.S. employment was generated by small businesses; U.S. companies started through venture capital employed more than 12 million people, or 11 percent of private sector employment, and generated $2.9 trillion in revenues, or 21 percent of U.S. GDP.  

Fully 100% of economic growth is created in private industry.  Government simply redistributes that wealth, destroying some portion of it in the process.  Never have we needed non-interventionist government policies more.

We Need a New Term for Federal Reserve "Profits"

The Federal Reserve, it has been reported, earned record "profits" of over $46 billion in the year ending December 31, 2009.  The previous record profit was $34.6 billion in 2007. The Fed earned $31.7 billion in 2008. The financial crisis has apparently been very good for the Fed, although, as a non-profit entity, all its profits are turned over to the Treasury.  As an aside, I wonder what the Treasury plans to do with its windfall?Reduce taxes? Hmmm. 

Be careful, however.  "Profits" are a bit of a misnomer for the Fed's activities, because they pay for what they do by creating money out of thin air.  To buy a financial instrument such a treasury bill or mortgage-backed security, which is added to the left-hand-side of their balance sheet as an asset valued at cost, they create (and I do mean "create," in the true sense of the word) an equivalent amount of deposits on the right-hand-side of their balance sheet. It does not "cost" them resources as it would you, or me, or a business.  The "expense" is deducts from revenues to arrive at this period's profits consist mainly of employee salaries.  
 

So if the Fed purchased a bunch of assets with reserves that they created, where do the "profits" come from?  Keep in mind, there are two major drivers of profits.  One is efficiency, or doing more with your resources. The second is pricing power, being able to charge an above-competitive price for a good or service either because you own something scarce or you make up the rules of the game.  

First, two minor sources of income to the Fed are the interest and fees it charges for operating the financial system, such as check clearing and interbank electronic payments, and those it charged participants in the emergency loan programs it undertook to support credit cards and auto loans.

By far the largest source of revenue to the fed, however, came from its open market operations and the purchase of toxic assets.  The Fed had about $1.8 trillion in U.S. government debt and mortgage-related securities on its books by the end of 2009, four times the level in 2008, and the interest payments it collected on this huge pile of assets generated much of their (so-called) profits.  But interest payments are only one source of returns on financial assets. The other is "capital gains" or "price appreciation."  If and when the Fed sells these assets, some of them considered "toxic," there is a real risk that they will incur significant capital losses.   For example, the central bank recorded a $3.8 billion decline in the value of loans it made in bailing out Bear Stearns and AIG.

So the Fed’s profits are this period’s interest income minus the Fed’s minimal operating expenses; the capital base on which it earns income is basically “free.”  And all of these figures focus on one-period accounting entries, ignoring the huge potential negative stock of value the Fed’s activities are generating.

Don’t misunderstand. The Fed provides an invaluable service to the national and world economies, and they generally execute those services very well.  But when they begin to try to act like a business, replacing existing investment banking with their own activities, and parade around profit figures as if they meant the same thing as private industry profits, we must step back and take a moment to understand that Fed profits mean something entirely different from corporate profits. 

Senate Version of Health Care Reform IS a Tax increase!

The latest from Washington on Health Care Reform is the Senate's version which taxes insurance companies on plans valued at over $8,500 for individuals and $23,000 for couples.

President Obama has defended the tax as a way to drive down health costs.  "I'm on record as saying that taxing Cadillac plans that don't make people healthier but just take more money out of their pockets because they're paying more for insurance than they need to, that's actually a good idea, and that helps bend the cost curve," the president said in an interview with National Public Radio just before Christmas. "That helps to reduce the cost of health care over the long term. I think that's a smart thing to do."   http://www.cbsnews.com/stories/2010/01/07/politics/main6066223.shtml  

Huh?  Mr. President, you need an Econ 101 primer. Let's begin now, with supply and demand: s

Supply is an upward-sloping marginal cost curve, and includes the taxes and fees a business must pay to the government.  By imposing this tax, the supply curve of insurance companies will shift up and to the left, as shown in the graph, representing a higher cost per unit of insurance coverage.  The demand curve slopes down, so when intersected by a more costly supply curve, the final price to consumers rises and the amount of insurance coverage falls. Period. End of story. Indisputable fact.  And nothing Obama or the Senate says will change this fact, though they will try. 

This Health Care Reform: The Ultimate Intrusion

Once a single-payer health care program is enacted into law, the government will assume the right to tell us how to live our lives.  Our health will be their responsibility.  Government officials will feel empowered to tell us what to eat and drink, what risks to take, whether we can smoke, how much weight we can gain and how much exercise we must get. 

If you have any doubt, consider the following statements from the Obama administration over the last year. The clear message is if the government pays for something with tax dollars, it has both a right and a responsibility to tell the recipients of those dollars how to conduct themselves.

• "This is America. We don't disparage wealth. We don't begrudge anybody for achieving success," Obama said. "But what gets people upset -- and rightfully so -- are executives being rewarded for failure. Especially when those rewards are subsidized by U.S. taxpayers."   http://wcbstv.com/national/executive.pay.limits.2.926332.html

• President Obama challenged top bankers to explore "every responsible way" to increase lending, saying they were obliged to help after being rescued by taxpayers. He asked them to "take a third and fourth look" at their small-business lending. He also exhorted the executives — both in private and in public — to drop their opposition to an overhaul of the nation's financial industry.  "If they wish to fight commonsense consumer protections, that's a fight I'm more than willing to have," Obama told reportersin the Diplomatic Reception Room of the executive mansion.  http://www.msnbc.msn.com/id/34416646/ns/business-us_business/

• "Treasury has instruments that can address the excessive retention bonuses, and add provisions to ensure that taxpayers are made whole," [White House spokesman] Gibbs said.  http://www.msnbc.msn.com/id/29714402/ns/business-us_business/page/2/ 

• "I intend to hold these banks fully accountable for the assistance they receive, and this time, they will have to clearly demonstrate how taxpayer dollars result in more lending for the American taxpayer," said President Obama.     http://www.whitehouse.gov/the_press_office/remarks-of-president-barack-obama-address-to-joint-session-of-congress/

• Obama said it is "wholly unreasonable to expect that American taxpayers would or should hand this administration or any administration a $700 billion blank check with absolutely no oversight or conditions, when a lack of oversight in Washington and on Wall Street is exactly what got us into this mess."  Obama said taxpayers should be treated like investors if they are being asked to underwrite the bailout.  http://www.cnn.com/2008/POLITICS/09/23/campaign.wrap/index.html

• "What’s really frustrating me right now is that you’ve got these same banks who benefited from taxpayer assistance who are fighting tooth and nail with their lobbyists up on Capitol Hill, fighting against financial regulatory control," Obama added.  http://au.biz.yahoo.com/091213/31/2aafh.html

More Political Shenanigans on Health Care Reform

This topic may seem to be more about politics than economics, but anything related to health care reform is squarely rooted in the most important of economic issues:  the costs of doing business, the size of the government, and the potentially oppressive role of government in private industry. 

To that end, the following is a must-read, and should make you angry, no matter what your political persuasion.  http://bostonherald.com/business/healthcare/view.bg?articleid=1224249&format=text

In this article, we see how the Senate Democrats are going to do whatever it takes to get their version of health care reform through, even if it comes down to essentially stealing votes.  Could the timing of this Massachusetts special election, to replace the temporary replacement put in for the late Senator Edward Kennedy, be one of the reasons that the Senate wants to rush this reform through before the President's State of the Union Address, typically set for mid-January, though the White House is curiously reluctant to commit to a date....  ?

Troubling U.S. Unemployment Figures

The U.S. unemployment rate remains at a 26-year high.  This is troubling for two reasons. One, the struggle and suffering of the unemployed (and underemployed) and the impact on the world economy. 

Two, the mixed signals it gives policymakers.  I worry that the White House will think that it needs to do "more" of what it's been doing, and will dismiss any negative comments about its economic policies as a knee-jerk reaction to the unemployment figure when I, in fact, would be saying the same things if the unemployment figures had improved.  It would be a harder sell, true, but that doesn't change the facts.

The reason?  Because I believe we would be in a better position today, with lower unemployment -- no matter what the current unemployment rate -- and higher growth, had the stimulus program never been initiated.  I base this on my understanding of the fundamentals of how the economy works, how businesses create value, and how labor makes itself indispensable to industry.  

And none of these areas were helped or improved by the economic policies of this President. 

The Deficit and the Money Supply

As the New Year begins, many writers are looking back on the events of 2009.  Many are focused on the impact of the bailout and stimulus programs on the U.S. economy.   While some credit those programs with ending the U.S. recession, others worry about the resulting deficit and the ability of the government to sustain this level of spending into the future. 

I, for one, believe that the economy would have been better off without the bailouts and the stimulus program.  But proving that claim is a difficult task, not just for me, but for anyone trying to address the question.  

I have a research project under way that I hope will lead to a better measure of the impact of government spending on GDP, but it will be some time before those results are in.  In the meanwhile, I want to help to clarify some economic issues that underlie much of the debate about the stimulus and the deficit.

First of all, the deficit is defined for the fiscal year only.  It is a one-period measure.  The deficit for 2009, for example, is total 2009 government spending (including interest on debt, which is the cumulated book value of deficits) minus total 2009 government "revenues."   Government revenues consist of taxes plus the proceeds from asset sales (http://www.govsales.gov/HTML/INDEX.HTM). 

Second, the U.S. deficit is our trading partners' surplus.  Our borrowing is their lending.  There is nothing inherently wrong or weak about the U.S. running a deficit, or selling Treasury bills or bonds to finance spending.   

Typically, the Treasury avoids using the Federal Reserve's balance sheet for its tax collecting and check writing activities, expressly to avoid tainting Monetary Policy with Fiscal Policy, or "monetizing the debt."  Of late, however, under Geithner's leadership and Bernake's followership, that distinction may be blurred beyond recognition.  The current level of the money supply, given fairly stable reserve requirements and discount window policy, is largely determined by open market operations (OMOs), or the purchase (or sale) of newly issued Treasury bills and bonds with newly created Fed reserves; i.e., the famous "the Fed creates money with the stroke of a pen" or, these days," with a click on the keyboard."

Pre-Geithner, the Fed created money strictly through OMOs and changes in reserve requirements and discount window activities, with the goal of supporting GDP with the appropriate interest rate target without excessive inflation. Now, it's worrisome how much policy independence the Fed seems to have retained.  In a real economy crisis with rampant unemployment, should the Fed "do something?" And what if those actions exacerbate inflation? Now what is our policy priority:  lowering unemployment or lowering inflaton?

No easy task here: find just the right level of money supply growth that will find the right level of short term interest rates without over- or under-stimulating inflation.