An American Loss to China in Global Economics Could Deprive Billions of the Opportunity to Live Under Democracy

For over 250 years America has been the proof that a free people can successfully govern themselves. A critical contributor to this success has been our choice of democratic capitalism as our economic system. Democratic capitalism works well with the freedoms that have characterized America.

Our constitution gives us the power to choose the representatives that are to set and guard the economic rules. Although there have been missteps the government generally guided capitalization toward activities that benefited the nation. The system steadfastly outperformed all other competing systems in the ability to deliver economic benefits to its citizens. We were without serious challenge as the leading economic force in the world.

This ended during the later years of the 20th century. We allowed our government to make terrible mistakes that have completely changed the game. We now face the results-financial, trade and investment deficits. excessive special interests influence, loss of manufacturing jobs, too much control by the financial sector-and the list goes on.

These self-inflicted wounds have allowed another form of capitalism to emerge. One that gives little freedom to its citizens but shows great skill in supporting the state. It is best described as state capitalism. China is currently its most successful user.

State capitalism uses the aggressive tools of capitalism but does not grant its citizens the participation and freedom they would enjoy under a democracy The goal is not the general welfare of the citizens but to increase the power of the state. It is a tenacious competitor in the global economy and is currently outperforming our damaged system. It definitely threatens the dominant position of democratic capitalism.

If it prevails and our system continue its current degradation the American vision will eventually collapse and the dream of free people governing themselves will fade. We must not let this happen.

The seriousness of the situation requires strong and immediate action. We must admit mistakes on past policies that have had bad results for the country and make the fixes. We must stop giving away economic opportunities that we need to other countries.

An encouraging example of what must become our standard practice is covered in a recent article in the Washington Post. It reports on an event where the US Export-Import Bank discarded past policy and helped the US vendor fight back. The result was the sale of 150 locomotives by GE. This was against aggressive bidding tactics of China that would normally get them the business.

As the article reports

“The political resistance to brash tactics which would imperil the delicate management of the China relationship has collapsed," said Rosen.

Way to go-US EX-IN Bank and GE!!. We need more of these “brash tactics.” Now let’s fix those other problems. The billions of people may still get the chance to live under a US style democracy.

Remember Wall Street Reform?

Ever wonder what happened to the Dodd-Frank Wall Street Reform Bill? Remember when It became effective on July 21? The Democrats hailed it as landmark legislation that was really tough on the big banks and would prevent a repeat of an economic meltdown. The Republicans said it was anti- business and the meltdown was the governments fault anyway. The banks were against it as it would keep them from “providing their creative services to the public and employers.”

In short, all parties put out pure BS. The issues were apparently too complicated for the daily media to be helpful. So it has remained a mystery to most of the public.

Finally on Dec 28, 2010 Business Week has released an article that attempts to put in understandable format what has happened in the bill. It also discusses the politics and lobbying behind the results. A total of 9 journalists from New York and Washington are listed as contributing to the report. We have to be grateful to Business Week for this difficult but very useful task.

The phase “Wall Street Gets Pretty Much What It Wants” is included in the article headline and portends the sinking feeling citizens will feel as they read the article. The Wall Street victory is confirmed by looking at the record profits at the major banks only two years after their mismanagement led to the economic meltdown and to a comment by an ex-Citibank executive.

“We continue to listen to the same people whose errors in judgment were central to the problem,” said John Reed, 71, a former co-chief executive officer of Citigroup Inc., who estimated only 25 percent of needed changes have been enacted.

The article covers almost all the issues that congress talked about but sadly did little when it came time to write the laws. Like the boy that murdered his parents and then asked for mercy because he was an orphan the banks destroyed the economy with bad management and now fight any regulation on the grounds that it would hurt the recovery.

The biggest laugh of all (if it weren’t so pitiful) is that the banks seem to have convinced many congressmen that they are adding value to the economy with their “innovative” instruments.

Read the article and learn what happened to all that big talk after the lobbyists worked over congress. Remember too big to fail, the revolving door, bringing bonuses into line, banning certain derivatives, and walling off risky ventures from government guaranteed funds? The article discusses the politics and final inaction on all of these.

The only pro-citizen event was the establishment of the Consumer Protection Agency as designed by Elizabeth Warren. The banks fought that desperately but seem to have lost.(as of now). I remember a talk show where the banking representative, fresh from helping the industry set a world record for dumb management, said he was worried about her because she didn’t have enough bank management experience.

Please, surely we aren’t so dumb we will let them do it to us again.

The report is certainly discouraging and confirms that we need a complete rethink on the nature of the organizations that this nation uses to manage its financial infra-structure,

Once again, thank you Business Week.

Our Ideology Regardless of the Problem

Recent polls show that approval of congress has hit a new low of only 13%. I had hoped that this would cause the political party elites to show some humility and give us at least a few ideas on how they were going to correct the situation. Not so.

Last week a group of senators, congressmen, and citizens (about 1000) met in New York to launch an organization dedicated to reducing the party ideologue-based bickering and drive both parties to cooperatively focus on the nations’ problems. It is named "No Labels”. Although they apparently didn’t have time to spend on the low 13% ratings both the Republican and Democratic media attacked the No Labels concept, giving various reasons to reject it.

There were scores of negative posts from both the right and left, They went from insistence that the two party system was critical for debate, to noting that there already were 63 parties in the US, that working together was useless because our current leadership is incompetent, and that No Labels is just plain left wing.

The scariest of all were several writers who contended that No Labels was being set up to be a platform for Bloomberg to run for president. Thankfully No Labels says that they had taken no money from Bloomberg and that he spoke at the launching in New York because he was the mayor. Bloomberg himself has said that in no way would he run for president. Some evidence please.

It is pathetic when citizens feel they must form another party to try to force the two major parties to act reasonably. It is even worse that the self serving ideological media focuses its guns on them before they can even begin. Very typical of the way they are addressing problems. Fred Brown of the Denver Post sums this situation up very nicely.

Regardless of its final accomplishments No Labels is an encouraging example of American citizens starting to recognize and rebel against the bad decisions our leadership has put us through. If No Labels could cause a fracture in the “my ideology for everything” attitude that is smothering individual analytical thought it would be very valuable. The Tea Party, No Labels, and many other small organizations that are being formed are coming from different directions but pointing to the same objective. We all want a constitutional government that is focused on passing opportunity and freedom to the American people rather than power to itself.

That is what the Founding Fathers intended and is what we are honor bound to support.

The More You Know the Worse it Gets…

While finance has never been my favorite area I became determined to gain a much better understanding of exactly what happened to cause the subprime waterfall of economic disaster that has fallen on our country.

Of the multitude of post meltdown books on the market I chose three: The Big Short by Michael Lewis, Gristopia by Matt Taibbi, and All the Devils are Here by Bethany Mclean and Joe Nocera. All authors have extensive experience as financial journalists during the 20 years of life in the subprime era. They tell their stories from different perspectives. The Big Short is from the viewpoint of a few low level hedge fund managers who discovered (to their surprise) glaring weaknesses in the execution of the sub primes business model. No one would listen to them but they initiated very successful hedge funds that played the subprime system short. Gristopia addresses in anger the outright foolishness behind the 20 years of government and private decisions that allowed the subprime business model to develop. He discusses the events, people and the bad decisions that allowed it to grow to the final catastrophic breakdown. All the Devils are Here presents a thoroughly documented historical approach of the last 20 years of bad management that lead to the meltdown. All three books cover the meltdown and the emergency effort by the government to save the financial sector.

This post only touches on a few of the items and at the thousand foot level. Read one of the books to get really incensed.

The subprime business developed during the Clinton administration, and was protected and grew under Bush. Then it fell completely apart. The naïve belief was that the industry would regulate itself. Greenspan was a powerful figure in furthering this philosophy.

The elements of the business plan are easy to understand. The goal was to drastically increase profits by tapping the revenue from the citizen’s multi trillion dollar housing market. This required transforming the normal low risk one lender to one borrower relationship into multi-mortgage securities which could be sold in the financial market with much greater profits. Thousand of mortgages were combined to create derivative securities, the most popular being called a collateralized debt obligation, or CDO. These were then sold on the open market at high yields.

A notable characteristic of the business model is the interconnected nature of the risks between the business units. A failure of due diligence or risk analysis in one business area could spread bankruptcy throughout the entire system. This is exactly what happened at the meltdown and explains the desperate and extremely expensive effort by the government to save the entire financial system.

Here are a few highlights of the role of the key participants and their contribution to the meltdown.

1.0 The mortgage originators that received revenue for finding the borrower

This is where the extraction of wealth from the American citizens began.

The demand for mortgages to bundle into securities was so great that several billion dollar plus public companies were created in this sector. To pay for the high fees the mortgage originators added closing costs that in some instances increased the mortgage cost by as much as 20%. Qualifications for a mortgage were lowered drastically to ensure a steady flow of applicants. Financial positions of borrowers were falsified and teaser rates with 2 year automatic resets to high rates were used to lure unsophisticated buyers into loans that they would never be able to repay.

Because the originators sold the mortgages to others they had little interest in their likelihood for later default. The mortgages they passed into the system were loaded with default potential.

2.0 The large banks and other institutions that assembled the thousands of mortgages into complex high yield securities.

These were the key drivers behind the business. They took the thousands of mortgages from the originators and chopped and structured them into levels of risk that determined the yields and levels of payback priority bundled into the securities. They were then sold to investors who received revenue from the mortgage payments. This was done to the tune of hundreds of billions of dollars. Because of the high yields the sub prime securities were very popular with investors and became the greatest source of profits for many of the banks

The banks did very little due diligence on mortgages being bundled into this essentially unregulated business. They packaged many bad loans into the securities. They placed pressure on the ratings companies for the necessary triple A rating for each security.

The amount of reserves held against failure of the loans of their own securities was left to the banks and proved to be ridiculously low.

3.0 The investors--consisting of institutions, retirement funds, insurance companies, hedge funds, and banks.

The investors received high yield revenue proportional to their ownership in the mortgage security. They also gained profits by trading their securities into the financial market. Obsessed by the high yields being offered they did little due diligence before investing billions of dollars-relying solely on the erroneous triple A ratings.

4.0 The rating companies

Default of a significant number of the mortgages in a CDO could drive its value to zero with complete loss to the investors. The probability of this happening was supposed to be indicated by the rating given by independent rating companies such as Moody’s A triple A rating means that the probability of default is small.

The rating companies did not accurately evaluate the risks of default of the mortgages making up the securities. Each security was complex with a very large number of embedded high risk mortgages. The rating companies could not adequately evaluate the securities and apparently yielded to the pressure to give undeserved triple A ratings. A few hedge funds did the necessary due diligence of the securities and discovered the rating companies error. They made large profits by short selling.

5.0 The companies that sold default insurance on the securities

Investors could buy insurance against the failure of the securities. These were called credit default swaps because they moved the credit risk from the investor to the insuring company. A leading company providing this insurance (AIG) took the insurance premiums but did not reserve capital to meet the amounts that became due on failure. This spread throughout the system and left many of the investors facing bankruptcy. The government eventually took over AIG and made the payments out of public funds.

General

When the mortgages in the securities began failing in very large numbers the whole system disintegrated. This left almost all of the investors with worthless (toxic) securities and mortgages on their books for which they had paid hundreds of billions. The failure of one business would cause failure in others as the securities became further devalued. None of the players had the reserves to meet their obligations and most were facing bankruptcy until the government and the Federal Reserve intervened with over a 3 trillion dollar injection of funds- announced so far. This does not include the toxic assets of Fannie Mae that are not yet publically announced.

The magnitude of the greed and sloppy business practices described by these three books certainly gives the lie to the fallacy that this industry is made up of the brightest of people who deserve the ridiculous bonuses paid.

There were many warnings of future problems by government regulatory agencies and other experts. Proposals of regulatory control were met by angry rejections of the concept from banks lobbyists, trade organizations and congress. This included threats of firings and loss of appropriations to government officials. While self regulation results were clearly becoming catastrophic the concept of self regulation was slow to die. In fact it still lives with many diehards.

The short term focus on immediate profits, sloppy business practices and the lack of executive foresight illustrates how poorly the financial sector is managed. There is really no concern for the American citizens who have paid a very high price for the incompetent practices. It also illustrates how ineffective the elected government is in protecting the citizen. The elected government and the financial sector mutually thrive on the basis of political power bought with our tax money.

Millions of Americans lives have been very badly affected because of the false values and incompetency of this sector. The sector has forgotten that its basic mission is to organize financial support for the productive enterprises of the country. They are now focused only on their own profits. This last gambit for their specific profits has caused terrible problems to the nation. Do we want to continue with them in their current position of power? This seems to be happening by default.

We need a complete review of the nation’s financial model with the goal of a new citizen oriented structure.

Our Moral Obligation and a Total National Restoration Plan

The bean counters correctly complain about the financial deficit we are creating while attempting to end the recession. But because they are bean counters they have only one solution—maniacal cost cutting. It is driven by their DNA. Bean counters never lead to growth and expansion.

Cost cutting of wasteful spending is a valuable activity but it should not be done as an isolated task. Cost cutting alone, without wise investment of the savings; will only further shrink the already starved economy. It belongs as an element of an integrated national program where savings can be immediately put back into the productive work of our economy. The problem is that after all the time, suffering, and damage to our nations global position our two party elected government has still not developed such a plan.

The American vision contends that free people can productively govern themselves for the common good. No despots needed. This was a unique basis for a nation when the US was formed and the vision has been kept intact in America for 230 years. Sadly it is now at risk. We must not let the vision end with us. Like the Founders we must pledge our sacred honor to passing an intact America on to future generations. To fail would be a terrible legacy to leave our children.

We will never succeed with the existing approach of one by one attempts at underpowered solutions-followed by years of the parties blaming each other for failure. The citizens need to see an integrated program that reverses the self inflicted damage that was done to our interconnected financial, manufacturing, job creation,and trading systems. We have the talent to do this if we can free the process from interference by self serving special interests and the political parties. It will be an honest national restoration plan that the citizens can evaluate and support.

This is a complex undertaking because of the special interest opposition it will generate. Many of those who led us into the disasters are still in power and have benefited from our difficulties. They will fight against openness on past mistakes and the continual transparency of the plan’s execution to citizens.

It can succeed, however, if the majority of Americans feel strongly enough about the moral obligation to actively and honestly participate.

We must first gain an elected government, business sector, and population that agrees strongly with the moral obligation and the need for an integrated plan as a basis for action. Lots of details to work out but a primary characteristic is that it is citizen, not government, run.

This sounds like a job for that non-party, the Tea Party.

Harmful Developments Not Covered by the Constitution

One of the inspiring thoughts that drove the framers of America was that after thousands of years of governments by despotism the United States experience would prove that free men can govern themselves. They carefully crafted the Constitution to guide America through a life expectancy of many years. It was hoped that with continual improvements made through a careful process the vision would be protected and passed forward from generation to generation.

While the Constitution was being drafted neither political parties or corporations were of major significance. They therefore were not mentioned in the Constitution.

We were, however, given vocal warnings against a future controlled by political parties from many of the Founding Fathers. Washington even included a warning in his farewell address. Jefferson also warned against corporations assuming power (see earlier post “Founding Father Warnings on Current Issues, Oct 3, 2010).

Each generation of Americans has been a critical link in preserving the vision of a government that is controlled by its free citizens. Although some may disagree, I believe that in general we have performed well in that part of the vision protected explicitly by the Constitution.

But time has taken its toll in areas not specifically covered by the Constitution. We have allowed a two party system to gain control of our electoral process. In addition we have given corporations many of the rights previously reserved for citizens. This has allowed them to use their vast financial resources to influence our political processes. Both of these events have reduced the ability of the citizens to govern themselves.

The Democrats claim roots back to early post revolutionary war, while the Republicans emerged just prior to the civil war. Since then, although competitors for specific offices, they have jointly beaten down any attempts for a third party. This has greatly limited the choices in candidates and policies available to the citizens.

The two parties now essentially limit our choice of candidates to those from either one party or the other, meaning either a far left or far right agenda. There is no moderate agenda available. Further, as predicted by many of the Founding Fathers the party members have developed stronger loyalties to their party than to the country. Thus each party spends most of its energy sabotaging the other. Finally, the two parties have legislated themselves elite rights and privileges to a level that would really have distressed the Founders. The record of the Congress has been so bad that a recent Gallop poll showed that only 17% of the voters approve of its performance.

The direct solution rests on the efforts of the citizens to take advantage of the ability given by the Constitution to replace a large portion of the Congress. There is some evidence from the mid-term elections that this is starting to happen.

The solution to excessive corporate political power is more difficult. Corporations have become irreplaceable engines in the global economic system. The legal shield that allows investors in a corporation to only risk their corporate investment as opposed to risking their total owned assets is the most powerful incentive for capitalization of companies. An overwhelming portion of the countries economic and technical strength rests with corporations.

In their formative years corporations were engines of commerce only and forbidden to participate in politics. Over the last 100 years this has evolved to the point that corporations now enjoy rights previously reserved for citizens. This has been generally affirmed by the courts. Vast sums are now spent by corporations and their organizations to influence legislatures. The critical task ahead is to formulate an industrial program which strengthens American corporations competing in the global economy while preventing them from acquiring such strength in the political process that they harm the creativity or well being of the citizens.

These are both fixable issues. They do require an aware and determined citizenry to keep the parties and the corporations from taking over ownership of our vision.

The Tea Party - Forerunner of a New American Political Architecture?

A No-Party Election Structure

With public approval of Congress at 17% it is unreasonable to think the current two-party system is serving us well. It has brought us very limited choice in candidates or philosophy and created inefficient and inept legislative houses. Worst of all, it has created leaders who have loyalty to their party that exceeds that to the country. Adams, Jefferson, and Washington were all strongly against the establishment of political parties. Very few citizens think that the parties operate for the general good of the citizens.

The country should give serious consideration to moving from the two party system to an architecture that is much more open to all citizens and that provides more choice. Forgetting for the moment the political agenda of the Tea Party we can use it as useful glimpse of how a no-party system might perform.

The Tea Party is not a political party in the conventional sense. It is a loose relationship of independent local organizations consisting of citizens from all walks of life. The local citizens support individual candidates that fall closest to their choice. This gives a very distributed architecture that has shown impressive power in the mid-terms for supporting new candidates in the primaries and opening the process to more citizens. It is taking a strong toll on the centralized power of the GOP.

How would it be if the entire American political system were organized on this basis, as opposed to the existing two party system? On the surface, not all that different. The all-controlling two parties would be replaced by many more advocacy groups. These organizations, many of whom would be national, could be more flexible in policies and indivdual candidates. They would replace the existing campaign headquarters of the two parties. Each center would normally present a slate of candidates and policies to support during the campaign. The multiple advocation oraganizations would offer a much broader political spectrum than the current two party system. The balloting would be the same as now but only vote on the position and candidates, not an organizational affiliation.

In the mid-terms the Tea Party used the GOP primaries to sort out the candidates which were to run in the finals. This would not be availabele in the no-party system. A new primary system would have to be designed, perhaps using state primary centers.

The advocate groups, of course, would have to be licensed and subject to qualifying rules.

Just a starting discussion, but worth exploring. It would be much closer to what our founders had in mind.

Wise Investment Versus Wasted Spending: Congress Better Learn the Difference

In the long term any successful business must eventually acquire good management of its resources-both financial and people. This requires spending in areas which return good value and cutting costs in areas that do not. A company with an especially strong product can avoid this requirement for a period but eventually the competitive forces of the marketplace take hold. Thus, there are hundreds of once imposing companies that became mediocre or bankrupt because of their management failures.

The analogy fits the US in the current global environment. We have enjoyed a powerful product made up of strong protection of individual freedom, intelligent aggressive citizens, and bountiful natural resources. This has allowed us to excel in providing advantages to our citizens and the world in spite of many missteps. The good treatment has made American citizenship a treasure valued around the world.

Unfortunately, we have allowed weak leaders and special interests to degrade our ability to serve the citizens. They have also created an investment deficit that if not corrected will override any other efforts at resurgence. To be effective we need to implement a wise investment plan of equal importance to any spending control program.

We have many reforms ahead, but one of the most important is to revitalize manufacturing. It is unconscionable that the Government and citizens allowed international trade to get so far out of hand. We are now in the position of asking other countries to agree to controlled trade balances between countries. This is an embarrassing attempt to correct a situation that our government should never have allowed to take root. With no real industrial plan and the only political talk directed at cutting spending rather than investing, the US is in a very weak negotiating position. China and Germany, through aggressive and wise industrial policies, have established large trade surpluses. They are not about to agree to give them up.

The result is that the new balances for the US can only be reached through the hard work of re-establishing a commanding industrial trade position. It requires investments for the future in research, development, education, and incentives for manufacturing in the US. The goal would be to allow our manufacturers to compete directly in the free global market. Faced with that strength by the US the other countries will be anxious to talk.

We desperately need our industrial leaders and the government to cooperatively attack this well known problem aggressively head on with a realistic and thoughtful plan.

But remember that this will require knowing the difference between wise investments and wasteful spending.

The Reform of the Senate: Enough Honest New Faces to Begin?

The constitution allows each House in Congress freedom in determining the rules of its proceedings. Over the years members of the Senate have abused this freedom to give themselves outrageous powers and self serving privileges. This has created a pathetically inept and corrupt body that exists to serve the two political parties and their members rather than the country. This has become clear to most citizens.

It is difficult to find an American citizen that does not believe that each member of congress puts their own interests and that of their political party ahead of the country and the citizens. The congress is sadly in need of radical reform,

The current situation is much too attractive to the current members for them to initiate significant reform. In fact, much of the need for reform is related to our monopolistic two party system. Until the majority of existing office holders are replaced with honest and dedicated candidates that place the higher value on the country and it citizens reform is not going to happen.

The constitution allows for elections to replace one third of the Senate every two years. Anti-incumbency as a step toward “taking back the country” was a major battle cry for the recent mid-term elections and won the new senators their jobs. The mid-term results reflect how the citizens took advantage of this opportunity.

Of the 33 positions open for seats in the Senate the recent mid-terms elected 16 candidates who were new to the Senate. Thus, when the new Senate convenes almost half of those who were up for election will have been replaced. Thirteen of the new senators are Republicans and three are Democrats. A short resume of each of the new senators is provided by Salon in this reference. Seven of the new senators have served in the House of Representatives. We therefore have nine new senators with no vested background in the federal machine. Three are small businessmen who have had no elected experience until this election. Four have held only state government positions. Two have been state governors.

Depending upon the position for reform of the seven from the House this mix could be a reasonable group to lead a series of reforms. It will take many more similar elections and very careful watching over the next years to return our Senate into the organization the Founders intended. But we have begun.

Rally for Sanity a Very Pleasant Surprise

When my two daughters asked me if I would like to go to the upcoming Stewart and Colbert Rally for Sanity it was an easy answer. No way was I going to travel the 65 miles to DC to hear Jon Stewart make jokes about the Tea Party and Sarah Palin. I hate listening to all that self-congratulating laughing and applause that comes with every lame joke told to a mass liberal audience.

But early Saturday afternoon I decided to turn on C-Span so I could intelligently criticize later. To my surprise there was a very large and lively crowd. It appeared to be larger than the Beck rally. The rally was publicized as aimed at calming the anger and fear that has taken control in today’s politics. The rally was true to that goal. There was music, singing, and Stewart and Colbert comedy skits directed specifically at that objective. The selections and speakers were patriotic. No ranting and partisan accusations. It was truly apolitical and filled with patriotism.

The media coverage has focused on the theatrics and essentially ignored the underlying principles of the rally. In this post I will focus on the values they were presenting without trying to reproduce the theatrics. You can find a summary of the show aspects in this reference. A full copy of the important closing remarks by Jon Stewart are here.

The basic principle is that we are all loyal Americans who must put aside irrational anger and fear and calmly face our real problems.

We must resist manipulated by the irresponsible media. To feed a 24hour news cycle it is saturating us with warnings of an infinite number of possible bad events which are very divisive and unlikely,and will probably never occur. Some will happen but they are solvable if we focus on those that are reasonable problems.

The anger and fear is further exaggerated by expanding the causes for problems from specifically identified individuals to much larger groups. This is being done without the required accompanying analysis.

It is important to realize that we are now one big mixed country of almost 300 million. We can expect many diverse opinions and consequences on issues that affect many groups differently. We must eschew one line insults to each other and try to reach reasonable solutions while showing respect for other's views. This does not mean we cannot aggressively address the causes of our problems. We should show strong aggression to the specific individuals behind the problem but be careful about extensions to a generalized congregate that will extend and magnify the problem.

If you have the chance, watch the video that shows media clips of both liberals and conservatives violating these very simple and common sense rules. You will recognize the faces.

Of course,calm discussion isn't "in" with the media so they have given the rally a big thumbs down.