I find it ironic that the next financial bubble to burst may be the lucrative defined benefit plans for unionized state and local employees. In the 1980’s after we had recovered from our last major bout with inflation and stocks became a viable investment option again, most businesses converted from defined benefit plans to defined contribution plans. It was a case where the scandals and mistakes concerning defined benefit plans made them very unattractive compared to defined contribution plans. Several of the defined benefit plans were seriously underfunded and there was was little oversight on how fund managers invested. Since I was alive at the time I can say that the average person was pretty sure they could get a better return on their pension using a stock index fund than these fund managers. Another widely held view was that the defined benefit plans of the steel and auto workers were a major cause leading to the demise of those industries. Businesses did not need the distraction that comes with mismanaged pension funds. Defined contribution plans promised financial responsibility by both the companies and the employees. It was a simple choice for businesses but defined contribution plans were the lesser of the two evils.

State and local employees chose to ignore the history surrounding defined benefit plans in return for promises of lucrative benefits. Now we appear to be entering an economic environment in which we will see low return on investments, increasing unemployment, and increasing inflation. This implies that state and local governments will either commit large amounts of their operating budget to fund pension benefits or to cut pension benefits. This is very similar to the situation we saw in the 1970’s in which defined benefit plans ate up operating budgets. Wow! Déjà Vu all over again!

Okay, I know it is easy to be critical of the mistakes made local and state governments. Here is my contribution to improving the situation. How about a federally insured pension benefit corporation to take over the underwater pension funds? Naturally it would have to extract some fiscal responsibility from the participants. I suspect that over the next couple of years the government pension benefits will be rationalized downward to what we may call a national standard. If the pension benefits can be viewed like an employer paid payroll tax we may get better fiscal responsibility by unions and governments. My view is that the pension benefit corporation would not need federal funding but would be able to borrow funds at federal rates. This may be useful as state and local governments make the transition from a seriously unfunded pension liability to solvency. Now if we can get this corporation to invest in treasury inflation protected securities we might have an efficient, workable pension system with low investment risk.

Zelinsky: Obama Embraces Defined Contribution Paradigm
Paul Caron
Sat, 11 Apr 2009 10:00:00 GMT

Recently I went back to read the Heritage position paper, Ten Myths About the Bush Tax Cuts. I was bothered by many of the premises of the Obama stimulus package. They seem to run counter to recent economic history. Here are some highlights from the paper.

Nearly all of the conventional wisdom about the Bush tax cuts is wrong. In reality:

• The tax cuts have not substantially reduced cur­rent tax revenues, which were in fact not far from the 2000 pre”“tax cut baseline and over the 2003 pre”“tax cut baseline in 2006;
• The increased child tax credit, 10 percent tax bracket, and fix of the alternative minimum tax (AMT) reduced tax revenues much more than most of the "tax cuts for the rich";
• Economic growth rates have more than doubled since the 2003 tax cuts; and
• The tax cuts shifted even more of the income tax burden toward the rich.

Whether you look at the Bush tax cuts or the Reagan tax cuts you have to agree they were successful at stimulating the economy and reducing unemployment. What bothered me was that despite the advantage of history, the Obama administration chose a different economic plan. Instead of putting together an economic plan that stole the best ideas from Reagan and Bush plans, they cobbled up an economic plan that is most similar to a plan that is generally regarded as an economic failure, FDR’s New Deal plan. The reactions by the stock market and businesses were predictable and swift. Businesses decided that they needed to go into survival mode. Business leaders concluded that there was nothing in the stimulus plan to give them hope for the near term. What they saw was an above average chance of inflation without economic growth. So they laid off employees and cut costs. It was obvious that they expected that it was going to be quite some time before their sales recovered.  As they scaled back operations the rest of the economy the rest of the economy followed in close pursuit. The business leaders did not like what they were doing but they could not ignore the possibility that things were going drastically wrong. Businesses were not alone with their pessimism about the economic future. Warren Buffet is scared. Our bankers, the Chinese, are panicking but are unable to do anything to stop it except to lower the maturity of their dollar denominated holdings.  This fear was avoidable but the Obama administration dropped the ball. They pandered to the fear to gather public support for the stimulus package. Then they tried to turn off the fear and put it back into the can. In one moment they wanted everyone to be scared. In the next moment they were looking in dismay at an economy that remained fearful and had lost its trust that the government would do the right thing in a financial panic. Obama and the Democratic party were hopeful they would get long term benefits as the savior from the economic crisis. Now the Democratic party looks like it will get most of the blame if the economy and the unemployment does not recover quickly. Already the average person is quickly losing their appetite for the one party system. Our experiment with the one party system was a terrible failure.   The question is not whether the public will start placing blame for the crisis on the ineptitude of the Democratic party and the one party system but when. A recent generic voter polls indicate that the independent voters are swinging their votes to Republican candidates over Democratic candidates for the first time in the history of poll. If the unemployment rate is still hovering around 10% with no economic growth on the horizon, the 2010 elections might tell a dramatically different story.

The problem for Obama and the Democratic party is that they keep on providing more fuel for the argument that they are incompetent at managing the crisis. I have begun to wonder whether this administration is the most incompetent administration since President Carter. The similarities between the two administrations are eerie. It is really to soon to give the Obama administration the crown but they have demonstrated an unusual aptitude for screwing up. The AIG affair is a case in point. Recently they made some political points by demonizing AIG executives for the bonuses they were receiving. It should come as no surprise that some of those officials are now leaving. These were the executives who were trying to wind down the AIG mess that is projected to cost the tax payer about 180 Billion dollars. So to recover $150 million we are willing to risk $180 billion. AIG says their employee situation is “manageable” but everyone knows that they are being forced to play a very complex game with their second string. It is increasingly likely that the gambit to sell off parts of the company to repay the government is doomed to failure. The more serious problem for the Obama administration is that the financial community is viewing the administration as an adversary rather than a partner. The bill recently passed to tax bonuses at 90% for all financial firms that took TARP money is an ominous sign. The reaction by the banks has been predictable. Any bank that took TARP money is now frantically trying to pay the money back as soon as possible. The unintended consequence of the AIG bonus affair is that the penalty for bankers making risky loans has gotten much higher. The banker’s worst fear is that they will make a bad loan to a business and the government will see that as an excuse to come in and micromanage their business. The cool reaction by the banks shows that they do not trust the Obama administration. As a result the banks are likely to continue to be suspicious of undertaking any additional credit risk when the political risks are so high. Those businesses who desperately need the loans are probably going to find the that credit markets might have actually gotten tighter. This adversarial relationship between the government and the financial community was unnecessary and further prolongs the credit crunch for businesses. There was a real lack of leadership on this issue by the administration. It should be interesting to see how long it takes for the Treasury Department to fill its posts.

If the economy was not a big enough problem, the Obama administration has decided to start up the political battles on health care and global warming. Either one of these issues could unravel a new administration under good circumstances. Taking on all three divisive issues at the same time in our economic condition is going to be distracting for the administration. It probably will be political suicide for these issues. With the way they are thinking I am surprised they did not bring up the race issue, too.

The inescapable fact is that the Obama administration owns the deficit problem. This graphic from the Heritage article, Bush Deficit vs. Obama Deficit in Pictures, leaves no doubt in my mind who owns the deficit. The best and brightest minds that supposedly surrounding President Obama appear to be missing in action.

Finally my greatest fear with electing President Obama was that he was too inexperienced to deal with the major issues and Congress would eat his lunch. So far my fear has been realized. President Obama looks like he is in over his head. In demonizing AIG executives he set up Senator Dodd as the sacrificial lamb for the administration. Since the discussion of the bonuses in the Senate offices and at the executive level appear to have been going on since last November, it is really hard for Senator Dodd or the executive branch to claim ignorance. Since Senator Dodd was already looking at a difficult 2010 campaign before the bonus issue raised its ugly head, he looks like the biggest loser in this deal. I doubt this went unnoticed by the rest of the folks in Congress looking at tight political races in 2010.

What is missing from the Obama administration is pragmatism. Many of the moderates and independents thought they were getting a pragmatic administration like that under President Clinton. Now these moderates and independents find themselves stuck with an ideological administration and policies. They see the future and they are feeling “buyer’s remorse”. Through this combination and politics the Obama administration has started a tax war with the traditional tax base for the local, state, and federal governments, the wealthy and businesses. These are the people who are going to pay for your plans and you are declaring war on them. They are the Golden Goose of the economy. It should not come as a surprise that the wealthy and businesses are loaded with the best and smartest advisors. History is on the side of the wealthy and businesses. History is full of examples of the clever tax avoidance tactics. This will be a quiet war and it will take some time to play out but it should be an amusing show. Over the next couple of weeks I will try to  highlight the unintended effects of the Obama administration policies as they try to kill the Golden Goose.

03/06/2009
Sat, 07 Mar 2009 03:08:31 GMT

If we had elected John McCain I doubt Congress and the people would have let a quarter of the nation’s wealth evaporate in 40 days.

Yesterday I was feeling a little despondent about the stimulus package and started to ponder what music would best describe the stimulus package. I needed music that was old and familiar but conveyed that sense of impending disaster. The music needed to convey a sense of drama and foreboding. My choice was Wagner’s Flying Dutchman Overture. Here is a YouTube version if you have forgotten the tune, YouTube – Wagner Flying dutchman overture.

Of course my sense of despondency did not improve when I found this piece from the sage from Omaha. The bad news just keeps on coming. Over the last two weeks the Obama administration has attempted to destroy the remaining stock value of the coal and health industries for the “greater good”. I wish him good luck trying to get the “rich” to pay more. In fifty years the only way I have seen the rich pay more was when Bush cut the capital gains tax.

I am not sure where the stock market will find leadership in 2009 and 2010. It is hard to find a favored sector after the effects of the recession and Obama’s plans. It is obvious what the stock market thinks of Obama’s plans. Every day this administration takes greater ownership of the recession and making the economy much worse than it had to be.

WARREN BUFFETT warns of a Treasury bubble. “Buffett said that with the U.S. Federal Reserve and Treasury Department going ”˜all in’ to jump-start an economy shrinking at the fastest pace since 1982, ”˜once-unthinkable dosages’ of stimulus will likely spur an ”˜onslaught’ of inflation, an enemy of fixed-income investors.”

WARREN BUFFETT warns of a Treasury bubble. “Buffett said that with the U.S. Federal Reserve and Tre…
Glenn Reynolds
Sun, 01 Mar 2009 22:53:58 GMT

Last May I wrote a story about a black community activist who was interviewed recently by a local radio station. When she was asked what she thought would be the impact on the community if Obama was elected president. She said,

I think we will have to come up with a new excuse. We can’t blame it on the man if he is one of us!

I find it ironic that despite electing our first black president and providing inspiration for black people throughout the country,  the highlight of our attorney general’s speech this week is how “in things racial” we are a “nation of cowards”. This week we also saw Rev. Sharpton point out that a cartoon that was obviously blasting the stimulus package was in fact, racist. My son who just completed an AP history course did not make the racist connection until I reminded him of the cartoons from over a hundred years ago. It is not hard to conclude that these comments by Sharpton and Holder will hinder many young black men and women trying to improve their lives. We have the opportunity for these young men and women to gain inspiration from the success of President Obama and Oprah Winfrey and our second line leaders are still reliving the civil rights movement. It is not hard to conclude that  some of our black leaders are hypocrites and  cowards on “racial things”.

AP – California lawmakers were stymied Monday in their frustrating search for one more vote to approve a $42 billion budget-balancing plan state leaders say is needed to stave off fiscal disaster.

Calif. lawmakers fail to pass budget — by 1 vote (AP)
Tue, 17 Feb 2009 05:09:24 GMT

Wow! Yesterday when I speculated in the post, “Will the US follow California’s path with dealing with a financial crisis?”, about how California was going to show the rest of the country how to resolve a budget crisis I did not know that California’s legislators were working on a budget-balancing plan. Now I am dealing with a weird feeling of cosmic coincidence since I live in Ohio and let’s just say that our local news is provincial. Let’s just say that I was surprised. Although the failure to pass a budget-balancing plan is interesting I doubt the budget game is over. Maybe this will be the time California will consider a special budget referendum to break the deadlock and settle the issue. California likes to be on the bleeding edge of change.

For the last couple of months I have been particularly fascinated with California’s economic mess. For at least thirty years I was fascinated that Californians could not only survive but thrive despite despite extraordinary high housing costs. Every year I expected the cost for a house in California to come back to a smaller multiple of the national average. Every year I was wrong.

Despite the housing costs California and myriad of lesser problems, California remained an attractive destination for people looking at potential job moves. California is a beautiful place to live with a great climate. It did have some significant drawbacks. It had one of the highest tax rates. Based on the taxes it placed on businesses, it ranked one of the three worst states for businesses. The state government seems unable or unwilling to deal with the budget problems. Then there are the water problems, electricity problems, and the strict environmental regulations. Despite all of these problems California kept chugging along until recently. For many years people ignored these problems and looked at moving to California as a step up in life style. Recently that trend has reversed and people who have the means to move have been leaving the state.

In a remarkably short time all of the good qualities about California have been overwhelmed by the collapse of the housing market and the financial collapse of the state and local governments. Existing house prices have been in free fall for two years and the construction market for new houses has disappeared. When you combine this trend with the most severe recession in at least twenty years, it is unlikely we will see the real estate market bottom out this year. The state and local governments which had consistently grown over the years of the real estate bubble are now saddled with very high salaries and benefits. Several towns are seeking to break labor agreements via bankruptcy. A the state level the sales tax and income tax revenue are expected to come in dramatically below the budget. Despite the severity of the financial problems the state legislature has been unable to pass the spending cuts or the tax increases necessary to balance the budget. So the governor is implementing a mandatory furlough for state employees to conserve cash. Everyone knows that this is a temporary fix. The real question is what will the state do about a long term short fall in revenue. Will they try to raise taxes or will they cut state spending? Can the state legislature pass a balanced budget for the good of the state? Has the democratic process failed in California?

It is at this point I find comparing the economic messes that the US and California are facing to be enlightening. I see California as a test market for assessing possible federal policy changes. Since California has very little financing flexibility left, they will soon be forced to decide whether to raise taxes and cut government spending. It is likely to be a bitter and divisive political battle and it is likely they will do both. Raising taxes will further exacerbate the business environment in California and encourage more businesses and tax payers to move to other states. The same budget and political issues exist at the federal level. The big difference is that the Democratic party controls the decision making at the federal level. If the Democratic spending plan does not stimulate the economy, the people will blame the Democratic party and the fragile coalitions within the party will shatter as the voters seek hope and change elsewhere. My best guess is that our recession will be beginning to end when our politicians start talking about making our federal government and our budget deficit smaller. The federal government is not omnipotent. Ultimately we need a lot more tax payers who are not government employees to have a sustainable economic future. Without progress toward a more sustainable economy, we risk high unemployment and stagnant economic growth for several years. We are on the verge of repeating the mistakes of the 1930’s.