Friday, October 3, 2008

The Encouraging Reckless Activity Bill

If you want proof that Congress does not understand finance/economics/money management, watch C-SPAN. While there are some good things in this bill, they overestimate their ability to make a positive difference.

The road to hell is paved with good intentions.

I have only listened to a part of the discussion. It continues as I type. I was out of the room and did not catch the name of the representative speaking. This comment was not something unique to this speaker. I am not fond of redundancy and I am paraphrasing -

We need to do this to guarantee that average Americans will be guaranteed a return on their investment in the stock market.

Well, that average American should buy bonds. They are guaranteed by the American government. The more people buy, the lower the interest rates go, but the interest rate will always be positive.[1] Of course, the government may default on these. US government default was seriously considered a few decades ago. The funny thing is The Encouraging Reckless Activity Bill increases the chances of a government default.

The argument from many of the speakers seems to be for the ability to guarantee investment return. This is a bad idea. This is already available with bonds, but if interest rates climb, the bonds may lose value .

A note on the screen listing some of the features of this bill listed Mental Health Benefits. I love irony.

Representative Jeb Hensarling made an amusing comment. Again I am only paraphrasing -

How can we have Capitalism on the way up, but Socialism on the way down?

This does capture a significant part of the problem. The idea that government can protect us from risk is Socialism. While many companies do a poor job of money management, the ability to take risk is the important part of having free markets (Capitalism is not the right term).

Too many people think that free markets will provide for survival of the fittest. This is usually a misunderstanding of how survival of the fittest works. Survival of the fittest depends on the circumstances of the environment - in the short term. Sometimes this includes criminal activity. Enron is one example of a company that was the darling of the market. Enron started out as a good company, but began to lie and cheat, in order to satisfy the expectations of the market analysts for ever increasing profits and projections. Should the government have bought Enron to keep people from losing money? No. If the government does that, it is subsidizing this criminal behavior. Were people hurt by this? Absolutely. A lot of innocent people.

What about the internet bubble? Should the government have bailed out the investors/speculators in the stocks that lost, in many cases over 90% of their value. Hey! I lost some money in that. I am not a great trader. I want my government bailout. On the other hand, I don't want the government to control how I can invest/speculate.

Representative Christopher Shays gave an excellent example of the misunderstanding of how markets work. He stated that the market dropped by a trillion plus dollars on Monday. He blames the lack of passage of the bill for this. That may be what many investors/speculators were thinking. He is using the open market behavior, which is usually wrong in the short term, to justify a removal of market forces and the introduction of greater political control of the markets. I guess he has never read Catch-22.[2] Maybe he read it and never understood it. When I write that the market is usually wrong in the short term, I don't mean that the reaction of the market is exactly opposite of the correct response. I mean that the extremes of the markets are usually wrong. The time of greatest panic is the time to buy. The time of greatest optimism is the time to sell.

If we want the government to guarantee that people do not experience financial hardship, where do we stop?

Should the government guarantee that you will not lose your job, when your employer is going to go out of business, regardless of the reason?

Should the government step in and take over these businesses?

Should the government establish more regulations to control that business, even if the regulations were a significant contribution to the failure?

Read this article, Fannie Mae Eases Credit To Aid Mortgage Lending,[3] from the New York times. It was written 9 years ago and points out the problems that were coming. Problems that have arrived. Problems that were encouraged by the government. The government that is now the solution to the problem.

And the example of Representative Chaka Fattah -

I request unanimous permission to revise and extend my remarks.

This is the way those in Congress make it seem as if they gave a literate speech, while not actually giving any speech. They add something, maybe ghost written, to the official record of the debate. Imagine if a presidential candidate were able to go back to revise and extend my remarks from a presidential debate. Just another example of how Congress isolates itself from reality. these are the saviors of the market.

I am waiting for the bill that will prevent injuries, because it is unfair for people to be injured. They try to legislate safety, and claim success, but when will they actually make rules that forbid activity that might put an individual at risk? We need to limit everyone to prevent the lowest common denominators. Read Harrison Bergeron.[4] A very short story by Kurt Vonnegut.

Then, the Speaker of the House, Representative Nancy Pelosi finishes up with -

(This is) only the beginning of our work to protect the American people

But is being saved by Nancy Pelosi a fate worse than death?

Even Paul Krugman is for it in his article Edge of the Abyss.[5] Could there be more convincing evidence that this is a mistake? Should we let him push us off of the edge of the abyss? He fancies himself standing on the abyss, pushing us away from the abyss. This is a good metaphor for the kind of footing he is accustomed to.

This mistake has now passed both the House (263 to 171) and Senate (74 to 25).


^ 1 If you have more demand for an item, in a market with open bidding, the price will go up. Buying a bond means that you are paying X dollars today for a fixed amount of dollars in the future. I use one year and round dollars for ease of explanation. If there are not many people bidding for the product, the price might be $96 now, for $100 in a year. A profit of $4 on a $96 investment. The interest rate would be 4/96 - just over 4% per year, since this is only for one year. If there are more people bidding for the product, the price might be $97 now, for $100 in a year. A profit of $3 on a $97 investment. The interest rate would be 3/97 - just over 3% per year, since this is only for one year. If there are a lot of people bidding for the product, the price might be $98 now, for $100 in a year. A profit of $2 on a $98 investment. The interest rate would be 2/98 - just over 2% per year, since this is only for one year. You are paying different amounts now, for a fixed amount in the future. The more you pay, the lower the interest rate.

At the end of that year, the interest rate could be higher, lower, or even the same. Even with bonds there is a risk of the interest rate being lower than inflation. Back in the 1970's this was common, since the interest rates rose very quickly. If you owned a long term bond before the interest rates started going up, you probably would not be able to sell that bond for as much as you paid for it, because the value of the money you paid has been eroded by inflation. At the end of the loan, the money you are paid is in current dollars. Dollars which have been devalued by inflation. You paid for it in earlier, pre-inflation dollars. Dollars that had more value than the current value of the loan. We do not currently have high inflation. Few predict it. This bill encourages it, because it decreases the confidence in the ability of the American government to manage its money competently. America becomes a greater credit risk. I do not base this on the current reaction of the of the bond market, because the market is usually wrong in the short term. The long term will tell us where interest rates will go. In the short term, the government sets some interest rates. In the long term, the impotence of the government to control interest rates is demonstrated by the markets.

^ 2 Catch-22
From The Straight Dope.

^ 3 Fannie Mae Eases Credit To Aid Mortgage Lending
New York Times Business section
September 30, 1999

^ 4 Harrison Bergeron
From Welcome to the Monkey House
By Kurt Vonnegut (1961)

^ 5 Edge of the Abyss
New York Times Op-Ed
October 2, 2008


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