Thoughts on the Stimulus

Initially drafted on Sunday, February 15 (the weekend after passing of the stimulus)….

Not more than 12 months ago, many were debating whether we were in a recession. I wondered how trivial it was. No one doubted that we were certainly heading for one, if not already in it. Today, you are beginning to hear rumblings that we’re in a depression – where the fundamentals of capital markets cease to work. There’s little doubt in my mind that history will view this period as a depression. Whether we’ll reach 25% unemployment or it will be characterized as a “lost decade,” we are in the fourth inning of cataclysmic economic pain.
The federal stimulus plan is an utter failure. Spending totals $223k for every job purported to create. Eleven percent of the $787 B spending bill is expected to be realized this year, although I’ve heard claims as high as 22%. At 9% of GDP it’s bold. What it’s not is stimulus. Add in the cost of financing and those entitlements, which are stated to be temporary but lack any mechanism to end them (as an aside, McCain was proponent of great idea to tie these entitlements to two quarters of positive GDP growth, after which point they would cease), and the burden for future generations is $2.3 T. Infrastructure spending is a small portion of the total. Only 18 – 27% of bill is tax cuts, and most of those are for people who will spend as they otherwise might or save.
Most importantly, it fails to use tax policy to sculpt behaviors. As is often the case, the best fixes are simple and have been around for a while. An immediate expensing (i.e. tax reduction) of business’ capital spending would fuel targeted improvements in innovation and create lasting jobs. Too bad our politicians don’t have the balls to pass it. Instead, they continue to pander to financial firms, making their profit (i.e. interest payments) tax deductible and creating a bias for debt. Another bias to debt is primary residence mortgage deductibility. Rates are higher and interest isn’t tax deductible in Canada so Canadians pay off their mortgages a.s.a.p. I happen to selfishly favor mortgage deductibility but it’s an interesting social question.
My admiration of China’s administration is largely because of their use of tax policy to cool the housing market a few years back and address causes of the problem (it helps to have a one-party system). The U.S. needs a governing body of wise, non-political academics responsible for spotting issues such as the U.S. total indebtedness rising to 3.5 times GDP. Who didn’t know that would end badly??
At least Obama was able to remove most of the protectionist language which would have incentivized other countries to retaliate and limit U.S. exports. There is near universal agreement that protectionist measures and putatively high marginal tax rates exacerbated the Great Depression.
Limits on executive pay for governmental infusions of capital? I don’t buy the brain drain argument: (a) the brains got us into this mess, and (b) where are they going to go? The senior-level executives with relationships might start or join smaller I-Banks but I doubt they’re the solution to the problem anyway. Innovation will start from the people in the trenches who figure out how to get our shadow banking market (i.e. syndications) back. There should be no higher priority for this administration. One idea kicked around that I like is to give B-Piece buyers with good track records the option to lever 10:1 with the fed’s money. Until spreads narrow in the secondary market, primary conduit lending will not resume.
The Congressional Budget Office projects the stimulus with detract from the economy’s 10-year growth rate.
One thing that continues to be reinforced in debacle after governmental debacle: Pelosi is as deleterious to the democratic process as Dick Cheney.

Finally time to delever, America

I finally found the debt graph you might have heard me reference. This is a great explanation of what we’re experiencing. Data came out in the past few days that consumers saved 5% of income in December. This was a five- or seven-year high (can't remember exactly. Expect the rate to approach 10% by YE as people repair their personal balance sheets. Not good for CPG firms.  Now, in light of this, does it make sense to bloat the federal budget in the manner in which Obama and Pelosi have proposed?  Download the full article at the Economist or here once that link fails.