The Senate today voted against a ban on earmarks claiming in part that earmarks are not expensive costing only $16b in fiscal 2010. However, there are some bills where earmarks are used to get enough votes to pass the bill which would otherwise fail and in these cases I think that you should count the total cost of the bill and not just the cost of the earmark in determining how much would be saved by banning earmarks.
Recall that when it appeared that healthcare reform did not have enough votes in the Senate to pass that an earmark was included in the bill which would pay 100% of Nebraska's additional Medicaid expense with the other states only receiving a 50% federal reimbursement of the increased Medicaid costs. Assuming that Nebraska's Senator Bill Nelson's vote made the difference between the healthcare reform bill passing, should you count the cost of this earmark as the $90 million in additional Medicaid reimbursement over 10 years or the $1 trillion of the new healthcare reform over 10 years?
The argument that earmarks are not a significant cost item is misleading.
Wednesday, December 1, 2010
Sunday, October 17, 2010
Diane Rehm - Please Retire
I am a long time NPR listener and routinely tune in to the Diane Rehm show primarily due to the quality of the quests she is able to attract. Over the last year, a significant number of her guests were invited to discuss financial and economic issues. Ms. Rehm's questions are frequently circutious and she explored popular prespectives almost exclusively. In my opinion, she is not comfortable with basic economic theories, the financial products (MBS, CDO, CDS, etc.) and industry practices that contributed significantly to the financial crisis. She missed numerous opportunities to ask probing questions which could have helped educate even the average listener on government policy and options for legislation.
However, what prompts me to write this entry is that I have listened to Ms. Rehm in two recent shows push her personal view that non-lawyers should be adppointed to the Supreme Court. The two shows were her interview with Justice Breyer and her discussion with panelists of cases on the 2010 Supreme Court docket. Her argument in support of appointing non-lawyers is that the Supreme Court should "represent a great variety of thinking, not just lawyers". I consider her point to be simplistic, insipid and not well thought out. The only thinking that is appropriate for a Supreme Court Justice is legal thinking. Justices need to have a detailed understanding of the Constitution, resources which illuminate the intent of the Constitution such as the Federalist Papers and detailed knowledge of case law decided by the court. The court needs to objectively make decisions based on the Constitution and case law and nothing else. If non-judicial thinking and personal experience were the basis of Supreme Court decisions, the court would become partisian and the decisions would not form a basis for a continuation of legal thought. If people without the requisite legal background, regardless of how much they know about other subjects, were justices, the opinions of the court would come to be seen as arbitrary and capricious and precedents would be routinely overturned such that no person or firm could rely on the legal opinion of their attorney in making decisions. I feel sorry for the mother who has lost her son to gun violence but this experience has no place in determining a 2nd amendment issue and I say this from a personal perspective of believing that easy access to guns is a problem and don't want a gun in my house. The Supreme Court should not be basing their decisions on their assessment of the impact or benefit to society at large as this is the job of the legislators. Do we really want Joe the Plumber voting on the court? It may sound fine to argue that common sense is a valid basis for a legal opinion but consider that one person's common sense is another person's folly. The Court should make legal interpretations and that requires someone well versed in the law. No, I am not a lawyer and generally agree with Shakespeare on the value of lawyers.
The host of a talk show must have some understanding of the topics being addressed in order for the show to be informative and Ms. Rehm is seriously lacking on the more serious topics which she is increasingly addressing. Perhaps she should stick with book interviews and other lighter topics.
However, what prompts me to write this entry is that I have listened to Ms. Rehm in two recent shows push her personal view that non-lawyers should be adppointed to the Supreme Court. The two shows were her interview with Justice Breyer and her discussion with panelists of cases on the 2010 Supreme Court docket. Her argument in support of appointing non-lawyers is that the Supreme Court should "represent a great variety of thinking, not just lawyers". I consider her point to be simplistic, insipid and not well thought out. The only thinking that is appropriate for a Supreme Court Justice is legal thinking. Justices need to have a detailed understanding of the Constitution, resources which illuminate the intent of the Constitution such as the Federalist Papers and detailed knowledge of case law decided by the court. The court needs to objectively make decisions based on the Constitution and case law and nothing else. If non-judicial thinking and personal experience were the basis of Supreme Court decisions, the court would become partisian and the decisions would not form a basis for a continuation of legal thought. If people without the requisite legal background, regardless of how much they know about other subjects, were justices, the opinions of the court would come to be seen as arbitrary and capricious and precedents would be routinely overturned such that no person or firm could rely on the legal opinion of their attorney in making decisions. I feel sorry for the mother who has lost her son to gun violence but this experience has no place in determining a 2nd amendment issue and I say this from a personal perspective of believing that easy access to guns is a problem and don't want a gun in my house. The Supreme Court should not be basing their decisions on their assessment of the impact or benefit to society at large as this is the job of the legislators. Do we really want Joe the Plumber voting on the court? It may sound fine to argue that common sense is a valid basis for a legal opinion but consider that one person's common sense is another person's folly. The Court should make legal interpretations and that requires someone well versed in the law. No, I am not a lawyer and generally agree with Shakespeare on the value of lawyers.
The host of a talk show must have some understanding of the topics being addressed in order for the show to be informative and Ms. Rehm is seriously lacking on the more serious topics which she is increasingly addressing. Perhaps she should stick with book interviews and other lighter topics.
Wednesday, October 13, 2010
Increase Interest Rates to Stimulate US Economy
The typical recession is the result of demand exceeding supply which leads to price inflation and is addressed by raising interest rates to reduce demand. However, in the case of a deflating bubble resulting in a financial bust, the resulting situation is too little demand yet the same remedy of lowering interest rates is prescribed. Is it possible that this is the incorrect policy to correct the weak economy resulting from a burst bubble and that the correct policy might be the counter-intuitive policy of raising interest rates? Is it possible that reduced interest rates to stimulate demand might be appropriate for an economy with a large manufacturing sector with a low savings rate but might not be appropriate for a mature service based economy with a significant savings rate such as the US or Japan?
A significant reduction in interest rates by the FOMC might in fact cause demand and GDP to contract while increased interest rates might cause demand and GDP to expand. Although this may seem counter-intuitive, consider the following;
- In 2008, $223.3 billion of interest income was reported to the IRS. As a result of FOMC rate cuts, interest rates paid to savers have declined by at least 80% which, in general terms, has lowered interest income by about $179b and, assuming a 25% federal and state marginal tax rate, has lowered tax receipts by about $44b. The result is that the savers spend less which reduces demand and the state and local governments tax more, cancel projects and/or reduce staff which reduces demand further.
- Insurance companies make a significant amount of money on their float (investing premiums collected until a loss payout is required). When their investment income declines for a given projected actuarial loss, the appropriate response is to increase premiums which reduces the demand of policyholders for other goods and services. Deutsche Bank alone which is the 3rd largest 3rd party insurance asset manager has $150b in US insurance company assets under management.
- US university income comes from tuition and fees and investment income from their endowment funds. In 2008, 4-year not-for-profit colleges and universities collectively held more than $400 billion in endowments with Harvard University alone having an endowment fund of $37b in 6/2008. Typically, a university uses 5-6% of the endowment fund each year to pay for expenses. When earnings from endowment funds decline, the university will either increase tuition, claim additional state tax dollars and/or reduce staff.
- US employers who offer pensions use pension funds to pay for the pensions. Generally, the pension fund calculates how much they need to pay their future obligations, subtract expected investment income and collect the remainder from the employer. Given that the total value of US pension funds at the end of 2007 was $17.3 trillion, a 1% decline in investment income would require that employers contribute an additional $173b which would reduce money available to firms and government for projects and staffing. It should be noted that pension funds are already assuming a much higher rate of return on investments than they can reasonably expect.
- Higher interest rates typically lead to higher prices (inflation) although in a post-financial bubble it isn’t clear that this generalization would hold in the short term. There are certain sources of income such as social security retirement and disability benefits that are indexed to the Consumer Price Index (CPI). Given that social security retirement payments in 2009 totaled $564b and disability payments in 2009 totaled $121b, a 1% increase in the CPI would increase annual benefit payments by about $6.9 billion. Keep in mind that although there are other income sources contractually tied to the CPI such as union contracts, many employers base annual wage increase on the CPI. Given that total 2008 wages and salaries reported to the IRS was $5.95 trillion, even if just 25% of this income was increased by 1% due to a higher CPI this would lead to an annual increase of $14.9b.
- A higher interest rate would typically lead to a higher exchange rate. The net impact of a higher exchange rate on the balance of trade (net imports/exports) is difficult to estimate. However, some imports such as oil are priced in US dollars and as the dollar weakens the US oil cost increases while the cost of oil imports to other countries such as the EU declines. Higher US energy costs reduces consumer demand while lower energy costs to international competitors such as Germany reduces their costs which could reduce US exports.
Note that the above is a general analysis and that there are offsets to increased interest rates. For instance, increased interest rates might increase credit card interest which would reduce demand but can credit card companies really increase above the current 30%?
Of course, when faced with lower investment returns from safe investments, the investor could chase higher returns by investing in riskier assets such as mortgage backed securities but this might just result in a new crisis. Keep in mind that Greenspan intentionally kept interest rates low following the busting of the tech bubble due to anemic job growth but this made the financial bubble possible if not inevitable.
A significant reduction in interest rates by the FOMC might in fact cause demand and GDP to contract while increased interest rates might cause demand and GDP to expand. Although this may seem counter-intuitive, consider the following;
- In 2008, $223.3 billion of interest income was reported to the IRS. As a result of FOMC rate cuts, interest rates paid to savers have declined by at least 80% which, in general terms, has lowered interest income by about $179b and, assuming a 25% federal and state marginal tax rate, has lowered tax receipts by about $44b. The result is that the savers spend less which reduces demand and the state and local governments tax more, cancel projects and/or reduce staff which reduces demand further.
- Insurance companies make a significant amount of money on their float (investing premiums collected until a loss payout is required). When their investment income declines for a given projected actuarial loss, the appropriate response is to increase premiums which reduces the demand of policyholders for other goods and services. Deutsche Bank alone which is the 3rd largest 3rd party insurance asset manager has $150b in US insurance company assets under management.
- US university income comes from tuition and fees and investment income from their endowment funds. In 2008, 4-year not-for-profit colleges and universities collectively held more than $400 billion in endowments with Harvard University alone having an endowment fund of $37b in 6/2008. Typically, a university uses 5-6% of the endowment fund each year to pay for expenses. When earnings from endowment funds decline, the university will either increase tuition, claim additional state tax dollars and/or reduce staff.
- US employers who offer pensions use pension funds to pay for the pensions. Generally, the pension fund calculates how much they need to pay their future obligations, subtract expected investment income and collect the remainder from the employer. Given that the total value of US pension funds at the end of 2007 was $17.3 trillion, a 1% decline in investment income would require that employers contribute an additional $173b which would reduce money available to firms and government for projects and staffing. It should be noted that pension funds are already assuming a much higher rate of return on investments than they can reasonably expect.
- Higher interest rates typically lead to higher prices (inflation) although in a post-financial bubble it isn’t clear that this generalization would hold in the short term. There are certain sources of income such as social security retirement and disability benefits that are indexed to the Consumer Price Index (CPI). Given that social security retirement payments in 2009 totaled $564b and disability payments in 2009 totaled $121b, a 1% increase in the CPI would increase annual benefit payments by about $6.9 billion. Keep in mind that although there are other income sources contractually tied to the CPI such as union contracts, many employers base annual wage increase on the CPI. Given that total 2008 wages and salaries reported to the IRS was $5.95 trillion, even if just 25% of this income was increased by 1% due to a higher CPI this would lead to an annual increase of $14.9b.
- A higher interest rate would typically lead to a higher exchange rate. The net impact of a higher exchange rate on the balance of trade (net imports/exports) is difficult to estimate. However, some imports such as oil are priced in US dollars and as the dollar weakens the US oil cost increases while the cost of oil imports to other countries such as the EU declines. Higher US energy costs reduces consumer demand while lower energy costs to international competitors such as Germany reduces their costs which could reduce US exports.
Note that the above is a general analysis and that there are offsets to increased interest rates. For instance, increased interest rates might increase credit card interest which would reduce demand but can credit card companies really increase above the current 30%?
Of course, when faced with lower investment returns from safe investments, the investor could chase higher returns by investing in riskier assets such as mortgage backed securities but this might just result in a new crisis. Keep in mind that Greenspan intentionally kept interest rates low following the busting of the tech bubble due to anemic job growth but this made the financial bubble possible if not inevitable.
Tuesday, July 27, 2010
Public Advocacy, Grassroots Organizations and Snake Oil
The Internet and email have made it very easy for small groups of people to organize large numbers of voters to influence legislative policy priorities. Unfortunately, what are essentially special interests are able to portray themselves as general interests. The effort usually starts with a small group or industry who will benefit, a narrative that distorts the special interest portraying it as a general interest and the commissioning of studies by reputable organizations which develop creditable but biased data to support the narrative.
A case in point is the supposedly grassroots organization Defend My Dividend which is flooding the bandwidth with commercials requesting voters to contact their representatives to demand that federal tax rates on qualified dividends (dividends on stock owned for one year or more) not be increased. Starting with the 2003 tax cut legislation, the tax rate on qualified dividends was reduced to 15% (0% tax for people in the 15% tax bracket or lower). If no change is made, the tax rate on qualified dividends will revert to the rate that existed prior to the 2003 tax law change which taxed dividends at the same rate as ordinary income (wages, salaries, savings account interest, etc.). The Obama administration is proposing that the reduced rates only be retained for married tax payers with less than $250,000 in annual income ($200,000 for single tax payers) starting in 2011.
The Defend My Dividend organization was organized by several major utilities. On their web site, a major justification for not raising the rate is that it is a myth that the lower rate only benefits wealthy tax payers. The organization, citing a study by Ernst & Young which was paid for by the Edison Electric Institute and the American Gas Association, claims that 27 million Americans benefit from the lower tax rates and that 65% of the people who benefit have an annual income of less than $100,000. These claims are technically true but are very misleading. The study focuses solely on the number of returns by income bracket which report qualified dividend income and not the dollar amount of the qualified dividends by income bracket. As such, the study considers the person with a 2007 taxable income of less than $5,000 with an average qualified dividend income of $42.37 the same as the people with a reported income of more than $10 million who in 2007 had an average annual qualified dividend income of $1.5 million. No points for guessing who benefits more from the reduced tax rate.
Using the same 2007 IRS data used by Ernst & Young, I find the following;
- 80.9% of all qualified dividend income was reported by people with annual incomes of $100,000 or more.
- 65.1% of all qualified dividend income was reported by people with annual incomes of $200,000 or more.
- The preferred tax rate on qualified dividends reduced IRS tax receipts in 2007 by about $23.6 billion.
- Approximately 86% of the $23.6 billion in tax savings went to people with income above $100,000 and 76% to people with incomes above $200,000 and 46% to people with income above $1 million.
Just like the snake oil salesmen of the 19th century, they are claiming that reduced tax rates for qualified dividends are good for everyone when in fact most people will not benefit and end up paying higher taxes someplace else to make up for the revenue lost due to the lower tax rate on qualified dividends.
A case in point is the supposedly grassroots organization Defend My Dividend which is flooding the bandwidth with commercials requesting voters to contact their representatives to demand that federal tax rates on qualified dividends (dividends on stock owned for one year or more) not be increased. Starting with the 2003 tax cut legislation, the tax rate on qualified dividends was reduced to 15% (0% tax for people in the 15% tax bracket or lower). If no change is made, the tax rate on qualified dividends will revert to the rate that existed prior to the 2003 tax law change which taxed dividends at the same rate as ordinary income (wages, salaries, savings account interest, etc.). The Obama administration is proposing that the reduced rates only be retained for married tax payers with less than $250,000 in annual income ($200,000 for single tax payers) starting in 2011.
The Defend My Dividend organization was organized by several major utilities. On their web site, a major justification for not raising the rate is that it is a myth that the lower rate only benefits wealthy tax payers. The organization, citing a study by Ernst & Young which was paid for by the Edison Electric Institute and the American Gas Association, claims that 27 million Americans benefit from the lower tax rates and that 65% of the people who benefit have an annual income of less than $100,000. These claims are technically true but are very misleading. The study focuses solely on the number of returns by income bracket which report qualified dividend income and not the dollar amount of the qualified dividends by income bracket. As such, the study considers the person with a 2007 taxable income of less than $5,000 with an average qualified dividend income of $42.37 the same as the people with a reported income of more than $10 million who in 2007 had an average annual qualified dividend income of $1.5 million. No points for guessing who benefits more from the reduced tax rate.
Using the same 2007 IRS data used by Ernst & Young, I find the following;
- 80.9% of all qualified dividend income was reported by people with annual incomes of $100,000 or more.
- 65.1% of all qualified dividend income was reported by people with annual incomes of $200,000 or more.
- The preferred tax rate on qualified dividends reduced IRS tax receipts in 2007 by about $23.6 billion.
- Approximately 86% of the $23.6 billion in tax savings went to people with income above $100,000 and 76% to people with incomes above $200,000 and 46% to people with income above $1 million.
Just like the snake oil salesmen of the 19th century, they are claiming that reduced tax rates for qualified dividends are good for everyone when in fact most people will not benefit and end up paying higher taxes someplace else to make up for the revenue lost due to the lower tax rate on qualified dividends.
Friday, June 11, 2010
Hacking BIOS and Windows Passwords
I'm going to do another tech post as I am totally frustrated with political economic policy development and wonder whether it is even worth my time to follow legislation and developments.
In any case, I was enjoying a beer at the local American Legion post the other day when the bartender asked if I could help with a problem with their PC. She couldn't remember the Windows password she had set so she could not use the office PC. I told her that I thought that it wasn't possible to bypass a Windows password and she would probably need to reformat the hard drive and reload Windows and all of her applications (she didn't know if she had the software) but that I would check it out. I was dead wrong. After about 30 minutes with Google, I found that not only is it possible but hacking a Windows password is incredibly easy.
There are several software applications that will hack the Windows password and tell you what the password is but the best that I found is Ophcrack. You need some advanced but basic PC skills in that you will need to be able to set the BIOS boot sequence to try to boot from the CD drive before the hard drive and will need to be able to make an ISO boot CD (takes about 2 minutes with some freeware) but beyond that you just boot from the CD and wait for Ophcrack to tell you what the Windows password(s) is.
I went to the Legion to crack the Windows password only to find that one of the people who had tried to help had set a BIOS password so back to the drawing board. I quickly found out that clearing the BIOS password is even quicker in most cases than hacking the Windows password. All you have to do is get access to the motherboard inside of the PC and move a jumper which on a Dell takes about 60 seconds. A notebook PC would be much harder only because it is more time consuming to take a notebook PC apart which is required in order to access the jumper on the motherboard. I should note that some notebook manufacturers such as Toshiba have reportedly implemented additional security to prevent clearing or hacking the BIOS password.
OK, so what are the comparative benefits of setting a BIOS versus a Windows password?
A BIOS password generally protects the PC in that the PC is not not usable if you can't get by the BIOS password. However, the data is not protected in that you can take the hard drive out of the PC and plug the hard drive into a working PC and access all of the data on the drive. Removing a hard drive from a notebook PC made in the last 6 years or so takes about 1 minute.
A Windows password generally protects your data but not your PC. If someone stole your PC which had a Windows password set, they could reformat the hard drive and reload Windows and have a functioning PC. However, even if they removed your hard drive and plugged the drive into another PC they would not be able to access your files on the drive.
As noted above, neither a BIOS password nor a Windows password will protect your PC or your data from a moderately competent advanced user but it will protect your data in the vast majority of cases.
In any case, I was enjoying a beer at the local American Legion post the other day when the bartender asked if I could help with a problem with their PC. She couldn't remember the Windows password she had set so she could not use the office PC. I told her that I thought that it wasn't possible to bypass a Windows password and she would probably need to reformat the hard drive and reload Windows and all of her applications (she didn't know if she had the software) but that I would check it out. I was dead wrong. After about 30 minutes with Google, I found that not only is it possible but hacking a Windows password is incredibly easy.
There are several software applications that will hack the Windows password and tell you what the password is but the best that I found is Ophcrack. You need some advanced but basic PC skills in that you will need to be able to set the BIOS boot sequence to try to boot from the CD drive before the hard drive and will need to be able to make an ISO boot CD (takes about 2 minutes with some freeware) but beyond that you just boot from the CD and wait for Ophcrack to tell you what the Windows password(s) is.
I went to the Legion to crack the Windows password only to find that one of the people who had tried to help had set a BIOS password so back to the drawing board. I quickly found out that clearing the BIOS password is even quicker in most cases than hacking the Windows password. All you have to do is get access to the motherboard inside of the PC and move a jumper which on a Dell takes about 60 seconds. A notebook PC would be much harder only because it is more time consuming to take a notebook PC apart which is required in order to access the jumper on the motherboard. I should note that some notebook manufacturers such as Toshiba have reportedly implemented additional security to prevent clearing or hacking the BIOS password.
OK, so what are the comparative benefits of setting a BIOS versus a Windows password?
A BIOS password generally protects the PC in that the PC is not not usable if you can't get by the BIOS password. However, the data is not protected in that you can take the hard drive out of the PC and plug the hard drive into a working PC and access all of the data on the drive. Removing a hard drive from a notebook PC made in the last 6 years or so takes about 1 minute.
A Windows password generally protects your data but not your PC. If someone stole your PC which had a Windows password set, they could reformat the hard drive and reload Windows and have a functioning PC. However, even if they removed your hard drive and plugged the drive into another PC they would not be able to access your files on the drive.
As noted above, neither a BIOS password nor a Windows password will protect your PC or your data from a moderately competent advanced user but it will protect your data in the vast majority of cases.
Monday, June 7, 2010
Health Care Reform - Individual Policy - Fine Print
An individual health care policy is medical insurance purchased by an individual rather than a group health care policy which is typically provided by an employer. Since I have an individual health insurance policy, as do about 22.5 million Americans, I have closely followed the health care reform legislation as it impacts individual policy holders and have summarized the major impact on individual policy holders below.
If you like your current insurance you won't be required to change - This is true if you don't need or want the federal premium subsidy but if you do then you will be required to change.
Reform is required to combat increasing premiums - For individual insurance policies, the Congressional Budget Office (CBO) has estimated that in 2014, premiums on individual policies will be 13% less than they would be without health care reform. Using my current Blue Cross policy, I can look forward to only paying %52 more in 2014 in premiums rather than %75 more without the reform. A 52% increase in premiums in 4 years (+ $300 per month) is not nearly good enough and that is assuming that the CBO estimate is accurate.
If you currently have an individual medical insurance policy I would suggest that you consider all options but I have decided to keep my grandfathered policy until the impact on premiums of the new legislation is more clear. You might get better coverage with the new legislation but might end up paying much more in premiums even with the subsidy.
- Subsidies - Starting in 2014, the legislation provides subsidies for health care premiums for those with incomes below 4 times the federal poverty level (in 2010 about $44K for a single person). However, in order to receive the subsidy you will have to buy an insurance policy through a health insurance exchange. You will not receive a subsidy if you stay with your current policy. However, policies sold through the exchanges will have to provide very low or no co-pays, charge very low calendar year deductibles, not exclude or charge more for pre-existing conditions and must cover medical services which many policies do not cover or only cover for an additional premium. Consequently, the premium charged might be much higher than a current individual policy so even with the subsidy you might end up paying more than you do now. Premiums on the state exchanges can charge an older person up to 3 times the premium for a healthy young person (some carriers currently charge 10 times the premium for an older person) can charge 50% more for a smoker (most carriers currently charge 25% more for a smoker). If you are in your early 60's, don't smoke, have a low income and have expensive pre-existing conditions you will probably pay less but for others you may pay more.
- Medical Loss Ratio is the percentage of medical insurance premiums that spent by the insurer on health care expenses (payments to hospitals, doctors, etc.) versus overhead expenses such as administration and profits. Starting in 2011, health insurers will be required to have a medical loss ratio of at least 80% for individual policies. Currently, health insurance is regulated by the individual states if regulated at all. In Florida, the state currently requires that insurers have a minimum medical loss ratio on individual policies so this change may lead to lower premiums on current policies in those states with minimum medical loss rations less than 80%. However, the legislation permits insurers to reclassify administrative expenses as medical expenses if the expense improves health care quality. WellPoint recently reclassified $500,000,000 of administrative expenses as medical expenses in anticipation of this change. The Secretary of Health and Human Services must approve of non medical expenses that are reclassified as medical expenses so the net impact of the 80% minimum medical loss is not clear. If you are in a state which currently has a low medical loss ratio you may see a premium decrease.
- High Risk Pools will be established in July 2010 by some states and residents of states who elect not to establish a high risk pool will be eligible for coverage through a federal high risk pool. These pools are for individuals who are not able to get an individual medical insurance policy due to pre-existing conditions. In order to qualify for the high risk pool you must not be able to get insurance from an employer and must have been without insurance for at least 6 months. These high risk pools are temporary and will end as of 1/2014. However, only $5 billion is being provided to subsidize the premiums in the pools which is not expected to be nearly enough. If you currently have expensive pre-existing conditions and currently have an expensive insurance policy you would need to take the risk and out of pocket expense of going without insurance for 6 months in order to take advantage of the high risk pool.
- Grandfathered insurance policies are those health insurance policies in effect prior to the health care reform being signed by the president in March 2010. These grandfathered policies are exempt from some of the requirements of the health care reform which require additional services, no exclusion or additional premium for pre-existing conditions and low co-pays and calendar year deductibles. I recently received my annual 15% premium increase from Blue Cross and inquired about increasing my deductible to off-set part of the $75/month premium increase. However, Blue Cross was still waiting for guidance from the Federal Government as to whether this would cause me to lose my grandfathered status so I elected not to make a change to my policy.
- Higher taxes - Prior to reform, people with individual policies could deduct as an itemized expense on their federal tax the medical expenses paid including premiums that exceeded 7.5% of their adjusted gross income (AGI). Reform raised the threshold to 10% of AGI so even if you pay less in premiums you will pay more in taxes.
If you like your current insurance you won't be required to change - This is true if you don't need or want the federal premium subsidy but if you do then you will be required to change.
Reform is required to combat increasing premiums - For individual insurance policies, the Congressional Budget Office (CBO) has estimated that in 2014, premiums on individual policies will be 13% less than they would be without health care reform. Using my current Blue Cross policy, I can look forward to only paying %52 more in 2014 in premiums rather than %75 more without the reform. A 52% increase in premiums in 4 years (+ $300 per month) is not nearly good enough and that is assuming that the CBO estimate is accurate.
If you currently have an individual medical insurance policy I would suggest that you consider all options but I have decided to keep my grandfathered policy until the impact on premiums of the new legislation is more clear. You might get better coverage with the new legislation but might end up paying much more in premiums even with the subsidy.
Monday, May 17, 2010
Top Tech Picks
For this post I am deviating from my usual political economic subject matter and will cover my favorite technical gadgets acquired over the last year.
1) Digital Video Recorder (DVR) - A DVR essentially performs the same functions that a VCR does except it records TV programs to a hard drive (same thing that your PC stores files on) rather than a tape and consequently offers a number of additional functions. Some of the most noteworthy functions are that it can a) record up to 170 hours of programming on the hard drive versus 6 hours on a tape, b) while the DVR is recording a program you can watch a program previously recorded on the DVR or a live TV broadcast, 3) all programs recorded are saved on the DVR as separate digital files much like on your PC so you can add a program name for easy identification or edit the program file to remove commercials, 4) the DVR has a DVD recorder so you can copy programs that you want to keep to a DVD, 5) you can "rewind" a live TV program which in essence gives you your own instant replay function and 6) if you have an old style analog TV (tube TV), you will be able to watch digital programs without needing a converter.
Tivo and most cable providers sell or rent DVR hardware but you need to pay a monthly subscription to use these DVR's. The only DVR that doesn't require a monthly subscription available in the US is a Magnavox H2160MW9. Don't bother looking for it at Best Buy because they will tell you that no such machine exists and will try to sell you a unit that requires a monthly subscription. Surprisingly, as far as national stores, I have only found the Magnavox DVR available from Walmart and Target and only through their web sites. Walmart's price, at the time of this posting, is about $50 less than Target.
2) U3 Launchpad with Allway Sync Software - I have always done backups (copies of my PC files) to protect against the loss of my data should my PC break or be stolen. The concerns I had with this is that I could not password protect the files on the backup media and backups took a very long time. Using a Sandisk flash drive, you can install the U3 launchpad from Sandisk at no charge which enables you to install and run applications from from your flash drive. The U3 launchpad allows you to encrypt the date on the flash drive so someone who gets your flash drive can not look at the files unless they enter the correct password. The Allway Sync software handles the copy of the files on your PC to the password protected flash drive. The backup is much quicker than usual because, after the first full backup, it only needs to copy/change/delete files to reflect the changes you have made since your last backup. It will also copy your Outlook contacts and mail message and your Internet Explorer favorites.
3) MP3 player - A Music Player 3 (MP3) device does much more than play music. A typical MP3 player will have an FM radio built in and will play any audio file. I am an NPR talk radio fan and I can not always listen to my favorite radio programs live. Most talk radio stations allow you to download what is called a podcast which is a file which contains the full audio of their shows. You can load the podcast onto the MP3 player and then listen to the radio program whenever you want with the additional benefit of being able to fast forward or rewind the program. I walk for exercise and if I was not able to listen to a podcast on my MP3 player I'm sure that walking would become so boring that I'd quit. Yes, you can also copy music albums or individual tracks to the MP3 player if you like.
1) Digital Video Recorder (DVR) - A DVR essentially performs the same functions that a VCR does except it records TV programs to a hard drive (same thing that your PC stores files on) rather than a tape and consequently offers a number of additional functions. Some of the most noteworthy functions are that it can a) record up to 170 hours of programming on the hard drive versus 6 hours on a tape, b) while the DVR is recording a program you can watch a program previously recorded on the DVR or a live TV broadcast, 3) all programs recorded are saved on the DVR as separate digital files much like on your PC so you can add a program name for easy identification or edit the program file to remove commercials, 4) the DVR has a DVD recorder so you can copy programs that you want to keep to a DVD, 5) you can "rewind" a live TV program which in essence gives you your own instant replay function and 6) if you have an old style analog TV (tube TV), you will be able to watch digital programs without needing a converter.
Tivo and most cable providers sell or rent DVR hardware but you need to pay a monthly subscription to use these DVR's. The only DVR that doesn't require a monthly subscription available in the US is a Magnavox H2160MW9. Don't bother looking for it at Best Buy because they will tell you that no such machine exists and will try to sell you a unit that requires a monthly subscription. Surprisingly, as far as national stores, I have only found the Magnavox DVR available from Walmart and Target and only through their web sites. Walmart's price, at the time of this posting, is about $50 less than Target.
2) U3 Launchpad with Allway Sync Software - I have always done backups (copies of my PC files) to protect against the loss of my data should my PC break or be stolen. The concerns I had with this is that I could not password protect the files on the backup media and backups took a very long time. Using a Sandisk flash drive, you can install the U3 launchpad from Sandisk at no charge which enables you to install and run applications from from your flash drive. The U3 launchpad allows you to encrypt the date on the flash drive so someone who gets your flash drive can not look at the files unless they enter the correct password. The Allway Sync software handles the copy of the files on your PC to the password protected flash drive. The backup is much quicker than usual because, after the first full backup, it only needs to copy/change/delete files to reflect the changes you have made since your last backup. It will also copy your Outlook contacts and mail message and your Internet Explorer favorites.
3) MP3 player - A Music Player 3 (MP3) device does much more than play music. A typical MP3 player will have an FM radio built in and will play any audio file. I am an NPR talk radio fan and I can not always listen to my favorite radio programs live. Most talk radio stations allow you to download what is called a podcast which is a file which contains the full audio of their shows. You can load the podcast onto the MP3 player and then listen to the radio program whenever you want with the additional benefit of being able to fast forward or rewind the program. I walk for exercise and if I was not able to listen to a podcast on my MP3 player I'm sure that walking would become so boring that I'd quit. Yes, you can also copy music albums or individual tracks to the MP3 player if you like.
Friday, March 5, 2010
Next Financial Crisis
If you have been irritated by the current financial crisis and the ensuing bank bailout then you are really going to hate the next financial crisis which is already being formed thanks in large part to the remedy for the current crisis.
The major goal of the US Treasury is to enable the US banking sector to make sufficient profits to offset the losses suffered by the banks over the last 2 years thereby restoring the banking sector to financial health. Secretary of the Treasury Geithner would probably prefer to just give the banks a no strings attached check in an amount equivalent to what the banks have lost over the last 2 years but realizes that this would be politically unacceptable. So, he is pursuing a more convoluted approach which essentially accomplishes the same thing. The banks are borrowing hundreds of billions from the Federal Reserve and paying 0.25% (one quarter of one percent) and then lending the borrowed money to the US Treasury and being paid 2% plus (about 3.5% on a 10 year bond, less on 2's and 5's). The banks are also using the borrowed funds to buy foreign government bonds which are paying much more such as Brazilian bonds that are paying in excess of 8%. The banks are making a fortune using the money borrowed from the fed to make low risk, low cost loans to the US and foreign governments which explains in part why the banks have borrowed so much but lent so little to US businesses and consumers.
The problem is that the banks are doing the same thing now that got them in trouble a couple of years ago. They are currently borrowing short term and lending longer term and pocketing significant profits. However, if interest rates increase and/or the dollar strengthens significantly over the next couple of years, the banks are going to take massive losses. I'm sure that the fed realizes this but is focused on fixing the short term problem even if the fix leads to a larger, longer term problem. The current method of resolving the financial crisis is analogous to giving a heroin addict more heroin to avoid the pain of with drawl.
The really disappointing thing is that having suffered such a huge hit to the economy over the last couple of years due to the financial crisis, the US Congress is not able to develop any effective financial reform. Increasing the disclosure requirements on consumer loans is not going to make any significant difference to financial stability.
The major goal of the US Treasury is to enable the US banking sector to make sufficient profits to offset the losses suffered by the banks over the last 2 years thereby restoring the banking sector to financial health. Secretary of the Treasury Geithner would probably prefer to just give the banks a no strings attached check in an amount equivalent to what the banks have lost over the last 2 years but realizes that this would be politically unacceptable. So, he is pursuing a more convoluted approach which essentially accomplishes the same thing. The banks are borrowing hundreds of billions from the Federal Reserve and paying 0.25% (one quarter of one percent) and then lending the borrowed money to the US Treasury and being paid 2% plus (about 3.5% on a 10 year bond, less on 2's and 5's). The banks are also using the borrowed funds to buy foreign government bonds which are paying much more such as Brazilian bonds that are paying in excess of 8%. The banks are making a fortune using the money borrowed from the fed to make low risk, low cost loans to the US and foreign governments which explains in part why the banks have borrowed so much but lent so little to US businesses and consumers.
The problem is that the banks are doing the same thing now that got them in trouble a couple of years ago. They are currently borrowing short term and lending longer term and pocketing significant profits. However, if interest rates increase and/or the dollar strengthens significantly over the next couple of years, the banks are going to take massive losses. I'm sure that the fed realizes this but is focused on fixing the short term problem even if the fix leads to a larger, longer term problem. The current method of resolving the financial crisis is analogous to giving a heroin addict more heroin to avoid the pain of with drawl.
The really disappointing thing is that having suffered such a huge hit to the economy over the last couple of years due to the financial crisis, the US Congress is not able to develop any effective financial reform. Increasing the disclosure requirements on consumer loans is not going to make any significant difference to financial stability.
Monday, March 1, 2010
Are Seniors Paying their Fair Share of Taxes
I was reading a piece this morning about income growth slowing which was attributed in large part to Social Security (SSA) recipients not receiving a cost of living increase in 2010 due to the fact that prices (CPI) did not increase in 2009. On the face of it, I didn't think that an annual increase in SSA payments would make that much difference in gross income on a monthly basis but proceeded to check my assumptions. Per the Social Security Administration, payments to social security recipients in 12/2009 were $55.9 billion so a 2% increase in payments in 1/2010 would have amounted to only about $1.2 billion of additional income in 1/2010 which is a very minor amount in an economy of $13.6 trillion.
However, what I did notice was that per the Social Security Administration trustees, the total payments to social security beneficiaries in 2007 was $585 billion. Per the IRS, total social security income in 2007 reported by taxpayers was $382 billion or $203 billion less than paid by SSA. In some cases, the income of a recipient would be so low that they are not required to submit an annual tax return but I would be surprised if $203 billion was paid to people who are not required to submit a tax return. I would hope that the IRS and the SSA are exchanging info to ensure that recipients are paying their fair share of takes.
What I also noticed was disability payments in 2007 were $99,086,000,000 ($99.1b) made to 8,920,371 recipients. In 1990, there were 4,265,981 disability recipients which represented 10.71% of total social security recipients while in 2009 there were 9,969,398 disability recipients which represented 18.5% of total social security recipients. Are Americans really getting sicker and more disabled to the tune of almost twice what they were just 20 years ago or is there an issue with fraud and perhaps extreme generosity. Based on the experience of some people I know, it appears that anyone with a good lawyer can qualify for disability. For a program that we taxpayers are paying $100 billion per year (more when you add in Medicare for which disabled individuals qualify), I think that it is time to review the goals of the program with the way that it is being implemented.
In the context of the current health care reform debate and the Republican claims that a public option would lead to rationing and Washington bureaucrats determining the health care that you get, I think it more likely that our elected representatives would provide more than the private insurance industry and more than what the taxpayer can afford.
However, what I did notice was that per the Social Security Administration trustees, the total payments to social security beneficiaries in 2007 was $585 billion. Per the IRS, total social security income in 2007 reported by taxpayers was $382 billion or $203 billion less than paid by SSA. In some cases, the income of a recipient would be so low that they are not required to submit an annual tax return but I would be surprised if $203 billion was paid to people who are not required to submit a tax return. I would hope that the IRS and the SSA are exchanging info to ensure that recipients are paying their fair share of takes.
What I also noticed was disability payments in 2007 were $99,086,000,000 ($99.1b) made to 8,920,371 recipients. In 1990, there were 4,265,981 disability recipients which represented 10.71% of total social security recipients while in 2009 there were 9,969,398 disability recipients which represented 18.5% of total social security recipients. Are Americans really getting sicker and more disabled to the tune of almost twice what they were just 20 years ago or is there an issue with fraud and perhaps extreme generosity. Based on the experience of some people I know, it appears that anyone with a good lawyer can qualify for disability. For a program that we taxpayers are paying $100 billion per year (more when you add in Medicare for which disabled individuals qualify), I think that it is time to review the goals of the program with the way that it is being implemented.
In the context of the current health care reform debate and the Republican claims that a public option would lead to rationing and Washington bureaucrats determining the health care that you get, I think it more likely that our elected representatives would provide more than the private insurance industry and more than what the taxpayer can afford.
Thursday, February 4, 2010
Supreme Court Decision on Campaign Finance
In a 5 to 4 decision in Citizens United v. Federal Election Commission announced on 1/21/2010, the US Supreme Court essentially ruled that corporations have the same first amendment rights as individual US citizens. The specific impact was that existing campaign finance restrictions for corporations were invalidated and that any corporation could spend any amount they wanted to support any candidate for any US political office. The ruling would have the impact that even foreign corporations could spend money to affect the outcome of a US election.
I really don't understand how the Supreme Court arrived at their decision but then I am not a US constitutional law specialist. The US Declaration of Independence states that "... all men are created equal" and endowed "with certain inalienable rights". The preamble to the US Constitution speaks in terms of "We the People of the United States". It seems to me that the protections in US law should only apply to US men and woman - nothing here about corporations, either foreign or domestic.
Supreme Court Justice Alito who votes with the right leaning justices and disagrees with the Supreme Court rulings on abortion (Roe v Wade) never-the-less has supported the court's view that a fetus is not a ‘person’ within the meaning of the Fourteenth Amendment. Justice Alito has stated that the US Constitution clearly states that the rights enumerated therein apply to men and therefore not to fetuses. So I wonder how it is that US constitutional rights that he believes don't apply to the unborn off spring of US citizens apply to corporations, both foreign and domestic.
In any case, the US Supreme Court has ruled and we need to play by the rules and accept this ruling. However, I believe that there are some options that the US Congress has to mitigate the effect which would be:
I really don't understand how the Supreme Court arrived at their decision but then I am not a US constitutional law specialist. The US Declaration of Independence states that "... all men are created equal" and endowed "with certain inalienable rights". The preamble to the US Constitution speaks in terms of "We the People of the United States". It seems to me that the protections in US law should only apply to US men and woman - nothing here about corporations, either foreign or domestic.
Supreme Court Justice Alito who votes with the right leaning justices and disagrees with the Supreme Court rulings on abortion (Roe v Wade) never-the-less has supported the court's view that a fetus is not a ‘person’ within the meaning of the Fourteenth Amendment. Justice Alito has stated that the US Constitution clearly states that the rights enumerated therein apply to men and therefore not to fetuses. So I wonder how it is that US constitutional rights that he believes don't apply to the unborn off spring of US citizens apply to corporations, both foreign and domestic.
In any case, the US Supreme Court has ruled and we need to play by the rules and accept this ruling. However, I believe that there are some options that the US Congress has to mitigate the effect which would be:
- Remove the tax deductibility for lobbying and campaign related efforts for corporations.
- Bar tax exempt status for any Political Action Committee (PAC) that accepts any funding from any source other than an individual US citizen. If the PAC accepts funding from a corporation then they lose their tax exempt status.
- For financing from a corporation, make them pay an equal amount which would be made available to PAC's with an opposing point of view to provide a balanced perspective. If needed, the money could be collected via import taxes on imports from the foreign company.
Friday, January 22, 2010
Financial Crisis - Who is Responsible
Congress has established the Financial Crisis Inquiry Commission (FCIC) to determine what caused the financial crisis that required a massive taxpayer bailout of the financial sector. Although various legislators and news pundits have pointed the finger at a number of decisions and institutions, it seems clear to me as I have stated in previous posts that unregulated derivatives were the root cause of the problem.
Some have blamed the Federal Reserve under Alan Greenspan for keeping interest rates too low for too long. In 2003, the Fed kept interest rates low to combat high unemployment rates that were persisting in the recovery from the bursting of the dot.com bubble. Although I agree that Greenspan bears significant responsibility for the financial crisis, his responsibility in my opinion does not derive from his role as Fed Chairman or for keeping interest rates low. Low interest rates are an appropriate economic method for increasing employment and full employment is a legally mandated objective of the Federal Reserve. Just because interest rates were low does not justify bankers taking unreasonable risks. If a bank manager forgets to lock the bank door and a thief walks in and steals money, the thief can not argue innocence blaming the theft on the bank manager.
Some people have argued that the Community Reinvestment Act (CRA) which required all federally chartered banks to increase mortgages to low and moderate income neighborhoods was responsible for the problem mortgages that caused the financial crisis. The CRA only applied to deposit taking banks covered by FDIC insurance and FDIC covered institutions wrote less than 20% of all sub-prime mortgages. In any case, the CRA was passed by Congress in 1977 - more than 30 years prior to the financial crisis - so if the CRA was responsible we should have seen problems earlier.
Some people have blamed Fannie Mae and Freddie Mac for the financial crisis. Fannie and Freddie buy mortgages from primary lenders to make more money available for mortgages thereby increasing home ownership and lowering mortgage interest rates. However, at the height of the financial crisis in 2006, Fannie and Freddie collectively held only 24% of all sub-prime mortgages. Also, keep in mind that Fannie and Freddie never wrote a single mortgage in their history. They only buy mortgages written by other lenders. Also, Fannie and Freddie were subject to much tighter restrictions on the types of loans that they could purchase than the lenders such a Country Wide.
Some people have argued that revoking the major provisions of the Glass Steagall Act in 1999 which separated commercial bank and investment bank activities was responsible. Although I believe that major portions of the Glass Steagall Act should be reimposed, I don't believe that the abolition of the Act was responsible since the Act only applied to deposit taking institutions who wrote and held a small percentage of the sub-prime mortgages and did not apply to the big investment banks such as Goldman.
About 80% of the sub-prime mortgages that caused the financial crisis were lent by unregulated organizations like Country Wide and sold by unregulated investment banks such as Bear Stearns. Consequently, although the Federal Reserve interest rate policies in the 2000's, Fannie and Freddie, and the CRA contributed a little to the problem, they were not responsible for the 2008 financial crisis.
The next step in determining the cause of the crisis requires that we look at what happened to these sub-prime mortgages. The investment banks packaged these sub-prime loans into Collateralized Debt Obligations (CDO's) which eventually came to represent a significant percentage of the portfolios of pension funds, money market accounts held by mom and pop savings accounts, college endowments and charities as well as large investors. Many of the largest buyers of these CDO's could only buy highly rated financial instruments. The way that the investment banks were able to get these CDO's rated highly buy the rating agencies (Moodys, S&P) was to purchase Credit Default Swaps (CDS) primarily from AIG. The CDS's were essentially insurance whereby if the sub-prime borrowers did not pay back their mortgages then AIG would pay for the loss. Consequently, at least on the face, the CDS essentially made investing in sub-prime mortgages risk free. Now the problem with the AIG insurance was that AIG never had sufficient reserves on hand to pay any significant amount in claims. What AIG did was essentially equivalent to me personally selling hurricane insurance to condo owners in Florida and spending the premiums I collected on yachts and vacations in years when there were no hurricanes and then when a hurricane hit, since I wouldn't have any money to pay the claims, I would just go bankrupt and sail off on my yacht.
In summary, if AIG did not sell the credit default swaps (or was required to keep adequate reserves to pay claims), the investment banks would not have been able to sell the sub prime CDO's to investors so there wouldn't have been any demand for sub-prime based mortgage investments so lenders would not have been able to sell the junk to anyone and would not have written the sub-prime mortgages and we would have avoided the financial crisis caused by the sub-prime mortgages. The rating agencies and the investment banks could reasonably be said not to have exercised due diligence for not checking out AIG's ability to pay off in the case of a claim.
OK, so if the root cause was the availability of credit default swaps sold primarily by AIG, who is responsible? When reading the following, keep in mind that a credit default swap is a type of financial instrument called a derivative. If I had to pick one person responsible for the financial crisis I would pick former president Bill Clinton.
Brooksley Born is a Stanford educated attorney with over 30 years experience as an attorney specializing in financial instruments and derivatives. She is a personal friend of Hillary Clinton who at Mrs. Clintons suggestion was considered for the position of Attorney General by President Clinton. President Clinton interviewed her and declined to nominate her because he found her personality colorless but did nominate and appoint her as chairperson of the Commodity Futures Trading Commission (CFTC) in 1994. In her role at the CFTC, Ms. Born became seriously concerned that unregulated derivatives, especially credit default swaps, posed the potential to cause a significant financial crisis. The CFTC consequently initiated a process to develop comprehensive regulations for the derivatives markets. Clinton's Council of Economic Advisors led by Alan Greenspan and Larry Summers with the support of then Treasury Secretary Robert Rubin and SEC Chair Levitt had a fit, threatened to have Born removed as CFTC chair and eventually persuaded Congress to pass a law that prevented the CFTC from regulating derivatives. Although Greenspan and Summers were the two who spearheaded the effort to prevent the regulation of derivatives, Greenspan and Summers reported to the President who supported their efforts. If Clinton had taken the time to understand the threat and supported Ms. Born, there is a good chance that derivatives would have been regulated, AIG would not have been able to sell swaps which would have caused the rating agencies to rate packages of sub-prime mortgages as junk which would have prevented the purchase of these investments by some of the largest purchasers which would have prevented the investment banks from selling them which would have prevented the lenders from writing sub-prime mortgages.
What concerns me at this time is that the regulations being proposed following the 2008 financial crisis do not address the causes of the crisis. The big money has been effective in removing the regulation that would make the system reasonably safe. I'll post more details on the proposed regulation at a later time but at this time I would have to say that with the changes made in response to the 2008 crisis that the financial system is even more at risk than previously.
Some have blamed the Federal Reserve under Alan Greenspan for keeping interest rates too low for too long. In 2003, the Fed kept interest rates low to combat high unemployment rates that were persisting in the recovery from the bursting of the dot.com bubble. Although I agree that Greenspan bears significant responsibility for the financial crisis, his responsibility in my opinion does not derive from his role as Fed Chairman or for keeping interest rates low. Low interest rates are an appropriate economic method for increasing employment and full employment is a legally mandated objective of the Federal Reserve. Just because interest rates were low does not justify bankers taking unreasonable risks. If a bank manager forgets to lock the bank door and a thief walks in and steals money, the thief can not argue innocence blaming the theft on the bank manager.
Some people have argued that the Community Reinvestment Act (CRA) which required all federally chartered banks to increase mortgages to low and moderate income neighborhoods was responsible for the problem mortgages that caused the financial crisis. The CRA only applied to deposit taking banks covered by FDIC insurance and FDIC covered institutions wrote less than 20% of all sub-prime mortgages. In any case, the CRA was passed by Congress in 1977 - more than 30 years prior to the financial crisis - so if the CRA was responsible we should have seen problems earlier.
Some people have blamed Fannie Mae and Freddie Mac for the financial crisis. Fannie and Freddie buy mortgages from primary lenders to make more money available for mortgages thereby increasing home ownership and lowering mortgage interest rates. However, at the height of the financial crisis in 2006, Fannie and Freddie collectively held only 24% of all sub-prime mortgages. Also, keep in mind that Fannie and Freddie never wrote a single mortgage in their history. They only buy mortgages written by other lenders. Also, Fannie and Freddie were subject to much tighter restrictions on the types of loans that they could purchase than the lenders such a Country Wide.
Some people have argued that revoking the major provisions of the Glass Steagall Act in 1999 which separated commercial bank and investment bank activities was responsible. Although I believe that major portions of the Glass Steagall Act should be reimposed, I don't believe that the abolition of the Act was responsible since the Act only applied to deposit taking institutions who wrote and held a small percentage of the sub-prime mortgages and did not apply to the big investment banks such as Goldman.
About 80% of the sub-prime mortgages that caused the financial crisis were lent by unregulated organizations like Country Wide and sold by unregulated investment banks such as Bear Stearns. Consequently, although the Federal Reserve interest rate policies in the 2000's, Fannie and Freddie, and the CRA contributed a little to the problem, they were not responsible for the 2008 financial crisis.
The next step in determining the cause of the crisis requires that we look at what happened to these sub-prime mortgages. The investment banks packaged these sub-prime loans into Collateralized Debt Obligations (CDO's) which eventually came to represent a significant percentage of the portfolios of pension funds, money market accounts held by mom and pop savings accounts, college endowments and charities as well as large investors. Many of the largest buyers of these CDO's could only buy highly rated financial instruments. The way that the investment banks were able to get these CDO's rated highly buy the rating agencies (Moodys, S&P) was to purchase Credit Default Swaps (CDS) primarily from AIG. The CDS's were essentially insurance whereby if the sub-prime borrowers did not pay back their mortgages then AIG would pay for the loss. Consequently, at least on the face, the CDS essentially made investing in sub-prime mortgages risk free. Now the problem with the AIG insurance was that AIG never had sufficient reserves on hand to pay any significant amount in claims. What AIG did was essentially equivalent to me personally selling hurricane insurance to condo owners in Florida and spending the premiums I collected on yachts and vacations in years when there were no hurricanes and then when a hurricane hit, since I wouldn't have any money to pay the claims, I would just go bankrupt and sail off on my yacht.
In summary, if AIG did not sell the credit default swaps (or was required to keep adequate reserves to pay claims), the investment banks would not have been able to sell the sub prime CDO's to investors so there wouldn't have been any demand for sub-prime based mortgage investments so lenders would not have been able to sell the junk to anyone and would not have written the sub-prime mortgages and we would have avoided the financial crisis caused by the sub-prime mortgages. The rating agencies and the investment banks could reasonably be said not to have exercised due diligence for not checking out AIG's ability to pay off in the case of a claim.
OK, so if the root cause was the availability of credit default swaps sold primarily by AIG, who is responsible? When reading the following, keep in mind that a credit default swap is a type of financial instrument called a derivative. If I had to pick one person responsible for the financial crisis I would pick former president Bill Clinton.
Brooksley Born is a Stanford educated attorney with over 30 years experience as an attorney specializing in financial instruments and derivatives. She is a personal friend of Hillary Clinton who at Mrs. Clintons suggestion was considered for the position of Attorney General by President Clinton. President Clinton interviewed her and declined to nominate her because he found her personality colorless but did nominate and appoint her as chairperson of the Commodity Futures Trading Commission (CFTC) in 1994. In her role at the CFTC, Ms. Born became seriously concerned that unregulated derivatives, especially credit default swaps, posed the potential to cause a significant financial crisis. The CFTC consequently initiated a process to develop comprehensive regulations for the derivatives markets. Clinton's Council of Economic Advisors led by Alan Greenspan and Larry Summers with the support of then Treasury Secretary Robert Rubin and SEC Chair Levitt had a fit, threatened to have Born removed as CFTC chair and eventually persuaded Congress to pass a law that prevented the CFTC from regulating derivatives. Although Greenspan and Summers were the two who spearheaded the effort to prevent the regulation of derivatives, Greenspan and Summers reported to the President who supported their efforts. If Clinton had taken the time to understand the threat and supported Ms. Born, there is a good chance that derivatives would have been regulated, AIG would not have been able to sell swaps which would have caused the rating agencies to rate packages of sub-prime mortgages as junk which would have prevented the purchase of these investments by some of the largest purchasers which would have prevented the investment banks from selling them which would have prevented the lenders from writing sub-prime mortgages.
What concerns me at this time is that the regulations being proposed following the 2008 financial crisis do not address the causes of the crisis. The big money has been effective in removing the regulation that would make the system reasonably safe. I'll post more details on the proposed regulation at a later time but at this time I would have to say that with the changes made in response to the 2008 crisis that the financial system is even more at risk than previously.
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