from Townhall.com Why Obama Does Not Get it by Bruce Bialosky

Excerpt:

Mr. Obama may be a smart man, but he cannot become a business brain through osmosis. It takes experience and a certain aptitude, neither of which he appears to have shown any interest in obtaining. He never even worked at a McDonald’s to understand simple business basics. There he would have observed manpower requirements, personnel management, inventory control, quality control, customer relations, and more – even if he was just an entry-level employee.

It is highly doubtful that anyone ever informed Mr. Obama that his recent small business bill will never work. First, the principal reason that a loan bank for small businesses is even necessary is because the federal government has soaked up almost all available funds to feed the massive $1.3 trillion deficit. Second, the economic uncertainty – directly caused by the Administration’s senseless obsession with raising taxes and imposing crippling new costs on American companies – has made small businesses hesitant to seek loans at all. To many entrepreneurs, the issue is no longer how to grow the company – it’s how to sell it! Finally, businessmen know that these artificially-low interest rates won’t last, and they realize that if they commit to adjustable-rate loans, they will eventually get whacked with unaffordable interest costs.

HKO comment- what is sorely missing from this economy is new business start-ups. I hear little about new businesses but I hear much from my collegues about jumping on the next opportunity to sell their businesses.

In a debate posted on YouTube between Connecticut Senate candidates Richard Blumenthal and Linda McMahon circulating on many conservative blogs and sites, Blumenthal falls for the trap set by his opponent when she asks him “how do you create a job?”  He gives a long clumsy answer involving a lot of government involvement.  Linda responds simply (paraphrased) “when a company can sell a product or service for more than it costs  a job is created.”

Linda’s response is so simple and so obvious that it seems brilliant. We have descended into a climate made so unnecessarily complicated by well meaning but incredibly ignorant bureaucrats that stating the obvious has become a sign of superior intelligence.

In Newsweek economic columnist Robert Samuelson in The Real Jobs Machine notes that  the problem is not just that we are not hiring but that startups are very weak.  A lot of businesses die for a lot of reasons and we need a steady supply of startups just to replace the ones that close or fail.  Most startups are not glamorous high tech sporting brilliant new items like iPads; most startups are electrical contractors,  pest control services, the guys that comes and inspects our trucks, welders, restaurants, dry cleaners, health foods stores, and just about any other common business we see daily but pay little attention to.

While credit is important,  many of these people are able to start with little credit.  They often start with just their reputation and a few solid customers that are willing to give them a chance. They keep their expenses low and grow as they are able. Most people outside of the business world are shocked to find out how small the net profit margins are with such businesses. They delicately balance their expenses with their sales and manage to eke out a living.  If they get new business and earn more profits they create more jobs. Linda McMahon has it exactly right.

These entrepreneurs do not need tax credits for R&D and those that think that will create jobs just show how ignorant they are of the real small business people. But mandated expenses such as the health care bill requires, and higher regulatory costs stops these businesses in their tracks. Many who started small business ignorant of these costs quickly throw in the towel, but many who would otherwise have made the leap of faith every entrepreneur makes decides they would be better off keeping the job they have or taking another job elsewhere. Most of the time this is a wise decision.

I see auction notices of businesses closing come across my desk every week.  I have seen a wave of businesses close their doors that have been doing business successfully for decades. They just do not see any light at the end of the tunnel.

By comparison the Reagan revolution was built on small businesses and entrepreneurs. They grew like wildfire.  Low taxes, less regulation, and most of all sound money made small businesses flourish. This drove unemployment way down. We are experiencing the opposite policies and we are getting the opposite outcomes.

This administration has less understanding of American entrepreneurship than any in memory. They have fewer people by far from the private sector than any president in a hundred years. They truly believe that the government can create consumer demand and that they can create jobs.

They should listen to Linda McMahon.

Every day on my 9.4 mile drive from my house along Eisenhower Parkway to our business at General Steel on Broadway I count empty buildings. Entire strip centers are abandoned. Free standing stores are boarded up.  The Macon Mall must be 50% vacant.

I went to visit a friend in a nearby small town. His contracting firm, like so many others, is shut down after a forty year run. Dozens of pieces of equipment lay idle in his yard. Large plants in his town with acres under roof are empty.  Every empty building is a building that will not need to be built.  All the idled trucks and tractors represent equipment that  does not need to be produced, sold or serviced.

It is becoming increasingly obvious that this inventory of empty buildings and idled equipment will burden the market for a very long time. It is a clear sign of how badly we as a country misallocated resources for decades.  We built buildings supported not by legitimate demand but by loose monetary policy and perverse financial and political incentives.

No amount of stimulus will restore the need for an empty building that isn’t needed.  This is why zero interest and massive stimulus spending, the default policy for a recession, is not working. This is why America’s corporations are sitting on top of 1.8 trillion dollars in cash they are not spending. This is not demand that is weak because of lack of consumer confidence, though that is sorely lacking; this is demand that is weak because it never really existed.

I have written numerous times how the current administration’s radical  legislation and anti-business sentiment is holding the economy back. I still maintain that assessment, but that is not the entire picture.  Tax cuts and government spending, especially on silly and wasteful cronyist projects, will not create a true demand for something we just don’t need or want.  When asked why he had just given a very generous charitable contribution a  wealthy friend once noted, “You can only wear one shirt at a time.”   Consumer demand, even in our super consumerist society, may have real limits.

We have learned that financial geniuses do not create true wealth or erase risk with PhD constructed models that omit rare but crucial details.  We are also learning that elected officials do not create wealth by borrowing money from itself and our children and spending it on themselves and their constituents. The more we depend on academic elites for solutions the worse the problems seem to get.

Managing in tough economies is a matter of simple math.  It is all addition and subtraction; if you cannot add revenues then you must subtract expenses.  This is how budgets are being balanced in New Jersey and Indiana by governors Chris Christie and Mitch Daniels.

This recession was not the sole fault of George Bush nor Barak Obama; it was a long time in the making and both parties added to the problem. Like ‘world peace’ we all claim to want a sound currency and a stable economy.  While we may disagree on how to achieve that elusive goal,  the bigger restraint is that we do not want to make the sacrifice required.

It is the nature of political leaders to promise benefits without paying for them. They refuse to say ‘no’ to worthwhile projects they cannot afford. Just as we wanted to believe in the wealth generating genius of Bernie Madoff,  we want to believe we are just a bigger stimulus package or a tax cut away from a return to the normal life we enjoyed yesterday.

Consider that the ‘normal’ we wish for was anything but normal. Perhaps this is the new normal, it just seems otherwise in comparison.  For an alcoholic sober is not fun.  Adjusting to political and economic sobriety is painful.

The problem is too much debt, complicated and poorly understood regulations, markets influenced to serve political objectives, and politics influenced to serve special interests.  Tax policies change so often that no business or investor can make long term plans which is so critical for stable employment. Few of these problems are being addressed in the mass of radical legislation passed and under consideration.

Like a disease we cannot cure it by pretending we don’t have it. Like the economist stuck in a deep hole, we cannot ‘assume’ a ladder. Only if we can get real about the problem can we hope to get real about the solution.

Otherwise we just will just continue to construct empty buildings.

originally published in The Macon Telegraph

The default belief  of our economic history of the last 100 years has been an acceptance of the dynamic growth of capitalism punctuated by excesses of market greed that have to be corrected by the singular wisdom of government regulation.

On closer examination many of those moments of market greed and excess look more like incompetent government meddling caused the problem.

During the Depression of 1929 we saw 10,000 banks collapse in the United States. Yet during that same period the number of bank failures in Canada were zero.  Was Canada spared the depression that engulfed the United States? No, but Canada was spared a regulation that prevented banks from crossing state lines.

Bending to pressure to protect local banks from encountering big business center banks, they got relief and protection from the Federal government in the restriction of interstate competition.  But that also severely limited their flexibility in dealing with a crisis, a limit that did not exist in Canada where risks were spread over larger areas and underutilized assets could be easily relocated.

Yet to respond to the bank failures that the government largely caused they created the FDIC (Federal Deposit Insurance Corporation).  FDR opposed the FDIC because he saw it would create a sanction for reckless behavior and penalize prudently run banks.  FDR capitulated in a compromise and the FDIC began by insuring deposits for $2500 in 1934. It was raised to $5,000 in 1935, $10,000 in 1950 (Truman), $15,000 in 1966 (Johnson), $20,000 in 1968 (LBJ again), $40,000 in 1974 (Nixon), and then $100,000 under Jimmy Carter in 1980.  Bush raised it to $250,000 before he left office, but it is due to revert back to $100,000 in 2013.

Ten years after Carter raised the limit we experienced the Savings and Loans meltdown, caused by the excessive risk taking in that industry. The government again intervened and created the Resolution Trust Corporation (RTC) to dispose of failed thrift institutions taken over by regulators after January 1, 1989 in an orderly manner.

The FDIC created the moral hazard FDR feared. It privatized the profits and socialized the risks.  This behavior was repeated, but on steroids, with the implicit assumption of risk by Fannie Mae and Freddie Mac.

Housing was deemed a federal priority, and helping the poorer people get into housing has been a priority since Fannie Mae was created again by FDR in 1938.  But housing prices were highest and least affordable in select areas where local ordinances had restricted supply and raised prices far more than in areas were market forces prevailed.

Tax policies such as mortgage interest deductions and preferred capital gains treatment increased the demand for housing. The Community Reinvestment Act, passed under Carter but exploited under Clinton and Bush, pressured banks to make mortgage loans to less and less qualified buyers. Fannie Mae guaranteed loans, clearing the ratings agencies which had a government protected franchise; to give higher ratings than these mortgage backed securities could have conceivably obtained on the merits of their assets. This widened the market for these securities and caused even more money to be driven into the housing market from all over the world creating the bubble that had to burst.

To compound the damage the government required a mark to market rule for valuing these mortgage loans at the worst possible time; when no market existed.  The market to market rule causes valuations to go to extremes, high and low.  This caused capital to dry up and regulations required banks to rebuild capital reserves instead of making loans. Then at a time when information was critical to valuing these securities, the government suspended short selling, a critical source of such information.

During the recent financial disaster, Canada did not exhibit near the real estate collapse we did in the United States.  In Canada they had far less exposure to sub prime loans, large down payments were still required while we all but eliminated down payments for the poorest home buyers in the name of ‘compassionate conservatism’, and mortgage borrowers in Canada were still held personally liable for their loans. Canada had tougher and more prudent lending standards, but they avoided the fiasco foisted on us by well intentioned but misguided moral supremacists on the government payroll.

The government in the U.S. inflated this bubble as eagerly as any on Wall Street, but our government “had a much bigger pump”.

Seventy five years ago we could have looked to our northern neighbor and learned better behavior instead of demonizing capitalism. Today we can learn the same lesson, but again we seek to demonize the private sector for conditions created by incompetent government regulation. Wall Street clearly has its demons to account for, but its greed was enabled and often encouraged by incompetent regulations and policy that has a long history.

As we crave more government oversight we should ask who will oversee the government that has demonstrated such spectacular failure.

We mortals pride ourselves as rational beings, but we act emotionally. We get attached to previous positions, and will discount or filter evidence rather than change our minds. We read the news for confirmation rather than information.  We are so inundated with information that we rely on emotional instincts to make quick decisions.

Our first instincts are emotional and we tend to then, and only then, rationalize our first decisions. I call this emotional rationalism. Marketers understand this very well.

When you add risk into our thought process we can become even more irrational. Risk is probability plus outrage or fear. Thus the chance of a 911 attack may be small but the outrage of that act may lead us to take extreme measures to prevent such an occurrence from happening again. We spend far more political capital to prevent gun deaths than deaths from swimming pools, which are far more common.

The Age of Reason did not stop wars and hatred; it just changed the institutions that expressed them. Anti-Semitism of the church simply became anti-Semitism in the halls of education and government. Hatred towards those who opposed established faith became even more bitter when it was applied to those who opposed established norms of reason.

Academic credentialism, as distinct from intellectual depth, is not immune to emotional rationalism. Academics will become attached to their theories even when they conflict with the realities of the world they attempt to explain. The world of experience will translate to the world of theory much better than the reverse. Once someone gets a theory in their head it is hard to get them to see the world objectively again.

Thus academics descended on Wall Street with sophisticated models to explain investment behavior. Long Term Capital, a hedge fund from the 1990’s was held in awe because of two PhD Nobel Prize winning economists on its board. Its first few years showed impressive results and helped it attract billions of dollars of capital. But Long Term Capital made bets on Russian bonds and went from a net worth of billions to bankrupt in a matter of a few months. In typical academic fashion the quants explained that the move on Russian bonds was a ‘25 standard deviation event’, so far outside the realm of a rational model that it could not be predicted.

A 25 standard deviation event is a way of saying the odds of this were as remote as getting hit by a meteor while playing the back nine at Augusta National. It is another way of saying that no rational person could be expected to have foreseen this. This is what happens when theory trumps experience. Our world is filled with the outcomes of ‘25 standard deviation events’.

But these same theories brought down a bigger house of cards only ten years later. Debt pools were assembled that were so complicated that when the underlying assets such as a mass of very crappy mortgages collapsed, the credit markets froze because nobody could figure out what any of these pools were worth. The reason these toxic assets are so hard to clean up is because our brightest accounting and financial minds cannot figure out what they are worth.

We still fail to understand the principles of probability and how our emotions filter and distort our reality. As Nassim Taleb notes in his book by the same name we are “fooled by randomness.”

We can discern the various probabilities of a specific outcome of a roll of a pair of dice, because the universe of outcomes is clearly limited and knowable. The same is true of guessing the chance of any combination of cards from one or multiple decks. Cards and dice are a world on known unknowns.

But making bets on the outcomes in the world of global finance is something wholly different. There is no limit to the combinations and outcome of hundreds of national policies, billions of investors, with millions of financial products, subject to the fears and exuberance brought by wars, inflation, and old fashion human greed. This is the world of infinite possibilities, the world of unknown unknowns. This is a world better served by a philosophical understanding of risk embedded in a world of experience than a delusional faith in theoretical models proposed by credentialed academics.

Yet we have still failed to understand this fundamental reason for our recent credit collapse and we are making the very same mistakes, only this time in the government sector. We still swoon for the sound of intelligence over experience.

A car ‘czar’ brags that he has no experience in the automobile business, but “business is business”. Steve Jobs at Apple was replaced by an executive from the soft drink business; Jobs was brought back- you can now Google the story on your iPhone.

In a subject as massive and as filled with unknown unknowns as global climates we are making bets with familiar delusional certainty and even declaring that the “debate is over”. I may not know which end of the test tube the cork goes into, but I would feel a bit better about reordering our entire economy and social structure based on a fifty year climate prediction if we could predict the weather next week.

Many blame the financial collapse on greed and capitalism, but these flaws have been with us forever.  As Thomas Sowell noted, blaming the financial collapse on greed is like blaming a plane crash on gravity; it is true but not a very useful description.

With some months to now reflect and study the causes of the credit collapse, we cannot hide the central role the government played in the disaster. Had Fannie Mae not guaranteed the crappy mortgages they could not have been assembled into vehicles earning AAA ratings and become acceptable to global investors on such a grand scale. We have been fleeced at the gaming table but the casino owners , the dealers, and the pit boss were all government bureaucrats. They just reserved the high roller tables for Wall Street.

As we watch and hope the government will reform the excess of Wall Street, we should be more concerned who will reform the excesses of government. We should ask how they plan to solve a problem by repeating the very same mistakes that caused it.