Gideon Rose, editor of Foreign Affairs, has written a book focusing on the conclusion and post military developments of America’s wars  from WWI though the current conflicts in Iraq and Afghanistan.  If How Wars End has a common theme is the need to carefully consider the consequences and costs of victory as a part of the planning of the overall campaign.

Few lenses provide the clarity of hindsight.  The failure of peace after the military victory of WWI was recognized and not repeated after WWII. But new mistakes cause the victories of WWII to degenerate into the Cold War.

The lessons of total victory did not apply to the limited actions, defined by our limited commitment, such as Korea and Vietnam.  But George H. Bush and his military advisors were strongly motivated not to repeat the many mistakes of Viet Nam.  Desert Storm was strong, decisive, devoid of political tampering and most of all, limited.  But it left a tyrant in power and did not protect us from a 9/11 from the region.

The emotions and fear of 9/11 dominated a largely unchecked effort  to eradicate all terrorist threats, whether directly responsible for 9/11 or not. But the strategic failure to plan or to competently execute a plan after Saddam’s fall left us with new lessons.

But other lessons are not in the book.  Americans are an impatient people. In war a deadline can be a disadvantage. We like our wars fast and cheap. A committed enemy can readily lose the war and win by making the peace or aftermath intolerable.  Once the troops come home we turn our television station to another channel and tend to neglect the aftermath of our actions.

Peace must take into account changing political dynamics.  Both Wilson’s and Nixon’s plans at the bargaining table were frustrated by changing political control at home.  A successful peace can require a consensus that was worn thin by the war.

When we cure one disease, we succeed in living longer and thus are able to contact another disease.  We do learn the lessons from our previous conflicts, both successes and failure. But this just creates the opportunities to confront new problems.

We have not inflicted total defeat and surrender since WWII. We now face an enemy that considers survival a victory.  We fight enemies unaligned with a nation state, and must adapt to armies without borders.

The lesson from our past conflicts was that victory was only the first step.  Now we have to find a whole new definition for what victory really is.

On the road listening to a bit of talk radio, I heard some lady substituting for Sean Hannity, leading the show with complaints about how much vacation time Obama has taken compared to other presidents.

I realize it is a challenge to fill so many hours of air time with interesting and pertinent news and perspectives, but is this at all important?  I even realize that Michelle’s staff is much bigger than Laura Bush’s, and that this president has take many more vacations and much more expensive vacations, and I even agree that in a time of high unemployment that this is less than stellar leadership.

But would any conservative care about his vacations if he supported sounder economic policies, and a less intrusive government?

We spoke of the ‘Bush derangement syndrome’ when criticism of the previous president crossed the line from legitimate criticism to cynical and vicious character assassination.  We see some of this again with a level of anger directed at Sarah Palin that far surpasses normally acceptable political discourse.  Much of the content of attacks on Obama is falling into similar unproductive rhetoric.

Eleanor Roosevelt noted, “Great minds discuss ideas; average minds discuss events; small minds discuss people.”

Let’s stay focused on ideas.  There are enough bad ideas out there that need correcting that we do not need to distract or shrink our thinking.

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.

In a world of uncertainty it is more important to know the odds than to know the facts.

In a business bet, if you have a thirty percent chance of winning one hundred dollars or a seventy percent chance of winning forty dollars (with return of principal guaranteed) the better bet is the 30% chance.  (30% of $100= $30 vs 70% of $40= $28.) What is pertinent is not just the chance of winning but the pay off or, conversely, the risk.

But risk is rarely known so precisely. In real life decisions risk is a combination of probability plus outrage. This is why we are more concerned with the threat of terrorism than swimming pools, which kill more people.

We all know that there is a chance we will die before our time. That is a known unknown. We can assess what the potential costs of that known unknown is with payroll and investment information, and make a prudent investment in life insurance.

In the financial world (as well as the world of politics, public policy, and foreign affairs) we are faced with unknown unknowns; not only are risks present that we are unaware of but the potential outcome is often unmeasurable.  This uncertainty is multiplied by the global extension of our financial institutions, where matters such as the likelihood of repayment of bond principle and interest is subject to cultural differences, religious tribalism, diplomatic shifts, political frailty, and economic amateurism.

Small banks in Iceland and German villages took large positions in the American mortgage market with poor understanding of the risks, the interconnectedness of financial assets and institutions and with a false sense of security in the professionalism of our financial leaders.  They did not know what they did not know.

Our financial professionals, rational and highly educated, were not immune to this uncertainty and were more blinded than enlightened by their intellect. With complicated mathematical models they deluded themselves with a false sense of certainty; they thought they had considered all the risk factors, but one never knows ALL of the risk factors.  The one risk factor they did miss was a decline in real estate and home prices; it seems obvious only in retrospect. Both regulators and law makers grossly misjudged the risk of the vast interconnectedness of our financial institutions.  What we thought was a market rich with competitors, was really just a giant company with redundant and interconnected divisions.

We valued math when we needed history. We replaced a philosophical understanding of risk with a delusional mathematical certainty.  This emboldened excessive risk taking and leverage, and convinced the financial titans that they had discovered financial alchemy.  The huge profits they enjoyed for a while only convinced them of their own genius, and encouraged them to take even bigger risks.  They thought they could ignore the risks of poor underlying junk assets and convert them into investment grade securities with mortgage backed securities, credit default swaps, and other derivative securities. They thought they could turn tin into gold.

But as John Galbraith noted, “genius is before the fall.” Every bubble in history has been built on delusional certainty, excessive leverage, and the mistaken association of money with intelligence.

This bubble would have been contained were it not for the political and tax policy that inflated the housing market, going back for several decades.  The mortgage tax deduction gives preference to housing over other investments. When Reagan eliminated deductions for consumer interest, it made housing interest even more valuable and equity lines of credit were tapped for boats and vacations.

Franklin Roosevelt opposed the FDIC (Federal deposit Insurance Corporation) because it would penalize prudent banks and encourage excess risk taking.  He capitulated in a compromise in 1934 and it grew from the original $2,500 to the $250,000 we have today. The implied government guarantees of Fannie Mae and Freddie Mac was  a moral hazard on steroids compared to the FDIC.

The Community Reinvestment Act, championed by Jimmy Carter, Bill Clinton and George W. Bush (as ‘Compassionate Conservatism’) put these moral hazards to political use and eschewed prudent financial policy to gain political favor. Wall Street thought they could make risk disappear with complex mathematical models; Washington thought they could make risk disappear by pretending they did not exist.

The absurd mark to market rules enforced on the banking system by the government regulators only served to accentuate extremes in market behavior, and could not have been imposed at a worse possible time.

Economics is not a science and the intellectuals and elites who pretend it is keep wreaking havoc.  Though not a science, there are principles that have stood for centuries and are ignored at our own risk.  There is no better teacher of these principles than to watch the results when they are ignored or violated.

Nancy Pelosi

Nancy Pelosi states that the new unemployment benefits package should be passed because unemployment benefits stimulate the economy and thus create jobs.  They are in fact, according to her, one of the best job creators because the unemployment benefits are so desperately needed that they will spend the money immediately thus stimulating the economy and generating jobs. The only thing more disturbing than her own belief in this ludicrous comment is that she is only two heartbeats away from being the president.

Arthur Laffer is one of the most insightful and successful economists because  his policies actually having been shown to work.  True understanding of complex systems can be demonstrated in the power to predict.  His predictions and rationales have demonstrated that understanding of wealth creation and economic behavior.  Laffer wrote a retort to Pelosi’s Alice in Wonderland statement, without mentioning her name, likely to avoid embarrassing her with her own words, in a recent Wall Street Journal article “Unemployment Benefits Aren’t Stimulus”, explaining how paying unemployment benefits does not create jobs.

Not only is the payment itself an incentive not to work, Laffer explains, but the dollar spent by the unemployed must be paid by another taxpayer so the net incentive must total zero, not including the huge costs the government incurs to execute the transfer that someone else must also pay for.  We have strayed so far from common sense that it is now considered profound just to state the obvious.

Arthur Laffer

George W. Bush was deemed an idiot by his strongest critics for his lack of eloquence at the microphone.  I am far more concerned with the statements from leaders that show a complete lack of understanding of the way the world works, a contempt for common sense, or a blind rejection of empirical evidence. Eloquence makes none of this more tolerable; it only makes it more disturbing.

YouTube holds political leaders more accountable that all the journalists in the field.  “We have to pass this bill so we can see what’s in it, and  “I have to listen to the experts so I will know whose ass to kick,”  become highly viewed video symbols of our leaders’ incompetence.

I was listening to a lady on talk radio explain why it was a good idea to spend stimulus money to help the owners of convenience stores puts racks of fresh vegetables next to the Slim Jims and Yahoo chocolate drinks.  It was amazing to listen to her quote the reams of data used to substantiate why this was both useful and necessary. In an age of unlimited information we apparently do not have to be restricted by common sense; we can substantiate anything.

I question whether such lunacy would have found a media outlet in the days before infinite channels. Perhaps the biggest benefit of less media was being forced to be more judicious in bringing viewpoints to the public airways, but the cost would be the risk that we may be spared the statements that show the true failings of our top leaders.

Dorothy reveals the Wizard

We may find comfort in illusions but if Dorothy and her posse did not pull back the curtains and expose the wizard they never would have been able to return to Kansas.