What Would President Jack Welch do about Bailing Out States?

Yesterday we talked about the importance of focusing on revenue growth and expense management in difficult economic times. We also contrasted what would be the fundamental difference in approach between Sam Walton and President Obama in addressing the problem of our national debt and deficits.

Today let's look at capital allocation and how it's best managed in economically challenging times. We'll review these choices in the context of America's dual or federalist system of government. Specifically, we'll discuss the national government's responsibility to provide funding for the various individual states (localities, too) in relation to their debts and deficits.

To bring clarity to this capital allocation issue, we'll compare what I believe would be the very different approaches of Jack Welch and President Obama.

No less than America's unique federalist system of government is at stake. Thus, the substantive issue of capital allocation between the central government and several states must be confronted directly. In other words, calling a bailout a jobs act won't make it a jobs act. Instead it's a wrongheaded and even dangerous thing to do, and inconsistent with our American way.

When comparing capital allocation decision making within a business to that of government, the obvious question to ask is why choose Welch over Walton? Why not simply stick with Walton?

The answer is simply because of the different government and business interests of Wal-Mart and GE. Yesterday's theme of revenue growth and expense management contrasts meaningfully with today's topic of capital allocation in a dual system of governance.

Today we'll deal with federalism, and the relationship between a central government and its satellite sovereign states. GE's several disparate businesses and our nation's fifty separate states make the comparison with GE an appropriate one.

Simply stated, the type of entity Jack Welch led was dual federalism in action. On the other hand, Sam Walton led an enormously successful but structurally simple single focused retail business.

Both Walton and Welch were great CEOs and great leaders as well, but one focused on a single retail business while the other oversaw several distinct businesses within one big corporate umbrella. Sam Walton focused his career on growing one business, the retail business of Wal-Mart. In contrast, Jack Welch was responsible for a portfolio of businesses within GE which included jet engines, NBC, commercial finance, medical systems, plastics, appliances and others.

Each separate state is an important piece of our unique American system of federalism. And one national government combines with those fifty sovereigns to make up our dual system of government.

Let's now review how a President Welch would handle these matters in comparison with President Obama's approach to the latest stimulus-er-jobs program. Stated another way, would Welch propose bailing out poor performing states with borrowed stimulus funds, as Obama has?

My unequivocal opinion is that the approaches taken by Obama and Welch would be as different as night and day. Welch's would make sense.

A Blue-State Bailout in Disguise says this about President Obama's latest $447 billion stimulus-er-jobs-bailout proposal:

"Last Thursday, the president urged Congress to pony up roughly $200 billion in taxpayer money to "provide more jobs for teachers [and] more jobs for construction workers" and more money to carry out other state and local activities. He urges Congress to spend this money even after handing out hundreds of billions of dollars for similar purposes as part of the 2009 stimulus package, as well as a score and more billion dollars again in 2010.

These vast contributions to the coffers of state and local governments, though pitched as a jobs bill, are in reality the latest in a series of bailouts for debt-ridden state and local governments. They are of special benefit to states in the blue regions of the country where the president's most fervent supporters reside.

In many blue states, legislators have copied the politicians in Washington by running up state debts to extraordinary levels. Nationwide, state debt is running around $3 trillion. If unfunded pension liabilities are factored in, estimated liabilities leap forward by another $1 trillion to $3 trillion, depending on the optimism of the assumptions made."

Jack Welch required that GE's various businesses be strong competitors and that each was a #1 or #2 performer in its sphere of competition. If an individual business didn't perform at that high level, its leadership and employees were challenged to "fix it" or know that Welch would "sell it" and remove it from the GE portfolio.

Totally unlike President Obama, GE didn't reward poor performers by bailouts or supplying them with additional investment monies. Basic economics teaches that investment funds are scarce, and choices have to be made about how to use them. As a matter of common sense, those scarce funds should be allocated, if at all, only to that piece of a business or federal structure where the money will be best spent or invested.

Investments should reward those doing well instead of those doing poorly. Said another way, we should not throw good money after bad but invest money only where we will realize appropriate rates of return.

That's only common sense portfolio management at work, and that's exactly what Jack would do. It's also what any other good stewards of the public trust would do.

That's the way our American brand of federalism has always worked. Until President Obama came along, this is.

The above referenced article candidly labels Obama's bailout proposal an existential threat to our remarkably unique and successful federalist system:

"But federal fiscal bailouts put our federal system at risk. In essence, the national government is acting as if states are too big to fail. In the next financial crisis, the federal government may decide that states need to be treated like General Motors or, at least, be given ever bigger handouts of the kind the Obama administration seems committed to making.

But if the federal government is going to tacitly assume responsibility for state debts, then those $3 trillion in sovereign state debt must be added to the $14 trillion national debt that has already caused grave concern, pushing the current U.S. debt into the danger zone. Even if pension liabilities are ignored, the combined federal-state-local debt runs in excess of 120% of GDP.

The costs go beyond dollars and cents. The more often the federal government bails out the states, the more Washington bureaucrats will insist on regulating state and local affairs. At some point the United States will see the end of state fiscal sovereignty and the demise our federal system of government."

Suffice it to say that Texas, North Dakota or other well functioning states shouldn't be forced to send money to Michigan, California or Illinois via Washington, D.C.

But if for some inexplicable reason they are so forced, there should at least be a recognized legal debt incurred which needs to be repaid on time and with interest.

Calling the latest government giveaway proposal the American Jobs Act and then making it a gift to the poor performing states and localities is disingenuous at best. And things like this would, if left unchecked, lead to the demise of our federalist system and American way of life.

Jack wouldn't do it that way, nor should we.

Thanks. Bob.

An American Hero

Today the Medal of Honor will be awarded to a true American hero, Marine Cpl. Dakota Meyer.

Mr. Meyer refers to this award as being recognized for what happened on the worst day of his life.

The Afghan Rescue Mission Behind Today's Medal of Honor is worth reading in its entirety.

In part it reads as follows: "As for Dakota Meyer, his Medal of Honor citation speaks for itself. Ignoring withering fire, he had carried 12 wounded Afghans to safety and covered the withdrawal of 24 other Americans and Afghans. He had killed at least eight enemy fighters. He would not be refused in battle.

Men do not suddenly acquire unshakable determination to face almost certain death. At the age of four, young Dakota wanted to drive the old tractor on the family farm in Kentucky. His father told him he had to be old enough to turn the hand crank. An hour later, the tractor roared to life—Dakota had repeatedly jumped from the tractor hood onto the crank until it turned over. When he was five, he solemnly assured his grandmother that he would guard her against robbers. A rugged athlete in high school, he also tutored autistic students. He volunteered for Afghanistan as his second combat tour and risked death to rescue Afghans as well as Americans.

Cpl. Meyer set the example, but he could not have succeeded alone. Others of like mind joined him. Their shared tenacity wasn't rooted solely in fighting for their fellow squad members. In fact, the core group at the end of the fight didn't know each other that well. Capt. Swenson had only a passing acquaintance with Cpl. Meyer, while Lt. Fabayo and Sgt. Rodriquez-Chavez lived at a different base.

Today's ceremony should be a source of pride for all Americans, because Ganjigal wasn't about one warrior. Inside that village on the Pakistan border, the defining values of America—individual initiative, comradeship, valor and determination to prevail despite any odds—were on display."

This bravery makes me even more proud to be called an American.

Thanks. Bob.

What Would President Sam Walton Do About the National Deficits and Debt?

Yesterday we discussed our nation's seemingly insurmountable debt problem. We also touched briefly on the long and difficult road ahead with respect to reaching a successful resolution to our deficits and debt issues.

Today I want to expand on the analogy concerning the similar problems faced by companies and governments when strong economic growth is followed by weak or stagnant conditions.

To reiterate, a period of strong growth often obscures existing financial problems. At such times, the country's or company's condition may appear to be better than it truly is. On the other hand, periods of stagnation or recession necessitate a much different leadership or management approach.

When the revenues of countries or companies are growing strongly, we're apparently doing well. That's also when we're prone to let our guard down and make our biggest mistakes. Conversely, when things later get tough and growth is slow or non-existent, a totally different and entirely sober leadership and management approach is required.

The analogy between government and business caused me to think about the entrepreneur Sam Walton, the fabulously successful founder of Wal-Mart, and his simple and straightforward approach to managing a successful and strongly growing enterprise. As perhaps the most successful entrepreneur of the late 20th century, his views are well worth considering.

In two short sentences, here's what Sam believed the essence to be about managing growth, expenses and maintaining the overall profitability and growth trajectory of the business.

(1) If Wal-Mart was earning profits of more than 4% on its sales, it was then time to reduce prices. (2) If the company was earning less than 3% on sales, however, it was time to reduce its expenses and cost structure.

In other words, it was always time to grow and satisfy customers and the company's many other constituents. As such, profitability (defined as the cost of staying in business) between 3% and 4% of sales would enable the company to grow, invest and prosper continuously. Walton's formula for success recognized that ongoing revenue growth is essential, and that customers demand value for money paid, meaning quality goods and services accompanied by everyday low prices.

In other words, raising prices wasn't part of the formula for growth. How did it work out? Well, Wal-Mart grew from its beginning of zero in 1962 to its current annual level of sales of more than $400 billion today. It also became the world's biggest private employer with more than 2 million employees.

Let's try to apply Wal-Mart's teachings to our national government's financial situation and see what happens. In other words, what would President Walton do that President Obama isn't doing?

First, he would face facts. If we are spending $1 and borrowing 40 cents to do so, as we are, he would question whether cents 61 through 100 were benefiting the health of the enterprise. He would then make and implement spending priorities on an urgent basis. We would then spend considerably less than $1, and what we did spend would be prioritized to achieve revenue growth.

Second, he wouldn't raise tax rates (prices) but would focus on increasing revenues/taxes/sales by increasing sales volumes and selling more of the current offerings as well as selling additional products and services, too.

In contrast, President Obama wants to hire more teachers and build more government structures, and he wants to pay for these efforts by raising taxes. As I interpret things, that's pretty much the opposite of what Sam Walton (Jack Welch and many others, too) would recommend that he do.

Hiring more teachers with borrowed money will only exacerbate our spending and debt issues, as will the construction of additional public buildings. And increased revenues won't be the result of that spending.

What would add to the revenue base? Drilling for more oil and natural gas would add government revenues and concurrently reduce spending on foreign oil. It would also add jobs, income and payroll taxes.

Making more globally tradable goods by manufacturing them for export and also selling them domestically would also increase revenues, jobs and tax receipts, while reducing spending for current imports.

Getting focused on economic growth is the single biggest thing we must do, and it's about the only thing we're not focused on doing. Cutting non-value added government spending comes in second place. Third, stop building government buildings we can't afford.

'Grand Bargains' Are a Budgetary Dead End makes the point crystal clear about the silliness of trying to tax our way out of the current financial mess. Here's what it says about taxes as the solution: "If we repeal the Bush tax cuts for those families with incomes over $250,000, we get $700 billion over the next 10 years—not much of a dent in either the deficit or the debt. If we repeal the Bush tax cuts for all Americans—something that Mr. Obama says he opposes—we get an additional $3.5 trillion over the same period. Again, pretty puny in relation to nearly $100 trillion in debt and long-term entitlement obligations. Confiscating all earnings over $250,000 in any year will only yield enough to meet one year's deficit.

The confiscation idea raises in stark terms the trade-off between tax increases and economic growth. There are only two ways for the U.S. to address the debt and entitlement obligations it has already assumed—inflating the currency and increasing the rate of its economic growth.

Inflation will create even greater burdens on the growing number of retirees living on fixed incomes, so that's not acceptable. Yet repealing the Bush tax cuts and placing even greater burdens on American taxpayers as part of future "grand bargains" will stifle the necessary economic growth. Even the 10-to-one spending cut to tax increase ratio famously rejected by Republican presidential candidates in a recent debate will place an unsupportable burden on American taxpayers."

Simply put, implementing higher tax rates won't help at all. What will bring higher tax revenues is economic growth and more competitive pricing and costing for tradable goods and services worldwide, pure and simple.

Accordingly, our only realistic way out is through a Sam Walton type approach to growth. Let me explain.

If our national debt plus unfunded entitlement obligations will amount to some $100 trillion by 2021, and it will, what would it take to service that debt over forty years, or by 2061?

Simply put, it would cost $7.5 trillion annually, or three times more than the total government annual revenues of $2.4 trillion today. {$100 trillion at 5% interest equals $5 trillion annual interest expense, combined with the $100 trillion in debt being amortized over forty years at $2.5 trillion annually, equals $7.5 trillion per year.} So that won't work.

Here's some more math. Our economy's GDP presently is approximately $15 trillion, and our present total national debt is roughly the same amount. {We'll set aside for now the other $85 trillion in government debt obligations, including entitlements, housing related mortgage guarantees and all future projected debt additions, even though these dwarf by several times the publicly acknowledged liabilities of $15 trillion.}

If we borrowed $15 trillion for ten years at a stated interest rate of 5%, our annual interest bill would be $750 billion. Our principal amortization in a sinking fund would be $1.5 trillion annually.

Thus, in year one we would have to pay or set aside a total of $2.25 trillion to service the loan. We collect about $2.4 trillion today. That leaves $150 billion to spend, in comparison to the $4 trillion we're spending today.

In other words, we'd have to virtually eliminate all government spending to pay off the $15 trillion loan over ten years.

Thus, we need to find a way to grow our tax base without increasing tax rates while reducing all non-value added spending at the same time. A walk and chew gum approach, to be sure.

{To repeat, since we will only collect ~$2.4 trillion in taxes, the $2.25 trillion for debt service leaves $150 billion to operate the government, inclusive of social security, medicare and all other government related spending. In other words, we'd go from spending $4 trillion to spending $150 billion, or a more than 95% reduction. Of course, that's not possible.}

The essential point to grasp from the foregoing is that each day we continue to make the already far too onerous debt situation even worse than the day before. As informed citizens, our basic concern must be that, albeit perhaps well intentioned, almost all of the politicians apparently have no clue that what they are doing will hasten our nation's ruination, let alone taking steps to address the dilemma in a straightforward and truth telling way.

Sam Walton wouldn't have gotten us into this mess, but had he inherited it, he would have known what to do to get us out.

He would have emphasized economic growth through volume increases, while working tirelessly to reduce non-value added government spending at the same time.

He would not have raised tax rates, but he would have done everything possible to raise tax revenues (through more drilling, more manufacturing, more exports and more jobs).

More importantly, he would have made every effort to sell the idea that we're all in this together instead of pitting interest group against interest group. He wouldn't have practiced class or generational warfare. Not for a second.

Most important of all, he would have told us the pure and unadulterated truth about the magnitude of the problem, the steps necessary to solve it and the status of those remedial actions on an ongoing basis.

Then we the people all together would have set about fixing the debt and deficits problem, once and for all.

See how simple this could be with a little leadership and truth telling? Not easy, that's for sure, but surely simple.

And despite the difficulty of the task, we'd all feel really good about what we were doing for future Americans, too.

Thanks. Bob.

It's The Debt, Stupid!

Bill Clinton adopted the slogan "It's the economy, stupid!" to keep his supporters focused on the primary issue in the 1992 presidential campaign. He won.

Today the appropriate focus would be on the nation's growing and unsustainable debt levels. Unfortunately, we do a lousy job of understanding what is happening and how this will affect us in the future. In fact, the government not only doesn't talk about the situation honestly or openly, but it really doesn't even account for debt properly.

Now that Greece is essentially broke, the world's financial watchdog, the International Monetary Fund (IMF), finally has admitted that it needs a better way to monitor and project the debt levels of individual countries, including ours.

IMF Says It Needs to Improve Debt Analysis is a just released report that says much about how the whole world failed to heed the warning signs and predict the Greek financial crisis. In the report, the international financial watchdog admits that it has no realistic way to monitor debt levels, including those of the U.S. and other developed economies.

Here's part of what the article says:

"Prior to the 2008 global economic crisis, government spending by rich countries was fueled by a reliance on strong growth. The financial meltdown and subsequent recession brought the debt levels into sharp focus as markets began questioning the ability of governments to pay off their huge debts. Those debt-overhangs only grew larger as advanced economies added to their burdens with massive stimulus programs. As growth projections have been repeatedly revised downward in recent months, tackling looming debt levels is increasingly urgent.

Greece is a perfect example for the IMF’s poor record on the issue.

Athens is teetering on the edge of a default with negotiations for IMF and European Union loans to cover Greece’s upcoming bills in serious jeopardy. But the IMF predicted in a 2007 economic review of Greece that its debt would only hit 98% of GDP in a worst-case scenario. Debt actually reached 142% in 2010 and some economists say it could peak around 180%.

“Before the crisis, fund analysis did not always pay sufficient attention to public debt sustainability in market access countries, particularly in advanced economies,” the fund said.

Many advanced economies would already trigger deeper IMF analysis of their balance sheets if the trigger-level is set at 60%, including the U.S. With expenditures continuing to outpace revenues, the IMF projects Washington’s debt-to-GDP ratio to rise from 99.5% this year to 112% within five years.

IMF economists estimate the maximum range that debt can be sustained without crippling the economy is between 60% and 80% of GDP.

Although some of the IMF’s board members were reticent, fund staff also said coverage of countries’ fiscal balance and public debt should be as broad as possible, taking into account liabilities such as entitlement programs."

That's a mouthful for the Greeks to swallow, for sure. But what about us? I'd say two mouthfuls at least.

In other words, we are in bad shape with respect to debt, too. Despite this simple fact, President Obama and team now want to spend another $447 billion on a new stimulus-er-jobs-program.

He also tells us not to worry, and that the new stimulus-er-jobs-program will be fully paid for by additional tax receipts and government spending reductions. Here's what I say.

How stupid, gullible or naive does he think we are? That feel-good-fully-paid-for-line is not only not true. It borders on lying.

Here's the truth as I see it.

Each time the U.S. government spends a dollar, it has previously collected only sixty cents thereof from the U.S. taxpayers. To spend the dollar, we borrow the other forty cents, and that increases the national debt, pure and simple.

Stated another way, we expect to collect $2.4 trillion in taxes this year and plan to spend a total of $4 trillion. As this happens, $1.6 trillion in additional debt will result.

Said yet differently, tax receipts will be only 15% of our nation's GDP and spending will be 25% this year.

But however we choose to say it, the answer is the same--60% revenues and 40% in new debt is the only way to get us to a dollar's worth of spending.

The debt hole is getting deeper and deeper each day, and the spending continues uninterrupted while politicians, led by the president, engage in more happy talk.

This approach will lead us down the road to certain catastrophe. The only question will then be when we get there.

To know for sure where we're headed, unless we change course, we must first know where we've been, how we got here and why (unless we change course) we're headed down the clear path to catastrophe.

To be fair, our only collecting 15% of our GDP in taxes is relatively recent. The historical norm has been more like 18%. But we're not growing like we used to either and aren't likely to anytime soon. Too much debt and too little private sector growth.

And federal government spending of 25% is relatively recent as well. The norm has been more like 20%. Too little private sector growth, too much spending and too little public sector restraint.

Thus, while historically we've incurred annual operating deficits of ~2% (20-18=2) of GDP, that's not where we are today, nor is it where we're currently headed. It's both too bad and seemingly too true, too.

Why are receipts only 15% of GDP today, and what about future years? For an answer to that, let's try an analogy. We'll compare strongly revenue growing companies to stagnant revenue growers.

Companies that experience strong growth have a much better chance of having receipts exceed spending than companies that experience little or no revenue growth. Volume works wonders, whether up or down.

The term operating leverage means simply that companies have fixed costs (buildings, equipment, management, utilities and so forth) whose costs don't change as volumes fluctuate. Accordingly, the effect of transaction related costs (inventory and labor for examples) works to the profitable advantage of companies as volume grows.

On the other hand, these same fixed costs remain the same when volume decreases. Thus, operating leverage is a strong positive when companies are growing and an equally strong negative if volumes stagnate or decline. We can call this negative effect reverse operating leverage.

Operating leverage pretty much works that way with governments, too. In fact, the leverage impact of volume or growth is even more pronounced with government than with companies.

That's because tax receipts are derived principally from personal income taxes and payroll taxes such as social security and medicare. When the economy shrinks or doesn't grow at its historical rate, tax receipts decline as personal income declines. That's how we went from 18% to 15%.

But at the same time, when payrolls and personal income decrease, unemployment, food stamps and other government provided benefits increase. That, combined with the fixed nature of entitlement spending for social security and medicare/medicaid expenditures, has caused spending to go from 20% to 25% of GDP.

Where will this lead us? Well, our national debt was less than $1 trillion in 1981, less than $4 trillion in 1991, and less than $6 trillion in 2001. It now stands close to $15 trillion.

The current trajectory would place our national debt at more than $30 trillion within less than another ten years, or well before 2021.

Suffice it to say that the fiscal path we're following is not sustainable. As a result, debt now represents our nation's single biggest problem and will for years to come.

We need to get this out in the open for all to see clearly. Only then can we begin to understand the genuine and perilous nature of our indebtedness and lack of private sector economic growth, present and projected.

We'll keep talking about this as we go along. That's for sure.

Thanks. Bob.

Fewer Entitlements or More Taxes?

We the American people, oldsters as well as youngsters, have a choice to make about the future structure and financing of government entitlement programs such as medicare, medicaid and social security. Public education, too.

Will we choose to continue these benefits provided by the New Deal and Great Society programs and agree to finally fund them fully? If so, it will necessitate higher taxes for not just the 2% of the top earners but for the 40%+ of the population in the middle class as well.

Middle class is hereby defined as those 40% of the taxpayers earning between $50,000 and $140,000, the normal definition, as well as those above that $140,000 level but not included by the Democrats as part of the targeted group of $250,000 earners and higher, or the top 2% of earners.

In other words, tax increases for all earning more than $50,000 annually will be required to actually "fix" the problem of entitlement underfunding. And if we really want to solve the problem while not changing the benefits, the necessary tax increases will be big ones. The "rich" simply don't have the numbers to fix the problem all by themselves. The solution of big problems requires the participation of big numbers of people.

Or will we choose to reduce or revise entitlements by rejecting or at least minimizing higher taxes while adopting changes to the programs such as raising the eligibility age for benefits, means testing recipients or somehow embracing market based reforms in lieu of the current one-size-fits-all welfare scenario.

Whatever we choose to do, it will be the end of the farcical notion that we are and all along have been "earning" these entitlement benefits with our taxes or "contributions." We will thereby acknowledge that there is no tooth fairy or some kind of magic insurance or money stashed somewhere within the government vault. There is no money in the vault.

Johnson and Roosevelt Legacies at Stake in Fiscal Fight discusses the political implications of this until recently unexpected but now upcoming donnybrook between the Remocrats and Depublicans. For a long time, it seemed like we would never confront this enormous financial problem.

Now we're apparently being forced to do so. Of course, the politicians may manage to duck it again this time, or at least not fully address it. If so, that would be too bad for all of us.

It's long past time to get serious about the future makeup of America and the role of government relative to our individual rights and responsibilities. Virtually everybody realizes that our ongoing fiscal deficits and accumulated debt issues must be dealt with sometime soon.

As a catalyst, President Obama's proposed $447 billion American Jobs Act may well bring these entitlement issues to the forefront. If we continue to elect not to deal with these financial problems, we're being extremely unfair to future generations of Americans.

After almost eighty years of the New Deal and sixty years after the adoption of the Great Society programs, it's time to vote on fully paying for our promises or revising those promises to what we are willing to provide financially. I'm anxious to see what we do, and which choices we make.

But most importantly, I hope we choose to do something meaningful and of a lasting nature. Then we can move on to the many other issues which urgently need addressing.

Thanks. Bob.

The Oldster's Debt Dilemma

Debt Hobbles Older Americans deals with the worsening debt picture of Americans in their 60s relative to earlier generations of the same age group. A few tidbits from the article worth mentioning are related to housing:
"All kinds of debt held by this age group have risen, but the big problem is mortgages. Thirty-nine percent of households with heads aged 60 through 64 had primary mortgages in 2010 and 20% had secondary mortgages, including home-equity lines, according to research group Strategic Business Insights' MacroMonitor. That was up from just 22% and 12%, respectively, in 1994."
It goes on, "The housing crash has made things worse. A few years ago, homeowners in their 60s with big mortgages could sell their homes for a profit and buy smaller places or rent. But the drop in housing values means that many homeowners have little equity, and some now owe more than their houses are worth."
Later the article deals with causation, "The combination of easy credit, low interest rates and a consumption-oriented culture helped fuel a spending binge for Americans until the financial crisis. People with problems aren't just those who took subprime loans or spent foolishly on lavish lifestyles. They are people from all backgrounds, including some with six-figure incomes."
I recommend that you consider taking the time to read and reflect on what the relatively brief article says about our American consumption-oriented culture, including the paucity of savings available for the retirement needs of older Americans.

My take on this unfortunate situation is simple and straightforward. Housing has long been viewed and even "sold" in our society, albeit incorrectly, as a one-way-can't-miss-bet. Borrowing all we could borrow to buy all the house we could buy was only the "smart" thing to do.

And when the asset/housing easy and cheap credit bubble eventually burst, as it certainly did, the oldsters were often caught with much more debt than their newly depreciated home was worth. And the problem isn't getting any easier with the passage of time.

Let's face facts. Virtually "everybody" was encouraged to "buy and own" a home asap upon reaching adulthood. The family, the friends, the government, the teachers, the banks, the builders, the realtors and all others preached the home ownership gospel.

So what happened this time to make it all end up so wrong? Sadly, despite all that was said about how great home ownership would be, the bursting of the home pricing asset bubble was nothing new when viewed in the context of history.

Financial debacles, such as the current one, are not new. They happen periodically and are predictable, even though we can never know exactly when the bubble will burst.

As an analogy, they can be likened to the 100 year flood syndrome. If a 100 year flood by definition occurs only once each century, that means it will only take place in one out of four twenty five year time periods.

Thus, like the flood, housing was a "can't miss" investment until it wasn't. Stated another way, as with the risk of precipitous housing price declines, we didn't need flood insurance for three of the four 25 year time periods during the prior 100 years.
Here are some basic facts about housing prices over time. Real home prices (adjusted for inflation) rose only a cumulative total of 27% in the 106 years ended 1996. In the subsequent 10 years ended 2006, however, they rose by 92%. At the peak real prices rose by 12% in 2005 alone.

In hindsight, that ten year 92% increase, let along the 2005 12% performance, clearly was not sustainable. Still, at the time the conventional wisdom was that home prices would always increase, so why worry about how much the mortgage debt was, since a buyer could always get his money out simply by selling the house.

That is, unless home prices went down, which of course they did, and like a rock, too. Now prices are roughly one third lower than five years ago. How much farther and how fast they will decline from here is the only remaining question. Stay tuned.
Why was the housing "flood" predictable? Here's why.

(1) Asset based inflation (homes in our example) financed with (2) cheap and readily available borrowed money (no/low money down mortgages in our example) combine with (3) current account deficits (heavy borrowing from the Chinese to buy the manufactured goods or homes) to (4) bring about a slowing economy (as developed in 2007), thereby resulting in a debt deflation scenario, which generally results in a severe financial catastrophe.

In a nutshell, this is what happened. This and many other similar examples are dealt with in the timely book "This Time Is Different" by Reinhart and Rogoff. Of course, the book's real message is that, unlike the book's title, this time really isn't different at all. In historical terms, it happens frequently and is quite predictable.
To quote the authors, "If there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom. Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are. Such large-scale debt buildups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short term and needs to be constantly refinanced. Debt-fueled booms all too often provide false affirmation of a government's policies, a financial institution's ability to make outsized profits, or a country's standard of living. Most of these booms end badly. Of course, debt instruments are crucial to all economies, ancient and modern, but balancing the risk and opportunities of debt is always a challenge, a challenge policy makers, investors, and ordinary citizens must never forget."
Accordingly, today's oldsters and near-oldsters are largely victims of circumstance. Since "everybody" knew housing was a no-lose situation, why not load up and then sell out when the time came to downsize for the golden retirement years? And that was the main idea, at least until the "flood of the century" hit.
In brief, we can summarize the debt dilemma of the oldsters compared to that of younger generations as follows: The principal difference between the debt dilemmas of old and young is simply date of birth.

In other words, the old have less and the young have more time for recovery when the periodic floods inevitably occur. Nothing at all complicated about that.
Thanks. Bob.

People have tried to reduce debt since the financial crisis, with limited success. Americans of all ages owed $11.4 trillion at the end of the second quarter, based on data from the Federal Reserve Bank of New York. That's down about 15% from 2007 but nearly double what they owed in 1999, adjusted for inflation and population.

Federalism and Ancestors

When ratified in 1788, our Constitution replaced the Articles of Confederation. Since those Articles of Confederation had only been in effect for seven years, it's helpful to review why they were repealed so soon.

In comparison, the Constitution has been in existence for more than 222 years, and represents the world's oldest written constitution in the world today. Staying power indeed, unlike the Articles of Confederation.

First, some brief background. When the Revolutionary War ended, the weak national government formed pursuant to the Articles of Confederation was essentially a legislative body. The national government had very little authority to act in domestic affairs and had neither the power to tax nor to regulate commerce among the several states.

In fact, the domestic powers of government remained with each of the states. Aptly named, the Confederation consisted of thirteen independent sovereigns that yielded little power to the central government other than with respect to international affairs.

Upon ratification by the states, the new Constitution provided for a dual system of government. A division of governmental powers occurred between the national government and the several states.

Since all powers of government were deemed to have been granted by the people, or the governed, America became a government of the people, by the people, and for the people. Nothing like it existed anywhere else in the world. Today we remain unique as a country.

The powers delegated by the people to each of the three branches of government (legislative, executive and judicial) were also specified in the document. The legislative branch was delegated the power to tax, spend and borrow, as well as to regulate commerce among the several states. (State governments also have tax, spend and borrowing powers as well, as do many other governmental entities. But that's another problem.)

Although the word federalism is not mentioned in the Constitution, a dual form of government, and what we call federalism, was in fact created by the Constitution. So far, so good.

But later this clear dual form of federalism was augmented by a benign sounding term--cooperative federalism--between the central government and the states. As applied over the last several decades, cooperative federalism has enabled the Congress to become ever more powerful in relation to the several states. (See our posting dated Wednesday, August 31 for a discussion of cooperative federalism.)

As a result, the Constitution's commerce clause has combined with cooperative federalism to enable the federal government to do just about anything it decides to do. Individual states have become very junior partners in governance. There are now some dim but hopeful signs that the pendulum of national versus state power is moving back in favor of a better balance between the central and state governments. Let's hope that continues.

Now let's talk about the various governmental entities' borrowing, taxing and spending habits. And as we do, economics has much to teach us about the future choices we will have to make as a society of the self-governed.

The fundamental question about "choice" that we citizens have to answer is the following: Will the citizens 200 years from now regard us as having been good ancestors?

In my view, that depends on what we choose to do about the financial mess we've made for ourselves. Our actions with respect to wasteful and unnecessary government spending have brought us to the brink of fiscal chaos.

Our individual, collective, immediate and ongoing attention to dealing effectively with the aforesaid mess is needed both now and for the foreseeable future, too. Our descendants deserve no less than that we do right by them, as our ancestors did for us.

Today let's lay out where we are with respect to the various governmental entities and their powers to tax, spend and borrow.

The national government, state governments, county governments, city governments, school districts (and other so-called special purpose entities such as sewer projects, stadiums and other government structures), all raise funds through their taxing powers. Unfortunately, we approve their recommendations for spending taxpayer money too casually.

In essence, none of these entities raises enough funds to pay for what it spends, or at least that's the way it seems to me. On our behalf, they seem to be willing to leave the bill behind for future taxpayers. To become good ancestors, we can't continue to allow that to happen.

One simple question helps me focus on all this ancestor stuff. Will we pay our way for what we spend, or will we spend and then send our descendants the bill instead?

Social security, as an example, was underfunded from the beginning. Contributions or taxes began in 1937 and payments to beneficiaries began in 1940. There wasn't enough money then to fund the benefits, and there isn't enough now. Same with medicare, medicaid, public employee pensions and the like.

If we don't begin either to set aside the appropriate amount of money to fund the promised benefits or reduce the future promises contained in these entitlement programs, our descendants will be stuck with the bill. That's doesn't seem very American to me.

And how about all the new government buildings, schools, stadiums and such that have been or are being constructed today and financed with borrowed money? How will we pay for them? Where will we get the money? What will we choose not to do? Or will we stick the next generation with the bill? That's not very American either.

And the above represent just a few examples. There are countless others as well.

Economists agree that taxes should be simple, broad based and fair. Let's just stay with simple today.

To my knowledge, there is nowhere we can look to see how much TOTAL public debt, inclusive of unfunded promises, we've incurred as a society and are continuing to incur.

The Republicans want a balanced budget amendment to prevent future deficits, or at least they say that's their plan. But how about the debt we already owe, or the obligations for which we're committed but aren't counting, such as the trillions in dollars of unfunded public employee pensions, social security and medicare promises. To more properly label what Republicans call "cut, cap and balance" would require that we at least add the words "fund" and "repay."

There is no way to get out of this self inflicted financial mess without doing two things. Stop spending money we don't have on government we can't afford, and start doing what we can to grow the private part of the economy. All other actions will be both ineffective and counterproductive.

Let's take a real simple example of what ongoing sustainable economic growth would mean. Most public employee pension funds are seriously underfunded, to say the least. But that's not the whole story.

These plans also typically assume that their pension portfolio's investments will realize an 8% compounded annual rate of return over the long term. Here's the simple math surrounding that 8% annual rate of return assumption.

A typical portfolio of pension plan investments would consist of a blend of 60% stocks and 40% bonds. If we assume that today bonds yield 5%, to get a blended overall investment result of 8%, stocks on average will have to return their historical return of 10% annually (10% of 60% = 6%: 5% of 40% = 2%; so 6% +2% = 8%).

Although that ~10% return for stocks has been the case for the past two hundred years, how many people are investing that way for the future? And how many believe that America's best days lie ahead in this now globalized and ultra-competitive world of today? An 8% return over time is not a no-brainer, and that's for sure.

Here's another small but telling example of needless government spending at work. How many privately financed buildings are going up in your local area compared to government financed structures? Hardly any private building where I live, and government, including schools, is winning by a knockout!.

This demonstrates to me that our "insane" priorities haven't changed. Something called a penny sales tax (where I live they call it SPLOST, aka special purpose local option sales tax) is used to build these government buildings, parks and such. While it's sold as a penny sales tax, it really costs taxpayers real money to build this stuff.

Federal income taxes, state income taxes, social security taxes, medicare/medicaid taxes, property taxes, sales taxes, gas taxes and all the rest of the taxes add up to a number that government officials aren't making easy for people to discover, let alone total. It's almost like they don't want us to know the truth. Whatever happened to simple and straightforward?

But whatever the total tax collections may be, they aren't even close to offset the money being spent and committed. This total "expenditure" at all levels includes spending on all public projects, as well as the future requirements to properly fund unfunded entitlement promises and to repay existing debt.

We made the mess, and we have an obligation to clean it up. That's the least we can do for our descendants.

Here's how simple this financing equation really is. Less economic growth = fewer jobs. Fewer jobs = less income. Less income = fewer income taxes paid. Fewer taxes paid = higher government transfer payments made. Higher government transfer payments made = less private sector economic activity, less consumer spending, fewer jobs and less income available to be taxed. And that means escalating government deficits and more government debt. And so on.

Nowhere does it say that more government construction and spending for more teachers will contribute to long term sustainable economic growth. We need to stop pretending that it works that way.

Now let's wrap it up.

Today's lesson in economics is a very simple one. Our resources are scarce, and we can't have everything we want. W e have to establish priorities and make choices.

Our politicians and governments at all levels have neglected that simple economic fact of life about scarcity and choice for far too long. And we the people have allowed them, perhaps even encouraged them, to act that way. Shame on us.

In education, will we continue to build infrastructure or use what limited money we have to improve teacher competency and pay? Will we emphasize learning and provide meaningful schooling throughout the year for those who want it, or will we keep the 180 day calendar for all in order to accommodate teachers, administrators and other workers who want the summers off?

Will we continue to spend limited tax dollars on more new public buildings, or will we use existing idle buildings instead?

How will "We the People" act now? Like irresponsible people who want it all today, or as the admired ancestors of the future?

Let's commit to work each day to make our descendants pleased with the society we leave behind, just as we have every right to be pleased with what was entrusted to us.

Thanks. Bob.

What's a Conservative?

The other day I was asked if I was a conservative. That caused me to ask myself, "What's a conservative?"

For starters, what's not a conservative? I believe that President Obama is not a conservative. He probably would call himself a progressive. He's for more central government involvement and control than I am. He also tends to rely upon public employees and unions for support and guidance. And it seems that he wants us to become more like the failed social democratic European countries. Thus, I'm definitely not a progressive. Not even close.

Is a conservative someone who believes in providing medicare and social security to those who can take care of themselves? If so, I'm definitely not a conservative either.

Or is a conservative someone who shies away from telling it like it is? Will a conservative spend money we don't have, feeding our society's strong tendency to increase deficits and public indebtedness, and all that entails? If so, I'm not in that camp.

Do conservatives support tax incentives such as mortgage interest deductions, property tax deductions, charitable deductions and the like while we continue to rack up record setting debts which our descendants will have to repay someday? If so, that's not me either.

The Myth of Conservative Purity pretty much describes the essence of what I believe. In part, it embraces the idea of both limited government and a strong central government as contained in our Constitution, at least in contrast to the government formed by the Articles of Confederation. It also argues for a problem solving, flexible approach to dealing with the issues of the day. In a word, it embraces realistic compromise complemented by a strong dose of common sense.

And the article says many other things that are worth quoting:

"The intellectual architects of the American political and economic order were also blenders and weavers. For example, John Locke, the great 17th-century theorist of individual rights and limited government, argued in "The Second Treatise of Government" that in the event a father dies and fails to provide for the care and education of his son, the state must make provision.

And in "The Wealth of Nations," Adam Smith, the father of free-market economics, maintained that the public should offer and require an education for almost all. While it would be grossly misleading to designate Locke and Smith as founders of the modern welfare state, it would be negligent to overlook their teaching that beyond securing individual rights, governments devoted to freedom had interests in the welfare of their citizens.

Today, we are urged by tea party activists, and with excellent reason, to look to the authors of "The Federalist," the authoritative expounders of the Constitution, to recover the principles of limited government. But it is instructive to recall that in their day the makers of the American Constitution were the enlargers and strengtheners of federal power.

Hamilton, Madison and Jay defended the new Constitution not only because of the many and varied limitations it imposed on the exercise of power. They also defended it because, in contrast to the Articles of Confederation, the Constitution incorporated in the national government the power to operate without the regular intervention of state governments; assigned it ultimate authority in matters requiring uniformity, including regulation of trade and naturalization; and made it supreme over the states, including in judicial matters.

On issue after issue, fidelity to the variety of conservative principles imposes not only the obligation to blend and balance but also to give due weight to settled expectations and longstanding practices. For instance, an appreciation of these crisscrossing obligations should impel conservatives to work both to improve the public schools we have and to increase competition and parental choice among an array of options.

While developing cost-cutting and market-based reforms for health care, conservatives should frankly acknowledge, as does Rep. Paul Ryan in his bold plan, the importance of maintaining a minimum social safety net. And in the Middle East and elsewhere, conservatism encourages a vigilant search for opportunities to promote liberty while counseling that our knowledge is limited, our resources scarce and our attention span poor."

Well said.

In contrast, it's somewhat sickening to watch self-described conservatives like Mitt Romney and other Depublicans and Remocrats running away from choosing between the only two alternatives concerning our most expensive entitlement programs; (1) how to properly fund medicare, medicaid and social security with additional taxes, or (2) how to radically overhaul these currently unaffordable entitlement programs.

In other words, if something can't go on forever it won't. And these programs can't go on as is for much longer. That's for sure.

But instead the Republican hopefuls play to the so-called "conservative" base and accuse Rick Perry of being a wild man when he calls social security a Ponzi scheme. But if it's not a Ponzi scheme, what is it? Sorry about that, fellow oldsters, but the truth is the truth. And whatever it is, we aren't paying for it now.

In that wild man versus play-it-safe scenario, Perry the Pinata covers part of the Perry/Romney dialogue concerning the social security program at the recent Republican presidential debate:

"Mr. Perry reaffirmed the position he laid out in his book "Fed Up!" that Social Security is essentially a Ponzi scheme, to which Mr. Romney retorted, "our nominee has to be someone who isn't committed to abolishing Social Security, but who is committed to saving Social Security."

Ok, Mitt. But how will we save it? Who will pay what? And who will receive what? And when?

The problem perceived by the Romneys of the world may be the voters' unwillingness to hear the truth. To see what the Romney campaign is saying about this, Romney Hits Perry Again on Social Security is quite revealing. The Romney supporters say that Perry's position on social security is a fatal flaw for his candidacy.

This may all be true, but I hope that's not the case. In any case, I'm not a Perry supporter, but it is refreshing to hear the truth told by our elected officials, even though it's a rarity.

Meanwhile, the above referenced "Perry the Pinata" article said this, "By deciding to embrace his previous comments on Social Security, Mr. Perry showed himself willing to gamble on authenticity and boldness. Of course, doubling-down doesn't always produce a winning hand. Moreover, Mr. Perry refused to remain above the fray, despite his status as the new front-runner."

If being an authentic and bold truth teller makes one unelectable, I guess being a conservative means being a one-eye-on-the-crowd-non-truth-teller. If that's the case, I'm absolutely not a conservative.

I wonder if there's a label for a leader who believes that we must tell the truth and choose to live within our means, while providing opportunity for one and all. If there is, that's what I'll choose to be.

And if enough voters aren't willing to follow such a truth teller, then we'll still get the government we deserve.

Thanks. Bob.

The Painful Process of Deleveraging

People, companies and governments take on excessive levels of debt in order to either spend money they don't have on things they want in the here and now, or in order to invest in projects which are intended to initiate growth. This debt assumption is called leverage.

Using leverage is always a risky process, and if economic or income growth does not result as planned, the risk assumed by borrowing can become too much to bear. When this happens, all the individual, company or country can do is delever by paying off or defaulting on the debt. Continuously reducing debt levels is known as the process of deleveraging.

In the current environment, it may be helpful to think of the deleveraging process underway as analogous to a football game consisting of four quarters. Different players in our worldwide economy are in different phases or quarters of completing the game.

Unfortunately, we have far too many players still in the beginning quarters of the game. As such, too many of us have a very long way to go before becoming healthy and "normal" again, if ever.

The Long Slog of Paring Debt summarizes the current debt level and its meaning for economic growth this way: "Add it up: U.S. bank deleveraging is in the fourth quarter, but European banks are in the first. Overall U.S. consumer deleveraging is at halftime with housing still in the first quarter. Government deleveraging has barely begun. This will hold back economic growth for a long time."

And that's why we need to study both the causes of deleveraging and its effects as well.

The article describes the end-to-end process as follows: "In finance, leverage allows the bold or the foolish to borrow to make bets today that are supposed to pay off later. But leverage magnifies losses when things go bad. Borrowing binges are followed by spells of deleveraging in which lenders, investors and consumers borrow less, save more and take fewer risks.

The U.S. went on a borrowing binge in the 2000s and is now in the deleveraging phase. To borrow a metaphor from Federal Reserve Chairman Ben Bernanke, this is creating "formidable headwinds" that are blowing against the economy's natural momentum and fiscal and monetary policies aimed at propelling it."

My view is that we have mindlessly and needlessly stumbled onto the biggest long term societal issue of our lifetime. Its successful resolution will take many years, regardless of which future course we choose.

Because what path we opt to follow will matter so much to future generations, it's imperative that we take the time to better understand the significance of what we've done to ourselves. We must avoid, albeit unintentionally, making matters worse for our descendants. In other words, let's not compound the formidable deleveraging problems we now have, the resolution of which will take many years and hard work.

In future writings, we'll try to teach ourselves how otherwise reasonable people could have acted so foolishly. As we come to a better understanding of all this, we'll know what Pogo meant when he said that "We have met the enemy and he is us."

More importantly, we'll know what advice to try to pass on to younger generations so that they don't needlessly repeat our mistakes. Sadly, for far too many of us, it's too late to do anything about it except to warn others of our folly. But that's a warning well worth giving for the sake of future Americans, even though it will be a painful admission to make for many of us.

In any event, it's a life lesson worth both learning and teaching. Accordingly, we'll take some considerable time to deal with the issue fully and thereby enhance our American "institutional" knowledge.

Thanks. Bob.

Tea Party and Unions

In case you missed it, here's what Teamsters leader Jimmy Hoffa had to say about the tea party while warming up the Labor Day crowd for his friend, President Obama.

I guess Hoffa believes that tea partiers don't work for a living.

In any event, Hoffa declared "war" on the tea party by the working people, thus declaring workers to be enlistees in Obama's re-election army.

See Notable & Quotable to get the full flavor of Hoffa's brief remarks.

Thanks. Bob.

Defining and Eradicating Poverty in America

What does impoverished mean?

One half of the world's population lives on less than $2 per day, while we currently define the poverty line in the U.S. as a family of four with less than $22,350 in annual income. For certain, poverty is a relative thing, and since America is a rich country, we define poverty differently than other countries. Being poor here isn't the same thing as being poor elsewhere.

That said, if we can choose, don't choose poor, even in America. Here's what old time entertainer Sophie Tucker once said, "I've been rich and I've been poor. Rich is better." Now that we've established our clear priorities, let's return to our discussion of poverty.

Notable & Quotable references a Census Bureau finding that 43 million Americans, or one of seven persons, are defined as poor. It then asks the question, "But what is poverty in America today?" The article then recounts all the things the typical American poor person is likely to own. Two color TVs, an Xbox or PlayStation, computers, microwaves and so forth are among the items commonly found. So what?

Owning two color TVs, air conditioning, microwaves and such is not a bad thing. But not helping people escape poverty by enabling their governmental dependence is a bad thing. We should stop it now.

Here's my point. It would be a good thing to incentivize learning and increase education of the poor by introducing educational vouchers. And it would be a good thing to encourage good health practices and personal responsibility by introducing appropriate incentives in the health field as well. Why do we need to pass everything through an expensive and paternalistic government "intermediary" that takes a "commission" for its efforts? If people need money, let's get it to them directly instead of passing it through a government agency or series of agencies. Save the money paid to the government intermediaries and give it to the poor instead.

Approximately 44 million people receive food stamps. Millions of the poor attend public schools, receive meals, child care assistance, after school programs and free transportation, too. Many also are eligible for housing assistance, child care and such. Why not just give them money directly, and let them decide how to spend it? My bet is that it would mostly represent money well spent.

Individual choice is always preferable to bureaucratic mandate. Besides, learning occurs through choice and experiencing the consequences of those choices. Similarly, "learned helplessness" and a corresponding lack of personal responsibility for one's actions are often the result of being in a state of government dependence. We don't help people become self-reliant and better decision makers by encouraging them to be dependent on government and its many separate inward focused bureaucracies.

LBJ's Great Society initiated welfare programs of the 1960s, albeit well intentioned, have been in existence now for approximately fifty years. They have failed and failed badly. Sadly, the law of unintended consequences has worked again. So it's time to try something new in our war on poverty. Give people the money directly, and let them choose what to do with it.

All people, including poor and rich alike, will choose to "maximize their own utility" or well-being, when given a chance to do so. We each have our own preferences as to what makes us "happy", fulfilled or otherwise satisfied. The unfettered freedom to choose and act on our own is an indispensable part of that "utility" effort. Thus, if proper incentives replaced the government's intermediary function, my strong conviction is that those we define as the poor would act more responsibly and enjoy life more fully. As a result, the general welfare of our society would prosper anew.

The harsh truth is that weak economies make poor people even poorer. They are hurt the most when times are tough. And times are tough. Still, self reliance, like learned helplessness, is very much a learned behavior.

We should help people help themselves by direct aid as opposed to using intermediaries in the form of commissioned government bureaucrats. It would cost less and we'd end up with more citizen taxpayers making good decisions on behalf of themselves and their families.

Thanks. Bob.

Chinese Graduate Students In America Are Growing As Are American Student Debts

Chinese Students Flood U.S. Grad Schools details the growing numbers of Chinese students in American graduate schools.

Our prestigious American business schools are experiencing a continuously increasing stream of applications and enrollment by Chinese and other international students as well.

My take on this is simply that business success is hugely important to the Chinese. Their ongoing strong economic performance means that many Chinese citizens now have the money to spend, and they consider education, particularly business education, as critically important to the future prosperity of their citizens and country as a whole.

Our American schools of business remain the world's finest and are the schools of choice for Chinese citizens in their quest to raise the standard of living for all Chinese citizens. Encouraging profitable, growing businesses in combination with the requisite business leadership knowledge represent the clearest path to prosperity.

One analyst attributes the Chinese student grad school growth in America to the economy in China by saying, "In China the economy is booming and both students and their parents have the money and are willing to invest it in education."

Conversely, the article points out, "Meanwhile, American students may have more difficulty finding the funds to cover tuition given the troubled economy ...." In that regard, Student Loan Debt Climbs points out how, unlike other forms of debt these past few years, student loan debt for Americans has risen by 25%.

At Stanford, Michigan and MIT, the percentages of international students to total enrollment in these highly regarded business schools are 37%, 34% and 40%, respectively.

A strong and growing domestic economy is essential to our citizens' future prosperity. So is a strong business community, which in turn depends largely on the knowledge and leadership capability of its business leaders.

The world is now and will remain a highly competitive place in which to do business, and we Americans know how to compete. We also have the best educational facilities, so now we just need to gather the personal and political will to get the job done.

Thanks. Bob.

Academic Freedom

Are college teachers paid well? It depends.

What about K-12 teachers? Are they paid well? I would say yes.

What is tenure? Tenure means essentially lifetime guaranteed employment. It's a distinguishing characteristic of the teaching field.

The article Hello, Adjunct, Meet Prof. Cozy divides university teachers into the three categories of tenured professors, non-tenured adjunct professors and graduate assistants. We'll limit our comparison to tenured and adjunct professors herein. The article points out that adjunct professors are paid much, much less than tenured professors.

Adjunct professors also on average earn as little as one half of what K-12 teachers are paid. And unlike adjunct professors, K-12 teachers after three years of teaching almost automatically are granted tenure.

So the obvious question is how is K-12 compensation determined? Well, it's not based on student or teacher performance.

Years of service or seniority is one criterion for K-12 pay. The more years worked, the greater the pay. Then if the K-12 teacher acquires a graduate degree, that teacher is paid even more. Thus, K-12 teacher pay is based on years worked and degrees earned. And most all are granted a lifetime employment guarantee after only a few years teaching.

Yet the K-12 compensation scale seems to be totally separate and apart from what college teachers earn. I have no idea why that should be the case. In fact, although K-12 teachers on average have much less education than adjunct college professors, they earn twice as much and have lifetime employment guarantees, too. This makes no sense to me.

And when I think about the appropriateness of tenure in K-12, I really question why it exists. Evidently, tenure began a couple of centuries ago to make teaching more attractive, since the pay was low compared to other jobs. Later it became a symbol of academic freedom. How and when it came into being in elementary and high schools is something to which I have no clue. Union power perhaps?

As mentioned hereinabove, at the K-12 level teacher pay goes up as more degrees are granted to the individual teacher. As a result, teachers take lots of graduate courses at universities, because that's in large part how they make more money. In fact, more than 25% of degrees at the university graduate level are granted in the field of education.

What seems all too apparent is this: Pay and pay raises don't depend upon teaching performance in the classroom. Not for K-12 teachers and not for college instruction either.

As far as faculty compensation and tenure are concerned, the student "customer" doesn't seem to count at all.

That system seems very wrong to me.

Thanks. Bob.

Public Schools and Teachers Unions ... Hard Work Lies Ahead

Learning the Hard Way was written by Joel Klein who served as head of the New York public schools from 2002 to 2010. In the editorial, Mr. Klein discusses the many problems of our public schools and reviews two recently published books on the subject. The books are "Class Warfare" by Steven Brill and "Special Interest" by Terry Moe.

"Special Interest" focuses on the power and influence of the teachers unions. My own view is that teachers unions are the biggest obstacles to a strong, effective and affordable system of public education in America, a system where parents and taxpayers are in control.

Klein summarizes the book's focus on the teachers union issue, "Mr. Moe's thesis is that the unions' ability to protect the interests of their members is virtually unmatched in American society. Their four million members are readily mobilized members, and they are, as he notes, "the nation's top contributors to federal elections." He describes the unions' influence in every political arena and their constant efforts to shore up their power. For example, the teachers unions make sure that school-board elections are scheduled when there will be low voter turnout, making it easy to control the outcome with the votes and resources the union can supply. School-board members elected with union support, in turn, are just the kind of "management" that unions like on the other side of the bargaining table when contract negotiations begin. In Mr. Moe's view, this kind of rigged process helps to embed anti-student policies, such as teacher tenure, seniority preferences and lock-step pay."

In other words, teachers unions negotiate across the bargaining table with the "management" that has been elected by the resources of that very same teachers union. The taxpayers, parents and students aren't well represented at the negotiating table at all.

Since the Democratic party is heavily influenced, if not controlled, by unions, there is little reason to expect progress in solving the problems with far too many of our public schools. More and more, teachers and other public employees aren't in agreement with the political actions of their unions, but that doesn't in any way influence the way union officials behave. For a timely and full discussion of how public employee union officials frequently don't properly represent the views of up to 50% of their members, please see Why the Labor Movement Moved Left. It's sad.

America needs a strong, affordable and vibrant educational system. If we don't have one, we won't have a well informed electorate and a world class competitive workforce. It's that important that our problems be addressed and fixed, too.

We must hurry to find a way to get better results from our system of public education. Both financially and academically as well, we can no longer afford to waste money that we don't have to achieve the lousy results we can't continue.

We can effectively remedy our widespread public schools problem by experimenting and implementing different than traditional solutions, especially when these remedies have been proven to work effectively.

But the solution isn't to be found by spending more money. We simply need to spend the available money wisely.

The traditional call by teachers unions for more money as the solution is dismissed by Mr. Klein. Here's what he says about that, "Since 1970 America has more than doubled the real dollars spent on K-12 education. We have increased the number of teachers by more than a third, created legions of nonteaching staff, and raised salaries and benefits across the board. Yet fewer than 40% of the students who graduate from high school are ready for college. At the same time, students in other countries are moving ahead of us, scoring higher--often much higher--on international tests of reading, math and science skills."

One popular definition of insanity is doing the same thing over and over and expecting a different result. This seems to fit our traditional approach to improving our public schools throughout America. If we continue to graduate classes where only 40% are ready to do college work, we won't represent an informed citizenry and a world class competitor much longer. That's a future that has to be totally unacceptable to all Americans.

The principal-agent problem is present in spades in K-12 education. The real agents, aka our current traditional school "Principals," need to start playing their proper "agent" roles. By that I mean that the current school principals and staff are in reality the servants or agents for the genuine principals--the genuine principals being the students, parents and taxpayers.

Even though hardly mainstream, isn't adopting this principal-agent designation worthwhile? If such a title change became accepted (and indeed it should), the attitude about the system of K-12 education might change overnight, and for the better.

In sum, my view is that "agent accountability" and "principal choice" are required changes if we are to end the monopolistic mindset and attitude of both administrators and teachers unions. We must act now to re-energize our entire public educational system.

Like all business minded enterprises, adopting a best practices approach is essential. If school administrators and teachers are held accountable for results, students and their parents will be positioned to make appropriate choices with respect to the schools attended.

It's as simple as that, and it's as hard as that, too. It's so hard because teachers unions are an extremely strong political force and a staunch ally of the Democratic party. Despite that, they would be no match for involved and committed students, parents and taxpayers acting as principals.

Klein's concluding paragraph sums it up for us.

"For things to really change, though, parents must become more engaged and enraged. When they are no longer willing to accept bad schools and teachers--and when the poor start insisting on choice just like the middle class and affluent do--the political dynamics will shift accordingly. The unions can't beat the parents. Meanwhile, the reformers need to enlist the support of a new generation of educators, as Mr. Brill argues, by persuading them that teaching is less a trade-union job than a true profession, deserving better compensation and greater status but also delivering a higher level of classroom competence. Last, the public must be persuaded to favor an aggressive reform agenda and support politicians who will make it happen. That's the hard work of democracy, never needed more than now."

Thanks. Bob.

Short Termism and Politicians

Here's a thought, albeit perhaps a bad one. Maybe we should elect our politicians for longer terms instead of the current Constitutionally mandated 2, 6 and 4 year terms for house members, senators and the presidency, respectively.

It at least would begin to address the problem of today's topic, time inconsistency or short termism, which has been the political way of life these past several decades.

I'm kidding, of course, but the short term oriented approach of our politicians to decision making isn't a laughing matter. Not at all. If we don't change this approach sooner rather than later, the future is definitely not bright.

Time inconsistency, aka dynamic inconsistency, is an economic term which simply means that our different selves make different choices depending upon what timeframe we're considering. What we prefer at one point in time is inconsistent with our preference at another point in time. In other words, our choices aren't consistently aligned over time periods, and we tend to pick the here and now over the better but later route. We opt for one bird in the hand versus going after two in bush, as they say.

Here are a few simple examples of time inconsistency applied.

The teenager; I know I should study today, but I really want to see that movie, watch that game or whatever else will allow me to "justifiably" avoid hitting the books.

The politician; We really need to address the debt and deficits and economic growth over the long haul, but I'll have a better chance of getting re-elected if I vote for more short term gain today, even if it means long term pain later.

The smoker or dieter; I'll stop smoking or start dieting but not until tomorrow.

With respect to today's politician, the well established game of short termism is about to be terminated due to the massive debt and deficits our nation has accumulated over the years. It's happening all over the world, and we'll not be excepted. The future is now, or at least coming real soon.

If the U.S.A. were a company, it wouldn't use the cash basis of accounting. It instead would use the accrual method. So what' s the difference and why does it matter, you say? Well, here's a sampling of the what and the why, too.

Cash accounting looks only at what we're spending today. It doesn't concern itself with what we're obligated to spend in the future. Accrual accounting looks at the total picture, short and long term alike. It includes our promises about the future.

Often, when government officials negotiate with public employee union representatives, they agree to "invisible" huge pension and health care promised benefits for future retirees while keeping the current and highly "visible" pay raises down. The taxpayer only sees the near term visible payroll impact and is assured that the budget is balanced. Which it is, using the cash method of accounting.

What the taxpayer doesn't see, however, is what long term invisible costs have been incurred in exchange for the modest pay raise. By the time those promised benefit chickens come home to roost, there is a new set of politicians and negotiators who can say they weren't involved in granting the retirement benefits. And they probably weren't, but so what? The taxpayer still has to pay.

If the cost to the taxpayer, whether in more current compensation or greater retirement benefits later, were to be the same amount either way, it would make no difference. But it's not, not even close. Accordingly, what is not seen is misleading for sure and is what makes a huge difference in the end. But let's leave the local public union alone for now and focus on the federal budget instead.

What about future budgets? Will we balance the books, matching receipts with expenditures? If so, how do we expect to achieve that result?

Well, balanced budgeting is really a simple exercise in revenue and expense matching. Let's look at the federal government. Today we're expecting a $1.6 trillion deficit for 2011, meaning we'll spend $1.6 trillion more than we receive.

Next year the deficit is projected to come down somewhat but still remain higher than $1 trillion. Even that forecast, however, is based on achieving 2012 economic growth of ~3%, an unlikely possibility. Accordingly, it's at least an even bet that next year's fiscal woes will closely resemble this year's dismal results. And 2013, too.

More importantly, what about 2021, which is ten years from now? Well, that result will depend most importantly on the cumulative actual economic growth we achieve between now and then.

Even if we hit every savings target for spending reduction that the politicians agree upon, this stunning (and unrealistic) accomplishment still won't make up for any substantial shortfall (all too realistic) in projected economic growth. Yet sadly, we aren't even focused on doing the necessary things required to enable our absolutely best chances for sustainable and strong economic growth over the next ten years.

There's simply too much here and now feel good short term politics and too little concern for the now largely invisible longer term impacts of today's decisions. We need to change the dialogue and get time consistency into the decision making picture.

Let's review only two recent examples of government mandated short termism that may have seemed like a good idea at the time but in reality harmed our financial situation: the government funded rebates of cash for clunkers (buying cars) and new home purchases (buying homes) made during a short term timeframe.

For the most part, the result was that some people bought earlier than they would have. Of course, later they didn't buy the same thing again, and very few people were induced to buy more than they would have anyway. The government, aka the taxpayer, paid the early buyers to move up their purchases through rebates, and there was no long term economic effect other than additional government spending and borrowing due to the rebates. As usual, the non-buying taxpayers got nothing for something.

That kind of popular short termism means we spend taxpayer money in the here and now and receive nothing for it other than a temporary "sugar high". This kicker quickly wears off except for the additional permanent added financial burden assumed by the taxpayers due to funding the earlier but not additional purchase. Thus, we get no more economic activity other than the new government debt which will need repaying. Stated differently, all the taxpayers subsidize those taxpayers who buy during the government giveaway programs

In contrast, genuine and sustainable economic growth results in a winning combination of more tax revenues and fewer cash outlays by government. That's due to the resulting impact of higher employment and profitability in the private sector. Payroll taxes increase, income taxes increase, corporate taxes increase, taxes on dividends and capital gains increase, sales taxes increase, personal spending increases and so on. Many, many concurrent taxpayer and citizen favorable whammies all at once.

When business grows, companies hire more people. Those hired come off the unemployment rolls. We get more government revenue and less government spending. For the foreseeable future, consumer spending will be more modest than historically due to paying back the massive debt borrowed during the boom times. To offset the weak consumer spending effect on our economy, more than ever we need to emphasize private sector productive investment and exports. We also need to get more employment in our domestic economy by inducing businesses to bring more jobs to the U.S. Why not subsidize private sector investment, hiring and even payroll for some time?

For every barrel of oil we produce domestically, that's one less barrel imported. And more manufacturing on our shores equals more jobs and payroll, too.

Let's put the focus squarely on helping regain our global competitiveness quickly. If we don't we won't realize the necessary economic growth required to get America back on track.

Thanks. Bob.

Getting Bigger By Consolidation Not Only Isn't Better ... Generally It's Worse

People responsible for leading governments, like those leading many companies, believe the exact wrong thing about size and what it means with respect to an organization's effectiveness and efficiency.

Getting bigger by combining several smaller entities all too often results in a much more costly and poorer performing organization. Thus, replacing smaller governments with a single and much larger government often brings disaster.

On the other hand, subsidiarity is a well established and entirely logical organizational principle which makes the case that decisions should be made at the lowest competent part of an organization. Subsidiarity is a foundational feature of federalism which asserts the rights of the parts over the whole. The smaller the better, assuming the competence to be present. The objective evidence strongly supports the principle of subsidiarity, counterintuitive though it may be.

Think about one specific example. If scale and size brought effectiveness and efficiency to an organization, our national government would be the most effective and efficient enterprise in our country. Of course, that's nonsense, and almost all bureaucracies are both costly and ineffective.

When Civic Mergers Don't Save Money makes the point well when it begins by saying, "Governors and lawmakers across the U.S., looking to trim the costs of local government, are prodding school districts, townships and other entities to combine into bigger jurisdictions. But a number of studies—and evidence from past consolidations—suggest such mergers rarely save money, and in many cases, they end up raising costs."


What it doesn't say is that government mergers not only don't save taxpayers money, but they usually result in poorer service, too. In sum, smaller is much better, according to the data.

Yet despite these facts, one Illinois state senator "proposed a bill that would lead to local governments being either combined or dissolved in a bid to save money." That's simply a wrong headed view of the virtue of big versus small organizations, including but not limited to government.

The above referenced article dismisses the Illinois politician's boneheaded argument by citing a fact based study of Illinois townships demonstrating the superiority of smallness:

"But a study this year for a group representing most of Illinois's 1,433 townships used state data to show that tiny townships are the state's most austere government operations. Spending by the state's townships grew 17% from 1992 to 2007, adjusted for inflation, according to the study. State expenditures over that same period grew 51%, while spending by larger municipalities grew 50%; school districts' spending rose 74%. One reason: Townships have fewer employees per person and use more part-timers, reducing salaries and benefits."

A similar situation arises as the result of corporate mergers. In fact, two thirds of corporate mergers don't add value for shareholders, and one third actually end up with the merged company performing worse than the two companies did prior to the merger.

One unimpeachable fact is that smallness brings greater focus, ownership and accountability to virtually any situation. If we know it's MOM (my own money) being spent, or close thereto, we'll be better fiduciaries than if it's OPM (other people's money). That's because OPM is easier to spend (for proof look to our Washington based elected officials), and it brings less ownership and accountability as well. It also brings less personal and hands-on knowledge to bear on the situation.

Subsidiarity works. People who know the job best are the people performing the job. If they also know the people personally who are counting on them to do their job well, they will have a greater tendency to perform up to that level of trust placed in them by their fellow citizens. Simply stated, we don't want to let our friends and neighbors down by slacking on the job.

And that's why bigger isn't always better. In fact, it hardly ever is close to the benefits of smaller.

And that principal-agent fact of life works in virtually all situations. The message; think personal and think small. Know the details and know the people involved.

The best governance decision making tree goes from (1) the individual to (2) the city to (3) the state to (4) the national level. I really wonder why we don't act that way. Things would be so much better if we did.

Thanks. Bob.

Examples of Self Government and Civil Disobedience

Two recent stories illustrate the difference between self government and totalitarian government.

Our system of self government received a grassroots boost from the direct action taken by citizens in a small Illinois township recently. Taxpayers Strike Back is a delightful example of self government and direct democracy in action.

The citizens of a small Illinois community got together to overturn a prior vote by their civic leaders in 2004. At that time the small number of citizens attending the meeting approved city officials' plans to build a $1.5 million office building for the city's nine employees.

Now the economy is weak, and taxpayer money is tight. Circumstances have changed, and the self governing taxpayers now say that clinging to 2004's view of the world is wrong and needs to replaced with a more current one.

In that regard, the leader of the local campaign's direct democracy movement had this to say about self government, "We directed an out-of-control government to listen to the people." And that's absolutely possible to do throughout America, assuming the grassroots willpower is present.

Then there's Cuba and another compelling story about "powerless" people standing up to their government.

Castro vs. the Ladies in White tells of a movement by dissident Cuban women to protest the Castro regime's attempted complete dominance of the words and actions of the Cuban people. The story exemplifies both what abuses people will endure to openly express their views, and what the oppressive government will do to stifle the expression of those views.

It's a great example of civil disobedience and its impact, as The Ladies in White are not easily intimidated by the Cuban Castro brothers.

The Ladies in White protest movement began in 2003 after a government "crackdown in which 75 independent journalists and librarians, writers and democracy advocates were rounded up and handed prison sentences of six to 28 years. The wives, mothers and sisters of some of them began a simple act of protest. On Sundays they would gather at the Havana Cathedral for Mass and afterward they would march carrying gladiolas in a silent call for the prisoners' release."

Now let's update this heartwarming example of civil disobedience, "Last Tuesday when four women dressed in black took to the steps of the capitol building in Havana chanting "freedom," a Castro bully tried to remove them. Amazingly, the large crowd watching shouted for him to leave them alone. Eventually uniformed agents carried them off. But the incident, caught on video, is evidence of a new chapter in Cuban history, and it is being written by women. How it ends may depend heavily on whether the international community supports them or simply shields its eyes from their torment."

In the Cuban situation, while the protest was outwardly directed at government officials, the real target is public opinion, sentiment and involvement. As a result, the protesting Ladies in White represent an existential threat to the Castro brothers and their communist government.

In Illinois, as members of a free society, engaged and involved citizens were simply freely using their civic powers by voting on a matter of local importance.

In the U.S., the people rule when we take action and get involved. In Cuba the people have no such power to rule. At least not yet.

We live in a great and free self governed country. Let's hope that someday soon the Ladies in White and their fellow citizens will as well.

Thanks. Bob.