Wednesday, April 28, 2010

Goldman, Greece, Lincoln, and China

The list of villains in the financial crisis of 2007-09 is long and well-known. It includes ninja (no income, no job, no assets) home buyers, unscrupulous mortgage brokers, lax government regulators, easy-money Federal Reserve Board, greedy investment bankers, irresponsible politicians, deficient economic and finance theories, and so on.

Imagine that a building is on fire. Forget, for the moment, who set or what caused the fire. The proper course of action is to put out the fire before it spreads to other buildings. What Goldman Sachs did was to pour gasoline, not water, on the blaze. That everyone else did it is no excuse. That no law explicitly forbade it is no excuse. Say what you want about grandstanding Torquemadas and Madame Defarges on the dais, what GS did and its putative explanations during Senator Levin’s Star Chamber proceeding was embarrassing.

The chickens, along with the hawks, vultures, wild turkeys, and eagles, have come home to roost on Greece and the viability of the euro experiment. Greek financial statistics have been a house of marked cards. Strikes and demonstrations reveal a population oblivious to its own misbehavior, unwilling to take the necessary belt-tightening medicine. The collapse of the Greek bond market threatens Portugal and Spain. The integrity of the eurozone and viability of the European Union are in grave danger. “You want the truth? Europeans can’t handle the truth.” The fat years are about to be replaced by lean years, regardless of any financial package extended to Greece.

Abraham Lincoln got it right. “You can fool some of the people some all the time, and all of the people some of the time, but you cannot fool all of the people all of time.” Replace “people” with “investors.”

The Greek crisis, which has driven down the value of the euro against the dollar, puts China’s plans to diversify its foreign currency reserves temporarily on hold. China’s long term solution lies in making the yuan (Chinese dollar) a trading and reserve currency. Until that day arrives, China will be known by a new acronym FBC: China can make everything faster, better, and cheaper. By 2020, perhaps sooner, I anticipate hearing a Chinese Mark Haines begin the morning financial show with the words “Live from the financial capital of the world in Shanghai.”

Sunday, April 25, 2010

Beware of Greeks Bearing Bonds

In his address to the nation from the tiny Aegean island of Kastellorizo, just off the coast of Turkey and home to a mere 500 persons, Prime Minister George Papandreou announced that Greece would ask the European Union and most likely also the International Monetary Fund for a temporary financing package of about $60 billion, enough for Greece to pay its bills for a year.

I’ve been to Greece a half-dozen times since 1967. It’s a tourist paradise. The Greeks party late into the night, enjoy late morning coffee and breakfast, and seemingly have lots of leisure time to sit around and play with beads. The wealthy keep their money offshore and tax evasion is a national sport.

But Greece is no longer a residential paradise. Having lied about economic statistics for years and having lived well beyond their means, Greeks are in for a nasty reduction in pay, benefits, consumption, and public services, the price of wanton profligacy.

In what must rank among the year’s top ten examples of chutzpah, Papandreou blamed “market speculators” for the dramatic rise to 10 percent interest on two-year bonds, an unsustainable level.

One German critic advised Greeks to get up early and begin work at 8:00 AM. China is concerned about Greek debt and its potential effect on the value of the euros it holds among its central bank foreign reserves. As Greece goes, do Portugal, Spain, and Italy follow later? Will putting a band aid on a deep financial cancer forestall national default? Watching some militant Greeks demonstrate and break windows in the central square of Athens is not an encouraging sign. Hardly good advertising for summer tourism either.

Friday, April 23, 2010

Arizona’s Legislature Pushes Immigration Policy to the Forefront

On April 20, 2010, Arizona’s legislature approved an immigration bill that makes it a state crime to be in Arizona without documents. As of this posting the governor has not yet signed it into law. J.D. Hayworth, opposing John McCain in a tough Republican senatorial primary, strongly supports it. McCain, a member of the “Gang of Fourteen” in the Senate, half Democrats and half Republicans which proposed comprehensive immigration reform several years ago, recently asked President Obama to send troops to help control the border, following the murder of an Arizona rancher.

The Mexican government, naturally, denounced the proposed law, charging the Arizona legislature with “racial profiling.” More to the point, opponents of the measure might sue in federal court on the grounds that immigration policy is a matter for the federal, not state, government. Pressed by Arizona, the Obama administration may feel compelled to deal with immigration reform sooner than it had planned.

I propose a simple thought experiment to evaluate the motives of those for and against comprehensive immigration reform. Suppose the vast majority of illegal immigrants were Asians, largely from China, rather than Hispanics from Mexico, Central America, and South America. Would Republicans and/or Democrats advocate comprehensive reform that includes a path to citizenship? If not, why not?

Thursday, April 22, 2010

Does Obama Deserve Credit for the Economic Recovery?

Scores of books, articles, and blogs, and those in press and under contract, have tried to explain the financial and economic crises of 2007-09. Important factors include unqualified home buyers, complicit lenders, policies promoting home ownership, overly loose monetary policy, lax government regulation, development of incomprehensible financial instruments, irresponsible investment houses, and others.

The same holds for recovery. What accounts for the rapid rise in stock prices since the low of March 9, 2010, the improvement in employment conditions, and return to economic growth? Posited factors include stabilizing the financial system, normal operation of the business cycle, accommodative monetary policy, tax cuts and stimulus spending, improving consumer confidence, and others.

Politicians, academics, the media, and the blogosphere are engage in a great debate to justify the policies they support to prevent another meltdown and improve current economic conditions. Left and right disagree on the role of the stimulus, how fast to tighten monetary policy, the need for additional financial regulation, and so on.

In November voters will cast their judgment on President Obama first two years in office in the mid-term elections. Democrats will find it hard, even if true, to blame Bush and Republicans for the financial crisis. If unemployment remains high, Democrats will be blamed and likely suffer large losses. If hundreds of thousands of new jobs are created every month between now and November, Democrats will lose fewer seats than forecast.

If the economy improves, Obama will get the credit. His achievements will include having passed a stimulus package that Democrats will claim prevented a second depression, restoring confidence in consumer and financial markets, enacting health reform to cover millions of uninsured, strengthened financial regulation (which appears increasingly likely) to prevent future meltdowns, withdrawing 50,000 troops from Iraq, and escalating the war against the Taliban. One thing is clear. Whether by hook or by crook, whether for good or for bad (where you stand depends on where you sit), Obama has delivered on several of his key campaign promises. This stands in contrast with many of his predecessors who, once installed in the White House, forgot their constituents.

Wednesday, April 21, 2010

Earth Day 2010

I think that I shall never see
A poem as lovely as a tree

These famous opening lines by Joyce Kilmer (1886-1918) are perfect to mark earth day, first begin on April 22, 1970. That was long ago.

When Japanese tourists began globe trotting in the 1970s, they viewed the sights through the lense of their camera. They never actually saw the sight they went to see.

The same has beset earth day. Walking around Stanford’s campus, one of the most beautiful in the world, witnesses droves of students, faculty, and staff looking at the screens of their iphones, blackberries, and cell phones to make sure they haven’t missed an “important message.” The only moment they see or appreciate any bit of nature is when the screen of their portable device puts up a picture of a tree as an advertising come on for earth day. Portable phones have turned too many into 1970s-style Japanese tourists.

Tuesday, April 20, 2010

Do Goldman Sachs and Wall Street Require Tougher Regulation?

Time will tell if Goldman Sachs is guilty of financial misconduct as charged by the Securities and Exchange Commission. But it is timely to weigh in on the firm’s conduct as an example of what can go wrong on Wall Street, and whether new legislation is required to prevent asset-backed securities and other derivatives from putting the financial system at risk.

In the wake of the 1997 Asian currency crisis, I was asked by some investor friends to meet with three hedge fund managers in Florida and New York in December 1997 to evaluate their trading strategies. These funds only allowed redemptions at the end of each quarter. Although they beat market indices every year since 1994, the investors were concerned about financial contagion spreading from Asia. They wanted to decide whether to adjust their positions before the doors closed on redemptions for another three months.

I met with the managers of the funds and the mathematicians who designed their trading strategies. At one I was given a fifty-page paper replete with mathematics explicating its winning trading strategy. I concluded in five minutes that the mathematician was from outer space and that the manager had hit a winning streak amplified by twelve-to-one leverage. I told my friends that I wouldn’t invest a penny with that fund. They closed their positions at the end of 1997. To conclude this particular story, the fund declined 16.2% in April 1998, 8.4% in May 1998, and 19.2% in June 1998. It reduced its positions from over $5 billion to just over $400 million. The other two funds were similar in their operations, of which one was later charged by the Internal Revenue Service for failing to report income and pay taxes.

What accounted for the losses? They resulted primarily from “unusual market conditions that affected the Fund’s mortgage pass-through securities and related hedging instruments and losses in liquidating positions.” The problem was falling bond yields that dropped home mortgage rates to their lowest levels in five years, below treasury bonds, which pummeled investors in leveraged mortgage-backed securities as home owners refinanced at lower rates and prepaid loans.

Imagine that! Mortgage-backed securities were at the root of hedge fund failures in 1998. No charges or allegations of fraud were leveled by the SEC. Nor were the risks understated in the funds’ prospectus. The operations of these funds never posed any risk to the financial system until Long Term Capital Management came along with its massive, highly-leveraged bets. Still, numerous high net worth individuals were attracted to funds promising high returns based on mathematical trading and hedging strategies.

Thursday, April 15, 2010

President Obama Bows to China’s President Hu at the Nuclear Security Summit

Critics of President Obama, conservative pundits and intellectuals, decry his bowing to third world oligarches and dictators. They say it shows weakness, not strength, encouraging such leaders as Iran’s Ahmadinejad to disregard U.S. warnings about Iran’s nuclear program.

Perhaps Obama believes he is being courteous, thereby rectifying eight years of perceived Bush swagger in dealing with foreign leaders that he thinks has alienated our allies and deeply offended those with whom we have to negotiate.

Culture influences the interpretation of pictures. Among Chinese, bowing to the supreme Chinese leader is redolent of China’s imperial past when foreign dignitaries kowtowed (bowed nine times) to the emperor when appearing in court. Kowtowing was seen as a sign of deference, great respect, and submission to the emperor’s place at the center of the world.

Millions of Chinese saw the leader of the U.S. show great deference to the leader of China. This may or may not have been President Obama’s objective, but that was how it was perceived in China. More so since President Hu made no firm commitment to imposing meaningful sanctions on Iran and revaluing China’s currency.

Wednesday, April 14, 2010

U.S. Aid to Israel: Much Ado About Less and Less

Critics of U.S. foreign policy cite foreign aid to Israel as a source of Arab discontent. The critics of aid to Israel include Europeans, virtually every Arab regime, and secular, left-leaning Jewish Americans, among others. They argue that aid props up Israeli hard-liners who oppose progress toward a two-state solution for Israel and the Palestinians.

On its face, the criticism seems plausible. On the facts, it is not.

Aid to Israel is a small part of the U.S. aid budget. Aid to Egypt and Jordan along with civilian aid to Iraq and Afghanistan exceeds aid to Israel. However, few argue that this aid props up Arab hard-liners who obstruct peace.

Aid to Israel has varied between $2-4 billion over the past three decades. In the four years 1980, 1990, 2000, and 2009 taken as examples, aid was $2.12 billion, $3.03 billion, $4.13 billion, and $2.55 billion respectively. In the same four years, the size of Israel’s economy, expressed in U.S. dollars at purchasing power parity, was $21.78 billion, $69.10 billion, $159.31 billion, and $201.32 billion.

As a percentage of Israel’s economy, U.S. foreign aid amounted to 9.7 percent, 4.4 percent, 2.6 percent, and 1.3 percent respectively for the four selected years. U.S. aid is symbolic of America’s commitment to Israel, but provides limited resources that “enable” Israel to frustrate peace between Israel and the Palestinians. Perhaps the problem is aid to regimes that prop up hard-line Arab critics of Israel, thus preventing Arab countries from granting official recognition to Israel.

Monday, April 12, 2010

Alan Greenspan’s Thoughts Circa 1980

In 1980 the Hoover Institution published its longest and most influential policy book, The United States in the 1980s, whose contributors included many members and advisors of the Reagan administration. I edited the fourteen domestic issues papers, which included a paper that can be read on Google books by Alan Greenspan entitled “Economic Policy.”

The context of his paper, the high and rising inflation of President Carter’s years, led Greenspan to warn of the risk inflation posed to investment and the efficiency of the economy. Reducing high-risk premiums, which were “blind-siding” the market system, should be the primary focus of Western economic policy. This, in turn, required a significant and credible reduction in the rate of inflation.

The policy question was how to lower inflation and contain it. He stated that the Federal Reserve Board alone would find it difficult to take the heat to reduce and contain inflation. It was also necessary to curb the growth in federal spending and deficits to restore balance to the financial system. Curbing spending and deficits necessitated reining in the growing number of fiscal constituencies that clamored for ever-more government programs.

The most effective constraint in his view was a constitutional amendment to restrain expenditure and tie it to a balanced budget requirement. Recognizing the political difficulty of achieving an amendment, second best was requiring 60 percent super majorities for Congress to pass money bills. Although a super majority provision could be readily overturned by simple majority passage of another law, he believed that the politics of appearing spendthrift could keep a super majority provision in place for some time.

Fed Chairman Paul Volcker succeeded in lowering inflation in the early 1980s, which threw the economy into recession. Its subsequent recovery and steady expansion over the next several decades in a non-inflationary environment suggests that presidential and Fed chairman will were the crucial ingredients. But Greenspan was prescient in warning that government spending and deficits would grow without some effective constraint. Sadly, no effective constraint exists.

Sunday, April 11, 2010

Learn from China

It is widely believed that America exports technology to China and imports, in return, low-tech assembled electronic goods, toys, clothing, and other consumer products. This belief, the conventional wisdom, rests on a widely-held view among Americans that Chinese in China are not creative, that they learn by rote with little emphasis on speaking out, that the society rests on a high degree of consensus and stifles individuality, and so on.

For those who have spent decades observing China’s remarkable economic transformation, conventional wisdom is dated. China’s government has just signed a cooperation agreement with the State of California High-Speed Rail Authority to provide engineering expertise and high-tech parts for the construction of high-speed rail (perhaps providing some of the financing). China is well ahead of the United States in building high-speed trains. China is planning thousands of miles of new high-speed rail construction in the next five years. It should be noted that China’s high-speed trains are faster than Japan’s bullet trains and France’s TGV.

As a general rule, China can make things better, faster, and cheaper. This rule is spreading throughout all sectors of economic activity, including high technology, and is poised to encompass biotechnology in the not-too-distant future.

(Hat Trip: Dean Baker)

Thursday, April 8, 2010

“Nagging Housework,” Part II

Yesterday’s post reported the research of Londa Schiebinger that women academics and professionals did twice the housework of men, ten hours vs. five a week, which put women scientists’ career advancement at a disadvantage.

Having given further thought to this problem, I have several suggestions to remedy this inequity, especially for women scientists who must put in long hours in laboratories to keep up with men, which can save the extra five hours, maybe more, they spend on nagging housework.

Eat and drink on paper or plastic plates, cups, bowls, and use plastic silverware. These can be discarded instead of washed, dried, and kept on shelves.

Have all laundry and dry cleaning picked up and delivered by a commercial firm.

Shop on-line for clothing and other apparel.

Shop at big box stores (e.g., Costco) once a week. Stock up on frozen prepared foods that only require a microwave to heat up. Buy fresh fruit and vegetables cut up for eating or heating. These purchases will help to minimize preparation time. Or, eat out five nights a week.

Live in an apartment, condo, town house, or home on a small lot to minimize gardening and other maintenance.

Older cars require more care. Lease, rather than buy, a car to minimize maintenance. Renew the lease on a new car every three years.

For those with teen-age children, require household chores in exchange for cash allowances, special clothing purchases, i-phones, etc.

Read journal articles on the treadmill. Multi-tasking, a specialty of women, will kill two birds with one stone.

Have a simple hairdo that requires less maintenance.

The above should save at least, but probably more than, five hours a week. It’s just a matter of more efficient allocation of time. Moreover, women scientists who follow this regimen will serve as excellent role models and mentors of younger scientific women.

Wednesday, April 7, 2010

April 7, 2010, “No Housework Day” at Stanford

Stanford University has declared April 7, 2010, “No Housework Day.” The Michelle R. Clayman Institute for Gender Research is hosting a panel discussion on “nagging housework” eating into job productivity, interfering with women’s career advancement, and reducing America’s global competitiveness in science.

Professor Londa Schiebinger, director of the institute, has studied the issue of housework. Despite women’s progress in recent decades, she found that women scientists do twice as much housework at their male counterparts: ten hours a week for women and five for men. The ratio applies to women in much of the academic and professional worlds.

Schiebinger proposes that employers provide benefits to support housework to all employees, both men and women, which would augment benefits for health care, day care, housing, and college tuition. Noting that Swedish firms provide housework benefits, Schiebinger suggests that this additional benefit would create better paid jobs for professional house cleaners, in turn reducing illegal immigration. Swedish firms also assist with gardening and cooking.

Schiebinger has left several questions unanswered. Would the benefit be a tax-free fringe? Does it make economic sense to provide the benefit to moderate-income secretarial and grounds maintenance staff? Is the benefit to be doubly provided for married couples? Would the budgets of employers require reductions of other benefits or lower increases in salaries? Would stay-at-home spouses be reimbursed for “nagging housework?”

In her essay that appeared in the Economist Debates, Schiebinger did not address the issue of taxation, especially of professional couples. On January 1, 2011, the current 35 percent top rate of tax will rise to 39.6 percent on couples earning more than $250,000. When effective in 2013, the Medicare tax will add another 0.9 percent to the top rate, and the 3.8 percent total Medicare levy will apply to capital income. A back of the envelope calculation suggests that Londa and her professional husband will pay an additional $15,000 or more in federal income taxes. At the average of ten hours a week of housework, $15,000 is sufficient to pay $30 per hour for household help for a year, which translates into $60,000 a year for house cleaners, no mean income. Perhaps the benefit should be means tested to exclude those earning more than $250,000, which would improve the distribution of income. If the U.S. needs more productive women scientists to compete with China, perhaps Schiebinger should oppose Obama’s tax-rate increases, which penalizes the efforts of female partnered scientists.

As for me, I’m scheduled for several hours of housework while TBW (the beautiful wife) takes the day off.

Tuesday, April 6, 2010

Searching for the Holy Grail of Social Justice

Many scholars, politicians, and pundits worry that large concentrations of income and wealth in the hands of a few in Western market democracies can lead to social and political instability. They contend that redistribution of income from the wealthy few to the less well-off many, thereby achieving a more “equitable” distribution of income, increases “social justice.” Improving the financial condition of the lower half of the income spectrum increases its access to health care, education, housing, and other goods and services. In particular, the high-tax, big-spending “social market economies” of Europe, especially the Nordic countries, are touted as ideal models.

During the past fifty years, I’ve visited Denmark, Finland, Sweden, and Norway numerous times. I’ve spoken with academics, business leaders, politicians, bureaucrats, and persons in the street. Residents of each country regard their political economy—the scope and size of government spending, taxation, and regulation—as the most just in the region.

I found no consensus on the “optimal level” of social justice among the four. Over the decades, opinion has changed in each country on the appropriate size of government that maximizes social justice. Sometimes the level of spending and taxes were too low, sometimes too high, sometimes just right, but the just right level never stayed intact for any length of time.

Turning to America, politicians who push for higher taxes on couples earning over $250,000 a year to fund more health insurance, prolong the solvency of Medicare and Social Security, and finance new programs of public investment often speak of achieving greater social justice. I, for one, would be more comfortable if someone, anyone, would define with absolute clarity and provide a standard of measurement that enables us to recognize social justice when it has been achieved. And, to insure we can keep it once we get it.

Monday, April 5, 2010

Definition of a Politician

Sir Henry Wotton (1568-1649) is known for his definition of a diplomat: “An ambassador is an honest man sent to lie abroad for the good of his own country.”

Rabushka’s definition of a politician: “A politician is an honest, or dishonest, person who is paid to lie to his (or her) own country.”

Nowhere is this more clear than newspaper reports of September 18-19, 2006, of a leaked tape that contained blunt remarks of Hungary’s prime minister, Ferenc Gyurcsany, speaking to a meeting of his Socialist Members of Parliament a few weeks after they won the election:

A melange of comments from the tape regarding his party’s statements on Hungary’s economy:

“Our party lied to the public....Evidently, we lied throughout the last year-and-a-half, two years. It was totally clear that what we are saying is not true....We lied in the morning, we lied in the evening....the lies were those politicians told citizens, who now believed they could have happiness as a gift....We have to stop the deluge of lies which have covered the country for many years.”

Perhaps Ferenc Gyurcsany is the most honest politician in the world?!

Sunday, April 4, 2010

Taxes of a Thousand Cuts

An interesting itemized list of taxes (not tax deductions):

Taxes upon every article which enters the mouth or covers the back or is placed under the foot. Taxes upon everything which it is pleasant to see, hear, feel, smell, or taste. Taxes upon warmth, light, and locomotion. Taxes on everything on earth or under the earth, on everything that comes from abroad or is grown at home. Taxes on the raw material, taxes on every fresh value that is added to it by the industry of man. Taxes on the sauce which pampers man’s appetite, and the drug which restores him to health; on the ermine which decorates the judge, and the rope which hangs the criminal; on the poor man’s salt and the rich man’s spice; on the brass nails of the coffin, and the ribbons of the bride; at bed or board, couchant or levant, we must pay. The schoolboy whips his taxed top; the beardless youth manages his taxed horse, with a taxed bridle, on a taxed road; and the dying Englishmen, pouring his medicine, which has paid 7 per cent., into a spoon that has paid 15 percent., flings himself back upon his chintz bed, which has paid 22 per cent., and expires in the arm of an apothecary who has paid a license of a hundred pounds for the privilege of putting him to death. His whole property is then immediately taxed from 2 to 10 per cent. Besides the probate, large fees are demanded for burying him in the chancel. His virtues are handed down to posterity on taxed marble, and he will be gathered to his fathers to be taxed no more.

Gordon Brown’s Britain? Obama’s future America?

This passage is taken from an essay of Sydney Smith, published in the Edinburgh Review in 1820, five years after the conclusion of the Napoleonic Wars.

Saturday, April 3, 2010

Some Thoughts on Inequality

Academic interest in feminist studies has grown at an exponential rate, from a handful of centers and university departments to more than a thousand over the past fifty years. Academic presses routinely publish books on feminist and gender studies.

A new field of study is developing around the theme of inequality and its relationship to minorities, poverty, school dropouts, family instability, and so forth. Inequality centers and research programs have been established at Stanford, Northwestern, Columbia, Princeton, Cornell, Wisconsin, Iowa, Yale, and Brookings, to name a few. The stated purpose of many of these centers is to design policies that reduce inequality on the view that greater equality in the distribution of income and wealth will improve living standards of lower income households and the workings of democracy.

How many of the scholars in these centers take vacations to see inequality? We routinely receive brochures in the mail promoting cruises, flight and hotel packages, and travel destinations to help us plan our summer holiday. Most destinations are in Europe, in Scandinavia, Eastern Europe, Russia, the Southern Mediterranean, Western Europe, and the British Isles.

The stops in each itinerary include the great cities and ports of Europe, with a choice of tours that focus on the basic foursome: monuments, museums, churches, and castles. In the course of lecturing on cruise ships during the past decade, my wife and I have taken many tours. Guides rarely if ever show us examples of inequality, for instance, workers’ housing blocks or welfare centers. The only workers’ sights I’ve ever observed were from the windows in taxi rides from airports in Belgrade, Zagreb, Vienna, Prague, and others en route to historical city centers.  Guides talk about kings and queens, architectural wonders, great art, colossal churches, country homes, nobles’ attire, and so forth. During our tour of St. Petersburg we learned about Czarist Russia, and then skipped the entire Communist period to the “new Russia.” Ditto in Gdansk.

Tours of Asia and Latin America are similar in focus. The chief attractions are colonial or dynastic buildings, monuments, churches, fortifications, etc. I have yet to visit a peasants’ museum (if there are any).

The sights of Europe (including most museum collections) are the result of concentrations of wealth that enabled the commissioning of paintings, buildings, and monuments. Had the history of Europe been socialist-style equality throughout the three past millennia, and of Asia for four millennia, there would be little of interest to see in our travels.

Friday, April 2, 2010

Confucius for Americans

Confucius is my favorite philosopher. Although his analects (sayings) are 2,500 years old, their truths may be more relevant than ever.

The Chinese Communist Party discouraged the study of Confucius and other classics during their rise to power and the years of Mao Zedong and his followers (1921-78). Since Deng Xiaoping put China on a path of opening up and modernization in 1978, Confucius is back in vogue. China has established hundreds of Confucian institutes around the world.

Confucius commented far and wide on politics, interpersonal relations, correct modes of behavior, and the importance of learning, among others. Like Aristotle, he described the good versions and the perversions of behavior in all of these areas. Confucius proposed a four-class system of social organization, with scholars at the top. Accordingly, education was his central focus, but he worried about its misapplication.

In illustrating his fear, Confucius says “Rarely do I meet a man who studies for three years without thinking of a [lucrative] post in government.” This has its counterpart in the United States. Rabushka says, “Rarely do I meet a man who works for three years in Washington, D.C. [in elected or appointed office] without thinking of a lucrative book deal, highly-paid speeches, and a fat post in a lobbying firm.” The concept of “public service” takes on a different meaning in the Confucian framework.

Thursday, April 1, 2010

Ending Snake Oil Salesmen

To get a driver’s license, we have to pass written and driving tests. To buy life insurance, we have to pass a medical exam. To be admitted to most colleges and universities, we have to earn reasonably good scores on the SAT or ACT entrance exam. To practice law we have to pass the BAR exam. Ditto for medicine, electrician, plumber, contractor, engineering, land surveying, real estate, social work, insurance, counselors, and so on.

In the last two years, several dozen books and numerous articles have been published trying to identify the causes of the financial and economic crisis of 2007-09. Most authors agree that an important cause was the subprime mortgage crisis; many individuals signed up for mortgages they did not understand. Most agree that another cause was the proliferation of complex financial instruments, such as asset backed securities (ABS), mortgage backed securities (MBS), collateralized debt obligations (CDO), synthetic CDOs, that many investors did not understand. Most agree that government agencies bore some responsibility for failing to regulate financial institutions undertaking excessive risk. And so on.

I propose, then, a regime of extending testing to specific financial decisions. To prevent another subprime housing crisis, home buyers applying for a loan must first pass an exam in which the applicant demonstrates knowledge of fixed interest rates, variable interest rates, principal payments, no-principal loans, prepayment penalties, property taxes, escrow, points, closing costs, insurance, monthly-payment-to-income ratio, and so forth. Passing an exam will reduce the ability of overly aggressive salesmen and lenders to confuse, deceive, or mislead buyers.

Ditto for investors. Anyone opening a brokerage account must first pass an exam demonstrating knowledge of different kinds of securities, margin, government guarantees, risk, rates of return, and so on.

The old adage of caveat emptor was replaced long ago by consumer protection, which clearly fell short in the areas of home buying and investing. Consumers would be better protected and make better choices if they commanded some level of understanding and proficiency in financial affairs instead of relying on the recommendations of salesmen whose incentive is to close the deal, however sound.