A Take on Obama’s Speech

Obama and Af/Pac Speech—a risky but utterly brilliant solution

Despite weeks of leaks and speculation there was a REAL surprise in the President’s speech, which was “move in and out FAST!!”-Obviously there is a lot of risk in that plan. But there may have been greater risk in any other plan.

The really brilliant part of his carefully reasoned plan was his recognition, through the fog and confusion of that war, that to avoid getting mired down, he had to lay down a clear, short, firm time table. Otherwise, they would simply continue to rely on us to do the heavy lifting [complaining all the while about our presence] thus creating the self fulfilling prophecy of an open-ended occupation.

And, as for the Taliban and Al Qaeda, if they choose to see this Plan as weakness that they can wait out, inevitably that will open an even better opportunity for our CIA and Special Forces to have a real turkey shoot.

Basically he said to the region “either get your stuff together fast and succeed on your own or you will face the consequences alone.”

Remember, nothing concentrates the mind like a hanging.

Let’s hope they all get it!!

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Between a Rock and a Hard Place

Every day in every way as I twist and squirm to see good news, all I see is the walls closing in around us squeezing out what little wiggle room is left in the most important issues facing our nation.

The economy: I see intractable problems on two fronts. While the credit/financial crisis has clearly eased/ended, the economy still has quite a long way to go to prove it is healthy again and on a steady road of growth. But worse yet, if the economy needs more stimulus [not at all clear at the moment], our ability to supply it runs head on into our fiscal pinch which includes real political headwinds. And to make matters worse our unemployment rate has reached 10.2% and while it may be peaking, it will be slow to recede and may be a long, long time away from getting back anywhere near its historical base of 4 to 5%. The bubble of the past generation saw consumption as a % of GDP move from a long held base in the low 60% range to about 70%. That was a huge and very rapid change in the makeup of the largest part of our economy brought about by cheap money which fueled massive increases in home, auto and other big ticket sales to non-sustainable levels which post the crisis cannot be reached again for a very long time. And that strongly suggests that unemployment will be stuck at very high levels with all the inevitable political baggage which accompanies that fact. Translate all that into a simple conclusion that says watch out: while the financial system may be out of the woods, the crisis has left behind a partially crippled economy at a time when we really do not have any significant tools available to overcome the disability.

Foreign Matters: The angst over Afghanistan [and Pakistan] and what to do, not to mention Iran and the rest of the Middle East, also betrays frightening limits on our options. It grows clearer daily that we are stuck half in/out, straining our fiscal deficit in dangerous ways, when we desperately need relief to afford an essential health care reform. History is against us. For 150 plus years England and the USSR [now Russia] could never succeed in Afghanistan as occupying powers, which we now have become. How can we even hope to succeed? We need to radically alter the game plan but ‘real politick’ seems to make that almost impossible. Add to that conundrum Iran, Pakistan and the rest of the Middle [muddle] East and go see your shrink fast.

Domestic Policy: Our brilliant new, young President early on staked out health care reform and the environment for his first and major issues. Health care has slowly, slowly been winding its way through our byzantine political system and finally [historically?] passed in the House by 2 votes with nearly 40 democrats standing aside over their reelection concerns. And now the Senate version has made it to the floor for debate without a single vote to spare and several Democrat Senators saying they cannot vote for a bill with several key provisions currently in it. That would NEVER have happened under Franklin Roosevelt, who would have given those Senators and Congresspersons other even more serious concerns for their reelect ability. But even Roosevelt probably could not have done that today because the process of Congress has been changed radically since the 1970’s with earmarks and giant campaign finance contributions and the virtual end of seniority. All that said health care now seems to be stuck in the muck of special interests in the Senate and may never emerge with anywhere nearly enough cost containment in either version. The silver lining to that is that both bills have far too little that addresses the real cost culprits [defensive medicine and a culture of pay for procedures] so maybe a next try might do better?

On the environment the President has solid ideas about ‘cap and trade’ but the special interests have already signaled what may be the death knell of those crucial global issues.

Inflation fears: The appropriate conventional wisdom today says “do not worry about inflation because deflation makes it impossible”. That is, of course, correct as far as it goes based on history’s experience. But, what is worrisome is that while inflation remains under the protective umbrella of deflation, there will be a lot of inflationary forces building up. When deflationary concerns finally begin to rise with the morning mist, out there emerging from the fog we will see an armada of inflationary battleships ready and beginning to fire their big guns. Those “battleships” simply put are our gigantic deficit accounts, domestic and foreign, which will put big downward pressure on the dollar, raise the cost of all our imports, including foreign capital, and inevitably trigger a weak dollar inflation bubble which will be the flip side of our recent consumption and finance bubbles. And, if we think our recent encounter with deflation was a big problem, we may have an even bigger challenge ahead. So once again we have to recognize that we are being squeezed between the powerful forces of deflation and inflation with very little wiggle room to maneuver.

What to do? Tough question. On the political front my suggestion is that the President go back to his mandate for change which was the central strength in his campaign and tackle head on the biggest obstacle of all. That obstacle is an unworkable Congress made more so by the money of special interests, to which far too many members are beholden, through which they seek to distort the national interest into their need for self preservation. Simply put, we must move toward a much larger role for public finance for elections to our House and Senate. That is unlikely to happen, if it has to go through those bodies. Therefore, it will need to be led by our popular President over and around Congress by arousing a lot of public support. About 75% of polled Americans already support this concept. And, the way it is proposed it should not cause any constitutional issues with abridgement of free speech.

On the foreign front I think we need to be very discriminating about what we take on. We cannot effectively project a strength, which sadly is already compromised and which is continually being eroded by our endless overextension of our precious resources: people and credit.

On the economic and investment front as a Nation we have to hunker down, roll up our sleeves and slog through the tough times of our recovering economy, out of which we will surely emerge stronger and smarter than ever.[So Buffett’s long term bet on S&P options should work out fine.] As investors we cannot/should not turn our backs on risk, indeed we must confront those dual risks by dividing our investments between those that protect us from deflation and those that can shelter us from inflation. That won’t be easy, because the easy options of mostly bonds and cash cannot be a safe haven much longer, due to the specter of inflation. Those who can should explore some special investments in innovations, commodities and possibly agricultural real estate. And, while investments in good businesses will continue to be essential, they may also be vulnerable to some extent as we go through the inflation/deflation squeeze.

So – onwards, onwards with hope and determination.

A Take on Health Care

Why oh why is health care such an impossible, vexing public policy problem? Actually the answer is basically quite simple.

On the one hand some 75 odd % of the American people in poll after poll say they are reasonably satisfied with THEIR health care and insurance.

On the other hand, and perversely, some 70 odd % of the same American people in poll after poll say they support health care reform to {1} contain costs {2} cover everyone and {3} fix problems like portability and job loss etc.

Taken together those two statements sound like a status quo confronted by a threatening, but well intentioned, challenge of change that could easily end up spelling ‘stalemate’.

Well, surprise, surprise that seems to be what we have. But, hold on a moment, maybe we have simply been going through a complex political sorting out process. And, once again our new, young President, who has taken lumps throughout this affair, may turn out to have been exactly right to give the body politic time and space to work it out.

There are, of course, several significant nodes of opposition to the President’s plan. One is people who want him to fail simply for the sake of injuring his whole Presidency. Another is people who are simply gradualists and want to limit change to modest increments allegedly to avoid making newer, different, bigger problems, but really to protect the status quo. And a last group who doubt that cost containment can be achieved short of fundamental structural changes in the incentives underlying the present health care system, which are not addressed anywhere in the present Plan.

At this moment the President’s unarguable, and overwhelmingly valid, point MUST take over the rational debate because the status quo is simply untenable. In just a matter of years, the country truly risks bankruptcy if we fail to control health costs.

And that is where we are now.

And that is why it is time for the silent, but complacent, majority to assert its voice in crafting compromises in several of the sub debates. For example, the “public option” debate is held out as risking socialism, which on its face really makes no sense at all because we already are there with Medicare. And, a major reason why there has been such broad acceptance of today’s status quo is because on balance Medicare really works quite well, partly because its costs are NOT constrained. An additional, new public option governed by marketplace rules of efficiency with no permitted deficits should not be objectionable, particularly if Medicare’s costs are also properly constrained.

On cost containment: there really are few arguments left about digitizing medicine; there begins to be common ground in the arena of tort reform and defensive medicine; and there really are few arguments left about conferring benefits on illegal immigrants except in serious emergencies. And, virtually all the points about prior conditions, portability, job moves or loss, etc have already effectively been resolved.

While we may not get a perfect bill that makes everyone happy, we can hope and expect to get a significant move forward so that in future years, we can hopefully address today’s unaddressed problems of misdirected incentives throughout the whole culture of our health care systems. And if you think today’s debate has been tough, wait for that one!

Just What Is a Credit Crisis?

An old friend, an 81 year old mathematical physicist, posed that somewhat astonishing question last October by email and again a couple of days ago in London when we visited where he lives. He wanted it in about 750 words.

Here is what he got. He was sufficiently satisfied to suggest that it could be useful if seen by a lot of ‘civilians’ who he believes, perhaps correctly, are too embarrassed to ask the same dumb question.

The answer begins by explaining that the word credit is derived from the ancient word “credere” meaning to believe, to trust.

For example, your credit card is based on the issuer’s, for example Visa, trust that you will pay them what they have advanced on your account to your “creditors” — the people who sold something to you and trusted you and Visa to pay them for what was sold.

Then the question begins to gets a bit more complicated. The balance in your bank account is called a credit balance because you trust your bank to keep it safe and pay it to you or, on your instruction, to someone else, whenever you want.

In the meanwhile your bank constantly has dealings with lots of borrowers and other banks and lends its depositors’ money, including yours, to those banks and other borrowers trusting them to pay fully and in a timely way.

When you buy your car on credit you promise the auto finance company that you will pay monthly over, say, three years the money you borrowed to buy the car. The auto finance company pays the car manufacturer the full purchase price and in turn borrows that money from all sorts of other lenders, who all trust your promise to pay what you owe when you owe it.

Similarly, when you buy a house, you take out a mortgage from a lender, which is a promise secured by your house, to pay over, say, 30 years the full price you had agreed to pay the seller. That lender in turn borrows the money to lend to you from a lot of institutional investors, including government backed companies which specialize in housing finance, all based on everyones’ promises to pay. That obviously again involves trust on all sides by everyone involved.

At this point the subject gets pretty complicated. Your promise to pay for your house can get packaged with the mortgage company’s promise to pay into another whole different type of loans called “derivatives” because they are derived from your original promise to pay. Those derivatives contain many different types of original buyers [old, young, rich and poor] and different types of mortgages [fixed rate, variable rates of interest etc] which are in turn sold to another different collection of institutional investors who trust that virtually all the participants will pay what they owe on time for years into the future.

And, to add another complication, some of those derivatives divide the risks they contain into different pieces that can be sold separately, for example early versus later pieces or interest versus principal. Believe it or not, simply because those packages contain blends of separated risks, they are presumed or alleged to be overall less risky than all their various separate underlying pieces. Therefore at least parts of them sell for a “better” price [profitable to them] than you paid for your original mortgage. These fancy instruments became very plentiful and supplied ‘wonderful’ profits for many years to many eager people up and down the marketing chain. Talk about trust!!!

In the meanwhile more housing was being encouraged in every way, by public and private policies, and more and more buyers were lured into the housing market at ever rising prices to the point that many people began to think they were really getting rich from their rising home prices and some started speculating by buying more houses simply to resell them at ever higher prices. Is that trust or greed or what??

And, in the meanwhile bankers of all stripes, conservative and ‘modern’ alike began senselessly buying more and more of these “riskless” derivatives without taking on more protective capital, because it appears they truly believed there were no real risks involved. They saw what they did as a public good because it helped finance more houses and because, by the way, it also generated giant trading profits for all the intermediaries along the way including lots of needy traders and bankers.

Trust in the power of profit incentive really did its work.  Then, lo and behold, after many years of uninterrupted continued success, suddenly , within about one year, there became many excess houses, cars and credit card overdue balances, and more and more owners/debtors could not meet their obligations and began to default on their promised payments. The overall default rate of broken promises began to rise rapidly and ripple throughout the whole economic system. That, of course, led to drops in sales of houses, cars and everything else everywhere and in turn led to lay-offs of workers, who of course were also borrowers, owners and investors, and, thus many more failed promises to pay on time. Trust in all its forms swiftly began to melt away.

That is a full blown credit crisis. Banks stop trusting each other as well as everyone else. Nearly everyone stops lending because they are all over extended, so that very few people now can borrow to buy a house, car, vacation, or whatever, and the whole economy begins to grind to a halt because there is no credit to supply the cash to power the economy in any direction except down.

Whatever happened to “trust but verify”?