Faceless

April 26, 2020

by Steve Stofka

In the name of public safety, our elected officials are picking winners and losers. In the process, they are selectively destroying businesses. Their job is to protect lives, they claim. Faceless legislative staff craft regulations that destroy some lives while they protect others.

In my neighborhood there is a Sprouts grocery store in a strip mall. That’s open. Next to it are several clothing stores, all closed now. A nail salon – closed. A mattress and bedding store is closed. The liquor store is open.

Across the street is a Walmart with a grocery store inside. The parking lot is almost full. Wal-Mart restricts access to the store entrance to safely stagger customers. There are a lot of signs and tape on the floor to remind people to stay six feet back when waiting in line. Most people are wearing masks.

The chiropractor across the boulevard is temporarily closed. We elect state and local politicians who delegate the work of governing to office staff. A committee decided that people with pinched nerves in their necks and backs are not important. Can’t work because you are having muscle spasms? Too bad. Some bureaucrat has decided that your pain is not essential. Stay home and ease the pain with marijuana or alcohol. Those store are essential. It is a slap in the face to those with chronic pain.

A month ago, the mayor’s office of Denver issued a stay-at-home order that did not include liquor stores and pet stores as essential businesses. What will be closed next? By mid-afternoon, just two hours after the edict was issued, cars crowded the streets of Denver and adjoining counties. People lined up inside liquor stores. Two bottles of Seagram 7. A few quarts of vodka. Four cases of Bud. Panic buying or those looking to profit from the coming shutdown. Social media alerted the mayor’s office and they immediately amended the order.

In some office buildings, therapists cannot get into their office because the building is locked. They are non-essential. Where are their patient notes? In the locked building. Got problems? Try Zooming your therapist. Remember – your government committee is trying to keep you safe.

Therapists and chiropractors not essential. Oil and gas extraction is essential because, well, it just is. The drop in demand for gasoline has produced a glut in oil. Companies are storing the extra in super tankers on the world’s oceans. Got back problems? Rub some crude oil on it.  

President Trump suggested that “medical doctors” – not the other kind of doctors like PhD doctors – but medical doctors could inject disinfectant like Lysol into people infected with the coronavirus. It’s OK if medical doctors do it. The maker of Lysol was quick to issue a warning. Do not inject Lysol into your body, they warned.   

Mr. Trump has become the country’s voodoo doctor. The warm weather was going to kill the virus. Then it was a malaria drug. Now it is Lysol. Put on your voodoo doctor headdress, Mr. Trump. Get your cauldron fired up and cook us up one of your special potions. The folks at Fox News will endorse your medicine. 

The President is the visible menace. The folks who work in our state and local offices are the invisible threat. A select few decide which businesses are essential, whose pain gets treated and who is important. They decide who gets unemployment insurance and who does not.  Many small businesses will not recover. It can take ten years or more to build up enough savings to start a small business. A second mortgage on a house is often used to capitalize a business. A faceless committee in a government building says your business is not important. Bye-bye business. Bye-bye savings. You can give up your dream and find work somewhere. Hope you can keep your house. It’s not essential. You are not important.

If – when – businesses reopen, business owners have a lot of questions. Will the state exempt businesses from liability if a customer or employee gets sick? Does the state have that power, the governor asks. The state has the power to issue edicts that crush small businesses but not the power to help business owners recover. You are not important.

After three deaths due to corona virus, the health department shut down a Wal-Mart store in our area (Butzer, 2020). Wal-Mart has deep pockets and legions of lawyers. Will an insurance company insure a small business against a coronavirus lawsuit? How much extra premium will it cost? What is the protocol? Should a business owner hire someone to screen customers before they come into the establishment? Does anyone have an answer?

The supply chain is an invisible river of goods and services that enables local businesses to service their customers. Is that supply chain broken? We will find out. The pandemic has caused a surge in orders for computers, but China has shuttered computer factories (Brandom, 2020).

Let’s turn to the faces of those we elected. Congress hurriedly passed an 800-page bill to provide $350 billion in loans and grants to small businesses – the Paycheck Protection Program (PPP). 28% of the funds were grabbed up by publicly held companies (Beltran, 2020).  The original provision in the bill was that any business with more than 500 employees was not eligible for the funds. Faceless lobbyists pressured the faceless staffs of lawmakers to make a small change. Just a few words. Change the wording to exclude companies with 500 employees at any one location. Done. No problem. The senator appreciates your support.

Senator Marco Rubio is the chairman of the Senate’s Committee on Small Business and Entrepreneurship. When the Wall St. Journal contacted his staff about large businesses scooping up the funds intended for small business, reporters were told they were mistaken. Mr. Rubio would not allow such language. The staff later admitted their error (The Journal, 2020). Lawmakers routinely vote for legislation without knowing what is in it. Prior to passage of the ACA (Obamacare) bill in 2010, House Speaker Nancy Pelosi replied that legislators wouldn’t know what was in the bill until it passed. Legislative sausage making by faceless staff and anonymous lobby groups. No, we’re not for sale, lawmakers insist. Yes, thank you for your support, they reply to the campaign contributions of the lobbyists.

The pandemic response of government has exposed our vulnerability. With great power and an incomprehension of the effect of their edicts, faceless legislative staff act as the executioners of the French Revolution.  Some small business owners must kneel down at the guillotine and await the fall of the blade.

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Notes:

Photo by Simon Migaj on Unsplash

Beltran, L. (2020, April 23). Restaurant Chains Received Many of the Biggest PPP Loans. Retrieved from https://www.barrons.com/articles/restaurant-chains-received-many-of-the-biggest-ppp-loans-51587573556

Brandom, R. (2020, March 27). Electronics companies are getting gridlocked by coronavirus lockdowns. Retrieved from https://www.theverge.com/2020/3/27/21195953/tech-manufacturing-companies-coronavirus-lockdown-apple-electronics-china

Butzer, S. (2020, April 24). Health department closes Aurora Walmart amid COVID-19 deaths, positive cases connected to store. KMGH. Retrieved from https://www.thedenverchannel.com/news/coronavirus/health-department-closes-aurora-walmart-amid-covid-19-deaths-positive-cases-connected-to-store

The Journal. (2020, April 22). How Big Businesses Got Small Business Relief Money. [Audio, 21 mins]. Retrieved from https://www.wsj.com/podcasts/the-journal/how-big-businesses-got-small-business-relief-money/7C5DAB5C-71C0-4D50-9D13-9D9633E633AC

Timing Models

May 22, 2016

Long term moving averages can confirm the shifting trends of market sentiment and market watchers customarily watch for crossings of two averages.  The 50 week (1 year) average of the SP500 index just crossed below the 100 week (2 year) average, indicating a  broad and sustained lack of confidence.  Falling oil prices since mid-2014 have led to severe earnings declines at some of the large oil companies in the SP500.  The index is selling for about the same price as the two year average.

What to do?  These crossings or junctions can mark a period of some good buying opportunities – unless they’re not – and that’s the rub with indicators like this one.  Downward crossings typically occur after there has already been a 5 – 15% decline from a recent high.  If an investor sells some stocks at that time, they wind up selling at an interim low, and regret  their action when the market rises shortly thereafter.  They should have bought instead of sold.  AAAARGHHH, a false positive!  Twice in the 1980s, the sentiment shift was less than a year long and an investor who did act lost 10 – 20% as the market climbed after several months.

Conversely, after a 10-15% decline, some investors do buy more stocks, figuring that the excess optimism, or “fluff,” has been shaken out of the market.  Then comes that sinking feeling as the market continues to decline, and decline, and decline.  In April 2001 and July 2008, the 50 week average crossed below the 100 week average.  Investors who lightened up on stocks at those times saved themselves some pain and a lot of money as the broader market continued to lose another 30% or so.

There are not one but two problems with timing models: timing both the exit from and entry back into the market.  Over several decades the majority of active fund managers – professionals who study markets – did not get it right.  They underperformed a broad index like the SP500 because the index is actually a composite of the buying and selling decisions of millions of market participants.  John Bogle, the founder of the now gigantic Vanguard Funds, made exactly this point in his dissertation in the 1950s.  A half century later, this “wacky idea” of index investing has taken over much of the industry.

Consistently successful timing is very difficult and has tax consequences in some accounts.  Investors are encouraged to focus instead on their investment allocation to match their tolerance for risk and volatility, and to consider any prospective income that they might need from a portfolio.

Since 1960, the average annual price gain of the SP500 index has been 6.7%.  Add in an average yield (dividend) of 3% and the total return is almost 10% that an investor gains by doing nothing, a formidable hurdle for any timing model.

Within an allocation model, though, is the idea that an investor might shift a small portion of a portfolio from stocks to bonds and back in response to market signals.  In several previous articles I have looked at a Case-Shiller CAPE10 model (here, here, here, and here) as well as another crossing model using the 50 day and 200 day moving averages, dramatically named the Golden Cross and Death Cross (here, here, and here.)  As already mentioned, we want to avoid some of the false signals of crossing averages.

Instead of a crossing, we can simply use a change in direction of both averages.  When not just one, but both, long term averages turn down, we would move a portion of money from stocks to bonds, and in the opposite direction when both averages turned up.

Over the course of several decades, this strategy has been suprisingly successful.  The market sometimes experiences a decade when prices may be volatile but are essentially flat.  From 2000 – 2012 the SP500 index went up and down but was the same price at the beginning and end of that 12 year period.  1967 to 1977 was another such period, a stagnant period when an investor’s money would be better put to use in the bond market rather than the stock market.

In recent decades, this long term weekly model would have favored stocks from 1982 to March 2001 while the market gained 850%, an annual price gain of 11%.  The model would have shifted money back to stocks in August 2003 at a price about 25% less than the exit price in March 2001. In March 2008, the model would have favored an exit from stocks to bonds.  The stock market at that time was about the same price that it had been 7 years earlier in March 2001.  The model captured a 30% gain while the index went nowhere.

In the 1967 – 1977 period, the model did signal several entries and exits that produced a cumulative 8% price loss over the decade but the model favored the bond market for half of that period when bonds were earning 8% per year, a net gain.

In almost two years, the SP500 has changed little; the yield is less than 2%, far lower than the 3% average of the past 50 years.  However, the broader bond market has also changed little in that time and is paying just a little over 2%.  There are simply periods when strategies and alternatives have little effect. Although the 50 week average crossed below the 100 week average earlier this month, they are essentially horizontal.  The 100 week average is still rising, but barely so, a time of drift and inertia.  In hindsight, we may say it was the calm before a) the storm (1974), or b) the surge (1995). Usually the calm doesn’t last more than two years so we can expect some clear direction by the end of the summer.

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It’s the economy, stupid!

One of the myths of Presidential politics is that Presidents have a lot to do with the strength or weakness of the economy, a superhero narrative carefully cultivated by the two dominant parties.  Here’s a comparison of GDP growth during Democratic and Republican administrations. The Dems have it up on the Reps since 1928, chiefly because the comparison starts near the beginning of the Great Depression when the Reps held the Presidency.

For several reasons, GDP data is unreliable during the Depression and WW2 years.  First, the GDP concept wasn’t formalized till just before the start of WW2 so data collection was new, primitive and after the fact.  Secondly, this 14 year period includes an extraordinary amount of government spending which warped the very concept of GDP.  The WPA program that put so many to work during the depression years was a whopping 7% of GDP (Source), like spending $2 trillion dollars, or half the Federal budget, in today’s economy.

The Federal Reserve begins their GDP data series after WW2 when data collection was much improved. If you’re a Dem voter, don’t mention this unreliable data.  Just tell friends, family and co-workers that the Dems have averaged 4% GDP growth since 1927; the Reps only 1.7%.  If you’re a Republican voter, exclude the 20 year period from 1928 to 1947 and begin when the Federal Reserve trusts the data. Starting from 1947,  Republicans have presided over economies with 2.75% annual growth during 36 Presidential years.  During the 30 years Dems have held the Presidency, there has been a slighly greater growth rate of 3.1%.

In short, economic growth is about the same no matter which party holds the Presidency.  Shhhh! Don’t tell anyone till after the election is over.  Legislation by the House and Senate has a much greater impact on the economy.

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Small Business

“If America is going to dominate the world again, the country has to fix the spirit of free enterprise. Small-business startups are in serious decline.”

“Gallup finds that one-quarter of Americans say they’ve considered becoming business owners but decided not to. ”

These foreboding quotes are from a recent Gallup poll.  Small businesses employ more than 50% of employees and are responsible for the majority of job growth yet many politicians and most voters pay little attention to the concerns of small business owners.  The giant corporations get most of the press, praise and anger.  Could the lack of small business growth be responsible for the lackadaisical growth of the entire economy during this recovery?  As the population  continues to age, growth will be critical to fund the dedication of community resources to both the old and young.

The BLS routinely tracks the Employment-Population Ratio, which is the percentage of people over 16 who are working, currently 60%.  But this ratio does not fully capture the total tax pressures on working people since it excludes those under 16, who require a great deal of community resources.  When we track the number of workers as a percent of the total population, we see a long term decline.  As this ratio declines, the per-worker burdens rise for it is their taxes that must support programs for those who are not working, the young and the old.

Regulatory burdens hamper many small businesses. A recent incident with a Denver brewery highlights the sometimes arbitrary rulemaking that business owners encounter.  Agencies protest that their mission is to ensure public safety.  An unelected manager or small committee in a department of a state or local agency may be the one who decides what is the public safety.  As the rules become more onerous and capricious, fewer people want to chance their savings, their livelihood to start a small business.  As fewer businesses start up, tax revenues decline and the debate grows ever hotter: “more taxes from those with money” vs “less generous social programs.”  Policy changes happen at a glacial pace, further exacerbating the problems until there is some crisis and then the changes are instituted in a haphazard fashion. Since we are unlikely to change this familiar pattern, the issues, anger and contentiousness of this election season are likely to increase in the next decade.  Keep your seat belts buckled.

Adults Wanted

The end of another month ending involving billing customers, paying taxes, balancing the bank accounts and closing the books.  Each month it becomes apparent that one of the reasons why there is not more robust job creation is the “invisible” employee costs, both in dollars and in the business owner’s liability.  By invisible, I mean that these costs are typically out of sight and out of mind to most employees.  These costs are quite visible to the owner who, failing to account for them in their business pricing, soon goes out of business.

These costs were designed to be invisible to employees because if most employees knew all the costs, some politicians might lose their jobs.  A paycheck with a gross amount of $1000 might have $200 or more taken out for taxes and health care premiums.  The net amount of the paycheck is $800, which is what we get to spend on bills, rent/mortgage, food, transportation and a movie. We grouse about the $200 in taxes but that $200 pales in comparison to the invisible costs that don’t show on that paycheck stub.  Most of these costs are mandated by either Federal or State law and include Workmen’s Compensation insurance, Unemployment Insurance, Liability Insurance, and Social Security and Medicare taxes (employer’s half).  The cost of these mandates goes into neither your pocket or the employer’s pocket. Benefit costs include health insurance, retirement contributions, education reimbursements, vacation and sick pay.  Mandated costs and benefits can easily add $500 to $1000 in cost to that $1000 gross paycheck amount.  In addition, there are indirect costs which include office and production equipment, rent, utilities, and transportation, as well as the internal costs of accounting, supervision, and training.  After those costs, that $1000 gross paycheck can have a final cost of $2500 or more. 

The indirect costs are simply a part of any business; they are the costs of producing a dollar of revenue to the business.  My chief concern is the invisible insurance and tax mandates whose costs are hidden from employees.  By making the employer, not the employee, responsible for the payment of these costs, politicians could more easily sweep them under the rug.  Some people strongly object to the health insurance mandate but how many protest or are even aware of the Unemployment Insurance mandate or the Workmen’s Compensation Insurance mandate?  Many are not aware simply because the cost is paid by the employer.  While the employer may write the check, the employer “deducts” the cost from the employee by lowering the gross amount that they can pay to an employee.

I am not making a case against these insurances and taxes that add a safety net for workers.  What I do object to is the surreptitious way that lawmakers have enacted them in order to hide the magnitude of the costs of these safety programs.  Because these mandates are structured as a payment from the business and not the employee, Workmen’s Comp, Liability, and Unemployment Insurance are rated based on the company’s industry classification and claims history.  An employee who has worked twenty years without an accident is charged the same amount of money as his/her co-worker who does not pay attention to safety regulations and common sense.  The same holds true for liability insurance; a thoughtful employee and a careless employee pay the same amount.  In some construction industries, Workmen’s Comp and Liability insurance can be 20% or more of gross pay – not a trivial amount.  Should a careless driver and an accident-free driver pay the same amount in auto insurance?  Of course not.  Yet that is how Workmen’s Comp, Liability and Unemployment Insurance are rated.  Since there is no individual worker history, no individual experience rating, there is no direct cost tied to a worker’s actions.  An employee can become naturally divorced from the consequences of their actions.  Often an employer will not add another employee if they are not sure whether he/she will be able to keep them on six months from now.  The reason is that many, if not all, states will increase the unemployment insurance rate for that business when the employee is let go in six months and files for unemployment insurance.  It can be more cost efficient for an employer to pay some overtime to existing employees to make up the extra work till the employer is sure that business volume is on the increase. 

Unlike the other insurance mandates, the health care mandate at least makes individuals personally responsible for their own insurance.  With no direct responsibility for their own Workmen’s Comp, Liability and Unemployment insurance, employees are effectively treated, in the eyes of lawmakers, like teenage children.  A host of state and federal employment regulations only confirms that status.  In the eyes of our laws,  employees are not quite adults.  Employers are treated by state employment agencies as though they were the parents of not quite fully responsible teenagers and the burden of proof is on the employer to show that the employer complied fully with regulations.

How did we get here?  During the second World War, the Federal Government was running up extremely large war costs and experiencing severe cash flow problems.  One problem the government had was that tax payments were not due till March 15th of each year (in 1954 the date was changed to the current April 15th), which meant the government had to borrow a lot of money each month.  Many people were not paying all of their taxes, either income or the Social Security tax enacted several years prior.  The problem of collecting delinquent taxes presented yet another costly headache for the government.  A noted economist of the time, John Kenneth Galbraith, suggested a solution last used eighty years earlier during the Civil War:  make employers withdraw the taxes before they paid their employees.  This would both solve the problem of timely collection of taxes and curb much of the delinquency.  It would be much easier for the government to go after the far fewer businesses in the country than millions of individual taxpayers.  Thus the withholding system was born again. (A history of taxes)

Once the mechanism of withholding was in place, politicians realized what a boon this was.  Taxpayers dislike taxes and the politicians who enact them. Politicians could now increase existing insurance costs and mandate new ones without the taxpayers – the voters – constantly being reminded of these now invisible costs.  Politicians simply had to change the law, then notify a relatively small number of businesses to pay more.  That created a new problem for business owners.  Politicians had effectively deflected the disapproval of voters onto employers.  When an insurance cost goes up, it is difficult for an employer to say to an existing employee that the employer will have to reduce an employee’s hourly wage or salary to make up for this increased cost.  For subsequent hires, an employer can reduce the hourly wage or salary that they will offer to a new employee.  The employer has two alternatives:  raise the price it sells its product or service; or eat the increased cost.  Employers complain about this state of affairs long and loud. They form trade groups and lobby their state legislatures.  The politicians get the better of a bad situation:  listen to loud protests from a lot of voters and possibly get thrown out of office or have to listen to a relatively few employer lobbyists.

I am not advocating the abandonment of the withholding system, which does solve the problem of timely tax payments.  I am advocating for a system that directly charges those who are going to benefit from the safety net that exists – the employees.  This is no longer the paper and pencil age of World War 2.  Digitized records would enable most state and federal agencies to assign individual ratings to employees based on their history.  A new or existing employee presents their individual rating for various types of insurance to the employer and the employer deducts the amounts and sends to the appropriate agency, just as they do now.  The difference is that the employee gets to see what he/she is being charged for and might in some cases be able to control some of those costs.  Instead of being paid $20 an hour, an employee might be paid $34 an hour.  The cost to the employer is the same.  For many of these mandated costs, the tax write offs to the employer are the same; it is a cost of producing business income.

What can we do about it?  Press your elected representatives for individual ratings for these insurances.  An employee who has never filed for unemployment insurance pays the same as a person who has collected six months of unemployment insurance last year.  Does that seem fair?  Why have an employee half and an employer half of the Social Security and Medicare tax?  It all comes out of the employee’s pocket in the long run.  Why the game of hiding the costs?

Imagine a world where an employer can have a bit more sales volume, hire an employee and let them go if sales subsequently fall off.  An employee who is let go would then make the choice of whether to collect unemployment.  They might absolutely need the unemployment insurance and that would affect their individual unemployment rating the same as it does when we file an auto insurance claim.  They might try harder to get another job or switch to a different job in order to keep their individual unemployment rating pristine.  It would be the employee’s choice.

Imagine a world where the employee controls what they put away for retirement.  If you want to put away $6,000 a year tax free into a 401K retirement plan, why shouldn’t you?  Why have the charade of the employer matching your contribution by some percentage?  How did we get to the point where employee compensation is a haunted house of smoke and mirrors?  

Imagine a world where an employee is not bound to an employer for insurances and benefits and tax benefits.  Imagine a world where the employee has choices.  Imagine a world where the employer pays the total of the employee cost to the  employee and the employee then sees the true scope of deductions.  In fact, we do have that world now.  Employers are increasingly using subcontractors and temporary agencies as a way to sidestep the burdens of employment.  From the BLS July Labor Report: “Temporary help services has recovered 98 percent of the jobs lost during the most recent downturn.” (Source).  Tell your state and federal representatives that you would like a different world – one in which you are treated like an adult.

Reckless Regs

In a 9/24/09 WSJ op-ed, Jeffrey Friedman, editor of the Critical Review journal, makes the case that the causes of the banking crisis lie more with reckless regulation than reckless bankers. Mr. Friedman notes that several studies suggest that “bank executives were simply ignorant of the risks their institutions were taking – not that they were deliberately courting disaster because of their pay packages.” He notes that “bank CEOs held about 10 times as much of their banks’ stock as they were typically paid per year, ” and that several high profile CEOs lost $500 million and more.

So what role did reckless regulation play in the debacle? In 2001, financial regulators in the U.S. amended international banking rules regarding mortgage backed securities (MBS). These “recourse rule” changes allowed banks to maintain less of a capital risk cushion for MBS than that needed for holding individual mortgages and commercial loans. By 2007, the rest of the G-20 countries implemented the same rules. Thus regulators created a profit opportunity for investment banks.

If banks had been out to take additional risk to maximize profit, Friedman argues, they would have bought far more lower rated packages of MBS. But they didn’t. Many opted for the least risky MBS packages, rated AAA, which provided lower profits. Reassured by the AAA rating, Citigroup brought all of the MBS packages it could. Doubtful of the underlying soundness of these financial products, J.P. Morgan Chase didn’t. In this competition, J.P.Morgan Chase emerged strong from the crisis while Citigroup is a taxpayer supported financial house of cards.

Friedman argues that capitalism is a competition of predictions about which procedures will bring profits. “Regulations homogenize,” he states, promoting a herd behavior on competitors in the market. The investment banking herd, prodded by regulatory ideas of what constitutes prudent banking, ran off the cliff. After this disastrous experiment in regulating capital allocation at banking institutions, the G-20 now wants to write rules on what should be prudent compensation practices in the banking industry.

The responsibility for the crisis is certainly shared by the regulators. Friedman neglects to mention the lobbying by the financial industry during the nineties to loosen up the recourse rules. Friedman contends that the purchasing of AAA rated MBS packages was a desire for safety. In 2001, Marty Rosenblatt, a well recognized expert on securitization, wrote an analysis of the rule changes on the capital requirements for banks. Rather than a desire for safety, as Friedman contends, purchases of AAA and AA rated MBS packages enabled banks to multiply the leverage of their capital by five times. Instead of requiring banks to hold 8 cents in capital for every $1 of risk, banks had to hold only 1.6 cents, a leverage of 60 to 1, or $1 of capital to $60 of risk. This highly leveraged capital to risk ratio dwarfs the high ratios of the late 1920’s, whose high leverages brought on the stock market implosion of 1929.

Why would the the Federal Reserve and other U.S. banking regulators adopt such a lax captial requirement? Because they were using historical data of losses on mortgage securitizations when lending requirements were stricter. Shortly after financial regulators loosened captial requirements for banks, the regulators at the U.S. mortgage giants, Freddie Mac and Fannie Mae, began relaxing lending standards for mortage holders in order to promote President Bush’s “ownership society” in the aftermath of 9/11. This uncoordinated confluence of regulatory changes laid the foundations for the crisis. The imprint of financial rule makers certainly conveyed a sense of sound and prudent financial standards. Investment banks discarded their internal risk management rules to take advantage of the opportunity to make large profits from the securitization boom.

Some, like Friedman, will lay most of the blame on the regulators while some place it at the feet of the investment banks who chose to ignore principles derived from decades of risk management experience. Investment bankers lay some of the responsibility on the “pressure” of savings, particularly savings accumulated in a rapidly industrializing Asia, chasing the higher yields of MBS. The demand for these financial products became a strong persuasion to bankers who scrambled to put financial packages together to meet the demand. To meet that demand, investment bankers reached out to mortgage brokers, who met the demand of the investment bankers by selling mortgages to people who really weren’t good mortgage risks. Those people simply took advantage of an opportunity to buy a house, to ride the wave of escalating property values.

This larger story is too often left out by op-ed writers. It is the gestalt of regulation, profit seeking capital markets and opportunistic savers and consumers that is responsible for the financial crisis. Each of these components are necessary to a well functioning market. Probably the one flaw common to each of these “players” was the decision to ignore an old maxim, “If it sounds too good to be true, it is.”

Financial Regulation

In 1966, Congress passed the Fair Packaging and Labelling Act, which required manufacturers of retail products to list the contents and weights of their products. The food industry fought hard against it. Breakfast cereal makers were accustomed to packing their cereal in big boxes to trick the consumer into thinking that they were getting more product.

In 1969, Congress tried to pass a law mandating unit pricing but the food industry lobbied hard against it and the bill died in the Senate. The reasoning was that consumers could figure out the unit price or the price per ounce of a product by themselves or bring recently introduced battery powered calculators with them when they went shopping. In 1970, some grocery stores began to offer unit pricing as a convenience feature to lure customers. Unit pricing in grocery stores is now commonplace.

Many years ago there was one mortgage product, a 30 year fixed loan, making it fairly easy to compare mortgages. Because easy comparison by a customer is not always good for the seller, mortgage companies competed by introducing a complexity of “points”, closing fees and prepayment penalty packages to distinguish their mortgage product from their competitors.

The 15 year mortgage arose a few decades ago, followed by a variety of mortgage products. This profusion of choices can be a boon to a consumer but it can also be confusing. This variety and confusion is an effective sales tool, making it more difficult for a customer to compare products and prices.

Just as the food industry fought packaging regulations, the financial industry will fight similar regulations on their products. Under proposed financial regulations, teaser rates of “0% interest for 6 months” will have to be followed by plain English of what that teaser rate will reset to in six months. No longer will credit card companies be able to bury the truth in impossibly small print referencing the greater of the LIBOR rate (what’s that?, you ask) or the Federal Reserve discount rate (what’s that?, you ask again). Mortgage companies would have to offer at least 2 – 3 standard products, like a 30 year fixed loan, that a consumer could compare pricing with a competing mortgage company. While this legislation works its tortuous way through Congress, the finance industry will be busy lobbying against it and figuring out how to outsmart it.