A month after each quarter ends, the Bureau of Economic Analysis (BEA) releases an advance estimate of the nation’s output of good and services, or GDP. As the Bureau receives more specific data, they revise their advance estimate, calling this revision a preliminary estimate.

On 5/29/09, the BEA released their preliminary estimate of first quarter GDP. The good news is that GDP didn’t fall as much as indicated by the advance estimate released at the end of April. It was “only” a decrease of 5.7% from the last quarter of 2008. Defense spending decreased 6.8%. While personal spending was up 1.5%, gross domestic purchases of goods and services declined by 7.5%.

Recent signs indicate that the deceleration in the economy has slowed. New housing permits have seen an increase. The rate of applicants for unemployment is less jaw-dropping. The manufacturing index, while not positive, has turned around from its steep decline. This is a big ship that had lots of momentum in the wrong direction. It will take a while.

We feel relief and entertain hope as flood waters continue to rise but at a slower pace. That’s the reaction to May’s unemployment report just released by the Labor Department.

“Only” 345,000 jobs were lost in May, making it the first month since October 2008 that the economy has shed less than 500,000 jobs.

In a 6/6/09 WSJ article, Justin Lahart examines the underlying labor data that reveal some trends in the US work force. Constituting 86% of the labor force, service jobs represent almost all of the US economy, nearly completing a decades long shift to a service economy. In this sector, May’s job loss of 120,000 was about half of April’s 230,000 job loss. Since this recession started in December 2007, the Labor Dept reports an all time record of service jobs lost. Some historic records are better to read about than live through.

Although manufacturing jobs are less than ten percent of the work force, companies let go even more factory workers than service workers in May.

In American Theocracy, Kevin Phillips notes that, in the past four hundred years, the decline of all leading economic powers, the Spanish, Dutch and English, have been marked by a pronounced shift in their economy away from producing goods to finance and services. Maybe it will be different this time around.

Chris Wilson at Slate.com has produced a county by county animation of employment gains and losses over the past two years. You can play the two year animation or click on a month in the series, then click on your county and look at the year over year gains or losses for that month.

What percentage of your income do you pay in taxes? At the beginning of March, I heard a working class person complain that Obama was “soaking the rich” at 35%. Presumably this person was complaining on principle. By another principle, that of self-interest, a working class person might also cheer that Obama is “soaking the rich.”

What is rich? For 2006, IRS data shows that the top 1% of tax returns had an AGI (Adjusted Gross Income) above $389K. I would say that the top 1% qualifies as rich. Yet, some rich people don’t feel rich.

In the 4/16/09 WSJ weekly “Currents” feature, Gary Fields spoke with several of the rich and near rich, those in the top 1 and 2% income tiers. The owner of a human-resources company in Silicon Valley, California and his wife make about $400K but feel like they are barely getting by. San Jose, CA mayor Chuck Reed calls a family making $250K in Silicon Valley “upper working class,” unable to afford a home in the area.

What did this top 1% pay in Federal income tax? Just under 23%. Wait a second.. what happened to the 35% rate? That is the marginal rate, not the average rate.

If someone is in the 35% tax bracket, that doesn’t mean they pay 35% on all of their income, only on the portion of income that is above the 35% bracket threshold. A person making a $500K salary still only pays 10% tax on the first $16K of that salary. In the 2008 tax year, if someone made $357,701 they paid 27% or $96,770 on the $357,700. They paid 35 cents on the extra dollar.

Warren Buffett once wryly remarked that he paid less in taxes as a percentage of his income than his secretary did. How do the top 1% cut their average tax rate? Many have a significant portion of their income in capital gains, which are taxed at 15%, the rate for middle class taxpayers earning less than $65K.

In a history of the capital gains tax, the Tax Policy Center reports that “The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) cut the top tax rate on long-term capital gains from 20 percent to 15 percent, the lowest level since World War II.” Obama’s budget proposes to restore the 20% tax rate on those families making more than $250K. For some historical perspective, this level is more favorable than the recommendations of a 1997 Congressional Joint Economic Committee Study.

There is an old saying: “The poor fight the wars, the rich pay for them.” Former President Bush, together with his party, had a novel idea on this centuries old maxim. Why not have the poor fight the wars in Iraq and Afghanistan and not have the rich pay for it? Instead, the U.S. would charge the war expense on its “credit card”, the U.S. Treasury. It was an interesting idea that didn’t work out so well as the “credit card balance”, the national debt, of the U.S. grew from $6.2T in 2002 to over $10T in 2008.

Defense spending has almost doubled since 2002. To keep our country strong, the rich need to do the noble thing and pay for it. Defense spending is an insurance policy on one’s assets.

President Obama and his wife paid over $700K in taxes last year on $2.7M in income, most of it from the sale of Obama’s books. They didn’t complain about paying that much in taxes and I promise that I will be noble and won’t complain if I make $2.7M next year.

Personal responsibility, a traditional value in America.

In his weekly WSJ column on 3/17/09, Joe White looked at the global car market. An example is the Ford Focus, a compact popular in Europe and also sold in the U.S.. “Next year, Ford will launch a new Focus in the U.S. that will have 80% of its parts in common with the European version.” Why not 100%, I thought. Oh yeh, I reminded myself, they have to put the steering wheel on a different side of the car over in Europe.

Silly me. Here’s the most expensive item on the list. “U.S. government crash standards … require car makers to take into consideration the potential harm to passengers who aren’t wearing seat belts.” Europeans, on the other hand, expects a driver to act responsibly. This and other minor differences like bumpers and mirror size add up to “hundreds of dollars a car”.

All 49 states except New Hampshire have seat belt laws. Jennifer Levitz, in a 3/18/09 WSJ article, tells us that protesters gathered last week in Concord, N.H. to voice their opposition to a proposed seat belt law in that state. One protestor said that “the state is moving toward, basically, communism.”

New Hampshire passes up $3.7 million in federal money if they don’t institute a law by July of this year. In 2007, “70% of those who died in traffic accidents in the state weren’t wearing seat belts.”

One protestor wears a seat belt now, but swears to stop wearing it if the law is passed. Representative Jordan Ulery, an opponent of the bill, said “New Hampshire is a sovereign state; we can do as we damn well please.”

In Turku Varadarajan’s Weekend Interview in WSJ 2/21/09 with the economist nicknamed “Dr. Doom”, Nouriel Roubini: Roubini makes a case for temporary and quick nationalization of some of the largest U.S. banks in order to “clean them up, and you sell them in rapid order to the private sector”.

Roubini is a believer in market economies as being the best of a lot of bad alternatives. He notes that “paradoxically, the proposal [of nationalization] is more market-friendly than the alternative of zombie banks.” Lindsey Graham, the conversative Republican senator, said he wouldn’t take the idea off the table. Alan Greenspan concurred that it might be necessary to “facilitate a swift and orderly restructuring.”

Banks that were too big to fail have become “even-bigger-to-fail” as one bank giant swallows up another bank on the verge of collapse. Roubini proposes a hypothetical takeover of one of the giant banks, splitting it into 3 or 4 pieces, making each piece a regional or national bank and selling them.

The more troubling question to Roubini is that we repeatedly get into periods of asset and credit bubbles, bubbles that a lot of people believe are sustainable until they implode. He criticizes Greenspan for losing sight of his central mission: as head of the central bank in the U.S., his job was to provide financial stability. Roubini believes that Greenspan kept a rigid ideological adherence to Ayn Rand’s philosophy, a belief that “there are no market failures, and no issues of distortions on incentives.”

Roubini characterizes the last decade as one of self-regulation which created a “law of the jungle”, where greed is untempered by either supervision or fear of loss. Lastly, he criticizes the media: “in the bubble years, everyone becomes a cheerleader, including the media.”

The Law of Unintended Consequences is older than Murphy’s Law. The struggle to limit the severance and other pay of CEOs at publicly held companies is an example of this law at work.

In the early eighties, the U.S. economy experienced two recessions, one of them deep, which led to a large number of company mergers and takeovers. Several high profile executive severance packages prompted Congress to enact a change in the tax code, known as a “golden parachute”, that subjected excess payouts to additonal taxes. Executives who received more than three times their annual salary in severance were subject to a 20% tax on that excess income. Before the enactment of this law, most companies paid their executives one year’s salary as severance. After the law passed, companies began to use the “3 times rule” as a benchmark. A study of CEO severance pay in the mid-nineties found that the median payout was two times annual salary. This increase in severance pay was hardly what Congress intended.

In 1993, President Clinton led a populist campaign to limit executive salaries by limiting the deductibility of salaries greater than $1M. Executives at the companies responded by designing pay packages that included stock options. The total CEO pay package grew from 100 times the average worker’s salary in 1993 to 300 times the average worker’s salary in 2000. By 2007, total CEO pay was 344 times that of the average U.S. worker.

I have been involved in several shareholder campaigns to have a greater say in executive compensation. As stock dividend returns decreased and executive pay increased in the past decade or more, the amount paid to executives seemed to come directly out of the dividends paid to shareholders. Some companies have allowed non-binding shareholder resolutions on executive pay but it has been my experience that management traditionally offers little more than a polite acknowledgment to these types of resolutions.

However, Congress would do well to pay attention to history and not make any law or rule that directly limits executive pay. Corporate law is a state issue and I don’t think that Congress could enact any changes in corporate law that would allow shareholders to have a binding vote on executive pay. Perhaps the first move Congress could make is to change the relationship between the federal government and states on corporate law. Large publicly held corporations typically incorporate in whatever state affords them the greatest operating flexibility. Unfortunately, this flexibility allows management to disregard the wishes of a majority of the owners, the shareholders.

Lydia brought up some good questions about my Foreclosures blog:
What do we do (under any of the plans including yours) with second mortgages and home equity lines?

The other problem, of course, is that all of these loans have been sliced, diced and tranched to the point that it is difficult to know who actually has what.

Then, of course, there are the Alt-A’s that will be resetting shortly.

And — who will pay for the appraisals and other evaluations your proposal requires?

And finally, while your plan seems very logical and workable, the government must change the mark to market rules for the lenders.

I replied:

Under this program, second mortgage and HomeEq lines would not qualify. There is too much potential for abuse here. On a house previously valued at $400K, a homeowner could have taken out a $100K second mortgage to start a business. Business has slowed down and it would help the business’ cash flow if the homeowner could simply call it a $100K income gain and pay the taxes on it for five years. Or a homeowner could have taken a $40K loan and built a nice swimming pool in the back yard. Now they are having problems making payments on the $40K. Not everyone can be helped. Some people made poor decisions.

The problem with writing down principal is that it is a violation of the existing contracts that the lenders have with the bondholders, many of whom are from other countries. It would require the consent of the bondholders to change the contracts so that the lender could write off part of the principal. It’s a big problem.

The slicing and dicing means that there may be many several contracts involved in the write down on one house. When the idea was first proposed in the nineties, the computer would make it possible to keep track of the slices and dices. But, in practice, is it possible?

There is a lively debate on “mark to market”. It is not the gov that does “mark to market”. It’s GAAP accounting rules. Some suggest a model of “future revenue stream”, pricing in a percentage of impairment or default. For a simple example, if you have an MBS of $1000, with a 10 year life, and the anticipated revenue stream is $17 a month for 120 months, why not price in an impairment or default of 20%, for example, and mark the MBS at $800? As it is now, some of these are being priced as low as $200, if there is much of a market for it at all. After Enron, changes to the “mark to market” rule are viewed skeptically by economists/accountants. Asset pricing has to have some basis other than the figment of someone’s imagination. However, it is difficult for some of these long term complex products where there is no market.

As to who pays for the eval, that’s a good debate. Most homeowners who are defaulting don’t have the money so as a matter of practicality, either the lender or the gov needs to pick up the tab. It is too onerous for the gov to pay promptly for these evals, so it would probably be best if the lender picked up the initial cost for the eval, then submitted a voucher to the gov. That puts a cash flow hurt on the lender, but I think they would prefer that to the limbo many of them are in now. They can at least show that as a good accounts receivable. The cost of the eval would then be included in the homeowner’s “gain” that they would pay taxes on.

Almost every plan I have read has some fault, some legal or moral hazard stumbling block.

Matt Miller, author of “The Tyranny of Dead Ideas”, in an op-ed in WSJ on 1/12/09 spoke with several former Congressional Budget Office (CBO) directors.

“If you do nothing on the spending side, you’re going to raise taxes whether you’re a Republican, a Democrat, or a Martian,” said Douglas Holtz-Eakin, the Republican-appointed director of the CBO from 2003-05.

Miller noted that Federal revenue today is 18.8% of Gross Domestic Product (GDP) and federal spending (excluding Fannie, Freddie and TARP bailouts) is 20% of GDP.

Holtz-Eakin notes that “pressures” (probably economic and social) could push spending and taxes to 23-24% of GDP, as much as 27% if health costs remain out of control. GDP is around $14T.

Dan Crippen is another CBO chief and adviser to McCain who predicts taxes of 22% of GDP by 2020, 24-25% by 2030. David Walker is another Republican (turned independent) who was comptroller general of the US from 1998 – 2008. Walker estimates taxes growing to 20-25% in the next 20 years, depending on how “radical” we get about cutting spending.

Matt Miller asked Holtz-Eakin why Republicans continue to tout tax cutting despite knowing that taxes have to go up. “It’s the brand,” Holtz-Eakin said, “and you don’t dilute the brand.”