“It’s the economy, genius”

What a time we live in.  The past few weeks have been fascinating, historic, scary, depressing, opportunity-laden, transformational and ominous all at the same time.  The convergence of the economic meltdown with the presidential election is a one-two power punch combo.  Since the two topics are virtually intertwined at this point, I think the handling of the economic situation will probably go a long way towards determining the outcome of the election, though that’s nothing particularly new.  I’ve had a bunch of interesting conversations over the past week about the economy and felt like jotting down a few (sometimes disconnected) thoughts on it.

My dad forwarded me this article by William Chafe (a Duke prof) on the parallels between 1929 and today.  I find it quite frightening.   Similarities between the two eras are:

  • Growth in salaries of workers fall way short of growth in executive pay (480x difference in current wage rates).
  • Strong Wall Street growth fueled by only 10% in equity.
  • No consumer savings, consumption growth on credit (living beyond our means).
  • Employment decline causes tightening of credit beginning downward spiral.

There are multiple possible solutions to fixing any problem, but two high-level approaches are (1) pump a bunch of money into the economy to prop it up or (2) focus on the structural weaknesses in the overall system and fix them.  The first approach is faster and easier, but might only be a short-term fix. The second is harder and more rigorous, but could set us up for the future.  Of course, a combination of the two may also be best.

The article digs into the differences between McCain and Obama’s approaches, and to avoid making this post too partisan, I’ll let you read it yourself if its of interest.  There are several other structural questions that have arose in recent conversations though, that I want to raise for discussion:

FDIC Insurance – The current FDIC insurance cap of $100,000 was set in 1980.  Inflation-adjusted, $100,000 then is worth approx $250,000 today.   By keeping the cap at $100,000, the program discourages saving and encourages investing. Since a predominant form of investing is in the stock market, the bond market or mutual funds, keeping this cap low serves the economy well and fuels growth at the expense of savings.  I’d argue that growth under those circumstances is somewhat artificially produced.

SBA Governance – On the surface, the SBA is a great program that gives citizens the opportunity to be entrepreneurs and start business, something I support.  From what I understand though, in recent years, the SBA has been judged by the number of loans issued, rather than the quality or credit-worthiness of those loans.  This smells a little fishy to me given the current credit crunch and rate of default.

Tax-Free Housing Sales – Since 1997, Americans have enjoyed the benefit of claiming up to $500,000 in real estate appreciation tax-free on sale of a home, provided they’ve lived in the house for two of the past five years.  First, this really benefits the wealthy, because the average home doesn’t cost anywhere near half a million dollars, let alone achieve that in appreciation.  Second, this makes selling a home easier and more attractive, which encourages flipping and discourages stability.  Third, since you can live in two separate homes for two years each, it encourages second home consumption.  It also encourages borrowing, building and increase in housing supply.  When the supply outstrips demand, we have problems.

Finally, on a political note, undecided voters keep telling me that Obama wants to spend, spend, spend.  Yes, its true that Obama probably plans to spend more than McCain.  I’d argue that much of that investment in domestic programs is long overdue.  Regardless of one’s opinion on that issue though, what’s planned and what actually transpires during a presidential term are often very different things.  To use the past eight years as an example, Bush certainly didn’t have a spend philosophy when he came into office.  He brought a classical Regan Republican small government approach to Washington.  But look what’s happened since he’s been there.  We’ve spent more annually during his administration (inflation-adjusted), and incurred more debt, than during any administration in the country’s history.  Now, he’s pressuring congress to approve a somewhat hastily assembled plan that would increase the cap on national debt from $10.6 trillion to $11.3.  The morale of the story is that making poor, short-sited decisions costs far more in the long run than spending money intelligently today.  This is as true in the startup world where I operate as it is in the national government.  Given the circumstances our country finds itself in, every American should vote for the candidate he/she believes is best equipped to (1) represent our country on the international stage and (2) invest the necessary resources to setup a framework that will assemble the sharpest minds, open dialogue, explore and make the best decisions possible.  That is the primary role of a president so let’s put everything else aside.

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September 24, 2008 · Filed Under Current Affairs, Politics

Comments

  • Matt
    Much like the Alternative Minimum Tax, the existing state of the FDIC deposit insurance program would appear antiquated, although not unintentionally puntative like the AMT has become. An annual increase in the FDIC deposit cap indexed to CPI would certainly seem appropriate. From a practical perspective, even small businesses often have cash balances in bank accounts that's used for ordinary course business practices such as making payroll, and it would make sense (at least philosophically) that those funds should be secure on an interim basis.

    However, I disagree with some of the conclusions you draw about the relationship between saving and investing, which are actually the same actions. Each action, however, has a different connotation, and its those connotations which you appear to be distinguishing between. The fundamental difference between an FDIC-insured account and nearly any other investment is likely the risk/reward profile. Appropriately in a free market economy, companies that need capital but that offer a higher risk profile than FDIC-insured deposits are compelled to offer a higher return to investors in order to attract that capital.

    There's nothing inherently bad about that per se, and I think the vast preponderance of economists in both the public and private sectors would agree that buying equities or mutual fund shares is very much "saving". In fact, a total concentration of personal capital in an asset class that does not provide returns which match inflation is a bad idea for even the most conservative households. In thinking further about the differences you draw between savings and investment, what would you consider the purchase of Treasury bills to be? More practically, an open-ended FDIC program is not fiscally prudent. Savings and investment activities are inherently risky, and there's no political or economic rationale for unequivocal protection in all circumstances. Given the above, how is growth driven by "investment" (to use your distinction) more artificially produced than growth driven by "savings"?

    I think quite the opposite could be true. While the FDIC bears the risk of insured deposits, the depository institutions themselves benefit from a lost-cost deposit base that they can reallocate to higher-yielding investments. In some form, FDIC insurance is a taxpayer financed subsidy for the private sector and likely encourages a form of moral hazard not unlike what transpired with Fannie Mae and Freddie Mac. If WaMu was on the hook for every dollar of capital deposited in its checking accounts, I suspect they would have thought harder about making loans to borrows who were unquailified to repay those obligations according to the contractual terms.

    The other topic I'll address is $500,000 tax exemption upon the sale of a primary residence. You neglected to clearly state that the benefit applies only to the sale of primary residences which is an important fact to bear in mind as this would exclude vacation homes, investment properties, etc. -- all assets that are more likely to be held by the "wealthy" (which you neglect to define) than by the "not wealthy". In this discussion, the average price of a home is totally irrelevant.

    For those are are not wealthy, a primary residence is likely to be their single largest asset, and the ability to profit from the sale of that asset on a tax-free basis is a terrific benefit. Given what I otherwise know of your position on may social and tax issues, I'm at a loss to understand how you think this exemption disproportionately benefits the rich. Taxing the first dollar of profit on the sale of all homes would be fair to everyone, but by exempting he first $500,000, policy effectively favors those with fewer sale proceeds. Isn't it the richer sellers who are paying the greater tax?!

    This tax benefit does nothing to make a house easier or harder to sell as it benefits sellers and buyers, although buyers are taking the risk of a change in legislation during the time of their ownership. You can only sell a house if there's a buyer, and factors such as interest rates are much more significant drivers of home sales activity.

    Philosophically, the government's claim to any tax on the sale of real estate is a dubious proposition. In what ways has price appreciation resulted from any government act? Improvement in local public services, new roads, schools? Those are mMost often paid for with local property taxes, not federal income taxes. Federal tax on the sale of real property - specifically real property - is nothing more than a swipe for revenue. Compare that to a highway toll where the toll (effectively a use tax) is reinvested into road maintenance and expansion. In that circumstance, there's a direct correlation between the act and the use. The same cannot be said for real property.

    I also think your final conclusions are misleading. All participants in the housing market are aware of the tax exemption - the market information is perfect and so is accurately reflected in prices. Buyers know they'll get the exemption when they sell and incorporate that fact into their valuation. I don't think it has any impact on the equilibrium of supply and demand - its a freebie, and one of the few that remains.

    These topics are too cumbersome to futher discuss here, but I'd be happy to take them up with you offline.
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