Ev Ehrlich's Everyday Economics

The Fed Under Seige

The ongoing saga of the recovery that wasn’t took a new turn this week when a group conservative politicians and economists – some of them often rational, at least in my book -- launched a coordinated assault on the Federal Reserve and its (Republican) Chairman, Ben Bernanke, for displaying the audacity to act in line with the Fed’s oft-repeated and uncontroversial mandate to provide full employment with price stability – the quantitative easing (QE2) program.

Faced with a situation in which inflation was less than the Fed’s (again) oft-repeated and uncontroversial target of 2 percent inflation, and with unemployment significantly less than the “non-accelerating inflation rate of unemployment,” as we economists have decided to call “all the employment the economy can handle,” the Fed has announced its intention to do what you would do if you read its owners’ manual – lower interest rates by printing money and using it to buy bonds, meaning more money gets into circulation and, hopefully, it sticks somewhere.  But since short-term interest rates are already pretty low, the Fed announced that this time it would march further out the “yield curve,” meaning it would be buying bonds of 5 or 10 years duration, to establish that money was not only going to be cheap, but be cheap for a while.

The best argument for the soundness of this policy may be the voices against it.  Liberal icons Joe Stiglitz and Paul Krugman have both questioned the policy on the grounds that more fiscal stimulus is needed instead.  That’s swell, guys, but since more fiscal stimulus isn’t forthcoming, what’s Plan B?  Apparently, it’s whining about how we didn’t do Plan A.  Gene McCarthy  once said that “the function of liberal Republicans is to shoot the wounded after battle.”  That appears to be Joe’s and Krugman’s function as well.

But the real stars of the show are a group of conservative economists, like my friend – really -- Doug Holtz-Eakin, the well-regarded and very droll senior economic advisor to the McCain campaign, and right-wing fellow travelers like Weekly Standard’s William Kristol or my good friend (and, again, I’m not kidding) and crackpot Amity Schlaes, who recently devoted an entire book to the remarkable? whacky? idea that Roosevelt’s Depression-Era policies were a big mistake that only hurt working people (here’s the link, which opens with a George Will quote about reappraising the New Deal, which is like asking the Mongoose for a review of a book reappraising the Road Runner). 

This new group has run an ad in the Wall Street Journal (from whence it will trickle down to the masses)   in the form of an open letter to Bernanke.  The letter says his plan will “…risk currency debasement and inflation, and we do not think …(will promote)… employment.”  Instead, perhaps like Stiglitz and Krugman, they offer “…improvements in tax, spending and regulatory policies must take precedence in a national growth program, not further monetary stimulus.”  But what they mean here is permanent extension of the Bush tax cuts, including cuts for the top of the income ziggurat, maintaining the distinction between wages and salaries on the one hand and (less-taxed) capital gains on the other, and better treatment for the rich dead through elimination of the estate tax, coupled with unspecified spending cuts and deregulation, which I suspect means repealing the new health care law.

How this will lead to sustained growth in employment is beyond me.  After all, the tax cuts have already happened – what they mean by improving tax policy is not raising taxes on the rich.  And spending cuts (as part of a deficit-reduction plan) are going to be sorely needed once the economy starts growing, but cutting spending in order to induce growth is like dowsing a campfire before dinner’s cooked in the name of forest safety.

And how this is going to lead to inflation is also hard to imagine.  Capacity is ample and the economy has plenty of slack.  Hundreds of millions of people around the world are entering the tradable economy and are prepared to send us an ever-increasing slate of products for next-to-nothing.  Astonishing technological progress is fueling productivity growth.  See anybody striking for higher wages recently?  Me, either.

Let me reiterate what I discussed last week; the Fed’s policy is the best option we have right now.  Like Joe and Krugman, I’d rather a new round of stimulus, but since that’s not going to happen, I’m for Plan B.  Specifically, I think the missing element of economic policy right now is a drive to refinance the stock of mortgage debt, which would give people lower payments and therefore more income, keep foreclosures down and therefore keep more houses off the market, firm up the price of housing a bit, and give consumers a reason to get up in the morning.  Too bad the Congress won’t do that – actually, too bad the Administration won’t do that – but the Fed can take us close to it by making 5-10 year money so cheap that it does.

The dissent of the conservative economists has the veneer of a polite debate over monetary policy.  There’s always been such a debate.  Back in the 1970s, when the Fed, under Nixon, Ford, and Carter, under such lesser lights as Arthur Burns and William Miller, either turned a blind eye to or tacitly encouraged rising inflation, a similar group of conservative economists formed what they called the Shadow Open Market Committee, which advocated a tougher line on monetary expansion.  In essence, they won the argument, since Paul Volcker became Fed Chairman soon thereafter and implemented the austerity the Shadows had long supported in order to squeeze inflation out of the system.  (The Shadows, however, proceeded to fight the war after they’d already won it, and continued to complain about unduly lax monetary policy even after the economy began to grow again, even though inflation had disappeared, thus rendering them a bit less prescient than you would have thought.)

The Shadow Committee was openly and avowedly for austerity, and anti-growth.  That’s not unfair in the least – their view was that if it took a recession to squeeze inflation out of the system, then so be it.  And Volcker had the guts to do it.  At the time, I was horrified – horrified – that we’d choose to have 10 percent unemployment.  Now, liberals like me see Volcker as the only guy who gets what’s going on in financial markets and, by the way, he did get rid of inflation.  So much for our objections.

But here’s the problem.  The new group of anti-Fed conservatives appears to be just as anti-growth as their Shadow predecessors, just less honest about it.  The vague discussion of tax, spending, and regulatory policies is the same melange of stuff that Congressional Republicans now favor but are yet to spell out.  Is extending tax cuts for people with incomes over $250,000 (or now, as Senator Schumer appeared to suggest over the weekend, incomes over $1 million, graciously taking me out of the mix) and repealing health care (actually, to my thinking, insurance regulatory) reform going to trigger a new round of growth and employment?  Or what – letting GM go broke?  Can I have some of what you’re smoking?

Or perhaps what’s really going on is that this new group of dissenting economists are riding the wave of interest and glory set off by Senator Mitch McConnell, whose avowed single most important thing to achieve is for President Obama to be a one-term president.  Not growth, not jobs – just defeat the president.  OK, that’s politics, it’s in that odd intersection between repugnant and fine – that’s how he rolls, he said it, I get it, I hope he doesn’t get what he wants, in fact, go fu--, well, at least we all know where we are.

My concern is that this attack on the Fed, born and coordinated over a sea bass dinner at the University of Pennsylvania Club (isn’t that an endangered species?), is really a new front in the political siege of the Obama Administration, and that the real problem with the Fed’s policy is that it might work.  Let’s return to Doug Holtz-Eakin, this time from this weekend’s Washington Post.

After the failure of the stimulus, the Obama Administration has turned to a new export strategy to generate growth. Unfortunately, export-led growth is already the policy of choice for China, Japan, Germany, Brazil and a host of other key economies. It is inconsistent for every country to simultaneously count on net exports to generate growth.

What Doug means by “a new export strategy” is that the QE2 monetary policy is likely to reduce the dollar’s value, which helps exports.  But that’s not the point of the policy.  If the Administration wanted to devalue the dollar, there are far more effective, direct ways of doing it.  And wait – this is the Fed’s policy, not Obama’s – why the sleight of hand, the bait and switch that lumps them together? 

Besides, if anybody has a right to a cheaper currency it’s us, since we have a big trade deficit.  The countries Doug cites all run trade surpluses – they should be happy when their currencies appreciate it, because now their people can buy more foreign stuff for the same amount of money.  If McCain were President, Doug, wouldn’t he favor China’s currency rising?  This criticism of QE2 is exactly what the Germans and Chinese said when they learned about it – that they didn’t want the US to export more.  Man, I get so tired of these right-wing economists who sign on to the arguments made by our competitors and blame America first.

Holtz-Eakin goes on:

The Fed (and President Obama, who curiously decided to violate the "Fed is independent" rule and weigh in on the topic) sees this as domestic monetary policy, but to the world it is a competitive devaluation of the dollar.

Well, there we go again – “the world” thinks such and such.  The world also thinks that the death penalty is barbarous, that climate change is scary as hell, and we all should get six weeks paid vacation, not to mention cradle-to-grave, government sponsored health care.  Are we good with that, too?  And what’s with this new rule about how Presidents shouldn’t comment on what the Fed does?  When did that start?   And that’s before we consider then-Fed Chairman Alan Greenspan dancing like a trained bear for tax cuts a decade ago.  Somebody send these guys the memo about the rule again.

He continues:

The Administration's approach has been to set quantitative targets for external balances - essentially "quotas" for shares of the global economic pie. It would never work and has been rejected.

I salute with grim admiration Doug’s ability to slip the word “quotas” into the mix, but what Tim Geithner really said was that if countries are running trade surpluses at really high levels, they should be under some obligation to cut them, meaning stimulating domestic demand and easing any trade barriers, pro-growth stuff.  And if it was rejected, it was rejected by the same list of trade surplus countries – China, Germany, Brazil – who actually do have the “export first” mentality Doug accuses Obama of having.

All of this suggests to me that the dissenting conservative economists –particularly given their overtly political so-signers -- are being guided by the McConnell Agenda, not a pro-growth one.  Cutting taxes for the rich, repealing health-care reform, and supporting any and all spending cuts except those that might happen (with the exception of Representative Paul Ryan, the new chairman of the House Budget Committee, who is perhaps the only Member of either party willing to enumerate what spending he’d cut) are not the makings of a program to restore output and employment growth – they’re modern day Hooverism.

And people who are good and thoughtful economists who signed this dissent – Holtz-Eakin, John Taylor, Niall Ferguson – need to think about what lies down this road – an populist attack on the Fed led by Sarah Palin and Ron Paul, folks who seem to lack the first idea of what the Fed does and why there’s more to monetary policy than a parable about gold coins.  If the Fed intends to do something that might help the economy while this Administration is in power, then off with its elitist head. 

Yes, the Wall Street Journal dissent is putatively above-board, but the board is surfing a very troublesome wave.  It’s a stalking horse – to some – for an attack on the Fed, for reasons ranging from ignorance to an anti-elitist Cultural Revolution.  The more responsible Fed critics should proceed with caution.

At Ease

Alright, let’s start with the World Series.  As I recall, I picked Texas in 7, asserting that Lee would win two games and the Texas line-up would find a way to win 2 more.  All of these prognostications had one central, shared characteristic – they were all wrong.  (I’m reminded of Alan Arkin playing “The Detective” in one of the greatest movies ever made, Little Murders – “What do these 345 homicides have in common?  They have in common three things.  One, they have nothing in common…”.)    As Ron Washington, Texas’ manager, said after the event, “They beat us soundly.”  Hell yes.  They gave you some broth without any bread, Ron.

The theme of being wrong segues gracefully to the economic issue of the moment, the Fed’s new Quantitative Easing announcement or, as economists call it, QE2.  (The “2” recognizes that the Fed did this in 2009, so it’s the second time.  And it makes the whole thing much more droll.) 

First, the background paragraph.  The Fed usually influences the economy by pegging the interest rate at which banks can borrow from it and manipulating the “Fed funds” rate, the rate at which you can borrow the least risky money for the shortest period of time – every other interest rate is a departure from that one, either by being riskier or by having longer duration.  But short-term interest rates today are pretty damn low, so if you want to goose the economy, you’ve got to come up with something else, and that’s QE2.  The Fed, under this policy, will buy longer-term assets, like 5 and 10 year government bonds, and start taking their rates down, too.  It’s a strong message – not only are we keeping rates low today, but we’re going to keep them low for a long, long time.

I support this policy – in fact, the picture shown here is an actual sign I carried to the March to Restore Sanity, one that provoked confused (and pitying) stares from most people and an occasional squeal of glee for kids who excitedly told me they were economics majors and could they take their picture with my sign.  It was as good a response as you could hope for, although I did better with one my other signs – like the guy who used to sit on the third base sided of Shea in the 1960s,  I brought several , including my show-stopping “This sign makes an Important Point.”  God, I love mass irony!

Like many of QE2’s supporters, I’m for it even though it’s not the right (or most right) thing to do.  The right thing to do is to stimulate the economy on the spending side, and to stabilize the housing market, so that families feel confident that their home is going to keep some of its value and they don’t have to live in fear of another shoe – or perhaps another shoe rack – dropping.  You do that by setting up a mortgage refinancing facility that mortgage writers can borrow from cheaply.  In fact, this kind of socialist, freedom-denying chicanery was recently proposed by Bolshevik-in-training Glenn Hubbard, who was the Council of Economic Advisors chair under President Bush II.  In my variant, which is very close to his, we’d allow everyone who hasn’t missed a mortgage payment for the last eighteen months refinance their entire mortgage – whether it’s underwater or not – at a rate that reflects the government’s low borrowing costs – 4 percent would work.  The Fed would then buy these mortgages and hold them, at least until the storm had passed. 

That’s a great idea.  Families who haven’t missed a payment after the last 18 months of hell are, prima facie, good credit risks, and letting them refinance their entire mortgage, even if their house has dropped in value, keeps them in their house, which supports housing prices and neighborhoods.  And there’s the rewarding-the-virtuous aspect of it; maybe even Rick Santelli would approve.  And it does so while freeing up families’ disposable income, which helps other consumption.

The only problem with that idea is that it’s not going to happen – pigs will fly to daylight before Washington producers that result.  It’s got everything – stimulus, socialism, a whiff of moral hazard.  The probability of the new Congress passing such a proposal is -5.

But, on the other hand, most economists near the center of the spectrum – in terms of both ideology and awareness – understand that something needs to be done, because the economy is too listless, wastefully so.  Yet all we stand to get from the new configuration in Washington is more of the same – lectures about the perils of long-term debt followed by extensions of tax cuts we can’t afford.  The policy favored by most of the electorate, or so their choices reveal, is “do nothing,” the classic, Hoover-esque prescription dressed up as setting the stage for a torrent of liberating entrepreneurial heroism.   Why the nation’s entrepreneurial spirit would be dashed by a stimulus or a wave of expedited mortgage refinancings is not clear to me, nor is what’s keeping it from cutting loose at the moment, but it shows you what I know.  Regardless, that’s one of the important takeaways of the Fed’s decision – it represents a judgment by the Fed that the political system is irretrievably broken, and that it has the choice of sitting idly by or taking its best shot.

A second point that can be made about QE2 is that, in some respects, its opponents think it will work more than its supporters think it will work.  I’m a supporter, and I’m not sure.  It will put more money into the economy and, specifically, lower interest rates over the medium and long terms.   That means it will be easier to write cheap mortgages, which goes back to the need to get the household sector of the economy and its real estate problem squared away.   A direct approach – like Hubbard’s -- would work better, but maybe this more roundabout tack will get the job done.  And more generally, there’s already a lot of money sloshing around there – we need to use stimulus to set it loose more than adding to the slosh.

But the program’s opponents think that the program is going to work so well that it’s going to lead to ruinous inflation, both in goods and in assets, like the prices of stocks.  Maybe they don’t think they think that, but ultimately they do.  Because if the program does lead to higher general inflation or a new stock bubble, it’s likely because economic growth has been rekindled.

That’s certainly the case for inflation in general.  There probably are still some diehard monetarists who believe that once you introduce more money into the system, inflation has to follow.  But we’ve learned enough about how the economy operates to relegate that to the realm of superstition.  The effect of money on the price level depends on a host of real world considerations.  Are banks lending it as fast as they can get it? Are people saving it or spending it?  Is the economy’s productive capacity booked to the brim, or does it have slack resources ready to be applied to the task of production?  And there are also the real-world considerations of the moment, such as, are there hundreds of millions of Asians, Eastern Europeans, and others around the world prepared to offer us whatever we want for, as they say, “a fraction of the price?”  The relationship between money and inflation is not like the relationship between a seed and a tree – you don’t plant money and come back at the end of the growing season to reap inflation.

So expecting a surge of inflation means expecting some positive response in the real economy.  Inflation – once it’s above the background noise level – isn’t a good thing.  But it would be a symptom of good things elsewhere.

There’s then a different inflation argument – that all this new cash swirling around will end up going into bidding up the price of stocks and other assets to irrational levels.  After all, we’re being promised that the Fed is going to keep the interest you earn on bonds very, very low for a long time.  So if you’ve got money and want to earn a reasonable return on it, you have to put your money in other assets – most obviously, riskier bonds (the below-investment grade stuff issued by more tenuous companies) or stocks.  It’s not surprising that the stock market had a big day yesterday, the day after the announcement was made. 

But what goes up usually comes down.  The Fed could be setting the stock market up for another bubble, another boom-bust cycle that will start heading south once the economy starts to recover more substantially and the need to keep these interest rates very low is no longer the paramount concern.  That’s a reasonable concern but, again, I think it’s a more theoretical danger than a real one.  If the economy does start to grow, earnings will make stocks more valuable even as higher rates make them less so.  And the Fed can use its ability to comment on the passing scene to shape investors’ expectations and, to use a word we once found appropriate in such a situation, “exuberance.”  Moreover, the newly-created systemic risk regulator created in the Seize The Means of Production Act of 2010 – excuse me, I meant Dodd-Frank – will also be on the beat.  It can use such devices as margin requirements to dial down any prospective bubble.  That’s why we created them in the first place.

I still believe in new stimulus – as I’ve said before, a payroll tax holiday, using the Fed’s balance sheet to buy new small business loans (with loss protections), a National Infrastructure Bank.  A program to accelerate mortgage refinancings and reward people who have hung tough is entirely in order as part of such a stimulus.  In fact, I could be a good segue to a long-overdue policy regarding the break-up and privatization of Fannie Mae.

The problem with QE2 is not the policy itself.  It’s that the political system appears incapable of making any kind of competent economic policy on its own.  That’s largely the doing of the Administration’s obstructionist opposition, but it was the Administration’s job to manage them and it couldn’t do it.  So we’re left with the Fed doing what it can in the government’s absence.  Ultimately, to my mind, the risk is not that the Fed fails, but that the Administration’s opponents in the new Congress decide that the Fed is a fair political target (see Ron and Rand Paul, but not my favorite Paul, Les), and truly damage the country by putting it in play.  Just when you think it couldn’t get scarier…

Texas Over San Francisco. And more.

Two things today.  The first is comments from last week’s discussion of Malcolm Gladwell’s article in the New Yorker.  Go figure.  You can say all sorts of stuff and people read it and shrug, but start talking about Malcolm Gladwell – or Robert Frank – and the phones start lighting up.  My point is not to keep this issue alive – I’m happy to, of course, but why bother you with it? – but to give people of good faith and reason an honest response.

Then we can move on to item two – the World Series.  Anybody who would rather read an extended discussion of scale building in the service industries than speculation about who’s going to win the World Series is invited to…well, we start with the mailbag.

Someone named CJ Alexander writes:

I wish CEO pay would stop getting lumped in with “Talent” like that of athletes and entertainers. Absurd CEO pay is largely an American phenomenon perpetuated and protected by rank cronyism rather than market forces.

There is a comedian in Seattle named CJ Alexander, and I am hoping this is from him.  A comedian is reading my stuff and making coherent comments?  How much better can it get?    

CJ, best to your namesake, C. J. Wilson, who’ll be throwing Game Three for the Rangers..oh, I’m getting ahead of myself.  And I’m impressed that we’re at a point where we wish our CEOs had the abilities of, say, athletes such as Tim Linceum and Cliff Lee.  But CEOs are paid a great deal in large part because a great deal is bet on them, and because their opportunities to create (or destroy) shareholder value grow exponentially as the economy becomes more complex and contested.

What do CEOs do?  The first one I worked for was Mike Blumenthal, an interesting if high-handed guy, and he once told me the CEO had two jobs – to provide a vision for the company and to make sure the resources were there to execute it.  I would add, as a corollary perhaps (but not Ehrlich’s Corollary, please), that the CEO has to explain the vision and the strategy to achieve it to both internal and external stakeholders.  This sounds like story telling, and it is, but it is the frame that allows the organization’s progress to be measured.

So I think there’s an objective, economic reason why CEO pay is so high, particularly in the U.S., where equity markets are deeper, more volatile, and where the market for corporate control more competitive.  If I wanted stability, I’d go be a CEO in Europe or Japan, where the forces acting on you are different.  Do cronyism and back-scratching play a role?  Yup.  But there’s a Darwinian thing to them – the stockholders that allow them end up the losers for it.

Jesse Fahnestock writes:

Ehrlich’s Rule about the fundamentals of human behavior being the same at large sale is really the Economist’s rule, and could be fairly restated as “Cultural factors Are Not Really Relevant.”  I think it would be worth looking at those factors on their own terms as well.

Man, here I am, pushing 60, still talking about Gramsci!  (as opposed to Gramscii, which is a programming language)!

I think I’m reminding people that economic rules are important, too.  But I think we might be conflating two different arguments.  The economist’s rule, as economists are taught it, is that the commonality of the human race is their homo economicus instinct – to maximize, optimize, calculate, and act with economic rationality (transitivity, consistency, and so on).  That’s so far-fetched that they’re now giving Nobel prizes to the people who show that people act differently.  If you think that view of humanity substitutes for the reality of human longing for relatedness and, ultimately self-actualization and fulfillment, you’re off by a wide mark.

But there’s a second level, in which different societies have different economic rules or conditions, and those rules have more pervasive effects than we let on.  I’m finessing trump here, a little, because you can argue that those rules – a consensus-driven corporate control culture in Japan, a co-determined one in continental Europe, a fiercely competitive one in the U.S. – in turn reflect underlying culture and some historical legacy.  Culture counts, to be sure.  But my point in writing the piece was that those who see pay and the distribution of income from a cultural or anthropological perspective ought to consider economics.

Then someone named MQ says:

Robert Frank made this point many years ago – the whole economic theory of “winner take all” is precisely about technologically enabled economies of scale in service provision.

Well, yes and no.  Here’s a good statement by Frank that shows that MQ – my old buddy Mollie Quasebarth?  The Modern Jazz Quarter dropping their middle name? – has a point: 

Winner-take-all has long been a feature of markets in entertainment and sports. But in recent years, many other fields have adopted the winner-take-all payoff structure. There are two reasons for its proliferation: developments in communications, manufacturing technology, and transportation costs that have enabled the most talented performers to serve ever broader markets, which has increased the value of their services; and changes in implicit and explicit rules that have led to much more open competition for top performers, which has made it more likely that they will be paid their economic "value" as determined by the marketplace.   

That’s pretty close to economies of scale, so MQ’s right.  And, in fact, I chose this cite (from a book review, not the book itself) because it makes the second point I made last week – that “changes in the …rules” have allowed more open competition for top performers – that’s another way of saying that Marvin Miller and a unified, multipolar, national market for baseball both were needed to get salaries to rise.

But I think there’s a disconnect in Frank.  I view services scale building as the driver of these rising salaries, but I don’t see Frank’s objection, which I might paraphrase, is 1) “this is bad for the income distribution” and 2) “kids see ARod or Lebron James make this money and waste their time trying to be them.”  These are important issues, but I’m still going to treat them cavalierly – 1) this is a less troubling aspect of the income distribution than many others, and 2) if they’re wasting their time, it’s because they’re rational and have few alternatives.

Let me let it stop there.  Frank and I area pretty close and we’re both distant from Gladwell.  MQ, good point.

Simon writes:

Your “Rule” has no basis in empirical evidence.

True dat, Simon.  Maybe I should have called it my Hypothesis, or better yet, Ehrlich’s Razor – it worked for Occam.  Empirical evidence is a pretty high standard, but at least you can derive, for example, Hotelling’s Rule or Tinbergen’s Rule, even if they aren’t obeyed in life.

Finally, Minot – I presume not the town in South Dakota – points out:

Henry Ford passed in 1947 so Ford was not run by an anti-Semite when it made IPO via Goldman.  You are the right track.

Yes, but I stayed on the train one generation too late.  My apologies to the late Henry Ford II for the confusion – no, wait, he’s dead, too.  And he wasn’t an anti-Semite, but he did give us the Edsel.

I wish CEO pay would stop getting lumped in with that of “Talent” like athletes and entertainers. Absurd escalation of CEO pay is largely an Ameican phenomenon, perpetrated and protected by rank cronyism rather than market forces. Except in very rare outlier cases, it has little or nothing to do with performance.

Stepping back and looking at the respective bottom-line contributions of each makes the difference pretty obvious. The “talent” is both the production labor as well as the work product itself; the CEO is a manager of those things. In consumer terms, the it’s the difference between “thing we pay for and care about” versus “bureaucratic overhead.”

And now, the World Series.

Here’s a comment made by Dave Shenin in today’s Washington Post about Cliff Lee, who has a lifetime post-season record of 7-0 and an ERA of 1.26;

among pitchers who have made at least five post-season starts, only Sandy Koufax (0.95) and Christy Mathewson (1.06) have lower ERAs.

Wow, that’s a lot to handle at breakfast.  But first, you have to love the idea that we’re comparing Lee to a guy who not only pitched a hundred years ago, but died almost a hundred years ago.  (Well, 85 – I’m being literary.)  Mathewson, The Big Six, put on the greatest week of pitching ever, (sorry, Johnny Vander Meer), when he pitched three shutouts in one World Series – in 1905.  In fact, Matty’s incredible effort – three shutouts in six days, 14 hits allowed in 27 innings, 13 Ks – saved the World Series as we know it. 

That’s true because…The first Series was in 1903, and the upstart Boston Americans (perhaps the Red Sox should think about changing their name back) stunned the world by beating the Pittsburgh Pirates (who featured Honus Wagner, the Flying Dutchman, best position player of his day) only two years into the upstart American League’s existence.  It was Namath and the Jets, just as astonishing, 66 years before. 

So in 1904, when John McGraw’s Giants won the senior circuit’s pennant, they announced it was beneath them to play Boston, which had won the American League pennant again.  So there was no World Series, owing entirely to McGraw’s arrogance.  It was the only Series that didn’t happen come hell, high water, war, Depression, and everything else until Bud Selig and a few other radicals decided that baseball could not exist without a salary cap – let me repeat that – would cease to exist without a salary cap – unless they broke the players’ union and cancelled the World Series so, motivated by their desire to save baseball, they let the Series go down.

Selig to date has never admitted he was wrong, but John McGraw won his pennant again in 1905 and ­–as a bigger man than they -- agreed to play the Philadelphia-Kansas City-Oakland-Santa Clara?/Las Vegas? Athletics.  It was a transcendental match-up – every game was a shutout and Mathewson pitched three of them.  “Iron Man” McGinnity, Chief Bender, and Eddie Plank also pitched in that Series – all four (with Matty) are in the hall of Fame.  The public was galvanized – think Ripken and McGuire after the 1994 debacle – and the Series as an institution was saved.  Mathewson.  McGinnity.  Bender.  Plank.  There were Giants in the Earth in those days, boys and girls, and Athletics, too.  When you see that little elephant patch on the uniform of the Oakland A’s, remember that Bender and Plank and God’s own abandoned child, Rube Waddell, wore it 100-plus years ago, just like Cahill and Ziegler and Breslow do today.  That’s got to count for something.

But there’s another aspect to the comparison of Lee to Matty and Koufax, and that’s this – how dare they?  There are all sorts of baseball fans who read that comparison and say, hold on a second.  Lee’s pitching against wild card teams, in three rounds of playoffs, how can you compare him to guys like Matty and Sandy, who only pitched in the Series?

I admit to reacting that way a bit, but reality has to intercede.  First, there were 16 Clubs in their day, and thirty today, so the idea that the teams aren’t as good is, by that standard, only half true.  But more importantly, Matty played in the apartheid league (to his credit, I think Bud’s apologized for that one), and Sandy – in the Series – against an American League that was slow to integrate (Elston Howard and whom?).  Neither played against a field that was international in scope – no Ichiros, few Pujolses.  And, more importantly, today’s ballplayer trains all year, knows the technique of playing far better than their predecessors of past eras (watch how many guys in newsreels are hitting off their front foot), and in a league in which the strategy of playing has evolved dramatically – bullpens, platooning, statistics, and so on.

Please – are you going to tell me that Ty Cobb was really a better ballplayer than Ricky Henderson?  That a guy with Ricky’s (as he’d call himself) ability wouldn’t have eaten up baseball 100 years ago?   Babe Ruth, great, great player, changed baseball.  Would he hit 60 home runs against 6-inning starters are specialized relievers throwing the slider and the cutter?  Get real.  You are watching the best baseball that was ever played, right now.

Was I writing about the World Series?  Oh yeah.  In the last ten years, there have been 13 different Clubs going – that’s almost half of baseball’s 30 Clubs that have been to the World Series in the past ten years.  Texas and San Francisco both emerged from the middle of the baseball pack, dethroned the sitting champs, and are quirky Clubs.  San Francisco has good pitching, a bullpen capable of greatness, and a great line-up of other (foolish) peoples’ cast-offs – Burrell from Philly and Tampa, Ross from Florida, Huff from lots of places, but Texas might have the ultimate cast-off – their catcher, Bengie Molina, whom they obtained from  San Francisco itself – man, I wouldn’t want to play a Club that had a guy who was, up to memorial Day, my catcher! A catcher is the guy who knows everything!  He’s got the keys to the kingdom, the formula for Coca-Cola!  Texas also has 1,2,3, here comes Mr. Lee, the underappreciated , free-swinging Vlady Guerrero, who now has the chance to put a capstone on a great career, and the amazing player, person, and narrative of Josh Hamilton, who lost years to dope and drink and reclaimed himself with faith, the real Roy Hobbs – the film version, mind you, not the book.   

So here it is:  Texas wins in 7.  Lee is the real deal, and while he’s up against one of my favorite players, Tim Lincecum, The Freak, who resembles the knitcapped punk on The Simpsons and has an incredibly delivery to the plate, he’s going to win twice, and the Texas line-up is good enough to find two more wins, Matt Cain, the Giants’ number two, and Brian Wilson, their overpowering and ironic closer, notwithstanding.  And my theory of the Series is that “good” teams beat “hot” teams, although you’ve got to be a little of both to be there.  Philly over Tampa in 2008, Sox over Rockies in 2007, Cardinals over Tigers in 2005.  (Exception: Florida over New York, 2003.) 

Either way, it’s the best week in sports.  Hey, how’d LeBron do last night?   Really?  Wake me in April.

Gladwell in The New Yorker

One of my personal, core principles of social science – if I were ever to have “Ehrlich’s Rule,” this would be it – is the basics of human behavior are constant over long stretches of time and place.  The 17^th Century Dutch were not different in instinct or ability from the denizens of Blackstone, the office cubicle dweller has the same human aspirations and native talents as the nascent industrial proletariat of the 1840s, and the differences between a contemporary American and her or his counterpart, whether in China, Malawi, or anywhere else on Earth, are mostly about technology, economic rules, and other material influences more than culture – people are much more alike than different. 

I’m not saying that “great individuals” don’t exist – the Union would have lost the Civil War absent Grant and, conversely, there was nothing inevitable about the monstrous societies that Stalin or Hitler created.  But every now and then, there’s a Hegelian whiff in the air, and a social scientist lays out a view of the world that essentially argues that people today have become smarter, or better, and that things happened in the world because of mankind fulfilling some kind of teleological destiny.  And it's particularlu true when discussing the economy and business, where all sorts of people think they were the first person to think of buttering toast.  Yeah, sure, nobody knew about radium before Madame Curie figured out it was there, but more often than not, and particularly in the social sphere, “great individuals” are, to paraphrase a way that  Gary Hart  once described himself, “a vessel into which history has poured content.”

A good example of this problem in social scientific thinking was found in last week’s New Yorker, in an article by Malcolm Gladwell  called “Talent Grab: Why do we pay our stars so much money?”  In that article, Gladwell (whom I not the first to note looks an awful lot like 70’s singer wash-out Leo Sayer) expands on what economists Robert Frank and Philip Cook some while back called “the winner take all society.”   Frank (an economist I admire and whose writing in The New York Times I enjoy) and Cook used that phrase to explain, or at least categorize, the rapidly escalating incomes of “stars” in a variety of professions – athletes, movie stars, executives – and the effect these rising elite salaries have had on the distribution of income.

Gladwell takes Frank and Cook’s observation to a new extreme, noting that, over the past 40 or 50 years, “Talent” has turned the tables on those who hire it, whom he terms “Capital.”  (It’s a shame he uses that term, “Capital,” instead of “management” or something like that, as it invites a comparison to the first economist who thought about “Capital” systemically, Marx, whose lasting insight to my thinking is that “capital” is not a thing, but a social relationship between people.  Had Gladwell started there, he might have run a better lap here.  But I better shut up about Marx -- look where it got Chris Coons.)   

“Talent” on Planet Gladwell is not just athletes and movie stars.  It’s just about everyone with an ability -- corporate lawyers, supermodels, investment bankers, producers.  To some extent, this is circular, as Gladwell’s “Talent” is almost by definition highly paid, but there is the commonality that they are folks who bargain individually for themselves.  In the last 40 or 50 years, their pay has burgeoned.  And it’s burgeoned because, at some point in the early 1970’s or thereabouts, a few remarkable individuals looked up and said, “That’s enough.  We’re done working for peanuts.”  And once they did, the “talent” class revolted against “Capital.”  Gladwell ends by assailing the outcome, comparing Robert Nardelli’s $210 million severance package at Home Depot to baseball salaries.  In fact, amazingly for a guy who jots down occasional pensees for money, Gladwell has the temerity to say “A negotiation in which a man can get paid twenty-two million dollars for hitting a baseball is not really a negotiation.  It is a capitulation…” and that the lingering question is “whether what Talent did with its newfound power did with its newfound power was simply create a new authority ranking, this time with itself at the top.” 

First, Gladwell ought to be careful; he’s on a slippery slope, deciding whose rewards in life are earned and whose aren’t.  I recall watching a hearing on baseball – Gladwell’s Exhibit A – ten years ago in which Commissioner Bud Selig and then-Governor Jesse Ventura complained about player salaries.  I mean, think about that – a used car salesman and a theatrical wrestler arguing that somebody else was making too much money!  I was reminded of that moment when I read Gladwell’s closing homage to Stan Musial, who asked management for a 20 percent pay cut after a disappointing season.  “It is hard,” Gladwell writes, “to be just a little nostalgic” for Musial’s explanation: “I had a lousy year.  I didn’t deserve the money.”  Frankly, until Gladwell goes into his publisher’s office and demands a smaller advance and royalty rate after one of his books sells less than its predecessor, he should keep his admiration and nostalgia in check.  (Musial, by the way, hit .255 the year in question, when he was 38.  He still had four years left in him, almost 1,700 plate appearances, 67 doubles and 63 homers, one season – at age 41 – when he batted .330, and had an OPS of about .840 from age 39 through age 42, slightly ahead of Chase Utley this year or Derek Jeter’s career.  Gladwell, who turned 37 last month, might hope to do as well in his dotage.)

Reading Gladwell opine about Stan Musial is one thing, but the problems run deeper than that.  A good place to start is with the view of the world Gladwell presents.  In his construct, Talent and Capital face each other across a bargaining table.  Capital – publishing houses, baseball Clubs, corporations – for decades had the upper hand.  But then, Talent – the ballplayer, the author, the investment banker -- started to get smart.  It started pressing its case and making larger and more audacious demands – whether it was Marvin Miller securing free agency for baseball players, Mort Janklow making sure authors kept their advances even if publishers changes their minds about publishing their books, Lauren Hutton holding out for big bucks to supermodel, or George Lucas demanding that he own any and all sequels to Star Wars.  Or, in violation of my basic principle, of Ehrlich’s Rule, they suddenly got smarter and better than their predecessors.

Well, if that doesn’t explain the very obvious trend of “Talent” getting more money in our economy, then what does?  If Frank and Cook are missing something when they describe the “winner takes all society,” what is it?

It’s this – “Talent” really means “skilled service providers,” and we have seen in recent decades dramatic increases in the economies of scale (and operational leverage) of service provision.  Ballplayers, entertainers, producers, and even CEOs are paid more now than previously because their potential contribution is now far greater than it was in prior decades, because of technology and globalization.  Yes, cronyism and idiosyncratic circumstances gave Nardelli a ridiculous severance or let Dick Grasso shake his board down for more money than real risk-takers made.  But the broader trends are not about who has bigger stones in negotiations.  They’re about underlying economics.

Lucas got an extraordinary deal on Star Wars sequels.  He was a great negotiator and had a good agent.  But he also happened to be in the right place at the right time.  In broad brush, the studio control of movies, which in the 1960s gave us Oliver, the Sound of Music, Lawrence of Arabia, and the like, was being challenged by the work of more independent directors and auteurs – Stallone’s Rocky, Woody Allen’s Annie Hall, Cuckoo’s Nest, to which the Douglas family had held the rights going back to when Kirk Douglas played McMurtry on stage.  Two Godfather films had already been awarded Best Picture.  The studios had already been weakened substantially – I mean, how else do you explain Robert Evans being in charge of one?  And at the same time, the world’s film market was becoming ever more global, and the success of the new auteurs was expanding their audience demographically – people who weren’t interested in Julie Andrews, but wanted to see Midnight Cowboy or Bonnie and Clyde.

So the moment was right for a rebalancing of the studios and the “Talent.”  And Lucas was a smart guy who hit upon the right moment.  In fact, he was the guy who told Coppola to take the Godfather assignment, which led to two Oscars before Lucas even began thinking about making Star Wars – so Lucas knew what sequels meant.  Besides, it’s only in retrospect that he looks like a genius.  Fox, which made Star Wars, was the only studio that didn’t turn Lucas down.  Who cared about sequels to a movie that the studio geniuses didn’t get?

Or consider Marvin Miller.  I have the privilege of knowing Miller, and it is a privilege.  His accomplishment – the liberation of ball players from the obligations of the “reserve clause” that bound them to one Club for as long as the club wanted them – is truly remarkable.  It’s best described elsewhere, (starting with his own account) but, in essence, he fashioned a very deliberate, multi-staged, long-term strategy to establish that the clause in question could only bind a player for one year, not perpetuity, and that once that year was done, the player was free to sell his services as would any other worker in any other industry.

But what if Miller had been active in the 1930s, or even the 1950s?   The underlying economics wouldn’t have supported his vision.  He would have been right about the legality of the reserve clause, but his victory wouldn’t have had the same effect.  Leaving aside the economy of the 1930’s, up until the 1960s, reserve clause baseball was an uncompetitive, New York-centric affair.  Until the 1961 American League expansion, all of baseball’s attendance records belonged to the 1948 season, led by Bill Veeck’s Cleveland Indians.

But by the late 1960s, things had changed.  Baseball had expanded or relocated to the West (LA and San Francisco) and the South (Houston and Atlanta), making national media more valuable and expanding attendance and revenue opportunities.  Changes in the amateur draft opened up competition and made baseball more lucrative in places such as Cincinnati, Baltimore, or Pittsburgh, and new stadia furthered interest, even if those stadia – Riverfront, Three Rivers, the original Busch Stadium, the Astrodome, Veterans Stadium – are now derided when compared to the facilities that replaced them. 

And, in fact, the free agency Miller won made baseball even more multipolar and therefore prospectively lucrative; in the ten years 1981 through 1989, sixteen different Clubs appeared in the ten World Series, even more than the thirteen that showed up in the decade just past.  Branch Rickey, like Miller, another Rushmore-level figure in baseball history, said it best – “Luck is the residue of opportunity and design.”

Don’t believe it?  Try it this way.  To believe otherwise is to believe that baseball’s owners experienced rapid revenue growth in the period after the institution of free agency and raised their prices and negotiated better television deals only because players were demanding more money – that they were leaving immense quantities of money on the table.  Nonsense.  Free agency was an important accomplishment and it made baseball better, but it also happened at a propitious moment.  It takes nothing away from Miller to note that.

Or consider entertainment.  About twenty years ago, I heard a senior executive of a European media conglomerate say – please imagine a thick German accent coming from behind a nimbus of cigar smoke – “Whitney Houston is a commodity.  And we deploy this commodity over a series of markets so as to maximize our rate of return.”  Can there be a better statement of operational leverage and scale-building in services?  And if it were true then, isn’t it even more true for, say Lady Gaga, whoever the hell she is?   Presley was on Ed Sullivan once and the world went nuts.  The Beatles made A Hard Day’s Night because their studio thought a movie would sell more records!  But the opportunities for Presley or even The Beatles to realize revenue were miniscule compared to a global, net-based market today.  Of course today’s entertainers – that is, service providers – outearn their counterparts of prior decades, even if they’ll never have the same impact. 

The same thinking – that changes in the provision of services, be they sports, entertainment, or even finance – are what’s behind the advent of “Talent,” as Gladwell has it, or “the winner takes all society,” as Frank and Cook do – extends to corporate management and to finance.  Gladwell is fascinated with the imbalance of power that occurred when Goldman Sachs took Ford Motors public in 1956.  It was, as Gladwell describes it, “the biggest initial public offering in history.”  Ford paid Sidney Weinberg, Goldman’s head, all of $250,000 for his efforts, a pittance and a fraction of what would be considered customary today.

But look at what we’re dealing with.  Ford was then a global company, selling cars around the world and part of a cozy American oligopoly.  Goldman was, by comparison, a small and not terribly important company – cars were a more global and extensive product than capital or finance.  David Rockefeller’s Chase Manhattan was a global bank, to be sure, but it worked on what we used to call “sneakernet” – it had scale and relationships, but nothing like the operational leverage finance does today.  But the advent of global finance, first in the Euromarkets, then through the informating and digitalization of capital, has made leading financial firms such as Goldman larger and more productive – they can originate more capital more easily and the opportunities to place it are far more extensive.  Sidney Weinberg wasn’t an idiot – I mean, do you think that the current generation of Goldman leadership is that much more aggressive or capable of representing their interests than Weinberg was?  Or that the companies being taken public today aren’t led by people as or more competent than an aging, cantankerous anti-Semite like Ford?

In fact, I see escalating corporate salaries in the same light.  The ratio of corporate executive pay to that of the average worker is rising off the charts, granted.  But the job of CEOs is expanding in scope, while the “average worker” is often handicapped by the same trends of globalization and technological progress.  The CEO is really a service provider to the firm, and is large part of the firm’s “brand” in capital markets, which themselves are more global and volatile.  And the environment within which any firm operates today is more complex than it was in Henry Ford’s day.  The difference between a good and bad guy in that role today is of far greater consequence than it was then.

Look, the point of this isn’t that the amounts of money that people get in life are just or, in some cases, remotely excusable.  But the question of how much inequality we want to tolerate is a separate one.  Gladwell doesn’t understand why the phenomenon about which he writes occurs.  It’s gloss substituting for good social science.  But the even greater injury might be the implication that the “average worker” – a person who is “Labor” or “Work” instead of “Talent,” let alone “Capital” – somehow screwed up, and that their ever-tenuous plight, their sad role as benighted denominator under the numerator of scale-driven CEO pay, is in some way deserved, a payback for their inability to grab the ring the way Lauren Hutton or Catfish Hunter or Robert Nardelli did.  Where else does Gladwell’s argument lead?  Does he think Henry Ford deserved to keep the money he didn’t pay Sid Weinberg, or that Stan Musial was doing the right thing when he put money in Cardinals owner Sam Breadon’s pocket?  Does he think that baseball today is other than a six-plus billion dollar industry?

And in the even larger sense, Gladwell’s concern about “Talent’s” prerogatives misdirects the problem.  The most important distributional problem we face today is not that ballplayers or movie producers or bankers make a lot of money, or even that guys like Nardelli or Grasso get away with it.  The problem is that teachers and factory hands and people who mop floors and empty bedpans are paid so little.  There’s the place to start making normative judgments about who gets what.

Public Works

In my last entry, I discussed one of two stimulus programs proposed by the President over the Labor Day weekend -- one that would reduce the taxes paid on investments.  Today, I want to address the second proposal -- one for a National Infrastructure Bank, (as opposed to the Nationals Infrastructure Bank, which hopefully will sign Adam Dunn as soon as the season's over).

I’m giving a paper at a conference this week.  The conference is the 2nd Annual North American Strategic Infrastructure Leadership Forum, an endeavor co-sponsored by an infrastructure consultant named CG/LA Infrastructure LLC and the Progressive Policy Institute, and the paper I'm giving can be found elsewhere on this site.  As a rule, I don't attend conferences – a conference is really the worst place for a narcissistic agoraphobic such as me – but this one is interesting if you think infrastructure is interesting and I do.  As my plea for policy reform in the area, co-authored with Felix Rohatyn and visible here begins,  these are rare times of ferment in one of the most neglected fields of public policy – the nation’s infrastructure, or what used to be known as public works.  OK, it’s not as catchy as “A specter is haunting Europe.” Or “Call me Ishmael.”  But it makes its point.

In fact, it made the point pretty well.  Since that article and, more importantly, the work of the Center for Strategic and International Studies Commission on Public Infrastructure (that Rohatyn and former Senator Warren Rudman co-chaired and which I served as Executive Director), we have seen a flurry of infrastructure “Bank” proposals.  The most conspicuous and yet incomplete of these was one by President Obama, who announced early in September that he would seek to create a National Infrastructure Bank that would invest in transport projects (including inter-city rapid rail and the next generation of air traffic control).  Much of the first $50 billion it would give out would come from ending some favorable tax treatments received by the oil and gas industry.  But beyond that, we don’t know much else, and the administration has been conspicuous in not putting its energies behind this opening salvo.  In fact, it’s been something of a meteor, briefly lighting up the night sky and then falling to Earth, unseen.

Infrastructure is a remarkable area – everybody’s for it, nobody talks about it as if it were government waste, fraud, or abuse, the policies that govern it are at best outdated and, more straightforwardly, sadly mistaken and much-abused, and nobody has any desire to fix them.  Consider the Highway Trust Fund or, as it might be called, the Road Fairy.  If a road makes it on to its list, then it gets either 90 or 75 percent of its costs paid for by the Feds.  The list, of course, is made by state legislatures who, armed with their superior knowledge of local conditions, spread the money around in ways that are largely divorced from national needs – unfortunately, the local conditions with which they’re most familiar are political ones.  Moreover, the money that keeps this zombie lurching forward is drying up, because it’s paid for by a motor fuels tax, and thanks to the recession, the higher price of gas, and gains in fleet fuel efficiency, all of which means fewer gallons of motor fuels are consumed. 

So here we have a program that was designed to get states to build the Interstate Highway System and did a damn good job of doing that, but now is pitifully ill-equipped to shift from construction and large-scale rehabilitation to ongoing maintenance and – and this is the future – non-structural management of our roads -- retrofitting technology onto highways that vary speed limits and traffic flow or that links road management to the availability of parking, or worse, forcing users to bear more of the costs they create through congestion-aware peak load pricing – variable tolls – or, as successfully done in London, fees for bringing your car downtown.  Or we might consider the Corps of Engineers, which is directed by the Congress to rationalize and perpetrate navigation projects with meager economic benefits yet regrettable environmental consequences, much as they famously favored a Louisiana barge project while constructing the levies that failed to protect New Orleans.

The problems raised by these types of programs are many.  It’s often not worth having the Feds pay for 75, or 90, or 100 percent of such a project, given the benefits they convey to local users.  This freedom from cost leads to near-infinite lists of infrastructure “needs” and to project selection unrelated to benefits.  It biases states and localities away from non-structural approaches and towards pouring concrete.  It leads states and localities to postpone legitimate projects (along with some bad ones) in the hope that their project might come up heads either in Washington or their state capital.

It’s time to sweep this mess clean.  And when I say that, I mean the rules that lead the system into this mess.  The people who work at the Corps or the Federal Highway Administration aren’t conspirators against the public weal; they’re technically competent folks who are doing what their organizations have been told to do.  The problem is the rules.

But no one wants to change the rules, even though they all know how bad they are.  For one, the concrete-pouring industry has worked up a healthy set of relationships in Washington and in state capitals that would be stripped of value in a process that took all infrastructure projects, regardless of type, and ranked them according to some measure of social return. – in other words, a rational [process for guiding investment.  and few politicians are prepared to move to a system thatr relies on users paying a fair share of their costs.  Many see the Infrastructure Bank as a way to produce 'free money' -- that divine oxymoron! -- by attracting private capital that "leverages" or 'gears" public dollars, but without returns to attract taht capital, it either won't be forthcoming, or will turn the bank into a Fannie Mae for roads.

And it doesn’t need to involve a sweeping re-organization of the entire apparatus – at least not on Day One.  In 1998, the federal government created a special (but not very big) pot of money named TIFIA for the Transportation Infrastructure Finance and Innovation Act that would finance “whatever” so long as it made sense.  We could blow that up to the $50 billion proposed by the President, give the program to the “Bank,” and start teaching the people who inhabit the transportation system new rules about project appraisal and selection.  From there, we could require that any federal involvement in any infrastructure project – regardless of whether it funded the national air traffic system or a road connecting one exurb to the next one – be evaluated by the “Bank” and approved as being not just shovel-ready, but shovel-worthy.  And we could then start taking the threshold for this evaluation down.

Those of you who are interested in infrastructure can go enjoy the paper – it’s not Nabakov, but it’ll do.  The rest of us, however, can hope that the administration is ready to change the way we invest in our infrastructure.  In 2009, it abandoned the idea of picking “shovel-worthy” projects and instead focused on what was “shovel-ready.”  It’s time to re-engineer the system so that the two become one.

An Arm And A Leg

The President this week announced two stimulus programs.  The first was some sort of a national infrastructure bank that would focus on transportation.  The second was a proposal to allow the expensing of all investment, that is, to allow all of the costs of a new piece of equipment or software to be deductable from income in the year the investment is made instead of being spread over the life of the investment.

Today I’m going to talk about the latter – we’ll discuss infrastructure some other time.  I’ve made some infrastructure proposals before, particularly regarding a National Infrastructure Bank, which I’ve written about with the true father of the idea, Felix Rohatyn.  The Administration has never shown any interest in this approach, and it’s not clear what their current thinking is, or what they’re really proposing.  I’m going to be talking about this at a conference at the end of the month, so let’s wait until then.

Now…tax incentives for investment, or “expensing.”

When you buy a building, or equipment, or software, you deduct its cost from your income (for the purpose of paying your taxes) over a bunch of years, because the thing you bought is going to provide you with service for a bunch of years.  That cost is called depreciation, because it represents the extent to which the machine lost value over the year in question. 

So if a piece of equipment has a useful life of ten years, you ought to spread its cost over ten years of tax returns.  If you don’t, you’re in effect subsidizing the investment, because you’re allowing the company in question to write down their incomes (and therefore their taxes) faster than it depreciates and, therefore, faster than the company would otherwise lower its tax bill. 

The President announced last week that he would seek to allow the expensing of investment.   The motivation, we’re supposed to think, is that this subsidizes investment – makes it cheaper – and therefore we’ll see more of it.  I mean, no one’s opposed to more investment, right?

The only problem with this argument is that the idea of a new and prospectively expensive tax credit to allow expensing of investment makes no sense in the current environment.  The level of investment in today’s economy is not constrained because it’s too expensive to invest.  In fact, it’s not really that constrained at all.  Investment is one of the few good spots in the current economic mess; it grew at an annual rate of over 20 percent in the first half of the year, and why shouldn’t it?  Interest rates are cheap as hell – I sure hope you’ve refinanced your mortgage recently, particularly if the mortgage rate you’re paying starts with a “5” --  and companies are flush with cash.  The Corporate sector, having gone through a restructuring of its balance sheet, is sitting on nearly $2 trillion in cash and liquid instruments.  So the true cost of investment is already pretty low, and neither the cost of investment nor the wherewithal to fund it is a problem in today’s environment. 

The problem is uncertainty about demand, and there is no tax-based fix to this problem, at least none involving depreciation rates.  The best reason not to invest right now is that it’s hard to say whether the things your investment produces can be sold.  A tax subsidy for investment right now only rewards investment that would have been made in the first place.  In fact, in a paradoxical way, there’s never really a “good” time to try to stimulate investment through taxes.  At moments such as these, when the problem is weak demand, investment is going to respond to this kind of incentive.  And when we’re in a phase of the economy when investment is flowing and companies might be susceptible to an incentive, they usually don’t need one.  They’re already investing.  And if the cost of capital is too high, then there are better ways to lower it – cut tax rates if they’re too high, pursue disinflationary policies, or cut federal deficits to eliminate government competition for a fixed pool of savings (as we’ll have to do at some point in the next few years).  But for now, bribing companies to invest more when they’re already growing investment and when all the determinants of investment are favorable except that people aren’t buying things is dumb, just plain-ass dumb. 

If we are going to pay someone to provide demand, there are far better candidates than a flush corporate sector, namely, households.  I’ve seen a variety of recent proposals to find ways to lower mortgage costs for people who don’t walk away from an underwater house – here’s one reported by Allan Sloan, a wonderful financial journalist.   

That would do all sorts of good starting with creating purchasing power by lowering payments and keeping houses off the market and therefore stabilizing house prices.

But underneath all of this is my suspicion that the Administration isn’t really that interested in expensing investment in order to subsidize it.  I think they’re trying to architect a situation in which Republicans Senators and Congresspeople are put in a position in which they have to vote against such a nakedly pro-business measure.  It’s a game of gotcha.

And I can’t imagine for the life of me how it works.  If I were an intransigent Republican member, why would I start voting for anything the Administration proposed, particularly now?  I’ve already made believe that health care was socialism and that it involve death panels, that climate change is a fraud and really just a tax increase, that stimulus wasn’t needed and didn’t prevent a disaster, that the bail-out was unnecessary and also didn’t prevent a disaster, and that deficits are dangerous now that a Democratic President has been forced to increase them, as opposed to his predecessor, who increased them unhesitatingly and unceasingly.  Why deal with reality at this late date?

No, if I’m Boehner or McConnell or one of those guys, I smile and say, “Well, that’s an interesting proposal, but we’d be better off taking a deep breath and coming back next year to rethink our entire approach,” and shake my head sadly while contemplating the need to rethink, meaning, let’s wait until we take over the Congress next year.  Then we can put something like the expensing of investment in our proposal, and dare the President to veto it after he supported it a few moments ago.

And that brings to mind a lesson Ron Brown, the late and much lamented Commerce Secretary and my boss for much of my time in the Clinton Administration, taught me once.  “When a shark approaches you, and you try to compromise and satisfy it by giving it an arm and a leg, it never says thank you.  It eats your arm and leg and then says, ‘What else you got?’”

By raising the idea of investment incentives, the Administration has given the shark its arm and leg.  We don’t need those incentives right now, and advocating for them only sucks up oxygen needed for legitimate efforts to restimulate the economy.  And someone needs to explain to me why, at this moment, you feed up your very few remaining arms and legs.

Baggage Handlers

I have a new favorite television show, although it will have to work hard to maintain that distinction once a new season of 30 Rock resumes – Baggage.  Baggage, simply put, is The Dating Game for neurotics and misfits.  Three contestants (“datees”) stand before a solitary “dator” and serially reveal three things about themselves that constitute their baggage – they believe they were descended by aliens, they save their hair from bikini waxes, they have specific sexual limitations or demands, they use coupons on dates, they were in a cult, and so on.  After three rounds, the dator picks a winner, but the dator must then reveal his or her own foible – my mother will always come first, I live with my ex-husband, I once was a pimp – and the selected date then decides if they’ll spend a romantic evening together at a restaurant in Beverly Hills or some such.

Well, where do you start peeling the onion?  At the simplest level, Baggage is a tremendous will-he-or-won’t-she proposition.  Will the New Age-y physical therapist, having weathered the selection process, be deterred when it turns out the guy who picked her is a bankrupt circus performer?  (She did, I’m pleased to report.  He seemed like a lovely guy and they looked genuinely pleased to meet each other.)  Or, in perhaps my favorite episode, the geeky-looking Star Trek devotee reveals in his final “piece of baggage” (suitcases are used quite dramatically for props) that he’s an award-winning porn star, and the very good looking woman charged with the selection, who had shown no interest in, if not outright disdain for, him, has an agonizing and instant reappraisal.  She picks him (with the active encouragement of my wife and daughter from a distance), and then reveals her baggage – she insists that a man pay for everything on dates – she even pumps her fist Arsenio-style when the audience catcalls in response.  In other words, an asshole.  The porn star shrugs and tells her that he knows all sorts of beautiful women (on a daily basis) and that he had hoped to meet someone with “more depth.”   He walks away, leaving her stunned, but then again, people without depth are often stunned in such moments.

There is also the host of Baggage, Jerry Springer.  I’ve always found him distasteful, but here, he’s in full flower.  He projects a sense of detached and intelligent amusement with the proceedings, and his occasional quipping is at its best delightfully reminiscent of (and this is the highest flattery possible) Groucho Marx.  It’s Springer, of course, so there’s a regrettable undertow to the smutty, and in Baggage’s second season there’s a little more of this, while the audience has been encouraged to voice their opinions, much as a similar audience doomed gladiators two millennia ago.  But it all works. 

Down another layer, Baggage is a field investigation into the calculus of mate selection.  I don’t want to go all Gary Becker on you and talk about how there’s a market for marriage and that you have to maximize your potential value in exchange when picking somebody against whom you’ve created a call option for a lifelong risk sharing agreement.  Character, age, looks, wealth, habits – all of it is somehow traded off in the mate selection market.  As Marilyn Monroe tells Charles Coburn in Gentlemen Prefer Blondes, after he’s accused her of marrying his son for the son’s money, “No, I’m marrying him for your money.”  Money in a man, she goes on to explain, is like good looks in a woman – just another superficial reason why people don’t address intimacy as a facet of their self-actualization in a sense reminiscent of Fromm, or Carl Rogers – well, that’s not really what she said, but it’s what she meant, I could tell.  Do a guy’s looks compensate for his ploy of trying to meet girls at gay bars?  How does a market participant assess a woman who is good-looking, flirts in French, and has a graduate education, but who is saving herself marriage and may well be a religious crackpot?  I have the fantasy that Malcolm Gladwell is a contestant on the program and intuits a selection who turns out to have a wardrobe of matching woman-and-dog outfits or movres their bowels every two hours or is currently involved with an 80-year-old man.  Look before you blink, brother.

And once we peel away these musing, we get down to the basics – economics.  The New York Times reported recently that Baggage is the runaway hit of the Game Show Network, one in the endless series of life-splintering cable channels (moving inexorably towards my friend David Moore’s prediction, made years ago, of The Parking Channel).  (Be sure to click the Times link – the woman in the red dress is the abstinent French speaker – she accepted the sofa-sleeping guy pictured with her.)   The Game Show Network, says the Times, is up 20 percent in the last three years, with Baggage the flagship of its recent efforts to create new programming (as opposed to its staple, reruns of the iconic Match Game and Hollywood Squares.  There are, apparently, 472,999 other households watching Springer.  But GSN’s strategy is not just to create programming, but to use the cable network as a platform for on-line gaming, live gaming on television, and as a partner for such websites as Pogo.com, purveyors of Poppit, which can destroy your day’s schedule if you’re not careful and have my specific personality disorder.

And at the nub of the economics is the role of aggregators, people you pay to buy your television programming for you, like Comcast or Time Warner or Verizon or ATT.  Their role was raised once again last week when Apple announced its revamped Apple TV device, a $99 box that plugs into your television and that delivers first-run television episodes for 99 cents each.  Sure, I’d pay 99 cents – if I had to – for an episode of 30 Rock – heck, at $10 a month of whatever it costs, I was paying that or more for episodes of The Sopranos and The Wire by subscribing to HBO. 

But Apple’s attempt to make this product work, and to make the pay-per-view model work for all of television, raises the question of whether people want to watch television that way.  I’m sure many people have, at some point, looked at their cable (or fiber) television bill and thought, “Why am I paying $50 a month for all this crap like Baggage when all I really want to watch is CNN and the Food Channel?”

But what that complaint misses is that cable, fiber, or whomever is an aggregator – they use their scale and presence in the market to get you the best rate on the Food Channel, GSN, or whatever it is.  The rights fees paid by cable television providers for something like the Food Channel is probably something on the order of 20 cents per household.  If Apple TV were to be the dominant medium and model, the ability to sell programming to cable and fiber aggregators with tens of millions of viewers would disappear.  Instead, networks such as The Food Channel would hone in on their core audiences and charge them the kind of rates others pay for HBO or Showtime, let’s say $10 a month.  You do the math – if you raise your monthly carriage fee 50-fold and keep more than 2 percent of your old audience, you’re ahead.  In essence, cable/fiber aggregators let you pay what you’d have been willing to pay for the stuff you watch regularly and then throw in the rest for free, and the free stuff is where I found Baggage, It’s Always Sunny in Philadelphia, and other light classics.

The proponents of Apple TV and the pay for service model note that the iPod put a fork into radio and records, and that the same will happen here.  I doubt it.  For one, they haven’t thought through the role of aggregators in getting consumers a mix of price and variety that will look attractive when they consider the alternative.  Second, television has a live component that gives it an ace in the hole – sports obviously comes to mind.   Fox’s regional sports channel only recently decided to pay the Detroit Tigers $40 million a year for ten years for the right to televise their games.  It’s a fairly substantial amount of money, but where else do you find programming that people will watch real-time, including commercials?

And, most crucially, people watch all sorts of programming, from Baggage and Inspector Poirrot.  But when you get down to it, my musical tastes run from A to B – my Pandora channels range from Bireli Lagrene to Count Basie to Art Farmer, with a Johnny Winter in case I need to amp it up a little.  But three out of the other four think they should play Stan Getz.   (When you ask Pandora for Red Shadow: The Economics Rock and Roll Band…well, I’ve never seen a digital device spit up before.)  I get XM for the ball games – otherwise, my jazz collection anticipates my tastes as well as theirs and the Grateful Dead channel is only interesting in small bursts, and even then, only when the burnouts who host it shut up.  I’m sure other people’s musical tastes are as limited, even if not as well-developed.   

So my guess is that the much-anticipated iAssault on programming aggregators isn’t about to take down the citadel.  In fact, other digital developments, like a monthly charge for access to up-market hulu, run the other way – they’re asking to be your aggregator, but on a different technological platform.  But perhaps the last and final lesson in the nesting-dolls of Baggage implications is that I might be wrong.  It’s happened before. 

But it makes no difference.  Content aggregators and pay-per-view (or click) providers are betting large quantities of money that they’re right, and we’ll find out soon enough.  And when the policy debate in telecommunications talks about a “cable/telco duopoly,” it misses this point.  Perhaps the most important competition underway in that world today is the competition of business models.  What does the consumer want – aggregators, pay-per-click, steaming, storage, discounts for time commitments, all you can eat?  Nobody knows, but people are investing to back up their guesses.  And beyond static price competition, this model competition is the most important feature of the market today.  It will decide who will become the next generation of Baggage handlers.

Sale of the Century

Here’s an interesting item from this week’s financial pages;  Norfolk Southern, the railroad company, has just sold to the public $250 million worth of bonds that will reach maturity in a hundred years.    These so-aptly-named “century bonds” will pay an interest rate of 5.95 percent until they are paid off, in 2110, presuming that the space aliens don’t land before then and conquer the cockroach people who survive the nuclear holocaust.   

The idea of lending someone – including a respectable company, even if not a top-tier one – money for a century seems outlandish to some people, I’m sure.  And in a way it is.  But in another and probably more important way, it’s not.  If you apply simple discounting – that is, using some arithmetic that reflects the time value of money -- the difference between a century bond and, say, a 30-year bond (the usual outer limit of bond “duration”) is not that large. 

I once came dangerously close to being the Dean of a Business School whose name I will not offer but that rhymes with Schmyracuse, and part of my platform was that every undergraduate should be required to take an elementary course in finance – meaning learning about the nature of risk, how companies report their income and wealth, and the nature of discounting to account for time.  And I still believe it.  So I will now address the third topic, class – the nature of discounting.  If you know about discounting, you can not only skip the following paragraph, but you can write a blog of your own.

Let’s start here.  If you promise me $100 tomorrow, that’s worth $100.  But if you promise me $100 ten years from now, and I can make 5.95 percent interest on my money between now and then, that $100 is only worth $56.10 to me right now, since I could put $56.10 away today and it would grow to $100 in ten years at that rate of interest.  If I had to wait 80 years for $100, I’d be just as well off with $1 today.   And if I had to wait a hundred years, that hundred dollar promise would only be worth thirty cents. 

If you apply this discounting to a $1,000 bond that pays 5.95 percent – meaning it pays $59.50 a year in “coupons”--  and then pays back the original $1,000, it turns out that 82 percent of the money you get over those hundred years happens in the first thirty years.  So a century bond is really only about 22 percent “riskier” than a 30-year bond (because after 30 years, 18 percent of the value remains and you’ve already been paid 82 percent, and 18 divided by 82 is 22 percent).  In fact, if Norfolk Southern had sold 30 year bonds instead, the interest rate it would have had to pay would probably only be about one percentage point lower than 5.95 percent (given where the bond market is today) which is about 20-odd percent less than 5.95 percent.  Believe me, there are squirrels at computers all around the world making sure this stuff works out.

So as long as you assume that the world oozes forward from one moment to the next without changing in a very interesting away, lending for 100 years is only marginally different from lending for 30 – in for a dollar, in for a dime, so to speak.

But if things start to change, then a longer bond gets more…interesting.  For example, Ford sold a bunch of century bonds in 1997 and they were worth 15 cents on the dollar at one point one short decade later.   And that takes us to the three reasons why a bond changes value.

The first is that the company in question, like Ford, (or the government – think Greece or Illinois) might not repay.  In fact, if it weren’t for this risk of default, all bonds would have roughly the same interest rate at any moment – it’s the risk of default that makes one bond more “risky” than another.   That was the brilliance of Credit Default Swaps, the financial derivative that led to the meltdown of the world a few years ago.  If I bought a $10 million CDS from you for Blobbo Corporation, for example, I paid you a small fee every year, but if Blobbo ever defaulted on its debt (which is called a “credit event,” much as we would call spewing chunks a “peristalsis event”), you would have to pay me the whole $10 million.  This was a great way to fine-tune exactly how risky individual companies were.  But when everybody went broke at the same time, it became the financial equivalent of everybody racing hysterically to the door during a club fire.

That’s the largest risk and, again, time heals all wounds – if Norfolk Southern goes broke decades from now, it becomes a “who cares?” moment.  Let’s try it this way.  NS could offer a 30 year bond for 4.95 percent or a 100 year bond for 5.95 percent.  So every year I get my 5.95 percent interest, I come out ahead. 

OK then, how long do I have to come out ahead before I do as well as I did by buying the 4.95 percent bond?  The answer is – 37 years.  That is, if I buy a 30 year bond worth one dollar at an interest rate of 4.95 percent and discount the payments I get (including total repayment after 30 years) at that same 4.95 percent, the present value of all those payments is… $1.0495.  But if I’m earning 5.95 percent interest and discounting those payments at 4.95 percent, I make the equivalent of 1.0495 after 37 years.  Even if the bond defaults - -turns into some wampum stardust vapor and is never seen again – after those 37 years, the extra one percent I made each year compensates me for that loss.  So if you offer me an extra percentage point of interest, after 37 years anything else I get is gravy.  And the payback after the century is over is just a very small cherry on top of a whole lot of ice cream.

So that’s the risk.  If NS goes broke in 100 years or 30 years, it makes only a little difference.  Now, I don’t know where NS will be in 30 years.  Railroads haul a lot of bulk commodities – like coal and grains – and who knows what those markets will be like with climate change, geographic and demographic population shifts, and other large-scale changes already underway around us.  But, from a bond market point of view, a calamity in 30 years and a calamity in 100 years isn’t all that different. 

I said there were three other reasons why bonds change in value, and we’ve only discussed one – the probability of default by the borrower.  The second reason is a change in the value of bonds generally – if there are too many bonds out there, you have to make your bond cheaper to attract the attention of buyers.  Or – and this means the same thing – you have to offer more interest to get your bond to stand out when investors go to the Bond Store.  That’s why large government deficits are bad – all those government bonds compete with the bonds of Norfolk Southern and every other private lender for investor attention.

And the third reason why bonds change in value is because the thing that people trade to get bonds – money -- changes in value.  If inflation is high, then the money I’ll be repaid with 30 or 100 years down the line won’t be worth much, which means I want more interest to compensate me for the fact that I leant Norfolk Southern dollar bills but they’re repaying me with Kleenex.  No mystery there.

The last two reasons are the ones that are perhaps the most interesting about the 100 year bond.  It goes to show that, today, money is cheap.  Much has been made about the massive debts that we’ve run up, and they are indeed massive.  When you do the math, Medicare is going to have to change substantially, not all of Social Security will be paid, and somebody’s taxes are going to have to rise one day.  There is simply no mathematical way to keep the debt from growing as a share of the economy, let alone take it back to something resembling the situation that President Bush inherited.  None of those outcomes are going to be easy to accomplish, particularly in an environment when people go nuts over a Muslim community center.  And there are still economists who will tell you that the incredible cheap-credit policy run by the Fed since the meltdown in 2008 will produce copious amounts of inflation down the line.

I disagree with the latter – I think the natural state of the world is deflation, not inflation, and that the inflation that accompanied the end of the postwar order in the 1970s was a historic aberration specific to that moment.  But there’s no disputing the former – our government, and the other governments around the world, owe a good deal of money.  Do the people who are lending money for 30 years, or a hundred years, just not get it?

That’s hard to figure.  More likely is that there is so little borrowing going on for purposes of investment that there’s an overhang of saving in the economy today, which speaks to the tepid recovery.  And it argues that there’s ample room in the economy for further stimulus.  As I wrote on The Daily Beast this week, in support of its “Manifesto”: 

Economic policy under the Obama Administration has succeeded in averting the most stunning economic implosion since the Great Depression. And it almost succeeded in setting a sustained recovery in motion. But just at the point when self-sustaining growth was about to take hold, the world was buffeted by a new crisis in the Eurozone, which confronted the economy with new uncertainty and stifled growth. Economists are right to worry about the growth in federal debt. Hopefully, their rectitude will persist into 2012 and 2013, when deficit reduction will be of growing importance. But, for the moment, the economy’s primary need is additional stimulus, not fiscal contraction. The examples of overstimulus during economic crises are few if any. Moreover, the primary danger of overstimulus, inflation, is far from a realistic concern – the real threat is deflation, which favors deferring demand and investment. And if the overhang of federal debt were an active (as opposed to prospective) concern, the interest rate on 10 year government bonds would be substantially in excess of the current and paltry 2.6 percent. The economy is primed for growth. Banks hold over a trillion in nonborrowed reserves. Corporations have accumulated $1.8 trillion in cash. But a spark is needed to turn this kindling into a fire. Only government can do this – stimulus will never be more appropriate nor prospectively productive than it is now. We should extend employer Social Security tax reductions, provide more aid to the states and localities, commit to a long-term program of public infrastructure investment, and use the Fed’s balance sheet to buy small business loans from banks if they will absorb the first 10 – 15 percent of possible loss.

So long as a second-tier railroad can borrow money at slightly less than 6 percent for a hundred years, those words hold true.

The Red Guards

Let’s review the bidding.  Last April, a court ruled that the FCC didn’t have a legal basis to implement “net neutrality,” the principle that everything on the Internet has to travel on the same speed and circumstances, whether your heart monitor attached to a remote medical station or a video of a cat playing the xylophone.  Or, alternatively, if a promoter were to put a live high-def concert of the Black-Eyed Peas on the Internet, and were to offer to pay Comcast, Verizon, and whomever else for an express lane to your computer so there would be no buffering problem and Fergie wouldn’t freeze up in the middle of Boom Boom Pow, the FCC would be legally bound to tell him to screw off.

The FCC, which has been promising “the groups,” as we call associations with an “interest,” whether “special” or “public,” that net neutrality regulation was on the way, was confronted with a hard choice.  Two options immediately suggested themselves.  One was that the FCC could abandon the campaign and get on with other tasks – like working to extend the high-speed Internet to unserved neighborhoods and communities and developing information standards that let consumers know the real cost and quality of the connections they’re buying .  A second was that it could find some other legal basis for neutrality, even if it was tenuous.  It chose the second, arguing that the Internet was essentially like the old Ma Bell phone system and that it could regulate it using the authority it was first given to regulate phones, almost eighty years ago.

At the time, I argued that this was a bad idea – that the courts would laugh them out of the room and the FCC would find itself out of the Internet policy game.  In fact, all the yammering about keeping the Internet “open” and “free of censorship” that you get from the neutrality groups was a cover for what was really a conflict between businesses.  The companies that build fiber and cable (and, increasingly, wireless) connections – Comcast, Verizon, ATT, and so on – wanted the right to offer sites like YouTube and its competitors preferential access in exchange for a posted price, meaning better service for users.  Google (which owns YouTube) and the other Big Websites, understandable, would rather the Internet be regulated instead of having to reveal and pay what a better connection was worth.

That’s really about it.  The reason why we have an “open” Internet, one “free of censorship,” is not because of regulation, but because that’s what consumers want, and if you don’t give them that, they’ll buy their access somewhere else.  When competition works, it’s a bitch.

Back then, I argued that there was a true “Third Way” – sit these guys down in the room and tell them to work it out, so civilization could resume its inexorable march towards progress.  And, quite remarkably – and wholly unrelated to anything I might have to say – we learned last week that the FCC has been doing exactly that!.   They’ve been holding a series of discussions with Verizon, Google, AT&T, Skype, the cable television trade association, and – follow me closely here – the “Open Internet Coalition,” an umbrella group that includes everyone from Amazon and Sony to the ACLU to neutrality advocate groups The Free Press and Public Knowledge.  In fact, after two of these meetings, the Executive Director of the Open Internet Coalition published on the Internet a summary of what the meeting talked about.

Fast forward to last week, when “news” of these “secret deal” meetings was broken.   This reminds me of the old joke about the guy who sees a sign in a hardware store window that says “Porcelain Sinks” and thinks, “everyone knows that!” 

Who “broke” this news?  Let’s see who’s quoted in the press.  Josh Silver, the president of the neutrality-seeking group, Free Press, whose representative was at these meetings,  said the FCC was trying to orchestrate a “secret deal” that risked having the FCC “abdicate its responsibility to protect Internet users.”  Gigi Sohn, president of the like-minded Public Knowledge, whose representative was at these meetings, said that “these kind of meetings where the substance isn’t being revealed go against the chairman’s promise of an open, transparent, and inclusive agency.”

Why did this “news” happen now?  Because, even though these “Secret meetings” have been going on since June and are reported by the FCC, and, according to the FCC, disclosed in public filings, the participants had what the Washington Post called “a rare Saturday session,” meaning they were getting somewhere.

And the possibility of progress towards a stable regulatory regime that allowed heart monitors to move ahead of xylophone-playing cats, and Black-Eyed Peas Concerts or World Cup Finals or whatever else appearing unbuffered on your screen was so unnervingto these groups that FCC Chairman Genachowski shut the process down.

As an enthusiastic friend and supporter of the Administration, I’m dumbfounded.  We were on our way to resolving a difficult problem in a mature, responsible – dare I say it? no-drama– way, and we fold like a cheap suitcase.  This has to be agonizing for Genachowski, who had a base among the groups and now is getting savaged by them.

The same goes for Google, which fanned the neutrality flames but now finds itself on the outside looking in.  For one, if the neutrality types had their way, Apple would have been forced to sell some variant of the iPhone to everybody on every mobile phone system, and Google’s stumbling efforts to enter this market, and the penetration of its Android platform, would have been even further obstructed.  What’s worse, the fringe of the neutrality movement is now discussing “search neutrality," which would ensure that Google doesn’t use nefarious means to manipulate its page rankings.  In essence, this crowd wants Google to reveal the algorithm it uses to rank website pages, which is the greatest industrial secret since the formula for Coca-Cola and the stuff in the coating of Kentucky Fried Chicken (which I think is salt and flecks of lawn mowings).

It’s an age old story, isn’t it?  Leaders and sponsors get devoured by their followers – it reminds you of the Red Guards. 

During the Cultural Revolution in China in the 1960s, a period in which the tree of liberty was amply watered with the blood of tyrants and substantial numbers of others, the Red Guards emerged as a student-based, radical faction.  By mid-1966, millions of them converged on Beijing and Mao openly embraced them, dispatching them throughout the country to root out old thinking, old ideas, and, inevitably old people.  They proceeded to ruin millions of lives, stopping occasionally to eat someone’s liver. 

But the Red Guards ended up trying to screw with factory workers and too many party cadres.  They became a source of division and resentment.  By 1968, Mao told them (reportedly, with a tear in his eye) their Spring Break was over.  Then the People’s Liberation Army started shooting them, less tearfully.

It’s a cautionary tale.

What’s next?

                The debate over whether to do something as simple as extending unemployment insurance highlight the current economic policy impasse.  The recovery we’ve experienced to date has been tepid and disappointing, and there is no agreement on the way out of these woods, let alone whether  the actions  we’ve taken to date worked.  So, in order to answer the question of “what’s next?,” it’s best to start with the question “what happened?”

                Which reminds me of this story.  I’m walking down 35^th Avenue in Jackson Heights, 1963 or ’64, I figure.  A woman in a Rambler heading west suddenly hits the brakes, and the bus behind her plows into the rear of her car.  The bus driver dismounts his bus, and a second bus pulls up behind him.  The second bus driver also alights and hollers to the first, “I saw the whole thing, man.  What happened?” 

                Well, I saw the whole thing, and here’s what happened.  In a nutshell, the Obama program of 2009 worked, and almost worked, in two different senses.  And, as a result, the Obama Administration needs to do more.

                The first sense, the one in which it worked, is that it averted a calamity.  A new paper by former Fed Vice-Chairman Alan Blinder and Moody’s chief economist Mark Zandi is all the rage this week and puts numbers on the magnitude of the disaster we avoided.   It estimates that GDP in 2010 is fully 11.5 percent higher than it would have been, and unemployment roughly 6.5 percent lower, than if we had done absolutely nothing.  Yes, that’s right -- they estimate the unemployment rate would have reached 16.5 percent by the end of this year in the absence of the two policy responses – fiscal stimulus on an unprecedented scale, and a wholesale bail out of the financial system.  And, much to my agreement, they conclude that most of these effects were obtained not by fiscal policy – by stimulating the economy through tax cuts and spending increases – but through financial policy -- wholesale recapitalization of the financial system, in essence, a substitution of public promises (after all, debt, like love, is little more than a promise) for private ones.  It could have been prettier, but it worked.

                I find these numbers entirely believable, but I suspect that the reactions to the Blinder/Zandi paper will parallel my own – however rigorous their work (likely) is (we’ll know about the details of their modeling effort as the discussion about it develops), humans don’t do dissonance well and very few economists accept results that contradict their world view. 

                Some critics of Blinder/Zandi, for example,  will probably argue that markets would have found a way to wire around the dead spots in the financial system, and that their model is hopelessly unable to depict those kinds of counterfactual developments.  (Go back to my June 3 entry, in which I note economist Casey Mulligan’s belief that university endowments and pension funds would step into the role that financial institutions play, that of matching up savers and investors.  I wonder if he still believes something that stupid.  Can you imagine a university endowment with a trading desk?  Harvard's Trust Fund lost...what?  $12 billion out of 3o-something?  They stopped serving hot breakfast in the studnet cafeterias, no lie.  And that's Harvard, where the smart guys are.)   

                 But I confess to being no better when push comes to shove.  My non-surprise over someone showing massive intervention was needed to bring the economy back from the precipice is rooted in my view of markets.  Believing in markets is not an either-or proposition, like being pregnant or left-handed.  You need to have an idea about where they’re strong and weak.  The constant rebalancing performed by markets is a remarkable thing, but markets alone rarely solve economic problems.  You solve an economic problem – like the ones left behind at the end of 2008 – by intervening to create conditions that subsequently allow markets to make adjustments and fill in the details, much as a doctor uses the body’s natural proclivity to heal itself to bring it improve its health.  When the economy is in some semblance of balance and stability, markets are a good way to keep it there.  But just as the body’s instinct for healing and regeneration doesn’t set broken bones or excise necrotic tissue, there are moment in the economy’s development when order and stability must to be restored so that markets have a framework within which to what they do well – coordinate uncountable numbers of individual judgments.  As Earl Weaver used to say (but not here), “always give the ball player a job he can do.”  Asking markets to fix a financial crash or a massively underemployed economy is not a job they can do.   Would the economy be one ninth smaller today, with an unemployment rate of one-in-six, if we’d tried to do that?  The numbers are so large as to be staggering, but the situation that confronted us was staggering as well. 

                The second sense of my opening statement – the one in which the Obama economic policy hasn’t worked – is that the economy hasn’t resumed “normal” growth, that is, growth that reflects the economy’s long-term trend plus a little extra for the usual up-thrust you see at this point in the cycle.  Back on January 30, I opined that it would, that “jobs are on the way.”  I was wrong – jobs have not materialized in significant numbers.  The reason, I think, is that in the Spring the Eurozone crisis emerged, which knocked the props out from under emerging confidence on the part of businesses and, on the rebound, many households.   It’s like the usual scene in disaster movies, somewhere about 75 minutes into the feature, when disaster appears to be averted but then, suddenly, the second shoe drops.

                Yes, this explanation has the quality of the remark that my one-time boss, Unisys Chairman Mike Blumenthal, made to me when paying off a bet on what the dollar-yen exchange rate would be by a certain day – “I was right,” he said as he handed me one of his Dunhill cigars (the terms of the bet), “it’s only a matter of when.”   I’m essentially saying the same gratuitous  thing, but I stand by it.  Absent the second shoe of Europe, we would have been at least much further, and perhaps substantially, down the path to recovery.

                One item of good news is that many of the preconditions to recovery are in place.  In that sense, the situation today reminds me of where we were in the Spring of 2009, but with regard to the stock market.  The market was then at very low levels, and fear was in the air – the DJIA was slightly over 8,000 when the President took office, and was at 6,600 six weeks later.  But it struck me – and having confessed to when I was wrong, I can now talk about when I was right – that earnings and underlying corporate values were strong and that there were immense amounts of cash cowering on the sidelines.  All that was needed was the assurance that there was going to be a program to revive the banking system and stop the financial madness.  The Administration’s announcement of the TARP program gave the idle cash the jolt it needed to enter the market and bring the DJIA to its current trading range in the low 10,000s by the end of the year.  Besides, as I told a friend (at a Mets game that April), if Citigroup isn’t worth more than a dollar a share, I’ll be using my money to build a fire in a cave, so I might as well buy the stock.  It was a rare moment when I was living five minutes in the future.

                The economy is at a similar juncture.  As I said six months ago, the economy in 2008-09 threw more people out of work than it had to, and there’s now a fairly broad consensus that companies are running incredibly lean.  Job loss is no longer the problem.  Firms aren’t hiring more out of uncertainty than because their people are idle. 

                There’s also a line of argument that the Administration’s anti-business instincts are leading companies to defer their hiring.  There have been occasional moments that would give me some pause if I ran a business larger than ESC Company – the darker side of insurance reform, specifically, more employer mandates (even if it’s far from a “government takeover of the health care system,” a statement that will support a clinical diagnosis of hopeless ideological baggage) or the senseless prospect of regulating broadband infrastructure providers.  But the Administration’s intervention to save the financial system, or to stimulate the economy, or to stabilize the auto industry is not why businesses are not hiring today.  That mischaracterizes those actions – there’s a big difference between short term acts designed to avert disaster and socializing the means of production.  Moreover, it’s a pretty foolish view if Blinder and Zandi are remotely right.

                The problem today is that, as in the Spring of 2009, there is too much cash cowering on the sidelines – this time in our banks and firms.  The corporate sector now has $1.8 trillion on its balance sheets, up by a quarter from two years ago.  This means that almost half a trillion has been drained from the economy in those two years – over a three percent of the economy.  Meanwhile, the total loans and leases held by commercial banks peaked at $7.3 trillion in October of 2008 and fell to $6.5 trillion by March, 2009.  It’s made up about half of that loss since then, but there’s still plenty of cash sitting around waiting to be leant.  Bank non-borrowed reserves, which traditionally have varied between nothing and next to nothing (meaning less than $50 billion), now total over a trillion dollars as well.

                The presence of all this idle cash in both the financial and non-financial sectors is an unmistakable sign that we’re not at the point when we can trust the natural healing forces of markets to bring us back to health.  To be sure, there is no active laissez-faire campaign in the debate today – it takes a special kind of free-market braggadocio to say “we’ve done our jobs, time to go home” when the unemployment and foreclosure rates are as high as they are.

                But, instead, the anti-intervention argument has taken two new forms.  The first is the Palin/Beck characterization of the Administration’s socialist bent.  (I’ll bet the people most irritated by that argument are the real socialists!)  The second, and more pressing, is that we can’t afford it – that we’re about to reach the point at which we undermine faith in our government’s ability to repay what it borrows.  Some smart people think so.   But perhaps the idea that further stimulus in the economy is the problem – which means that we will have to hand its rebound over to the natural healing forces of markets -- was best expressed by a car that passed us on I-270 this weekend.  Written in its back window – and I mean, all across the window, like a swim meet pep sign, in a way that obscured the driver’s rear vision – was the epithet MORE JOBS!!  LESS GOVERNMENT SPENDING!!  I credit the driver with finding a sensational new medium for expressing his policy preferences, but, at least in the short term, he just as readily could have written LOSE WEIGHT!! MORE CHOCOLATE CAKE!! and made just as much sense.

                A contraction of government spending at this moment would lead to further unemployment – that‘s a certainty.  But whether more government spending would create more jobs is less certain, or at least a question over which reasonable people differ.  I think the answer is surely more yes than no, but that relying on simple stimulus alone won’t work.

                Stimulus shows up on the agenda because the economy has low levels of demand.  So the standard view is that you use stimulus to restore that demand.  I’ll agree insofar as it’s foolhardy to cut back on spending at such a moment.  The problem is that this prescription is too mechanical.  It as if the answer to the question “why is demand so weak?” was “because we haven’t stimulated the economy enough.”  But the best way to stimulate the economy right now is to give both non-financial and financial firms the confidence, the incentive, the motivation – all these words are appropriate – to part with the cash they’ve accumulated.

                Which means that there’s still an important role for further intervention to get the economy back to growth.  I can imagine a series of steps that would be helpful.  One is another round of revenue sharing to states and large localities, to offset the contractionary effects of spending cutbacks at that level.  A second is an extension of the exemption on employers’ share of Social Security taxes through 2012.  A third is an expansion of the Earned Income Tax Credit, putting more income into the hands of the working poor and de facto raising paychecks.  (I could even imagine deferring some part of the tax increases on higher-income Americans found in the Obama plan if it helped us move forward.)

               And a fourth is a true program of public investment – of “shovel worthy” as opposed to just “shovel ready” projects – a multi-year commitment to the nation’s infrastructure that also includes a program to improve the energy-efficiency of public buildings (most importantly schools) and housing.  The last item seems like a complete no-brainer to me.  It’s an investment that produces some tangible return and creates a range of jobs – from skilled trades to unskilled labor – in precisely those neighborhoods where jobs are most likely needed most.  A large and multi-year program would be a good idea for several reasons.  For one, if intelligently administered, it would fund worthwhile projects.  But it would also avoid the mistake made in the 2009 program, the sense that the projects to be funded had to be ready right away, as if the crisis was going to go away and we’d miss it if we didn’t act right now.  Now we know better.

                 These policies all serve to revive the demand for goods and services, and therefore for labor.  But their effect on the trillions of idle money in the economy today is at best indirect.  Perhaps they will do enough to resolve the uncertainty that now obstructs lending, investment, and employment.  But we should also be prepared to act against these problems.  One way to do so would be to have the Fed purchase packages of commercial bank loans to small and medium size businesses, on the proviso that the originating banks take a meaningful first exposure to loss.  In essence, the program would pay (bribe) banks into making good loans, but not bad ones.

                We can afford this kind of program.  The challenge of the car on I-270 is misplaced.  For all the talk about a “sovereign debt bubble,” the U.S. isn’t Greece.   The cost of borrowing – the so-called “credit spread” -- to European governments with big deficit problems has risen dramatically, alongside markets’ perceptions of the risk that they will one day renege on their promise to pay.  (And, in the case of Greece, I think they’re right.)  But we’re not Greece.  Our cost of borrowing is incredibly low – the ten-year Treasury bond now yields 3 percent.  That’s a sign that we’re not yet testing the bounds of market tolerance.  Moreover, as I’ve discussed before, perhaps the greatest long-term economic risk we face today is deflation – the prospects of prices continuously falling.  That will make it easier to borrow for the long term.  It also makes a further expansion of the supply of credit – like the small business loan swap I proposed above – an appropriate credit policy instrument.

                 And that goes to the best way to put the trillions in unspent cash in the economy to work – borrow it and spend it.  That’s essentially where it’s going now – companies and banks are buying safe government securities with it.  When they decide instead to use it for investment, they’ll stop giving it to us.  When they do, it will be time to unwind the borrowing and bring the budget back into balance.  That’s going to be a very difficult thing to do, particularly insofar as most of the people who carp the loudest about the deficit have no plan to close it, save Paul Ryan.  But the fact that it will be hard to fix the nation’s fiscal imbalance doesn’t mean that we need to suffer through slow growth and sustained high unemployment now.  Who knows? – maybe the add impetus to close the deficit will lead to good changes – a value-added consumption tax, means-tested entitlements, a tilt towards investment over consumption in the federal budget.  We have the wherewithal to do more – markets are telling us that.  Taking action today has a cost down the line, but it’s a cost worth paying.