OK, so this is the epitome of economic nerdiness, but admittedly I love it. John Maynard Keynes and F.A. Hayek come back to life to debate whether Keynesian or Austrian economics explain the economy, the only way they know how; rap-off:

The inflation fighter himself, Paul Volcker knows government safety nets. And stogies.

The inflation fighter of the 1970s and 80s, former Federal Reserve Chairman Paul Volcker, wants to make sure banks don’t take the economy to the brink of destruction yet again. Said Volcker:

“If banking institutions are given protection by the taxpayers — I may not live long enough to see the next crisis — but my soul is going to come back to haunt you.”

Let’s hope so. The “Volcker Rule” is an attempt to restrict banks from making speculative investments that do not benefit their customers, and limit the ability of the largest banks to use borrowed money to fund expansion plans. Similarly, President Obama has proposed to restrict proprietary trading by banks and get them out of the hedge fund business.

A man who worked during the presidencies of Jimmy Carter and Ronald Reagan, Volcker now heads the Economic Recovery Advisory Board for Obama. Volcker’s vast experience, and knowledge, makes him far wiser than many of the relatively green people in the White House. Volcker knows the federal government has provided safety nets to the financial sector for decades.

Take the Savings and Loan crisis of the 1980s and early 90s. The Federal Savings and Loan Insurance Corporation, which insured depositors’ money, became insolvent. In 1989, Congress and the president agreed on a taxpayer-financed bailout measure known as the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA). This act provided $50 billion to close failed S&Ls, totally changed the regulatory apparatus for savings institutions, and imposed new portfolio constraints. A new government agency called the Resolution Trust Corporation (RTC) was set up to liquidate insolvent institutions. In March 1990, another $78,000 million was pumped into the RTC. But estimates of the total cost of the S&L cleanup continued to mount, topping the $200,000 million mark.

If you didn’t think there was a wink and a nod relationship between large banks and the feds, the “Volcker Rule” should serve as an acknowledgment. Because lending and credit is so crucial to the economy, financial institutions know the government will backstop them during an industry crisis.

We’ve seen dumbfounded bank CEOs on Capitol Hill, or in media interviews, during this most recent financial crisis, the worst since the Great Depression. When asked why they made such risky decisions, and why the entire industry followed lock step, their response is always about the same. Said one fictional banker:

“Well, I don’t really know. I suppose we just wanted to remain competitive and really didn’t think about the dire consequences of such risk-taking. We’re working to make sure it doesn’t happen again.”

Right. Most of us pass this type of behavior off as greed, and one way capitalism can fail. But in-between the lines, I see smart financial minds who knew full well the path was unsustainable. Greed can consume the new mortgage broker. But the CEO, generally quite experienced, is responsible for the long-run consequences of organizational actions. They knew the taxpayer would catch them if their risky bets ever led to bank insolvency. It’s a win-win for banks: make investments with huge potential returns, in large volume, while being protected from the downside. This is moral hazard, and Volcker knows it all too well.

Unfortunately, major bank conglomerations are fighting against some practical, sensible regulations to curb risk-taking. As a result, the “Volcker Rule” may need to be watered down to pass through the Senate.

The financial system is far from healthy as banks are still weighed down by toxic debt. The last thing we need is for banks, that were bailed out by taxpayer funds, to make high-risk investments that do not benefit their customers, or use money from the discount window to expand; all while the taxpayer safety net remains securely fastened underneath.

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More Articles About the Financial Meltdown:

The Financial Crisis – Part 1: Is Deregulation to Blame? Well, Kinda…

The Financial Crisis – Part 2: The Rest of the Story

Chris Edwards of the Cato Institute took a little trip back in time to check the accuracy of government’s budget forecasts… they get an F minus. As Walter Williams points out here, this is not new for the federal government, but this is a particularly bad case. In 2001, the Bush Administration forecasted that by 2011, the federal government would have a $2.71 trillion dollar budget. According to Obama’s 2011 budget estimate, it will be $3.83 trillion dollars! The following chart shows the real budget vs. the forecast.

As Chris Edwards explains:

“It reveals that Bush and his team started blowing their budget almost immediately. They kept spending more and more — wars, a giant new homeland-security bureaucracy, a big-government response to Katrina, the prescription-drug bill, doubling K-12 education spending, big pay raises for federal workers, financial bailouts, and so on. I can’t think of a single crisis that occurred on President Bush’s watch that the Bush-Rove team didn’t have an interventionist and big-spending response to.”

And Obama has simply been “Bush on steroids.” If nothing else it shows pretty convincingly that government forecasting is all but useless. But the more important thing to ponder is what Edwards finishes the article saying:

“It scares the hell out of me that federal spending down the road could be 41 percent higher than even the huge increases projected by Obama. But that seems to be where we are headed unless we put in place laws or constitutional amendments to really clamp down on the spend-happy politicians of both parties.”

Treasury Secretary Timothy Geithner discusses the burdens of his position, why he felt it was necessary to bailout the financial system and the paternal role taken by the federal government:

Ultimately, I believe the economy would have been in an awful, terrible state for 6-12 months had insolvent financial institutions been allowed to fail. As former Treasury Secretary Hank Paulson suggested, unemployment may have reached 25%. (1) The Federal Deposit Insurance Corporation (FDIC) would have only been able to repay a portion of lost bank account balances. With a void in the financial system of that magnitude, businesses wouldn’t have received loans to meet short-term obligations, expand or fund start-ups. (But it should be noted that banks were not making loans anyway, even after receiving bailout funds. I would’ve done the same thing if I owned a bank.) Life would have been rough, to say the least.

But when a paternal government wishes to quell the people’s pain, do they simply prolong it? Geithner acknowledges in the video that taxpayers should be outraged by the bailouts, as well as banks pushing the system to collapse, but given all other alternatives, he says it was best for us:

“We looked at all alternatives and there was no alternative, except default and collapse, [a] much greater cost and expense to the taxpayer to the one we chose, and we think we did what was in the best interest of the public and the taxpayer, and have an outcome today which is much less damaging because of what we did there.”

It’s easy to see why Geithner and the brain trust behind the government intervention of Henry Paulson, Ben Bernanke, George Bush, Barack Obama and company, would feel this way. The scenario I painted above speaks for itself. The problem is that the “outcome today” is not that amazing either. Underemployment was at 17.6% in December; unemployment at 10%. Probably more important is the fact that the original problems really haven’t been fixed. Toxic debt is still weighing down the bank’s balance sheets. Housing is still overvalued. The United States consumes, not produces. Entrepreneurs have no certainty of what government action will be moving forward. And all of this with pledges on the taxpayer’s behalf for roughly $11 trillion in bailouts and stimulus. Click the link for a breakdown which includes all of the various programs and initiatives.

The economy is not in a position to thrive. Which, frankly, is what I want, Mr. Geithner. An economy that can grow for the long haul, in a sustainable trajectory free from bubbles. So it’s not only that we have a right to be outraged by the government actions, and inactions prior to the collapse, and the ensuing government response. It is also true that trading 6-12 months of Armageddon for potentially years of an only somewhat crappy situation, is not everyone’s option of choice. Some people actually want a sound economy.

Banks began collapsing in March of 2008. If the banks would have been allowed to fail, toxic home loans, unrecorded derivatives, and credit default swaps would have been liquidated; the system flushed clean. Other banks still standing would have swooped in and taken the fallen bank’s infrastructure: buildings, technology, etc. The government could have assisted in fast-tracking the bankruptcy process. It is possible the financial system could have been fully revamped, and ready to actually start underwriting loans by 2009. Surely they would be back on their feet by now. Had the government not been spending its time propping up overvalued home prices, maybe buyers would be purchasing excess housing inventories by now.

The answer to any dilemma is almost never covering up the real problems. The bailouts are certainly unfair, as Geithner points out. But so is life. The greed and bailout culture reveals a values crisis in this country. Couple that with an economy in no position to thrive for the long-run and it’s difficult to be optimistic about our leadership. The people will survive and figure it out. We have no other choice. But I gave up on the two-party system long ago. It has failed us and we need a greater diversity of options.

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(1) Hank Paulson: Without Bailout, Unemployment Could Have Reached 25% – CBSNews.com, retrieved January 29th, 2010, http://www.cbsnews.com/blogs/2010/01/28/politics/politicalhotsheet/entry6152317.shtml

Economic forecasts are a funny thing. If they attempt to project anything beyond the short-run (one year), be very skeptical. But short-run forecasts are not iron-clad either. I have a great time on this site making fun of economists and their predictions. Guessing what the intricate convergence of millions, if not billions, of different economic agents and their decisions will be, is kind of an exercise in futility. So if I were to predict what crude oil will do in 2010, I’d give you some markers to help you make your own decision long before I took a specific barrel price and defended the position.

I don’t have to; that’s what the likes of Merrill Lynch, Goldman Sachs, Barclays and Deutsche Bank are for. Oh by the way, the Congressional Budget Office (CBO) projects the U.S. government will make $7 billion from the TARP bank bailouts. Unfortunately, the CBO also estimates the total cost of TARP will be $99 billion, due to money loaned to AIG, GM and Chrysler that will not be recovered. Taxpayers really had to ante up to keep the banks breathing but at least the merging conglomeration of banks we subsidized can make forecasts for our viewing pleasure.

Merrill feels as though crude will be pushed up to $92/barrel in 2010, possibly pushing the century mark. The guess is supported by the belief that global economic growth will be 4.4% in 2010 and interest rates will remain low. Goldman Sachs and Barclays share similar feelings. (1)

Deutsche Bank says the economy won’t be quite so rosy. They have global economic growth pegged at 3.2%, and a concern that rising interest rates will support a stronger dollar. (1) Because oil transactions are denominated in dollars, the more the US dollar is worth, the fewer dollars it takes to purchase the same amount of oil. Thus, a strong dollar lowers the price of crude oil, all else equal. I have made the case on this website that crude oil spiked to over $140/barrel 18 months ago, during a recession, because the Federal Reserve dumped unprecedented money into the economy. The precipitous rise in the money supply to lower interest rates also devalued the dollar. Therefore, it took more dollars to purchase the same amount of oil. A lot more dollars.

It shouldn’t be overlooked that crude oil is a fixed marketplace (as in “the fix is in”), with the oil cartel OPEC able to control levels of supply to manipulate prices to their liking. Speculators play a role in oil prices, although I believe it is a short-run role, and not nearly as significant as supply and demand.

Banks have different views of what interest rates will do in the coming year. Because interest rates affect the value of the dollar, which affect the number of dollars necessary to purchase a given amount of crude oil, interest rates are a key marker to keep your eye on.

The Federal Reserve said in mid-December that economic conditions are “likely to warrant exceptionally low levels of the federal funds rate for an extended period.” Bernanke and company have not said anything since to change the outlook on interest rates. Currently the federal funds rate is between 0-0.25%. The deficit keeps ballooning as well, another negative for the dollar. One of the many examples of this is a recent Congressional Budget Office (CBO) estimate that the stimulus bill will cost an additional $75 billion more than expected, from $787 billion to $862 billion. (2) (5)

I would anticipate interest rates to remain near zero for the lion’s share of 2010, if not beyond. After all, the national unemployment rate was still 10% in December, and underemployment was pegged at 17.3% in the same month. (3) (4) With oil hovering around $80/barrel today, any pickup in economic growth across the globe should push prices upward some. I also don’t see OPEC going the entire year offering levels of supply that minimize profits. And, if speculators buy into the global economic growth story offered by Merrill and company, we may see a short-run bump from futures trading.

In conclusion, keep an eye on interest rates, because interest rates affect the value of the dollar. Interest rates and crude oil tend to be negatively correlated. Other factors that hurt the dollar include fiscal and monetary policy. If the U.S. continues to run up major deficits, the dollar will take a hit. Also, look at the supply levels OPEC plans to bring to market. And lastly, if global economic growth expands in 2010, so, too, will demand for energy.

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(1) Clueless about oil prices – CNNMoney.com, retrieved January 26, 2010, http://money.cnn.com/2010/01/26/news/economy/oil_prices/index.htm

(2) New York Federal Reserve – newyorkfed.org, retrieved January 26, 2010, http://www.newyorkfed.org/markets/omo/dmm/fedfundsdata.cfm

(3) Bureau of Labor Statistics – BLS.gov, retrieved January 26, 2010, http://www.bls.gov/CPS/

(4) Bureau of Labor Statistics – BLS.gov, retrieved January 26, 2010, http://www.bls.gov/news.release/empsit.t12.htm

(5) Stimulus is now $75 billion more expensive – CNNMoney.com, retrieved January 26, 2010, http://money.cnn.com/2010/01/26/news/economy/stimulus_cbo/index.htm

Congressmen Ron Paul and Paul Kanjorski have a good debate on Ben Bernanke’s reappointment hearings, H.R. 1207 (auditing the Fed) and the Federal Reserve in general. It is a very good debate and definitely worth watching:

If economics is supply and demand, wouldn’t it be useful for companies if they could pull demand out of a hat; if they could create new marketplaces out of thin air, instantly cashing in on the first-mover advantage. There they would stand, titans of industry, as the lone player in a market.

Sportswear and equipment giant, Nike, has accomplished exactly that with their Nike Pro Combat line. The Combat line is essentially a Dri-FIT compression base layer, complete with “advanced padding in key areas.” Included is compression underwear and basketball shirts. Both retail at $75.00.

Nike Pro Combat was first developed into a Nike Football line, with the famous image of honeycombed Minnesota Vikings running back, Adrian Peterson. Pro Combat gear is now being unveiled as a Nike Basketball line, with the likes of Lebron James and Amar’e Stoudemire as front pitchmen. Nike, the principal inventor of sports marketing, and the undeniable revolutionary, has really outdone themselves this time around. I will attempt to see through the “elite” brand of Lebron James. For sports fans, I would encourage you to look past deflected glory, a term I learned at Nike U (University of Oregon). Deflected glory is a fan (shortened for fanatic, remember), emotionally connected with their team, projecting the team’s current or past successes. Some fans even take credit for their squad’s success. And if it’s not that extreme, all fans talk as if they’re “part of the team.” It’s a classic, subconscious comment like “we were dominant on the blocks tonight.” I wasn’t taught this term but I suppose there is such thing as deflected depression when a team loses, or if the team happens to be the Chicago Cubs.

Strong emotional ties to a team’s success boosts a fan’s own self-esteem or happiness. Imagine the fan who riots, setting the city on fire after their team wins a championship. Pure youthful exuberance, and an I’m-better-than-all-of-you mentality. Never mind many of the people living in the city are fans of the same team. Nobody ever said emotions made sense. In addition to arson, a sports team’s success also encourages fans to buy officially licensed team products, which the sports marketing game relies on. Think college football bowl apparel rolled out in the month of December while fans are on a high. Gear that most fans will never wear after the bowl game.

It’s time to call Nike’s bluff, for once, on Pro Combat Gear; or marketing genius, if you prefer.

Firstly, what are the merits of “preparing for combat” with ergonomically designed foam padding on the thighs, hips and tailbone? I suppose it makes sense. If it doesn’t bother the athlete on the court, it protects them from nasty falls when they get upended in the air, or get elbows to the thighs (I’m looking at you Bruce Bowen).

Actually, the mere existence of Bruce Bowen really upends my argument. Fortunately, city league players down at the “Y” probably aren’t matching up against Bruce anytime soon.

Elbows just don’t hit you in the thighs very often out on the basketball court. You pretty much have to be going up against a Bruce Bowen protégé for thigh pads to come in handy. Tailbone pads could come in handy if you get knocked on your butt, but the only time it’s an injury concern is if your vertical leap is considerable. It’s not until you get way up into the air to dunk or lay it in, that someone can really make you lose control of your body. Not sure that really applies to most of the people who have and will inevitably buy these products. And as far as hips go, I can’t think of anybody messing with my hips other than the above tailbone scenario.

The Combat shirt provides protection for the ribs, sides and lower back. Some people are kind of ticklish in those areas. I guess that’s a plus. Unless basketball starts to allow Ali right hooks and jabs to the liver, I think my ribs and sides will be just fine playing ball. And protection of the low back could be helpful if you’ve had major back surgery on a few discs, but maybe pickup ball isn’t the smart place to be anyway, in that case. Like the hips, the low back could be vulnerable in the tailbone scenario.

If the recreational basketball you’re playing has any substantiated parallels to combat, I would recommend seeking health insurance before entering the battlefield.

Pro Compression shorts without padding retail at $25 or $30, depending on length. It is just like Nike to throw in some foam padding which add limited value, triple the price, and trot out Lebron James and company to sell them. This is one of the reasons it makes economic sense to pay Lebron James $90+ million; it’s easy to move product and to instantly validate new product lines from the Nike lab. There is no other product on the market similar to Nike Pro Combat, particularly in basketball. Nike creates a new product class with no alternatives for the consumer, wraps the products in adored athletes and watches the cash roll in.

The power of information, and misinformation, is immense. Google provides access to a vortex of data, images and videos with the press of a button (particularly when a user is “feeling lucky”). With the Internet age comes major concerns about privacy. What people find out about you on the Internet could influence whether you get that scholarship or government grant. It could be the reason why you’re turned down for health insurance. It could even be why you attract Facebook stalkers. In any case, there may be a way out of this unstoppable exposition of your personal life: move to a remote village. The Onion News Network reports:

Well at least someone is making money these days. The Associated Press reports that the Federal Reserve made $52.1 billion for the fiscal year of 2009 (sorry conspiracy theorists, it returned $46.1 billion to the Treasury), which is $14.4 billion more than 2008. These profits come from interest on securities the Fed purchased in programs designed to rescue the economy (not including the $700 billion bailout), such as:

“…[in] one program that ended last year, the Fed snapped up $300 billion in government debt. Under another program, the Fed is on track to buy a total of $1.25 trillion in mortgage securities from Fannie Mae and Freddie Mac by the end of March. It also will wrap up purchases of $175 billion in debt issued by the mortgage giants at that time. Those programs have boosted the value of securities held by the Fed.

The Fed has certainly taken unprecedented action, much of which I have been quite critical of. And the way I see it, the Fed faces a double edged sword right now. As the article states:

“The Fed faces a risk, however. It could lose money if it had to sell those securities after their prices had fallen. The Fed might need to sell the securities to sop up some of the money it pumped into the economy during the crisis.”

The question in my mind isn’t whether the Fed loses money, though. The problem the Fed faces is can it take enough money out of the economy without sending us back into a severe recession, or will the excess money lead to high inflation. Personally, I’m predicting some pretty vicious stagflation is coming our way. We’ll see…

In a recent column on Lewrockwell.com, Peter Schiff explains why the current health bill will have devastating unintended consequences. He explains:

“The bill’s centerpiece is a clause prohibiting insurers from denying coverage based on a pre-existing medical condition. However noble and marketable an idea, this proscription removes the very basis upon which any insurance model operates profitably…the health care bill removes the need for healthy individuals to carry insurance. Knowing that they could always find coverage if it were eventually needed, people would simply forgo paying expensive premiums while they are healthy, and then sign on when they need it. But insurance companies cannot survive if all of their policyholders are filing claims!”

The administration isn’t stupid, however. They did recognize this perverse incentive, but as Peter Schiff elaborates, the government’s solution won’t help:

“Correctly anticipating this incentive, the Senate bill imposes an annual fine which gradually escalates to $750 for those who fail to buy coverage. So what? I would gladly pay $750 in order to avoid the $8,000 per year I pay now for personal health insurance.”

The incentive to freeload could very possibly bring the whole system to its knees. And then what? Well, a logical guess would be that the government will come riding in to the “rescue.” So is this just an end-around to sneak in a single-payer system? Barack Obama has, after all, admitted he would prefer a single-payer system:

And unfortunately, as Peter Schiff notes, the health care bill does little to address the real problems with American healthcare:

“The real tragedy is that the current bill does nothing to restrain the forces that are propelling healthcare costs into the stratosphere, namely: regulatory bans of insurance competition, the out-of-control medical malpractice industry, federal programs and subsidies, and a tax code that favors a third-party payment system – which alienates the patient from the cost of his care.”

What’s disheartening is the American health care system desperately needs reform, but first we’d have to stop the wrong reforms being proposed before actually fixing the system. It’s a long road ahead.