Thursday, March 12, 2009

Obama Talks Sense! Reason Rallies with Markets!

I swear, it is like Obama is reading my blog.

A week ago, I opined that Obama's lack of bipartisanship destroyed the market's confidence, and that he needs to cut corporate taxes in line with European/OECD rates and rethink his energy plan in order for the markets to rally and the economy recover. Today, addressing CEOs at the Business Roundtable, Obama put corporate tax cuts and energy plan redesign on the table. And the markets rallied.

Even better, Obama apparently linked cutting corporate taxes to closing loopholes and ending subsidies. Amen. One can only hope this does not turn out to be another example of his famous fake right, go left hoops tactic.

But really, the last couple of days has seen an epidemic outbreak of reason, tracking the current stock market rally. On Tuesday, Barney Frank announced the re-instatement of the uptick rule, which slows down a short-selling avalanche and so will give a lift to markets. On Wednesday, both Fed Chairman Bernanke and Warren Buffet urged "improvements" in mark to market accounting rules, which many argue triggered the current financial crisis and collapse of major investment banks by forcing valuable assets to be listed at zero market value when markets are not functioning.

Then the Europeans chimed in: "In Berlin Thursday, with German Chancellor Angela Merkel at his side, French President Nicolas Sarkozy explicitly rejected Mr. Obama's push for more global fiscal stimulus, declaring, 'the problem is not about spending more, but putting in place a system of regulation so that the economic and financial catastrophe that the world is seeing does not reproduce itself.'"

Since the mere mention of European technocrats can induce fits of boot licking and forelock tugging among American liberals, one can only hope Obama will listen closely to this advice. Hopefully, Sarkozy will also find time at the G-20 summit to explain to Obama the policy of green tax cuts that he and British Prime Minister Gordon Brown helped steer through the European Parliament this winter – the addition of which could seriously improve Obama's energy plan.

One can only hope that good sense is contagious, and these ideas all take root, as they should have months ago, sparing us all much unnecessary pain and loss. My expectation is that the degree to which these various great ideas are adopted or rejected, the markets and the economy will rise or fall.

Thursday, March 5, 2009

How to Dodge "The Obama Depression"

Google "Obama Depression" and you will find that an increasing number of bloggers and pundits are throwing the term around. Since a depression occurs only when real GDP declines more than 10%, more circumspect publications like the Wall Street Journal are now calling it "The Obama Economy" and warning that the possibility of depression has been increased by the President and his party's policies and statements.†

While there is plenty of blame to go around, there are perhaps reasons to lay some responsibility for the post-inauguration stock market free fall at Obama's doorstep, and if GDP falls 10% or more, it will be called the Obama Depression, and the name will likely stick. Why?

1) Lack of bipartisanship on the stimulus bill, budget and financial recovery plans destroyed confidence. This goes beyond the obvious fact that these were all the highly partisan creations of Team Obama, so he will get the credit, or blame, for the results. More importantly, by insisting on a partisan economic plan, Obama guarantied that only about half the country would like the plan, and the other half would have no confidence in it. Obama failed to restore consumer or investor confidence, and in fact destroyed it, by rushing through plans half the country would certainly hate. Plunging stock markets and lowest-ever consumer confidence index are a direct reflection of that dynamic.

The perception among many moderates (like myself) that Obama has broken his pledge to govern in a bipartisan manner has also increased uncertainty about how extreme his policies might become (i.e., nationalization). This uncertainty has obviously helped fuel the market decline as well.

2) Obama promotes economic policies that have failed in the past, while he rejects policies that have succeeded. Obama's stimulus is entirely demand-side spending in hopes of sparking more demand and spending, and no supply-side tax cuts to stimulate work and investment. In fact, his plan even includes supply-side depressants in the form of tax hikes and a more steeply graduated tax code. History gives fairly clear guidance that this is the wrong approach. Supply-side tax cuts were put into effect under Kennedy/Johnson, Reagan and Bush, and each time resulted in economic expansion and the end of a recession or slump. However, the last time large scale demand-side stimulus was attempted in conjunction with tax hikes it resulted stagnation and inflation under Carter. When FDR raised taxes in 1937, he re-tanked the economy and undid whatever good he had done up until that point. Anyone who is aware of this history – as are many sophisticated investors – would be understandably concerned about Obama's dangerous combination of demand-side stimulus and tax hikes.††

Thus, many investors lack confidence in Obama's plans because there is fairly strong evidence that they won't fix the economy and might even set back any recovery.

While Obama often contrasts his plan to "those who think we should do nothing," in reality most Republicans and libertarians actually advocate supply-side corporate tax cuts. The US rates are 15 percentage points higher than the OECD average but produce about a third less revenue. That is good evidence that not only are the rates out of line internationally, placing the US at a competitive disadvantage, but that the rates are too high on the curve, so reducing them could likely result in more tax revenue, and a greater stimulus effect than spending. There really is no good excuse not to do this, given the OECD data. Ironically, Obama can now be criticized for not doing enough, for rejecting the most promising solutions because of ideological prejudice.

So how can the President best prevent "The Obama Depression" and revive the markets and the economy? First, by actually living up to his pledge to govern in a bipartisan mannner, particularly with respect to the stimulus and budget. We need a recovery plan that can give confidence to ALL Americans, not just half of them. There needs to be elements in the plan that everyone can cheer. Specifically, by revising the stimulus plan to cut corporate tax cuts to average OECD levels (24%) and including other supply-side incentives to work and invest, he can give hope and confidence to all Americans, not just his followers. Markets would rally. Such tax cuts would increase the earnings derived value of corporate stock by over 23%, so help markets to rise and recover, which would in turn boost spending and renewed investment. All that would boost the economy, and so reduce the rate of foreclosures, taking pressure off the banking crisis.

Getting buyers back in the markets is key, both to help stocks recover, and in order to clean up the CDO mess. Here are a few suggestions to encourage such investments: For the next twelve months, let's make any stock purchased be capital gains and dividend tax free for as long as it is held. That would be a very strong encouragement for buyers to come back into the markets... and we are not giving up any current revenue to do so. In fact, we could raise a great deal of current revenue if instead, for twelve months, buyers paid a .25% sales tax on stock at purchase rather than a 15% or 20% capital gains tax when it is sold: that is quite a good deal for investors, and would raise quite a bit here and now, while pulling buyers back to the market.

Eliminating gains taxes on existing distressed CDOs would increase their value and marketability to private investors, and reduce the amount taxpayers would have to pay for any bailout. Along these lines, I suggest interest income taxes be eliminated in cases where banks voluntarily reduce the interest or principal due on a loan in foreclosure by at least the value of the taxes due. This would encourage voluntary loan adjustments, reduce foreclosures, and also help to increase the marketability of CDOs.

Other parts of Obama's plan could also be accomplished with more stimulus effect, less economic drag and reduced cost. For instance, aggressive supply-and-demand-side tax cuts for clean, efficient renewable energy technologies could replace most of the Obama energy plan with better results for less. Expensive subsidies often end up rewarding failure, while carbon taxes depress the economy and simply don't work.†† CAFE regulations recently put the successful Caterpillar diesel truck engine division out of business, and could do the same to other companies. By contrast, steep tax cuts or tax freedom for green energy businesses that meet the desired standards would stimulate the entire economy by lowering the cost of clean energy while increasing and diversifying the supply. This would create a stronger, more entrepreneurial green energy sector, while avoiding the pitfalls of political patronage, heavy-handed over-regulation, subsidized failure and corporate dependency. And it could help save and transform the auto industry without a bailout.

Obama can turn around the economy and take out an insurance policy against "The Obama Depression" by embracing smart, supply-side, bipartisan solutions that markets can cheer. Indeed, given the unprecedented severity of the crisis, and the extent to which people are suffering as never before, it is unconscionable for Obama to leave undone anything that could help, particularly the proven solutions that have worked in the past.

†I spoke to soon: even the WSJ has published the "Obama depression" moniker here.
††Obama has a similar problem with his energy program. While Obama promotes a carbon cap-and-trade plan, many green advocates believe cap-and-trade is ineffective and unenforceable, and prefer a carbon tax. Unfortunately, the empirical evidence from Scandinavian countries is that carbon taxes do not work. Norway has had carbon taxes since the 1990's and their per capita emissions are up over 40%. Denmark's experience shows that what really works is investment in renewable energy and efficiency. So the question then becomes how to best support such investment: direct subsidy or supply-and-demand-side tax cuts for green energy? Unless you want to subsidize failure an create a culture of patronage and corporate dependency, the only real answer is tax cuts. This approach would be cheaper, more effective, and better at stimulating both green energy and the economy.