July 15, 2012

Review Corner

Or, Why didn't we nominate this Bain guy?

Edward W. Conard is, I believe, the current Managing Director of Bain (you know how hard it is to figure out when those guys come and go!) but for our purposes, the author of a magisterial book on the "Panic of '08," which Conard refers to as "the Financial Crisis" (caps his).

Unintended Consequences, Why Everything You've Been Told About the Economy Is Wrong. is a very serious look at the banking system, political economics, and policy. He pulls no punches and he goes into the weeds when he must to explain complex financial instruments.

Anybody who remains interested in the Po08 needs learn about MBSs, CDSs, SIVs and the like. I considered myself -- not a financial whiz -- but self-congratulatory that I understood what these were and why they were used. Conard's book took me to a brand new level. On a good day, I could now explain whey the mezzanine tranches of subprime mortgage backed securities were as deserving of AAA status as a 20% down home mortgage. But I'd still suggest you pick it up from Conard.

More interesting to the average ThreeSourcer is his philosophy. I would compare him to Larry Kudlow: he is an outstanding proponent of free markets and their benefits, yet he is in no way "all-in" on freedom when it conflicts with asset prices. He sees roles for government that many ThreeSourcers will not appreciate, yet his cogent appeals to liberty make his heterodoxies difficult to dismiss [If we had editors at ThreeSourcers, that last sentence would have a big red line through it...]

Speaking of Heterodoxy, he opens early with a numbingly-counterintuitive chapter to get things flowing. Conard credits Roe v. Wade as the source to American freedom vis-à-vis Europe. Fusionism writ large, the alliance of anti-abortion social conservatives and free-market folk saved the country from the general human disposition toward wealth redistribution. US and European GDP growth tracks closely through the 1960s, splits near Roe, and diverges from there.

By the random dint of history, the landmark Supreme Court case Roe v. Wade brought pro-investment voters to power in the United States. This faction, representing about 35 percent of the electorate, combined with enough of the now-mobilized social conservatives-- principally the Christian Right, who vote Republican and represent 15 percent of the electorate-- seized the majority and permanently shifted the political economic center to the right. Without a similar legal ruling in Europe and Japan, a similar shift in political power never occurred.
Nixon was the last Republican president before voters contested Roe. Without the 15 percent bloc of evangelical Christian voters in his back pocket, Nixon had to accept a 70 percent marginal tax rate to capture 51 percent of the vote. Even then, he only won the election because of the unpopularity of the Vietnam War. Eisenhower only won by accepting a 90 percent marginal tax rate! Clinton was the first Democratic president in office after voters contested Roe. With only 85 percent of the vote available to him, where 40 percent of that vote supported tax reduction.

He is brilliant on trade and immigration. I don't think he is up late worrying that the Chinese are sewing our Olympic Uniforms. He asks "if offshore workers were to offer their labor to US consumption for free -- how much would we want?" All of it, right? As much as we could get. Well, seventy-five cents an hour is essentially free. Let us have Americans do something more wealth-producing and have others stitch up our homoerotic, paramilitary athletic uniforms.
In addition to talented workers thinking about how to improve future outcomes, there are other forms of overlooked investment. Immigration has freed many talented workers from household tasks and increased their availability for more productive activities-- namely, work.

This is a hefty and serious book, which I do no favors by summarizing in a blog post, but he does see a role for government as lender of last resort. FDIC prevented bank runs for 75 years. If institutions keep sufficient liquid reserves to prevent runs, there will not be sufficient risk capital and growth will be slowed. Much has been written as to why Bear Stearns and Lehman Brothers received different treatment. Conard would have had the Fed and Treasury save both. And backstop AIG.

The crisis was an old fashioned bank run -- only the investment vehicles were changed. As only government can provide enough warm fuzzies to depositors to prevent withdrawls, it makes sense to have them backstop these 75-year storms so that the economy can grow at full strength in-between. He has some innovative ideas to address concerns of moral hazard.

Of greatest appeal 'round these parts is his appreciation for the morality of freedom. I wish that "that other Bain guy" could explain so well the benefits of risk taking and capital accumulation:

Who captures the value from the tractor? Not the farmer who competes with other farmers for unskilled tractor-driving wages; his return comes largely from avoiding the cost of not investing. Not the tractor manufacturers who compete fiercely with one another on price. Not the landowners-- tractors make it easier to plow more difficult land-- and not investors, such as banks, that compete with one another to supply the capital at perhaps a 7 percent return. The consumer captured almost all of the value through lower food prices.

Long review corner, sorry. And I have still not captured much from this fascinating book. Five Stars.

Review Corner Posted by John Kranz at July 15, 2012 10:06 AM
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