#1 – If you were advising President Obama, what would your #1 economic action item be? Ignore political viability, if possible.

On a “big picture” basis I would set an agenda that was clearly moving in a direction of unwinding many/all of the emergency measures that were introduced in 08. For confidence to be restored we have to get the sense that the crisis is behind us. There is nothing that can be done “tomorrow” that can magically restore home values and reduce unemployment. Bernanke will try to save the day with QE-2, but it will not work any better than QE-1 did. A short term benefit at most. Same with fiscal policy. We can have another stimulus and borrow another $1 trillion. That would give us a few quarters more of anemic growth. But after that we would fall off the shelf when the life support ends. Our policies appear to me to be a bridge to no-where. A smooth ride till the end of the ramp and then a crash.

I think the Europeans have it closer to “right” than we do. They are moving in the direction that I think is better if one is looking out five years and asking, “What do we want to look like?” We are headed in the direction of Japan. We will have 1% growth (disaster) and debt to GDP of 150% (death).

But you asked a narrow question. What would I do?

I think we do need a stimulus. But it has to be different this time. We need the private sector to pick up the slack. So let’s give them a chance. I want a one year (18 months?) Payroll tax holiday. That tax is currently 12.4%. For 2011 that tax will be equal to about $700 billion. A very big drag. I want to cut SS by 60% during the holiday. I want the reduction to be shared by workers and and their employers. I would have a ratio of 60% for the workers and 40% for the employers. I want to put $400b in the hands of the private sector. This is money that does not even get collected by D.C.. So the government can’t spend it. I believe that the 150 million American workers will make the best use of that extra $240B. They will spend some of it and they will save some of it. The companies that get a break will also spend it. I would require that the savings that the employers get have to be re-invested.

BUT. This has to be PayGo. This can be done. I estimate that a ~4 year cut of SS benefits for those who are getting checks now but also have taxable income in excess of ~$200k PA is required. I call this the Bill Gates/Warren Buffet tax. These guys do not need the extra 1500 a month SS is paying them. This is a means test. It taxes wealth. I do not like that, but it is necessary. We have to raise revenue.

The percentage of people that this would affect is small. Therefore it is politically “sale-able”. It is a significant change of the rules of SS. But those changes would be temporary. To attempt to make this “fairer” I would give those that lost benefits a tax credit. That tax credit would be available to offset (dollar for dollar) any federal estate taxes that would be due at death. What would this do? It would put more “wealth” back into the hands of the next generation. Everything we do robs from the next generation. This has the opposite impact. It puts more in the hands of our children.

Some would object to this. But my guess is that Bill and Warren and many others who would lose benefits would be happy to do so. Those that would be impacted by this have a great stake in America. These are the ones who have the most to lose if we fall into a debt spiral or a depression. They are getting the money, but only after they are dead.

Trust me. A $400b reduction in PR taxes would be a very effective stimulus. It would work. The economy would stabilize. But it must be paid for. If we just borrow and spend we will have accomplished nothing. Making it PayGo would instill confidence.If confidence is restored markets will improve and interest rates will return to more normal levels. Those that lost SS benefits would rejoice at that result.

Disclosure: I would lose my benefits if this plan were implemented.

#2 – You have written extensively about Social Security. Which aspect of this program do you feel is most misunderstood? How much of a threat are baby-boomers to entitlement programs?

Hmmm. Most misunderstood? There are so many aspect of this that are misunderstood.

The $2,500,000,000 Trust Fund has to be at the top of the list. I typed all the zeros to show just how big the number is. $2.5 Trillion. Hard to think of.

Some say there is no money or assets in the TF. That it was robbed by some prior administration. Many refer to it as a ponzi scheme. Just a fictional accounting scam.

Those on the extreme other side look at this as massive pile of AAA Treasury bonds that will mature and be available to pay scheduled benefits for the next 25 years or so. They think that SS is sound and nothing need be done about it.

Both of these views are wrong in my opinion. The bonds in the TF will be paid on time. They are legally just as sound as those held by the Chinese central bank. We exclude these debts when evaluating our current Debt/GDP ratios.  We are doing ourselves a disservice, this is real money that is owed.

But to honor these debts means that the Debt Held By the Public will increase $ for $. That can’t and will not happen. Yes there are real assets, and no they can’t be used without a (my word) disastrous consequence to the bond market. There is a limit to what can be sold. I think we are dangerously close to that limit today. Adding in another 2.5t will make us lose our AAA and our financing cost will go up. We will become Greece.

On the Boomers. They have been the problem for decades. This demographic bulge is probably our most significant medium term challenge. When the boomers were born they created a housing boom. That has not stopped until 2007. 2008 is the first year of the boomers getting to 65 folks. That is not a coincidence. The mcmansions, second and third homes are coming up for sale now. The boomers are downsizing. This will go on for many years.

While the boomers did pay a lot of taxes and funded the surpluses in SS they are now going to start costing us big time. The aging of our population is accelerating. We still have a decade to peak.

If the economy were growing by 4-5% we could afford this transition. But that is the least likely thing to happen. Because of the boomers, we will be lucky to grow at 1.5%. Should that be the case the boomers will sink the economy.

Resources are are scarce. Allocations will have to be made. It will not be pretty. We have the risk of “age warfare”. We may be faced with the choice, “Who do we protect?” The health and education of people 25 and younger, or the health and well being of those over 80. If we are faced with triage we will have to support the former over the latter.

Socially, we may be looking at a bad end for the boomers.

I am a boomer.

#3 – Reports of under-funded pensions at corporate, state, and federal levels are widespread. Are you concerned?

Not my area of expertise.  I read the reports as you do. I am certain they are right. We are on a train wreck with this. The problem is that there was an assumption about how quickly assets would grow (8%) and and how big future contributions will be. Both are wrong. The lines are crossing in public and private PFs all over the country.

Cuts will have to be made. But these were promises that were made in ink, so it will not be easy. To a very significant extent this is another boomer problem. I will repeat from above:

Socially, we may be looking at a bad end for the boomers.

#4 – Could you briefly sum up your thoughts on U.S. equities?

Briefly? What a tough assignment.

There are today some excellent investment opportunities in the capital markets. That will be the case every day for the next ten years. But I don’t know what they are and if I did I would not share them. Those that “share” are just selling their book. I am convinced of one thing:

THE “BUY AND HOLD” IS DEAD. DEAD. DEAD….

Thanks to Bruce for taking the time. He’s one of the more level-headed and knowledgeable finance bloggers out there, and has the real-world experience many of us lack.

This documentary was no small production. It’s a Sony Pictures Classics documentary. Matt Damon narrates.

And judging by the trailer, this doc looks more daring than previous examinations of the crisis. TBTF was good, but I got the feeling Mr. Sorkin had to bite his tongue on several issues, in order to ensure access to key figures. Not his fault, it’s how the system works.

Film opens Oct 8 in NY and Oct 15 in LA. When it opens here, I’ll be there. Mini corn-dogs and Cherry Coke in hand. My annual trip to the movie theater.

Hat tip to reader jail time.

Born had all the experience one could ask for in such a post. She was the first female president of the Stanford Law Review.

She worked as a lawyer specializing in derivatives at her former-firm. Yet, ultimately her campaign to regulate these contracts was denied by Robert Rubin, Larry Summers, and Alan Greenspan.

We know that unregulated derivatives played a key role in the crisis. They’re at the heart of the TBTF problem.Watch PBS’s excellent documentary The Warning for more.

Geithner plays the role of Rubin

Now Tim Geithner, Rubin’s protege, is trying to block the appointment of Elizabeth Warren as head of the new Consumer Financial Protection Bureau.

Coincidence warning: Warren’s competitors for the job include another Bob Rubin protege, Michael S. Barr. He served as special assistant to the Mr. Rubin, and as Deputy Assistant Secretary of Treasury.

Huffington Post broke the story on Geithner’s opposition to Warren. Their source is reportedly “familiar with Geithner’s views”. Excerpt:

Warren’s persistent oversight is part of the reason for Geithner’s opposition, according to the source

We shouldn’t be surprised to learn that Geithner fears a regulator who “persistently oversees”. The horror.

The Agency Warren Should Lead

Elizabeth Warren should be the clear front runner to head the CFPB. In 2007 she wrote a paper titled Unsafe at Any Rate, which strongly influenced to new agency’s creation. She’s the most knowledgeable, honest, and motivated candidate we have.

Yet Geithner, sworn to serve the American people as Treasury Sec. doesn’t want her in the post? Some guesses as to why:

1. She’s a lawyer who understands the complex issues at hand.
2. She seems determined to enact real change in America’s broken TBTF banking system.
3. She’s smarter than him.
4. She asks questions that make Tim squirm, as seen below:

Denying Mrs. Warren this chance  would be a historic mistake.

She knows what needs fixing in our broken financial system, especially as it relates to TBTF banks. Banks that are massively subsidized by ultra-low interest rates, lax capital requirement, and guarantees both implied and explicit.

The new agency will exist under the Fed. Obviously, that’s not ideal. But it’s all we have at this point. Having Warren in there to keep an eye on the boys would be a huge step.

I got the chance to see Elizabeth Warren speak at last year’s Buttonwood conference. She is sharp as a tack and asks all the right questions. Unlike most other speakers, she didn’t shy away from criticizing banks. Here are a few quotes:

The reason banks lost confidence in each other is because they looked at their own books. (in reply to a question about cross-exposure among banks).

What we have confidence in is the fact that big institutions will be bailed out. (in reply to a question about the importance of economic confidence).

At the time (Oct ’09), I wrote:

Unfortunately, Mrs. Warren’s position is toothless; her role has no enforcement authority, after all.

This would prove to be a recurring theme throughout the conference. The speakers with the best ideas were usually in no position to act on them. Power-players like Summers and Geithner said little of substance, dodging the best questions.

Let’s not allow Elizabeth Warren to become the next Brooksley Born. If you want to get involved, contact your local representative and let them know you support the nomination of Elizabeth Warren as head of the CFPB .

More:

• Naked Capitalism
• WaPo
• WSJ

hat tip Shahien Nasiripour @ HuffPo

Anyone else got ideas? This market is obnoxious.

Some people think that employment statistics reflect direct government knowledge of all labor related transactions, and of the absence of labor related transactions, in a similar way that the government directly know how much revenue and expenditure it has had. But at least not yet, “Big Brother” isn’t that big.

So, employment statistics is instead based on surveys (polls). In the case of employment statistics this means in most countries surveys based on household respondents.

Unlike in most other countries, the United States government tries to compile two different employment surveys. One is based on the standard international method of household surveys, and the other is based on a survey of employers (the payroll survey).

Usually the message from the household survey is pretty much the same, though the exact details almost always differ somewhat. The latest employment report however had two different messages. The household survey indicated a very weak economy, as despite massive Census-related hirings, total employment actually fell.

By contrast, the payroll survey had a bullish undertone. While private (non-Census) payrolls increased only marginally, total payrolls increased significantly and both the average work week and average hourly earnings increased, suggesting a relatively solid recovery.

Since the survey results differ, and since there is only one reality, it follows that at least (maybe both) one of them is wrong. I don’t know which one of them is more accurate, but based on other reports it seems likely that the truth lies somewhere in between, which would imply a continuing U.S. recovery, but only at a moderate pace.

Read more of Stefan’s excellent economic analysis at his blog or view some rather prescient articles he wroter for Mises.org.

Tom Montag, then a senior Goldman executive and now head of corporate and investment banking at Bank of America, was quoted as describing the deal in an e-mail as follows: ‘Boy that timeberwof (sic) was one shi**y (sic) deal,’  according to the Senate subcommittee.

The subcommittee said that Matthew Bieber, the Goldman trader responsible for managing the deal, later described the day that the Timberwolf security was issued as ‘a day that will live in infamy’, recalling the language President Franklin Roosevelt used for the Japanese attack against Pearl Harbor.

The $1 billion CDO was sold to a Bear Stearns owned hedge fund. It went on to lose 80% of its value in FIVE MONTHS — causing the hedge fund to liquidate and contributing to the demise of Bear (who was conveniently one of GS’ biggest competitors).

The Timberwolf CDO was a financial time bomb, not an investment product. And GS knew it. If nothing else comes out of this, it should be a big fat signal to anyone considering doing business with GS — don’t.

Bloomberg has more details. After saying, “Boy that timberwolf was one shitty deal”, Thomas Montag told the Senate panel today, “I didn’t use that term in respect to this deal”.

The balls on these guys are truly Randy-sized…

And for no specific reason other than my liking it:

Jesse: “This could be construed as a deft way of throwing red meat to the angry mob, nailing a specific individual at Goldman while limiting the criminal charges against the company although there will be significant civil cases, and dealing with the billionaire hedge fund owner Paulson who made a fortune betting against the subprime market.”

Zero Hedge #1: “Creamer has just come to the rescue of this former co-workers at Goldman, claiming a “source” has notified him that Goldman was “long” Abacus. Well, duh – that’s how structured finance works.”

Zero Hedge #2: “What will Buffet’s response be now that Goldman’s ‘ethics’ are exposed?”

Barry Ritholtz: “I’ve been racking my brain for the easiest way to get people to understand what GS did. The best I could come up with was Mel Brook’s “The Producers.” They purposefully tried to create the worst play ever, lose their investors money and pocket the proceeds.”

Mish: “While Goldman can claim it did not “know” anything, the statement rings as hollow as saying we do not “know” if the sun will come up tomorrow. Goldman is nothing more than a giant hedge fund that front runs trades and bets against advice it gives clients, with one important exception.

Yves Smith: “This is also interesting because Paulson appears not to have bought the CDS created to serve as collateral for the transaction, but instead shorted (via Goldman) some of the tranches. We’ve been told that shorting CDO tranches (as opposed to shorting BBB supbrime bonds) was pretty uncommon, but “pretty uncommon” may not be quite as rare as we had been told.”

Bill Black and Barry Ritholtz on Tech Ticker: “Rotten to the core”. Must watch.

Will post more as I come across them.

Hat tip BR.

More than half of U.S. borrowers who received loan modifications on delinquent mortgages defaulted again after nine months, according to a federal report.

The re-default rate of loans modified in the first quarter of 2009 was 51.5 percent by the end of the year, the Office of the Comptroller of the Currency and the Office of Thrift Supervision said in a joint report today. The figure, which measures payments at least 30 days late, climbed to 57.9 percent for changes made in the prior 12 months.

U.S. homeowners are struggling to make payments as depressed housing prices leave them owing more than their properties are worth. About 24 percent of properties with a mortgage were underwater in the fourth quarter, First American CoreLogic said last month. The median price of a U.S. home was $165,100 in February, down 28 percent from its peak in July 2006, according to the National Association of Realtors.

The current round of foreclosure-prevention plans have failed after just 9 months, even though they were short-sighted extend/pretend in nature — reducing interest rates to 2% for 5 years and extending loan schedules out to 40 years. They probably thought this would buy them at least a couple of years. So while banks collected a ton of fees from the govt for “trial” modifications, they obviously aren’t working.

It’ll be interesting to see what happens after the Fed ends MBS purchases, and rates (presumably) go up a bit. The homebuyer tax credit expires in April, which could also negatively affect demand. But so far the efforts appear to be an utter waste, more backdoor bank bailouts.

If anything, they only pulled demand forwards, and served to reward people lucky enough to buy during the bonanza. Buy a house a day before or after the tax credit is in effect? Tough sh*t.

Extend and Pretend Take Two: Principal Reduction (For a Few)

Some have applauded Bank of America’s recently announced principal reduction program, which cuts loan amounts up to 30%. But it should also be noted that BofA isn’t doing this out of the kindness of their heart. It’s part of a settlement with multiple attorneys general in connection with their sketchy Countrywide loan portfolio. The Obama administration is expected to announce a more widespread program tomorrow.

This efforts’ prospects nearly as bad as the original loan-modification programs. To qualify, borrowers must be at least 20% underwater, have an ARM or Interest-only loan,  and be at least 2 months behind on their payments. The prospect of a $40,000 reduction in a loan will inspire a lot more people to be a lot later on their mortgage payments. And probably a lot of fraud losses along the way. More moral hazard incoming…

The disconnect between interest rates and CPI from 2002-07 is especially noteworthy in light of Greenspan’s recent arguments that low interest rates weren’t responsible for the housing bubble. Apparently giving banks access to a spigot of cash does not encourage reckless lending. Here’s Greenspan rationalizing extended low interest rates during this period:

We had been lulled into a sense of complacency by the modestly negative economic aftermaths of the stock market crash of 1987 and the dotcom boom

Given history, we believed that any declines in home prices would be gradual. Destabilizing debt problems were not perceived to arise under those conditions

Given that we had never seen home price appreciations this rapid, might an objective observer have thought something off? Someone who’s full-time job it was to assess these things?

Vacancies

Here’s another great chart from Contrary Investor (again – CI is subscription only, but well worth it IMO. I have no stake in posting these links, but they offer some of the best charts and analysis I’ve found).

The chart below shows various home and rental market vacancy stats. Though things have improved, we still have to see what goes down when (and if) the Fed/Govt ends their massive support programs (currently scheduled to expire near the end of Q1 2010). Things may start deteriorating all over again, but we’ll have to see.