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When former Labor Secretary Robert Reich offered his solutions for ending the Great Recession in the New York Times, he repeated the same errors expressed in a CNBC debate the week before.

Reich appears to have all the credentials for knowing what he is talking about: degrees from Dartmouth College, Yale Law School, and a Rhodes Scholarship to Oxford University. Having served as a law clerk to the chief judge of the U.S. First Circuit Court of Appeals and then assistant to the U.S. Solicitor General, followed by an appointment by President Jimmy Carter as Director of Policy Planning at the FTC, most would accept his opinions and suggestions for ending the recession as useful and relevant.

An early indicator that something might be wrong with his thinking, however, was revealed in his blog in April, 2008, when he publicly announced his support for Obama in the presidential election. He said that “although Hillary Clinton has offered solid and sensible policy proposals, Obama’s strike me as even more so:

His plans for reforming Social Security and health care have a better chance of succeeding. His approaches to the housing crisis and the failures of our financial markets are sounder than hers…He has rightly identified the armies of lawyers and lobbyists that have commandeered our democracy, and pointed the way toward taking it back…Finally…his life history exemplifies this, as do his writings and his record of public service. For these…reasons, he offers the best possibility of restoring America’s moral authority in the world.

In his Times article, Reich admits that much of what the Obama administration has done to boost the economy hasn’t worked, pointing out correctly that the private sector isn’t generating anything like the number of jobs needed just “to keep up with the growth of the potential work force”:

The national economy isn’t escaping the gravitational pull of the Great Recession. None of the standard booster rockets are working: near-zero interest rates from the Fed, almost record-low borrowing costs in the bond market, a giant stimulus package and tax credits for small businesses that hire the long-term unemployed have all failed to do enough.

But then he reveals, not what’s wrong with the economy, but what’s wrong with his thinking about the economy: “Consumers no longer have the purchasing power to buy the goods and services they produce as workers; for some time, their means haven’t kept up with what the growing economy could and should have been able to provide them.” (Emphasis added.) And he further exposes his lack of understanding of basic economics by adding: “Even if nearly everyone was employed, the vast middle class still wouldn’t have enough money to buy what the economy is capable of producing.”

The problem, he says, is the rich. They don’t spend enough by themselves to keep the economy rolling, and the best thing to do is to relieve them of their wealth and give it to those who didn’t earn it, who are much more likely to spend it buying the goods they are producing. Reich says: “The rich don’t…invest their earnings and savings in the American economy…They send them anywhere around the globe where they’ll summon the highest returns.” Furthermore, “the rich also put their money into [hard] assets [such as] commodities and real estate.”

Then Reich dusts off the myth that only such redistribution of wealth got the country out of the Great Depression: “There is only one way back to full recovery: through more widely shared prosperity.” (Emphasis added.) From that underlying provably false assumption, Reich offers his solutions to ending the Great Recession: exempting the first $20,000 of income from payroll taxes and paying for it with an additional tax on incomes over $250,000.

Early childhood education “should be more widely available, paid for by a small 0.5 per cent fee on all financial transactions. Public universities should be free; in return, graduates would then be required to pay back 10 per cent of their first 10 years of full-time income.”

He offers something called “earning insurance” for workers who lose their jobs and have to settle for positions that pay less, and would be paid “half the salary difference for two years [which] would probably prove less expensive than extended unemployment benefits.” He concludes that these are “policies that [would] generate more widely shared prosperity…and that’s good for everyone.” (Emphasis added.)

Peter Schiff, one of those “rich” entrepreneurs who is Reich’s target (he is the founder of Euro Pacific Capital), explains the problem with this thinking: “Reich believes that the cart pushes the horse. In his worldview, businesses produce goods and services simply because consumers spend. Therefore, anything that increases spending fuels growth.” But that is exactly backwards. It takes capital formation, and the incentives only provided by a free market (which rewards success by providing products and services that customers need and want and are willing to pay for, and punishes failure to provide such products and services), to create production. Schiff puts it neatly:  “capital formation must precede production, which then allows for consumption.”

Schiff adds:

Every consumer either lives off his own productivity or the productivity of someone else. When individuals work, the wages earned result from the productivity of [their] labor. The ability to consume is directly related to the production of goods or services that result from one’s efforts…In the Soviet Union, everyone had a job, yet workers had to stand in line for hours for basic necessities…If stimulus could produce demand, then no nation would be poor…African poverty would be wiped out if African governments simply printed money more freely. Africans are not poor because they lack currency to spend [consider Zimbabwe]; they are poor because their governments inhibit production, deny [private] property rights, abrogat[e] contracts, prevent the accumulation of capital, and nationaliz[e] profits.

Schiff says that Reich should call for greater savings by reducing taxes on the rich, allowing them to invest in the new business ventures that are the driving force behind new jobs and higher employment.

Economist Thomas Sowell agrees with Schiff:

What would probably get the economy recovering fastest and most completely would be for the President of the United States and Congressional leaders to shut up and stop meddling with the economy…[but] true believers [like Reich] have to believe that it is only because [government intervention and redistribution efforts haven’t] been tried long enough, or with enough money being spent.

Investors.com said on September 3 that “all the actions this government has taken…haven’t ‘saved or created’ 3.8 million jobs, as claimed. Instead, they’ve destroyed millions of jobs. But the administration remains clueless, hinting that it may seek another “stimulus” costing billions. This bunch is either willfully doing damage to the U.S. economy, or [is] completely incompetent.

With Robert Reich’s credentials, it’s hard to believe that he is clueless or incompetent.

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The Obama administration is “taking the first steps to confiscate retirement dollars,” according to Dr. Jerome Corsi who predicts that the end result will be retirees with 401(k) plans holding near-worthless government debt “that will be paid off in a devalued currency worth…pennies on the dollar.”

The move to confiscate those retirement dollars for government purposes was best illustrated by Christina Kirchner, President of Argentina, in 2008 when she announced plans to seize her citizens’ private pension funds. Writers at the Heritage Foundation said that while Kirchner claimed such seizure was necessary to protect her citizens’ investment accounts from the global meltdown, “most observers believe[d] her real motive [was] to use the $30 billion in seized assets to ease the massive debt obligations her leftist spendthrift government [had] run up.” The Wall Street Journal agreed, saying that “taking over the…pension fund assets [would] ease the cash crunch faced by [her] government.”

Corsi said he has a letter from the Treasury Department, Bureau of Public Debt, informing U.S. citizens that the federal government is rolling out a new program called “Treasury Direct” that will allow citizens “to purchase, manage, and redeem…savings bonds” electronically, as well as offering an option to purchase such bonds automatically through payroll savings or a personal checking account. This happened to coincide nicely, according to Corsi, with a bill offered by Senator John Kerry (D-Mass.) to create “Automatic IRAs” that would require all employers and employees to invest in IRAs using that automatic deduction option, “whether they want to do so or not.”

And this happened to coincide also with a program being pushed by the Service Employees International Union (SEIU) called “Retirement USA” which would create a government-forced retirement program with assets being directed into special Treasury Retirement Bonds, or R-Bonds. “Retirement USA” is promoting the idea that all workers have a “right” to a government retirement account, in addition to Social Security and any private pension plans those workers already have in place. Others behind “Retirement USA” also support more government dependency for workers, including the AFL-CIO, the Economic Policy Institute, the National Committee to Preserve Social Security and Medicare and the Pension Rights Center.

All of this is being promoted by the idea that individual citizens aren’t saving enough for their retirement, and that consequently government has to “do something.” Rep. Jim McDermott (D-Wash., above photo), Chairman of the House Ways and Mean’s Committee’ Subcommittee on Income Security and Family Support, is confused about whose money is in those 401(k) plans: the individual contributor, or the government. He said that “since the savings rate isn’t going up for the investment [Congress is making] of $80 billion [in 401(k) tax savings], we have to start to think about whether or not we want to continue to invest that $80 billion for a policy that’s not generating what we now say it should.”

The worldview of Rep. McDermott is revealing, and brings clarity to the point of view of many in the Washington establishment that the $4.5 trillion currently invested in 401(k) plans and other private pension plans that enjoy tax breaks actually belong to the government, and that when Congress loses $80 billion that would otherwise flow to Washington due to those tax breaks, it’s an “investment” that must “generate what we say it should”, or else it must be replaced with something else that works better.

The real “story behind the story” was revealed by Joe Wolverton here when he said,

…since the day of his inauguration, Barack Obama and his congressional co-conspirators have consistently and unapologetically set out to systematically nationalize the economy of the United States: first the banks; then the insurance companies; then the auto industry; then healthcare; and now the piece de resistance, the private savings accounts of millions of middle-class Americans.

But, thanks to the SEIU and their program “Retirement USA,” it’s all dressed up to look like a good deal for unsuspecting owners of retirement plans. In “Making the Case for a New System” they take the view that “A secure retirement is part of the American dream. Yet our retirement system is failing many Americans. Social Security is the cornerstone of our system, but as currently structured, is not meant to be our only retirement program. Pensions and savings plans are supposed to fill the gap, but too many workers don’t have plans, and too many plans don’t do the job.” They complain that:

• Private retirement plan coverage is not UNIVERSAL…
• For millions of Americans, private retirement benefits are not SECURE…
• And Private retirement benefits are not ADEQUATE…

And, continues “Retirement USA”’s website, “Social Security must be preserved and strengthened… [and] we must encourage employers to offer and maintain them.”[emphasis added]

Underlying all of this is, of course, the statist presumption that government knows best what’s good for the citizens, and when the citizens’ behavior fails to meet government expectations, then mandates and force must be used to do for those citizens what the government thinks is best.

And the fact that Washington is looking at annual trillion-dollar deficits “for as far as the eye can see,” that $4.5 trillion of private monies is just too tempting to ignore.

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Notable in the statement from the Securities and Exchange Commission (SEC) last week that it was charging the State of New Jersey with securities fraud was the lack of fines, punishment, or names of the guilty. The fraud began in 2001 and wasn’t uncovered until the New York Times exposed it in April of 2007.

What the SEC did say was that New Jersey failed to make disclosures 79 times in the sale of $26 billion worth of municipal bonds, creating “the false impression that the Teachers’ Pension and Annuity Fund (TPAF) and the Public Employees’ Retirement System (PERS) were being adequately funded, [while] masking the fact that New Jersey was unable to make contributions to TPAF and PERS without raising taxes, cutting other services, or otherwise affecting the budget.” Robert Khuzami, Director of the SEC’s Division of Enforcement, said:

All issuers of municipal securities, including states, are obligated to provide investors with the information necessary to evaluate material risks. The State of New Jersey didn’t give its municipal investors a fair shake, withholding and misrepresenting pertinent information about its financial situation.

New Jersey got into trouble in 2001 when the legislators increased retirement benefits for employees and retirees in both plans but failed to provide funding for those increases. Instead, a paper account created “Benefit Enhancement Funds (BEF)” into which monies were to be placed to pay for the increases. But no funds were ever placed into those accounts, even though the state budgets showed that amounts of either $551 million, $56 million, or nothing at all were set aside, depending upon which state documents were considered. According to the Times, New Jersey said the state contributed $551 million to the BEF in 2005, according to a bond offering statement. The $56 million figure appeared in an audited financial statement for the BEF. In fact, nothing was ever placed in the BEF, and the whole paper game folded 5 years later.

The SEC’s Chief of Municipal Securities and Public Pensions Unit, Elaine Greenberg, said “Issuers of municipal bonds must be held accountable when they seek to borrow the public’s money using offering documents [which contain] false and misleading information. New Jersey hid its financial challenges from the very people who are most concerned about the state’s financial health when investing in its future.” However, nowhere in the SEC press release was a single name mentioned, not even those who did the auditing of the books or those who sold the bonds.

They do have names, however. Frederick Beaver, director for the Division of Pensions and Benefits in the New Jersey Treasury Department, when pressed by the Times for an explanation about various questionable practices involved in hiding the truth, pointed out that “other places had taken similar steps occasionally when dealing with a budget crunch.” He said, “The problem we had was doing it on a repeat basis.” Donald DiFrancesco, acting governor of New Jersey in 2001, when the pension increases were approved, said he recalled “people thought it was good public policy,” which was devised to attract the best people. He said he did not think the measure was financially unsound and “did not recall” anyone challenging it or calling it improper.

Jon Corzine (above, former chairman of Goldman Sachs) took office in January 2006 and warned that the pension funds were in bad shape, saying publicly that “It’s impossible for us to stay on the course that we are on today, and deliver what people are asking for. The money will not be there.” Although Corzine succeeded in persuading the legislature to increase contributions to the funds, they were not nearly enough to restore them to financial health.

John Megariotis, the Deputy Director of New Jersey’s Division of Pensions and Benefits, claimed innocence: “We were [only] the bean-counters…Those are not my numbers.” And then he assured theTimes that New Jersey would not fudge the numbers ever again.

John Bennett, majority leader of the Republican State Senate at the time of the increase, blamed DiFrancesco’s administration which had pushed for the increase, assuring him that “there would be money to cover it.”

Those responsible for promoting the fraud to bond investors include Citigroup, J. P. Morgan, Morgan Stanley, Bank of America, Merrill Lynch, Barclays Capital, and, of course, Corzine’s former employer, Goldman Sachs.

The SEC said its action was its first ever against a state government, and that its order “requires the State of New Jersey to cease and desist from committing or causing any violations and future violations…New Jersey consented to the issuance of the order without admitting or denying the findings.”

In a separate interview, Greenberg said that “Hopefully, [the SEC’s action] will send a message to other states or local governments.” However, it may just be too late for New Jersey. As noted here, it is going to take much more than “conjuring magic” and “pension fairies” to restore the state’s fiscal balance sheet. As CNBC put it,

By the time Gov. Chris Christie took office this year, the pension funds had been deprived of contributions for so long that it had become near[ly] impossible to catch up. The state needs to come up with billions of dollars every year, something it cannot do without raising taxes, cutting public services or going even deeper into debt.

Ian Mathias, writing for the Daily Reckoning, hopes that some lessons have been learned: “Now you have all but absolute proof that State administrators are not only unable to balance their books, but they’re willing to cook ‘em too.” Because the action came without pain, punishment or exposure, it provides little incentive for those administrators to change their ways. In fact, only one state has ever defaulted on its bonds: Arkansas defaulted on its obligations back at the bottom of the Great Depression, in 1934.

So, he adds, “The odds are still in your favor [if you own municipal bonds]. But reason is not. Now ethics aren’t, either.”

On June 28, the day the Supreme Court ruled in McDonald v. Chicago that individuals have the right to keep and bear arms, Bob Unruh wrote that the decision “has opened the door for a long list of legal challenges to city, county and other rules and regulations that may now infringe on the 2nd Amendment.”

Although both the National Rifle Association (NRA) and the Brady Campaign to Prevent Gun Violence applauded the ruling by the Supreme Court, they differed in how that long list of legal challenges will play out in the courts.

Wayne LaPierre, Executive Vice President of the NRA, said that his group has “a lot of work ahead” in attempting to overturn regulations that now infringe on citizens’ Second Amendment rights, while Paul Helmke of the Brady Campaign predicted that the NRA is “going to lose most of those lawsuits.” John Velleco, director of federal affairs for Gun Owners of America (GOA), said that McDonald “flips the burden onto the government and legislatures to show why they need to restrict what the court has [just] said is an individual right.” He added, “This is a tremendous victory for the 2nd Amendment [because it] opens the door of the courtroom for us to look at laws in many other jurisdictions where there are highly restrictive gun laws.”

One of those jurisdictions is Chicago which, just four days after the Supreme Court ruling, enacted a “tough new gun-control regime.” That regime flaunted the McDonald decision, but according to Attorney Stephen Holbrook who worked on the McDonald case, “If the courts take the Second Amendment seriously, the chances are good” that Chicago’s new ordinance will also be struck down.

The Second Amendment Foundation (SAF) is suing the state of Maryland for requiring their residents to demonstrate that they face a specific “apprehended danger” in order for the state to issue or renew a handgun permit. Raymond Woollard was issued a carry permit after a man broke into his home in 2002, and his permit was renewed three years later when the felon was released from prison and moved into a nearby neighborhood. But state officials now denied renewing his permit because Woollard failed to “demonstrate cause” for the permit to be renewed. The lawsuit says, “Individuals cannot be required to demonstrate that carrying a handgun is necessary as a reasonable precaution against ‘apprehended danger’ as a prerequisite for exercising their Second Amendment rights.”

Executive vice president of SAF, Alan Gottlieb explained, “Laws that empower bureaucrats to deny the exercise of a fundamental civil right because they cannot show good cause to exercise that right can’t possibly stand up under constitutional scrutiny. We are supporting Mr. Woollard in this action because constitutional rights trump bureaucratic whims.”

A similar requirement by Westchester County, New York, that citizens must have a “good cause” to request a handgun permit, is also being challenged by SAF. The plaintiffs in that case, Alan Kachalsky and Christina Nikolov, were denied permits because, in Kachalsky’s case, he could not “demonstrate a need for self-protection distinguishable from that of the general public,” and Nikolov because she couldn’t show that there was “any type of threat to her own safety.” Gottlieb said these “American citizens…should not have to demonstrate good cause in order to exercise a constitutionally-protected civil right. Our civil rights, including the right to keep and bear arms, should not be subject to the whims of a local government or its employees, just because they don’t think someone needs a carry permit…Our lawsuit is a reminder to state and local bureaucrats that we have a Bill of Rights in this country, not a Bill of Needs.”

North Carolina has a law being challenged in court that forbids citizens from carrying firearms or ammunition whenever officials declare a “state of emergency.” This may occur when “public safety authorities are unable to…afford adequate protection for lives or property,” such as during the recent East Coast record snowfall. A commenter on the website of Winston-Salem’s WXII-TV wrote: “This has to be the most ridiculous event of the century! This is the ultimate denial of liberties for the most asinine reason—bad weather!”

The most important lawsuit, however, may just be one in California that was first brought over seven years ago, Nordyke v. King. Following a shooting at the Alameda County Fair, the county passed an ordinance prohibiting the carrying of firearms on county property. It was contested by Russell Nordyke who operated a gun show on county property. The Second Amendment Foundation recently weighed in on the case with an “amicus curiae” brief that argued that Second Amendment issues in the case must be decided on a “strict scrutiny” basis and that the ordinance in question could not withstand that level of standard of review.

“Strict Scrutiny” is the highest, most stringent standard of judicial review used by courts in the United States and arises when a “fundamental” constitutional right is infringed, “particularly those listed in the Bill of Rights.”

The brief was written by Alan Gura who argued in both the Heller v. DC case and the McDonald v. Chicago case, and is working with the Second Amendment Foundation in several other court challenges. Said Gottlieb, “[Nordyke] is a very important case because it could establish the highest standard of scrutiny to which [all] gun laws around the country would be subjected.” He added, “While gun prohibitionists were upset by the 2007 Heller ruling and demoralized by our victory this year in the McDonald case, they are terrified of a strict scrutiny standard that could be established by the Nordyke case.

As WorldNetDaily explained, “The ‘strict scrutiny’ standard is what is applied to disputes involving constitutional rights, and applying it in this case would strengthen virtually all arguments against local limits and restrictions except the ones that meet the very highest standards of need.”

Back on June 28, Gottlieb said, “This morning’s high-court ruling clearly shows that the right of the individual citizen to have a gun is constitutionally protected in every corner of the Unites States. We are already preparing to challenge other highly restrictive anti-gun laws across the country. Our objective is to win back our firearms freedoms one lawsuit at a time.” The Nordyke case could be one of the most important of all.

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It was news to many when Scott Powell announced that an obscure novel published in 1957, Atlas Shrugged, “may be second to the Bible as the most influential book read in America.” His statement that BB&T, the 12th largest bank in America, which resisted taking TARP bailout funds, requires reading of that same book as part of its management training program astonished many more.

American Conservative Magazine noted that “a week before the President’s inauguration, more people were buying it than Obama’s Audacity of Hope.

Says Powell, the novel “explains our current economic woes more straightforwardly than most of what we hear from today’s experts…What happened in Rand’s narrative is coming to pass today, with an anti-business administration reviling private industry and capitalizing on [the current] crisis to expand and redirect investment within and between sectors of the economy—setting quotas, prices and compensation.” Noting that the economy has ground down essentially to a standstill, due to business owners ceasing to invest because of the continuing threat of government mandates, rules and regulations, Powell points out that while the private sector has lost eight million jobs in the last 2 ½ years, the federal government has expanded both in employment and in spending.

The biggest obstacle to getting the economy working again is government unions, according to Powell, with members of those unions becoming “the country’s most powerful entitlement group,” with no accountability. “Thus,” he said, “government-run schools controlled by the teachers’ unions can fail decade after decade without consequence or substantive reform.” In a free economy, the whole point of Rand’s novel, such obstacles wouldn’t exist. He says,

The media…largely ignore the most consequential story of our time: the Obama administration’s drive to shift wealth and power from the productive private sector to the nonproductive public sector. Rand calls this appropriation of wealth by the government nothing less than looting.

Edward Younkins describes Atlas Shrugged as “an apocalyptic vision of the last stages of conflict between two classes of humanity—the looters and the non-looters. The looters are proponents of high taxation, big labor, government ownership, government spending, regulation and redistribution.” They include:

Politicians and their supporters, intellectuals, government bureaucrats, scientists who sell their minds to the bureaucrats, and liberal businessmen who, afraid of honest competition, sell out their initiative, creative powers, and independence for the security of government regulation.

The non-looters—the thinkers and the doers—are the competent and daring individualists who innovate and create new enterprises. These prime movers love their work, are dedicated to achievement through their thought and effort, and abhor the forces of collectivism and mediocrity. The battle is thus between non-earners who deal by force and profit through political power and earners who deal by trade and profit through productive ability.

When the looting exceeds the ability of the earners to fork over the loot, the looters then destroy the currency. From one of the heroes of Atlas Shrugged comes this broadside:

So you think that money is the root of all evil?…Have you ever asked what is the root of money? Money is a tool of exchange, which can’t exist unless there are goods produced and men able to produce them. Money is the material shape of the principle that men who wish to deal with one another must deal by trade and give value for value. Money is not the tool of the moochers, who claim your product by tears, or the looters who take it from you by force. Money is made possible only by the men who produce. Is this what you consider evil?…Not an ocean of tears nor all the guns in the world can transform those pieces of paper in your wallet into bread you need to survive tomorrow…Whenever destroyers appear among men, they start by destroying money, for money is men’s protection and the base of a moral existence. Destroyers seize gold and leave its owners a counterfeit pile of paper. This kills all objective standards and delivers men into the arbitrary power of an arbitrary setter of values…Paper is a mortgage on wealth that does not exist, backed by a gun aimed at those who are expected to produce it. Paper is a check drawn by legal looters upon an account which is not theirs: upon the virtue of the victims. Watch for the day when it becomes marked: ‘Account Overdrawn.’”

Yaron Brook, President of the Ayn Rand Institute, says the reason for the novel’s current popularity is its relevance. Quoting Rand in her Capitalism: The Unknown Ideal, he said, “If you understand the dominant philosophy of a society, you can predict its course.” He adds,

Why do we accept the budget-busting costs of a welfare state? Because it implements the moral ideal of self-sacrifice to the needy. Why do so few protest the endless regulatory burdens placed on businessmen? Because businessmen are pursuing their self-interest, which we have been taught is dangerous and immoral. Why did the government go on a crusade to promote “affordable housing,” which meant forcing banks to make loans to unqualified home buyers? Because we believe people need to be homeowners, whether or not they can afford to pay for houses.

All of which is exactly wrong as Rand tells the story of John Galt, the ultimate free-market entrepreneur. At the end of the novel, the politicians come to Galt and beg him to help them get the economy going again. Here is the dialogue:

Galt: You want me to be Economic Dictator?
Mr. Thompson: Yes!
Galt: And you’ll obey any order I give?
Mr. Thompson: Implicitly!
Galt: Then start by abolishing all income taxes.
Mr. Thompson: Oh, no!  We couldn’t do that. How would we pay government employees?
Galt: Fire your government employees.
Mr. Thompson: Oh, no!

Powell is optimistic that something similar can still be done here: “The catalyst for course correction is [just] around the corner…President Obama can be thanked for making this midterm election an overdue referendum on liberalism. Average Americans are now more informed and engaged than they have been in generations, and they are highly motivated to vote…The most credible and successful candidates…are likely to be those resolutely committed to deficit– and debt-reduction and getting the government out of the way of private-sector job creation—the essence of Ayn Rand.”

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When Kevin Hall, writing for McClatchy Newspapers, said “the Obama administration got what it was looking for at its summit on the future of housing finance,” he was very close to the truth: No matter who spoke at the summit or what “new” ideas might be proposed, nothing would change—the government would remain fully in charge of mortgage financing for the country.

Hall said the summit (officially called, the Conference on the Future of Housing Finance) designed to develop a proposal for Congress by January, “was a starting point for [the] debate, [which will] carry consequences for all Americans,” even including taxpayers who don’t have mortgages.

How this debate is decided could affect everything from the supply of affordable rental housing to tax deductions for mortgage interest to whether Americans pay significantly more to be homeowners.

Treasury Secretary Timothy Geithner made it clear from the start that the private market would have no influence on the conversation: “We will not support returning Fannie and Freddie to the role they played before conservatorship [in September 2008] where they fought to take market share from private competitors while enjoying the privilege of government support. We will not support a return to the system where private gains are subsidized by taxpayer losses.”

Naturally, the people involved in the summit have been enjoying the fruits of government intervention in the housing market for years, as confirmed by Jim McLeod, the president of Coastal States Bank, a community lender in Beaufort County, South Carolina: “I’m impressed with the fact that they’re asking the right people.” One of those heavily involved in profiting from such intervention was Bill Gross, the managing director of PIMCO, the world’s largest bond fund, who opened the summit by proposing still more government intervention to protect lenders from their errors during the housing bubble. His first proposal was “that the Obama administration order Fannie Mae and Freddie Mac to refinance all outstanding mortgages that they back…into today’s historically low interest rates.”

Speaking as one who would profit from such a move, and also as a Keynesian, Gross said that such an order “would free up a significant amount of income for millions of Americans,” who would then go out and spend the money they were previously paying for housing, which would then “boost the economy.” The fact that previous such efforts to stimulate the economy have failed miserably was missing from his comments. In addition, however, Gross said that the new lower-interest mortgages created should continue to be guaranteed by the taxpayer. In short, Gross was proposing that the taxpayer “eat” the difference between the old, toxic, high-rate mortgages that banks are continuing to hold on their books and the newly-created low-interest rate mortgages, which would continue to enjoy government backing just in case they go bad as well. Either way, Gross and PIMCO would continue successfully to game the system.

Gross made sure that there would be no discussion of reinstituting private market entities to resolve the government-created difficulties by adding that “the private sector can’t return to the pre-crisis market share…because the psychological scars of the deep recession will change investors’ and consumers’ behavior for decades.”

One participant at the summit, however, did propose doing just that. Alex Pollock, a fellow at the American Enterprise Institute, said that privatizing all the functions of Fannie and Freddie would allow the market to operate more efficiently, pointing out that “70 percent of the mortgage market involved prime loans to borrowers with good credit histories…[and] hence the private sector should be pooling those plain vanilla loans for sale to investors, not some government-chartered company.”

Investor’s Business Daily scoffed at the reluctance of participants to point out the role these entities, along with the Department of Housing and Urban Development (HUD), played in creating the problems in the mortgage industry in the first place. IBD reminded its readers that as far back as 1996 HUD “required that 42 percent of Fannie’s and Freddie’s mortgage financing go to ‘underserved’ borrowers with unproven or damaged credit.” In 2000 HUD required the mortgage giants to raise their targets to 50 percent. And by 2008, at the top of the bubble, 56 percent of all mortgages were going to those borrowers, which turned “toxic” as the market imploded.

Just to make sure that this summit was headed in the right direction, Ellen Seidman, who enforced the Community Reinvestment Act (CRA) under the Clinton administration, argued that whatever the final proposals the summit came up with, that Fannie’s and Freddie’s support for “low-income and minority communities…[remains] absolutely critical…The private sector will not do it on its own, and we should just stop having that debate.” As IDB editorialized, “In other words, Fannie and Freddie aren’t going anywhere. They’ll just be absorbed into the government.”

As the summit continued its inevitable march to the inescapable conclusion that more intervention in the mortgage market is just what the banks need to protect themselves and their balance sheets, ordinary Americans have the opposite opinion. A new Rasmussen Reports survey finds that “most Americans remain opposed to government intervention,” with 56 percent saying that the “government should stay out of the housing market all together.”

Remarkably, Rep. Ron Paul (R-Texas) saw the housing bubble coming as far back as 2003. In a hearing with Treasury Department officials, Paul said that the “explicit promise by the Treasury to bail out GSE’s [like Fannie Mae and Freddie Mac] in times of economic difficulty…is a promise on behalf of the government to engage in a huge unconstitutional and immoral income transfer from working Americans to holders of GSE debt [the banks]…By transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market.” (Emphasis added.)

Like all artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged over-investment in housing.

The mortgage summit should listen to Dr. Paul instead of those profiting from the government’s continuing intervention in the mortgage market.

When Fed Chairman Ben Bernanke speaks on Friday at the Fed’s annual meeting in Jackson Hole, Wyoming, Fed-watchers from around the world will be hanging on his every word, phrase, and nuance for clues. They’ll be listening to hear that the chairman knows what’s happening in the economy, and that if things get worse, he has a plan.

The economy continues to suffer as shown by weak demand for housing, high unemployment, and declines in hard goods manufacturing. As Randall Forsythe put it, “Every data point on employment and housing since midyear has fallen short of expectations, in some cases, far short.” The numbers just
released by the National Association of Realtors for July were horrific, despite the Fed’s efforts to “re-flate” the housing market, as Tom Eddlem pointed out.

And it’s foolish to look for a recovery in housing without a recovery in employment. As noted here there are three main reasons why housing isn’t likely to rebound anytime soon: 1) There is a mountain of unsold homes on the market, more than a year’s supply; 2) There aren’t enough qualified buyers trying to purchase a home right now; and 3) bankers are still holding onto their cash, preferring to keep it invested in risk-free Treasuries.

Michael Feroli of JP Morgan Chase said that July’s durable goods report on Wednesday was “disastrous,” with “core” capital goods off 8 percent in one month and the most since January, 2009. Looking forward, he said that business capital spending looks “atrocious,” while Nouriel Roubini,the New York University economist, expects that growth next quarter will be “well below” 1 percent, adding, “With growth at a stall speed of 1 percent or below, the stock markets could sharply correct … [creating] a negative feedback loop between the real economy and … risky asset prices [that could] easily then tip the economy into a formal double-dip.” David Wyss, chief economist at Standard & Poor’s, agrees with Roubini: “The economy is surely not in good shape — the odds of a double dip are a long ways from zero.”

The trouble is that policymakers themselves are divided about what to do. The Washington Post pointed out that the Fed’s policy intentions “have been unusually muddled in the past two months,” and according to the view shared by many mainstream economists, “it is unclear how likely it is that the Fed will undertake major new efforts … [or] what form those actions would take.”

Those attending the conference have differing opinions. President of the St. Louis Fed James Bullard said that the Fed should consider pumping additional billions of dollars into the moribund economy, while Kansas City Fed chief Thomas Hoenig says the Fed should raise interest rates to choke off incipient inflation. Most of them, however, favor muddling through, taking a wait-and-see attitude.

What are the Fed’s options? At bottom, the Fed can do only two things: speak, and print. If the Fed follows Bullard and expands the money supply even further (inflation), rising prices will eventually be the result. Some will say that a cheaper dollar will make American goods look cheaper abroad, which will stimulate exports. But the long term course of that policy is the ultimate destruction of the dollar. If the Fed follows Hoenig and stops the printing press, the resultant rise in interest rates will add another burden to the struggling economy.

Some Fed people admit that they don’t know what to do. Dennis Lockhart, president of the Atlanta Fed, just trusted his gut when the Fed’s balance sheet started shrinking because of mortgages being paid off due to refinancings. Said Lockhart, “The shrinking of the balance sheet just didn’t feel right to meunder the circumstances.” (Emphasis added.)

And equivocating isn’t good either. Fed governor Kevin Warsh argued that an abrupt change in either direction would spook the markets since the public would believe that the Fed is more worried about the economy than it is letting on. This may explain the nervousness shown by investors of late. As David Callaway succinctly put it, “If this group can’t tell whether we’re headed for Japanese-style deflation or German-style hyperinflation, then investors certainly don’t want to be in the game at all.”

Hans Sennholz claimed that “faith in the Fed” to know what it is doing is not only foolish but dangerous.

It is the federal moneybag which can finance any government expenditure and come to the rescue of any number of banks and financial institutions, it can create new money with the speed of a computer command and transfer it in seconds by high-speed modem. It can create deposits of one dollar as efficiently as it can create one million, one billion, or even one trillion dollars. The Fed derives this magical power from its position as money monopolist, from the legal tender force of its money, and from its regulatory powers over financial institutions. Its power is purely political, created and granted by the United States Congress, sanctioned by the courts, and enforced by the police….

When the Chairman speaks, the financial world holds its breath.…

Most economists view the vast powers of the Fed with favor and applaud its managers. Unfortunately, they seriously overestimate the Fed’s power and take no heed of the fateful role played by the Fed. Their blind faith in political power cannot bear to look.

On Friday, the chairman will use one of the only two tools the Fed has at its disposal: words. In a rational, free-market world, Bernanke would be sight-seeing in Jackson Hole, and nobody would care. And the free market would determine the the value of money, with no one granted monopoly power to create it out of thin air.

Image via Wikipedia

(This article is a follow-up to Conjuring Magic To Cover States’ Debts.)

Economist Niall Ferguson of Harvard wrote an article entitled “Complexity and Collapse” for the March/April issue of Foreign Affairs, a publication of the Council on Foreign Relations. Ferguson uses the visual image of a series of paintings by Thomas Cole, The Course of Empire, which currently hangs at the New York Historical Society, to illustrate his point that every society goes through five stages. He says that Cole “beautifully captured a theory of imperial rise and fall to which most people remain in thrall to this day.”

1. The first, The Savage State, pictures a handful of hunter-gatherers eking out a bare existence surrounded by a lush wilderness.
2. The second, The Arcadian or Pastoral State, shows an idyllic setting where the people have cleared the trees and rocks, planted fields, and have built themselves a temple of worship.
3. The third painting, The Consummation of Empire, highlights the transformation of the people into citizens of a benign state, opulently clad, enjoying their existence.
4. The fourth painting, Destruction, shows cities ablaze, citizens fleeing an avenging horde.
5. The fifth and final painting, Desolation, shows no inhabitants, only a few decaying columns that remind one of the poem “Ozymandias”:

I met a traveler from an antique land 
Who said: Two vast and trunkless legs of stone Stand in the desert. Near them, on the sand, Half sunk, a shattered visage lies, whose frown, And wrinkled lip, and sneer of cold command, Tell that its sculptor well those passions read Which yet survive, stamped on these lifeless things, The hand that mocked them, and the heart that fed; And on the pedestal these words appear: “My name is Ozymandias, king of kings: Look upon my works, ye Mighty, and despair!” Nothing beside remains. Round the decay of that colossal wreck, boundless and bare the lone and level sands stretch far away.

Ferguson quotes the British political philosopher Henry St. John, First Viscount Bolingbroke, who wrote in 1738 that even “the best instituted governments carry in them the seeds of their destruction: and, though they grow and improve for a time, they will soon tend visibly to their dissolution. Every hour they live is an hour less that they have to live.”

Precipitating Collapse

Ferguson then relates a series of evidences and examples, including the topic discussed here, to illustrate and support Cole’s theory of imperial rise and fall. Where Ferguson sheds light that would be helpful in understanding the current crisis facing the United States is that, in general, politicians make the mistake of focusing only on the short term. Accordingly, “political leaders in almost any society—primitive or sophisticated—have little incentive to address problems that are unlikely to manifest themselves for a hundred years or more.” Ferguson then reviews the Congressional Budget Office’s various alternative scenarios concerning the country’s public debt and concludes: “It hardly seems to matter which number is correct. Is there a single member of Congress who is willing to cut entitlements or increase taxes in order to avert a crisis that will culminate only when today’s babies are retirees?”

Ferguson then incisively makes his point: The crisis may come sooner, much sooner. As he puts it, “A very small trigger can set off a ‘phase transition’ from a benign equilibrium to a crisis—a single grain of sand [that] causes a whole pile of sand to collapse.” Ferguson continues:

These numbers are bad, but in the realm of political entities, the role of perception is just as crucial, if not more so. In imperial crises, it is not the material underpinnings of power that really matter but expectations about future power. The fiscal numbers cited above cannot erode U.S. strength on their own, but they can work to weaken a long-assumed faith in the United States’ ability to weather any crisis. For now, the world still expects the United States to muddle through, eventually confronting its problems when, as Churchill famously said, all the alternatives have been exhausted…But one day, a seemingly random piece of bad news—perhaps a negative report by a rating agency—will make the headlines during an otherwise quiet news cycle. Suddenly, it will be not just a few policy wonks who worry about the sustainability of U.S. fiscal policy but also the public at large, not to mention investors abroad. It is this shift that is crucial: a complex adaptive system is in big trouble when its component parts lose faith in its viability.

Ferguson then ends his article: “Empires behave like all complex adaptive systems. They function in apparent equilibrium for some unknowable period. And then, quite suddenly, they collapse. To return to the terminology of Thomas Cole, the painter of The Course of Empire, the shift from consummation to destruction and then to desolation is not cyclical. It is sudden.”

In a presentation to the Peterson Institute for International Economics, Ferguson referred to his article in Foreign Affairs, and then addressed the central question: What are the ways out of America’s debt crisis? He stated:

That surely should be the burning question in the western world today, on both sides of the Atlantic. What do we do now that we are in this situation? Well, ladies and gentlemen, in theory, there are six ways out, which I will share with you now. One is to raise the growth rate of your economy. The second is to lower the interest rate on your borrowing. The third is to get bailed out by somebody. That’s the route that at the very last minute the Greeks were able to go down. The fourth, of course, is fiscal pain. You increase taxes or you cut public spending and you try to run a primary budget surplus; you start, if you possibly can, to pay off the debt. The fifth is that you print money. That fancy term seigniorage is just a fancy term for printing money in order to inflate the debt away. And the sixth option is to default. There are all kinds of wonderful words for default that you need to know because they’ll be appearing in the Wall Street Journal and the Financial Times quite frequently in the months ahead. You can have repudiation, standstill, a moratorium, restructuring, rescheduling, and so on. But it all boils down to changing the terms of the original loan—default.

Unfortunately, I have to strike out three of these six options right away because certainly from the vantage point of the United States, they’re very unlikely to materialize. It’s very hard for me to believe, given our present predicament, that we’re going to see a sudden upsurge in economic growth in the United States. I think one consequence of the financial crisis has been to lower the growth path of the United States. At this point we’ve seen some slight recovery [in US bonds], but that, of course, reflects a flight to safety as investors have exited Europe. At the moment the view persists that US treasuries are a safe haven, the safe haven for investors. But as I pointed out in the Financial Times some months ago, US treasuries are a safe haven the way Pearl Harbor was a safe haven in 1941; safe but not for much longer. [Emphasis added.]

The nasty fiscal arithmetic sooner or later catches up with all sovereign borrowers no matter how strong they feel themselves to be—which just leaves fiscal pain, inflation, or default.

Cut, print, or default. Ladies and gentlemen, history affords only one example of a country that managed to get itself out from excessive debt-to-GDP burden without either inflating or defaulting. The only case that I can find is Britain after 1815. For a long century, Britain paid down its debt through growth and through running primary budget surpluses. There was no default. There was no inflation. But this, unfortunately, is the only case that history offers us. And remember Britain did have some unusual advantages at that time. It was, of course, the first country to enjoy an Industrial Revolution. It also had the world’s biggest empire to draw on, and it had a nondemocratic franchise throughout the period, which meant the propertied were represented and the propertyless essentially were not. That makes it much easier to make tough fiscal decisions—believe me.

Back From the Abyss

Despite Ferguson’s discouraging appraisal, he failed to remind his audience of what happened in New Zealand in the late 1980s and ’90s. Maurice McTigue, a former member of the New Zealand Parliament, made a presentation at Hillsdale College in 2004, outlining his country’s successful ability to “step back from the brink” of financial disaster. In his remarks, he said:

New Zealand’s per capita income in the period prior to the late 1950s was right around number three in the world, behind the United States and Canada. But by 1984, its per capita income had sunk to 27th in the world, alongside Portugal and Turkey. Not only that, but our unemployment rate was 11.6 percent, we’d had 23 successive years of deficits (sometimes ranging as high as 40 percent of GDP), our debt had grown to 65 percent of GDP, and our credit ratings were continually being downgraded.

Government spending was a full 44 percent of GDP, investment capital was exiting in huge quantities, and government controls and micromanagement were pervasive at every level of the economy. We had foreign exchange controls that meant I couldn’t buy a subscription to The Economist magazine without the permission of the Minister of Finance. I couldn’t buy shares in a foreign company without surrendering my citizenship. There were price controls on all goods and services, on all shops and on all service industries. There were wage controls and wage freezes. I couldn’t pay my employees more—or pay them bonuses—if I wanted to. There were import controls on the goods that I could bring into the country. There were massive levels of subsidies on industries in order to keep them viable. Young people were leaving in droves.

When his reform government was elected in 1984, it identified three problems: too much spending, too much taxing, and too much government control. McTigue said, “As we started to work through the process, we asked some fundamental questions of the agencies. The first question was, ‘What are you doing?’ The second question was, ‘What should you be doing?’ Based on the answers, we then said, ‘Eliminate what you shouldn’t be doing—that is, if you are doing something that clearly is not a responsibility of the government, stop doing it.’”

The results? At the start of the process, the Department of Transportation had 5,600 employees. At the end, it had 53. The Forest Service had 17,000 employees at the start, and at the end it had 17. The Ministry of Public Works initially had 28,000 employees, and when the downsizing process was completed, McTigue himself remained the only employee.

When challenged about having killed all those jobs, McTigue made an interesting discovery: “I visited some of the forestry workers some months after they’d lost their government jobs, and they were quite happy. They told me that they were now earning about three times what they used to earn—on top of which, they were surprised to learn that they could do about 60 percent more than they used to!”

Some of the things that government was doing simply didn’t belong in the government. So we sold off telecommunications, airlines, irrigation schemes, computing services, government printing offices, insurance companies, banks, securities, mortgages, railways, bus services, hotels, shipping lines, agricultural advisory services, etc. In the main, when we sold those things off, their productivity went up and the cost of their services went down, translating into major gains for the economy. Furthermore, we decided that other agencies should be run as profit-making and tax-paying enterprises by government. For instance, the air traffic control system was made into a stand-alone company, given instructions that it had to make an acceptable rate of return and pay taxes, and told that it couldn’t get any investment capital from its owner (the government). We did that with about 35 agencies. Together, these used to cost us about one billion dollars per year; now they produced about one billion dollars per year in revenues and taxes.

In summary, after reform, the size of the New Zealand government as measured by the number of employees dropped 66 percent. The government’s share of the country’s GDP dropped from 44 percent to 27 percent. Federal debt dropped from 63 percent of GDP to 17 percent.

The benefits of such radical downsizing are still being felt today. According to Wikipedia, “New Zealand has a modern, prosperous, developed economy [with] a relatively high standard of living with an estimated GDP per capita of US$31,067 in 2010, comparable to Southern Europe. Since 2000 New Zealand has made substantial gains in median household income [and NZ citizens] have a high level of life satisfaction.” Marketing ads for New Zealand claim, “New Zealand is now an entrepreneurial power house,” is “ranked first as the least corrupt,” is the “5th freest economy in the world,” and is “first in the world for protecting investors.”

At a recent Cato University conference, this writer interviewed John Boscawen, a Member of Parliament of New Zealand, who was present during the economic revival. The reason for the success, he stated, was “the awareness among our people that we were in desperate shape financially. We had to do something, and the Labor Party had disintegrated. Our coalition was able to push through the reforms that were needed, with remarkable results.”

If the United States is to have any chance for a similar recovery, it is going to require increasing awareness and understanding of how the country came to such a pretty pass. As Thomas Jefferson put it:

I know of no safe depository of the ultimate powers of the society but the people themselves; not enlightened enough to exercise their control with wholesome discretion, the remedy is not to take it from them, but to inform their discretion. Enlighten the people generally and tyranny and oppressions of body and mind will vanish like evil spirits at the dawn of day.

Image by Getty Images via @daylife

The first warning about the possible bankruptcy of the town of Vallejo, California, was reported by the Associated Press on February 28, 2008, when Councilwoman Stephanie Gomes said, “Our financial situation is getting worse every single day. No city or private person wants to declare bankruptcy, but if you’re facing insolvency, you have no choice but to seek protection.”

Marci Fritz, vice president of the California Foundation for Fiscal Responsibility, blamed the action on promises made earlier by the council to the city’s employees concerning salaries and retirement benefits that the city no longer can afford. According to Fritz, these were promises made during economically flush times, and were due to the city council’s unrealistic expectations that those times would continue indefinitely. She said, “It’s a nightmare for city governments because they have to continue to pay these benefits that were granted when they had extra money from real estate and sales tax[es].”

Vallejo, a city of 120,000 across the bay from San Francisco, faced a $9 million budget shortfall at the time, owing to soaring payroll costs for its firefighters and police officers whose pay and pension costs make up almost 80 percent of the city’s budget. Those pay packages were negotiated with the unions representing those workers, and were necessary, according to spokesmen for the city, to be competitive with surrounding towns.

In May of 2008, the council voted 7–0 to declare Chapter 9 bankruptcy to “reorganize its finances,” which meant attempting to break the promises it had made earlier to the unions through the bankruptcy court. By this time, the budget shortfall had increased from $9 million to $15 million, despite efforts to cut expenses for museums, public works, senior centers, and libraries. The bankruptcy process allows the judge to void the union contracts, which essentially forces the city workers to accept a pay package that the city can afford, in light of declining tax revenues. But city employees weren’t the only ones at risk: The city had sold tax-exempt general obligation bonds whose interest payments would also be reduced or even eliminated. With an annual budget of $80 million, the city owed $53 million to those bondholders, and another $220 million in unfunded pension and retirement health benefits, totaling more than three times the city’s annual revenues.

When Judge Michael McManus determined that labor contracts can be broken in the Chapter 9 bankruptcy, union spokesmen said this set a dangerous precedent for other cities and townships in similar trouble to “do a Vallejo.” However, because of a binding arbitration clause inserted into the city charter in 1970, unions were able to renegotiate another contract with the city and, starting in July, 2010, police officers are getting a seven-percent pay raise. New Vallejo Councilwoman Marti Brown was appalled: “No one is getting a 7 percent increase, even in cities not in bankruptcy.” This raise takes place when the city’s budget has decreased from over $80 million in 2008 to just over $63 million in 2010.

The city of Maywood, California, took a different approach to its fiscal difficulties. On July 1, 2010, everyone on the payroll was fired. The Los Angeles Times said that by laying off an estimated 100 workers and contracting the remaining essential services such as finance, records management, parks and recreation, and street maintenance to a nearby town, Maywood would save the city $165,000 a year. On July 1, “We will become a 100 percent contracted city,” said interim City Manager Angela Spaccia.

San Diego is considering bankruptcy as a result of a report by the San Diego Grand Jury that “such a step could help the city cut its onerous retirement and health benefits.” At present the city has an unfunded pension obligation of $2.2 billion and another unfunded retiree healthcare liability of $1.3 billion. And MoneyNews said that San Diego is the fifth major city in the state to consider such a move, along with Los Angeles.

The recent exposure by the Los Angeles Times of the outrageous salary and retirement benefits being provided by Bell City to its City Manager and Chief of Police confirms the attitude of entitlement and disregard for fiscal responsibility that appears to be rampant in cities across the state and the country.

Papering Over Problems

All of this is putting the state of California on the “verge of system failure,” warns Jean Ross, executive director of the California Budget Project. With an annual budget of about $125 billion, California faces a $19 billion shortfall this year, and an expected $37 billion gap next year. But that’s just the tip of the iceberg. A recent Stanford University study concluded that the state’s pension fund is short by roughly $500 billion. The study urged Governor Schwarzenegger “to inject $360 billion into its public benefit systems…[just to] have an 80 percent chance of meeting 80 percent of [the state’s] obligations over the next 16 years.”

As Agora Financial put it,

The problem, just like with the subprime [meltdown], is an irrational form of leverage. In essence, municipalities borrow current earnings of public employees in exchange for some of the most favorable retirement plans in the world. That borrowed money is invested aggressively, just like a private-sector employee would in his 401(k).

Except if the fund loses money, which they all have over the last 10 years, pension funds don’t adjust payouts. The social and political pressure to maintain the status quo—keeping our public employees comfortably retired—is just too strong. So municipalities kick the can down the road. New employees buy into the funds. Fund managers maintain their projections of endless 8 percent annual returns. Retirees keep taking out the funds they were promised…and no one pays the tab.

And it’s not just California. Orin Kramer of New Jersey’s pension program estimates a national funding gap among all the states of around $2 trillion. The Center on Budget and Policy Priorities, a Washington research institution, announced that “finances in Arizona, New Jersey, New York and other states show few signs of improvement. Forty-six states face budget shortfalls that add up to $112 billion for the fiscal year ending next June [2011].” The May/June issue of Chief Executive magazine published its annual “Best and Worst States for Business 2010” and gave its “booby” prize for worst state to California, with New York, Michigan, New Jersey, and Massachusetts rounding out the bottom five.

Hugo Tassone, a retired Yonkers, New York, policeman, recently received a lot of unwanted attention when it was revealed that when he retired three years ago, at age 44, his pension was $74,000 a year. Now 47, his pension is $101,333 a year. He is just one of over 100 retired Yonkers police officers and firefighters who are collecting more in retirement than they did while they were working. Statewide, more than 3,700 retired public workers are getting pensions of more than $100,000 a year. The problem, according to David Simpson, a spokesman for the Mayor of Yonkers, is that “once you give something, you can’t take it away.”

This fades into relative insignificance in light of Bell City, California’s problems. When City Manager Robert Rizzo’s pension kicks in, he will receive “at least $600,000 a year for the rest of his life,” according to the Los Angeles Times. This would make him the highest-paid retiree in the California Public Employees Retirement System (CalPERS). Third on that list would be Bell City’s Police Chief Randy Adams, who will receive more than $400,000 annually.

Bell City’s misfortunes will be shared with 140 other cities and districts such as Norco, La Canada, Flintridge, and Goleta because they are in the same pension “liability pool” as Bell. And there appears to be no way out. As the Times put it, “Public pensions are difficult to rescind. Courts have repeatedly upheld the [pension benefits] in favor of employees.” A slight glimmer of hope was offered by Stephen Silver, a Santa Monica attorney specializing in pension law, who said that “investigators [would have to] show that Bell’s high salaries were an unlawful expenditure of public funds.”

In June, New York’s cash crunch was so severe that Governor David Paterson said the state might have to start paying its bills with I.O.U.s, much like California did last year. The very next day, however, the New York State legislature came up with an ingenious way to kick the can: borrow from itself. By borrowing from the state’s own pension fund, the state could help close its current $9 billion budget gap, in exchange for a promise to pay back the loan starting three years from now. But don’t call it borrowing. Robert Megna, New York’s budget director, said, “We’re not borrowing. We would view it more as an extended-payment plan.” Lt. Governor Richard Ravitch challenged that characterization: “Call it what you will, it’s taking money from future budgets to help solve this year’s budget.”

Legislators in other states have promoted similar budgetary sleight of hand. One way to “fix” the pension shortfalls has been to take more risks with the invested funds in the hopes of getting higher returns. ANew York Times article quoted Frederick Rose, former chairman of the Texas Pension Review Board, “In effect, they’re going to Las Vegas [to play] ‘double up to catch up.’” Naturally, the money managers disagree, saying that such strategies are merely aimed at “diversification,” which now includes investing in commodity futures, junk bonds, foreign stocks, and deeply discounted mortgage-backed securities, as well as investing on margin. In addition, some managers are betting on hedge funds to help enhance their returns. According to the Times: “The problem now is that bond rates have been low for years, and stocks have been prone to such wild swings that [the usual] 60–40 mixture of stocks and bonds is not paying 8 percent. Many public pension funds have been averaging a little more than 3 percent a year for the last decade, so they have fallen behind where their planning models say they should be.” Some states, like New Jersey, “have fallen so far behind they may never catch up again.”

Any attempt to lower the estimated or projected rate of return, however, would only exacerbate the problem because it would increase the contributions required to be made by the states. In Colorado, for instance, its $30 billion pension fund requires that the fund earn no less than 8 ½ percent annually. At present, because of much lower real returns, the plan is underfunded by nearly $18 billion. But if that projected return were adjusted downward by just one-half of one percent, the plan’s shortfall would jump to more than $21 billion, requiring the state to increase its contribution. But Colorado cannot even make the contribution currently required and has fallen several billion dollars behind, despite reducing current retirees’ cost-of-living adjustment down to 2 percent from the previous 3 ½ percent. And employees’ unions are threatening to sue to have that downward adjustment reversed.

Exacerbating the Problems

California’s problem isn’t just fiscal. Chief Executive magazine’s recent survey quoted one CEO: “Texas is pro-business with reasonable regulations, while California is anti-business with anti-business regulations.” Another respondent agreed: “California is terrible. Even when we’ve paid their high taxes in full, they still treat every conversation as adversarial. It’s the most difficult state in the nation. We have actually walked away from business rather than deal with the government in Sacramento.” A third complained, “The leadership of California has done everything in its power to kill manufacturing jobs in this state. As I stated at our annual meeting, if we could grow our crops in Reno, we’d move our plants [there] tomorrow.”

Texas, on the other hand, is where 70 percent of all new U.S. jobs have been created since 2008, and has gained nearly a million new residents over the last 10 years. By comparison, California lost 1½ million residents, and New York lost even more than California. New Jersey lost so many residents that it has dropped from 10th to 11th place in population. Part of the attractiveness of the top states in the Chief Executive survey is that their budgets are relatively under control. For example, Montana Governor Brian Schweitzer said recently, “It gives us a great deal of pride that when 48 states zigged, we zagged. We were certainly not visionaries, but when times were good, we put money aside to get through the current downturn. Do we have enough money set aside to get us through this? I don’t know. I think so. I hope so, but I know this: We did a better job than 48 other states.”

Forbes magazine did a “Political Litmus Test” and discovered that the states in the worst financial condition were also heavily Democratic. Said Forbes: “The five states in the worst financial condition—Illinois, New York, Connecticut, California and New Jersey—are all among the bluest of blue states [while three of] the five most fiscally fit states—Utah, Nebraska and Texas—boast Republican majorities.” Kent Redfield, former professor at the University of Illinois, concluded that the difference “comes down to stronger unions and a larger appetite for public programs. Unions in general have more influence in Democratic-controlled states. This isn’t to say that unions are bad, but where they’re strong you have bigger demands for social services and coalitions with construction companies, road builders and others that push up debt.” Utah, according to Forbes, is the most fiscally responsible state in the union, with just $442 of debt per resident and unfunded pension obligations of $7,272 per resident. It is also the reddest state in the Union, with a 21 percentage point advantage for Republicans. And it boasts a triple-A credit rating from Moody’s. By contrast, Illinois, a blue state, has a per resident debt of $1,877 and unfunded pension liabilities of $17,230. Moody’s rates its general obligation debt second lowest in the country, just ahead of California.

Added together, 46 states face budget shortfalls this year of more than $110 billion. Dean Banker of the Center for Economic and Policy Research concludes that the states have few options: “States are going to have to cut back spending and raise taxes, the same way Greece and Spain are.” Former New Jersey Governor Christine Todd Whitman was more direct: “States don’t have a choice anymore. These problems are going to require major surgery.”

Not if the politicians themselves can avoid facing the music, however. Illinois Governor Pat Quinn recently signed legislation that would slash retirement benefits for state workers, saying, “We can’t afford to deny reality or delay action any longer.” But the New York Times exposed Quinn’s deceit: “That vaunted $300 million in immediate savings? [Quinn] produced it by giving [Illinois] credit [today] for the much smaller checks it will send to retirees many years in the future—people who must first be hired and then, for full benefits, work until age 67.” (Emphasis added.) In other words, through the magic of accounting and obfuscation, Quinn’s savings are coming from workers who haven’t even been hired yet!

Not Saying No to Constituents

The creativity of politicians trying to stay in office and avoid making hard decisions is something to behold. The city of Wichita, Kansas, will soon begin imposing a “false alarm fee” that applies to residents whose security alarms go off by accident. San Francisco has decided to charge a euthanasia tax of $25 per pet, and another $20 if residents want the city to dispose of the newly deceased pet. Residents in Washington, D.C., are now charged $51 a month to keep the streetlights on at night. Las Vegas will start taxing amateur sports, and fees will double for all youth and adult sports leagues and summer camps. Smokers in New York get to pay an additional $1.60 per pack of cigarettes, while Baltimore just passed a “beverage tax” of 2 cents per bottle, which includes water as well as soda. Probably the most notorious was New York State’s “borrowing from itself” but not calling it borrowing, just “smoothing” out the revenue stream. New Hampshire was recently ordered by the courts to “put back $110 million that it took from a medical malpractice pool [in order to] balance its budget,” according to the New York Times. Connecticut tried to revise its accounting rules to reduce the impact of its budget shortfall. Hawaii has already initiated a four-day school week. California accelerated its corporate income tax this year, making companies pay 70 percent of their 2010 taxes by April 15. And many states have attempted to balance their budgets using federal healthcare dollars that Congress has not yet even appropriated. Colorado tried unsuccessfully to raid that state’s worker’s compensation program in the amount of $500 million.

The audacity is breathtaking. According to MoneyNews, seven states that are in financial trouble continue to hire new workers. Joshua Rauh, a finance professor at Northwestern University, released a study showing that Illinois, Connecticut, Indiana, New Jersey, Hawaii, Louisiana, and Oklahoma have hired 9,700 new workers during the Great Recession. Says Bloomberg columnist Joe Mysak, “Politicians have talked a lot about layoffs during this recession. In most cases, that talk is…empty.” Politicians have an “attitude of entitlement and arrogance,” he adds.

Pension Fairies

Some despair that politicians and pensioners will continue to believe in “the pension fairy,” as Gary North put it recently. He says that “voters are poorly informed but [they are] not stupid. They know that some future group of voters will simply stop funding the pension program[s]. They know that when things get tough there will be a new Legislature, and there will be a new Governor, and these faithful politicians will do whatever is necessary to get themselves re-elected.” North compares the states’ situations to that of General Motors before the government takeover. The company’s debt was restructured [read: defaulted] which “stiffed all of the pensioners [and] stiffed all of the bondholders…What happened to General Motors is going to happen to most pension funds in most municipal governments and most state governments…one by one, they are going to go belly up.”

Others are making “zero-sum” recommendations, such as selling digital ads on state-issued license plates; selling off state-owned properties, as was proposed in Minnesota when they suggested selling the Minneapolis-St. Paul International Airport to private businesses; or offering statewide, private vouchers for education, as was recently tried in the District of Columbia, generating some savings. Writing for the Los Angeles Times, columnist Michael Hiltzik complained about all the “corporate welfare” in which California engages. He referred to the “Hollywood” subsidy, currently $100 million annually in tax credits and “enterprise zones,” which costs the state upwards of $500 million. He further complains that “California is the only major oil-producing state that doesn’t levy a severance tax on oil taken from the ground, even though such a tax could yield billions of dollars a year.”

But all of these “raids” and “adjustments” and sleight-of-hand accounting tricks are simply nibbling at the edges of the problem. Joshua Rauh, quoted earlier, recently recalculated the pension obligations of all the states using the rules followed by bond issuers. The states’ unfunded liability is $3.23 trillion (with a T).

The reality is that with politicians’ interest in kicking the can down the road, the vested “entitlement” interests of the retirees, and belief in the “pension fairy,” bankruptcies will continue to claim victims. States are already looking to the federal government for “assistance.” If General Motors is too big to fail, what about California? And if California, why not New York? If New York, why not Illinois? The irony is, as always, the federal government has no money of its own. It’s already past the “tipping point,” and is taking on water faster every day. To many, the future appears grim indeed.

Cover of Capitalism: The Unknown Ideal

When John Stossel of Fox Business Network wrote his recent “Memo to Alan Greenspan” column, he recounted many of Greenspan’s failings while Chairman of the Federal Reserve, including especially Greenspan’s relentless expansion of the money supply and lowering of interest rates that set in motion the housing bubble that burst in 2007.

But Stossel got one part of his memo wrong. He said, “We libertarians were distressed by Greenspan’s apparent abandonment of his free-market philosophy and his neglect of the government’s decisive role in the [current] crisis.” Stossel is referring to Greenspan’s friendship with and close ties to Objectivist Ayn Rand, for whom he wrote a number of articles on the principles of the free market, including “Antitrust,” “Gold and Economic Freedom,” and “The Assault on Integrity,” which were later published in Rand’s collection of articles Capitalism: The Unknown Ideal.

Greenspan understood clearly those principles. In “Antitrust,”, he wrote:

The ultimate regulator of competition in a free economy is the capital market. So long as capital is free to flow, it will tend to seek those areas which offer the maximum rate of return…

The capital market acts as a regulator of prices…it leaves an individual producer free to earn as much as he can by lowering his costs and by increasing his efficiency relative to others. Thus, it constitutes the mechanism that generates greater incentives to increased productivity and leads, as a consequence, to a rising standard of living.

In “Gold and Economic Freedom,” he wrote:

Stripped of its academic jargon, the welfare state is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support a wide variety of welfare schemes…

This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the “hidden” confiscation of wealth. Gold stands in the way of this insidious process.

And in “The Assault on Integrity” Greenspan writes:

Government regulation is not an alternative means of protecting the consumer. It does not build quality into goods, or accuracy into information. Its sole “contribution” is to substitute force and fear for incentive as the “protector” of the consumer. The euphemisms of government press releases to the contrary notwithstanding, the basis of regulation is armed force. At the bottom of the endless pile of paper work which characterizes all regulation lies a gun.

Any claim that Greenspan didn’t know how the market works free of government interference is absurd. He did know, and he wrote eloquently and persuasively about that knowledge.

In August 1987, just a month after Greenspan was appointed as Chairman of the Federal Reserve System by President Ronald Reagan, free-market economist and scholar Murray Rothbard wrote A Minority Report in which he said: “I knew Alan thirty years ago, and have followed his career with interest ever since.” His “real qualification is that he can be trusted never to rock the establishment’s boat. He has long positioned himself in the very middle of the economic spectrum. He is…a conservative Keynesian.” Rothbard goes on to say:

There is one thing, however, that makes Greenspan unique, and that…is that he is a follower of Ayn Rand, and therefore “philosophically” believes in laissez-faire and even the gold standard. But…Alan only believes in laissez-faire “on the high philosophical level.” In practice, in the policies he advocates, he is a centrist like everyone else because he is a “pragmatist.”

At no time in his prominent twenty-year career in politics has he ever advocated anything that even remotely smacks of laissez-faire, or even any approach to it. For Greenspan, laissez-faire is not a lodestar, a standard, a guide by which to set one’s course; instead, it is simply a curiosity kept in the closet. [Emphasis added.]

In Ryan McMaken’s recent review of Panderer to Power by Frederick Sheehan, he points out that Greenspan’s real ability was his skill in playing the political game, and “his ability to convince virtually all the world that he was perhaps the greatest economist of the age.” Even Ayn Rand and her associate Nathaniel Branden early on saw through him, when she asked, “Do you think Alan might basically be a social climber?” Sheehan noted that “Rand and Branden were instinctively suspicious of Greenspan’s motivations,” and that “Branden recalls a man without philosophical inclinations.” Interesting to note was the association Greenspan had with another Randian, Martin Anderson, who later became a member of the Reagan Administration “who would prove instrumental in Greenspan’s rise,” as he put it.

So adept was Greenspan that even when called out on his willingness to manipulate the markets with his words, no one minded. In an interview with Maria Bartiromo on CNBC she asked the chairman:

All of these important economic events you are overseeing…you’ve got to convey what’s going on to people. That means Congress, the president, the media, the public. So what? You come up with Green-speak?

Greenspan:  Otherwise known as Fed-speak.

Bartiromo:  What is it?

Greenspan: It’s a language of purposeful obfuscation, to avoid [answering] certain questions…I proceed with four or five sentences which get increasingly obscure. The congressman thinks I answered the question [when I haven’t].

When CBS’ Leslie Stahl said that “in public Greenspan was inscrutable whenever Congress asked about interest rates. Greenspan admitted that “I would engage in some form of syntax destruction, which sounded as though I were…answering the question, but, in fact, [I] had not.”

Greenspan was able to defend his inability to predict the coming crash successfully until Barron’smagazine uncovered a copy of his 1977 Ph.D. thesis, which had been removed from NYU’s library at his request. The author stated that Greenspan “knew exactly the consequences of the Fed’s action long before he ever took over as Fed chair in 1987.”

Others along with Stossel have been “distressed” at Greenspan’s lack of consistency in supporting the free market, including Harry Binswanger who said back in 1999: “Somewhere deep below his polished political exterior, there’s an economist who knows the value of the gold standard. I suspect that Mr. Greenspan knows a lot more about good economics than he lets the public or his colleagues at the Federal Reserve and Treasury know.”

When pressed, Greenspan describes himself as a “lifelong libertarian Republican.”

Without debating semantics, Greenspan made abundantly clear his true position as a statist when he called on Congress to let the Bush tax cuts expire at the end of the year: “I’m in favor of tax cuts…[but] the problem we now face is the most extraordinary financial crisis that I have ever seen or read about.”

Thomas Jefferson really wouldn’t care if Greenspan were a Randian, a statist, an inflationist, or a “libertarian Republican.” His remedy would remain the same:

In questions of power, then, let no more be heard of confidence in man, but bind him down from mischief by the chains of the Constitution.