The Homeless Crisis

 There has been a lot of talk about homelessness in the past few years.  It's a problem.  There's no doubt about that.  Where the conflict comes in is when people start talking solutions.  At one end of the spectrum are the "ride them all out of town on a rail" people.  At the other end of the spectrum are the "Governments should spend tons of money on either new construction or housing subsidies for the poor" people.

The former strategy has been employed with modest success in the past.  It drove numbers down, at least temporarily, and only in some places.  What it mostly did was move the problem around without actually eliminating it.  The later strategy has also been moderately successful in the past.  It too drove the numbers down. at least in some places.  And it had the virtue of not moving the problem around.  But it too did not eliminate the problem.

These two strategies are only two examples of the many strategies that have been tried in the past.  That means that we can look to history for guidance as to the likelihood of success of any strategy we might now consider.  And that means, as anyone who has read my previous work knows, it's time for a dive into history.

For my historical dive I am going to stick with Seattle's history on the subject.  The historical experience of every city and every region is distinct.  Seattle, for instance, featured a large "Hooverville" encampment during the Great Depression.  The homeless congregated in large numbers on then undeveloped land.

Hooverville was the historical equivalent of the "Tent Cities" we now see, but on a much larger scale.  Back then the homeless built shacks out of tarpaper and scrap lumber rather than scrounging up cheap tents.  And they congregated in one place.  But the idea was the same.

Not every city had a Hooverville, but many did.  It was one of many common patterns that have emerged and reemerged over the years in response to the periodic bouts of homelessness the country has suffered through.

Seattle's experience with homelessness has some unique components.  But there is enough commonality of experience to permit Seattle to stand in for all those other places without loosing anything essential.  And away we go.

And I am going to start with a simple question?  Seattle didn't always have a homeless problem, did it?  And the answer is NO.  Seattle didn't always have a homeless problem.  That's why history, which is almost always helpful, is even more helpful than usual. We can see how things were when there wasn't a problem.  Then we can see what changed to cause the problem, and to make it go away.

And we know there is a solution:  go back to the way things were when homelessness was at most a minor concern.  So, let's start with the way things were during some of those periods.  Early in Seattle's history it had something called "Skid Road".  Over time this phrase morphed into the now widely used term "Skid Row".  A skid row is a neighborhood full of cheap, crappy housing.  As a result, poor people live there.  They do so because that's the only place they can afford to live.

Skid Road came about because of Seattle's early connection to the timber industry.  '49ers flooding into San Francisco and surrounding areas in search of gold set off a local construction boom.  The completion of the first transcontinental railroad a decade or so later caused the San Francisco metropolitan area to continue to flourish for more decades.  That extended the construction boom.  Both events also cemented San Francisco's position as the financial capital of the west coast until well into the twentieth century.

But for our purposes what's important is that the wood used to build all of those buildings in the then booming metro San Francisco area had to come from somewhere.  And a major source for that wood was the Puget Sound region.  The headquarters of the regional timber industry was Port Townsend, now a sleepy tourist destination, but then a very big deal.  But Seattle, in the form of the Yesler Sawmill, got in on the action.

The big industry in Seattle in the early years was cutting down trees, milling them into lumber, then putting them onto ships bound for San Francisco.  Seattle had, and still has, steep hills.  Back then the hills were covered with trees.  If Seattle was to grow into a metropolis the trees had to go.  Luckily, trees were valuable due to the San Francisco construction boom.  This allowed the timber industry to power a lot of Seattle's early growth.

But it is harder than one would think to get the trees down Seattle's steep hills and into the mill.  So, something called a "log flume" was constructed.  Instead of water, the thing a flume normally moves, Seattle's flume moved logs.  And it was, in essence, a giant slide.  The process of cutting down the trees, turning them into logs, putting the logs into the top of the flume, letting them slide down into the water at the bottom, then floating them to the sawmill, was called "skidding".

And after all the trees had been cut down the flume no longer had a purpose, other than being an eyesore and being in the way, that is.  So, it was then taken apart and the timber it had been constructed from was fed into the sawmill.  What was left was a road.  But before that Skid Road was a neighborhood.  It was an undesirable neighborhood.  No one wants heavy logs flying by their house.  And, of course, there was always a chance that a log would pop out of the flume and crash into someone's house.

Given all that, it is no surprise that the only people who lived in that particular neighborhood were poor people who had no better option.  So, the association between a Skid Row neighborhood and poor people dates back to the origin of the term.   And the term originated in Seattle and nowhere else.

Back in those early days there were no zoning laws.  If someone wanted to build a log flume in the middle of town there was no law against it.  In fact, it was encouraged.  After all, it would bring money into the local economy.  Similarly, if someone wanted to throw up crappy housing that only poor people could be induced to live in, there was no law against that either.  That's how things worked back in the day.

People always had a place to live.  It was substandard, dangerous, and often uncomfortable, but it was.  It put a roof over the head of almost everybody.  When it came to housing poor people, and thus keeping them off the street, all that was necessary was to have Skid Row type neighborhoods in your city.  Poor people found hanging out in the more desirable parts of the city could be herded into the less desirable parts.

And it worked.  Cities were cut up into neighborhoods.  The poor people lived in the slums, i.e. the Skid Row parts of town.  Rich and powerful people lived in the fancy parts of town.  There were usually gradations in between.  Some parts of the city were closer in nature to the slums.  But they were a step up from the worst slums.  Some parts were quite nice, just not quite as nice as the nicest parts of town.

Eventually, this got formalized in the form of zoning laws.  City Governments started putting rules in place to designate the boundaries of the various neighborhoods.  And they started mandating construction standards.  These varied from pretty much anything goes in the slums to allowing only high quality construction in the fancy parts of town.

Codes for the fancy parts of town might mandate minimum square footage, both of the house and of the lot, forbid activities like multifamily dwellings, manufacturing, retail, warehousing, and the like.  Other neighborhoods permitted all of the activities prohibited in the fancy parts of town, and were silent on things like minimum square footage and the like.

These zoning laws worked.  There was a place for everybody and everybody knew their place.  One modern twist on this idea was called Redlining.  Supposedly, lines on a map were used to delineate the boundaries of the various neighborhoods.  Red lines were used to delineate the boundaries of the neighborhoods set up for the undesirable groups, Asians or Blacks, for instance.  They weren't allowed to cross the "red line" and move into the rest of the city.

Seattle, had a Chinatown, for a long time the only place where people of Chinese extraction were allowed to live.  It was eventually joined by Japantown (Japanese), Little Saigon (Vietnamese), and others.  Each maligned group got its own ghetto.

The term "ghetto" was coined in Europe.  It referred specifically to the neighborhood Jews were confined to.  But the usage of the term was eventually broadened by Americans.  In the U.S. it was most commonly used in association with the neighborhood were Black people were forced to live.  In Seattle, the Black neighborhood was called the "Central District".

One feature of ghettos of all kinds is that housing prices are lower there.  One popular excuse for creating and maintaining ghettos is that "those people drive housing prices down".  The point of ghettos was to discriminate against the people who were forced to live there.  That made living in or near a ghetto unpopular.  And popularity is really what determines the desirability of a particular location.

There is only a modest correlation between the actual desirability of a location and its price relative to land in other locations.  There are intrinsic factors that go into how desirable a specific location is.  They are things like convenience, the view, amenities like being on the waterfront, and so on.  But a study of these intrinsic factors only gets you so far when it comes to predicting a piece of property's market value.

Subjective factors also figure into the calculation.  If we study actual land values for a typical U.S. city in the 1950s, a city like Seattle, then we can subtract the intrinsic factors to determine the how much subjective considerations affect a property's value.  It turns out that subjective factors are very important.  Land in a "rich" neighborhood was highly overvalued while land located in a ghetto was highly undervalued.  Zoning had a large influence on land values.  But that, after all, was the point.

Since then, a number of forces eventually substantially diminished the ability of zoning to distort land values.  Two big ones were suburbanization and civil rights.  Suburbanization had two effects.  First, a lot of middle class and rich people moved to the suburbs.  That siphoned off a lot of the people occupying the top financial tiers.  This made it harder to maintain inflated land values in pricier neighborhoods.

In Seattle's case the metropolitan population was growing just enough to exactly offset suburban flight.  As a result, migration to the suburbs did not cause Seattle's population to decline.  On the other hand, it didn't grow either.  Instead, it remained essentially unchanged for several decades.  That meant that enough rich and middle class people continued to live in the city to keep prices stable, or increasing slowly, in rich and middle class neighborhoods.

To this day there are lots of neighborhoods in Seattle that are filled with nice houses occupied by middle class people.  These kinds of neighborhoods provide more than half the housing currently available in Seattle.  And these neighborhoods have seen little change.  Change has been confined to the poorer neighborhoods.

The other impact of suburbanization eventually had an equally large effect.  Seattle got hemmed in.  The last time Seattle expanded its borders was in the '60s.  That meant that Seattle couldn't implement the "sprawl" strategy used by cities like Huston and Phoenix.  Given a choice, people preferred to live in detached single family homes.

But there was just no place inside Seattle's city limits to build more.  So, Seattle built high density housing, apartments and condos.  This should have caused the population to increase.  But there was a countervailing trend.  The number of people living in the typical house declined.  In Seattle's case, these two opposing trends balanced out.  It wasn't until the '90s that the high density trend got the upper hand and Seattle's population started growing again.

Initially, suburban living was very desirable.  Cheap land allowed suburban developments to be reasonably priced.  Huston, Phoenix, and other similarly situated cities, were able to grow by annexing more and more land, which they filled with suburban sprawl.  But that sprawl eventually meant that new suburbs kept getting farther and farther away.  And that has caused the commute to anywhere interesting to get longer and longer.  So these new outer suburbs have gotten less attractive over time.  As a result, they now attract poorer and poorer people.

What civil rights did, starting in the  '60s, was to make discriminatory zoning practices like redlining illegal.  Initially, these anti-discrimination laws were honored in the breach.  But over time enforcement slowly ramped up.  Eventually, this made it harder and harder to use zoning to enforce the rigid boundaries that used to characterize neighborhoods.  The eventual result was gentrification.

People started viewing neighborhoods not by who traditionally lived in them but by the intrinsic factors they provided.   Previously undesirable neighborhoods started becoming sought after.  Take, for example, Seattle's aptly named Central District.  As the name implies, it is centrally located.  That is a very desirable feature.

Gradually, many of the Blacks that had traditionally lived there were pushed out by white people with more money.  And besides being able to pay more in the first place than many Blacks could afford, they had the money to fix up the housing they found there.  Early adopters took advantage of what had been undesirable, and therefore cheap, to snap up properties that they otherwise couldn't have afforded.  These properties eventually became desirable, and therefore valuable.

Over a period lasting more than thirty years all of the less expansive parts of Seattle have gotten gentrified.  And what that meant was that all of the cheap housing got replaced by expensive housing.  Contemporary Seattle no longer has a Skid Row.  And that means that there is no place in Seattle for the poorest people to live.  Seattle used to have a bunch of SRO (Single Resident Occupancy) hotels.  These were essentially flop houses where even very poor men could afford to live.  They are now all gone.

Seattle is an extreme case.  But the general trend is universal.  Not every city has lost all of its "flop house" quality housing the way Seattle has.  But pretty much every city has far less of it now than it had fifty years ago.  And pretty much every city has lost a lot of the housing that people occupying the bottom few rungs of the economic ladder could afford.

Seattle used to be an easy place for a person making the minimum wage, or perhaps a little above it, to find housing that was both affordable and decent.  That kind of housing is now effectively nonexistent.  Again, the near universal trend is for people in those income brackets to find it very hard to find a place they can afford to live in, even if they live in a place that is thousands of miles away from Seattle.

That has put a lot of people into a severe squeeze when it comes to finding housing they can afford.  Then there are drugs and mental health.  We are more than fifty years into the War on Drugs.  It has been a failure all along the way.  But one side effect is that people who end up with serious drug problems too often find that they have little access to effective treatments.  As a result, a lot of them end up on the street.

People having mental health problems also have trouble getting effective treatment.  Their illness causes them to have poor judgement.  And that leads to the kinds of actions that lead to them also finding themselves out on the street.

Finally, there are the otherwise squared away people who for one reason or another have hit a serious financial problem.  That is often enough to put them out on the street.  The street has become the dumping ground for all the problems that society does not want to deal with.

Tents are cheap.  Sleeping bags are cheap.  Grocery carts are cheap.  Derelict cars and motor homes are cheap.  The result is a lot of people living on the street, in a tent tucked back somewhere, or living in a junker vehicle.  Things have gotten out of hand.

There are several problems here that need to be fixed.  We tried dealing with drugs by locking lots of people up.  What we ended up with was a fantastically expensive prison industry and no relief on the drug front.  We used to have mental hospitals.  But we got rid of them and decided that "community based" treatment was the way to go.  That too has been a failure.

If we give the squared away people a helping hand they will take it and soon be off the streets.  But the number of helping hands are far fewer than the number of people who could use the help.  At the other end of the spectrum are the people who have become comfortable living on the street.  They steadfastly refuse all offers of help.  I have no interest in making their lives easier.  In fact, I am okay with some of the yesteryear tactics that were designed to get them to go elsewhere.

I am firmly of the opinion that throwing money at this particular problem is a mistake.  Government, no matter what level you want to talk about, doesn't have enough of it.  Nor am I convinced that an infinite amount of money, should it become available, would be effective.  Even if a lot of money was available, this is the kind of problem where the need will always expand by the amount necessary to consume however much resource is thrown at it.

But the problem is not insolvable.  It didn't used to exist.  It can be made that way again.  History tells us that the proper approach is a legal/regulatory one.  Before discussing the main change, let me address some changes in the law that would not solve the problem, but they would help.  Current law make sit almost impossible to deal with junker vehicles and the people living in them.

The law should be changed so that it is illegal to park a vehicle on a public street that is not "street legal".  All vehicles parked on city streets would have to conform to all safety standards and the like; and they should be required to have current "tabs".  This would get the worst of the junker vehicles off of public streets.  If people want to allow people to live in junker vehicles parked on their private property, okay.  But not on public streets.

It should also be illegal for someone to pitch a tent on a sidewalk, in a public park, etc.  Again, if people want to allow other people to pitch tents on their private property, that's another thing.  Will these changes make it harder for homeless people to find a place to lay their head?  Yes.  But it will also free up a lot of resources that are currently playing whack-a-mole.  That's not enough to fix the problem.  But it is a start.

Then there's the big one, zoning.  Zoning is the most powerful tool in the government toolbox.  Lots of zoning changes have been made over the last few decades that have increased the minimum standards for major remodels or new construction.  This has made it illegal to construct slum housing.  A tight housing market has made it a good idea for owners to upgrade cheap housing to the point where it is no longer cheap.  What has been done can be undone.

But there is no political will to do this.  And for a very good reason, NIMBY.  I own my house.  It has increased tremendously in value since I bought it.  I like that.  And a significant contributing factor to its increase in value has been tight zoning.

Tight zoning floats all boats.  Even if you don't fix your house up the fact that the housing market is tight means that prices have been going up and up and up.  It has also made deciding to fix up your house (and maybe flip it) into a no brainer for anyone owning a house at the low end of the market.  (Flipping houses has now been a thing since This Old House went on  the air in 1979.)  All of this has had a positive impact on my net worth and the net worth of the pretty much every other home owner in Seattle.

The single largest class of housing in Seattle is single family residences.  All those people have a vested interest in keeping prices increasing at a good clip.  They are the silent majority in this discussion.  They don't say much, but politicians hear them anyhow.  These voters want the homeless problem fixed.  But they want it fixed in a way that doesn't interfere with the steady rise in the value of their house.

That kind of thinking blocks the best way to fix the homeless problem.  If cheap, slum-quality housing was readily available then lots of people would move off the street.  If developers can make a profit building cheap slum-quality housing, they will build it.

But nobody (meaning all the people who own single family homes in Seattle, and many of the ones who live in multi-family units) wants a bunch of slum-quality housing being built in Seattle.  And the resistance is especially fierce to building such housing nearby.  Not.  In.  My.  Back.  Yard.

Most slum-quality housing comes about as a side effect of the real estate cycle.  Prices go up and builders build.  They keep building and building as long as demand is strong.  Then something happens.  Demand dries up.  But construction involves long lead times.  They can't just stop on a dime.

When the market turns by the time all the projects that were in the pipeline complete a substantial housing surplus has built up.  This causes the value of some properties to drop by a lot.  This drop puts downward pressure on the entire housing market.  In a declining market often the only way landlords can keep their financial heads above water is to turn some of their property into slum-quality housing.

In this scenario nobody has any real say in the matter.  Market pressures overwhelm people's normal inclinations.  So, the fact that some people (those still hanging on who live near the newly created slum-quality housing) object vigorously to what is happening doesn't matter.  They don't have the leverage necessary to stop it from happening.  So, it happens.  The market now has slum-quality housing and poor people have some place to get off of the street and out of the weather.

Historically, this is what has happened in Seattle.  The Roaring Twenties turned into the Great Depression.  That produced a lot of cheap housing.  Besides the creation of Hooverville, a significant number of large houses that had been occupied by a singe family got turned into boarding houses.  The landlady maintained some public spaces in common, living room, dining room, etc.  Tenants got a room of their own.  But that was it.  They shared a bathroom down the hall and did all their entertaining in the shared public areas.

There are no rooming houses in contemporary Seattle.  Nor are there any apartments where tenants share a bathroom.  And nobody now lives an a unit where their bed swings down from behind a door in the wall (a "Murphy" bed).  Most people would find these kinds of accommodations appalling.  Not surprisingly, current zoning laws make these types of units illegal.  But they are how we used to have cheap housing.

The closest we come in the modern era is the Tiny House.  These feature a minimum of amenities and very little in the way of square footage.  Tiny Houses initially violated all kinds of Seattle's zoning laws.  I think a loophole has since been introduced that makes them legal, but I'm not completely sure about that.  And, of course, nobody wants Tiny Houses in their neighborhood.  And heaven forbid that anyone would propose the apartment equivalent of Tiny Houses.

So we continue to go in circles.  The thing that would actually work gets vetoed.  And, as I pointed out above, it gets vetoed for good reason.  It is also important to note that people who buy newspapers or who watch the local news on TV are the people doing the vetoing.

And it is bad business to alienate the people your business depends on.  So, the people who write for the newspaper, or report the news on local TV, go out of their way to avoid pointing out the obvious.  But I don't own a newspaper or TV station.  So, there it is.

Not surprisingly, I don't expect anything to change any time soon.  Lots of whining.  No effective action.  Before leaving the subject, let me make a couple of additional observations about what does not work.  The first one is rent control.  New York City is the poster child for rent control gone badly awry.

NYC has a lot of apartments, and has had them for a long time.  Not surprisingly, landlords sometimes get up to mischief.  About a century ago NYC put in some laws that were supposed to reign in this mischief.  But times changed and markets evolved.  NYC kept updating and updating their rent control laws in an attempt to stay ahead of the situation.

In spite of cycle after cycle of updates the regulations could never keep up.  Eventually, the rent control rules were so byzantine that nobody could understand them.  Support for rent control in its then current state slowly collapsed.  That led to successful efforts to roll back and simplify rent control regulations.  NYC still has rent control.  But the current system is a shadow of its former self.

The point is that in the long run it didn't work.  It got so bad at one point that NYC had more slum-quality housing than any other type.  At that point nobody was happy.  Rent control is one of those things that sounds like a good idea.  And it can work pretty well for short periods of time.  But in the end it doesn't deliver the desired result, enough low cost housing to satisfy demand.

What does deliver large quantities of low cost housing is zoning.  With proper zoning laws the market can deliver housing in quantities sufficient to make a difference.  Builders will build if they can do so profitably.  But right now they can't build cheap housing profitably.  That is unlikely to change any time soon for the reasons listed above.  But it needs to be said.  Rent control discourages construction.  Over time, it makes things worse.

Another idea that keeps getting proposed is to severely restrict the ability of landlords to evict tenants.  This idea comes from a good place.  Lots of landlords have engaged in discriminatory practices of one kind or another in lots of places and at lots of times.  Restricting the rights of landlords to evict tenants seems like a good way to fix this problem.

It too is another problem that can work well in the short run.  Seattle had an eviction moratorium during COVID.  As a short term measure it kept people housed in a time of severe economic distress for many.  But to see how things play out over the long term when a landlord's ability to evict is severely constrained we need to look no farther than Cabrini Green.

Cabrini Green was a large public housing development that was built in Chicago.  Its goal was to humanely house poor people at a price they could afford.  It was part of a federal program that reached its peak in the '60s.  And in the early years Cabrini Green was a big success.  It consisted of a series of large apartments that provided decent housing at subsidized prices.  A lot of God fearing and law abiding families moved in and were initially happy.

But it soon became almost impossible to evict anyone from Cabrini Green.  The ostensible reason was to avoid discrimination as most of the tenants were Black.  But over time an unintended consequence surfaced.  In a population as large as the one at Cabrini Green there were bound to be a number of bad apples.

They formed gangs and things soon got out of control.  That led to a situation where nobody was safe.  And it became impossible to deal with vandalism.  Later, drug use, drug dealing, and shootings became rampant.  Eventually Cabrini Green became one of several projects that gave public housing a bad name.  It was eventually torn down.  By that time it had degenerated into a lawless slum.

Appropriate eviction regulations are not something where a black-and-white solution is possible.  Landlords need to be able to kick bad apples out.  Discrimination needs to be controlled.  There is no simple solution that delivers both objectives simultaneously.  Only a nuanced approach can do that.

People like bright-line laws and regulations.  This is where some behaviors are always permitted and other behaviors are always prohibited.  But that kind of approach has been tried many times and has failed every time.

We need to allow the enforcers to exercise a degree of discretion.  Then we need to monitor the enforcers to make sure they are using that discretion wisely.  That's not something that we as a society are good at.

If we continue to avoid doing what works when it comes to homelessness, remember that there is another way to fix the problem.  We can just have another Great Depression.  Maybe continuing to bump along ineffectually is not such a bad idea after all.

Debt Ceiling - Here we go again

 The Debt Ceiling negotiations have been a bumpy ride so far.  That was to be expected.  As such, it was something press should have been telling us to expect all along.  But, as is all too typical of them, the press coverage of the current negotiations has been terrible.

This is bad for all of us because public opinion has a lot to do with how things turn out.  And, as is unfortunately the norm, the Republicans are winning the messaging war.  This is only partly due to ineptitude on the part of Democrats in general and the Biden Administration in particular.  The rest is on the press, which should know better by now.

It's not like we haven't gone through all of this before.  I was blogging in 2011 when we last went down this road and I posted extensively about this subject.  Here's a good starting point:  Sigma 5: Debt Ceiling Negotiations.  Then as now bad press coverage contributed to a bad outcome.

Rather than pointing out from the get-go that the whole thing was a crass political ploy on the part of Republicans, the press engaged in a lot of both-sides-ism.  Toward the end they did come around to some extent and start assigning most of the blame to the GOP.  But by then a lot of damage had already been done.

In 2011 we were slowly coming out of the recession caused by the crash of '08.  High government spending would have sped up the recovery.  But the deal the Obama Administration was forced into by Republicans resulted in a contraction in Federal spending.  That slowed the rate of recovery unnecessarily.

But let's go back to the beginning.  Where did the Debt Ceiling come from?  I only recently learned the answer to that question.  It was put in place for the first time in 1917 in the run-up to U.S. entry into World War I.  Before that, we got along just fine without one.

At that time, however, the Federal Government was looking at the need to issue a large number of bonds.  They would be used to finance our part in the War effort.  A big increase in the Debt was a concern, and not just to fiscal conservatives.  In an effort to mollify the opposition "Debt Ceiling" legislation was put through.  The legislation required Congress to approve future increases in the national debt.  The legislation was nicknamed the "Debt Ceiling", or equivalently the "Debt Limit".

It turned out that nobody cared.  No votes were changed by the institution of a Debt Ceiling.  Fortunately, the government had no trouble authorizing and selling the bonds.  And the U.S. participation in World War I ended up being relatively modest, so funding our participation never became a big political issue.  But the Debt Ceiling remained a part of U.S. law.

And it's still there.  Efforts to get rid of it have so far fallen short.  Voting to repeal it makes one an easy target for accusations of being a spendthrift or worse.  On the other hand, for a long time no one found a reason to screw things up by holding up the routine increasing of the Ceiling.  So, for decades it was quietly increased as a matter of routine housekeeping.  That all changed in 2011.

Republicans have long labeled Democrats as the "irresponsible tax and spend" party.  I have looked at history and done the math.  It is the Republicans who are the spendthrifts and the Democrats who are fiscally responsible party.  But GOP messaging has been very effective, so people believe the opposite.

And in 2010 Republican operatives ginned up the "TEA Party".  TEA stood for "Taxed Enough Already".  A number of well-funded stealth operations created a completely phony "ground swell of support from the grass roots" for the TEA Party movement.  This was a good investment because it provided the political cover necessary for Republicans to be able to get away with opposing a routine increase in the Debt Ceiling when it came up in 2011.

Republican refusal to go along was supposedly based on the opposition arising "spontaneously" from the grass roots.  And by "grass roots" they meant the very TEA Party organizations they had carefully constructed.  The press covered the TEA Party as if it was a legitimate grass roots movement and not a construct supported and nurtured by rich and powerful interests closely aligned with GOP leadership.

The very first TEA Party organizers actually were ordinary people who were genuinely concerned about the size of the Federal Debt.  But the GOP establishment quickly recognized the opportunity these people represented.  They poured large amounts of money and professional organizational skill into turning a few scattered groups into a large organization with a national reach.

So, the TEA Party was the opposite of a spontaneous grass-roots movement.  But the press didn't get around to noticing this until several years later.  That's when the money spigot got turned off.  As soon as that happened the whole movement quickly fell apart.  

The press also ignored the history dating all the way back to the Reagan Administration of the GOP blowing up the deficit and then leaving it to Democrats to clean up the mess.  By 2011 that left Democrats and the Obama Administration in a week position.  They felt they had an obligation to not blow the economy up, something the other side seemed perfectly willing to do.  The result was a deal that hurt the U.S. economy for a decade.

And now we're back at it in 2023.  The press coverage is still bad.  Republicans have been able to hold on to their completely unjustified reputation for fiscal probity.  And that has put Democrats and the Biden Administration back into a weak bargaining position.

And then there is this.  The negotiations are going exactly like I (and anyone who was paying attention in 2011) have expected.  But that hasn't stopped the press, who never seem to learn, from engaging in their usual penchant for breathlessly covering any small twist or turn as if it actually meant anything.  It is too soon for anything meaningful to be happening.

By now they should understand how negotiations work.  But, if they do, this understanding is not affecting their coverage. Negotiations are also a subject I know a thing or two about.  Here's a primer on the subject that I put together all the way back in 2010:  Sigma 5: Negotiation 101.  For those that don't feel the need for a refresher, let me cut to the chase.  These things always go down to the last possible second.  Why?

Imagine two parties who are in opposition engaging in a negotiation.  More for one side means less for the other side.  Now let's say that the negotiators put together a deal well before the deadline.  What happens?  One or both sides become angry.  Whether it is true or not some of the parties on one or both sides of the negotiation that were not directly involved in the negotiation come to believe that if their side had held out longer, they would have gotten a better deal.

Deals have to be sold to all parties, not just the ones present at the negotiations.  Both sets of negotiators have to be able to go back to their people and credibly be able to say, "we got the best deal possible".  Going into a negotiation both sides usually ask for the moon.  Inevitably they will have to make concessions in order to craft the final deal.

The idea is to make the fewest concessions possible.  If negotiations go to the last minute, or even past the "deadline", then it bolsters the case that each side got the best deal possible.  So, in contentious situations, negotiations ALWAYS go to the last minute.  The template for this is the 2011 Debt Ceiling negotiations.  They went down to the very last minute.

In this context, "deadlines" are extremely useful.  This often results in artificial deadlines being manufactured.  The question is not whether the deadline is manufactured or real.  The question is whether the deadline is credible.

We see this all the time in labor contracts.  The "deadline" is often the expiration of the previous contract.  But I have seen union members work without a contract for many years.  In these cases, the end of the old contract "deadline" was both artificial and not credible.  Things often change when workers go out on strike.  But if employers can keep operating while workers are striking then this too can turn into an artificial deadline.

Strikes often take time before they start to inflict real pain on management.  The current Writer's Strike in the movie/TV business is a good example.  A finished script may be produced well before the project (movie or TV show) is ready to be aired. So, not much gets held up for those first few days or weeks.  But over time more gets held up and the cost of those delays start piling up.  The last Writer's Strike took 100 days to settle.  This one is likely to last that long or longer.

And that brings us back to the Debt Ceiling negotiations.  We passed one artificial deadline a couple of months ago.  That's when we actually reached the Debt Ceiling.  It was not a credible deadline because we have been there before.  We reached the Debt Ceiling well before the impasse was broken in 2011.  But the Treasury Department employed "Extraordinary Measures" to keep things working, at least for a while.

It was not until the Treasury announced that they had reached the end of their Extraordinary Measures in 2011 that a deal was made.  In 2011 this "Extraordinary Measures" business was new because no one had played fast and loose with the Debt Ceiling before.  People had made symbolic gestures, but only because they knew the symbolic gestures would fail.

In 2011 the important players in Congress and the Administration knew that something like what was eventually labeled "Extraordinary Measures" were possible.  And after 2011, so did anyone who was paying attention.  This time around the press did take Extraordinary Measures into account.

There was little coverage when we hit the actual Debt Ceiling.  When they did start covering the issue in May, however, they went with their usual "why isn't a deal being made right now" approach.  It is as if they had never seen a contentious negotiation before.

Treasury Secretary Yellen announced weeks ago that her department would likely run out of Extraordinary Measures on or about June 1.  Since then, June 1 has become more and more firm.  The process is complicated so the Department will not know it has hit the limit until the last minute.  But it is going to be very close to the end of the business day on June 1.

And the whole argument about whether or not to raise the Debt Ceiling has always been ridiculous.  Congree passes legislation that creates revenue, mostly in the form of taxes.  All of this revenue is strictly controlled by laws which are subject to review by the courts.  All expenses are strictly controlled by "Appropriations" bills passed by Congress and also subject to review by the courts.  So, the size of the deficit is completely determined by the details of the legislation Congress passes.

If Congress is unhappy with the size of the deficit, then all it has to do is revise the tax code or modify the contents of various appropriations bills.  Do that and the problem will be solved.  This too the press could and should note but doesn't bother to.  So, the only real purpose the Debt Ceiling law fulfils is to provide one side with a lever it can use to try to squeeze concessions out of the other side.

But to what end?  There are other, more direct means of achieving the result they claim to be aiming for.  As I noted above, if the deficit is too large either raise taxes or cut spending.  But republicans don't actually want to do either.  They want Democrats to do it for them.

That way they can blame Democrats for the tax increase or spending cut.  When they are in control, they cut taxes and increase spending.  Both are popular.  Both are also irresponsible when done together.  The combination blows the deficit up, something they pretend to care deeply about.  That is, when a Democrat is in the White House.  Just not enough to raise taxes, close loopholes, or reduce spending on popular programs.

And certainly not when a Republican is in the White House.  Every instance of Debt Ceiling hostage taking that I know of involves Republicans doing it to a Democratic President.  Democrats do not reciprocate.  As a recent example, the Debt Ceiling was raised three times during the Trump Administration without any problems.  The deficit and the National Debt also ballooned wildly under Republican President Trump.

And there are at least two ways to legally get around the Debt Ceiling law.  There was a lot of discussion about one of them in 2011.  If the U.S. Mint makes a coin, then the value of the coin counts as revenue.  So, every time the Mint makes a quarter the national debt goes down by twenty-five cents.  That's not much.

But it turns out that the Mint doesn't have to consult Congress when it decides which denominations they produce, nor how many of each they make.  So, at the request of the Administration, the Mint could decide to make a Trillion Dollar coin, presumably in Platinum.  President Obama said he wouldn't do it.  But, if the Biden Administration were to mint thirty-two or more Trillion Dollar coins, the entire National Debt would be wiped out instantly.

The other option was a new one on me when I recently heard about it for the first time.  Section Four of the Fourteenth Amendment to the U.S. Constitution reads:

The validity of the public debt of the United States, authorized by law, including debts incurred for payments and bounties for services rendered is suppressing insurrection or rebellion, shall not be questioned.  But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.

There is a lot of verbiage in this section dealing with issues arising out of the Civil War.  It validated the Civil War debt run up by the North and repudiated the similar debt run up by the South (and denied compensation to slave owners for the value of freed slaves).

If we slice away all the Civil War stuff we end up with, "The validity of public debt of the United States, authorized by law, shall not be questioned".  The Debt Ceiling law has the effect of questioning of the validity of the public debt.  That is not allowed by the plain language of section Four of the Fourteenth Amendment.

Any law which contradicts the Constitution is unconstitutional, so the Debt Ceiling law is unconstitutional.  So, President Biden has the option of minting Trillion Dollar coins and/or of declaring that the Debt Ceiling law can be ignored because it is unconstitutional.  So far, he was said he will not exercise either option.

Joe Biden is an institutionalist.  In part, that is a result of him having served in the U.S. Senate for 36 years.   He respects the way things are supposed to be done and what role each the various branches of the government are supposed to undertake.  As such, he sees it as the job of Congress to deal responsibly with the Debt Ceiling.  He keeps hoping that they will do so.  But the current batch of House Republicans seem disinclined to do so.

But at the time I am writing this we still have a few days.  The various parties have time to come to a deal and implement it.  If I were President Biden, I would have left both options on the table.  Both can be used as bargaining chips in trying to get a decent deal.  He has chosen not to do this, at least not publicly.  Again, that is in his nature.  He wants to preserve things, not blow them up.

But he is free to exercise the 14th Amendment option at any time.  All he would need to do is to get the Office of Legal Council (a part of the Whie House operation) to issue an opinion.  He can have them do that at any time.  Then he can wait until the stroke of midnight to publish it.  Attached to it would be an order to the Treasury Department to resume business-as-usual.  Crisis averted.

Until, of course, someone sues.  But by the time the Supreme Court rendered a final decision on the case, assuming it went against the President, and the current composition of the U.S. Supreme Court makes anything possible; the consequences would be truly catastrophic.

Even if the courts moved expeditiously, by that time final judgement came down the Federal Government would have blown a long way past the current Debt Ceiling.  At that point the only remedy that would be effective and could be quickly implemented would be to raise the Ceiling immediately.  And, of course, the Court should be of the opinion that the Debt Ceiling law is unconstitutional.  If they did then the problem would be eliminated permanently.

Exercising the 14th Amendment option puts us on a path that is fraught with danger.  That's one reason it is not the scenario that most people expect to see.  And selecting the "minting coins" option is even less likely happen.  Most people, including myself, expect Biden to cave to Republican demands.

But that assumes that Republicans have a coherent set of demands, and that caving to them will be enough to get the Debt Ceiling raised.  The problem is that it is unclear what those demands are.  (This is another area where the press has fallen down on the job.)

There may never be a single "deal" for the President to agree to.  Given that talks have been paused while Republicans figure out what they want to do next, it is possible that the Republican position has already fractured beyond repair.

Unfortunately, it is now critical that top level politicians and bureaucrats be great poker players.  They need to be able to hold their cards close to their vests.  They need to be able to pull off outrageous bluffs.  And they need to be willing to go all-in.  In a saner political environment, none of this would be necessary.

Given all this, I do not expect a resolution before June 1.  There is a real chance that things will end up stretching a day or two past June 1.  Some groundwork can be laid before then.  But if that is happening, it is happening behind the scenes.  So, I expect the drama to continue, but action to be lacking right up until the very last minute.  Unless, of course, the Republicans implode.  If that happens, I have no idea how all this will play out.  Buckle up.  From here on out the ride is going to get bumpier and bumpier.

Bonds, Banks, and the Fed

A bank nobody had heard of called Silicon Valley Bank (SVB) crashed recently.  Since then, all hell has been breaking loose.  If you look in the right nooks and crannies of the press the story is actually being covered reasonably well.  But the usual oversimplifications and lack of appropriate context and background dominate the coverage provided by the media that most people actually follow.  This gives me the opportunity to fill in some blanks and provide some the appropriate context and background.

Starting at the beginning, stocks are supposed to be risky, and bonds are supposed to be safe.  The logic is simple.  Many organs of the press report where the Dow's closes at the end of each day.  That number has been bouncing all over the place.  One day it's up.  The next day it's down.  The volatility of the Dow, and other indexes like the S&P 500 and the NASDAQ, reinforces the idea that it is easy to both make and lose money when investing in stocks.

Bonds, on the other hand are supposed to be safe as houses.  You know what you're getting from the get-go, and you almost never lose money on the deal.  Instead, you almost always get what you were promised when you signed up.  And, in fact bonds rarely default (fail to pay investors what was promised on time and in full).  But it is still possible to lose money on bonds even if they don't default.  To understand why it is necessary to dive into how bonds work.

Bonds are characterized by an amount (often called the "face value" or the "denomination"), a "term" or duration, and an interest rate.  So, for the purposes of explanation, let's talk about a $10,000 bond (the amount), whose duration is 10 years, and that has an interest rate of 1%.  These numbers have been picked to make the math simple, but bonds of this exact type have actually been issued in the recent past.

The way things are supposed to go is that an investor hands over $10,000 in exchange for the bond.  Some bonds pay interest quarterly.  Some pay semiannually.  Either way, our investor receives $100 (1% of $10,000) in the first year, another $100 in the second year, and so on.  At the end of the tenth year the $10,000 is returned.  In all, the investor puts in $10,000 and gets back $11,000.

And, as I said, bonds rarely default.  Even "Junk" bonds, bonds issued by institutions who have problems of one kind or another, usually pay off.  So, what could possibly go wrong?  It turns out that if the investor holds the bond to maturity, 10 years in our example, usually nothing.  The interest gets paid on time and in full.  The investor gets his initial investment back, on time and in full.

But what happens if events similar to what has happened in the past several months happen?  It turns out that the "Fed", the Federal Reserve Bank of the United States, jacked up interest rates.  I am going to skip the details of how the Fed manipulates interest rates because it's complicated.  Just trust me, it can, and it does.

The Fed has twin responsibilities.  It is supposed to manipulate things so that inflation stays low, and the economy grows steadily at a relatively even rate.  The standard tool for doing this is to manipulate interest rates.

If the Fed moves interest rates lower, it is supposed to make it easier for businesses to grow and expand.  That lowers unemployment and increases economic growth, perhaps increasing inflation.  If it moves interest rates higher, then that is supposed to decrease business activity with the likely side effect that unemployment goes up, hopefully decreasing inflation.

There is a lot wrong with this simplistic scenario.  If you troll through my past blog posts, you will see me diving into all this in more detail and pointing out how poorly this works.  Nevertheless, this is the standard tool the Fed has traditionally used.  And, for various reasons, which I am again going to skip, the Fed has been goosing the economy by keeping interest rates near zero for most of the last decade.

But supply chain problems and other issues that coincided with the end of the critical phase of the COVID epidemic led to a consensus that the economy had gotten overheated.  This resulted in rampant inflation.  Unemployment was extremely low, so it would there would be little or no harm if it went up a bit.  This was the analysis pushed by the business community.  There was, however, little dissent from this view coming from other sectors.  Not surprisingly, the Fed adopted this view and started raising rates very rapidly.

Typically, the Fed meets once per month to decide whether or not an interest rate adjustment is warranted.  Most months they decide to do nothing.  But for several months in a row the Fed decided to raise interest rates by 75 basis points.  A basis point is 1/100th of a percent, so that amounts to three quarters of a percent change.  That's a big change.  To increase the interest rate by a large amount month after month is unprecedented.

Large increases in the interest rate coming month after month was supposed to quickly cool the economy off.  A cool economy was supposed to decrease inflation to the Fed's target of 2%.  Increasing interest rates quickly and dramatically was supposed to slam the brakes on spending by both businesses and consumers.  That, in turn was supposed to drive inflation down.

But there was little change in spending behavior even after several months of drastic action.  As a result, inflation, while declining, stayed high.  So, the Fed kept jacking rates up.  Recently, some signs of a slowdown finally started appearing, so the Fed only increased rates by 25 basis points the last time around.

But the consensus among Fed watchers was that the Fed was going to continue with its "higher, ever higher" strategy.  The only item that lacked consensus was how fast the Fed would raise rates.  Would it go back to 75 basis points per month, or would it stick with a slower rate of 25 basis points per month.  So, what's all this got to do with SVB?  Interesting question.

It has to do with how you can lose money on bonds that don't default.  Let's say that one year into the life of our 10-year bond we decide to sell it.  Well, if interest rates are still at about 1% then the sale price will be $10,000, more or less.  No harm.  No foul.  But what happens if instead in the interim the Fed has jacked rates up by a lot, and done it very quickly?  Which, by the way, is exactly what they have done recently.

Then why should someone buy our bond for $10,000 more or less?  It only pays a paltry 1% and they can buy a new 10-year bond that pays 4%.  Instead of getting $100 per year in interest payments they can get $400.  In those circumstances they wouldn't touch our bond with a ten-foot pole.

But what if we were to "discount" our bond, say by asking only $8,000 for it?  That way they would eventually pick up an extra $2,000 when the bond got redeemed for the full $10,000 amount.  $8,000 might not be the right price.  But there is a price that would attract a buyer.

The business of figuring out exactly what that price would be is complicated.  Fortunately, there is a "secondary" market in bonds.  You can just look there to find out how much a particular bond needs to be discounted to in order to sell.  The secondary market provides a "current market price" for our bond.

SVB did not get into trouble by selling a bunch of bonds and taking a bath on them.  The situation was slightly more complicated.

As a result of the crash of 2008 a lot of institutions were required to periodically "mark to market" all of their assets.  This stopped them from carrying "Zombie" assets on their books.  These were assets that used to be worth a lot but were now worth far less.  Zombie assets could make everything look fine when, in fact, it was not.

I don't know whether SVB was required to mark their assets to market, but investors and large customers became aware that SVB had a bunch of problematic assets on their books.  They forced SVB to mark them to market and report a big loss.

At this point we don't have a problem.  SVB could spread the actual losses over a period of years by not selling the bonds right away.  So the problem could have been managed.  They also did what they were supposed to do in a situation like this.  They immediately set out to increase their capitol.

But when it comes to finance, it often resembles a game of musical chairs.  In this case the loser of the game would end up having to eat the losses.  So, a bunch of investors on a group chat decided it wasn't going to be them.  It was going to be someone else.  They all decided to immediately pull their money out of SVB.  That way none of them would be stuck with the check.

Banking and finance are now just files on computers.  A "bond" used to be a piece of paper that someone kept in their safe.  Now it is information in a computer file.  So are account balances.  And now it only takes a matter of seconds to move money around.  The time it takes is not affected by whether the amount is question is $1 thousand, $1 million, or $1 billion.  The money moves equally fast in every instance.

A bunch of depositors pulling a few thousand apiece out of SVB wouldn't have made any difference.  But a bunch of investors pulling out millions and billions made the difference between solvency and insolvency.  SVB went from "just fine" to "dead man walking" in less than 48 hours.  And SVB had another problem.

SVB specialized in funding for Venture Capitalists (VCs) and for other high-risk sectors of the tech industry.  Tech has been hit hard in the last few months.  It turns out that the economy was under enough pressure that they stopped seeing the growth rates that investors and VCs expected.  Stock prices of even solid, well-established tech companies have declined substantially in the last six months.

In far too many cases, the companies SCB was investing in were not big and well-established.  They were start-ups.  As a result, they were likely hit even harder than the big, well-established firms.  So, it was likely that the non-bond part of SVB's portfolio was also in a lot of trouble.

There is currently no hard evidence of this.  But the fact that the FDIC, the part of the government responsible for cleaning up the mess that the failure of SVB left in its wake, has not been able to sell SVB off, either as a whole or in pieces, is a good indication of problems here too.

An over-reliance on a single market segment, or a number of closely related market segments, has been a red flag for forever.  SVB should have not been allowed to do that.  But the public does not care about the minutia of bank regulation while bankers and Wall Street does.  So, regulators were pressured to look the other way.  And they were not allowed to put regulations in place to outlaw this sort of behavior.

In that sense, SVB was unique, or nearly so.  But as soon as SVB went under people started looking for other similarly situated banks.  Signature Bank immediately went to the top of that particular list.  It was over-invested in Cryptocurrency, another high-risk market segment.  And it didn't take long for it too to go down.

When things are going well, high-risk market segments can create high profits.  But when pressure is applied, they tend to go down farther and faster than more boring market segments do.  It should come as no surprise to learn that both SVB and Signature Bank were Wall Street darlings.

Thank goodness, an over-concentration on high-risk market segments is not as common in the banking business as it once was.  But the problems with their bond portfolio that SVB had is much more common.  That's because of how banks actually work.

When you put money into a bank the bank doesn't sock it away in a vault.  Instead, it loans it out to other people.  The interest on their loan portfolio is how banks cover operating costs and the cost of whatever interest they pay on CDs, for instance.  It is also how they generate a profit for their shareholders.  This sounds risky, but if done properly it usually isn't.

Banks are aggregators.  As part of how they do business they mix your money in with everybody else's.  If on a given day more money comes in as deposits than goes out as withdrawals, loans, etc., then everything is fine.  There is more than enough money to go around.  However, if more goes out than comes in, this is a potential problem.  But if the net is small, and over time it gets balanced out by more money coming in on other days, then it is an easily managed problem.

As a safety measure, banks are required to set a certain percentage of deposits aside as a "reserve".  Is this money stacks of bills in a vault?  Again, no.  They are, however, required to invest this reserve money in "safe" securities.  The regulators determine what securities qualify as safe.  But they always include U.S. Treasury bonds in the list of securities that qualify.  So, banks own a bunch of them as part of their reserve requirement.  Well, guess what.  These are the very bonds the Fed was jacking the rates up on.

So, it's not just SVB that was subject to this problem.  And it's not just around SVB that musical chairs got played.  The collapse of SVB caused people in the know to look at banks near and far.  They soon zeroed in a bank called First Republic Bank.  It's another of those banks that I had previously never heard of.  But the jackals started circling within a day or so of the collapse of SVB.

First Republic is still in trouble.  But apparently it wasn't in as bad a shape as SVB, because the Feds swooped in and started propping it up rather than shutting it down.  As of this writing First Republic is still in business.  If the pressure lightens up it will survive.  If the pressure intensifies, it likely won't.  The irony is that in a normal environment it would have sailed along nicely, and people like me would still have never heard of it.

And it's now not just U.S. banks.  A giant Swiss bank called Credit Suisse was soon in trouble.  They were old enough and big enough that their name was familiar to me from long before the present crisis.  But first a digression because the story of Swiss banks is an interesting one.  And it turns out to be relevant.

Up until the '30s they were the kinds of banks you would expect to find in a country the size of Switzerland.  But Swiss banks smartly leveraged Swiss neutrality laws to their advantage in the run-up to Word War II.  They took in deposits from people being persecuted like the Jews.  They also were happy to deal with the persecutors.

As more and more countries cut ties with the Nazis, Germany started doing business through Swiss banks.  Swiss banks grew enormously during this period.  In the aftermath of World War II lots of money was stranded in Swiss banks because its owners, Nazis, Jews, and others, were no longer around to collect it.

Swiss banks quickly moved on to playing the same "collect money from both sides" game during the Cold War.  Only the players changed.  As opportunities there eventually diminished with the end of the cold war, they shifted to doing business with drug lords, authoritarian dictators, and the like.

But all good things eventually come to an end.  In the last ten or twenty years the Swiss have been forced to open up their banking system to outside scrutiny.  And other countries like Panama have also gotten into the business of hiding and laundering money, so the Swiss lost their near monopoly.

This has diminished the advantage of Swiss bankers.  But by now they were hooked on the power and prestige of being major players.  They have since resorted to getting into the business of playing the Wall Street game where they get involved in risky ventures in order to juice their balance sheet.  When the game of musical chairs went international, a development that only took a few days, Credit Swisse was the fattest target.

The Swiss government brokered a deal where Union Bank of Switzerland (UBS), the other Swiss behemoth bank, took them over.  The Swiss government was so concerned that they didn't let a little thing like the law get in the way.  They simply changed the law that made such mergers illegal overnight to permit this particular merger to go through.  UBS has its own problems.  But the Swiss government decided that putting all the problems into one basket made them easier to manage.

Is the banking system now back in good order?  It's too soon to tell.  If we can go a couple of weeks without anything else popping up, then we are likely out of the woods.  But if another big bank starts making headlines for being in trouble, or if First Republic goes under, or if the Swiss merger goes south, then we are in for more trouble.

There is a lot more I could get into.  How we got into this mess.  What should be done to fix it.  What will be done to fix it.  But I am going to confine myself to one additional subject.

There is talk of raising the limit on how much of an account balance the FDIC insures.  The current limit is $250,000.  Almost all of the money on deposit at SVB was uninsured because it was in an account that had far more than $250,000 in it.  Most banks have a far lower percentage of their total deposits that are outside of the insurance umbrella in this way.

Theoretically, the FDIC could have left the owners of those accounts hanging out to dry.  The law permitted the FDIC to say, "here's your $250,000 - sorry about the rest".  The whole reason there was a run on SVB was because a bunch of big depositors did not want to take a haircut.  And who can blame them?

With that in mind, it looks like it would make sense to increase the amount.  An argument against increasing the limit to infinity as some are proposing goes under the rubric of "moral hazard".

Let's stay that all deposits are insured.  Then what's to stop someone from putting their money into a bank that they know has problems?  The incentivizing of bad behavior like this leads to a moral hazard.  Or so the argument goes.  But the "how high should the insurance limit be" ship sailed a long time ago.

At this point I would not characterize our current banking crisis as a big one.  Compared to the size of the economy (trillions) even a few billion is small beer.  But in the last few decades we have had two banking crises that do qualify as big banking crises.  There is the one that people still remember, the crash of 2008, and the one they don't.

The one that everyone now conveniently forgets about is the Savings and Loan Crisis of the late '80s and early '90s.  It turns out that there are lots of different types of "banks".  The easiest way to organize them is by looking at who regulates them.

What most people think of as a "bank" is actually a "commercial" bank.  They often have the phrase "National Bank" in their name.  These operate under a "charter" issued by the Federal Government.  They are regulated by Federal agencies and insured by the FDIC.  As a group they are the most heavily regulated and have the strictest operating requirements.

But then there are the state-chartered banks.  These used to be regulated and insured by the state equivalent of the Feds and the FDIC.  I don't know if that is still true.  SVB was a state-chartered bank, but the Feds, including the FDIC, have been all over them.

Then there are Savings and Loans (S&Ls).  Back in the day they couldn't make loans to businesses and couldn't offer checking accounts.  The biggest "bank" failure in the U.S. is Washington Mutual.  Technically, it was a "mutual saving bank", but it was regulated by the same people that regulated S&Ls.

The original idea was that S&Ls couldn't cause much trouble, so regulation was much lighter on them.  And at one time that was true.  But in one of the waves of deregulation that swept the U.S. they were deregulated to the point that they could offer checking accounts and make a much wider variety of loans.

What could possibly go wrong?  Lots.  S&Ls started doing all kinds of things.  Besides doing stupid things some were run by outright crooks.  The whole thing came crashing down during a ten-year period running from roughly 1986 to 1996.  S&Ls went under by the scores and the Federal Government ended up picking up the pieces.

Some laws were changed but S&Ls were not forced to confirm to the rules national banks had to operate under.  Standards and regulations remained much looser.  And throughout the S&L Crisis almost all cases depositors were made whole even if they had far more than the amount on deposit that was covered by insurance.  At this point it became de facto policy to cover all deposits no matter the amount.

The demise of Washington Mutual (or WaMu, as it was commonly called) was not part of the S&L Crisis.  It managed to make it through the S&L Crisis unscathed, because at that time it was well run.  Instead, it belonged to the events connected to the crash of 2008.  By that time good management had been replaced by bad.

And one contributing factor to WaMu's demise was the light regulatory environment it operated under.  In the case of WaMu, and all the other "banks" that went under in this event, depositors were made whole regardless of the size of their account balance.

And the crash of 2008 introduced a whole new group of players into the public consciousness, "investment" banks.  Again, the actual game was to find an excuse for diminished regulation.

A law called Glass-Steagall had been passed in 1933 carving out investment banks as a group subject to a separate, more permissive, regulatory regime.  They couldn't do "retail" banking, offering checking accounts, making loans to individuals and businesses.  They were restricted to only doing business with Wall Street.

The argument was that the customers of investment banks were sophisticated people who were savvy about money and risk.  As such, a heavy regulatory hand was not required.  Unfortunately, Glass-Steagall was repealed in 1999 as part of yet another wave of deregulation.  As a result, most of the names mentioned in the headlines surrounding the crash of 2008 were investment banks.  Not surprisingly, they had done stupid things in pursuit of ever higher profits.

All depositors caught up in the S&L Crisis and in the crash of 2008 were made whole regardless of how much of their balance was or was not supposed to be covered by insurance.  In fact, I can't think of a time in the last half century when a depositor has taken a haircut as a result of a "bank" failing.

So, the limit on how much of a deposit is insured by the Federal Government is a fiction.  Changing it will make literally no difference.  Except, perhaps, to fool some people into believing that something is being done when nothing is being done.

And finally, to return to my original subject, bonds.  SVB was a publicly traded company.  As such it issued stock and was nominally owned by its shareholders.  They are in for a haircut.  But SVB also issued SVB bonds.  The holders of these bonds are likely to be reimbursed 100%.  It may take a few months, but they will probably get all of their money back.

It is common to see stockholders losing a lot and bondholders not losing anything when a company goes bust.  And that is part of the reasoning behind the idea that bonds are safe while stocks are not.

Inflation and the Fed

We are now going through a period of high inflation.  Until a few months ago the only thing a lot of people remembered experiencing was low inflation.  Now that inflation has spiked up everyone is tearing their hair out and spouting the economics equivalent of "we are all going to die".  We are not all going to die.

What has thrown people's expectations off is the extended period of low inflation that, up until recently, we have all been living through.  Many think that what we are now experiencing (high inflation) is unprecedented.  And, therefore, there is nothing that can be done.  It is going to continue on forever.  But this is a situation where history can be a very accurate guide.  We have been here before.

And there is a second factor.  That's the current position the Fed finds itself in.  (Queue the segue into historical mode.)  I have been following the general state of the U.S. economy for decades.  I am familiar with the Fed.  I know what it is about.  I have investigated how it works (or doesn't) across a period spanning an even longer period.  Let's start with the pre-Fed era.

In the 1800s, and especially in the late 1800s, the U.S. went through a series of "panics".  That's what they were called, and for good reason.  The way banks work is that they take deposits.  They then put most of the money back out in the form of loans.  The interest and fees the loan portfolio generates allows the bank to make a profit, and perhaps pay a little something back to the depositors for the use of their money.

But every once-in-a-while a rumor would start circulating that a particular bank was in trouble.  Sometimes it was true.  Sometimes it was not.  But once a significant number of people believed that the rumor was true, or even only believed that it only might be true, they moved immediately to pull all of their money out of the bank.  This was perfectly sensible.  If the bank went under, they stood to lose all or most of any money still held by the bank.

This behavior was called a "bank run".  If too many people withdrew their money, then the bank got into trouble.  They had enough money around, assuming they were sound, to cover the normal in and out of daily business.  But they didn't have enough money to pay off a significant percentage of the funds on deposit.  It was out in the form of loans.  As a result, few banks survived a run.

And this turned into a self-fulfilling prophecy as more and more people learned how bank runs worked.  And that meant more rumors.  And that meant more bank runs.  And that meant more bank failures.  If a number of banks got into trouble people panicked and started pulling money out of all banks.  By late in the century panics, periods when there were runs on a lot of banks at the same time, happened once every five to ten years.

This was very destructive to the economy.  Banks failed.  Business was disrupted.  Individuals and companies lost lots of money.  Pressure built to do something about it.  The result was the establishment of the Federal Reserve, or "Fed" for short, in 1914.  It was supposed to regulate banks.  That was supposed to reassure depositors and put an end to panics.

It wasn't enough.  Until the FDIC, the Federal Deposit Insurance Corporation, was created in response to the start of the Great Depression, panics continued.  The FDIC insured banks that the Fed blessed.  It had enough money to pay depositors in the event of a run.  So sound banks stopped going under and we stopped having financial panics.

But remember, the Fed's job is to be a regulator.  Besides making sure that banks are sound they are responsible for the general state of the economy.  They are supposed to manage the banking system so that the economy grows steadily, unemployment remains low, and inflation does not get out of control.

For a long time, the Fed was able to do a good job.  Banks were sound because the Fed forced them to be conservatively run.  Essentially from the end of World War II the Fed was able to keep the economy growing, the unemployment rate relatively low, and inflation under control.  I can put numbers to these goals.

The magic number for economic growth was 3.8%.  For a long time, if the economy grew at or above a 3.8% rate the incumbent political party retained control at the Federal level.  If it fell below 3.8%, we saw a change in which party was in control.  The target for unemployment was 3-5%.   It was believed that it was impossible to go below 3%.  But anything under 5% was considered good.

The target for inflation was 2%.  Why not 0%?  It turns out that it is hard for businesses to lower prices in a healthy economy.  The reasons are complex, and I am not going to get into them.  But if the general rate of increase in prices is 2% then some companies will not be able to raise prices that fast.  Relative to the rest of the economy, their prices will deflate without the necessity of them actually cutting prices.  So, an inflation rate of 2% was considered the Goldilocks spot.

The Fed missed one or more of these targets regularly.  But they were generally able to steer the economy back into the sweet spot.  But the Fed was a victim of its own success.  After a few decades of things working great for everybody, people (the banks and big business) decided that keeping things locked down so tight was not justified.  So, a push, led primarily by Republicans, gathered steam to "deregulate".

A Democrat, President Carter, was the first to actually start deregulating things.  He didn't deregulate banks.  That came later.  But the deregulation bandwagon gained so much momentum that it ground on for more than a half century.  So, after a period of both incredible economic growth and economic stability, we have gone back to the bad old panic days.

We had the Savings and Loan scandal of the '90s.  (Don't ask - everybody has forgotten about it by now.)  We had the "Dot Com Bomb" of the early 2000's.  We had the Wall Street meltdown just before 2010.  And now we have the economic disruption attributed to COVID.  The latest sub-phase is the inflation spike that has been all over the news for the last few months.

Truth be told, it was more than deregulation that has been a problem for the Fed.  Historically, the main tool the Fed has used was its ability to manipulate interest rates.  If the Fed forced raised interest rates, then business would pull back.  They would borrow less.  That left them with less money with which to grow.  Or so the theory went.  This pullback would cause the economy to shrink.  This caused inflation to decline, but economic growth was hurt, and unemployment went up.  This was all to the good if the economy was "overheated".

On the other hand, a lowering of interest rates would cause business to borrow more.  That's the theory, anyhow.  Businesses would use the increased borrowing to grow and expand.  That made economy as a whole grow more quickly.  Unemployment would go down, but inflation would go up.  This is all to the good if the economy is underperforming, if it is "stalled".  And practice matched theory for a long time.

The interest rate tool is often equated to the rudder on a supertanker.  A slow turn will result in a large change in direction, if it is allowed to go on for long enough.  That is good enough, so supertankers are notorious for having small rudders in comparison to their total size.  A small rudder is no problem if it gets the job done.

But what if a supertanker encounters a big storm?  The wind can push the supertanker around.  After all, it has these giant flat sides.  Similarly, a supertanker is big.  That means that small waves don't affect it much.  But big waves, waves generated by a large storm, do.  Supertankers are careful to stay away from storms because of this.

The economy can also be subjected to large and powerful storm-like events.  And, if that's what is happening, then the small interest rate "rudder" the Fed uses to put the economy back on course, gets overwhelmed.  That's what happened in the Wall Street meltdown.  By itself, the interest rate rudder was too small to get the economy back on course.

And then there's the trade-off.  The economy is supposed to have either high growth and high inflation or low growth and low inflation.  That allows the Fed to play growth off against inflation to move the economy in the right direction to get it back on track.

But the economic theory that predicted that it was impossible to have slow growth and high inflation at the same time proved to be wrong.  It happened late in the Nixon/Ford administration.  President Carter got growth going, but at the cost of super-high inflation.  President Reagan got inflation back under control by forcing a short recession.  After that, the standard trade-off was back on.

But the side effect of the Reagan move was to permanently depress economic growth.  We have had periods of high employment since.  We have had periods of low employment since.  But we haven't had a period of sustained high growth since.  Experts are now satisfied with a growth rate in the 1-2% range.  This is fine for Wall Street.  They have figured out how to make money in a low growth environment.  But it has been bad for main street and for workers.

So, we have been living in this low growth, low inflation regime for a long time.  It looks a lot like stagflation.  But, since the stock market has been doing great, the poor state of the underlying economy, and the poor state of household wealth and income (if you exclude the top 1%), gets consistently ignored.

But then things changed drastically a few months ago.  The Biden Administration has put a lot of money into the pockets of ordinary Americans.  For a while, COVID made it hard for them to spend it.  But the response to COVID has evolved and it became easier and easier for people to spend, spend, spend.  And they did.

And they spent on goods, not services.  Early in the pandemic they spent on services like Netflix.  But by the second half of 2021 they were spending heavily on goods like Pelotons.  The problem was that the economy was totally unprepared.

The Reagan Administration made it easier for companies to offshore manufacturing jobs, initially to China, but later to all over.  The U.S. economy gradually transitioned from being manufacturing based to being service based.  We no longer make much in the U.S.A.  Instead, we import it.

And COVID screwed that up.  Manufacturing was disrupted by the Chinese "zero tolerance" approach to COVID.  Shipping was disrupted due to a shortage of longshoremen at the ports and truckers further inland.

The first introduction to this for most of the public was the lack of facemasks.  When demand skyrocketed it turned out that the only real mass producer was China.  And initially China needed all the masks it could make for domestic use.

Since, then we have been introduced to a variant of the mask story in commodity after commodity after commodity.  And it turned out that the U.S. had little or no capability to manufacture masks, or pretty much anything else, domestically.

It is important to understand that the underlying cause of a lot of these problems was a side effect of demand rising sharply.  Demand for masks certainly soared almost overnight.  Demand for other goods didn't rise as dramatically as the demand for masks did.  But demand went up pretty dramatically for many goods at the same time.

In recent years the world economy had gotten used to producing a certain amount of goods.  It has also gotten used to the demand for goods growing only slowly.  That's a side effect of the slow-growth regime that we have all gotten used to.  When an across-the-board spike in demand for goods of all kinds hit, the world system for production and distribution got overwhelmed.

So, we saw bottlenecks everywhere.  They happened at the manufacturing level.  They happened at the shipping level.  They happened at the warehousing and retailing level.  Volumes in all these areas shot up and none of them were prepared to handle the increase.  Chaos ensued.

The size and breadth of the increase in economic activity is best demonstrated by the fact that in 2021 U.S. GDP shot up by 5.7%.  Remember, the old "good" number was 3.8%.  It turns out that you have to go back to the Reagan Presidency to find a year in which U.S. GDP grew by a comparable amount.  And, with the notable exception of China, GDP went up substantially pretty much everywhere.  It was not just a U.S. phenomenon.

The obvious and expected side effect of this is inflation.  If there is a shortage of goods, and people will continue buying them even after the price goes up, then prices are bound to go up.  But it is important to note that this is happening in a surprising environment.  Unemployment is way down.  And wages are up.  Owners are finding it hard to hire and retain employees even after raising wages by historically large amounts.

The law of supply and demand predicts that, if an employer raises wages, more people will apply for a job.  But that hasn't happened.  It has particularly not happened in traditionally low wage sectors of the economy like hospitality and retailing.  This difficulty in filling jobs is one of several contributors to the widespread "we are all going to die" sentiment.

I am now going to focus on the Fed.  It is part of the Fed's remit to worry about this sort of thing.  And they do.  If we go back a few years, there was this long period of time where the general consensus was that the Fed was not up to the task.  It was the whole "rudder on the supertanker" problem.  The Fed saw the economy getting deeper and deeper into trouble.

The Fed needed to apply stimulus.  So, they did.  The kept lowering and lowering and lowering interest rates, trying to get the economy to improve.  It didn't, at least not by enough.  Eventually the Fed lowered interest rates all the way to zero.  If that doesn't work, what's the next move?

Some central banks (the term applies to the Fed equivalents in other countries) managed to find a way to drive interest rates negative.  That was supposed to be impossible, but they found a way.  But even negative interest rates didn't work.

This all happened during the Wall Street meltdown.  By itself, right full rudder was not enough to turn the supertanker.  The Fed, staring into the economic abyss and aware of its own history, decided to do more.  Specifically, they turned to what became known as "extraordinary measures".  One measure went by the name "quantitative easing".  Mostly what they did, however, was to buy lots of investment securities.  Eventually that worked and the hemorrhaging stopped.  And the economy began to slowly recover.

After it became apparent that the economy was on the mend, the Fed stopped all the extraordinary measures except its program of purchasing investment securities.  That it continued, but at a reduced rate.  Many, but not all experts argue that one reason the recovery was so slow was because the Fed dialed back prematurely.  In their defense, they never completely stopped, and opinions on the matter differ.  After a few years they also moved interest rates up slightly.

They went back to zero interest rates and increased the amount of investment securities they were purchasing at the insistence of President Trump.  Both of these steps were highly stimulative.  The changes forced by Trump were, in my opinion, unnecessary.  But he wanted the economy to do as well as possible on the theory that it would help with his reelection.  He did not care whether or not it was the right policy for the economy.

The point of all this is to make it crystal clear that the Fed is currently stimulating the hell out of the economy.  They have effectively had the interest rate rudder jammed all the way over to the right for many years now.  That means that, if they shift the rudder to the left by forcing interest rates up, they have a rudder that is effectively twice as big as it ordinarily would be.

But wait.  There's more.  They are also still buying lots of investment securities every month.  That also stimulates the hell out of the economy.  In the years immediately after the Wall Street meltdown they had the "stimulate the economy" knob turned way up.  They have since dialed it back down some.  Then Trump made them dial it back up.  It is not dialed as high as it was in the early days.  Still, it is still dialed high enough to produce a strong stimulative effect.

If we return to our supertanker analogy, think of the securities purchase program as a second rudder, a really big one.  For a while it too was jammed far to the right.  Then it was moved more toward the center.  Then it was moved right, but not so much that it is now jammed all the way over.

The result of all this is that the Fed is in a great position to get inflation under control.  They can do the usual "move the rudder left " thing by increasing interest rates.  FYI, a typical range for 10-year government bonds is 3-5%.  Today, the rate is 1.8%, and that's up considerably from where it was a couple of months ago.

Historically, a normal range for mortgages would be in the 4-6% range.  But it has been a long time since people expected to pay 5% for a mortgage.  For contrast, I paid 8.5% in the '80s for my mortgage.

Moving interest rates to the range that used to be considered normal would take some steam out of the economy.  The Fed has recently signaled that it intends to do so.  That was enough to drive the "big three" (the Dow Jones Industrial Average, the S&P 500, and the NASDAQ) stock indexes down sharply.  (They have all recovered somewhat in the past few days.)

But that's not even the modern Fed's big gun.  The Fed now has what is described as an "inflated balance sheet".  The Fed literally owns a lot of investment securities.  And, as part of its extraordinary measures it has been buying more because that's what Trump pressured it to do.

At a minimum it could shut down its program for buying securities.  The current plan is for it to "taper", to lower the total amount of securities it purchases each month.  Eventually the amount would get to zero.  That would move the effect of the extraordinary measures to neutral.

The Fed can go even further, if it decides it needs to.  It can raise interest rates to a level that is above historic norms.  It could also begin selling off its large portfolio of investment securities.  It has complete control over how fast it sells them.  It can go with whatever rate is necessary to get the economy back to where it needs to be. 

So, the Fed is in a position to exert however much pressure is necessary in order to bring inflation down.  But that's not all.  COVID is still gumming up the works.  But it may be that Omicron will be the last wave.  And Omicron is likely to decline nearly as fast as it increased.  The economy may soon no longer have COVID holding it back.

Doing almost anything is hard now, due to COVID.  The movie and TV production business has responded to the threat COVID represents by saddling itself with a long list of safety protocols.  They slow things down and make it harder and more expensive to do a show.  We see this play out in the way new content is currently being released in dribs and drabs.

If COVID is in our rear-view mirror, TV and movie production can ramp back up to where it was in the before times.  It could even expand.  And the same is true, usually to a lesser extent, in industry after industry.

For instance, it will be easier to unsnarl shipping delays by adding capacity when COVID is no longer an issue.  And then there is the hospitality business.  Cruise ships are a mess.  The COVID inspired rules and regulations add to costs and diminish the cruising experience.

In spite of all the new rules and procedures there have been multiple instances of large COVID outbreaks on ships.  Adding to their problems is the fact that this has got to be keeping some cruisers away.  That's bad for business.  It also gets in the way of efforts to increase business.

Cruise ships are run by large companies.  Their size gives them access to a lot of resources.  Consider the plight of a small business like a restaurant.  They don't have the same access.  But that doesn't stop them from having the same kinds of problems.  People have to be staying away because of COVID concerns.

Unfortunately, so have the people who work at restaurants.  Restaurants have been having awful problems getting and retaining staff.  This is true even after wages have been raised substantially.  No doubt, some people don't want to take the risk.  But also consider the hassle.

When it comes to dealing with COVID, restaurants have a number of approaches to choose from.  But the only one that is totally hassle free is choosing to close.  If they decide to stay open instead, no matter what approach they decide on, some group or another is going to be mad at them.

That anger translates into more unruly patrons, and patrons who, when the get out of line, get much further out of line than they used to.  Who wants to work a dead-end job with shitty pay and then have to deal with asshole patrons?

If COVID goes away, then restaurant employees will no longer be worried about their health.  They will also no longer be expected to be the COVID police.  That is going to result in fewer irate patrons.  That should translate into happier employees and more business.

If there are more restaurants chasing the diner's dollar, that should put pressure on restaurants to keep their prices down.  And that should translate to less inflation.  A similar analysis can be applied to many other industries.

So, there are many reasons to believe that our current bout of inflation will be a transient one.  Does that mean that it will be gone in a month or three?  No!  But we are already seeing signs that inflation is starting to moderate.  It will take a while, but we will get there.

The press will still be able to come up with scary inflation stories for a few more months.  As long as they can compare the current situation to how things were early last year, the current numbers will look bad by comparison.  But that ploy will stop working at some point.  And when it does, the stories will disappear, as if by magic.

The Fed is in a better position to deal with the inflation problem than at any other time I am aware of.  And, as I said, I have studied many decades of Fed policy and how well it has or hasn't worked.   They have the tools, and they know how to use them.  We will be fine as long as they are allowed to do so.

And the Fed won't be going it alone.  There are other forces in play that will also be pushing in the direction of inflation moderating.

Good news.