Thursday, June 9, 2011 - Debt Limit

Debt Limit: Last week, the House voted down a debt limit increase without any conditions by a vote of 97-318. Not a single Republican voted for it. Then, last Tuesday, the President invited the entire Republican caucus to the White House for a discussion on the debt limit. Frankly, all the President succeeded in doing was angering us. His arrogance, haughty nature and his unwillingness to say anything other than his campaign talking points left us all quite discouraged about any potential agreement. Still, the debt limit looms. Treasury Secretary Geithner says that we have already technically hit the ceiling, but that he is raising cash using "extraordinary measures" until August 2nd, at which he point he predicts we will be at the end of our financial rope and run out of cash. Conveniently, that day is just a couple of days before the House and the Senate are scheduled to go on summer recess. The potential to have to cancel that recess will focus negotiators in Washington.

So, what happens if we breeze past August 2nd without increasing the debt limit? Virtually every media outlet would have you believe that we will default on our debt. Even the business press, like the Wall Street Journal and CNBC, say that we will default without a debt limit increase. That means we would stiff bondholders, which would cause the bond market to run away from U.S. treasuries for a long time to come and would have a likely catastrophic effect on interest rates and the U.S. economy. Greece is experiencing this now as they dabble with defaulting on their debt.

But, it's not true. A failure to increase the debt limit will not trigger a default. Here's why:

• Reaching the debt limit means that the government is forbidden from borrowing an amount of money which would, in combination with all money already borrowed, exceed that limit. It does not mean that we stop paying interest or principal on the debt we already have.  As proof of this, the Treasury Secretary says we have already reached the debt limit. But, there was an auction of Treasury bills this morning. How could we sell new bills when we have already reached the limit? Some older Treasury Bonds and short-term Treasury Bills are always coming due. And, we pay them off by selling new debt of the same amount. That's not exceeding the debt limit. That's keeping total debt at the limit. So, if $100 billion in debt matures, we pay it off with $100 billion in new debt and the total remains the same. As I said, we are doing this right now even though we are supposedly at the debt limit. We are not defaulting.

• The Treasury Secretary has well-established and enumerated powers to allocate payments of funds. The Secretary could in theory choose to default on the debt and prioritize other payments. But, this would be a hugely irresponsible move with negative long-term implications, which no sensible administration would do. Furthermore, such action might be challenged in court as the bondholders would claim their right to the "full faith and credit" of the United States and they could likely prevail.

• Once the debt limit is reached, the Treasury has a lot of "ordinary" and "extraordinary" measures it can take to find cash to fund the budgeted and appropriated costs of government for a while without additional borrowing. Whether those measures run out at, before, or after August 2nd, I do not have the information to know.

• But, if there is no debt limit increase, at some point that cash will run out. At that point, for the reasons enumerated above, we will not default. What we will have to do is only spend that which we have cash to fund. We are currently borrowing about 40 cents of every dollar we spend. So, subject to the monthly fluctuations in actual revenue receipts, we would have to spend 40% less almost immediately. As attractive as that may sound, the effects would not be benign. We either stop paying for most of the government as we know it, potentially including the courts and the military, or we reduce Social Security and Medicare payments for all enrolled dramatically. That would be a substantial economic shock in itself. We would be truly in a "pay-as-you-go" mode, which the Democrats, at least in theory, love. The Treasury Secretary would have the power to decide what gets paid, what doesn't and when.

So, no default, but still a bad result. However, the reality is that we are headed towards a crisis right now if we don't get the deficit under control. We will have a worse collapse if we just increase the debt limit and continue deficit spending. This collapse will occur when the markets decide they won't loan us any more money because the U.S. becomes a bad credit risk and they are afraid we may not pay them back. In effect, we have 2 debt limits. One is the statutory limit on borrowing.  The other is the maximum amount that the markets are willing to lend us. If we do not control the first limit, the second one will unquestionably cause a crisis soon. And, if that crisis comes, we will not be able to control its timing or its end.

I have become somewhat despondent lately at how little progress we are making in Washington on the deficit front. The 2011 spending reductions were miniscule. The responsible Medicare reforms put forth in the Paul Ryan budget are being demagogued heavily by Democrats who now believe they have found their 2012 campaign issue. Their "Mediscare" demagoguery is based on complete falsehoods. But, the point is that they are painting themselves into a corner where they cannot politically accept reforms that they have attacked so bitterly. Most Republicans won't reduce defense spending because it is defense, and most Democrats won't reduce any spending at all, including defense. So, the 2012 budget foresees a sizable increase in defense and homeland security spending. Because of this, the Ryan budget only reduces non-entitlement spending by $31 billion below actual spending for this year. Remember the deficit is $1.2 trillion. Democrats would like to raise taxes, an idea with which I obviously disagree. But, they only propose raising taxes on corporations and incomes over $250,000. Even if you do all the tax increases they are proposing, you don’t come close to balancing the budget. This is why Democrats in the House and Senate have thus far failed to even propose a budget for the last 2 years. The only budget they will vote for makes deficits worse instead of better. I had hope for the Senate "Gang of Six", but that broke up. The President is showing absolutely zero leadership as he seems to only be giving campaign speeches of late. We can improve revenue with job creation and growth (which I will write about in a future laptop), but there is no bipartisan agreement on that either. And, part of the current economic malaise is caused by the overhang of the federal debt.

Part of the problem is that both parties believe that if they wait until after the 2012 election, they may control the House, Senate and the White House, and then they can solve the problem on their terms. But, markets won't wait for our election. And, it is certainly possible that neither party controls all the levers of government after the election either and, by that point, we will be 2 years closer to collapse and have lost 2 years of potential mending.

Taking all this into account, we must use this controllable debt limit of our own making to get good enough reforms to curtail future federal spending so that we avoid the inevitable crash that will occur when we hit the market-imposed debt limit. And, if that means going over the brink, so be it. I'm not sure we have 18 months to wait past the next election, and I obviously don't have much confidence in an agreement under normal conditions before then. This would bring on a crisis, but we will control it and we can end it. Hopefully it will bring on a longer-term solution. Sir Winston Churchill famously remarked that, "Americans can be counted upon to do the right thing, after they have exhausted all other possibilities." We need to do the right thing. Let's get there sooner rather than after it's too late.

Friday, June 3, 2011 - Jobs and the Economy

Jobs and the Economy: Things are not so good out there. The unemployment rate, already stubbornly high, climbed even higher in May. Economists are revising economic growth predictions downward. Housing prices continue to drop, thereby further reducing household wealth. Real returns on bank deposits and Treasury Bills are negative. The dollar is dropping. Gas prices are up, inflation is up. There are some bright spots, certainly, but the overall picture is that of stagnation. Unfortunately, none of this is a great surprise given what the government has been doing of late. We are printing money and artificially holding down interest rates to try and spur recovery. But, this is creating those negative real (after inflation) interest rates, which are distorting capital flows. Most of the country's tax policies expire in 18 months, so no one can do any long-term investment planning about taxes with any certainty. The government is retarding the development of almost all forms of economical energy (oil, gas, coal, nuclear), while subsidizing expensive wind and solar. We continue to run record deficits, which divert capital from other more productive uses and create the massive public debt overhang that retards growth. In almost every part of the executive branch, increased regulatory requirements and costs are driving foreign investment and jobs out of America. The causes for this exodus range from ObamaCare and the Dodd/Frank overregulation to the FDA, FCC, and just about every other agency with a federal acronym.

So, what should we do? First of all, there is no one "silver bullet". No one action will start the economy on a path to more robust growth and job creation. Instead, we need to do a lot of things. Things that will give everyone in and out of this country confidence as to our future path such that they build and create and hire again. If I were King of the Forest (not Queen, not Duke, not Earl - Wizard of Oz reference for those of you who don't know), here is what I would do right now:

1. Enact a spending reduction plan, which I think should be even more aggressive and work more quickly than the Paul Ryan Budget plan, that puts the country on a firm and credible path to a balanced budget in less than 10 years. This should be done with spending reductions, entitlement reform, and revenue growth through economic growth, not tax increases.

2. Create a new long-term tax plan that has no expiration date. This should include flatter, lower tax rates with fewer deductions, similar to the "Optional Simplified Tax" which Paul Ryan (R-WI), Jeb Hensarling (R-TX) and I have introduced for several congresses now. Also, eliminate the death tax and the tax on U.S. corporations that repatriate money earned overseas.

3. Go on a domestic energy development binge as a part of an energy policy plan to make us energy independent. Take advantage of the many untapped oil reserves we have all over this country and offshore. Do the same with natural gas and coal and nuclear, as well as some alternatives, and eliminate/streamline the regulatory requirements to make this happen. Doing so should lower energy prices immediately because markets are anticipatory. But, even if it didn't, we would create a huge number of high paying new jobs right now.

4. Create a U.S. manufacturing policy built on special depreciation rates and free trade agreements and relaxed labor regulations in order to encourage domestic manufacturing of complex devices. We are unlikely to manufacture many rubber toys in this country, but we can and should continue to make complicated things here and have the good paying jobs that come with them.

5. Repeal ObamaCare and major parts of Dodd/Frank, and ease regulatory burdens across the economy to remove impediments to entrepreneurship, new products, and new ideas.

6. Pass the Housing Finance Reform Bill that I am championing in order to give certainty to the future of 30-year home financing. The economy will never have robust growth without the housing market leading the way. My bill can jump-start that needed growth.

7. Pass a number of specific bills to remove impediments and uncertainties and create opportunities in many segments of the economy. This list includes things like reforming the FDA, rewriting the patent system, and increasing the number of H-1B visas, so that highly talented foreign individuals with advanced degrees from U.S. universities can stay and create new products and ideas here instead of doing it in some other country.

8. Put the nation on a path to universal, free internet wi-fi accessibility from coast to coast. The availability of free internet access will drive growth and jobs as the tech sector creates new products to utilize this capability. This is the technology equivalent of the interstate highway system. We can also create a new round of public infrastructure construction and rehabilitation by attracting private sector money through a new form of Infrastructure Master Limited Partnership.

OK, so that's a start. I could actually go on. There is no shortage of ideas. Just a shortage of leadership and agreement. Note that nothing I have presented will create any government jobs. We have too many of those. We need private sector job creation. And, that can only happen when the private sector can increase productivity and create new markets and new products and new industries. Right now, the government is very inward looking. Everything the government does is about the government and how to make itself bigger and more powerful and more controlling. This plan is the opposite. It is about getting the government out of the way in some cases, and having the government create an environment in which the private sector has new opportunities for growth in other cases.

Are you listening to this, Mr. Obama? Probably not. I'm sure he's busy on next year's March Madness picks.

Tuesday, May 31, 2011 - Netanyahu

Netanyahu: I have been in Congress nearly 6 years now. During that time, I have heard a number of speeches from the podium on the House floor. I have heard 2 U.S. presidents and any number of prime ministers and presidents and chancellors of other nations. But, last week's speech by Israeli Prime Minister Benjamin Netanyahu was the best speech I have yet heard in those chambers.

First, from a clinical perspective, he is a great speaker. He used notes, but no teleprompter. Those little glass stands that you always see when Obama speaks were not there. Not using a teleprompter allowed him to ad-lib, as he did when a protestor started yelling in the gallery, without worrying that he would get out of synch with whoever was operating the prompter and thereby either miss or repeat a paragraph. Without that machine in between him and the audience, he made a connection that others fail to make. I could feel his courage. I could feel his strength. And, most importantly, I was overwhelmed by the sincerity of his remarks. I felt he was being completely honest and authentic. Many American politicians could learn something from him.

And, from the standpoint of the message, that too was delivered resolutely and with clarity. The friendship between the U.S. and Israel benefits both countries. I suppose I could count how many times he used the word "peace" in the address, but suffice it to say that he used it a lot. Israel has no aspirations for anything other than to continue to exist as a Jewish state in peace with its neighbors. I loved it when he said that the U.S. doesn't need to employ in nation building with Israel, because they have already built. That we don't need to democratize them because they are already a Democracy. And, that we don't need to defend them because they can defend themselves. They want to recognize a Palestinian state, but only one that agrees to recognize Israel's right to exist. That is not an unreasonable request. It is also not unreasonable to request that the government of said state not include the terrorist organization, Hamas, which has not called for just the elimination of Israel, but for the elimination of all Jews. The Jewish people have seen this movie before. And, they have a right to do everything they can to ensure that they don't have to watch it again. I think that President Obama is wrong about most things. But, there is bipartisan agreement in Washington that he is wrong about trying to force Israel to return to the 1967 borders that led to their being attacked then, and will lead to attacks in the future. And, as a Christian, I believe that having Jerusalem entirely within this free country ensures access to this most holy of cities to people of all faiths around the world.

I was encouraged and inspired by the leader of the one enduring democracy and economically free and prosperous country in the Middle East. I hope there will soon be democratic, free and prosperous Arab countries in the Middle East without aspirations to destroy their neighbors. And, I wish there were more world leaders like Netanyahu. Shalom, my friend. May you succeed in attaining it.

If you would like to see the entire 45 minute speech, click on the screenshot below:

Click To Watch Video

Tuesday, May 24, 2011 - Housing Finance Reform Act Q&A

About 10 days ago, I wrote you all about the Housing Finance Reform Bill (H.R. 1859) that I have written and am sponsoring along with Gary Peters (D-MI). I mentioned in that missive that this is an important bill that will consume a great deal of my time and energy over the coming months. Based on the numerous responses from all of you, you seem to agree. I appreciate all those who responded offering your support and assistance in moving this bill forward. I will be separately contacting those of you who did soon.

Reading your responses last week, I noticed there were questions on this fairly complex issue that came up several times. So, I have decided to include the “most asked” questions into this edition and am answering them to give you an even better idea of what this bill is, how it works and why I wrote it:

1. John, isn't your bill just recreating the Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac again? It looks like you are just going to have 5 of them instead of two. 

No. The whole point of this bill is to kill the old GSE system and replace it with something completely different that will provide stability for housing finance. The GSEs were/are monopoly entities formed by the government. The "associations" in H.R. 1859 will be entirely private entities and there will be at least 5 of them, but we frankly hope there will be dozens in order to create competition and spread the risk around. The existing GSEs can make mortgages, hold them in their portfolios, sell them and engage in all kinds of other businesses. In my bill, associations can only guarantee conforming mortgages and they cannot make or hold any mortgages themselves. The GSE's themselves were guaranteed by the federal government for dollar one of loss. The associations will not have any federal guarantee. The only federal guarantee will be on the mortgages and not the associations, and it will only kick in after the down payment, all capital in the entity, and all capital in the insurance fund is gone. The GSEs pay nothing for their federal guarantee, but the associations will pay a market rate to put a guarantee on a group of mortgages. In short, the GSEs were their own special entity and there was and is nothing like them. The associations in my bill will follow the model of public utilities (your electric company, for example) and the banking system. Remember that when you make a deposit in a bank, it is guaranteed by the FDIC. But, the capital requirements, limits, insurance fund and number of banks out there have made the system work even through the recent crisis.

2. How is the taxpayer protected? How do I know there won't be another bail-out like the current bail-out of the GSEs? 

As I mentioned above, my system is very different than the GSEs. The fact that there will be many of these associations and that they are not themselves guaranteed by the government means that they can fail and, if they do, there will be no government money used to prop up the entities. In order for the taxpayers to be at risk, a group of mortgage portfolios would have to first decline enough to eat through the 20% down payment (more on that later). Then, the losses would have to eat through the entire substantial capital of the association, which would then have to be insolvent. If that occurs, the losses would still then have to eat through another layer of private capital, which is the insurance fund (again, similar to the FDIC) into which all of the associations pay. Even then, the government can ask the remaining associations to pay more into the insurance fund to top it up. Bottom line is that the amount of private capital and the control of these organizations will be such that a collapse like we had in 2008 would not trigger any taxpayer liability.

3. Why not let the GSEs wind down and then not replace them with anything? Why not rely on the private sector?

Throughout my lifetime, we have always had some government support for home mortgages. Without some support, the 30 year mortgage will go away. Investors will simply not make loans of that duration, with a fixed rate, and additionally take the 30 year risk that you might not ever pay them back. If we were to wind down the GSEs without some viable replacement system, home loans would likely require 25% down or more and mortgage durations would fall to 15 years or less. This would easily trigger a 30% decline in housing prices as the payments for any home loan would rise dramatically. This decline would plunge the economy into a major recession/depression and greatly reduce the number of people able to own homes in the future. This is a disaster scenario which is completely avoidable. The government is making over 95% of all home loans right now through the GSEs and FHA. That alone is proof that there is no viable private market for such loans or it would be developing now.

4. Will I have to put 20% down to buy a house? That's a lot more than many people can afford.

Yes and no. The federal government will only provide a guarantee for 80% or less of the value of the house at the time of the loan. That means you need 20% down. This protects the taxpayer. But, there is a provision in the bill to allow for a guarantee of 10% down only if the entity originating the loan either buys separate mortgage insurance on that 10% or the originator puts up that capital themselves. In other words, my bill allows 10% down if someone else other than the association or the government takes the risk on that 10%. Furthermore, remember that loans can be made without this guarantee. It is not mandatory. And, it costs money to get it. So, if some in the private sector want to make 5% or no-down loans they can absolutely do it. But, the taxpayer and these associations will have nothing to do with them.

5. Do investors really need a government guarantee? Isn't this preferential to them?

As I mentioned above, someone who makes a 30 year fixed rate loan is taking on a lot of risk. There is the risk that interest rates will go up and their investment will lose value. This is called rate risk. There's the risk that the market will go cold on these sorts of investments.  This is market risk. There is the fact that they are loaning money for a long time and can't plan to be paid back in full for 30 years. That is duration risk. Then there is the risk that the house will drop dramatically in value and the borrower will default. That is called credit risk. The fact is that very few investors will take on all 4 of these risks at an interest rate that any borrower could pay or would be willing to pay. Would you? Would you loan money to me at 4% now for the next 30 years? No? Neither will anyone else. What the associations provide is the removal of the 4th risk (credit risk) from the equation for the end-user investor. With that risk insured by the new associations, investors are willing to accept the other risks. Then, money will flow into the market for homebuyers to borrow.

6. What about low income people? Do you provide special assistance for them in your bill?

No. By definition, the low-income borrower wants government backing because they are a significant credit risk. I understand that there are people who believe that the government should be subsidizing or otherwise assisting low income families into home ownership that they cannot afford under the structure with which all other such loans are made. I happen to disagree with those people. I believe that there is no shame in renting, and that we do nothing to help people by incentivizing them to buy something that they cannot afford. But, even if you believe as they do and not as I do, the place to do such a thing is FHA. The original purpose of FHA was to help low income people buy low priced housing. One of the causes of the housing bubble and its subsequent collapse was that we loaned money to people who could not afford to pay it back. Let's not pollute 95% of the market again with this small percentage of loans, and either eliminate social engineering or keep it separate and contained.

7. The housing market is still recovering. Doesn't an entirely new system jeopardize that recovery? 

Quite the opposite actually. Everyone knows that the GSEs can't continue as they are presently. But, no one knows what will be next. That uncertainty hangs over the housing market right now and is part of what is holding it back. This bill removes that uncertainty and gives the marketplace the assurance that 30 year fixed rate mortgages will be available in the future on a stable and consistent basis. People will then feel confident re-investing in housing.