Tuesday, April 29, 2008

Curing The Recession, Part I: The Sub Prime Mess

The Executive and Congress have used the Fed as the "Miracle Worker" and gone their own foolish ways concentrating not on sound fiscal policies but on re-election (a personal fiscal and power policy.)

The fed has no more solutions and will not until the household sector can be induced to further liquify financial institution balance sheets.

The Japanese Central Bank could get away with lowering the its rate to as close to zero as accountants would permit because of the high savings rate of the Japanese household. That we do not have.

What we do have is a consumption/gratification society, with the political system riding the backs of increased consumer installment and home equity debt. The sector is tapped out; and housing debt is so large, given market values, that many home owners have zero equity and increasing interest rates. Thus, foreclosures, jingle mail and the lot.

Financial institutions have been playing the turnover game not holding but sending mortgages for securitization by the whiz kids -- even dumping their servicing businesses to an out of town firm. They are out of touch with the real world of their retail customers.

There are two huge, parallel problems. The first is in the housing market, which is really a domino business with people selling their entry level houses to first time buyers and fleeting up to the next level, using equity from that sale to provide the downstroke for the next level, and so on up the line.

There are entry level buyers, but at a reduced price. At the same time, the home equity loans have to be paid on sale, putting these step-up buyers in a position where they are unable to make the step up, because if they sell, they have little cash to move up with.

This problem can be solved by not moving up, of course. It is complicated by the under qualifica
tion of home buyers, the teaser rates offered, etc. If the mortgage could be desecuritized a solution presents itself.

Provided that the objective is to keep home owners solvent, participating in the economy and not incidentally depositing money on a regular basis in demand and savings accounts, a jointly beneficial solution presents itself. It demands that we take a new look at the home owner's balance sheet.

Traditionally it has had one Asset -- the property; one Liability -- the mortgagee provided loan; one Equity entry -- Owner's position, the remainder after subtracting the principal amount of the Liability from the value of the Asset. Prudent lending in accordance with GNMA criteria held the Liability to be no more than 80% of the appraised market value at closing of the Asset purchase. Owner's verified Income Statement showed that the mortgage payment would be no more than 25% of his income and that the combined mortgage and installment debt would be no more than 33% of his income.

That is the hallmark, forever stained by a combination of sub prime loans based on no documentation and faulty appraisals. These were complicated by teaser rates folded into a higher rate after the initial one, two or three year period and the present fall in home values.

Without the expected increase in home values the conversion of teaser into permanent rate caused mortgagors at the margin to fall outside of the GNMA criteria. Home equity loans caused further deterioration of the mortgagor's credit position

Problems were compounded by the fact that the original lender had no permanent customer relationship; everything was on a transaction basis. Some fault lay there.

Ideally, we would hope to rescue the balance sheet in being by restoring GNMA standards for balance sheet and income statement, while keeping the mortgagor in good standing, occupying the property and making a positive contribution to the economy.

We can do this by adjusting the balance sheet and income statement relationships and requiring future annual adjustments based on the hopefully improving financial position of the mortgagor. All that is required is that we open a new Equity category, a Preferred position in the Asset, nominally held by the Mortgagee -- the Lender.

It will be determined by reducing the First Mortgage amount to that level at which, given the market interest rate on the one hand and the Mortgagor's income stream on the other, the GNMA criteria are met, The difference between the principal amount of the First Mortgage and the the qualifying amount is the par amount of the Preferred Equity. We then set an interest rate which will accrue to the holder of the preferred position. Annually, the Preferred Equity will be paid down by the Mortgagor, given an improvement in his income position.

Upon sale, the Preferred position will receive the first money. the Mortgagor, after paying of his mortgage will receive the remainder. In the interim, no Home Equity financing will be permitted without the permission of the Preferred holder. The Mortgagor will be required to maintain his personal and business accounts with his Lender.


Wednesday, April 23, 2008

Obtaining an Efficient System for Educational Development in Ilinois

I. The Goal

Section 1 of Article X of the Illinois Constitution succinctly summarizes the Goal of Public Education. Unfortunately, attention is usually drawn only to the last sentence which deals with State finance.

The State does have the primary responsibility for financing Illinois schools, but that is clearly subject to interpretation. That authority does not extend to a requirement that the State provide the majority of funding direct to all schools. First, 'primary' does not equal 'majority'. No Illinois Court has ever, nor will they ever rule that the two are the same. That would be equivalent to ruling that no local plus Federal funding can ever exceed what the State provides or that the State must provide at least the same amount of funds that are provided from Federal and local resources.

Each is a tautology. Finances are only a means to an End. The End is clearly stated at the beginning of the Section. It is in realizing and reaching for the Goal that we are failing.

SECTION 1. GOAL - FREE SCHOOLS A fundamental goal of the People of the State is the educational development of all persons to the limits of their capacities. The State shall provide for an efficient system of high quality public educational institutions and services. Education in public schools through the secondary level shall be free. There may be such other free education as the General Assembly provides by law. The State has the primary responsibility for financing the system of public education. (Source: Illinois Constitution.) (Emphasis Supplied)

That goal can be achieved only by a private-public effort. It is like a three legged school, with Knowledge being the seat, and the legs being the parent in the home, the teacher in the classroom and government providing the environment. When the parent is not or can not be part of the process of education, the stool is uneven, the child's capacities do not reach their upper limits. Similarly, when the teaching is inadequate, the system is not high quality that result is also uneven and the student sitting on the seat of knowledge is unable to reach the capacities nurtured by the family unit.

II. The Multiple Failures

We see today failure in the system, in the classroom, and in the home supporting the system.

At the bottom of the income spectrum too many parents having had the system fail them in the past face the real world inadequately prepared. This failure holds them back in society and makes them less able to reinforce at home the lessons taught at school. At the worst, they no longer believe that Education is an Economic or a Social Good and this example is passed down to the child. At the opposite end of the income spectrum, affluent parents, perhaps gulled into inactivity by the Education establishment are distracted by work or play and pay scant attention to the educational achievement of the child and rely on grades on paper instead of demonstrated excellence. At both ends, parents fail to instill loyalty to the family in its members and a sense of sacrifice for the future good of the unit. The parents fail as role models and the children take as models what they see on television instead. Education is best achieved with a sense of urgency. The opportunity for learning passes the child by. In much the same fashion the family elders fail to provide the moral discipline necessary for adults to function in a civil society.

The State for its part has failed its Constitutional Duty above. Both the Executive (primarily through the State Board of Education) and the Legislative branches have failed to demand that local Districts provide a quality education to their students. Curriculum oversight is miniscule, It is based solely on periodic statewide testing controlled by the very agency whose members and staff are not truly independent and whose objective appears to be the validation of the present system of instruction in the several schools, rather than the knowledge base of the students.

Test results are seen to be a function of funding rather than the quality of instruction. Criticism of the latter is out of bounds. As a result, while a problem may be discerned, the solution proposed is and will always be more money. Firms like Augenblick and Myers get employed by an ISBE foil to conduct regression analyses whose solution is always 'increased funding'. The quality of instruction is not considered as a variable in the analysis.

ISBE does its best to hide matters. Its staff is composed of education school graduates -- contemporaries of the teachers in the schools. ISBE admits to both dumbing down the tests and norming up the results. This effectively hides the systemic failure. Compounding this failure is the effective (and expensive) lobbying done by the teachers, administrators and the local school boards

The system also fails to exercise responsible financial oversight until individual Districts are drowning.

Two legs of the Seat of Knowledge are effectively lowered.

What of the third -- the classroom teachers? Effective classroom teaching requires a mastery of techniques learned in training, a mastery and love of the subject matter, and an affection and respect for the students. Each is necessary.

Training in techniques is provided routinely in schools of education prior to employment and validated by unpaid practice teaching before entering full time employment. Affection for and respect for the students is an essential part of the teaching personality. No individual without it will ever be truly effective. These are the qualities which are reciprocated by the students and create a classroom discipline conducive to learning.

It is in the area of Subject Matter Mastery that teachers, and thus students and schools stand or fail. There are quantitative measures for this. Does the instructor have a degree in the subject matter being taught? While most instructors return to education schools for evening and summer courses to pick up classes in education technique (and thus step increases in pay for completed coursework and advanced degrees), do District teachers similarly upgrade their Subject matter degree, obtaining Masters and perhaps Doctorates? .

This should be easily discernable in the curriculum vitae of a District's instructional staff, Freedom of Information blockades notwithstanding. Lesser qualified teachers means that the Seat of Knowledge has been shortened all around.

This failure is especially harmful in the hard sciences and mathematics. Science proficiency exams show our classes in elementary through high school with very low proficiency percentages

Look not at the statewide rankings of schools but at International rankings. United States secondary school quality is abysmal, even unto the so-called Advanced Placement classes. When compared to Western Europe and the Asian littoral from Japan and China around to India, our classes rank at or near the bottom in Mathematics and in Physics -- the very subjects which require the highest subject matter qualification from our teachers. The ACT people have acknowledged this by announcing a review of the Advanced Placement Class designations.

It is perhaps ironic that teachers complain about the amount of time they must spend preparing for the standardized tests. Should not therefore the inability to raise test scores be accounted in evaluating teacher quality?

Look beyond the high schools and one will see dumbed down ACT tests as well, billions of dollars in remedial instruction required in our Community Colleges and our four year colleges. Our Graduate programs are unable to find sufficient numbers of qualified American students.

And worst, we are not producing the knowledge levels which will enable is to compete in a 21st Century world economy.

Meanwhile, back on the ranch, more money into an existing system is not the answer. It will not increase parental involvement, nor will it aid better government oversight.

The argument is made that additional money will improve results. To date, it has not. More money will lower class size and not incidentally require more teachers. The question is clear: if the poor results we are now seeing come from the best qualified teachers we have, with what quality of instructor do we staff the additional classrooms? A wry answer will do.

We see charter schools delivering better instruction at lower cost. We see 'choice' schools getting along with less money using vouchers and producing equal to better results. Charter and choice invest the parents and energize them. Management is more efficient, the hiring of teachers comes from a larger pool, which seems to be better motivated.

Two cries come from the existing bureaucracy. Their carefully construed research purports to show no better results in charter and choice schools. On a cost benefit basis, even if it were true, equal results at lower costs provides savings to the Education system which can be used in each local District.

Similarly comes the skimming idea which implies that only parents with better performing children want to have Choice. This is clearly not correct and a canard upon the universe of parents wishing better for the child. Even if there were a scintilla of truth, the savings would be placed back into the public school system to better its instruction and enable it to retain better students while it allocated additional resources to the problem ones.

A+ Illinois, Martire and company are not for a better educational system, it is clear. They are for the retention of the status quo in which a closed shop union can maintain a monopoly with full job security for all its members.

This is not unlike the closed shop industrial Auto Workers union whose lack of craftsmanship made it possible for foreign manufacturers to come to this country, employ American workers and thrive.

Let us remember that Public Education is not about a System, it is about the education of children and young adults in a way in which the next and subsequent generations can achieve the interclass mobility which is an essential part of the American dream and continued prosperity. The alternative – a class bound statist society -- is not an option for the Republic.

Monday, April 14, 2008

What is missing, as it is from all Labor Department Statistics -- and from what I can ascertain from all Academic Economic Studies -- is a reliable estimate of the Gray Market -- the cash and barter economy into which people move regularly and without reporting.

It exists for many reasons, two of which are as follows.

First, cash wages escape detection by agencies which manage welfare payments, thuis creating dual sources of income for families that qualify for welfare.

Second, the most regressive tax on income at the bottom of the wage scale is that of withholding, FICA and medicare taxes. Bargains are struck with employers to receive cash wages instead. The employer then need not pay his share of the above and FUTA. To do this economically, the employer than under reports sales, pays cash to his wholesaler, etc.

The net effect is to lower reported GDP to a point well below Real GDP. Only gross estimates can be made by economists as to the total effect, but it is likely to be in the double digits.

The legal minimum wage serves as a benchmark for the true minimum wage -- the one actually being paid to the lowest wage earners, which is set in the cash market by the supply of and demand for labor. Is it above or below the legal minimum wage? I would suggest that it is probably a close approximation, perhaps lower in cases where welfare augmentation (see above) occurs, higher where the employee is an independent actor.

Assaying the Gray Market based on changes in the minimum wage might be possible. We surmise that as the legal minimum wage rises, so do the number of jobs which are paid by cash wages. This might be detectable from Labor market statistics.

But the real problem for policy makers is determining what the Real as opposed to the Reported GDP is. That can only be done by minimizing the size of the Gray Market.

One approach (and it would be sound anti recessionary policy on its own) would be to eliminate for employees all offsetting FICA and Medicare deductions, leaving the employer on the hook to pay his share. Raise also the income tax payment threshold to ensure that minimum wage employes have no such liability.

This would incentivize workers to stay in the open market and observe the proper payment of FICA, etc by the employer. In spite of all the uncertainty regarding the future of social security, the employee would be able to see that he was being provided for.