DON QUIXOTE LIVES ... AMERICA'S FINANCIAL MANDARINS STILL TILTING AT MARKET WINDMILLS

One of the endearing qualities we find in the fictional character Don Quixote is his innocent but delusional approach to life. Living in a fantasy world, Don Quixote's valiant adventures had him fighting evil and defending the helpless against mythical monsters. Unfortunately for the primary protagonist from Cervantes' Man of La Mancha (1604), the battles he waged  - though real to him - were against characters only he saw.

The bravery Don Quixote displayed against mythical monsters - like battling a row of windmills he believed were giant knights - makes him perhaps history's most famous errant knight of chivalry. 

Over the course of the story, battered by time and experience, Don Quixote abandons the well intended but delusional truths he pursued. Reality forced Don Quixote to see the world as it was, rather than as he wanted. 

I bring up Don Quixote because his story provides us with a nice backdrop for understanding the delusions market players in the financial sector experience today. It doesn't matter whether we're talking about the financial mandarins in our Too Big To Fail banks, or the self proclaimed wizards on Wall Street. They live and operate in a mythical world of their own creation. 

By now most of you know their world by heart. 

They tell us that they deserve big fees, large bonuses, and bigger salaries for managing and fighting in a mysterious market economy that's full of pitfalls and danger. According to them, they slay financial windmills and make us all better off because of how they keep the wheels of commerce moving. But they say nothing about how their decisions over the last 35 years have led to a string of bailouts orchestrated by the federal government, which have cost trillions of dollars (and will cost us trillions more in the future).

In spite of this reality, market players see themselves through Quixotic-like lenses, where they take on market monsters that are even bigger and more dangerous than the windmills that Don Quixote vanquished. And like Don Quixote, many of these market players want you and me to buy into their fantasies, and to view them as our valiant saviors. 

While they might believe we need to acknowledge their expertise the reality is most market players are delusional about the markets they operate in, and the financial windmills they slay.

The following helps illustrate the point. 

A FINANCIAL MANDARIN BECOMES UNGLUED
I recently got into a discussion with a retired investment adviser from Morgan Stanley. For the sake of this post let's call him Mr. Stanley. As it turns out Mr. Stanley didn't agree with a post from a mutual friend because the posted meme explained how President Obama wants to build more opportunities for the middle class by raising taxes on profitable investments (the capital gains tax), and by raising rates on the estate tax, which is assessed on estates worth more than $5 million when a family member dies and passes it on. 

In the eyes of Mr. Stanley raising taxes in these areas would ruin the economy. His argument was Quixotically simple.

Mr. Stanley argued that the proposed plan to raise taxes represented "class warfare" (I know, real original). To make his point he argued that people who inherited a family farm worth $10 million would have to sell their farm to pay the estate tax if taxes were raised, as President Obama proposed. 

It was the standard market talk of a market neanderthal: "Taxes bad. No taxes good. Drink free market grog."

Here's where Mr. Stanley - and almost everyone in his industry - gets it wrong. 

As I informed Mr. Stanley, he was using the same argument that the American Farm Bureau used when they bullied Congress into getting rid of the estate tax several years after 2001.*  I further explained that the American Farm Bureau - when pressed - could not come up with a single example of a family farm being lost to the estate tax, as he suggested would happen. 

I explained that because his example was not realistic neither were his assumptions. 

For example, when President Clinton raised the capital gains tax the economy took off. When Clinton left office (after raising taxes) our nation's economy was prosperous and generating over $200 billion a year in surpluses. 

To make my point to Mr. Stanley I made it clear that cutting the capital gains tax has never created enough growth or generated enough income to create Clinton-like surpluses (let alone eliminate the national debt) as Ronald Reagan promised when he introduced tax cuts for the rich - or "trickle down" economics - over 30 years ago. 

I went a step further and pointed out how Harvard economist Gregory Mankiw - the chair of the second President Bush's Council of Economic Advisers - went after Ronald Reagan's "trickle down" argument in his economics textbook. Mankiw called trickle down economics a "crank theory." 

Mr. Stanley became unglued. 

This is normal. People who live in fantasy world, where they believe they are masters of the market universe, don't like coming to terms with the knowledge that they're really not market gurus. Faced with an alternative reality, unlike Don Quixote who quit tilting at windmills once he saw the world as it was, people like Mr. Stanley dig in their heals and get ugly. 

It's actually fun to watch, and egg on, as the following makes clear.

DECIPHERING MR. FINANCIAL ADVISER'S FANTASY WORLD 
After reading my response to his trickle down (supply-side) economic nonsense Mr. Stanley complained about my condescending tone. Worse, he started to whine about me being a bully. 

To be fair, it's hard not to feel belittled or threatened when you realize you have no clue what you're talking about. 

Frustrated because I also called him out on his jingoistic reference to "class warfare," Mr. Stanley then asked how people like me could dare to pit "one segment of the population against another" (ignoring how "trickle down" economics and their accompanying policies shifted massive amounts of money from the middle class to the richest Americans). This was especially irksome to Mr. Stanley because so many market players bravely put their "their capital" at risk. Specifically, Mr. Stanley wrote:  

Mark, there you go with the condescension, generalization and just plain BS. "Jingoism", Really!? What do you call pitting one segment of the population against another? What do you call attacking one segment that risks their capital and saves because that succeeded? As for the farm example, I don't care about what the Farm Bureau said, I used farms an example because we have some large farms here in Kern county. 

Mr. Stanley went on to explain how he was such a super economic adviser that he helped a little old lady cross the street (OK, I made that one up) as he made her a million dollars in the stock market.

Under different circumstances Mr. Stanley's achievements might be an impressive feat. But like Don Quixote, Mr. Stanley's story is based on his free market fantasies, which help him ignore how the real world actually works. To help Mr. Stanley out I reminded him that ever since the early 1980s the federal government has helped organize a succession of market bailouts for the financial sector and Wall Street. 

These bailout have not only kept our markets from collapsing, but have allowed people like Mr. Stanley to operate in a bubble-like environment. In this environment financial market players are insulated from having to deal with the worst aspects of their mistakes. Even better for market players like Mr. Stanley, with the federal government backstopping their bets when things go bad, they can make money as if market mistakes don't matter.

So, yeah, they're really not risking their capital if they're always getting bailed out.  

I offered four examples to illustrate my point.

1. I reminded Mr. Stanley of 1982, when our nation's biggest banks stupidly lent Latin American states over 50% of their assets, and in some cases over 100%. In part because Latin American nations at the time were run by military dictators and corrupt regimes, paying off their debts became a problem. The banks were in trouble, which ended up putting the entire financial system at risk. 

There were no worries on Wall Street, though. The federal government, under the direction of free market purist Ronald Reagan, orchestrated a bailout of Mexico (wink, wink), which actually saved the banks and America's financial system.

2. Then I reminded Mr. Stanley of 1987 & 1997, which saw the Long Term Capital Management threat (starting in 1997) and the start of the infamous Savings & Loan debacle. According to Alan Greenspan, "prosperity in our time" was threatened. The feds, acting on Ronald Reagan's and then George H.W. Bush's orders, reorganized and spent hundreds of billions fixing these messes too.

3. Then I brought up 1994, when Mexico was "bailed out" (again) so that America's financial sector could be saved (again) after making a lot of stupid bets (again).

4. Then we have 2008, the Mother of All Bailouts. Over $4.3 trillion is already out the gate, while another $11-14 trillion is waiting to be flushed into Wall Street at the next bailout party.

There are more bailouts I could list during this period, but you get the point. Market players risk nothing when the federal government (you and I) backstop their bets.

I ended our exchange by emphasizing to Mr. Stanley that the financial sector's successes - going back at least 30 years - have depended on regular bailouts and government props (favorable legislation, the Greenspan Put, Quantitative Easing, favorable legislation, etc.). 

With trillions of dollars dumped into the market I made it clear to Mr. Stanley that the industry, and those who work in the industry, have effectively become wards of the state. 

End of story.

CONCLUDING COMMENTS
Again, there are more bailout stories than those listed above. Still, what happened in 1982, 1987 & 1997, 1994 and 2008 make it clear that we haven't had a functioning market system for some time now. We still don't.

Put more bluntly, whatever successes market players like Mr. Stanley have had in "the market" have been state sponsored. Like the kid who goes bowling and has the bumpers put up to make sure they don't get discouraged by the gutter balls, the successes of market players over the past 35 years have been made possible by government bumpers (amounting to trillions of dollars in bailouts) that people like Mr. Stanley like to believe were never there.

This is why I asked Mr. Stanley one simple question at the end of our exchange: What happens to the little old lady's million dollar stock market bonanza that "he created" if the feds had never stepped in to bailout and clean up the financial sector's messes in 1982, 1994, 1987 & 1997, and 2008? 

I asked the question because Mr. Stanley, like many who operate in the financial sector, willingly ignore the impact that a succession of market bailouts have had on our market environment, and on their clients' portfolio performance over time. How do you ignore the cumulative effect of a series of bailouts that have dumped trillions of dollars into our markets?

You can't unless you choose to ignore it. This is Mr. Stanley's reality. 

Like Don Quixote, Mr. Stanley didn't really slay any financial windmills. The federal government has been guaranteeing the markets success for years now. Put more simply, market players like Mr. Stanley, who believe their clients have successful portfolios because of their market acumen alone, are fools. 

- Mark


* The federal estate tax was not applicable from 2001 through 2004. According to the IRS, you need to inherit an estate worth more than $5,430,000 before you begin paying an estate tax. What this means is that 99.85% of all estates owe no estate tax when it passes from a deceased family member to another. There are very few state governments - which includes California - that apply an inheritance tax. 
Note: In the original version I failed to list 1997 as the beginning date of the Fed organized LTCM rescue.

KEVIN McCARTHY'S DOUBLE LIFE

For those of you who haven't seen it, below I've attached the article Robert Price - editor and CEO of the Bakersfield Californian - wrote about Kevin McCarthy, our local congressman and aspiring Speaker of the House. 

In "A Tale of Two Cities and One Congressman" Mr. Price writes what Rep. McCarthy's constituents have been grumbling about for years. Kevin is more concerned about his position in Washington than the interests of his constituents, or the interests of our nation. Enjoy.

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Congressman Kevin McCarthy leads a double life.

In Washington, he's golden: Heir apparent to retiring House Speaker Paul Ryan, frequent and familiar White House guest, donor-connected darling of vulnerable Republican incumbents.

In Bakersfield, not quite so much anymore: He's still a man constituents really, really want to believe, considering his warm reception at fundraisers and service club luncheons. But recent events have at least some of them wondering on which coast his allegiances truly lie.

In Washington, he collects big checks and hands them out too. McCarthy personally raised $12 million in campaign donations in the second quarter of 2018, running his take in this election cycle to a cool $40 million, and he has already distributed half of that total to GOP candidates. That doesn't include Thursday's haul at the Capitol Hill Club, where McCarthy secured commitments for $10 million from House Republicans — with the biggest check, $6 million, coming from McCarthy himself.

But back in his hometown district, growers are still sweating President Trump's tariffs. California is on the front lines of this growing U.S.-China trade war, and Kern County, the state's biggest agricultural producer, is especially vulnerable. Tree nuts, a huge local crop, have been specifically hard hit, a fact that must be particularly painful given McCarthy's personal connections with people in the Kern County almond and pistachio business.

Thank goodness for that $12 billion federal farm aid package, right? You know, the money that's supposed to ease the impact of China's retaliatory counter-tariffs. Except the people benefitting from the aid package are primarily the producers of soybeans, sorghum, corn, wheat, cotton, dairy and hogs — in other words Midwestern states and not (except for dairy) California.

How can that happen, you ask, given McCarthy's co-starring role in the Donald Trump show alongside House Intelligence Committee chairman Devin Nunes of Fresno? They're both Trump favorites who've gone to bat for the president time and time again. And they represent vital California farming districts.

Tough luck, Central Valley. Republican strategists know their districts will send McCarthy and Nunes back to Washington in November (and California will still be blue in 2020) no matter what they pull on constituents. But things aren't so certain in vulnerable pockets of the heartland. So, campaign strategy, not district economic need, carries the day.

McCarthy has his challenges in Washington, too. His path to the speakership was cleared considerably when Ryan and the majority whip, Rep. Steve Scalise of Louisiana, endorsed him; Scalise had considered a run himself. But it was muddied again Thursday when Rep. Jim Jordan of Ohio, co-founder of the conservative Freedom Caucus, announced that he would seek the speaker post.

Most House Republicans recognize that Jordan is a long shot. But Jordan could try to extract promises from McCarthy, should Republicans hold the House in November. And one of those promises is sure to involve an immigration game plan that rejects anything that smells even remotely like amnesty.

Already McCarthy has had to go back on a promise to hold a vote before the August recess on a conservative immigration bill that included a much-needed guest-worker program for farmers. That flip put McCarthy in an awkward spot; just last month he had assured several rank-and-file members there'd be a vote, and his assurances compelled at least two congressmen to withhold support for legislation that would have created a pathway to citizenship for Dreamers. They figured they'd have the opportunity to do so again in August. Now they probably won't.

“There are those of us (who) need to go back (home) and show that we’re doing all we can to do (on immigration reform)," one of those Republican congressmen, Dennis Ross of Florida, told Politico. "... And if it fails, it fails."

The American Farm Bureau Federation supports a guest worker program, and so does the Kern County Farm Bureau, which reprinted in its members' newsletter one of my recent columns criticizing McCarthy's conflicting allegiances.

Bakersfield has noticed, Kevin.

I'll concede McCarthy has one tough job. He's supposed to keep 236 Republicans in line and on the same page, a task that is quite impossible. He's also supposed to be looking out for the 707,000 people of the 23rd Congressional District, however, and when the interests of those two jobs diverge, he regularly chooses the former over the latter.

In Washington, McCarthy is the golden goose, the man you want by your side if you're an at-risk Republican member of Congress in need of financial assistance.

But back in Bakersfield, if you're an almond grower worried about who might buy your crop next year, or a grape grower wondering who might be picking yours, McCarthy looks, more and more, like a different sort of poultry.

Robert Price's column appears Wednesdays, Saturdays and Sundays. Reach him at rprice@bakersfield.com or @stubblebuzz. The opinions expressed are his own.

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- Mark

NO, YOU DIDN'T BUILD YOUR BUSINESS ON YOUR OWN ...

At the beginning of chapter one of my book, The Myth of the Free Market, I tell the story of Montana farmer Lynn Cornwell. I begin by explaining how Mr. Cornwell was such an ardent opponent of the inheritance tax that he showed up on a tractor in Washington, D.C. in 2000 to dramatize how paying the inheritance - or estate - tax was breaking the American family farm. The estate tax is essentially what the offspring of the wealthy owe on their inherited wealth after they receive their first tax free million.

It didn't matter that the American Farm Bureau could not produce one case where a family farm had been lost as a result of the estate tax. Mr. Cornwell was opposed to the estate tax and didn't like the idea of the Paris Hilton's of America having to pay taxes on wealth that is essentially handed to them. 

But there was a problem. The Cornwell Ranch received hundreds of thousands of dollars in federal subsidies, which placed it in the top ten percent of Montana ranches that received federal handouts between 1996 and 2000. Ironically, the wealthy Montana rancher who balked at paying taxes on inherited wealth - arguing that the grim hand of the state undermined the logic of the market - had no problem asking for taxpayer funded handouts from the federal government. Nice. 

I bring up the issue of wealthy businessmen securing taxpayer subsidized handouts because Mitt Romney's new television ad features an offended (but subsidized) businessman quizzically asking, "My father's hand didn't build this company? My hands didn't build this company? My son's hands aren't building this company?"

So what inspired the "offended" businessman - who has also received tax payer funded subsidies - to mockingly claim that his business was not built by his family? Check this out.

President Obama spoke at Roanoke, Virginia on July 13 about the government providing services like infrastructures, security, parks, libraries, legal infrastructures, and an educated workforce. You know, all the things that make our markets work. Specifically, President Obama said: 

If you were successful, somebody along the line gave you some help…Somebody helped to create this unbelievable American system that we have that allowed you to thrive. Somebody invested in roads and bridges. If you’ve got a business – you didn’t build that. Somebody else made that happen. The Internet didn’t get invented on its own. Government research created the Internet so that all the companies could make money off the Internet. The point is, is that when we succeed, we succeed because of our individual initiative, but also because we do things together.

The Romney campaign, however, decided to cut out the "roads and bridges" part of President Obama's speech. Mitt Romney wants voters to believe that President Obama was simply saying "it may be your business but you didn't build that ...".  Unfortunately, for certain people, this kind of campaigning works. Sigh ...

In fact, the Romney campaign has teamed with Fox News, Rush Limbaugh and the right wing noise machine to spread the lie that President Obama was telling business owners that they didn't create their own business. In reality President Obama was trying to explain that there are services and infrastructures that they didn't build, which have made their successes possible.

The point is, as I point out throughout my book, the state creates the conditions under which wealth is created. Is that so hard to understand?

Apparently, it is.

Indeed, currently I am responding to people on Facebook who believe some kind of homo economicus exists, and that non business people are drags on society. This happens because they don't know history, and have very little understanding of what stabilizes markets in the modern world. I won't go into the details here (read my book), but a bit of history helps to illustrate how the state has made the wealth creation we see in America today possible.

Simply put, we need to keep in mind that the government cleared the way for American settlers in the 19th century with war and what we would call genocide today. 

The government then made possible the transfer of land to "homesteaders." The capturing and confiscation of one's property and transferring it to another group would be called socialism today. History tells us that this is simply our "pioneer" period.

At the end of the day, God's hand, Manifest Destiny, and the "magic of the market" had nothing to with the wealth creation that was made possible by these developments. It was all planned and done with the brute force of the state. Getting property rights right (through the state) followed. Excluding blacks and women from the marketplace (through custom, law, and simple racism) helped skew market rewards by effectively keeping one half of the population from participating fully in the market. And on it goes ...

Yet, for our free marketeers today, there has been some kind of mystical fairy sprinkling magic fairy dust throughout America since our founding. So, no, you didn't build your business on your own.

The ignorance on all of this is - or should be - embarrassing.

- Mark