Thursday, September 16, 2010
2 By 4 ? What's Up With This?
Have you ever wondered why we call a piece of wood that measures no more than one and five eighth inches by three and one half inches a two by four? Have you ever noticed that coffee makers say they will make 12 five ounce cups of coffee, while you thought a cup was a measure of 8 ounces? What's up with all this? Do we live in a time when measures and weights and credit ratings don't mean anything?
For months, I have written about the relationship of credit ratings, its failure, and the recession that the United States now finds itself in. Many very bright economists have written what they think will turn this economy around and get people back to work. There are arguments about taxes and who should pay what. I have never studied the impact of taxes on the growth rate of our domestic economy, but I am sure taxes, if set too high, could keep the economy from growing at a faster rate. But, when you look at tax rates around the world, our taxes are hardly at the top.
The problem with our domestic economy is the fact that credit has dried up. Credit has dried up at many levels, and the tools that gave this country the ability to sell its private debt around the world in the form of bonds are now broken. The fact that we no longer can have an active bond market for structured debt obligations such as mortgage-backed bonds, car loan bonds and other collateralized debt obligations, has impacted our economic growth. This is the problem not taxes. Tax rates were much higher in the 1980s and there was economic growth that set the stage for the economic growth of the 1990s.
The problem as I see it is not taxes, but the reluctance of Wall Street to clean up its act and bring creditability back to the credit rating system. When New York City defaulted on their General Obligation Notes in the 1970s, Wall Street firms that sold and underwrote municipal bonds started building their own bond analysis departments and started printing weekly credit reports on the new issues that were coming to market each week. Unfortunately, given the state of creditability of Wall Street banks such a solution today would be meaningless.
The fact remains: without a viable credit rating system, the movement of debt to investors around the world has broken down. The dollar denominated private debt securities from our domestic economy would be sought the world over, but first it has to be a real two by four before investors will touch it.