Winning the Battle, Losing the War: Part I

The current political dispute between Wisconsin Governor Scott Walker and the state’s public employee unions is the first battle in a struggle that will dominate the public policy arena at all levels of government in the next 10 years -- how to pay for public employee retirement benefits, what role public employee unions will play delivering government services and their role in the future of the Democratic Party.

I seek to explore these ideas in a series of forthcoming posts. My initial post will cover the cost of retirement benefits to state and local governments (SLGs). Future posts will cover what Walter Russell Mead calls the blue model, the problems of federal deficit spending and the how these disputes will change the political environment of America. Although I expect battles between Republican governors and public employee unions to energize the base of the Democratic Party in the 2012 elections, helping Obama secure his second term, the core public policies in dispute threatens to tear apart the Democratic Party – and will force a substantial political realignment.

Pensions & Unfunded Liabilities

Unlike the federal government, every state in the union (except for Vermont) has a legal requirement of a balanced budget. Although this can be offset in deficit years by relying on the bond market to cover shortfalls SLG’s don’t have the luxury of printing the world’s reserve currency to keep interest rates low, much less pay back the loans.

The wretched standing of SLG budgets has been a victim of the Great Recession. California alone saw revenues fall from $103 billion in 2007-08 to $83 billion in 2008-2009, and will only recover to an expected $94 billion in 2010-11. Revenue figures will improve as our nation’s economic recovery continues. Nevertheless, larger budget problems have been exposed during the crisis and loom ominously in the future.

Rather remarkably, the money discussed in the Troubled Asset Relief Program (TARP) is just a mere fraction compared to the amount of money needed to right SLG pension obligations. Originally estimated to cost taxpayers $300 billion, recent Congressional Budget Office (CBO) figures estimated TARP will end up costing taxpayers $25 billion. This does not include bailing out Fannie and Freddie Mac, which has cost $153 billion so far with the potential of an addition $68-$210 billion needed by 2013.

Estimates on the unfunded liabilities of the states vary. The Pew Center recently estimated the total to be $1 trillion at the end of fiscal year 2008, yet this study used the accounting standards of state pension boards. Using standards required by the private sector the total could be as much as $3 trillion – and this doesn’t even include local governments! These unfunded liabilities has been recognized from figures across the political spectrum, from Reason to the Heritage Foundation to Washington Post progressive pundit Ezra Klein.

As the daunting dilemma has revealed itself investors and public officials have taken notice. Moody’s, the rating agency that rated junk housing derivates as AAA, recently announced they would factor in pension obligations into their credit ratings – even though these figures are not listed on their audited financial statements. This will certainly lower state credit ratings, increase interest rates on state issued debt and augment the strain placed on state budgets. An additional long term issue SLGs will have to confront is increasing health care costs for retired employees; not only will the number of retirees increase, so has the inflation rate for health care.

The same New York Times article linked above revealed states already have $2.8 trillion worth of outstanding bonds. This set of financial realities doesn’t paint an appealing picture for the future of state government budgets.

What in the World to Do?

Reserve Chairman Ben Bernanke: "We have no expectation or intention to get involved in state and local finance.” The states "should not expect loans from the Fed."

Felix Rohatyn, the longtime advisor to the Democratic Party and legendary financier who helped save New York City from bankruptcy in the 1970’s, recently told the New York Times “it seems to me that crying wolf is probably a good thing to do at this point.”

Former Los Angeles Mayor Richard Riordan: “throughout the country, 90 percent of cities and states are going to go bankrupt within the next five years, many of them sooner.”

SLGs are looking at financial armageddon in the next 10 years and the Fed won’t bail them out. What we are about to witness is best describe by astrophysicists as an “Impact Event.” The governance and political alliance structure of SLGs will never be the same after the dust settles.

The Newspaper are Dead... Long Live the Newspaper

It is no secret the Gray Lady is facing serious financial difficulties. Just 18 months ago The New York Times Co. had a market cap of $2.7 billion -- it is only $542 million today. While the Times motto is "All the News That's Fit to Print", their business model/plan is best summarized by their debt rating -- junk. The Times's financial difficulty is epitomized with the fact a share of the The New York Times Company costs less than the Sunday edition of the New York Times.

Newspapers across the country are facing a similar financial problems. Their content is in demand by consumers -- google major local events and the local print stories almost always appear first -- yet they have lost their monopoly of delivering information on demand (before the Internet one could not pull up a radio interview or TV newscast whenever/where ever one desired).

Warning: Wild Speculation

Perhaps the best business model for the local established media would be for television stations to buy out and merge with local newspapers?

Government litigation/regulation, once again (see federal government anti-trust cases against IBM and Microsft -- it wasn't the litigation that ended their monopolies... it was the firms failure to innovate), has failed to keep up with the technological advances in the marketplace and this time threatens to destroy the 4th estate. If this issue sounds familiar, recall the contentious ideological battles in the last 30 years over the concept of "cross-ownership". The "progressive left" has fought any attempt to lift this restrictions claiming it would place too much media power in too few hands, increase media layoffs and therefore reducing the quality of local news coverage and stiffle local democracy. As Amy Goodman wrote in a 2007 article:

The problem facing Martin and his big media friends isn’t that newspapers are unprofitable; it’s that they are simply not as profitable as they used to be. This is in part because of the Internet. People no longer have to rely on the newspaper to post or read classified ads, for example, with free online outlets like Craigslist.

The media system in the United States is too highly concentrated and serves not the public interest but rather the interests of moguls like Rupert Murdoch and Sumner Redstone, who controls CBS/Viacom. Media corporations that will benefit from Martin’s handout are the same ones that acted as a conveyor belt for the lies of the Bush administration about weapons of mass destruction in Iraq. We need a media that challenges the government, that acts as a fourth estate, not for the state. We need a diverse media. The U.S. Congress has a chance to overrule Martin and the FCC, and to keep the newspaper-broadcast cross-ownership ban in place. It should do so immediately, before the consolidated press leads us into another war.

While I agree it is in the American public interest to have "media that challenges the government, that acts as a fourth estate," I simply do not see any other way to ensure the survival of local media outlets other than consolidation. Two ideas that have raised to address the financial difficulties of local newspapers have been government subsidies (horrible idea for very obvious reasons) and establishing local non-profit trusts (sounds good, yet I doubt this actually works + who is going to subsidize the entities... rich local elite who do not want negative press coverage).

The viability of local news coverage depends on increasing the efficiency with which local news is produced and distributed. Breaking up existing "cross-ownerships" or preventing further consolidation does nothing to address this fundamental reality. The "progressive left" needs to come up with better arguments than demonization of MSM to argue against the repeal of the "cross-ownership" rule and come up with realistic, viable solutions to save local media outlets.

A Possible Solution: Repeal "Cross-Ownership" Regulations

Although my prediction of four daily newspapers by the end of Obama's first term may be a bit aggressive, their is little doubt that an unprecedented number of daily newspapers will cease publication in the next four years. Newspapers have seen their two sources of income (advertising and subscriptions) massacred by the combination of the Internet and recession (esp. the collapse of the real estate and automobile industry). Significant job loses are inevitable. The daily print newspaper model is dead -- and the income from an outlet's Web site is not nearly enough to sustain current news operations.

Consolidation with local TV stations may offer the best opportunity to preserve as much journalistic talent and reporting as possible. Unlike newspapers, local TV stations income stream is far more stable than newspapers. While local TV news broadcasts have seen advertising and audience share drop, their core income stream is far more reliable long-term than print and has not fallen nearly as much.

Like all firms in any sector, newspapers are going to need need to innovate, to adapt -- and many are. Numerous print reporters are already filing video along with the written story to enhance the effectiveness of the piece on the Internet. Local televisions stations are now posting written news stories on the front page of their Web sites without a produced news clip. The delivery mechanism of these two media genres is rapidly merging -- and they are competing with each other for SEO rankings and an increased online readership.

I fear if "cross-ownership" regulations are not removed many daily newspapers will cease publication. The quality of local news coverage will be greater if the remnants of the daily newspaper are allowed to merge with local TV stations than simply go online as a shell of their former selves. In the aggregate local news coverage will be greater if consolidation allows for increased efficiency in news gathering.

"The Problem with Socialism is that you Eventually Run Out of Other People's Money"

The title of this blog posts is one of the best quotes from Margaret Thatcher. The market economy is far more efficient than government at allocating resources and identifying investments in a cost-effective manner. When government grows as a percent of GDP it crowds out the true engine of American society -- entrepreneurs -- to the detriment of future economic growth.

The forthcoming cover story for the February 16, 2009 edition of Newsweek declares "We Are All Socialists Now." Key passage:

Whether we like it or not—or even whether many people have thought much about it or not—the numbers clearly suggest that we are headed in a more European direction. A decade ago U.S. government spending was 34.3 percent of GDP, compared with 48.2 percent in the euro zone—a roughly 14-point gap, according to the Organization for Economic Cooperation and Development. In 2010 U.S. spending is expected to be 39.9 percent of GDP, compared with 47.1 percent in the euro zone—a gap of less than 8 points. As entitlement spending rises over the next decade, we will become even more French.

This is an extremely alarming trend. Politicians, in my experience and perspective, are far more concerned being viewed as "doing something" to address perceived problems than actually solving them. An incredible amount of money is wasted and misallocated by government bureaucrats. When firms fail they go out of business. When firms stop being competitive they lose market share to competitors. Entrepreneurs and businesses thus have powerful incentives to continually look to innovate, increase productivity and seek creativity ideas and solutions. The largest incentive for government bureaucrats is to protect their turf and budgets.

Furthermore, these figures only add to my firm belief George W. Bush was by far the worst President in the history of our republic. Beyond that fact that he did not produce one significant piece of legislation in regards to public policy (Medicare Part D? the education bill? Please...) his assault on liberty was simply stunning:

1. Iraq. If misleading the public and resorting to fear tactics to drive our nation into a war of choice was not bad enough, this misadventure saddled our nation with an incredible debt that only adds to our future massive financial liabilities with the retirement of the baby boom generation.

2. The Patriot Act.

3. Implicitly condoning torture as an acceptable interrogation tactic.

4. Allowing government to grow as a percent of the economy PRIOR to the financial meltdown:
5. Failure to prevent the extent of the financial meltdown. As 43 claimed he was a man who favored less government and the virtues of free trade (despite the steel tariffs in his first administration, allowing the Democratic Party to push Fannie and Freddie to take increased risk with the goal of increasing the home ownership rate, etc.). Consequentially, the ideology that he claimed to adhere to, and aided by his incredibly high disapproval ratings, has has led many to question the virtues of the free market and provided greater credence to the belief that government can and should "solve" people's problems.

edit: Per an op-ed from John Taylor, professor of economics at Stanford and originated of The Taylor Rule:

My research shows that government actions and interventions -- not any inherent failure or instability of the private economy -- caused, prolonged and dramatically worsened the crisis.

6. Bailouts. The government had to prevent the complete meltdown of the financial sector. However, the rush to approve TARP and the failure to have any kind of transparency was simply stunning.

7. Failure to reform long-term entitlement spending.

I'm probably missing a few more. So much for 43's belief that "the advance of liberty is the path to both a safer and better world."

Why I am against the Proposed Bailout of the Big Three

Reposting my thoughts I e-mailed to a few friends the other day. The remarks in quotations are statements from a really good friend of mine.
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"No other industry has been similarly crippled because external circumstances - fuel prices - don't have such a major effect on the health of any other industry."

Fuel prices are NOT the reason the American auto industry is having problems. That is an absurd argument. Why are Toyota, Honda and other foreign manufacturers still in the black? The foreign companies have achieved profitability in America mainly by setting up their factories in Southern and border states where they could avoid the UAW, and thereby introduce efficient methods of production.

"The automakers also rely heavily on loans and bonds to operate; the complete collapse of the credit market was another factor beyond their control."

Not really. Only a couple of years ago, GM was paying $5 billion per year in health benefits to retirees and current employees. The UAW was intent on saddling GM, Ford and Chrysler with absurdly high benefit liabilities knowing if all else failed government would pick up the tab.

There is a reason foreign automobile companies have easier access to credit -- they are simply run better and limit the power unions have.
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Back to the principle point at hand.... why bankruptcy is the needed cure and why the bailout is a bad idea.

Bankruptcy Needed

1. Bankruptcy would help GM and Ford become more competitive by allowing them to rip up significant parts of their labor contracts with the UAW. Allowing the big three to dramatically reduce their health care liabilities to past and present workers and reduce the wages of current workers would lead to dramatic cost savings. I doubt this is possible without declaring bankruptcy.

Here is an analogy for you... United Airlines. By entering bankruptcy it was able to reduce its inflated cost structure by breaking contracts it had with the pilots union and other employee unions. It exited bankruptcy a slimmer and more efficient airline. Although it remains to be seen if UA can still survive, it is in much better shape to compete than before it entered bankruptcy.

2. Bankruptcy would force a massive reorganization. The current management would be forced out and allow the firms to reorganize and become more productive and efficient firms.

Why Bailout Bad

1. A bailout of the big three without forcing fundamental change in how these firms are managed will only result in another round of $25-$50 billions checks in the very near future. It is simply a terrible idea to simply write a check to the auto industry without demanding major, major restructuring of its labor contracts. Without that the money will simply go down a rat hole and the automakers will just be back again in a year or two asking for more money. Why should we as taxpayers subsidize a business model imposed on the big 3 by the UAW that is fundamentally not feasible?

The Democrats need the mid west for political power, and rely on the UAW and other unions to get out the vote. No way are the Dems going to get the needed massive concessions out of the UAW to allow the Big 3 to be able to compete without subsidies against foreign car companies that are profitable without massive government subsidies.

2. Government is inherently bad about picking economic winners and losers. Rewarding political patronage and enhancing electoral power is more important than creating a viable profitable business.

3. What is the objective of the bailout? To save jobs? At least with the bailout of the financial sector we have an objective of keeping banks capitalized enough where they can continue to lend money. Pretty straightforward.

We just don't have any good blueprint for what we want them to do!!!
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"what matters is getting the policy right so that we don't put too many people out of work, on the one hand, or waste the government's money on the other."

I would argue that a bailout in of itself is a waste of taxpayer money. Government should not be in the business of deciding economic winners and losers -- that my friend is socialism.
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Bottom line is Detroit needs to dramatically cut production, wages and health care costs.