Hooverprintingpresses asks:

“People will be offering their possessions and their labor for sale to try and get the cards to pay the tax”

Says who? Thomas Paine? Didn’t he go to jail for awhile?

Warren, so ultimately I am being told that I will have some thug with a gun lock me up in a small room if I don’t play ball with the “rules” some other human being has made for me. Heck like my friend in prison said – three meals, free AC, TV, free medical, nice gym and library, no taxes. He encourages everyone to sit down and get arrested – since I know you are a big thinker – what percentage of the population can you “allow” to develop this mindset and be locked up before the model breaks down? You assume all your agents will WANT to pay taxes and sell their services/labor to avoid jail, but I know more and more people who are just choosing to sit down and are tired of the treadmill and jail is not a big enough deterrent to motivate them to run on your treadmill.

I went to the local court last year and watched the judge look at the 200 or so people that day who did not pay lots of things, taxes, child support, alimony and he told one of the non paying mothers who owed child support that she was going to jail, and she said Judge, you can’t lock us all up, there isn’t enough resources to imprison everyone.

You are correct.

The currency is only as good as the government’s ability to enforce tax payment.

Some taxes are easier to enforce than others, which is why I keep coming back to a real estate tax as the base case. If you don’t pay the tax, the government sells the house. They don’t even have to know who owns it.

I don’t like income tax because of the high compliance cost. I know it sounds high, but those costs might be 10-15% of GDP when you include all of the time spent in record keeping, laws, contracts, and enforcement.

And the fact that there is so much money in tax law means that the brightest and the best gravitate to those positions. So instead of having our brightest and best cure cancer, they are working in difference places in tax law and, of course, other places in the financial sector.

It is the biggest brain drain in human history, and it’s getting larger everyday.

Also to your question, if we legalize most of the drugs and take the money out of that sector, there should be plenty of room in the jails at least for the near future. But with the real estate tax, of course, there is not jail, apart from the odd case of fraud; the property just gets sold if the tax isn’t paid.

One last thing, we already have a national real estate tax at the local level. So, switching over from all the federal taxes to a federal real estate tax should be relatively simple and add substantially to our real standard of living.


Russel asks:

Any reason why the Saudi’s are allowing the price of oil to slide?

Just a guess. The futures liquidations were large enough such that holding spot prices up and letting futures free fall would have made it obvious the Saudis are price setter.

There also could be some liquidation of physical inventory going on in which case they would have to let inventories fall before resuming control of prices, or else actually buy in the spot markets which is out of the question of course.

It’s like if some pension fund had a hoard of NYC subway tokens and decided to sell them ‘at the market’. The price would go down from the current $2 price until that selling pressure abated. Then the price would go back to whatever NYC was charging.

So most likely they just let this inventory liquidation run its course, and then work prices higher again.

Much like happened in Aug 2006 with the massive Goldman liquidation and again in a smaller way at year end back then.


Jim Baird asks:


Hey Warren,

I noticed the crude spreads have slipped back into contango today. Are the ETFs up to their old tricks?

For sure inventory conditions have shifted, but they always seasonally shift up around this time. Could be ETFs to some degree.

More interesting, if the Fed is still up to their old ways, this would signal to them that markets are anticipating higher prices down the road, rather than elevated inventories, and may nudge them to hike sooner than otherwise.


Hi Warren,

Do you think there is any chance that the Fed ever puts us into a steeply inverted curve, say something like 10% short rates with 6% long rates? Hard to imagine that happening with the housing market weak, but what do you think?

Very high probability – I’d say 85% chance if, as I expect, crude stays here or goes higher. maybe a lot higher.

Hiking causes inflation to accelerate via the cost structure of business, so when they start hiking, inflation accelerates. Guaranteed!

Only a major supply response will break the inflation. Like pluggable hybrids in 5-10 years or cutting the national speed limit to 30mph, which is highly doubtful.


Why would shareholders approve the sale of Bear Stearns at $2 per share?

Answer, they may not. They may take their chances with getting more $ in bankruptcy.

Or a higher bid might surface.

The Fed has turned Bear Stearns into a ‘free call’ with their non recourse financing,

And the Fed has moved spreads of agency and AAA paper back towards ‘fair value’ with their open-ended funding lines. This removes ‘liquidity risk’ and allows the securities to return to being priced on ‘default risk.’

This has dramatically increased the business value of Bear Stearns.

The large shareholders can now say no to the sale, maybe add a bit of capital or take on a ‘business partner,’ and outbid JPM for the remaining shares (if needed).

Might even start a bidding war.

There could still be well over $60 per share of value for the winner.

And there’s a reasonable amount of time for them to put something together.

And maybe this was Bear’s plan all along.

They knew they needed Fed funding to maximize shareholder value, and the JPM involvement to stabilize their client base and buy the time to find a real bid.

(CNBC now showing a chart showing $7.7 billion in breakup value.)


Seth asks:

For 2 a share is Chase getting a boat load of non prime paper that over time is worth a lot more than 2?

From what I’m hearing it’s already worth maybe 75 or more.

And the Fed gave JPM a free call.

The $2 is the least that it’s worth, as the fed is providing non recourse funding for the assets at prices that support the $2 price.

And at the same time the Fed took action to restore pricing of agency and AAA assets to more accurately reflect their actual default risk, which is near zero.


This is different. In this case the moral hazard is in not funding the primary dealers. It’s too easy for the predators (other dealers, hedge funds, etc.) to first get short the stock and then start a run on any broker that has to have any non tsy inventory financed and drive them out of business.

By funding the primary dealers who are in good standing (they report their finances to the fed) and regulating capital requirements and haircuts predators are kept at bay and shareholders continue to assume the business risk of the primary dealers.

Steve asks:

And the Fed has said in times of crisis they will not punish the many for the few.

Moral hazard is not a fixed doctrine. It requires flexibility and in times of crisis they accept that their action (the Fed’s) will not address the doctrine. On balance it is a price (overlooking moral hazard) they must pay for the greater good.

They have done it in the past so doing it again reflects a degree of consistency not a change in policy.


Paul asks:

How do you respond to the moral hazard argument of the Fed bailing out Bear Stearns?

I’ll let the word ‘bailout’ go for now, and begin by saying the liability side of banking is not the place for market discipline, and it’s also probably not the place for market discipline for the Fed’s appointed (anointed?) ‘primary dealers.’

(I will also not here question the idea of having primary dealers in the first place, but don’t take that mean i approve of that setup, thanks!)

So given the Fed wants primary dealers, it then follows there are specific securities they go along with this assigned role.

Presumably those would include the likes of tsy secs, maybe agency paper, maybe AAA rated mtg backed securities, etc.

Presumably also are functions the Fed wants its primary dealers to perform, like being market makers, providing some notion of liquidity, etc. etc.

And, presumably, the Fed has some notion of public purpose behind this entire creation.

So, given all that, to support this ‘institution of public purpose,’ it behooves the Fed to ensure the primary dealers themselves have the available lines of credit to perform this vital public function (almost hurts to write that”¦).

The bank primary dealers do have ‘guaranteed liquidity’ and so are safely able to function as primary dealers, knowing they can always finance their inventory positions. This can be done via raising fed ensured bank deposits, and borrowing from the fed by using their inventory as collateral, etc.

The non banks were at a disadvantage to the banks in that they relied on the banks to fund their inventories.

Bear Stearns got shut down when the banks said ‘no’ for non credit related reasons. Bear had perfectly good collateral that they held as part of their primary dealer function (as defined by the govt regulations), and the banks said no, perhaps because they had their own internal issues.

The same would happen to the banks, and the entire economy, if the Fed simply said no to the banking system and one morning and didn’t open the payments system.

It’s just one of countless flaws in the institutional structure that doesn’t get noticed until it’s a problem, no matter how many times I’ve pointed it out to ‘authorities.’

So to your question, while I do see a lot of other moral hazard issues, I don’t see this as one of them.

The Fed simply told JPM to deal with Bear in the normal course of business and lend vs qualifying collateral as has always been the case, and as is the case when the Fed lends to JPM.

Let me know if I’m missing something, thanks!