Tuesday, February 24, 2009

The Mistakes and the Lies

by Mr. Quarter.

This post will discuss two issues that I have found interesting information on recently. The first is the underlying causes of the current economic problems and the second is the Obama budget and tax program proposed last night.

The causes of the current economic problems? Two foundation events that I have identified. The first event was alluded to in my post of February 20 where I quote Phil Gramm on the effects of the Community Reinvestment Act, a Democratic boondoggle that forced banks to make mortgage loans to customers that were unworthy of the loans. In that article, Mr. Gramm points out that in 1994, 4.5% of the mortgage market was subprime and 31% of those subprime loans were securitized, but by 2006, 20.1% of the entire mortgage market was subprime and 81% of those loans were securitized. The second event was illuminated in this article published in Wired Magazine online on the 23rd of February. In 2000, while working at JP Morgan/Chase, a young man named David X. Li published what became widely recognized as a breakthrough mathematical model called the Gaussian Copula Function that allowed hugely complex risks to be modeled with more ease and accuracy than ever before. Because of its elegance, it was widely adopted by financial and investment houses up and down Wall Street. Mr. Li's formula represented an ingenious way to model loan default correlations without even looking at historical default data. Basically, he accounted for this with a sort of coefficient that assumed that prices would not go down. As a result, banks and investment houses developed more and more complex financial instruments, slicing up bundles of mortgages, trading, insuring for default - all based on a formula that assumed no decline in prices. Guess what happened?

Incidently, Mr. Li. he now works in Beijing and heads the risk-management department of China International Capital Corporation which is the China sovereign wealth fund. He is currently unavailable for comment. One wonders whether this was a stealthy attack on America from within by a mole.

On the the Obama budget outline and tax increases. Mr. Obama is proposing a budget of $3.94 trillion with a $1.7 trillion deficit. Not to worry says Mr. Obama, much of this is paid for by increasing the income tax rate on those making greater than $250,000. Says Obama, "No one with an income under $250,000 a year will pay $1 more in taxes." Well, lets examine that a bit more. According an article the Wall Street Journal today, the IRS reported for 2006 (the most recent year this data is available) that income tax filers reporting over $200,000 annual income paid $522 billion in income tax at the top rate of 35% (this group is 7% of all tax payers and pays 57% of all income tax). Obama has indicated that his program will raise the top rate to 39.6% and that he will add another 2% through elimination of certain itemized deductions that are now claimed - so lets make the top tax rate an even 41%. We will have $1.75 trillion deficit and we need to come up with the money to close that gap. Well, through the magic of algebra (thank you Mr. Schwab) we can at least see in approximate terms how much tax revenue would be generated by increasing the top tax rate to 41% - about $104 billion additional. In fact, as the WSJ points out, if you raise the top income tax rate of all filers with income over $200,000 to 100%, the total revenue generated would be $970 billion - still not be enough to cover even the deficit. So where do you think that Obama is going to get the rest? That's right Mr. and Mrs. Oppressed Middle Class. He will be coming to your wallet next.

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