The Oser View

How Much Does a House Cost?

What a simple question! Houses are listed for sale with the prices clearly stated. You make a bid, usually 10% below the list price. If it's accepted and validated by an appraisal, the price is set. On Wall Street, the agreement of a willing buyer and a willing seller is called "price discovery." Let's assume that, through this price discovery process, we have determined that the cost of the house pictured above is $250,000 and we want to buy it.

But there's a problem. Our house, like many others, costs $250,000, but we, like most ordinary Americans, do not have $250,000. We cannot pay the cost of our house from our own pocket. We can, however, pay monthly mortgage payments of principal and interest. Now, it might seem that the price of our house determines the amount of our mortgage, which in turn determines our monthly payment. That's how the math works, but the fundamental economic dynamic is exactly the other way around: Our monthly payment, which is what we actually pay and can afford, determines the amount of our mortgage, which in turn determines the price of our house. This commentary explores how and why this is so.

The median annual household income in the United States is about $50,000. It's a rule of good personal financial management that the cost of shelter should be no more than one-third of gross income. For a family at the median income, that's about $1,400 a month, of which about $1,100 would be for the mortgage, with the rest going to real estate taxes and insurance. As it happens, $1,100 is just about the monthly mortgage payment for a $250,000 house under current conditions. So, while we, like most people, can't pay $250,000, we, like most people, can pay $1,100. The result is that many houses can cost $250,000…under current conditions.

The most important current conditions are our required down payment, our mortgage's interest rate, and its term. We can buy our house with a down payment of $8,750, at an interest rate of 3.5%, and for a term of 30 years.

Mortgage conditions were very different during the Great Housing Bubble. Back in 2006, if we could afford a monthly mortgage payment of $1,100, we could buy a house with an appraised value of $660,000 or even more. Here's how it was done. In our imaginary mortgage's first year we only had to pay interest, not principal, and the rate was set artificially low. A rate of 2% or less was typical. Twelve monthly payments of $1,100 is $13,200, which is 2% of $660,000. It was in everyone's interest—the seller, the real estate agent, the mortgage broker—that our house cost as much as possible. We, the buyer didn't mind either, because after the first year we were sure we could refinance… or the house's market value would increase… or something.

That's how, within a few years, the cost of our house could vary by more than $400,000. But that's not nearly the whole story. In fact, now is when things get interesting. Why would anyone grant an ordinary American household a 30-year loan equivalent to five times our annual income? Think of all the vicissitudes of life that are likely to affect us over three decades! A sensible lender might be willing to make us a loan with a term of five to seven years. Lots of bad things can happen in seven years, but at least we will be reducing the principal balance of our loan quickly. This will give the lender more value in its collateral and thus a greater sense of security. Again, let's suppose we can afford a monthly mortgage payment of $1,100. Assuming the same interest rate and down payment, but a seven-year term, the cost of our house would be $85,000.

So what does our house cost? Is the answer $660,000, $250,000, or $85,000? The right answer is $250,000 because the federal government makes it so.

The Federal Housing Administration (FHA), a division of the Department of Housing and Urban Development (HUD), is the largest mortgage insurer in the world. For a fee paid by the mortgagee, FHA agrees to pay lenders in the event of a homeowner's default. Mortgage loans insured by FHA are pooled and readily sold to investors worldwide in huge amounts because the timely payment of principal and interest is guaranteed by the US Treasury. Many other US mortgages are pooled and sold under similar protection by Fannie Mae and Freddie Mac. These companies are also part of the federal apparatus.

In this discussion of the cost of our house, I have assumed that the mortgage we need to buy it will be insured by the FHA. I noted that we needed a down payment of $8,750 to buy our $250,000, because 3.5% of the principal balance is all that FHA requires. Similarly, the mortgage's low interest rate and 30-year term are possible only because, effectively, we are not the borrower. If we fail to pay our mortgage, the federal government will step in and make the lender whole.

The numbers produced by the major federal housing finance companies are truly staggering. FHA claims to have insured 40 million properties since it was created by Congress in 1934. In the last three years alone, Fannie Mae has provided $2.6 trillion in liquidity to the mortgage markets and helped borrowers to refinance 7.4 million mortgages and purchase 2.1 million homes.

And there's more. The biggest buyer of mortgage pools guaranteed by various federal government agencies is the Federal Reserve. At the end of last week, the Fed held $884 billion of mortgage-backed securities on its balance sheet, as part of its Quantitative Easing program. The Fed is buying $40 billion of new mortgage backed securities every month and reinvesting existing mortgages as they roll off.

And more and more. We can deduct the interest we pay on our mortgage from our federal tax obligations. We can deduct our real estate taxes too. And if we need a second mortgage to pay for home repairs, we can also deduct the interest on that loan.

To sum up, our house costs $250,000 because we can afford a mortgage payment of $1,100 a month. Our $1,100 monthly payment is made possible because the FHA is willing to insure our 30-year, 3.50% mortgage, which the Federal Reserve is willing to buy because it is as part of a federally-guaranteed pool of mortgages.

Some might complain that it's all a giant scam perpetrated on taxpayers, but it's not, for an extremely good reason. The people who pay taxes and the people who own homes with mortgages are one and the same. In fact, many of those people make their living in some aspect of the housing or related industries: construction, finance, appliance sales and service, furniture-making, and on and on. Housing is a giant job-creating machine made possible for massive federal government support and subsidy. The government's role is so big and multi-faceted, and we have taken it for granted for so long, that we hardly notice it any more. And we can't even begin to imagine what life would be like without it.

 

 

Chickenfeed: The State of New York vs. Standard Chartered Bank

"Rogue institution" or "grandstanding" regulator? "A victory for Benjamin M. Lawsky and his 10-month old agency" or a bank that "acted with pragmatism and integrity in the face of extreme provocation?"

The case at issue is the New York State Department of Financial Services (DFS) and its head, Benjamin Lawsky, versus the New York branch of a 150-year-old British banking giant, Standard Chartered Plc. On August 6, the DFS issued a scathing order against the bank. The order charged Standard Chartered (SCB) with "willful and egregious violation of law" over more than a decade. Specifically, the bank "schemed with the Government of Iran and hid from regulators roughly 60,000 secret transactions, involving at least $250 billion, and reaping SCB hundreds of millions of dollars in fees. SCB's actions left the U.S. financial system vulnerable to terrorists, weapons dealers, drug kingpins and corrupt regimes, and deprived law enforcement investigators of crucial information used to track all manner of criminal activity."

 

The reaction in the financial markets was swift and brutal. Between the close of business on Friday August 3 and the following Tuesday, Standard Chartered's share price fell in London from £15.45 to £12.11. The loss in market value was nearly £8 billion. That was just the start. Analysts speculated that the New York DFS might fine the bank $1.5 billion and that its senior management might be forced to resign. Worst of all, from Standard Chartered's point of view, the DFS was threatening to revoke the bank's license to conduct business in New York. This combination of penalties would have weakened the share price further, making the bank a sitting duck for a rival to acquire.

 

Lawsky's announcement was a complete surprise to the financial world, including Standard Chartered. Yet, the bank was quick to deny the allegations. It claimed that 99.9% of its Iranian transactions were in compliance with US law. A mere handful were not, and their dollar value was less $14 million. We may pause here to ask, if the DFS's order was a bolt from the blue, how could Standard Chartered produce an immediate and detailed response? It turns out that the bank's Iranian business has been under investigation since 2010 by, among other, the Department of Justice, the Federal Reserve Bank of New York, and the US Treasury. But none of the other regulators or governmental authorities nor the bank knew the DFS order was imminent. The surprise was that Lawsky acted without informing the other government agencies and before what they had understood to be a cooperative investigation was complete.

 

The combined surprise of its vituperative tone and suddenness dramatically heightened the order's effect. Standard Chartered had thought the investigation was just business as usual, or at least that was its public pose. On August 1, the bank issued a lengthy press release describing its earnings for the first half of 2012: The following paragraphs were buried deep in a section on risks the Standard Chartered Group of banking businesses was facing:

 

"We have a commitment to maintaining strong relationships with governments and regulators in the countries in which we operate. At any time the Group may be in discussion with a range of authorities and regulatory bodies in different countries on matters that relate to its past or current business activities. These discussions may lead to financial penalties or other enforcement actions which are not material to the Group [Emphasis added]

 

"As reported previously, the Group is conducting a review of its historical US sanctions compliance and is discussing that review with US enforcement agencies and regulators. The Group cannot predict when this review and these discussions will be completed or what the outcome will be."

 

It became frighteningly apparent a few days later when "the Group's" share price cratered, that potential "penalties or other enforcement actions" could be very material indeed. Representatives of Standard Chartered and the New York DFS held a series of emergency meetings and reached a settlement on August 14. The key point was a $340 million fine that the Bank agreed to pay to the DFS. Like the original order, neither the negotiations nor its outcome involved the Fed, the Treasury, Justice, or any other governmental body. As I write, the final details are being worked out, but it's a safe bet that there will be no direct admission of guilt by Standard Chartered.

 

Let's examine what this $340 million fine really means, first for Standard Chartered. As I noted above, the bank lost nearly a quarter of its market value immediately after the DFS published its order. That loss was nearly £8 billion, or, in American money, $12.8 billion, But, the stock began to recover just as quickly. By the close on August 15, when the settlement had been made public, it made almost two-thirds of its loss or more than £5 billion ($8.2 billion). The stock's price is now just where it was in early July. Its one-year return is 7.81%. Only speculators who leaned very much the wrong way in the last couple of weeks lost serious money. The $340 million fine is chickenfeed in comparison to these billion pound swings. It's also less than 10% of Standard Chartered's net income for the first half of 2012. Overall, Standard Chartered came out way ahead by settling quickly.

 

Next, what about the New York Department of Financial Services and Benjamin Lawsky? Media reaction has been mixed. The New York Times hailed Lawsky's "victory" while the Wall Street Journal accused him of "grandstanding" to "get a big publicity score." The Journal got it right. Lawsky was grandstanding, probably to further his own political career, in the long, New York tough-guy-prosecutor tradition of Theodore Roosevelt, Thomas Dewey, Rudy Giuliani, and Eliot Spitzer. (The Journal only compared Lawsky to Spitzer, perhaps because the others were Republicans.) His eagerness to put the spotlight on himself has done little to illumine the case against Standard Chartered and may well have made the probe by the Department of Justice and the others more difficult.

 

In the end, it will be hard for any outsider to know for sure who are the real good guys or bad guys. The probe has already taken years and involves tens of thousands of documents. Given the complexity and detail of the case, we will have to settle for the opposing spins of government and bank officials. But this much should be plain: If Standard Chartered systematically and deliberately broke US law for more than 10 years, the only commensurate punishment is the loss of its license to operate in New York.

 

By his precipitate action, Lawsky may have put the State of New York in a very unpleasant position. If further investigation proves the allegations against Standard Chartered, the paltriness of $340 million fine will be obvious. If, however, the investigation goes in Standard Chartered's favor, well, it seems to me the bank would have strong basis for legal action against Lawsky's DFS. Either way, New York loses.

 

Trillions

The concept of "trillions" has always eluded my comprehension. The picture shows how physically large a stack of a trillion one dollar bills is, which helps a bit. Now try to imagine a stack eleven times as large. That would represent the present amount of US Treasury debt. As of June 30, the US Treasury owed the public—defined as all foreign and domestic individuals, corporations, state and local governments—exactly $11,072,381,954,476.80. This amount has increased by $1,330,158,589,630.22 just in the last year. It has increased 220% or $7,608,234,581,695.98 in the last ten years. But, as I say, such numbers are incomprehensible. I expect you didn't really read them; your eyes just glazed through them.

The average interest rate for all US Treasury debt, again as of June 30, was 2.651%. This means that the annual cost to the Treasury of its current debt is $293,528,845,613.18. This is a bit more comprehensible; to put it in perspective, it is less than five times Bill Gates' net worth.

It is also significantly overstates the true cost to the Treasury.

A few weeks ago , The Oregonian published a piece by an economics professor named Eric Schuck correctly pointing out that the inflation rate must be subtracted from the nominal rate of 2.651% to determine the Treasury's real interest cost. The year-over-year increase in the consumer price index—a common proxy for inflation—is 1.7%, Taking 1.7% from $2.651% leaves 0.951%, which results in a real annual interest cost to the Treasury of a rather paltry $105,298,352,387.07.

But, from the Treasury's vantage point, it's much better than that. Since 2003, the Treasury has published a daily calculation of real inflation-adjusted yields on its debt. These yields reflect the earnings investors demand to buy Treasury securities on the open market. At the beginning of 2003, investors required a real yield of 2.43% to buy ten-year US Treasury Notes. A year ago, the yield had fallen to 0.74%. On June 30, 2012, investors were willing to buy 10-year Treasury debt at a negative yield of 0.46%. To quote Professor Schuck, "Effectively, people buying US Treasury bonds are paying the government to borrow money from them."

Why would anyone do something so crazy? The answer is… safety. The US Treasury will repay its debts. As I discussed last month, this is the power of the rule of law. But today, I am more interested in the implications of such astonishingly cheap debt.

America is suffering from any number of infrastructure deficiencies, from crumbling bridges, to a fragile power grid, to chronically underfunded schools. Federal government investment in infrastructure is the greatest job-creation machine ever invented, the Interstate Highway system being Exhibit A. Properly funding education not only creates jobs directly, but it creates jobs for the future.

President Obama is only one among many who have acknowledged the critical role of community colleges in practical and vocational job creation. Where I live, in northwest Oregon, the one institution beyond the high school level is Clatsop Community College. It provides an affordable start to recent high school graduates, vocational training to local residents of all ages, and continuing education for those needing to improve or maintain their current positions. In the 2011-12 school year, CCC enrolled 5,980 students, of whom 454 were seeking vocational certificates or degrees.  In addition, the college enrolled 386 apprentices in training. Programs leading directly to employment opportunities include nursing, automotive repairs, and office skills.

CCC's 2012-13 operating budget is $10,068,296 or 0.000091% of outstanding Treasury debt. Student tuition and fees cover 42% of the college's operating budget, despite the fact that 61% of credit students receive income-dependent financial aid. Another 43% comes from property taxes from a tax base whose average per capita income is less than $40,000.

The chart shows the amounts Clatsop receives from the State of Oregon in dollars and as a percentage of its total revenues. Because of these drastic cutbacks, the college has reduced its staff by 30.5 full- time-equivalents, eliminated the criminal justice program, and raised tuition.

The State of Oregon's revenues are stretched thin everywhere, and it is constitutionally prohibited from issuing debt to cover operating deficits.

The Treasury Department is under no such restraints. Borrowing just the $1,471,773 to bring Clatsop's government support back to the 2009-10 level would add a mere 0.000013% to the national debt.

And the public would pay the Treasury $6,770.16 a year for the privilege of borrowing the money. Now that's a number I can comprehend.

 

 

 

The Rule of Law

Interest is usually defined as the cost for the use of money. But that's not precisely correct. Interest is the cost of using a particular kind of money—the money a lender expects to get back. Obvious? Maybe, but unless we clearly grasp what allows this crucial expectation to persist, we will fail to understand why interest rates in some countries, including the US, have been so low for so long, while those in other places are sky high.

In theory, the movement of interest rates is a purely monetary phenomenon. Money has no intrinsic value; it is simply a means to an end. Consider this decision matrix: You want to buy a refrigerator. It costs $1,000. You can buy it now or a year from now. But, if you wait a year, will it still cost $1,000 or will it cost more? If you decide to buy the refrigerator later and invest the money in the meantime, you will have to earn enough interest to cover the increased price. Of course, it's impossible to know today what the refrigerator will cost 12 months from now, so you will have to make a guess.

That's what the $31 trillion market for US government bonds is doing all the time. As investors and speculators buy and sell government bonds of various maturities, they are making their best guess about the value of money when the bonds mature. Investors require a high rate of interest when they believe money will have less purchasing power in the future. These days, investors believe that money will retain its present value over long periods of time. That's why interest rates are low. In theory.

In practice, there is something deeper going on. At best, the world is struggling through a very weak economic recovery. At worst, we may be on the brink of an even more severe global recession. In a time of such uncertainty and fear, shouldn't money be expensive to borrow, not cheap? Imagine that, instead of being the buyer of a refrigerator, you were the owner of the company that makes the refrigerators. As more potential customers deferred their purchases, you might need to borrow money to keep your business going. If you could borrow at all, you would find the cost—that is, the rate of interest you had to pay—much higher than if times were good and you were selling refrigerators like hotcakes. The reason, obviously, is that your lender is taking a bigger risk, which requires more compensation. You might not be in business when the time comes to repay your debt.

The same dynamic is at work for countries. The table shows the yield for 10-year government bonds as of June 8. The buyer of a US, a Swiss, a Japanese, or a German government bond does so with virtually complete confidence that, at maturity, that government will repay its obligation. Brazil? Portugal? Greece? Not so much.

What is the basis for this confidence? It is not a country's wealth. Neither Japan nor Switzerland has much natural wealth. Russia, which has more natural resources than any other nation, doesn't issue long-term debt because it would be prohibitively expensive.

Nor does a country's history guarantee confidence. Greece was the world's first democracy. Spain and Portugal once owned all of South and Latin America.

No. Investors have confidence in nations where the rule of law is fundamental, pervasive, and transparent. The rule of law—that is, basic honesty, fair-dealing, and consistent moral standards—is the bedrock of the American economy. Because investors have the confidence to loan our government long-term money at favorable rates, our country has the inestimable benefit of Time to resolve economic problems without being crushed by either hyperinflation or draconian austerity.

In a recent paper, "Money, Politics, Power: Corruption Risks in Europe," Transparency International reports that, while 19% of Danes consider corruption a major problem in their country, 98% of Greeks consider it a major problem in theirs. The perception is grounded in fact. The report notes that "Greece, Portugal and Spain highlight in particular that inefficiency, malpractice, and corruption are neither sufficiently controlled nor sanctioned." It is hardly a coincidence that Denmark pays 1.23% to borrow for 10 years, while Italy, Spain and Greece pay the highest rates in Western Europe.

 

We won't become like Greece just by borrowing a lot of money. If we ever become like Greece, it will because we abandon the rule of law.

Gains & Losses

By now, everyone is aware of that most publicized, and most politicized, of economic statistics: payroll employment in the United States rose by 115,000 in April. This does not mean that the economy simply added a total of 115,000 jobs; rather, it means that some very large number of new jobs and some very large number of lost jobs netted to an increase of 115,000. Figuring out those two large numbers is much harder and takes much longer than simply noting the net change.

On May 1, the Bureau of Labor Statistics, that great storehouse of useful information, released its most recent count of job gains and losses. It is a mark of difficulty that the "most recent period" is the third quarter of 2011. The chart below summarizes the data. The gray bars show periods of recession, the blue line tracks job gains and the red line, job losses. At this high level, the picture is clear: In bad times more jobs are lost; in good times more jobs are gained.

From the beginning of 2001 through the third quarter of 2011, the economy created 316 million jobs and lost 319 million. These are both astonishingly large and astonishingly close numbers. To put it in perspective, 2.4 jobs were created and 2.4 jobs lost for every American currently employed, a demonstration, apparently, of tremendous mobility and vitality in the economy. But the details show a more nuanced picture. In the recession years of 2001 and 2008-09, job losses exceeded job gains by 12.1 million. In contrast, during the three boom years, 2004-06, job gains exceeded job losses by only 6.0 million. Bad times have been considerably worse than good times have been good.

Looking even closer, we find that both job creation and job destruction have slowed dramatically over the past decade. The vertical axis on the chart at left adds together jobs created and destroyed. The red line tracks the changes in the total in each year from 2001 to 2011, what one might call job volatility. As you can see, job volatility declined sharply during and immediately after the 2001 recession. It evened out during the mid-decade boom, but dropped again in the Great Recession. It is leveling off in the present recovery but at a much lower level.

I suspect this trend is related to and reflects the decline in the labor participation rate. The last chart shows the percentage of Americans over age 16 in the labor force over the last 10 years. The drop, from nearly 67% to 63.5% has been drastic. Of course, every person who stops looking for a job has his or her own reasons, but individual circumstances should not blind us to a central fact: fewer Americans have to work to provide all the goods and services we need. Indeed, fewer Americans have to work to keep the US economy the strongest in the world.

Economists have a typically cold-blooded term for describing this phenomenon: the Non-Accelerating Inflation Rate of Unemployment or NAIRU (pronounced like the former Indian prime minister). It means that in order for the economy to adjust dynamically to changing demand, technologies, and competition, some fairly significant percentage of would-be employees will always be out of work. Employees are the economy's unwilling elastic.

In one sense NAIRU is an obvious concept. Its alternative is a command economy in which people have jobs for life, few businesses are created and fewer still are allowed to die. It's an approach that has been tried and found wanting. As factory hands in the old Soviet Union used to say, "We pretend to work and they pretend to pay us." The problem, though, is that nobody knows what the lowest sustainable rate of unemployment actually is. Economists tend to come to the ex post facto conclusion that NAIRU is simply the current unemployment rate. In the boom periods of the 1990s, they were saying that the NAIRU may be as low as 4-5%; now they are saying it may be 7-8%.

This is more than an academic exercise. If an ever smaller proportion of Americans has to work, how will the growing number of non-workers live? In my opinion, this will be the great social and political question of the next 50 years. If addressed constructively, it will result in a redefinition of usefulness and productivity. If ignored, it will perpetuate an underclass whose hopes for a better life will be blighted from birth.

 

 

 

 

 

I Dreamed I Saw Joe Hill Last Night

Joe Hill ain't dead, he says to me
Joe Hill ain't never died
Where working men are out on strike
Joe Hill is at their side

 

There was a time in America when the labor union movement was a powerful force for social change. Work in the newly industrialized nation was long, poorly-paid, and dangerous. One of the first great labor causes in the Massachusetts textile mills of the 1830s was the reduction of working hours to ten a day, six days a week. Pay was as low as hours were long, and workers were at the mercy of the owners of industry. When the Panic of 1893 reduced demand for his luxurious sleeping cars, George Pullman cut workers' wages an average of 25-33%. He neglected, however, to drop the rents in his company town where the workers were forced to live. But the truly horrendous part was how many workers were injured, maimed, and killed. In mining, deaths averaged 6,600 between 1900 and 1904. The worst years for fatalities among railway workers were 1889 (8,500), 1895 (6,450), and 1901 (7,350).

Today, work is short, reasonably well-paid, and safe. The average work week for all workers has hovered around 34 hours for years; in manufacturing, it's typically a bit above 40 hours. Last month, production and non-supervisory employees earned an average $19.64 an hour ($40,851 annualized), a figure that increases almost every month. The biggest improvements have been in safety. In 2010, the last year for which data is available, total work fatalities were 4,547, a mere three-thousandths of a percent, and almost 1,000 were caused by traffic accidents.

Who can we thank for these great achievements? Organized labor, of course, with its great heroes and martyrs, like Joe Hill, framed for murder in Utah in 1914 and executed because he was a member of the radical union, Industrial Workers of the World.

But in modern America, labor unions are nearly as dead as Joe Hill. Labor statistics are a bit dicey until the 1970s, and comparisons are difficult over time. Nevertheless two trends stand out. First, union membership increases in good economic times and falls in bad times. Second, membership rates track closely with manufacturing as a percentage of the economy. At the turn of the 20^th century, there were fewer than 800,000 unionized workers in America, but Labor's ranks grew steadily. Thanks to World War I production, trade union membership nearly doubled between 1915 and 1920, from about 2.5 million to 5 million. This latter figure was about 19% of the non-farm workforce. Moreover, in 1920, 47% of payroll employment was generated by manufacturing, a figure that has never been approached since. Union membership declined during the '20s, hitting bottom at the depth of the Depression, when about 12% of the workforce was unionized and unemployment reached 25%. The World War II boom was a great stimulus to unions. As early as 1940, nine million workers, more than a quarter of the non-agricultural workforce, were in unions. By war's end membership had swelled to 15 million, and it continued to climb in the postwar boom period. In 1955, nearly 17 million workers were unionized, representing fully a third of the workforce. The number of union members topped out in 1978 at 22.9 million, but, with the growth of the workforce, the percentage of unionized labor was back down to 26% and falling. Not coincidentally, the percentage of manufacturing payroll employment was also falling, from a steady 41% in the 1930s through the 1950s, to 38% in 1960, 33% in 1970 and 28% in 1980. By 1983, following the terrible recession of the early '80s, the union membership rate was down to 20.1% and the number of unionized workers was back down to 17.7 million.

The downward trend has never been halted. Last year, only 14.7 million workers were union members, just under 12% of the non-farm workforce. But, and it's a very large "but", a mere 6.9% of private sector workers (7.2 million) were in unions, compared to 37% of public-sector workers. In no private sector occupation did union representation reach more than 25%. The following chart shows a selection of private section union representation in traditionally organized occupations:

Industry	Number Employed	Union Members	Percent of Employed
Mining	780,000	56,000	7.2
Construction	6,244,000	874,000	14.0
Durable Goods Manufacturing	8,530,000	871,000	10.2
Non-durable Goods Manufacturing	5,070,000	553,000	10.9
Transportation	4,335,000	887,000	20.4

 

The drop in union membership is nothing compared to the drop in union militancy. In the 1950s, there were 3,517 work stoppages involving a thousand or more workers each. Almost 16 million workers were involved in one time or another. By the 1980s, comparable figures were 831 and five million. In the first decade of this century, there were 201 work-stoppages involving 1.3 million workers. Last year there were precisely 19 work-stoppages of 1,000 or more workers. The percentage of estimated working time lost was less than .005%. Of the 19 stoppages, just four lasted more than a month, and one of those was the National Football League.

Nor should we imagine that workers have nothing to complain of. In 2009, when there were only five major work-stoppages involving 13,000 workers, there were more than 10,000 mass layoffs (defined as 50 or more workers) affecting 1.2 million workers in the manufacturing sector alone. In all there were more than 28,000 mass layoffs that year, resulting in more than 2.8 million unemployment insurance claims.

Some might say that unions have no one to blame but themselves. Organized crime and corruption were endemic in many big unions, especially the Teamsters where leaders like Dave Beck and Jimmy Hoffa were little more than gangsters. The unions also failed to cement their ties with the Democratic Party. Indeed, pro-Vietnam "Hard-hats for Nixon" turned many 1960's liberals permanently anti-union. Also, the ties between Big Business and Big Labor have long seemed too cozy. Others might blame Big Government, which has co-opted Labor's issues with all sorts of laws and programs, most notably the Fair Labor Standards Act, Minimum Wage laws, the Occupational Health & Safety Act, Workers Compensation, and many more. The strongest argument, though, is that organized labor is just a poor fit for a service and information economy. Today, the entire goods producing sector employs a mere 13.8% of the total workforce and 16.5% of the private sector workforce. Manufacturing employs just 9%.

And yet, there's something wrong with this picture. In every recession over the previous 30 years, it has taken progressively longer for employment to recover. The economy is still something like five million jobs from its pre-Recession peak, and an 8.3% unemployment rate is nothing to brag about. It makes me wonder. Why haven't unions been able to make more inroads among private, service sector white-collar workers? Nearly half of all local government employees are unionized, and more than a third of state and federal employees. Why isn't there a bank tellers union? Or a union for telemarketers? Or temporary workers?

Back in 1909, an economist named Herbert Croly provided a rationale for organized labor that holds even truer today:

A simple and poor society can exist as a democracy on a basis of sheer individualism. But a rich and complex industrial society cannot so exist; for some individuals, and especially those artificial individuals called corporations, become so very big that the ordinary individual…cannot deal with them on terms of equality. It therefore becomes necessary for these ordinary individuals to combine in their turn, first in order to act in their collective capacity through that biggest of all combinations called the government, and second, to act also in their own self-defense, through private combinations, such as farmers' associations and trade unions.

 

It's impossible to know if fewer Americans would be unemployed today if the Labor movement was still vibrant, but I suspect so. More generous unemployment benefits, more federal stimulus to rebuild infrastructure, and greater support for career education are Labor causes. The AFL-CIO website boasts, "Working people's power is our strength in numbers. That's how we win change at City Hall and pass legislation at the state level and in Congress to create jobs, boost the economy, ensure quality education for our children and much more." Unfortunately, as we have seen, "strength in numbers" is exactly what Labor no longer has. There was a time when Labor was an effective opponent of the power of corporations. There was a time when it stood firm in defense of the ordinary worker. But those times are gone. I'm afraid old Joe Hill really is dead.

The Fundamentals

January 25, 2012

Coaches love to preach the fundamentals. There is a story, possibly apocryphal, about Green Bay Packers coach, Vince Lombardi, addressing his team after a particularly egregious loss. Pointing to an object on his desk, he said, "Gentlemen, this is a football." A player, standing towards the back, is said to have responded, "Uh, coach, could you go over that again."

Still, it's not a bad idea to go review the fundamentals now and then, even for those who are, or are supposed to be, seasoned professionals. Today, the Federal Open Market Committee, the policy arm of the Federal Reserve System, went back to basics in explaining its purposes and actions. Finance professionals may skim past these background parts of FOMC's press releases, issued following a two-day policy meeting. But they are extremely, indeed fundamentally, important. The FOMC, after all, is not talking just to professionals. The Committee is talking to everyone who is affected by monetary policy; which is to say, everyone. "The Committee seeks to explain its monetary policy decisions to the public as clearly as possible. Such clarity facilitates well-informed decision-making by households and businesses…" (emphasis added). "Transparency and accountability…are essential in a democratic society."

It doesn't get more fundamental than that, and we should take the FOMC's announcements at face value. We are so distrustful of public officials and so used to looking behind their words for the real, hidden, meaning that we have all but lost the facility of belief. I am not asking you to agree or disagree with the FOMC's statements. I do urge you to believe the Fed means precisely what it says, and for that reason, consider its points seriously.

The statements continually reference the Fed's dual statutory mandate, "to foster maximum employment and price stability." Every word here is important. The mandate is "dual" because both parts are equally important, and they contain the entirety of what the Fed is empowered to do. It has often been noted that the two goals can be contradictory. Jobs tend to be created quickly when the production of goods and services heat up to meet demand, but ultimately the cycle can turn inflationary as prices spiral out of control. Stable price tend to retard employment because people have less money to spend resulting in less production of goods and services. Here the danger is that the economy will stall and fall into recession. Economies rarely stay in equilibrium for long. But, it's the Fed's responsibility to balance the two mandates. Second, the mandate is "statutory;" Congress has specified by law what the Fed is required to do. Intervening in the economy in other ways would not just be misguided but illegal. In its statements, the FOMC emphasizes its responsibilities and authority with great clarity because it wants you to understand clearly what it can and cannot do.

At present, the Fed believes

1. "The unemployment rate remains elevated" and "the unemployment rate will decline only gradually towards levels that the Committee judges to be consistent with its dual mandate." (Mandate #1), and
2. "Over coming quarters, inflation will run at levels at or below those consistent with the Committee's dual mandate." (Mandate #2)

For the first time ever, the Fed specifically defines the optimum levels of inflation and unemployment. An inflation rate of 2%, as measured by the annual change in the price index of personal consumption expenditures (PCE), will be the Fed's long-term inflation target. Determining an ideal unemployment rate is, surprisingly, more difficult. You might think the best unemployment rate is 0%, but in a healthy economy there are always people changing jobs voluntarily as well as a certain amount of creative destruction leading to involuntary job losses. The economy's health is demonstrated by how quickly people get new jobs. The Fed has established a target range of 5.2% to 6.0% for unemployment, while emphasizing that, unlike inflation, this range can be expected to vary over time.

Directly following on these conclusions, the FOMC announced three actions to achieve its mandates:

1. It will maintain the fed funds target rate—that is, the rate banks pay for overnight loans from other banks—between 0% and 0.25%;
2. It expects to maintain the fed funds rate at these extremely low levels "at least through late 2014."
3. It will continue its purchases, and extend the maturities, of long-term US Treasury bonds and similar securities.

To many people, these actions may seem meager and extraneous to the real problems of the economy. Herein lies the Fed's communication problem. In practice, the actions outlined by the Fed do have a substantial economic effect. Very low short-term interest rates anchor all interest rates at low levels. The announcement that short-term rates will be kept low for three years—virtually a millennium the way the financial markets measure time—encourage a long-term investment horizon at current rates. Investors and lenders need not fear that their assets will lose value quickly due to rapidly rising interest rates. Finally, the Fed's continued purchases of very large amounts of bonds are simply an application of the law of supply and demand. The more the Fed buys, the less other investors can buy. Hence, bond prices are kept high and interest rates low.

The bottom line is that our nation's central bank expects the economy to grow slowly and below its potential for years to come. The Fed's policy makers intend to use the bank's powers to their utmost to lessen and shorten the period of economic malaise. But, as the FOMC points out, we live in a democratic society, not a command economy. All that the FOMC can do is "maintain a highly accommodative stance for monetary policy;" that is, it can use its tools to keep short-term interest rates low. Low interest rates should encourage more borrowing and lending, which in turn should fuel economic activity. But the Fed cannot order economic conditions to its liking. Again, you don't have to agree with the FOMC's opinions or methods. But understand that, today, the Fed has made some fundamental statements, which they will live by and we will all live with.

Looking Backward: 2012-1888

Grover Cleveland, 22^nd & 24^th President              Benjamin Harrison, 23^rd President

In a recent New York Times column, David Brooks complains that members of the Obama administration have been comparing the present political and social environment to the Progressive era. The Progressives came to prominence early in the last century. The movement reached its apogee in the presidential election of 1912, when, as a third-party candidate, Theodore Roosevelt received 27% of the popular vote on a platform of reducing the outsized gap between rich and poor Americans. Brooks repudiates the comparison, pointing to the many differences between America in 1912 and 2012. One distinction he makes is that a century ago "the economy was in its adolescence," whereas now it is in middle-aged doldrums. But the real distinction is moral: A hundred years ago, America "still had a Victorian culture, with its rectitude and restrictions. Back then, there was a moral horror at the thought of debt… In the progressive era, there was an understanding that men who impregnated women should marry them." This is just Golden-Ageism, the notion that life was better in some favorite "good old days." In fact, in 1912-America prejudicial stereotypes of all sorts were taken for granted, capitalists routinely cooked their corporations' books, and violence against organized labor was supported by all three branches of government.

Still, I agree that with Brooks that the comparison of 2012 to 1912 is not especially apt. A more useful comparison is to 1888, when Republican Benjamin Harrison narrowly defeated Democrat Grover Cleveland for the presidency. One similarity between the campaigns of 1888 and 2012 is the role of corporate finance. The coming election marks a turning point in which corporate money, after years of at least partially successful limits, can now be spent with few restrictions on pro-business candidates. There were no political spending restrictions at all in the 19th Century. By 1888, the necessary preconditions of increased corporate wealth and improved nationwide transportation and communication were in place to make large-scale fund-raising possible. Of course business had contributed to campaigns before and would exercise a much greater influence in the years ahead, but 1888 was a turning point. In that year, Philadelphia department store magnate John Wanamaker toured the country, selling business groups with a pro-Republican pitch. He successfully lobbied for substantial campaign contributions by likening support for his party to buying insurance, "If you were confronted by from one to three years of general depression…what would you pay to be insured for a better year?"

But the essential similarity between 1888 and today is the disparity between the small number of the very rich and the large number of those for whom daily life is a financial struggle. Today, the battleground is whether to raise taxes on the highest earners. Then, the battle was over the tariff, which was the income tax equivalent of the day. Tariffs and excise taxes—that is, sin taxes on tobacco and alcohol—were the main sources of federal revenue from the country's founding until the First World War. Income taxes had been assessed briefly during the War of 1812 and in the Civil War, but a peace-time attempt to impose them was ruled unconstitutional in 1895. It took the 16th amendment to Constitution to validate them in 1913.

Tariffs are taxes on imported raw materials and manufactured products designed to raise their costs to consumers and thereby make domestic materials and products more competitive. The traditional rationale is that tariffs nurture "infant industries" until they are strong enough to hold their own in free markets. The Democrats of 1888 pointed out that US industries were no longer infants; indeed, our industrial might even in the 1880s, let alone 30 years later, was well past adolescence. Trusts, near monopolies that controlled all phases of the extraction, manufacture, and distribution of key commodities, ruled nearly all major fields of commerce. The steel industry was actually more competitive than most, yet the Carnegie Steel Company produced a quarter of the nation's steel. Its annual profits exceeded $40 million (something like $800 million in today's money), a fantastic sum back then.

The Democrats also pointed out that tariffs, far from protecting ordinary working people, were an extremely regressive tax. It's easy to see why. If the tariff on an imported product in everyday use caused its price to rise by 50%, a domestic manufacturer of the same product would simply raise his price to just under the foreign price. Moreover, the excess profit did not trickle down to the American workers who made it. An 1888 Bureau of Statistics report gave many examples of this sad fact. For instance, a pound of domestic sewing silk could be sold for $5.66 a pound. Thirty percent of the price ($1.69) was a result of simply coming close to the tariff-adjusted price of imported silk. American workers were paid just 85¢ a pound. In summary, the Democrats' position was that high tariffs enriched capital through windfall profits and impoverished ordinary citizens by raising their cost of living. Reducing tariffs would shift the economic burden from those who could least afford it and to those who could most afford it.

Republicans defended the tariff with equal fervor. Ohio representative William McKinley claimed that protective tariffs were a job-creation machine for American workers. "Every pound, every bushel, every ton, every yard of foreign product that comes into this country to compete with ours deprives American labor of what justly belongs to it." To the extent that tariffs reduced the influx of foreign goods, they strengthened American industries, provided markets for American producers, and work for American wage-earners. The Republicans argued that Democratic attacks on the tariff were no more than attempts to stir class warfare, designed to pit one group of Americans against another. Reducing tariffs would harm employers and thereby workers as well.

The denouement is instructive. The argument that Wealth should not be hampered in its mission to create jobs convinced enough laboring men to put Harrison across over the incumbent Cleveland. The Republicans emerged with small majorities in both the House and the Senate. A bill raising tariffs and named for its guiding spirit, McKinley, became law in 1890. Its effect could have been foretold—in fact, was foretold by the Democrats. Consumer prices soared, and disillusioned voters rolled back the Republicans' congressional majorities in the 1890 mid-term elections. Then, in 1892, Grover Cleveland became the first and only person to serve two non-sequential terms when he was elected the 24th President of the United States.

Unfortunately for Cleveland, his vindication soon turned bitter. Almost immediately, the economy plunged into the Panic of 1893. This catastrophe, called the Great Depression, until the 1930s, lasted all through Cleveland's term. He left office lamented by none, especially as prosperity returned soon after the inauguration of Cleveland's successor, William McKinley.

The notion that the well-to-do should be left relatively undisturbed by restrictions on their earnings dies hard. The common argument is that the American Dream, that everyone can get rich in our egalitarian society, makes even the non-rich resistant to steeply progressive tax rates. The Republican victory in 1888 did not usher in an era of high wages and cooperation between employers and employees. In fact, several of the bloodiest labor-management confrontations, including the Homestead steel strike and the Pullman strike, happened in the next few years. Lowering tariffs would not have been a panacea in 1888, and higher tax rates on incomes over $1 million won't eliminate the deficit in 2012. But policies of high tariffs then and low income taxes did nothing but exacerbate disparities in wealth. They benefited a small section of the economy for a while and hurt nearly everyone in the long run. Lincoln said, "You can fool some of the people all of the time." Will the same arguments that fooled people in 1888 work in 2012?

Two for One: Ben Bernanke’s Jackson Hole Speech

Over the years I have read many speeches—and have been privileged to attend a few—given by high officials of the Federal Reserve System. Despite the differing economic circumstances and economic views expressed, what's most remarkable is how similar the speeches are. In the first place, they are always read verbatim from a prepared text. The speakers understand the power their words have to move markets; they don't want to be blamed for a slip of the tongue or an off the cuff remark. Second, the officials realize they are public servants, so even when the speeches touch on technical subjects, they are accessible to any reasonably intelligent person. Third and most interestingly, the speeches are rarely about especially technical subjects; instead they tend to be general overviews, either of economic conditions as a whole or some specific aspect of the economy.

In consequence, the speeches can sound bland and even formulaic, leading veteran commentators to gloss over most of the content, in favor of focusing on one or two sentences or even words that seem to be new or, better yet, controversial. This is natural, but it's a mistake. These speeches are very well thought out for their overall effect. Those given in especially important venues, like the one Fed Chairman Ben Bernanke gave at a conference of top economists at Jackson Hole, Wyoming, last week, are worth a more comprehensive review. This speech was divided into two parts, "Near-Term Prospects for the Economy and Policy" and "Economic Policy and Longer-Term Growth in the United States." Economic commentary has been almost entirely taken up with the second part, though the first part is both more interesting and more revealing about our current economic problems.

In this initial part of his speech, Bernanke admits that the Fed, along with the rest of the country, has been dissatisfied with the economic recovery. In fact, the Fed, despite its hundreds of economists, was taken by surprise by the most recent data. "We have learned that the recession was even deeper and the recovery even weaker than we had thought." Not only is economic output still less than it was before the recession, but growth rates remain "insufficient to achieve sustained reductions in unemployment, which has recently been fluctuating a bit above nine percent."

Next, he explains the virtuous cycle of the typical recovery: Pent-up demand leads to increased output, which leads to more hiring, which creates more disposable income and greater willingness to borrow, which leads to more demand, and on and on. The cycle has not developed in this recovery because of "both a very deep slump in the housing market and a historic financial crisis."

The two are intimately tied together. Demand for home ownership and almost constantly increasing home values have been the main drivers of recovery from every previous recession since the Great Depression. The demand was fueled by mortgage credit, which consistently became easier to obtain. Required down payments dropped from 20% to 10% to 3% and finally to nothing at all. Creditworthiness was measured on a similarly downward sloping trajectory. The psychology that ruled for several decades was that home values always went up. If a borrower couldn't pay the mortgage, the property could be sold quickly and the lender usually got out whole. But now the psychology has completely turned around. Housing markets in virtually every part of the country are shackled by "tight credit conditions for builders and potential homebuyers, and ongoing concerns by both borrowers and lenders about continued house price declines."

We should stop a moment and consider the words "tight credit conditions." Since 2007, the Federal Reserve has been trying to ease credit conditions. They have set the target rate for overnight borrowing between banks at 0-0.25%. They have poured trillions of dollars into the economy by buying securities, all in an effort to get consumers and businesses to save less while borrowing and spending more. It hasn't worked for a very simple reason. The cost of credit is cheap, alright; mortgage rates are at all-time lows. But credit itself is far from easy. The financial crisis led to new and burdensome regulations that make getting a mortgage extremely difficult. Mortgage bankers are not even allowed to speak to appraisers—they have to go through a middleman—and the required documentation continues to increase. It's all done in the name of protecting the consumer, but the result is that record numbers of contracts to buy houses are falling through. Both new and existing home sales remain stuck at historically low levels.

Chairman Bernanke has said many times that the Fed has "a range of tools that could be used to provide additional monetary stimulus." That may be so, but the tools used so far, which are the standard, long-established methods that always worked in the past, have been ineffective. Why should we expect some secret weapon to do the trick now? The fact is that Chairman Bernanke does not expect to unveil any such weapon. In the second part of his speech, he points to the real hope for improvement.

As I mentioned earlier, this second part of the speech has been more thoroughly analyzed. In it, Bernanke tells Congress very clearly that the ball is in their court. "Without significant policy changes, the finances of the federal government will inevitably spiral out of control." That's laying it on the line. Bernanke becomes more circumspect, however, when he explains what needs to happen and how it needs to be done. He says, "Although the issue of fiscal sustainability must urgently be addressed, fiscal policymakers should not, as a consequence, disregard the fragility of the current economic recovery." The repetition of the word "fiscal" is important. Bernanke is emphasizing the distinction between the Fed, which makes monetary policy, and Congress, which makes fiscal policy. Second, though he does not say it in so many words, he is specifically urging the Republican majority in the House not to concentrate solely on cutting expenditures. "Fiscal policymakers can also promote stronger economic performance through the design of tax policies and spending programs." Fiscal as well as monetary stimulus is necessary to propel the recovery forward. Rigid austerity programs, like the policies instituted by Prime Minister David Cameron in Great Britain, are not the answer.

Bernanke's last point is that "the country would be well served by a better process for making fiscal decisions." Like the President, Bernanke is calling on our elected representatives to act like grown-ups. But I think he is saying something more substantive. Bernanke must be comparing the Fed's well-organized, civil, and effective decision-making process with the pitiful spectacle that Congress made of itself this summer. What a mess monetary policy would be in if it were conducted like fiscal policy! Come on Congress, look at how the Fed does it and try to be like them. The Governors of the Fed have widely differing opinions and political backgrounds, just like you. But they make rational and timely decisions. Why can't you?

 

Empire Builder

James J. Hill was a poor boy, born in Canada in 1838 and blind in one eye. Yet, he became one of the great American railroad tycoons of the 19^th century. His signal accomplishment was building the Great Northern Railroad from his home base in St Paul to Seattle, 1700 miles away. Hill earned the nickname, Empire Builder, from this feat. In his later years, Hill became a philanthropist, donating to many religious, educational, and charitable causes, mostly in Minnesota. One of his sons, Louis W. Hill, inherited not only business acumen, but also the desire to contribute to his community. Gifts and bequests from the younger Hill provided the endowment for a charitable foundation that ultimately became the Northwest Area Foundation (NWAF).

The Foundation, which ranks in the top 1% of all US foundations by assets, operates in the eight states through which the Great Northern ran. Its goal is "to reduce poverty and achieve sustainable prosperity." This January, NWAF published a document called "Gaining Perspective: Lessons Learned from One Foundation's Exploratory Decade." It's a courageous, voluntary disclosure of a strategy that failed. In 1996, under the leadership of a new president and CEO named Karl Stauber, NWAF's board developed and announced a new goal worthy of an empire builder: "In 10 years, at least 200 communities with whom the Foundation had partnered would be demonstrably better off." It turned away from its traditional practice of providing short-term, focused grants to non-profit organizations. Instead, NWAF would become "an equal partner" with communities in comprehensive, long-term plans to alleviate poverty. NWAF committed $200 million to achieve its goal. "Gaining Perspective" tells the story of why the goal was not met.

Three ideas in the story stand out. The first is why NWAF decided to make such a radical shift at all. The reasoning of Stauber and the board was faultless: "The activist era of federal domestic policy effectively [had] ended." From Franklin Roosevelt's New Deal to Lyndon Johnson's War on Poverty, the federal government had tried to be, in the words of the old song, "the poor man's friend." By the late 1990s, the old liberalism was near the end of its run. Government programs for those least able to fend for themselves were continually being scaled back and are still at the top of the list for spending cuts. NWAF's insight was that "traditional philanthropy required an activist federal government with broad public support—neither of which exists any longer." NWAF's leap was in thinking it could fill the gap. It called its new vision a "Big, Hairy Audacious Goal," a phrase that evokes 1960's idealism and counter-culturalism. But the world had moved on; a bold vision in a good cause was not enough. NWAF became too focused on the end and lost sight of the means. As a board member who initially supported the strategy later commented ruefully, "My uncertainty was the methodology, not the goal."

The second prominent idea is the meaning of community. The most humbling lesson NWAF learned was what a slippery concept community can be. "A fundamental flaw in the Foundation's theory of change…was that the Foundation could define a given community." Despite the best of intentions, an outside agency cannot create or mold a community. Instead, the agency must bend to the community's sense of its own identity.

One of NWAF's exploratory projects involved groups of poor Latino and Indian farmworkers in Washington's Yakima Valley. When NWAF decided not to fund the groups' strategic plan, group members sued for breach of contract. They claimed NWAF led them to believe that it had obligated itself to provide long-term funding. NWAF won the suit, but only on the technicality that the plaintiffs lacked the legal standing to sue a charitable trust. NWAF's problem in Yakima was that it defined community based on common economic interest among the Valley's Hispanic, Native American, and white residents. In fact, as a board member explained to the authors of "Gaining Perspective," NWAF "eventually learned that the three ethnic groups had a history of disconnection from (and distrust of) one another that could not possibly be overcome by staff or consultants coming into the valley from outside."

The Yakima experience wasn't the worst blow to NWAF's reputation and self-esteem. Far more serious were NWAF's difficulties with what it conceived of as an Urban Indian Coalition in Seattle, Portland, Billings (Montana) and Rapid City (South Dakota). The "coalition" apparently existed more in the minds of NWAF staff than among Native American leaders and tribal groups in those cities. According to Karl Stauber, when the project began in 2003, "NWAF anticipated that it would ultimately enter into a collective long-term relationship with these urban communities and learn from the shared experience." He assumed that a shared sense of community existed among Native American across the four cities. The local groups understood something quite different. They thought that $20 million of separate program funding would be made available to help Native Americans in each city.

NWAF's attempt to impose community was compounded by miscommunication over such fundamental issues as the differences between the Foundation's and the Native American groups' definition of poverty. According to Nichole Maher, Executive Director of the Native American Youth and Family Center in Portland, "Most Native Americans do not define poverty in dollars and cents. Poverty is measured by one's ability to exist. To practice your culture. To speak your language. To get a fair and quality education. To be sufficiently housed. To not have to choose between medicine and food."

The argument was encapsulated in two articles, one by Stauber and the other by Maher, for the journal, Responsive Philanthropy, in 2006. After two years of work and an investment of $650,000, NWAF had decided not to fund the Urban Indian project. Needless to say, the Native American groups were not pleased. Maher, as the underdog, stated the Native American position with eloquence and passion: "When examining the ethics of the intervener, it is important to examine the history and collective experience of any cultural group with whom they may work. For American Indians, this history is steeped in paternalism. There is a very real legacy of historical trauma—and repercussions based on interveners' actions—in the experience of American Indians. Some of the more abhorrent examples include allotment of reservation lands, federal relocation policy, the boarding school system, and tribal termination—all of which constitute an important backdrop for any discussion of our experience." Stauber didn't have a chance. His article in response appeared pedantic, and yes, paternalistic.

Soon afterwards, Stauber left NWAF, and the board revamped its strategy, essentially returning to the earlier model as a maker of grants to non-profits, but with what it hopes is a difference. That difference is the third prominent idea. NWAF intends to "be clear about strategy before you implement." It affirms that "Understanding where you are going, and why, is critical to ensuring that all feet are marching in the right direction." In practice, the Foundation intends to focus more on what it calls the "downside of risk." NWAF will continue to seek innovative ways to alleviate poverty, but it will focus as much on the methodology, as the goal. As the new CEO, Kevin Walker, noted in the introduction to "Gaining Perspective," experimentation always entails the risk of failure, but NWAF is now committed to analyzing its risks up front. That awareness of risk was lacking in the past. Failure, writes Walker, "comes with the territory, and it comes at a cost. I believe we found ourselves unprepared for that reality from 1998 to 2008."

Walker's point is that there's an essential difference between failing with your eyes closed and failing with them open. The difference is the management of risk, both the upside and the downside. Risk management is a discipline I believe in deeply. It involves the identification of risk, the measurement of risk, the mitigation of risk, and the communication of risk to stakeholders. It does not mean that Risk, with a capital "R," can be eliminated; sometimes it doesn't even mean that mitigation can accomplish very much. And it's unfortunately true that failure hurts, whether you are prepared for it or not. It's a mistake, though, to imagine that risk management is an excuse for inaction; just the opposite. The lesson that NWAF learned is that managing "the downside of risk" is exactly what will strengthen the Foundation to move forward to new challenges.

To summarize, "Gaining Perspective" presents a fascinating insight into how a large charitable foundation tried, and failed, to build a poverty-fighting empire. Recognizing the retreat of government from the battle, it attempted to substitute a new brand of philanthropy. Its reach exceeded its grasp, but it learned in the process that community, in all its forms, cannot be imposed from above. The real poverty-fighters are those local organizations, embedded in their communities, that achieve small successes one by one, rather than a "Big, Hairy Audacious Goal." But the last insight is the most important. Don't give up. Learn from your mistakes and try again. So, let's applaud the Northwest Area Foundation for being willing to share its painful experience. That's an act of real bravery worthy of an Empire Builder.