Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:

The first four men (the poorest) would pay nothing.

The fifth would pay $1.

The sixth would pay $3.

The seventh would pay $7.

The eighth would pay $12.

The ninth would pay $18.

The tenth man (the richest) would pay $59.

So, that’s what they decided to do. The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. ‘Since you are all such good customers, he said, ‘I’m going to reduce the cost of your daily beer by $20. Drinks for the ten now cost just $80.

The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men - the paying customers? How could they divide the $20 windfall so that everyone would get his ‘fair share?’

They realized that $20 divided by six is $3.33. But if they subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man’s bill by roughly the same amount, and he proceeded to work out the amounts each should pay.

And so:

The fifth man, like the first four, now paid nothing (100% savings).

The sixth now paid $2 instead of $3 (33%savings).

The seventh now paid $5 instead of $7 (28%savings).

The eighth now paid $9 instead of $12 (25% savings).

The ninth now paid $14 instead of $18 (22% savings).

The tenth now paid $49 instead of $59 (16% savings).

Each of the six was better off than before And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.

‘I only got a dollar out of the $20′, declared the sixth man.

He pointed to the tenth man,’ but he got $10!’

‘Yeah, that’s right’, exclaimed the fifth man. ‘I only saved a dollar, too. It’s unfair that he got ten times more than I!’

‘That’s true!!’ shouted the seventh man. ‘Why should he get $10 back when I got only two? The wealthy get all the breaks!’

‘Wait a minute,’ yelled the first four men in unison. ‘We didn’t get anything at all. The system exploits the poor!’

The nine men surrounded the tenth and beat him up.

The next night the tenth man didn’t show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill!

And that, boys and girls, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.

David R. Kamerschen, Ph.D.
Professor of Economics, University of Georgia

For those who understand, no explanation is needed. For those who do not understand, no explanation is possible.

Well I went flat yesterday near the close expecting a jam higher with the passage of the Paulson Bankers and Traders Bonus Pool Replenishment Act. Like a lot of others, I suspect. What we got was a classic “buy on mystery, sell on history,” as the market basically sold off all afternoon. I got back on the bus basically where I got off yesterday, and then went flat again at the close. We’re very oversold and should get a bounce, but it looks like there’s a lot of retail liquidation going on, causing the mutual funds to sell into any strength.

Rumors are flying of an emergency rate cut. I’m actually surprised that Ben has stayed his hand this long.

We’re still way up in the overvalued zone in terms of P/E, facing a deep and long recession. There’s a lot of downside to go. A good piece by Carl Swenlin, whose excellent Decision Point site I use.

As you can see, current prices are very overvalued, and possibly near the selling opportunity of a lifetime. To those who think this is the time to buy, I must ask, based upon what? Clearly, prices can rise even when stocks are overvalued, but current economic fundamentals makes that outcome a long shot.

There’s a saying in sailing that the most effective bilge pump is a terrified man with a bucket. Hank, you need to bail faster, the water is still rising.

And this has nothing whatsoever to do with finance but is such a spectacular picture that I think it is worth making an exception.

Bloomberg:

I suspect that part of what we’re seeing in the freezing up of lending markets is strategic behavior on the part of big financial players who stand to benefit from the bailout,” said David K. Levine, an economist at Washington University in St. Louis, who studies liquidity constraints and game theory. 

The Rasmussen Poll reports that voters overwhelmingly reject the “Paulson Plan.” Amazingly, there may be intelligent life on the planet after all. This morning, Mr Bernanke confessed that the real goal of the plan was to re-capitalize the banks, which basically means overpaying for the assets so that the banks can show profits. If you want to re-capitalize the banks, why not just - put capital in? Just buy super-preferred convertibles, essentially as was done for AIG? The answer is, of course, that would hurt the shareholders. Ben and Hank’s buddies, in fact. If, as proposed, they pass the re-capitalization through the P&L, then of course it will yield profits. And profits yield - bonuses! And bonuses will yield - campaign contributions! speaking engagements! corporate jet junkets! interns! Voilà! Problem solved! Anyway, after the political theater in Washington is over doubtless it will be passed without substantial change.

Edit: Good piece by Martin Weiss (Weiss Research’s business is rating banks):

1. Disregard data based on the list of troubled banks maintained by the Federal Deposit Insurance Corporation (FDIC). The FDIC’s list currently has 117 institutions with $78 billion in assets. However, based on a broader analysis of recent FDIC call report data, we find that institutions at risk of failure include 1,479 FDIC member banks and 158 thrifts with total assets of $3.6 trillion, or 36 times the assets of banks on the FDIC’s list.

2. Think twice before providing a broad bailout for U.S. debts given the wide diversity of mortgage holders and the great magnitude of the total debts outstanding in the United States. Just-released Federal Reserve Flow of Funds data show that, beyond mortgages, there are another $20.4 trillion in private sector consumer and corporate debts, plus $2.7 trillion in municipal securities outstanding.

3. Recognize that, among banks and thrifts with $5 billion or more in assets, there are 61 banks and 25 thrifts that are heavily exposed to nonperforming mortgages.

I’ve been talking about a $700 billion bailout. That’s wrong. It is an UNLIMITED bailout. The $700 billion is just the maximum that the Treasury can hold at any one time. So Paulson and Bernanke can buy unlimited amounts of paper by simply reselling it (at a loss, of course), so long as they don’t have more than $700 billion in inventory at any one time. Outrageous. Some good questions for Paulson and Bernanke.

Quite apart from anything else, the ignorance of the Fed got us into this trouble. What makes anyone think that their ad-hoc antics are likely to get us out?