The Remarks below do not necessarily reflect the philosophy or moral values of Dr. Gobar, but have been set forth in an exaggerated form to raise the point of over-regulation and the free market system and our need to work to reduce regulations and stimulate the revitalization of our economy.
By Dr. Alfred J. Gobar
Alfred Gobar Associates
This is the talk I gave to Lambda Alpha a little over 21 years ago. Because our speakers are usually dull, I tried to present a humorous discussion to make people laugh. To my surprise some of the audience took notes throughout, someone recorded the talk, transcribed it, and allowed me to edit for accuracy – which I did. It’s scary how topical this charade turned out to be some 21 years later. The question and answer was not part of the humorous presentation but followed immediately after.
I define some of our most pressing economic/political problems as being related to education, law enforcement, budget deficits, and health care. These problems are manifest in what many perceive as overly high taxes, over concentration of power in the hands of government at too high a level, and an unfavorable regulatory environment. The most effective economic tools to address these issues would mobilize the market system and the initiative of individual consumers and businessmen to create more constructive output and less “heat” with less input. To that end I will outline several hypothetical policies that I think deserve consideration even if expressed in a light-hearted and humorous form, some of which deal with local economic policy and others of which deal with policy formation at the national level. A brief tongue-in-cheek discussion of some of the more salient of these is as follows:
Deterioration of the schools has led to consequent enthusiasm for a vouchersystem to create competition between private and public schools, therefore stimulating public schools to improve. A voucher system, however, may not be easily achieved because of the entrenched strength of teacher unions and other advocates of the monopolistic public education industry. A local option policy that could address this issue as well as the law enforcement issue is as follows:
- Decriminalize the sale of narcotics-especially marijuana and cocaine – and make this a regulated industry within the free market system.
- Allow local agencies to establish a tax rate on dope sales that occur within their jurisdictions and commit tax revenues generated from this industry to the support of local education with no reduction in subventions from state agencies to local schools as a result; i.e., create public sector competition.
This policy would have several benefits, some of which are as follows:
- It would free law enforcement agencies from a good deal of their commitment to the enforcement of the war on drugs and permit them to concentrate on important factors such as seat belt law enforcement, motorcycle helmet laws, and parking violations.
- It would reduce state expenditures to maintain prisons – about one third of incarcerated persons in California are there for dope-related reasons.
- It would allow local communities to compete with one another in terms of the quality of schools subject to their willingness to devise tax policies that are optimal in terms of generating maximum revenue – taxes high enough to generate revenue but not so high as to discourage dope sales within the community. In essence, the communities would have to compete with one another in terms of tax structure and eventually in terms of the quality of their schools, the improvement of which would be derivative of the availability of additional funds from the local option dope tax.
- As was the case before the Serrano decision, the result would be increase in home sales and, therefore, stepped-up property tax values for housing in the communities that prospered under this system.
- It would also provide entry-level jobs for young people who are now criminals and would introduce them to the concept of competition on some basis other than brute force.
- It would also contribute to amelioration of one of our national problems – support of the agriculture industry – by encouraging farmers to grow marijuana as a cash crop.
A similar local option alternative with regard to prostitution would be desirable in terms of providing police with more time to devote to real crime – seat belt andmotorcycle helmet enforcement. A similar taxing structure could be implemented producing the following benefits:
- Noncompetitive motels constructed during the boom in hotel/motel construction could be converted to a more profitable use, generating increased property taxes.
- The spread of various and sundry sex-related diseases could be controlled by periodic health inspections by the bordello staff.
- Competition could be established on the basis of quality rather than the size and the strength of pimps – a lesson in market economics for young people who would otherwise be thugs.
- It would provide entry-level jobs for young ladies who might otherwise be reduced to similar efforts to be rewarded by aid to dependent children.
Another statewide recommendation along the same general line would be to establish a “strip” of casinos and related businesses ten miles north of Yermo, stimulating local employment in the High Desert where there is a deficit of jobs, capturing revenues that would otherwise flow to Nevada, enhancing property values in San Bernardino county ;minimizing air pollution through reduced automobile traffic to Las Vegas, providing entry-level jobs for young people who would otherwise be criminals, and just generally kicking the daylights out of Las Vegas’ strong economy.
Another tax policy that would have an effect on the educational field and, therefore, on local level government constraints, would be a surtax for households with children. Regardless of whether a household is on welfare or not, I propose a 2.0 % surtax over the basic income tax (federal and state) for households with one child, an additional 5.0 percent for a second child, and additional 10.0 percent surtax for the third child. These tax rates would be doubled if the children happen to be illegitimate. This would tend to discourage production of children and, therefore, pressure on schools. It would also generate revenues to help compensate for the short-falls in income related to “dead beat dads.” I expect it would also have a beneficial impact on the budget for aid to dependent children. A variation on this theme would be a similar surtax (the rates not yet determined) on divorced people who have not remarried. Disaggregation of households tends to be economically inefficient and create a dependency class.
In order to control demand for college education at the state universities, junior colleges, and the University of California, establish a similar surtax at about a 5.0 % rate over the combined federal and state tax for individuals or members of families in which one or more individuals hold degrees or have been significantly educated by one of the public institutions defined. This tax would have the finite life determined by aggregate collections that will eventually match the cost of the education plus interest on the unrecovered balance until fully paid off. Beneficial results of this policy would include:
- It would reduce pressure of demand on what is essentially now a free service. This will result in a reduction in state budgets for higher education, as well as for levels of funding at the local level for junior colleges.
- It would encourage graduates of public institutions in California to move somewhere else to work and, therefore, graduates of schools elsewhere in the country to move to California, creating a turnover of residential real estate assets and continually stepping up the property tax base without having to set aside the constraints of proposition 13.
- I think this alternative is significantly better than some type of forced public service such as that being recommended by Slick Willie. In fact, I am a little surprised he had the courage to recommend a civilian draft when he took such strenuous steps to avoid the military draft.
There is a good deal of general resentment to the high pay scale and excellent benefits accorded public sector employees. As a result, we recommend several policies that would bear on this issue. Among them are the following:
- Reduce public sector pay scales to a level such that when a public sector job becomes available, no more than ten qualified applicants show up. The long lines of applicants for new fireman positions attest to the likelihood we are over-paying for this type of position.
- Immediately allow private firms to compete directly with the post office and require the post office to not only be self funding in terms of revenues but also to pay a shadow property tax in order to create a level playing field. This may result in increasing postal rates which would in turn induce more effective use of electronic mail, maximizing the use of our electronic infrastructure and reducing the use of our physical infrastructure to distribute hard copies of various types of materials. The side benefit of this would be an increased number of jobs for high tech people who were made redundant because of the cessation of the cold war.
- I would also impose a surtax, calculated as a percentage of the combined federal and state income taxes on retired employees of public agencies, based on the differential between their retirement income and other cumulative benefits and the average benefits of retired people form the private sector. This would encourage public sector employees to save for the future, which would address another of our persistent economic problems – inadequate savings levels. It would also make much of the general public substantially happier than they are currently. The surtax, by the way, should be higher for those public sector retirees who are double dipping, enjoying wallowing in more than one public trough.
By raising the registration fees on older cars, we would, in essence, destroy their value, making it more feasible for industrial polluters to purchase old cars and destroy them in order to meet pollution targets. It would also take a lot of poor people who have no insurance out of cars and put them in public transportation, which currently is highly subsidized and achieves sub-optimal ridership. This is, in essence, a tax on poverty and irresponsibility, which should reduce poverty and make people more responsible while at the same time reducing pollution inexpensively and aiding our public transportation investment to better perform.
In addition to the benefits to the healthcare industry derivative of dope users living a more normal life and, therefore, being less subject to disease, specific policies that address the high cost of providing medical service to all include the following:
- Establish a two-tier medical industry, the lower tier of which would be staffed by qualified professionals who do not meet California medical bar standards but who could qualify in another country in order to provide medical service to indigents, illegal immigrants, and others who now put substantial pressure on medical resources, demanding the same quality of service as provided more affluent sick people. Dr. Kwan can only do so many open-heart surgeries a day. If Dr. Gonzales were to do a few (albeit not quite as well), more people would get surgery and the cost of this procedure would be reduced. We now have a two-tiered demand system – those with insurance who all want the “best” medical attention and those who are excluded from any medical care.
- Specific facilities would have to be developed either here or in nearby locations in Mexico to accommodate the second-tier medical market.
- Staffing for the second-tier medical market could also be generated by lowering professional standards – i.e., a more liberal level medical bar for people who can’t pass licensing requirements as they now exist. These practitioners would be restricted to the second tier of the consumer population, i.e., make the supply subject to variation in quality to match the variable quality and capacity of demand.
- Two-tiered service levels are not unique. Recently, the airlines went to a two-tier pay scale for pilots and other crucial professionals because of the competitive impact of deregulation. If we deregulate the medical industry to some degree, we might also be able to enjoy wider distribution of a broader quality spectrum of services at a range of costs. Specific diploma mill medical schools could be created to train second-tier professionals, if necessary. My grandfather was a respected physician in North Orange county for over thirty-five years on the basis of what amounted to about two years of medical training at Rush Medical College in Chicago before the turn of the century.
I would immediately, of course, allow for full deductibility of the purchase of productive assets. Machinery purchases, construction of new facilities, etc., for manufacturing firms and all businesses would be written off in the year in which they were incurred, causing a short-term reduction in taxes because of the accelerated depreciation but also contributing significantly to the development of new infrastructure and facilities, as well as stimulating the capital goods industry.
In order to encourage savings and reinvestment, we should eliminate any income tax (federal and state) on interest income or dividend income, as well as income generated as a result of working more than 40 hours a week – a special benefit to entrepreneurs (I am preparing this on a Sunday). As a matter of fact, I am not getting paid very much today, either.
There should be no tax on the proceeds of the sale of a business to its employees in order to foster broader ownership of productive assets (as distinct from homes) and stimulate more intense gut-level awareness of the concepts of entrepreneurship.
Because entitlements, particularly for older people, and for medically impaired people, consume such a large proportion of our gross domestic product, some thought should be given to each of the following potential policies:
- Instead of using extraordinary efforts to sustain the viability of alcoholics, dope addicts, and others, we should establish country club facilities for those people in which they would have custodial medical care and ample availability of the mind-altering substance of their choice. The effect of this would be to accelerate their demise and, therefore, minimize their drain on society, while at the same time giving them a happy guilt-free life – what little of it they have left.
- A Kervorkin bonus concept would pay a bonus to hemlock society euthanasia assistors for assistance provided to those who truly wish to cross over. The bonus would be inversely related to the age of the client. Bonuses paid to euthanasia facilities for clients in their sixties would be substantially larger than bonuses paid with regard to services provided to clients in their eighties in order to reduce the number and extent of old people drawing down entitlement funds. Similar bonuses for abortion (less likely to be an issue because of policies described above) would minimize pressure of demand on elementary school facilities, cost of aid to dependent children, etc.
An income tax surtax based on age would also encourage people to live shorter lives partly out of frustration. A sliding scale income tax that increased every year after age sixty-one would be a useful device to encourage people not to live too long. A variation on the surtax that seems to be productive would be an exemption from the surtax for all people regardless of age who are still employed on a day-to-day basis and, therefore, not putting as much pressure on the entitlement system.
Since dividend and interest income are taxable, older people would be encouraged to save for retirement rather than to rely on entitlements subject to a tax and surtax.
No-fault workman’s comp in which the beneficiaries would be restricted to access to the second-tier medical system might also be beneficial by putting an overt price on medical service, not in terms of its cost, but in terms of its relative quality.
It could be argued that removal of the concept of depreciation as an income tax consideration, as well as exemption of interest and dividend income from taxation, would reduce public sector revenues. These reductions, however, will be accompanied by a reduction in demand for public services inherent in the policies described above, as well as an increase in revenue from other sources – a dope tax, surtaxes on various sectors, and an expanding economy. Many of these policies exhibit the crystalline logic of reducing demand at the same time as we increase resources – a combination that should improve everybody’s standard of living – except for a few public sector retirees and some really old people who don’t work, and perhaps some young ladies who don’t know how to spell contraception.
My initial thought to addressing some of these problems occurred many years ago in conjunction with my plans to develop an alcoholic retirement home in Mexico in which the guests would sign over their entire estate to the foundation in return for which they would receive an unlimited supply of the beverage of their choice daily along with some type of custodial care to minimize the negative impacts of hangovers. The guests would be considerably happier. Their life span would be significantly reduced. The foundation would make a lot of money because of the reduced life span and it would provide jobs for semi-alcoholic doctors during their retirement years.
The concept of allowing employees to purchase businesses and farms with what amounts to tax deductible dollars that do not generate taxable income to the seller establishes a basis for transferring productive assets to the next generation and allows for the possibility of creating 100.0 % inheritance tax; i.e., crucial assets could be transferred essentially tax free and the monetary assets would either be commandeered at death or donated to a private university or college or other charity which would provide an alternative (and more efficient) source of human services. Heirlooms and residential estate assets could probably be excluded from the 100.0 percent estate tax concepts. In addition, the kids could keep us on the payroll so that we could avoid the aged surtax for most of our life.
The litany of benefits derivative from these policies is virtually endless. My energy, however, is not.
Actually, there is a seed of merit in some of these ideas. They represent a reversal of conventional wisdom that the solution of problems is more regulation and more restrictions while, in fact, the solution to most problems comes from mobilizing each individual’s energies for his own best self-interest and the use of energy to create solutions rather than to resist or comply with regulation.
Dr. Gobar Also Responded to Specific Questions About our Economy as Follows:
Q. There has been a lot of talk lately that economic summits are popular, and there has been talk of at least two economic summits in this County. Would you share with the people in this room, seriously, what you think an economic summit could do and, if you could wave a wand and make changes, what recommendations would you make to summit attendees about things that need to be changed in this County? Specifically, in the State and in general.
A. It’s really hard for me to make irresponsible recommendations as I did before, but I think the bulk of the problems we have in Orange County and Southern California’s economy that anybody can do anything about would be resolved if we had a regulatory environment that wasn’t innately hostile to business, and I think that involves certainly workman’s compensation – not only in reality when you’re looking at the workman’s comp for a roofer being 50% of what he’s paid – that raises the cost of a lot of things and makes it difficult to do business, but also in terms of the symbolism (not that I believe that much in symbolism) that basically the employer is a victim and is a giant cow to be milked. I would really lobby hard to get the tort lawyers put where they should be – well maybe not completely where they should, but close – and do something about regulation; and I think that the people that go to a summit tend to be people who are prominent and tend not to want to say things that will come back to haunt them. I no longer have that concern. You need people who are basically not afraid to say, “Screw you, this is basically what is happening.” I don’t think the business community as a whole, because of our paranoia about regulations, is really willing to come out and be blunt with people about what is wrong with the regulatory system. I think the regulations are much more crucial than a lot of stuff that we talk about, and what I am afraid of is we will have summits, we’ll create committees, we’ll get a whole bunch of other people to stand around and hold hands and jump up and down and shout about things and write white papers, and that is just incredibly wasteful. I really think instead of building more agencies and committees and groups, we should work at destroying agencies and committees and groups and regulatory things that interfere. That is probably the most significant benefit I could see from a summit. If someone should get through to Willie Brown and whoever that there are a large number of people in California who do listen to Rush Limbaugh and who buy his book and may not agree with him, but really kind of believe in freedom rather than solving problems by increasing regulation. We have had a pretty severe recession and it’s concurrent with the restructuring of the economy and most of you haven’t heard me talk lately – look up Joseph Schumpeter’s book, Capitalism, Socialism, and Democracy and read it. During thi recession, you know the only category of manufacturing employment that has grown in some parts of Southern California has been apparel manufacturing, which is a third-world industry. If we can have growth in a third-world industry in the environment we have now – what could we have if every business person either had the disdain for regulations or the ability to side-step regulations that are a typical characteristic of apparel manufacturers. By and large, the growth in jobs in apparel acknowledged by the EDD probably represents less than half the true growth in jobs because so many of them are underground. That, I think, is a significant indicator of the underlying strength of Southern California’s economy that is being hampered by regulations here, and a lot of us are not physiologically adaptive to conceiving of ourselves as a mixed third-world and first-world economy in one County. We just can’t deal with the fact that a larger and larger proportion of our economy is potentially a third-world economy. Hong Kong’s got a lot of rich people.
Q. There is some speculation that there is tremendous demand for things like housing and that banks really do have money, but we are not getting those two together. What recommendations would you make in terms of how to get projects financed?
A. I think the banking system (I’ll probably insult a few bankers) . . . I think the S&Ls have managed to shoot themselves in the foot, and they will never come back to doing what they did before. I’m on the Board of a fairly good-size S&L, and we haven’t made a construction loan in three years and, historically, that’s what we did. Now what we do is buy paper discounted from other S&Ls so they can meet their liquidity requirements. We are having record profits, record profit ratios, etc. It’s a wonderful business, but we’re not doing what we were set up to do. The commercial banks are so thoroughly regulated now that a guy in this room and I were trying to borrow some money. In this case his net worth is insignificant. I called a couple of my banks and said if get a Mickey to sign with me and they said, “Well despite that, we might loan you the money,” but the interesting thing to me was the chairman of a bank who I know real well said, “I won’t make you a real estate loan, Al, but if you’ll write me a side letter that guarantees you won’t encumber the real estate, I’ll make you a personal loan, unsecured.” That’s frightening! Which to me means that the commercial banks are not really functioning very well in providing construction financing. My doctoral dissertation dealt with the evolution of Small Business Investment Companies, and my conclusion was that it would never amount to anything. As a matter of fact, it really hasn’t, but I like to look at the way the financial system changes. I think just like when you get a heart blockage, the system will find a way around the banks and the S&Ls and will begin to direct loanable funds to where there is a high yield. I was talking to a group of homebuilders yesterday morning, and they said, basically, from nontraditional sources their construction loans are costing 18%. A prime rate of 6% in the banks meant you should get a construction loan at about 8% for a pretty good borrower; but, in fact, in the real market, they are paying 18%. I think the money will eventually follow the yield. It will eventually find a way around the over-regulated financial sector, and I expect to see a non-regulated surrogate for the banking system to overcome what Mickey and I talk about a lot from one of the newsletters he forces me to read on the “socialization of credit” that has occurred in the S&Ls and the banks. If we socialize credit, it becomes inefficient. By the way, one of our local Orange County Republicans/Clintonites made that suggestion at the economic summit.
For those of you who find that interesting, Kathryn Thompson made that recommendation, and I think it was after talking to the good doctor about his white paper on ways in which we can develop some financing opportunities.
Q. It’s the first time I ever heard of construction interest being 18%. Capital funding is only so efficient. How can you afford to pay that kind of a premium for the cost of funds and create a product of housing or apartments efficiently? Are they just taking fees, no profits, capitalization?
A. Basically, the way they wind up paying that is they split the profit from the project, which would normally be 10% to 15% of the sales price. They split that with the lender one way or another for credit enhancement and it comes out to be that much or more, and lot prices for people who are doing construction loans now have come down, which gives them a little edge over the poor guy next door who is still trying to recover from the lot price he paid in 1989. So, you have a little room in there to do real well. An interesting thing we see – the projects that are being built on newly acquired lots at “today’s market price” are selling very well – Kaufman and Broad had a project in Rancho California next to a project that used to be called Red Hawk, and is now called Dead Hawk, which gives you some idea of what went on down there. Kaufman and Broad opened 55 units of prototypical Moreno Valley housing – 1,300 square feet, $121,000 in today’s market and sold 17 homes a week last summer. The reason is you back into their lot price – you know Kaufman and Broad – they didn’t pay that much – but I think backing in with my economics, they probably paid about $37,000 or $38,000 a lot and Red Hawk in 1989 was selling you tickets to a barbecue to be told about lots available for $80,000. Other developers are still battering it out on $80,000 lots, trying to unload their inventory. K&B can slide in, under price them, make a ton of money, and be gone. That’s the reason developers can afford high construction interest rates. It’s a two-tier situation also.
Q. RTC is offering the balance of the Dead Hawk lots for less.
A. In 1989, we told some of our clients – one of them comes here a lot – he’s a former student of mine – that we thought home prices in 1989 would have to come down by 26% to get the market energized again. In 1989 the market hadn’t really stopped, but you could see that it was beginning to stop and with the relationship between home prices, which was already highin Southern California relative to income – about twice what it should be nationally – would have taken a 26% reduction in price. Since then, for those people who are still working and who are not in the real estate business, household incomes have edged up and lot and home prices have edged down – not as much as people would like to have you believe because they talk about individual instances. In 1990 in Southern California, we had 5,887,000 occupied units (of which 826,000 were in Orange County). If we had the same ratio of jobs to housing occupancy in 1990 as it was nationally, we would have had 800,000 more occupied units because we’d need fewer jobs per unit. If we had the same ratio of housing ownership as was typical of the rest of the country, even at 5,887,000 units, we would have had 600,000 more homeowners than we had. What has kept the for-sale market going for the last three or four years is the kind of a half-life of this reservoir of potential first-time homebuyers who get into the system and then, through the food chain, let somebody sell a house at the far end. So there is demand for housing (not for apartments) right at the moment. We have seen apartment prices in Orange County come down by $20,000 a unit off of $80,000 which, by the way, is almost exactly 25%, which is kind of consistent with our theory. I don’t think they have come down quite enough yet because we are sill having this lack of ability to have transactions. If the buyer who has the cash to qualify for the loan wants a return on his cash (unique in apartment investing), the seller who bought the thing on a zero cash flow with a 7% cap doesn’t want to admit that he made such a giant blunder kind of tilted situation. We have gone from over 100 deals a year in apartments in Orange County down into the mid-20 deals a year because the market is not working smoothly because we are still in denial phases regarding the value that is supportable by rent incomes.
Q. We are being told regularly that businesses are leaving California in droves – particularly manufacturing businesses. Is that true?
A. I think that’s a crock.
Q. How do you really feel about it?
A. That’s an economic term. The Business Round Table did a survey a few years ago. It was a mail survey. They got back a response that indicated a whole bunch of manufacturers fully intended to move out of state, and that this was evidence of the fact that we are shooting ourselves in the foot. As I said earlier, we do have severe regulatory problems, but the regulations are such that if we really force somebody to move, we’ve really got to be onerous. What they do is tend to keep people from coming in or tend to keep people from expanding. I remembered seeing something in one of the ULI letters that come out every month which I thumb through to look for a number I could use in a speech – about a survey of manufacturers all over the United States and how many of them intended to move in a certain time frame and how many of them were going to move out of the city where they are located. The numbers from the national survey were much higher than the numbers from the Business Round Table survey, and the Business Round Table survey was a mail survey, which would automatically create a biased response from people who are upset about something. Because of the concern, I took the County business patterns and sat down and made a list of all the manufacturers (all the employers) in Orange County that employed over 500 people – not by company, but by type of company – the newspapers aren’t going to move, the hotels aren’t going to move, Disneyland’s not going to move, Knottsberry Farm’s not going to move, the hospitals are not going to move, major retailers are not going to move – you get down the list, we identified – I’ve forgotten how many firms – but I think 5% to 10% were likely candidates to move. They were people who made aluminum castings or people in the trucking business who needed larger, low-cost sites, but you are not going to see Kimberly Clark pick up and move because of the huge cost of relocating all of that heavy equipment which is already pretty well written off. They don’t have a high tax environment. I don’t really share the belief that we have droves of people moving out. What we don’t have is people moving in to offset the ones that would ordinarily be moving out. When I worked for Beckman Instruments and the Deutsch Co. and Microdot, we opened plants in other places. At Beckman, we had plants in New Jersey because we were looking for the technology and not much of anything else. This was a time when California was paradise, and Beckman was headquartered here, but we still opened plants out of state because it made good business sense. The Deutsch Co. didn’t because Alex Deutsch couldn’t find a place he could fly to in an hour out of state.
Q. Are you suggesting that the economic strategy of this County ought to be to viciously get rid of regulation and disincentives and then concentrate on attracting new people to come in because of the new environment.
A. I don’t even think you have to do the second one. I think if you could really create a less stringently regulated environment, the information would get out that this is not a hostile political environment and is, in fact, a positive environment and you wouldn’t really have to go the other way. In 1964, which is a little out of date now, I identified 18,000 major openings in the United States with over some number of employees (a reasonable number) and then I identified the number of local state economic development agencies, and it was basically about five agencies per major plant. That said if you were a really efficient or average efficient local development agency, you would make a home run maybe every five years. Some are going to be a lot more efficient than others, but I think there is an incredible amount of wasted effort that goes into the local promotion to cause job growth when the market system will cause it to happen if you get out of the way and let the market system do it.
Q. Just confirming – get rid of the regulatory environment and this other will take care of itself, then we are back to Willie Brown, the EPA. In other words, we come back to the polls again, don’t we?
A. Well, we come back to politics. It’s a basic political message – a basic political feeling that business is the cow that they get the money from and they are the taxing agency. You tax the business, the business has to pass it on to the consumer, the consumer doesn’t get mad because they don’t understand the message, and so the consumer continues to vote for the person who is making the business pay the taxes when, in fact, the business can’t survive without making a profit – so if they can’t pass it along, they go out of business. That basic set of economics has never been taught to people in high school. It should be.
Q. Do you put any credibility in some of the articles where they are talking about the administration making a deal with the Federal Reserve? In other words, when you lower the deficit, the Federal Reserve kicks down interest rates? Do you think that could possibly happen?
A. I don’t have as much confidence as Jim Doti in the ability of the Federal Reserve to control interest rates. They can ration credit, in essence, have created a system now through the banking system where it’s more productive as a banker to get the money from low-cost deposits or to get it from the discount window and put it into T-bills than it is to make loans to you and me. The bank doesn’t have to make the same capital requirements for that kind of investment as it does to make loans. The Fed has not so much driven interest rates down in the real market (credit card interest rates are still 18% or 19%), and we talked about construction loan interest rates. What we have done is take the measuring stick and say “Look-it, we really got rates low on the measuring stick.” The problem is that measuring stick doesn’t measure the credit economy anymore because society has had to go around the formal financial system. I don’t believe that Federal Reserve policies can sustain at the same time low interestrates, low inflation, and an expansionary monetary policy and the kind of fiscal policy we have had. I have been amazed that rates have stayed as low as they have, given the fiscal policy that we have here. We complain about rates being too high. One of the most instructive things to read on a regular basis is The Economist. The only thing you have to read is the last two pages. Every two weeks, they list international interest rates and growth rates and so forth. For a good part of the last year, we have either had the lowest or the second lowest interest rates anywhere in the industrialized world. I am amazed there hasn’t been more hot money going to the Deutsch Bank or someplace like that. I don’t think that we really have the ability to manipulate the system the way we used to. An economist by the name of Keynes, who wrote a book in the 1930s about how you use these techniques to manipulate the economy, referred to a concept called the “monetary illusion” which basically says the consumer is a dumb guy; if you give him more money, but it buys less, he thinks he’s better off. I think in 1968 we lost our innocence in this country, and the monetary illusion no longer works. We know if they give us more money, but if it buys less we’re worse off; and now I don’t think we have the ability to manipulate the credit markets nearly to the degree that an economist like me likes to think we should.
Q. Do you see them loosening the regulations on the banking system in this country? That is one of the things that came out of the Round Table that looked like it was attractive.
A. The question was did I think they were going to loosen the banking regulations. I really think they have to. I have a friend who is president of a bank and has been my banker for 20+ years. He is in his 50s and he says, “Yeah, I have been president of a bank somewhere for 20 to 25 years and never before in my life did I turn over the running of a bank to a 28-year-old regulator who told me what I could do everyday.” When I had to make a swing loan of about two months, I had the money in the bank to do it, but it was locked up in a CD. It was better to borrow the money than to cash a CD for accounting purposes, also. My banker told me that the file on that loan was two inches thick by the time he got through, and he said, “You know, when you first started dealing with me, you could come in and ask for a loan of the same magnitude, I would give it to you without going to a loan committee and all I had to add in there was a note with your signature on it. Now, I have to have a file, we have to have credit reports on you, we have to verify stuff. It’s prohibitive to make loans.” So, this bank is very heavily into passive investments and not making many loans. It’s a small bank for businessmen. That’s the kind of bank that the small business guy deals with, and it’s a pain in the neck for them to make loans. I think the regulators are going to have to get off their backs. Now, we’ve got some kid, who’d probably get a C in my finance class, who is telling us “you’ve got to do this and you’ve got to do that.”
Q. How do you re-regulate rather than de-regulate. In other words, we don’t want to go back to a mid-age, so where do we want to go with bank regulations?
A. What I think will happen is we’ll back off a little on bank regulations for political reasons because Kathryn Thompson and people like her who advise Clinton are saying, “Hey, you’ve got a lot of business people upset at the banking system.” But, I think what will happen is that we’ll set up a new set of institutions that are unregulated and do business that way. I have a friend in Las Vegas who builds homes whom I asked about how he got his construction financing. He said, “I can get a loan funded in less than 24 hours from a non-traditional lender, and if I pay it off on time, they let my wife and kids out. It works. They trust him; he trusts them; there’s not 45 lbs. of paper. When an institution in a capitalist or market driven economy fails to function, I think that the economy goes around it. I gave a speech to a group in Hacienda Heights; and when I was talking about it afterwards to a young Chinese lady, she said that she delivered over 60% of the business within five miles of where we were, didn’t have a business license, didn’t pay any income taxes, and just ignored the regulations because they say, “Well, I didn’t understand this stuff, we didn’t have to do this in Taiwan.” That, I think, happens. You read about Italy. Forty percent of the gross domestic product was underground, and I think a very large proportion of our economy is moving underground. We’ve seen a sharp decrease in taxable sales with this recession, and I think part of that decrease is real; but I also think an awful lot of it is swap meets and unreported sales tax. An example I use is the merchant works all day, sells $100 worth of stuff, pays the rent, labor, and so forth. He winds up with $6 or $8. In his other drawer there’s $8 that has to go to the government, and he stands there and thinks, “You know, I could double my profit by a simple process of not filing a piece of paper, and that’s a lot easier than sweating it out here all day to make $6. I can make $14 by not writing this thing on this piece of paper.” Now, I think there are probably massive amounts of under-reporting, non-reporting, since the penalties are not all that severe. One of my cousins used to be Chief Enforcement Officer for the State Board of Equalization. He’d probably disown me if he heard me say that I really fundamentally believe that the drive of a market system transcends the ability to regulate.
Q. I am going to give you two or three types of land uses. What I would like you to do when I give you the type of use is to give me a real short answer on where you think the future of that land use is in Orange County. General Retail?
A. General retail. Be very, very careful in general retail. There is a big revolution in retailing going on. We are going to need a lot less square feet per capita consumer than we used to. Because of subsidies from cities, we are building a lot more than we need to. This is something to be very careful about, and it’s very location sensitive because the most important thing about retail is location because you do have a monopoly, you could have a flourishing neighborhood center here and three miles away, you could have three dying; and yet their death wouldn’t kill this one.
Q. Anything different about auto sales.
A. We are going to have fewer auto dealerships or the cities that have sub-sized auto plazas are not going to realize their expectations because they were predicated on the belief that car dealerships in auto plazas do two to three times the volume that the average car dealership in the county does. When all of the dealerships are in an auto plaza, we are either going to have half as many or a third as many dealerships as we had before, or the average sales volume per dealership is going to regress down to what it was, and the sales tax give-backs that were predicated on sales may not match the front-end value of what was implied. There is going to be a lot of screaming and hollering going on. I think it is going to result in a lot fewer dealerships myself rather than the regression. The reduction in dealerships will make a bunch of old dealerships sites available.
Q. Office Space?
A. Don’t worry about running out. I used the real numbers on this. We were doing some work for the former employer or current employer of an awful lot of people in this room on this topic, and I won’t tell the part that’s proprietary to them. But I had to do some detailed background on our perceptions of Orange County overall. We expect to see (optimistically) by 1997 vacancy rates overall in office space come down from what they are now (depending on who you listen to, it’s 18% or 19%) down to on the order of 13%. So, that is probably a 5% or less reduction in vacancy rate. That really means to get down into single digits, you probably have got another three or four years beyond that. One of the things people tend to forget is that even when it is overbuilt, everybody knows it’s overbuilt and nobody can make any money building it, some office buildings will get built by companies that are expanding and need to have build-to-suits and by doctors who pay no attention to economies anyway.
Q. Industrial Development?
A. I think industrial development is going to be a surprise once we write down the value of R&D space, which is not really industrial space anyway. We are getting that out of the way, we are seeing building prices come down from $85 a square foot to $65 a square foot and less very rapidly. We think that the industrial sector demand, the true demand, is going to pop back a lot quicker than most people believe because two of the three legs of demand for industrial space are very sensitive to recession. Manufacturing employment and contract construction. We don’t expect either of those to come rushing back, but we expect them to come back with recovery. The problem in the office market is not the recession. The problem in the office market is just flat-out overbuilding. The problem in the industrial market is a little bit of both; but because it’s a little bit of both, it comes back a lot quicker. A corollary of that is if you assume we have a 20% vacancy factor in industrial space, which I disagree with although the broker surveys say 20% plus or minus, we think they don’t include in their base the Hughes, Rockwells, etc., because they forget about them. We think the effective vacancy rate is like 10% rather than 20%. No matter what, we think that vacancy rate will spin off a lot quicker in terms of the absolute magnitude than in the office sector. But if you say 20% and you say 20% in the office, the increase in employment in those two categories, which combined represents about 65% of jobs, the increase in employment to fill that space, basically a 25% increase, would create in essence 25% of 75% or 70% or say 80% at 20%, a 15% increase in jobs, which would increase demand for housing in Orange County by 15% because of the close connection between housing and jobs. Before the office guys get well, somebody is going to be making a lot of money in the housing sector just because that’s the nature of the beast.
Q. How about housing?
A. There are two ways to get overbuilt by our terminology. One is to have too many units, and the other is to have them too high priced. The elements that determine purchase or occupancy of housing are you need a place so you can sleep and whatever it is you do, and you need to be able to pay for it. So you have apparent demand and effective demand: Economics 100A. We overbuilt the market in Southern California, particularly in Orange County, in price in 1988, 1989, and 1990. We didn’t, I don’t think, over-build it in units, because if the units had been at the price that was consistent with our incomes, it wouldn’t have taken as many jobs to support occupancy of the units, and we would have occupied (as I mentioned earlier) in Southern California as a whole about 800,000 units more than we really did. This would have meant in 1990 we would have had a negative vacancy rate around 500,000 units. If you take Orange County’s median household income, which is higher than it should be because we have sort of a Will Rogers thing – we send the middle-income people from Orange County to the Inland Empire, raising the average income for both places – if you take that and divide it into our median home price, it is something like a ratio of 5.6:1. If you take the median income nationally and divide it into the median home price nationally, the number is 2.6:1. So, you have almost a double intensity in terms of disparity of price here. People like me who have lived in a house for a long time don’t notice the cost because it’s not an overt cost – but it’s a major problem, and I don’t think there is any way we are going to build significant amounts of new houses below the median price, except for some attached housing, because the lot prices in Orange County didn’t come down the way I thought they would when the bad news about Lusk and Lyon became conventional wisdom.
Q. The final land use is one that this County has a lot of and one of those land uses is going to expand – at least if they have their way. What about commercial entertainment? And I am talking about Disney.
A. It’s such a specialized use. We have a lot of it as a percentage of what there is in the county, but as a percentage of our total land, it is not the critical element. The critical element in terms of the impact of Disney or Knotts or whatever (Disney-like entities) is not the primary impact of that land use itself, but the derivative impact of all the land that is needed to house the people that work there, the hotel, the people who work the hotels, etc. For example, in Orange County, if you develop five acres of manufacturing land successfully and it’s occupied, you create demand for probably 90 acres of other land for urban uses because of the economic multiplier effect of those jobs and then the derivative jobs and the derivative people who create demand for land. For those kinds of economic multiplier land uses, the impact is not the facility itself; the impact is the derived impact that could easily be 20 times the primary impact as manifest in land use. The high density of employment in recreation entities implies a high economic multiplier in terms of land use.