Upper-floor hallway opening onto 12 rooms in large shack occupied by cranberry pickers on Forsythe's Bog, Turkeytown, near Pemberton, New Jersey.
Ilargi: Today we start with another tale by Dan W at Ashes Ashes. It fits in remarkably well with the first few articles.
Once upon a time there was an ugly little man who wanted to be rich. This little man told all of the kings and queens that he knew everything there was to know about being rich. He even told the kings and queens, in more words than he needed to because he was a wordy self-important little man, that he could take their straw and spin it into gold. And while this news thrilled the kings and queens, they were understandably a tad skeptical as to the veracity of the ugly little man's grandiose claims.
And the kings and queens, doing what came easily to them, took all of the citizens of the land and threw them into the dungeon---because servitude of the masses was what the kings and queens did best---and the kings and queens demanded that the citizens make good on the little man’s promise---the promise of creating wealth out of thin air---because the ugly little man had explained, though not with as much clarity as I am currently providing to you, that the kings and queens dreams of avarice lay in the exploitation of the citizens. And the kings and queens gave the citizens three days to spin the straw into gold, that is, to make them rich and to fulfill the promises made by the ugly little man.
And the citizens wept, for they knew deep in their hearts that to spin straw into gold was impossible. But on the 1st night of their collective incarceration, the citizens were visited by the very same ugly little man. And the man promised the citizens that if they all filled out these credit card applications and mortgage applications and personal loan applications and automobile financing applications that he just so happened to have with him, that he would make them happy and free. And so on the 1st night all of the citizens filled out the applications.
And on the 2nd night the little man returned, and this time he told all of the citizens to use the laptops that he just happened to have with him and to go online and to max out all of their credit cards and to buy every home that they could find on the realtors’ listings and spend all of their personal loan monies on new HD TVs and on trips to The Bahamas and on new Mustang convertibles and on anything they could possibly buy. And the little man told the citizens not to worry about whether or not they could actually repay these debts because in time these debts would work out because the little man said so using lots of big words and sounding so smart. And the little man reassured all of the citizens by telling them that the economy was sound and strong. And the citizens, being a tad on the simple side, did as they were told, and they spent hundreds of billions of dollars that they did not, in fact, have.
And on the 3rd night the little man returned, and with him were the all the kings and queens, and the citizens were puzzled. And the kings and queens embraced the citizens and thanked the citizens for spinning all of the straw into gold! And the citizens were really perplexed. All of the straw on the floor of the dungeon was still, as far as they could tell, just plain old straw. But the kings and queens seemed happy, and they freed the citizens, and so the citizens shrugged their shoulders and scurried out of the dungeon with their credit card bills and automobile titles and mortgages, and they celebrated their perceived freedom well into the evening, and everything seemed to have come true just as the little man had assured them it would.
But on the 4th night the little man came BACK to the citizens, and he demanded that they repay their debts, and pay off their credit card bills, and pay their balloon payments on their mortgages, or else he would have them all thrown back in the dungeon. And the citizens looked at each other in horrified astonishment. First of all, how in the hell were they going to be able to fulfill the demands of the little man!? The citizens were all in debt up to their eyeballs! And the little man made them a new deal. He told the citizens that he would return on the morrow, and if the citizens could guess his name than he would go to the kings and queens and tell the kings and queens that it was in fact their responsibility---not the citizens’---to make sure that the citizens could live on in relative peace and harmony.
And the little man told the citizens they would have three opportunities to try and guess his name, no more. And if they failed in their task, then they would be sent back to the dungeon to die! And the citizens trusted the little man, partially because they were delusional idiots who refused to acknowledge reality, and partially because the little man sounded like he knew what he was talking about even if at times he was angeringly verbose. But the citizens were also in a bit of a bind, because this name-guessing thing was pretty tough. And try as they might, the citizens could not agree upon which three names to choose. And unlike in the real German fairy tale, no messenger for the citizens overheard the little man dancing around some fire singing his name. That just doesn’t happen anymore. And so the next morning the little man returned, and the citizens made their three guesses, and of course they were wrong, and all of the citizens were thrown back in the dungeon.
And on the 5th day the little man returned to the dungeon---he had some nerve---and he told the citizens that he felt badly for them, and that he had made a mistake, and yet that he could still save them, but only if the citizens believed him and followed his ideas without so much as a hint of opposition. And the citizens listened intently to his words, because they were not the brightest citizens in the world.
And the little man promised the citizens that if they agreed to have their taxes increased so that their tax money could be paid directly to the kings and queens, and if the citizens agreed to giving every cent they earned at their jobs to the kings and queens to repay the interest on their debts, and if the citizens agreed to put all of their money in the banks owned by the kings and queens and not to question the kings and queens as to why the kings and queens seemed to live such lavish lifestyles whilst the citizens lived in squalor, then the little man promised that the lives of the citizens would be spared.
And so the citizens agreed because they were obviously desperate, and again the kings and queens came to them in the dungeon and told all of the citizens how wise they were to listen to the words of the little man and to agree to the conditions set forth by the little man. And the citizens were released from the dungeon, and again they made merry and sang the praises of the little man, even though somewhere deep in their hearts they knew that it was in fact the little man who had thoroughly screwed them. And to this day, if one listens very carefully to C-Span, one actually can hear the song sung by the little man as he celebrates himself in a masturbatory haze of self-admiration and contritionlessness:
"To-day do I bake, to-morrow I brew,
And everyday my life is grand!
I fooled them all with the shit I spew
And my name of course is Robert Rubin!"
And the kings and queens loved and honored the little man, and they sat with him at their table and broke bread with him and together they drank the sacramental wine with him, and he was indeed a happy, ugly little spud of a man. And he forgot all about the citizens whose futures he had trashed, and he counted his millions, and he played tennis, and he lived happily ever after.
Obama's Perilous Compromise with Looters
Looters have taken over America's Treasury. The executives who successfully ransacked their own banks, investment funds and insurance companies have set their eyes on Obama's stimulus. Tragically, the architects of the current economic fiasco have been placed in charge of America's recovery. President Obama has made an enormous mistake. Instead of cracking down on serial looters and complicit regulators, he wants to guarantee the financial sector's obligations, which are several times larger than America's economy. This is a Ponzi scheme far beyond Bernie Madoff's imagination. Simply put: The government is breaking the rules of capitalism to reward the most reckless capitalists. Such is not the "creative destruction" Schumpeter hailed.
Is it unfair to criticize President Obama before he and his experienced team have a chance to enact new laws and regulations? For guidance on this question, let's turn to the father of capitalism, Adam Smith. Here's how Smith concludes Wealth of Nations, Book I:"The proposal of any new law or regulation of commerce which comes from this order [the capitalists], ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it."Consider Obama's Economic Czar, Larry Summers, who comes fresh from heading a highly secretive hedge fund. As Clinton's Secretary of the Treasury, Summers championed the repeal of the Glass-Steagall Act, which led directly to the excessive risk-taking by newly enlarged financial entities deemed too big to fail when they failed. Additionally Summers and Robert Rubin lobbied intensely for legislation signed by Bill Clinton that forbid government oversight of derivatives, the toxic instruments that have poisoned balance sheets around the world. Summers' former deputy Tim Geithner, the new Secretary of the Treasury, has supervised more recent rip-offs. He bears significant responsibility for the Lehman Brothers' catastrophe and for the flawed Fannie Mae, Bear Stearns and AIG bailouts. At Geithner's confirmation hearing, he must be asked repeatedly why the looters were rewarded and why plans giving taxpayers more equity were rejected.
Sherlock Holmes was once famously asked by a Scotland Yard detective: "Is there any other point to which you would wish to draw my attention?" Holmes: "To the curious incident of the dog in the night-time." Detective: "The dog did nothing in the night-time." Holmes: "That was the curious incident." Why haven't America's economists barked timely alarms? Are they blinded by their faith in markets? Perhaps the old saying should be reworked: In America, those who can, loot. Those who can't, teach wealth-friendly philosophies masquerading as hard science. In their mind-set, fraud is the province of Bernie Madoff, not Robert Rubin.
But what could be more criminal than Rubin's former employees, Hank Paulson and Tim Geithner, awarding the sweetest of all bailout deals to Citi, where Rubin sits as a highly-paid senior counselor and director. Throughout his career Rubin has pushed for more complex risk instruments and less government regulation. How stupid does the quintessential Wall Street/Washington wise man think people are when he claims never to have heard of Citi's most toxic assets? And to brag that he's been "very involved" at Citi, but blames the company's excessive risk-taking on a presentation made one day by an outside consultant? After confessing such failures of oversight, an honest man would have resigned his posts.
Yet it's not only Rubin's acolytes who are pushing Obama's recovery plan. Experts from both parties have also endorsed it. The only catch? These are the same experts who were blind-sided by the mortgage security frauds that led to the credit freeze that triggered the de-leveraging that's plunged the world close to a Depression. Does all this sound like a simple-minded diatribe? Perhaps it is. But when analyzing America's financiers, a simple-minded (as opposed to a naïve) approach may be best. For example, Hank Paulson, Ben Bernanke and Tim Geithner thought that the banks they generously recapitalized with the taxpayers' money would begin lending again. Instead the banks used the bailout cash to buy other banks, issue dividends or simply profit on Treasury spreads - i.e., to make what bookies call their juice.
It's altogether possible that Barack Obama's recovery plan will bless sweetheart deals and generate enough public debt to destroy global confidence in our government's bonds. Foreigners, who own about half of all Treasuries, could stop funding America's deficit-driven recovery plan. During Obama's administration, the dollar might lose its reserve-currency premium. Would all Americans then suffer equally? No. Those likely to profit most from Obama's stimulus before we go bust are his political allies, and especially his big donors. That's the nature of the doling-out beast. To minimize corruption, Obama must pro-actively prevent Chicago-style swindles. E.g., who owns the real estate adjacent to the infrastructure the government will build? What specific penalties will be incorporated into Obama's recovery plan to punish politically-connected profiteers? If a spiraling out-of-control stimulus seems as if it's undermining the full faith and credit of the U.S. government, Obama's biggest donors will hedge their personal risk by parking some of their capital abroad. Have they've done so already? A senator should ask prospective nominees this question at their confirmation hearings.
Obama could be a different kind of president. His broad base of financial support ensures he won't lack funds for a reelection run. The dark side of Obama's presidency, however, is likely to come less from ethical failings than from his fondness for compromise. You can't compromise with America's looters. They're too opportunistic. The economics team Obama assembled betrays his respect for elites and a caution that may doom his presidency. A bolder politician would stimulate the economy and simultaneously expose the moral violations at the core of our economic predicament. Leaders who sent the cops home need to be shamed, not promoted. Financiers who misled investors should be prosecuted, not bailed out. Attorney General nominee Eric Holder, the man who pardoned Marc Rich, doesn't seem likely to take up these tasks. On Inauguration Day, President Obama will surely deliver an inspirational address. But the confidence he inspires will be worthless until he calls out and cuts off the thieves.
Barack Obama needs to re-introduce Glass-Stegall to begin to end this crisis
Appearing on BBC Radio 4's Today programme over the festive period, this columnist was labelled "miserable". But, as I explained to John Humphrys, our financial predicament is no laughing matter. What did the great radio inquisitor want me to do? Insist that if the Government keeps borrowing and listeners merrily load-up their credit cards during the post-Christmas sales, then everything will be fine? Well it won't be. The UK - like most Western economies - is in a grave situation. Our money markets are frozen, denying vital liquidity to millions of credit-worthy firms. Unless the inter-bank market reboots, then even hastily revised 2009 Western growth forecasts - down from 2-3pc a year ago to a 1-2pc contraction now - could turn out to be too optimistic.
We face the very real danger of chronic unemployment across the so-called "advanced economies" and widespread social unrest. Yet the Keynesian bail-out solution, accepted as "essential" by practically every mainstream commentator, will do nothing to unfreeze our credit markets. It's even more dangerous than the disease it's supposed to cure. Panicked politicians have now closed their ears to reason and are ripping up the rules. And as the bail-out continues, and the investment banks channel public funds to senior executives, the vested interests that caused this crisis are adding insult to injury. With failure and incompetence thus rewarded, huge damage is being done to the very fabric of Western market-driven commerce. That could spark a damaging populist backlash, recreating the economic dark ages of heavy regulation and state diktat, crushing the entrepreneurial spirit that has long driven human progress.
So there are good reasons, Mr Humphrys, to be miserable - not only about where we are but, even more so, where the policy consensus is taking us. And when asked to give my opinion on the UK's most important radio show, I'd rather be miserable than wrong. Commentators shouldn't only criticise, but also suggest ways out of this mess. So I'll repeat my call for banks everywhere to be legally forced to "fully disclose" and write-down their sub-prime liabilities BEFORE further taxpayer-funded recapitalisation. The Swedes took this hard-headed approach during their early 1990s banking crisis. We've adopted, instead, the head-in-the-sand Japanese variant – creating our very own zombie banks which are technically alive (allowing powerful executives to keep their jobs and save face) but commercially dead and a drain on society, given the weight of their toxic debts. On top of full disclosure, Barack Obama could now make a move which, for all the hype of his inauguration later this month, would prevent a repeat of this credit crunch.
The incoming President is fond of citing America's New Deal of the mid-1930s – given that he wants to repeat the depression-era use of public works. But the most important part of the US policy response to the 1929 Wall Street Crash was the more obscure Glass-Steagall Act of 1933. Named after the two Democrat senators who sponsored it, Glass-Steagall prevented commercial banks – which take deposits from ordinary households and firms – from engaging in the high-risk speculative activities undertaken by investment banks. Or at least it did – until 1999 when, after millions of dollars of political donations from investment banks, Glass-Steagall was repealed by then President Bill Clinton – at the urging of Robert Rubin, his Wall-Street trained Treasury Secretary.
That unleashed the forces which have landed us where we are now. Investment banks took over commercial banks - using their retail deposit base, on which there was an implicit government guarantee, for risky speculative trading, not least in opaque derivatives. The promised "Chinese Walls" were fiction, as swash-buckling investment bank culture pervaded "plain vanilla" institutions supposed to be servicing regular activity. The situation was made more dangerous when, on top of this repeal, the US financial authorities allowed the investment banks to raise their debt-to-capital ratios from 12:1 to 30:1 or even higher. This lit the fuse on the commission-driven securitization and debt-fuelled purchase of tens of millions of dodgy mortgage-backed securities – which inflated the US housing market as politicians wanted, but spread "sub-prime" sickness around the world.
So will Obama re-introduce Glass Steagall? Will he heck. On the contrary, the man upon whom the hopes of the West now rest is bringing back into government many of Rubin's acolytes who drove the repeal in the first place. Meanwhile, some of America's most powerful investment banks have been allowed to convert themselves back into commercial banks – attempting not only to qualify for more bail-out finance, but to close down any debate on the need for a new Glass-Steagall. Has Obama got the audacity to end the party and order the Wall Street denizens to behave? Will he reintroduce the necessary firewalls upon which the stability of Western banking depends? My instincts tell me he won't. But perhaps I'm just being miserable.
Obama Considers Major Expansion in Jobless Aid
President-elect Barack Obama and Congressional Democrats are considering major expansions of government-assisted health care insurance and unemployment compensation as they begin intensive work this week on a two-year economic recovery package. One proposal, as described by Democratic advisers, would extend unemployment compensation to part-time workers, an idea that Congressional Republicans have blocked in the past. Other policy changes would subsidize employers’ expenses for temporarily continuing health insurance coverage to laid-off and retired workers and their dependents, as mandated under a 22-year-old federal law known as Cobra, and allow workers who lose jobs that did not come with insurance benefits to be eligible, for the first time, to apply for Medicaid coverage.
The proposals indicate the sorts of potentially long-range changes that Mr. Obama intends to push in his promised American Recovery and Reinvestment Plan, as he named it in his weekly Saturday address on the radio and YouTube. They will be combined with one-time measures that are more typical of federal stimulus packages to jump-start a weak economy, like spending for roads and other job-creating public works projects. As the economy worsened in the weeks after Mr. Obama’s election, advisers and Congressional leaders suggested that a stimulus plan would be ready by the new year for House votes this week. But the House is not expected to vote until next week at the earliest, which will most likely push final action into February, Democratic aides said.
The aides said delays were probably inevitable given the holiday interruptions, the big ambitions of the undertaking and internal tensions over the plan’s components and their costs. Obama advisers have said the package will carry a total cost of at least $775 billion. Still, Democrats are wary of slowing down the economic stimulus by provoking the opposition of Republicans, who have warned in recent days that the package must be neither excessive nor rushed. They are also fielding concerns from fiscally conservative Democrats. In his address on Saturday, Mr. Obama, just off a two-week vacation, also announced that, as expected, he would begin meeting in Washington on Monday with Congressional leaders of both parties in a bid for bipartisan cooperation. “Economists from across the political spectrum agree that if we don’t act swiftly and boldly,” Mr. Obama said, “we could see a much deeper economic downturn that could lead to double digit unemployment and the American dream slipping further and further out of reach.”
Mr. Obama has pledged to “create or save” three million jobs over the next two years. In his address, he omitted the word “save,” suggesting he would create three million jobs, a goal that many economists consider unattainable under current conditions. His plan, he said in his address, would “put people back to work today and reduce our dependence on foreign oil tomorrow” through spending and tax incentives to double production of renewable energy; make government buildings more energy efficient; build and renovate roads, bridges and schools; and modernize health care technology. A main factor slowing down the Obama team’s drafting, it is now apparent, has been the difficulty of reconciling his sometimes conflicting directives.
The president-elect called for including in the plan only proposals that would quickly stimulate the economy. Typically that means one-time spending that gets money into consumers’ hands quickly to spark demand for goods and services. Both Mr. Obama and Congressional leaders are intent on keeping the price tag below the politically charged figure of $1 trillion. In the emerging Obama plan, such items will include $140 billion to $200 billion in relief to states to offset their budget-busting costs for Medicaid and education; extension of unemployment compensation for former full-time workers, which runs out in March; and billions of dollars for construction projects that Mr. Obama has called “shovel ready.” But Mr. Obama has also said his recovery plan must make down-payments on his campaign promises for permanent changes that will reshape the economy, especially for the good of low-wage and middle-class workers. Such changes could carry permanent costs for new energy, education, health care and tax policies.
For example, Mr. Obama previously indicated that he would seek money to develop a national energy grid to harness and distribute power from wind, water and other local alternative energy sources. Additional money to subsidize local governments’ education costs in the downturn could become a fixture, increasing the once-small federal role beyond its expansion under President Bush. Besides money for school construction and renovations, Congressional aides said they expected an increase in financing to educate students with disabilities and special needs. Officials also are exploring potential increases for Head Start childhood education programs and Pell Grant scholarships for college students. Rather than propose a one-time tax rebate for all but the most affluent Americans, Mr. Obama is likely to propose what he called during his campaign a “Making Work Pay” tax credit of $500 for eligible individuals and $1,000 for couples. Those who earn too little to pay federal income taxes would receive the credit in the form of a check, intended to offset the payroll taxes they pay for Social Security and Medicare.
Disputes also are percolating in the Obama camp and between Congressional committees over what constitutes spending earmarks for special projects, which Mr. Obama has sworn to oppose. The disputes are similar to, if less testy than, past tiffs between Mr. Bush and Congress. Democratic leaders in Congress say they are serious about helping Mr. Obama keep the emerging legislation free of the pork-barrel projects that could invite criticism from Republicans and foster public skepticism. “Every dollar will have to be justified as to whether it is targeted to our economy,” Speaker Nancy Pelosi, Democrat of California, said last week. “This is not a bill that will be an excuse to put things in that otherwise might not be justified.”
To get around Mr. Obama’s potential objections, some lawmakers are including projects that Congress previously authorized but failed to pass in appropriations. In a 41-page memorandum, the House Transportation and Infrastructure Committee has outlined $85 billion in previously authorized infrastructure spending over two years, including $30.2 billion for highway projects and $12 billion for local public transportation. The House approved money for many of the projects in September as part of a $61 billion stimulus package that was blocked by Republicans in the Senate. Still, officials said the size of the proposed two-year stimulus, equivalent to nearly a year of federal discretionary spending, had tested imaginations both in Congress and the Obama camp. Aides and advisers are struggling to identify enough projects that would meet Mr. Obama’s criteria that they be truly stimulative, create jobs and not be open to being branded as pork.
“This has really forced people to think outside the box,” one aide on the House Appropriations Committee said, “because this is more money than anybody expected to be spending.” Tensions on the opposite side involve demands from fiscally conservative Blue Dog Democrats in the House and from some Senate Democrats — notably the Senate Budget Committee chairman, Kent Conrad of North Dakota — for provisions imposing budgetary controls on future spending and tax cuts for the long-term health of the economy. According to both sides, Obama officials have assured the fiscal conservatives that Mr. Obama would propose long-term controls in his first five-year budget, which is due by late February. But the Blue Dogs see the recovery package as their best chance to get budget reforms enacted quickly.
While the fiscally conservative Democrats support deficit spending to jump-start the economy, “these are debts that will have to be paid,” said Representative Jim Cooper, Democrat of Tennessee. “We have to combine short-term stimulus with a focus on the long term,” he continued. Among their ideas are a bipartisan commission to propose limits on future benefits for Social Security, Medicare and Medicaid, the entitlement programs whose projected future costs would squeeze out all other spending; a nonpartisan entity to designate infrastructure projects, like roads and public buildings, based on merit; and federal pay-as-you-go rules that require offsetting savings for spending increases and new tax cuts.
Asia needs to fully wake up to the scale of the West's economic crisis
Asia is not going to rescue the world economy. The news from Japan, China, and the Pacific tigers has moved from awful to calamitous since the global industrial system snapped in October. A raw reality is being laid bare. The mercantilist export model of the East is proving dangerously geared to the debt-driven excesses of the West. As we go down, they go down too. Some are going down even harder. Japan's industrial output contracted by 16.2pc in November, year-on-year. "For an economy which lives from the prowess of its industrial exports, this is simply earthquake," said Edward Hugh from Japan Economy Watch.
Japanese exports fell 26.7pc. Real wages fell by 3.1pc, the seventh monthly fall. Taken together, the figures are worse than anything during Japan's "Lost Decade". They have a ring of 1931. The fall-out in Japan has already shattered the authority of premier Taro Aso. His approval rating has dropped to 21pc. The cabinet is in revolt. The world's second biggest economy no longer has a functioning government. Credit Suisse warns that Japan could slide into deflation of minus 2pc by the autumn. Since interest rates are already near zero, which means that real rates will rise as the slump deepens – the surest path to a liquidity trap. Kyohei Morita from Barclays Capital estimates that Japan's GDP shrank at an annual rate of 12.2pc in the fourth quarter. "It's shocking," he says. Singapore has already reported. Fourth-quarter GDP contracted at an 12.5pc annual rate.
Taiwan's exports fell 28pc in November. Shipments to China dropped 45pc. Korea's exports dropped 18pc in November and 17pc in December. "We are looking right in the face of an unprecedented regional depression," said Frank Veneroso, the investment guru. "If there is one part of the global disaster that is not reflected in today's massacred markets it is this Asian debacle. The source of the collapse appears to be above all a contraction in China." One has to careful with Chinese figures. When I covered Latin America in the 1980s, veteran analysts watched electricity use to gauge economic growth since they could not trust official data. It is striking that China's power output fell 7pc in November. Asia has clearly failed to use the fat years to break its dependency on the West. It has stuck doggedly to its export strategy – by holding down currencies, or by subtle policy bias against consumption.
In China's case it has let the wage share of GDP drop from 52pc to 40pc since 1999, according to the World Bank. The defenders of this dead-end strategy are now coming up with astonishing proposals to put off the day of reckoning. Akio Mikuni, head of Japan's credit agency Mikuni, has called for a "Marshall Plan" to bail out America by cancelling $980bn of US Treasury bonds held by the Japanese state. This debt jubilee does have the merit of creative thinking, but it is entirely designed to keep the old game going. "US households won't have access to credit they have enjoyed in the past. Their demand for all products, including imports, will suffer unless something is done," he said. Let me be clear. I make no moral judgment on the "neo-Confucian" model, nor – heaven forbid – do I defend the debt depravity of the West. A stale debate simmers over whether the Great Bubble was caused by Anglo-Saxon and Club Med hedonism, or by an Asian "Savings Glut" spilling into global bond markets and fuelling asset booms, as Washington claims. It was obviously a mix.
Two cultural systems interacted through globalisation, locking each other into a funeral dance. The point is that this experiment has now blown up. Whether or not we slam straight into a global depression depends on how we – East, West, all of us – handle this. The top sources of net global demand as measured by current account deficits over the last 12 months have been the US ($697bn), Spain ($166bn), Italy ($71bn), France ($57bn) Australia ($57bn), Greece (53bn), Turkey ($47bn), and Britain ($46bn). Most are tightening their belts drastically, and in the case of Britain the shift has been so swift that the arch-sinner may soon be in surplus. If they are draining world demand, then world demand is going to collapse unless others step into the breach.
The surplus states – China ($378bn), Germany ($266bn) Japan ($176bn) – have not yet done so, which is why the global economy went off a cliff in October, November, and December. Beijing is planning a $600bn fiscal blitz. But how much of it is an unfunded wish-list sent to local party bosses? It will not kick in until the middle of the year, an eternity away. For now, China is dabbling with protectionism to gain time – a risky move for the top surplus country. It has let the yuan fall to the bottom of its band. Vietnam has devalued. Thailand and Taiwan are buying dollars. Watching uneasily, the Asian Development Bank has warned against moves to "depreciate domestic currencies". Anger is mounting in the West. Alstom chief Philippe Mellier has called for a boycott of Chinese trains.
"The Chinese market is gradually shutting down to let the Chinese companies prosper. There's no reciprocity any more," he told the Financial Times. Optimists say the collapse in oil prices will give Asia a shot in the arm. Governments are still flush, with ample scope for fiscal rescues. Asia's central banks are sitting on $4.1 trillion of reserves. They have the means, perhaps, but do they have the will to act in time? Or do Beijing, Tokyo, Taipei, Kuala Lumpur, – and indeed Berlin – still cling to their assumption that others will spend for them?
Fed has abandoned monetary policy, critic says
The Federal Reserve has embarked on a campaign of unsupervised industrial policy to end the country's financial crisis, a move that could undermine its independence, a former top U.S. official said on Saturday. John Taylor, who was under secretary of treasury for international affairs from 2001 to 2005, said the explosive growth of the Fed's balance sheet since September was "unbelievable." "This doesn't really seem like quantitative easing in the sense of finding a growth rate in the money supply," he told a panel discussion during the annual meeting of the American Economics Association.
"What you are looking at now is really being determined by other considerations. How much should we buy of mortgage-backed securities? How much should we loan to foreign central banks? This is really more like an industrial policy," he said. The Fed's balance sheet has more than doubled in size to over $1.2 trillion in recent months as it has tried to shield the U.S. economy from the worst financial crisis since the Great Depression by supporting key credit markets. This has included direct purchases of mortgage-backed bonds by the Fed and support for top-rated non-financial borrowers in the crucial commercial paper market, as well as hundreds of billions of dollars lent to banks on the basis of collateral.
"If you have a situation where the Fed is borrowing to invest in all these sectors it seems to me you have a huge governance issue...that demands a lot of thought," Taylor said. Taylor said the U.S. Congress has a legitimate right to demand a say in who the Fed lends money to. The outcome would be "radical reform" that would risk monetary policy independence, he said. This concern was echoed somewhat by the president of the St Louis Federal Reserve Bank, James Bullard, who also took part in the panel discussion. He said the close collaboration between the Fed and U.S. Treasury in fighting the crisis could have unintended consequences. "We are blurring the institutional arrangements a little," Bullard said. "I am concerned about independence. Fed independence is very important," he told reporters.
Time ripe for Fed inflation target: Bullard
Setting an explicit inflation target would help the U.S. Federal Reserve keep deflation at bay now that interest rates have been cut to almost zero, a top central banker said on Saturday. "Now would be a particularly good time to do that because you have this possibility of expectations drifting off to deflation or a lot of inflation," James Bullard, president of the St Louis Federal Reserve Bank, told a panel discussion during the annual meeting of the American Economics Association. Deflation, a sustained period of widespread falling prices, is considered a threat to the economy because it can cause consumers to delay purchases on expectations that prices will fall further, causing the economy to contract.
Bullard said that the Fed is limited in its ability to flag policy preferences by the very low level of rates and needs to find another tool to communicate with markets. "You can't count on your nominal interest movements to signal to the private sector about how you are reacting to events. So my main concern for the Fed in the medium term...is how to keep inflation expectations anchored. ... We can no longer send signals by moving interest rates," he said. Fed Chairman Ben Bernanke is a long-standing advocate of adopting an explicit inflation target, but he put this goal on hold after failing to convince other policy-makers that it was worth the loss in flexibility.
Bullard said aggressive Fed policy action to restore growth means the U.S. central bank has a real opportunity to introduce the target at a time when communication is extremely tough. The Fed last month cut its overnight funds rate target to a range between zero and 0.25 percent and said it would focus on unconventional tools to end the year-long U.S. recession. Charles Evans, president of the Chicago Fed, told the panel that the action had been aimed at driving the funds rate below zero. "If it were not constrained by zero those (economic) models would want to push it below zero, but that's not possible," Evans told reporters, adding quantitative measures "is a way to mimic below-zero rates and provide support to the economy."
These actions have massively expanded the size of the Fed's balance sheet as it has sought to stimulate U.S. domestic demand by targeting specific sectors of the economy like the housing market, whose collapse last year sparked the recession. Some economists expect U.S. growth to have contracted by 6 percent or more on an annual basis in the final quarter of 2008 and will continue shrinking until the second half of 2009. Evans said the U.S. jobless rate appears on pace to exceed 8 percent in 2009, from the most recent reading of 6.7 percent in November. Private sector economists are even gloomier. This reversal has led to a collapse in commodity prices, dragging down the rate of headline inflation and raising fears the United States could suffer the same fate as Japan's so-called lost decade after the collapse of its property market at the end of the 1980s.
Those years of stagnation were made worse by deflation, which caused domestic economic activity to contract even more. Bullard said such a scenario was not likely in the United States, noting that core U.S. inflation, which excludes food and energy prices, was running around 2 percent compared with a year ago. He said it would take a lot to push that pace into negative territory, but acknowledged the threat must not be ignored. "If deflationary expectations were to become entrenched then I think deflation could become a reality. So it is a serious risk that we should be thinking about," he said.
Chicago Fed Chief Cites Weakness in Regulatory System
The ongoing upheaval in financial markets and the economy has revealed "significant weaknesses" in the U.S. regulatory system that must be tackled on several levels, the president of the Federal Reserve Bank of Chicago said Saturday. In prepared remarks to the annual meetings of the American Economic Association, Charles Evans said the current "patchwork of regulatory authorities failed to curb excessive risk-taking or detect systemic vulnerabilities. "These failures call for a reassessment of the roles of market discipline and our regulatory structures in supporting the efficient functioning of financial markets," Mr. Evans said.
The most obvious issues for regulators to tackle are reckless mortgage lending practices, and the exposure of many firms to off-balance sheet vehicles. Specifically, the central banker saw a need for closer oversight of organizations that could pose a threat to the stability of the financial system. "Questions about changes in the treatment of clearing houses, exchanges, hedge funds, and private equity investors must be studied carefully," he said. Mr. Evans welcomed the establishment of a clearing house for credit derivatives. But the central banker warned that a clearing house -- which would function as an intermediary guaranteeing both sides of trades in this opaque, privately negotiated market -- is not a panacea.
"Centralized clearing does not eliminate performance risk; it simply concentrates it at the clearinghouse," he said. "This means the clearinghouse itself becomes a potential single point of failure. Accordingly, adequate capital, good risk-management and prudential oversight are essential." The Chicago Fed president is a voting member on the central bank's rate-setting committee this year. There's no longer much suspense in rate decisions, since the FOMC last month officially launched its zero-interes
Wall Street: Bracing for bad news
After a strong start to the new year in very light trading, Wall Street gets serious. The weeks ahead will prove the true test, as market pros return from the holidays to digest a barrage of bad economic news, a smattering of corporate profit warnings -- and possibly a new economic stimulus plan. But with many of the negatives factored in already and the market primed for near-term gains after 2008's battering - analysts say the advance could stretch out a few more weeks. "In the short term, I think it's sustainable," said Paul Mendelsohn, chief investment strategist at Windham Financial Services. "Investors are looking to the inauguration, a lot of tax-loss selling is out of the way, which is massive, and the recent advance, although on light volume, has been across the board."
But beyond that, he said it's likely Wall Street will drop back down to the lows of last November, or fall even further, as the focus on the recession resumes. Stocks have rallied over the last week, experiencing the classic Santa Claus rally, as identified by the Stock Trader's Almanac. Almanac research shows the combination of the last five trading days of one year and the first two of the next has yielded an average return of 1.5% for the S&P 500 since 1950. So far, the S&P 500 has gained 7.3%, with Monday the last day of the period.
In a heavy week of economic news, this week's big standout is the government's December unemployment report, due Friday. Employers are expected to have cut 475,000 jobs from their payrolls after cutting 533,000 jobs in the previous month. The unemployment rate, generated by a separate survey, is expected to have risen to 7% from 6.7% in the previous month. "Investors should be prepared for the worst in terms of the labor market," said Matt King, chief investment officer at Bell Investment Advisors. "The unemployment rate could rise to more than 7% this month and may go to 8%, 9%, or 10% in the year ahead."
Despite the scary numbers, King thinks investors have likely already accounted for this amid the deepening recession. Separately, the ADP survey of private sector employment is due two days ahead of the national report and will also be in focus. And on Thursday, the latest weekly reading on initial claims - the number of jobless who are filing for unemployment - is due out before the market opens and it is expected to continue showing steep increases.
Credit squeeze will hit poor nations
Developing countries face the threat of a financial drought in the next 12 months, as rich governments embark on a round of "capital market protectionism", corralling the funds of their battered banks for borrowers back home. The conditions placed on many banks as a result of government bail-outs are forcing them to focus on key domestic customers such as small businesses, leaving overseas borrowers out in the cold, according to analysis by Stephen King, chief economist at HSBC. "If the flow of credit to ring-fenced sectors is to be held at prescribed levels, net lending to the remaining sections of the economy will fall by a greater amount than would otherwise be the case," he said in his forecast for 2009. "The most vulnerable area during this process could well be international lending."
King added that this would "threaten an outbreak of capital market protectionism" - a more subtle, financial version of the protectionist trade policies which were widely seen as exacerbating the Great Depression of the 1930s. Most notoriously, the 1930 Smoot-Hawley Tariff Act in the US slapped punitive import taxes on a wide range of goods, as Washington fought to protect domestic manufacturers. It was followed by tit-for-tat measures from America's international rivals, and a dramatic slump in international trade flows.
Clare Melamed, head of policy at Action Aid, said banks should be encouraged to take a long-term perspective. "There are two things in play: on the one hand, we can see that governments want to encourage banks to lend domestically, and the political imperative there is very strong; but they also want profitability, so if you can make investments overseas that are more profitable, then that's also going to be good in the long run for domestic banks - so it's a trade-off," she said. She added that developing countries could be hampered in their battle against poverty by a lack of funds from overseas investors.
"The opportunity costs for developing countries, in terms of investors being more risk averse, are quite high, because that is where new employment is going to come from." Mansoor Dailami, a senior economist at the World Bank and author of its annual Global Development Finance report, said even without the imposition of protectionist measures, developing countries faced a sharp decline in capital flows. "I think the concern we have right now is that we may see a significant number of corporates and sovereigns coming to the markets to refinance debts, and running into difficulties, even for short-term trade finance," he said.
Investments into developing countries soared to a record $1.1 trillion at the height of the boom in 2007, but next year the World Bank expects them to total just $550-600bn. As this emerging market credit squeeze bites, Dailami said the Washington-based lender would be monitoring a number of countries with urgent financing requirements that could find themselves short of funds. He urged investors not to lose sight of potentially profitable opportunities in emerging markets. "I think from a medium-term perspective, the potential in developing countries is sound. If you look at the size of their populations, if you look at their investment requirements, particularly in infrastructure and social areas, there's a significant need for capital flows, both from banks and from equity finance," he said.
UK’s refinancing timebomb
Corporate Britain is facing a refinancing timebomb this year as more than £50 billion of bank debt expires during the biggest credit crunch in global history. The soaring cost of capital and the paucity of available debt financing will squeeze even blue-chip companies which need to renew or restructure existing loan facilities. According to the ratings agency Standard & Poor’s, a £140 billion debt mountain needs to be refinanced in the UK between now and 2011. Meanwhile, a cumulative total of €1.6 trillion (£1.5 trillion) of debt rated by S&P will mature across Europe between now and then.
David Brooks, head of M&A at Grant Thornton, said: “It is going to be very tough. A lot of the big corporates whose debt does not mature until the end of 2009 are looking to refinance now or at least go to the market in good time. But the lenders who have been told off for being too cavalier are being cautious about who they are going to lend to and how they are going to price it. “It is going to get worse before it gets better. There are still some big refinancings that will cause indigestion in the system.” Gareth Davies at Close Brothers said: “Refinancing risk is significant. There is no new money available and so in most cases the borrower will have no choice but to renegotiate a facility extension with the existing syndicate.
In the past it was the borrower who dictated the terms of a refinancing; now the tables have turned. For many companies, securing access to the capital will be the key issue, rather than how much they pay for it.” A recent report by Goldman Sachs estimated that half of the companies it covers will have to cut capital spending and 60% will need to hold dividends flat to maintain appropriate debt levels. The S&P statistics are unlikely to include £22 billion of commercial-property loans due to mature in 2009.
Consumer cash crisis turns the screw on the high street
A quarter of all British families will have no disposable income in 2009, dealing yet another blow to the beleaguered retail sector. In November, a survey by Nielsen, the market research firm, and trade body the British Retail Consortium (BRC) found that 21 per cent of families had no spare cash left after essential living expenses. However, sector insiders expect this to grow to at least 25 per cent by the spring.
A PricewaterhouseCoopers (PwC) survey last week showed that six in 10 people believe they will have less disposable income in 2009 than they had last year. Those in the lower socio-economic DE classifications were particularly gloomy, with nearly 70 per cent convinced they would have less money to spend on the high street. Stephen Robertson, director-general at the BRC, said: "A fifth of all families had nothing left to spend [after core expenses] and I think that will get worse during 2009." A leading retail figure predicted that the next Nielsen/BRC survey, due in May, will show at least 25 per cent of families lacking the cash needed for minor luxuries.
Andy Garbutt, director of retail at PwC, added: "The increase in unemployment and the falling level of bo-nuses mean it would be no surprise that about a quarter of families would not have disposable income." Food retailers are believed to have been almost as hard-hit as fashion stores over Christmas, according to Mr Robertson, but the supermarkets have come out fighting this month. Asda cut the price of 1,000 products to £1 each on Friday, with chief executive Andy Bond admitting that "2009 is going to be a very difficult year" for its customers. But he added that Asda had enjoyed one of its most successful-ever festive periods.
Morrisons will follow Asda's tactics tomorrow, with selected fresh fruit and vegetables, including six-packs of Golden Delicious apples and 1.5kg of onions, selling for £1. On New Year's Day, Tesco reduced its petrol by 3p per litre, and it is now considering which products it should discount in response to Asda's move. Sainsbury's, widely acclaimed last year for the price strategies led by chief executive Justin King, plans to expand the number of its low-cost "Basics" products to around 630, from 550, by the end of this month. About half the goods in this range are priced at £1 or less. Sainsbury's is also expected to issue strong third-quarter results this week, while fashion chain Next and department store giants Marks & Spencer and Debenhams could show depressed sales figures.
Retailers have suffered a miserable two months, with a number going into administration. The highest-profile casualty has been Woolworths, with around 200 shops due to close yesterday and the last stores expected to be shut on Tuesday, marking the end of a 99-year trading history in the UK. Adams, the children's clothing retailer, appointed PwC as administrator on New Year's Eve, putting more than 3,000 jobs at risk across 271 stores. Experian, the market research firm, has estimated that 1,600 UK retailers could shut in 2009, of which some 230 would be food sellers.
Fifth of British small firms to go bust
Almost one in 20 of the UK’s small firms could fail this year as the recession starts to bite in earnest. Of the 4.7m British small firms, 200,000 could go bust in 2009, according to a forecast from the Forum of Private Businesses. The FPB’s Phil McCabe said this was a worst-case prediction but a realistic one if banks do not increase lending to small firms in the next few months. Such a failure rate would mark a huge increase from previous years. In 2007 some 13,500 firms went under. In the two years of the last recession in 1991-92, 100,000 firms failed. Mass failures of small and medium enterprises would also add to Britain’s mounting job losses because such companies employ 60% of the 22m workforce.
McCabe said there was already evidence of staff cuts. “While many of our members are well placed to ride out the recession, these are testing times and we do get a lot of calls from firms that are struggling,” he said. The failure rate of small firms will depend to a great extent on the willingness of the banks to resume lending to viable firms, said McCabe. “We are not satisfied with the level of lending or the approach taken by a number of banks, including those that have benefited from the bailout. “There’s a creeping tendency to label small businesses in certain sectors as high risk. We want to see a return to judging each lending decision on its merits.”
Government-backed plans to revive bank lending to small firms, due to be revealed in greater detail on January 15, are likely to come too late for the entrepreneur Asad Khan. He has spent a gloomy festive period contemplating the prospect of repossession after his attempts to refinance the loan on the third London restaurant in his India Dining chain came to nothing. Khan said he was furious about a lack of communication by the bank that left him thinking he had a mortgage deal that would have replaced a costly bridging loan he had taken out in the summer.
In late December the bank told Khan it was not prepared to offer the £280,000 loan after all. “They will not allow us to exit the bridging loan without having the restaurant up and running but we can’t progress any further because we have run out of money. We seem to have exhausted all the options.” Unless he can do a deal in the next two weeks, the interest rate on the loan will double to 36% and the payments would be at a level Khan could not meet. If he defaults and the property is repossessed Khan will also lose the £100,000 he has spent fitting out the premises so far, which he has managed to fund from the cash flow from his other two restaurants.
What galls Khan the most is that the bind he finds himself in is of the bank’s making. And he is particularly exasperated given the track record he has with his bank, which he declined to name. “We have a history with them. They have more than enough equity and security but they still don’t want to do the deal. “It’s outrageous. It seems they will only do deals that are a dead cert.”
Ilargi: The Bank of England dates back to 1694. William III, a Dutch prince who had taken the British crown five years earlier, had spent so much on wars against Louis XIV and other catholic leaders that the country was broke. William Paterson, a Scotsman, offered him a £1.2 million loan, on behalf of a group of rich investors. In exchange, they would be allowed to print the nation’s money. The interest rate over the loan was 8%, plus a £4000 annual fee. Reportedly, about 40% of the loan was never paid; it was simply printed by the new central bank. Paterson knew what he was doing, He is quoted as saying "The bank hath benefit of interest on all moneys which it creates out of nothing.". It took another 219 years for the US to squander control over its money.
UK industry calls for lowest Bank rate in 300 years
Business says the Bank of England should slash interest rates again this week to prevent the recession turning into depression.
“The rapid worsening in the economic situation and growing fears over rising unemployment reinforce the need for the MPC [monetary policy committee] to continue with aggressive interest-rate cuts,” said David Kern, economic adviser to the British Chambers of Commerce. “To alleviate the most devastating consequences of the serious recession, we urge the MPC to cut rates by a full 1% on Thursday, to 1%. A prolonged depression can still be averted if the authorities adopt forceful measures.” A job-market survey by KPMG and the Recruitment & Employment Confederation, to be published on Wednesday, will show a further significant weakening in employment, driven by a slump in demand for staff.
The Bank is widely expected to cut interest rates again this week, taking them down to the lowest level since it was founded more than 300 years ago, despite a series of moves that have seen Bank rate drop from 5% to 2% since October. The City is looking to the MPC to cut by at least half a point on Thursday, following a broad hint in the minutes of its December meeting that there was more easing to come. A half-point cut would take Bank rate, already at its lowest level since 1951, down to 1.5%, the lowest since 1694 when William III was on the throne. Not everybody thinks the Bank should cut rates further. The “shadow” MPC, which meets under the auspices of the Institute of Economic Affairs, says the Bank should hold rates at 2% this week and instead focus on other measures for boosting the economy, including so-called quantitative easing. While three members of the shadow MPC vote for rate cuts, the remaining six say cutting rates further will not have any additional benefit.
“The events of 2008 have shown that monetary policymaking consists of much more than the setting of interest rates by a committee of the great and the good,” said shadow MPC member Tim Congdon. “I believe that, handled properly, debt-management operations could add 5% to bank deposits in the first quarter of 2009, ending the liquidity squeeze and the worst of the recession.” The shadow MPC calls for a series of such “unconventional” measures, including expanding the money supply by underfunding government borrowing – halting the issuance of gilts – discouraging the flow of deposits into National Savings, normalising money markets and directing the banks to lend to companies and households rather than to their own financial subsidiaries.
There was a general view that the benefits from further cuts in Bank rate were subject to rapidly diminishing returns and that there was a need for additional monetary instruments,” the shadow MPC said. “One suggestion was that the remit of the Debt Management Office should be altered to allow the government to borrow directly from the banking sector, in order to boost bank liquidity and the broad money supply. “Several members criticised the government’s incoherent and damaging approach to the banking system. In particular, senior politicians’ populist demands for lower borrowing costs were logically incompatible with the need to recapitalise the sector.” Rapid reductions in interest rates have taken their toll on savers, with some accounts now paying as little as 0.1%, even before this week’s expected cut in Bank rate.
However, lower rates have so far failed to stimulate lending. The Bank’s latest credit-conditions survey, published on Friday, showed that banks tightened credit availability to businesses and households in the final three months of last year and expect to do so further in the first quarter of 2009. Treasury sources said yesterday that a series of options were being considered to stimulate bank lending. They include government guarantees to enable the banks to access wholesale funding markets, taking “toxic” assets off bank books and a possible further recapitalisation of the banks.
The Irish Economy’s Rise Was Steep, and the Fall Was Fast
It's 3 a.m. at Doheny & Nesbitt, a favorite watering hole of Dublin’s political and business elite, and the property tycoon Sean Dunne stoops to retrieve a penny from the pub’s grimy floor. One would think that Mr. Dunne, Ireland's best-known building developer, would be in bed at this hour. It’s a weeknight, after all, and he has meetings that begin before first light. What’s more, the Irish economy, pummeled by the most severe housing bust in Europe, has collapsed. And the gossip around town is that Mr. Dunne, whose brazen deal-making and Donald Trump-like lifestyle epitomized the country’s euphoric boom, might be going bankrupt. But, no matter, a penny is a penny. “I am never, never too proud to pick a penny up from the floor,” Mr. Dunne said. He is on perhaps his fifth pint of Guinness, capping a rollicking night of Champagne cocktails, followed by a wine-soaked dinner — yet his thick brogue is clear of even the faintest slurring.
“I grew up with nothing and I know the value of money,” he adds. “The Celtic Tiger may be dead and if the banking crisis continues I could be considered insolvent. But the one thing that I have is my wife and children — that they can’t take away from me.” It is not known whether Mr. Dunne will fall victim to today’s world financial catastrophe, but there is no doubt that his country has. Everything, it seems, has grown worse here. The recession started earlier and its bite has been deeper. Housing prices have fallen by as much as 50 percent. Bank shares have plummeted by more than 90 percent. Unemployment is approaching 10 percent. The roots of Ireland’s fall date to more than 20 years ago, when a clutch of economists, politicians and civil servants put their heads together in this very pub and planted the philosophical seeds for the Irish economic miracle.
Known widely as the “Doheny & Nesbitt School of Economics,” these beery musings soon became government policy that chopped taxes in half, sharply reduced import duties and embraced foreign investment — a radical transformation that gave birth to the Celtic Tiger and perhaps the most open and vibrant economy in Europe. But beyond the glow of this sudden efflorescence that made Ireland the fourth most-affluent country in the Organization for Economic Cooperation and Development, a housing bubble had begun to form. Low interest rates, a wave of inward immigration and a bank lending spree drove housing’s share of the economy to 14 percent, the highest in Europe, from 5 percent. Developers like Mr. Dunne became multimillionaires and — much like the hedge fund and private-equity elite in America — became visible public and cultural figures. They were living large in a country just coming to grips with its ability to show a little swagger.
Ireland’s policy makers, like their counterparts in the United States and Britain, were seduced by record tax inflows and a full-employment economy. They paid little heed to the lonely voices that warned of the crash that finally came over the summer, when interest rates in Europe began to rise. Banks that had steered more than 60 percent of their loans toward property stopped lending, and asset values plummeted. “We have repeatedly warned that the government’s housing policy was extremely dangerous,” said John Fitz Gerald, an economist at the Economic and Social Research Institute, a leading policy center in Dublin, who has long urged that the government stanch housing demand by raising taxes. “You will now see unemployment going to 10 percent and we will experience a sharp drop in output.” He shakes his head and sighs: “This was predictable, but the government just did not deal with it.”
By wide consensus here, two events have come to define — both culturally and financially — the sweep and excess of the Irish property boom. Both revolve around Sean Dunne. In July 2005, Mr. Dunne paid 379 million euros for a seven-acre plot in the exclusive Ballsbridge neighborhood of Dublin and promptly announced that he would tear down the two luxury hotels on the site to build a high-end commercial and residential development. That deal amounted to 54 million euros an acre, one of the highest amounts ever paid for land in Europe. His subsequent architectural plan featured a soaring Dubai-like office tower cut in the shape of a diamond that anchored a futuristic community of expensive houses and glamorous shops, and the price tag of one billion euros shocked Dubliners with its gall and ambition. Hobbled by delays and vocal neighborhood opposition, the project sits before a local planning board that on Jan. 30 will either approve or scrap the plan.
The second moment occurred in 2004 when Mr. Dunne, who is now 54, celebrated his second marriage, to Gayle Killilea, a former gossip columnist 20 years his junior, by inviting 44 of his friends on a two-week Mediterranean wedding cruise on the yacht Christina O, on which Aristotle Onassis and Jacqueline Kennedy married. Much as the $3 million birthday party for Stephen A. Schwarzman, the Blackstone Group founder, came to be seen as a crass display of private equity’s manifold riches, the Dunne wedding was viewed similarly in Ireland: as a conspicuous and garish expression of the man and his business. That a billion euro property plan and a gaudy wedding celebration should be held up as cautionary exemplars of Ireland’s pursuit of money angers Mr. Dunne. In his view, it speaks to what some call the Irish disease. “Jealousy and begrudgery are still alive and well in Ireland, and whoever eradicates them should be prime minister for life,” he says as he tucks into a heaping plate of gravy-drenched turkey and mashed potatoes in the restaurant of one of the two hotels he owns — and is hoping to raze. “It’s part of the Irish psyche and it is the result of 800 years of being controlled by other people, of watching everything the master or landlord is doing.”
Mr. Dunne’s compact paunch, reddish cheeks and mischievous grin — which he occasionally deploys with a wink of his eye — can give him the air of a department store Santa. But his business methods are far from jolly: he is notorious for taking legal action against all who cross him, from local newspapers to rival property developers. He defends his purchase of the Ballsbridge site as responsible, not reckless, as his critics have deemed it. He points out, too, that his winning bid was just slightly more than the second-highest offer and that subsequent property sales had far exceeded his submission of 54 million euros an acre. Still, he recognizes that times have changed. Just recently, he pruned staff at his development company, and some of his senior executives agreed to take 50 percent pay cuts. Asked where he will find the 600 million euros that he needs to tear down the two hotels, dig a massive hole in the ground and erect his vision of a new Dublin, he ruefully remarks: “It is fair to say that there is not a queue of bankers lining up to lend to me right now.”
But he says the project will be completed, assuming that it wins approval of the planning board. “If anyone wants to bet I can’t do this, I will take that bet,” he says, citing, without specifics, talks with Asian banks and a sovereign wealth fund. “You have to have steel in a certain part of your body to do this job, and as one of my bankers recently said to me, ‘Sean, the only thing that will take you out is a stray bullet.’ ” In many ways, the ups and downs of Mr. Dunne’s life and career mirror the Irish economy’s own rise and fall. Born into a house without electricity or running water in the small provincial town of Tullow, outside Dublin, Mr. Dunne studied construction economics at a technical college in the 1970s. Along with many of his countrymen, he forsook the stagnant Irish economy — in his case, choosing bartending in New York City and working on an oil rig in Canada. With the Irish economy still afflicted by an unemployment rate of about 20 percent in the 1980s, and a punitive overall tax rate, he began his real estate career in London. He moved back to Ireland in 1990 and began a string of property deals.
He initially focused on government-sponsored housing projects. But as the Irish economy began its true take-off, demand came from the growing corps of newly wealthy Irish, many of whom were returning to Ireland from abroad. They were joined by a wave of foreign workers. After years of emigration and economic stagnation, Ireland’s housing stock was depleted, precipitating a housing euphoria. Capital gains taxes were low, as were interest rates. Banks stood ready to lend, offering mortgages with no money down to a house-hungry population. The projects of Mr. Dunne and a small circle of developers grew in size and scope until the skyline of Dublin, never known for its tall buildings, began to fill with cranes and great shiny towers.
Signs of a bubble were everywhere: a family home in Dublin cost as much as a similar abode in Beverly Hills; house prices more than doubled over a 10-year period; and household debt as a percentage of G.D.P. jumped to 160 percent from 60 percent during the same period. Irish banks, unlike those in the United States, didn’t dole out that many subprime loans. Rather, they lent furiously to big property developers who themselves were liberated to build pell-mell by government-imposed tax breaks. Mr. Dunne, who says he put 35 percent cash down — or about 125 million euros — for the Ballsbridge project, says that even with the drop in asset values, he still has hope that the project can be completed. “This is the way God made me, with heavy shoulders and an ability to carry a great load,” he says, forcefully rejecting the rumors of his financial demise buzzing around Dublin. (One of the more fantastic claims was that his financial troubles had forced him to take a month’s recuperation in a mental institution.)
“Failure is not an option for me,” he says. But others aren’t so sure. The Irish government recently announced a $7.5 billion bank bailout and took majority stakes in the country’s largest banks, a move that followed the government’s earlier promise to guarantee all bank deposits. Analysts are uncertain that the government will allow the banks to continue to support the type of high-risk, high-reward projects that have become the bane of their financial existence. “The banks in Ireland did not lend recklessly to individuals; they lent recklessly to developers,” says Ronan Lyons, an economist at Daft, Ireland’s largest property Web site. As for the Ballsbridge project, he may well take Mr. Dunne’s bet. “I would be surprised if it gets built,” Mr. Lyons says. “The migrants are going home, there is a surplus of properties for sale, and even though this is a landmark project there is just not an appetite for large projects now.”
While the pain is acute in Dublin, at least the city has the small comfort of having enjoyed the full benefit of the boom. Such is not the case in the city of Limerick. Traditionally one of Ireland’s more depressed cities, Limerick was a latecomer to the property party. While there were some good times, the downturn has had a more wrenching effect there, with unemployment over 14 percent — among the highest rates in Ireland. The layoffs have picked up speed around Limerick in the last month, as construction companies have stopped work, seemingly on a dime, sending such a procession of jobless to seek assistance that the local unemployment office became the second busiest in the country.
The waiting room in the office is dank and gloomy, and Dale McNamara, 20, wonders how a professional life once so charmed came to be so hopeless. Since graduating from high school as an electrician, flourishing building work in the area kept him more than busy and flush enough to buy a new car, start a family and consider buying a house. Then, without warning on Dec. 5, he was told that it would be his last day of work, just six months before he would have received his certificate as an independent electrician. Since then, he has been frantically knocking on doors, but to no avail. Now, as rent, heating bills and car payments pile up, he is beginning to feel desperate, unable to afford a night out or a Christmas present for his 20-month-old baby. “If I don’t get a job in the next two weeks, I am worried about losing my house,” he says. “We have no money.” He looks at his number in the unemployment lines and grimaces — he has been waiting four hours now and his name has still not been called. “My grandfather says this reminds him of the 1930s when everyone left for America and Australia,” he adds. “There is just no work here.”
More dire, however, is the condition of the permanently unemployed in Limerick’s festering ghettoes, where experts say the unemployment rate touches 70 percent. During the early years of the economic revival, the government did its best to spread money to such areas, which are a feature of urban life all over Ireland. In fact, it was through social housing projects like these that Mr. Dunne got his start as a developer. But as the investment returns in the private sector became quite obviously more lucrative, the attention paid to so-called social estates like Moyross, on the northern outskirts of Limerick, wavered. Crime, gangland disputes and a sense of anomie flourished as Moyross and other similar projects evolved as cocoons of poverty and hopelessness amid the riches and celebration of the Irish miracle. “This place missed out entirely on the moment,” says Stephen Kinsella, an economist at the University of Limerick. “There has been no accumulation of wealth here.”
Walking through the garbage-strewn, empty roads on a cold, misty afternoon, Mr. Kinsella points to the shuttered houses and the mothers still dressed in pajamas taking their children home from school. Social workers in Moyross refer to the “pajama index”: the more men and women one sees who do not take the time and care to dress for the day, the worse the economic situation tends to be. The Irish government has recently begun a regeneration project in Moyross that would result in large new investments in housing and infrastructure, but the going so far has been slow. For Brother Shawn O’Connor, a Franciscan monk who has been living and working with the poor in Moyross for more than a year now, the vicissitudes of the Irish property market are a notion as distant as is his hometown, Red Hook, a village in the Hudson Valley of New York.
Brother O’Connor is the local superior of the community of Franciscan Friars, who do their work in some of the world’s most destitute communities. He and his fellow monks extend day-care assistance and spiritual counseling to the needy. They survive themselves on four hours of daily prayer and food handouts from neighbors — as Franciscans, they take a vow of chastity, poverty and obedience and thus do not spend money on any personal items, including food. He recognizes that the deprivation of his community is severe, but suggests that it may be an easier hardship than the experiences of many Irish who have seen their riches disappear. “There was this one story of a guy who shot his wife, son and daughter,” he says. “He had overextended himself. There is this desperation for wealth and people go after it — only to find out that it is not enough.”
Chinese Manufacturing Shrinks in December
The manufacturing sector in China continued to shrink in December, bolstering expectations that the economy will weaken further before any pickup, but the contraction wasn't as sharp as before. The Purchasing Managers Index issued Sunday by the China Federation of Logistics & Purchasing rose to 41.2 last month from 38.8 in November, while another PMI, issued Friday by CLSA Asia-Pacific Markets, rose to 41.2 from 40.9. A PMI reading above 50.0 indicates manufacturing growth, and a reading below 50 indicates decline. Both gauges stayed below 50 in the fourth quarter of last year, suggesting that economic growth is likely to have slowed further, especially because industry, including manufacturing, accounts for more than two-fifths of China's production.
China's economy grew 9% in the third quarter from the year-earlier period, slower than the 11.9% growth in all of 2007. Economic-growth data for 2008 and the fourth quarter are expected later this month. "With five back-to-back PMIs signaling contraction, the manufacturing sector...is close to technical recession," said Eric Fishwick, head of CLSA Economic Research, which puts out the CLSA PMI together with Markit Economics. The CLSA PMI has been below 50 starting in August. Beijing, which will invest 1.18 trillion yuan ($173 billion) on railways, housing and other projects till the end of 2010, is set to introduce more measures to help industry. Premier Wen Jiabao said Friday the government has come up with plans to help the automobile and steel sectors, and is working to come up with overarching plans to help others. He didn't elaborate.
Manufacturing surveys in the U.S. and the euro-zone fell to multi-year lows last month, while the PMIs for Hong Kong, Japan and India declined as well. Despite the 9% growth rate, Beijing is concerned a sharp slowdown would put many people out of jobs and create social unrest. The government is targeting economic growth of about 8% this year, the same target as in the past few years, and has warned of a grim jobs outlook. The employment component of the CLSA PMI fell to 45.2 last month from 46.0 in November, while that of the CFLP PMI fell to 43.3 from 44.3.
In addition, companies have been drawing down inventories to deal with dwindling demand, worsening the downturn. The inventory component of the CLSA PMI fell to 48.5 in December from 50.2 in November, while that of the CFLP PMI fell to 44.7 from 50.8. An analyst for the CFLP PMI, Zhang Liqun, predicted that growth will stabilize as expansionary policies start to have an impact and as companies approach the end of their efforts to run down inventory.
Ukraine Seeks EU Involvement in Resolving Russian Gas Dispute
Ukraine sought assistance from the European Union in resolving its dispute with Russia over the pricing of gas supplies as OAO Gazprom increased natural-gas deliveries to Europe via three alternative routes. NAK Naftogaz Ukrainy Chief Executive Officer Oleh Dubina said talks had reached a “dead end.” Russia’s state-owned gas exporter said it boosted shipments along two routes through Belarus and one to Turkey. Officials from both Russia and Ukraine have each visited the Czech Republic, which holds the European Union’s rotating presidency, in the past three days, with neither side showing signs of resolving the impasse that led Gazprom to cut gas supplies to Ukraine on Jan. 1.
“Both sides will need to find a compromise,” Alexander Rahr, director of Russian programs at the German Council on Foreign Relations in Berlin, said by phone. “The risk if they don’t is they both will lose and suffer financially.” Russia supplies a quarter of Europe’s gas, 80 percent of which is transported through Ukraine. A similar dispute in 2006 disrupted supplies to Europe, prompting the EU to call for supply and transit commitments to be honored “under all circumstances.” “We have missed all deadlines to sign an agreement between Ukraine and Russia ourselves,” Dubina said in an interview broadcast late yesterday on Ukraine’s Channel 5 television. “We probably need the EU to be involved in the process.” Gazprom Deputy Chairman Alexander Medvedev said today the Russian company is “willing to meet” with Ukrainian officials immediately. “We implore Ukraine to come back to Moscow to negotiate once and for all a mutually acceptable gas supply deal,” he said in an e-mailed statement.
Gazprom increased supplies along by the Yamal-Europe pipeline and Beltransgaz system, both which cross Belarus, and the Blue Stream link to Turkey after halting shipments to Ukraine as the two sides failed to agree on 2009 prices for supplies and transit. Bohdan Sokolovskyi, Ukrainian President Viktor Yushchenko’s energy adviser, said yesterday the shutoff may cause difficulties in pumping gas to Europe in the next 10 to 15 days because of falling pipeline pressure. “In such conditions and in January temperatures, the system will automatically stop renewing pressure,” Sokolovskyi told reporters in Kiev. “In other words, we will have serious interruptions of transit via Ukrainian territory.” It’s unlikely that Gazprom’s supplies skirting Ukraine will be enough to meet European needs for a sustained period, Rahr said. “It’s very difficult to circumvent gas around Ukraine, otherwise they would have done it before,” Rahr said.
Ukrainian Energy Minister Yuriy Prodan is leading a delegation to the EU. Gazprom Deputy Chief Executive Officer Alexander Medvedev yesterday held meetings in the Czech capital. “The European Union calls for an urgent solution to the commercial dispute on gas supplies from the Russian Federation to Ukraine, and for an immediate resumption of full deliveries of gas to the EU member states,” the Council of the European Union said in a statement. Gazprom said Jan. 2 it had boosted deliveries via Belarus to compensate for shortages caused by siphoning in Ukraine. Chief Executive Officer Alexei Miller said yesterday his company plans to seek international arbitration to ensure transit via Ukraine. Naftogaz, Ukraine’s state-run energy company, said the siphoning accusations “have no basis in fact.”
Polskie Gornictwo Naftowe i Gazownictwo SA’s supplies from Ukraine had fallen by 11 percent late Jan. 2 and shipments from Belarus are offsetting them, Joanna Zakrzewska, spokeswoman for Poland’s largest gas company, said by phone yesterday. Deliveries of gas from Russia to Romania have dropped by 30 percent since the start of the dispute, Agence France-Presse reported. The country is receiving 7 million cubic meters, down from its usual 10 million cubic meters, the news service cited Ioan Rus, director of pipeline operator Transgaz, as saying. Ukraine is transporting 283 million cubic meters of gas to Europe a day and the country’s partners will understand that any transit difficulties “are not caused by the Ukrainian side,” Sokolovskyi said. Gazprom’s Posyagin said deliveries via Yamal- Europe went up by 20 million cubic meters, and by shipments were increased by 6 million cubic meters each via the other two routes. Gazprom on Jan. 1 withdrew an offer to sell Ukraine gas at $250 per 1,000 cubic meters as Ukraine, which relies on Russian gas for 70 percent of its needs, sought a cheaper rate. Ukraine must now pay a European market price of $418, Gazprom said.
Ukraine’s political leadership, grappling with a financial crisis that has forced it to seek a $16.4 billion International Monetary Fund bailout, said $201 would be a fair price. Naftogaz proposed a price of $235 per 1,000 cubic meters on Dec. 31 before talks broke down. Russia said its $250 offer already marked a concession to Ukraine, pointing out that Gazprom will pay an average of $340 per 1,000 cubic meters of gas from three Central Asian nations in the first quarter. Naftogaz said it’s ready to return to a 2005 agreement to resolve the current standoff by allowing Gazprom to pay for transit with gas supplies. The Ukrainian company is seeking 23 billion cubic meters of fuel from Russia this year in exchange for pumping gas to Europe, Chief Executive Officer Oleh Dubina said in an e-mailed statement. “From 2010, we are ready to take 28 billion cubic meters of gas to 29 billion cubic meters of gas a year in exchange for transit,” Dubina said.
The proposal is odd and has no legal basis because Gazprom has a transit contract through 2010, Gazprom spokesman Sergei Kupriyanov said, according to state-run news service RIA Novosti. Gazprom has no information about when the Ukrainian side intends to return to the negotiating table, Deputy CEO Valery Golubev said in comments at a company meeting chaired by Miller today and shown on state television. “They are going to renegotiate because neither Ukraine nor Russia can afford to have its image deteriorate in the eyes of the West,” Rahr said. “Ukraine has to fulfill its obligation and live up to its image as a transit country for oil and gas from the East to the West. Russia has to make sure Europeans will get their gas and trust Russia as one of the biggest and most important suppliers.” Naftogaz on Dec. 31 also asked for a transit rate for gas from Russia of $1.80 per 1,000 cubic meters per 100 kilometers (62 miles). That compares with the agreed 2008 rate of $1.70. Dubina said yesterday Ukraine is now seeking a transit fee of $2.05. Russia is refusing to renegotiate the transit tariff, saying its agreement runs until the end of 2010.
Bail us out, say Madoff victims
Lawyers representing the victims of Bernard Madoff's alleged $50bn fraud are calling on the US government to bail them out with billions of taxpayers' dollars. They say the government should bolster the Securities Investor Protection Corporation, which helps creditors of collapsed brokerages. The SIPC has little more than $1.6bn of funds and has promised $500,000 to each Madoff victim who had an account with his firm in the past 12 months. Losses in the Madoff affair are estimated to be between $30bn and $50bn.
Michael Sirota, a lawyer representing KML Investments, a firm claiming to have lost $80m, said: "What if SIPC needs $15bn to compensate all the victims because this fraud is bigger than anything they imagined could happen? The government should step up with funds like it has for the banking sector and the automotive sector." Stuart Rich, a lawyer representing seven investors who lost sums from $3m to $30m, says: "We desperately need to see the pool of assets we are working with and the pool of losses." Madoff has presented a list of his assets to the Securities and Exchange Commission, the US market regulator, but the document remains under seal.
Made Money With Madoff? Don’t Count On Keeping It.
The lucky folks who cashed in and got out before Bernard Madoff's $50 billion investment empire came crashing down might not be as lucky as they think. Sources close to the Madoff case say that a recent court ruling in a similar collapse—a Ponzi scheme called the Bayou Group—is likely to provide the legal road map for recovering as much money as possible from the Madoff mess. And if so, those who profited stand to lose not only their gains but also, in some cases, the original principal they invested in the scheme.
Madoff's reputation as a financial wizard evaporated following disclosures that his business was a giant Ponzi scheme in which he paid out generous but fake profits to early investors from funds deposited by later ones. The clean-up is likely to fall under the jurisdiction of the federal bankruptcy court in Manhattan, which is already sifting through Bayou wreckage. That case made headlines last summer when Sam Israel, the fraud's mastermind, disappeared shortly before he was due to report to prison; his abandoned SUV was discovered outside New York City with the words SUICIDE IS PAINLESS scrawled on its hood. A few weeks later, Israel turned himself in to authorities.
In October 2008 a judge in the Bayou case, Adlai Hardin Jr., ruled that investors who cashed out their interests within two years of the scheme's exposure had to hand back their principal as well as their profits—even though they were innocent victims of the swindle—if there was evidence that they got out because they suspected, or had been warned, there was something amiss. (The court also ordered profits made within the last six years to be surrendered.) Legal experts say the Madoff litigation could follow the Bayou ruling's lead. "Even though the potential scale of losses in the Madoff scheme seems to dwarf the $450 million at issue in Bayou," says an analysis by the KL Gates law firm, which represents victims of the earlier fraud, the Bayou case "provide[s] instructive guidance to [Madoff] investors and other affected parties." The lawyer in charge of the Madoff clean-up, Irving Picard, did not respond to a request for comment.
Mitchell Banas, a lawyer who represents an endowment for Christian Brothers High School in Memphis—which got its money out of the Bayou fraud before it collapsed but now must return both profits and principal—says the outcome is "extremely unfair." His client, he says, withdrew its money from the scheme on the advice of financial advisers who smelled a rat; now the school is left "between a rock and a hard place." Eventually, the school and other investors will be able to seek a share of any recovered Bayou money. But in what could be a harbinger for those caught up in the Madoff mess, lawyers estimate that the Bayou fraud victims will do no better than 15 to 20 cents for every dollar originally invested. And, of course, zero profit.
Flowers, Soros, Michael Dell team to buy IndyMac
A seven-member investor group including billionaire George Soros and Dell Inc. founder Michael Dell have agreed to purchase failed lender IndyMac Bank, one of the largest casualties of the housing bust, for $13.9 billion. IndyMac, which specialized in loans made with little down payment or proof of assets, was seized by the government in July after a run on the bank as the U.S. housing market collapsed. The Federal Deposit Insurance Corp. said Friday that a holding company led by Steven Mnuchin, co-chief executive of private equity firm Dune Capital Management, agreed to buy IndyMac in a deal reached Wednesday. The investors have formed a partnership, called IMB Management Holdings LP, that includes Dell's investment firm, MSD Capital. Once the deal closes, the investment group will pour $1.3 billion in new capital into IndyMac and continue to operate the Pasadena, Calif-based bank, the FDIC said.
"We have assembled a group of experienced private investors in financial services to acquire the former IndyMac and operate it under new management with extensive banking experience," Mnuchin said in a statement. "We will inject significant private capital into IndyMac so that it can once again effectively serve its customers and communities." Investors in the partnership include five private equity firms or hedge funds: J.C. Flowers & Co.; Stone Point Capital; Paulson & Co.; a fund controlled by billionaire George Soros' Fund Management; and a fund controlled by Silar Advisors LP. Dune Capital was founded in 2004 by former Goldman Sachs Group Inc. partners Mnuchin and Daniel Niedich. J. Christopher Flowers, who launched, then dropped, a bid to buy student lender Sallie Mae last year, also is a former Goldman Sachs partner. Paulson & Co. made billions in profits in recent years by betting on the failure of risky home loans. IndyMac has 33 bank branches in Southern California with about $6.5 billion in deposits, about half the company's total at the time of its failure.
Other IndyMac assets include a $157.7 billion loan servicing business, which collects mortgages and distributes them to investors, and a reverse-mortgage company, known as Financial Freedom. The failure of IndyMac, which had $32 billion in assets, was the second-largest last year, trailing only the September failure of Washington Mutual Inc. Under terms of the sale, the new investors will shoulder the first 20 percent of the bank's loan losses, with the FDIC agreeing to take on the majority of any losses thereafter. The FDIC said Friday its bank insurance fund stands to lose $8.5 billion to $9.4 billion on IndyMac. The FDIC used a similar loss-sharing agreement when Downey Savings and Loan Association failed in November. In return, the IndyMac investors agreed to continue a closely watched home-loan modification program launched by FDIC Chairman Sheila Bair in August that has completed about 8,500 loan modifications so far.
The investors have received preliminary clearance from the federal Office of Thrift Supervision to run the bank as a federal savings association. A final decision is expected in the coming weeks. Thrifts have been the most troubled regulated institutions during the financial crisis and among the most spectacular failures. By law, they must have at least 65 percent of their lending in mortgages and other consumer loans -- making them particularly vulnerable to the housing downturn. Seattle-based thrift Washington Mutual was the biggest bank to collapse in U.S. history, with around $307 billion in assets. It was later acquired by JPMorgan Chase & Co. for $1.9 billion. FDIC officials noted that private equity firms have bought up failed institutions before. In the early 1990s, two failed banks -- Bank of New England and CrossLand Federal Savings Bank -- were sold to private equity firms. The IndyMac deal comes as regulators have eased restrictions on such purchases.
Previously, private-equity firms could not hold more than a 24.9 percent stake in a bank without becoming a bank-holding company. A total of 25 U.S. bank failures in 2008 compare with three for all of 2007 and are far more than in the previous five years combined. Many more banks are expected to sink this year. One unresolved issue is IndyMac's relationship with investors in mortgage-linked securities, including Fannie Mae and Freddie Mac, the government-controlled mortgage finance titans. Fannie, Freddie and other investors have the right to try to return IndyMac loans if they claim they violate the terms under which they buy mortgages. About $1 billion in loans owned or guaranteed by Fannie Mae are in question. Fannie Mae "is working constructively with the FDIC and IndyMac to reach a resolution that is in the best interests of all parties involved," Fannie spokesman Chuck Greener said Friday.
Would You Pay $103,000 for This Arizona Fixer-Upper?
The little blue house rests on a few pieces of wood and concrete block. The exterior walls, ravaged by dry rot, bend to the touch. At some point, someone jabbed a kitchen knife into the siding. The condemnation notice stapled to the wall says: "Unfit for human occupancy." The story of the two-bedroom, one-bath shack on West Hopi Street, is the story of this year's financial panic, told in 576 square feet. It helps explain how a series of bad decisions can add up to the worst financial crisis since the Great Depression.
Less than two years ago, Integrity Funding LLC, a local lender, gave a $103,000 mortgage to the owner, Marvene Halterman, an unemployed woman with a long list of creditors and, by her own account, a long history of drug and alcohol abuse. By the time the house went into foreclosure in August, Integrity had sold that loan to Wells Fargo & Co., which had sold it to a U.S. unit of HSBC Holdings PLC, which had packaged it with thousands of other risky mortgages and sold it in pieces to scores of investors. Today, those investors will be lucky to get $15,000 back. That's only because the neighbors bought the house a few days ago, just to tear it down. At the center of the saga is the 61-year-old Ms. Halterman, who has chaotic blond-gray hair, a smoky voice and an open manner both gruff and sweet. She grew up here, working at times as a farm hand, secretary, long-haul truck driver and nurse's aide. In time, the container of vodka-and-grapefruit she long carried in her purse got the better of her. "Hard liquor was my downfall," she says.
Ms. Halterman says she had her last drink on Jan. 3, 1996. These days, her beverage of choice is Pepsi. She collects junk. Her yard at the West Hopi house was waist-high in clothes, tires, laundry baskets and broken furniture. In June, the city issued a citation for what the enforcement officer described as "an exorbitant amount of rubbish/debris/trash." Ms. Halterman also collects people. At one time, she says, 23 people were living in the tiny house or various ramshackle outbuildings. Her circle includes grandchildren, an old friend who lost her own home to foreclosure, a Chihuahua, and the one-year-old child of a woman Ms. Halterman's former foster-daughter met in jail. In the mail recently, she noticed a newsletter sent by a state agency with an article titled "Raising Children of Incarcerated Parents, Part I." "I need to read that one," she said aloud to herself. She keeps the children in line with cuddles and mock threats.
"You better put that shirt on, or that cop will come and take you to jail," she tells one. Another, whose father is in prison, was born with a heart problem related to his mother's drug use, Ms. Halterman says. She patiently nursed him to health. "It took me forever to get him past 15 lbs.," she recalls. Ms. Halterman hasn't had a job for about 13 years, she says. She receives about $3,000 a month from welfare programs, food stamps and disability payments related to a back injury. "I may not have everything I want, but I have everything I need," she says. Four decades ago, when she bought the West Hopi Street house for $3,500, Avondale was a small town built around cotton farms. From 2000 to 2005, the heart of the housing boom, it doubled in size to 70,000 residents.
Today, one in nine Avondale houses is in foreclosure or close to it. Her lender, Integrity, was one of a flurry of small mortgage firms that sprang up nationwide during the boom, using loans from big banks to generate mortgages to resell to larger financial institutions. Whereas traditional mortgage lenders profit by collecting borrowers' monthly payments, Integrity made its money on fees and commissions. The company was owned by Barry Rybicki, 37, a former loan officer who started it in 2003. Of the boom years, he says: "If you had a pulse, you were getting a loan." When an Integrity telemarketer called Ms. Halterman in 2006, she was cash-strapped, owing $36,605 on a home-equity loan. The firm helped her get a $75,500 credit line from another lender. Ms. Halterman used it to pay off her pickup, among other things. But soon she was struggling again.
In early 2007, she asked Integrity for help, Mr. Rybicki's records show. This time, Integrity itself provided a $103,000, 30-year mortgage. It had an adjustable rate that started at 9.25% and was capped at 15.25%, according to loan documents. It was one of 197 loans Integrity originated last year, totaling almost $47 million. For a $350 fee, an appraiser hired by Integrity, Michael T. Asher, valued the house at $132,000. Mr. Asher says although he didn't personally believe the house was worth that much, he followed standard procedures and found like-sized homes nearby that had sold in that price range in 2006. "I can't appraise it for the future," Mr. Asher says. "I appraise it for that day." T.J. Heagy, a real-estate agent later hired to sell the property, says he can find only one comparable house that sold nearby in 2007, for $63,000.
At closing, on Feb. 26, 2007, Integrity collected $6,153 in underwriting, broker, loan-origination, document, application, processing, funding and flood-certification fees, mortgage documents show. A few days later, Integrity transferred the loan to Wells Fargo, earning $3,090 more, Mr. Rybicki says. Kevin Waetke, of Wells Fargo Home & Consumer Finance Group, said in a written statement that "it appears that the appraisal ... confirms that the property values were fully supported at the time the loan closed." Mr. Rybicki says neither he nor his loan officer ever saw the blue house. When shown a picture last month, he said: "Wow." "When you have 50 employees, as much as you are responsible for holding their hands, you just can't," Mr. Rybicki says. After the fees and her other debts were paid, Ms. Halterman walked away from closing with $11,090.33. Ms. Halterman says she spent it on new flooring, a fence, minor repairs and food. "No steak or lobster," she says, "hamburger and chicken."
Soon the money was gone. Within a few months she grew worried the rickety house wasn't safe for children. She moved to a rental nearby. Her son Leslie Merritt took up residence at West Hopi Street and assumed responsibility for the $881 monthly payments. When Wells Fargo sold Ms. Halterman's loan to London-based HSBC, it got bundled with 4,050 other mortgages and used as collateral for a security issued in July 2007. More than 85% of the mortgages were, like Ms. Halterman's, "subprime" loans to borrowers with blemished credit, according to Tom Atteberry of First Pacific Advisors LLC, a Los Angeles investment-management company. Credit-ratings firms Standard & Poor's and Moody's Investors Service gave the new security their top "triple-A" ratings, which suggested investors were extremely likely to get their money back plus interest. S&P declined to explain its assessment. A Moody's spokesman didn't respond to requests for comment.
Thus was Ms. Halterman's diminutive blue house tossed into the immense sea of mortgage-backed securities that would eventually imperil the U.S. financial system. Some $4.1 trillion in American mortgages were put into securities such as these between 2005 and 2006, including $1.6 trillion in subprime or other high-risk home loans, according to Inside Mortgage Finance, a trade publication. Among other investors, the Teachers' Retirement System of Oklahoma bought $500,000 of the new security, according to chief investment officer Bill Puckett. Also buying in was bond-giant Pacific Investment Management Co., which declined to comment. Soon, Ms. Halterman's son, Mr. Merritt, says he stopped paying the mortgage. He had slipped back into his methamphetamine addiction. "I lost interest in pretty much everything except my habit and the girl I was seeing," he says. Mr. Merritt is now in prison for trafficking in stolen copper pipe. In January, Ms. Halterman stepped back in and made the last mortgage payment. Foreclosure began in May. September brought eviction. Ms. Halterman says she wishes she had never taken out the first home-equity loan. "I felt like I needed it," she says. "In retrospect, I needed my a -- kicked."
Other loans backing the HSBC-issued security were souring, as well. As of November, 25% were foreclosed, in the foreclosure process or at least a month delinquent, Mr. Atteberry says. HSBC declined to comment. Mr. Rybicki gave up his mortgage-banking license in September. He now works for a venture-capital firm. "The banks have part of the blame," Mr. Rybicki says of the housing bubble. "I think we have part of the blame. We were part of the system. So does the consumer." Wells Fargo, which serviced the West Hopi Street loan, boarded up the house and hauled away the debris. And this past Monday, the property sold for $18,000 to Daniel and Delia Arce, who live next door in a tidy brick rambler. After expenses, investors in the mortgage-backed security will probably divide up no more than $15,000 in proceeds. A few weeks ago, Mr. Arce asked Mike Summers, a city code-enforcement officer, whether a permit was required to raze the blue house. "Yes," Mr. Summers replied, "but all you need is the big, bad wolf to come out and huff and puff."
The End of the Financial World as We Know It
Americans enter the New Year in a strange new role: financial lunatics. We’ve been viewed by the wider world with mistrust and suspicion on other matters, but on the subject of money even our harshest critics have been inclined to believe that we knew what we were doing. They watched our investment bankers and emulated them: for a long time now half the planet’s college graduates seemed to want nothing more out of life than a job on Wall Street. This is one reason the collapse of our financial system has inspired not merely a national but a global crisis of confidence. Good God, the world seems to be saying, if they don’t know what they are doing with money, who does? Incredibly, intelligent people the world over remain willing to lend us money and even listen to our advice; they appear not to have realized the full extent of our madness. We have at least a brief chance to cure ourselves. But first we need to ask: of what?
To that end consider the strange story of Harry Markopolos. Mr. Markopolos is the former investment officer with Rampart Investment Management in Boston who, for nine years, tried to explain to the Securities and Exchange Commission that Bernard L. Madoff couldn’t be anything other than a fraud. Mr. Madoff’s investment performance, given his stated strategy, was not merely improbable but mathematically impossible. And so, Mr. Markopolos reasoned, Bernard Madoff must be doing something other than what he said he was doing. In his devastatingly persuasive 17-page letter to the S.E.C., Mr. Markopolos saw two possible scenarios. In the “Unlikely” scenario: Mr. Madoff, who acted as a broker as well as an investor, was “front-running” his brokerage customers. A customer might submit an order to Madoff Securities to buy shares in I.B.M. at a certain price, for example, and Madoff Securities instantly would buy I.B.M. shares for its own portfolio ahead of the customer order. If I.B.M.’s shares rose, Mr. Madoff kept them; if they fell he fobbed them off onto the poor customer.
In the “Highly Likely” scenario, wrote Mr. Markopolos, “Madoff Securities is the world’s largest Ponzi Scheme.” Which, as we now know, it was. Harry Markopolos sent his report to the S.E.C. on Nov. 7, 2005 — more than three years before Mr. Madoff was finally exposed — but he had been trying to explain the fraud to them since 1999. He had no direct financial interest in exposing Mr. Madoff — he wasn’t an unhappy investor or a disgruntled employee. There was no way to short shares in Madoff Securities, and so Mr. Markopolos could not have made money directly from Mr. Madoff’s failure. To judge from his letter, Harry Markopolos anticipated mainly downsides for himself: he declined to put his name on it for fear of what might happen to him and his family if anyone found out he had written it. And yet the S.E.C.’s cursory investigation of Mr. Madoff pronounced him free of fraud.
What’s interesting about the Madoff scandal, in retrospect, is how little interest anyone inside the financial system had in exposing it. It wasn’t just Harry Markopolos who smelled a rat. As Mr. Markopolos explained in his letter, Goldman Sachs was refusing to do business with Mr. Madoff; many others doubted Mr. Madoff’s profits or assumed he was front-running his customers and steered clear of him. Between the lines, Mr. Markopolos hinted that even some of Mr. Madoff’s investors may have suspected that they were the beneficiaries of a scam. After all, it wasn’t all that hard to see that the profits were too good to be true. Some of Mr. Madoff’s investors may have reasoned that the worst that could happen to them, if the authorities put a stop to the front-running, was that a good thing would come to an end.
The Madoff scandal echoes a deeper absence inside our financial system, which has been undermined not merely by bad behavior but by the lack of checks and balances to discourage it. “Greed” doesn’t cut it as a satisfying explanation for the current financial crisis. Greed was necessary but insufficient; in any case, we are as likely to eliminate greed from our national character as we are lust and envy. The fixable problem isn’t the greed of the few but the misaligned interests of the many. A lot has been said and written, for instance, about the corrupting effects on Wall Street of gigantic bonuses. What happened inside the major Wall Street firms, though, was more deeply unsettling than greedy people lusting for big checks: leaders of public corporations, especially financial corporations, are as good as required to lead for the short term.
Richard Fuld, the former chief executive of Lehman Brothers, E. Stanley O’Neal, the former chief executive of Merrill Lynch, and Charles O. Prince III, Citigroup’s chief executive, may have paid themselves humongous sums of money at the end of each year, as a result of the bond market bonanza. But if any one of them had set himself up as a whistleblower — had stood up and said “this business is irresponsible and we are not going to participate in it” — he would probably have been fired. Not immediately, perhaps. But a few quarters of earnings that lagged behind those of every other Wall Street firm would invite outrage from subordinates, who would flee for other, less responsible firms, and from shareholders, who would call for his resignation. Eventually he’d be replaced by someone willing to make money from the credit bubble.
Our financial catastrophe, like Bernard Madoff’s pyramid scheme, required all sorts of important, plugged-in people to sacrifice our collective long-term interests for short-term gain. The pressure to do this in today’s financial markets is immense. Obviously the greater the market pressure to excel in the short term, the greater the need for pressure from outside the market to consider the longer term. But that’s the problem: there is no longer any serious pressure from outside the market. The tyranny of the short term has extended itself with frightening ease into the entities that were meant to, one way or another, discipline Wall Street, and force it to consider its enlightened self-interest. The credit-rating agencies, for instance.
Everyone now knows that Moody’s and Standard & Poor’s botched their analyses of bonds backed by home mortgages. But their most costly mistake — one that deserves a lot more attention than it has received — lies in their area of putative expertise: measuring corporate risk. Over the last 20 years American financial institutions have taken on more and more risk, with the blessing of regulators, with hardly a word from the rating agencies, which, incidentally, are paid by the issuers of the bonds they rate. Seldom if ever did Moody’s or Standard & Poor’s say, “If you put one more risky asset on your balance sheet, you will face a serious downgrade.” The American International Group, Fannie Mae, Freddie Mac, General Electric and the municipal bond guarantors Ambac Financial and MBIA all had triple-A ratings. (G.E. still does!) Large investment banks like Lehman and Merrill Lynch all had solid investment grade ratings. It’s almost as if the higher the rating of a financial institution, the more likely it was to contribute to financial catastrophe. But of course all these big financial companies fueled the creation of the credit products that in turn fueled the revenues of Moody’s and Standard & Poor’s.
These oligopolies, which are actually sanctioned by the S.E.C., didn’t merely do their jobs badly. They didn’t simply miss a few calls here and there. In pursuit of their own short-term earnings, they did exactly the opposite of what they were meant to do: rather than expose financial risk they systematically disguised it. This is a subject that might be profitably explored in Washington. There are many questions an enterprising United States senator might want to ask the credit-rating agencies. Here is one: Why did you allow MBIA to keep its triple-A rating for so long? In 1990 MBIA was in the relatively simple business of insuring municipal bonds. It had $931 million in equity and only $200 million of debt — and a plausible triple-A rating. By 2006 MBIA had plunged into the much riskier business of guaranteeing collateralized debt obligations, or C.D.O.’s. But by then it had $7.2 billion in equity against an astounding $26.2 billion in debt. That is, even as it insured ever-greater risks in its business, it also took greater risks on its balance sheet.
Yet the rating agencies didn’t so much as blink. On Wall Street the problem was hardly a secret: many people understood that MBIA didn’t deserve to be rated triple-A. As far back as 2002, a hedge fund called Gotham Partners published a persuasive report, widely circulated, entitled: “Is MBIA Triple A?” (The answer was obviously no.) At the same time, almost everyone believed that the rating agencies would never downgrade MBIA, because doing so was not in their short-term financial interest. A downgrade of MBIA would force the rating agencies to go through the costly and cumbersome process of re-rating tens of thousands of credits that bore triple-A ratings simply by virtue of MBIA’s guarantee. It would stick a wrench in the machine that enriched them. (In June, finally, the rating agencies downgraded MBIA, after MBIA’s failure became such an open secret that nobody any longer cared about its formal credit rating.)
The S.E.C. now promises modest new measures to contain the damage that the rating agencies can do — measures that fail to address the central problem: that the raters are paid by the issuers. But this should come as no surprise, for the S.E.C. itself is plagued by similarly wacky incentives. Indeed, one of the great social benefits of the Madoff scandal may be to finally reveal the S.E.C. for what it has become. Created to protect investors from financial predators, the commission has somehow evolved into a mechanism for protecting financial predators with political clout from investors. (The task it has performed most diligently during this crisis has been to question, intimidate and impose rules on short-sellers — the only market players who have a financial incentive to expose fraud and abuse.)
The instinct to avoid short-term political heat is part of the problem; anything the S.E.C. does to roil the markets, or reduce the share price of any given company, also roils the careers of the people who run the S.E.C. Thus it seldom penalizes serious corporate and management malfeasance — out of some misguided notion that to do so would cause stock prices to fall, shareholders to suffer and confidence to be undermined. Preserving confidence, even when that confidence is false, has been near the top of the S.E.C.’s agenda. It's not hard to see why the S.E.C. behaves as it does. If you work for the enforcement division of the S.E.C. you probably know in the back of your mind, and in the front too, that if you maintain good relations with Wall Street you might soon be paid huge sums of money to be employed by it.
The commission’s most recent director of enforcement is the general counsel at JPMorgan Chase; the enforcement chief before him became general counsel at Deutsche Bank; and one of his predecessors became a managing director for Credit Suisse before moving on to Morgan Stanley. A casual observer could be forgiven for thinking that the whole point of landing the job as the S.E.C.’s director of enforcement is to position oneself for the better paying one on Wall Street. At the back of the version of Harry Markopolos’s brave paper currently making the rounds is a copy of an e-mail message, dated April 2, 2008, from Mr. Markopolos to Jonathan S. Sokobin. Mr. Sokobin was then the new head of the commission’s office of risk assessment, a job that had been vacant for more than a year after its previous occupant had left to — you guessed it — take a higher-paying job on Wall Street.
At any rate, Mr. Markopolos clearly hoped that a new face might mean a new ear — one that might be receptive to the truth. He phoned Mr. Sokobin and then sent him his paper. “Attached is a submission I’ve made to the S.E.C. three times in Boston,” he wrote. “Each time Boston sent this to New York. Meagan Cheung, branch chief, in New York actually investigated this but with no result that I am aware of. In my conversations with her, I did not believe that she had the derivatives or mathematical background to understand the violations.” How does this happen? How can the person in charge of assessing Wall Street firms not have the tools to understand them? Is the S.E.C. that inept? Perhaps, but the problem inside the commission is far worse — because inept people can be replaced. The problem is systemic. The new director of risk assessment was no more likely to grasp the risk of Bernard Madoff than the old director of risk assessment because the new guy’s thoughts and beliefs were guided by the same incentives: the need to curry favor with the politically influential and the desire to keep sweet the Wall Street elite.
And here’s the most incredible thing of all: 18 months into the most spectacular man-made financial calamity in modern experience, nothing has been done to change that, or any of the other bad incentives that led us here in the first place. Say what you will about our government’s approach to the financial crisis, you cannot accuse it of wasting its energy being consistent or trying to win over the masses. In the past year there have been at least seven different bailouts, and six different strategies. And none of them seem to have pleased anyone except a handful of financiers. When Bear Stearns failed, the government induced JPMorgan Chase to buy it by offering a knockdown price and guaranteeing Bear Stearns’s shakiest assets. Bear Stearns bondholders were made whole and its stockholders lost most of their money.
Then came the collapse of the government-sponsored entities, Fannie Mae and Freddie Mac, both promptly nationalized. Management was replaced, shareholders badly diluted, creditors left intact but with some uncertainty. Next came Lehman Brothers, which was, of course, allowed to go bankrupt. At first, the Treasury and the Federal Reserve claimed they had allowed Lehman to fail in order to signal that recklessly managed Wall Street firms did not all come with government guarantees; but then, when chaos ensued, and people started saying that letting Lehman fail was a dumb thing to have done, they changed their story and claimed they lacked the legal authority to rescue the firm. But then a few days later A.I.G. failed, or tried to, yet was given the gift of life with enormous government loans. Washington Mutual and Wachovia promptly followed: the first was unceremoniously seized by the Treasury, wiping out both its creditors and shareholders; the second was batted around for a bit. Initially, the Treasury tried to persuade Citigroup to buy it — again at a knockdown price and with a guarantee of the bad assets. (The Bear Stearns model.) Eventually, Wachovia went to Wells Fargo, after the Internal Revenue Service jumped in and sweetened the pot with a tax subsidy.
In the middle of all this, Treasury Secretary Henry M. Paulson Jr. persuaded Congress that he needed $700 billion to buy distressed assets from banks — telling the senators and representatives that if they didn’t give him the money the stock market would collapse. Once handed the money, he abandoned his promised strategy, and instead of buying assets at market prices, began to overpay for preferred stocks in the banks themselves. Which is to say that he essentially began giving away billions of dollars to Citigroup, Morgan Stanley, Goldman Sachs and a few others unnaturally selected for survival. The stock market fell anyway.
It’s hard to know what Mr. Paulson was thinking as he never really had to explain himself, at least not in public. But the general idea appears to be that if you give the banks capital they will in turn use it to make loans in order to stimulate the economy. Never mind that if you want banks to make smart, prudent loans, you probably shouldn’t give money to bankers who sunk themselves by making a lot of stupid, imprudent ones. If you want banks to re-lend the money, you need to provide them not with preferred stock, which is essentially a loan, but with tangible common equity — so that they might write off their losses, resolve their troubled assets and then begin to make new loans, something they won’t be able to do until they’re confident in their own balance sheets. But as it happened, the banks took the taxpayer money and just sat on it.
How to Repair a Broken Financial World
Continued from "The End of the Financial World As We Know It"
Mr. Paulson must have had some reason for doing what he did. No doubt he still believes that without all this frantic activity we’d be far worse off than we are now. All we know for sure, however, is that the Treasury’s heroic deal-making has had little effect on what it claims is the problem at hand: the collapse of confidence in the companies atop our financial system. Weeks after receiving its first $25 billion taxpayer investment, Citigroup returned to the Treasury to confess that — lo! — the markets still didn’t trust Citigroup to survive. In response, on Nov. 24, the Treasury handed Citigroup another $20 billion from the Troubled Assets Relief Program, and then simply guaranteed $306 billion of Citigroup’s assets.
The Treasury didn’t ask for its fair share of the action, or management changes, or for that matter anything much at all beyond a teaspoon of warrants and a sliver of preferred stock. The $306 billion guarantee was an undisguised gift. The Treasury didn’t even bother to explain what the crisis was, just that the action was taken in response to Citigroup’s “declining stock price.” Three hundred billion dollars is still a lot of money. It’s almost 2 percent of gross domestic product, and about what we spend annually on the departments of Agriculture, Education, Energy, Homeland Security, Housing and Urban Development and Transportation combined. Had Mr. Paulson executed his initial plan, and bought Citigroup’s pile of troubled assets at market prices, there would have been a limit to our exposure, as the money would have counted against the $700 billion Mr. Paulson had been given to dispense.
Instead, he in effect granted himself the power to dispense unlimited sums of money without Congressional oversight. Now we don’t even know the nature of the assets that the Treasury is standing behind. Under TARP, these would have been disclosed. There are other things the Treasury might do when a major financial firm assumed to be “too big to fail” comes knocking, asking for free money. Here’s one: Let it fail. Not as chaotically as Lehman Brothers was allowed to fail. If a failing firm is deemed “too big” for that honor, then it should be explicitly nationalized, both to limit its effect on other firms and to protect the guts of the system. Its shareholders should be wiped out, and its management replaced. Its valuable parts should be sold off as functioning businesses to the highest bidders — perhaps to some bank that was not swept up in the credit bubble. The rest should be liquidated, in calm markets. Do this and, for everyone except the firms that invented the mess, the pain will likely subside.
This is more plausible than it may sound. Sweden, of all places, did it successfully in 1992. And remember, the Federal Reserve and the Treasury have already accepted, on behalf of the taxpayer, just about all of the downside risk of owning the bigger financial firms. The Treasury and the Federal Reserve would both no doubt argue that if you don’t prop up these banks you risk an enormous credit contraction — if they aren’t in business who will be left to lend money? But something like the reverse seems more true: propping up failed banks and extending them huge amounts of credit has made business more difficult for the people and companies that had nothing to do with creating the mess. Perfectly solvent companies are being squeezed out of business by their creditors precisely because they are not in the Treasury’s fold. With so much lending effectively federally guaranteed, lenders are fleeing anything that is not.
Rather than tackle the source of the problem, the people running the bailout desperately want to reinflate the credit bubble, prop up the stock market and head off a recession. Their efforts are clearly failing: 2008 was a historically bad year for the stock market, and we’ll be in recession for some time to come. Our leaders have framed the problem as a “crisis of confidence” but what they actually seem to mean is “please pay no attention to the problems we are failing to address.” In its latest push to compel confidence, for instance, the authorities are placing enormous pressure on the Financial Accounting Standards Board to suspend “mark-to-market” accounting. Basically, this means that the banks will not have to account for the actual value of the assets on their books but can claim instead that they are worth whatever they paid for them.
This will have the double effect of reducing transparency and increasing self-delusion (gorge yourself for months, but refuse to step on a scale, and maybe no one will realize you gained weight). And it will fool no one. When you shout at people “be confident,” you shouldn’t expect them to be anything but terrified. If we are going to spend trillions of dollars of taxpayer money, it makes more sense to focus less on the failed institutions at the top of the financial system and more on the individuals at the bottom. Instead of buying dodgy assets and guaranteeing deals that should never have been made in the first place, we should use our money to A) repair the social safety net, now badly rent in ways that cause perfectly rational people to be terrified; and B) transform the bailout of the banks into a rescue of homeowners.
We should begin by breaking the cycle of deteriorating housing values and resulting foreclosures. Many homeowners realize that it doesn’t make sense to make payments on a mortgage that exceeds the value of their house. As many as 20 million families face the decision of whether to make the payments or turn in the keys. Congress seems to have understood this problem, which is why last year it created a program under the Federal Housing Authority to issue homeowners new government loans based on the current appraised value of their homes.
And yet the program, called Hope Now, seems to have become one more excellent example of the unhappy political influence of Wall Street. As it now stands, banks must initiate any new loan; and they are loath to do so because it requires them to recognize an immediate loss. They prefer to “work with borrowers” through loan modifications and payment plans that present fewer accounting and earnings problems but fail to resolve and, thereby, prolong the underlying issues. It appears that the banking lobby also somehow inserted into the law the dubious requirement that troubled homeowners repay all home equity loans before qualifying. The result: very few loans will be issued through this program.
This could be fixed. Congress might grant qualifying homeowners the ability to get new government loans based on the current appraised values without requiring their bank’s consent. When a corporation gets into trouble, its lenders often accept a partial payment in return for some share in any future recovery. Similarly, homeowners should be permitted to satisfy current first mortgages with a combination of the proceeds of the new government loan and a share in any future recovery from the future sale or refinancing of their homes. Lenders who issued second mortgages should be forced to release their claims on property. The important point is that homeowners, not lenders, be granted the right to obtain new government loans. To work, the program needs to be universal and should not require homeowners to file for bankruptcy. There are also a handful of other perfectly obvious changes in the financial system to be made, to prevent some version of what has happened from happening all over again. A short list:
Stop making big regulatory decisions with long-term consequences based on their short-term effect on stock prices. Stock prices go up and down: let them. An absurd number of the official crises have been negotiated and resolved over weekends so that they may be presented as a fait accompli “before the Asian markets open.” The hasty crisis-to-crisis policy decision-making lacks coherence for the obvious reason that it is more or less driven by a desire to please the stock market. The Treasury, the Federal Reserve and the S.E.C. all seem to view propping up stock prices as a critical part of their mission — indeed, the Federal Reserve sometimes seems more concerned than the average Wall Street trader with the market’s day-to-day movements. If the policies are sound, the stock market will eventually learn to take care of itself.
End the official status of the rating agencies. Given their performance it’s hard to believe credit rating agencies are still around. There’s no question that the world is worse off for the existence of companies like Moody’s and Standard & Poor’s. There should be a rule against issuers paying for ratings. Either investors should pay for them privately or, if public ratings are deemed essential, they should be publicly provided.
Regulate credit-default swaps. There are now tens of trillions of dollars in these contracts between big financial firms. An awful lot of the bad stuff that has happened to our financial system has happened because it was never explained in plain, simple language. Financial innovators were able to create new products and markets without anyone thinking too much about their broader financial consequences — and without regulators knowing very much about them at all. It doesn’t matter how transparent financial markets are if no one can understand what’s inside them. Until very recently, companies haven’t had to provide even cursory disclosure of credit-default swaps in their financial statements.
Credit-default swaps may not be Exhibit No. 1 in the case against financial complexity, but they are useful evidence. Whatever credit defaults are in theory, in practice they have become mainly side bets on whether some company, or some subprime mortgage-backed bond, some municipality, or even the United States government will go bust. In the extreme case, subprime mortgage bonds were created so that smart investors, using credit-default swaps, could bet against them. Call it insurance if you like, but it’s not the insurance most people know. It’s more like buying fire insurance on your neighbor’s house, possibly for many times the value of that house — from a company that probably doesn’t have any real ability to pay you if someone sets fire to the whole neighborhood. The most critical role for regulation is to make sure that the sellers of risk have the capital to support their bets.
Impose new capital requirements on banks. The new international standard now being adopted by American banks is known in the trade as Basel II. Basel II is premised on the belief that banks do a better job than regulators of measuring their own risks — because the banks have the greater interest in not failing. Back in 2004, the S.E.C. put in place its own version of this standard for investment banks. We know how that turned out. A better idea would be to require banks to hold less capital in bad times and more capital in good times. Now that we have seen how too-big-to-fail financial institutions behave, it is clear that relieving them of stringent requirements is not the way to go. Another good solution to the too-big-to-fail problem is to break up any institution that becomes too big to fail.
Close the revolving door between the S.E.C. and Wall Street. At every turn we keep coming back to an enormous barrier to reform: Wall Street’s political influence. Its influence over the S.E.C. is further compromised by its ability to enrich the people who work for it. Realistically, there is only so much that can be done to fix the problem, but one measure is obvious: forbid regulators, for some meaningful amount of time after they have left the S.E.C., from accepting high-paying jobs with Wall Street firms.
But keep the door open the other way. If the S.E.C. is to restore its credibility as an investor protection agency, it should have some experienced, respected investors (which is not the same thing as investment bankers) as commissioners. President-elect Barack Obama should nominate at least one with a notable career investing capital, and another with experience uncovering corporate misconduct. As it happens, the most critical job, chief of enforcement, now has a perfect candidate, a civic-minded former investor with firsthand experience of the S.E.C.’s ineptitude: Harry Markopolos. The funny thing is, there’s nothing all that radical about most of these changes. A disinterested person would probably wonder why many of them had not been made long ago. A committee of people whose financial interests are somehow bound up with Wall Street is a different matter.
Ilargi: Sharon Astyk writes this on the interesting new Vermont food stamp program. I think the reasoning behind the program is pretty brilliant. A community needs to take care of its weakest.
Along with new focus, Food Stamps get new name
Say goodbye to "Food Stamps." Say hello to "3Squares VT." The well-known Food Stamp program got a new updated name Friday, and Vermont Gov. James Douglas was on hand for the launch, standing in front of three tables of food at Shaw's Supermarket Friday afternoon. The state's expanded nutrition program was symbolized by the display of foods for breakfast, lunch and dinner, underscoring the new name and "3Squares" focus on healthy eating. Enrollment in the program currently stands at 31,000, or more than 12 percent, of Vermont's approximately 250,000 households. Those households represent more than 61,000 individuals in the state.
The program has expanded by about 57 percent since 2001, when it served 39,000 individuals, said Steve Dale, the commissioner of the Department for Children and Families. Douglas said he anticipates that "tens of thousands of additional Vermont families will be eligible" for 3Squares VT. "What better time to make that important change than now, when so many Vermonters are struggling to pay their bills in these challenging economic times," he said. During the summer, anti-hunger advocates and members of the Vermont Food and Fuel Partnership looked for the most effective way to confront an expected winter crisis caused by spiking fuel bills that could force Vermonters to cut back on food. The consensus was to raise the eligibility ceiling for the supplemental nutrition assistance program and eliminate the asset test, which Douglas called "a burden to participation." Those changes, agreed to last summer, went into effect Jan. 1.
Now people with gross incomes of 185 percent of the federal poverty level, up from 130 percent, are eligible for the program. That's $3,269 a month for a family of four. And people will no longer have to spend down their savings for their children's college education or their retirement to qualify. "That's still lower income, but when you take away the onus of being the poorest of the poor, people realize, 'This is for me!'" said Renée Richardson, the director of the program. "3Squares VT is more than just a renamed Food Stamp program," Douglas declared. "It is an expanded supplemental nutrition assistance program that can help more hard-working Vermonters than ever put three square meals on their table. Calling the program by a more accurate name can help mit-igate some of the embarrassment or stigma some applicants might associate with the program."
The process of coming up with the name wasn't easy. It started with a survey of the Economic Services Division. "We got 291 responses," Richardson said. "We weeded through those responses, and we said, 'We can't pick anything out of this!'" Then she and her staff held focus groups and conducted interviews with stakeholders. Finally, they narrowed the choices down to four names, and "(3Squares VT) seemed to be the one that resonated with us." Douglas noted that the original "food stamps" have not been used to issue benefits since the early 1940s. The coupon books that replaced the stamps have not been seen in Vermont since 1998, when the state began issuing benefits through a system that uses plastic cards resembling credit cards. To provide more privacy and flexibility for the elderly and disabled, recipients over 65 and those receiving SSI have their benefits deposited as cash to their bank accounts.
"We see the new name in the same light as 'Dr. Dynasaur,' helping us all think differently about this program – it's designed to help people have balanced, nutritious meals on their tables," said Dale. "I don't sense any stigma or shame or anything connected with Dr. Dynasaur. There's a huge percentage of the population of children that are covered by Dr. Dynasaur." He said he hopes 3Squares will be seen in the same way as the state's health care access program for children, or as other entitlement programs such as Social Security and Medicare.
Dale noted that Douglas was responsive to the idea of expanding access to the nutrition program when the issue was raised, and that he supported hiring additional staff to handle the increased caseload. Dale thanked staff members for their hard work over the fall. "This is no small project," he observed. "To actually have it happen on schedule is a major undertaking." Richards observed that qualifying for 3Squares VT automatically qualifies people for a variety of other programs, such as Lifeline, a discount on basic telephone service, free day-care meals and free school meals. School meals cost an average of $70-$90 a month for each child, she said, and the money saved can be spent on meals the family eats at home.
Richards noted that 100 percent of the program's benefits are paid for by the federal government. In November, $6.7 million in Food Stamp benefits were distributed around the state, she said. Because the benefits can't be saved or used to pay previous grocery bills, the money functions as direct economic stimulus. Richards estimated the stimulus effect of November's benefits at more than $12 million. The new program expansion could mean an additional $12 million per year in food assistance for low-income Vermont families, which would have the effect of infusing $22 million into the state's economy, according to the governor's office.
The state's interest in expanding the program is two-fold. "It's in the interest of all of us that people receive proper nutrition," Dale said. "We certainly all know the cost of obesity. We know the cost of diabetes. We know the cost of chronic diseases. Obviously nutritious food is absolutely essential to the health of all of us, and in the health world we've all come to learn that preventive health care is the most cost-effective approach. At a minimum, the interest of government ... is in keeping the population healthy."
Dale also cited a second reason. "I think the government's interest in promoting this program is that it really isn't OK from a social justice perspective for people to be going hungry in a country that has the kind of plenty that we have," he said. "The program was created to address that issue, and we would hope that people will take advantage of it."