Storage tanks, Phillips gasoline plant, Borger, Texas.
Ilargi: Tons of stories today, of course, on the reform plans presented and defended by Obama and Geithner. A few critical ones make some sense, at least. Still, I keep thinking they all miss the point. Which is that you very simply can't have bankers decide how reform themselves, even if they're on a brief sojourn in government. There is no doubt about the side of the equation (banks vs you) the likes of Geithner, Summers, Rubin and all the rest represent. The financial reform then, is an exercise in insanity. And so, by extension, is our discussing it.
It's by no means easy, but attempting to grant even bigger (or is that higher?) than existing powers to the Federal Reserve may be even more crazy. We don't know what the Federal Reserve do, other than what they like us to think they do. An organization that would, under Obama's scheme, have nigh dictatorial control over all financial institutions in the country, ostensibly all with the best interest of the people at heart, but that cannot be held to account, cannot be audited, and is at least in part owned (the people are not allowed to know that either), by private enterprises whose interests may potentially be 180 degrees different from those of the people.
How did we ever get here, what happened along the way? Are the people not supposed to rule themselves, is that not how the whole thing started, what the country's foundations were all designed to be based on? Am I the only one thinking that once more under the guise of protection of the people, yet another set of rights and votes and self-determination is being "legally" stripped away, this time to an extent that makes it hard to see what will be left, if anything?
I mean, even if the negative aspects of what is being brewed in Washington now take some time to become evident, even if there may initially seem to be some things that can be perceived as positive by some that still would be the wrong focus to have as a people. It's a matter of principle, one that your founding fathers would have understood perfectly well. There's no such thing as an opaque democracy.
You can't, or should we say you shouldn't, continue to pretend you live in a democracy, and at the same time hand over all end-control over your welfare, if not well-being, as a people, as a society, to a group of individuals, corporations and interests who operate in a sphere that fundamentally excludes you from entering, from questioning and from voting them out of their powers. What you can do, today, is make sure they don't get that level of control.
That will not be easy. You know now that the government you recently voted in is not on your side in this issue. Which means you’ll have to find other democratic ways to make sure your interests, and those of your children, are guarded. Alternatively, if you don't, you place your fate in the hands of the same small group of financiers that, in order to turn a -larger- profit, has brought your society to the brink of abject poverty. Are you going to let them push you over the edge?
States in Deep Trouble Over Plunging Income Tax Revenues
The Nelson A. Rockefeller Institute of Government has issued a State Revenue Flash Report discussing an across the board enormous drop in personal income tax revenues.Total personal income tax collections in January-April 2009 were 26 percent, or about $28.8 billion below the level of a year ago in states for which we have data. In April 2009 alone (April being the month when many states receive the bulk of their balance due or final payments), personal income tax receipts fell by 36.5 percent, or $18.2 billion. Personal income tax receipts in the first four months of calendar year 2009 were greater than in 2008 in only three states — Alabama, North Dakota, and Utah.
In FY 2008, personal income tax revenue made up over 50 percent of total tax collections in six states — Colorado, Connecticut, Massachusetts, New York, Oregon, and Virginia. Personal income tax revenue declined dramatically in all six of these states for the months of January-April of 2009 compared to the same period of 2008. Among all 37 early-reporting states, the largest decline was in Arizona, where collections declined by nearly 55 percent. In the month of April alone, 37 early reporting states collected about $18.2 billion less in personal income tax revenues compared to the same month of 2008.
This $18.2 billion is close to the $20 billion shortfall that states experienced in overall tax revenue collections in the first quarter of calendar year 2009. This is particularly bad news for the states that rely most heavily on personal income tax. Given the ominous picture of personal income tax collections, deeper overall revenue shortfalls and further deterioration in states’ fiscal conditions are likely on the way for most states for the April-June quarter of calendar year 2009.What a Bad April Does to State Budget Processes
An April income tax shortfall comes at the worst time of year for two reasons. First, by the time it is recognized in late April or mid-May, it is just 6-10 weeks before the end of the fiscal year for 46 states. For states without large cash balances, this can create a cash flow crunch or even a cash flow crisis. There is not enough time to enact and implement new legislation cutting spending, laying off workers, raising taxes, or otherwise obtaining resources sufficient to offset the lost revenue before the June 30 end of the fiscal year. As a result, a state without sufficient cash on hand to pay bills must resort to stopgap measures to “roll” the problem into the future.
Second, the increased budget problems caused by an April income tax shortfall come late in the fiscal year and late in the budget process — often as states are supposed to wrap up their budget negotiations. The new bad news for elected officials can unsettle carefully balanced gap-closing plans already tentatively negotiated. Since the budget actions included in these tentative plans presumably were the most attractive options available to them, almost by definition actions to close new budget gaps will be much more difficult.
All of this makes it hard for budget negotiators to reach agreements that will fully close the new budget gaps. It raises the risk that the newly adopted budget will take an optimistic view of the year ahead and may unravel as the year progresses, requiring midyear cuts. And because those solutions that are adopted may be nonrecurring in nature, it raises the risk that states will face larger gaps for 2010-11 when such nonrecurring resources go away.
There are numerous tables in the report worth a look. In fact, the entire 9 page PDF is worth reading in entirety.
States most dependent on Personal Income Taxes
- 68.5% of Oregon's Tax Revenue from PIT.
Collections off 27.0%
- 57.2% of Massachusetts' Tax Revenue from PIT.
Collections off 28.5%
- 55.9% of New York's Tax Revenue from PIT.
Collections off 31.8%
- 47.5% of California's' Tax Revenue from PIT.
Collections off 33.8%
- 52.4% of Connecticut's Tax Revenue from PIT.
Collections off 25.9%
- 52.7% of Colorado's Tax Revenue from PIT.
Collections off 25.4%
Arizona's collections were down a whopping 54.9% depending 25.3% on Personal Income Taxes. South Carolina, Michigan, Vermont, Rhode Island, New Jersey, Idaho, and Ohio are also in deep trouble. 20 states depending on personal incomes taxes for > 25% of total taxes were down 20% or more on collections. This is a very grim report on state finances.
Look What Happens To Tax Rates When Debt And Deficits Balloon
We don't know about you, but we're not excited about the apparent correlation here between massive government debt and deficits (blue and dotted blue lines) and sky-high marginal tax rates (red). Yes, in previous eras, it appears that high taxes preceded the exploding debt and deficits. But we have this sneaking suspicion that that apparently comforting pattern will be reversed this time. Paul Sutter, who sent us the chart, notes the "30 year tax hangover" it took us to work off the debt we accumulated in WW2. He also notes that it takes a lot less time to accumulate a mountain of debt than it does to pay it off.
Consumer Price Index June 2009
After a near decade of an aggressive rising inflation level, we are still in a period of Deflation. As someone else (David Rosenberg perhaps?) has said, as of right now,"Deflation is a fact; Inflation is an Opinion."
We Have Mortgage Lift Off
The spread between mortgages and the 10 year just exploded...
But not because anyone is buying the 10 year.
I think the banks are a great short
U.S. Unemployment Benefit Rolls Fall; Claims Rise
The number of Americans receiving claims for unemployment benefits dropped for the first time since January, adding to evidence the job market is starting to thaw. The number of people collecting unemployment insurance plunged by 148,000 in the week to June 6, the most since November 2001, to 6.69 million, the Labor Department said today in Washington. Initial claims rose by 3,000 to 608,000 in the week ended June 13, in line with forecasts.
The average number of claims over the last four weeks fell to the lowest level in four months, an indication that the U.S. economy is stabilizing after the worst recession in half a century. Even so, companies are likely to be slow to hire new employees, sending unemployment rates higher, analysts said. “The labor market remains weak but it’s starting to stabilize,” said Maxwell Clarke, chief U.S. economist at IDEAglobal in New York. “An improvement in employment conditions and improvement in confidence go hand in hand with an improvement in consumer spending.”
Treasuries dropped to their lows of the day after the report, sending yields on benchmark 10-year notes up to 3.74 percent at 9:20 a.m. in New York from 3.69 percent late yesterday. Futures on the Standard & Poor’s 500 Stock Index rose 0.3 percent to 908.20. Economists forecast claims would rise to 604,000, according to the median of 40 estimates in a Bloomberg News survey, from a previously reported 601,000 a week earlier. Estimates ranged from 586,000 to 632,000. The four-week moving average of initial claims, a less volatile measure, fell to 615,750, the lowest level since February, from 622,750.
The jobless rate among people eligible for benefits dropped to 5 percent in the week ended June 6, the first decrease since December, from 5.1 percent. Last week’s data coincides with the week the Labor Department conducts its monthly payrolls survey. Forty-five states and territories reported an increase in new claims for the week ended June 6, while eight had a decrease. The government is scheduled to release its June payrolls report July 2. The Federal Reserve said last week said the U.S. downturn may be slowing in almost half of its regions though a “weak” labor market persists.
“Labor market conditions continued to be weak across the country, with wages generally remaining flat or falling,” the Fed said in its Beige Book business survey. Some employers were freezing or cutting wages or reducing workers’ benefits and hours, the report said. Still, “several districts saw signs that job losses may be moderating,” and staffing firms “reported some modest signs of recovery,” the Fed said. Fed policy makers are scheduled to meet again next week on the direction of monetary policy.
News Corp.’s MySpace social-networking unit fired almost 30 percent of its staff to save money in response to falling advertising sales and gains by larger rival Facebook Inc. Bankruptcies at General Motors Corp. and Chrysler Group LLC may also inflate benefit rolls for weeks to come. Chrysler, which resumed production at one plant this week, may not open some facilities until late July. Chrysler likely will reopen its plants on a staggered schedule and some will be open only a week or two before the company’s annual two-week shut down that begins July 13, said Dianna Gutierrez, a company spokeswoman. She declined to release the start-up dates for its individual plants.
The Doubling Of Unemployment "Paychecks"
by Tyler Durden
As program trading computers pretend to care about such fundamental things as continuing jobless claims, a peculiar trend emerges. Over the past two months, it has become obvious that while continuing claims have doubled (up 124% to be precise from March 2007) - a major metric that many market participants (at least ones not based on a SPARC architecture) have been following - another, potentially more troubling observation is that Monthly Unemployment Payments have doubled the rate of increase in jobless claims (234% from March 2007 based on the Treasury Daily Statement). (For Leibniz fans, is this a third derivative issue?)
In summary, over the past two years, while unemployment claims have climbed from 2,688 million in March 2007 to 6,157 in May 2009, monthly unemployment payments have skyrocketed from $3,238 million to $10,807 over the same time period. Furthermore, run rating June 15 intramonth results, indicates that this will be the all time most cash outflowing month for unemployment benefits, at $12,354 million.
What all this means is that the Average Monthly Unemployment "Paycheck" has exploded from on average $1,000 to $1,800 in recent months (and over $2,000 runrated for June). Has the government been "pushing" benefits to the unemployed since December of 2008, when the increase commenced? The trend can be visualized easily in the chart below.
This would make sense practically: as there is way too much money that needs to be pushed to the consumer (either employed or unemployed), and since neither is borrowing from banks, maybe the Fed/Treasury have decided to facilitate the collection of outsized unemployment benefits in order to push the propagation of dollars in the economy. Of course, absent significant legislative change this would likely not be a legal approach to enhance M2 or MZM.
by Bill Bonner
Summer begins in 3 days. We can hardly wait. We predict it will be a killer.Several interesting things are likely to happen this summer.
- Unemployment rates will go up.
- Rising joblessness will increase rates of defaults, foreclosures, and bankruptcies. Not just at the consumer level - but throughout the system...including banks, states, businesses, as well as households
- The stock market will take a dive as earnings fall and investors realize that there will be no quick recovery
Oh...and one more thing: U.S. bonds could collapse. But watch out...here's where it gets tricky. Another swoon in the stock market could send investors running for the smelling salts in the bond market. A collapse of bond prices, on the other hand, could send them helter skelter into stocks. Yesterday, the Dow rose 7 points. Oil held at $71. The dollar lost a little ground - to $1.39 per euro. And gold added 3 bucks. It is impossible to predict what will happen - or when - in the markets. So let us turn our attention to the real economy.
Here, we see the picture more clearly: We're in a depression. We write depression with a small 'd.' We're saving the big one for later. Few economists or analysts will tell you we're in a depression. They're looking at "green shoots" and rising trendlines. They'd do better to read a little history. Such as the history of the Great Depression. Martin Wolf in the Financial Times (reporting the results of a study by two American professors):First, global industrial output tracks the decline in industrial output during the Great Depression horrifyingly closely. Within Europe, the decline in the industrial output of France and Italy has been worse than at this point in the 1930s, while that of the UK and Germany is much the same. The declines in the US and Canada are also close to those in the 1930s. But Japan's industrial collapse has been far worse than in the 1930s, despite a very recent recovery.
Second, the collapse in the volume of world trade has been far worse than during the first year of the Great Depression. Indeed, the decline in world trade in the first year is equal to that in the first two years of the Great Depression. This is not because of protection, but because of collapsing demand for manufactures.
Third, despite the recent bounce, the decline in world stock markets is far bigger than in the corresponding period of the Great Depression.
The two authors sum up starkly: "Globally we are tracking or doing even worse than the Great Depression... This is a Depression-sized event."
Yesterday, we proposed two sine qua non for a new boom. Either the feds revive the old economy - by getting people to borrow and spend more money. Or, the mistakes of the past must be corrected...whereupon new investment and growth can take place. While the free market is busy working on the latter, central banks and national governments all over the world are trying to stop it. They've got the voters and campaign contributors to answer to, none of whom wants to get what he deserves. Instead, they're hoping to revive the Bubble Epoque. Citizens are already up to their necks in debt; but the feds raise the water level! This flood of fed liquidity seems to be raising boats and animal spirits among speculators. But it is doing nothing to revive the real economy.
"Consumer Costs Fall Most in Six Decades," reports Bloomberg. Europe is already in deflation. America is not far behind. We had a hard time following the Bloomberg report. It said consumer prices were 1.3% below those of 12 months ago. We don't believe that's true. What we think Bloomberg meant to say was that prices are increasing at the slowest pace in 6 decades...but, for the moment, inflation is still (barely) positive. With prices falling, the last thing the feds are worrying about is inflation. Except that there isn't any. And they're going to worry a lot more over the summer, when the hot sun beats down on a lifeless economy and it becomes obvious that their revival efforts have failed.
Global commerce has fallen in line with the Great Depression. That means producers don't need to produce so much...and don't need so many people to produce it. Jobs are lost. And then the people who lose their jobs don't go out to restaurants and malls so much...so more jobs are lost. These job losses take time to show up. And then they take time to "ripen." People tend to have a little something set aside for a rainy day - or at least, unemployment compensation. But after a few weeks of stormy weather, the reserves are exhausted. Then...they have to cut back much more.
USA Today asked people: "If you lost your job, how long could you afford to pay for your own health insurance?" More than 65% of respondents said they could only manage for 6 months or less. In America "there hasn't been a shock like this since the de- mobilization of millions of soldiers following WWII: something like 3 million unemployed people are going to fall out of the safety net in the third quarter. With their families, that's about 10 million people who will sink suddenly into deep poverty," says GEAB a private research service headquartered in Paris. The group anticipates a "Very Great Depression" coming to the United States.
More than three million jobs have been lost in the United States during the last five months. As these out-of-work cases ripen, there will be some rotten fruit falling to ground. There are also the millions who are working fewer hours and earning less money. In fact, the number of hours worked per week has fallen to a record low. Where do people without jobs, without incomes, without savings - and without benefits - shop? What money do they spend? How does a consumer economy launch a boom when consumers have less money to spend? These questions have obvious answers and obvious implications: there ain't going to be any consumer spending boom in the U.S.A....not this summer...and probably not for many summers to come. Martin Wolf explains why:"Robust private sector demand will return only once the balance sheets of over-indebted households, overborrowed businesses and undercapitalised financial sectors are repaired or when countries with high savings rates consume or invest more. None of this is likely to be quick. Indeed, it is far more likely to take years, given the extraordinary debt accumulations of the past decade. Over the past two quarters, for example, US households repaid just 3.1 per cent of their debt. Deleveraging is a lengthy process."
If we assume that debt levels need to go back to where they were before the Bubble Epoque...well, let's say to 200% of GDP just to make the math easy...that means 170% of GDP worth of debt needs to be paid off. That's $20 trillion, in round numbers - or about 40% of the total. At 6% per year, even if households kept paying off debt at the current rate it would still take nearly 7 years to get household debt down to pre-bubble levels. Then, of course, there is the government debt - now expanding faster than ever. The United States has the biggest deficit - even as a percentage of GDP - of any serious country in the world. The U.S. deficit is 12% or 13% of GDP. Compare that to Russia at 2.6%...Spain at 6%...France at 5%...Brazil at 1.3%.... Even Argentina has a much smaller deficit than the US - only 3.6% of GDP.
But don't worry about it. The 'Committee to Save the World, Part II' is on the case. Geithner, Bernanke and Summers are staying in the office throughout the hot months. They kept us out of trouble so far, didn't they? So enjoy the beach! The United States has entered the Third Stage of a great nation. The Political Stage. In the late 20th century, power and money moved from the banks of the Monongahela to the banks of the Hudson. Now they're moving again - to the banks of the Potomac. Washington calls the shots.
"Obama Blueprints Deepen Federal Role in Markets," says a headline in yesterday's Washington Post. Of course, this change didn't happen overnight. George W. Bush was a trailblazer - turning 'conservatives!' into big spending activists. And the business community - particularly the banks - saw it coming and got ready. In 2001 the banking industry spent $5 million on lobbying in Washington. The total went up every year. By 2008, they were spending $20 million. Campaign contributions from bankers increased too...from only $4 million from the bankers' political action committees in 2000 to $8 million last year. Judging from the bailouts given to Wall Street last year, this investment paid off handsomely.
Michael Lewis slams the political influence of Wall Street
How We're Going To Fix Wall Street
by Tim Geithner
Chairman Dodd, Ranking Member Shelby, members of the Banking Committee. I'm pleased to be here today to testify about the Administration's plan for financial regulatory reform.
Over the past two years, our nation has faced the most severe financial crisis since the Great Depression. Our financial system failed to perform as it should have – by distributing and reducing risk.
Instead, the system magnified risk. Some of the world's largest institutions failed. The resulting damage on Wall Street hit Main Streets across the country, affecting virtually every American.
Millions have lost their jobs, families have lost their homes, small businesses have shut down, students have deferred college, and seniors have shelved retirement plans. American families are making essential changes in response to this crisis. It is our responsibility to do the same – to make our government work better.
That is why yesterday President Obama unveiled a sweeping set of regulatory reforms to lay the foundation for a safer, more stable financial system; one that can deliver the benefits of market-driven financial innovation even as it guards against the dangers of market-driven excess. Every financial crisis of the last generation has sparked some effort at reform. But past efforts have begun too late, after the will to act has subsided.
We cannot let that happen this time. We may disagree about the details, and we will have to work through those issues. But ordinary Americans have suffered too much; trust in our financial system has been too shaken; our economy has been brought too close to the brink for us to let this moment pass. In crafting our plan, the Administration sought input from all sources. We consulted extensively with Members of Congress, regulators, consumer advocates, business leaders, academics and the broader public.
We considered a full range of options and decided that now is the time to pursue the essential reforms, those that address the core causes of the current crisis; and that will help to prevent or contain future crises. Let me be clear, our plan does not address every problem in our financial system. That is not our intent. It does not propose reforms that, while desirable, would not move us towards achieving those core objectives and creating a more stable system. By now, the details of our proposals are widely available so I would like to spend a few minutes explaining the priorities that guided us.
If this crisis has taught us anything, it is that risk to our financial system can come from almost any quarter, so we must be able to look in every corner and across the horizon for dangers. Clearly, our current regulatory structure was not able to do that. While many of the firms and markets at the center of the crisis were under some form of federal regulation, that supervision didn't prevent the emergence of large concentrations of risk.
A patchwork of supervisory responsibility; loopholes that allowed some institutions to shop for the weakest regulator; and the rise of new financial institutions and instruments that were almost entirely outside the government's supervisory framework left regulators largely blind to emerging dangers. And regulators were ill-equipped to spot system-wide threats because each was assigned to protect the safety and soundness of the individual institutions under their watch. None was assigned to look out for the system as a whole.
That is why we propose establishing a Financial Services Oversight Council to bring together the heads of all of the major federal financial regulatory agencies. This Council will fill gaps in the regulatory structure where they exist. It will improve coordination of policy and resolution of disputes. And, most importantly, it will have the power to gather information from any firm or market to help identify emerging risks. The Council does not have the responsibility for supervising the largest, most complex and interconnected institutions. The reason is simple: that is a specialized task, which requires tremendous institutional capacity and organizational accountability.
Nor would the council be an appropriate first responder in a financial emergency. You don't convene a committee to put out a fire. The Federal Reserve is best positioned to play that role. It already supervises and regulates bank holding companies, including all major U.S. commercial and investment banks. Our plan gives a modest amount of additional authority - and accountability - to the Fed to carry out that mission. But it also takes some authority away.
Specifically, we propose removing from the Federal Reserve and other regulators, oversight responsibility for consumers. Historically, in those agencies, consumer interests were often perceived to be in conflict with the safety and soundness of institutions. That brings me to our second key priority -- consolidating protection for consumers and ensuring they can understand the risks and rewards associated with products sold directly to them.
Before this crisis many federal and state regulators had authority to protect consumers, but few viewed it as their primary charge. As abusive practices spread, particularly in the market for subprime and nontraditional mortgages, our regulatory framework proved inadequate. This lack of oversight led millions of Americans to make bad financial decisions that emerged at the heart of our current crisis. Consumer protection is not just about individuals but also about safeguarding the system as a whole.
Congress, the Administration, and regulators have already taken steps to address consumer problems in two key markets, those for credit cards and mortgages. But here too we need comprehensive reform. Our proposed Consumer Financial Protection Agency will serve as the primary federal agency looking out for the interests of consumers of credit, savings, payment and other financial products. This agency will be able to write rules that promote transparency, simplicity and fairness, including defining standards for "plain vanilla" products that have straightforward pricing.
Our third priority was making sure that reform, while discouraging abuse, encourages financial innovation. The United States is the world's most vibrant and flexible economy, in large measure because our financial markets and our institutions create a continuous flow of new products, services and capital. That makes it easier to turn a new idea into the next big company. Our core challenge is to design a system that has a proper balance between innovation and efficiency on the one hand, and stability and protection on the other. We did not get that balance right. That requires reform.
We think that the best way to keep the system safe for innovation is to have stronger protections against risk with stronger capital buffers, greater disclosure so investors and consumers can make more informed financial decisions, and a system that is better able to evolve as innovation advances and the structure of the financial system changes. I know that some suggest we should ban or prohibit specific types of financial instruments as too dangerous. And we are proposing to strengthen consumer protections and enforcement by, among other things, prohibiting practices such as paying brokers for pushing consumers into higher-priced loans or penalties for early repayment of mortgages.
However in general, we do not believe that you can build a system based on banning individual products because the risks will simply emerge in new forms. Our approach is to let new products develop, but to bring them into a regulatory framework with the necessary safeguards. America's tradition of innovation has been central to our prosperity. These reforms are designed to strengthen our markets by restoring confidence and accountability.
A fourth priority was addressing the basic vulnerabilities in our capacity to manage future crises. The United States came into the current crisis without an adequate set of tools to confront the potential failure of large, interconnected financial institutions. That left the government with extremely limited choices when faced with the failure of the largest insurance company in the world and one of the largest US investment banks. That is why, in addition to addressing the root causes of our current crisis, we must also act preemptively to provide the government better tools to manage future crises.
We propose a new resolution authority, modeled on the existing authority of the FDIC to handle weak or failing banks, that will give the government more options. That authority will reduce moral hazard by allowing the government to resolve failing institutions in ways that impose the costs on owners, creditors and counterparties, making them more vigilant and prudent. We must also minimize the moral hazard of institutions considered too big or too interconnected. No one should assume that the government will step in to bail them out if their firm fails. We do this by making sure financial firms follow the example of families across the country that are already saving more money as a precaution against bad times.
We require all firms to keep more capital and liquid assets on hand as a greater cushion against losses. And the bigger, most interconnected firms will be required to keep even bigger cushions. The critical test of our reforms will be whether we make this system strong enough to withstand the stress of future recessions and the failure of large institutions. That's our basic objective; we want to make it safe for failure. We cannot afford inaction. We cannot afford a situation where we leave in place vulnerabilities that will sow the seeds for future crises. And in the weeks and months ahead I look forward to working with this Committee to build a new foundation for a stronger American economy. Thank you.
Geithner on defensive over reforms
Tim Geithner met immediate resistance to his regulatory reform package on Capitol Hill on Thursday, at the start of what promises to be a lengthy sales pitch to protect the white paper from critics in Congress. At a Senate hearing, the Treasury secretary defended his proposal to grant new systemic risk regulation powers to the Federal Reserve, an issue that is vulnerable to being overturned by sceptical lawmakers.
“You cannot convene a committee to put out a fire,” Mr Geithner told the Senate banking committee, insisting the Fed was the best body to guard against risks in a large institution that could pollute the entire financial system. The Fed’s new role as systemic risk regulator will be supplemented by a council of regulators, according to the reform plan, but Mr Geithner and Lawrence Summers, chief economic adviser to President Barack Obama, are determined that the real power resides with the central bank.
“I think they’ve got the best incentives to make sure those basic safeguards are strong enough to help us withstand future crises,” said Mr Geithner. Richard Shelby, senior Republican on the committee, said the proposals presented a “grossly inflated view of the Fed’s expertise”. David Vitter, a Republican from Louisiana, said new accountability placed on the Fed was “really crossing a line” in compromising the bank’s independence.
Some Democrats have also argued that the Fed should concentrate exclusively on monetary policy. Opposition to a proposal that the government have the power to seize and wind up a failing institution is another problem for Mr Geithner, who has to convince lawmakers or see his white paper comprehensively rewritten. The Senate is set to be the main stumbling block to passing the reforms, according to Congressional aides. The House of Representatives is more divided on party lines with most of the dominant Democrats happy to proceed quickly. “Every financial crisis of the last generation has sparked effort at reform, but past efforts have begun too late,” Mr Geithner said. “We cannot let that happen this time.”
In his testimony, Mr Geithner said the Fed was “best positioned” to regulate systemic risk. “It already supervises and regulates bank holding companies, including all major US commercial and investment banks. “Our plan gives modest additional authority – and accountability – to the Fed to carry out that mission. But it also takes some authority away.” Mr Geithner is proposing to divest the Fed’s consumer protection role and give it to a new Consumer Financial Protection Agency.
Senators skeptical about expanding Federal Reserve's power
Treasury Secretary Tim Geithner went to Capitol Hill Thursday to sell the Obama administration’s proposal for sweeping reforms of financial industry regulation. The leaders of the Senate Banking Committee agreed that regulatory reforms were needed, but they were skeptical about giving the Federal Reserve additional powers. Under the administration’s proposal, the Federal Reserve would be given the responsibility to supervise “the largest, most complex and interconnected institutions” and be “the first responder in a financial emergency,” Geithner said.
Sen. Chris Dodd, D-Conn., who chairs the Senate Banking Committee, questioned why the Fed should be given more power when many experts question its track record on its current responsibilities. Its proposed new role as the regulator of systemic risk also could conflict with its primary role of setting monetary policy, he said. Sen. Richard Shelby, R-Ala., said it was unrealistic to expect the Fed to handle so many roles, and that its structure is not suited for the role of a systemic risk regulator. Plus, he said, Congress has not spent enough time discussing the concept of systemic risk and how -- or if -- it can be regulated.
Geithner said he saw no conflict between regulating systemic risk and setting monetary policy. The additional authority that would be given the Fed is “quite modest, and builds on their existing authority” to supervise financial institutions, he said. The administration’s plan would transfer the Federal Reserve’s consumer protection responsibilities to a new regulator, which would take away some authority and remove “a distraction” from the Fed. “I wish consumer protection had been more of a distraction at the Fed,” Dodd responded.
Dodd strongly supported the administration’s proposal to create a Consumer Financial Protection Agency. This new regulator would look out for the interests of consumers of financial products and write rules that, in Geithner’s words, “promote transparency, simplicity and fairness.” Existing regulators “turned a blind eye” to the subprime mortgages and that caused the financial crisis, Dodd said. “It was regulatory neglect that allowed the crisis to spread,” he said. “Let’s put a cop on the beat so this spectacular failure” is never repeated again.
Critics of this proposal contend it would needlessly add another layer of government regulation and could stifle innovation in the financial sector. Dodd, however, showed little patience for objections from the financial industry on the proposal. The people who created the nation’s economic crisis are arguing that consumers shouldn’t be protected, he contended. “What planet are you living on?” he said.
Sorry, America, The Financial Overhaul Will Probably Fail
Despite the grand rhetoric we heard from the president yesterday about building a new foundation for fixing financial regulation, the sharp operators of Wall Street will find ways around the new rules. That was the message from Jim Chanos on CNBC. The problem is basically that the incentives for getting around the rules is too great, and the people designing the new structure are no match for those they are regulating. The regulators just aren't as shrewd as the guys they are charged with overseeing.
"We still have by and large academics and lawyers who are trying to regulate an industry in which they've never run a fund, they've never bought and sold stocks professionally, they've never cold-called a client," the president of Kynikos Associates said. "It's a little tough because the guys who are the bad guys are one step ahead of the cops on the beat every single time."
Chanos said that financial regulation is overrated in general, and those seeking to prevent the next big catastrophe are bound to be disapointed. It's never worked before, so why would it work now. "I'm worried we're just directing yet another Maginot Line that the forces of financial innovation will get around next time," he said.
Overhaul Leaves Rating Agencies Largely Untouched
Four stars, two thumbs up, a must read: Rave reviews like those might seem a bit suspect if they were paid for by the restaurateurs, movie makers and authors being reviewed. But that is essentially how things work in the credit-rating industry, a central culprit of the financial crisis that, to its critics’ dismay, now seems to be escaping serious change.
In the overhaul of financial regulation proposed by the Obama administration on Wednesday, rating services — which, during the boom, stamped high ratings on many subprime securities — will avoid the radical changes their detractors have urged. While the administration is proposing some modest changes, none addresses what many see as the central problem: Services like Moody’s and Standard & Poor’s are paid by the companies whose securities they are evaluating. It is as if Hollywood studios paid movie critics to review their would-be blockbusters.
Despite calls to shake up the ratings establishment, the industry’s “issuer-pay” system is deeply entrenched. And, while the services have taken some steps to mitigate conflicts, they reject the idea that they should have been more vigilant. “This is not an effort to remake the industry,” Jerome Fons, a former managing director of credit policy at Moody’s, said of the administration’s proposals. “If we believe the system is broken, this doesn’t offer a fix.”
The rating services play a crucial role in the capital markets by rating everything from plain-vanilla corporate bonds to trickier “structured” investments. By law, banks must take ratings into account when investing in bonds. Big money managers often base investment guidelines on them. But over the last decade, the rating services helped Wall Street repackage mortgages into securities, thereby fostering the spread of risky lending that eventually imperiled the economy. Many securities that had been rated AAA are now worthless.
Yet now the agencies appear poised to retain their lucrative, and well-protected, perch. Many of the proposals laid out Wednesday are vague principles or paper standards that go little beyond changes being contemplated by the Securities and Exchange Commission, or even the rating agencies themselves. The proposals call for the agencies to improve disclosure and release more detailed information, as well as establish policies for “managing and disclosing conflicts of interest.”
But the plan does not alter the issuer-pay model, whereby the companies selling securities pay to have them rated. Nor does it encourage competitors to enter the industry, which many regard as an oligopoly. The proposal does call for regulators to reduce their reliance on agency ratings when deciding whether structured investments are safe enough for banks, insurance companies, pension funds and money market mutual fund investors. Regulators should encourage more independent analysis, a Treasury official said, but the administration did not propose an alternative standard.
Many of the other proposals rehash “best practices” that the major agencies were either moving toward or had already begun to employ. For example, the proposal calls for disclosing ratings methodology and the types of risks that the services do — and do not — assess. It also would require the agencies to distinguish between their grades for complex mortgage-related investments and more traditional bonds, one of the few elements of the proposal that the industry strongly opposes.
“It’s like a scarlet letter,” George Miller, the head of the American Securitization Forum, said of the possible designation. “It indicates that there is something to be aware of, but it doesn’t tell you what it is.” He also said such a step would be a burden for some investors, who would have to rewrite their investment guidelines. But the proposals do little to address the behavior that contributed to the crisis, industry critics maintain.
“Lacking any significant performance history, rating agencies rated unratable products for regulatory approval and escaped liability for doing so under First Amendment protection,” said Joseph Mason, a finance professor at Louisiana State University. “Nothing in the Treasury proposal changes that.”
The ratings proposals are part of a broader plan to revive and overhaul the securitization markets, which supply roughly two-thirds of the credit in the economy (banks provide the rest, with loans). To keep banks and other lenders from bundling the riskiest loans, the administration proposed requiring loan originators to keep 5 percent of loans that they package, so the banks have their own money at stake.
While that step, in theory, should make banks more careful, industry experts said they were unsure if it would. After all, in the current crisis, many banks got stuck holding too many risky mortgage bonds. “The reason why so many investment banks got into difficulty was that they did have skin in the game,” said Lawrence J. White, a New York University economics professor.
But the proposal gives regulators the flexibility to adjust the size of the banks’ interest in the securities and leaves room for institutions to offset some risk to ensure they are sound. Given the failures of the credit rating industry — and the conflicts laid bare by the mortgage collapse — some industry experts said the Obama administration is missing a rare chance to rework the industry. “It’s the equivalent of grabbing the rating agencies by the lapels, shaking them, and saying ‘do a better job,’ ” said Professor White. “This was a big-time missed opportunity.”
Obama Reform Plan Fails to Fix Whats Broken
by Barry Ritholtz
So much for “not letting a crisis go to waste.” The initial read on the Obama Regulatory plan was an enormous disappointment. Both supporters and critics who expected him to take a hard turn to the Left have been left either surprised or disappointed, depending upon their leanings. To the pragmatic center, including your humble blogger, what stands out is the number of half measures and omitted actions that were viewed as necessary to prevent a replay. Some very obvious omissions from the plan include:
- No major changes for the ratings agencies!
This is a giant WTF from the White House. It implies that the team in charge STILL does not understand how the problem occurred. The ratings agencies are not the only bad actors, but they are a BUTFOR – but for the rating agencies putting a triple A on junk paper, many many funds could not have purchased them, the number of mortgages securitized would have been much less, the insatiable demand on Wall Street for mortgage paper would have also been much lower. Why is this important? If mortgages originators couldn’t sell a mass amount of loans, they would not have had the need to give a mortgage to anyone who could fog a mirror — and that means no Liar Loans, no NINJA loans, and no huge subprime debacle.
Better Solution: Take apart the ratings oligopoly! Eliminate the Pay for Play/Payola structure. Strip Moody’s S&P and Fitch from their uniquely protected status — they have proven they are neither worthy nor competent. Open up ratings to competition –including open source.
- Turn Derivatives into Ordinary Financial Products:
The Obama team does a series of minor steps for Derivatives, but they don’t go far enough.
Better Solution: Force derivatives to be traded like option/stocks, etc. (including custom one off derivatives) Trade them only on Exchanges, full disclosure of counter-parties, transparency and disclosure of open interest, trades, etc. REQUIRE RESERVES LIKE ANY OTHER INSURANCE PRODUCT.
- If they are too big to fail, make them smaller.”
That is the famous quote from Nixon Treasury Secretary George Shultz, and it applies to the banks as well as insurers, Fannie & Freddie, etc. We have a situation where 65% of the depository assets are held by a handful of huge banks - most of wom are less than stable. The remaining 35% is held by the nearly 7,000 small and regional banks that are stable, liquid, solvent and well run.
Better Solution: Have real competition in the banking secrtor. Limit the size fo the behemoths to 5% or even 2% of total US deposits. Break up the biggest banks (JPM, Citi, Bank of America)
- The Federal Reserve, Despite its Role in Causing the Crisis, Gets MORE Authority:
Under Greenspan, the Fed did a terrible job of overseeing banking, maintaining lending standards, etc. Why they should be rewarded for this failure with more resposibility is hard to fathom. Yet another example of rewarding the incompetent.
Better Solution: Have the Fed set monetary policy. They should provide advise to someone else — like the FDIC — who haven’t shown gross incompetence.
- Require leverage to be dialed back to its pre-2004 levels.
Have we even eliminated the Bears Stearns exemption yet? This was a 2004 SEC decision to exempt five biggest banks from the mere 12 to 1 prior levels. Note that all 5 are either gone, acquired or turned into holding companies.
Better Solution: 12-to-1 should be enough leverage for anyone . . .
- Restore Glass Steagall:
The repeal of Glass Steagall wasn’t the cause of the collapse, but it certainly comntributed to the crisis being much worse.
Better Solution: Time to (once again) separate the more speculative investment banks from the insured depository banks.
All of which suggests that the status quo preserving, sacred cow loving, upward failing duo of Lawrence Summers and Tim Geithner are still in control of economic policy. The more pragmatic David Axelrod and the take-no-prisoners, don’t-give-a-shit-about-Wall Street Rahm Emmanuel have yet to assert authority over the finance sector.
Obama Poll Sees Doubt on Budget and Health Care
A substantial majority of Americans say President Obama has not developed a strategy to deal with the budget deficit, according to the latest New York Times/CBS News poll, which also found that support for his plans to overhaul health care, rescue the auto industry and close the prison at Guantánamo Bay, Cuba, falls well below his job approval ratings.
A distinct gulf exists between Mr. Obama’s overall standing and how some of his key initiatives are viewed, with fewer than half of Americans saying they approve of how he has handled health care and the effort to save General Motors and Chrysler. A majority of people said his policies have had either no effect yet on improving the economy or had made it worse, underscoring how his political strength still rests on faith in his leadership rather than concrete results.
As Mr. Obama finishes his fifth month in office and assumes greater ownership of the problems he inherited, Americans are alarmed by the hundreds of billions of dollars that have been doled out to boost the economy. A majority said the government should instead focus on reducing the federal deficit. But with a job approval rating of 63 percent, Mr. Obama has the backing of Democrats and independents alike, a standing that many presidents would envy and try to use to build support for their policies. His rating has fallen to 23 percent among Republicans, from 44 percent in February, a sign that bridging the partisan divide may remain an unaccomplished goal.
The poll was conducted after Mr. Obama completed his fourth international trip as president. He received high marks for his focus abroad, with 59 percent of those polled saying they approve of his approach to foreign policy. And after weeks of criticism from former Vice President Dick Cheney and other Republicans, 57 percent say they approve of how Mr. Obama has dealt with the threat of terrorism.
The White House is entering a critical summer with Mr. Obama pledging to push his plans to revamp health care and financial regulation through Congress and Senate hearings scheduled on his first nominee to the Supreme Court. The poll suggested Americans remain patient, even as a strong majority expressed concern that they or someone in their family could lose their jobs in the next year. “My feeling is that Obama is just throwing money at things, but I don’t see anything being specifically targeted,” Lynn Adams, 62, a Republican from Troy, Mich., said in a follow-up interview. “But I’m giving him the benefit of the doubt because he hasn’t been in office long enough.”
Judge Sonia Sotomayor, whom Mr. Obama nominated to the Supreme Court three weeks ago, is still widely unknown to the public, the poll found. A majority of people surveyed, 53 percent, said they did not know enough about Judge Sotomayor, who would be the first Hispanic justice, to say whether she should be confirmed. But 74 percent said that it was either very or somewhat important for the Supreme Court to reflect the country’s diversity.
Before the Senate votes on her confirmation, 48 percent of people said her positions on issues like abortion and affirmative action were very important to know about. The national telephone poll was conducted Friday through Tuesday with 895 adults, and has a margin of sampling error of plus or minus three percentage points. The poll highlights the political and governing challenges on the horizon for Mr. Obama, including the towering federal budget deficit, which is expected to push the national debt to levels that many economists say could threaten the economy’s long-term vitality.
Six in 10 people surveyed said the administration has yet to develop a clear plan for dealing with the deficit, including 65 percent of independents. Mr. Obama, in an interview on Tuesday with CNBC and The New York Times, said the budget deficit was “something that keeps me awake at night.” While Republicans have steadily increased their criticism of Mr. Obama, particularly on the budget deficit, the poll found that the Republican Party is viewed favorably by only 28 percent of those polled, the lowest rating ever in a New York Times/CBS News poll. In contrast, 57 percent said that they had a favorable view of the Democratic Party.
The nomination of a Supreme Court justice, as well as the fatal shooting of an abortion doctor in Kansas late last month, injected a fresh dynamic into the national abortion debate. But the poll found essentially no change in the public’s views of abortion in the last two decades, with 36 percent saying it should be generally available, 41 percent saying it should be available but under stricter limits than are now in place and 21 percent saying it should not be permitted.
The nomination of Judge Sotomayor also has renewed discussion about affirmative action. Half of those surveyed said they favored programs that make special efforts to help minorities get ahead, a number that rises among nonwhite respondents and women. Far more, 8 in 10, said they favored programs to help low-income Americans get ahead, regardless of gender or ethnicity.
The issues of abortion and affirmative action sharply divide voters in each major political party. Among Democrats, 71 percent oppose overturning Roe v. Wade, while Republicans are closely divided. And 67 percent of Democrats support affirmative action programs for minorities, while 60 percent of Republicans oppose them. Beyond these issues, which Mr. Obama has sought to avoid becoming entangled in, he faces a divided public as he works to carry out his executive order to close the prison for terrorism suspects at Guantánamo Bay. The poll found that 8 in 10 expressed worry that detainees released to other countries might be involved in future attacks here.
Half of the poll respondents said closing the prison would have no effect on protecting the nation from terror threats, but 3 in 10 said they thought it would make the United States less safe. Many of the detainees being held at the prison have not been charged, and nearly 7 in 10 people surveyed said they would support charging them or releasing them back to the country of their capture. Just 24 percent said the detainees should continue to be held without charge for as long as the government deems necessary.
The poll found that a wide majority of those who support closing the prison said their views would not change even if detainees were sent to maximum security prisons in the United States. “It’s a bad symbol for our country: Preach one thing and do something else,” said Roberta Hall, 73, a Democrat from Barboursville, W.Va. “We can transfer them here. We’re good at keeping prisoners. That’s what we do best.”
Why Obama Blinked On Merging The CFTC And The SEC
Barack Obama's plan to overhaul the structure of financial regulation leaves in place the split between those regulators who supervise the trading of futures at the Commodities Futures Trading Commission and those who supervise stock trading at the Securities Trading Association. And while there may be good reasons to keep the commissions separate, mostly likely none of those informed the Obama administration's decision. Instead it was probably just cold politicial calculation.
Merging the commissions has long been a popular idea with reformers. It was proposed by Hank Paulson when he was Treasury Secretary, and it is supported by many who think that the divide between the New York centered functions at the SEC and the Chicago centered functions at the CFTC has created unhealthy regulatory gaps. Opponents of merging the commissions can argue that regulatory consolidation rarely leads to greater effeciency, that the Chicago-New York divide in the regulatory structure is beneficial because it reflects a real divide among trading cultures, that years of turf battles that follow regulatory mergers would be too much during while the financial crisis continues and that competition between regulators for jurisdiction leads to bettter regulation.
But the merger's greatest obstacle weren't these ideas. Indeed, it's hard to find anyone willing to make these points--they're more like debaters points that you could imagine an imaginary opponent of reform making. Instead, what seems to have made merging the commissions is that fact that each commission is supervised by different legislative committees. The SEC is regulated by the Senate Banking Committee and the House Financial Services Committee. The CFTC falls under the oversight of the Agricultural committees in each house. Any consolidation would deprive one set of committees of its jurisdiction, a serious loss of power, influence and access to campaign cash for the leaders and members of that committee.
Most likely, it would have been the agricultural committees that would have lost their supervisory role. And, as the steadfastness of agriculutral subsidies demonstrates, those committees are some of the most powerful on Capitol Hill. Obama needs support of Congressional and Senate Democrats to pass not only the financial regulatory reform, but also his climate and health care proposals. He mosst likely decided he couldn't risk angering the members of the agricultural committees by proposing taking away their authority. And so one of the most basic pieces of regulatory change was dropped for political considerations.
In reform, more of the same
Tim Geithner and Larry Summers offered a sneak peak at the plan in an op-ed in yesterday’s Washington Post, proclaiming, “we must begin today to build the foundation for a stronger and safer system.” Among the proposals: “raising capital and liquidity requirements for all institutions”; “consolidated supervision by the Federal Reserve”; “robust reporting requirements on the issuers of asset-backed securities” including “strong oversight of ‘over the counter’ derivatives”; and providing “a stronger framework for consumer and investor protection across the board.”
As with so much of the Obama administration, great-sounding words, but nothing in the way of substantive change. Particularly disturbing are the moves on derivatives, notably “credit default swaps”. Excuse us for not liking a market that is rigged in favor of the sellers, the monopoly dealers, who even today refuse to allow open price discovery in credit default swaps among and between other dealers. True to their Wall Street ethos, Summers and Geithner have capitulated on the most important aspect of derivatives, by refusing to place these instruments on a regulated exchange, where transparency and standardisation would be far more operative.
The credit default swap market–indeed, virtually all non-exchange listed derivatives–are deceptive by design. They are a deliberate evasion of established norms of transparency and safety and soundness, norms proven in practice by the great bilateral cash and futures exchanges over decades. These instruments represent a retrograde development in terms of the public supervision and regulation of financial markets. Of course Wall Street hates this: Wall Street loves opacity because the very lack of transparency of these products has done so much to fatten the profits of its largest firms. But reducing the profits of Wall Street is precisely what we want. We want finance to become a much less dominant component of the US economy, a sector which doesn’t contribute to over one-third of GDP (versus around 2 percent over 40 years ago).
Simply stated, running these instruments through “centralised clearing houses” is a fig-leaf that does nothing to alleviate the problems of transparency. The deliberate opacity of the CDS market is a dedicated subsidy meant to benefit one class of financial institutions, namely the large dealer banks, at the expense of other market participants. Every investor in the markets pays the credit default swap tax via wider spreads, and the taxpayers in the industrial nations pay due to periodic losses to the system caused by the AIGs of the world. For every large overt failure like AIG, there are dozens of lesser losses from over-the-counter derivatives buried by the professional managers of funds and financial institutions in the same way that gamblers hide their bad bets.
As with all of the Obama financial “reforms,” these latest steps start from a flawed conceptual premise: Restore bank balance sheets and profits, and credit will invariably flow, thereby reviving our economy. Of course, nothing can be further from the truth. The key is to restore personal balance sheets and aggregate demand as a precondition for improving bank balance sheets. Improved creditworthiness and improved credit conditions will invariably follow. The history of major banking crises unambiguously shows that insolvent financial institutions need to be resolved.
There are variations on the theme: The government can take them over and recapitalize them, clean them up and re-sell them, as in Sweden. You can wipe out equity investors and bondholders; you can try new twists, like various good bank proposals that have surfaced lately (making new entities out of the deposits and good assets and leaving the dreck with the existing bond and shareholders). While there would be many important details to be sorted out, this is not path-breaking, except in the scale at which it needs to occur. And now, having had four acute phases of a credit crunch, the Fed and other central banks have plenty of liquidity facilities ready to deal with any initial overreaction. Rest assured, although radical measures would not be pleasant or easy, there are plenty of models and precedents.
But…here we have two Rubin proteges, serving up the same fatally flawed approach as before: Let’s just throw money at the banks and hope they get better. This is tantamount to using antibiotics to treat gangrene. You waste good medicine and the progression of the rot threatens to kill the patient. Let’s hope they do better with health care, or that Congress grows a spine and actually tries to introduce real financial reform which will prevent a recurrence of our recent credit fiasco, rather than simply offering yet another huge subsidy to Wall Street under the guise of “reform.”
China sells US bonds to 'show concern'
A decision by China to reduce its US Treasury holdings suggests concern about the US attitude towards its economic woes, Chinese economists were quoted as saying in state media Wednesday. The remarks, coming after US data showed a modest decline in Chinese investments in US government bonds, were in contrast to an earlier statement in Beijing which had said the recent sell-off was a routine transaction.
"China is implying to the US, more or less, that it should adopt a more pragmatic and responsible attitude to maintain the stability of the dollar," He Maochun, a political scientist at Tsinghua University, told the Global Times. According to US Treasury data issued Monday, Beijing owned 763.5 billion dollars in US securities in April, down from 767.9 billion dollars in March. It was the first month since June 2008 that Beijing failed to purchase more US T-bills.
Zhang Bin, a researcher at the Chinese Academy of Social Sciences, said China's move showed a more cautious attitude. "It is unclear whether the reduction will continue because the amount is so small. But the cut signals caution of governments or institutions toward US Treasury bonds," Zhang told Xinhua news agency. China's foreign ministry said Tuesday that its purchases of US Treasuries remained based on "security, liquidity and value preservation".
For Zhao Xijun, deputy director of the Finance and Securities Research Institute of People's University, China may have reduced its holding of US Treasuries simply because it needed the money. Zhao said the sell-off could have been in order to pay for its own economic stimulus package. "The reduction was a result of composite factors, such as the investment need and the market change," Zhao told Global Times.
Brazil, Russia, India and China form bloc to challenge US dominance
With public hugs and backslaps among its leaders, a new political bloc was formed yesterday to challenge the global dominance of the United States. The first summit of heads of state of the BRIC countries — Brazil, Russia, India and China — ended with a declaration calling for a “multipolar world order”, diplomatic code for a rejection of America’s position as the sole global superpower.
President Medvedev of Russia went further in a statement with his fellow leaders after the summit, saying that the BRIC countries wanted to “create the conditions for a fairer world order”. He described the meeting with President Lula da Silva of Brazil, the Indian Prime Minister, Manmohan Singh, and the Chinese President, Hu Jintao, as “an historic event”. The BRIC bloc brings together four of the world’s largest emerging economies, representing 40 per cent of the world’s population and 15 per cent of global GDP. The leaders set out plans to co-operate on policies for tackling the global economic crisis at the next G20 summit in the US in September.
“We are committed to advance the reform of international financial institutions so as to reflect changes in the world economy. The emerging and developing economies must have a greater voice,” they said. The BRIC states also pledged to work together on political and economic issues such as energy and food security. Co-operation in science and education would promote “fundamental research and the development of advanced techologies”.
The declaration also satisfied a key Kremlin demand by calling for a “more diversified international monetary system”. President Medvedev is seeking to break the dominance of the US dollar in financial markets as the world’s leading reserve currency. He favours the establishment of more regional reserve currencies, including the Russian rouble and the Chinese yuan, to prevent economic shocks. Mr Medvedev said: “The existing set of reserve currencies, including the US dollar, have failed to perform their functions.”
The declaration made no specific mention of the dollar, an indication of China’s reservations about the Russian idea. Beijing holds almost $2 trillion in foreign currency reserves and a large portion of US debt. The BRIC summit coincided with a two-day meeting of the Shanghai Co-operation Organisation (SCO) in Yekaterinburg, which further underlined the determination of Moscow and Beijing to assert themselves against the West. The SCO comprises Russia, China and the Central Asian states of Kazakhstan, Uzbekistan, Tajikistan and Kyrgyzstan. Iran, Pakistan, India and Mongolia have observer status and President Karzai of Afghanistan attended the summit as a guest.
Iran’s embattled President, Mahmoud Amadinejad, defied protests at home to attend the conference, where he hit out at the US and declared that the “international capitalist order is retreating”. But he beat a swift retreat from the summit just hours after arriving, cancelling a planned press conference to return to the crisis in his country. China pledged $10 billion in loans to Central Asian countries struggling in the economic crisis, adding financial muscle to its leading role in the SCO. Russia and China regard the organisation as a means to restrict US influence in their Central Asian “back yard”.
Mr Medvedev held separate meetings about the situation in Afganistan with President Karzai and President Zardari of Pakistan, a clear signal to President Obama not to ignore Russian interests as he presses US policy in the region in the fight against the Taleban.
India PM: Replacing dollar highly complex issue
Replacing the dollar as the gobal reserve currency with another is a highly complex issue and it required proper examination by Indian policy makers, the Economic Times quoted Prime Minister Manmohan Singh as saying on Thursday. At a summit in Yekaterinburg in Russia earlier this week, Brazil, Russia, India and China demanded a greater say in the global financial system but steered clear of any assault on the dollar.
"It was agreed that these are highly complex issues, replacing the dollar by which other currencies - a national currency or SDR's," Singh told the paper after returning from the summit. "And it was felt that this matter required proper examination by our foreign ministers and governors of central banks," he said.
Bill Calls for $15,000 Any-Time Home Buyer Credit
The Mortgage Bankers Association (MBA) on Monday declared its support for a Senate bill, S 1230 or the Homebuyer Tax Credit Act of 2009, which expands the current first-time home buyer tax credit from $8,000 to $15,000. The bill also makes the tax credit available to anyone who purchases a principal residence in the year following the enactment of the bill. The MBA is already calling for monetization of the credit at the closing table on the grounds that more consumers will become home buyers if they don’t have to struggle to put away a substantial down payment.
“The current $8,000 credit for first-time buyers has had a positive effect on the housing market this year,” said MBA chairman David Kittle in a media statement. “Increasing the amount and expanding the benefit to include all home buyers will have an even larger impact in spurring the housing market and stabilizing the economy.” The percent of the purchase price eligible for the tax credit stays at 10% under the bill, but the broadening of the dollar limitation expands the potential for the tax credit to reach higher-end housing.
The bill eliminates the earnings caps of $75,000 for an individual and $150,000 for a joint-filing couple. Sen. Johnny Isakson, D-Ga., the bill’s sponsor, says these targeted, demand-side solutions aim to increase consumer participation in the housing market, to stimulate natural home price recovery over foreclosure and short sales and to broaden the tax credit’s reach across all tiers of home buyers. “The first-time homebuyer tax credit has made a difference,” Isakson said in a media statement.
“First-time home buyers used it and the market stabilized, but we don’t have a recession in first-time home buyers. We have a recession in the move-up market.” “One of the biggest problems facing the American people today,” he added, “is an illiquid housing market, a decline in their equity, a decline in their net worth and a depression in the housing market that we are obligated to correct if we possibly can.”
The bill went to a Senate finance committee last week, where it awaits further action. Critics of the bill and similar efforts to subsidize a housing market recovery argue that these incentives may only falsely exaggerate the current level of housing demand, making any stabilization seen an unreliable indicator of recovery. But the efforts are gaining traction among lawmakers, with a separate House bill also calling for a broadening of the credit. HR 2801, or the Home Ownership Moves the Economy Act, was introduced late last week and calls for the current $8,000 tax credit to apply to all who purchase a primary residence through the end of 2010. The House bill also awaits further action.
Demand for FHA Loans Is Overtaxing Agency, HUD Official Says
Record-high demand for government- backed home loans is overtaxing the Federal Housing Administration and may weaken the integrity of Ginnie Mae mortgage bonds, a U.S. inspector general said. “FHA will be challenged to handle its expanded workload or new programs that require the agency to take on riskier loans than it historically has had in its portfolio,” Kenneth Donohue, the inspector general for the Housing and Urban Development Department, told lawmakers today.
“The surge in FHA loans is likely to overtax the oversight resources of FHA, making careful and comprehensive lender monitoring difficult.” The freeze in the mortgage markets has driven FHA’s market share to 63 percent this year, from 24 percent in the fiscal year ended Sept. 30, Donohue told a House Financial Services Committee panel on Oversight and Investigations. The volume of single-family mortgage loans insured by FHA, which is overseen by HUD, more than tripled to $180 billion in 2008, he said.
FHA has historically been most vulnerable to fraud and exploitation when loan volume is high, Donohue said. He said that Ginnie Mae, the government agency that insures mortgage bonds backed by FHA loans, is also at risk. “We are also concerned that increases in demand to the FHA program are having collateral implications for the integrity” of Ginnie Mae mortgage bonds, Donohue said. “HUD too needs to consider the downstream risks to investors and financial institutions of Ginnie Mae’s eventual securitization.”
Donohue said the rise of mortgage fraud among FHA lenders has depleted FHA’s mortgage insurance fund, which has fallen to $12.9 billion, or 2 percent of all insured assets as of Sept. 30, from $21 billion, or 6.4 percent of assets a year earlier. Under some economic projections, that ratio could fall below the statutory requirement of 2 percent, requiring taxpayer assistance or an increase in premiums, he said.
The Greatest Non-Apology of All Time
by Matt Taibbi
“While we regret that we participated in the market euphoria and failed to raise a responsible voice, we are proud of the way our firm managed the risk it assumed on behalf of our client before and during the financial crisis,” he said.
via Goldman Regrets ‘Market Euphoria’ That Led to Crisis - DealBook Blog - NYTimes.com.
Anyone else out there find himself doubled over laughing after reading Goldman, Sachs chief Lloyd Blankfein’s “apology” for his bank’s behavior leading up to the financial crisis? Has an act of contrition ever in history been more worthless and insincere? Even Gary Ridgway did a better job of sounding genuinely sorry at his sentencing hearing — and he was a guy who had sex with dead prostitutes because it was cheaper than paying live ones. Looking at Blankfein’s one-sentence apology, I’m struck in particular by a couple of phrases:While we regret that we participated in the market euphoria…
Really, Lloyd? You “participated” in the market euphoria? You didn’t, I don’t know, cause the market euphoria? By almost any measurement, Goldman was a central, leading player in the subprime housing bubble story. Just yesterday I was talking to Guy Cecala at Inside Mortgage Finance, the trade publication that tracks statistics in the mortgage lending industry. He said that at the height of the boom, in 2006, Goldman Sachs underwrote $76.5 billion in mortgage-backed securities, or 7% of the entire market.
Of that $76.5 billion, $29.3 billion was subprime, which is bad enough — but another $29.8 billion was what’s called “Alt-A” paper. Alt-A mortgages are characterized, mainly, by crappy documentation and lack of equity: no income verification, no asset verification, little-to-no cash down. So while “only” 38% of the mortgage-backed securities Goldman underwrote were subprime, more than three-fourths of their securities were what is called “non-prime,” ie either subprime or Alt-A. “There’s a lot of crap in there too,” says Cecala.
Let’s be clear about what that meant. These crap/sham mortgages, a lot of them adjustable-rate deals with teaser rates that featured sudden rate hikes two or three years after closing, they would never have been possible had not someone devised a method for selling them off to secondary buyers. No local bank is going to keep millions of dollars worth of Alt-A mortgages on its books, because no sensible company lends out money to very risky customers and actually keeps those loans on its balance sheet.
So this system depended almost entirely on banks like Goldman finding ways to securitize these instruments, ie chop the mortgages up into little bits, repackage them as mortgage-backed securities like CDOs and CMOs, and sell them to unsuspecting customers on the secondary market, most of them large institutional buyers like pensions and insurance companies and workers’ unions, many of them foreigners.
Most of those customers were snookered into buying this stuff because they had no idea what it was: in the case of pensions and unions particularly, a lot of these customers only bought this crap because the peculiar alchemy banks like Goldman used in devising their mortgage-backed securities made radioactive mortgages look like AAA-rated investments. (Or at least they were given these ratings by Moody’s and Standard and Poor’s, ratings agencies that were financially dependent upon the very banks they were supposed to be rating — but that’s another story).
So some Dutch teachers’ union that a year before was buying ultra-safe U.S. Treasury bonds in 2006 runs into a Goldman salesman who offers them a different, “just as safe” AAA-rated investment that, at the moment anyway, just happens to be earning a much higher return than treasuries. Next thing you know, a bunch of teachers in Holland are betting their retirement nest eggs on a bunch of meth addicted “homeowners” in Texas and Arizona.
This isn’t really commerce, but much more like organized crime: it was a gigantic fraud perpetrated on the economy that wouldn’t have been possible without accomplices in the ratings agencies and regulators willing to turn a blind eye. Imagine a meat company that bred ten billion rats, fattened them on trash and sewage, ground their bodies into chuck, and then sold it all as grade-A ground beef to McDonald’s and Burger King, right under the noses of the USDA: this is exactly the same thing, only with debt instead of food. We’re eating it, they’re counting the money.
Any way you slice it, Goldman was responsible for putting tens of billions of toxic mortgages on the market, resulting in mass foreclosures, mass depletion of retirement funds, and a monstrously over-leveraged financial system that we will now all be bailing out for the next half-century or so. All of this so that Goldman could make a few billion bucks acting as the middleman in all of these deadly transactions. Anyway, I was also struck by this phrase:…we are proud of the way our firm managed the risk for our clients…
First of all, generally speaking, when one apologizes for having done a bad thing (like for instance destroying the world economy), it is good form to wait at least until the end of the sentence to start bragging again. Second of all, what is particularly obnoxious about this phrase is that Goldman is bragging about the fact that it actually made money while it was pumping the economy full of explosive leverage.
While companies like Lehman and Bear were dumb enough to actually eat their own rat meat, Goldman knew what it was doing and was careful to bet against the same stuff it was selling, which makes its behavior many times worse than that of other banks, not better. I get into this more in a Rolling Stone piece coming out next week, but Goldman’s continual bragging about its mortgage hedges is one of the more obnoxious phenomena in the recent history of Wall Street, given that it was selling this shit by the ton during that same period.
Beyond that, Goldman’s “risk management” also involved buying massive hedges on its mortgage exposure from…drum roll please… AIG. In fact Goldman was AIGFP’s single largest customer; while the bank was busy flooding the world financial system with doomed mortgages, it was also busy piling bets on the back of the insurance behemoth — $20 billion worth, to be exact.
And AIG’s death spiral was triggered not so much by its bets going sour, but by companies like Goldman that demanded that AIG put up cash to show its ability to pay. These collateral calls were what killed AIG last September, and Goldman was one of those creditors pulling the trigger: what makes this fact even more obnoxious is that ex-Goldmanite Henry Paulson then stepped in and green-lighted an $80 billion taxpayer bailout. Ultimately another ex-Goldmanite named Ed Liddy was put in charge of AIG, and Goldman ended up getting paid 100 cents on the dollar for its AIG debt.
So basically Goldman helped kill AIG, necessitating a federal bailout, after which time it got paid off handsomely for bets that it certainly would not have been paid off completely for had AIG simply been liquidated. And again, AIG probably does not have a market to sell its CDS insurance to firms like Goldman, if firms like Goldman had not cooked up this insane scheme to underwrite billions upon billions of toxic debt and sell it off to secondary buyers as safe investments. Moreover AIG would not have even had this business of selling CDS insurance had not a bunch of ex-Goldman guys, in particular Bob Rubin, quietly pushed to deregulate the derivatives market back at the end of the Clinton administration.
So when Goldman says it is proud that it “managed the risk” for its clients, what it’s really saying is, “We’re proud that we kept the extreme crapness of our mortgage securities secret from everyone but our clients, and fobbed off the nightmare leverage they created on dumbass AIG and all the pensioners and teachers and other idiots who bought this stuff. Go fuck yourselves and suck on our yachts.” There’s a much larger story about all of this coming out in the magazine next week, but in the meantime… hey, Lloyd, thanks for the apology. It makes us all feel a lot better.
Investors are finally seeing the nonsense in the efficient market theory
The best response I've heard to the efficient markets theory that has dominated thinking about investment for 30 years or more is a joke. Two men walking down a street spot a £20 note on the pavement. One, an economics professor, says to the other: "don't bother to pick it up – if it were really a £20 note it wouldn't be there". He means that because market prices always capture everything anyone knows about a share or index there can never be any hidden value for a shrewd investor to "pick up".
It is nonsense, of course - like telling Warren Buffett that all the investment opportunities he's been exploiting over the years can't logically exist. But when has being nonsense ever stopped people believing something? In this context, it was interesting to see a report this week that the Chartered Financial Analyst Institute, which has been teaching efficient markets theory for decades, has admitted that most of its members have lost the faith. Two thirds say they no longer believe market prices reflect all available information and three quarters disagree that investors as a whole behave "rationally".
What's amazing is that it has taken so long for the penny to drop. It has seemingly required investors to lose their collective senses twice in a decade (dotcom bubble, housing boom) for people to realise that the crowd is mad as often as it is wise. Markets have always been prone to bouts of "irrational exuberance". The price of tulips in 17th century Amsterdam, that of South Sea Company stock in 18th century London and of Florida real estate in the 1920s are just highlights of the procession of booms and busts down the ages that has taught every subsequent generation that markets often get it wrong. They do so for two reasons.
They get it wrong because they reflect human behaviour in all its fearful, greedy irrationality. And they get it wrong because they reflect a world that is inherently unpredictable. This is why, for all my rude comments last week about technical analysts' "dirty raincoats and large overdrafts", sensible investors take account of both the fundamentals (sales, profits, balance sheets and so on) and the charts of price movements. Those charts are no more nor less than snapshots of the millions of fearful, greedy decisions made by investors every minute of the day and, as such, they tell a fascinating tale to anyone who learns their language.
There are many reasons why those decisions are invariably irrational. These heuristics, or psychological biases, are beginning to be unpicked by the new science of behavioural finance. One is "anchoring", the tendency of people to measure the value of an asset against some wholly irrelevant number. A study of this asked groups of people to estimate the number of doctors in London but only after they had first provided the last four digits of their phone number. People with the highest phone numbers consistently gave higher estimates of the number of doctors.
Completely irrational, of course, but no different from fixating on RBS's share price two years ago when assessing whether it is good value now. There are many more of these biases, often relating to over-confidence: most people think they are better than average investors just as they over-estimate their driving ability but we can't all be better than average. We are overconfident about forecasts and in the power of systems – securitisation of dodgy mortgages spreads and so reduces risk, doesn't it?
So, increasingly few people still believe that markets are wholly efficient and that is a good thing. It means fewer people will believe, as governments and regulators did, that the prices of loss-making internet stocks in 1999 and Miami condominiums in 2006 were in any way not a disaster waiting to happen. It might mean that fewer people are tempted by passive investments which promise an answer to the awkward fact that most active fund managers do not beat the market but can only do so by guaranteeing that you will hold all the market's very worst stocks as well as its good ones.
However, there is one problem with dismissing out of hand the efficient markets theory. It is that markets are not so inefficient that anyone can safely bet against them. Assuming that you know more than the market is a dangerous game to play when most of the time most of the information is accurately factored in. The answer is not to give up trying to beat the market but it argues for finding someone who, because of their skill, knowledge or intuition, is good at spotting the £20 notes on the pavement – and sticking with them.
Rogers & Soros: Farmland 'One of the Best Investments of Our Time'
We have no shame here at Notes. When legendary underground investor Jim Rogers makes a call we listen. And we listen good. Rogers correctly predicted the commodities rally in 1999. And between 1970 and 1980, when he partnered with George Soros at the Quantum Fund, his portfolio made gains of 4,200% when the S&P 500 rose by 47%. To say he’s a legend is an understatement. Rogers and Soros are snapping up farmland right now. These two old hands are betting that demand for food will soar, pushing up the price of arable land. This from MoneyNews.com:
Falling commodity prices aren’t bringing prices for farmland down with them. Even as the price of grain goes down, the cost of the land it’s grown on keeps going up, leading George Soros and other guru investors to bet big on agricultural land. The fundamentals are easy to understand: Over the next 40 years the population of the world is projected to grow from 6 billion to 9 billion, hugely increasing the strain on arable farmland worldwide. The spiking grain prices that caused food shortages and rioting in dozens of countries in spring of 2008 fell some 50 percent by December. Yet even after the correction, grain prices remain above their 20-year average, and food stocks around the world are still near 40-year lows.
“Land is scarce and will become scarcer as the world has to double food output to satisfy increased demand by 2050,” Joachim von Braun, director general at the International Food Policy Research Institute, told Fortune Magazine. “With limited land and water resources, this will automatically lead to increased valuations of productive land. And it goes hand in hand with water. Water scarcity will probably increase even more than land.” “I’m convinced that farmland is going to be one of the best investments of our time,” says commodities guru Jim Rogers.
Fed's Soup Kitchen Becomes Magnet for Lobbyists
Maybe it’s a sign of the times, or a manifestation of bailout fatigue, that news of lobbyists descending on the Federal Reserve creates little reaction and no outrage. “Executives and lobbyists now flock to the Fed, providing elaborate presentations on why their niche industry should be eligible for Fed financing or easier lending terms,” writes the New York Times’s Edmund Andrews in a June 13 article. When I read that, I felt a pang in my stomach. It’s my gut that warns me when something’s “not right.”
Traditionally the Fed was credit neutral. It bought or sold U.S. Treasury securities when it wanted to adjust interest rates or the size of its balance sheet. Once the Fed got into the credit business, providing financing for selected assets and essentially picking winners and losers, it was only a matter of time before interested parties wanted to sit down for a chat. “The minute you start to engage yourself in the business of buying different kinds of assets, it opens up the opportunity for various potentially affected groups to apply for those subsidies,” says Robert Eisenbeis, chief monetary economist at Cumberland Advisors Inc. and a former research director at the Atlanta Fed.
Andrews goes on to describe how Hertz, the rental car company, enlisted lawyer Stuart Eizenstat, a veteran of the Carter and Clinton administrations, to provide “elaborate presentations on why their niche industry should be eligible for Fed financing or easier lending terms.” I can just picture K Street’s three-piece suits descending on 20th Street and Constitution Avenue, NW, the home of the Federal Reserve Board, armed with facts, statistics and pre- written legislation.
Wouldn’t it be simpler, not to mention more transparent, to hold a street fair, with tables set up for specific industries? That way, lobbyists could stop by, drop a card in the fish bowl -- entering them in the drawing for a free weekend at Harrah’s - - network with their peers and perhaps speak with a Fed “specialist” about his industry’s particular concerns and needs? It’s one thing to seek feedback on new rules and regulations. Most federal government agencies are guided by the Administrative Procedure Act, which provides for a period of public comment. (Nothing there about a private audience.) It’s another thing for the central bank to receive lobbyists.
While the practice arose in response to the Term Asset-Backed Securities Loan Facility (TALF), it is something that the Fed should dispense with as soon as possible. The TALF was created to increase credit availability to consumers and small businesses. The idea was to make loans to investors for the purchase of AAA-rated asset-backed securities. The market for ABS had shut down last year, and the Fed wanted to encourage banks to make more credit-card, auto and student loans. Creating an incentive for investors to buy them seemed like the best way to get credit flowing.
The Fed announced the creation of TALF in November, but it didn’t make its debut until March because of legal hurdles and gun-shy investors, who were afraid their participation would subject them to the long arm of government. What’s more, the Fed was moving into new territory and needed an education in order to understand and manage risk. Hence, the outreach to various industries interested in being included in the program.
To be sure, this isn’t the first time the Fed has gotten feedback from interested parties. When the central bank decided in 2003 to impose a penalty for borrowing at the discount window, setting the rate above that on interbank loans, it received feedback from depository institutions. There’s something different, even unseemly, about mobile- home manufacturers, equipment makers and car dealers lining up at the Fed with cup in hand. These, and other types of collateralized loans, are now TALF-eligible, along with commercial and residential mortgage-backed securities.
Perhaps it was inevitable that getting into the credit business would subject the Fed to all the political trappings. After all, if you hand out subsidies, people will come, Eisenbeis says. “This is the soup kitchen.” If the public perceives the Fed as propping up various industries instead of ministering to the economy at large, the central bank may lose some of its hard-won credibility. And that would be a bad thing with the Fed doubling the size of its balance sheet in the fourth quarter of last year.
The Fed wants to make sure inflation expectations remain anchored. Unfortunately, most of the increase in long-term Treasury yields this year has been in inflation expectations, not real rates. The boat appears to be dragging its anchor. Fed officials can’t be happy to read that a couple of hedge funds are raising money to bet on a resurgence of inflation, even hyper-inflation. They’re well aware that their credit policy and flirtation with lobbyists may undermine their credibility and affect their ability to conduct old-fashioned monetary policy.
I suspect Fed chief Ben Bernanke has even less interest in financing Center City Motors’ floorplan loans, which car dealers use to carry their inventory, than President Barack Obama has in running General Motors. Now, if Kobe Bryant were to request special consideration for his securitized future endorsements, the hoops-shooting President and Fed chief might be interested.
Bailout Bonus At Bank Of America
Bailed-out Bank of America has been doling out millions in bonuses in an effort to lure talent and keep investment bankers who management views as vital, sources tell The Post. Among those who are said to have received payouts are two former Merrill Lynch bankers, Fares Noujaim, who was recently appointed as BofA's vice chairman of investment banking, and Harry McMahon, a well-connected West Coast-based banker. Both were offered guarantees not to leave the firm.
Noujaim, a former Bear Stearns banker who joined Merrill last year, is said to have received roughly $15 million over two years. Sources say Noujaim -- a well-regarded banker focusing on the Middle East -- was offered a vice-chairman role, and may have been offered at least $5 million more to stay. His earlier employment contract was nullified once Merrill merged with BofA earlier this year, sources said. The guarantees being shelled out by the embattled bank run by CEO Ken Lewis are raising eyebrows on Wall Street because BofA has taken $45 billion in capital from the Troubled Asset Relief Program and hasn't been allowed to refund that money.
A BofA spokeswoman argued that paying talented employees top dollar to stay is necessary because rival firms are poaching its best execs at an alarming rate. "Competitive recruiting in investment banking and capital markets continues to be very intense and we're taking the steps necessary to retain key talent in response to competitive pressures," said spokeswoman Jessica Oppenheim. She added, "Any reference to [a] specific associate's compensation in this story is inaccurate."
The issue of bonus payments by TARP recipients became a flash point earlier this year when Congress discovered that American International Group shelled out $454 million in retention bonuses after receiving a total of $182.5 billion in rescue cash. Since then, Washington has clamped down on how banks in general, and TARP banks in particular, pay their employees. Last week, the Obama administration named Kenneth Feinberg its pay czar to oversee how TARP recipients pay their top 100 employees.
However, compensation is also a sore spot for banks under the government's thumb, as they try to compete with foreign banks not subject to restraints on pay. Meanwhile, internally, BofA's guarantees have added to the friction that already exists between former Merrill workers and BofA employees, the latter of whom complain Merrill bankers are more often getting the guarantee bonuses.
The Case for California Defaulting, Even If It Won't
The State of California is having another horrible week. This one started with the legislature missing Monday's deadline for a new budget to be submitted -- a deadline that laughably ungovernable California has dutifully missed every year since 1986 -- and it continued with S&P putting the state on credit watch for a possible downgrade. Bill Lockyer, the state's treasurer (sic.), ignored the former news, but, via his spokes-thingie, went bat-shit nuts at the latter development.
Why? Because he knows there is precisely zero chance the state's on-beyond-incompetent legislature will entirely close California's $24-billion and growing budgetary deficit. At best we might see it halved through cuts, a goodly chunk of which will be phantom and/or punts to the future. So that means Treasurer Lockyer must make up the difference with Other People's Money, which puts him on the bond-flogging trail sometime this summer. That will be at higher than usual higher yields, but not nearly so high as yields would be if S&P followed through on its threat and downgraded California's droopy, A-rated GO bonds.
The root issue, of course, is that California is insolvent, and irritating people like S&P analysts keep noticing. The state -- let's call it Latvia by the Pacific -- has a $24-billion budget gap that must be closed for it to continue operating (and I use that word advisedly). Without a clear sense of how that will happen rational creditors are going to be increasingly skittish about filling the hole. Now, does that mean California can't sell enough bonds to backfill the gap this time? You bet it can, and it will. This is part Schwarzenegger/Lockyer Financial Theater, and partly a laughably transparent attempt to demonstrate budgetary semi-competency in hopes of a few basis-points of relief on the inevitable bond sale. That's all.
Because California has $5.7-billion in debt servicing obligations. And while that will grow, debt occupies pride of place in California's constitution -- only education must be paid off before the next slug of cash goes to creditors. Get that? Healthcare, prisons, and other frivolities can all go to rack and ruin, but creditors must be paid, constitutionally speaking. That means, if you're looking at this through the gimlet eyes of muni-bond ghouls, that California has something like $50-billion in budgetary space to make its $5.7-billion in payments. It's pretty easy to calculate that California can make the payment nut, even if it has to close hospitals, release prisoners and stop patrolling the highways to do it.
And that's the problem. Because while California won't default, at least not right now, for practical purposes it should. Its income and expenses are structurally out of whack, not merely temporarily so. The imbalance is an artifact of a bygone era, one that won't come back any time soon -- perhaps not in our lifetimes. So, default. Say "whoops", financially speaking, and bite it. Better now than later. But California can't. It operates at the mercy of its creditors, and when this bit of theater is over said creditors will buy more debt, and California will keep making payments on it, right up until it can't.
When it comes to global banks, size matters
by Gillian Tett
Do the big global banks need to be cut down to size? That question has been hovering, half-stated, over the financial system ever since Bear Stearns blew up. But until this week, most policymakers were reluctant to attack the big banks too publicly, in terms of size. After all, this has been the decade when global leaders – or the infamous “Davos man” – worshipped at the altar of free-market capitalism, globalisation and innovation.
Inside the Davos creed it was long assumed that private sector banks had the right to be as big as the market would bear, since scale was supposed to make finance efficient, and thus better able to promote innovation.
Now that creed has crumbled. The collapse of Lehman Brothers has shown the havoc that can ensue when large, interconnected banks implode. Worse, in the aftermath of Lehmans, as governments have rushed to rescue the banks, the potential fiscal costs – and risks – have become clear. In the UK, for example, the balance sheet of the Royal Bank of Scotland at its peak was not far from the size of the British economy.
Thus, a new debate about “size” is finally starting. On Wednesday Mervyn King, Bank of England governor, warned that regulators might need to rethink the wisdom of letting some banks become “too big to fail”. In Washington, the Obama administration has voiced similar thoughts, albeit more diplomatically and obliquely. On Thursday, though, an even more interesting and outspoken intervention emerged. Philipp Hildebrand, the next head of the Swiss National Bank, revealed that the central bank was considering introducing “direct and indirect measures to limit the size” of large international banks (which in the case of Switzerland means Credit Suisse and UBS).
“A size restriction would of course be a major intervention in an institution’s corporate strategy,” Hildebrand, the central bank’s current vice-chairman, observed with masterful understatement. “Naturally the SNB is aware that there are advantages to size. [But] in the case of the large international banks, the empirical evidence would seem to suggest that these institutions have long exceeded the size needed to make full use of these advantages.”
Now, to be fair to Hildebrand, I should stress that he only presented size controls as a policy of last resort. He is not, in other words, demanding the immediate break-up of UBS or Credit Suisse.
For what really worries the SNB is not any abstract issue about size, but the very practical problems that emerge when big banks collapse due to the absence of any international regime to wind down a large, cross-border bank smoothly – or restructure its operations. What Hildebrand really wants to see is a credible international framework to handle big bank failures in a way that does not blow up the financial system. Call it, if you like, a call for a global Chapter 11 regime for banks.
Hildebrand is also a realist who spent the early years of his career working for a US hedge fund. He does not consider it a good trading bet to sit around waiting for global bureaucrats to actually produce a global insolvency regime any time soon. Hence his determination to start talking about plan B – and to stop banks from becoming too big if there is no global framework in place to deal with a collapse. Whether Hildebrand’s idea will actually fly is unclear. Some Swiss politicians hate the idea of introducing measures that might leave their banks at a disadvantage relative to others. And Credit Suisse and UBS have powerful lobbying muscle, precisely because they are so ... er ... big.
Hildebrand is not the only western policy maker mulling these concepts. And he has successfully stuck his neck out before. Last year he was the first western central banker to call for the use of a leverage ratio to help monitor bank capital levels. The concept was loathed by Swiss banks, but is now being introduced into Switzerland and may yet be incorporated into a revamped Basle code.
So it will be worth watching closely to see how the SNB’s debate about size curbs develops. And I, for one, think the proposals deserve to be taken seriously. Quite apart from the fact that the world is littered with banks which are too big to fail (but too costly to keep saving), the world also has banks that are too big to manage. The sorry tale of UBS’s disastrous dealing with subprime securities is a case in point. So are the sagas of Citigroup and Merrill Lynch. Thus making banks smaller may not only be good for non-banking taxpayers, but it might yet bring some real benefits for bankers too – not just in small countries (such as Switzerland) but places which tend to worship size too (such as the US). This is a debate which needs to be aired in the widest possible way.
EU set to tighten rules for markets
The UK, France and Germany are set to reach a broad understanding on Thursday on how to strengthen financial regulation in the European Union, in spite of British reservations about the powers to be given to EU authorities. At a two-day summit in Brussels, leaders of the 27-nation bloc are expected to approve a plan to create two agencies – a European risk-monitoring board and a system of financial supervisors – to watch over the banking, insurance and securities markets.
Their aim is to upgrade arrangements under which EU committees, made up of national supervisors, play a purely advisory role and have no power to draw up and enforce EU-wide rules. There are still differences between the UK, on the one hand, and France, Germany and most other EU governments, on the other, over whether EU-level supervisors should be able to force a government to recapitalise a stricken bank with taxpayers’ money. British officials thought they had secured an important concession last week when finance ministers issued a joint statement to the effect that the powers of EU authorities “should not impinge in any way on member states’ fiscal responsibilities”.
However, a draft of a communiqué to be released at the Brussels summit does not include this language, and merely refers to the finance ministers’ statement in general terms. According to EU diplomats, Gordon Brown, UK prime minister, may seek to amend the draft communiqué so it explicitly repeats that no EU-level authority can force a government to burden its taxpayers with the cost of a bank bail-out. Mr Brown may also question whether the European Central Bank should always provide the head of the risk-monitoring agency, as foreseen under current EU proposals.
A senior government official in Berlin said Germany and France would like more clarity on supervisory issues, but were optimistic they could come to an arrangement with London. Some British bankers and brokers are advising Mr Brown’s government that the City of London would be harmed by any measures that allow regulators from countries with competing or relatively undeveloped financial markets to impose their wishes on the UK. But EU diplomats said there was recognition in European capitals that London’s eminence as a financial centre was an asset for the EU, and it would be folly to undermine the City.
UK household finances still worsening
Households' finances are continuing to deteriorate as the credit crisis eats into consumers' balance sheets, according to new research which underlines the economy's continued fragility. A new index, produced by Markit, the research house behind the influential purchasing managers indices, shows that the pressures facing UK households are continuing to intensify. This comes despite interest rates at their lowest level in history and a series of tax cuts by the Government. The group's Household Finance Index (HFI), produced in conjunction with YouGov, underlines the likelihood that even if the recession itself soon ends, families will continue to experience hardship.
The index shows that in June 32pc of respondents saw their financial situation deteriorate compared with the previous month, while only 6pc reported an improvement. The resulting index, in which a score above 50 indicates overall improvement, was 37.5, up from 36.5 in May. The index is designed to give an early signal of how fast households' finances are changing each week. Markit also found that households' confidence in the Government's economic management also deteriorated, with only 6pc reporting that they had become more confident, compared with 59pc reporting a drop in their trust of the Government.
Chris Williamson, Markit's chief economist, also pointed out that consumers' house price expectations improved dramatically. He added: "While this adds to hope that the economy may have experienced a turning point in the second quarter, spending is nevertheless being reined in as households grew increasingly worried about job security, adding to fears that any recovery in the economy will be subdued by weak consumer spending."
UK 'powerless' to stop EU regulation
A senior French official has confirmed Gordon Brown is almost powerless to stop the creation of a European regulatory machinery at today's EU summit, opening the way for a transfer of control over the City from London to Brussels. "There will be a pincer movement on Britain," said a key aide to President Nicolas Sarkozy, speaking at a pre-summit briefing. Paris believes the push for tighter regulation by the Obama administration leaves Britain in a weak position as it tries to fight off the assault on the City.
"If the Americans make strong commitments towards regulation and on derivatives and other sophisticated products, I believe they are going further than the Europeans. That will provide a boost to the most determined among the Europeans," said the official. "It will be a reminder to the British that they cannot be quite isolated within Europe and at the same time refuse to accept for the City the kind of rules being imposed on Wall Street." Europe's key proposal is for three new bodies to oversee banking, insurance and securities. Each would rank as EU "authorities" and have binding powers to dictate decisions over sweeping areas of regulation.
Britain cannot veto the proposals because EU single market laws are passed by qualified majority voting (QMV). While a few countries have reservations – Germany views the plan as "too ambitious" – London will struggle to put together a blocking minority. It would be a serious political matter if the EU proceeded against vehement objections from the British Government. Any outcome depends on whether Mr Brown is willing to risk a showdown with Europe. Chancellor Alistair Darling said Britain will not agree to any measures that erode "fiscal sovereignty", an area that is still covered by the national veto.
Bank of England governor calls for banks to be 'cut down to size'
Mervyn King, the governor of the Bank of England, tonight called for banks that are "too big to fail" to be cut down to size as he opened a deep rift with Alistair Darling over the future regulation of the City. While the chancellor used the annual Mansion House gathering of City grandees to oppose a break up of the big financial institutions, King sketched out plans for a much more radical overhaul.
He voiced opposition to high street banks having taxpayer-funded guarantees for their speculative investment banking activities and expressed scepticism about changes to regulation in the aftermath of the run on Northern Rock that would limit the Old Lady of Threadneedle Street to delivering "sermons". In a clear divergence with the chancellor, King said: "If some banks are thought to be too big to fail, then, in the words of a distinguished American economist, they are too big. It is not sensible to allow large banks to combine high street retail banking with risky investment banking or funding strategies, and then provide an implicit state guarantee against failure."
The governor argued that "something must give". "Either those guarantees to retail depositors should be limited to banks that make a narrower range of investments, or banks which pose greater risks to taxpayers and the economy in the event of failure should face higher capital requirements. Or we must develop resolution powers such that large and complex financial institutions can be wound down in an orderly manner. Or, perhaps, an element of all three," King said.
In contrast, Darling, in remarks released on Tuesday, which were attacked by politicians and unions for failing to signal a far-reaching overhaul of the banking system, stressed the answer was not about impeding the size of the banks. Labour has overseen the creation of Lloyds Banking Group by using a new public interest test to permit Lloyds TSB to rescue HBOS, rather than face an investigation by the competition authorities.
"Many people talk about how to deal with the big banks – banks so important to the financial system that they cannot be allowed to fail. But the solution is not as simple, as some have suggested, as restricting the size the banks," Darling explained, adding it was also important to have a system to tackle failures. But King also criticised the new regulatory changes made after the collapse of Northern Rock in which the Bank is responsible for financial stability, but the Financial Services Authority is in the front seat in deciding whether a bank is failing.
"To achieve financial stability the powers of the Bank are limited to those of voice and the new resolution powers. The Bank finds itself in a position rather like that of a church whose congregation attends weddings and burials, but ignores the sermons in between," he said. "It is not entirely clear how the Bank will be able to discharge its new statutory responsibility if we can do no more than issue sermons or organise burials," King added. He also expressed divergent views to Darling who made an assault on boardrooms by saying they should have "the right people, skills and experience to manage themselves effectively".
King put it differently. "Blaming individuals is no substitute for acknowledging the failure of a system, of a certain type of banking. We have a real opportunity now to put that right and regain the trust that has been lost." The Conservatives have already called for a break up of banks that are "too big to fail" and signalled a willingness to dismantle Lloyds Banking Group and Royal Bank of Scotland. Vince Cable, the Liberal Democrat Treasury spokesman, concurred with the governor on the issue of sprawling banking empires. "The concept of private banks being 'too big to fail' is an economic and democratic outrage.
Either they must be subject to tight state control or they should be broken up so that they are no longer 'too big to fail'," Cable said. He added: "Alistair Darling has thrown in the towel when it comes to the big banks. Self-regulation got us into this mess and to continue with business as usual would be madness. What we need is a radical reform of the City of London." King called on the banking industry to win back the trust of the public as the crisis has "wreaked havoc" on the wider economy through rising unemployment, which yesterday hit a 12-year-high of 2.26 million.
King contrasted the billions of pounds poured into shore up the banking system with that offered directly to the public affected by the crisis. "It is the banking system that has received financial support on an almost unimaginable scale. We who work in the financial sector have much to do to regain the trust of those who work outside it. 'My word is my bond' are old words, but they were important. 'My word is my CDO-squared' will never catch on," King said.
Unite, Britain's biggest union, also highlighted the plight of the unemployed. "You only have to look at the latest unemployment figures, the highest in 12 years, to see what the bankers have done to our economy. Tinkering with the regulatory system is not an option, there needs to be radical reform," said Derek Simpson, Unite's joint general secretary. He added: "Working people in the UK are justifiably angry about the behaviour of bank bosses, for causing the crisis and for slashing jobs in banks as a result of it." He called for unions to have a seat on the board of UK Financial Investments, which looks after the taxpayer stakes in the bailed out banks.
UK public borrowing hits record as tax receipts slump
UK public borrowing has soared to the highest on record for the month of May, underlining the dire state of the country's finances, official figures showed on Thursday. Britain's budget deficit hit £19.9bn in May compared with £12.2bn in the same month in 2008, according to figures from the Office for National Statistics. Public sector net borrowing reached £30.5bn for the first two months of the financial year - more than double the level in 2008. The figures come as the dust is still settling on Mervyn King's fiercest rebuke yet to the Chancellor over the state of the public finances.
In his Mansion House speech last night, called on the Government to provide a "clear plan to show how prospective deficits will be reduced during the next Parliament." Alistair Darling is borrowing a record £175bn in this financial year alone. Even though May is traditionally a weaker month for public finances, the borrowing surpasses March's £19bn and is the biggest figure since the ONS records began in 1993. Britain's overall net debt now stands at a mammoth £774.8bn. This is almost £150bn higher than a year ago and equivalent to 54.7pc of the UK's entire annual economic output - the biggest proportion for more than 30 years.
The figures painted a stark picture of the impact of the current economic woes on the Government's tax receipts. During April and May, corporation tax takings were down 27pc to £5.2bn; VAT revenues over the same period were down 21pc to 11.9bn and takings from income tax fell 14pc to 21.1bn. Meanwhile Government spending on social benefits rose 8pc, or £1bn, to £13.5bn - reflecting higher unemployment payouts. Figures yesterday showed unemployment rising to a 12-year high of 2.26m and it is expected to increase further to three million.
Swiss franc drops as traders say BIS bought euros
The euro jumped against the Swiss franc on Thursday amid speculation the Bank for International Settlements was acting on behalf of the Swiss National Bank to defend the 1.50 level. Several traders in the United States and London said they saw bids from the BIS in the currency market for the euro and offers to sell the Swiss franc. The BIS and SNB both declined to comment though.
The euro jumped to 1.5126 francs on electronic trading platform EBS from 1.5008. It was last at 1.5119 francs. "It looks like the BIS have been in ... it's probably fair to say it's SNB-related," a London-based trader said. Another trader said he saw a bid from a big Swiss bank at 1.5035 and was also aware of a BIS bid on the euro. The Swiss franc's move came after the SNB held interest rates at a record low on Thursday, keeping its target rate for three-month Swiss franc LIBOR at 0.00-0.75 percent with an aim to lower it to 0.25 percent.
SNB Governor Jean-Pierre Roth said he would continue to stop an irrational rise in the Swiss franc, but analysts said he did not confirm the SNB had acted beyond initial intervention after its last policy meeting on March 12 when the euro jumped to nearly 1.5350 francs from around 1.4750 francs. Analysts said some traders were testing the resolve of the SNB on intervention, and the market was figuring out how low the euro/Swiss franc pair had to fall before the central bank would enter the market.
Another analyst at a U.S. currency firm said he noted a distinct change in tone from the SNB's press conference on Thursday. "I think the 'easy trade' of buying EUR/CHF on the 1.50 handle has now run its course." While this analyst would not suggest selling EUR/CHF, he strongly suggests exiting longs on the currency strength or at least tightening stops significantly.
Markets were constantly on the alert for SNB action after the bank in March stunned the global foreign exchange market and bought euros and dollars versus the Swiss franc. Before that, the SNB had last physically intervened in August 1995. The Swiss National Bank became the first central bank in the industrialized world to sell its currency as part of its fight against deflation. The bank's selling of the Swiss franc is part of a series of measures to avert deflation now that its rates have hit rock bottom.
Lithuania rules out devaluation
Lithuania on Thursday ruled out devaluation as a tool to fight its severe economic crisis and said it would not ask its European Union partners for special favours to ensure early admission to the eurozone. “It’s clear that we are suffering a bit more because of our currency board arrangement tying the litas to the euro, but devaluation is not an option,” Andrius Kubilius, prime minister, told the Financial Times in an interview. Lithuania’s finance ministry forecasts that the economy will contract by 18.2 per cent this year, while the national central bank predicts a slump of 15.6 per cent. The public spending cuts and tax increases required to tackle the recession, while keeping the litas pegged to the euro, have generated social and political tensions in Lithuania, as in neighbouring Latvia.
But Mr Kubilius, speaking in Brussels ahead of an EU summit, said his government would press ahead with its austerity programme and would not request a relaxation of the terms for joining the euro area that are set out under EU treaty law. Some prominent international economists say that, although it is difficult to revise EU law on this subject, there is little doubt that the best way for Lithuania to emerge from its crisis would be to adopt the euro as rapidly as possible. “It’s an interesting debate, but we are not looking for special favours or salvation,” Mr Kubilius said. “The lesson of this crisis for is very simple. It was a bad development that we missed entry into the eurozone in 2006. If we were in the eurozone now, we would have a much easier situation to deal with.”
The European Commission and European Central Bank barred Lithuania from joining the eurozone in 2006 because its inflation rate was deemed to be slightly above the limit set in the EU’s Maastricht treaty. By contrast, Cyprus, Malta, Slovakia and Slovenia have each been authorised to join the eurozone in recent years and have therefore been protected from the worst effects of the world financial crisis. Mr Kubilius said the campaign for the June 4-7 European parliament elections had convinced him that Lithuanian society was willing to accept his government’s austerity measures in spite of rising unemployment and falling living standards.
“During the election campaign, going around the country, I was absolutely surprised at meetings that people were criticising me for not being tough enough in cutting expenditure,” he said. “Pensioners and older people were saying, ‘Why are you letting us keep a job, when more and more young people are unemployed or can’t get a job?’” Mr Kubilius said Lithuania’s success in raising €500m in eurobonds this week demonstrated the faith of financial markets in his government’s policies. “It’s a signal that the international markets are coming back with trust in our ability to keep our public finances stable,” he said.