.U.S. Treasury building, Fifteenth Street, Washington, D.C
Ilargi: Want to go over the math one more time with me?
- According to the latest Case-Shiller Index, US home prices have dropped 32% since their 2006 peak, and 17.8% in the past year. The rate was 19.1% in the first quarter of 2009. The man behind the index, Professor Robert Shiller, expects prices to keep falling for years to come.
- Fannie Mae and Freddie Mac own or guarantee about half of the U.S. residential mortgage debt, for a total amount in the vicinity of $5.5 trillion. It's good to note that they own a far bigger percentage of loans made in the last few years.
- The two "companies" have lost some $150 billion in the past 18 months, and losses are increasing fast as home prices keep falling, though exact numbers are kept hidden. Their exposure to -potentially toxic- securities is, if possible, even more opaque. The two GSE's have asked for $84.9 billion in additional aid under a Treasury program that buys preferred shares.
- The Bush administration in late 2008 ordered Fannie and Freddie to buy $40 billion in mortgages from lenders every month. The vast majority of mortgages comes from the 4 biggest banks.
- President Obama has pledged to spend $275 billion to help keep 9 million Americans in their homes. His "Home Affordable" program, announced February 18, is aimed at "saving" 5 million homeowners who owe more on their mortgages than their homes are worth. To date, 4 months after, Fannie Mae and Freddie Mac claim to have refinanced a grand total of 80,000 loans under the program. Call back in 20 years.
- Over 20% of all homeowners who have mortgages already owe more than their homes are worth, and their number grows fast.
- There is presently a program in place that hands $8000 to purchasers, no questions asked. Since it doesn't work as intended, there is a proposal to raise the amount to $15.000 (which is more than enough to buy a home in Detroit, where the median sales price is $6000).
- Federal Housing Finance Agency Director James Lockhart, who oversees Fannie and Freddie, claimed this week that his "protégés" will need another "year or two" before they return to profitability. Lockhart also said that Fannie Mae and Freddie Mac’s $5.4 trillion in mortgage assets creates "substantial uncertainty" as to their future structure.
- Which must be, don't you think, why Tim Geithner yesterday refused to commit to anything regarding the future of the two "private hybrids".
- There are current ideas to wind the companies down and scatter both their assets and their ashes.
- To me, these ideas look absurd. Who's capable of winding down $5.5 trillion in loans and who knows how much more in securities?
- Two other reasons why it's highly unlikely that they'll be forced to close:
- Losses could well be in the trillions, and don't look don't tell certainly would be preferred by many parties.
- Wall Street would lose the vehicle that allows it to write loans at zero risk, cash in on fees, and transfer them to the government. If possible, all in one day.
- Losses could well be in the trillions, and don't look don't tell certainly would be preferred by many parties.
I've said it before, but let's do it one more time: think about where US home prices would be today if Fannie and Freddie would not be there to buy up the banks mortgages and finance the home your neighbor buys with your money and your guarantee.
There is a lot of talk, in the aftermath of the botched regulatory reform plans presented this week, about firms that are Too Big To Fail (or as the government calls them now:"Tier 1 Financial Holding Companies"), and whether it's a good idea to have such firms. Hint: it is for the firms themselves, who successfully use the moniker to get unlimited access to public funds. For the public, it's not.
If the label “Too Big To Fail" fits anywhere, it's on the foreheads of Fannie and Freddie. And that's why they'll stay. If they fail, the banks would fail. And the construction industry would fail. And the mortgage industry. Home prices would fall across the board to Detroit levels. A large part of the population would go bankrupt, and not just homeowners.
And in the end, the government itself would fail.
Fannie Mae and Freddie Mac are to American society as a whole what bagmen are to its streets corners and boardrooms.
PS: A bagman is a street corner small crook two bit drug pusher
UK real estate lending 'close to zero', says Bank of England
Banks made virtually no new loans to real estate companies in April and May, according to the Bank of England, revealing for the first time the extent of the funding crisis facing the industry. The Bank also said that lending to all businesses fell by its biggest amount in nearly nine years in April and that high street lenders had reported this trend had continued in May. Mortgage approvals by major UK lenders picked up to 45,000 in May, from 42,100 in April, the Bank's Trends in Lending report showed.
The Government will be concerned that credit flows to cash-starved firms are getting weaker despite record low interest rates and a £125bn asset-buying programme aimed at boosting the economy. Net lending to private non-financial corporations fell by £5.4bn in April – the biggest fall since June 2000. Property investors and developers are among those being denied credit lines, the Bank revealed, citing information provided to the Chancellor's lending panel, set up in November to monitor bank lending, that showed "net new facilities granted was close to zero" in the last two months.
"Lenders reported that the outlook for real estate lending was very subdued," the Bank stated in its June review of bank lending trends. High street banks said that "an increasing number" of their real estate customers had breached loan-to-value convenants attached to their loans. But they reported that instead of forcing customers into fire sales of the property they were either supporting customers that could cover the interest due from rental income or were "encouraging companies to inject equity where possible". Companies that have conducted recent fund-raisings include British Land, Land Securities and Hammerson.
The comments echo those made by the Royal Bank of Scotland chief executive, Stephen Hester, earlier this week. "Courtesy of Government support and the Asset Protection Scheme, we have time to allow customers to restructure themselves in an orderly way," he said. British banks have lent £225bn to commercial property, with £105bn due to be refinanced in the next three years. They told Bank officials that if they were to agree new loans they would be set at loan-to-value ratios of around 70pc rather than around the 85pc typical before the financial crisis.
The officials examined commercial property lending in an attempt to explain why total bank lending to the sector had continued to grow during the recession. The high street banks said that the growth had been driven "almost entirely by previously committed facilities being drawn down". Property financiers and developers can take years to use loans, reflecting the time it takes to complete a commercial property project.
6 States Hitting Residents With Big Tax Hikes
State legislators faced with mammoth budget gaps and sharply lower revenue are looking to residents to bail them out.
Right now, at least 47 states are facing significant shortfalls in their 2009 and/or 2010 budgets, according to the Center on Budget and Policy Priorities, a think tank in Washington, D.C. And many of those states are looking to taxhikes to help fill the gaps.
Pretty much everyone is doing poorly,” says Kim Rueben, senior research associate at the Tax Policy Center. “It’s just a question of who’s hurting more than others.”
The top honor goes to California, which is projecting that it will fall about $25 billion short come fiscal 2010. Taking second place is New York with a projected $17.6 billion deficit for fiscal 2010, according to the National Conference of State Legislatures, a bipartisan policy research organization in Washington, D.C.
How can these states miss the mark so badly? The recession has sapped the two major sources of state revenue: income taxes (thanks to rising unemployment, fewer people are getting paid) and sales taxes (quite simply, consumers are spending less.) “Those two things together really, really lead to a high loss of tax revenues, far in excess of loss of income,” says Michael Hicks, director of Ball State University’s Center for Business and Economic Research.
Even though raising taxes are typically a last resort, many states have no choice but to do so. And, in some, lawmakers are leaving no stone unturned when it comes to finding items or services to tax. New York, for instance, has raised taxes on tobacco, wine and limo services. Meanwhile, Massachusetts is proposing a tax on satellite television service and Georgia lawmakers are proposing a “pole tax” that would charge gentlemen’s club patrons $5 at the door.
To figure out which states are inflicting the biggest tax hikes on residents, SmartMoney pored over reports from tax research groups and contacted state budget offices. We looked at state budget deficits tracked by the National Conference of State Legislatures and current sales tax rate data from the Federation of Tax Administrators, a group that provides services to state tax authorities. Finally, we turned to the TaxFoundation -- a nonpartisan tax research group -- for figures on tax burden, the average percentage of each state's residents' income that is paid in state and local taxes (the figures we use are for 2008).
California: Diminishing This Huge Deficit May Just Be a Dream
State deficit estimate for fiscal 2010: $24.7 billion
Percent of general fund budget: 22.3%
State and local tax burden: 10.5%; Rank: 6
California is facing the biggest budget deficit in the nation, yet voters' willingness to chip in is starting to wane. Last month, they voted down five ballot measures that included sales and income tax increases. Who could blame them? At 11%, California has one of the worst unemployment rates in the country, the housing market has been decimated, and the state already raised taxes on sales by 1% to 8.25% and income by 0.25% (both of which expire in 2011). Gov. Arnold Schwarzenegger’s latest budget plan includes steep spending cuts across the government and cutbacks in social services.
In a testament to California’s grim predicament, one assemblyman’s proposal to legalize marijuana for personal use and allow counties to tax it is gaining public support. It’s one of the “wacky things you might be able to get away with now,” says Rueben.
New York: If It's Bad for You, It Will Be Taxed
State deficit estimate for fiscal 2010: $17.6 billion
Percent of general fund budget: 31.9%
State and local tax burden: 11.7%; Rank: 2
New York State Gov. DavidPaterson may have been unsuccessful in levying an 18% tax on soda and other sugary drinks in the name of combating obesity, but he’s had a hand in raising taxes on plenty of other "sinful" items, including tobacco (up to 46% from 37%) and wine (up 58% per gallon, or about two cents more per bottle).
For those living in New York, all those taxhikes can really add up. Second only to New Jersey, New Yorkers bear the second-highest tax burden thanks to a high income-tax rate of 7.85% (for those earning more than $200,000). And property and gas taxes are among the highest in the nation, according to the Tax Foundation. Nevertheless, shoppers can rejoice: The salestax here remains relatively low at just 4%.
Florida: Driving and Smoking Will Cost You
State deficit estimate for fiscal 2010: $6 billion
Percent of general fund budget: 27%
State and local tax burden: 7.4%; Rank: 47
Florida passed its budget in May with a not-so-pleasant surprise for smokers: a $1-per-pack hike (the first such increase in 19 years). Motorists also got hit with higher fees to renew a license or register a vehicle. It could have been worse, though. Senatelawmakers had proposed eliminating the sales tax exemption on items like bottled water and tickets to sporting events, both of which didn't make the cut.
Still, residents here aren't feeling as much tax pain as some of their peers in other states. Overall, Florida's tax burden is the third-lowest in the nation and it's one of eight states that imposes no individual income tax, according to the Tax Foundation. But those perks may be outweighed by the rest of Florida's economic situation. Home values are among the nation's hardest hit and the state's $6 billion budget deficit could mean more tax hikes are on the horizon.
Massachusetts: Shoppers and Couch Potatoes, Prepare to Pay Up
State deficit estimate for fiscal 2010: $3 billion
Percent of general fund budget: 11.2%
State and local tax burden: 9.5%; Rank: 23
Just when Massachusetts was starting to shake its "Taxachusetts" nickname (it's ranked a middle-of-the-road 23rd in the TaxFoundation's tax burden assessment), the state is preparing to hike taxes on everything from alcohol to satellite TV.
The most hard-hitting for residents is a proposed increase in the salestax to 6.25% from 5%. Both the House and Senate approved the measure and it's looking likely the increase will pass by the July 1 deadline, says Noah Berger, executive director of the Massachusetts Budget and Policy Center, an independent research group. Satellite TV subscribers may also get hit. The state is proposing a 5% sales tax on satellite services. Providers, of course, are fighting the tax.
Arizona: Proposed Sales-Tax Hike Could Hurt Already-Strapped Residents
State deficit estimate for fiscal 2010: $3 billion
Percent of general fund budget: 28.2%
State and local tax burden: 8.5%; Rank: 41
The recession has thumped Arizona harder than most other states, says Lee McPheters, research professor of economics at Arizona State University’s W.P. Carey business school. The housingslump is partially to blame: During the boom, construction accounted for at least a quarter of new jobs created. Since home prices have fallen 43% from their peak, the construction industry has lost tens of thousands of jobs, says McPheters. Arizona's unemployment rate in April was 7.7%, shy of the 8.9% national average.
If Gov. Janice Brewer gets her way, residents will pay for the state's problems by shelling out an extra 1% at the cashregister. The proposed sales-tax hike, which would bring the rate to 6.6%, was omitted from the budget the legislature passed this month, but the governor may veto the budget until it’s put back in. (She could also place it on a November special election ballot.)
Nevada: What Happens in Vegas Is Going to Cost You More
State deficit estimate for fiscal 2010: $1.2 billion
Percent of general fund budget: 32%
State and local tax burden: 6.6%; Rank: 49
Nevada's freewheeling, low-tax past is coming back to haunt it like a bad hangover. The state levies no personal incometax and imposes some of the lowest taxes on businesses in the nation, says Bert Waisanen, a fiscal analyst at the National Conference of State Legislatures.
Nevada used to be able to afford being so generous with its residents. Revenue from tourism and gambling supported the state just fine. But now, as consumers would rather put their coins in a bank account than a slot machine, that revenue source is drying up. In fact, the state boasts the dubious honor of having the largest deficit in the country as a percentage of its budget – 32%. It's hiked the sales tax by 0.35% to 6.85% and taxes on hotel rooms are up 3%. It's even gambling with its business-friendly climate by raising taxes on businesses.
Unemployment Exceeds 10% in Quarter of U.S. States, Threatening Recovery
More than one-quarter of American states now have unemployment rates higher than 10 percent, and all but two saw a further job-market deterioration in May. Tennessee and Indiana joined the rank of states, now 13, that have jobless rates exceeding 10 percent, and eight states - - including California, Florida and Georgia -- reached their highest level of joblessness in May since records began in 1976, the Labor Department reported today in Washington.
The figures make it likely President Barack Obama, whose home state of Illinois also passed 10 percent for the first time since 1983, was correct this week in forecasting the national unemployment rate will reach that level this year. With no region escaping the rout, consumers across the country will probably curtail their spending, preventing any boom out of the deepest recession in half a century, analysts said. "It’s tough everywhere," said Mark Vitner, a senior economist at Wachovia Corp. in Charlotte, North Carolina. "Nobody’s really been spared." The biggest increases in unemployment will be in states most dependent on manufacturing, construction and financial services, he said.
For the country, "unless hiring magically picks up, a 10 percent unemployment rate is pretty much baked in," Vitner said. Michigan’s jobless rate, at 14.1 percent, showed the biggest jump from April and remained the highest in the nation. The bankruptcy of General Motors Corp. and Chrysler LLC is likely to deepen the labor-market slump in the Midwest and ripple through other areas and industries. Kentucky and Florida were the other two states that passed the 10 percent mark last month. Those remaining on the list included California, Ohio, Oregon, Rhode Island, Nevada and North and South Carolina.
Overall, 48 states and the District of Columbia posted increases in their unemployment rates in May from the prior month. Nebraska was the only one to post a drop, to 4.4 percent from 4.5 percent; Vermont held at 7.3 percent, the Labor Department said. Payrolls decreased in 12 states in May, led by California with a 68,900 loss, and Florida, where 61,000 workers were dismissed. North Dakota and Alaska reported gains in employment.
Nationwide, payrolls fell by 345,000 in May after a 504,000 decline in April, government figures showed earlier this month. The economy has lost 6 million jobs since the recession began in December 2007. The jobless rate reached a 25-year high of 9.4 percent last month. "It’s different times," said Stephanie Moyna-Gilbert, a 36-year-old mother of three from Fishers, Indiana. "This is absolutely the longest time I’ve been unemployed."
She lost her job as a recruiter and human-resource manager for Interactive Intelligence Inc., an Indianapolis-based telephone software maker, in December, and is finding it hard to find a full-time position for herself after four years of hiring and training staff. Moyna-Gilbert is doing some consulting work to expand her professional contacts and try to bring home some cash. Still, "the income isn’t there until I place people," she said. "Being without benefits isn’t a good thing."
Employers remain reluctant to hire even as there are signs that the worst of the job cuts are over. A Bloomberg News survey this month showed economists project the jobless rate will reach 10 percent by year-end and average almost that rate in 2010. Obama, in a June 16 interview with Bloomberg News, said he couldn’t predict when unemployment will start to decline because it was a "lagging indicator." "As soon as this economy has stabilized, we want the market to do what it does best, and that is produce jobs, invest," he said.
California’s Credit Rating May Be Cut by Moody’s
California’s credit rating, already the lowest among U.S. states, may be cut several levels by Moody’s Investors Service as government leaders seek ways to eliminate a $24 billion budget deficit. The move would affect $72 billion of debt, Moody’s said in a statement today. California’s full faith and credit pledge is rated A2 by Moody’s, five steps above high-yield, high-risk status, or junk. A downgrade may increase the state’s borrowing cost and raise the yield paid to investors on its bonds. Standard & Poor’s put California on watch for a possible reduction earlier this week, and Fitch Ratings did the same thing May 29. The rating companies cited the most-populous state’s deficit -- amounting to more than 20 percent of the general fund -- and lawmakers’ inability to agree on how to close the gap.
"If the Legislature does not take action quickly, the state’s cash situation will deteriorate to the point where the controller will have to delay most non-priority payments in July," Moody’s said in a report today. "Lack of action could result in a multi-notch downgrade." Earlier this week, Republican Governor Arnold Schwarzenegger said he would refuse to back any tax increase as Democrats proposed a budget that would raise $2 billion from cigarette consumers and oil companies to help the state deal with declining revenue. The veto threat signaled an escalating battle over the deficit just a month and a half before the most- populous U.S. state is forecast to run out of cash to pay bills.
"I don’t think I’ve ever seen the phrase multi-notch in a ratings write-up," said Schwarzenegger’s budget spokesman H.D. Palmer. "It’s another clear warning from the financial markets that there will be costly consequences if the Legislature doesn’t’ quickly send the governor a budget plan that he can sign." California taxable 30-year Build America Bonds paying 7.55 percent traded at about 94.56 cents on the dollar yesterday to yield 8.03 percent, down from as high as 98.16 cents and 7.71 percent a week earlier, according to Municipal Securities Rulemaking Board trade data.
A further California reduction might ripple through the U.S. economy and its financial markets, said Shaun Osborne, chief currency strategist in Toronto at TD Securities Inc., a unit of Canada’s second-biggest bank. "California has to solve its budget issues itself but the issue reflects the weak fiscal position of the U.S. overall," Osborne said. "California is the eighth-largest economy in the world, and so I think it would be a psychological blow for the U.S. dollar if there was a downgrade." Without a balanced budget, California’s treasurer and controller have said the state will have difficulty securing the short-term loan needed to fund the government until the bulk of tax collections come in later during the budget year.
Under U.S. Securities and Exchange rules, money market funds are only allowed to buy tax-exempt bonds that carry AA ratings or higher. Issuers with municipal ratings below AA have been forced to buy credit enhancement, such as bond insurance, to make their bonds available to the funds. "We have historically traded above our GO rating," Palmer said, referring to general obligation debt. "That said, if in fact there were to be multi-notch downgrade, there would be significant costs associated with it and that underscores the necessity for the Legislature to move very quickly to get a budget down to the governor in a form that he can sign."
Tom Dresslar, spokesman for California Treasurer Bill Lockyer, said Moody’s should have more prominently noted in its report the nominal chance that the state would actually default. Lockyer has led an effort to push rating companies to assign municipal bond grades that reflect their lower risk of default compared with corporate debt. "This is Moody’s opinion and as we have seen time and time again, the opinion of Moody’s, Fitch and Standard & Poor’s is worth squat," Dresslar said. "They say that the likelihood of bond repayment is very high. That’s an understatement. We have never failed to make a bond payment on time and in full, never in our history. They buried the lead."
Treasury to Auction Record $104 Billion In Debt Next Week
The Treasury announced Thursday a record $104 billion worth of bond auctions for next week, part of its herculean efforts to finance a rescue of the world's largest economy. The sales will exceed the previous record of $101 billion set in auctions that took place in the last week of April and consist of two-year, five-year and seven-year securities. That record was matched by another $101 billion week in May.
Though next week's total was broadly in line with expectations, worries about supply have weighed on the U.S. government bond market, which will see a mammoth $2 trillion worth of new debt issued this year. "Maybe the Treasury market reacted a little negatively and it will continue to be like this," said Suvrat Prakash, U.S. interest rate strategist with BNP Paribas in New York. "Supply announcements and auctions on the horizon will make the market a bit nervous about upcoming debt." Bond prices were lower already in anticipation of the Treasury's announcement and continued to sell off in reaction.
The government is likely to raise about $85 billion in net new cash given that there are about $19 billion worth of coupon securities maturing during the week. The Treasury's include $40 billion in 2-year notes on Tuesday, $37 billion 5-year notes on Wednesday and $27 billion in 7-year notes on June 25. The U.S. bond market has been under pressure for three months, with benchmark yields surging to an eight-month high of 4 percent last week, as investors worried about a budget deficit expected to reach an astounding 13 percent of the economy this year.
The Treasury routinely sells billion of dollars worth of debt paper to fund the federal budget deficit. The Treasury Department's report for May, released last week, pointed to a growing gap between government spending and income at a time when the economy is struggling to emerge from recession and tax revenues are likely to decline. The U.S. government posted a $189.65 billion budget deficit in May, a record for the month and the eighth straight monthly deficit, the Treasury Department said on June 10.
Twin Threat: Jobless Rate, Deficit
President Barack Obama faces a dilemma as he fights the recession: The public identifies both rising unemployment and soaring budget deficits as its top policy concerns -- but fixing one could worsen the other. Mr. Obama can ill afford to lose public support on the cusp of the biggest political fights of his presidency, over health care, energy and financial reregulation. Three separate polls this week, including one from the Wall Street Journal/NBC News, have raised red flags at the White House that the president, though still personally popular, is losing some ground with the public on his economic policies.
Officials concede there is little the president can do to please everyone, given the economic Catch-22. If he heeds concerns on the deficit and pulls back on economic stimulus, he risks choking off the "green shoots" of what may be a fledgling recovery. Mr. Obama said this week that he expects the unemployment rate to reach 10% this year. Without sustained stimulus spending, it could move even higher heading into next year's midterm congressional elections. Rising joblessness could trigger pressure for another injection of spending or tax cuts beyond the billions of dollars already spent.
Yet the sustained push -- even without another fiscal stimulus plan -- threatens to push the budget deficit over the $2 trillion mark, a percentage of the economy unmatched since World War II. "Traditionally people haven't paid enough attention to the looming fiscal crisis in this country, so people seem to be waking up," said R. Glenn Hubbard, who was chairman of the White House Council of Economic Advisers when President George W. Bush pressed forward with tax cuts in the face of rising deficits. "The issue the administration faces here is a trade-off between short-term [spending] to fix the economy and long-term deficit control."
In a Wall Street Journal/NBC News poll released this week, 58% said the president and Congress should worry more about keeping the budget deficit down, even though such action may mean a longer recession and slower recovery. Just 35% said they favored boosting the economy, even though it might mean larger budget deficits. Democrats are more evenly split, with 50% favoring boosting the economy, and 42% urging a deficit focus, while Republicans are overwhelmingly more concerned about the red ink.
White House officials are more closely watching independents. By 2 to 1, that politically pivotal group would rather see the White House and Congress bring the deficit under control. That said, 31% of those in the Journal/NBC poll identified job creation and economic growth as the highest priority for the federal government to address, by far the biggest priority. The deficit and government spending came next, at 19%.
Given the public's conflicting impulses, the White House is urging Americans to stay the course. Christina Romer, chairman of the White House Council of Economic Advisers, cites the Great Depression. In the opening years of Franklin Roosevelt's New Deal, annual economic growth averaged over 9%. Unemployment fell from 25% to 14%. Then came 1937, when a large bonus for World War I veterans came to an end, Social Security taxes were collected for the first time, and the Federal Reserve Board, looking for an exit strategy, began reining in the money supply. The budget deficit fell, by about 2.5% of the gross domestic product. Unemployment leapt to 19%.
"The 1937-38 recession shows what can happen if policy support is withdrawn too soon from an economy struggling to recover from a severe financial crisis. The key is to plan an exit strategy, but to resist a return to normal policy until the economy is again approaching full employment." The real dilemma could come late this year or early next, if it becomes clear a recovery is stalled but rising long-term interest rates make another stimulus plan a gamble, said Martin Baily, a former chairman of President Bill Clinton's Council of Economic Advisers. "I'd say go ahead and do it, probably as a tax cut and not more of this infrastructure spending," he added, "but I'd be worried as hell about it."
40 banks failures in 2009
Regional banks in North Carolina, Kansas and Georgia were closed by state regulators Friday, bringing the total number of failed banks this year to 40, the Federal Deposit Insurance Corporation said. The 24 branches of Wilmington, N.C.-based Cooperative Bank will reopen Monday as branches of First Bank, which is based in Troy, N.C. Cooperative bank had assets of $970 million and total deposits of approximately $774 million. First Bank will assume all of the failed bank's deposits and agreed to purchase $942 million of its assets.
In Kansas, First National Bank of Anthony, which operated 6 branches - including two under the name of First National Bank of Johnson County - will be taken over by Bank of Kansas. Bank of Kansas, which is based in South Hutchinson, acquired all of First National Bank of Anthony's $156.9 million deposits. It also purchased the bulk of the failed bank's $156.9 million worth of assets. Meanwhile, the five branches of Southern Community Bank, which is based in Fayetteville Ga., will become part of United Community Bank of Blairsville. It was the seventh bank to fail in Georgia this year. United Community Bank paid a premium of 1% to acquire all of the of the $307 million deposits held in the failed bank. It also agreed to purchase approximately $364 million of assets.
The assets not purchased by the acquiring banks will be retained by the FDIC and sold later. The FDIC said it entered into a "loss-share transaction" with the acquiring banks for a portion of the assets belonging to the failed banks. The arrangement is designed to maximize returns on the assets covered by keeping them in the private sector, the FDIC said. "Under the loss sharing agreement the FDIC will reimburse United Community Bank for losses on Southern Community Bank's loans and foreclosed properties," said Jimmy Tallent, president and chief executive of United Community Banks, in a statement.
The total cost of Friday's bank failures to the FDIC is $203 million, bringing the total for this year to $11.53 billion. That compares with $17.6 billion in all of 2008. So far this year, the number of bank failures has already exceeded last year's total of 25, with an average of nearly 7 failures per month. The FDIC expects roughly $70 billion in losses due to the failures of insured institutions over the next 5 years. The FDIC, which is funded primarily by fees paid by banks, insures individual deposits up to $250,000. The amount was increased from $100,000 late last year in response to concerns about the stability of the nation's banks.
The Obama Administration unveiled a highly-anticipated new plan to overhaul how banks and other firms are regulated in the hope of preventing another financial collapse. Under the new proposal, the FDIC and other regulators would have more power to take over and unwind troubled financial companies beyond banks. The plan would also, among other things, expand the powers of the Federal Reserve and create a new agency dedicated to consumer protection.
Fannie, Freddie in Limbo as Geithner Seeks More Time
Fannie Mae and Freddie Mac will remain in limbo as the U.S. Treasury secretary said the government doesn’t have time now to deal with the future of the two mortgage-finance companies it seized in September.
"We did not believe that we could at this time -- in this time frame -- lay out a sensible set of reforms to guide, to determine what their future role should be," Treasury Secretary Timothy Geithner told the Senate Banking Committee in Washington today. "We’re going to begin a process of looking at broader options for what their future should be."
"We just didn’t think its an essential thing to do just now, but it is an essential thing to do," Geithner said. Fannie Mae and Freddie Mac, which have posted $150 billion in losses going back to the third quarter of 2007, will need another "year or two" before they return to profitability, Federal Housing Finance Agency Director James Lockhart said. While the government has stabilized the companies since seizing them in September, "turning around may be too strong a statement," Lockhart said at a National Association of Real Estate Editors Association conference in Washington today. Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac, which own or guarantee almost half of the U.S. residential mortgage debt, were seized in September because of their losses and reshaped into integral components of government anti-foreclosure programs.
The results of those government efforts are still below the administration’s initial goals. Lockhart said today that President Barack Obama’s program to help homeowners avoid foreclosure, which Fannie Mae and Freddie Mac help run, may now be hampered by a rise in mortgage rates. "There’s a big pipeline, so it probably won’t hit for another few months," Lockhart said in response to questions at the conference in Washington. "But at some point, if we don’t see some moderation in rates it could have an impact on the refinancings."
Higher borrowing costs have come as Obama has pledged to spend $275 billion to help keep as many as 9 million Americans in their homes and stem the rise of foreclosures. His measures also include a tax break of as much as $8,000 for first-time homebuyers that wouldn’t require repayment. Mortgage rates started climbing in May along with Treasury yields. The average 30-year rate was 5.38 percent this week, Freddie Mac said today in a statement. The rate is up from a low of 4.78 percent at the end of April.
Fannie Mae and Freddie Mac have refinanced 80,000 loans under Obama’s Making Home Affordable program, Lockhart said. A quarter of those loans are to borrowers who have less than 20 percent equity in their homes, he said. The program, announced in February, includes helping 5 million borrowers whose homes have declined in value. The program lets the companies refinance loans they already own or guarantee without adhering to the companies’ usual legal underwriting standards requiring extra insurance on properties that have lost value. Lockhart said the companies are more aggressively modifying loans as well. More than half of their loan modifications in the first quarter cut borrower payments by more than 20 percent, compared with an average of 2 percent last year, he said.
Fannie Mae was created in the 1930s under President Franklin D. Roosevelt’s "New Deal" plan to revive the economy. Freddie Mac was started in 1970. The companies were designed primarily to lower the cost of home ownership by buying mortgages from lenders, freeing up cash at banks to make more loans. They make money by financing mortgage-asset purchases with low-cost debt and on guarantees of home-loan securities they create out of loans from lenders. A Treasury report this week said the Obama administration "will engage in a wide-ranging process and seek public input to explore options regarding the future" of Fannie Mae and Freddie Mac and will deliver a report to Congress when the president gives his fiscal 2011 budget in February.
Options considered by lawmakers include winding the companies down and liquidating assets or using Fannie Mae and Freddie Mac to provide insurance for covered bonds. Lockhart said earlier this month that the size and credit quality of Fannie Mae and Freddie Mac’s $5.4 trillion in mortgage assets creates "substantial uncertainty" as to their future structure. Fannie Mae and Freddie Mac have requested $84.9 billion in taxpayer aid through the Treasury’s $400 billion program to buy preferred stock in the companies to keep them solvent. The remainder of the lifeline should still be "sufficient" until the government decides how to restructure the companies, Lockhart said in June 3 testimony to a House subcommittee.
Obama May Expand Refinancing Plan to Buyers Who Owe More Than Home's Value
Fannie Mae and Freddie Mac may get permission to begin refinancing mortgages with loan-to-value ratios above 105 percent as the Obama administration seeks to boost participation in its anti-foreclosure programs. "We’re actively considering how to structure a program that makes sense over 105 percent," Federal Housing Finance Agency Director James Lockhart said yesterday. He said a ratio of 125 percent "is a number" that’s on the table, though "not necessarily the number we’re going to end up with."
President Barack Obama’s Home Affordable program announced Feb. 18, sought to help as many as 5 million Americans who may owe more on their mortgages than their homes are worth. Fannie Mae and Freddie Mac have refinanced 80,000 loans under that program, Lockhart told a National Association of Real Estate Editors Association conference in Washington yesterday. He didn’t say when the loan-to-value ratio could be raised. "While this will help some borrowers with higher interest rate loans, you really need to get mortgage rates down below 5 percent to have a huge impact on refinancing," Scott Buchta, a strategist at Guggenheim Capital Markets LLC in Chicago, said.
Home Affordable has been "seeing a slowdown" as mortgage rates increase, Lockhart said. The average rate on a typical 30- year fixed loan was 5.38 percent in the week ended yesterday, according to Freddie Mac. The rate is up from a record low of 4.78 percent at the end of April. The program applies to mortgages that meet Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac’s conforming loan limits. That cap is $417,000 for some areas and as high as $729,750 for the 250 most expensive real estate markets.
Under the program, borrowers with loans owned or guaranteed by Fannie Mae or Freddie Mac who have loan-to-value ratios of 80 percent to 105 percent and aren’t delinquent can refinance without buying mortgage insurance, or paying for more insurance than they already have. Expanding the program to a 125 percent loan-to-value level may benefit about 10 percent of borrowers that have loans backed by Fannie Mae or Freddie Mac, according to Mahesh Swaminathan, a mortgage strategist for Credit Suisse in New York. He said an additional 4 percent of borrowers with Fannie Mae or Freddie Mac loans are further underwater. "If home prices decline further, this bucket" of underwater borrowers could expand, he said.
A drop in values has left about 20.4 million of the U.S.’s 93 million houses, condos and co-ops with mortgages higher than the properties are worth as of March 31, Seattle-based real estate data service Zillow.com said in a report May 6. Fannie Mae and Freddie Mac own or guarantee more than half of the single-family mortgages in the U.S. The government- chartered companies were seized by regulators in September amid concern that their capital wasn’t sufficient to weather the worst housing slump since the Great Depression.
Lockhart also said yesterday that his agency, the companies’ regulator, is looking at ways for Fannie Mae and Freddie Mac to help the so-called warehouse lending market, which provides financing to smaller, independent mortgage companies, amid a credit crunch. While Fannie Mae and Freddie Mac are prohibited by law from lending directly to other firms, Lockhart said they may be able to provide the market some liquidity by committing to purchase multifamily and other loans.
Freddie's Accidental CEO Tries to Shed Job
Over the past four decades, John Koskinen's roles have included salvaging a bankrupt railroad, owning an unprofitable soccer team and managing a shutdown of federal agencies during a budget impasse. Now, approaching his 70th birthday June 30, Mr. Koskinen has what may be his most thankless assignment: chairman as well as interim chief executive and finance chief of Freddie Mac, a big mortgage company on Treasury Department life support. Near the top of his to-do list is finding a new CEO and finance chief.
Other troubled companies also have called in specialists to fix what ails them. Edward Liddy, a retired insurance industry executive, has run American International Group Inc. since last September. The Obama administration in March put Kent Kresa in charge of General Motors Corp.'s board after ousting Rick Wagoner as chairman and CEO. Former AT&T Corp. CEO Edward Whitacre Jr. was selected last week to become GM's next chairman. But recruiting for permanent spots is tricky at Freddie and other companies getting propped up with federal money.
For one thing, the pay likely will be comparatively modest. Though Mr. Koskinen says it isn't clear how much regulators will allow Freddie to pay top executives, it will be far lower than in the past, when CEO compensation sometimes topped $10 million a year. Mr. Koskinen has declined compensation for the CEO and finance positions but is being paid $290,000 a year as chairman. Another issue is that regulators now have veto rights over major decisions at Freddie and its sister company, Fannie Mae.
In an interview at Freddie's headquarters in the Washington suburb of McLean, Va., Mr. Koskinen says he hopes to name a new CEO and finance chief next month. He also has to find a new chief operating officer, but that may come later. He plans to stay on as chairman. Mr. Koskinen says the ideal CEO candidate should have a deep, intuitive understanding of mortgage and financial markets. And since the government has assigned Freddie a central role in averting foreclosures, running the company is "an opportunity to give something back" to the nation, he says. Yet even those interested in public service might avoid getting entangled with a government-backed company.
One former Wall Street executive says he was approached about the CEO spot but declined. He says he envisioned working for minimal pay while getting "raked over the coals" by lawmakers for matters beyond his control. Freddie also sounded out Steve Preston, who served as secretary of Housing and Urban Development under President George W. Bush, according to a person familiar with the situation. Mr. Preston withdrew from consideration June 5, in part because he felt he couldn't "move the dial" at Freddie Mac in the face of significant government oversight, the person says. Freddie declines to comment on Mr. Preston.
A former Clinton administration official and deputy mayor of Washington, Mr. Koskinen is no stranger to politics. As a deputy director at the Office of Management and Budget in 1995, he helped temporarily shut federal agencies during a budget impasse. He owned the Washington Stars soccer club of the American Professional Soccer League in the late 1980s, calling the experience "a hedge against wealth." Mr. Koskinen also worked as a congressional aide. His Washington contacts led to a job at Palmieri & Co., a consulting firm specializing in restructuring, where he helped overhaul the Penn Central Transportation Co. railroad and Levitt & Sons, a home builder.
In August, Ken Wilson, a Wall Street executive then serving as an adviser to Treasury Secretary Henry Paulson, called Mr. Koskinen and asked if he could help out at "a local company" the government was taking over. Mr. Wilson says he asked Mr. Koskinen to serve as chairman because of his integrity, judgment and experience in restructuring companies. Mr. Koskinen became interim CEO in March when David Moffett stepped down after six months on the job, in part citing political frustrations. Mr. Koskinen became acting finance chief in April after the death of David Kellermann.
Holding all three posts would be a challenge even at a company that is running smoothly. But Freddie isn't. It has posted losses totaling $60 billion over the past four quarters, mainly stemming from a surge in mortgage defaults. Despite his troubleshooting pedigree, Mr. Koskinen says he isn't the ideal candidate to be Freddie's CEO, which he says requires deeper knowledge of the mortgage market. "There's a hubris involved in thinking you can do anything," he says.
Fed's Next Job: Figuring Out Just Who Is Too Big
Who will be the most regulated of them all? Under the Obama administration's proposed regulatory revamp, certain companies would be set aside for special scrutiny if they are seen as large and interconnected enough that their failure would send a shudder through the economy. The plan would require these companies, even if they aren't banks, to face much stricter oversight from the Federal Reserve. The central bank could examine everything from the company's domestic parent to its smallest foreign subsidiary.
Officially designated "Tier 1 financial holding companies," they could be banks, insurers or almost any other large market player. Government officials believe most potential candidates already would be under Fed scrutiny because they are so-called bank-holding companies, such as Citigroup Inc. or Bank of America Corp. It is possible only a handful of others might qualify. Candidates, according to analysts and some industry officials in Washington, include GE Capital, the financing arm of General Electric Co., and some large insurers. Big money managers such as Pacific Investment Management Co., or Pimco, and BlackRock Inc. mightn't qualify because they aren't as leveraged as commercial or investment banks.
In deciding whether to bring a company under such oversight, the Fed would be able to assess the impact of the company's failure on the broader economy, its size, use of debt and dependence on short-term funding, and whether it is a critical source of credit for households, businesses, and state and local governments. The Fed also would be able to consider any "other relevant factors," the proposal states. Treasury Secretary Timothy Geithner said at a Wednesday news briefing that he had an idea how many companies fell into this group but wouldn't provide a number. Asked if he believed hedge funds might qualify, he said "no."
National Economic Council Director Lawrence Summers quickly countered that it was too early to tell, because the government hadn't analyzed enough information on the country's largest hedge funds. "I don't think we have all the information that would be necessary to judge the situation of all the institutions that trade," Mr. Summers said. ("I accept the amendment," Mr. Geithner said in response.) The creation of this new class of financial institutions is one of the most significant elements of the administration's proposal and is one area where the Fed could have the most discretion to change the rules over time.
The central bank would have broad discretion to sweep any company into its net, which means the list could expand or shrink depending on the Fed's view of risk in the system. This flexibility also would make it difficult for companies to intentionally manage their size or leverage solely to avoid qualifying for the strictest level of supervision. Some industry lawyers said the new policy could force large companies like GE to spin off divisions such as GE Capital, because of strict new policies the Obama administration proposed about separating financial operations from commercial operations. The Fed has long wanted stricter divisions between those areas.
GE spokeswoman Anne Eisele said it was unclear whether the company would qualify as one of the super-regulated. "Tier 1 criteria have not been established, so it is too early to comment," she said. "We are strongly capitalized, with healthy ratios." Ms. Eisele said GE was "committed to retaining GE Capital as an important part of our business." GE's shares fell 4% Wednesday to $12.15 on news that GE Capital could be regulated by the Fed. It fell another 1.5%, or 18 cents, on Thursday to $11.97.
Given the bankruptcy of Lehman Brothers Holdings Inc. and near-collapse of American International Group Inc., Obama administration officials believe it is now necessary to bring the country's largest, most interconnected businesses under a microscope so the government understands their risks. While companies appeared leery of the prospect, some lawmakers worried about the opposite: that companies might benefit from being on this list by being able to borrow money less expensively than rivals. "Tell me why that isn't a big, flashing neon sign, 'Too Big To Fail?' " Sen. David Vitter (R., La.) asked Mr. Geithner at a Senate hearing Thursday.
Mr. Geithner said the administration's plan would require these companies to hold more capital and would require them to give the government a "credible" plan for their dissolution, should it ever occur. The administration also is asking Congress for authority to establish a system to prevent an uncontrolled collapse of such companies. Part of the Fed's new jurisdiction would direct it to come up with rules that would guide the identification of candidates for this list. It would have the power to review the books of a potentially large universe of companies in making that determination.
'Too Big to Fail' Policy Must End, F.D.I.C. Chair Says
Sheila C. Bair, the chairwoman of the Federal Deposit Insurance Corporation, is adding to the debate over what may be the largest overhaul of the nation’s financial rules in decades. In an interview on CNBC Friday morning, Ms. Bair said a main priority was ending the "too-big-to-fail doctrine" — the idea that a financial institution can become so large and interconnected that it must be propped up at all costs — and called the Obama administration’s proposed regulatory changes an "opening in the process" toward that goal.
She said she wanted a seat at the table in redrafting banking rules and reiterated her support for higher insurance fees for large banks that take big risks, an issue that has been a sore spot between her and John C. Dugan, the comptroller of the currency. As the insurer of $6 trillion in bank deposits, the F.D.I.C. should be included in the decision-making process, Ms. Bair said Friday, especially when it comes to dealing with risks to the entire financial system.
"We would obviously like a seat at the table in decision making on systemic risk," she said. "The F.D.I.C. has tremendous exposure to the system." Ms. Bair is seeking to create a separate insurance pool, similar to, but separate from, the deposit insurance premiums the F.D.I.C. currently collects from banks, which would be designed to curb systemic risk. The fee would be paid by large bank holding companies that engage in risky activities beyond traditional banking.
Ms. Bair mentioned proprietary trading and over-the-counter derivative trading as two examples of activities that could warrant the payment of the new insurance fee. Ms. Bair said the fees would create economic disincentives for banks to take on more risk and grow to a size that would make them too big to fail, thereby posing a risk to the whole financial system. She also said that she is not likely to continue in her role at the F.D.I.C. past her five-year term, which ends in 2011. "I am very much looking forward to getting back to more sane hours and more time with my family," Ms. Bair.
Bair criticises regulation plan
Sheila Bair, the chairman of the Federal Deposit Insurance Corporation, went public on Friday with her criticism of the Obama regulatory plan, saying her agency should have a bigger decision-making role over companies that pose systemic risk. "We would obviously like a seat at the table, a decision-making role,’’ Ms Bair said in an interview with CNBC. "The FDIC has tremendous exposure to the system, so we would like a real say on systematic risk issues." Her comments were made ahead of what is likely to be intense wrangling over the details of the Obama administration’s sweeping plan to overhaul financial regulation. The plan needs congressional approval.
Under the plan, the Federal Reserve would assume the primary responsibility for averting financial crises and overseeing institutions that are deemed "too big to fail’’. While a council of financial regulators, of which the FDIC would be a member, would improve co-ordination between agencies, the real power would reside with the Fed. Ms Bair, who wants the council to have more "teeth’’, urged legislators to have a robust debate on the appropriate role of the council and the Fed. "This is an institutional issue, it’s not a turf issue or personality issue,’’ she said. "We’re hoping Congress, and the White House too, and the Treasury, will continue those discussions to get the balance right.’’
Ms Bair said that ending the philosophy that some financial institutions were "too big to fail" was the most important financial reform to make and suggested that her agency, which is responsible for taking over failing deposit- taking banks, had already played a key role in stabilising the system. Her comments echo some of the concerns on Capitol Hill, where senators from both parties are already questioning the wisdom of vesting the central bank with more powers, as is being urged by Tim Geithner, the Treasury secretary.
Too Big To Fail, Politically
What is the essence of the problem with our financial system – what brought us into deep crisis, what scared us most in September/October of last year, and what was the toughest problem in the early days of the Obama administration? The issue was definitely not that banks and nonbanks could fail in general. We’re good at handling some kinds of financial failure. The problem was: a relatively small number of troubled banks were so large that their failure could imperil both our financial system and the world economy.
And – at least in the view of Treasury – these banks were so large that they couldn’t be taken over in a normal FDIC-type receivership. (The notion that the government lacked legal authority to act is smokescreen; please tell me which statute authorized the removal of Rick Waggoner from GM.) But instead of defining this core problem, explaining its origins, emphasizing the dangers, and addressing it directly, what do we get in yesterday’s 101 pages of regulatory reform proposals?
- A passive voice throughout the explanation of what happened (e.g., this preamble). No one did anything wrong and banks, in particular, are absolved from all responsibility for what has transpired.
- A Financial Services Oversight Council, which sounds like a recipe for interagency feuding, with the Treasury as the referee and – most important – provider of the staff. The bureaucratic principle is: if you hold the pen, you have the power.
- Some of the largest banks ("Tier 1 Financial Holding Companies", or Tier 1 FHCs) will now be subject to supervision by the Federal Reserve Board – although under the confusing jurisdiction also of the Financial Services Oversight Council in many regards (e.g., in the key setting of material prudential standards) and subsidiaries can have other regulators.
- Tier 1 FHC should have higher prudential standards (capital, liquidity and risk management), but "given the important role of Tier 1 FHCs in the financial system and the economy, setting their prudential standards too high could constrain long-term financial and economic development." Sounds like a banker drafted that sentence. None of the important details/numbers are specified, although the Fed should use "severe stress scenarios" to assess capital adequacy. Is that the same kind of actually-quite-mild stress scenario they used earlier this year?
- In terms of risk management, "Tier 1 FHCs must be able to identify aggregate exposures quickly on a firm-wide basis." There is no notion here that risk management at these big banks has failed completely and repeatedly over the past two years. How exactly will FHCs be able to identify such risks and how will the Fed (or anyone else) assess such identification?
- In case you weren’t sufficiently confused by the overlapping regulatory authorities in this plan, we’ll also get a National Bank Supervisor (NBS) within Treasury. Regulatory arbitrage is not gone, just relabeled (slightly).
- There is no greater transparency or public accountability in the regulatory process. We still will not know exactly what regulators decided and on what basis. Such secrecy, at this stage in our financial history, clearly prevents proper governance of our supervisory system.
- There appears to be no mention that corporate governance within these large banks failed totally. How on earth can you expect these banks to operate in a responsible manner unless and until you address the reckless manner in which they (a) compensate themselves, (b) destroy shareholder value, (c) treat boards of directors as toothless wonders? The profound silence on this point from the administration – including some of our finest economic, financial, and legal thinkers – is breathtaking.
There’s of course more in these proposals, which I review elsewhere and Secretary Geithner’s appearances on Capitol Hill today may be informative – although only if his definition of the underlying "too big to fail" issue uses much stronger language than yesterday’s written proposals. But based on what we see so far, there is little reason to be encouraged. The reform process appears to be have been captured at an early stage – by design the lobbyists were let into the executive branch’s working, so we don’t even get to have a transparent debate or to hear specious arguments about why we really need big banks.
Writing in the New York Times today, Joe Nocera sums up, "If Mr. Obama hopes to create a regulatory environment that stands for another six decades, he is going to have to do what Roosevelt did once upon a time. He is going to have make some bankers mad." Good point – but Nocera is thinking about the wrong Roosevelt (FDR). In order to get to the point where you can reform like FDR, you first have to break the political power of the big banks, and that requires substantially reducing their economic power - the moment calls more for Teddy Roosevelt-type trustbusting, and it appears that is exactly what we will not get.
The Defanging of Obama’s Regulation Plan
by Simon Johnson
There is much to worry about in President Obama’s financial regulation proposal, officially unveiled on Wednesday. It’s a long wish list, but intense and nontransparent financial sector lobbying already ensured that four out of the five sets of measures are unlikely to have any lasting positive impact. As Stephen Labaton reports:"In the last two weeks alone, the administration has heard from top executives from Goldman Sachs, MetLife, Allstate, JPMorgan Chase, Credit Suisse, Citigroup, Barclays, UBS, Deutsche Bank, Morgan Stanley, Travelers, Prudential and Wells Fargo, among others. Administration officials also discussed the president’s plan with the top lobbyists at major financial trade associations in Washington."
What is the outcome of all this behind-the-scenes maneuvering to get the financial sector fully on board? Not much change that we can really believe in.
For example, take the points that President Obama himself stresses. First and foremost, he says the Federal Reserve will become the official "system risk regulator" (section 1 of his proposal). But in principle the Fed had exactly this kind of leadership role before — and under both Alan Greenspan and Ben Bernanke it was a reckless cheerleader and facilitator for the unsustainable real estate boom. If the Fed had been stronger before, the crisis now would be worse.
Hedge funds and other private pools of capital have to register with the Securities and Exchange Commission, also in section 1. But the once-proud S.E.C. has fallen on hard times, effectively just as much captured by the intellectual bubble of Wall Street as all our other regulators. Originators of securitized products will be required to retain some stake in what they issue (section 2). But the major shock of early 2008 was when we learned that Bear Stearns, Lehman Brothers, and others had done exactly that. There is no serious attempt here to recognize that our leading financial firms have completely failed in their efforts to measure and control risks.
In addition, the administration will now seek a "resolution authority" that makes it easier to take over and shut down large financial companies (section 4 in the proposal). But effectively they had this power before — Continental Illinois, for example, was handled as a negotiated conservatorship in the 1980s, and Citigroup could have been taken over at various points in the past nine months. The government blinked in the face of financial sector complexity and scale. "Too big to fail" is "too big to exist," but the president’s document goes nowhere near this fundamental principle.
And while the proposal is no doubt right to emphasize the need for international cooperation in re-regulation, section 5 is so vague as to be meaningless. There is, however, one interesting piece — the creation of a Consumer Financial Protection Agency (section 3). The president himself seems to recognize that previous consumer protection was scattered and ineffectual. A strong agency could help protect us all both in boom times and during crises.
But protecting consumers is not the same thing as protecting investors and taxpayers. Major financial players will once again be able to float bubbles, creating the illusion of growth and the reality of further expensive bailouts. Our financial sector has become very powerful politically — and these proposals are a further sad reminder of that fact.
Only a Hint of Roosevelt in Financial Overhaul
Three quarters of a century ago, President Franklin Roosevelt earned the undying enmity of Wall Street when he used his enormous popularity to push through a series of radical regulatory reforms that completely changed the norms of the financial industry. Wall Street hated the reforms, of course, but Roosevelt didn’t care. Wall Street and the financial industry had engaged in practices they shouldn’t have, and had helped lead the country into the Great Depression. Those practices had to be stopped. To the president, that’s all that mattered.
On Wednesday, President Obama unveiled what he described as "a sweeping overhaul of the financial regulatory system, a transformation on a scale not seen since the reforms that followed the Great Depression." In terms of the sheer number of proposals, outlined in an 88-page document the administration released on Tuesday, that is undoubtedly true. But in terms of the scope and breadth of the Obama plan — and more important, in terms of its overall effect on Wall Street’s modus operandi — it’s not even close to what Roosevelt accomplished during the Great Depression.
Rather, the Obama plan is little more than an attempt to stick some new regulatory fingers into a very leaky financial dam rather than rebuild the dam itself. Without question, the latter would be more difficult, more contentious and probably more expensive. But it would also have more lasting value. On the surface, there was no area of the financial industry the plan didn’t touch. "I was impressed by the real estate it covered," said Daniel Alpert, the managing partner of Westwood Capital. The president’s proposal addresses derivatives, mortgages, capital, and even, in the wake of the American International Group fiasco, insurance companies.
Among other things, it would give new regulatory powers to the Federal Reserve, create a new agency to help protect consumers of financial products, and make derivative-trading more transparent. It would give the government the power to take over large bank holding companies or troubled investment banks — powers it doesn’t have now — and would force banks to hold onto some of the mortgage-backed securities they create and sell to investors. But it’s what the plan doesn’t do that is most notable.
Take, for instance, the handful of banks that are "too big to fail"— and which, in some cases, the government has had to spend tens of billions of dollars propping up. In a recent speech in China, the former Federal Reserve chairman — and current Obama adviser — Paul Volcker called on the government to limit the functions of any financial institution, like the big banks, that will always be reliant on the taxpayer should they get into trouble. Why, for instance, should they be allowed to trade for their own account — reaping huge profits and bonuses if they succeed — if the government has to bail them out if they make big mistakes, Mr. Volcker asked.
Many experts, even at the Federal Reserve, think that the country should not allow banks to become too big to fail. Some of them suggest specific economic disincentives to prevent growing too big and requirements that would break them up before reaching that point. Yet the Obama plan accepts the notion of "too big to fail" — in the plan those institutions are labeled "Tier 1 Financial Holding Companies" — and proposes to regulate them more "robustly." The idea of creating either market incentives or regulation that would effectively make banking safe and boring — and push risk-taking to institutions that are not too big to fail — isn’t even broached.
Or take derivatives. The Obama plan calls for plain vanilla derivatives to be traded on an exchange. But standard, plain vanilla derivatives are not what caused so much trouble for the world’s financial system. Rather it was the so-called bespoke derivatives — customized, one-of-a-kind products that generated enormous profits for institutions like A.I.G. that created them, and, in the end, generated enormous damage to the financial system. For these derivatives, the Treasury Department merely wants to set up a clearinghouse so that their price and trading activity can be more readily seen. But it doesn’t attempt to diminish the use of these bespoke derivatives.
"Derivatives should have to trade on an exchange in order to have lower capital requirements," said Ari Bergmann, a managing principal with Penso Capital Markets. Mr. Bergmann also thought that another way to restrict the bespoke derivatives would be to strip them of their exemption from the antigambling statutes. In a recent article in The Financial Times, George Soros, the financier, wrote that "regulators ought to insist that derivatives be homogeneous, standardized and transparent." Under the Obama plan, however, customized derivatives will remain an important part of the financial system.
Everywhere you look in the plan, you see the same thing: additional regulation on the margin, but nothing that amounts to a true overhaul. The new bank supervisor, for instance, is really nothing more than two smaller agencies combined into one. The plans calls for new regulations aimed at the ratings agencies, but offers nothing that would suggest radical revamping. The plan places enormous trust in the judgment of the Federal Reserve — trust that critics say has not really been borne out by its actions during the Internet and housing bubbles. Firms will have to put up a little more capital, and deal with a little more oversight, but once the financial crisis is over, it will, in all likelihood, be back to business as usual.
The regulatory structure erected by Roosevelt during the Great Depression — including the creation of the Securities and Exchange Commission, the establishment of serious banking oversight, the guaranteeing of bank deposits and the passage of the Glass-Steagall Act, which separated banking from investment banking — lasted six decades before they started to crumble in the 1990s. In retrospect, it would be hard to envision even the best-constructed regulation lasting more than that. If Mr. Obama hopes to create a regulatory environment that stands for another six decades, he is going to have to do what Roosevelt did once upon a time. He is going to have make some bankers mad.
Big Change in Store for Brokers in Obama's Oversight Overhaul
Buried in President Obama's proposed regulatory overhaul is a change that could upend Wall Street: Brokers would be held to a higher "fiduciary" standard that would compel them to place their client's interests ahead of their own. Currently, brokers are only required to offer investments that are "suitable," which means they can't put clients in inappropriate investments, such as a highly risky stock for an 80-year-old grandmother. The move could change the way products are sold and marketed and even how brokers are compensated.
"This is a smart and overdue move" for the large brokerage firms owned by investment banks, says Sallie Krawcheck, who formerly ran the wealth-management business at Citigroup Inc. "It's certainly a victory for clients." Many investors don't even know the difference between the two standards, believing their brokers already are acting in their best interests. But requiring brokers to operate under a fiduciary standard could force them to offer products that are less costly and more tax-efficient.
They will have to disclose any potential conflicts of interest, such as any fees they may get for favoring one product over another. That could mean clients will be offered fewer proprietary products if the broker can find a lower-cost option elsewhere. For example, a broker couldn't put you in a mutual fund with higher fees -- or one he gets a bigger commission for selling -- if he could get a comparable fund with lower fees elsewhere, says Tamar Frankel, an expert on fiduciary law at Boston University School of Law. The proposal addresses a long-simmering debate over how brokers and investment advisers, who have traditionally offered more financial-planning advice, are regulated.
For years, investment advisers -- regulated by the Securities and Exchange Commission as part of the Investment Advisers Act of 1940 -- have been held to a fiduciary standard, meaning that in serving the clients, they have to put their clients' interests first. Brokers were excluded from that definition of investment advisers as long as they didn't get paid special compensation for that advice, and gave it as "solely incidental" to their brokerage services.
But over the years, that distinction became more blurred as brokers held themselves out as financial planners, even as they continued to operate under the more lenient standards. Making matters more confusing is the fact that some brokers became dually registered, operating under a suitability standard when they are selling products, but under a fiduciary standard when doling out investment advice. Richard Ketchum, chairman of the Financial Industry Regulatory Authority, says "a fiduciary standard should be established for broker-dealers when they are offering investment advice." He said the SEC should lead a discussion of how to define those situations and adds that features of both broker and adviser regulation should be kept.
The change also will give investors more power if they take their broker to court. "If a fiduciary violates his duty -- that is, gives advice which is contaminated by self-interest -- he could be sued not only for damages that have been caused for this advice but could also be sued for punitive damages," says Boston University's Ms. Frankel. The tougher fiduciary standard would discourage brokers from charging trading commissions instead of fees based on a client's assets, says Alois Pirker, a senior analyst at Aite Group LLC. That is because brokers could be accused of recommending trades simply to drive up their commissions. Some firms have already been encouraging brokers to register as investment advisers.
The Securities Industry and Financial Markets Association, a Wall Street lobbying group, has pushed for updating standards so brokers and financial advisers are held to the same rules when they provide the same service to clients. But the group stops short of saying the standard should be the more expansive and potentially more costly fiduciary standard. Changing to a tougher standard won't be easy. "They're going to have to rejigger the whole bloody thing...and rethink what services they offer and by whom," said William Spiropoulos, chief executive of CoreStates Capital Advisors LLC, a Newtown, Pa., money manager. Mr. Spiropoulos, who worked as a broker for many years, now operates under the tougher standard.
Congress Considering Banning Some TARP Execs From Public Companies
The White House unveiled the outlines of its new ground rules for the financial game Wednesday, but seemed resigned to leave the same failed players on the field. That could change, however, if some members of Congress get their way. "The main thing is that not a single person has been held accountable for the destruction of multibillion-dollar businesses, and that's disturbing. We have to learn from our mistakes," Rep. Alan Grayson (D-Fla.) told the Huffington Post. "Letting the people who destroyed these huge institutions continue to function in the financial industry is like giving a gun to my four-year-old child. A loaded gun."
Grayson is spearheading a push for accountability from executives and boards of directors who led companies that have relied on TARP funds to survive. One possibility for action, which has gained some steam since last week's House hearings on executive compensation, is the use of civil injunctions to bar individuals from serving as officers or directors at any public company, sometimes for life. The Securities and Exchange Commission typically levies such bans against corporate officers, investment bankers or stockbrokers convicted of fraud and deemed "unfit to serve."
When it comes to the collapse of the financial sector, this doesn't necessarily apply. But a some financial-regulatory experts are suggesting that a modified approach could be used to bar TARP-recipient executives and boards of directors, based on a standard of negligence. "I think it's doable to say there's a certain point of negligence beyond which we will not let them serve again," said Nell Minow of The Corporate Library, an independent corporate-governance research firm. "I consider this simply somebody who has demonstrated unfitness for the job not being allowed to be in it."
The litmus test for negligence and "fitness" shouldn't necessarily apply to all public companies, Minow said, but she would have instituted it as a condition of the TARP banks taking taxpayer money last fall. Harvey Pitt, who chaired the SEC from 2001-'03, said Congress should have no trouble doing just that, should legislators desire. "If the government is going to give funds to companies, it presumably has the right to condition the award of those funds on whatever terms it thinks appropriate," he said. "This strikes me as a solution in search of a problem."
Pitt cautioned, however, that granting the SEC authority to bar officers and directors based on negligence would require clear standards subject to judicial review. Blanket bans have unintended consequences, after all, especially given the interconnected nature of corporate America, noted Columbia Law School professor and securities-regulation expert John Coffee. "I think a prophylactic ban is too strong," Coffee said. "Suppose we have General Motors fail, and we have 15 directors there, many who are on the major corporations around the country. What if one of them was the CEO of IBM? Would you tell him he can't serve in his role as the CEO of IBM because he was on the board of General Motors when it failed?"
Proposed legislation featuring bans from industry is likely to face strong opposition in the House, including from powerful Financial Services Committee chairman Barney Frank. Frank called the idea "wacky," noting that some TARP recipients were urged by then-Treasury Secretary Hank Paulson to take the federal money. "Why does that mean they're unfit to serve, if they were forced to take TARP funds, didn't want it and paid it back?" Frank asked the Huffington Post. "I am not for treating people who have not committed fraud as if they committed fraud."
A more moderate solution could focus on cutting or reclaiming compensation from an executive who accrued short-term risk that handed the company a long-term loss. Coffee cited Citigroup's asset-backed securitization group as an example where executives should have been forced to return their pay, but said any such clawback measure should be attached to triggers like ratings downgrades or major stock losses.
Another way to strengthen accountability could be to enhance the role of shareholders in seating directors or vetoing officers. Minow said that shareholder votes, or at least more transparency in the appointment process, are essential to reform executive cronyism that can often run rampant.
"It seems to me that you could have standards for serving on a board," Minow said, citing one board's provision that conviction of a felony was not grounds for its CEO's termination. "A director from Enron still continues to serve on boards. When I first started working in the field, O.J. Simpson was on five boards, including an audit committee ... I don't want to sound cynical, but I just feel, after observing this process for 20 years, the only thing that makes any difference is replacing board members."
Still, the core problem is ensuring transparency and accountability, said Grayson, citing further hearings and systemic-risk regulation as steps in the right direction on the legislative side, where he said the fight belongs. Spokesmen from the SEC and the Securities Industry and Financial Markets Association declined to comment unless there was draft legislation on the table. Whatever solution results, people will be watching, Grayson said. A YouTube video of Grayson demanding TARP transparency from Federal Reserve Inspector General Elizabeth Coleman has garnered more than 1.2 million views since January, and he said he still regularly hears feedback from constituents on the subject. "Make heads roll. That's the suggestion I hear most often," he said. "Make heads roll."
Eight Attorneys General, Bondholders, Unions Object to GM Bankruptcy Plan
Eight state attorneys general are opposing a provision in General Motors Corp.'s bankruptcy plan that would free the auto maker from liability for vehicle defects. Attorneys general from Connecticut, Kentucky, Maryland, Minnesota, Missouri, Nebraska, North Dakota and Vermont filed an objection in U.S. Bankruptcy Court in the Southern District of New York Friday, arguing that GM's plan to shed these liabilities would bar accident victims from "key legal rights." The states could face an uphill battle. Chrysler Group LLC emerged from bankruptcy earlier this month free of such liabilities.
And legal precedent shows that most companies have wide latitude to leave claims behind in bankruptcy court. GM's case is on a much larger scale than other bankruptcies because it has tens of millions of vehicles on U.S. roads. That has drawn attention from consumer advocates and lawyers. GM plans to sell its "good" assets – including automotive brands Chevrolet, Cadillac, Buick and GMC – to a new company owned by the U.S. government. Under GM's proposed terms, consumers suffering injuries or death from vehicles currently on the road wouldn't be able to bring claims against the "New GM." Instead, they'd be left as unsecured creditors seeking claims against GM's old estate in bankruptcy court, where they'd likely receive little recompense.
The plan would also prevent future accident victims driving current GM vehicles from bringing claims, even though they couldn't anticipate suffering injuries. The brief filed by the attorneys general said freeing the new GM from product liability claims would be "contrary to state law" and an "unconscionable and wholly insupportable result that would harm innocent consumers." The plan "seems very unfair and unwise," said Connecticut Attorney General Richard Blumenthal in an interview. "So much is at stake. We have fought repeatedly for repair or recall of vehicles and parts that are defective so that people can be spared injury, and there are far-reaching ramifications of failing to apply accountability to the New GM."
A GM spokeswoman said claims related to vehicles sold before the sale would be addressed by the auto maker's old estate in bankruptcy court. "Product liability claims are going to be part of the ongoing court process and we would expect those get addressed under the court process and applicable laws," the spokeswoman said. "All claimants are going to have an opportunity to submit their claims and have them heard." In addition to the state attorneys general, consumer advocate groups and lawyers for accident victims are fighting the Obama administration's plan to create a new GM "free and clear" of product liabilities.
Separately Friday, a group of GM bondholders moved to block the auto maker's bankruptcy restructuring, saying the plan discriminates against them in favor of other creditors. The group, which aims to represent small individual GM bondholders, said the auto maker's proposed overhaul, orchestrated by the U.S. government, gives a disproportionate recovery to the United Auto Workers union at their expense. "GM bondholders appear to be the most disfavored and discriminated against class in this scheme," the bondholder group said in court papers.
The argument echoes that made by secured lenders in Chrysler's bankruptcy case. The lender group in that case said the U.S. government was swiping their collateral to give a better recovery to the UAW than it deserved. That argument failed, and Chrysler successfully pulled off its sale to a new company led by Fiat SpA. The bondholders argue that, as individual creditors without ties to large financial institutions, they weren't given an opportunity to participate in GM's restructuring negotiations. Before GM entered bankruptcy protection, more than half of the auto maker's bondholders had signed on to the proposed restructuring.
Under the proposal, GM will split into two companies: a leaner "New GM" and an "Old GM," which will be wound down in bankruptcy. GM intends to accomplish the split through a Section 363 sale, which would transfer the "New GM" assets to an entity owned by the U.S. and Canadian governments, the UAW and the bondholders. The individual bondholder group, however, said the proposed transaction is "inequitable and offends basic notions of fairness."
By restructuring through a sale, GM is avoiding the more traditional route of developing a bankruptcy plan that gives creditors more control by allowing them to vote on it. The bondholders say the sale, if approved by the court, threatens "the very integrity" of bankruptcy laws because protections for creditors built into the law will be "so easily evaded as essentially to be dead."
GM says it needs to proceed with a swift sale to save the ailing auto maker and avoid liquidation, an argument the bondholders scoffed at, calling it "wholly fabricated, contrived and unsupportable." They say GM can pull off its restructuring in the same amount of time by allowing creditors to vote on the plan. "There is no evidence and no reason to believe that the additional time needed to do this right will create any political or commercial harm," they said.
By urging a quick sale to save the company, GM and the government are trying to pressure the bankruptcy court and gain advantage over opponents, the bondholders said. And unlike Chrysler's sale to Fiat, GM is not selling itself to a strategic buyer that wants to quickly take control of assets that are losing value.
"The 'buyer' is a shell company being carved up by the favored creditor groups and the government," the bondholders said. GM's bondholders, owed a total of $27 billion, are slated to get a 10% stake in the reorganized GM and warrants to buy an additional 15% of the company's shares. A court hearing on the sale is scheduled for June 30. Several labor unions that represent GM's workers are also protesting the sale, saying the deal will strip health-care coverage from 50,000 of their retirees while maintaining those benefits for United Auto Workers members.
The International Union of Electronic Workers-the Communication Workers of America and two other unions filed an objection to the sale Friday, the deadline to formally oppose the deal. The IUE-CWA, the United Steelworkers and the International Union of Operating Engineers complain that their $3 billion in retiree health-care obligations will be treated as unsecured claims, slated to recover pennies on the dollar. Meanwhile, workers represented by the UAW would receive a 17.5% stake in the reorganized auto maker along with $19 billion in cash, notes and preferred stock to satisfy their health-care claims.
"It is up to this court to recognize that the 50,000 Americans from the objecting unions, whose tax moneys are being utilized to fund this transaction, cannot be discarded simply because their unions currently have a less powerful bargaining position than other players," attorneys for the unions said in court papers. Under GM's sale proposal, 10% of the reorganized auto maker's stock would be left with the remnants of the old company to satisfy billions in unsecured claims.
Most of the IUE-CWA members worked at GM's Packard Electric division and at an assembly plant in Dayton, Ohio. The IUE-CWA represents the largest number of retirees among the three objecting unions. In the late 1990s, that union represented 18,000 active GM workers, before the Packard division was included in the Delphi Corp. spinoff. GM maintained lifetime health-care and life insurance benefits for IUE-CWA workers who retired before the spinoff or remained with the auto maker. GM again assumed obligations for those who left for Delphi after the auto supplier filed for bankruptcy protection itself in 2005.
The unions say their members did the same or similar work as UAW members at other locations and should be treated equally in the bankruptcy case. The IUE-CWA said that it even agreed in late 2008 to enter into a similar retiree health-care fund, known as a VEBA, as the UAW, but GM never funded that plan before it filed for bankruptcy protection on June 1. Under the sale "GM will have effectively eliminated its retiree obligations," for former workers and their spouses, the objecting unions said. Several other parties have filed objections ahead of the 5 p.m. EDT Friday deadline to oppose GM's sale plan. Among them are numerous local taxing authorities that fear the sale could terminate their liens against GM property.
Congress Approves IMF Gold Sales, War Funding And Cash For Clunkers
A $106 billion war-spending bill won final congressional approval after the Senate voted to retain a "cash for clunkers" provision aimed at helping the auto industry. Action by the Senate today sends the measure to President Barack Obama for his signature. The Senate passed the bill on a 91 to 5 vote; the House approved the measure earlier this week. Senator Judd Gregg, a New Hampshire Republican, led the effort to drop a provision providing as much as $4,500 to people who trade in their vehicles for more fuel-efficient models. He said the plan, which would cost $1 billion, was a poor use of tax dollars when the government is projected to run its biggest budget deficit since 1945.
"It is a clunker," Gregg said of the plan. "Why should our children and our grandchildren have to pay the bill" for the government subsidizing "somebody to buy their car today? How fiscally irresponsible is that?" he said. Senator Debbie Stabenow, a Michigan Democrat, said the proposal was needed to help auto dealers hit by an "economic tsunami." She said the plan would "help those who have been having an extremely difficult time just holding their head above water." The legislation provides more than $82 billion to fund military operations in Iraq and Afghanistan, which would bring total spending on the wars to more than $900 billion.
Voting against the bill in the Senate were Republicans Tom Coburn of Oklahoma, Jim DeMint of South Carolina, and Mike Enzi of Wyoming, Democrat Russ Feingold of Wisconsin and Independent Bernie Sanders of Vermont. Lawmakers included in the bill $2.7 billion to buy eight C- 17 aircraft made by Boeing Co. and seven C-130 aircraft manufactured by Lockheed Martin Corp. Another $600 million would go to purchase four F-22 aircraft, also produced by Lockheed Martin.
Lawmakers agreed to Obama’s request to include $5 billion to secure $108 billion in aid, primarily in the form of a line of credit, to the International Monetary Fund. The legislation would permit U.S. representatives to the IMF to agree to its planned sale of 13 million ounces of gold, one-eighth of the organization’s holdings, to help finance aid to poor countries. The bill also would provide $7.7 billion for pandemic flu programs. The "cash for clunkers" provision provides temporary rebates to those buying cars that get at least 4 miles more per gallon than their trade-ins. Truck purchases could qualify if the purchased vehicle gets as little as 1 more mile per gallon than the trade-in.
The purchased vehicles, which must be new and cost no more than $45,000, must be bought between July 1 and Nov. 1 to qualify. Critics, including some Democrats, said the plan would subsidize the purchase of gas-guzzling sport-utility vehicles while not helping the market for used hybrid cars. Backers of "cash for clunkers" needed 60 votes to thwart Gregg’s bid to strip it from the bill, and they hit that mark exactly. The vote to retain the provision was 60-36. Lawmakers split largely along party lines, with just four Republicans backing the program and only one Democrat opposing it.
Other provisions would allow the Pentagon to transfer suspected terrorists held at the military prison at Guantanamo Bay, Cuba, to the U.S. for trial, though not for long-term incarceration or release. Lawmakers set aside $534 million for special payments to troops who have served under "stop-loss" orders that have prevented them from returning home at the end of their regular tours. The bill would provide $500 for every extra month served since the Sept. 11 terrorist attacks.
The White House has said the legislation will be the last time the administration relies so-called "supplemental" appropriations bills to pay for war-related expenses. Such bills, which are considered outside Congress’s annual budget process and are exempt from yearly spending caps, are supposed to be reserved for unexpected expenses. Former President George W. Bush relied on the bills to fund the Iraq and Afghanistan conflicts, which critics, including some Republican lawmakers, said made it more difficult to keep spending in check. The bill is H.R. 2346.
Treasury Department Admits Challenging Independence of TARP Inspector General
ABC News' Jake Tapper and Matt Jaffe report: Officials of the Treasury Department admitted late Thursday that they have asked the Justice Department to weigh in on how much power they have over the Special Inspector General for the $700 billion Troubled Asset Relief Program, known as SIGTARP. The push for a legal ruling on SIGTARP's independence came after Special Inspector General Neil Barofksy had asked Treasury Department officials to hand over documents regarding a TARP recipient, a request that was denied.
Sen. Chuck Grassley, R-Iowa, in a letter to Secretary Tim Geithner earlier this week, said that he understood the denial to have been based on "a specious claim of attorney-client privilege." In the Treasury Department's first official comments on this issue, spokesman Andrew Williams today acknowledged the request to the Justice Department. "The request to clarify the SIGTARP’s complex legal status within the executive branch was sent to the Department of Justice only after Department of Treasury consulted with Mr. Barofsky who had no objection," Williams told ABC News.
In requesting the legal review, Williams said, "the Treasury Dept included Mr. Barofsky's own legal analysis of the issues along with the Department’s position." Treasury tonight also provided an unredacted April 7 memo from Barofsky to the Department's counsel during this back-and-forth over SIGTARP's attempt to get documents. In the letter to Geithner earlier this week, the lawmaker had written, "It is my further understanding that this disagreement then escalated into broader questions about whether SIGTARP is subject to your direct supervision and direction, which may have been referred outside Treasury for an independent legal opinion."
Along with confirming the DOJ request, Williams also said tonight that "no documents have been withheld from the SIGTARP based on the attorney-client privilege." But Williams did not say that no documents have ever been withheld from the watchdog. Williams did note that ultimately "all documents requested by the SIGTARP have been produced to date."
Iraqi Oil Minister Accused of Mother of All Sell-Outs
Iraqi Oil Minister Hussein al-Shahristani plans to award international oil companies service contracts to develop six of Iraq's largest oilfields. To public fury, the country is handing over control of its oilfields to foreign companies. Furious protests threaten to undermine the Iraqi government's controversial plan to give international oil companies a stake in its giant oilfields in a desperate effort to raise declining oil production and revenues.
In less than two weeks, on 29 and 30 June, the Iraqi Oil Minister, Hussain Shahristani, will award service contracts to the world's largest oil companies to develop six of Iraq's largest oil-producing fields over 20 to 25 years. Senior figures within the Iraqi oil industry have denounced the deal. Fayad al-Nema, the director of the South Oil Company, which comes under the Oil Ministry and produces most of Iraq's crude, said on the weekend: "The service contracts will put the Iraqi economy in chains and shackle its independence for the next 20 years. They squander Iraq's revenues." Mr Nema is reported to have since been fired because of his opposition to the contracts, which he says is shared by many other officials in Iraq's state-owned oil industry.
The government maintains that it is not compromising the ownership of Iraq's oil reserves - the third-largest in the world at 115 billion barrels - on which the country is wholly dependent to fund its recovery from 30 years of war, sanctions and occupation. But the fall in the oil price over the past year has left the government facing a financial crisis; 80 per cent of its revenues go to pay for salaries, food rations and recurrent costs. Little is left for reconstruction and the government is finding it hard to pay even for much-needed items such as an electrical plant from GE and Siemens.
The development of Iraq's oil reserves is of great importance to the world's energy supply in the 21st century. They may be even larger than Saudi Arabia's, as there was little exploration while Iraq was ruled by Saddam Hussein. International oil companies are desperate to get their foot in the door. "Everyone wants to be in Iraq," says Ruba Husari, an expert on Iraqi oil. "Together with Iran, this is the only oil province in the world that has great potential. It is a great opportunity for oil companies because nobody knows the size of Iraq's reserves. Iraq itself needs to know what is under its soil."
But Iraqis are wary of the involvement of foreign oil companies in raising production in super giant fields like Kirkuk and Bai Hassan in the north and Rumaila, Zubair and West Qurna in the south. They suspect the 2003 US invasion was ultimately aimed at securing Western control of their oil wealth. The nationalisation of the Iraqi oil industry by Saddam Hussein in 1972 remains popular and the rebellion against the service contracts has been gathering pace all this week.
Parliament is demanding that bidding be delayed. MPs summoned Mr Shahristani, a nuclear scientist imprisoned and tortured under Saddam Hussein, to answer questions about the service contracts and the fall in Iraq's oil production and exports. Jabir Khalifa Kabir, the secretary of parliament's oil and gas committee, says the contracts will "chain the government with complex contractual terms" and will abort South Oil Company's own plans to raise production. The government says the bidding must go ahead.
The contracts are not particularly favourable to the international oil companies. They are rather the outcome of the companies' extreme eagerness to get into Iraq and the government's attempt to obtain expertise and investment without ceding control. The companies will be paid a fee linked to first restoring and then increasing oil output. They will, however, have greater control when there is a second round of bidding for oilfields which have been discovered but not yet developed. Separate again is the question of exploration for as yet undiscovered oil reserves.
Critics of the deal in parliament say that Iraq has already invested $8bn (£4.9bn) in developing its super giant fields. But Mr Shahristani needs $50bn over the next five or six years to raise current production levels from 2.5 million barrels a day of crude and knows the money and expertise can only come from outside Iraq. The government in Baghdad may be near broke but Iraqis ask whose fault that is. The Oil Ministry, like much of the government, is dysfunctional when it comes to carrying out long-term projects. Mr Shahristani is blamed for poor management skills, though he eloquently defends himself by saying that when he took over the ministry in 2006, he had to cope with attacks by guerrillas who once were blowing up a pipeline every day.
This explains Mr Shahristani's problems in northern Iraq, where the Sunni Arab insurgency of 2003-08 was strong, but not in the far south, where the Shia community is dominant and there was no uprising. Jabbar al-Luaibi, the former head of the South Oil Company, who battled to maintain oil production in these years, gave a devastating interview detailing the failings of the Oil Ministry to provide the most basic equipment needed to monitor the oil reservoirs. "It's like driving your car without any indicators on the dashboard," he said, adding that if mismanagement continued in the same way as in the past "who knows, we might have to start importing crude oil".
The Iraqi government made two other mistakes for which it is now paying. It optimistically believed the price of oil would stay high at $140 a barrel. Instead of investing extra revenues by paying for outside expertise and equipment to raise production in the oilfields, it spent the money on raising the pay of government employees and increasing their number. This increased Prime Minister Nouri al-Maliki's popularity in the provincial elections in January but left the government short of cash when oil prices collapsed. Prices have risen since then, but not nearly enough to solve the government's problems.
In June 2008 the Iraqi oil industry seemed poised to receive foreign help by signing two-year technical support contracts with oil companies. Control would have remained with Iraq. However, at the last minute, the contracts were cancelled despite being supported by Mr Shahristani and the council of ministers. The reason why this happened explains much about why the state machine is unable to carry out long-term policies. Jobs are allocated to members of political parties regardless of their experience or abilities. After 2003 the Oil Ministry had been the fief of the Fadhila, a Shia Islamic party strong in Basra, and, though it left the government, it never wholly accepted Mr Shahristani as minister.
Showing a certain cheek, Fadhila members - having sabotaged the plan to acquire foreign expertise when money was available to buy it last year - now criticise the government for being forced to accept worse terms because it cannot invest itself. Many Iraqis will be angered to see their historic oilfields being partially run by foreign companies. But the government believes it has no choice.
New, Hard Evidence of Continuing Debt Collapse
by Martin Weiss
While most pundits are still grasping at anecdotal “green shoots” to celebrate the beginning of a “recovery,” the hard data just released by the Federal Reserve reveals a continuing collapse of unprecedented dimensions.
It’s all in the Fed’s Flow of Funds Report for the first quarter of 2009, which I’ve posted on our website with the key numbers in a red box for all those who would like to see the evidence.
Here are the highlights:
Credit disaster (page 11). First and foremost, the Fed’s numbers demonstrate, beyond a shadow of a doubt, that the credit market meltdown, which struck with full force after the Lehman Brothers failure last September, actually got a lot worse in the first quarter of this year.
This directly contradicts Washington’s thesis that the government’s TARP program and the Fed’s massive rescue efforts began to have an impact early in the year.
In reality, the credit market shutdown actually gained tremendous momentum in the first quarter. And although it’s natural to expect some temporary stabilization from the government’s massive interventions, the first quarter was SO bad, it’s impossible for me to imagine any scenario in which the crisis could be declared “over.”
Here are the facts:
- We witnessed one of the biggest collapses of all time in “open market paper” — mostly short-term credit provided to finance mortgages, auto loans, and other businesses. Instead of growing as it had in almost every prior quarter in history, it collapsed at the annual rate of $662.5 billion. (See line 2.)
- Banks lending went into the toilet. Even in the fourth quarter, when the meltdown struck, banks were still growing their loan portfolios at an annual pace of $839.7 billion. But in the first quarter, they did far more than just cut back on new lending. They actually took in loan repayments (or called in existing loans) at a much faster pace than they extended new ones! They literally pulled out of the credit markets at the astonishing pace of $856.4 billion per year, their biggest cutback of all time (line 7).
- Meanwhile, nonbank lenders (line 8) pulled out at the annual rate of $468 billion, also the worst on record.
- Mortgage lenders (line 9) pulled out for a third straight month. (Their worst on record was in the prior quarter.)
- And consumers (line 10) were shoved out of the market for credit at the annual pace of $90.7 billion, the worst on record.
- The ONLY major player still borrowing money in big amounts was the United States Treasury Department (line 3), sopping up $1,442.8 billion of the credit available — and leaving LESS than nothing for the private sector as a whole.
Bottom line: The first quarter brought the greatest credit collapse of all time.
Excluding public sector borrowing (by the Treasury, government agencies, states, and municipalities), private sector credit was reduced at a mindboggling pace of $1,851.2 billion per year!
And even if you include all the government borrowing, the overall debt pyramid in America shrunk at an annual rate of $255.3 billion (line 1)!
Asset-backed securities (ABS) got hit even harder (page 34). This is the sector where you can find most of the new-fangled “structured” securities — the ones Washington had already identified as a major culprit in the credit disaster.
Did they make any headway in stopping the ABS collapse? None whatsoever! The total outstanding in this sector (line 3) fell at an annual pace of $623.4 billion in the first quarter, the WORST ON RECORD!
U.S. security brokers and dealers were smashed (page 36). Brokers were forced to reduce their total investments at the breakneck annual pace of $1,159.2 billion in the first quarter, after an even hastier retreat in the prior quarter (line 3)!
What’s even more revealing is that they were so pressed for cash, they had to dump their Treasury security holdings in massive amounts — at an annual pace of $424 billion (line 7)! Given the Treasury’s desperate need for financing from any source, that’s not a good sign!
Government agencies got killed (page 43). Households dumped their Ginnie Maes, Fannie Maes, Freddie Macs, and other government-agency or GSE securities like never before in history, unloading them at the go-to-hell annual clip of $1,395.7 billion (line 6).
And the rest of the world (mostly foreign investors), which had started unloading these securities in the third quarter of last year, continued to do so at a fevered pace (line 10).
Mortgages got chopped again (page 48). Home mortgages outstanding were slashed at an annual clip of $87.3 billion in the second quarter of last year, $324.2 billion in the third quarter, $271 billion in the fourth, and another $61 billion in the first quarter of this year (line 2).
A slowdown in the collapse? For now, perhaps. But the first quarter also brought the very first reduction in commercial mortgages, an early sign of bigger commercial real estate troubles ahead (line 4).
Trade credit is dying (page 51, second table). If you’re in business and you don’t have cash on hand to buy inventories, supplies, or other materials, beware! Large and small corporations all over the country have been slashing trade credit at an accelerating pace (line 3).
In the first quarter of last year, this aspect of the credit crisis was still in its early stages; trade credit outstanding was shrinking at an annual pace of just $15 billion. But by the second quarter, this new disaster burst onto the scene at gale force, with trade credit getting docked at the rate of $151.2 billion per year. And most recently, in the first quarter of 2009, it was slashed at the shocking pace of $277.2 billion per year.
And I repeat:With ALL of these figures, we’re not talking about a decline in new credit being provided, which would be bad enough. We’re talking about a collapse that’s so deep and pervasive, it actually wipes out 100 percent of the new credit and brings about a net reduction in the credit outstanding — a veritable dismantling of America’s once-immutable debt pyramid!
For the long-term health of our country, less debt is not a bad thing. But for 2009 and the years ahead, it’s likely to be traumatic, delivering …
The Most Wealth Losses of All Time
Who is suffering the biggest and most pervasive losses? U.S. households and nonprofit organizations (page 105)!
The losses have been across the board — in real estate, stocks, mutual funds, family businesses, life insurance policies, and pension funds.
In U.S. households alone, the losses have been massive: $1.39 trillion in the third and fourth quarters of 2007 (not shown on page 105) … a gigantic $10.89 trillion in 2008 … $1.33 trillion in the first quarter of 2009 … $13.87 trillion in all, by far the worst of all time.
And these losses have equally massive consequences for 2009 and 2010:
- Deep cutbacks in consumer spending ahead, plus a virtual disappearance of conspicuous consumption …
- More massive sales declines at most of America’s giant manufacturers, retail firms, transportation companies, restaurants, and more, plus …
- Big losses replacing profits at most U.S. corporations!
Rescues That Make the Crisis Worse
The U.S. government has taken radical, unprecedented steps to counter this credit collapse. And for the moment, it HAS been able to avert a financial meltdown.
But no government, even one run amuck with spending and money printing, can replace $13.87 trillion in losses by households.
Consider just two of the government’s most egregious escapades:
- On January 7, Fed Chairman Bernanke was so desperate to revive U.S. mortgage markets that he embarked on a new, radical program to buy up mortgage-backed securities. So far, he has pumped over a half trillion dollars of fresh federal money into that market. But it has barely made a dent; despite all his efforts, mortgage rates have zoomed higher anyway, snuffing out a mini-boom in mortgage refinancing.
- Four months later, on May 17, the Fed was so desperate to revive other credit markets, it even caved in to industry appeals to finance recreational vehicles, speedboats, and snowmobiles, according to Saturday’s New York Times. But that has barely made a dent in those industries. And the expansion of direct Fed financing to these esoteric areas is not possible without greatly damaging the credibility — and credit — of the U.S. government. Result: Higher interest rates.
Can Mr. Bernanke take even MORE radical steps? Can he trek where no other modern-day central banker has ever gone before?
Not without shooting himself in the foot! It still won’t be enough to avert a continuation of the debt crisis. Indeed, all it can accomplish is to kindle inflation fears, drive interest rates even higher, and actually sabotage any revival in the credit markets.
Look. The nearly $14 trillion in financial losses suffered by U.S. households has inevitable consequences. And massive, nonstop borrowings by the U.S. Treasury in the months ahead — driving interest rates still higher — can only make them worse.
My urgent warning: If you fall for Wall Street’s siren song that “the crisis is over,” you could be in for a fatal surprise.
Don’t believe them. Follow the numbers I have highlighted here. Then, reach your own, independent conclusions.
The Secret History of Government Debt
One of the biggest lies in history is the idea that government debt is a "safe haven." Today we’re going to revisit one of The Sovereign Society’s favorite "hidden histories" for the real scoop…
It was one of the greatest heists in history.
The scene? London, 1660. The perpetrator? King Charles the II...of England. The loot? All the gold he could con out of the country's goldsmiths, bankers and businessmen in a lifetime. The tool? A stick. A Tally Stick. Tally Sticks were a brilliant invention. But they were also insidious, as they formed the foundation for the fiat currency systems we still have today. One where the root of a currency's value is in a promise from a faceless institution, and not in the actual value of a tangible object…
Counterfeit-proof Receipts for an Illiterate Public
Put into use about a thousand years ago, they were a common sense solution for a young, "gold and goods" economy where gold was scarce. By the time of the heist they were used in everyday transactions. Here's how it worked. When a loan was made, the debt was carved in a standard fashion on the surface of a small (preferably hazel-wood) stick, and then the stick was split in half through the center of the carving. The longer end of the IOU was given to the purchaser, and its handle was called the 'stock'...the root of the word's use in today's markets.
Even a mostly illiterate public could read the amount scratched into the wood, and the stick would only fit perfectly with its original other half. That way, when the debtor returned with the money (or goods) owed, the sticks would be matched and the debt would be "tallied." In that fundamental use, they worked perfectly. But of course - as is governments' way - the King was tempted to stretch those bounds…
King Chuck to the Rescue...of Nobody
Charles II ruled at a time when royal power was still based on a "divine mandate". His government and institutions - and indeed he himself - saw the King as a "Chosen One." Which was a real shame for him…because it bound him to the laws of Christendom. And Christianity at the time still forbade lending or borrowing with 'usury' (interest). So he had trouble in terms of "living like a king" and financing several failing wars against various neighbors. Instead he turned to the trusted tally...and the keen idea of selling his (government) tallies (debt) at a discount. That way, he could allow his lenders to profit without charging interest...it's the basis for government debt being sold at a discount today.
And he could issue advance tallies for 'emergency spending'...an idea that proved all too tempting. He sold the tallies collected by his Excheqeur (tax collector) from the country's Sheriffs, essentially trading future tax receipts to the country's goldsmiths (bankers) for quick cash. The tallies were receipts for taxes to be paid later in the year...and this is a crucial part of the story. They weren't trading on the value of the objects being traded, but on the cost of waiting for a return and the government's ability to collect taxes and keep honest.
But if the government is not honest, this is an outright Ponzi scheme...one where new debt issue could theoretically pay for passing bills, for a while. The King realized that he'd stumbled onto something big. He could wage all the war he wanted and pay his bills with hazel-wood sticks. The King spent and spent, and the goldsmith's vaults filled up with more and more sticks.
But didn't the Goldsmiths get Wise?
Well, yes and no. Yes, they did get wise - which we'll talk about shortly - but they also had a reason to play along. As we discussed in the last 'lies' report, goldsmiths were handing out certificates for fractional gold reserves and inflating the young economy in a con all their own…one called 'fractional reserve banking'. And since the King played along with their early building of a banking system, they played along with the 'sticks-for-gold investment strategy'.
But as mentioned above, they did get wise. At least the market did…
Buyers started attaching larger and larger discounts to the King's debt to offset the perceived risk in loaning money to the King. The discounts prompted the King to issue even more tallies to reach the same desired return, promising out more future tax revenues just to meet his short-term spending desires. But remember, only the discount was changing here. So even though he was getting less and less in return for his sticks, he still had to fulfill them at face value…an obligation that soon overwhelmed the King's income.
By the time the whole Ponzi scheme came to an end, the King's sticks were trading at a 10% discount (to put that into perspective, short-term T-Bills have recently traded with discounts of one-tenth of one percent or less). The payments on his newer issues trading at that discount soon outmatched all the Kingdom's tax revenues, effectively bankrupting his Excheqeur, derailing his Ponzi scheme, and threatening to put the monarchy in the poorhouse. So with the stroke of a pen, the King simply declared those debts illegal and ceased payment. It is – as they say – good to be the king.
With that single stroke he stole a huge amount of the country's gold - having already spent it - and forced the young economy to fall flat on its face. The King's various creditors ended up on 'the short end of the stick' (again, this is the source of that expression) and all credit in the country evaporated pretty much overnight.
But Wait 'til you Hear What Happened to the Sticks...
The sticks were still in use for over a century afterward...the Bank of England even had some on their books when they opened in 1694. But in 1834, Parliament ordered all the sticks be destroyed and the system finally retired. The men at the furnace were happy to comply...and so too - apparently - were the sticks themselves. The fire overwhelmed the Parliament building's basement furnace and burnt the building to the ground.
I'm not kidding. You Think that Might've been a Sign?
This is the history of government debt. And it's important to remember that even government debt is not risk-free. Governments have been known to default on debt. Russia, Ecuador, Chile...and many more have defaulted just in the last century. Why don't you hear about it? Why are government bonds always called "risk-free" or "Inflation-Protected Securities"? Why don't they come out and tell you that government debt has a reckless - even disastrous - past?
Because it's Bad for Business
And it really kills the Ponzi scheme. If a government is facing serious trouble, it's almost a universal truth that they need (or desire) more money. But if they're honest about their troubles, the market might affix a greater discount to their debt...leaving them with less money. So it's best for business just to tell them that everything's okay. Just tell them you're "fundamentally sound," or "well-capitalized".
What else aren't they telling you? Sovereign Society Chairman John Pugsley compiled a special report to give you the knowledge that translates to power in today's confused markets. It covers some of the biggest lies out there today and tells you how we plan to profit from knowing what others don't. Our economy today is much more robust, and the systems for handling government debt are much more sophisticated. But these threats still exist...and we shouldn't assume that any of their consequences are impossible.
Outsider in the world of economics takes a dim view of 'rotten' banks
The American economist Jamie Galbraith is refreshingly open about the benefits and disadvantages of being the son of the nearest thing the economics profession has to a legend. "I grew up knowing many of the giants," remembers the son who spent part his childhood in India when President John F Kennedy dispatched his friend G K Galbraith to New Dehli as ambassador. "The thought that I could escape from this heritage never crossed my mind."
Still, the childhood experience of debating political and economic issues over the dinner table with the elite that ran the United States at the height of its powers has left Jamie Galbraith disillusioned by the calibre of today's economists. "The economics profession is like a Brazilian indigenous tribe that has a proud heritage behind it but is now surviving in a rain forest with no memory of its own history," he rails before adding, in a typical Galbraithian touch, that he hopes his tirade is not offensive to Brazilian tribes.
Both father and son have made their reputations promoting a left-leaning economic philosophy that is often at odds with mainstream economics but tends to find favour in times of economic crisis.
Outsiders in the world of economics, they have influenced the debate in a series of provocative and influential books. Jamie approvingly quotes his father who once told the 'Washington Post' that he felt "like the streetwalker who had just learned that the profession was not only legal but the highest form of municipal service" when President Nixon followed his advice and introduced price controls in 1971.
It is this appetite for jousting in the political arena that sets him aside from many other university-based economists. He has a low opinion of bankers and their role in the present economic crisis, arguing that fraud is endemic in the banking sector and many banks should be allowed to fail. "There was a situation in which fraudulently originated loans were consciously extended on untenable terms because the lenders had no reason to care," he says. "You had massive fraud in the extension of loans to borrowers who could not, or would not, document their incomes while houses were consciously appraised far beyond their values so as to maximise the banks' loans on terms that were untenable."
While declining to talk directly about the situation in Ireland, his comments have a deep resonance for taxpayers here who have bailed out Anglo Irish Bank and are being asked to continue funding the bank's operations. "There are banks that were deeply rotten and those banks should be forced to recognise the losses that occurred rather than covering up the losses. "The management should be replaced and there should be clean, thorough accounting so the taxpayers know what the extent of their liabilities are."
Galbraith, who likes Bill Black's 2005 classic 'The Best Way to Rob a Bank Is to Own One', insists that a bank's management must be culled before any bank can be reformed. "The incumbent management will never give you a choice you have confidence in, because the incumbent management will never come clean," he says. While cautioning that not all banks are rotten, Glabraith says no bank should be allowed to be "too big to fail" while also being allowed to take risks.
Retail banks which lend to the public and companies should be little more than utilities "and should be run as such" which means not taking any risk. "Big banks are intrinsically too big and too dangerous to trust with the protection of deposits," he argues. We have got to "recognise it is not good practice to have the financial sector in lead position driving the direction and pace of the economy because the tendency of that sector is towards instability," he says, looking into the future. "You get a boom and bust of the kind we have been experiencing in the past 20 years."
While it is "unquestionable" that President Barack Obama's fiscal stimulus is working", Galbraith warns that unemployment will continue to rise and that this is a social tragedy. "It means you are wasting a large proportion of the talent of the workforce. The economist says he would not want to be in his mid-20s today because unemployment will really hit this age group, delaying or destroying the chance to form families or have children and gain the sort of work experience that sets people up for life.
It's a while since we've seen that here in Ireland but anybody who hit their 20s in the late 1980s will know exactly what he is talking about, having either experienced these problems themselves or seen others fail to marry or progress in their careers because of a lost decade. Galbraith's solution is to make it easier for people to retire early by providing guaranteed healthcare to anybody over 55 years. The economist is gloomy about the future unless "focussed, directed action" is taken to reduce carbon dioxide emissions.
The world now needs a period of 30 to 40 years of transforming growth to alter the way it produces green house gas or we face "deeply troubling, catastrophic climate change" within the lifetime of our children. The solution, he suggests is "a cabinet level department of climate with a great deal of authority over transport" and other carbon-producing activities. The suggestion is made with verve and vigour but also a touch of sadness. One can't help thinking that deep down Galbraith fears that the world has largely ignored the collective advice of the two Galbraiths for almost a century now.
Bleeding Heart Liberals Proven Right: Too Much Inequality Harms a Society
An important new book substantiates something progressives have long intuited. Published first in Britain and now headed for the United States, it's by epidemiologist Richard Wilkinson and health researcher Kate Pickett, and its title conveys its message: The Spirit Level: Why More Equal Societies Almost Always Do Better. Since the French Revolution, belief in the social benefits of egalitarianism has been central to progressive thought. Now Wilkinson and Pickett have produced some hard evidence for this plank in the liberal platform.
They show conclusively that the well being of whole societies is closely correlated not with average income level but rather with the size of the disparity of income between the top 20% and the bottom 20%. Countries with smaller disparities like Norway, Sweden, and Japan (4 to 1) have fewer medical, mental, crime, and educational problems than countries like the Britain, U.S. and Portugal with higher disparities (7 or 8 to 1). France and Canada both have mid-range disparities (6 to 1) and place in the middle on health, education and psychological indicators. Even within American society, it's not the absolute income level of a state that determines its social well being, but rather the level of income disparity.
Economic inequality and social dysfunction go hand in hand, and Wilkinson and Pickett have marshaled the evidence to make the case. It's one thing to demonstrate the social benefits of egalitarianism, and another to spell out the underlying political, economic, and psychological mechanisms that explain these findings. Only as we understand how the level of income disparity affects social well being will we be able to generate the political will to undo the damage wrought by gross inequality.
Dignity and Its Enemy--Rankism
An explanation of the social dysfunction associated with large income disparities can be organized around the notion of rankism. Rankism is defined as a generalization of the familiar isms and encompasses them all. Specifically, in the same way that racism insulted the dignity of blacks, and sexism was an affront to the dignity of women, so, too, rankism is behavior that diminishes human dignity--black or white, female or male, gay or straight, immigrant or native-born, poor or rich, etc.
Rankism is the abuse of power attached to rank. A difference of rank alone does not cause indignity, but abuse of rank invariably does. Put simply, rankism is what somebodies may do to nobodies. But just as not all whites were racists, so too not everyone of high rank is a rankist. Therefore, rankism, not rank differences, is the source of indignity. Indignity causes indignation, and indignation takes its toll either on the health of the individual who must contain it or it manifests as withdrawal or anger/aggression.
Rankism functions socially in the same way that racism does. No one doubts any longer that racism cemented in large, self-perpetuating income disparities between the white majority and black victims of slavery and segregation. In a parallel way, rankism marginalizes the working poor, keeping them in their place while their low salaries effectively make the goods and services they produce available to society at subsidized prices. This process, whereby the most indigent Americans have become the benefactors of those better off, is vividly described by Barbara Ehrenreich in Nickel and Dimed. In The Working Poor: Invisible in America, David Shipler depicts the less fortunate as disappearing into a "black hole" from which there is virtually no exit. As class membranes become ever less permeable, resignation, cynicism, and hostility mount.
In the economic realm, the market mechanism, at least when it's working, functions to limit abuses of power, but political arrangements can trump the market. Large enough disparities in economic power may be used to influence politics so that laws and regulations perpetuate the economic gap. Once established, economic inequality, if it is steep enough, also perpetuates exploitation because it imprisons the poor in their poverty. When missing a single paycheck means homelessness, people are not likely to demand better wages or working conditions. As Rev. Jim Wallis says, "Poverty is the new slavery."
There is another important reason that eightfold factors in wealth disparity cause more social distress than factors of four. When the top 20 % are eight times better off than the bottom 20 %, far more people are vulnerable to rankism because people in the middle quintiles are also separated from the top and bottom quintiles by significant differences in economic status and power. Instead of being confined within a narrower spectrum (characterized by, say, a disparity factor of four or five), people are spread out over a broader economic range. When the first (poorest) quintile is further from the top (richest) quintile, so, too is the second quintile further from the fourth, and the third from the first and the fifth. These larger differences in economic power make possible more abuse.
Economic gaps soon become dignity gaps. As rankism gains ground, more people experience its indignities and humiliations, and these individual wounds compound into illness and social dysfunction. Dignity is to the identity what food is to the body--indispensable. By confirming our identity and affirming our dignity, respect and recognition provide assurance that our place in the group is secure. Absent periodic and appropriate validation, our survival feels at risk. Without proper recognition, individuals may sink into self-doubt and subgroups are marginalized and set up for exploitation.
Dignity and recognition are inseparable. We can't all be famous, but fortunately recognition is not limited to the red carpet. We can learn to understand the effects on those who are either denied a chance to seek it, or from whom it is otherwise withheld. Once aware of the deleterious effects of "malrecognition," we can act against it as we now take steps to prevent malnutrition. Like malnutrition, malrecognition lowers the body's resistance to disease and reduces life expectancy. For most people, just the opportunity to contribute something of themselves to the world is enough to stifle the indignation that accumulates from exposure to indignities caused by rankism. This means that malrecognition, like its somatic counterpart, is a preventable and treatable malady.
To increase the supply of recognition we need only discern people's contributions, acknowledge them appropriately, and compensate them equitably. When the average compensation of the richest 20 % exceeds that of the poorest 20 % by factors greater than four or five, the poor experience this as unfair, unjust distribution of recognition. The deleterious consequences of malrecognition manifest in the familiar array of social problems tracked in The Spirit Level--mental illness, drug and alcohol abuse, obesity and teenage pregnancy, an elevated homicide rate, a shorter life expectancy, and lower educational performance and literacy rates.
More than either liberty or equality, people need dignity. In contrast to libertarian or egalitarian societies, a dignitarian society is one in which everyone, regardless of role or rank, is treated with equal dignity. The findings reported in The Spirit Level: Why More Equal Societies Almost Always Do Better suggest that as societies become more dignitarian they will, in the words of the subtitle, "do better." A startling example of this proposition comes from, of all places, our prison population where indignity and malrecognition are endemic. Recent work done under the auspices of The Center for Therapeutic Justice in Virginia indicates that the recidivism rate for inmates who serve their sentences in a dignitarian community drops from 50 % to 5 %.
Social Isolation and Depression
In explaining their findings, Wilkinson and Pickett put the emphasis on the lack of trust fostered by large wealth disparities. Put the other way round, the connectedness experienced in dignitarian communities is the equivalent of social oxygen. Some thirty years ago a physician (Wolf) and a sociologist (Bruhn) teamed up to explain why, in the town of Roseto, Pennsylvania, there was a group of poor Italian immigrants whose health and welfare were vastly better than their neighbors.
After a twenty year study of immigrant families in Roseto, and a comparable study in a nearby, non-immigrant town, they found that health and welfare were dependent on what they called cohesion, the opposite of isolation and the antithesis of distrust. As the younger generation adopted American ways of geographic and status mobility, their health and welfare levels decreased to the level of the neighbors. In addition to directly affecting health and welfare, disconnection has an effect on the emotions. Just as being closely connected with others leads to authentic pride, so disconnection leads to shame and humiliation.
The isolated person is apt to feel rejected, if not completely worthless, and live in a more or less permanent state of shame. One way of defending against the shame of malrecognition is to withdraw, sometimes all the way into the isolation of depression. Such withdrawal then leads to further isolation, which in turn compounds the rejection by the community and accelerates the downward spiral. Again, malrecogntion compounds into social dysfunction as confirmed in this eye-opening book.
In addition to caring for the weak, humans are still capable of predatory behavior towards those lacking the protection of social rank. Rankism is the residue of more overt predatory practices of the past. Now that rankism has a name, the miasma of malrecognition is visible and we are in a position to begin rooting it out. Rooting out rankism, like overcoming racism, is a multi-generational undertaking. Despite the enormity of the task, we are likely to look back on the 21st century as marking an epochal transformation from a predatory to a dignitarian era.
Disallowing rankism betters human well being in the same way that disallowing racism and sexism improve the lives of blacks and women. The hard evidence that Wilkinson and Pickett have provided demonstrates the benefits of dignitarian societies and validates the egalitarian instinct that has long been a mainstay of the liberal creed.
EU leaders endorse new regime regulating financial sector
European government leaders agreed today to establish a new pan-European regime regulating the financial markets and institutions, in what President Nicolas Sarkozy of France described as a "sea-change in the Anglo-Saxon" approach to financial supervision. While senior German officials described the new system of risk agencies and financial supervisors as "more ambitious" than initially envisaged by the European commission, Sarkozy and other leaders termed the pact a breakthrough that would have been inconceivable previously.
Sarkozy said: "My objective was to get a Europe-wide regulator. We have just given birth to a new European body with binding powers. It's just a starting point." The new system, to be enshrined in European law this autumn and expected to be up and running next year, comprises a European Systemic Risk Council monitoring financial stability and a troika of European agencies policing the banking, securities and insurance sectors.
Gordon Brown resisted pressure to have the risk council headed by the president of the European Central Bank, which is in charge of the single currency. The leaders decided to have the position filled by election among the 27 European Union countries. "Given that there are more countries in the eurozone than not [16 to 11], the result will be the same," noted Sarkozy. Brown also successfully fought attempts to endow the new agencies with binding powers to force governments to take fiscal action in a financial emergency. The leaders agreed that the new agencies would not be able to dictate terms that had a fiscal impact on national treasuries or budgets.
German, French, and British officials stitched up the pact on the new regime in advance of the two-day summit that ended in Brussels today, sources said. But Germany also opposed giving the new supranational authorities the power to order governments to bail out or recapitalise banks, said officials in Berlin. That view was confirmed by Sarkozy, who said: "Brown was not the only one to be worried about the fiscal and monetary implications. Merkel said we can't be in a position where Europe forces us to dig into our pockets." The British government portrayed its position as one determined to defend the interests of the City of London, which is by far the biggest financial centre in the EU.
But non-British European sources insisted that there was little opposition to the UK demands, rather some surprise that London had agreed so swiftly to a new European rule book standardising the activities, powers, and conduct of financial regulators across the EU. "If you asked me a year ago if a UK prime minister would accept a common system and principles, no one would have believed that was possible," said a senior EU official.
Another senior Brussels official voiced satisfaction with the outcome, explaining that the leaders had gone to the limits of what was possible for now. There would be an impact on debate over common economic and financial policy-making in Europe and that debate would continue, he said. While Sarkozy clearly relished parading as the victor over "Anglo-Saxon strategies" in the tussle to determine the future of European regulatory authorities, he also paid tribute to Brown for "assuming his responsibilities".
Brown said: "I have ensured that British taxpayers will be fully protected." The summit recommended that "a European system of financial supervisors be established aimed at upgrading the quality and consistency of national supervision, strengthening oversight of cross-border groups through the setting up of supervisory colleges and establishing a single European rule book applicable to all financial institutions in the [European] single market."
Gordon Brown surrenders key powers over financial regulation to Brussels
Gordon Brown looks to have surrendered significant powers over the City of London to new bodies of European Union financial regulators, according to a high-ranking Brussels official. The European Commission and other EU officials are celebrating after the Prime Minister accepted on Thursday night the creation of European supervisors over national regulators. Senior EU officials described how in return for a promise that Brussels regulators can not have power to tell the British government when, and by how much, to bail out banks, Mr Brown has given ground on a broad range of other supervisory powers.
"One year ago, if you had asked if was it possible to go so far as to have the Prime Minister of Britain accepting not only common principles but common systems of auditing and binding decisions at the EU level, then I think that no one would have believed it," said a senior official. Meeting in Brussels, EU leaders are agreed on the need for better oversight of banks and financial institutions to prevent a repeat of last year's crisis, which has tipped the global and European economy into its worst downturn for 70 years.
The proposals involve creating three pan-European watchdogs next year to ensure countries introduce new rules on supervision. Under the proposals, there is to be a European Banking Authority in London, an Insurance Authority in Frankfurt, and a Securities Authority in Paris. All European leaders agreed today to their creation. The new bodies will have the authority to ensure European Union market laws are implemented similarly in every country. There is also to be the establishment of a new European Systemic Risk Board that would monitor the build-up of risks to stability in the region. According a draft EU summit communiqué, Mr Brown has also lost a battle to keep control of a powerful "Systemic Risk Board" (ESRB) out of the hands of the European Central Bank.
The ESRB will monitor potential threats to financial stability and, where necessary, issue risk warnings and recommendations for action and supervise their implementation. Britain had fought hard to ensure chairmanship of the new body was rotated among all EU countries but appears to have conceded control to eurozone countries. "The members of the general council of the European Central Bank will elect the chair of the ESRB," the draft communique states.
EU ‘risks lagging US on regulation’
Europe risks falling behind the US in policing the financial system and the current crisis could prove "a wasted opportunity" to ensure its future stability, a top European Central Bank policymaker has warned. The toughly-worded comments by Lorenzo Bini Smaghi, an ECB executive board member, came as European Union leaders approved plans for a new regulatory framework that will include a "European systemic risk board" and a European system of financial supervisors. Mr Bini Smaghi voiced specific concern that the systemic risk board, intended to look at general threats to the financial system, would have insufficient power over national authorities. But he also feared more generally that the EU was losing its will to undertake wholesale reform.
With global financial markets showing signs of stabilisation, "there is a risk that the sense of urgency for reform fades away and nationalistic tendencies and institutional jealousies re-emerge," Mr Bini Smaghi told a conference on financial regulation at Bocconi University in Italy. "The forces pushing towards maintaining the status quo are gaining strength. If these forces are not firmly counteracted, this crisis could turn out to have been a wasted opportunity. And the next crisis could move closer," he said. Concern was also rising about the effectiveness of the EU "in comparison to the reforms that have been put forward in the US," Mr Bini Smaghi added.
The proposed European systemic risk board would include the 27 EU central bank governors and would be supported logistically and analytically by the ECB. Its chairman would almost certainly be Jean-Claude Trichet, ECB president. The board would have the power to make recommendations – but not to implement policies directly. Such restrictions would overcome fears, especially in the UK, that national authorities would be surrendering influence to EU institutions. But Mr Bini Smaghi warned that recommendations could be implemented differently in different counties – without clear justification. "Ultimately the incentive to safeguard the competitiveness of the national systems would induce the respective authorities to adopt a minimalist approach, which would be to the detriment of overall stability."
Mr Bini Smaghi preferred giving Europe’s central bankers specific tools to ensure financial stability – on top of their control over interest rates, which would remain focused on combating inflation. He noted this was the system proposed this week in the US, where the Federal Reserve would be given powers to address the build up of risks that threatened the financial system as a whole. Mr Bini Smaghi also noted that the current EU proposals would create a "very peculiar situation" in which those countries outside the eurozone would have risks to the financial system monitored at both at the European and national levels. But eurozone members would only have the EU level – unless the ECB decided to issue itself recommendations for the eurozone.
Green shoots extinguished by 'dire' Government borrowing figures
Hopes that the economy has started to recover have been extinguished by a series of poor data, released on Thursday, including "dire" public sector borrowing figures. Public borrowing hit a record £19.9 billion in May, more in a single month than the Government borrowed throughout the 12 months of 2002. With the recession continuing to take its toll, the Government is relying on a dwindling number of taxpayers to fund an increasingly large benefits bill – which in turn has forced it to raise more money from the bond markets.
The amount the Government raises from VAT, corporation taxes and income tax has fallen substantially in the last 12 months. May's borrowing was nearly double the £10.6 billion borrowed in April and the highest amount since records began in 1993. The figures were much worse than economists expected, with one describing them as "absolutely dire". They came as official retail sales figures suggested shoppers, who in recent months have been out in force on the high street, are spending less. Also, the Council of Mortgage Lenders warned that house prices will not see a significant recovery in the coming months, as figures show mortgage lending dropped further last month.
The Office for National Statistics said retail sales fell 0.6 per cent in May after a 0.9 per cent rise in April. Sales were 1.6 per cent lower than a year ago. Retail sales have been remarkably resilient in recent months, but many experts fear – despite the recession running for a full year – only now are shoppers tightening their belts. Separate figures from accountancy firm Ernst & Young suggest that consumers have 25 per cent more disposable income than a year ago, because of lower mortgage payments and cheaper utility bills. It calculates that the average family has £1,075 to spend on luxuries at the end of each month – after paying key bills – compared with £859 a year ago. However, consumers are using this extra money to pay off debts, rather than spend.
Jason Gordon, retail director at Ernst & Young, said: "Alongside falling house prices, the bleak economic climate and fears of job losses have had a devastating impact on consumer confidence. Consequently, many consumers are using their increased monthly spending power to repair savings balances and pay off credit cards and other debts. These gains are certainly not being spent freely on the high street." Public sector borrowing for this financial year is now £30.5 billion and on course to be greater than the £175 billion target that Alistair Darling set during this year's Budget.
Howard Archer, chief UK economist at IHS Global Insight, said: "Mr Darling clearly has a major battle in limiting the [public borrowing] to £175 billion in 2009/10. Shadow Chancellor George Osborne, said: "These terrible borrowing figures show that Labour's debt crisis is getting worse. It is clear the Government has lost control of the public finances, and the Prime Minister's ridiculous claim that Labour won't have to cut spending flies in the face of the facts."
UK car production slumps 43% from 2008
A total of 67,754 cars were made in the UK in May 2009 - a drop of 43% on the May 2008 figure, the Society of Motor Manufacturers and Traders (SMMT) said. The previous four month-on-month falls had each been more than 50% and this was the least-steep reduction since November 2008. However, commercial vehicle (CV) production in May 2009 was 73.5% - a much worse figure than in any recent month.
Last month the UK joined other European countries in introducing a Government "cash for bangers" car-scrappage scheme. Earlier this week the Government said that more than 60,000 orders have been placed under the scheme since it was first announced in the Budget in April. UK production was bound to fall sharply this year, with companies cutting back on manufacturing to match the downturn in new car sales. Honda shut down all production at its plant in Swindon in Wiltshire for four months, but restarted manufacturing there at the beginning of this month.
On Friday, SMMT chief executive Paul Everitt said: "Prompt action by manufacturers to realign supply with demand has been painful, but was necessary. There is now a direct link between demand in the marketplace and production volumes. "The scrappage schemes in place across Europe are now beginning to have a positive impact, although the full benefits will take a little longer to flow down to companies at all levels in the supply chain." Car production for the year so far (January-May) is 54% down compared with the first five months of 2008, while CV production has fallen 65.4%.
Spanish Central Bank Warns on Spending
Concerned over rising deficits, the governor of Spain's central bank says the chance to use fiscal policy for economic stimulus "has now been exhausted". Spain's central bank told the government on Tuesday (16 June) there is no room for further spending measures above those already announced, and warned that the country's rising budget deficit could hamper growth when a global upturn arrives.
"We have to stop public sector debt becoming an obstacle when the Spanish economy is in a better condition to grow," said central bank governor Miguel Angel Fernandez Ordonez in a speech accompanying the Bank of Spain's annual report. "Any chance of using fiscal policy to increase spending has now been exhausted," he said. His words are unlikely to please the government of Socialist Prime Minister Jose Luis Rodríguez Zapatero, who reacted testily to earlier pronouncements by the bank governor this year on the need for pension and labour market reforms.
"I wish it was the last time I had to disagree with the governor of the Bank of Spain," labour minister Celestino Corbacho said a few months ago following comments by Mr Fernandez Ordonez. Despite also being a Socialist and a former government official, tensions between Mr Fernandez Ordonez and the government have grown this year as the Spanish government embarked on one of Europe's largest fiscal stimulus plans to counter the recession. Former finance minister Pedro Solbes was replaced by Elena Salgado earlier this year following his complaints over government overspending. Ms Salgado – whose economic forecasts have generally proven to be overoptimistic – appears to have adopted a more realistic tone following the end of European election campaigning, during which the state of the economy was a central issue.
Spain's unemployment – by far the highest in Europe – hit 18.1 percent in April and is expected to top 20 next year, bringing with it a corresponding increase in social spending and a growing strain on state coffers. The country's unemployment rose to 24 percent in the early 1990s and stayed in double figures until 2005. Added to this, the latest government forecasts now predict the economy will exit the recession later than most EU member states and will not return to annual growth before 2011. However Mr Fernandez Ordonez says further fiscal spending to boost the economy would raise expectations of future tax hikes, with a rising budget deficit also likely to arouse investor concern. Spain's credit rating was downgraded earlier this year, along with a number of other European countries.
Switzerland looks at cutting size of banks
Switzerland upped the ante in a global regulatory assault on the banking industry on Thursday as its central bank warned that Zurich was examining the forced shrinkage of banking groups such as UBS and Credit Suisse to contain the risks posed by their size. The central bank is looking at imposing constraints on the size of its biggest domestic banks unless global policymakers can come up with a new system to deal with large banks when they fail. Philipp Hildebrand, vice-chairman of the Swiss National Bank, said: "There can be no more taboos, given our experiences of the last two years."
"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," Mr Hildebrand said as the central bank unveiled its stability report. UBS and Credit Suisse prompted alarm among authorities about the risks their size posed to the Swiss economy when they reported heavy losses as a result of the financial crisis. Last year, their collective assets were equivalent to six times Swiss GDP. The central bank envisaged "direct and indirect measures to limit [large banks’] size," said Mr Hildebrand. His comments on Thursday caused unease among Swiss banks, which said that the SNB did not have direct responsibility over banking regulation and therefore lacked powers to implement any such controls.
"This is strong language," said one bank executive. "But the SNB doesn’t have a direct say in the regulation of the banks." Another said Mr Hildebrand’s comments were "little more than sabre-rattling". However, the remarks will be scrutinised by policymakers and investors on both sides of the Atlantic. They come as central bankers and regulators around the world are ratcheting up language on banking reform. Mr Hildebrand called for regulators to work together to develop an international process for the orderly wind-down of a broken bank. But he warned that, if that process could not be designed in a "reasonable" time frame, then more direct measures should be examined.
He did not spell out exactly how he wished to curb banks’ size. However, the ideas being looked at involve crude limits on the absolute size of balance sheets or discouraging growth into risky areas by raising capital requirements. On Wednesday, the governor of the Bank of England Mervyn King fired a warning shot across the bows of the industry, pointing out that regulators could not tolerate a situation where numerous banks were deemed "too big to fail." And the debate could intensify in Washington in the coming weeks, since politicians are due to start debating a series of reform measures that the Obama administration hopes to implement to clean up the banks.
In Brussels on Thursday, the European Union’s 27 member states were poised to approve plans to strengthen financial supervision in Europe amid British reservations about yielding certain national powers to EU authorities. Gordon Brown, UK prime minister, on Thursday night secured a guarantee from EU leaders that the new supervisory system would not include powers to force national governments to bail out banks. Diplomats said the summit communiqué would say that any EU-level decision would "not impinge in any way on the fiscal responsibilities of the member states".
'Impossible to Understand' Swap Burns 290-Person Italian Hamlet
Ortenzio Matteucci points to towns down the wooded Nerina valley in Italy’s Umbria region and blames peer pressure for his decision to let Polino, population 290, buy a U.S.-inspired financial swap he didn’t understand. A retired steelworker with wavy gray hair, Polino’s Mayor Matteucci says he agreed to the interest-rate swap because Milan, with more than 1 million residents, and local towns Arrone and Stroncone all bought derivatives to try to save money. Polino’s contract has cost the village 6,579.66 euros ($9,200) more than it has earned since the town made the deal in 2005.
"At the time I thought: Can the Province of Terni, the City of Terni and all the other municipalities bigger than us, such as Milan, be all wrong?" said Matteucci, 59, dressed in a blue polo shirt and jeans. "You can make a mistake if you don’t have an appropriate and deep knowledge of this and just follow what other local governments do." Derivatives have burned towns from Polino to Milan to Erie, Pennsylvania. Jefferson County, Alabama, said it might need to declare bankruptcy because of costs associated with the contracts. Responsibility for the expenses in Italy’s second- biggest city and in Umbria’s smallest village sits with elected officials who agreed to financial instruments they didn’t fully grasp, said Stefano Taurini, a lawyer who specializes in corporate law in Milan.
In Italy, some 600 local authorities had taken out more than 1,000 derivative contracts on about 35.5 billion euros of debt by the end of last year, according to national Treasury data provided to the Italian Senate Finance Commission. The governments had unrealized losses of 1.93 billion euros on over-the-counter derivative bets placed with Italian banks and local units of foreign banks at the end of 2008, according to data from the Rome-based Bank of Italy, the country’s central bank.
"An educated buyer just shouldn’t buy something he cannot fully understand and doesn’t have the means to go comparison shopping for," said Stefano Ghersi, chief executive officer of Synergy Global Capital LLP, a London investment firm. Ghersi is also the former head of international capital markets for Tokyo- based Nomura Holdings Inc., which sold derivatives to and arranged financial offerings for Italian local governments. Nomura wasn’t involved in Polino’s transaction. Jefferson County, Alabama’s most populous, last year defaulted on $3.2 billion of debt amassed during the construction of its sewer system. More than $3 billion of that carried floating interest rates and used derivatives to protect against the risks.
The strategy failed when the bond rates jumped to as high as 10 percent, while the rate the county received under the swaps dropped as central banks worldwide slashed borrowing costs. Speaking in the square that holds Polino’s fountain, built with off-white limestone blocks and featuring a statue of Giovanna, queen of Naples in the 15th century, Matteucci now promises his fellow citizens that he will get out of the swap. Yet doing so would cost Polino an additional 21,077.21 euros, according to a March 31 valuation from the bank that sold the swap. That’s equal to the cost of a year of repairs and maintenance for the village’s streets, its gray stone buildings with terra cotta roofs and its Renaissance-era fortress.
The payout would amount to about 4.2 percent of the town’s annual budget of about 500,000 euros, according to Primo Giovannelli, who works in the mayor’s office. The equivalent in the city of New York, which has a fiscal 2010 spending plan of $59.4 billion, would be about $2.5 billion. "It makes no sense for local governments to dabble in derivatives," said Giorgio Questa, a finance professor at London’s Cass Business School and a former investment banker at Milan-based Banca IMI SpA. "At best they get ripped off." Swaps are agreements to exchange interest payments, such as a fixed rate for one that varies based on an index. They are a type of derivative, a category of contracts whose value is tied to assets including stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.
The swaps market took off in 1981 after Salomon Brothers, now part of New York-based Citigroup Inc., arranged a currency and interest rate contract between Armonk, New York-based International Business Machines Corp. and the World Bank in Washington, said Robert Pickel, CEO of the International Swaps and Derivatives Association in New York. "Salomon Brothers helped to broker that deal, and once they had structured it, they and other banks used it as a basis for working on other types of transactions," Pickel said.
The global market for interest-rate swaps totals $328 trillion, based on figures from the Bank for International Settlements in Basel, Switzerland. "The derivatives are like a big sword of Damocles over the heads of administrators," said Luca Del Gobbo, mayor of Magenta, a town of 25,000 outside Milan. He was alluding to the ancient tale of a courtier who sat in constant peril beneath a sword suspended by a single horsehair. Magenta bought interest rate swaps from Caboto Holding SIM SpA, now a unit of Milan-based Intesa Sanpaolo SpA, in 2001 on 4.6 million euros in fixed-rate loans. "It’s become really difficult to plan beyond the coming year," Magenta’s mayor said.
Italy’s municipal bond market was built up largely by U.S. banks, says Joseph Taylor, who wrote a research report for Merrill Lynch & Co. on the city of Naples for a $195 million bond issue in 1996. Merrill Lynch, now owned by Charlotte, North Carolina-based Bank of America Corp., underwrote that issue, the first modern Italian local government bond aimed at attracting foreign investors, said Taylor, an emerging market debt strategist for Boston-based Loomis Sayles & Co.
The transaction also included a swap to transform the issue back into payments in lira, and later euros, as required under a 1995 law, according to Ottavio Muzi-Falconi, head of debt capital markets for Merrill for southern Europe at the time. A 2001 law in Italy stipulated that local authorities could buy swaps only if the transaction would improve the town’s finances, said Taurini, the Milan lawyer. Italy banned local governments from signing new derivatives contracts in mid-2008, he said. In Milan, prosecutor Alfredo Robledo is probing allegations that four banks deliberately defrauded the city when they sold it derivatives. His office claims the banks made about 101 million euros in illicit profit for arranging the deals. Separately, the city said in January that it’s suing the banks in Milan’s civil courts.
When Polino did its swap, the village had a dozen loans from the Cassa Depositi e Prestiti SpA totaling about 547,367 euros, at an average rate of 4.65 percent. The municipality listened to what was pitched as a potentially money-saving plan by bankers from Banca Nazionale del Lavoro SpA in October 2005, said Sabrina Orsini, Polino’s financial director. The Rome-based Cassa Depositi e Prestiti is a state- controlled lender that provides funds to local authorities for public works investments and other operations. BNL was bought by Paris-based BNP Paribas SA in 2006. "I knew it was speculative, but interest rates were low," said Orsini, 38. She added that the town council had given general approval to the idea before she received the actual two- page contract.
On Dec. 15, 2005, Orsini signed with BNL, inking the document with rubber stamps bearing her name and Polino’s seal. She also signed and stamped a four-page appendix outlining the payments the two parties would make to each other, the interest rates they were based on, and the collar -- minimum and maximum rates -- that would apply. The contract runs through 2025, according to a copy provided to Bloomberg. She signed for a town too small to have its own dry cleaner. Every few days, a white van rolls into town in late morning, a loudspeaker on its roof playing a jingle, to drop off cleaned clothes and pick up a new load. Eight or nine children take a state-funded bus to Arrone, 12 kilometers (7.5 miles) away, the closest town with a primary school, Orsini said.
"Given the current macro environment and the monetary policy of the main international central banks, we have developed financial derivatives proposals characterized by a high degree of caution and aimed at delivering significant potential financial savings," BNL said in its contract offer to Polino, provided by Orsini to Bloomberg. Lanfranco Forlucci and Ugo Mezzetti, whose names appear on the Polino contract offer as the bank contacts, declined to comment. A spokesman for BNP Paribas in Rome, Gerardo Tommasiello, also declined to comment. The agreement provided Polino with a guaranteed gain of 4,813.66 euros in the first two semi-annual payments. Polino continues to pay its balances due to Cassa Depositi, Orsini said.
"It is so complicated that it is impossible to understand it," said Mayor Matteucci, sitting behind a desk piled with 6- inch stacks of papers and with no computer. "In the end, it looks like the bankers are always the ones on the right side." The contract was based on the six-month euro interbank offered rate, or Euribor, a gauge of bank funding costs, plus 1.16 percentage points, the contract shows. If the rate falls to 2.1 percent or lower, a floor kicks in and the town pays 4.3 percent; if Euribor rises to 6 percent or higher, Polino’s rate is capped at 7.16 percent, the contract shows.
As a result, although six-month Euribor has slumped to 1.45 percent, Polino’s rate on the swap is 4.3 percent, or 0.35 percentage point below the average rate it is paying on the fixed-rate loans from the Cassa Depositi, the contract shows. After having lost money since the middle of 2007, the town is now slated to receive a 1,222.61-euro payment this month, Orsini said. "The real effect of these contracts on the public economy will be perceived only at their expiration," Taurini, the lawyer, said. "Their finances will necessarily bear in the future the consequences of the wrong decisions made in the past."
Matteucci and Orsini met with three BNP Paribas bankers, including Mezzetti, on May 8, 2008, Orsini said. The bank told them the town had the best contract the bank could offer and made no changes, Orsini said. Orsini and Matteucci said they decided in December not to give the bank any more money and began to look for a way out. Polino now plans to hold a new round of meetings with the bank, Matteucci said. If nothing changes, the village will look to file a lawsuit, he said.
Matteucci’s family has run Polino for almost 50 years. His father, Amerigo, was mayor for more than four decades before the son took office in 2004. Above the town, a path leads up the mountain to a long- abandoned mine. The wood-framed, bullet-holed sign at the mine’s mouth says metal extracted there starting around 1760 was used to mint coins for Pope Clement XIII. According to local legend, the sign reads, the mine produced gold.
The Auto Slump Hits Eastern Europe
As "Detroit East" falters, carmaking-dependent Slovakia is struggling to revamp its national business plan. Tractor-trailers hauling shiny Kia compacts or Citroën minivans have been a common sight on Slovakia's D1 highway in recent years. But these days you'll see far fewer big rigs on the road as it follows the Vah river beneath hilltop castle ruins and past seedy truck stops. With car sales plunging worldwide, the heart of "Detroit East"—an automaking corridor that stretches from Poland to Slovakia and the Czech Republic—is suffering woes that echo those in the original Motown.
Korea's Kia Motors, which produces cars in Zilina at the foot of the pine-clad Tatra mountains, has trimmed shifts to six hours from eight as it dials back production 15%. Volkswagen (VLKAY) makes SUVs for the U.S. and Europe at a sprawling plant outside Bratislava, the capital, but temporarily shut down assembly lines this spring. France's PSA Peugeot Citroën (PEUGY) has laid off 6% of the 3,500 workers at its factory making compact sedans and minivans in Trnava, 30 miles east of Bratislava.
Such cutbacks may seem mild compared with the troubles in Michigan, but they're a big deal for this nation of 5.4 million people. Some 80,000 Slovaks work for the automakers and a dense cluster of suppliers, such as Visteon (VC), Delphi (DPHIQ.PK), and U.S. Steel (X). Last year Slovakia churned out 591,000 vehicles—the highest per capita car production in the world. But this year output is likely to drop below 500,000 and won't grow again until 2011, researcher IHS Global Insight figures. "We are really feeling the impact of the crisis," says Peter Ziga, the No. 2 official in the Slovak Economy Ministry.
Unemployment has shot up to 10.5% from 8.7% at the end of 2008, while the economy contracted at an annual rate of 5.4% in the first quarter. Foreign investment has slowed to a trickle. Even as Slovakia's adoption of the euro has eliminated currency risk for many businesses, it has made Slovak workers more expensive than those in Hungary or the Czech Republic, not to mention Romania and Ukraine, countries whose currencies are much weaker than the euro. In 2007 the Slovak Investment & Trade Development Agency attracted 64 foreign projects worth $1.8 billion, mostly auto-related. This year, just two projects have been completed. "Everybody is on hold," says Barbora Mikloskova, head of development at the agency.
As the automakers adjust to a shrunken market, Slovaks are realizing it's time to update the national business plan. "Slovakia needs to shift gears," says François Lecavalier, regional director in Bratislava for the European Bank for Reconstruction & Development. Cheap manufacturing takes an emerging economy only so far. To achieve long-term prosperity and growth, developing countries have to create their own innovative products and nurture domestic companies that can compete internationally. The government is doing what it can to reduce Slovakia's dependence on carmaking.
Plants built by Sony (SNE) and Samsung Group in recent years were a step in the right direction, though both concentrate on manufacturing. A new law will offer better financial incentives—such as covering half the cost of land in depressed areas—to companies setting up research and development. The crisis has also added urgency to efforts to help the east and south, where the auto-driven prosperity never had much impact. In July construction will begin on a four-lane highway to link Bratislava better with the east. But those measures may not be enough.
Slovakia's boom began with economic reforms led by center-right Prime Minister Mikulas Dzurinda, but three years ago he was bounced by voters who hadn't benefited much from the new prosperity, and left-leaning Robert Fico took over. The new government hasn't tampered drastically with the reforms, but it also hasn't moved as quickly as business would like to upgrade education and health care. And while Slovakia is trying to attract more high-paying R&D jobs, particularly in autos, that strategy pits it against China and other countries where costs are lower and the pool of educated workers deeper.
It's doubtful whether Slovakia can be as successful at attracting R&D as it was at luring assembly lines. Auto companies gravitated to Slovakia and elsewhere in Central Europe not only for cheap labor but also because the region is close to both Western Europe and growth markets in Eastern Europe and Russia. Geography doesn't matter as much for R&D. After all, the Detroit automakers do much of their design work in California, notes Mary Stokes, an analyst at economic consultancy RGE Monitor. "Slovakia is an ideal location for auto production, but does it have a comparative advantage as it moves up the value chain?" she asks.
Indeed, none of the three automakers in Slovakia has significant R&D or design in the country. To change that, executives say, Slovakia needs to upgrade its poorly equipped universities so the country produces more engineers. Despite some well-regarded technical schools, Slovakia ranks at the bottom of the European Union in the number of people employed in R&D. "There is definitely a lack of a high level of education," says Jean Mouro, Peugeot Citroën's Slovakia chief. "That will be a huge drawback." The auto industry slump is a blow for one of the most successful members of the former Soviet bloc and a model for emerging countries everywhere.
In 2004, Slovakia introduced a 19% flat tax on both business and personal income. That and a low-cost, skilled workforce prompted a surge in foreign investment, helping push growth to more than 10% by 2007. Thanks to prudent government spending, Slovakia raced past its neighbors to join the euro common currency this year. The auto industry, which accounts for 8% of gross domestic product and 40% of exports, played a crucial role in the country's success. "We have written the recent history of the auto industry in Slovakia," says Andreas Tostmann, chief executive of Volkswagen Slovakia, which in 1991 took over a state-owned auto factory that now accounts for 10% of the country's overall exports.
The modern Slovak plants couldn't be further from the gritty Communist-era combines they replaced. The Kia factory, which makes Sportage SUVs and a compact called the cee'd (pronounced "seed"), looks as clean as a hospital. "Redukujeme Poruchy Na Nulu," implores a banner above the assembly line—Slovak for "Reduce Defects to Zero." Outside, freshly mowed grass surrounds orderly flower beds. Even though the country's workers earn an average of $16,800 annually—or less than half the average manufacturing wage in Western Europe—Kia planners knew salaries would rise. So they designed the plant with plenty of automation, such as robotic welders and computerized trolleys that fetch parts from metal racks as the assembly line needs them.
The Kia factory will cut production to 170,000 vehicles this year, from 200,000 in 2008, well below capacity of 300,000 vehicles. But Kia doesn't regret investing in Zilina, says In Kyu Bae, CEO of Kia Motors Slovakia. The location gives the company easy access to both Western Europe and Russia, which has become a larger market for Kia than Germany. And Slovak workers are more productive than Romanians or Ukrainians, even if they are more expensive. "I'm very satisfied with our employees," Bae says over green tea in a room furnished Korean-style, with a low, round table. One of those workers, Robert Ondrejkovic, a 38-year-old senior operator on the Kia assembly line, says he's grateful to management for avoiding layoffs. But he could be speaking for all of Slovakia when he adds, "People need to buy more cars."
How Derivatives, Collateralized Debt Obligations and Credit Default Swaps crushed the world economy
“The banks run the place… they give three times more money than the next biggest group,” says Congressman Collin Peterson, the Chairman of the Agriculture Committee. Peterson, who says banks are controlling Congress, has introduced a bill to bar Derivatives trading in any clearinghouse regulated by the New York Federal Reserve, and thereby bring Derivatives trading out of the shadows of the private clearing houses, and onto public exchanges.
You see, it finally took someone who knows about agriculture, to get down to the nitty-gritty of the Derivatives dilemma. The trouble is, according to Congressman Peterson, that his bill will not pass unless it is materially changed to the satisfaction of his colleagues in Congress, the ones who are accepting the contributions and perks from their bankster superiors.
Derivatives, along with their cousins the Collateralized Debt Obligations (CDO’s), and Credit Default Swaps (CDS), are the financial instruments that have in recent times been defined as a bottomless pit of incomprehensibly written economic jargon, or Wall Street hocus pocus. They are being blamed by many bankers, politicians and high government officials, to be the underlying cause of AIG’s recent quarterly loss, over 67 billion dollars, and the ongoing world financial crisis, among a few other things.
Specific people are not being held to blame mind you, just Derivatives, Collateralized Debt Obligations and Credit Default Swaps. This is almost like saying that Hitler didn’t do anything wrong, it was National Socialism… and since I mentioned National Socialism… well, never mind, for the time being…
Here’s what really happened. This is how bankers just caused the largest economic collapse in the history of the world. Up until about 2007, Wall Street and their international counterparties got away with running what amounted to a colossal pyramid scheme. They started by selling millions of bundled together mortgages in packages called Structured Investment Vehicles, to the world’s banks, trusts, institutions, and municipal, corporate or government entities. In order to sell these investments to municipalities and other state entities, that are regulated to keep their portfolios conservatively safe, many of those pools of mortgages were packaged into larger, supposedly more stable instruments called Collateralized Debt Obligations (CDO’s) that contained several kinds of debt such as corporate or credit card debt, in addition to mortgage loans. The main theory behind the structuring was that diversification of different kinds of debt within the CDO’s would diminish the overall risk of default.
As the banks endeavored to create more attractive terms and yields to entice further end buyers, the terms of the underlying mortgage loans became ever more egregious to American homeowners. In many instances, cash incentives were awarded to brokers and loan officers at the banks, as a reward for steering borrowers into more profitable sub-prime (predatory) loans, when the borrowers were actually qualified for better terms. In other cases, “liar’s loans” for undocumented or unqualified borrowers were pushed through with predatory terms and rates in order to enhance the yields of the packages, and feed the pyramiding machine.
Many of those aggressive mortgage documents were written in such a way that the interest payment would often double or triple within a few years, often placing the borrowers within an astoundingly unethical debt- to-income ratio of 80% or even more. In other words, the rate of interest, and hence the rate of return, promised on much of that paper, was clearly unsustainable, and designed by the banks to fail sometime in the future after they had packaged and sold the paper to unwitting investors in the secondary market.
To conceal the high risk nature of such mortgage instruments, and the CDO’s into which they were packaged, our largest American banks used three different rating agencies to rate the risk for purchasers. Unfortunately, our own government was conveniently looking the other way, as the banks, who just happened to own the rating agencies, and apparently our government as well, paid the agencies to rubber stamp the mortgages Triple A (AAA) so that they could be bundled into “Triple A” Structured Investment Vehicles and Collateralized Debt Obligations, and sold all around the world.
As a measure to manage the risk, and as a further inducement to facilitate more trades, the banks utilized a device called the Credit Default Swap (CDS), under which for a monthly premium, another institution, bank, or insurance corporation such as AIG, would agree to pay off the debt if the borrowers defaulted. The Federal Reserve and the Office of the Comptroller of the Currency thought it was such a great idea, that they exempted banks from having to keep cash reserves for the Credit Default Swap protected obligations the banks held. This allowed the banks to make more loans with their cash reserves that previously under federal law would have been required to remain in the banks to balance their loan to reserve ratios. That the secretive Federal Reserve led the way in allowing the banks to do such a thing, was no real surprise because the Chairman of the Federal Reserve has always been appointed by the President of the United States from a list of three people supplied by the banks.
The main problem with the scheme was that the institutions providing the Credit Default Swap protection were not even required by government regulators to prove that they had enough reserves to actually pay off the debts in the event that, God forbid, defaults occurred and world’s financial institutions, real estate trusts, worldwide municipal and government entities that bought the Structured Investment Vehicles, CDO’s and Derivatives, started to suffer losses and demanded that Wall Street buy back the bogus “Triple A” rated paper.
One can imagine that if the stalwart individuals who structured this debacle were really sharp, they would have at least thought of a way around the annoying buy- back clauses in the contracts. But you see, they were busy trying to figure out how the CDS, CDO’s and the Derivatives were going to work mathematically. Not even past chairman of the Federal Reserve Alan Greenspan, nor present chairman Ben Bernanke, nor former Goldman Sachs CEO and Secretary of the Treasury Henry M. Paulson Jr., nor former head of the New York Federal Reserve and current Secretary of the Treasury Timothy F. Geithner, or anybody else for that matter, could accurately figure out how these Derivatives, Collateralized Debt Obligations (CDO’s) and Credit Default Swaps (CDS), were supposed to actually work, because the language and the formulas in the instruments was incomprehensible, and there wasn’t nearly enough money in reserve to insure potential losses.
The sad news at the moment… is that less than half of the underlying time bomb mortgages in the United States have yet to adjust dramatically upward and fall into default. Meanwhile, due to the “credit freeze”, many borrowers who thought they would be able to convert to more reasonable loan terms, have been forced to continue to make unreasonably high interest payments compared to their income, draining all of their savings reserve and retirement accounts, while our government and their superiors at the banks, in spite of their rhetoric to the contrary, continue to make it extremely difficult for such borrowers to have their loan terms modified.
How Derivatives, Collateralized Debt Obligations and Credit Default Swaps crushed the economy Part 2
Not long ago, perhaps just to add the little figurines of the bride and groom atop the pinnacle of the many tiered cake celebrating the wedding of our government and their banking betters, the last administration arrogantly turned its back upon the American consumer, and sided with the banks. They did so by using as its tool, a previously little publicized federal entity called the Office of the Comptroller of the Currency, in order to claim jurisdiction and prohibit all State Attorneys General from defending consumers within their states who have been defrauded by banking institutions.
Don’t get me wrong. It’s not as though the last administration has never done anything right with regard to bank regulation. In 2008, out of the desperation of watching banks seize more private property than they could ever hope to maintain much less pay taxes on, the administration raised the ceiling for Fannie Mae and Freddie Mac loans up to $729,000. The resultant refinancing of mortgages within that category, from predatory terms to more traditional terms, helped somewhat to slow foreclosures.
But mortgages above that limit have seen no relief. In other words, America’s mortgage crisis, and economic collapse, is likely only at the intermission. This is happening at the same time that the stock exchanges are delisting solid companies, that have good products such as ground breaking medical devices, simply because the stock market as a whole has fallen, and investors are afraid to invest. Further, our government appears to be assisting big corporations that prey upon society, to crush such smaller innovative companies that enrich and contribute to it. And the next recourse of banks that are seizing more private property than they can maintain, appears to be a plan to start bulldozing whole tracts of empty homes.
Meanwhile, in the midst of this economic turmoil, Congressman Collin Peterson is in the public eye, fighting to gain support for his bill to bring Derivative trading out from the shadows and the unaccountable reaches of the private clearing houses of the banking elite, and onto public exchanges. Peterson’s bill was supposed to bar Derivatives trading in a clearinghouse regulated by the New York Federal Reserve, which he mentioned to the New York Times, is only “a tool of the big banks” that wouldn’t do much to regulate contracts. But Peterson has now come to the realization that his bill will never pass, unless it is materially changed to the satisfaction of his colleagues in Congress - the ones who are accepting large contributions and perks from their bankster superiors.
Treasury Secretary Timothy Geithner recently stated his own preference that Derivative trading should be monitored by the New York branch of the Federal Reserve. Bankers prefer this option, as does Secretary Geithner, and their like-mindedness is understandable, given the fact that for many years, the banks have hand-picked the short list of candidates from which the President picks the Secretary of the Treasury and the Chairman of the Federal Reserve.
Still, Congressman Peterson had much of his act right when he told the New York Times two weeks ago, “The banks run the place… I will tell you what the problem is… they (the banks) give three times more money than the next biggest group. It’s huge the amount of money they put into politics.”
But what Representative Peterson and many others in Congress have got wrong, whether unintentionally or not, is their well publicized perception that Derivative, CDO and CDS trading was the Achilles heel that nearly collapsed the US financial system. They are telling us that it was the secret trading of these instruments, wherein buyers had no clue what actually comprised the portfolios, that brought the entire US financial system and hence the world economy to the brink of collapse. Well, I remember back when the senators and congressmen were telling us that our problems were all on account of that pesky Sub-prime Crisis.
Yes, as I said in Part I of this series, the Derivatives, Collateralized Debt Obligations and Credit Default Swaps were merely utilized in such a way as to crush the world economy. But there is a more fundamental ingredient involved. What brought the US financial system and the economy down, which by the way is still down, and secretly submerging further like a Top Secret science fiction submarine, was not Derivatives and CDO’s and Credit Default Swaps, but simply people - the shadowy people who control international and national banking policy, and the Federal Reserve. Until those people change their behavior, or are brought under control by government, and until our government in Washington D.C. gets out from under their control, there is going to be a lot of suffering in the world, and maybe even World War III.
Unfortunately, we can’t expect President Obama and his administration to make sufficient changes in how they are allowed to behave. His campaign received $69,823,872 from the banks, if you include real estate, according to the Center for Responsive Politics, more than any other group. Senator John McCain only received $60,605,254. Look at this. Obama got a bit more than McCain, and Obama won. It reminds me of most all campaigns of recent memory, in that the winner most always received more money than the banks contributed to the runner up. It is reminiscent of how France lost the war of 1815 when Napoleon Bonaparte and his French Army were loaned less from the international bankers, than the same bankers loaned to the alliance of England, Russia, Prussia and Austria. For one thing, Napoleon’s army couldn’t afford the newly invented rubber boots that kept the feet of Wellington’s allied army dry at Waterloo.
It brings to memory America’s devastating Civil War, which was for the most part instigated by international bankers in England, France and Germany in order to destabilize the United States, and for their own financial gain, and how that war was won by the North after it received more money from international bankers than the South. I really don’t like to get up on the soap box about this… because most people won’t immediately see how this could be possible, given the way history is often incomplete or revised, but the same kind of international profiteering happened in World War I, and then again in World War II.
Just this month, the banks used their lobby in Washington D.C. to prevent the Senate from passing a provision that would have allowed bankruptcy judges to unilaterally reduce the principal amount on mortgages. Last month, the Senate voted, 51-45, against the so-called mortgage cram-down bill, that would have allowed judges to rewrite mortgage terms for struggling borrowers before they faced foreclosure.
This is alarming, because with the banking industry’s destruction of the secondary market for pools of real estate loans, there is no ability for banks to get those loans off their books and make room to initiate new loans. Hence, borrowers with predatory or escalating loan terms, with loans above the Fannie Mae and Freddie Mac limit of $729,000 as mentioned in paragraph two, have nowhere to refinance out of those loans, and so mortgage modifications and reductions are their only option. In other words, with no relief from the banks or congress, homeowners caught within the trap will continue to default, and no amount of phantom stimulus money to the banking elite or the federal bureaucracy will curtail the loss of private property, and the downward pressure on the economy.
Now it may appear to some that I’m wrong, and if so that’s because the banksters, the politicians in their pockets and their unwitting accomplices in Washington, the establishment news media, and millions of folks who are just plain confused about what is really going on, God bless ‘em, are unable to face the painful truth. They are going to be perennially optimistic that the current administration is courageously engineering an economic recovery. That might even make the stock market go up for a while.
After all, we've all seen the market go up due to the shadowed machinations of large corporations, Wall Street and the government. The Dow can go up 2,000 or more points that way, and when it does the experts will say the market was right, and the general consensus of the media and the public mind will believe that things are truly improving, even when fundamental ethical and economic problems have not been addressed, and the rich are becoming fewer but richer, and the ranks of the desolate are growing.
Today, June 18, 2009, as I write this, former Chairman of the New York Federal Reserve, current Secretary of the Treasury Timothy F. Geithner is speaking before congress. He is advocating greater control of the Federal Reserve over non banking institutions, in other words more of those large corporations that are too big to fail. The justification for greater Federal Reserve control, Geithner said, is that our economy was brought to the brink of collapse and we can never allow that to happen again. He urged swift action on the part of congress.
I just don’t see it that way. It appears to me that the economy wasn’t brought to the brink of collapse at all. It was pushed over the edge of collapse, and is still in free fall, although the powers that be are doing a fair job of hiding it. It is ridiculous, and it is saddening for me to think that our elected officials are even entertaining the idea of giving the shadowy tool of the largest banks and corporations, an entity misnomered the Federal Reserve, that is not any more federal than the Federal Express, more power to say which banks and corporations can live or die.
Why is congress entertaining this? What kind of pressure upon them has captured their minds? Can’t they see that these banks and their minions at the Federal Reserve need to be saved from themselves? For how long can a few elected officials and certain unethical folks in corporate boardrooms who are wagging this dog, get away with it? Forever?
Well not necessarily. Not if we have the discipline to stop voting for who we think will be the winner of rhetorical arguments between Republicans and Democrats, or Capitalists and Socialists. Not if we exercise our lawful power to initiate petitions and force a public vote to enable the public funding of campaigns. Not if we thereby take the election of our legislators out of the hands of those who care only about financial profit, and not about what happens to people. And not if we then identify and replace the legislators who have continued to align themselves with their cronies in the banks, insurance companies and big corporations to the detriment of the people they swore to serve.
Ilargi: The full-hour version!
Breaking the Bank
In Breaking the Bank, FRONTLINE producer Michael Kirk (Inside the Meltdown, Bush's War) draws on a rare combination of high-profile interviews with key players Ken Lewis and former Merrill Lynch CEO John Thain to reveal the story of two banks at the heart of the financial crisis, the rocky merger, and the government's new role in taking over -- some call it "nationalizing" -- the American banking system. It all began on that fateful weekend in September 2008 when the American economy was on the verge of melting down. Then-Secretary of the Treasury Henry Paulson, his former protégé John Thain, and Ken Lewis, one of the most powerful bankers in the country, secretly cut a deal to merge Bank of America and Merrill Lynch.
The merger of the nation's largest bank and Merrill Lynch was supposed to help save the American financial system by preventing the imminent Lehman Brothers bankruptcy from setting off a destructive chain reaction. But it became immediately clear that it had not worked. Within days, the entire global financial system was collapsing. In Washington, Secretary Paulson was determined to spend billions of government dollars to prevent the American banking system from dragging the country into a depression.
That October, Lewis, Thain and other top bank CEOs found themselves at an emergency meeting at the Treasury Department. Paulson told the group they had no choice but to accept $125 billion of capital from American taxpayers in order to save the financial system. Initially, Bank of America's CEO Lewis was supportive of the plan. "We are so intertwined with the U.S. that it's hard to separate what's good for the United States and what's good for Bank of America," Lewis tells FRONTLINE.
But some observers now say that Paulson's injection of public capital was the beginning of unprecedented government involvement in the nation's banking system, with consequences few understood. "I think we nationalized the banks in the U.S. on that day," former International Monetary Fund chief economist Simon Johnson says. "The government got a lot of say in how they are run, a lot of constraints, a lot of responsibility. A lot of downside risk was taken on that day."
By December, Lewis was discovering what it meant to have the government as a partial owner. When fourth-quarter losses at Merrill grew to $15 billion, Lewis began to look for a way to get out of the deal. But in tense negotiations with government officials, Lewis was told he had no choice. If he did not go through with the merger, regulators threatened to change the bank's management. "Ken Lewis blinked, the full force of the government is being brought upon him. The rules of the game have changed," Wall Street Journal reporter Dan Fitzpatrick says. "Ken Lewis is on top of the financial services world, but he's not in charge. The government holds all the cards at the end of the day."
FRONTLINE's Breaking the Bank tells the story of Lewis' struggle to survive in this new financial order, where public outrage and government edicts are now as important to banking as shareholders and deposits. With his bank on the brink, Lewis now finds himself the subject of a shareholder revolt, congressional indignation, presidential pressure and the increasingly conflicting demands of private investors and government officials. "This is more than a story about just one man or one bank," says producer Michael Kirk. "This is the story of the most important change in the relationship between government and private business in a generation."