Jacques Cartier Square, Montreal
Ilargi: The US unemployment rate is soaring; over the past half year by about 0.5% per month. Here are the numbers once again:
- Jan 7.6%
- Feb 8.1%
- Mar 8.5%
- Apr 8.9%
- May 9.4%
At last tally U3 unemployment stood at 9.4%, while U6 hit 17.8%. Last week, the White House predicted a 10% U3 rate by the end of the year. I ripped into that prediction on June 16, in The double or nothing moment:
Realistically, though, even if the rate of growth were to come down, it doesn't seem possible to halt it at 10%. If it grows at 0.45% per month, as it has done to date, U3 will end the year at 12.55%. If it would grow at 0.1% per month, which seems highly improbable, it would still surpass Obama's 10%.
A few days ago, for a reason I find as yet hard to fathom (I doubt they read me), the White House deemed it necessary to publicly point out that a 10% unemployment rate (U3) would arrive earlier than it had forecast just days before, word now is that 10% will be "achieved" this summer. Here once more the BIS graphs I showed before. First, the rapid rate of change over the past 18 months:
And this is the picture over the past 60+ years:
This means that sometime this summer (we could well be there already) the American unemployment rate will reach its highest point in well over 60 years. And that is despite all the government efforts to paint the picture in rosier colors than it merits, and to force-feed trillions of dollars into the financial system. We are therefore looking at nothing less than a historic tragedy.
Still, as tragic as this already is, it is not even the main problem. Actually, the way I see it is that there are two main problems. The first is that the numbers are still rising at high speed, that there is neither an end in sight, nor anything that can stop these numbers from rising. The second problem is that the government, and in its wake the media, continues to downplay, embellish and, if you take an objective view, downright lie about the gravity of the situation.
Today, we see that initial jobless claims rose by 15,000 to 627,000 in the week ended June 20, while continuing claims increased by 29,000 to 6.74 million. Those numbers haven't changed much from the past half year, so we can expect the unemployment rate to keep going up at about the same clip as well.
And there's a hidden flaw in these stats, that is long overdue for serious consideration (and inclusion). I'm talking about the people who've gone through their 26 weeks of UI and are kicked off the program. What happens to them? As the following graph from the Department of Labor shows, roughly half the people who claim a first weekly check also claim their 26th and last one. Since 627.000 people filed claims for an initial check, it follows that over 300.000 will be pushed off the edge and no longer be counted. And that this happens every week.
Now, it's of course obvious that we don't have 52 times 300.000 newly jobless per year who don’t get a penny save for welfare. And that’s the sort of picture that's hard to get your fingers behind. What if a third of those who lose the right to claim UI end up falling by the wayside? Seems like a reasonable estimate in the present job climate. And let's not for now talk about those who wind up downgrading to burger flipper and Wal-Mart greeter.
If that is true, and yes, it's a bit of a guess, we may be missing some 5 million people from official unemployment stats. If nothing else, that's another valid reason to look much more closely at U6 numbers instead of U3.
Anyway, I started thinking about all this, again, because of this morning's Bloomberg headline (they changed it since):
US economy: jobless claims rise in sign labor market stagnantThat made me think: Stagnant? What do you mean? What about this picture is stagnant? We are about to break a six-decade negative record, if we haven't already, and you yourselves are reporting on the fact that numbers were worse, not better, than the week before, in a gruesome job market that hurts people right down into misery and bankruptcy.
And you see something stagnant in there? What are you folks smoking, and what planet do you buy it on? Can we at least have some honesty somewhere here, or is Compulsory Liar a job requirement in journalism these days? We are talking about real people, real lives, and real tragedy, and you think it's appropriate to sweep all those human lives, and all their anxiety, under a carpet of your fake reality?
The most disrespectful, and the lowest, thing you can do is to use your media pedestal to try and make these people invisible.
US economy: jobless claims rise in sign labor market stagnant
The number of Americans filing claims for unemployment benefits unexpectedly rose last week, a reminder that companies will keep cutting staff even as the economy stabilizes. Initial jobless claims rose by 15,000 to 627,000 in the week ended June 20, from a revised 612,000 the week before, the Labor Department said today in Washington. A report from the Commerce Department showed gross domestic product shrank at a 5.5 percent annual pace in the first three months of the year.
Recent data show some areas of the economy, such as housing and manufacturing, are seeing a smaller pace of decline, consistent with the Federal Reserve’s projection that the slump is “slowing.” Even so, companies are unlikely to hire until there are sustained gains in demand, meaning a recovery remains dependent on the effectiveness of government stimulus efforts.
“We’re in the prelude to the end of the recession,” said Stuart Hoffman, chief economist at PNC Financial Services Group Inc. in Pittsburgh, who accurately forecast the drop in GDP. “The stimulus will build steam, but it’ll be a pretty tepid recovery.” The loss of jobs “is one factor holding back consumer spending,” he said. Stocks gained as higher oil prices triggered a rally in energy shares. The Standard & Poor’s 500 index closed up 2.1 percent at 920.26 in New York. Treasuries rose, sending the yield on the benchmark 10-year note down to 3.53 percent at 4:30 p.m. from 3.69 percent late yesterday.
Economists forecast claims would fall to 600,000, according to the median of 41 estimates in a Bloomberg News survey, from a previously reported 608,000 a week earlier.
The number of people collecting unemployment insurance increased by 29,000 in the prior week, to 6.74 million. The four-week moving average of initial claims, a less volatile measure, rose to 617,250 from 616,750.
The jobless rate among people eligible for benefits held at 5 percent in the week ended June 13. The June 13 data coincides with the week Labor conducts its monthly payrolls survey, which the department is due to report on July 2. Thirty-six states and territories reported a decrease in new claims for the week ended June 13, while 17 had an increase. Some states that don’t ordinarily report layoffs related to the end of the school year saw larger than expected job losses in education services, Labor said, declining to be specific.
The contraction in first-quarter GDP, which was less than the 5.7 percent drop estimated last month, capped the worst six- month performance in half a century, the revised figures from Commerce showed. The world’s largest economy shrank at a 6.3 percent annual rate from October to December. The biggest slump in business investment and inventories since records began in 1947 and the worst contraction in homebuilding since 1980 paced the decline last quarter. The housing recession, now in its fourth year, is showing signs of abating. Builders broke ground on more homes than forecast in May, with single-family starts posting a third straight gain, Commerce figures showed earlier this month.
Business investment may also be on the mend. Orders for non-defense capital goods excluding aircraft, a proxy for future spending on new equipment, jumped in May by the most since 2005, Commerce reported yesterday. Some companies are seeing signs of stabilization. Nucor Corp., the second-largest U.S. steelmaker, may boost plant operating rates to as much as 60 percent of capacity in the third quarter as customers use up inventories, Chief Executive Officer Dan DiMicco said.
“We have seen distributors begin to order at a level consistent with real demand,” DiMicco said in a Bloomberg television interview yesterday in New York. Still, “we will not be happy, and our competitors will not be happy, until we are north of the 80 percent levels again,” he said. Fed officials said in a statement at the end of their two- day meeting yesterday said “the pace of economic contraction is slowing.” Consumer spending “remains constrained by ongoing job losses, lower housing wealth and tight credit.”
At the same time, the slack in the economy means “inflation will remain subdued for some time,” they said. Part of that slack is being created by the bankruptcies of General Motors Corp. and Chrysler LLC. Earl Hesterberg, chief executive officer of Group 1 Automotive Inc., the owner of 99 U.S. and U.K. dealerships, this month said car sales remain weak. “We now have eight or nine months of bouncing along the bottom,” Hesterberg said in an interview, referring to the industry. “Really we don’t see much difference from month to month.”
Still, other areas show signs of improvement this quarter. Retail sales rose in May for the first time in three months, government figures showed. The economy may not yet need a second stimulus after the administration’s $787 billion initiative, which includes tax cuts and spending on infrastructure, President Barack Obama said at a White House news conference this week. “I think it’s important to see how the economy evolves and how effective the first stimulus is,” the president said.
US economy contracts by revised 5.5%
The US economy continued to contract in the first quarter of this year, but at a slower pace than previously thought, official figures showed on Thursday. Separately, the labour department said that new claims for unemployment benefits grew more than expected last week, offering a stark reminder that even as the economy turns around the stricken labour market could be slow to follow. Revised commerce department figures revealed that US gross domestic product declined by an annualised rate of 5.5 per cent in the first three months of the year. That was better than economists expected and a smaller contraction than the original estimate of a 6.1 per cent contraction and last month’s estimate of a 5.7 per cent decline.
Output is slowly beginning to rekindle in the US economy, which has been mired in its worst recession in the last 50 years. The first quarter result, while grim, was an improvement from the end of 2008 when GDP declined by 6.3 per cent, the steepest fall since 1982. Economists expect to see more significant improvement in the second quarter of this year. On Wednesday the Federal Reserve said in its Federal Open Market Committee statement that economy activity was likely “remain weak for a time” but that sustainable economic growth would then resume gradually while inflation remains “subdued”. Meanwhile the Organisation for Economic Co-operation and Development improved its outlook for the US and predicted the economy would grow by 0.9 per cent next year. Housing and manufacturing have shown signs of life lately. Home prices and sales have begun to stabilise in some areas and businesses have begun to ramp up their capital investment with more orders for durable goods.
However, analysts fear that rising joblessness could slow the recovery. The labour department said on Thursday that initial jobless claims rose by 15,000 to 627,000 last week. That was more than expected and boosted the four-week average to 617,250. The number of Americans continuing to claim unemployment benefits rose in the second week of the month to 6.74m, up from 6.71m the prior week. “With initial claims still very high at above 600,000, it is unlikely that new hiring has picked up in any meaningful fashion,” said Joshua Shapiro, chief US economist at MFR. “More probable is that long-term unemployed are starting to fall off the rolls as the duration of their unemployment benefits reaches the statutory limit.” The US unemployment rate rose to 9.4 per cent last month and is expected to climb to 9.6 per cent in June.
Building America With Obama Bonds Signals Munis’ Fall
Barack Obama may be the worst thing that ever happened to tax-exempt bonds and, so far, states and municipalities are loving it. Build America bonds, taxable securities that pay 1 percentage point more in interest than corporate debt on average, are such a hit with investors that the government is already considering expanding the program, according to John J. Cross, the Treasury’s tax legislative counsel. Municipalities sold $14.4 billion of the securities and Barclays Plc analysts predict the amount may grow 10-fold because the federal government helps pay the bonds’ interest.
The debt -- which finances everything from roads to schools to electric lines -- is helping Obama create jobs and may allow him to rein in the municipal market, where $2.7 trillion of bonds are outstanding, according to Ann-Ellen Hornidge of Mintz Levin Cohn Ferris Glovsky & Popeo PC, a law firm in Boston. Presidents since Franklin D. Roosevelt have tried to tax the interest payments from municipal bonds without success.
“There is a giant experiment going on here,” said Hornidge, whose firm advised municipalities on $4.3 billion of debt sales last year. “The Treasury has never liked tax-exempt bonds, and I think you can assume they have tax-exempt bonds in their crosshairs.” Tom Gavin, a spokesman for Obama, said in March that the president planned a task force to “rebalance the federal tax code,” which created the current municipal market.
Build America bonds, part of the president’s $787 billion stimulus plan, helped municipalities raise cash after the seizure in credit markets that started in August 2007, increased yields on debt due in 20 years to 6.01 percent, the highest since 2000, according to the Bond Buyer’s 20 General Obligation Bond index. Sales of fixed-rate municipal bonds fell 17 percent to $281.1 billion in 2008 from $338.2 billion the previous year, according to data compiled by Bloomberg.
The program is attractive to towns and cities because the federal government pays borrowers 35 percent of the interest cost if they issue taxable debt instead of tax-exempt securities for capital projects. The Nebraska Public Power District sold $50 million of the notes this month to overhaul some of its 5,000 miles of electric transmission lines. The securities -- $17.5 million of 6.6 percent revenue bonds maturing in 2026 and $32.9 million of 7.4 percent debentures due in 2035 -- saved 0.61 percentage point in annual interest because of the federal subsidy, said Christine Pillen, the district’s deputy assistant treasurer in Columbus. “It’s just bottom-line cheaper money,” she said.
More than 110 borrowers from New Jersey to California sold the securities since the first sale in April. Strategists at London-based Barclays forecast about $150 billion in taxable municipal securities will be issued before the program expires at the end of 2010. Build America bonds are part of Obama’s efforts to lift the economy out of the deepest recession since the 1930s. The government and the Federal Reserve have agreed to lend, spend or guarantee $12.8 trillion to support the financial system. The jobless rate rose to 9.4 percent in May, the highest since 1983. Obama’s spokesman, Robert Gibbs, said this week that it will likely reach 10 percent.
The Plainfield Fire Protection District in Plainfield, Illinois, raised $8.2 million with 6.625 percent notes in April to help finance a 65,000-square-foot administration and training center. The project is creating 150 construction jobs over 15 months, according to Mark Carlson of Carlson Brothers Inc. the Joliet, Illinois-based construction manager. The Treasury may seek congressional authorization to extend the program instead of letting it expire at the end of next year, according to Cross, who joined the Treasury as tax counsel in 2006 from the law firm Hawkins Delafield & Wood LLP in Washington. It could also be expanded, letting states sell the bonds to refinance tax-exempt bonds, he said.
“The obvious next step in the whole thing would be: Should you make a program like this permanent?” Cross said at a bond market conference in New York on June 8 sponsored by the Securities Industry and Financial Markets Association. “Maybe it’s more successful than originally assumed.” Alan Krueger, a Princeton University economist appointed assistant Treasury secretary by Obama this year, said the department will monitor the Build America bonds “and as we get closer to 2010 make a decision about whether we would seek to have them extended.” It is “premature to make a judgment” because the program is only two months old, he said in an interview with Bloomberg News.
The Treasury prefers the taxable bonds because tax-exempt debt mostly benefits investors in higher tax brackets, said Krueger, who also testified last month at a House Ways and Means subcommittee hearing on the programs. Taxable municipal securities are more “efficient” than tax-exempt, he said. Individuals with gross incomes of more than $500,000 a year claimed 44 percent of the $72 billion in interest on municipal bonds that wasn’t taxed in 2006, according to the most recent data from the Internal Revenue Service. Of the 143 million household tax returns filed in 2007, 6.3 million claimed they received $76 billion in tax-exempt interest, up from 6 million and $73 billion in 2006.
“The federal government, like a bad house guest, is going to be reluctant to leave this market after 2010,” said Christopher Mier, a municipal bond analyst at Loop Capital Markets in Chicago. The Build America program would allow the Treasury to control how much gets allocated to subsidies during any given year, he said. In a budget forecast in May, the administration said the government would provide $340 million next year for muni interest payments. The administration is underestimating the amount of the bonds being sold and overestimating tax collections, according to Philip Fischer, a municipal bond strategist in New York at Merrill Lynch & Co., a unit of Charlotte, North Carolina-based Bank of America Corp.
Fischer estimates the Treasury will pay about $240 million for the first $13.5 billion of bonds, subsidizing securities that have an average coupon of 7.5 percent and taxing that interest at an average 11 percent. Most of the buyers are institutions such as mutual funds and pension funds that don’t pay taxes, he said. If sales reach $80 billion, the cost of the subsidies could exceed $1 billion a year, he said. “It’s quite good for the issuers and it brings to the market a new source of capital, but it potentially has costs that were larger than originally estimated,” Fischer said.
Even with the savings, borrowers may not be getting the best rates. New York’s Metropolitan Transportation Authority sold $750 million of the securities in April. The debt surged 8.6 cents on the dollar within two weeks, driving the yield down to 6.6 percent from 7.34 percent, according to the Municipal Securities Rulemaking Board. The $273 million in 6.875 percent taxable bonds the New Jersey Transportation Trust Fund sold on May 25 to yield 7 percent have gained about 5 percent in price, according to MSRB data. Muni bonds maturing in more than 22 years lost 3 percent in the same period, according to Merrill Lynch & Co. index data.
Barney Frank, chairman of the House Financial Services Committee, says there’s “zero chance” Congress would permit the muni exemption to be eliminated. The Massachusetts Democrat said in an interview last month that Build America bonds can co- exist with the rest of the market. “I don’t see one as displacing the other,” said Frank, who has sought to reform the muni market with new regulations for credit rating companies and financial advisers. He has most of his $896,000 in savings invested in tax-exempt bonds sold in Massachusetts, according to financial disclosures.
“It’s been a beneficial program that has supported municipal bond issuers during this time of economic dislocation,” said Leslie Norwood, an associate general counsel at the Securities Industry and Financial Markets Association in New York. The group supports it “with the understanding that it’s a temporary program.” Interest on state and local government bonds sold for public purposes has been exempt from federal levies since the Constitution was ratified and remained so after the 16th Amendment was approved in 1913 creating the federal income tax.
Presidents and lawmakers have tried to roll back the exemption for decades. Since the 1960s, Congress has passed legislation prohibiting use of public debt for racetracks, massage parlors, golf courses and other private purposes. The House Ways and Means Committee initially proposed subsidizing taxable municipal bonds in 1969. President Jimmy Carter and Bill Clinton also embraced the idea. Municipalities opposed the efforts as well as alternatives that give the federal government more control over state and local capital spending, said Jeffrey Esser, the executive director of the Government Finance Officers Association in Chicago.
There were no hearings on Build America bonds before they debuted, so there was no opportunity to mount opposition, Esser said. States and local governments already sold some taxable debt for private projects that don’t qualify for the tax- exemption. Investors are reaping the Build America rewards. The Utah Transit Authority, which is rated AAA, sold $261.4 million of 5.94 percent Build America securities maturing in 2039 on May 21 that yielded 6.41 percent, or 165 basis points more than Treasuries of similar maturity. Redmond, Washington-based Microsoft Corp., the world’s largest software maker, also sold bonds rated AAA in May. It paid a yield of 5.65 percent, or 90 basis points, more than Treasuries. A basis point is 0.01 percentage point.
Utah paid a higher yield even though Moody’s Investors Service says the 10-year default rate for investment grade municipal bonds it rates is 0.1 percent. For corporate debt, the overall default rate was 9.7 percent as of 2007, according to the New York-based company. “There’s nothing to say the capital market can’t work for municipal bonds without an exemption,” said Mark Robbins, an associate professor of public policy at the University of Connecticut in West Hartford. “It looks like a whole new era in municipal finance if this thing catches on.”
Britain facing biggest deficit in Western world, warns OECD
Hopes that the biggest post-war economic slump will soon end have been dashed after the rich world's leading economic institution slashed its forecasts for economic growth and warned that Britain next year faces the worst deficit in the industrialised world. In a further blow for Alistair Darling, the Organisation for Economic Co-operation and Development also warned that the Government may have to pump more than £130bn extra into the banking system. Most economic statistics released in recent months have been better than expected, including the CBI's distributive trades survey yesterday, which was the strongest for a year.
However, the OECD downgraded its forecast for UK growth this year to a contraction of 4.3pc – compared with a previous forecast of -3.7pc. The cut is significant, since the OECD chose on the other hand to increase its growth forecast for the world's leading industrialised economies from -4.3pc to -4.1pc. It added that the 30 member OECD would grow by 0.7pc next year, while Britain would stagnate, not growing at all. The bearish forecast comes as something of a surprise, since many economists expect the UK to be among the first countries to emerge from technical recession, aided by the weakness of the pound and the Bank of England's decision to pump £125bn or more cash into the financial system through quantitative easing.
However, the OECD said that not only was Britain's fiscal position far weaker than its neighbours, following many years of high borrowing by Gordon Brown, the UK was also more vulnerable to a consumer slowdown associated with falling house prices. The Paris-based institution said the Government's fiscal deficit next year would climb to 14pc of gross domestic product – higher than anywhere else in the OECD, including Ireland and Iceland. The report urged the Bank of England to keep "the [interest] rate as close to zero as possible up to end 2010." It also warned that more taxpayers' money may have to be poured into the financial system, saying: "further bank losses may well require substantial further capital injections by governments." It said the UK may have to spend a further 3-9pc of GDP – equivalent to £45bn-£135bn.
Irish economy is the sickest of them all, IMF study claims
Ireland is suffering the severest recession of any advanced economy, the International Monetary Fund said in its annual health check. The country is in “the midst of an unprecedented economic correction” with losses at its banks predicted to swell to €35bn (£30bn) over the next two years. “The stress exceeds that being faced currently by any other advanced economy and matches episodes of the most severe economic distress in post-World War II history,” the IMF said in its report. The lender forecast that Ireland's economy would contract by 13.5pc between 2008 and 2010, and start to grow around 1pc in 2011 before it stabilizes around 2.5pc for several years.
Despite the bleak view, the fund said Ireland was taking the right steps to counter the economic and financial “shocks”. Ashoka Mody, head of the IMF mission to Ireland, said there was “absolutely no reason” to think that the country will default on its debt. The collapse of the Irish property markets has led to mounting bad debts at Irish lenders, led by Bank of Ireland and Allied Irish Banks. Home loans are expected to soar further over the next few years as the recession deepens and the IMF said the losses faced by the banks are equivalent to about 20pc of GDP. Brian Lenihan, the Finance Minister, has proposed creating a "bad bank", known as the National Asset Management Agency, to buy up such loans as a step toward restoring lending and reviving the economy. “We must ensure we have a viable banking system to protect jobs and our economy,” Mr Lenihan said after the publication of the IMF report.
“The one way of doing that is to clean up the balance sheets of the banks by removing the impaired assets and returning them to normal functionality.” The IMF expects Irish GDP to shrink a cumulative 13.5pc in the three years to 2010. It also forecast that Ireland’s budget deficit may widen to 12pc of GDP this year, four times the European Union limit and above the government’s 10.75pc projection. The state will only bring the deficit back to the EU limit in 2014, a year behind target, it said. Ireland had its credit rating lowered to AA from AA+ this month by S&P, which cited the nation’s rising bill for propping up its banks. Fitch Ratings in April downgraded the country to AA+ from AAA. Standard & Poor’s expects Irish house prices to fall 13pc in 2009 and a further 10pc in 2010. Prices have already dropped 20pc from their peak in early 2007 after almost quadrupling over the previous decade.
Chancellor Merkel Visits the Debt President
The occupant of the White House may have changed recently. But the amount of ill-advised ideology coming from Washington has remained constant. Obama's list of economic errors is long -- and continues to grow. The president may have changed, but the excesses of American politics have remained. Barack Obama and George W. Bush, it has become clear, are more similar than they might seem at first glance. Ex-President Bush was nothing if not zealous in his worldwide campaign against terror, transgressing human rights and breaking international law along the way.
Now, Obama is displaying the same zeal in his own war against the financial crisis -- and his weapon of choice is the money-printing machine. The rules the new American president is breaking are those which govern the economy. Nobody is being killed. But the strategy comes at a price -- and that price might be America's position as a global power. In his fight against terrorism, Bush had the ideologue Dick Cheney at his side. "We must take the battle to the enemy," he said -- and sent out the bomber squadrons toward Iraq on the basis of mere suspicion. The result of the offensive is well known.
Obama's Cheney is named Larry Summers. He is Obama's senior-most economic advisor, and like the former vice president, he is a man of conviction. The financial crisis may be large, but Summers' self-confidence is even larger. More importantly, President Barack Obama follows him like a dog does its master. The crisis, Summers intoned last week at a conference of Deutsche Bank's Alfred Herrhausen Society in Washington, was caused by too much confidence, too much credit and too many debts. It was hard not to nod along in agreement. But then Summers added that the way to bring about an end to the crisis was -- more confidence, more credit and more debt.
And the nodding stopped. Experts and non-experts alike were perplexed. Even in an interview following the presentation, Summers was unable to supply an adequate explanation for how a crisis caused by frivolous lending was going to be solved through yet more frivolity. Summers has no misgivings, and doesn't recognize those held by others. The fact that German Chancellor Angela Merkel recently gave a speech in which she was critical of the US economic stimulus program did not impress Summers. In our conversation, he said he thought Merkel's position was a tactical one.
"She only says that out of domestic concerns," he said and rolled his eyes in disapproval. The battle must be taken to the enemy. Just as the US public initially rallied behind the war President Bush -- even to the point of re-electing him -- Americans have now thrown their support behind the debt president Obama. The mistakes of the Bush administration are now widely accepted. The mistakes of the Obama administration are still not recognized as such. They are seen as the truth.
Mistake number one: It's not as bad as it seems. The US amassed much more debt during World War II, it is often said. That, though, is not true. According to conservative forecasts, Obama's policies could end up being three times as expensive as US expenditures during World War II. If one calculates using today's prices, America spent $3 trillion for the war. Obama's budgetary calculations for the decade between 2010 and 2020 assume additional debt of $9 trillion.
Second: It is generally assumed that the money is part of an effort to resuscitate the crisis-plagued economy and is thus serving a good purpose. The truth of the matter is that the bulk of the borrowed money will be used to finance the normal US budget. American borrowing in 2009 comprises about half of Obama's budget. The country is living beyond its means -- and it still would have been even if it weren't for the economic crisis.
The third error: Many believe that when the crisis ends, borrowing will automatically fall. The truth is that it could climb afterwards. The graying of American society creates a new fiscal policy challenge for the country that so far hasn't been reflected in any budget plan. According to calculations by the International Monetary Fund, Washington would need to spend several times more than it is now just to service current pension entitlements and the free, state-funded medical care provided to senior citizens. In addition, Obama has promised to introduce healthcare coverage for America's close to 46 million uninsured. That would be like adding a country the size of Spain to the US.
Fourth: The world believes that the US is borrowing money from capital markets. It is often said that the Chinese and the Japanese will buy government bonds. But the truth of the matter is that trust in the gravitas and reliability of the United States has suffered to such a great degree that fewer and fewer foreigners are purchasing its government bonds. That's why the Federal Reserve is now buying securities that it has printed itself. The Fed's balance sheet has more than doubled since 2007, making the US central bank one of the world's fastest-growing companies. The purpose of this company, though, is to create money out of thin air.
Fallacy No. 5: The additional money is harmless because the economy is starting to pull together again and there is no threat of inflation. The truth is that the quiet on the inflation front is deceptive. The hot money is accumulating in people's savings accounts and in the balance sheets of banks that aren't keen to lend money at the moment. The supply of money has increased by 45 percent in the last three years and there has not been a corresponding rise in hard assets or production. That imbalance will eventually make itself felt in the form of inflation.
The dollar, which has already lost 40 percent of its value against the euro since 2000, would then devaluate and its reputation would be further diminished. The world's reserve currency could be pushed through the floor by the shockwaves. At that point, those waves would also wash over the rest of the world. Then people would have to look back and say that the means the US used to fight the economic crisis in fact paved the way for a currency crisis. The German response to the excesses of the Bush era was refusal and obstinacy. Gerhard Schröder refused to go to war in Iraq with America and he organized a European resistance front the reached from Moscow to Paris. Germany still hasn't provided its response to the Obama administration's fiscal policy excesses. Perhaps its time for Merkel to take her cue from Schröder.
Britain's government debt: That’ll be £2.2 trillion, please
Today is Cost of Government Day. Average taxpayers in Britain now have to work almost half the year – 176 days – to pay their share of the cost of running Gordon Brown’s administration. Every penny we have earned since January 1 has gone to feed the state leviathan. It is only from today that, at last, you have started working for yourselves and your families. More than five months of our servitude – from New Year until May 14 – were spent working to pay taxes, such as income tax, national insurance, council tax, VAT and many others including the notorious “stealth” taxes.
But all that effort was still not enough to feed the monster, and when he had run out of our money, the Chancellor, Alistair Darling, had to borrow – at £20? million an hour – to pay his bills.So for the past six weeks, day in, day out, we have been working to fund that borrowing. No wonder Mervyn King, the governor of the Bank of England, warned yesterday of the “truly extraordinary” scale of deficits. We have had to put in 10 days’ more work than last year in order to keep the Government afloat.
It is not just the money that Brown and Darling borrowed to bail out the banks. It is the fact that every bit of public spending – national and local – is rising faster than taxpayers’ incomes. In 1999 – when Brown had finished with New Labour’s 1997 election pledge to match Conservative budgets – government spending was just 36 per cent of the nation’s income. Now it is a third more – 47.5 per cent this year – and rising. Not that you can believe official figures. The International Monetary Fund thinks things will be far worse. Our national income will take a knock, and more people will be out of work and receiving benefits from the Government rather than paying it taxes. That makes it probable that public spending will be more than 50 per cent of our income – sending Cost of Government Day into July.
It amounts to a huge surge in the burden of government for those of us trying to earn a crust – twice that in France, and even more than when Britain was reeling from the oil-price shocks in the early 1970s. In fact, it’s not far off the 1940s, when at least we were paying off the cost of saving the world from Hitler. But then Alistair Darling’s budget predictions have proved just as over-optimistic as his predecessor’s. In November 2008, despite all the drama in the banking industry, his forecasts seemed almost rosy. Now, he expects the Government’s budget shortfall this year and in 2010 to be four times that prediction, with 2011 and 2012 about five times bigger. The gap between what the Government expects to spend and what it actually brings in has risen five-fold, from £120?billion to £608?billion in the space of six months.
At that rate, according to the Institute for Fiscal Studies, it will take 23 years to return government borrowing to anything like normal levels – Gordon Brown’s famous “golden rule”. And of course, every year you borrow keeps adding to what you owe. Right now, the Government calculates that it owes a total of £2.2 trillion – about £144,000 per household. The figure has trebled since the bank bail-outs. Some traders are beginning to wonder if Britain can actually pay its debts. If they start pulling out, then we really are bust.
And the real picture is worse, because the Government does not record all its debts on the official books. Take all those new schools and hospitals being built on tick at a future cost equal to £5,600 per household; Network Rail’s borrowing, another £1,000 per household; nuclear decommissioning, another £2,750; those generous civil service pensions – a future cost of almost £50,000 per household; not to mention the state pension. Add those in, and the real national debt is twice the official figure.
Do not imagine that all this extra spending and borrowing are the fault of the financial crisis and the need to counter recession – interest payments, social benefits and suchlike. A good half of it is simply feeding the Government’s pre-election spending splurge. And do not believe the spin that the Conservatives would make 10 per cent cuts to balance the books. They have pledged not to cut education, the NHS, or overseas aid, and they are stuck with the debt repayments and the EU’s demands; even if they cut 10 per cent off everything else, it amounts to just 3 per cent overall. They would be shrinking next year’s spending bill from £717?million to £695 million. That is still more than Labour has ever spent.
“What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom,” wrote Adam Smith. If your family had debts as big as the Government’s, you would know what you had to do:spend less or earn more – and preferably both. The Government won’t earn more by putting up taxes. The Centre for Economic and Business Research estimates that the proposed 50 per cent top tax rate will make 25,000 people leave the UK, costing 140,000 jobs and reducing revenues. Britain is already overtaxed.
And the private sector has borne nearly the whole burden of the economic downturn. Wages have fallen, and unemployment is heading up to 3?million. But the public sector has been largely unaffected. That is why people are so angry when they see how much of their 176 days’ effort is simply wasted – or abused, as with MPs’ expenses. The task is to reduce public expenditure without it showing. A freeze on spending and recruitment for a couple of years, then pegging it to inflation, would be surprisingly effective at re-balancing the books. (If spending since 1997 had risen no faster than inflation, we would be spending a third less than we do now, and could abolish income tax, VAT, and council tax entirely.)
Another useful move would be to publish online every cheque the Government signs, so we can see what it is spending and where. Private firms would be able to show what they could do more cheaply. And citizens could point out where they think their money is being scandalously wasted, as with the £300 million on departments’ service contracts, wasted through bad management, or the £200?million lost through bad procurement of hospital buildings.
Then there are the IT projects, such as the NHS records system, that are billions over budget and months or years late (the Department of Employment alone spent £59 million on a computer system that did not work). Exposing such wasteful incompetence would help eliminate it. And do we really need to spend tens of billions on ID cards? Along with the Royal Mail, we can privatise the Tote, Channel 4, BBC Worldwide, air traffic control and various utilities, which would bring in a handy £20 billion.
And we can get rid of central bureaucracy by measures like simply handing head teachers their bit of the budget and telling them to get on and spend it as they see fit, rather than as Whitehall bureaucrats think they should. The same could go for health – give the budget to patients or their doctors, not to layers of bureaucracy such as the strategic health authorities. And the quangos need to be culled again: they have grown in number, cost and power under Brown. For what gain?
Meanwhile, dozens of local government officers are now paid more than £100,000 and retire on generous index-linked pensions – something now almost unknown among the private-sector employees that work to support them. As this newspaper reported yesterday, PricewaterhouseCoopers claims that 96 per cent of companies regard final salary schemes as unsustainable. About a third of Child Benefit is little more than pin-money for the middle classes. It should be given to the poorest. By taking everyone on the minimum wage out of tax entirely, we would see a stampede into work by those who we presently make better off on benefits.
Another huge saving would be to speed up the plans to raise the pension age, reflecting improvements in health and longevity. This is by far the largest spending change one could make. Yes, many people would not like it – though others would be delighted to avoid forced retirement at 65. But it would be hugely symbolic – a return to honesty in the public finances, and an end of the idea that we can all live at someone else’s expense. If this recession has taught us anything, it should have taught the politicians that.
Ron Paul: Obama 'Goal' Is Economic Collapse
U.S. Rep. Ron Paul, R-Texas, says he was dismayed that Congress passed the war supplemental appropriations bill so easily last week. “An economic collapse seems to be the goal of Congress and this administration,” Paul said during his weekly radio address Monday. “Washington spends with impunity, domestically bailing and nationalizing basically everything they can get their hands on,” Paul said. Mocking the idea that Obama was a “peace candidate,” Paul pointed out that hisadministration will be sending another $106 billion it doesn't have "to continue the bloodshed in Afghanistan and Iraq without a hint of a plan to bring American troops home."
Paul noted that many of his congressional colleagues who previously voted with him in opposition to every war supplemental request under the Bush administration seem to have changed their tune. He maintains that a vote to fund the war is a vote in favor of the war. “Congress exercises its constitutional prerogatives through the power of the purse,” Paul said. “As long as Congress continues to enable these dangerous interventions abroad, there is no end in sight: that is until we face total economic collapse.”
Paul noted that, as Americans struggle through the worst economic downturn since the Great Depression, the foreign aid and International Monetary Fund appropriations in the spending bill passed last week can be called an international bailout: The emergency supplemental appropriations bill sends:
- $660 million to Gaza
- $555 million to Israel
- $310 million to Egypt
- $300 million to Jordan
- $420 million to Mexico
- $889 million to the United Nations for so-called “peace-keeping” missions
- $1 billion overseas to address the global financial crisis outside U.S. borders
- $8 billion to address a potential pandemic flu, which he said could result in mandatory vaccinations “for no discernable reason other than to enrich the pharmaceutical companies.”
Perhaps most outrageous, Paul said, is the $108 billion loan guarantee to the IMF. “These new loan guarantees will allow that destructive organization to continue spending taxpayer money to prop up corrupt leaders and promote harmful economic policies overseas. Not only does sending American taxpayer money to the IMF hurt citizens here, evidence shows that it even hurts those it pretends to help.” Paul said that IMF loans require policy changes called “structural adjustment” programs, which amount to “forced Keynesianism.”
“This is the very fantasy-infused economic model that has brought our own country to its knees,” Paul said, “and IMF loans act as the Trojan horse to inflict it on others." Leaders in recipient nations tend to become more concerned with the wishes of international needs than the needs of their own people, he said. “Argentina and Kenya are just two examples of countries that followed IMF mandates right off a cliff. The IMF frequently recommends currency devaluations to poorer nations, which has wiped out the already impoverished over and over.”
Paul noted a long list of brutal dictators the IMF happily supported and propped up with loans that left their oppressed populaces with staggering amounts of debt with no economic progress to show for it. The continued presence of U.S. forces in Iraq and Afghanistan does not make America safer at home but, in fact, undermines national security, he said. “We are buying nothing but evil and global oppression by sending [our] taxpayer dollars to the IMF — not to mention there is no constitutional authority to do so.”
Wall Street Begins Campaign to Thwart 'Populist Overreaction'
Wall Street’s largest trade group has started a campaign to counter the “populist” backlash against bankers, enlisting two former aides to Treasury Secretary Henry Paulson to spearhead the effort.
In memos of confidential meetings with top financial executives, the Securities Industry and Financial Markets Association said it began this month the “execution phase” of the operation, which pledges to “embrace change” and accountability. The plan targets policy makers and the media in New York, London, Washington and Brussels and calls for a “city-by-city, grass roots” approach.
The securities industry “must be perceived as part of the solution, which will allow it to better defend against populist overreaction,” the documents, prepared for a June 17 meeting of SIFMA’s board, said. The board meeting minutes and staff-written papers, obtained by Bloomberg News, outline the program crafted by polling, lobbying and public relations companies paid at least $85,000 a month. The memos provide a glimpse, in often candid language, into how Wall Street is grappling with its pariah status.
“It is imperative that in this historic period of reform, the industry be recognized as playing a positive role in seeking change and providing solutions to the problems we face,” one of the documents said. “There is currently widespread skepticism about the industry’s commitment to this needed change.” The internal papers call for using regional securities firms, many of which have escaped notoriety in the financial crisis, to push the industry’s message with their local members of Congress. The plan notes that brokers across the country can also be used.
“The foot power of the private client group has proven to be effective in blunting populist messages in the past,” said board member Paul Purcell, chief executive officer of Milwaukee investment firm Robert W. Baird & Co., according to the minutes of one meeting. To advise on the strategy, the trade group turned to a bipartisan roster of consultants. Such advice doesn’t come cheap and SIFMA is discussing dipping into its reserves to cover some of the costs, according to one memo.
Michele Davis, Paulson’s former spokeswoman, and Jim Wilkinson, his former chief of staff, are among those leading the effort. SIFMA is paying their firm, Brunswick Group LLC, a monthly retainer of $70,000, the documents show. Both Davis and Wilkinson declined to comment. Paulson left office in January. Assisting them is a Democratic polling company, Brilliant Corners Research and Strategies, which is paid $5,000 a month. It is run by pollster Cornell Belcher, who worked on President Barack Obama’s campaign. BKSH & Associates Worldwide, a lobbying firm chaired by Republican strategist Charlie Black, signed on for $10,000.
In response to questions about the push for an image makeover, SIFMA President Timothy Ryan said the organization has taken a lead advocating for a federal systemic risk regulator and has pushed for increased government power to wind down financial firms that don’t own banks. He also touted the group’s recently issued recommendations on executive compensation. “This effort, which is not uncommon for a trade association, is designed to ensure our ideas for improved accountability, oversight and transparency are heard by the widest possible audience,” Ryan said.
The industry has “a duty to help craft a solution, so we’ll continue leading by example in our efforts to properly safeguard our financial system and serve the needs of the overall economy, local communities and individual investors,” he added. SIFMA represents about 600 securities firms, brokerages and asset-management companies. It counts among its members the biggest U.S. banks, including Goldman Sachs Group Inc., Citigroup Inc. and JPMorgan Chase & Co., which have received capital injections from the $700 billion Troubled Asset Relief Program. Bloomberg Tradebook, a broker-dealer subsidiary of Bloomberg News’s parent Bloomberg LP, also belongs.
While financial companies’ lobbying clout has been reduced in the crisis, SIFMA’s memos said that Wall Street can’t afford to be left out as the Obama administration and Congress push for increased oversight, executive-pay limits and other restrictions likely to affect the industry for decades. “The mess is so big that we all have to work together,” minutes from one meeting said. The group’s polling “indicated that there is a lot of anger out there and feelings that the industry is not focused,” the minutes said. While “Wall Street and CEOs” received low scores, local banks and brokers got better marks.
The outside consultants join SIFMA staff for a daily 10:00 a.m. conference call, “given the importance, complexity and real-time nature of the campaign style-implementation,” according to one of the memos. Still, that kind of approach may not be enough for Wall Street to lift its reputation, said Bill Brown, a visiting professor at Duke University School of Law in Durham, North Carolina. “It’s right for them to try to come back from this, but they have to realize that they are not going to be reborn into what they were,” said Brown, who was global co-head of listed derivatives at Morgan Stanley. “The best P.R. comes from doing good, not from having to manage your image.”
Too Big to Fail: Breaking Up These Big Boys Is an Essential Battle for Our Time
With the possible exception of the health care fight, there is no more important battle for the future of our economy and democracy than breaking up these too-big-to-fail financial institutions. Limiting their size, their economic power, and their political power is urgent and absolutely essential. The problem is that these Wall Street behemoths have such incredible power that very few politicians want to take them on.
The Obama administration, while they proposed some reasonably good regulatory changes in terms of consumer protections and dealing with the so-called "dark markets" (the derivatives and credit default swaps that were kept away from regulators over the past dozen years), appears to have for now decided they want to take a pass on the fight. Larry Summers, according to a recent story in the NYTimes, says that there is no going back to the days of small banks: "I don't think you can completely turn back the clock." The President himself, in a New York Times magazine interview, seemed focused more on regulation than on breaking up the big banks:Q: There was this great debate among F.D.R.'s advisers about whether you had to split up companies - not just banks - you had to split up companies in order to regulate them effectively, or whether it was possible to have big, huge, sprawling, powerful companies - even not just possible, but better - and then have strong regulators. And it seems to me there's an analogy of that debate now. Which is, do you think it is O.K. to have these "supermarkets" regulated by strong regulators actually trying to regulate, or do we need some very different modern version of Glass-Steagall, in which we basically slim them down?
THE PRESIDENT: You know, I've looked at the evidence so far that indicates that other countries that have not seen some of the problems in their financial markets that we have nevertheless don't separate between investment banks and commercial banks, for example. They have a "supermarket" model that they've got strong regulation of.
The modest-sized regulatory package the White House just proposed reflects that this theory that regulation as opposed to Teddy Roosevelt style trust-busting is the way the administration wants to go. So far, there doesn't seem to much more excitement for such a fight on Capitol Hill. Even progressive organizations have been slow to take up the fight, although I'm told the new coalition Americans for Financial Reform will be coming out with a policy paper soon on the issue.
The problem is that the too-big-to-fail is the central issue of our economic collapse. I become more convinced with each passing day, as I watch these should-be-discredited-pariahs dominate the Congress, that our economy will not start to seriously recover until we deal with this problem. Our only hope is to build an outside of DC movement that rattles the walls. Politicians will not have the courage to take this on until we make it impossible for them to stop avoiding the issue.
Can they pay it back?
When Peter Schiff was making the rounds on U.S. cable news shows in 2007, warning about the collapse of the housing market, anchors and fellow guests literally laughed in his face when he launched into his gloomy predictions. That kind of meltdown could never happen, they said. The economy was on rock-solid ground. In those rosier economic days, Schiff, the president of Darien, Conn.’s Euro Pacific Capital, was repeatedly cast as a successful broker who’d gone off the deep end.
These days, a vindicated Schiff is back on the talk show circuit with an even darker message. The current recession, he argues, is only the beginning of a larger economic restructuring. The American economy has been destroyed by years of reckless spending and borrowing. And now, the U.S. government is so deeply in debt that at some point in the very near future, he says, its lenders—namely China—are going to come to their senses and cut America off. “We can’t have one country that just borrows and one country that just consumes that’s supported by the rest of the world. It doesn’t work.” When this system collapses—and it inevitably must, he insists—inflation will run wild as the U.S. prints money to support its spending habit. Interest rates will jump and everyone will suffer. The real day of reckoning is still to come.
This time around, nobody is laughing at Schiff. Anyone who has taken so much as a cursory glance at America’s financial books and seen the masses of red ink has come to a grim conclusion: not only is the situation no longer sustainable, it’s rapidly getting worse. The Congressional Budget Office estimates that the U.S. deficit this year will amount to $1.8 trillion (all figures in US$) and it sees the government spending about $1.2 trillion more than it brings in for each of the next several years. That’s one of the more optimistic forecasts.
Others say that over the next few decades, revenues will remain relatively flat while spending soars as demand grows for benefits such as health care for an aging population. The U.S. debt now stands at over $10 trillion and will hit $17 trillion within the decade, according to the Congressional Budget Office—a number so large that it will nearly match the entire yearly output of the world’s most powerful country. In short, America is about to go broke and every Western country, including Canada, will pay the price.
What’s alarming about the situation in the U.S. is just how quickly and easily the country found itself buried under a mountain of debt. Back in 2001, the Congressional Budget Office was estimating that by now, the U.S. should be running a healthy annual surplus—in fact it figured that when added together, the surpluses between 2001 and 2011 would total $5.6 trillion. At the time, it seemed like a reasonable projection. After all, in 2001 the government recorded a surplus amounting to $128 billion. But two important things happened since then that launched the U.S. into a very different future: the dot-com bust and George W. Bush. The recession that followed in 2001 caused tax revenues to fall and spending on social services to rise, taking a good bite out of those estimated budget surpluses.
At the same time, newly elected president George W. Bush—emboldened by the surplus he’d inherited when he came to office—proceeded to dole out steep and widespread tax cuts, which cut revenue by about five per cent. That was followed by a new $530-billion drug benefit program in 2003. To top it all off, the wars in Iraq and Afghanistan caused defence spending to explode. (The bill for those wars so far: $830 billion.) In just four years, America’s massive budget surplus was decimated and turned into a $400-billion annual deficit. Since then, it briefly showed signs of recovery, but when the recession hit in 2008, the deficit quickly plummeted back down to around $400 billion.
President Barack Obama hasn’t helped matters. Faced with a severe recession he has had little choice but to push policies that have piled debt on top of debt. Nearly $3 trillion has been spent rescuing banks and the automakers (that’s about as much as the entire government spent in all of 2008), and stimulus programs have added another $800 billion to the government’s tab. “It’s hard to overestimate the massive spending spree we’ve had in the United States over the past few years,” says Brian Riedl, a budget analyst at the Heritage Foundation, a Washington-based research organization. Under Obama’s budget, the debt-to-GDP ratio will double to 82 per cent by the end of the decade—a level not seen since the 1950s, when the U.S. was recovering from the Second World War.
But that’s not the worst of it. The biggest spending is still to come. With 75 million baby boomers retiring, there will be massive new strains on social services in the coming years. Three programs alone—Medicare, Medicaid and Social Security—will create a $43-trillion liability over the next 75 years, says Riedl. That kind of spending would push America’s debt-to-GDP ratio to levels that have only been touched by bankrupt Latin American nations. To cover these costs, the government would have to more than double income tax rates to more than 60 per cent—an option no lawmaker would dare consider.
These trends mean that even if Obama’s stimulus spending packages wind down as planned and the economy recovers this year and next, there is still no hope whatsoever that deficits can be eliminated in the short term. This is an unprecedented position. After the Second World War, when the U.S. had a debt-to-GDP ratio of more than 100 per cent, nobody expected deficit spending to continue, and it didn’t, says Alan Auerbach, an economist at the University of California, Berkeley, who has studied the debt problem. The deficits of the 1980s were also quickly erased. “The difference here is that things will continue to unravel because we’re going to have rapidly growing entitlement spending and no comparable growth in taxes under current policy.”
Add it all up and by the end of the decade, the interest payments alone on the debt will cost U.S. taxpayers $800 billion a year. That figure will rapidly worsen, as the money spent on interest payments is added to the deficits, which in turn are added to the debt, which leads to even higher interest payments. “The whole process can start to feed on itself,” says Isabel Sawhill, a senior fellow at the Brookings Institution and a former budget official in the Clinton administration. “You get into a vicious cycle which can become explosive at some point.” By 2040, those interest payments will eat up 30 per cent of government revenues, according to some estimates. Sooner or later, the U.S. will be handcuffed by its debt, with a diminishing ability to pay for basic services, from defence to infrastructure to education.
The dismal state of America’s finances, and the prospect of decades of ballooning deficits, have understandably started to make the country’s lenders a little nervous. The U.S. raises money by selling Treasury Securities, largely to foreign buyers. Lately, those investors have been increasingly wary of the stability of those treasuries, which were once considered the safest bet in the investing world. Demand at recent U.S. Treasury auctions has been weak, leading to slight rises in interest rates—a potentially troubling indicator. Late last month, well-known bond guru Bill Gross, founder of Pacific Investment Management Co., warned the U.S. could eventually lose its AAA investment grade ranking.
The largest buyer of U.S. debt is China, which held $768 billion worth of Treasury Securities as of March. Recently it has openly expressed concerns about America’s ability to repay the loans. “Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried,” said Chinese Premier Wen Jiabao at a news conference earlier this year. “I’d like to take this opportunity here to implore the United States to honour its words, stay a credible nation and ensure the safety of Chinese assets.”
Those are the kinds of politically loaded statements that keep Schiff up at night. What happens if lenders like China and Japan come to the conclusion that their investments in America have turned out to be bad ones? “The fact that we squandered all the money they loaned us, and the fact that by lending us money they’ve contributed to our economy being less efficient and less productive, they’re actually in a situation where the more money they lend us the less likely we are to pay them back,” he says.
Many scoff at the idea that China will suddenly say “no more” to the U.S. After all, the two countries have had a mutually beneficial relationship for years. China lends money to the U.S. and the U.S. buys masses of consumer goods from China. What’s more, it’s a long-standing relationship and many doubt that China would want to upset the status quo. Schiff sees no logic in that argument. “That they’ll keep lending indefinitely makes about as much sense as the argument that real estate prices have been rising, so they’ll rise forever,” he says. “Nothing that is unsustainable will go on forever.”
But the thing is, China doesn’t have to entirely cut off the U.S. to cause problems. Even if China decided to pull back slightly there would be consequences. The U.S. would still find itself short of the cash it needs to pay its bills, and like a homeowner who misses a mortgage payment, it would have to find that money somehow. Regardless of precisely how and when this all unfolds, the dollar will inevitably become less valuable and interest rates will rise as the U.S. scrambles to attract new lenders. That will translate into inflation and higher interest rates for the average person, too.
The cost of living will go up and the value of people’s savings will decline. Canada would likely get dragged into the mess too, just as it was affected by the current downturn in the U.S. The question is how severely this will all hit. “We could have another economic crisis or we could simply have a termites-in-the-woodwork scenario where we gradually have an erosion of our standard of living and become a nation in decline,” says Sawhill. At the very least, from here on in, the debt will act as a giant anchor, slowing whatever modest economic growth the U.S. can muster.
For the past five years or so, a small group of economists, researchers and former government officials have put on what they call the Fiscal Wake-Up Tour. It’s a kind of travelling road show aimed at raising awareness among citizens about America’s looming debt crisis. “We’ve been frustrated that there hasn’t been more attention paid to [the debt] and that steps weren’t taken earlier,” says the Brookings Institution’s Sawhill, who’s taken part in the tour.
Lately, however, the issue has been getting more attention, say some of the tour’s participants. The trouble is, nobody has any faith that this new-found interest will translate into any timely reaction from lawmakers. There really is no politically feasible solution to America’s debt crisis at the moment. For starters, no amount of economic growth can erase the deficits the U.S. is now facing, says Susan Irving, the director of federal budget analysis at the U.S. Government Accountability Office, a congressional body that oversees how the government spends tax dollars. No matter what numbers they enter in their simulations, she says, they can’t fix the problem.
That means any solution boils down to highly unpopular tax hikes and big spending cuts. To maintain the current debt-to-GDP ratio and prevent a debt explosion from happening over the next 75 years, the government would have to either raise revenues by 44 per cent or cut spending by 31 per cent, says Irving. It’s clear that there’s no appetite whatsoever for either of those options. Tax hikes are especially daunting when you consider that health care costs in the U.S. have been growing about two per cent faster than the economy. “You can’t raise taxes fast enough to catch up,” adds Irving.
Canadians know first-hand how hard and painful it can be to wrestle down a growing national debt. In the 1990s Canada embarked on an effort to slay its much more modest annual deficits. It worked, but not without sacrifice. We ended up with higher taxes and deep cuts to services like health care. For the Americans, the first step is to at least “stop digging,” says the Heritage Foundation’s Riedl. “Take a step back and think twice before enacting [Obama’s] very expensive proposals.”
Then, somehow, lawmakers need to get together and put some spending caps in the budget, he adds. Eventually, taxes will have to go up—on that point everyone can agree. The question now is whether this happens in the midst of a crisis, or in a more measured way, with some foresight and planning. “It’s just tragic that we’re not dealing with this now,” says Auerbach. “If we do it under time pressure because suddenly U.S. interest rates are going up, it’s not going to be nice.”
But all of this is much easier said than done. What’s happened in Washington so far is minor, says Sawhill, “a drop in the bucket . . . or in the sea,” she says. There are some signs that political pressure to curb deficit spending is growing (mostly from the opposition Republicans), but no agreement on how to proceed. Democrats generally fear the looming spending cuts while Republicans fear the taxes. “Those fears are understandable—but they should be outweighed by the fear of what will happen if we fail, if our debts overwhelm us, and if the fiscal meltdown comes,” said House majority leader Steny Hoyer, in a speech last month.
Riedl finds some cause for optimism in the fact that at least Americans, both inside and outside of Washington, are finally talking about the debt problem after ignoring it for all these years. That may be one of the few positive outcomes of the economic downturn: it has led Americans to slowly begin to acknowledge the elephant in the room. “The financial crisis has shown a lot of people that dire economic calamities can happen,” he says.
Schiff, the broker-turned-celebrity-prognosticator, is concerned enough about such a calamity that he says he’s now considering taking his message straight to Washington and running for a seat in the U.S. Senate. His threat to enter politics, which he first made last week on The Daily Show with Jon Stewart, has caused some buzz in Washington. But much as he seems to crave the spotlight, he says there’s another reason for his bid. “I’d do it because somebody has got to do something to stop this. It’s going to end in misery.”
Three Real Risks to the Future of the Banks
Last night, Jefferies said that it expects second-quarter earnings to far surpass earnings estimates. Per the release:The firm expects that Fixed Income and Commodities revenues will exceed the record set in the first quarter of 2009, driven by record quarterly results in the sales and trading of corporate bonds, mortgage- and asset backed securities, rates, municipal bonds and emerging markets debt."
The firm also reported strong results in high-yield and investment banking. I can already hear analysts extrapolating Jefferies' results to its peer firms, raising estimates going into quarter's end. But be careful: I expect the second quarter may go down in the record books as one of the best, if not the best, 90-day periods for spread products and commodities in history. And, while I have no doubt that other firms benefited from this extraordinary market performance, it's very difficult for me to see how any of this is sustainable.
For financial services firms, earnings are the past; the balance sheet is the future. My sense is that most banks and brokerages (including obvious heavy hitters like Citigroup, Wells Fargo, and Bank of America have used this quarter to sell anything and everything they had on the balance sheets at whatever gain they could during the second quarter. Furthermore, firms like Jefferies were in a sweet spot as stock issuance boomed, with corporations and banks raising equity to repay both TARP and other debt. While I expect many analysts will offer that the second quarter is just the beginning of the earnings recovery for banks and brokerages, let me offer 3 counter-risks:
- While "stock may be the new debt," it's far from clear that equity underwriting (often characterized as investment-banking revenue) can enjoy the same kind of profitability it has during the second quarter's "celebration of survival." Selling equity when everyone wants it, is a lot easier than selling it when corporations need it, but nobody wants it. (A scenario that I think will define the second half of 2009 and most of 2010).
- The Obama Adminstration's proposed banking reforms suggest that, in future, brokers will be required to act as fiduciaries. While the details have yet to be fleshed out, I would offer that there are irreconcilable differences between today's broker-as-salesperson model and the broker-as-fiduciary model -- and none of it bodes well for profitability.
- With most financial firms focused on short-term survival and current-quarter earnings maximization, it feels to me like the cupboard is increasingly bare.
And it isn't clear that there are any earnings rabbitts left in the hat.
Inflation is the greater threat to a sustained recovery
by Alan Greenspan
The rise in global stock prices from early March to mid-June is arguably the primary cause of the surprising positive turn in the economic environment. The $12,000bn of newly created corporate equity value has added significantly to the capital buffer that supports the debt issued by financial and non-financial companies. Corporate debt, as a consequence, has been upgraded and yields have fallen. Previously capital-strapped firms have been able to raise considerable debt and equity in recent months. Market fears of bank insolvency, particularly, have been assuaged. Is this the beginning of a prolonged economic recovery or a false dawn?
There are credible arguments on both sides of the issue. I conjectured over a year ago on these pages that the crisis will end when home prices in the US stabilise. That still appears right. Such prices largely determine the amount of equity in homes – the ultimate collateral for the $11,000bn of US home mortgage debt, a significant share of which is held in the form of asset-backed securities outside the US. Prices are currently being suppressed by a large overhang of vacant houses for sale. Owing to the recent sharp drop in house completions, this overhang is being liquidated in earnest, suggesting prices could start to stabilise in the next several months – although they could drift lower into 2010.
In addition, huge unrecognised losses of US banks still need to be funded. Either a stabilisation of home prices or a further rise in newly created equity value available to US financial intermediaries would address this impediment to recovery. Global stock markets have rallied so far and so fast this year that it is difficult to imagine they can proceed further at anywhere near their recent pace. But what if, after a correction, they proceeded inexorably higher? That would bolster global balance sheets with large amounts of new equity value and supply banks with the new capital that would allow them to step up lending.
Higher share prices would also lead to increased household wealth and spending, and the rising market value of existing corporate assets (proxied by stock prices) relative to their replacement cost would spur new capital investment. Leverage would be materially reduced. A prolonged recovery in global equity prices would thus assist in the lifting of the deflationary forces that still hover over the global economy. I recognise that I accord a much larger economic role to equity prices than is the conventional wisdom.
From my perspective, they are not merely an important leading indicator of global business activity, but a major contributor to that activity, operating primarily through balance sheets. My hypothesis will be tested in the year ahead. If shares fall back to their early spring lows or worse, I would expect the “green shoots” spotted in recent weeks to wither. Stock prices, to be sure, are affected by the usual economic gyrations. But, as I noted in March, a significant driver of stock prices is the innate human propensity to swing between euphoria and fear, which, while heavily influenced by economic events, has a life of its own. In my experience, such episodes are often not mere forecasts of future business activity, but major causes of it.
For the benevolent scenario above to play out, the short-term dangers of deflation and longer-term dangers of inflation have to be confronted and removed. Excess capacity is temporarily suppressing global prices. But I see inflation as the greater future challenge. If political pressures prevent central banks from reining in their inflated balance sheets in a timely manner, statistical analysis suggests the emergence of inflation by 2012; earlier if markets anticipate a prolonged period of elevated money supply. Annual price inflation in the US is significantly correlated (with a 3?-year lag) with annual changes in money supply per unit of capacity.
Inflation is a special concern over the next decade given the pending avalanche of government debt about to be unloaded on world financial markets. The need to finance very large fiscal deficits during the coming years could lead to political pressure on central banks to print money to buy much of the newly issued debt. The Federal Reserve, when it perceives that the unemployment rate is poised to decline, will presumably start to allow its short-term assets to run off, and either sell its newly acquired bonds, notes and asset-backed securities or, if that proves too disruptive to markets, issue (with congressional approval) Fed debt to sterilise, or counter, what is left of its huge expansion of the monetary base.
Thus, interest rates would rise well before the restoration of full employment, a policy that, in the past, has not been viewed favourably by Congress. Moreover, unless US government spending commitments are stretched out or cut back, real interest rates will be likely to rise even more, owing to the need to finance the widening deficit. Government spending commitments over the next decade are staggering. On top of that, the range of error is particularly large owing to the uncertainties in forecasting Medicare costs. Historically the US, to limit the likelihood of destructive inflation, relied on a large buffer between the level of federal debt and rough measures of total borrowing capacity. Current debt issuance projections, if realised, will surely place America precariously close to that notional borrowing ceiling.
Fears of an eventual significant pickup in inflation may soon begin to be factored into longer-term US government bond yields, or interest rates. Should real long-term interest rates become chronically elevated, share prices, if history is any guide, will remain suppressed. The US is faced with the choice of either paring back its budget deficits and monetary base as soon as the current risks of deflation dissipate, or setting the stage for a potential upsurge in inflation. Even absent the inflation threat, there is another potential danger inherent in current US fiscal policy: a major increase in the funding of the US economy through public sector debt.
Such a course for fiscal policy is a recipe for the political allocation of capital and an undermining of the process of “creative destruction” – the private sector market competition that is essential to rising standards of living. This paradigm’s reputation has been badly tarnished by recent events. Improvements in financial regulation and supervision, especially in areas of capital adequacy, are necessary. However, for the best chance for worldwide economic growth we must continue to rely on private market forces to allocate capital and other resources. The alternative of political allocation of resources has been tried; and it failed.
Europe: Will a Record Fiscal "Injection" Save the Stock Market?
The European Central Bank pumped a record €442 billion ($662 billion) into euro-zone money markets Wednesday ... as it continues battling the Continent's deep recession. (The Wall Street Journal) Financial bureaucrats the world over remain convinced they are in control. Never mind the fact that as they lowered interest rates and “injected liquidity” over and over since late 2007, stocks kept falling, credit markets remained frozen and global economies stalled as deflation spread.
The excerpt you can read below explains just who is really in control and why the governments' previous efforts have failed so badly. It's a quote from the December 2007 Elliott Wave Theorist, which remains a most relevant read: It was published by EWI’s founder and president Robert Prechter after the central bankers’ first major (and failed) rescue attempt in late 2007. As you read this, please keep in mind that at the time, U.S. and European stocks were still trading near their all-time highs, the global economy was yet to crumble, and the investors' belief in the powers of central bankers was still unshaken.Robert Prechter, December 2007 Elliott Wave Theorist, excerpt
The world’s “big five” central banks -- the Federal Reserve, the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank -- have just made ... a plan to bolster confidence among the world’s creditors and borrowers. The Wall Street Journal (12/13) calls it “the biggest coordinated show of international financial force since Sept. 11, 2001” [that] would provide billions of dollars worth of “liquidity” in the form of low-cost, one-month loans to qualified banks [in] a drive to create more inflation.
[T]his is probably the single most important central-bank pronouncement yet. But it is not significant for the reasons people think. [T]he tremendous significance of this seismic engagement of the monetary jawbone is that if this announcement fails to restore confidence, central bankers’ credibility will evaporate.
At least that’s the way historians will play it. But of course, the true causality, as elucidated by socionomics*, is that an evaporation of confidence will make the central bankers’ plans fail. The outcome is predicated on psychology. If wave c of the bear market has begun, nothing the Fed does will engender confidence. On the contrary, everything it does will be interpreted, in the trend toward negative social mood, as something bad. The Fed’s failures will not create fear; fear will create the Fed’s failures. You can’t tell the market what you will or won’t accept. It tells you. Good luck changing the mood of the crowd.
[T]oday’s central banks are many multiples bigger than the biggest banks of 1929, and they have unlimited credit and no real-money standard. They are nothing less than super-banks, which can create credit from nothing; all a customer has to do is ask for it. Ah, but that’s the problem. Someone has to ask. The expansion of credit depends on willing and able borrowers.
The root of today’s systemic dilemma is not mechanical, as the monetary engineers believe, but psychological. Bernanke thinks he can pull switches to prevent deflation. But you can’t pull switches on a crowd. It pulls switches on you. When the Fed’s credibility withers in the environment of a bear market, the monster will have overpowered his makers, and the gunfight will be over.
When global stocks fell to lows unseen in years back in March, “the gunfight” clearly ended in favor of the bear market psychology which had shredded ALL central banker efforts. So, does this mean that they shouldn’t even try?
Well, as the old saying goes, there is a time to throw stones and a time to gather them. Government interventions only work when they are aligned with the mood of the crowd. The previous rescue attempts got trumped by fear. But the rallies in global stocks since March show that investors’ collective mood is rebounding; fear is receding.
Because of that, the timing of the ECB's latest "liquidity injection" could turn out to be quite good. Call it luck -- because it’s exactly what it would be. However, as the June issue of EWI's European Financial Forecast (published on May 29) warned, there is a reason why for European stocks, "upside potential is limited and a sizable move lower should begin soon."
The Bloodless Coup of the Global Financial Stability Board: From Guidelines to Rules
by Ellen Brown
You must be a pirate for the Pirate's Code to apply and you're not, and the code is more of what you call guidelines than actual rules.
-- The evil Captain Barbossa who stole the Black Pearl, in Pirates of the Caribbean
Buried on page 83 of the 89-page Report on Financial Regulatory Reform issued by the U.S. Administration on June 17 is a recommendation that the new Financial Stability Board "strengthen" and "institutionalize" its mandate to "promote global financial stability." Financial stability is a worthy goal, but the devil is in the details. Some see the new agency, which is based in the Bank for International Settlements in Switzerland, as the latest sinister development in a centuries-old consolidation of power by an international financial oligarchy.
When the G20 leaders met in London on April 2, 2009, they agreed to expand the powers of the old Financial Stability Forum (FSF) into this new Financial Stability Board (FSB). The FSF was chaired by the General Manager of the Bank for International Settlements and was set up in 1999 to serve in a merely advisory capacity for the G7 (a group of finance ministers formed from the seven major industrialized nations). The new FSB has been expanded to include all G20 members (19 nations plus the EU) and it has real teeth, imposing "obligations" and "commitments" on its members. What is the FSB's mandate, what are its expanded powers, and who is in charge?
The Shadowy Financial Stability Board
An article in The London Guardian gives these details:The secretariat is based at the Bank for International Settlements' headquarters in Basel, Switzerland.
To the wary, this is not a comforting sign. The BIS has a dark and controversial history. Prof. Carroll Quigley, Bill Clinton's mentor at Georgetown University, said in Tragedy and Hope that the BIS was created to be the apex of "a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole." The goal was "[control] in a feudalist fashion by the central banks of the world acting in concert, by secret agreements arrived at in frequent private meetings and conferences."The Financial Stability Forum is chaired by Mario Draghi, governor of the Bank of Italy.
Draghi was director general of the Italian treasury from 1991 to 2001, where he was responsible for widespread privatization (sell-off of government holdings to private investors). From January 2002 to January 2006, he was a partner at Goldman Sachs on Wall Street, another controversial player.The regulator . . . will cooperate with the IMF, the Washington-based body that monitors countries' financial health, lending funds if needed.
The IMF is an international banking organization that is also controversial. Joseph Stiglitz, former chief economist for the World Bank, charges it with ensnaring Third World countries in a debt trap from which they cannot escape. Debtors unable to pay are bound by "conditionalities" that include a forced sell-off of national assets to private investors in order to service their loans.What will the regulator oversee? All 'systemically important' financial institutions, instruments and markets.
The term "systemically important" is not defined. Will it include such systemically important institutions as national treasuries, and such systemically important markets as gold, oil and food?The body will . . . act as a clearing house for information-sharing and contingency planning for the benefit of its members.
In some contexts, information-sharing is called illegal collusion. Would the information-sharing here include such things as secret agreements among central banks to buy or sell particular currencies, with the concomitant power to support or collapse targeted local economies? Consider the short-selling of the Mexican peso by collusive action in 1995, the short-selling of Southeast Asian currencies in 1998, and the collusion among central banks to support the U.S. dollar in July of last year -- good for the dollar and the big players with inside information perhaps, but not so good for the small investors who reasonably bet on "market forces," bought gold or foreign currencies, and lost their shirts.To prevent another debt bubble, the new body will recommend financial companies maintain provisions against credit losses and may impose constraints on borrowing.
What sort of constraints? The Basel Accords imposed by the BIS have not generally worked out well. The first Basel Accord, issued in 1998, was blamed for inducing a depression in Japan from which that country has yet to recover; and the Second Basel Accord and its associated mark-to-market rule have been blamed for bringing on the current credit crisis, from which the U.S. and the world have yet to recover. These charges have been explored at length elsewhere.
The Amorphous 12 International Standards and Codes
Most troubling, perhaps, is this vague parenthetical reference in a press release issued by the BIS titled "Financial Stability Forum Re-established as the Financial Stability Board":As obligations of membership, member countries and territories commit to . . . implement international financial standards (including the 12 key International Standards and Codes) . . .
This is not just friendly advice from an advisory board. It is a commitment to comply, so you would expect some detailed discussion concerning what those standards entail. However, a search of the major media reveals virtually nothing. The 12 key International Standards and Codes are left undefined and undiscussed. The FSB website lists them, but it is vague. The Standards and Codes cover broad areas that are apparently subject to modification as the overseeing committees see fit. They include:
- Money and financial policy transparency
- Fiscal policy transparency
- Data dissemination
- Corporate governance
- Payment and settlement
- Market integrity
- Banking supervision
- Securities regulation
- Insurance supervision
Take "fiscal policy transparency" as an example. The "Code of Good Practices on Fiscal Transparency" was adopted by the IMF Interim Committee in 1998. The "synoptic description" says:The code contains transparency requirements to provide assurances to the public and to capital markets that a sufficiently complete picture of the structure and finances of government is available so as to allow the soundness of fiscal policy to be reliably assessed.
We learn that members are required to provide a "picture of the structure and finances of government" that is complete enough for an assessment of its "soundness" -- but an assessment by whom, and what if a government fails the test? Is an unelected private committee based in the BIS allowed to evaluate the "structure and function" of particular national governments and, if they are determined to have fiscal policies that are not "sound," to impose "conditionalities" and "austerity measures" of the sort that the IMF is notorious for imposing on Third World countries?
For three centuries, private international banking interests have brought governments in line by blocking them from issuing their own currencies and requiring them to borrow banker-issued "banknotes" instead. "Allow me to issue and control a nation's currency," Mayer Amschel Bauer Rothschild famously said in 1791, "and I care not who makes its laws." The real rebellion of the American colonists in 1776, according to Benjamin Franklin, was against a foreign master who forbade the colonists from issuing their own money and required that taxes be paid in gold. The colonists, not having gold, had to borrow gold-backed banknotes from the British bankers instead.
The catch was that the notes were created on the "fractional reserve" system, allowing the bankers to issue up to ten times as many notes as they actually had gold, essentially creating them out of thin air just as the colonists were doing. The result was not only to lock the colonists into debt to foreign bankers but to propel the nation into a crippling depression. The colonists finally rebelled and reverted to issuing their own currency. Funding a revolution against a major world power with money they printed themselves, they succeeded in defeating their oppressors and winning their independence.
Political colonialism is now a thing of the past, but under the new FSB guidelines, nations can still be held in feudalistic subservience to foreign masters. Consider this scenario: Like in the American colonies, the new FSB rules precipitate a global depression the likes of which have never before been seen. XYZ country wakes up to the fact that all of this is unnecessary -- that it could be creating its own money, freeing itself from the debt trap, rather than borrowing from bankers who create money on computer screens and charge interest for the privilege of borrowing it. But this realization comes too late. The FSB has ruled that for a government to issue money is an impermissible "merging of the public and private sectors" and an "unsound banking practice" forbidden under the "12 Key International Standards and Codes." XYZ is forced into line. National sovereignty has been abdicated to a private committee, with no say by the voters.
A Bloodless Coup?
Suspicious observers might say that this is how you pull off a private global dictatorship: (1) create a global crisis; (2) appoint an "advisory body" to retain and maintain "stability"; and then (3) "formalize" the advisory body as global regulator. By the time the people wake up to what has happened, it's too late. Marilyn Barnewall, who was dubbed by Forbes Magazine the "dean of American private banking," wrote in an April 2009 article titled "What Happened to American Sovereignty at G-20?":It seems the world's bankers have executed a bloodless coup and now represent all of the people in the world. . . . President Obama agreed at the G20 meeting in London to create an international board with authority to intervene in U.S. corporations by dictating executive compensation and approving or disapproving business management decisions. Under the new Financial Stability Board, the United States has only one vote. In other words, the group will be largely controlled by European central bankers. My guess is, they will represent themselves, not you and not me and certainly not America.
Adoption of the FSB was never voted on by the public, either individually or through their legislators. The G20 Summit has been called "a New Bretton Woods," referring to agreements entered into in 1944 establishing new rules for international trade. But Bretton Woods was put in place by Congressional Executive Agreement, requiring a majority vote of the legislature; and it more properly should have been done by treaty, requiring a two-thirds vote of the Senate, since it was an international agreement binding on the nation. The same should be mandated before imposing the will of the BIS-based Financial Stability Board on the U.S., its banks and its businesses.
Even with a two-thirds Senate vote, before Congress gives its approval it should draft legislation ensuring that the checks and balances imposed by our Constitution are built into the agreement. The legislatures of the member nations could be required to elect a representative body to provide oversight and take corrective measures as needed, with that body's representatives answerable to their national electorates. If we are to avoid abdicating our national sovereignty to a private foreign banking elite, we need to insist on compliance with the constitutional and legal mandates on which our country was founded.
Judge grapples with her discovery of 15,000 unserved foreclosure cases
A Miami-Dade Circuit Court judge discovered more than 15,000 foreclosure cases filed this year haven’t been served. It’s the latest shoe to drop in a foreclosure crisis garnering nationwide attention, and an unwelcome discovery in the face of state budget cuts that produced layoffs for courts and clerks. The backlog is critical because cases where homeowners haven’t been served within four months are subject to dismissal.
Civil Division Administrative Judge Jennifer D. Bailey made the discovery last month as she was taking stock of the circuit’s foreclosure load. She noticed 15,219 cases with no letters of correspondence, no answers and no motions to dismiss. “In other words, no service,” she said. The circuit is scrambling to find the root of the problem, which could jeopardize most of this year’s 17,000 foreclosure filings. Most of the cases still fall within the four-month window, but no program is in place to speed things up.
If a foreclosure proceeds to a default judgment with no service on the defendants, it could lead to a title dispute down the road. Bailey said there is no sign that has happened so far but recognizes the potential for problems. The circuit adopted a foreclosure mediation program for owner-occupied properties through the nonprofit Collins Center for Public Policy in Tallahassee on May 1. As the fledgling program moved forward, lenders argued the center should start contacting borrowers after they’ve been served, said Collins Center president Rod Petrey. But Florida circuits don’t keep statistics on foreclosure service, which is why Bailey requested the statistics last month.
“There’s no feedback loop that circles back to the court, and we were not able to wait,” Petrey said. The center contacts defendants in foreclosure after lawsuits are filed; it has received 1,689 Miami-Dade cases since May 1. Petrey was at a loss to say why foreclosure service is so difficult. Some, like Charles Taylor, president of Metro Process Servers in Miami, think the problem is on the clerks’ end. “I don’t think the bottleneck is in service. I believe the bottleneck is that they’re not equipped to handle this stuff,” he said. The crushing volume of foreclosures combined with clerk layoffs conspired to swamp the system.
Home abandonment plays a factor in failed service, but the rate of home abandonment in foreclosure cases hasn’t been calculated. “No one really keeps those statistics,” said Alex Sanchez, president of the Florida Bankers Association in Tallahassee. “You would have to call every FDIC-insured institution and every non-bank” to get it. Fort Lauderdale foreclosure defense attorney Morton Antman, says the problem is that lenders and process servers don’t have the resources to pursue every foreclosure properly, and mistakes are made along the way. In Antman’s mind, volume is a factor, but chasing residents who don’t want to be found is a persistent problem.
“The primary issue is that most of these people leave their house,” he said. “They just vanish, and how do you make service on these people? Constructive service is a lengthy process.” And the high number of South Florida investment properties in foreclosure with absentee landlords further complicates service problems, said Marc Ben-Ezra, a Fort Lauderdale partner with Ben-Ezra & Katz, who represents lenders. “A lot of people are making it difficult for the plaintiffs to serve them, or in other cases, people have just left the properties,” he said. “The plaintiffs have to do a significant amount of work in order for the plaintiffs to try to find them.”
Bailey speculates the problem is procedural. Summonses are issued by clerks after a lawyer files a foreclosure action and sent to process servers for service, which can take up to five business days. The proof-of-service materials then get sent back to lawyers as process servers serve the parties. “Obviously, those numbers are staggering. Maybe their own internal systems are not able to keep up,” said Richard Burton, a Miami attorney who launched a pro bono foreclosure-defense project.
But the scope of the foreclosure service problems could be much worse than the 15,000 cases without service that Bailey discovered. Some foreclosure lawyers question whether there are more cases where service hasn’t been done, but court records show the defendants have been served. Take a foreclosure case filed by Indymac Federal Bank against Ahron and Amitza Benvenisti, who bought a North Miami Beach condo for $177,938 in January 2006.
Indymac attempted to serve the husband through constructive service — or service by publication without actual notice — and the wife through a relative in Massapequa, N.Y. The lender moved for a default judgment against the couple. Antman, who represented the couple, argued the process server contradicted himself by checking boxes stating he successfully served the wife through the relative, though Amitza Benvenisti doesn’t live at the relative’s address. The relative, Gilan Benvenisti, swore in an affidavit that she doesn’t live with him. A docket entry dated Monday said the clerk’s office was not authorized to enter a default because of a lack of service.
“I don’t know if this was intentional or not, but this isn’t the first time we’ve had situations where process servers do stuff like this,” Antman said. “I think it’s a mistake.” Ron Rice Jr., a Plantation attorney with Kahane & Associates who represented Indymac, did not return calls seeking comment by deadline. Bailey said she still is trying to interpret the data to determine the source of the problem and chart a new course. But whoever is at fault, Bailey quickly notes the problem threatens to overwhelm a court system that already is strapped.
“The question I now face is what do I do with this?” she asked. The cases “would potentially be subject to dismissal,” but she noted many cases are recent enough that service within the four-month window is still possible. “Let’s assume a third of these are subject to dismissal. In my spare time, I’ve got to figure out ways to generate orders in 5,000 cases and pay for 5,000 stamps and serve everyone,” Bailey said. “Are we going to do that? Yes. Am I trying to figure it out? Yes.” “It all starts with service. If people don’t get served, all we’re doing is buying ourselves a bunch of title cases in six years,” the judge said.
Gerstner Says Short-Term Gains Should Be Taxed at 80%
Louis Gerstner, the former International Business Machines Corp. chief executive officer, said that short-term investment gains should be taxed at 80 percent as a way to counter the culture of greed on Wall Street. “If you buy something -- a stock or a bond -- in the morning, and you sell in the afternoon, the tax probably ought to be 80 percent,” said Gerstner, also a former chairman of Carlyle Group, the world’s second-largest private equity firm. “If you hold it for six months, maybe it ought to be 60 percent,” Gerstner told Bloomberg Television.
Selling an investment after five years should carry a zero rate “to try to get the incentives for investment to go back to being a true investor and not a trader,” he said. Gerstner acknowledged that such a change would be “controversial” yet argued it is necessary to encourage investors to think about the longer term. The top tax rate on gains from investments sold within one year is now 35 percent. “We do have a greed or an inefficiency that comes out of excessive focus on the short term,” said Gerstner, who bemoaned an investment climate driven by quarterly earnings and a 24-hour news cycle. He was an executive at American Express Co. and RJR Nabisco Inc. before joining IBM.
Gerstner, 67, also criticized compensation practices, saying “there’s been astoundingly unnecessary, excessive executive compensation in certain instances.” He said the solution isn’t government rules or caps on pay.
“I despair of a government solution,” Gerstner said. “We’ve had governments attempt to control executive compensation for 40 or 50 years.” Instead, Gerstner called for more disclosure and oversight of boards of directors by shareholders, “because ultimately the boards need to make these decisions.” “The system can fix itself without rigid rules,” he said.
Gerstner, who approves of generous compensation for executives who add shareholder value, called for an end to golden parachutes for failed managers. “We have to see an elimination of pay for people who get fired and then wind up with these huge payments,” he said. Gerstner acknowledged that Wall Street executives he knows wouldn’t like his plan for higher taxes on investment gains. “They wouldn’t like it at all,” Gerstner said. “Wall Street is driven by transactions. That’s what they live by. They don’t live by long-term investment decisions.”
Fed extends credit programs until early 2010
The Federal Reserve announced Thursday that it was extending most of its credit liquidity programs until February 2010 to avoid any disruptions over the end-of-the-year period. While the central banks said there has been some market improvement in many markets, it was not prepared to scale back its innovative assistance to credit markets. "Conditions in financial markets have improved in recent months, but market functioning in many areas remains impaired and seems likely to be strained for some time," the Fed said in a statement.
Many of the programs had been scheduled to expire by the end of October. The extension allows the programs to remain in place over the end of the calendar year, which can be a period of stress for markets. The Fed has set up an alphabet soup of programs designed to take illiquid assets off the balance sheets of financial firms in return for liquid assets and cash in order to keep the private credit markets operating. The Fed said it was hopeful that it could step back from assisting markets early next year.
Should the recent improvements in market conditions continue, the Fed "currently anticipate[s] that a number of these facilities may not need to be extended beyond February 1," the statement said.
However, the programs could be extended again if necessary. Robert Brusca, chief economist at FAO Economics, likened the Fed programs to a backup quarterback in a football game. Markets have continued to function with the Fed's help, but at a diminished fashion.
The Fed ended a backup program designed to help backstop money markets. The program was never used. One major program, the term-auction-facility, is scheduled to expire on Dec. 31. The Fed also extended a number of its dollar liquidity swap arrangements with 14 foreign central banks until next February. Use of these swap plans has steadily declined over the past several months after peaking in early December, The Fed board used its emergency powers to extend the programs.
Bernanke Defends His Record on Bank of America Talks
Federal Reserve Chairman Ben S. Bernanke defended the central bank against lawmakers’ charges it put undue pressure on Bank of America Corp. to take over Merrill Lynch & Co. last year at the height of the financial crisis. “The Federal Reserve acted with the highest integrity throughout its discussions,” Bernanke said today in testimony to the House Oversight Committee. He said actions by the Fed and other central banks last year helped avert a financial meltdown that would have produced a “Depression-like environment.”
Legislators are trying to determine whether Bernanke overstepped his authority in pressuring Bank of America to complete the purchase of Merrill. Bernanke’s record on the issue and lawmakers’ reactions may also figure in whether he will be reappointed by President Barack Obama, and in debates on overhauling the Fed’s powers and responsibility. “These are the kind of questions that need to be answered before the president makes his decision,” Elijah Cummings, a Maryland Democrat and member of the committee, said in a Bloomberg Television interview earlier today.
Bank of America Chief Executive Officer Kenneth Lewis told the committee earlier this month that he decided to proceed with the takeover of Merrill after regulators said they might remove management and because his company’s future was “intertwined” with Merrill’s fate. Completing the purchase of New York-based Merrill was in the best interests of the bank, Lewis also said June 11. He cited the potential benefits to the company, as well as consequences for the bank if the deal was scuttled and the financial system was disrupted.
Republican lawmakers who have consistently opposed government rescues of financial companies have accused the central bank of overstepping its authority in pressuring Bank of America to absorb Merrill Lynch. Republican congressional staff wrote in a memo on documents received by the House panel from the Fed through a subpoena that a “gun placed to the head of Bank of America” forced the Charlotte, North Carolina-based bank to go through with the merger, which was announced in mid-September.
Representative Darrell Issa, the ranking Republican on the panel who voted against the $700 billion financial-rescue program last year, also said the Fed withheld concerns about the deal from other agencies.
Issa said in opening remarks that he questions “the appropriateness” of Fed actions which “ought to be a note of caution to those who want to dramatically increase its power and authority.” Bernanke said today he didn’t threaten Lewis that he’d be fired if the bank withdrew from the Merrill deal. He said the takeover came at a time of “extreme stress in financial markets,” and noted the government had taken extraordinary steps to prevent the collapse of systemically important firms, including Citigroup Inc., Fannie Mae, Freddie Mac and American International Group Inc.
Bernanke said in the testimony that the Fed didn’t try to limit public disclosures or force the merger. He said in answering questions that he also “personally” informed Federal Deposit Insurance Corp. Chairman Sheila Bair and Comptroller of the Currency John Dugan about the Bank of America situation. “I did not play a role in arranging this transaction and no Federal Reserve assistance was promised or provided” when the acquisition was announced on Sept. 15, Bernanke said.
Bank of America in December considered retreating from the Merrill deal because of large losses at the brokerage firm. Merrill reported a $15.8 billion loss during the fourth quarter. The Fed chairman said if the deal fell through it “might have triggered a broader systemic crisis” that could have enveloped both Bank of America and Merrill. Also, Bank of America might have raised questions about its risk-management and due diligence by citing rising losses at Merrill as a reason for withdrawing from the deal after three months of preparation, Bernanke said. Moreover, use of the so- called MAC clause could provoke “extended and costly litigation,” he said.
“The decision to go forward with the merger rightly remained in the hands of Bank of America’s board and management, and they were obligated to make the choice they believed was in the best interest of their shareholders and company,” Bernanke said. The Fed’s actions “have strengthened both companies while enhancing the stability of the financial markets and protecting the taxpayers,” he said. The Fed chairman said neither he nor any member of the Fed “instructed, or advised Bank of America to withhold from public disclosure any information relating to Merrill Lynch, including its losses, compensation packages or bonuses, or any other related matter.”
The disclosures “belong squarely with the company, and the Federal Reserve did not interfere in the company’s disclosure decisions,” he said. Bernanke didn’t comment on the outlook for the economy or monetary policy in his prepared statement. During the hearing, the Fed announced that it will let one of its emergency programs expire and trim two others in a sign that improving financial markets allow a first step toward ending its unprecedented interventions.
The Obama administration released a blueprint last week for overhauling regulation that would give the Fed more authority to supervise and regulate large financial holding companies that may pose a risk to the financial system. The plan also proposes stripping the central bank of some consumer protection powers and curbing its independence in providing emergency loans to non-bank corporations. Bernanke characterized the Treasury’s regulatory plan as a change in approach, not an increase in power. He also made an appeal to keep consumer protection powers within the Fed and said the central bank would focus more on protecting consumers.
“The Federal Reserve was late to invoke those consumer protection powers,” Bernanke said in response to a question from Representative Paul Kanjorski, a Pennsylvania Democrat. “It is very important if the Fed retains those powers that we strengthen their priority.” When asked about legislation that would allow for broad audits of the Fed by the Government Accountability Office, Bernanke said such powers would compromise the central bank’s independence and be “highly destructive to the stability of the financial system, the dollar and our national economic situation.” Maintaining independence on monetary policy is “critical,” he said.
The central aim of financial regulatory reform should be to increase supervision of firms that are so big that they would require taxpayer-funded safety nets should they fail, Bernanke said. When asked if large banks should be broken up, Bernanke said Congress has two options as it considers legislation. “One is to allow large banks, but to take steps that will protect the economy if in fact one comes to the brink of failure,” an approach currently proposed by Treasury, Bernanke said. “The other possibility is to restrict the size of banks. I think it is legitimate to discuss both options.”
G.O.P. to Paint Bernanke as Big Government Ally
In a peculiar role reversal, Republican lawmakers are mounting a ferocious attack on the Republican chairman of the Federal Reserve, while Democrats are coming to his defense. Ben S. Bernanke, the Fed chairman, will be grilled on Thursday by the House Oversight and Government Reform Committee about his role in orchestrating Bank of America’s controversial takeover of Merrill Lynch late last year. The House investigation is heavily colored by partisanship. President Obama is proposing to give the Federal Reserve formidable new powers to regulate giant institutions, including Bank of America, that could pose risks to the financial system.
Republicans, along with some Democrats, argue that the Fed already has too much power. Unhappy about the huge bank bailouts that the Fed arranged with the Treasury Department during the Bush administration, many Republicans are even more displeased that Mr. Bernanke is now working hand-in-glove with the Obama administration. The result is a set of dueling narratives and agendas, all of which will be on full display when Mr. Bernanke testifies on Thursday. Henry M. Paulson Jr., the former Treasury secretary, is expected to testify next month.
A memo written by Republicans, citing e-mail and internal Fed documents that were subpoenaed from the central bank, is building a case that Mr. Bernanke was a Machiavellian autocrat who forced Bank of America to go through with a disastrous merger that it no longer wanted to complete. But the committee’s Democratic chairman, Representative Edolphus Towns of New York, is investigating whether Bank of America executives were engaged in an elaborate shakedown, demanding that the Fed and the Treasury provide more than $100 billion in fresh capital and guarantees against the losses that were building up at Merrill Lynch.
Republicans are circulating newly unearthed e-mail that suggests Fed officials kept the Securities and Exchange Commission and the Office of the Comptroller of the Currency in the dark about its efforts to keep the merger alive by informally reassuring Kenneth D. Lewis, the chief executive of Bank of America, that the government would provide the bank with extra help if it was needed. By that point, however, the S.E.C. had abdicated to the Fed its authority over investment banks like Merrill Lynch. And the comptroller’s office was responsible for overseeing commercial banks, but not the umbrella holding company.
The new e-mail message reinforces the impression that Fed officials badly wanted Bank of America to complete the Merrill takeover, despite Merrill’s spiraling losses. But other e-mail between Fed officials shows that Bank of America executives were pressuring the Fed and the Treasury up to the last minute on Dec. 30, when the deal was scheduled to close, to provide written promises that the government would provide billions in new capital and other protection.
The documents show that Fed officials refused to provide any specific commitments, though a top official did assure the bank’s chief financial officer, Joe L. Price, that the government would provide help, if needed. “I told Joe that we were not yet in a position to proffer a package, but we were working toward something that works for them and for us,” wrote Kevin M. Warsh, a Fed governor, in an e-mail message to a senior Treasury official on Dec. 30.
A little more than two weeks later, the Fed and the Treasury indeed provided huge assistance — $20 billion in new capital and guarantees against losses for $118 billion in Merrill Lynch assets — over the protests of Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corporation, whose agency would be the guarantor. Mr. Lewis told the oversight committee on June 11 that Fed and Treasury officials pressured him to keep the deal alive, even threatening his job and those of his board members. Mr. Lewis testified early this year to the New York attorney general that Fed and Treasury officials urged Bank of America not to disclose Merrill’s losses, but he retreated from that assertion at the June 11 hearing.
Fed officials have acknowledged that they warned Mr. Lewis that he would be on shaky legal ground if he tried to back out of the deal by invoking a “material adverse change” clause. But Fed officials insist they never threatened to oust the bank’s executives if they scuttled the deal. In e-mail disclosed before the last hearing, Mr. Bernanke referred to Mr. Lewis’s qualms about the merger as a “bargaining chip” to get more help from the government. Despite Mr. Bernanke’s Republican roots, and the fact that President Bush nominated him to be Fed chairman, the Republican memo prepared for the hearing on Thursday describes Mr. Bernanke as a champion of government intrusion and an ally of President Obama.
“Given the Obama administration’s proposal to vastly expand the Federal Reserve’s financial regulatory power over virtually any economic actor,” it warned, “the Fed’s willingness to keep key regulatory partners such as the S.E.C. and O.C.C. in the dark raises important questions.” But Kevin Mukri, a spokesman for the Office of the Comptroller of the Currency, said on Wednesday that Fed officials had in fact kept the agency informed about Bank of America’s situation. “We were kept apprised,” Mr. Mukri said.
The efficient markets theory is as dead as Python's parrot
The efficient markets hypothesis (EMH) is the financial equivalent of Monty Python's dead parrot. No matter how much you point out that it is dead, the believers simply state that it is just resting. In part, this is testament to the high degree of inertia academic theories enjoy. Once a theory has been accepted, it seems to take forever to dislodge it. As Max Planck observed: "Science advances one funeral at a time."The EMH states that all information is reflected in current prices. It is bad enough that the EMH exists as an academic theory (filling student's heads with utter garbage) but the very real damage it does comes from the fact that, as Keynes opined, "practical men are usually the slaves of some defunct economist". The EMH has left us with a long litany of bad ideas that have influenced the very structure of our industry.
For instance, the capital asset pricing model (son of EMH) has left us obsessed with performance measurement. The separation of alpha and beta is at best an irrelevance and at worst a serious distraction from the true nature of investment. Sir John Templeton said it best when he observed: "The aim of investment is maximum real total returns after tax." Yet, instead of focusing on this target, we have spawned an industry (the consultants) that only pigeonholes investors into categories.
The obsession with benchmarking also gives rise to one of the biggest sources of bias in our industry - career risk. For a benchmarked investor, risk is measured as tracking error. This gives rise to homo ovinus - a species concerned purely with where they stand relative to the rest of the crowd. This species is the living embodiment of Keynes' edict that "it is better for reputation to fail conventionally than to succeed unconventionally".
The EMH also lies at the heart of risk management, option pricing theory, the concept of shareholder value and even the regulatory approach (markets know best), all of which have inflicted serious damage on investors.
However, the most insidious aspect of the EMH is the advice it offers as to the sources of outperformance. This may sound oxymoronic but the EMH is actually very clear on how you can outperform. You either need inside information, which is, of course, illegal. Or you need to forecast the future better than everyone else. There isn't a scrap of evidence to suggest that we can actually see the future at all. The desire to outforecast everyone else has sent the investment industry on a wild goose chase for decades.
EMH also tells us that opportunities will be fleeting. Why? Because smart, rational arbitrageurs will eradicate any opportunities swiftly. This is akin to the age-old joke about the economist and his friend walking along the street. The friend points out a $100 bill lying on the pavement. The economist says: "It isn't really there because, if it were, someone would have already picked it up." This mindset encourages investors to focus on the short term (where the opportunities lie, according to EMH) rather than on the long term (where the true informational advantage is likely to lie).
EMH fails dramatically when presented with the real world. The most damning evidence against the EMH scarcely merits discussion in academic circles. The elephant in the room for EMH is the existence of bubbles. So terrified are academics of bubbles that they go to enormous lengths to justify them. Believe it or not, two economists have even written a paper arguing that the Nasdaq wasn't actually a bubble when the composite index rose above 5,000 at the start of this decade.
Fund management firm GMO defines a bubble as at least a two standard deviation move from (real) trend. Under EMH, two standard deviation events should occur roughly every 44 years. However, GMO found some 30 plus bubbles since 1925 - slightly more than one every three years. While the details and technicalities of each episode are different, the underlying dynamics follow a very similar pattern. Ex-ante diagnosis of bubbles is surely the fatal blow to EMH.
Faced with this damning assault, EMH supporters fall back on what they call their "nuclear bomb", the failure of active management to outperform the index. However, if fund managers are all trying to outforecast each other, it is no wonder that they don't outperform. New research shows that career risk (losing your job) and business risk (losing funds under management) are the prime drivers of most professional investors. They don't even try to outperform.
Surely, it is high time to consign EMH and its legacy to the dustbin. Shall we manage it? I'm a pessimist. As JK Galbraith said, financial markets are characterised by "extreme brevity of financial memory . . . there can be few fields of human endeavour in which history counts for so little as in the world of finance".
Russia considers banks bail-out
Russia is considering a banking bail-out that will go further than measures taken by the US, as fears grow that bad loans could paralyse the economy. Igor Shuvalov, deputy prime minister, will consider taking stakes in troubled banks when a group of experts on the crisis meets on Friday to discuss ways to recapitalise the country’s banking system, according to a draft proposals seen by the Financial Times.
The proposal, one of several under consideration, would see the government issue OFZ treasury bills, a type of bond, to boost the balance sheets of the biggest banks. In return the state would get preferred shares. Unlike the US bank bail-out, the Russian scheme would see the government take board seats and get veto rights at the banks it bails out. Analysts said such a plan could allow banks to declare the true level of bad loans on their balance sheets, which, once cleaned up under the programme, would break the credit squeeze and allow them to start lending again in 2010.
About $100bn (€72bn, £61bn) in domestic loans fall due by the end of the year and the central bank has said banks’ profits would be totally wiped out if non-performing loans hit 10 to 12 per cent. Standard & Poor’s warned last week problem loans could reach as high as 38 per cent. With inflation, high interest rates, a dearth of new credit and a sharp fall in commodity prices still squeezing companies, bankers say they fear non-performing loans could hit as much as 20 per cent of overall credit portfolios by the end of the year. International ratings agencies Moodys and S&P have warned that Russia could need to spend as much as $40bn recapitalising the banking system by the end of the year.
Under the draft bill being considered on Friday the prefs would be convertible into ordinary shares in 10 years’ time should the bank be unable to pay back the bond when it matures in 2019. The recapitalisation funds would be limited to the top 55 banks in Russia’s 1,100-strong banking system, analysts said. The draft bill says only banks with a minimum of Rbs50bn ($1.6bn, €1.4bn, £1.0bn) in assets would be eligible. People familiar with the discussions said other factions were still pressing for an alternative “bad bank” to be created. The government may not make a final decision until the autumn. Natalya Orlova, chief economist at Alfa Bank in Moscow, said she feared the government could drag its heels on a plan and allow banks to avoid disclosing non-performing loans in hopes the economy would later improve.
The Central Bank has already eased disclosure rules on non-performing loans once this year. But lack of transparency over the depth of the bad loan problem has already added to market volatility – the stock market fell as much as 20 per cent this month after more than doubling this year – and exacerbated a credit squeeze that is likely to help wipe more than 7 per cent off the economy this year. If the government continues to delay, “this means that many banks will just stop operations. They will continue to exist but they won’t be able to provide new loans,” Ms Orlova said.
The government fears it could spend its entire Rbs4,000bn reserve fund and more, once it begins to recapitalise the private banking sector, she added. But Yevgeny Gavrilen?kov, chief economist at Troika Dialog, the Moscow investment bank, said it would be best if the government did not attempt to interfere in the problem but concentrated on lowering inflation instead.
UK Treasury 'failed' on Northern Rock
The Treasury was "ill-prepared" for the collapse of Northern Rock, failed to assess the scale of the bank's bad debts even after bailing it out, made over-optimistic projections about a recovery, and gave too much authority to its advisers, Goldman Sachs. The catalogue of errors is listed in a damning report on the nationalisation of Northern Rock from the influential House of Commons Public Accounts Committee. Edward Leigh, the chairman, said: "The Treasury must never again be so ill-prepared." The report also reveals the cost to the taxpayer of banking, legal and accounting advice over Northern Rock.
Since the Government's intervention in September 2007, fees have totalled £26.8m. Lawyers Slaughter & May have been the main beneficiary, drawing £9.4m, followed by Goldman Sachs with £4.8m and Ernst & Young with £4.3m. Separately, the Liberal Democrats on Wednesday claimed the Treasury has paid Slaughter £22m in fees on the banking crisis in the past year. Lord Oakeshott, Lib-Dem Treasury spokesman, said: "The Treasury should have driven a much harder bargain." Northern Rock's failure could have been avoided, the committee's report suggests, as the Treasury was aware of the risk of a run on a bank after "an exercise in 2004 [that] identified gaps in the framework to protect depositors".
It "did not judge the work to address these gaps to be a priority," it said. The report added that the Treasury failed to do due diligence on the bank's bad debts before putting £51bn of taxpayer's money at risk. It let the bank continue to write 125pc mortgages, and base its strategy on "over-optimisitic" projections on house prices "even compared to forecasts publicly available at the time". Goldman Sachs was also criticised for "refusing the National Audit Office access to the financial modelling underpinning its analyses, even though this had been paid for by the taxpayer".
UK mortgages: 'Fixed rates could reach 6% within weeks'
The average cost of a two-year fixed-rate mortgage has broken through the 5pc barrier for the first time since January and could soon reach 6pc. Lenders are now charging an average of 5.04pc to home owners who want to fix their repayments for two years, up from 4.92pc on Monday and 4.74pc at the beginning of last week. The steep rise in the average rate seen in recent days has been driven by Nationwide's decision to increase the cost of some of its fixed-rate deals for the second time in two weeks. Nationwide was followed by the Woolwich, which raised the cost of one of its two-year fixed-rate deals by 0.7pc, and other lenders are now expected to increase their rates again in the days ahead.
Darren Cook of moneyfacts.co.uk, the financial information group, said the cost of fixed-rate deals looked set to continue rising as lenders increased their rates so that they did not appear to be too competitive. He warned that if the current trend continued, the average cost of a two-year fixed-rate mortgage could break through the 6pc barrier within two weeks, despite the Bank of England base rate being kept on hold at a record low of 0.5pc. He said: "Banks are saying they don't want to be overly competitive and they are being forced to put up their rates, and this is having a spiral effect. If it carries on like this, within a couple of weeks we could see an average rate of 6pc." Nationwide sparked the latest round of price increases when it repriced its entire fixed rate mortgage range on June 12.
Other lenders were quick to follow suit, with major groups such as Halifax, Cheltenham & Gloucester, Abbey and Alliance & Leicester all increasing the cost of the deals they offered. The latest round of price rises is bad news for home owners, with almost 90pc of mortgage borrowers opting for a fixed-rate loan, according to Legal & General, in a bid to lock in to low borrowing costs before the base rate starts to rise again. But there are still good deals available, with Mansfield Building Society offering a two-year fix of 3.39pc for people with a 25pc deposit who pay a £999 fee, while Britannia Building Society has a two-year rate of 5.99pc for those with only a 10pc deposit who pay a £599 fee. For those looking to fix for five years, the Post Office has a rate of 4.45pc at a 60pc loan to value ratio with a £599 fee, and Britannia Building Society is offering 6.19pc at a 90pc LTV with a £999 fee.
An Englishman doesn't have to own his castle
Most of us have a vague notion that home ownership is a peculiarly British thing. We entertain Arcadian fantasies about our houses and gardens, assuming that having your own slice of this green and pleasant land is part and parcel of grown-up life. I am all for fairytales. I have a deep affection for Father Christmas. I adore the Easter Bunny. I even have a little crush on the Tooth Fairy. But it is high time we put an end to the bunk that surrounds the British property market. There is nothing unique about the relationship between Britons and their homes: levels of ownership in Spain and Norway are comfortably higher than they are here.
Owning a house is not a prerequisite for economic maturity: many Germans never buy a property. And the idea that an Englishman's home is his castle has everything to do with his legal rights and nothing to do with owning the blasted place. It's rather surprising that I have to labour this point, with the housing crash now approaching its second year. We ought to have learnt the hard way that home ownership is not a one-way bet – yet I feel keenly that we have not. Once the property market reacquainted itself with the law of gravity, after more than a decade of ever more improbable increases, house prices fell faster than in any post-war property slump. Your home is now worth around a quarter less than in the summer of 2007; as a result, negative equity is fast approaching the heights seen in the early 1990s.
Thanks largely to the unprecedented dose of economic adrenaline pumped into the system in the form of near-zero interest rates, quantitative easing and a stamp duty holiday, the worst of the crash now seems to be over. Prices rose unexpectedly in May, according to Nationwide; and the Royal Institution of Chartered Surveyors claims that buyers are returning to the market in droves. This recovery is probably something of a mirage: prices are likely to fall further in the coming months, though perhaps not as consistently or as rapidly. The recession itself may be coming to an end, at least in the technical sense, but the long saga of rising unemployment and a sickly housing market has some years left to run.
But that's not really the point. The problem is that, however chimerical the recovery, we have not yet absorbed the more fundamental message. Housing bubbles are bad news – yes, even when prices rise rather than fall. In bad times, there are families that suffer the pain and indignity of losing their homes, and households that see their finances crippled, perhaps permanently, by the whims of the market. But an overheated property market is also a ferociously disruptive force in most families' lives: it prompts them to buy homes that are bigger than they really need, and buy them sooner than they probably should, and leaves them vulnerable to a fall in prices. Also, bubbles distribute wealth (or at least perceived wealth) at random.
Someone buying their first home in 2002 would have seen its value leap by more than 40 per cent over the next two years; anyone doing so in 2007 would have seen the price drop by around 25 per cent in the same period. For much of the boom, prices were higher than could have been justified by the simple fundamentals: the value of the bricks, mortar and land, and the supply and demand for housing. As many of us warned, prices were higher not because houses were worth more, but because of the proliferation of debt – the phenomenon that eventually put paid to the financial system. The solution is twofold: first, to ensure that banks never allow their customers to take on debt that could cripple them. This is where the Bank of England comes in. In the past, it has had a single target – to control inflation.
In the future, it must at the very least have a second power alongside this: the ability to control the loan-to-value levels at which banks lend to customers. When it is worried that banks and consumers are overextending themselves, it can tighten the criteria, preventing excessive lending without punishing the rest of the economy with higher interest rates. Second, the Government must reshape the tax system so that it does not favour home ownership. This may mean experimenting with a land tax, whereby families pay annual taxes based on the value of their home and land; it may mean imposing capital gains tax on first homes. Both steps would help prevent another bubble, although they would have unpredictable side effects.
Most of all, however, it is time to remove the stigma associated with not owning a home. A century ago, barely a tenth of households owned their place of residence. Owner occupation was artificially pushed higher by a series of lucrative tax breaks in the post-war era. It could just as easily have been different. The idea that home ownership should be enshrined as a human right – alongside free health care and education – is plain wrong. It is about time that sunk in.
Ireland’s Banks Face $49 Billion of Losses, IMF Says
Ireland’s banks face losses of as much as 35 billion euros ($49 billion) through next year as the economy shrinks at an “unprecedented” pace, the International Monetary Fund said. Gross domestic product will shrink a cumulative 13.5 percent in the three years through 2010 as the bursting of a decade-long property boom ripples through the economy, the Washington-based lender said in a report late yesterday. The losses envisaged are bigger than those forecast by the biggest Irish securities firms.
Bank of Ireland Plc and Allied Irish Banks Plc have the biggest share of bad debts and will probably account for more than half of loans due to go into a proposed bad bank, known as the National Asset Management Agency. Finance Minister Brian Lenihan has said the agency will purchase as much as 90 billion euros in souring property loans. “The assessment of the bad debt outlook is at the top end of estimates for cumulative losses,” Kevin McConnell, head of research at Bloxham Stockbrokers in Dublin, said in a note today. “Much will depend on the working of NAMA, the haircut applied to the bad assets and the level of international recovery seen over the next 18 months.”
The IMF also forecast that Ireland’s budget deficit may widen to 12 percent of GDP this year, four times the European Union limit and above the government’s 10.75 percent projection. The state will only bring the deficit back to the EU limit in 2014, a year behind target, it said. “The stress exceeds that being faced currently by any other advanced economy and matches episodes of the most severe economic distress in post-World War II history,” the IMF said. Lenihan said the IMF’s assessment of the economy was “realistic.”
While the IMF’s forecasts for the economy and the budget deficit are more pessimistic than the government’s, the fund said Ireland is taking the right steps to counter the economic and financial “shocks.” Ashoka Mody, head of the mission to Ireland, said there was “absolutely no reason” to think that the country will default on its debt. NAMA is the government’s latest plan to revive lending and help the economy after it was forced to take control of Anglo Irish Bank Corp. earlier this year. The agency will buy the loans at an as-yet-undetermined discount and the IMF said the state shouldn’t restrict purchases to real-estate loans.
“As the economy continues to contract, a more extensive category of loan could become non-performing,” said Mody. “While not saying this will necessarily happen, it seems to us that there is no harm in having the flexibility.” Goodbody Stockbrokers has estimated that Irish banks face losses of around 30 billion euros, while securities firm Davy has predicted 33 billion euros. The losses faced by the banks are equivalent to about 20 percent of GDP, the IMF said, citing a review of estimates. Mody said the estimates it gathered were “calibrated” against the outlook for economic growth and asset prices.
Standard & Poor’s said yesterday it expects Irish house prices to fall 13 percent in 2009 and a further 10 percent in 2010. Prices have already dropped 20 percent from their peak in early 2007 after almost quadrupling over the previous decade. “We must ensure we have a viable banking system to protect jobs and our economy,” Lenihan said after the publication of the report. “The one way of doing that is to clean up the balance sheets of the banks by removing the impaired assets and returning them to normal functionality.”
Ireland had its credit rating lowered to AA from AA+ this month by S&P, which cited the nation’s rising bill for propping up its banks. Fitch Ratings in April downgraded the country to AA+ from AAA. While Lenihan has said that further bank nationalizations would be “a last resort” for the state, the IMF said that he should keep the option open. Where a bank has been rendered “economically insolvent,” the “only real option” would be temporary nationalization, it said. “In that case, NAMA would continue to act in its capacity as an agency managing bad assets.”
Asia will struggle to escape its export trap
There has been much talk about Asia's rising middle class and the development of a new model based on domestic consumption. So far, that is all it has been: talk. The plain fact is - the dazzling retail emporia of Asia's up-and-coming cities aside - the region has become more, not less, dependent on foreign demand. A decade ago, when Asia was in the midst of its home-grown crisis, exports accounted for 37 per cent of regional output. Partly in reaction to that shock, which exposed an overreliance on flows of fickle foreign capital, economies ramped up their production of manufactured goods. A decade later, overseas shipments accounted for 47 per cent of output.
Asia's heightened reliance on external demand has been masked. In many countries, particularly China, consumption has conspicuously risen: people have been trading in their bicycles for scooters, and their scooters for cars. But consumption has lagged behind overall economic expansion. While they were buying at home, their governments were even more furiously spending swelling trade surpluses on what Paul Krugman, the
Nobel economist, calls "sterile claims" on the US Treasury.
China's household consumption, for example, has fallen to a lowly 35 per cent of gross domestic product, against 50 per cent in the 1980s. Inter-regional trade has also risen sharply, creating a false impression that Asia has somehow broken free of dependence on western consumers. But as much as 60 per cent of inter-regional trade is in components, part of an increasingly sophisticated regional supply chain whose final demand has nevertheless remained predominantly American and European.
As a forthcoming article by Brian Klein and Kenneth Cukier in the journal Foreign Affairs points out, Asia's export-dependent economies - with the important exception of China - have fared even worse than the western economies where the lightning of the financial crisis struck. Taiwan's exports shrank in the last quarter of 2008 by 42 per cent, while production dropped at a faster rate than the US experienced during the Great Depression. Similarly sharp contractions have happened all over Asia. As long ago as 1985, when Washington and Tokyo were at loggerheads over what were, even then, considered Japan's unsustainable trade surpluses, Japan commissioned the Maekawa report to come up with ideas for breaking export dependence. Nearly a quarter of a century later, the job remains undone.
As Clyde Prestowitz, a trade negotiator in Ronald Reagan's administration, says: "I was in the room in 1984 when Japanese prime minister [Yasuhiro] Nakasone promised that Japan would become an importing superpower. It hasn't happened." His explanation is that economic structures are resistant to change. "Export-led economies are organised to export. All the incentives are to save, invest, produce and export. All the politics are organised around that system." China, an economy in an earlier stage of development, has a better shot at transformation. But in China, too, national policies are more stuck in their ways than meets the eye.
It is now nearly universally accepted, for example, that one way to get Chinese to spend more is to im-prove the social safety net to encourage people to run down precautionary savings. Doubtless there is some truth in this. Yet, even if it could be achieved quickly, effects on spending would not be dramatic. The truth is Chinese household savings are not particularly high - lower, say, than in India. The big Chinese savers are the state and state-led corporations.
"It's not clear to me that Chinese consumers have lots of idle cash lying around," says Yasheng Huang, a professor at the Massachusetts Institute of Technology. Prof Huang argues that the real cause of China's low consumption is stagnating incomes, particularly among the 700m rural inhabitants. He blames China's political-economic structure which, he says, since the 1990s has stifled lending to rural enterprises and prioritised spending on the cities. Poor Chinese - and that means most of them - simply have not shared fully in economic growth.
Such structural difficulties do not mean China and others cannot establish new growth models less dependent on debt-fuelled American consumers. If Prof Huang is right, much could be achieved in China simply by incentivising lending to the countryside or legalising underground rural banks. Some of the adjustment will happen automatically. As exports fall, domestic consumption becomes a higher proportion of GDP, whether you like it or not. Stimulus packages are already having an effect. The Jap-anese are buying fuel-efficient cars; the Chinese household electronics. But the trick will be to make domestic consumption - whether of goods or services - a permanent engine of growth.
Hedge-Fund Guy Points Toward Z-Shaped Recovery
Dear investor, our statutory obligations demand that we update you on how well we’ve taken care of your money here at Coin-Toss Investment Management. Attached to this missive is a picture illustrating our fund’s performance this year, showing how wonderfully our back- to-basics approach is working after the derivatives-inspired lunacy of recent years. We’re calling our new strategy “mark- to-flatline” -- slow and steady, it sure beats floundering on the double-black expert slopes of last year’s chaotic madness.
Any resemblance to a chart of how the Standard & Poor’s 500 Index has fared so far in 2009 is purely coincidental, although the more discerning among you may glean some insight into our current market strategy by laying one on top of the other and holding them up to the light. Transparency is a wonderful thing, our auditors keep telling me. The more cynical among you might be tempted to ask what the difference is between a long-only hedge fund, such as ours has become, and a bog standard mutual fund.
The answer, to be disarmingly honest, is found in our fee structure. Simple as that. We trust you will continue to find our services reassuringly expensive in these troubled times. Money should go to where it is welcomed and stay where it is well looked after and, trust me, no-one loves money quite as much as a hedge-fund guy with an unbreakable Ferrari habit.
We do note, though, that some of our so-called competitors are offering to drop their fees. Lest this crazy talk sound at all tempting, we would remind you that any time someone is dropping something, either someone risks breaking a toe or someone is about to catch a cold. Sniffles and cracked digits have no place in the cut and thrust of hedge-fund management. We strive to be in the top quartile of everything we do, including getting paid.
An integral element of our top-down, bottom-picking approach to investing is the time we spend scrutinizing the economic evidence. The debate currently focuses on which letter of the alphabet the chart of global growth will most resemble. Current favorites are a V, a W, a U or an L. Funny how nobody ever suggests an O; call us old-fashioned, we think a cyclical view of the, errr, cycle still has a role to play.
We had been betting on what we think of as a “dot-com” recovery, which would look more like a WWW; in line with the maverick approach for which we are justly famous, however, we now favor a Z-shaped outlook for the world economy. For additional insight into how this is shaping our sophisticated portfolio choices, please refer to the charts already mentioned.
So far, our efforts to wedge our snouts in the U.S. government’s various bailout troughs have, sadly, failed. We note, however, that Bernard Madoff is seeking to serve just 12 years for his $65 billion caper. Even the rusty abacus that serves as our algorithmic ideas generator can work that out at about $5.4 billion per year; we would happily spend six months as someone’s cell buddy for a couple of billion. Our industry faces enormous challenges going forward, not least of which is how to cope with the onerous burden of regulation as the dead hand of government flops onto our Armani- clad shoulders. We are already as busy as a dog with two noses at a bone-smelling competition; the idea that we should have to fill out a form every single year disclosing where the money comes from and where it goes is, frankly, outrageous.
We recently were awarded a Hedge-Fund Operational Quality rating by Moody’s. We would like to claim that we’re not disclosing the results of the analysis, for fear of arousing envy and resentment among our less diligent peers; our score on the “compliance and truthfulness” section of the study suggests that might not be wise. Suffice it to say that it’s a good job nobody pays any attention to the credit-rating companies anymore, not even when Standard & Poor’s threatens to cut Her Majesty Queen Elizabeth’s top grade.
Some of our rivals have generated a lot of publicity by launching funds to jump on the hyperinflation bandwagon. The only evidence we see of rising prices is the cost of winning the annual auction for lunch with Warren Buffett, though we concede that if we’d matched the six-year 600 percent returns of Zhao Danyang at Pureheart Asset Management Co. in Hong Kong, we too might have been tempted to pony up more than $2 million to slice steak with the Oracle of Omaha.
Finally, we would like to give you a rare glimpse into what we feel is one of our most promising investments of the moment, involving Apple Inc., whose overpriced gadgets we have long admired. Our 21-year-old nephew, recently graduated with a degree in computing science, is busy coding a new application for the iTunes store that will run on the iPhone. At just $9.99 a pop, we are convinced there’s a huge market for an app calculator that works out what percentage of a chief executive officer’s body parts have to be replaced before the surgery becomes an event requiring disclosure to the shareholders.
Yours, Hedge-Fund Guy.