Tamasopo River Canyon, San Luis Potosi, Mexico
Ilargi: I'm looking for the proper metaphor here. Let's see. Say, you have an apple that's rotten all over as far as you can see from the outside. And you know that for every rotten apple you need to keep a healthy banana in reserve. 'Cause you got a kid to feed. But your kid doesn't like bananas and insists on having an apple, and throws a big ADD tantrum and all that. Now you happen to know a guy who says he can turn a bad apple into a good one. So you go see the guy. He takes the apple, slices it up, puts the rotten bits to one side and has a few pieces left that at first glance don't look all that bad. He even manages to make it look sort of like an apple again, a small one, but still. He takes a few bits for himself and sends you on your way. Now, you're all excited of course, because you have an apple to feed your kid, and you can sell the banana to someone else, or maybe even trade it for an apple. And the bag of rotten bits in the little bag the guy gave you? Of course, you can sell that to the government.
It's far from perfect as far as metaphors go, but it kind of makes the point. Wall Street is slicing up securities held by banks, insurers and other institutions, for a nice fee, taken out the good parts, shoving the rest off the table into a bin labeled PPIP Potential, and handing back nice looking packages covered in AAA stickers. The holders of the stuff now don’t need to hold as much capital in reserve, so they can go out and wager some more, and their balance sheets look way better too. You would think that everybody's happy except for the taxpayer, but since the latter has no idea what's going on, he's happy too, because he thinks that what's good for the banks is good for him too.
The taxpayer can play the role of Sleeping Beauty, and bite full-force into that rotten fruit. That story only works, though, if and when that beautiful and noble handsome prince actually shows up to pull off his Heimlich maneuver. Well, here's the bad news: the prince ain't coming, he died of AIDS sometime in the 1980's and the dogs are fighting over the last scraps torn off the carcass of Mother Goose.
The banks need to pay the FDIC advance premiums for their insurance policies, and they're happy to do it, because the premiums can be listed in their year-end books as assets with zero risk, for which no capital requirements are necessary.
Did anything change for the better, is there a market opening up for rotten toxic apple bits? No, nothing of the kind. Wall Street has an A-class make-up department, that's all there is to say. The PPIP bamboozle hasn't taken off until now, but the Treasury takes another shot at starting it up, with the reassuring idea that it will be smaller than initially thought. It can do that because what will be bought now, after the rotten apple trick, is indeed less expensive. What it doesn’t say it that will be bought now is really absolutely and totally worthless, and buying that part with taxpayer money and guarantees is really nothing but a complete scam. Wonder if this time around anyone has the chutzpah to claim that the taxpayer might make a nice profit off that deal. My money says someone will.
You know, a lot of those securities are mortgage backed, and in 2009 the Federal Reserve alone has bought more mortgages than were issued in total. Throw in Fannie and Freddie and Ginnie and the FHA and soon you the taxpayer will have bought every bad mortgage that's been issued ever since Glass-Steagall was buried in a shallow grave.
And if Washington and Wall Street have their way, it won't stop there. No sirree, ma'am. A report by Amherst Securities estimates that the number of already delinquent mortgages that have yet to be liquidated stands at 7 million today. Which means home prices will keep on falling for a long long time to come. It also means that if nobody stops the scheming, another $1.5 trillion will be added to your tab from this source alone.
The only consolation for the poor slobs in the street -yes, that's you, you just don't know it yet- is that it will all come to a crashing halt when the stock markets do. And no matter how many times no matter how many people try to make you believe that jobless recoveries are some sort of natural phenomenon, and that home prices can indeed stabilize as foreclosure rates rise at exponential rates, and now's the time to buy because surely the bottom must have been reached, the game is up and a whole new rulebook must be written once investors start withdrawing their money en masse from the markets.
And look at the world markets today. Think that maybe nerves are getting jittery out there? Think perhaps those nerves will prove to be contagious little pests? I asked it before: how many people do you think there are left out there who think stocks will keep on going up after a 50%-odd rally based on job losses and foreclosures?
There are ever more stories popping up about the direct phone lines linking Wall Street to the Treasury. And these stories have an ever harder time making it to the front pages. They are not news anymore, since they no longer surprise us.
There once was a time, and it's not even that long ago, when the term "Moral Hazard" had a profound meaning that everybody in finance had respect for. Today, Moral Hazard means nothing anymore. The gutting of the term has become a cornerstone of government policy. And that harks back to something I told you a long time ago: this is not a financial crisis we're in, it's a political crisis, and a full-blown one.
Wall Street Wizardry Reworks Mortgages
A new wave of financial alchemy is emerging on Wall Street as banks and insurers seek to make soured securities look better. Regulators are pushing back, saying the transactions don't have enough substance and stand to benefit bankers and ratings firms. The deals come as Wall Street firms, buoyed by surging markets, are seeking to profit from the unwinding of the complicated securities that helped fuel the credit crisis. Regulators, meanwhile, are struggling to prevent a recurrence of the crisis.
The popular deals are known as "re-remic," which stands for resecuritization of real-estate mortgage investment conduits. The way it works is that insurers and banks that hold battered securities on their books have Wall Street firms separate the good from the bad. The good mortgages are bundled together and create a security designed to get a higher rating. The weaker securities get low ratings. The net result is financial firms' books look better and they need to hold less capital against those assets, even though they are the same assets they held before the transaction.
Some state insurance regulators worry that current ratings are flawed -- perhaps even too harsh -- for determining the capital that should back up residential-mortgage securities. But they are chafing at the re-remic strategy. That's partly because of the fees and partly because re-remics rely on ratings firms -- faulted for failing early on to identify problems with mortgage-backed bonds -- to rate the new securities. At hearings Wednesday on Capitol Hill focused on the ratings firms, U.S. Rep. Dennis Kucinich (D-Ohio) raised concerns about the mounting number of re-remics, saying, "The credit-rating agencies could be setting us up for problems all over again."
New York and some other key regulators are considering an alternative to re-remics that doesn't entail insurers paying millions in fees to investment banks and the ratings firms; they also have debated possibly unfavorable accounting treatment for the re-remic deals. Regulators would like "a lot fewer dollars" paid to Wall Street, as well as "less reliance on the ratings agencies," said Kermitt Brooks, first deputy insurance superintendent in New York. The state is an important voice on financial matters at the National Association of Insurance Commissioners, or NAIC.
The alternative solution, proposed by trade group American Council of Life Insurers, calls for hiring an analytical firm with expertise in residential mortgage-backed securities to help regulators determine the value of deteriorated holdings on insurers' books, bypassing the ratings providers. This firm would help size up potential losses and how much capital the insurers need to hold. The re-remic accounting treatment, meanwhile, is expected to be taken up at a meeting of NAIC regulators in December. It is unclear how big a concern this is for banking regulators. Alabama Deputy Banking Superintendent Trabo Reed said he has seen only a few examples of re-remics. His concern is that banks engaging in this practice account for it correctly.
Wall Street analysts said activity in re-remics has ramped up this year, from a trickle in January to several billion dollars from March to June, with a big increase in volume in July, partly thanks to reviving credit markets. Estimates of volume this year range from $30 billion to more than $90 billion. The transactions are typically done as private placements and aren't disclosed publicly. A hypothetical example cited in research by Barclays Capital said that a $100 million asset that required $2 million in capital at a triple-A rating may require $35 million if downgraded to double-B-minus. At triple-C, the capital requirement might rise to 100%, or $100 million.
In a re-remic, three-fourths of the same asset may regain a triple-A rating, requiring just $1.5 million in capital, Barclays said. The remaining one-quarter may require 100% capital, but the total capital requirement would fall to $26.5 million. Wall Street bankers and analysts said a minority of re-remics, perhaps as little as 10% to 30%, are aimed at helping firms like insurers manage capital requirements. The general goal, as one banker put it, is to help "create buyers for orphan securities that otherwise would have languished."
"There is $350 billion to $400 billion in market value of securities with no natural buyer due to their rating," Barclays said in a June report. "The re-remic market provides a way out of this gridlock by creating new AAA securities, which are likely to be viewed as attractively priced." Wall Street firms that have acted as middlemen in re-remics include J.P. Morgan Chase & Co., Credit Suisse Group, Jefferies & Co., Royal Bank of Scotland Group PLC, as well as Barclays PLC, according to a Barclays tally.
Citigroup Inc., meanwhile, is pursuing its own re-remic strategy, to repackage some toxic real-estate securities on its balance sheet, according to people familiar with the bank. Insurance executives estimate that insurers pay 0.35% or so of a deal's size in investment banking, ratings firm, legal and other costs. American Equity Investment Life Holding Co. has told analysts that it is considering a re-remic. Recent downgrades of its mortgage bonds overstate their risk by a wide margin, its executives said. Still, a re-remic is "not cheap," John Matovina, the company's finance chief, said in an interview.
On Sept. 15, an executive at American Financial Group Inc. noted to investors that re-remic transactions there involving about $1.2 billion of mortgage bonds provide "flexibility." And Protective Life Corp. said in August that its re-remics, totaling about $1.4 billion, improve the company's capital standing "in the ballpark" of $75 million. At an NAIC hearing last week, ratings firms described changes over the past year to improve their analytical, compliance and corporate-governance processes. But they also generally agreed that their ratings weren't ideal as a sole basis for determining insurers' capital levels.
Government Makes First Foray Into Buying Toxic Assets
The Treasury Department's long-delayed initiative to purchase toxic assets from financial firms launched Wednesday, nearly a year after Congress authorized the government to tackle what once was billed as the most critical problem facing the banking system. With the financial crisis abating this year, the government's first foray into buying troubled assets totaled around $4.5 billion. A quarter of the money comes from private investors.
Administration officials said the program could eventually expand to $40 billion, a fraction of what was initially envisioned by the Obama administration. The Treasury program is billed as a Public-Private Investment Partnership, or PPIP, in which a fund is set up with private dollars that are matched by government money. The fund is then eligible for even more funding in the form of a favorable government loan.
While the program is starting off modestly, officials in government and industry say it could still play an important role. Banks are still saddled by toxic assets, which constrain their ability to lend. Many firms can rid themselves of the problem only by recognizing vast losses, said Wilbur Ross, who was one of the nine managers selected by the Treasury to run one of the PPIP funds.
"This is a good use of money to shore up institutions," said Ross. "Frankly, the big part of the reason why bank lending has gone no where is because of these toxic assets." Ross, who is heading up Invesco's PPIP fund, and a separate fund set up by TCW Group raised a total of $1.13 billion in recent weeks. The Treasury has matched that amount, dollar for dollar. If the investments turn out to be profitable, both taxpayers and the private investors could see soaring returns.
In addition, the Treasury is offering a loan of $2.26 billion that will give the funds even more buying power. This loan can magnify profits but also can cause losses to be more severe. "I am pleased with the progress we have made in launching PPIP," said Treasury Secretary Timothy F. Geithner in a statement. "This program allows Treasury to partner with leading investment management firms to increase the flow of private capital into the market for legacy securities and give taxpayers a chance to share in the profits."
Seven other major investment firms are in the process of raising more money. These initial efforts could bring the first round of toxic asset purchases to more than $10 billion, according to industry and government sources familiar with the program.
US Foreclosure Rate Rises 17 Percent
The number of homes lost to foreclosures rose about 17 percent in the second quarter of this year despite the launch of an extensive government program aimed at helping borrowers save their home, according to government data released Wednesday.
Completed foreclosures reached 106,007 during the second quarter, compared with 90,696 during the first three months of the year, according to the report by the Office of Thrift Supervision and the Office of the Comptroller of the Currency, which regulates banks. Their quarterly report examines 64 percent of outstanding mortgages in the country. The increase was primarily the result of various government and industry foreclosure moratoriums, the report said.
Efforts to keep borrowers in their homes increased during that same period, including the implementation of the Making Home Affordable plan. Under that plan, lenders are paid to lower a borrower's monthly payments. Government data has shown that since the program was launched in March, nearly 400,000 borrowers have been helped. The Obama administration aims to complete 500,000 loan modifications by November.
But even as that program ramps up, rising unemployment continues to hamper foreclosure prevention efforts. The level of foreclosure actions started during the quarter stayed steady, while the number of seriously delinquent borrowers -- those who had missed at least two payments -- increased 10 percent, according to the report. The mortgage data "continued to reflect negative trends influenced by weakness in economic conditions including high unemployment and declining home prices in weak housing markets," the report said.
The report also reflected the risks still posed by hundreds of thousands of risky home loans known as option adjustable-rate mortgages, which reset to significantly higher payments. With these "option ARMs," also known as pick-a-pay loans, a borrower chooses how much to pay each month, often less than the interest due. But the payments on these mortgages eventually rise significantly, putting the borrower at risk of losing the home.
More than 15 percent of these types of loans were seriously delinquent during the second quarter, compared with 5.3 percent of all mortgages, according to the report, and 10 percent were in the process of foreclosure. "The risks of these loans and geographic concentration caused them to perform significantly worse than the overall portfolio," the report said.
Federal Reserve Buys More Than 100% of Mortgages Issued in 200
by Chris Martenson
This is important information. What I've found and present below is that the Federal Reserve is not just supporting the housing market, it is the housing market.
Just as important as a person's desire to buy a home is their ability to gain access to mortgage funding.
The mortgage market is a gigantic beast with many moving parts, but it is pretty easy to understand from a high level.
The process works like this: A homeowner secures a mortgage from a bank or mortgage company. Then the mortgage is sold off to another company, with the cash generated by that sale now available to lend to other potential homeowners. Ultimately the mortgage may pass through several sets of hands but ultimately it lands with a terminal holder.
In that chain, the mortgage might get sold off several times, or perhaps sliced and diced by Wall Street wizards, but all that matters is that some company (with cash) is there at the end to buy the mortgage to keep the whole chain moving along.
Lately, the "terminal buyers" in that chain have increasingly ended up being the federal government (through the GSEs) and the Federal Reserve.
And not just by a little bit, but by a lot.
Here are the numbers:
Taken together, and assuming that we live in a world where 10% is the average down payment, we get this table:
That is, a total of ~$686 billion in new mortgages were issued in 2009 (through August).
Now let's look at how many Mortgage Backed Securities (MBS) and agency debt obligations were accumulated by the Federal Reserve on its balance sheet over the same period of 2009:
It turns out that in 2009 (again, through August), the Federal Reserve has bought $624 billion of MBS and a further $98 billion of Agency debt, for a total of $722 billion in money injection into the housing market through Fannie Mae, Freddie Mac, and the FHLB.
In other words, the Federal Reserve alone bought $722 billion of mortgages and agency debt when only $686 billion in new mortgages were issued. So, through August, the Fed bought more than 100% of the entire supply of new (purchase) mortgages in 2009.
That's not a free housing market; that's a market bought, owned, and sustained by the Federal Reserve's willingness to print up three quarters of a trillion dollars out of thin air.
While the individual mortgages issued in 2009 may or may not be the exact same ones purchased by the Federal Reserve, that's immaterial. All the mortgage issuers care about is that when they issue a mortgage, a purchaser with money exists somewhere down the line. The chain needs a terminal buyer, and that buyer has become the Federal Reserve.
The impact of these purchases by the Federal Reserve is to both provide liquidity and to drive down the rate of interest for new mortgages. By lowering both the long end of the Treasury curve (which the Fed does by actively buying Treasuries) and providing more than sufficient demand for MBS and agency paper, long-term interest rates come down.
Without the Fed's activities, it is a rock-solid certainty that mortgage interest rates would be higher than they are, and possibly a LOT higher.
What all this means is that when (not if) the Federal Reserve begins to try and unwind itself from all of the magnificent interventions of the past year, it must contend with the fact that it is the housing market.
Where the Fed is hoping that it can gently release the soft chubby fingers of the housing market, which will then toddle off under its own power, it will discover that it is actually carrying a helpless newborn.
Massive Housing Overhang Will Swamp The Market
The latest Case-Shiller reading showed another sequential uptick in July, which is all fine and well, but watch out: There's a huge flood of houses being held back from the market, either due to bank-ownership, or loan delinquency.
Check out the chart below, from Amherst Securities. It shows the number of delinquent mortgages that have yet to be liquidated-- a number that Amherst puts at a shocking 7 million (135% of the number of houses sold in a year right now). Eventually the houses attached to these loans have to hit the market. When they do, expect them to go at a firesale.
Fannie Mae Serious Delinquency Rate Increases Sharply
Here is a hockey stick graph ...
Fannie Mae reported that the serious delinquency rate for conventional loans in its single-family guarantee business increased to 4.17 percent in July, up from 3.94 percent in June - and up from 1.45% in July 2008.
"Includes seriously delinquent conventional single-family loans as a percent of the total number of conventional single-family loans. These rates are based on conventional single-family mortgage loans and exclude reverse mortgages and non-Fannie Mae mortgage securities held in our portfolio."
Just more evidence of some shadow inventory and the next wave of foreclosures.
Update: These stats include Home Affordable Modification Program (HAMP) loans in trial modifications.
Unprecedented U.S. corporate defaults seen for '09
U.S. corporate debt default rates are expected to hit "unprecedented" levels in 2009, even though the economy may be past the halfway mark of the U.S. recession, according to a forecast unveiled on Monday at the Reuters Restructuring Summit. "There is a lot of pain left -- we are only just half way through the 600 or so defaults in this cycle," said Phil Kleweno, a partner at Bain's corporate renewal group.
The forecast for the 2009 corporate default rate has risen to 12 percent to 14 percent, from a May forecast of 11 percent to 13 percent, according to Bain's corporate default outlook. That suggests a total of about 180 to 210 companies could default on their debt this year. "Our ongoing gross domestic product models are calling for a softer and longer climb out" of the economic decline than previously thought, said Kleweno.
Defaults will rise to 500 to 600 in the period between 2008 and 2011, up fivefold from the previous four-year period. About 50 percent of defaults to-date have occurred in media, entertainment, automotive, chemicals and packaging industries. Going forward, there will be little relief for these sectors, he said. "Consumer facing companies will continue to be at a higher risk of default," said Kleweno.
More defaults will come from debt exchanges -- meaning a company agreed with its bondholders to exchange old debt for new debt and equity -- rather than from corporate bankruptcies, according to the study. Distressed debt exchanges have occurred 40 percent more often than bankruptcies so far this year. "People are being proactive," said Kleweno. But he added that these amendments are only buying time. Rather than fixing the balance sheet, the amendments and lender negotiations tend to kick the can down the road and defer the problem, he said.
Though Bain expects the U.S. economy to bottom by the end of this year, corporate default pressures will remain as many companies continue to struggle to meet interest payments on heavy debt loads. Bain expects the default rate in 2010 to be around 9 to 11 percent of debt issuing companies, or about 140 to 160 defaults. A spike of maturities beginning next year will cause the next wave of financial distress, according to the Bain study.
Debt maturities are expected to rise 50 percent in 2010, from the year before, to $62 billion, then almost double again the following year, to $117 billion. "As debt matures over the next couple of years, speculative grade refinancing will prove difficult," according to the Bain study.
Red Bull Crash
It's a fine day for the pessimists.
Very rarely does the consensus estimate miss the Purchasing Managers’ report by six points, and never in my recollection when it went from even to a pronounced negative.
Purchasing Managers’ % Showing Expansion
The problem is that Americans have not yet begun to save. With the largest retirement wave in history underway (bringing retirees from 19% to 25% of the population by 2020), and an enormous savings deficit, the savings rate has barely climbed up to 5%:
The “normal” rate during the 1970s and 1980s with a much younger population was around 10%. With an aging population, the savings rate should rise markedly; it should rise all the faster given the shock to wealth during the past year; and it should rise even faster given extremely low real returns available on bonds.
The real yield on 10-year Treasuries as measured by inflation-indexed instruments is only 1.5%. The nominal yield on two-year AAA municipal bonds is 0.75%, less than the rate of inflation.
The savings rate will rise to the 10%-15% range. As long as exports contribute marginally to output, the increase in savings must come out of spending. The Red Bull high of government spending won’t last long.
U.S. Income Inequality Is Frightening - And Much Worse Than We Thought
The newest economic inequality numbers, which ran counter to the expectations of almost all experts, are frightening.
The Associated Press released an article titled, US income gap widens as poor take hit in recession. The opening paragraph of the article, based on recent census data, reads:The recession has hit middle-income and poor families hardest, widening the economic gap between the richest and poorest Americans as rippling job layoffs ravaged household budgets.
The article, which then discussed the Census statistics that led to this conclusion, failed to mention that the Census Bureau considered the differences between 2007 and 2008, with regard to economic inequality, statistically insignificant.
But, whether the Census Data shows a meaningful increase, or not. is irrelevant. The Census Data reports that, contrary to the almost universal expectations of economists, economic inequality most likely did not decrease in 2008. Experts had anticipated that the declines in income of the rich would lead to a reversal in this groups ever–widening share of our national income. Instead, the Census reported that the 2008 income losses by the top 10% of Americans were offset by larger losses among middle class and poorer Americans.
MIT economist Simon Johnston appears to have been one notable exception to this expectation of a shrinking income gap.
Let’s review what we know about the measurement of income inequality before discussing the disturbing implications of this newest government report.
About two weeks ago, I critiqued a Sept 10, 2009 front page story in the Wall Street Journal titled, Income Gap Shrinks in Slump at the Expense of the Wealthy. My critique had three central points:
First, economists have, with few exceptions, agreed that Census Data is inappropriate for measuring income inequality because it consistently understates the income of the wealthiest families. To protect the privacy of reporting individuals, the Census “top-codes” income, which means that no one is ever recorded as making more than about $1.1 million in a single year. So, oil traders, hedge fund executives and anyone else at the super-high end of the income strata who might earn $100, $50 or $5 million in a single year, always earn $1.1 million or less in this Census Data. In addition, the Census Data does not include capital gains income, which is typically a large source of income for the wealthiest Americans.
Two economists, Professors Emmanuel Saez and Thomas Piketty, developed a method for measuring income inequality using IRS data, which avoided the problems inherent in using Census Data. This data was recently updated in response to the IRS release of 2007 information, and found that: Economic inequality in 2006 was, by some measures at the highest levels, ever found in the data available for the past 95 years. In 2007, these same measure showed a further jump further bringing America to it it’s highest levels of economic inequality in recorded history.
As a consequence of Census top-coding and the lack of capital gains data, the Saez-Piketty methodology has consistently shown that the Census substantially understates the extent of economic inequality in the nation. This means that, there is a real possibility that the the new Census Data understated the extent to which income inequality grew in 2008, and that the relative losses of the wealthiest families, versus less fortunate Americans, will be more than statistically insignificant.
It is possible that losses in reported capital income by the wealthiest Americans, if captured by the Saez-Piketty methodology, will be larger than the the incomes above $1.1 million that were not reported and offset the Census findings, leading as economists anticipated to a decline in the share of income going to the rich. However, I view this as unlikely. In considering this possibility, its important to remember that the IRS works on reported income gains, not gains which were never captured as taxable income. For income reporting purposes, the question is not whether the market value of capital assets declined but whether they were sold at an actual loss from their purchase price.
We will not know the answer to this question until July or August 2010, but in weighing the available evidence my working hypothesis is that as demonstrated by this new Census Report, income inequality did not decrease from 2008 to 2007.
Second, the original Journal article expressed a strong expectation that, as a result of the Great Recession, the ongoing growth of income inequality would decline substantially through 201o. My critique indicated that this was “far from clear.” The conventional economic wisdom, based on historical data, is that income inequality decreases, at least temporarily, as the richest Americans lose income faster than less-well-off Americans during a downturn. In contrast, this new data suggests that the dangerous cycle toward increasing income at the top of America has become even more self-reinforcing than previously recognized. We are now at the point where the pure market forces, which many economists told us would eliminate this issue, are no longer effective.
Third, the Journal article implied that the decrease in economic inequality it incorrectly predicted might be the start of a long-term trend. Instead, I demonstrated that, even if income inequality did decline in 2008 and 2009, it would almost certainly be “temporary.” The historical evidence shows that economic inequality frequently declines in a downturn, in the absence of strong government action, but that it will almost inevitably rebound and continue its march forward.
Now, let’s return to our main point:
Early next week, my new book It Could Happen Here will be released by HarperCollins. The book is an in-depth look , based on a historical analysis, of the implications of our historically high levels of economic inequality for the nation’s ultimate, long-term political stability. As economic inequality grows, nations invariably become increasingly politically unstable: Should we complacently believe that America will be different?
A central conclusion of the book is that once economic inequality reaches a self-reinforcing cycle it is halted only by inevitably controversial, hard-fought, bitterly opposed government action. Senator Jim Webb encapsulated this idea, when he wrote in his book, A Time to Fight: Reclaiming A Fair and Just America:“No aristocracy in history has decided to give up any portion of its power willingly.”In 1928, economic inequality was near today’s levels. Franklin Roosevelt succeeded in reversing the trend toward the continuing concentration of wealth, but it was a turbulent battle. In 1936, while campaigning for his second term and speaking at Madison Square Garden, FDR told the crowd:Never before in all our history have these forces [Organized Money] been so united against one candidate as they stand today. They are unanimous in their hate for me and I welcome their hatred.
I should like to have it said of my first Administration that in it the forces of selfishness and of lust for power met their match. I should like to have it said, wait a minute, I should like to have it said of my second Administration that in it these forces met their master.
In FDR’s era and in our own, money brings power: both explicitly and implicitly, in hundreds of different ways, both large and small. Today, the wealthiest Americans, together with a number of financial and corporate interests that act on their behalf, protect their ever-increasing influence through activities that include, among others, lobbying, supplying expertise to the councils of government, casual conversation at dinner parties, the potential for jobs after government service, the power to run media advertisements that influence public opinion. Indeed, MIT economist Simon Johnston, writing in The Atlantic asserted that the U.S. is now run by an oligarchy:The great wealth that the financial sector created and concentrated [ from 1983 to 2007] gave bankers enormous political weight–a weight not seen in the U.S. since the era of J.P. Morgan (the man) … Of course, the U.S. is unique. And just as we have the world’s most advanced economy, military, and technology, we also have its most advanced oligarchy.
The new inequality data suggests that the potential problems for the nation associated with the concentration of wealth and power are even more severe than previously recognized. Two weeks ago, I wrote that “Once income concentration becomes a reinforcing cycle of the kind we are witnessing, it is never stopped by pure market forces.” This mechanism is now in full swing. The market forces associated with the Great Recession, which many economist had expected to stem the growing, corrosive gap between the rich and the poor, appear to have become ineffective.
The great strength of American democracy has always been its capacity for self-correction. However, Robert Dahl, the eminent political scientist, recognized that political power fueled by wealth may ultimately neutralize this central aspect of our democracy. In his 2006 book, On Political Equality, Dahl wrote:As numerous studies have shown, inequalities in income and wealth are likely to produce other inequalities..The unequal accumulation of political resources points to an ominous possibility: political inequalities may be ratcheted up, so to speak, to a level from which they cannot be ratcheted down. The cumulative advantages in power, influence, and authority of the more privileged strata may become so great that even if less privileged Americans compose a majority of citizens they are simply unable, and perhaps even unwilling, to make the effort it would require to overcome the forces of inequality arrayed against them.
In the chapter following this quote, Dahl notes “that we should not assume this future is inevitable.” He’s right. But, was clearly concerned. Three years late, we should be even more concerned.
Many current Executive Branch initiatives deserve our support and praise: However, nothing proposed to date will effectively halt growing economic inequality, and its corrosive impact on our economy and the long-term future of the nation. (In a future post, I will explicitly discuss the proposed regulatory reform of the financial sector.)
My analysis in It Could Happen Here concludes that without a vibrant middle class, the the American democracy as we know it, is not sustainable. Before the Great Recession, the middle class was in far worse shape than was generally acknowledged. In an economy with a record number of job seekers for every available job, the potential for nearly one-half of all home mortgages to be underwater, and increasing foreclosures, the collapse of the middle class will accelerate. With each job loss and each foreclosure, another family becomes a member of the former middle class.
America has never been a society sharply divided between have’s and have not’s. Unfortunately, this new data says to me we continue to head in that direction. Economists assumed that the Great Recession would be a circuit breaker that would halt this advance, at least temporarily. It did not.
With no new legislation, it appears we are potentially on course for 13 million foreclosures, almost one in every four mortgages in the nation, from the end of 2008 through 2014. Do we really believe that we can turn such huge numbers of Americans out of their homes with no consequences for the health of our system of governance? Could our democracy survive a transformation into a nation composed principally of a privileged upper class and an underclass which struggles from paycheck to paycheck and lacks basic economic security?
We will only stop the growth of economic inequality if the President and the Congress are ready to fight in the style of Franklin Roosevelt. FDR was a divider not a conciliator. Before World War II, he fought an all-out war at home. Today, “There’s class warfare, all right,” as Warren Buffett said, “but it’s my class, the rich class, that’s making war, and we’re winning.”
I fervently hoped that we have not passed the point of no return, described by Professor Dahl. The recent news shows we are one step further on this road. If we continue down it, our nation may be on the path to becoming a House divided against itself, which ultimately cannot stand.
States and Towns Lean on Taxpayers
State and municipal governments, struggling with sinking revenue, are raising money by levying fees on consumers, slapping local businesses with back taxes and tweaking tax laws in ways that force many businesses to pay more. That is leading to accusations -- and, in some cases, lawsuits -- that governments are trying to rake in more money without officially raising taxes, sometimes illegally. The San Francisco Board of Supervisors, which can't easily raise taxes without a referendum, has approved a controversial cigarette "fee" of 20 cents a pack that takes effect next month.
Last week, five retailing groups sued New York state alleging that a new tobacco-registration fee was unconstitutional. The groups argued the new fee, which uses a sliding scale based on a retailer's total sales, instead of just cigarette sales, "is essentially a tax," said Andrew Curto, a lawyer representing the groups. Across the nation, lawyers say municipalities are stepping up audits of businesses in a hunt for back taxes. "We have several cases right now that are at the audit stage, and the localities are taking very aggressive stances," said Eric Tresh, a partner in the Atlanta office of corporate law firm Sutherland Asbill & Brennan. "We're going to see a lot more of these cases in court."
After an audit last year, the city of Sandy Springs, Ga., sent locally based electricity producer Mirant Corp. a tax bill for about $14 million in occupation tax, including interest and penalties, for 2006 to 2008. That compared with a bill of about $85,000 in occupation tax -- a kind of sales tax levied on companies instead of consumers -- that the company paid in 2005. Mirant fired back with a lawsuit alleging the city's reading of Georgia tax law was "erroneous and unlawful."
A few months later, Mirant saw some relief as Sandy Springs retroactively capped its occupation tax at $400,000 a year, resulting in Mirant owing about $1.2 million -- still about $1 million more than what it believes it owes in taxes. The city said it is simply collecting its due. "Our ordinance is valid, and we are in court defending our right to collect the tax," said Wendell Willard, the city's attorney. In San Francisco, tax lawyers say the city is sidestepping the electorate by labeling the new cigarette levy as a fee instead of a tax. A spokesman for San Francisco Mayor Gavin Newsom said the fee only would recover the annual cost directly tied to cleaning up cigarette butts.
States' tax revenue fell 11.7% in the first three months of 2009, the steepest decline on record, and collections have gotten even weaker since, according to a recent report by the Nelson A. Rockefeller Institute of Government at the State University of New York. Falling business profits and consumer skittishness have crimped income and sales taxes. At the local level, falling real-estate values have forced cities to lower property taxes -- the primary source of funding in many places.
Nobody tracks the number of states or municipalities that have more broadly interpreted their tax laws to make up for these lost revenues, or the number of lawsuits challenging them. But local tax lawyers and organizations that represent corporate taxpayers say such disputes often go up in a slowing economy, and are on the rise today. "Companies are feeling besieged by the increased aggressiveness of certain state departments of revenue," said Doug Lindholm, president of the Council on State Taxation, a group that represents state taxpayers.
One of the more common disputes involves what tax lawyers call "nexus," or rules that guide what businesses the state can and can't tax. The most well-known example is New York's "Amazon law," which refers to a state law that requires online retailers to collect local sales taxes even if the company has no physical presence in the state. Amazon has challenged the law in court, lost and is now in appeal. Rhode Island and North Carolina have passed similar legislation. Among the more aggressive states has been California, which teetered on the brink of insolvency during a budget impasse earlier this year.
In addition to new taxes and employee furloughs, the state's legislature recently passed a 20% surcharge on companies that underpay taxes by $1 million or more. California has also revised its tax code to clarify the definition of what it means to do business in the state. A company is doing business there if, among other things, its California sales are 25% of total sales or more than $500,000, whichever is lower. The old standard stated that companies doing business in California were those "actively engaging in any transaction for the purpose of financial or pecuniary gain or profit" -- an ambiguous statement, but one that many lawyers took to mean that a company had to have a physical presence in California to be subject to tax.
S&P/Case-Shiller Home Price Index Fell 13.3% In July
While home prices continue to show a notable decline compared to a year ago, Standard and Poor's released a report Tuesday morning showing that the pace of decline in home prices slowed for the sixth consecutive month in July. The report showed that the S&P/Case-Shiller 20-City Composite Home Price Index fell at an annual rate of 13.3 percent in July compared to the 15.4 percent drop reported for June. Economists had expected the index to be down 14.2 percent year-over-year.
Jobless rates rise in all U.S. cities in August
Unemployment rates rose in all cities across the United States in August from a year earlier, with 16 recording jobless rates of 15 percent or higher, according to the Labor Department. At the same time, only 11 metropolitan areas said they had gained jobs in August, while 356 had lost positions. For the eighth consecutive month, all 372 cities that the department surveys had year-on-year increases in jobless rates.
The largest rise was in Detroit, where the rate rose by 7.9 percentage points, followed by its Michigan neighbor Muskegon, where it increased 7 percentage points. Detroit also has the highest unemployment rate in the country at 17 percent. But Los Angeles lost the most jobs in August from a year earlier, followed by Chicago and Detroit. Looking at the data, the Associated General Contractors of America found that construction employment had dropped in 324 metropolitan areas over the year. Reno, Nevada, lost 35 percent of its construction workforce, it said, showing that the housing bust that has rattled most of the West still continues to damage construction employment.
"The problems facing the construction industry aren't just devastating construction workers, they are crippling our broader economy," said Stephen Sandherr, the association's chief executive officer in a statement. The federal stimulus plan in February was intended to address the staggering construction job loss the country has experienced since home sales dropped and home building came to a near standstill. But the contractors' group said the package had not done enough and the country needs a new plan that will reverse its projections that construction payrolls continue to shrink through next year.
The U.S. nonfarm employment report on Friday should shed light on how much the stimulus helped put construction workers back to work, especially in the road repaving and infrastructure projects that dominated the $787 billion plan. But the contractors said the city data for August shows that 13 areas saw a total increase in construction of 2,800 people over the course of the year, during half of which the stimulus was in effect. During the same time period, Sandherr said, the industry lost 1 million jobs.
ADP Says U.S. Companies Cut 254,000 Jobs This Month
Companies in the U.S. cut 254,000 jobs this month, more than forecast, a private report based on payroll data showed today. The estimated drop, which was the smallest since July 2008, compares with a revised 277,000 decline the prior month, figures from ADP Employer Services showed. The ADP report was forecast to show a decline of 200,000 jobs, according to the median estimate of 33 economists in a Bloomberg survey. Projections ranged from decreases of 300,000 to 133,000.
Companies may keep firing workers until they see sustained gains in demand. While economists predict a return to growth this quarter, the Federal Reserve said last week that sluggish income growth and tight credit are curbing household spending and slowing the pace of the recovery. “The state of the labor market is still very weak,” Julia Coronado, senior U.S. economist at BNP Paribas in New York, said before the report. Job losses are “weighing on wages and income,” she said, and “still a headwind to growth.”
The world’s largest economy shrank at a 0.7 percent annual rate from April through June, the best performance in more than a year, according to revised figures from the Commerce Department released today.
Futures on the Standard & Poor’s 500 Index rose after the better-than-forecast report on gross domestic product, gaining 0.6 percent to 1,061.1 at 8:37 a.m. in New York. ADP includes only private employment and doesn’t take into account hiring by government agencies. Macroeconomic Advisers LLC in St. Louis produces the report jointly with ADP.
The report comes two days before a Labor Department release forecast to show the U.S. unemployment rate rose to 9.8 percent in September, the highest since 1983, while employers cut 180,000 jobs. The economy has lost 6.9 million jobs since the recession began in December 2007, the most of any economic slump since the Great Depression.
Today’s report showed a decrease of 151,000 workers in goods-producing industries including manufacturers and construction companies. Service providers cut 103,000 workers. Employment in construction fell by 73,000, the 32nd straight monthly drop, while financial firms decreased jobs by 19,000, ADP said, the 22nd consecutive decline for the industry. Companies employing more than 499 workers shrank their workforce by 61,000 jobs. Medium-sized businesses, with 50 to 499 employees, eliminated 93,000 jobs, and small companies cut 100,000, ADP said. Announcements of staff reductions continued last week.
UAL Corp.’s United Airlines, the third-biggest U.S. carrier, furloughed 290 more pilots under a plan to trim payrolls and limit labor costs. The layoffs bring to 1,164 the number of furloughed pilots at Chicago-based United, the Air Line Pilots Association told members in a Sept. 22 recorded message. The ADP report is based on data from 400,000 businesses with about 23 million workers. ADP began keeping records in January 2001 and started publishing its numbers in 2006.
Bank of America's Ken Lewis to Retire Dec. 31 Amid Probes
Embattled Bank of America Corp. Chief Executive Ken Lewis, fatigued by multiple government probes into himself and his company, will retire at the end of the year. Bank of America said a successor was yet to be determined. Mr. Lewis, 62, faces probes from Congress, the Securities and Exchange Commission and two state attorneys general, including Andrew Cuomo from New York. Mr. Cuomo's office issued a statement Wednesday night, saying, "Ken Lewis's decision to step down will have no impact on our continuing investigation," and the Ohio Attorney General's office made a similar statement.
Mr. Lewis has also been dogged by congressional scrutiny of its acquisition of Merrill Lynch for months. Mr. Lewis grew fatigued with the litigation and investigations, which began to interfere with his ability to run the bank, a person familiar with the matter said. Mr. Lewis completed two huge mergers in the past two years -- mortgage lender Countrywide Financial and Wall Street titan Merrill Lynch -- that cemented Bank of America's position as a massive financial conglomerate headquartered in Charlotte, N.C. Both deals were initially seen as rescues that helped secure a teetering financial system.
Ultimately, though, he became enmeshed in the troubles Bank of America acquired with Merrill Lynch, whose losses spiked between the deal's signing and its closing. Public outrage soared when it became known that Merrill Lynch executives received billions in bonuses despite the steep losses. Congressional investigators increasingly focused on what they saw as discrepancies between his public statements, testimony to Mr. Cuomo and various government documents. In June, Mr. Lewis was called to testify before a U.S. House committee, where he was criticized over his negotiations with top U.S. officials that resulted in the bank receiving billions in additional aid to ensure the bank completed the Merrill deal.
"It's about your responsibility and your failure to inform your shareholders and could constitute a fundamental violation of security laws," Rep. Dennis Kucinich (D., Ohio) said in a heated exchange with Mr. Lewis at the June hearing. Since then, the investigation has only intensified as congressional investigators have centered in on whether Bank of America should have disclosed burgeoning losses at Merrill ahead of a shareholder vote on the deal last December. Hostilities between bank management and lawmakers flared again earlier this month after Mr. Lewis and the bank declined to turn over thousands of internal documents that had been requested by Rep. Edolphus Towns (D., N.Y.), chairman of the House Committee on Oversight and Government Reform. Mr. Lewis's retirement is unlikely to slow the investigation.
Rep. Towns said Wednesday, "Our investigation has uncovered troubling facts about Bank of America's acquisition of Merrill Lynch, and Mr. Lewis was at the center of this controversy. We hope that Bank of America's new leadership will quickly repay American taxpayers and help us finally resolve unanswered questioned about this merger." Mr. Lewis, who has been chief executive since 2001, was stripped of his title as chairman in April after a shareholder resolution passed by a razor-thin margin. Walter Massey was elected to replace him.
The press release from Bank of America announcing Mr. Lewis's planned departure said the board plans to name a successor for Mr. Lewis, to be determined by a competition, by the time he leaves. Last month, Bank of America shook up its management team, opening up the field of potential successors to Mr. Lewis. Among the most bandied-about names are Brian Moynihan, who heads the bank's global corporate and investment bank; Thomas Montag, who heads global markets for the bank; and Sallie Krawcheck, who runs the bank's wealth-management operations. Mr. Lewis will also leave the board.
"Bank of America is well positioned to meet the continuing challenges of the economy and markets," Lewis said in the release. "The Merrill Lynch and Countrywide integrations are on track and returning value already. We are in position to begin to repay the federal government's TARP investments." Representatives for Bank of America didn't immediately return calls seeking comment from Lewis. Bank of America shares fell 0.1%, to $17.13 in after-hours trading. The stock has lost half of its value in the past year.
Are we getting ready for subprime 2.0?
Old habits are hard to break. When the Nasdaq tech-bubble burst, the US government and the Federal Reserve chairman "Bubbles" Greenspan created an even bigger asset-bubble to replace it (the US housing bubble). It was characterised by a 1% "benchmark" interest rate, ridiculously lax lending standards, rampant fraud -- and non-existent oversight.
By refusing to allow its economy to purge itself of bad debt and excessive credit, the US government created a much more damaging bubble -- aggravated by Wall Street's multi-trillion dollar, global Ponzi-scheme. With the US housing market now experiencing its worst collapse in history as the aftermath of that bubble, and with no "bottom" in sight, the US government is once again trying to take the easy way out -- this time by trying to re-inflate the same bubble which has just burst.
This time, the Fed's benchmark interest rate is at 0%. This time, it's the US government itself which has lowered the bar with its lending standards. This time, there is even more mortgage-fraud (up 23% from last year) -- and there is still no oversight. Now it is the Federal Housing Administration (FHA), a government agency, which is handing out subprime loans like a financial "Pez-dispenser". An illuminating article by business consultant David DePhillips provides a long list of ugly numbers.
- The FHA's market share of the US mortgage market has risen from 2% to 23% in just four years
- It already has a 7% delinquency rate on its loan portfolio, despite the fact that most of these are new loans
- It has become the new employer for thousands of private sector "mortgage brokers", who were the instigators of most of the mortgage-fraud during the first housing bubble, with the number of "FHA approved" lenders rising by more than 40% since the end of 2007 -- from 9,600 to nearly 14,000.
If this was an otherwise-healthy market, then perhaps the FHA's reckless expansion into this sector could be seen as "support" for struggling US homeowners. In fact, nothing could be further from the truth. US banks are holding millions of already-foreclosed/ repossessed homes off of the market. The most recent statistics show that total foreclosures and repossessions are on pace to go well over 4 million units this year.
Meanwhile, sales statistics over the last two months show US "REO" (bank-owned real estate) sales will be less than 2 million units. This adds to the existing glut of 20 million empty homes. What is worse is that the US housing sector hasn't even gotten to the peak of its mortgage-resets of bad loans from the last bubble. This upcoming spike in resets begins next year and will continue through 2011, before beginning to tail-off in 2012.
To make this upcoming "train-wreck" even worse still, the US's spendthrift baby-boomers are starting to retire, and their retirements are grossly under-funded -- even if the US's pension system can remain solvent. With real estate comprising 75% of the assets for these financial lemmings, and with these boomers needing to come up with trillions of dollars just to come close to maintaining their standard of living, there is no mystery as to what they will be selling -- year after year after year.
Adding "insult to injury", the Obama regime is essentially doing nothing to help out the homeowners themselves -- despite loud and frequent claims to the contrary. With 4 million homeowners potentially eligible for aid in his "housing rescue", less than 5% of that number have received any formal offers of mortgage relief. Now the FHA is almost broke -- joining other government entities like Fannie Mae, Freddie Mac, and the FDIC. None of the hundreds of billions of dollars which these agencies need to remain solvent has been factored into Obama's fantasy-budget.
Thus, the only real difference between the US housing bubble, "chapter I" and the new "chapter II" is that much of the future trillions in hand-outs, "loans" and other, assorted bail-outs which will be squandered in the next wave of insolvencies will be used to prop-up government entities.
ISM contraction creates dollar chaos
A mid-morning report showing an unexpected reversion to economic contraction in the Chicago-area had the same impact on currency values today as the butterfly that flapped its wings in the Amazonian jungle. An earlier report showing a larger slowdown in the pace of GDP contraction had boosted the dollar and highlighted the appeal of higher-yield plays around the world. Chaos theory struck forex town as investors were thrown off the currency market rollercoaster before the dollar’s decline regained traction.
The Chicago-area ISM index of factory activity was supposed to register an above-50 and so expansionary reading for September after a 50 reading last time around. However, the data failed to confirm expansion plans of manufacturers and slipped back into the contraction zone, reading 46.1. The dollar gained from $1.4625 ahead of the report to $1.4575 immediately after before resuming its daily slip. The dollar pared losses against the Canadian and Aussie dollars after the report. It’s probably fair to say that this shock-report inflicted significant damage to several investors who were clearly left short of dollars and had to scramble to cover damaging losses.
Earlier in the day confirmation that the U.S. second quarter GDP report had suffered less of a contraction than thought earlier, served to warm investor appetite to a broader recovery around the world. The dollar had eased on the session as the third quarter comes to a close today and currently the dollar is set to weaken versus 14 of 16 major trading partners.
The 0.7% shrinkage in the economy on the quarter compares to earlier government flash estimates of minus 1% and means the economy shrank by 6.4% over one year ago. The boost to consumption via government auto and housing programs is clear in the data and the critical issue going forward is whether the economy is ready to stand alone without government plans. Hence the chaotic reaction to today’s ISM number.
Within the data there were encouraging signs as business investment spending fell at half the reported pace of the first estimate, while government spending running at the highest pace in seven years has some way to run before it stops impacting consumption.
Still the rally for stock prices of the third quarter came to another critical juncture after the ISM reading. Currently losses of around 1% are apparent for the main indices eroding some of the 26% quarterly gains for financial share prices and 22% for industrial companies.
Other external influences conspired to weigh upon the dollar this morning.
The euro was firmer after an auction of 12-month money resulted in allocation of about €75 billion at a 1% rate. The size of bids tendered was about half what some analysts had predicted. The result adds to evidence that the state of credit markets has indeed eased and shows that confidence in a recovery and lesser counterparty risk means fewer banks find the need to show up at the auction and ask the central bank for a loan. On balance the event today means that very, very gradually the need for stimulus is diminishing and prompts thoughts of when monetary policy can be tightened. This weighed on the dollar earlier today.
The pound continues to see its fortunes revived. Today’s GfK NOP index of sentiment saw its largest leap in 14 years and lifted the balance to minus 16. The pound is currently off its $1.6120 intraday peak and stands at $1.5971.
As we noted in earlier commentary, the Aussie dollar’s interest rate outlook makes it an appealing play to investors. Another layer of positive news emerged today with a 0.9% gain in August retail sales compared to an expectation of 0.5%. The prior month’s reading was negative. Investors continue to line the streets waiting to buy the Aussie’s dip and currently the unit stands at 88.06 cents against the dollar making it close to its best level since August 2008.
The Canadian dollar seemed to advance on a sharper gain in an index of raw materials last month. A simultaneous flat reading of monthly GDP failed to dent the appeal of the commodity-linked unit. Earlier gains for the price of crude oil, which was up 1.9% and gold, which was 1% firmer, helped lift investor appetite. One Canadian dollar purchases 93.17 U.S. cents this morning.
As for today’s news on the Japanese yen, Mr. Fujii is on record as stating that the government has no intention of raising the yen’s movement (read strength) at a forthcoming G7 meeting. In their infinite wisdom, traders took his comments as a green light to buy the yen, which is currently trading at ¥98.58 per dollar. Against the euro the yen also advanced to ¥131 and ¥143.19 against the pound.
US consumer confidence dip is bad holiday omen
A key measure of consumer confidence fell in September, after a gain in the previous month, raising concerns about retail sales in the upcoming holiday season, a research group said Tuesday. The Conference Board, a New York-based business research group, said its Consumer Confidence Index fell to 53.1 in September from an upwardly revised 54.5 in August. Economists were expecting a reading of 57, according to a Briefing.com consensus survey.
"Consumers remain quite apprehensive about the short-term outlook and their incomes," said Lynn Franco, director of the Conference Board Consumer Research Center. "With the holiday season quickly approaching, this is not very encouraging news." The index component that measures consumers' assessment of the present situation fell to 22.7 from 25.4. The expectation index, which gauges consumers' outlook over the next few months, dropped to 73.3 from 73.8 last month.
The percentage of consumers saying that jobs are currently "hard to get" rose to 47% from 44.3%, while the percentage of those expecting a difficult job market in the months ahead inched lower to 17.9% from 18%. "Consumers are still very concerned about employment conditions," said Mark Vitner, an economist at Wells Fargo. After falling to an all-time low in February, the overall index has been trending higher as more upbeat economic news helped improve consumers' moods. But the weak job market continues to weigh on consumer confidence and the measure remains at historically low levels. An overall reading above 90 indicates the economy is solid, and 100 or above signals strong growth.
Retail concerns: The lower reading doesn't bode well for the nation's retailers, who make more than half of their annual profit during the holiday season. "This year consumers have less income available to spend and credit is tighter," Vitner said. Overall retail sales surged in August, but the gain was fueled by a temporary government program aimed at boosting car sales. Sales excluding autos were up modestly after a slight decline in the previous month.
The success of the Cash for Clunkers program shows that consumers are responding to incentives, Vitner said. But retailers have been battling slumping sales for several months and may not have the resources to offer big holiday deals. "I'm not sure retailers are in good shape to offer incentives to get people to go out and spend," Vitner said. The government will report on September retail sales Oct. 14.
Economy: Tuesday's report, which is based on a survey of 5,000 households, is closely watched because consumer spending makes up the bulk of economic activity in the United States. On Tuesday, the government will release its final reading on second-quarter gross domestic product. Economists surveyed by Briefing.com believe GDP, the broadest measure of economic activity, fell at an annual rate of 1.2% in the second quarter. That's a slightly sharper decline than the previously reported 1% drop, but is an improvement over the 6.4% contraction in the first quarter.
Euro-Zone Consumer Confidence Rises
Economic and consumer confidence in the 16 countries that use the euro hit its highest level in a year in September, supporting speculation that the economy grew in the third quarter of the year. According to a monthly survey by the European Commission, the overall economic sentiment indicator for the euro zone rose sharply to 82.8 from 80.8 in August. The increase was stronger than expected, with economists surveyed last week having forecast it would increase to 82.2.
The continued pickup in confidence is consistent with other recent survey evidence that has indicated the economy grew in the third quarter when compared with the second. That would represent the first gross domestic product rise since the first quarter of 2008. This "is another encouraging sign that the euro-zone economy continues to recover," said Jennifer McKeown, European economist for Capital Economics. However, some members of the European Central Bank remain unconvinced that the recovery will be strong or sustainable.
ECB President Jean-Claude Trichet said Monday that it is still too early to begin implementing plans to end the current liquidity support the central bank is operating. "There remains a very strong case for the ECB to retain an accommodative stance for some considerable time to come and not to be tempted into any early tightening of monetary policy," said Howard Archer, chief euro zone and U.K. economist for IHS Global Insight. The commission reported that consumer confidence in the euro zone rose three points in September to -19 from -22 in August. This was the best level since -19 in September last year and was also stronger than expected. Economists had forecast this measure would rise to -21.
While the strong uptick in euro-zone sentiment bodes well for an early recovery from the worst recession in postwar Europe, separate data cast shadows over the continent's weaker parts. In Italy, business confidence unexpectedly declined in September after rising for five consecutive months, according to a survey by Italian think tank ISAE. And deflationary fears grew in Spain, where preliminary data from the national statistics institute showed the consumer price index fell 1% in September from a year earlier, a steeper drop than the 0.8% posted in August.
Eurozone inflation falls more than expected
Eurozone consumer prices fell this month by more than economists had expected, reinforcing expectations the European Central Bank will not raise interest rates yet in spite of a nascent economic recovery.Prices in the 16-country area fell 0.3 per cent year on year in September, the European Union statistics office said in an estimate released in Luxembourg. They had dipped 0.2 per cent in August, 0.7 per cent in July and 0.1 per cent in June. Economists polled by Reuters had on average expected a 0.2 per cent fall in September.
“This is probably a temporary relapse, mainly related to food- and energy-price base effects,” said Martin van Vliet, economist at ING. “Headline inflation will likely turn positive again in November and edge up further going into 2010, as the earlier sharp drop in oil and food prices increasingly drops out of the calculation,” he said. The ECB wants inflation to be just below 2 per cent. It says it does not expect deflation – which it defines as prolonged price falls accompanied by expectations of more declines – because the current drops in prices are mainly a result of the record high cost of oil a year earlier.
With survey and hard data signalling the eurozone is likely to have emerged from recession in the third quarter, markets are speculating when the ECB might start tightening policy after cutting borrowing costs to 1 per cent earlier this year. A monthly consumer survey by the European Commission showed on Tuesday that inflation expectations among households and companies rebounded from all-time lows in September after six months of falls.
But economists said that even once prices started growing again, the rises would be small because firms continued to compete for market share at a time of weak demand. “The most likely scenario, in our view, is that inflation will also remain below the ECB’s target of below but close to 2 per cent in 2011. The benign inflation outlook means the ECB has plenty of time left before it needs to start reversing monetary stimulus,” van Vliet said. Economists now expect the bank will not raise rates until the third quarter of 2010. A detailed breakdown of the inflation estimate and month-on-month data will be available on October 15.
Japan tips ever deeper into deflation
Japan is sliding into the deepest deflation since the Second World War, forcing the new-broom Democrats to abandon their strong yen policy within weeks of taking office. Core inflation fell a record 2.4pc in September, a steeper drop than at any time during the country's Lost Decade. A surging yen is twisting the knife further. The currency has risen 22pc against the euro, 27pc against the dollar, and 43pc against sterling since mid-2007. Hirohisa Fujii, finance minister, ditched his non-intervention policy yesterday, saying Tokyo would "take necessary steps" to prevent disorderly currency moves.
Yen strength is asphyxiating Japanese exporters and feeding a self-reinforcing spiral of lower prices and wages. This 1930s process increases the real burden of debts. Corporate debt alone is 180pc of GDP. Junko Nishioka from RBS said a yen near ¥90 to dollar has broken through the "break-even rate" for manufacturers such as Toyota, Honda, and Sony. "Exporters face the possibility of exchange losses," he said. The crisis engulfing the world's second economy is remarkable. Profits fell 53pc in the second quarter. Total cash earnings have dropped 7.1pc this year. Tax revenues have plunged 27pc. While the economy is no longer in recession, GDP has shrunk by 8pc from its peak and exports are down 36pc (in yen).
Andy Xie, a leading consultant in Asia, said Japan's Democrats have been handed a poisoned chalice. "The bursting of the global credit bubble in 2008 brought down Japan's export machine. Of all OECD countries, Japan's looks most like a depression." It is Japan's misfortune that the yen tends to rise in times of turmoil as its own citizens repatriate savings. But other complex forces are also at work. The fall in rates to near zero in the West has closed the yield gap.
Tokyo's grim experience is a lesson for Europe, where a mini-deflation scare is emerging. September inflation was -1.2pc in Belgium, -1pc in Spain, -0.3pc in Germany. Governments have been expecting a short bout of deflation as lower oil prices (from last year's peak) feed through. However, a pattern has emerged where the downward pressure is proving more persistent than expected in a string of countries. Gabriel Stein from Lombard Street Research said the European Central Bank is taking a gamble assuming that prices will rebound safely in 2010. "What is remarkable is that the ECB seems so unconcerned.
The M3 money supply has been contracting since April. The ECB's quantitative easing (€60bn) has been just 0.5pc of GDP. We think they should be doing 5pc of GDP. Germans have this fear that inflation is an ever-present danger, but deflation can be a bigger danger," he said. For now it is Japan in the deflation hotseat. The Democrats long opposed action to cap the yen when in opposition, saying the policy favoured corporate elites, hurt consumers, and perpetuated a dysfunctional export model. But they have taken office in circumstances that make it nigh impossible to do what they want.
Japan stayed afloat in its Lost Decade by holding down the yen and exporting into a booming global economy. The DPJ is condemned to repeating this, though it will be harder this time. Simon Derrick from the Bank of New York Mellon said Japan spent $600bn in the exchange markets to weaken the yen from 1993 to 2004. Private savings also leaked abroad, fleeing zero rates to chase higher yields from Iceland, to New Zealand and Britain through the "carry trade".
None of this can be repeated easily. The Anglo-Saxons, Swiss, and Swedes are pursuing covert or overt devaluation. The dollar has become a rival funder for the carry trade. As the oldest society on earth, Japan is a laboratory for structural decline. Its workforce has been declining since 2005. The savings rate has fallen to 2pc of GDP, below America. The IMF says public debt will reach 227pc of GDP next year, the result of past stimulus packages.
Japan has been able to fund its deficits cheaply through a captive bond market. Bond yields are currently 1.29pc. "Can these benign conditions be expected to continue in the face of even-larger increases in public debt?" asked the IMF. Hardly. Japan's top pension fund became a seller of state bonds this year. The Democrats can only weep. After waiting half century to launch their child-care, health, and welfare policies, they have taken power only to find an empty exchequer.
IMF warns of further recession risks
Banks round the world have still to reveal about half of their likely losses resulting from the financial and economic crisis, the International Monetary Fund said on Wednesday, warning that there was still a "significant" risk of another downward lurch in the global recession. The IMF described credit risks as remaining "elevated" even though financial conditions have improved significantly since spring. It said these risks, alongside weakened banks, were likely to depress the availability of new credit and damp the global economic recovery unless significant additional capital was raised to improve the health and lending capability of banking systems.
In its twice-yearly Global Financial Stability Report, published on Wednesday in Istanbul, the IMF, estimated the ultimate losses in the financial system would total $3,400 billion between 2007 and 2010, an improvement from the $4,000 billion estimate it published in April. The improvement in the prediction of likely losses reflects growing confidence in financial markets and higher assets prices, which have reduced mark-to-market losses on banks' books, and an improved economic outlook, with lowered estimates of credit losses.
Even so, the IMF warned that much still needed to be done to secure a recovery and to ensure that renewed stresses in the financial system did not restart the vicious spiral of banking losses, rationed credit, deeper recession, increased defaults and further banking losses. Within the banking systems, the IMF estimates that losses will total $2,800 billion alone and that banks have so far recognized only $1,300 billion of those losses. "U.S. domiciled banks have recognized about 60 percent of anticipated writedowns, while euro area and UK domiciled banks have recognized about 40 percent," the report said.
The largest proportionate losses in banks are in the U.S. and UK, where losses on residential loans and commercial property, the loans with the highest default rates, account for a greater proportion of banks' balance sheets. Although banks have been profitable this year as their borrowing costs have fallen with exceptionally low interest rates and the rates charged on lending have remained higher, the IMF warned that this happy position for banks might not last. "In the medium term, banks are likely to suffer reduced margins from paying more for deposits and incur higher interest costs," it said, so greater capital-raising measures were still necessary.
But the capital-raising exercises by banks and recapitalisation by government already undertaken have made banks more resilient to the losses they are likely to incur, the IMF added. Capital will be drained by future losses, but the emergency measures implemented so far meant that "banks in all regions have achieved a degree of stability in their capital positions". Massive public deficits also complicated the financial stability picture, the IMF warned. They implied that total borrowing needs in certain countries, particularly the U.S. and UK, will exacerbate the difficulties in raising finance for the private sector, and imply the need to raise finance from abroad, potentially undermining the dollar and sterling, or raising long-term market interest rates.
"In terms of regional vulnerability, the UK appears most susceptible to credit constraints ... given its significant reliance on the banking channel and the projected sharp decline in domestic bank balance sheets, as well as substantial public financing needs," said the IMF.
IMF: UK faces credit rationing or higher interest rates unless Bank prints more money
International Monetary Fund's comments back the Bank of England's programme of quantitative easing. Britain will face credit rationing or higher interest rates unless the Bank of England continues its emergency money creation programme to support growth, the International Monetary Fund warned today. Highlighting the risk of a £180bn funding gap in 2010, the IMF said there was a "significant tension" between the supply of finance from a weakened banking sector and rising demands for funds, primarily caused by the soaring government deficit.
José Viñals, the IMF's financial counsellor, said that despite avoiding a global meltdown, the shortage of credit and the pressures on government finances posed risks to recovery. Launching the fund's half-yearly Global Financial Stability Report (GFSR), he said the UK was likely to face "difficulties" in meeting the demand for credit. "Either there will have to be continuing support on the part of the authorities to underpin the credit process or there will be higher lending interest rates, or credit will be constrained." The comments provided clear support for the Bank of England's programme of quantitative easing (QE), which is designed to compensate for the inability or unwillingness of banks to lend.
For the first time since the financial crisis began in August 2007, the fund cut its estimate of the write-downs facing banks and other financial institutions. In the spring it predicted a $4tn bill (£2.5tn) but has now pared this back to $3.4tn. "Over a year has now passed since the Lehman Brothers bankruptcy prompted a potential global financial meltdown," said Viñals. "Fortunately, the situation is very different today due to unprecedented policy actions and the overall improvement in economic conditions. We are on the road to recovery, but this does not mean that risks have disappeared." Viñals added that countries such as Britain, which had high levels of debt relative to the size of the economy, were particularly vulnerable to higher long-term interest rates because of fears about the sustainability of the public finances.
In August the Bank of England increased the QE budget to £175bn, following a meeting where the governor, Mervyn King, was outvoted in his attempt to raise the ceiling to £200bn. Discussions continue within the Bank on what additional measures – possibly extra quantitative easing or even negative interest rates – it could take in the future. Although Viñals' comments do not amount to an explicit call for more QE, they do indicate that the IMF would not stand in the way of an enhanced programme by the Bank of England to increase credit availability. David Miles, a member of the Bank's monetary policy committee, told a conference in Belfast this morning that QE was having an impact, although it was hard to say how much exactly. Miles added that he saw little reason to proceed particularly cautiously with QE as the policy was "not irreversible".
The IMF's six-monthly snapshot of global financial conditions singled out the UK as the country most at risk from a potential dearth of funding, due to its weak banks and the need to finance the government's budget deficit. "In terms of regional vulnerability, the UK appears most susceptible to credit constraints ... given its significant reliance on the banking channel and the projected sharp decline in domestic bank balance sheets, as well as substantial public financing needs," said the GFSR. The fund said the UK could be facing a funding gap of £180bn next year – 15% of gross domestic product – and far higher than the 2.4% projected for the United States and the 3% for the eurozone.
Britain and the United States' reliance on foreign investors to fund its budget deficit meant there was a risk of higher long-term interest rates and weaker currencies, the IMF stressed. "If foreign investors become concerned about long-term fiscal sustainability in these countries, interest rates on government securities would need to adjust higher and the exchange rate would depreciate." The GFSR said US and UK banks had suffered most from the financial crisis that started in August 2007. Cumulative loss rates for the UK banking system between 2007 and 2010 are projected to be 7.3%, similar to the 8.1% in the US but much higher than the 3% in the eurozone. Britain had seen house prices decline sooner than countries in the eurozone and UK consumers were more heavily reliant on credit card debt, the IMF said. It expects bad loans to be particularly heavy this year in commercial property and buy-to-let mortgages.
Despite lowering its estimate of total write-downs, the IMF added that the financial sector was only halfway through the write-down process, with American banks further advanced than those in Europe. US banks have recognised 60% of anticipated losses against 40% for banks in Britain and the eurozone. Despite the rally in stockmarkets and the reduction in credit spreads in recent months, the IMF said it was too early to claim that the crisis was finally over. "The risk of a re-intensification of the adverse feedback loop between the real and financial sectors remains significant as long as banks remain under strain and households and financial institutions need to reduce leverage."
FDIC: Bank Failures To Cost Around $100 Billion
Regulators expect the cost of bank failures to grow to about $100 billion over the next four years – up from an earlier estimate of $70 billion. Faced with that sobering news, they voted Tuesday to require banks to prepay $45 billion in premiums to replenish an insurance fund that will start running dry on Wednesday. The proposal by the board of the Federal Deposit Insurance Corp. to require early payments of premiums for 2010-2012 could take effect after a 30-day public comment period.
The FDIC is fully backed by the government, which means depositors' money is guaranteed up to $250,000 per account. But it would be the first time the agency has required prepaid insurance fees. "I do think this is a good balance," FDIC Chairman Sheila Bair said. The plan requires the banking industry "to step up" while spreading the financial hit to banks over a number of years, she said. An insurance payment by the industry of $45 billion "is not going to constrain lending," she said.
The insurance fund has been sapped by billions from a rash of bank failures that began in mid-2008. The banking industry prefers the prepaid premiums over a special emergency fee – which would be the second this year. Without additional special fees or increases in regular premiums, the insurance fund – at $10.4 billion at the end of June – will become "significantly negative" next year and could remain in deficit until 2013, the FDIC is now projecting.
Ninety-five banks have failed so far this year as losses have mounted on commercial real estate and other soured loans amid the most severe financial climate in decades. That has cost the fund about $25 billion, the FDIC said Tuesday. The $10.4 billion already was the fund's lowest point since 1992, at the height of the savings-and-loan crisis. That is equivalent to 0.22 percent of insured deposits, below a congressionally mandated minimum of 1.15 percent.
Most of the $100 billion in costs are expected to come from failures this year and next, the agency said. Some analysts expect hundreds more banks to fail in coming years. Bair didn't rule out the possibility of the FDIC tapping its $500 billion credit line with the Treasury Department, if the economy unexpectedly worsened. "But today is not that day," she said before the vote. The deficit partly reflects higher reserves the FDIC has set aside for anticipated bank failures. At the same time, the balance of cash and assets of failed banks that can be sold by the FDIC remain positive, the agency said.
An emergency insurance fee on banks, which took effect June 30, brought in around $5.6 billion. Another one would allow the healthiest banks to keep more capital for investment, but could drive weaker banks toward failure, further depleting the insurance fund. "The prepaid assessments represent money that the FDIC expects to receive from banks anyway over the next several years, but having the cash on hand sooner ... provides more flexibility for dealing with any contingencies over the foreseeable future," James Chessen, chief economist of the American Bankers Association, said in a statement. "Another special assessment would likely do more harm than good as it would directly reduce bank income, hinder capital growth, and make lending much more difficult."
In addition to the insurance fund, the FDIC has about $21 billion in cash available in reserve to cover losses at failed banks, down from $25 billion at the end of the first quarter. "There's lots of liquidity; there's lots of cash. Liquidity's not an issue for the banking system right now," Bair told reporters.
Ilargi: Word is that the extra and early premiums banks will pay to the FDIC will show up on their balance sheets at the end of the year as zero-risk carrying assets (which require no reserves). This, like many other measures, will make the banks look better than they really are.
Bank-Bailout Fund Faces Years in Red as Failures Jolt System
The government said the fund that protects consumer bank deposits has fallen into the red and will remain there into 2012, a pointed symbol of how the aftershocks of the financial crisis will reverberate for years as banks continue to fail at a high rate. The negative balance is a headache for the Federal Deposit Insurance Corp., which runs the fund. On Tuesday, it proposed the unprecedented step of having the banking industry prepay $45 billion in fees by the end of the year to give the government more breathing room to handle future failures. The only other time the fund fell into the red was in 1991, during the savings-and-loan crisis, and it shows how U.S. officials underestimated the impact of this crisis on the government's cash needs.
"Though some of our largest bank failures have already taken place, there are still hundreds and hundreds of banks that are going to fail in this cycle," said Gerard Cassidy, a bank analyst at RBC Capital Markets. FDIC officials stressed that the fund's depleted state wouldn't affect depositors because federally insured deposits are backed by the full faith and credit of the U.S. government. The prepayment proposal was met with unexpected support from banks. Some saw it as preferable to another option the FDIC seriously considered -- an emergency charge of $5.6 billion on top of the regular fees. This would have likely come directly out of the capital reserves at thousands of banks.
FDIC officials said banks would be able to spread the impact of the fee prepayment over several years by the way they account for it on their balance sheet. J.P. Morgan Chase & Co. Chief Executive James Dimon, in an interview, praised the FDIC's plan as "an elegant way for them to do it." In essence, the FDIC is proposing that most banks hand over by the end of the year their deposit-insurance fees -- the fund's standard source of income -- for the end of 2009 and all of 2010, 2011 and 2012. The FDIC said that without the new policy, its cash on hand would be outpaced by its cash needs sometime early next year. Bank failures are expected to hit their peak either this year or in 2010.
The FDIC continues to have cash even though its deposit insurance fund has fallen into the red. It has already taken more than $30 billion out of the fund to cover bank failures over the next year. This is the money that is expected to run dry early next year without the prepayment assessments. FDIC officials estimated the deposit insurance fund wouldn't be back to comfortable levels until 2017. Government officials on Tuesday estimated that bank failures from 2009 through 2013 will cost the FDIC $100 billion, up from a projection several months ago of $70 billion. Ninety-five banks have failed so far this year.
The FDIC's proposal reflects a growing recognition from government officials that more money will be needed to mop up the mess than they projected just months ago. It is also a stark reminder of how the banking sector continues to be strangled by bad loans. There have been bank failures in most states since January 2008, hitting Georgia, Illinois and California particularly hard. The FDIC had 416 banks on its "problem" list at the end of June, and the number is expected to grow.
FDIC officials project the deposit insurance fund will remain in the red into 2012, despite the prepaid assessments from banks. This is largely an accounting issue -- the FDIC has to count the prepaid assessments as both an asset and a liability because it is technically deferred revenue. Another option the FDIC considered was to borrow billions of dollars from the Treasury Department. Officials felt such a move would send the wrong message to the public.
"I do think that the American people would prefer to see an end to policies that looked to the federal balance sheet as the remedy to every problem," FDIC Chairman Sheila Bair said. But for the first time, Ms. Bair said Tuesday that she had directed the agency to prepare the "mechanics" for borrowing from the Treasury in case it ever became necessary, although "today is not that day." The evaporating deposit-insurance fund had $10.4 billion in June, the latest figure available, down from $45.2 billion in June 2008. That posed a public-relations problem for Ms. Bair. She has had to both move rapidly to close failing banks, which is costly for her agency, while retaining public confidence in the FDIC.
The rising number of bank failures has infuriated some politicians who have recently begun pressuring Ms. Bair's regulators to ease up on their increasingly close supervision of the industry. The FDIC said banks could ask for an exemption if they didn't have the cash on hand to prepay the fees.
CIT Group again on brink of collapse
CIT Group Inc. shares plunged in premarket trading Wednesday as the commercial lender is reportedly trying to craft an exchange that would cut its debt and offer bondholders an equity stake in the company in a bid to avoid bankruptcy. Shares of the New York-based financial firm, one of the largest U.S. lenders to small and midsize businesses, fell 95 cents, or 43 percent, to $1.25 in premarket trading. CIT Group is preparing an exchange offer that would eliminate as much as 40 percent of its more than $30 billion in outstanding debt, The Wall Street Journal said, citing anonymous sources. The exchange would hand control of the company over to its bondholders and wipe out common stockholders, according to the report. A spokesman for the company declined comment on Wednesday.
CIT Group spent the summer trying to stave off a potential collapse amid mounting loan losses and rising funding costs. It has been devastated by the downturn in the credit markets and is attempting to restructure its operations to remain in business. CIT in the past relied heavily on cheap, short-term debt to fund its operations -- a type of funding that essentially evaporated during the peak of the credit crisis last year. The financial firm, which received $2.3 billion in federal bailout aid last fall, received a $3 billion emergency loan in July from some of its largest bondholders and completed a debt repurchase program in August to help ease its cash crunch. Those measures appear to still be short of saving CIT Group, which has said in the past it would need to continue to reduce its debt burden to survive.
Any deal with bondholders would likely wipe out most of the government's $2.3 billion bailout loan, according to the Journal. The Journal added that if the debt exchange with key bondholders fails, CIT Group would seek bankruptcy protection in order to restructure its operations. That would make CIT Group the fifth largest bankruptcy in U.S. history. CIT Group shares have been especially volatile in recent days amid continued uncertainty of the company's survival. A New York Post report Tuesday, saying that hedge fund manager John Paulson is considering merging the troubled finance company with failed mortgage lender IndyMac Federal Bank sent shares soaring 31.7 percent.
Max Keiser: Predicting the collapse of Iceland
Aljazeera re-aired Max's 2007 prediction of a collapse of the Icelandic economy. While the program aired in August 2007, it was filmed in April 2007.
Watch for the scene in the Blue Lagoon in which Max predicts a global Depression to be caused when all these debts driven by low interest rates burst.
Why narrow banking alone is not the finance solution
The FT has a new series on the future of investment. But what, I wonder, is the future of finance itself? Who is confident that the financial system now emerging from the crisis is safer, or better at servicing the public’s needs, than the one that went into it? The answer has to be: few people. The question is how to remedy this dire situation. What entered the crisis was, we now know, an ill-managed, irresponsible, highly concentrated and undercapitalised financial sector, riddled with conflicts of interest and benefiting from implicit state guarantees. What is emerging is a slightly better capitalised financial sector, but one even more concentrated and benefiting from explicit state guarantees. This is not progress: it has to mean still more and bigger crises in the years ahead.
My friend and colleague, John Kay, is aware of these dangers, as readers of his column know well. His answer, laid out in a pamphlet for the London-based Centre for the Study of Financial Innovation, is “narrow banking”*. Mr Kay rejects the notion that regulation can solve the problem created by state-guaranteed finance. Supervision, he notes, is always subject to regulatory capture. Moreover, banks “entered the crisis with capital generally in excess of regulatory requirements. These provisions proved not just inadequate but massively inadequate for the problems faced.” Worse, many of the dangers – notably the growth of off-balance-sheet finance – reflected attempts to circumvent regulation. Regulation, then, has not been the answer, but hitherto has been part of the problem.
So what is the answer? Division of banking into a “utility” and a “casino” is Mr Kay’s answer. The big idea is that insured deposits should be backed by “genuinely safe liquid assets” – known as 100 per cent reserve banking. In practice, these assets would be government bonds. This is the most rigorous form of narrow banking. But he is not clear on whether he would insist on this. It seems he might accept looser constraints. For the sake of clarity, however, let us focus on 100 per cent reserve banking, an idea also discussed in Austrian economics. Is it workable? What might it imply? To answer, we need to understand how we entered our world of credit-based money.
Suppose someone came up with the following design for the core institutions of our financial system: they would be mainly financed by deposits, redeemable on demand; they would invest in a wide range of often illiquid and opaque assets; they would engage in complex trading activities; but they would have a wafer-thin equity cushion. Surely, people would conclude, this is fraudulent. They would be right. Such a structure can only endure because central banks act as lenders of last resort. The government’s ability to create money is put at the disposal of private interests. Right at the moment, the ability to borrow from the government at zero interest is a licence to print money.
In practice, however, we have gone much further than this. We have also explicitly guaranteed many deposits and implicitly guaranteed many more liabilities. Indeed, in the crisis, policymakers guaranteed all the liabilities of institutions deemed systemically significant. Today, the core financial institutions are, beyond doubt, a part of the state. Mr Kay’s proposal is, in sum, to end the fraud: banks would be forced to hold assets as safe and liquid as their liabilities. We know there are other ways of making a system of fractional-reserve banks relatively safe: a stable domestic oligopoly achieves much the same thing. But that does seem highly regressive.
Is Mr Kay’s the answer? One obvious objection is that it would impose a massive upheaval in finance. But, given the crisis, such an upheaval is the least we should fear. Another objection (though, to some an advantage) is that, taken to its conclusion, it would eliminate monetary policy. Public debt held by banks would set the money supply.
A more profound issue is whether a financial system based on narrow banking could allocate capital efficiently. Here there are two opposing risks. The first is that the supply of funds to riskier, long-term activities would be greatly reduced if we did adopt narrow banking. Against this, one might argue that, with public sector debt used to back the liabilities of narrow banks, investors would be forced to find other such assets. The opposite (and greater) risk is that the fragility of banking would be re-invented, via “quasi-banks”. This is what has just happened, after all, with “shadow banking”. In the end, those entities, too, have been rescued. The big point is that a financial structure characterised by short-term and relatively risk-free liabilities and longer-term and riskier assets is highly profitable, until it collapses, as it is rather likely to do.
The answer to the second dilemma is to make banking illegal. That is to say, financial intermediaries, other than narrow banks, would have the value of their liabilities dependent on the value of their assets. Where assets could not be valued, there would be matching lock-up periods for liabilities. The great game of short-term borrowing, used to purchase longer-term and risky assets, on wafer-thin equity, would be ruled out. The equity risk would be borne by the funds’ investors. Trading entities would exist. But they would need equity funding. Laurence Kotlikoff of Boston University and Edward Leamer of the University of California at Los Angeles are among those who have proposed such radical ideas. It is the simplest way I can see of avoiding the danger that narrow banking would shift the risks inherent in such activities elsewhere.
The most important point is that where we are now is intolerable. Today’s concentrations of state-insured private wealth and power must surely go. At present, the official sector believes tighter regulation, particularly higher capital requirements, can contain these risks. But this is likely to fail. If it does, we will need to be radical. Yet narrow banking would still not be enough. We would need to rule out quasi-banking. Otherwise, we would soon return to the world of fragility and bail-outs. Funds that replace banks would have to pass the risks directly on to the outside investors. The authorities will not entertain such radical ideas right now. But the financial system is so inherently fragile that radical reform cannot be pronounced dead. It is only dormant.
The secret to Goldman Sachs' good fortune
by John Crudele
So, is this how Goldman Sachs does it? "It," of course, is making gobs of money even when nobody else on Wall Street can. And those profits then go into outrageous bonuses to employees, which cause rancor on Capitol Hill and on Main Street.
You've heard the old saying, "it's not what you know, but who you know." Goldman Sachs knows lots of important people. That fact is indisputable, mainly because former Goldman employees are scattered around the country, and the globe, in important, decision-making financial positions. But I'd like to make an addendum to that old saying, which I'll explore for you today: Who you know is only important if you can get them on the phone anytime you want.
Today's column is about Thursday, Sept. 18, 2008. It's also about the unparalleled access that Goldman Sachs had to Treasury Secretary Hank Paulson, whose mission -- according to his own words -- was to bring Wall Street and market regulators (not to mention decision makers) together, so that they were "seeing the same issues, the same problems and working toward the same solutions." On Wednesday, Sept. 17, 2008 -- the day before the one I am writing about -- the stock market performed horribly.
By the end of the session the Dow Jones industrial average tumbled 449 points as investors worried about the nation's financial system. The next morning, Sept. 18, Paulson placed his first call of the day at 6:55 a.m., to Lloyd Blankfein, who succeeded Paulson as CEO of Goldman. It's unclear whether the two connected because Blankfein called Paulson minutes later. And then Blankfein placed another call to Paulson at 7:05 a.m. for what looks like a 10-minute conversation.
After that Paulson called Christopher Cox, Securities & Exchange Commission Chairman twice; British Chancellor Alistair Darling and New York Federal Reserve head (and now Treasury Secretary) Tim Geithner two times. Then Paulson took another call from Goldman's Blankfein. It wasn't even 9 a.m. yet -- 30 minutes before the stock market was to open -- and Paulson and Blankfein had already exchanged three phone calls.
This wasn't particularly unusual. On Wednesday, Sept. 17, the day the stock market was in trouble, Paulson spoke with Blankfein five times, including a pair of calls at 7:20 p.m. and 8:45 p.m. One of the earlier calls -- at 12:15 p.m. -- is listed on Paulson's log in the same five minute interval as a call to Geithner, which could indicate that this was a conference call. If Paulson did set up a conference call, it would have been an extreme instance of putting someone who wielded a lot of power -- Geithner -- together with someone -- Blankfein -- who could profit from that connection.
And all of this doesn't include possible cell phone calls. The Treasury turned over to me Paulson's official schedule and phone records after I made a request under the Freedom of Information Act. There's no way for me, or anyone else, to know what Blankfein and Paulson talked about during those first three calls on Sept. 18. But it would be reasonable to assume that the conversation, coming as it did in a period of market turmoil, had something to do with what was happening on Wall Street. So no matter how you slice, dice or excuse it, Blankfein by 9 a.m. would have had information that was not available to anyone else who makes their money trading securities. And, as you can imagine, there is a whole lot of value in that kind of inside access.
Robert Scully, a co-president of Morgan Stanley, called Paulson at 8:50 a.m. on the 18th. But he appears to be the only Wall Street-type who was in contact with Paulson until Larry Fink, head of the private investment firm Blackrock, called at 12:40 p.m. By then the stock market was going down again. But the decline wouldn't last long. Stocks began a miraculous recovery at 1 p.m. on Sept. 18, when rumors started to spread that Paulson was considering a "government entity to bail out troubled banks" and that a meeting was going to be held that night on the matter.
At 1:05 p.m. Blankfein called Paulson again. Paulson would call Blankfein for the last time that day at 4:30 p.m. when he "left word." That was the sixth time these two men called each other on Sept. 18.
That's one time less than Paulson spoke with Federal Reserve Chairman Ben Bernanke, arguably the most important person when the fin ancial markets are in trouble. But Bernanke didn't get his first call from Paulson until 9:30 a.m. -- and it included Cox and Geithner.
President Bush only spoke with Paulson twice that day. To be fair, on the afternoon of Sept. 18 Paulson did call John Mack, head of Morgan Stanley (at 1 p.m.) and Merrill Lynch's John Thain(at 1:10 p.m.). But Fink is the only one who seems to have gotten through to Paulson anywhere near the time the market started rallying.
By the end of the day, the Dow was up 410 points in an astonishing comeback.
Goldman Sachs In Vanity Fair: Andrew Ross Sorkin Details Secret Meetings During Financial Crisis
Add The New York Times' Andrew Ross Sorkin to the list of writers who've pondered the mystery of Goldman Sachs. The latest issue of Vanity Fair has an excerpt form Sorkin's book Too Big To Fail: The Inside Story Of How Wall Street And Washington Fought To Save The Financial System - And Themselves. In it, Sorkin writes that the government tried to arrange a secret deal for Goldman Sachs to buy Wachovia in the weeks following the implosion of Lehman Brothers. At one point, Sorkin reports, the Federal Reserve even tried to push Citigroup and Goldman into a merger.
Sorkin's reports go further than any other published accounts in establishing a link between the government's actions during the financial crisis and the benefits Goldman Sachs received during the bailout. His piece contains some very damning reports about the behavior of participants in the high-level meetings between the Federal Reserve and the nation's largest banks during the peak of last year's financial collapse. Specifically, Sorkin reports on direct communication between government officials and Goldman Sachs, and scuttled deals that even caused Warren Buffett to raise an eyebrow. Sorkin quotes Buffett, who was offered to invest in a possible merged Goldman-Wachovia bank:"By tonight the government will realize they can't provide capital to a deal that's being done by the former firm of the Treasury secretary with the company of a former vice-chairman of Goldman Sachs and former deputy Treasury secretary," Buffett said. "There is no way. They'll all wake up and realize, even if it was the best deal in the world, they can't do it."
Here's more from Vanity Fair's press release:According to Sorkin, Goldman co-president Gary Cohn had agreed to engage in talks with Wachovia only on the presumption that the Fed would help Goldman guarantee some of Wachovia's most toxic assets. And [Fed governor Kevin] Warsh, in a bold gesture, made a commitment that the Fed would strongly consider it. Paulson spoke with [Goldman Sachs CEO Lloyd] Blankfein and told him to take the talks seriously.
"If you go into this looking for all the problems and how much help you're going to get, it's never going to happen," he said, adding, "You're in trouble, and I can't help you." Much to their dismay, Cohn and [Wachovia CEO Robert] Steel spent 24 hours working on a deal that they thought was near closure--and had the support of the Fed--but which ultimately died after Paulson, Bernanke and Geithner decided against pursuing it, in part, because of the "optics" of Goldman's ties to the government. "I'm sorry. I understand--I'm just as frustrated as you are. We just don't have the money; we don't have the authorization," Warsh explained.
An Inside Look at How Goldman Sachs Lobbies the Senate
by Matt Taibbi
The SEC is holding a public round table Tuesday to explore several issues around securities lending, which has expanded into a big moneymaker for Wall Street firms and pension funds. Regulation hasn’t kept pace, some industry participants contend.Securities lending is central to the practice of short selling, in which investors borrow shares and sell them in a bet that the price will decline. Short sellers later hope to buy back the shares at a lower price and return them to the securities lender, booking a profit. Lending and borrowing also help market makers keep stock trading functioning smoothly.
Later on this week I have a story coming out in Rolling Stone that looks at the history of the Bear Stearns and Lehman Brothers collapses. The story ends up being more about naked short-selling and the role it played in those incidents than I had originally planned — when I first started looking at the story months ago, I had some other issues in mind, but it turns out that there’s no way to talk about Bear and Lehman without going into the weeds of naked short-selling, and to do that takes up a lot of magazine inches. So among other things, this issue takes up a lot of space in the upcoming story.
Naked short-selling is a kind of counterfeiting scheme in which short-sellers sell shares of stock they either don’t have or won’t deliver to the buyer. The piece gets into all of this, so I won’t repeat the full description in this space now. But as this week goes on I’m going to be putting up on this site information I had to leave out of the magazine article, as well as some more timely material that I’m only just getting now.
Included in that last category is some of the fallout from this week’s SEC “round table” on the naked short-selling issue.
The real significance of the naked short-selling issue isn’t so much the actual volume of the behavior, i.e. the concrete effect it has on the market and on individual companies — and that has been significant, don’t get me wrong — but the fact that the practice is absurdly widespread and takes place right under the noses of the regulators, and really nothing is ever done about it.
It’s the conspicuousness of the crime that is the issue here, and the degree to which the SEC and the other financial regulators have proven themselves completely incapable of addressing the issue seriously, constantly giving in to the demands of the major banks to pare back (or shelf altogether) planned regulatory actions. There probably isn’t a better example of “regulatory capture,” i.e. the phenomenon of regulators being captives of the industry they ostensibly regulate, than this issue.
In that vein, starting tomorrow, the SEC is holding a public “round table” on the naked short-selling issue. What’s interesting about this round table is that virtually none of the invited speakers represent shareholders or companies that might be targets of naked short-selling, or indeed any activists of any kind in favor of tougher rules against the practice. Instead, all of the invitees are either banks, financial firms, or companies that sell stuff to the first two groups.
In particular, there are very few panelists — in fact only one, from what I understand — who are in favor of a simple reform called “pre-borrowing.” Pre-borrowing is what it sounds like; it forces short-sellers to actually possess shares before they sell them.
It’s been proven to work, as last summer the SEC, concerned about predatory naked short-selling of big companies in the wake of the Bear Stearns wipeout, instituted a temporary pre-borrow requirement for the shares of 19 fat cat companies (no other companies were worth protecting, apparently). Naked shorting of those firms dropped off almost completely during that time.
The lack of pre-borrow voices invited to this panel is analogous to the Max Baucus health care round table last spring, when no single-payer advocates were invited. So who will get to speak? Two guys from Goldman Sachs, plus reps from Citigroup, Citadel (a hedge fund that has done the occasional short sale, to put it gently), Credit Suisse, NYSE Euronext, and so on.
In advance of this panel and in advance of proposed changes to the financial regulatory system, these players have been stepping up their lobbying efforts of late. Goldman Sachs in particular has been making its presence felt.
Last Friday I got a call from a Senate staffer who said that Goldman had just been in his boss’s office, lobbying against restrictions on naked short-selling. The aide said Goldman had passed out a fact sheet about the issue that was so ridiculous that one of the other staffers immediately thought to send it to me. When I went to actually get the document, though, the aide had had a change of heart.
Which was weird, and I thought the matter had ended there. But the exact same situation then repeated itself with another congressional staffer, who then actually passed me Goldman’s fact sheet.
Now, the mere fact that two different congressional aides were so disgusted by Goldman’s performance that they both called me on the same day — and I don’t have a relationship with either of these people — tells you how nauseated they were.
I would later hear that Senate aides between themselves had discussed Goldman’s lobbying efforts and concluded that it was one of the most shameless performances they’d ever seen from any group of lobbyists, and that the “fact sheet” the company had had the balls to hand to sitting U.S. Senators was, to quote one person familiar with the situation, “disgraceful” and “hilarious.”
I’m including the Goldman fact sheets here. They will not make a whole lot of sense to people outside of the finance world, but if you can fight through them, what you’ll find is the statistical equivalent of a non-sequitur. Goldman here is lobbying against restrictions to naked short-selling, and in arguing that point they include a graph showing the levels of “short interest” during two time periods, September-October 2008 (when there was a temporary ban on all short-selling, naked or otherwise) and January-March 2009.
Goldman’s point seems to be that short-selling declined during a period when the market fell sharply, and short-selling went up when the market rallied. I guess on some planet, perhaps not on earth but some other spherical space-boulder, this is supposed to indicate that short-selling is good for the market overall.
(Which, incidentally, it might be. But we’re not talking about short-selling here. We’re talking about naked short-selling).
The thing is, you can’t deduce anything at all about naked short-selling by looking at a graph showing levels of normal short selling. This is like trying to draw conclusions about the frequency of date rape by looking at the number of weddings held. The two things have absolutely nothing to do with one another.
I was so sure that I was missing something that I started asking around. “If you are confused, you are not alone,” one economist wrote back to me. “I have no idea why they are conflating short selling and naked short selling. Members of Congress are probably confused as well.”
The thing is, the only way to draw conclusions about whether or not naked short-selling is a problem is to look at individual cases of individual declines in the share prices of specific companies, and then check to see if there have been large numbers of failed trades in those stocks.
Goldman is not only not doing that here, they’re taking two statistics with no relation to naked short-selling (short interest and stock prices), stats cherry-picked during two seemingly random time-periods, and then slapping them underneath a cover sheet full of platitudes like “The US equities market is increasingly efficient and broadly regarded as the best in the world.” It’s not so much that this is a bad argument, it’s just… not really an argument at all. It’s lazy, really. It makes you wonder what’s going on at that company.
Anyway, I’ve got to run. I’ve got some more stuff coming out in the next few days, including some transcripts of compliance officers from certain banks blabbing about this issue.
Do Lawmakers Legally Insider Trade?
by Damien Hoffman
Lawmakers possess many perks. However, legal insider trading may be the biggest fringe benefit of all. A study* released by Professor Alan Ziobrowski at Georgia State University concluded legislators in Congress make “significant abnormal returns.” Moreover, active traders outperform corporate executives. “We have every reason to believe they are trading on information that the rest of us don’t have,” reports Ziobrowski.
How the hell is this bullshit going on? Craig Holman at consumer watchdog organization Public Citizen notes, “The Securities and Exchange Act does not apply to members of Congress, congressional staff, or even lobbyists.” Outraged? If you are a voting citizen, your public representatives can legally trade investment vehicles based on information received at work. And much information is gleaned long before trickling down to the good ‘ole People. Thus, as you already deduced, a major conflict of interest exists when your political representative must choose between your needs and those of his/her portfolio.
This is another example of the cosmic irony in which Wall Street is overseen by Washington yet no one is overseeing DC. During my interview with Congressman Alan Grayson he explained the importance of auditing the Federal Reserve. While we’re making a list and checking it twice, let’s get lawmaker insider trading into the “Must Do Now” column.
* The study used hundreds of personal financial disclosures and more than 6000 stock transactions by members of Congress going back up to 15 years.
China orders crackdown on industrial overcapacity
China announced sweeping curbs on surging investment in steelmaking, cement and other industries, warning that chaotic overexpansion was raising the danger of job losses and trouble for banks. Business groups and economists have warned that Beijing's huge stimulus might fuel a dangerous boom and bust. The government said in August it would rein in investment in a range of industries but gave no details until now.
Under Wednesday's order, new aluminum production projects are banned for three years and regulators will limit spending on factories to make steel, cement, glass, polysilicon used in solar panels and wind power equipment. Without controls, "it will be hard to prevent vicious market competition and increase economic benefits, and this could result in facility closures, layoffs and increases in banks' bad assets," the Cabinet said on its Web site. Beijing appeared to be trying to fine-tune measures to keep China's recovery going by ensuring adequate supplies of industrial goods while preventing a glut that could set off price wars, hurting financially weak producers.
Businesses and investors have waited uneasily for details of how industries would be affected, worried the measures might squeeze profits. Wednesday's announcement said local authorities were partly to blame for runaway spending because they ignored planning guidelines. "Some regions act illegally, give approvals in violation of regulations or allow building before approval is granted," the statement said. The investment boom also has been fueled by government orders to state-owned banks to support growth by sharply raising lending in the first half of this year. Economists say that is likely to lead to excessive industrial investment, especially with stimulus-financed construction boosting demand and prices for steel, cement and other materials.
Beijing's two-year, 4 trillion yuan ($586 billion) stimulus is meant to reduce reliance on slumping exports by boosting domestic consumption with massive spending on construction of highways, airports and other projects. It helped to boost economic growth to 7.9 percent in the quarter ended June 30, up from 6.1 percent the previous quarter. New steel mills, cement factories and other projects will have to meet higher environmental and energy efficiency standards, the Cabinet statement said. It gave no details of how each industry's production capacity might be affected.
China is the world's biggest steel producer, and Beijing is trying to make the industry more competitive by closing smaller, dirtier mills. Regulators have tried to enforce similar changes in cement and other industries but local leaders who don't want to lose jobs and tax revenue resist closing outmoded facilities. China's annual steel production capacity of 660 million tons already exceeds its needs of 500 million tons, and another 58 million tons of capacity is under construction, "much of it illegitimate," the statement said. "Steel production capacity could exceed 700 million tons and overcapacity could worsen if curbs are not imposed promptly," it said.
New steel mills must be approved by Beijing instead of local authorities to ensure they meet environmental standards, the statement said. Smaller blast furnaces are to be shut down by 2011, though it was unclear how many might be affected. Coal and petrochemical projects must meet higher energy efficiency standards and regulators will "speed up the elimination of backward projects," the statement said. It said no experimental projects will be approved for three years.
Proposed cement factories will be reviewed and developers will be forced to redesign any that do not meet standards, it said. Proposed glass factories will be reviewed and must meet higher energy efficiency standards while "backward glass production" will be shut down. New polysilicon factories must be able to capture and recycle up to 99 percent of waste gases, the government said. Facilities also will face minimum size requirements to promote efficiency and limits on how much land they can use.
House price bounce leaves Bank of England stunned
The Bank of England has been taken aback by the recent rebound in house prices and is watching the market carefully for any signs of excessive 'exuberance'. The comments to economists at a meeting at the Bank came amid signs of a recovery in household confidence and a firmer set of lending figures. Property values have staged a marked rebound in recent months, with the Halifax reporting the average price now stands at £160,973, almost the same level as in December 2008.
Net mortgage lending rose just over £1billion in August, Bank figures showed, as home loan approvals held roughly steady at 52,317. The Mail understands that chief economist Spencer Dale yesterday told economists the strength in property values had been surprising. Officials would start to get worried if the revival gets out of hand, he said, although we are not there yet. This comes only a week after Dale said in a speech that the Bank's money-printing programme could lead to 'unwarranted increases in some asset prices that could prove costly to rectify'.
The Bank called the meeting to discuss its quantitative easing scheme to City analysts. Coupled with rates of just 0.5 per cent, the £175billion scheme amounts to an unprecedented effort to refloat the economy. Governor Mervyn King has previously suggested he might take the additional step of cutting the rate paid to banks on their BoE reserves, in order to discourage them from hoarding cash. Officials yesterday suggested any such move is a long way off. A spokesman for the Bank refused to comment on the meeting, which was confidential.
Optimism about the property market was heightened as HSBC said the housing crash appeared to be over and made £500million available to homebuyers who can afford 10 per cent deposits. Confidence in the economic outlook rebounded to +4 in September, the firmest reading since 1998, according to a survey by GfK NOP for the European Commission. Separately, economic output fell 0.6 per cent between the first and second quarters of the year, the Office for National Statistics said, a slightly shallower decline than a prior 0.7 per cent estimate. However, the ONS figures revealed that many families are becoming more careful with their money, saving £13.4billion in the second quarter, the most since Labour came to power in 1997. That drove the saving rate to 5.6 per cent, the highest level since 2003.
The Dow Zero Insurgency
The nothing-can-be-believed chaos of the financial crisis created a golden opportunity for a blog run by a mysterious ex-hedge-funder with a dodgy past and conspiracy theories to burn.
Last spring, in a far corner of the Internet, an unknown blogger began to piece together a conspiracy theory: The investment bank Goldman Sachs was using sophisticated, high-speed computers to siphon hundreds of millions of dollars in illegitimate trading profits from the New York Stock Exchange, invisibly undercutting the market and sidestepping the regulatory reach of the Securities and Exchange Commission.
Only a few loyal readers paid attention to the blog called Zero Hedge, a no-frills site full of arcane analysis decipherable only by finance professionals. But when a former Goldman Sachs computer programmer was arrested for allegedly stealing software codes used for the firm’s electronic trading arm, and a federal prosecutor was quoted saying the codes could be used to manipulate markets in unfair ways, the once-obscure blog ignited a chain reaction. While on a golf outing, an editor at the New York Times learned from a friend who worked on Wall Street that the Zero Hedge allegation was the talk of the industry, and an assignment ensued. On July 24, the Times published a front-page article on so-called high-frequency trading and its potential abuses, which in turn prompted Chuck Schumer, a member of the Senate Finance Committee, to draft a letter to the SEC that same day. Twelve days later, the SEC signaled that it was considering a ban on the very computerized trading that Zero Hedge had attacked.
Suddenly, the shadowy figure behind Zero Hedge was a full-blown cult heroa blogger with a bullet. His readership of angry traders and anti-government malcontents celebrated his newfound power. Welcome to the party pal!!! declared one of his fans in the comments section.
In a sign of just how radically the order has shifted in the political and media world, neither the Times nor Schumer had a clue about the identity of the pseudonymous author behind Zero Hedge. As it happens, the founder is a 30-year-old Bulgarian immigrant banned from working in the brokerage business for insider trading. A former hedge-fund analyst, he’s also a zealous believer in a sweeping conspiracy that casts the alumni of Goldman Sachs as a powerful cabal at the helm of U.S. policy, with the Treasury and the Federal Reserve colluding to preserve the status quo. His antidote? A purifying market crash that leads to the elimination of the big banks altogether and the reinstatement of genuine free-market capitalism.
Never mind Dow 10,000. Dan Ivandjiiski is all about Dow Zero.
Last year’s financial implosion left the investing public deeply unsettled about who or what to trust. The information that flowed from the banks, the ratings agencies, the regulatory agencies, and the mainstream mediathe bedrock of the financial markets, in a sensewas viewed with great suspicion, and that created an opportunity for financial bloggers: a motley assortment of amateurs and professionals from all over the map. There are traders, economists, venture capitalists, financial advisers, and pajama-clad cranks all vying to explain the complex machinations that got us into this mess and to critique governmental solutions. Sites like Naked Capitalism, Seeking Alpha, the Big Picture, Infectious Greed, Angry Bear, Calculated Risk, and Zero Hedge have hatched communities based on discontent and disbelief, forming a kind of ragtag insurgency against the financial Establishment and what they view as its feckless lackeys in the government and media.
We’re all happily cruising along, doing our financial-journalism thing, until late 2007, explains Felix Salmon, who now blogs for Reuters. We have relationships with flacks, and suddenly they started lying to us. Outright lies. And you’re like, Wait, that’s not kosher, you can’t do that.’ Among bloggers, Salmon is more of the Establishment type, with little tolerance for the sloppy thinking of excitable bloggers.
Financial blogs grew out of the message boards launched by Yahoo! Finance in the late nineties, which were primarily a forum for day traders to argue investment ideas and vent little-guy frustrations about the Wall Street power structure.
The first financial blogger, according to Barry Ritholtz of the Big Picture, was Todd Harrison, the head trader for the hedge fund run by CNBC talking head Jim Cramer (also a New York Magazine contributing editor) in the early aughts. Harrison, who wrote a daily market column for Cramer’s TheStreet.com, would crank out these little notes intraday, recalls Ritholtz. It was a real-time trader with real assets under management discussing trading flow.
In the years that followed, blogs proliferated. They were mostly side projects, updated sporadically. Ritholtz, who started the Big Picture in 2003, was a market strategist who zeroed in on flaws in the government’s inflation data. Calculated Risk was started by a retired businessman in Southern California who took an obsessive interest in exotic mortgages and saw the housing collapse years in advance. Naked Capitalism, which features the work of a small gang of contributors, is overseen by a former Goldman Sachs and McKinsey executive who goes by the pseudonym Yves Smith.
Early on, the readers of these blogs seemed to be a relatively small and disparate groupa smattering of day traders, academics, and people who worked in and around the edges of the financial industry. They were gold bugs and dollar bears united by their hostility to Wall Street and their conviction that the U.S. economy was heading off a cliff. When Bear Stearns blew up, the bearish view was validated and these blogs gained credibility with a larger audience. Amid the chaos on Wall Street, they found themselves with much greater influence than they’d ever imagined possible.
Such is their power today that the Treasury and Federal Reserve both circulate blog watch e-mails, which are sent to the White House every day. Aides on Capitol Hill solicit bloggers for advice and explanations on complex regulatory issues, according to government spokespeople and the bloggers themselves. When John Hempton, whose blog is called Bronte Capital, wrote a massive post on the Treasury Department’s banking-reform planmeticulously noting the government’s poor judgment in assessing the solvency of banksI went from having ten readers in Washington to 700, he says.
Out of this scrum, Zero Hedge would distinguish itself as one of the most enterprising and the most combative, although not right away. The site was launched in January of this year, a few days after Dan Ivandjiiski, who lives on the Upper East Side, lost his job at Wexford Capital, a Connecticut-based hedge fund run by a former Goldman trader.
Blogging may seem like an odd career shift for a well-paid hedge-fund analyst, but for Ivandjiiski, it marked something of a return to the family business: His father, Krassimir Ivandjiiski, is a writer and editor at Bulgaria Confidential, a tabloid known for its controversial investigative reporting. In 1996, the elder Ivandjiiski exposed what he said was political corruption and drug trafficking in, of all places, Montana, in a story republished in the U.S. in a shoestring periodical called Free Speech Newspaper.
The story prompted Montana’s governor at the time, Marc Racicot, to charge that a number of libelous statements and defamatory untruths are included in the article, including statements that I have a history of drug abuse and that I am a recovering alcoholic. (Free Speech’s editor responded with a lengthy rebuttal, and the matter faded away.)
Dan Ivandjiiski moved to the U.S. to study molecular biology at the University of Pennsylvania in preparation for medical school. After graduation, Ivandjiiski instead took a job as a junior investment banker at Jefferies & Company in Los Angeles, followed by a brief stint at Imperial Capital. In 2005, he moved to New York to work for the firm Miller Buckfire, where he was accused of personally buying shares in an airline company one day prior to the announcement of a major deal with his former firm Imperial. Though he made only $780 on the trade, an official probe was launched and Ivandjiiski was barred from working in the broker-dealer business. The ban forced him into the unregulated world of hedge funds, where he learned the inner workings of the kinds of high-stakes trading he’d soon be writing about.
When he started blogging, Ivandjiiski billed himself online as Tyler Durden, after the masochistic anarchist played by Brad Pitt in the film Fight Club, who blows up the headquarters of major credit-card companies. The early iteration of Zero Hedge used free online software to publish a generic white page with the name ZERO HEDGE in red at the top, along with a quote from Fight Club: On a long enough timeline, the survival rate for everyone drops to zero. The site’s first post appeared on January 9 at 4 p.m., and it set the tone: One can follow the daily creation and destruction of wealth simply by looking at the constantly shifting landscape in New York, Ivandjiiski wrote, predicting that an upcoming wave of Page 6’worthy scandals that would disgrace Wall Street.
At first, Ivandjiiski seemed intent on imitating the snarky, gossipy tone of Gawker and Dealbreaker, lampooning the financial disasters splashing across the papers, from Madoff to Citigroup. Zero Hedge posted several times a day, much of it toothless and not very interesting. Ivandjiiski seemed timid about revealing his own views. Nobody commented. The first post to elicit significant feedback was a Risk-Free Profit Idea of the Day: Buy barrels of oil and store them.
But after two weeks, the attempts at humor began to recede, replaced by dense market analysis with technical charts and graphs. It read like the work of a financial analyst gone AWOL. Overview of Implied Default Rates and Probabilities went one typically scintillating headline. In late January, when asked by a reader how long he’d been blogging, he replied in the comments: two weeks now. not sure if that’s too long or too little.
But he slogged away, e-mailing his links to established bloggers, like the San Diegobased investor and doom enthusiast Paul Kedrosky, who blogs at Infectious Greed. If Zero Hedge got four comments, it was a great day. His early readers were day traders, many running their own private message boards and invite-only blogs. Commenters tended to be confrontational, poking holes in his lengthy arguments about the inevitable implosion of New York’s pension funds or how Citigroup’s stock was a bear-market bellwether: You’re kind of a moron, said one anonymous reader.
But as his posts got more detailed, a theme began to emerge: Wall Street was a vast conspiracy. Nothing could be trusted. All markets were corrupt. The darker his vision the more popular he became. Ivandjiiski grew emboldened, confident that there was an audience, maybe even a big one, for his radical notions. Commenters voiced their approval. He scored with a post on the bank bailouts called Bailoutspotting (Or the Search for the Great Financial Methadone Clinic), which argued that the government’s Temporary Liquidity Guarantee Program was the heroin of bank-bailout programs, destined to break the backs of taxpayers. Using pretexts, subterfuge, and lies, the administration’s charade triage will only end once there are no more gullible taxpayers to provide their cash, no more demagogue senators and congressmen who will bend reality to make it seem that their actions benefiting a select few are for the benefit of all, and no more naïve investors who buy into the promises that U.S. debt is the safest investment,’ he wrote. It drew wild cheers from the peanut gallery. A commenter named Stockhustler wrote, This is by far the greatest blog on the Internet.
By March, Zero Hedge was getting up to 40 comments a post. The blog’s inscrutability was part of its appeal. It had the feel of a financial insider leaking forbidden information. Some of it actually was proprietary. In May, Zero Hedge made several posts based on the research of David Rosenberg, who was then the chief economist for Merrill Lynch. Rosenberg’s views on the market were extremely bearish; he predicted a slow, protracted recovery and dismissed his bullish peers as pom-pom wavers. Merrill Lynch was peeved to see research that its clients paid handsomely for made available for nothing on a blog. Lawyers were dispatched, and the material was removed from the site.
Unversed in copyright law, Ivandjiiski pitched this as a case of censorship, feeding into the image of Zero Hedge as a guerrilla force battling the big firms. In late March, when the White House invited more-mainstream bloggers, like the authors of Clusterstock, to an online discussion of the TALF program (the Term Asset-Backed Securities Loan Facility, a temporary lending arm of the Federal Reserve), Ivandjiiski savored his outsider status: Not surprisingly, Zero Hedge was not invited, but we will participate anyway and provide our readers with as much info from this public medium’ as we can.
Zero Hedge’s popularity metastasized with its increasingly paranoid focus. The greatest bait and switch of this generation in all its visual splendor, he announced under the headline The Amazing talf Bait and Switch, describing how the government’s lending program could easily be gamed by banks and hedge funds. Other bloggers, as well as some of his own readers, evinced skepticism at his analyses, but a growing number felt he was expressing something they all felt. The whole thing smells of rank conspiracy and blackmail, said one reader.
As the stock markets surged back to life in the spring, Ivandjiiski’s economic predictions only became bleaker. On April 11, Zero Hedge wrote The Imminent Disinformation Schism, a 3,000-word opus on the split between the naïve, easily-manipulated, small-time mom-and-pop investors and a rising new group of tea-party-style skeptics, the forward-looking taxpayers, who see the upcoming budget-deficit fiasco, the Social Security Ponzi scheme, the Medicare/Medicaid debacle, the ridiculous underfunding in public and corporate pension funds, the rising city and state taxes, the shuttering factories, the rising unemployment, the plummeting American production base, the seasonally’ upward-adjusted economic data coupled with consistently downward revised prior economic releases, the increasing savings rate and the multi-trillion discrepancy in consumer purchasing power.
The cold facts, he continued. When you stare at the abyss, the abyss stares back at you.’ Why is everyone so afraid to stare at the proverbial abyss? Readers of Zero Hedge know all too well about my fascination with the economic fundamentals, and my desire to expose the real abyss in all its deep glory.
It was around this time that Federal Reserve chairman Ben Bernanke mentioned green shoots, the first tiny signs of economic recovery. The financial blogosphere savagely mocked Bernanke’s rhetoric, even as the stock market endorsed it by rallying. It was a sham, Zero Hedge maintained; the market was clearly being manipulated. But how?
In April, Zero Hedge began drawing reader attention to weekly trading data issued by the New York Stock Exchange. The reports showed that Goldman Sachs was conducting a highly disproportionate percentage of all the trades on the exchange. This giant footprint, Ivandjiiski suggested, gave Goldman Sachs unprecedented opportunities to take advantage of a situation that has a very fishy feel’ about it.
His report reverberated widely. Zero Hedge’s traffic spiked. Goldman Sachs spokesman Ed Canaday felt compelled to respond, calling some of Zero Hedge’s charges untrue and offensive. Which of course only inspired Zero Hedge to dig deeper.
Bit by bit, Ivandjiiski pieced together a theory as to how the firm’s dominance of high-frequency computer trading, specifically so-called flash trades, enabled it to see other people’s trades moments before they were executed. Goldman used this information, alleged Ivandjiiski, to jump in and pinch off pennies in the price differences, a practice that he estimated could add up to millions of dollars a day. This, he decided, was how the firm was producing such huge profits so quickly after its near-death experiences in 2008.
Zero Hedge made such a compelling case that mainstream-media reporters started paying attention. Ivandjiiski happily walked journalists through his theories in off-the-record conversations, becoming a trusted resource, especially for reporters at Bloomberg News, which published several stories riffing on Zero Hedge’s pursuits, starting with a July 7 report speculating on the misuses of high-frequency trading following the arrest of Sergey Aleynikov, a former Goldman Sachs computer programmer accused of stealing the firm’s codes. Goldman Sachs Loses Grip on Its Doomsday Machine, went a story by Bloomberg columnist Jonathan Weil. Later, Ivandjiiski, using his alias Tyler Durden, was interviewed on Bloomberg Radio.
Ivandjiiski, meanwhile, started peddling a much larger conspiracythat ever since Robert Rubin ran Goldman Sachs’s arbitrage trading desk in the seventies, the firm and its network of powerful alumni had essentially rigged the market in its favor. If that sounds like something you read in Rolling Stone last July, that’s because Zero Hedge served as a key source for the infamous article on Goldman Sachs written by gonzo journalist Matt Taibbi. I didn’t understand a word he was saying, says Taibbi, recalling his first conversations with Ivandjiiski last spring. I went through the tape-recorded interview trying to decipher it minute by minute.
Analysts on CNBC mocked Taibbi’s story, but Zero Hedge, of course, loved it, calling it one of the best comprehensive profiles of Government Sachs done to date. Speaking of GS, they sure must be busy today, now that Bernanke is about to be impeached and take the fall for all their machinations.
Taibbi, who says he still exchanges e-mails regularly with Ivandjiiski, believes the blog was responsible for the New York Stock Exchange’s decision to alter the way it releases weekly trading data: Pretty clearly this guy has so pissed off Goldman Sachs they managed to get that rule change about how the data got released, and that’s almost certainly because of Zero Hedge.
On September 17, the SEC drew up a proposal to ban flash trading, scoring a bona fide victory for Zero Hedge. He was on the cutting edge of bringing attention to the problems posed by flash trades, says Brian Fallon, a spokesman for Senator Schumer, and his writings certainly bring an insider’s perspective to anyone wading through this highly technical issue.
Conspiracy theories are hot sellers these days, and Goldman Sachs is the new Warren Commission. Following the lead of Zero Hedge, both Michael Moore and Glenn Beck have hit pay dirt by attacking the firm. It’s an attractive target for almost anyone. Blogger Cullen Roche of the Pragmatic Capitalist says that whenever he writes about Goldman Sachs, he sees immediate results. My traffic automatically shoots through the roof, he says. It resonates with people, that sentiment, that frustration with other things that are going on.
And so it goes with Zero Hedge.
Something like Zero Hedge, which takes an extremely conspiratorial view of the markets and possible manipulation, is going to happen in part because the world has become more conspiratorial, says John Carney, who blogs at Clusterstock. You don’t even need a conspiracy theory to say the most powerful people and the wealthiest people are working together to accomplish their mutual goals.
Four days after the Times story on high-frequency trading, Zero Hedge re-launched with a sleeker design and more advertising space, adding staff and posting phone numbers to offices in London and Zurich. Zero Hedge has seen its page views triple since July. It began selling $37 Zero Hedge T-shirts, modeled by a rumpled hipster in a green camouflage cap. The new logo looks vaguely like a Masonic symbol, and Tyler Durden’s posts now feature the image of Brad Pitt’s pummeled face from Fight Club, a glowering radical.
You can tell he was feeding that conspiratorial audience, says Roche, who posted a comment on Zero Hedge about his concern that the site was losing its focus and indulging in cheap theatrics. The comment was promptly deleted by Zero Hedge. He got a backlash from a lot of readers, says Roche. Personally, I thought it detracted from his credibility.
But not necessarily from his revenue stream. In July, Zero Hedge joined Halogen Network, an online-advertising company, which has placed Delta Airlines and Forex Trading ads on the blog’s pages. Halogen plans on conducting a reader survey for the site in the coming month. Greg Shove, founder and CEO of Halogen, says it will likely show the same demographics as other successful financial blogs: men between 35 and 55 who make $200,000 and up a yeara pretty juicy target audience. Zero Hedge could potentially rake in $25,000 a month in ad revenue alone. That’s a pittance for someone accustomed to hedge-fund wages, but it’s a healthy foundation for a nascent web-publishing firm that’s less than a year old.
Zero Hedge has certainly attracted high-powered readers drawn to his way of thinking. Jim Chanos, the founder of the investment firm Kynikos Associates, calls it a must read for his firm. A famed short-seller, Chanos is strategically sympathetic to Ivandjiiski’s radically bearish market views. Zero Hedge’s central argument, that the big banks are a menace and must be broken up, is one that I and a lot of people secretly support, says Chanos.
Chris Whalen, a banking analyst who met Ivandjiiski for lunch this year at the Peking Duck House in Manhattan, compares him to the pamphleteers of early-nineteenth-century America, non-journalists who distributed opinionated political tracts. If we just relied on the old media, we’d have nothing right now, he says. He’s taken some things on that could easily have gotten him a lawsuit. He’s got a lot of balls.
It’s fair to say that Zero Hedge’s success has given Ivandjiiski a newly minted sense of his own importance. In conversations with reporters, he regularly touts his influence with political figures like Schumer and Senator Ted Kaufman of Delaware, whose aides, he says, call him all the time.
For all his flame-throwing, Ivandjiiski is very sensitive to criticism. When a fellow blogger, who declined to be named, privately corrected him on some evidence he used to criticize the Fed, Ivandjiiski responded with a chest-thumping defense, citing his background working for a $10 billion hedge fund as evidence of his undeniable expertise. I am well aware what I am talking about, he told the blogger, and the truth is there are many other things happening that I have yet to bring up Unlike the mainstream media, I don’t tip my cards all at once My style may hyperventilate, but at least it achieves its goalwhich is to wake the people up from the stupor.
Zero Hedge’s reputation has grown so much that last month, CNBC personalities Charlie Gasparino and Dennis Kneale felt moved to attack the site on-airKneale was particularly aggrieved by Zero Hedge’s ridicule of his declaration that the recession was over and delighted in describing anonymous bloggers as dickweeds. (Gasparino used the more prosaic morons.) Zero Hedge struck back with an Open Letter to the Financial Media, characterizing criticism as the dying gasps of the old media. Ladies and Gentlemen, it reads, one-line zingers and contrived time limits designed to impale your hapless guests do not constitute constructive conflict’ worthy of your interest in the Fourth Estate, which, incidentally, you do not own, but rather hold in trust on behalf of the citizenry.
Zero Hedge’s critics aren’t confined to the old media, though. Some financial bloggers see Tyler Durden as a fact-bending, fear-mongering opportunist. It’s nihilist, and that kind of vision lends itself to all manner of overreaching and conspiracy, says Felix Salmon of Reuters. You need some kind of critical judgment to separate out the [stories] that make sense and the ones that don’t. Zero Hedge just seems to not care about that. It doesn’t matter if it’s not true.
Even Zero Hedge’s great triumph, the flash-trading exposé, is dismissed by some of his blogger peers. It’s like one of those Star Trek episodes where computers are taking over, says Paul Kedrosky of Infectious Greed. It makes no sense, but it’s fun to imagine. It hit the sweet spot of paranoia.
John Hempton of Bronte Capital has been among Zero Hedge’s toughest critics, arguing that the high-frequency-trading issue is a storm in a teacup and massively overstated, writing that the argument that Goldies blowout trading profits have been caused by its recent forays into high-frequency trading is absurd. Everyone I know of who has hugely electronic trading systems is making less money, not more.
Hempton also says he was among the first to raise the question of who the hell Zero Hedge isand what his dollar on the chit is. Which is to say, what’s his agenda?
Ivandjiiski was initially enthusiastic about being interviewed for this story and considered confirming his real identity, then backed out, citing the objection of a Chicago-based partner, who used to blog at Dealbreaker under the pseudonym Equity Private. She now calls herself Marla Singer, another character from Fight Club. She feared Ivandjiiski’s exposure would lead to her unmasking as well. But more important, he made clear, a measure of secrecy is essential to the site’s mission as an incorruptible critic of the market.
Ivandjiiski did arrange for me to speak with Singer. It was a bizarre exchange. Tyler Durden isn’t one person, she said, but up to 40 different people allowed to post under that name. We are all Tyler Durden, Singer claimed.
It was around this time that Ivandjiiski, in his e-mails to me, began referring to himself in the third person. And one day after declaring our conversation over, he e-mailed again to flag yet another example of Zero Hedge’s influence: a scathing analysis he wrote last March about the National Rural Utilities Cooperative Finance Corporation (NRUC), which prompted an angry press release from the company before the rating agency Fitch downgraded NRUC. In his final post on the subject, Zero Hedge predicted the move would leave the Virginia-based utility in [a] smoldering heap of electric and telephone poles.
Whatever its other accomplishments, Zero Hedge has won the fierce loyalty of its readersso fierce are they that two prominent financial bloggers I spoke with declined to comment on Ivandjiiski or his site for fear of a digital assault. I have no interest in having his defenders storm over and attack my site, says one blogger. Says another, You can offer any logical argument, they just don’t care. They’re going to follow him over the cliff.
When John Carney of Clusterstock merely posted about a blogger named John Jansen, who had called a Zero Hedge post egregiously incorrect, Clusterstock was invaded by Zero Hedge fans who said he had sold out to CNBC. Start a war with ZH at your own peril, one of them warned.
A lot of the readers are people who felt like they’ve lost money to machinations on Wall Street in some way, reasons Carney. They see Zero Hedge as standing up for them, so any critique of Zero Hedge is taken as something that really needs to be fought back against. All hands on deck.
Leo Kolivakis, a Montreal-based pension-fund analyst who recently started making occasional guest posts on Zero Hedge, says he enjoys the large and energized readership he gets writing for Zero Hedge. But even he doesn’t buy everything the site promotes, including the assertions about Goldman’s flash trading. You can claim that, but where’s your proof? How do I know Lehman and Morgan Stanley weren’t doing the exact same thing? If that was really going on, I think the SEC would move and close that operation up.
But the Zero Hedge faithful, and Ivandjiiski himself, would call that the naïve faith of the stupefied masses. He’s plunging ahead with a new crusade, going after so-called dark pools, unregulated markets where big investors can anonymously unload securities. (Just guess which firm dominated this practice.) Now that flash trading is practically a thing of the past, everyone’s attention is shifting to dark pools, Ivandjiiski announced last week, readying Chuck Schumer for his next mission: The investing world is looking to you to continue your pursuit of a level playing field.’
Wall Street is about speculation, and Wall Street blogs are no different. At this point, Zero Hedge has staked everything on a doomsday scenario, a takedown of the old order, a deleveraging at every level of modern society. Even as the market has improved, the economy has shown glimmers of stability, and many of his fellow bears have capitulated, Ivandjiiski has clung ever more tightly to his convictions. The manipulation of the market will eventually fail, he believes, and the pyramid scheme will be exposed for all to see. But it better happen soon or Zero Hedge may lose its mojo. The higher the Dow Jones climbs, the more righteous he necessarily becomes: Every hopeful data point a fraud, every bull a conspirator. There’s an old Wall Street term for this, for when you hold firm to your belief in defiance of the marketfighting the tape. It’s considered inadvisable, but that’s what Ivandjiiski is doing, convinced that he is destined to win.