Long Branch bathing beach, New Jersey
Ilargi: The Wall Street Journal has an eye-opening piece in today's paper, entitled Banks Load Up on Mortgages, in New Way . Sometimes you don't know whether you should laugh or cry. And I'm thinking I must have probably gotten this all wrong and upside down and whatnot, because, you know, they just wouldn't dare pull a stunt like that. And apparently what I've been trying to explain to you about the perverting influence of Fannie Mae and Freddie Mac on the US housing market is already outdated. There's a new pervert in town. Or two. Or three. I bet you, they've been working on this plan for quite a while now.
Here's the picture I’ve gathered so far. As I said, I must be wrong, this can't be true, but this is what my feeble brain manages to come up with.
US banks collect TARP funds. They take that money and use it not to expand their lending, which is what it's for, but to buy Ginnie Mae securities. Ginnie is backed directly by the government, so the securities are deemed risk-free, and banks therefore need to hold no loss reserves. Because Fannie and Freddie, despite the fact that the government has taken them over, still don’t have the explicit backing, their securities force a 20% loss reserve.
So the banks sell their Fannie and Freddie's, plus any other mortgage-backed securities they may have left (like for instance their own), and use the receipts to buy ... mortgage backed securities of the Ginnie flavor. Are these better or less risky? No, of course not, but they are for the banks. All the risk is for the taxpayer.
With all the paper gone that forced them to hold any reserves, every single one of these alphabet soup failed-out banks is now free to use ALL their resources to purchase 100% risk-free silly Ginnie "securities" -a misnomer if ever there was one-, which are fully backed by the good faith and credit of all the millions of former homeowners who are underwater and/or in foreclosure on the homes they bought with the mortgages that, along with the taxpayer, back the securities that carry no risk whatsoever to speak of.
Except that Ginnie Mae’s risk free paper is backed by mortgages issued by the FHA, the only go-to address left for those who can't be bothered to be bothered by details such as down payments. 3.5% down is fine by the FHA. And Ginnie Mae. And the federal banking regulators, who claim that mortgages with 3.5% down are absolutely risk free. 20% of all 2009 US mortgages, $298 billion worth, had been sold off as risk free securities by August . And those 20%, because of FHA standards, are bound to be the riskiest loans out there, since there simply are no private lenders left that accept 3.5% down.
All the while, we’re stuck right in the thick of the seven fat years of on-going talks on how to improve bank regulation. No, I’m not kidding, much as I wish I was. If there's one thing I’m certain of, it's that a government and a banking system that manage to cook this one up don't want no improved regulation. Not till they sucked this baby dry for all she can be bled for. The housing market keeps going, and banks can make loans at the same time they get to clean up their books, all without a worry in the world about future losses. Those are all yours.
Don't worry, I will freely and gladly admit that I am mightily confused here, and somehow quite sure that this cannot possibly be true. Except I still do think I got quite a bit of it right. And that's plenty crazy enough for my taste. You can't make this stuff up. Hollywood would reject it on account of a lack of credibility. I guess it's way past time that someone should call a halt to these threacherous practices, but you won't catch me holding my breath. It's all a way of thinking that's been around for so long, people think of it as normal. It brings to mind a Springsteen line:
You get used to anything, sooner or later it becomes your life.
Banks Load Up on Mortgages, in New Way
Banks have been silent partners in the meteoric rise of the Federal Housing Administration. In the past year, the nation's financial institutions have snapped up securities backed by Ginnie Mae, a government-owned agency that guarantees payments on mortgages backed by the FHA. That helped drive demand for Ginnie securities and created an outlet for billions of dollars of FHA-backed loans made to borrowers who in many cases couldn't afford big down payments.
As of June 30, the roughly 8,500 federally insured banks and thrifts were holding $113.5 billion of Ginnie securities, compared with just $41 billion a year earlier, according to a Wall Street Journal analysis of bank financial disclosures. It is the largest amount that banks have reported holding since at least 1994. Banks, sometimes with the blessing of federal regulators, have been loading up on Ginnie securities for one main reason: They make their balance sheets look healthier.Since the securities are guaranteed by the government, federal banking regulators have deemed them risk-free, meaning that adding them to a bank's investment portfolio, or replacing assets deemed riskier, lowers the overall risk of the portfolio in the eyes of regulators.
Some banks have used government cash infusions under the Troubled Asset Relief Program to buy Ginnie Mae bonds. Having an eager buyer for its securities has made it easier for Ginnie Mae to increase the amount of debt it issues, though there appears to be no connection between the banks' increased appetite and the increasing supply of Ginnie Mae securities. Because Ginnie Mae can issue significant amounts of securities, the FHA can back more loans and the high demand helps keep interest rates low. The irony is that banks that are reluctant to lend and are trying to unload their own mortgage holdings are at the same time helping to prop up the housing market by buying up securities backed by mortgages.
Through August, Ginnie had backed $298 billion of mortgage-backed securities in 2009, the most in its 41-year history and nearly double the amount in the same period last year. That represents about 20% of total new mortgages in the U.S. In addition to FHA-backed loans, Ginnie also guarantees securities comprising mortgages backed by the Department of Veterans Affairs and other federal agencies.
Ginnie and the FHA, units of the U.S. Department of Housing and Urban Development, have become two of the most powerful mortgage financiers in the U.S. When banks make home loans, the FHA insures them against default. Then the mortgages are pooled together and packaged into mortgage-backed securities. Ginnie guarantees that buyers of those securities -- including banks and other investors -- will continue to receive interest and principal payments on the debt, even if borrowers start to default.
Over the past year, FHA has played a key role in supporting the struggling housing market by buying up mortgages made to home buyers who can't afford big down payments or homeowners who want to refinance but have little equity in their homes. The FHA may be paying a price for all its lending. Rising losses on the mortgages have drained the agency's reserves. Holding Ginnie bonds help banks look better because federal bank-capital guidelines give the Ginnie securities a "risk weighting" of 0%. That means banks don't have to hold any cash in reserve to protect against losses.
By contrast, securities backed by Fannie Mae and Freddie Mac, the two mortgage giants seized by the government, carry a 20% risk weighting, meaning some cash needs to be set aside to hold them, even though most banks and investors think there is scant risk of Fannie or Freddie securities defaulting. Privately issued mortgage-backed securities can receive risk weightings of 50%, while many other types of debt carry 100%.
Because of the different risk weightings, bankers say they are selling relatively safe assets like Fannie securities and replacing them with Ginnie securities. The move doesn't shrink banks' balance sheets or remove their troubled assets. But it reduces their total assets on a risk-weighted basis. That is important because risk-weighted assets are the denominator in some key ratios of bank capital. "With the pressure for capital, that's really made the Ginnie Maes more attractive," said John C. Clark, chief executive of First State Bank in Union City, Tenn. The bank's holdings of Ginnie securities jumped to $66 million at June 30 from less than $4 million a year earlier.
Like some peers, First State bankrolled those purchases partly with taxpayer dollars that were intended to stabilize the banking industry and jump-start lending. The 32-branch bank used a "significant portion" of the $20 million it received through TARP to buy Ginnie securities, Mr. Clark said. Mr. Clark credits the strategy with helping First State preserve its capital ratios even as loan defaults swelled to $9.5 million on June 30 from $1.6 million a year earlier. During the same period, its total risk-based capital ratio climbed to 11.3% from 10.7%. That gave First State some breathing room above the 10% ratio regulators require for banks to be deemed "well capitalized."
This spring, executives from Warren Bancorp Inc., a small Michigan lender struggling with rising losses, sat down with examiners from the Federal Reserve to discuss the bank's dwindling capital. Bank officials pitched the idea of buying millions of dollars of Ginnie securities "The examiners thought it was a good strategy for us to use," said Kim Keeling, the six-branch bank's chief financial officer. She called it "the quickest and the least costly option" for addressing the bank's depleted capital ratios. Ms. Keeling acknowledged that the strategy doesn't ease the bank's underlying problems. "The whole capital ratio can be manipulated ... in many ways to make it appear better or worse," she said.
Some bankers and other experts criticize the strategy's benefits as largely cosmetic, saying it is an example of how the federal rules governing bank capital are prone to manipulation. Buying Ginnie securities "helps alleviate some of the pressure but doesn't address the problem at large," said Ken Segal, senior vice president with Howe Barnes Hoefer & Arnett, a brokerage firm that advises small and midsize banks. "There's still the endemic problem" of bad loans. Others say bank purchases of Ginnie securities are a prudent risk-reduction strategy. Bankers rightly perceive Ginnie securities as safer than almost any other investment, said Roger Lister, chief credit officer for financial institutions at bond-rating firm DBRS. "It may not just be for regulatory-capital arbitrage," he said.
In St. Augustine, Fla., Prosperity Bank increased its holdings of Ginnie securities tenfold over the past year. The lender, with 20 branches and $1.2 billion in assets, simultaneously dumped most of its Fannie and Freddie securities, even though they seemed safe. "There's no more risk in Fannie and Freddie securities than in a Ginnie security," despite the different capital treatments, said CEO Eddie Creamer.
Mr. Creamer worries the capital rules could inadvertently make mortgages harder to come by. As banks dump Fannie and Freddie securities, their prices are likely to come under pressure. That inflates their yields, which translates into higher interest rates on the mortgages that they finance. "It has a broader implication on the availability of those mortgages and the costs of those mortgages," Mr. Creamer said.
Home Prices Could Fall by Another 25%: Whitney
Home prices in the US could fall by another 25 percent because of high unemployment and another leg down will come for stocks, banking analyst Meredith Whitney told CNBC Thursday. "No bank underwrote a loan with 10 percent unemployment on the horizon," Whitney said. "I think there is no doubt that home prices will go down dramatically from here, it's just a question of when." Local governments and states are chronically under-funded and "most states are under water," adding to the problem of low private consumption, she said.
"If you look at the drivers for unemployment I don't see that reversing very soon," Whitney said. If consumers were to decide to spend, "that would be a game-changer," but it would be an unnatural thing to do in a recession, she said. "A lot of themes are constant, which is the US consumer and the small business doesn't have any credit, credit is still contracting," Whitney said.
Consumer debt and consumer credit have dropped according to the latest figures which also show that people have been spending more from their debit cards than from their credit cards. "Obviously that doesn't bode well for spending," Whitney said. She said another leg down was coming for stocks but that Goldman Sachs still has "gas in the tank" and she kept her 'buy' on its stock. "Goldman is taking a lot of the place that Lehman left," she said.
But banks are not going to see their earnings rise too much from now on, she warned. "Banks are taking advantage of what the government is doing by artificially inflating asset prices so they can ride a steep yield curve and they're going to have a third quarter that reflects that," Whitney said. Their shares are unlikely to be uplifted by these results as it happened in mid-July, because then they were under-valued, she added.
US Banks Face Loss of Debt Guarantee
The Federal Deposit Insurance Corp. is preparing to wind down an emergency program it launched last year, which could become an early test of how the banking industry will fare without extraordinary government assistance. The FDIC's program, which guaranteed debt issued by banks, is credited with helping to stabilize the financial system during last year's turmoil. The agency said it was considering either letting the debt-guarantee program expire on Oct. 31, or continuing it for another six months for "emergency" purposes.
The latter would require case-by-case approval from FDIC Chairman Sheila Bair and a hefty fee from participants. "As domestic credit and liquidity markets appear to be normalizing and the number of entities utilizing the Debt Guarantee Program has decreased, now is an important time to make clear our intent to end the program," Ms. Bair said. The debt-guarantee program is a part of the Temporary Liquidity Guarantee Program, which Ms. Bair reluctantly agreed to implement last fall under pressure from then-Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke.
Many credit it with helping bring the banking industry back from the brink of collapse because it allowed banks, for a fee, to issue new debt with government backing that protects investors in the event of a collapse. Banks leapt at the opportunity. As of Sept. 4, there was $304.14 billion in FDIC-backed debt outstanding, including promissory notes, commercial paper and unsecured portions of secured debt. To enact the program, the FDIC had to cite a "systemic risk" to the economy. The agency has collected roughly $9.3 billion in fees from banks that have participated, and to date has not faced any guarantee payouts.
Banks need to issue debt to fund their operations. When credit markets seized last year, the cost of issuing debt spiked because of worries that banks would later go bust. Many government officials and bankers believe the FDIC's program allowed banks to access funding at a time when they otherwise would have been frozen out. As worries about the stability of the banking system have eased, many financial firms have been able to issue debt relatively cheaply without government backing. The program's largest users have issued more than $81.3 billion in medium-term debt outside of the program, according to data provider Dealogic. The number of government-backed deals, which hit a high of 60 in the first quarter, fell to eight in the third quarter.
The FDIC discussions represent an early example of how the banking industry and the federal government are gingerly unwinding their interconnected relationship. Next week, a government guarantee protecting investors against losses on money-market mutual funds is also set to expire, and officials say they expect to let it do so. In other areas, such as the housing market, government support will be harder to withdraw.
The biggest users of the debt-guarantee program were General Electric Co. and Citigroup Inc. Others, such as GMAC, the auto and housing lender that is essentially a ward of the state, relied heavily on it. Anne Eisele, a spokeswoman for GE, said the company has issued about $18 billion in debt without government guarantees and had already announced plans to stop using the program. The FDIC proposed two options Wednesday for its exit strategy. One option is to allow the program to expire as scheduled on Oct. 31. Banks would not be able to issue any new government-backed debt after that date.
The other option is to wind down the program for most banks on Oct. 31, but to allow the FDIC to guarantee debt in "emergency" situations through April 30. Some government officials believe the FDIC might agree to that alternative because it gives the government flexibility if credit markets seize up again. The FDIC said federally insured banks and "certain other entities" participating in the program would be eligible. The FDIC's proposal said any company participating in the "emergency" scenario would face an annualized fee of at least 300 basis points, or 3% of the amount of debt issued, substantially more than the 75 basis points initially charged. The FDIC could increase the fee if it felt the case posed a greater risk to the agency.
Gaming the Market
by Doug Short
During the summer I've occasionally looked at volume in the S&P 500 for clues about market behavior (for example here and here).
Volume in our current market, however, appears to be a less reliable indicator than in the past. I've seen several claims that trading in five beaten-up financial stocks has dominated market volume. A quick Google search led me to this article by Tyler Durden.
I was intrigued. So I decided to investigate further.
According to Standard & Poor's, the S&P 500 has a capitalization of approximately 8,943.02 billion. The five financial stocks and their market caps (as of this morning) are shown in the accompanying table. These five stocks account for a tad less than half of one percent of the index market cap. But as the charts show, they have increasingly dominated the trading volume of the S&P 500.
The first chart shows the index with its daily volume and an overlay in yellow of the trading volume of the five financials from 2007 — well before the financial crisis. In the first six months of 2007, their volume doesn't even register on the chart.
The second chart normalizes the index volume to 100% with the trading volume of the five shown as a percent of the total volume. I've also included a 10-day moving average for the financial five. As we can see, in the week before Labor Day, less than half of one percent of the market accounted for over 30% of the transactions.
Some quick observations:
- Volume has been relatively weak this summer, which is not a resounding endorsement of the 50% rally since the March bottom.
- Over the past year gaming has trumped investing, a trend that has accelerated over the past three months.
Will the post-Labor Day market continue to resemble a high-stakes casino?
US Job Openings Fell to Record Low in July
Employers appear to be in no rush to hire back the millions who lost their jobs in the recession, despite signs of improvement in the economy. The U.S. had a record low 2.4 million job openings in July, the Labor Department said Wednesday, the fewest since the department started tracking the figure in 2000, and half the peak of 4.8 million in mid-2007.
Meanwhile, the Federal Reserve's report on business conditions around the U.S., known as the Beige Book, said "labor market conditions remain weak," a significant hurdle for a strong recovery from the recession that began in December 2007. Economists worry that companies' hesitance to hire will restrain consumer spending, the biggest component of U.S. gross domestic product. Spending has stabilized since declining sharply in the second half of 2008, and is on track to grow about 2% in the current third quarter. But the boost could be short-lived.
"The fourth quarter is looking much more uncertain," said Zach Pandl, an economist at Nomura Securities. "We need to start seeing some hard evidence of a recovery in consumer spending and investment, and the longer the labor market is weak, the longer it will take to get that." Companies are squeezing more from fewer employees through overtime or temporary workers. Nonfarm workers' productivity grew at a 6.6% annualized rate in the second quarter, the most in six years.
Business in much of the U.S. are "cautiously positive" on the economy's outlook, according to the Beige Book, which surveys all 12 Fed districts. Companies are similarly cautious about hiring and remain wary of adding permanent staff, the report showed. "We will have to be very thoughtful about the investments that we make, and they have to return value," said Bill McDermott, president of global field operations at international business software provider SAP, speaking Wednesday at a technology conference in New York. "We will not restore hiring, for example, to its prior levels until we know there's a market there that can substantiate that," he said.
The Walldorf, Germany, company is cutting its global work force from 51,300 to about 48,500 by the end of the year to lower costs. That will include 5% to 6% of its more than 8,000 positions in the U.S. Such caution explains why the nation's unemployment rate -- 9.7% last month -- continues to climb, leaving some 14.9 million Americans unemployed.
For job hunters, the prospects of finding work vary by region. In Detroit, where the local economy is reeling from the struggles of auto companies, there are 18 unemployed people per job opening, the most of any large metropolitan area, according to Indeed.com, a Stamford, Conn.-based job-search engine. To arrive at the ratio, Indeed.com cross-referenced job-listing data with Labor Department figures from July. Competition for jobs is also steep in Sunbelt cities hit hard by the real-estate collapse.
The Rochester, N.Y., metropolitan area, where Mike Lally, 41 years old, lost his job in December, had seven unemployed people for every job opening. Mr. Lally had been a product manager for a local online education company until his position was cut in December. "Obviously I didn't want to see myself get caught in it, but I can see why it was a necessary move on their part," he said. He immediately began searching for a new job in the area, but has found few opportunities.
Rochester, whose metro area has about half a million workers, had an 8.2% jobless rate in July, up from 5.6% a year ago. Meanwhile, the metro areas of Washington and nearby Baltimore have just one unemployed person per job opening. "You've got the federal government here, the big defense contractors and they've got lots of openings right now," said Zachary Duck, president of ZKD LLC, a staffing firm in Manassas, Va. Washington's unemployment rate, which includes its suburbs, was 6.2% as of July, compared with Detroit's 17.7%.
Chinese Derivatives Defaults Worry Foreign Banks
Foreign banks that entered oil-derivative contracts with some Chinese airlines and shippers could find they have little recourse if the companies make good on threats to default on obligations. This week, China's State-Owned Assets Supervision and Administration Commission offered encouragement to some Chinese companies to challenge losses stemming from derivatives used to protect against sudden spikes in the price of fuel.
Some of China's biggest airlines and shippers lost hundreds of millions of dollars last year on derivative trades when the price of oil plunged. They are now seeking to claw back those losses. Last month, China Eastern Airlines Corp., Air China Ltd. and China Ocean Shipping (Group) Co. sent letters to a handful of foreign banks, including Deutsche Bank AG, Goldman Sachs Group Inc., J.P. Morgan Chase & Co., Citigroup Inc. and Morgan Stanley. The letters warned that the companies reserved the right to default on those obligations.
Bankers said they haven't heard of any defaults thus far. A spokeswoman for the International Swaps and Derivatives Association, a global trade association for over-the-counter derivatives, declined to comment.
Still, support from the Chinese government has heightened concerns among Western investment banks about the risks of doing business in China. Bankers and lawyers said firms' ability to collect on outstanding obligations, especially in the event of a dispute, always has been tenuous, but the recent letters have pushed these concerns to the fore.
Western banks already are planning to impose higher costs on Chinese companies that want to enter into such hedging arrangements, including requiring larger amounts of collateral to back any future contracts, bankers said. Typically, such hedging arrangements are struck in Hong Kong, Singapore or other jurisdictions with a well-established framework for resolving contract disputes. Foreign court rulings are difficult to enforce on the mainland, lawyers said. In addition, derivatives counterparties generally include mandatory binding arbitration, said Thomas Britt, a Hong Kong-based lawyer at Debevoise & Plimpton LLC. The parties agree to select their own arbitrators, usually experts in the field, and abide by the resulting decision.
Lawyers said China has agreed to enforce arbitration awards on the mainland, under terms of a multilateral convention drafted in the late 1950s. Still, Beijing can opt to set aside an arbitration outcome. "The government can still conclude that it is contrary to public policy to enforce complex and unfair contracts when Chinese companies have made a legitimate claim that they were misled," Mr. Britt said. People close to the banks that received letters said that if China balks at accepting arbitration terms, the firms still could seek a court ruling in Hong Kong, Singapore, the U.K. or whichever jurisdiction governs a particular contract.
In that case, they may be able to seize overseas assets of the Chinese companies -- a Chinese aircraft that touches down in London, for example. But it is an unlikely course of action, these people said. No global bank wants to be responsible for heightening international political tensions with China. It remains unclear whether the Chinese companies will actually default. They still rely on their ability to enter into these deals to smooth out jet-fuel costs.
Japan May See 'Catastrophic' Finances, Weinberg Says
Japan’s incoming government is likely to favor spending and tax policies that may cause a surge in government borrowing and higher long-term bond yields, said international economist Carl B. Weinberg. "We have a government coming in that’s committed to spend even more than the previous government at a time when increased borrowing to spend is just not a plausible option," Weinberg, chief economist at High Frequency Economics in Valhalla, New York, said in an interview today with Bloomberg Radio.
Weinberg’s judgment reflects skepticism among private analysts that the Democratic Party of Japan, led by Yukio Hatoyama, will follow through on its pledge to avert an increase in government bond issuance. The incoming administration has said it will pay for its priorities -- increased funds for child care, education and employment -- partly through diverting as much as 5 trillion yen ($54 billion) of stimulus spending already approved. "A catastrophic breakdown of Japan’s public-sector finances will be the biggest story ever to hit the world economy in our times, eclipsing the current financial crisis," Weinberg said earlier in an e-mailed response to questions. "Coming in the midst of the yet-to-be-resolved global financial crunch, it will worsen and prolong that still- unfolding crisis."
Japan’s bond market has shown little evidence that investors are concerned about the DPJ’s victory. The party unseated the Liberal Democratic Party that held power for most of the nation’s postwar history. Benchmark 10-year bonds yielded 1.335 percent today, compared with 1.31 percent before the Aug. 30 vote. The DPJ needs to find 7.1 trillion yen to fund its election pledges in the year starting April 1, and the amount would swell to 16.8 trillion yen in 2013, according to its campaign manifesto.
It may be hard to fulfill the promises without worsening a public debt already nearing 200 percent of gross domestic product, especially when the economic slump is trimming tax receipts, economists say. "Most of the DPJ’s pledged spending requires semi- permanent funding, and tax revenue is falling," said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo. "If the DPJ implements all the promises, it may end up increasing bond sales and eventually will need to raise the sales tax to finance them."
Outgoing Finance Minister Kaoru Yosano said on Aug. 4 that the DPJ’s policies would require a sales tax of 25 percent or more. Hatoyama has said he won’t raise the consumption tax from the current 5 percent for the next four years. Muto said the DPJ may be able to scrape together enough money to fulfill Hatoyama’s pledge of preventing next year’s new bond sales from exceeding the current period’s record 44.1 trillion yen. The year starting April 2011 is a different story, Muto added, saying issuances may exceed 50 trillion yen.
"Even though Japan is dealing with a once-in-a-century recession, it’s crazy to expand spending more given these fiscal conditions," he said. Weinberg predicted "a near-vertical yield curve at the end of the day." A yield curve is a graph of the same type of bond with differing maturities. The curve for Japan’s government debt market is currently flatter, or has narrower spreads between shorter-dated and longer-dated securities, than those of other markets.
The spread between two-year and 10-year Japanese securities is 1.09 percentage points, compared with 2.53 percentage points for similar-maturity U.S. Treasuries, and 2.21 percentage points for German notes. Some analysts say falling consumer prices and weak economic growth will keep Japanese bond yields low. "It’s highly uncertain whether the DPJ will manage to cut wasteful spending and finance its pledges," said Nobuto Yamazaki, executive fund manager at DIAM Asset Management Co. in Tokyo. "But Japan is in deflation and the economic recovery is likely to be slow, preventing bond yields from rising."
Martin Schulz, senior economist at Fujitsu Research Institute in Tokyo, said bond investors will only tolerate the incoming government’s fiscal expansion for so long before they demand an "exit strategy." "By the latter half of next year, the market will have to see a framework about what they plan to do about taxes and social security," Schulz said. "They’ll need to raise taxes, there’s no other way out of this."
Japanese Machinery Orders Tumble 9.3% as Recovery Weakens
Japanese machinery orders fell more than economists forecast in July as declining profits forced companies to limit investment even amid signs overseas markets are recovering. Orders, an indicator of capital spending in the next three to six months, declined 9.3 percent from June, when they jumped 9.7 percent, the Cabinet Office said today in Tokyo. Economists surveyed by Bloomberg News projected a 3.5 percent decline.
Companies including Toyota Motor Corp. are cutting costs to limit losses even after a rebound in demand helped Japan climb out of its worst postwar recession last quarter. More than a third of the country’s factory capacity is sitting idle, leaving little need for investment in plant and equipment, spending that last year made up 15 percent of the economy. "There’s been an enormous wave of confidence in the stock markets but that hasn’t been shared by business leaders," said Martin Schulz, senior economist at Fujitsu Research Institute in Tokyo. "Producers know that lots of the improvement in exports and in the overall outlook has been on the back of government programs and they’re still troubled by the outlook."
More than $2 trillion in emergency spending by governments worldwide has fueled a global economic revival. China, Japan’s biggest export market, expanded 7.9 percent last quarter from a year earlier, while the U.S. shrank an annualized 1 percent, its best performance since the second quarter of 2008. Japan’s gross domestic product grew at a 3.7 percent annual rate last quarter, buoyed by exports and a stimulus package that spurred consumer spending on cars and electronics. Revised figures are due tomorrow.
Economists don’t expect the rebound to last as the effects of the stimulus packages fade, forcing the Democratic Party of Japan, which won national elections on Aug. 30, to contend with a weakening economy. Companies plan to cut capital spending 9.2 percent this fiscal year, a survey published last month by the Development Bank of Japan showed. Reductions by manufacturers will be the steepest since 1993. Toyota, which estimates it will make about a third fewer cars this year than it has the capacity to build, said last month it will close an assembly line at its Takaoka plant in central Japan. The carmaker plans to cut capital spending by 36 percent in the year ending March 31.
Spending cuts by electronics-makers are taking a toll on companies such as Ishii Hyoki Co., a Hiroshima-based producer of equipment used to make circuit boards. The company, which had forecast earnings of 579 million yen ($6.3 million), said last week it’s now expecting a 393 million yen loss. "Orders are down and at this point it’s hard to make a forecast," said company spokesman Hironobu Seo. "Our customers are running below capacity, so there isn’t much demand for new equipment."
Corporate cost cuts have also hurt Japan’s workers, darkening the outlook for retailers including Seven & I Holdings Co., which last month lowered its profit forecast and said it may close 20 supermarkets. The unemployment rate surged July to a record 5.7 percent in July and employees who have managed to keep their jobs have suffered unprecedented pay cuts.
Treasury says millions more foreclosures coming
Only 12 percent of U.S. homeowners eligible for loan modifications under the Obama administration's housing rescue plan have had their mortgages reworked, and millions more foreclosures are coming, the Treasury Department said on Wednesday. A Treasury report showed 360,165 people had their monthly payments reduced through August, up from 235,247 through July, but a senior Treasury official conceded much more must be done to soften the impact of a severe and prolonged housing crisis.
Treasury has begun releasing monthly reports on the loan modification program, called the Home Affordable Modification Program or HAMP. In July, it said that just 9 percent of the estimated number of homeowners eligible had had their loans modified, so Treasury's assistant secretary for financial institutions, Michael Barr, was able to claim modest progress in August.
He told a House Financial Services subcommittee that the program launched in February, which brings banks and loan servicers together with at-risk homeowners, was on target to help a half million Americans homeowners by November 1. But that is a small start on a huge problem at the heart of U.S. economic woes. Barr said that "even if HAMP is a total success, we should still expect millions of foreclosures" as administration and industry efforts continue to stabilize a crisis-stricken housing sector.
Barr said a strong housing market was "crucial" to a sustained U.S. economic recovery and described the slump in prices and demand in the housing sector as being "at the center of our financial crisis and economic downturn." He noted that analysts anticipate more than six million Americans could lose their homes in the next three years. "Much more remains to be done and we will continue to work with other agencies, regulators and the private sector to reach as many families as possible," Barr said.
The Treasury report showed that some lenders had not helped any of their borrowers who were eligible for loan modifications. Others had helped varying numbers of those who were 60 or more days delinquent on their mortgages, ranging up to 100 percent for one bank that only had one eligible borrower.
Overspending on Debit Cards Is a Boon for Banks
When Peter Means returned to graduate school after a career as a civil servant, he turned to a debit card to help him spend his money more carefully. So he was stunned when his bank charged him seven $34 fees to cover seven purchases when there was not enough cash in his account, notifying him only afterward. He paid $4.14 for a coffee at Starbucks — and a $34 fee. He got the $6.50 student discount at the movie theater — but no discount on the $34 fee. He paid $6.76 at Lowe’s for screws — and yet another $34 fee. All told, he owed $238 in extra charges for just a day’s worth of activity.
Mr. Means, who is 59 and lives in Colorado, figured employees at his bank, Wells Fargo, would show some mercy since each purchase was less than $12. In addition, a deposit from a few days earlier would have covered everything had it not taken days to clear. But they would not budge. Banks and credit unions have long pitched debit cards as a convenient and prudent way to buy. But a growing number are now allowing consumers to exceed their balances — for a price.
Banks market it as overdraft protection, and the fees it generates have become an important source of income for the banking industry at a time of big losses in other operations. This year alone, banks are expected to bring in $27 billion by covering overdrafts on checking accounts, typically on debit card purchases or checks that exceed a customer’s balance. In fact, banks now make more covering overdrafts than they do on penalty fees from credit cards.
But because consumers use debit cards far more often than credit cards, a cascade of fees can be set off quickly, often for people who are least able to afford it. Some banks further increase their revenue by manipulating the order of a customer’s transactions in a way that causes more of them to incur overdraft fees. "Banks will let you overspend on your debit card in a way that is much, much more expensive than almost any credit card," said Eric Halperin, director of the Washington office of the Center for Responsible Lending.
Debit has essentially changed into a stealth form of credit, according to critics like him, and three quarters of the nation’s largest banks, except for a few like Citigroup and INGDirect, automatically cover debit and A.T.M. overdrafts. Although regulators have warned of abuses since at least 2001, they have done little to curb the explosive growth of overdraft fees. But as a consumer outcry grows, the practice is under attack, and regulators plan to introduce new protections before year’s end. The proposals do not seek to ban overdraft fees altogether. Rather, regulators and lawmakers say they hope to curb abuses and make the fees more fair.
The Federal Reserve is considering requiring banks to get permission from consumers before enrolling them in overdraft programs, so that consumers like Mr. Means are not caught unaware at the cash register. Representative Carolyn Maloney, Democrat of New York, would go even further by requiring warnings when a debit card purchase will overdraw an account and by barring banks from running the most expensive purchases through accounts first.
The proposals carry considerable momentum given the popularity of credit card legislation signed into law in May. They also have a certain inevitable logic, since the credit card legislation requires a similar "opt in" decision from consumers who want to spend more than their credit limits and pay the corresponding over-the-limit fees. Overdrafts are simply the reverse, where the limit is zero, and the bank charges a fee for going under it. But with so much at stake, the banking industry is intent on holding its ground.
Bankers say they are merely charging a fee for a convenience that protects consumers from embarrassment, like having a debit card rejected on a dinner date. Ultimately, they add, consumers have responsibility for their own finances. "Everyone should know how much they have in their account and manage their funds well to avoid those fees," said Scott Talbott, chief lobbyist at the Financial Services Roundtable, an advocacy group for large financial institutions.
Some experts warn that a sharp reduction in overdraft fees could put weakened financial institutions out of business. Michael Moebs, an economist who advises banks and credit unions, said Ms. Maloney’s legislation would effectively kill overdraft services, causing an estimated 1,000 banks and 2,000 credit unions to fold within two years. That is because 45 percent of the nation’s banks and credit unions collect more from overdraft services than they make in profits, he said. "Will they be able to replace it with another fee?" Mr. Moebs said. "Not immediately and not soon enough."
They will certainly try. For instance, some banks have said they might slap a monthly fee of between $10 to $20 on every free checking account. At the moment, people who pay overdraft fees help subsidize the free accounts of those who do not. Banks may also have to answer a question that many consumers ask and that Ms. Maloney has raised in her proposal: Why can’t banks simply alert a consumer at the cash register if they are about to spend more than they have in their account, and allow them to say right then and there whether they want to pay a fee to continue?
The banking industry says that simply is not possible without new equipment and software, costs that would be borne by consumers. "If you think about when you swipe your card at, let’s say, Starbucks or at the Safeway or the Giant, there is no real sort of interaction there," said Mr. Talbott. "It’s just approved or disapproved. So how logically would that work? Would a screen come up? Would someone at the bank call the checkout clerk and say, ‘That customer is overdrawn?’ Logistically that would be very difficult to implement." No one could have imagined this controversy decades ago, when the A.T.M. card was born. Back then, it was simple: when money ran out, the card was usually rejected by the banks.
But then A.T.M. cards started acquiring Visa or MasterCard logos, allowing users to "debit" their bank accounts for purchases. A thorny issue soon sprang up. What if there wasn’t enough money in a cardholder’s account to cover a purchase? For years, banks had covered good customers who bounced occasional checks, and for a while they did so with debit cards, too. William H. Strunk, a banking consultant, devised a program in 1994 that would let banks and credit unions provide overdraft coverage for every customer — and charge consumers for each transgression.
"You are doing them a favor here," said Mr. Strunk, adding that overdraft services saved consumers from paying merchant fees on bounced checks. Some institutions do not see it that way, and either do not offer overdraft services or allow their clients to decline the service. "We’ve never subscribed to the notion that individuals who overdraw or attempt to should be allowed to do so without the opportunity to opt in," said Gary J. Perez, the president and chief executive of the University of Southern California Credit Union.
A Source of Easy Money
But many of the nation’s banks have found that overdraft fees are easy money. According to a 2008 F.D.I.C. study, 41 percent of United States banks have automated overdraft programs; among large banks, the figure was 77 percent. Banks now cover two overdrafts for every one they reject. In all, $27 billion in fee income flows from covering overdrafts from debit card purchases, A.T.M. transactions, checks and automatic payments for bills like utilities; an additional $11.5 billion arrives from bounced checks and other instances in which banks refuse to pay overdrafts, Mr. Moebs said.
By contrast, penalty fees from credit cards will add up to about $20.5 billion this year, according to R. K. Hammer, a consultant to the credit card industry. For instance, customers incur penalties for paying their bills late or by spending beyond the credit limit the bank has set for them. Banks also make billions in interest from credit cards. Most of the overdraft fees are drawn from a small pool of consumers. Ninety-three percent of all overdraft charges come from 14 percent of bank customers who exceeded their balances five times or more in a year, the F.D.I.C. found in its survey. Recurrent overdrafts are also more common among lower-income consumers, the study said. Advocacy groups say banks are making a fortune because consumers are unaware of the exorbitant costs of overdraft services. And banks, they argue, have an incentive to keep it that way.
That is what Mr. Means found when he approached his Wells Fargo branch in Fort Collins, Colo., to redress the $238 in fees he was billed. An employee explained that her ability to waive fees had been revoked by the bank because she had refunded fees for too many customers, Mr. Means said she told him. Rory Foster, a former branch manager in Illinois, said that Wells Fargo based its compensation for managers in part on overall branch profitability. Fee income, including that from overdrafts, is part of the calculation. A spokeswoman for Wells Fargo, Richele J. Messick, said the bank did not tie branch manager pay directly to fee collection.
‘I Can’t Afford That’
Yet fees, and how they are generated, remain a mystery to many consumers. Because regulators do not treat overdraft charges as loans, banks do not have to disclose their annualized cost to consumers. And often, the price is enormous. According to the F.D.I.C. study, a $27 overdraft fee that a customer repays in two weeks on a $20 debit purchase would incur an annual percentage rate of 3,520 percent. By contrast, penalty interest rates on credit cards generally run about 30 percent. "People would be shocked at how brutally high those fees are relative to the costs of a credit card," said Edmund Mierzwinski, the consumer program director for the United States Public Interest Research Group.
Ruth Holton-Hodson discovered that the hard way. She keeps close tabs on the welfare of her brother, who lives in a halfway house in Maryland and uses what little he has in his account at Bank of America to pay rent and buy an occasional pack of cigarettes or a sandwich. When the brother, who has a mental illness that she says requires her to assist with his finances, started falling behind on rent, Ms. Holton-Hodson found he had racked up more than $300 in debit card overdraft fees in three months, including a $35 one for exceeding his balance by 79 cents.
Ms. Holton-Hodson said she spent two years asking bank employees if her brother could get a card that would not allow him to spend more than he had. Though Bank of America does not typically allow customers to opt out of overdraft protection, it finally granted an exemption. "I’ve been angered and outraged for many years," she said. "When there is no money in his account, he shouldn’t be able to pay." Anne Pace, a spokeswoman for Bank of America, said the case was "complicated issue without any simple solutions," but declined to elaborate, citing privacy concerns. She added the bank allowed customers to opt out of overdraft services on a "case-by-case basis."
And when a consumer does overdraw an account, banks have found a way to multiply the fees they collect by rearranging the sequence of transactions, critics say. Ralph Tornes, who lives in Florida, is pursuing a lawsuit against Bank of America for charging him nearly $500 in overdraft fees in 2008 after it rearranged his purchases from largest to smallest. In May 2008, for instance, Mr. Tornes had $195 in his account when he made two debit purchases for $8 and $13; the bank also processed a bill payment of $256. He claims that Bank of America took his purchases out of chronological order and ran the biggest one through first. So instead of paying $35 for one overdraft fee, he was stuck with three, for a total of $105.
Mr. Talbott, of the Financial Services Roundtable, said some banks reordered purchases based on surveys showing that consumers want their most vital bills, like rent and car payments, which tend to be for larger amounts, paid before items like a $3 coffee. Consumers who have been slapped with large fees as a result of this practice have a different perspective. "There is no reason they should get the little guy because he’s only got a few bucks in his account," said Ryan Pena, 24, a recent college graduate who has filed suit against Wachovia, now part of Wells Fargo, for what he says are abusive practices, including reordering his purchases. "I can’t afford that." Officials at Bank of America and Wachovia declined to talk about specific complaints, but echoed Mr. Talbott’s remarks on processing payments.
The Debate in Washington
These lawsuits open a window onto the questions that government officials and banks are now trying to answer. Do consumers actually want overdraft service? Can they use it responsibly? If so, what is the best way to deliver it? Federal regulators have acknowledged problems with overdraft fees since at least 2001 but have done little aside from improving disclosure and issue voluntary guidelines they hoped the industry would follow. That year, Daniel P. Stipano, deputy chief counsel for the Office of the Comptroller of the Currency, wrote that a company that markets overdraft programs to banks showed a "complete lack of consumer safeguards."
In 2005, after intense industry pressure, the Federal Reserve ruled that overdraft charges should not be covered by the Truth in Lending Act. That meant bankers did not have to seek consumers’ permission to sign them up, nor did they have to disclose the equivalent interest rate for the fees. That same year, the Federal Reserve said that some banks had "adopted marketing practices that appear to encourage consumers to overdraw their accounts." It issued a list of "best practices" that asked banks to more clearly disclose overdraft fees, let customers opt out of overdraft programs and provide an alert when a purchase occurs that would put the account below zero. But critics said the recommendations had no teeth.
"No regulator has made any of their bank examiners adhere to best practices," said Mr. Halperin, of the Center for Responsible Lending. "The result is over that time period consumers have paid probably upwards of $80 billion in overdraft fees while the Federal Reserve considers and considers and considers whether or not they are going to do anything." Officials at the Federal Reserve dispute that they have not taken sufficient action on overdraft fees, noting that they imposed tougher disclosure requirements in 2004 and are now considering additional regulations to address abusive practices. They will disclose their intent before the end of the year.
What no one disputes is that the stakes in the coming battle on overdraft fees are enormous. Ms. Maloney said she did not push her overdraft legislation this spring because the uproar from the banking industry could have jeopardized the credit card bill. "It was very important to provide more tools to consumers to better manage their credit cards," she said. "And now I think they deserve the same treatment with debit cards."
Overhaul Falters as Shock Fades
Nearly one year after the collapse of Lehman Brothers sent shock waves across the globe, the world is a different place. The investment bank's messy death intensified the deepest recession since the Great Depression. It helped open the way to a bigger role for government in managing the economy. It cast doubts in the public's mind about the wisdom of relying on markets to correct themselves. But to a surprising degree, there are some big things that Lehman's demise hasn't changed.
On the regulatory front, Democrats' efforts to rework the rules for finance have bogged down amid infighting between federal regulators, fury among bankers and opposition from many lawmakers who believe that further expanding the government's reach will only create new problems. The all-consuming debate over health care has damped enthusiasm for tackling such complex legislation. Meanwhile, major U.S. banks have regained their footing, and some of their swagger. Profits are off their lows. Large compensation packages are back. And so is risky business.
Companies are selling exotic financial products similar to those that felled markets and the world economy last fall. And banks' appetite for risk has grown: The nation's top five banks collectively stood to lose more than $1 billion on an average day in the second quarter of 2009 should their trading bets go sour, a record level. Now, the federal government is locked in a kind of regulatory limbo. U.S. officials say they are committed to preventing history from repeating and have pleaded for fresh powers to do so. But today, they have few new options -- excepting another bailout -- should financial markets seize up again or a large institution totter.
"There's no fundamental change in the way the banks are run or regulated," said Peter J. Solomon, a former Lehman vice chairman who runs an eponymous investment bank in New York. "There's just fewer of them." Washington officials say they are encouraged that financial markets and the economy appear to be healing after the turmoil. But they also say they feel an urgent need to establish new rules. "We are under no illusion that things left to their own devices will evolve back to a healthy normal," said White House National Economic Council Director Lawrence Summers in an interview. "The concern...is that a resumption of confidence, which is a good thing, not become a return to hubris, which would be a very bad thing."
Wall Street's rebound presents a mixed bag for consumers. These banks' clients are demonstrating a renewed appetite for risk, a sign that confidence is returning to markets. But credit remains scarce for all but the healthiest borrowers and lenders are imposing new fees and higher interest rates on credit cards and other products. Corporations, too, are likely to have trouble getting credit if they can't access the capital markets or have less-than-pristine debt ratings.
The financial world has been on a wild ride since Sept. 14, 2008, the Sunday that Lehman toppled toward bankruptcy. The Dow Jones Industrial Average dropped from 11,422 on Sept. 12 to 6,547 on March 9. More than 100 banks have failed. The federal government has pumped more than $200 billion in taxpayer money into banks, and the government temporarily deemed the country's 19 largest as too big to fail in a disorderly fashion. Some of Wall Street's most notorious practices are unlikely to reappear. Banks say they've permanently abandoned housing risky assets in off-balance-sheet vehicles. Top banks have also stockpiled capital to raise their reserves to the highest levels in recent memory, providing a bigger cushion against market downturns.
Last December, at a black-tie gala in New York's Plaza Hotel, Bank of America Corp. CEO Kenneth Lewis told a crowd of bankers to expect a humbler industry to emerge from the wreckage. "We play a supporting role in the economy, not a leading role. Financial services are a means, not an end," Mr. Lewis said. "There should be some humility in that." The audience applauded. But the mood has shifted as the Dow strengthened this year. Some of the government's rescue programs are coming to an end, and big banks are paying back funds they borrowed under the Troubled Asset Relief Program, releasing them from Washington's control.
The top five Wall Street firms -- Bank of America, Citigroup Inc., Goldman Sachs Group Inc., J.P. Morgan Chase & Co. and Morgan Stanley -- made $23.3 billion in profits in the first six months of 2009. That compared with a $6.7 billion loss a year earlier at those banks and the companies they acquired, but it fell short of the $49.8 billion they earned in the first half of 2007, the peak of Wall Street's boom. These banks' biggest profit engines remain their trading arms, which place short-term wagers -- much of it with the firms' own money -- on stocks, bonds, commodities, currencies and other financial products and markets. Losses at these arms in recent years crippled firms such as Merrill Lynch & Co. and Citigroup. This year, trading has generated windfalls.
In the first half of 2009, the top five firms generated $56 billion in trading revenue, compared with $22 billion in the first half of 2008 for those banks and the firms they acquired, and $58 billion at the boom's peak. On 46 separate days in the second quarter, Goldman's traders pocketed at least $100 million in revenue, while losing money on two days. Overall, the top firms are assuming greater trading risks than they were a year ago, based on a standard measure called value at risk. The $1 billion that the top five banks stood to lose on an average day in the second quarter represents an 18% increase from a year earlier and is up 75% from the $592 million in the first half of 2007, according to regulatory filings. Wall Street "has been tiptoeing back into the pond," said Robert Glauber, who ran the National Association of Securities Dealers, Wall Street's self-regulatory arm, until 2006. "They have short memories."
Despite a continuing outcry over bankers' compensation, large pay packages are still the norm at some companies as they lure talent and try to keep competitors from poaching employees. In the first half of 2009, the top five firms set aside about $61 billion to cover compensation and benefits for their employees. A year earlier, the total for those firms, plus the big banks they subsequently acquired, was about $65 billion; in the first half of 2007, the figure was $77 billion. Per employee, the payouts may exceed previous years since the firms have collectively eliminated tens of thousands of jobs.
Congress earlier this year imposed restrictions on bonus payments. So instead, several companies, including Bank of America and Citigroup, opted to pay larger salaries. J.P. Morgan is planning a similar move. The trend has caught the attention of world leaders. "The abatement of financial tensions has led some financial institutions to imagine they can return to the same modes of action prevalent before the crisis," British Prime Minister Gordon Brown, French President Nicolas Sarkozy and German Chancellor Angela Merkel wrote in a letter to other world leaders on Sept. 3. The three leaders advocate strict new limits on bonus payments.
Regulators have told banks to avoid excessive risk, but haven't been specific, executives say. In fact, federal officials are pushing banks to quickly return to profitability, which Wall Street executives have interpreted as a blessing of vigorous trading. Goldman and Morgan Stanley were expected to face tougher oversight after they converted last fall into bank holding companies overseen by the Federal Reserve, a move to gain access to government funding and ease concerns about their stability. Both have dialed back their bets with borrowed money. For every dollar of trading assets on their books, the firms are holding roughly twice as much capital as they did in prior years, according to Brad Hintz, an analyst at Sanford C. Bernstein & Co. This deleveraging makes their businesses safer but less lucrative.
But much remains the same. Both firms were expected to sell power plants and oil rigs they own in their commodities-trading businesses, because commercial banks generally aren't allowed to hold such physical assets. But the banks, after a discussion with the Fed, believe they're allowed to keep them because of a provision in federal law that allows newly formed bank holding companies to retain certain long-held assets, according to people familiar with the matter.
Perhaps the best indicator of Wall Street's revived exuberance is its continued pursuit of exotic financial engineering. The market for credit derivatives, widely blamed for helping destabilize markets, remains vast. As of March 31, the notional value of credit derivatives outstanding in the U.S. banking system, a widely used measure, stood at $14.6 trillion, according to the Office of the Comptroller of the Currency. That was down 8% from three months earlier, but still almost triple the $5.5 trillion level of three years ago.
Total return swaps -- a type of derivative that lost favor during the crisis -- are among the instruments regaining popularity, bankers and investors say. Banks use the swaps to provide hedge funds with low-cost financing, which the hedge funds in turn use to purchase leveraged loans or other assets from the bank. The hedge funds pledge the purchased assets as collateral for the loan. During the crisis, the swaps burned banks that seized collateral from hedge funds, only to find that the assets' values had plunged along with the overall markets.
Even collateralized debt obligations, perhaps the biggest money-loser in Wall Street history, are staging a comeback of sorts. Banks are disassembling securities produced by bundling home and commercial mortgages and repackaging them into what market experts describe as mini-CDOs. The goal is to cobble the mortgage-backed securities, seen as high-risk, into instruments more palatable to investors. Wall Street firms defend their use of the complex products. "A structured or engineered product may be entirely appropriate for the purchaser," said Citigroup spokesman Alex Samuelson, whose bank is among those marketing new types of derivatives to investors. "They're not intrinsically bad."
The Obama administration, financial regulators and many lawmakers believe that more regulation is necessary to protect the U.S. economy from another crisis and to bolster confidence. Certain elements enjoy broad support, such as a proposal to empower government officials to take over and break up large, faltering financial companies whose failure could destabilize the economy. Many policy makers believe that such powers would have allowed the government to mitigate the impact of Lehman's collapse.
But many Republicans and some Democrats are skeptical of some elements of the proposal, such as a proposed consumer-protection agency and a plan to expand the Federal Reserve's powers to regulate the country's largest financial institutions. In Washington on March 26, newly minted Treasury Secretary Timothy Geithner took a rough outline of President Barack Obama's financial rules to Capitol Hill. Administration officials knew it would take months for these proposals to work their way through Congress. But Mr. Geithner argued that the government urgently needed the power to take over big failing companies. At a congressional hearing, he urged lawmakers to grant that authority "as quickly as you can."
Political support was lukewarm. Rep. Don Manzullo (R., Ill.) called the idea "radical." In June, House Financial Services Committee Chairman Barney Frank (D., Mass.) delayed an immediate vote on the issue, pending a broader review of financial regulation. In the meantime, regulators have tried to crack down on dozens of banks, slapping hundreds with penalties that restrict their growth and direct them to raise capital. The Fed has centralized more of its supervision of large banks through top officials in Washington.
In July, FDIC Chairman Sheila Bair told a congressional panel that big banks were able to essentially "blackmail" the government because some companies were so large that officials had no way of breaking them apart if they were to falter. Regulators know it would be difficult to break up Citigroup's complex bank holding company operations, for example, even if they wanted to. Bank of America, J.P. Morgan and Wells Fargo & Co. each controlled more than 10% of the nation's deposits -- once a firm regulatory cap -- because of acquisitions performed during the heat of the financial crisis, sometimes at the government's urging.
The Obama administration is expected to intensify its push for the new regulation regime in the coming weeks. During a weekend summit, the world's top finance ministers agreed to create higher capital requirements for top global banks once they recover from the financial turmoil, a move that would force them, in effect, to become more conservative. At the meeting in London, Mr. Geithner implored policy makers to continue fighting for tougher financial regulations in their own countries. "We can't let momentum for reform fade as the crisis recedes," he pleaded.
No Growth in Private Sector in 10 Years... Manufacturing in Almost 70 Years
The Big Picture details:Speaking with Marketwatch’s Rex Nutting, I learned yet another incredible datapoint: Over the past decade, the U.S. private-sector has lost 203,000 jobs.No surprise to EconomPic readers, as I reported this same stat back in May. But, in looking at the details behind this tremendous job stall, it is apparent where the majority of the jobs lost have come from... manufacturing.
That’s right: Zero job growth for 10 years.
That's right. The manufacturing sector now utilizes 35% less man-hours than it did just 10 years ago. Sound bad? It's a LOT worse than that.
We are now at the lowest level of manufacturing employment since... 1941 (even though the number of overall workforce is up just about four-fold in that time).
10 Year Rolling Change in Manufacturing Employment
New York Nears Charges on Merrill Deal
New York state's attorney general, Andrew Cuomo, moved closer Tuesday to filing securities-fraud charges against Bank of America Corp. executives, citing at least four "failures" to tell shareholders material information related to the bank's takeover of Merrill Lynch & Co. The warning came in a Tuesday letter to the Charlotte, N.C., bank from David Markowitz, the chief of Mr. Cuomo's investor-protection bureau, who demanded more information about conversations deemed privileged by Bank of America officials. Mr. Markowitz accused the bank of "indiscriminate invocation of the attorney-client privilege" and "hindering" efforts to determine which company officers should be charged.
Mr. Cuomo's office is pursuing its investigation of the Merrill deal, reached last September as Lehman Brothers was tumbling into bankruptcy, under the Martin Act, a New York state law that broadly defined securities fraud and can be used to pursue civil and criminal penalties. In contrast, the Securities and Exchange Commission didn't move to hold any specific BofA executives responsible for securities filings that the agency concluded last month had misled investors about $3.6 billion in bonuses at Merrill.
BofA agreed to a $33 million settlement of those civil allegations, without admitting or denying wrongdoing. A federal judge has declined to approve the settlement without more information on how it was reached. Court filings from both sides are due Wednesday. The Merrill bonuses are one of four examples cited by Mr. Cuomo's office as wrongdoing by BofA "and its senior officers," according to the letter. In addition, BofA didn't disclose before a December shareholder vote either ballooning losses at Merrill or a goodwill charge related to a subprime lender owned by Merrill, Mr. Cuomo's office alleged Tuesday. An internal forecast circulated inside the bank two days before the vote and reviewed by The Wall Street Journal assumed "no goodwill write-off" at the subprime unit.
Former BofA General Counsel Timothy Mayopolous testified to Mr. Cuomo's investigators that executives discussed four days before the vote whether the bank should back out of the deal by invoking a "material adverse change" clause, according to the letter. But BofA "has precluded Mr. Mayopolous from answering any substantive questions about the meeting," Mr. Markowitz wrote. BofA has said repeatedly that it followed the advice of its lawyers in making decisions on what to disclose and when. Statements about Merrill "complied with the law and all applicable rules and regulations," bank spokesman Robert Stickler said Tuesday.
BofA Fires Back AT Cuomo, Says It's Not Hiding Behind Lawyers
Bank of America Corp. fired back at New York Attorney General Andrew Cuomo on Tuesday with a letter calling his office's allegations of wrongdoing "spurious" and claiming the bank is not hiding behind its lawyers by refusing to provide testimony on privileged discussions surrounding the purchase of Merrill Lynch & Co. The Sept. 8 letter from Bank of America outside attorney Lewis Liman is a response to a letter from David Markowitz, chief of Mr. Cuomo's investor-protection bureau, that accused the bank of "indiscriminate invocation of the attorney-client privilege" and "hindering" efforts to determine which company officers potentially should be charged with securities-law violations.
Mr. Markowitz also outlined four "failures" to tell shareholders material information related to the bank's takeover of Merrill. "The basic premise of the letter is simply wrong," Mr. Liman wrote. The bank, Mr. Liman said, has not "offered reliance on legal advice as a justification for its disclosures" and "no one has sought to take unfair advantage of the assertion of the privilege by hiding information from your office or anyone else." He also notes that Mr. Cuomo's office rejected requests to talk about the "relevant facts" of the case.
Mr. Cuomo's office on Tuesday highlighted several areas of alleged wrongdoing by BofA and "its senior officers," including a merger proxy document that did not mention $3.6 billion in Merrill bonuses, nondisclosure of Merrill's forecasted losses, no mention of a $2 billion goodwill charge and a discussion before a December 5 shareholder vote about whether Merrill's losses amounted to a "material adverse effect." The finding of a material adverse effect could be a trigger for the bank to back out of the deal.
Mr. Liman refuted each of these points in his letter, noting that the merger proxy document "did not contain any false or misleading statements," that the goodwill charge was reconciled via purchase accounting at the completion of the merger and that there was no law requiring the bank to disclose Merrill mounting losses or discussions about terminating the merger. "Bank of America and Merrill Lynch properly reported Merrill Lynch's results when they were required to do so -- after the close of the quarter."
On the subject of early December conversations between bank executives and then-general counsel Timothy Mayopolous about a material adverse effect, Mr. Liman said "the testimony is uncontroverted that Bank of America did not consider invoking the material adverse effect until the middle of December, after the shareholders voted to approve the merger and after Bank of America had received updated forecasts including the actual results for November 2008."
Senate must raise debt ceiling above $12 trillion
The Senate must move legislation to raise the federal debt limit beyond $12.1 trillion by mid-October, a move viewed as necessary despite protests about the record levels of red ink. The move will highlight the nation’s record debt, which has been central to Republican attacks against Democratic congressional leaders and President Barack Obama. The year’s deficit is expected to hit a record $1.6 trillion.
Democrats in control of Congress, including then-Sen. Obama (Ill.), blasted President George W. Bush for failing to contain spending when he oversaw increased deficits and raised the debt ceiling. "Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren," Obama said in a 2006 floor speech that preceded a Senate vote to extend the debt limit. "America has a debt problem and a failure of leadership." Obama later joined his Democratic colleagues in voting en bloc against raising the debt increase.
Now Obama is asking Congress to raise the debt ceiling, something lawmakers are almost certain to do despite misgivings about the federal debt. The ceiling already has been hiked three times in the past two years, and the House took action earlier this year to raise the ceiling to $13 trillion. Congress has little choice. Failing to raise the cap could lead the nation to default in mid-October, when the debt is expected to exceed its limit, Treasury Secretary Timothy Geithner has said. In August, Geithner asked Senate Majority Leader Harry Reid (D-Nev.) to increase the debt limit as soon as possible.
Changing the debt cap "does provide an opportunity to look at fiscal policy and what its failings are, and ideally it could give both sides an opportunity to think about what we need to do so we don't keep raising the debt limit," said Robert Bixby, the executive director of the Concord Coalition, a fiscal watchdog group. "But probably as a practical matter, it will get more attention as a partisan back-and-forth," Bixby said.
When the House raised the debt limit to $13 trillion as part of a budget resolution approved in April, Democratic leaders used a maneuver known as the "Gephardt rule," named after former House Democratic Leader Dick Gephardt (Mo.), to avoid taking a roll call vote on the debt limit increase. The Senate isn’t so lucky. It lacks a similar mechanism, meaning each senator must cast a politically perilous vote on raising the debt ceiling.
The Senate Finance Committee will "carefully review Treasury's request on behalf of the American taxpayers," according to an aide to the committee's chairman, Sen. Max Baucus (D-Mont.). "Sen. Baucus understands the critical importance of signaling to the world that the U.S. maintains the confidence and security to continue to lead the global economy out of recession," the Baucus aide said. "The request to raise the debt limit is serious and must be addressed thoroughly and in a nonpartisan manner."
The aide noted that Baucus is pressing the Treasury Department to be more transparent about its efforts to pull the economy out of recession. "He will continue to demand the necessary communication and cooperation going forward," the aide said. Both the White House and the independent Congressional Budget Office last month said that they expect the debt to increase by another $9 trillion over the next decade. Should the Senate follow the House's lead and set the new debt limit at $13 trillion, lawmakers would probably have to raise the limit again next year, when the Obama administration expects to run a $1.5 trillion deficit.
The business community has supported Geithner's push for a higher debt ceiling. Bruce Josten, the top lobbyist for the U.S. Chamber of Commerce, said it's essential to the U.S. economy. "If we fail to address this in a timely fashion, then you run the risk of having to curtail government operations," Josten said. "The last thing our economy and the world economy needs is greater uncertainty throughout global credit markets."
Josten said that the high level of debt is a reality during the recession, but it's unsustainable and needs to be reduced by reforming Medicare and Social Security. "While we can freely and openly acknowledge completely and lobby to raise the debt ceiling and incur some more debt, the longer trends ultimately need to be reversed," he said. Congress raised the debt limit just a few months ago when it passed the $787 billion stimulus package.
Moody's Says Triple-A Ratings for U.S., U.K. Not at Risk
The triple-A sovereign debt ratings of the U.K. and the U.S. aren't under threat, rating agency Moody's Investors Service said Wednesday, in a move that may boost the battered British pound. Moody's said in a report it doesn't expect any downgrades of countries with triple-A ratings -- the highest possible -- in the "near future," adding that only a sustained increase in government debt over several years, which it doesn't anticipate, would warrant such a decision.
Moody's remarks are especially significant for the pound because previous Moody's statements on the U.K.'s "deteriorating" financial situation caused a currency sell-off earlier this year. "This is actually quite relevant," said David Forrester, a Singapore-based foreign exchange strategist with Barclays Capital. "It does reverse that [concern] quite a bit." The British pound rose against the U.S. dollar and the Japanese yen Wednesday, following the release of the report, but market observers said gains should be contained ahead of the planned meeting Thursday of the Bank of England's Monetary Policy Committee.
The MPC is expected to provide updates on its programs to increase liquidity in the U.K.'s banking system, which has been badly hit by the current financial crisis. These programs, combined with a surge in the government's budget deficit, have resulted in mounting concerns on the pound's stability over the last few months. The pound traded at US$1.6522 at 0344 GMT, up from US$1.6487 late Tuesday, but is still down 7% against the greenback over the last 12 months, and is one of the worst performers among major currencies since the financial crisis started last year.
In its report Wednesday, Moody's singled out the U.S. and the U.K. as two countries that "have lost altitude" among those with triple-A ratings, but noted they remain in the group of "resilient" economies, better placed to keep their ratings intact than Spain, which it called "vulnerable." "Although highly unlikely, it's conceivable that a large and wealthy economy could lose its Aaa rating if it were to experience a material and irreversible deterioration in its debt conditions over the next five years or so, following the fate of Japan in the 1990s," said Pierre Cailleteau, managing director of Moody's Sovereign Risk Group. Moody's also cited other triple-A rated countries, like France and Germany, which it called "resistant," saying they face a better scenario, in terms of fiscal prospects, than either Spain, the U.S. or the U.K.
As an Exotic Mortgage Resets, Payments Skyrocket
Edward and Maria Moller are worried about losing their house — not now, but in 2013. That is when the suburban San Diego schoolteachers will see their mortgage payments jump, most likely beyond their ability to pay. Like millions of buyers during the boom, the Mollers leveraged their way into a house they could not otherwise afford by taking out a loan that required them to make only interest payments at first, putting off payments on the principal for several years.
It was a "buy now, pay later" strategy on a grand scale, meant for a market where home prices went only up, and now the bill is starting to come due. With many of these homes under water — worth less than the loans against them — many interest-only mortgages will soon become unaffordable, as the homeowners have to actually start paying principal. Monthly payments can jump by as much as 75 percent. The Mollers owe so much more than their house is worth, and have so few options, that they are already anticipating doom. "I’m praying for another boom," said Mr. Moller, 34. "Otherwise, we’ll have to walk."
Keith Gumbinger, an analyst with HSH Associates, said: "This is going to be the source of tomorrow’s troubles. The borrowers might have thought these were safe loans, but it turns out they bet the house." After three brutal years, evidence is growing that the housing market has turned a corner. Sales in July were the highest in a year, and August gives signs of having been even better. In nearly all major cities, home prices are now rising. Celebration, however, might be premature. The plight of the Mollers and many others in a similar position is likely to weigh on any possible recovery for years to come.
Experts predict a steady drumbeat of defaults over much of the next decade as these interest-only loans mature. Auctioned off at low prices, those foreclosed houses could help brake any revival in home prices. Interest-only loans are not the only type of exotic mortgage hanging over the housing market. Another big problem is homeowners with "pay option" loans; in many of these loans, principal balances are actually increasing over time. Still, interest-only loans represent an especially large problem. An analysis for The New York Times by the real estate information company First American CoreLogic shows there are 2.8 million active interest-only home loans worth a combined total of $908 billion.
The interest-only periods, which put off the principal payments for five, seven or 10 years, are now beginning to expire. In the next 12 months, $71 billion of interest-only loans will reset. The year after, another $100 billion will reset. After mid-2011, another $400 billion will reset. John Karevoll, a longtime senior analyst for MDA DataQuick, sees the plight of interest-only owners this way: "You’re heading straight for a big wall and you can’t put the brakes on."
The greater the length of the interest-only period, the more years the owners have to hope for a recovery, government help, or a miracle. But a long interest-only period works against them, too. A loan that is interest-only for its first 10 years means the entire house has to be paid off in the next 20 rather than the more typical 30 years. One possible solution: start paying extra each month now to pay down the principal before the loans reset. But many homeowners took out the maximum they qualified for, and don’t have the means to pay more, or at least not enough to make a sizeable dent in the principal.
A decade ago, interest-only loans were rare. But as the boom heated up and desperate buyers sought any leverage they could, these loans became ubiquitous. They were especially popular in Florida, Nevada and above all California. In 2004, nearly half of all buyers in the state got one. The Mollers bought in 2005, paying $460,000 for their three-bedroom, thousand-square-foot house. A quick refinance a few months later supplied cash to pay debts. Now the house is worth perhaps $310,000. After their interest-only period is up, they expect their monthly payments to increase 20 percent if not more.
"Everyone out here always preached to me, ‘Buy real estate. It’s the best investment you’ll ever have,’ " said Mr. Moller, who grew up in Iowa. "Then all this stuff started crumbling and I was like, ‘You’re kidding me.’ " While default may be a long way off, the prospect is already dampening the couple’s spending habits. They are postponing the new windows the house needs. They recently bought a 2005 Nissan Murano instead of a new car, and they have put off buying a flat-screen TV.
Mark Goldman, a San Diego mortgage broker, said many interest-only buyers thought they would be in control when the loans reset. "They expected to move or refinance," he said. "But you can’t do either when you’re under water." Among the people Mr. Goldman put into interest-only loans was himself. He refinanced five years ago to shrink his payments so he and his wife, Julie, could put their two sons through college. When the interest-only period expired a few months ago, their payments went up by 40 percent.
The Goldmans have been in their house for 20 years, which means they still have some equity. Still, they are unhappy to find themselves in "a world different than we planned for," said Mr. Goldman, a lecturer in real estate finance at San Diego State. "If you purchased your home with an interest-only loan between 2003 and 2006, you’re cooked." The federal government, through the finance company Fannie Mae, increased the scope of a program this summer that might help some interest-only borrowers by letting them refinance. But it will not help many in coastal California. Only loans owned by Fannie Mae are eligible, and during the boom Fannie had a limit of $417,000 — not enough to buy a home at the peak in a middle-class community.
Dean Janis, a Southern California lawyer who bought a $950,000 home in 2004, will see his interest-only loan reset in December. He calculates that will send his payments up a minimum of 27 percent, to $3,726. A rise in rates could eventually push it as high as $6,700. "I understand I took a risk," Mr. Janis said. "But I did not anticipate that the real estate market would go down 30 percent." He talked with Wells Fargo about his options, and the lender said he had none.
Homeowners with interest-only loans have a much greater likelihood of default, the First American CoreLogic figures indicate. Nationally about 18 percent of prime interest-only loans are at least 60 days delinquent. In California, the level is even higher: 21 percent, a rate exceeded only in the other bubble states of Florida and Nevada. "The bailout is not trickling through to help many of us who have worked hard, under very difficult circumstances, to keep paying our bills," Mr. Janis said. "I am stuck with nowhere to go — absent trashing my credit and defaulting."
A year after financial crisis, the consumer economy is dead
One year after the near collapse of the global financial system, this much is clear: The financial world as we knew it is over, and something new is rising from its ashes.
Historians will look to September 2008 as a watershed for the U.S. economy. On Sept. 7, the government seized mortgage titans Fannie Mae and Freddie Mac. Eight days later, investment bank Lehman Brothers filed for bankruptcy, sparking a global financial panic that threatened to topple blue-chip financial institutions around the world.
In the several months that followed, governments from Washington to Beijing responded with unprecedented intervention into financial markets and across their economies, seeking to stop the wreckage and stem the damage. One year later, the easy-money system that financed the boom era from the 1980s until a year ago is smashed. Once-ravenous U.S. consumers are saving money and paying down debt. Banks are building reserves and hoarding cash. And governments are fashioning a new global financial order.
Congress and the Obama administration have lost faith in self-regulated markets. Together, they're writing the most sweeping new regulations over finance since the Great Depression. And in this ever-more-connected global economy, Washington is working with its partners through the G-20 group of nations to develop worldwide rules to govern finance. "Our objective is to design an economic framework where we're going to have a more balanced pattern of growth globally, less reliant on a buildup of unsustainable borrowing . . . and not just here, but around the world," said Treasury Secretary Timothy Geithner.
The first faint signs that the U.S. economy may be clawing its way back from the worst recession since the Great Depression are only now starting to appear, a year after the panic began. Similar indications are sprouting in Europe, China and Japan. Still, economists concur that a quarter-century of economic growth fueled by cheap credit is over. Many analysts also think that an extended period of slow job growth and suppressed wage growth will keep consumers — and the businesses that sell to them — in the dumps for years.
"Those things are likely to be subpar for a long period of time," said Martin Regalia, the chief economist for the U.S. Chamber of Commerce. "I think it means that we probably see potential rates of growth that are in the 2-2.5 (percent) range, or maybe . . . 1.8-1.9 (percent)." A growth rate of 3 percent to 3.5 percent is considered average. The unemployment rate rose to 9.7 percent in August and is expected to peak above 10 percent in the months ahead. It's already there in at least 15 states. Regalia thinks that it could be five years before the U.S. economy generates enough jobs to overcome those lost and to employ the new workers entering the labor force. All this is likely to keep consumers on the sidelines.
"I think this financial panic and Great Recession is an inflection point for the financial system and the economy," said Mark Zandi, the chief economist for forecaster Moody's Economy.com. "It means much less risk-taking, at least for a number of years to come — a decade or two. That will be evident in less credit and more costly credit. If you are a household or a business, it will cost you more, and it will be more difficult to get that credit."
The numbers bear him out. The Fed's most recent release of credit data showed that consumer credit decreased at an annual rate of 5.2 percent from April to June, after falling by a 3.6 percent annual rate from January to March. Revolving lines of credit, which include credit cards, fell by an annualized 8.9 percent in the first quarter, followed by an 8.2 percent drop in the second quarter. That's a sea change. For much of the past two decades, strong U.S. growth has come largely through expanding credit. The global economy fed off this trend.
China became a manufacturing hub by selling attractively priced exports to U.S. consumers who were living beyond their means. China's Asian neighbors sent it components for final assembly; Africa and Latin America sold China their raw materials. All fed off U.S. consumers' bottomless appetite for more, bought on credit. "That's over. Consumers can do their part — spend at a rate consistent with their income growth, but not much beyond that," Zandi said. If U.S. consumers no longer drive the global economy, then consumers in big emerging economies such as China and Brazil will have to take up some of the slack. Trade among nations will take on greater importance.
In the emerging "new normal," U.S. companies will have to be more competitive. They must sell into big developing markets; yet as the recent Cash for Clunkers effort underscored, the competitive hurdles are high: Foreign-owned automakers, led by Toyota, reaped the most benefit from the U.S. tax breaks for new car purchases, not GM and Chrysler. Need a loan? Tough luck: Many U.S. banks are in no condition to lend. Around 416 banks are now on a "problem list" and at risk of insolvency. Regulators already have shuttered 81 banks and thrifts this year.
The Federal Deposit Insurance Corp. reported on Aug. 27 that rising loan losses are depleting bank capital. The ratio of bank reserves to bad loans was 63.5 percent from April to June, the lowest it's been since the savings-and-loan crisis in 1991. For all that, the U.S. economy does seem to be rising off its sickbed. The latest manufacturing data for August point to a return to growth, and home sales are rising. Indeed, there are many encouraging signs emerging in the global economy.
It's all growth from a low starting point, however, and many economists think that there'll be a lower baseline for U.S. and global growth if the new financial order means less risk-taking by lenders and less indebtedness by companies and consumers. That seems evident now in the U.S. personal savings rate. It fell steadily from 9.59 percent in the 1970s to 2.68 percent in the easy-money era from 2000 to 2008; from 2005 to 2007, it averaged 1.83 percent.
Today, that trend is in reverse. From April to June, Americans' personal savings rate was 5 percent, and it could go higher if the unemployment rate keeps rising. Almost 15 million Americans are unemployed — and countless others are underemployed or uncertain about their job security, so they're spending less and saving more. A few years ago, banks fell all over themselves to offer cheap home equity loans and lines of consumer credit. No more. Even billions in government bailout dollars to spur lending haven't changed that.
"The strategy that was stated at the beginning of the year — which is that you would sustain the banking system in order that it would resume lending — hasn't worked, and it isn't going to work," said James K. Galbraith, an economist at the University of Texas at Austin. Over the course of 2008, the nation's five largest banks reduced their consumer loans by 79 percent, real estate loans by 66 percent and commercial loans by 19 percent, according to FDIC data.
A wide range of credit measures, including recent FDIC data, show that lending remains depressed. Why? The foundation of U.S. credit expansion for the past 20 years is in ruin. Since the 1980s, banks haven't kept loans on their balance sheets; instead, they sold them into a secondary market, where they were pooled for sale to investors as securities. The process, called securitization, fueled a rapid expansion of credit to consumers and businesses. By passing their loans on to investors, banks were freed to lend more.
Today, securitization is all but dead. Investors have little appetite for risky securities. Few buyers want a security based on pools of mortgages, car loans, student loans and the like. "The basis of revival of the system along the line of what previously existed doesn't exist. The foundation that was supposed to be there for the revival (of the economy) . . . got washed away," Galbraith said.
Unless and until securitization rebounds, it will be hard for banks to resume robust lending because they're stuck with loans on their books. "We've just been scared," said Robert C. Pozen, the chairman of Boston-based MFS Investment Management. He thinks that the freeze in securitization reflects a lack of trust in Wall Street and its products and remains a huge obstacle to the resumption of lending that's vital to an economic recovery.
Enter the Federal Reserve. It now props up the secondary market for pooled loans that are vital to the functioning of the U.S. financial system. The Fed is lending money to investors who're willing to buy the safest pools of loans, called asset-backed securities. Through Sept. 3, the Fed had funded purchases of $817.6 billion in mortgage-backed securities. These securities were pooled mostly by mortgage finance giants Fannie Mae, Freddie Mac and Ginnie Mae. In recent months, the Fed also has moved aggressively to lend for purchase of pools of other consumer-based loans.
Today, there's little private-sector demand for new loan-based securities; government is virtually the only game in town. That's why on Aug. 17, the Fed announced that it would extend its program to finance the purchase of pools of loans until mid-2010. That suggests there's still a long way to go before a functioning securitization market — the backbone of consumer lending — returns to a semblance of normalcy.
Taxpayers Face Heavy Losses on Auto Bailout
Taxpayers face losses on a significant portion of the $81 billion in government aid provided to the auto industry, an oversight panel said in a report to be released Wednesday. The Congressional Oversight Panel did not provide an estimate of the projected loss in its latest monthly report on the $700 billion Troubled Asset Relief Program. But it said most of the $23 billion initially provided to General Motors Corp. and Chrysler LLC late last year is unlikely to be repaid.
"I think they drove a very hard bargain," said Elizabeth Warren, the panel's chairwoman and a law professor at Harvard University, referring to the Obama administration's Treasury Department. "But it may not be enough." The prospect of recovering the government's assistance to GM and Chrysler is heavily dependent on shares of the two companies rising to unprecedented levels, the report said. The government owns 10 percent of Chrysler and 61 percent of GM. The two companies are currently private but are expected to issue stock, in GM's case by next year.
The shares "will have to appreciate sharply" for taxpayers to get their money back, the report said. For example, GM's market value would have to reach $67.6 billion, the report said, a "highly optimistic" estimate and more than the $57.2 billion GM was worth at the height of its share value in April 2008. And in the case of Chrysler, about $5.4 billion of the $14.3 billion provided to the company is "highly unlikely" to ever be repaid, the panel said.
Treasury Department officials have acknowledged that most of the $23 billion provided by the Bush administration is likely to be lost. But Meg Reilly, a department spokeswoman, said there is a "reasonably high probability of the return of most or all of the government funding" that was provided to assist GM and Chrysler with their restructurings. Administration officials have previously said they want to maximize taxpayers' return on the investment but want to dispose of the government's ownership interests as soon as practicable.
"We are not trying to be Warren Buffett here. We are not trying to squeeze every last dollar out," Steve Rattner, who led the administration's auto task force, said before his departure in July. "We do want to do well for the taxpayers but the most important thing is to get the government out of the car business." Greg Martin, a spokesman for the new GM, said the company is "confident that we will repay our nation's support because we are a company with less debt, a stronger balance sheet, a winning product portfolio and the right size to match today's market realities."
The Congressional Oversight Panel was created as part of the Troubled Asset Relief Program, or TARP. It is designed to provide an additional layer of oversight, beyond the Special Inspector General for the TARP and regular audits by the Government Accountability Office. The panel's report recommends that the Treasury Department consider placing its auto company holdings into an independent trust, to avoid any "conflicts of interest."
The report also recommends the department perform a legal analysis of its decision to provide TARP funds to GM and Chrysler, their financing arms and many auto parts suppliers. Some critics say the law creating TARP didn't allow for such funding. The panel's members include Rep. Jeb Hensarling, a Texas Republican, who dissented from the report. Hensarling said the auto companies should never have received funding and criticized the government for picking "winners and losers." Other agencies have also projected large losses on the loans and investments provided to the industry. The Congressional Budget Office estimated in June that taxpayers would lose about $40 billion of the first $55 billion in aid.
Max Keiser: US is on the slippery slope to economic collapse
Bankruptcy threat brings new concept to the Cayman Islands … taxes
The white sands of Seven Mile Beach on Grand Cayman have long caressed the toes of the world's wealthiest financiers, who flock to this balmy spit to avoid the taxman's prying eyes. But the world's biggest hedge-fund venue and fifth-biggest bank centre is now threatened, as the government of the Cayman Islands heads for bankruptcy — unable to pay its own staff and facing the prospect of introducing taxes as income from the world's shrunken financial system collapses.
But the situation is about to get worse after the British government, which has ultimate responsibility for the islands, last week refused to bail out the Caribbean idyll. It is not convinced the country will have the money to pay it back. At the same time, hundreds of civil servants found that pension contributions and health insurance payments were missing from their pay slips. Contractors and government suppliers also had bills unpaid.
The leader of government business, William McKeeva Bush, begged the British government to borrow $310m (£190m) from banks. In a strongly worded response, Chris Bryant, a junior Foreign Office minister, has demanded the Caymans cut its borrowing and debt. And in a shockwave that will send tremors through the island's financial elite, Bryant even suggested that the tax haven introduce taxes.
"I fear you will have no choice but to consider new taxes – perhaps payroll and property taxes," Bryant wrote to Bush. "I understand, of course, that in so doing you will want to consider carefully the implications for Caymans' economy, including the financial services industry." The wealth in the Caymans is staggering. Its hedge funds alone look after $2.3tn (£1.4tn), according to figures last year, and its GDP places it as the world's 12th richest jurisdiction, despite a population of only 51,900.
It made the Caymans a high-profile target as the global financial storm clouds broke. The Caymans were singled out by Barack Obama last year in his presidential campaign. It was also placed on a "grey list" of harmful tax jurisdictions by the OECD last April. Chris Johnson, a British accountant who has lived there since 1968, is worried about his future for the first time in decades. "I would say I am pessimistic now. The island is in terrible trouble financially," he said.
The Cayman Islands, like most Caribbean island nations, is deeply divided socially and economically. On the one hand there are the ultra-wealthy – Microsoft's Paul Allen and golf champion Tiger Woods both moor their yachts there. On the other there are the native Caymanians, many of whom live in simple single-storey breeze block homes typical of the islands, with chickens and goats running about on scrub-like surrounding land.
They are poor people who largely exist on the island to serve the wealthy in the hotels, private clubs and staffed households. Cayman islanders say the previous government spent a huge amount of money upgrading the island's ancient infrastructure, betting it would be able to pay back a budget deficit of $67.5m as its financial sector continued to grow. But the global financial crisis has created a huge black hole in its budget.
The government charges financial institutions a licence fee based on employee numbers. But as banks and hedge funds shrink, income has declined. More seriously, US tourists cannot afford to visit. To fix the hole, taxes on personal income, financial transactions and tourism are being discussed. Most likely will be the introduction of a property tax. Richard Murphy, of the campaign group Tax Justice Network, said: "Cayman is proving three things. The first is that tax havens are not sustainable: their business model is bankrupt. The second is that free-riding the tax system can't pay. The third is that international finance services that uses these places undermine the effective operations of states by denying them the resources they need to fulfil local electoral mandates."
One hedge-fund insider who lived in the Caymans said: "The heavy spending was well-intentioned because Caymans' infrastructure – schools, public health services, social services – are quite poor, given the assumed wealth of Grand Cayman. The devastating hurricane Ivan in 2004 didn't help … The problem was, the debt created to finance the capital expenditures was only affordable if the island's economy continued to grow rapidly. It was said many times that a US recession could lead to big problems." And so it has been proved. The British government, which has ultimate responsibility for the Caymans, will hope that the islands' problems do not wash up on its shores.
Dutch Equity Value Down 30% In 2008
The equity value of shares held in the Netherlands fell 29.6% to EUR597 billion in 2008, the country's the Central Bureau for Statistics, or CBS, said Wednesday. The value of household-held shares fell 27%, or EUR66 billion in total, CBS said in a macroeconomic review of 2008. The value for pension funds and insurers dropped 33%, or EUR160 billion, and that for banks fell 21%, or EUR25 billion.
Dutch Bankers' Code To Limit Bonuses Next Year
The Netherlands Bankers' Association, or NVB, will implement a code of conduct for banks next year that will limit the level of bonuses awarded and strengthen corporate governance, the association said Wednesday. According to the Code for Banks, bonuses for board members may not exceed their fixed income by more than 100%. The code also determines that bonuses can be reclaimed, "if long term targets will not be met," NVB spokesman Kees Verhagen said to Dow Jones Newswires. "This also means that in practice bonuses will often be paid in terms related to achieved targets and not all at once in advance anymore", he added.
The code also requires strengthening of governance, risk management and auditing for banks. NVB said that the code will apply from Jan. 1, 2010, and banks must report on the implementation of the code's regulations in their annual reports. NVB, with almost 100 member banks, said an independent commission will monitor the implementation of the Code for Banks. "The members of this commission will be appointed in close consultation with the Dutch Ministry of Finance", Verhagen said. Shareholders and supervisory boards will also play an important role in monitoring the compliance of the code, he said. According to the NVB spokesman, the Dutch Code for Banks anticipates a discussion of bankers' bonuses at the summit of leaders from the Group of 20 industrial and developing nations in Pittsburgh later this month.
British pension liabilities break through £1 trillion mark
Liabilities in defined benefit workplace pensions in the UK have broken through the £1 trillion mark. The Pension Protection Fund (PPF), which oversees the assets of nearly 7,400 defined-benefit occupational schemes and administers payments to members of schemes where employers have gone bust, said ballooning liabilities were driving up deficits despite the recent stock market rally which has improved asset values. Deficits – liabilities minus assets – worsened during August by £16bn to £195bn, while the value of the FTSE All-Share Index rose by 7.1pc. This time last year, deficits stood at just £93bn. The PPF said 6,304 schemes are now in deficit – representing 85pc of the total.
Surpluses in those schemes which still have them have also plummeted, from £53bn this time last year to £21.4bn now. Although rising share prices caused the value of assets in pension funds to increase by 3.3pc, lower gilt yields forced pension scheme liabilities to rise by 5.2pc. A spokesman for the PPF said: "Over the past year, falling equity markets and bond yields have led to an overall worsening of the funding position. Lower bond yields resulted in a 9.6pc increase in aggregate liabilities, while weaker equity prices reduced assets by 3.1pc over the year." Pensions consultant John Ralfe warned that pension liabilities will continue to grow, in spite of recovery in the stock market. The Government’s appetite for quantitative easing is one factor causing them to expand.
Mr Ralfe said: "It is easy to focus on asset growth, but we need to look at what has happened to pension liabilities. Higher UK share prices have been largely driven by falls in bond yields, which have also increased pension liabilities. UK pension plans have been running to stand still. UK plc continues to run a huge asset and liability mismatch through holding equities to meet bond-like pensions." Growing pension liabilities have already caused nine out of 10 final-salary schemes to close the doors to new employee members. Many employers are now closing schemes to existing members as well.
Steve Webb, Liberal Democrat work and pensions spokesman , said the plight of workplace pensions will put intolerable pressure on the state in future to support people who had expected to rely on them in old age. "With public sector pensions likely to be reined back along with their private sector counterparts, more and more workers will find themselves facing means-testing in old age," he said. "If the Government really wants to give people dignity and security in old age, it should guarantee a more generous basic state pension."
UK on course to keep triple-A credit rating
Ratings agency Moody's says a downgrade to Britain's credit status looks unnecessary if public spending is brought under control. Britain is set to keep its top triple-A credit status after ratings agency Moody's announced today that a downgrade was unlikely despite spiralling public debt. Gross public debt had almost doubled to above 80% of GDP in three years and was not expected to stabilise for many years to come, Moody's said. But a downgrade of the UK's credit rating, which would drive up the government's borrowing costs, had been averted because of the growing political consensus on the need to cut public spending as the economy recovered.
The ratings agency said that "the adjustment to the UK's public finances that is likely to take place in the context of the forthcoming elections – probably through cuts in spending – will keep the debt trajectory within AAA boundaries". "All AAA countries now have stable outlooks, indicating that we do not expect rating downgrades over the near term, beyond our recent downgrade of Ireland, from AAA to AA1 with negative outlook, which had been the most 'vulnerable' AAA," Moody's said. "The two 'resilient' countries, the UK and the US, are showing signs of recovery." Moody's cut Ireland's triple-A status in July. But it said Britain had significant advantages that meant its debt would remain affordable. A big proportion of UK debt is long-dated, which means its cost will not rise rapidly if interest rates go up.
The agency's verdict on the UK economy was: "Overall, following a sharp contraction over the winter and spring, the UK economy appears to be stabilising at GDP levels similar to those of early 2006, but [is] not yet on a solid recovery path." Alistair Darling said today he was "confident" that the economy would see growth around the turn of the year, pointing to "encouraging signs" in the UK other countries in the last few months. He said: "But I do say to people: 'This is not the time to break out the flags'. We still have to be cautious, there is some way to go yet and the key thing is we have got to see this through...to make sure we get recovery firmly entrenched and then make sure we can plan for the future."
He reiterated his budget pledge to reduce borrowing by half over the next four years. "I don't take the Tory approach that using this crisis is a blanket excuse to cut spending," he added. The news came as some UK economists declared the recession over, with government data showing mothballed factories springing back to life and rising optimism in the City stoking a new merger spree. The FTSE 100 index of blue-chip companies pushed close to the 5000 mark yesterday for the first time since the Lehman Brothers collapse 12 months ago, prompting the second multibillion-pound deal of the week. On Monday, confectionery group Cadbury rejected a £10.2bn approach from the American Kraft Foods and yesterday Orange and T-Mobile announced plans to merge their UK operations and create Britain's largest mobile phone operator.
Government figures yesterday showed that Britain's hard-pressed manufacturers had cranked up production for a second successive month in August, after running down stocks dramatically in the early months of the year. And the National Institute for Economic and Social Research thinktank (NIESR) has calculated that the recession is likely to have ended in May. As consumers are buoyed by stabilising house prices and return to the shops, many analysts agree the economy should now show growth in the third quarter of the year.
Barney Frank wants Cabinet post
Rep. Barney Frank is interested in capping his political career as a member of the president’s Cabinet, according to a new biography of the Financial Services Committee chairman. Frank (D-Mass.) told author Stuart Weisberg that he would like to be Housing and Urban Development secretary. However, the 69-year-old lawmaker stresses that his departure from Congress is not imminent.
He first wants to pass more legislation on affordable housing, saying, "I want at least two years with President Obama and a solidly Democratic Senate so that we can get the federal government back in the housing business."
No president has ever appointed an openly gay man or woman to the Cabinet.
Weisberg, who used to work for Frank on Capitol Hill, spent five years on his authoritative book, titled "Barney Frank, The Story of America’s Only Left-handed, Gay, Jewish Congressman". He interviewed over 150 people, including compiling 30 hours of interviews with Frank.
Frank talks about how he struggled as a gay man growing up in blue-collar Bayonne, N.J. He dated women throughout high school and college, but knew he was gay at 13. Still, he delayed revealing his sexuality until he had established a foothold in the House.
In the 501-page tome — to be released later this month — Frank is described by people who know him well as a masterful legislator, an impatient boss, and "socially handicapped."
Frank has been the subject of many profiles, but Weisberg provides news that political junkies crave.
In his first race for the House, Frank almost went head to head with now-Sen. John Kerry (D-Mass.) in the 1980 primary. After a meeting with Frank, Kerry opted not to run. Ten years later, Republicans tried to persuade Bill O’Reilly to run against Frank. O’Reilly also passed on the seat, but the Fox News commentator would clash with Frank 18 years later in a 2008 interview that has been viewed more than 2 million times on YouTube.
There are other rich details in Weisberg’s book, including Frank’s political battles with then-Massachusetts Gov. Michael Dukakis (D) and Clarence Thomas, when the Supreme Court justice served as director of the Equal Employment Opportunity Commission. Weisberg also states that Frank was friends with the late Rep. Sonny Bono (R-Calif.) and admires Rep. Dan Lungren (R-Calif.).
One of the most riveting parts of the book is Frank’s recollection of his ethics scandal, when he paid a male prostitute for sex. Various media outlets called for Frank to resign, but he persevered by admitting his mistakes and asking the ethics committee to investigate him in 1989. Many Republicans, including then-Rep. Larry Craig (Idaho), called for serious sanctions against Frank, who was ultimately reprimanded by the House, 408-18. (California Democratic Reps. Nancy Pelosi and Henry Waxman both voted against the measure.)
The following year, a Republican challenger to Frank’s seat — described as "not the smartest person in the district" — called on Frank to take an AIDS test and reveal the results publicly. Frank replied that he would do so if his GOP challenger would take an IQ test and release it to the public.
Throughout his life, Frank has battled bouts with depression and his voracious appetite. When Frank was advised by a political operative to improve his appearance, Frank responded that "when you are 5 feet 10 inches and you have a 46 waist and your thighs rub together, your clothes have a way of not looking good."
At other points in his life, he was able to lose weight — a lot of it. He once lost 100 pounds in eight months. Knowing that avoiding obesity would be a lifelong struggle, Frank said, "The day I die, I will either be fat or hungry."
Sometimes to his detriment, Frank was not shy in criticizing Democrats publicly, most notably President Bill Clinton during the "don’t ask, don’t tell" debate. He also irritated Sen. Edward Kennedy (D-Mass.) by suggesting Kennedy had no chance of becoming president after his 1980 bid fell short.
The personal details about Frank show a side of the Financial Services panel chairman that Washington insiders have not seen. He pumped gas as a teenager at his father’s truck stop in New Jersey, formally changed his name from "Barnett" to Barney and was an avid baseball and tennis player. Weisberg writes that only Frank’s mother Elsie, and his sister, Democratic strategist Ann Lewis, consistently won arguments against him. Elsie Frank died in 2005.
There are many amusing quotes from the quick-witted Frank. After then-Majority Leader Dick Armey (R-Texas) called Frank "Barney Fag" and then attributed the remark to a slip of the tongue, Frank said, "There are many ways to mispronounce my name. That one is the least common."
Amid the GOP-led Congress’s actions to intervene in the Terri Schiavo case, Frank challenged Republicans who offered their medical analysis during the debate: "The caption tonight ought to be: ‘We’re not doctors — we just play them on C-SPAN.’ "
Frank acknowledges missteps in crafting the 2008 financial bailout bill, saying the measure gave the Treasury secretary too much discretion in how to use the funds. But he asserts that passing the legislation was a necessity.
Weisberg writes that "the best of times is now" for Frank, noting the 15-term member is "at the top of his game as a lawmaker and as a deal-maker … He feels comfortable with who he is and he is no longer emotionally isolated.
"I am what I am," Frank said, adding, "sort of like Popeye."
How The Federal Reserve Bought The Economics Profession
The Federal Reserve, through its extensive network of consultants, visiting scholars, alumni and staff economists, so thoroughly dominates the field of economics that real criticism of the central bank has become a career liability for members of the profession, an investigation by the Huffington Post has found.
This dominance helps explain how, even after the Fed failed to foresee the greatest economic collapse since the Great Depression, the central bank has largely escaped criticism from academic economists. In the Fed's thrall, the economists missed it, too.
"The Fed has a lock on the economics world," says Joshua Rosner, a Wall Street analyst who correctly called the meltdown. "There is no room for other views, which I guess is why economists got it so wrong."
One critical way the Fed exerts control on academic economists is through its relationships with the field's gatekeepers. For instance, at the Journal of Monetary Economics, a must-publish venue for rising economists, more than half of the editorial board members are currently on the Fed payroll -- and the rest have been in the past.
The Fed failed to see the housing bubble as it happened, insisting that the rise in housing prices was normal. In 2004, after "flipping" had become a term cops and janitors were using to describe the way to get rich in real estate, then-Federal Reserve Chairman Alan Greenspan said that "a national severe price distortion [is] most unlikely." A year later, current Chairman Ben Bernanke said that the boom "largely reflect strong economic fundamentals."
The Fed also failed to sufficiently regulate major financial institutions, with Greenspan -- and the dominant economists -- believing that the banks would regulate themselves in their own self-interest.
Despite all this, Bernanke has been nominated for a second term by President Obama.
In the field of economics, the chairman remains a much-heralded figure, lauded for reaction to a crisis generated, in the first place, by the Fed itself. Congress is even considering legislation to greatly expand the powers of the Fed to systemically regulate the financial industry.
Paul Krugman, in Sunday's New York Times magazine, did his own autopsy of economics, asking "How Did Economists Get It So Wrong?" Krugman concludes that "[e]conomics, as a field, got in trouble because economists were seduced by the vision of a perfect, frictionless market system."
So who seduced them?
The Fed did it.
Three Decades of Domination
The Fed has been dominating the profession for about three decades. "For the economics profession that came out of the [second world] war, the Federal Reserve was not a very important place as far as they were concerned, and their views on monetary policy were not framed by a working relationship with the Federal Reserve. So I would date it to maybe the mid-1970s," says University of Texas economics professor -- and Fed critic -- James Galbraith. "The generation that I grew up under, which included both Milton Friedman on the right and Jim Tobin on the left, were independent of the Fed. They sent students to the Fed and they influenced the Fed, but there wasn't a culture of consulting, and it wasn't the same vast network of professional economists working there."
But by 1993, when former Fed Chairman Greenspan provided the House banking committee with a breakdown of the number of economists on contract or employed by the Fed, he reported that 189 worked for the board itself and another 171 for the various regional banks. Adding in statisticians, support staff and "officers" -- who are generally also economists -- the total number came to 730. And then there were the contracts. Over a three-year period ending in October 1994, the Fed awarded 305 contracts to 209 professors worth a total of $3 million.
Just how dominant is the Fed today?
The Federal Reserve's Board of Governors employs 220 PhD economists and a host of researchers and support staff, according to a Fed spokeswoman. The 12 regional banks employ scores more. (HuffPost placed calls to them but was unable to get exact numbers.) The Fed also doles out millions of dollars in contracts to economists for consulting assignments, papers, presentations, workshops, and that plum gig known as a "visiting scholarship." A Fed spokeswoman says that exact figures for the number of economists contracted with weren't available. But, she says, the Federal Reserve spent $389.2 million in 2008 on "monetary and economic policy," money spent on analysis, research, data gathering, and studies on market structure; $433 million is budgeted for 2009.
That's a lot of money for a relatively small number of economists. According to the American Economic Association, a total of only 487 economists list "monetary policy, central banking, and the supply of money and credit," as either their primary or secondary specialty; 310 list "money and interest rates"; and 244 list "macroeconomic policy formation [and] aspects of public finance and general policy." The National Association of Business Economists tells HuffPost that 611 of its roughly 2,400 members are part of their "Financial Roundtable," the closest way they can approximate a focus on monetary policy and central banking.
Robert Auerbach, a former investigator with the House banking committee, spent years looking into the workings of the Fed and published much of what he found in the 2008 book, "Deception and Abuse at the Fed". A chapter in that book, excerpted here, provided the impetus for this investigation.
Auerbach found that in 1992, roughly 968 members of the AEA designated "domestic monetary and financial theory and institutions" as their primary field, and 717 designated it as their secondary field. Combining his numbers with the current ones from the AEA and NABE, it's fair to conclude that there are something like 1,000 to 1,500 monetary economists working across the country. Add up the 220 economist jobs at the Board of Governors along with regional bank hires and contracted economists, and the Fed employs or contracts with easily 500 economists at any given time. Add in those who have previously worked for the Fed -- or who hope to one day soon -- and you've accounted for a very significant majority of the field.
Auerbach concludes that the "problems associated with the Fed's employing or contracting with large numbers of economists" arise "when these economists testify as witnesses at legislative hearings or as experts at judicial proceedings, and when they publish their research and views on Fed policies, including in Fed publications."
Gatekeepers On The Payroll
The Fed keeps many of the influential editors of prominent academic journals on its payroll. It is common for a journal editor to review submissions dealing with Fed policy while also taking the bank's money. A HuffPost review of seven top journals found that 84 of the 190 editorial board members were affiliated with the Federal Reserve in one way or another.
"Try to publish an article critical of the Fed with an editor who works for the Fed," says Galbraith. And the journals, in turn, determine which economists get tenure and what ideas are considered respectable.
The pharmaceutical industry has similarly worked to control key medical journals, but that involves several companies. In the field of economics, it's just the Fed.
Being on the Fed payroll isn't just about the money, either. A relationship with the Fed carries prestige; invitations to Fed conferences and offers of visiting scholarships with the bank signal a rising star or an economist who has arrived.
Affiliations with the Fed have become the oxygen of academic life for monetary economists. "It's very important, if you are tenure track and don't have tenure, to show that you are valued by the Federal Reserve," says Jane D'Arista, a Fed critic and an economist with the Political Economy Research Institute at the University of Massachusetts, Amherst.
Robert King, editor in chief of the Journal of Monetary Economics and a visiting scholar at the Richmond Federal Reserve Bank, dismisses the notion that his journal was influenced by its Fed connections. "I think that the suggestion is a silly one, based on my own experience at least," he wrote in an e-mail. (His full response is at the bottom.)
Galbraith, a Fed critic, has seen the Fed's influence on academia first hand. He and co-authors Olivier Giovannoni and Ann Russo found that in the year before a presidential election, there is a significantly tighter monetary policy coming from the Fed if a Democrat is in office and a significantly looser policy if a Republican is in office. The effects are both statistically significant, allowing for controls, and economically important.
They submitted a paper with their findings to the Review of Economics and Statistics in 2008, but the paper was rejected. "The editor assigned to it turned out to be a fellow at the Fed and that was after I requested that it not be assigned to someone affiliated with the Fed," Galbraith says.
Publishing in top journals is, like in any discipline, the key to getting tenure. Indeed, pursuing tenure ironically requires a kind of fealty to the dominant economic ideology that is the precise opposite of the purpose of tenure, which is to protect academics who present oppositional perspectives.
And while most academic disciplines and top-tier journals are controlled by some defining paradigm, in an academic field like poetry, that situation can do no harm other than to, perhaps, a forest of trees. Economics, unfortunately, collides with reality -- as it did with the Fed's incorrect reading of the housing bubble and failure to regulate financial institutions. Neither was a matter of incompetence, but both resulted from the Fed's unchallenged assumptions about the way the market worked.
Even the late Milton Friedman, whose monetary economic theories heavily influenced Greenspan, was concerned about the stifled nature of the debate. Friedman, in a 1993 letter to Auerbach that the author quotes in his book, argued that the Fed practice was harming objectivity: "I cannot disagree with you that having something like 500 economists is extremely unhealthy. As you say, it is not conducive to independent, objective research. You and I know there has been censorship of the material published. Equally important, the location of the economists in the Federal Reserve has had a significant influence on the kind of research they do, biasing that research toward noncontroversial technical papers on method as opposed to substantive papers on policy and results," Friedman wrote.
Greenspan told Congress in October 2008 that he was in a state of "shocked disbelief" and that the "whole intellectual edifice" had "collapsed." House Committee on Oversight and Government Reform Chairman Henry Waxman (D-Calif.) followed up: "In other words, you found that your view of the world, your ideology, was not right, it was not working."
"Absolutely, precisely," Greenspan replied. "You know, that's precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well."
But, if the intellectual edifice has collapsed, the intellectual infrastructure remains in place. The same economists who provided Greenspan his "very considerable evidence" are still running the journals and still analyzing the world using the same models that were incapable of seeing the credit boom and the coming collapse.
Rosner, the Wall Street analyst who foresaw the crash, says that the Fed's ideological dominance of the journals hampered his attempt to warn his colleagues about what was to come. Rosner wrote a strikingly prescient paper in 2001 arguing that relaxed lending standards and other factors would lead to a boom in housing prices over the next several years, but that the growth would be highly susceptible to an economic disruption because it was fundamentally unsound.
He expanded on those ideas over the next few years, connecting the dots and concluding that the coming housing collapse would wreak havoc on the collateralized debt obligation (CDO) and mortgage backed securities (MBS) markets, which would have a ripple effect on the rest of the economy. That, of course, is exactly what happened and it took the Fed and the economics field completely by surprise.
"What you're doing is, actually, in order to get published, having to whittle down or narrow what might otherwise be oppositional or expansionary views," says Rosner. "The only way you can actually get in a journal is by subscribing to the views of one of the journals."
When Rosner was casting his paper on CDOs and MBSs about, he knew he needed an academic economist to co-author the paper for a journal to consider it. Seven economists turned him down.
"You don't believe that markets are efficient?" he says they asked, telling him the paper was "outside the bounds" of what could be published. "I would say 'Markets are efficient when there's equal access to information, but that doesn't exist,'" he recalls.
The CDO and MBS markets froze because, as the housing market crashed, buyers didn't trust that they had reliable information about them -- precisely the case Rosner had been making.
He eventually found a co-author, Joseph Mason, an associate Professor of Finance at Drexel University LeBow College of Business, a senior fellow at the Wharton School, and a visiting scholar at the Federal Deposit Insurance Corporation. But the pair could only land their papers with the conservative Hudson Institute. In February 2007, they published a paper called "How Resilient Are Mortgage Backed Securities to Collateralized Debt Obligation Market Disruptions?" and in May posted another, "How Misapplied Bond Ratings Cause Mortgage Backed Securities and Collateralized Debt Obligation Market Disruptions."
Together, the two papers offer a better analysis of what led to the crash than the economic journals have managed to put together - and they were published by a non-PhD before the crisis.
Not As Simple As A Pay-Off
Economist Rob Johnson serves on the UN Commission of Experts on Finance and International Monetary Reform and was a top economist on the Senate banking committee under both a Democratic and Republican chairman. He says that the consulting gigs shouldn't be looked at "like it's a payoff, like money. I think it's more being one of, part of, a club -- being respected, invited to the conferences, have a hearing with the chairman, having all the prestige dimensions, as much as a paycheck."
The Fed's hiring of so many economists can be looked at in several ways, Johnson says, because the institution does, of course, need talented analysts. "You can look at it from a telescope, either direction. One, you can say well they're reaching out, they've got a big budget and what they're doing, I'd say, is canvassing as broad a range of talent," he says. "You might call that the 'healthy hypothesis.'"
The other hypothesis, he says, "is that they're essentially using taxpayer money to wrap their arms around everybody that's a critic and therefore muffle or silence the debate. And I would say that probably both dimensions are operative, in reality."
To get a mainstream take, HuffPost called monetary economists at random from the list as members of the AEA. "I think there is a pretty good number of professors of economics who want a very limited use of monetary policy and I don't think that that necessarily has a negative impact on their careers," said Ahmed Ehsan, reached at the economics department at James Madison University. "It's quite possible that if they have some new ideas, that might be attractive to the Federal Reserve."
Ehsan, reflecting on his own career and those of his students, allowed that there is, in fact, something to what the Fed critics are saying. "I don't think [the Fed has too much influence], but then my area is monetary economics and I know my own professors, who were really well known when I was at Michigan State, my adviser, he ended up at the St. Louis Fed," he recalls. "He did lots of work. He was a product of the time...so there is some evidence, but it's not an overwhelming thing."
There's definitely prestige in spending a few years at the Fed that can give a boost to an academic career, he added. "It's one of the better career moves for lots of undergraduate students. It's very competitive."
Press officers for the Federal Reserve's board of governors provided some background information for this article, but declined to make anyone available to comment on its substance.
The Fed's Intolerance For Dissent
When dissent has arisen, the Fed has dealt with it like any other institution that cherishes homogeneity.
Take the case of Alan Blinder. Though he's squarely within the mainstream and considered one of the great economic minds of his generation, he lasted a mere year and a half as vice chairman of the Fed, leaving in January 1996.
Rob Johnson, who watched the Blinder ordeal, says Blinder made the mistake of behaving as if the Fed was a place where competing ideas and assumptions were debated. "Sociologically, what was happening was the Fed staff was really afraid of Blinder. At some level, as an applied empirical economist, Alan Blinder is really brilliant," says Johnson.
In closed-door meetings, Blinder did what so few do: challenged assumptions. "The Fed staff would come out and their ritual is: Greenspan has kind of told them what to conclude and they produce studies in which they conclude this. And Blinder treated it more like an open academic debate when he first got there and he'd come out and say, 'Well, that's not true. If you change this assumption and change this assumption and use this kind of assumption you get a completely different result.' And it just created a stir inside--it was sort of like the whole pipeline of Greenspan-arriving-at-decisions was
It didn't sit well with Greenspan or his staff. "A lot of senior staff...were pissed off about Blinder -- how should we say? -- not playing by the customs that they were accustomed to," Johnson says.
And celebrity is no shield against Fed excommunication. Paul Krugman, in fact, has gotten rough treatment. "I've been blackballed from the Fed summer conference at Jackson Hole, which I used to be a regular at, ever since I criticized him," Krugman said of Greenspan in a 2007 interview with Pacifica Radio's Democracy Now! "Nobody really wants to cross him."
An invitation to the annual conference, or some other blessing from the Fed, is a signal to the economic profession that you're a certified member of the club. Even Krugman seems a bit burned by the slight. "And two years ago," he said in 2007, "the conference was devoted to a field, new economic geography, that I invented, and I wasn't invited."
Three years after the conference, Krugman won a Nobel Prize in 2008 for his work in economic geography.
One Journal, In Detail
The Huffington Post reviewed the mastheads of the American Journal of Economics, the Journal of Economic Perspectives, Journal of Economic Literature, the American Economic Journal: Applied Economics, American Economic Journal: Economic Policy, the Journal of Political Economy and the Journal of Monetary Economics.
HuffPost interns Googled around looking for resumes and otherwise searched for Fed connections for the 190 people on those mastheads. Of the 84 that were affiliated with the Federal Reserve at one point in their careers, 21 were on the Fed payroll even as they served as gatekeepers at prominent journals.
At the Journal of Monetary Economics, every single member of the editorial board is or has been affiliated with the Fed and 14 of the 26 board members are presently on the Fed payroll.
After the top editor, King, comes senior associate editor Marianne Baxter, who has written papers for the Chicago and Minneapolis banks and was a visiting scholar at the Minneapolis bank in '84, '85, at the Richmond bank in '97, and at the board itself in '87. She was an advisor to the president of the New York bank from '02-'05. Tim Geithner, now the Treasury Secretary, became president of the New York bank in '03.
The senior associate editors: Janice C Eberly was a Fed visiting-scholar at Philadelphia ('94), Minneapolis ('97) and the board ('97). Martin Eichenbaum has written several papers for the Fed and is a consultant to the Chicago and Atlanta banks. Sergio Rebelo has written for and was previously a consultant to the board. Stephen Williamson has written for the Cleveland, Minneapolis and Richmond banks, he worked in the Minneapolis bank's research department from '85-'87, he's on the editorial board of the Federal Reserve Bank of St. Louis Review, is the co-organizer of the '09 St. Louis Federal Reserve Bank annual economic policy conference and the co-organizer of the same bank's '08 conference on Money, Credit, and Policy, and has been a visiting scholar at the Richmond bank ever since '98.
And then there are the associate editors. Klaus Adam is a visiting scholar at the San Francisco bank. Yongsung Chang is a research associate at the Cleveland bank and has been working with the Fed in one position or another since '01. Mario Crucini was a visiting scholar at the Federal Reserve Bank of New York in '08 and has been a senior fellow at the Dallas bank since that year. Huberto Ennis is a senior economist at the Federal Reserve Bank of Richmond, a position he's held since '00. Jonathan Heathcote is a senior economist at the Minneapolis bank and has been a visiting scholar three times dating back to '01.
Ricardo Lagos is a visiting scholar at the New York bank, a former senior economist for the Minneapolis bank and a visiting scholar at that bank and Cleveland's. In fact, he was a visiting scholar at both the Cleveland and New York banks in '07 and '08. Edward Nelson was the assistant vice president of the St Louis bank from '03-'09.
Esteban Rossi-Hansberg was a visiting scholar at the Philadelphia bank from '05-'09 and similarly served at the Richmond, Minneapolis and New York banks.
Pierre-Daniel Sarte is a senior economist at the Richmond bank, a position he's held since '96. Frank Schorfheide has been a visiting scholar at the Philadelphia bank since '03 and at the New York bank since '07. He's done four such stints at the Atlanta bank and scholared for the board in '03. Alexander Wolman has been a senior economist at the Richmond bank since 1989.
Here is the complete response from King, the journal's editor in chief: "I think that the suggestion is a silly one, based on my own experience at least. In a 1988 article for AEI later republished in the Federal Reserve Bank of Richmond Review, Marvin Goodfriend (then at FRB Richmond and now at Carnegie Mellon) and I argued that it was very important for the Fed to separate monetary policy decisions (setting of interest rates) and banking policy decisions (loans to banks, via the discount window and otherwise). We argued further that there was little positive case for the Fed to be involved in the latter: broadbased liquidity could always be provided by the former. We also argued that moral hazard was a cost of banking intervention.
"Ben Bernanke understands this distinction well: he and other members of the FOMC have read my perspective and sometimes use exactly this distinction between monetary and banking policies. In difficult times, Bernanke and his fellow FOMC members have chosen to involve the Fed in major financial market interventions, well beyond the traditional banking area, a position that attracts plenty of criticism and support. JME and other economics major journals would certainly publish exciting articles that fell between these two distinct perspectives: no intervention and extensive intervention. An upcoming Carnegie-Rochester conference, with its proceeding published in JME, will host a debate on 'The Future of Central Banking'.
"You may use only the entire quotation above or no quotation at all."
Auerbach, shown King's e-mail, says it's just this simple: "If you're on the Fed payroll there's a conflict of interest."
How Bad Will Unemployment Get, And What Can We Do About It?
By George Washington
Unemployment is disastrous on both the individual and societal level.
Individuals who look for work but can’t find it are miserable. Indeed, most people who lose their job are unprepared for their circumstances.
On the national level, high unemployment is both cause and effect concerning other problems with the economy. As we’ll see below, high unemployment results from a weak economy and - in turn - weakens the economy.
Until the causes of, and solutions to, high levels of unemployment are understood, we will not be able to solve the problem.
How High is Unemployment?
Before we can even start looking at causes or solutions, we have to understand what the current level of unemployment really is, and what the trends portend for the future.
Let’s use America as an example. With the largest economy in the world, it has often been said that “when America sneezes, the rest of the world catches cold”. And much of the rest of the world has adopted the “Washington Consensus” - America’s neoliberal view of economics. Moreover, the rest of the world has been infected by many types of “toxic assets” invented in America, such as credit default swap derivatives, as well as Wall Street style banking strategies. So I will use the United States has a case example, but will also touch on global trends.
Official figures put unemployment in the United States somewhere between 9 and 10 percent. But the official figures use a very different measure for unemployment than was used during the Great Depression and for many decades afterwards.
Specifically, the official unemployment reports of the Department of Labor’s Bureau of Labor Statistics (BLS) provide conventional “U-3″ figures and various alternative measures including “U-6″. 
For example, as of December 2008, U-3 unemployment was 7.2 percent, while U-6 was 13.5 percent. 
U-6 is actually more accurate, because it includes those who would like full-time work, but can only find part-time work, or have given up looking for work altogether.
As can be seen by the December 2008 figures, U-6 unemployment rate can almost double the more commonly-cited U-3 figures.
But those in the know argue that the real rate is actually even higher than the U-6 figures.
For example, Paul Craig Roberts  - former Assistant Secretary of the Treasury and former editor of the Wall Street Journal - and economist John Williams both said in December 2008 that - if the unemployment rate was calculated as it was during the Great Depression - the December 2008 unemployment figure would actually have been 17.5%.
According to an article  summarizing the projections of former International Monetary Fund Chief Economist and Harvard University Economics Professor Kenneth Rogoff and University of Maryland Economics Professor Carmen Reinhart, U-6 unemployment could rise to 22% within the next 4 years or so.
As the New York Times pointed out in July :
Include [those who have given up looking for a job and those part-time workers who want to be working full time] — as the Labor Department does when calculating its broadest measure of the job market — and the rate reached 23.5 percent in Oregon this spring, according to a New York Times analysis of state-by-state data. It was 21.5 percent in both Michigan and Rhode Island and 20.3 percent in California. In Tennessee, Nevada and several other states that have relied heavily on manufacturing or housing, the rate was just under 20 percent this spring and may have since surpassed it.
Indeed, the chief of the Atlanta Federal Reserve Bank -Dennis Lockhart - said in August 2009:
If one considers the people who would like a job but have stopped looking — so-called discouraged workers — and those who are working fewer hours than they want, the unemployment rate would move from the official 9.4 percent to 16 percent. 
Former Labor Secretary Robert Rubin notes:
Over the past three months annual wage growth has plummeted to just 0.7%. At the same time, furloughs — requiring workers to take unpaid vacations — are on the rise: recent surveys show 17% of companies imposing them. 
Temporary employment is still falling as well. 
And economist David Rosenberg points out:
65% of companies are still in the process of cutting their staff loads…
The Bureau of Labor Statistics also publishes a number from the Household survey that is comparable to the nonfarm survey (dubbed the population and payroll-adjusted Household number), and on this basis, employment sank — brace yourself — by over 1 million, which is unprecedented…
In addition to the failure of official BLS unemployment figures to take into account discouraged and underemployed workers, many analysts argue that BLS’ “Birth-Death Model” severely understates unemployment during recessions. 
Many people - including economists and financial reporters - say that unemployment is much lower than it was during the Great Depression. What they mean when they say that is that current U-3 figures in America are under 10%, while unemployment hit 25% during the Great Depression.
But most people forget that the worst unemployment numbers during the Great Depression did not occur until years after the initial 1929 crash . Specifically, unemployment did not hit 25% until at least 3 years after the start of the Depression.
As of this writing (2009), we are only a year into the current economic crisis. Therefore, we have at least 2 more years to go until we hit the same period that unemployment peaked during the Great Depression.
Indeed, former Secretary of Labor Robert Reich wrote in April that the unemployment figures show that we are already in a depression.
And Chris Tilly - director of the Institute for Research on Labor and Employment at UCLA - points out that some populations, such as African-Americans and high school dropouts, have been hit much harder than other populations, and that these groups are already experiencing depression-level unemployment.
Assuming that Williams, Roberts or Lockhart’s calculations of unemployment are correct (using the same methods of measuring unemployment as were used during the Great Depression), and depending on when we deem the current crisis to have commenced, then - as shown by the following charts - unemployment percentages may actually be worse than they were during a comparable period in the Great Depression:
We also know that, in terms of total numbers of unemployment people (as opposed to percentages), more people will be unemployed than during the Great Depression. 
What Are the Unemployment Trends?
If unemployment is anywhere near as bad as during a comparable period during the Great Depression, the obvious question is where the trends are heading.
It is well known among economists that unemployment is a “lagging” indicator.  In other words, there is a lag time. When the economy hits a rough patch, the economic weakness will not show up in the unemployment numbers until several months or years later.
For example, as Europe’s largest bank - RBS - warns:
Even if the economy starts to turn up the headwinds will be formidable," [the company's CEO] warned. "The green shoots are short in duration and you need to be cautious about interpreting them. Even if growth returns, unemployment will rise for some time afterwards …
Because of the lag time between conditions in the economy and unemployment, we have to ask the following two questions in order to forecast future unemployment trends:
1) How bad were conditions in 2008 and early 2009?
2) What will economic conditions be like in the future?
How Bad Did It Get?
Unfortunately, many experts - including the following people - have said that the economic crisis which started in 2008 could be worse than the Great Depression:
- Federal Reserve chairman Ben Bernanke said on July 26, 2009:
A lot of things happened, a lot came together, [and] created probably the worst financial crisis, certainly since the Great Depression and possibly even including the Great Depression. 
- Economics professors Barry Eichengreen and and Kevin H. O’Rourke said that world-wide conditions are worse than during a comparable period during the Great Depression  (updated in June 2009 )
- Investment advisor, risk expert and bestselling author Nassim Nicholas Taleb said that the current crisis could be “vastly worse” than the Great Depression 
- Former Fed Chairman Paul Volcker believes the current crisis may be even worse than the Depression 
- Nobel prize winning economist Joseph Stiglitz said “this is worse than the Great Depression” 
- Economics scholar and former Federal Reserve Governor Frederick Mishkin said that conditions were worse than during the Depression 
- Well-known PhD economist PhD Economist Marc Faber believes this could be far worse than the Great Depression
- Former Goldman Sachs chairman John Whitehead thinks that the current slump is worse than the Depression 
- Morgan Stanley’s UK equity strategist Graham Secker predicts economic collapse worse than the Great Depression 
- Former chief credit officer at Fannie Mae Edward J. Pinto said in January 2009 that the current housing crisis was worse than the Depression, and that current efforts to rescue the mortgage industry are less successful than those used during the 1930s. 
- Billionaire investor George Soros said in February 2009 that the current economic turbulence is actually more severe than during the Great Depression, comparing the current situation to the demise of the Soviet Union. 
What Will Economic Conditions Be Like In the Future?
As of this writing, the fact that unemployment will substantially increase is quite controversial. Most people still assume that the benefits of the government’s policies will soon kick in, the economy will recover, and then jobs will recover soon afterwards.
In order to accurately determine how bad general economic conditions - and thus unemployment - might be in the future, it is necessary to look at a variety of trends, including residential real estate, commercial real estate, toxic assets held by banks, loan loss rates, consumer spending, age demographics, the decline in manufacturing, and destruction of credit.
Residential Real Estate
Citigroup is projecting that unemployment in Spain will rise from its current 17.9% to 22% next year. 
Spain’s unemployment is largely driven by the bursting of its housing bubble. 
(And unemployment in Japan is apparently at the highest level since the government began collecting the data in 1953, a year after the U.S. military occupation ended.)
Unfortunately, while the peak in subprime mortgages is behind us, many analysts say that Alt-A mortgage defaults have not yet occurred (as of this writing), but will not peak until 2010.
Indeed, the crash in real estate and rising unemployment together form a negative feedback loop. As McClatchy notes, foreclosures rise as jobs and income drop. 
Former chief IMF economist Simon Johnson notes that a vicious cycle also exists between unemployment and property foreclosures:
Unemployment is always a lagging indicator, and given the record low number of average hours worked, it will turn around especially slowly this time. Until then, people will continue to lose their jobs and wages will remain flat, and any small rebound in housing prices is unlikely to help more than a few people refinance their way out of unaffordable mortgages. So unless the other part of the equation – monthly payments – changes, the number of foreclosures should just continue to rise.
Indeed, the Washington Post notes:
The country’s growing unemployment is overtaking subprime mortgages as the main driver of foreclosures, according to bankers and economists, threatening to send even higher the number of borrowers who will lose their homes and making the foreclosure crisis far more complicated to unwind. 
Commercial Real Estate
Moreover, a crash in commercial real estate is now picking up speed. Unlike the subprime mortgage meltdown - which affected mainly the biggest banks - the commercial meltdown will apparently affect a huge number of small to medium-sized banks. 
On August 11, 2009, the Congressional Oversight Panel on the bailouts issued a report saying that small and medium sized banks are especially vulnerable, the report will say, in part they hold greater numbers of commercial real estate loans, “which pose a potential threat of high defaults.” 
That could spell real trouble for employment by small businesses since (1) smaller institutions are disproportionately responsible for providing credit to small businesses , (2) credit is essential for many small businesses, (3) commercial real estate is crashing even faster than residential , and (4) industry experts forecast that the commercial real estate market won’t bottom out for three more years.
Indeed, largely because of the commercial real estate crash, the FDIC expects 500 banks to fail in the coming months. 
Unfortunately, the crash in commercial real estate is occurring world-wide. 
The Congressional Oversight Panel report also says that banks remain threatened by billions of dollars of bad loans on their balance sheets, more could fail if the economy worsens, and that - if unemployment rises sharply or the commercial real estate market collapses – the banking system could again crash:
The financial system [still remains] vulnerable to the crisis conditions that [the bailout] was meant to fix…
Financial stability remains at risk if the underlying problem of toxic assets remains unresolved.
As Reuters notes:
The chairman of the congressional oversight panel, Elizabeth Warren, said no one even knows the value of the toxic assets still on banks’ books…”No one has a good handle how much is out there,” Warren said. “Here we are 10 months into this crisis…and we can’t tell you what the dollar value is.”
Loan Loss Rates
Loan loss rates in could also be worse than the Great Depression, at least in the United States. Specifically, during the depths of the Great Depression, the loss rate which banks suffered on their loans climbed as high as 3.4% (it is normally well under 2.0%).
Last month, banking analyst Mike Mayo predicted that loan loss rates could go as high as 5.5%, which is substantially higher than during the 1930s.
But the Federal Reserve’s more adverse scenario for the stress tests - which everyone knows is too rosy concerning most of its assumptions - predicts a loan loss rate of 9.1%, nearly three times higher than during the 1930s.
As US News and World Report wrote in May 2009:
For most of the past 50 years, the loss rate on all bank loans has stayed well under 2 percent. The Fed estimates that over the next two years the loss rate could reach 9.1 percent. You know all those historical comparisons that end with “the worst since the Great Depression”? Well, 9.1 percent would be EVEN WORSE than during the 1930s. Still looking forward to a soft landing or a quick recovery?
Consumer spending accounts for the vast majority of the economy in the United States. The figure commonly cited is that consumer spending accounts for 70% of U.S. Gross Domestic Product. . (Consumer spending has been a lower percentage of GDP in most other countries. )
But the economic crisis is driving consumer spending downward. Economist David Rosenberg  says that consumers have undergone a generational shift in spending habits, and will be frugal for a long time to come.
The head of Collective Brands, Matthew Rubel, states:
Consumer spending as a percentage of GDP has moved down, will probably continue to move down through the end of year, and then normalize as we get into somewhere in early-to-mid next year, from our point of view.
The chief economist of IHS Global Insight, Nariman Behravesh, says consumer spending will decline to 65 percent of GDP:
With individuals more focused on saving than spending, Behravesh said retail consumer spending as a percentage of GDP is likely to fall from 70 percent to 65 percent. "It will take a while, maybe 10 years," he said. "Correspondingly other countries are going to have to shift in the opposite direction to rely more on their own consumers rather than the U.S. consumers."
Jason DeSena Trennert, Chief Investment Strategist for Strategas Research Partners, says:
Consumer spending as a percentage of GDP is going to go in one direction for a long time — lower.
Time points out :
Economist Stephen Roach, chairman of Morgan Stanley Asia, says that “there is good reason to believe the capitulation of the American consumer has only just begun.” U.S. consumer spending as a percentage of GDP reached 72% in 2007, well above the pre-bubble norm of 67%. Using that as a gauge, Roach says that only 20% of the potential retrenchment of spending has taken place, even after the dramatic decline at the end of 2008. “The imbalance that contributed to the crisis — overconsumption and excessive savings — cannot continue,” says Ajay Chhibber, director of the Asia bureau at the United Nations Development Program in New York City. “The model where you stimulate and [then] go back to the old days is gone.”
The Wall Street Journal notes:
“Economists also see an upturn in U.S. household saving as the beginning of a prolonged period of thrift…..”
Financial analysts who have studied U.S. demographics - like Harry Dent and Claus Vogt - point out that the U.S. population is aging:
United States Population Pyramid for 2010Predicted age and sex distribution for the year 2010:
United States Population Pyramid for 2020Predicted age and sex distribution for the year 2020:
United States Population Pyramid for 2050Predicted age and sex distribution for the year 2050:
Vogt argues that an aging population within a given nation is correlated with a decline in that country’s economy. . Certainly, a population with less working-age people and more dependent elderly people will experience a drag on its economy.
Dent argues that one of the main drivers of a country’s economic growth is the number of people in the country who are in their peak spending years.
For example, Dent says that in the U.S., 45-54 year olds are the biggest spenders, because that is when - on average - they are paying for their kids’ college, paying mortgage on the biggest house they will own during their life, etc. Dent argues that the American economy will tend to grow when the number of 45-54 year olds grows, and to shrink when it shrinks.
As the charts above show, the number of 45-54 year olds in the U.S. will shrink considerably in the year ahead.
Decline in Manufacturing
As everyone knows, the manufacturing has shrunk in the United States and the service sector has grown. Even in a manufacturing center such as Detroit, manufacturing jobs have been declining for decades:
Indeed, according to professor of economics Dr. Mark J. Perry, manufacturing jobs have dropped to their lowest level since 1941, and are now below 9% of the workforce for the first time. 
Wayne State University’s Center for Urban Studies argues:
For each job lost in the manufacturing industry, more spinoff jobs are lost than would be in other sectors. Each manufacturing job helps support a larger number of other jobs than do most other sectors. 
That means that the ongoing reduction in manufacturing jobs will adversely affect unemployment for the foreseeable future.
Destruction of Credit
The amount of credit outstanding has been reduced by trillions of dollars in the past year.
For example, the amount of consumer credit outstanding has plummeted:
Banks have become tight-fisted about lending, and this will probably not change any time soon. As the New York Times wrote in an article from October 2008 entitled “Banks Are Likely to Hold Tight to Bailout Money”:
“Will lenders deploy their new-found capital quickly, as the Treasury hopes, and unlock the flow of credit through the economy? Or will they hoard the money to protect themselves?
John A. Thain, the chief executive of Merrill Lynch, said on Thursday that banks were unlikely to act swiftly. Executives at other banks privately expressed a similar view.
‘We will have the opportunity to redeploy that,’ Mr. Thain said of the new capital on a telephone call with analysts. ‘But at least for the next quarter, it’s just going to be a cushion.’
Lenders have been pulling back on credit lines for businesses, mortgages, home equity loans and credit card offers, and analysts said that trend was unlikely to be reversed by the government’s money.
Roger Freeman, an analyst at Barclays Capital, which acquired parts of the now-bankrupt Lehman Brothers last month [said] ‘My expectation is it’s quarters off, not months off, before you see that capital being put to work.’ "
And another New York Times article included the following quote:
"It doesn’t matter how much Hank Paulson gives us," said an influential senior official at a big bank that received money from the government, "no one is going to lend a nickel until the economy turns." The official added: "Who are we going to lend money to?" before repeating an old saw about banking: "Only people who don’t need it."
Reading between the lines, the bank officials are saying that they will not lend freely until the economic crisis is over.
As WLMLab Bank Loan Performance points out, outstanding loans in the United States have dropped $110 billion dollars quarter-over-quarter. 
Over the course of 2008, the nation’s five largest banks reduced their consumer loans by 79 percent, real estate loans by 66 percent and commercial loans by 19 percent, according to FDIC data. A wide range of credit measures, including recent FDIC data, show that lending remains depressed.
Indeed, total seasonally adjusted consumer debt fell $21.55 billion, or at a 10.4% annual rate, in July 2009 alone. credit-card debt fell $6.11 billion, or 8.5%, to $905.58 billion. This is the record 11th straight monthly drop in credit card debt. Non-revolving credit, such as auto loans, personal loans and student loans fell a record $15.44 billion or 11.7% to $1.57 trillion 
In addition, the securitization market has largely collapsed, which in turn has destroyed a large proportion of the world’s credit. As noted in an article in the Washington Times:
"Before last fall’s financial crisis, banks provided only $8 trillion of the roughly $25 trillion in loans outstanding in the United States, while traditional bond markets provided another $7 trillion, according to the Federal Reserve. The largest share of the borrowed funds - $10 trillion - came from securitized loan markets that barely existed two decades ago. . . .
Mr. Regalia [chief economist at the U.S. Chamber of Commerce] said … 70 percent of the system isn’t there anymore,’ he said."
The reason that seventy percent of the system “isn’t there anymore” is because the traditional bond markets and securitized loan markets (part of the “shadow banking system”) have dried up. As the Washington Times article notes:
"Congress’ demand that banks fill in for collapsed securities markets poses a dilemma for the banks, not only because most do not have the capacity to ramp up to such large-scale lending quickly. The securitized loan markets provided an essential part of the machinery that enabled banks to lend in the first place. By selling most of their portfolios of mortgages, business and consumer loans to investors, banks in the past freed up money to make new loans. . . .
"The market for pooled subprime loans, known as collateralized debt obligations (CDOs), collapsed at the end of 2007 and, by most accounts, will never come back. Because of the surging defaults on subprime and other exotic mortgages, investors have shied away from buying the loans, forcing banks and Wall Street firms to hold them on their books and take the losses."
Senior economic adviser for UBS Investment Bank, George Magnus, confirms:
The restoration of normal credit creation should not be expected, until the economy has adjusted to the disappearance of shadow bank credit, and until banks have created the capacity to resume lending to creditworthy borrowers. This is still about capital adequacy, where better signs of organic capital creation are welcome. More importantly now though, it is about poor asset quality, especially as defaults and loan losses rise into 2010 from already elevated levels.
And McClatchy writes:
The foundation of U.S. credit expansion for the past 20 years is in ruin. Since the 1980s, banks haven’t kept loans on their balance sheets; instead, they sold them into a secondary market, where they were pooled for sale to investors as securities. The process, called securitization, fueled a rapid expansion of credit to consumers and businesses. By passing their loans on to investors, banks were freed to lend more.
Today, securitization is all but dead. Investors have little appetite for risky securities. Few buyers want a security based on pools of mortgages, car loans, student loans and the like.
“The basis of revival of the system along the line of what previously existed doesn’t exist. The foundation that was supposed to be there for the revival (of the economy) . . . got washed away,” [economist James K.] Galbraith said.
Unless and until securitization rebounds, it will be hard for banks to resume robust lending because they’re stuck with loans on their books.
Not only has the supply of credit been destroyed, but the demand for many types of loans - such as commercial real estate loans - is also drying up.
So there is simply much less credit flowing through the economic system than there was prior to 2007.
The New Normal - Lower Economic Activity
As chief economist for the International Monetary Fund, Olivier Blanchard, said:
This recession has been so destructive that “we may not go back to the old growth path … potential output may be lower than it was before the crisis.” 
All of the above trends force many economists to conclude that economic activity as a whole will be lower for many, many years. In other words, they say that “The New Normal” will be a much lower level for the economy.
Pimco CEO Mohamed El-Erian says elevated unemployment and record wealth destruction will keep growth at 2 percent or less for years. 
As Bloomberg writes:
The New Normal theory predicts that the recession will leave unemployment, forecast to reach 10 percent for the first time since 1983 early next year, higher for years. 
Indeed, the “overhang” of inventory - that is, the inventory of unsold goods - in everything from housing [91 and 92] to cars  to consumer electronics  means that the newly reduced consumer demand is meeting up with very high levels of supply. This is a recipe for unemployment.
Many economists also point out that the length of time people are remaining unemployed is skyrocketing. As the Washington Post notes:
Another disturbing development was that the number of people out of work for 27 weeks or longer reached a record 5 million, accounting for a third of the unemployed. That suggests to some economists that those job losses were caused by structural changes in the economy and that many of those people won’t be called back to work once the economy picks up. The longer people are out of work, the harder it becomes for them to find jobs and the more likely they are to exhaust savings or lose their homes to foreclosure. 
The following chart from the St. Louis Federal Reserve Bank shows that people are staying unemployed much longer than they have in any previous economic downturn since 1950:
As David Rosenberg writes:
The number of people not on temporary layoff surged 220,000 in August and the level continues to reach new highs, now at 8.1 million. This accounts for 53.9% of the unemployed — again a record high — and this is a proxy for permanent job loss, in other words, these jobs are not coming back. Against that backdrop, the number of people who have been looking for a job for at least six months with no success rose a further half-percent in August, to stand at 5 million — the long-term unemployed now represent a record 33% of the total pool of joblessness. 
[98: for graphical updates on the state of the economy, see charts from the Cleveland Federal Reserve Bank posted at http://www.clevelandfed.org/research/data/updates/index.cfm?DCS.nav=Local]
Another Trend: Increased Productivity Means Less Jobs
All of the aforementioned economic trends point to lower levels of job creation, and thus higher unemployment.
In addition, the chief economist for MarketWatch, Distinguished Scholar of Economics at Dowling College (Irwin Kellner) points out that worker productivity is rising, and that increased worker productivity means less new people will be hired. 
Other Theories Regarding the Causes of Unemployment
The main cause of unemployment today is the economic crisis. For example, a report from the the National Industrial Conference Board pointed out in 1922 stated the obvious: depressions increase unemployment. 
The report also points out that seasonal variations, “immigration and tariff policies and international relationship” can affect unemployment figures. 
In fact, economists from different schools of thought ascribe different causes to unemployment. For example:
Keynesian economics emphasizes unemployment resulting from insufficient effective demand for goods and services in the economy (cyclical unemployment). Others point to structural problems, inefficiencies, inherent in labour markets (structural unemployment). Classical or neoclassical economics tends to reject these explanations, and focuses more on rigidities imposed on the labor market from the outside, such as minimum wage laws, taxes, and other regulations that may discourage the hiring of workers (classical unemployment). Yet others see unemployment as largely due to voluntary choices by the unemployed (frictional unemployment). Alternatively, some blame unemployment on disruptive technologies or Globalisation.
For example, many Americans believe that globalization has increased unemployment because “American jobs” have moved abroad. Certainly, the American government has encouraged multinational corporations based in the U.S. to move jobs overseas. But quick fixes may lead to new problems. For example, a new American protectionism could stifle trade, further weakening the American economy.
Similarly, some economists believe that inflation decreases unemployment. However, that is only true where the workers drastically underestimate the extent to which higher prices are decreasing the real value of their wages. Indeed, as the Cato Institute notes:
This reduction in unemployment cannot occur unless workers systematically underestimate the inflation rate. When workers are aware of the inflation rate and, for example, have their pay adjusted according to the cost of living, they will interpret wages properly and not be misled into thinking that a normal wage offer is a relatively high wage offer.
Rather than merely failing to decrease unemployment, inflation may actually increase the unemployment rate. Frequent concomitants of inflation, such as high interest rates and volatility and uncertainty in the financial and product markets, increase the risks inherent in business operations and thereby discourage the expansion of firms and the creation of jobs. 
Therefore, many “quick fixes” for unemployment may actually do more harm than good.
Isn’t the Government Helping to Reduce Unemployment?
The government has committed to give trillions to the financial industry. President Obama’s stimulus bill was $787 billion, which is less than a tenth of the money pledged to the banks and the financial system. 
Of the $787 billion, little more than perhaps 10% has been spent as of this writing. 
The Government Accountability Office says that the $787 billion stimulus package is not being used for stimulus.  Instead, the states are in such dire financial straights that the stimulus money is instead being used to “cushion” state budgets, prevent teacher layoffs, make more Medicaid payments and head off other fiscal problems. So even the money which is actually earmarked to help the states stimulate their economies is not being used for that purpose.
Mark Zandi - chief economist for Moody’s - has calculated which stimulus programs give the most bang for the buck in terms of the economy:
But very little of the stimulus funds are actually going to high-value stimulus projects.
Indeed, as the Los Angeles Times points out:
Critics say the [stimulus money reaching California] is being used for projects that would have been built anyway, instead of on ways to change how Californians live. Case in point: Army latrines, not high-speed rail.
Critics say those aren’t the types of projects with lasting effects on the economy.
“Whether it’s talking about building a new [military] hospital or bachelor’s quarters, there isn’t that return on investment that you’d find on something that increases efficiency like a road or transit project,” said Ellis of Taxpayers for Common Sense.
Job creation is another question. A recent survey by the Associated General Contractors of America found that slightly more than one-third of the companies awarded stimulus projects planned to hire new employees. But about one-third of the companies that weren’t awarded stimulus projects also planned to hire new employees.
“While the construction portion of the stimulus is having an impact, it is far from delivering its full promise and potential,” said Stephen E. Sandherr, chief executive of the contractors group.
It’s unclear how many jobs will be created through the Defense Department projects. Most of the construction jobs are awarded through multiple award contracts, in which the department guarantees a minimum amount of business to certain contractors, and lets only those contractors bid on projects.
That means many of the contractors working on stimulus projects already have been busy at work on government projects.even the stimulus money which is being spent 
David Rosenberg writes:
Our advice to the Obama team would be to create and nurture a fiscal backdrop that tackles this jobs crisis with some permanent solutions rather than recurring populist short-term fiscal goodies that are only inducing households to add to their burdensome debt loads with no long-term multiplier impacts. The problem is not that we have an insufficient number of vehicles on the road or homes on the market; the problem is that we have insufficient labour demand.
Donald W. Riegle Jr. - former chair of the Senate Banking Committee from 1989 to 1994 - wrote (along with the former CEO of AT&T Broadband and the international president of the United Steelworkers union):
It’s almost as if the administration is opting for a rose-colored-glasses PR strategy rather than taking a hard-nose look at actual consumer and employment figures and their trends, and modifying its economic policies accordingly.
How Much Unemployment Do We Want?
On the one end of the spectrum, Article 23 of the United Nations’ Universal Declaration of Human Rights declares:
Everyone has the right to work, to free choice of employment, to just and favourable conditions of work and to protection against unemployment.
In other words, the U.N. says that there should be essentially no unemployment for those who wish to work.
On the other end of the spectrum, some people - who make a lot of money during periods where the condition lead to high levels of unemployment - are comfortable with unemployment percentages reaching those in the Great Depression.
Societies should decide for themselves what level of unemployment they consider acceptable, and then demand policies which will accomplish that goal to the greatest extent possible. As discussed above, there are many factors which affect employment levels, and so solutions are complicated.
However, without an open and visible public policy debate about the issue, unemployment levels will either remain second order affects of policy choices concerning other elements of the economy, or will be decided behind closed doors by decision-makers who may or may not have the best public interest in mind.
As the above facts show, unemployment is a very serious problem in the United states, and world-wide. The policy responses of the U.S. and other Western governments has not been working. As discussed above, there is no simple solution.
Senator Riegle recommends a 4-part prescription, including:
Ensure that loans and credit facilities are readily available to the nation’s small and medium size businesses and manufacturers.
Many of the top economists argue that we need to break up the giant banks which are insolvent in order to save the economy. Fortune, BusinessWeek and Federal Reserve governor Daniel K. Tarullo have pointed out that breaking up the largest, insolvent banks would allow more competition from small to mid-size banks, and that such banks may actually make more loans to small businesses. More loans to small businesses would lead to more employment by those many small businesses.
In addition, the U.S. has largely been financing job creation for ten years. Specifically, as the chief economist for BusinessWeek, Michael Mandel, points out, public spending has accounted for virtually all new job creation in the past 1o years:
Private sector job growth was almost non-existent over the past ten years. Take a look at this horrifying chart:
Between May 1999 and May 2009, employment in the private sector sector only rose by 1.1%, by far the lowest 10-year increase in the post-depression period.
It’s impossible to overstate how bad this is. Basically speaking, the private sector job machine has almost completely stalled over the past ten years. Take a look at this chart:
Over the past 10 years, the private sector has generated roughly 1.1 million additional jobs, or about 100K per year. The public sector created about 2.4 million jobs.
But even that gives the private sector too much credit. Remember that the private sector includes health care, social assistance, and education, all areas which receive a lot of government support.***
Most of the industries which had positive job growth over the past ten years were in the HealthEdGov sector. In fact, financial job growth was nearly nonexistent once we take out the health insurers.
Let me finish with a final chart.
Without a decade of growing government support from rising health and education spending and soaring budget deficits, the labor market would have been flat on its back. 
Raw Story argues that the U.S. is building a largely military economy:
The use of the military-industrial complex as a quick, if dubious, way of jump-starting the economy is nothing new, but what is amazing is the divergence between the military economy and the civilian economy, as shown by this New York Times chart.
In the past nine years, non-industrial production in the US has declined by some 19 percent. It took about four years for manufacturing to return to levels seen before the 2001 recession — and all those gains were wiped out in the current recession.
By contrast, military manufacturing is now 123 percent greater than it was in 2000 — it has more than doubled while the rest of the manufacturing sector has been shrinking…
It’s important to note the trajectory — the military economy is nearly three times as large, proportionally to the rest of the economy, as it was at the beginning of the Bush administration. And it is the only manufacturing sector showing any growth. Extrapolate that trend, and what do you get?
The change in leadership in Washington does not appear to be abating that trend…
So most of the job creation has been by the public sector. But because the job creation has been financed with loans from China and private banks, trillions in unnecessary interest charges have been incurred by the U.S.
Former Washington Post editor and author of one of the leading books on the Federal Reserve, William Greider, points out that governments actually have the power to create money and credit themselves, instead of borrowing it at interest from private banks:
If Congress chooses to take charge of its constitutional duty, it could similarly use greenback currency created by the Federal Reserve as a legitimate channel for financing important public projects–like sorely needed improvements to the nation’s infrastructure. Obviously, this has to be done carefully and responsibly, limited to normal expansion of the money supply and used only for projects that truly benefit the entire nation (lest it lead to inflation)…
This approach speaks to the contradiction House Speaker Pelosi pointed out when she asked why the Fed has limitless money to spend however it sees fit. Instead of borrowing the money to pay for the new rail system, the government financing would draw on the public’s money-creation process–just as Lincoln did and Bernanke is now doing.
By creating the credit itself - instead of borrowing from private banks and foreign nations - the American government could finance the creation of new jobs without incurring huge interest charges owed to the private banks and foreign countries which lent America the money. In other words, the U.S. government would itself create the new credit, just as Lincoln did to finance the civil war.
By financing new projects with credit created by the government itself, America might be able to pick itself up by its bootstraps and put its people back to work.
The same may be true for other countries as well.