Ilargi: There is an interesting discussion about something Chris Martenson wrote a few days ago, on which I have commented, and so has Mike Shedlock, and, somewhat indirectly, Stoneleigh as well. I saw the text below, which I’m about to show you, at the comment section on Martenson's website, and thought it is a wonderful example of how Stoneleigh's writings are more valid than just about anyone's, and yes, that includes Chris Martenson. And there’s more: when I mailed Stoneleigh saying I’d use her words you find below, she was at the same moment listening to Chris Martenson deliver his speech as ASPO. Coincidence trumps all.
Which leads me beautifully into where Chris Martenson is dramatically wrong, and Stoneleigh is not.
A commenter on Martenson's site compiled the following sequence of Stoneleigh observations, which are not direct comments on Martenson's piece, but do put him into his place. Chris wrote a piece called The Sound of One Hand Clapping: What Deflationists May Be Missing , in which he suggests that central banks and governments could play games forever, as long as no-one calls their dare. Chris seems to think they can, and then moves into inflation as a likely option to come out of that..
My initial reaction was that Martenson is better at gathering data than at drawing conclusions from them. And that stands. Then Mike Mish Shedlock tackled the one hand issue (see below), and concluded: "Pretending that defaulted debts do not exist is itself the "Sound of one hand clapping". Which is what I said: assuming that a central bank and Treasury, of any country, can keep losses hidden forever, means not understanding the dynamics at play.
Here's the commenter, his/her name is FunkySpec, not with a direct reaction to the One Hand Clapping piece, but still as dead on as they come.
FunkySpec: And Ilargi over at TAE has also chimed in basically agreeing with Mish and Nate's critique, that the banks and the government cannot keep bad assets on their books with no ill effects for much longer.
Also, here is something from Stoneleigh posted in the TAE comments a couple of weeks ago. She concurs with Chris' point on the necessity for confidence, but she describes it in terms of the impending end of the stock market rally and the limits of the Fed:
The Fed is not omnipotent, especially in comparison to the weight of the collective that will be ranged against it once the market turns. If it were possible to print one's way out of trouble then we would never have seen periods of deflation historically. No one can print confidence. All they can do is to play confidence games temporarily - promising to stand behind everything, knowing perfectly well that it's a promise they could not keep. They hope that by making it, they will not have to keep it, but the market is very good at calling desperate bluffs like that.
The market will turn when confidence does, and I believe that will be soon. As I have said before, this will not lead to an imminent bond market dislocation. First I would expect a flight to safety and record low nominal interest rates. IMO a bond market dislocation, where rates shoot up into the double digits, is perhaps a year away, at an initial guess. When it happens it will be because everyone will be trying to borrow (this being a global crisis) and few of the very small number of parties still able to lend will wish to do so, due to tremendous (and entirely understandable) risk aversion.
The global economy is not a machine that can be directed with appropriate levers. It is a messy, subjective and thoroughly irrational human construct. Crowd psychology is the most important element to understand in predicting what it will do next.
IMO we will see the Fed revealed as essentially powerless (as the little man behind the curtain) as the next leg of this crisis unfolds. It was never a public service duty bound to trash its own balance sheet for the supposed wider benefit, although it has done so to some extent. IT has limits, and we are going to see them soon enough.
As mentioned above, TAE are predicting an imminent end to the stock market rally, followed by a "flight to safety." Stoneleigh again:
As stocks fall, we should see the US dollar rise, the Canadian dollar and the Euro fall, gold and silver fall, and oil fall. We should see nominal interest rates fall to record lows (perhaps even moderately negative nominal rates), although the on-going collapse of credit will mean high interest rates in real terms, so that the central bankers will still be 'pushing on a string'. As bond yields fall, prices should rise.
A bond market dislocation (where interest rates spike up and government spending is slashed to the bone) comes further down the line.
As to the limits placed on the Fed in regards to printing, Stoneleigh again:
The bond market will prevent printing. Debt junkie economies are dependent on access to international debt financing, and that will not be available to nations that print. There will be far more nations trying to borrow than willing to lend, and that is a recipe for much higher rates (once the initial panic, flight to safety and record low rates are over).
All the Fed is doing is adding to the huge number of excess claims created by the credit hyper-expansion. The underlying real wealth pie is still the same size, but more and more mutually exclusive claims are being produced, and these surplus claims are destined to be extinguished en masse in a deflationary collapse.
The Fed is granting these additional excess claims to the very people who were instrumental in causing the problem in the first place, and who are in the best position to know that claims to real wealth will only be worth anything if they are cashed in before the herd tries to cash in. Essentially, the claims of the public are being actively subverted to an even greater extent, as by the time they try to cash out there will be nothing left. The little guy never gets an even break.
TAE agree with Chris that we are heading for a bond market dislocation and funding crisis.
We will eventually see a default. It is simply inevitable. You just can't keep kicking the can down the road indefinitely. However, just because a default is inevitable does not mean it is imminent. A flight to safety is a knee-jerk reaction to threat. It is not a rational response and does not look at the reality of the dollar's position. A rush to the dollar is something people will do on an emotional imperative, and it will push up the value of the dollar substantially. Betting on a dollar carry trade is therefore a sucker play - evidence of an imminent dollar bottom in fact.
The dollar should first rise and then collapse in value. I would expect the rising phase to last perhaps a year. When the collapse happens it will probably coincide with the coming bond market dislocation. However, the value of the dollar relative to other currencies will be much less important in practice than the value of cash in relation to available goods and services domestically.
And finally, one more point regarding the negative emotions we'll have to deal with on this next leg down and on our need to focus:
The anger and recrimination that are coming this time will be something almost none of us have any experience with, and it will be terribly easy to be caught up in it. Don't do it, as that kind of vengeful and punitive mindset will drain energy and resources from what you need to do to help yourself and your loved ones. Ultimately it fractures the trust that holds society together at a time when cohesiveness matters most. While this is inevitable at a national scale, it need not be at a very local level where a few individuals can make a difference.
I find the advice given by both Chris and TAE to be remarkably similar. Whether there is a chance for imminent collapse of the dollar / hyperinflation as Chris contends, or whether we must first pass through a period of continuing deflation as TAE contends, both advise similar steps of holding no debt, not trusting the banking system, and building connections to your loved ones and community, among others. TAE also advises to hold cash in hand or cash equivalents (short term US Treasuries for US citizens) during the deflationary period, but to be ready to convert to hard, physical assets prior to the onset of hyperinflation.
Their How to Build a Lifeboat piece contains much of their advice and reasoning and echoes much of what Chris says.
Ilargi: I’m far less optimistic on the similarities between Chris and TAE than FunkySpec, I don’t see much common ground in one party predicting inflation and the other deflation, or one claiming Bernanke is God and the other that he's a bearded crook, but we'l deal with that later, shall we............
Ilargi: On a bit of a side note, you may have seen our new Fall Fund Drive as it appears these days in the left hand column. We are not very comfortable at all asking you for money, but at the same time we realize, and we think you should too, that without your donations there can and will be no Automatic Earth. Clicking the ads our pages display, on a regular basis, helps as well. I have always been, and remain, confident that you, our readers, have a pretty good understanding of the value The Automatic Earth represents to you. Still, evidently, you may have to be reminded from time to time of the role you yourself play in the continued existence of this site.
We're not talking about, nor asking for, large amounts of money. There are many thousands of people who read us every single day. It's easy to see that if every single one of them would donate a dime for every time they read us, and what's a dime these days, we'd be doing just fine, thank you. It’s, however, not just about the continuation of the present situation here that I think about. I would love to be able to expand on what we do, to involve more people, more opinions, a more diverse view from more places in the world. And that is unfortunately not possible right now. Along the same lines, we would like for Stoneleigh to be much more involved at TAE. Which also is not in the cards right now.
As you probably know, Stoneleigh and I are convinced that all of us are moving into a crucial phase in the development of our financial systems, our economy and indeed our societies. Which of course means we are about to enter a time when The Automatic Earth, in order to do what we set out to do, will be busier than ever. What we've done so far was just a dress rehearsal compared to what lies ahead. Inevitably that will take more from us, and we hope you will do more as well.
As for those among you who have donated to us, and those who will do so in the days and weeks and months to come, please know we are deeply grateful for and humbled by the confidence you have shown in what we do on a daily basis. And rest assured, you can have confidence in us too: we ain't done by a long shot. What you've seen to date was merely the prologue.
The Biggest Bust Will Follow the Biggest Bubble
by Bill Bonner
Our ‘Crash Alert’ flag goes back up the pole…
October is almost half over. Will we get through the month without a major sell-off?
Dear reader, if you think we know the answer to that you’ve got us mixed up with someone else. Someone who is crazy.
No one with his wits about him thinks he knows what the stock market is going to do.
Still, here at The Daily Reckoning, we have our hunches. We think it’s time for a major pull back. Frankly, we’ll be disappointed if we don’t get one soon. Because, once again stocks are too expensive.
Too expensive for what? Too expensive for the circumstances.
The Dow rose another 20 points yesterday to a new bounce record. Oil rose to over $73. Gold didn’t budge.
Of course, everyone now knows that the recession is over. NABE interviewed 44 economic forecasters. Four-fifths of them said the recession was over.
But we don’t care what they said. These are the same seers who missed the biggest single event in financial history. There are many banking crises, recessions, panics and defaults in the record books. But none were as great as the one that hit September a year ago. Most economists didn’t see it coming; why should we trust them to tell us when it is going?
Besides they’ve got the whole thing wrong. It isn’t a recession; it’s a depression. There is no recovery from a depression; instead, the economy has to re-invent itself in another form. Things aren’t going ‘back to normal,’ in other words. Because the period leading up to the crisis was not ‘normal;’ it was a bubble. After a bubble explodes, you have a lot of debris to clean up. The bigger the bubble, the more damage it does when it blows up.
“The force of a correction is equal and opposite to the deception that preceded it.”
You’ve heard our dictum before. In fact, you’ve heard our explanations for all these points before.
We just lived through the biggest bubble in history. Get ready for the biggest bust. Not just two years of falling stock prices and news-making bailouts. Not just 10% unemployment. Not just 100 bank failures and 30% off housing prices.
Noooo… We’re talking about a worthy correction…a real correction…a noble and distinguished correction…a correction that can hold its head up in public.
This is a correction that will take many years…one that will knock housing prices down for at least five years…and stock prices down to the point where people no longer want to buy them. It’s a correction that goes deep enough and continues long enough to do its work – wiping out the bad investments and mistakes of the Bubble Era, while allowing the survivors to pay down their debts and build up their savings.
Now, here’s a confusing little item. Yesterday’s news tells us that consumer spending as a percentage of the entire economy has edged up to 71%. Now wait just one cotton-pickin’ minute. How could consumer spending be going up?
Hold on, cupcake. It’s not going up. It’s going down. It’s just that the other components of the economy are going down even more.
In the second quarter consumers spent $195 billion less than they did the year before – a 1.9% drop. In the 20 years before that, consumer spending increased at an average rate of 3.3%. So, you do the math… that’s an about-face of more than 5% of GDP – a loss to the economy of about $700 billion!
Consumer credit is going down (we reported the figures earlier in the week)…unemployment is going up…consumer spending is going down…
…those are not the circumstances in which stocks sell for 27 times earnings…and move higher. Those are the circumstances in which stocks crash.
“By some measures, the S&P 500 is already trading at valuation levels that would ordinarily be consistent with an economic expansion that is five-years old as opposed to a recovery that, at best, is in its infancy stages.
“On an operating (‘scrubbed’) basis, the trailing P/E multiple on the S&P 500 has expanded a massive 10 points from the March lows, to stand at 27.6x. Historically, when the economy is taking the turn away from contraction towards expansion, which indeed was the case in Q3, the trailing P/E multiple is 15x or half what it is… While we will not belabor the point, when all the write-downs are included, the trailing P/E on ‘reported’ earnings just widened to its highest levels in recorded history of nearly 140x, which is three times the levels prevailing during the height of the tech bubble.”
So, here goes…yes…today, we are officially running our “Crash Alert” flag up the pole here at the London headquarters of The Daily Reckoning. Cross Blackfriars Bridge and you might see if flapping in the wind, between the two huge gold balls on the roof.
Our Crash Alert flag is out because stocks have become too expensive…and because this bounce should be reaching its apogee by now. Already, central banks are talking about cutting back on their efforts to sustain the bounce with easy credit. Australia led the way last week with a rate hike.
It is also becoming clearer and clearer that the feds’ efforts aren’t really working. They can give money to their friends in the banking industry. They can give money to speculators who then make bets on the stock market, among other things. They can bailout major companies. But they can’t really get much money into the real economy.
Au contraire; they take money OUT of the real economy. The feds will absorb $700 billion of private savings this year alone…to finance their deficit. They expect $1 trillion deficits at least for another 10 years. That won’t leave much money for the private sector.
Naturally, Washington, DC, is doing well. While unemployment is near 10% in the rest of the nation, it’s only about 6% in the Washington area.
But let’s face it… What’s good for Washington is bad for the rest of the nation. The feds have used this correction to increase their power…and add to their wealth. The average federal employee now earns twice as much as his counterpart in the private sector – if the fellow in the private sector has a job at all.
A news item tells us that TARP recipients spent $114 million lobbying for their bailout money – most of it going into Washington, of course.
And the feds now own major stakes in what used to be the private sector – insurance, automobiles, and banking industries.
This has been a great period for government. Money, power…it is all floating down the Potomac like raw sewage…and coming to rest in the capitol city.
Our advice to the feds: enjoy it while you can. When stocks fall again…and people figure out what a mess you’ve made of the economy…you’ll be lucky if you aren’t tarred, feathered and run out of town on a rail.
Barack Obama has won the Nobel Peace Prize. Everyone is talking about it. They want to know what they put in the water in Stockholm. Why would the Nobel committee give the prize to someone who hadn’t really done much for world peace? Of course, the committee spokesmen had their lame answers. Now, they’re just hoping Obama doesn’t make fools of them.
It is as if the Pulitzer committee had given the prize to someone whose book had just one chapter; “We hope this will encourage him to finish it well,” says the committee.
But the Nobel committee might have done worse. Barack Obama is not the first American president to win the award. Woodrow Wilson got it before him. Obama seems ready to continue unnecessary wars. But at least he didn’t start them. Wilson sent American troops into the Europea in 1917. He transformed the European war into a World War and drew it out for another 2 years…at a cost of millions of lives, not to mention trillions in expenses.
Wilson was a fool and a humbug, no more deserving of the Nobel Peace Prize than Kaiser Wilhelm. As for Obama, we haven’t quite gotten his measure yet. Fool? Fraud? It’s still too early to say.
But if he had been smart, he would have followed the example of another US president – Millard Fillmore. Go to Washington. You will find no monuments to Fillmore. ’Tis a pity. Fillmore actually kept the peace. Not only that, he made improvements; he installed running water in the White House. Then, when Oxford University offered him an honorary degree, he turned it down. The degree was written in Latin. Fillmore said he didn’t want a degree he couldn’t understand.
Chris Mayer, currently in Dubai with Addison Wiggin, sends us this note:
“The real boom in Dubai really only kicked off recently. After spending some time here and chatting with those who live here, I would boil down the more important ingredients to these:
- Low regulations, low tax. This has probably been a Dubai advantage for a hundred years, but people here told us repeatedly how easy it is to set up shop in Dubai and how your privacy is protected. There are also no income, property or corporate taxes. Zero.
(The city funds itself with taxes on hotel occupancy, liquor sales and restaurant meals, as well as permits for roads and such. Part of the budget also comes from the Sheikh’s business interests – such as Emirates Airlines and the aluminum smelters.)
- The introduction of freeholds. In 2002, Dubai allowed foreigners to own property in so-called freeholds. That was a big milestone that kicked off a wave of immigration. So now there are these freeholds where the Penthouse Gypsies live in high style and in very nice communities.
- The backlash of 9/11. Before 9/11, Middle-Eastern exporting countries re-invested $25 billion a year in the US. After 9/11, that slowed to about $1.2 billion a year. Arabs no longer felt welcome and feared what might happen to their wealth. So guess where the money went?
Arab wealth started flowing back to their own countries. The economies of the eight states of the Gulf Coast grew 60% between 2001-08, compared to 18% for the US. ‘Cash poured into Dubai,’ Krane writes. And Dubai’s growth rate topped China’s, averaging 13% per year.
Essentially, the repatriation of Arab wealth in the US was a big driver and still continues to today. As the Middle East region gets wealthier, a good chunk of that wealth will flow through Dubai.
- Finally, the UAE fixes the value of its currency to the dollar – at least for now. What this means is that as the US printed dollars the effects were exported to Dubai, too. That is where Dubai got into trouble. Lots of speculative capital flowed to building islands in the shape of date palms or creating residential communities with robotic dinosaurs from Japan. Now Dubai is suffering through a massive real estate bust as a result.
“Still, Dubai’s important position in world trade is many layered, like a wedding cake.”
“What happened to global warming?” asks a headline at the BBC.
Folks in the Rockies are shivering. “Western Montana breaks records,” says a report. Missoula reported a low of 8 degrees yesterday…14 degrees lower than the previous record for this early in the season.
Nearby Idaho had heavy snow last week too. Same thing in New Zealand, where roads were blocked by heavy snow.
In New Zealand, two major North Island highways remain closed after unseasonal heavy snow days stranded motorists for two nights. “Even if this was the middle of winter this is extreme,” said an analyst.
And right now, it’s spring in NZ. They had a spring snowstorm that put their winter snowstorms to shame.
“Forget global warming,” says old friend Jim Davidson. “Get ready for another ice age.” Buy Brazil, he advises; the cold will drive down farm output in North America and Europe.
As the BBC reports, worldwide temperatures are not increasing; they’ve been falling for the last 10 years. No one knows why. Global warming enthusiasts say the trend is still towards higher temperatures. Their opponents say the world is actually beginning a major period of cooling – driven by solar activity, not by man-made carbon emissions.
Who’s right? We get out our mittens and wait to find out.
The rumours of the dollar’s death are much exaggerated
by Martin Wolf
It is the season of dollar panic. These panic-mongers are varied: gold bugs, fiscal hawks and many others agree that the dollar, the dominant currency since the first world war, is on its death bed. Hyperinflationary collapse is in store. Does this make sense? No. All the same, the dollar-based global monetary system is defective. It would be good to start building alternative arrangements.
We should start with what is not happening. In the recent panic, the children ran to their mother even though her mistakes did so much to cause the crisis. The dollar’s value rose. As confidence has returned, this has reversed. The dollar jumped 20 per cent between July 2008 and March of this year. Since then it has lost much of its gains. Thus, the dollar’s fall is a symptom of success, not of failure.
Can we find deeper signs that the world is abandoning the US currency? One beloved indicator is the price of gold, which has risen four-fold since the early 2000s (see chart). But its price is a dubious indicator of inflation risks: its previous peak was in January 1980, just before inflation was crushed. Higher prices of gold reflect fear, not fact. This fear is not widely shared. The US government can borrow at 4.2 per cent over 30 years and 3.4 per cent over 10 years. During the crisis, the inflation expectations implied by the gap in yields between conventional and inflation-protected securities collapsed. These have since recovered – yet another sign of policy success. But they are still below where they were before the crisis. The immediate danger, given excess capacity, in the US and the world, is deflation, not inflation.
The dollar’s correction is not just natural; it is helpful. It will lower the risk of deflation in the US and facilitate the correction of the global “imbalances” that helped cause the crisis. I agree with a forthcoming article by Fred Bergsten of the Peterson Institute for International Economics that “huge inflows of foreign capital to the US facilitated the over-leveraging and underpricing of risk”.* Even those who are sceptical of this agree that the US needs export-led growth.
Finally, what can replace the dollar? Unless and until China removes exchange controls and develops deep and liquid financial markets – probably a generation away – the euro is the dollar’s only serious competitor. At present, 65 per cent of the world’s reserves are in dollars and 25 per cent in euros. Yes, there could be some shift. But it is likely to be slow. The eurozone also has high fiscal deficits and debts. The dollar will exist 30 years from now; the euro’s fate is less certain.
This view may be too complacent. The danger of a collapse of the dollar is small and of its replacement by another currency still smaller. But a global monetary system that rests on the currency of a single country is problematic, for both issuer and users. The risks are also growing, particularly since the emergence of “Bretton Woods II” – the practice of managing exchange rates against the dollar.
In the 1960s, Robert Triffin, a Belgian-American economist, argued that a global monetary system based on the dollar had a flaw: the increased liquidity the world sought would require current account deficits in the US. But, sooner or later, the overhang of monetary liabilities would undermine confidence in the key currency. This view – known as the “Triffin dilemma” – proved prescient: the Bretton Woods system fell in 1971.
Strictly speaking, reserves could be created if the key-currency country merely borrowed short term and lent long term. But, in practice, the demand for reserves has generated current account deficits in the issuing country. In a floating exchange-rate regime reserve accumulations should also be unnecessary. But, after the financial crises of the 1990s, emerging countries decided they needed to pursue export-led growth and insure themselves against crises. As a direct result, three quarters of the world’s currency reserves have been accumulated just in this decade.
Yet this very search for stability risks creating long-run instability. Indeed, Chinese policymakers are worried about the risk to the value of their vast dollar holdings that, on Triffin’s logic, their own policy exacerbates. US policymakers may repeat the “strong dollar” mantra. But this is an aspiration without an instrument. Relevant policy is made by the Federal Reserve, which has no mandate to preserve the dollar’s external value. The only way China’s policymakers can preserve the domestic value of external holdings is to support the dollar without limit, which compromises China’s domestic monetary stability and will prove self-defeating in the end.
At this point, the widespread concerns about US monetary stability and the dollar’s external role converge. A standard recommendation on the former is to preserve both the independence of the Federal Reserve and ensure long-run fiscal solvency. If the fear grows that either – or, worse, both – is in danger, a self-fulfilling crisis might ensue. The dollar could tumble and long-term interest rates soar. In such a crisis, it might well be feared, a less-than-independent Federal Reserve would be compelled to buy public debt. That would accelerate flight from the dollar. The two key preconditions for long-run stability, then, are a credibly independent central bank and federal solvency, both of which seem to be within US control.
Yet this is too simple. Most analysts assume that the US fiscal position can be determined independently of decisions taken elsewhere. But if the US private sector were to deleverage over a long period (and so spend substantially less than its income), while the rest of the world wanted to accumulate dollar-denominated assets as reserves, the US government would naturally emerge as the borrower of last resort.
A corollary of the Triffin dilemma is that the international role of the dollar could make it hard for the US to manage its fiscal affairs successfully, even if it wanted to do so. I arrive, by a somewhat different route, at the same conclusion as Mr Bergsten: the global role of the dollar is not in the interests of the US. The case for moving to a different system is very strong. This is not because the dollar’s role is now endangered. It is rather because it impairs domestic and global stability. The time for alternatives is now.
One Hand Clapping Theory Analyzed
by Mish Shedlock
Numerous people have asked me to comment on Chris Martenson's article The Sound of One Hand Clapping - What Deflationists May Be Missing.
Chris Writes:The hot topic of the day is "Inflation or Deflation?" and the camps are firmly divided into groups of inflationistas and deflationistas. When asked which camp I am in, I reply "Yes." Some would say that puts me in the confusionista camp, but I actually have an explanation for why are living in a world encompassing both.Mish: So far so good. No one should argue with the idea that we are in the "one of the most powerfully deflationary periods in history". However, many do so anyway, typically based on faulty definitions of inflation and deflation.
From a technical perspective, we are absolutely in one of the most powerfully deflationary periods in history, yet, besides housing prices and a few over-produced consumer goods, we find that stocks, bonds, and commodities are all well-bid at the moment.
While we can ascribe some of this to the artificial wall of liquidity (come to think of it, is there any other kind?) currently being thrown into the financial market(s) by the Fed, it leaves hanging the question of why that money is not being completely swallowed into the bottomless black hole that the deflationist camp says lies at the heart of our current financial system.
And they are right; there is a black hole at the center. If we treat the credit doubling that occurred between 2000 and 2008 (from $26 to $52 trillion) as a normal bubble that will follow the same pattern of decline as numerous historical bubbles, then we might reasonably predict that some $26 trillion of debt will somehow "go away" over the next 6 years. This is indeed a massive black hole.
The pertinent question now is: does one judge a deflationary period by what stocks and corporate bonds are doing "at the moment"?
Let's take a look at things in an appropriate timeframe.
Please consider some excerpts from Creative DestructionTwo Lost DecadesThe chart shows that over the last two decades, Japan had four rallies of 50% or greater, yet two decades later the Nikkei is 75% off its peak.
The Japanese Stock Market is about 25% of what it was close to 20 years ago! Yes, I know, the US is not Japan, that deflation can't happen here, etc, etc. Of course deflation did happen here, so the question now is how long it lasts.
The five month, 50% rebound in the S&P 500 was certainly spectacular. However, the more important question is where to from here?
Take a look at Japan's "Two Lost Decades" for clues.
Creative destruction in conjunction with global wage arbitrage, changing demographics, downsizing boomers fearing retirement, changing social attitudes towards debt in every economic age group, and massive debt leverage is an extremely powerful set of forces.
Bear in mind, that set of forces will not play out over days, weeks, or months. A Schumpeterian Depression will take years, perhaps even decades to play out.
Is it impossible for that to happen here?
Chris:Yet everything just keeps perking along. What gives?Mish: Just because the market is ignoring something now, does not mean it will continue to do so forever.
The answer, I believe, requires us to ask a Zen-like question along the lines of, "What is the sound of one hand clapping?" That question is, "If nobody recognizes a defaulted debt on their balance sheet, does it exist?"
Suppose, for the sake of argument, that there is a world in which banks are allowed by their regulators to pretend their default losses simply do not exist. And, even more outlandishly, some of these banks are allowed to sell heavily damaged loans to their central bank at nearly their full original price.
What does "deflation" mean in such a world? Not much, as it turns out. At least from a monetary perspective, because money is not being destroyed at nearly the rate that would be expected or predicted by the size and rate of the defaults.
Furthermore, the pretending (or as Chris puts it "If nobody recognizes a defaulted debt on their balance sheet, does it exist?") started much sooner than just this March.
On March 29, 2008, I wrote SEC Openly Invites Corporations To Lie, a discussion of Securities and Exchange Commission letter on Fair Value Measurements that openly invited corporations to lie.
Not Practical To Tell The Truth
Inquiring minds are also considering Not Practical To Tell The Truth, written August 1, 2008.FASB Postpones Off-Balance-Sheet Rule for a YearCitigroup Weekly Chart
The Financial Accounting Standards Board postponed a measure, opposed by Citigroup Inc. and the securities industry, forcing banks to bring off-balance-sheet assets such as mortgages and credit-card receivables back onto their books.
FASB, the Norwalk, Connecticut-based panel that sets U.S. accounting standards, voted 5-0 today to delay the rule change until fiscal years starting after Nov. 15, 2009. The board needs to give financial institutions more time to prepare for the switch, FASB member Thomas Linsmeier said at a board meeting.
"We need to get a new standard into effect," Linsmeier said, though "it's not practical" to begin requiring companies to put assets underlying securitizations onto their books this year.
click on chart for sharper image
The SEC openly invited corporations to lie on March 31, 2008. On July 30, 2008, the FASB postponed mark-to-market rules until November 2009. They will most likely be postponed again.
Did those actions prevent Citigroup from crashing? Ambac? AIG? Fannie Mae? MBI? Anything?
Chris:Trillions in probable and provable losses quietly exist, out of sight, on the balance sheets of the Federal Reserve and other financial institutions. If they ever come out of hiding and onto the books, I think the deflationists will be proven correct beyond all doubt.If banks really believed their own mark-to-fantasy marks they would be lending. Instead, we see this.
But let me ask this: What prevents the authorities from simply storing them out of sight forever? Or at least long enough to allow the wave of liquidity to work its inevitable magic? So far, much to my great surprise, they've managed to do exactly that, with hardly a squeak from the mainstream press (although the blogsphere is on the job, as usual). I am now wondering if they cannot keep this up indefinitely.
Excess Reserves At Depositary Institutions
Does that look like banks believe their own mark?
Bank Credit All Commercial Banks
Total Bank Credit is negative year-over-year for the first time in the data series, since 1974.
Chris:So from a purely monetary perspective, money can only be "destroyed" if banks and other financial institutions are compelled to recognize the losses and take a hit to capital. If the loss is not recognized, no money is destroyed. At least it is not recognized as gone.I like the structure of the argument because it implies agreement with my definition of deflation: A net contraction of money supply and credit, with credit being marked-to-market.
Indeed, in a credit based economy, it is vital to consider credit in any analysis of inflation and deflation.
However, the argument itself is flawed. Money (credit really and there is a huge difference) is logically destroyed as soon as market participants realize things for what they are. All the pretending in the world can only have limited temporary effect as the share price of Citigroup, MBI, Ambac, Fannie Mae, Freddie Mac shows.
Greenspan Chastised Japan Over Failure To Write Down Debt
One irony in this mess is that Greenspan and the fed openly criticized Japan for failure to write down debts, telling Japan that writeoffs were the best way to end deflation.
Japan refused to do so. Did it help?
All the pretending in the world, along with all its quantitative easing did not halt a deflationary collapse in Japan.
Will Pretending Work Here?
Japan has proven that pretending does not work, yet we try it anyway. And now the stock market has risen over 50% from the lows. Is this because of the pretending, or in spite of the pretending? There was a massive stock market rally early in 1930 as well.
Given that the pretending started 18 months ago with invitations to lie and suspension of rules, it's a mistake to assign pretending as the reason for this rally.
In a credit based economy, the odds of a sustainable rebound without bank credit expanding, and consumers participating is not very good.
Even if one mistakenly assumes that the recent rally is a result of pretending, should we count on sustained success now more so than a measurement of stock prices in April of 1930, or any of Japans' four 50% rallies?
I think not. Pretending cannot accomplish much other than prolonging the agony for decades. This is the message of Japan.
Moreover, the US is arguably is worse shape than Japan because our problems are unsustainable consumer debt, high unemployment, and massive retail sector overcapacity.
Those are structural problems that no amount of pretending in the world can possibly cure. In due time, the market will focus on those problems.
Thus, careful analysis shows the answer to the question: "If nobody recognizes a defaulted debt on their balance sheet, does it exist?" is yes.
Pretending that defaulted debts do not exist is itself the "Sound of one hand clapping". It did not work for Japan, and it will not work here.
More Banks to Fail, But Bailout Probably Not Needed: FDIC's Bair
Bank failures are going to continue at a fairly strong rate but taxpayers hopefully won't be asked to foot the bill, FDIC Chair Sheila Bair told CNBC. Amid speculation that the Federal Deposit Insurance Corp might need to ask the Treasury Department for help covering insured deposits, Bair said the agency should be solid this year but acknowledged that 2010 could be difficult.
"Everyone has bailout fatigue so, yes, we do want to avoid that," she said in a live interview. "I never say never. But at this point based on our current projections I think we can continue to rely on the industry to fund the FDIC." But bank health continues to be an issue. A tepid economic recovery combined with defaults on commercial and residential mortgages will put pressure on the industry.
"Our projection right now is bank failures will continue at a pretty good clip through 2011. We're prepared for it, we're ready for it," she said. "The rate of healing the economy will drive the rate of healing of the banking sector." Selling the toxic assets that are clogging bank balance sheets has been going well, Bair added. The FDIC has developed a test mechanism that is showing alt-A, or nontraditional loans, fetching 71 cents on the dollar in the open marketplace.
At the same time, Bair welcomed new banking regulations to avoid the causes of the financial crisis but cautioned against putting too much pressure on struggling institutions, particularly in capital reserve requirements. "We need to be very careful in how we do that. It needs to be a gradual process," she said. "If we spike up capital levels too much now it could impair banks' ability to lend, and we need them to lend into the economy now."
Who Needs Big Banks?
by James Kwak
At a panel discussion at the Pew Charitable Trusts (captured for posterity by Planet Money), Alice Rivlin floated the idea of breaking up big banks. Luckily for us, Scott Talbott of the Financial Services Roundtable (a lobbying group for big banks) was there to slap that idea down.
Talbott: “We need big companies, and they can be managed, and they are being managed …”
Alex Blumberg (Planet Money): “But why, why do we need big companies?”
Talbott: “They provide a number of benefits across the globe. We have a global economy, and these institutions can handle the finances of the world. They can also handle the finances of large, non-bank institutions like General Electric or Johnson & Johnson. They need these institutions [that] can handle the complex transactions. Simply breaking them up … then you’re discouraging a company from achieving the American Dream, working hard, earning money, producing products, and getting bigger.”
There are two things I object to strongly. The second is easy. The American Dream is for people, not companies. And people dream of working hard, being successful, making money, and having an impact on the world. The American Dream does not imply any particular company size. There are situations in which your products are just so much better than anyone else’s that your company becomes big as a result; Google comes to mind. But Citigroup is the product of no one’s American Dream. When Talbott says “American Dream,” what he really means is “American Bank CEO’s Dream” — because, as we all know, CEO compensation in the financial sector is extremely correlated with assets.
The first is this “we need big banks to serve global corporations” line. I’ve heard this before and I don’t buy it, for a number of reasons.
First (sorry, I have this habit of embedding numbered lists inside numbered lists), how global is Bank of America? Until it bought Merrill Lynch, it was pretty much a midget overseas compared to, say, Morgan Stanley, which was a small fraction of its size. How global is Wells Fargo? Yet those are two of our four biggest banks.
Second, the argument doesn’t pass the test of basic business logic. My company did (and does) business in many countries around the world. We had different alliances and different service providers in each one. There were overlaps — we worked with some consulting firms in multiple countries — but we made the decisions independently in each country, because every country is different. And in each country, you want the people who are the best in that country. Sometimes that will be a division of an American multinational; often it won’t. If I’m “General Electric” or “Johnson & Johnson,” I’m not going to do all my banking with Citigroup out of some misplaced customer loyalty.
Third, what global services is Talbott talking about? Sure, as an individual, it would be nice if my bank had offices in every country I might ever travel to. But that’s because I’m an individual, and I don’t want to have more than a few bank accounts. I would guess that General Electric has, oh, thousands of bank accounts around the world, with dozens if not hundreds of banks. The “one-stop shop” idea applies — barely — to people like me, who would like the convenience of doing all of our financial stuff with one company, but generally figure out that it’s impossible, because my bank offers crappy investment products, and crappy insurance products, and … you get the idea. It’s laughable for a big company, which has hundreds of P&Ls, each of which is different, and has different objectives and preferences.
Fourth, let’s take a big, global transaction — say, a debt offering. Here, arguably, it might be good to have a single bank with global scale, since you want to sell bonds in as many markets as possible in order to get the broadest possible pool of investors. In 2008, J&J issued $1.6 billion (face value) of bonds. Who got the deal? Goldman, JPMorgan, Citi, Deutsche Bank, Bank of America, Morgan Stanley, Williams Capital Group, BNP Paribas, HSBC, Mitsubishi UFJ, and RBS Greenwich Capital. Eleven investment banks based in five countries, including five U.S.-based banks. (In 2007, J&J issued 500 million pounds of debt, using thirteen underwriters — six of whom were not involved in the 2008 offering; two out of three book-running managers were European banks.)
So when push comes to shove, our beloved mega-banks are nowhere near up to the task. What this tells me is that it’s the big companies that call the shots, and they like parceling out business to lots of banks. This is another basic principle of business: it’s better to have multiple suppliers than one supplier, so you can keep them in competition. This whole argument, that global companies need massive banks, is one of those things that sound plausible until you actually start thinking about them. Is there something big that I’m missing here?
Whitney Cools On Banks, Cuts Goldman To NeutralA
s earnings season gets under way, noted banking analyst Meredith Whitney said bank stocks are "now at least fairly valued," and she cut Goldman Sachs Group Inc. to "neutral" from "buy" Tuesday morning due to the stock's strong price rise. Whitney, whose bearish calls on large bank stocks gained renown during the financial crisis, said in a note she is now "far less bullish" on banks than last quarter and urged clients "either to take profits or go neutral into the next two weeks." She also lowered her earnings outlooks for Bank of America Corp. and Citigroup Inc..
Ahead of Goldman's scheduled quarterly earnings on Thursday, Whitney said the company's fundamentals are still strong, but the rapid rise in its share price since the second quarter limits the upside in coming months, she said. Goldman shares traded at $185.86 Tuesday morning, down 2.3%; on July 13, when Whitney raised the stock to a buy, the shares closed at $149.44. "Specifically, we invoke a 'why be greedy' rationale with such a stunning move in shares over such a short period of time," Whitney wrote Tuesday.
Whitney has a $186 price target on Goldman's shares, less than the median $205 price target among analysts surveyed by Thomson Reuters. In reassessing other banks, Whitney said she now expects Bank of America to deliver a 5-cent loss per share in the third quarter. She previously expected a 6-cent profit. On Citigroup, Whitney said she now sees a deeper loss of 50 cents per share from 23 cents. But she upgraded her estimate for American Express Co. (AXP), predicting earnings of 30 cents from 11 cents.
The cautious remarks on banks and on Goldman are consistent with the sentiments Whitney has voiced over the airwaves and on op-ed pages in recent weeks. The Goldman downgrade contrasts with some recent favorable analyst commentary. In new coverage last week, Deutsche Bank rated Goldman shares a "buy," the day after Calyon Securities analyst Mike Mayo, also known for his banking downgrades, raised his Goldman price target to $230 from $194.
Mayo gave a laundry list of positives for the stock, touting the bank's ability to build market share, benefit from high bid-ask spreads, build up operations in Asia, and draw upon liquidity from the Federal Reserve - all under a management he credited with consistency. Goldman Sachs had no comment on the downgrade, and Meredith Whitney Advisers couldn't immediately be reached for comment. Bank of America shares were off 2.3% Tuesday to $17.60, while Citigroup shares were up 0.6% to $4.79 and American Express rose 0.5% to $3
US Senate Finance Panel Approves $829 Billion Health Overhaul
The U.S. Senate Finance Committee on Tuesday approved an $829 billion health-care overhaul measure that would extend health insurance coverage to an estimated 29 million people, drawing the Senate one step closer to debating a health-care bill despite broad Republican opposition.
The bill, the product of a negotiating process that saw countless starts and stops since talks began last year, won only one Republican vote: that of Sen. Olympia Snowe, R-Maine. The final tally approving the bill was 14-9. Snowe's endorsement of the bill didn't extend to future versions of the bill in the Senate - "my vote today is my vote today," she said. But she told the committee that rapidly rising costs in future years would bring the existing U.S. health-care system into a "death spiral" if changes are not made.
Senate Finance Chairman Max Baucus, D-Mont., has argued the Finance Committee bill is the best approach to win enough votes in the Senate to avoid a filibuster. As part of an appeal to Senate centrists, it doesn't include a government-run insurance plan, unlike every other health-care bill passed by House and Senate committees this year. "Americans want us to craft a package that will get the 60 votes needed to pass," Baucus said. The next step in the process in the Senate is to merge the Finance Committee bill and a measure approved by the Senate Health, Education, Labor and Pensions Committee in July, with meetings set to begin as soon as Tuesday evening.
A spokesman for Senate Majority Leader Harry Reid, D-Nev., Jim Manley, said the merger "process will hopefully only take a couple days." But he added the blended bill would then "be carefully vetted" with all Senate Democrats and analyzed by the nonpartisan Congressional Budget Office. Reid has indicated he wants to bring a unified health-care bill up for debate before the full Senate later this month. Baucus, the driving force behind the bill in the committee, oversaw a bipartisan group of six senators seeking compromise on the measure that fell apart in September. Republicans involved in the group, such as Sen. Charles Grassley, R-Iowa, complained the bill was too costly and that negotiators saw their hands forced by a rigid schedule imposed by Senate Democratic leaders.
Baucus on Tuesday, attempting to show the lengths to which he sought bipartisan agreement on the bill, said the group met 31 times. "We went the extra mile," said Baucus. Grassley, while complimenting Baucus for his efforts to find agreement on the bill, said the bill bore an increasingly partisan imprint. "I don't blame anyone on this committee, but I do blame people outside this committee for that process not working," Grassley said. "We can now see clearly that the bill continues its march leftward." Snowe said that she would oppose the bill if a public health insurance option is added, although she has proposed adding a provision to the bill that would create state-based public plans if private insurers didn't provide affordable insurance to enough people in a given state.
Sen. Thomas Carper, D-Del., has proposed allowing states to voluntarily start up public plans. Carper said he planned to discuss health-care legislation with Snowe on Tuesday night. A third possibility for compromise on a public plan, floated by Sen. Charles Schumer, D-N.Y., would establish a nationwide public plan but allow states to opt out of it. Carper mentioned the plan Tuesday and said it is possible a national plan could be designed conversely - so that that states would voluntarily opt into.
The bill approved Tuesday aims to bring more Americans under the umbrella of insurance coverage through a system of tax credits for low- and middle-income people, as well as an expansion of the low-income Medicaid program. Individuals would be required to purchase coverage, although the bill was amended in committee to ease penalties for those who don't purchase coverage and delay the year in which the penalties take effect. Individuals couldn't be charged more than $750 in a given year for not purchasing insurance coverage, and some people would be granted a "hardship waiver" if the cost of insurance exceeded 8% of an individual's income. Health insurers have warned the individual mandate wouldn't be stiff enough to convince people to buy insurance coverage, which they said would result in higher premiums for policyholders.
The leading trade group of health insurance companies - America's Health Insurance Plans, or AHIP - has warned in recent days that health insurance premiums would balloon to more than double their current price in 10 years, if the bill in its current form is enacted. Their claims were backed by a study commissioned by them and conducted by the consulting firm PricewaterhouseCoopers LLP. But that study was swiftly rebutted by Senate Finance Committee staff, which said it relied on faulty assumptions and didn't take into account proposed subsidies for individuals that would make premiums more affordable.
The bill's price tag, estimated by the Congressional Budget Office at $829 billion, brings the committee into line with the White House, which has pledged to keep the cost of health-care legislation under $900 billion. But the bill would leave 25 million Americans uninsured - fully 6% of the population, excluding illegal immigrants, according to the CBO. The bill is paid for by a gamut of cost-cutting measures, $130 billion in new fees on various medical sectors and an excise tax on high-cost insurance plans that would generate $201 billion in revenue.
Ilargi: One of the few remaining sane voices in the thick of things is TrimTabs' Charles Biderman. Here he explains why the US government doesn’t want, and doesn't have to, follow actual data.
Charles Biderman: "Gravity usually works at some point”
Colorado minimum wage to drop to $7.24 as living costs fall
Colorado officials have confirmed that the state next year will become the first to lower its minimum wage because of a falling cost of living. The state Department of Labor and Employment ordered the wage down from $7.28 to $7.24. That's lower than the federal minimum wage of $7.25, so most minimum wage workers will lose 3 cents an hour. Colorado is one of 10 states where the minimum wage is tied to inflation. The indexing is thought to protect low-wage workers from having flat wages as the cost of living goes up. But because Colorado's provision allows wage declines, the minimum wage will drop because of a falling consumer price index. It will be the first decrease in any state since the federal minimum wage law was passed in 1938.
Foreclosures Grow in Housing Market's Top Tiers
New data suggest that foreclosures are rising in more expensive housing markets. About 30% of foreclosures in June involved homes in the top third of local housing values, up from 16% when the foreclosure crisis began three years ago, according to new data from real-estate Web site Zillow.com. The bottom one-third of housing markets, by home value, now account for 35% of foreclosures, down from 55% in 2006.
The report shows that foreclosures, after declining earlier this year, began to accelerate in the late spring and that more expensive homes have more recently accounted for a growing share of all foreclosures. "The slope of that curve in recent months is much sharper than it was recently," said Stan Humphries, chief economist for Zillow. Rising foreclosures among more-expensive homes could create added pressure for a housing market that has shown signs of stabilizing in recent months as sales of lower-priced homes pick up. The Zillow research compared homes against the median values for their local market and broke each market into three tiers by value. Zillow then looked at the share of monthly foreclosures in each tier over the past decade.
Foreclosures are rising in more expensive markets as home values in those areas fall, leaving more homeowners with mortgages that exceed the value of their properties. Prime loans accounted for 58% of foreclosure starts in the second quarter, up from 44% last year, according to the Mortgage Bankers Association. Subprime mortgages accounted for one-third of foreclosure starts, down from one-half last year. The prime category includes so-called exotic mortgages that were increasingly used to buy more expensive homes, including interest-only mortgages that allowed borrowers to defer principal payments during an initial period. Borrowers often aren't able to refinance out of these products because the drop in home values has left them with little equity in their homes.
Default rates are particularly high and expected to rise on option adjustable-rate mortgages, which allow borrowers to make minimum payments that may not cover the interest due. Monthly payments can increase to sharply higher levels after five years or when the outstanding balance reaches a certain level. A study by Fitch Ratings found that 46% of option ARMs were 30 days past due last month, even though just 12% of such loans have reset to higher monthly payments. Zillow estimated that nearly one in four homes with mortgages was worth less than the value of the property at the end of June. Mr. Humphries said he didn't expect to see foreclosure volumes level off until later in 2010.
Wary of Fannie and Freddie
Robert Tipp, Prudential's fixed-income strategist, sees plenty of reasons for optimism. An economic recovery, however sluggish, should buff up companies balance sheets and prod Americans to stash more of their savings into investments that pay better than their savings accounts. All sorts of bond markets – corporate, emerging market, asset-backed securities – would rise higher. But Tipp sees trouble spots. In his recent outlook for the fourth quarter, he points to two: deeply indebted companies and the government-sponsored mortgage buyers, Fannie Mae and Freddie Mac.
Since January, the Federal Reserve has been buying securities guaranteed by these mortgage-finance giants in an effort to support the housing market. Fannie and Freddie buy mortgages from banks then package them into securities and sell them off. So far, Tipp says, the Fed's program seems to have succeeded in stabilizing mortgage rates by sopping up new supply.
Bond buyers are even beginning to call agency mortgage-backed securities expensive. These bonds have returned 5.4% this year and 10.2% over the past 12 months, as measured by a Bank of America-Merrill Lynch index. They now yield 2.9% on average, a mere 0.17 percentage points more than similar Treasuries. The Fed plans to wrap up the $1.25 trillion program by the end of next March. What happens to residential mortgage bonds, when the dominant buyer exits? Tipp questions whether the market will be able to stand on its own.
To judge by one portfolio, Prudential's money managers aren't betting on another crisis. Prudential Financial handles the JennisonDryden mutual funds. The Dryden Total Return Bond Fund, which Tipp helps run, has sold off some government-backed mortgage securities but still has $122 million, or 27% of its holdings, in mortgage-backed notes from Freddie Mac, Ginnie Mae and Fannie Mae, according to regulatory filings made in late September. It has also sold short $8.2 million in Fannie Mae 30-year mortgage-backed securities.
In the corporate credit rally, bonds from the companies with the most tattered balance sheets have turned in the best performance. Junk bonds from the lowest rungs on the credit-ratings scale, CCC-ratings or worse, have returned 78% this year, compared with 49% for the broader high-yield market. Investors' willingness to buy them has helped companies with credit ratings in the CCC range – such as Standard Pacific, Beazer Homes and Delta Air Lines-- sell new bonds last month. The effect works both ways. If the economy runs into more trouble, Tipp cautions, these same bonds would get hurt the worst. He's especially wary of low-rated retailers and companies that rely on consumers' spending on discretionary goods – objects they don't need.
Schwarzenegger Fiscal-Repairman Legacy Defined by $38 Billion Budget Deficit
California Governor Arnold Schwarzenegger, who vowed as a candidate in 2003 to tame the most populous U.S. state’s budget deficits, is fighting a new fiscal gap testing his ability to bring squabbling lawmakers together. The Republican governor, 62, who can’t seek re-election because of term limits, convinced the Democratic-controlled Legislature twice this year to cut $32 billion in spending and increase taxes by $12.5 billion. A $1.1 billion drop in tax revenue disclosed last week may force a third budget fix.
“Most of his last couple years have been basically dominated by this horrendous budget problem, and everything got swamped in that, even the most simple stuff,” said Christopher Thornberg, principal of Beacon Economics LLC, a research and consulting firm in Los Angeles. “Had times been more ordinary, he may very well have had more success in trying to accomplish what he was doing.” Schwarzenegger is trying to change the way the state collects revenue in order to end the persistent deficits that have plagued his six years in office, said David Crane, a special adviser to the governor on jobs and economic growth.
“We had real growth in California in 2008, but our budget revenues were down 20 percent,” Crane said in an interview. “And that’s because we have a budget system that’s not correlated with our economy.”
About half of the state’s personal income tax revenue, which finances 50 percent of the California government’s general fund, comes from 144,000 taxpayers, or about 1 percent of the total, Crane said.
Since February, lawmakers and Schwarzenegger have faced projected budget deficits of $60 billion covering the two years ending in June 2010. California, where unemployment reached 12.2 percent in August, was so short of cash as it confronted the worst economic slump since the Great Depression that it paid some vendors and tax refunds with IOUs from June through September. The Legislature, which requires a two-thirds vote to raise taxes or pass a new spending plan, has struggled to respond as the state’s fiscal strains worsened this year.
In addition to spending cuts and tax increases, Schwarzenegger and lawmakers agreed to cover $6 billion of the deficit with borrowing and what Pacific Investment Management Co.’s Bill Gross, co-chief investment officer of the world’s biggest bond fund, in an online commentary this month, called “accounting tricks that couldn’t fool a grade-schooler.” Even with those actions, budget officials predict an additional $38 billion in deficits in the next three fiscal years, including $7.4 billion in the year starting July 1.
The governor supports a budget overhaul, proposed last month by a bipartisan commission, that would reduce personal income taxes as well as eliminate corporate and sales levies. Instead, revenue would be raised through a new business receipts tax that would collect more revenue from companies providing services, according to Crane. That plan wouldn’t affect the state’s total receipts. If it passes along with other measures proposed by Schwarzenegger, then “you’d have a radically different state” than when he first took office, Crane said.
“Everyone, no matter who they are, acknowledges that we need to reform our tax structure,” said Barbara O’Connor, director of the Institute for the Study of Politics and Media at California State University in Sacramento, in an interview. “The question is how. He seems to be the only one who wants to give it a chance.” Aaron McLear, a spokesman for Schwarzenegger, said the governor wasn’t immediately available to comment.
California, which has the world’s eighth-largest economy and accounts for 13 percent of the U.S. gross domestic product, sold $4.1 billion in bonds last week while possessing a Standard & Poor’s A rating, the lowest among U.S. states. “We were able to get a $4 billion-plus deal in a cold and inhospitable market,” said Tom Dresslar, a spokesman in the California state treasurer’s office. “We believe that is a significant accomplishment.” The state’s debt totaled $67.1 billion, according to Treasurer Bill Lockyer. California accounts for $50 billion in bond issuance this year out of a U.S. total $281 billion, according Bloomberg data.
Schwarzenegger, a former body builder and actor better known for his role as a time-traveling robot in the “Terminator” movie series than for his public-policy views when he campaigned for governor in 2003, bested more than 100 other candidates as part of a recall effort that ousted Democrat Gray Davis as governor. Some of Schwarzenegger’s changes have worsened California’s fiscal situation, said Mike Spence, past president of the Republican Assembly, a group seeking to elect more party members.
“Unfortunately, he’s gotten too much done,” Spence said. “He’s definitely entering his lame-duck phase, but that may be good, because when he had more influence, things didn’t get better, they got worse.”
Spence said Schwarzenegger increased tax rates, expanded the size of government and took on more bond debt, which has hurt the economy. “There’s a whole list of things that we may have been better off if Gray Davis had stayed governor,” Spence said. “I don’t think he would have done some of these things. He was much more cautious.”
Cost Cuts Lift Profits But Vex Economy
U.S. stocks notched new 52-week highs again on Monday, thanks to corporate America showing better-than-expected profits. But that optimism belies deep worries among company executives about the strength of the economic recovery. Tool maker Black & Decker Corp. said earnings this quarter will be roughly twice its earlier forecast, while Dutch consumer-goods conglomerate Royal Philips Electronics NV also reported an unexpected profit. The Dow Jones Industrial Average rose 20.86 points to 9885.80, its highest since Oct. 6, 2008. The S&P added 4.7 points to 1076.19.
Starting with aluminum giant Alcoa Inc., which Thursday reported its first profitable quarter in a year, 78% of the 32 U.S. companies that have so far reported have beat analysts' expectations. Even so, third-quarter earnings for S&P 500 companies are predicted to fall about 25% from a year earlier, according to data provider Thomson Reuters. In an ominous sign for the economy, much of the profit is being eked out through cost cuts. Executives say they are hesitant to reinvest such profits into their businesses. With large portions of their factories, fleets and warehouses sitting idle, some say they probably won't see reason to do so for a year or more.
That means job growth and any significant rise in business spending could be a long time coming. That creates a chicken-and-egg problem at a time when the unemployment rate is already nearly 10%: Without more jobs, U.S. consumers will have a hard time increasing their spending; but without that spending, businesses might see little reason to start hiring. Already, the economy is being starved of investment it needs to spark growth. Net private investment, which includes spending on everything from machine tools to new houses, minus depreciation, fell to 0.1% of gross domestic product in the second quarter of 2009, according to the latest government data. That's the lowest level since at least 1947.
"Things have stabilized, but we're trying to be extremely cautious and not anticipate the recovery before it occurs," says William Zollars, chief executive of YRC Worldwide Inc., one of the country's biggest trucking companies. "Like every other company in America, we're looking to cut back as much as possible." Freight tonnage at YRC was down 35.3% from a year earlier in the second quarter. Mr. Zollars says he hasn't seen his clients, who range from retailers to heavy industry, doing much restocking to prepare for increased business.
In coming weeks, the details of earnings reports -- including items such as capital expenditures, as well as revenues for companies that sell capital goods -- will demonstrate the extent to which executives are turning their relative optimism and cash into actual investment. Bellwether companies include Intel Corp., International Business Machines Corp. and General Electric Co., scheduled to report earnings this week, followed by heavy-equipment maker Caterpillar Inc. (Oct. 20) and conglomerate Honeywell International Inc. (Oct. 23). So far, the signs aren't good. Alcoa's $77 million profit came as the company slashed its research and development spending to $39 million, down 36% from a year earlier.
And while companies are finding the credit-market thaw is making it easier to borrow money they would need to expand, many are stashing these funds rather than spending them. Of the 100 largest bond issues globally this year, only seven listed expansion, investment, capital expenditures or research and development as the purpose of the money-raising, according to Dealogic. In industries ranging from apparel to heavy machinery, executives say they don't yet have enough faith in the recovery to take significant risks.
Guess Inc. President and Chief Operating Officer Carlos Alberini says the fashion company plans to open 17 new stores in North America this year, compared to 60 last year. Guess intends to boost its store openings next year to develop new brands such as the G by Guess line, but the expansion plans are rare in an industry still dominated by caution, he says. "The environment is more stable," says Mr. Alberini. "But most companies will probably take more time before they start investing in growth opportunities."
Even so, corporate executives on average say they are a lot more optimistic than they were a year ago, amid the financial turmoil that followed Lehman Brothers Holdings Inc.'s bankruptcy filing. In a recent survey conducted by the Conference Board, 51% of chief executives said they expect conditions in their industries to improve over the next six months, compared with 12% in the fourth quarter of 2008. Economists are also more upbeat about the broader outlook for earnings. Consultancy Macroeconomic Advisers, for example, expects corporate profits across the economy to rise 8.3% in 2010, after rebounding 27% this year from last year's 25.1% plunge.
One big obstacle: Many industries have excess capacity that, even if the economy perks up, will take many months to absorb. Mike Arnold, president of the bearings and power transmission group at Timken Co., says his company was running at only 35% of capacity as of the end of the second quarter. Last month, Timken successfully raised $250 million through a bond issue, but the funds will be used to refinance long-term debt maturing in February. The company slashed its capital expenditures by more than half in the first six months of this year compared with the same period a year ago. Mr. Arnold says it has no plans to boost spending anytime soon.
"We've now spent the last 12 to 14 months just surviving," says Mr. Arnold, whose company is expected by analysts to report a loss of 25 cents a share on Oct. 29. Mr. Arnold says he isn't seeing signs of any upturn aside from the effects of government stimulus, which he views as transitory. The cautious mood is reflected in companies' new orders for nondefense capital goods such as computers, trucks and office furniture, which in August were down 0.4% from the previous month and down about 20% from the same month a year earlier.
Even some companies that initially weathered the downturn are now more cautious. Cummins Inc., a Columbus, Ind.-based maker of big diesel engines, was humming through the first 10 months of last year thanks to booming foreign sales. But in October, the bottom fell out. Truck sales skidded world-wide, dropping 70% in the U.S. That ricocheted through a vast network of suppliers of metal, steel and tires. Cummins cut costs as fast as it could, shedding about 15% of its global work force of 50,000 people, or about 9,000 people, says president and chief operating officer Tom Linebarger.
The company reported 81% lower earnings in the second quarter, but still beat analysts' expectations. The company reports third-quarter results on Oct. 30 and Mr. Linebarger says "generally, revenues have stabilized -- we're beginning to see forecasts that stay the same week to week." Still, Cummins has no plans to start spending on new capacity. It is investing about $350 million in 2009, about 50% less than it would have if markets hadn't slid, Mr. Linebarger says. The company recently brought back about 900 U.S. workers to handle what is expected to be a temporary uptick in demand. Mr. Linebarger says Cummins will probably have to let them go again. "The politicians want people to think things are getting better, because a better mood feeds a turnaround," Mr. Linebarger says. "Things are getting better, but compared to what."
Summers To GOP's Boehner: Recovery Act Is Working
Responding to Republican criticism of the $787 billion economic stimulus package, White House economic adviser Lawrence Summers said Monday the Recovery Act is having its desired effect, dismissing GOP calls for a dramatic change in course. "Thanks largely to the Recovery Act, alongside an aggressive financial stabilization plan and a program to keep responsible homeowners in their homes, we have walked a substantial distance back from the economic abyss and are on the path toward economic recovery," Summers said in a letter to House Republican Leader John Boehner, R-Ohio.
House Republicans wrote President Barack Obama last week asking him to consider a host of tax breaks and other measures aimed at small businesses. The letter, which called the stimulus package "unsuccessful," detailed GOP proposals to give small businesses a tax deduction equal to 20% of their income, lower individual tax rates, expand health-savings accounts and allow businesses to band together to purchase healthcare.
In a lengthy response, Summers didn't discuss any of the Republicans' specific proposals but said he would "continue to review the ideas you have suggested." He offered a recent history of the U.S. job market and fiscal situation, contrasting the job creation and surpluses of the 1990s to the "anemic" expansion and rising deficits that occurred during the Bush administration. "To understand the Administration's economic approach, it is important to understand recent economic history," Summers wrote. "The most recent economic expansion was weak compared to previous expansions with respect to both job growth and our nation's fiscal circumstances."
Boehner responded quickly Monday. "Where are the jobs?," he said in a statement. "In February, Mr. Summers himself said Americans would see the effects of the stimulus 'almost immediately' but since it took effect our economy has lost roughly three million jobs and more families and small businesses are struggling than ever before." The back-and-forth comes as Republicans press the White House to abandon health-care and energy legislation they believe would kill jobs. At the same time, Democrats are pressing Obama to extend some elements of the stimulus and consider new tax cuts.
The White House has said it is open to extending unemployment benefits and subsidies to purchase health insurance, but Democrats also are pushing for an extension of a tax credit for first-time homebuyers and new tax credits for employers who hire new workers. Even though the National Association for Business Economics declared an end to the U.S. recession in a new survey Monday, joblessness is expected to continue to rise, eclipsing 10% early next year.
In a speech to NABE in St. Louis, Summers said the economy is showing signs of normalcy, but said the administration won't be satisfied until job creation returns. "This is for all its problems a better picture than most expected six or nine months ago. We are no longer discussing panics, we are no longer using metaphors about balls falling off tables," Summers said. "But it is also, I would suggest, an unsatisfactory state of affairs."
America's Most Impoverished Cities
The Great Recession is rewriting the rules of American poverty
The Great Recession is rewriting the rules of American poverty. Data from the Census Bureau, released in September, show that during the first year of the recession, incomes fell farther and poverty leaped higher than during almost any other time in a generation.
In 2008, U.S. median income fell to $50,303 from $52,163 in 2007. That 3.6% decline is the largest one-year drop since records begin. The poverty rate increased to 13.2% from 12.5%, meaning the recession has brought 2.6 million more Americans into poverty. The Economic Policy Institute projects that in the next two years, incomes could decline by another $3,000 and poverty could increase by 1.9 percentage points. Just as the recession has changed the map of unemployment, it has redrawn the contours of poverty.
To find out who is being hit worst, we used new data from the U.S. Census Bureau's 2008 American Community Survey. Although the Census Bureau defines poverty simply as people earning below a certain income level, (which varies based on family size) we also looked at per capita incomes for a region, the percentage of food stamp recipients, the percentage of people under age 65 receiving public health care and the unemployment rate.
Poverty may once have been worst in the Deep South. And cities on the border with Mexico are plagued with poverty. But the recession--and the decline of American manufacturing--has left Rust Belt cities with comparable levels of poverty. The problem is concentrated in these three regions. All 10 cities on our list are southern cities, border cities or declining manufacturing centers.
Four southern cities make the list: Pine Bluff, Ark.; Albany and Macon, Ga.; and Rocky Mount, N.C. In these cities, per capita incomes are between $18,000 and $23,000, but the bottom 20% are bringing in between $7,500 and $8,500. The most impoverished region is at the southern tip of Texas. The metropolitan statistical areas for McAllen and Brownsville, Texas, have the lowest incomes and most food stamp recipients of any in America.
"When looking at the entire [metro area] we have a lot of communities that do have large pockets of poverty," says Mike Perez, the city manager of McAllen, Texas. "A lot are recent immigrants--that's part of it. There's a language barrier. And because they're recent immigrants, they don't have the education. That's tied to having jobs that pay well. It's a bit of a vicious cycle."
Despite the discouraging statistics, McAllen has been adding jobs rapidly--Forbes rated McAllen the best medium-size city for job growth earlier this year. Perez and other city leaders are quick to point out that they don't have control over their entire regions or local economies. Metropolitan statistical areas include counties that are tied to a central city economically, but are oftentimes beyond the control of the mayor. As well, the regions on this list are usually subject to national economic trends that even the best of local governments may be unable to fight.
"We just got our rating upgraded to AA by Standard & Poor's," says Perez. "Sometimes when you look at an entire region, you paint the entire region with the same brush. I think sometimes that's not quite fair. There are areas in the MSA that are very strong and doing very well." The same could be said of any of the regions on the list. Further west, in El Centro, Calif., and Yuma, Ariz., incomes are higher, but Yuma and El Centro have the highest unemployment rates of any cities in the country.
Cathy Kennerson, CEO of the El Centro Chamber of Commerce, says a host of alternative energy companies--in geothermal, wind, biomass and solar--are looking to invest in the region, but she says Uncle Sam is holding things up with a slow approvals process. "It's such a great area here in the desert for renewable energy manufacturing," says Kennerson, who notes that one sector that continues to grow in the county is the federal government.
Finally, the industrial Midwest is creeping onto the list. The metropolitan areas around Saginaw, Mich., and Flint, Mich., have some of the worst poverty in the nation. Although per capita incomes are higher, the percentage of the population living below half of the poverty line is near 10% in both cities, and 15% of the populations are on food stamps. Other cities in the region are not far behind as manufacturing jobs continue to disappear. In the 1990s, there were nearly 18 million manufacturing jobs in the United States. The recession in 2001 lowered that number to about 14 million, and the current recession to 12 million. The result: a once-great production engine is collapsing into one of the most impoverished regions of America.
Slow US recovery blamed on low demand
Weak demand from battered consumers will be a “major constraint” on the US economy for the foreseeable future, a key White House adviser said on Monday, as the administration mulls over further ways to spur demand and create jobs. Lawrence Summers, the director of the National Economic Council, has been banging the drum for the $787bn (€532bn, £499bn) stimulus package in the face of Republican criticism that it is not creating the jobs it promised.
With political pressure building as unemployment nears 10 per cent, the administration is looking for additional ways to mitigate the problem, though it insists there will be no “second stimulus”. “It is not for me?.?.?.?to preview policies that President Obama will announce in coming weeks,” said Mr Summers in a speech to an economics conference on Monday. But he said that while the economy had improved substantially, people had to recognise that demand was hobbled and US consumers and exports should be supported.
“We need to recognise that lack of demand will be a major constraint on output and employment in the American economy for the foreseeable future,” he said at the National Association for Business Economics conference. “Direct public investment has a crucial role at a time like this.” He also sent a rebuttal to John Boehner, Republican leader in the House and a fierce critic of the stimulus, arguing the package was working and many of the economy’s problems had built up during the previous administration.
His speech was made as a survey of 44 leading economists by the NABE showed many were worried about the effects of unemployment and the budget deficit on the US economy. Four in every five said that the worst recession since the 1930s was over. But while they expected the stock market and corporate profits to rise next year, they saw unemployment hitting double digits and did not expect all the jobs that have been lost to return until 2012.
Wage growth will be only 1 per cent this year and 2.2 per cent next year: the slowest two-year period on record. That leaves the outlook for consumer spending, which typically accounts for two-thirds of gross domestic product, fairly bleak. Next year it will grow at an anaemic 1.6 per cent, the economists predict, while car sales will not bounce much from this year’s 40-year low. “From a technical standpoint [the recession] is probably over, but that doesn’t mean in any way shape or form that it’s over from the point of view of an awful lot of people,” said Dr Tony Cherin, finance professor at San Diego State University.
But they upgraded their expectations for real gross domestic product growth, forecasting it to rise at a pace of 2.9 per cent in the second half of this year and 3 per cent next year. They think the housing market will recover enough in 2010 to contribute to overall growth for the first time in five years. Business investment will also pick up next year, they reckon, while corporate profits will rise 11 per cent and the S&P 500 will add 7.5 per cent.
Bank of America Set to Reveal Merrill Advice
In a stunning reversal, Bank of America’s board has voted to reveal the legal advice that the bank received late last year about its merger with Merrill Lynch, according to three people briefed on the matter. After six months of digging in its heels, the bank is expected to provide legal documents that could shed light on how its lawyers advised executives to deal with the disclosure of key information about losses and bonuses at Merrill Lynch to the bank’s shareholders.
With a stroke of a pen, the bank’s decision will remove a stumbling block in a wide range of cases. The documents may exonerate bank executives, like its retiring chief, Kenneth D. Lewis, or may provide the evidence that some investigators are seeking to lay blame at individuals’ feet. The bank has refused to allow its attorneys to answer questions about many aspects of the deal, even as pressure to do so surged from many corners. Some of the pressure came from lawmakers in Congress and regulators who are deciding whether to allow Bank of America to return part of the $45 billion it received in bailout funds — an outcome the bank has been urgently pursuing.
The bank’s decision was prompted by a series of conversations over the last two weeks with the office of New York’s attorney general, Andrew M. Cuomo, who had threatened to charge individual Bank of America executives — including Mr. Lewis — with wrongdoing, the people briefed on the matter said. The bank also faced a deadline this week to provide a log of its private legal documents to a House committee.
The legal and public relations cost of the bank’s merger with Merrill Lynch, conceived in the heat of the financial crisis last fall, have threatened to overwhelm most of the benefits from the merger. Mr. Lewis, a 40-year veteran of the bank and its predecessors, announced his retirement two weeks ago — far earlier than expected — in part due to exasperation and weariness over the slew of legal cases.
At their core, the investigations center on why the bank kept key information about Merrill’s bonuses or its losses secret from its shareholders. Each case raises a different set of questions about decisions made just before shareholders voted to approve the merger; as well as how the decisions were made and why they were not shared with the public or at least bank shareholders.
In particular, the bank’s decision not to disclose millions of dollars in bonuses that Merrill hastily paid out before the deal has grabbed the attention of prosecutors. But serious questions have also been raised about surprise losses at Merrill that were not disclosed.
For Bank of America, providing the legal documents to Mr. Cuomo and other investigations offers the chance of moving toward a resolution. Lawyers from Cleary Gottlieb Steen & Hamilton as well as Paul, Weiss, Rifkind, Wharton & Garrison advised the bank to waive its right to legal secrecy, which is known as attorney-client privilege. Bank officials supported the idea because they felt they have nothing to hide and want the bank to be able to move on, according to a person familiar with the bank’s decision.
U.S. Corporate Issues Surpass $1 Trillion in 2009
Borrowers have sold more than $1 trillion in U.S. corporate bonds in 2009, the fastest pace on record, taking advantage of lower rates and government support to bolster cash holdings after last year’s credit freeze. Citigroup Inc., the third-largest U.S. bank by assets, and General Electric Co.’s finance unit in Stamford, Connecticut, were the year’s biggest issuers, according to data compiled by Bloomberg. Sales compare with $873.2 billion in all of 2008, and $1.17 trillion for 2007, the biggest year for bond sales.
Issuance soared as companies that couldn’t sell debt following the collapse of Lehman Brothers Holdings Inc. in September 2008 grabbed at opportunities to tap the market. Investors reached for yields near the widest on record relative to benchmark Treasury rates, amid a wave of government intervention to repair financial markets, according to Mark Kiesel, global head of corporate debt portfolios at Pacific Investment Management Co., manager of the world’s largest bond fund.
“Credit markets have the wind at their back, thanks to accommodative fiscal and monetary policy from global central banks,” Kiesel wrote this month on Newport Beach, California- based Pimco’s Web site. “Many investors who swung aggressively into credit were rewarded well for the risk they took.” Corporate bond spreads tightened 4.59 percentage points this year to 3.45 percentage points as of Oct. 9, according to Merrill Lynch & Co.’s U.S. Corporate & High Yield Master index. Spreads narrowed to 3.43 percentage points on Sept. 24, the tightest this year.
Using that index, corporate bonds, including reinvested interest, have returned 23 percent this year, which is better than any full year since 1997, the Merrill Lynch data show. The Federal Reserve last year cut its target for overnight loans among banks to a range of zero percent to 0.25 percent as the government created programs to free up credit amid the worst crisis since the Great Depression. Financial companies sold $192 billion of debt in 2009 under the Temporary Liquidity Guarantee Program, which opened a new avenue for funding for banks shut out of debt markets since September.
As the government’s efforts to revive credit markets took hold, corporate-bond issuance surged at the beginning of the year “as if somebody had turned a light switch on,” said Chuck Lieberman, chief investment officer at Advisors Capital Management LLC in Hasbrouck Heights, New Jersey. “A year ago, we were only buying high-quality credit with short maturities,” Lieberman said in a telephone interview. “By early 2009, we had switched completely and were buying BBB and BB, and only long maturities.” Lieberman said his firm is buying BB- and B-rated credit as returns on the higher-quality debt are no longer attractive.
High-yield bonds are rated below BBB- by Standard & Poor’s and less than Baa3 by Moody’s Investors Service. The difference between investment-grade bond yields and Treasury issues narrowed to 233 basis points on Oct. 9, 30 basis points wider than the average in 2007, according to Merrill Lynch’s U.S. Corporate Master index. Spreads for high-yield debt are 195 basis points wider than the 2007 average, according to Merrill Lynch’s High Yield Master II index. A basis point is 0.01 percentage point. “I felt the risk spreads were too wide” at the beginning of the year, Lieberman said. “I also saw the Fed’s efforts as likely to bear fruit.”
Steep Losses Pose Crisis for Pensions
The financial crisis has blown a hole in the rosy forecasts of pension funds that cover teachers, police officers and other government employees, casting into doubt as never before whether these public systems will be able to keep their promises to future generations of retirees. The upheaval on Wall Street has deluged public pension systems with losses that government officials and consultants increasingly say are insurmountable unless pension managers fundamentally rethink how they pay out benefits or make money or both.
Within 15 years, public systems on average will have less half the money they need to pay pension benefits, according to an analysis by Pricewaterhouse Coopers. Other analysts say funding levels could hit that low within a decade. After losing about $1 trillion in the markets, state and local governments are facing a devil's choice: Either slash retirement benefits or pursue high-return investments that come with high risk. The urgent need for outsize returns by these vast public pension funds, which must hit high investment targets year after year to keep pace with rising retirement costs, is in turn fueling a renewed appetite for risk on Wall Street.
Before the crisis, many public pension funds had experimented with risky trading techniques or committed more of their money to hedge funds and other nontraditional firms, which in turn invested some of it in complex mortgage securities. When these melted down, pension funds got burned. Now, facing an even bigger funding gap, some systems are investing in the same securities, betting that a rebound in their value will generate huge returns. "The amount that needs to be made up is enormous," said Peter Austin, executive director of BNY Mellon Pension Services. "Frankly, they are forced to continue their allocation in these high-return asset classes because that's their only hope."
Some pension experts say the funding gap has become so great that no investment strategy can close it and that taxpayers will have to cover the massive bill. The problem isn't limited to public pension funds; many corporate pension funds have lost so much ground that they are also pursuing riskier investments. And they, too, could end up a taxpayer burden if they cannot meet their obligations and are taken over by the federal Pension Benefit Guarantee Corp. Public systems still have enough to meet their current obligations. If governments take no action, retirees could keep drawing full benefits for the foreseeable future even under the most pessimistic projections.
But already, some funds are seeking to trim benefits to conserve money. Some governments have also proposed increasing the amount of public money paid each year into the funds. In practice, however, some political leaders have begun doing the opposite -- cutting annual contributions to pension funds -- as a way of balancing state and local budgets buffeted in the recession by falling tax revenue and rising costs.
Around the country, governments are struggling with the pact they've made with employees. In New Mexico, lawmakers passed legislation this year requiring public employees to contribute about 1.5 percent of their salary to cover retirement benefits. Labor unions representing 57,000 of the workers sued the state in response.
In Philadelphia, officials delivered an ultimatum to state lawmakers: Allow the city to take a two-year break from contributing to its pension system or Philadelphia would lay off 3,000 workers and cut sanitation and public safety services. Last month, the lawmakers not only granted the request, but extended the funding holiday to thousands of cities and counties, despite severe pension deficits in many of these places.
In Montgomery County, officials last year committed to setting up an investment fund to finance about $3 billion in retiree health-care benefits promised to employees. But when it came time to put the first round of seed money into the fund this year, county officials balked, citing budget constraints. "We know we've got a huge health-care liability," chief administrative officer Timothy L. Firestine said. "Our plan was to work gradually to fund that. And this year we abandoned that plan."
Just a few years ago, it seemed far-fetched that Virginia's pension system would hit hard times. In 2003, the state's primary pension funds either had more money than they needed or, at a minimum, were nearly fully funded. And like their counterparts across the country, state officials assumed they would earn around 8 percent a year from investing in financial markets for years to come given the outstanding performance of stocks in the 1980s and 1990s.
But officials in Virginia and elsewhere soon began to wonder whether those two decades were a fluke. As pension deficits began to rise, officials questioned whether the investment assumptions were too optimistic. In 2006, Virginia's pension officials suggested scaling back benefits or requiring current employees to begin paying into the pension fund. The state's lawmakers took no action. Then the crisis hit. Virginia lost 21 percent of the value of its portfolio, or about $11.5 billion. Maryland and the District, meantime, suffered drops of 20 percent.
The losses were typical of what pension funds suffered around the country. State and local government officials had predicted before the crisis they would have $3.6 trillion in their accounts by now, according to the Center for Retirement Research at Boston College. Today, they are $1.2 trillion short of that mark.
Pension funds were not equally affected. Officials in Arlington County, for instance, say their funding levels remain above 90 percent. And even those that suffered huge losses say they have enough money to payout retirement benefits for years to come. Virginia, for instance, still has nearly $43 billion in its accounts. But Virginia officials now estimate the funding level of its major pension funds will sink to about 60 percent by 2013.
From there, the deficit will grow even wider, according to Kim Nicholl, the national director of PricewaterhouseCoopers public sector retirement practice. Even if public pension funds were to hit their 8 percent investment targets every year, Nicholl calculated they would have less than half of what they need by 2025. This is because a greater share of the population will be retired and those who are will live longer, thus collecting benefits longer, she said.
"I don't think you can invest your way out of this. Plans are going to have to make changes," Nicholl said. "The scale of the losses was just so great and the liabilities are growing so fast, much faster than they can keep up." For these reasons, billionaire investor Warren Buffett has called these pensions ticking "time bombs." The financial crisis, experts say, shortened the fuse. Last month, Virginia Gov. Timothy M. Kaine signaled he would consider the politically sensitive step of requiring the state's 100,000 employees to contribute part of their 2011 salaries toward their pensions. But the two candidates running to replace him -- and who would have to carry out the proposal -- have said they oppose it.
This is the dilemma confounding pension funds as they emerge from the wreckage of the financial crisis: If they shy away from riskier investments, they would be settling for lower returns that leave future shortfalls unaddressed. But by aggressively pursuing the higher rates of return they need, pension funds increase the chances they will be burned again by investment bets gone bad. "State pension fund directors face enormous pressure trying to recover their investment losses. It will be tempting for them to consider investments that promise a high rate of return," said Sue Urahn, managing director of the Pew Center on the States, which plans to release a report on pension losses within weeks.
Traditional investment strategies, which rely on stocks, haven't fared well in recent years. To meet their obligations to retirees, pension funds tend to assume they will earn an eight percent return on investments each year. The stock market, as measured by the Standard & Poor's 500-stock index, is actually down 32 percent this decade. Like many states, Maryland had begun moving money from stocks into hedge funds and private equity before the financial crisis. The goal was not only to earn a higher return but to diversify the investment portfolio. Should stocks sink, the thinking went, less traditional investments might hold up.
The financial crisis offered a shocking retort. Nearly all investments, save for government bonds, tumbled at the same time. Yet Maryland is now continuing its shift away from stocks and into nontraditional investments. Pension officials argue they have little choice. "How do I act in the new environment? There aren't any ready answers for that," said Mansco Perry, chief investment officer for Maryland's pensions. "But I have difficulty throwing away 30 to 40 years worth of knowledge and practice and say that doesn't work anymore." Some pension funds are also continuing to engage in other investment practices that got them in trouble during the crisis.
One such trading technique is called securities lending. In this transaction, a pension fund lends a stock it holds to a hedge fund and receives cash in return as collateral. The deal is meant to provide a twofold benefit: The pension fund can make money by investing the cash collateral and can continue to benefit from the stock through its dividends and any appreciation in its value. Before the crisis, states committed billions of dollars to this practice. But when the credit markets seized up last year, pension funds got stuck. They could not access the investments they made with the cash collateral. Some had to sell off other investments at a loss to pay retiree benefits.
California's pension fund lost $634 million from securities lending as of March 31, but the total could reach $1 billion after a full accounting is done, according to a report from the system's consultant, Wilshire Associates. Still, the pension fund says it remains committed to the practice because it boosted returns in the two decades before the financial meltdown. Pension funds have also been aggressively pushing into real estate and troubled mortgage securities that were crushed in the crisis. California's pension fund is putting $2 billion into buying these toxic bank assets.
Financial analysts say the prices for these assets have fallen so far that they may be a better bet than in the past. But the crisis showed how unreliable these investments can be. And their prices may not yet have hit bottom. In August, California's pension fund took a similar gamble by investing $463 million in shopping centers across 17 states and the District of Columbia, though many experts forecast a prolonged slump in commercial real estate. Even if these strategies succeed, the shortfall may still be insurmountable.
In Ohio, for instance, the teachers pension system reported that it would take 41 years for its investments to catch up with the costs of meeting its obligations to retirees. That was before the worst of the financial crisis. During the last fiscal year, Ohio's fund lost 31 percent. Its most recent annual report detailed how long it would now take for its investments to put the fund back on track. Officials simply said: "Infinity."
Democrats Weigh Tax On Financial Transactions
Taxing financial transactions on Wall Street is gathering support in high places. With federal budget deficits soaring, policy makers and other advocates are eyeing the huge sums that could be raised as a way to cover the costs of new initiatives. Labor unions, in particular the AFL-CIO, have proposed a financial-transactions tax as a way to defray costs of a health-care overhaul. Lawmakers have discussed a similar fee as a way to cover the cost of future financial oversight. Liberal advocates are pushing the tax to pay for new stimulus spending.
This week, the left-leaning Economic Policy Institute floated the idea of a national transaction tax that would raise $100 billion to $150 billion a year. The tax, at a rate of 0.1% to 0.25% of the value of the trade, would be levied on all financial transactions such as stock trades, but not on consumer transactions such as with credit cards. The money would be used initially to pay for temporary aid to states, hiring incentives for public- and private-sector employers and school construction money.
"We are in a difficult time right now, so people are looking at every opportunity to gain some revenue to fund" new initiatives, said Rep. Stephen Lynch (D., Mass.), a member of the House Financial Services Committee. "Because I was one of the first to suggest using this to fund [new] regulatory infrastructure, folks have come to me and said, 'That's a good idea; I've got a better one: Why don't we use it for stimulus or especially health care?'"
One Democratic aide said the idea is under consideration among House leadership, though the discussions are preliminary. A spokeswoman for Republican House leader John Boehner of Ohio criticized the idea. "How is killing more American jobs by stifling capital investment, further eroding families' savings and diverting much-needed investment out of the United States a good idea during a severe economic downturn?" said the spokeswoman, Antonia Ferrier.
Unnoticed by many, the concept already has found its way into federal law. At the urging of House Democratic leaders, last year's $700 billion financial-bailout bill contains a provision requiring the president to submit legislation to "recoup" from the financial-services industry any eventual shortfall in the Troubled Asset Relief Program, or TARP. The provision, inserted during last-minute negotiations, was encouraged by moderate Democrats who worried that taxpayers would be left footing the bill if the government investment produced big losses.
Transactions taxes first were proposed in the 1970s for currency trading, to reduce volatility in exchange rates. The idea later was seized on as a way to reduce volatility in financial systems. In an interview Friday, Rep. Barney Frank, chairman of the House Financial Services Committee, said he supported the legislation's idea of recouping future losses from the industry. "I was one of the ones who suggested" the idea for the TARP provision, said the Massachusetts Democrat. He said he didn't specifically propose a financial-transactions tax. The provision could be structured as either a tax or a fee, he said, and could be a one-time provision rather than a permanent tax.
That would make it less likely that parties to financial transactions would seek to escape the tax by moving activity to another country. He said imposing such a tax "country by country...would be a problem." Many economists have argued against a financial-transactions tax on policy grounds, saying it could have consequences for markets, in part by driving activity outside the U.S. Critics said it also would throw sand in the gears of capital markets.
Still, some appear to be changing their minds. "I'm not as hostile as I used to be," said Len Burman, a Syracuse University professor and former head of the Tax Policy Center, a venture of the left-of-center Brookings Institution and Urban Institute. Curbing frequent trading might be a good idea, he said, though he is "skeptical this is the best way to do it." Mr. Frank said additional fees might be imposed on financial-industry participants such as payday lenders in order to pay for a consumer-protection agency.
Fees to pay for regulatory activities aren't considered a tax under House rules. The new fees would be relatively minor, he said, adding that details haven't been worked out. Similar fees already help pay for the operations of some agencies such as the Securities and Exchange Commission. A broader question is whether levies on the financial industry might be used to help establish a rescue fund for future calamities.
In response to a question at a House hearing in September, White House economic adviser and former Federal Reserve Chairman Paul Volcker said it "might be interesting" if Congress ordered a study of the idea of a transactions tax. But he pointed to the problem of driving transactions to other countries. "That's the No. 1 problem; you'll have to get some consistency internationally," he said. Trade unions are backing the idea to reduce government deficits and pay for new jobs initiatives, among other purposes. Amid their urging, the Group of 20 industrial and developing nations recently pushed the International Monetary Fund to study the idea, which has drawn endorsements from some leaders in the U.K. and Germany.
Britain has worst quality of life in Europe, study says
British people have the worst quality of life in Europe, according to a report which highlights the long hours, bad weather, low life expectancy and high price of many consumer goods. In a study of ten of the largest European countries, Britain comes last followed by Ireland, with France and Spain topping the table. Though British households enjoy the highest income, at £35,730 a year, £10,325 higher than the European average, British families have to contend with a high cost of living, with fuel, food and alcohol all costing more than the European average.
With a litre of unleaded petrol at £1.08 a litre, the UK is the second most expensive country in Europe. However, diesel is more expensive in the UK than anywhere else in Europe – £1.13 a litre, which is 19p or 20 per cent above the European average of £0.94. The report by price comparison website uSwitch analyses 10 European countries against 17 different benchmarks, from the price of gas, electricity, fuel, food and drink to the amount each country spends on education, health to working conditions and the weather.
The top three countries are France, Spain and Denmark, with Sweden, Ireland and Britain coming eighth, ninth and tenth respectively. The study comes less than a week after the United Nations moved Britain out of the top 20 list of most desirable countries to live in for the first time. While France and Germany were initially hit hard by the global financial crisis, both have officially exited their recessions, while Britain has yet to confirm this has happened. Later this week, despite signs of recovery in the housing market and buoyant retail sales, there is expected to be grim economic news with unemployment predicted to have climbed to above 2.5 million for the first time since 1994.
The uSwitch report indicated that Britain suffers from the lowest number of days holiday per year, with the average worker entitled to 26 days, well below Spain on 41. British consumers also pays the highest prices for diesel, food and the country spends below the European average, as a percentage of GDP, on health, and education. It also has the 4th lowest life expectancy in Europe, at 78.9 years, compared with above 80 years in France, Italy and Sweden and workers retire later than most of their European counterparts.
Ann Robinson, Director of Consumer Policy at uSwitch, said: "There is more to good living than money and this report shows why so many Brits are giving up on the UK and heading to France and Spain. "We earn substantially more than our European neighbours, but this level of income is needed just to keep a roof over our heads, food on the table and our homes warm. It’s giving us a decent standard of living, but it’s not helping us achieve the quality of life that people in other countries enjoy."
A Secret Deal Between Wall Street and Washington Shines a Harsh Light on Federal Housing Agency
by Pam Martens
While the Federal Trade Commission was receiving gut-wrenching documentation of predatory lending abuses at a unit of Citigroup, the Federal agency mandated to level the playing field for low income homeowners, the U.S. Department of Housing and Urban Development, was quietly awarding 19,968 mortgages of homeowners in distress to Citigroup to dispose of as it saw fit. HUD legally became Citigroup’s joint venture partner in at least two of the deals, retaining a minority interest.
On March 6, 2001, the FTC brought suit against Citigroup, CitiFinancial Credit Company and two firms it had acquired (Associates First Capital Corporation and Associates Corporation of North America) charging them with engaging in deceptive and illegal lending practices. The FTC had substantive evidence that a culture of incentivizing an aggressive sales force to pile predatory loans onto unsophisticated borrowers was an enshrined business model at Citigroup’s consumer lending unit. On July 20, 2001 a former Assistant Manager for CitiFinancial, Gail Kubiniec, testified as follows to the FTC:“At CitiFinancial, emphasis was placed on marketing new loans, particularly real estate loans (loans secured by a home mortgage), to present borrowers of CitiFinancial. Employees would receive quarterly incentives, called “Rocopoly Money,” based on how many present borrowers they ‘renewed’ (refinanced) into new loans…Typically, employees would only state the total monthly payment amount in selling a proposed loan. Additional information, such as the interest rate, and the financed points and fees, closing costs, and ‘add-ons’ like credit insurance, were only disclosed when demanded by the borrower…It was also common practice to try to sell borrowers the largest loan possible…
All CitiFinancial branch offices had quotas for the sale of credit insurance…Loans were typically presented to consumers with ‘100% coverage,’ meaning that real estate loans were presented with at least credit life and disability already included, and personal loans were presented with at least credit life, disability, involuntary unemployment, and property insurance already included. When quoting the monthly payment, I frequently quoted the payment with coverages already included, telling the consumer only that it was ‘fully protected.’ This was a common practice used by employees at CitiFinancial…The pressure to sell coverages came from CitiFinancial’s Regional and District Managers. Each branch had monthly credit insurance sales goals to meet…If these goals were not met, the District Manager would call and put pressure on the Branch Manager to get the branch up to par.”
Also in the trove of documents at the FTC, a series of Faxes to the sales force from one CitiFinancial manager, Mike Moniot, had the creepy feel of a Survivor-type reality tv show:
“Fax dated December 30, 2000: ‘…The manager must personally attempt to sell the loan while the customer is still on the phone if our offer is rejected when the employee pitches it. No call backs. Manager must get on the phone immediately. I expect to see notes from the managers on the results of their attempt. It makes sense for managers, our best salespeople to pitch the most difficult sales…’
“Memorandum dated June 12, 2001: ‘Good morning ladies and gentlemen. Today is the day we must rally on real estate. Our team has booked 7 R/E loans this month. This is a pathetic number folks. I will be calling you for your commitment this am…’“Fax dated June 26, 2001: ‘Enough is enough ladies and gentlemen. We did not achieve the improvement I hoped for last week. The following is in place effective today for the remainder of this month: Tom Politano, Cindy Lee: You are substantially below the min $/1000 level. You will personally close all personal loans the rest of this month…’
“Fax dated July 2, 2001: “The transfer by zip code of former Associates accounts was processed over month end…We have a contest in place for July to determine who does the best job of renewing these accounts. I will award points for renewing transferred accounts…The branch with the most points earns a day off for each employee in August.’”
The FTC also had testimony from Michele V. Handzel, a former Branch Manager for CitiFinancial:
“CitiFinancial put much more pressure on employees than the Associates did to include as many credit insurance and ancillary products as possible on every loan….In fact, I feel that the credit insurance sales practices at CitiFinancial were worse than at The Associates. From January to June 2001, the policy was that no personal loan at CitiFinancial would be approved if it did not include some type of credit insurance, nor would a real estate loan be approved without some type of ancillary product…There were several internal measures in place to effectuate this policy. For instance, District Managers would frequently refuse to send a loan to underwriting if it did not include some type of insurance product. Moreover, loans that were closed and did not include any insurance would be identified by CitiFinancial’s internal insurance auditors, and the employee who closed the loan would be written up…Closings at CitiFinancial resembled those at The Associates – they were brief. Personal loan closings took approximately 10 minutes. Real estate loan closings took a little longer but also did not provide a lot of details about the loan. At CitiFinancial, I was instructed to do a ‘closed folder’ closing, meaning that information would be discussed orally first. Only after the borrower indicated that he wanted to sign would the employee open the folder and have the borrower sign the papers.”
Around this same time Citigroup was running a “Live Richly” ad campaign conceived by ad agency Fallon Worldwide. According to Citigroup, the campaign was to communicate “that Citi is an advocate for a healthy approach to money. Citi is an active partner in achieving perspective, balance, and peace of mind in finances and in life for its customers.” In reality, the dark underbelly of the consumer lending divisions of Citigroup was creating a torrent of mail to federal agencies and members of Congress: On April 22, 2001, a resident of San Antonio, Texas wrote:“I ask for you help. Federal law and regulations are being violated intentionally in CRIMINAL, perhaps RACKETEERING, manner by a spaghetti-like entanglement of corporations…I refer to Sanford Weil[l]’s Citigroup…The particular criminal activity is that, despite federal law & regulation, despite what is written on its customers’ statements, Citigroup/Universal Card refuses to abide by mandated policy about the purchase of defective merchandise…”
On August 28, 2001, an Ohio woman wrote to HUD as follows:“This will be my 3rd request for someone from this dept to assist me. I am a victim of predatory lending. Citifinancial gave me a loan at 24.99% in June of ’99. I had a perfect credit score. The[y] called me back into their office one week later. Refinanced that same loan at 18.99% and had a check for $500.00 waiting for me…this time they told me that I had to use my home as collateral to get the lower interest rate…I feel that because I am a female and black that they…thought they could get away with this…”
A distraught woman in Enid, Oklahoma wrote to her Senator, James Inhofe:“…We had paid our home loan off in full…The new loan…was in the amt. of $24,139.20. This was a rehabilitation loan for our home. The first problem occurred when we wanted to hire L.E. Clark as our General Contractor. The loan officer (whose name is Audrey) said that we had to use B&K Home Improvement Inc. as our contractor. We told her that we did not want B&K. We knew Mr. Clark and his work. She said that it was none of our business. She had hired B&K and if my husband called back she would file harassment charges…We were supposed to co-sign a check to B&K every ? of work approved. Audrey gave B&K ? of money up front. This was done without our knowledge or consent...at this time we are desperate…We are living in our ‘gutted’ house which is actually unlivable but we had no choice. Any help that you can give us would/will be very much appreciated. You are our last hope. We have tried everything.”
Was there any evidence to support the premise that CitiFinancial was targeting minorities and the vulnerable? Absolutely. According to their former Assistant Manager, Gail Kubiniec:“I and other employees would often determine how much insurance could be sold to a borrower based on the borrower’s occupation, race, age, and education level. If someone appeared uneducated, inarticulate, was a minority, or was particularly old or young, I would try to include all the coverages CitiFinancial offered. The more gullible the consumer appeared, the more coverages I would try to include in the loan…”
The FTC settled their suit on September 19, 2002 for $215 million. But the press release issued by the FTC made it appear, incorrectly, that the abuses stemmed from The Associates firms that Citigroup had acquired when the evidence clearly demonstrated that CitiFinancial was fully holding up its end of the predatory brotherhood. The press release quoted Timothy J. Muris, Chairman of the FTC at the time: “I am pleased that Citigroup has agreed to remedy the grave injury caused by The Associates and that Citigroup has announced new measures at CitiFinancial aimed at preventing these kinds of problems.”
Just one month later, HUD would make its second award to Citigroup in as many years, handing over 6,656 mortgage loans insured by HUD sibling, FHA, of people experiencing financial hardship and delinquent on their loan payments. HUD left the decision in Citigroup’s hands as to whether to foreclose, sell off the loans en masse to other investors (securitization), or restructure the loans. The HUD mortgage sales in 2002 though 2005 are a stark departure from HUD’s stated mandate of helping low income people remain in their homes during periods of financial hardship. Even the controversial sales HUD made in the 90s that eventually erupted into charges and counter-charges of improprieties had many built-in protections that do not appear to have been present in the current round of sales.
According to a June 1999 report from the U.S. Government Accountability Office (GAO), “Homeownership: Information on Single Family Loans Sold by HUD,” the purchasers were required by HUD “to offer borrowers the same forbearance, or lower loan payments, that HUD was required to offer before the loans were sold.” To monitor that the purchasers were actually honoring the protections contained in the loan sales agreements -- including reduced mortgage payments -- HUD conducted reviews of loan servicers and established a toll-free telephone complaint line for borrowers whose loans had been sold.
That contrasts with the current program which states that the private partners “determine how best to maximize the return on the loan…Loans liquidated through note sales generally earn a higher return than property sales, so the JV [joint venture] has an incentive to maximize the share of note sales relative to property sales.”
Turning over a swath of a critical social policy mandate to the piranhas of Wall Street who have demonstrated an unprecedented knack for financial incompetence except in the realm of campaign donations, is clearly a matter for congressional subpoenas and testimony under oath. Both Congress and the public at large will be more cognizant of the escalating devastation to lives and property values by making the time to watch Andrew and Leslie Cockburn’s emotionally-gripping film, American Casino.
Despite repeated requests over the past ten days to Lemar Wooley in the Public Affairs Office of HUD, Kathleen Malone, Director of the Office of Asset Sales, and John Lucey, Deputy Director, HUD refuses to confirm the names of the winning bidders and co-bidders of distressed single family mortgage sales that stretched from at least 2000 through 2005.
In addition to the awards reported in the first part of this series (see Wall Street Titans Use Aliases to Foreclose on Families While Partnering With a Federal Agency, CounterPunch, October 5, 2009), we have learned from outside sources that a division of Citigroup also received a bid award in 2000 consisting of 8,503 loans. As we previously reported, Lehman Brothers (now bankrupt) won a 2003 award and Bear Stearns (rescued by JPMorgan Chase and the Federal Reserve) won a 2005 award.
Deborah Leggett found out the hard way that HUD, a taxpayer funded agency legislatively mandated to serve the public interest, had joined ranks with the “heads I win, tales you lose” swashbucklers on Wall Street. In a desperate legal battle to save her home that stretched from 2005 through February of this year, HUD and its joint venture partner Citigroup, using the alias of SFJV-4 (Single Family Joint Venture 2004), buried Ms. Leggett under motions, briefs, counter-claims and even a request for sanctions in the United States District Court for the Northern District of Texas. According to their own record put before the court on November 11, 2008 they did not offer Ms. Leggett the HUD required protections of an effort for loan modification or forbearance prior to moving for and obtaining foreclosure. Indeed, Ms. Leggett’s attorney quoted counsel from the other side stating that they could not even produce the mortgage note as proof they even owned the property (raising the question as to whether the property had already been sold off to investors in a securitization).
Ms. Leggett lost her court battle as well as her home and was evicted. There is nothing in the court record to suggest that Ms. Leggett ever knew her court adversary was her own government.
We’re still lynching people in America. It’s not a physical lynching, it’s more nuanced now. Today, the noose is a stack of indecipherable loan papers or a court order compelling one to hand over your home and your dignity to a Wall Street bank that robbed you just because it could; that stripped you of your hope and aspirations just because your government did not stand in its way or, as here, joined forces.
Iceland Economy Shrinks 8% as Prices Increase 11% in Deepest Recession
Arni Hallgrimsson lost his job as a public relations consultant when Iceland’s three biggest banks collapsed last year, putting him out of work for the first time since 1980. After a stint cleaning the docks at a whaling station during the summer hunt, he’s unemployed again. “Nightmares come to an end when you wake up, but this one just goes on and on and on and on,” the 53-year-old father of three said at his home in Reykjavik, Iceland’s capital. “I’ve applied for many jobs that fit my profile. Sometimes I’ve been on the short-list, but eventually not been offered the job.”
A year after the banking crisis brought Iceland to the brink of bankruptcy, the island nation is mired in the deepest recession among advanced economies. The stock market has lost 97 percent of its value, and more than 780 companies have buckled under the weight of foreign currency loans as the krona plunged. Consumers refuse to borrow at Europe’s highest interest rates, and international banks reject requests for new financing.
Prime Minister Johanna Sigurdardottir, who took office in February, pinned hopes for a recovery on the International Monetary Fund after Kaupthing hf, Landsbanki Islands hf and Glitnir Banki hf racked up $80 billion in debt, 16 times Iceland’s economic production. Now she says the economy may implode again as a dispute over Icelandic savings accounts held by overseas depositors delays a promised $5.1 billion bailout.
“It’s been a year since all hell broke loose and there hasn’t actually been much done to ease the situation,” said Almar Gudmundsson, secretary general of the Federation of Icelandic Trade, which represents importers, exporters, wholesalers and retailers. “We don’t think that we as a nation are doing enough to make the wheels get going again.” Iceland’s economy will shrink 8.5 percent this year and consumer prices will climb 11.7 percent, both the worst performances among the world’s 33 advanced economies, according to the IMF’s latest forecasts. As the rest of the world begins to recover, Iceland’s recession will stretch into next year, with the economy contracting 2 percent, more than any developed nation except Ireland.
Unemployment will rise to 8.6 percent this year, from less than 1 percent in December 2007, the IMF estimates. Iceland will still trail the eurozone average of 9.9 percent and Spain’s 18.2 percent jobless rate, the highest in the developed world. One of the hardest-hit industries has been construction, where 202 companies filed for bankruptcy in the 11 months after the crash, 67 percent more than in the same period a year earlier, according to data compiled by Statistics Iceland.
Hallgrimsson’s firm primarily helped builders sell their projects and persuade the public that all environmental concerns were being met. “The contractors were the first to go bust,” he said. “They couldn’t secure financing, meaning they completely threw out marketing and PR. Before we knew it, there wasn’t a single contractor on our list of clients.”
The crash followed four years in which the economy grew at an average annual rate of 4 percent following the sale of Icelandic banks to private investors from 1998 to 2002. The banks and investors, including Jon Asgeir Johannesson’s Baugur Group hf, went abroad to escape the shackles of a nation of 320,000 people. The expansion was financed by international investors who bought bonds paying as much as 10 percent. They defaulted as the credit crisis dried up financing.
The chief executive officers of New Kaupthing hf, Islandsbanki hf and Landsbankinn hf, the state-owned successors of the failed banks, said they’re still trying to win the trust of overseas lenders and as yet are unable to obtain foreign- currency loans. The CEOs, all brought in after the collapse, said the banks no longer have global ambitions. “We are starting with just introducing ourselves,” said Islandsbanki CEO Birna Einarsdottir, who worked at Royal Bank of Scotland Group Plc in Edinburgh for six years before returning to Iceland in 2004, in an interview. “What we do internationally is going to be very, very focused.”
The krona’s official exchange rate has declined 53 percent against the dollar since Nov. 2, 2007, making it the laggard of 175 currencies tracked by Bloomberg.
Iceland’s benchmark stock index plunged 77 percent on Oct. 14, 2008, when it resumed trading after a three-day suspension. It is the world’s worst-performing equity index since reaching its high in July 2007, according to data compiled by Bloomberg. Listings have dropped to 10 from 22. The central bank left its benchmark rate unchanged last month at 12 percent, the highest in Europe. Only Pakistan and Lebanon, at 13 percent, have higher rates among the 58 central banks tracked by Bloomberg. The European Central Bank’s benchmark rate is 1 percent.
Companies are struggling as the krona’s decline and high interest rates wipe out consumer demand on the North Atlantic island, which imports about 70 percent of the products it uses, including raw materials such as lumber and oil. “People aren’t buying flat screens, they aren’t buying furniture, they aren’t traveling abroad or buying luxury goods,” said Bogi Thor Siguroddsson, owner of Johan Roenning hf, an importer and retailer, who says his sales volume has dropped 50 percent. “What is selling now is food, drugs and gasoline.”
Before the crash, Hallgrimsson and his wife were reducing their debts and making extra payments on their mortgage. That became harder and harder because the loans were indexed to inflation. Now he says he worries about every krona. “Recently my daughter asked if she could take a drama class and we had to think hard about whether or not we could afford it,” Hallgrimsson said. “Eventually we decided to let her go, and I’m glad we did because she loves it, but just the fact that we had to think about it is a little sad.”
Borrowing rates charged by New Kaupthing, Islandsbanki and Landsbankinn remain at a prohibitive level of about 15 percent, New Kaupthing CEO Finnur Sveinbjoernsson said in an interview. “Credit will be more expensive and less abundant,” he said at the bank’s waterfront offices, which sport a glass wall covered by a waterfall, warehouse-style furnishings and a coffee bar, all built during the boom. “A more responsible fiscal attitude will have to be the norm going forward.”
The government of former Prime Minister Geir Haarde, whose Independence Party oversaw the privatization of the banks, crumbled in January. Voters in April elected a coalition of Social Democrats and Left Greens, who have promised more welfare and bigger government. Sigurdardottir, 67, said this month that more transparency and tighter financial regulations are needed. She also plans to pursue European Union membership and possible adoption of the euro to protect Iceland against swings in the krona.
IMF funding hinges on efforts to settle the claims of overseas depositors who had accounts with Icesave, a unit of Landsbanki Islands. The U.K. and Dutch governments have stalled funding until Iceland agrees to cover the claims. Opposition politicians say the demands are unfair, and members of the Left Green Movement are split on the issue, threatening to leave Sigurdardottir’s government in the minority.
The government estimated Oct. 1 that Iceland will post a deficit of 182.3 billion kronur ($1.5 billion), or 14 percent of gross domestic product this year. The proposed 2010 budget includes new energy, environment and natural resources taxes. “If the government is taxing its way through the fiscal problem, it will just prolong the crisis,” said Gudmundsson, the head of the trade federation. “We think heavy cost cuts in the expenditures of the government are necessary.”
Some of those in power during the good years are beginning to make a comeback. Former Prime Minister and central bank Governor David Oddsson was named editor-in-chief of Iceland’s oldest newspaper, Morgunbladid, last month. The day before the announcement, 40 of 100 employees were fired. Oddsson, 61, was Iceland’s longest-serving prime minister, holding office for 13 years after he was first elected in 1991. He became foreign minister in 2004 and was central bank governor in 2005. He refused to step down after the economy collapsed, so parliament passed a law that removed him from office.
Thus far no one has been charged with a crime in connection with Iceland’s economic failure. Gunnar Andersen, director of Iceland’s Financial Supervisory Authority, said Aug. 5 that 20 cases of banking malpractice have been sent to a special prosecutor, and the FSA is investigating another 20 cases. A commission, created by parliament to “seek the truth” about events that led to the banks’ downfall, is scheduled to announce its findings Nov. 1. Chairman Pall Hreinsson, a Supreme Court judge, has said that never before has any group had to break such bad news to the Icelandic people.
Icelanders have already taken it upon themselves to punish those they think are responsible, spray painting the homes of Hreidar Mar Sigurdsson and Bjarni Armannsson, the former CEOs of Kaupthing and Glitnir. A Hummer owned by Bjorgolfur Thor Bjorgolfsson, the former chairman of the Straumur investment bank, was doused with red paint. Baugur Chairman Johannesson, 41, whose firm owned 32 percent of Glitnir, blamed the collapse on the global recession.
“Due to the size of the banks in comparison with the economy, due to a worthless currency and way too little reserves, the central bank had a limited ability to provide the banks with short-term loans or assistance,” he wrote in a letter published Dec. 29 in Morgunbladid. “The owners of all three banks didn’t have the financial capabilities to increase the banks’ capital following difficult times and recent losses, as was also the case in many places abroad.”
The banks’ freewheeling activities dragged down companies that received cheap money to speculate on financial derivatives or borrowed against shares in one business to buy stock in another. Others failed as payments on foreign-currency loans soared after the krona’s plunge. One example was Baugur, which bought retailers in London and New York during a 10-year acquisition spree. Baugur filed for bankruptcy in March with debts that exceeded assets by 148 billion kronur. Johannesson didn’t respond to messages seeking comment.
Erlendur Gislason, an attorney with the Logos law firm in Reykjavik, has spent the past six months piecing together the financial picture at Baugur. His conclusion: little of any value is left to pay 158 claims made by 60 unsecured creditors. “Most of the assets in Baugur were mortgaged before the bankruptcy,” Gislason said. “It’s quite a meager piece of assets that are left.” Landsbankinn took control in February of Baugur’s U.K. unit, which had stakes in department store chain House of Fraser Plc, Iceland Foods Ltd. and jewelry chain Goldsmiths.
Hekla, a 76-year-old car dealer and importer in Iceland, is now owned by New Kaupthing. Standing in Hekla’s showroom, marketing manager Brynjar Oskarsson is surrounded by new Volkswagens and Audis. There are no customers, and Oskarsson doesn’t expect any. People aren’t buying cars because prices have risen 66 percent in the past two years as the krona slumped in value, Oskarsson said. He estimates that just 2,100 vehicles will be sold this year in Iceland, down from a peak of 18,058 in 2005. Hekla has cut its staff to 160 workers from a high of 250. “I feel disappointed with how a few individuals ruthlessly gambled with many of our best companies and, without blinking, used Iceland’s reputation and good image as their best weapon,” Oskarsson said.
The only winners in Iceland’s collapse are companies paid in foreign currency. Along the waterfront, the smell of fish pervades the headquarters of HB Grandi hf, Iceland’s largest fishing company. Grandi hauls in 12 percent of the island’s annual catch, including cod, halibut and haddock, and exports all of its fish. The company hasn’t laid off any of its 650 workers and employees received a raise this year. “In today’s business world in Iceland, that’s all good news,” said CEO Eggert Gudmundsson, 45, who joined the company five years ago from a Silicon Valley technology firm, after he and his family decided to return to their native Iceland.
It’s been even better for the tourism industry as the krona’s decline makes Iceland a bargain for foreign travelers. A record 353,110 people visited the country in the first eight months of the year, selling out hotels, filling restaurants and inundating tour companies such as Ishestar travel, where a sign outside the office door reminds visitors to take off their boots after visiting the stables for Icelandic ponies. “This difficult year has been by far our best,” said owner Einar Bollason, adding that he’s had to turn away customers because he didn’t have the capacity to serve them. “Of course, this is a wonderful problem to have.”
As for the banks, Iceland’s financial industry will probably get smaller, with consolidation likely, the CEOs said. Johann Bergthorsson lost his part-time job at Landsbankinn’s predecessor when the lender was nationalized. He has since founded Dexoris, which is creating video games for Apple Inc.’s iPhone and iPod Touch. “When the whole economy of the country collapses, you just have to change your plans,” said Bergthorsson, a 22-year-old mathematician. “When the bank went overboard, the decision was made. I decided to do something different, something more creative.”
The ownership of Islandsbanki, formerly Glitnir, and New Kaupthing will be determined this month when creditors decide whether to exchange debt for stakes in the banks. Landsbankinn’s future is less certain because of the Icesave talks. Eventually, the banks plan to sell shares to the public, the CEOs said. Such a move is probably years away, and requires rebuilding the trust of investors, they said.
“I don’t expect them to forget what happened,” Landsbankinn CEO Asmundur Stefansson, said at the bank’s wood- paneled headquarters in Reykjavik’s old downtown. “I mean, what happened was terrible. We have obviously burned many bridges in the process. We cannot deny that.” Hallgrimsson said he can’t move on because he’s struggling to pay his bills and waiting to see whether the whaling station will hire him as a maintenance worker this winter. “Nobody seems to have learned a thing,” he said. “Instead of dealing with the enormous tasks at hand, politicians are playing the blame game. I’m not optimistic.”
Spanish Office Building Prices May Plunge to 2001 Levels as Jobs Disappear
It wasn’t hard for Miguel Angel Zuniga to persuade his landlord to drop the rent for his printing company in northern Madrid by 20 percent. More than a third of the buildings in the industrial park a 30-minute drive from the city center are empty. One close to Zuniga’s burned down and the owners haven’t rebuilt. Zuniga also knew he could get a third more space in the same complex for what he was paying.
“Three years ago when the business was set up, you had to fight tooth and nail to find premises; now you can pick and choose,” said Zuniga, 46, manager of Grupo Imant, whose monthly rent for 1,000 square meters (10,764 square feet) of office and warehouse space fell to 3,600 euros ($5,319) from 4,500 euros. Spain’s commercial property market is suffering as the unemployment rate approaches the highest in at least 15 years. Business rents in city centers have dropped 22 percent in the past year, the most since 2002, according to Jones Lang LaSalle Inc. Average selling prices for all office buildings in Spain may fall 25 percent through the end of next year, bringing them back to 2001 levels, said RR de Acuna & Asociados, a property researcher in Madrid.
Office values in the country’s central business districts have already fallen about 50 percent since the peak in 2007, according to Savills Plc in London, the largest publicly traded U.K. commercial real-estate adviser. Zuniga’s landlord, Daniel Estebaranz, didn’t respond to telephone calls left at his Madrid office for comment. The supply of potential tenants is shrinking as more businesses fold. About 66,400 Spanish companies closed in 2008, and about 2,770 sought protection from creditors in the first half of 2009, up from 901 a year earlier, according to the National Statistics Institute.
“Commercial property prices are very much linked to the performance of the economy, and at the moment nobody knows when it’s going to flourish again,” said Pedro de Churruca, managing director for Spain at Jones Lang in Madrid. Spain’s property boom started after it adopted the euro in 1999 and interest rates plummeted to about 3 percent from as high as 15 percent. Real estate and construction accounted for as much as 20 percent of gross domestic product at the peak in 2007, according to KPMG. Commercial real estate prices climbed 51 percent from 2000 to the end of 2007, research from Investment Property Databank Ltd. shows.
Office space has expanded 38 percent in Madrid since 2000 to 11 million square meters, said Cushman & Wakefield Inc., the largest closely held commercial property broker. It jumped 41 percent in Barcelona. Spain now has 514 shopping malls, up from 300 in 2000, according to the Spanish Association of Shopping Malls. The global credit crisis led Spain’s economy to contract for the first time in 15 years in the third quarter of 2008. The unemployment rate rose to 18.9 percent in August of this year, almost double the euro-region average, the European Union statistics office said. It will probably reach about 25 percent by the end of 2010, according to Fernando Rodriguez de Acuna, president of Acuna.
Some developers in Spain were trapped when the boom ended because they had already committed to projects that can take as long as five years to complete, said José Luis Suárez, professor of financial management at the IESE business school in Madrid. “You have to take into consideration planning, getting permits and financing and actually constructing the buildings,” he said.
Warehouses and shops in Spain will probably lose 31 percent and 20 percent of their value, respectively, by the end of 2010, according to Acuna. Evidence of the country’s decline can be found even on the upscale Calle Velazquez in central Madrid, where an antiques store, a bar, a gift shop and a home-decoration store have all closed. For Rent and For Sale signs are scattered on either side of the street. Sara Perez-Frutos, managing director at Dracon Partners, an investment company on Calle Velazquez, said about half the 20 tenants in her building have left in the past three months. She can now get a parking space outside her office every day. “You don’t encounter a soul in the lift these days,” said Perez-Frutos, 35.
Madrid’s office vacancy rate was 8.4 percent as of June 30, the highest since 2005, according to Aguirre Newman, a Madrid- based property consultant. “The amount of stock will continue to rise above 10 percent as demand continues to fall and new supply continues to enter the market,” analysts Javier Garcia-Mateo and Angel Estebaranz from Aguirre wrote in a July report. The severity of the slump means Spain may be starting to represent good value to some investors, said Michael Haddock, director of research for Europe, Middle East and Africa at CB Richard Ellis Group Inc. in London.
Yields on the best properties have risen more than 2 percentage points since the middle of 2007 to between 6.75 percent and 7.5 percent, he said. That’s about 50 percent more than the increase in yields on similar buildings across the EU since peak prices. Signs of recovery may already be emerging, Haddock said. He cited the 235 million-euro sale of a Madrid shopping mall by Banco Santander SA’s real estate fund in May, and Inmobiliaria Colonial SA’s sale of another retail center in June for 126.5 million euros.
“We are at a moment of opportunity, where prime assets can be purchased at good prices before the competition between buyers increases,” Rafael Merry del Val, general director of Savills’s Spanish unit in Madrid, said during a presentation to reporters in September. Analysts Nick Webb and Jacqueline Cheung at Goldman Sachs Group Inc. are less optimistic. They rate Metrovacesa SA, Spain’s biggest real estate company by market value, as a “sell” and expect the stock to reach 12.8 euros. Metrovacesa now trades at 21 euros, after a 59 percent decline in the past year. “Our greatest caution surrounds Spain and industrial rents,” Webb and Cheung wrote in the report. “Spain will remain challenging for some time.”
Industrial production slid for a 16th month in August, down 13.1 percent from a year earlier. GDP shrank 4.2 percent in the second quarter, according to the National Statistics Institute. The Organization for Economic Cooperation and Development expects Spain’s GDP to contract 0.9 percent in 2010 as consumer spending dwindles, making it the worst performer in the 30- nation group after Ireland and Hungary. House prices in Spain fell 8.3 percent in September from a year earlier, Tasaciones Inmobiliarias SA, the country’s biggest home valuer, said today.
Spain plans to raise the rate of value-added tax on goods and services to 18 percent from 16 percent in July to address a budget deficit slated to reach 9.5 percent of GDP this year. That could hurt real estate even more, de Churruca said. “Increased taxes will reduce consumption that will in turn have a negative impact on commercial properties,” he said. “I don’t see adequate measures are being taken to reactivate the economy.”
That’s bad news for Zuniga’s printing business. He’s worried companies will scale back more on advertising and he’ll get fewer contracts for less money as he cuts prices to fend off the competition. Sales in the industry are already down as much as 35 percent, he said. “My old rent was set on the premise that Spain was booming and there was no sign of the economic crisis we are caught in now,” he said. “Those times have long gone.”
Australia May Double Mortgage-Backed Bond Investments
Australia may double its investment in residential mortgage-backed securities to promote competition in the nation’s lending market and put “downward pressure” on borrowing costs. The Australian Office of Financial Management will be directed to support as much as A$8 billion ($7.2 billion) of new issues, “depending on market conditions,” Treasurer Wayne Swan said today in an e-mailed statement. The government has spent A$7.4 billion buying RMBS in the past 12 months, according to information posted on its Web site.
The government began buying mortgage-backed bonds last year as international investors retreated from property lending after markets were frozen by the global credit crunch. Australia’s four largest lenders, which can use also deposits to raise funds, have won residential mortgage market share from smaller players because of problems selling bonds. “We do need to see a revival of smaller players in the mortgage market because the current level is being dominated by the major banks,” said Craig James, a senior economist at Commonwealth Bank of Australia in Sydney. “Developers and investors are finding it very difficult to get new funding because banks are very cautious in their attitude.”
Efforts to support lenders haven’t attracted as many investors to the market as hoped, a Senate Committee said last month. “In the past few months, there has been a notable improvement in investor sentiment in both primary and secondary RMBS markets,” Swan said today. “However, the RMBS market continues to be affected by the fallout from the global financial crisis, and pricing and volumes have not yet improved enough to support affordable new issuance from a variety of smaller lenders.”
Australia & New Zealand Banking Group Ltd.,Commonwealth Bank of Australia, National Australia Bank Ltd. and Westpac Banking Corp. increased their combined portion of new owner- occupier mortgages to 81 percent in July from 60 percent as of mid-2007, the Reserve Bank of Australia said Sept. 24. The extra yield investors demand to own mortgage-backed bonds over the bank bill swap rate, a benchmark for borrowing costs, widened to as much as 550 basis points this year from 15 basis points before the credit crunch, the RBA said in its report. That spread has fallen to about 150 basis points today, Swan said,
Today’s announcement won’t add to net debt because the government will be buying AAA-rated assets, Swan said. Eligibility for the program will be extended to include a greater number of residential mortgages used by small business owners to fund their business. “The government’s temporary extension of the program will help smaller lenders to continue to issue RMBS in the short term as the securitization market recovers,” Swan said. “This will help small business owners who access finance for their business using loans secured against residential property.”
One nation, under illusion
The hoariest and most oft-repeated cliche in American politics may be that America is the greatest country in the world. Every politician, Democrat and Republican, seems duty bound to pander to this idea of American exceptionalism, and woe unto him who hints otherwise. This country is “the last, best hope of mankind,’’ or the “shining city on the hill,’’ or the “great social experiment.’’ As if this weren’t enough, Jimmy Carter upped the fawning ante 30 years ago by uttering arguably the most damning words in modern American politics. He called for a “government as good as the American people,’’ thus taking national greatness and investing it in each and every one of us.
Carter was speaking when Watergate was fresh, and government had been disgraced, but still. The fact of the matter is that whenever anything really significant has been accomplished by our government, it is precisely because it was better than the American people. Think of World War II, America’s entrance into which was strenuously resisted by the populace until Franklin Roosevelt carefully laid the groundwork and Pearl Harbor made it inevitable.
Think of civil rights, which Lyndon Johnson pressed despite widescale opposition, and not just in the South. Even then it took more than 100 years. Or think of the current health care debate in which Americans seem to desire some sort of reform, just not a reform that would significantly help people in dire need, while the Obama administration is pushing to provide that assistance. In the end, government has inspired Americans far more than Americans have inspired their government. They are too busy boasting.
There is nothing wrong with self-satisfaction or national pride. But the incessant trumpeting of our national superiority to every other country in the world is more than just off-putting and insulting. It is infantile, like the vaunting of a schoolyard bully that his Dad is better than your Dad. It is wrong. And it might be dangerous both to ourselves and to the rest of the world.
Consider what it means. By what standard is one nation any greater than any other nation? Yes, the United States has vast material resources - we rank eighth in gross domestic product per capita - but we also have, according to the Organisation for Economic Cooperation and Development, the “highest inequality and poverty rate’’ in the world, outside of Mexico and Turkey, and things are getting worse. Nothing to boast of there.
Yes, we have a relatively high median income, but our standard of living as measured by the Human Development Index of the United Nations ranks us only 15th in the world, behind, among others, Norway, France, Canada, and Australia. Are they better than we are? Even our home ownership rate trails that of the citizens of Canada, Belgium, Spain, Norway, and even Portugal. Yes, the United States has the best system of higher education in the world, but, according to an Educational Policy Institute report, we rank 13th in the affordability of that education, and we are much less successful with lower education - 11th in the percentage of the 25 to 34 population with a high school diploma and 22d in science education.
And though Americans love to crow about the “best health care’’ in the world, the fact is that according to the World Health Organization Index, we actually rank 37th in the quality of our health care. And we are still the only industrialized country in the world without a national health care system.
Even when one considers anecdotal evidence - “If this isn’t the greatest country then why do so many people want to come here?’’ - the case isn’t particularly persuasive. Mexicans cross the border to the United States for economic opportunity. Turks go to Germany, Indians and Pakistanis to Great Britain, Arabs to France. This isn’t a sign of our special greatness, just a sign that desperate people seek a more powerful economy for their betterment.
The point of all this isn’t that America doesn’t have a lot to be proud of. It does. The point is that just about every country has a lot to be proud of, and America has no more right to assume it is the greatest nation in the world than does France, Switzerland, China, or Russia.
None of this would make much difference if the self-congratulation was just harmless bragging. But there are consequences. A country that believes it is the greatest in the world is also less likely to be constrained by that world. One could argue that the Iraq war was a direct result of a sense of national infallibility. So was our willingness to torture, our reluctance to admit our mistakes in Afghanistan, our culpability in the global recession, and our foot-dragging on global warming. Such a nation is also less likely to introspect or to strive for true greatness because it believes its greatness has already arrived.
There is something bizarre about a country whose leaders have constantly to toady to their constituents and in which any criticism is tantamount to a lack of patriotism, but that describes America today. Every politician feels compelled to ape Jimmy Carter’s old words to the point where our alleged greatness has also become our national mantra. It seems eons ago when Bobby Kennedy, a politician who didn’t like to stroke even his own supporters, actually scolded a rally for booing Lyndon Johnson because, Kennedy said, Johnson couldn’t have done what he did in Vietnam if he didn’t have the American people, including Kennedy’s audience, as his facilitators.
We aren’t going to hear that sort of honesty from political leaders any more because the American people are too thin-skinned and arrogant to tolerate it. Arrogance in an individual is unbecoming. It is no more becoming for a nation. The Greeks understood that the gods punished mortals for their hubris - for feeling that they were godlike. They knew that overweening pride preceded a fall.
One suspects that nations are no more immune to punishment than individuals. A nation that brooks no criticism, a nation that feels it is always better than any other, a nation that has to be endlessly flattered and won’t face the truth, a nation whose people think they possess some special moral exemption and wisdom, a nation without humility is a nation spoiling for calamity.
We’ve been living in a fool’s paradise. The result may be a government that is as good as the American people, which is something that should concern everyone.
New fears for species extinctions
Scientists have warned of an alarming increase in the extinction of animal species, because of threats to biodiversity and ecosystems. The threats are posed by pollution, climate change and urban spread. The comments come two days ahead of a meeting of the Diversitas group of global experts on biodiversity in the South African city of Cape Town.
Group members say world leaders have failed to honour commitments on reducing the loss of biodiversity.
These latest warnings are stark. They point to statistics that demonstrate that the extinction rates of animal species are much higher than had been predicted only a few years ago. The worst affected - according to the scientists from the Diversitas group of biodiversity experts - are freshwater species like fish, frogs, turtles and crocodiles.
The scientists warn that these freshwater species are becoming extinct six times faster than their terrestrial and marine cousins. Some of the group's experts predict that by 2025 not a single river in China will reach the sea - except during floods. The members of Diversitas are meeting from Tuesday in Cape Town to come up with new goals to slow down the extinction rates.
They lay the blame on these increased threats to animal species on world leaders. The leaders, they say, have failed to implement the policies needed to make good on their commitments - drafted at the Earth Summit in Johannesburg seven years ago - to significantly reduce the loss of biodiversity by 2010.
The Collider, the Particle and a Theory About Fate
More than a year after an explosion of sparks, soot and frigid helium shut it down, the world’s biggest and most expensive physics experiment, known as the Large Hadron Collider, is poised to start up again. In December, if all goes well, protons will start smashing together in an underground racetrack outside Geneva in a search for forces and particles that reigned during the first trillionth of a second of the Big Bang.
Then it will be time to test one of the most bizarre and revolutionary theories in science. I’m not talking about extra dimensions of space-time, dark matter or even black holes that eat the Earth. No, I’m talking about the notion that the troubled collider is being sabotaged by its own future. A pair of otherwise distinguished physicists have suggested that the hypothesized Higgs boson, which physicists hope to produce with the collider, might be so abhorrent to nature that its creation would ripple backward through time and stop the collider before it could make one, like a time traveler who goes back in time to kill his grandfather.
Holger Bech Nielsen, of the Niels Bohr Institute in Copenhagen, and Masao Ninomiya of the Yukawa Institute for Theoretical Physics in Kyoto, Japan, put this idea forward in a series of papers with titles like “Test of Effect From Future in Large Hadron Collider: a Proposal” and “Search for Future Influence From LHC,” posted on the physics Web site arXiv.org in the last year and a half. According to the so-called Standard Model that rules almost all physics, the Higgs is responsible for imbuing other elementary particles with mass.
“It must be our prediction that all Higgs producing machines shall have bad luck,” Dr. Nielsen said in an e-mail message. In an unpublished essay, Dr. Nielson said of the theory, “Well, one could even almost say that we have a model for God.” It is their guess, he went on, “that He rather hates Higgs particles, and attempts to avoid them.” This malign influence from the future, they argue, could explain why the United States Superconducting Supercollider, also designed to find the Higgs, was canceled in 1993 after billions of dollars had already been spent, an event so unlikely that Dr. Nielsen calls it an “anti-miracle.”
You might think that the appearance of this theory is further proof that people have had ample time — perhaps too much time — to think about what will come out of the collider, which has been 15 years and $9 billion in the making. The collider was built by CERN, the European Organization for Nuclear Research, to accelerate protons to energies of seven trillion electron volts around an 18-mile underground racetrack and then crash them together into primordial fireballs.
For the record, as of the middle of September, CERN engineers hope to begin to collide protons at the so-called injection energy of 450 billion electron volts in December and then ramp up the energy until the protons have 3.5 trillion electron volts of energy apiece and then, after a short Christmas break, real physics can begin. Maybe.
Dr. Nielsen and Dr. Ninomiya started laying out their case for doom in the spring of 2008. It was later that fall, of course, after the CERN collider was turned on, that a connection between two magnets vaporized, shutting down the collider for more than a year. Dr. Nielsen called that “a funny thing that could make us to believe in the theory of ours.” He agreed that skepticism would be in order. After all, most big science projects, including the Hubble Space Telescope, have gone through a period of seeming jinxed. At CERN, the beat goes on: Last weekend the French police arrested a particle physicist who works on one of the collider experiments, on suspicion of conspiracy with a North African wing of Al Qaeda.
Dr. Nielsen and Dr. Ninomiya have proposed a kind of test: that CERN engage in a game of chance, a “card-drawing” exercise using perhaps a random-number generator, in order to discern bad luck from the future. If the outcome was sufficiently unlikely, say drawing the one spade in a deck with 100 million hearts, the machine would either not run at all, or only at low energies unlikely to find the Higgs.
Sure, it’s crazy, and CERN should not and is not about to mortgage its investment to a coin toss. The theory was greeted on some blogs with comparisons to Harry Potter. But craziness has a fine history in a physics that talks routinely about cats being dead and alive at the same time and about anti-gravity puffing out the universe. As Niels Bohr, Dr. Nielsen’s late countryman and one of the founders of quantum theory, once told a colleague: “We are all agreed that your theory is crazy. The question that divides us is whether it is crazy enough to have a chance of being correct.”
Dr. Nielsen is well-qualified in this tradition. He is known in physics as one of the founders of string theory and a deep and original thinker, “one of those extremely smart people that is willing to chase crazy ideas pretty far,” in the words of Sean Carroll, a Caltech physicist and author of a coming book about time, “From Eternity to Here.” Another of Dr. Nielsen’s projects is an effort to show how the universe as we know it, with all its apparent regularity, could arise from pure randomness, a subject he calls “random dynamics.”
Dr. Nielsen admits that he and Dr. Ninomiya’s new theory smacks of time travel, a longtime interest, which has become a respectable research subject in recent years. While it is a paradox to go back in time and kill your grandfather, physicists agree there is no paradox if you go back in time and save him from being hit by a bus. In the case of the Higgs and the collider, it is as if something is going back in time to keep the universe from being hit by a bus. Although just why the Higgs would be a catastrophe is not clear. If we knew, presumably, we wouldn’t be trying to make one.
We always assume that the past influences the future. But that is not necessarily true in the physics of Newton or Einstein. According to physicists, all you really need to know, mathematically, to describe what happens to an apple or the 100 billion galaxies of the universe over all time are the laws that describe how things change and a statement of where things start. The latter are the so-called boundary conditions — the apple five feet over your head, or the Big Bang.
The equations work just as well, Dr. Nielsen and others point out, if the boundary conditions specify a condition in the future (the apple on your head) instead of in the past, as long as the fundamental laws of physics are reversible, which most physicists believe they are. “For those of us who believe in physics,” Einstein once wrote to a friend, “this separation between past, present and future is only an illusion.”
In Kurt Vonnegut’s novel “Sirens of Titan,” all of human history turns out to be reduced to delivering a piece of metal roughly the size and shape of a beer-can opener to an alien marooned on Saturn’s moon so he can repair his spaceship and go home. Whether the collider has such a noble or humble fate — or any fate at all — remains to be seen. As a Red Sox fan my entire adult life, I feel I know something about jinxes.