Starlight Park, the Bronx, Joan Desborough (ready for a dive)
Ilargi: Let’s take a look at what Obama says versus what he does, and what he has done since becoming president. For that last part we can turn to this week’s "Obama's Big Sellout" by Matt Taibbi in Rolling Stone, for the first let's take a look at this Agence France Presse article, "Obama slams 'fat cat bankers'".
"I did not run for office to be helping out a bunch of fat cat bankers on Wall Street," Obama said Friday in excerpts of an interview with CBS television to be aired on Sunday. With unemployment still hovering at around 10 percent, amid a recession triggered in part by the excesses of financial institutions, Obama voiced frustration that "some people on Wall Street still don't get it."
Excuse me, Mr. President, but I'm pretty sure it’s either you who still doesn't get it, or it's the American people who still don't get it. I think the bankers do get it. And the lowest approval rating in history for a president after 1 year might just indicate that the American people are starting to get it too. According to Mr. Taibbi and me, ALL you’ve done since assuming office is help out a bunch of fat cat bankers.
On Friday, the US House of Representatives approved the most sweeping regulatory overhaul of the financial sector since the Great Depression of the 1930s, one of Obama's key goals. Lawmakers voted 223-202 to pass the 1,300-page legislation, a package of measures Obama's Democratic allies crafted in response to the global financial meltdown of 2008.
The legislation gives regulators the power to dismantle giant financial firms and lays out a systematic way to unwind them in case of collapse that ensures shareholders and unsecured creditors, not taxpayers, bear the losses. It also reinforces the powers of the Securities and Exchange Commission to detect irregularities that could provide an early warning of fraudulent investment schemes......
The SEC has failed totally in the past decade, if not longer. Why, pray tell, would it become successful all of a sudden? As for the taxpayer's losses, it would be hard to find a more glaring example of closing a barn door an eon or so too late.
Protecting the taxpayer from losses when they still had something left to lose would have made sense. This sort of bill, however, is just cheap political publicity posturing. And you and I both realize that the taxpayer doesn't know yet that all (s)he had is gone, and then some, simply and only because you and your administration have actively worked to hide the losses of the financial sector through TARP, fraudulent government give-aways (re: AIG) and Bada-Bing! accounting standards.
And the most sweeping regulatory overhaul in 80 years? Your entire economic policy-making team comes straight out of Wall Street. Who exactly are you trying to fool?
"American families will no longer be at the mercy of Wall Street in terms of their jobs, their homes, their pension security, the education of their children," Pelosi said Thursday.
No, Nancy, they’re at the mercy of the government, which has Wall Street dictate its terms, as Taibbi states. The past year has guaranteed that many millions of American families will no longer have jobs, homes, pension security or an education for their children in the years to come.
Obama blasted collusion between congressional Republicans and Wall Street lobbyists who he believes have forged an alliance to block stronger government regulation of the financial sector.
Well, doesn't that ever provide an ideal way to move on to Matt Taibbi's article.
First, let me say that Taibbi puts into detail what I've said ever since Obama presented his economic team of Robert Rubin, Larry Summers and Timothy Geithner last year, namely that the game was up as soon as he nominated them. These, after all, were the guys responsible for both the Glass Steagall repeal in 1999 and the non-regulation of OTC derivatives through the 2000 Commodity Futures Modernization Act, devised when Rubin was Clinton's Treasury Secretary, Summers was his deputy and Geithner their talented and devious handyman.
The only real question that remains is whether Barack Obama is really that dumb, whether he's been aware all along of what he's doing, or whether perhaps someone's made him an offer he can't refuse.
Let me also reiterate Robert Rubin's career in a few words. Rubin spent 26 years, climbing to the top, at Goldman Sachs. He left in 1992 to become the first director of the National Economic Council under Clinton, and was Treasury Secretary from 1995-1999. In that function, he made sure that derivatives remained unregulated and that commercial banks could again merge with investment banks and insurance companies. Even before these proposals were voted on and accepted (the game was fixed), Rubin had left his "boy" Larry Summers in charge at the Treasury and moved to Citigroup, a newly-formed finance behemoth where he could reap the fully ripened fruits of his own "labor", to the tune of hundreds of millions of dollars in income and bonuses.
Barack Obama ran for president as a man of the people, standing up to Wall Street as the global economy melted down in that fateful fall of 2008. He pushed a tax plan to soak the rich, ripped NAFTA for hurting the middle class and tore into John McCain for supporting a bankruptcy bill that sided with wealthy bankers "at the expense of hardworking Americans." [..]
Then he got elected.
What's taken place in the year since Obama won the presidency has turned out to be one of the most dramatic political about-faces in our history. Elected in the midst of a crushing economic crisis brought on by a decade of orgiastic deregulation and unchecked greed, Obama had a clear mandate to rein in Wall Street and remake the entire structure of the American economy.
What he did instead was ship even his most marginally progressive campaign advisers off to various bureaucratic Siberias, while packing the key economic positions in his White House with the very people who caused the crisis in the first place. This new team of bubble-fattened ex-bankers and laissez-faire intellectuals then proceeded to sell us all out, instituting a massive, trickle-up bailout and systematically gutting regulatory reform from the inside.
How could Obama let this happen? Is he just a rookie in the political big leagues, hoodwinked by Beltway old-timers? Or is the vacillating, ineffectual servant of banking interests we've been seeing on TV this fall who Obama really is?
Whatever the president's real motives are, the extensive series of loophole-rich financial "reforms" that the Democrats are currently pushing may ultimately do more harm than good. In fact, some parts of the new reforms border on insanity, threatening to vastly amplify Wall Street's political power by institutionalizing the taxpayer's role as a welfare provider for the financial-services industry.[..]
How did we get here? It started just moments after the election — and almost nobody noticed.
In case we might have thought that Bob Rubin stopped at bringing in just his main lieutenants Summers and Geithner, Taibbi has a list of Rubin pupils:
Michael Froman, Jamie Rubin (yes, the son), Timothy Geithner, Lewis Alexander, Gene Sperling, Lael Brainard, Larry Summers, Jason Furman, Diana Farrell, Jacob Lew, Gary Gensler, Peter Orszag, Mark Patterson, Lee Sachs, Rahm Emanuel.
These people are all tied to Rubin. They have filled the most important positions in the White House and the Treasury. They do what Robert Rubin tells them to do, and they have taken over American politics. As Taibbi phrases it:
There are four main ways to be connected to Bob Rubin: through Goldman Sachs, the Clinton administration, Citigroup and, finally, the Hamilton Project, a think tank Rubin spearheaded under the auspices of the Brookings Institute to promote his philosophy of balanced budgets, free trade and financial deregulation. [..]
Taken together, the rash of appointments with ties to Bob Rubin may well represent the most sweeping influence by a single Wall Street insider in the history of government.
And these are the people responsible for the financial regulation reform that the AFP journalist above labeled "the most sweeping regulatory overhaul of the financial sector since the Great Depression of the 1930s". Who believes that? Matt Taibbi doesn't.
The push for reform seemed to get off to a promising start. In the House, the charge was led by Rep. Barney Frank, the outspoken chair of the House Financial Services Committee, who emerged during last year's Bush bailouts as a sharp-tongued critic of Wall Street. Back when Obama was still a senator, he and Frank even worked together to introduce a populist bill targeting executive compensation.
Last spring, with the economy shattered, Frank began to hold hearings on a host of reforms, crafted with significant input from the White House, that initially contained some very good elements. There were measures to curb abusive credit-card lending, prevent banks from charging excessive fees, force publicly traded firms to conduct meaningful risk assessment and allow shareholders to vote on executive compensation. There were even measures to crack down on risky derivatives and to bar firms like AIG from picking their own regulators. Then the committee went to work — and the loopholes started to appear.
The most notable of these came in the proposal to regulate derivatives like credit-default swaps. Even Gary Gensler, the former Goldmanite whom Obama put in charge of commodities regulation, was pushing to make these normally obscure investments more transparent, enabling regulators and investors to identify speculative bubbles sooner.
But in August, a month after Gensler came out in favor of reform, Geithner slapped him down by issuing a 115-page paper called "Improvements to Regulation of Over-the-Counter Derivatives Markets" that called for a series of exemptions for "end users" — i.e., almost all of the clients who buy derivatives from banks like Goldman Sachs and Morgan Stanley. Even more stunning, Frank's bill included a blanket exception to the rules for currency swaps traded on foreign exchanges — the very instruments that had triggered the Long-Term Capital Management meltdown in the late 1990s.
According to those close to the markup process, Frank's committee inserted loopholes under pressure from "constituents" — by which they mean anyone "who can afford a lobbyist," says Michael Greenberger, the former head of trading at the CFTC under Clinton.
This pattern would repeat itself over and over again throughout the fall. Take the centerpiece of Obama's reform proposal: the much-ballyhooed creation of a Consumer Finance Protection Agency to protect the little guy from abusive bank practices. Like the derivatives bill, the debate over the CFPA ended up being dominated by horse-trading for loopholes.
In the end, Frank not only agreed to exempt some 8,000 of the nation's 8,200 banks from oversight by the castrated-in-advance agency, leaving most consumers unprotected, he allowed the committee to pass the exemption by voice vote, meaning that congressmen could side with the banks without actually attaching their name to their "Aye."
As well as:
[..] the real kicker came when Frank's committee took up what is known as "resolution authority" — government-speak for "Who the hell is in charge the next time somebody at AIG or Lehman Brothers decides to vaporize the economy?" What the committee initially introduced bore a striking resemblance to a proposal written by Geithner earlier in the summer. A masterpiece of legislative chicanery, the measure would have given the White House permanent and unlimited authority to execute future bailouts of megaconglomerates like Citigroup and Bear Stearns.
Democrats pushed the move as politically uncontroversial, claiming that the bill will force Wall Street to pay for any future bailouts and "doesn't use taxpayer money." In reality, that was complete bullshit. The way the bill was written, the FDIC would basically borrow money from the Treasury — i.e., from ordinary taxpayers — to bail out any of the nation's two dozen or so largest financial companies that the president deems in need of government assistance.
After the bailout is executed, the president would then levy a tax on financial firms with assets of more than $10 billion to repay the Treasury within 60 months — unless, that is, the president decides he doesn't want to! "They can wait indefinitely to repay," says Rep. Brad Sherman of California, who dubbed the early version of the bill "TARP on steroids."
This is how America writes its laws these days:
[..] all of these great-sounding reforms get whittled down bit by bit as they move through the committee markup process, until finally there's nothing left but the exceptions. In one example, a measure that would have forced financial companies to be more accountable to shareholders by holding elections for their entire boards every year has already been watered down to preserve the current system of staggered votes. In other cases, this being the Senate, loopholes were inserted before the debate even began: The Dodd bill included the exemption for foreign-currency swaps — a gift to Wall Street that only appeared in the Frank bill during the course of hearings — from the very outset.
The White House's refusal to push for real reform stands in stark contrast to what it should be doing. It was left to Rep. Pete Kanjorski in the House and Bernie Sanders in the Senate to propose bills to break up the so-called "too big to fail" banks. Both measures would give Congress the power to dismantle those pseudomonopolies controlling almost the entire derivatives market (Goldman, Citi, Chase, Morgan Stanley and Bank of America control 95 percent of the $290 trillion over-the-counter market) and the consumer-lending market (Citi, Chase, Bank of America and Wells Fargo issue one of every two mortgages, and two of every three credit cards).
These "pseudomonopolies" control not only the derivatives and consumer credit markets. They also control the White House.
Around the same time that finance reform was being watered down in Congress at the behest of his Treasury secretary, Obama was making a pit stop to raise money from Wall Street. On October 20th, the president went to the Mandarin Oriental Hotel in New York and addressed some 200 financiers and business moguls, each of whom paid the maximum allowable contribution of $30,400 to the Democratic Party. But an organizer of the event, Daniel Fass, announced in advance that support for the president might be lighter than expected — bailed-out firms like JP Morgan Chase and Goldman Sachs were expected to contribute a meager $91,000 to the event — because bankers were tired of being lectured about their misdeeds.
In other words, Robert Rubin owns Barack Obama. And if Obama stays on as president, he's as guilty as anyone else of what transpires, whether he's an evil spirit or a dumb nitwit. Taibbi concludes:
What's most troubling is that we don't know if Obama has changed, or if the influence of Wall Street is simply a fundamental and ineradicable element of our electoral system. What we do know is that Barack Obama pulled a bait-and-switch on us. If it were any other politician, we wouldn't be surprised. Maybe it's our fault, for thinking he was different.
But why be surprised, Matt? Or rather, why now? The surprise would have been relevant a year ago, when the Rubin team took over. Being surprised at what the team has done since is silly. There was always only one possible outcome.
As I said before, I can’t think of one single thing Obama did on finance that George W. Bush wouldn’t have done the exact same way. And whether that means that Obama is a lame duck or a full-blown perpetrator of illegal acts doesn't matter. The president should certainly be smart enough to know when he's being played, and step down the very moment he figures that one out. The fact that he's still in office makes the suspicion that Obama is more than just an innocent and ignorant fall guy a lot stronger. He could have said no, and he still can, any moment he chooses, just as he could have said no to the ridiculous "peace prize for warmongers" he collected last week.
All in all, what this makes clear, once again, is that the US is in the depths and thralls of a full blown political crisis. The country is run by its own particular form of oligarchy, a cabal of visible and non-visible money lenders who through the past two or three decades have gotten an ever stronger grip on the nation's finances, and thereby its very well-being as well as that of its citizens.
If Obama's presidency shows one thing, it's that there no longer are any genuine differences between political parties; the policies adopted and executed are identical. There is therefore no longer any real choice, or any influence, for the average citizen in his or her own life. In China, that’s the accepted life as usual; in America, it's not yet.
One last thing, and one where I disagree with Matt Taibbi (do read his entire article, it’s a great read!). Taibbi calls Rubin a huge failure:
[..] Rubin has been held in awe by the American political elite for nearly 20 years despite having fukced up virtually every project he ever got his hands on. He went from running Goldman Sachs (1990-1992) to the Clinton White House (1993-1999) to Citigroup (1999-2009), leaving behind a trail of historic gaffes that somehow boosted his stature every step of the way.
As Treasury secretary under Clinton, Rubin was the driving force behind two monstrous deregulatory actions that would be primary causes of last year's financial crisis: the repeal of the Glass-Steagall Act (passed specifically to legalize the Citigroup megamerger) and the deregulation of the derivatives market. Having set that time bomb, Rubin left government to join Citi, which promptly expressed its gratitude by giving him $126 million in compensation over the next eight years (they don't call it bribery in this country when they give you the money post factum). After urging management to amp up its risky investments in toxic vehicles, a strategy that very nearly destroyed the company, Rubin blamed Citi's board for his screw-ups and complained that he had been underpaid to boot. "I bet there's not a single year where I couldn't have gone somewhere else and made more," he said.
Despite being perhaps more responsible for last year's crash than any other single living person — his colossally stupid decisions at both the highest levels of government and the management of a private financial superpower make him unique — Rubin was the man Barack Obama chose to build his White House around.
I think it's obvious that Rubin is a failure only when you presume he should have done things for the greater good, or something in that vein. For himself and his puppet masters, Robert Rubin has been a colossal success. And thanks to Barack Obama, he continues to be so to this day, and beyond.
Ilargi: Donate to The Automaric Earth this Christmas. You’ll need all the wise kings you can summon in 2010.
Obama slams 'fat cat bankers'
US President Barack Obama has hit out at Wall Street "fat cats", expressing anger that banks bailed out by the government plan huge bonuses while millions of Americans battle poverty and unemployment. "I did not run for office to be helping out a bunch of fat cat bankers on Wall Street," Obama said Friday in excerpts of an interview with CBS television to be aired on Sunday. With unemployment still hovering at around 10 percent, amid a recession triggered in part by the excesses of financial institutions, Obama voiced frustration that "some people on Wall Street still don't get it."
Lavish pay and bonuses on Wall Street have been blamed for encouraging the excessive risk-taking that with the subprime mortgage housing crisis fueled the global maelstrom and brought the US financial sector to the brink of collapse a year ago. That prompted the US administration to unveil a rescue package topping 700 billion dollars, in part to shore up troubled institutions. A so-called pay czar, appointed by the government, has since reviewed compensation at bailed-out firms and in most cases has restricted salaries to 500,000 dollars a year.
But several of the nation's largest banks such as Bank of America have already repaid the billions of dollars they were given by the US Treasury under the Troubled Asset Relief Program, or TARP.. Only two major banks still hold US government capital from the program: Wells Fargo, which received 25 billion dollars, and Citigroup, with some 45 billion dollars. Obama told CBS he believed some banks had paid back all the bailout funds in order to escape government controls regulating such things as bonuses.
"They're still puzzled why it is that people are mad at the banks. Well, let's see. You guys are drawing down 10, 20 million dollar bonuses after America went through the worst economic year... in decades and you guys caused the problem. "These same banks who benefited from taxpayer assistance who are fighting tooth and nail with their lobbyists... up on Capitol Hill, fighting against financial regulatory control," Obama added.
On Friday, the US House of Representatives approved the most sweeping regulatory overhaul of the financial sector since the Great Depression of the 1930s, one of Obama's key goals. Lawmakers voted 223-202 to pass the 1,300-page legislation, a package of measures Obama's Democratic allies crafted in response to the global financial meltdown of 2008. The legislation gives regulators the power to dismantle giant financial firms and lays out a systematic way to unwind them in case of collapse that ensures shareholders and unsecured creditors, not taxpayers, bear the losses.
It also reinforces the powers of the Securities and Exchange Commission to detect irregularities that could provide an early warning of fraudulent investment schemes, like the fraud perpetrated by Wall Street swindler Bernie Madoff. But the legislation is now expected to move to the US Senate in 2010, where it faces stiff opposition from the financial industry and its Republicans allies, not one of whom voted in favor of the plan. Democratic House Speaker Nancy Pelosi has described the measure as a clear warning to Wall Street that "the party is over."
"American families will no longer be at the mercy of Wall Street in terms of their jobs, their homes, their pension security, the education of their children," Pelosi said Thursday. It has drawn fierce opposition though from the financial sector and Republicans, who accuse the bill of stifling innovation with weighty new rules. The number two House Republican, Representative Eric Cantor, said the legislation "frightens people and creates uncertainty in the American economy, preventing job growth."
But on Saturday, Obama blasted collusion between congressional Republicans and Wall Street lobbyists who he believes have forged an alliance to block stronger government regulation of the financial sector. "Just last week, Republican leaders in the House summoned more than 100 key lobbyists for the financial industry to a 'pep rally', and urged them to redouble their efforts to block meaningful financial reform," the president said in his weekly radio address. However, the Treasury Department told AFP on Friday it had no plans to follow in the footsteps of Britain and France and impose a one-off 2009 tax on bankers' bonuses. Asked if the United States was planning to follow moves unveiled this week by Britain and France for "community" taxes on bankers bonuses, Treasury spokeswoman Meg Reilly said in an email: "Not at this time."
Obama's Big Sellout
by Matt Taibbi
Click to open video in new window
'Just look at the timeline of the Citigroup deal," says one leading Democratic consultant. "Just look at it. It's fucking amazing. Amazing! And nobody said a thing about it." Barack Obama was still just the president-elect when it happened, but the revolting and inexcusable $306 billion bailout that Citigroup received was the first major act of his presidency. In order to grasp the full horror of what took place, however, one needs to go back a few weeks before the actual bailout — to November 5th, 2008, the day after Obama's election.
That was the day the jubilant Obama campaign announced its transition team. Though many of the names were familiar — former Bill Clinton chief of staff John Podesta, long-time Obama confidante Valerie Jarrett — the list was most notable for who was not on it, especially on the economic side. Austan Goolsbee, a University of Chicago economist who had served as one of Obama's chief advisers during the campaign, didn't make the cut. Neither did Karen Kornbluh, who had served as Obama's policy director and was instrumental in crafting the Democratic Party's platform. Both had emphasized populist themes during the campaign: Kornbluh was known for pushing Democrats to focus on the plight of the poor and middle class, while Goolsbee was an aggressive critic of Wall Street, declaring that AIG executives should receive "a Nobel Prize — for evil."
But come November 5th, both were banished from Obama's inner circle — and replaced with a group of Wall Street bankers. Leading the search for the president's new economic team was his close friend and Harvard Law classmate Michael Froman, a high-ranking executive at Citigroup. During the campaign, Froman had emerged as one of Obama's biggest fundraisers, bundling $200,000 in contributions and introducing the candidate to a host of heavy hitters — chief among them his mentor Bob Rubin, the former co-chairman of Goldman Sachs who served as Treasury secretary under Bill Clinton. Froman had served as chief of staff to Rubin at Treasury, and had followed his boss when Rubin left the Clinton administration to serve as a senior counselor to Citigroup (a massive new financial conglomerate created by deregulatory moves pushed through by Rubin himself).
Incredibly, Froman did not resign from the bank when he went to work for Obama: He remained in the employ of Citigroup for two more months, even as he helped appoint the very people who would shape the future of his own firm. And to help him pick Obama's economic team, Froman brought in none other than Jamie Rubin, a former Clinton diplomat who happens to be Bob Rubin's son. At the time, Jamie's dad was still earning roughly $15 million a year working for Citigroup, which was in the midst of a collapse brought on in part because Rubin had pushed the bank to invest heavily in mortgage-backed CDOs and other risky instruments.
Now here's where it gets really interesting. It's three weeks after the election. You have a lame-duck president in George W. Bush — still nominally in charge, but in reality already halfway to the golf-and-O'Doul's portion of his career and more than happy to vacate the scene. Left to deal with the still-reeling economy are lame-duck Treasury Secretary Henry Paulson, a former head of Goldman Sachs, and New York Fed chief Timothy Geithner, who served under Bob Rubin in the Clinton White House. Running Obama's economic team are a still-employed Citigroup executive and the son of another Citigroup executive, who himself joined Obama's transition team that same month.
So on November 23rd, 2008, a deal is announced in which the government will bail out Rubin's messes at Citigroup with a massive buffet of taxpayer-funded cash and guarantees. It is a terrible deal for the government, almost universally panned by all serious economists, an outrage to anyone who pays taxes. Under the deal, the bank gets $20 billion in cash, on top of the $25 billion it had already received just weeks before as part of the Troubled Asset Relief Program. But that's just the appetizer.
The government also agrees to charge taxpayers for up to $277 billion in losses on troubled Citi assets, many of them those toxic CDOs that Rubin had pushed Citi to invest in. No Citi executives are replaced, and few restrictions are placed on their compensation. It's the sweetheart deal of the century, putting generations of working-stiff taxpayers on the hook to pay off Bob Rubin's fuck-up-rich tenure at Citi. "If you had any doubts at all about the primacy of Wall Street over Main Street," former labor secretary Robert Reich declares when the bailout is announced, "your doubts should be laid to rest."
It is bad enough that one of Bob Rubin's former protégés from the Clinton years, the New York Fed chief Geithner, is intimately involved in the negotiations, which unsurprisingly leave the Federal Reserve massively exposed to future Citi losses. But the real stunner comes only hours after the bailout deal is struck, when the Obama transition team makes a cheerful announcement: Timothy Geithner is going to be Barack Obama's Treasury secretary!
Geithner, in other words, is hired to head the U.S. Treasury by an executive from Citigroup — Michael Froman — before the ink is even dry on a massive government giveaway to Citigroup that Geithner himself was instrumental in delivering. In the annals of brazen political swindles, this one has to go in the all-time Fuck-the-Optics Hall of Fame.
Wall Street loved the Citi bailout and the Geithner nomination so much that the Dow immediately posted its biggest two-day jump since 1987, rising 11.8 percent. Citi shares jumped 58 percent in a single day, and JP Morgan Chase, Merrill Lynch and Morgan Stanley soared more than 20 percent, as Wall Street embraced the news that the government's bailout generosity would not die with George W. Bush and Hank Paulson. "Geithner assures a smooth transition between the Bush administration and that of Obama, because he's already co-managing what's happening now," observed Stephen Leeb, president of Leeb Capital Management.
Left unnoticed, however, was the fact that Geithner had been hired by a sitting Citigroup executive who still had a big bonus coming despite his proximity to Obama. In January 2009, just over a month after the bailout, Citigroup paid Froman a year-end bonus of $2.25 million. But as outrageous as it was, that payoff would prove to be chump change for the banker crowd, who were about to get everything they wanted — and more — from the new president.
The irony of Bob Rubin: He's an unapologetic arch-capitalist demagogue whose very career is proof that a free-market meritocracy is a myth. Much like Alan Greenspan, a staggeringly incompetent economic forecaster who was worshipped by four decades of politicians because he once dated Barbara Walters, Rubin has been held in awe by the American political elite for nearly 20 years despite having fucked up virtually every project he ever got his hands on. He went from running Goldman Sachs (1990-1992) to the Clinton White House (1993-1999) to Citigroup (1999-2009), leaving behind a trail of historic gaffes that somehow boosted his stature every step of the way.
As Treasury secretary under Clinton, Rubin was the driving force behind two monstrous deregulatory actions that would be primary causes of last year's financial crisis: the repeal of the Glass-Steagall Act (passed specifically to legalize the Citigroup megamerger) and the deregulation of the derivatives market. Having set that time bomb, Rubin left government to join Citi, which promptly expressed its gratitude by giving him $126 million in compensation over the next eight years (they don't call it bribery in this country when they give you the money post factum).
After urging management to amp up its risky investments in toxic vehicles, a strategy that very nearly destroyed the company, Rubin blamed Citi's board for his screw-ups and complained that he had been underpaid to boot. "I bet there's not a single year where I couldn't have gone somewhere else and made more," he said. Despite being perhaps more responsible for last year's crash than any other single living person — his colossally stupid decisions at both the highest levels of government and the management of a private financial superpower make him unique — Rubin was the man Barack Obama chose to build his White House around.
Goldman Played Bigger Role in Fueling AIG Gambles Than Disclosed
Goldman Sachs Group Inc. played a bigger role than has been publicly disclosed in fueling the mortgage bets that nearly felled American Insurance Group Inc. Goldman was one of 16 banks paid off when the U.S. government last year spent billions closing out soured trades that AIG made with the financial firms. A Wall Street Journal analysis of AIG's trades, which were on pools of mortgage debt, shows that Goldman was a key player in many of them, even the ones involving other banks.
Goldman originated or bought protection from AIG on about $33 billion of the $80 billion of U.S. mortgage assets that AIG insured during the housing boom. That is roughly twice as much as Société Générale and Merrill Lynch, the banks with the biggest exposure to AIG after Goldman, according an analysis of ratings-firm reports and an internal AIG document that details several financial firms' roles in the transactions.
In Goldman's biggest deal, it acted as a middleman between AIG and banks, taking on the risk of as much as $14 billion of mortgage-related investments. Then Goldman insured that risk with one trading partner—AIG, according to the Journal's analysis and people familiar with the trades. The trades yielded Goldman less than $50 million in profits, which were mostly booked from 2004 to 2006, according to a person familiar with the matter. But they piled risks onto AIG's books, which later came to haunt the insurer and Goldman. The trades also gave Goldman a unique window into AIG's exposure to losses on securities linked to mortgages. When the federal government bailed out the insurer, Goldman avoided losses on its trades with AIG covering a total of $22 billion in assets.
A Goldman spokesman says that up until AIG was rescued by the government, the insurer "was viewed as one of the most sophisticated financial counterparties in the world. It wasn't until the government intervened in September 2008 that the full extent of AIG's problems became apparent." "What is lost in the discussion is that AIG assumed billions of dollars in risk it was unable to manage," the Goldman spokesman added. More clarity has emerged recently over the roles that firms such as Goldman played, as complex deals carried out by banks are now being untangled in legal and regulatory inquiries. Last month a government audit of part of the AIG bailout described Goldman's middleman role.
One of Goldman's trades with AIG involved a financial vehicle called South Coast Funding VIII. South Coast was one of many pools of bonds backed by individual homeowners' mortgage payments that Wall Street turned into collateralized debt obligations or CDOs. Merrill Lynch, now part of Bank of America Corp., underwrote the South Coast CDO in January 2006 by stuffing it with packages of home loans originated by firms such as Countrywide Financial Corp., the big California lender. Once a CDO debt pool is assembled, it is sliced into layers based on risk and return. Merrill sold the safest, or top layer, of deals like South Coast to large banks, including in Europe and Canada.
The banks wanted protection in case the housing market tanked. Many turned to Goldman, which effectively insured the securities against losses. Then, to cover its own potential losses, Goldman bought protection from AIG, in the form of credit-default swaps. Goldman charged more than AIG for the protection, so it was able to pocket the difference, making millions while moving the default risks to AIG, according to people familiar with the trades. The banks eventually realized they didn't need to use Goldman as a middleman. The trades seemed prudent at the time given AIG's strong credit rating and the fact that AIG agreed to make payments to Goldman, known as collateral, if the value of the CDOs declined. The trades were also low risk for Goldman as long as AIG stayed afloat.
Other banks also acted as middlemen, including Merrill Lynch, which did roughly $6 billion of these deals compared to $14 billion for Goldman, according to people familiar with the trades and the analysis of banks' exposures to AIG. "It seems shocking to me that Goldman would become so exposed to AIG and kept doing deals with them and laying on the risk," says Tom Savage, a former chief executive of AIG's financial products unit who left in 2001 before the explosive growth of insuring mortgage-debt pools.
The middleman trades began to unravel in mid 2007 when the U.S. mortgage market started slumping. Goldman was the first of AIG's trading partners to notify AIG that the CDOs were losing value and demand collateral. Other banks including Société Générale and a unit of Credit Agricole that had bought insurance from AIG eventually did the same. A Goldman spokesman said that between mid-2007 and early 2008, Goldman showed AIG "market price levels" at which trades could be undone, allowing AIG to decrease its risk, but "AIG refused to accept that the market was deteriorating."
When Goldman didn't get as much collateral as it wanted from AIG, in 2007 and 2008 it bought protection against a default of AIG itself from other banks. AIG officials were skeptical of the prices Goldman presented, according to the minutes of a February 2008 AIG audit committee meeting, which noted that Goldman was "unwilling or unable to provide any sources for their determination of market prices." Additional calls for collateral from Goldman and other banks eventually led to AIG's September 2008 bailout and led the New York Federal Reserve two months later to fully cover $62 billion of insurance contracts Goldman and 15 other banks had with the financial products unit of AIG.
Goldman's other big role in the CDO business that few of its competitors appreciated at the time was as an originator of CDOs that other banks invested in and that ended up being insured by AIG, a role recently highlighted by Chicago credit consultant Janet Tavakoli. Ms. Tavakoli reviewed an internal AIG document written in late 2007 listing the CDOs that AIG had insured, a document obtained earlier this year by CBS News. The Journal analysis of that document in conjunction with ratings-firm reports shows that Goldman underwrote roughly $23 billion of the $80 billion in mortgage-linked CDOs that AIG agreed to insure.
One such deal was called Davis Square Funding VI. That CDO, assembled by Goldman in March 2006, contained mortgage securities underpinned by subprime home loans originated by firms such as Countrywide and New Century Mortgage Corp., one of the first subprime lenders to fail in 2007. A big investor in Davis Square's top layer was Société Générale, which bought protection on it from AIG, according to the internal memo. The French bank was the largest beneficiary of the New York Fed's Nov. 2008 move to pay off banks in full on their AIG insurance contracts.
A company financed largely by the New York Fed ended up owning both the Davis Square and South Coast CDOs. Société Générale received payments from AIG and the New York Fed totaling $16.5 billion. Goldman received $14 billion for its trades that were torn up, including $8.4 billion in collateral from AIG.
The special inspector general for the Troubled Asset Relief Program, which recently reviewed the New York Fed's effort to stanch collateral calls last year, said Goldman officials said the company believed it would have been fully protected had AIG been allowed to fail because of collateral it had amassed and the additional insurance it had bought against an AIG default. The auditor, however, questioned that conclusion. The report said Goldman would have had a difficult time selling the collateral and that the firm might have been unable to actually collect on the additional insurance.
Goldman Sachs Trading Should Get No U.S. Backstop, Volcker Says
Goldman Sachs Group Inc., which took $10 billion in U.S. bailout funds last year, shouldn’t get taxpayer support if the firm focuses on trading over banking, according to former Federal Reserve Chairman Paul Volcker. The "safety net" provided by the U.S. government "should not be extended beyond the core commercial-banking business," Volcker, 82, said in an interview yesterday at Deutsche Bank AG’s Berlin office, where he was attending a conference. "They can do trading and do anything they want, but then they shouldn’t have access to the safety net."
Goldman Sachs, the most profitable investment bank in Wall Street history, has reaped more than 90 percent of its pretax earnings this year from trading and so-called principal investments, which include market bets on securities and stakes in companies. The other 10 percent came from advising clients on takeovers and capital-raising and from asset management, which includes managing hedge funds and buyout funds.
When the collapse of smaller rival Lehman Brothers Holdings Inc. triggered a crisis of investor confidence last year, regulators allowed Goldman Sachs and Morgan Stanley, another competitor, to convert into bank holding companies. That put the New York-based firms under the Fed’s purview and gave them access to cheap funding. The two firms received federal guarantees on new debt issues, as did commercial banks and some companies with financing businesses, such as General Electric Co.
Goldman Sachs does "a lot of proprietary trading" and General Electric "does a lot of kind of complicated financial services," said Volcker, an economic adviser to President Barack Obama. "This is one of those kind of things that have to be sorted out." Since January, Volcker, who was Fed chairman from 1979 to 1987, has called for regulators to provide government support only to banks that provide essential services like deposit- taking and business payments. He has suggested prohibiting them from owning or sponsoring hedge funds, private-equity funds or from engaging in proprietary trading.
Goldman Sachs returned the $10 billion it received from the U.S. Treasury last year with interest. As of September, $20.85 billion of the firm’s $189.7 billion of unsecured long-term borrowing was guaranteed by the Federal Deposit Insurance Corp., according to a company filing. Lucas van Praag, a spokesman for Goldman Sachs, said that the majority of the firm’s trading revenue comes from transactions with clients and not from proprietary trading, or bets with the firm’s own money. "Proprietary trading accounted for less than 10 percent of revenues and earnings this year," van Praag said. "Since 2003, proprietary trading has accounted for just 12 percent of net revenues."
Goldman Sachs generated $203 billion net revenue from 2003 through September, meaning that about $24 billion was proprietary trading. David Viniar, Goldman Sachs’s chief financial officer, said in October that the firm doesn’t benefit from any implicit government guarantee. "We operate as an independent financial institution that stands on our own two feet," Viniar said in a conference call with reporters on Oct. 15. Anne Eisele, a spokeswoman for Fairfield, Connecticut-based General Electric, declined to comment. By the end of 2009 about $59 billion of the debt of GE Capital, General Electric’s finance subsidiary, will still be guaranteed by the FDIC, according to a company presentation.
Volcker said there is a "temptation" at some banks to return to the risk-taking practices that enable them to pay large bonuses. "It’s natural, you like to return to normalcy, make some money and get on with it," he said. "I’m very interested in using this crisis as a way to avoid the next one," Volcker said. "This isn’t any time to go back to business as usual."
America Must 'Reassert Stability and Leadership'
Paul Volcker, 82, is one of US President Barack Obama's leading economic advisors. SPIEGEL spoke with him about the economic challeges facing the US, whether new taxes are needed to address public debt and how America can return to a position of economic leadership.
SPIEGEL: Mr. Volcker, you grew up during the Great Depression. What sort sort of childhood memories do you have from those difficult times?
Volcker: Well, my memories are quite limited. My father had a stable job. He was a city manager at that time. We weren't wealthy, just middle class living in a growing suburb of New York, and that was not in the middle of depressed America. I know that my mother at that time did not let me take a part time job and she often said that other people needed the job more than I did.
SPIEGEL: Can the current situation be compared with the Great Depression?
Volcker: I remember there were people, beggars and tramps as we called them, who wanted to be fed. So it's true, today we also have people who are relying on food stamps and other payments but we are a long way from the Great Depression. We are in a serious, great recession. Today we have 10 percent unemployment, but at that time it was more like 20 or 25 percent. That's a big difference. You had mass unemployment.
SPIEGEL: But even though there are still more people being fired than hired, the Chairman of the Federal Reserve Ben Bernanke is saying that the recession is technically over. Do you agree with him?
Volcker: You know, people get very technical about these things. We had a quarter of increased growth but I don't think we are out of the woods.
SPIEGEL: You expect a backlash?
Volcker: The recovery is quite slow and I expect it to continue to be pretty slow and restrained for a variety of reasons and the possibility of a relapse can't be entirely discounted. I'm not predicting it but I think we have to be careful.
SPIEGEL: What is the difference between this deep recession and all the other recessions we have seen since World War II?
Volcker: What complicates this situation, as compared to the ordinary garden variety recession, is that we have this financial collapse on top of an economic disequilibrium. Too much consumption and too little investment, too many imports and too few exports. We have not been on a sustainable economic track and that has to be changed. But those changes don't come overnight, they don't come in a quarter, they don't come in a year. You can begin them but that is a process that takes time. If we don't make that adjustment and if we again pump up consumption, we will just walk into another crisis.
SPIEGEL: As chairman of the Economic Recovery Advisory Board, you advise President Barack Obama on how to prevent such a recurrence. Is he following your guidance?
Volcker: We have various working groups that work on and make recommendations on particular problems like retirement programs and social security. We made some recommendations on financial reforms which were not accepted, but that is part of the game. The president is more eloquent than I can be on these issues. Getting it done as compared to talking about it is a problem, but we have some suggestions along that line.
SPIEGEL: The US has not yet instituted any kind of reform policy. What we see is the government and the Federal Reserve pouring money into the economy. If one looks beyond that money, one sees that the economy is in fact still shrinking.
Volcker: What should I say? That's right. We have not yet achieved self-reinforcing recovery. We are heavily dependent upon government support so far. We are on a government support system, both in the financial markets and in the economy.
SPIEGEL: To get the recovery to the point where it is right now has cost a lot of money. National debt will probably reach $12 trillion in 2019. Just serving the debt costs $17 billion a year -- at least according to this year's forecast. That's difficult to sustain.
Volcker: You've got to deal with the deficit and you've got to deal with it in a timely way. Right now, with the unemployment rate still very high, excess capacity is still evident, and the economy is dependent on government money as we said. We are not going to successfully attack the deficit right now but we have got to prepare for attacking it.
SPIEGEL: Should Americans prepare themselves for a tax increase?
Volcker: Not at the moment, but I think we would have to think about it. The present tax system historically has transferred about 18 to 19 percent of the GNP to the government. And we are going to come out of all this with an expenditure relationship to GNP very substantially above that. We either have to cut expenditures and that means reducing entitlements and certainly defense expenditures by an amount that may not be possible. If you can do it, fine. If we can't do it, then we have to think about taxes.
SPIEGEL: What kind of taxes do you have in mind?
Volcker: Maybe we should talk about energy taxes, which could be a big revenue producer.
SPIEGEL: The Harvard Professor Niall Ferguson has written a Newsweek cover story where he essentially argues that America is in great danger due to steep debt, slow growth and high spending. Do you think it is overblown?
Volcker: The challenge is real. That is the kind of threat that we want to deal with and reassert stability and leadership. I grew up in an environment in which the United States was leading, was a pole of strength.
SPIEGEL: At that time, America was the biggest exporter in the world and not the biggest importer. The America you are referring to was the biggest lender in the world and not its biggest borrower.
Volcker: That is correct. And we don't perhaps have to get all the way back there, but we have to get back in an area where there is confidence in the stability and the authority of the United States. I think we can do that but we have a challenge, we have gotten a wake-up call. There is concern in our recovery advisory group about how to rebuild the competitiveness of the United States, which inevitably means rebuilding, in part, the manufacturing sector of the economy.
SPIEGEL: What part of the manufacturing sector do you envision?
Volcker: I think there are a lot of opportunities in the so-called green economy for taking leadership. On the technical side, I mean technology development, research development, the US is doing ok, but when it comes to manufacturing some of this stuff, somehow the Germans do it all!
SPIEGEL: And a lot of Americans try to blame the Germans for this, saying that we are depending too heavily on the export industry.
Volcker: I must say, I admire Germany in this situation even with its high costs. In some ways, I think the labor cost is higher in Germany than it is in the United States but you can somehow maintain that export edge. You are dedicated to exporting, we are dedicated to financial engineering and it hasn't worked out too well. I wish we had fewer financial engineers and more mechanical engineers. Tell me the secret of how the Germans keep this going.
SPIEGEL: Maybe the reason is that the Germans don't trust the American boom and bust economy with its dedication to fast money.
Volcker: I think part of it is the psychological. The young, ambitious Germans realize that export industry and heavy engineering is the German competitive advantage. The best Americans don't even think about that. We have the Silicon Valley and that whole kind of high tech industry is still our strength but we need something broader than that too.
SPIEGEL: Outsourcing and off-shoring have been the key words of the last decades. You don't think that the times of "made in America" are over forever?
Volcker: That has been the mentality and we have to change that somehow. I think it's self-correcting in part. The glamour of going to Wall Street is not as great today as it was a few years ago.
SPIEGEL: Are you sure? The Wall Street businesses are doing well. The big bonuses are back.
Volcker: It's amazing how quickly some people want to forget about the trouble and go back to business as usual. We face a real challenge in dealing with that feeling that the crisis is over. The need for reform is obviously not over. It's hard to deny that we need some forward looking financial reform.
SPIEGEL: In Germany, the government, but also the Bundesbank, is still waiting for a clear American approach toward that goal.
Volcker: I grew up in a world in which American leadership was important and, I thought, constructive. It's more difficult now because we are not as relatively strong as we used to be. If you are right in saying that somebody is waiting for our voice, I hope we can speak clearly.
SPIEGEL: You have been clear about your ideas. Do you really believe we have to break up the big banks in order to create a more sustainable financial system?
Volcker: Well, breaking them up is difficult. I would prefer to say, let's just slice them up. I don't want them to get heavily involved in capital market activities so my view is: Hedge funds, no. Equity funds, no. Proprietary trading, no. Trading in commodities, no. And that in itself would reduce the size of the big banks. So you get some reduction in size. Equally important, you make them more manageable and easier to deal with if they do get in trouble.
SPIEGEL: Banking should become boring again?
Volcker: Banking will never be boring. Banking is a risky business. They are going to have plenty of activity. They can do underwriting. They can do securitization. They can do a lot of lending. They can do merger and acquisition advice. They can do investment management. These are all client activities. What I don't want them doing is piling on top of that risky capital market business. That also leads to conflicts of interest.
SPIEGEL: But the American government seems to have lost some eagerness in setting a tougher regime of rules and regulations to control Wall Street. Everything is being watered down. Why?
Volcker: I will do the best I can to fight any tendency to water it down. What we need is broad international consensus to make things happen.
SPIEGEL: Your old German friend, the former Chancellor Helmut Schmidt, is already on your side. He is now speaking about the current economic system as a kind of predator capitalism which must be tamed.
Volcker: I'm glad he is speaking out. I am a great admirer of Helmut Schmidt. He was very straightforward and kind of brutally outspoken in a way, to which many people reacted adversely.
SPIEGEL: Are you thinking of a particular situation?
Volcker: The famous incident happened in 1979 shortly after I became Chairman of the Federal Reserve Bank…
SPIEGEL: …and the inflation in the US had reached 12 percent.
Volcker: I was flying with the Secretary of Treasury to a meeting in Belgrade but for some reason an arrangement had been made, Helmut probably suggested it, that we stop in Hamburg on the way to Belgrade to hold a meeting. The meeting was mostly Helmut speaking for an hour about how "you Americans" have got to do something about inflation. My Secretary of Treasury was kind of taken back by the force of ot all, but it was fine with me since I had been planning the same kind of policy.
SPIEGEL: During your tenure as chairman of the Federal Reserve, the bank was always part of the solution. Today with the Fed's policy of easy money, many experts see it as part of the problem.
Volcker: Given the difficulty of the economic situation and the large amount of money being spent to support the economy, The Fed is receiving the brunt of the criticism. Some support for the economy was certainly necessary, but the mere fact that in this situation emergency measures were necessary should not dictate a liberal approach in the future.
SPIEGEL: Lawmakers on Capitol Hill are thinking about tougher controls over the Federal Reserve.
Volcker: I think the loss of independence and authority of the Federal Reserve would be a very serious matter for the United States. Not just in terms of monetary policy but in terms of our place in the world. People look to strong, credible institutions and I think the Federal Reserve has been such an institution. If that's lost or too hamstrung by legislation I think we will regret it.
SPIEGEL: But is the Fed still the same kind of institution as during your tenure as chairman? Or is it now more of a governmental instrument? The Fed is managing the TARP program and is also buying government bonds.
Volcker: In some sense the Federal Reserve is always an instrument of the government. It is a government body but it is independent within government. But you are right in the sense that part of the concern is that they have involved themselves quantitatively in entering markets and in that process, you are supporting some markets and not others. That is an area in which the Federal Reserve has never wanted to get into and one that most central banks don't want to get into. If you are going to maintain your independence you have to avoid that. To intervene in particular sectors of the market is not the proper role for the central bank over time. It could be justified only by extreme emergency.
SPIEGEL: So what do you expect in the very near future?
Volcker: As an American, I have to be an optimist. But we have got a big challenge and we have to face up to it. And as you know, there is a lot of concern about the dysfunction of the political system.
SPIEGEL: So it is becoming harder to be an optimist?
Volcker: It's a challenge.
Democrats plan nearly $2 trillion debt limit hike
Democrats plan to allow the government's debt to swell by nearly $2 trillion as part of a bill next week to pay for wars in Afghanistan and Iraq. The amount pretty much equals the total of a year-end spending spree by lawmakers and is big enough to ensure that Congress doesn't have to vote again on going further into debt until after the 2010 elections. The move has anxious moderate Democrats maneuvering to win new deficit-cutting tools as the price for their votes, igniting battles between the House and the Senate and with powerful interest groups on both the right and the left.
The record increase in the so-called debt limit -- the legal cap on the amount of money the government can borrow -- is likely to be in the neighborhood of $1.8 trillion to $1.9 trillion, House Majority Leader Steny Hoyer, D-Md., said Friday. That eye-popping figure is making Democrats woozy but is what is needed to make sure they don't have to vote again before next year's midterm elections. The government's total debt has nearly doubled in the past seven years and is expected to exceed the current ceiling of $12.1 trillion before Jan. 1.
Democratic leaders say they will try to raise the ceiling to nearly $14 trillion as part of a $626 billion bill next week to pay for the wars in Afghanistan and Iraq and other military programs in 2010. The bill doesn't include the additional $30 billion President Obama is expected to seek early next year to pay for his 30,000-troop buildup in Afghanistan but it might carry an added $50 billion to pay for a six-month extension of unemployment benefits and health care insurance subsidies for the long-term jobless.
The entire strategy, however, is teetering because of brinksmanship involving moderate Senate Democrats who are demanding a bipartisan deficit reduction task force with special powers to recommend spending cuts or tax increases that would be guaranteed House and Senate votes. That idea is a total no-go with House Speaker Nancy Pelosi, D-Calif. Playing tit for tat, moderate House "Blue Dog" Democrats announced Friday that their votes for any debt limit increase depend on winning a "pay-as-you-go" budget law aimed at ensuring that new tax cuts or new spending programs don't increase deficits.
Under a pay-as-you-go regime, if offsetting cuts or revenue hikes are not found to pay for new policies, across-the-board spending cuts would hit selected programs such as farm subsidies and Medicare. Minority Republicans, meanwhile, are refusing to provide any support for raising the debt ceiling. "Instead of reducing the size of government and controlling spending, Democrats are planning to raise the debt limit by $1.8 trillion, putting American taxpayers in even deeper debt to countries like China," said Rep. Todd Tiahrt, R-Kan.
Vice President Joe Biden, Majority Leader Steny Hoyer, D-Md., Blue Dog leaders and Senate Budget Committee Chairman Kent Conrad, D-N.D., were involved in several sets of negotiations Friday in an effort to break the impasse between House and Senate Democrats. If a deal can't be found, Democrats might have to move on to Plan B, which would be to have the Senate pass a smaller, $925 billion increase that's already available to them. That bill passed the House because of a quirky rule that automatically passes debt limit legislation -- without an up-or-down vote -- when Congress ratifies its annual budget blueprint. That was done last April.
Under the second scenario, the House would adjourn, leaving the Senate no choice but to pass the $925 billion increase in order to avoid a first-ever default on U.S. government obligations. "We're going to have to face the moment of truth at some point," said Sen. Evan Bayh, D-Ind., who is one of about a dozen Senate Democrats pressing for the special deficit task force as the price for voting for an increase in the debt limit. The debt limit conundrum comes as Congress is wrapping up its annual appropriations bills, including a $1.1 trillion omnibus measure pending in the Senate. A vote to cut off a GOP filibuster of that measure is scheduled for Saturday morning with a final vote likely on Sunday.
The omnibus appropriations bill is opposed by most Republicans. It awards domestic programs and foreign aid considerable funding boosts and also provides money for more than 5,000 home-state pet projects pushed by lawmakers. The omnibus bill comes on top of an infusion of cash to domestic agencies in February's economic stimulus bill and a $410 billion measure in March that also bestowed budget increases well above inflation.
The measure survived a test vote Friday that demonstrated it should receive on Saturday the 60 votes needed to overcome the GOP stalling tactics. Three senior Republican members of the Appropriations Committee joined forces with all but three Democrats to keep the measure from effectively being killed.
Ilargi: No, this does not mean that Wall Street doesn’t own Capitol Hill anymore. However, it will have many people fooled into thinking so. Which is the idea. But just wait till the Senate gets done with the bill. Political posturing reaches new heights. It’s becoming an art form.
House Strikes at Wall Street
The House of Representatives, in a display of anti-Wall Street sentiment, passed sweeping legislation Friday that rewrites the rules governing financial markets, aiming to restrict the operations of big banks and the powers of the Federal Reserve. The legislation, if enacted, would bring the biggest change to financial rules since the 1930s, changing business practices for everyone from mortgage brokers in California to traders on Wall Street. The vote advances a major White House initiative designed to tackle the perceived causes of last year's financial crisis.
The House's action isn't the final word. The Senate has yet to act, and an early version of its bill is different from the House version in many respects. But senators hope to have an agreement in principle by the end of December and to pass a bill in the first half of 2010. Under the House version, large financial companies including Goldman Sachs Group Inc. and J.P. Morgan Chase & Co. would be hit with billions of dollars in fees and would see new restrictions on their operations.
The bill would strip nearly all of the Federal Reserve's powers to write consumer-protection laws and would allow -- for the first time -- an arm of Congress to audit the Fed's monetary policy decisions, supposedly a politics-free zone. The Fed has fiercely resisted the idea. For consumers and individual investors, the bill gives shareholders an advisory vote on executive compensation and creates a new Consumer Financial Protection Agency. The new federal agency would write rules and examine banks for compliance with consumer protection policies on mortgages, credit cards and other products.
The bill, written in large part by House Financial Services Committee Chairman Barney Frank, aims to fill gaps in the regulatory toolkit exposed by last year's crisis. It would give the government the power to break up even healthy financial companies if regulators believe they pose a threat to the financial system. It will also direct the Federal Deposit Insurance Corp. to collect $150 billion in fees from big financial institutions to create a fund to pay for future large failures. Business and banking groups lobbied hard to kill the bill, particularly the consumer agency, which critics charge would have the effect of restricting credit to consumers.
"Certain provisions in the legislation will undermine our shared goal of market stability and reducing systemic risk," said Timothy Ryan, president and chief executive of the Securities Industry and Financial Markets Association, in a written statement. "We believe there can be additional improvements in the Senate," said a spokesman for Bank of America Corp. "A new agency is just a whole new bureaucracy," J.P. Morgan Chase & Co. Chief Executive James Dimon said Tuesday at an industry conference. The final vote was 223-202, with 27 Democrats joining unanimous Republican opposition.
Attention now shifts to the Senate, where lawmakers fought bitterly several weeks ago about what future financial rules should look like. A big issue is what to do with the CFPA. Liberals view it as central to any regulation. House lawmakers have already agreed to exempt smaller banks from its examiners. Senate Republicans don't want the agency created in the first place. One Senate deal under consideration would allow the new agency to be created, but wouldn't let it examine or enforce new rules against banks in most cases.
Senate Banking Committee Chairman Christopher Dodd has proposed creating a single federal bank regulator, stripping supervisory powers from the Fed and FDIC. His goal was to more closely focus each agency on their core responsibilities and eliminate the turf-fighting between different regulators. Three days of debate on the House bill highlighted deep philosophical differences between Democrats and Republicans about the role of regulation in capitalism. Democrats argued that more government involvement was necessary to prevent a future financial collapse and to protect consumers. "We are sending a clear message to Wall Street," said Speaker of the House Nancy Pelosi (D., Calif.). "The party is over. Never again."
Republicans countered that the Democrats' plan would create huge government bureaucracies, stifling access to credit. "Their bill will continue the destruction of jobs in this country," said Rep. Scott Garrett (R., N.J.). House lawmakers made multiple changes to an original White House proposal, often injecting a more populist bent to penalize large financial companies while also exempting smaller firms from certain bank examinations. Democratic leadership narrowly defeated an amendment by Rep. Walt Minnick (D., Idaho) that would have quashed the creation of the Consumer Financial Protection Agency. In one victory for banks, Republicans and more than 70 Democrats defeated an amendment that would have allowed bankruptcy judges to rework the terms of mortgages.
Treasury Restricts Pay at Four Firms
The U.S. pay czar mandated restrictions on compensation at four firms receiving large sums of government aid, a move designed to more closely tie employee pay to company performance. Kenneth Feinberg's determinations, which affect roughly 300 highly compensated employees at four firms receiving Troubled Asset Relief Program funds, don't dictate exactly how much each employee can earn but instead set guidelines governing the mix of cash and stock and incentive compensation.
Under the ruling, at least 50% of an employee's compensation must be held for three years either in the form of long-term stock or some other long-term compensation. Regular salaries for 2009 can't exceed $500,000 in most cases and total cash compensation, which can include cash bonuses or other cash awards, must be limited to 45% of total pay. The new rules apply to the 26 to 100 most highly compensated employees at American International Group Inc., Citigroup Inc., General Motors Co. and GMAC. While the policy only affects 2009 compensation that hasn't already been paid, the guidelines are expected to form the basis of similar restrictions for 2010.
Mr. Feinberg also required that the firms limit the total amount of money available for bonuses. The companies will be required to establish a "pool" based on a percentage of certain earnings or "other metrics" that have yet to be determined, the Treasury Department said. Mr. Feinberg said the guidelines are "designed to send a message not only to these companies, but, we hope, to the greater corporate community."
Compensation consultants said most of what Mr. Feinberg is requiring hews closely to what many companies are already doing, but noted one difference is in requiring employees hold 50% of incentive compensation for the long term. "That's going to be the biggest change for most companies," said David Wise, senior consultant at the Hay Group, a pay consulting firm. "More of that compensation is being deferred over the long term, and that is going to hurt recruitment at these firms."
The guidelines do provide a way around the $500,000 salary caps, with board compensation committees able to pay an employee more in cases where "good cause" can be shown for going higher. Of the employees under review, Mr. Feinberg said fewer than 12 were given exemptions to go above $500,000. Those individuals will receive regular salaries of between $500,000 and $950,000, with one employee getting about $1.5 million. Mr. Feinberg declined to name the employees or the firms.
Citigroup has intensified its push to repay the government over the past two weeks, but the pay czar's ruling wasn't a factor, according to people familiar with the matter. Executives are more focused on escaping Mr. Feinberg's jurisdiction when setting 2010 compensation, these people said. "We are pleased this decision has been issued and we will comply with the structure as outlined in the decision," a Citigroup spokeswoman said.
Mr. Feinberg's limits are less restrictive than what he imposed on the top 25 executives and employees in October. In particular, this group of employees isn't prohibited by Congress from receiving cash bonuses. And, unlike the top 25, Mr. Feinberg wasn't required to set overall pay for this group, making it difficult to gauge the exact impact on any of the individuals.
U.S. bank failure tally reaches 133
Regulators close regional banks in Florida, Kansas and Arizona, at a cost of $252.1 million to the FDIC.
Regulators closed regional banks in three U.S. states Friday, bringing the total number of failed banks this year to 133, the Federal Deposit Insurance Corp. said. Customers of the failed banks are protected. The FDIC, which has insured bank deposits since the Great Depression, currently covers accounts up to $250,000. In Florida, the Office of the Comptroller of the Currency (OCC) closed Republic Federal Bank, NA, and the FDIC was named receiver.
The four offices of the Miami-based bank will reopen Monday as branches of 1st United Bank, which is based in Boca Raton, Fla. 1st United will acquire all of the failed bank's $352.7 million deposits. It will also buy $267.1 million of the $433 million worth of assets Republic Federal had on its books as of late September. Elsewhere, state regulators in Kansas closed the six branches of SolutionsBank, which is based in Overland Park. Arvest Bank, of Fayetteville, Ark., will assume all of the failed bank's $421.3 million worth of deposits and will purchase all of its $511.1 million in assets.
SolutionsBank branches will reopen Monday as branches of Arvest Bank. The sole branch of Mesa, Ariz.-based Valley Capital Bank, NA, was closed by the OCC. Its roughly $41 million in deposits and $40 million in assets will be assumed by Enterprise Bank & Trust, of Clayton, Miss. The FDIC said customers of the failed banks can access their money over the weekend by writing checks or using ATMs or debit cards. Checks will continue to be processed, and borrowers should make mortgage and loan payments as usual. An average of 11 banks have failed per month this year, and the FDIC's deposit insurance fund has slipped into the red for the first time since 1991.
As of the end of September, the fund was $8.2 billion in the hole. But that figure includes $21.7 billion the agency has earmarked for future bank failures. Friday's failures of the three banks will cost the FDIC an estimated $252.1 million. The fund is expected to move back into the black by 2012 as banks repay their insurance premiums over the next three years, which the FDIC says could raise $45 billion. This year's tally of bank failures is the highest number since 1992, when 181 banks failed. But the total is far from 1989's record high of 534 closures which took place during the savings and loan crisis, when the insurance fund also carried a negative balance.
Morgan Stanley’s Roach Sees 'Great Risk' in Fed Exit Strategy
The Federal Reserve may cause another crisis by botching the withdrawal of liquidity from the U.S. economy, Morgan Stanley Asia Chairman Stephen Roach said. The Fed is the "weak link" among central banks and may fail to tighten monetary policy in time to stop asset bubbles from forming, Roach said at a conference in Berlin today. The Fed helped trigger the boom and then bust of the subprime mortgage market by being "quick to slash, slow to normalize" interest rates, he said.
Fed Chairman Ben S. Bernanke said Dec. 3 he doesn’t rule out using monetary policy to prevent unfounded increases in asset prices, though he said financial regulation is a better approach. Bernanke said this week the U.S. economy continues to face "formidable headwinds," signaling the Fed will keep its benchmark interest rate near zero for an extended period.
"There is a great risk in the coming exit strategy," said Roach, a former Fed economist. "They are lacking primarily a political will to execute the exit in a timely and expeditious fashion that will avoid the mistakes of the last crisis." The traditional view of central bankers that asset bubbles are hard to spot and deflate with rates is "ludicrous," he said.
"This is a failed flaw in the intellectual construction of modern central banking that must be addressed," said Roach. "If we don’t fix this problem we’re doomed to repeat the failed asymmetric policies of the past and set ourselves up" for another crisis. Roach recommended the Fed be required to "hardwire" the goal of preserving financial stability into its mandate, alongside the pursuit of full employment and low inflation. Central banks should not be "allowed to outsource their responsibilities" to regulatory bodies, he said.
Bernanke said Dec. 3 that "regulation of the financial system is the strongest, most effective" way to deal with bubbles. "I do not rule out using monetary policy if necessary, if that situation does become worrisome and threatening," though there are no signs of "extreme misvaluations," Bernanke told the Senate Banking Committee.
Treasury Yield Curve Steepens to Highest Since 1980 Amid Sales
Treasuries declined, with the yield gap between Treasury 2-year notes and 30-year bonds reaching the widest since at least 1980 amid lower-than-forecast demand for the $74 billion in notes and bonds auctioned in the week. Treasury 10-year notes fell for a second consecutive week as reports showed consumer confidence and retail sales rose more than forecast. Federal Reserve Chairman Ben S. Bernanke said the U.S. economy faces "significant headwinds" and economists forecast policy makers will leave rates unchanged after next week’s Federal Open Market Committee meeting.
"We had sloppy 10- and 30-year auctions at time when there are less people in the market," said Larry Milstein, managing director in New York of government and agency debt trading at RW Pressprich & Co., a fixed-income broker and dealer for institutional investors. "The short end is locked in by the Fed and the long end is starting to see pressure from supply. Also, consumers are seeing some positive signs." The 10-year note yield climbed seven basis points on the week, or 0.07 percentage point, to 3.55 percent in New York, according to BGCantor Market Data. The 3.375 percent security due November 2019 fell 19/32, or $5.94 per $1,000 face amount, to 98 18/32.
Thirty-year bond yields rose 11 basis points on the week to 4/50 percent. The spread between 2- and 30-year Treasuries reached 374 basis points on Dec. 10, the most in 29 years, as the U.S. sold $13 billion of the so-called long bonds in the last of the week’s auctions. "The curve reflects the Fed taking short-term rates as low as it can go and the Treasury piling on out the curve," said Ward McCarthy, chief financial economist at Jefferies & Co. Inc. in New York. Jefferies is one of 18 primary dealers required to bid at Treasury auctions. "The slope of the curve reflects the concession necessary to attract sufficient buyers to take the issue down."
The bonds drew a yield of 4.52 percent at the auction, compared with a forecast of 4.483 percent in a Bloomberg News survey of five of the primary dealers. The $21 billion of 10- year notes sold on Dec. 9 yielded 3.448 percent, compared with a 3.421 percent average forecast. U.S. marketable debt rose to a record $7.17 trillion in November as President Barack Obama borrows record amounts to fund spending programs.
Treasury officials on Nov. 4 announced a long-term target of six to seven years for the average maturity of Treasury debt and said the department wants to cut back on its issuance of bills and two- and three-year notes. The shift to longer- maturity debt has raised concern that investors will demand higher yields to offset the risk of inflation as government spending drives the deficit to a record $1.4 trillion.
"People are looking at what’s going on with deficits and that over time, the long end is going to be under pressure as fiscal policy has a question mark," said Thomas Tucci, head of government bond trading at primary dealer RBC Capital Markets in New York. Ten-year yields touched their highest levels since August yesterday as retail sales rose 1.3 percent in November, above the median forecast for an increase of 0.6 percent in a Bloomberg News survey, and the Reuters/University of Michigan preliminary index of consumer sentiment for December increased to 73.4, also higher than forecast.
The U.S. "economic data so far points to a fairly robust recovery out of the recession," strategists led by Mustafa Chowdhury, head of interest-rates research in New York at the securities unit of Deutsche Bank AG, wrote in a note. "The peaking of job losses could lead to a revival of consumption growth, such as inventories and government spending that have so far led this year." Treasury two-year notes gained for the week as Fed Chairman Ben S. Bernanke repeated in a speech Dec. 7 that the central bank expected an "extended period" of low rates. Yields on two-year notes fell on Dec. 8 below levels seen on Dec. 3, a day before they surged the most since August after a report showed that the unemployment rate declined to 10 percent in November from a 26-year high of 10.2 percent the previous month.
"We still have a 10 percent jobless rate so what’s the Fed going to do?" said David Robin, an interest-rate strategist in New York at Newedge USA LLC, an institutional brokerage firm. "Not much. Bernanke told you that there’s a long way to go before sustainability and before there’s any comfort that what’s happening is going to give them reason to react from a rate standpoint." The Federal Open Market Committee will announce its rate decision at the end of a two-day meeting on Dec. 16. Fed funds futures contracts on the Chicago Board of Trade show a 100 percent change the central bank will keep its target rate near zero. U.S. government debt lost investors 2.5 percent this year, according to Bank of America Corp.’s Merrill Lynch Treasury Master Index.
Charting The Government's Chronic And Flawed Overrepresentation Of Household Net Worth: A $2.1 Trillion Downward Revision In One Quarter
by Tyler Durden
After we posted our preliminary thoughts on the Z.1 "Flow of Funds Accounts of the U.S." report earlier, we had the chance to dig deeper through the data in the governmental cash flow report. To our surprise we uncovered some dramatic data revisions whose presence highlights the recent "consumer resurgence" in a very different light. The key finding is that the government has been chronically overrepresenting Household Net Worth in original publications, and subsequently revising the data dramatically in order to hide the fact that consumers' wealth is nowhere near as impressive as originally represented. Putting a number to this statement: a $2.1 trillion downward revision in just one quarter.
Exhibit A - ratio of Household Net Worth to Disposable Income
Two of the most critical data sets in the Z.1 are total Household Net Worth and Disposable Income, and their respective ratio. Over the past decade this ratio has averaged roughly 5.5x, and as the confluence of the real estate and stock price market lifted household net worth into the unrealistic stratosphere, this ratio hit an all time high of 6.5x in 2006. Ever since then the ratio has collapsed, and according to today's release it hit 4.86x. Yet what is notable are the recent revisions to this data, whereby this ratio, which in Q2 was disclosed to be 4.87x originally, was subsequently reduced to 4.63x per today's data. This is a dramatic revision.
What was the reason for this revision? One specific item.
Exhibit B - Household Real Estate Worth
Comparing the constituents of household net worth, yields one glaring disparity. While in Q2 Household Real Estate was valued at $18.3 trillion dollars, in today's data it was revised by a stunning $2.1 trillion lower. To put that into perspective, the entire increase in HNW from Q2 to Q3 was $2.7 trillion, of which $2.3 trillion was from "Equity Shares At Market Value." In other words, had the government not fudged the data initially (or had it not subsequently revised it by a whopping 11.4%), today's Z.1 would have shown a much less ebullient picture, with just a $600 billion increase in HNW instead of $2.7 trillion: an 80% haircut! Our data demonstrates that over the past 5 quarters this has been a habitual game of over-inflating household real estate by the government, only to trim it subsequently, as the stock market picks up courtesy of an imaginary (and soon to be revised massively downward) "improvement" in the consumer's net worth status. A big (and potentially fraudulent) Catch 22 perpetrated by the government: consumers believe they are richer (when they are not), they buy into the ponzi, the government then removes the "net worth" crutches, but the ponzi has ratcheted up a notch in value; next period: rinse, repeat.
The comparison of originally reported real estate value and any given period's most recent revision is presented below. Ever since the peak of the housing bubble, 10 quarters ago, the government has been consistently deflating the margin of actual-revised numbers, while over the past 5, the revisions have gotten simply blatant, with a record $2.1 trillion in actual-revised adjustments in Q1 and Q2 of 2009. Not a bad way to make it seem that the consumer is $2.1 trillion dollars richer based on "adjustments," even if these disappear into thin air after a mere 90 days.
And if the United States government is willing to "adjust" numbers to the tune of $2 trillion+ within 90 days, who is to say what goes on in the Bureau of Labor Statistics, Department of Labor and the Census Bureau...
Bair says FDIC was pressured to aid Bank of America
The Federal Deposit Insurance Corp resisted pressure from the administration of President George W. Bush to extend assistance to Bank of America to complete its purchase of Merrill Lynch but was ultimately convinced of the need, FDIC Chairman Sheila Bair said on Friday. Bair said the agency continued to raise questions about whether further assistance was really necessary and about the potential exposure for the FDIC. "The FDIC's board ultimately was persuaded that BofA's condition presented a systemic risk," Bair told a House oversight panel examining Bank of America's acquisition of investment bank Merrill Lynch.
The hearing is the fifth in a series looking at the government's role in the merger, which was announced late last year during the height of the financial crisis, and whether Bank of America misled investors about Merrill's looming losses as well as bonuses paid to Merrill employees. Bank of America is defending itself on multiple fronts over the Merrill deal -- against shareholder lawsuits and civil charges from the U.S. Securities and Exchange Commission.
On Friday, the SEC's chief enforcer, Robert Khuzami, told the oversight panel that the agency will continue to "vigorously pursue" charges that Bank of America misled investors over the Merrill bonuses. The SEC has been forced to go back to the drawing board after a federal judge rejected a $33 million settlement between the bank and it. Khuzami said the SEC is further pursuing facts and determining "whether to seek additional charges."
For months the oversight panel has been trying to figure out when the bank knew Merrill was on its way to a $15.8 billion loss and whether Bank of America was prepared to try to stop the merger or seek government help to finish it. Bair, who has been a vocal opponent of poorly underwritten government bailouts, said the FDIC was told by the Federal Reserve and Treasury near December 21, 2008, that Bank of America had expressed reservation about completing the Merrill deal.
The FDIC continued to raise questions about whether further aid was really needed, despite former Treasury Secretary Henry Paulson indicating that he hoped the FDIC would provide asset guarantees similar to those it provided for Citigroup, Bair said. Over the following days, she said, the FDIC requested detailed information about where Bank of America's exposures resided, particularly how much of the risk was housed in BofA's insured depository business.
The FDIC board ultimately agreed on January 15, 2009, that Bank of America's condition posed a systemic risk that a "ring fence transaction" involving asset guarantees from the FDIC would mitigate, Bair said. The government wanted to wall off, or "ring fence," the risky assets in the merged Bank of America-Merrill company so that insured deposits would not be affected. An asset guarantee deal and a capital infusion were announced on January 16, but the ring fence transaction was never finalized and was ultimately terminated.
Federal Reserve Chairman Ben Bernanke, Paulson have already been blasted by oversight committee members for how they handled the merger. The panel has also ripped into two Bank of America directors and Brian Moynihan, one of the bank's leading contenders to replace outgoing CEO Ken Lewis. Moynihan, currently Bank of America's retail bank head, was the bank's general counsel when the deal closed in January.
The Retarded Recovery
by Bill Bonner
Nothing is quite as disagreeable as a neighbor who has made a lot of money by not following your advice. After 9 months of 'recovery' they are all around us. They think they have perfected the art of bubble riding.
Here on the back page, we alert investors. We wag our fingers and shake our heads. Little good it does. We might as well warn surfers about an approaching storm. They don't head for cover; they rush to the beach, hoping it's not too late to catch a big one.
As of this week, investors are still making money. Almost everything has outperformed cash over the last 9 months. Stocks, commodities, gold - you name it. This wouldn't be happening were it not for the government. The feds are making waves from Malibu to Manila. 'Don't worry about the depression,' they tell us; 'we're on the case.' That, of course, is what we're worried about.
Instead of allowing things to settle down, the feds are doing all they can to keep them stirred up. Amid the foam and splash, nobody knows what is really going on. For example, they've driven the yield on cash down to near zero. What's a borrower to think? Why are interest rates so low? Are there so many trillions in idle savings that he can have them for nothing?
Investors don't know whether they are coming or going either. They're buying S&P stocks at more than 80 times earnings, while people who know what they are doing - the insiders - dump 82 shares for every one they purchase.
And in the economy, last Friday, came a puzzling report from America. According to the feds, unemployment dropped by 0.2% last month. That leaves only 15 million without work. Another report tells us that each job created by US government stimulus costs $246,000. What were they hiring, bankers?
While the feds muddy the waters, the de-leveraging of the American consumer continues. Consumer credit fell in the US in October, for the 9th month in a row. As long as consumers are cutting back there is no way a real recovery can begin.
What to make of it all? We turn to a ghost for an explanation. Friedrich Hayek described a similar situation 76 years ago:
"There can...be little doubt that ...a deflation process is going on...Central Banks, particularly in the United States, have been making earlier and are more far-reaching efforts than have ever been undertaken before to combat the depression by a policy of credit expansion - with the result that the depression has lasted longer and has become more severe than any preceding one.
"...all conceivable means have been used to prevent the readjustment from taking place; and one of those means , which has been repeatedly tried though without success, from the earliest to the most recent stages of depression, has been this deliberate policy of credit expansion... To combat the depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about..."
He could have been describing Japan's 20-year depression, too. So far, we have no evidence that the authorities can improve a depression. All we know is that they can stretch it out.
A real recovery is a process of discovery: it begins in misery and ends in prosperity. Investors figure out what their boom-era investments are really worth. Businessmen figure out how to turn a profit in a new environment. Households learn how to match their incomes against their expenses in a world where credit is less forthcoming and jobs are harder to find. Needless to say, the faster these discoveries are made, the better.
But the first thing people realize is that they have been idiots. Then, they call for the government to prove it isn't so. In Britain, the government has spent about $8,000 per family to bail out the banking sector. As a result, we don't get to discover what the bankers would do if they were forced to seek honest employment. Nor do we discover what the poor taxpayers would have done with that $8,000 if it hadn't been forcibly transferred to the City.
Likewise, what we want to know about an insurance company is how well it holds up under pressure. But when the feds rushed in to save AIG they corrupted the facts. Then, in the US alone, there were Bear Stearns, Citigroup, Washington Mutual, General Motors, Chrysler, Fannie Mae and Freddie Mac, not to mention the small fry. Our curiosity remains unsatisfied; what kind of world would it be if they had gotten what they deserved?
Alas, the feds have created a world of darkness and depression. No one knows anything. And what they think they see clearly is often a mirage. Employers don't know whether to hire or fire. Consumers are blind too; they don't know whether things are getting better or worse. Finally, government even pokes its own eyes out. Relying on 'funny money' to cover its deficits, it has no idea how far it can go before it falls off a cliff.
Credit rating agencies: the untouchable kings of finance
There are any number of organisations and individuals who can be blamed for the credit crunch, but right up there at the top of any league table of culprits – along with the bankers, credit-drunk consumers, half- asleep policy makers and incompetent regulators – would have to be the credit rating agencies, those shadowy creatures that sit in judgment over the trillions of dollars of debt that swirl around the world's money markets.
By assigning a top-notch, triple-A rating to many of the products that emerged from the boom in "structured finance", the credit rating agencies played a pivotal role in fostering the mad dash into sub-prime mortgage lending which eventually triggered the worst banking crisis since the Great Depression.
The rating agencies had thought the risk of default negligible, yet when the balloon went up, many of these "asset-backed securities" turned out to be worthless. To make matters worse, the agencies then rushed to catch up and, by downgrading vast tracts of debt previously thought safe, helped prompt an extreme retreat from risk that caused the banking system to fail and economies to collapse into recession. The sub-prime meltdown is only the latest offence in a serial list of failings, be it the Latin American debt crisis of the 1980s, the Far Eastern crisis of the 1990s, Enron, and just about any other major default you can think of in recent history.
In all cases, the rating agencies failed to see it coming. The charge list is damning, yet despite this latest, calamitous example of wrong-headedness, little is being done to reform the industry, curb its powers, or monitor its activities. With fiscal deficits around the world going out of control, the focus of credit markets has shifted from sub-prime to sovereign debt. It's not just the future of mortgages and corporations that the agencies preside over. Like Caesar, they can dispense life and death to entire countries, too.
Discredited the agencies may be, but governments still hang on their every word and live in terror of a downgrade from the ranks of "teenage scribblers" they employ. The greater the perceived risk of sovereign default, the more that has to be paid for borrowings and the less there will be for spending on hospitals, schools and public services. Whole teams of British Treasury officials are employed to sweet talk the agencies into a fuller understanding of the security of our fiscal position.
Since the economic crisis started, Ireland has already been stripped of its Aaa credit rating, and though there is as yet no serious threat to Britain, the rating agencies have warned that unless more is done after the election to address the explosive growth in public debt, the UK, too, could be vulnerable. Only this week, Moody's placed Britain in a less safe category of Aaa-rated nations than Germany and France. Many of the peripheral eurozone nations are already directly threatened with downgrades from lower ratings.
So who are the credit rating agencies, why are they are so powerful and, given their manifest failings, why does anyone still take them seriously? Part of the problem with credit rating is that there are only three organisations of any importance that do it – Fitch, Moody's and Standard & Poor's. Rating the world's debt is an expensive business, requiring thousands of analysts around the globe. Only three agencies have attained the critical mass necessary to allow for a comprehensive service. Undue reliance on this limited choice of credit assessments has accentuated the consequences of any misjudgment.
Necessarily in many respects, investors have become overly reliant on their judgments. The range and quality of debt instruments available on world markets is so vast as to be virtually impossible even for very large, institutional investors to assess individually. Investors have thus become ever more dependent on the agencies to do it for them. This in turn has encouraged a herd-like approach to debt, which is universally and sometimes blindly accepted as of good quality if the agencies say so. The consequent "outsourcing", or abdication of investment judgments to a relatively small number of rating agencies, was one of the key causes of the explosive growth in credit markets, for if debt issuers managed to pull the wool over the eyes of the agencies, they would also gain the support of investors, who would buy oblivious to underlying risks.
As the good times rolled, almost any old junk became repackaged as gold standard credit and was awarded a triple-A rating. What began as a public service to bond markets became an accident waiting to happen. As Lloyd Blankfein, chief executive of Goldman Sachs, has observed, in January 2008 there were only 12 triple A-rated companies in the world and only about the same number of countries too, but at the same time there were 64,000 structured instruments, such as the notorious Collateralised Debt Obligations (CDOs), which were rated on the same basis.
Bizarrely, securities backed by mortgages sold to people without the income to service the debt they were taking on were being judged a better credit risk than the sovereign government of Japan, with the ability in extremis both to raise taxes and print money to avoid a default. The agencies had failed to model adequately for a fall in the housing market or a rise in individual mortgage defaults beyond historic norms. Worse, their entire business model had conspired to produce just such a catastrophic oversight.
Ever since the development of the photocopier, it has been increasingly difficult for the agencies to charge investors for their services. So they take their fee from the debt issuer. The potential for conflict of interest is obvious. What little competition there is among the rating agencies seems confined to that of producing the most favourable rating, for no debt issuer wants to pay for an adverse assessment. Predictably, regulators have compounded the problem by themselves blindly placing too big a reliance on the ratings.
Because banks were required to hold less capital against Aaa-rated securities, they maxed out on CDOs. Worse, one of the reasons British banks ran out of money to pay their depositors was that with regulatory approval they were holding a substantial proportion of their liquidity pool, designed to meet heavy withdrawals, in triple A-rated American mortgage-backed securities that turned out to be worthless. In defence of the rating agencies, they didn't ask to be trusted as completely as they were and have never pretended to be able to predict individual defaults. As Chris Huhne, a former managing director of Fitch Ratings and now the Liberal Democrat home affairs spokesman, points out, the function of a credit rating is to assess the probability of a default based on analysis of historic data.
With Aaa-rated securities, the risk of default is meant to be negligible, maybe 0.1 per cent, but every now and again even a triple A will go belly-up. The problem occurs when there is financial innovation, and therefore no data by which to judge the security. This lack of history will invariably make the product more risky, but like a new-born baby, the security will be sold as flawless. If the product begins to gain traction, everyone wants a part of the fees it generates, including the rating agencies, and all caution is thrown to the winds. This time it's different, the debt issuers promise; but of course it never is.
There's a pretty extensive history with sovereign debt, the latest area of explosive growth in credit markets, so you might think that at least the rating agencies would get this one right. Ignoring devaluation and inflation, which can be as effective a method of default as the real thing, Britain has only once in the entire history of government bond markets been in technical default on its debt – on war loans during the 1930s. There is virtually no chance of that mishap being repeated. Yet because of the deep recession and the co-ordinated fiscal approach to it, the rating agencies feel obliged to assess the possibility of meltdown, where the country becomes incapable of servicing its debts, or prints so much money that the debt becomes worthless.
On this front, there's very little for the agencies to go on, since never before have so many big advanced economies all at the same time been so fiscally challenged. Some are plainly going to be better than others at easing themselves out of the mire. Conscious of the mistakes made over sub-prime, the agencies are applying an ultra-cautious, safety first approach. All the same, it's odd, to put it mildly, that Moody's thinks France more secure in its triple A-rating than Britain, even though France's debts will end up as big and it has no plans for fiscal consolidation. When a fiscal crisis hits, it tends to do so rapidly without much warning. A dime to a dollar that when it does, the rating agencies will again be left struggling to catch up – and their clients wondering what on earth happened.
Ilargi: There are a whole slew of gems in this 15 minute interview with Rogers. Recommended.
Gold Not a Bubble, Silver a Better Buy: Rogers
Commodities are still a great place to invest, while some currencies also offer value and investors should stay away from US stocks and bonds, Jim Rogers, chairman of Jim Rogers Holding, told CNBC Thursday. Rogers has long been bullish on commodities, especially since central banks started to print money to combat the financial crisis.
He is holding gold right now and despite the recent spike in the metal's price, said he things the market is not experiencing a bubble. "I wouldn't think of selling," Rogers said. "If gold goes to $1,000 (per ounce) -- or pick a number -- I hope that I'm smart enough to buy more." With central banks now buying gold and many people worried about paper money, gold will be a great investment over the next decade and relatively few people are invested in it, he said.
At a speech in Prague Rogers surveyed about 300 people, including big money managers, and 76 percent had never owned gold, he said. "So when you say it's a bubble … nobody owns gold yet," Rogers said. Still, silver is preferable, with silver 70 percent off its all-time high and gold near it's all-time high, he said. Agriculture indexes are also good to own, he added. Investors should also learn about foreign currencies, which will be great opportunities, Rogers advised.
If a short-term rally in the dollar happens, the yen, Swiss Franc and Canadian dollars could all benefit, he said. Rogers does not have any money in US stocks because the market is up about 70 percent in eight-to-ten months. "I don't like to buy anything like that," he said. "I'm sceptical of the economy going forward." He also reiterated his view that the US bond market is the next bubble.
Spain Says Adios to Xmas as 19% Jobless Hits Spending
For the first time in their lives, Consuelo Serrano’s kids won’t get a visit from Santa Claus. The Spanish mother will give presents only on the Jan. 6 Epiphany holiday, a Christian feast that marks when three wise men visited Jesus. As Spain grew faster than the region over the last decade, Serrano and millions like her handed out gifts at Christmas too. Now, she’s the sole breadwinner as the nation’s jobless rate soared to the euro area’s highest.
"The children used to ask for PlayStations and computers but they know that won’t happen this year," said Serrano, 43, who earns 1,100 euros ($1,620) a month at a bakery in Madrid and has three children aged from 11 to 14. Spanish holiday spending will drop 9.1 percent this season, according to Deloitte, more than the 6.3 percent decline forecast for western Europe. El Corte Ingles SA, the nation’s biggest department store operator, is advertising 70 percent discounts to lure shoppers.
The credit crunch exacerbated the collapse of Spain’s housing boom last year, leaving people struggling to pay household debt that is among the highest in the euro region. The protracted crisis means more than half the jobless, including Serrano’s husband, have been out of work too long to get full benefits. Spain’s unemployment rate is 19 percent. The outlook for next year doesn’t give consumers much reason for holiday cheer. The economy is forecast to contract 0.8 percent in 2010, lagging behind the European Commission’s estimate for European expansion of 0.7 percent. Spanish unemployment is expected to rise to 20 percent.
"There won’t be any presents," said Luis Alberto Llumipanta, 36. The father of three, an Ecuadorian who’s lived in Spain for 12 years, lost his job as a carpenter and has had to refinance his mortgage. Shoppers may be skipping Christmas gifts and are likely to delay spending on any presents as long as possible, hoping for bigger discounts, said Miguel Angel Fraile, head of the Spanish Retailers Association. Spanish consumer prices fell from March to October, the first decline for 50 years. Even after prices rose in November, inflation remains below the euro-region average. "People are going to buy more at the last minute, thinking that there will be better offers," Fraile said. He estimates prices for some gifts are as much as 15 percent cheaper than a year ago.
El Corte Ingles slashed the price of a Fisher Price activity center by 40 percent to 50 euros and offered 50 percent off of fur coats last week. The department store is making a "very significant effort" on discounts this year to stimulate demand, said a spokeswoman. Foreign retailers like Carrefour SA are also having trouble. In Spain, the Paris-based retailer’s second-biggest market, it cut prices as much as 25 percent on 10,000 products per store this year, a spokesman said. This week, it offered 20 percent off toys. Carrefour’s same-store sales in Spain dropped twice as much in the third quarter as they did globally.
"Spain is the worst of all," for sales, said Enric Casi, general director of Barcelona-based clothing chain Mango, which makes a fifth of its revenue in Spain. The company plans to open 200 stores next year. None are planned in Spain, Casi said. Credit Agricole Cheuvreux cut Zara fashion-chain owner Inditex SA to "underperform" today, saying sales were weaker than forecast and there wasn’t enough evidence to raise its earnings estimates. Inditex posted a 4.3 percent increase in third-quarter net income yesterday, helped by business in Asia.
Fewer than half of Spain’s 3.8 million unemployed are still receiving their contributions-based jobless pay, which lasts a maximum of two years, according to Labor Ministry data. Another 1.2 million receive smaller subsidies, such as a 420 euro-a- month benefit introduced in August. Unemployment among people younger than 25, who account for 10 percent of the labor force, is more than 40 percent, posing a further risk to companies that focus on young fashion such as Hennes & Mauritz AB, or Inditex’s Bershka brand, said Francisco Ruiz, an analyst at Fortis Bank SA in Madrid.
Debt built up during a decade-long real estate boom is also crimping households’ ability to spend. Mortgages, consumer credit and other loans account for 77 percent of Spanish GDP, compared with 51 percent in the euro region and 55 percent in Germany, according to European Central Bank data. Monthly mortgage payments that exceed her income are keeping 42-year-old Nidia Vargas away from the shops after her husband lost his job as a builder.
"We’ll try to do something for the children, but minimal, something from the corner store," said Vargas, a Peruvian who’s lived in Madrid for three years and works in a home for disabled people. Compared with last year, when household consumption fell an annual 3.4 percent in the fourth quarter, this year may not look as bad, said Gregorio Izquierdo, head of research at the Institute of Economic Research in Madrid. A year ago, higher interest rates also cut into spending power in a country where home ownership runs at about 80 percent. "I think this Christmas season will be better than last year, not because it’ll be particularly good, but because last year was especially tough," said Izquierdo.
Still, retailers may not see a real recovery until jobs are created, which won’t happen on a net basis until the end of next year, Deputy Finance Minister Jose Manuel Campa said last month. That’s bad news for Serrano’s husband, a technician for a telephone company, who’s been out of work for two years and is searching for any job he can find. "We have to get out of this somehow, I just don’t know how," Serrano said.
Ohio Governor: Education nightmare draws near
The Strickland administration is warning of massive losses for Ohio schools and higher education if the General Assembly fails to resolve a budget shortfall by Dec. 31. A fiscal doomsday analysis released yesterday projected that a failure by lawmakers to close an $851 million budget hole by year's end could trigger the loss of more than $5 billion to education coffers during the next 18 months. The new analysis comes on the heels of a state Department of Education analysis forecasting about $1.7 billion in needed reductions if the budget stalemate continues.
A key reason that yesterday's figure is much higher is that it included the potential loss of federal funding for both primary and secondary schools and state colleges and universities. "I think this demonstrates the seriousness of the consequences," said Amanda Wurst, spokeswoman for Gov. Ted Strickland. "It shows not only what would happen to school districts but our institutions of higher education, too."
The Democratic-controlled House approved Strickland's plan to delay this year's 4.2 percent rollback of the state income tax to shore up the budget. The Republican-controlled Senate, however, has refused to vote on the Democrats' plan or any alternative. Yesterday, GOP leaders downplayed the administration's dire predictions. "The world does not end Dec. 31 if we don't do anything," said Senate Finance Committee Chairman John A. Carey Jr., R-Wellston. "The only thing magical about Jan. 1 is, after that, the option of the income-tax delay goes away and it would become a tax increase."
What's the problem?
The budget impasse threatens the loss of more than $5 billion for schools and colleges if it's not resolved by Dec. 31. Here is what the standoff is about:
- Gov. Ted Strickland has proposed filling the $851 million budget deficit by delaying this year's 4.2 percent income-tax cut.
- The 21 Senate Republicans say they want to reform state construction and prison-sentencing laws as part of the budget deal. Although such reforms eventually would save the state millions, they would provide little help to fix the current budget deficit.
- Senate Democrats say construction and sentencing reforms should be introduced in separate bills and sent to legislative committees for hearings. If those reforms are in the budget fix, they say they won't provide their 12 votes needed to pass the budget.
If the issue is not resolved by the end of the year, Carey said, cuts would not have to be made immediately, nor would they have to be made to education. The $851 million shortfall technically is in the education budget because the money represented anticipated revenue from slot machines at racetracks, which by law had been earmarked for schools. The Ohio Supreme Court, however, nixed the slot-machine plan by deeming it subject to referendum.
According to a seven-page analysis by the state Office of Budget and Management, if the state cuts aid to primary and secondary schools, Ohio could be disqualified for federal education aid because it would no longer meet requirements for minimum state-spending levels. By not fixing the budget hole, state leaders would jeopardize more than $4 billion in federal stimulus money and funding for students living in poverty and those with special needs in the two-year budget ending June 30, 2011, the report said.
Analysts also warned that the state could be ineligible for a share of the $4 billion in federal Race to the Top funds, which will be awarded by the U.S. Department of Education next year. States must submit their funding applications by Jan. 16. According to the report, the loss of state and federal funds for education likely would result in "large-scale layoffs" of teachers. The impact would be felt throughout the state, but will be concentrated in those districts where state funding makes up a larger share of the total operating budget, which are low-wealth districts.
For higher education, there could be staff reductions, salary reductions, significant midyear tuition increases and reductions in institutional aid to students, the report said. "This could have been over a long time ago," Carey said. "All the governor had to do is agree to his own construction proposal. If this is what's at stake, he can end it by agreeing to construction reform." Senate Republicans say they will provide five votes for Strickland's plan if it includes changes to state construction and criminal-sentencing laws. That would require all 12 Senate Democrats to vote for it, but Democratic leaders say they will support the income-tax rollback with no extras. House Democrats agree.
Unwinding of dollar-carry trade a danger for stock market
Wall Street is now debating whether the dollar has hit the bottom of its eight-year decline, and the potential danger ahead for the stock market once the so-called dollar-carry trade starts to unwind. Essentially central bankers have underwritten risk by pumping lots of liquidity in the economy, and some of the liquidity is used to sell the dollar and buy higher-yielding assets, such as equities, said Marc Chandler, head of currency strategy at Brown Brothers Harriman.
"What's GM going to do, build another car factory?" Chandler asks. And, whether one fully understands the nuances, the dollar-carry trade has been a major factor behind the stock market's nine-month climb, as well as the ascent of commodities such as gold and oil, analysts say. "Investors in all kinds of financial instruments have been impacted by the carry-trade strategy as the size of these trades have contributed to the big move in commodity and stock prices over the last year," Fred Dickson, chief market strategist, Davidson Companies, writes Thursday in an early note.
These trades are now being viewed as a major risk factor when they begin to unwind, a scenario Dickson doesn't see playing out in full until mid-to-late 2010. And, while the trade has had ramifications for global markets and investors at large, "the dollar carry-trade strategy realistically is only employed by institutions with huge size and active involvement in the currency markets, not by individual investors," Dickson said.
The currency-carry trade strategy involves selling a currency -- in this case the U.S. dollar -- backed by a relatively low interest rate, then using the funds to buy a different currency backed by a much higher interest rate. Traders use the approach to capture the difference between the rates, and some extend the strategy by borrowing massive amounts of funds overnight at the low interest rates of the currency sold to leverage their trade.
"We have seen hedge funds and major global traders extend the dollar carry-trade strategy by borrowing funds overnight in the U.S. at very low rates and reinvesting the proceeds into other currencies of hard assets like gold, crude-oil futures and global equities," the analyst said. The strategy has worked during the last nine months primarily due to the drop in the dollar that came along with the Federal Reserve's near-zero interest-rate policy "that encourages overnight borrowing by institutions at very low rates needed for the trade to make sense," Dickson added.
But in six to eight months, the Federal Reserve should begin hiking interest rates, and the reduced liquidity will become "a test for these correlated trades," the analyst said. "There are fads in the market, which are really just patterns, and if people make money they want to stick to it, even if fundamentals don't justify it any more," said Chandler of his thinking the currency-carry trade will likely persist into 2010.
Chandler foresees the stock market will have a modest pullback in the early part of 2010, beginning the transition from a liquidity-driven to an earnings-driven market. The key question, he says, is whether earnings will be strong enough to carry the market. On Thursday, the major stock indexes climbed, extending gains into a second day, after the government reported the four-week average of those filing first-time jobless claims declined and the U.S. trade deficit narrowed as the weaker dollar bolstered exports.
The Post-American World: Federal Salaries Soar
Henry Ford. Motor City. Cadillac. The drive-thru window. "Happy motoring," as J.H. Kunstler likes to say. They will always have their roots in America, but today it is official — China is their new home. 12.7 million cars and trucks will be sold in China in 2009, says a report today from J.D. Power and Associates. That’s an incredible 44% growth from 2008 and — perhaps more notably — far larger than the 10.3 million sales forecast for the US.
It’s not entirely America’s fault… of course, the U.S. is mired in the Great Recession while China is booming (bubbling, if you ask some). China’s got about a billion more people over there too, which might help. But it’s time to face the music: The future of the auto industry — and many others — is in China. We represent its aging past. Along the same lines, US patent filings fell in 2009 for the first time in 13 years, says a preliminary report from the US Patent and Trademark Office. Filings fell 2.3% this year, the first downturn since 1996. The really interesting part: In 2009, the United States issued 6.3% more patents to inventors and businesses in foreign nations.
So where is the new focus of the US? Where are we devoting our resources? Here’s the scoop straight from USA Today… if you think you might throw up, stop reading: "The number of federal workers earning six-figure salaries has exploded during the recession, according to a USA Today analysis of federal salary data. "Federal employees making salaries of $100,000 or more jumped from 14% to 19% of civil servants during the recession’s first 18 months — and that’s before overtime pay and bonuses are counted.
"Federal workers are enjoying an extraordinary boom time — in pay and hiring — during a recession that has cost 7.3 million jobs in the private sector. "The highest-paid federal employees are doing best of all on salary increases. Defense Department civilian employees earning $150,000 or more increased from 1,868 in December 2007 to 10,100 in June 2009, the most recent figure available. "When the recession started, the Transportation Department had only one person earning a salary of $170,000 or more. Eighteen months later, 1,690 employees had salaries above $170,000."
At college, your editor took a few law classes (it was a phase). We remember a phrase judges threw around a lot, especially in situations of gross injustice or patent obscenity: As they would say, this "shocks the conscience."
Drug money saved banks in global crisis, claims UN advisor
Drugs money worth billions of dollars kept the financial system afloat at the height of the global crisis, the United Nations' drugs and crime tsar has told the Observer. Antonio Maria Costa, head of the UN Office on Drugs and Crime, said he has seen evidence that the proceeds of organised crime were "the only liquid investment capital" available to some banks on the brink of collapse last year. He said that a majority of the $352bn (£216bn) of drugs profits was absorbed into the economic system as a result.
This will raise questions about crime's influence on the economic system at times of crisis. It will also prompt further examination of the banking sector as world leaders, including Barack Obama and Gordon Brown, call for new International Monetary Fund regulations. Speaking from his office in Vienna, Costa said evidence that illegal money was being absorbed into the financial system was first drawn to his attention by intelligence agencies and prosecutors around 18 months ago. "In many instances, the money from drugs was the only liquid investment capital. In the second half of 2008, liquidity was the banking system's main problem and hence liquid capital became an important factor," he said.
Some of the evidence put before his office indicated that gang money was used to save some banks from collapse when lending seized up, he said. "Inter-bank loans were funded by money that originated from the drugs trade and other illegal activities... There were signs that some banks were rescued that way." Costa declined to identify countries or banks that may have received any drugs money, saying that would be inappropriate because his office is supposed to address the problem, not apportion blame. But he said the money is now a part of the official system and had been effectively laundered.
"That was the moment [last year] when the system was basically paralysed because of the unwillingness of banks to lend money to one another. The progressive liquidisation to the system and the progressive improvement by some banks of their share values [has meant that] the problem [of illegal money] has become much less serious than it was," he said. The IMF estimated that large US and European banks lost more than $1tn on toxic assets and from bad loans from January 2007 to September 2009 and more than 200 mortgage lenders went bankrupt. Many major institutions either failed, were acquired under duress, or were subject to government takeover.
Gangs are now believed to make most of their profits from the drugs trade and are estimated to be worth £352bn, the UN says. They have traditionally kept proceeds in cash or moved it offshore to hide it from the authorities. It is understood that evidence that drug money has flowed into banks came from officials in Britain, Switzerland, Italy and the US. British bankers would want to see any evidence that Costa has to back his claims. A British Bankers' Association spokesman said: "We have not been party to any regulatory dialogue that would support a theory of this kind. There was clearly a lack of liquidity in the system and to a large degree this was filled by the intervention of central banks."
Ireland, Greece May Leave Euro, Standard Bank Says
Greece and Ireland are among countries in an "intolerable" economic situation, which may lead to bailouts or even an exit from the euro area by the end of next year, according to Standard Bank Plc. The absence of a mechanism to permit so-called fiscal transfers within the 16-nation region may undermine the exchange-rate system, said Steve Barrow, head of Group of 10 foreign-exchange strategy at the bank in London.
Concern some nations will need to be rescued may drive the premium investors demand to hold 10-year Greek debt instead of benchmark German bunds to 400 basis points next year, from 214 basis points today, he said. The Irish premium may also jump, he said. "Countries like Ireland and Greece may not be able to grow out of the current crisis," Barrow said in a telephone interview today. "With interest-rate cuts, exchange-rate depreciation and significant fiscal support all off limits for these countries, bailouts or even pullouts from EMU may happen next year."
The Irish Finance Ministry called the suggestion it might leave the euro area "uninformed comment," and Greece said there was no chance it would leave. The widening difference in yield, or spread, between Greek and Irish bonds and German securities may accelerate, increasing the debt burden for these countries, he wrote in a report today. The Irish-German 10-year spread may rise to 300 basis points next year, from about 170 basis points, he said. The spread averaged about 43 basis points in the past five years, with the Greek-German average at 67 basis points in the period. "It can, in many ways, be a more destructive line of attack for the market than currency pressure," Barrow wrote.
Greek yields soared this week after a cut in the country’s credit by Fitch Ratings, which said Prime Minister George Papandreou’s government doesn’t grasp the debt crisis’ severity. Standard & Poor’s signaled it may also reduce Greece’s ranking. The spread with bunds reached 251 basis points yesterday, the widest since April 2. Yields on two-year Greek government notes jumped 66 basis points on Dec. 8, the most since 1998, after Fitch cut the rating to BBB+, the lowest level of any of the countries sharing the euro.
"This suggestion is an example of completely uninformed comment," the Irish finance ministry said in a statement today. "As the Minister for Finance stated nine months ago, it is akin to stating that Texas will leave the dollar." Greek Prime Minister George Papandreou said that European Central Bank President Jean-Claude Trichet and Luxembourg Prime Minister Jean-Claude Juncker see "no possibility" of a Greek default. Papandreou was speaking "There is no possibility of a default for Greece," Papandreou told reporters at a European Union summit in Brussels. He also said there was no possibility of Greece leaving the euro area.
Greece: A Looming Default?
Greece’s credit rating was downgraded from A- to BBB+ by Fitch Ratings on Dec. 8, due to concerns over the country’s debt levels. A number of other eurozone nations, however, are facing fiscal situations nearly as difficult as Athens’, and the European Union may decide to make an example of Greece to encourage other high-spending nations to cut their debt levels.
Financial rating agency Fitch Ratings downgraded Greece’s long-term foreign currency and local currency issuer credit ratings to BBB+ from A- on Dec. 8, citing concerns about the country’s rising budget deficit. This is the first time since Greece joined the eurozone that it has been downgraded below an "A" grade rating. Meanwhile, rating agency Standard & Poor’s warned Dec. 7 that Greek banks faced the highest long-term economic risks in Europe.
Economic problems in Greece are causing investors to worry that the entire eurozone could become destabilized. Indeed, one day following the Greek cut, Standard & Poor’s cut Spain’s debt outlook from AAA to AA+. The growing Greek budget deficit and total government debt will be a subject of discussion at the European Central Bank’s (ECB) Governing Council meeting on Dec. 17. Faced with the possibility that it will be made an example of by the European Union as a way of sending a message to other big spenders in the EU like Ireland, Italy, Portugal and Spain, Athens is staring at difficult budgetary cuts for 2010.
ROOTS OF THE CRISIS
Greece is considered one of Europe’s most notorious overspenders. Even prior to the current crisis, it was fighting high budget deficits, primarily caused by high social spending, a symptom of the country’s ever-present social tensions. The government’s liabilities on the pension system and through ownership of unprofitable enterprises, such as Olympia Airways, have been difficult to jettison due to the threat of unrest, which flares up whenever Athens tries to rein in spending. Total government spending on social programs represented almost 20 percent of gross domestic product (GDP) in 2008, the highest percentage in Europe and one that has risen almost every year since 1997, when it was 13.9 percent of GDP. This is higher than even Italy (17.7 percent of GDP) and France (17.5 percent of GDP), the two traditional big spenders in Europe. Because of the large public debt and the increasing deficit, the government has often turned to methods such as fudging statistical reporting to the EU in order to avoid disciplinary measures from Brussels.
GREEK BUDGET DEFICIT
The ouster of center-right Prime Minister Costas Karamanlis by his leftist rivals, the Panhellenic Socialist Movement (PASOK) in early October continues the cycle of wild swings in Greek politics. PASOK has pledged to not cut any social spending for the poor and instead increase taxes on the rich, as well as crack down on tax evasion (a notorious problem in Greece) to reduce the budget deficit. Despite an expected decline in GDP for 2010, PASOK is forecasting an extremely unlikely 9 percent gain in revenues — which means that in all likelihood the current budget imbroglio is only the beginning.
GREEK BANKING TROUBLES
In the background of the country’s perennial spending problems are the troubled Greek banks. STRATFOR cautioned about the Greek banking system at the onset of the current global financial crisis. As the Baltic states and ex-communist Central European states entered the European Union, Austrian, Italian and Swedish banks looked for new markets where they would have an advantage over their larger German, French, British and Swiss counterparts. They found that advantage in their former geopolitical spheres of influence, with the Austrians and Italians entering the Balkans and Central Europe, and the Swedes entering the Baltics.
European banks offered foreign-denominated currency loans — mainly in euros and Swiss francs — that carried with them lower interest rates than domestic currency loans. Because they were the latecomers to this game, Greek banks had to be particularly aggressive, using ever-lower interest rates to attract clients and undercut the more resource-rich Italian and Austrian lenders. Greek banks also had to rely much more heavily on foreign-denominated currency loans because their domestic deposits were much smaller than those of Austrian and Italian banks (a strategy similar to the disastrous banking methodology employed by Icelandic banks.
GREEK ECONOMIC INDICATORS
Greek exposure, particularly to the Balkans, is therefore troubling for the overall economy. The fear is that, unlike the larger Italian and Austrian banks, Greek banks will not be able to refinance loans or absorb losses of affiliates abroad. Greek banks have thus far drawn around 40 billion euros of cheap credit from the ECB, out of a total of around 665 billion euros extended to all eurozone banks. This represents between 6 and 7 percent of total ECB outstanding liquidity, much higher than the Greek share of EU economy (2.5 percent), and puts Greek banks second only to the Irish in terms of dependence on ECB emergency liquidity.
Due to the overall effects of the crisis, the yield spreads between Greek and German bonds (considered the safest government debt in the eurozone) have widened to 246 basis points on Dec. 9 (from 75 basis points in September 2008 before the current economic crisis struck).
THE ROAD AHEAD
The road ahead is not going to be easy for Greece. There are a number of options, but all are bad.
First, the Greeks could "simply" balance their budget. To do this they would need to slash their government spending by over half. That sort of cut would easily send unemployment above 20 percent for a sustained period of time. At a minimum this would set the country afire in a storm of protests and result in a series of revolving-door governments. This may sound normal for Greece, but the political and social chaos of the past is the country’s baseline. Just imagine what it would look like under austerity measures.
European government debt
Second, Greece could leave the eurozone. Membership in the eurozone requires surrendering control over one’s currency. Leaving it would allow Greece to print currency to pay off the debt, triggering inflation which would eat away at the remaining debt’s value. Such a move would also devalue the Greek currency, giving Greece a trade advantage globally. Such measures were commonplace in European countries more powerful than Greece in the time before the euro.
The downsides, however, make this a startlingly unattractive option. Greece would suddenly find it next to impossible to raise funds. Many are willing to invest in Greece’s euro-denominated debt, but very few would be willing to invest in the drachma-denominated debt of a loan-dodger. Greece could well find itself broke, cut off from capital markets, and spiraling into hyperinflation. And even that is assuming that the rest of its former euro colleagues don’t take its decision to jump ship personally.
Third, while STRATFOR doesn’t see this option as viable, Greece could simply walk away from the debt and default. Such an action would sever Greece from capital markets — including simple things like trade financing even within the European Union. It would lay a very sturdy foundation for the utter destruction of Greece as a modern economy.
STRATFOR only sees discussion of this option as a means of pressuring other European states to bail Greece out. After all, a Greek default would instantly translate into much higher borrowing costs for other eurozone states — most notably Ireland, Portugal, Spain, Italy, and France, roughly in that order. The only way these states could then recover financially would be to face the same gamut of choices Greece is currently facing. As all are more socially stable than Greece, most would likely raise taxes, and the result would be lower growth, higher interest rates and lower inter-European trade. If the EU can do something to avoid a Greek default, they’ll do it.
Which leaves this final option — some sort of external assistance. Unlike many other states that have sought assistance, the International Monetary Fund (IMF) is not a likely source of significant help. In addition to the austerity measures it would demand being extremely unpopular, the non-European members on the IMF’s board are unlikely to look kindly on bailing out a member of the eurozone.
That leaves an internal European bailout. Here the obstacle is Germany. The Germans feel that they have already bailed out all of Europe — twice (once by absorbing East Germany without a cent of assistance from the rest of the Continent, a second time in absorbing so many small and weak economies into the eurozone which Germany underwrites). If Germany is to sign off on a Greek bailout, therefore, it will only be under terms which give EU institutions an unprecedented ability to regulate Greek finances. Since Athens has already signed away monetary policy in order to accede to the eurozone, all that is left is budgetary control.
The question is how the left-wing government of new Prime Minister George Papandreou will handle the inevitable social pressures that will accompany any attempts at budgetary cuts, especially ones being dictated by Berlin. His predecessor, Karamanlis, faced these same pressures during the December 2008 rioting, and ultimately buckled under the pressure. The one year anniversary of the December 2008 rioting was marked by unrest in Athens, foreshadowing the potential for more social angst in Greece in 2010.
Ukraine wants $2 billion loan from IMF
Ukraine has made an urgent appeal to the International Monetary Fund for about $2bn in emergency loans. It says it needs the money to meet external obligations and avoid the danger of a "spill-over effect" on other economically vulnerable states. "The next three months are crucial," said Hryhoriy Nemyria, Ukraine's deputy prime minister, who has just returned from a mission to IMF headquarters. The country has received $11bn of a $16.4bn IMF loan.
The rest of the money was suspended by the IMF after it said Ukraine needed to implement economic reforms before it would hand over any more. Ukraine says it desperately needs the money. It has hinted that if it does not get extra funds soon, the consequences could be serious. At risk could be its ability to pay salaries, foreign debt and, crucially for its neighbours, its gas bill - notoriously supplied by Gazprom.
Mr Nemyria told the Financial Times newspaper: "Wait and see is not an option. The cost of inaction is greater than the cost of action and may aggravate the situation in the wider region." Mr Nemyria declined to say whether Ukraine would be forced into default without immediate fresh IMF support. But he said it would be "extremely difficult" for the government to pay state salaries and pensions or to cover foreign obligations, including, crucially, monthly payments to Russia.
Ukraine is Europe's most troubled large economy. Its economy shrank by 15% this year. Kiev's political leaders are divided, with President Viktor Yushchenko, Prime Minister Yulia Tymoshenko and ex-Prime Minister Viktor Yanukovych all campaigning for a presidential election to be held next month.
Baltics Risk New Crisis If Fiscal Steps Lag, ECB Says
The Baltic states risk being sucked into a second debt-fuelled economic crisis if their governments fail to impose adequate austerity measures that support their euro pegs, the European Central Bank said. Latvia, Lithuania and Estonia suffered a deeper economic slump than the rest of the European Union because tight euro pegs too early in the convergence cycle led to asset bubbles, the ECB said in a confidential document obtained by Bloomberg News. The narrow currency bands add to pressure on fiscal policy to ensure the economies aren’t prone to imbalances, it said.
Absent tighter fiscal measures, "the authorities in the Baltic states may not be able to prevent a renewed emergence of macro-economic imbalances and a repetition of the boom-bust cycle," the ECB said in a document dated Nov. 17 and prepared for a meeting of the EU’s economic and finance committee. The three countries this year suffered the deepest recessions in the EU after their 2004 accession to the bloc fuelled borrowing and sent wages up by as much as 85 percent, leaving their overheated economies vulnerable to the credit vacuum created by the global crisis. Their central banks enforce tighter euro pegs than the 15 percent mandated by the exchange rate mechanism, with Latvia defending a 1 percent band.
"The experience of the Baltic states suggests that, for countries that have opted for pegging tightly their exchange rates, there is a significant risk that relatively low interest rates lead to excessive domestic borrowing and the emergence of asset price bubbles," the ECB said. "This document was an unpleasant surprise to us three weeks ago, but by now it’s been officially resolved," Estonia’s Finance Minister Jurgen Ligi was cited as saying by the E24 news service. Addressing the Baltic states together in the context of their budget policies was "inappropriate," Ligi said. "Our budget policies are very different, the deficit and debt burden differ by an order of magnitude."
Credit-default swap spreads on five-year Estonian and Latvian debt declined 4 basis points to 198.5 and 549, respectively, according to CMA DataVision prices in London. Lithuania’s CDS rose by one basis point to 325. The Baltic spreads have narrowed since hitting record highs earlier this year, signaling improved investor confidence. Since being engulfed by the credit crisis, the Baltic economies have contracted as much as 20 percent on an annual basis. Latvia’s gross domestic product shrank 19 percent last quarter, Estonia’s output fell 15.6 percent and Lithuania’s economy declined 14.2 percent.
The region’s "adjustment is much sharper than that in other central and eastern European EU member states that have allowed their exchange rates to fluctuate," the ECB said. "The tight peg of the exchange rate of the Baltics has implied that these countries have lost significantly on competitiveness versus their neighboring countries." Latvia, which is relying on a 7.5 billion euro ($11.1 billion) loan from the European Union and the International Monetary Fund to stay afloat, has pledged to cut its budget deficit by 500 million lati ($1 billion) every year through 2012 to satisfy donor demands. The country joined ERM II in January 2005, though it never applied to switch currencies.
Lithuania, which joined ERM in 2004, is targeting budget cuts equivalent to 5 percent of GDP next year. Lithuania’s attempt to join the euro in 2007 was rejected because the country’s inflation breached EU caps. Estonia, which entered ERM II the same year as Lithuania and is due to adopt the single currency in 2011, has cut its budget by 9 percent of GDP this year, sacrificing demand to fulfill convergence criteria. The country had planned to join the euro in January 2007, though it was forced to abandon that target because it didn’t fulfill EU inflation criteria.
The boom-to-bust fate of the Baltic states has been exacerbated by euro-denominated borrowing since the countries joined the EU more than five years ago. That’s obliged central banks to stick more rigorously to their euro pegs or risk leaving households and businesses unable to service their debt. The ECB said the three countries need to improve regulation of their banking systems, which are dominated by Nordic lenders such as Stockholm-based Swedbank AB and SEB AB. Measures should include imposing restrictions on foreign currency lending, the bank said.
The countries also need to make their labor markets more competitive, the ECB said. Wage setting should be made more flexible, more resources should be pooled into export-oriented industries and competition in product markets must increase, the bank said. The ECB criticized the bloc’s mechanisms for monitoring the progress of ERM states on their way to euro adoption. Tracking methods need to be more country specific with a view to preventing any regional contagion if currency pegs are deemed to be under threat.
"Surveillance procedures for countries participating in ERM II have been clearly deficient," the bank said. It is "crucial" to improve surveillance of ERM countries, it said. The bank said ERM central banks should make clear to market participants that unilateral euro pegs don’t rule out the option of revaluations or devaluations. "In countries with unilateral pegs or currency boards, it is crucial to communicate transparently to the public that, until the eventual adoption of the euro, exchange rate changes against the euro remain a possibility," the bank said.
All three countries have pledged to defend their euro pegs until they switch currencies. Latvia targets euro adoption in 2014 while Lithuania aims to join the monetary union between 2013 and 2015. Latvia’s bailout program requires the country to stick to its peg.
Gold exports propel Canada into trade surplus
Higher exports of precious metals, especially gold, pushed Canada's trade balance into surplus in October against all expectations after its economy was flattened by the US recession, a government agency said Thursday. A 3.4-percent rise in total exports combined with a slight 0.8 percent drop in imports in October to unleash an unexpected turnaround trade surplus of 428 million Canadian dollars (408 million US), said Statistics Canada. It was only the fourth month since the start of the year that Canadian exports -- which largely drive its economy -- outpaced imports, the agency said.
"Industrial goods and materials led the growth, representing more than half of the increase in exports," largely on the strength of precious metals exports, Statistics Canada said in a statement. "Exports of precious metals rose 34 percent to a record high of 1.3 billion Canadian dollars (1.2 billion US). Worldwide surges in gold prices and in the demand for gold bars fuelled the rise," it said. Exports of copper ores and of other crude non-metallic minerals also posted solid gains in October, but the "major driver" was gold, affirmed Anne Couillard, a spokeswoman for Statistics Canada. "Gold has been a big story ... and alone accounted for roughly a quarter of the improvement in the overall trade balance in the month," echoed analyst Douglas Porter of BMO Capital Markets.
Gold prices have skyrocketed to new record highs of late amid forecasts of dwindling deposits and a stagnating US dollar. According to the latest rankings by Natural Resources Canada, Canada is the world's eighth largest gold producer at 102 tonnes of gold produced in 2007. Economists also pointed out that a burst of activity is now taking place in most Canadian sectors which was a cause for optimism. "There's something a bit more important, a bit more encouraging, in terms of what is starting to unfold, it's the participation of several sectors in the economic turnaround that is unfolding," said Stefane Marion, an economist at National Bank.
Canada's economy returned to growth in the third quarter after an almost nine-month recession and registering in December 2008 its first trade deficit in more than 32 years due to fewer exports to the United Nations. "Barring an about-face, the figures unveiled today indicate exports will contribute positively to economic growth in the fourth quarter of 2009," predicts Benoit Durocher, an economist for Mouvement Desjardins. In the fourth quarter, exports could bolster Canada's economic growth by as much as three percentage points, reckons Marion.
Strong gains in exports to the United States accounted for three-quarters of the increase in exports in October and led the unexpected turnaround, said Statistics Canada. The Canadian economy grew by a paltry 0.4 percent in third quarter, devastating expectations, including that of the central bank that had forecast a two-percent increase. But many economists remain optimistic that the fourth quarter will mark the end of Canada's economic downturn, with gross domestic product rising by four percent. The Bank of Canada forecast 3.3 percent growth.
Robert Prechter: It's A Great Time To Get Out Of The Market
Elliott Wave International CEO Robert Prechter appeared on Bloomberg earlier today. Here's what he had to say:"I think it's a great time for people who turn bullish in the first quarter to get out of the stock market... we're now in territory where you need to think about lightening up stocks, even getting short. I think 2010 is going to be a big down year very much like 2008."
He expects the dollar to go up throughout 2010 with most of the financial markets falling.
Popular Culture and the Stock Market
The following article is adapted from a special report on "Popular Culture and the Stock Market" by Robert Prechter. Although originally published in 1985, the report remains so timeless and relevant that USA Today described its insights in a recent Nov. 2009 article. For the rest of this revealing 50-page report, download it for free here.
Both a study of the stock market and a study of trends in popular attitudes support the conclusion that the movement of aggregate stock prices is a direct recording of mood and mood change within the investment community, and by extension, within the society at large. It is clear that extremes in popular cultural trends coincide with extremes in stock prices, since they peak and trough coincidentally in their reflection of the popular mood. The stock market is the best place to study mood change because it is the only field of mass behavior where specific, detailed, and voluminous numerical data exists. It was only with such data that R.N. Elliott was able to discover the Wave Principle, which reveals that mass mood changes are natural, rhythmic and precise. The stock market is literally a drawing of how the scales of mass mood are tipping. A decline indicates an increasing 'negative' mood on balance, and an advance indicates an increasing 'positive' mood on balance.
Trends in music, movies, fashion, literature, television, popular philosophy, sports, dance, mores, sexual identity, family life, campus activities, politics and poetry all reflect the prevailing mood, sometimes in subtle ways. Noticeable changes in slower-moving mediums such as the movie industry more readily reveal changes in larger degrees of trend, such as the Cycle. More sensitive mediums such as television change quickly enough to reflect changes in the Primary trends of popular mood. Intermediate and Minor trends are likely paralleled by current song hits, which can rush up and down the sales charts as people change moods. Of course, all of these media of expression are influenced by mood changes of all degrees. The net impression communicated is a result of the mix and dominance of the forces in all these areas at any given moment.
It has long been observed, casually, that the trends of hemlines and stock prices appear to be in lock step. Skirt heights rose to mini-skirt brevity in the 1920's and in the 1960's, peaking with stock prices both times. Floor length fashions appeared in the 1930's and 1970's (the Maxi), bottoming with stock prices. It is not unreasonable to hypothesize that a rise in both hemlines and stock prices reflects a general increase in friskiness and daring among the population, and a decline in both, a decrease. Because skirt lengths have limits (the floor and the upper thigh, respectively), the reaching of a limit would imply that a maximum of positive or negative mood had been achieved.
Five classic horror films were all produced in less than three short years. 'Frankenstein' and 'Dracula' premiered in 1931, in the middle of the great bear market. 'Dr. Jekyll and Mr. Hyde' played in 1932, the bear market bottom year, and the only year that a horror film actor was ever granted an Oscar. 'The Mummy' and 'King Kong' hit the screen in 1933, on the double bottom. Ironically, Hollywood tried to introduce a new monster in 1935 during a bull market, but 'Werewolf of London' was a flop. When filmmakers tried again in 1941, in the depths of a bear market, 'The Wolf Man' was a smash hit. These are the classic horror films of all time, along with the new breed in the 1970's, and they all sold big. The milder horror styles of bull market years and the extent of their popularity stand in stark contrast. Musicals, adventures, and comedies weave into the pattern as well.
Pop music has been virtually in lock-step with the Dow Jones Industrial Average as well. The remainder of this report will focus on details of this phenomenon in order to clarify the extent to which the relationship (and, by extension, the others discussed above) exists.
As a 78-rpm record collector put it in a recent Wall Street Journal article, music reflects 'every fiber of life' in the U.S. The timing of the careers of dominant youth-oriented (since the young are quickest to adopt new fashions) pop musicians has been perfectly in line with the peaks and troughs in the stock market. At turns in prices (and therefore, mood), the dominant popular singers and groups have faded quickly into obscurity, to be replaced by styles which reflected the newly emerging mood.
The 1920's bull market gave us hyper-fast dance music and jazz. The 1930's bear years brought folk-music laments ('Buddy, Can You Spare a Dime?'), and mellow ballroom dance music. The 1932-1937 bull market brought lively 'swing' music. 1937 ushered in the Andrews Sisters, who enjoyed their greatest success during the corrective years of 1937-1942 ('girl groups' are a corrective wave phenomenon; more on that later). The 1940's featured uptempo big band music which dominated until the market peaked in 1945-46. The ensuing late-1940's stock market correction featured mellow love-ballad crooners, both male and female, whose style reflected the dampened public mood.
Learn what's really behind trends in the stock market, music, fashion, movies and more... Read Robert Prechter's Full 50-page Report, "Popular Culture and the Stock Market," FREE
The Fed: At Last, Others See that the Emperor Wears No Clothes
Even central bank critic U.S. Rep. Ron Paul is surprised that both his colleagues and the nation now listen to his calls for an audit of the notoriously untouchable Federal Reserve. Paul has represented Texas for 22 years and, as a Libertarian, he actually believes that the Fed should be abolished, but he will settle for the next best step. Meanwhile, even longer than Ron Paul has campaigned against the Fed, Bob Prechter has steadily built the case that the Fed is powerless to change the trends in the economy. He thinks the biggest mistake is to view the Fed as a leader rather than a follower of the markets. Here's an excerpt from his question-and-answer book, Prechter's Perspective, which describes why the financial markets trump the Fed's moves.
Excerpt taken from Prechter's Perspective, originally published 2002, re-published 2004
Aren't there instances in which the government can intervene in ways to throw the Wave Principle off? A lot of people say the Fed stepped in and bought futures after the crash of 1987, for instance. Isn't that an example of enlightened government action?
Bob Prechter: First, remember that the Fed did not prevent the 1987 crash. It happened. Many claim that the Fed averted further collapse, but in our opinion, it acted on the day the market was due to bottom anyway, the evidence being that The Elliott Wave Theorist said in print four days earlier that the two-week cycle was due to bottom on October 20, and the market bottomed that morning. Then there's what happened in 1929 when a consortium of bankers amassed a pool of money to halt the October decline. On the strength of that buying and the resulting euphoria, stocks soared, for one day. Then they fell even harder, utterly ignoring a second attempt at "organized support" on the 28th. History provides several examples of failed attempts to stop a market collapse.
The unprecedented popularity of [former Federal Reserve Chairman] Alan Greenspan suggests that most people believe in the power of the Fed to prevent a crash.
Bob Prechter: The Fed's apparent success in 1987 made people, including Fed governors, confident that they can stop the next crash. But it won't work (more than briefly, anyway), because the wave of selling will be much bigger. When the Fed itself, then the professionals and soon afterward the public, realize that the Fed's attempt is failing, the overall panic will increase, at minimum negating any bullish effects of whatever actions it takes.
But there are no restrictions on the Fed, and, in recent years, especially in "crisis situations," we have seen there is no hesitancy to do whatever it takes to bail out troubled entities. Won't the Fed just lend its way out of the problem?
Bob Prechter: While it is true that the Fed has an unlimited power to offer credit, it cannot create liquidity, because it cannot force businesses and consumers to lend and borrow no matter how cheaply it offers credit. So deflation can happen regardless of the Fed's desires. As I see it, there are only two possibilities: (1) The Fed will act on the bottom day of a collapse and appear to have been effective, or (2) it will try to stem the tide early and fail. Either way, the market's ultimate destiny will be unaffected. Only people's thinking will be affected. Hope-filled bulls will hold on for the slaughter and irresolute bears will give up their positions. In other words, the main effect of this soothing news will be to produce a psychological deterrent to proper investment action.
The Fed has always been a focal point for the financial markets. In recent years, people's attention is absolutely riveted on every Fed meeting. Is this attention misplaced?
Bob Prechter: The obsession with the Fed's meetings is ludicrous. The Fed votes only to change its own rates, and it has always followed the rates set by the free market. In 1999 and 2000, when the Fed raised rates several times, it was repeatedly claimed everywhere that the Fed was conducting a "pre-emptive strike against inflation." But rates had been rising for months, and the Fed simply adjusted to the market, as always. We watch the market, which leads the Fed.
In the wake of an unexpected central bank action, have you ever had a wave pattern that skipped a beat or altered its course in any way?
Bob Prechter: Central bank action is never really unexpected because it's a product of the social mood, which permeates society. When you examine the charts, you can locate waves, but you can't locate central bank actions. Central bankers hope and panic and make decisions the same way the public does. Bankers are people, too, after all. They say, "We've got to react to this new condition. We've got to move money here. We've got to move money there." They are racing back and forth in rhythm with the market.
A Flaw in the Hyperinflationary Argument
People assuming hyperinflation are assuming that the cash injected into the system will be spread equally or nearly equally, resulting in competitive bidding with more dollars for the current pool of goods and services. I believe this assumption to be in error. It is my opinion that the cash being pumped into certain hands is being pumped deliberately into those hands in order to change the ratio of wealth in the country. In other words, it's being used purely as a wealth redistribution mechanism.
Imagine for a moment if there are 10 people in a room and each has $100 and there are a fixed amount of goods in the room held by each person. Prices will balance out between people at some level. If I give each person another $100 then prices will rise to reflect the decrease in the value of the currency. But if I give $1000 to one person, prices are unlikely to rise much at all. If I raise prices on my goods, the other 8 people (aside from myself) won't be able to afford them. And I can't legally charge higher prices to the one person. That $1000 is inflationary but far far less inflationary than a roughly equal distribution of the same amount through the general population. Yet the person with the additional cash now can purchase more than the rest of us. In effect, he has become wealthier while we have become poorer.
This is what I believe is the intent of the current financial policies of the central banks today - to further entrench the wealthiest people at the top of the pyramid. This process can never be hyperinflationary unless the excess cash escapes into the general populace. And I doubt that it ever will. Instead it will be used to manipulate and buy the stocks and major resource flows of the world, placing the elite in even more control of our society. And of course, this leaves the door open to mistakes by the ruling elite that can lead to a deflationary collapse. Unless Helicopter Ben actually gets in a helicopter and starts dropping $100 bills around the country, there cannot be a hyperinflationary blowoff under the current credit/debt conditions.
P.S. Note also that Ben can also lose the devaluation war if Japan and Asia choose to devalue faster than he does. And Ben is bound by practicality in that if he devalues too fast, he destroys himself and those he is trying to protect due to the reserve currency status of the dollar.
Deglobalization- The surprisingly steep decline in world trade
In November, I met with an executive at one of China's new private equity firms. He talked up the firm's investments in energy software and mobile communications. But companies that export? He wouldn't touch them.
The fact that China's smart money is now looking inward and avoiding the sector that brought it so much growth in recent years highlights a surprising and spreading new trend: deglobalization. For the last few decades, goods, services, and people have been whizzing around the world at ever-greater speeds and over ever-greater distances. The presumption was that globalization was the most efficient way to organize the world's economic affairs. But now comes the backlash, motivated by economics, politics, and the shift of wealth from West to East.
In the months after September 2008, pretty much every metric that testified to the growing interconnectedness of the global economy collapsed. Between April 2008 and April 2009, foreign currency trading volumes in London were down 25 percent. The Inter-American Development Bank in August reported that remittances from Latin America and Caribbean expats would fall 11 percent in 2009, back to the level of 2006. The International Monetary Fund projects that the volume of world trade in goods and services will plummet nearly 12 percent this year.
Of course, you'd expect such developments when the global economy shrinks, as it did in 2009 for the first time since 1944. But the decline in trade was far larger than the quite small drop in global economic output. It turns out that many aspects of globalization were overleveraged. Exports, currency trading, and cross-border investment were fueled by debt and credit. In the United States, consumption of imports was stoked by borrowing and the booming housing market.
While trade has rebounded from its lows, the volume is nowhere near its peak. In September, the combined total of U.S. imports and exports was 24 percent below the level of July 2008. Countries stung by the sudden drop-off in demand from foreign buyers have realized that they can no longer simply export their way to prosperity. China's exports fell 23 percent between August 2008 and August 2009. Smart investors are channeling resources to companies that produce domestic goods for domestic markets.
There's also a greater appreciation on the part of Western firms that cheap labor isn't the be-all and end-all. Businesses have learned in the past two years that the longer the supply chain, the more possibilities there are for disruptions—from flu viruses, geopolitical disturbances, and spikes in energy prices. While China is still the world's factory, in an age of volatile demand, some companies have realized that manufacturing closer to home is more efficient, even if production costs are higher. In March U.S. Block Windows, an acrylic block window manufacturer based in Pensacola, Fla., bought competitor Hy-lite, a division of Fortune Brands. Hy-Lite was outsourcing the molding of acrylic blocks to China.
"It became very evident to us, that we could do it cheaper in-house, because we had the facilities, and we were operating at less than capacity," said Roger Murphy, president of U.S. Block Windows. More significantly, manufacturing in China had its downsides. U.S. Block Windows ships orders within four days of receipt. But the lead time in production from China was 12 to 16 weeks. In a period where it's difficult to forecast demand far out into the future, "it's very difficult to match those two things up," said Murphy. In September, U.S. Block Windows moved Hy-Lite's molding work from China to Florida.
Politics is also playing a role in deglobalization. The plunge into recession triggered a predictable set of protectionist responses. Developed economies in Asia, Europe, and North America have erected new tariffs, offered subsidies to exporters, stipulated that stimulus funds be spent locally, and provided special support to home-grown banks and automakers.
This trend has led American and foreign companies alike to reconsider the way they've approached the vast U.S. market, especially in areas that are getting a boost from the government: energy, finance, automaking. For example, Suzlon and Vestas, Indian and Danish wind-turbine makers, respectively, are making massive investments in U.S. manufacturing not only because it's expensive to ship turbines long distances but also in order to be perceived as "American" to state and federal officials involved in green purchasing.
In November, Ted Strickland, the governor of Ohio, one of the states hit hardest by globalization, showed up at a corporate campus in Milford, a suburb of Cincinnati, to celebrate the fact that Tata Consultancy Services, the Indian outsourcing giant, now employed 300 workers at its North America Domestic Delivery Center. The outsourcer has become an in-sourcer. Perhaps we're not seeing deglobalization, but rather, reglobalization.
by Dmitry Orlov
Around this time of year, some brave souls venture to put their reputations at risk by attempting to predict what the next year will bring. Some do so with uncanny accuracy, others — not so much. Being a serious author who hardly ever makes jokes, I generally sit out this annual bout of frivolity, but, noting that a new decade is about to burst upon us, I thought it reasonably safe to paint a picture of how I see the next decade. (In the unlikely case that my predictions turn out to be completely wrong, I would think that they will have been very thoroughly forgotten by the time 2020 rolls around.) And so, without further ado, here are my predictions for what it will be like in The United States of America during the second decade of the XXI century.
The decade will be marked by many instances of autophagy, in business, government, and in the higher echelons of society, as players at all levels find that they are unable to control their appetites or alter their behavior in any meaningful way, even in the face of radically altered circumstances, and are thus compelled to consume themselves into oblivion, as so many disemboweled yet still ravenous sharks endlessly gorging themselves on their own billowing entrails.
Governments will find that they are unable to restrain themselves from printing ever more money in an endless wave of uncontrolled emission. At the same time, rising taxes, commodity prices, and costs of all kinds, coupled with a rising overall level of uncertainty and disruption, will curtail economic activity to a point where little of that money will still circulate. Inflationists and deflationists will endlessly debate whether this should be called inflation or deflation, unconsciously emulating the big-endians and little-endians of Jonathan Swifts Gulliver's Travels, who endlessly debated the proper end from which to eat a soft-boiled egg. The citizenry, their nest egg boiled down to the size of a dried pea, will not be particularly vexed by the question of exactly how they should try to eat it, and will regard the question as academic, if not idiotic.
Distressed municipalities throughout the country will resort to charging exorbitant fees for such things as dog licenses. Many will experiment with imprisoning those unable to pay these fees in state and county jails, only to release them again as the jails continuously overflow and resources run low. The citizenry will come to regard jails as conveniently combining the features of a soup kitchen and a homeless shelter. Some towns will abandon the idea of having a fire department and decide that it is more cost-effective to just let house fires run their course, to save on demolitions. In an effort to plug up ever larger holes in their budgets, states will raise taxes, driving ever more economic activity underground. In particular, state liquor tax revenues will drop for the first time in many decades as more and more Americans find that they can no longer afford beer and switch to cheap and plentiful Afghan heroin and other illegal but very affordable drugs. Marijuana smoke will edge out car exhaust as America's most prevalent smell.
Several countries around the world will be forced to declare sovereign default and join the swelling ranks of defunct nations. There will be a mad shuffle to find safe havens for hot money, but none will be found. Investors around the world will finally be forced to realize that the best way to avoid losses is to not have any money to start with. Despite their best efforts to diversify their holdings, investors will find that they are all long paper, be it stocks, bonds, deeds, promissory notes, or incomprehensible derivative contracts. They will also find that, in the new business climate, none of these instruments make particularly formidable weapons: as the friendly game of rock-paper-scissors turns hostile, they will discover that rocks stave in skulls, that scissors puncture vital organs, but that the paper, even when wielded expertly, just causes paper cuts.
Those formerly well-heeled persons who tend to believe that "possession is nine-tenths of the law" will find many extralegal exorcists eager to liberate their demons. In particular, organized crime rings will start using data mining software to identify lightly guarded cabins and compounds in Montana and other remote locations that are well-stocked with canned food, weapons and gold and silver bullion, and start harvesting them by softening the target with mortars, rockets and aerial bombardment, then sending in commando teams with grenades and machine guns. Once the harvest is in, they will expatriate the proceeds using the diplomatic pouches of defunct nations held in their sway.
While the bullion is expatriated, the Pentagon will attempt to repatriate troops from Iraq, Afghanistan and the numerous US military bases around the world, soon finding that they lack the wherewithal to do so, stranding the troops wherever they are, and forcing them to resupply themselves. Military families will be invited to donate food, uniforms, clean underwear and toiletries for their loved ones overseas. American weaponry will flood the black market, driving down prices. Some servicemen will decide that returning to the US is a bad idea in any case, and go native, marrying local women and adopting local religions, customs and garb.
Although national leaders will continue to prattle on about national security whenever there is a microphone pointed at them, their own personal security will become their overarching concern. Officials at all levels will attempt to assemble ever larger retinues of bodyguards and security consultants. Members of Congress will become ever more reticent and will avoid encountering their constituents as much as possible, preferring to hide in Washington's hermetically sealed high-rises, walled compounds and gated communities. Meanwhile, outside the official security perimeter, a new neighborliness will take root, as squatting becomes known as "settling in," trespassing as "beating a new path," and fences, walls and locks are everywhere replaced by watchful eyes, attentive ears and helping hands.