Ilargi: Right, Americans and their economy. Well, it's an ideal situation, isn’t it? Every marketeer’s wet dream. That is, through appealing to people's need and desire for hope and good tidings, you succeed in making them believe that they will benefit from the very things that hurt them more than anything else in the world. You have them convinced that black is white. This is what the US government, media, and big industry are pulling off, and since they do it so well, nary a soul is any the wiser for it. You use their very own cash to deceive them, by boosting markets for a while, which makes them believe the future is rosy, and you can use the resulting economic lull to take as much of their wealth as you can possibly carry.
All it takes to convey the positive message and image are rising stock markets and still bad but slightly less awful unemployment and housing numbers. That’s how desperate people are for their hope. They’ll believe just about anything. They don’t even want to know that these somewhat positive numbers have been bought with their own money. That banks haven't tumbled yet simply and only because their losses have been transferred to public accounts.
And you've got to give it to the marketeers: it's not yet 100% sure that the US economy will crash, and all hope asks for is a 1% window. At least theoretically, the US can still get out from underneath its debt yoke. It would probably have to grow its economy by over 10% or so for the next three decades or so, which is, to put it mildly, not bleeding likely, but it's not 100% impossible. Play your story line the right way, hand them some words they can believe in who are so eager to believe, and the people will let you rob them blind in broad daylight. And give you an encouraging smile and pat on the back for working so hard while you're at it.
There is no better way to summarize the year we just left behind, 2009, nor the way 2010 has started. And it's brilliant.
It's of course nothing new that once inside the government, you can get to play with lots of other people's money, but still, for those that run these games and marketing campaigns it must have been a profound Aha-Erlebnis, a Eureka moment, when they realized there really wasn't any restriction that would force them to stop when the average US citizen's balance sheet read zero. That that was just the beginning, and taking control of the government effectively means you can push the average US citizens' balance sheet into breathtakingly deep negative territory, nobody has even pointed out a limit yet, so deep that you can plunge Americans into far greater debt than they will ever be able to pay off in their entire lives, just by assuming control of the government. America as a bottomless pit. As long as they don't notice it, or don’t recognize it for what it is, and as long as you tell them it’s for their own good, you can keep at it for quite a while. Need a higher debt ceiling? Congress will never vote you down, because the show must go on. And if you can't be bothered with Congress, there's always Christmas Eve.
And whether it’s the fact that about one in 50 Americans now lives in a household with a reported income that consists of nothing but a food-stamp card (on top of the many millions who get only a $200-$300 monthly unemployment benefit), or whether it's the Christmas Eve move to free Fannie and Freddie from all monetary constraints, or the recent measures to prevent an apparently expected and feared run on money market funds from materializing, all of it fits one and the same playbook. If you choose to not understand that, and instead focus on another fleeting high on Wall Street, I would by now be mighty tempted to say that you are welcome to what you got coming.
You can sell a president through an effective marketing campaign. You can also sell his policies the same way. Neither the man nor the measures need truthfully be anything like the image you paint of them, no more than a car or a detergent need anything but a feel-good recognition factor. Both the person and the acts only need to resemble as much as possible what people would like them to be. The best liar wins. The secret of life is honesty and fair dealing.. if you can fake that, you've got it made, said Groucho. That’s not some sort of accident, it's what the country was built on.
And they only need to do it for as long as it takes to move all gambling debt magically off the books of the players and onto the national public balance sheet. Then when the loot has been loaded into the get-away planes, trains and automobiles, they will get the hell out of Dodge and slip away like so many thieves in the night as literally as they can. Après ça, le deluge.
Gerald Celente: 2010 Market Trends
This Is The Government: Your Legal Right To Redeem Your Money Market Account Has Been Denied
When Henry Paulson publishes his long-awaited memoirs, the one section that will be of most interest to readers, will be the former Goldmanite and Secretary of the Treasury's recollection of what, in his opinion, was the most unpredictable and dire consequence of letting Lehman fail (letting his former employer become the number one undisputed Fixed Income trading entity in the world was quite predictable... plus we doubt it will be a major topic of discussion in Hank's book).
We would venture to guess that the Reserve money market fund breaking the buck will be at the very top of the list, as the ensuing "run on the electronic bank" was precisely the 21st century equivalent of what happened to banks in physical form, during the early days of the Geat Depression. Had the lack of confidence in the system persisted for a few more hours, the entire financial world would have likely collapsed, as was so vividly recalled by Rep. Paul Kanjorski, once a barrage of electronic cash withdrawal requests depleted this primary spoke of the entire shadow economy. Ironically, money market funds are supposed to be the stalwart of safety and security among the plethora of global investment alternatives: one need only to look at their returns to see what the presumed composition of their investments is.
A case in point, Fidelity's $137 billion Cash Reserves fund has a return of 0.61% YTD, truly nothing to write home about, and a return that would have been easily beaten putting one's money in Treasury Bonds. This is not surprising, as the primary purpose of money markets is to provide virtually instantaneous access to a portfolio of practically risk-free investment alternatives: a typical investor in a money market seeks minute investment risk, no volatility, and instantaneous liquidity, or redeemability. These are the three pillars upon which the entire $3.3 trillion money market industry is based.
Yet new regulations proposed by the administration, and specifically by the ever-incompetent Securities and Exchange Commission, seek to pull one of these three core pillars from the foundation of the entire money market industry, by changing the primary assumptions of the key Money Market Rule 2a-7.
A key proposal in the overhaul of money market regulation suggests that money market fund managers will have the option to "suspend redemptions to allow for the orderly liquidation of fund assets."
You read that right: this does not refer to the charter of procyclical, leveraged, risk-ridden, transsexual (allegedly) portfolio manager-infested hedge funds like SAC, Citadel, Glenview or even Bridgewater (which in light of ADIA's latest batch of problems, may well be wishing this was in fact the case), but the heart of heretofore assumed safest and most liquid of investment options: Money Market funds, which account for nearly 40% of all investment company assets.
The next time there is a market crash, and you try to withdraw what you thought was "absolutely" safe money, a back office person will get back to you saying, "Sorry - your money is now frozen. Bank runs have become illegal." This is precisely the regulation now proposed by the administration. In essence, the entire US capital market is now a hedge fund, where even presumably the safest investment tranche can be locked out from within your control when the ubiquitous "extraordinary circumstances" arise. The second the game of constant offer-lifting ends, and money markets are exposed for the ponzi investment proxies they are, courtesy of their massive holdings of Treasury Bills, Reverse Repos, Commercial Paper, Agency Paper, CD, finance company MTNs and, of course, other money markets, and you decide to take your money out, well - sorry, you are out of luck. It's the law.
Ilargi: Then there's a part where "the Tyler Durdens" offer a lengthy explanation (too long to quote here) of the state, legal status, future and changing regulations (re: SEC) of money market funds. If you have the stomach, I'd say don't miss it. It’s both very well written and very informative on a field of financial regulation that doesn’t get nearly enough attention. To wit:
[..] what the SEC is proposing is simple - the entire market structure has been converted to a hedge fund. When investors hear the word "suspend redemptions" they envisioned a battered, pro-cyclical, leveraged, permabullish hedge fund, that suddenly "found itself" down 30, 40, 50 or more percent, and to avoid instantaneous liquidation, had to bar redemptions.
Forgive us, but is the SEC confirming that the entire market is now one big casino, one big government subsidized hedge fund, where as long as things go up, all is good, but the second things take a leg down, just like any ponzi, nobody will be allowed to pull their money? Maybe Madoff should have created the same redemption suspension: his fund would still be alive and thriving, now that the government has become the biggest ponzi conductor of all time.
And nobody would have been the wiser. But instead, the Securities and Exchange Commission, in discussions with the Group of 30, Barney Frank, and any other conflicted individuals who only care about protecting their own money for one more year, has decided, in its infinite wisdom, to make money markets a complete scam. And this is the gist of regulatory reform in America.
At this point it is without doubt that even the government understands that when things turn sour, and they will, the run on the bank will be unavoidable: their solution - prevent money from being dispensed, when that moment comes. The thing about crises, be they liquidity, solvency, or plain-vanilla, is that "price discovery" occurs all at once, and at the very same time. And all too often, investors "discover" they were lied to, as the emperor, in any fiat system, always has no clothes.
Just like in September 2008, when the banks were forced to look at each-others' balance sheet and realize that there are no real assets on the left backing up the liabilities on the right, so the moment of enlightenment occurs are the most importune time: just ask Hank Paulson. Had he known his action of beefing up Goldman's FICC trading axes would have resulted in the "Ice-Nine'ing" (to borrow a Mark Pittman term) of money markets, who knows- maybe Lehman would have still been alive. Perhaps risking the cash access of 20% of US households and 80% of companies was not worth the few extra zeroes in Goldman's EPS.
But we will never know. What we will know, is that now i) the government is all too aware that the market has become one huge ponzi, and that all investment vehicles, even the safest ones, are subject to bank runs, and ii) that said bank runs, will occur. It is only a matter of time. And just as the president told everyone directly to buy the market on March 3, so the SEC, the Group of 30, and Barney Frank are telling us all , much less directly, to get the hell out of Dodge. Alternatively, the game of "last fool in", holding the burning hot potato, can continue indefinitely, until such time as the marginal utility of each and every dollar printed by Ben Bernanke is zero.
Global Bear Rally Of 2009 Will End As Japan's Hyperinflation Rips Economy To Pieces
by Ambrose Evans-Pritchard
Milton Keynes will be vindicated. Lord Keynes will lose some of his new-found gloss. The Krugman doctrine that we should all spend our way back to health by pushing deficits to the brink of a debt spiral – or beyond the brink – will be seen as dangerous. The contraction of M3 money in the US and Europe over the last six months will slowly puncture economic recovery as 2010 unfolds, with the time-honoured lag of a year or so. Ben Bernanke will be caught off guard, just as he was in mid-2008 when the Fed drove straight through a red warning light with talk of imminent rate rises – the final error that triggered the implosion of Lehman, AIG, and the Western banking system.
As the great bear rally of 2009 runs into the greater Chinese Wall of excess global capacity, it will become clear that we are in the grip of a 21st Century Depression – more akin to Japan's Lost Decade than the 1840s or 1930s, but nothing like the normal cycles of the post-War era. The surplus regions (China, Japan, Germania, Gulf ) have not increased demand enough to compensate for belt-tightening in the deficit bloc (Anglo-sphere, Club Med, East Europe), and fiscal adrenalin is already fading in Europe. The vast East-West imbalances that caused the credit crisis are no better a year later, and perhaps worse. Household debt as a share of GDP sits near record levels in two-fifths of the world economy. Our long purge has barely begun. That is the elephant in the global tent.
We will be reminded too that the West's fiscal blitz – while vital to halt a self-feeding crash last year – has merely shifted the debt burden onto sovereign shoulders, where it may do more harm in the end if handled with the sort of insouciance now on display in Britain. Yields on AAA German, French, US, and Canadian bonds will slither back down for a while in a fresh deflation scare. Exit strategies will go back into the deep freeze. Far from ending QE, the Fed will step up bond purchases. Bernanke will get religion again and ram down 10-year Treasury yields, quietly targeting 2.5pc. The funds will try to play the liquidity game yet again, piling into crude, gold, and Russian equities, but this time returns will be meagre. They will learn to respect secular deflation.
Weak sovereigns will buckle. The shocker will be Japan, our Weimar-in-waiting. This is the year when Tokyo finds it can no longer borrow at 1pc from a captive bond market, and when it must foot the bill for all those fiscal packages that seemed such a good idea at the time. Every auction of JGBs will be a news event as the public debt punches above 225pc of GDP. Finance Minister Hirohisa Fujii will become as familiar as a rock star. Once the dam breaks, debt service costs will tear the budget to pieces. The Bank of Japan will pull the emergency lever on QE. The country will flip from deflation to incipient hyperinflation.
The yen will fall out of bed, outdoing China's yuan in the beggar-thy-neighbour race to the bottom. By then China too will be in a quandary. Wild credit growth can mask the weakness of its mercantilist export model for a while, but only at the price of an asset bubble. Beijing must hit the brakes this year, or store up serious trouble. It will make as big a hash of this as Western central banks did in 2007-2008. The European Central Bank will stick to its Wagnerian course, standing aloof as ugly loan books set off wave two of Europe's banking woes. The Bundesbank will veto proper QE until it is too late, deeming it an implicit German bail-out for Club Med.
More hedge funds will join the EMU divergence play, betting that the North-South split has gone beyond the point of no return for a currency union. This will enrage the Eurogroup. Brussels will dust down its paper exploring the legal basis for capital controls. Italy's Giulio Tremonti will suggest using EU terror legislation against "speculators". Wage cuts will prove a self-defeating policy for Club Med, trapping them in textbook debt-deflation. The victims will start to notice this. Articles will appear in the Greek, Spanish, and Portuguese press airing doubts about EMU. Eurosceptic professors will be ungagged. Heresy will spread into mainstream parties. Greece's Prime Minister Papandréou will balk at EMU immolation . The Hellenic Socialists will call Europe's bluff, extracting loans that gain time but solve nothing. Berlin will climb down and pay, but only once: thereafter, Zum Teufel.
In the end, the Euro's fate will be decided by strikes, street protest, and car bombs as the primacy of politics returns. I doubt that 2010 will see the denouement, but the mood music will be bad enough to knock the euro off its stilts.
The dollar rally will gather pace. America's economy – though sick – will shine within the even sicker OECD club. The British will need the shock of a gilts crisis to shatter their complacency. In time, the Dunkirk spirit will rise again. Mervyn King's pre-emptive QE and timely devaluation will bear fruit this year, sparing us the worst. By mid to late 2010, we will have lanced the biggest boils of the global system. Only then, amid fear and investor revulsion, will we touch bottom. That will be the buying opportunity of our lives.
Origins of an American Kleptocracy
by Marla Singer
Some days ago we wondered aloud at the blank check extended to Fannie and Freddie along with the suspiciously convenient timing of those announcements on Christmas Day. Back then we wondered if we had been told the entire story. To wit:So. Let us summarize:The other shoe having now dropped, Bloomberg has joined in our skepticism:
We do not expect the GSEs to grow their portfolios at all, so we are fixing the bloated portfolio problem by easing the portfolio caps to permit a quarter trillion dollar expansion thereof.
We do not expect either of the GSEs to need more help from the Treasury, so we are responding to the underutilized $400 billion "lifeline" the GSEs have with the Treasury ($111 of which is currently used) by expanding it to... infinity.
Oh, and though they have collectively lost nearly $200 billion, we are paying the CEOs around $6 million each.
Great work team! It's already almost 11:00. Let's go to lunch.Taxpayer losses from supporting Fannie Mae and Freddie Mac will top $400 billion, according to Peter Wallison, a former general counsel at the Treasury who is now a fellow at the American Enterprise Institute.Wallison continues:
“The situation is they are losing gobs of money, up to $400 billion in mortgages,” Wallison said in a Bloomberg Television interview. The Treasury Department recognized last week that losses will be more than $400 billion when it raised its limit on federal support for the two government-sponsored enterprises, he said.“It was always safe to buy these notes,” he said. The U.S. government was always going to stand behind them. They’re as good as Treasury notes.”We are no longer sure this is the most inspiring comparison. Wallison also chimes in via the Wall Street Journal and points to a darker vein shot through the GSE story:New research by Edward Pinto, a former chief credit officer for Fannie Mae and a housing expert, has found that from the time Fannie and Freddie began buying risky loans as early as 1993, they routinely misrepresented the mortgages they were acquiring, reporting them as prime when they had characteristics that made them clearly subprime or Alt-A.It has become conventional wisdom, perhaps even cliche, to pin the origins of the credit crisis on the big banks or, AIG or even the practice of financial modeling. Certainly, these actors have received the most play in the media, and have now endured the focus of populist ire for more than a year. We now think that the analysis leading commentators to focus blame on these entities is fatally flawed.
In general, a subprime mortgage refers to the credit of the borrower. A FICO score of less than 660 is the dividing line between prime and subprime, but Fannie and Freddie were reporting these mortgages as prime, according to Mr. Pinto. Fannie has admitted this in a third-quarter 10-Q report in 2008.
But because of Fannie and Freddie's mislabeling, there were millions more high-risk loans outstanding. That meant default rates as well as the actual losses after foreclosure were going to be outside all prior experience. When these rates began to show up early in 2007, it was apparent something was seriously wrong with assumptions on which AAA ratings had been based.
Losses, it was now certain, would invade the AAA tranches of the mortgage-backed securities outstanding. Investors, having lost confidence in the ratings, fled the MBS market and ultimately the market for all asset-backed securities. They have not yet returned.
We have seen no credible data that any of the large banks or other underwriters of mortgage backed securities ("MBSs") or collaterized debt obligations ("CDOs") or firms like AIG selling protection on same actually misrepresented the character of underlying collateral. This is in direct contrast to the allegations of Edward Pinto as printed by the Wall Street Journal. If Pinto is correct such that the mis-marking of mortgages by the GSEs and the discovery thereof destroyed confidence in the accuracy of ratings in mortgage backed securities and their derivatives (and it seems probable to suspect that he is) then it seems almost beyond question that the policies (or policy malfeasance) of Fannie and Freddie, and not the actions of large banks or firms like AIG are the proximate cause of not just the credit crisis, but also the continuing multi-act, multi-bailout farce that continues to be passed off to the public as necessary "stimulus."
It takes only a cursory examination to suspect that misdirection plays a key part in the latest act of the ongoing crisis theater of the absurd. Misdirection to distract attention from the key complicity of GSEs in the crisis. Misdirection to deflect scrutiny away from the political personalities from both sides of the aisle responsible. Misdirection to conceal what could only be described as the most damaging acts of accounting and securities fraud in the history of accounting, securities or fraud.
Precious few assumptions are required to come to conclusions laying responsibility for the largest economic disaster in recent memory at the feet of the GSEs.
First, that the GSEs had substantial influence over the mortgage market.
This is a no-brainer with the GSEs either holding or guaranteeing 51% of outstanding home mortgage debt in 2003. To put this in perspective, that figure was around 33% of the GDP of the entire United States in 2003. Read that last line again. Anyone wishing to play in the market had to compete with the rates set by Fannie and Freddie.
Second, that the GSEs artificially depressed rates (read: underpriced risk).
This is equally trivial to find given that this precise mandate has been the express purpose of the GSEs since at least 1993. The GSEs were not tasked with increasing the capacity for mortgage lending. They were tasked with making loans "affordable." They used a number of tools to do so, but the key elements were acting as a proxy for quasi-government guarantees and bundling mortgages into risk tiers to act as a sort of clearing house for securitization pools. It is often said that providing a guarantee (particularly governmental) reduces risk. This is, of course, a fantasy. All that explicitly or implicitly tax dollar backed guarantees do is socialize risk. However, they manage to do so without requiring consolidation of the resulting liabilities on the government's balance sheet.
Convenient that, yes? A guarantee is a subsidy. Period. Failing to understand this is what permitted the political class to mislead the American public into thinking that cheap loans for everything from housing to small businesses to education (the next fiscal disaster on the horizon) come with no cost. (Or that cheap debt wouldn't pump up the price of everything from education to housing). Today's pundits seem to enjoy blaming "moral hazard" (by which they mean "corporate moral hazard") for the crisis. Oddly, government guarantees, particularly those that everyone assumes will be costless, are not typically part of this definition.
These assumptions, on their own should be sufficient to indict the GSEs, the totally unqualified and unaccountable recipients of political payoffs who occupied the executive offices of these fiscal singularities1 and their other supporters (including the voters who continued year after year to return these jokers to public office) on charges of gross negligence.
If, as Pinto suggests, we add purposeful misrepresentation of underlying collateral to the mix three things become apparent:
First, absent some intervening criminal act by actors farther downstream (and we may yet find some), we have isolated absolutely the cause of all that followed.
Second, it becomes quite easy to construct a criminal case for literally millions of counts of accounting, securities, wire and mail fraud against the GSEs. To the extent executives at Fannie and Freddie signed off on financial statements disclosing the portion of their balance sheets that held "AAA" securities and these had been purposefully misidentified we should be exploring prosecution for violations under e.g., Sarbanes-Oxley. (Given, however, Rham Emanuel's involvement in Freddie and Fannie, we aren't holding our breath).
Third, given the presence of blatant government price fixing in more than a third of the entire economy, the United States hasn't been anything like a "free market" since before 2003.
It should shock you that literally a third of the U.S. economy should become a playground for the social experiments of any political group of any party affiliation.
It probably will not shock you (since you are reading Zero Hedge) to find what may be the largest example of securities fraud ever directly connected to elected officials of the United States and their cronies.
Taking a step back, it should shock you that power over literally a third of the U.S. economy should ever have been allowed to become concentrated in two entities with blatantly socialist aims and under the control of executives with no relevant qualifications of any note other than loose purse strings on their political contribution satchels.
What should grip readers with even more substantial alarm is the combination of blank checking for Fannie and Freddie backstops, and the shifty manner in which these disclosures were made. Is it possible anymore to doubt that the administration simply lied through its teeth while promising us it expects no need of increased credit lines for the GSEs while simultaneously expanding same literally to infinity?
Given that Fannie, Freddie and the FHA have now taken up the mandate of supporting housing prices at any cost (to the taxpayer via endless bailouts and unlimited credit) is it possible in any way to credit the current "upturn" to fundamentals? When we factor in similar capture of the FDIC and the like, where does this leave us, exactly?
Permit us to ask a few questions:
1. Why are Fannie and Freddie still operating in any way whatsoever?
2. Given that their credibility for reliable (or even remotely non-fiction) financial disclosure nears complete obliteration, who is likely to buy anything from these entities in the future? (If you said "The Fed" you may advance to the bonus round). Surely the conflict of interest implicit in government ownership does nothing to improve the situation. Perhaps the news that the Fed plans to issue securities to shrink its balance sheet and reverse "quantitative easing" describes an attempt to securitize the tattered reputation of the GSEs? Will the Fed simply aggregate its balance sheet and issue tranches? Does that make the Fed simple the collateralized debt obligation ("CDO") of last resort? Who will do the rating? Who will be writing protection on CDO Fed Tranch A-1 (AAA)?
3. Given that neither entity is currently monitored by an Inspector General (despite what used to be statutory language so mandating) and both entities are completely captured by the current administration, how can it be anything other than insanity to expect any result from these entities other than the formation (or expansion) of a ravenous fiscal black hole?
4. Given increasing government control beyond Fannie and Freddie that now extends far beyond 33% of GDP, what can we expect if we continue to permit political parties of any stripe to exercise command and control influence over what is now probably a simple majority of our economy?
There was a time when we hoped that the United States would learn its lesson with respect to permitting political control over large swaths of private markets. Today that time seems very long ago, and somewhat naive.
Perhaps we are being too harsh on the likes of Barney Frank and other GSE proponents. Adopting a slighty more relativistic economic morality, we might count Frank as one of the greatest legislators of all time. Consider:
To the extent Mr. Frank and his ilk self-identify as advocates for low-cost housing for those ill-able to afford it, or beset by poor credit, the last 20 years have represented the largest single wealth transfer (composed primarily of real estate and flat screen TVs) to that sector known to us. Not only that, but given the de facto nationalization of MBS portfolios (we'll give you three guesses who have been the largest MBS buyers over the last several quarters) the GSEs and their supporters have managed to get taxpayers to pay for it all. Of course, had they simply proposed such a measure in Congress it would have been laughed from the chamber. And yet, it almost seems as if these individuals simply wrote a multi-trillion dollar check to their constituents that happened to be drawn on the United States Treasury.
It almost seems this way because it was this way.
The Price for Fannie and Freddie Keeps Going Up
by Peter Wallison
Barney Frank's decision to 'roll the dice' on subsidized housing is becoming an epic disaster for taxpayers.
On Christmas Eve, when most Americans' minds were on other things, the Treasury Department announced that it was removing the $400 billion cap from what the administration believes will be necessary to keep Fannie Mae and Freddie Mac solvent. This action confirms that the decade-long congressional failure to more closely regulate these two government-sponsored enterprises (GSEs) will rank for U.S. taxpayers as one of the worst policy disasters in our history.
Fannie and Freddie's congressional sponsors—some of whom are now leading the administration's effort to "reform" the financial system—have a lot to answer for. Rep. Barney Frank (D., Mass.), chairman of the House Financial Services Committee, sponsored legislation adopted in 2008 that established a new regulatory structure for the GSEs. But by then it was far too late. The GSEs had begun buying risky loans in 1993 to meet the "affordable housing" requirements established under congressional direction by the Department of Housing and Urban Development (HUD).
Most of the damage was done from 2005 through 2007, when Fannie and Freddie were binging on risky mortgages. Back then, Mr. Frank was the bartender, denying that there was any cause for concern, and claiming that he wanted to "roll the dice" on subsidized housing support. In 2005, the Senate Banking Committee, then controlled by Republicans, adopted tough regulatory legislation that would have established more auditing and oversight of the two agencies. But it was passed out of committee on a partisan vote, and with no Democratic support it never came to a vote.
By the end of 2008, Fannie and Freddie held or guaranteed approximately 10 million subprime and Alt-A mortgages and mortgage-backed securities (MBS)—risky loans with a total principal balance of $1.6 trillion. These are now defaulting at unprecedented rates, accounting for both their 2008 insolvency and their growing losses today. Since 2008, under government control, the two agencies have continued to buy dicey mortgages in order to stabilize housing prices.
There is more to this ugly situation. New research by Edward Pinto, a former chief credit officer for Fannie Mae and a housing expert, has found that from the time Fannie and Freddie began buying risky loans as early as 1993, they routinely misrepresented the mortgages they were acquiring, reporting them as prime when they had characteristics that made them clearly subprime or Alt-A. In general, a subprime mortgage refers to the credit of the borrower. A FICO score of less than 660 is the dividing line between prime and subprime, but Fannie and Freddie were reporting these mortgages as prime, according to Mr. Pinto. Fannie has admitted this in a third-quarter 10-Q report in 2008.
An Alt-A mortgage is one in which the quality of the mortgage or the underwriting was deficient; it might lack adequate documentation, have a low or no down payment, or in some other way be more likely than a prime mortgage to default. Fannie and Freddie were also reporting these mortgages as prime, according to Mr. Pinto. It is easy to see how this misrepresentation was a principal cause of the financial crisis. Market observers, rating agencies and investors were unaware of the number of subprime and Alt-A mortgages infecting the financial system in late 2006 and early 2007.
Of the 26 million subprime and Alt-A loans outstanding in 2008, 10 million were held or guaranteed by Fannie and Freddie, 5.2 million by other government agencies, and 1.4 million were on the books of the four largest U.S. banks. In addition, about 7.7 million subprime and Alt-A housing loans were in mortgage pools supporting MBS issued by Wall Street banks—which had long before been driven out of the prime market by Fannie and Freddie's government-backed, low-cost funding. The vast majority of these MBS were rated AAA, because the rating agencies' models assumed that the losses that are incurred by subprime and Alt-A loans would be within the historical range for the number of high-risk loans known to be outstanding.
But because of Fannie and Freddie's mislabeling, there were millions more high-risk loans outstanding. That meant default rates as well as the actual losses after foreclosure were going to be outside all prior experience. When these rates began to show up early in 2007, it was apparent something was seriously wrong with assumptions on which AAA ratings had been based. Losses, it was now certain, would invade the AAA tranches of the mortgage-backed securities outstanding. Investors, having lost confidence in the ratings, fled the MBS market and ultimately the market for all asset-backed securities. They have not yet returned.
By the end of 2007, the MBS market collapsed entirely. Assets once carried at par on financial institutions' balance sheets could not be sold except at distress prices. This raised questions about the stability and even the solvency of most of the world's largest financial institutions. The first major victim was Bear Stearns, the smallest of the five major Wall Street investment banks but one invested heavily in risky MBS. The government rescue of Bear Stearns in March 2008 signaled that the U.S. government, and perhaps others, would stand behind other large financial institutions.
The moral hazard this engendered was deadly when Lehman Brothers' solvency came under challenge. Spreads in the credit default swap market for Lehman, despite massive short-selling, showed very little alarm by investors until just before the fateful weekend of Sept. 13 and 14, when they blew out on fears that the firm might not be rescued. By that time it was too late for Lehman's counterparties to take the protective action that might have cushioned the shock. As it turned out, however, none of Lehman's largest counterparties failed—so much for the idea that the financial market is "interconnected"—but all market participants now realized they had to know the true financial condition of their counterparties. The result was a freeze-up in interbank lending.
For most people, that freeze-up is the beginning of the financial crisis. But its roots go back to 1993, when Fannie and Freddie began stocking up on subprime and other risky loans while reporting them as prime. Why Fannie and Freddie did this is still to be determined. But the leading candidate is certainly HUD's affordable housing regulations, which by 2007 required that 55% of all the loans the agencies acquired had to be made to borrowers at or below the median income, with almost half of these required to be low-income borrowers.
Another likely reason for Fannie and Freddie's mislabeling of mortgages was their desire to retain congressional support by "rolling the dice" while making believe they weren't betting. With the Federal Housing Administration, Wall Street investment banks, and Fannie and Freddie all competing for these loans, the bottom of the barrel had long before been scraped and the financial system set up for a crisis.
Mr. Wallison is a senior fellow at the American Enterprise Institute.
U.S. to Lose $400 Billion on Fannie, Freddie, Wallison Says
Taxpayer losses from supporting Fannie Mae and Freddie Mac will top $400 billion, according to Peter Wallison, a former general counsel at the Treasury who is now a fellow at the American Enterprise Institute. "The situation is they are losing gobs of money, up to $400 billion in mortgages," Wallison said in a Bloomberg Television interview. The Treasury Department recognized last week that losses will be more than $400 billion when it raised its limit on federal support for the two government-sponsored enterprises, he said.
The U.S. seized the two mortgage financiers in 2008 as the government struggled to prevent a meltdown of the financial system. The debt of Fannie Mae, Freddie Mac and the Federal Home Loan Banks grew an average of $184 billion annually from 1998 to 2008, helping fuel a bubble that drove home prices up by 107 percent between 2000 and mid-2006, according to the S&P/Case- Shiller home-price index. The Treasury said on Dec. 24 it would provide an unlimited amount of assistance to the companies as needed for the next three years to alleviate market concern that the government lifeline for Fannie Mae and Freddie Mac, the largest source of money for U.S. home loans, could lapse or be exhausted.
Lax regulation of Fannie Mae and Freddie Mac led to the mortgage companies taking on too many risky loans, Wallison said. "It turns out it was impossible to regulate them," he said. "They were too powerful." He said no one knows how much will be needed to keep the companies solvent. From 1990 to 1999, Wallison served on the board of directors of MGIC Investment Corp., the largest U.S. mortgage insurer, including a stint on the audit committee, according to Bloomberg data and company filings. The continued government support of Fannie Mae and Freddie Mac makes buying their debt a good investment, Wallison said. "It was always safe to buy these notes," he said. The U.S. government was always going to stand behind them. They’re as good as Treasury notes.
Don’t Be Fooled by the Housing Market’s False Bottom
by Martin Hutchinson
Existing home sales surprised the markets by rising 7.4% to an annual rate of 6.54 million units in November, the highest since February 2007, according to the National Association of Realtors (NAR). That's only 10% below the all-time peak in 2005. What's more is that house prices, as measured by the S&P/Case-Shiller 20-city Home Price Index, rose for the fourth consecutive month in September before stabilizing in October when prices were flat. The NAR is inevitably convinced that the worst is over and that housing is due for a rapid recovery, and that home prices will take out 2006's peaks some time in 2011 or 2012. Not so fast, guys!
The recovery in housing has been boosted by just about every artificial means you can imagine:
- Interest rates have been kept at a historically low level of 0%-0.25% for a very long time.
- Fannie Mae and Freddie Mac, the bankrupt behemoths of housing finance, have been bailed out with what amounts to a blank check from taxpayers.
- The Federal Housing Agency (FHA) went on making mortgages with 3% down payments when nobody else was, thus very likely landing taxpayers with another bill for some large fraction of $1 trillion.
- And the government has been handing out cash subsidies for refinancing houses that were about to be repossessed and $8,000 subsidies for first time buyers - now $6,500 for all homebuyers.
Of course it looks like the housing market has recovered! The question is what happens when some of these subsidies are taken away? Even if we wanted to provide gigantic subsidies to housing finance in every form for evermore, we couldn't afford to. The U.S. government is running trillion dollar deficits, and something has to change. So at some point the feather cushions that have surrounded every aspect of the housing market will be taken away.
To see how far housing might fall, look at the Case-Shiller index's bottom after the last housing bust in 1989-90 (as the 20-city index did not exist back then, we used the 10-city index). The index bottomed in September 1993 - more than two years after the U.S. economy had begun to recover - at a value of 75.81. Nominal gross domestic product (GDP) rose by 109% between the third quarter of 1993 and the third quarter of 2009.
However, the population rose by about 20%, so nominal GDP per capita rose by 74%. (Real GDP per capita rose by 27%, a pretty mangy performance over 16 years.) House prices can be expected to inflate about as fast as nominal GDP per capita, in a large country like the United States where space is not yet at a premium. Thus the Case-Shiller Index this time around might be expected to bottom at 132 (75.81 x 174%). Its current value is 157, so we can expect a further 16% drop, even if you assume the bottom is no lower than after the milder housing downturn of 1989-90. That bottom will probably be reached around the end of 2011 if the 1990-93 post-recession pattern plays out.
To give you an idea of what that might mean, the Case-Shiller 10-city index passed 132 in June 2002. That means, on average, everybody who has bought a house since June 2002 can be expected to be underwater on the deal when the bottom is reached. Every mortgage with a 10% down payment made since about April 2003 (when the Case-Shiller index was 147 - 90% of which is 132) would be underwater. Every prime mortgage with a 20% down payment - not that many of these were being made in those years - made after February 2004 would be underwater.
Of course, that's an average. In Dallas, there would probably be few foreclosures beyond those we already have seen, because prices didn't go up so much. On the other hand, in Las Vegas, pretty well every mortgage made since Bugsy Siegel started developing the Flamingo in 1946 would be kaput. The housing market is unlikely to turn around while there's so much cheap money about, or while the feds are subsidizing home purchases to such an extent. However, at some point next year, reality will hit the U.S. economy and the federal budget - maybe simultaneously.
The house purchase subsidies are likely to be extended for one more six-month period, through December 2010, over the midterm elections, but not beyond that. At some point, the losses on the FHA mortgage portfolio will become large enough that some of them will have to be taken "on budget." And at some point, either resurgent inflation or soaring commodity prices will force Ben Bernanke to raise interest rates - or crash the Treasury bond market because he won't do so. At that point, reality will return to the housing market too.
Shadow Inventory Is For Real
It feels like I've been writing about "shadow inventory" -- homes that are in foreclosure but haven't hit the market yet -- forever. Yet no flood of foreclosures has yet inundated the market, and as a matter of fact, inventory has been quite scarce lately. Is there anything to this shadow inventory concept? As Kelly Bennett documented in a recent blog entry, the answer is yes. Kelly noted as of Tuesday, there were 19,453 San Diego homes that were in foreclosure but that were not yet listed for sale. That, my friends, is your shadow inventory.
For purely illustrative purposes, let's try to understand what the effect would be if all these homes in foreclosure were to suddenly hit the market. That's certainly not going to happen, and as I'll discuss below, these homes may never come on the market at all. But this approach helps understand the scale of what lurks in the shadows.
- There are currently 11,976 homes listed for sale in San Diego. If all the shadow inventory were to hit the market, inventory would increase by 162 percent to 31,429.
- The 11,976 figure in the prior bullet includes active inventory as well as inventory that is marked "contingent," meaning that the property is a short sale or the like that has an accepted offer that is awaiting lender approval (thus, the property is not really available for sale). Using only the active inventory of 7,964 homes, shadow inventory would swell the number of homes for sale by 244 percent.
- Using the average number of sales over the past year, releasing the shadow inventory into the wild would add 7.3 months' worth of inventory. By comparison, in November there were 4.6 months of inventory if you count both active and contingent homes, and only 3.0 months if you count just active listings. So adding all that shadow inventory would increase the number of homes actively for sale from 3 months' worth to 10.3 months' worth -- more than a three-fold increase.
Shadow inventory is very real, then, in the sense that there are foreclosed (but not yet for sale) homes out there in numbers that would have a substantial impact on the county's housing supply if they were to come onto the market. Whether that will actually happen is another question entirely. So far, foreclosed homes are only making it to the market in a trickle.
The rationale that banks are too swamped to process foreclosures seemed plausible at first, but this has gone on so long that I am increasingly skeptical of it. So I can only assume that the foreclosures are being held back by some combination of moratoria and other bailout programs (or hope for more of the same), "extend and pretend" (in which lenders put off foreclosure in an attempt to prop up the paper value of their mortgage assets), and political pressure from the folks who run the bailout printing press.
As with other aspects of the housing market, this has become a largely political issue and is accordingly difficult to forecast. But I think it's a fairly safe bet that the politicians will find new and exciting ways to throw money at the situation. (To this point, local housing analyst Ramsey Su has conjectured that the Christmas Eve lifting of the limits on how much money the government will provide to Fannie Mae and Freddie Mac is a prelude to widespread mortgage principal reduction by the two mortgage giants).
It's tough to know, then, how many of those 19,453 homes will complete the foreclosure process and make it onto the market. And for the ones that do, we don't know over what timeframe it will happen. It's certainly within the realm of possibility that the government could borrow, print, and spend enough money to substantially lessen the shadow inventory's potential impact. It's within the realm of possibility, but not a sure thing. And there is no doubt that the shadow inventory is out there in great numbers. Until the path forward is more clear (and regardless of whether prices are rising right now) shadow inventory is a factor that should not be dismissed or ignored.
U.S. Loan Effort Is Seen as Adding to Housing Woes
The Obama administration’s $75 billion program to protect homeowners from foreclosure has been widely pronounced a disappointment, and some economists and real estate experts now contend it has done more harm than good. Since President Obama announced the program in February, it has lowered mortgage payments on a trial basis for hundreds of thousands of people but has largely failed to provide permanent relief. Critics increasingly argue that the program, Making Home Affordable, has raised false hopes among people who simply cannot afford their homes.
As a result, desperate homeowners have sent payments to banks in often-futile efforts to keep their homes, which some see as wasting dollars they could have saved in preparation for moving to cheaper rental residences. Some borrowers have seen their credit tarnished while falsely assuming that loan modifications involved no negative reports to credit agencies. Some experts argue the program has impeded economic recovery by delaying a wrenching yet cleansing process through which borrowers give up unaffordable homes and banks fully reckon with their disastrous bets on real estate, enabling money to flow more freely through the financial system.
"The choice we appear to be making is trying to modify our way out of this, which has the effect of lengthening the crisis," said Kevin Katari, managing member of Watershed Asset Management, a San Francisco-based hedge fund. "We have simply slowed the foreclosure pipeline, with people staying in houses they are ultimately not going to be able to afford anyway."
Mr. Katari contends that banks have been using temporary loan modifications under the Obama plan as justification to avoid an honest accounting of the mortgage losses still on their books. Only after banks are forced to acknowledge losses and the real estate market absorbs a now pent-up surge of foreclosed properties will housing prices drop to levels at which enough Americans can afford to buy, he argues. "Then the carpenters can go back to work," Mr. Katari said. "The roofers can go back to work, and we start building housing again. If this drips out over the next few years, that whole sector of the economy isn’t going to recover."
The Treasury Department publicly maintains that its program is on track. "The program is meeting its intended goal of providing immediate relief to homeowners across the country," a department spokeswoman, Meg Reilly, wrote in an e-mail message. But behind the scenes, Treasury officials appear to have concluded that growing numbers of delinquent borrowers simply lack enough income to afford their homes and must be eased out.
In late November, with scant public disclosure, the Treasury Department started the Foreclosure Alternatives Program, through which it will encourage arrangements that result in distressed borrowers surrendering their homes. The program will pay incentives to mortgage companies that allow homeowners to sell properties for less than they owe on their mortgages — short sales, in real estate parlance. The government will also pay incentives to mortgage companies that allow delinquent borrowers to hand over their deeds in lieu of foreclosing.
Ms. Reilly, the Treasury spokeswoman, said the foreclosure alternatives program did not represent a new policy. "We have said from the start that modifications will not be the solution for all homeowners and will not solve the housing crisis alone," Ms. Reilly said by e-mail. "This has always been a multi-pronged effort." Whatever the merits of its plans, the administration has clearly failed to reverse the foreclosure crisis.
In 2008, more than 1.7 million homes were "lost" through foreclosures, short sales or deeds in lieu of foreclosure, according to Moody’s Economy.com. Last year, more than two million homes were lost, and Economy.com expects that this year’s number will swell to 2.4 million. "I don’t think there’s any way for Treasury to tweak their plan, or to cajole, pressure or entice servicers to do more to address the crisis," said Mark Zandi, chief economist at Moody’s Economy.com. "For some folks, it is doing more harm than good, because ultimately, at the end of the day, they are going back into the foreclosure morass."
Mr. Zandi argues that the administration needs a new initiative that attacks a primary source of foreclosures: the roughly 15 million American homeowners who are underwater, meaning they owe the bank more than their home is worth. Increasingly, such borrowers are inclined to walk away and accept foreclosure, rather than continuing to make payments on properties in which they own no equity. A paper by researchers at the Amherst Securities Group suggests that being underwater "is a far more important predictor of defaults than unemployment."
From its inception, the Obama plan has drawn criticism for failing to compel banks to write down the size of outstanding mortgage balances, which would restore equity for underwater borrowers, giving them greater incentive to make payments. A vast majority of modifications merely decrease monthly payments by lowering the interest rate. Mr. Zandi proposes that the Treasury Department push banks to write down some loan balances by reimbursing the companies for their losses.
He pointedly rejects the notion that government ought to get out of the way and let foreclosures work their way through the market, saying that course risks a surge of foreclosures and declining house prices that could pull the economy back into recession. "We want to overwhelm this problem," he said. "If we do go back into recession, it will be very difficult to get out."
Under the current program, the government provides cash incentives to mortgage companies that lower monthly payments for borrowers facing hardships. The Treasury Department set a goal of three to four million permanent loan modifications by 2012. "That’s overly optimistic at this stage," said Richard H. Neiman, the superintendent of banks for New York State and an appointee to the Congressional Oversight Panel, a body created to keep tabs on taxpayer bailout funds. "There’s a great deal of frustration and disappointment."
As of mid-December, some 759,000 homeowners had received loan modifications on a trial basis typically lasting three to five months. But only about 31,000 had received permanent modifications — a step that requires borrowers to make timely trial payments and submit paperwork verifying their financial situation. The government has pressured mortgage companies to move faster. Still, it argues that trial modifications are themselves a considerable help.
"Almost three-quarters of a million Americans now are benefiting from modification programs that reduce their monthly payments dramatically, on average $550 a month," Treasury Secretary Timothy F. Geithner said last month at a hearing before the Congressional Oversight Panel. "That is a meaningful amount of support." But mortgage experts and lawyers who represent borrowers facing foreclosure argue that recipients of trial loan modifications often wind up worse off.
In Lakeland, Fla., Jaimie S. Smith, 29, called her mortgage company, then Washington Mutual, in October 2008, when she realized she would get a smaller bonus from her employer, a furniture company, threatening her ability to continue the $1,250 monthly mortgage payments on her three-bedroom house. In April, Chase, which had taken over Washington Mutual, lowered her payment to $1,033.62 in a trial that was supposed to last three months.
Ms. Smith made all three payments on time and submitted required documents, Chase confirms. She called the bank almost weekly to inquire about a permanent loan modification. Each time, she says, Chase told her to continue making trial payments and await word on a permanent modification. Then, in October, a startling legal notice arrived in the mail: Chase had foreclosed on her house and sold it at auction for $100. (The purchaser? Chase.) "I cried," she said. "I was hysterical. I bawled my eyes out."
Later that week came another letter from Chase: "Congratulations on qualifying for a Making Home Affordable loan modification!" When Ms. Smith frantically called the bank to try to overturn the sale, she was told that the house was no longer hers. Chase would not tell her how long she could remain there, she says. She feared the sheriff would show up at her door with eviction papers, or that she would return home to find her belongings piled on the curb. So Ms. Smith anxiously set about looking for a new place to live.
She had been planning to continue an online graduate school program in supply chain management, and she had about $4,000 in borrowed funds to pay tuition. She scrapped her studies and used the money to pay the security deposit and first month’s rent on an apartment. Later, she hired a lawyer, who is seeking compensation from Chase. A judge later vacated the sale. Chase is still offering to make her loan modification permanent, but Ms. Smith has already moved out and is conflicted about what to do.
"I could have just walked away," said Ms. Smith. "If they had said, ‘We can’t work with you,’ I’d have said: ‘What are my options? Short sale?’ None of this would have happened. God knows, I never would have wanted to go through this. I’d still be in grad school. I would not have paid all that money to them. I could have saved that money." A Chase spokeswoman, Christine Holevas, confirmed that the bank mistakenly foreclosed on Ms. Smith’s house and sold it at the same time it was extending the loan modification offer. "There was a systems glitch," Ms. Holevas said. "We are sorry that an error happened. We’re trying very hard to do what we can to keep folks in their homes. We are dealing with many, many individuals."
Many borrowers complain they were told by mortgage companies their credit would not be damaged by accepting a loan modification, only to discover otherwise. In a telephone conference with reporters, Jack Schakett, Bank of America’s credit loss mitigation executive, confirmed that even borrowers who were current before agreeing to loan modifications and who then made timely payments were reported to credit rating agencies as making only partial payments.
The biggest source of concern remains the growing numbers of underwater borrowers — now about one-third of all American homeowners with mortgages, according to Economy.com. The Obama administration clearly grasped the threat as it created its program, yet opted not to focus on writing down loan balances. "This is a conscious choice we made, not to start with principal reduction," Mr. Geithner told the Congressional Oversight Panel. "We thought it would be dramatically more expensive for the American taxpayer, harder to justify, create much greater risk of unfairness."
Mr. Geithner’s explanation did not satisfy the panel’s chairwoman, Elizabeth Warren. "Are we creating a program in which we’re talking about potentially spending $75 billion to try to modify people into mortgages that will reduce the number of foreclosures in the short term, but just kick the can down the road?" she asked, raising the prospect "that we’ll be looking at an economy with elevated mortgage foreclosures not just for a year or two, but for many years. How do you deal with that problem, Mr. Secretary?" A good question, Mr. Geithner conceded. "What to do about it," he said. "That’s a hard thing."
Foreclosures Send Home Appraisals Plummeting
It wasn't the first time that Katherine Scheri ruined a real estate agent's day with a low property appraisal. Scheri, a real estate appraiser, had sized up a three-bedroom, two-bath house in Santa Ana, Calif., for $30,000 less than what the buyers offered to pay. A typical deal-killer for a seller. The agent urged the lender to force Scheri to consider several other properties that could back up the original $310,000 sale price. Then he tried good old-fashioned guilt, telling Scheri her appraisal was going to ruin the buyers' shot at the American Dream.
"That's what he laid on me," Scheri recalled. "And I said, 'Don't you care they could be potentially spending $30,000 too much for a house?" Across the country, agents and homebuilders are complaining too many appraisals are coming in low, scuttling deals. The National Association of Realtors says nearly one in four of its members has reported clients losing a sale due to botched appraisals. The National Association of Home Builders, meanwhile, said low appraisals were sinking a quarter of all new home sales and argues it's not fair to compare distressed properties to brand-new homes. And that gets to the heart of the problem.
Roughly 40 percent of all home sales this year were foreclosures or short sales, meaning the property sold for less than the mortgage. In some markets, like Las Vegas and Phoenix, they've hit more than 50 percent. Appraisers determine the value of a property by looking at recent sales of comparable homes. They take an apples-to-apples approach, excluding or making adjustments for certain features, such as a swimming pool or finished basement. And generally, a foreclosure isn't used as a comparison for a standard sale.
But in some areas, appraisers like Scheri contend they are only sizing up homes according to the reality of the market, though they concede its becoming increasingly harder pinpoint what a home is worth. Home prices in many large metro areas, including Los Angeles and San Diego, hit bottom earlier this year and are recovering, data last week showed. Yet there are many neighborhoods across the country where foreclosures and other financially distressed sales are still rising. "It used to be a very infrequent thing that you did an appraisal and the value wasn't supported," says Scheri, who is based in San Diego. "Now, it's more common than not."
So, if you're trying to sell your home in a neighborhood where foreclosures and short sales are predominant, an appraiser could determine your home is actually worth less than what some buyers may be willing to pay.
Part of the problem, critics contend, is that many real estate appraisers are now hired under new industry rules. Designed to limit conflicts of interest that can bias an appraisal, the rules bar mortgage brokers from ordering appraisals themselves, forcing them to do so through a mortgage lender.Lenders may order appraisals through in-house staff or appraisers hired by outside firms known as appraisal-management companies. But neither may talk to the appraisers about the value of the property they're evaluating.
The result, however, can mean that low-cost appraisers are hired from outside the area and don't have the local knowledge to find homes that can be a better benchmark for regular homes. Chris Heller, agent-owner of Keller Williams Realty in northern San Diego, recently had the sale of a home nearly botched for the second time because of a low appraisal. The three-bedroom, two-bath house in the Poway suburb of San Diego was appraised for $55,000 less than what the buyer agreed to pay. The seller wasn't willing to drop the price down to $400,000, but knocked off $20,000 when the buyer agreed to come up with $35,000 in cash.
"The seller is taking less because of the appraisal," Heller said, noting that almost all of the comparable homes used to gauge the property's value were distressed sales. Still, the buyer is paying a premium not to have to deal with the risks involved in buying a foreclosed home or a short sale, which can take several months to close.
So, should distressed homes sales be compared with other homes? Is one inherently worth more than the other? A new analysis of foreclosure and non-foreclosure sales by Zillow.com found that even when most of the market is made up of bank-owned homes, non-foreclosures sell for as much as 30 percent more. Another study by Harvard's Joint Center for Housing Studies came up with a similar conclusion.
In Las Vegas, which has one of the highest foreclosure rates in the nation, the median sale price for bank-owned homes sold in September was about 23 percent less than other types of properties, according to the Zillow study. "There are two markets, two very distinct markets," said Zillow economist Stan Humphries. That doesn't mean foreclosures don't weigh down the value of nearby homes, although there's loud disagreement on how much.
The Joint Center for Housing Studies examined home sales over 20 years in Massachusetts and found that a foreclosure within less than 100 yards of a home lowers the price of that home by 1 percent. So it appears that in neighborhoods with high foreclosure rates, values for all homes are being pulled lower than in areas where there are few or none. That means you can live in one area of Las Vegas and values can be down twice as much as they are in another neighborhood just a few miles away. When it comes to appraisals, that leaves a lot of room for interpretation.
Living on Nothing but Food Stamps
After an improbable rise from the Bronx projects to a job selling Gulf Coast homes, Isabel Bermudez lost it all to an epic housing bust — the six-figure income, the house with the pool and the investment property. Now, as she papers the county with résumés and girds herself for rejection, she is supporting two daughters on an income that inspires a double take: zero dollars in monthly cash and a few hundred dollars in food stamps.
With food-stamp use at a record high and surging by the day, Ms. Bermudez belongs to an overlooked subgroup that is growing especially fast: recipients with no cash income. About six million Americans receiving food stamps report they have no other income, according to an analysis of state data collected by The New York Times. In declarations that states verify and the federal government audits, they described themselves as unemployed and receiving no cash aid — no welfare, no unemployment insurance, and no pensions, child support or disability pay.
Their numbers were rising before the recession as tougher welfare laws made it harder for poor people to get cash aid, but they have soared by about 50 percent over the past two years. About one in 50 Americans now lives in a household with a reported income that consists of nothing but a food-stamp card. "It’s the one thing I can count on every month — I know the children are going to have food," Ms. Bermudez, 42, said with the forced good cheer she mastered selling rows of new stucco homes.
Members of this straitened group range from displaced strivers like Ms. Bermudez to weathered men who sleep in shelters and barter cigarettes. Some draw on savings or sporadic under-the-table jobs. Some move in with relatives. Some get noncash help, like subsidized apartments. While some go without cash incomes only briefly before securing jobs or aid, others rely on food stamps alone for many months. The surge in this precarious way of life has been so swift that few policy makers have noticed. But it attests to the growing role of food stamps within the safety net. One in eight Americans now receives food stamps, including one in four children.
Here in Florida, the number of people with no income beyond food stamps has doubled in two years and has more than tripled along once-thriving parts of the southwest coast. The building frenzy that lured Ms. Bermudez to Fort Myers and neighboring Cape Coral has left a wasteland of foreclosed homes and written new tales of descent into star-crossed indigence.
A skinny fellow in saggy clothes who spent his childhood in foster care, Rex Britton, 22, hopped a bus from Syracuse two years ago for a job painting parking lots. Now, with unemployment at nearly 14 percent and paving work scarce, he receives $200 a month in food stamps and stays with a girlfriend who survives on a rent subsidy and a government check to help her care for her disabled toddler. "Without food stamps we’d probably be starving," Mr. Britton said.
A strapping man who once made a living throwing fastballs, William Trapani, 53, left his dreams on the minor league mound and his front teeth in prison, where he spent nine years for selling cocaine. Now he sleeps at a rescue mission, repairs bicycles for small change, and counts $200 in food stamps as his only secure support. "I’ve been out looking for work every day — there’s absolutely nothing," he said.
A grandmother whose voice mail message urges callers to "have a blessed good day," Wanda Debnam, 53, once drove 18-wheelers and dreamed of selling real estate. But she lost her job at Starbucks this year and moved in with her son in nearby Lehigh Acres. Now she sleeps with her 8-year-old granddaughter under a poster of the Jonas Brothers and uses her food stamps to avoid her daughter-in-law’s cooking. "I’m climbing the walls," Ms. Debnam said.
Florida officials have done a better job than most in monitoring the rise of people with no cash income. They say the access to food stamps shows the safety net is working. "The program is doing what it was designed to do: help very needy people get through a very difficult time," said Don Winstead, deputy secretary for the Department of Children and Families. "But for this program they would be in even more dire straits."
But others say the lack of cash support shows the safety net is torn. The main cash welfare program, Temporary Assistance for Needy Families, has scarcely expanded during the recession; the rolls are still down about 75 percent from their 1990s peak. A different program, unemployment insurance, has rapidly grown, but still omits nearly half the unemployed. Food stamps, easier to get, have become the safety net of last resort.
"The food-stamp program is being asked to do too much," said James Weill, president of the Food Research and Action Center, a Washington advocacy group. "People need income support." Food stamps, officially the called Supplemental Nutrition Assistance Program, have taken on a greater role in the safety net for several reasons. Since the benefit buys only food, it draws less suspicion of abuse than cash aid and more political support. And the federal government pays for the whole benefit, giving states reason to maximize enrollment. States typically share in other programs’ costs.
The Times collected income data on food-stamp recipients in 31 states, which account for about 60 percent of the national caseload. On average, 18 percent listed cash income of zero in their most recent monthly filings. Projected over the entire caseload, that suggests six million people in households with no income. About 1.2 million are children. The numbers have nearly tripled in Nevada over the past two years, doubled in Florida and New York, and grown nearly 90 percent in Minnesota and Utah. In Wayne County, Mich., which includes Detroit, one of every 25 residents reports an income of only food stamps. In Yakima County, Wash., the figure is about one of every 17.
Experts caution that these numbers are estimates. Recipients typically report a small rise in earnings just once every six months, so some people listed as jobless may have recently found some work. New York officials say their numbers include some households with earnings from illegal immigrants, who cannot get food stamps but sometimes live with relatives who do. Still, there is little doubt that millions of people are relying on incomes of food stamps alone, and their numbers are rapidly growing. "This is a reflection of the hardship that a lot of people in our state are facing; I think that is without question," said Mr. Winstead, the Florida official.
With their condition mostly overlooked, there is little data on how long these households go without cash incomes or what other resources they have. But they appear an eclectic lot. Florida data shows the population about evenly split between families with children and households with just adults, with the latter group growing fastest during the recession. They are racially mixed as well — about 42 percent white, 32 percent black, and 22 percent Latino — with the growth fastest among whites during the recession.
The expansion of the food-stamp program, which will spend more than $60 billion this year, has so far enjoyed bipartisan support. But it does have conservative critics who worry about the costs and the rise in dependency. "This is craziness," said Representative John Linder, a Georgia Republican who is the ranking minority member of a House panel on welfare policy. "We’re at risk of creating an entire class of people, a subset of people, just comfortable getting by living off the government."
Mr. Linder added: "You don’t improve the economy by paying people to sit around and not work. You improve the economy by lowering taxes" so small businesses will create more jobs. With nearly 15,000 people in Lee County, Fla., reporting no income but food stamps, the Fort Myers area is a laboratory of inventive survival. When Rhonda Navarro, a cancer patient with a young son, lost running water, she ran a hose from an outdoor spigot that was still working into the shower stall. Mr. Britton, the jobless parking lot painter, sold his blood.
Kevin Zirulo and Diane Marshall, brother and sister, have more unlikely stories than a reality television show. With a third sibling paying their rent, they are living on a food-stamp benefit of $300 a month. A gun collector covered in patriotic tattoos, Mr. Zirulo, 31, has sold off two semiautomatic rifles and a revolver. Ms. Marshall, who has a 7-year-old daughter, scavenges discarded furniture to sell on the Internet.
They said they dropped out of community college and diverted student aid to household expenses. They received $150 from the Nielsen Company, which monitors their television. They grew so desperate this month, they put the breeding services of the family Chihuahua up for bid on Craigslist. "We look at each other all the time and say we don’t know how we get through," Ms. Marshall said.
Ms. Bermudez, by contrast, tells what until the recession seemed a storybook tale. Raised in the Bronx by a drug-addicted mother, she landed a clerical job at a Manhattan real estate firm and heard that Fort Myers was booming. On a quick scouting trip in 2002, she got a mortgage on easy terms for a $120,000 home with three bedrooms and a two-car garage. The developer called the floor plan Camelot. "I screamed, I cried," she said. "I took so much pride in that house."
Jobs were as plentiful as credit. Working for two large builders, she quickly moved from clerical jobs to sales and bought an investment home. Her income soared to $180,000, and she kept the pay stubs to prove it. By the time the glut set in and she lost her job, the teaser rates on her mortgages had expired and her monthly payments soared. She landed a few short-lived jobs as the industry imploded, exhausted her unemployment insurance and spent all her savings. But without steady work in nearly three years, she could not stay afloat. In January, the bank foreclosed on Camelot.
One morning as the eviction deadline approached, Ms. Bermudez woke up without enough food to get through the day. She got emergency supplies at a food pantry for her daughters, Tiffany, now 17, and Ashley, 4, and signed up for food stamps. "My mother lived off the government," she said. "It wasn’t something as a proud working woman I wanted to do."
For most of the year, she did have a $600 government check to help her care for Ashley, who has a developmental disability. But she lost it after she was hospitalized and missed an appointment to verify the child’s continued eligibility. While she is trying to get it restored, her sole income now is $320 in food stamps. Ms. Bermudez recently answered the door in her best business clothes and handed a reporter her résumé, which she distributes by the ream. It notes she was once a "million-dollar producer" and "deals well with the unexpected." "I went from making $180,000 to relying on food stamps," she said. "Without that government program, I wouldn’t be able to feed my children.
Bernanke Says Low Rates Didn’t Cause Housing Bubble
Federal Reserve Chairman Ben S. Bernanke said the central bank’s low interest rates didn’t cause the past decade’s housing bubble and that better regulation would have been more effective in limiting the boom. "The best response to the housing bubble would have been regulatory, rather than monetary," Bernanke said today in remarks to the American Economic Association’s annual meeting in Atlanta. The Fed’s efforts to constrain the bubble were "too late or were insufficient," which means that regulatory actions "must be better and smarter," he said.
Bernanke said the Fed is working to improve its supervision of banks and has strengthened measures to protect consumers of mortgages and other financial products. Senate Banking Committee Chairman Christopher Dodd, who backs Bernanke for a second term, has called the Fed’s oversight of banks leading up to the crisis an "abysmal failure." Dodd proposes stripping the Fed and other agencies of bank supervision powers and moving them to a new regulator. Scholars such as Allan Meltzer, a historian of the central bank, have criticized the Fed for helping fuel the housing boom by keeping interest rates too low for too long. The bursting of the housing bubble led to the worst recession since the Great Depression and the loss of more than 7 million U.S. jobs.
Meltzer’s argument has been echoed by lawmakers including Senator Richard Shelby of Alabama, the senior Republican on the Banking Committee, who says Bernanke doesn’t deserve a second term as Fed chief. Shelby, at a Dec. 17 vote on Bernanke’s nomination to a second four-year term starting next month, said the former Princeton University professor "missed clear signals" of a financial crisis when he was a Fed governor from 2002 until 2005. "I strongly disapprove of some of the past deeds of the Federal Reserve while Ben Bernanke was a member and its chairman, and I lack confidence in what little planning for the future he has articulated," Shelby said.
Bernanke didn’t discuss the outlook for the U.S. economy or Fed monetary policy in today’s speech or an accompanying slide presentation. Increased use of variable-rate and interest-only mortgages, and the "associated decline of underwriting standards," were more responsible for the bubble, Bernanke said in a speech at an economics conference. He left the door open to using interest rates for preventing "dangerous buildups of financial risks" should regulatory changes fail to be made or turn out to be insufficient.
"We must remain open to using monetary policy as a supplementary tool for addressing those risks -- proceeding cautiously and always keeping in mind the inherent difficulties of that approach," Bernanke said. Responding to audience questions after the speech, Bernanke said he wasn’t "particularly concerned" about a possible loss of investor confidence in the U.S. financial system. The dollar is still the "dominant" world reserve currency, and when financial conditions become more "worrisome," investors see the currency as a safe haven and U.S. markets as the deepest and most liquid, he said.
Fed Vice Chairman Donald Kohn said in a speech to the same conference that tight bank credit and caution among households and businesses may impede spending amid an improvement in financial markets. "Credit constraints are a key reason why I expect the strengthening in economic activity to be gradual and the drop in the unemployment rate to be slow," he said.
Bernanke devoted most of his speech to rebutting criticism that the Fed’s rate policy fueled the housing bubble. Monetary policy after the 2001 recession "appears to have been reasonably appropriate, at least in relation to" a formula based on the so-called "Taylor Rule." In addition, Bernanke said Fed research shows the rise in housing prices had little to do with monetary policy or the broader economy. John Taylor, a Stanford University economist and former Treasury undersecretary, created the Taylor Rule, a shorthand formula that suggests how a central bank should set interest rates if inflation or growth veers from goals.
Under former Chairman Alan Greenspan, the Fed lowered its benchmark interest rate to 1.75 percent from 6.5 percent in 2001 and cut the rate to 1 percent in June 2003. The central bank left the federal funds rate, or overnight interbank lending rate, at 1 percent for a year before raising it at a "measured pace" of quarter-point increments over two years, from 2004 to 2006. Bernanke, 56, joined the Fed as a governor in 2002 and supported all of the interest-rate decisions under Greenspan before being appointed chairman in 2006. After the financial crisis struck, he cut the federal funds rate almost to zero in December 2008 from 5.25 percent in September 2007.
The standard Taylor Rule would have recommended that the Fed raise the rate to a range of 7 percent to 8 percent through the first three quarters of 2008, "a policy decision that probably would not have garnered much support among monetary specialists," Bernanke said. A variation of the rule used by the Fed focused on anticipated rates of inflation, not actual rates, he said. An index of U.S. home prices in October was down 11 percent from its peak in April 2007, the Federal Housing Finance Agency in Washington said last month. The federal tax credit for homebuyers has boosted demand, helping prices increase 0.6 percent in October from September, the first monthly increase since July.
One in four U.S. homeowners owe more on their mortgage than their house is worth, according to a November report by First American CoreLogic, a Santa Ana, California-based real estate research firm. Foreclosure filings in 2009 probably reached a record for the second consecutive year with 3.9 million notices sent to homeowners in default, RealtyTrac Inc., the Irvine, California- based company, said last month.
A hell of a decade - to come
by Peter Schiff
In its recent look back on the first 10 years of the century, Time Magazine proclaimed the period to be "the decade from hell". The editors made their case based on what they saw as the signature events of the past 10 years, notably the ravages of terrorism, failed wars, and a global financial crisis. Taken together, these factors produced an era that Time is convinced will be remembered as one of the low points in our history.
As the media hate to dwell on the negative, the commentary was rife with notes of optimism about pending recovery. It could hardly be accidental that in the very next issue, Fed Reserve chairman Ben Bernanke was named "Man of the Year" for his supposedly Herculean efforts to keep the economy afloat as we departed the Naughty Aughties. Although Time takes pains to point out that the "Person of the Year" honor reflects impact rather than adulation, its profile of the chairman was triumphant.
Even if you believe the "survived the worst/turned the corner" narrative offered by Time, it still should strike anyone as ironic that Bernanke, a chief architect of the economic problems that surfaced in 2007, should be held in such high esteem. Apart from its misplaced reverence for the Fed chairman, I would take issue with Time's entire characterization of what has now become history. Under no circumstances could the past 10 years be described as "the decade from hell". In fact, in terms of economic good fortune, the period shares parallels with the Roaring Twenties. I would describe this as a decade of sin that paved the way to hell.
Yes, we had spectacular problems like September 11, 2001, and the invasion of Iraq in 2003 - which were horrific for those who were directly affected - but for most Americans, it was a time of unexpected wealth and unearned prosperity. Up to the days of the stock market crash, the economics of the decade will be remembered for cash-out refinancing for millions of homeowners, no-doc liar loans, no-money-down car purchases, eight-figure Wall Street bonuses, cheap Chinese imports, and trample-to-death holiday sales. In other words, the decade now closing gave us the biggest and most irresponsible spending orgy in US history. The past decade was the party; the one ahead will be the hangover.
The fact that Time completely ignored these issues shows how poorly the mainstream media understand the forces bearing down on our economy. Yes, they were able to identify some of the adverse consequences we experienced this decade. That's the easy part. But as far as seeing the causes behind the effects, they haven't a clue. As a result, Time has no ability to see the underlying pattern and will happily encourage our leaders to repeat the mistakes of the past on a grander scale.
For now, Congress and the president remain as clueless as Time. To show its resolve to "get to the bottom of things", the Barack Obama administration has impaneled a commission to investigate the causes of the financial crisis. Do not expect the proceedings, which are just getting underway, to come up with anything but the most politically useful explanations.
Blame will be laid at the feet of "ineffective regulators" who failed to "get tough" with industry, banks, and corporate leaders who held the "public good" hostage to their "personal greed." There is no hope that anyone who actually saw the crisis coming will actually be asked to testify. If they called me, I would be happy to give them an earful. Unfortunately, the only way my views will ever be heard by the powers-that-be is if I am elected to the Senate - which is exactly what I plan to do next fall in my home state of Connecticut.
My sincere hope for the coming decade is that I can help our leaders see what Time cannot: we need to stop committing the economic sins that are leading us to hell, so that our stay down there will be as brief as possible. We need everyone to stop spending more than they earn. That is true not just for individuals, but for our government as well. Just this week, the Treasury Department removed its internal caps on bailout funds to Fannie Mae and Freddie Mac. Meanwhile, another bailout was proffered to ailing GMAC. If we continue the same bad behavior, it might not just be one decade from hell, but several.
However, if we can confess our sins, and vow to reform our ways, perhaps this will merely be a decade in purgatory. Perhaps we can turn it into the decade of hope, hard work, individual liberty, savings, production, investment, sound money, de-regulation, exports, budget surpluses, capitalism, limited government, and respect for the Constitution. These traits will harden us to withstand the fallout from our reckless past.
As of yet, our troubles continue to snowball - and I don't like a snowball's chances if we have a real decade from hell.
Ilargi: The following is a set of three audio files posted on YouTube.
Gerald Celente Top 10 Predictions for 2010: NEO-SURVIVALISM
The States and the Stimulus
Remember how $200 billion in federal stimulus cash was supposed to save the states from fiscal calamity? Well, hold on to your paychecks, because a big story of 2010 will be how all that free money has set the states up for an even bigger mess this year and into the future. The combined deficits of the states for 2010 and 2011 could hit $260 billion, according to a survey by the liberal Center on Budget and Policy Priorities.
Ten states have a deficit, relative to the size of their expenditures, as bleak as that of near-bankrupt California. The Golden State starts the year another $6 billion in arrears despite a large income and sales tax hike last year. New York is literally down to its last dollar. Revenues are down, to be sure, but in several ways the stimulus has also made things worse.
First, in most state capitals the stimulus enticed state lawmakers to spend on new programs rather than adjusting to lean times. They added health and welfare benefits and child care programs. Now they have to pay for those additions with their own state's money. For example, the stimulus offered $80 billion for Medicaid to cover health-care costs for unemployed workers and single workers without kids. But in 2011 most of that extra federal Medicaid money vanishes. Then states will have one million more people on Medicaid with no money to pay for it.
A few governors, such as Mitch Daniels of Indiana and Rick Perry of Texas, had the foresight to turn down their share of the $7 billion for unemployment insurance, realizing that once the federal funds run out, benefits would be unpayable. "One of the smartest decisions we made," says Mr. Daniels. Many governors now probably wish they had done the same.
Second, stimulus dollars came with strings attached that are now causing enormous budget headaches. Many environmental grants have matching requirements, so to get a federal dollar, states and cities had to spend a dollar even when they were facing huge deficits. The new construction projects built with federal funds also have federal Davis-Bacon wage requirements that raise state building costs to pay inflated union salaries.
Worst of all, at the behest of the public employee unions, Congress imposed "maintenance of effort" spending requirements on states. These federal laws prohibit state legislatures from cutting spending on 15 programs, from road building to welfare, if the state took even a dollar of stimulus cash for these purposes. One provision prohibits states from cutting Medicaid benefits or eligibility below levels in effect on July 1, 2008. That date, not coincidentally, was the peak of the last economic cycle when states were awash in revenue. State spending soared at a nearly 8% annual rate from 2004-2008, far faster than inflation and population growth, and liberals want to keep funding at that level.
A study by the Evergreen Freedom Foundation in Seattle found that "because Washington state lawmakers accepted $820 million in education stimulus dollars, only 9 percent of the state's $6.8 billion K-12 budget is eligible for reductions in fiscal year 2010 or 2011." More than 85% of Washington state's Medicaid budget is exempt from cuts and nearly 75% of college funding is off the table. It's bad enough that Congress can't balance its own budget, but now it is making it nearly impossible for states to balance theirs.
These spending requirements come when state revenues are on a downward spiral. State revenues declined by more than 10% in 2009, and tax collections are expected to be flat at best in 2010. In Indiana, nominal revenues in 2011 may be lower than in 2006. Arizona's revenues are expected to be lower this year than they were in 2004. Some states don't expect to regain their 2007 revenue peak until 2012. So when states should be reducing outlays to match a new normal of lower revenue collections, federal stimulus rules mean many states will have little choice but to raise taxes to meet their constitutional balanced budget requirements. Thank you, Nancy Pelosi.
This is the opposite of what the White House and Congress claimed when they said the stimulus funds would prevent economically harmful state tax increases. In 2009, 10 states raised income or sales taxes, and another 15 introduced new fees on everything from beer to cellphone ringers to hunting and fishing. The states pocketed the federal money and raised taxes anyway. Now, in an election year, Congress wants to pass another $100 billion aid package for ailing states to sustain the mess the first stimulus helped to create. Governors would be smarter to unite and tell Congress to keep the money and mandates, and let the states adjust to the new reality of lower revenues. Meanwhile, Mr. Perry and other governors who warned that the stimulus would have precisely this effect can consider themselves vindicated.
US state and local tax revenues plummet
New US census data show that state and local government tax revenue continued their year-long plunge in the third quarter, falling by 7 percent from the same period last year. In response, governments are cutting spending on social programs, infrastructure and education, and are laying off or cutting the wages of government workers.
It was the fourth straight quarter in which tax receipts fell on a year-over-year basis, the Census Bureau’s Quarterly Summary of State and Local Tax Revenue shows. Collections for 2009 through the third quarter were down $76 billion, or 8 percent, from a year ago, while federal tax revenue fell even more sharply in the same period, by 19 percent.
Every major form of state and local tax revenue declined. Totals for sales and personal income taxes fell by 9 percent and 12 percent, respectively. The erosion of these two taxes, on which state governments rely, is owed largely to unemployment and wage cuts. Taxes on business profits fell precipitously, by 18 percent in the third quarter, year-over-year.
Property tax collections actually increased by 3.6 percent in the third quarter of 2009 from 2008. However, analysts explain that government property assessments have simply not yet caught up with market-determined home and commercial real estate values. This gap is expected to begin to be bridged in 2010, imperiling municipal and county governments heavily reliant on property taxes. "At minimum, cities will be working through the catastrophic drops in revenue for the next 18 months to two years," said Mark Muro of the Brookings Institution’s Metropolitan Policy Program.
Like unemployment, the fiscal health of state and local governments is considered a "lagging indicator." Even when, and if, the economy begins to improve, tax collections follow slowly. The burden is compounded by the extra costs economic downturns place on state budgets in the form of unemployment benefits, Medicaid and other social programs, and accounting tricks states have used to defer red ink from this fiscal year to the next. "We expect continued weakness well into 2010 if not further," concluded Lucy Dadayan of the Rockefeller Institute of Government at the State University of New York.
According to a study by the National Conference of State Legislators (NCSL), states cut nearly $150 billion in spending to balance budgets in the current fiscal year. But already, 36 states have seen gaps reopen to a combined deficit of $28.2 billion. These deficits will worsen. In 2011, 35 states making estimates predict a combined deficit of $55.5 billion. In 2012, just 23 states offering data already estimate red ink totaling $68.8 billion.
No state has been spared from falling revenues. Energy-rich states that averted budget crises last year were hit particularly hard by third-quarter revenue declines, among them Texas, Oklahoma, Wyoming, North Dakota and Alaska. The latter, with a 65 percent decline, experienced the biggest year-over-year dropoff. In all, 22 states, including Illinois, saw a third-quarter revenue decline greater than 10 percent.
These shortfalls will inevitably lead to more cuts in social spending and further layoffs, wage cuts and furloughs for state workers. Layoffs of government workers could produce the next wave of unemployment in the US, where fully 15 percent of the non-agricultural workforce is employed by state or local governments.
By all indications, the budget cuts being put in place will not be restored. "The economic fallout has hammered state budgets with an intensity we haven’t seen since the Great Depression," said Sujit M. CanagaRetna, an analyst with the Council of State Governments. "The way that we have cut and slashed governments indicates that we’re only going to be able to provide the most basic services."
"Anything and everything’s on the table," Todd Haggerty, a policy associate with the National Conference of State Legislators, was quoted by Stateline.org as saying. States have "cut the fat, cut the muscle and are now cutting bone," Haggerty said. "The easy decisions have already been made."
Among the hardest-hit states is New York. This week, state Comptroller Tom DiNapoli issued a statement saying that the nation’s third most populous state was "down to petty cash" in its treasury. "New York State is barely scraping by in December," DiNapoli said. "While measures were taken by the legislature and Governor to get the state through December, the state is literally down to petty cash. New York’s fiscal troubles are far from over." After the first week of January, New York may have no more than $300 million cash on-hand.
The total deficit of the states from 2009 to 2012 is now estimated at $460 billion. While an enormous amount of money, it will prove far less than US military spending and the cost of the wars in Afghanistan and Iraq over the same period, and is dwarfed by the multi-trillion-dollar bailout of Wall Street.
There is little chance of help from the federal government, which is itself experiencing its worst budget shortfalls since World War II. On the contrary, the Obama administration will likely inflame the states’ fiscal crisis. Governors and legislators of both parties warn that health care "reform" will likely add significantly to their fiscal crises through new, unfunded mandates. And with the $300 billion in aid allotted the states through last February’s American Recovery and Reinvestment Act set to run out after the next fiscal year, the Obama administration has all but ruled out further relief.
Will latest $174 billion jobs bill really produce jobs?
When the Senate takes up a jobs bill later this month or early in February, the debate will center on whether it really will create jobs and be worth plunging the government tens of billions of dollars further into debt. Republicans scoff at the "Jobs for Main Street Act" title that House Democrats put on their $174 billion package last month. They refer to it as "son of the stimulus," the $787 billion economic recovery plan of nearly a year ago that they say was ineffective at producing jobs. In its last vote of 2009, the House narrowly passed the bill, 217-212, without a single Republican supporter.
Democrats tick off the job prospects from the House bill's $75 billion in infrastructure and public sector spending: tens of thousands of new construction jobs, 5,500 more police officers, 25,000 additional AmeriCorps members, 250,000 summer jobs for disadvantaged youth, 14,000 part-time jobs for parks and forestry workers. "Why don't we just put everyone in the United States on the federal government payroll and call it a day?" counters Rep. Jerry Lewis, R-Calif.
House Democrats diverted $75 billion from the Wall Street bailout fund to offset some of the costs. Opponents said that amounted to a shell game because unused bailout money is supposed to be used to reduce the deficit, which hit $1.4 trillion in the 2009 budget year. The Senate, however, has less of an appetite for another costly round of economic stimulus measures, particularly with a vote on tap for Jan. 20 to again raise the ceiling on the government's total debt just a month after upping it to $12.4 trillion.
Conspicuously absent from the House plan were President Barack Obama's proposals to attack unemployment through tax credits for small businesses that create jobs and for homeowners who make their dwellings more energy efficient. A job-creating tax credit for small businesses has support among some Democrats in the Senate, even though critics fear it may be too complex to work. "Small business people have too much to do just to keep their businesses afloat to try and figure out some fancy, complex credit," Lawrence Lindsey, an economic adviser to former President George W. Bush, told a Democratic panel last month.
But Gene Sperling, an adviser to Treasury Secretary Timothy Geithner, said tax credits would empower growing small businesses.
"If these have even a marginal incentive on even a few ... employers, the bang for the buck in terms of job creation would be one of the highest of any of the types of incentives that we've had," Sperling said. The job creation issue is complicated. Much of the money in the House bill goes to programs that may stimulate the economy but don't appear to directly put people to work. There's $41 billion to extend unemployment benefits for six months and $12.3 billion to extend a health insurance subsidy for people who have lost their jobs. There's extension of a child tax credit for poor families, $23.5 billion to help states cover Medicaid costs and $23 billion so states can support some 250,000 education jobs over the next two years. An additional $2.8 billion goes to clean water and environmental restoration projects.
Even the investment in "shovel-ready" highway and bridge projects may not immediately translate into a reduction in the nation's 10 percent unemployment rate. Republicans cited government figures showing that, as of Sept. 30, only 9 percent of $27.5 billion for highways in the first stimulus bill had been spent. The Congressional Budget Office estimates that of the $39 billion in the new House jobs bill directed to the departments of Transportation and Housing and Urban Development, only $1.7 billion will get spent before next October. A lot of the money "hasn't even gotten out of Washington yet," said Rep. Eric Cantor of Virginia, the House's second-ranked Republican. "Why is it still here if it was designed to create jobs?"
Rep. James Oberstar, D-Minn., chairman of the House Transportation and Infrastructure Committee, said some 8,000 highway and transit projects -- more than half those designated under last February's stimulus bill -- are under way, creating or sustaining 210,000 direct jobs. When indirect jobs are included, that number reaches 630,000, he said. The low federal spending rate, committee officials said, is because the treasury outlay comes at the end of the process, after the contractor bills the state and the state bills Washington. Dan DuBray, spokesman for the Interior Department's Bureau of Reclamation, said his agency will have no problem putting to work the $100 million it would receive under the jobs bill to provide clean drinking water to rural areas. "Projects in Reclamation are much akin to planes waiting on the taxiway waiting to take off."
Matt Jeanneret, spokesman for the American Road and Transportation Builders Association, agreed that "a lot of jobs" have been saved by the stimulus act, although in many cases federal money is basically replacing lower levels of private or state investment. The unemployment rate in the construction industry remains at about 19 percent, almost double the national level. The stimulus is "a needed shot in the arm, but the real solution is a long-term highway and transit investment bill," Jeanneret said. Congress has put off consideration of a six-year $450 billion infrastructure measure to replace the highway and transit act that expired in September. The CBO has estimated that employment was 600,000 to 1.6 million higher in the third quarter of 2009 because of the stimulus act.
Eurozone credit contraction accelerates
Bank loans and the M3 money supply in the eurozone contracted at an accelerating pace in November, raising the risk that a lending squeeze will choke the region's fragile recovery next year. The European Central Bank said that loans to companies fell by a record 1.9pc from a year earlier. The broad M3 money supply – watched closely as a leading indicator for the economy a year ahead – fell by 0.2pc and has now been shrinking for several months. Julian Callow from Barclays Capital said the decline in lending was steeper than expected and will cause the ECB to move with great care before withdrawing emergency stimulus. "This is the weakest data since the statistics began in 1970 and probably in the post-war era. It is a message about what is happening to the banking system, which is the lending nexus for the eurozone economy," he said.
Hans-Peter Keitel, head of Germany's industry federation (BDI), said there was a danger of a credit crunch next year as banks take fright at the ugly state of corporate balance sheets. He accused lenders of returning to their gambling habits – in some cases with state money – while refusing to roll over loans for companies with a good track record that have run into short-term problems. The Bundesbank is bracing for a second wave of the credit crisis as corporate downgrades by rating agencies forces lenders to set aside more money. Big companies in the eurozone have been able to tap the bond and equity markets, raising €130bn of fresh money in the first 10 months of the year. However, smaller Mittelstand firms that form the backbone of Germany's export industry are often shut out of the credit system.
Banks have chosen to restrict lending as they struggle to meet tougher capital rules rather than dilute shares by raising fresh equity or accepting the onerous terms of state support schemes. This has prompted harsh criticism from finance ministers, but Professor Tim Congdon from International Monetary Research said the authorities themselves are to blame. "This is becoming ridiculous. How can banks raise capital asset ratios and lend more at the same time? These people are barmy," he said, comparing the new rules with policy mistakes in the early 1930s. The ECB has played down the decline in M3, believing that it reflects portfolio shifts by investors. But the longer this trend continues, the greater the concern. Mr Congdon said Club Med states will suffer the brunt of the ECB's restrictive policies . "Business surveys in these countries are getting worse, and so are property markets. Fractures in the euro system are becoming clearer by the day."
The Worst May Not Be Over for Europe
Never before has Europe’s monetary union seemed so fragile. Day by day, fears are growing that Greece or another weak country may default on its sovereign debt obligations, forcing the richer countries in Europe to ride to the rescue or risk having one or more of its most vulnerable members leave the 16-nation euro zone. Many European economists discount such a fracture as a remote possibility. But that doesn’t mean Europe has safely emerged from crisis.
Instead, it faces a longer-term challenge to restore the fiscal credibility of at least half the countries that use the euro. The true test for the world’s largest common currency zone, analysts say, will be whether it can withstand the economic, political and social strains once the European Central Bank begins to raise interest rates in response to economic improvements in Germany, France and other Northern European countries.
At that point, the laggards on the union’s fringe — Portugal, Ireland, Italy, Greece and Spain (the so-called Piigs) — will face even tougher choices to cope with what looks like several more years of stagnant economies, high unemployment and gaping budget deficits. "If inflation picks up in France and Germany, the smaller economies will be left behind in stagnation and deflation," said Jordi Galí, a Spanish economist recognized for his work on business cycles who heads the Center for Research in International Economics in Barcelona. "Such an asymmetric recovery is pretty likely, and if the E.C.B. raises rates, it could get very ugly."
Mr. Gali, like a number of other European experts, takes the view that the euro zone’s resilience has been underestimated. He says the recent convulsions are more the result of trigger-happy ratings agencies that have downgraded the sovereign debt of Greece and others in atonement for having failed to foresee the subprime mortgage crisis. Still, he says, there is no escaping this emerging growth divide, and he points out that the mandate of the European Central Bank is to ensure broad price stability in the union, not to look out for the interests of individual nations.
France and Germany have already emerged from the recession. Business confidence in Germany, Europe’s largest economy, has hit a 17-month high. Yet on the periphery, the hangover from more than five years of a credit-infused boom shows little sign of diminishing. Ireland, the first economy to stumble, has taken the most severe fiscal action, cutting public wages sharply. A new Greek government, punished by the rough treatment of bond investors no longer willing to countenance soft promises of reform, is just now promising steep spending cuts. But it is not clear whether the political system in Greece will accept them.
Meanwhile, Spain, to the frustration of many major lenders, seems to be putting off difficult fiscal questions in the hope that its economy will soon recover. Critics of the euro zone contend that weak governments in the peripheral economies, facing high unemployment and restive voters, will not have the stomach to hold down wages, pensions and public expenditures. "Are these people serious about reform, or are they just telling people what they want to hear?" asked Edward Hugh, a British-trained macroeconomist who lives in Barcelona and has been critical of Spain’s unwillingness to take difficult economic decisions.
Paradoxically, the very dysfunction of a struggling two-tier Europe may represent the best chance for recovery if it leads to devaluation of the euro against the dollar, which many see as long overdue. Already, in the last month, the euro has lost more than 5 percent of its value against the dollar. Many economists predict that the currency will weaken more as the growth gap between the core and peripheral states creates further disharmony.
Then, it will be the type of export-led recovery that has helped the United States and is likely to soon help Britain that could bring Europe’s economies closer to convergence. "If there are fears now that a breakup of the euro zone will lead to weakening of the euro, then that is good news," said Paul De Grauwe, an economist based in Brussels who advises the president of the European Commission, José Manuel Barroso. "So we should congratulate Greece for getting us out of this anomaly of having a euro that is too overvalued."
Any such recovery will not be rapid, however. In Ireland, where prices are falling by 5 percent, reordering the economy from its deep reliance on construction and property will take years. And an already unpopular Irish government, along with others on Europe’s periphery, will have a difficult time explaining to recession-bruised voters why they must accept an central bank’s decision to raise interest rates — a move that may protect German and French savers from inflation but that does little for the many millions of citizens out of work.
Yet the painful, historic steps taken by Ireland offer a ray of hope, says Philip Lane, a professor of international macroeconomics at Trinity College Dublin who oversees the widely read Irish Economy blog. He points to signs of wage compression in the hard-hit service, property and government sectors as proof that there is a recognition that recovery, distant as it may seem, must occur inside the euro zone, not outside. "It takes a crisis to learn a lesson," Mr. Lane said. "Could it be that by getting countries to change their behavior you might get improved cooperation within the euro zone? "What does not kill you," he added, "often makes you stronger."
In Spain, a Soaring Jobless Rate for Young Workers
Like hundreds of thousands of other young people, Jesus Pesquero Peñas dropped out of school to go to work when the Spanish economy was booming. But since he was laid off from his construction job two years ago, he has been living on unemployment benefits. Now Mr. Peñas finds himself part of a lost generation in Spain, where unemployment among people ages 16 to 24 is 42.9 percent, the highest in Europe, and more than double the overall rate.
"I went to work because the money was good, the lifestyle was good and I really wanted to get out of school," Mr. Peñas, 25, said as he waited on a long line snaking down the block from an employment office in suburban Madrid. "I totally regret it now," Mr. Peñas said, who has a 5-year-old daughter by a former girlfriend who is also out of work.
Spain is the extreme, but the experience of younger workers here reflects similar problems in the United States, as well as other European countries still struggling to emerge from the recession. In the last 12 months, the jobless rate in the United States among workers ages 16 to 24 has risen to 19.1 percent from 13.9 percent. Economists expect the rate to remain high even as the overall jobless rate in the United States — now 10 percent — begins to shrink. That is because the sectors that employ young people in the greatest numbers — fast food, construction, retail — are expected to take the longest to recover.
In the United States, workers on the first rungs of the job market run the risk of lower earnings even after the recovery gets going, said Paul Osterman, a professor at the Sloan School of Management at M.I.T. who also teaches at the Institute de Empresa business school in Madrid. Young Spanish workers, like their counterparts in the rest of Europe, face other obstacles like union rules, long-term contracts and legal protections that shelter older workers and discourage new hiring, Mr. Osterman said. "There is a cohort of people who are condemned to a permanently stagnant career path in Spain," he said. "It’s very worrisome."
People like Mr. Peñas, with few skills, bleak prospects and little desire to go back to university alongside younger students, are the most vulnerable. "There has been a loss of human capital," said José Antonio Herce, director of economics at ASI, a Madrid-based consulting firm. "It will take a long time for this cohort to be absorbed." Spain may be the worst example, but it is not alone, "Young people are the last in the queue when it comes to finding permanent jobs," said Anne Sonnet, a senior economist with the Organization for Economic Cooperation and Development. "Even with university degrees, there are many barriers to young people."
Adding to Spain’s woes, its government is unable to inject more stimulus and offer further support for job creation while its economy languishes as one of the weakest in Europe. The outlook on Spanish sovereign debt was recently downgraded, and the government is moving to raise taxes and cut spending. The country’s budget deficit, which hit 11 percent of gross domestic product this year, is supposed to be within the 3 percent threshold enshrined in the treaty that established the euro. The European Union wants Spain and other European countries relying on the euro to return to that range by 2013.
"Spain is under tremendous pressure from the E.U. and the bond markets," Mr. Osterman said. "They’re in a very difficult box." To be sure, Spain has traditionally suffered from relatively high unemployment, and at 19.3 percent, its overall rate today is double the 9.8 percent average for the European Union. But the sharp increase among young people is particularly problematic. It has jumped from 17.5 percent three years ago at the height of the boom to the current 42.9 percent.
At this level, Spain stands out from other troubled European countries. In Greece, for example, the youth unemployment rate is 25 percent, while Ireland’s is 28.4 percent and Italy’s is 26.9 percent. Spain is even worse off than countries in Eastern European where youth unemployment has traditionally been high. In Slovakia, for example, unemployment among young people is 27.9 percent. In Poland, youth unemployment is 21.2 percent, down from over 35 percent a few years ago.
In part, Spain is paying the price for its efforts to make it easier to put young people to work. In recent years, a disproportionate share of Spanish youth were employed on temporary contracts. So they were the easiest to lay off when the economy sank, said Alfonso Prieto, deputy director general of employment studies at the Ministry of Labor and Social Affairs. During the most prosperous years, a culture of temporary work developed, Mr. Prieto and others explained. Young workers like Mr. Peñas became known as "mil euristas," for the 1,000 euros, or $1,438, a month they typically earned.
Once looked down upon as temporary, entry-level positions, the few remaining mil eurista jobs are now highly sought, Mr. Herce, the economic consultant, said. Besides drawing young Spanish workers out of school, the growth years lured young immigrants by the millions. Many of them are out of work as well. Katy Mejia, for example, moved here seven years ago from Ecuador with her parents, having just finished high school at age 16. She later married a Spaniard and worked in restaurants and bars in downtown Madrid. "Jobs were plentiful," Ms. Mejia said, "You could pick and choose."
Today, she is jobless, and her husband is working four hours a day driving a delivery van, forcing them to move in with her family. "It’s difficult to go back to living with your parents when you are married," she said. Although low-skilled workers are the hardest hit, Mr. Prieto said, professionals are also suffering. Vanessa Larrosa, who was recently laid off as a veterinarian, lives around the corner from the unemployment office in Santa Eugenia on the outskirts of Madrid. She was used to seeing a line forming in the dark each morning, as peopled huddled in blankets.
"But I personally never expected to be here," Ms. Larrosa said. "I’d like to continue to work as a vet, but I’d be happy with anything." Spain is spending roughly 30 billion euros ($43 billion) a year on unemployment benefits, but the money is doing little to prepare younger workers for the future. Mr. Herce said that Spain needed to invest more heavily in vocational education and retraining, and require the jobless to improve their skills.
That is what Carlos Herras, 26, is counting on. He is taking a course in renewable energy and hopes to find a job installing solar panels. But at this stage, he too would be happy with almost anything. "I started working so young," he said, ticking off jobs beginning at 14 in a bar, then a hotel and finally in the construction industry until last January. "I am optimistic. I may not find a job that I want, but I’ll find a job."
Wall Street ready to claim billions in tax breaks on bonus payments
2009 closed with the stock market rebounding 61 percent from its March lows, and "Wall Street is ready to pat itself on the back for its huge gains with big bonuses," potentially surpassing the record payouts of 2007. Analysts estimate that Wall Street’s 2009 bonus pool could total $200 billion — led by Goldman Sachs’ $23 billion — as the New York Times reported today, the return to big bonuses will also allow Wall Street banks to claim billions in tax breaks:Many American banks already pay minuscule federal income taxes, because of various deductions and clever tax planning; the payout-related breaks will reduce their tax bills further in coming years…Altogether, the top three Wall Street banks — Goldman Sachs, JPMorgan Chase and Morgan Stanley — will gain nearly $20 billion in tax breaks based on their employee compensation this year.
Compensation related tax deductions will total about $80 billion across Wall Street, according to New York City tax analyst Robert Willens. In 2008, Goldman Sachs paid an effective tax rate of just 1 percent thanks to a variety of deductions and keeping profits offshore.
JAL employees OK 53% pension benefit cuts, retirees' position unclear
Japan Airlines Corp. said Monday that more than two-thirds of its current employees have agreed to accept the company's proposal to cut pension benefits substantially as part of efforts to turn the struggling carrier around. Around 10,700 of the approximately 16,000 employees had responded positively to JAL's proposal as of Monday evening, but it remains unclear whether a similar proportion of the company's retirees will accept the proposed pension benefit cuts.
Japan's top airline, suffering from heavy losses, has sent letters to its retirees and current workers seeking their approval for cuts to pension benefits and has set Jan. 12 as the deadline to respond. Of the approximately 9,000 retirees, only 3,000, or one-third, had responded positively to the proposal.
The retirees have been asked to agree to a cut of over 30 percent, while current employees have been asked to accept a reduction of 53 percent. JAL needs to obtain agreement from two-thirds of each group. The cuts in pension benefits are deemed necessary for the company to secure long-term financial support from a government-backed corporate turnaround body, the Enterprise Turnaround Initiative Corp. of Japan.
Economic Aspects Of The Pension Problem
by Antal E. Fekete
As It Appears Sixty Years Later
In Two Parts. Part One: Euthanasia of the Pension Funds
On February 23, 1950, The Commercial and Financial Chronicle published an article from Ludwig von Mises with the above title. In it the author concentrated on the threat of inflation as the greatest danger to pension rights. Sixty years later another danger is looming large on the horizon: the threat of deflation, and a new examination of the pension problem is timely.
Deliberate Dollar Debasement
In 1950 Mises looked at the pension problem from the point of view of the shrinking purchasing power of the dollar, a consequence of what he called the deliberate policy of currency debasement by the U.S. government. In 1950 a pension of $100 per month was a substantial allowance, he noted. Shelter could be rented for a month for less than $30 in most parts of the country. (In 2010, $100 hardly buys one night's stay at a decent hotel.) In 1950 the Welfare Commissioner of the City of New York reported that 52 cents would buy all the food a person needed to meet his daily caloric and protein requirements. (In 2010, $100 barely buys a cup of coffee and a muffin for every day of the month.)
Of course, currency debasement does far more damage than simply eroding the purchasing power of pensions. As Mises observed, it also leads to the insufficiency of capital accumulation. Companies report phantom profits that mask losses, since depreciation quotas understate the wear and tear of productive equipment. Savings are hardly adequate to pay for capital maintenance, let alone new capital or technological improvements in production -- the only source from which pensions to an increasing labor force can be paid. When young workers who now join the labor force are ready to retire, the necessary funds to pay their pensions will simply not be available.
Capital destruction due to declining interest rates
I have written extensively about the proposition, one that mainstream economists doggedly refuse to discuss, that a falling interest-rate structure has a deleterious effect on accumulated capital. Capital is destroyed across the board simultaneously and stealthily. By the time the damage is discovered, it is too late to do anything about it and firms go bankrupt in droves. The falling trend of interest rates is the unrecognized cause of the depression that is presently devastating the world economy -- just as it also was 80 years ago.
Nowhere is the erosion of capital caused by falling interest rates is more obvious than in the case of the capital of the pension funds. They must earn adequate return on their investments, but a falling rate of interest frustrates this effort. At the lower rate the original schedule of capital accumulation cannot be met.
Those who disagree argue that if the present value of a future stream of payments is lower when discounted at a higher rate, then it must be higher when discounted at a lower rate. Thus the steady future receipts of a pension fund from payroll contributions will have a higher value under a regime of falling interest rates. There is no need to argue this point. It is clear that the fund must be around to be able to collect future contributions enhanced by a fall in interest rates. Many of them won't be, as they will have succumbed to capital squeeze caused by the very fall of the interest rate that is supposed to be their savior. At any rate, rules of sound accounting do not allow pension funds to treat expected future payroll contributions as if they were cash payments in the process of clearing.
The repercussions for society are devastating. Just as the aging segment of population in the industrialized countries becomes vitally dependent on its pension income, the falling rate of interest undermines the pension plans. In many cases the money to pay out pensions won't be there. For the rest, payoutreductions will be inevitable. Defined-benefit pension plans will have to be discontinued. Of course, the problem is even more acute in the case of unfunded pension plans such as Social Security, the pension plan of the military, or that of the civil service of the federal, state, and municipal governments. Under these plans the contributions of the active members directly pay the pensions of the retired ones. We shall see below that such plans exhaust the definition of a Ponzi scheme.
The Great Milch-Cow
When a large segment of the population is facing a drastic cut in income, and especially since most retired people have no alternative and cannot augment their diminished pension with income from other sources, consumption falls back and lower demand will have further deflationary consequences on the economy. Yet this problem, just as the kindred problem of the erosion of the capital of productive enterprise, is ignored by the profession of economists and that of the accountants. They apparently believe that the Great Milch-Cow, the government, will always be there and able to cover any shortfall.
The decades-long slide of interest rates is far from over. As I argued in my other articles, large-scale monetization of government debt in the wake of every new bail-out plan and stimulus-package is going to impart a falling (rather than a rising) trend to the interest rate structure, due to the opportunity it creates for risk-free profits. Bond speculators ambush the Federal Reserve on its periodic trips to the bond market to make its regular open market purchases of government bonds in order to increase the money supply. They buy the bonds beforehand in order to dump them after the Federal Reserve has bought its quota. They pocket the difference. These risk-free profits explain a large part of the present deflation: the rising bond prices (read: falling interest rates) as well as falling prices. The new money that the Federal Reserve has created through its open market purchases will not flow to the commodity, real estate, or equity markets as hoped by the policy-makers. It will stay in the bond market where risks are the smallest, and will be financing further bullish bond speculation. The ultimate result will be a further fall in the rate of interest, exposing the pension funds to even greater dangers.
Note that these dangers are in addition to the threat to the value of pensions undermined by past inflation, about which Mises was warning sixty years ago. It could be further undermined in case the reckless increase in government debt scared bond speculators and other investors, including foreign holders of the debt of the U.S., for example, the Chinese government. Should they start dumping the bonds, they would push interest rates and commodity prices to much higher levels.
Pensions are doomed whatever the government does. Whether interest rates go up or whether they go further down, the pensions are at risk. In the case of rising interest rates their value will be decimated. In the case of falling interest rates pension contributions will not be able to earn a return necessary to accumulate the capital needed in order to pay defined-benefit pensions.
The relevance of the gold standard to the pension problem
As we can see, at the heart of the problem is the destabilization of the rate of interest due, first, to sabotaging and, then, to destroying the gold standard by the government. There is no known way to stabilize interest rates but by defining the value of the unit of currency as a fixed quantity and fineness of gold. In this way the amount owing on deferred payments will be fixed. Any breach of promise of future payments will be immediately obvious as soon as it occurs. The difference is this, and a very important difference it is: a promise to make future payments in irredeemable currency is a meaningless promise, because breaching it can be ? and will be ? camouflaged in many ways.
This spells catastrophe. The retired segment of the population will be plunged into penury. The only way to avoid this is to stabilize the rate of interest structure through the rehabilitation of the gold standard with all deliberate speed.
A fall in the rate of interest has a direct effect of decreasing the return to capital of the pension funds. This decrease should be compensated for by increasing payroll deductions. It is clear that this is never done. What is not clear is whether the reason for this omission is ignorance on the part of the economists' and the accountants' profession, or whether it is due to a political decision. Is it possible that the government, motivated by the principle "let the sleeping dog lie". Certainly, the government does not want to alarm the people and put wind into the sails of the budding movement demanding the immediate return to the gold standard, even though this is the only way to stabilize interest rates thus making pensions affordable again.
The last vestiges of the gold standard were unilaterally discarded by the government of the United States in 1971. This event was coincident with the onset of the greatest gyration in the rate of interest on a world-wide scale. In a decade interest rates shot up to two-digit figures in the high teens. Then a slow decline started in the 1980's pushing interest rates relentlessly towards zero. The first move (rising interest rates) was accompanied with a great surge of inflation, wiping out a large part of the value of pension rights. The second move (falling interest rates), which is still continuing, has brought deflation. It has not yet fully manifested its corrosive effect on the pension funds as yet. Even so, the forces that drive the rate of interest to zero are squarely responsible for the erosion or destruction of all capital, including the accumulated capital of the pension funds.
Although historians do not advertise the fact, a lot of pension funds went bankrupt in the 1930's, and the remaining ones had to scale back the amounts they had contracted to pay to their pensioners. Economists failed to offer an explanation for this universal phenomenon. Yet the explanation is clear: the accumulated capital of the pension funds was badly impaired, and in some cases completely wiped out, by the falling interest rate structure. Exactly the same causes are operating right now, and exactly the same effects will follow. The only difference is the larger scale of capital destruction in the present episode.
Indexed pensions = Ponzi pensions
In recent years the pension problem has been swept under the rug. During the past sixty years experts have invented "indexing" as the cure for the erosion of pension rights. Indexing means that pensioners can be compensated for the erosion of their pensions due to inflation by making yearly adjustments upwards tied to some index numbers "measuring" inflation. This means that the powers that be are aware of the pension problem. They are willing to treat the symptoms, but they still refuse to treat the real cause of the disease. Their outlook on inflation as being "nature given", beyond the power of man to address, is hypocritical and devious.
The basic idea of indexing pensions is that the redistributive society will always have the wherewithal to validate all pension rights, since the government can borrow and tax without limit. Funding pensions is an anathema to Keynesian economics. The "modern" way of financing pension rights is to make pensions "pay-as-you-go". This is euphemism for Ponzi pensions, whereby currently active workers are made to pay the pensions of retired members. Present workers will be compensated after their retirement by the contributions of members then active.
This is clearly fraudulent as it makes a hypothetical third party bear the full brunt of the arrangement. People are brought into the compact without their concurrence. Some of the members who will pay the pension of the now active workers may not have been born yet! The key point is: contributions are not capitalized upon receipt but are instead dissipated. Pension contributions must be capitalized in order to make them a meaningful source of future pensions. Current workers' pension rights could be subject to veto by tomorrow's workers, should they find this arrangement unfair. Only fully-funded pensions are secure (and what use is a pension if it is not secure?) and it is only under a gold standard that such security can exist.
Any other arrangement may unravel, as the victims of the redistributive society may one day wake up and revolt.
John Maynard Keynes, in a bout of sincerity, blurted out a phrase that only now has revealed its true meaning: the euthanasia of the rentier. It gives away the "shabby little secret" of the redistributive society: robbing the pensioners who can no longer take "strike action" and with the proceeds throwing dust into the eyes of the rest of the people.
Deflation and the pension problem in Japan
The United States is following Japan down the garden path to zero interest. Therefore it is instructive to look at deflation and the pension problem in Japan in order to see the shape of things to come. Consider the plight of JAL, Japan Airlines. The economic slowdown hit travel and cargo traffic hard. Saddled with the equivalent of $15 billion in debt and a massive pension fund deficit, the airline was forced to apply for "mediated debt restructuring" -- euphemism for Chapter 11 bankruptcy. Asia's largest carrier by revenue said in its earnings report that there was a great deal of uncertainty about its ability to continue as a going concern. It has applied for help to the Enterprise Turnaround Initiative Corp., a government-backed fund. However, capital injection or additional financing or additional financing alone would not improve the carrier's prospects, as asserted by the November 14, 2009, news report of Reuters, because of its severely underfunded pension plans. JAL president Nishimatsu met with the leaders of the airline's retirees association to seek their approval on pension payout reductions. Media reports say that the leaders have expressed their desire to cooperate in some ways with management to save the airline, but many retirees are expected to oppose strongly the proposed pension cuts.
The cancer of depression has been metastasizing across the Pacific through the yen-carry trade foolishly encouraged by the Federal Reserve and the Bank of Japan as a way to push interest rates even lower in the United States. Rather than analyzing the Japanese example and drawing the appropriate conclusions, American policy-makers have an irresistible itch to follow Japan's jump into the abyss of the Black Hole of zero interest. The result, perfectly predictable, is catastrophic.
What should American labor leaders do?
American labor faces the greatest challenge ever. Its achievements on the wage front and on the pension front are at stake, due to inane government policies of destabilizing the rate of interest, causing an unprecedented destruction of capital, in particular, destroying the capital of pension plans.
If the labor leaders want to preserve the achievements the labor movement, they must address the root cause of the problem: the regime of irredeemable currency. Interest rates can be stabilized and pension plans can be saved only through outlawing of the irredeemable dollar.
We are currently on a course that will result in the destruction of pension funds. If not wiping them out altogether, the irredeemable dollar will drastically reduce the pension rights of the workers. This is a wake-up call. The unions must act now and demand that the Supreme Court of the United States declare Federal Reserve credits and notes unconstitutional. The manner in which these are presently issued is the root cause of our economic instability and the vicious swings between inflation and deflation. The unions must demand through legal challenges in the courts that wages, salaries, and pensions be paid in constitutional dollars, that is, dollars redeemable in the coin of the realm, defined as a fixed weight and fineness of gold and silver.
The U.S. Mint must be open to the unlimited coinage of gold and silver free of seigniorage charges. To prevent future tinkering with the monetary system by charlatans, the metallic value of the dollar ought to be enshrined in the Constitution, so that any change in the gold content of the dollar would take a constitutional amendment -- rather than an executive proclamation.
U.S. government bonds must be deprived of their monopoly position and they must be exposed to competition with the gold coin before the saving public. This is indispensable for the stabilization of the rate of interest, but no less for the health of the pension funds. Government bonds are unsuitable for pension funds to hold on capital account. In case of a demographic shift such as that when more people leave the labor force with pensions than those entering it while joining pension plans, the net selling of government bonds from portfolio may collide with selling by the government, causing an unwarranted rise in the rate of interest. In the case of net selling of corporate bonds from portfolio the same problem does not arise. In fact, it should be treated as a signal for the corporations to retrench.
If the American labor leaders fail to challenge the constitutionality of the irredeemable dollar, and ask the Supreme Court for the protection of the pension funds on constitutional grounds, then a century of gains on the pension front will be irretrievably lost. Penury for the retired segment of the population will follow. The plight of the JAL pensioners is not some kind of exception: this is the future norm unless the current irredeemable currency system is replaced with the gold standard.