New York. Evelyn Thaw arriving from Southampton on White Star liner Olympic. The former teen beauty Evelyn Nesbit, shown here at age 29, achieved notoriety in 1906 when her lover Stanford White, the noted architect, was killed by her husband, Harry Thaw
Ilargi: I’ve said it before and I know I'll have to say it a million more times, and you still won't get it, because you just don’t want it to be true. But it's time.
We're having the wrong conversations.
We speak the language of the world of finance, a language that doesn’t contain any words or expressions to describe the final stages of the world of finance itself. And I’m not saying that world is about to end, just that it lacks the terms to tell of its own demise. Modeled after other holy writings.
And it's not all that farfetched either. If we, the taxpayer, hadn’t bought off their debts, none or close to none of the major financial institutions in America would still be alive. That includes Goldman Sachs, Bank of America, and all the rest too busy with paying bonuses to answer our phone calls. Still, despicable as all that may seem to you, they're not really the masterminds or main culprits, are they, the bankers?
They operate in an environment allowed and legislated for them by the very same people that you all voted for, from the President to your local Congressman. Anger directed at bankers is anger misdirected and misunderstood. How about you? Bankers can only act within the law. And who makes the laws?
Obama could have come in on January 21, 2009 with a proposal to kill any and all bankers’ influence in American politics. He did not do that. He did a 180 and chose to invite Wall Street to run American finance policy.
That’s a choice, it's not some sort of accident, as some prefer to believe. Thinking anything else equals selling Obama short as some sort of douche. And then the president has left all these people in place one year later.So here we are. And that's no accident either.
Tall tales keep on emerging on Obama's confidantes, and even if every single one were a lie, he couldn't keep all of them at a safe distance from the presidency, neither the stories nor the people. Geithner, Summers, Rubin, Romer, Goolsbee and Volcker, by now they're all entangled in the same web, as is the nation. And there's no way out using the same kind of thinking, nor the same people. Some may be helpful in defining new laws, new measures, new ways to limit Wall Street influence in Washington. But those limits will necessarily be limited. That’s how Washington works. Got a newborn? Lemme break its shinbones, just in case.
If the US ever wishes to get out of its present predicament, it needs to force its representatives to do two things. Which they will never do, because having that as a platform will be so sure of a losing bet that no bookie will take your spread. Here goes, and no, I can’t believe either I’m posting this for free:
First thing that has to happen on Capitol Hill if we want to preserve the US as a country, a society, and an idea for that matter, to live on and G-d help us prosper, is this:
- Get business out of politics
Joe Blow you and me will never have any say, or regain it, as long as Goldman, Cargill and GE can buy theirs. That is really all that needs to be said. The Supreme Court decision to increase corporate influence just was the icing on the cake that makes one think, in the words of Bugs: "Each people gets what they desoive”. It's a death blow to anyone not in the inner circle having even a faint and remote say in where we're heading, though, and that's not what the Constitution meant to convey. But then again , once you get away with re-interpreting both Darwin and the Bible, what does the Constitution have on you?
Humbug! Politics! Let’s get to number 2, something strangely missing from all Obama, his elves and his reindeer have said so far.
- Come up with a plan B
It’s not just us having the wrong conversations either, it's all over the planet, where people who have nice jobs, especially the government ones, refuse to take a pay cut and insist they have a right to what’s theirs even if that means others will lose their jobs. Smart. Not.
We need a plan B. Obama isn’t sure his plans will work, neither are Geithner or Bernanke or Volcker or any of them, but none will admit that the present course, bar a change or 2, 3, may be headed for calamity.
Just as those making far too much money in the financial world (I know, it’s all about perspective, well, here’s mine) can’t grasp the fundamental changes coming, neither can you. You need to grab what’s yours and hold it as close to your chest as you possibly can. Now.
You think you’ll get a pension and all that. I first wrote about that years ago, but I’ll try a recoup :”You'll never get that pension", It was invested in high risk-carrying assets, and the risk didn’t pay off. The fund managers did fine, thank you very much, but hey, they were working with money that had to be paid out in , how old are you, 20-30-40 years, so why would they worry about 2030? their salaries come in in 2010.
That's your pension plan, and that’s why you won't get any.
And the question for Obama and his elves is really very simple, deceptively so: "What are we going to do if all your great plans don’t work out?" What if home prices keep on dropping, and jobless numbers keep rising? It's, after all, all we've seen for 2 years now, and no, thanks, we don’t think the BLS numbers solve the core problem.
Thing is and that's why I'm talking about "we're having the wrong conversation", this problem will never be solved. We've accumulated so much debt we'll never be able to pay it off. And so the financial world is dead on arrival. As are most politicians. They're all stuck in a defunct model. And now the people are going to take over, and it'll be ugly. Obama could have prevented it, but chose not to do so.
So the American people, out on the streets, will have to come up with the Plan B their government refuses to supply. We're stuck in the middle of a mastodont political crisis, and we don’t even see it, and not even just in the US, and nobody'd be talking about it but those who better not talk at all.
Well, that has to change. And this is where you come in.
We can talk till the cows are well fed, dressed, pampered and powdered and back about out on the town till we all come home, but nothing will ever be solved until the representatives in Washington vote to take away the powers from the corporations that own them. How's that sound to you?
Obama's Budget Has One Small, Missing Piece .... For $6.3 Trillion Dollars
by Tyler Durden
Today, to much fanfare, the administration released its ridiculous $3+ trillion budget (we say + because at that size the one thing certain is that the budget will certainly never hit the target and while we wish it would be lower, we are certain it will end up materially higher), which consists of a "short" 192-page summary section and a 1420 page appendix. We are confident that not one politician will read the whole thing from cover to cover. We won't either.
Not because we don't care about what's in it, but because we are much more concerned with what is not included, namely $2.8 Trillion and $1.9 Trillion of MBS guaranteed portfolios at Fannie and Freddie, and an additional $782 billion and $809 billion in company debt outstanding for the two GSEs, respectively. This amounts to a total of $6.3 trillion in liabilities which should be counted toward the budget. And yet, oddly, the error-checker somehow made this rather justifiable omission: after all if we were to look at a number which written out looks as follows $6,264,000,000,000.00, we would also probably just avoid it - it is somewhat difficult to hide a number that big even in the 1,420 pages of the budget's appendix.
That's ok, we are here to remind them about the omission, and also to remind Mr. Orszag, who himself, in that long ago 2008, espoused that these companies should be put on the Federal Budget. Isn't it strange what one and a half years worth of realizations just how broken beyond repair the system is, will do to one's convictions?
Let's remind our readers of what then-CBO director Peter Orszag said on September 8, 2008, at the press conference announcing the conservatorship of the bankrupt mortgage titans. Below we transcribe the relevant Q&A:
QUESTION: (OFF-MIKE) completely incorporated into the federal budget?
ORSZAG: What I— what I said was it is our view that at this point they should be incorporated into the federal budget, that we intend to do that in our January baseline and that with regard to the budget of the United States, which is put together by the administration’s Office of Management and Budget, that—the treatment therein will obviously be up to OMB, but it is our hope that working with the budget committees and OMB we can have a consistent treatment between our baseline and their budget.
QUESTION: This may be a little repetitive, but can you give—and if—if you do what you just said you would do, incorporating the mortgage companies into the federal budget directly, can you estimate at all the impact on federal receipts and federal outlays?
ORSZAG: I don’t—I could but I don’t want to. And the reason is that—is that again that can depend very sensitively—there is a lot of mortgage-backed security activity, and it can depend a lot on how this tension between whether if you buy a hundred-dollar’s worth of mortgage-backed securities that is scored as a hundred dollars in spending or whether that’s evaluated at its subsidy value, the numbers can be dramatically different. So I’m—until we reach judgment on, in particular, that issue but a few others, it’s premature for me to give you the raw (ph) numbers.
Christian (ph) and then (inaudible).
QUESTION: Sure, but just in a conceptual sense, though, you are ruling that—that Fannie and Freddie are now part of the public sector. They’re now part of the government. They are in effect nationalized.
ORSZAG: We are saying that the degree of control exercised by the federal government over these entities is so strong that the best treatment is to incorporate them into the federal budget.
Alas now the now-White House budget director is singing a radically different tune. According to a statement from the administration: "The administration continues to monitor the situation of the GSEs closely and will continue to provide updates on considerations for longer-term reform of Fannie Mae and Freddie Mac as appropriate." We hope this update will come at least a few days before America files for bankruptcy. Oh, and what is this difference in MBS scoring between "spending" and "subsidy value." Could we maybe please got some color on which of these two concepts applied to the nearly $100 billion in MBS sales initiated by Bill Gross, with the US taxpayer as an unwitting buyer.
As there may have been some confusion as to the magnitude of the numbers we are discussing here, we are providing a break down of total GSE debt introduced just a few days ago by Neil Barofsky.
As readers can see, we are not talking about just any paltry amount: the most recent US total debt balance was $12.222 trillion. It would seem a little presumptuous that an amount representing more than half of the total US sovereign debt is conveniently swept under the rug.
And with the omission from the Federal Budget, America's population once again has absolutely no visibility into the real fiscal costs associated with the government's support for the Debtor Nation Sponsored Entities (aka DeNSEs). Not only that, but at some point we really should have a discussion over just what the delicate transition from the existing "conserved" [sic] status to a full nationalization and permanent US debt onboarding. Because otherwise the ignorant morts may think that the Federal Reserve was responsible for purchasing just $300 billion worth of US debt, when in reality, courtesy of what should have been a Budget liability, the Bernanke policy will have been responsible for purchasing essentially $1.7 trillion worth of US securities. And the whole MBS-UST rotation by China, PIMCO and everyone else who was clever enough to hold the worst possible security around, would just have been a little more formalized than assorted discussions in the fringe media.
Luckily for the administration, today's budget provided absolutely no color, and further confirmed that Orzsag is nothing but a pure-blood hypocrite who says whatever is suitable for the occasion. Seeing how the Volcker plan is about to be retracted, we reserve judgment for the President until such time as he formally announces his prop trading ban was simply the result of an HFT algorithm gone amok in his teleprompter. But we digress. As for the whole "GSE-reform" thing, the administration will do it soon. Not today... But soon. After all: what is 40% of GDP? Bernanke can print that in like 2 days.
What we do know, is that recently the Treasury formally gave itself unlimited bailout capacity as pertains to the GSEs, once again making the case that in the grand scheme of things Treasury and GSEs liabilities are essentially the same concept. Of course, the public's, media's, and assorted CDS traders' reactions, were they to suddenly uncover that the US debt-to-GDP is actually more like 130% than 90%, would be quite amusing. We also know that by this action the administration has avoided the recognition of about $100 billion in cash outlays compared to the prior CBO estimate. Oh yes, we almost forgot how self-congratulatory the Treasury was when it announced that its January-March and March-June quarter borrowing needs would be lower than expected.
What we definitely know is that we now live in a system where delusion is the norm: we have an administration that willfully and consistently deludes its population from representing just how bad our economic debacle really is, and we have a population, that willfully and consistently is happy to accept lies and delusions from every media and administrative outlet, and in turn deludes the administration that it will pays it taxes, or not walk away from yet another underwater mortgage. Rinse. Repeat.
What we are positive, is that this arrangement of mutual delusion will persist will spectacular success. Until it doesn't.
Fannie, Freddie Kept Off Budget, Dividends Counted
President Barack Obama’s budget blueprint for the next fiscal year excludes the $6.3 trillion in liabilities of government-controlled Fannie Mae and Freddie Mac and delays for a second time a decision on restructuring the mortgage-finance companies that were seized 17 months ago. The companies may need $54.4 billion more in U.S. Treasury Department preferred stock purchases to stay afloat in the current year that ends Sept. 30, and $23 billion more for the next fiscal year, according to calculations made from the Obama administration’s 2011 budget proposal to Congress today.
“The administration continues to monitor the situation of the GSEs closely and will continue to provide updates on considerations for longer-term reform of Fannie Mae and Freddie Mac as appropriate,” the Obama administration said. White House budget director Peter Orszag delayed a decision on whether to bring the companies’ $1.6 trillion in corporate debt and $4.7 trillion mortgage obligations onto the federal budget. As the director of the Congressional Budget Office, Orszag criticized the Bush administration for keeping the 2008 rescue of the government-sponsored enterprises off budget.
At the time, Orszag said “the degree of federal control over Fannie and Freddie is so strong, we are incorporating them into the federal budget.” “We continue to be on track to release a statement in the very near future” on the GSEs, Housing and Urban Development Secretary Shaun Donovan said in a conference call with reporters today. More ideas on Fannie Mae and Freddie Mac’s future may be released “in the coming weeks and months,” Michael Barr, the assistant Treasury secretary for financial institutions, said at the American Securitization Forum’s annual conference near Washington. “We want to be sure, that as we move to reform the GSEs, we are focused on retaining strong market stability in our housing sector,” Barr said.
For now, Obama’s budget plan classifies the GSEs as “non- budgetary” items and excludes them from being counted as federal liabilities because “they are privately owned and controlled.” The administration counts $110.6 billion in taxpayer support already paid to the companies and $225 billion in GSE mortgage bonds purchased by the Treasury. Fannie Mae rose 7 cents, or 7.3 percent, to close at $1.03 today in regular New York Stock Exchange composite trading. Freddie Mac increased 5 cents, or 4.2 percent, to $1.23. So far, the companies have paid $6.8 billion in dividends to the Treasury on their borrowings.
The Office of Management and Budget estimates the two will pay $18 billion in dividends in fiscal 2011 and $6.73 billion in annual dividends thereafter. The companies are required to pay an annual dividend of 10 percent on their borrowings, which Fannie Mae and Freddie Mac have separately estimated will cost at least $10 billion a year. “They are using the Treasury’s borrowings to repay” the Treasury, said Paul Miller, a former examiner for the Federal Reserve who is now an analyst with FBR Capital Markets in Arlington, Virginia. “They never made that much money in their heyday,” Miller said. “My guess is that Treasury and the government will come to the conclusion that the GSEs will not be able to pay this back and will begin to look at the banking industry to repay the loans.”
Cloudy Future for Fannie and Freddie
The Great Bailout is mostly over for the banks. But for those troubled behemoths of the nation’s housing bust, Fannie Mae and Freddie Mac, the lifeline from Washington just keeps getting longer. Fifteen months after Fannie and Freddie were effectively nationalized, neither the Obama administration nor Congressional leaders see a quick solution to one of the thorniest problems in American finance: how to fix the twin mortgage giants without choking the flow of credit to homeowners and dealing a blow to a still-fragile housing market.
The administration had said for months that it would begin charting a new course for Fannie and Freddie when it released its budget proposal on Monday. The companies, crucial pillars of American housing, already have consumed over $112 billion of taxpayer dollars. Bankers, builders and homeowners stand to win or lose from any plan for the two so-called government-sponsored enterprises, or G.S.E.’s. But, on Monday, that plan amounted to a single, ambiguous sentence from the White House: “The administration continues to monitor the situation of the G.S.E.’s closely and will continue to provide updates on considerations for longer-term reform of Fannie Mae and Freddie Mac as appropriate.”
Treasury officials say more details may be forthcoming, although they decline to say when. To many experts, however, the message is that Fannie and Freddie are likely to remain wards of the state for years. And, given the alarm in some quarters over the mounting budget deficit, these two giants and their vast obligations are likely to remain conveniently — and controversially — off the federal books. Fannie Mae and Freddie Mac have obligations of $3.9 trillion to investors who bought bundles of mortgages that the companies assembled.
Powerful and often competing interests are grappling over the companies’ futures. Lawmakers on both sides of the aisle, eager to demonstrate their scorn for the companies, have called for their eradication. But few policy makers are willing to take aggressive steps that might weaken the housing market. On Christmas Eve, the White House quietly disclosed that it had, in effect, given the companies a blank check by making their federal credit line unlimited; the ceiling had been $400 billion.
For decades, Fannie and Freddie have played a central role in the housing market. But when the market began falling apart in 2008, so many of the home loans that Fannie and Freddie had bought or guaranteed went bad that the companies nearly went bankrupt. The government essentially took them over. Today, many financial companies are pushing to shrink or even dismantle the two G.S.E.’s in hopes of expanding their own businesses into the resulting vacuum. Financial executives contend that the government does not belong in the housing market. Given the animosity directed at the financial industry in general, however, few will criticize the government publicly.
“Almost no other country has companies like Fannie and Freddie, where the government essentially competes with private banks,” said one executive who was not authorized to speak to the media or willing to publicly criticize any government decisions. “People still manage to buy houses in France and England,” the executive continued. “One of the attractions of abolishing Fannie and Freddie is that a source of competition is gone. But, by the same token, if Fannie and Freddie hadn’t existed, maybe things wouldn’t have gotten so out of hand in the first place.”
Others disagree — often also for reasons of self-interest. The construction and real estate industries, two powerful political constituencies, essentially want to preserve the status quo so that their customers, homebuyers, can continue buying homes. “If the government isn’t involved, you run the risk of the secondary mortgage market drying up at exactly the wrong time,” said Jerry Giovaniello, the chief lobbyist for the National Association of Realtors. “Private companies get tighter with money when things get bad. The government is the only one who can make sure capital continues flowing.”
Shading all of this is election-year politics. In a polarized Washington, Democrats and Republicans seem to agree that flogging Fannie and Freddie might play well to an electorate weary of costly bailouts and anxious about the rising national debt. The Treasury secretary, Timothy F. Geithner, has pledged to propose “detailed reforms” this year. Democrats and Republicans in Congress are scheduling hearings. Politicians from both parties have demanded the eradication of Fannie Mae and Freddie Mac.
But for now, the only real consensus is that no one quite knows what to do with the companies. Whatever happens is almost certain to determine which Americans can — and cannot — get mortgages, and how much those loans will cost. That, in turn, will most likely influence home values for decades. And so, despite talk of dislodging political gridlock in Washington, many policy makers seem happy to put off making any real decisions. Many policy makers concede that there are no easy options. Trying to reinvent Fannie Mae and Freddie Mac, they say, could push the housing market into even more dire straits.
“I’ve said we should abolish Fannie Mae and Freddie Mac in their current form and come up with a whole new system of housing finance,” said Representative Barney Frank, a Massachusetts Democrat and the chairman of the House Financial Services Committee. “I can’t say when. And I don’t have any idea what that new system will look like. No one, I believe, knows. All we really know is that we need something new.”
Indeed, most of the recent enthusiasm for public discussions about Fannie and Freddie have been attempts by both parties to gain political advantage. Aides to high-ranking Republican and Democratic lawmakers say that opinion polls suggest that independent voters are unlikely to support candidates who defend Fannie and Freddie. Republicans are trying to emphasize the companies’ longtime Democratic ties. They attacked the Treasury Department in December when the government announced multimillion-dollar pay packages for the companies’ top executives.
“Awarding millions of dollars in bonuses on the taxpayers’ dime is unconscionable,” Representative Jeb Hensarling, Republican of Texas, wrote to the Treasury secretary in a letter signed by 70 Republicans. On Monday, after the White House announced it did not yet have a firm plan for the companies, Representative Spencer Bachus, Republican of Alabama, said, “It is irresponsible for the administration to give Fannie and Freddie a blank check and offer no strategy for reforming the G.S.E.’s.” To counter such salvos, Democratic lawmakers are now searching for opportunities to publicly distance themselves from Fannie and Freddie.
“We’re going to provide a lot of chances for Democrats to vote against Fannie and Freddie and to openly criticize them,” said a Congressional staff member working for a high-ranking Democrat. “Everyone is going to get a chance to say something bad about the companies if they want to, and we’re going to make sure the volume is up on the microphone.” The White House, already under attack for mounting debts, has so far disregarded advice from the Congressional Budget Office to fold the costs associated with Fannie and Freddie into the budget. In Monday’s statement, the administration emphasized that because Fannie and Freddie may one day come out from under government control, they should stay off the books.
Meantime, everyone is waiting for the big fix. “No one has come up with a new model that can both maintain liquidity and eliminate all the bad or conflicting incentives that caused the crisis in the first place,” said Thomas A. Lawler, an economist who worked at Fannie Mae for more than two decades before leaving in 2006 to become a consultant. “And the longer the government relies on entities like Fannie and Freddie to implement the recovery, the harder it is to get rid of them. This is a really, really hard problem, and it’s going to take a long time to figure out the right solution.”
US Housing Bubble v2.0
by Tracy Alloway
Here’s one thing that the Sigtarp’s quarterly report to Congress, released on Saturday, made very clear: propping up house prices is now an explicit goal of the US government.
So explicit in fact, that the Special Inspector General for the Troubled Asset Relief Program has knocked up this little chart to show how various policy programmes (Hamp, MHA, etc.) lead to higher houseprices:
See? It’s like crystal.
As the report states:Supporting home prices is an explicit policy goal of the Government. As the White House stated in the announcement of HAMP for example, “President Obama’s programs to prevent foreclosures will help bolster home prices.”
In general, housing obeys the laws of supply and demand: higher demand leads to higher prices. Because increasing access to credit increases the pool of potential home buyers, increasing access to credit boosts home prices. The Federal Reserve can thus boost home prices by either lowering general interest rates or purchasing mortgages and MBS. Both actions, which the Federal Reserve is pursuing, have the effect of lowering interest rates, which increases demand by permitting borrowers to afford a higher home price on a given income.
Similarly, the Administration is boosting home prices by encouraging bank lending (such as through TARP) and by instituting purchase incentives such as the First-Time Homebuyer Tax Credit. All of these actions increase the demand for homes, which increases home prices. In addition to direct Government activity, home prices can be lifted by general expectations among homebuyers of future price increases.
Questions related to moral hazard on a postcard to the below please.
The White House
1600 Pennsylvania Avenue, NW
Washington, DC 20500
The Federal Reserve
20th Street and Constitution Ave.
Washington, DC 20551
The Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220
SIGTARP Warns of Second Housing Bubble
by Austin Kilgore
The Special Inspector General for the Troubled Asset Relief Program (SIGTARP), which oversees the federal government’s economic recovery program, called for reform to prevent government bailouts in the future and warned of a government-induced second housing bubble.
“Even if TARP saved our financial system from driving off a cliff back in 2008, absent meaningful reform, we are still driving on the same winding mountain road, but this time in a faster car,” SIGTARP wrote in its latest quarterly report (download here). “To the extent that institutions were previously incentivized to take reckless risks through a ‘heads, I win; tails, the government will bail me out’ mentality, the market is more convinced than ever that the government will step in as necessary to save systemically significant institutions.”
The report warns the government’s efforts to stabilize the housing market may create a second bubble. “The government has done more than simply support the mortgage market, in many ways it has become the mortgage market, with the taxpayer shouldering the risk that had once been borne by the private investor,” the report said.
Included in the report was the above chart, which tracks the expanding percentage of mortgage flows attributable to the government-backed mortgage entities like Fannie Mae, Freddie Mac , and Ginnie Mae in the mortgage-related finance market. As the chart shows, during the housing bubble, government-sponsored enterprises (GSE)-sponsored lending was at extremely low levels, but has since increased beyond levels even seen during the government intervention during the Savings and Loan crisis 20 years ago.
SIGTARP said while segments of the financial system are more stable than they were at the height of the financial crisis, many of TARP’s stated goals “have simply not been met.”
“Despite the fact that the explicit goal of the Capital Purchase Program (CPP) was to increase financing to US businesses and consumers, lending continues to decrease, month after month, and the TARP program designed specifically to address small-business lending — announced in March 2009 — has still not been implemented by Treasury,” the report said.
The report also notes that despite TARP’s other stated goals — preserving homeownership and promoting jobs — nearly 16 months later, foreclosures remain at record levels, the TARP foreclosure prevention program has only permanently modified a small fraction of eligible loans, and unemployment is the highest it has been “in a generation.”
“Whether these goals can effectively be met through existing TARP programs is very much an open question at this time,” the report said. “And to the extent that the government had leverage through its status as a significant preferred shareholder to influence the largest TARP recipients to carry out such policy goals, it was lost with their exit from TARP.”
The report said many of the institutions considered “too big to fail” and that received extraordinary assistance have recovered, having repaid their debt to the federal government, but are now even larger. The report added institutions are incentivized to exit TARP to escape the program’s compensation restrictions, noting recent bonuses payments show some improvements in the form that bonus compensation takes for some executives, but “there has been little fundamental change in the excessive compensation culture on Wall Street.”
At the end of 2009, 67 TARP recipients had paid back all or a portion of their principal or repurchased shares for an aggregate total of $165.2bn of repayments and a $5.0bn reduction in exposure, leaving $368.8bn, or 52.8%, of TARP’s allocated $698.8bn available for distribution. TARP’s collected $12.9bn in interest, dividends, and other income and made an additional $4bn from the sale of warrants and preferred stock received as a result of exercised warrants.
But some TARP participants have missed dividend payments, and at the end of 2009, there was $140.7m in outstanding unpaid CPP dividends. In addition, three TARP recipients that received a combined $2.6 billion in TARP funds have filed for bankruptcy.
Rising FHA default rate foreshadows a crush of foreclosures
The share of borrowers who are falling seriously behind on loans backed by the Federal Housing Administration jumped by more than a third in the past year, foreshadowing a crush of foreclosures that could further buffet an agency vital to the housing market's recovery. About 9.1 percent of FHA borrowers had missed at least three payments as of December, up from 6.5 percent a year ago, the agency's figures show.
Although the FHA's default rate has been climbing for months and eating into the agency's cash, the latest figures show that the FHA's woes are getting worse even as the housing market shows signs of improvement. The problems are rooted in FHA mortgages made in 2007 and 2008. Those loans are now maturing into their worst years because failures most often occur two to three years after a mortgage is made. If the trend continues and the FHA's cash reserves are exhausted, the federal government would automatically use taxpayer money to cover the losses -- a first for the agency, which has always used the fees it charges borrowers to pay for its losses.
As these loans from 2007 and 2008 go bad and clear off of the FHA's books, agency officials said, losses are expected to taper off, aided by the housing market's anticipated recovery and an influx of more creditworthy borrowers, who have flocked to the FHA's home-buying program in the past year. Agency officials said they have cracked down on poorly performing lenders and announced higher qualifying fees for borrowers. On Monday, the agency projected that the fees should generate $5.8 billion in fiscal 2011, up from $2 billion this year. That would fatten the FHA's cash cushion, used to cover unexpected losses.
For now, just about every major measure of the agency's financial health is worsening. The FHA does not make loans but insures lenders against losses. And claims have already spiked. The agency had to pay out on 47 percent more loans in October and November than in the corresponding period a year earlier, according to an FHA report. The number of loans in foreclosure, including those that have not yet been billed to the agency, has also increased. They were up 26 percent in the last quarter from a year earlier.
FHA Commissioner David H. Stevens, who joined the agency in July, flagged his agency's troubles with the 2007 and 2008 loans in October, when he told a House panel that "rogue players on the margin" immediately migrated to the world of FHA lending after the subprime mortgage market collapsed. Their aggressive lending tactics attracted borrowers with unusually poor credit profiles to the FHA. "That clearly impacted the books of business in 2007 and 2008, and that performance data is showing up very clearly in today's balance sheet," Stevens said at the time. Plunging home prices have exacerbated matters by leaving some FHA borrowers unable to sell or refinance their homes because they owe more than their homes are worth. Yet with unemployment running high, many borrowers can't afford to keep up their payments.
Adding to the trouble was a now-defunct FHA program that enabled sellers to cover the down payments of buyers. This meant many borrowers had no skin in the game and were more likely to walk away at early signs of trouble. The program resulted in excessive defaults before it was ended in late 2008, and it is projected to cost FHA an additional $10.5 billion in losses, Stevens said. For all these reasons, the FHA projects that it will pay out claims to lenders on one out of every four loans made in 2007 -- the worst rate in at least three decades. The claim rate should be nearly the same on the vastly larger volume of loans made in 2008.
But agency officials said they have reasons to be optimistic. The FHA-backed loans made in 2009 tended to go to borrowers with higher credit scores than in previous years. These borrowers turned to the FHA when the mortgage market collapsed and other lending sources dried up. By then, reputable lenders doing business with the agency were already imposing tougher restrictions on FHA borrowers, further boosting the credit profile of those loans. The average credit score of an FHA borrower is now 690, up from 630 only two years ago, agency officials said.
These higher-quality loans are expected to result in lower losses, so the agency should make money on loans issued this year and over the next few years, according to an independent audit designed to gauge the agency's health. The audit, released in November, found that the cash the FHA set aside to pay for unexpected losses had dipped to historic lows, well below the level required by law. As of Sept. 30, those reserves were estimated at $3.6 billion, down from nearly $13 billion a year earlier. The most recent figure represents 0.53 percent of the value of all FHA single-family-home loans -- far lower than the 2 percent required by Congress.
But Ann Schnare, a former Freddie Mac official, said the situation could be even worse. She said the audit underestimates future losses because it does not take into account all loans that are now overdue, only those that the FHA has paid claims on. Stevens said his agency has pored over its data to analyze risk and is taking steps to shore up its financial health. "You have a limited set of options under these circumstances: Raise fees [for borrowers] or make policy changes," Stevens said in an interview. "We've done both." The agency banned 268 lenders from making FHA loans last year, more than double the total terminated in the previous eight years. The FHA suspended six other firms. Among them were some of the largest FHA lenders -- Taylor, Bean & Whitaker and Lend America, both of which shut their doors soon thereafter.
The agency also proposed a rule that would require banks to hold up to $2.5 million in capital that they can use to repay the agency for losses if they were involved in fraud. Banks are now required to hold only $250,000. Borrowers are also facing tougher scrutiny from the agency. People taking out FHA loans will have to pay higher upfront fees, perhaps as early as this spring. Those with especially weak credit scores will also have to put down at least 10 percent instead of the usual 3.5 percent down payment. The amount of money sellers can kick in toward closing costs and other fees will also be limited.
The Next Leg Of The Housing Crisis In Five Simple Charts
by Tyler Durden
Everything that the government has done so far, with a few minor detours, has been almost exclusively focused on maintaining home prices high, by tweaking either the supply or the demand side of the housing equation. As the bulk of consumer net wealth is concentrated in the housing sector, and a wealthy and confident consumer, much more so than the banking system, is critical to the recovery of America's economy, the Administration will do everything in its power to achieve its goal of artificially manipulating the housing market, thereby not causing an incremental loss of wealth to those still stuck with overpriced houses, while the real intersection of actual supply and demand curves would indicate a materially lower equilibrium price.
This is ironic, as proper price discovery is critical for a true recovery, since Americans realize all too well that buying a house at prevailing levels in advance of the second down-leg in housing is senseless, the continued pursuit of such flawed policies by the Fed and President Obama merely pulls the market ever further away from its equilibrium, thereby making the anticipated second dip so much more likely and not that far off in the distant future. Below are 5 simple charts the highlight just how precarious the housing situation in the U.S. is, and how likely the second, and probably much more fierce, leg down in the markets is going to be.
A bearish report by CIBC 1captures precisely the highly unstable system that U.S. housing has become, and deconstructs it along the five key axes of weakness which while individually may be controllable to a degree, combined represent a recipe for disaster. CIBC's main sources of concern arise from:
- Short-lived remedies; used by the administration to prevent further price deterioration (tax-credits);
- Shadow Inventory; in reality when accounting for the surging shadow inventory which very few dare talk about, the total number of available unit sdouble to over 8 million, representing a record high 16 months of supply.
- Strategic defaults; the amount of households with negative equity is roughly 10 million or about 20%, in 2009 25% of all foreclosures were strategic; as populist anger against banks accelerates look for strategic defaulits to keep rising
- Quantitative Easing expiring; This needs no introduction: the sole reason why mortgage rates have been as los as they have, has been due to the Fed's constant manpulation of the MBS market via the $1.4 trillion MBS/Agency QE purchase program. With this program set to expire in 2 months, rates are set to explode.
- House Prices are already entering a double dip; Previously we discussed the Case Shiller NSA home price index number which indicated that a double dip in prices has already commenced. A positive feedback loop will only lead to further deterioration here
Analyzing CIBC's factors one by one:
During the past year in which the program has been in effect, sales of existing homes have climbed by 15%, while new home sales have actually dropped by 5%. In fact, the usually stable sales ratio between the two has more than tripled, recently hitting a record high 18 (Chart 1). But after being extended once by the Obama Administration, this tax credit will expire at the end of April—putting downward pressure on demand for existing home sales. That prospect will make it more difficult to clear out the next wave of foreclosures, prompting another down leg in US house prices.
the risk of a double dip in US home prices is not simply the result of properties being sold at “fire-sale” valuations, but also due to a deluge of shadow inventory coming onto the market. Although conventional inventories are trending lower, shadow inventories, capturing seriously delinquent and bank-owned properties, are just as large.
There are close to two million mortgages that are more than 90 days delinquent, and nearly all of these will end up in foreclosure, given that over the past three years the “cure rate” of this category fell from 40% to less than one percent. Add to that the 2.3 million properties that are in foreclosure or already seized by banks, and total inventories (conventional and shadow) are now running at over 8 million units (Chart 2). At current sales rates, that adds up to a record high 16 months of supply. True, this “shadow” stock will not hit the market all at the same time as banks manage their supply of seized properties, but this constant flow is likely to keep markets depressed for a while.
A big part of the problem is a still weak labour market, which has left a record 15 million Americans unemployed and another 9 million underemployed for economic reasons. However, just as significant is the roughly 10 million households in a negative home equity position of worse than -20%, for whom strategic default - failing to pay when one could - is a very real option. While negative equity is a necessary but not sufficient condition for default, it’s a clear risk; out of the 2 million or so foreclosures in 2009, roughly 25% were strategic (Chart 3).
It’s not just inventories and tax credits that are looming large over the housing market, but also interest rates. Aggressive central banks’ rate cuts along with large amounts of agency MBS purchases by the Federal Reserve have lowered mortgage rates by over 100 bps since the height of the financial crisis. That spurred a refinancing boom, which, according to First American Corelogic, saved $2.3 billion in mortgage payments—a roughly 10% reduction—in 2009 alone. Although we don’t expect policymakers to raise the fed funds rate until 2011, mortgage rates have already started to head higher, and could keep climbing towards the end of the first quarter when the Fed’s $1.25 trillion agency MBS purchase program is completed. Those purchases made up almost 50% of all MBS issuance last year, and despite the improvements in the securitization market, their absence will likely have a material impact on rates (Chart 4).
Price Double Dip
In the final analysis, the end of unprecedented government tax support for housing, along with the looming overhang of supply and a higher cost of borrowing will keep new home building activity trudging along at historic lows over the next two years and could see prices drop again by 5-10% (Chart 5).
And there you have it: the best that the government can hope for is to extend and pretend, and to avoid presenting the sad but very simple reality to the American public. Because lack of knowledge is half the battle. Alas, as long as the reset button is not pushed, the only beneficiaries are the very same Wall Street kleptocrats who want nothing more than further perpetuating the status quo. At this point nothing absent a complete socio-economic catharsis can help America; the rest is just Congressional hearings, angry presidential outbursts scripted on the teleprompter, and neverending smoke and mirrors.
US January U.S. Private-Sector Jobs Fell by 22,000
The labor market showed positive signs of recovering in January. Private-sector jobs in the U.S. fell by 22,000 in January, the smallest drop since February 2008, and service jobs continued to rise, according to a national employment report published Wednesday by payroll giant Automatic Data Processing Inc. and consultancy Macroeconomic Advisers. A separate report indicated that the U.S. service sector resumed expansion in January. The ADP loss is slightly below the 30,000 drop projected by economists in a Dow Jones Newswires survey. The estimated change of employment from November to December 2009 was revised by 23,000, from a decline of 84,000 to a decline of 61,000.
The ADP survey tallies only private-sector jobs, while the Bureau of Labor Statistics' nonfarm payroll data, to be released Friday, include government workers. Economists surveyed by Dow Jones expect the BLS will report January payrolls were unchanged, following the 85,000 jobs lost in December. The total payroll figure should be lifted by expected hiring of census workers by the federal government. The January unemployment rate is projected to edge up to 10.1% from 10.0%. Friday's report will include benchmark revisions to the establishment survey which covers the nonfarm payroll data. The latest ADP report showed large businesses with 500 employees or more shed 19,000 jobs and medium-size businesses added 9,000 workers in January. Small businesses that employ fewer than 50 workers cut 12,000 jobs.
Service-sector jobs added 38,000, the second increase in a row, while factory jobs dropped another 60,000 last month. ADP, of Roseland, N.J., said it processes payments of one in six U.S. workers, while Macroeconomic Advisers, based in St. Louis, is an economic-consulting firm. In other Wednesday job reports, outplacement firm Challenger, Gray & Christmas said U.S. companies in January announced plans to reduce payrolls by 71,482 workers, the highest job-cut tally in five months. Last month's job cuts, which were up 59% from December's tally, were led by retail-sector employers, which not only eliminated many of the seasonal positions added between October and December, but also many of the full-time, permanent jobs that existed before the holidays, the Challenger report said.
Plus, TrimTabs Investment Research estimated the U.S. economy lost 104,000 jobs in January. TrimTabs bases its employment estimates on analysis of daily income tax deposits to the U.S. Treasury from all salaried employees. A report from the Institute for Supply Management Wednesday said that its non-manufacturing index moved to 50.5, from 49.8 in December, while the business activity index hit 52.2, from 53.2. The overall index had been expected to hit 51.0. Readings over 50 indicate expanding activity. The private research group's non-manufacturing index is comprised largely of service-sector activity, which makes up the majority of American economic output. The report comes at a time where the economy is in recovery mode.
On Monday, the ISM reported that the manufacturing sector saw its biggest activity gain in over five years in January, amid signs factory employment may be starting to pick up. The service sector has, however, been lagging the nation's factory base, although survey director Anthony Nieves said "respondents" comments overall are cautiously optimistic about business conditions." The report's details were generally positive. Hiring faced continued headwinds, with that index coming in at 44.6, from December's 43.6, indicating a slowing rate of contraction. Meanwhile, new orders were higher, with that measure at 54.7, from 52.0. The inflationary pressures faced by the non-manufacturing sector rose, with the prices index at 61.2, after December's 59.6.
Planned layoffs rise for first time since July, up 59% from December
Planned layoff announcements at major U.S. corporations increased 59% in January, reaching 71,482 from a nine-year low of 45,094 seen in December, according to the latest job-cut tally by Challenger Gray & Christmas. It was the first month-to-month increase in layoffs since July, the outplacement firm reported Wednesday. The figures are not seasonally adjusted. Layoff plans ran 70% lower than the 241,749 announced in January 2009, which was a seven-year high.
Planned reductions for last month were led by retail companies, which announced 16,737 job cuts, and telecommunications companies, which cut 14,010 jobs. Challenger's monthly tally covers only a small fraction of those who lose their jobs each month. Most layoffs are not announced in press releases. According to the government's most recent report, 2.05 million people lost their jobs via layoffs or terminations in November. Through the first 11 months of the 2009, the government counted 25.6 million layoffs. By Challenger's count, companies announced 1.288 million job cuts during 2009.
In a separate report, ADP estimated that U.S. private-sector employment fell by 22,000 in January, the fewest jobs lost in two years. The declines have lessened every month since March, when firms cut 736,000 jobs in one month. The report is based on a sample of hundreds of thousands of companies using ADP for their payroll services. See our full story on the ADP employment report.
Ilargi: Dylan Ratigan does another great rant. Basically, listen to what he says, and you may need 2 or three tries, and you know what is wrong with what you see happen around you. No kidding.
FED GAVE Banks Access to 23.7 TRILLION DOLLARS NOT $700 Billion!
Blackrock’s massive Friday afternoon dump…
As we monitored filings on Friday afternoon, we wondered why EDGAR seemed unusually sluggish. But it wasn’t until late Friday that we realized why: Blackrock (BLK) had done a massive document dump on Friday afternoon of 13G filings related to its acquisition of Barclay’s Global Investors.
We counted over 1,800 13Gs that Blackrock dumped on Friday, which explains why EDGAR might have been a tad bit pokey. The stream started at just after 2 p.m. est and didn’t let up until just after 4:30, when the last one, which reported a 6.5% stake in Vodafone came in. For those less familiar with the 13G, since we don’t often write about these filings, it’s a requirement when ownership exceeds 5% of the outstanding shares. With few rare exceptions, these filings represented new positions for Blackrock since we only counted 11 amended 13Gs, which in itself seems very surprising, given the long list of stocks.
Though it’s hard to tell from the SEC’s EDGAR database the names of those 1,800-plus companies without clicking on each filing (and who has time to click on 1,800 of them?), it’s a bit easier in 10KWizard (now known as Morningstar Document Research). And, indeed, there’s a lot of household names on the list including some big names in tech like Apple, AOL , Google, Yahoo — several of which Dow Jones picked up on on Friday afternoon. But there’s a lot more names on the list too, including United Technologies, Toll Brothers, and even footnoted frequent flyer Martha Stewart Omnimedia where Blackrock disclosed a stake of just over 7%.
Actually, a far more interesting project might be trying to figure out who wasn’t on the list since with 1,800-plus filings, just about any company over even a relatively modest market cap — Martha Stewart’s is currently around $240 million — seems to have made the cut.
Our debt time bomb is ready to go ka-boom
by Paul Farrell
Retire? You can fuggetaboutit if the new Global Debt Time Bomb is detonated by any one of 20 made-in-America trigger mechanisms.
Yes, 20. And yes, any one can destroy your retirement because all 20 are inexorably linked, a house-of-cards, a circular firing squad destined to self-destruct, triggering the third great Wall Street meltdown of the 21st century, igniting the Great Depression II that George W. Bush, Ben Bernanke, Henry Paulson and now President Obama have simply delayed with their endless knee-jerk, debt-laden wars, stimulus bonanzas and bailouts.
Deficit as national-security threat?
WSJ's Jerry Seib previews his column in tomorrow's Journal in which he writes the federal budget deficit has become so large, it's time consider it a natural-security threat. Plus, the News Hub provides a February market outlook and also discusses the findings of a new autism study. Wow, what an epic Hollywood blockbuster this will make: You know the drama, can't miss the warnings. The financial press is flooding us with plot lines ... a Forbes cover story focuses on a "Global Debt Bomb: How It Could Wreck Your Life" ... Leaders at the World Economic Forum on Swiss Mt. Davos fear another global meltdown will trigger mass rebellions ... The Economist calls the plot a "Global Asset Bubble," with cheap money fast driving up asset prices.
Plus, Bloomberg BusinessWeek is adding jet fuel to the ticking time-bomb in: "After the Stimulus Binge, a Debt Hangover: Trillions of dollars have been spent keeping the global economy afloat. But now fears about the Great Recession are giving way to worries about something else: The Great Reckoning" when massive debts come due. Then the debt bomb explodes "and the results won't be pretty for investors or elected officials."
Forbes discovered the trigger mechanism in "This Time Is Different: Eight Centuries of Financial Folly," by economists Carmen Reinhart and Kenneth Rogoff: The "90% ratio of government debt to GDP is a tipping point in economic growth." For 800 years "you increase it over and beyond a high threshold, and boom!" Well guess what? "The U.S. government-debt-to-GDP ratio is 84%." Soon, Ka-Booom! Depression. Kiss your retirement goodbye.
Who knows? Forbes? Bloomberg BusinessWeek? The Economist? Davos-World Economic Forum? True, they're all looking at the same plot line for a Hollywood blockbuster about the "Global Debt Time Bomb." But the financial press navigates in a fog. There's not just one, but many triggers, all linked in a lethal network. We've reported on it for years. Now you tell us: What triggers this firestorm?
Poll: 20 economic weapons of mass destruction triggering ticking Global Debt Time Bomb
1. Federal Budget Deficit Bomb. The Bush/Cheney wars pushed America deep into a debt hole. Federal debt limit was just raised almost 100% with Obama's 2010 budget, to $14.3 trillion vs. $7.8 trillion in 2005. The Congressional Budget Office predicts future deficits around 4% through 2020. Get it? America's debt at 84% of GDP will soon pass that toxic 90% trigger point.
2. U.S. Foreign Trade Bomb. Monthly deficits actually dropped from $50 billion per month to roughly $35 billion. But the total continues climbing as $400 billion is added each year. Foreigners now own $2.5 trillion of America, with China holding over $1.3 trillion in Treasury debt.
3. Weakening U.S. Dollar as Foreign Reserve Currency Bomb. Fear China and other currencies will replace dollar as main foreign reserves. The dollar's fallen: The main index measuring dollar strength has gone from 120 at the Clinton-to-Bush handoff to below 80 today.
4. Cheap Money Bomb: Credit Ratings Down, Rates Up. Economists at S&P, Fitch and Moody's were totally co-conspirators of Fat Cat Bankers, misleading investors before meltdown: Soon, debt up, ratings down, interest rates soar.
5. Global Real Estate Bomb. Dubai Tower, new "world's tallest building" is empty. BusinessWeek warns that China's housing collapse could be worse than America's. Plus the U.S. commercial real estate bubble is now $1.7 trillion, a "ticking time bomb" bloating 25% of bank balance sheets.
6. Peak Oil and the Population Bomb. China and India each need 500 new cities. The United Nations estimates world population exploding 50% from 6 billion to 9 billion by 2050: Three billion more humans demanding more automobiles, exhausting more resources to feed their version of the gas-guzzling "America Dream."
7. Social Security Bomb. We have no choice; eventually we must either cut benefits or raise taxes. Politicians hate both, so they'll do nothing. Delays worsen solutions. Without action, by 2035 Social Security and Medicare benefits will eat up the entire federal budget other than defense.
8. Medicare: A Nuclear Bomb. Going broke faster than Social Security. Prescription drug benefit added an unfunded $8.1 trillion. In 5 years estimates rose from about $35 trillion to over $60 trillion now.
9. Health-care Insurance Bomb. Burden increasingly shifted to employees. Costs rising faster than inflation. Recent Obamacare plan would have cost $90 billion annually, paid to Big Pharma and insurers.
10. State and Local Government Budget Bombs. Deficits of $110 billion in 2010, $178 billion in 2011on top of more that $450 billion in underfunded state and municipal employee pension funds.
11. Underfunded Corporate Pensions Bomb. From $60 billion surplus in 2007 to $409 billion deficit in 2009. And a whopping 92% of the pension plans of companies are now underfunded. Defaults are guaranteed by taxpayers.
12. Consumer Debt Bomb. Americans are still living beyond their means. Even with a downturn, consumer debt rose from about $2.3 to $2.5 trillion. Fat Cat Bankers love it -- yes love making matters worse by gouging cardholders and mortgagees, blocking help in foreclosures and bankruptcies.
13. Personal Savings Bomb. Before the 2008 meltdown savings rate dropped from about 10% in the early 1980s to below zero. Now it's increasing, slowing retail recovery. Today, government's the big "unsaver."
14. War and Military Defense Deficits. Costs of Iraq and Afghanistan wars -- $200+ billion annually, $3 trillion minimum, with massive long-term costs for veteran medical care, equipment renewal, recruitment.
15. Homeland Insecurity Bomb. Security at airports, seaports, borders, vulnerable chemical plants all increase budgets.
16. Fed/Treasury Bailout Bombs. Tax credits, loans, cash and purchase of toxic assets from Wall Street banks estimated at $23.7 trillion as new debt was shifted from too-big-to-fail Fat-Cat banks to taxpayers.
17. Insatiable Washington Lobbyists Bombs. Paulson, Goldman, Geithner, Morgan and Wall Street banks, through their lobbyists and former employees working inside now have absolute power over government spending. Democracy and voters are now irrelevant in America's new corporate-socialism.
18. Shadow Banking: The Derivatives Bomb. Wall Street wants no regulation of this $670 trillion, high-risk, out-of-control casino that's highly leveraged versus the $50 trillion total GDP of all nations. We forget that derivatives almost destroyed global economies in 2008-09, finally will by 2012.
19. Dysfunctional Two-Party Political Bomb. Polarized partisanship increasing: Every day both parties show zero interest in cooperating for the public good. Instead they fight viciously, resisting everything and anything proposed by opponents. Only goal: Score political points, make the other side look bad.
20. The Coming Populous Rebellion Bombs. Nobody trusts anyone in authority. For good reason. So immediate gratification, short-term betting and a lack of long-term perspective wins for individual investors, consumers and taxpayers as well as Washington, Wall Street and Corporate America CEOs. Today: "Doing what's right for the common good and country" is just empty political rhetoric.
Forbes. The Economist. Davos-World Economic Forum. Bloomberg BusinessWeek. All one voice, one loud, lonely chorus echoing that famous Beatles tune: "Head in a cloud ... The fool on the hill, sees the sun going down ... a thousand voices talking perfectly loud. But nobody ever hears him, or the sound he appears to make ... And the eyes in his head, see the world spinning 'round ...ooh, round and round and round." Historians and behavioral economists tell us most investors are blind optimists. Investors cannot see bubbles from inside their bubble. Nor Fat Cat Bankers from inside their mega-bonus-bubble. Nor politicians from inside the beltway bubble.
Why? The optimist's brain filters out bad news. They know their dreams of prosperity will come true. Then, when they finally do see that the proverbial light at the end of the tunnel is an oncoming train, it's always too late. I will say it again, gently: A new meltdown is coming. The Great Depression II is coming, soon. And yet, I know your mental filters are working, blocking warnings of a bomb. I can even hear you calling me "the fool on the hill who sees the sun going down, the world spinning round" ... sees you kissing your retirement goodbye.
US Deficit Balloons Into National-Security Threat
The federal budget deficit has long since graduated from nuisance to headache to pressing national concern. Now, however, it has become so large and persistent that it is time to start thinking of it as something else entirely: a national-security threat. The budget plan released Monday by the Obama administration illustrates why this escalation is warranted. The numbers are mind-numbing: a $1.6 trillion deficit this year, $1.3 trillion next year, $8.5 trillion for the next 10 years combined—and that assumes Congress enacts President Barack Obama's proposals to start bringing it down, and that the proposals work.
These numbers are often discussed as an economic and domestic problem. But it's time to start thinking of the ramifications for America's ability to continue playing its traditional global role. The U.S. government this year will borrow one of every three dollars it spends, with many of those funds coming from foreign countries. That weakens America's standing and its freedom to act; strengthens China and other world powers including cash-rich oil producers; puts long-term defense spending at risk; undermines the power of the American system as a model for developing countries; and reduces the aura of power that has been a great intangible asset for presidents for more than a century.
"We've reached a point now where there's an intimate link between our solvency and our national security," says Richard Haass, president of the Council on Foreign Relations and a senior national-security adviser in both the first and second Bush presidencies. "What's so discouraging is that our domestic politics don't seem to be up to the challenge. And the whole world is watching." In the 21st-century world order, the classic, narrow definition of national-security threats already has expanded in ways that make traditional foreign-policy thinking antiquated. The list of American security concerns now includes dependence on foreign oil and global warming, for example.
Consider just four of the ways that budget deficits also threaten American's national security:
- They make America vulnerable to foreign pressures. The U.S. has about $7.5 trillion in accumulated debt held by the public, about half of that in the hands of investors abroad. Aside from the fact that each American next year will chip in more than $800 just to pay interest on this debt, that situation means America's government is dependent on the largesse of foreign creditors and subject to the whims of international financial markets. A foreign government, through the actions of its central bank, could put pressure on the U.S. in a way its military never could. Even under a more benign scenario, a debt-ridden U.S. is vulnerable to a run on the American dollar that begins abroad. Either way, Mr. Haass says, "it reduces our independence."
- Chinese power is growing as a result. A lot of the deficit is being financed by China, which is selling the U.S. many billions of dollars of manufactured goods, then lending the accumulated dollars back to the U.S. The IOUs are stacking up in Beijing. So far this has been a mutually beneficial arrangement, but it is slowly increasing Chinese leverage over American consumers and the American government. At some point, the U.S. may have to bend its policies before either an implicit or explicit Chinese threat to stop the merry-go-round. Just this weekend, for example, the U.S. angered China by agreeing to sell Taiwan $6.4 billion in arms. At some point, will the U.S. face economic servitude to China that would make such a policy decision impossible?
- Long-term national-security budgets are put at risk. This year, thanks in some measure to continuing high costs from wars in Iraq and Afghanistan, the U.S. will spend a once-unthinkable $688 billion on defense. (Before the Sept. 11, 2001 attacks, by contrast, the figure was closer to $300 billion.) Staggering as the defense outlays are, the deficit is twice as large. The much smaller budgets for the rest of America's international operations—diplomacy, assistance for friendly nations—are dwarfed even more dramatically by the deficit. These national-security budgets have been largely sacrosanct in the era of terrorism. But unless the deficit arc changes, at some point they will come under pressure for cuts.
- The American model is being undermined before the rest of the world. This is the great intangible impact of yawning budget deficits. The image of an invincible America had two large effects over the last century or so. First, it made other countries listen when Washington talked. And second, it often—not always, of course, but often—made other peoples and leaders yearn to be like America. Sometimes that produced jealousy and resentment among leaders, but often it drew to the top of foreign lands leaders who admired the U.S. and wanted their countries to emulate it. Such leaders are good allies.
The Obama administration has pledged to create a bipartisan commission charged with balancing the budget, except for interest payments, by 2015. The damage deficits can do to America's world standing is a good reason to hope the commission works.
Huge Deficits May Alter U.S. Politics and Global Power
In a federal budget filled with mind-boggling statistics, two numbers stand out as particularly stunning, for the way they may change American politics and American power. The first is the projected deficit in the coming year, nearly 11 percent of the country’s entire economic output. That is not unprecedented: During the Civil War, World War I and World War II, the United States ran soaring deficits, but usually with the expectation that they would come back down once peace was restored and war spending abated.
But the second number, buried deeper in the budget’s projections, is the one that really commands attention: By President Obama’s own optimistic projections, American deficits will not return to what are widely considered sustainable levels over the next 10 years. In fact, in 2019 and 2020 — years after Mr. Obama has left the political scene, even if he serves two terms — they start rising again sharply, to more than 5 percent of gross domestic product. His budget draws a picture of a nation that like many American homeowners simply cannot get above water.
For Mr. Obama and his successors, the effect of those projections is clear: Unless miraculous growth, or miraculous political compromises, creates some unforeseen change over the next decade, there is virtually no room for new domestic initiatives for Mr. Obama or his successors. Beyond that lies the possibility that the United States could begin to suffer the same disease that has afflicted Japan over the past decade. As debt grew more rapidly than income, that country’s influence around the world eroded. Or, as Mr. Obama’s chief economic adviser, Lawrence H. Summers, used to ask before he entered government a year ago, “How long can the world’s biggest borrower remain the world’s biggest power?”
The Chinese leadership, which is lending much of the money to finance the American government’s spending, and which asked pointed questions about Mr. Obama’s budget when members visited Washington last summer, says it thinks the long-term answer to Mr. Summers’s question is self-evident. The Europeans will also tell you that this is a big worry about the next decade. Mr. Obama himself hinted at his own concern when he announced in early December that he planned to send 30,000 American troops to Afghanistan, but insisted that the United States could not afford to stay for long.
“Our prosperity provides a foundation for our power,” he told cadets at West Point. “It pays for our military. It underwrites our diplomacy. It taps the potential of our people, and allows investment in new industry.” And then he explained why even a “war of necessity,” as he called Afghanistan last summer, could not last for long. “That’s why our troop commitment in Afghanistan cannot be open-ended,” he said then, “because the nation that I’m most interested in building is our own.”
Mr. Obama’s budget deserves credit for its candor. It does not sugarcoat, at least excessively, the potential magnitude of the problem. President George W. Bush kept claiming, until near the end of his presidency, that he would leave office with a balanced budget. He never got close; in fact, the deficits soared in his last years. Mr. Obama has published the 10-year numbers in part, it seems, to make the point that the political gridlock of the past few years, in which most Republicans refuse to talk about tax increases and Democrats refuse to talk about cutting entitlement programs, is unsustainable. His prescription is that the problem has to be made worse, with intense deficit spending to lower the unemployment rate, before the deficits can come down.
Mr. Summers, in an interview on Monday afternoon, said, “The budget recognizes the imperatives of job creation and growth in the short run, and takes significant measures to increase confidence in the medium term.” He was referring to the freeze on domestic, non-national-security-related spending, the troubled effort to cut health care costs, and the decision to let expire Bush-era tax cuts for corporations and families earning more than $250,000. But Mr. Summers said that “through the budget and fiscal commission, the president has sought to provide maximum room for making further adjustments as necessary before any kind of crisis arrives.”
Turning that thought into political action, however, has proved harder and harder for the Washington establishment. Republicans stayed largely silent about the debt during the Bush years. Democrats have described it as a necessary evil during the economic crisis that defined Mr. Obama’s first year. Interest in a long-term solution seems limited. Or, as Isabel V. Sawhill of the Brookings Institution put it Monday on MSNBC, “The problem here is not honesty, but political will.”
One source of that absence of will is that the political warnings are contradicted by the market signals. The Treasury has borrowed money to finance the government’s deficits at remarkably low rates, the strongest indicator that the markets believe they will be paid back on time and in full. The absence of political will is also facilitated by the fact that, as Prof. James K. Galbraith of the University of Texas puts it, “Forecasts 10 years out have no credibility.”
He is right. In the early years of the Clinton administration, government projections indicated huge deficits — over the “sustainable” level of 3 percent — by 2000. But by then, Mr. Clinton was running a modest surplus of about $200 billion, a point Mr. Obama made Monday as he tried anew to remind the country that the moment was squandered when “the previous administration and previous Congresses created an expensive new drug program, passed massive tax cuts for the wealthy, and funded two wars without paying for any of it.” But with this budget, Mr. Obama now owns this deficit. And as Mr. Galbraith pointed out, it is possible that the gloomy projections for 2020 are equally flawed. Simply projecting that health care costs will rise unabated is dangerous business.
“Much may depend on whether we put in place the financial reforms that can rebuild a functional financial system,” Mr. Galbraith said, to finance growth in the private sector — the kind of growth that ultimately saved Mr. Clinton from his own deficit projections. His greatest hope, Mr. Galbraith said, was Stein’s law, named for Herbert Stein, chairman of the Council of Economic Advisers under Presidents Richard M. Nixon and Gerald R. Ford. Stein’s law has been recited in many different versions. But all have a common theme: If a trend cannot continue, it will stop.
Wall of Junk Debt Maturities Looms, Moody’s Says
The boom in the high-yield debt markets has bought time and breathing space for companies needing extra financial flexibility. But that has come at a cost, according to the latest annual report by Moody’s Investors Service: more than $700 billion will come due between 2012 and 2014. Thanks to both the earlier buyout boom, born of an unprecedented wave of cheap credit, and the recent reopening of the financial markets, companies with speculative-grade paper will find themselves in need of refinancing or repayment in a few years. Whether the improvement in the economy and the rediscovered appetite for risk will head off another disaster remains to be seen, Moody’s analysts caution.
“If everything behaves normally and you have an efficient market, things should be OK,” Kevin Cassidy, a senior credit officer at Moody’s, told DealBook on Monday. “But that’s a big if.” With the onset of the credit crunch in 2008, restructuring professionals — the bankers, lawyers and consultants who shepherd clients through reorganizations or bankruptcy filings — found themselves busier than they had been in years. While the number of filings declined later last year, these advisers cautioned that a wall of coming maturities could make increase their workloads yet again.
According to Moody’s, roughly 995 of 1,300 issuers have debt that matures between this year and 2014. The coming crush of maturities won’t materialize this year, with Moody’s calculating about $21 billion in high-yield debt maturing this year. But in 2014, that number swells to $338 billion in loans and bonds coming due. The story of the explosion in cheap lending during the credit boom is well known at this point, and that bubble’s popping has already led to big bankruptcy filings and bracing debt reorganizations. Of the top ten issuers with debt maturities coming due between 2010 and 2014, several are tied to boom-era buyouts, including a subsidiary of the utility player TXU (now known as Energy Future Holdings); the hospital operator HCA; the data services provider First Data; and the chip maker Frescale Semiconductor.
But 2009 also saw a wave of high-yield debt offerings as well, some $145 billion in new junk bond issuances. Over all, speculative-grade companies raised about $200 billion in new debt for the year. What’s especially notable is that about 78 percent of that debt was for refinancing existing obligations, Moody’s points out. While those loans and, increasingly, bonds has postponed the day of reckoning for companies, it does nothing to relieve their overall debt loads. “Despite significant spread-tightening in the credit markets, there remain only limited options for rolling over this debt,” Peter Fitzsimmons, the North America president for the consulting firm AlixPartners, said in a press release last week. “Therefore, the potential for a very serious cash crunch could be knocking on the door of Corporate America.”
The Moody’s report also raises another concern. With so much of the recent issuances taken up by refinancings, it’s not clear how much appetite the high-yield market may have for debt meant for other purposes, notably mergers and acquisitions. Deal-makers have predicted that their business will pick up again as the financing markets again become receptive to new offerings. If the overall market for debt grows, that won’t be much of a problem. But with banks still largely filled to near-capacity for lending and the hunger among bond investors unknown at this point, it’s not clear whether M.&A. will rise to the hoped-for frothier levels anytime soon.
Double Dip Risk Rises After Inventory Blowout
When is quarterly gross domestic product growth of almost 6 percent bad news? When it looks like what was reported last week. U.S. GDP increased 5.7 percent at the end of last year, with more than half of that growth -- 3.4 percent -- attributable to changes in inventories. This astonishing impact of inventory has ample historical precedent, and the bottom line has terrible implications for 2010. Inventories are a remarkable corner of the economy. They are the goods and materials that companies keep on hand to make sure that their operations run smoothly. They are the boxes of food on shelves at the grocery store and the bins of metal parts sitting next to the assembly line in a manufacturing plant.
Inventories were a big part of the story during the worst of this recession, and that is nothing new. In a landmark paper published in 1980, Princeton University economist Alan Blinder found that inventories, while accounting for less than 1 percentage point of national output, accounted for 37 percent of the fluctuations in output. Since Blinder’s paper came out, inventories have held onto their important role. Updating Blinder’s calculations through the fourth quarter of last year, inventories have accounted for about 34 percent of historical fluctuations in GDP since 1947. Inventories are even more important during recessions. In another paper, co-authored with Louis Maccini in 1991, Blinder found that 87 percent of the decline in GDP from the peak to the trough of the recession was attributable to inventories.
Something that constitutes a small share of GDP can have a big impact on its overall volatility only if it is swinging about wildly. Inventories fluctuate so much for a simple reason: Predicting the future is really hard. A firm tries to set its inventory level to match expected future sales. It must balance the financial cost of carrying inventoried items against the risk that customers might not find the product they are looking for. In good times, inventories are relatively easy to manage. Demand grows a little bit each quarter, and firms have a good idea what their future sales will be.
Around turning points, expectations can go horribly wrong, and inventories are often the first sign that firms are being surprised by their customers. A car manufacturer might expect that it will sell 100 cars next month and set its production accordingly. If sales fall short, the unsold cars sitting on the lot represent inventory piling up. The manufacturer will likely respond by cutting output, since it already has enough cars on hand to meet next month’s sales. In other words: If we see inventories piling up, firms may need to adjust their future activity downward. On the other hand, sales sometimes jump unexpectedly, driving inventories below their desired levels. When that happens, we can expect firms to ramp up production to replenish their stocks.
Since 1970, there have been nine quarters, like the last one, when GDP grew by at least 3 percent and inventories accounted for at least half of that growth. The history of those quarters is hardly a favorable sign of what is in store. Inventory spikes make for blowout quarters. In the nine quarters with such spikes, the average growth rate was 6.6 percent and the average inventory contribution was 4.4 percent, even higher than what was observed for last quarter. Spikes also produce hangovers. The average growth rate in the quarter after a spike was 0.9 percent, a whopping 5.7 percent lower. In the second quarter following a spike, the average growth rate is just 1.6 percent.
To be sure, the inventory story is not the only red flag right now. The unemployment rate in the U.S. is hovering around 10 percent and has shown little sign of recovery. In addition, any positive effects of the economic stimulus are likely dwindling. On top of that, the tax cuts enacted by President George W. Bush are set to expire, and the U.S. deficit is so high that even a subtle swing in interest rates can have major negative budget implications. Given those factors, we might consider ourselves lucky if we experience only the typical decline in growth that follows an inventory spike. In that case, first-quarter growth in 2010 will be right around zero. If that happens, talk of a double-dip recession will ignite. Such talk probably should begin now.
Volcker rule unlikely to move forward in Senate, lawmakers say
A proposal by former Federal Reserve Chairman Paul Volcker to limit bank’s proprietary trading will be either be dropped or significantly modified in the Senate, lawmakers and staffers told dealReporter. Senate Banking Committee ranking member Richard Shelby (R-AL) said he opposes the so-called Volcker rule and the Obama administration’s call to levy a USD 90bn tax on banks. His comments come as House Financial Services Committee Chairman Barney Frank (D-MA) predicted the proposals outlined by President Obama could be law within six months.
Speaking to this news service on Thursday, Shelby said if Democrats push forward with the proposals they risk unravelling much of the bipartisan support already reached regarding the passage of financial regulatory reform in the Senate. Shelby said that the Obama administration risks losing Republican support for the bill if they begin to “politicise” the issue. However, Shelby said he expects to hold a meeting with Banking Committee Chairman Chris Dodd (D-CT) regarding the way forward on regulatory reform in two weeks time. A Democratic banking committee staffer confirmed that the meeting between Dodd and Shelby will be critical as Dodd needs to determine the level of bipartisan agreement and the timing of bringing the bill through committee and on the Senate floor.
With the election of Republican Scott Brown to the Senate, the Democrats no longer have the necessary 60 votes to force through a Regulatory Reform package, and any bill will need at least some Republican support to pass. A Dodd staffer said the senator is likely to quietly drop or modify many of the recommendations in the Volcker rule to ensure Republican support for regulatory reform. “Chris is retiring so he wants to end his career with an important regulatory reform bill and he wants to make the bill bipartisan,” the staffer said. “He is not going to risk bipartisan support to make the White House happy.”
The Democratic staffer said there is an ongoing debate among members of the banking committee about whether the Volcker rule would effectively push risk out of regulated markets and thus ultimately create more risk to the financial system. Dodd told this news service on Thursday that the banking committee will begin mark-up of the financial regulatory bill in the near future and his committee will hold a committee meeting on the Volcker Amendment on Tuesday with Volcker and a follow-up hearing on Thursday.
Senator Mark Warner, a Democrat on the banking committee from Virginia, also said he has concerns regarding elements of the Volcker rule, many of which are already being dealt with by the committee. He said that one of the problems is in the definition of what constitutes proprietary trading and that regulators should be more proactive in determining what constitutes excessive risk taking by financial players. Warner also said that the prospective Senate version of the Kanjorski amendment passed by the House also includes using capital adequacy standards to reign in excessive risk taking by financial institutions and that such an approach gives regulators greater flexibility.
A Democrat committee staffer said the Senate committee is loathe to include statutory capital adequacy standards included in the House bill and that such standards should be determing by regulators. House Financial Services Subcommittee Chairman Paul Kanjorski told this news service he is only 80% to 85% in agreement with the Volcker rule and that many issues raised by Volcker are already included in his amendment passed by the House.
Warner blamed much of the political storm connected to regulatory reform on bankers. He called Goldman Sachs’s proposal to lend USD 500m to small businesses over a five-year period derisory, and said banks need to come out in front of the issue regarding compensation. Warner said he is proposing that US banks set up a USD 1trn fund to invest in US infrastructure projects as a way to avoid the USD 90bn bank levy. A staffer said that Warner is not calling for the banks to place USD 1trn in cash, but to raise such an amount through leverage.
Banks Gear Up for a Battle
U.S. Takes Aim at Proprietary Trading, But Just What is It?; 'the Volcker Rule'
The showdown over the future of proprietary trading by U.S. banks is about to begin. One likely fight: defining exactly what proprietary trading is. Wall Street has been hungry for details ever since President Barack Obama proposed curbs last month that would limit the ways banks with insured deposits bet with their own capital. Some answers will emerge Tuesday at a Senate Banking Committee hearing where former Federal Reserve Chairman Paul Volcker is set to testify. "There is a broad distinction between proprietary trading and responding to a customer requirement," Mr. Volcker said in an interview shortly after Mr. Obama announced his new initiative, which the president dubbed "the Volcker rule." Mr. Volcker's position helped shape Mr. Obama's position.
It mightn't be so easy. Many bankers and lawmakers agree that traders who buy and sell securities strictly for their company's gain, and are removed from day-to-day customer servicing, are proprietary traders. If approved by Congress, Mr. Obama's proposal probably would push hundreds of traders at Goldman Sachs Group Inc., Morgan Stanley and other financial firms with federally insured banking units to hedge funds and trading funds outside the government's safety net.
But what about market makers? Such traders use a bank's capital to buy and sell securities to customers. When customers are in a hurry or don't have a ready counterparty, market makers step into the middle of the trade. Market-making can be especially profitable in bond trading, where regulations are looser than for trading stocks. The confusion arises because many market-making traders also are allowed to do noncustomer trades using firm capital. Senior traders and executives at U.S. banks say the vast majority of such side trading is done to offset risks taken for customers, who often expose firms to risky positions they wouldn't otherwise take.
David Trone, a brokerage analyst at Macquarie Capital, estimates that 5% to 10% of the revenue at the trading divisions of major banks comes from side trading that isn't strictly for customers. That activity could generate billions of dollars in annual revenue for the biggest firms. "There are, in fact, a gazillion customer trades going through," said Mr. Trone. "That is their primary business. But it is a very dynamic game, and they can take proprietary bets with those dealer books if they feel like they're seeing an opportunity."
Here is one example of how hard it can be to untangle proprietary trading from market-making: As a market maker, a bank buys from a customer $25 million of 10-year bonds issued by government-sponsored mortgage company Fannie Mae. To offset the risk of those bonds falling in value if interest rates rose, the bank might then sell $25 million of 10-year Treasurys. That sale could be considered a proprietary trade. And, at some banks, market-making trades and proprietary trades are commingled in the same accounts. That can makes it hard to discern why a trade was made.
Treasury and White House staffers are working to define the Volcker rule for banks and regulators. "On the substance of proprietary trading, there are complicated issues here," said Neal Wolin, deputy Treasury secretary. "In the coming weeks, we will propose legislative language," he added."We have obviously listened to a full range of people who have insights that could be brought to bear." Mr. Wolin also is set to testify Tuesday before the Senate Banking Committee. Wall Street executives, including Gerald Corrigan, a Goldman managing director, and J.P. Morgan Chase & Co. Chief Risk Officer Barry Zubrow, will speak Thursday.
Banks have argued that any curbs on their ability to use capital to hedge customer trades could have dire consequences. The deep liquidity, or ease of trading, in many markets would dry up, they contend. In markets where a lack of trading volume makes involvement by the firms essential, activity could grind to a halt, companies have warned. Some analysts think banks are overreacting to Mr. Obama's tough talk. "It doesn't appear the proposal is designed to kill the capital markets," said Brad Hintz, the senior analyst covering banks for Sanford C. Bernstein & Co. "It appears that what the proposal is designed to do is to reduce the risk-taking."
How much in bank profits come from proprietary trading and investing is hard to quantify. Statements and figures from Goldman, probably the biggest player in proprietary trading, suggest it accounts for less than 7% of annual revenue. At Morgan Stanley, which closed all but two proprietary-trading desks after big losses in 2007, about 2% to 3% of revenue stems from such trading. At J.P. Morgan and Bank of America Corp., proprietary trading is an estimated 1% or less of total revenue. Citigroup Inc. estimates it gets less than 2% of revenue from proprietary trading.
Greece under EU protectorate as funds shift fire to Portugal
By Ambrose Evans-Pritchard
The European Commission has ordered Greece to slash public spending and spell out details of its austerity plan within "one month", invoking sweeping new EU Treaty powers to impose a radical shake-up of the Greek economy. Greece's labour federation immediately called a general strike for February 24, dashing hopes that Europe's provisional backing for Greek crisis policies would restore investor confidence. Joaquin Almunia, the EU economics commissioner, said tough measures were "extremely urgent" to prevent a further flight from Greek debt. "The huge imbalances from which the Greek economy is suffering are not sustainable in the long run. The fact of the matter is that markets are putting on pressure. This pressure cannot be ignored."
Mr Almunia said concerns have spread beyond Greece to other eurozone countries where public finances are spinning out of control, chiefly Spain and Portugal. "In these countries we have seen a constant loss of competitiveness ever since they joined the eurozone. The external financing needs are quite big," he said. Yields on 10-year Portuguese bonds jumped 21 basis points yesterday as funds switched their fire to the next "domino", questioning whether the government of Jose Socrates can deliver spending cuts without a parliamentary majority. "The lightning rod has been passed to Portugal: who is next – Spain?" asked Marc Chandler, from Brown Brothers Harriman.
George Papandreou, the Greek premier, has agreed to a rise in fuel taxes and a partial freeze in public wages to stop the country "falling off a cliff". Even this will not be enough to satisfy Brussels – itself under pressure from Germany and the European Central Bank. The EU's hard-line faction is afraid that fiscal discipline will break down altogether across "Club Med" nations unless Greece first suffers public flagellation. Brussels invoked new EU powers under Article 121 of the Lisbon Treaty, allowing it to reshape the structure of pensions, healthcare, labour markets and private commerce – a step-change in the level of EU intrusion.
The EU told Greece to "spell out the implementation calendar of (budget) measures within one month". Athens must be ready to "adopt additional measures if needed" and to submit quarterly updates. To cap the humiliation, the EU is taking Greece to court over past falsification of budget figures. "This is the first time we have established such an intense and quasi-permanent system of monitoring," said Mr Almunia. The Greek Left said the measures reduce Greece to an economic protectorate The gap between what EU demands and what ordinary Greeks seem willing to accept is so wide that it may prove extremely hard for Mr Papandreou carry the country. The top union bloc said the government had "succumbed to the will of the markets" but would now have to face the stronger will of the people.
Samir Patel, from the consultancy BH2, said austerity plans will "almost certainly send Greece into a deflationary spiral", and tip its banking system "into the Mediterranean Sea". Greece is being told to carry out IMF-style retrenchment without the IMF cure of devaluation. One banker described events as eerily similar to market confusion before the failure of Bear Stearns and Lehman Brothers in 2008, this time involving sovereign states rather than banks. It is assumed that Europe must in the end rescue Greece, but Germany is so far sticking to its "no bail-out" mantra and nobody knows for sure how the drama will end.
The legal and political structure is simply not ready to cope with an escalation of the crisis and the problems spreading to Spain, should that occur. Spain's budget deficit reached 11.4pc last year, and is on a worrying trajectory for a country that has lost so much intra-EMU competitiveness and cannot let the currency take the strain. Spanish bank BBVA shocked markets last week with a 94pc fall in profits, largely due to property losses. Spain's mortgage association said days later that the "real estate sector is bankrupt" and threatened the financial system. Spain's total public and private debt is over 300pc of GDP, much higher than Greek debt. With unemployment already above 4m – or 4.5m including regional jobless schemes – Madrid will not react well to the sort of austerity imposed on Athens. Fears that the slow fuse on Spain's political crisis may soon detonate a timebomb is creeping into the markets.
Eurozone states take on record debt levels
Eurozone governments have borrowed a record €110bn from the markets so far this year, forcing up borrowing costs for those countries with the weakest public finances as they pay a heavy price for their ballooning debt levels. Investors warned that the yields, or interest rates, they would demand to lend to Greece and other peripheral economies, such as Portugal, Spain, Ireland and Italy, would rise until they were convinced they had put their finances in order. Theodora Zemek, global head of fixed income at Axa Investment Managers, said: "The problem of sovereign risk is just beginning. Countries with high debt levels will have to pay higher and higher yields to issue new bonds."
Another investor said: "Confidence in high-debt countries has reached such a low point. If there is any sign from politicians that they are not prepared to tackle their debt levels, then there will be a sell-off in eurozone bonds." The warning from investors came as the Greek government insisted that it would keep its borrowing programme on track in spite of concerns in financial markets, which saw bond yields hit 10-year highs last week. Senior Greek finance ministry officials, speaking on condition of anonymity, said the country still planned to issue a 10-year bond in the form of a syndicated loan and would also go ahead with a marketing trip to the US and Asia, although no dates had been set.
Athens' attempt to calm markets followed an emergency meeting on Sunday of Greek bankers and financial officials chaired by George Papandreou, prime minister, to discuss the debt crisis. Greece is expected to announce more stringent measures in response to tomorrow's assessment of its three-year stability plan by the European Commission. Athens' moves to tighten fiscal policy and rebuild credibility with financial markets follow a rise in 10-year bond yields last week to 7.25 per cent at one point. Although Greek 10-year bond yields, which have an inverse relationship with prices, fell yesterday to 6.62 per cent, they still remain 3.44 percentage points more than Germany's, close to a record premium.
Investors said the Greeks, and other peripheral economies, were facing credibility problems and a threat of crowding out - where debt managers have to raise yields to lure investors because of competition from other governments. The threat of crowding out will remain for a while yet as governments continue to raise record amounts of bonds to pay off debts taken on to bail out the banks and reverse the downturn in their economies. This week eurozone countries expected to borrow another €27bn ($38bn, £24bn), according to Barclays Capital, close to a weekly high. One official said: "We intend to go ahead with a 10-year-bond . . . but the date may be delayed beyond next month." After raising €8bn in a syndicated offering last week - more than double the targeted amount - Greece had covered its debt financing needs until the end of March, he said.
EU toughens demands on Greece
By Ambrose Evans-Pritchard
Investor flight from Southern European debt markets has begun to subside as EU political leaders move closer to some sort of rescue for Greece, but it remains far from clear whether the Greek people will accept Europe’s increasingly draconian terms. Yields on 10-year Greek bonds have fallen back by over 50 basis points from the wild spike to 7.15pc last week, though spreads over German Bunds are still at crippling levels. Growing confidence that the EU will not allow a domino crisis across the edges of the eurozone led to a recovery in Spanish, Portuguese, Italian, and Irish bonds.
Germany’s foreign minster, Guido Westerwelle, said before flying to Athens that Greece had the "full backing" of his country and other EU partners, but warned that the EU would not tolerate any delay in carrying out spending cuts. The EU draft calls for cuts in "average nominal wages" across the entire public sector, pensions cuts, a rise in the retirement age, a fuel levy and luxury taxes. Mr Papandreou has agreed to cut the budget deficit from 12.7pc to 3pc in three years, but hopes to rely on growth do to much of the work. Brussels has made short shrift of that illusion.
Joaquin Almunia, the EU’s economics commissioner, said targets would be enforced vigorously. "Every time we see or perceive slippages, we will ask for additional measures to correct these slippages. Never before have we established so detailed and tough a system of surveillance," he said. Conservative leader Antonis Samaras said his party would back the austerity plans for the good of the country but it is less clear whether citizens will prove so amenable to "EU diktats", as they are described in the Greek media. Protesters camped in front of the Greek parliament over the weekend. Widspread strikes are planned this month.
"There is a huge perception gap between what Greeks think is the problem and the reality," said one hedge fund manager with Greek ties. "Germany is looking for some blood-letting before coming to the rescue, and I don’t think the people or even the Greek government yet understands that." Mr Papandreou said in Davos that Greece had been targeted by speculators trying to damage the euro. His claim serves a useful legal function because it may allow Greece to invoke Article 122 of the Lisbon Treaty, which clears the way for EU help to any member "in trouble for reasons outside its own control."
The European Central Bank said last month Greece was responsible for its own problems and could not expect an EU rescue. If claims of speculative attack are accepted as broadly true, this could enable more sympathetic EU officials to put together a package that overrides the statutory prohibition on EU bail-outs.
Hedge Funds Speculate on Greek Debt
Greece's debt problems are attracting hedge funds which are betting that the country will default. Meanwhile a leading German economist has argued that the European Central Bank should allow inflation to rise in a bid to avoid a costly and unpopular bailout for Greece. Greece's ailing state finances are increasingly attracting speculators. "The hedge funds are operating very aggressively," Hans Redeker, chief currency strategist at French bank BNP Paribas, told SPIEGEL. In recent weeks the funds have been dealing in so-called credit default swaps (CDS) on a large scale. A CDS is a contract under which one side pays an annual fee to buy protection against default, while the seller promises to cover losses in the event of a default. They are in effect an insurance policy against defaults of bonds and other debt. The buyer gets a payoff if the underlying bond goes into default.
In the case of Greece, the dealers in CDS are betting that the Greek government won't be able to repay its debts and that the price of CDS will therefore rise. The prices of credit default swaps on Greek sovereign debt have already reached astronomical levels, rising to a record high of 410 basis points last week, twice as high as in December. That means that investors who want to insure €10 million worth of Greek government debt against default for five years now have to pay around €400,000 a year. The equivalent hedging price for a German government bond amounts to just €35,000. "It's the same game as a year ago with Austria," says Philip Gisdakis, credit analyst at Italian bank Unicredit. At the time, hedge funds benefited from rising CDS prices for Austrian debt. Austria's close economic ties with cash-strapped eastern European countries was regarded as a potential trigger for a government default.
Fears of a debt default by Greece and other EU countries that have been hit hard by the financial crisis have caused the euro single currency to depreciate sharply in recent weeks. The euro member states now face a dilemma, according to Thomas Straubhaar, president of the Hamburg-based HWWI economic institute. "If they help Greece, they will spark a speculation race. There will be a domino effect in which other indebted states will also have to be bailed out. That will cost all euro countries -- including the relatively stability-oriented ones such as Germany -- a lot of money," Straubhaar wrote in an article published on SPIEGEL ONLINE. Bailing out Greece with taxpayers' money would be deeply unpopular and difficult to sell to voters, but if euro zone countries abandon Greece, economic imbalances within the euro area would grow, and hopes for closer European integration would be dashed.
Straubhaar says one solution would be to allow inflation in the euro area to rise. That would lessen the real burden of nominal debt, and in political terms would be the simplest way to deal with excessive government debt. "Inflation lessens the real purchasing power of the masses like an indirect tax (...). But there's a tremendous difference: It requires no parliamentary approval," Straubhaar wrote. He said the European Central Bank will need to tolerate higher inflation. "Higher inflation rates are the cost that an economically strong euro country like Germany would have to pay to prevent a break-up of the European Monetary Union, which would be even more expensive." Rising inflation would also cause the euro to depreciate further against other currencies -- good news for exporters, but bad news for importers, holidaymakers and savers, wrote Straubhaar.
Spain's Tax-Dodging Landlords, Tenants Adding to Country's Burgeoning Debt
More than half of Spain’s landlords are dodging taxes as the rental market expands, depriving the financially strapped government of more revenue each year. Owners are asking for payment in cash from tenants to avoid tax on 2.5 billion euros ($3.5 billion) of earnings annually, the Gestha union of tax inspectors estimates. An increase in rental properties nationwide hasn’t generated any more tax revenue. The Spanish government, seeking to pull the country out of its deepest recession in 60 years, needs all the money it can get right now. The slump was triggered by a crash in the housing market and has left Spain with the highest budget deficit since at least 1980. Taxes go unpaid on income equal to about a quarter of gross domestic product, Gestha estimates.
“The deep economic crisis in which the country is submerged is once again making the hidden economy flourish,” said Juan Jose Figares, chief analyst at Link Securities in Madrid. “The government will be compelled to clamp down on rent fraud.” A drop in house prices starting in the second quarter of 2008 has forced many people who bought homes as investments to seek tenants for their properties rather than selling at a loss. At the same time, more Spaniards are trying to lease homes after they were priced out of the market in the years before the crash, making it easier for landlords to strike deals that don’t involve the taxman. The number of properties for rent increased 18 percent to 2.2 million units in 2008, according to data from Spain’s Housing Ministry. Rental income declared by landlords rose by just 0.1 percent over the same period, a report on the Web site of Spain’s tax office shows.
The rental market has a lot of room to grow. At 13 percent, the proportion of renters to homeowners in Spain is still low compared with other European countries, where 40 percent to 60 percent of housing is rented, according to Madrid-based property consultant Aguirre Newman. Around 65 percent of Spaniards aged 25 to 29 live with their parents, compared with about 22 percent in France and the U.K., economic research institute Fedea estimates. “During the housing boom, the state was earning so much from home sales that it wasn’t worth chasing the odd landlord,” said Fernando Encinar, co-founder of Idealista.com, Spain’s largest real estate Web site. “Now, with the economic crisis, the government really does need the money and will make efforts to prosecute tax dodgers.”
Encinar, whose company lists 360,000 properties for rent and purchase, said Gestha’s estimate that 54 percent of landlords are ducking taxes “falls short of the true figure, which is set to grow further.” The penalty for avoiding tax on rent is a fine equivalent to 150 percent of the unpaid amount, according to the Spanish tax office. The tax also must be repaid. There is no punishment for the tenant. The penalty is almost never applied because tax dodgers are not being investigated, Gestha General Secretary Jose Maria Mollinedo said. “As both the landlord and the tenant make an agreement not to declare tax or their residency, there is absolutely no way to prove that tax fraud is taking place and therefore no non- declaring landlords are brought to book,” Mollinedo said.
A tax break adopted in 2008 accounts for part of the difference between rising rentals and the lack of tax revenue growth. It gives landlords a 100 percent tax break if they rent to tenants who are under 35, according to a spokesman for Spain’s tax office who declined to be identified by name, citing government policy. He didn’t provide information on how many landlords claimed the tax break. The incentive makes little difference because most leaseholders are over 35 and landlords worry that the break will be repealed in a couple of years, after they’re all registered with the state, Mollinedo said. Spain can ill afford to lose revenue it should be collecting. The country, which had a record budget surplus equal to 2 percent of GDP in 2006, will probably have an overall public-sector deficit of 9.8 percent this year, according to Finance Ministry data submitted to the European Commission today.
Sellers pay 18 percent capital gains tax in Spain on any profit made from home sales. There were 106,273 transactions in the third quarter of 2009, according to the most recently published data from the housing ministry. That was 14 percent lower than a year earlier and 58 percent less than the market’s peak in the second quarter of 2006. Values decreased as much as 11 percent last year, Idealista.com said. Rent fraud is just the tip of the iceberg, with Spaniards avoiding tax on income of 240 billion euros, equivalent to 23 percent of the economy, according to Gestha. If Spain could reduce that figure 13 percent, the country generate another 25 billion euros of tax revenue annually, it said. Tenants, happy to find a place at all, aren’t likely to turn into whistleblowers. While rents fell 8.4 percent in Madrid and 12 percent in Barcelona during the first half of 2009, increases over the previous five years continue to squeeze budgets. Rent levels climbed 28 percent in the capital and 56 percent in Barcelona in the five-year period.
Ruben Gonzalez, a 33-year-old Madrid resident, said he received 120 calls in four hours after placing an advertisement in Idealista.com for a 2-bedroom apartment on behalf of his current landlord. Then he turned his cell phone off.
Gonzalez showed the first 30 callers around the 60-square- meter (645-square-foot) city center apartment, which has a broken refrigerator and faulty boiler, rising damp and peeling paint. “‘Everyone was fighting over the place because it’s better than a lot of what is out there and the owner is legal and insists on a contract.” Gonzalez said. “One couple even offered to pay more than the asking price and another offered a cash bribe to put them at the top of the list.”
Should Germany bail out Club Med or leave the euro altogether?
By Ambrose Evans-Pritchard
Germany faces a terrible dilemma. Either Europe's paymaster agrees to underwrite a Greek bail-out and drops its vehement opposition to a de facto EU economic government, treasury, and debt union, or the euro will start to unravel, and with it Germany's strategic investment in the post-war order. The spike in yields on 10-year Greek bonds to 400 basis points above German Bunds has been shockingly swift – a warning to Britain, too, that markets can suddenly strike any country that takes creditors for granted. We can argue over whether Greece, Portugal, or Spain are at risk of being forced out of the euro. But there is another nagging question: whether events will cause Germany and its satellites to withdraw, bequeathing the legal carcass of EMU to the Club Med bloc.
This is the only break-up scenario that makes much sense. A German exit would allow Club Med to uphold contracts in euros and devalue with least havoc to internal debt markets. The German bloc would enjoy a windfall gain. The D-Mark II would be stronger. Borrowing costs would fall. The North-South gap in competitiveness could be bridged with less disruption for both sides. To be sure, Germany is happily placed in the current EMU system. By compressing wages for a decade it has stolen a march on EMU. Critics unfairly call this a beggar-thy-neighbour policy. It is simply the way Lutheran society operates, in deep contrast to the way Latin society operates – a cultural clash that should have given pause for thought before Europe's elites launched headlong into their adventure.
German goods are flooding the South. In the 12 months to November, Germany-Benelux had a current account surplus of $211bn: Spain had a deficit of $82bn, Italy $74bn, France $57bn, and Greece $37bn. German industry will not give up this edge lightly. However, the matter will in the end be decided by democracy. German citizens were given a pledge by their leaders in the 1990s that loss of the D-Mark would not lead to monetary disorder, or leave them liable for Club Med debt. That is the sacred contract of EMU. "Politically," said Bundesbank chief Axel Weber, "it's not possible to tell voters that they are bailing out another country so that it can avoid painful austerity measures that they themselves have gone through. Such aid, whether conditional, or – even worse – unconditional, is counterproductive."
Dr Weber is right on both counts. Fresh loans for Greece can achieve nothing useful at this stage. Greece already has a public debt hurtling towards 138pc of GDP by 2012 (Standard & Poor's). It is already in a debt compound spiral. The EU elites have yet to acknowledge that Greece and much of Club Med need gifts – not loans – akin to transfers paid to East Germany after unification, or North Italian perma-subsidies to the Mezzogiorno.
Athens has promised to slash the budget deficit by 10pc of GDP over three years, though the country is sliding deeper into slump, faces 20pc unemployment by the year's end, has a tottering banking system, and has already lost control of its streets before spending cuts have even begun. Such a policy is economically self-defeating – since it risks tipping the country into depression, and causing tax revenues to collapse – but will it be tolerated by Greek society?
The Papandreou government has craftily invited the European Commission to set up a vice-regal inspectorate in Athens, to become the focus of popular fury. The media talks of "guardianship". Ta Nea, an Athens newspaper, writes of "ultimatums" and "suffocating deadlines" for wage and pension cuts. "Either we obey the commands of unprecedented austerity and face the risk of widespread social unrest or we refuse to implement the orders."
Spain's troubles are less immediate, but it lost as much competitiveness during the early EMU boom, that debt trap of negative real interest rates. External corporate debt is dangerously high. The budget deficit was 11.3pc of GDP last year. Madrid has drawn up €50bn of cuts to sweeten the markets, even though unemployment is already 19pc. The jobless typically receive 50pc to 60pc of former earnings for around 18 months, then the axe falls. The social distress hits with a lag. How much more tightening can Spain endure before Catalan, Basque, and Galician seperatism rocks the Spanish state?
Fiscal austerity in these circumstances without monetary and exchange stimulus to offer a lifeline is incoherent. These policies must fail because they are based on EU wishful thinking that high-debt nations can regain competitiveness within EMU against a zero-inflation Germany. Such a strategy will drive them into a debt-deflation spiral. Europe will have to embrace "fiscal federalism" if it is to hold monetary union together. That is when we will probe the limits of EMU solidarity. Hedge funds are betting that Berlin will pay to ensure stability. No doubt Chancellor Angela Merkel is of that mind, but the Free Democrats are not, nor are Bavaria's Social Christians, or the Bundestag's finance committee. Economy minister Rainer Bruderle said last week that there would be "no bail-outs" regardless of risks to EMU. Is that just brinkmanship?
EMU architects were warned in the early 1990s that monetary union would prove unworkable as constructed. They scoffed, sure that any crisis could be exploited to force the pace of economic union. Commission chief Romano Prodi later admitted as much. "The euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible now. But some day there will be a crisis and new instruments will be created." We will soon learn if this gamble will pay off, or prove catastrophically wrong.
Russia's GDP falls 7.9%, hit by falling oil prices
The economy of resource-rich Russia contracted nearly 8% last year, as prices for its key commodity exports -- particularly oil -- fell sharply. Gross domestic product declined 7.9% in 2009, according to media reports on Monday, citing preliminary data from the Federal Statistics Service in Moscow. Most economists expected a contraction of 8.5%. The decline comes after Russia's GDP grew 5.6% in 2008. The sharp drop in oil prices in 2009 weighed heavily on the Russian economy, which is very dependent on oil and gas exports. Meanwhile, the ruble came under selling pressure and credit was very hard to come by.
The data "confirm that last year's economic decline was the biggest since 1994, surpassing even the 5.1% fall seen during the 1998 financial crisis," said Neil Shearing, senior emerging market economist at Capital Economics, in a note to clients. The government's fiscal stimulus gained more traction than expected in the final months of 2009, indicating that the economy may post strong gains in the first half of the year, he said. However, Shearing expects oil prices to decline in the second half of 2010 and that's likely to trigger a slowdown in the pace of the recovery. "The upshot is that healthy-looking growth of around (or even above) 4% in 2010 will only mask ongoing difficulties in the Russian economy," Shearing said, adding that growth will likely fall back to 1.5% in 2011.
The World Bank expects the Russian economy to grow by 3.2% in 2010, boosted by higher oil prices and stronger global demand. However, real GDP will not return to pre-crisis levels before late 2012, according to the bank, which has emphasized the importance of structural reforms. Other data released on Monday indicated that a recovery in the Russian economy is under way. VTB Capital's Russian Purchasing Managers' Index rose to 50.8 in January, the second reading pointing to an expansion across the sector over the past 18 months.
"Output rose for the sixth straight month and at a faster rate, as new orders increased for the first time since last October," VTB Capital said in a statement on Monday. While companies continued to cut jobs, they did so at a much slower rate than the pace recorded over late-2008 and 2009, the bank said. The PMI index is based on a monthly survey of 300 purchasing executives in Russian manufacturing companies.
Ilargi: A development we've predicted for ages. When its members need income bad enough, OPEC is a dinosaur organization. Quote Schmota, show me the money. Barring new large-scale hostilities in the Mideast, the oil price has a long way to fall.
Opec says oil supply increase 'worrying'
Oil producers' cartel Opec has told the BBC that compliance with production targets fell to 55-56% last month compared with 80% a year ago. Secretary General Abdalla Salem El-Badri told the BBC's Business Daily programme the move was "worrying". "The risk is you see a lot of oil in the market and no one is buying it. Then the price will come down." At its last meeting in Angola, Opec decided not to change the amount of oil being produced by its members.
Oil prices have doubled from their lows of December 2008, but are way down on the record $147 a barrel reached in July 2008. US light, sweet crude is trading at about $78 a barrel - its highest level in two weeks. Mr El-Badri said: "We need a price where we can invest in new capacity, new supply and also cater for the wealth of our people. Anything below $70 will not permit us to invest." He also said that while the global recovery was "still fragile", Opec was experiencing growing demand from China, India and the Middle East.
Opec countries produce about 40% of the world's oil supply and have nearly 80% of the world's crude reserves.
Ilargi: From last week, but potentially useful.
Central banks end US dollar emergency swap lines
The Bank of England said Wednesday that it and other major central banks are ending emergency lending arrangements put in place with the U.S. Federal Reserve in the wake of the global credit crisis, citing improvements in financial markets. The decision marks the first unified retraction by central banks around the world of extraordinary support measures to boost lending after credit markets seized up in late 2007, causing the global economic downturn.
The Bank of England was joined by the European Central Bank, the Bank of Japan and the Swiss National Bank in announcing that the temporary reciprocal currency arrangements with the Fed would expire on Feb. 1. "These lines, which were established to counter pressures in global funding markets, are no longer needed given the improvements in financial market functioning seen over the past year," the bank said in a statement. "Central banks will continue to cooperate as needed."
The Fed announced in December 2007 that it had authorized so-called liquidity swap lines with the European Central Bank and the Swiss National Bank. The agreement was extended to include several other central banks in April 2009. Under the arrangements, central banks around the world provided each other with foreign currency -- the Fed made U.S. dollar liquidity available elsewhere, with the ECB providing euros and the Bank of England providing sterling. The agreements added up to hundreds of billions of dollars.
The aim was to improve liquidity conditions in U.S. and foreign financial markets after banks became nervous of lending to each other amid concerns about the state of balance sheets across the industry. The stagnation in the interbank lending pushed up the premium for short-term U.S. dollar funding in particular, a currency that features widely in both asset and liability tables of banks and companies around the world. That led to a sharp rise in interbank lending rates, which flowed through to the rest of the financial system. The Bank of England said it conducted its last U.S. dollar repo operation under the arrangements on Wednesday.
Copper Market Set for 'Catastrophe'
Copper prices, which more than doubled last year, are set to plunge as speculators unwind positions and global inventories expand, according to David Threlkeld, president of metals trader Resolved Inc. “We’re going to see a catastrophe in the market,” said Threlkeld, who first got the world’s attention in 1996 when he showed that hoarding by Sumitomo Corp.’s Yasuo Hamanaka would lead to a collapse. Prices may slump to less than $1 a pound, he said by phone. That about 67 percent less than today’s levels.
Copper, used in pipes and wires, sets the pace for other industrial metals. A slump in prices may reduce profits at mining companies including Freeport-McMoRan Copper & Gold Inc. and drag other commodity prices lower. Some 90 percent of buying “has been from speculators,” said Threlkeld, who has traded the market for more than 40 years. “Whether they are exchange-traded fund speculators or China pig farmer speculators it doesn’t really matter, because that buying is going to come back to the market,” he said from Arizona. Three-month copper futures on the London Metal Exchange, which surged 140 percent last year after governments spent billions of dollars to lift their economies out of recession, traded today at $6,750 a ton. China, the world’s largest user, imported a record 3.2 million tons of the refined metal in 2009, up 119 percent from the previous year.
There are about 3 million tons of unreported inventories in China, said Threlkeld. The forecast for a slump to less than $1 a pound -- equivalent to $2,205 a ton -- may be driven by higher interest rates in China and the U.S., he said. The prediction reiterates an earlier call and didn’t come with a timeframe. “Three million tons seems a bit excessive, given that that’s more than half of China’s total consumption last year,” said Li Rong, chief analyst at Great Wall Futures Co. China’s copper consumption was about 5 million tons in 2009, he said. China’s gross domestic product accelerated to 10.7 percent in the fourth quarter, the fastest pace since 2007, adding to speculation the country may step up efforts to prevent asset bubbles. The International Monetary Fund says China’s growth will accelerate this year to 9 percent from 8.5 percent in 2009.
“The way the figures are being reported is anything that’s shipped to China is assumed to be consumed, which is clearly ridiculous,” Threlkeld said. Stockpiles monitored by the Shanghai Futures Exchange totaled 101,210 tons last week, more than three times the level a year ago. “What we have now is we have a unique situation, whereby we have a surplus and production has gone up and consumption has gone down,” he said. Output exceeded demand by 191,000 tons in the 11 months to November 2009, the World Bureau of Metal Statistics said on Jan. 20. Inventories monitored by the London Metal Exchange grew about 48 percent last year and stood at a one-year high of 543,525 tons yesterday. “The price of copper is not just a function of how much inventory there is in the market,” said Li Junchao, an analyst at Western Mining Co.’s futures department. “While it’s true that prices last year rallied way beyond their fundamentals, we expect the market to normalize this year and $1 doesn’t quite seem feasible.”
Never short a country with $2 trillion in reserves?
by Michael Pettis
I am traveling in DC, NY and Boston over the next few days, and between meetings and jet-lag it is hard for me to do much on my blog, but I did want to extend a short piece I wrote that was published yesterday in the South China Morning Post. This is because it is about central bank reserves, a topic that to my dismay probably generates more confused and mistaken thinking than any other topic in economics.
As many of my readers know (although I have not made any reference to it on my blog) hedge fund manager Jim Chanos recently made some headline-inducing claims about China. Chanos, a successful hedge fund manager who has made his reputation – and fortune – by identifying and shorting seriously overvalued assets, most famously Enron, seems to have read the PivotCapital piece that got a lot of attention last year, and partly as a consequence he claimed that China is undergoing a speculative bubble that makes it the equivalent of “Dubai times 1,000 – or worse”.
His claim was met with incredulity by New York Times columnist Thomas Friedman. Freidman is best known for his writings on globalization, and although I have no doubt that he is a very smart man when it comes to getting politics right, especially in the Middle East, which I believe is his area of specialty, I also have no doubt that he does not understand China much and understands almost nothing about central bank reserves and the functioning of the global balance of payment. I have read many of his articles, and so far I am pretty sure that these aren’t his strong points.
In response to Chanos’ claim Friedman made a number of very questionable statements about China. These are matters of dispute and although I think they are completely wrong, they are at least defensible. For example he says its true that there may have been risks of bubbles. ”In the last few days, though, China’s central bank has started edging up interest rates and raising the proportion of deposits that banks must set aside as reserves — precisely to head off inflation and take some air out of any asset bubbles.” Really? I think you have to be a tad credulous to believe that the RMB 7.5 trillion lending target for 2010 and the slightly higher interest rates represents taking air out of the asset bubble. I would argue that they simply mean that the astonishing rate at which they were pumping air into the bubble has moderated slightly, to merely excessive.
He also says:Now take all this infrastructure and mix it together with 27 million students in technical colleges and universities — the most in the world. With just the normal distribution of brains, that’s going to bring a lot of brainpower to the market, or, as Bill Gates once said to me: “In China, when you’re one-in-a-million, there are 1,300 other people just like you.”
Aside from perhaps his overestimating the quality of the education system, this is very bad statistics, and perhaps shows how easily we can get intellectually overwhelmed by large numbers. If China indeed has the same distribution of geniuses, or talent, as other countries, the fact that it has so many people won’t make it richer (and what about India?). After all if you cut China into four countries, each country will have only one-fourth the number of geniuses. Does that really mean that the four countries together are stupider? If we combine the US, Canada and Mexico into one country, its a pretty safe bet that the total number of geniuses will be more than any of the three countries currently possess, but will average intelligence rise? Can we really make the three countries richer that way (of course there may be good economic arguments for suggesting that unifying North American into a single country will make it richer, but the larger number of geniuses is not one of these arguments).
Ok, we can argue about these things, and we can agree to disagree, but where he completely blew it was, I suspect, on the one topic are where he was absolutely certain he could not be wrong. Too bad, because he was. Friedman proposed, yet again, a common misconception over the meaning of China’s huge accumulation of foreign reserves. He argued that thanks in part to the size of the reserves it would be impossible to make money by shorting China. “First,” he warned, “a simple rule of investing that has always served me well: Never short a country with US$2 trillion in foreign currency reserves.”
Really? Friedman proposed the rule sarcastically – as both untestable and too obvious to need testing. It is so obvious that no country has ever had such high levels of reserves, so you can’t really test the hypothesis, but it’s also pretty obvious that a country with $2 trillion in reserves is in great shape. Anyone who wanted to short it must be pretty stupid, right? But it turns out that reality is not as obvious as he imagines. Let us leave aside that the PBoC’s reported reserves are a lot more than $2 trillion, and that if correctly accounted they would be pretty close to $3 trillion. China’s foreign reserves are certainly huge. They add up to an amount equal to about 5-6 % of global gross domestic product. But they are not unprecedented. Twice before in history a country has, under similar circumstances, run up foreign reserves of the same magnitude.
The first time occurred in the late 1920s when, after a decade of record-beating trade and capital account surpluses, the United States had accumulated what John Maynard Keynes worriedly described as “all the bullion in the world”. At the time, total reserves accumulated by the US were more than 5-6% of global GDP. My back-of-the-envelope calculations suggest that this was probably the greatest hoard of central bank reserves ever accumulated as a share of global GDP, but please check before you accept this claim.
The second time occurred in the late 1980s, when it was Japan’s turn to combine huge trade surpluses, along with more moderate surpluses on the capital account, to accumulate a stockpile of foreign reserves only a little less than the equivalent of 5-6% of global GDP. By the late 1980s, Japan’s accumulation of reserves drew the sort of same breathless description – much of it incorrect, of course – that China’s does today. Needless to say, and in sharp rebuttal to Friedman, both previous cases turned out badly for long investors and brilliantly for anyone dumb enough to have gone short. During the early years of the Great Depression of the 1930s, US stock markets lost more than 80 per cent of their value, real estate prices collapsed, and the US economy contracted in real terms by an astonishing 30-40 per cent before recovering in the 1940s.
Japan’s subsequent experience was economically less violent in the short term, but even costlier over the long term. During the period following its astonishing accumulation of central bank reserves, its stock market also lost more than 80 per cent of its value, real estate prices collapsed, and economic growth was virtually non-existent for two decades. The idea that massive levels of reserves are a guarantor of economic stability is, in other words, based on a profound misunderstanding both of history and of the nature of reserves. Reserves of course are not useless as an enhancer of financial stability, but their use is for very specific forms of instability. Having large amounts of reserves relative to external claims protects countries from external debt crises and from currency crises.
Great, but neither Chanos, nor even the most pessimistic Sino-analyst, has ever said that these are the kinds of risks China faces today, any more than they were the risks faced by the US in the late 1920s or Japan in the late 1980s. The risks that China faces today (and the US in the late 1920s and Japan in the late 1980s) is of excessive domestic liquidity having fueled asset and capacity bubbles, the latter requiring the uninterrupted ability of foreign countries to absorb via large and growing trade deficits. These risks include an explosion in domestic government debt directly and contingently through the banking system.
These are, very typically, the kinds of risks that threaten rapidly developing large economies, unlike the external debt and currency risks that typically threaten small economies. And reserves are almost totally useless in protecting these economies from the risks they face (and, no, no, no, reserves cannot be used to recapitalize the banks – only domestic government borrowing or direct or hidden taxes on the household sector can be used to recapitalize the banks). In fact, it was the very process of generating massive reserves that created the risks which subsequently devastated the US and Japan. Both countries had accumulated reserves over a decade during which they experienced sharply undervalued currencies, rapid urbanization, and rapid growth in worker productivity (sound familiar?).
These three factors led to large and rising trade surpluses which, when combined with capital inflows seeking advantage of the rapid economic growth, forced a too-quick expansion of domestic money and credit. It was this money and credit expansion that created the excess capacity that ultimately led to the lost decades for the US and Japan. High reserves in both cases were symptoms of terrible underlying imbalances, and they were consequently useless in protecting those countries from the risks those imbalances posed.
We must be careful how we read history. The fact that the US and Japan had terrible decades following periods during which they had amassed levels of reserves that China has subsequently matched, and under conditions similar to those of China, does not necessarily mean that China too must have a lost decade or two. Chanos is not being crazy when he worries, but it is still an open question as to whether or not he will turn out to be right. But the history does indicate that facile statements about central bank reserves should, at the very least, be measured against the obvious historical precedents. Chanos might still lose this debate, but Friedman has already proven himself to be hopelessly wrong.
Zombie Update: Loan Repurchases and REO Anyone?
by Chris Whalen
"It's like a rash that won't go away. That lousy GDP report. It has been buggin' me since it hit the screen on Friday morning. The release just won't gel with certain official data we had already seen, with any of the abundant anecdotal evidence available and most of all, with all the excess input that is simultaneously dredged from the subconscious periphery of the mind when it's time to tie it all up."
Joan McCullough, East Shore Partners. February 1, 2010
As February 2010 begins, we are firmly in the McCullough camp when it comes to the data overload and outlier confusion category. Evidence of financial improvement and decay are both in abundance, with no clear direction in either case. More noise than signal is the current state of many specific counterparty and market indicators, in part because many established assumptions are being dragged back into the maybe bucket.
Take the seniority of holders of OTC credit default swaps to other creditors in bankruptcy. Our friends at HousingWire report that a federal bankruptcy judge in New York sitting on the Lehman Brothers bankruptcy, has voided the seniority claims of holders of various qualified investment contracts, ruling that their ipso facto clauses which subordinated other claims to their own were "null and void in bankruptcy." This is an important victory for fans of equal protection and due process, and a big setback for the OTC derivative dealer banks which exert considerable influence at the Fed and OCC.
We have always held the view that the attempts by the large dealer banks, ISDA and regulators to carve out a special, privileged place in the law for OTC derivatives contracts in the event of default is inherently unfair and is doomed to failure, or at least would be challenged, on Constitutional grounds. This case and others make that challenge and review process a reality and also leaves much of the world of complex structured finance in a shambles when it comes to the legal reality of counterparty risk.
Indeed, the same legal art that gave the swap counterparties in this latest case the impression that they were senior to the other creditors of the bankruptcy estate was used by former Treasury Secretary Hank Paulson and his successor, Timothy Geithner, to justify the rescue of American International Group (AIG). The very same type of investment contracts that Secretary Paulson and Secretary Geithner swore under oath, over and over again, just had to be paid at par in the case of AIG, were just set aside by New York Bankruptcy Judge James Peck.
And notice that the world has not ended when the holders of OTC contracts are treated like everyone else. Indeed, Judge Peck has made a number of rulings over the past two years re-leveling the playing field between holders of OTC contracts and other claims against the Lehman bankruptcy estate. As we have noted before, the admirable conduct of the Lehman Brothers bankruptcy case by Judge Peck and US Bankruptcy Trustee Harvey Miller is the starkest condemnation possible of the AIG bailout, a hideous political contrivance that ranks with the great acts of political corruption and thievery in the history of the United States.
The question of the enforceability of the documentation in a complex structured securitization involving OTC swaps is not just a matter of debate in the AIG case. Across the US and around the world, investors and trustees are grappling with this same issue. The result is litigation by bond trustees against bond issuers as well as claims by guarantors such as MBIA and the housing GSEs, including the Federal Home Loan Banks, against sponsor banks. Many of these claims regarding derivatives are being made in the context of claims for the repurchase of defaulted residential and commercial loans.
The wave of loan repurchase demands on securitization sponsors is the next area of fun in the zombie dance party, namely the part where different zombies start to eat one another. The GSE's are going to tear 50-100bp easy out of the flesh of the banking industry in the form of loan returns on trillions of dollars in exposure, this as charge-offs on the several trillion in residential exposure covered by the GSEs heads north of 5%. The damage here is in the hundreds of billions and lands in particular on the larger zombie banks, especially Bank of America and Wells Fargo.
To put the growing combat in the loan repurchase channel into perspective, keen analysts will already know that a new item has appeared in the disclosure for non-interest income by many larger banks that have been active in the securitization markets. In the case of WFC in Q4 2009, gross income of $1.2 billion in mortgage loan originations was net of $316 million in loss reserves for loan repurchases. Imagine if we add a zero to the loss allocation, then another, and you get to the worst-case exposure on OBS loan repurchases.
Watch this heretofore obscure part of the mortgage banking business become downright material in coming quarters as a race of sorts develops between banks that want to restart the securitization markets and those that are being dragged under water by the weight of legacy liabilities. Notice, for instance, that in the MBIA litigation against Countrywide Financial et al, MBIA Insurance Corporation v. Countrywide Home Loans, Inc. et al. the lawsuit now includes BAC explicitly.
The action "arises out of the alleged fraudulent acts and breaches of contract of Countrywide in connection with fifteen securitizations of pools of residential second-lien mortgages" Take particular care to savor the fact that these are second lien pools and that, where defaults have occurred on the primary mortgage, loss severities on the seconds will tend to be 100%. Or the cost could be more than par if you count the cost of remediation and recovery efforts.
With private issuers trying to find a workable formulation for new securitizations, the mounting litigation in the secondary market for structured deals comes at a bad time for efforts to revive the patient and confirms our worry that there is a lot of tough work ahead in the loss mitigation channel. More, we worry that the level of claims and defaults now visible in the US markets is just a taste of the high tide we could see in 2010-2011, especially as and when interest rates start to rise even modestly. Did somebody say "interest rates?"
The funny thing, of course, is that signs of economic recovery are more a function of official actions and artificially low interest rates than a true demand-pull rebound. We see the happy talk on the greater financial television channel and in the President's daily pep talks, then we look at the backlog in the recovery and disposal channels for all manner of collateral. There is no way to deal with the current backlog, much less the volume of new foreclosures in 2010, without immediate action by the financial industry on areas such as securitization and broad restructuring of current residential mortgages. More on the solution in the next issue of The IRA.
One reader of The IRA with a nice view of the White House comments in response to reports of a vigorous economic recovery in 2010:
"While it is true spreads have come in at a prodigious rate of speed, it's hard to tell how much of this has been (and continues to be) influenced by official sector actions. Certainly we have been witness to an unprecedented increase - globally - of central bank machinations. I believe these actions have served to artificially give the impression of health; health that doesn't really exist. Like taking pain killers. I would like nothing better than to be wrong, but credit conditions remain structurally different this time around, as do leverage and capital requirements."
Warning: This is Not Another Wall Street Conspiracy Theory, These are the Facts
by R. Shah Gilani
Just last week, the House Committee on Oversight and Government Reform held a hearing on the U.S. Federal Reserve's decision to directly pay billions of dollars to banks as part of its scheme to bail out insurance giant American International Group Inc. According to committee Chairman Dennis Kucinich, D-Ohio, the testimony that congressmen heard just didn't "pass the smell test." What really stinks about the whole mess is not only the cover-up of what really happened and why, but the inability of anybody in Congress to actually do their homework and be able to frame pointed questions and get to the truth. It's not complicated, but it is convoluted. Here are the facts and some questions that Congress needs to ask - and that the American people deserve straight answers to.
What the House Committee heard, overwhelmingly, on Wednesday was that AIG had to be bailed out because if it wasn't, the financial implosion that would result would send unemployment to 25% and America into the tailspin of another Great Depression. U.S. Treasury Secretary Timothy Geithner and former Treasury Secretary Henry M. "Hank" Paulson Jr. both testified that the systemic risk resulting from the bankruptcy of AIG would destroy the company's insurance businesses, devastating millions of Americans and resulting in economic ruin.
Let's start there. The reality is that at the time of the government's initial $85 billion infusion into AIG on Sept. 16, 2008, for which it received a 79.9% ownership interest, there was no mention of AIG's endangered insurance subsidiaries. In fact, New York Insurance Superintendent Eric Dinello, who oversaw AIG's insurance businesses, was confident enough in the subsidiaries to consider transferring $20 billion in excess reserves from the insurance subsidiaries to their AIG parent. What was really sucking the life out of AIG were collateral demands - in other words, margin calls. A wholly owned, London-based financial-products subsidiary of AIG had written hundreds of billions of dollars of credit-default-swap contracts on exotic collateralized debt obligations (CDOs).
The derivative swaps on the CDOs were insurance policies that would protect the buyers of those CDOs against losses on underlying subprime mortgage pools. As losses on subprime mortgages mounted, the insured parties demanded more collateral from AIG. AIG ran out of cash to make the collateral calls. At the time of AIG's crisis, the Fed and the Treasury Department were terrified that if the "counterparties" to AIG's credit default swaps weren't paid, the ripple effect would threaten all counterparties - not to mention the entire financial system.
So here's what the Fed did. It formed two Delaware-based, limited-liability companies, Maiden Lane II and Maiden Lane III (Maiden Lane I had already been set up and funded by $29 billion of taxpayer money to buy and hold the bad assets from the failure of The Bear Stearns Cos., so that JPMorgan Chase & Co. (NYSE: JPM) could take over whatever remained of Bear's carcass). Maiden Lane II borrowed $19.5 billion from the Federal Reserve Bank of New York to buy $39.3 billion of residential mortgage backed securities from AIGs solvent insurance subsidiaries for $20.8 billion, or about 50 cents on the dollar. Maiden Lane III borrowed $24.3 billion from the New York Fed to buy an asset portfolio of CDOs, whose "fair value" was estimated to be $29.6 billion.
The CDOs were purchased from AIG's counterparties. Between the $29.6 billion the counterparties received, and the cash they got from the collateral calls provided by taxpayers when AIG didn't have the cash to make good on its obligations, those counterparties were made 100% whole on more than $62 billion in par value of toxic-derivative CDOs. Here's the rationale behind this egregious maneuver: Government officials believed that the counterparties would sell their toxic junk, and would then cancel their CDS insurance contracts with AIG - which would then end the margin calls. In the public hearings, House Committee members focused on why the Fed paid out 100 cents on the dollar to the counterparty banks and why those involved in the payout scheme then tried to hide who got that taxpayer money.
But the real story was unfolding behind the scenes. Congress doesn't know about it, and the American people don't know about it. But it will prove to be nightmare of massive proportions. Although there were many U.S. banks that received inordinate amounts of money in this pay-off scheme, an equally sickening amount was paid to a handful of foreign banks. But the biggest recipient of the cash siphoned from taxpayers was Goldman Sachs Group Inc..
A Conspiracy Theory You Can't Laugh Off
The same day that AIG received the $85 billion taxpayer infusion back in September 2008, Goldman Sachs Chief Financial Officer David A.Viniar said he "would expect the direct input of our credit exposure to both of them [referring also to bankrupt Lehman Brothers Holdings] to be immaterial." Goldman officials had been telling every analyst or journalist who would listen that the investment bank was hedged against any counterparty risk. But what Goldman officials weren't saying at the time was that the company was also hedged against AIG going bust. How? The company had purchased credit-default-swap insurance on AIG's demise. We know that is true because Stephen Friedman - the former Goldman CEO and onetime New York Fed chairman who was called to testify at the hearing - said so.
Attached to Friedman's "Factors Affecting Effects to Limit Payments to AIG Counterparties: Prepared Testimony of Stephen Freidman Jan. 27, 2010," was a "Chronology of Selected Events and Disclosures." That chronology included a reference to an Oct. 31, 2008 Wall Street Journal article that Friedman specifically chose to illustrate that it was common knowledge that Goldman was not in need of any government assistance, and wouldn't be in any danger if AIG were to fail. This Journal excerpt included by Friedman contained the statement: "Goldman hedged its exposure by making a bearish bet on AIG, buying credit-default swaps on AIG's own debt, according to one person knowledgeable about this move."
Friedman was called to testify for one very key reason: At the time of the payments to the counterparties, he was chairman of the board of the New York Fed, which authorized those payments. But that's not all. As a member of the board of directors and a former CEO of Goldman Sachs, Friedman would no doubt have had an excellent idea of the investment bank's exposure to AIG - as well as what it stood to gain from those payments. Freidman subsequently resigned from his post at the New York Fed on May 7, 2009, in response to criticism of his December 2008 purchase of $3 million of Goldman stock, which added to his substantial holdings - a purchase made only after he had ushered through Goldman's approval to become a bank-holding company, enabling the firm to feed at the Fed's generous liquidity trough. Friedman continues to serve on Goldman's board. But that's another story.
Another Way to Print Money
Congress and the public have forgotten what was happening in the fall of 2008. Mortgage-backed securities (MBS) were not trading. There were no buyers. It was impossible to accurately price mortgage securities and even harder to price CDOs. The only "price discovery" mechanism was the London-based Markit Indices. These indices were supposed to represent various pools of mortgage securities and CDOs. Unfortunately, it is possible to make bets on the direction of the indexes. In order to hedge what holders of these complex and toxic assets couldn't sell - or for pure speculation or "other" purposes - traders sold short and drove down the indexes.
It didn't matter that mortgage pools really weren't defaulting and that they were still paying out cash flow, they were judged to be worth pennies on the dollar simply because the only "active" price-discovery mechanism against which they could be valued were the indexes. And it was these indexes - which were being shorted by "interested parties" - that drove down prices and triggered collateral payments on credit default swaps to AIG's counterparties. Goldman was paid 100 cents on the dollar - or some $12.9 billion - for the CDOs it had AIG write credit default swaps on. All the counterparties got 100 cents on the dollar. Why is that an issue? Because the CDOs that were insured hadn't actually defaulted and were still - according to what Maiden Lane III paid - worth about 50 cents on the dollar. So why would the Fed assume the CDOs were never going to recover and that the insured parties were entitled to get paid as if the collateralized securities were totally worthless?
Even more suspicious is the fact that there was a more elegant and simple solution to the problem. And that solution was already available. Why was it not used? The problem at the time was that rating-agency downgrades were about to trigger more margin calls against AIG. By then, however, the U.S. government already owned 79.9% of AIG. Surely it would have been cheaper for the government to make any margin calls than to pay off all of the counterparties. Even more sickening: If that solution was implemented as the value of the CDOs increased (which some have), collateral that was given to the counterparties would actually have to be returned to AIG - now 80% owned by U.S. taxpayers.
This whole affair raises scores of questions. Last week's hearing before Congress drove that point home. In fact, as I watched the testimony, I realized that our elected representatives didn't even know the correct questions to ask. That's why it's time to write your congressmen and tell them to ask:
- Why didn't the Treasury Department make the required margin calls - if they were needed - and stand to get collateral back if the insured CDOs rose in value?
- Why did the New York Fed buy paper at 50 cents on the dollar and pay banks 100 cents, when they had no idea what the intrinsic value of those securities was at the time?
- Who really leaned on the New York Fed to not disclose who got our taxpayer money?
- What did Stephen Friedman know about the payments to Goldman?
- What records exist of correspondence between Friedman and Timothy Geithner, who was then president of the New York Fed?
- What records exist of correspondence between Friedman and Henry M. Paulson, Geithner's predecessor as Treasury secretary and a former Goldman CEO himself.
- If Goldman was really hedged as Friedman appeared to claim, then why did taxpayers pay the investment bank 100 cents on the dollar?
- Did Goldman (and others) drive down the value of securities to collect cash, demand to be made whole and at the same time buy credit-default-swap insurance on AIG, which they were helping to sink?
- Can we see the trade blotters of Goldman's trading desks to determine what trading strategy those traders employed during this period and later when making record profits?
- Why are so many Goldman Sachs people in so many powerful government positions?
- Why has the United States government allowed a cabal of financial interests to hijack America?
That's a start. I urge you add to the list and forward it to President Barack Obama and to your elected representatives in Congress. It's our money, our future and our financial freedom being held hostage.
Turkeys Voting for Christmas
Why do people often vote against their own interests?
The Republicans' shock victory in the election for the US Senate seat in Massachusetts meant the Democrats lost their supermajority in the Senate. This makes it even harder for the Obama administration to get healthcare reform passed in the US. Political scientist Dr David Runciman looks at why there is often such deep opposition to reforms that appear to be of obvious benefit to voters.
Last year, in a series of "town-hall meetings" across the country, Americans got the chance to debate President Obama's proposed healthcare reforms. What happened was an explosion of rage and barely suppressed violence. Polling evidence suggests that the numbers who think the reforms go too far are nearly matched by those who think they do not go far enough. But it is striking that the people who most dislike the whole idea of healthcare reform - the ones who think it is socialist, godless, a step on the road to a police state - are often the ones it seems designed to help. In Texas, where barely two-thirds of the population have full health insurance and over a fifth of all children have no cover at all, opposition to the legislation is currently running at 87%.
Instead, to many of those who lose out under the existing system, reform still seems like the ultimate betrayal. Why are so many American voters enraged by attempts to change a horribly inefficient system that leaves them with premiums they often cannot afford? Why are they manning the barricades to defend insurance companies that routinely deny claims and cancel policies? It might be tempting to put the whole thing down to what the historian Richard Hofstadter back in the 1960s called "the paranoid style" of American politics, in which God, guns and race get mixed into a toxic stew of resentment at anything coming out of Washington. But that would be a mistake.
If people vote against their own interests, it is not because they do not understand what is in their interest or have not yet had it properly explained to them. They do it because they resent having their interests decided for them by politicians who think they know best. There is nothing voters hate more than having things explained to them as though they were idiots. As the saying goes, in politics, when you are explaining, you are losing. And that makes anything as complex or as messy as healthcare reform a very hard sell.
Stories not facts
In his book The Political Brain, psychologist Drew Westen, an exasperated Democrat, tried to show why the Right often wins the argument even when the Left is confident that it has the facts on its side. He uses the following exchange from the first presidential debate between Al Gore and George Bush in 2000 to illustrate the perils of trying to explain to voters what will make them better off: Gore: "Under the governor's plan, if you kept the same fee for service that you have now under Medicare, your premiums would go up by between 18% and 47%, and that is the study of the Congressional plan that he's modelled his proposal on by the Medicare actuaries."
Bush: "Look, this is a man who has great numbers. He talks about numbers. "I'm beginning to think not only did he invent the internet, but he invented the calculator. It's fuzzy math. It's trying to scare people in the voting booth." Mr Gore was talking sense and Mr Bush nonsense - but Mr Bush won the debate. With statistics, the voters just hear a patronising policy wonk, and switch off.
For Mr Westen, stories always trump statistics, which means the politician with the best stories is going to win: "One of the fallacies that politicians often have on the Left is that things are obvious, when they are not obvious. "Obama's administration made a tremendous mistake by not immediately branding the economic collapse that we had just had as the Republicans' Depression, caused by the Bush administration's ideology of unregulated greed. The result is that now people blame him."
Thomas Frank, the author of the best-selling book What's The Matter with Kansas, is an even more exasperated Democrat and he goes further than Mr Westen. He believes that the voters' preference for emotional engagement over reasonable argument has allowed the Republican Party to blind them to their own real interests. The Republicans have learnt how to stoke up resentment against the patronising liberal elite, all those do-gooders who assume they know what poor people ought to be thinking. Right-wing politics has become a vehicle for channelling this popular anger against intellectual snobs. The result is that many of America's poorest citizens have a deep emotional attachment to a party that serves the interests of its richest.
Thomas Frank says that whatever disadvantaged Americans think they are voting for, they get something quite different: "You vote to strike a blow against elitism and you receive a social order in which wealth is more concentrated than ever before in our life times, workers have been stripped of power, and CEOs are rewarded in a manner that is beyond imagining. "It's like a French Revolution in reverse in which the workers come pouring down the street screaming more power to the aristocracy."
As Mr Frank sees it, authenticity has replaced economics as the driving force of modern politics. The authentic politicians are the ones who sound like they are speaking from the gut, not the cerebral cortex. Of course, they might be faking it, but it is no joke to say that in contemporary politics, if you can fake sincerity, you have got it made. And the ultimate sin in modern politics is appearing to take the voters for granted.
This is a culture war but it is not simply being driven by differences over abortion, or religion, or patriotism. And it is not simply Red states vs. Blue states any more. It is a war on the entire political culture, on the arrogance of politicians, on their slipperiness and lack of principle, on their endless deal making and compromises. And when the politicians say to the people protesting: 'But we're doing this for you', that just makes it worse. In fact, that seems to be what makes them angriest of all.
Chanos Sees 'Overheating and Overindulgence' in China
Hedge fund trader Jim Chanos holds a one hour lecture on the problems he sees with China. Highly recommended.