David Leung in sailor suit
Ilargi: Today we present another essay by our young roving reporter in Africa, VK, who links bonds to bondage, an interesting notion if only for purely linguistic reasons (and it goes well beyond those). It fits in well with some of the material I read and watched over the weekend, between trains, planes, automobiles and buses.
Some of the most interesting finance videos I’ve seen in a long time come featuring the likes of Jim Grant, Bill Black and Dave Rosenberg. Zero Hedge contributor Chindit13 describes banking in a country without banks as we know them, Myanmar. I’ve always said the only people who need our present banks are those that work for them and those that rely on them for campaign contributions. The rest of us need only access to our money, which we could have in a myriad of ways, most of which need not involve forking over more than we have in our accounts just to maintain that access.
And at the very least in essence VK is right, of course, no matter how one would want to enter any debate on the issue: every singly bond issued by your country, your municipality or the company you work for is a direct claim on you, or even your children. Knowing that record amounts of issuance are taking place these days makes that an all the more (de-)pressing realization. Which is why Jim Grant calls them "Certificates of confiscation". It's a valuable point of view when it comes to trying to understand that you will really actually truly have to pay back everything your government borrows to keep the "losers at the casino" banking system alive. And perhaps an incentive, also, to wonder what would happen if we did let those banks fail.
After all, you bailed them out to stave off a crisis, but here we find ourselves neck deep in that crisis regardless (a little fact hidden from us by mixed-up muddled-up accounting standards), only now without the trillions we dumped onto the crap table. They’re long gone. Last I heard they moved to Paraguay and the Caymans. Bill Black explains it well, once again: "To rob a country, own a bank". I’d want to add: or own a government (supposing that’s not the exact same thing anyway). That way you can issue bonds backed by "the full faith and credit of the American taxpayer. Well, I have a sneaky suspicion your credit is shot already, so it’ll all have to depend on your faith. How's that going for you?
VK: Certificates of confiscation: Of bonds and bondage
Recently I had a private conversation with Automatix Earth contributor El Gallinazo in which he proceeded to chide me for my shortcomings in viewing the stock markets only, clamoring I should focus my attention more on the debt markets, since, as he so graciously put it, "the stock market is but a pimple on the debt markets ass".
I went surfing for knowledge as it were and noted the value of the world's stock markets as of November 2009 was about $44.2 trillion (That's a pretty big pimple!) while global debt markets were valued at $82.3 trillion.
What does this mean? I got out my notes on the debt market from my days not so long ago in University. And came across many long forgotten concepts: par values, coupon rates, zero coupon bonds, basic bond pricing, duration, convexity, credit risks,inverted price yield relationships etc. Aaaarrgggh!! Enough to make my head spin. Too much jargon is bad for you.
Then I stumbled upon a little line: Indenture: Agreement containing the terms under which money is borrowed.
That's what they call bond contracts. Indenture. According to the dictionary, or in this case a convenient google search, Indenture refers to a type of contract in the past that forced a servant or apprentice to work for their employer for a particular period of time.
What struck me was how true this is, not referencing past shenanigans, but present day reality. Society as we know it is indentured, we are virtual debt slaves, servants of our corporate and political elites.
Every time a sovereign, municipal or corporate bond is sold somewhere, every time you hear the national debt going up, that's a piece of you being sold off. There's nothing more to the bond market, nothing less. Human beings are being lined up on the chopping block, sold to the highest bidder, for a price.The future of their children and their hopes and dreams sold at a price determined by a large market for human debt slaves. A modern day global debt gulag if you ask me.
If you work for a corporation, the private debt issued by them promises to extract everything from you while they can milk you for all that you are worth. If the debt is issued by your country or town, the promise is to extract everything necessary to pay up from your you and your children.
Hence, in today's world, there are multiple claims on you, your life, your children and your hopes, dreams and ambitions, as well as theirs. The elites through various frauds, machinations, complex algorithms and at its heart plain greed for unbridled power have bundled you into little packages and sold you off many times over to the point that there are claims on your life, your soul and its third derivative.
Which brings me to the monster $1000+ trillion derivatives market (Exchange Traded + Over The Counter), which has been to a large extent built (leveraged) on top of the $44.2 trillion stock markets and $82.3 trillion debt markets.
At least in the pre-derivatives era a human life had been reduced to the value of the cash flow it produced over its lifetime, conveniently called Net Present Value.
In today's world, a human life has been further reduced to and by bets being played on a global video game network much like Call of Duty/ World of Warcraft, except in this case, you can't opt out nor can you log off. The consequences are very real, the outcome of suffering is inevitable. There is no reset button.
I can understand cattle not having a complex enough awareness to be able to judge their own imminent demise at the slaughter house, but people? Why, they have no excuse at all, we are a real tragi-comic bunch. Not only do we elect our herders and executioners i.e. politicians, we elect them with cheer, pomp and adulation, we also commend their choice of weapon, in this case being debt to wave away whatever happens to ail us. Debt, the very thing that we are slowly but surely being slashed with. Death by a thousand cuts if you will.
What will you tell your children? What excuse have you prepared? The numbers were too big? Economics is really confusing? I didn't realize I was selling you off at an auction? You'd almost think we're all delusional Catholics, sending our children to schools where they can be molested by hordes of conniving predators who, when pressed, won't shy away from calling themselves the victims. The Vatican and Goldman Sachs have way more in common than just the fact that both swim in luxury.
Next time you read that the National Debt has gone up by $1,600,000,000,000, that total debt owed by the US internally and externally is $54 trillion, that there are $65-100 trillion in unfunded liabilities, one thing I hope you take from this little rant is that you and your family are on the hook for all this debt owed to Kings and psychopaths, bankster mafia elites and drug lords with Caribbean accounts. I hope you also realize that they've decided to feast on your children with a sprinkling of shattered futures, dreams and hopes.
I'll sign off with The Automatic Earth's Ilargi's saying, "Tails you lose. Heads you die." Now that's a bet you never should have taken.
A World Without Banks
Imagine a world without bankers.
That thought either rattles you to the core of your being, or it brings on the kind of ecstasy heretofore only available in a Southeast Asian massage parlor. If you are a Congressman, addicted to the effluent from the wallets of your owners on Wall Street and their lobbyists in Washington, if you are a real estate developer who believes no amount of office space and no amount of luxury condominiums is too much, or if you summer in the Hamptons and Nantucket, then you are clearly in the first camp. If you are a typical ZH’er, spending your weekends at the range with your Beretta or sharpening the tines on your pitchfork, then welcome to SE Asia and the world of your wildest fantasy.
Yes, there is a country without banks as we know them, where no one knows the meaning of subprime, Alt-A, securitization, HFT, prop desks, insurance---portfolio or otherwise---CDS’, CDO’s, CDO^2’s, CLO’s or Too Big to Fail. There is a country where the financial crisis went almost unnoticed, where no bank assets went toxic because there are no bank assets. No depositors faced loss because there are few depositors. Mortgages did not take a hit because there are no mortgages. No car loans, student loans, or HELOC’s went bad. The country is the Union of Myanmar, known to many in the West as Burma. It is also called the Golden Land, which is entirely apropos given its wealth of natural resources.
Many reading this might have a political view on the country and its leadership, to which you are most welcome. Other websites, other writers, and the activist community address that issue elsewhere and have been doing it almost as long and almost as successfully as America has been enforcing sanctions against Cuba. I’ll leave politics to them, for this is not a political fluff piece; it is an economic fluff piece.
While much of what you will read here will seem odd, please don’t let the bizarre nature of this system scare you off. What they have, albeit in a different form, is workable even in a large society. If any of you find humor in this piece, then that is good enough, for at times like this humor is what keeps some of us going. More than that, however, I write this to attempt to counteract the fear mongering foisted upon us all by the likes of Hank Paulson, Timmy Geithner, Ben of the Inkjet Bernanke and that drooling, semi-embalmed cadaver who goes by the name of Representative Paul Kanjorski.
“We were that close”, so they told us ad nauseum in order that we accept the passage of TARP and all of the other alphabet soup of programs that shifted the wealth of America’s savers, elderly and Middle Class to the same people on Wall Street who nearly brought the system---their system---down. Yes, the collapse of the financial system would have had dire consequences---for the ones who caused its near demise. Their world almost did cease to exist, and it would have eviscerated them, one and all. Sadly, we lost an opportunity. Our world, on the other hand, though difficult, would have survived, and we would have found a way to continue. Humans are resourceful. Humans adapt. Anarchy creates its own communities, its own bonds, out of necessity and the will to survive. Burma is an example. Now I’ll tell you why.
Let me begin by getting a salient point right out front: Burma’s economy probably grew 15% in 2009. Fifteen percent. Their currency was the world’s strongest currency in 2009, climbing against everything from the dollar to euro to swissie to loon.
Nobody really knows the actual GDP number, because no one really bothers to keep track. Much of the economy is of the underground variety, and even the official economy is cloaked in secrecy. Fifteen percent---which would be the top growth in the world amongst countries with a population greater than 50 million souls---is my own estimation based on what I see, and comparing it to what I have seen there over the last fifteen years, or over the last thirty in places as diverse as Saudi Arabia, Japan, China, Thailand and Burma. 2009 was staggering in the amount of development, as anyone who spent time in the country could attest. Why I am there and why I know this is a long story. Suffice it to say I left a host of Wall Street prop desks when I thought my pockets were full enough, and when I wanted to try to find a way to add value in the world while I was still young. As most of you believe, if not know for a fact, Wall Street adds precious little value to the greater good of the human species. It’s a nice place to visit but I wouldn’t want to live there. I mean Wall Street, not Burma.
It is possible not every country could do what Burma has done. Few countries in the world have the breadth and depth of natural resources Burma has, which include economically significant deposits of gold, platinum group metals, silver, antimony, molybdenum, copper, nickel, iron ore, zinc, tin, uranium, chromite, rare earths and gypsum. Burma also has approximately eighty-five percent of the world’s remaining tropical hardwoods, including the world’s best teak, plus stunningly beautiful woods such as padauk, pyinkado and yemane. Burma has most of the world’s top jadeite, gobbled up to the tune of a billion dollars a year by the emerging Middle Kingdomites. It has precious gemstones such as rubies, sapphires and spinels. Its biggest source of wealth in recent years has been natural gas, plus some oil, which accounts for upwards of 80% of government revenues. Major investors in the country---mostly in mining and oil/gas exploration---include China, (both public and private sector), Singapore, Thailand, India and Russia. Also trying to exploit Burma's vast natural wealth are companies from Malaysia, Vietnam and Australia. A gas pipeline run by France's Total and US Chevron (oddly exempt from the sanctions that prevent me from even buying a home-sewn shirt) is single handedly responsible for nearly 25% of total Myanmar Government revenues via a long term sales contract with Thailand. As with the financial industry, lobbying Congress has its benefits, allowing Chevron privileges denied to you and me and the other lesser members of our egalitarian society. TransOcean (RIG) is also allowed to lease drilling rigs, at $210,000/day, to a project controlled by a company called Asia World, run by a man name Lo Hsing Han and his Harvard MBA educated son Steven Law. Google that and ask US Dept of Treasury, Office of Foreign Asset Control, why RIG gets an exemption. I am not criticizing the Burmese here; I am calling America a hypocrite nation, however.
At present China is constructing two new pipelines from the Arakan (Yakhine) Coast on Burma’s western side to Kunming in China's Yunnan Province. One line will carry Burmese natural gas; the other will carry oil obtained from the Middle East, enabling China to bypass the dangerous Straits of Malacca and save 14-20 days shipping costs. Burma will reap billions from this, despite the odd fact that 35% of its standing army will be involved in guarding the two lines. India just paid $1.4 billion for gas exploration rights in an offshore block off Yakhine and for a 12.5% stake in the twin pipelines. Of course that’s small money for a hedge fund type who bet on TBTF in America, but it’s enough to make it boom time in this all but bankless society.
Situated between the two largest populations on Earth---China and India---both of which are hungry for resources, has undoubtedly benefited Myanmar and helped it pass through the crisis the rest of the world experienced full bore. Still, the other thing that helped it avoid financial calamity was its lack of banks, because people were always forced to pay as they went. Lack of banks and insurance does not prevent dealmaking or trade, it just means that it must be self-financed and self-insured. Projects are carried out only when they are paid for up front, and if a project fails, the loss is born by the owner. Goods are moved with the acceptance that losses are possible, but goods are still moved, potential loss factored in to prices. There’s trucks on the highway carrying manufactured goods, produce, and people. Homes get built, as do office buildings, restaurants and shopping centers. People only buy what they can afford because if they cannot afford it, nobody will sell to them. Other than neighborhood loan sharks who charge upwards of 5% per month, there is almost no debt. Growth comes only from what one can pay for in the here and now. That encourages saving, though most savings are of the cash-under-the-mattress variety. Business still gets done. Banks can be an aid, but they are not a necessity. Eating and having shelter are necessities, and these will happen with or without banks, whether it's in Burma or America.
In the end, rather than shift risk around the economy so that it eventually ends up in the hands of those least able to weather it (AIG), risk stays with the risk taker in a bankless/insurance-less world. People, or firms, do not impose their own burdens or ineptitude on to others. One might argue it’s a better form of capitalism. It is certainly more fair than you and me paying for AIG’s FP Desk stupidity.
The Greeks used to say “everything in moderation”, though the last few months have shown the world that that belief is as decayed as the frescoes on the Parthenon (except for the ones ‘liberated’ by Lord Elgin). Humans, if given the chance, will forever shy away from moderation. Too much is never enough. Banks may occasionally do a little bit of God’s work in congregating and allocating capital, but they do much more of the devil’s work. Bank profits come from Oscar Wilde-ing society (“the only thing I cannot resist is temptation”), whether it is in the form of indebted consumers or customers chasing yield (these are the ones Blankfein, in a bold faced lie in front of a Congressional hearing, called “sophisticated investors”.). Easy credit encourages people to over consume, and over consumption always leads to obesity, either in body or in debt. Americans are textbook examples of both: fat and indebted. They are addicted to immediate gratification, so much so that it is almost held up as entitlement. The junkie, however, does not get rich; the pusher does. If the pusher becomes rich enough, he eventually owns society.
Banks also over consume, in that they continue to rope in consumers and institutional customers until the bank itself becomes obese. Unbridled greed, or uncontrolled appetite, as we have come to learn all too well, leads to Too Big to Fail. No limits on the consumer leads to no limits on the banks which then leads to the dire situation in which we find ourselves now. Indebted consumers, however, lack the ability to manipulate our democracy. Bankers do not. That is why Goldman Sachs get bailed out and why you and me must pay for it.
The Burmese, whose society lacks this negative feedback loop, are puzzled by what happened to us. Exploding debt? What’s that? For them , it is buy what you need or want only when you can afford it. Given the chance they would have become like us. That lack of opportunity saved them from what we now have.
A change of lifestyle, necessitated by a sudden change in a society where debt is almost impossible to obtain, would not be easy for spendthrift Americans, but living on a pay-as-you-go basis imposes a kind of discipline most Americans need. It would hurt, but it could be done. Losing Bank of America, Goldman Sachs, JPMorgan, Citibank and Wells Fargo would not have destroyed America, though it would have given a kick in the teeth to Lloyd and Jamie and their ilk. Like the Burmese now do, however, we would have survived and found a way to deal with the new reality. We might even be better off, rather than having to pay off---and having our offspring continue to pay off---the mistakes of the Blankfeins and Dimons and Fulds and Mozilos and McMansion buyers. We will never know, because the powers that be did not allow us to see that alternative. They tried to scare us, then ignored the vehement public opposition to TARP and passed it anyway. And some criticize Burma for a lack of democracy! Congress and the powers that be did not allow big bank failure, because for them the alternative would have been horrible in lost bonuses and lost contributions. For the rest of us, we may well have been better off. At the very least, we wouldn’t be working until May each year to fund, via our taxes, the bonuses and lifestyles and re-election campaigns of those who blew it.
Another plus is that if we as a society jumped off the over consumption bandwagon for a while, we might have had time to rediscover each other, which might also have necessitated that we all develop personalities again. I'll end this segment with a curious observation. I am two days out of Yangon at this moment and in Tokyo. In Yangon I often take a break in a local tea shop, full of crowded tables where people are chatting, joking, romancing and just passing time with others of the same species. In Tokyo today, which is a society very much like the US, I sat in a Starbucks and saw twenty people, all sitting alone, playing with their laptops, iPods, iPhones, Kindles and assorted other gadgetry that allows them to exist alone in their own soul-less world. Is that what we really want?
If you wish to continue reading, it gets a little fluffy and travelogue-ish here, but you might find it amusing. What the heck, have a read.
Now banks do exist in Burma, they just are not like any bank you know. The best description is that they are glorified Western Union offices, since almost all bank business involves domestic cash money transfers.
I should mention here that Burma is a cash society. Credit cards were tried for a period in the earlier part of the decade, but were just as quickly eliminated. If you come here, forget your Visa, Mastercard or Amex; they are not accepted. All purchases are cash and none is on credit. That includes real estate and cars. If you want to buy a house, you deliver the purchase price in physical cash to the seller. The same thing for a car.
At first you might not think this is such a big deal, suspecting as you probably do that since Burma is a poor country (per capita income around $250/year), prices cannot be too high. You would be wrong to think that, for two reasons.
The first reason is that up until very recently, the largest note in circulation in Burma was the one thousand kyat note (they just introduced a five thousand kyat note). Converted to dollars, that makes the largest piece of fiat paper in circulation the equivalent (at current black market rates) of one US dollar.
The second reason you would be wrong is that both real estate, and car prices in particular, are quite high. Real estate appreciation over the last seven years in some of the most sought after parts of the former capital city of Yangon (the new capital of Naypyidaw is only a few years old) approaches five thousand percent. That is, a piece of land that sold for $100K in 2003 now sells for $5 million. Car prices are worse, impacted by import restrictions that keeps the supply of vehicles significantly less than the demand. How much below demand? Try this: a 1981 Toyota Corolla Station Wagon in white (until 2000 this vehicle represented approximately 80% of all road going passenger vehicles) currently sells for US$20,000. A 1992 Toyota Mark II, the present fan favorite, fetches US$46,000. Top-of-the-line Toyota Landcruisers recently went for US$540,000, though prices have come down a bit as of late. These prices are not for pristine, cherry examples; these are for all of a given make/model/year, as if it were a commodity. The lack of internal upholstery, bare metal roofs and floors, hand-held windshield wipers operated by a long-armed front seat passenger (me)...none has any impact on the value. One is as another. My typical ride has four of six windows, which may or may not open, little or no side upholstery, and a hole in the floor through which I can see the passing road. In some of them zero to sixty times are still being determined.
Banks do not make car loans, though one bank tried in the past and went bust. Lessons were learned from that, as they should be in a capitalist system. A car buyer must ferry the bales of cash to the seller before he or she can take delivery of the chariot, which creates a kind of barrier to entry for car ownership in that one almost needs to already own a car to carry all the cash required to buy one.
A real estate purchase is done the same way: all cash, baled up and stuffed into the kind of nylon sacks migrant workers from developing countries carry their lives in when they return home. Years ago another bank tried to introduce the concept of mortgage, or at least a home equity loan. Many recipients did not know they had to repay, thinking that the loan was some kind of reward for owning a home. (I guess Americans are not that much different from Burmese after all.) That bank went bust, too. Capitalism works if allowed to work.
A visit to the buildings known as banks is quite an experience, one from which I have yet to tire. Some of the buildings are rather grand, while others look as if a good strong wind could bring the entire edifice down. Inside one would be hard pressed to find a loan officer or even someone to open an account. Indeed, I have never seen either one. What they do have are facilitators who arrange for fund transfers, a slew of strong young men to lift the heavy sacks of money that get carried inside, and a gaggle of barely-out-of-their-teens women behind the counter, each manning a bill counting machine.
The banks are crowded and the atmosphere is hectic. A flat panel TV hanging precariously from the ceiling blares out the latest local music video. Children play around on the floor. Bales of money are tossed about like medicine balls, often over the heads of the rows of customers sitting on primary color plastic chairs awaiting word that their money either arrived or was successfully sent. There are no formal lines, but the crowd gushing around the counters seems to follow a natural law that allows first come first served. Forms are filled out, ID cards shown, the obligatory stamps and signatures obtained, and the money is sent, arranged via a telephone call with the receiving branch. A truck arrives in the front, and five barefoot young men pile out and begin tossing sacks of money passed the security guards into the bank lobby. Customers make room, though there is not much free space. Soon, the bags are ripped open and bales tossed on to the service desk, from which the women, faces smeared with yellow thanaka paste, then begin the long process of counting what might be fifty or even a hundred thousand pieces of fiat paper. If the money is part of a real estate deal, the number might be in the millions. The whirr of the machines is constant, the women focused. The scene has a simple beauty.
As the piles of money move from in front to behind the counter, a kind of makeshift furniture is formed which sometimes serves as a place for staff to sit and take a tea break. Five money bricks for a seat, ten for a table. When the money is counted, a receipt is given, and the customer walks out just in time for another truck of money to arrive. It is mayhem. Cacophony. It certainly ain’t Bank Pictet, but it works.
Most of the banks have vaults where the excess from a day of inflows and outflows is stored. Some banks do not have vaults. I can only assume that with the denomination of the currency being as small as it is, it would take a robber so long to remove enough cash to make theft worthwhile, that by the time he finished, the work crew would be arriving for the new day and would catch him in the act. It might also be that the people are pretty honest.
My favorite treat is to arrive early and watch the staff in banks where vaults do exist, unload cash into the counter area in preparation for customers’ arrivals. In assembly line style, three or four men spread themselves out in a line, from vault to counter, and pile stacks of notes baled in thousand piece packs. Ten of these packs are piled, but not bound, then tossed from man to man, bucket brigade style. That’s $10K equivalent per toss, by the way. In ten minutes perhaps a million dollars has been tossed from vault to floor, and not a single brick has been dropped. Tinkers to Evers to Chance would play second fiddle to this display. I seriously doubt Lloyd Blankfein could pull it off. In things that excite and fire the soul, he is a man of lesser talents.
So there it is. A world without banks. It could have been us.
Ilargi: A view from the right on the banking debacle. How will this be exploited during the next elections?
Break Up the Banks
by Arnold Kling
Big banks are bad for free markets. Far from being engines of free enterprise, they are conducive to what might be called “crony capitalism,” “corporatism,” or, in Jonah Goldberg’s provocative phrase, “liberal fascism.” There is a free-market case for breaking up large financial institutions: that our big banks are the product, not of economics, but of politics.
There’s a long debate to be had about the maximum size to which a bank should be allowed to grow, and about how to go about breaking up banks that become too large. But I want to focus instead on the general objections to large banks.
The question can be examined from three perspectives. First, how much economic efficiency would be sacrificed by limiting the size of financial institutions? Second, how would such a policy affect systemic risk? Third, what would be the political economy of limiting banks’ size?
It is the political economy that most concerns me. Freddie Mac and Fannie Mae represent everything that is wrong with the politics of big banks. They acquired lobbying prowess, their decisions were distorted by political concerns, and they were bailed out at taxpayer expense. All of these developments seem to be inevitable with large financial institutions, and all are deeply troubling to those who value economic freedom. Unless there are tremendous advantages of efficiency or systemic stability from having large banks, their adverse effect on the political economy justifies breaking them up.
If we had a free market in banking, very large banks would constitute evidence that there are commensurate economies of scale in the industry. But the reality is that our present large financial institutions probably owe their scale more to government policy than to economic advantages associated with their vast size. Freddie Mac and Fannie Mae were created by the government, and they always benefited from the perception that Washington would not permit them to fail — a perception that proved accurate. Similarly, large banks were viewed as “too big to fail,” which gave them important advantages in credit markets and allowed them to grow bigger than they otherwise would have. In 2007 and 2008, Lehman Brothers was able to obtain substantial short-term credit from what otherwise would have been risk-averse money-market funds, notably the Reserve Primary Fund, which “broke the buck” after Lehman’s collapse, greatly intensifying the subsequent financial panic. It is difficult to view Reserve Primary’s large position in Lehman debt as anything other than a bet that the government would engineer a bailout. It probably would have parked its funds elsewhere had Lehman been considered small enough to fail.
Other policies in recent decades have subtly favored big banks. The government encouraged the boom in securitization, for instance, which helped swell the size of financial firms and was stimulated by banks’ desire to skirt capital-requirement rules. And the credit-rating agencies’ outsized role in financial markets — indeed, the very existence of a small, powerful cabal of federally approved rating agencies — was the work of regulators. Such policies fostered large financial institutions such as AIG, which built its huge portfolio of credit-default swaps on the basis of Triple-A grades from the credit-rating cartel.
Turn now to the question of efficiency: Is bigger better for consumers? Bankers speak mystically about the “financial supermarket” and claim that there are tremendous economies of scope in financial services, meaning that a consumer benefits from being able to have a checking account and a stock portfolio at the same large firm. But in practice, whatever benefits might be derived from such a supermarket are probably more than offset by the diseconomies of managing such a complex entity.
Another unsound argument is that large banks are needed to finance large multinational firms. If large international firms require big capital investments, these can be obtained by issuing securities or by loan syndication, in which the risk of borrowing is spread across several banks. The existence of large non-bank firms does not imply the need for similarly gigantic banks.
There are economies of scale, but small banks can take advantage of them, too. For instance, a small bank can join an ATM network or contract with a third party to develop Internet services. It does not have to build such systems from scratch, and we do not need big banks to make them possible.
Which brings us to the question of systemic risk. Regulation can, of course, make systemic risk worse: The U.S. banking crisis of the 1930s was exacerbated by the fact that banks could not start new branches across state lines or, in many cases, even within the same state. This led to poor diversification of regional risk. The regulation in question was admittedly poor, but we need not return to the banking system of the 1930s to achieve a reduction in the size of America’s largest banks.
Some point out that the Canadian banking system performed relatively well during the financial crisis, noting that Canada’s assets are concentrated in just five large banks. This is offered as evidence that large banks are conducive to financial stability. But while Canada’s big banks have a big share of the country’s assets, they still are much smaller than America’s largest banks: Bank of America and JP Morgan Chase are three or four times the size of the Royal Bank of Canada, Canada’s largest. And while its banking marketplace is dominated by five big players, Canada’s population is less than one-seventh that of the United States; even if we concede that Canada is served well by five large banks, the equivalent in the United States would be 35 large banks. In 2008, total assets of the U.S. banking system were about $10 trillion, with the top five bank holding companies in possession of $6 trillion. If the entire $10 trillion had been divided evenly among 35 banks, none would have accounted for more than $300 billion in assets; all of our banks would have been smaller than the fifth-largest Canadian bank.
Overall, there is little evidence that really big banks are necessary to a sound financial system. The financial crisis demonstrated that they are not sufficient for a sound financial system. And it is possible that without very large banks the system actually would be more robust. Certainly, the failure of any one bank would be less traumatic if the size of that bank were small relative to the overall market.
I am not optimistic that there is an easy cure for financial fragility even if we break up the banks. To the extent that they share exposure to the same risk factors, a system with many small banks could be just as vulnerable as a system with a few large ones. The fundamental sources of financial risk — including leverage, interest-rate risk, exchange-rate risk, and speculative bubbles — have a way of insinuating themselves regardless of the banking industry’s structure and in spite of the best intentions of regulators. But while no one can promise that breaking up large banks would make the financial system safer, it would without question make it less corporatist. Which returns us to the question of political economy.
In the United States, big banks provide an invitation to mix politics and finance. Large financial firms get caught between public purposes imposed on them by Congress and the interests of private stakeholders. If they do not maintain good relations with legislators, they risk adverse regulation. Therefore, it behooves them to shape their regulatory environment.
And they have done so. In recent decades, the blend of politics and banking created a Washington–Wall Street financial complex in the mortgage market. This development, and its consequences, have been well documented. Michael Lewis’s 1989 book Liar’s Poker includes a portrayal of the political exertions of investment bankers to enable mortgage securitization to take off. “The Quiet Coup,” an article by Simon Johnson that appeared in the May 2009 issue of The Atlantic, chronicles the rapid accrual of profits and power by large financial institutions over the past 30 years; during this period, Wall Street firms were able to shape the basic beliefs of political figures and regulators, a phenomenon that Brookings Institution scholar Daniel Kaufmann has dubbed “cognitive capture.” Andrew Ross Sorkin’s Too Big to Fail, which describes the response of the Federal Reserve and Treasury to the financial crisis, leaves the distinct impression that senior bankers had much more access to and influence over Washington’s decision makers than did career bureaucrats.
Notwithstanding the good intentions of policymakers, who no doubt plan to create a stronger regulatory apparatus going forward, large banks will inevitably have too much power for the apparatus to govern them. They will shield themselves from its attentions by making political concessions on lending practices. So long as big banking is conjoined to big government, that is, we risk a return to the regime of private profits and socialized risk.
I would prefer a completely hands-off policy when it comes to financial markets, but the political reality is that deposit insurance and regulation are not going away. Given that they are not, the worst possible outcome is that the marriage of politics and finance evolves into outright corporatism, as it did with Freddie Mac, Fannie Mae, and the rest of the nation’s largest financial institutions. And that evolution is directly attributable to the influence that comes from banks’ being big enough to achieve real political power. To expand free enterprise, shrink the banks.
Arnold Kling is an adjunct scholar with the Cato Institute and a member of the Financial Markets Working Group of the Mercatus Center at George Mason University. He is the author of Unchecked and Unbalanced: How the Discrepancy Between Knowledge and Power Caused the Financial Crisis and Threatens Democracy.
The Municipal Market
by Rick Bookstaber
This represents my personal opinion, not the views of the SEC or its staff.
My first blog post was in June, 2007. It was titled “What sorts of crises am I worried about now”. My answer was housing and credit. With the benefit of hindsight, this might be considered a no-brainer, although at the time it was not so clear where things would go.
Now as the dust settles from the crisis that emerged in 2008, we can start to think about what might come next. And yes, the crisis really is settling down, despite the alarmists who, thinking we were in a 1930’s style depression, pushed the panic button and stuffed their mattresses (or portfolios) with cash. For whatever reason, be it astute government intervention or the natural healing process, we are looking back at something along the lines of a bad, credit-driven recession.
I don’t think we will see a big crisis emerging for some time in banks, hedge funds or derivatives, mostly because, like with a knockout punch, the risks that matter don’t come from where you are looking. Unless the current push for legislation is a failure, which, of course, still remains to be seen, we will have steely eyes hovering over these sources of crisis. It will be awhile before the guards start dozing off at their posts.
So, where to look next. To see other potential sources of crisis, let’s first recount the lessons learned from this crisis:
Well, guess where we have a market that is (1) leveraged and opaque, that is (2) very big and tied to the credit markets; and is (3) viewed by investors as being diversifiable by holding a geographically broad-based portfolio; with (4) huge portfolios where assets and liabilities are apparently matched; and with (5) questionable analysis by rating agencies; and where (6) there are many entities, entities that may not approach default with business-like dispatch, and that have already mortgaged sources of revenue that are thought to support their liabilities?
- Problems occur when things get leveraged and complex (and thus opaque).
- If the problems occur in a very big market, especially in a very big market like housing that is tied to the credit markets, things can go systemic.
- The notion that you can diversify by holding a geographically broad-based portfolio, (“there has never been a nation-wide housing recession”), works fine – until it doesn’t.
- A portfolio that is apparently hedged can blow apart. So we have to look at the gross value of positions, even if they are thought to be hedged.
- Don’t bet on ratings, because rating agencies are conflicted and might not be all too dependable at their job.
- Defaults are never easy to manage, but it gets worse when there are a lot of them happening at the same time. It is harder to manage the mess, and there is less of a stigma in defaulting. And it is all the worse when, as is the case in the housing markets, those defaulting are not businessmen. As an added complication, with housing the revenue that we thought was there really wasn’t. Income that was supposed to be there to finance the mortgages – even when that income was fairly stated – became committed to other areas (like second mortgages). .
Answer: The municipal market.
Leverage and Opacity. Leverage in the municipal market comes from making future obligations to employees in order to pay them less now. This is borrowing in the form of high pension benefits and post-retirement health care, but borrowing nonetheless. Put another way, in taking lower pay today, the employees have lent money to the municipality, with that money to be repaid via their retirement benefits. The opaqueness comes from the methods of reporting. For example, municipalities are not held to the same standards as corporations in their disclosure.
Size and potential systemic effects. That this is a big market in the credit space goes without saying.
Diversification. Geographic diversification would give a lot more comfort for municipals if it hadn’t just failed for the housing market. Think of why housing breached the regional barriers. It was because similar methods of leveraging were being employed through the country. So the question to ask is: Are there common sorts of strategies being applied in municipalities across the nation?
Gross versus net exposure. The leverage for municipals is not easy to see. It might appear to be lower than it really is because many, including rating agencies, look at the unfunded portion of these liabilities. They ignore the fact that these promised payments are covered using risky portfolios. And not just risky -- the portfolio might apply hefty (a.k.a. unrealistic) actuarial assumptions of asset growth.
Rating agencies. In terms of the work of the rating agencies, here are two questions to ask. First, list the last time they did an on-site exam of the municipalities they are rating. Second, are they looking at the potential mismatch between assets and liabilities, or simply at the net – the under funded portion of the portfolio.
Defaults. Municipalities are not quite as numerous as homeowners, but there certainly are a lot of them. And they have the same issues as homeowners. Granted, they will not pour cement down the toilet before walking away. But they have a potentially equally irrational group – the local taxpayers – to deal with.
Oh, and just as homeowners took their income and locked it up via secondary loans, much of the tax base for municipalities is already mortgaged, through the sale of tax-related revenues streams like tolls and parking fees. Indeed, although general obligation bonds are considered the cream of the crop, they might just as well be regarded as the residual claim after anything with solid fee streams has been sold off.
Once a few municipalities default, there is a risk of a widespread cascade in defaults because the opprobrium will be lessened, all the more so if the defaults are spurred along by a taxpayer revolt – democracy at work.
Rick Bookstaber is Senior Policy Adviser at the SEC and author of "A Demon of Our Own Design"
Ilargi: Don’t miss Jim Grant. His perspective is fresh and unique.
Jim Grant: I’m Downgrading U.S. Credit Rating
by Paul Kedrosky
Never one to wait around for ratings agencies to slam the barn door after the credit cows have gone, here Jim Grant does it preemptively.
• 1:42 Improper Payments (checks that should not have been written by the Treasury) last year totaled $98.7 Billion
• 3:00 Points out that 1792 Coinage Act states that penalty of debasing the currency is death
• 3:20 People need to remember that currencies are unsecured
• 3:40 Wonders when people will wake up to currencies based on nothing
• 5:40 Expects rates are likely to rise due to credit worthiness of U.S. Treasury
Ilargi: More absolutely must see video. Bill Black is very candid and clear on what happens today in American finance. A recovery it is not. Everyone can understand this the way Black explains it.
William Black: To rob a country, own a bank
by Tyler Durden
In this must watch Real News Network interview with William Black, the outspoken critic of all that is wrong and broken with the current system spares no words to once again denounce the (purposeful) ineffectiveness of the administration, and rightfully predicts that with Obama's current track record of inactivity in dealing with the corruption and criminality at the nexus of finance and politics, there will be a massive loss for Democrats at the upcoming mid-term elections.
In Black's words: "We knew as soon as we saw Summers and Geithner that the finance side of the administration would be a disaster, but we hoped that political side would be preeminent and say a) this is substantively wrong to continue get in bed with finance and b) it's terrible politics. The democratic party will be crushed if it does this. The political side has failed to get involved. This is one of those rare things where doing the right thing is really good politics, so support candidates that will actually do the right thing.
And if the Obama administration continues this way, it's going to have a record disaster at the mid-term elections. There's going to be a massive loss of democratic seats."Everyone should ask themselves the same rhetorical question that forms the basis of Black's conclusion: "What would it take if the greatest economic catastrophe in 80 years, if an epidemic of fraud by your top elites, if the corruption of your most senior professionals, in accounting, law, appraisal, rating agencies, isn't enough to make you fundamentally reconsider and say we are headed along a disastrous path. What will it take, because the next big one will be even worse." Full five part interview below:
Economist Warns of Public Bubble
by Conor Dougherty
The U.S. economy has traded a public bubble for a private one, according to this forecast by California forecasting firm Beacon Economics. The firm’s stance is that the $787 billion federal stimulus package and the Federal Reserve’s near-zero interest rates have propped up the economy but will prove unsustainable and are actually exacerbating some of the imbalances that led to the recession. "The nation seems to be trading in its private bubble for a public one, swapping one set of unsustainable economic drivers for another," the report said.
The firm cites a lot of familiar problems, such as the deficit and the potential for inflation down the road. (For the record, inflation is so tame right now that some economists are more worried about deflation) And, like many reports that call "bubble," it is light on specifics as to how, when or if it might pop.
The gist is this: The stimulus and other such measures have prevented a shedding of debts that needs to happen before the economy can return to sustainable growth. The saving rate has grown from its record lows, but has been propped up by tax cuts that have exacerbated the mountain of debt at all levels of government. Property values have fallen, but accounting changes have prevented banks from acknowledging a lot of underwater loans. Even the roaring stock market is artificial, in the firm’s view.
"The rally in the equity markets seems to be occurring despite the fact that overall asset prices still seem too high given our long-run potential for growth. And the bounce in the asset markets overlooks the fact that overall the national deleveraging that needs to occur to shed off record levels of debt has yet to really get underway," the report said. This is, obviously, a bearish stance.
Beacon’s founder, former UCLA Anderson Forecast economist Chris Thornberg, has done well forecasting bubbles before. He serves on the advisory board of New York hedge fund Paulson & Co., which made many billions of dollars betting on a housing collapse and was subject to a book by Journal reporter Gregory Zuckerman. To be sure, even Beacon acknowledges that there are ways out of a bubble that don’t involve a pop. "The best-case scenario is that the Federal Reserve and the Obama administration manage to draw down the public bubble slowly, a possibility that private bubbles typically don’t share," the report says.
The downside? "The worst-case scenario is that the bubble pops rapidly, putting the economy squarely back into another recession — the double dip."
I Saw the Crisis Coming. Why Didn’t the Fed?
by Michael J. Burry
Alan Greenspan, the former chairman of the Federal Reserve, proclaimed last month that no one could have predicted the housing bubble. "Everybody missed it," he said, "academia, the Federal Reserve, all regulators."
But that is not how I remember it. Back in 2005 and 2006, I argued as forcefully as I could, in letters to clients of my investment firm, Scion Capital, that the mortgage market would melt down in the second half of 2007, causing substantial damage to the economy. My prediction was based on my research into the residential mortgage market and mortgage-backed securities. After studying the regulatory filings related to those securities, I waited for the lenders to offer the most risky mortgages conceivable to the least qualified buyers. I knew that would mark the beginning of the end of the housing bubble; it would mean that prices had risen — with the expansion of easy mortgage lending — as high as they could go.
I had begun to worry about the housing market back in 2003, when lenders first resurrected interest-only mortgages, loosening their credit standards to generate a greater volume of loans. Throughout 2004, I had watched as these mortgages were offered to more and more subprime borrowers — those with the weakest credit. The lenders generally then sold these risky loans to Wall Street to be packaged into mortgage-backed securities, thus passing along most of the risk. Increasingly, lenders concerned themselves more with the quantity of mortgages they sold than with their quality.
Meanwhile, home buyers, convinced by recent history that real estate prices would always rise, readily signed onto whatever mortgage would get them the biggest house. The incentive for fraud was great: the F.B.I. reported that its mortgage fraud caseload increased fivefold from 2001 to 2004. At the same time, I also watched how ratings agencies vouched for subprime mortgage-backed securities. To me, these agencies seemed not to be paying much attention.
By mid-2005, I had so much confidence in my analysis that I staked my reputation on it. That is, I purchased credit default swaps — a type of insurance — on billions of dollars worth of both subprime mortgage-backed securities and the bonds of many of the financial companies that would be devastated when the real estate bubble burst. As the value of the bonds fell, the value of the credit default swaps would rise. Our swaps covered many of the firms that failed or nearly failed, including the insurer American International Group and the mortgage lenders Fannie Mae and Freddie Mac.
I entered these trades carefully. Suspecting that my Wall Street counterparties might not be able or willing to pay up when the time came, I used six counterparties to minimize my exposure to any one of them. I also specifically avoided using Lehman Brothers and Bear Stearns as counterparties, as I viewed both to be mortally exposed to the crisis I foresaw. What’s more, I demanded daily collateral settlement — if positions moved in our favor, I wanted cash posted to our account the next day. This was something I knew that Goldman Sachs and other derivatives dealers did not demand of AAA-rated A.I.G.
I believed that the collapse of the subprime mortgage market would ultimately lead to huge failures among the largest financial institutions. But at the time almost no one else thought these trades would work out in my favor. During 2007, under constant pressure from my investors, I liquidated most of our credit default swaps at a substantial profit. By early 2008, I feared the effects of government intervention and exited all our remaining credit default positions — by auctioning them to the many Wall Street banks that were themselves by then desperate to buy protection against default. This was well in advance of the government bailouts.
Because I had been operating in the face of strong opposition from both my investors and the Wall Street community, it took everything I had to see these trades through to completion. Disheartened on many fronts, I shut down Scion Capital in 2008. Since then, I have often wondered why nobody in Washington showed any interest in hearing exactly how I arrived at my conclusions that the housing bubble would burst when it did and that it could cripple the big financial institutions.
A week ago I learned the answer when Al Hunt of Bloomberg Television, who had read Michael Lewis’s book, "The Big Short," which includes the story of my predictions, asked Mr. Greenspan directly. The former Fed chairman responded that my insights had been a "statistical illusion." Perhaps, he suggested, I was just a supremely lucky flipper of coins. Mr. Greenspan said that he sat through innumerable meetings at the Fed with crack economists, and not one of them warned of the problems that were to come.
By Mr. Greenspan’s logic, anyone who might have foreseen the housing bubble would have been invited into the ivory tower, so if all those who were there did not hear it, then no one could have said it. As a nation, we cannot afford to live with Mr. Greenspan’s way of thinking. The truth is, he should have seen what was coming and offered a sober, apolitical warning. Everyone would have listened; when he talked about the economy, the world hung on every single word.
Unfortunately, he did not give good advice. In February 2004, a few months before the Fed formally ended a remarkable streak of interest-rate cuts, Mr. Greenspan told Americans that they would be missing out if they failed to take advantage of cost-saving adjustable-rate mortgages. And he suggested to the banks that "American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage." Within a year lenders made interest-only adjustable-rate mortgages readily available to subprime borrowers. And within 18 months lenders offered subprime borrowers so-called pay-option adjustable-rate mortgages, which allowed borrowers to make partial monthly payments and have the remainder added to the loan balance (much like payments on a credit card).
Observing these trends in April 2005, Mr. Greenspan trumpeted the expansion of the subprime mortgage market. "Where once more-marginal applicants would simply have been denied credit," he said, "lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately." Yet the tide was about to turn. By December 2005, subprime mortgages that had been issued just six months earlier were already showing atypically high delinquency rates. (It’s worth noting that even though most of these mortgages had a low two-year teaser rate, the borrowers still had early difficulty making payments.)
The market for subprime mortgages and the derivatives thereof would not begin its spectacular collapse until roughly two years after Mr. Greenspan’s speech. But the signs were all there in 2005, when a bursting of the bubble would have had far less dire consequences, and when the government could have acted to minimize the fallout. Instead, our leaders in Washington either willfully or ignorantly aided and abetted the bubble. And even when the full extent of the financial crisis became painfully clear early in 2007, the Federal Reserve chairman, the Treasury secretary, the president and senior members of Congress repeatedly underestimated the severity of the problem, ultimately leaving themselves with only one policy tool — the epic and unfair taxpayer-financed bailouts.
Now, in exchange for that extra year or two of consumer bliss we all enjoyed, our children and our children’s children will suffer terrible financial consequences. It did not have to be this way. And at this point there is no reason to reflexively dismiss the analysis of those who foresaw the crisis. Mr. Greenspan should use his substantial intellect and unsurpassed knowledge of government to ascertain and explain exactly how he and other officials missed the boat. If the mistakes were properly outlined, that might both inform Congress’s efforts to improve financial regulation and help keep future Fed chairmen from making the same errors again.
Michael J. Burry ran the hedge fund Scion Capital from 2000 until 2008.
Sharp Increase in March in US Personal Bankruptcies
by Duff Wilson
More Americans filed for bankruptcy protection in March than during any month since the federal personal bankruptcy law was tightened in October 2005, a new report says, a result of high unemployment and the housing crash. Federal courts reported over 158,000 bankruptcy filings in March, or 6,900 a day, a rise of 35 percent from February, according to a report to be released on Friday by Automated Access to Court Electronic Records, a data collection company known as Aacer. Filings were up 19 percent over March 2009. The previous record over the last five years was 133,000 in October.
"Even with the restrictive new law, we’re back up over where we were before the law changed," Mike Bickford, president of Aacer, said in a phone interview Thursday from his headquarters in Oklahoma City. He faulted the stagnant economy, saying a surge in bankruptcies generally follows economic contraction by 6 to 18 months, and he pointed to March as a historically busy month for bankruptcy filings. Other experts point out that filings invoking Chapter 7 of the bankruptcy code, a simple and inexpensive option, are rising faster than more complex Chapter 13 reorganization filings, under which consumers repay a portion of their debts so they can keep their homes, suggesting that more homeowners are simply walking away from underwater mortgages.
"Fewer people are trying to save their homes," Katherine M. Porter, a University of Iowa law professor and bankruptcy expert, said in an interview by phone on Thursday. "They realize their payments are not affordable, and bankruptcy judges do not have the power to adjust the mortgages to make them more affordable." Statistics from the United States Trustee Program, the Justice Department office that oversees bankruptcy cases, show that Chapter 7 filings as a percentage of all bankruptcies have increased to about 73 percent in 2009 from about 62 percent in 2006-07. Of the 158,141 bankruptcy filings in March, 118,505, or 75 percent, were Chapter 7s and 38,241 were Chapter 13s, the Aacer report says.
"We think that means fewer and fewer families think they’re really going to save their homes," Professor Porter said. "They don’t have any equity, so why try to keep up with their home payments?" The nation’s high unemployment rate is one more reason for people to choose Chapter 7, Professor Porter said. "To file Chapter 13, you need ongoing income, and to the extent we have more people who are unemployed, they can’t use Chapter 13 because they don’t have that income to pay into the plan," she said.
Finally, Professor Porter said, March is the high season for bankruptcy filings because many people in financial distress get a tax refund check that they can use to pay the $1,500 to $3,500 that a bankruptcy lawyer charges. "People use their tax refunds to pay their attorney fees," she said.
Deflation on the prowl as Bernanke shuts down his printing press
by Ambrose Evans-Pritchard
The most audacious monetary experiment in modern history ended on April Fools' Day. America must walk without crutches, on gangrenous legs. The US Federal Reserve has completed its purchase of $1.7 trillion (£1.1bn) of mortgage securities, agency debt and US Treasuries, the conjuring trick of "credit easing" that allowed Ben Bernanke to create stimulus equal to 12pc of GDP. The Fed's money creation has been more or less the size of Washington's borrowing needs for the last year, as Beijing notes with suspicion.
We will never know whether it was wise to go nuclear. My view – anathema to readers, I fear – is that Ben Bernanke and Britain's Mervyn King saved us from potential calamity. We were all too close to the tipping point illustrated in Irving Fisher's Debt Deflation Causes of Great Depressions, the moment when the sailing ship catches water and capsizes instead of righting itself by natural rhythm. Work by Berkeley Professor Barry Eichengreen shows that global trade, industrial output, and stock markets all crashed at a faster rate over the six terrifying months after the Lehman crisis than during the early 1930s. How quickly we forget, and how easily we are seduced by a 76pc stock rally into thinking it was a storm in a teacup. Just wait until the day fiscal retribution comes.
The $1.7 trillion created out of nothing will vanish as the bonds are sold on the open market. Not too quickly, let us hope. Easy money must cushion the blow of spending cuts. Even talk of ending QE amounts to tightening. While the US economy has begun to create jobs again – plus 114,000 in March, stripping out short-term census workers – there were false dawns in 2002 and 1982. The broader U6 jobless rate nudged up to 16.9pc. Bond vigilantes ask who will step into the Fed's shoes to soak up the flood of debt from Washington, whether from the Obama Treasury or from Fannie Mae and Freddie Mac – the mortgage giants on death row.
Yields on 10-year Treasuries have jumped 30 basis points in two weeks to 3.94pc. Alan Greenspan called it "the canary in the mine" for US sovereign debt. The yield spike is happening even though core inflation (trimmed mean PCE) has been dropping like a stone, touching a record low of 1.04pc in February. The Fed's Monetary Multiplier is languishing at 0.815, a flat tire. The basic 30-year fixed mortgage has risen to 5.08pc from 4.71pc in December. The US housing market looks too sickly to withstand this. New home sales have fallen for four months in a row, dropping to a half-century low in February. The inventory of unsold homes has jumped to 8.6 months supply. Some 24pc of mortgages are in negative equity.
Mr Bernanke is taking the fateful decision to knock away the props of the mortgage market even though the M3 broad money supply has been contracting at an epic pace of 6pc since September. If M3 gives early warning of six to 12 months, beware. Mr Bernanke does not look at M3, disdaining such monetarist eccentricities as medieval sorcery. The M3 signal has certainly been erratic over the years. It can be distorted by portfolio shifts. But the refusal to even look at it has been the root of much trouble over the past four years.
Had Mr Bernanke paid attention, he would have seen the need to pop the credit bubble earlier. He would also have avoided his catastrophic error in the early summer of 2008. Robert Hetzel, chief economist at the Richmond Fed, writes in Monetary Policy In The 2008-2009 Recession that central banks themselves triggered the crisis by failing to cut rates fast enough as the economy tanked from March to July 2008. Cast your mind back to that moment. Rates had already been slashed from 5.25pc to 2pc. Oil and copper prices were rocketing. Inflacionistas were screaming, accusing the Fed of 1970s debauchery and some Fed hawks seemed to agree.
Dr Hetzel said the Fed "effectively tightened" policy in June 2008 by tough talk that led the futures market to price in a half-point rate rise by September 2008. Evidence that the growth rate of broad money had long been plummeting was ignored. The European Central Bank went further, raising rates in July even though the eurozone was already deep in recession. We know what happened. Lehman, AIG, Fannie and Freddie fell apart in September. The wheels came off the world's financial system.
My fear is that the Fed will repeat the mistake – in this case by reversing QE too soon. The problem is Mr Bernanke's ideological doctrine of "creditism". Is the Fed chairman worshipping a false religion? Was Milton Friedman right in arguing that the quantity of (broad) money is what is what matters most, not the credit mechanism? Upon this abstruse doctrinal point will depend – perhaps – whether the Atlantic economies rise above stall speed or lurch into a double-dip recession.
Ilargi: It is astonishing to note that the folks at the Fed have no idea what inflation really is. The notion that inflation is rising prices may be nice for the popular press, but it absolutely useless, in this case aka harmful, when it comes to setting monetary policy. As noted by Evans-Pritchard in the article above, Bernanke doesn't even bother with M3. This can only mean one thing: if the decisions they make turn out alright, it will be akin to the rolling of the dice. And that is not a particualrly comforting thought, not when multiple trillions of taxpayer dollars are at stake.
Inflation Fears Cut Two Ways at the Fed
by Jon Hilsenrath
The Federal Reserve's decisions to keep interest rates near zero and to flood the financial system with credit are sparking fears of an eventual outbreak of inflation. But inside the Fed, an influential band of policy makers is fretting over the opposite: that the already-low rate of inflation is slowing further. The presidents of the New York and San Francisco regional Fed banks, William Dudley and Janet Yellen, see the abating inflation rate as convincing evidence the economy still is burdened by excess capacity and needs to be sustained by the Fed.
Others, led by Philadelphia Fed President Charles Plosser, argue that current inflation measures are distorted by an epic decline in housing costs and could mask a buildup of inflationary pressures. This intensifying internal Fed debate over the behavior of inflation comes as the central bank plots an exit from an unprecedented experiment in easy money. Its read on inflation will influence how quickly it moves to raise short-term interest rates—which impacts everything from mortgage rates to new business costs to stock performance—and drain huge sums it pumped into the financial system during the recession. Recent developments have given the inflation-rate-is-dropping camp an upper hand.
In 2008, overall consumer prices actually fell for the first time in half a century, but then rebounded as energy prices stabilized. Over the past 12 months, the consumer-price index has risen 2.1%. But measures of inflation that strip out volatile energy and food prices are decelerating. Excluding food and energy, consumer prices in February were 1.3% higher than a year earlier. That was the smallest 12-month increase in six years, and well below year-over-year increases of above 2% before the recession.
"When unemployment is so high, wages and incomes tend to rise slowly, and producers and retailers have a hard time raising prices," Ms. Yellen, who is expected to be President Barack Obama's nominee to become the Fed's vice chairman, said in a speech last week. "That's the situation we're in today, and, as a result, underlying inflation pressures are already very low and trending downward." Mr. Dudley made similar comments in comments in Lexington, Va., last week. "The substantial amount of slack in productive capacity that exists today will likely only be absorbed gradually. Consequently, trend inflation, at least over the near term, should remain very low."
In this camp, one worry is that inflation-adjusted interest rates—also known as real interest rates—could rise even if the Fed sits on its hands. Such a rise would be a disincentive for businesses to invest in new projects and for consumers to spend. This unintended increase in rates could put a brake on the economic recovery. The opposing camp believes the combination of low rates and more than $1 trillion the Fed has pumped into the financial system is a formula for inflation down the road. "As the economy improves and as lending picks up, the longer-term challenge we face will not be worrying about inflation being too low," Mr. Plosser said in an interview. "The risk is really to the upside of inflation over the next two to three years."
This camp focuses less on the amount of slack in the economy—the high unemployment rate and the number of empty office buildings, shopping malls and idle factories—and more on the risk that consumers and businesses will anticipate inflation and act accordingly. At the Fed's mid-March meeting, Thomas Hoenig, president of the Kansas City Fed, argued for an increase in short-term interest rates "soon" to "lower the risks of...an increase in long-run inflation expectations." Surveys and bond price movements suggest Americans expect inflation of around 2% year-in and year-out, and Fed officials believe this helps keep the inflation rate stable. A change in inflation expectations in either direction could become important in Fed deliberations.
Mr. Plosser also argues that the recent decline in the inflation rate is a mirage, greatly influenced by an unusual decline in housing costs, which are heavily weighted in many price indexes. Excluding the cost of shelter, consumer prices were up 3.4% from a year earlier in February, pushed up in part by energy prices. Excluding food, energy and housing, they were up 2.6% from a year ago. "I want to be careful not to read too much into one measure of inflation that is very influenced by housing," Mr. Plosser said.
Researchers at the San Francisco and New York Fed are scheduled to release a retort to this argument Monday that shows that among 50 different categories of consumer spending—from computers to hotels to jewelry—inflation rates have slowed over the past 18 months from the earlier trend. The Fed has said it would keep short-term rates low for an "extended period," a phrase which means at least several months—as long as inflation is subdued, inflation expectations are stable and the economy is slack. A persistent slowing of the inflation rate could push rate increases further into the future, possibly into 2011. But if officials dismiss recent data or if the pace of price increases accelerates, the Fed may boost rates before year-end.
Traders in futures markets anticipate the Fed will raise its benchmark federal-funds rate—which it has been holding near zero since December 2008—to 0.5% by November. A wide range of companies recently have noted difficulty in trying to raise prices. General Electric Co., for instance, in a conference call with analysts, said prices of locomotive engines were falling because of excess supply. Speedway Motorsports Inc., which operates Nascar racetracks and drag strips, said it would reduce ticket prices between 4% and 5% this year. "We have started to see a glimpse of the economy stabilizing," said Marcus Smith, Speedway's president. But he said he still had to fight hard to keep his customers.
"We're doing everything we can to make sure our existing customers are very happy. If they'll extend [contracts] this year for multi years we're willing to give better pricing and better terms." But last week's Institute for Supply Management survey of factory managers found a rising fraction of respondents report paying higher prices for materials. In March, 53% said they were paying more—especially companies using petroleum products, wood and primary metals.
Although the consumer-price index gets more public attention, the Fed prefers another measure—the personal consumption expenditures index. Excluding food and energy, it is up 1.3% from a year ago, and the slowdown is intensifying: Over the past three months, it has risen at an annual pace of just 0.5%, a slowdown that has been noticed by Fed officials. The Fed's preferred level for this measures is between 1.5% to 2%.
Rubin and Greenspan face crisis inquiry
by Francesco Guerrera and Alan Rappeport
Robert Rubin, the former Treasury secretary who played a key role in financial deregulation during Bill Clinton’s presidency and who has kept a low profile since stepping down as a special adviser to Citigroup in January 2009, is to be questioned by the US financial crisis inquiry commission this week. The committee, created by Congress and given sweeping powers in May 2009, is also to question Chuck Prince, the former chief executive of Citi, as well as Alan Greenspan, former chairman of the Federal Reserve Board.
The line-up suggests the committee is narrowing the scope of its investigation ahead of a final report to Congress in December. Phil Angelides, the commission’s chairman, said he would ask Mr Greenspan, who led the Fed between 1987 and 2006, why the central bank did not curb subprime lending before the housing bubble burst. Mr Angelides, a former California state treasurer, said: "The fact is that the Fed, as the main regulator, had the power to impose rules that would apply to everybody. "We need to peel the veil from these events so that the American people find out what really happened."
On Sunday, Mr Greenspan appeared to be clinging to his free market ideology, telling ABC News there remained "no alternative" to competitive markets in democratic societies and that regulators could not have foreseen the events that would follow the collapse of Lehman Brothers. Bill Thomas, vice-chairman of the FCIC and the former Republican chairman of the House’s ways and means committee, said he would ask Mr Greenspan: "what did you know, when did you know it and if you didn’t know it, why didn’t you know it?".
Mr Angelides and Mr Thomas said the questioning of Mr Prince and Mr Rubin, who have kept a low profile since leaving Citi, will focus on how a once-mighty financial giant lost more than $50bn and had to be bailed out by the US government. Mr Angelides said Mr Prince would be confronted with his famous assertion - in an interview with the Financial Times in July 2007 - that Citi was "still dancing" to the tune of the cheap credit-fuelled boom.
Geithner: Fannie, Freddie Debt Isn’t Sovereign Debt
by Michael Crittenden
Debt from Fannie Mae and Freddie Mac shouldn’t be considered sovereign debt, but there should be no doubt about the U.S. government’s support for the two firms, Treasury Secretary Timothy Geithner said in a recent letter to a U.S. House lawmaker. Geithner, responding to a letter from to Rep. Scott Garrett (R., N.J.), said debt from the two government-sponsored enterprises isn’t the same as U.S. Treasurys, but that support for the two firms "is crucial in helping to stabilize the housing market and the overall economy.
The Treasury’s actions regarding the two firms, which have been under government control since September 2008, "should leave no uncertainty about Treasury’s commitment to support Fannie Mae and Freddie Mac," Geithner wrote. "The Administration will take care not to pursue policies or reforms in a way that would threaten to disrupt the function or liquidity of these securities or the ability of the GSEs to honor their obligations," Geithner wrote.
The question of what to do with the two firms has been a growing issue in Washington, where the Obama administration and Congress are already focused on overhauling regulation of U.S. financial markets. Geithner and administration officials hope to move regulatory overhaul legislation through Congress before tackling the future of the two mortgage finance firms, though the administration will begin seeking public comments on the housing finance system beginning April 15.
Geithner Delays Currency Report, Urges Flexible Yuan
by Greg Stohr and Phil Mattingly
U.S. Treasury Secretary Timothy F. Geithner delayed a scheduled April 15 report to Congress on exchange-rate policies, sidestepping a decision on whether to accuse China of manipulating the value of the yuan. Geithner in a statement yesterday urged China to move toward a more flexible currency and said a series of meetings over the next three months will be "critical" to bringing policy changes that lead to a stronger, "more balanced" global economy. The delay comes as Chinese President Hu Jintao is scheduled to visit Washington for a nuclear summit April 12-13.
The Treasury chief faces demands from Congress to label China a currency manipulator for keeping the value of the yuan little changed from about 6.83 to the dollar for almost two years. Geithner is instead betting that China will take steps on its own in the next several months to strengthen its currency, analysts said. "There is pressure within China for a yuan revaluation and, as long as exports continue to rebound, there is a good chance that it will happen," said Elizabeth Economy, director of Asia studies at the Council on Foreign Relations in New York. "If, however, there is a lot of public pressure emanating from the U.S., that will likely give support to those in the Chinese government who do not want to see a revaluation."
Geithner’s statement said countries such as China "with inflexible exchange rates" can promote global growth by "combining policy efforts to strengthen domestic demand with greater exchange-rate flexibility." "A move by China to a more market-oriented exchange rate will make an essential contribution to global rebalancing," he said. Lawmakers from both parties said Geithner is wrong to expect that negotiations will prompt such a move from China’s leaders. With the U.S. unemployment rate hovering near a 26-year high, some lawmakers say China’s policies give its exporters an unfair advantage over their U.S. competitors.
"We are disappointed, but not surprised, by the administration’s decision," Senator Charles E. Schumer, a New York Democrat, said in an e-mailed statement yesterday. "After five years of stonewalling, punctuated by occasional, but halting action by the Chinese, we have lost faith in bilateral negotiations on this issue." Schumer, along with four other senators including South Carolina Republican Lindsey Graham, last month introduced legislation to require the Treasury to determine if a nation had a currency misaligned with the dollar and make it easier to respond by imposing import duties.
The Treasury’s delay "underscores the urgent need" for Congress to pass such legislation, said Alan Tonelson, research fellow with the U.S. Business and Industry Council, a Washington-based organization representing about 2,000 manufacturing companies. "There can be no question that attempts to negotiate an end to China’s currency manipulation have failed for eight years and it is long past time for unilateral U.S. responses," Tonelson said in an interview yesterday. Schumer, a member of the Senate Finance and Banking committees, said in his statement he intended to push forward with his legislation.
Still, Yu Yongding, a former adviser to the People’s Bank of China, welcomed Geithner’s decision as "of course good news," adding that confrontation is "meaningless." "Problems between China and the U.S. can be solved through negotiations," Yu said in a telephone interview from India today. "If you want to hurt the other side, then you’ll hurt yourself."
"The past few years have proven that denying the problem doesn’t solve anything," Senator Charles Grassley of Iowa, the top Republican on the Senate Finance Committee, said in an e- mailed statement. "The Treasury Department should cite China as a currency manipulator." Representative Sander Levin of Michigan, the Democratic chairman of the House Ways and Means Committee, was more supportive.
The delay "is for a definite period and for a defined purpose," Levin said. "If the multilateral effort does not result in China’s making significant changes, the administration and Congress will have no choice but to take appropriate action." Geithner, in an April 2 interview on Bloomberg Television, expressed confidence that China will decide a stronger yuan is in the country’s interest, saying the U.S. is trying to "maximize the chance that they move quickly" to let the yuan appreciate.
Yang Yuanqing, chief executive officer of Beijing-based computer maker Lenovo Group Ltd., said gains would boost consumers’ purchasing power. Qin Xiao, chairman of China Merchants Bank Co., said an end to the yuan’s 20-month peg to the dollar would let lenders set market-based interest rates. Chen Daifu, chairman of Hunan Lengshuijiang Iron & Steel Group Co., said a stronger currency would cut import costs.
Yuan forwards posted their biggest weekly gain in almost three months on mounting speculation China will loosen its grip on the currency after data showed an economic recovery is gathering pace. Twelve-month non-deliverable forwards advanced 0.2 percent to 6.6491 per dollar as of 5:30 p.m. April 2 in Hong Kong, reflecting bets the currency will strengthen 2.7 percent from the spot rate of 6.8256, according to Bloomberg data. While a stronger yuan will help cut costs in imported fertilizers and pesticides, some agricultural sectors may face a "collapse" if exchange-rate pressures climb, the China Chamber of Commerce of Import and Export of Foodstuffs, Native Produce & Animal By-Products, said in an April 2 report on its Web site.
Chinese exports of vegetables, fruits, aquatic products and tea will "totally" lose their competitiveness should the yuan strengthens, said the chamber, affiliated with China’s commerce ministry. The report proposed adjustments to tax rebates on agricultural products to aid farming businesses, most of whose profit margins are between 2 percent and 3 percent. The yuan probably will strengthen in time without the Chinese government taking any public action, said Donald Straszheim, the director of China research at International Strategy & Investment Group. "They will start to allow the currency to gradually appreciate, and we will know what has happened by looking at the tape," Straszheim said.
The Treasury hasn’t labeled any country a currency manipulator since 1994. The Treasury’s currency report has been delayed in the past under both Democratic and Republican administrations. In January 1999, President Bill Clinton’s Treasury even published a compendium of those that had been due in 1997 and 1998 and President George W. Bush’s administration also repeatedly missed the deadline. The latest delay "is probably the politically smart thing to do," with Hu planning to be in Washington for talks with President Barack Obama, said Charles Freeman, a China expert at the Center for Strategic and International Studies in Washington.
"I’m not sure Treasury really knows what it wants to do yet," said Freeman. "It’s testing the political waters on Capitol Hill." Geithner said April 2 that Hu’s visit, along with a meeting of Group of 20 finance ministers and central bank governors this month and a U.S.-China Strategic and Economic Dialogue scheduled for May, will offer "the best avenue for addressing U.S. interests at this time." "Our objective is to use the opportunity presented by the G-20 and S&ED meetings with China to make material progress in the coming months," he said.
Mortgage Fraud, Anyone?
by Barry Ritholtz
This would be terribly funny if it weren’t so God-damned tragic: Mark Hanson, via Abelson:"Mortgage Guaranty Insurance Corp., familiarly known as MGIC, which also has taken more than its share of lumps from the housing collapse, is wrestling with Countrywide over a bunch of the latter’s bum mortgages it insured. At issue is whether those mortgages were mortally flawed from birth, something, alleges MGIC, that Countrywide had more than a little reason to be aware of.
In its complaint to the American Arbitration Association, MGIC makes no bones that it thinks Countrywide, eager to exploit the housing bubble, embarked on "a reckless strategy to attract new subprime and other high-risk business." And the insurer goes on to cite a clutch of cases to prove its point. We found the narrative lively reading (and we’re grateful to Mark Hanson for bringing it to our attention).
There is, for example, the woman who bought a $600,000 house, claiming she worked as an account exec at a California investment firm, earned $13,494.03 (nice touch that three cents) a month, had a $45,000 bank account at Wells Fargo and, according to the insurance application, made a $30,000 down payment. When MGIC nosed around, it discovered the investment firm she supposedly worked for didn’t exist, neither did the bank account, she hadn’t made a down payment and she actually earned $3,901.58 a month as a janitor at a medical facility.
In another instance, a $350,000 loan was extended by Countrywide to a fellow who wanted to buy a home valued at that amount and claimed he was a dairy foreman earning $10,5000 a month. Again, the snoops at MGIC discovered the guy was a milker at the dairy who earned $1,100 a month and signed the documents where he was told to — even though he couldn’t read English. There’s plenty more of the same in the complaint by MGIC charging that Countrywide agents were complicit in various and sundry deceptions.
Frankly, we found it all something of a hoot, though it’s not hard to see why MGIC isn’t laughing. But even comic tales typically embody a moral, and this one is no exception. Fraud played no small role in the great demolition of housing, but the principal perpetrators were never diligently pursued and, for the most part, went crying all the way to the bank. Moral hazard, anyone?
I believe mortgage fraud was endemic during the Credit bubble/Housing boom. My best guess was that half of all subprime mortgages, and probably 20% of all other mortgages where there was a mortgage broker involved . . .
I am surprised at some of the comments, especially when it comes to the blame portion. As I made clear in the book, there is lots of blame to go around — including a healthy portion to those people who bought more house than they could possibly afford. However — AND THIS IS CRUCIAL — an individual mortgagee has a very different standard of care and legal fiduciary obligations than does a lender, bank and/or mortgage broker.
The individual’s obligation is to pay their mortgae or forfeit the house. The bank, on the other hand, has very specific fiduciary obligations, laws it must follow, standards it is obligated to meet. When a bank doesn’t ask for an Income or credit check, they are telling the borrower they we don’t care what your income is. What some people have foolishly termed "predatory borrowing" is in reality a poor excuse for what is nothing more than half arsed, incompetent banking.
Federal Prosecutors Leaning Against Charges in AIG Probe
by Amir Efrati
Federal prosecutors, after a two-year investigation, may soon decide not to charge American International Group Inc. executives for their role surrounding financial contracts that nearly brought down the company, according to people familiar with the matter. Recently obtained evidence has prosecutors leaning against pursuing charges, though no final decision has been made by Justice Department prosecutors in Washington, these people said.
The high-profile probe has centered on Joseph Cassano, people familiar with the matter have said. Mr. Cassano headed a London-based unit of the giant insurer called AIG Financial Products. The unit entered into insurance-like contracts with other financial institutions that ended up being financially disastrous for AIG. When the mortgage market imploded, AIG had to hand over tens of billions of dollars worth of collateral to financial institutions that had entered into the contracts, known as credit-default swaps, with AIG. These collateral calls nearly felled the company and led to a massive government bailout that's generated intense public outrage and political scrutiny.
At issue in the investigation was whether, starting in 2007, Mr. Cassano and his colleagues deceived investors and the firm's outside auditor about AIG's financial exposure from those contracts, which were tied in part to mortgages, people familiar with the matter have said. As of last fall, the Justice Department had been planning to empanel a grand jury in Brooklyn, N.Y., to consider an indictment of Mr. Cassano, people familiar with the matter have said. But information obtained in recent months from AIG's outside auditor, PricewaterhouseCoopers LLP, has suspended those plans, these people said.
Mr. Cassano, who no longer works at AIG, is expected to meet with prosecutors this upcoming week to discuss his reasoning behind making the accounting adjustment and other issues related to the swaps, according to a person familiar with the matter. Representatives for Mr. Cassano and PwC declined to comment. Mr. Cassano's lawyers have maintained he did nothing wrong. CBS News reported on Friday that Mr. Cassano would meet with prosecutors next week and that prosecutors likely wouldn't charge him.
Federal prosecutors had been focused on a December 2007 investor presentation in which Mr. Cassano and other AIG executives made reassuring statements and projected confidence about the firm's exposure to the mortgage crisis, people familiar with the matter have said. Mr. Cassano said at the conference that write-downs tied to the swaps had reached an estimated $1.6 billion. The authorities looked at whether Mr. Cassano should have disclosed to investors that that figure would have been higher by several billion dollars if not for the aid of a value adjustment AIG made, known as "negative basis," those people have said.
Several months later, when AIG disclosed that PricewaterhouseCoopers found a "material weakness" in its accounting of the swaps, it said it would abandon the adjustment, according to company filings. As of last fall, authorities believed Mr. Cassano may not have properly disclosed the adjustment to PwC, people familiar with the matter have said. But in a series of meetings last fall, Mr. Cassano's lawyers insisted to federal prosecutors that he had been forthright about the adjustment, according to people familiar with the matter. Prosecutors have since obtained notes written by a PwC auditor from a November 2007 meeting that appear to show Mr. Cassano informed the auditor about the adjustment and its potential positive impact, according to people familiar with the matter. That would make it difficult to bring a strong criminal case against Mr. Cassano, these people said.
The negative basis adjustment hasn't been prosecutors' only concern, but it has been a central issue. The Justice Department so far has had little success proving there was criminal wrongdoing at financial companies whipsawed by the extraordinary economic events of the last few years. In the first and only securities-fraud case against Wall Street executives in the wake of the credit crisis, two former hedge-fund managers at Bear Stearns were acquitted at trial after being accused of misleading their investors before their funds collapsed.
Despite dire budget warnings, Los Angeles' payroll continued to grow
by Phil Willon
Threats this week by Los Angeles' powerful municipal utility to withhold $73 million from the treasury helped reveal a city that has become increasingly dependent on indirect and onetime sources of revenue to pay its bills. Combined with the worst economic decline since the Depression, those dwindling sources of cash have forced city officials to confront a problem they have long tried to ignore -- a steady growth of the city payroll for the last decade. The city's core 35,000-member workforce increased by at least 3,000 between 2000 and 2009. During the same time, Los Angeles' yearly pension contributions more than tripled to $723 million, fueled by investment losses but also by the larger payroll.
When the effects of the failing economy surfaced in late 2007, Mayor Antonio Villaraigosa and the City Council approved significant raises for union workers and pressed ahead with a police force expansion even as they talked openly of a need for cutbacks and threatened layoffs. "It's a head-scratcher," said Jack Kyser, a Los Angeles County Economic Development Corp. economist. "If you know that tough times are coming, you should be ultra-cautious. You've had ongoing warnings about the magnitude of the downturn and they haven't been listening."
Now, the city's $4.4-billion general fund -- which pays for police, libraries, parks and other city services -- has a $212-million budget deficit that could grow to $1 billion in four years without drastic cuts. Publicly, city officials have blamed the steep drop in tax revenue, but concede that the payroll increases have played a major role as well. When he took office in 2005, Villaraigosa promised to erase the city's long-recognized "structural deficit" -- the gap between revenue and spending. He weeded out budget gimmicks used for years, yet, according to the city's chief legislative analyst, in his first budget the mayor proposed the creation of 805 positions.
Villaraigosa now acknowledges that his efforts were undermined not only by rapidly declining tax revenues but by salary increases and his vow to expand the LAPD. "It's a crisis of spending and it's also a revenue crisis. It's a crisis of both," Villaraigosa said. "I take responsibility. It predates my administration, but there's no question that it also occurred during my administration."
City Administrative Officer Miguel Santana said officials for years have relied on finding one-time pots of money to cover up to $200-million annual budget gaps created by a growing workforce, expanded services and generous pay packages. "If you look in the context of our $4-billion budget, this year's drop in revenue is not unsurmountable -- $184 million," Santana, Los Angeles' top financial analyst, said in a March interview. "But it is significant if you're living by the skin of your teeth."
To help cover the city's bills, elected leaders have reached beyond staple tax revenue collections; liquidating city property, increasing parking meter and trash fees, and diverting revenue from the Department of Water and Power. Since 1992, the DWP has provided the city budget $2.7 billion collected from electric bills. On Thursday, Controller Wendy Greuel warned that the city could run out of money by June 30 if the DWP withheld a promised $73-million payment to the general fund. Acting DWP General Manager Raman Raj favored rejecting the transfer after the council turned down a proposed increase in electric bills, which Raj said put the DWP's "financial outlook in significant jeopardy."
Now Villaraigosa and the council have few options, with Los Angeles voters in no mood to approve a tax increase and with few other sources of revenue left. The mayor and council already have authorized the elimination of up to 4,000 city jobs, on top of the 2,400 workers who were allowed to retire early. Former City Controller Laura Chick said officials waited until things were so bad that they had no choice but to act. "That's an insane way of governing. We don't have political leadership today that is strong, courageous and thoughtful enough to look into the future."
What makes things worse is that the mayor and council members had been put on notice, Chick said. As city controller, she warned in 2007 that the reserve fund was depleted. That same year, then-City Administrative Officer Karen Sisson projected a $215-million shortfall. Council member Bernard C. Parks urged colleagues to prepare layoff lists because of a potential "drastic reduction" in revenues. Despite those warnings, the mayor and council signed off on raises for the Coalition of L.A. City Unions, which represents 22,000 civilian employees. The projected cost of the labor contracts, which have been renegotiated as a result of the crisis, was $255 million over five years. One union hailed its agreement as the "best contract in 40 years."
Villaraigosa said later that he never would have supported the contracts had he known that a fiscal meltdown was on the horizon. At the time, however, it appeared affordable: UCLA economic experts were predicting a 4% increase in revenue. "They told us it was going to be bright and rosy," the mayor said. Villaraigosa added that the 2007 contracts included a provision to bring the unions back to the table in the event of a fiscal crisis.
Still, those concessions took more than a year to negotiate. That delay was, in part, because the mayor failed to promptly replace Sisson, the city's lead labor negotiator, after she resigned in July 2008. At the time, Villaraigosa also was campaigning for reelection and weighing a run for governor. The mayor said he was not distracted. His first choice to replace Sisson withdrew amid questions from council members about his salary demands and ties to lobbying firms. Union leaders said, however, that the delay froze discussions over cuts to the workforce, preventing the city from saving millions of dollars much sooner.
"In 2007, we recognized, together with Karen Sisson, that there was a serious problem," said Victor Gordo, an attorney for the union coalition. The unions started lobbying in 2007 for early retirement, saying it could take thousands of workers off the books. Villaraigosa said labor leaders refused to consider increasing workers' pension contributions to cover the costs. "The unions weren't ready to negotiate," he said. "Yeah, they were talking about it, but they didn't want to pay for it."
A deal was not reached until six months ago. In return, union coalition members were exempted from layoffs and furloughs until July 1. That provision severely limited the city's ability to balance the books when tax revenues recently fell more sharply than expected. Now the mayor and council plan to tap the city's reserve fund, which has triggered a downgrade of the city's credit rating on Wall Street. Parks, who heads the council's budget committee, said that even amid the current crisis, it has been difficult to persuade city leaders to find the political will to make cuts. "Every time there's a discussion about reducing the workforce, like there is now, we have elected officials looking for money to make it go away," he said.
Pay Garnishments Rise as Debtors Fall Behind
by John Collins Rudolf
When the bank sued Leann Weaver for not paying her credit card balance, her reaction was typical for someone in that situation. Personal and financial setbacks weighed her down, and she knew she owed the $2,470. So she never went to court to defend herself. She was startled by what happened next. When she swiped her debit card at the grocery store, it was declined. It turned out Capital One Bank had taken $224.25 from her paycheck, a quarter of her wages for two weeks of work at a retail chain, and her bank account was overdrawn. "They’re kicking somebody who’s already in the dirt," she said.
One of the worst economic downturns of modern history has produced a big increase in the number of delinquent borrowers, and creditors are suing them by the millions. Concern is mounting in government and among consumer advocates that the debtors are not always getting a fair shake in these cases. Most consumers never offer a defense, and creditors win their lawsuits without having to offer proof of the debts, much less justify to a judge the huge interest charges and penalties they often tack on.
After winning, creditors can secure a court order to seize part of the debtor’s paycheck or the funds in a bank account, a procedure called garnishment. No national statistics are kept, but the pay seizures are rising fast in some areas — up 121 percent in the Phoenix area since 2005, and 55 percent in the Atlanta area since 2004. In Cleveland, garnishments jumped 30 percent between 2008 and 2009 alone. Debt collectors say they are being forced into the action by combative debtors who dodge attempts to settle. "I think there’s a lack of accountability among debtors, and a lack of interest in reaching out to their creditors to resolve things amicably," said Fred N. Blitt, president of the National Association of Retail Collection Attorneys.
Bankruptcy can clear away most debts. Yet sweeping changes to federal law in 2005 — pushed by the banking lobby — complicated that process and more than doubled the average cost of filing, to more than $2,000. Many low-income debtors must save for months before they can afford to go broke. In some states, courts allow creditors to charge high interest rates for years after a lawsuit is decided in their favor. In others, creditors can win lawsuits by default and seize wages and bank accounts without a case ever appearing before a judge.
Lack of participation is the most fundamental problem. Some consumers do not even know they are being sued; the people who are supposed to serve them with formal notice have sometimes been caught skipping that step and doctoring the paperwork. In far more cases, consumers are served but still do not offer a defense. Few can afford lawyers; others are intimidated or confused. In their absence, judges can offer little relief. In the rare event that a consumer battles back, creditors frequently lack the documentation to prove their claim, and cases are dropped. That is because many past-due debts are owned not by the banks that issued them, but by debt collectors who bought, for cents on the dollar, a list of names and amounts due.
"If the consumers were armed with more education about how to defend against these debts, they’d be successful," said Jeffrey Lipman, a civil magistrate in Des Moines. The case of Sidney Jones shows how punishing the system can be. In January 2001, Mr. Jones, 45, a maintenance worker from California Crossroads, Va., took out a $4,097 personal loan from Beneficial Virginia, a subprime lender now owned by HSBC, the big bank. He fell behind, and Beneficial sued. Mr. Jones did not appear in court. "I just thought they were going to take what I owed," he said. By default, Beneficial won a judgment of $4,750, plus $900 in lawyers’ fees, with the debt accruing interest at 27.55 percent until paid in full. The bank started garnishing his wages in March 2003.
Over the next six years, the bank deducted more than $10,000 from Mr. Jones’s paychecks, but he made little headway on his debt. According to a court order secured by Beneficial’s lawyers last spring, he still owed the company $3,965, a sum nearly equal to the original loan amount. Mr. Jones, who did not graduate from high school, was baffled. "Where did all this money go that I paid them?" he said.
Dale Pittman, a consumer law lawyer in Petersburg, Va. , took Mr. Jones’s case without charge, and found that all but $134 of his payments had gone toward interest, fees and court costs. "It’s a perfectly legal result under Virginia law," Mr. Pittman said. HSBC said it ceased collection shortly after Mr. Pittman took the case, but declined further comment. "We are confident we are treating our customers fairly and with integrity," Kate Durham, a spokeswoman for HSBC North America, said in an e-mail message.
The rare debtors who press their claims, and catch a sympathetic judge, have a shot at a result more to their liking. Ruth M. Owens, a disabled Cleveland woman, was sued by Discover Bank in 2004 for an unpaid credit card. Ms. Owens offered a defense, sending a handwritten note to the court. "After paying my monthly utilities, there is no money left except a little food money and sometimes it isn’t enough," she wrote. Robert Triozzi, a judge at the time, heard the case. He found that over a period of several years, Ms. Owens had paid nearly $3,500 on an original balance of $1,900. But Discover was suing her for $5,564, mostly for late fees, compound interest, penalties and other charges. He called Discover’s actions "unconscionable" and threw the case out.
Discover defended its actions. "This account was placed with an attorney only after all other efforts to reach the card member were exhausted," Matthew Towson, a bank spokesman, said in an e-mail message. Going to court is no guarantee of victory, of course. Consumers who do go are sometimes intercepted by collection lawyers, who press them to sign papers settling without a trial. These settlements may be against the interests of debtors, but they sign anyway. "We’re signing off on a lot of settlement agreements where we shake our heads and ask, ‘Why is this person settling to this?’ " Judge Lipman said.
For the working poor, losing a lawsuit can mean disaster. Federal law permits creditors to seize as much as a quarter of a worker's paycheck, though the cutoff is lower for the lowest-paid workers, and a few states also offer greater protection. The working poor "have difficulties maintaining payments on life’s necessities with their full paycheck," said Angela Riccetti, a lawyer with Atlanta Legal Aid who represents indigent clients whose wages are being garnished. "You lose 25 percent of it and everything folds."
For Leann Weaver, the woman at the grocery store, Capital One’s lawsuit made a bad situation worse. After being evicted from her apartment, she moved in with her grandparents. Without them, she might have ended up on the street or in a shelter, she said. Capital One declined to comment on Ms. Weaver’s case. "We encourage anyone facing difficulties meeting their financial obligations to contact us right away," Tatiana Stead, a bank spokeswoman, said in an e-mail message.
Ms. Weaver said she repeatedly asked Capital One for more time to pay her $2,470 debt, but last year the bank filed suit. She failed to show up in court, and a judgment was entered against her, swollen by $1,800 in interest and lawyers’ fees. Then the garnishment began, almost $500 a month, or a quarter of her pay. "I can’t even look at my paychecks any more," she said.
Ilargi: Once more, the point I was trying to make in my April 2 2010 post, The long and the short of numbers.
Again, The Big Problem With Unemployment Is The LENGTH OF TIME People Are Unemployed
by Calculated Risk
Here is a graph of the unemployment rate seasonally adjusted and not seasonally adjusted - plus, by request, two more graphs of the duration of unemployment.
Click on graph for larger image in new window.
The first graph shows the calculated unemployment rate - both seasonally adjusted (SA) and not seasonally adjusted (NSA).
Some sites noted the NSA rate was "only" 9.5% when the SA moved above 10% last October. Other sites noted that the NSA rate had hit 10.6% in January. Both sites were correct - but there is a clear seasonal pattern for employment, so the SA unemployment rate is the one to use. Note: the SA rate will be above the NSA rate in April.
ALSO - the graph above uses the calculated unemployment rate (unrounded). For March, the calculated unemployment rate was 9.749% up from 9.687% in February. Both were rounded to 9.7% ...
And on duration of unemployment, by request:
This graph shows the duration of unemployment as a percent of the civilian labor force (line graph unstacked). The graph shows the number of unemployed in four categories as provided by the BLS: less than 5 week, 6 to 14 weeks, 15 to 26 weeks, and 27 weeks or more.
Note: The BLS reports 15+ weeks, so the 15 to 26 weeks number was calculated.
This really shows the change in turnover - there was more turnover in the '70s and '80s, since the 'less than 5 weeks' category was much higher as a percent of the civilian labor force than in recent years. This changed in the early '90s - perhaps as a result of more careful hiring practices or changes in demographics or maybe other reasons - but if the level of normal turnover was the same as in the '80s, the current unemployment rate would probably be the highest since WWII.
The last graph is a repeat, but the information is stacked in reverse order.
In March 2010, there were a record 6.55 million people unemployed for 27 weeks or more, or 4.3% of the labor force.
For more on duration (and possible causes) see my post yesterday: Duration of Unemployment
Did We Make a Profit on Citigroup?
by Dean Baker
The Washington Post (aka Fox on 15th Street) once again proclaimed TARP a success. The cause for the latest revelry is the fact that the government appears to be in a position to make an $8 billion gain on the stock it holds in Citigroup. Before we join the Post in breaking out the champagne, it's worth taking a bit closer look at our investments in Citigroup.
Our ownership of Citigroup stock has it origins in the dark days of late November of 2008. At the time, Citi's stock price was rapidly descending toward zero and private investors would not go near the collapsing behemoth. The Treasury and Fed boys spent the weekend before Thanksgiving working out a rescue package.
They came up with a package that had the Treasury buying $20 billion in preferred Citigroup stock and guaranteeing the value of $300 billion in troubled assets. In exchange for this guarantee, the government got another $7 billion in preferred Citigroup stock. The total value of this deal -- $27 billion - exceeded the full market value of Citi's stock on the last trading day prior to the rescue. In other words, the government could have owned Citigroup outright for the money that it handed the bank that weekend.
Four months later, the government traded its preferred shares for common stock that gave it a 27 percent stake in Citi. While we had put up enough money in November to buy Citi outright, when Treasury did the conversion to common stock, taxpayers only got a 27 percent stake.
Citi's shares had risen in the interim. The highly paid executives at Citi no doubt attribute the rise in stock prices to their expertise and shrewd business dealings. The rest of us attribute Citi's recovery to the immense amount of aid and coddling that these highly paid executives got from the Fed and Treasury. If we try to put some dollar figures on our other handouts to Citi, it is clear that taxpayers have not come close to making a profit on this deal.
First on the list of taxpayer handouts to Citi would be the "too big to fail" (TBTF) subsidy. This subsidy is the result of the fact that investors know that the government will not allow Citi to fail because it would create too much disruption in the economy. In effect, taxpayers are implicitly guaranteeing Citi's loans. This allows Citi to borrow at much lower cost than if it had to compete in the market like other businesses. In a paper I co-authored with Travis McArthur last year, we calculated that Citi's TBTF subsidy could be as much as $4.4 billion a year.
If the markets expect this subsidy to persist (a safe bet given the current status of financial reform legislation), then the value of this subsidy would account for most of the current market value of Citi's stock. In effect, the government's profit is entirely due to the value of the government's guarantee. In Washington Post land, the government could make money by buying shares of a company's stock, offering to guarantee the company's debt, and then selling our shares at a gain when the market recognizes the value of the government's guarantee. Of course this strategy provides much larger gains to the other shareholders and allows the top executives to score billions in bonuses for being such shrewd managers, but in Washington Post land they don't pay attention to such things.
Of course this is just the beginning of the list of handouts to this sick financial giant. The rescue in November of 2008 was actually Round II. The first round took place the prior month when Treasury handed Citi $25 billion in TARP money. While we did collect interest payments on this money, in addition to stock warrants, taxpayers got far less than the market rate. The Congressional Oversight Panel for TARP commissioned an independent study to compare the value of the assets that Citi gave us with our $25 billion investment. In their assessment, we overpaid Citi by $9.5 billion.
Citigroup also borrowed money that was explicitly guaranteed by the Federal Deposit Insurance Corporation (FDIC). As recently as this January, Citi still had $64.6 billion in FDIC guaranteed loans outstanding. It was paying just a 0.91 percent interest rate on these loans due to the government's safety blanket. If we assume that this crippled giant might otherwise pay something close to 3.0 percent on these loans in a free market, then this subsidy would be worth almost $1.4 billion a year.
So far we have $4.4 billion in TBTF subsidies, $9.5 billion in TARP handouts, and $1.4 billion in FDIC subsidies. That's a total of $15.3 billion. This is in addition to only getting 27 percent of the company when taxpayers put up more than enough money to own Citigroup outright. But wait, there's more.
Fannie Mae and Freddie Mac have already lost close $120 billion. There is good reason to believe that more losses are on the way. (The night before Christmas, Treasury removed the $400 billion limit on their combined line of credit. This move would have been unnecessary unless there was some possibility that this limit would actually be crossed.)
Fannie Mae and Freddie Mac lose money by paying too much for mortgages and mortgage-backed securities. Undoubtedly some of these purchases were from Citigroup. Fannie and Freddie's losses were effectively Citi's gains, since if Fannie and Freddie were not there to buy the bad mortgages, Citigroup would have suffered larger losses on its books.
While some of these losses were undoubtedly incurred prior to September of 2008 when Fannie and Freddie collapsed, many of the losses likely were incurred after this date (remember more losses are on the way). If we cut it 50/50, then Fannie and Freddie incurred losses of roughly $60 billion after they went into conservatorship. Citigroup's assets and deposits give it roughly 10 percent of the market. If we assume that it accounted for 10 percent of the overpriced mortgages sold to Fannie and Freddie in the conservatorship era, then Citi's Fannie and Freddie subsidy comes to $6 billion.
We also have roughly $30 billion in losses incurred at the Federal Housing Authority (FHA) over the last two years. In this case, the FHA is guaranteeing mortgages that might not otherwise have been issued. The FHA's losses mean that the guarantee did not reflect the true risk being incurred. If we assume that Citi got 10 percent of the FHA's losses (this is a bit more of a leap, since in many cases the mortgages simply would not have been issued), then Citi's FHA subsidy comes to $3 billion.
There are also the various special lending facilities created by the Federal Reserve Board, in addition to its ongoing operations through the discount window. Through these facilities, Citigroup could borrow short-term money at near zero cost. At its peak, more than $2 trillion was lent through these facilities. The Fed refuses to tell taxpayers who it lent our money to, but let's assume that Citi got 10 percent of this stash as well, or $200 billion. If Citi lent the money back to the government by buying Treasury bonds that pay 3.7 percent interest, then it could earn more than $7 billion a year by lending our money back to us. Nice work if you can get it.
And, there is also the matter of the Fed's massive program to buy mortgage-backed securities to push down mortgage rates. If the impact of this program lowered 30-year mortgage rates from 5.5 percent to 5.0 percent, then this would raise the price of the 30-year mortgages on Citi's books by more than 7.0 percent. If Citi has $500 billion in mortgages on its balance sheets, then this would increase the market value of these mortgages by more than $35 billion. This gift will not be costless to the Fed. It bought $1.25 trillion in mortgages. If it ends up reselling them in a market in which the 30-year mortgage rate averages 6.0 percent, then it will have incurred a loss of almost 15 percent, or more than $180 billion.
In short, anyone looking at the fuller picture would see that it is silly to claim that taxpayers made a profit in our investment in Citi. But, hey the banks and the bankers did well, not much else matters in Washington Post land. (For a recent tally of how much money is still outstanding from the bailout see Wall Street Bailout Cost.)
The Post concludes its piece by repeating the dire warning that: "the country faced imminent disaster" when the TARP money was handed out. Actually, the country has gotten the disaster. It's called 9.7 percent unemployment. High unemployment is projected to persist for most of the next decade. But, the banks were saved and everyone is now happy in Washington Post land.
Contesting Jobless Claims Becomes a Boom Industry
by Jason DeParle
With a client list that reads like a roster of Fortune 500 firms, a little-known company with an odd name, the Talx Corporation, has come to dominate a thriving industry: helping employers process — and fight — unemployment claims. Talx, which emerged from obscurity over the last eight years, says it handles more than 30 percent of the nation’s requests for jobless benefits. Pledging to save employers money in part by contesting claims, Talx helps them decide which applications to resist and how to mount effective appeals.
The work has made Talx a boom business in a bust economy, but critics say the company has undermined a crucial safety net. Officials in a number of states have called Talx a chronic source of error and delay. Advocates for the unemployed say the company seeks to keep jobless workers from collecting benefits. "Talx often files appeals regardless of merits," said Jonathan P. Baird, a lawyer at New Hampshire Legal Assistance. "It’s sort of a war of attrition. If you appeal a certain percentage of cases, there are going to be those workers who give up."
When fewer former workers get aid, a company pays lower unemployment taxes. Wisconsin and Iowa passed laws to curtail procedural abuses that officials said were common in cases handled by Talx. Connecticut fined Talx (pronounced talks) and demanded an end to baseless appeals. New York, without naming Talx, instructed the Labor Department staff to side with workers in cases that simply pit their word against those of agents for employers.
Talx officials say they have been unfairly blamed for situations caused by tight deadlines, confusing state rules or uncooperative employers. Talx cannot submit information about idled workers, they say, until clients give it to them. They say Talx improves the system’s efficiency by mastering the complexities of 50 state programs, allowing employers to focus on their businesses. "We can speed the whole process, rather than bog it down," said Michael E. Smith, a senior Talx executive. "The whole idea is to protect those employees who have lost their job through no fault of their own and make sure they get unemployment insurance."
Mr. Smith said employers, not Talx, controlled decisions about which cases to contest. "We just do what the client asks us to do and leave it to the state to decide," he said. Advocates for the unemployed cite cases like that of Gerald Grenier, 47, who spent four years as a night janitor at a New Hampshire Wal-Mart and was fired for pocketing several dollars in coins from a vending machine. Mr. Grenier, who is mentally disabled, told Wal-Mart he forgot to turn in the change. Talx, representing Wal-Mart, accused him of misconduct and fought his unemployment claim.
After Mr. Grenier waited three months for a hearing, Wal-Mart did not appear. A Talx agent joined by phone, then seemingly hung up as Mr. Grenier testified. The hearing officer redialed and left an unanswered message on the agent’s voice mail. The officer called Mr. Grenier "completely credible" and granted him benefits. Talx appealed, claiming that the officer had denied the agent’s request to let Wal-Mart testify by phone. (A recording of the hearing contains no such request.) Mr. Grenier won the appeal, but by then he had lost his apartment and moved in with his sister. "That was a nightmare," he said.
In the case of Dina Griess, Talx and its client, the subprime lender Countrywide Financial, were involved in what a judge deemed an outright fraud. Ms. Griess worked for Countrywide outside Boston and quit as it collapsed in 2008, saying she was distressed by internal investigations of lending practices. People can receive unemployment benefits if they quit for "good cause," like unsafe working conditions, but Talx argued that Ms. Griess’s reason did not meet the legal standard. She won benefits at a hearing that Talx and Countrywide skipped, but Talx successfully appealed, saying the Countrywide witness had missed the hearing because of a family death. Later asked under oath if that was true, the witness said, "No, it’s not."
A Massachusetts judge reviewing the case, Robert A. Cornetta of Salem District Court, denounced the deceit and gave Ms. Griess benefits. "The court will not be party to a fraud," he said. Despite the large role that Talx and other agents play in a program that spent $120 billion last year, the federal Department of Labor has done little to measure their impact. Talx, which is based in St. Louis, declined to make clients available for interviews, citing pledges of confidentiality, and none of those contacted chose to comment. Other major employers that have used Talx include Aetna, AT&T, Best Buy, FedEx, Home Depot, Marriott, McDonald’s and the United States Postal Service. (The New York Times uses Talx for a different service, to answer inquiries from lenders about its employees’ earnings.)
Talx entered the field brashly, buying the industry’s two largest companies on a single day in 2002. In the next few years, it bought five more. Until then, Talx had never handled an unemployment claim, and skeptics wondered how well it could blend seven companies in an unfamiliar industry. The Federal Trade Commission argued in a 2008 antitrust complaint that the acquisitions, which cost $230 million, had allowed Talx to "raise prices unilaterally" and "decrease the quality of services." Talx modified some contracts to settle the case, but admitted no legal violations. Financially, the gamble paid off: Talx was acquired three years ago by Equifax, the credit-rating giant, for $1.4 billion. But work once done locally became centralized — at a loss, critics say, of responsiveness and expertise.
Wisconsin officials were among the first to complain, passing a law in 2005 to prevent what they called a common Talx practice: failing to respond to requests for information, only to appeal when workers got benefits. That clogged the appeals docket and drained the benefits fund, since money sent to ineligible workers was hard to get back. While the law brought about quicker participation, said Hal Bergan, the state’s unemployment insurance administrator, the company’s overall speed and accuracy "still leaves something to be desired."
Indeed, years of e-mail messages, obtained through an open records law, show a continually exasperated Wisconsin staff. While a few cited improved performance, others complained that Talx "returned half-empty questionnaires," sent back "minimal or ‘junk’ info," reported in error that applicants were dead, filed "frivolous protests" and caused "the holdup of many claims." "Same problems as always," wrote Amy Banicki, a senior manager, in a 2008 e-mail message. "Talx is Talx."
Iowa passed a similar law in 2008 to curtail unnecessary appeals. Of the 10 employers who most often appealed after failing to respond to data requests, officials said nine were represented by Talx, including Cargill, Target, Tyson Foods, Wal-Mart and Wells Fargo. Connecticut cited "frivolous motions" and "unnecessary delays" in filing a complaint against Talx under a law that regulates employer agents. Without admitting fault, Talx paid a $12,000 fine and agreed to tell clients in writing that it would not file baseless appeals.
While there is no comprehensive research, the Labor Department did an internal study of 2,000 cases in 2007 and found Talx significantly slower and less complete in answering auditors’ questions than employers who handled their own claims. Officials said they did not release the study, which drew on seven states, because they could not ensure it was representative. The New York Times obtained it under the Freedom of Information Act. Talx supporters say the program’s tight deadlines often give Talx just a few days to answer requests. They emphasize that Talx is working with states to develop a common computer format that will help provide the data more rapidly. They also say scrutiny of claims by companies like Talx helps deter fraud.
"Increased vigilance is an appropriate thing," said Douglas J. Holmes, president of UWC, a Washington group that represents employers on unemployment issues. "Integrity is important." But others say that Talx, by promising to save clients money, has an incentive to fight even legitimate claims. In marketing materials, it warns employers that "a single claim can result in a higher tax rate" and makes the promise that "we deliver increased winning percentages." Joseph Walsh, deputy director of Iowa’s employment security agency, said, "We are more likely to see a claim of misconduct that is completely unsupported by the factual record" when agents are involved.
Officials in the New York State Department of Labor were so concerned last year about the credibility of agents that they warned staff members against taking their word over that of jobless workers. Absent other evidence, the officials wrote, "give greater weight to the claimant’s statement." That guidance was relevant in the case of Genssy Frias, a Bronx woman who took a maternity leave from a sales job at Lord & Taylor. Ms. Frias said that she tried to return but that her supervisor told her she had been laid off. A Talx agent said Ms. Frias quit because she lacked child care. "We did not hear from her again," the agent wrote. New York canceled Ms. Frias’s benefits and accused her of lying.
In an interview, Ms. Frias said the agent’s response to the state was not only inaccurate but also deceitful, because she did not disclose that she worked for Talx and implied first-hand knowledge by using the pronoun "we." Had she identified herself as an agent, officials would have given her statement less weight. A Talx spokeswoman said the agent made a clerical error in writing "we" and called it an isolated incident. Lord & Taylor did not respond to requests for comment. Ms. Frias appealed and presented a baby sitter’s note, which vouched that she had arranged for child care. Neither Talx nor Lord & Taylor appeared at the hearing, and Ms. Frias won. "I was thinking, how can they lie like that when they know I didn’t quit?" Ms. Frias said.
Growth of Unpaid Internships May Be Illegal, Officials Say
by Steven Greenhouse
Convinced that many unpaid internships violate minimum wage laws, officials in Oregon, California and other states have begun investigations and fined employers. Last year, M. Patricia Smith, then New York’s labor commissioner, ordered investigations into several firms’ internships. Now, as the federal Labor Department’s top law enforcement official, she and the wage and hour division are stepping up enforcement nationwide.
Many regulators say that violations are widespread, but that it is unusually hard to mount a major enforcement effort because interns are often afraid to file complaints. Many fear they will become known as troublemakers in their chosen field, endangering their chances with a potential future employer. The Labor Department says it is cracking down on firms that fail to pay interns properly and expanding efforts to educate companies, colleges and students on the law regarding internships. "If you’re a for-profit employer or you want to pursue an internship with a for-profit employer, there aren’t going to be many circumstances where you can have an internship and not be paid and still be in compliance with the law," said Nancy J. Leppink, the acting director of the department’s wage and hour division.
Ms. Leppink said many employers failed to pay even though their internships did not comply with the six federal legal criteria that must be satisfied for internships to be unpaid. Among those criteria are that the internship should be similar to the training given in a vocational school or academic institution, that the intern does not displace regular paid workers and that the employer "derives no immediate advantage" from the intern’s activities — in other words, it’s largely a benevolent contribution to the intern.
No one keeps official count of how many paid and unpaid internships there are, but Lance Choy, director of the Career Development Center at Stanford University, sees definitive evidence that the number of unpaid internships is mushrooming — fueled by employers’ desire to hold down costs and students’ eagerness to gain experience for their résumés. Employers posted 643 unpaid internships on Stanford’s job board this academic year, more than triple the 174 posted two years ago.
In 2008, the National Association of Colleges and Employers found that 83 percent of graduating students had held internships, up from 9 percent in 1992. This means hundreds of thousands of students hold internships each year; some experts estimate that one-fourth to one-half are unpaid. In California, officials have issued guidance letters advising employers whether they are breaking the law, while Oregon regulators have unearthed numerous abuses. "We’ve had cases where unpaid interns really were displacing workers and where they weren’t being supervised in an educational capacity," said Bob Estabrook, spokesman for Oregon’s labor department. His department recently handled complaints involving two individuals at a solar panel company who received $3,350 in back pay after claiming that they were wrongly treated as unpaid interns.
Many students said they had held internships that involved noneducational menial work. To be sure, many internships involve some unskilled work, but when the jobs are mostly drudgery, regulators say, it is clearly illegal not to pay interns. One Ivy League student said she spent an unpaid three-month internship at a magazine packaging and shipping 20 or 40 apparel samples a day back to fashion houses that had provided them for photo shoots.
At Little Airplane, a Manhattan children’s film company, an N.Y.U. student who hoped to work in animation during her unpaid internship said she was instead assigned to the facilities department and ordered to wipe the door handles each day to minimize the spread of swine flu. Tone Thyne, a senior producer at Little Airplane, said its internships were usually highly educational and often led to good jobs. Concerned about the effect on their future job prospects, some unpaid interns declined to give their names or to name their employers when they described their experiences in interviews.
While many colleges are accepting more moderate- and low-income students to increase economic mobility, many students and administrators complain that the growth in unpaid internships undercuts that effort by favoring well-to-do and well-connected students, speeding their climb up the career ladder. Many less affluent students say they cannot afford to spend their summers at unpaid internships, and in any case, they often do not have an uncle or family golf buddy who can connect them to a prestigious internship.
Brittany Berckes, an Amherst senior who interned at a cable news station that she declined to identify, said her parents were not delighted that she worked a summer unpaid. "Some of my friends can’t take these internships and spend a summer without making any money because they have to help pay for their own tuition or help their families with finances," she said. "That makes them less competitive candidates for jobs after graduation."
Of course, many internships — paid or unpaid — serve as valuable steppingstones that help young people land future jobs. "Internships have become the gateway into the white-collar work force," said Ross Perlin, a Stanford graduate and onetime unpaid intern who is writing a book on the subject. "Employers increasingly want experience for entry-level jobs, and many students see the only way to get that is through unpaid internships."
Trudy Steinfeld, director of N.Y.U.’s Office of Career Services, said she increasingly had to ride herd on employers to make sure their unpaid internships were educational. She recently confronted a midsize law firm that promised one student an educational $10-an-hour internship. The student complained that the firm was not paying him and was requiring him to make coffee and sweep out bathrooms. Ms. Steinfeld said some industries, most notably film, were known for unpaid internships, but she said other industries were embracing the practice, seeing its advantages. "A few famous banks have called and said, ‘We’d like to do this,’ " Ms. Steinfeld said. "I said, ‘No way. You will not list on this campus.’ "
Dana John, an N.Y.U. senior, spent an unpaid summer at a company that books musical talent, spending much of her days photocopying, filing and responding to routine e-mail messages for her boss. "It would have been nice to be paid, but at this point, it’s so expected of me to do this for free," she said. "If you want to be in the music industry that’s the way it works. If you want to get your foot in the door somehow, this is the easiest way to do it. You suck it up." The rules for unpaid interns are less strict for non-profit groups like charities because people are allowed to do volunteer work for non-profits.
California and some other states require that interns receive college credit as a condition of being unpaid. But federal regulators say that receiving college credit does not necessarily free companies from paying interns, especially when the internship involves little training and mainly benefits the employer. Many employers say the Labor Department’s six criteria need updating because they are based on a Supreme Court decision from 1947, when many apprenticeships were for blue-collar production work.
Camille A. Olson, a lawyer based in Chicago who represents many employers, said: "One criterion that is hard to meet and needs updating is that the intern not perform any work to the immediate advantage of the employer. In my experience, many employers agreed to hire interns because there is very strong mutual advantage to both the worker and the employer. There should be a mutual benefit test." Kathyrn Edwards, a researcher at the Economic Policy Institute and co-author of a new study on internships, told of a female intern who brought a sexual harassment complaint that was dismissed because the intern was not an employee. "A serious problem surrounding unpaid interns is they are often not considered employees and therefore are not protected by employment discrimination laws," she said.
Europe laments craftman's demise
by Scheherazade Daneshkhu
Europe's luxury goods makers have warned that numbers of skilled craftsmen are dwindling rapidly as suppliers source more production from Asia. The continent's main luxury trade bodies meet next week to sound the alarm over the erosion of skills in the industry, one of the few in which the region is world leader. European brands account for 75 per cent of the €170bn (£151bn, $229bn) global luxury market, according to figures from Boston Consulting Group.
In spite of rising demand from Asia for expensive European fashion, the highly fragmented sector is in danger, say the industry bodies of France, Britain, Italy and Spain - the Comité Colbert, Walpole, Fondazione Altagamma and Foro del Lujo Español. Guy Salter, deputy chairman of Walpole and spokesman for the alliance, said the loss of skills was a big concern. "All young people want to be designers and very few, makers. We want to try to change that by promoting craftsmanship in the luxury sector," he said. High labour costs and the strong euro have pushed companies to source production from Asia and eastern Europe even though the imprimatur of an established producer in France or Italy is seen as essential to the high price tags.
Mr Salter said Britain had only a "handful" of small factories making leather accessories, compared with more than 100 about 50 years ago. In France, the government is pushing big companies to sign a charter of good practice this month to place more orders with national suppliers. Confection Rousseau, which employs 47 staff in Vierzon, central France, specialises in cutting and stitching thick fabrics, and counted Christian Lacroix among its customers until the designer went into administration last year. Marc Rousseau, company founder, said: "I want the large luxury companies to answer the question: is it necessary to preserve manufacturing and savoir-faire in France? My fear is that these companies are happy to sell through the use of marketing and celebrities and that they don't care about quality any more. So there is a real threat."
Embroidery is in danger of disappearing, to the advantage of India, insiders said. Another, according to Agnès Troublé, founder and designer of Agnès B, is menswear manufacture. It was Lacroix's demise that spurred Christian Estrosi, industry minister, to announce measures to support the industry. Some companies have been unhappy with outsourcing. Céline, the French fashion house owned by LVMH, the world's biggest luxury goods company, returned production of its prêt à porter from China to France last year.
More than 60 per cent of luxury goods made in Europe are exported outside the region. In spite of famous brands such as Louis Vuitton, Versace, Burberry and Gucci, the industry, which employs 800,000, is fragmented. The top 10 groups represent less than half the market, says BCG, unlike the car industry where the top 10 represent 75 per cent. The luxury goods sector should pick up this year after sales fell about 8 per cent last year, according to Bain, the consultancy.
by Dmitry Orlov
We are heading toward economic, political and social collapse, and every day that passes brings it closer. But we just don't know when to stop, do we? Which part of "the harder we try, the harder we fail" can't we understand? Why can't we understand that each additional dollar of debt will drive us into national bankruptcy faster, harder and deeper? Why can't we grasp the concept that each additional dollar of military spending further undermines our security? Is there some sort of cognitive impairment that prevents us from understanding that each additional dollar sunk into the medical industry will only make us sicker? Why can't we see that each incremental child we bear into this untenable situation will make life harder for all children? In short, what on earth is our problem?
Why can't we stop? We can blame evolution, which has produced in us instincts that compel us to gorge ourselves when food is abundant, to build up fat reserves for the lean months. These instincts are not helpful to us when there is an all-you-can-eat buffet nearby that's open year-round. These instincts are not even specifically ours: other animals don't know when to stop either. Butterflies will feast on fermented fruit until they are too drunk to fly. Pigs will eat acorns until they are too fat to stand up and have to resort to crawling about on their bellies in order to, yes of course, eat more acorns. Americans who are too fat to walk are considered disabled and the government issues them with little motorized scooters so that they don't have to suffer the indignity of crawling to the all-you-can-eat buffet on their bellies. This is considered progress.
Or we can blame our education, which puts mathematical reasoning ahead of our common sense. Mathematics uses induction—the idea that if 1 + 1 is 2 then 2 + 1 must be 3, and so on up to an arbitrarily large quantity. In the real world, if you are counting acorns, then 1 + 1 acorns is not the same as 1,000,000 + 1 acorns—not if there are squirrels running around, which there will be once they find out that you are the one who's been stealing their acorns. A million acorns is just too many for you to keep track of, and your concerted effort to keep adding one more to the pile while fighting off squirrels may cause small children to start calling you silly names.
The bigger the pile grows, the more likely you are to have to take inventory, and in the process you are increasingly likely to make a mistake, so that it turns out that 1,000,000 + 1 is in fact 1,000,001 - ?, where ? is the number of acorns you have lost track of, somehow. Once ? > 0, you have achieved diminishing returns, and once ? > 1, you have achieved negative returns. In the real world, the bigger you think a number should be, the smaller it actually turns out to be. At some point, trying to add one more to the pile becomes a particularly wasteful way of making the pile smaller. This result is not intellectually pleasing, and there is no theory to back it up, but it is observable anywhere you care to look. The fact that we are unable to adequately explain any given phenomenon by using our feeble primate brains does not make it any less real.
The concept of diminishing returns is quite simple for most people to understand and to observe, but notoriously difficult to detect for the person who is at the point of achieving them. The point of negative returns is even harder to detect, because by that point we tend to be too far gone to detect much of anything. If you already had N drinks, can you tell if you are at the point of diminishing returns yet? Will another drink make you happier and more sociable, or will it not make much of a difference? Or will it cause you to embarrass yourself and spend the next day nursing a debilitating hangover? Or will it send you to the emergency room to be treated for vomit inhalation? As a general rule, the more you imbibe, the more difficult it becomes for you to draw such fine distinctions.
This rule does not seem to be limited to drinking, but applies to almost all behaviors that produce a feeling of euphoria rather than the simple satisfaction of needs. Most of us can stop ourselves from drinking too much water, or eating too much porridge, or stacking too many bales of hay. Where we do tend to run into trouble with self-control is when it comes to things that are particularly pleasurable or addictive, such as drugs, tobacco, alcohol, and rich and delicious food. And we tend to lose it completely when it comes to euphoria-inducing social semi-intangibles: satisfaction of greed, status-seeking, and power over others.
Is this the best we can do? Certainly not! Human culture is full of examples where people stood up and successfully opposed such primitive tendencies within themselves. The ancient Greeks made a virtue of moderation: the temple of Apollo at Delphi bore the inscription MH?EN A?AN—"Nothing in excess." Taoist philosophy focuses on the idea of balance between yin and yang (? ?)—seemingly contrary natural forces that in fact work together and must be kept in balance. Even in contemporary engineering culture one sometimes hears the motto "Better is the enemy of good enough." Sadly, though, engineers who are good enough to abide by it are something of a rarity. At the micro level of solving specific problems most engineers do strive to achieve the clever optimum rather then the stupid maximum, but at the macro level the surrounding business culture forces them to always go for the stupid maximum (maximum growth, revenue and profits) or the stupid minimum (minimum cost, product cycle time and maintainability). They are forced to do so by the influence of a truly pernicious concept that has insinuated itself into most aspects of our culture: the concept of competition.
The concept of competition seems to have first been elevated to cult status by games that were played as a form of sacrifice before gods, in cultures as different as ancient Greece and the Mayan civilization, where competitive events were held to please their various deities. I much prefer the Olympic version, where the object of the games was to express the ideal of human perfection in both form and function, rather than the Mayan version, where the outcome of the game was used to decide who would be sacrificed on the altar of some peculiar cultural archetype, but being open-minded I am ready to accept either as valid, because both are competitions in defense of principle. It was Aristotle who pointed out that pursuit of principle is the one area where moderation is not helpful, and who am I to refute Aristotle?
But when moving from defending an ideal or a principle to performing mundane, practical, utilitarian functions it is the idea of competition itself that should be offered up as a nice, sizzling-fat burnt offering on the altar of our common sense. If the goal is to achieve an adequate result with a minimum of effort, then why would two people want to compete to do the job of one? And if there is in fact work enough for two, then why wouldn't they want to cooperate instead of wasting their precious energies in competition? Well, they may have been brainwashed into thinking that they must compete in order to succeed, but that's beside the point.
The point is that there is a major difference between competing for the sake of a principle—such as the perfection of divine creation—and competing for mere money. There is nothing divine about a big pile of money, and, just as with a big pile of acorns, the bigger the pile, the more "squirrels" it tends to attract. In fact, those who are sitting on some of the bigger piles of acorns often seem rather squirrely themselves. To mix metaphors, they also tend to be chicken-like, roosting on their acorns and expecting them to hatch into more acorns. But be they squirrels or be they chickens, or be they drug-addled mutant chicken-squirrels on steroids, they are certainly not gods, and their acorns are not worthy of our sacrifice.
Once we dispense with the idea that competition is in any sense necessary, or even desirable, new avenues of thought open up. How much is enough? Probably much less than we have now. How hard do we need to work for it? Probably a lot less hard than we are working now. What happens if we don't have enough? Well, perhaps then it's time to try working just a tiny bit harder, or, better yet, perhaps it is time to take a few acorns from those who still have too many. Since having too much is such hard work (mind the damn squirrels!) we'd only be helping them. We certainly don't want to keep up with them, because we know where they are headed—a quaint, exclusive little place called collapse. What we should probably be trying to do instead is to establish some sort of balance, where enough is, in fact, enough.