Game of craps, Cincinnati, Ohio
Ilargi: One more time (could this be the last?), we delve into the notion that energy, and oil in particular, might have caused the financial crisis. We've done this more times at The Automatic Earth than we should have already, if you ask me, but Stoneleigh, who has far more patience than I do, has this Q and A with a TAE reader. My view: oil and oil prices as a causative agent for the credit crunch remains a non-starter for all but the peak oil religious fanatics.
The most obvious issue to address in the reader’s statements below is the idea that if we had $20 oil today, there would be no financial crisis. I don’t think I even see the possible relevance here. For example. one of the main and most obvious symbols of this crisis so far has been Bernie Madoff. He's not Lehman, AIG or Goldman Sachs, and he's not the government of Greece, or Britain, or America, but his spiel, his schtick and his scheme are the exact same. The key word is Ponzi. Not oil.
But no, neither Madoff, nor AIG, nor Goldman nor any of the governments did what they did because of oil, or oil prices. All these schemes started out when oil was still dirt cheap, and it never factored in. Really, hard as it is to fathom or accept, the financial crisis has fed simply and only off itself, though non-existent regulation and the ensuing opportunity for endless greed. It never needed anything else. Ponzi schemes are like those secret service messages: self-destructing.
Which is not to say that oil couldn't bankrupt BP, but that's a whole other story. Here's Stoneleigh:
Stoneleigh: Let me try to resolve the apparent contradictions by answering some questions from a TAE reader:
Q: In 1933 there was a shortage of everything. Commerce had been dead for enough years - killed by gold- buggery - that there was shortages except for crops that were rotting in the fields (and petroleum that was wasted, according to Jeffrey Brown, who I believe.) No money meant no production = shortages = no commerce = no new money in the system in a self- reinforcing cycle....
....citizens hoarded paper dollars as they had hoarded specie. Paper dollars were still worth more than (pauperish) 1930's commerce.
Stoneleigh: Exactly. The lack of money led to shortages because without it one could not connect buyers with sellers, so production died. But not for want of raw materials. Farmers threw milk they couldn't sell in ditches while down the road people were starving. That is what I have been saying will happen again.
Money is the lubricant in the economic engine. Trying to run an economy without it is like trying to drive your car with the oil light on. The vast majority of the effective money supply consists of credit, and deleveraging will take care of that. As for the small amount of money left, people will be hanging on to it with both hands because they won't know when they'll be able to earn any more.
The fall in the velocity of money will aggravate credit collapse dreadfully. The result will be an unbelievably severe liquidity crunch, worse than the 1930s because the scale of the hangover is proportionate to the scale of the party that preceded it.
For a while it will look like we have surpluses, merely because production will be set to meet a level of aggregate demand that will no longer exist due to a collapse of purchasing power. Then production will disappear as well.
We tell people to make sure they have preserved capital as liquidity, as dollars (and other currencies) will indeed be worth a great deal in relation to available goods and services. Those who still have money will be the only ones with purchasing power.
Q: 1933 = Diff'rent times, less people, less demand and less production in (all) aggregates.
Stoneleigh: Quite so. This time there are far more people with far fewer skills and far higher expectations. Moving into the same kind of crunch scenario will hurt far more this time. This is why I tell people that they have to build relationships of trust now to carry them (hopefully) through hard times. I don't say this because it's any kind of guarantee of success, but because it's all they can do and one has to do something. The big picture can look so awful as to be paralysing, so people need to keep taking one step at a time. It's far better to do that than to lie down and die, or drink one's self to death as many Russians did after their smaller collapse.
Q: If we have $20 oil there will be no crisis, guaranteed. $20 oil and we have lots of credit/money expansion. Multipliers working and inflation/growth. We would have commerce. We would all be buying shit from (low- wage/cheap coal) China.
Stoneleigh: I disagree. I think we will see $20 oil, but only because of a massive fall in aggregate demand due to the evaporation of purchasing power. $20 oil will not be cheap oil. On the contrary, it will seem very expensive to most people.
That is what deflation does - prices fall but purchasing power falls faster, making almost everything less affordable. As a much larger percentage of a much smaller money supply will be chasing the essentials, they will receive relative price support, meaning that their price will fall less than everything else, so the essentials will be the least affordable of all.
As with many things, demand collapse sets up a supply collapse and a resource grab, so we could see oil go from $20 to $500, if in fact there is any oil left on the open market at all by that point. Since oil IS hegemonic power in a very dangerous world, that may not be the case.
Prices can rise in a deflation if there is a sufficient shortage of a critical good (just as they can fall in inflationary times if there is a sufficient surplus or production costs are falling rapidly). If prices are rising in nominal terms, they are going through the roof in real terms against a backdrop of a collapsing money supply.
Q: Oil shortages (relative to credit- fueled demand) force an allocation regime on a 'super- size me' economic model of 'all of the above, please!'
Stoneleigh: By the time we have oil shortages, we won't have any credit-fueled demand because there will be no credit. First we lose the credit, which cripples purchasing power, then we lose demand (where demand is not "what you want", but "what you can pay for"). We'll have a temporary glut of oil, which will kill investment.
The lack of investment in new production, and lack of money for maintenance of existing equipment, and potential sabotage of existing equipment by those with nothing left to lose, set up a supply crunch. By that point very few have any purchasing power at all, and none of it credit-based, but governments and their militaries will be chasing down whatever is available for their own use (and hoarding where possible).
Q: Look around you ... everything you see, that you will see tomorrow and the next day ... what you eat and wear and sleep under ... the computer you write on ... is a product of cheap oil. Where would finance be without it?
Stoneleigh: There was a primitive derivatives market in Holland in the 1630s (at the time of the Tulipmania). Bubbles of 'financial innovation' (ie the rediscovery of leverage) do not depend on fossil fuels. They have happened time and time again in history and are a product of human nature.
Energy, in one form or another, absolutely is a key driver of expansion, although one can build a ponzi scheme on surprisingly little of it because ponzi wealth is virtual wealth. It takes energy to build real things, but much less to build imaginary value.
Once a ponzi scheme has been created, it will collapse, as these structures are inherently self-limiting. Finance becomes a key driver to the downside, even where energy is still available.
Q: Maybe I'm wrong and maybe I'm an idiot but the confluence between you and I is where the US dollar becomes a proxy for crude oil rather than the proxy for commerce/business that was once upon a time leveraged from it.
Stoneleigh: I am not convinced we will see the dollar become a proxy for oil. I think the dollar will rise substantially as dollar-denominated debt deflates (creating demand for dollars), and people make a knee-jerk move into it on a flight to safety. However, I don't think this will last more than a year or two at most.
I think we are headed into a chaotic currency regime where floating exchange rates are dropped, currency pegs instituted in an attempt to 'beggar they neighbour', and those currency pegs fail. I can't see any fiat currency coming that's being backed by hard goods, in that time. I can imagine a true hard currency down the road a few years, but I very much doubt it will be a currency that exists now.
Q: Nobody seems to have any idea what the hard dollar is going to do to them, their families, loved ones, dogs, goldfish, etc. Almost nobody alive has ever experienced hard currency. The deflationary power of the hard dollar is going to hit this country like the hammer of Thor. It's conservation by the back door.
Stoneleigh: Much of that will happen just by taking the credit out of the system, and if we do see a true resource-backed currency down the line, then it would be very much worse. It would amount to far more than conservation by the back-door though. It would be brutal deprivation with no regard for the most basic needs, let alone wants.
Q: Conservation isn't an issue unless there is something vital that needs conserving! It's not finance, Stoneleigh ... there is no limit to finance that is credit- based. There are only limits to finite natural capital!
Stoneleigh: There is a limit to credit expansion, as there is to every ponzi scheme. Eventually the debt created can no longer be serviced, the biggest sucker has been fleeced, expansion can no longer continue and we see the implosion of the structure, where the excess claims to underlying real wealth are messily and rapidly extinguished. The virtual wealth disappears. That is deflation.
Q: If cheap, accessible oil was available (still) it would be drilled, no?
Stoneleigh: It might well be left in the ground for later if there was already an excess of production relative to demand at the time.
Q: Take away oil and we have what we have ... a finance world without anything to leverage but rioting Greeks.
Stoneleigh: People have managed to leverage the darnedest things in human history. I'm not suggesting they do it in the absence of energy, but as I said before, the creation of virtual wealth through leverage takes much less energy than the creation of something real. Energy is required to fuel the necessary socioeconomic complexity of course, and it can be energy in many forms - food surpluses, wood or cheap/slave labour from colonies for instance.
Fossil fuels have enabled the largest increase in socioeconomic complexity in history, and financial innovation is part of that.
But finance is not purely a passive consequence. It is a key driver in its own right, especially during contractionary times, or maybe we should say: THE key driver both during Ponzi growth times and Ponzi contraction (collapse) times.
Budget proposal deals blow to California's poor
by Wyatt Buchanan and Marisa Lagos
State programs that help California's neediest residents would be significantly cut or outright eliminated under Gov. Arnold Schwarzenegger's updated spending plan announced Friday. Schwarzenegger proposed ending the entire state welfare program along with most state-subsidized child care, cutting mental health services by 60 percent and considerably slashing in-home care services for elderly, sick and disabled people. Those cuts, along with others, would save the state an estimated $12 billion in the year starting July 1.
"California no longer has low-hanging fruits, we don't have any medium-hanging fruits and we also don't have any high-hanging fruits," Schwarzenegger said. "We have to take the ladder from the tree and shake the whole tree." But the Republican governor refused to suspend the implementation of corporate tax breaks that will cost the state $2.1 billion.
That stance infuriated Democrats. Sen. Denise Moreno Ducheny, D-San Diego, the chairwoman of the Senate Budget Committee, said the decision shows the governor believes "corporate tax breaks that do not exist today have more value than the children of California." While slashing some state services, Schwarzenegger fulfilled his pledge to increase the budgets for the University of California and California State University systems.
Deficit revised down
The governor revised the projected deficit from $20 billion to $19 billion. Total general fund spending would decrease to $83.4 billion, the lowest level in six years but about half a billion more than Schwarzenegger's initial January proposal. Democratic leaders blasted the proposal, with state Senate President Pro Tem Darrell Steinberg, D-Sacramento, calling it a "nonstarter." "God forbid this budget became a reality," Steinberg said. "California would be the only state in the union to not have a safety net for kids."
He promised that the Legislature would not pass a budget that eliminates the welfare program, called CalWORKS. CalWORKS serves 1.4 million people, two-thirds of whom are children. Eliminating the program would save the state $1.6 billion, although California also would lose about $4 billion in federal dollars. The governor proposed eliminating the program last year as well, but that was dropped in negotiations. The revised budget plan counts on $3.4 billion in federal money and $3.1 billion in internal borrowing and other alternative funding.
By law, the Legislature has until June 15 to pass a spending plan for the 2010-11 year, but lawmakers routinely miss that deadline. Two-thirds of the Legislature must pass the budget, which means any plan must win at least some Republican support.
Governor wants reforms
The governor vowed not to sign a budget plan unless the Legislature passes reforms to the budget process and state pension system. Several months ago Steinberg said taxes would not be part of the Democrats' deficit solution, but Friday he said the Legislature needs to consider extending the taxes passed as part of the budget deal last year and possibly increasing the vehicle license fee.
The governor also called for a major realignment of government services, shifting some programs from the state to the local level and giving local entities some state money and the ability to raise revenue for the programs. Assembly Speaker John Pérez, D-Los Angeles, was hosting a golfing fundraiser at Pebble Beach but released a statement saying the plan was "more reflective of a hyper-partisan political agenda than in finding real solutions to our problems."
Committed to tax breaks
The governor defended the cuts and the tax breaks. Those breaks, he said, would help stimulate the economy, which in turn would provide additional revenues to the state. He has said he would not support any tax increases. Republican leaders in Sacramento generally applauded the governor's proposal, especially his commitment on taxes. Senate Republican Leader Dennis Hollingsworth, R-Murrieta (Riverside County), called it "bitter medicine." "The spending reductions are unfortunate but necessary to begin restoring our budget's fiscal health," he said.
Other parts of the budget proposal include:
- Moving 15,000 nonviolent inmates from state prisons to county jails, saving $243.8 million.
- Cutting $2.8 billion from K-12 education, though education money that wasn't spent in years pass allows per-pupil spending to remain the same.
- A $602 million cut to mental health services.
- A $750 million cut to the In-Home Supportive Services program, which provides home care to 430,000 elderly, sick or disabled Californians and employs 360,000 people.
- Limiting services and increasing fees for people on Medi-Cal, saving $523 million.
- Eliminating child care funding except for preschool, saving $1.2 billion and affecting 142,000 children in the state.
Bryte Skolfield, spokesman for the Children's Council of San Francisco - a child care resource and referral agency that helps both providers and families - said the proposed cuts would be "another punch to an already unhealthy economy." He said in general, the state gets $3 from the federal government for every dollar it spends subsidizing child care. "At first glance, what he is proposing is very dangerous for the state of California," he said. "If you look at these types of cuts, it's not just state cuts - it's dollars going back into the economy through small businesses." Democratic leaders said as many as 50,000 child care centers could close in the state if the cuts are made.
Worries about welfare
There are also concerns that eliminating the welfare program could have devastating effects on families. And local officials said the proposal would shift billions of dollars in costs to counties and cities already reeling from their own deficits. Trent Rohrer, San Francisco's Human Services chief, said CalWORKS helps 5,200 families and 12,000 children in the city. Of those families about 25 percent, or 1,300, are participating in a federally subsidized job program intended to pull them out of poverty and off of government assistance.
"You're taking away the safety net for the poorest families in the community - it would undoubtedly result in homelessness and create a permanent underclass with no prospects for families to get out of poverty," he said. "People will have little to no prospect of working - no child care, no transportation assistance, no job training or job placement. ... Thousands of families could fall into homelessness. There are 125 families on our shelter wait list now - we could be looking at thousands."
Schwarzenegger compares California's woes to euro zone
by Jim Christie and Peter Henderson
California Governor Arnold Schwarzenegger on Friday compared the state's predicament to that of weaker euro zone economies and called for scrapping the state welfare system to close a $19.1 billion budget gap. The movie star turned governor said California, the most populous U.S. state with an economy that would be the eighth largest in the world, faced the same dilemma of dismal growth and budget gaps as Greece, Spain and Ireland.
California's government has been living beyond its means and has little choice but to cut $12.4 billion in spending over the remainder of this fiscal year and the next, Schwarzenegger told a press conference in Sacramento. "You see what is happening in Greece, you see what is happening in Ireland, you see what is happening in Spain now," Schwarzenegger said, referring to swelling deficits and austerity measures that have concerned investors worldwide. "We are left with nothing but tough choices."
Democrats and Republicans, who must muster a two-thirds majority to pass a budget, are likely to ignore many of his suggestions in a debate which, if it follows recent history, could drag on for months. Democratic State Senate President Darrell Steinberg told Reuters that lawmakers in his party, who control both chambers of the legislature, could not support Schwarzenegger.
"The cuts are absolutely unacceptable," Steinberg said, adding that instead of slashing spending Schwarzenegger should help Democrats delay business tax breaks. Republican Assemblyman Jim Nielsen, the vice chair of the budget committee, said both sides felt the "absolute imperative" for immediate action and praised Schwarzenegger's decision not to push for new taxes. "That would simply fund the broken budget at the higher levels that are not sustainable," he said.
Bonds Selling Fast
Thanks to stronger than expected revenue early in the year and new finance rules the state will be able to pay debt coming due in May and June, although it could face problems late in the summer, Schwarzenegger said. Investors have scooped up recent offerings of California debt with high yields, convinced by state payment guarantees.
Meanwhile schools have cut teachers, social services are drying up and most state employees face regular furlough days. The spending cuts in Schwarzenegger's proposed $83.4 billion 2010-2011 budget include eliminating the CalWORKS welfare program and many child care programs and cutting funding for local mental health services by 60 percent. California's budget deficit had been estimated at $19.9 billion at the beginning of the year.
Since then some revenues have come in higher than expected but opportunities to make cuts have also dried up, concerning credit agencies who now rate state debt only a few notches above speculative, or "junk," status. Schwarzenegger in January acknowledged his proposed spending cuts for health and welfare programs were "draconian." But the state already has some of the highest income and sales tax rates of any U.S. state.
"There is something wrong with our system. That is what I'm trying to tell people. There are going to be people screaming for more taxes -- we've done that," Schwarzenegger said. "Let's stimulate the economy and let's create the jobs. That's the important thing." He called on lawmakers to tackle growing costs for the state pension fund and to reform its tax system, which relies heavily on volatile personal income and capital gains taxes for revenue.
Outside the event, protesters denounced Schwarzenegger's plan, chanting "Shame on you". Handicapped activists said they feared losing caregivers funded by the state. "I might as well just die," said wheelchair-bound Carmen Rivera-Hendrickson, who relies on daily in-home health care.
Merkel, ECB: $1 trillion rescue package only buys time
by Jürgen Bätz
The €750 billion ($1 trillion) rescue loan package only bought euro zone countries more time, but didn't resolve the continent's underlying debt problem, German Chancellor Angela Merkel and a European Central Bank official said.
The market turmoil will only calm down if the 16 member states of the euro zone reform their economies and reduce their deficits, ECB chief economist Juergen Stark told the Frankfurter Allgemeine Sonntagszeitung newspaper on Sunday. Stark was quoted as saying about the loan package that "We bought time, not more than that." The euro was not in danger "but in a critical situation," he added.
Merkel on Sunday defended the loan package as the right step to stabilize the currency, but she also acknowledged it only bought time. "We didn't do more than buy time to get the differences in competitiveness and budget deficits of euro-zone countries in order," she said at a conference of the Confederation of German Trade Unions in Berlin.
In the past few days, Merkel has repeatedly urged euro-zone countries to trim their budget deficits. She also called for greater cooperation in financial and economic policy across Europe to ensure the currency's long-term stability. "The underlying problem are the high budget deficits in the euro-zone countries," she told daily Sueddeutsche Zeitung on Saturday.
Defending the latest bailout package — which is unpopular among German voters — Merkel said it's not only the currency's stability that is at stake, but the European idea as a whole. "Because we know if the euro fails, then more is failing," the paper quoted her as saying.
In the wake of Greece's debt crisis, the euro has come under intense pressure because of fears about problems spreading to other heavily indebted euro-zone countries. The euro sank to near a four-year low against the dollar on Friday in late New York trading, buying $1.2355.
Another top German top banker, meanwhile, expressed doubts about Greece's ability to repay its huge debts in an orderly fashion. Dekabank's chief economist Ulrich Kater on Sunday told German news Web site Handelsblatt that he shares the doubts voiced by Deutsche Bank AG's chief executive Josef Ackermann. "It will be very, very difficult for Greece to orderly repay its debt," he was quoted as saying.
He said Greece's new austerity measures and its lack of competitiveness were dooming its prospects for economic growth, making debt reduction difficult. Ackermann, CEO of Germany's biggest lender, caused outrage and nervousness on already jittery markets by publicly doubting Greece's ability to repay its debt and mentioning the possibility of a debt restructuring.
In Athens, Greek Prime Minister George Papandreou said he is not ruling out taking legal action against U.S. investment banks for their role in creating the spiraling Greek debt crisis. "I wouldn't rule out" going after the U.S. banks, he said in a CNN interview aired Sunday. The government and many Greeks have blamed international banks for fanning the flames of the debt crisis with comments about Greece's likely default. The Greek leader also said a parliamentary investigation will soon examine the rapid swelling of Greece's debt and the country's banking practices.
The European Union and the International Monetary Fund have approved a euro110 billion ($136 billion) bailout package for Greece. In an interview with German news weekly Der Spiegel to be published Monday, the European Central Bank president said Europe's economy "is in its most difficult situation since World War II or perhaps even since World War I."
Jean-Claude Trichet said the euro zone's debt crisis had provoked a market reaction similar to that at the height of the global financial crisis in 2008. "The markets didn't function anymore, it was almost like in the wake of the Lehman (Brothers) bankruptcy in September 2008," Trichet was quoted as saying. Trichet also urged European leaders to take further action to address the crisis' underlying problems, calling for a "quantum leap" in control of financial and economic policy across the 16-nation currency zone.
"We need improved structures, to avoid and sanction wrongdoing," Trichet was quoted as saying. Stark also urged European Union leaders to swiftly introduce new rules to increase stability and growth, stressing the need for new automatic sanctions for countries that don't abide by the EU's debt rules. "The process has to be depoliticized," he said.
Euro heads for parity with dollar
The euro is set to slide further and could be heading for parity with the dollar, analysts say. The single currency’s weakness and mounting fears over Europe’s recovery prospects could hit growth in Britain. The euro fell to a 19-month low against the dollar of $1.23 on Friday night, amid fears that the austerity measures countries need to adopt to satisfy the EU authorities and the International Monetary Fund could tip them back into recession. Sterling ended the week up against the euro at €1.18, but down against the dollar at $1.45.
Olli Rehn, Europe’s economic and monetary affairs commissioner, stoked fears about the pain ahead for Europe when he said yesterday that the €750 billion (£638 billion) crisis mechanism agreed last week should be made so unattractive that countries will not want to use it. "It is essential that we prepare ourselves for the worst-case scenario. But of course there is the issue of moral hazard," he said at the annual meeting of the European Bank for Reconstruction and Development. "This mechanism must be made so unattractive that no EU leader will resort to it." He also said that the EU should have an exit strategy from its crisis measures.
The Bank of England warned last week that weakness in the eurozone was one of the main risks to Britain’s recovery. Jean-Claude Trichet, president of the European Central Bank, said in an interview with Der Spiegel, the German magazine, that "profound changes" were needed in the oversight of countries’ fiscal positions within the eurozone. A report this weekend from UBS suggests that the appetite for holding euros among private sector institutions and managers of official currency reserves is fading.
"This month’s €750 billion package of support for the eurozone isn’t sufficient to turn the tide of the euro," said Mansoor Mohi-uddin at UBS, the investment bank. "That is the verdict both of private sector players, who now have record shorts, but also of reserve managers that we’ve been visiting around the world. This suggests the decline in the euro will keep going."
UBS predicts that the euro will drop from its current €1.23 level against the dollar to €1.10 next year. Others fear it could drop further than that, to dollar parity or below, replicating the single currency’s weakness in the early years after it came into being. State Street Global Advisors, in a report to clients on last week’s euro rescue package, said: "The package buys time, but does not fix the underlying problem. Countries may need more loans over the intermediate term. The debt arithmetic is daunting. Some kind of debt restructuring cannot be ruled out."
Commerzbank, the German bank, expects the euro to stabilise and end the year about current levels, but it warns that conditions could arise for a slide to parity with the dollar. "There are risks: a continued loss of credibility for the ECB, difficulties in financing the stabilisation mechanism or legal risks could put additional pressure on the euro," it said.
US faces one of biggest budget crunches in world
by Edmund Conway
Earlier this week, the Bank of England Governor, Mervyn King, irked US authorities by pointing out that even the world’s economic superpower has a major fiscal problem -"even the United States, the world’s largest economy, has a very large fiscal deficit" were his words. They were rather vague, but by happy coincidence the International Monetary Fund has chosen to flesh out the issue today. Unfortunately this is a rather long post with a few chunky tables, but it is worth spending a bit of time with – the IMF analysis is fascinating.
Its cross-country Fiscal Monitor is not easy reading and is a VERY big pdf (17mb), so I’ve collected a few of the key points. The idea behind the document is to set out how much different countries around the world need to cut their deficits by in the next few years, and the bottom line is it’s going to be big and hard (ie 8.7pc of GDP in deficit cuts around the world, which works out at, gulp, about $4 trillion).
But the really interesting stuff is the detail, and what leaps out again and again is how much of a hill the US has to climb. Exhibit a is the fact that under the Obama administration’s current fiscal plans, the national debt in the US (on a gross basis) will climb to above 100pc of GDP by 2015 – a far steeper increase than almost any other country.
Compare it with the UK, which is often pinpointed as a Greece in the making. As you can see, gross debt increases sharply, but not by anything like the same degree.
Another issue is that, according to the IMF, the cost of extra healthcare and pensions will increase by a further 5.8pc over the next 20 years. This is the biggest increase of any other country in the G20 apart from Russia, and comes despite America having far more favourable demographics. It is significantly more than the UK’s 4.2pc.
But level of debt isn’t the only problem. Then there’s the fact that the US has a far shorter maturity of government debt than most other countries, meaning that even if it weren’t borrowing any extra cash it would have to issue a large chunk of new stuff each year as things are. The killer table to show you that is this one, which shows a country’s "gross financing needs" – in other words how much debt it has to issue in the coming years to keep itself functioning.
Britain, as you can see from the second column on the left, has one of the biggest deficits in the world. However, because it also has the longest maturity of average debt in the world (far right column), and so doesn’t have to issue as much new debt each year just to keep rolling that stuff over, its gross financing needs are – at 32.2pc of GDP, way bigger than Britain’s, at 20pc. Come to think of it, it’s actually worse than Greece on this measure.
What does this mean? Basically with a large financing need, you are particularly vulnerable if the market suddenly decides it doesn’t want your debt, since those extra interest rates they charge you mount much more quickly. Japan, by the way, is the one with a real problem on this front. It could hardly be any more vulnerable to a sudden drop in investor demand, and many over there fear that the moment domestic savers stop buying JGBs, the country is doomed to Greek-style collapse (though it doesn’t share Greece’s current account deficit and, crucially, has its own currency, so I don’t know about that).
On the flip side, unlike Japan or Britain, the US does not have a central bank with quite such a large stock of government debt. Both the Bank of England and Bank of Japan have done so much quantitative easing (buying bonds with printed money) over the past few years that they have the power to cause a fiscal shock if they decided they wanted to sell off their bonds at once. This table shows you that America, while not entirely guiltless on this front, has less of a shadow hanging over it.
But all of the above is what explains why the US, according to the IMF’s projections, has more to do than any other country in the developed world (apart from Japan) when it comes to bringing its debt back towards sustainable levels. Here’s the killer table. The column to look at is on the far right: note how the US needs a 12pc of GDP chunk chopped out of its structural deficit (ie adjusted for the economic cycle). That’s $1.7 trillion. Wow – that’s not far off Britain’s total annual economic output.
So does all of this mean the US is Greece? The answer, you might be surprised to hear, is no. Now, it is true that the US has some similar issues to Greece – the high debt, the need to roll over quite a lot of debt each year, the rising healthcare costs and so on. But it has two secret (or not so secret) weapons. The first is that unlike Greece it is not trapped in a monetary union. The US, like Britain and Japan, can independently control its monetary policy; it can devalue its currency. These are hardly solutions in and of themselves, but they do help make the adjustment a lot easier and more gradual. Second, the US has growth. It remains one of, if not the, world’s most dynamic economies. It is growing at a snappy pace this year (in comparison to other countries). And a few percentage points of GDP make an immense difference, since they make those debts much easier to repay.
Finally, some might be tempted at this point to cite the fact that the US has the world’s reserve currency in the dollar as another bonus. I am less sure. There is no doubt that this has made the US a safe haven destination (people buy US bonds when freaked out about more or less anything), and has meant that America has been able to keep borrowing at low levels throughout the crisis. However, the flip side of this is that because it has yet to feel the market strain, the US also has yet to face up properly to the public finance disaster that could befall it if it does not do anything about the problem. America is not Greece, but if it does not start making efforts to cut the deficit within a few years, it will head in that direction. The upshot wouldn’t be an IMF bail-out, but a collapse in the dollar and possible hyperinflation in the US, but it would be horrific all the same. America has time, but not forever.
Greek leader considers action against US banks
by Demetris Nellas
Greek Prime Minister George Papandreou declared he is not ruling out taking legal action against U.S. investment banks for their role in creating the spiraling Greek debt crisis. Both the Greek government and its citizens have blamed international banks for fanning the flames of the debt crisis with comments about Greece's likely default, actions that are causing the country's borrowing costs to soar.
"I wouldn't rule out that (legal action) might be a recourse. But we need to let due process (take its course) and then make our judgments once we get the results from the investigations," Papandreou said in a CNN interview broadcast Sunday. Papandreou also said a parliamentary investigation will examine the rapid swelling of Greece's debt and international banking practices to examine whether the financial sector engaged in "fraud and lack of transparency."
The European Union and the International Monetary fund have approved a euro110 billion ($136 billion) bailout package for Greece, part of an overall euro750 billion ($1 trillion) rescue loan package to protect the euro, the common currency of 16 European nations. The Greek leader also urged more regulation of the markets which, in his view, are now betting against the European governments that have poured billions into them since the global financial crisis began in 2008. Some European governments plan to push for tighter regulation of hedge funds this week — a move opposed by Britain, home to the financial hub of London.
Papandreou also tried to counter criticism, expressed mainly in Germany, that Greeks are getting a free ride and rejected widespread international skepticism about Greece's ability to pay back its loans. Greek debt is scheduled to exceed 140 percent of its economic output in 2012. "We are paying back the loans we are getting ... this saying that 'we are handing out money to Greece' is not true," he told the CNN show "Fareed Zakaria GPS." "It is very easy to scapegoat Greece and Greece bashing very often gets entangled in regional politics."
He insisted his government has made the unpopular but necessary decision to implement austerity measures. "We are ready to make the changes ... we have made our mistakes. We are living up to this responsibility. But at the same time, give us a chance," Papandreou said.
Still, another top German economist expressed doubts Sunday about Greece's ability to repay. Deutsche Bank AG's Chief Executive Josef Ackermann created an uproar Thursday for mentioning the possibility that Greece might have to restructure its debt — but Dekabank's chief economist, Ulrich Kater, was quoted as agreeing with him Sunday in the German news website Handelsblatt.
"It will be very, very difficult for Greece to orderly repay its debt," Kater was quoted as saying, adding that Greece's new austerity measures and its lack of competitiveness were dooming the country's prospects for economic growth, making debt reduction difficult. Despite widespread anger about tax hikes and other austerity measures imposed by Papandreou's Socialist government, his party still enjoys more support than its predecessor, the discredited conservative party.
According to a poll published Sunday in conservative-leaning newspaper Kathimerini, Papandreou's popularity has plunged from 53 percent in January to 43 percent in May. The same poll showed that opposition leader Antonis Samaras has sunk from 26 percent approval in February to 18 percent in May. On the other hand, 76 percent of respondents also say they are unsatisfied with the Socialist government's performance. The poll was conducted May 6-10 with a sample of 1,006. Its margin of error was plus or minus 3.2 percent.
SEC Chief's Big Bet on Goldman
by Monica Langley , Kara Scannell, Susan Pulliam and Susanne Craig
It was standing-room only in the windowless room where the Securities and Exchange Commission's five commissioners met last month to decide whether to sue Goldman Sachs Group Inc. for fraud. From top to bottom at the beleaguered agency, staffers and lawyers who saw the giant Wall Street firm on the confidential enforcement calendar wanted to witness the drama.
Once the enforcement team laid out its recommendation to sue Goldman—arguing that the firm had misled investors about highly complex securities linked to the cratering mortgage market—the commissioners questioned the lawyers on the strength of the evidence. They also debated whether the SEC was essentially sailing into uncharted territory by attacking a relatively new financial product. "I have serious doubts about the evidence of fraud" prevailing in court, said Troy Paredes, one of the two Republican appointees on the commission, according to two people in the room.
The enforcement staff argued that it could build a record strong enough to support the fraud charges. Finally, SEC Chairman Mary Schapiro called for a vote, even though it was obvious there was serious disagreement among the commissioners. In the end, the two Democratic commissioners voted for the case to proceed and the two Republicans against. Ms. Schapiro, an independent named by President Obama, cast the deciding vote to go ahead.
It was a career-defining moment for Ms. Schapiro, and a gut-churning roll of the dice. The suit is shaping up as one of the most explosive confrontations in Wall Street history, pitting the world's most profitable securities firm against a regulatory agency with a battered reputation as a watchdog. The decision to proceed without unanimous agreement from the commissioners—unusual in such a high-profile case—exposed the agency to accusations that its actions were influenced by politics despite its nominally independent status. The agency denies any political agenda.
There's no denying that the SEC could use a big win for its own bureaucratic health. During an April 2009 meeting with top enforcement-division lawyers, Ms. Schapiro warned that the agency needed to prove its mettle quickly in going after Wall Street malefactors. She reminded them of the SEC's failure to detect fraudster Bernard L. Madoff. "If we don't get serious about this process, we may cease to exist," she said, according to several people at the meeting.
Ms. Schapiro—never before known as a hard-nosed enforcer during her long career as a Wall Street regulator—is gambling that she can at least extract a humbling, costly settlement from Goldman, which denies it duped investors. The lawsuit says Goldman broke the law by selling a collateralized debt obligation called Abacus 2007-AC1 without disclosing that hedge-fund firm Paulson & Co. helped to pick some of the underlying securities and was betting on the deal's decline.
At the moment, despite a case that appears far from airtight, the 54-year-old SEC chief seems to have Goldman on the defensive. Settlement talks began last week, and Goldman Chairman and Chief Executive Lloyd C. Blankfein has for the first time faced questions from investors about his whether he should continue as the firm's leader. Mr. Blankfein said at last week's annual meeting that he has no plans to step down. This account of how the SEC decided to pursue Goldman and how the Wall Street giant responded is based on dozens of interviews with regulators, executives, traders, lawyers and other people with knowledge of the situation.
The interviews reveal that people were coming to the SEC to complain about Goldman's mortgage-related dealings at least as far back as January 2008. That's when an Australian hedge fund that blames Goldman for a $100 million loss on a bond deal showed up at the agency with a stack of documents. Goldman has struggled to contain the damage in the wake of its initial pledge to fight the charges. Its shares have fallen 22%, wiping out more than $20 billion of the firm's stock-market value. It is facing a federal criminal probe of its mortgage business. Goldman declines comment on the criminal investigation.
The SEC's willingness to challenge Goldman represents a big shift for the agency. In recent years, it has pursued investigations that were controversial or that sought large fines only if there was consensus among its five commissioners. Some current and former SEC lawyers say employees in the trenches took this to mean that there was little appetite for tough cases. Morale plunged when the Madoff fraud was exposed in December 2008. One ex-SEC lawyer was asked at his mother's birthday party: "How does it make you feel that your agency is absolutely incompetent?"
The roots of the Goldman case extend back to before Ms. Schapiro took over in January 2009. After the U.S. housing market collapsed in 2007, agency officials launched a subprime-mortgage working group led by Reid Muoio, now 43 years old, a veteran of bribery and insider-trading cases who had worked his way up to deputy chief of a new unit focusing on complex financial products. Within the agency, he was known for blunt talk and an aggressive style.
In January 2008, the working group got a break in its effort to understand how Wall Street profited from soured mortgage deals. David Mapley, a former outside director for an Australian hedge fund, Basis Yield Alpha Fund, called an SEC lawyer to complain about a Goldman mortgage-related investment product called Timberwolf I Ltd. "Our belief is the trade was portrayed in a fraudulent manner," Mr. Mapley told an SEC lawyer, complaining that Goldman misled the hedge fund about an investment that cost Basis about $100 million when housing prices tumbled. That March, Mr. Mapley and two Basis executives met with 11 SEC investigators, including Mr. Muoio, for several hours.
The SEC investigators said they already were working on a case related to Timberwolf, according to a person who attended the meeting, and that it had questioned Daniel Sparks, the head of Goldman's mortgage department, about Timberwolf. It is unclear how the information about Timberwolf figured into the SEC's investigation of Goldman's mortgage dealings. In a January 2008 securities filing, Goldman disclosed that the SEC had requested information about subprime loans.
Prior to taking over the SEC, Ms. Schapiro had led the Financial Industry Regulatory Authority, Wall Street's self-regulatory body. It, too, had failed to detect the Madoff scandal, and enforcement fines against securities firms shrank near the end of her tenure there. Two months after becoming SEC chief, she taped to her office door a note about the agency's work: "How does it help investors?" She began putting in 12-hour workdays, eating lunch at her desk, working Sundays and firing off emails into the early-morning hours.
Soon after being sworn in, Ms. Schapiro recruited Robert Khuzami, head of the U.S. legal division of Deutsche Bank AG, as her enforcement chief. She said she wanted someone who would help the SEC to restore its swagger. The former federal prosecutor, who had helped convict blind sheik Omar Abdel Rahman in the 1993 World Trade Center bombing case, challenged agency lawyers to either file stagnant cases or drop them. He assembled 10 different groups to analyze how the SEC should change. A PowerPoint presentation about the shakeup of the enforcement division, circulated anonymously by SEC employees, compared Mr. Khuzami to Michael Corleone in "The Godfather."
One of Ms. Schapiro and Mr, Khuzami's biggest priorities was building what SEC officials called a "body of work" in mortgage lending by bringing enforcement actions. The SEC's investigation of Goldman eventually yielded eight million documents, according to Goldman. It isn't clear why investigators eventually zeroed in on the $1 billion Abacus deal, completed in April 2007. In filings related to the suit, Goldman said the SEC had interviewed five current or former Goldman employees with knowledge of the Abacus deal.
Depositions of key Goldman employees and clients began around the spring of 2009 and lasted at least through January 2010, according to a person familiar with the situation. Last July 29, agency officials called Goldman to tell the firm it was being served with a Wells notice—a formal warning that civil fraud charges could be forthcoming. Shocked Goldman lawyers and executives took notes as the SEC laid out its accusations against the company. In a September submission to the SEC aimed at fending off an enforcement action, Richard Klapper, a Sullivan & Cromwell lawyer representing Goldman, said, "If this matter is litigated, Goldman Sachs is confident that a fuller record—including its own discovery of all transaction participants—will underscore that no one in fact considered Paulson's role important and that no one was misled."
As tensions mounted, the SEC told Goldman that the company wasn't moving fast enough to provide documents and responses to the agency, which the SEC saw as a stalling ploy known as "slow walking." Inside Goldman, some contended that Mr. Khuzami had a conflict of interest because of his previous job at Deutsche Bank, a Goldman competitor, according to people familiar with the situation. The German bank, like Goldman, created collateralized debt obligations. An SEC spokesman said Mr. Khuzami's involvement in the case fully complies with ethics guidelines. In March, Goldman's lawyers called the SEC for an update on the case. The call wasn't returned, Goldman says.
On April 14, Messrs. Khuzami and Muoio and other SEC lawyers gathered in the meeting room for commission enforcement actions. Mr. Muoio outlined the case against Goldman, laying out the SEC's strongest evidence and potential problems if the lawsuit went to trial. Then the commissioners started asking questions. One topic of discussion was a deposition from Paolo Pellegrini, the Paulson & Co. executive who appeared to claim in one part of his testimony that he told an investor that his firm would be betting against the Abacus deal, according to someone who attended. Ms. Schapiro, who asked the last round of questions, pushed for facts that would buttress an enforcement action against Goldman, according to another person who was in the room. The lawsuit passed 3-2.
Mr. Blankfein, 55, was in his 41st-floor office at Goldman's new headquarters when the SEC announced the suit at 10:35 a.m. on April 16. Seventy-nine minutes later, Goldman said in a statement that the accusations are "completely unfounded in law and fact." In a conference call arranged by John Rogers, the Goldman board secretary and a confidant of Mr. Blankfein, executives agreed that giving in at all would cast doubt on every CDO deal arranged by the company, according to a person familiar with the call. Over the next four days, Mr. Blankfein called hundreds of clients to answer questions and listen to suggestions.
The lawsuit set up Mr. Blankfein for another big headache: a grilling by the Senate Permanent Subcommittee on Investigations. For days leading up to the April 27 hearing, Goldman lawyers bunkered inside "war rooms" where they sifted through thousands of pages of emails and other documents. "Hot" documents considered especially damaging were stacked in one pile, according to one person close to the situation. Goldman officials worried that lawmakers would pounce on Fabrice Tourre, the only employee accused by name in the SEC lawsuit, and would leak documents about him during the weekend before the hearing.
Goldman decided to strike first. On a Saturday morning, the firm released several emails from Mr. Tourre to two female friends. In one, he described mortgage deals like Abacus that he worked on as "a product of pure intellectual masturbation…which has no purpose, which is absolutely conceptual and highly theoretical and which nobody knows how to price." That Sunday, Messrs. Tourre and Blankfein went to Goldman headquarters in New York to prepare separately for the hearing. Mr. Blankfein practiced his answers. His goal was to provide simple answers and emphasize that Goldman's market-making role in CDOs doesn't require it to have the same view as its clients, according to the person close to the situation.
At the hearing, though, Mr. Blankfein looked defensive, tilting his head and squinting at lawmakers as they questioned him for hours. He stumbled when asked why Goldman didn't release the emails of any employees other than Mr. Tourre. "He's the guy that's getting hung out to dry, because nobody else had their personal emails released," said Sen. Tom Coburn, an Oklahoma Republican. "I wasn't close to the decision," the CEO answered. The Wall Street Journal reported April 29 that federal prosecutors are conducting a criminal investigation into whether Goldman or its employees committed securities fraud in connection with its mortgage trading, people familiar with the probe say.
Since then, Goldman's public stance has begun shifting from defiance to reconciliation. Goldman lawyers met last week with representatives of the SEC in a first step toward a potential settlement of the fraud lawsuit, though they remain far apart. Meanwhile, morale is soaring at the SEC, staffers say. After a recent meeting on proposed rules with Ms. Schapiro, two regulatory lawyers walked into the hall and fist-bumped before getting on the elevator.
Web of probes spreads over Wall Street
by Francesco Guerrera
When testifying alone in front of a high-powered US Senate committee last month, Lloyd Blankfein, Goldman Sachs' chief executive, said he could have done with some company from other Wall Street luminaries. This week, his wish was partially granted, as news of a flurry of different investigations broadened the post-crisis regulatory backlash beyond the civil fraud charges from the Securities and Exchange Commission against Goldman. Goldman denies the charges.
From unconfirmed reports that Morgan Stanley and other banks are being probed by federal prosecutors over mortgage-related securities, to the subpoenas sent to eight banks by Andrew Cuomo, New York's attorneygeneral, over their dealings with credit rating agencies, Wall Street is firmly in the regulators' sights. Talk that the SEC was looking at banks' activities in the municipal bond market amid concerns they bet against securities they sold on behalf of cities and states, was the appropriate end to a week dominated by financial investigations.
With the political temperature rising because of horse-trading over a financial reform bill, and the authorities seeking to be seen to be "doing something" about the causes of the turmoil, there is no sign the pressure will ease any time soon. Industry executives profess to be worried about probes that could force banks to fight prolonged legal battles or settle with regulators at the cost of hundreds of millions of dollars. Yet, unlike the violent reaction to news of charges against Goldman - whose market value fell by more than $12bn after the SEC announcement - investors' response to the latest developments has been relatively muted.
Share prices in many banks named in the inquiries did fall this week - and the cost of insuring against their debt rose. But losses were fairly contained considering that financial stocks were also weakened by worries over Europe's sovereign debt crisis and US financial regulation. Shares in Morgan Stanley, whose chief executive denied any knowledge of the federal probe, ended the week about 3 per cent lower - not a good performance but better than the double-digit percentage loss suffered by Goldman after the charges were unveiled.
As Keith Horowitz, an analyst at Citigroup, wrote in a note to clients: "Morgan Stanley and other capital markets-related stocks already price in some risk after the Goldman Sachs investigation that the SEC may be investigating all brokers regarding collateralised debt obligations [mortgage-backed securities]." Securities law experts point out that, unlike Goldman, none of the other banks has been charged and that many of the probes appear to be at a preliminary stage and may not end up with anything.
In addition, the seemingly all-encompassing nature of the inquiries, which focus on several banks, makes it less likely that any one of them will be the focus of regulatory retribution. "We are still at a very early stage," said John Coffee, a Columbia University law professor. "If anything, these investigations raise the possibility of a global settlement, which could be beneficial to share prices because it would mean that no single entity would be singled out for punitive damages."
Others suggest a law of diminishing returns to regulatory inquiries, especially when they appear to have been encouraged by the political climate. "The more probes you have, the more you run into scandal fatigue," said Charles Elson, a corporate governance professor at the University of Delaware. "The more political it appears the more difficult it is to quantify the damage to any one institution."
Secretive Speed Traders In Spotlight After Flash Crash On Wall Street
by Bernard Condon
If you saw a penny on the sidewalk, would you pick it up? You may think it's not worth the effort, but a breed of investors who have been in the news do. Using super-fast computers, high-frequency traders in effect bend down to pick up pennies lying about in the stock market – then do it again, sometimes thousands of times a second.
More than a week after the Dow Jones industrial average fell nearly 1,000 points, its biggest intraday drop ever, regulators are still sifting through buy and sell orders to figure out what sparked it. One big focus are orders placed by high-frequency traders, or HFTs, and for good reason. These quick-buck firms barely existed a few years ago but now account for two-thirds of all U.S. stock trading. In other words, all those TV pictures of the stately New York Stock Exchange building on the evening news are an illusion. The real action on Wall Street is far away in Kansas City, Mo., and in New Jersey, in towns like Carteret and Red Bank, where HFTs named Tradebot and Wolverine and Tradeworx ply their trade.
High-frequency trading firms, which number over 100, use computers programmed with complex mathematical formulas to comb markets for securities priced too high or too low because traders haven't had to time to react to the latest data. The computers then buy or sell in a split second, locking in a profit. The opportunities seem hardly worth noting. They're not just fleeting, but small, often a penny or less.
But those pennies can add up to a lot of money, enough to draw the attention of Goldman Sachs Group Inc., the giant Chicago hedge fund Citadel Investment and other big financial firms. In recent years they've paid hundreds of millions of dollars for stakes in high-frequency trading companies. The money has stoked what was already fierce competition among the firms for a leg up. To spot opportunities and act on them before others, HFTs are constantly hunting for faster computers. They also locate themselves close to the big exchanges' data centers. That can cut their trade times by milliseconds.
One way these traders make money is by exploiting the fact that stock indexes sometimes don't immediately reflect falling or rising prices of their component stocks, said Manoj Narang, chief executive at Tradeworx of Red Bank, N.J. If Microsoft shares rise 5 percent but an index fund that includes it such as the SPDR S&P 500 lags by a fraction of second to adjust, his computers will automatically buy shares of SPDR S&P 500 at the lower price and then sell them again when they are fully valued.
Or maybe Microsoft is trading in London at a penny less than it's trading at the same moment in New York. A high-frequency trader will buy shares in London and wait for them to rise. Since the discrepancy lasts a mere fraction of a second, speed is key. Narang boasts it takes only 15 millionth of a second for his computers to place a buy or sell order after detecting an opportunity. Or, as he puts it, "If you try to pick up the penny, we'll probably beat you to it."
So is that good or bad for the market? If you listen to HFTs, all their fast trading benefits big and small investors alike. More trading means more bids and asks for shares, and that cuts the time needed to find someone willing to buy what you're selling or vice versa. Costs also fall. With more bids and asks, the difference between the price you seek and the price offered (what traders call the "spread") will likely narrow. You get to keep more of your money.
High-frequency traders see themselves as part of a long tradition of using technology to shake up Wall Street. For decades an order to buy or sell a security went to a person in a trader's jacket standing on the floor of an exchange, often at the NYSE in Lower Manhattan. If you wanted to sell stock in General Electric, for instance, these so-called specialists would find a buyer. If they couldn't find one, they bought it themselves.
In exchange for their services, the specialists pocketed some of the difference between the price at which you were willing to buy and the price at which a GE holder was willing to sell. This system came under attack in the early 1980s from Nasdaq, a rival marketplace for stocks, which began using computers to make trades. The pitch was it could match buyers and sellers faster than humans, and for less money.
Then, starting in the late '90s, the NYSE specialists got hit again, this time with a series of blows: new rules encouraging computer matching of buyers and sellers, a shift to quote stock prices in minute increments of decimals instead of fractions, and a decision to cut the minimum spread that specialists or other middlemen could grab for themselves from 6.25 cents per share to a penny.
"It used to be an oligopoly, an old boy's club," said Irene Aldridge, head of an HFT shop called Able Alpha Trading and author of "High-Frequency Trading." "But now it's a completely level field." Critics of high-frequency trading say all this talk about narrowing spreads for ordinary investors distracts from a key problem: Split-second trading without human supervision is a recipe for disaster.
Exhibit A: the May 6 crash. One theory about the drop is that, unlike the NYSE, the new exchanges and trading networks catering to HFTs didn't apply any "circuit breakers." These are designed to halt trading momentarily during a freefall to stop selling from feeding on itself.= In other words, without circuit breakers the computers went crazy. Another theory holds that it wasn't quick-fire trading by HFTs that made things worse but a lack of it. Some reportedly pulled back when stocks started dropping, removing liquidity when it was needed the most.
Whatever the answer, this much is true: These secretive firms are likely to grab the spotlight for a while now. And their trading might get even more frenetic. After the May 6 freefall, all manner of trading rules are up for debate. But it's worth noting that until recently regulators were considering cutting the minimum spread again, possibly to half a penny. "People will be needing even better computers," said author Aldridge.
How C.D.O.’s Helped Bring Down a Credit Union
by Gretchen Morgenson
When Wall Street is accused — as it has been so often these days — of selling risky products to unwitting customers, it usually argues that investors in such exotic stuff are sophisticated adults capable of assessing any hidden dangers.
So it goes with collateralized debt obligations, or C.D.O.’s, which are bonds, loans and other assets that the Street pools together and sells as packages of securities. Purveyors of C.D.O.’s maintain that buyers who lost billions in these mortgage-related instruments were, of course, sophisticated. But as a recent report from the inspector general of the National Credit Union Administration shows, it is neither credible nor factual that only savvy investors bought C.D.O.’s.
The report analyzes the April 2009 collapse of the Eastern Financial Florida Credit Union. Based in Miramar, Fla., this state-chartered institution was created in 1937 to serve the Miami employees of what later became Eastern Airlines. The institution added other Florida employee groups and was serving 208,000 members when it failed last year.
Eastern Financial had $1.6 billion in assets at the end of 2008. The company was placed in conservatorship on April 24, 2009. It was taken over by the Space Coast Credit Union of Melbourne, Fla. The failure will cost the National Credit Union Share Insurance Fund, the federal agency that guarantees credit union deposits, an estimated $40 million. Because it was based in Florida, the doomed credit union had its share of bad real estate loans on its books. But the inspector general’s autopsy report said that the major cause of the Eastern Financial collapse was its decision to dive head-first into toxic C.D.O.’s just as the mortgage mania was faltering.
Between March 2007 and June 22, 2007, the credit union committed nearly $100 million to buy 16 of these instruments; most contained dicey home equity loans. The timing of these purchases is intriguing. The spring of 2007 was when Wall Street’s mortgage machinery was sputtering; New Century Financial, a big subprime lender, filed for bankruptcy that April. Brokerage firms that had provided funding to lenders like New Century and Countrywide began pulling in their credit lines. At the same time, it became a matter of some urgency for these firms to jettison mortgage-related securities in their pipelines.
Who sold Eastern Financial its toxic securities? Alas, the inspector general identifies neither the C.D.O.’s the credit union bought nor the firms that peddled them. But the report did note that the instruments Eastern Financial bought were private placements, "which provided less readily available market data to perform analysis and provide better understanding of underlying assets and grading system, tranches, etc." In other words, the most obscure C.D.O.’s imaginable.
"This situation illustrates yet again why over-the-counter securities and derivatives are not suitable for federally insured banks and other ‘soft’ institutional clients," said Christopher Whalen, editor of The Institutional Risk Analyst. "Wall Street securities dealers who knowingly cause losses to federally insured depositories should go to jail."
Credit unions are nonprofit entities and typically do not engage in the risky investing that bank executives did during the credit bubble. Federal credit unions are also limited in the types of securities they can buy. While they can purchase mortgage-backed securities, they are barred from buying C.D.O.’s. State-chartered credit unions have more leeway to invest in exotic instruments if their home states allow it. Florida, California and Michigan are three such states. But according to the National Credit Union Administration, less than 1 percent of all credit union investments fall into the exotic category.
Those state-chartered institutions that can buy C.D.O.’s and other riskier investments must set aside reserves of 100 percent of mark-to-market losses in such securities when they decline in value. This is intended to deter credit union executives from venturing down the risk spectrum. The Florida credit union met that requirement, but clearly the deterrence didn’t work. Eastern Financial’s failure may be an outlier, but it makes for a terrific case study.
Indeed, the inspector general’s analysis is depressingly familiar. Eastern Financial’s management and board "relied too heavily on rating agencies’ grading of C.D.O. investments," it concluded, and failed to evaluate and understand their complexity. Almost immediately after the credit union bought the C.D.O.’s, they fell in value. By September 2007, the credit union had recorded $63.4 million in losses on the products, almost two-thirds of the original investment. By the time of its failure, the credit union had charged off all 18 C.D.O. investments, resulting in total losses of nearly $150 million.
Richard Field, managing director of TYI, which develops transparency, trading and risk management information systems, says the Eastern Financial collapse is yet another example of why investors in complex mortgage securities need to be able to consult complete loan-level data on what is in these pools. "A sizable percentage of the problems in the credit markets and bank solvency are directly related to this lack of information," Mr. Field said. But the Eastern Financial insolvency also illustrates why regulators should make Wall Street adhere to concepts of suitability for institutions as well as individuals, Mr. Whalen said.
"The dealers who sold the C.D.O.’s to this credit union should be sanctioned," he said. "It might even be possible to pursue the dealer who sold the C.D.O.’s under current law. At a minimum, the Securities and Exchange Commission should impose retail investor suitability standards onto banks and public sector agencies to end the predation by large Wall Street derivatives dealers." Will the National Credit Union Administration pursue any of the credit union’s executives or the firms that sold it the toxic securities? "We always consider potential claims of third-party liability in cases of this magnitude," said John J. McKechnie III, director of public and congressional affairs at the administration.
What's the Cure for Financial Insanity?
by Les Leopold
Now that the bank lobbyists are nearly finished neutering the financial reform bill, it's time to face reality: our financial world will continue to be run by the very financiers who crashed the system two years ago. The bankers' arguments ricocheting through the halls of Congress make it seem as if our financial system is basically rational and sound -- that only a few flaws need fixing. That's lunacy. Our bright bankers may be rational as individuals, but collectively they perpetuate a fractured system gone utterly mad... and getting madder every day.
So the financial insanity will continue, with such psychotic outcomes as these:
1.Our pensions and 401ks will continue on their roller coaster ride, driven by market chaos and high-speed computer cacophony. Last week, the automatic trading programs our financial geniuses invented sent the Dow into a one-hour, 1,000-point freefall. Thank goodness it was only one hour. Two would have set off a global panic. No one is sure what happened or why. But don't worry, we're told. The glitches will be fixed and all will be well. (Just as a little technological tinkering is sure to prevent another offshore oil disaster too--not a problem!) In a saner world we would be asking the obvious: Does that high-speed trading serve the needs of our people, or is it just another high-risk strategy to enrich the largest and most connected investors?
2. Big financial institutions, now fully assured that they are indeed too big to fail, will continue to dominate both finance and politics. Anyone in their right mind knows that allowing five or six banks to control our entire financial system is a recipe for disaster and a major threat to democracy. What's the excuse for this form of madness? Well, we're told, during the Great Depression 4,000 banks failed (including lots of little ones), which proves that size doesn't matter. Please help me with this logic: Many banks failed and caused the Great Depression. A few big banks failed and caused our recent Great Recession...Therefore big banks are better? (Somebody flunked their Logic 101 class.) Here's what our experience tells us. Banks, both big and small, when left to play out in the street unsupervised, often end up at the casino tables-- gambling with our money. Big banks are an even bigger risk, because they have the power to gamble with our democracy as well.
3. We'll continue to pay top hedge fund managers 26,000 times more than we pay teachers. This goes back to a question I asked in an earlier post: Are 25 hedge fund managers worth 658,000 teachers? Apparently they are, since that's what they netted in 2009 during which they enjoyed the benefits of our $8 trillion (not billion) bailout. We rescued every hedge fund and bank, but left more than 30 million Americans scrambling for full-time work. This soaring unemployment caused tax revenues to tank, touching off fiscal crises in nearly every state. So governments dramatically cut spending and axed tens of thousands of teachers. The ultimate losers? Public school kids all over the country who were hoping for a good education. The winners? The bankers who caused the crisis. Even during the worst year since the Great Depression.--the sun was still shining on Wall Street, with a $150 billion bonus pool and a billion dollars each for the top 25 hedge fund managers. We put no windfall profits taxes on those billions, even though the money came directly from the U.S. treasury in the form of bailouts. We even allowed that income to be taxed at lower capital gains rates. That's rational?
4. Little countries that falter, like Greece, will continue to put the whole global economy at risk. We're told that the Greeks have only themselves to blame: They retire too early, drink too much retsina and often break into dance without warning....all on borrowed money. Yes, they broke the EU's debt limit rules. But they had a bit of help from Goldman Sachs, which made hundreds of millions of dollars in fees for creating complex derivatives to "help" the Greek government hide their debt. And yet Congress still refuses to regulate these scary financial items because they are "customized." Of course it was the global crash begun by our big banks that sparked the Greek fiscal crisis in the first place. In a sane world, the largest banks and the wealthiest investors in Greek debt (who caused the crash in the first place) would be forced to make reparations for the damage they caused. Instead, we have to make the Greeks stop dancing? Sicko.
5. The deficit hysteria drumbeat will build to a deafening crescendo. Forget about taxing the super-rich--we've got to cut benefits for working people instead. Respected journalists like New York Times columnist David Leonhardt warn us that we're all living beyond our means. It's time to tighten our belts or we'll end up like Greece. No more tax breaks for health and housing. We've got to retire later, with less money, and cut our medical expenses. And our wages have to become more "competitive." But who is "we"? Where are all these high-living people? The average non-supervisory production worker in America (about 75 percent of the workforce) has already seen an 18 percent drop in real wages since the mid 1970s. Meanwhile productivity increased by more than 90 percent. Yet now we've got to tighten our belts? Where did all that money from the higher productivity go, if not to us? No surprise here: into the hands of the few.
It all goes back to that most glaring symptom and cause of our psychosis: our insane maldistribution of income, which gets worse and worse every year. The richest 1 percent of Americans now earn more than the bottom 50 percent. Back in 1973, the richest 1 percent of earners collected 8 percent of the national income. By 2006, the top 1 percent got nearly 23 percent of the national income -- the highest proportion since 1929. Or look at the pay gap on the job: In 1970, the top 100 CEOs earned 45 times more than their workers, on average. In 2009 the ratio was 1,071 to 1.
Here's an example of what this maldistribution is costing us: The top 400 richest Americans have a combined wealth of more than $1.3 trillion. And that's enough money to endow every public college and university in the country so that students could attend tuition-free in perpetuity. (Hopefully some would decide to graduate before then.)
We need to return to Eisenhower era tax rates: 91 percent on those earning over $3 million in today's dollars. The money would roll in, and the deficit hawks would sound like parakeets.
The ultimate insanity of our current moment is that the richest investors and the largest bankers in the world just crashed our system, got bailed out by taxpayers, grew even larger, and now are back to earning record profits and bonuses. They caused the biggest jobs crisis since the Great Depression and drove the entire global economy into a ditch--and they could do it again any minute. And now they're telling us to tighten our belts and act more responsibly?
Here's the good news. The American people sense something is really wrong. They're angry at Wall Street and anyone in its pocket. It's taken a while, but the truth is seeping in. The angry public forced Congress to bring those squirming bankers into their hearing rooms. Unfortunately, Congress caved when it came to actually passing a strong reform bill that would bust up the biggest banks, end windfall profits and curb the gambling. Too bad the average citizen has no way to register his or her anger except to vote the "ins" out. Since. both parties are largely in the pocket of the financial industry (and other industries), it's hard, if not impossible, to be optimistic about the new "ins."
Imagine if we could vote for something like a jobs and environment party, free from Wall Street's money, that was dedicated to putting ALL of our people to work building a truly sustainable economy? Now that would be really insane.
Ireland: From Bubble to Broke
by Bennett Stancil
Greece, Italy, Portugal, and Spain have all come under fire for a varied mix of labor inflexibility, high-spending, and lost competitiveness, yet Ireland’s experience demonstrates that the Aegean flu can attack even apparently flexible, parsimonious, and competitive economies. Following a massive financial crisis, Ireland now faces the same double-edged sword wielded at the other GIIPS1: lost competitiveness and an unsustainable government debt trajectory.
The Celtic Tiger
Well before the euro’s introduction in the late 1990s, Ireland was prospering. From 1990 to 1995, GDP was growing significantly faster than in other GIIPS, and inflation and borrowing costs were not only below that of the other GIIPS, they were close to German levels.
Additionally, Ireland’s governance and business climate indicators2 were among the world’s strongest. Labor markets were flexible and the education system was one of the best in Europe.
A Path to Crisis
Whereas in other GIIPS, the euro added confidence where there previously was none, in Ireland, the euro gave an unsustainable boost to an already booming economy.
From 1995 to 2000, growth in Ireland accelerated to an average of 9.6 percent per year, and interest rates fell below German levels by 2005. Irish wages grew nearly five times faster than the Euro area average from 1997 to 2007, resulting in the real effective exchange rate (REER) increasing by 36 percent from 1999 to 2008, compared to an average increase of 13 percent in the other GIIPS.
This rapid growth and a European monetary policy which was far too loose for Ireland fueled the enormous overleveraging of the financial sector. The supply of credit exploded, surpassing 200 percent of GDP by 2008 after averaging around 40 percent from 1975 to 1994. In just 10 years, financial and monetary institutions expanded their balance sheets by approximately 750 percent of GDP, and by 2007, gross financial exposure had reached nearly 1400 percent of GDP. In the other GIIPS, balance sheets expanded by “only” 100 percent of GDP and exposure averaged close to 200 percent.
An extraordinary housing bubble emerged. From 1997 to 2006, housing completions grew by 9.6 percent a year, and by IMF calculations, Irish house prices grew by 90 percent more than fundamentals predicted, compared to 28 percent in Spain and 20 percent in the United States.
As in other GIIPS, the economy shifted away from manufacturing and toward services and housing. Financial intermediation, real estate, and business sectors sapped 10 percent of GDP away from the industrial sector from 1999 to 2006. Residential investment grew from 5 percent of GDP in the mid-1990s to over 12 percent by 2007.
Throughout the course of this boom, the Irish government appeared to behave responsibly, running an average budget surplus of 1.6 percent of GDP from 1997 to 2007, helped by surging tax revenues. Over that period, the aggregate Euro area never once recorded a surplus, and Greece averaged a deficit of 4.8 percent.
Ireland’s Massive Bust
In 2008, Ireland’s bubble burst. Over the next two years, domestic demand fell by 16 percent, investment collapsed by over 40 percent, and housing prices plunged 30 percent. By the end of 2010, Irish output will likely have contracted by 14 percent since the beginning of the crisis.
The financial sector was hit even harder. Financial equities plummeted by more than 70 percent. In June of 2009, bank losses through 2010 were estimated to be as high as 35 billion euros, or 20 percent of GDP; since that estimate, nationalized Anglo Irish Bank announced losses of 12.7 billion euros, the biggest loss in Irish history.
The government responded to the financial crisis with extraordinary measures, issuing capital injections and guarantees to depositors and creditors of major banks and purchasing troubled assets. The total assets of the guaranteed banks are now valued at 440 billion euros, or 270 percent of Irish GDP and 2700 percent of Ireland’s average yearly net debt issuance.
These measures obviously took a heavy toll on government finances. At 13.9 percent of GDP, estimated financial sector stabilization costs through 2009 are the highest of any advanced country.
In addition, the loss of output and increase in unemployment—the largest rate increase of any advanced country—drove tax revenues down by 11.6 percent in 2009, exposing the prudent budget as a mirage: the IMF estimates that the structural balance (which ignores cyclical increases in revenues or expenditures) was in deficit, at -9 percent of GDP in 2007. Real government expenditures, despite staying steady relative to GDP, had been among the fasting growing in Europe.
This, coupled with public support of the financial sector, plunged the government balance into deficit; it reached -14.8 percent of GDP in 2009. Debt—even excluding the government guarantees of the financial sector—is expected to leap from 25 percent of GDP in 2007 to nearly 90 percent in 2011.
Finding the Way Back
To escape the trap now ensnaring the GIIPS, Ireland must follow a path similar to the others—restore competitiveness and return public finances to a sustainable trajectory.
Competitiveness is already returning. Since its peak in mid-2008, the REER has fallen by 10 percent and exports are adding to growth. The wage adjustment is already underway as well, as public sector wages were reduced by 5 to 15 percent in December of 2009. This will help rebalance the economy away from services and the financial sector and—drawing on Ireland’s sound business climate and flexible labor market—towards exports.
Irish leaders have already taken bold steps—including expanding the tax base, increasing the minimum pension age, reducing social welfare benefits, and cutting public wages—to lower spending by 2.5 of GDP in 2010 and reduce the deficit below 3 percent of GDP in 2014. Achieving these goals will be difficult: as increasing unemployment and still-retreating domestic demand continues to cut into tax revenues, deficits are still expected to exceed 10 percent of GDP through 2011. Both steady, tenacious leadership in Ireland and the “ruthless truth telling” of the IMF—now a major player in resolving the European crisis—are critical in ensuring that these much-needed reforms persist, especially if public support wanes.
The financial sector still presents a difficult-to-evaluate risk to Ireland’s budget reform. If events in Ireland or Europe shake banks, the government will be forced to make good on its guarantees and debt could balloon even higher. To reduce this risk, flexibility is needed in how financial support programs respond to continuing trouble and, when appropriate, unwind these guarantees.
The case of Ireland underscores the fact that flexibility and dynamism do not make a country immune to the disease now afflicting southern Europe. A financial bust can overwhelm public budgets in a matter of months, even after many years of rapid growth and budget surpluses.
During the boom, the Irish state could have moderated the economic misalignment toward services and real estate through taxes: for example, a large VAT hike on services and home construction. This would have both reduced the tidal wave of capital that flooded real estate markets and the financial industry and cushioned the fiscal adjustment when the boom ended. As Ireland discovered, reducing spending during lean years is much more difficult than withholding expenditures during a boom.
Detroit Shrinks Itself, Historic Homes and All
by Alex P. Kellogg
Wrecking crews are preparing to tear down a landmark 5,000-square-foot house in the posh neighborhood of Palmer Woods in the coming weeks, a sign that Detroit is finally getting serious about razing thousands of vacant and abandoned structures across the city. In leveling 1860 Balmoral Drive, the boyhood home of one-time presidential candidate and former Massachusetts Gov. Mitt Romney, Detroit is losing a small piece of its history. But the project is part of a demolition effort that is just now gaining momentum and could help define the city's future.
Detroit is finally chipping away at a glut of abandoned homes that has been piling up for decades, and intends to take advantage of warm weather and new federal funding to demolish some 3,000 buildings by the end of September. Mayor Dave Bing has pledged to knock down 10,000 structures in his first term as part of a nascent plan to "right-size" Detroit, or reconfigure the city to reflect its shrinking population. When it's all over, said Karla Henderson, director of the Detroit Building Department, "There's going to be a lot of empty space."
Mr. Bing hasn't yet fully articulated his ultimate vision for what comes after demolition, but he has said entire areas will have to be rebuilt from the ground up. For now, his plan calls for the tracts to be converted to other uses, such as parks or farms. Even when the demolitions are complete, Detroit will still have a huge problem on its hands. The city has roughly 90,000 abandoned or vacant homes and residential lots, according to Data Driven Detroit, a nonprofit that tracks demographic data for the city.
After a stuttering start, caused by a dispute over the disposal of asbestos from demolished homes, the program is just now gaining pace. City officials say they aren't sure how many structures ultimately need to be torn down. The mortgage crisis compounded Detroit's economic decline, leaving nearly 30% of the city's housing stock vacant, according to Data Driven Detroit. "Neighborhoods that are considered stable are now at 20% vacancy," said Deborah Younger, a development consultant involved in the demolition effort.
Until recently, the city didn't have the funds to tackle its growing list of houses slated for demolition. But $20 million in federal funds, primarily stimulus dollars has helped to kick-start the effort. Demolition, particularly of historic buildings, is a sensitive issue in Detroit, often leading to wrenching battles between developers, residents, city officials and preservationists. But many residents are now pleading with the city to tear down decaying structures that are attracting crime and repelling home buyers. However, some still worry that the sort of large-scale bulldozing that the city is now talking about will forcibly dislocate longtime homeowners and preclude any chance of a comeback for Detroit. "The city has never done this before," says Ms. Henderson, the Building Department chief. "We had to make a culture change."
The demolition of the Romney family home is the first of its kind in Palmer Woods, a high-end enclave in northwest Detroit that was developed at the dawn of the U.S. auto industry and housed many of its pioneers. Palmer Woods has just a handful of vacant properties among its 292 homes, according to residents. It's one of the anchor neighborhoods that is critical to the success of Mayor Bing's right-sizing effort. The house was owned by Mr. Romney's parents, George and Lenore Romney, from 1941 until 1953, when the family moved to the northern suburbs. The elder Mr. Romney would go on to become head of American Motors Corp., then governor of Michigan and U.S. secretary of Housing and Urban Development.
As recently as 2002, the house sold for $645,000. But it has had a troubled history since then, lapsing into foreclosure more than once, bouncing between lenders and falling into disrepair. Last year, following years of complaints from neighbors, Wayne County declared it "a public nuisance and blight" and ordered it demolished. The younger Mr. Romney, who is considered a leading GOP presidential candidate for 2012, said "it's sad" that his childhood home is being razed, "but sadder still to consider what has happened to the city of Detroit, which has been left hollow by fleeing jobs and liberal social policies."
Residents of Palmer Woods take pride in their tradition of historic preservation. But they're happy to see this house go. "This is an eyesore, and it makes no economic sense to fix it," said Joel Pitcoff, a retiree who lives around the block. "Who wants to spend $1 million on a house so it will be worth $400,000?"
Spain’s Jobless Find It Hard to Go Back to Farm
by Suzanne Daley
During Spain’s construction boom, Antonio Rivera Romero happily traded long hours and backbreaking labor in the fields for the better-regulated building trades, earning four times as much as a bricklayer. He took out a mortgage and enlarged his house on a quiet side street in this small city in southern Spain. Now, with the construction jobs gone, Mr. Rivera is behind on his bank payments and eager to return to the farmwork he left behind.
But Spaniards have been largely shut out of those jobs. Those bent over rows of strawberries under plastic greenhouse sheeting or climbing ladders in the midday sun are now almost all foreigners: Romanians, Poles, Moroccans, many of them in Spain legally. "The farmers here don’t want us," Mr. Rivera said with a defeated shrug. Local officials and union leaders say Mr. Rivera has it right. Farmers have been reluctant to take Spanish workers back — unsure whether they will work as hard as the foreigners who have been picking their crops, sometimes for a decade now.
So far, only 5 percent of the pickers this year are Spaniards, said Diego Cañamero, the head of one of Spain’s largest labor organizations, the Field Workers Union, or S.O.C. He said the union was working to keep tempers from flaring and to persuade farmers to employ local people again, but with little success. "There is a sense of bewilderment among the Spanish workers," he said. "They say: Why do they let people come 5,000 miles, when we need the jobs?"
The unemployment rate in the Andalusia region is now 27 percent, the highest in Spain except for the Canary Islands. Spaniards have always been resilient, helping out one another in hard economic times. But these days entire families like that of Mr. Rivera and his wife, who have five working-age children — most at home — are jobless. Unemployment benefits go only so far, and for those who have house or car payments, not nearly far enough.
Mr. Rivera, 50, gets 420 euros a month, about $530. His mortgage takes up half of that, he said. His wife, Encarnación Román Casillas, 49, started going to the local soup kitchen. "At first, I could not do it," she said. "My sister-in-law went for me. But then we went together, and now I do what I have to do." In addition to two hot meals, she is given a loaf of bread, a liter of milk and four containers of yogurt.
Soon, the Riveras will borrow a car from a relative and go to France, where they expect to camp while picking beets, asparagus and artichokes, then grapes in the fall. They got work there last year, though the cost of the campsite ate up half their wages. This time, a French farmer has agreed to let them stay on his property. Mr. Rivera’s predicament is hardly unique. Mayors across Andalusia say local residents come to their offices all the time looking for work. Some do not want farmwork, saying it is too hard. But many, says Emilio Vergara, mayor of Paterna del Campo, a small farming village outside Huelva, would gladly take it.
Together with three other nearby mayors, Mr. Vergara began an effort to persuade farmers to hire local people. But, he says, of the 450 people who signed up from his village, none have been offered a job. "I am concerned about a potential outburst of xenophobia, and hope that it can be avoided at all costs, because Spain is traditionally a hospitable country," Mr. Vergara said.
Experts say some farmers do hire immigrants to take advantage of them. Mr. Cañamero, the union leader, says 15 to 20 cases of serious abuse are reported each year, in which workers have not been paid or do not have enough food or water. But in most cases, Mr. Cañamero says, that is not why farmers turn to foreigners. He said hiring was governed by a web of prejudices about who are the best workers. For the very hot work in the summer, farmers prefer to hire Africans. For strawberry picking, they prefer women. "It is not written anywhere," he said. "That would be terrible discrimination. But that is how it works."
Wages vary as well. The Africans tend to be paid 30 euros a day, about $38. Other pickers can earn as much as 40 euros. Many farmers argue that they have found a reliable work force and that they cannot afford to jeopardize it. Diego Luis Camacho Rodríguez, who owns a small strawberry farm outside Huelva, has hired some local people. But the bulk of his workers are foreigners, like the Polish woman and her daughter who were delicately placing ripe fruit on plastic trays on a May afternoon.
"Once you start working with people and they know your operation," he said, "you want to keep working with them." Still, he hired Francesco Gil Barrera, 29, this year, when the young man lost his construction job. He also gave Elena Rosado Pérez, 28, a job. She had been working as a waitress, but the restaurant was doing so poorly that its owners decided to close except for weekends.
Manuel Recio, the regional minister for employment and immigration, said the government lowered the number of contracts available to foreign workers this year. But he said he doubted that Spaniards were really interested in the farm jobs. And he was quick to point out that many of those in the fields were citizens of European Union countries, and that they were as entitled to the jobs as Spaniards.
Even more than the Spaniards, illegal immigrants, who had flocked to Spain in recent years looking for work of any kind, are suffering. Hundreds of them are living in encampments in the woods. Recently, even immigrants with working papers have arrived at the camps.
Abdoulaye Diallo, who came from Senegal in 2002 and worked steadily until 2008, lives in one of the camps, on a dirt road that divides two farms outside Huelva. Like hundreds of others living under a patch of trees, he has fashioned a shelter from plastic sheeting. Most of the men have not worked in 18 months. They survive on handouts from the Red Cross. Not so long ago, they were sending money home to wives and children. "We live like animals," Mr. Diallo said. "I keep looking for work. But there is nothing."
Canadian governments overspent budgets by $65 billion in last decade
by Julian Beltrame
Canadian governments overspent their budgets by a massive $65 billion over the last decade, a transgression that has come back to haunt them in this new era of high deficits, a new study shows. The annual "Pinocchio" Index by the C.D. Howe Institute suggests governments with the most fiscal room — particularly resource-rich Alberta and Saskatchewan — have grown the longest noses over the decade.
But even the federal government, under both the current Conservatives and the predecessor Liberals, has routinely spent more than the budgets they presented and received approval for in Parliament. Over the 10 years ending in 2009, Ottawa has overspent its budgets by $21.7 billion cumulatively. "It is a lot of money," said C.D. Howe chief executive William Robson. "If Ottawa and the provinces together had actually succeeded in sticking to their budget targets, then when we got hit by this downturn (they) would have been able to go into modest deficits without any fears along the lines of what we're seeing in Europe and the United States."
In March, the Harper government said it would post a $53.8 billion deficit in the just completed fiscal year, and would fall another $49.2 billion into the hole during the current year that ends next March 31. Economists, however, say many provinces face an even bigger fiscal squeeze in the future, particularly as they have fewer revenue sources and will be most impacted by skyrocketing health care bills to care for aging baby boomers.
Ontario, relative to its population, faces the biggest obstacle with deficits of $21.3 billion and $19.7 billion in the past and current fiscal years. The provincial government has estimated it will take eight years to return to a balanced fiscal position, assuming the economy goes as expected. The economic think-tank notes that the $65 billion represents what governments spent beyond what they said they would in their budgets, and is not a judgment on whether the budgets themselves were prudent.
And that's the problem, says Kevin Gaudet, the national director for the Canadian Taxpayers Federation. Governments in general have been "profligate" in their budget targets, so there should have been little excuse for exceeding them. "I've been following this issue for years and we think there should be a law that precludes them from overspending their budget ... except for a national disaster or war," he said.
According to the study, Alberta and Saskatchewan place last among provinces for overspending their budget commitments with overruns of $11.4 billion and $3.4 billion respectively. Ontario, Canada's most populous province, overspent its budget by $14.5 billion, but in percentage terms placed fourth overall in terms of accuracy. Perhaps surprisingly, given its reputation as a high-spending jurisdiction, Quebec placed first in terms of accuracy — how closely spending matched the budget — followed by New Brunswick.
However, all those provinces and their finances were hit hard by the unexpected impact of the 2008-2009 recession, which squeezed their revenues and led to higher spending pressures long after budgets had been set months earlier during better times. In the case of Alberta and Saskatchewan, a sharp drop in oil and natural gas prices during the recession squeezed royalty revenues and slowed down the western provincial economies.
In Ontario, the near collapse of the auto sector led to thousands of job cuts and the need to spend billions of dollars in government bailouts by the federal and Ontario governments. As far as controlling spending, the C.D. Howe report says Newfoundland topped the list by spending $200 million less over the past decade than they had budgeted. But because the province often missed its targets both up and down, it's accuracy rating fell to number five among the 14 governments. The territorial governments generally were well down the list for accuracy.
Ottawa's record looks far better if the goalpost is moved from annual accuracy to how much it exceeded projections on average over the 10 years — from eighth among the 14 governments to second, thanks to the 2005-06 fiscal year when spending was less than budgeted. As well, the low federal ranking is skewed by one particularly egregious overshoot during the last year of the Paul Martin minority government, when spending exceeded projections by $11.5 billion.
Overall, Robson said Canadian governments do well when stacked up against European nations or the United States, and Ottawa's far better than its record would have looked in the 1970s, 1980s and early '90s when it was racking up massive annual deficits. "The federal government's performance over time has improved significantly," he said. "There are some bad stories of mismanagement here, but by world standards, Canada is not all that bad."
Giant Plumes of Oil Found Forming Under Gulf of Mexico
by Justin Gillis
Scientists are finding enormous oil plumes in the deep waters of the Gulf of Mexico, including one as large as 10 miles long, 3 miles wide and 300 feet thick in spots. The discovery is fresh evidence that the leak from the broken undersea well could be substantially worse than estimates that the government and BP have given. "There’s a shocking amount of oil in the deep water, relative to what you see in the surface water," said Samantha Joye, a researcher at the University of Georgia who is involved in one of the first scientific missions to gather details about what is happening in the gulf. "There’s a tremendous amount of oil in multiple layers, three or four or five layers deep in the water column."
The plumes are depleting the oxygen dissolved in the gulf, worrying scientists, who fear that the oxygen level could eventually fall so low as to kill off much of the sea life near the plumes. Dr. Joye said the oxygen had already dropped 30 percent near some of the plumes in the month that the broken oil well had been flowing. "If you keep those kinds of rates up, you could draw the oxygen down to very low levels that are dangerous to animals in a couple of months," she said Saturday. "That is alarming."
The plumes were discovered by scientists from several universities working aboard the research vessel Pelican, which sailed from Cocodrie, La., on May 3 and has gathered extensive samples and information about the disaster in the gulf. Scientists studying video of the gushing oil well have tentatively calculated that it could be flowing at a rate of 25,000 to 80,000 barrels of oil a day. The latter figure would be 3.4 million gallons a day. But the government, working from satellite images of the ocean surface, has calculated a flow rate of only 5,000 barrels a day.
BP has resisted entreaties from scientists that they be allowed to use sophisticated instruments at the ocean floor that would give a far more accurate picture of how much oil is really gushing from the well. "The answer is no to that," a BP spokesman, Tom Mueller, said on Saturday. "We’re not going to take any extra efforts now to calculate flow there at this point. It’s not relevant to the response effort, and it might even detract from the response effort."
The undersea plumes may go a long way toward explaining the discrepancy between the flow estimates, suggesting that much of the oil emerging from the well could be lingering far below the sea surface. The scientists on the Pelican mission, which is backed by the National Oceanic and Atmospheric Administration, the federal agency that monitors the health of the oceans, are not certain why that would be. They say they suspect the heavy use of chemical dispersants, which BP has injected into the stream of oil emerging from the well, may have broken the oil up into droplets too small to rise rapidly.
BP said Saturday at a briefing in Robert, La., that it had resumed undersea application of dispersants, after winning Environmental Protection Agency approval the day before. "It appears that the application of the subsea dispersant is actually working," Doug Suttles, BP’s chief operating officer for exploration and production, said Saturday. "The oil in the immediate vicinity of the well and the ships and rigs working in the area is diminished from previous observations."
Many scientists had hoped the dispersants would cause oil droplets to spread so widely that they would be less of a problem in any one place. If it turns out that is not happening, the strategy could come under greater scrutiny. Dispersants have never been used in an oil leak of this size a mile under the ocean, and their effects at such depth are largely unknown. Much about the situation below the water is unclear, and the scientists stressed that their results were preliminary. After the April 20 explosion of the Deepwater Horizon, they altered a previously scheduled research mission to focus on the effects of the leak.
Interviewed on Saturday by satellite phone, one researcher aboard the Pelican, Vernon Asper of the University of Southern Mississippi, said the shallowest oil plume the group had detected was at about 2,300 feet, while the deepest was near the seafloor at about 4,200 feet. "We’re trying to map them, but it’s a tedious process," Dr. Asper said. "Right now it looks like the oil is moving southwest, not all that rapidly." He said they had taken water samples from areas that oil had not yet reached, and would compare those with later samples to judge the impact on the chemistry and biology of the ocean.
While they have detected the plumes and their effects with several types of instruments, the researchers are still not sure about their density, nor do they have a very good fix on the dimensions. Given their size, the plumes cannot possibly be made of pure oil, but more likely consist of fine droplets of oil suspended in a far greater quantity of water, Dr. Joye said. She added that in places, at least, the plumes might be the consistency of a thin salad dressing.
Dr. Joye is serving as a coordinator of the mission from her laboratory in Athens, Ga. Researchers from the University of Mississippi and the University of Southern Mississippi are aboard the boat taking samples and running instruments. Dr. Joye said the findings about declining oxygen levels were especially worrisome, since oxygen is so slow to move from the surface of the ocean to the bottom. She suspects that oil-eating bacteria are consuming the oxygen at a feverish clip as they work to break down the plumes.
While the oxygen depletion so far is not enough to kill off sea life, the possibility looms that oxygen levels could fall so low as to create large dead zones, especially at the seafloor. "That’s the big worry," said Ray Highsmith, head of the Mississippi center that sponsored the mission, known as the National Institute for Undersea Science and Technology. The Pelican mission is due to end Sunday, but the scientists are seeking federal support to resume it soon. "This is a new type of event, and it’s critically important that we really understand it, because of the incredible number of oil platforms not only in the Gulf of Mexico but all over the world now," Dr. Highsmith said. "We need to know what these events are like, and what their outcomes can be, and what can be done to deal with the next one."
Oil spill imperils an unseen world at the bottom of the gulf
by Joel Achenbach
In total darkness at the bottom of the Gulf of Mexico lives a creature with many scuttling legs and two wiggling antennae that jut from a pinched, space-alien face. It is the isopod, Bathynomus giganteus, a scavenger of dead and rotten flesh on the mud floor of the gulf. "If you think of a giant roach, put it on steroids," said Thomas Shirley, a marine biologist at Texas A&M University. "They can be scary big."
There is beauty in the lightless deep as well. Fan corals, lacylike doilies, form gardens on the seafloor and on sunken ships. The deep is full of crabs, sponges, sea anemones. Sharks hunt in the dark depths, as do sperm whales that feed on giant squid. The sperm whales have formed a year-round colony near the mouth of the Mississippi River, and have been known to rub themselves on oil pipes just like grizzlies rubbing against pine trees.
This is the unseen world imperiled by the uncapped oil well a mile below the surface of the gulf. The millions of gallons of crude, and the introduction of chemicals to disperse it, have thrown this underwater ecosystem into chaos, and scientists have no answer to the question of how this unintended and uncontrolled experiment in marine biology and chemistry will ultimately play out.
The leaking gulf well, drilled by the now-sunken rig Deepwater Horizon, has cast a light on a part of the planet usually out of sight, out of mind, below the horizon, and beyond our ken. The well is surrounded by a complex ecosystem that only in recent years has been explored by scientists. Between the uncapped well and the surface is a mile of water that riots with life, and now contains a vast cloud of oil, gas and chemical dispersants and long, dense columns of clotted crude.
"Everybody fixates on the picture of the cormorant or the bird flailing around all covered with oil, and while that's obviously sad to see, no one should assume there's not similar things occurring in the open ocean," said Andy Bowen, an oceanographer at Woods Hole Oceanographic Institution in Massachusetts. "It's not like the open ocean is irrelevant."
More is known about the surface of the moon than about the world at the bottom of the sea. Scientists long ago clung to the "azoic hypothesis" about the deep -- the presumption that nothing could possibly be alive so far from the photosynthetic world. Gradually that belief succumbed to living proof to the contrary. Life finds a way. Instead of photosynthesis, there is chemosynthesis. Organic matter rains into the depths from higher in the water column. Oil itself is a part of this mysterious universe, leaking naturally from the seafloor. It is testament to life's ingenuity that for some bacteria, oil is food.
The broken well is 5,000 feet below the surface, on the continental slope, which is the long hill that runs from the edge of the continental shelf to the abyssal plain in the central gulf. The pressure is about 2,230 pounds per square inch, 152 times that of the atmosphere at sea level. The temperature is just a few degrees above freezing. But the Deepwater Horizon well is in an area that is comparatively well explored. Scientists have been actively studying the deep coral reefs of the gulf, in many cases venturing personally in submersible vessels that can withstand the crushing depths. This strange realm can be disorienting.
"It's sort of like being in the Grand Canyon with the lights out and in a snowstorm," Bowen said. The topography is full of knolls, hills, canyons -- the leaking well is located in Mississippi Canyon Block 252 -- and the sea bottom is not simply mud. "You can go one place and it would be like quicksand. You can move over another ways, and it would be as hard as a sidewalk," said Rich Camilli, an oceanographer at Woods Hole who in 2006 made a series of dives to the gulf floor eight miles northwest of the blown-out well. His journey about 3,000 feet below the surface took place right after an earthquake. "It looked like all hell had broken loose on the seafloor," Camilli said.
Embedded in the mud are structures made of methane hydrates, the slushy ice that forms when pressurized gas mixes with very cold water at depth. These are the hydrates that accumulated inside a huge steel containment dome that had been lowered over the major leak from a collapsed pipe. Because of the hydrates, BP engineers had to abandon that strategy for capturing the leaking oil.
When Camilli observed hydrates after the earthquake, they "had broken away from the seafloor and had floated up and away. They're buoyant. One site, called Sleeping Dragon, a massive hydrate block was working its way out of the seafloor -- about the size of a school bus. There were pockmarks where the hydrates come out of the sea floor."
This region of the gulf is fertilized by organic matter from the Mississippi River. It is rich in plankton and other organisms. The result is what is called marine snow, which is easily seen in the brief snippets of video released by BP that show the leaking pipe. "There's this particulate matter that's falling like rain, or like snow, through the ocean, all the way from the surface to the bottom," said Peter Etnoyer, a marine biologist with the National Oceanic and Atmospheric Administration. "There's thousands of creatures in the water column. As you descend though the water column, you'll see many bioluminescent plankton."
The depths of the gulf are also a potential answer to a question that has been in the air for weeks now: Where, exactly, has all the oil gone? A partial explanation is that the slick has been bombed with more than half a million gallons of the chemical dispersant Corexit 9500, made by Nalco. More dispersants have been applied at depth, directly on the main leak. Much of the oil sinks to the bottom.
"If you apply the dispersants to the source of the oil down there, you are completely hiding the problem," said Kert Davies, research director for Greenpeace. "It looks like it's gone away, but there is no 'away' in the ocean. It's like sweeping it under the rug." Shirley, the marine biologist, notes that oil is not a foreign substance in the gulf: "What most people haven't considered is that there's 48 million gallons of oil that's leaked naturally in the gulf every year."
Ian MacDonald, the Florida State University professor who has gained attention with his estimate, based on aerial images, that the leak is five times the official estimate of 5,000 barrels a day, said nature will ultimately have to fix the gulf mess. "BP is not going to clean up this spill," he said. "The Coast Guard is not going to clean up this spill. What's going to clean up this spill is the physical, chemical, biological process of the good ol', poor, downtrodden Gulf of Mexico."
Life is an active and improvisational agent in the deep water. Corals have found purchase on dozens of ships sunk in the gulf in 1942 when Nazi U-boats patrolled the shipping lanes. Scientists study the doomed vessels to get a better idea of coral growth rates at depth. Less than a mile from the uncapped well, now upside down, is the hulk of the Deepwater Horizon rig. It is now, in effect, an artificial reef, destined to become another garden of the deep.