Those strange filaments are background galaxies. Gravity can bend light, allowing huge clusters of galaxies to act as telescopes, and distorting images of background galaxies into elongated strands. Almost all of the bright objects in this Hubble Space Telescope image are galaxies in the cluster known as Abell 2218. The cluster is so massive and so compact that its gravity bends and focuses the light from galaxies that lie behind it. As a result, multiple images of these background galaxies are distorted into long faint arcs -- a simple lensing effect analogous to viewing distant street lamps through a glass of wine. The cluster of galaxies Abell 2218 is itself about three billion light-years away in the northern constellation of the Dragon (Draco). The power of this massive cluster telescope has allowed astronomers to detect a galaxy at the distant redshift of 5.58.
Ilargi: No, the biggest, the main, the major threat to the US economy hasn't gone away. In fact, it hasn't gone anywhere. It’s merely been veiled and papered over. And that means it will come back onto the scene with a vengeance. When exactly it will do so basically depends on one issue only: how much longer the US government decides (or should we say "believes") that it can and should throw its citizens' grandchildrens' future tax revenues at obligations incurred yesterday, an idea, accidentally, that's hard to beat for braindead perversity.
Who are we to hand our problems to our offspring to solve? Then again, that's also what we're doing in the case of the Gulf of Mexico, so there's nothing new under the sun, it's fast establishing itself as a theme familiar to our generation(s). There are native tribes in North America who to this day maintain an ancient pledge to preserve the world they were born in for the next seven generations. If we were to have such a pledge, it would be about the opposite: we ruin the world for the next seven generations.
That main threat to the US economy, of course, is housing. Grossly overpriced housing, to be precise, "paid for" with mortgages that an increasing number of "homeowners" can't possibly afford anymore. This morning on CNBC, Meredith Whitney stated that while the risk of a double-dip in the overall economy is "greater than 1%", a housing double-dip is assured. But that's all just semantics, and of course she knows it; it's just not a popular way to look at things. In reality, neither housing nor the economy as a whole ever got out of the first dip. A trillion dollars a month worth of future obligations just made it look like they did.
Whitney pointed to the rising numbers of foreclosures and short sales as signs of deterioration. Banks are becoming more aggressive towards borrowers in default, and they're selling off properties faster as well, often at steep discounts of 50 or 60 cents on the dollar. Talk about capital destruction! All this additional inventory on the market, in which the soon to be delisted government-owned zombies Fannie Mae and Freddie Mac play the title roles, can do but one thing: bring prices down further. Banks that have kept bad loans on their books just to profit from the extend and pretend don’t look don't tell appearance game of face value now need money, cash, at - at least soon- almost any price.
We have longtime since established the link between housing and unemployment. Whitney connects the dots talking about US states and their financial predicaments. They will receive $50 billion from Washington, but they need $200 billion (and that's still a very conservative estimate). Which is why the states, in Whitney's words, are "cutting jobs in a mercurial way for the first time on record."
And lay-offs are not the only measure taken at state level, where, unlike in Washington, the law dictates budgets must be balanced. Mary Williams Walsh writes in the New York Times:
In Budget Crisis, States Take Aim at Pension Costs. In case you hadn't noticed, the pension plan situation across the board and around the world is worsening fast. And at state level in the US, it could all well get worse. In that regard, there's one paragraph in Walsh's piece that jumps out:
If a state pension fund ran out of money, the state would be legally bound to make good on retirees’ benefits. But paying public pensions straight out of general revenue would be ruinous. In Illinois’s case, it would consume about half the state’s cash every year, bringing other vital state services to a standstill.
Now that spells trouble. Walsh: "Illinois raised its retirement age to 67, the highest of any state, and capped public pensions at $106,800 a year."
Look, if state services for the newly and longtime laid-off and foreclosed-on are cut because scores of civil servants must be paid $100,000 a year, we're stirring up a dangerous brew. We're creating a theater for a fight that cannot possibly have any winners. And it's the federal government with its moronic messages of economic recovery and all that which is responsible to a large extent for the fact that people get into these fights without any idea of what the outcome will and must inevitably be.
Which takes me right back to Fannie and Freddie and Meredith Whitney's prediction for a housing double-dip. The Congressional Budget Office said in January that the final losses for American taxpayers in the Fannie and Freddie morass, which now stands at some $150 billion, could reach $389 billion, but anyone with one remaining functioning neuron and/or a calculator can figure out what the $5.5 trillion or so they hold in loans could cause in losses when home prices dive another 20%, or 50%. And then we're not even yet talking about the mortgage-based derivatives these publicly owned walking dead are involved in. Delisting Fannie and Freddie looks to me like an invitation to go even crazier with the whole shebang.
And by now, and I’ll volunteer to be the first one to admit it, there are very few options and alternatives left. If you let them fall, the whole banking system, read: economy, falls with them. But that doesn't mean it’s possible to keep them upright forever. The banks that are feeling squeezed ever more will in turn squeeze their borrowers, take away their homes and sell them to a neighbor at a 50% discount.
The Mary Williams Walsh article deals with a bunch of real estate folks whose only business is exactly that, selling your home to someone else for half the price, wheras you yourself might have been able to afford that too. Which makes me wonder how many homes need to be sold at half price before people start noticing that Fannie and Freddie's $5.5 trillion portfolio is worth $3 trillion or less. And that the American population has then lost $2.5 trillion, just like that.
Anything else is just an illusion, a hologram, that persists because heretofore successful businessmen and the incumbent politicians they have purchased deem it best, so far, for their own short term personal interests, to let people believe for a bit longer that all is and will be well.
It doesn’t all seem that hard to comprehend, if you ask me, at least when it comes to the numbers. The consequences may take a while longer to sink in.
Housing Double-Dip to Slow Economic Recovery: Meredith Whitney
by Jeff Cox - CNBC
The US economy faces a perilous second half as a new set of problems hits real estate and thwarts any chance for a strong recovery, banking analyst Meredith Whitney told CNBC. While stopping short of predicting a full-blown double dip in the broad economy, Whitney said one is certainly in store for the housing market. "People doubt there's a double-dip in housing," she said. "It's amazing."
The primary reason she cited for another leg down in housing is that banks are getting more aggressive foreclosing on delinquent borrowers. That in turn will push more inventory into the market, pressuring prices and ensuring that economic growth will be tepid at best. "Banks are actually accelerating their foreclosure programs, accelerating their short-sale programs. People who have been paying their mortgage now have to start paying rent," Whitney said. "You'll see a real leg down in supply displacement when you foreclose and you have to sell."
Consumer behavior has exhibited traits Whitney said she's never seen before. Primary among the anomalies has been the trend of homeowners not paying their mortgages and instead paying down other bills and increasing their personal spending. Elsewhere, problems from state and local governments also will weigh on the national economy, particularly in the way that they are "cutting jobs in a mercurial way for the first time on record."
"They're being squeezed from all sides and there's really nowhere to turn," she said. Whitney also said financial regulation reform and policy-making that is not friendly to the middle class will hurt growth. "The populist incumbents argue that we've got to get money to redistribute wealth," she said. "This squeezes the middle class further down the food chain. The unintended consequences of this are maddening."
Cost of Seizing Fannie and Freddie Surges for Taxpayers
by Binyamin Appelbaum - New York Times
Fannie Mae and Freddie Mac took over a foreclosed home roughly every 90 seconds during the first three months of the year. They owned 163,828 houses at the end of March, a virtual city with more houses than Seattle. The mortgage finance companies, created by Congress to help Americans buy homes, have become two of the nation’s largest landlords.
Bill Bridwell, a real estate agent in the desert south of Phoenix, is among the thousands of agents hired nationwide by the companies to sell those foreclosures, recouping some of the money that borrowers failed to repay. In a good week, he sells 20 homes and Fannie sends another 20 listings his way. "We’re all working for the government now," said Mr. Bridwell on a recent sun-baked morning, steering a Hummer through subdivisions laid out like circuit boards on the desert floor.
For all the focus on the historic federal rescue of the banking industry, it is the government’s decision to seize Fannie Mae and Freddie Mac in September 2008 that is likely to cost taxpayers the most money. So far the tab stands at $145.9 billion, and it grows with every foreclosure of a three-bedroom home with a two-car garage one hour from Phoenix. The Congressional Budget Office predicts that the final bill could reach $389 billion.
Fannie and Freddie increased American home ownership over the last half-century by persuading investors to provide money for mortgage loans. The sales pitch amounted to a money-back guarantee: If borrowers defaulted, the companies promised to repay the investors. Rather than actually making loans, the two companies — Fannie older and larger, Freddie created to provide competition — bought loans from banks and other originators, providing money for more lending and helping to hold down interest rates.
"Our business is the American dream of home ownership," Fannie Mae declared in its mission statement, and in 2001 the company set a target of helping to create six million new homeowners by 2014. Here in Arizona, during a housing boom fueled by cheap land, cheap money and population growth, Fannie Mae executives trumpeted that the company would invest $15 billion to help families buy homes.
As it turns out, Fannie and Freddie increasingly were channeling money into loans that borrowers could not afford. As defaults mounted, the companies quickly ran low on money to honor their guarantees. The federal government, fearing that investors would stop providing money for new loans, placed the companies in conservatorship and took a 79.9 percent ownership stake, adding its own guarantee that investors would be repaid.
The huge and continually rising cost of that decision has spurred national debate about federal subsidies for mortgage lending. Republicans want to sever ties with Fannie and Freddie once the crisis abates. The Obama administration and Congressional Democrats have insisted on postponing the argument until after the midterm elections. In the meantime, Fannie and Freddie are editing the results of the housing boom at public expense, removing owners who cannot afford their homes, reselling the houses at much lower prices and financing mortgage loans for the new owners.
The two companies together accounted for 17 percent of real estate sales in Arizona during the first four months of the year, almost three times their share of the market during the same period last year, according to an analysis by MDA DataQuick. Valarie Ross, who lives in the Phoenix suburb of Avondale, has watched six of the nine homes visible from her lawn chair emptied by moving trucks during the last year. Four have been resold by the government. "One by one," she said. "Just amazing."
The population of Pinal County, where Mr. Bridwell lives and works, roughly doubled to 340,000 over the last decade. Developers built an entirely new city called Maricopa on land assembled from farmers. Buyers camped outside new developments, waiting to purchase homes. One builder laid out a 300-lot subdivision at the end of a three-mile dirt road and still managed to sell 30 of the homes.
Mr. Bridwell sold plenty of those houses during the boom, then cut workers as prices crashed. Now his firm, Golden Touch Realty, again employs as many people as at the height of the boom, all working exclusively for Fannie Mae. The payroll now includes a locksmith to secure foreclosed homes and two clerks devoted to federal paperwork. Golden Touch gets more listings from Fannie Mae than any other firm in Pinal County. Mr. Bridwell said he was ready to jump because he remembered the last time the government ended up owning thousands of Arizona houses, after the late-1980s collapse of the savings and loan industry.
"The way I see it," said Mr. Bridwell, whose glass-top desk displays membership cards from the Republican National Committee, "is that we’re getting these homes back into private hands." Selling a house generally costs the government about $10,000. The outsides are weeded and the insides are scrubbed. Stolen appliances are replaced, brackish pools are refilled. And until the properties are sold, they must be maintained. Fannie asks contractors to mow lawns twice a month during the summer, and pays them $80 each time. That’s a monthly grass bill of more than $10 million.
All told, the companies spent more than $1 billion on upkeep last year. "We may be behind many loans on the same street, so we believe that it’s in everyone’s best interest to aggressively do property maintenance," said Chris Bowden, the Freddie Mac executive in charge of foreclosure sales.
Prices have plunged. So by the time a home is resold, Fannie and Freddie on average recoup less than 60 percent of the money the borrower failed to repay, according to the companies’ financial filings. In Phoenix and other areas where prices have fallen sharply, the losses often are larger. Foreclosures punch holes in neighborhoods, so residents, community groups and public officials are eager to see properties reoccupied. But there also is concern that investors are buying many foreclosures as rental properties, making it harder for neighborhoods to recover.
Real estate agents tend to favor investors because the sales close surely and quickly and there is the prospect of repeat business. But community advocates say that Fannie and Freddie have an obligation to sell houses to homeowners.
David Adame worked for Fannie Mae’s local office during the boom, on programs to make ownership more affordable. Now with prices down sharply, Mr. Adame sees a second chance to put people into homes they can afford. "Yes, move inventory," said Mr. Adame, now an executive focused on housing issues at Chicanos por la Causa, a Phoenix nonprofit group, "but if we just move inventory to investors, then what are we doing?"
Executives at both Fannie and Freddie say they have an overriding obligation to limit losses, but that they are taking steps to sell more homes to families. Fannie Mae last summer announced that it would give people seeking homes a "first look" by not accepting offers from investors in the first 15 days that a property is on the market. It also offers to help buyers with closing costs, and prohibits buyers from reselling properties at a profit for 90 days, to discourage speculation. Fannie Mae said that 68.4 percent of buyers this year had certified that they would use the house as a primary residence.
Freddie Mac has adopted fewer programs, but it said it had sold about the same share of foreclosures to owner-occupants. The companies also have agreed to sell foreclosed homes to nonprofits using grants from the federal Neighborhood Stabilization Program. Chicanos por la Causa, which won $137 million under the program in partnership with nonprofits in eight other states, plans to buy more than 200 homes in Phoenix in the next two years. It plans to renovate them to sell to local families. The scale of such efforts is small. The home ownership rate in Phoenix continues to fall as foreclosures pile up and renters replace owners.
But John R. Smith, chief of Housing Our Communities, another Phoenix-area group using federal money to buy foreclosures, says he tries to focus on salvaging one property at a time. "I tell them, ‘O.K., you want to unload 10 houses to that guy, fine,’ " he said. " ‘Now give me this one. And this one. And one over here.’ "
The Credit Crunch That Won't Go Away
by Emily Maltby - Wall Street Journal
Forget the improving economy. Entrepreneurs still find it hard to get loans. Here's why we're in this mess—and how we may get out of it.
The economy is on the mend. The government has launched a boatload of programs to get small businesses financing. President Barack Obama has urged banks to give the companies a "third and fourth look" before rejecting them for loans. Yet entrepreneurs are still struggling to land credit. Only half of small businesses that tried to borrow last year got all or most of what they needed, according to a survey by the National Federation of Independent Business. In the mid-2000s, 90% of businesses said they got the loans they needed.
What's going on here? Why is the credit crunch alive and well when it comes to small businesses? Part of the problem is that most of the government programs created to address the problem have focused on Small Business Administration loans, which total less than 10% of overall lending to small companies. But there's a wider issue at work. Banks and the government are trying to avoid repeating the mistakes that led to the subprime meltdown. It's a perfectly understandable goal—but it's freezing up financing.
Federal regulators, for instance, say they want banks to make prudent loans, even as the pressure to give out credit grows. Some banks, meanwhile, think many more businesses are bad risks these days, and they don't want to damage their balance sheets by making questionable loans. There's also lots of finger-pointing. Some bankers say loan volume is down because demand is down; small businesses, they argue, are wary of taking on debt in uncertain times. Other bankers accuse regulators of pressuring them to curb lending, while regulators say banks are just making them the fall guy.
Stuck in the middle are entrepreneurs. During the downturn, many of them lost their credit lines and couldn't get access to other sources of financing, such as home-equity loans. Now that things are looking up, they're frustrated that they can't get the financing they desperately need. So, many of them are curbing expansion and hiring plans—and that, in turn, may be slowing the nation's recovery and keeping unemployment high.
Julio Valencia is one of those frustrated owners. In the past eight months, he has tried working with four large banks to land a $500,000 credit line for his young business. He has been turned down each time, he says, because JTI Landing Systems, which fixes landing gear for commercial aircraft, doesn't yet have three years of financial history to show the banks. Mr. Valencia, along with his business partner, have exhausted personal cash and retirement savings for start-up purchases and payroll. If his Las Vegas company can't land funding, it can't expand—and may even have to close, he says. "If we don't have the cash flow to support our employees, well, no one works for free," Mr. Valencia says.
How We Got Here
The lending freeze stretches back to 2007, when the nation plunged into recession. In the first quarter of that year, more banks were tightening standards for small-business loans than loosening them, according to the Federal Reserve's quarterly Senior Loan Officer Opinion survey of large lenders. By October 2008, the percentage was up to 84%—roughly where it is today.
Along the way, of course, the housing bubble burst. Banks suffering from heavily weighted real-estate portfolios compensated by reducing—and in some cases eliminating—credit lines, while raising interest penalties. What's more, the secondary markets, where many lenders bundled their SBA loans and sold them to investors, clamped shut, so banks couldn't get enough capital to make new loans.
Every potential borrower suffered, but small businesses were particularly hard hit. In 2009, small-business loan portfolios at big banks dropped by 9% from the previous year—more than double the 4.1% drop for their entire lending portfolios, according to a recent Congressional Oversight Panel report. At the smallest banks, small-business lending portfolios fell 2.7%, while overall portfolios fell 0.2%. Heeding Mr. Obama's call to increase lending, a few big banks have made ambitious pledges. Bank of America Corp., for one, announced a goal of lending $5 billion more to small companies this year than last.
Some small banks are making efforts, too. Lani Hayward, executive vice president of communications at Umpqua Holdings Corp.'s Umpqua Bank, in Portland, Ore., says the bank has gone "a touch further in extending credit" through its MainStreet Lending program, which gives applicants who would otherwise be rejected another review. Ms. Hayward says about 30% of the loans that move through that program get approved. Still, she says, "it's not like we are opening the coffers. For the regulators' sake and our own sake, there needs to be a gatekeeper."
Who's Clamping Down?
Some banks, particularly smaller lenders, say they want to lend more. But they say they're being pressured to be more selective by too-strict regulators, who have stepped up oversight to ensure banks are well capitalized and have balanced loan portfolios. For instance, the Independent Community Bankers of America, a Washington-based advocacy group, announced as part of its 2010 policy priorities that it would urge a "more measured approach from overzealous bank examiners so that they do not further exacerbate the current economic downturn and community banks' ability to aid recovery efforts."
Regulators, though, say they haven't been urging banks to adopt overly rigorous standards—they simply want the banks to be prudent. "Sometimes the regulators are a convenient excuse for banks who really don't want to tell borrowers they can't make the loan," says Timothy W. Long, senior deputy comptroller and chief national bank examiner at the Office of the Comptroller of the Currency in Washington. "Deciding which borrowers the banks should lend to is not part of our examination process. We tell them to lend in a safe and sound manner."
He says the effort has worked. Banks are underwriting more carefully, he says, and marginal borrowers aren't getting the overly favorable terms they often did before the recession. Some bankers, mostly at large institutions, argue that their standards—and federal oversight—haven't gotten stricter. "What has changed is the financial condition of most small businesses," says Kathie Sowa, a commercial-banking executive at Bank of America. "Few small businesses have not been impacted" by the downturn.
The bankers say few creditworthy candidates are walking through their doors despite signs of economic recovery. The requests banks are getting these days are "disproportionately from businesses that we would have a difficult time lending to with confidence we'd get the money back," says Marc Bernstein, who heads small-business lending at Wells Fargo & Co. Some bankers also argue that loan volume is down because many businesses are choosing to go without funding. They say many owners don't want to take on additional debt during uncertain economic times and are opting to rein in spending and shave overhead.
"Demand has been down," says Maria Coyne, executive vice president of business banking at KeyBank, a national lender operated by Cleveland-based KeyCorp. Ms. Coyne believes that lending won't bounce back to the levels of years past because borrowers realized the dangers of assuming too much debt. "We saw America deleverage by hundreds of millions of dollars, and businesses did the same thing," she says. "They hunkered down. They got refocused."
Under the Microscope
Are small companies actually seeking fewer loans? It depends on whom you ask. Through the recession, the National Federation of Independent Business consistently reported in monthly surveys that the credit crunch was not the biggest issue for its constituency, because so many owners weren't seeking loans. Other small-business advocacy groups such as the National Small Business Association offer a different view. Although lower demand "may be a small part of the equation, the decrease in loans is more likely related to the terms and availability of such loans," said the association's 2009 end-of-year report.
As for the quality of borrowers these days, many businesses have undeniably become less creditworthy because of reduced sales, tighter cash flow, and lower credit scores from debts and slashed credit lines. But most business owners, like Mr. Valencia, don't view themselves as risky investments. His company pulled in $2 million in sales last year, he says, and has received interest from some large international airlines. With credit access, he adds, JTI could hire 100 employees in the next four years. Without it, the company has had to shave its staff of 12 down to four.
"We spent quite a bit of money to procure machines and equipment," says Mr. Valencia. "I have the experience. I know what we're capable of doing." Mr. Valencia says he is having trouble with cash flow, often a red flag for bankers. But he adds that the problems are stemming not from his financial mismanagement but instead from his customers who have been slower to pay—a point he thinks banks fail to take into consideration.
What Happens Next?
So far, efforts from the administration to spur small-business lending have fallen flat. As part of last year's stimulus package, for instance, the SBA enhanced its loan-guarantee program, which gives banks more confidence to lend by reimbursing them in the case of default. The program eliminated loan fees for borrowers while increasing the maximum guarantee amount to 90% from 75%. But such programs haven't proved as popular as hoped, in part because many banks are disenchanted with SBA lending programs. Particularly for community lenders, programs are too paperwork intensive and require personnel that banks can't afford. Streamlining the programs was one of the banks' top requests at a roundtable meeting with Mr. Obama in December.
Last week, the House passed a $30 billion initiative for community banks to borrow from the government at low rates. President Obama, who announced the idea last October, is encouraging the Senate to quickly pass the program into law. The president has also asked legislators to pass a regulatory overhaul and raise the limits on SBA loans. There are other proposals on the table. Among other Democrats, New York Congresswoman Nydia Velázquez, who heads the House Small Business Committee, has proposed expanding the SBA's disaster-loan program, which issues loans directly to businesses in areas that have been hit by catastrophes. The agency, she says, could underwrite loans to small businesses that have not been able to get funding from banks.
The SBA has vehemently opposed this idea, arguing that it lacks the infrastructure to take on such a task and would not want to compete with the lenders that use their loan products. Other proposals center on nontraditional lenders that don't work like banks and have more flexibility in lending guidelines. Some politicians, such as Yvette Clarke, another House Democrat from New York, want to expand a Treasury Department fund that supports Community Development Financial Institutions. These groups, usually nonprofit microlenders, often have a mission to target people who don't qualify for traditional loans, provided the borrowers can ameliorate the risk. For instance, some CDFIs will lend to less-creditworthy people if they enroll in financial-education courses.
Similarly, the Small Business Intermediary Lending Pilot Program Act of 2009, sponsored last year by Sen. Carl Levin, a Michigan Democrat, would authorize the SBA to make direct, low-interest loans to 20 nonprofit intermediary lenders, which would then use the money to make loans of up to $200,000 to eligible small businesses. Another proposal targets credit unions, which have boosted their lending through the recession. Legislation in both the House and Senate would let these nonprofits lend 25% of their assets, up from 12.25% under current law.
Meanwhile, Mr. Valencia and other hopeful borrowers continue to pound the pavement in search of financing. Until they can procure it, the promise of full recovery may continue to be out of reach. "There are millions of us that are trying to get this economy back to where we were," says Mr. Valencia. "The government is not creating programs to support start-up businesses. It's irritating."
The Inflatable Loan Pool
by Gretchen Morgenson - New York Times
Amid the legal battles between investors who lost money in mortgage securities and the investment banks that sold the stuff, one thing seems clear: the investment banks appear to be winning a good many of the early skirmishes.
But some cases are faring better for individual plaintiffs, with judges allowing them to proceed even as banks ask that they be dismissed. Still, these matters are hard to litigate because investors must persuade the judges overseeing them that their losses were not simply a result of a market crash. Investors must argue, convincingly, that the banks misrepresented the quality of the loans in the pools and made material misstatements about them in prospectuses provided to buyers.
Recent filings by two Federal Home Loan Banks — in San Francisco and Seattle — offer an intriguing way to clear this high hurdle. Lawyers representing the banks, which bought mortgage securities, combed through the loan pools looking for discrepancies between actual loan characteristics and how they were pitched to investors.
You may not be shocked to learn that the analysis found significant differences between what the Home Loan Banks were told about these securities and what they were sold. The rate of discrepancies in these pools is surprising. The lawsuits contend that half the loans were inaccurately described in disclosure materials filed with the Securities and Exchange Commission.
These findings are compelling because they involve some 525,000 mortgage loans in 156 pools sold by 10 investment banks from 2005 through 2007. And because the research was conducted using a valuation model devised by CoreLogic, an information analytics company that is a trusted source for mortgage loan data, the conclusions are even more credible. The analysis used CoreLogic’s valuation model, called VP4, which is used by many in the mortgage industry to verify accuracy of property appraisals. It homed in on loan-to-value ratios, a crucial measure in predicting defaults.
An overwhelming majority of the loan-to-value ratios stated in the securities’ prospectuses used appraisals, court documents say. Investors rely on the ratios because it is well known that the higher the loan relative to an underlying property’s appraised value, the more likely the borrower will walk away when financial troubles arise. By back-testing the loans using the CoreLogic model from the time the mortgage securities were originated, the analysis compared those values with the loans’ appraised values as stated in prospectuses. Then the analysts reassessed the weighted average loan-to-value ratios of the pools’ mortgages.
The model concluded that roughly one-third of the loans were for amounts that were 105 percent or more of the underlying property’s value. Roughly 5.5 percent of the loans in the pools had appraisals that were lower than they should have been. That means inflated appraisals were involved in six times as many loans as were understated appraisals.
David J. Grais, a lawyer at Grais & Ellsworth in New York, represents the Home Loan Banks in the lawsuits. "The information in these complaints shows that the disclosure documents for these securities did not describe the collateral accurately," Mr. Grais said last week. "Courts have shown great interest in loan-by-loan and trust-by-trust information in cases like these. We think these complaints will satisfy that interest."
The banks are requesting that the firms that sold the securities repurchase them. The San Francisco Home Loan Bank paid $19 billion for the mortgage securities covered by the lawsuit, and the Seattle Home Loan Bank paid $4 billion. It is unclear how much the banks would get if they won their suits.
Among the 10 defendants in the cases are Deutsche Bank, Credit Suisse, Merrill Lynch, Countrywide and UBS. None of these banks would comment. As outlined in the San Francisco Bank’s amended complaint, it did not receive detailed data about the loans in the securities it purchased. Instead, the complaint says, the banks used the loan data to compile statistics about the loans, which were then presented to potential investors. These disclosures were misleading, the San Francisco Bank contends.
In one pool with 3,543 loans, for example, the CoreLogic model had enough information to evaluate 2,097 loans. Of those, it determined that 1,114 mortgages — or more than half — had loan-to-value ratios of 105 percent or more. The valuations on those properties exceeded their true market value by $65 million, the complaint contends.
The selling document for that pool said that all of the mortgages had loan-to-value ratios of 100 percent or less, the complaint said. But the CoreLogic analysis identified 169 loans with ratios over 100 percent. The pool prospectus also stated that the weighted average loan-to-value ratio of mortgages in the portion of the security purchased by Home Loan Bank was 69.5 percent. But the loans the CoreLogic model valued had an average ratio of almost 77 percent.
It is unclear, of course, how these court cases will turn out. But it certainly is true that the more investors dig, the more they learn how freewheeling the Wall Street mortgage machine was back in the day. Each bit of evidence clearly points to the same lesson: investors must have access to loan details, and the time to analyze them, before they are likely to want to invest in these kinds of securities again.
What is a public sector pension worth?
by Paul Farrow - Telegraph
How much would you need to save to get a civil service-standard pension? Public sector workers look set to face the harsh reality of saving for retirement following the announcement of a review. The cost of the schemes has become untenable and workers may have to retire later or be asked to put more into their pension.
It is estimated that, on average, private sector workers would need to put 37pc of their salary into their pension to match the retirement income paid to a public sector worker on a similar wage, if you believe a report by accountants PricewaterhouseCoopers. Even public sector workers on modest final salary schemes might be surprised to learn how much they would need to save if they were in the private sector.
To get the average civil service pension of £5,928 a year you would need a pension pot of £189,151. The average NHS pension of £6,931 is equivalent to a pension pot of £221,155 and the average teachers’ pension of £9,358 is equivalent to a pot of £298,596, according to Hargreaves Lansdown, the financial adviser. Building a pension pot of more than £150,000 is no mean feat – and the longer you leave it, the harder it is to catch up on missed time.
If you want a pension of £25,000 a year, you need to be putting £322 each month into your pension, assuming you start saving at the age of 25. Leave it until you are 35 and that monthly figure jumps to £543. At 45 it becomes £1,017 a month. If you want your pension to rise in line with inflation you will have to invest even more each month. Hargreaves Lansdown said the figure would rise to £500 a month for a 25-year-old, £843 for a 35-year-old and £1,578 for a 45-year-old.
The public sector pension debate is always emotive. There is the argument that public sector workers are paid lower wages in exchange for security and a decent pension. But recent labour statistics call this into question. The figures showed that average total pay, including bonuses, in the private sector in February was £451 a week. Excluding bonuses it was £418 a week. In the public sector the corresponding figures were £462 a week and £459 a week. Public sector pay, on average, is also rising at twice the rate of private sector wages.
But the unions disagree. Unison said it was "time to nail this myth that pensions in the public sector are 'gold-plated'. The retirement age for most public sector workers is 65 and, on retirement, local government workers can expect an average yearly pension of just £4,000, which drops to £2,600 for women."
In Budget Crisis, States Take Aim at Pension Costs
by Mary Williams Walsh - New York Times
Many states are acknowledging this year that they have promised pensions they cannot afford and are cutting once-sacrosanct benefits, to appease taxpayers and attack budget deficits. Illinois raised its retirement age to 67, the highest of any state, and capped public pensions at $106,800 a year. Arizona, New York, Missouri and Mississippi will make people work more years to earn pensions. Virginia is requiring employees to pay into the state pension fund for the first time. New Jersey will not give anyone pension credit unless they work at least 32 hours a week.
"We can’t afford to deny reality or delay action any longer," said Gov. Pat Quinn of Illinois, adding that his state’s pension cuts, enacted in March, will save some $300 million in the first year alone. But there is a catch: Nearly all of the cuts so far apply only to workers not yet hired. Though heralded as breakthrough reforms by state officials, the cuts phase in so slowly they are unlikely to save the weakest funds and keep them from running out of money. Some new rules may even hasten the demise of the funds they were meant to protect.
Lawmakers wanted to avoid legal battles or fights with unions, whose members can be influential voters. So they are allowing most public workers across the country to keep building up their pensions at the same rate as ever. The tens of thousands of workers now on Illinois’s payrolls, for instance, will still get to retire at 60 — and some will as young as 55. One striking exception is Colorado, which has imposed cuts on its current workers, not just future hires, and even on people who have already retired. The retirees have sued to block the reduction.
Other states with shrinking funds and deep fiscal distress may be pushed in this direction and tempted to follow Colorado’s example in the coming years. Though most state officials believe they are legally bound to shield current workers from pension cuts, a Colorado victory could embolden them to be more aggressive. Colorado pruned a 3.5 percent annual pension increase to 2 percent, concluding that was the fastest way to revive its pension fund, which was projected to run out of money by 2029. The cut may sound small, but it produces big results because it goes into effect immediately. State plans vary widely, but many have other costly features, like subsidized early-retirement benefits, which could likewise be trimmed for existing workers.
Despite its pension reform, Illinois is still in deep trouble. That vaunted $300 million in immediate savings? The state produced it by giving itself credit now for the much smaller checks it will send retirees many years in the future — people who must first be hired and then, for full benefits, work until age 67. By recognizing those far-off savings right away, Illinois is letting itself put less money into its pension fund now, starting with $300 million this year. That saves the state money, but it also weakens the pension fund, actually a family of funds, raising the risk of a collapse long before the real savings start to materialize.
"We’re within a few years of having some of the pension funds run out of money," said R. Eden Martin, president of the Commercial Club of Chicago, a business group that has been warning of a "financial implosion" for several years. "Funding for the schools is going to be cut radically. Funding for Medicaid. As these things all mount up, there’s going to be a lot of outrage."
Joshua D. Rauh, an associate professor of finance at Northwestern University who studies public pension funds, predicts that at the current rate, Illinois’s pension system could run out of money by 2018. He believes the funds of other troubled states — including New Jersey, Indiana and Connecticut — are also on track to run out of money in less than a decade, unless they make meaningful changes.
If a state pension fund ran out of money, the state would be legally bound to make good on retirees’ benefits. But paying public pensions straight out of general revenue would be ruinous. In Illinois’s case, it would consume about half the state’s cash every year, bringing other vital state services to a standstill. Mr. Rauh said he thinks any state caught in that trap would have little choice but to seek a federal bailout. Bigger pension contributions and higher taxes can go only so far.
Many state officials, hoping for a huge recovery in the markets, say that such projections are too pessimistic, and that cutting benefits for future workers must suffice, given laws and provisions in state constitutions that make membership in a state pension fund a contractual relationship that cannot be breached. Lawyers, though, are raising the possibility that those laws are being misinterpreted.
"It makes no sense to suggest that an employee who works for the state for a single day has acquired a right to have future pension benefits calculated for the next 20 to 40 years under whatever method was in effect on that single first day of service," states a legal memorandum prepared for the Commercial Club of Chicago, which is concerned that a public pension collapse would badly damage the city’s business climate.
The club’s members include senior executives of big companies, like Boeing, Aon, Kraft, Motorola and I.B.M., that have frozen pensions or slowed the rates at which their workers build up benefits. Some of those cuts set off titanic battles. The most famous was at I.B.M., which changed its pension plan just when many of its older workers were about to earn sharply higher retirement benefits. Aggrieved workers sued, but after a long battle, a federal appellate court found that the cuts were legal.
"An employer is free to move from one legal plan to another legal plan, provided that it does not diminish vested interests," or the benefits workers have already earned, wrote Chief Judge Frank H. Easterbrook of the Seventh Circuit Court of Appeals in Chicago. He did not distinguish between corporate employers and states. Colorado is basing its legal defense, in part, on a 1961 state supreme court ruling that said pension cuts for current workers were allowed if "actuarially necessary," and will argue that it applies to retirees as well.
Other states may not have such legal tools. In California, Gov. Arnold Schwarzenegger has gone a different route, bargaining with the 12 unions that represent public employees. Last week four of them agreed to let the state cut its own contributions by requiring current workers to pay sharply more for the same pensions. The workers will contribute 10 percent of their pay, in some cases double the previous rate, to the state pension fund. Some other states are raising employee contributions as well, though less sharply.
In New Jersey, the administration of Gov. Christopher J. Christie recently imposed pension cuts on future hires, but has been quietly looking into whether it could also reduce the benefits that current employees expect to accumulate in the coming years. "Can they change the benefit formula going forward? Sure. It’s not etched in stone," said Edward Thomson III, an actuary and trustee of the New Jersey pension system who was asked to offer an opinion on whether New Jersey could adopt the federal pension law — the one that covers companies — as its governing statute.
A state assemblyman, Declan J. O’Scanlon Jr., recently introduced a bill to ratchet back a 9 percent pension increase that the state gave most workers in 2001. "I think this will pass constitutional muster," Mr. O’Scanlon said. "Otherwise, I fear the whole system will fall apart. Nine years — we’re out of money."
China Forex Move Could Thwart US Hopes: Roubini
China's decision to move away from its currency peg might mean the yuan weakens against the dollar instead of strengthens as Washington wants, Nouriel Roubini, one of Wall Street's most closely followed economists, said Saturday. China said Saturday it would gradually make the yuan more flexible after pegging it to the dollar for nearly two years, a move that the U.S. government and others around the world have long been calling for.
"This is the first significant signal in years of a change in Chinese currency policy," Roubini, best known for having predicted the U.S. housing meltdown, told Reuters. But it remains to be seen how China would put the new system into practice including the composition of a basket of currencies that Beijing will use as a reference point for the yuan—also known as the renminbi—and the base date for that basket, he said in an e-mail. "Since they have not changed the previous range for the band—plus or minus 0.5 percent—most likely on Monday China will allow the renminbi vs U.S. dollar to move," said Roubini.
The yuan has risen sharply in recent months against the euro, which sank over Europe's debt problems, so a stronger yuan could not be taken for granted, he said. If the euro were to continue to depreciate, "the renminbi would have to be allowed to depreciate relative to the dollar, a paradoxical outcome," Roubini said.
His comments echoed those of an adviser to China's central bank Saturday. Li Daokui, an academic adviser to the monetary policy committee of the People's Bank of China, told Reuters in Beijing that the yuan could depreciate against the dollar if the euro falls sharply against the U.S. currency. Roubini, like other analysts, said a major strengthening of the yuan looked unlikely.
"Even if the Chinese were to allow a gradual renminbi appreciation relative to the U.S. dollar, the size of such appreciation would be modest over the next year, not more than 3 or 4 percent as the trade surplus has shrunk, growth is likely to slow down on China and labor/employment unrest remains of concern to the Chinese."
China Currency at Strongest Level in Nearly Two Years
by Bettina Wassener - New York Times
The Chinese currency strengthened Monday to the highest level in nearly two years in the biggest one-day move since 2005, an early indication that China would allow a gradual rise in the renminbi that it had hinted at over the weekend.
Officials from Japan to Thailand to Germany on Monday hailed China’s pledge Saturday to "proceed further with reform" of the exchange rate and "enhance" flexibility as a potential boon to their exports and national economies. Many economists believe the stronger renminbi will increase the purchasing power of ordinary Chinese citizens and companies, helping promote global trade in one of the world’s largest markets. But China on Monday continued to play down the significance of the renminbi’s value in helping to re-balance the global economy. A commentary in the state-run China Daily placed the onus on global leaders to overhaul the global financial system.
If leaders don’t to make progress at a forthcoming Group of 20 summit to overhaul the financial system, "the international community will soon find to its disappointment that its leaders look only for red herrings, rather than real solutions, at a time when true leadership is badly needed," the commentary said. By the close of business in Asia, the renminbi had advanced 0.42 percent to 6.7976 per dollar. Though seemingly small, the one-day gain is the largest in five years and marks an extraordinary change in China’s currency stance. China has hardly allowed the currency to budge over the past two years as it tried to promote its exports during the global economic and financial crisis.
At the same time, the announcement triggered an across-the-board rally in Asian and European equity markets as investors cheered the political and economic implications of the move. The key market indexes in mainland China and Hong Kong rallied 2.9 percent and 3.1 percent, respectively, and the Nikkei 225 index in Japan closed 2.4 percent higher. European markets also were higher by midday. Mainland Chinese airlines were among the biggest gainers in Shanghai: China Southern Airlines soared 8.1 percent, China Eastern jumped 5.6 percent, and Air China rallied 6.4 percent.
The reason: Investors believe that a rise in the Chinese currency will ultimately bolster passenger and cargo business while reducing airlines’ fuel costs. Because oil is denominated in dollars on the world markets, a rise in the renminbi would make oil cheaper for Chinese purchasers. Oil also rose on expectations that a stronger renminbi will bolster demand from China. U.S. crude for July delivery rose $1.69 to as high as $78.87, its highest level since early May.
China’s announcement stopped well short of an all-out revaluation for the Chinese currency and provided little detail as to what the added flexibility for the renminbi would entail, or when it would be introduced. And in a sign that underscored that the authorities in Beijing are in no hurry to initiate marked reform — a step that might fuel criticism at home that they were succumbing to pressure from abroad — the central bank on Monday left its reference rate for the currency unchanged from Friday’s level, at 6.8275 per dollar.
Officially the renminbi is allowed to trade as much as 0.5 percent below or above Beijing’s daily reference rate to the dollar, but in reality the divergence from that level has been much smaller over the past two years. Monday’s gain showed a striking hands-off attitude on the part of Chinese authorities who manage the exchange rate. But analysts will closely watch Beijing’s announcement Tuesday morning of its daily reference rate to get a better sense of how swiftly China will allow financial markets to determine the renminbi’s level.
The weekend’s statement and Monday’s gains in the currency were widely interpreted as a precursor to a gradual and modest appreciation of the renminbi, which has been informally pegged against the dollar since the middle of 2008. That policy has caused political tensions with the United States: Many economists and U.S. policy makers believe that the renminbi exchange rate is artificially low, giving Chinese exporters an unfair competitive advantage over U.S. manufacturers.
Saturday’s announcement, coming just days before the G-20 meeting of world leaders in Canada later this week, appeared aimed at defusing the currency debate and shifting the focus of the meeting toward other issues, like Europe’s debt troubles, analysts said. "The renminbi is a political tool. Clearly the timing of the move was politically determined. It is not an economic tool yet. This will take years, not days or weeks," Bill Belchere, a global economist at Mirae Asset in Hong Kong, wrote in a note Monday. He added: "This is a move in the right direction: politically and economically. Market disappointment may grow if China’s actions remain slow and don’t add up to real shift in policy. But the verdict is out."
Economists at Bank of America Merrill Lynch echoed this, writing in a note that although they did not expect a significant appreciation against the dollar, Saturday’s announcement was a "key step for Chinese macro policy." Foreign exchange flexibility would help China to control asset price bubbles and reduce the threat of protectionism, economists believe. The stock markets took the news unequivocally well, shrugging off both the lack of clarity on the timing and likely small size of any actual appreciation.
Most analysts expect Beijing to allow an increase of between only 2 percent and 5 percent by the end of the year. A Reuters survey Monday showed that economists broadly expected the renminbi to end 2010 at 6.67 per dollar. In addition to China and Japan, major indexes elsewhere also gained, with rises of 1.8 percent in Singapore, 1.9 percent in Taiwan and 1.6 percent in South Korea. The Sensex in India was 1.7 percent higher in late trading, and the benchmark index in Australia closed up 1.3 percent. Consumer goods companies and overseas companies that export their goods and services to China are seen as the biggest winners of a stronger renminbi.
The Swiss watch maker Swatch rose 5.6 percent by early afternoon in Europe, and the French luxury groups LVMH and Richemont climbed 3.2 percent and 4.6 percent, respectively. The exact impact on companies will depend to a large extent on how much they export to and from China and whether they have manufacturing operations there. Longer term, analysts said, a renminbi appreciation could have far-reaching macroeconomic implications.
An appreciation of the renminbi against the yen is "clearly good for Japanese companies that stand to benefit from growth in the Chinese market," analysts at Nomura wrote in a note on Monday, though they added that it also would have some negative implications for Japanese companies that have manufacturing operations in China and that export to other regions.
The Japanese finance minister, Yoshihiko Noda, said he expected the move "to be a plus for the China and Asia economies as well as the world economy. Basically I welcome it," Reuters reported. And Bandid Nijathaworn, the deputy governor of the Thai central bank, said gains in the renminbi, also commonly known as the yuan, would buoy exports to China and help reduce trade imbalances in the long term. "China is a Thai export market. If the yuan strengthens and our exports can still compete with others, we should benefit," he said, according to Reuters.
Gold reclaims its currency status as the global system unravels
by Ambrose Evans-Pritchard - Telegraph
We already know that the eurozone money markets seized up violently in early May as incipient bank runs spread from Greece to Portugal and Spain, threatening the first big sovereign default of our era. Jean-ClaudeTrichet, the president of the European Central Bank (EC), talked days later of "the most difficult situation since the Second World War, and perhaps the First".
The ECB’s latest monthly bulletin gives us some startling details. It reveals that the bank’s "systemic risk indicator" surged suddenly to an all-time high on May 7 as measured by EURIBOR derivatives and stress in the EONIA swaps market, exceeding the strains at the height of the Lehman Brothers crisis in September 2008. "The probability of a simultaneous default of two or more euro-area large and complex banking groups rose sharply," it said.
This is a unsettling admission. Which two "large and complex banking groups" were on the brink of collapse? We may find out in late July when the stress test results are published, a move described by Deutsche Bank chief Josef Ackermann as "very, very dangerous". And are we any safer now that the EU has failed to restore full confidence with its €750bn (£505bn) "shock and awe" shield, that is to say after throwing everything it can credibly muster under the political constraints of monetary union? This is the deep angst that lies behind last week's surge in gold to an all-time high of $1,258 an ounce.
The World Gold Council said on Friday that the central banks of Russia, the Philippines, Kazakhstan and Venezuela have been buying gold, and Saudi Arabia’s monetary authority has "restated" its reserves upwards from 143m to 323m tonnes. If there is any theme to the bullion rush, it is fear that the global currency system is unravelling. Or, put another way, gold itself is reclaiming its historic role as the ultimate safe haven and benchmark currency.
It is certainly not inflation as such that is worrying big investors, though inflation may be the default response before this is all over. Core CPI in the US has fallen to the lowest level since the mid-1960s. Unlike the blow-off gold spike of the Nixon-Carter era, this rally has echoes of the 1930s. It is a harbinger of deflation stress. Capital Economics calculates that the M3 money supply in the US has been contracting over the past three months at an annual rate of 7.6pc. The yield on two-year Treasury notes is 0.71pc. This is an economy in the grip of debt destruction.
Albert Edwards from Societe Generale says the Atlantic region is one accident away from outright deflation - that 9th Circle of Hell, "abandon all hope, ye who enter" . Such an accident may be coming. The ECRI leading indicator for the US economy has fallen at the most precipitous rate for half a century, dropping to a 45-week low. The latest reading is -5.70, the level it reached in late-2007 just as Wall Street began to roll over and then crash. Neither the Fed nor the US Treasury were then aware that the US economy was already in recession. The official growth models were wildly wrong.
David Rosenberg from Gluskin Sheff said analysts are once again "asleep at the wheel" as the Baltic Dry Index measuring freight rate for bulk goods breaks down after a classic triple top. The recovery in US railroad car loadings appears to have stalled, with volume still down 10.5pc from June 2008. The National Association of Home Builders’ index of "future sales" fell in May to the lowest since the depths of slump in early 2009. RealtyTrac said home repossessions have reached a fresh record. A further 323,000 families were hit with foreclosure notices last month. "We’re nowhere near out of the woods," said the firm.
It is an academic question whether the US slips into a double-dip recession, or merely grinds along for the next 12 months in a "growth slump". For Europe, nothing short of a sustained global boom can lift the eurozone out of the deflationary quicksand already swallowing up the South. Spain had to pay a near-record spread of 220 basis points over German Bunds last week to clear away an auction of 10-year bonds, roughly what Greece was paying in March.
Leaked transcripts of a closed-door briefing to the Cortes by a central bank official revealed that Spanish companies have been shut out of the capital markets since Easter. Given that the Spanish state, juntas, banks and firms have together built up foreign debts of €1.5 trillion, or 147pc of GDP, and must roll over €600bn of these debts this year, this is a crisis unlikely to cure itself.
By their actions, investors show that they do believe the EU can be relied upon to back its rescue rhetoric with hard money, and for good reason. Germany’s coalition risks breaking up at any moment, fatally damaged by popular fury over the Greek bail-out. Far-Right populist Geert Wilders is suddenly the second force in the Dutch parliament. Flemish separatists have just won the Belgian elections in Flanders. The likelihood that an ever-reduced group of German-bloc creditors facing disorder and budget cuts at home will keep footing the bill for an ever-widening group of Latin-bloc debtors in distress is diminishing by the day.
Fitch Ratings said it will take "hundreds of billions" of bond purchases by the ECB to stop the crisis escalating. Since Bundesbank chief Axel Weber has already deemed the first tranche of purchases to be a "threat to stability", it is a safe bet that Germany will fight tooth and nail to prevent such a move to full-blown quantitative easing. The blood-letting along the fault-line between Teutonic and Latin Europe will go on, as the crisis festers.
Yet the markets are already moving on, in any case. They doubt whether the EU’s strategy of imposing of wage cuts on half of Europe without offsetting monetary and exchange stimulus can work. Such a policy crushes tax revenues and risks tipping states into a debt-deflation spiral, as if everbody had forgotten the lesson of the 1930s. Greece’s public debt will rise from 120pc to 150pc of GDP under the IMF-EU plan. There is a futile cruelty to this. As Russia’s finance minister Alexei Kudrin acknowledges, a Greek "mini-default" has become inevitable.
EU president Herman Van Rompuy confessed that EMU lured countries into a fatal trap. "It was like some kind of sleeping pill, some kind of drug. We weren’t aware of the underlying problems," he said. What he has yet to admit is that the North-South imbalances built up since the euro was launched - indeed, because the euro was launched - cannot be corrected by further loans from the North or by pushing the South in depression. The political fuse will run out before this reactionary and self-defeating policy is tested to destruction.
Dead On Arrival: Financial Reform Fails
by Simon Johnson - Baseline Scenario
The House-Senate reconciliation process is still underway and some details will still change. But the broad contours of "financial reform" are already completely clear; there are no last minute miracles at this level of politics. The new consumer protection agency for financial products is a good idea and worth supporting – assuming someone sensible is appointed by the president to run it. Yet, at the end of the day, essentially nothing in the entire legislation will reduce the potential for massive system risk as we head into the next credit cycle.
Go, for example, through the summary of "comprehensive financial regulatory reform bills" in President Obama’s letter to the G20 last week.
The president argues for more capital in banking – and this is a fine goal, particularly as the Europeans continue to drag their feet on this issue. But how much capital does his Treasury team think is "enough"? Most indications are that they will seek tier one capital requirements in the range of 10-12 percent – which is what Lehman had right before it failed. How would that help?
"Stronger oversight of derivatives" is also on the president’s international agenda but this cannot be taken seriously, given how little Treasury and the White House have pushed for tighter control of derivatives in the US legislation. If Senator Lincoln has made any progress at all – and we shall see where her initiative ends up – it has been without the full cooperation of the administration. (The WSJ today has a more positive interpretation, but even in this narrative you have to ask – where was the administration on this issue in the nine months of intense debate and hard work prior to April? Have they really woken up so recently to the dangers here?)
"More transparency and disclosure" sounds fine but this is just empty rhetoric. Where is the application – or strengthening if necessary – of anti-trust tools so that concentrated market share in over-the-counter derivatives can be confronted. The White House is making something of a show from Jamie Dimon falling out of favor, but all the points of substance that matter, Dimon’s JP Morgan Chase has won. The Securities and Exchange Commission is beginning to push in the right direction, but the reconciliation conference looks likely to deny them the self-funding – CFTC and FDIC, for example, collect fees from the industry – that could help build as a regulator. At the same time, the conference legislation would send a large number of important questions to the SEC "for further study". None of this makes any sense – unless the goal is to block real reform.
The president also asks for a "more effective framework for winding down large global firms" but his experts know this is politically impossible. The G20 (and other) countries will not agree to such a cross-border resolution mechanism – and this was an important reason why Senators Sherrod Brown and Ted Kaufman argued so strongly that big banks had to become smaller (and be limited in how much they could borrow). Now administration officials brag to the press, on the record, about how they killed the Brown-Kaufman amendment. These people – in the White House and around the Treasury – simply cannot be taken seriously.
And as for "principles for the financial sector to make a fair and substantial contribution towards paying for any burdens", this is a sad joke. This is not an oil spill, Mr. President. This is the worst recession since World War II, a 40 percentage points increase in government debt (attempting to prevent a Second Great Depression), loss of at least 8 million jobs in the United States, and a painfully slow recovery (in terms of unemployment) – not to mention all the collateral damage in so many parts of the world, including Europe. Could someone in the White House at least come to terms with this issue and provide the president with a sensible and clear text? Honestly, as staff work, this is embarrassing.
There is great deference to power in the United States, and perhaps that is appropriate. But those now calling the shots should remember that they will not be in power for ever and – at some point in the not too distant future – there will be a more balanced assessment of their legacies.
Simply claiming that the president is "tough" on big banks simply will not wash. There are too many facts, too much accumulated evidence, pointing exactly the other way. The president signed off on the most generous and least conditional bailout in world financial history. This is now widely understood. The administration has scrambled to create some political cover in terms of "reform" – but the lack of substance here is already clear to people who follow it closely and public perceptions will shift quickly.
The financial crisis of fall 2008 revealed serious dangers have developed in the heart of the world’s financial system. The Bush-Obama bailouts of 2008-09 confirmed that our biggest banks are "too big to fail" and the left, center, and right can agree with Gene Fama when he says: "too big to fail" is perverting activities and incentives.
This is not a leftist message, although you hear people on the left make the point. But people on the right also increasingly understand what is going on – there is excessive and abusive power at the heart of our financial system that completely distorts markets (and really amounts to a hidden, unfair and dangerous taxpayer subsidy).
This administration and this Congress had ample opportunity to confront this problem and at least wrestle hard with it. Some senators and representatives worked long and hard on precisely this issue. But the White House punted, repeatedly, and elected instead for a veneer of superficial tweaking. Welcome to the next global credit cycle – with too big to fail banks at center stage.
Sleight of hand is not the best reform
by Clive Crook - Financial Times
A US House-Senate conference has started work on merging the chambers’ respective financial reform bills. This tortuous process still has some way to go. The good news is that the plans are similar, and not that different from the blueprint suggested by the administration last year. Agreement will most likely be reached, and the final measure will tick the main boxes. It will be better than nothing. The bad news is that it will be no more than a start.
At a conference last week in New York, 15 distinguished finance and economics scholars presented their own recommendations for financial reform*. The Squam Lake Group, as the economists call themselves, represents a wide range of opinion but is in agreement about most of what should happen. Broadly, the emerging finance bill conforms to the same consensus. Ben Bernanke, chairman of the Federal Reserve, told the meeting: "It appears that final legislation that addresses in some way the great majority of the recommendations ... could be enacted in the next few weeks."
"In some way": that is the problem. The fine print will be of paramount importance, but in most cases critical details will be left to the discretion of regulators – or will be settled or shelved in various international forums. At best, the endeavour will stretch on for many months. Ahead of this week’s Group of 20 meeting in Toronto, Dominique Strauss-Kahn, head of the International Monetary Fund, is complaining that the commitment to global co-operation on financial regulation is fading, and has said that the task facing policymakers is still "huge".
Two key principles stressed by the Squam Lake economists seem universally accepted. One is that financial regulation can no longer concentrate on the soundness of financial groups taken one at a time: the system as a whole also needs to be patrolled, with linkages between institutions and markets taken into account. The second principle is that financial groups – all financial groups – should be made to bear the costs of their failure. This is about efficiency as well as equity. If a bank that gambles can keep its winnings and pass its losses to taxpayers, it will take too many risks.
The Squam Lake economists and the legislative draftsmen agree that a systemic regulator – the Fed – should be given the first job. Defining the second set of tasks is much more complicated. It requires measures to make financial breakdown less likely, and others to ensure that if a bank does fail, its shareholders and creditors, and not taxpayers, suffer the consequences.
Albeit with few specifics, the report and the emerging bill both propose more demanding requirements for capital, liquidity and control of leverage. They call for greater use of standardised instruments and central counterparties, so that risks are smaller, easier to calculate and gathered in plain sight. They provide for new rules on the structure but not the level of financial pay, to discourage excessive risk-taking, chiefly by holding back bonuses.
They envisage a new early resolution system for shadow banks, such as hedge funds and specialist vehicles, because ordinary bankruptcy is too disruptive and too likely to put taxpayers on the hook. The report is also keen on contingent convertible bonds – debt that converts to equity under conditions of stress, thus replenishing capital. The bill does not require coco bonds, but could accommodate them.
However, none of this will work without willingness to face down pressure from the industry. Wall Street has conducted a formidable lobbying effort to neuter costly aspects of the bill. How far this has succeeded is debatable. The main planks of reform have survived, so far – but the wide discretion handed to regulators arouses suspicion that the buck is being passed and that the changes in practice will amount to less than they should.
The trouble all along has been that Congress and the regulators are receptive to the argument that stricter regulation will raise the costs of US banks and shadow banks – putting them at a competitive disadvantage. But raising their costs is the whole idea. Risky finance imposes a burden on society. The challenge is to tax banks’ activities in such a way as to bring social and private costs into line.
A capital requirement that rises in proportion to a bank’s size – a policy endorsed by the Squam Lake Group – would tax and discourage balance-sheet growth. This would weigh the taxpayers’ interest in avoiding "too big to fail" – and the subsidy it implies – against economies of scale. Similarly, a capital charge that rises in proportion to a bank’s reliance on short-term borrowing would raise costs in good times in the hope of promoting safety in bad. Most likely, shareholders would suffer from both policies, but that is beside the point: taxpayers would be better off.
Financial regulators supervise an industry where gigantic sums are at stake and workers are clever and mobile. If banks lobby regulators for competitive advantage and fail, they can move to milder jurisdictions. The only remedy is international harmonisation, or at any rate close co-operation. But this looks problematic. Big differences in philosophy are evident. Much of Europe prefers a heavier-handed approach. Germany, for example, recently moved to ban naked short selling – the selling of securities you do not possess. In the end, if the US and Europe cannot act in concert, the work that Congress has done on financial reform may be for naught.
Business Rallies to Shape Finance Endgame
by Damian Paletta and David Wessel
Caterpillar Inc., Cargill Inc. and the municipal utility of Sacramento, Calif., were largely bystanders in the financial crisis. Yet as Congress moves this week toward a sweeping rewrite of the rules of finance, they are major players: One of the most contentious issues is whether organizations like these should be subject to a net being readied by the Obama administration.
They are users of the financial contracts known as derivatives, which they employ to hedge their bets on anything from the price of fuel to the possibility that a customer will default. The administration and its congressional allies are determined to rein in the largely unregulated derivatives market to make the financial system safer. For a year, users have been fighting furiously to fend off changes in how the securities are bought and sold, and have had considerable success in the House. Then, this spring the tide turned against them in the Senate. Now, with a bloc of business-friendly Democrats pressing hard, the issue has exploded into one of the biggest battles as a House-Senate conference crafts the final version of a financial-regulation overhaul.
The outcome—which may come as early as this week—will influence the profits of the nation's largest banks, the nature and cost of hedging by businesses, and the extent to which the financial overhaul meets its goal of reducing the odds of a future meltdown. Billions ride on the legislation's precise wording on seemingly obscure points, such as who is a "major participant" in the market? And what is a "substantial position"?
A derivative is a security whose value depends on something else: interest rates, mortgages, oil or the ability of a company or homeowner to pay debts. They range from the simple, like the futures farmers use to lock in a price on corn they will grow, to custom derivatives in which a financier can place a bet on the shifting relationship between two countries' interest rates. Trading in derivatives is a big business, accounting for roughly $23 billion in annual revenues for the five banks that dominate it, according to Comptroller of the Currency data.
In some accounts of the financial crisis, derivatives were at its core, particularly the credit-default swaps that allow investors to bet on the likelihood a borrower will repay, which felled insurer American International Group Inc. In competing narratives of the crisis, derivatives played only a bit part.
The Obama administration leans to the first view, saying the crisis showed the vulnerability of the financial system to activities beyond the scope of regulation. Part of its remedy is to standardize most derivatives, instead of relying on the arrangements many companies favor, which users negotiate privately with banks. The administration would force trading of those standardized derivatives more into the open, in some cases onto exchanges, with settlement handled by clearinghouses.
The administration isn't alone. The Group of 20 major economies last year supported trading standardized derivatives on exchanges by the end of 2012. At first, about the only people paying attention to the details of proposed U.S. derivatives legislation were banks and the businesses affected. This spring, something changed. The White House, no longer preoccupied by health care, turned to financial-regulatory legislation. Critics of big banks were emboldened in April when the Securities and Exchange Commission accused Goldman Sachs Group Inc. of fraud in a derivatives deal. Then the derivatives issue moved to the Senate floor, becoming a litmus test of standing up to Wall Street.
"One unfortunate part of the Washington debate is the perception that's been created that all derivatives products somehow are evil," says Clay Thompson, director of government affairs for Caterpillar, which uses the swaps to protect itself from fluctuations in interest rates, currencies and raw materials. The Obama plan to standardize derivatives and force them into clearinghouses would affect nearly everyone who uses them to hedge business risks, known as the "end users." Today, most derivatives are over-the-counter deals between two parties; if one goes under, the other gets stuck. Multiply that enough times, and the result is a financial crisis.
In a clearinghouse, akin to a cooperative, all parties to derivatives deals chip in to cover losses if any one goes under. To make that work, companies that use derivatives, either to hedge or speculate, post collateral, in case the bets go against them. End users hate this idea. It "will have a significant drain on working capital at a time when capital is highly constrained and credit is in short supply," David Dines, head of risk management at commodities giant Cargill, told a Senate committee in 2009.
Business lobbies, pressing their case to conferees in a letter Thursday, said 100,000 to 120,000 jobs at big companies could be lost if they are forced to post collateral. The administration scoffs at such claims. End users say that because they aren't speculating but just trying to control risk, they should have an exemption from new derivatives rules. That principle that has gained wide support, though there is little agreement on how the exemption should be written. While the Treasury and Federal Reserve have had a number of priorities in the financial-regulation bill, Gary Gensler, chairman of the Commodity Futures Trading Commission, had only this one. He became the Energizer Bunny of the issue.
"Over-the-counter derivatives are meant to lower risk on our economy, and to some extent they do," Mr. Gensler says. "But they have concentrated risk in a few big banks...through their interconnectedness." He says forcing them onto clearinghouses would shift the risk from any single institution to the clearinghouse. It can more easily offset, for instance, bets that interest rates will rise with bets that they will fall. That would make it possible to allow a big financial firm that is floundering to fail, restoring market discipline.
Banks that deal in derivatives saw their profits threatened by the push to change the system of private, two-party deals into one that is more open—and thus more competitive. Aware of their own unpopularity, banks nudged business customers to weigh in. Morgan Stanley executives convened a conference call for business clients last July. The talking points, according to a copy provided by a participant: "Could impair the ability to accurately hedge risks... Could put additional liquidity pressures on balance sheets."
The U.S. Chamber of Commerce, one of several business organizations that joined forces on the issue, brought 15 or so corporate treasurers to Washington to do a tutorial for about 50 congressional staffers. One treasurer was Tom Deas of FMC Corp., a Philadelphia chemicals company. "We're not speculating" with derivatives, he says. "We're swept up in the regulatory reaction to AIG."
Even the Sacramento Municipal Utility District has lobbied in Washington, seeking an exemption from new derivatives rules. The district uses derivatives to hedge against volatile energy prices. "We're not here on behalf of the banks," says Elisabeth Brinton, the district's chief business and public-affairs officer. "We are concerned it will impact the cost of us doing business." The House moved first on financial regulation. Mr. Gensler warned in testimony against allowing any exemptions that "provide a giant-sized loophole for financial institutions to avoid standardization and maintain their profit margins...at great potential risk to the overall economy."
Though the House's Financial Services Committee is dominated by old-time liberals from Democratic strongholds, many of its 42 Democrats represent districts that aren't reliably Democratic or particularly liberal. These "new Dems," as they're known, became major players in the derivatives battle. Two of them, Michael McMahon (from Republican-leaning Staten Island in New York) and Scott Murphy (upstate New York) offered end users that don't pose a "systemic risk" to the financial system an exemption from the clearinghouse rule. "We must work to protect the end users, good American businesses that are just trying to manage their cash flows and hedge against uncertain risks," Mr. McMahon said on the floor.
Committee Chairman Barney Frank (D., Mass.) responded, "[W]hen an end user is employing that exemption in a way that puts counter-parties at risk, I don't want to have to wait until a cataclysm." But the Murphy-McMahon amendment passed, 304-124. It exempted end users unless they had "a substantial net position in outstanding swaps" held for purposes other than "hedging, reducing or mitigating commercial risk." Other users would be pushed toward standardized contracts settled on clearinghouses. But the House resisted Treasury efforts to require dealers to hold bigger capital cushions for customized derivatives, which would have made them more expensive.
Business lobbyists figured the bill could only get better for them in the Senate, where Republicans and farm-state and manufacturing-state Democrats have substantial sway. The Senate was indeed poised to move in the direction of businesses and bankers. Blanche Lincoln, the Arkansas Democrat who heads the Senate Agriculture Committee, and its senior Republican, Saxby Chambliss of Georgia, came close to a business-friendly deal. But the Senate was riven by tension among Democrats; between Democrats and Republicans; and between its banking and agriculture committees. When administration officials got a copy of the Lincoln-Chambliss bill, they moved aggressively to block it.
The plan fell far short of the president's objectives, Mr. Gensler and Michael Barr of the Treasury told Sen. Lincoln. She, as it happened, was facing a tough primary challenge from the left and was looking to defend herself against the idea she was too pro-business. Messrs. Gensler and Barr told several other Democrats on her committee the business-friendly bill would be harshly criticized by the White House.
That killed it. Sen. Lincoln, in fact, turned into a fierce derivatives skeptic. She even added a provision that would force banks to spin off their derivatives-trading businesses, which went beyond anything the Treasury wanted. Ms. Lincoln has said her proposal wasn't offered for political reasons and reflects what she believes is the best policy. Then, on April 16, came the SEC's accusation that Goldman had deceptively marketed a debt derivative. Goldman denied it, but the charge hardened antibank, anti-Wall Street, antiderivative sentiment in Congress.
Corporate treasurers marshaled by the U.S. Chamber made a last-ditch effort to sway Deputy Treasury Secretary Neal Wolin, the Treasury's rhetorical pit bull on financial regulation, at a meeting in his office on April 20. Among the petitioners: the treasurer of BP PLC, who would soon have other problems. That was the day a BP well in the Gulf of Mexico blew out. Mr. Wolin told the companies the new rules were in their interest because in a more transparent market, banks wouldn't charge them as much.
Derivatives by now had erupted as a political issue, becoming a test of whether Congress would stand up to Wall Street. "This week we brought sunlight to a $600 trillion derivative markets where Wall Street speculators can no longer gamble with the trust and good faith of Main Street and taxpayers in Arkansas," Ms. Lincoln said in an April 23 debate for her ultimately successful primary election. The Lincoln bill cleared the committee 13-8—even winning the vote of a Republican, Charles Grassley of Iowa—and passed the full Senate 59-39.
The end-user lobby was left reeling. The Senate bill narrowed exemptions, meaning far more firms might be forced to use standardized derivatives, with all the clearing and collateral rules these entail. Whereas the House bill said the new rules covered only end users with "a substantial net position" in derivatives used for other than hedging, the Senate bill left out the word "net." The House had largely exempted the finance arms of manufacturers; the Senate didn't. And the Senate bill gave more latitude to Mr. Gensler's CFTC.
In another contrast, the Senate bill required regulators to set a "substantially higher" capital requirement for banks offering derivatives that don't go through clearinghouses. As the conference of nearly 40 lawmakers wades through the 1,974-page Senate bill, members repeatedly cite the treatment of end users to highlight how much is at stake. The "new Dems" continue to press for clear protections for end users who pose little risk to the financial system, contending the Senate version fails that test. The administration and its congressional allies are pushing back just as hard.
On Wednesday, at a fund-raiser at the Source restaurant near the Capitol, officials from Ford Motor Co. and MillerCoors LLC asked Sen. Charles Schumer, one of the conferees, about the end-user exemptions. The New York Democrat, in keeping with the subject, hedged. Derivatives play an important, constructive role in the economy, he said. But, he added, there has to be more transparency, which he said pushing them onto clearinghouses and exchanges would provide.
Summers cites recovery, risks
by Robert Gavin - Boston Globe
The US economy has probably begun a lasting recovery, but the outlook has become more uncertain in recent weeks in the face of the European debt crisis, gyrating stock markets, and weaker-than-expected job growth, said Lawrence Summers, President Obama’s top economic adviser.
Summers, in an interview with Globe editors and reporters this week, cited progress made during the 18 months of the Obama administration, but acknowledged that the recovery still faces risks, from the premature withdrawal of federal spending aimed at stimulating the US economy to a financial meltdown in Europe to increased tensions in Korea. Summers, the former Harvard University president and Treasury secretary under President Clinton, presented a cautious, measured view of economic conditions. For example, after expressing confidence that European policy makers would contain the government debt crisis and avoid another global financial crisis, he added that the assessment was "my best guess, and I could be wrong.’’
Or, when asked if the nation had achieved a self-sustaining recovery, Summers responded, "I think that’s the right presumption and my expectation. I wouldn’t be foolish enough to be certain.’’ Most economists believe the US economy emerged from recession late last summer. It has expanded at a solid pace since then, and created jobs in each of the past five months. In recent weeks, however, new concerns about the strength of the recovery have emerged.
In May, for example, the economy added more than 400,000 jobs, but only 41,000 were in the private sector and most of the gains were attributed to temporary hiring for the US Census. Housing starts plunged following the expiration of federal home buyer tax credits at the end of April. And first-time claims for unemployment insurance remain stubbornly high, increasing by 12,000 last week to 472,000.
Summers said that economic data fluctuates, and analysts should be careful not to draw conclusions from one month’s numbers. He noted that employment gains in April — including more than 200,000 private sector jobs — were better than expected, and estimated the economy is creating an average of 120,000 to 130,000 private sector jobs a month. Housing is also on the mend, Summers said, with prices nationally higher than expected and "the sense of freefall generally arrested.’’ Despite the downshift that has followed the expiration of home buyer tax credits, he said housing markets should regain traction this summer and policy makers shouldn’t rush to put buying incentives back in place.
Summers said the federal government’s stimulus spending has worked, and he hasn’t seen evidence, such as a spike in interest rates or plunge in consumer confidence and spending, that would suggest otherwise. Over the medium and long term, Summers said, policy makers and lawmakers must reduce mounting federal deficits, but should move carefully in the short term. If spending is cut too much or too quickly, it could derail the recovery, he said.
One risk to the recovery, Summers said, would come if investors and capital markets began to view the US situation as similar to that of Japan, which in the early 1990s experienced its own real estate crash and banking crisis. When the Japanese economy began to show signs of improvement, policy makers withdrew stimulative policies too soon, leading to "false dawns’’ and economic stagnation.
Other risks — "none super-high,’’ Summers said — would include a widespread aversion to risk that would lead investors to pull out of capital markets and a "rush to cash,’’ and geopolitical events, such as a new conflict in Korea, another terrorist attack in the United States, or events that would drive a spike in oil prices. Summers said he doesn’t expect the BP oil well disaster in the Gulf of Mexico to lead to such a spike, or to damage the broader US economy. "It is locally devastating,’’ he said.
More turmoil looms in CDO market
by Aline van Duyn - Financial Times
The recent cancellation of monoline insurance contracts on $16bn of collateralised debt obligations backed by subprime mortgages is raising the prospect of more turmoil for one of the most beleaguered corners of the financial markets. Insurers that guaranteed CDOs - complex securities backed by pools of mortgages, loans or other assets - have suffered heavy losses, leading to widespread efforts to unwind, or "commute", CDO insurance contracts.
This month, Ambac Assurance struck a deal to wipe out insurance contracts - called credit default swaps - on $16.4bn of CDOs as the insurer hovered on the brink of bankruptcy. This means "controlling rights" to the underlying assets will pass from the insurer to the holders of the securities, mostly banks. Analysts said this could lead to a wave of selling of the securities, which could depress prices in markets still struggling to recover from the financial crisis.
This could have knock-on effects for financial institutions still holding toxic mortgage-backed debts, potentially forcing another round of writedowns. "The impact of CDO sales could be negative," said Paul Forrester, an attorney at Mayer Brown. "No one is going to deliberately shoot themselves in the foot, but it is hard to know exactly who is selling and when, which makes the impact unpredictable."
Leonid Mogunov, analyst at Moody's Investors Service, said credit insurers typically resist liquidating underlying assets in CDOs because doing so means they have to compensate their CDS counterparties for any losses suffered in the sales. "[The insurer] prefers to delay the liquidation as much as possible because it must make payments to its CDS counterparties for any losses to the insured note on liquidation," he said. "The CDO commutation by Ambac increases the risk of CDO liquidations."
Banks, on the other hand, may wish to liquidate the CDO, especially if they own the senior, or more highly rated, tranches. Liquidation stops interest payments to holders of junior tranches, as well as other payments, such as to lawyers and rating agencies. One structured finance trader said there was already about $9.5bn of distressed CDOs waiting to be liquidated, and that figure did not include the Ambac-insured CDOs. "We're worried that there may be too many structured finance assets about to hit the street," he said.
Demand for structured finance - the type of securities that fuelled hundreds of billions of dollars of losses and a global financial crisis - is also hampered by uncertainty about regulation and capital rules.
The Undeserving Unemployed
by Nancy Folbre - New York Times
>Maybe they don’t deserve assistance. Or maybe they don’t deserve unemployment. Attitudes toward the approximately 10 percent of our labor force that is actively seeking work and not finding it have become a defining feature of our political landscape.
Fierce and intensely partisan disagreements over the extension of unemployment benefits are blowing up on Capitol Hill.
Long-term unemployment, a jobless period of six months or longer, has reached a historic high. In March 2010 more than 44 percent of the unemployed fell into this category.
Whose fault is this? Some argue that wages in the United States are too high. If everybody would just agree to work for less – or if employers were gutsy enough to cut wages – we could solve the problem. Just let the forces of supply and demand do their job!
Unfortunately, as John Maynard Keynes pointed out, both unemployment and falling wages lower consumer demand and can lead to even greater unemployment.
A more popular view (especially among Republican members of Congress and on the opinion pages of The Wall Street Journal) lays the blame squarely on government itself. Extended unemployment benefits and other means-tested programs can undermine incentives to work.
Evidence suggests that individuals do prolong their job search when they receive unemployment benefits, partly because they are looking for the best possible job. But the magnitude of this effect is likely to be small.
A recent study by Rob Valletta and Katherine Kuang, economists at the Federal Reserve Bank of San Francisco, compared lengths of unemployment among those eligible for unemployment insurance with those who were not eligible. Their statistical analysis suggests that extended benefits accounted for only four-tenths of 1 percentage point of the nearly 6 percentage point increase in the national unemployment rate over the last few years.
Do numbers like these influence the Congressional debate? They should, but they seem to pack less punch than more primal underlying emotions. How do people with jobs feel about those who are trying to find one, but can’t?
Some studies, such as those showing that long-term unemployment causes emotional anguish as well as economic stress, may elicit sympathy.
On the other hand, it’s not hard to find articles emphasizing that the long-term unemployed are lucky to have so much free time, or suggesting that they’re better off than they were in previous eras because they are more likely to have a working spouse.
In other words, maybe the unemployed and those who are most worried about them should just stop whining.
The moral and emotional tenor of the debate over extending unemployment benefits is consistent with psychological research showing that we all like to believe that people generally get what they deserve. We tend to have a high opinion of individuals who receive fortuitous rewards, and a low opinion of individuals who are victims of bad luck.
Melvin Lerner, the psychologist best known for his book, "The Belief in a Just World," considered this belief a delusional means of avoiding moral discomfort.
The economists Roland Bénebou and Jean Tirole argue that however delusional the belief in a just world may be, it can be economically advantageous. Individuals who believe they will inevitably be rewarded for their effort and initiative are likely to exercise more discipline and self-control than those who don’t.
Professors Bénebou and Tirole observe that the belief that individuals always get what they deserve is stronger in the United States than in European countries with more redistributive public programs. Indeed, they argue that this belief helps explain why our policies are different (though the causality can run both ways).
They also argue that our policies reward merit more effectively – even if they are harder on the poor (and, presumably, the unemployed). But Professors Bénebou and Tirole don’t offer much support for this lofty claim. Nor do they consider the possibility that meritocracy might be undermined by trends toward increased income inequality and long-term unemployment.
Belief in a just world is not a self-fulfilling prophecy. While it may bolster individual effort, it can also undermine collaborative efforts to make reality conform a little more closely to our ideals of justice.
Nancy Folbre is an economics professor at the University of Massachusetts Amherst.
Home Loans Get Easier For Spaniards
by Sara Schaefer Muñoz and Christopher Bjork
Spain has one of the world's most-troubled housing markets, yet some buyers are suddenly able to get mortgages with 100% financing, and developers are building new homes on empty lots despite a huge glut. The reason: Spain's banks took possession of a large inventory of homes, buildings and land two years ago, forgiving the debt in hopes of heading off defaults. The plan was to resell the properties when the market bounced back and evade the worst impact of the looming housing crisis.
But Spain's housing market has only gotten worse, and now the bill is coming due as the banks labor under the weight of an estimated €59.7 billion ($73.8 billion) in real-estate assets on their books. Under pressure to make further markdowns on the assets by their main regulator, the Bank of Spain, many banks are now scrambling to unload the properties as quickly as possible. In some cases, that means offering deals to consumers that are suspiciously like those that got the global housing market in trouble in the first place. The tactics include not just 100% loans, but also low initial teaser rates for buyers or initial payment deferrals for as long as three years.
At the same time, banks that own big plots of unbuilt land are announcing plans to build new houses to give the illiquid lots more value, despite the country's estimated glut of one million empty homes. "On the one hand, they are selling the properties that already exist, and on the other, they are building houses," said Fernando Encinar, the director of research at www.idealista.com, a Spanish real-estate website.
The banks making such financing offers, which range from giants like Banco Santander SA to Spain's small regional banks, say they are for primary homes and only available to credit-worthy buyers. To be sure, such financing accounts for a small portion of the Spanish mortgages; 81% of mortgage loans to households in Spain have a loan-to-value ratio below 80%, according to March data from Bank of Spain. The higher the loan-to-value ratio, the riskier the mortgage is considered to be.
Some analysts, however, suspect the strategy is simply kicking today's housing problems into the future. "They're making a bet," said Alfonso de Gregorio, director of wealth and fund management at Gesconsult, a Spanish fund manager. "Wait for the economic crisis to resolve itself, push forward the problems by three or four years, and try not to let it show too much on the bottom line."
Others worry that the generous financing, which helps maintain the prices, is muddying the long-term picture for a sour Spanish housing market. Unemployment in Spain is currently 20% and is likely to rise with the austerity measures recently announced by the government of Prime Minister Jose Luis Rodriguez Zapatero. A recent Standard & Poor's report said that housing prices, which have fallen 16% from their peak in 2008, could fall another 12%. "In other countries, the prices have adjusted significantly," said Rafael Repullo, professor of economics at the Center for Monetary and Financial Studies in Madrid. "The sooner they adjust in Spain, the better."
Two years ago, debt-for-asset swaps were seen as a way for banks to get ahead of the housing crisis bearing down on them. The program usually targeted developers who hadn't yet missed payments, but who the bank judged would have problems over the long term. Banco Santander was one of the first to aggressively pursue a debt-for-asset program two years ago. It now holds €4.2 billion worth of these acquired assets, with loan-loss provisions on 33%. Competitors made similar deals.
But last month, offloading such properties became more urgent as the Bank of Spain unveiled proposals that would require banks that haven't already to set more funds aside against potential losses on these assets. This gives the banks a choice: take more hits in the coming months or unload the assets into a difficult market. The Bank of Spain wants "banks to be banks, and not real-estate companies," said Javier Ariztegui, deputy governor, in a speech Friday. He said it is reasonable that banks use the tools at their disposal to minimize losses, but that doesn't mean they should postpone recognizing them.
Banks are piling on incentives. Midsize Banco Espanol de Credito SA offers deferred deposit payments and 100% financing "for many of our houses," according to its website. Larger lender Banco Bilbao Vizcaya Argentaria SA and smaller Banco Pastor SA offer generous financing and lower teaser rates, as well. "Need a home? Now is the moment!" says Caja Madrid on it website, where it also advertises financing options and special offers, such as an apartment in the small city of Manresa, near Barcelona, for €247,000.
"Escape your old home!" says the site of Valencia-based savings bank Bancaja, which advertises no payments for as long as three years at the start of the mortgage. Such programs are having some impact. Santander sold 2,045 of the 2,745 homes it has placed on sale through its Altamira subsidiary since January, 2009, said a spokesman. Caja Madrid said it sold 10 times the amount of properties in the first five months of 2010 compared with a year earlier.
Meanwhile, to grapple with illiquid empty lots on their books, banks such as Caixa Catalunya, Banco Sabadell SA and Banco Popular SA are working with developers to build cheap housing on the land to boost its value. In April, Caixa Catalunya announced plans to build 400 apartment units on empty lots in Madrid, and 100 more in Barcelona, through Procam, its property-management subsidiary. Sabadell is in talks to build public housing on some land in Barcelona, and eventually sell it to the local government. "You have to find different exit strategies, and how to get your best return on the land," said a Sabadell spokesman.
Gulf paymaster: People are in 'desperate' shape
The man President Barack Obama picked to run the $20 billion Gulf oil spill damage fund said Monday many people are in "desperate financial straits" and need immediate relief. "Do not underestimate the emotionalism and the frustration and the anger of people in the Gulf uncertain of their financial future," Kenneth Feinberg told interviewers. "It's very pronounced. I witnessed it firsthand last week."
Feinberg, who ran the victims claim fund set up in the wake of the Sept. 11, 2001 terror attacks, said he is determined to speed up payment of claims. His appearance came a week after the administration worked out an arrangement with oil giant BP to establish an independent claims fund — initially $20 billion — and pledged to reconfigure the system and expedite payments. Feinberg said BP has paid out over $100 million so far, and various estimates place total claims so far in excess of $600 million.
"The top message is the message conveyed to me by the president," Feinberg said. " ... We want to get these claims out quicker. We want to get these claims out with more transparency." He said people can file electronically for relief, if they wish, and they need not hire a lawyer. He also said he believes that "when a person comes in and asks for emergency assistance, they shouldn't have to keep coming back," suggesting lump-sum emergency payments.
Asked how officials can guard against false claims, Feinberg said he didn't think that would be a major problem, and said that in the 9/11 experience, there were only a handful of such claims. He did say there could be an issue involving claimants who say they were indirectly harmed by the spill, such as a Boston restaurateur theoretically arguing that his business was hurt by the inability to bring shrimp in from the Gulf.
In such instances, Feinberg said, officials might have to resort to whatever existing state law says on that issue. In another interview, he said, "The emergency payments going out under my watch do not require that any claimant give up rights to litigate or go forward in court ... If you want to litigate, go ahead." But he added that he considers that "very unwise," because it could take years to resolve the issue that way. "The emergency payments are without any conditions," Feinberg said.
Tony Hayward will get £10.8m pension if he steps down as chief executive
by Rowena Mason - Telegraph
Tony Hayward will walk away from BP with a £10.8m pension pot if he steps down from his position in the wake of the Gulf of Mexico oil spill. The chief executive of the oil giant is likely to receive an annual pension north of £500,000, according to experts from Hargreaves Landsdowne. US politicians suggested the BP boss should step down during an eight-hour cross-examination on the causes of the oil spill on Thursday. "It's time for heads to roll at BP," Kathy Castor, a Florida Democrat, added over the weekend.
BP's stricken well is still leaking up to 60,000 barrels a day into the ocean, and the company is only managing to capture a third of it. The company's clean-up bill has now hit $2bn and it has paid out $105m in damages to those affected by the disaster. At last week's hearing, Mr Hayward declined to say whether he would leave the company, simply repeating that his "highest priority" was to stop the flow of oil.The BP boss, who lives in a manor house in Sevenoaks, took home £1m in pay and a £2m bonus last year, after success in cutting costs during the recession.
In a sign that the BP board may eject their chief executive, Carl-Henric Svanberg said at the weekend that he did not rule out the longer-term possibility that Mr Hayward may go. "What we have to do is put all our efforts into stopping the leak as quickly as possible," Mr Svanberg said, in an interview with a Swedish newspaper. "To change CEO now would be a bit like being in the middle of the ocean in a storm and starting to discuss the suitability of the captain." However, Mr Hayward has been backed by a number of heavyweight shareholders, including top 10 investor Standard Life.
Deepwater Horizon worker claims oil rig leaking weeks before explosion
by Graeme Wearden - Guardian
Oil worker told the BBC's Panorama programme that both BP and Transocean, who owned the rig, were informed of the leak
An oil worker who survived the BP Deepwater Horizon explosion has claimed that the oil rig's safety equipment was leaking several weeks before it exploded, triggering the huge spill in the Gulf of Mexico. Tyrone Benton says that he spotted a leak on the rig's Blowout Preventer (BOP), the device that is meant to shut the well down if there is an accident. He told the BBC's Panorama programme that both BP and Transocean, who owned the rig, were informed of the leak, and the faulty part – a control pod – was switched off rather than being repaired.
"We saw a leak on the pod [and] we informed the company," Benton told the programme, which will be broadcast at 8.30pm tonight. "They have a control room where they could turn off that pod and turn on the other one, so that they don't have to stop production." Benton added that he was unsure whether the leaking control pod had been turned back on again before a huge gas explosion ripped through the rig on 20 April, killing 11 workers.
The failure of the BOP was one key factor that led to the ongoing environmental disaster. The BOP is designed to clamp the well tightly shut, using cutting equipment to slice through the casing, but on 20 April it did not engage. After the explosion, BP sent robot submarines down to the seabed to try to trigger the BOP, but failed. The company has already admitted to a Congressional committee that the robots discovered a leak in the BOP's hydraulic systems, which meant they could not generate enough force for its giant shears to cut through the pipe.
Last week, BP chief executive Tony Hayward repeatedly cited the BOP as a major cause of the disaster, saying it was "not as failsafe" as BP had been told. Benton's revelations will pile even more pressure on BP, at a time when its minority party in the leaking well is refusing to pay its share of the costs. Anadarko Petroleum Corporation argues that BP was "grossly negligent" or guilty of "willful misconduct" in the way it drilled the Macondo prospect, which some workers described as a "nightmare well". Last week the Congressional committee accused BP of taking "risky" decisions to save time and money.
And in another development, BP has been accused of lying after internal documents showed that it has estimated that the leak could reach 100,000 barrels a day, much higher than its public forecasts.
$2 billion and rising
The cost of the clean-up operation has now broken through the $2bn (£1.3bn) mark, BP told the City this morning. That is just a fraction of the total bill, though, with BP already committed to putting $20bn into an escrow account to cover compensation claims. That will not cap its liabilities, though, and there are suggestions that BP is now looking to raise $50bn.
The company has said it will sell off some of its assets. This has raised concerns in several countries, including Russia, where the TNK-BP joint venture generates around a quarter of BP's global production. Hayward is to fly to Russia to assure the Kremlin that BP can survive the oil spill disaster, the Financial Times reported today. BP's chief executive took the decision to meet Russian president Dmitry Medvedev in the next few weeks following a weekend board meeting, and after Medvedev warned that the catastrophe could lead to BP's "annihilation".
BP continues to insist that it will clean up the spill and pay "all legitimate claims", and rejected Anadarko's claims. "These allegations will neither distract the company's focus on stopping the leak nor alter our commitment to restore the Gulf coast," said Hayward. "Other parties besides BP may be responsible for costs and liabilities arising from the oil spill, and we expect those parties to live up to their obligations."
Shares in BP fell by more than 3% this morning to 345p, making it the biggest faller on the FTSE 100. Swiss bank UBS warned shareholders that it did not expect the company to resume paying dividends until 2012. Last week it agreed to cancel payments for the rest of this year, but UBS believes that the cost of the Deepwater spill means a longer suspension is inevitable. City sources believe that BP may have to sell its operations in the North Sea as part of its drive to cut spending and raise funds.
BP estimates spill up to 100,000 barrels per day in document
by Tom Bergin and Ernest Scheyder - Reuters
An internal BP document released by a U.S. lawmaker estimated that a worst-case scenario rate for the Gulf of Mexico oil spill could be about 100,000 barrels per day, far higher than the current U.S. figure. Shares in the oil giant, which have nearly halved in value since an explosion at an oil well in the Gulf of Mexico on April 20, slid 4.3 percent in early trade.
The group said the cost of its response to the spill had hit $2 billion and it had paid out $105 million in damages to those affected by the disaster. It rejected claims by its partner in the oil well, Anadarko Petroleum, that it had been negligent in the way operated the installation.
"It's a combination of things (affecting the share price)," said Barclays Capital analyst Lucy Haskins. "Over the weekend we were getting the newsflow about Anadarko refusing to pay and then there's these stories about higher flow rates in an internal memo. "The shares are very vulnerable to any movement in terms of newsflow," she added.
The estimate in the undated BP document released by U.S. Representative Ed Markey, chairman of the energy and environment subcommittee of the House of Representatives Energy and Commerce Committee, compares with the current U.S. government estimate of up to 60,000 barrels (2.5 million gallons/9.5 million liters) gushing daily from the ruptured well.
BP spokesman Toby Odone said the document appeared to be genuine but the estimate applied only to a situation in which a key piece of equipment called a blowout preventer is removed. "Since there are no plans to remove the blowout preventer, the number is irrelevant," Odone said.
Struggling To Cope
The British energy giant, still struggling to stop a leak that began on April 20 and is causing an economic and environmental disaster along the U.S. Gulf Coast, is planning to raise $50 billion to cover the cost of the largest oil spill in U.S. history, London's Sunday Times reported. The newspaper, without citing sources, said BP planned to raise $10 billion from a bond sale, $20 billion from banks and $20 billion from asset sales over the next two years to cover the cost of the spill.
The Financial Times said that BP CEO Tony Hayward was planning to travel to Russia to reassure President Dmitry Medvedev that the oil group is not on the brink of collapse. A BP spokeswoman said she had no knowledge of any trip. BP said last week it would suspend dividend payments to its shareholders and increase the pace of asset sales to $10 billion this year to offset liabilities from the spill, which began after an explosion on an offshore rig that killed 11 workers.
The amount of oil spewing from the well has been a matter of considerable controversy in the two months since the spill erupted, with critics saying BP has understated the flow rate. "Right from the beginning, BP was either lying or grossly incompetent," Markey told NBC's "Meet the Press" on Sunday, the 62nd day of the spill. "First they said it was only 1,000 barrels, then they said it was 5,000 barrels." The spill has dealt a body blow to fishing and tourism industries across four Gulf states, soiling coastlines that are a playground for tourists and a key habitat for wildlife.
Huge amounts of oil continue to leak into the sea from the ruptured well a mile below the ocean surface despite BP containment systems. BP said on Sunday that 21,040 barrels of oil (883,680 gallons/3.34 million liters) leaking from the well was collected by its siphoning systems on Saturday. One of the two systems was restarted on Saturday after a 10-hour shutdown to fix a problem with fire-prevention equipment, BP said.
Kenneth Feinberg, the independent administrator running the $20 billion fund set up by BP to compensate victims, said on Sunday he would make sure that "every eligible, legitimate claim is paid and paid quickly. Appearing on "Meet the Press," Feinberg also rejected the complaint of a senior Republican congressman, Joe Barton, who last week likened the fund, set up under pressure from President Barack Obama, to a government "shakedown" of the company. "I don't think it helps to politicize this program," Feinberg said. Feinberg, an arbitration lawyer, dispensed hundreds of millions of dollars to victims of the September 11, 2001 attacks on the United States.
'Nothing Is Satisfactory'
The spill threatens the coastal economies of four states including hard-hit Louisiana. It has also severely dented BP's finances and reputation and eroded Obama's popularity. Mississippi Republican governor Haley Barbour, also appearing on "Meet the Press," said he was anxious to see the well capped, the spill cleaned up and BP cover the entire tab.
"Nothing is satisfactory until the well is shut in. When the well is capped, then clean up the oil, and then BP pays the bills. Until all of that is done, nothing is satisfactory," he said said.
Despite assurances of swift compensation, Louisiana Gulf residents remained skeptical. "Every time they say there's a fund for fishermen, we wait years and years," said Tal Plork, whose fisherman husband, Phan, faced long waits for aid after two hurricanes rampaged across the Gulf region in 2008. "It was like that for Gustav and Ike. Hopefully, now they will go faster."
Clean the Gulf, Clean House, Clean Their Clock
by Frank Rich - New York Times
President Obama is not known for wild pronouncements, so it was startling to hear him liken the gulf oil spill to 9/11. Alas, this bold analogy, made in an interview with Roger Simon of Politico, proved a misleading trailer for the main event. In the president’s prime-time address a few days later, there was still talk of war, but the ammunition was sanded down to bullet points: “a clean energy future,” “a long-term gulf coast restoration plan” and, that most dreaded of perennials, “a national commission.” Such generic placeholders, unanimated by details or deadlines, are Washingtonese for “The buck stops elsewhere.”
The speech’s pans were inevitable, but in truth it was doomed no matter what the words or how cool or faux angry the performance. The president had it right the first time — this is a 9/11 crisis — and only action will do. The sole sentence that really counted on Tuesday night was his prediction that “in the coming weeks and days, these efforts should capture up to 90 percent of the oil leaking out of the well.” He will be judged on whether that’s true. The sole event that mattered last week was his jawboning of BP for a $20 billion down payment of blood money — to be overseen, appropriately enough, by Kenneth Feinberg of the September 11th Victim Compensation Fund.
That action could be a turning point for Obama if he builds on it. And he must. In this 9/11, it’s not just the future of the gulf coast, energy policy or his presidency that’s in jeopardy. What’s also being tarred daily by the gushing oil is the very notion that government can accomplish anything. The current crisis in that faith predates this disaster. In the short history of the Obama White House, two of its most urgent projects, reducing unemployment and pacifying Afghanistan, have yet to yield persuasive results. The dividends on the third, health care reform, won’t be in the mail for years.
Given that record of incompletes, the government’s failure to police BP and the administration’s seeming impotence once disaster struck couldn’t have been more ill-timed. And there’s no miracle fix. Obama can’t play Aquaman in the gulf, he can’t coax a new jobs program out of a deficit-fixated Congress, and he can’t quit Harmid Karzai. Indeed, if the president had actually outlined new energy policies Tuesday night, they would have been dismissed as more empty promises from a government that can’t even measure the extent of the spill.
While Obama ended his speech with an exhortation for prayer, hope for divine intervention is no substitute for his own intercession. He could start running his administration with a 9/11 sense of urgency. And he could explain to the country exactly what the other side is offering as an alternative to his governance — non-governance that gives even more clout to irresponsible corporate giants like BP. As our most popular national politician, Obama still has power, within his White House and with the public, to effect change — should he exercise it.
Some exposure to the voluminous investigative reporting incited by this crisis might move him to step up his game. After all, the muckraking of McClure’s magazine a century ago, some of it aimed at Standard Oil, helped fuel Teddy Roosevelt’s activism. T.R. called it “torrential journalism,” and a particularly torrential contemporary example is a scathing account of Obama’s own Interior Department by Tim Dickinson in Rolling Stone, a publication often friendly to this president. Dickinson’s findings will liberate Obama from any illusions that the systemic failure to crack down on BP was the unavoidable legacy of the derelict Minerals Management Service he inherited from Bush-Cheney.
In Rolling Stone’s account, the current interior secretary, Ken Salazar, left too many “long-serving lackeys of the oil industry in charge” at M.M.S. even as he added to their responsibilities by raising offshore drilling to record levels. One of those Bush holdovers was tainted by a scandal that will cost taxpayers as much as $53 billion in uncollected drilling fees from the oil giants — or more than twice what Obama has extracted from BP for its sins so far.
Dickinson reports that Salazar and M.M.S. continued to give BP free rein well after Obama took office — despite the company’s horrific record of having been “implicated in each of the worst oil disasters in American history, dating back to the Exxon Valdez in 1989.” Even as the interior secretary hyped himself as “a new sheriff in town,” BP was given a green light to drill in the gulf without a comprehensive environmental review.
Obama has said he would have fired Tony Hayward, BP’s chief executive, but his own managers have not been held so accountable. The new director of M.M.S. installed by Salazar 10 months ago has now walked the plank, but she doesn’t appear to have been a major player in lapses that were all but ordained by policy imperatives from above. The president has still neither explained nor apologized for his own assertion in early April that “oil rigs today generally don’t cause spills” — a statement that is simply impossible to square with Salazar’s claim that the administration’s new offshore drilling policy, supposedly the product of a year’s study, was “based on sound information and sound science.”
The president must come clean and clean house not just because it’s right. He must rebuild confidence in his government for that inevitable day when the next crisis hits the fan. That would be Afghanistan, and the day is rapidly arriving. Already Obama’s chosen executive there, Gen. Stanley McChrystal, is calling the much-heralded test case for administration counterinsurgency policy — the de-Talibanization and stabilization of the Marja district — “a bleeding ulcer.” And that, relatively speaking, is the good news from this war.
The president’s shake-up of his own governance can’t wait, as tradition often has it, until after the next election. The Tea Party is at the barricades. When Obama said yet again on Tuesday that he would be “happy to look at other ideas and approaches from either party,” you wanted to shout back, Enough already! His energy would be far better spent calling out in no uncertain terms what the other party’s “ideas and approaches” are. The more the Fox-Palin right has strengthened its hold on the G.O.P. during primary season, the sharper and more risky its ideology has become.
When Rand Paul defended BP against Salazar’s (empty) threat to keep a boot on the company’s neck, he was not speaking as some oddball libertarian outlier. His views are mainstream in his conservative cohort. Traditional Republican calls for limited government have given way to radical cries for abolishing many of modern government’s essential tasks. Paul has called for the elimination of the Department of Education, the Federal Reserve and the Americans with Disabilities Act. The newest G.O.P. star — Sharron Angle, the victor in this month’s Republican senatorial primary in Nevada — has also marked the Energy Department, the Environmental Protection Agency, the Department of Veterans Affairs, Social Security and Medicare for either demolition or privatization.
Pertinently enough, Angle has also called for processing highly radioactive nuclear waste at Nevada’s Yucca Mountain. If Americans abhor poorly regulated deepwater oil drilling, wait until they get a load of nuclear waste on land with no regulatory agency in charge at all. The choice between inept government and no government is no choice at all, of course. But there would be a clear alternative if the president could persuade the country that Washington, or at least its executive branch, can be reformed — a process that demands him to own up fully to his own mistakes and decisively correct them.
While the greatest environmental disaster in our history is a trying juncture for Obama, it also provides him with a nearly unparalleled opening to make his and government’s case. The spill’s sole positive benefit has been to unambiguously expose the hard right, for all its populist pandering to the Tea Partiers, as a stalking horse for its most rapacious corporate patrons. If this president can speak lucidly of race to America, he can certainly explain how the antigovernment crusaders are often the paid toadies of bad actors like BP. Such big corporations are only too glad to replace big government with governance of their own, by their own, and for their own profit — while the “small people” are left to eat cake at their tea parties.
When Joe Barton, the ranking Republican on the House Energy and Commerce Committee, revived Rand Paul’s defense of BP last week by apologizing on camera to Hayward for the “tragedy” of the White House’s “$20 billion shakedown,” the G.O.P. establishment had to shut him down because he was revealing the party’s true loyalties, not because it disagreed with him. Barton was merely echoing Michele Bachmann, who labeled the $20 billion for gulf victims a “redistribution-of-wealth fund,” and the 100-plus other House members whose Republican Study Committee had labeled the $20 billion a “Chicago-style shakedown” only a day before Barton did.
These tribunes of the antigovernment right and their Tea Party auxiliaries are clamoring for a new revolution to “take back America” — after which, we now can see, they would hand over America to the likes of BP. Let Deepwater Horizon be ground zero for a 9/11 showdown over the role of government. There couldn’t be a riper moment for Obama, as a man once said, to bring it on.
Closing BP's Escape Routes
by Robert Weissman - Huffington Post
BP generates enough cash to absorb its liabilities from the oil gusher in the Gulf of Mexico. But that doesn't mean it will.
One of the benefits of the corporate form is that it gives giant corporations the ability to escape liability. BP may or may not choose to capitalize on such escapes, but it would be foolish to presume that it won't. That's why President Obama's call for the company to establish a $20 billion escrow account is such a positive and needed -- if still inadequate -- step. Consider first the liabilities that BP may face. No one really knows what the damage from the oil gusher or the overall costs to BP may ultimately be. Some analysts are now throwing around numbers of $70 billion on the upper end -- but it's not hard to see how the ultimate cost to BP could rise even higher.
The company faces civil fines of up to $3,000 per barrel of oil polluting the ocean. If the gusher lasts for four months at 40,000 barrels a day, the fine alone could hit $14 billion. If it is found that the actual oil flow is double that level, the fine could potentially approach $30 billion -- more, if the gusher lasts for more than four months.
Beyond the payments the company is making, it is going to face massive lawsuits, with damages surely in the billions and quite possibly in the tens of billions. On top of that, it may face a massive punitive damage award. Exxon challenged a punitive damages award of $10 billion in the Valdez case, and succeeded through appeals in dragging out payment for 20 years and lowering the amount to $500 million. But that was $500 million on top of compensatory damages of $500 million. On top of all this, BP's brand -- just a couple months ago, the most valued among oil companies -- is now ruined.
Still, as hard as it is to conceptualize, BP can afford to pay $70 billion. The company made $14 billion in profits in 2009, a bad year. Before the Gulf disaster, it was on track to make much more in 2010. BP may be able to pay $70 billion, but it surely doesn't want to. Even as the company pledges again and again to cover all "legitimate" claims, you can be sure that its attorneys are conjuring a variety of maneuvers to avoid paying. Here are five approaches they must be considering:
1. The AH Robins/Dalkon Shield Bankruptcy Scam
A.H. Robins, the manufacturer of the defective Dalkon Shield intrauterine device, filed for Chapter 11 bankruptcy in 1985. Women who were victims of the dangerous device received less compensation than they otherwise would have. Meanwhile, with the company's otherwise open-ended liability demarcated in the bankruptcy process, Robins' value shot up. AHP (now part of Wyeth, itself now part of Pfizer) acquired the company at a premium, with the Robins family making off with hundreds of millions of dollars.
BP wouldn't follow the Robins' model exactly. The play for BP would not be to declare bankruptcy for the parent company, but for BP America or another subsidiary that could be tagged with the liability for the Gulf of Mexico gusher. In advance of such a move, BP might try to move assets out of the designated subsidiary and into other subsidiaries in its vast network. Such asset shifting is not permissible, and creditors would challenge any such moves, if they could discover them. But using its labyrinthian structure, BP might hope to evade the creditors. Even without the asset shifting effort, bankruptcy for an affiliate could prove attractive for BP.
2. The Union Carbide Disappearance
Union Carbide was the company responsible for the world's worst industrial disaster. A gas escape from its chemical facility in Bhopal, India killed many thousands (likely tens of thousands) and severely injured tens of thousands more. After settling for a paltry amount with the Indian government, Union Carbide disappeared as a standalone company. It is now a subsidiary of Dow Chemical.
Says Dow: "Dow has no responsibility for Bhopal."
Moreover, "the former Bhopal plant was owned and operated by Union Carbide India, Ltd. (UCIL), an Indian company, with shared ownership by Union Carbide Corporation, the Indian government, and private investors. Union Carbide sold its shares in UCIL in 1994, and UCIL was renamed Eveready Industries India, Ltd., which remains a significant Indian company today."
BP might conceivably be acquired by another oil major. Or, more likely, it might just sell some or all of its U.S. subsidiaries. If the liability cap in the Oil Pollution Act works to protect BP from legally recoverable claims (perhaps less likely than has been reported, since the cap does not apply to a spill caused by violation of applicable federal rules), an acquiring company could simply state that it refuses to make good on the liabilities that BP now says it will voluntarily accept. A new company would also benefit from operating BP assets with a new, uninjured brand name.
3. The Shell Company Game
A variant on the Union Carbide Disappearance gambit would involve selling one or more subsidiaries' assets, but leaving the current corporate structure in place. Liability would still attach to the old subsidiaries, but it would be devoid of assets to pay -- if BP could find a way to move the cash it received for selling assets out of the subsidiary and out of reach of creditors. Again, such a move should not be legal. But it would be a mistake to assume that formal legal rules provide guarantees when billions or tens of billions of dollars are at stake for a giant, global multinational.
4. The Exxon Hardball Approach
BP's lawyers are undoubtedly considering other, more straightforward approaches to limit the company's liability. Under the Exxon Hardball approach, BP would follow its oil company brethren's approach to the Valdez spill. Drag out compensation payments. Challenge adverse legal rulings. Rely on a corporate-friendly judiciary to overturn or scale back any large scale jury verdicts or government-proposed fines.
5. The Big Tobacco Global Deal
Another approach might be for BP to offer a "global settlement" of all claims arising from the Gulf Oil gusher. This would follow the precedent of Big Tobacco, which in 1997 offered to put hundreds of billions of dollars on the table, and accept some regulatory restraints, to settle lawsuits for its past misconduct and effectively preclude new litigation. (This deal was ultimately scuttled). For BP, the play would be to put a "shock and awe" amount of money on the table to resolve all claims and penalties. Its aim would be to eliminate the prospect of getting hit with outsized punitive damages or fines, and escaping payment for ecological damage that may not be apparent for many years -- amounts that might vastly exceed what BP pays.
Against this panoply of available maneuvers, public officials have limited options. The Obama administration is finally doing the right thing in first, talking about the danger of BP draining company assets via dividend payments, and, second, demanding the establishment of an escrow fund. Calling attention to abusive corporate stratagems not yet underway is one of the best ways to prevent their deployment. And an escrow fund would establish a guaranteed pool of available money for victims -- establishing the fund apart from BP's control is at least as important as ensuring fair and independent handling of victims' claims.
What this and future administrations also need is a way to exert control over companies facing environmental or other liabilities of the scale now facing BP -- a kind of receivership to prevent manipulations of the corporate form to enable corporate goliaths to escape liability. Forcing corporations to pay for the damage they cause is not sufficient to prevent them from recklessly endangering people and the planet, but it is certainly necessary. Permitting them to avoid liability and foist costs on to others is to ensure more and worse corporate catastrophes.
BP to sue partner in Gulf oil well
by Rowena Mason and Damian Reece - Telegraph
Legal action aims to share clean-up costs as Anadarko is accused of 'shirking' responsibilities over spill
BP is preparing to sue its main partner in the leaking Gulf of Mexico oil field for its share of clean-up costs after the company, Anadarko, said BP's behaviour revealed "gross negligence" and that the accident was preventable.
In a fundamental split between the two companies with lead responsibility for the well, a senor BP source told The Sunday Telegraph that Anadarko was "shirking its responsibilities", not accepting its liabilities and that legal action in the US was now likely to follow. Anadarko, which has a 25pc stake in the well, signalled this weekend that it will refuse to pay up. BP has already sent the company one demand for payment but, the BP source said, had yet to receive any costs for the multi-billion dollar clean-up operation.
Jim Hackett, Anadarko's chief executive, launched a damning attack on BP, the majority owner and operating partner, alleging there were signs of "gross negligence or wilful misconduct". "The mounting evidence clearly demonstrates that this tragedy was preventable and the direct result of BP's reckless decisions and actions," said Mr Hackett. "BP's behaviour and action is likely represent gross negligence or wilful misconduct."
Mitsui, the 10pc owner of the well, has made no decision on whether to admit liability for its share of costs, but is likely to join Anadarko in its refusal to contribute. BP could then also take legal action against that company as well. The deepening row over costs followed a call from US Congressman Edward Markey, saying Anadarko and Mitsui should be held accountable and set aside money to pay a share of claims tied to the spill. "They cannot escape responsibility," he said.
As the highest estimates for the total bill of the accident rose to between $30bn and $100bn, BP is understood to be adamant that the American and Japanese companies ?contribute their share. Their role in the well was purely financial and they had no operational responsibility. A BP spokesman said the company strongly disagreed with Anadarko's claims. "These allegations will neither distract the company's focus on stopping the leak nor alter our commitment to restore the Gulf coast," said BP's chief executive officer, Tony Hayward. "Other parties besides BP may be responsible for costs and liabilities arising from the oil spill, and we expect those parties to live up to their obligations."
BP has established a $20bn fund to meet environmental compensation claims, but did not have discussions with its partners about how they would contribute. "Although we have not been involved in any way with the White House or BP in the process, we are pleased that BP has agreed to establish a $20bn escrow fund," said John Christiansen, an Anadarko spokesman. "We believe this action by BP is consistent with their ?continued message that they will pay all legitimate claims."
A Mitsui spokesman said: "With regard to the issue of the escrow account, drawing an immediate conclusion about the underlying matters at hand would be premature." BP is selling the oil captured from the leak and donating the proceeds to charity, but neither Anadarko or ? Mitsui will make a similar commitment. Anadarko shares have dropped 43pc since the April 20 explosion that caused the spill, and Mitsui shares have declined 25pc, indicating that the market believes they will have to bear some costs. However, their share prices have risen slightly from recent lows in mid-June on speculation that they will try to avoid having to pay for their share of costs.
The two companies have made few public statements on the accident until this point. Mitsui & Co, whose oil unit holds the stake in BP's field, has said that it has made no decisions on whether to take responsibility for the disaster. "There are no negotiations," Shoei Utsuda, Mitsui's chairman, said at a press conference. "As far as I know, nothing has been decided." BP has shouldered the majority of criticism from the US government about its role in the run-up to the leak.
Analysts are also getting restive about the uncertainty surrounding Anadarko and Mitsui because their involvement in paying claims would have a huge impact on BP's financial position. "Investors still lack absolute clarity over whether the groups will share the cost of the spill," said Jonathan Jackson, head of equities at Killik, the City stockbroker. "The company stated it expected its partners to meet their obligations.
"However, BP hasn't had discussions with them and it is unclear whether it was legally allowed to enter into this agreement without the consent of its partners." More than £56bn has now been wiped off BP's market value since the accident, which has created unprecedented anger in the US against the oil company. This week, BP confirmed it would suspend its $10.5bn dividend and its chief executive, Tony Hayward, was accused of presiding over a "cavalier attitude" to risk during an eight-hour US political hearing.
The oil spill colors the fabric of Gulf coastal life
by Lesley Clark - Miami Herald
Lisa Harbin shuts off the air conditioners at a Coden, Ala., bait-and-tackle shop to save money, worried about staying in business, fishing now but a memory. The live bait well has been drained and she's not sold a single ticket to the Mystic Striper Society Fishing Rodeo. On Grand Isle, La., college students working a pelican emergency room don't have time to think about the fate of the oiled birds they've triaged before a crate harboring another shivering, oiled avian arrives.
And in Waveland, Miss., Nadine Brown frets about a falloff in tourists at the bar she rebuilt with more than just a little grit after Hurricane Katrina washed it away, along with most of the waterfront city's downtown. For many in the weathered fishing villages and tiny towns along the Gulf of Mexico, the unrelenting eight-week siege of oil is taking a toll on the psyche. A drive along the coast from Louisiana to Florida finds towns still littered with hurricane debris, families struggling to recover and a mounting worry that oil will finish off what Katrina did not.
In Bayou La Batre, the "Seafood Capital of Alabama'', Kenny Dang, 32, fears for his parents. "All they've ever known is shrimping,'' he said, coming in from a day aboard the family vessel, this time spotting for oil off Alabama's coast. In Pensacola, where enjoying the water defines life, marina owners like John and Anita Naybor _ who had to rebuild a marina, and their home, after Hurricane Ivan. grimly consider the future. Miles away from the coast, in New Orleans, artists in anguish over the thick crude washing ashore have created a haunting portrayal of the Gulf's fragile beauty, hanging works in a downtown art gallery that illustrate its ties to the fishing communities and dependence on the oil industry.
Fishermen find themselves in limbo, unable to make decisions about their future while the gusher continues to flow. Diners in the French Quarter ask about the provenance of their seafood. A bar offers $1 shots of "BP blood … Save the Coast, Have a Shot!'' and Save NOLA, a shop that benefits local nonprofits, is selling new T-shirts depicting with oiled pelicans that say "I want my life back too!'' ,a play on BP CEO Tony Hayward's lament.
Everywhere, the spill dominates. "I find myself dreaming of waves of brown oil,'' said Kim Cheek, 47, a social worker and musical director at Christ Episcopal Church in Bay St. Louis, Miss. But for a bell tower, the church was wiped away by Katrina. Parishioners worshipped in the parking lot, under a funeral home tent and in a donated Quonset hut before opening a glorious new structure just three weeks ago.
Nearby, yards from the church's front door, work crews patrol the beach for oily invaders, a cache of absorbent boom nearby. "I guess we all have a touch of post-traumatic stress disorder,'' said Cheek, noting a post-Katrina surge of divorce, drug use and depression. "This is triggering all those bad feelings. All that fear of the unknown.''
Although oil hasn't reached Mississippi's beaches and they're open to swimming, tourism is down and the unease is palpable. Cheek said the crowd at a recent street fair reached pre-Katrina levels … "but you walked close to the beach and you couldn't miss the smell of oil. Your heart just sinks.'' Pastor Ted Dawson encourages forgiveness, "even for BP.'' And there is faith: After Katrina, Christ Episcopal not only rebuilt, it edged even closer to the Gulf. There is hope that this, too, can be bested. But for every Christ Episcopal, there are congregations still meeting in tents.
"The pastor tries to keep the services short,'' Waveland bar owner Brown, 54, said. She and her husband, Charlie, reopened C&R's Bar & Grill, but now worry about a sustained decline in tourists, and the local economy, fueled by the fishing industry. Still, echoing many who live by the ocean, she adds, "It's another day in paradise because we love it here, despite it all.'' Miles down the coast, in the tiny fishing village of Coden, Harbin, 47, has cried for her grandchildren, whom she fears will never know a life on the water.
"What do I tell my grandson when he says to me, 'Nana, I want to go fish?'‚'' she said. "How do you tell a 3-year-old we don't know how long? Or if we'll ever be able to fish again.'' Her employer took over the tackle shop three days before the Deepwater Horizon explosion killed 11 and sent oil spewing into the Gulf. The shop still bears the old name, "Ben's Bait and Tackle.'' Plans to put up a new sign, proclaiming it "Coden Bayou Bait & Tackle'' are on hold. "There's not a whole lot of point in changing it now,'' Harbin said. "Business has just gone to nothing.'' One recent day's tally: a bag of ice and a can of soda. They plan to add more food, to feed the fishermen-turned oil spotters plying the bayou.
In Pensacola, the Naybors reminisce about moving to the Panhandle some 15 years ago for its laid-back lifestyle on the water. Now they watch as neighbors collect white sand from the beach _ in case it never recovers from the brown stains of oily tar _ and count the number of boat owners who have left the Island Cove Marina on Bayou Chico since the spill: only a few so far, but likely growing. "It's been a bit of a ride,'' Anita Naybor said. "I guess we'll just roll with it.''
In Cocodrie, La., the uncertainty prompted Carroll Belanger, 47, to push for one last cast in his favorite fishing haunt before the gusher in the Gulf closes it. "Laissez les bon temps roulez, that's going to be history,'' Belanger said recently, nursing a beer at the marina during a downpour. "We're fixing to suffer this thing out, but it's just never going to be the same. "Everywhere that oil hits is dying,'' Belanger said as restaurant crews behind him packed lunches for BP clean-up crews. "And we got no idea how much is under there. How big, how wide and how deep.''
He and his pals tick off the losses: redfish … "you ain't never lived til you wrassled a redfish'' … red drum, black drum, speckled trout and flounder. They share a mordant humor, joking that there's a new category for Louisiana shrimp: "We got shrimp by the 16-20 count, 21-30 count, 10W-30, 10W-40,'' Kirk Mitchell, 51, says, referring to oil viscosity grades. In a tiny tin trailer at the Sand Dollar Marina on Grand Isle, a trio of Louisiana State University vet students, white coveralls stained brown with oil, administer electrolytes and Pepto Bismol down the long throats of oil-soaked pelicans.
They're the first line of recovery, stabilizing the birds for transport to a clinic where they'll be bathed and scrubbed of oil. "We just assume they're doing the best they can,'' Jaden Kifer said of the birds sent for further treatment. "We can't worry about them when we're moving on to the next bird.''
Callers to radio talk shows light up the boards with worry and fierce opposition to the six-month deepwater drilling moratorium that President Barack Obama imposed after the spill. In Houma, where energy giant Halliburton welcomes new arrivals to town, M.J. Plaisance, who works on "plug and abandonment'' of oil wells, fears that if the giant oil rigs working Gulf waters move elsewhere, "it's going to take this state's whole economy south. "No one's happy about what's happened, but you can't shut a whole industry down,'' Plaisance said, picking up the tab for lunch with co-workers at A-Bear's Cafe. "This economy is built on oil. We can't take another hit like that.''
In New Orleans, where P&J Oysters _ an institution since 1876 _ closed after shucking the last of its oysters, the spill "is all anyone talks about,'' said Arthur Roger, owner of the gallery that bears his name. The showcase of works created by artists before the oil spill changed the landscape opened quietly, without the reception that traditionally accompanies new shows. "There's nothing to celebrate,'' Roger said.
Even if the well is plugged, the summer season is only heightening anxiety: In Coden, Reese McKinney, 68, who owns a Katrina-battered marina and tackle shop, fears another storm _ this one bearing waves of oil. "If we have a hurricane, we can just pack it in. There's no living with oil,'' McKinney said, surveying his property. "We may be all southern hillbillies and dumb, but we got smarts enough to know it's over once the oil hits land.''
Louisiana Governor Asks Judge to Lift Drilling Ban
by Laurel Brubaker Calkins - Bloomberg
Louisiana Governor Bobby Jindal and state Attorney General Buddy Caldwell asked a U.S. judge to lift a six-month moratorium on deepwater drilling in the Gulf of Mexico within 30 days to avoid "turning an environmental disaster into an economic catastrophe." The drilling ban may cost Louisiana’s economy, "which was already weakened by Katrina and is now crippled by the Deepwater Horizon disaster," almost 11,000 direct and indirect jobs in five months, Caldwell said in papers filed yesterday in federal court in New Orleans.
"Even after the catastrophic events of Sept. 11, the government only shut down the airlines for three days," Caldwell said in support of Hornbeck Offshore Services LLC’s lawsuit seeking to end the moratorium. U.S. President Barack Obama temporarily halted all drilling in water deeper than 500 feet on May 27 in response to the worst oil spill in U.S. history, caused by the April sinking of the Deepwater Horizon drilling rig off the Louisiana coast.
The ban, implemented at the recommendation of Interior Secretary Kenneth Salazar, gives a presidential commission six months to study ways to improve the safety of deepwater drilling. Hornbeck and more than a dozen Louisiana offshore service and supply companies have sued U.S. regulators to lift the ban, which has idled 33 deepwater drilling rigs in the Gulf of Mexico. The companies claim the ban is costing between $165 million and $330 million each month in lost wages for Louisiana jobs tied to the drilling.
U.S. District Judge Martin Feldman said today that he will rule on the request for a preliminary injunction that would lift the ban as early as noon tomorrow, and no later than June 23. "You are admittedly struggling with a horrible event in the Gulf," Feldman told government lawyers at a hearing in New Orleans. "But your decision has to be faithful to the law before it can be accepted by the public." Feldman had ordered regulators and the offshore companies to appear in his court after rejecting the U.S. government’s request to delay the litigation until late July.
"The issues presented are of national significance and to delay resolution would be irresponsible." Feldman said in a handwritten note at the bottom of the order denying that request. Today, Feldman asked lawyers whether the government considered "doing something terrible to the tanker industry" after the Exxon Valdez oil spill in Alaska in 1989. "Why shouldn’t the entire railroad industry be stopped until the government looks at the safety of all railroad crossings" following a fatal train accident, he said.
"That’s exactly our point," Carl Rosenblum, a lawyer for the companies, replied. U.S. regulators didn’t shut down the automobile industry when Toyota Motor Corp.’s cars developed acceleration problems, either, Rosenblum said. "We’re here to make sure the government follows the law." "The Deepwater Horizon was a game-changer, a real illustration of the risks that are inherent in deepwater drilling," Guillermo Montero, a Justice Department lawyer, told Feldman. "We want to be sure it is as safe as we thought it was the day before this happened." added Brian Collins, another government lawyer. The oil-industry jobs at risk from the ban should be weighed against the thousands of fishing and tourism jobs imperiled by the spill, Collins said.
In court papers last week, lawyers for U.S. regulatory agencies said the ban is necessary to "ensure more lives are not lost and that new blowouts and spills do not occur. "A second deepwater blowout could overwhelm the efforts to respond to the current disaster and dramatically set back recovery," the government said. Caldwell argued that drilling can be safely resumed within 30 days if federal inspectors are permanently stationed on each rig. The inspectors would re-certify all blowout prevention equipment, enforce compliance with all drilling procedures, and ensure training of all rig personnel to industry standards, including any new safety recommendations made by the presidential commission.
"After confirming the correctness and preparedness of each rig and well design, these deepwater rigs should be permitted to resume work, and the Department of Interior should resume issuing permits," Caldwell said in yesterday’s brief. Such a "balanced approach" would allow safe resumption of a vital portion of the state’s economy "without the necessity of shutting down an entire industry segment," he said.
Caldwell and Jindal said regulators failed to consult with state officials or conduct a "risk benefit analysis" of the impact an extended ban would have on Louisiana’s economy. A moratorium lasting as long as 18 months could cost the state 20,000 new and existing jobs, the Louisiana Department of Economic Development estimates.
Deepwater rigs probably will ship out for work overseas during the U.S. ban, Caldwell said, so "there will likely be no deepwater rigs available to resume drilling in the Gulf of Mexico. Having to wait an additional year or more for available rigs will turn the short-term adverse effects of the moratorium into a long-term economic disaster for Louisiana." Hornbeck’s suit was joined by Bollinger Shipyards Inc., Chouest Shipyard Cos., Bee Mar LLC and other deepwater support companies that employ a total of more than 13,000 workers and 7,000 vendors. The companies told Feldman they have been contacted by customers planning to cancel contracts because of the deepwater ban.
Diamond Offshore Co., owner of the world’s second-largest fleet of floating drilling rigs, sued last week in federal court in Houston seeking to overturn the moratorium. Houston-based Diamond accused the government of illegally "taking" its drilling contracts, worth as much as $500,000 a day, and causing analysts to downgrade the company’s shares because of the ban.