"Gas station, Edcouch, Texas"
Stoneleigh: As the world has become a smaller and smaller place over the last few decades, we think less about the differences between locations. Global trade has allowed us to circumvent many local constraints, evening out surpluses and shortages in a more homogenized world.
We have a just-in-time world built on comparative advantage, in the name of economic efficiency. Under this economic principle, every location should specialize in whatever activity it executes most efficiently and the resulting products from all areas would then be traded. The idea is that all will then be better off than they would have been had they attempted to cover all bases themselves for reasons of self-sufficiency.
Where countries had been inclined towards more expensive self-sufficiency, market forces have often made this approach untenable, as large cost differences can make countries or industries uncompetitive. Local production has been progressively out-sourced as a result.
By 'better off', economists mean that goods will be cheaper for all, thanks to global wage arbitrage and economies of scale. Globalization has indeed delivered falling prices for many consumer goods, particularly electronics. In an era of massive credit expansion (effectively inflation), such as we have lived through for decades, one would normally have expected prices to rise, as a lagging indicator of money supply expansion, but prices do not always follow money supply changes where other major complicating factors exist.
In recent years, the major complicating factors have been the ability to produce goods in places where wages are exceptionally low, the ability to transport those goods to consumer markets extremely cheaply and ready access to letters of credit.
For nominal prices (unadjusted for changes in the money supply) to fall during an inflationary period, real (inflation adjusted) prices must be going through the floor. This has been the effect of trade as we have known it, and it is all many of us have known. What we are not generally aware of is the vulnerability of the global trade system, due to the fragility of the critical factors underpinning it.
By producing goods, particularly essential goods, in distant locations, we create long and potentially precarious supply lines. While relative stability reigns, this vulnerability does not cause trouble and we enjoy cheap and plentiful goods. However, if these supply lines are disrupted, critical shortages could result. In a very complex just-in-time system, this may not take very long at all. Such as system is very brittle, as it has almost no redundancy, and therefore almost no resilience. When Jim Kunstler refers to efficiency as "the straightest path to hell", it is this brittleness he is referring to.
The most ephemeral critical factor for trade is the availability of letters of credit. These became scarce during the first phase of the credit crunch in 2008, and the result was goods stuck in port even though there was robust demand for them elsewhere. Goods simply do not move without letters of credit, and these can dry up extremely quickly as a systemic loss of confidence results in a systemic loss of liquidity. In a very real way, confidence IS liquidity.
The Baltic Dry shipping index fell 96% in 2008 as a result, meaning that shipping companies were suffering. Although the index has recovered slightly during the recent long rally, it is still very depressed in comparison with its previous heights. Now that the rally appears to be over, on the balance of probabilities, letters of credit for shipping will come under renewed pressure, and goods will once again have difficulty moving. As demand also starts to fall, due to the loss of purchasing power in the depressionary era we are moving into, this will get far worse.
In a depression, trade is very adversely affected. One reason for this a highly protectionist beggar-thy-neighbour economic policies. For instance, the Smoot-Hawley Tariff Act of 1930 in the US, which drastically raised tariffs on imports, lead to retaliation by trading partners, and the resulting trade war dropped global trade by 66% between 1929 and 1934.
Thanks to globalization, we are much more dependent on trade than people were in the 1930s. The combination of credit drying up on the one hand and global trade wars on the other is an extreme threat to our vulnerable supply lines. Add to that the general upheaval created by severe economic disruption, which can easily lead to increased physical risks to transporting goods, and the longer term potential for much higher energy prices, and we could see an outright collapse of global trade in the approaching years.
The benefits of self-sufficiency will be seen in places where it still exists. So long as the whole supply chain is local, localized production means being able to maintain access to essential goods at a time when obtaining them from overseas may be difficult or impossible. It is currently more expensive, but the relative security it can provide can be priceless in a dangerous world. The ability to produce locally does not arise overnight however, especially where there are no stockpiles of components. In places where it has been lost, it will take time to regain. There is no time to lose.
We will be returning to a world of much greater diversity as we lose the homogenizing effect of trade. That means the existing disparities between areas will matter far more in the future than they have in the recent past. We will need to think again about the pros and cons of our local regions - what they can provide and what they cannot, and for how many people. Some areas will be in a great deal of trouble when they lose the ability to compensate for deficiencies through trade. As the global village ceases to exist, the world will once again be a very large and variable place.
Credit Crunch 2010?
by Michael Snyder - The Economic Collapse
Over the past several decades, one of the primary engines of U.S. economic prosperity has been a constantly expanding debt spiral. As long as the U.S. government, state governments, businesses and American consumers could all continue to borrow increasingly large amounts of money, the economy was going to continue to grow and “the greatest party on earth” could continue.
But many of us knew that if anything ever came along and significantly interrupted that debt spiral, it could cause a credit crunch even more severe than we saw at the beginning of the Great Depression back in the 1930s. You see, back in the “roaring 20s”, American businesses and consumers had leveraged themselves like never before. Debt soared to record levels and when the credit spigot was suddenly turned off the whole thing came crashing down and it took an entire decade and a world war to recover. Well, today things are frighteningly similar.
Over the past 30 years we have piled up unprecedented mountains of debt. In fact, today our entire economic system is based on debt. So what would a credit crunch do to an economy based on debt? Well, it would absolutely devastate it of course. So are we facing a credit crunch in 2010? Yes. Consumer credit in the United States has already contracted during 15 of the past 16 months, and there is every indication that things are about to get even worse.
The truth is that once a deflationary cycle starts, it tends to feed on itself. People quit spending money, banks quit making loans and everyone starts hoarding cash. And right now there is a lot of fear out there. According to one major indicator, consumer sentiment declined in early July to its lowest in 11 months.
U.S. consumers are starting to pay down debt and are holding on to their money. Others can’t spend more money because they are out of work or are completely tapped out. But without more spending, the U.S. economy won’t get revved up again. And if the U.S. economy does not get going soon, there are going to be more foreclosures, more bankruptcies and even more jobs lost.
In a recent article for The Telegraph, Ambrose Evans-Pritchard set out some of the statistics that show that the U.S. economy is in really, really bad shape right now….
The US workforce has shrunk by a 1m over the past two months as discouraged jobless give up the hunt. Retail sales have fallen for the past two months. New homes sales crashed to 300,000 in May after tax credits ran out, the lowest since records began in 1963. Mortgage applications have fallen by 42pc to 13-year low since April. Paul Dales at Capital Economics said the “shadow inventory” of unsold properties has risen to 7.8m. “The double dip in housing has begun,” he said.
It seems like almost everyone is using the words “double dip” these days. It is almost as if it was already a foregone conclusion. But the truth is that this would have just been one long economic decline if the U.S. government (and many of the other governments around the globe) had not pumped so much “stimulus” into their economies over the past several years.
Now that governments around the world are pulling back and are beginning to implement austerity measures, the “sugar rush” of the stimulus money is wearing off and the original economic decline is resuming. All that the trillions in “stimulus” did was to give the world economy a temporary boost and get us into a whole lot more debt.
In his recent article entitled “The U.S. Is On The Edge Of A Growing Deflationary Sinkhole”, Lorimer Wilson did a really good job of detailing how all of this debt has gotten us into a complete and total mess…. Capitalism cannot function unless its constantly compounding debt is serviced and/or paid down. Today, the U.S., the world’s largest debtor, can no longer pay what it owes except by rolling its debt forward and borrowing more [in] what the late economist Hyman Minsky called ponzi-financing, financing common in the final stages of mature capital systems.
The amount of outstanding U.S. debt, according to Martin D. Weiss, www.moneyandmarkets.com, has now reached levels that can never be paid off. The United States government and its agencies have, by far,
- the largest pile-up of interest-bearing debts ($15.6 trillion),
- the largest accumulation of unsecured obligations (over $60 trillion),
- the largest yearly deficit ($1.6 trillion), and
- the greatest indebtedness to the rest of the world ($4.8 trillion).
The truth is that the United States is in the early stages of a truly historic financial implosion.
Earlier this year, all of the focus was on the European sovereign debt crisis, but now all eyes are turning back to the U.S. once again. David Bloom, currency chief at HSBC, recently remarked that world financial markets are extremely concerned about the state of the U.S. economy right now….
“We’re in a world of rotating sovereign crises. The market seems to become obsessed with one idea at a time, then violently swings towards another. People thought the euro would break-up. Now we’re moving into a new phase because we’re hearing alarm bells of a US double dip.”
Without direct intervention from the U.S. government, the U.S. financial system is headed for a world of hurt. The truth is that the credit markets are freezing up, and without efficiently operating credit markets, the economic system we have constructed simply will not work.
The following information comes courtesy of the Consumer Metrics Institute. If you have never visited their site, you should, because it is packed full of excellent data. In their most recent report, they do a good job of detailing the astounding credit contraction that we have been witnessing….
During the past week there has been a flurry of Federal Reserve reports and commentary concerning the levels of credit in the current economy. The two most notable were:
• On July 8th they reported that the level of seasonally adjusted outstanding U.S. Consumer Credit (their G.19 report) decreased during May by $9.1 billion, representing an annualized rate of credit contraction of 4.5%. Although even this change is above the average for the preceding twelve months, it is much smaller than a quiet revision to the previously published April U.S. Consumer Credit figure — which is now reported to have decreased by $14.9 billion (a 7.3% annualized contraction rate).
The Federal Reserve fails to put these numbers into perspective:
1) Consumer credit has contracted during 15 of the past 16 reported months, and it is down a record total $148 billion over that time span.
2) The $14.9 billion in credit ‘lost’ during just April is the second highest monthly amount in history, second only to the $23.4 billion ‘lost’ during November, 2009.
3) And the nearly 6% cumulative reduction in consumer credit over the past 16 months is the largest (on a percentage basis) for any 16 month span since September 1944 — when FDR was still in the White House and people were buying War Bonds instead of tightly rationed consumer goods.
• On July 12th Federal Reserve Chairman Ben Bernanke noted that small businesses were not getting the loans that they need to create new jobs. The Federal Reserve’s own data reports that lending to small businesses dropped to below $670 billion in Q1 2010, down about $40 billion (5.6%) from two years ago.
The New York Times reported Mr. Bernanke wondered: “How much of this reduction has been driven by weaker demand for loans from small businesses, how much by a deterioration in the financial condition of small businesses during the economic downturn, and how much by restricted credit availability? No doubt all three factors have played a role.”
Small businesses, which account for over 60% of gross job creation, are not - for whatever reason - tapping into the credit necessary to create those jobs.
If you know anything about economics, the excerpt that you just read should be chilling you to your bones right about now.
Without loans, businesses can’t start or expand, consumers cannot buy homes or vehicles and retail spending will be in the toilet. But, as a recent USA Today article pointed out, part of the problem is that so many Americans now have very, very low credit scores….
Figures provided by FICO show that 25.5% of consumers - nearly 43.4 million people - now have a credit score of 599 or below, marking them as poor risks for lenders. It’s unlikely they will be able to get credit cards, auto loans or mortgages under the tighter lending standards banks now use.
As I recently pointed out on The American Dream blog, historically only about 15 percent of Americans have had credit scores that low.
So can the U.S. economy fully recover if the number of Americans that are a bad credit risk has nearly doubled? That is a very good question. As I noted in a previous article, the truth is that the retail sector is already a huge mess, and if we don’t get the American people pulling out their credit cards soon this holiday season may not be very jolly at all….
Vacancies and lease rates at U.S. shopping centers continued to get even worse during the second quarter of 2010. In fact, in some of the most depressed areas of the United States, many malls and shopping centers could end up looking like ghost towns by the time Christmas rolls around.
So this is the point where Barack Obama comes riding in on his white horse and rescues the U.S. economy, right?
Well, at this point Obama has joined with the other G20 leaders in pledging to get government spending under control. So right now there are not any plans for new stimulus packages.
But as the U.S. economy starts sinking into a deflationary depression, the temptation to pump up the economy with even more government spending will become too great. This will especially be true the closer to the election of 2012 that we get. By the time election season rolls around, Obama will likely be much more willing to pile up even more debt for a short-term economic boost.
So yes, we are headed for a complete and total economic nightmare, but exactly how it all plays out is going to depend a lot on what Barack Obama, the Federal Reserve, other world leaders and other central banks decide to do. For the moment, we are heading for an absolutely brutal credit crunch, and if something is not done quickly, it is going to dramatically slow down the world economy.
The Real Reason Geithner Is Afraid of Elizabeth Warren
by John R. Talbott - Huffington Post
As reported on HuffPost last week, Treasury Secretary Timothy Geithner has expressed opposition to the possible nomination of Elizabeth Warren to head the Consumer Financial Protection Bureau, according to a source with knowledge of Geithner's views.
One can assume that Geithner, being very close to the nation's biggest banks, is concerned that Warren, if chosen, will exercise her new policing and enforcement powers to restrict those abusive practices at our commercial banks that have been harmful to consumers and depositors.
Certainly, Warren is not the commercial banking industry's first pick to serve in this new role. And unlike other legislation in which an industry's lobbying effort would naturally slow or cease once the legislation is passed, the new financial reform bill is continuing to attract enormous lobbying action from the banks. The reason is simple. The bill has been written to put a great deal of power as to how strongly it is implemented in the hands of its regulators, some of which remain to be chosen. The bank lobby will work incredibly hard to see that Warren, the person most responsible for initiating and fighting for the idea of a consumer financial protection group, is denied the opportunity to head it.
But this is not the only reason that Geithner is opposed to Warren's nomination. I believe Geithner sees the appointment of Elizabeth Warren as a threat to the very scheme he has utilized to date to hide bank losses, thus keeping the banks solvent and out of bankruptcy court and their existing management teams employed and well-paid.
To see how this scheme works during the current crisis we must go back and examine previous crises and recessions in order to understand their cause. As Kenneth Rogoff explains in his new book, This Time is Different, most crises are preceded by a boom or bubble period in which asset classes, such as homes in this case, reached unsustainable pricing levels. The main driver of most of these asset bubbles is loose bank lending in which banks offer money to asset buyers on very liberal terms, thus guaranteeing that asset prices will inflate abnormally. Eventually, all bubbles burst, and in the worst cases we are led into financial crises. The banks make things even more difficult because as prices fall the banks end up with substantial increases in problem loans.
To deal with this increase in problem loans, the banks typically pull back on all lending, not just lending in the affected sector. The banks, now primarily concerned with their own survival if they wrote off the problem loans, literally stop almost all new lending, thus driving the economy into a deep recession. It is difficult to sustain economic activity when there is no credit being supplied by the banking system. The banks, instead of lending to businesses and consumers, shift their investments to very safe instruments like US Treasury securities. The result is a risk-free cash flow that over time eventually repairs the banks' balance sheets by increasing their profitability and thus restoring their book equity.
Typically, during crises, the Federal Reserve also lowers interest rates and the cost of bank borrowing so as to make this risk-free profit spread to banks even greater. In the current financial crisis, the Federal Reserve has lowered interest rates to almost zero percent per annum thus assuring that the banks can profit enormously by doing almost nothing, not lending and sitting on risk free Treasury investments. While good for the banks, one can see how damaging this lack of credit extension can be to an economy trying to recover from an economic crisis.
What is most damaging about this approach to an economy attempting to recover from a recession is that it ensures that the policy of tight money from the banks will continue for some time. Time is needed for the banks to earn their way out of their loan losses and insolvency problems if they decide not to quickly write off the bad loans. In Japan, after their banking crisis of 1994, it took more than a decade for the banks to repair their balance sheets and resume normal lending thus retarding economic growth for decades.
This is exactly the plan that Geithner and Larry Summers have proposed for the current crisis. If you remember, Hank Paulson, the Treasury Secretary at the time, had announced that the $700 billion TARP funds would be used to buy toxic assets like bad mortgage loans from the commercial banks. But this never happened and now the amount of bad bank loans has increased in the trillions. Immediately after receiving authorization of the funding for TARP from Congress, Paulson reversed direction and decided to make direct equity investments in the banks rather than using the TARP funds to acquire their bad loans.
So where are the trillions of dollars of bad loans that the banks had on their books? They are still there. The Federal Reserve took possession temporarily of some of them as collateral for lending to the banks in an attempt to clean up the banks for their supposed" stress tests". But as of now, the trillions of dollars of underwater mortgages, CDO's and worthless credit default swaps are still on the banks books. Geithner is going to the familiar "bank in crisis" playbook and hoping that the banks can earn their way out of their solvency problems over time so the banks are continuing to slowly write off their problem loans but at a rate that will take years, if not decades, to clean up the problem.
And this is where defeat of the nomination of Elizabeth Warren becomes critical for Geithner. For Geithner's strategy to work, the banks have to find increasing sources of profitability in their business segments to balance out their annual loan loss recognition from their existing bad loans in an environment in which they continue to recognize new losses in prime residential mortgages, commercial real estate lending, sovereign debt investments, bridge loans to private equity groups, leverage buyout lending and credit card defaults.
The banks have made no secret as to where they will find this increase in cash flow. They intend to soak their small retail customers, their consumer and small business borrowers, their credit card holders and their small depositors with increased costs and fees and are continuing many of the bad mortgage practices that led to the crisis (ARM's, option pay deals, zero down payments, second mortgages, teaser rates, etc). American and Banking Market News reports this week that the rule changes in the financial reform bill may lead banks to start implementing fees that had essentially disappeared from the industry early in the new millennium, such as fees for not meeting minimum balance requirements on a checking account, or reinstituting fees for certain online banking transactions that are currently free or charging to receive a paper statement or to talk to a live teller as Bank of America's CEO has recently proposed.
It is exactly these types of unwarranted fees on small consumers and poorly designed products that Elizabeth Warren will fight against as head of the new consumer finance protection group. And it is why Geithner sees her as so threatening. Unless the banks are allowed to raise fees and charges on their smaller consumer customers, Geithner's and Summers' scheme for dealing with the banking crisis by hiding problem loans permanently on the banks' balance sheets will be exposed for what it is, an attempt at preserving the jobs of current bank executives at the cost of dragging out this recovery needlessly for years in the future. For the investment banks without small consumers and depositors to soak, Geithner and Summers have offered an environment with fewer competitors, more dominant market shares for the surviving firms and near monopoly pricing of their investment banking and derivative products to corporate clients and institutional investors to ensure continued and increasing profitability and growth.
Warren's appointment wouldn't just be a setback, it would devastate Geithner's entire plan on how to deal with trillions of bad assets the banks still won't recognize as losers. That is why I think she is going to face enormous resistance, even inside of the administration. The next one to oppose Warren after Geithner will be Larry Summers for this very reason. Then they will see if they can get Bernanke and finally Obama on board. The pitch to Obama and Bernanke will not be personal, it will be the same phony argument that Paulson and Bernanke used to justify TARP to congress, they will say that if Warren is appointed the entire world of banking and finance as we know it will come to an end.
I am reminded of when Bernie Sanders offered an amendment to audit the Fed to the financial reform bill earlier this year. While it was just one of many amendments being considered, the administration came out and said it was not against any of the amendments being discussed, with one exception, they would fight the "audit the Fed" idea to the death (me thinks the lady doth protest too much). Why? The same reason, a complete audit of the Fed would show that we have still not dealt with the bad loans on the banks' books.
As to the other two potential nominees on Obama's short list for the position, Michael S.Barr is Geithner's boy currently working for him as an Assistant Secretary at Treasury. More importantly, he is Bob Rubin's boy, having served as Rubin's assistant in the Clinton administration. If you are Rubins' boy, you are the bank lobby's boy as this position of Rubin's boy was previously held by Summers and then Geithner. Eugene Kimmelman seems like a nice enough person who has no background in finance. If the banking lobby can't get their guy in, the next best thing is to get a completely clueless person in who is too afraid to act boldly given he couldn't tell a CDO from a CEO. He has been the top lobbyist for the Consumers Union, so he is pro-lobbying and as a positive comment, really understands how toasters and garage door openers work.
Elizabeth Warren won't just protect consumers, her Oklahoma bred sense of honesty, fairness and decency just might reinvigorate and redirect a government and a banking industry that for too long has seen the average American taxpayer and the typical small consumer as the enemy to be taken advantage of at every turn.
If you want to help make sure Elizabeth Warren is appointed to head the new consumer finance protection agency, please take a minute and sign this online petition that will be presented to the President and then use the accompanying email opportunity to invite your friends to do the same.
John R. Talbott is the bestselling author of eight books on economics and politics that have accurately detailed and predicted the causes and devastating effects of this entire financial crisis including, in 2003, "The Coming Crash in the Housing Market", in January 2006, "Sell Now! The End of the Housing Bubble" and in 2008, "Contagion: The Financial Epidemic that is Sweeping the Global Economy".
US Treasury under fire on impact of car rescues
by Stephanie Kirchgaessner - Financial Times
The US Treasury faces criticism that it did not sufficiently weigh the impact of tens of thousands of job losses when it pushed General Motors and Chrysler to close hundreds of car dealerships rapidly as a condition of the government’s $81bn bail-out of the comtwo Detroit carmakers.panies. The criticism comes at a difficult time for the Obama administration, which has said that the bail-out was an undesirable but necessary intervention that ensured the companies’ long-term viability.
Suggestions that the administration’s decisions encouraged tens of thousands of job losses will also sting the White House at a time when it is already under fire over high unemployment. A report to be released on Monday by the special inspector-general for the troubled asset relief programme will find that the Treasury neglected its responsibility to protect the broader US economy when in March last year it rejected initial plans by the two carmakers to close dealerships gradually.
Under pressure from the government, the companies sped up that process, with GM announcing plans to wind down 1,454 dealerships by this October, and Chrysler terminating 789 dealerships in 2009. "The Treasury should have taken every reasonable step to ensure that accelerating the dealership terminations was truly necessary for the long-term viability of the companies and should have at least considered whether the benefits ... outweighed the costs to the economy," the special inspector-general found.
Administration officials rejected the report on Sunday, saying the Treasury’s actions had saved 1m jobs and paved the way for both companies to thrive. The plan would have failed, they argued, without shared "sacrifices" from all stakeholders. "From the very beginning, the president understood and explained that a responsible approach to these companies was not to simply just continue kicking the problems down the road. Those jobs were unsustainable," one official said.
The report’s findings were seized on by Darrell Issa, a Republican congressman and one of the administration’s most outspoken critics. "This sobering report should serve as a wake-up call as to the implications of politically orchestrated bail-outs," Mr Issa said. The US Treasury decision to force the companies to accelerate the closure of dealerships was based on a theory that, with fewer dealerships, the companies would be more profitable.
Obama Omits Jobs Killed or Thwarted from Tally
by Caroline Baum - Bloomberg
Can you believe they’re still touting that silly metric? When I heard last week that the White House would be announcing the number of "jobs created or saved" as a result of the 2009 American Reinvestment and Recovery Act, my first reaction was embarrassment.
Imagine how Christina Romer must feel. The chairman of the President’s Council of Economic Advisors was dressed in a cheery, salmon-colored jacket, a complement to the upbeat news she had to deliver on July 14. The $787 billion stimulus enacted in February 2009, which subsequently grew to $862 billion, increased gross domestic product by 2.7 percent to 3.4 percent relative to where it would have been, and added anywhere from 2.5 million to 3.6 million jobs compared with an ex-stimulus baseline.
"By this estimate, the Recovery Act has met the president’s goal of saving or creating 3.5 million jobs -- two quarters earlier than anticipated," Romer said with a straight face. (More than 2.5 million non-farm jobs have been lost since ARRA was enacted in February 2009, all of them in the private sector, according to the Bureau of Labor Statistics.) How does the CEA arrive at these numbers? It uses two methods, Romer said. The first is a standard macroeconomic forecasting model that estimates the multiplier effect of fiscal policy. (The government’s spending is someone else’s income.) The second method is statistical, using previous relationships between GDP and employment to project future behavior.
These numbers might just as well have been pulled out of a hat. Recall that it was the same model and method the administration used in January 2009 to predict an unemployment rate of 7 percent in the fourth quarter of 2010 with the enactment of the fiscal stimulus and 8.8 percent without. The unemployment rate now stands at 9.5 percent. This same model convinced policy makers that the subprime crisis was contained, encouraged the rating companies to slap AAA ratings on collateralized garbage, and led banks to believe they had adequately managed their risks and reserved for potential losses.
Econometric models rely on the assumption that $1 of government spending generates more than $1 of GDP, the so-called multiplier effect. There is no allowance for the negative multiplier on the other side. Sure the government can spend money and generate GDP growth in the short run: Government spending is a component of GDP! What it giveth it taketh away from the private sector via taxation or borrowing. Every dollar the government spends is a dollar the private sector doesn’t spend, an investment it doesn’t make, a job it doesn’t create. This is what is unseen, as Frederic Bastiat explained in an 1850 essay.
"If the administration wants to take credit for ‘jobs created or saved,’ it should also accept responsibility for ’jobs destroyed or prevented,’" said Bill Dunkelberg, chief economist at the National Federation of Independent Business. Ignoring the flaws in the stimulus for the moment, Congress raised the hurdle for hiring entry-level workers when it refused to delay the third step in a three-stage minimum wage increase last year.
And the Department of Labor cracked down on unpaid internships, outlining six criteria that businesses had to satisfy in order to hire someone willing and able to work for nothing to get the experience. For example, the employer must derive "no immediate advantage from the activities of the trainees, and on occasion the employer’s operations may actually be impeded." You can’t make this stuff up.
At the White House briefing last week, Romer touted the leveraging of public investment with private funds, with $1 of Recovery Act funds partnering with $3 of outside spending. Romer said this public spending "saved or created 800,000 jobs" in the second quarter alone. Once again, what would have happened in the absence of the government’s targeted intervention?
According to a June 2009 study by the Kauffman Foundation in Kansas City, Missouri, well over half of the companies on the Fortune 500 list, and almost half of the fastest growing companies in America, were started during a recession or bear market. Dunkelberg calls this phenomenon "negative push starts." People might not be willing to quit their jobs, but if they get laid off during a recession and were thinking about starting a business, they might seize the day, he said. "When people ask me when the best time to start a company is, I tell them the day before the recession ends," Dunkelberg said. "They can do it on the cheap, and the next day you get cash flow."
What’s more, firms less than five years old are responsible for all of the net new jobs created in the U.S., the Kauffman study found. Job creation by start-ups is more stable, less sensitive to the business cycle. So, if the goal is to create more jobs, and start-ups are the ones that create them, why is the Obama administration partnering up with existing firms? "Job-creation policies aimed at luring larger, established employers will inevitably fail," said Tim Kane, Kauffman Foundation senior fellow in research and policy and author of a follow-up study released this month.
Not to worry. The White House has a model that turns failure into success.
Housing outlook clouded by expiration of tax credit
by Rex Nutting - MarketWatch
For the first time in more than two years, the U.S. housing market is standing on its own, without extraordinary help from the government. It hasn't been pretty. Following the expiration of the home-buyers' tax credit, home building, home sales, and home prices have fallen. It could be months before a clear view of the housing market is revealed.
In the coming week, four major housing indicators will be released. Although everyone expects the numbers in the medium-term to be consistent with a very weak housing market, economists are more uncertain than usual about which way the latest numbers will swing. The other big newsmaker of the week will be Federal Reserve Chairman Ben Bernanke, who will go to Capitol Hill for two days of testimony about the economy and what should be done to make it better. The Fed has marked down its economic forecast and there's talk that the Fed could try more unconventional policy moves if the economy weakens further. Bernanke will surely be asked about what the trigger would be for further easing, and the lawmakers will want to know what, if anything, Congress should be doing.
The big housing number of the week will come on Tuesday when the Commerce Department reports on housing starts for June. Starts dropped 10% (including a 17% drop in single-family houses) in May after the deadline for the tax credit expired at the end of April. The median forecast of economists surveyed by MarketWatch calls for a further 2% decline in starts in June to a seasonally adjusted annual rate of 583,000, which would bring new construction back to the levels of last summer, well above the record low of 477,000 in April 2009, but about 75% below the peak of 2006.
The median forecast hides a wide divergence of opinion, with forecasts ranging from 525,000 to 620,000. "There is very little demand for housing of any kind," economists at Capital Economics wrote. "New construction activity will remain quite depressed for some time," said Meny Grauman, an economist for CIBC World Markets. Some economists are slightly more upbeat about June's figures. "The decline may have overshot the mark," wrote Peter D'Antonio, an economist for Citigroup Global Markets, who nonetheless agrees that "the housing market remains weak." "The noise associated with the credit has made assessing the housing market difficult," D'Antonio said.
Homebuilders themselves say they are very pessimistic about the market going forward. The home builders' sentiment index fell from 22 in May to 17 in June. Economists think it may have fallen back to 16 in July. On Thursday, the National Association of Realtors will report on June's home resales. Economists are looking for a 9% drop in existing-home sales to a seasonally adjusted annual rate of 5.15 million, with estimates ranging from 4.48 million to 6.20 million.
To qualify for the tax credit, a buyer had to sign a sales contract by the end of April, and close on the sale by the end of June (this has now been extended to the end of September). Existing-home sales are recorded at the time of closing, so June's closings would qualify. It takes a month or two to close on the loan in normal times, but realtors and lenders have reported long delays related to appraisals, higher lending standards and administrative backlogs. That's why the deadline was extended.
The number of sales contracts plunged about 30% in May, while mortgage applications for purchase loans also fell by about 30%. It seems as if demand may have started to weaken even before the tax credit expired. Economists at Credit Suisse look for a "fierce correction" in home sales, with sales of existing homes falling into the mid-4 million range in coming months. That would take sales all the way back to the lows hit in late 2008 and early 2009, when the crisis was at its full fury. Also on Thursday, the Federal Housing Finance Agency will report on home prices for May. Prices rose 0.8% in April compared with March, but were down 1.5% compared with a year earlier.
Home prices are likely to continue falling as sales dry up. The freefall in sales "appears destined to apply additional downward pressure on home prices," said Michael Gregory, senior economist for BMO Capital Markets. Housing has fallen so far that it's simply too small to have much impact on growth, said Joseph LaVorgna, chief U.S. economist for Deutsche Bank. Housing now accounts for a record-low 2.4% of gross domestic product, he said. LaVorgna may be right when considering the contribution housing makes to investment and employment, but the impact that falling home prices could have on consumer sentiment, consumer spending and bank balance sheets could still be considerable.
US homebuilders losing confidence in the recovery
by Alan Zibel - AP
Homebuilders are feeling increasingly pessimistic about their industry, more evidence that the economic recovery is slowing. The National Association of Home Builders said Monday that its monthly reading of builders' sentiment about the housing market sank to 14 — the lowest level since March 2009. Readings below 50 indicate negative sentiment about the market.
The weak job market and an increasing number of foreclosed properties have prompted builders to limit construction of new homes. A modest revival in sales over the past year ended in May after federal tax credits expired at the end of April. Conditions are not likely to improve soon. Reports this week on new home construction and previously owned home sales in June are expected to show the housing market remains deeply hobbled. An update on the Obama administration's effort to help those in danger of losing their homes is also expected Tuesday.
While the overall economy appears unlikely to fall back into recession, many analysts expect housing to struggle for some time. "With growth slumping again, and unemployment hovering near the double digits, we simply don't have the necessary ingredients for a sustainable recovery in housing," said Mike Larson, real estate and interest rate analyst at Weiss Research. Builders have sharply scaled back construction in the face of a severe housing market bust. The number of new homes up for sale in May fell to 213,000, the lowest level in nearly 40 years. And, at the current sales rate, it would take 8.5 months to exhaust that supply. In a healthy economy, new home inventory takes about six months to exhaust.
Five years ago, at the peak of the housing boom, there were about 460,000 unsold homes on the market. And because of the frenzied pace of sales, it would have taken a little more than four months to exhaust that supply. In some ways, it could be good news that builders are scaling back. It means they won't add to the supply of homes on the market and that could create more demand for the current stock.
But it won't help the job market. Each new home built creates, on average, the equivalent of three jobs for a year and generates about $90,000 in taxes paid to local and federal authorities, according to the builders' trade group. The impact appears in multiple industries, from makers of faucets and kitchen appliances to lumber yards. New home sales in May dropped 33 percent to the slowest pace in the 47 years records have been kept. The number of buyers who signed contracts to purchase previously occupied homes tumbled 30 percent in May. The drop-off came immediately after the tax incentives to sign a contract on a home ended on April 30.
Still, the trade group's latest survey of 502 residential builders nationwide suggests the market will remain sluggish for the rest of the year. The index is broken into three separate readings. Its index measuring expectations for the next six months fell one point to 21. Current sales conditions fell two points to 15 and foot traffic from prospective buyers sank to 10. Even if homebuilders keep construction to a minimum, it could be three years before the supply of housing comes into balance with demand, said Paul Dales, U.S. economist for Capital Economics. "The supply of housing remains very high and could rise even further," Dales said. "It's going to be a very long time before all the excess supply is worked off."
An Outspoken Fund Manager With Contrarian Views
by Julia Werdigier - New York Times
Hugh Hendry has a big mouth, as Hugh Hendry will tell you. With a sharp wit and a sharper tongue, Mr. Hendry, a plain-spoken Scot, has positioned himself as the public contrarian thinker of London’s very private hedge fund community.
The euro? It’s finished, Mr. Hendry proclaims. China? Headed for a fall. President Obama? "If there was a way to short Obama, I would," Mr. Hendry said.
Mr. Hendry runs the successful hedge fund firm Eclectica Asset Management. It is an old-school macroeconomic fund company with a big-think, globe-straddling style more akin to the Quantum Fund, of George Soros fame, than to the high-tech razzle-dazzle of Wall Street’s math-loving quant analysts. "Hugh is an anachronism," said Steven Drobny, a founder of Drobny Global Advisors. "He reminds one of the original hedge fund managers from the ’70s and ’80s." At 41, Mr. Hendry is also emerging from the normally secretive world of hedge funds to captivate fans and foes with a surprising level of candor.
Last May, on British television, he verbally sparred with Jeffrey D. Sachs, director of the Earth Institute at Columbia and perhaps the best-known economist writing on developmental issues. Before that, he took on Joseph E. Stiglitz, the Nobel laureate, about the future of the euro. "Hello, can I tell you about the real world?" Mr. Hendry interjected at one point. It was a huge hit on YouTube.
His verbal pyrotechnics have won Mr. Hendry a reputation for challenging the economics establishment. He is regarded and appreciated by many as overly pessimistic about, well, just about everything. His big worry lately has been China. Like James Chanos, a prominent hedge fund manager in the United States, Mr. Hendry says he believes China’s days of heady growth are numbered. A crisis is coming, he insists.
"He’s an original thinker, and he’s definitely not afraid of saying what he thinks, even if he’s not always right," said Jacob H. Schmidt, founder of Schmidt Research Partners. Mr. Hendry has made — and sometimes lost — money for his investors. Eclectica’s flagship fund, the Eclectica Fund, is up about 13 percent this year, besting by far the average 1.3 percent loss among similar funds. But returns have been erratic — "too much sex, drugs and rock ’n’ roll" for some investors, he concedes. In 2008, the Eclectica Fund was up 50 percent one month and down 15 percent another. Mr. Hendry plans to change that.
The firm bet correctly that the financial troubles plaguing Greece would eventually ripple through to the market for German bonds, considered the European equivalent of ultra-safe United States Treasury securities. But the firm lost money betting on European sovereign debt in the first quarter of last year.
Last week, Mr. Hendry was musing about the financial world in his office behind a scruffy shopping mall in the Bayswater section of London. No Savile Row here: He was sporting a white oxford shirt, jeans and blue Converse Chuck Taylor sneakers, along with a three-day stubble and hipster horn-rim glasses. His latest obsession is China. He likens the country to Starbucks: good at growing quickly but not so good at creating wealth. "The idea is that things would happen today that are commonly thought of as impossible, most notably a significant reversal of China," Mr. Hendry said.
Maps cover the walls of his office. On one, blue magnetic pins plot his recent trip through China. He filmed himself there in front of huge, empty office buildings and giant new bridges in the middle of nowhere — signs, he said, of a credit bubble. Along with his fund co-manager Espen Baardsen, a former goalie for the Tottenham Hotspur soccer team, Mr. Hendry is devising ways to bet on a spectacular deterioration of China’s economy. He declined to divulge any details.
Mr. Hendry’s outspokenness has won him both fans and detractors. Marc Faber, the money manager known as Doctor Doom for his bearish views, calls Mr. Hendry "a deep thinker." "He has strong views and expresses them, not to get publicity but because he has a great understanding of the markets," Mr. Faber said. Some London investors are less charitable. Two declined to comment on Mr. Hendry, saying they did not want to "get into a fight" with him.
Mr. Hendry certainly does not fit the stereotype of a discreet London moneyman. The son of a truck driver, he was the first in his family to attend a university — Strathclyde, in Glasgow, not Oxbridge. He studied accounting and joined Baillie Gifford, a large Edinburgh money manager. Frustrated that he could not challenge the investment strategies of his bosses, he jumped to Credit Suisse Asset Management in London. There, a chance meeting with an equally opinionated hedge fund manager, Crispin Odey, led to a job. Before long, Mr. Hendry struck out on his own.
The inspiration for his investment approach comes from an unlikely source: "The Gap in the Curtain," a 1932 novel by John Buchan that is borderline science fiction. The plot centers on five people who are chosen by a scientist to take part in an experiment that will let them glimpse one year into the future. Two see their own obituaries in one year’s time. Mr. Hendry calls the novel "the best investment book ever written" because it taught him to envision the future without neglecting what happened leading up to it, a mistake many investors make, he said.
Mr. Hendry hopes Eclectica will grow to $1 billion — still relatively small by hedge fund standards. But neither admirers nor rivals expect him to change his plain-talking ways. "I’ve got such a big mouth," he said, "I have to be very careful what I say."
Europe freezes out Goldman Sachs
by Elena Moya - The Observer,
European governments are turning their backs on Goldman Sachs, the all-conquering investment bank that has suffered a series of blows to its reputation, capped by the biggest ever fine imposed on a Wall Street firm. According to data from Dealogic, Greece, Spain, France and Italy have all denied the bank a lead role in their recent sovereign bond sales. Last Thursday, Goldman agreed to pay a $550m fine to settle US regulators' claims that the bank misled investors in a mortgage-backed security. Goldman admitted that its marketing materials were incomplete, because they failed to state that the same third party that helped choose the assets had taken a bet against them.
But governments have also been shocked at the emergence of past transactions between Goldman and Greece and Italy, where products the bank helped to sell aided both in hiding government debt. Greece, which used Goldman in a bond sale this year, is practically at war with the bank. A sharp contrast with the situation months before, when Goldman bankers dined with the prime minister in a private meeting overlooking the Acropolis. The relationship broke down, though, after news leaked earlier this year that Goldman was about to strike a bond sale deal with China's sovereign fund – which never materialised.
Spain, which used Goldman among its top 10 bookrunners last year, has not done so in 2010, while Italy has not given the bank a leading role since 2007. France has not used Goldman in any lead position over the past three years, and it seems doubtful that it will do so in the near future. "French people would riot in the streets if we chose Goldman," said a person familiar with the French treasury.
The French government has said it will only use banks that cap management and traders' bonuses. This year, Goldman limited the pay and bonus compensation to its London partners at £1m, though other bankers and traders can receive much more, provided they are not partners. Goldman has also been criticised of for taking short positions, or betting on a price fall, against some European sovereign bonds – after taking part in a bond sale, a person involved in sovereign debt sales said. The bank says it has presence in the European sovereign bank market and that it has recently participated in deals in Britain, Portugal and Belgium.
Countries such as Spain and France have also shied away from Goldman because their traditionally conservative treasury departments prefer to steer clear of risky investments. The French treasury, for instance, only issues debt in euros, staying away, like Spain, from the complex foreign exchange or swap deals that brought trouble to Greece and Italy. "The Spanish treasury can't justify in parliament why, if things go wrong, they have a multimillion-euro position in Indian rupees, for example," a sovereign bond banker said.
Governments also stick to plain-vanilla deals, with little complexity, in order to keep their prized AAA rating, reducing their borrowing costs as much as possible, a source familiar with the French Tresor said. IKB, the failed bank bailed out by the German government, recently considered suing Goldman because of its exposure to the structured products sold by the US bank. Following the settlement between Goldman and the SEC, the US securities regulator, last week, IKB said the German lender was "reviewing the settlement documents". Germany has only made one syndicated bond sale in the last three years, in 2009, when it appointed Deutsche Bank, Citibank, HSBC and BofA-Merrill Lynch as lead managers.
SEC Split Over Goldman Deal
by Kara Scannell And Susanne Craig - Wall Street Journal
The Securities and Exchange Commission split in its decision to settle its landmark lawsuit against Goldman Sachs, The Wall Street Journal has learned, in a dispute over the agency's move to levy a $550 million fine even after diluting its fraud allegations against the giant bank. The 3-2 decision on party lines Thursday came after a 30-minute closed-door session where the SEC's two Republican commissioners voted against settling, said people familiar with the matter. Mary Schapiro, the SEC chairman appointed by President Obama, cast the deciding vote, the people said.
Thursday's settlement—in which Goldman agreed to pay a $550 million fine, but didn't have to admit it committed fraud—capped one of the most closely watched cases in the SEC's 76-year history. The agency had charged Goldman with intentionally duping clients by selling a mortgage-security product that secretly was designed by another Goldman client betting that the housing market would crash. People familiar with the matter say Republican Commissioner Kathleen Casey questioned the SEC staff Thursday on their decision to abandon the strongest fraud charge and strike a settlement involving a lesser allegation, and given that, how the SEC could justify such a large penalty on a lesser charge.
The political split over the case comes at a time when the agency remains under fire for its policing of the financial markets during the financial crisis. The SEC commissioners often split on party lines over policy decisions, but rarely do so on such high-profile enforcement cases. The disclosure of the dispute also raises fresh questions about how strong a case the SEC had against Goldman. Russell Ryan, a former SEC enforcement lawyer, said the negotiation to drop the strongest fraud charge is "usually a strong indication the SEC had some doubt whether it could prove intentional fraud." Mr. Ryan, now a defense lawyer at King & Spalding, said the SEC typically insists a defendant settle on the strongest allegation made in its complaints. Watering down the toughest charge, as in this case, is unusual.
Neither Ms. Casey nor the other Republican commissioner, Troy Paredes, returned calls to comment. Ms. Schapiro, the two other Democratic commissioners and an SEC spokesman declined to comment. The SEC initially alleged that Goldman violated a rule—known as Rule 10b of securities laws—which contains a sweeping antifraud provision covering trading in securities. The charge is one of the most serious the SEC can make, and carries greater stigma for a financial firm than the lesser charge included in the settlement. The lesser charge Goldman settled on comes under a rule known as 17a. These charges can involve intentional and unintentional fraud, as well as negligence.
The SEC staff, led by Kenneth Lench, head of the agency's structured-products unit, told the commission the shift stemmed from the settlement negotiations, a person familiar with the matter said. The staff also was asked how the size of the proposed penalty—one of the largest in SEC history—fit in with other cases, this person said. Mr. Lench declined to comment.
Lorin Reisner, deputy director of the SEC's enforcement division, said "Section 10b and Section 17a1 are functional equivalents. Section 17a1 is a more appropriate claim in the context of a fraud in connection with the offering of securities." He declined to comment on why the agency dropped the 10b charge. In April, Ms. Casey and Mr. Paredes had voted against filing the fraud case in the first place, concerned that the agency didn't have the strongest case and risked losing it in court, people familiar with the matter say.
The division in the settlement vote casts a cloud over what the SEC had claimed on Thursday was a major victory. Investors had expected any SEC fine in the case to be $1 billion or more. Goldman's shares have jumped since Thursday. As part of the settlement, which has to be approved by a New York federal court, Goldman was required to issue a statement saying it made "a mistake" by not disclosing the role of hedge fund Paulson & Co. to investors for helping to arrange the mortgage deal. Goldman pledged to toughen oversight of mortgage securities, certain marketing materials and employees who create or pitch such securities. It neither admitted nor denied the charges.
Thursday's settlement came together quickly after months of tense talks. The tensions began April 16, when, Goldman says, the SEC filed the fraud charges without even an hour's heads-up, a notice regulators typically give before charges are brought. The charges rocked Wall Street and wiped $12 billion off the firm's stock market value that day. The firm, ordinarily prepared for public announcements, had no initial response. Seventy-nine minutes later, Goldman said in a statement the accusations are "completely unfounded in law and fact."
In a conference call, Goldman executives agreed that giving in at all would cast doubt on every mortgage-derivatives deal arranged by the company, according to a person familiar with the call. But the firm soon reached out to the SEC, people familiar with the matter say. In early May the two sides met face to face. Little progress was made. The talks picked up this month. Goldman pushed the SEC for a deal to resolve both the fraud lawsuit against Goldman and some of the agency's lower-profile probes of the firm's mortgage department, say people familiar with the situation.
The strategy: Combining a settlement of the SEC suit with a resolution of related SEC probes could calm Goldman's restive clients and investors, while shielding the firm from information that could be used against Goldman in private litigation. Goldman's paramount concern was removing the more serious fraud charge rather than knocking down the size of the fine, say people familiar with the matter. But in order to agree to a settlement, the SEC insisted it reserve the right to revisit the cases if new damaging evidence arises, the people familiar with the matter say.
On Wednesday, upon learning The Wall Street Journal was preparing an article on catch-all settlement talks, SEC enforcement chief Robert Khuzami grew furious and blasted Goldman. He accused the firm of leaking a story that suggested Goldman had bested the SEC, a person familiar with the matter says. Mr. Khuzami didn't return calls for comment. Worried about further leaks, the SEC decided to move fast. After the commission's Thursday vote, Mr. Khuzami and his staff made their way down to the basement of the SEC's Washington headquarters, unveiling the settlement to reporters.
Growing outrage over Goldman Sachs settlement
After Goldman Sachs settlement, SEC looking at exotic financial products
by Zachary A. Goldfarb - Washington Post
The new Securities and Exchange Commission unit that obtained a $550 million settlement from Goldman Sachs in a fraud suit is pressing ahead with investigations into wrongdoing during the financial crisis by big banks, but is also turning its attention to exotic financial products that might be used to harm average investors, officials said.
The Structured and New Products Unit, one of several specialty groups in the agency's enforcement division, filed the landmark suit against Goldman and later negotiated with the powerful Wall Street bank's lawyers on a settlement. A source familiar with the unit's work, who was not authorized to discuss the matter publicly and spoke on the condition of anonymity, said that while it is looking at wrongdoing by other big firms, it's unclear whether the Goldman case will be replicated with other Wall Street firms.
Agency veteran Kenneth Lench, chief of the 40-person unit, said the agency is looking to examine exotic financial products that might be used to deceive or defraud ordinary investors. The investors allegedly defrauded by Goldman were Scottish and German banks. "While the Goldman case -- which is the first case out of the unit -- involved larger institutional victims, we also are looking at products that are marketed and sold to retail or less sophisticated investors," Lench said in an interview Friday. "We are looking forward, looking around the corner for what's next. We assign small teams of people to do a deep dive into a new product that hasn't been around all that long."
Historically, the SEC has launched probes based on a specific tip about wrongdoing at a company or when a whistleblower comes forward. The Structured and New Products Unit will sometimes be more aggressive, scanning the marketplace for securities that seem unduly risky for investors, then examining those products and the companies that might be trading them. For example, the group could target securities that have been touted by financial firms as ultra-safe for investors who have been burned by the ups and downs of financial markets.
A few months ago, when the SEC filed its suit against Goldman, it would have been hard to anticipate that the unit would obtain a settlement so soon and be free to focus on other cases. The Wall Street bank at first slammed the SEC and said it had done nothing wrong. Sources close to the case said that about a month after the SEC filed its fraud suit, however, Goldman changed its attitude and began to seem much more serious about considering a settlement.
At the time, Goldman was facing a new Justice Department criminal probe and harsh questions from Congress about its conduct. Televised hearings put senior Goldman executives, including chief executive Lloyd Blankfein, through the gantlet. The SEC case wiped billions of dollars off the firm's market value. A source familiar with Goldman's deliberations who spoke on the condition of anonymity to describe an internal matter said the bank determined it was important to put the SEC case behind it and preserve its reputation, despite the costs involved. On Friday, Goldman's stock closed up 95 cents, or 0.7 percent, after rising several dollars in morning trading on the news of the settlement. The gains came despite a broad market sell-off that weighed on financial shares.
To win the settlement, the Structured Products unit not only had to reach an agreement with Goldman but also had to convince the agency's five commissioners. Just as they had when the SEC filed the lawsuit against Goldman, the two Republican commissioners voted against the settlement, according to a source familiar with the vote who spoke on the condition of anonymity because the proceeding was not public. But SEC Chairman Mary Schapiro and the two Democratic commissioners voted for it.
The SEC team moved on two fronts in recent months, building a court case against Goldman while negotiating with the firm over a settlement. The agency wanted Goldman to pay more than a fine. It wanted the bank to admit some sort of guilt and to undertake remedial actions. Such prescriptive settlements are being embraced by the SEC more commonly than in the past. The agency required a series of changes to how Bank of America runs its business in a settlement earlier this year. SEC officials said they expect both Goldman's statement of regret and the remedial actions to serve as a template for future settlements. The SEC has long faced criticism that its settlements allow firms to pay a fine but avoid any sort of culpability.
Under the settlement, Goldman must review the role and responsibilities of company lawyers and compliance executives in the preparation of marketing materials for mortgage securities. Goldman employees in the mortgage business must receive additional education and training. Those changes put more pressure on Goldman to increase the vetting of disclosures that accompany products the bank sells to clients. The deal let both the SEC and Goldman claim a share of victory. The SEC was able to secure its largest penalty ever against a financial firm, make Goldman acknowledge it had made mistakes and strike at an issue at the heart of the financial crisis. For Goldman, the company was able to put the matter behind it, pay a fine that won't make a big dent in its bottom line and avoid officially admitting wrongdoing.
Timing of Goldman Sachs settlement seems suspect
Lloyd Blankfein's Days Are Numbered as Chairman of Goldman Sachs
by Charlie Gasparino - Zero Hedge
It's a testament to the odd world in which we live that when a Wall Street firm pays a $550 million fine by conceding negligence in how it dealt with clients, its stock surges, adding billions of dollars in market value for the firm's shareholders. But that's what's happening to Goldman Sachs, as it reached its long awaited settlement with the Securities and Exchange Commission over how it sold a basket of mortgage related debt to investors in 2007.
Back when the SEC brought the case, the conventional wisdom on Wall Street and the financial media was that Goldman didn't have to settle -- the case was weak and Goldman is, after all, Goldman. As I wrote on these pages back then, Goldman would have to settle because: (a) the SEC dug up some real questionable activity; and (b) no Wall Street firm, not even one with the ties to government that Goldman possesses can go to war with its primary regulator.
Now that Goldman has indeed settled, the news is being spun, again mostly by the financial media, that the deal with the SEC was a victory for Goldman's CEO Lloyd Blankfein, who survived the investigation largely unscathed, paying a measly $550 million to the government (equivalent to a few days trading gains at Goldman) and without having to give up any power, such as relinquishing his role as chairman of the board, as senior executives both inside Goldman and at competing firms believed would be part of any settlement.
Well, if history is any guide, Blankfein may not go tomorrow, or even next month, but sometime in 2011, Blankfein will at the very least no longer be chairman of Goldman, and may also be forced out of the firm altogether. If you don't believe me ask former Citigroup CEO Sandy Weill. Like Blankfein, Weill (at least on paper) was a good CEO from an operational standpoint. Following the creation of Citigroup in 1998, shares of the big bank soared. The bank was what's known as a Wall Street darling for its strong earnings and a surging stock price, and Weill was regarded as the King of Wall Street, having engineered the largest financial deal ever when he merged his company, the Travelers Group brokerage, insurance and investment banking empire, with commercial banking powerhouse Citicorp.
At the height of his power, Weill suddenly popped up on the radar screen of New York Attorney General Eliot Spitzer. Before Spitzer got involved with hookers and became a TV host, he was the sheriff of Wall Street, looking to right wrongs from the last great scandal, the internet bubble where firms sold worthless dotcom and tech stocks to unsuspecting investors. Emails he uncovered showed that Weill at least did something stupid, if not fraudulent: He pressured an analyst, Jack Grubman, to inflate his stock rating on telecom giant AT&T, which was an investment banking client (Weill also sat on AT&T's board, while AT&T CEO Michael Armstrong sat on Citi's board)
Grubman wrote in an email that as a favor for upgrading the stock, Weill got his kids in an exclusive pre-school. The scandal, was described by the Wall Street Journal, as a "kid pro quo." Weill continued to deny wrongdoing and was never charged. Citigroup, however, was charged with fraud and ended up paying a $400 fine to settle the matter, but Weill appeared to have retained his control of the bank. The initial reaction in the press and among his peers in the financial business was that Weill had won, by having the bank pay a relatively small fine, and his status as CEO and the King of Wall Street secure.
Not quite. A few months later, Citigroup announced that Weill was stepping down as CEO, handing that job to Chuck Prince, who basically negotiated the settlement package. Citigroup maintained that the two moves were unrelated. But people in Spitzer's office told me they really weren't: While negotiating the settlement, Citigroup's board made it clear to investigators that Weill's days were numbered at the top of the firm that he founded. Spitzer was merely affording Weill a graceful exit in an effort to end the case.
Full disclosure: I have no knowledge that Goldman's board has tacitly agreed to pull a Weill on Blankfein and has plans for him to step aside, but the circumstances involving the two men are so remarkably similar. While Blankfein wasn't directly involved in the questionable trade that landed Goldman in trouble, he is responsible for remaking Goldman into predatory trading culture that has caught the attention of regulators, Congressional committees (recall Sen. Carl Levin badgering Goldman traders for selling "shitty" investments to their clients) and hurt Goldman's once stellar reputation, as Weill's actions hurt Citigroup's.
Some would say that's where the comparisons end; Citigroup deals with the general public that buys stocks through its brokerage unit (Smith Barney) and makes deposits in its branch banking offices. Goldman deals with large sophisticated investors who couldn't care less how Darwinian the company behaves. That used to be true, but no more. Goldman's image has been battered, not as bad as say a company like BP, but not far behind. And image does count these days given the scrutiny and oversight placed on Wall Street and the banks following the financial collapse-induced bailouts.
Now that financial reform has been passed, Goldman will have to cut back on some of that aggressive trading that powered its earnings and was Blankfein's forte. That means it will have to devote more and more resources to developing its client business and relationships, convincing blue chip companies that it is the right firm to handle delicate negotiations involving mergers, acquisitions, and other corporate financing assignments.
More and more, these clients do care about image (ask yourself why has so many top companies embraced the useless but politically correct "green agenda"). In fact some have already jettisoned Goldman as scrutiny of the firm grew over the past year. Who is the right guy to change Goldman's image to fit the new paradigm it faces? It's not Lloyd Blankfein and that's why he won't survive.
Holding Bankers’ Feet to the Fire
by Gretchen Morgenson - New York Times
Kudos to the Federal Housing Finance Agency, overseer of Fannie Mae and Freddie Mac, the crippled mortgage finance giants. While some in Washington have continued to coddle the big banks even after they drove our economy into the ditch, this agency seems serious about recovering money for taxpayers by holding bad financial actors to account.
The agency announced last Monday that it had issued 64 subpoenas to a throng of unidentified financial services institutions, seeking documents related to mortgage securities that Fannie and Freddie bought from Wall Street during the boom years. The subpoenas are designed to tell the agency what many of us want to know: How did Wall Street package and sell private-label mortgage securities to investors, even though the nature and quality of some of the loans crammed inside those tidy little packages were, at best, suspect?
Once that question has been answered, Fannie and Freddie can force the institutions that sold the securities to repurchase the improper loans, allowing taxpayers to recover some of the losses they’ve swallowed on Fannie’s and Freddie’s federal bailout.
Investigating this aspect of the mortgage mess seems a pretty logical step for a regulator. But in the topsy-turvy world of Washington, the housing finance agency’s move is unusually aggressive. Edward J. DeMarco, its acting director, seems to be that rarity — a regulator who not only talks about looking out for the taxpayer, but actually does something about it.
The subpoenas went to companies that act as trustees for mortgage pools or that service the loans in them. The housing finance agency wants to see loan files and transaction documents related to those pools, including mortgage applications and property appraisals. Recipients of the subpoenas have 30 days to produce the requested documents. Additional subpoenas may follow, it said. The agency had to resort to subpoenas, it said, because when it asked the institutions for the records it got nowhere for many months. "Difficulty in obtaining the loan documents has presented a challenge to the enterprises’ efforts" to ascertain whether losses at the companies are the responsibility of others, its press release said.
Fannie and Freddie bought only the highest-rated pieces of these deals, but they bought buckets of them. During 2006-7, these entities bought $294 billion of so-called private-label securities. Not all of these purchases are under scrutiny, the agency said. It is clearly turning up the heat on the major players in mortgage servicing and securitization. Among the bigger trustees in the business are Deutsche Bank and the Bank of New York, while loan servicers include Bank of America and many more. None of the banks would confirm if they had received subpoenas.
Fannie and Freddie played pivotal roles in the housing market by buying mortgages from banks that issued them so the banks could turn around and lend even more. After both companies overindulged in the mortgage frenzy they nearly collapsed, prompting the federal rescue. Since then, the government has continued to use the firms to buttress a shaky housing market. In the immediate aftermath of a government takeover of Fannie and Freddie, the companies were persistent in seeking to recover money from the estates of Lehman Brothers and other defunct lenders related to dubious loans.
But more recently, they have ratcheted up their buyback requests of the banks with which they continue to do business. Last March, for example, Freddie said it had submitted $4.8 billion in repurchase requests to such banks, up from $3.8 billion at the end of 2009. Generating actual money from these requests, however, takes time and effort. While Fannie and Freddie can point to a borrower’s misstatements on a loan application as reason for a buyback, the banks often counter these requests with arguments that some borrowers are defaulting because they have lost their jobs or suffered other woes — not because they originally lied on their loan applications about their income and finances. As a result, these can be lengthy and testy negotiations.
But there is a big difference between recovering on loans that were contractually improper versus those that involved fraud. And the subpoenas suggest that officials at the Federal Housing Finance Agency believe that there are large numbers of loans that fall into the latter category. Mr. DeMarco would not comment further on the subpoenas. But he appears to be taking a fairly literal approach to the agency’s role as conservator of Fannie and Freddie — because the taxpayers own these companies, it must conserve their assets and get money back where it is owed.
"Most or all of our conservatorship actions are taken to minimize further taxpayer losses," Mr. DeMarco said last week in an interview. He pointed to the agency’s effort on foreclosure prevention, which "minimizes losses on seriously delinquent loans and provides greater stability to neighborhoods." But Mr. DeMarco has also barred Fannie and Freddie from entering new businesses and, according to people briefed on the discussions, was behind Fannie’s new and aggressive approach to combat so-called strategic defaulters — borrowers who can afford to pay their mortgages but stop doing so to get out of their obligations. Last month, Fannie said it would deny access to a government-backed mortgage for seven years to those defaulters.
A career government official, Mr. DeMarco was appointed acting director of the agency in September 2009; he spent 10 years at the Treasury Department, beginning in 1993. For seven of those years he oversaw public policy analysis involving Fannie, Freddie and other financial institutions. As a result, he had a front-row seat for Fannie’s and Freddie’s aggressive growth years, when they routinely strong-armed their regulators and bashed their critics. Those days are over, thankfully, but taxpayers are still on the hook for the mess those practices wrought. At least we now seem to have a strong cop on the Fannie and Freddie beat, someone who genuinely cares about the taxpayers’ losses and is working hard to stanch them.
Citigroup Profit Declines 37%
by Randall Smith - Wall Street Journal
Citigroup Inc. reported a second-quarter profit of $2.7 billion and beat analysts' earning expectations, but its stock fell on sluggish expected revenue growth, a product of the bank's more risk-averse profile after its near-death experience in 2009. Citigroup's per-share profit of nine cents topped the five cents expected by analysts. Still, the profit was down 37% from a year earlier, when Citigroup avoided a loss only with a $6.7 billion gain on the sale of its Smith Barney brokerage.
The stock was down 26 cents, or 6.3%, to $3.90 at 4 p.m. in New York Stock Exchange trading amid a market-wide decline, as analysts focused on the bank's lack of revenue growth. The $22.1 billion of revenue was down 33% from a year earlier and 13% from the first quarter. Chief Executive Vikram Pandit attributed that decline partly to the impact of "the market environment" on securities and banking. "Top-line growth is the main issue here," said Mike Mayo, a bank analyst at Credit Agricole Securities (USA) Inc. "The patient is out of the hospital bed, just walking around the hallways."
Citigroup said net interest margin, a closely watched gauge of how much banks earn on assets compared with funding costs, narrowed to 3.15% from 3.32% in the first quarter, "mainly reflecting de-risking of the loan portfolios." Deposits fell 2% from the first quarter to $814 billion, while loans fell 3.3% to $710 billion. Citigroup Chief Financial Officer John Gerspach said demand for new loans is weak. While there is "some demand" in Asia, he said overall there is "not a lot of new demand for loans" among corporations. "If you're going to make less risky loans and less loans generally," profit margins will decline, Mr. Mayo said.
Citigroup buttressed its profit by releasing $1.5 billion from the reserves set aside for losses on loans, reflecting the fourth consecutive quarter of lower net credit losses. Credit charge-offs declined 5%, nonperforming assets fell 9%, and 30-day credit-card delinquencies fell slightly from the first quarter. Still, expenses rose slightly, reflecting the impact of a tax on bankers' bonuses on the U.K.
Citigroup made progress in whittling down its basket of unwanted assets by $38 billion to $465 billion, which Mr. Pandit noted is now less than one quarter of the entire company's $1.9 trillion balance sheet. When it received a new round of government aid in January 2009, Citigroup said it would exit noncore businesses and shed its riskiest assets. The businesses, dubbed Citigroup Holdings, generated $1.2 billion in second-quarter losses, compared with the profit of $3.8 billion at the remaining core Citicorp unit.
As it tries to revive growth, the bank is making investments to boost its stock trading and underwriting business, its transaction-services division and its banking business in emerging markets such as Asia and Latin America, Mr. Gerspach said. Asia and Latin America are contributing less than 40% of revenue but 70% of profit, he said. The impact of rocky markets, with the stock market down 10% in the quarter, was felt in Citigroup's institutional securities business. Revenue from stocks fell 65% to $620 million from a year earlier, while fixed-income revenue slid 40% to $3.5 billion and investment-banking revenue fell 42% to $674 million.
Mr. Gerspach attributed the declines to "increasing investor uncertainty and volatility during the quarter." The bank has also pulled back in its institutional business to focus on profitability as opposed to market share, Citigroup officials say. Its rank in first-half global underwriting fell to seventh from third the first half of 2009, according to Dealogic.
Stress-testing Europe's banks won't stave off a deflationary vortex
by Ambrose Evans-Pritchard - Telegraph
Euroland's authorities are inflicting a triple shock of fiscal, monetary, and currency tightening on a broken economy. They are doing so in a region where industrial output is still 14pc below its peak, where growth barely scraped above zero over the winter "recovery", and where youth unemployment is at 40pc in Spain, 35pc in Slovakia, 29pc in Italy, and 26pc in Ireland.
They seem unaware that China is slowing and the US is tipping into a second leg of the Long Slump. Last week's collapse in America's ECRI leading indicator to -9.8 marks the end of the V-shaped rebound. If this means what it normally means - recession within three months - Europe must take immediate action to prevent being drawn into a deflationary vortex. Spiralling public debt precludes further Keynesian spending, so this must come from central bank stimulus. Tight fiscal policy offset by ultra-loose money is the only option for Europe, the US, and Japan.
No student of Milton Friedman is surprised by the US relapse. The Fed has allowed M3 money to contract at a 10pc pace for much of this year - the Great Depression rate. The economy has hit the wall with the usual lag. Textbook stuff. Never ignore the quantity theory of money. The US Conference Board's indicator is not yet flashing a red alert, but that is because it gives weight to "yield curve inversion", where long rates fall below short rates. This indicator is meaningless in a Japan-style bust where policy rates are zero.
I suspect that Fed chair Ben Bernanke knows the economy buckled around the Ides of June, but is stymied by hawks at the regional Feds. All he can do for now is to talk down credit costs through hints of more quantitative easing, or QE2. In this he has succeeded. The yield on two-year Treasuries fell to an all-time low of 0.5765pc on Friday. It's Weimar, all right: circa 1931, not 1923.
So what is the European Central Bank doing to prevent southern Europe asphyxiating from debt-deflation, and knowing that M3 contracted in February (-0.3pc), March (-0.1pc), April (-0.2pc) and May (-0.2pc)? It is tightening, as it did in mid-2008 when the eurozone was already tanking. Far from taking steps to offset Club Med austerity, it is winding down its €60bn (£50bn) purchase of government bonds - "sterilized" in any case to prevent net stimulus. It is draining liquidity fast. The ECB's loans to credit institutions fell from €870bn to €635bn in the two weeks to July 9.
"This is the equivalent in central banking of the Charge of the Light Brigade," said Tim Congdon from International Monetary Research. Cash reserves in the interbank market have fallen by a third in days. No wonder three-month Euribor (the stress gauge) has risen to an 11-month high of 0.86pc. The funding squeeze has turbo-charged the euro rally, pushing the currency to 8.67 Chinese yuan. German exporters can take the pain. It is the strappado for Spain and Latin Europe. They are smiling in Guangdong.
Perhaps the stress tests for Europe's banks will clear the air and unblock the credit system. But such tests worked in the US only because that was a banking crisis. Few questioned whether the US Treasury could stand behind the system, or whether the US would hold together as a political entity. In Europe, sovereign states are themselves the risk, and a dysfunctional EMU is the Achilles heel. A memo from Germany's regulator BaFin earlier this year said the worry is contagion from "collective difficulties" in Club O'Med, not an isolated default. Once under way, the crisis might turn into a conflagration. Investors know this.
It is why the simulation test by RBS adjusts for €400bn of losses in Spain and €1.3 trillion for the eurozone, and called for "overwhelming policy intervention" by the ECB to stop this happening. Will the EU carry out such tests? Of course not. All now hangs on the credibility of the EU's €440bn rescue fund or Stability Facility (EFSF), itself subject to challenges in Germany's constitutional court. Will the EU stress test the "non-negligible" risk that the court will block it? No.
The EFSF is a bluff that Italy could provide its rescue share for Portugal, Spain, and Ireland, on top of Greece, in the context of a serious crisis without suffering its own debt run. Is this credible? Should any rating agency give this body a AAA grade given that 10 of the 16 states are rated lower, and knowing that Germany has refused to allow pre-funding so that it cannot raise money until matters are already out of hand? Besides, euroland solidarity goes only so far. Slovakia's new government has agreed to the EFSF but withdrawn from the Greek bail-out, refusing to uphold of the pledge of the last lot.
The loss of money does not matter. The politics do matter. We see again that the eurozone is a network of democracies, each subject to its own political rhythm. Any country may change its mind and walk away, at any time. Especially Germany.
Germany's Hypo Real Estate Said to Fail EU Banking Stress Test
by Aaron Kirchfeld, Oliver Suess and Jann Bettinga - Bloomberg
Hypo Real Estate Holding AG, the German lender taken over by the government following the financial crisis, failed a Europe-wide banking stress test, two people familiar with the results said. Hypo Real Estate didn’t pass a stress scenario on its capital that assumes an economic slowdown and sovereign-debt losses, said the people, who declined to be identified before an announcement on July 23. The Munich-based lender is probably the only German bank to fail the test, one person said.
European Union regulators are examining the strength of banks as they seek to reassure investors about the firms’ resilience to potential losses amid the region’s sovereign-debt crisis. The tests are being applied to 91 of Europe’s biggest banks, including 14 German lenders. "The government won’t let Hypo Real Estate collapse," said Andreas Plaesier, a banking analyst at M.M. Warburg in Hamburg. An official at Hypo Real Estate declined to comment.
Banks may be required to have a Tier 1 capital ratio, a key measure of financial strength, of at least 6 percent under the EU stress tests, the same threshold U.S. lenders faced last year, said two people briefed on the talks. Hypo Real Estate’s Tier 1 capital ratio was 7.7 percent at the end of March, according to a presentation on its website dated June 2010. The lender holds 72.1 billion euros ($93.4 billion) of debt in Greece, Italy and Spain, it said in May.
Germany’s Soffin bank-rescue fund had provided Hypo Real Estate with 7.87 billion euros in funds by the end of March. The state-owned lender has said it may require a total of 10 billion euros from the fund. The lender said on July 8 that it received approval to establish a so-called bad bank to transfer as much as 210 billion euros of investments consisting of "non-strategic assets and risk positions." The assets will be transferred in the second half of this year, according to the German Financial Markets Stabilization Agency, which manages the bank-rescue fund.
Hypo Real Estate has said it doesn’t expect to return to profit before 2012. The lender needed a total of 103.5 billion euros in credit lines and debt guarantees from the state and financial institutions to save the company from collapse in 2008 after the lender’s Dublin-based Depfa Bank Plc unit couldn’t raise financing when the bankruptcy of Lehman Brothers Holdings Inc. froze credit markets.
A summary of results of the stress tests will be released on July 23 at 6 p.m. CET, the Committee of European Banking Supervisors said in a statement on its website today. According to CEBS, the other German lenders tested are Deutsche Bank AG, Commerzbank AG, Deutsche Postbank AG, Landesbank Baden-Wuerttemberg, Bayerische Landesbank, Norddeutsche Landesbank Girozentrale, WestLB AG, HSH Nordbank AG, Landesbank Hessen-Thueringen Girozentrale, Landesbank Berlin AG, DZ Bank AG, WGZ Bank AG and DekaBank Deutsche Girozentrale.
Hungary Refuses Further Austerity After IMF Talks End
by Edith Balazs - Bloomberg
Hungary’s government won’t impose further austerity measures even after falling out with its international creditors, Economy Minister Gyorgy Matolcsy said, expressing confidence a new loan agreement will "eventually" be reached. The government, which faces local elections on Oct. 3, is committed to a tax on financial institutions for three years and seeks to raise 200 billion forint ($893 million) from the levy in 2010, Matolcsy said on M1 television today. "The alternative to the bank tax would be austerity measures which would restrain growth even more," he said.
The International Monetary Fund and European Union ended talks with Hungary at the weekend without endorsing the budget plans. The EU demanded "tough decisions, notably on spending," to meet deficit requirements. The IMF said the planned tax will have a negative impact on lending and growth. The suspension of talks is rattling investor trust in Hungary barely a month after politicians from the ruling Fidesz party compared the nation to Greece, roiling international markets. The government, which swept to power in a landslide victory in April, may delay spending cuts until after autumn municipal elections, analysts said.
"The new government has not learned its lessons from the previous gaffe, while the market is in no mood to overlook any fiscal laxity," Timothy Ash, head of emerging market research at Royal Bank of Scotland Plc in London, wrote in a note today. Hungary’s credit rating could come under threat as the country seems "to be going off-piste. Without IMF financing over the longer term, we doubt that Hungary can finance itself."
The forint slumped as much as 2.7 percent per euro and was trading 2.2 percent lower at 288.72 at 10:27 a.m. in Budapest from 282.10 on July 16. The currency is at its weakest since June 7. The benchmark BUX stock index fell 2.3 percent, the most since June 29, and credit default swaps, the price of insuring against a default rose 47.5 basis points to 370, according to UBS AG.
Hungary, the recipient of a 20 billion-euro ($25.8 billion) emergency bailout, is enduring its fifth consecutive year of austerity. The economy last year suffered its biggest decline in almost two decades, shrinking 6.3 percent. The government agreed to keep this year’s budget deficit target at an IMF-approved 3.8 percent of gross domestic product while indicating it wanted more fiscal room in 2011.
‘Force the Government’
"We believe market reality will finally force the government to take the necessary measures but this might not come before October," Gyula Toth, an emerging-market strategist at UniCredit SpA in Vienna, wrote in a note today. The Cabinet may be forced to announce some measures ahead of the elections, he said.
The IMF will return to Hungary in September to continue negotiations and an agreement with the Washington-based lender will eventually be reached, Matolcsy said at a conference in Vienna today. The suspension of IMF payments doesn’t endanger Hungary’s economic stability, he said. Concluding the review is a condition for disbursing funds from the bailout loan. Hungary has 5.7 billion euros of the package available. The government refrained from tapping it this year because it was able to finance spending through debt sales.
‘Funding May Freeze’
Hungary is seeking a new "precautionary" loan agreement with the IMF from next year as its current bailout expires in October. Even without the need to use the available funds, the backing of international creditors helps reassure markets and allows the government to borrow on the market, said analysts including Eszter Gargyan at Citigroup Inc. in Budapest. "The government has been planning to extend the current program until year-end and set up a new precautionary" loan " "from 2011, which in our view is an important assurance for the market," Gargyan said in a note to clients today. "The lack of agreement means Hungary’s access to market funding may freeze, especially if European financing conditions deteriorate."
The central bank may be forced to raise interest rates if the government fails to act quickly and currency weakness persists, Gyorgy Kovacs, an economist at UBS AG in London, wrote in a note today. "Financial markets might not grant the government breathing space until the municipal elections in October, and in this case the Hungarian government will have to present measures earlier to soothe investor sentiment," Kovacs said. The central bank left the benchmark rate unchanged at 5.25 percent today.
Ireland's debt downgraded by Moody’s
by Julia Kollewe - Guardian
Credit ratings agency Moody's has downgraded Ireland's debt rating, adding to investor jitters about the state of Europe's heavily indebted economies. The agency cut Ireland's sovereign bond rating by one notch to Aa2 this morning, citing weaker growth prospects and the high cost of rebuilding the country's crippled banking system. It added that the outlook was stable. But the downgrade comes after the International Monetary Fund and the European Union pulled a €20bn (£17bn) financing deal for Hungary over the weekend. Talks broke down on Saturday after the European commission voiced concerns over the newly elected Hungarian government's budget plans.
This means Hungary will not have access to remaining funds of €5.5bn in its €20bn credit line, agreed two years ago, until a review is completed. Gary Jenkins at Evolution Securities noted that Moody's also placed Spain's ratings on review at the end of last month. "Nothing on Italy yet, but considering that there is a two-notch differential between Moody's and S&P it would not be a major surprise if Moody's didn't take a look at Italy next," he added.
Europe's governments are rushing to shore up their finances after a spate of ratings downgrades – most notably to Greece, Spain and Portugal – plunged stock markets into turmoil. So-called austerity measures are being pushed through parliaments across the continent and in the UK, ranging from increasing retirement ages to slashing public sector wages and jobs.
Hungary's economy minister was defiant on this morning, ruling out further austerity measures, and insisting that the government would push through a new financial sector tax this year. "Hungary has experienced a programme of austerity over the past five years, we inherited this from the previous governments and we would like to do away with the unfortunate consequences of these steps," Gyorgy Matolcsy told public television station m1. "We have told our partners that further austerity packages were out of the question."
The IMF insisted on Saturday that Hungary will need to take additional measures to meet its deficit targets this year and next. In a separate statement, the European commission said reducing Hungary's deficit by next year "will require tough decisions, notably on spending". However, Matolcsy wants to cut Hungary's budget deficit to 3.8% of GDP mainly with funds raised from the planned tax on banks.
European shares fell for a third session this morning, led lower by banks, and the euro slipped off two-month highs. It bought $1.2925 this morning in early European trading, down from $1.2947 in New York on Friday night. In London, the FTSE 100 index traded down about 18 points at 5140.74. Market players are eagerly awaiting the results of stress tests on 91 European banks, which are due to be published on Friday.
What Germany Knows About Debt
by Tyler Cowen - New York Times
In many countries, including the United States, there are calls for the government to spend more to jump-start the economy, and to avoid the temptation to cut back as debts mount. Germany, however, has decided to cast its lot with fiscal prudence. It has managed rising growth and falling unemployment, while putting together a plan for a nearly balanced budget within six years. On fiscal policy and economic recovery, Americans could learn something from the German example.
Twentieth-century history may help explain German behavior today. After all, the Germans lost two World Wars, experienced the Weimar hyperinflation and saw their country divided and partly ruined by Communism. What an American considers as bad economic times, a German might see as relative prosperity. That perspective helps support a greater concern with long-run fiscal caution, because it is not assumed that a brighter future will pay all the bills.
Even if this pessimism proves wrong more often than not, it is like buying earthquake or fire insurance: sometimes it comes in handy. You can’t judge the policy by asking whether your house catches on fire every single year. Keynesians have criticized fiscal caution at this point in the economic cycle, arguing that fiscal stimulus will give economies more, not less, protection against adverse events. But is that argument valid?
Certainly, in Germany, the recent history of fiscal stimulus wasn’t entirely positive. After reunification in 1990, the German government borrowed and spent huge amounts of money to finance reconstruction and to bring East German living standards up to West German levels. Millions of new consumers were added to the economy. These policies did unify the country politically but were not overwhelmingly successful economically. An initial surge was followed by years of disappointing results for output and employment. Germany’s taxes remain high, and overall West German living standards failed to rise at the same rate as those of most other wealthy countries.
Persuading former East Germans to spend more as consumers turned out to be less important than making sure that they had the skills to mesh with the economic expansion of the country. It is no surprise that many Germans are now skeptical about debt-financed government spending or excessive reliance on domestic consumers.
In recent times, Germany has shown signs of regaining a pre-eminent economic position. Policy makers have returned to long-run planning, and during the last decade have liberalized their labor markets, introduced greater wage flexibility and recently passed a constitutional amendment for a nearly balanced budget by 2016, meaning that the structural deficit should not exceed 0.35 percent of gross domestic product.
Amid the sluggish economies of much of Europe, Germany has booming exports and is nearing full capacity utilization. And many of its workers are postponing vacations to produce, and earn, more. The unemployment rate in Germany is 7.5 percent — below that of the United States — and falling. Far from embracing this social democratic model, American Keynesians have criticized it for relying too heavily on exports and not enough on spending and debt. Yet it is not just the decline in the euro’s value that supports the German resurgence.
Most of the other euro-zone economies are not having comparable success because they did not make the appropriate investments and reforms. Moreover, the euro is still stronger than its average value since 2001, which suggests that the recent German success is not attributable only to a falling currency. In any case, the Germans are exporting much quality machinery and engineering (not just glitzy autos), which can help other nations recover. It is an odd state of affairs when the relatively productive nations are asked to change successful policies because of an economic downturn.
The German government is also making credible long-term commitments to reduce its debt. Germany’s ratio of debt to G.D.P. has been hovering in the unhealthy range of more than 70 percent, and the country has one of the lowest birth rates in the developed world, which raises the question of how to pay for future pensions. Yet many investors consider German bonds a haven, in part because the government has a reputation for addressing fiscal issues promptly and responsibly. It is working to cut government spending, although not in crucial long-term areas of research and education.
Germany is likely to continue having a higher relative level of government spending than the United States. But the German civil service has a stronger hand in writing legislation — a role that limits the sort of waste and short-term thinking that Congress injects into American law. It is also well understood in German political discourse that tax cuts need to be paid for.
The German economy is far from perfect. In addition to high taxes and a low birth rate, there are potential solvency problems in German banks, and these institutions lack transparency. Furthermore, poorer countries may need a looser monetary policy from the European Central Bank than Germany wishes to support. Nonetheless, it’s a common German attitude that adding debt, whether private or public, will not solve those problems. In fact, debt can provide the illusion of relief and thus postpone their resolution. Increased spending is a quick fix for what are very often more fundamental difficulties.
The point is not that Americans can or should copy Germany. But are German policy makers so wrong in their long-term orientation? We can lecture, or we can listen. The choice is ours.
Tyler Cowen is a professor of economics at George Mason University.
IMF seeks $250 billion boost to resources
by Christian Oliver and Alan Beattie - Financial Times
The International Monetary Fund is seeking commitments by as early as November to boost its lending resources to $1,000bn from $750bn to build safety nets that could prevent financial crises.
Instead of responding solely to crises with conditional loan packages, the IMF wants financing agreed in advance and specially tailored to individual countries, to cool market nerves over any nation facing an imminent liquidity crunch.
"Even when not in a time of crisis, a big fund, likely to intervene massively, is something that can help prevent crises," Dominique Strauss-Kahn, the IMF managing director told the Financial Times. "Just because the financing role decreases, doesn’t mean we don’t need to have huge firepower ... a $1,000bn fund is a correct forecast." South Korea, as this year’s president of the Group of 20 leading economies, is helping craft the plan. Seoul hopes to convince the G20 countries to back the increased IMF funding at a summit in South Korea in November. The G20 meeting in London in 2009 tripled IMF resources from $250bn. A US official said Washington was sympathetic to improved safety nets but needed more details on the Korean-IMF plan.
South Korean economists forged the plan because of their own bitter experience of their currency and stock market plunging in 2008. In spite of robust economic fundamentals, Seoul needed to be rescued from a dangerous liquidity shortfall by swaps from the US, Japan and China. To avoid a repetition of this, markets need to know there are pre-arranged facilities at the IMF backing a country up, said Shin Hyun-song, adviser on international economy to South Korea’s president. "This is meant to mitigate the type of liquidity spiral that we saw after the Lehman episode of 2008," Mr Shin said.
He said a "global stabilisation mechanism" being discussed could involve drawing up a risk curve for nations, with the least risky enjoying a status akin to platinum or gold credit card holders. These would be entitled to financing such as the IMF’s flexible credit lines, already used by Mexico, Poland and Colombia. They could be deployed before a crisis struck and would impose practically no conditions. Countries further down the curve would face tougher conditions. Loans to them would be called "precautionary credit lines".
Still, Mr Shin added that tighter regulation would be needed to avoid the moral hazard of countries taking greater risks because of the safety net. He also said discussions would need to resolve how not to put certain countries in speculators’ sights by revealing that they only had second tier protection. Eswar Prasad, a former head of the IMF’s China division and a professor at Cornell University, said this new lending scheme could simply shift the problem "from one place to another" and doubted that the plan would encourage many emerging markets to cut back their bumper reserves.
"If you have a country that is on the brink of trouble and the IMF says it does not qualify, then it will undoubtedly come under more pressure," he said. Mr Shin stressed the plan should still be complemented by the type of swaps that had proved so valuable to South Korea in the past.
Hedge Funds to Boost Use of Trading Algorithms for Stocks
by Nina Mehta - Bloomberg
Asset managers such as hedge funds will probably increase their use of computer programs known as algorithms to execute their stock trades in 2011, according to securities-industry research firm Tabb Group LLC. The proportion of orders processed by algorithms will probably amount to 35 percent next year, up from 29 percent in 2010, according to a report from Tabb analyst Cheyenne Morgan and director of research Adam Sussman. Human traders at broker- dealers will execute 35 percent of orders in 2011, down from 39 percent this year, the report said.
The growth during the past decade of electronic trading that allows investment firms to exert greater control over their orders has diminished the importance of sales traders at securities firms. Sales desks will generate $9.5 billion of the $15.3 billion in equity commissions paid to brokers this year, compared with almost $3 billion paid for algorithms, Tabb said. Algorithms break larger orders into pieces, executing them over a set time period to help ensure customers get the best prices. "In 2008 and the beginning of 2009, buy-side traders turned more to sales traders for guidance and advice about how to navigate the market, but that trend has reversed," Morgan said in an interview. "During the financial crisis they also became more comfortable with how algorithms performed."
Expectations for volatility in U.S. equities peaked in November 2008, two months after Lehman Brothers Holdings Inc. filed the biggest bankruptcy in the nation’s history. The Chicago Board Options Exchange Volatility Index, or VIX, which measures the cost of using options to protect against declines in the Standard & Poor’s 500 Index, closed at a record 80.86 on Nov. 20, 2008, and has retreated about 67 percent since then.
The Tabb study is based on interviews with 66 head traders at investment management firms with a total of $12.1 trillion in assets and 57 head traders at hedge funds with $182.1 billion. In the former group, 52 percent managed less than $50 billion, compared with 36 percent in 2009, New York-based Tabb said. Large firms, defined as investment companies overseeing more than $150 billion and hedge funds with more than $3 billion, accounted for 86 percent of total assets in each group.
The top five providers of algorithms to asset managers and hedge funds are Credit Suisse Group AG, Investment Technology Group Inc., Bank of America Corp., Goldman Sachs Group Inc. and UBS AG. Credit Suisse trading strategies are used by 69 percent of firms, the study found. Algorithms from Sanford C. Bernstein & Co. are used by 19 percent of firms and those from Weeden & Co. by 13 percent. The report described the latter two firms as "winners" among mid-tier brokers.
The estimated $15.3 billion asset managers and hedge funds will pay brokers in equity commissions this year is up slightly from $14.9 billion last year, the report said. The firms paid $17.2 billion in 2008. Asset managers accounted for 73.3 percent of those fees, down from 74.6 percent in the two previous years. Traders at the firms surveyed will manage 9 percent of their volume themselves next year -- the same as this year -- by placing orders directly on exchanges in what’s called direct market access, the report said. Their use of crossing networks and dark pools, or private venues that don’t display quotes publicly, will rise 1 percentage point to 13 percent in 2011, Tabb said.
Brokers get 3.2 cents per share from hedge funds using their sales trading desk, compared with 2.9 cents paid by asset managers. Hedge funds pay higher commissions than asset managers for sales trading, direct market access, dark pool executions and baskets of stocks sent to so-called program desks at broker- dealers. The only category in which hedge fund rates are lower is algorithms, for which they pay an average 0.9 cents per share, compared to 0.7 cents paid by asset managers.
Commissions to sales desks have "probably hit bottom" while investment firms are likely to "demand more services on the low-touch side," Morgan said. Low touch refers to the use of electronic trading tools. Sales traders at some brokers will need to provide more guidance to customers about how and when to use algorithms, while at others that advice may come from people staffing electronic desks, she said. "The buyside will also want more market color from low-touch desks," she added.
Goldman’s Sigma X dark pool is used by 33 percent of the study participants, followed by Credit Suisse’s Crossfinder at 24 percent. Aqua, a system for transacting larger trades than are sent to stock exchanges, and UBS’s PIN dark pool are used by 20 percent of firms. Morgan Stanley’s MS Pool has connections to 17 percent of the firms surveyed, Tabb said.
Pensions: how to defuse the Britain's savings time bomb
by Louisa Peacock - Telegraph
Life is full of little ironies. Steve Webb spent years in opposition with a smart office in the Houses of Parliament overlooking the River Thames. Now the Liberal Democrat MP has finally made it into office as the Minister of State for Pensions, he has been booted out of his riverside suite into a dingy little room baked in artificial yellow light. So much for power. Thrust into the biggest attempted pensions reform since the post-war years, Webb has his work cut out. Decades of lucrative final salary pension schemes and rising life longevity have caused liabilities to swell to an estimated £1.2 trillion in the public sector and about £239bn in the private sector.
In a week where the state was told it faced a £23bn pensions bill if BT ever went bust, Webb promised to consider how people can dip into their pension pots early and the Government vowed to ban the requirement to buy an annuity at 75. In both the public and private sector, pressure has now built up to boiling point to provide a system that works and is affordable. At the same time, there is now evidence that not enough people are saving for retirement and that up to 10m workers have no pension plan. Employers will be forced to offer all staff workplace pensions from 2012, a costly measure, and staff will be automatically enrolled in schemes unless they opt out.
Surely one of the consequences of all this is that people will have to work into their 70s before they can draw their state pension, right? Wrong, according to Webb. "The Secretary of State, Iain Duncan Smith, has already said 70 is nonsense," he says. "What we've said is, we'll look at 66 in the autumn, and then 67, and then 68."
If anyone can dispute the idea of having to wait until 70 before drawing a state pension, Webb can. He has more than seven years combined experience of working on pension matters for the Lib Dems prior to taking a seat in the coalition Government, but can he actually make pension reform work? He doesn't underestimate the scale of the challenge when he says the whole pensions system is often completely confusing. "There are corners of it that are profoundly utterly baffling. How can we expect people to understand what they'll get?" he asks. "People don't know what they're getting from the state, they don't know what private pension pots they're going to get. We need to set about all of that."
At the top of his to-do list, he tells me, is getting workers into occupational pension schemes. "In a few years' time, if you've got a situation where big swathes of the workforce are building up [pension] provision on top of the state pension, that would be one heck of an achievement," he says. "We need to get people that are historically unpensioned and under-pensioned into something that works for them, and it becomes a positive thing."
Webb concedes that to do this will be a "real cultural shift" – businesses already have concerns about the new auto-enrolment system, due to come into force in 2012 and currently under review. But the pensions minister insists the Government is serious about reform. "One of the things that's striking about the Coalition agreement is that you've got page one: world peace, and page two: automatic enrolment of workplace pensions. So the commitment to automatic enrolment is clear."
Under the plans, which were drawn up under Labour and could remain unchanged, the Government is set to introduce a new workplace pension scheme called the National Employment Savings Trust (Nest), formerly known as "personal accounts". This is designed for employers who do not have a pension scheme, but can be used by companies with an existing scheme. Employers will eventually be required to pay 3pc in contributions, although this will be introduced in stages, with a further 1pc coming from tax relief and 4pc from the employee.
One of the key concerns is that small firms, struggling to recover in a tough economic climate, cannot shoulder the extra costs. Webb agrees it is too early for small businesses. "It will be big employers going in first," he says. "It's several years then before we get to the smallest ones." But what about the potential problem facing all companies: the possibility that from day one of employment, workers can start accruing pension rights even if they are contractors? Webb assures me the review, due to report its recommendations in September, will address this.
Also up for debate is whether the lowest paid workers who can less easily afford contributions can be exempt from auto-enrolment. Webb hints this is unlikely. "The version we've inherited [from Labour] of auto-enrolment is terribly comprehensive, which means that in terms of having to enforce any of this, it's quite straight forward. As soon as you start moving the thresholds and so on, then you're drawing lines that people fall either side of."
To some extent Webb is relying on word of mouth and a bit of "trial and error" during the first few months, if not years, of the new auto-enrolment system for it to become a success. As with the National Minimum Wage legislation, there will be fines for employers who don't comply. But the approach is one of carrot rather than stick. It's a risky strategy, given that all the forthcoming state pension age changes – including the rise from 60 to 65 for women – and the phasing out of the default retirement age are "quite messy" for employers. What's to stop businesses getting so confused they just give up and carry on doing what they've always done?
The Chartered Institute of Personnel and Development adds fuel to this fire when it warns organisations "face a range of challenges", not least communicating and educating staff about the "complex" pensions system. "It's early days," Webb says. "I've been in place about eight weeks or so. I'm not being too hard on myself just yet." However, Webb admits employers could end up ignoring the new Nest scheme altogether. "One of the first things we think will happen is that those employers [with occupational pension schemes] will put their current workers into schemes already up and running and that will improve workplace pension coverage in a very simple way."
He sums up the Government's expectation on employers when he says: "We will expect people to auto-enrol their workers over the next few years into a workplace pension." Whether it's Nest or any other scheme, it doesn't seem to matter. What will matter to a huge number of employers that currently offer schemes is whether they can take advantage of the Government's recent decision to wipe as much as £100bn off the final salary pensions deficit, by linking retirement payments to a lower price of inflation. From next April, the Government will allow employers to use the Consumer Prices Index to calculate retirement promises, rather than the Retail Prices Index, a typically higher measure of inflation.
Although the changes are intended to be positive for business, experts have warned they create a "big headache" for about 50pc of employers whose pension plans refer expressly to RPI and cannot be changed by law. Many employers could miss out on the savings unless the Government changes the law. Webb neatly sidesteps this issue. "We will try to resolve all these matters as soon as we can," he says. "A scheme is entirely free to carry on... so it's only a burden if they want to change things." But doesn't that defeat the point? "We're not obliging anybody to do that. If you as an employer see RPI as part of the package you're offering, you may not want to switch."
Looking ahead on the pensions horizon, radical European Commission proposals could force British companies to inject an extra £500bn into their final salary pension schemes to meet a new funding demand, according to the CBI. Webb promises to fight against any unnecessary EU regulation that won't work in the UK. "There isn't a one-size-fits-all on these things," he says. "We're keen that anything that comes out of that final process is very much allowing members states to have schemes that fit their own needs."
Will Thousands Of Police Layoffs Unleash Chaos And Anarchy Across America?
by Michael Snyder - The Economic Collapse
Thousands of police officers have been laid off all across America since the current economic crisis began. Thousands more are getting ready to be laid off. So could we be on the verge of a new era of chaos and anarchy in America as crime runs wild and there are just far too few police to respond to it all? That is the message that one blood-smeared billboard in Stockton, California is trying to get across. Paid for by the Stockton, California police union, the message of the billboard is chillingly clear: "Welcome to the 2nd most dangerous city in California. Stop laying off cops." As state, city and local governments across the United States continue to be devastated by the ongoing economic crisis, budget cuts are becoming much deeper and police forces have suddenly become a very popular target.
Officer Steve Leonesio, the president of the Stockton Police Officers Association, has announced that the police union plans to spend approximately $20,000 on at least 20 more billboards.
Why is the union putting up all of these billboards?
Well, it turns out that Stockton has been considering a plan to lay off 53 police officers in an effort to eliminate a $23 million budget deficit.
But law enforcement in Stockton has already been cut to the bone. Recently, the Stockton Police Department dropped this bombshell....
"We absolutely do not have any narcotics officers, narcotics sergeants working any kind of investigative narcotics type cases at this point in time."
Do you think drug dealers will be flocking to Stockton after they hear that?
But the truth is that so many of these local governments around the nation are just flat broke at this point.
Even major cities are having to admit that they have accumulated such large debts that they cannot even afford to provide the most basic services any longer.
In Oakland, California the battle over police layoffs has made national headlines over the past couple of weeks. Oakland has laid off 80 police officers, and now the police chief says that there are some crimes that his department simply will not be able to respond to.
In fact, Chief Anthony Batts has compiled a list of exactly 44 situations, including grand theft, burglary, car wrecks, identity theft and vandalism, that his officers will not be available to handle any longer.
What in the world?
Once upon a time in America you could get a police officer to come out for just about anything - including for getting a cat down out of a tree.
But those days are long gone.
Today it is very hard to get a police officer to come out for anything short of murder.
The following is a partial list of crimes that police officers in Oakland will no longer be responding to....
- grand theft
- grand theft: dog
- identity theft
- false information to peace officer
- required to register as sex or arson offender
- dump waste or offensive matter
- discard appliance with lock
- loud music
- possess forged notes
- pass fictitious check
- obtain money by false voucher
- fraudulent use of access cards
- stolen license plate
- embezzlement by an employee (over $ 400)
- attempted extortion
- false personification of other
- injure telephone/power line
- interfere with power line
- unauthorized cable tv connection
Not that Oakland wasn't already a mess, but now how long do you think it will be before total chaos and anarchy reigns on the streets of Oakland?
But Oakland is far from alone.
The sheriff's department in Ashtabula County, Ohio has been slashed from 112 to 49 deputies, and there is now just one vehicle remaining to patrol all 720 square miles of the county.
So what are the citizens of that county supposed to do to protect themselves?
Well, when asked about what they should do, Judge Alfred Mackey gave this stunning piece of advice....
So is that what we are left with?
Is American society degenerating into a "Road Warrior-style" wasteland where we are all left to fend for ourselves?
It gets really frightening when you start considering just how many police are actually being laid off across the United States....
*Acting State Police director Jonathon Monken has announced that the Illinois State Police will lay off more than 460 troopers and close five regional headquarters by this fall.
*Atlantic City Mayor Lorenzo Langford has proposed a plan to lay off 40 police officers.
*The police department in Vallejo, California will temporarily suspend its K-9 and SWAT programs at the end of the month in a move to delay officer layoffs.
*Last year, 18 special police units in Toledo, Ohio - including the gang task force and the mounted patrol - were eliminated or downsized in an effort to replace the 130 patrol officers who were laid off because of a $20.7 million budget deficit.
*Of 315 municipalities the New Jersey State Policemen's union canvassed, more than half indicated that they were planning to lay off police officers.
*Four police officers in one town in New Jersey were greeted at work this past Monday morning with notices informing them that they will be laid off on August 31st.
*Police in Phoenix, Arizona have been told that more than 400 officers could be impacted by layoffs if "the worst case scenario" plays out.
*Police and firefighters in Flint, Michigan decided that layoffs were preferable to taking a 15 percent pay and benefits cut.
*The city of Maywood, California laid off all 68 of its employees July 1st and is now "contracting out" police services.
*In Colorado Springs, dozens of police positions are going unfilled and the police helicopters were put up for sale on the Internet.
The sad thing is that as local police forces across America are being stripped down or dismantled, many communities are opening their arms wide to increased federal law enforcement "assistance".
In recent years, we have seen a large number of examples where the U.S. military is being used for domestic law enforcement, which is supposed to be against the law. In addition, federal government agencies are increasingly taking over the financing, training and even command of local police.
But is this "federalization" of local law enforcement a good thing?
Of course not.
Unfortunately we live at a time when almost everything is being centralized under federal government control. Of course this is completely contrary to everything that our founders intended, but most of our "officials" don't seem too concerned about actually following the Constitution these days.
RICO law made to combat Mafia used in BP lawsuits
by Curt Anderson - AP
Using a law originally enacted to combat the Mafia, attorneys are filing lawsuits accusing BP PLC and Transocean Ltd. of committing a longterm series of crimes by concealing flaws in deepwater drilling plans and lacking safeguards to contain a catastrophic Gulf of Mexico spill. BP has been named in at least three lawsuits brought under the federal law known as RICO, which stands for Racketeering Influenced and Corrupt Organizations. Transocean, which leased the ill-fated Deepwater Horizon drilling rig to BP, has been named in two lawsuits filed in Louisiana and Florida.
The lawsuits accuse both companies of committing wire and mail fraud over a number of years by filing false documents with the U.S. government, and by misleading investors through other documents and falsehoods. They also claim both companies are guilty of bribery because they are part of an overall oil and gas industry effort to "infiltrate" federal regulators by providing favors such as alcohol and drugs, sex, golf and ski trips, concert and sports tickets, and more.
"The pattern of racketeering activity engaged in by defendants involves a scheme to fraudulently create a pretense of safety to the public while, at every turn, seeking to avoid the costs associated with actually conducting their operations in a safe manner," claims a lawsuit filed by Louisiana attorney Daniel Becnel and others on behalf of a restaurant seeking to represent a huge class of businesses suffering economic loss from the oil spill.
RICO, passed by Congress in 1970, contains both a civil and criminal component, but both of them rely on proof of longterm violations of at least two specific crimes from a lengthy list. The attraction of the civil portion, which are being used in the current lawsuits, is that any damages would be tripled. In the past, civil RICO cases have often been followed by criminal prosecutions. The Justice Department has not ruled out using RICO in its ongoing criminal investigation of the Deepwater Horizon explosion, which killed 11 rig workers and triggered a massive oil spill that has affected five Gulf Coast states.
Criminal convictions can lead to prison sentences of 20 years on each racketeering count, plus hefty fines and forfeiture of ill-gotten gains. "We are investigating any possible violations of the law," said Justice Department spokeswoman Hannah August.
Florida attorney Peter Prieto, a former federal prosecutor, said it might be a stretch for the Justice Department to bring a criminal RICO case when there might be easier-to-prove offenses. "If it's a simpler crime, that's what they are going to do. Prosecutors are going to use RICO when it is truly applicable or when it involves organized crime," said Prieto, who is not involved in the oil spill cases. "It is kind of a hammer, but if the facts fit RICO, you can use RICO."
Even as use of RICO in criminal cases has waned somewhat, it's become increasingly popular on the civil side. This year alone, RICO lawsuits have been filed against the Roman Catholic Church over priest abuses; Toyota over its sudden acceleration problems; a group of title insurers over alleged overcharges; and online cigarette vendors over lost tax revenue. In March, pharmaceutical giant Pfizer was ordered by a Boston jury to pay $142 million in damages for wrongly marketing the epilepsy drug Neurontin as treatment for migraines and bipolar disorder.
The difficulty in the BP and Transocean cases, some experts say, is finding evidence tying the companies' actions to damages caused by the spill. On the criminal side, a prosecutor would have to have ironclad proof of criminal intent, not just negligence or stupidity. "The problem is just connecting the dots," said Thomas Walker, an Idaho attorney who has tried about 20 civil RICO cases and maintains a blog on RICO. "The fraudulent communications, if they were fraudulent, went from BP to the government. The damage was not caused by the letter, it was caused by the oil spill."
The RICO lawsuits are among more than 200 filed against BP, Transocean and other companies seeking damages for economic losses, environmental damage and shareholder losses. A federal judicial panel will meet July 29 in Boise, Idaho, to consider whether to consolidate some or all of them for pretrial purposes. Potential damages from those lawsuits would come on top of the $20 billion BP has pledged to set aside to pay claims and other spill cleanup costs.
Most of the criminal allegations in the RICO lawsuits are taken from testimony and documents produced by congressional investigations of the spill, documents filed with financial regulators and investors, and even investigative news articles by The Associated Press and other news outlets. For example, the Louisiana complaint charges that:
• According to an AP story, an independent firm hired by BP in 2009 found the company was violating its own policies by failing to have key engineering documents aboard the deepwater drilling rig Alantis. The study was never disclosed to regulators.
• BP filed documents showing it had a solid response plan for a catastrophic oil spill, when in fact it "lacked any meaningful ability" to resond.
• BP repeatedly failed to disclose to the U.S. Interior Department a range of safety concerns about the Deepwater Horizon, including use of a risky well cementing technique and problems with pockets of flammable natural gas.
• Transocean assured investors and regulators that it had an excellent safety record, when in fact it was responsible for an increasing number of accidents on deepwater drilling rigs.
• Both companies are part of an oil industry effort to prevent the Minerals Management Service — now renamed the Bureau of Ocean Energy Management — from imposing tough rules, in part through industry events where government officials were given cocaine, marijuana and alcohol, had sex with company executives and received gifts ranging from exotic travel to concert tickets.
Matt Simmons still says BP covering up MASSIVE HOLE miles away, cap test is absurd
What If He's Right?
by James Howard Kunstler
Just when America was celebrating the provisional end of BP's Macondo oil blowout, and getting back to important issues like Kim Kardashian's body-suit collection, along comes Matthew Simmons with a rather strange and alarming outcry on doings in the Gulf of Mexico that contradicts the mood of renewed festivity, as well as just about every shred of reportage from any media outlet, mainstream or otherwise.
Matt Simmons Houston-based company has been the leading investment bank to the US oil industry for a long time, financing exploration and drilling in places like the Gulf of Mexico. Simmons, 68, recently retired from day-to-day management of the company. For much of the decade he has been what may be described as a peak oil activist. His 2005 book, Twilight in the Desert, warned the public that Saudi Arabia's oil production had reached its limits and, more generally, that an oil-dependent world was entering a zone of serious trouble over its primary resource. He took this aggressive stance despite risking the ire of the people he did business with.
Matt Simmons is a sober individual and a very nice man (I've met him twice over the years), a button-downed corporate executive who's been around the oil business for forty years. His knowledge is deep and comprehensive. From the beginning of the BP Macondo blowout incident in April, he's taken the far out position that the well-bore is fatally compromised and that BP has been consistently lying about their operations to stop the flow of oil. Perhaps most radically, Simmons claims that an oil "gusher" is pouring into the Gulf some distance from the drilling site itself.
Last week, Simmons came on Dylan Ratigan's MSNBC financial show, but he did a longer interview over at the King World News website. Simmons's current warning about the situation focuses on the gigantic "lake" of crude oil that is pooling under great pressure 4000 to 5000 feet down in the "basement" of the Gulf's waters. More particularly, he is concerned that a tropical storm will bring this oil up - as tropical storms and hurricanes usually do with deeper cold water - and with it clouds of methane gas that will move toward the Gulf shore and kill a lot of people. (I really don't know the science on this and welcome any reader to correct me, but I suppose that the oil "lake" deep under the Gulf waters contains a lot of methane gas dissolved at pressure, and that as the oil rises toward the ocean's surface, and lower pressures, the gas will bubble out of solution.)
Simmons makes two additional points that are pretty radical: he says that several states along the Gulf ought to begin systematic evacuations in counties along the shore now. From his experience in Houston with Hurricane Rita (2005), he says a last-minute evacuation is bound to be a disaster -- the highways jammed hopelessly, drivers ran out of gas, and then the gas stations ran out of gas. Based on where the nation's collective state-of-mind is these days, I can't imagine that any Gulf state governor or mayor will heed this warning and begin preparing an evacuation now. (The practical problems are obvious for householders but what if it really is a matter of life and death?)
Secondly, Simmons maintains - as he has from near the beginning of the blowout - that the US military should take over operations from BP and ought to set off a "small" nuclear device down in the well-bore to fuse the rock into glass and seal the site permanently. Simmons says, based on his experience growing up in Utah near the government's underground nuclear testing sites in neighboring Nevada, where scores of very large atomic bombs were set off for years with no measurable consequences above ground, that a small nuclear explosion down in the Macondo well is unlikely to have any effect above the undersea rock surface. I have no idea, personally if this is true.
Matt Simmons is taking a position so "out there" that even the radical peak oil website theoildrum.com won't comment on his remarks (at least not as of early Monday morning July 19). I don't know how to evaluate Simmons's contentions myself, except to say that I don't believe Simmons is a nut, or that he's lost his marbles. We also must suppose that someone in his position is able to talk with an awful lot of the best people in the oil industry. Simmons has put his reputation on the line. A lot of bystanders and commentators are treating him as a fool. Simmons himself is painfully aware of his lonely stance and seems, in his public appearances, to be a very regretful messenger.
In the past twenty-four hours, BP has reported some possible leaks coming out of the seabed some distance from the well-bore. Nobody has been able to confirm yet exactly what is happening down there. One other thing Simmons said is that BP should be barred from the media airwaves since, he says, they have lied consistently in order to cover up their criminal negligence and culpability. The company itself cannot be saved because the claims against it are much greater than the value of its assets - but the people running the company could be sent to jail, so the incentive to keep lying remains high.
Jesse at the Jesse's Café Américain website makes an excellent point that if Matt Simmons is correct, and it turns out that the US government has been played by BP, then remaining public trust in the competence and legitimacy of government could evaporate. This is not a happy thing to contemplate at a time when the state of the nation and its economy are so fragile. What follows could make the current political situation seem like little more than, well, than a tea party, compared to the politics-to-come.
Readers here at Clusterfuck Nation are probably well aware of my past declarations of being allergic to conspiracy theories and crazy ideas generally. I'm not really equipped to evaluate Matt Simmons's warnings about the exact nature of the Macondo blowout and what might happen in the months ahead. But I am confident, having met the guy and corresponded with him and read his books, that he is a straight shooter. I'm sure that he is sincere in proclaiming his extreme discomfort with the position he's taken.