"Two men in corridor of Mineral Bath House, Ypsilanti, Michigan"
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Ilargi: In the fore- and after math of last week's QE2 announcement by Ben Bernanke (by the way, I really like Frederick Sheehan's observation: Ben Bernanke: The Chauncey Gardiner of Central Banking), a vast majority of the usual experts and analysts were convinced that A) the dollar would greatly devalue, and B) vast amounts of money would blow giant bubbles in markets across the world, especially in Asia.
Since the announcement, though, the US dollar has gained some 4-5% against the euro, while last night's plunges of -5.16% in Shanghai, -2% in Hong Kong and Indonesia, and -1.4% in Tokyo, don't exactly corroborate the usual suspects' bubble theories either.
There are two reasons why their predictions are not coming through. First, the whole "inflationary" theme was dissolved even before last Thursday: an asset-for-asset swap like QE2 is, is by definition not inflationary. And investors may run with the expert pack for a while, but they're not all completely silly.
Second, Europe has seen Bernanke's latest act as the ultimate and final move -well, for the moment- from Washington to devalue the dollar; not the first or worst as some would have you think. Cue the stories about Ireland's demise, renewed Portuguese and Greek troubled waters, and France following Germany in its hard-line stance against further EU bail-outs.
The USD lost 15% of its value vs the euro over the summer, and while the highly export-dependent richer nations in Western Europe may have patiently waited for the US to lose its devaluation drive, their goals haven't changed a bit in the meantime. They may not aim for US dollar-euro parity, but a €1 to $1,10 exchange rate would suit them just fine.
And then it all becomes a question of power and control. In my view, the American financial press continues to assume far too easily that the US has the tightest grip on those. There are advantages to having so many foreigners use your currency for international transactions, but those show mostly in times of growth and prosperity. In times of contraction, significant disadvantages may appear.
It's all been pretty well scripted, wouldn't you agree? And as I was saying, I simply don't believe that the rest of the world sees a measure such as QE2 as a sign that the US can prolong its "beggar-thy-dollar" politics. I think it's widely perceived as a sign that the US has lost control of its currency policies, not gained more control. And that inevitably will lead to attempts, or even a concerted effort, by just about anyone but the US to revalue the dollar upward.
Even China may chime in, and even if that means, because of the peg, that the yuan will go up too. China's foreign reserves have lost a lot of value the past half year, and this might well be seen as a way to get some of it back. And then sell it off to the Fed in QE3.
This whole notion of devaluing the dollar (don't you just love the way Tim Geithner denies any such notion even exists in his neck of the woods) has many facets. Bring it down long enough, for instance, and the reserve currency status is at peril. Now you can ask ten economists what that would mean, and get eleven different answers, but one thing that's certain is that even simply questioning that status will lead to a huge surge in uncertainty.
The G-20 thingy in Seoul will, if you read through the official and subsequent media blah, serve to make one thing very clear. There is no possibility of any sort of any international agreement or even plan anymore. The knives are on the table, and they've been sharpened far too well to be put back into the respective pockets around the table. It's game-on time. And since there is no reason to believe that the US is stronger than all the rest of the world combined, there is a solid probability that the US dollar will increase in value, despite Q2, Q3, or Q826. A question of control.
Down the line all major currencies that exist in the world today will be toast, since they're all fiat, and they all represent economies about to implode inward on themselves. That does not, however, justify the claim that the US will fall vs the others while the process of implosion takes hold for real. Betting against the US dollar is a very risky wager from here on in, one that I for one won't take.
Ben Bernanke: The Chauncey Gardiner of Central Banking
by Frederick Sheehan - Credit Writedowns
"[H]igher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes."
-Federal Reserve Chairman Ben S. Bernanke, Washington Post, November 4, 2010
In Ben Bernanke’s Washington Post elucidation of Fed policy, "What the Fed Did and Why: Supporting the Recovery and Sustaining Price Stability," the Fed chairman cut-and-pasted misleading paragraphs from earlier misleading speeches. He did not discuss the two most important aspects of his money experiment. Bernanke did not address, first, the real economy or, second, the rest of the world. It will be the first of these lapses that will be discussed below.
On November 3, 2010, the Federal Open Market Committee’s [FOMC] decided to buy $600 billion in bonds. The exchange works as follows: $600 billion of cash will be dispensed to the banking system by the Fed and $600 billion of U.S. Treasury bonds will be extracted. The Fed will also reinvest over $400 billion of maturing mortgage securities it bought earlier and buy Treasuries. The total purchases of over $1 trillion will satisfy, to some degree, the Federal Reserve’s unstated but sine qua non obligation to fund the Treasury Department’s deficit.
This package is known as QE2: quantitative easing, second round. The first round was initiated in March of 2009. On March 18, 2009, the Fed announced it would buy $750 billion of mortgage-backed bonds, $100 billion of Fannie Mae and Freddie Mac securities, and $300 billion of long-term Treasury securities.
To herald the New Era in central banking, Chairman Bernanke appeared on "60 Minutes." His March 15, 2009, TV appearance was introduced with fanfare: "You’ve never seen an interview with Ben Bernanke… By tradition, Federal Reserve Chairmen do not do interviews. That is, until now."
On the show, Chairman Bernanke forecast that "green shoots [will] appear in different markets."
INTERVIEWER: "Do you see green shoots?"
Chairman BERNANKE: "I do. I do see green shoots."
"Do you see green shoots?," became the question on CNBC that every guest was asked. Most saw green shoots, some were looking for them, and others thought the question was childish, and probably did not receive another invitation to this carnival.
Before embarking on QE2, one might suppose the FOMC studied the aftermath to QE1. In this regard, the central bankers were handed a treat. Bernanke’s Domino Theory in the November 4, 2010, Washington Post is quoted above. The catalyst for recovery is "higher stock prices." The stock market has risen 75% since March 9, 2009. Bernanke could not have asked for a more boisterous number to plug into his equation.
The result? Incomes have fallen. Employment is hard to find. In the Washington Post, the Fed chairman justified QE2 (as he had QE1) by stating the Fed’s mandate "to promote a high level of employment." The official and understated unemployment rate was 8.1% when Bernanke was interviewed in March 2009. The official rate has risen to 9.6%. The "U-6" level of unemployment has risen from 15.6% to 17.0% since March 2009.
This number, calculated and released monthly by the Bureau of Labor Statistics, includes the unemployed plus those who are "discouraged" – people who have not looked for a job in the past four weeks because they think there are none – plus, those working part time because they cannot find a full-time job. The number of unemployed who have been without a job for 27 weeks or longer rose from 3.2 million in March 2009 to 6.2 million in October 2010.
Nevertheless, Bernanke’s central-planning unit will fix higher stock prices: Please note, in his Domino Theory, "higher stock prices" are not conditional. Bernanke’s assumption should not be taken unconditionally to the market, since Bernanke’s plan will fail, but it may produce a Garden of Eden before we drown in a Valley of Tears.
An example of Bernanke’s checkered record in market rigging is the Fed’s failure to boost the housing market. The Fed has bought over $1 trillion of mortgage securities. According to the National Association of Realtors, the average existing home sales price in March 2009 was $170,000. This rose to $183,000 in June 2010, but has now fallen to $172,000. This much can be said of the Fed’s mortgage effort: without it, house prices would be much lower.
Another noteworthy feature of the Post article is Bernanke’s narrow understanding of an economy. He described it as a "virtuous circle that will ‘further support economic expansion.’" (Further expansion is false, but so was the entire article.) The virtuous circle will "lower mortgage rates" and "lower corporate bond rates" and prod "higher stock prices," according to Bernanke. This will "spur spending."
He did not mention that personal consumption did rise in September 2010 (by 0.1%). Alas, this was achieved the old-fashioned way: Americans spent more than they earned. The chairman shows no signs of understanding there are many paths by which "increased spending will lead to higher incomes" and that he is navigating the worst one. (For the lower 99.9% of the American people that is, not for the Federal Reserve chairman.)
That is the entire American economy according to the Fed chairman, the former college economist, who calls himself a macroeconomist. What "macro" means to the professor is uncertain, but the dictionary defines a macroeconomist as one who studies the economy "as a whole."
It is surprising the P.R. division at the Fed did not tell the horticultural expert he should at least mention "Main Street," or the "real economy," two terms used to distinguish the rest of America from Wall Street and Washington. (Wall Street and Washington being one in the same.)
In the Post, Bernanke’s only solution to economic doldrums is to manipulate asset prices. He has spent the past 18 months distorting stock, bond, commodity, and currency markets. This is from a man who never spent a day off a university campus until he went to Washington. (From the "60 Minutes" interview: "I’ve never been on Wall Street.")
Jobs and higher incomes are produced from profits. Bernanke never used the word "business" in his Post piece. He never mentioned "banks" or "banking" or "credit." Saving the banking system was (apparently) his crutch for pouring money into banks and regenerating their criminal culture. He is, after all, running the central bank, but his financial system, and his economy, has been reduced to stocks and bonds.
Nevertheless, taking the world as it is and not as Simple Ben would have it, business and bank loans are part of the economy and QE1 had little influence on either. In his one, glancing reference to the job-creating world, the Fed chairman asserted: "Lower corporate bond rates [courtesy of the Fed's manipulations - editor's note] will encourage investment."
Really? In its latest poll, the National Federation of Independent Business (NFIB), which represents small businesses, found that 52% of its members do not want a loan. That is a record high. Only 3% of NFIB members said getting a loan was a problem.
Stephen Schwartzman, co-founder of Blackstone, the ubiquitous private-equity buyout firm, sees no point to QE2: "It’s not an enormous incentive to do something different with your businesses because rates are down a few basis points. Money is already quite cheap." It is so cheap that Wall Street has leveraged itself to an estimated record $144 billion payout in 2010 bonuses, according to MSN News.
Again, taking the world as it is and not as it should be, we are stuck with Simple Ben. He has announced QE2, restating the same ambitions as when he launched QE1. Albert Einstein has been quoted by several critics in reference to QE2: "The definition of insanity is doing the same thing over and over again and expecting different results." Bernanke’s inability to do anything other than what he has done before resembles a fictional character with a narrow view of the world.
Chauncey Gardiner (actually, Chance the Gardener), was the mentally incapacitated gardener played by Peter Sellers in the screen version of Jerzy Kozinski’s sagacious novel Being There. Chauncey, a man whose life was limited to gardening and watching TV, became, through a series of misapprehensions, the top adviser to officials in Washington, including the President:President "Bobby": Mr. Gardener, do you agree with Ben, or do you think that we can stimulate growth through temporary incentives?
Chance the Gardener: As long as the roots are not severed, all is well. And all will be well in the garden.
President "Bobby": In the garden.
Chance the Gardener: Yes. In the garden, growth has it seasons. First comes spring and summer, but then we have fall and winter. And then we get spring and summer again.
President "Bobby": Spring and summer.
Chance the Gardener: Yes.
President "Bobby": Then fall and winter.
Chance the Gardener: Yes.
Benjamin Rand: I think what our insightful young friend is saying is that we welcome the inevitable seasons of nature, but we’re upset by the seasons of our economy.
Chance the Gardener: Yes! There will be growth in the spring!
Benjamin Rand: Hmm!
Chance the Gardener: Hmm!
President "Bobby": Hmm. Well, Mr. Gardiner, I must admit that is one of the most refreshing and optimistic statements I’ve heard in a very, very long time.
[Benjamin Rand applauds]
President "Bobby": I admire your good, solid sense. That’s precisely what we lack on Capitol Hill.
President Bobby adopted Chance’s optimistic advice in an address before the Financial Institute of America. His speech was the talk of the town. Television, even in that distant past (Being There was written in 1970), was on the spot, with its unfailing ability to trivialize any topic.
The host of "This Evening," a fictional, national TV news show with 40 million viewers, asked Chauncey Gardiner to appear after the Vice President cancelled.
Chauncey was asked for his opinion of the President’s address, in which President Bobby "compared the economy of this country to a garden and indicated that after a period of decline a time of growth would naturally follow." Chauncey replied: "I do agree with the President: everything in it will grow strong in due course. And there is still plenty of room in it for new trees and new flowers of all kinds."
At the end of Chauncey’s appearance, the host embraced him center stage. The audience’s "applause mounted to uproar."
After his "green shoots" prophecy, Chairman Bernanke closed his "60 Minutes" performance. He offered Americans a sunlit future: "I think we will see recession coming to an end, probably this year . We’ll see recovery beginning next year, and it will pick up steam, over time." In the wake of this rousing prediction from the Chauncey Gardner of Central Banking, Wall Street TV performers have talked the stock market up 75%. We are seeing new vistas of instability.
Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009).
Jeremy Grantham: US Markets Dangerously Overpriced'
In an extended interview, Jeremy Grantham, chief investment strategist at Grantham Mayo Van Otterloo (GMO), talks to Maria Bartiromo about the markets, the economy, and his investment strategy.
"In 2000 the Fed had a good balance sheet and the government had a good balance sheet. in '08 it was still semi-respectable, and now it's not. It's not very respectable at all," Grantham says in the second minute of the interview. "So what are they going to use as ammunition if they cause another bubble and it breaks in, say, a couple of years? Then we might have some real Japanese-type experiences".
Ireland: The Celtic Tale of Jonah and the Whale
by Peter Atwater - Minyanville
I think this morning’s Wall Street Journal cover story on Ireland does a pretty good job of describing how Jonah, or in this case Sian, swallowed the proverbial whale.
Longtime Minyans know I've been asking for some time “Who will save the lifeguards?” and among my list of the lifeguards most at risk, Ireland has long been at the top. For put simply, relative to its domestic GDP, the “empire” banks that the well-intended Irish government chose to bring on board are simply too big for the boat.
But with all due respect to the team at the Wall Street Journal, I think they concluded their article too soon, for there are important events that have occurred in the past few weeks that I believe are critical to understanding how this crisis may unfold from here.
As part of its latest rescue of Anglo Irish, Irish Finance Minister Brian Lenihan introduced the concept of “burden sharing,” concluding that it was one thing for Irish taxpayers to make depositors and senior debtholders whole, but another thing altogether for subordinated bondholders to be bailed out as well. And the net result was that subordinated bondholders now have the opportunity to “exchange” their bonds for either $0.25 on the dollar or take just a penny on the dollar.
In many respects this follows the model that the US government used in its bailout of Fannie Mae and Freddie Mac, in which the senior debtholders were protected, but those below in the capital structure were sacrificed.
But please appreciate that the “burden sharing” genie has now been let out of the Bailey’s bottle. And ever since the Anglo Irish subordinated debtholders were taken to the financial woodshed, Irish spreads have widened considerably -- with the thought being, if Ireland is willing to “burden share” with subordinated bondholders at Anglo Irish, what is there to stop the country from moving further up the capital structure to Anglo Irish (and now Allied Irish) senior bondholders as well. And then there's the whole issue of Irish sovereign debt. With the lifeboat now seemingly sinking, it's all beginning to look like an episode of Survivor where the audience knows that somebody is about to be voted off, it just doesn’t know who.
But there's another dimension to the situation as well. Until recently, Europe thought that the EFSF (the European Financial Stability Fund) would be brought in to buoy sinking ships like Ireland until conditions improved. The EFSF would buy Irish debt, ensuring sovereign liquidity, while the country got its financial house in order.
As readers know, I've been particularly leery of the fundamental soundness of the ESFS with regards to its ability to act as tug/fire boat. For a start, its Rube Goldberg SIV structure is precariously cumbersome. And I've been deeply troubled for sometime that the ESFS’s ratings are entirely dependent on “the ability and willingness of Germany, France, and The Netherlands” to support the program. Each of those countries has a contingent, not funded, obligation.
Having witnessed the decoupling of “willingness” and “ability” here in the US by both unworthy and worthy mortgage borrowers alike, I have felt that it was only a matter of time before we'd see this same behavioral change move to governments. (And as a related side note I’d highlight another article in the Wall Street Journal entitled “New Risks Emerge in Munis” where this exact behavioral change is afoot among US state and local governments as well.)
I raise the decoupling of “willingness” and “ability” because two weekends ago at an ECB meeting, German leaders made it clear that German taxpayers will not carry Europe alone. As German Chancellor Angela Merkel said, “The president of the European Central Bank has the view that he wants to do everything to ensure that markets take a calm view of the eurozone… We are also interested in that, but we also have to keep in mind our people, who have justified desire to see that it’s not just taxpayers who are on the hook, but also private investors.”
Call me crazy, but that sure sounds like German for “burden sharing” to me.
So now we have Irish Finance Minister Lenihan and German Chancellor Merkel effectively saying the same thing. Neither weak country nor strong country taxpayers will step up without bondholders coming to the table.
Unfortunately, that doesn’t exactly foot with the ECB Stress Tests from this summer. As readers may recall, in that exercise banks were only required to consider potential market-to-market volatility for their trading accounts. Held-to-maturity sovereign debt -- which, per the OECD, accounts for almost 83% of all bank holdings -- were assumed to mature at par. It’s why I said at the time that it wasn’t the haircut, but rather the hairstyle that mattered. And the ECB chose a “mullet” -- business in the front, party in the back.
So to pull all of these pieces together, we now have a high likelihood of some kind of European sovereign debt default. And one that was not a Stress Test scenario.
That’s where we are today and it will be very interesting to see how it unfolds from here. So watch Ireland.
But while I'm on this topic, I have one final thought that I think is important for US-only investors. For the first time in this crisis, “resolution” is going to be driven by non-US participants. There's no real role for US policymakers as Ireland, Germany, France, the ECB, and bondholders come to the table. But very soon, precedence will be set; and one that attempts to simultaneously tackle the future financial condition of both Jonah and the whale, at the expense of their bondholders.
Why do I raise this? Because with every passing day, there appears to be a growing whale in Joey’s lifeboat. Last week, media reports suggested that the cost of bailing out Fannie and Freddie could reach $600 billion.
To date, the bailout of Fannie and Freddie has been absorbed by US taxpayers, with, as I mentioned above, burden sharing limited to subordinated creditors and shareholders.
I don’t pretend to know Washington’s threshold for pain. But we are about to discover Europe’s.
Tough choices are about to be made as Ireland answers whether the story is “Jonah and the whale” or rather “Jonah or the whale.” But the net result is that we soon know the answer to “Who will save the lifeguards?” And that answer has global, not just European, implications.
The wind is changing directions. As they say at sea, “All hands on deck. Get ready to come about.”
Portuguese, Irish Debt Lead Peripheral Drop on Budget Concern
by Keith Jenkins - Bloomberg
Irish government bonds tumbled for a 13th day on mounting concern that the nation will be forced to restructure its finances. Spanish bonds also headed for a 13th day of declines as data showed the nation’s economic growth stalled. French Finance Minister Christine Lagarde said yesterday that investors must share in the cost of safeguarding sovereign debt. German bunds advanced on demand for the safest assets, while Portuguese debt recovered from earlier losses. Italian bonds fell.
“Lagarde’s comments mentioned restructuring, and that’s another nail in the coffin” for so-called peripheral nations’ debt, said Steven Major, global head of fixed-income research at HSBC Holdings Plc in London. “There’s still a big constituency of investors and traders who have not recognized until now that restructuring could happen.”
The yield on the Irish 10-year bond added 31 basis points to 9.07 percent at 4:18 p.m. in London. The 5 percent security maturing in October 2020 slipped 1.65, or 16.5 euros per 1,000- euro ($1,367) face amount, to 74.09. The decline extends the longest losing streak in at least three years. Irish securities slid yesterday as clearing house LCH Clearnet Ltd. demanded its clients place a larger deposit when trading the debt. The Irish spread over bunds reached an all- time high of 652 basis points, or 6.52 percentage points, Bloomberg generic data shows.
The best bid for Irish 10-year bonds was 9.07 percent, or a price of 74.09, while the nearest offer was at 8.61 percent, or a price of 76.55, Bloomberg data show. “The wide bid-offer spread indicates how thin trading has become, and reflects a lack of two-way market activity,” said Peter Chatwell, an interest-rate strategist at Credit Agricole Corporate & Investment Bank in London. For 10-year bunds, the difference between the bid and the offer was less than one basis point, the Bloomberg data show.
The euro weakened, stocks declined and the cost to insure Portuguese, Spanish and Irish sovereign debt from default rose to a record. “All stakeholders must participate in the gains and losses of any particular situation,” Lagarde said during an interview in Paris for Bloomberg Television’s “On the Move” with Francine Lacqua. “There are many, many ways to address this point of principle.”
Portuguese 10-year bonds pared a decline which earlier today widened the yield difference, or spread, over benchmark German bunds to as much as 484 basis points, a record, according to Bloomberg generic data. The spread was little changed at 459 basis points. The Portuguese 10-year yield was at 7.15 percent, down two basis points from yesterday.
Peripheral nations’ bonds have dropped since European Union leaders agreed on Oct. 29 to consider German Chancellor Angela Merkel’s proposal for a permanent rescue mechanism that would involve restructuring with losses for private holders of sovereign debt. The proposal is part of discussions to create a permanent crisis facility to replace the rescue fund created in May after Greece’s near-default.
Greek bonds erased declines which earlier today drove the Greek-German 10-year spread as wide as 930 basis points. That compares with the record 973 basis-point premium reached on May 7 before the European Union crafted a rescue package worth 750 billion euros. The 10-year Greek yield dropped three basis points to 11.68 percent.
CDS Prices Rise
The yield on the 10-year German bund, Europe’s benchmark, fell one basis point to 2.44 percent. The yield on 10-year Spanish bonds rose seven basis points to 4.60 percent. The cost to insure Irish government debt against default rose 20 basis points to a record 617, according to data provider CMA, using credit-default swap prices. CDS’s on Portugal added 17 basis points to 494 and Spain’s rose 12 to 289.
Irish central bank Governor Patrick Honohan said he’s convinced the country will be able to return to bond markets in 2011 as the government steps up austerity measures to restore investor confidence. Finance Minister Brian Lenihan’s plan involves 15 billion euros in savings over four years to reduce the deficit below the EU limit of 3 percent of gross domestic product by 2014. The deficit will be about 12 percent of GDP this year, or 32 percent of GDP when the costs of the banking rescue are included.
“There is no reason why Ireland shouldn’t be able to go back to bond markets next year,” Honohan, who also sits on the European Central Bank’s 22-member Governing Council, told Bloomberg Television in an interview in Dublin yesterday. “It takes time for markets to be reassured. It takes more than calming words from me or others.”
Spanish bonds stayed lower as data showed the nation’s economy stalled in the third quarter as the deepest austerity measures in three decades undermined the recovery from an almost two-year recession. Gross domestic product was unchanged from the previous three months after two quarters of expansion, the National Statistics Institute in Madrid said, confirming a Nov. 5 estimate by the Bank of Spain. The economy expanded 0.2 percent from a year earlier, the first annual increase in two years.
The Spanish-German 10-year yield spread widened to 215 basis points today from 206 yesterday. That’s still below an intraday euro-era high of 232 basis points reached on June 17. The Italian 10-year bond fell for a sixth straight day, its longest run of declines since June, before the nation sells as much as 8.25 billion euros of 2015, 2026 and 2034 debt tomorrow.
The spread against bunds was at 176 basis points, up from 166 basis points yesterday. That compares with a peak of 185.5 basis points reached on June 8. “Italian paper has been under pressure recently on a combination of periphery woes and political uncertainty,” Chiara Cremonesi, a fixed-income strategist at UniCredit SpA in London, wrote in an e-mailed report today. “We expect demand at tomorrow’s auction to be good,” with “support from the current level of spread,” she said.
Bunds have returned 8.5 percent this year, the same as U.S. Treasuries, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Greek debt lost 18.7 percent, Portuguese bonds lost 10.6 percent and Irish securities declined 14.3 percent, the indexes show.
Ireland's Fate Tied to Doomed Banks
by Charles Forelle and David Enrich
With doubts swirling about the solvency of the Irish state in early September, Finance Minister Brian Lenihan summoned a dozen senior government and bank officials to a conference room nicknamed the "torture chamber," a nod to its history as a venue for painful meetings. For two years, Ireland had poured money on a raging banking crisis, to no avail. Each estimate of the rising price of rescuing Ireland's banks turned out too low. Mr. Lenihan needed to halt the drip-drip of bad news that was leading his country to ruin. "I want a final figure ASAP," he told the group.
Two weeks later, the estimate came in: Up to €50 billion—nearly $50,000 for every household in the Emerald Isle. But now, investors are betting the bill could be higher still and could reignite Europe's sovereign-debt crisis. The unpopular government is bracing for collapse, and on Tuesday, Irish government bonds continued a week-long slide to a fresh record low. The debt is judged as risky as Greece's was this spring just before that nation begged for a European Union bailout. Mr. Lenihan, racing to ease those fears, proposed Thursday shrinking the country's 2011 budget by €6 billion. Proportionally, that's as if the U.S. suddenly eliminated the Defense Department.
Ireland's troubles are Europe's. The 16 euro-zone countries have agreed to guarantee up to €440 billion in loans if any among them is unable to borrow from private markets. It wasn't supposed to be this way. In October 2008, Mr. Lenihan boasted that his government had devised "the cheapest bailout in the world so far." Ireland's financial regulator pronounced the banks "more than adequately capitalized."
Interviews with dozens of bank and government officials, and an examination of documents released by the Irish parliament, reveal that Ireland misjudged its crisis early on. Desperate to preserve the homegrown banking system, the government—blind to just how sour Irish loans had gone—yoked the fate of the nation to the fate of its banks.
Along the way, the government was hobbled by faulty information from outside advisers, from a trust-and-don't-verify regulatory culture and from the troubled banks themselves.
The result has been calamitous: Bad loans at five once-sleepy banks have snowballed into an existential threat. The crisis has hammered Ireland's economy and left taxpayers with a bill that will take a generation to pay. Irate Dubliners burned one big bank's ex-boss in effigy and blocked the gates of parliament with a cement truck in protest. Bankers face criminal probes and a parliamentary inquiry.
The miscalculations are severe. In December 2008, the state laid plans to pour €1.5 billion into Ireland's sickest institution, Anglo Irish Bank Corp. Over the next two years, the government upped the figure a half-dozen times, pumping in a total of €22.9 billion. In September, the central bank said Anglo might need as much as €11.4 billion more.
In an email, Mr. Lenihan said the cost estimates announced in September had put an "upper end" on the price of the bailout in order to "eliminate any uncertainty in the market."
The cost rose over time in part because "the information provided by the banks was not a true reflection" of the health of their loans. His 2008 comment that the bailout was the cheapest in the world didn't imply, he said, that "there would be no cost to the bailout."
For a decade, Ireland was the EU's superstar. A skilled work force, high productivity and low corporate taxes drew foreign investment. The Irish, once the poor of Europe, became richer than everyone but the Luxemburgers. Fatefully, they put their newfound wealth in property. As the European Central Bank held interest rates low, Ireland saw easy credit for construction loans and mortgages. Developers turned docklands into office towers and sheep pastures into subdivisions. In 2006, builders put up 93,419 homes, three times the rate a decade earlier.
Anglo, founded in 1964, spent its first three decades making small commercial real-estate loans. But when Sean FitzPatrick, an ambitious accountant, took the bank's reins in 1986, he opened big offices in London and the U.S. Anglo bankrolled marquee projects, putting $70 million behind the Chicago Spire, planned as America's tallest building.
Rivals followed suit. Allied Irish Banks PLC deployed "win-back teams" to claw away borrowers from Anglo. Bank of Ireland executives wooed clients with trips on corporate jets.\ The party ended in 2008, when the property bubble popped and the global economy tipped into recession. The government remained optimistic; an internal finance-department memo concluded in May that the Irish banking system was "sound and robust based on all key indicators of financial health."
Yet by September, Irish banks were struggling to borrow quick cash for daily expenses. The government thought they faced a classic liquidity squeeze. Ireland—whose hands-off regulator had assigned just three examiners to two major banks—didn't recognize the deeper problem: Banks had made too many bad loans, whose defaults would leave the lenders insolvent.
"Liquidity, not capital, is the main issue in the current crisis," financial regulator Patrick Neary wrote to Kevin Cardiff, a top finance-department official, on Sept. 10. A week later, Anglo executives told government officials that the bank's core business, despite the cash crunch, was healthy: "Loan book remains strong," they said. And Merrill Lynch bankers working for the government advised that another lender, Irish Nationwide Building Society, could absorb any bad loans. (It has since needed €5.4 billion in bailout money.)
The warnings grew louder at the end of September 2008. Anglo's depositors were fleeing. At 8:40 p.m. on Sept. 29, a PricewaterhouseCoopers partner working for the government emailed Mr. Cardiff with bad news: Anglo "borrowed €0.9 billion from the Central Bank and do not have any reserves left." The next morning, Ireland launched the bailout Mr. Lenihan would dub the world's cheapest, guaranteeing every deposit and nearly all debt issued by Irish banks. Dublin hoped that would free others to lend to Irish banks, and Ireland would muddle through without shelling out a dime.
But while that quickly restored cash to the banks, it didn't address the bad loans. Those loans were now very much the government's problem because the guarantee had made it the protector of the entire financial system.
PwC was sent to look at the banks' books. It found defaults creeping up. Still, banks insisted they could soldier on unaided. In December meetings with bankers in the fifth-floor boardroom of Ireland's debt agency, the government resolved to act. "It's not credible that you don't need equity," John Corrigan, the agency's chief, snapped. "You're taking capital. That's it."
Four days before Christmas, the government announced it would buoy Anglo with €1.5 billion in capital. Bank of Ireland and Allied Irish would get €2 billion each. PwC found that Anglo burnished its financial reports with temporary deposits and had secretly loaned its directors €179 million. Mr. FitzPatrick, the chairman, resigned. Mr. Neary, Ireland's financial regulator, was eased out with €640,000 in severance and a €143,000 annual pension. Mr. FitzPatrick's lawyer declined to comment.
Predictions that the guarantee would stem the crisis soon looked like fantasies. In January, Ireland nationalized Anglo. The following month, taxpayers put €7 billion into Allied Irish and Bank of Ireland; the government, using PwC's data, had predicted €4 billion weeks before. And PwC missed the mark further. Relying largely on the bank's own data, it estimated Anglo's bad loans might hit €3 billion a year. Today, Anglo has lost about €20 billion and classifies more than three-quarters of its €64 billion in outstanding loans as "at risk" of default. A PwC spokeswoman declined to comment.
On March 6, 2009, Mr. Lenihan met with advisers to bat around remedies. None sounded promising. He turned to Peter Bacon, an economist he'd hired a week earlier, who shocked the crowded room with a figure far bigger than the few billion Ireland had spent. The banks made more than €150 billion of potentially toxic property and land loans, he said. "That's the extent of your problem."
Mr. Bacon suggested the government buy loans from the banks at discounted prices, effectively handing them cash and easing doubts about their viability. By insisting on steep discounts, Ireland would be less likely to lose money on the purchases. On the flip side, bargain prices would trigger losses at the banks—which the government would probably have to patch with more capital. The taxpayer would foot the bill either way, but at least Ireland would understand how big it was.
The approach "has the merit of certainty and clarity," Mr. Bacon argued. But, he added, it would only work if "the projection of the extent of impairment is accurate in the first place." It wasn't.
A small team at the debt agency, including Mr. Corrigan, the chief, and a top lieutenant, Brendan McDonagh, pulled together a plan for a new entity, the National Asset Management Agency, to buy €77 billion worth of loans for €54 billion, a 30% discount. Those estimates shaped public expectations about the rescue bill. But they were based on information from the banks, which told NAMA their loans were well collateralized. In early 2010, Mr. McDonagh's team got a rude surprise upon diving into the books. "We opened it up and said, 'Oh, my God,"' Mr. McDonagh said in an interview. "What they are telling us is not the reality."
The banks had said they had loaned 77% of the value of a property, on average. The other 23%, put up by the borrower, would cushion a default. The NAMA teams found that banks often piled on "equity releases" that amounted to lending out 100% of the value, and left them fully responsible in a default. Worse, much of the collateral was shaky. Several times, a developer pledged future profits on other ventures. Many loans were riddled with flawed documentation, leaving banks without solid legal rights to the property they had believed was backing up the loans.
When NAMA disclosed its first round of loan purchases on March 30 this year, the average discount—or "haircut"—was 47%, far above the 30% originally estimated. "The detailed information that has emerged from the banks in the course of the NAMA process is truly shocking," Mr. Lenihan told lawmakers. But, he added, "we now know the extent of the losses in our banks....This certainty will further boost international confidence in our ability to recover."
He was wrong. NAMA, preparing its next purchases, demanded steeper cuts. Property prices were tumbling, and the agency was under public pressure not to squander money. Once, a banker complained the agency was drastically undervaluing a loan. "You're damn lucky to be able to get the money you're getting," a NAMA official shot back.
In August, when NAMA announced the next round of purchases, the average haircut rose to 56%, again leaving Anglo short of capital. Again, the government wrote a check. On the afternoon of Sept. 8, Mr. Lenihan, at work despite a diagnosis of pancreatic cancer nine months earlier, convened government officials and Anglo's brass in his latest bid to put a firm figure on the bank rescue's cost. The ground-floor Finance Department conference room where they met was adorned with photos of past ministers. That day, one of them, Anglo Chairman Alan Dukes, was seated across from his own picture.
Mr. Lenihan told the men that Anglo couldn't be kept afloat. He instructed NAMA to calculate the final haircuts quickly. Over the next two weeks, NAMA priced Anglo's loans at a 67% discount, causing the bank to require another €6.4 billion from taxpayers. It said it would take a 60% haircut on the rest of AIB's loans—likely putting the government in control of that bank.
The total capital injected into banks by the government so far: €34 billion, with at least another €12 billion on the way. The bailouts mean Ireland will run a government deficit equal to 32% of its gross domestic product, the highest figure ever in any euro-zone country. Skeptics say a still-sinking property market will next sour residential mortgages, inflating the government tab even more.
Patrick Honohan, Ireland's central-bank governor, says the government is fighting on two fronts. While wrestling with the banks' bad loans, it must repair state finances badly damaged by a deep recession and a swift erosion of the tax base. The bailout bill, he says in an interview, "is not Ireland's only problem."
Ireland's Next Blow: Mortgages
by David Enrich and Charles Forelle - Wall Street Journal
Ireland's commercial-property bust has knocked the country's banks to their knees. Now the lenders are bracing for another blow: losses on home loans. So far, residential mortgages haven't been nearly as big a problem for Irish banks as their portfolios of loans to finance real-estate development and construction projects. Those ill-fated property loans have saddled the banks with tens of billions of euros in losses, forcing the government to mount a series of costly bailouts that have pushed Ireland to the brink of insolvency.
But problems in the residential-mortgage arena are starting to crop up, fueling fears that a second wave of losses could hit even Ireland's healthiest banks. Those fears are one reason why jittery investors punished shares of Irish banks. An index of Irish financial stocks fell 5.3%, and shares in Bank of Ireland, one of the country's biggest mortgage lenders, tumbled 5.6% in Dublin.
A rising tide of Irish households has been falling behind on their mortgage payments. More than 36,000 borrowers, representing 4.6% of Irish mortgage loans, were at least 90 days behind on their loans as of June 30, according to Ireland's financial regulator. That compares with 26,000, or 3.3%, nine months earlier. Data for September, due next month, is expected to show another rise but remain below the U.S. rate, which was above 9% in June.
In a foreboding sign, nearly 200,000 Irish mortgages—about one of every four outstanding home loans—is expected to be "underwater" by the end of the year, according an estimate made earlier this year by David Duffy, a research officer at the Economic and Social Research Institute in Dublin. That means the outstanding loan balance will be greater than the underlying value of the home, increasing the odds that borrowers will default. If the house-price decline becomes even more calamitous, Mr. Duffy said in a March paper, some 350,000 homeowners could be underwater.
Peter Mathews, a former Irish banker who now is an independent banking-sector analyst, reckons between 10% and 20% of the value of home loans made during the three frothiest years of Ireland's property bubble, which peaked in 2007, could be written down. "There's a bigger bump on the horizon than people would like to admit," he said. Such fears were shoved into the spotlight Monday. Morgan Kelly, an economics professor at University College Dublin, published an opinion column in the Irish Times newspaper warning that the country was headed over a financial cliff due partly to a coming flood of mortgage defaults.
"The perception growing among borrowers is that while they played by the rules, the banks certainly did not, cynically persuading them into mortgages that they had no hope of affording," Mr. Kelly wrote. "Facing a choice between obligations to the banks and to their families—mortgage or food—growing numbers are choosing the latter."
Meanwhile, Irish government bonds continued to weaken as investors worry that the country is moving toward a sovereign default due to the ever-rising costs of the banking bailout. The gap between yields on Irish 10-year debt and similar German debt widened to record levels, and the troubles spread to other euro-zone countries. The cost of buying insurance on Portuguese and Spanish bonds hit new highs Monday, while the cost of insurance on Irish debt hovered near record levels.
The renewed concerns about the continent's health rubbed off on the euro, which fell below $1.40 after rising to $1.43 last week. And the European Central Bank said Monday that it had resumed its purchases of bonds from struggling countries like Ireland, after a three-week hiatus. While Irish banks' disastrous commercial real-estate lending has received the most attention, the banks were similarly profligate when it came to home loans. Residential-mortgage debt soared from about €49 billion in late 2003 to €113 billion in March 2010, or from about $69 billion to about $159 billion, according to Ireland's central bank.
Banks relaxed their lending standards, doling out large loans to first-time home buyers. In 1995, the average first-time buyer would borrow an amount roughly equal to three years of his earnings, Mr. Kelly wrote in a December 2009 research paper. By 2006, that figure had swelled to eight years of earnings. Unlike in the U.S., where surging defaults on home loans helped ignite a global financial crisis, residential mortgage defaults have been relatively rare in Ireland. The percentage of mortgages on which Irish borrowers are at least 90 days behind on payments is roughly half the level of the U.S.
Some experts say that is partly because banks in Ireland typically can pursue borrowers' other assets if they walk away from mortgages—a powerful disincentive to default.
Government actions also have kept a lid on defaults. Its financial regulator last year instituted a rule that lenders must wait six months from the time a borrower falls into arrears before going to court to seize his property. In February 2010, that period was stretched to 12 months.
And Ireland's state welfare system will, with some limits, pay the interest on the mortgage of a person who is suddenly unemployed. In 2008, a total of 8,091 Irish borrowers took advantage of the interest-supplement program, receiving €28 million. This year, the government expects to spend €64 million on the mortgages of 17,500 people. But those efforts neither absolve the borrower of his debt nor make the bank whole. Residential mortgages are a "suspended crisis," said Mr. Mathews, who has criticized the government for not admitting to higher banking losses. "It's only really postponing the problem, not dealing with it."
Merkel refuses to back down over debt burden
by Arthur Beesley and Derek Scally - Irish Times
German Chancellor Angela Merkel is refusing to back down from her push to force private investors to share the burden of the euro debt crisis, which helped send Irish borrowing costs to record levels.
Speaking in Seoul, where she is attending the G20 summit, Dr Merkel acknowledged her demands have upset the markets but insisted it was unfair for taxpayers to be saddled alone with the cost of sovereign rescues. “Let me put it simply: in this regard there may be a contradiction between the interests of the financial world and the interests of the political world,” Dr Merkel said.
“We cannot keep constantly explaining to our voters and our citizens why the taxpayer should bear the cost of certain risks and not those people who have earned a lot of money from taking those risks.”
European Commission chief José Manuel Barroso moved to shore up confidence in Ireland by saying euro countries stand prepared to provide emergency aid if required, but officials stressed the Government has not asked for such assistance. The Irish Times has established, however, that informal contacts are under way between Brussels, Berlin and other capitals to assess their readiness to activate the €750 billion rescue fund in the event of an application from Dublin.
Amid a loss of market confidence in Ireland, political anxiety in Europe centres on the fragility of the Government’s position as it prepares to extract €6 billion in cutbacks and tax increases in the budget and a total of €15 billion in the four-year recovery plan. Further concern surrounds the position of Ireland’s banks, whose shares have fallen steadily in recent days amid fears the €45 billion bailout bill might rise.
Although some diplomats say it is to Ireland’s advantage that the Government is not at present borrowing from the investors, fear of contagion emerged again yesterday as the premium on Spanish and Italian debt jumped to record levels.
With the single currency falling to a one-month low against the dollar, euro-zone finance ministers will discuss Ireland’s position at their monthly meeting next Tuesday in Brussels. As 10-year borrowing costs reached 9.26 per cent yesterday, Ireland is seen to be at the centre of renewed market turbulence. “What is important to know is that we have all the essential instruments in place in the EU and euro zone to act if necessary,” Mr Barroso said.
In Brussels, a commission spokesman said the European authorities are following the situation very closely. “There is no request for the moment. There is no need to activate any mechanism, Mr Barroso just confirmed that, in case of need, the mechanisms are in place,” he said. Minister for Finance Brian Lenihan attributed some of the pressure on Ireland to “unintended” remarks from German officials about new rescue measures that would compel private lenders to shoulder some costs in future bailouts. “The bond spreads are very serious and there is international concern throughout the euro zone about that,” Mr Lenihan said.
The Government wanted clarification of the German plans and will proceed without aid, he added. “We have the capacity to put the State on a sustainable and credible basis.” Although Dr Merkel’s strategy has met resistance in the European Central Bank, France spoke up in her support when its finance minister, Christine Lagarde, spoke in favour of the “principle” of bondholders assuming bailout costs. “All stakeholders must participate in the gains and losses of any particular situation,” she said.
In spite of discussions between major European governments and Brussels, Berlin dismissed German reports yesterday that it was “concerned” about Ireland’s financial situation and readying a bailout. On its website, business newspaper Handelsblatt quoted an unnamed German government source expressing concern about Irish sovereign bonds and saying governments were examining whether Ireland needed help.
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Barack Obama’s Debt Commission Is An Exercise In Futility – The U.S. Government Will Never Have A Balanced Budget Ever Again
by Michael Snyder - Economic Collapse
In a surprise move, the co-chairs of Barack Obama's national debt commission released their preliminary proposals to the media on Wednesday. The proposals are actually quite modest - they recommend that nothing be implemented until 2012 because of the weak economy, and their plan would not balance the federal budget until 2037 - but almost as soon as it was released Democrats and Republicans both started screaming bloody murder about how they would not support it.
The truth is that virtually none of our politicians are willing to make the hard choices that would be necessary to get the national debt under control. Today, the U.S. national debt is rapidly approaching 14 trillion dollars and it is growing at an exponential rate. It is the single largest debt in the history of the world, and it has increased in size for 53 years in a row.
It would be very difficult to understate the true horror of the debt that the U.S. federal government has accumulated. So what is the solution? As you will see below, there isn't one. In fact, it will be an absolute miracle if our leaders are able to even slow down the rate at which the debt is growing in the years ahead.
The deficit reduction plan put forward by Erskine Bowles, a former White House chief of staff under Bill Clinton, and Alan Simpson, a former Republican Senator from Wyoming does not even have support from the rest of Barack Obama's national debt commission. There is no way that either most Democrats or most Republicans in Congress will ever accept it. But at least the Bowles-Simpson plan is making headlines around the world and has brought the national debt back to the center of the political debate in this country.
In some ways, the Bowles-Simpson plan is a complete and total fantasy. For example, it assumes that the U.S. economy is going to fully recover and will experience solid growth for many years to come. That simply is not going to happen. The prosperity of the last couple of decades has been fueled by the biggest debt bubble in the history of the world, and there is no way that is going to continue. At some point the U.S. economy is going to fall apart like a house of cards.
But even if the U.S. economy could magically meet the projections contained in the Bowles-Simpson plan, it still contains a whole host of "poison pills" which make it completely and totally unacceptable to both political parties....
- The plan calls for deep cuts to U.S. military spending. The Republicans will never go for that.
- The plan reduces Social Security benefits to most retirees in future decades. The Democrats will never go for that.
- The plan raises the Social Security payroll tax cap to $190,000. The Republicans will never go for that.
- The plan envisions a very slow rise in the retirement age from 67 to 68 by 2050 and finally to 69 by 2075. The Democrats will never go for that.
- The plan includes a "less generous" annual cost-of-living adjustment for Social Security benefits. Considering the fact that Social Security benefits are already not going to see an increase this upcoming year, this proposal is likely to upset a large number of seniors.
- The plan calls for the federal tax on gasoline to approximately double by 2015. The Republicans would never go for that, and if that was ever implemented it would have a very serious negative impact on the economy.
- The plan would eliminate the deductibility of mortgage interest payments. Millions upon millions of homeowners would be absolutely furious.
- The plan would tax health benefits provided by employers. That would make millions of people very angry.
- The plan also calls for huge cuts in farm subsidies. There are a lot less farmers than there used to be, but that would still be extremely unpopular.
But the truth is that hard choices need to be made. The national debt is spinning wildly out of control. The U.S. government is essentially bankrupt.
Unfortunately, the majority of the federal budget is made up of entitlement programs. Entitlement programs are not subject to budget freezes or budget cuts - unless Congress changes the underlying laws. But any change to major entitlement programs would potentially upset millions of voters.
Not that there are not other areas that could be cut. Today, the average federal worker earns far more than the average private sector worker. In fact, wages for federal workers have been escalating at a frightening pace. In 2005, 7420 federal employees were making $150,000 or more per year. Today, 82,034 federal employees are making $150,000 or more per year. That is more than a tenfold increase in just five years.
But any major cuts to federal spending are going to really upset a lot of voters, and our politicians really, really like to get re-elected. The kinds of cuts that are really needed will never get through the Democrats in Congress and the Republicans in Congress and signed into law by Barack Obama. There are just way too many things that both major political parties consider to be "untouchable".
Meanwhile, the U.S. government debt continues to explode. The debt is already so big, interest on that debt is scheduled to escalate so dramatically, and we have made so many unsustainable promises regarding Social Security and Medicare that it is basically impossible to balance the federal budget at this point. If serious attempts were actually made to balance the budget in 2011, it would likely create a financial panic, and suddenly sucking over a trillion dollars in federal spending out of the system would crash the economy.
The following are 15 facts that reveal just how obscene the U.S. national debt has become, and why it is now basically impossible to balance the budget of the U.S. government at this point....
#1 On average, the U.S. government accumulates about 4 billion dollars more debt each day.
#2 In just the last 30 years the U.S. government has accumulated 12 trillion dollars more debt.
#3 According to a U.S. Treasury Department report to Congress, the U.S. national debt will climb to an estimated $19.6 trillion by 2015.
#4 The U.S. government has to borrow 41 cents of every dollar that it currently spends.
#5 If the U.S. government was forced to use GAAP accounting principles (like all publicly-traded corporations must), the annual U.S. government budget deficit would be somewhere in the neighborhood of $4 trillion to $5 trillion.
#6 The Congressional Budget Office projects that the health care bill recently passed by Congress will add an additional trillion dollars to our debt over the next ten years.
#7 Approximately 57 percent of Barack Obama's 3.8 trillion dollar budget for 2011 consists of direct payments to individual Americans or is money that is spent on their behalf. Any attempt to reduce those payments will make a lot of people very angry.
#8 According to the Congressional Budget Office, in 2010 the Social Security system will pay out more in benefits than it receives in payroll taxes. That was not supposed to happen until at least 2016.
#9 Back in 1950, each retiree's Social Security benefit was paid for by approximately 16 workers. Today, each retiree's Social Security benefit is paid for by approximately 3.3 workers. By 2025 it is projected that there will be approximately two workers for each retiree.
#10 According to an official U.S. government report, rapidly growing interest costs on the U.S. national debt together with spending on major entitlement programs such as Social Security and Medicare will absorb approximately 92 cents of every dollar of federal revenue by the year 2019. That is before a single penny is spent on anything else.
#11 Right now, interest on the U.S. national debt and spending on entitlement programs like Social Security and Medicare falls somewhere between 10 percent and 15 percent of GDP each year. By 2080, they are projected to eat up approximately 50 percent of GDP.
#12 The present value of projected scheduled benefits exceeds earmarked revenues for entitlement programs such as Social Security and Medicare by about 46 trillion dollars over the next 75 years.
#13 After analyzing Congressional Budget Office data, Boston University economics professor Laurence J. Kotlikoff concluded that the U.S. government is facing a "fiscal gap" of $202 trillion dollars.
#14 At our current pace, the Congressional Budget Office is projecting that U.S. government public debt will hit 716 percent of GDP by the year 2080.
#15 Sometimes we forget just how big a trillion dollars is. If right this moment you went out and started spending one dollar every single second, it would take you more than 31,000 years to spend one trillion dollars. The U.S. national debt increased by more than a trillion dollars last year, it will increase by more than a trillion dollars this year and it is being projected to increase by more than a trillion dollars the following year.
We are literally drowning in debt. We have been living beyond our means for decades, and most Americans do not understand that eventually that is really, really going to start catching up with us.
Already, the United States is fading as an economic power. According to the Conference Board, China will surpass the United States and will become the biggest economy in the world by the year 2012.
That is just two years away.
So how did we get into such a mess? Well, it all goes back to the creation of the Federal Reserve in 1913. The Federal Reserve was created to enslave the United States government in an endlessly growing spiral of debt from which it would never be able to escape.
That is exactly what has happened. Our money is actually debt-based. That is why they are called "Federal Reserve notes". When the Federal Reserve creates more money for the U.S. government to borrow, it does not also create money for the interest to be paid on that debt. Eventually the U.S. government is forced to borrow even more money just to keep up with the game.
Today, if you gathered up all of the physical currency from every bank, every business and every individual in the United States, you would not even put much of a dent in the national debt. That is how bad things have gotten.
A lot of people got elected to Congress by promising to balance the federal budget and by promising to start reducing the U.S. national debt. But those ships have sailed. The U.S. government will always have a national debt under the Federal Reserve system, and things have gotten so bad financially for our government that it is now virtually impossible to even balance the budget for a single year.
In the 90s, the Clinton administration and the Republican Congress briefly balanced the federal budget by "borrowing" massive amounts of money from the Social Security surplus. Using GAAP accounting, the budget was not even close to balanced at that point, but many point to that time as a moment when the U.S. government was at least somewhat fiscally responsible.
Well, the Social Security surplus is gone forever. Now we have a Social Security deficit which is only going to explode in size in future years.
In addition, the financial condition of the U.S. government has deteriorated enormously over the past 10 years, and things only look worse the further you look into the future.
Meanwhile, the U.S. economy is falling to pieces all around us. We are experiencing our longest bout of serious long-term unemployment since the Great Depression, 42 million Americans are on food stamps and the United States is being deindustrialized at a pace that is mind blowing.
As America continues to get poorer, the U.S. government is going to really struggle to raise revenue. But interest payments and financial obligations are projected to escalate wildly. At this point it is really hard to envision a scenario that does not lead to the eventual financial collapse of the U.S. government.
Cracked Economic Reports Not as Cracked Up To Be
by Lee Adler - Wall Street Examiner
Two key economic reports out today require closer scrutiny. Their positive readings may not be all that they appear to be on the surface. Both the MBAA’s Mortgage Applications Index and the weekly unemployment claims were reported as positives this morning. But just how good were they?
Seasonally adjusted purchase mortgage applications were up 5.5% week to week. Sounds great, but then the MBAA noted in its press release that on an unadjusted basis they were up 3.1%. That’s funny, I didn’t realize there was a change of seasons between October 29 and November 5. But still, up is up.
The MBAA does not make its index public, although it does report weekly changes in the seasonally adjusted index, and it used to report the actual index level, so it’s not too hard to reconstruct. Reuters actually reports the seasonally adjusted historical data in a weekly table that it publishes. But the MBAA doesn’t want the unwashed masses to have access to the actual unadjusted data. Someone might notice that the market is bad. Besides, they make good money selling the data, then prohibiting purchasers from republishing it. This is an altruistic industry group working for the good of all Americans.
So how “up” was this week? It was down 14.6% from last year at this time, down 35.2% since the April end of the homebuyers’ tax credit, and down 25% since April 2009, which was the last time mortgage rates were remotely near current levels. Today the 30 year fixed rate is around 4.28%. In April 2009 the lowest it got was 4.62%. Wait… that can’t be right. All the economists say that lower rates stimulate housing demand. Rates are down by 34 basis points from the last cycle low and purchase applications are down 25%? I guess the economists are wrong about lower rates stimulating demand. I am shocked. SHOCKED.
Here’s a chart. The mortgage rate line is on an inverse scale so that you can see directly how well lower mortgage rates correlate with an increase in housing demand. There is no correlation. In fact, the lower mortgage rates have gone over the past couple of years, the weaker demand has gotten. The Fed’s suppression of mortgage rates by buying MBS, GSE, and government paper has been an abject failure. So gee, let’s do more of it! Maybe that will work.
Image: Lee Adler
The other thing I note is the massive jump in purchase mortgage demand over the past 4 weeks. Wow. That’s really something. We are on the road to recovery! Let’s see what happens in the next week or two when the line gets to the 52 week moving average. Until that line is broken and turns up, the market will remain weak.
This index is virtually real time. It foreshadows the NAR’s pending home sales index by more than a month to the release of that data and existing home sales by two months. The mortgage applications assure us that the next couple of reports from the NAR will continue to be awful.
The second item released this morning was the weekly claims data. Claims were widely reported to be down by 24,000. But the truth is that they were really up by 28,000. But hey, who’s counting. We don’t care about the real numbers, we just care about the seasonally adjusted hocus pocus. That’s what everybody reports. Here again, I didn’t realize that the seasons changed between October 30 and November 6. Did it get a lot colder where you are? Did a bunch of businesses lay off workers because of the weather? How stupid is it to apply massive seasonal adjustments to week to week changes that actually reverse the direction of the change?
The raw data is the real data, and it was indeed up by 28,000. It is true that this is a better performance than some years, and it was certainly better than November 2008 when the economy was collapsing and November 2009 when it was still in recession. In those years, the first week of November saw jumps of 73,446 and 49,324 respectively. So this year was a lot better.
However, there are 8 MILLION fewer people eligible to claim unemployment benefits than there were in November 2008. They have used up their benefits. Too bad for them. Actually the number may be even greater than 8 million, but that’s what the Department of Labor is reporting. They use a 6 month moving average that is current through June. We know that many more people have dropped off the rolls since then. We don’t know if just as many have gotten jobs and regained eligibility.
The 28,000 new applicants last week were also higher than the first week of November 2007, when the recession was just starting. Then there were 22,500 new claims. Here’s a chart showing how claims stack up based on the number of claims as a percentage of those eligible. That rate is just a little below last year at this time and it has reached an inflection point. QE2 is supposed to drive that line back down, keep the 52 week moving average declining, and force the 2 year moving average to start down. At the very least, it should keep the seasonal peak at year end well below the trendline connecting 2008 and 2009. In a few weeks we should begin to get a picture of how successful it is.
Image: Lee Adler
In the meantime, instead of believing all the mainstream reports that new claims were so great, maybe we should take them with a grain of salt every week. The actual real numbers often tell a different story
Mortgage Lenders Meet Resistance in Courts
by Ruth Simon, Robin Sidel and Nick Timiraos - Wall Street Journal
The push by mortgage companies to accelerate the snarled foreclosure process is running into resistance from judges who are cracking down on sloppy paperwork. In Florida, a state-court judge has begun forcing lawyers to defend fees charged to borrowers by law firms. Maryland's state appeals court told judges that they can hire experts to scrutinize paperwork filed in foreclosure proceedings—and make lawyers swear that the documents are accurate.
Since last month, New York has threatened to use "penalties of perjury" against lawyers caught filing bad documents, even if they didn't know about the problems when the foreclosure process began. The moves by dozens of state courts across the U.S. could add to the delays brought about by foreclosure-document crisis. Sales of foreclosed homes have slowed, and mortgage servicers face new expenses as they scramble to shore up their operations.
Over the long run, borrowers are likely to pay hundreds of dollars in additional fees or slightly higher interest rates, as toughened quality control ripples through the market for new and refinanced mortgages, many experts predict. "The cost of servicing has gone through the roof, and the legal risks are almost unknowable," said Dan Cutaia, president of capital markets at Fairway Independent Mortgage Corp. in Sun Prairie, Wis. As a consequence of rising servicing costs for lenders, "there will be higher pricing for the consumer."
The new roadblocks being imposed by judges come just as many mortgage companies claim they are starting to see the end of the foreclosure mess, which erupted six weeks ago. J.P. Morgan Chase & Co. said in a securities filing Tuesday that it hopes to start foreclosures again "expeditiously." J.P. Morgan said in its filing that it found "certain instances" where "underlying loan file review and verification" of documents submitted in foreclosures was handled by someone other than the employee who signed an affidavit, or that the affidavit might be improperly notarized. The basic information was "materially accurate," the company said.
Delays are costing the nation's second-largest bank in assets as much as "a couple hundred million dollars a month," said Charles Scharf, head of the New York bank's retail financial services-unit.
J.P. Morgan and Ally Financial Inc. both said they brought in outside law firms and auditors to review their foreclosure procedures. Still, just one-third of the 34 mortgage-servicing companies tracked by Fitch Inc. have finished vetting themselves, according to the credit-ratings firm. The reviews are still in their "infancy," said Ed Delgado, a former Wells Fargo & Co. executive who leads the Five Star Institute, a provider of educational and training programs for the mortgage industry.
Pressure from state attorneys general, federal regulators, title insurers and judges is prodding the mortgage-servicing industry to do a "broad-based examination of the servicing process," not just fix the problem of robo-signing, he added, referring the practice of signing lots of documents without reviewing their contents. Bank of America Corp. recently created a new affidavit that can be used in the 23 states where courts handle homeowners in default. The largest U.S. bank says it is trying to streamline the foreclosure process and reduce the chances of error. It now requires that a notary and affidavit signer both be present when an affidavit is signed.
Ally, which is majority-owned by the U.S. government, now reviews pending foreclosure sales the week before a scheduled foreclosure sale and is inspecting a sample of newly filed affidavits "to ensure that no wrongful foreclosures take place," a company spokeswoman said. Last week, Ally Chief Executive Michael Carpenter said the company "screwed up on robo-signer affidavits." The company says no one was foreclosed on in error.
Tim Rood, a partner with real-estate-finance advisory firm Collingwood Group in Washington, predicts that the six-week-old foreclosure mess will result in a "quality tax" that could amount to about $300 per loan. Borrowers typically pay about 2% of the loan amount in closing costs, according to HSH Associates in Pompton Plains, N.J. Sales listings of bank-owned homes have shrunk as loan servicers and mortgage giants Fannie Mae and Freddie Mac pull properties off the market. In south Florida, listings of foreclosed homes are down 24% since September 27, according to data tracked by real-estate brokerage Condo Vultures LLC.
Over the long run, the foreclosure process could take a few weeks longer as a result of changes made by mortgage companies, said Clifford Rossi, a former Citigroup Inc. consumer-lending executive now teaching at the University of Maryland. The typical foreclosure already takes nearly 16 months, according to LPS Applied Analytics, a unit of Lender Processing Services Inc.
Judges are a major cog in the foreclosure machine, especially in the 23 states where foreclosure cases are required to go through the court system. "What is at stake is the integrity of the judicial process," says Alan Wilner, a retired judge for the Maryland Court of Appeals who now is chairman of the state rules committee reviewing court procedures. The Maryland appeals court's new policy permits judges to require lawyers to testify to the validity of the underlying affidavit in a foreclosure case. Judges also can order notaries public to appear in court or appoint special masters to review foreclosure documentation.
Ohio's Cuyahoga County Court of Common Pleas said last week it would give servicers and lenders 30 days to ensure that they have filed proper paperwork—or else their cases will be dismissed. The court, which covers Cleveland, also said judges will require lawyers in residential foreclosure cases to file affidavits swearing that they have taken "reasonable steps" to verify the accuracy of documents filed to the court.
In New York, lawyers representing lenders filing a foreclosure complaint are now required to sign a document verifying the paperwork in the case is accurate. The state has about 78,000 pending foreclosure cases, up nearly 60% from a year earlier. "Given the serious consequences of these kinds of proceedings, it behooves the lawyer to make sure these proceedings are not frivolous or fraudulent or lacking in credibility," said Jonathan Lippman, chief judge of New York's statewide court system, in an interview.
In Florida last week, Judge Susan Gardner of the Sixth Judicial Court, a two-county region that includes St. Petersburg, ordered three lawyers to appear in her courtroom next month to defend fees contained in foreclosure affidavits. She threatened to lock them up if they don't show. In one case, a lawyer for Florida Default Law Group in Tampa signed an affidavit that included $1,630 in fees for a process server, according to legal documents. A review of the file found that the fees incurred were $175, according to an order signed by Judge Gardner.
Ilargi: "Naked Capitalism's Yves Smith on Banks to Cash In on QE2 "Carry Trade" - The Fed's $600 billion quantitative easing may well make more profits for bankers." While she says a lot of things I agree with, these are her views, not mine; I'm not so sure increased government spending is that hot of an idea in the US today. She also seems to make an odd mistake in part 2, saying that 10,000 jobs at $25,000 each means adding $2,5 trillion in GDP. Not even 10 million jobs would accomplish that.
Yves Smith on the QE2 Carry Trade and more
Foreclosure Crisis, Part 2: Modifications
by Jessica Silver-Greenberg - Wall Street Journal
The Obama administration's program to help struggling borrowers keep their homes is being hurt by the same miscommunication, botched documents and other snafus that caused the original foreclosure crisis. After J.P. Morgan Chase & Co. agreed in January to her trial loan modification under the Home Affordable Modification Program, Stephanie Lulko made six $767-a-month mortgage payments, even though the bank said it had no record of her loan and then warned in a letter that she would be foreclosed on unless she paid $4,091.94.
The 44-year-old Ms. Lulko, of Oklahoma City, says bank employees told her to ignore the letter. Their tune changed in June, when J.P. Morgan said she earned too much to qualify for a permanent modification. The problem this time: The bank's numbers were wrong. "I wish I had never applied for this modification," she says. In September, the bank rejected her request for a permanent loan modification for a second time. She faces foreclosure unless she pays nearly $5,000—the difference between her original and modified loan payments, plus late fees. Ms. Lulko has been unemployed since her temporary job at the U.S. Census Bureau ended in August.
J.P. Morgan denies any wrongdoing related to Ms. Lulko's loan. "We worked with the borrower over a number of months and communicated the status of the loan modification during that time," spokesman Tom Kelly says. He adds that the lender has converted 29% of temporary modifications into permanently reduced payments as of September. The foreclosure-paperwork furor is deepening criticism of the U.S. government's high-profile mortgage-restructuring effort, which has fallen short of its goal of helping three million homeowners. More than half of the 1.4 million borrowers approved for temporary modifications have fallen out of HAMP because they didn't qualify.
The program "has undoubtedly put people into foreclosure," says Neil Barofsky, the special inspector general overseeing the Troubled Asset Relief Program, which funds HAMP. "It's a parade of documentation horrors." In a report to Congress on Oct. 26, Mr. Barofsky concluded that some borrowers seeking loan modifications through HAMP might wind up "worse off than before they participated." Back payments, penalties and late fees triggered when homeowners are rejected for a permanent fix can push some borrowers over the edge, he said.
As part of HAMP, mortgage servicers and investors get financial incentives to modify a borrower's loan payment to 31% of monthly gross income. Servicers typically hit that number by lowering interest rates or extending a loan's life. Borrowers must make at least three "trial payments" to be considered for a permanent fix. Borrowers who miss a payment or otherwise fail to win a permanent modification essentially are stuck with the original terms of their mortgage. "The trial period provides homeowners an immediate reduction in payments at no expense to taxpayers," says Andrea Risotto, a Treasury spokeswoman. "It is the gateway for many homeowners to get the help they need."
The Treasury Department doesn't record how frequently errors occur with documentation on home loans submitted to more than 2,500 financial institutions and servicers empowered by the U.S. government to grant and reject HAMP requests. An outside review of borrowers denied permanent modifications disagreed with the servicer's decision in 4.8% of the loans during the fiscal quarter ended in August. Treasury officials don't keep track of how many of the disputed loans are subsequently averted from foreclosure. Ms. Risotto says borrowers can call a counseling hotline if they believe they were wrongly denied.
Meanwhile, anecdotal evidence points to a modification process at least fraught with miscommunication and misunderstanding. Bank of America Corp. says it "inadvertently verbally reviewed" a loan-modification request by Lindsey Farnsworth of Sugar Hill, Ga., who started making reduced payments to the Charlotte, N.C., bank in May after being told she was "preapproved" for HAMP.
Ms. Farnsworth, who quit her job after her daughter was diagnosed with leukemia, says she was stunned when Bank of America said in September that she didn't qualify for a loan restructuring because the mortgage was made by the Federal Housing Administration. Bank spokeswoman Jumana Bauwens says Ms. Farnsworth also isn't eligible for a loan modification under separate FHA guidelines "due to her financial situation." She was told last month to pay $4,860 or face foreclosure.
Loan servicers are required to follow government guidelines on loan modifications. Last month, the Treasury Department sent a notice "reminding them of their requirement to comply with all applicable state and federal laws," says Ms. Risotto, the Treasury spokeswoman. Mr. Barofsky says the oversight is toothless, noting that no servicers have been fined for bungled paperwork or improper foreclosures. At the request of nine U.S. senators, Mr. Barofsky is auditing whether servicers in HAMP are correctly following Treasury's guidelines when deciding whether borrowers should get a loan modification. The inspector general also is scrutinizing how borrowers are notified that they failed to qualify.
Later this month, PennyMac Loan Services LLC plans to auction in a foreclosure sale the Queens, N.Y., home of Luis and Violeta Alvarez, who got a temporary loan modification from another loan servicer in February. Mr. Alvarez, 67, found about the sale when a lawyer called to say he had seen it listed on a website. His lawyer says PennyMac denied the couple a permanent modification but won't say why. Mr. Alvarez says PennyMac and the previous loan servicer have lost various paperwork eight times.
"How can you do this to people?" says Yvonne Alvarez, adding that her father has made every payment on time since his $4,612-a-month mortgage was reduced to $2,440 in February. PennyMac declined to comment on Mr. Alvarez's case, citing privacy concerns.
Sometimes, it can be hard for borrowers to tell if a servicer is putting them through HAMP or its own loan-modification process. Last December, Connie and Michael Umphress got a "reduced payment plan" from Wells Fargo & Co. for the mortgage on their Portland, Ore., home. The couple thought their lower monthly payments were triggered by HAMP. Instead, the San Francisco bank said last month that they were rejected for a permanent loan modification under an in-house Wells Fargo program. Wells Fargo warned it would foreclose unless they paid $12,000.
Mr. and Mrs. Umphress were scrambling to come up with the money when Wells Fargo told them that they qualify for a temporary HAMP modification. "It feels like Groundhog Day," she says. "We are relieved, though, and can breathe easier now." Vickee J. Adams, a Wells Fargo spokeswoman, says the December approval was based on "verbal or stated income," which isn't allowed under HAMP. As of September, 30% of temporary loan modifications by Wells Fargo had been converted to permanent fixes, she adds.
Mr. Barofsky, a frequent critic of HAMP, says the foreclosure furor that erupted in mid-September convinced him even more strongly that mortgage servicers have wrongly denied permanent loan modifications to deserving borrowers. "If there are problems like we've seen on one side of the shop, why would we expect anything different on the modification side?" Mr. Barofsky says in an interview.
Fed's QE2 Misadventure Costs U.S. Households $4.6 Trillion
by Charles Hugh Smith
The Fed's Quantitative Easing Part 2 has destroyed $4.6 trillion in household wealth, all to boost the stock portfolios of the top 10%.
The Federal Reserve's stated goals in launching QE2 were to trigger a "wealth effect" and boost inflation. The net result of their program is a massive destruction of household wealth.
The basic idea is that goosing "risk assets," i.e. stocks, then consumers will feel wealthier and thus motivated to open their wallets and spend, spend, spend. This spending won't be based on any increase in income (household income fell in 2009 despite the massive run-up in stocks) but on the illusion of greater wealth created by a temporarily rising stock market.
(Median household income fell 0.7% to $49,777 in 2009, down 4.2% since 2007, when the recession started.)
The Fed must be aware that the top fifth of households collects 50.3% of all pre-tax income and the bottom two-fifths receive 12%, so the "wealth effect" is in essence another "trickle down" scheme in which the top earners buy more handbags manufactured in China and the bottom 80% of Americans are supposed to benefit by being hired to stock the shelves with Elite goods.
As I often report, only the top 10% of households own enough equities to feel wealthier; so the Fed's central faith is doubly a "trickle down" theory: only the top 10% can possibly experience a wealth effect.
But the destruction of purchasing power as the Fed destroys the dollar is felt by all households--especially the bottom 80%. The Boiling Frog: Effects of QE2 On The Bottom 80% of the U.S. Population.
As I noted in Are the Fed's Honchos Simpletons, Or Are They Just Taking Orders? (November 1, 2010), Quantitative Easing 2 makes no sense. Today I will quantify just how perverse and destructive the Fed's policies have been to U.S. households.
The latest snapshot of the household's balance sheet comes from the Fed Flow of Funds for the second quarter (June 30, 2010). If we measure what has happened to the U.S. dollar and the S&P 500 since July 1, then we can measure the effects on the household balance sheet.
Let's collect a few key numbers from the Balance Sheet of Households and Nonprofits. All numbers are as of June 20, 2010 (Q2 2010).
Real estate:$18.8 trillion, down from $24.9 trillion in 2006 (bubble top)
Total financial assets: Q2 2010 $43.7 trillion, down from $50.6 trillion in 2007 (pre-recession)
Deposits (cash): $7.55 trillion, down from $7.9 trillion
Credit market instruments: (bonds etc.) $4.3 trillion, up from $4 trillion in 2007
Corporate equities (stocks): $6.7 trillion, down from $9.6 trillion in 2007
mutual fund shares: $4 trillion, down from $4.5 trillion in 2007
Liabilities (debts, mortgages, etc.):
Total liabilities: $13.9 trillion, down from $14.4 trillion
home mortgages: $10.15 trillion,down from $10.5 trillion
Net worth: $53.5 trillion, down from $64.2 trillion, a decline of $10.7 trillion
So mortgage debt decreased by a trivial $.35 trillion, total liabilities decreased by a modest $.5 trillion, and net worth declined by a whopping $10 trillion. Most of the mortgage and debt declines result from write-downs of debt by lenders, not from households paying down debt.
In other words, after suffering a staggering 17% decline in net worth, households managed to write down or pay down a tiny 3.4% of their liabilities.
Disposable personal income: $11.3 trillion, up from $10.4 trillion. As noted above, the increase flowed to the top 20%, as median income has declined by almost 5%.
Homeowners equity: $6.9 trillion, down from $12.8 trillion in 2006. So homeowners have lost roughly $6 trillion in home equity: about 60% of the total decline in net worth. Since the bottom 80% have few financial assets (stocks and bonds) then this destruction of home equity means their only real asset base has been largely wiped out.
Owners equity as a % of household real estate: 40.7%
As I have noted before. since a third of all homes are owned free and clear, then 33% of the 40% equity left in homes results from homes with no mortgage, and thus a mere 7% of equity is all that's left for the 2/3 of homes with mortgages: 7% of $18.8 trillion (total value of all household real estate) equals $1.3 trillion in equity for the 50 million homes with mortgages.
Now let's calculate the decline in purchasing power as the Fed purposefully depreciated the U.S. dollar:
Decline in the dollar since July 1, 2010: 12.2%
Decline in value (purchasing power) of all household assets since June 1: (12.2% of non-equities net worth--$42.8 trillion) -$5.2 trillion
Decline in value (purchasing power) of household disposable personal income: (annualized: 12.2% of $11.3 trillion): -$1.4 trillion
And exactly how much did household wealth in stocks rise as the dollar was crushed?
Rise in S&P 500 since July 1, 2010: 19%
Increase in net worth ofequities from July 1: (19% of $10.7 trillion): +$2 trillion
Net loss due to Fed's QE2 (from July 1): -$3.2 trillion. Decline inpurchasing power of household disposable personal income (annualized): -$1.4 trillion
Total loss inflicted on households by QE2 to date: $4.6 trillion. The Fed's QE2 has been an unmitigated disaster for 90% of American households, as it has destroyed the value of their purchasing power in a Devil's Pact to goose stocks, which only benefits the top 10% of households--and most of those paper gains are reserved for the top 1%.
Those are the numbers; exactly what conclusion can be drawn from them except the Fed is a horrendously misguided, Elite-dominated destructive force which must be reined in politically?
Is the Fed's Debt-Buying Unconstitutional?
by Elizabeth MacDonald - FOXBusiness
Is the Federal Reserve violating the U.S. Constitution’s separation of powers with its new purchases of $600 billion worth of U.S. Treasuries? Is the Fed engaging in an unconstitutional monetization of the U.S. Congress' out of control spending spree that is really a bridge loan to fiscal insanity? At minimum, should the Fed be avoiding these purchases until the fiscally debauched U.S. Congress, packed to the ceiling with fiscal dipsomaniacs, follows Great Britain’s lead in its fiscal abstinence that may "out Thatcher" even Margaret Thatcher, as a top Dallas Fed official says?
Isn’t the problem fiscal incontinence and regulatory misfeasance, and business uncertainty about all of that, which is creating joblessness? Not a lack of liquidity and not deflation, which is not a clear and present danger, as instead inflation is still with us? And isn’t the Fed dangerously habituating the stock, bond and commodities markets to a "new normal" of constant quantitative easing?
Germany, China, Russia and Brazil are attacking the Fed’s move. President Barack Obama is now defending the Fed in his overseas trip to India. Former Republican vice presidential candidate Sarah Palin demanded that the Fed "cease and desist" on its bond purchases. Wall Street experts are now starting to call the Fed's moves an end run around the legislature. And even Fed chairman Bernanke has criticized such extracurricular activity on the part of central banks in the past.
Watching closely in the wings are the Congressmen who want a full-fledged audit of the Fed, including Rep. Ron Paul (R-Texas), who said he will push to examine the Federal Reserve’s monetary policy decisions if he takes control of the Congressional subcommittee that oversees the central bank, as expected, in January.
Last week, the Federal Reserve announced it plans to buy more U.S. Treasury notes and bonds at a massive clip, $600 billion, between now and the end of June in a bid to spur economic demand, lower the jobless rate and resuscitate a still fragile U.S. economy. Already, from December 2008 through this past March, the Federal Reserve bought about $1.6 trillion of government debt and mortgage-backed securities to stem the economy’s free fall.
Federal Reserve Act Sanctions Such Purchases
Although Article I of the Constitution specifically gives Congress the power to "borrow," "coin" and "regulate" money, a little understood section of the Federal Reserve Act, section 14(b)(1), does let the Fed buy Treasuries in the open market — and under the Act the central bank can buy foreign debt, too. But that act, put in place in the early part of the 20th century, was meant for smaller bore purchases to help the government build bridges and roads--not the massive intervention planned now. Fed historians fear the central bank is now pushing the envelope of the Federal Reserve Act. For more on the section, click here.
Why the Fed Intervention?
The banks say there is still a lack of demand, at the consumer and business levels. Banks are being criticized for not lending more, even though the Fed has kept interest rates at nearly zero, and even though they hold more than $1 trillion in excess reserves. Loans as a percentage of assets are declining, notes the Dallas Federal Reserve, although it sees a pickup in bank corporate lending. The central bank hopes to lower the 10-year note even more, helping homeowners teetering on the brink to refinance their mortgages and businesses to obtain cheaper credit.
The Heart of the Problem
The problem is, businesses say they face hyper-taxation and hyper-regulation at the federal, state and local, and that is what is helping to create joblessness. Fed officials agree. "The remedy for what ails the economy is, in my view, in the hands of the fiscal and regulatory authorities, not the Fed," said Richard Fisher, president and CEO of the Federal Reserve Bank of Dallas in a speech to members of the Association of Financial Professional that was critical of the central bank’s debt purchases.
Uncertainty rightfully abounds in the business community because businesses do not know what else will pop up in the health and financial reform bills that many in Congress have not read that could hurt their businesses. The problem is the Fed is buying much of next year’s fiscal deficit spending at a time when fiscal austerity is nowhere to be found in Congress. The problem is the Fed won’t stop buying Treasuries unless the government fixes a jobless rate stuck at 9.6%, the goals of "maximum employment" being part of the Fed’s mandate.
The problem is this vicious circle: the Fed’s dollar printing could undo the government’s stimulus deficit spending because it will cause the dollar to drop and it will trigger inflation, as already food and gas prices have risen, hurting the U.S. consumer. The danger is monetary policy acts with a lag. "I liken it to a good single malt whiskey or perhaps truly great tequila: It takes time before you feel its full effect," says the Dallas Federal Reserve’s Fisher. So the Fed’s moves could take effect when the economy is already healing — igniting inflation, which the U.S. already sees in food and energy prices.
But What Else is Going On?
Illiquid bank balance sheets.
Could the Fed simply be printing money to plug banks’ damaged balance sheets? The way it works is, the Fed buys bonds and notes off of the banks, who then get an uptick in in their reserve accounts. Perhaps those funds can then be used to help the banks refill the potholes on their balance sheet that they wide open with impenetrably foolish bets. Bank balance sheets still face sizable writedowns from the shadow inventory of foreclosed homes, borrowers in negative equity, credit card debt, and commercial real estate problems--as well as trillions of dollars in omni-directional derivatives that could go south.
One of the world’s top bankers, Bank of England Governor Mervyn King told an Economist Magazine Buttonwood conference recently that liquid assets held by the banks are now just a microscopic 2% to 3% of their total assets, which is down from 33% of their assets in decades past. So that means if just 2% of the banks’ money is "at risk" and goes belly up, then the banks can become insolvent. King added that "small movements in asset valuations are enough to render banks insolvent" and that "banks are much riskier than commonly believed as an investment." Many are already zombie banks.
On top of that, banks are still overexposed in a scary way to derivatives. According to the Office of the Comptroller of the Currency, the notional value of derivatives held by U.S. commercial banks is around $223.4 trillion. The nation’s top five banks account for 95% of this. While much of that sum is offset with hedges, most of the derivatives are tied to interest rates. Maybe all of this is why Bernanke is fighting to keep rates low to avoid another massive TARP injection.
Plus, the banks will need the reserves since government regulators are demanding more in the way of capital reserve cushions to back their books of business, known as the international accords called the Basel regime.
The Markets Cheer
The stock markets have cheered the Fed's purchases. The Dow Jones Industrial Average has risen 12% higher as the dollar has dropped about 10% versus the euro since Federal Reserve chairman Ben Bernanke first hinted at more purchases in his Jackson Hole, Wyoming speech last August.
Investors have seen an estimated $1.4 trillion in paper gains in their portfolios since then, the wealth effect Bernanke had hoped for to revive consumer confidence and spending. However, market watchers now fear a trifecta of bubbles is forming in stocks, bonds and commodities — and foreign governments, notably in Asia, are hollering that this flood of money is ending up on their shores creating bubbles there, too.
Already, as the dollar drops, oil is trading at two-year highs, and gold has hit a nominal high of $1,400, still off its inflation adjusted high of $2,314 reached in 1980. "Right now, the world is faced with the unprecedented consequence of demand-pull inflationary forces fueled by the voracious consumption of oil, wheat, corn, iron ore, steel and copper, and all other kinds of commodities and inputs, including labor, among the three billion new participants in the global economy," says Fisher.
But instead of what former Fed chairman William McChesney Martin once famously said -- that the job of a good central banker is to take away the punchbowl just as the party gets going -- Bernanke is spiking the bowl even more.
Fed’s Scary Exit Strategy
And another gargantuan problem looming is the Fed’s exit strategy out of its dollar printing, which involves selling those exact same Treasuries it is buying to remove the excess liquidity the central bank is creating. All of those bonds seeking a finite pool of investors could cause a bond market crack up, because higher yields would have to be offered to lure investors in. The Fed’s exit strategy could cause bond yields and borrowing rates to spike way higher.
Controversy Stretches Back Decades
Since the Federal Reserve Act of 1913 created the Fed, scholars have argued the Fed itself as an entity is unconstitutional. Texas Republican Rep. Ron Paul and his newly elected son Rand have made similar arguments.
FOX Business' top legal analyst, Judge Andrew Napolitano, notes that "the Supreme Court has never ruled on the constitutionality of the Federal Reserve, believe it or not. But the lower federal courts that have addressed the issue have found it to be constitutional by employing the argument that Congress can enter into a contract with private entities to perform governmental services; and that is what it has done with the private bankers who own and operate and profit greatly from the Fed."
Fox Business news director Ray Hennessey notes that in 1952, Rep. John Wright Patman of Texas, who was head of what was then called the House Committee on Banking and Currency, crystallized the argument, saying, "In the United States we have, in effect, two governments. We have the duly constituted Government. Then we have an independent, uncontrolled and uncoordinated government in the Federal Reserve System, operating the money powers which are reserved to Congress by the Constitution."
The U.S. central bank grudgingly bought U.S. debt during the Great Depression under pressure from Congress to battle deflation—a playbook Bernanke is following now. Between 1926 and 1929, the Fed bought $1.7 billion in US debt, but then ramped that up from $729 million to $1.8 billion in 1933, averaging $2.4 billion in purchases every year after that until 1941.
While these moves helped lower interest costs corporate debt "and appeared to arrest the decline in prices and economic activity," Bernanke said. "Fed officials remained ambivalent about their policy of monetary expansion. Some viewed the Depression as the necessary purging of financial excesses built up during the 1920s..slowing the economic collapse by easing monetary policy only delayed the inevitable adjustment."
The Fed also bought U.S. debt in the 1940s to keep interest rates low after World War II, a move some economists say helped usher in the post-war economic boom. And back in the 1970s, it was Congress that pressured the Fed into adding Fannie Mae and Freddie Mac securities to its portfolio in order to help develop the market for those mortgage-backed securities. That was unpopular with the Fed at the time too.
Fed chairman Bernanke himself said he was nervous about such extracurricular moves by any central bank in a 1999 speech, where he discussed the Bank of Japan’s monetary easing to help fix the country’s banking collapse that led to its lost decade of the ‘90s, now two decades running. Bernanke said that if the BOJ outright bought nonperforming bank loans, such purchases would be "correctly viewed as an end run around the authority of the legislature, and so are better left in the realm of theoretical curiosities."
But the Fed effectively did make such a monetary gift to Fannie Mae and Freddie Mac when it bought its rotten mortgage-backed securities, notes John Hussman of Hussman Funds. Hussman says: "It is doubtful that when Congress drafted the Federal Reserve Act to allow the use of mortgage-backed securities, it ever dreamed that the Fed would purchase these securities outright when the issuer was insolvent. Until this issue is clarified in legislation, Bernanke will continue to see it as "perfectly sensible" for the Fed to make ‘money financed gifts’ that substitute his own personal discretion for those of a democracy."
Quantitative easing simply lets the Fed to not just buy Treasuries, but also other assets that may not be allowed by the Constitution, Hussman says. "Creating government liabilities to acquire goods and assets, unless those assets are other government liabilities, is fiscal policy, pure and simple" and "that fiscal authority is enumerated by the Constitution as the sole right of Congress," Hussman notes.
And "nowhere in the Federal Reserve Act did Congress provide authority for the Fed to create subsidiary corporate entities as it did with the Maiden Lane vehicles," to take on rotten assets from Bear Stearns and AIG, says Chad Emerson of the William & Mary Business Law Review. "The Fed cannot simply establish off-the-books shadow companies to avoid its restrictions under the Act. The legislative power of Congress cannot be circumvented by merely creating a LLC."
When Bernanke Acted
Bernanke first raised the idea of purchasing Treasuries in a Dec. 1, 2008 speech, which the Federal Open Market Committee later reaffirmed in a statement on Jan. 28, 2009. But when the Bank of England later that year succeeded in dropping long-term rates by buying U.K. gilts, that’s when the Fed took notice. The 10-year gilt yield slid to the lowest level in at least 20 years after the BOE’s purchases began. But Great Britain became abstemious with its deficit spending. The U.S. has not.
Wall Street Collects $4 Billion From Taxpayers as Swaps Backfire
by Michael McDonald - Bloomberg
The subprime mortgage crisis isn’t the only calamity Wall Street created that’s upending the finances of U.S. states and cities. For more than a decade, banks and insurance companies convinced governments and nonprofits that financial engineering would lower interest rates on bonds sold for public projects such as roads, bridges and schools. That failed promise has cost more than $4 billion, according to data compiled by Bloomberg, as hundreds of borrowers from the Bay Area Toll Authority in Oakland, California, to Cornell University in Ithaca, New York, quietly paid Wall Street to end agreements since 2008.
California’s water resources department this year spent $305 million unwinding interest-rate bets that backfired, handing over the money to banks led by New York-based Morgan Stanley. North Carolina paid $59.8 million in August, enough to cover the annual salaries of about 1,400 full-time state employees. Reading, Pennsylvania, which sought protection in the state’s fiscally distressed communities program, got caught on the wrong end of the deals, costing it $21 million, equal to more than a year’s worth of real-estate taxes.
"It was brilliant, and it all blew up on me," said Brian Mayhew, chief financial officer of the Bay Area Toll Authority, the state agency that gave Ambac Financial Group Inc., the New York-based bond insurer that filed for bankruptcy this week, $105 million to end $1.1 billion of interest-rate agreements. The payments equal more than two months of revenue on seven bridges the authority oversees around San Francisco.
The termination payments to Wall Street firms come at the worst possible time. The longest recession since the Great Depression left states facing budget gaps of $72 billion next fiscal year, according to the National Conference of State Legislatures. U.S. cities saw their general fund revenue fall the most since at least 1986 in the budget year that ended June 30, according to the National League of Cities.
Wall Street banks and insurers peddled financial derivatives known as interest-rate swaps to governments and nonprofits that bet they could lower the cost of borrowing. There were as much as $500 billion of the deals done in the $2.8 trillion municipal bond market before the credit crisis, according to a report by Randall Dodd, a senior researcher on the Financial Crisis Inquiry Commission, published by the International Monetary Fund in June.
Borrowers from New York to California are now paying to get out of agreements. Altogether, they have made more than $4 billion of termination payments to firms including New York- based Citigroup Inc., New York-based JPMorgan Chase & Co. and Charlotte, North Carolina-based Bank of America Corp. since the beginning of 2008, according to a review of hundreds of bond documents and credit-rating reports by Bloomberg News.
In contrast to the subprime crisis, few taxpayers know anything about the cost of untangling municipal swaps. The only disclosure of payments to Wall Street often is buried in documents borrowers have to give investors when they sell bonds. In many cases, firms getting payments aren’t explicitly identified and government officials often don’t call attention to payments made to cancel contracts. Many of the telephone calls and e-mails from Bloomberg News to dozens of government and nonprofit officials over the last eight months seeking comment on derivative transactions went unanswered.
"Money that should be invested in students, classrooms and fixing infrastructure in Pennsylvania is instead lining the pockets of Wall Street," Jack Wagner, the state’s auditor general, said in a statement in April after calling on lawmakers to ban swaps. "State and local governments must stop gambling with public money," he said.
In an interest-rate swap, two parties exchange payments on an agreed-upon amount of principal. Most of the swaps Wall Street sold in the municipal market required borrowers to issue long-term securities with interest rates that changed every week or month. The borrowers would then exchange payments, leaving them paying a fixed-rate to a bank or insurance company and receiving a variable rate in return. Sometimes borrowers got lump sums for entering agreements.
The swaps were popular because governments and nonprofits could pay a rate that was lower than what they would otherwise face had they sold conventional fixed-rate securities. The agreements backfired after the credit crisis broke out. While borrowers had to continue selling adjustable-rate securities under the deals, the payments made by Wall Street plunged and no longer were enough to cover the municipalities’ own debt costs.
Banks and insurance companies such as New York-based American International Group Inc. started designing municipal swaps in the 1990s as derivatives trading on Wall Street soared. Derivatives are agreements whose value is derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in interest rates or the weather. They were blamed in part for causing the global financial panic.
The financial manipulation was a boon for Wall Street. While banks got paid to underwrite municipal bonds for public projects, they were able to generate additional fees if the borrower used a swap with the transactions. Because the contracts were unregulated and privately negotiated, the profits that Wall Street booked were never disclosed.
"The basic idea from the bank’s perspective is just to do a swap because that’s where the money is," said Andrew Kalotay, head of the debt-management advisory firm Andrew Kalotay Associates Inc. in New York. "Look at all the fees they get."
In Alabama, $5.8 billion of swaps Jefferson County used in a sewer-system financing in 2002 and 2003 produced $120.2 million in fees for banks, as much as $100 million more than it should have based on prevailing rates, according to James White, an adviser hired by the U.S. Securities and Exchange Commission. The derivatives, which pushed the home of the city of Birmingham to the brink of bankruptcy, led to a $722 million settlement with JPMorgan in November 2009 after an SEC probe and the conviction of a county commissioner who steered business to bankers in exchange for bribes.
The New Jersey agency that makes college-student loans and grants paid tens of millions of dollars when it canceled derivative agreements with banks led by UBS AG and Citigroup in January. The deals by the Higher Education Student Assistance Authority date back to April 2001, when the agency was getting ready to sell $190 million of fixed-rate bonds. Paul Wozniak, a UBS investment banker, told a meeting of the authority’s board in Trenton it could borrow more cheaply by using swaps rather than selling conventional tax-exempt bonds, according to minutes and a copy of his presentation obtained by Bloomberg News after a request to state officials.
All the authority had to do to get the deal from UBS was to sell auction-rate securities, he said. The Zurich-based bank would help cover the cost of that adjustable-rate debt in exchange for annual fixed-rate payments from the authority, he said. The fixed rate was 4.65 percent, about a half percentage point less than the 5.18 percent the state would pay if it sold conventional bonds, he said.
The disadvantages were few, Wozniak told board members. The swap was a contract, so it would have to be footnoted in the authority’s financial statements, he said. The state would have to count on getting periodic payments from UBS over the deal’s life, he said. "They found the swap agreements extremely complicated," New Jersey’s former Inspector General Mary Jane Cooper said in a report in May after auditing the authority and interviewing board members who listened to Wozniak’s pitch.
"The explanations were not particularly helpful," she said. In the end, they relied on recommendations made to them by management, according to the report. The 18-member board, which consisted of college administrators and New Jersey government officials and students, approved about $1 billion of the deals over the next five years. The authority started exiting the contracts in January, making $49 million in termination payments, including $23 million to UBS and $17 million to Citigroup.
"Government operates with a very short-term mentality," said Matt Fabian, a senior analyst at Municipal Market Advisors in Westport, Connecticut. "There isn’t much upside to look long term. They are looking for near-term savings on things." AnnMarie Bouse, a spokeswoman for the authority, referred to Cooper’s report, which included written responses from management.
"A board member’s decision to rely on the recommendation of management where the underlying transaction remains unclear is a reflection on that particular board member, not necessarily an authority deficiency," Michael Angulo, the authority’s executive director, wrote in the report. Wozniak, who is chairman of Las Vegas-based education lender College Loan Corp. and left UBS in 2008, said he doesn’t recall the meeting. "You wouldn’t have done it if you wouldn’t have thought it would save you money," he said in a telephone interview.
New York Governor George Pataki was seeking ways to close an $11 billion budget deficit in 2003 when he embraced Wall Street’s alchemy. The former governor included a provision in his spending plan that authorized all state agencies to use swaps, resulting in a total of $5.9 billion of the deals with firms such as Goldman Sachs Group Inc., based in New York.
The state sold floating-rate securities to refinance existing fixed-rate bonds and then locked in lower fixed rates on the new debt using swaps. Before the credit crisis, officials said they had generated $203 million of savings. Since the crisis, unwinding the swap contracts has cost $247 million, according to the state budget office.
Pataki didn’t return telephone calls and e-mails to his office at the New York-based law firm Chadbourne & Parke LLP seeking comment. Erik Kriss, a spokesman for the state’s budget department, said the "swap portfolio will continue to show modest savings," in part because state officials are refinancing existing debt with lower fixed rates.
New York was among about 40 states that passed laws, often at Wall Street’s urging, permitting municipal derivatives before the credit crisis, according to Dodd’s research for the IMF. Tennessee passed rules in 2001 that required borrowers to attend a swap school.
Memphis-based Morgan Keegan Inc., a division of Birmingham, Alabama-based Regions Financial Corp., was selected to teach the classes. The firm sold many of the $12.7 billion of the deals subsequently done by more than 40 counties, municipalities, districts and authorities, according to Justin Wilson, the state comptroller.
"There’s just no reason these entities should be playing with this stuff," said Christopher Whalen, managing director at the Torrance, California-based research firm Institutional Risk Analytics. "They don’t have the capacity to evaluate these instruments. They are totally lost."
Just as banks loosened mortgage underwriting standards as part of the effort to create more subprime-linked securities, Wall Street targeted some of the riskiest credits in the municipal market with its swaps pitch. Nonprofit and government- run health-care providers, which pay higher tax-exempt interest rates because they have among the lowest bond ratings, accounted for 40 percent of the derivative deals, Standard & Poor’s found in a study in 2007.
The business was so lucrative that banks and insurers were able to write teaser checks to lure borrowers into swaps. The arrangements were akin to Goldman Sachs giving Greece $1 billion in off-balance-sheet funding in 2002 through a currency swap, helping the nation mask budget gaps to meet a European Union debt target.
"Tinkering with debt was something that you could hide behind," said Jeffrey Waltman, a city councilor in Reading. The city got upfront payments totaling $7.6 million from Wachovia Corp. in 2005 and 2006 for contracts it later terminated. "Maybe it didn’t mean so much of a tax increase, or maybe it didn’t mean laying off people," said Waltman. "It was what appeared at the moment to be a painless effort." Ferris Morrison, a spokeswoman with San Francisco-based Wells Fargo & Co., which acquired Wachovia in December 2008, didn’t respond to a request for comment.
Reading taxpayers weren’t Pennsylvania’s only swap victims. The school district in Butler, 32 miles (51 kilometers) north of Pittsburgh, got a $730,000 check in 2003 from JPMorgan. It cost officials $5.3 million two years ago to exit the contract, enough to hire 100 new teachers for a school year. In a lawsuit it filed against its adviser and JPMorgan, the district said the bank booked an $890,000 fee from the transaction, which it called excessive. A New York court last year dismissed the complaint and others alleging securities fraud, ruling that interest-rate swaps were privately negotiated contracts and not securities.
Borrowers in the municipal market primarily sold two types of adjustable-rate debt to do swaps. Auction-rate securities were bonds maturing typically in about 40 years that paid investors a rate that changed every 7, 28 or 35 days at bidding run by banks. Variable-rate demand bonds were similar except they were also often secured by an agreement from a bank to buy the debt if no investors did when rates were periodically reset.
The $330 billion auction-rate securities market, which dates back to the 1980s, collapsed in February 2008. Investors stopped buying the bonds because much of the debt was backed by bond insurers that were about to lose their AAA ratings after expanding into mortgage-related derivatives. When banks that ran the bidding started permitting auctions to fail, rates paid by borrowers to bondholders were reset in some cases as high as 20 percent.
While auction rates soared, the periodic payments that banks made to borrowers as part of the swaps plunged because they were linked to benchmarks such as U.S. Federal Reserve lending rates, which were slashed to almost zero percent to combat the financial panic. "That’s the black swan," said Robert Fuller, a municipal financial adviser at Capital Markets Management LLC in Hopewell, New Jersey. "The things you can’t imagine kill you."
The University of California had to unwind derivatives it used with debt sold for its medical centers, which form the third-biggest U.S. public hospital system. In April 2008, it sold $322 million of fixed-rate bonds to refinance auction-rate securities and pay $6.8 million to JPMorgan, Goldman Sachs and Merrill Lynch & Co., later acquired by Bank of America, to terminate swaps, according to bond documents. The exit fee was enough to cover the annual tuition of 200 students in its public-health program.
The pace of swap cancellations in the municipal market accelerated after Lehman Brothers Holdings Inc. filed for bankruptcy in September 2008. The filing triggered the termination of all the New York-based bank’s derivative contracts, including hundreds with tax-exempt borrowers.
While the market for variable-rate demand bonds didn’t collapse, the cost of the debt increased as banks lifted the fees they charge to serve as buyers of last resort. California’s State Department of Water Resources refinanced almost $4 billion of the securities this year and terminated swaps as its so- called liquidity agreements with banks expired. The agency began borrowing the money in 2002 to buy electricity to help alleviate the state’s energy shortage.
‘Something More Stable’
"They wanted to get out of this variable rate," said Joe DeAnda, a spokesman for state Treasurer Bill Lockyer, whose office oversaw the water resource department’s refinancing. "They wanted to move into something more stable."
Municipal borrowers have refinanced or retired about $135 billion of $525 billion of variable-rate demand bonds since 2008, according to a report in September from Christopher Mauro, head of municipal-market strategy at RBC Capital Markets in New York. There is another $101 billion of the securities backed by banks under contracts that expire next year, he said.
In addition to getting termination payments, Wall Street is finding a way to profit from the meltdown by underwriting bonds that borrowers sell as they unravel their swaps. Morgan Stanley, JPMorgan and Bank of America were among firms that got termination money from California’s water resources department this year at the same time they were paid to help the agency sell bonds, according to offering documents.
Mary Claire Delaney, a Morgan Stanley spokeswoman, declined to comment, as did Danielle Robinson from Bank of America and JPMorgan’s Justin Perras. JPMorgan in September 2008 said it would stop selling interest-rate swaps to government borrowers.
Even Ivy League universities were caught in the market’s demise. Harvard University paid $497.6 million in December 2008 to end $1.1 billion of interest-rate swaps with JPMorgan and Goldman Sachs, and separately agreed to end another $764 million of the agreements at a cost of $425 million. JPMorgan was the lead banker when the university in Cambridge, Massachusetts, sold bonds whose proceeds were used to make the termination payments.
Cornell, one of the eight private colleges and universities in the Ivy League, paid $22.8 million in May to get out of deals with Wall Street firms. The exit fee would cover the annual tuition for 500 students at the university. Unwinding the derivatives gave the university "greater future flexibility" because it was able to replace 50 percent of its variable-rate debt with fixed rates, Joanne DeStefano, chief financial officer, said in an e-mail.
Many borrowers are unwinding swaps because they want to refinance variable-rate debt with municipal fixed rates at historic lows. The savings can offset the cost of termination fees, said Peter Shapiro, managing director of Swap Financial Group in South Orange, New Jersey. The financial engineering also generated savings before the crisis, he said.
Shapiro, 58, the former head of Essex County, New Jersey, who ran for governor as the Democratic nominee in 1985, formed his municipal-swap company in 1997 and may be the biggest industry adviser, with more than 100 government and nonprofit clients, according to his website. There are no formal rankings because the business is all privately negotiated.
"The swap relied upon an orderly functioning variable-rate market," said Shapiro, who has advised borrowers such as the California Housing Finance Agency, which has more than $4 billion of the derivatives. "There hasn’t been an orderly functioning variable-rate market for two-and-a-half years."
Some public officials are trying to prevent a repeat of the swaps meltdown. Tennessee’s comptroller last year tried to ban municipal derivatives outright before pushing through rules that place limits on who can use them. In Pennsylvania, Wagner, the state’s auditor general, last year asked lawmakers to adopt rules to outlaw financial fiddling after investigating school- district deals.
The board of the Delaware River Port Authority voted to ban using swaps last December after losing more than $60 million on the contracts. Pennsylvania’s auditor general is on the board of the authority, which operates four toll bridges and a commuter rail line between Philadelphia and southern New Jersey. Houston, which still has two swaps linked to about $900 million of its bonds, says it’s done with the derivatives after the promised savings disappeared.
"If you have to create a flow chart to explain how a transaction works," Annise Parker, the Texas city’s mayor, said in a September interview at Bloomberg’s New York headquarters, "that’s a problem even for a city the size of Houston."
Nearly 59 million lack health insurance: CDC
by Maggie Fox - Reuters
Nearly 59 million Americans went without health insurance coverage for at least part of 2010, many of them with conditions or diseases that needed treatment, federal health officials said on Tuesday. They said 4 million more Americans went without insurance in the first part of 2010 than during the same time in 2008. "Both adults and kids lost private coverage over the past decade," Dr. Thomas Frieden, director of the U.S. Centers for Disease Control and Prevention, told a news briefing.
The findings have implications for U.S. healthcare reform efforts. A bill passed in March promises to get health insurance coverage to 32 million Americans who currently lack coverage. But Republicans who just took control of the House of Representatives last week have vowed to derail the new law by cutting off the funds for it, and some want to repeal it. Experts from both sides predict gridlock in Congress for the next two years in implementing healthcare reform's provisions.
Even before the healthcare reform act, Congress passed provisions expanding free health coverage for children. "As private insurance coverage fell, the safety net protected children, but did not adequately protect adults," Frieden said.
Nine percent of adults lost private insurance, and public insurance picked up just 5 percent of them, the CDC said. Frieden said 22 percent of adults aged 18 to 64 are uninsured.
The CDC analyzed data from the National Health Interview Survey or NHIS for 2006, 2007, 2008, and 2009 and the first quarter of 2010 for its report. "It's an in-person household survey interviewing nearly 90,000 individuals from around 35,000 households," Frieden said. The analysis found that in the first quarter of 2010, an estimated 59.1 million people had no health insurance for at least part of the year, an increase from 58.7 million in 2009 and 56.4 million in 2008.
More than 80 percent were adults aged 18 to 64. People over 65 are eligible for Medicare, the federal health insurance plan for the elderly. Frieden said more people also went for a year or more with no health insurance -- from 27.5 million in 2008 to 30.4 million in the first quarter of 2010. "That's an increase of 3 million in chronically uninsured adults," he said. "Now, the data also allow us to debunk two myths about health care coverage," Frieden added.
"The first myth is that it's only the poor who are uninsured. In fact, half of the uninsured are over the poverty level and one in three adults under 65 in the middle income range -- defined arbitrarily here between $44,000 and $65,000 a year for a family of four -- were uninsured at some point in the year." And Frieden said many people argue that only the healthy risk going without health insurance. "In fact ... more than two out of five individuals who are uninsured at some point during the past year had one or more chronic diseases and this is based on just a partial list of chronic diseases," he said.
For example, 15 million of the people who went without health insurance had high blood pressure, diabetes or asthma. People with such conditions often end up in emergency rooms and require treatment, paid for by hospitals or taxpayers, that is far more expensive than getting proper preventive care would have been. "If you have diabetes and you don't get needed care in the short term you end up in the intensive care unit," Frieden said.
Unemployment payouts push California $40 million deeper into debt each day
by Marc Lifsher - Los Angeles Times
The state is borrowing $40 million a day from the federal government to provide assistance to jobless workers, but has resisted changing the formulas it uses to determine and fund those benefits.
California's fund for paying unemployment insurance is broke. With one in every eight workers out of a job, the state is borrowing billions of dollars from the federal government to pay benefits at the rate of $40 million a day.
The debt, now at $8.6 billion, is expected to reach $10.3 billion for the year, two-thirds greater than last year. Worse, the deficit is projected to hit $13.4 billion by the end of next year and $16 billion in 2012, according to the California Employment Development Department, which runs the program. Interest on that debt will soon start piling up, forcing the state to come up with a $362-million payment to Washington by the end of next September.
That's money that otherwise would go into the state's general fund, where it could be spent to hire new teachers, provide healthcare to children and beef up law enforcement. Continued borrowing, meanwhile, means that employers face an automatic hike in their federal unemployment insurance taxes, pushing up annual payroll costs $21 a year for each worker.
Those costs are expected to more than double over the next five years if California continues to borrow from the federal government. "It's a fiscal problem for elected officials in our state," said Todd Bland, director of social services at the nonpartisan Legislative Analyst's Office. "The deficit is ongoing and will continue to grow." The state Legislature has turned away two attempts to raise payroll taxes to fix the deficit and ignored a similar proposal by Gov. Arnold Schwarzenegger.
Now California's governor-elect, Jerry Brown, has to devise a way to minimize the tax burden on employers without drastically slashing benefits for the jobless — and get lawmakers on board. Neither Democrat Brown nor his Republican opponent in last week's election, Meg Whitman, publicly focused on the bulging deficit in the unemployment insurance fund.
California heads a list of 32 states that have been forced to borrow a total of $41 billion so far from the federal government to pay claims. Putting the fund back into balance, at least theoretically, shouldn't be overly complicated, experts say. "You can increase your contributions, decrease money going out of the fund as benefits, or do a combination of both," said Employment Development Department spokeswoman Loree Levy. "But the hole will keep getting bigger the longer that we go without addressing the problem."
California's unemployment insurance program began heading toward insolvency when the state started hemorrhaging jobs in late 2007. The fund took out its first loan from the federal government early last year as the worst recession since the Great Depression devastated the economy. Over the last three years, the total of unemployment insurance benefits paid out by the state rose 122% and the number of claims climbed 119%.
As a result, California last year paid out $11.3 billion in regular unemployment insurance benefits while collecting only $4.2 billion in payroll taxes from employers. The disparity has been exacerbated by a 2001 law that nearly doubled maximum benefits to $450 a week for up to 26 weeks but didn't raise the payroll tax on employers. The average benefit now is $307 a week for 17 weeks.
In an Oct. 20 report, Mac Taylor of the Legislative Analyst's Office suggested that lawmakers adopt a strategy that includes hiking the unemployment insurance tax rate and raising the individual income limit used to calculate the tax closer to the national average of $14,321, while at the same time reducing benefits by a modest amount. Finding that middle ground has been difficult in recent years.
The unemployment insurance fund has depended on the same source of revenue since 1984: a tax based on a worker's first $7,000 of annual wages, the minimum level allowed by federal law. California is one of only six states in the nation that collect taxes using a wage threshold that low. Next year, three of those six states plan to raise their wage thresholds.
An effort to address a short-term deficit in the unemployment insurance fund went nowhere in 2004. Lawmakers and lobbyists for employers and labor unions lost interest in an overhaul after the economy recovered from the bursting of the dot-com bubble. Four years later, Schwarzenegger took another stab at the problem. He proposed both raising revenues collected from employers and tightening eligibility requirements for some jobless workers seeking benefits.
Schwarzenegger's proposal, which was largely ignored by lawmakers, would have raised the threshold on taxable income to $10,500 per employee and increased the maximum state tax rate to 8.1% from 6.2%. "The Legislature didn't have the political will to act," said Jeff Wyly, a spokesman for the governor's Labor and Workforce Development Agency. "The Republicans don't want to raise taxes, and the Democrats don't want to reduce benefits. That's where the problem lies."
That paralysis continued during the latest two-year legislative session. Two bills that attempted to increase unemployment insurance payroll taxes died soon after they were introduced. Chances for raising unemployment taxes on employers seem just as remote for the upcoming legislative session that begins in December. Lawmakers are expected to focus most of their attention on how to fill a potential $12-billion gap in next year's state budget.
For his part, Senate President Pro Tem Darrell Steinberg (D- Sacramento) recognized that he couldn't ignore the growing unemployment insurance fund deficit. "We have to tackle this one early on," he said. "We know what the options are. There's the benefit side and there's the fee side on employers. We have to look at both very closely."
Getting any tax increase through the Legislature is a daunting task because of the constitutional requirement that it be approved by a two-thirds vote in both the Assembly and the Senate. "It's a high bar," said Angie Wei, a lobbyist for the California Labor Federation. "But, somehow the system has to get more money into it." Wei hopes that Brown's election will give organized labor the leverage it needs to bring employers to the bargaining table and agree to beef up the unemployment insurance fund.
Business, however, has little appetite for any type of tax increase. "In the current economic situation, any tax increase will result in fewer jobs being created," said Michael Shaw, the California legislative director for the National Federation of Independent Businesses. He wants Congress and the Obama administration to continue granting states a waiver that forgives interest charges on federal loans. The waiver is scheduled to expire Dec. 31.
Keeping the waiver could buy California time while it waits for the economy to strengthen, said Marti Fisher, a lobbyist for the California Chamber of Commerce. "If we have increased revenues and we get some relief from federal government, we can figure out the best approach" to fixing the system, she said.
Some business advocates believe companies will have to bite the bullet. "Probably we have to do something in the benefit area and we have to raise taxes," said Scott Hauge, executive director of Small Business California, a San Francisco advocacy group. "I'd rather have something planned to deal with the issue," he said, "than not do anything and have things come down that are unintended and could be worse."
High-Frequency Traders Lobby, Donate to Head Off U.S. Rules
by Jesse Westbrook, Robert Schmidt and Frank Bass - Bloomberg
The high-frequency trading industry is stepping out of the shadows in Washington. Closely held companies with undisclosed profits and obscure names like Getco LLC, Hard Eight Futures LLC and Quantlab Financial LLC, are beginning to act more like Wall Street banks, cutting checks to politicians, forming trade groups and hiring lobbyists and ex-regulators. They’re looking to fend off tighter rules and appease lawmakers who say the firms disadvantage small investors and contribute to wild swings in stock prices.
While the companies, which use high-powered computers to execute thousands of trades in milliseconds, aren’t approaching the big banks in Washington spending, they have more than quadrupled their political giving over the last four years, a Bloomberg News analysis shows. The top recipients include Eric Cantor, set to become House majority leader, and several incoming senators who won in last week’s Republican rout.
"They are under attack as an industry and they are fighting back," said James Angel, a professor at Georgetown University’s business school who is on the board of Direct Edge Holdings LLC, which operates stock exchanges. "There is an old saying in Washington that if you are not at the table, you are on the table."
In just over a decade, high-frequency trading has evolved from a little-known investment strategy practiced by mathematicians to a force that accounts for the majority of U.S. stock trades. The companies, which prefer to be called automated proprietary trading firms, say they benefit all investors by keeping markets liquid and transaction fees low.
Periods of Stress
The Securities and Exchange Commission is less certain of the benefits. The agency is considering a requirement that high- frequency traders keep buying and selling shares during periods of stress, instead of just abandoning the market. The SEC is also evaluating whether it should slow down computers that submit and cancel thousands of orders in milliseconds by requiring bids to stand for a minimum amount of time.
While regulators may need to address some issues, any rules shouldn’t get in the way of innovation, said David Hirschmann, president of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness. "There are those who really want to turn the clock back to 1980," said Hirschmann, whose trade group’s members include stock exchanges, financial firms and public companies.
The SEC and members of Congress already were examining the business when the May 6 market plunge temporarily wiped out $862 billion of share value in 20 minutes. Although an investigation by regulators didn’t put direct blame on high-frequency firms, the volatility of stock prices focused more attention in Washington on their operations.
"Those with powerful computers are able to use them to their own financial advantage," Senator Carl Levin, a Michigan Democrat, said Sept. 28 on the Senate floor. "Those who exploit our markets to the detriment of long-term investors and the real economy will not be able to do so without a battle from the Senate."
In addition to writing proposed rules, the SEC’s enforcement division is investigating whether computer-driven traders have manipulated prices. "You have to be concerned every time there’s a lack of transparency into a market practice, particularly one like high-frequency trading that is so prevalent," Robert Khuzami, the SEC’s enforcement chief, said in an interview.
The scrutiny has spurred the industry to seek friends in Washington. Managers and employees of 21 of the largest computerized-trading firms, including Getco, Allston Trading LLC and Infinium Capital Management LLC gave about $490,000 for this year’s congressional elections, compared with just over $100,000 in 2006, according to federal election reports filed through Oct. 15. In 2000, when some of the firms didn’t yet exist, contributions totaled about $10,000.
Although high-frequency trading wasn’t addressed by Congress in the Dodd-Frank regulatory overhaul, SEC Chairman Mary Schapiro in September 2009 began issuing proposals to curtail market developments that cater to the industry. After the May 6 stock plunge, she went even further by saying the SEC will examine whether it should restrict a practice by high-frequency firms of canceling most of the orders they submit.
Last January, Representative Cantor of Virginia, the second highest-ranking Republican in the House, sent Schapiro a letter saying her agency’s ideas for regulating fragmented, electronic markets, including a proposal that would prohibit exchanges from giving high-frequency traders and other market participants a split-second peek at stock orders, "appeared ad hoc in nature."
The SEC should "collect all the facts and develop coherent and rational policy objectives before adopting any potentially far-reaching rulemaking proposals," Cantor wrote in the Jan. 27 note. Cantor, who helped spearhead his party’s successful campaign to win the House back from Democrats, has been among the largest recipients of contributions from the industry, with he and his political action committee taking in $23,000 since last year, records show.
On Oct. 5, 2009, for example, eight top executives from Chicago-based Getco, including the chief executive officer, general counsel and chief financial officer, gave Cantor more than $10,000, records show. He collected $1,400 the same day from James Simons, the legendary founder of Renaissance Technologies Corp., a hedge fund that engages in high-frequency trading. Other firms whose employees have contributed money to Cantor include Tradelink LLC and Traditum Group LLC. No one at Getco has asked Cantor to discuss regulatory policy with the SEC, spokeswoman Sophie Sohn said.
‘Share Our Experience’?
Getco supports some rules for high-frequency trading under consideration by the SEC, Sohn said. She said the company already faces obligations to buy and sell stock at the best offer price, because it’s a designated market maker at the New York Stock Exchange. "As a major participant on many of the world’s leading exchanges, we believe it is important to share our experience with regulators, lawmakers, fellow industry participants and members of the press who are seeking to improve their understanding of market structure," she said.
Cantor also wrote to the SEC after the agency responded to the May crash by urging stock exchanges to implement so-called circuit breakers that halt trading of any stock with a 10 percent price-swing in less than five minutes. "I am concerned that this was done before conducting a holistic review of the causes of the disruption," Cantor wrote in his second letter dated May 21. Cantor wasn’t available to comment, said his spokesman John Murray.
Another advocate for electronic trading has been Representative Jeb Hensarling, a Texas Republican who sits on the House Financial Services Committee.
Hensarling and Representative Spencer Bachus, the Alabama Republican in line to become chairman of the financial services panel, advised Schapiro in an Aug. 24 letter to get a better understanding of what caused the crash before "assigning blame to algorithmic or high-frequency trading firms."
Hensarling received $4,800 last month from Suhas Daftuar and Alexander Morcos, two managing directors of Hudson River Trading LLC, a New York high-frequency trading firm. Hudson River Trading didn’t respond to a request for comment. In an interview, Hensarling said he’s concerned the SEC is acting "precipitously" in singling out high-frequency trading. "I’m not necessarily saying they are wrong, but the accountability function of Congress is to ensure there is justification for what you’re doing," he said.
Donations to Democrats
Other politicians who were the biggest recipients of donations from high-frequency traders include Mark Kirk, a Republican who won a U.S. Senate seat in Illinois, Senator Charles Schumer, a New York Democrat, Representative Melissa Bean, an Illinois Democrat, and Robin Carnahan, a Democrat who lost her race for a U.S. Senate seat from Missouri.
In June, about two dozen high-frequency trading firms formed a trade association to respond to legislative and regulatory proposals. Known as the Principal Traders Group, the association said it plans to reach out to the media to improve its understanding of electronic trading. "They felt their voice was missing in the press," said James Overdahl, a vice president at NERA Economic Consulting in Washington who advises the group. The firms want to make sure that any proposed rules are "data driven and responding to actual evidence," he said.
The Principal Traders Group is a part of the Futures Industry Association, which advocates on behalf of financial companies in Washington. The unit doesn’t lobby, said Overdahl, a former chief economist at the SEC and Commodity Futures Trading Commission. Still, a number of high-frequency firms, including members of the Principal Traders Group, have retained former aides to lawmakers to push their interests in Washington.
Getco in April 2008 hired the Rich Feuer Group, which represents financial titans such as Goldman Sachs Group Inc. and Credit Suisse Group AG. Getco has paid Rich Feuer at least $730,000 in the past two years to lobby Congress and the SEC on rules affecting electronic trading and U.S. market structure, according to federal disclosure records. RGM Trading LLC, a high-frequency trader based in Austin, Texas, hired Patton Boggs LLP’s Micah Green this year and has paid his firm $180,000. Green, who was head of the Bond Market Association, also lobbies on behalf of Quantlab, a computerized- trading firm based in Houston.
Alex Sternhell, a former aide to Senate Banking Committee Chairman Chris Dodd, has been paid $310,000 since last year to lobby for Hudson River Trading, records show. Some of the companies have also employed former regulators. Getco hired SEC lawyer Elizabeth King in June, adding to a roster of agency alumni that includes John McCarthy, the company’s general counsel, and former SEC Chairman Arthur Levitt, who’s a consultant. Cameron Smith, Quantlab’s general counsel, worked at the SEC in the 1990s.
The high-frequency trading firms’ Washington education is following a well-worn path, traveled by such companies as Microsoft Corp. and Google Inc. that avoided the political process until they grew too big to escape notice. "Like so many other cutting edge technologies that have run into the media and regulatory whipsaw, high-frequency trading firms would be smart to engage in the Washington public policy discussion," said Israel Klein, a lobbyist at the Podesta Group who represents financial companies.
Will You Be Able To Heat Your Home This Winter? Millions Of American Families Will Not
by Michael Snyder - Economic Collapse
Will you have a warm house to come home to this winter? If so, you should consider yourself to be very fortunate. With the United States experiencing the highest levels of long-term unemployment that it has seen since the Great Depression, millions of Americans families are simply out of money. All across America this winter, families are going to be forced to make some heart breaking decisions. For many, the choice will come down to either heating their home or putting food on the table. According to the National Energy Assistance Directors' Association, more than 10 million U.S. households will not be able to afford to heat their homes this winter without assistance, which would be a new all-time record. So, if you are in a position to easily heat your home this winter, be very, very thankful. The number of American families that cannot even afford the basics of life is growing by the day.
As I have written about previously, millions of formerly middle class families have been absolutely ripped apart by this economy. There simply is not nearly enough jobs for everyone, and those who have been left on the outside looking in are becoming increasingly desperate.
Of course there is federal help available, but it doesn't go nearly far enough for those who are truly in need. For example, the Low Income Home Energy Assistance Program (LIHEAP) assists low income households in paying their home heating bills. However, the truth is that usually only a small fraction of heating costs are covered. Nationally, the average benefit represents only about 8% of the average winter heating bill.
Last winter, a record number of U.S. households applied for home heating assistance. In fact, in 17 states application requests were up more than 20% from the year before. Due to rapidly spreading poverty, the number of Americans filing for heating assistance is expected to increase even more this winter.
If you cannot heat your home, it is a really, really big deal. In 2009, a 93-year-old man in Bay City, Michigan actually froze to death inside his own home.
These days, many American families are finding that their budgets are stretched beyond the breaking point. Most Americans take it for granted that they will be able to heat their homes, but for the poor, being able to have enough heat is a great blessing. Today, the poorest 20 percent of Americans spend more than 50 percent of their after-tax income on food and energy....
So can't the U.S. federal government just pay for everyone to have heat?
No, they cannot.
The truth is that as millions upon millions of Americans jump on to the "safety net" it is rapidly approaching the breaking point. For example, 42 million Americans are now enrolled in the food stamp program. That is a whole lot of hungry mouths to try to feed every month.
Not that feeding hungry people should not be a priority. It is just that the U.S. government continues to spend way, way more money than it is bringing in and is basically bankrupt at this point.
So what about the states? Can't they step in and help?
No, the truth is that most U.S. states are absolute basket cases financially. A recent article that I wrote about the state of California illustrates this point very well.
Unfortunately, most Americans families are just going to have to scrape by the best that they can.
It is hard to even describe the horrible pain that many Americans are experiencing because of this economy. The following story from the Unemployed-Friends website is from a woman named Leetah who is desperately hoping that her family will be able to get through this upcoming winter....
The place I live in right now has no jobs and no places to live. My fiance, Lloyd, and I have been looking for anything but he lost his job from McDonald's and the factories (the only jobs to make a living off of) consider him an insurance liability. I can't get hired to a factory because of I was fired from our major factory for attendance (I had to miss 3 days of work because I was sick). So we are moving to the Edmond/OKC region where we are hoping to find a job and a place with running water and heating. We've spent the last few years without heat and running water and so having a place with water and heat would be heaven.
Winter is coming up fast and I am so afraid. Last winter we almost died from the cold and now the thought of cold makes my throat close up and my heart pound. But it isn't just ourselves we are looking out for, we have our dog too. Our wonderful APBT Maggie who is 2-years-old and has been with us since she was 5-months-old. She's our baby girl and we can't lose her. We almost lost her to the cold too and it scared me so much. We are going to be living in our car soon with our dog.
I am hoping to be able to keep our food stamps in the new city so we can still eat. I have already applied for ten+ jobs and nothing yet but I am keeping my hopes up. Hopefully it will get easier to find a job once we get there. Then we just have to save up and then we can afford an apartment. Now finding an apartment with my awesome dog is another story.
Please say a prayer for those who are hurting this winter. This economy has pushed millions of Americans to the absolute edge of despair. Another participant on the Unemployed-Friends forum named Sanskay sounds like the hard reality of her situation has sucked almost all of the life out of her....
I met the love of my life when I was 19, and we moved in together. He had an excellent job and savings (he was several years older than me), and we decided together that I would stay home. When I was 26, he started feeling sick to his stomach a lot. By the time he was diagnosed with colon cancer (at 33!), it had already spread to his liver. We lost everything to medical bills, treatments, and medications. We fought so hard to prolong his life, and we drained his (our) savings accounts to try to cure him. Well, it did not work. He died in agony.
So then I was 26 and a widow and penniless, and I had not worked since college. I moved back in with my parents and decided to go back to school. Everyone told me that the health care fields were all in demand, so I studied to become an ultrasound tech. I excelled in my classes. It took me two years to do all of my prerequisites before I entered the program. By then, the recession had hit, but everyone at the school told me that I would have no problem landing a job as long as I was willing to move. This ended up being all lies. By that point, they knew that they were having trouble placing grads from 2007 and 2008, but that was never mentioned to me. This was a community college with a good reputation, and not some for-profit school, and I believed them.
I graduated last year (2009) and have been looking for employment as an ultrasound tech for over a year now. I have applied to over 400 jobs. I have gained three in-person interviews and seven phone interviews. None of them have amounted to anything. I am still unemployed. There are many per-diem (they'll call you when they need you, and you have no guaranteed hours) jobs listed, but I cannot move unless I have a full-time job.
It's awful because they are still funneling people into the program and telling them that as long as they're willing to move out of state, they will have no trouble finding full-time work. They're just concerned with keeping the seats full and they don't care if their new graduates are unable to find work. I feel betrayed.
So now I'm 30 years old and still living in my parents' basement, as I have been for years now. I feel like such a loser. My parents paid for my community college degree and my registry exams, which are all worthless now. It's been so long that I have scanned anyone that I don't remember what to do for some of the exams any longer, not to mention what the pathologies look like.
I haven't applied to a job in a month. The official unemployment rate in my county is 15.6%, but the "unofficial" unemployment rate (REAL unemployment rate!) is easily double that. There is no work here, and I have no money to move, and no salable skills even if I had the money to move.
I miss my husband terribly. Suicide has definitely crossed my mind many times, but it would literally kill my mother if I did anything rash (she has a heart condition and can't allow herself to become over-excited or her heart starts beating out of rhythm, which could cause a heart attack). It seems most days that the best years of my life are far behind me and that I have nothing to look forward to anymore.
Hopefully as you read these kinds of stories you feel your heart move. The truth is that it could be any of us that are next.
In this economy, no jobs is secure. In this economy, no business is secure. There is no guarantee that the income that you are enjoying today is going to be there tomorrow.
The U.S. economic system is slowly dying. There are many that are cheering this downfall, but the cold, hard truth is that tens of millions of us are going to experience horrible economic pain as the economy unravels.
It is not going to be a fun time. So count your blessings while you still have them.
New Risks Emerge in Munis
by Michael Corkery - Wall Street Journal
Debtholders Are Left Steamed as Some Cities Forgo Repayment Promises
The housing crisis was fueled by cash-strapped homeowners who walked away from their mortgages. Some analysts and investors now are worried about the same problem happening with debts of cities and towns.
For more than a year, Menasha, Wis., hasn't paid back about $23 million in principal for short-term notes tied to a failed steam plant, even though the deal's offering documents include a statement that the city would use tax revenue to cover any debt payments, if needed. But that statement "was no guarantee" to repay the debt, says Edward Fuhr, a lawyer for Menasha, a small industrial city that has spent an average of $80,000 a month to fight investor lawsuits in three courts over the notes, which matured in September 2009.
The tangle underscores concern in the municipal-debt world about the longstanding assumption that local governments will do whatever it takes to repay their debts—including raising taxes—because failing to do so would make it more expensive or even impossible to turn to investors for future financing. Such cases are rare but could increase in number as municipal governments struggle to meet their obligations on projects that have run into trouble. The greatest default risk is in small municipalities with overleveraged projects buffeted by the recession. Those places also might need to access credit markets less in the future than big cities, making it easier to walk away from their debt.
Cost overruns doomed Menasha's steam plant, which was shuttered in the fall of 2009 after the debt more than doubled to about $40 million. In Harrisburg, Pa., an incinerator project has forced the city to weigh a potential bankruptcy filing.
Another trouble spot for investors: Buena Vista, Va., a city of about 6,200 on the edge of the Blue Ridge Mountains that didn't appropriate money in its 2011 budget to make debt payments on $10 million in bonds that financed a municipal golf course, according to Moody's Investors Service. Moody's downgraded Buena Vista's credit rating in June to junk from "low credit risk," citing "uncertainty about the city's willingness to meet its obligations." The city's lawyer couldn't be reached for comment.
Of 54 defaults on Moody's-rated municipal debts from 1970 to 2009, about 78% were in stand-alone housing and health-care projects. Defaults like the Menasha steam plant are somewhat different because they often are backed and operated by the local municipality. "Where you have a stressed, weak government coupled with a weak enterprise, that puts bondholders at particular risk," says Robert Kurtter, Moody's managing director of U.S. state and local government ratings.
The credit-ratings firm has told analysts who follow municipal debt to "dig into government audits to make sure they are identifying these issues and that our ratings are correct," he adds. Investors in municipal debt backed by so-called appropriation pledges typically are unsecured creditors, but they might not realize the risks until default is imminent, says Howard Cure, director of municipal research at the Evercore Wealth Management LLC unit of Evercore Partners Inc. "It's only when there is bad news that you realize what you have or don't have as security," he says.
In 2004, Cicero, a small town in upstate New York, didn't appropriate payments on $15.3 million in debt to finance a recreational center, according to Moody's. Bond investors recovered $1.6 million when the property was sold in a foreclosure sale. The town supervisor couldn't be reached for comment. In deciding not to return $23 million to investors who paid for the steam plant, Menasha (pop. 17,000) is behaving like homeowners who decide not to sink more money into properties worth less than their mortgage, regardless of the consequences to their credit profile.
The project was supposed to supply steam to local paper mills, a large Menasha employer. But it was doomed when a large customer fell through, says Edward Damutz, the Moody's senior credit officer who oversaw the rating of Menasha debt. The city planned to roll the steam plant's short-term financing into long-term debt, but revenue never adequately matched costs, he says.
In 2005, Moody's assigned its highest rating to the steam plant's $12.7 million "revenue bond anticipation notes." Mr. Damutz says he was reassured partly by the city's pledge to cover any shortfall in debt payments from its "general tax levy" or "surplus funds" from its water and electrical facilities. "It said it 'will' appropriate," Mr. Damutz says, adding that the language was "strongly worded."
Moody's dropped its credit rating by one notch when the steam plant borrowed an additional $11.5 million. With the city abandoning the project rather than laying off additional workers, Moody's rates the debt as junk. "The city has an obligation, and it is not stepping forward to resolve it," says James Chatterton, president of American Bank in nearby Fond du Lac, Wis., who recently attended a city meeting to plead for a settlement. He put $2 million of the bank's $230 million in assets into the steam-plant debt.
Menasha officials counter that the pledge to appropriate money that was spelled out to investors in the bond document gives the city wiggle room to decide whether to pay back the notes. That vow isn't as ironclad as general-obligation bonds, which require governments to raise taxes if needed to repay municipal debts. Investors suing Menasha in a federal court in Indiana "have woven a fictional story that there was a general obligation by the city to pay off the bonds," says Mr. Fuhr, a partner at law firm Hunton & Williams LLP who is representing the city in the suits.
Menasha City Attorney Pamela Captain says the offering documents made it clear that the deal wasn't general-obligation debt, which the city would be required to pay. Menasha recently received some help from the state to refinance portions of $17.6 million of general-obligation debt tied to the plant. "They should have done their homework ahead of time," she says of an investor request for more financial information under the state's public-records law. The investors allege that Menasha might have hidden information from the public.
Investors were given many of the documents they sought, she says. A judge ruled that city officials don't have to provide the documents sought in court, at least for now, because the dispute is part of a securities-related lawsuit.
Close Fannie And Freddie, Liquidate Bubble Debt, and Ban Progressive Economics
by Michael David White - Housingstory.net
Any person who knows the basic facts of lending knows that mortgage loans are the easiest loans in the world to make. Why? The first reason is that the lender has two avenues for repayment. The lender can rely on the collateral and the borrower. That makes repayment more likely. This makes mortgage lending easy, and you need to know nothing more to know the way to plan the future of Fannie & Freddie.
Not convinced? Consider a car loan. It has some of the same features as a mortgage. It has collateral, but of lesser quality. The collateral can drive away and may be difficult to locate and it loses value quickly. When you seize a home its value is more certain than that of a car, but the legal process of seizing the collateral is lengthy. Both loans have collateral advantages and both loans are much less risky if the borrower makes a large downpayment. Eliminate the downpayment and start a credit bubble.
The balance on a car loan is small so it’s a hassle to get money on the street. The primary and difficult job of a banker is to get money on the street (to make loans to persons who repay). You have to make a whole bunch of car loans to get to one mortgage loan. The car loan is too much work. That’s another reason mortgage loans are the easiest when you compare them to car loans or even credit card loans.
A credit card is inferior because there is no collateral beyond the borrower’s promise. If income changes the promise to pay back may lose its meaning. So the mortgage loan is safer and easier to make because it is easier to collect in the case of job loss.
The key risk reducer inherent in mortgage loans is the collateral. It doesn’t lose its value when the borrower has financial difficulties. You sell the house to pay back a defaulted loan.
If a black-swan credit-bubble crash kicks in and it’s a 100-year-severity financial crisis, then adjustments must be made. Now down is up and right is wrong. All bets are off. All reason is gone.
By the way, do you know what we should do with Fannie and Freddie? If you don’t know now, then count yourself among the financial illiterates who have written or read about this subject before. The illiterates include every writer of every argument I have seen both Conservative and Liberal. It’s a large subset of misinformation.
The government should only grant monopolies in the rare instances where they are required. This rule tells you everything about planning the future of Fannie and Freddie.
A monopoly is required for roads and bridges because competition is senseless. A monopoly is required for a standing army because competition is dangerous. A monopoly is not required for mortgage loans or car loans or credit cards but especially not mortgage loans because mortgage loans are the easiest loans to make.
Have you ever seen anybody make the case that mortgage loans are so strange and dangerous and bizarre that we need a federally-granted monopoly for house lending? If you haven’t seen it, then every defense you have read of Fannie and Freddie was simply mindless ravings. Any valid defense depends upon proving the need for a monopoly. The proof doesn’t exist so those in favor talk about something else.
A classic case in which we grant a monopoly is the case of war. You don’t want to have private players owning and managing standing armies because they might decide to use their assets to take over the country they were hired to defend. If we had five privately-held armies, how would they compete for more business? By killing each other? You give the government a monopoly on war.
Everybody knows that this monopoly on war has an imperfect management technique. Snafu management systems runs state-owned monopolies like the army.
If mortgage loans are the easiest loans in the world to make, and if making mortgage loans are not the same as waging war or building two bridges right next to each other, then why do we give to mortgage banking the same legal exemption from competition that we give to the armed forces? One reason: Economists have cowered in the corner like spoiled children and failed to speak up and right this obvious clear misuse of regulation.
I read a prominent voice the other day saying there was no proof Fannie & Freddie were a leading cause of the financial crisis. The question is complicated and I don’t pretend to know the answer about what exactly explains the origin of the financial crisis.
Even if Fannie & Freddie are not leaders in the financial crisis — and you have to be way out there in the blue to say a $5 trillion institution is un-influential — the more important truth is that a government-approved monopoly breaks the first rule of economics. We broke a basic law of economics and now we fail to point out the obvious error and fix the obvious error. It’s like a doctor performing an autopsy on a person who has starved to death and listing organ failure as the cause of death. Yes, maybe it’s true, but the absence of food and water should be at the center of your attention.
How do we provide food and water to the mortgage market? The right place to start is to kill Fannie and Freddie. Why? Because mortgage loans are easy to make and need no special powers granted by the federal government; namely the power of monopoly. End of story.
The way that we kill Fannie & Freddie could be complicated. That we should kill them is simple and easy. Yes, kill Fannie and Freddie. Undo the mistake started over 70 years ago when we neglected basic fundamental questions about mortgage loans and monopolies.
Bankers love mortgage loans because they are collateralized; because borrowers will lose shelter when they don’t pay and so they are highly motivated to pay; because repayment is assured by the income of the borrower and the value of the collateral; because they are written for large balances where one mortgage might equal 20 car loans or 200 credit cards; because they remain outstanding for years or decades.
Bankers love mortgage loans. Therefore we committed a monstrous and obvious error when we broke the fundamental rule of free-market economics. The fundamental rule says — Break up monopolies so that competing enterprises will offer cheaper terms and better service to win clients. With Fannie and Freddie, we didn’t break up a monopoly. We created a monopoly. Our regulators ignored settled economic law and created what they are supposed to stop and close and break up.
It was backwards from day one. And every economist, both right and left, should denounce this sad failure. Conservative and liberal should be arm-in-arm on this, but that unanimity is not what we find in the real world. What could be the reason for dissent? Do Progressive economists now believe in a single-party state? Do they believe in central planning? Are they against competition? Are they in favor of the creation of monopolies when there is no need for the monopoly? Is this why everybody is confused about Fannie and Freddie? Are they embarrassed to admit in public that free markets are the greatest invention in the history of the war against poverty?
You must wonder reader how many economists know mortgage loans are the easiest loans for a banker to make. My guess? Five percent of that population. And the percentage who have applied this knowledge to judge the future of Fannie & Freddie? Empty set. None. Nobody. Nobody has asked the fundamental questions whose obvious answers lead to obvious policies. Economics can be very simple. Especially when you understand it.
The strangest thing in all defenses I have seen of Fannie and Freddie is that the defenses are looking at their role in the past and in the credit bubble. No defender asks the current question: Is it good that we have unlimited government funding available today to make mortgage loans after a radical property bust has sent private money running for the hills?
The current price of real estate is still higher above trend than any previous bubble we have had in the last 120 years. Our efforts to stabilize prices are efforts to maintain bubble pricing. Now evaluate the intelligence of Bernanke and Geithner. Judge if we are fortunate to have Fannie & Freddie? If you want the whole nation to pay much more than is necessary for housing, then you are home free and you have found your economic policy (Please see the chart above showing the current price of real estate is still higher than the highest point of any previous bubble.).
Does having this public mortgage machine in place guarantee a greater tragedy? Are the affordable housing and crony job-bank and lobbying contracts worth it all? Do the apologists for Fannie and Freddie skip a defense of the current status of the mortgage giants because it is impossible to be anything but dumb in defending their current role? Is this underground fiscal stimulus smart when property prices are still above the any previous bubble high?
Bernanke and Geithner et al. are attempting to maintain bubble-level house prices at a time when American competitiveness is weak based upon the cost of labor. Maintaining bubble pricing will put American workers at a huge disadvantage in competing against China, India, the others. How can this be smart?
Let me see if I can get this right. About 70 years ago some radically incompetent person fought and won a monopoly on mortgage lending for Fannie Mae. They ignored or more probably didn’t know the key fact and principle – mortgage loans are easy to make and therefore economic law demands that no monopoly be given. Through time and chance this money machine unleashed five trillion of investment power.
The money monopoly provided half of the funds needed to blow up a spectacular mortgage and property bubble greater by a factor of four than any previous bubble in the last 120 years of United States history. Guess what happens? A financial collapse throws the world into panic. Prices reverse radically.
Even after collapse, house prices are still higher than any previous bubble. The Treasury and the Fed desperately want to support this bubble pricing which they can try to do because a government monopoly in mortgage lending can be pushed and pulled in any direction. Losses are irrelevant. They are using somebody else’s money.
At the same time everybody but especially Liberals decry the falling income of the middle class. What is the biggest expense that class pays for? Housing. And where is the federal government putting its full muscle? Fannie and Freddie, the monopoly established for affordable housing, is now putting its full faith and credit into propping up unaffordable housing prices. They are attacking the middle class. Go ahead and argue that Fannie and Freddie didn’t cause the crisis, but you can’t say they aren’t the leading players in continuing the crisis.
Some of you read Martin Wolf at the Financial Times. He is the most learned and ambitious weekly commentator on economics. He reads and understands every new paper. He takes on big jobs. He is constantly trying to answer the biggest and most difficult questions.
“Wolf is widely regarded as one of the most influential economics journalists in the world,” according to his Wikipedia entry. “Lawrence H. Summers has called him ‘the world’s preeminent financial journalist’. Mohamed A. El-Erian, CEO of the world’s largest bond investor, said Wolf is ‘by far, the most influential economic columnist out there.’ Prospect magazine described him as ‘the Anglosphere’s most influential finance journalist’. While economist Kenneth Rogoff has said ‘He really is the premier financial and economics writer in the world.’”
As great as he is, I question whether he understands the basic definition of a financial crisis. Take a look first at his views on Andrew Mellon.
“Some argue that the economy is always in equilibrium – that, in the words of Voltaire’s Dr. Pangloss, everything is for the best in the best of all possible worlds. Others argue, with Andrew Mellon, US secretary of the Treasury under Herbert Hoover, that, after a big credit boom, we should ‘liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate … it will purge the rottenness out of the system.’ I am not addressing inhabitants of either of these caves.” (Why plans for early fiscal tightening carry global risks, June 17, 2010, Financial Times)
I define a post credit-bubble economy as an economy strangled by a legacy of mania-fueled debts. You look back upon the mania and see huge sections of debt with no income to pay it back. This is the phony debt Mr. Mellon wants to liquidate. My theory for crisis management repeats Mr. Mellon’s plan. Liquidate rotten debt to bring the economy back in to balance.
“How rotten is the United States economy?” you ask. It’s so rotten that one of five mortgage borrower will default (Please see the breakdown above of the one-in-five default ratio predicted by Amherst Mortgage Securities LP, one of the most respected mortgage analysts.).
What happens if you pretend rotten bubble debt and rotten bubble-asset values are real? You are committed to a fantasy which promises to bring poverty and ruin on a magnificent scale. Do we know anybody like this?
Yes, we do. Say hello to Japan — 20 years after the great real estate bubble. If we fail to liquidate our rotten debt, we will relive their paralysis. They have endured 20 years of torture by preserving rotten debt.
What has become of Japan in the years since the end of their mammoth real estate bubble? Japan has had 20 years of zombie paralysis. The heavy weight of rotten bubble debt is still strangling them today. No, it’s worse. Their massive monetary and fiscal policy interventions have radically added to their debt balances. And the result? The Japanese economy has had zero growth in 20 years. Nothing. Zero. Completely useless. Does anybody argue in favor of a policy of no-growth for 20 years? Should we use massive fiscal and monetary intervention to increase debt when we are in a debt crisis? Does the drunk need a drink?
The wayward pathetic Japanese eat sleep and die in Mr. Wolf’s stinking cave. Welcome to the land of feces and maggots. You will learn to appreciate the smell.
Mr. Wolf’s dismissal of Mr. Mellon’s cure proves there is some kind of hysteria-inducing Kool-Aid-drunk depraved group-think destroying the intelligence of Progressive economists. They know nothing and cannot lead.
What should they learn? It isn’t the monetary policy of low interest rates. It isn’t the fiscal policy of deficit spending. It’s the debt policy. The choice is simple. Liquidate rotten debt or go zombie.
Debt policy determines your success or failure after a financial crisis. All else is footnotes, forgery, imbecility. And what is the right debt policy? Liquidate. Liquidate. Liquidate.
Property values blew up in the bubble four times higher above trend when compared to any previous bubble. Should our policy pretend this debt is valid and normal? Or we should we call this debt the product of irrational mania? Should we dedicate the next 10 or 20 years to paying off the debt used to purchase this bubble (Please see the chart above showing the wild move up in housing prices.)? Or should we take a dagger to its heart and liquidate it now?
The property bubble in the United States was radical and the worst we have had in 120 years.
Many other leading economies had housing bubbles even more extreme. This is important because if you are buying a house today, you are taking on an asset and a debt in a global economy which has been radically mismanaged. We can blow up into a mega depression at any time. I don’t pretend to understand all of the consequences of such a depression, but if it allows for writing off rotten bubble debt, then that is the medicine we must take. Or we can go the zombie route.
Depression and mass bankruptcy – by individuals and companies and countries –are true cures of a credit bubble. Japan skipped a massive systemic bankruptcy and they are skipping recovery and they are skipping growth and they still keep digging a bigger and bigger hole for themselves.
Our economic masters, with Mr. Wolf as their star director, are blind, deaf, and dumb to the true cure of this disease. Just look at Fannie and Freddie. They can’t get the money out the door fast enough.
Fannie and Freddie are forcing us to walk backwards. Every day they reinforce a massive balance of consumer debt when the liquidation of unpayable debt on a massive scale is job one. Fannie and Freddie aren’t just supporting expensive housing prices, they are also the glue freezing us into a zombic economic paralysis. Does any of this qualify as an unintended consequence? Has the Liberal program of crisis management put us on the path to hell?
How backwards is the world now? It is so backward that mortgage loans are no longer easy to make. The first rule of lending which has guided this argument is a lie. Mortgage loans are impossible to make. They are dangerous. Property values have fallen 30%. Who says that they cannot fall another 30%? Who can say with confidence what the value of the loan collateral is?
The Progressives finally have a perfect excuse today for Fannie and Freddie. Nobody can make mortgage loans anymore, not if they use their own money. If we don’t have Fannie and Freddie, property values in the United States will fall off a cliff and initiate global depression. I guarantee this one thousand percent. Yet the poor fools don’t even know their time has arrived.
We sometimes do need to invoke the power of the state to solve our problems. The state may logically be used to stop a global depression. That doesn’t mean it isn’t dumber than a box of rocks, but it has logic and the goal is massive and could not be more important. The better question: If we avoid global depression, do we guarantee a zombie global economy?
Any smutz off the street can act as a lender of last resort – which is the first job of a financial-crisis manager. In our case the Fed and the Treasury provides massive funding to the banking system. If you want to know the reason for this just imagine if you had a ton of bills you couldn’t pay but you had the ability to borrow as much money as you wanted to pay your bills. That’s what the banks have. Nice setup if you can get it.
The lender-of-last resort function is just the first job. After a massive credit bubble you need to bring in your Superman economist to liquidate rotten debt as quickly and easily as The Man of Steel flies over tall buildings in a single bound. That work takes intelligence, courage, and ambition.
Think of starting with Lehman as bankruptcy number one. Then orchestrate the failure of a string of commercial and investment banks. Take all the big houses down which cannot stand up to the crisis. Shoot to take out the top ten financial companies. Kill every dollar of equity. Ruin the bankers who ruined the country. And wake up the bank’s debt holders and tell them: “Hello, and good morning. You own a bank. We wish you luck. And one other thing: Your debt is now equity.”
The greater the amount of internal bank debt that is liquidated, the more and more you send leverage to bankruptcy hell and emerge with rock-solid equity. If 50% of a bank’s balance sheet is converted from debt to equity, then the bank can easily write off 50% of its assets. You go from high-risk in finance to high caution. Make your first and last words “Convert debt to equity.”
Since these heroic efforts were missed the first time around, remember hell will break loose again. The debts haven’t changed. Our credit-bubble persists. We are only a shock away from a new crisis.
Fannie and Freddie reinforce our insolvency by constantly issuing new mortgage debt. Economists cower and know nothing. Pathetic fools argue Fannie and Freddie didn’t cause the crisis. The battle rages between deficit spending or not and zero interest rates or not and quantitative easing or not. Entitlements are protected. Deficits expand wildly. Debt is ignored.
There’s no control. There’s no prediction. Confusion speaks loudly and carries the day.
If property values fall 40% from the peak, approximately $5 trillion of mortgage debt will be “rotten” and prone to default. What do you do with “rotten” debt after a credit mania? What do you do with “rotten” debt when one of three mortgage-dollars owed is a default candidate? Do you follow Mr. Wolf and say it has no importance? I say you do the exact opposite.
You create a program for liquidation and you make it your highest priority. You foreclose. You short sale. You bankrupt. You strategic default. You abandon. You write-down. You write-off. You use any liquidation vehicle to radically cut down the universe of mortgage-debt balances. Follow this plan religiously and you will dramatically increase the affordability of housing, the solvency of homeowners, and the vitality of your economy. Call it a zombie killer. Call it a humane act of creative destruction. Call it “Killing catastrophe”. Call it “Bankrupting leverage”. Call it “Crisis solved”. I call it “Plan Orange”.
US sparks concerns of food price hikes
by Gregory Meyer and Jack Farchy - Financial Times
The US government raised the spectre of rising agricultural price inflation after it spooked traders by slashing key crop forecasts for a second consecutive month.
Prices of soyabeans, cotton and corn jumped on Tuesday after the US Department of Agriculture made further cuts to its projections for production and inventories, and warned of higher prices.
Benchmark corn futures rose above $6 a bushel in Chicago for the first time since August 2008, soyabeans climbed 4.3 per cent and wheat gained 1.8 per cent. Cotton jumped to a new all-time high above $1.50 a pound in New York. In Europe, milling wheat surpassed an earlier peak reached after Russia banned grain exports in August. Abdolreza Abbassian, senior grains economist at the UN’s Food and Agriculture Organisation in Rome, said the USDA report was "alarming". "It reiterates the tightening of the overall situation as we go into 2011, which means eventually even those basic food commodities that haven’t risen so much could be influenced."
The USDA said corn yields in the US, the largest grower and exporter, would be 154.3 bushels per acre, down 1.5 bushels from an October forecast that itself included sharp downward revisions. At 827m bushels, stocks left over from this year’s harvest would be the lowest in 15 years. Corn farmers’ average selling prices are expected to be "well above" previous records amid the global food crisis of 2007-08. The widely followed agency also bucked analysts’ estimates by lowering US soyabean yields to 43.9 bushels per acre, 0.5 bushels less than its previous estimate. Export sales, led by China, are at a record pace.
Ricardo Leiman, chief executive of Noble, the trading house that is one of the top oilseed processors in China, cited "enormous demand" in that country "because of just a stronger economy, stronger habits, very strong feed milling margins and at the same time very strong prices domestically." "The demand is real, it’s strong, and we see very strong numbers for 2011," he said.
Markets could grow more jittery as hot, dry conditions begin to emerge in Brazil and Argentina, both important growing regions, said Dan Basse, president of AgResource, a Chicago crop forecaster. "The world cannot afford to lose any more crop production going forward," he said.
China’s surging imports also loomed large in cotton. The agency took the rare step of lowering estimates of China’s 2010 supply cushion by 3m bales, citing "shortages in mill inventories that have become apparent in recent weeks." World cotton consumption is only falling because of "supplies insufficient to meet demand," the USDA said.
In the US, the world’s leading cotton exporter, farmers could this year receive the highest prices since the US civil war, the USDA said, while domestic stocks are expected to fall to their lowest levels since 1925. Mike Stevens, a Louisiana cotton broker, said: "The report is the most bullish in our lifetime."
Advisers scrambled to come to grips with the latest report, whose monthly appearance has caused big swings in agricultural markets throughout the year. Jerry Gidel, an analyst at North America Risk Management in Chicago, told clients: "We are cancelling all previous new crop 2011 sales recommendations at this time and will re-evaluate price levels once prices calm down."