"Tramps in boxcar playing cards, location unknown"
Ilargi: Let's start off with what Tom McGurk wrote in Ireland's Sunday Business Post:
Time to reclaim the land that is rightfully oursLast Thursday, a group of ten leading economists wrote to the Irish Times, arguing that some form of mortgage debt forgiveness was not only essential for our society, but also for the economy.
The group argued that, were mortgage debt forgiveness not introduced - and radical reform not introduced to our debt and bankruptcy laws - then our financial crisis would only deepen. At the core of their argument was the following assertion: ‘‘As there are three parties to the problem - the banks, the regulator (ie the state) and the individual - these three must also be part of the solution."
With the government having insisted on a year’s grace for home repossessions by the banks, we are currently in some sort of unreal financial hiatus. It means that the full dimensions of the crisis to come are still hidden.
But late next year, when property and water taxes have been introduced - and when interest rates begin to rise, as they surely must - then the personal debt crisis has the potential to become the most serious crisis in the history of the state.
If the banks attempt a process of mass repossession next year, then they must be met by organized citizens’ action. Boycotting was invented in 19th century Ireland, and the time to use it again may be now.
The problem here is that, if we restrict ourselves to looking at recent events, operations like QE2 and the impending bail-out of Ireland all play out against a backdrop that hasn’t changed one iota from that of earlier bailouts in the past three years, even if the media and public attention have shifted away from it. That is to say, while these measures are being presented as being beneficial for 'the people', they’re in actual fact the exact opposite.
If there’s one common theme in all of this, it's that the one and only haircuts involved involve taxpayers; they conveniently get to pay the entire bill.
Financial restructurings of bankrupt and failed institutions have routinely always, and should, involve and hurt everyone with "skin in the game". Hence, bondholders, stockholders, taxpayers et al should divide losses among them. And that’s what usually happens, or at least should happen. In the present situation, however, it does not.
Now we can argue that this has a lot to do with the fact that financial institutions have dramatically increased their level of political power in recent years, and that argument would most certainly be valid.
But there’s another, a "B", factor that comes into play, and though it's not entirely separate from the A factor, the political power grabbing, it's a new player introduced into the game.
If debt restructuring would follow its normal path, which would see all stakeholders take their losses, we'd see a problem emerge that past examples didn't have to deal with.
The kind of haircut that used to be seen as normal for parties such as banks and other financial institutions, and pension funds and more, - re: the US Savings and Loans crisis-, would today put many of these parties in a position where quite a few of them would be challenged to survive at all.
That is why the EU is negotiating with Ireland on the terms that it is, and that is why QE2 has taken the shape it has. The bottom line, which hasn't changed for three years, is that the debts inside the vaults of these parties, the major global financial instituitions, are so great that any disturbance to the established non-mark-to-market Wile E. Coyote status quo instantly threatens to topple them.
And no living politician will volunteer to initiate a potential domino reaction that may see either their national or even global banks struggling to live another day. When faced with the choice right now, every Tom Dick and Harry dreaming of political power will side with the banks, and choose to spend your future tax revenues to save the banks as well as their own political future. None among them will say: "I can’t vote this or that way, because my conscience won’t let me, but this means you won’t have access to your bank accounts anymore as per tomorrow morning."
For Ireland, and the Irish people, this is something like: "sorry that you have to be first in line, but we need to set an example". The EU will take over Irish fiscal and economic sovereignty, and the first thing that will go is the tax advantages for foreign corporations. And frankly, I have to say I never really got those: if and when you’re part and parcel of a union such as the EU, you can’t really hope to base your prosperity on handing Intel and Microsoft conditions they could otherwise only find in Vietnam, and still hope no-one in that union doth protest.
A large part of the blame lies within Ireland itself. It had and has blatant corruption, and it has scores of politicians that are either for sale or too dumb to put their socks on the right foot in the morning, or -which seems quite likely- both.
But the thing is that it’s not the Irish people, even if they might have known better when Dublin real estate prices increased five- or tenfold. The Irish have through their history gone through literally hundreds of years of hardship the kind of which is presently seen only in places like Bangla Desh or Rwanda, and it very much looks like that's where the country is heading once again.
And before, wherever you are on the globe, you elect to count your blessings, beware: most of you will see your politicians, too, choose to save their banks rather than their people, and you too will follow the Irish down that same steep slope. It’s the old "be careful what you wish for" theme.
If Ireland should mean anything to the rest of us today, and in the days going forward, it's as a big bold read flashing warning sign: you're next in line.
Debt crisis team heads for Dublin
by Peter Spiegel, George Parker and David Oakley - Financial Times
European Union authorities and Dublin have agreed that a team of EU and International Monetary Fund officials will visit Ireland for what senior European officials called a “short and focused discussion” on the country’s debt crisis, the clearest sign yet that a bail-out for the country’s ailing banks is imminent. There were also signs that the UK, Ireland’s neighbour but not a member of the eurozone, was considering providing its own direct loans as part of the aid effort.
George Osborne, UK chancellor, was considering billions of pounds in loans to help the bail-out, a move likely to be more palatable to his Conservative party’s Eurosceptic members than joining in an EU package. Before heading to a meeting of European finance ministers later on Wednesday Mr Osborne said: “Britain stands ready to support Ireland in the steps that it needs to take to bring about stability.”
Although officials in Brussels on Tuesday night refused to term the visiting group an official assessment team to prepare for a rescue, it will include personnel from the same three agencies – the IMF, European Central Bank, and European Commission, the EU’s executive branch – that were sent to Athens earlier in the year as part of Greece’s bail-out. “This can be regarded as an intensification of preparations of a potential programme in case it is requested and deemed necessary,” said Olli Rehn, the EU’s top economic official, speaking after a Brussels summit of finance ministers from the 16 countries that use the euro.
Brian Lenihan, the Irish finance minister, told reporters following the meeting that it was “not inevitable” that the country would require a bail-out, but said the talks would begin later this week. “I’m not going to impose timelines, but this is urgent,” Mr Lenihan said of the new talks. “We do have to examine how security and stability can be brought into the system.” The minister told Irish broadcaster RTE on Wednesday morning that the government would “fully engage with the process”. “[We will] work with the mission to ensure that everything possible is done to secure the Irish banking system,” he said.
However he stressed that there was “no question of loading on to the Irish sovereign and the Irish state some kind of unspecified burden”. “That’s why the government took great care not to make a formal application at this stage but to engage in intensive discussions to see exactly what the options are ... and should be taken at this stage.” The talks are scheduled to start on Thursday, Mr Lenihan said.
Separately, clearing house LCH.Clearnet raised its margin requirements to trade Irish debt to 30 per cent of net position. The last time LCH increased the same margin, a week ago, it led to a flurry of selling as traders were forced to close positions, but Wednesday’s moved appeared to have little impact on Dublin’s paper. The agreement comes after days of speculation over whether Ireland would accept an EU-led aid package, with Dublin resisting entreaties from European officials, particularly from the ECB, to take aid and stabilise financial markets. Irish and other “peripheral” EU bonds have been beaten down in recent weeks, making it nearly impossible for at-risk economies to borrow money at reasonable rates and pushing the eurozone to the verge of another debt crisis.
In an address to the Irish parliament, Brian Cowen, prime minister, acknowledged that Ireland had to help calm the debt markets, but added: “This is not an insurmountable challenge.” Christine Lagarde, the French finance minister, said she believed the Irish talks would go more smoothly than those leading up to EU-led Greek bail-out. “The big difference with the previous crisis is that we are fully equipped,” Ms Lagarde said. Although Ireland has not made a request for aid, Mr Osborne arrived in Brussels on Tuesday night for a full Ecofin meeting amid growing expectation that Britain will play its part in a rescue alongside other EU countries and the IMF.
UK Treasury officials stressed no request had so far been received from other eurozone countries for the UK to make bilateral loans to Dublin, but they refused to rule them out. A request for British participation in an Irish rescue effort would prove highly controversial with Eurosceptic Conservative MPs. Senior Conservatives believe that loans to Ireland – a country with which Britain has a land border and strong financial and trade ties – would be easier to sell to Tory MPs if they were not part of an EU rescue. “Tory backbenchers would not be opposed to UK assistance to Ireland but they are worried about a European mechanism,” said one leading Tory.
Britain is already committed to about £6bn in contingent liabilities if Ireland approached the €60bn European financial stability mechanism but the UK is not part of a wider €440bn European financial stability facility. Tory eurosceptics are already voicing deep concern over UK taxpayers underwriting a eurozone bail-out, but their anger might be diluted if British assistance was made directly or through the IMF. Douglas Carswell, a Tory MP, said on his blog: “I wonder what excuses they’ll be using for spending our money on bailing out the euro? What blah blah sound bites will the politicians be rehearsing to justify another EU bill?”
Ireland resists humiliating bail-out as UK pledges £7bn
by Bruno Waterfield - Telegraph
Brian Cowen, the Prime Minister, dismissing the term 'bailout' as pejorative, said: "There has been no question of the government ... [being] in a negotiation for a bail-out." Instead Ireland committed itself to working with a European Union-IMF mission on urgent steps to help its stricken banking sector. Financial markets appeared unimpressed by Dublin's decision to reject assistance, with the premium investors charge for holding Irish 10-year bonds rather than German Bunds rising to a near-record 595 basis points.
The cost of insuring against default by Ireland jumped, with five-year credit default swaps widening by 25 basis points on the day to 545 bps, while those for Spain and Portugal also rose - a sign of the contagion that EU policymakers fear most. George Osborne, the British Chancellor, has pledged British support of up to £7bn for an EU bail-out of Ireland and its banking sector. The Chancellor arrived in Brussels for a meeting of EU finance ministers aware that exposure of British financial institutions to Irish banks is £140bn.
“Ireland is our closest neighbour. And it's in Britain's national interest that the Irish economy is successful and we have a stable banking system,” he said. “Britain stands ready to support Ireland.” Britain is not part of the 16 member eurozone but is a member of a £51bn “European Financial Stabilisation Mechanism” that will be used to aid Ireland. The European Commission said a potential British role was “under discussion” as EU and IMF officials headed to Dublin today to carry out “intensified, short and focused” preparations for a bailout of Ireland. Officials said that multi-billion cash injection could be ready within “five to eight days” of a eurozone decision to step into save Irish banks.
The intervention is climb down for Ireland after other eurozone countries pushed it into accepting an intervention against its wishes. Brian Lenihan, Irish finance minister, insisted that a bail-out was not inevitable but admitted that Irish sovereignty was compromised by its membership of the euro. “When you borrow, you lose a little bit of your sovereignty, no matter who you borrow from,” he said. “Sovereignty, in my view in a European context, is shared. We have a duty to the eurozone as our currency and it is Ireland’s currency as much as it is Germany’s or France’s. We have a duty to sustain the stability of the eurozone. Ireland is the zone of attack in the eurozone.”
Mr Lenihan said talks with the IMF-EU team would begin on Thursday. He set out his stall ahead of the talks by dismissing suggestions that Ireland should raise its ultra-low 12.5pc corporation tax rate to help cut its debt. "Of course our corporate tax rate is safe," he said.
However, higher-tax countries, including Britain, have long seen the Irish rate as a form of unfair competition and many commentators believe the raising the rate will be a conditions attached to any rescue package - be it for the country or just the banks. The European Central Bank and other euro currency members have been concerned that that Irish banks have been increasingly dependent on support and putting Ireland under intense pressure to give to controversial aid conditions that will reduce the country economic independence.
No details of a rescue emerged at meeting of eurozone ministers last night but it is likely that a bail-out will be choreographed with an Irish four year spending plan and austerity programme which could be as early as next week. Jean-Claude Juncker, Luxembourg’s Prime Minister and chairman of the eurogroup, said he expected a decision on the bail-out “within the coming days”. “Market conditions have not normalised and pressures remain, giving rise to concerns that further reforms and stabilisation measures may be appropriate,” he said.
EU economics commissioner Olli Rehn said the talks would centre in the main on a package to stabilise Ireland’s banks and said it would be available if the Government choose to seek aid. Olli Rehn, the European economic and monetary affairs commissioner, said the EU-IMF teams sent into Ireland would have an “accent on restructuring its banking sector”. “This can be regarded as an intensification of preparations for a potential programme in case it is requested and deemed necessary,” he said. “This is a time for cool heads and clear determination to take the necessary decisions to that effect both at the EU level and in every member state.”
The Irish government has insisted that it can afford to repay its record debts, despite having an annual deficit equivalent to almost a third of the size of its economy. The growing market turmoil surrounding Ireland has also threatened to push Spain and Portugal into crisis. The cost of Spanish government borrowing rose sharply on Tuesday. A full EU-IMF bail-out would mean Ireland losing key areas of political and economic sovereignty. This would be deeply controversial and could cost the Irish government its majority.
Senior EU figures have suggested that Ireland should increase its low corporate tax rates, regarded by the Irish as key to Ireland’s economic recovery. Herman Van Rompuy warned on Tuesday, that the deepening debt crisis in Ireland which has spread to other parts of the eurozone has left the single currency and EU fighting for their “survival”. “We are in a survival crisis,” he said. “We all have to work together in order to survive with the euro zone because if we don't survive with the euro zone, we will not survive with the EU.”
Irish Obstinacy Unsettles the Euro Zone
by Carsten Volkery - Der Spiegel
Ireland's government insists it needs no assistance -- and the euro has become highly unstable as a result. Euro-zone finance ministers were unable to persuade Dublin otherwise at Tuesday's crisis meeting in Brussels. Their half-hearted assurances of help are unlikely to calm financial markets.
The rhetoric sounded strangely familiar. There is no Europe without the euro, German Chancellor Angela Merkel had said ahead of Tuesday's meeting of the 16 euro-zone finance ministers in Brussels. The EU was in a "survival crisis," seconded European Council President Herman Van Rompuy. Meanwhile Luxembourg's Prime Minister Jean-Claude Juncker, the head of the Eurogroup of finance ministers, asserted that they would defend the euro by any means.
Europe's leaders had used precisely such words back in May, before they decided on a €110 billion ($150 billion) rescue package for Greece. Are they about to do the same thing for Ireland? Apparently not. When the next candidate for a bailout was discussed at the late-night meeting on Tuesday in Brussels, the finance ministers appeared unwilling to put their money where their mouths are. Instead of announcing a concrete aid figure for Ireland, the finance ministers were basically content to repeat -- for the umpteenth time -- that the EU would help Ireland in an emergency.
No Figures Given
Merkel also attempted to strike a calming note. "I do not believe that the euro zone is at risk, but we are experiencing turbulence and situations of a kind that I would never have dreamed of a year and a half ago," she told the German public broadcaster ARD. "The most important thing is that, apart from the rescue measures that have been agreed to, we coordinate our economies better with each other."
The EU and the International Monetary Fund (IMF) will now send a larger group of experts to Dublin to work out a support package for the Irish banks, as a precursor to a possible bailout. "This can be regarded as an intensification of preparations of a potential program in case it is requested and deemed necessary," European Monetary Affairs Commissioner Olli Rehn said after the meeting. He did not, however, give details or name any figures. Neither did other participants in the meeting. Hence the question remains open why a second emergency plan is required, given that the EU's €750 billion stabilization fund has been available since the Greek crisis and could be used to help Ireland.
After the meeting, the ministers went to bed without having reached any concrete decisions and were presumeably awaiting the opening of financial markets on Wednesday morning with a certain amount of trepidation. They must have been asking themselves if the markets would believe their assurances, or if they would send the euro into turmoil again.
Fears of Bailout Stigma
The reason for the vague statements from Brussels is simple. The Irish government does not want help. It took a firm line at the meeting, despite pressure from the other troubled euro-zone countries -- Portugal, Spain and Greece -- and the European Central Bank (ECB). They are all concerned that the euro will falter once again and that yields on bonds issued by all the euro zone's problem countries will rise dramatically.
Ireland is nevertheless insisting it does not need the EU's aid. It does not need to refinance its government bonds on the markets until next summer, and it hopes that the worst will be over by then. Irish Finance Minister Brian Lenihan told his colleagues on Tuesday that he did not have a mandate from the Irish government to negotiate an emergency package. The government in Dublin fears the stigma that would be attached to a bailout. The bond markets would effectively be closed to the country for years, and the EU and the IMF would have even more power to dictate the Irish government's policies than is already the case.
The other euro-zone finance ministers can not force Ireland ministers to accept the money. They are now hoping that Dublin will have a change of heart over the coming days. In a concession to the conservative Prime Minister Brian Cowen, they talked of preparing an emergency plan for the ailing Irish banks as an alternative to a bailout for the state. The Irish government has now a few days to make a decision, Juncker said. The Irish government has set up a deposit guarantee scheme for six of the country's financial institutions, the most prominent being the nationalized Anglo Irish Bank. As a result, Ireland's deficit has temporarily ballooned to 32 percent of its gross domestic product -- over 10 times as much as allowed under the EU's Stability Pact.
A Continent Divided
The disagreement of the finance ministers illustrates just how far apart the euro-zone countries are in their positions on how to deal with the crisis:
- Portugal, Greece and Spain accuse the Irish government of unsettling the financial markets with its obstinacy and driving up interest rates.
- Together with Ireland, they accuse Germany of having caused the latest debt crisis through its insistence that private-sector creditors take their share of losses in future debt crises.
- Germany in turn sees itself as the guardian of the long-term stability of the euro zone and wants to ensure that taxpayers are not left to foot the bill in future crises.
- The ECB is insisting that Ireland should avail itself of the EU's stabilization fund, so that it can roll back its existing emergency support for the country. In October, the ECB made €130 billion in emergency loans available to the Irish banking system -- one-fifth of the total funds that the central bank currently has on loan to all euro-zone banks. Without this help, the Irish banking system would collapse. The ECB argues that the current situation is not sustainable in the long run.
The financial markets will hardly be impressed by the half-hearted assurances made by the euro-zone finance ministers. Besides, expectations for Tuesday's meeting had been ratcheted up too high over the past few days. As a precaution, several representatives of the euro zone made statements emphasizing that an aid package for Ireland would be available within days if a call came from Dublin.
The Irish government's resilience will be tested again in the coming days. Other European countries will try to entice it with promises. According to French Finance Minister Christine Lagarde, bilateral aid would be possible, involving Britain alongside the euro-zone countries. According to the Financial Times, the British government is considering providing assistance to the tune of several billion pounds. So far, the Irish government has continued insisting that it will manage by itself. It is currently working on its four-year budgetary plan, which is expected to be presented next week. The plan is supposed to calm the markets. Many observers fear that hope will be in vain.
The horrible truth starts to dawn on Europe's leaders
by Ambrose Evans-Pritchard - Telegraph
The entire European Project is now at risk of disintegration, with strategic and economic consequences that are very hard to predict. In a speech this morning, EU President Herman Van Rompuy (poet, and writer of Japanese and Latin verse) warned that if Europe’s leaders mishandle the current crisis and allow the eurozone to break up, they will destroy the European Union itself. “We’re in a survival crisis. We all have to work together in order to survive with the euro zone, because if we don’t survive with the euro zone we will not survive with the European Union,” he said.
Well, well. This theme is all too familiar to readers of The Daily Telegraph, but it comes as something of a shock to hear such a confession after all these years from Europe’s president.
He is admitting that the gamble of launching a premature and dysfunctional currency without a central treasury, or debt union, or economic government, to back it up – and before the economies, legal systems, wage bargaining practices, productivity growth, and interest rate sensitivity, of North and South Europe had come anywhere near sustainable convergence – may now backfire horribly.
Jacques Delors and fellow fathers of EMU were told by Commission economists in the early 1990s that this reckless adventure could not work as constructed, and would lead to a traumatic crisis. They shrugged off the warnings. They were told too that currency unions do not eliminate risk: they merely switch it from currency risk to default risk. For that reason it was all the more important to have a workable mechanism for sovereign defaults and bondholder haircuts in place from the beginning, with clear rules to establish the proper pricing of that risk.
But no, the EU masters would hear none of it. There could be no defaults, and no preparations were made or even permitted for such an entirely predictable outcome. Political faith alone was enough. Investors who should have known better walked straight into the trap, buying Greek, Portuguese, and Irish debt at 25-35 basis points over Bunds. At the top of boom funds were buying Spanish bonds at a spread of 4 basis points. Now we are seeing what happens when you build such moral hazard into the system, and shut down the warning thermostat.
Mr Delors told colleagues that any crisis would be a “beneficial crisis”, allowing the EU to break down resistance to fiscal federalism, and to accumulate fresh power. The purpose of EMU was political, not economic, so the objections of economists could happily be disregarded. Once the currency was in existence, EU states would have give up national sovereignty to make it work over time. It would lead ineluctably to the Monnet dream of a fully-fledged EU state. Bring the crisis on.
Behind this gamble, of course, was the assumption that any crisis could be contained at a tolerable cost once the imbalances of EMU’s one-size-fits-none monetary system had already reached catastrophic levels, and once the credit bubbles of Club Med and Ireland had collapsed. It assumed too that Germany, The Netherlands, and Finland would ultimately – under much protest – agree to foot the bill for a ‘Transferunion’.
We may soon find out whether either assumption is correct. Far from binding Europe together, monetary union is leading to acrimony and mutual recriminations. We had the first eruption earlier this year when Greece’s deputy premier accused the Germans of stealing Greek gold from the vaults of the central bank and killing 300,000 people during the Nazi occupation.
Greece is now under an EU protectorate, or the “Memorandum” as they call it. This has prompted pin-prick terrorist attacks against anybody associated with EU rule. Ireland and Portugal are further behind on this road to serfdom, but they are already facing policy dictates from Brussels, but will soon be under formal protectorates as well in any case. Spain has more or less been forced to cut public wages by 5pc to comply with EU demands made in May. All are having to knuckle down to Europe’s agenda of austerity, without the offsetting relief of devaluation and looser monetary policy.
As this continues into next year, with unemployment stuck at depression levels or even creeping higher, it starts to matter who has political “ownership” over these policies. Is there full democratic consent, or is this suffering being imposed by foreign over-lords with an ideological aim? It does not take much imagination to see what this is going to do to concord in Europe.
My own view is that the EU became illegitimate when it refused to accept the rejection of the European Constitution by French and Dutch voters in 2005. There can be no justification for reviving the text as the Lisbon Treaty and ramming it through by parliamentary procedure without referenda, in what amounted to an authoritarian Putsch. (Yes, the national parliaments were themselves elected – so don’t write indignant comments pointing this out – but what was their motive for denying their own peoples a vote in this specific instance? Elected leaders can violate democracy as well. There was a corporal from Austria … but let’s not get into that).
Ireland was the one country forced to hold a vote by its constitutional court. When this lonely electorate also voted no, the EU again disregarded the result and intimidated Ireland into voting a second time to get it “right”. This is the behaviour of a proto-Fascist organization, so if Ireland now – by historic irony, and in condign retribution – sets off the chain-reaction that destroys the eurozone and the European Union, it will be hard to resist the temptation of opening a bottle of Connemara whisky and enjoying the moment. But resist one must. The cataclysm will not be pretty.
My one thought for all those old friends still working for the EU institutions is what will happen to their euro pensions if Mr Van Rompuy is right?
Europe seems at loss to stop rot
by Paul Taylor - Reuters
Despite public assurances of unity and determination, it’s not clear that eurozone finance ministers know how to stop the rot gnawing away at the 16-nation European currency area. Ireland, the latest member to come under intense bond market pressure, agreed on Monday to discuss with an EU-ECB-IMF team how to stabilise its state-guaranteed banks but continues to resist applying for the kind of state bailout granted to Greece.
Even if, as seems likely, Dublin accepts an international rescue after more face-saving words, analysts increasingly doubt that will stop contagion spreading to fellow weakling Portugal and, more ominously, perhaps to the much larger Spain. “In practice, hopes that Ireland can be ’ring-fenced’ are unlikely to succeed,” Citi economists Juergen Michels, Giada Giani and Michael Saunders wrote in a note to clients.
In what can become a self-sustaining frenzy, investors bid up the borrowing costs of troubled countries on the bond market until they reach an unsustainable level when a government needs to raise money or roll over expiring debt. The European Union stemmed the first wave of debt crisis in May with “shock and awe” tactics by rescuing Greece along with the International Monetary Fund and creating a US$1-trillion financial safety net for other euro zone states in distress.
Six months later, the deterrent effect of the 440 billion euro European Financial Stability Facility (EFSF), the main component of that contingency fund, which EU officials said they believed would never need to be used, seems to have worn off. German Chancellor Angela Merkel and European Commission President Jose Manuel Barroso played down any sense of a renewed eurozone crisis this week, saying all the necessary instruments were now in place in case a country needed help.
But with typical European cacophony, the man who chairs EU summits and heads a task force on reforming euro zone economic governance, Herman Van Rompuy, undermined such soothing talk by saying the currency bloc was now in a “survival crisis.”
Markets are concerned not just by the scale of deficits, public and private debts and economic contraction or stagnation around the euro zone periphery, but also by Germany’s campaign for the EU to make bond holders share with taxpayers the pain of any future debt restructuring. “The successful ring-fencing of Greece owed much to the fact that the EFSF was created at the same time, plus strong political commitments that no euro area sovereign would be allowed to default,” the Citi economists wrote. “That commitment has been greatly weakened, given Germany’s recent insistence on the need for a sovereign default mechanism in the future.”
Assurances by the EU’s big five last week that this would only apply to debt issued after mid-2013 and all existing bonds were safe failed to calm investors trying to reprice the risk of peripheral eurozone government debt. Berlin may have backed off from its call for private creditors to take a “haircut” on the value of their holdings of a distressed state’s debt, but months of uncertainty lie ahead before the EU agrees on a debt resolution mechanism and all 27 member states ratify the necessary treaty amendment.
Diplomats say Merkel cannot climb down from her core demand both due to domestic political pressure and because the German Constitutional Court may otherwise rule the existing EU rescues incompatible with the treaty’s “no bailout” clause. Meanwhile, Austria’s threat on Monday to delay its share of the next tranche of emergency loans to Greece because Athens has not met the agreed deficit reduction target has highlighted the complexity of the euro zone-IMF bailout mechanism.
Recipients are potentially at the mercy of 15 individual governments — some of them fractious coalitions with restive parliaments — as well as being subject to decisions taken in Brussels, Frankfurt and Washington. Slovakia, the newest and poorest member of the eurozone, refused to take part in the 110 billion euro rescue for Greece, declining to lend money to a country wealthier than itself. The public backlash in wealthy, fiscally conservative Germany and the Netherlands against bailing out Greece is only likely to grow if additional states have to be assisted.
Each eurozone struggler’s case is different. Ireland and Spain had healthy budgets and below-average public debt before real estate bubbles burst in 2007-8, leaving huge private debts, mass unemployment and a gaping hole in government revenues. Ireland has been dragged down by its banks’ reckless property lending, while EU stress tests in July showed Spain’s biggest banks remain healthy and Madrid has begun to isolate and resolve problems in its weaker savings banks. Portugal has suffered an inexorable loss of competitiveness since in joined the euro at its creation in 1999.
Back-of-the-envelope calculations on the volume of emergency loans required for Ireland and Portugal suggest each could need up to 100 billion euros over three years, market analysts say. The EFSF, and a more readily accessible 60 billion euro European Financial Stability Mechanism, should be able to cover those needs with the IMF lending up to a quarter of the total. However a financial rescue for Spain, if that were to become necessary, would pose a challenge of a different dimension.
Some economists are urging radical action that seems politically unrealistic — pre-emptive debt restructuring by the most indebted states, large-scale sovereign bond purchases by the European Central Bank or big fiscal transfers from richer to poorer euro zone countries. In May, the EU briefly managed to get “ahead of the curve” in its response to the crisis. But there is little sign that its current course can restore confidence in the markets.
“Unless the EU changes track and agrees to make the EFSF permanent and the ECB steps up its purchases of the hard-hit countries’ government bonds, investors will believe that default is inevitable and demand correspondingly punitive interest rates,” said Simon Tilford, chief economist at the Centre for European Reform in London. “Contagion to other member states will be all but inevitable. If, and when, it reaches Spain, the crisis risks spiralling out of control.”
Austria says Greece will have to wait for next pay out, EU denies delay
by Sarah Harman - AP
Austria says it won't hand over its share of the funds for the next installment of Greece's 110 billion euro bailout until Greece fufillls its side of the bargain. Greece's 2010 deficit is even higher than thought. Austrian Finance Minister Josef Proell announced Wednesday that the decision to grant the delay was made on the sidelines of the EU finance ministers' meeting in Bruessels on Tuesday night. Proell said Austria would not release its share of the money because Greece had not fulfilled the requirements of the bailout agreement.
However, the EU has denied that the next loan payout will be delayed. The office of the EU's monetary affairs chief refuted Austria's claims, saying "it has always been the case that the actual release of the third tranche should be taken in December and that the release will be in January."
The European Union and the International Monetary Fund (IMF) agreed to lend Athens 110 billion euros ($150 billion) earlier this year to save the debt-wracked nation from bankruptcy. The money is to be doled out over three years, in accordance with the country's progress in reducing its budget deficit. In return, the Greek government of Prime Minister Giorgos Papandreou agreed to enact drastic austerity measures in order to get the deficit under 3 percent of gross domestic product (GDP) by 2014.
On Monday the European statistics agency Eurostat announced that Greece's 2010 deficit would exceed earlier forecasts, climbing 2 points to 15.4 of GDP, almost 2 points higher than the previously indicated 13.6 percent.
Time to reclaim the land that is rightfully ours
by Tom McGurk - Sunday Business Post
Ireland invented the boycott during the land wars, and perhaps it is time to take this effective weapon of resistance down from the thatch to deal with repossessions and resales Despite the spiralling economic crisis we are in, there was, last week, an epiphany at a small auction in Co Meath.
A 67-acre farm in Crossakiel, which had been repossessed by ACC bank, was up for sale. Despite a reasonable attendance by local farmers at the auction, there was only one derisory bid of €1.
There was, according to some present, ‘‘an atmosphere’’ in the room, and the auctioneer later told the Irish Times that ‘‘there was no question but that people weren’t bidding because it was being sold by the bank’’.
At one stage, one person present questioned whether the land was being sold with the goodwill of the owner - and was told that the bank had the authority to sell the land.
The owner of the land had reached this financial crisis after using the land to raise funds for a property development which then crashed. The farm remains unsold.
It is not difficult to imagine the historical ghosts which haunted that Meath auction room, and I make no excuse for returning yet again to the personal debt crisis that I have been writing about for some weeks now.
One result of this issue has been the emergence of the New Beginning organisation, a group of some 50 barristers, businesspeople and citizens who are prepared to give free legal support to those facing repossession. And three cheers for them.
The failed land sale in Meath is yet another sign that, if the banks think they can regain the high financial ground over the thousands to whom they over-loaned in a reckless fashion by repossessing land, they may have to think again.
This applies equally to the government, which scooped up so many million euro in stamp duty.
Given Ireland’s history, those silent farmers in the auction room in Co Meath last week would have had a far better sense of where all of this will lead than the men running our banks. If the banks and the political and financial establishment think that our current bank repossession methods and laws on debt and bankruptcy are adequate for the forthcoming crisis, they had better think again. Parallels with the land and eviction crisis of the 19th century are beginning to look pertinent, particularly when one considers that, by late next year, almost 20 per cent of Irish home ownership may be in negative equity.
At the outset of this crisis, most people didn’t really understand what had happened and were prepared to let the government get on with saving the banks since they were essential - so the government argued - to safeguarding our economic future. Well, we did that, but the economy is still in crisis.
As the months have passed, the government’s financial targets have been missed, the debt crisis has grown and the public mood has changed. The realisation that thousands of families in this country are so in debt to the banks, that their children and unborn children will be paying it off, is slowly sinking in.
The auction in Meath last week may prove to have been be a significant turning point.
There have been two recent significant interventions in this debate. Professor Morgan Kelly of UCD warned in an Irish Times article that we were headed to what he depicted as a new type of land war between those who could pay their mortgages and those who could not.
He summed up the public mood as follows: ‘‘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.
‘‘Facing a choice between obligations to the banks and to their families’ mortgage or food, growing numbers are choosing the latter," he wrote.
Last Thursday, a group of ten leading economists wrote to the Irish Times, arguing that some form of mortgage debt forgiveness was not only essential for our society, but also for the economy.
The group argued that, were mortgage debt forgiveness not introduced - and radical reform not introduced to our debt and bankruptcy laws - then our financial crisis would only deepen. At the core of their argument was the following assertion: ‘‘As there are three parties to the problem - the banks, the regulator (ie the state) and the individual - these three must also be part of the solution."
With the government having insisted on a year’s grace for home repossessions by the banks, we are currently in some sort of unreal financial hiatus. It means that the full dimensions of the crisis to come are still hidden.
But late next year,when property and water taxes have been introduced - and when interest rates begin to rise, as they surely must - then the personal debt crisis has the potential to become the most serious crisis in the history of the state.
If the banks attempt a process of mass repossession next year, then they must be met by organised citizens’ action. Boycotting was invented in 19th century Ireland, and the time to use it again may be now.
Like the Tea Party movement in the US, which was organised on the internet and through websites and social networking, people in Ireland now have the organisational resources in their living rooms to bring the full power of the boycott against bank repossessions and attempted resales.
Boycott.ie - when it is set up - should be the rallying point to help those facing eviction. It could lead to the organised boycott of anyone involved in the eviction and, most especially, the auction of repossessed property. In the forthcoming general election, independent candidates fighting the repossession crisis should be put up through Boycott.ie.
It seems that, in this crisis, everyone except the taxpayers and homeowners of Ireland were allowed to make up the rules as they went along.
Now is the time for the citizens of the Republic to take back control of their lives and their finances and, like the Meath farmers, bond together in an unbreakable moral crusade for justice.
Our great-grandfathers and great-grandmothers did this before, and we can do it again.
Ghost estates and broken lives: the human cost of the Irish crash
by Michael Savage and Donald Mahoney - The Independent
They stand empty across Ireland: 300,000 unoccupied homes, a silent reproach to those who built them believing that the country's economic boom would never end. As Europe's finance ministers laboured in vain to reach an agreement on how to ease Ireland's economic misery last night, the so-called ghost estates were an awful reminder that the "survival crisis" the politicians were warning was under way had already hit ordinary people.
Dave O'Hara was one of those who bought into the "Celtic Tiger" at the beginning of the decade, eschewing a seven-generation family tradition of carving headstones in favour of a piece of the country's building boom. He founded a firm that constructed bespoke windows and doors for the thousands of upscale homes being built. The firm grew into a multimillion-euro enterprise, until the recession – and the collapse of the building industry – hit in September 2008. Now his company is in liquidation, and Mr O'Hara, 41, who has one child, is on the dole. He owes the Bank of Scotland more than €1m (£850,000).
Like many others, Mr O'Hara's anger is aimed at the banks, which have already been bailed out and seem destined to force the government to seek further help of some kind from Ireland's European partners. "Everyone is responsible for their own actions, but the burden is being brought to bear on the people on the end of the line. In Ireland right now, it's better to owe €50m than €50,000. The people who have sinned the most are suffering the least," he said, sitting in his cottage along the borderlands between Leitrim and Sligo, in the boggy north-west of the country. "I don't know what's coming, but I know what we've got isn't going to stay. I've lost all faith and confidence in our system."
Not far from Mr O'Hara's home, the "ghost estates" are well-known eyesores along the rugged landscape. And the crisis that created them has hit not just the people who built them, but those who might once have expected to move in, as well. Hundreds of thousands of homeowners have already found themselves saddled with negative equity as a result of the crash, economists estimate, with as many as one in seven families affected. The toxic combination of the glut of house-building during Ireland's boom and the current dearth in demand means they have been lumbered with a property worth less than the loan they secured to buy it.
Personal indebtedness is also an issue, as are redundancy and the end of easy loans, meaning around 100,000 households are struggling to make regular repayments on the money they owe. And yet, house prices continue to fall precipitously. Together with slumping disposable incomes due to frozen wages and stubbornly high unemployment, still running at more than one in every eight adults of working age, many fear a social disaster is unfolding. Even for the few who have yet to feel the pinch from the crisis, its effects on families will be felt next week, when the Budget that was brought forward yesterday yanks a further €15bn out of the economy through major spending cuts and tax rises.
Many have taken drastic action already. With youth unemployment topping 30 per cent, some have already fled abroad to seek their fortune, or at least stay above the breadline.
The Economic and Social Research Institute think-tank estimates that the labour market will not pick up within the next two years, pushing as many as 100,000 people to seek work abroad. In a country of just 4.5 million, that would cause a dent in potential consumer spending, as well as a level of emigration-fuelled social upheaval reminiscent of the 1980s and after the Second World War.
In Dublin, ministers were maintaining a tough-talking stance, refusing to go cap-in-hand to the EU even as discussions were continuing in Brussels. There was a not-so-subtle resentment in the capital that a growing number of European players were insisting a bailout was the best option. Yesterday, Jean-Claude Juncker, the Luxembourg politician leading the group of euro-area finance ministers, said help was there if it was wanted.
There must be a bitter irony in it all for Mr O'Hara. While the Irish government is working hard to avoid calling on the ample help on offer, he continues to struggle. However, he is opposed to Ireland opting for an embarrassing bailout. "I use be to be pro-European," he said. "But my feeling now is that the solution can't come from Europe. It's akin to giving a credit card to a family already massively in debt. I think the banks need to collapse."
There are some who now want their leaders to swallow their pride and take the help on offer, however humiliating. "Maybe a bailout isn't such an bad thing," said Jackie McKenna, a sculptor in Manorhamilton, Co Leitrim. "It wouldn't be the end of the world. If we don't we won't get out of this. Something needs to be done. Businesses are closing and we need to do something."
Despite his plight, Mr O'Hara remains remarkably upbeat. "I'm actually excited for the future," he said, adding that his situation was a "time for reinvention". Now it can no longer rely on its building sector, the Irish economy will also have to undergo a similar, and painful, transformation.
Don’t blame the euro for Ireland’s mess
by Philippe Legrain - Financial Times
Sceptics of the euro see the Irish crisis as proof of the single currency’s folly. But while the eurozone needs reform, the notion that the euro is to blame for Ireland’s travails is simplistic. Even many euro supporters now regret that in the boom years the currency permitted huge capital flows from Germany and other surplus countries to Spain, Portugal, Greece, and Ireland. These imbalances, conventional wisdom has it, are unhealthy – and the European Union is now drafting rules to limit them.
Yet enabling capital to flow from one member country to another without exchange-rate risk is a key advantage of the euro. If this were possible globally, emerging economies would not feel compelled to amass huge reserves to protect against crises and could be net recipients of investment instead. When integrated financial markets work well, they offer investors higher returns, businesses cheaper finance and a better allocation of capital all around.
The problem is not that savings flowed from Germany to Europe’s periphery. It is that they funded property bubbles rather than productive investment. But the blame for that lies with herd-like investors, flawed banks and foolish governments, not the euro. After all, America, Britain, Iceland and other non-euro countries all had huge property bubbles too.
Granted, joining the euro did slash Irish interest rates, creating cheap borrowing that fuelled the boom. But at a macro level the Irish government could have tightened fiscal policy – in effect, run large budget surpluses. At a micro level, it could also have limited banks’ property lending – through higher, counter-cyclical capital requirements for instance – rather than encouraging it with tax breaks.
Ireland’s property bubble was particularly big. The value of its housing stock quadrupled in the decade to 2006, with construction swelling to an eighth of the economy. The price of a typical Dublin house shot up more than fivefold – and has since nearly halved. Such a property crash is inevitably painful. But it need not have led to a sovereign debt crisis. Ireland’s public debt was only 25 per cent of gross domestic product on the eve of the crisis, the lowest in the eurozone.
The government’s fatal mistake was stepping in to guarantee not just all the depositors of Irish banks but also all their bondholders. Now the bust banks’ huge losses are dragging down the Irish state with them. Had Britain’s recession worsened, the UK government might have ended up in a similar situation.
Only cheap finance from the European Central Bank has kept those bust Irish banks on life-support, until now. Outside the euro, Ireland would doubtless have suffered Iceland’s fate: its currency would have crashed and its central bank would have run short of foreign funds to keep its banks afloat. Far from precipitating the crisis, the euro has given Ireland vital breathing space. More’s the pity that the government has failed to make good use of it.
It is true that, outside the euro, Ireland would now enjoy a weaker currency. That could boost exports, and hence growth. But in very small open economies, devaluations tend to feed through rapidly into inflation, so the competitive boost might not have been that great. In any case, Ireland has already slashed wages and prices to restore competitiveness – in effect, an internal devaluation. And if it wished to cut unit labour costs further, it could reduce its high payroll taxes and replace the revenues with higher value added tax or a tax on land values.
Leaving the euro and reintroducing the punt is certainly not a solution, since Ireland would be incapable of repaying its euro-denominated debts in devalued punts. Nor, on its own, is an EU or International Monetary Fund “bail-out” – in practice, a loan at punitively high interest rates. That would merely postpone the crisis.
Irish taxpayers should not be bled dry to pay off investors – among them, European banks and American hedge funds – who gambled on lending to Irish banks. Instead those creditors should take a haircut, via a debt restructuring with the EU or IMF providing a bridging loan until Ireland has fixed its budget deficit. Ironically, it is Germany’s proposal that bondholders should lose out in future that brought this crisis to a head. It is such a good idea that it should be implemented now.
Anger at Germany boils over
by Peter Spiegel and Gerrit Wiesmann - Financial Times
When George Papandreou, the Greek prime minister, this week aired frustration with Germany for pushing the eurozone to the brink of another debt crisis, he was saying publicly what other senior European officials and diplomats have been saying privately for weeks. The drive by Angela Merkel, the German chancellor, to rewrite the European Union’s treaties to set up a new bail-out system for future Greek-like collapses – and her insistence that private investors bear more of the cost of such rescues – was quietly resented when she bulldozed it through last month’s summit of EU leaders.
But as bond markets have reacted and plummeted in the weeks since, that resentment has begun to boil over, with increasing accusations that Ms Merkel has put many of her fellow eurozone leaders in untenable positions in order to reinforce her own standing with German taxpayers. “They’re unprintable at times,” said Daniel Gros, director of the Brussels-based Centre for European Policy Studies, of the angry remarks he has heard aimed towards Berlin.
German officials insist their campaign to get private bondholders to shoulder more bail-out costs is not just about domestic considerations. The government is more concerned that the current system – which condemns well-managed states to bailing out badly managed ones – is unsustainable. But even some of those well-managed states have expressed anger at German tactics. Countries such as the Netherlands, Finland and Austria, all normally allies of Germany in economic governance issues, have raised questions about Berlin’s behaviour.
Anger first arose in October after Berlin cut a deal with France over the new bail-out system, even as it was working closely on economic reform issues with several of its allies among the northern, fiscally prudent caucus. Ever since the deal was struck, Germany has slowly lost support for its hardline stance on the new rescue mechanism and has been forced to back away from its original ideas about setting strict rules for private investors’ role in a bail-out “ex-ante”, or before a rescue even occurs. “Everybody should be more [of] an owner of this process; it shouldn’t just be Germany,” said Mikolaj Dowgielewicz, Poland’s EU minister.
Senior EU officials have become increasingly alarmed by the internecine sniping. Olli Rehn, the EU’s top economic official, on Tuesday called for leaders to “restore the sense of unity” and to end the “somewhat divisive tone in the public debate”. Several European officials said, however, that Germany was unprepared for the market’s angry reaction to the bail-out proposal and has since begun to backtrack. Two senior officials briefed on deliberations during the G20 summit in Seoul said a statement put out there by finance ministers of the EU’s five largest economies, in which they reassured bondholders that no current owner of debt would be forced to pay for a sovereign bail-out, was in part a concession by Berlin that it had overplayed its hand.
Mr Gros noted the dust-up is the second time Ms Merkel has pushed the eurozone into turmoil by digging in her heels on what, to her, is a principled stand against bailing out profligate member states. Earlier this year, Ms Merkel refused for months to offer concrete help for Greece until forced into action in May by an angry bond market. “That is the fundamental flaw in Merkel’s approach,” Mr Gros said. “What she somehow doesn’t get is that markets are not like political systems. They anticipate things. And they anticipate vaguely, not rationally.”
As the turmoil has gathered steam, German officials have insisted they are sympathetic with Ireland’s plight, particularly since Dublin was the first “peripheral” EU economy to slash budgets to try to get its fiscal house in order. Berlin has repeatedly insisted that they are not putting pressure on Ireland to accept EU aid. At the same time, Berlin has grown frustrated with Dublin’s handling of the crisis, believing Irish officials have failed to inform other eurozone members how they want to move forward. But Berlin appears prepared to tough it out, despite the criticisms from the likes of Mr Papandreou and Jean-Claude Trichet, the European Central Bank president who loudly opposed the German move to reopen the treaties for fear that the markets would react exactly as they have. German officials acknowledge that uncertainty over the future bail-out system is not ideal, but they insist they need more time to work out its details.
Sovereign Debt Crisis Redux? "Tough Medicine" Isn't Curing Europe's PIIGS
by Aaron Task - Tech Ticker
Financial markets were relatively and notably calm Monday despite the latest evidence of Europe's ongoing sovereign debt crisis. Irish officials repeatedly denied they are seeking a bailout, although major EU nations pledged to provide one at the G20 confab and are expected to follow through Tuesday when European Finance Ministers meet in Brussels.
The need for Ireland to get its financial house in order before its Dec. 7 budget announcement was highlighted by the latest news about Greece: Eurostat, the EU's official statistical organization, revised Greece's 2009 budget shortfall to 15.4% of GDP from 13.6% and vs. the EU's target of 3%.
"The revisions mean that Greece won't achieve the deficit targets it agreed to in return for the 110 billion euros ($150 billion) in EU-IMF emergency loans," Bloomberg reports. After Eurostat's revisions, the Greek Finance Ministry revised its own targets for 2010; Greece now projects debt will hit 144% of GDP in 2010 vs. 126.8% in 2009, which is already the highest in the EU. The Greek experience shows the paradox of austerity, especially in Europe's "Club Med" nations, where economic growth is traditionally heavily dependent on government spending.
The Paradox of Austerity
Cutting back on government spending means lower GDP, which means more spending on unemployment insurance and other social safety nets. "The medicine is pretty tough [so] you never really get the expected cuts in the deficit," notes Gary Shilling, president of A. Gary Shilling & Co. "The whole things feeds on itself." Yields on Greek debt rose Monday and the dollar hit a 6-week high vs. the euro in reaction. Amid hopes for a EU bailout, yields on Irish debt actually fell, albeit modestly and from record levels reached last week.
But overall, the financial markets reacted with a collective shrug, especially compared with the drama that unfolded last spring, Shilling, whose latest book The Age of Deleveraging is out this week, attributes the market's relative lack of concern about Europe to a "been there, done that" mentality among fund managers. "People say ‘I shouldn't have sold back then,'" he quips, and are putting their faith in the $1 trillion "euro TARP" put together by the EU-IMF.
In addition, the dollar has not strengthened dramatically in reaction to the EU crisis, as was the case last spring. But it's probably not a coincidence the stock market hit a bit of an air pocket last week as the dollar recovered from its pre-QE2 shellacking. Noting U.S. banks have about $750 billion of debt exposure to the EU and U.K., Shilling is less sanguine than most on Wall Street about goings on ‘over there.'
"Another sovereign debt crisis [is] possible," he says, wondering: "Is that euro bailout fund going to save the day - or will there be issues with implementing it?"
Of Course The Fed's Latest Plan Won't Work, Says Gary Shilling--We're Still Deleveraging!
by Henry Blodget - Tech Ticker
The theory behind most of what the Federal Reserve does to stimulate the economy is this: If we make money cheaper, people will borrow more of it--and then they'll start spending again.
That theory works in most recessions. When the economy begins to weaken, the Fed cuts interest rates. Banks, companies, and consumers see that it now costs less to borrow money to buy the things they want to buy. So they borrow money and buy them. And the economy strengthens again.
But we aren't in a normal weak economy, says economist Gary Shilling of A. Gary Shilling & Co. We're in a "deleveraging" economy. And that means that we will keep reducing our debts and borrowing, no matter how cheap money gets.
The key to understanding the difference between today's economic weakness and normal economic weakness, Gary says, is to look at the past 30 years. Beginning in 1982, Americans spent their way to apparent prosperity. Savings rates plummeted, as consumers spent almost everything they earned. Home equity withdrawals soared, as consumers realized they could use their rapidly appreciating houses as personal ATM machines. And, across the economy, total debt surged to a previously unheard-of 375% of GDP.
But now all those forces have reversed. Savings rates are climbing again, as consumers realize they have almost nothing left to retire on. Home equity withdrawals have ceased, because house prices have stopped appreciating and started falling (Gary thinks they'll fall another 20%). And consumers are looking at ways to reduce their debts, not borrow more money. These trends will continue for at least another decade, Gary Shilling thinks. He lays out this theory in his new book, "The Age Of Deleveraging."
The economy will grow in the next decade, Gary says, but it will grow much more slowly than it has grown in the past. Unemployment will remain high. Consumers will continue to be forced to embrace a new frugality. And no matter how cheap the Fed makes money, overall borrowing will continue to decrease. In the process of this, stocks will do poorly. House prices will fall another 20%. Only Treasury bonds will do well.
Middle Class in Crisis: America Needs a Reality Check
by Stacy Curtin - Tech Ticker
This country was built atop a strong middle class workforce and with the belief that anyone could aspire to achieving the American dream. But that foundation has been crumbling as middle class jobs -- manufacturing and service alike -- have been sent overseas in recent decades to low-cost labor markets. The 'Great Recession' isn’t helping this reality. Unemployment is stuck at 9.6% and record numbers have been out of the workforce six months or longer.
To top it off, CEO pay is on the rise -- even during this economic downturn -- and the wage gap between the rich and poor is the widest it has ever been. The percent of income garnered by the wealthiest 10% of U.S. households hit 48.2% in 2008, up from 34.6% in 1980, according to a recent report on income equality by the Congressional Joint Economic Committee. "Much of the spike was driven by the share of total income accrued by the richest 1% of households. Between 1980 and 2008, their share rose from 10% to 21%, making the United States one of the most unequal countries in the world."
And the income gap has actually widened since the financial crisis: According to the 2010 Census, the top 20% of workers -- those making more than $100,000 each year -- received 49.4% of all income generated in the U.S., compared with the 3.4% earned by those below the poverty line. As reported by Slate.com, that ratio of 14.5-to-1 was an increase from 13.6 in 2008 and nearly double a low of 7.69 in 1968.
This dire situation is not likely to get better any time soon, says Gary Shilling, president of A. Gary Shilling & Co, who predicts a prolonged period of slow economic growth and high unemployment. Even when thing do start to look up, "people are going to have to be much more realistic about their income levels." Shilling believes there will be jobs, but says, "People are going to have to work very hard to get trained and educated for jobs that do exist."
To that point, in his latest newsletter he makes the argument that a college degree is not for everyone, nor should you expect a degree to yield you a certain level of income. "Wouldn’t many be better off learning a skilled trade rather than facing bleak job prospects and lifetime student loan repayments after graduating from lesser institutions?," he writes.
Shilling, author of a new book "The Age of Deleveraging", is optimistic and believes that America is "still the land of opportunity" where the American dream can be achieved. But first, he says, Americans need to "align themselves with reality" and become comfortable with the fact that things are not going to be the same as during the "salad days" of the 1980s and 1990s.
U.S. Sets 50 Bank Probes
by Jean Eaglesham - Wall Street Journal
The Federal Deposit Insurance Corp. is conducting about 50 criminal investigations of former executives, directors and employees at U.S. banks that have failed since the start of the financial crisis. The agency responsible for dealing with bank failures is stepping up its effort to punish alleged recklessness, fraud and other criminal behavior, as U.S. officials did in the wake of the savings-and-loan crisis a generation ago. More than 300 banks and savings institutions have failed since the start of 2008, but just a few have led to criminal charges being filed against bank officials.
In an interview, Fred W. Gibson, deputy inspector general at the FDIC, which works with the Federal Bureau of Investigation to investigate crime at financial institutions, said the probes involve failed banks of all sizes in cities across the U.S. The FDIC is also ramping up civil claims to recover money from former bankers at busted lenders. He declined to identify any of the people or banks under investigation. "We anticipate results from our investigations, although we cannot predict when a particular case will reach a stage at which disclosure of specifics would be appropriate," Mr. Gibson said.
Pressure is high on regulators to identify and prosecute bankers for any wrongdoing that contributed to the largest number of failures in nearly 20 years. The September 2008 collapse of Washington Mutual Inc. was the biggest ever, with seven times the value of the assets that Continental Illinois Corp. had when it failed in 1984. The current epidemic of bank failures, including 146 so far this year, has deepened the nation's lending drought and left the industry's survivors with more muscle to squeeze customers.
The S&L crisis of the 1980s and 1990s killed more than 1,800 institutions. From 1990 to 1995, federal officials prosecuted about 1,850 bank insiders. More than 1,000 officers, directors and other officials went to prison, and federal agencies collected $4.5 billion in professional-liability claims. In the current mess, no high-profile banker has been criminally charged in connection with a financial institution's demise, as Charles Keating was for fraud after American Continental Corp. failed in 1989. He served four years in prison and became synonymous with the S&L crisis.
FDIC officials also are ramping up efforts to use civil litigation to recover money from former bank officials. Hundreds of "demand" letters have been sent to former executives, directors and other employees, as well as their professional-liability insurers, putting them on notice of potential claims, the FDIC says. The agency's board has authorized the filing of lawsuits seeking to recover more than $2 billion from more than 80 officers and directors of failed banks. The total is up from about 50 approved suits as of last month, seeking more than $1 billion. "These numbers will continue to increase as time goes on," Richard Osterman, acting general counsel at the FDIC, said in an interview.
Authorization of a civil suit by the FDIC doesn't necessarily mean a case will be filed in court. Some former bank officers and directors could avoid being sued by negotiating settlements with the agency. So far, the FDIC has filed just two civil lawsuits related to recent failures. The agency is seeking $300 million in damages from four former executives of IndyMac Bancorp, the Pasadena, Calif., lender that sank in 2008. Eleven former directors and officers of Heritage Community Bank are being pursued for $20 million in damages related to the Glenwood, Ill., bank's collapse last year.
In a statement through their lawyers, the Heritage directors and officers said the FDIC's suit is "regrettable and wrong," adding that the agency is blaming them "for not anticipating the same market forces that also caught central bankers, national banks, economists, major Wall Street firms and the regulators themselves by surprise." The former IndyMac executives have denied wrongdoing. Kirby Behre of law firm Paul Hastings, who is acting for two of the former IndyMac directors, said: "Not only weren't they negligent, they were very diligent, and forces beyond their control were responsible for any losses."
Michael W. Fitzgerald, of Corbin, Fitzgerald & Athey LLP, which is representing the other two former IndyMac executives, said the "charges by the FDIC are completely false and we will vigorously defend them." The few criminal prosecutions of failed banks so far include Integrity Bank, which opened in Alpharetta, Ga., in 2000 and was seized by regulators in 2008. In July, two former executives pleaded guilty to fraud-related charges. Prosecutors alleged that the executives helped the bank's biggest customer use a construction loan to buy a private island in the Bahamas.
Mr. Gibson, the FDIC's deputy inspector general, said the roughly 50 criminal investigations under way typically relate to loan officers at the vice president or senior vice president level. Some of the probes involve higher-ranking officials, including former directors of failed institutions, he added. Suspected criminal activity is handled by the FDIC's office of investigations, usually working with the FBI. Recommendations for prosecutions are referred to the Justice Department. It often takes at least 18 months for legal action to be brought after a bank fails, meaning the surge in scrutiny is likely to continue for years. FDIC officials expect the failure wave to peak this year.
Some lawyers predict it will be hard to win convictions in many cases. "To prove criminal fraud and get a conviction, you really need the equivalent of stealing money from the vault,'' said Thomas Vartanian, a partner at law firm Dechert LLP. As a result, many civil and criminal defendants are "eventually likely to settle for money,'' he said. Federal officials also will have to overcome the likely defense that bank failures were caused by an unforeseeable real-estate bust. Samuel Buffone, a partner at law firm BuckleySandler LLP, said the most striking part of the FDIC's civil suit against former Heritage officers and directors is "the call for 20/20 hindsight.'' Mr. Buffone isn't involved in the case.
Mr. Osterman, the FDIC's acting general counsel, noted that the "same argument'' was used by defendants during the S&L crisis. "The courts didn't agree that time, and we don't expect they will this time,'' he said. "People are allowed to exercise business judgments. As long as they comply with their legal duties, they don't have anything to worry about.''
Bond Market Defies Fed
by Mark Gongloff - Wall Street Journal
Interest Rates Rise Despite Launch of Treasury Buying as Investors Take Profits
Bucking the Federal Reserve's efforts to push interest rates lower, investors are selling off U.S. government debt, driving rates in many cases to their highest levels in more than three months. The Fed's $600 billion program to buy Treasury bonds began late last week and is kicking into high gear this week, with the central bank buying up tens of billions of dollars of debt.
That should have driven prices up on those bonds and lowered their interest rates, or yields, which move opposite to the price. Instead, yields on almost every Treasury have been rising. The trend is a potential problem for the economy and the Fed. Rates had fallen sharply for months in anticipation of a Fed buying program, and in a short time much of that effect has been lost, spelling an unwelcome rise in borrowing costs throughout the economy.
That could throw a wrench in what the Fed is trying to accomplish: to use low rates to encourage more borrowing and risk-taking by consumers, businesses and investors, thereby reviving growth. Still, it is far too early to declare that the Fed's plan is failing, and many rates remain near historic lows. And recent economic indicators, such as a Monday report on retail sales, suggest the economy continues to recover—which is the Fed's ultimate concern. "The recent run-up in bond yields is worrying to many," said Dan Greenhaus, chief economic strategist at Miller Tabak, a New York trading firm, but "you need to keep it in context of what happened before the Fed moved."
The Fed has only begun to put its plan in motion, and many investors are simply cashing out of lucrative bond-market bets they placed in the long prelude to the Fed's announcement of its purchasing program. Rates in most cases are still far lower than they were in the spring. Many observers still believe that the power of the Fed's printing press will prove overwhelming and economic growth disappointing. Both forces would eventually drive rates lower. Still, the recent move in rates has been jarring, raising some market worries that the Fed's program might be ineffective or backfiring. That could damage the Fed's credibility and raise borrowing costs broadly.
The recent move in interest rates may be due partly to the rosier tone of economic data recently, including data released on Monday that showed retail sales at their highest level since August 2008, the month before the fall of Lehman Brothers Holdings Inc. Sales rose 1.2% to $373.1 billion in October, compared with the month before. If the economy keeps improving, then the Fed's bond-buying program could end sooner than expected. That would be a much happier outcome for the Fed, though most economists still don't expect it. In an interview conducted last week, the Fed's new vice chair, Janet Yellen, defended the program, given an economic outlook that seemed to portend high unemployment, low inflation and lackluster growth for some time.
"I'm having a hard time seeing where really robust growth can come from," Ms. Yellen told The Wall Street Journal. "And I see inflation lingering around current levels for a long time." For now, the market seems to be driven mainly by the momentum of investors selling Treasury bonds to take a hefty profit after a rally that began in the spring, gathered steam as the economy weakened this summer and peaked amid talk of a new Fed buying program.
The 10-year Treasury note's yield, which influences most residential mortgage rates, surged on Monday to 2.911%, the highest since Aug. 5. Bond prices and yields move in the opposite direction. The 10-year note has now more than erased all of the beneficial effects of comments in late-August by Fed Chairman Ben Bernanke in Jackson Hole, Wyo., in which he first hinted at another round of bond-buying. And on Monday, the yield on the 7-year Treasury note rose to 2.14%, a 2-month high, despite the Fed's buying $7.92 billion in 6- and 7-year Treasury debt in the morning. Yields were more or less steady while the Fed was buying, but surged through the end of the day.
Several other factors have been working against Treasurys in recent days, including a backlash against the Fed's program overseas and among conservative politicians and economists in the U.S. Corporate bond issuance has been heavy since the Fed announced its bond-buying plan, which often leads to a temporary selloff in Treasurys. Moody's Investors Service may have contributed to the punishment late on Monday when it warned that an extension of Bush-era tax cuts, set to expire on Dec. 31, could harm the country's fiscal standing. Though the tax-cut issue isn't new, and though Moody's said the U.S. credit rating was secure, the bond market is sometimes sensitive to rating-agency comments.
The Fed plans to buy Treasurys every day this week, including 2- to 3-year notes on Tuesday and 8- to 10-year notes on Wednesday. It has committed to buying through the second quarter of 2011. It also plans to use whatever cash it gets from expiring mortgages on its balance sheet to buy still more Treasurys, taking total purchases closer to $900 billion, according to some estimates. That, Mr. Greenhaus notes, is more Treasury debt than China owned at the end of August. "Those screaming the end of the bond-market rally might be better served by waiting just a bit longer," he said.
California Will Default On Its Debt, Says Chris Whalen
by Henry Blodget - Tech Ticker
Municipal bonds have plummeted in recent days, as investors have suddenly focused on huge state and city budget deficits that there's no easy way to fix. Nowhere has this collapse been more visible than California, which faces a massive $25 billion shortfall and red ink for as far as the eye can see.
After years in which every looming financial crisis has been met with a government bailout, you might think that the same solution awaits California, as well as all the other states that have huge obligations that they can't afford to meet. But this time that may not happen, says Chris Whalen, a financial industry analyst and Managing Director of Institutional Risk Analytics.
In fact, Whalen thinks that California will default on its debt--hammering all the pension funds and other investors who have loaded up on apparently safe state bonds. The state won't immediately default, Whalen says. It will start by issuing the same sort of IOUs that it issued to by itself time during its budget crisis last year. But, eventually, the debts will have to be restructured, and this will result in those who own California's bonds receiving less than 100 cents on the dollar.
Why won't California just get a bailout? Because the Republicans now control Congress, Whalen says. And also because, if California gets bailed out, dozens of other states will immediately line up with their hands out. The public is fed up with bailouts, Whalen says--and eventually, the country will be forced to face up to its bad debts and write them off.
Of course, if Whalen is right, the country could have a major crisis on its hands. California is hardly the only state in trouble (click here to see the worst ones), and pension funds and other "safe" investments that Americans depend on will get hammered if states begin to default. Fixing state and local obligations will also require the renegotiation of pensions and salaries that government workers have long since taken for granted. And they certainly won't give those up without a fight.
U.S. housing starts fall 11.7% in October
by Jeffry Bartash - MarketWatch
Construction of new U.S. homes sank 11.7% to an annualized rate of 519,000 in October, the lowest level in 18 months, but permits rose slightly, the Commerce Department reported Wednesday. The last time starts were that low was in April 2009. In addition, housing starts in September were revised down to 588,000 from an original reading of 600,000. Economists surveyed by MarketWatch had expected housing starts in October to drop to an annual rate of 600,000 on a seasonally adjusted basis. Permits for new construction, viewed as a more accurate gauge of home building, rose 0.5% in October to an annualized rate of 547,000. Permits were also revised slightly higher in the prior month.
From the Census Department:Building Permits
Privately-owned housing units authorized by building permits in October were at a seasonally adjusted annual rate of 550,000. This is 0.5 percent (±3.0%)* above the revised September rate of 547,000, but is 4.5 percent (±3.1%) below the October 2009 estimate of 576,000. Single-family authorizations in October were at a rate of 406,000; this is 1.0 percent (±1.3%)* above the revised September figure of 402,000. Authorizations of units in buildings with five units or more were at a rate of 121,000 in October.
Privately-owned housing starts in October were at a seasonally adjusted annual rate of 519,000. This is 11.7 percent (±8.6%) below the revised September estimate of 588,000 and is 1.9 percent (±9.6%)* below the October 2009 rate of 529,000. Single-family housing starts in October were at a rate of 436,000; this is 1.1 percent (±8.6%)* below the revised September figure of 441,000. The October rate for units in buildings with five units or more was 74,000.
Privately-owned housing completions in October were at a seasonally adjusted annual rate of 613,000. This is 3.2 percent (±15.3%)* below the revised September estimate of 633,000 and is 18.4 percent (±11.4%) below the October 2009 rate of 751,000. Single-family housing completions in October were at a rate of 501,000; this is 2.7 percent (±16.8%)* above the revised September rate of 488,000. The October rate for units in buildings with five units or more was 107,000.
"Great Irony" of Fannie, Freddie: Government MORE Involved in Housing, Post-Crisis
by Stacy Curtin - Tech Ticker
Should the government get out of the housing business? That's the big question on everyone’s minds and the fates of Fannie Mae and Freddie Mac hang in the balance. Nearly all mortgage loans are now backed by the two government-sponsored enterprises (GSEs), which received a $150 billion taxpayer bailout in 2008 and then in late 2009 got an unlimited blank check from Uncle Sam that doesn't expire for three years.
President Obama is slated to discuss the overhaul of Fannie and Freddie for January, but with Republicans now presiding over the House of Representatives, will anything be done to remedy their debt-ridden balance sheets? Or will the plug finally be pulled on Fannie and Freddie as many in the GOP purportedly desire? "Nothing. Absolutely nothing," will happen, predicts Bethany McLean, co-author of the new book All the Devils Are Here. "No one knows what to do, and no one is going to take the risk of doing something."
McLean, also a contributing editor to Vanity Fair, co-authored her new book with Joe Nocera, business columnist for The New York Times. As the title suggests, they believe many players – or "Devils" -- contributed to our housing and economic crisis, not any single entity or person.
"There is the notion that Fannie and Freddie caused the housing crisis, and that would be really nice, right?," she argues. But in truth, Wall Street is responsible for creating the subprime loans that led to the housing crash, McLean says. "Wall street wanted a place where they didn’t have to deal with Fannie and Freddie’s dominance over what were conforming loans."
Fannie and Freddie are to blame too, but they were in the backseat of this crash. They were actually not in the subprime business until they began to lose marketshare to Wall Street and began to see "their relevance fading," McLean explains; and not until then did the GSEs dive into the dangerous business of subprime mortgages. Billions of taxpayers’ dollars later, we're no longer in a place where a GSE-backed mortgage has an implicit government guarantee, now it's an explicit guarantee, as Dan points out in this clip.
So, is it reasonable to think that the government can get out of housing? Both Nocera and McClean agree that there are no easy fixes or any good solutions on the table. Everyone is just scared to see what happens if you remove government support from a very weak housing market. It has always been controversial to have the government in the business of backing home loans. But the "great irony" of the situation is that we may "come out of this with the government even more involved in the housing market" than when we started, McLean says.
TARP Watchdog Calls For Brand New Foreclosure-Gate Bank Stress Tests
by Joe Weisenthal - Business Insider
The Congressional Oversight Panel tasked with monitoring TARP has put out a big report covering the robosigning scandal. In the executive summary of their findings, they lay out the worst-case scenario, that the whole scandal could undermine the system again:To put in perspective the potential problem, one investor action alone could seek to force Bank of America to repurchase and absorb partial losses on up to $47 billion in troubled loans due to alleged misrepresentations of loan quality.
Bank of America currently has $230 billion in shareholders equity, so if several similar-sized actions – whether motivated by concerns about underwriting or loan ownership – were to succeed, the company could suffer disabling damage to its regulatory capital. It is possible that widespread challenges along these lines could pose risks to the very financial stability that the Troubled Asset Relief Program was designed to protect.
Treasury has claimed that based on evidence to date, mortgage-related problems currently pose no danger to the financial system, but in light of the extensive uncertainties in the market today, Treasury?s assertions appear premature. Treasury should explain why it sees no danger. Bank regulators should also conduct new stress tests on Wall Street banks to measure their ability to deal with a potential crisis.
And in the meantime...The Panel emphasizes that mortgage lenders and securitization servicers should not undertake to foreclose on any homeowner unless they are able to do so in full compliance with applicable laws and their contractual agreements with the homeowner.
Former Sen. Ted Kaufmann made a video explaining the findings
Why Credit Raters Keep Their Power
by Jean Eaglesham and Deborah Solomon
Curbing the influence of credit-rating firms, a goal of this year's financial overhaul, is so far proving easier said than done, reflecting the industry's deeply embedded role in the financial system.
One example: Though many U.S. banks suffered losses on mortgage-related deals blessed by ratings firms before the crisis erupted, some financial institutions have been lobbying against a provision in the Dodd-Frank financial-regulation law passed in July that bans the use of ratings in federal agencies' rules.
Regulators now use ratings to assess the risk of assets, such as mortgage-backed securities, in determining how much capital banks must hold against potential losses. Banks contend that alternative approaches, including coming up with their own risk assessments, could have unintended consequences. Among outcomes they say they fear: The U.S. ban could create an unfair advantage for foreign banks whose regulators continue to use ratings. Also, they say, smaller banks could shy from buying certain bonds, and additional administrative costs for banks could make loans more expensive. The ban "unnecessarily and unintentionally results in increased risk, cost and burden," said Bank of America Corp. in a letter to regulators.
Regulators seem sympathetic to their warnings. John Walsh, the acting Comptroller of the Currency, said in September that the provision "goes further than is reasonably necessary" and suggested it be amended. Sheila Bair, chairman of the Federal Deposit Insurance Corp. warned in August that "finding an alternative is going to be very, very difficult." Government officials don't expect Congress to undo the ban. But their struggle to settle on another option points up how interwoven ratings are in the fabric of the financial system.
Last week, the Federal Reserve convened regulators and industry participants to discuss options. Among possibilities being floated: having regulators gauge the risk level of individual assets, requiring banks to perform in-house assessments subject to oversight, or allowing firms to use a third-party "financial assessor" to gauge the risk level of assets. Regulators want what some call a "simple" solution that allows large and small banks to comply without overburdening financial institutions or creating an oversight nightmare for regulators. A person who attended the meeting said that no clear consensus emerged.
"It's not easy to wave a magic wand and get rid of rating agencies overnight, and that's been borne out by the big raters' dramatically improved financial performance this year and last year," said Michael Meltz, an equity analyst at J.P. Morgan Chase & Co. "It's clear there remains high demand for the firms' services." The looming U.S. prohibition on the use of ratings to assess banks' risks contrasts with the more cautious approach of global banking regulators.
The second Basel accord for international financial regulation, implemented by European countries in 2008, embeds ratings into its capital rules. The Financial Stability Board, in charge of coordinating financial regulations internationally, said last month that clear milestones were needed to reduce reliance on rating firms "over a reasonable time frame into the medium term." Meanwhile, Moody's Corp. reported last month that third-quarter profit surged 35%, handily beating analysts' expectations, as the company's credit-rating unit, Moody's Investors Service, benefited from a surge in bond issuance. The parent company of rating firm Standard & Poor's, McGraw-Hill Cos., saw third-quarter profit rise 13%.
The raters haven't come through the crisis unscathed. As of Monday, Moody's shares traded at about $28, less than half the $74.84 closing price the stock reached in February 2007 before the housing market collapsed. The new Dodd-Frank law imposes a swath of changes for the firms beyond the agency rule ban. The leading ratings firms were a prime target of lawmakers drafting the Dodd-Frank legislation. The companies were criticized as catering to investment banks and issuers to secure a steady flow of business at the expense of exercising independent judgment about risks of bonds backed by mortgages. Ratings firms have said they have instituted a long list of corporate governance, analytic and compliance changes.
The defense of ratings by U.S. banks comes amid a wider campaign to use Republican gains in this month's elections to try to roll back elements of the Dodd-Frank law seen as particularly onerous or costly for the financial-services industry. Regulators have until July to strip all references to credit ratings from rules for assessing whether banks hold sufficient capital. Rating firms say they aren't opposed to the Dodd-Frank ban on the use of ratings in federal agencies' rules. S&P said in a statement that it supports removing rating requirements from regulations and believes "the market—not government mandates—should decide the value of our work."
Bank analysts cite the credit-ratings ban as a candidate for inclusion in any forthcoming "technical relief" or "corrections" bill, designed in part to address implementation problems in the legislation. "This is one of the issues that the regulators will push hard to get in the technical relief act," said Jaret Seiberg, an analyst at MF Global Holdings Inc. Short of such an amendment, some industry officials hope regulators could find creative ways to essentially bypass the ban. "Ultimately, the regulators have a lot of latitude to allow ratings to continue to be used, just not required to be used," says Tom Deutsch, executive director of the American Securitization Forum, a securitization-industry trade group.
Canada's coming housing bust
by Kit R. Roane - FORTUNE
America may be on the ropes, but its neighbor to the North wants everybody to know that, in contrast, it's doing just fine. Canada, once known mainly for its Mounties, maple leaves, and muscular peacekeeping presence, now can crow about how it managed to avoid the financial crisis that devastated many of the economies of the Western world. For instance, not one Canadian bank failed during the crash and only one reported a loss.
As David Rosenberg, economist for Gluskin Sheff, told Fortune earlier this week, he couldn't "recall a time, ever, where on the fiscal, economic, or political basis, relative to the United States, the downside risks were as limited and upside potential so compelling in Canada as is the case today."
All of this rings true, for now at least. But Canada still faces some stiff odds if it plans to slip through the crisis with nary a scratch. CIBC recently reported that Canada was likely to see its economic recovery squeezed next year, with a still-overvalued loonie falling to 93 U.S. cents and growth rates averaging "no better than 2% over the next few quarters." Canada's economy, said CIBC, was shifting "into a new phase of greater uncertainty."
One problem is that it's hard not to catch a close neighbor's cold. Although bolstered by a heavy trade of natural resources, 75% of Canadian exports end up in the United States, so Canadian trade will likely suffer if American consumers don't begin spending again. "At the end of the day, the Canadian economy just can't fight the gravitational pull of sluggish U.S. activity. End of story," Doug Porter, deputy chief economist at BMO Capital Markets recently wrote.
A decelerating economy at home means the labor market (currently running at just under 8% unemployment) will probably soften further. Canadian household debt continues to rise and currently runs at about 144% of disposable income, comparable with rates in the US, although household debt is falling there. As with their American counterparts, debt-sodden Canadians could soon begin putting away those charge cards too.
A housing bubble?
But perhaps the greatest issue looming over Canada's fortunes is its housing market, which has, despite a brief blip, continued to drive higher through the world's economic snow bank due to easy credit, low interest rates and encouraging government tax breaks.
Believers in the Canadian miracle say the country's housing market is not likely to have much of a correction at all, and certainly not the sort of housing swoon seen in the United States or Europe. One reason is that most mortgages were written by one of Canada's six major banks, all of which have existed under tighter regulations than their brethren in the U.S.
Another is that sub-prime mortgages were never in vogue. At the height of the American property bubble in 2006, sub-prime mortgages accounted for only 5% of the mortgages taken out in Canada, compared with 25% of those obtained in the United States. Roubini Global Economics says the chance of a "U.S.-style housing bust is unlikely given sound fundamentals of the Canadian financial system and mortgage lending."
But the Canadian housing market is showing signs of strain. Driven by an overhang of supply and by recent government efforts to tighten lending standards, housing starts in October were down 9.2% compared with September, and down more than 12% in urban areas. Also, housing prices have begun to level off after a decade of scaling ever-greater heights. Over the last ten years, housing prices have increased more than 95% nationwide.
Lower housing prices could hit Canadians fairly hard. Housing accounts for more than 20% of Canada's GDP, and its employment gains have been fueled by continued spending in the construction industry, which is one of Canada's largest and fastest growing employment sectors. In October, while the number of workers in Canada's massive service sector declined by 33,000, construction added 21,000 jobs.
There may also be less wiggle-room for Canadian homeowners than many perceive. Canadian banks didn't slice and dice millions of sub-prime mortgages, but they still offered - and continue to offer -- pretty generous terms. Edward Jones wrote in a recent note to clients that the mortgage credit in Canada increased more than 10% a year from 2006 to 2008, more than double the rate of growth from 1997 to 2001. Edward Jones added that "credit is currently more easily available than it was prior to the recent recession."
Canadians easily obtained mortgages with only 5% down and payments running out 35 years. More than 65% of Canadian mortgages are fixed for five years (and now face more stringent renewal terms and likely higher interest payments). But variable rate mortgages offered in Canada were at least as creative as those doled out in the US, with banks allowing terms as short as six months. Unlike in the US, people who default on mortgages in Canada don't just lose their houses, they risk other assets as well.
A fast or unexpected rise in interest rates (Canada was the first G7 country to begin moving them higher following the recession) could leave Canadians with little cushion. Last year the IMF noted that, by some measures, Canadians were paying a larger percentage of their income for housing than Americans did prior to the housing bust.
That level hasn't improved. Recent government data shows that the average Canadian with a two-story home spends almost 50% of his household income on mortgage servicing, with the average is closer to 70% in red-hot markets like Vancouver. "By and large the affordability situation remains within a safe range in Canada; however there are local markets where the share of household income taken up by homeownership costs is at worrisome levels," the Royal Bank of Canada wrote in September, adding that the situation in Vancouver raises "a red flag."
One red flag doesn't make a trend. But it should prick up the ears of investors still hoping for fortune in Klondike country. As the long-time Canada bull James Grant noted in July, "the track of Vancouver housing prices matters far beyond the province of British Columbia," adding that, perhaps, the best place for investors to park their money was in "a country in which a housing bubble has already popped, rather than one -- Canada, for instance -- in which it is just beginning to deflate."
Pressure Builds Over Loan Modifying
by Vanessa O'Connell and Victoria McGrane - Wall Street Journal
State attorneys general are intensifying pressure on lenders to fix the system they use to modify mortgages as part of a potential settlement in their multistate investigation of the foreclosure problems. The attorneys general are scrutinizing whether home-loan servicers violated state laws against deceptive practices by using "robo signers" to submit affidavits and foreclosure documents without confirming the paperwork's accuracy. But the states' investigation, which could lead to civil charges, already has expanded to include other issues, such as the fees charged by servicers.
State attorneys general have taken the lead in investigating banks over paperwork problems. Many feared banks and investors might have to shoulder huge costs if the problems led them to reduce the principal of tens of thousands of mortgages. While principal reduction isn't being ruled out, some attorneys general appear willing to settle for a more transparent loan-modification system. With the midterm elections over, the pace of discussions about a possible resolution has picked up. Several people familiar with the probe said the attorneys general aim to wrap up their investigation by as soon as December, though the effort could take longer. Bank of America Corp. has already met with Iowa Attorney General Tom Miller, who is spearheading the 50-state probe, about foreclosure issues.
The major mortgage servicers as a group are expected to meet in late November with Mr. Miller and the dozen or so other attorneys general leading the probe, people familiar with the matter said. A Bank of America spokesman said, "We have had constructive meetings with Attorney General Miller, and a number of positive steps have been discussed, but there has not been an agreement." The states want banks to modify mortgages in instances where doing so would result in a cash flow from the borrower that is greater than the likely proceeds of a foreclosure sale, Mr. Miller said.
Although the states are moving relatively fast in their coordinated probe, Mr. Miller's own prediction was that reaching a resolution with all of the major lenders could take months. The stepped up discussions come amid hearings by lawmakers in Washington, D.C., probing the causes of the foreclosure problems, and how to solve them. In a Tuesday hearing of the Senate Committee on Banking, Housing and Urban Affairs, executives for two major U.S. mortgage servicers, J.P. Morgan Chase & Co. and Bank of America, expressed contrition for errors their companies have made in processing foreclosures and pledged they are working hard to fix those problems.
Senators of both parties expressed frustration with lenders, regulators and others involved in the foreclosure process and called for more hearings and investigations. Sen. Richard Shelby (R., Ala.), the top Republican on the panel, called for the committee to expand its oversight to regulators, who may have missed widespread problems at institutions they oversee, as well as mortgage finance giants Fannie Mae and Freddie Mac.
Sen. Michael Bennet (D., Colo.) noting the hearing was nearing its end, said he was "still completely unclear" why it is so hard for servicers to conduct modifications. Several witnesses, including Iowa's Mr. Miller, told lawmakers that part of the issue lies with servicers who see it as more profitable to foreclose on homeowners than undertake modifications. Mr. Miller sounded the most confident that he had a potential solution to the mess. But Mr. Miller provided no details about the specifics of the discussions so far between the states and lenders.
His testimony signaled that the attorneys general likely won't relent until they manage to get a standardized loan-modification program from servicers. "The multi-state investigation is about more than robo-signing," Mr. Miller said. "The biggest issue is fixing the loan-modification system." Mr. Miller said he wants to "change the paradigm within the current system so it functions." Among other things, he said he wants to fix the dual-track system of foreclosures and modifications, and to perhaps have a monitor, or possible penalties for lenders that don't comply. "We all hear stories of borrowers who thought they were approved for a loan modification receiving a notice of foreclosure sale," he said, noting that the system is currently overwhelmed.
Bank of America is embracing reform of the dual-track system of foreclosures and modifications. But when asked if he would be willing to ditch the two-track system, David Lowman, chief executive for J.P. Morgan's home-mortgage division, said, "I think we'd have to be careful with that." One person familiar with the matter said there is a growing awareness on the part of the states that any settlement that involves writing down loan balances would have to include conversations with Fannie Mae and Freddie Mac, which own or guarantee half of the nation's $10.6 trillion in mortgages.
Fannie and Freddie and other investors who own mortgage-backed securities rarely approve loan modifications that forgive principal, instead preferring to reduce interest rates or offer some form of forbearance. The firms, which were taken over by the government two years ago, are under orders to conserve assets. Any efforts to force principal reductions on the firms would likely require the approval of their regulator, the Federal Housing Finance Agency, and the U.S. Treasury, which has injected $151 billion into the firms to keep them afloat. The multistate group hasn't yet reached out to Fannie and Freddie but intends to do so, Mr. Miller said.
Bank of America in 'Hand-to-Hand Combat' Over Mortgage Disputes
by Hugh Son and David Mildenberg - Bloomberg
Bank of America Corp. Chief Executive Officer Brian T. Moynihan said resolving investor demands for refunds over faulty mortgages is a battle that will last at least several more quarters. "It’s a day-to-day, hand-to-hand combat," Moynihan said today during an investor conference held by the lender in New York. "It’s manageable in the context of who we are, but we’re not going to spend your money unwisely."
Moynihan’s comments highlight the tensions between Bank of America, the biggest U.S. lender, and clients who bought its mortgages or bet on securities backed by home loans. The Charlotte, North Carolina-based company faces demands to repurchase almost $13 billion of loans that may have failed to document required data such as income and home values.
Bank of America has said it would review claims "loan-by- loan" to protect shareholders as Fannie Mae, bond insurers and private investors press for so-called putbacks. Some of the claims stem from loans made by Countrywide Financial Corp., the mortgage lender Bank of America acquired in 2008. "There’s a lot of people out there with a lot of thoughts about how we should solve this, but at the end of the day, we’ll pay for the things that Countrywide did," said Moynihan, 51.
The bank’s resistance has rankled lawmakers and business partners, with Dominic Frederico, CEO of Assured Guaranty Ltd., saying in August that settlement talks with BofA were "like Chinese water torture." In an August letter to President Barack Obama, Representative Barney Frank, the Massachusetts Democrat who leads the House Financial Services Committee, said the battle to get refunds "should be fought with every tool" to ensure that Fannie Mae and Freddie Mac recover money from banks on improperly written loans.
Insurers are negotiating repurchases and suing firms including Bank of America as they seek to recover from losses on mortgage-security guarantees. The bank is the largest servicer of U.S. home mortgages and second-biggest originator of loans after Wells Fargo & Co. The company expects costs tied to resolving loan disputes averaging $500 million each quarter for "the next couple of years or so," according to an Oct. 19 conference call. Bank of America declined 22 cents, or 1.8 percent, to $11.88 in New York Stock Exchange composite trading at 9:52 a.m. The lender has slipped 21 percent this year, while the 24- company KBW Bank Index has gained 9.6 percent.
The bank said last month it would start resubmitting foreclosure affidavits in 102,000 cases in which judgment is pending. Under pressure from lawmakers and state officials, bankers had been delaying action until they could answer allegations that filings were marred by so-called robosigning, in which employees vouched for the accuracy of court filings without personally checking loan records. Flaws in Bank of America’s foreclosure paperwork haven’t caused the lender to seize any homes improperly, Barbara Desoer, president of the company’s home-loan division, said in testimony prepared for the Senate Banking Committee.
Desoer is among at least seven banking officials who will face lawmakers’ questions today and Thursday in the first congressional hearings on problems with foreclosure documents that surfaced publicly in September. Also scheduled to testify today is David Lowman, chief executive of JPMorgan Chase & Co.’s home loan division. "Thus far we have confirmed the basis for our foreclosure decisions has been accurate," Desoer said in her prepared testimony. "At the same time, however, we have not found a perfect process."
Bank of America, which gets more than three-quarters of its revenue from the U.S., is a "mirror" to the domestic economy, Moynihan said this month. The U.S. is in a slow rebound as consumer spending and commercial lending improve, he said today. "Everything we see points to a continued recovery, albeit a slow recovery," Moynihan said. "We continue to see delinquencies improve in all our products across the board."
The bank has posted three unprofitable quarters since the beginning of 2009 as new regulations pressure fee income and unemployment holds near 10 percent, limiting customers’ ability to repay debts. The firm reported a $7.3 billion third-quarter loss tied to new rules on credit cards and consumer accounts.
The US Debt Commission's Free Ride for Boomers
by Chris Farrell - Businessweek
It sure doesn't seem fair. The co-chairs of the National Commission on Fiscal Responsibility and Reform have largely given Baby Boomers—the generation that created the current fiscal mess—a pass on fixing the problem.
One major recommendation from Erskine Bowles and Alan Simpson is to scrap the tax deduction for mortgage interest. That's fine for older Boomers, since many have paid off that debt or have little interest left to deduct. No child credit? Hey, they're (hopefully) out of the house. Boosting the retirement age for Social Security to age 69 by 2075? The Boomers will be dead then. Gradually hiking the federal gas tax by 15¢ per gallon from its current 18.4¢ starting in 2013? Aging Boomers won't be driving much in their dotage. End the employee-sponsored health-benefit exclusion from income taxes? Boomers will be on Medicare.
"The more you protect the Baby Boomers, the more the relative hit has to fall on younger generations," says Maya MacGuineas, director of the fiscal policy program at the centrist New America Foundation in Washington.
When all is said and done, Boomers may end up shouldering more of the burden to pass a sustainable government to future generations. Bowles and Simpson, long-time political operators, have much of official Washington in a frenzy. They've made it clear that bringing the budget into balance and the debt under control mean abandoning cherished positions.
"Fairness" toward aging boomers could be a casualty. It's as if they consulted The Prince, the classic exegesis of power politics by Niccolò Machiavelli, before issuing their preliminary recommendations. "From this arises the question whether it is better to be loved rather than feared, or feared rather than loved," mused the Renaissance scholar in Chapter 8. "It might perhaps be answered that we should wish to be both: but since love and fear can hardly exist together, if we must choose between them, it is far safer to be feared than loved."
"Thank You," Bowles And Simpson
Bowles and Simpson have attracted their share of fear and loathing. For instance, Americans for Tax Reform, the antitax advocacy organization headed by Grover Norquist, blasted the Bowles-Simpson plan. The government would be still "spending too much" and the panel ignored how to balance the budget "without raising taxes," it said. The group pointedly reminded more than 235 congressmen and 41 senators that supporting the plan would violate a no-tax-increase pledge that they made to their constituents. Richard Trumka, president of the AFL-CIO, said the co-chairs' scheme for fiscal balance "tells working Americans to 'Drop Dead.'"
The anxious rush to defend familiar positions is why the nation owes Bowles and Simpson a big "thank you." The report has made it clear just how daunting a fiscal challenge the U.S. faces. Anger doesn't cut it, let alone business as usual. "There is no way to get on top of the debt and the deficit with policy changes that are easy or fun," MacGuineas says. "This is about the hard stuff." Adds Leonard Burman, professor of public affairs at the Maxwell School, Syracuse University: "They did a real service. What they came out with is unpalatable to everyone, and now people can get serious negotiating."
The scale of the national debt and budget deficit is well known. In 2009 and 2010 the federal government's red ink ran in the neighborhood of 10 percent of gross domestic product. The $3 trillion in net borrowing over the same period will leave the federal government with debt of roughly 60 percent of GDP for the first time since the end of World War II. The longer-term projections are most ominous. In one of its scenarios, the Congressional Budget Office assumes that the Bush tax cuts are permanent, the alternative minimum tax patch is lasting, and health-care costs rise at close to their historic levels. The national debt explodes to 100 percent of GDP by 2023 and 200 percent of GDP by 2038—a mere 13 and 28 years, respectively, from now.
That the scope of the problem may be understood hardly makes reform easier to swallow. There is much to dislike among the Bowles-Simpson suggestions. For instance, their plan leans heavily on slashing spending, compared to raising tax revenue, with some $3 in cuts for every additional revenue dollar. Instead of weighing the costs and benefits of different government programs, it advocates limiting government's take to 21 percent of GDP.
Most Would Pay More Taxes
That said, Bowles and Simpson emphasize critical areas for review. They would significantly reduce military expenditures, as well as discretionary spending. They slightly increase the progressivity of Social Security and they highlight the need to bring health-care spending—the core of the long-term structural budget deficit—under control. Perhaps most significantly, they push for major tax reform. The co-chairs propose eliminating many of the deductions and credits that clutter up the tax code in return for lowering overall tax rates.
They offer three basic tax reform options. The most intriguing would eliminate the mortgage interest deduction, the preference for employer health-care insurance, favorable rates on dividends and capital gains, child tax credit, and similar tax expenditures in exchange for a sharp drop in brackets—to 8 percent, 14 percent, and 23 percent. "Most people will end up paying more in taxes, but they should be doing it in a system they can understand and [that] will be perceived as fair," says Burman, the Syracuse professor.
Odds are that the Bowles-Simpson preliminary plans will go the way of most blue-chip panel studies: Directly into the dustbin of history. Washington is gridlocked, especially since the Nov. 2 midterm elections. The nation's political class is mired in a giant game of chicken. Everyone knows a deal has to be struck eventually. But the players don't want to cede anything too soon. "You're a fool and weak if you're the first to give in on the things you care about," says Daniel Shaviro, professor of taxation at New York University. "But on the other hand, if you don't give, nothing gets done."
The way out is for President Barack Obama to change the rules of the game of chicken. He can use the power of the bully pulpit to appeal directly to the electorate. President Franklin D. Roosevelt used the power of radio with his fireside chats to bypass the traditional media to push his New Deal initiatives. President Ronald W. Reagan turned his back on official Washington and Gucci Gulch lobbyists when he resuscitated major tax reform in 1986. (It's also forgotten that Reagan responded to the debt and deficit concerns of the centrist voter by raising taxes three times between 1982 and 1984.) It's a leadership playbook Obama should heed. After all, in Chapter 26 of The Prince, Machiavelli wrote: "Where the willingness is great, the difficulties cannot be great."
Ruling on Behalf of Wall Street's "Super Rich": The Financial End Time has Arrived
by Michael Hudson - Global Research
Now that President Obama is almost celebrating his bipartisan willingness to renew the tax cuts for the super-rich enacted under George Bush ten years ago, it is time for Democrats to ask themselves how strongly they are willing to oppose an administration that looks like Bush-Cheney III. Is this what they expected by Mr. Obama’s promise to rise above partisan politics – by ruling on behalf of Wall Street, now that it is the major campaign backer of both parties?
It is a reflection of how one-sided today’s class war has become that Warren Buffet has quipped that “his” side is winning without a real fight being waged. No gauntlet has been thrown down over the trial balloon that the president and his advisor David Axelrod have sent up over the past two weeks to extend the Bush tax cuts for the wealthiest 2% for “just” two more years. For all practical purposes the euphemism “two years” means forever – at least, long enough to let the super-rich siphon off enough more money to bankroll enough more Republicans to be elected to make the tax cuts permanent.
Mr. Obama seems to be campaigning for his own defeat! Thanks largely to the $13 trillion Wall Street bailout – while keeping the debt overhead in place for America’s “bottom 98%” – this happy 2% of the population now receives an estimated three quarters (~75%) of the returns to wealth (interest, dividends, rent and capital gains). This is nearly double what it received a generation ago. The rest of the population is being squeezed, and foreclosures are rising.
Charles Baudelaire quipped that the devil wins at the point where he manages to convince the world that he doesn’t exist. Today’s financial elites will win the class war at the point where voters believe it doesn’t exist – and believe that Mr. Obama is trying to help them rather than shepherd them into debt peonage as the economy settles into debt deflation.
We are dealing with shameless demagogy. The financial End Time has arrived, but Mr. Obama’s happy-talk pretends that “two years” will get us through the current debt-induced depression. The Republican plan is to make more Congressional and Senate gains in 2012 as Mr. Obama’s former supporters “vote with their backsides” and stay home, as they did earlier this month. So “two years” means forever in politician-talk. Why vote for a politician who promises “change” but is merely an exclamation mark for the Bush-Cheney policies from Afghanistan and Iraq to Wall Street’s Democratic Leadership Council on the party’s right wing? One of its leaders, after all, was Mr. Obama’s Senate mentor, Joe Lieberman.
The second pretense is that cutting taxes for the super-rich is necessary to win Republican support for including the middle class in the tax cuts. It is as if the Democrats never won a plurality in Congress. (One remembers George W. Bush with his mere 50+%, pushing forward his extremist policies on the logic that: “I’ve got capital, and I’m using it.” What he had, of course, was Democratic Leadership Committee support.)
The pretense is “to create jobs,” evidently to be headed by employment of shipyard workers to build yachts for the nouveau riches and sheriff’s deputies to foreclose on the ten million Americans whose mortgage payments have fallen into arrears. It sounds Keynesian, but is more reminiscent of Thomas Robert Malthus’s lugubrious claim (speaking for Britain’s landed aristocracy) that landlords would keep the economy going by using their rental income (to be protected by high agricultural tariffs) to hire footmen and butlers, tailors and carriage-makers.
It gets worse. Mr. Obama’s “Bush” tax cut is only Part I of a one-two punch to shift taxes onto wage earners. Congressional economists estimate that extending the tax cuts to the top 2% will cost $700 to $750 billion over the next decade or so. “How are we going to go out and borrow $700 billion?” Mr. Obama asked Steve Croft on his Sixty Minutes interview on CBS last week.
It was a rhetorical question. The President has appointed a bipartisan commission (right-wingers on both sides of the aisle) to “cure” the federal budget deficit by cutting back social spending – to pay yet more bailouts to the economy’s financial wreckers. The National Commission on Fiscal Responsibility and Reform might better be called the New Class War Commission to Scale Back Social Security and Medicare Payments to Labor in Order to Leave more Tax Revenue Available to Give Away to the Super-Rich. A longer title than the Deficit-Reduction Commission used by media friendlies, but sometimes it takes more words to get to the heart of matters.
The political axiom at work is “Big fish eat little fish.” There’s not enough tax money to continue swelling the fortunes of the super-rich pretending to save enough to pay the pensions and related social support that North American and European employees have been promised. Something must give – and the rich have shown themselves sufficiently foresighted to seize the initiative. For a preview of what’s in line for the United States, watch neoliberal Europe’s fight against the middle and working class in Greece, Ireland and Latvia; or better yet, Pinochet’s Chile, whose privatized Social Security accounts were quickly wiped out in the late 1970s by the kleptocracy advised by the Chicago Boys, to whose monetarist double-think Mr. Obama’s appointee Ben Bernanke has just re-pledged his loyalty.
What is needed to put Mr. Obama’s sell-out in perspective is the pro-Wall Street advisors he has chosen – not only Larry Summers, Tim Geithner and Ben Bernanke (who last week reaffirmed his loyalty to Milton Friedman’s Chicago School monetarism), but by stacking his Deficit Reduction Commission with outspoken advocates of cutting back Social Security, Medicare and other social spending. Their ploy is to frighten the public with a nightmare of $1 trillion deficit to pay retirement income over the next half century – as if the Treasury and Fed have not just given Wall Street $13 trillion in bailouts without blinking an eye. President Obama’s $750 billion tax giveaway to the wealthiest 2% is mere icing on the cake that the rich will be eating when the bread lines get too long.
To put matters in perspective, bear in mind that interest on the public debt (that Reagan-Bush quadrupled and Bush-Obama redoubled) soon will amount to $1 trillion annually. This is tribute levied on labor – increasing the economy’s cost of living and doing business – paid for losing the fight for economic reform and replacing progressive taxation with regressive neoliberal tax policy. As for military spending in the Near East, Asia and other regions responsible for much of the U.S. balance-of-payments deficit, Congress will always rise to the occasion and defer to whatever foreign threat is conjured up requiring new armed force.
It’s all junk economics. Running a budget deficit is how modern governments inject the credit and purchasing power needed by economies to grow. When governments run surpluses, as they did under Bill Clinton (1993-2000), credit must be created by banks. And the problem with bank credit is that most is lent, at interest, against collateral already in place. The effect is to inflate real estate and stock market prices. This creates capital gains – which the “original” 1913 U.S. income tax treated as normal income, but which today are taxed at only 15% (when they are collected at all, which is rarely in the case of commercial real estate). So today’s tax system subsidizes the inflation of debt-leveraged financial and real estate bubbles.
The giveaway: the Commission’s position on tax deductibility for mortgage interest The Obama “Regressive Tax” commission spills the beans with its proposal to remove the tax subsidy for high housing prices financed by mortgage debt. The proposal moves only against homeowners – “the middle class” – not absentee owners, commercial real estate investors, corporate raiders or other prime bank customers.
The IRS permits mortgage interest to be tax-deductible on the pretense that it is a necessary cost of doing business. In reality it is a subsidy for debt leveraging. This tax bias for debt rather than equity investment (using one’s own money) is largely responsible for loading down the U.S. economy with debt. It encourages corporate raiding with junk bonds, thereby adding interest to the cost of doing business. This subsidy for debt leveraging also is the government’s largest giveaway to the banks, while causing the debt deflation that is locking the economy into depression – violating every precept of the classical drive for “free markets” in the 19th-century. (A “free market” meant freedom from extractive rentier income, leading toward what Keynes gently called “euthanasia of the rentier.” The Obama Commission endows rentiers atop the economy with a tax system to bolster their power, not check it – while shrinking the economy below them.)
Table 7.11 of the National Income and Product Accounts (NIPA) reports that total monetary interest paid in the U.S. economy amounted to $3,240 billion in 2009. Homeowners paid just under a sixth of this amount ($572 billion) on the homes they occupied. Mr. Obama’s commission estimates that removing the tax credit on this interest would yield the Treasury $131 billion in 2012.
There is in fact a good logic for stopping this tax credit. The mortgage-interest tax deduction does not really save homeowners money. It is a shortsighted illusion. What the government gives to “the homeowner” on one hand is passed on to the mortgage banker by “the market” process that leads bidders for property to pledge the net available rental value to the banks in order to obtain a loan to buy the home (or an office building, or an entire industrial company, for that matter.) “Equilibrium” is achieved at the point where whatever rental value the tax collector relinquishes becomes available to be capitalized into bank loans.
This means that what appears at first as “helping homeowner” afford to pay mortgages turns out merely to enable them to afford to pay more interest to their bankers. The tax giveaway uses homebuyers as “throughputs” to transfer tax favoritism to the banks.
It gets worse. By removing the traditional tax on real estate, state, local and federal governments need to tax labor and industry more, by transforming the property tax onto income and sales taxes. For banks, this is transmuting tax revenue into gold – into interest. And as for the home-owning middle class, it now has to pay the former property tax to the banker as interest, and also to pay the new taxes on income and sales that are levied to make up for the tax shift. I support removing the tax favoritism for debt leveraging. The problem with the Deficit Commission is that it does not extend this reform to the rest of the economy – to the commercial real estate sector, and to the corporate sector.
The argument is made that “The rich create jobs.” After all, somebody has to build the yachts. What is missing is the more general principle: Wealth and income inequality destroy job creation. This is because beyond the wealthy soon reach a limit on how much they can consume. They spend their money buying financial securities – mainly bonds, which end up indebting the economy. And the debt overhead is what is pushing today’s economy into deepening depression.
Since the 1980s, corporate raiders have borrowed high-interest “junk bond” credit to take over companies and make money by stripping assets, cutting back long-term investment, research and development, and paying out depreciation credit to their financiers. Financially parasitized companies use corporate income to buy back their stock to support its price – and hence, the value of stock options that financial managers give themselves – and borrow yet more money for stock buybacks or simply to pay out as dividends.
When the process has run its course, they threaten their work force with bankruptcy that will wipe out its pension benefits if employees do not agree to “downsize” their claims and replace defined-benefit plans with defined-contribution plans (in which all that employees know is how much they pay in each month, not what they will get in the end). By the time this point has been reached, the financial managers have paid themselves outsized salaries and bonuses, and cashed in their stock options – all subsidized by the government’s favorable tax treatment of debt leveraging.
The attempted raids on McDonalds and other companies in recent years provide object lessons in this destructive financial policy of “shareholder activists.” Yet Mr. Obama’s Deficit Reduction Commission is restricting its removal of tax favoritism for debt leveraging only for middle class homeowners, not for the financial sector across the board. What makes this particularly absurd is that two thirds of homeowners do not even itemize their deductions. The fiscal loss resulting from tax deductibility of interest stems mainly from commercial investors.
If the argument is correct (and I think it is) that permitting interest to be tax deductible merely “frees” more revenue to pay interest to banks – to capitalize into yet higher loans – then why isn’t this principle even more applicable to the Donald Trumps and other absentee owners who seek always to use “other peoples’ money” rather than their own? In practice, the “money” turns out to be bank credit whose cost to the banks is now under 1%. The financial-fiscal system is siphoning off rental value from commercial real estate investment, increasing the price of rental properties, commercial real estate, and indeed, industry and agriculture.
Alas, the Obama administration has backed the Geithner-Bernanke policy that “the economy” cannot recover without saving the debt overhead. The reality is that it is the debt overhead that is destroying the economy. So we are dealing with the irreconcilable fact that the Obama position threatens to lower living standards from 10% to 20% over the coming few years – making the United States look more like Greece, Ireland and Latvia than what was promised in the last presidential election.
Something has to give politically if the economy is to change course. More to the point, what has to give is favoritism for Wall Street at the expense of the economy at large. What has made the U.S. economy uncompetitive is primarily the degree to which debt service has been built into the cost of living and doing business. Post-classical “junk economics” treats interest and fees as payment for the “service” for providing credit. But interest (like economic rent and monopoly price extraction) is a transfer payment to bankers with the privilege of credit creation. The beneficiaries of providing tax favoritism for debt are the super-rich at the top of the economic pyramid – the 2% whom Mr. Obama’s tax giveaway will benefit by over $700 billion.
If the present direction of tax “reform” is not reversed, Mr. Obama will shed crocodile tears for the middle class as he sponsors the Deficit Reduction Commission’s program of cutting back Social Security and revenue sharing to save states and cities from defaulting on their pensions. One third of U.S. real estate already is reported to have sunk into negative equity, squeezing state and local tax collection, forcing a choice to be made between bankruptcy, debt default, or shifting the losses onto the shoulders of labor, off those of the wealthy creditor layer of the economy responsible for loading it down with debt.
Critics of the Obama-Bush agenda recall how America’s Gilded Age of the late 19th century was an era of economic polarization and class war. At that time the Democratic leader William Jennings Bryan accused Wall Street and Eastern creditors of crucifying the American economy on a cross of gold. Restoration of gold at its pre-Civil War price led to a financial war in the form of debt deflation as falling prices and incomes received by farmers and wage labor made the burden of paying their mortgage debts heavier. The Income Tax law of 1913 sought to rectify this by only falling on the wealthiest 1% of the population – the only ones obliged to file tax returns. Capital gains were taxed at normal rates. Most of the tax burden therefore fell on finance, insurance and real estate (FIRE) sector.
The vested interests have spent a century fighting back. They now see victory within reach, by perpetuating the Bush tax cuts for the wealthiest 2%, phasing out of the estate tax on wealth, the tax shift off property onto labor income and consumer sales, and slashing public spending on anything except more bailouts and subsidies for the emerging financial oligarchy that has become Mr. Obama’s “bipartisan” constituency.
What we need is a Futures Commission to forecast just what will the rich do with the victory they have won. As administered by President Obama and his designated appointees Tim Geithner and Ben Bernanke, their policy is financially and fiscally unsustainable. Providing tax incentives for debt leveraging – for most of the population to go into debt to the rich, whose taxes are all but abolished – is shrinking the economy. This will lead to even deeper financial crises, employer defaults and fiscal insolvency at the state, local and federal levels.
Future presidents will call for new bailouts, using a strategy much like going to military war. A financial war requires an emergency to rush through Congress, as occurred in 2008-09. Mr. Obama’s appointees are turning the U.S. economy into a Permanent Emergency, a Perpetual Ponzi Scheme requiring injections of more and more Quantitative Easing to to rescue “the economy” (Mr. Obama’s euphemism for creditors at the top of the economic pyramid) from being pushed into insolvency. Mr. Bernanke’s helicopter flies only over Wall Street. It does not drop monetary relief on the population at large.
“The Wurst of Obama: He’s Carving the Middle Class into Sausage Filler as a Super-Meal for the Rich.”