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Ilargi: The story of the day must be Steve Kroft's 60 Minutes segment that aired yesterday under the title “The Day of Reckoning” (see video below). While it’s sort of a shame Kroft didn't interview, say, California's outgoing and incoming governors Arnold Schwarzenegger or Jerry Brown, there's still plenty of good stuff in the show, in particular his conversations with Meredith Whitney and New Jersey Governor Chris Christie.
Whitney predicts -at least- between 50 and 100 municipal and county defaults in the US within the next year. "You could see 50 sizeable defaults. Fifty to 100 sizeable defaults. More. This will amount to hundreds of billions of dollars' worth of defaults."
Christie is his usual "lovable" blunt self: "I have no money". Or this gem about public employee pension systems: “I think the general public thinks: I can't believe anyone gets a pension anymore". And on the same topic: "If you don't partner with me to get this done, in 10 years you won't have a pension".
Only the Federal Government can go over budget -seemingly- as much as it wants; lower levels of government need to balance their budgets. And they can't. They live on money they themselves borrow from Washington, and/or that their creditors borrow from financial institutions, just to stay afloat while waiting for what the states owe them. As illustrated by the fact that, as per Kroft, the state of Illinois spends twice as much as it collects in taxes. And even then can't pay either its employees or its creditors.
A strong indication of how hard it will be to even begin to solve these issues comes from Meredith Whitney. When Kroft asks her: "How accurate is the financial information that's public on the states? And municipalities?" , Whitney says: "The lack of transparency with the state disclosure is the worst I have ever seen." "Ultimately we have to use what's publicly available data and a lot of it is as old as June 2008. So that's before the financial collapse in the fall of 2008."
In other words, it’s safe to assume that the financial situation the majority of states is in is worse, if not much worse, than is known today. Still, Meredith Whitney thinks states will honor their debts. Only, they will achieve this by squeezing the last drops of financial blood from those levels of government that are lower than they are: counties and municipalities. I wonder if Whitney's right here, but if she is, that will be one painful squeeze at municipal and county level. And a very temporary "solution" to the problems.
Steve Kroft concludes: "No one is talking about it now, but the big test will come this spring. That's when $160 billion in federal stimulus money, that has helped states and local governments limp through the great recession, will run out. The states are going to need some more cash and will almost certainly ask for another bailout. Only this time there are no guarantees that Washington will ride to the rescue."
Now, none of this is real news to those of you who have followed the Automatic Earth. I have written extensively on the topic, and I will now be bold enough to quote myself extensively on it:
States of Shock (September 4, 2009)Ilargi: At this point, many states still have rainy day funds. But they are limited and depleting fast. And the chances of tax revenues increasing are slim, in the face of rising unemployment numbers, while those same numbers foretell rising expenditures for benefits.
There is no doubt that all states, with perhaps 1 or 2 exceptions, will go into the next fiscal year with a budget that is far too optimistic. This is how politics works. Whatever can be made tomorrow's problem will be. And tomorrow's problems are set to be huge.
In a typical example, Arizona, like many states, is bound by law to balance its budget, but still came up with a $500 million shortfall over the past fiscal year. From a legal point of view, that is very thin ice. From a financial one, it's a nightmare.
States will increasingly try to push their troubles onto counties, who in turn will lean on municipalities. This will lead to a slew of lawsuits, which will paralyze decision making and cause a lot of bad blood. Politicians won't be looking to tackle the issues as best they can, they will try to handle them in such a way that their chances for (re-)election don't get hurt. This is a surefire recipe for wrong decisions if ever there was one.
State leaders are reluctant to lay off their employees. It’s bad politics. It’s much less damaging for their careers to cut funding for the sick, the old, the young, the handicapped and the homeless, who either don't vote or are unlikely to change their voting habits and even more importantly have no unions to raise a racket on their account. That is why they will be the first victims of the cuts, along with schools and their students, health care services etc.
States of Emergency (September 7, 2009)Ilargi: Now, first of all: California is the big stinking elephant in the room. Its predicaments add greatly to the absolute numbers, since it’s so large, and -at least for now- likely also to the percentages. That said, it is a state, and should remain part of the overall story. Which, by the way, puts total state budget spending at $700 billion. Which will go down significantly before the fiscal year is over. That's after all where the pain is.
The average shortfall for the 2010 fiscal year (July 1 2009-June 30 2010) is 24,3% of the total budget. The biggest gaps: California: 49.3% , Arizona: 41.1%, Nevada: 37.8%, Illinois: 37.7% , New York: 36.1%, Alaska: 30.0%.
And that’s not all. Two months after fiscal year 2010 began, there are already $28 billion in additional "losses". Potentially, that could add another $168 billion (6x$28 billion) to the shortfalls, which would double the gap to $336 billion, or 48% of total budgets. Again, California plays an outsize role here, it’s for example responsible for about two-thirds of the additional gap, which also has already been "addressed", but before that starts to make you feel better, don't forget that it may continue to "surprise" on the downside. California has some of the highest foreclosure and unemployment numbers around, which will impact losses significantly.
But that's not all either. For fiscal year 2011, expectations are even worse than for 2010. - Note: the report uses the phrase "at least" a lot, because a number of states don't have numbers available -. The preliminary estimated budget gap for FY 2011 is $182 billion, based on "expected spending and estimated revenues".
Of course, if we can agree that FY2011 is likely to be worse than FY 2010, we need to take into account the already "discovered" and additional potential gaps in the 2010 numbers. When you look at it that way, the estimated $350 billion, 25%, gap over two years ($168 billion + $182 billion) seems to be on the very conservative side. There is no way incumbent politicians as a group have erred on the side of caution. The vast majority will have erred on the side of positivism, for reasons varying from wanting re-election to not understanding the data.
States of Disbelief (October 5, 2009)Ilargi: [..] what could already be foreseen in early September is indeed happening. That is, most states now have budget agreements, and that's about all the good news there is to report.
As for the rest of the news, a few months into the new fiscal year, with all these hard-fought budgets in their hands, all states that I could find already have sparklingly shining new deficits that they will claim could not have been foreseen by anyone. Tax revenues across the board are down 10-20-30%, and without looking at any details you just know the vast majority budgeted for maybe 5%.
Why? Well, there's political strategy, of course, which is a notoriously short-term. But most of all: They are all counting on a recovery! The hope that springs eternal forgives all foolishness in the short term. Which, conveniently, is the only term politicians understand and care about. Unfortunately, beyond the short term, and if that magical recovery doesn't show up, or even if it's a shallow one, it’ll be debt that springs eternal. Which will be a matter not for the present clique, but for their successors, whose empty promises will tempt their victims to vote for them instead.
A census estimate of a $350 billion combined shortfall seems a pittance compared to what Washington's been doling out recently, but it's easily enough to bankrupt a whole slew of states in the near future. 28% less in income taxes, 10% less in sales taxes, and neither an end nor a savior in sight.
We may be focused on Wall Street, the government and their proclaimed end to the recession, but where actual people live the misery is just getting started and nothing is being recovered, quite the contrary. Against the backdrop of a national health care debate primarily framed by arguments that seem to come straight out of some Monty Python skit, states are cutting budgets for care left, right and center and anywhere in between. Keeping up appearances at the expense of the weakest among you. That is the most predictable factor in all of it.
And if the president and the brightest minds in the country promise economic growth, why would a state governor not believe him -or pretend to- and budget accordingly?
If Tim Geithner says on Capitol Hill that no Plan B is needed for his plans, why would a simple state governor or representative draw up one?
States of Bewilderment: The Mad Hatter Reigns Supreme (March 30, 2010)Ilargi: James Altucher at Formula Capital [..] claims there are no problems with muni and state bonds, specifically because in the instance of for example California, the constitution states that bondholders have to be paid before anyone else, including employees, once the 40% of the budget allocated to education is paid. So bondholders must be paid ahead of policemen and firemen.
Altucher continues to say that both the housing markets and the employment situation are stabilizing, and we are very far removed from any kind of "breakdown of social order". Really, when you have to fire your police force in order to pay your debtholders? "Very far removed"?
At least that makes us realize where he stands. And/or dreams. Mr. Altucher may have an inkling of knowledge about capital and/or bond markets, but he's entirely out of whack when it comes to the real world.
Look, if Greece didn't have to pay its employees, there would be no problem there either, from a purely financial point of view. The problem with this "analysis" is that both Sacramento and Athens DO have to pay their employees. The alternative is to face ever more protesters, who grow ever more angry, with ever less police, who grow ever less motivated.
It’s not about defaults per sé, since as Mr. Altucher rightly observes, while companies can go bankrupt, states and countries can't (well, not really, they can't close their doors). He claims that since California has $90 billion in revenues and "only" $6 billion in outstanding -bond- debt, all’s well that ends well.
But here's the rub (-ber ducky), courtesy of Jan Norman at the OC Register:California state tax collections drop 14% in '09State taxes collected in California dropped 13.94% in 2009 from a year earlier, according to a new report from the U.S. Census Bureau. That compares with an 8.6% drop nationwide. The report doesn’t include local or federal taxes or state unemployment compensation taxes. The state collected just over $101 billion in 2009, down $16.4 billion, even though the legislature and governor approved the largest tax increase in state history including hikes in sales, motor vehicle and income taxes.
Ilargi: In other words, of the $90 billion Mr. Altucher quotes as California's revenues, 13.94%, or $12,55 billion, evaporated last year. Which happens to be more than twice the value of just the outstanding bond debt. Obviously, the next claim then is: "they’re going to have to raise taxes". But that just so happens to be a death knell for any politician who seeks re-election, even in good times, let alone in a crisis.
From which I venture to conclude that the all the budget crises in the various US states and towns, just like the ones in many nation states, have only just begun to unfold their leaves and secrets, and the phenomenon the outcome of all this will most resemble is the tried and proven scorched earth strategy. The need to cling to the religion of economic growth till it's clawed from your cold dead hands has never been greater, at the same time that the chances such growth will materialize are rapidly shrinking.
The theme song that goes "all is fine" because debt holders must be paid before police officers, come to think of it, evokes visions of Mad Max and The Road. The "be careful what you wish for" kind. Because it should be obvious that if the debt holders keep being paid ahead of all others, there's no way you can not ask yourself on occasion how far removed we are from any kind of "breakdown of social order". Which should make those debt holders ask their own set of questions.
Ilargi: The reason for bringing all this up again should, I think, be obvious. The debt levels of lower levels of government in the US will be one of the main global financial and economic issues in 2011. There'll be more kicking cans down roads and snowballs down hills, but there will be a big stubbornly hard and heavy wall down that road or hill as well, and that wall will bring things to very sudden stops (multiple because it won’t all hit at exactly the same moment).
Little difference there with the situation in Europe. Say Illinois is Ireland and Spain is California, and you're well on your way. Sure, you can replace Ireland with Belgium and Spain with Italy, and push the urgency snowball down the road on the hill a tad more, but none of it will make any essential difference. The debts have been incurred, and they will have to be paid, whether it’s tomorrow or the day after tomorrow. Which, as you saw above, is what I've been saying for quite some time now.
Perhaps the fact that a main stream Wall Street analyst like Meredith Whitney, or a "respectable" news organization like CBS, now highlight what we have all along, will cause more people to take it seriously. But the only thing that has changed in the past two years is that the situation has become much more dire still. What has not changed is that the initial cuts and the initial hurt will still be thrown at the doorsteps of the most vulnerable amongst us. No politician will or can be able to resist the temptation to do exactly that. Take what little they have away from those who have very little. It's simply politics 101, and most certainly US politics 2010.
One last thing: Mike Shedlock (we have a ton of respect for him) wrote on the same issue earlier today, and I want address what he says. I agree with Mish on many points; we famously are about the sole voices insisting that deflation is the only option going forward. But I don't like the so-called libertarian stuff. Mostly because it never really turns out to be.
Mish defines the following as solutions for the financial crisis in the American states:
Six Common Sense Solutions
- Scrap Davis-Bacon and all prevailing wage laws.
- Scrap collective bargaining for public union workers entirely.
- Implement national right-to-work laws.
- Outsource every public sector job possible including police and fire departments to the lowest cost private sector provider.
- Kill defined benefit pension plans for all new hires and for all public employees that do remain in the system.
- Tax public union retiree benefits over a certain amount.
And that, in my view, leads nowhere.
• The Davis-Bacon Act is a 1931 piece of legislation under Herbert Hoover that was basically meant to prevent a developer from bringing in hundreds of dirt-cheap and abused Chinese workers into a community where unemployment was huge, in order to build a bridge or railroad at prices that wouldn’t have allowed the local population to persist. What is so bad about that?
• Implement "National right-to-work-laws" sounds good, but not if you don't add "for a living wage". Indeed, if you don't, it doesn't sound good at all. It sounds like Hoovervilles to me.
• "Outsource every public sector job possible... " is something I’m very much against.
Mish includes police and fire departments, and undoubtedly means to include health care and schooling too. But a community needs to keep its basic needs in its own hands; food, water, sewage, safety, healthcare, you name it. You don't ever want to hand those things over to people 1000's of miles away who only got into the game to make a profit.
Your water, your health care, your kids' schools, they shouldn't be profit based. They should be community based. If, for example, a private enterprise takes over a prison, it will have to show growth from one year to the next. In other words, next year it will have to either have more prisoners or give the existing ones even worse services. Ditto for schools; ditto for hospitals. This is a major reason why the US has 5-10-50 times more domestic incarcerations than any other country that calls itself civilized. Profit.
Yes, government-run institutions are often poorly-run. But you still have no choice but to re-organize them, since the only alternative is to lose control of what you really can't afford to lose control of. I don’t want to cover all services right here and now, but you don’t for instance want to let some private company uphold and police the law in your community. After all, what would be next? Let them make the laws too? What, we’re not close enough to exactly that yet? Really, you tell me, what's the difference between making the laws on the one hand versus interpreting the existing ones on the other? Blackwater, anyone?
"Outsource every public sector job possible", Mish? I don't think so. It's the road to hell, because the Carlyle Group and Blackrock and a bunch of Chinese and Arab multi-billion dollar enterprises and sovereign wealth funds will wind up telling you what you can do and say, what health care you can get, and whether or not you’ll have clean water in the morning. And the decisions between these options will be based on profit, not on whether your kids get a good education, or a good doctor, or whether they can drink their tap water or not. "Sorry, no profit in that."
Most of all, Mish goes against his favorite enemy: unions. However, as much as there may be wrong with unions, especially the public employee variety, "Scrap collective bargaining for public union workers entirely" sounds just plain silly.
If you support a free market system, as Mish obviously does, then you will need to accept that parties within that market system have the right to organize. It’s either that, or nothing. It's either that or you must also ban the Chambers of Commerce (where employers gather), at every level they exist. Certainly on the federal level, they are at least as destructive a force as the unions are. They are the no. 1 donor, bar none, to political campaigns in the America.
If you want to prevent workers from organizing, you must also prevent employers from doing so. That said, there are plenty of astonishing instances of firemen walking away with $100,000-+ pensions. But how is that a direct and inevitable result of employees organizing? It looks more like a cancer growth to me, a fault in the system, instead of a systemic fault, but a single tumor is still not a reason to throw out the entire body.
You need to re-negotiate all contracts, all over the country, both for those who have retired and for those who are still working or will start doing so. You want to do this on an individual basis? You sure? "Scrap collective bargaining for public union workers entirely"? Sorry, I think that would be a really counterproductive idea. What you need to do is tell people that they inevitably will face a huge drop in income and benefits, no matter what. And then try and figure out a way to find middle ground.
Sure, that will be hard. But banning any and all workers' associations, be they public or private, is not an answer at all. That just makes you a free marketer telling Karl Marx he was right all along. "No collective bargaining for you": we're going to play you all against each other, until you make as much as a Chinese peasant.
And no-one can afford a Chevy anymore. Which dooms GM. Or a home. Which dooms the real estate sector, and the banks.
We have a long way down, say after me: down, to go. The fate of the individual states will guide our way down there. They can't exist on hot air anymore than we as individual people can.
We all try though!
Hey, I’ve said it for ages now: this is not a financial crisis.
This is a political crisis.
How do you know? Well, people keep on saying: "Hey, the stock markets are up, we must be recovering". But the stock markets are up only because the states are going bankrupt, and homes are foreclosed upon, and there's millions upon millions of Americans who haven't had a job for over a year. It's all about priorities. Political priorities.
Washington has elected to taper and paper over what's really awfully wrong and lost, and it's done so at the expense of the people. Any and all bail-out money spent so far, and what is it, $15 trillion, $20 trillion?!, has gone towards banks, not people. While it's the people's money to begin with.
That is a choice. It's not an inevitable one, it’s simply a choice. In this case, one that tells you who holds the real power. And it isn't you.
State Budgets: The Day of Reckoning
by Steve Kroft - CBS
By now, just about everyone in the country is aware of the federal deficit problem, but you should know that there is another financial crisis looming involving state and local governments. It has gotten much less attention because each state has a slightly different story. But in the two years, since the "great recession" wrecked their economies and shriveled their income, the states have collectively spent nearly a half a trillion dollars more than they collected in taxes. There is also a trillion dollar hole in their public pension funds.
The states have been getting by on billions of dollars in federal stimulus funds, but the day of reckoning is at hand. The debt crisis is already making Wall Street nervous, and some believe that it could derail the recovery, cost a million public employees their jobs and require another big bailout package that no one in Washington wants to talk about.
"The most alarming thing about the state issue is the level of complacency," Meredith Whitney, one of the most respected financial analysts on Wall Street and one of the most influential women in American business, told correspondent Steve Kroft
Whitney made her reputation by warning that the big banks were in big trouble long before the 2008 collapse. Now, she's warning about a financial meltdown in state and local governments.
"It has tentacles as wide as anything I've seen. I think next to housing this is the single most important issue in the United States, and certainly the largest threat to the U.S. economy," she told Kroft.
Asked why people aren't paying attention, Whitney said, "'Cause they don't pay attention until they have to." Whitney says it's time to start.
California, which faces a $19 billion budget deficit next year, has a credit rating approaching junk status. It now spends more money on public employee pensions than it does on the state university system, which had to increase its tuition by 32 percent.
Arizona is so desperate it sold off the state capitol, Supreme Court building and legislative chambers to a group of investors and now leases the buildings from their new owner. The state also eliminated Medicaid funding for most organ transplants.
Then there's New Jersey. It has the highest taxes in the country, a $10 billion deficit and a depressed economy when first-year Governor Chris Christie took office. But after looking at the books, he decided to walk away from a long-planned and much-needed project with New York and the federal government to build a rail tunnel into Manhattan. It would have helped the economy and given employment to 6,000 construction workers.
Gov. Christie acknowledged that's a lot of jobs. "I canceled it. I mean, listen, the bottom line is I don't have the money. And you know what? I can't pay people for those jobs if I don't have the money to pay them. Where am I getting the money? I don't have it. I literally don't have it."
Asked if this is going on all over the country, Christie told Kroft, "Yes. Of course it is. It's not like you can avoid it forever, 'cause it's here now. And we all know it's here.
And the federal government doesn't have the money to paper over it anymore, either, for the states. The day of reckoning has arrived. That's it. And it's gonna arrive everywhere. Timing will vary a little bit, depending upon which state you're in, but it's comin'."
And nowhere has the reckoning been as bad as it is in Illinois, a state that spends twice much as it collects in taxes and is unable to pay its bills. "This is the state of affairs in Illinois. Is not pretty," Illinois state Comptroller Dan Hynes told Kroft.
Hynes is the state's paymaster. He currently has about $5 billion in outstanding bills in his office and not enough money in the state's coffers to pay them. He says they're six months behind. "How many people do you have clamoring for money?" Kroft asked. "It's fair to say that there are tens of thousands if not hundreds of thousands of people waiting to be paid by the state of Illinois," Hynes said.
Asked how these people are getting by considering they're not getting paid by the state, Hynes said, "Well, that's the tragedy. People borrow money. They borrow in order to get by until the state pays them." "They're subsidizing the state. They're giving the state a float," Kroft remarked. "Exactly," Hynes agreed.
"And who do you owe that money to?" Kroft asked. "Pretty much anybody who has any interaction with state government, we owe money to ," Hynes said.
That would include everyone from the University of Illinois, which is owed $400 million, to small businessmen like Mayur Shah, who owns a pharmacy in Chicago and has been waiting months for $200,000 in Medicaid payments. Then there are the 2,000 not-for-profit organizations that are owed a billion dollars by the state. Lutheran Social Services of Illinois has been around since 1867 and provides critical services to 70,000 people, mostly the elderly, the disabled, and the mentally ill. The state owed them $9 million just before Thanksgiving, and they nearly had to close up shop.
Asked how long his organization can go on like this, Rev. Denver Bitner, the president of Lutheran Social Services of Illinois, told Kroft, "Well, we wonder that too because we really don't know." He says they were forced to tap their entire line of credit and all their cash reserves before the state would finally pay them as a hardship case. "It has to be that you've sold off all your assets, you have borrowed from everybody that you can borrow from, and then, we'll think about it," Rev. Bitner explained.
And according to Bitner, that's even though the state owes his organization the money. "The first words out of my mouth are usually an apology, because they have been you know put in this situation, that is really unacceptable. And you know there is very little I can do or say other than apologize," Comptroller Dan Hynes said.
It's not just the social safety net that Hynes has to worry about: there have been Illinois legislators that have been evicted from their offices because the state didn't pay their rent, and stories about state troopers being turned away from gas stations because the owners refused to take their state credit cards.
"The state's a deadbeat," Kroft remarked. "Yeah. I mean, the state of Illinois is known as a deadbeat state. This is a reputation that has taken us years to earn and we've reached, you know, the heights of, I think, becoming the worst in the country," Hynes said.
Not all of the problems that Illinois and other states are facing right now can be traced to the recession. But the precipitous drop in tax revenues did expose decades of financial irresponsibility, reckless spending, unrealistic benefit packages for public employees, and the use of political gimmicks to cover up hidden deficits. It's forcing state governors and the public to confront some harsh realities.
"This is different, isn't it?" Kroft asked New Jersey's governor, Chris Christie. "It is very different," Christie said. " The reason it's different is because the only choices left are choices that people previously have said were politically impossible, that you couldn't do. You couldn't cut K to 12 education funding. You couldn't do those things. They were, you couldn't talk about pension and benefit reform for the public sector unions. That were third rails of politics. We are now left with no alternatives."
"Just the third rail?" Kroft asked. "Yeah, that's it. I'm just gonna grab it and go, and let the chips fall where they may," Christie said.
In some ways, Christie is the political canary in the coal mine of the state fiscal crisis. He slashed New Jersey's budget by 26 percent, including a billion dollars in cuts to education, forcing the layoffs of thousands of teachers. He got rid of 1,300 state workers and drastically reduced funding to New Jersey cities, counties and villages which have their own financial problems. And he's still facing another $10 billion deficit next year.
Long term, the situation is much, much worse. "Okay. Let's talk about the pension obligations. Forty-six billion unfunded liability for pensions? Sixty-six billion unfunded for healthcare liability ?" Kroft asked.
"Yes, Sir," Christie said. "That's a lot of money," Kroft remarked. "That's a lot of money, even for the federal government." "That's a lot of money," the governor agreed.
When Kroft pointed out that there are people who think it's worse, Christie said, "Yeah, I think that's an optimistic view. I think that's an optimistic view. Listen, at this point, if it's worse, what's the difference? I mean, it's bad enough as it is, so what's the difference? I mean now, we're talkin' about money that none of us can really get our arms around." "This is unsustainable, right?" Kroft asked. "Totally unsustainable. We have a benefit problem," Christie said. "It's not an income problem from the state. It's a benefit problem. And so we gotta change those benefits."
Asked what the reaction to that has been, Christie said, "Well, it depends on where you sit. I mean, I think the general public thinks, 'I can't believe anybody gets a pension anymore. I've got a 401(k). It got killed in the stock market. I don't know what I'm gonna do for my retirement. I can't believe people get a pension anymore.' So I think amongst the broad, general public, they've said, 'Amen.' And I think among the public sector unions, they are yellin' and screamin'."
And Christie is yelling back. He provoked a very public fight with the teachers union, which is one of the most powerful political forces in the state of New Jersey. When one teacher told him at a public hearing, "And you're not compensating me for my education and you're not compensating me for my experience. That's all," the governor replied, "Well you know what, then you don't have to do it!"
It's a scene that is starting to play out all over the country. Governors of cash-strapped states are beginning to cajole or bully public employee unions into making concessions on what are considered to be gold-plated retirement and health care packages, which are now collectively underfunded to the tune of $1 trillion. "Some union leaders have suggested that you're running the state like Tony Soprano," Kroft told Christie.
"Well, as an Italian American, I take great offense to that," he replied, laughing. "Listen, you know what it is? I'm the first person to expose them for what they've been doin' to the public."
Asked if he wants the public employee unions to share the pain, Christie told Kroft, "You bet. I want them to share in the sacrifice. And this is what I say to public sector unions: 'Listen you can boo me now, but I'm the first governor who has walked into this room in ten years and told you the truth. And here is the truth. If you don't partner with me to get this done in ten years you won't have a pension.' And that's the truth."
It's also the truth that some of the responsibility for New Jersey's pension woes lie at the doorstep of the governor's mansion. Christie and his predecessors have failed to contribute to the state's share of its pension obligation in 13 of the last 17 years, one of the reasons the fund is going broke. Christie says it's ancient history.
"We spent too much on everything. We spent too much. We spent money we didn't have. We borrowed money just crazily. The credit cards maxed out, and it's over. It's over. We now have to get to the business of climbin' out of the hole. We've been diggin' it for a decade or more. We've gotta climb now, and a climb is harder. Gotta do it," he said.
The problem with that, according to Wall Street analyst Meredith Whitney, is that no one really knows how deep the holes are. She and her staff spent two years and thousands of man hours trying to analyze the financial condition of the 15 largest states. She wanted to find out if they would be able to pay back the money they've borrowed and what kind of risk they pose to the $3 trillion municipal bond market, where state and local governments go to finance their schools, highways, and other projects.
"How accurate is the financial information that's public on the states? And municipalities," Kroft asked.
"The lack of transparency with the state disclosure is the worst I have ever seen," Whitney said. "Ultimately we have to use what's publicly available data and a lot of it is as old as June 2008. So that's before the financial collapse in the fall of 2008."
Whitney believes the states will find a way to honor their debts, but she's afraid some local governments which depend on their state for a third of their revenues will get squeezed as the states are forced to tighten their belts. She's convinced that some cities and counties will be unable to meet their obligations to municipal bond holders who financed their debt. Earlier this year, the state of Pennsylvania had to rescue the city of Harrisburg, its capital, from defaulting on hundreds of millions of dollars in debt for an incinerator project.
"There's not a doubt in my mind that you will see a spate of municipal bond defaults," Whitney predicted. Asked how many is a "spate," Whitney said, "You could see 50 sizeable defaults. Fifty to 100 sizeable defaults. More. This will amount to hundreds of billions of dollars' worth of defaults."
Municipal bonds have long been considered to be among the safest investments, bought by small investors saving for retirement, and held in huge numbers by big banks. Even a few defaults could affect the entire market. Right now the big bond rating agencies like Standard & Poor's and Moody's, who got everything wrong in the housing collapse, say there's no cause for concern, but Meredith Whitney doesn't believe it.
"When individual investors look to people that are supposed to know better, they're patted on the head and told, 'It's not something you need to worry about.' It'll be something to worry about within the next 12 months," she said.
No one is talking about it now, but the big test will come this spring. That's when $160 billion in federal stimulus money, that has helped states and local governments limp through the great recession, will run out. The states are going to need some more cash and will almost certainly ask for another bailout. Only this time there are no guarantees that Washington will ride to the rescue.
California's State Budget Balancing Act
by Editorial - The Reporter
Gov.-elect Jerry Brown campaigned on a promise to make balancing the state budget his priority, and he's off to an auspicious start. Weeks away from taking office, he hosted a pair of forums that made clear just how deep a fiscal hole California has dug itself into.
The use of one-time fixes and short-term solutions -- 75 percent or more of which didn't even materialize -- since the 2008-09 fiscal year will leave California with at least a $25 billion gap next fiscal year between what it spends and what revenue it brings in. Put another way: If lawmakers closed down every state prison and every UC and CSU campus next year, they would still have to cut another $10 billion to close the deficit.
Since 71 percent of state spending ends up back in local communities, mostly paying for local schools and community colleges or county-run health and social service programs, the effects of any cuts will be felt by every Californian. Most communities are already feeling the pinch, since budgets have been slashed regularly in recent years.
Solano County is already in the middle of chipping away at an $18 million structural deficit. Just last week, the Board of Supervisors accepted a $1 million cut from the Department of Health and Human Services' budget, accomplished by reducing management positions and looking to the federal government to pick up the tab for some services. Of course, with the federal government running up a $1.3 trillion deficit, it isn't exactly flush with cash either. Counting on the feds to bailout anyone seems risky.
Local school districts, still reeling from an overall 13 percent reduction in state revenue since the 2007-08 school year, were warned by Mr. Brown last week to brace for what could be a 25 percent cut next year. That could be devastating. Already in Solano County, two school districts -- Travis and Vallejo -- have already told the state they can't meet their financial obligations and two more -- Fairfield and Dixon -- are in danger of not being able to.
In conducting the two forums, one in Sacramento, the other in Southern California, Mr. Brown has said he wants to make everyone aware of the situation and get officials all on the same page. Being able to agree on what the problems are would be a good start to solving them. Critics and supporters of the governor-elect believe that Mr. Brown is also building a case for asking voters to approve more taxes.
Mr. Brown has said that he wants to have a no-gimmicks, balanced budget in place within 60 days of taking office. That would give Californians time to assess what's in store for the state when the fiscal year starts in June. If there is a tax proposal on a spring ballot, voters could have the final say about whether they wish to live with those cuts or increase state revenue to reinstate programs.
Since this recession started, the state's budget decisions have been made essentially by five people behind a closed door. Perhaps it's time to try a different approach. Gov.-elect Brown and the Legislature should balance the budget once and for all and then let voters decide whether this state should live within its current means or try to afford something more.
Only tough decisions will solve Arizona budget crisis
by Tom Franz - Arizona Republic
The uncertainty created by the fiscal imbalance in our state budget hurts our efforts to retain and grow existing Arizona businesses, and it works against our ability to attract and grow any new businesses.
Greater Phoenix Leadership members are the largest employers in the Phoenix region and represent the region's greatest number of private-sector employees. Our businesses are like all businesses, small, medium and large: We are concerned that our state has an ongoing structural deficit, and we are certain that it is a problem that will not correct itself and needs deliberate policy action. Arizona is faced with some hard choices, and delaying those choices in hopes that the economy comes back will only make the structural deficit worse, not better.
General-fund revenue in Arizona has met or exceeded general-fund spending only twice since 2000. While revenue is up over last year, it still lags projections.
The Legislature did make cuts last budget cycle that helped, but right now, legislators face difficult decisions on how to balance this year's budget with a shortfall of more than $825 million before they even begin to craft next year's budget. At the current pace, the projected structural deficit for 2014 is at least $2 billion, which is 20 percent of Arizona's projected general-fund budget.
Even with this year's spending cuts, and the voter-approved temporary sales-tax increase that bought us some time, the state has relied on short-term financial tools, long-term debt and overly optimistic revenue forecasts that mask the state's ongoing financial condition in the short run. While such measures temporarily assist with annual deficits, they do not reduce - and indeed aggravate - the permanent, ongoing structural deficit.
More than 93 percent of our state budget goes to four areas: K-12 education, universities, health and welfare (including AHCCCS), and prisons. Even if you eliminated all other functions of state government and its spending, it is a minor share of the budget and wouldn't fix the structural deficit. Plus, that's unrealistic. The current budget year is half over, so there are relatively few options, and they may have to include one-time changes in addition to spending cuts. Increasing revenue isn't an option because of the time lag to get approval and start collections.
With more than half of the state's budget going to education, and the fastest-growing part of state spending being AHCCCS, our health-care program for the poor, choices for where those cuts are made will have to be focused on where the bulk of the budget is spent. Those will be difficult decisions, but we can't afford to kick the problem to the next budget any longer.
It's critical to the future of every family and business in Arizona that our structural deficit is eliminated and that we align our ongoing spending and ongoing revenue over the long term to avoid continued annual budget-deficit scrambles. Order and stability in Arizona's fiscal house will provide the certainty that will ensure a strong future for individuals and businesses alike.
Revenue stop is big challenge for Pennsylvania budget
by Robert Swift - Times Tribune
At first it seems like a paradox. The current $28 billion state budget is reasonably close to being in balance. State revenue growth is picking up as far as corporate taxes and sales taxes are concerned. Cost-cutting measures such as layoffs of state employees have yielded savings. So an assumption could be made that Pennsylvania's years of fiscal turmoil are nearing an end.
That's not the case. A huge deficit ranging from $3 billion to $4 billion is projected for the 2011-12 budget, the first one for incoming Gov. Tom Corbett. The reason things are still headed south is that chunks of revenue that propped up the last two painful state budgets are disappearing. The biggest loss will come with the end of $2.6 billion in federal stimulus aid to Pennsylvania and another $750 million in one-time revenue transfers from other special state funds.
It's a predicament facing other states as well. "While state revenues are starting to pick up, the growth is unlikely to be sufficient to replace expiring ARRA (American Recovery and Reinvestment Act) funds or cover projected increases in program areas such as Medicaid and K-12 education," said the National Conference of State Legislatures in a recent report.
Congress is in no mood to renew ARRA given controversy about adding to the federal deficit and the fact that one-time revenue transfers to the taxpayer-supported General Fund were just that. The larger transfers this year included $745 million from the Rainy Day Fund, $180 million from the Oil and Gas Lease Fund through additional leasing of state forest land for natural gas drilling and $250 million from the Tobacco Settlement Transfer Fund.
Several tax changes designed to bring additional revenue expire also. In addition to disappearing revenue, Mr. Corbett and lawmakers will have to deal with added costs for medical assistance to low-income families and senior citizens, pension obligations, public employees and prison operations. Proposals to sell the state-owned liquor stores to private owners and revamp the Pennsylvania Turnpike Commission are being discussed as revenue generators.
"It's going to be a tough year next year," said outgoing Gov. Ed Rendell last week. He voiced regret that lawmakers rejected his proposal to create a special fund to offset the stimulus loss. Mr. Rendell proposed changes in the state sales tax to fill the fund. "How we address the 2011-12 state budget will impact Pennsylvania's economy for at least a decade," said Erik Arneson, spokesman for Senate Majority Leader Dominic Pileggi, R-9, Chester. "Our goal will be to position Pennsylvania to emerge from this recession as an economic leader." [sic!]
Texas state services unlikely to escape budget ax
by Peggy Fikac - Houston Chronicle
The hard choices Texas legislators start making on the state budget next month could mean harder times for Texas residents who rely on state services. That is the bottom line as lawmakers draft a budget for the next two years in the face of a shortfall that some put at well over $20 billion, thanks to the recession, past state budget decisions and the demands of a growing population.
The ensuing debate over how to meet the expected shortfall will be caught squarely in the intersection of policy and politics as legislators wrangle over what constitutes a spending cut, a tax increase, even the extent of the money gap. With state leaders saying the November election sent a no-new-taxes, lean-government message, no program is expected to escape the knife - including education and health and human services, which take up the bulk of state dollars.
For some programs, the budget crunch will mean spending cuts. Others will not get increases that state agencies say are needed to keep services at the current level given population growth and rising costs in some areas. College financial aid could be cut; class-size limits could be eased in public schools; universities are reducing faculty; reimbursement rates for those who provide care for Medicaid patients have been slashed; a medley of grant programs could be put on hiatus; state payroll could be cut; and some leaders have raised the specter of employee furloughs and shutting some state agencies.
"There's no way I can tell people that families aren't going to get hurt," said Sen. Leticia Van de Putte, D-San Antonio.
Living within means
GOP Lt. Gov. David Dewhurst said Texans have tightened their belts and expect government to do the same. "The people of Texas want us to live within our means and figure out a way to maintain all of our essential services, and that's what I'm committed to doing," he said.
Spending cuts will not be the only thing lawmakers consider. A super-majority of lawmakers can vote to spend money out of the state's Rainy Day Fund savings account, which could make as much as $9.9 billion available. Some payments for education and human services programs could be delayed. A disbursement from the state school trust fund will help. An expansion of gambling could get a look, although there is no great optimism for its chances. Fee increases are expected.
"This is a budget that, ultimately, will impact all Texans, whether it's providing less health care services than what we did two years ago. It's also going to likely be higher parks fees. It's going to be bigger classrooms. It's going to be roads that aren't as good as what some might want them to be," said Dale Craymer, president of the business-based Texas Taxpayers and Research Association. "Balancing this budget is going to require some sacrifice on the part of all Texans."
Effects of the recession
Texas' current, two-year budget is $182.2 billion in state and federal funds. Lawmakers have discretion over the $80.6 billion in general-revenue money; 91 percent of that goes for education and health and human services.
Like other states, Texas is dealing with the effects of the recession and rising health care costs. Lawmakers also must account for the loss of one-time funds used to balance the current budget, including federal stimulus dollars and unspent state cash balances from the previous budget. Some cite continuing budget pressure from a 2006 school-finance package that lowered local school property tax rates. The state took on a bigger share of the cost of public education, but lawmakers did not raise state taxes enough to pay for all of it.
The gap was compounded when the retooled business tax that was part of the package significantly under-performed. As lawmakers wrestle with the shortfall, they differ on how to define it. Some put it at more than $28 billion, which factors in lower-than-expected tax collections, the use of one-time funds that no longer are available, and the increase needed to maintain basic state services at current levels in a growing state.
Others, like Senate Finance Committee Chairman Steve Ogden, R-Bryan, narrowly define it as the amount that revenues are expected to fall short of covering the current budget. The rest will be allocating scarce dollars among priorities. "The budget shortfall is $3 to $4 billion. That's it," Ogden said. "Everything else is a contest between new spending and available revenue."
Revenue estimate coming
Rep. Mike Villarreal, D-San Antonio, said such a low estimate amounts to "denial." "It's certainly denial of the misalignment between revenues and expenditures," said Villarreal, who put the shortfall at about $28.4 billion. Rep. Garnet Coleman, D-Houston, said, "If it's a current-services budget - meaning what we're doing now, we continue to do, with growth in people that need to be served because we're a growing state - it is likely to be $25 billion or more."
The picture will come into sharp focus next month when state Comptroller Susan Combs issues her revenue estimate for the next two years. "Until we get the official estimate from the comptroller, it's all guesswork as to what the next budget's going to look like," said Rep. John Otto, R-Dayton, chairman of the House Select Committee on Fiscal Stability. However, he added, "The (large estimated) shortfall is assuming you're going to have the same level of spending as the current budget. We all know we're not going to have the same level of spending."
Eva DeLuna Castro, of the Center for Public Policy Priorities, which advocates for programs for lower-income Texans, noted that Texas already ranks 50th in per capita state spending. "One of the challenges of describing how these cuts will affect people is that we have such a small state budget in terms of how much we're spending per person," she said. "That means we already are not doing anything for most people who live here."
How much ripple effect will state job cuts create?
by Dennis Thompson - Statesman Journal
How many folks out there are full of anxiety about the coming year?
It's a question based on a specific set of circumstances for the Salem area — namely, that the major employer around these parts (known informally as "da Gumminment") is preparing to deal with a projected $3 billion budget deficit.
The Oregon government will have to cut back to deal with that deficit, and some people are worried that the cuts will send Salem's economy spiraling back down into recession. The Statesman Journal is working on a series of articles aimed at assessing the depth of these economic fears and judging whether or not they are founded. We're already seeing some of the scrambling that the state will have to do to keep providing services.
Last week's meeting of the E-Board featured legislators shifting around millions of dollars in state and federal money to make sure that services such as day care and senior care remain in effect and prisons and Oregon Youth Authority centers continue to hold offenders who otherwise would be released to the streets.
The impact will start with folks who work for the state. All the sources I talk with on a regular basis figure that layoffs at state agencies are inevitable. That $3 billion is just too daunting a number to contemplate without including some job losses. As I wrote in an earlier column, state employees seem pretty resigned to the possibility of more unpaid furlough days in the upcoming biennium. (The furlough days that they took this biennium amounted to at least 5 percent of their pay.)
But what's interesting is looking at how ingrained state government has become in the everyday economic life of Salem. For example, the state spends a lot of money contracting goods and services from local businesses. What's going to happen to those contracts when the state starts cutting expenses?
Lots of state employees who work in the Capitol Mall area step out to eat lunch and wander down to Salem Center mall to do a little bit of mid-day shopping. What will happen to those businesses when there are fewer state workers and workers with fewer dollars to spend on pizza slices and pumps from Nordstrom? These are the questions we're looking at, and we'd love to have your help.
If you're a state worker who spent less money during the past couple of years because of furloughs, we'd like to hear from you. If you're a restaurant employee who saw fewer lunch patrons wander in from state offices, we'd like to hear from you. If your business has a contract with the state and you're worried about what might happen to it, we'd like to hear from you.
More importantly, if you might be affected by the potential state cutbacks in some way we haven't even thought of, we really, really want to hear from you. Salem's economy just bottomed out, according to economists I've interviewed. All the indicators say that we're in the middle of a painfully slow recovery. Is that recovery going to be over and done with after the Lege leaves town some day this summer? Let me know what you think.
12 Things I Believe
by John Hussman - Hussman Funds
1) Investors dangerously underestimate the risk of an abrupt and possibly severe equity market plunge
Look back over history at points in time where stocks were trading at a rich multiple to normalized earnings (the Shiller multiple is a useful gauge here, as forward operating and price/peak earnings are both corrupted by profit margins that are about 50% above their historic norms). Combine that with overbought, overbullish conditions and rising interest rates. What you will get is a list of most historical pre-crash peaks. Depending on precisely how you define your classifier, you may pick up one or two benign outcomes, such as April 1999 (which I noted in the Hazardous Ovoboby piece in early 2007), but ask whether, on average, you would have knowingly chosen to take market risk at those points.
2) Agreement among "experts" is not your friend
“Tarnished! Nobody expects gold prices to turn up soon: It's difficult to find any positive news in the depressed gold market. At around $260 an ounce, the metal continues to trade near its cost of production, and almost no one believes it will rally soon. ‘Financing is tough to come by these days' in the unpopular gold-mining sector, says Ferdi Dippenaar, Harmony's director of marketing. ‘Unfortunately, there is nothing positive on the horizon.'”
Barron's Magazine, Commodities Corner: February 12, 2001
"Not a Bear Among Them"
Barron's Investment Roundtable, December 1972 (at the beginning of a 50% market plunge - No intent to pick on Barron's - they've just been around the longest, so we have lots of back-issues)
"Wall Street Heavyweights Agree: Time to Get Back Into Stocks!"
USA Today Investment Roundtable, December 2010
3) Downside risk tends to be elevated precisely when risk premiums and volatility indices reflect the most complacency
I could go on, but nobody cares.
4) We did not avoid a second Great Depression because we bailed out financial institutions. Rather, the collapse in the economy and the surge in unemployment were the direct result of a gaping hole in the U.S. regulatory structure that prevented the rapid restructuring of insolvent non-bank financials. Policy makers then inappropriately extended the "too big to fail" doctrine to ordinary banks. Following a striking loss of public confidence that resulted from arbitrary policy responses, coupled with fear-mongering by exactly those who stood to benefit from public handouts, the self-fulfilling crisis was contained by a change in accounting rules that effectively disabled capital requirements for all financial companies. We are now left with a Ponzi scheme.
While it's clear that the four-second tape in Ben Bernanke's head is an endless loop saying "We let the banks fail in the Great Depression, and look what happened," any disruption caused by the "failure" of a financial institution is not due to financial losses to bondholders, but is instead due to the necessity of liquidating the assets in a disorganized, piecemeal way, as was the case with Lehman Brothers. Large, sometimes major banks fail every year without a material effect on the economy. The key is to have regulations that allow these failures to occur with the minimal amount of disruptive liquidation.
It is important to recognize that nearly every financial institution has enough debt to its own bondholders on the balance sheet to absorb all of its losses without any damage to depositors or customers. These bondholders lend at a spread, and they knowingly take a risk.
Bank regulations intelligently allow the FDIC to cut away the "operating" portion of a financial institution from the obligations to its bondholders and stockholders. Consider a bank with $100 billion of assets, against which it owes $60 billion of customer deposits, $30 billion of debt to its own bondholders, and $10 billion in shareholder equity. Now suppose those assets decline in value to just $80 billion, creating an insolvent institution ($80 billion in assets, $60 billion in deposit liabilities, $30 billion in debt to bondholders, and -$10 billion in equity). The "operating portion" is the $80 billion in assets, along with the $60 billion of customer deposits, which can be sold as a "whole bank" transaction for $20 billion to another institution. The stockholders are wiped out, while the bondholders get the $20 billion residual and take a loss on the rest. Depositors and customers now get statements with a different logo at the top. The seamless "failure" of Washington Mutual is a good example of this in action.
The problem with Bear Stearns and Lehman was that no equivalent set of regulations was in place to allow "cutting away" the operating portion of a non-bank institution. Instead, the Fed illegally expanded the definition of the word "discount" in Section 13(3) of the Federal Reserve Act and created a shell company to buy $30 billion of Bear Stearns' questionable long-term assets without recourse. The remaining entity was sold to JP Morgan, where Bear Stearns bondholders still stand to get 100 cents on the dollar plus interest. Lehman was allowed to "fail," but because there was still no set of regulations that allowed cutting away the operating entity, it had to be liquidated piecemeal.
Importantly, and even urgently, it was not this "failure" that produced the economic downturn. If you carefully observe what happened in 2008, the large-scale collapse of the financial markets and the U.S. economy started literally sixty seconds after TARP was passed by Congress on October 3, 2008. At that moment, the world was told not that the smooth operation of the global financial system would be ensured by taking receivership of failing financial institutions; not that the focus of policy would be the protection of depositors, customers, and U.S. fiscal stability; but instead that insolvent private balance sheets would now be defended, subject to the arbitrary decisions of policy makers in which nobody had confidence. Lehman's failure simply told investors that these decisions could be completely arbitrary, since there was really no operative distinction between Bear Stearns, which was saved, and Lehman, which was not. Moreover, in order to pass TARP, the public had to be convinced that a global meltdown would result if financial institutions weren't preserved in their existing form. In this way, policy makers created a crisis of confidence.
Skip forward and carefully observe what happened in 2009, and you'll see that the crisis was suspended once the FASB threw out rules requiring financial companies to report their assets at market value, while at the same time, the Federal Reserve illegally broadened the definition of "government agency" in Section 14(b) of the Federal Reserve Act in order to purchase $1.5 trillion of Fannie Mae and Freddie Mac obligations. These actions replaced the arbitrary discretion of policy makers with confidence that no major institution would be at risk of failing because, in effect, meaningful capital standards would no longer apply.
Thus, our policy makers first created a crisis of confidence, and then resolved it by legalizing a global Ponzi scheme.
As David Einhorn at Greenlight Capital has noted, "We learned the wrong lesson." We should have learned that existing capital standards were insufficient and that there was a large, gaping hole in our regulatory structure that failed to provide "resolution authority" for non-bank financial companies. Instead, we've learned the dangerously misguided notion that some institutions are simply too big to fail. This inevitably creates a situation where reckless misallocation of capital continues to be subsidized at increasing public cost, while bondholders go unscathed and insiders take bonuses with the same alacrity as Bernie Madoff's early investors.
In short, the downturn in the real economy occurred because regulators refused to take receivership of insolvent institutions, while pushing a story line that the entire global economy would crumble if bondholders had to take losses. This created a fear among depositors and consumers that the entire system was arbitrary and unstable, fueled periodic runs on various financial institutions, tightened the availability of credit to companies having nothing to do with real estate, and created a self-fulfilling prophecy of global economic weakness. Had our policy makers said "depositors and customers will be protected, we will immediately exercise resolution authority over insolvent institutions, and bondholders will not be spared" we could have simply had a "writeoff recession" in paper assets, rather than an implosion of the real economy and an explosion in public debt.
The facts simply do not support the idea that taking receivership of insolvent financials leads to economic distress. Rather, it properly rests losses on the bondholders, and preserves the operation of the financial system by bolstering its solvency. One might argue that we could not possibly let bondholders take the trillions of dollars of losses that would have been required in order to restructure debt and get the bad obligations off the books. This is absurd. A 20% stock market decline wipes out about $3 trillion in market value. Indeed, given the size and average maturity of the U.S. bond market, just the increase in interest rates that we've observed over the past 6 weeks has knocked off trillions in market value.
The financial markets are perfectly capable of taking losses. They don't do well with disorganized piecemeal liquidation - where perfectly good loans are called in and countless positions have to be unwound - but that isn't required if your regulatory structure allows receivership/conservatorship that can cut away and gradually transfer the operating portion of an institution. What the global economy is not capable of taking is the uncertainty that results when policy makers apply arbitrary rules, leaving all other decision makers in the economy frozen at the edge of their seats to discover what the results of those arbitrary decisions will be. We have learned the wrong lesson, and we continue to pay for it.
5) The U.S. economy is recovering, but that recovery is vulnerable to even modest shocks.
As I noted a couple of weeks ago, in the ideal case where the economy grows continuously without further credit strains, the "mean-reversion benchmark" scenario would be for GDP growth to approach an average rate of 3.8% annually for about 4 years, followed by about 2.3% annual growth thereafter. The corresponding mean-reversion benchmark for employment growth would be an average of about 200,000 new jobs per month on a sustained basis.
There has certainly been some improvement in various indicators of economic activity. As strange as this may sound, given my criticism of the Fed, I would attribute much of this improvement to a sentiment effect in response Fed's policy of quantitative easing. While long-term Treasury yields are significantly higher than before QE2 was announced, and though I continue to believe that the main effect of QE2 has been to encourage ultimately short-sighted speculation, the Emperor's-clothes enthusiasm about QE2 has had at least the short-term effect of buoying short-term spending and hiring plans. Unfortunately, this sort of sentiment-dependent bounce in activity is not very robust to shocks.
So while the surface activity of the U.S. economy has observably improved, it is in the context of an overvalued, overbought, overbullish, rising-yields market that is vulnerable to abrupt losses, a global financial system that remains subject to strains from sovereign default, a housing market where one-in-seven mortgages is delinquent or in foreclosure, and nearly one-in-four is already underwater with a huge overhang of unliquidated foreclosure inventory still in the pipeline, and a domestic financial system that lacks transparency and may still be slouching toward insolvency. The U.S. economy is progressing on the surface, but it remains a house built on a ledge of ice.
6) The U.S. fiscal position is far worse than our present $1.3 trillion deficit and nearly 100% debt/GDP ratio would suggest.
On the deficit side, there is certainly a "counter-cyclical" pattern to the U.S. federal deficit. As I noted a few weeks ago, every 1% shortfall of real GDP from potential (as estimated by the CBO) tends to be associated with a roughly 0.67% increase in the deficit as a percentage of potential GDP. So it is certainly true that part of the existing deficit reflects normal "automatic stabilizers." Unfortunately, this only explains about half the present deficit. Moreover, in order to adequately evaluate the existing deficit, it is essential to recognize that this figure reflects interest costs that are dramatically less than we can expect as a long-term norm. Consider the chart below. The blue line represents interest on the gross Federal debt at the average of prevailing 10-year Treasury yields and 3-month Treasury yields. Presently, this figure is comfortably low, thanks to the depressed level of interest rates. In contrast, the red line shows what the interest service would be at a 5.2% interest rate, which is the post-war norm.
Even if we restrict the analysis to publicly-held debt, the interest service at a 5.2% rate would still easily approach $500 billion annually. Investors and policy-makers risk an unpleasant surprise if they do not factor the unusually low level of interest rates into their evaluation of present fiscal conditions.
7) A long period of generally rising interest rates will not negate the ability of flexible investment strategies to achieve returns, provided that the increase in rates is not diagonal, and the strategy has the ability to vary its exposure to interest rate risk.
One of the most frequent questions received by shareholder services is what investors should expect if the "great bond bull" is now over. From my perspective, the answer is straightforward - we can't squeeze water from a stone if interest rates advance diagonally and persistently, but they rarely do. Provided that we observe natural cyclical fluctuation in yields, I expect that we'll have sufficient opportunities to vary our exposure in the event that yields advance over time.
Without detailing our own investment approach, which classifies Market Climates based on the level and pressure on bond yields, even a very simple model will suffice to demonstrate the point. Below, I've charted the total return of buy-and-hold strategy using 10-year Treasury debt, compared with the total return from a variant of a simple switching method described by Mark Boucher. The model is long when the 10-year Treasury yield is below its 10-week average and either the Dow Utility average is above its 10-week average or the 3-month Treasury yield is below its 50-week average.
The chart shows the period from 1963 to 1983 which captures the steepest interest rate increase in U.S. history. It isn't a performance claim, and the model is overly simplistic to follow in practice - it's too binary (i.e. either in or out) and trades too frequently to be effective as a stand-alone strategy. Still, the signal itself is clearly a useful indicator. Again, the basic point is that as long as yields don't rise in a perpetual diagonal line, strategies with the flexibility to vary interest rate exposure can perform admirably over time.
8) Stocks are a poor inflation hedge until high and persistent inflation becomes fully priced into investor expectations. At the same time, short-dated money market debt has historically been a very effective inflation hedge.
Investors sometimes make the mistake of believing that since nominal earnings can be expected to grow during periods of inflation, stocks should be a good inflation hedge. Straightforward reasoning, but unfortunately, it's not true. Sustained periods of inflation are disruptive, so even during the period between 1960 and 1980, S&P 500 nominal earnings still did not accelerate from their normal 6% peak-to-peak long-term growth rate. Moreover, stocks only behave as a good inflation hedge after high inflation is already fully anticipated. During the transition from low inflation to high inflation, stock prices have historically provided awful returns.
In contrast, short-term Treasury securities have historically been quite good inflation hedges. This is because short-term interest rates quickly adjust to reflect prevailing inflation rates, so unless you get a period of persistently negative real interest rates, the strategy of staying relatively liquid in interest-bearing securities has been fairly effective. It is certainly true that non-interest bearing cash is ineffective in preserving real purchasing power during a period of inflation, but the same is not true for short-dated money market securities.
9) It will be harder to inflate our way out of the Federal debt than investors seem to believe.
This is a corollary to 8). A significant portion of the U.S. Treasury debt is represented by short-duration paper, which makes the U.S. far more sensitive to rollover risk, and also makes the value of the debt less sensitive to inflation. See, if you borrow funds for 30 years, you can turn around and create a massive inflation to diminish the real value of that debt. But if you've borrowed funds for a year and then create a massive inflation, you'll find that investors will require a higher interest rate on the debt next year, which prevents the obligation from being diminished over time. This is good for the investors, but bad for the Federal government.
10) It will be harder to grow our way out of the Federal debt than investors seem to believe
This is simple algebra. A reduction in the ratio of debt to GDP - even assuming a balanced budget - requires the growth rate of nominal GDP to exceed the interest rate on the debt. Equivalently, real GDP growth has to exceed the real interest rate on the debt. Historically, 10-year Treasury yields have exceeded inflation in the GDP deflator by about 2.6% annually, while 3-month Treasury yields have averaged about 1.2% over inflation in the GDP deflator. The CBO estimates the probable growth of potential GDP to be about 2.3% over the coming 20 years. At best, and even assuming immediate budget balance, this economic growth would bring down the ratio of debt to GDP by no more than 1% annually.
11) Based on a variety of valuation methods that have a strong historical correlation with subsequent long-term market returns, we estimate that the S&P 500 is presently priced to achieve a total return averaging just 3.6% annually over the coming decade.
We would have a different expectation if other competing methods (such as the Fed model) had a better record of accuracy, but we do not observe this. The decade of negative returns following the market peak in 2000 was entirely predictable. Presently, we have a market that is priced to achieve the weakest 10-year return of any period prior to the late 1990's market bubble. Still, stocks were more overvalued at the 2007 peak than they are today, and were certainly more overvalued in 2000. Both of those peaks were followed by declines that cut prices in half. The current overvalued, overbought, overbullish, rising yields combination compounds the headwinds for the market here, but nothing is certain, and we can't rule out further speculation on hopes of ever larger government distortions.
Despite these valuations, we are willing to adopt moderate, periodic exposure to market fluctuations at points that we clear overbought and overbullish conditions, provided that market internals do not clearly break down in the process. We may see this opportunity in a few weeks, or a few months, but we do not observe it here. For now, we remain tightly defensive.
12) The specific features of a given economic cycle don't change the mathematics of long-term returns - they simply affect the level of valuation that investors demand or are willing to temporarily tolerate.
At the 2000 bubble peak, and again at the 2007 peak, and again today, we received notes asking whether factors such as the internet, or the emergence of China, or the level of interest rates, or Fed intervention somehow had created a world that was "different this time" in a way that made historical analysis inapplicable. From my perspective, the answer in each case is "no."
It's certainly true that the enthusiasm about the internet and other new technologies, coupled with years of uninterrupted, low-volatility economic growth, encouraged investors to tolerate far higher valuations in 2000 than history had ever witnessed. Yet this still did not change the longer-term algebra, which indicated correctly that stocks were likely to produce negative returns over the following decade. Likewise, the emergence of China as a major economic power did not prevent the market from losing well over half of its value from 2007 to 2009.
Indeed, even in early 2009, the valuation mathematics briefly suggested that stocks were priced to achieve 10-year total returns averaging just over 10%. My concern at that time was not that stocks were overvalued. Rather, history indicated that following periods of major credit strains in the U.S. and internationally, investors had typically demanded far greater prospective returns as compensation for the risk. On that assessment, I was clearly wrong, as the actions of the FASB, Fed and Treasury encouraged a quick resumption of speculation. Still, none of this threw the mathematics of long-term returns out the window. It simply compressed a good portion of those prospective 10-year returns into a 2-year window, so that we would estimate the probable total returns for the S&P 500 over the coming 8 years at roughly 3% annually.
In short, it's not impossible that specific features of the current market could make investors more tolerant of rich valuations, or more careful to demand conservative ones. Regardless, my impression is that a decade from today, investors will view the present time as a relatively undesirable moment to put investment capital at risk.
Self-righteous Germany must accept a euro-debt union or leave EMU
by Ambrose Evans-Pritchard - Telegraph
If Germany and its hard-money allies genuinely wish to save the euro – which is open to doubt – they should stop posturing, face up to the grim imperative of a Transferunion, and desist immediately from imposing their ruinous and reactionary policies of debt deflation on southern Europe and Ireland.
One can sympathise with the German people. Their leaders in the 1990s told them "famine in Bavaria" was more likely than the preposterous suggestion that Germany might have to bail out countries as a result of EMU.
But events have moved on and, rather than striking tones of Calvinist righteousness, the Teutonic bloc might do well to acknowledge equal responsibility for the capital flows, trade imbalances, and cumulative errors that caused the EMU debacle, and therefore accept that the honourable course is to meet the struggling south halfway.
Readers may have a better menu, but here is my own rough sheet: a debt union, funded by Eurobonds; a calibrated jubilee on traditional IMF lines for Ireland, Greece, Portugal, and if necessary Spain, to occur in parallel with austerity cuts; and a monetary blitz by the European Central Bank to prevent the victims tipping into core deflation, even this stokes inflation of 4pc or 5pc in northern Europe.
It beggars belief that the ECB should continue to allow the contraction of the M3 money supply and credit to private firms. Since EU leaders have already shown their willingness to ram through treaty changes without full ratification under Article 48 of the Lisbon Treaty, they can likewise bring ECB ideologues to heel with a new mandate.
If the Teutonic bloc cannot accept such a political revolution, it should withdraw from monetary union before inflicting any more damage to the social fabric of southern Europe, or at least allow a 30pc appreciation within EMU by creating a Doppelmark.
An internal adjustment could be done overnight, if necessary with temporary capital controls. The residual euro states would undergo a relatively seamless devaluation to levels that reflect the reality of current account deficits and labour productivity, yet their existing contracts in euros would be upheld.
Creditor states – and Britain – would have to stand ready to recapitalise their own banks at great cost to fortify them against the systemic shock of haircuts on the entire debt stock of peripheral EMU. True burden-sharing at last. Needless to say, EU leaders failed to grasp the nettle at last week's summit, despite a pre-insurrectional mood in Athens where one former minister was bludgeoned by anarchists outside parliament, and in Rome where a police officer was almost lynched in political violence that left 80 people injured.
Not even the warning shot of Spain's debt auction on Thursday seemed to break the impasse. Chancellor Angela Merkel must know that the Spanish state, juntas, and banks cannot refinance €300bn (£254bn) next year at a bearable cost if the Tesoro is already paying a decade-high of 5.45pc to sell 10-year bonds, yet she continues to play for time she does not have.
"Behind the curve", was the understated rebuke by IMF chief Dominique Strauss-Kahn. His own IMF team has indicated the policy that it is being told to enforce as junior partner of the EU rescues. It warned of "adverse fiscal and financial feedback loops" in Ireland, in its latest report. "A prolonged period of deep recession could weaken loan repayment capacity of households and businesses and increase bank losses beyond current projections, leading the economy into a negative spiral. Wage and price deflation – coupled with contraction in activity – could have a powerful negative effect on debt dynamics," it said.
"There are significant risks that could affect Ireland's capacity to repay the Fund," it said. Indeed, so why is the IMF board giving a green light to this obscurantism? The EU torture policy of thrusting yet more debt on crippled states already caught in a debt trap – and then forcing them even deeper into downward spiral with a 1930s policy of wage cuts and "internal devaluation" – is an intellectual disgrace.
Let it never be forgotten that Ireland and Spain are struggling because EMU caused a collapse in real interest rates to -1pc or -2pc, setting off an uncontrollable boom. This is what the Gold Standard did to Germany in the late 1920s, when US banks funded a German credit bubble. That ended with the destruction of German democracy.
Klaus Regling, the EU's chief bail-out officer, said Eurosceptics will "eat their words again" as the policy is vindicated. Excuse us, Dr Regling, but we have not yet eaten any words on the fundamental critique of EMU. Perhaps it is unkind to point out that Dr Regling was the European Commission's director-general of economic affairs from 2001 to 2008, more or less spanning the incubation period of the catastrophe now at hand. To borrow the immortal line from Watergate: what did you know and when did you know it?
Ireland's UK property empire unwinds as it sells London assets
by Graham Ruddick - Telegraph
It was the heady days of July 2007 – the last moments of the pre-credit crisis era and the first of Gordon Brown's leadership – when Irish tycoon Derek Quinlan and joint venture partner Glenn Maud announced a property deal that would rock the City. Quinlan and Maud revealed they had won the race to buy the Citigroup tower at Canary Wharf from Royal Bank of Scotland for £1bn. The deal was the second biggest ever in the UK, behind only the sale of HSBC's headquarters a few weeks earlier.
It confirmed the Celtic Tiger's increasing prominence in the key central London commercial property market. Two-and-a-half-years on, however, and the tiger is whimpering. The Citigroup deal was the peak of Ireland's influence, and it is a peak that is unlikely to be revisited for years, if not decades, to come. Following the EU's €85bn (£72bn) bail-out of Ireland last month, industry sources are preparing for Ireland's London empire to start unwinding.
The collapse of the global credit markets and Ireland's economy had a heavy impact on property investors whose growth to prominence was fuelled by a debt surge supported by the country's hungry banks. Property loans to the tune of €90bn are now being taken under the control – at times with opposition – of the Irish government's National Asset Management Agency, which was set up to work-out distressed debt. NAMA was created in 2009 but has only become fully operational this year, collecting business plans from its main debtors in order to determine a strategy for the loans.
The task facing the organisation appears monumental, with 69pc of the loans linked to non-income-producing land and development sites, according to research seen by The Sunday Telegraph. NAMA has a stated aim of reducing the loanbook by 25pc over the next three years and also has €5bn to invest in its assets, but the unwinding process could take a decade.
How Nama behaves is key to London and the UK, because 30pc of its assets are in Britain. One executive at a leading British property company who met with NAMA directors recently says it is "preparing to act" and has a "clarity of purpose" that puts it ahead of British banks in the unwinding process. The EU bail-out, the source said, provides NAMA with headroom and flexibility, and the fact the loans were bought at such a sharp discount – an average of 58pc for the first tranche – means it does not have to worry about suffering writedowns by agreeing disposals below the book value of properties.
NAMA has not publicly stated that its policy on foreign assets will be different to those in Ireland – and it declined to respond to telephone and email questions from The Sunday Telegraph. But sources believe disposals in London are likely to be targeted quickly because of the liquidity of the bullish market. The Citigroup tower is already up for sale, after Maud and Quinlan were encouraged to seek a disposal by the syndicate of lenders, which includes NAMA, that provided £875m for the deal.
Analysts estimate that there is £10bn of Irish-owned property in London, although much of it, including Hamley's toy store on Regent Street, which is owned by the family behind Brennans Bread, is not in NAMA.
The organisation has not publicly revealed which assets are under its remit, but they are thought to include The Connaught, Berkeley and Claridge's hotels – although McKillen, the owner, is legally challenging the transfer of the debt to NAMA – along with Battersea Power Station, Goldman Sachs' European headquarters at River Court, Louis Vuitton's flagship store on New Bond Street which is owned by Daly, and 20 Grosvenor Square, a former European HQ of the US navy, which is backed by debt from Irish Nationwide.
Some assets are already being off-loaded, such as Audley Square Car Park in Mayfair, which was owned by Quinlan. NAMA is understood to have agreed to sell the site to Qatar Holdings for €180m after buying the loan from Anglo Irish for €40m, leaving it with a healthy profit. The site has planning consent for a 220,000 sq ft residential scheme and the deal highlights the demand for prime assets with development potential.
According to Harm Meijer, property analyst at JP Morgan, the demand for such assets in London means the market could "absorb" any NAMA sales without asset values being dampened. "The evidence we are seeing is that some prime buyers are now prepared to look at quality secondary," he said. "Average transaction volumes in the UK are about £31bn a year. I think we could go above that next year."
Rob Corbett, head of Irish investment in the UK at Jones Lang LaSalle, pointed to another potential impact from the unwinding of Ireland's property bubble – the disappearance of two key drivers for the pre-2007 UK property market, Irish investors and Irish banks such as Bank of Ireland, Anglo Irish, and Allied Irish. "I would say there had been a 99pc reduction in buyside activity," Corbett said.
However, the central London investment market has powered on. Last week, Hammerson and the Oman Investment Fund sold Bishops Square for £557m, more than 25pc the office building valuation of last year. "There is so much equity chasing London at the moment," says Corbett. Nonetheless, the unwinding of Irish assets is set to be a key topic for the property market in 2011 and beyond. In 2007, Quinlan and Co had the market dancing to the Irish flute, but next year the sound from Irish investors threatens to be the Death March as they depart trophy London assets.
Jim Corr: Top-down engineered financial crash designed to take over Europe
China Expands Its Influence in Europe
by Wieland Wagner - Dee Spiegel
China is seizing on Europe's debt problems to expand its influence on the continent with large-scale investments and purchases of government bonds issued by highly-indebted states. The strategy could push Europe into the same financial dependency on China that is posing a dilemma for the US.
Portugal's cavalry staged a magnificent parade to welcome Chinese President and Party General Secretary Hu Jintao, 67. Suddenly, one of the horses reared up and threw its rider to the ground. The state guest from China waited motionless until the end of the ceremony before he went to the fallen cavalryman, embraced him, and asked if he was all right. There was symbolic value to Hu's caring gesture in early November in Lisbon: China's foremost party organ, the People's Daily, wrote enthusiastically that this was the "Best moment for the world to see a true China in flesh and blood."
Given the acute debt crisis in the euro zone, there is a wealth of opportunities for China to show sympathy in Europe these days. With pledges of financial aid and statements of support for the euro, Beijing is endeavoring to stabilize its largest trading partner -- primarily in pursuit of Chinese interests. Even before his arrival in Lisbon, many in Portugal were yearning for Hu to come to the rescue. In view of the alarming Portuguese government debt, the Chinese leader promised that he would support the country with "concrete measures." He said China intended to double bilateral trade by 2015.
This wasn't exactly what the cash-strapped Portuguese were hoping to hear. They wanted Hu to also help out by buying government bonds. Nonetheless, before his visit, Chinese Vice Foreign Minister Fu Ying had already hinted that this was a definite possibility.
Offers of Aid for Troubled Euro Members
Indeed, the rising superpower is cleverly capitalizing on the euro crisis to extend its long-term political and economic influence in Europe. Chinese offers of aid are mainly directed at the shakiest members of the euro zone, the heavily indebted so-called PIIGS countries (Portugal, Ireland, Italy, Greece and Spain). The People's Republic would like to win them over as long-term allies in the EU.
In the past, China had shown itself to be a "friend" of Greece, Spain and Italy, and it purchased their government bonds at a time when other investors had fled, Premier Wen Jiabao said during a trip to Europe in October. "We will continue to provide aid and help certain countries overcome their difficulties."
Speaking to the parliament in Athens, Wen made a promise to the Greeks. He said that China would purchase Greece's government bonds as soon as they were available again on the financial markets. These were only words, but the jittery markets saw them as a vote of confidence in the euro: They were spoken by the man who helps decide how China invests the largest currency reserves in the world.
China has amassed some $2.5 trillion (€1.9 trillion), and an estimated 70 percent of this has been invested in dollar-based holdings. But the rulers in Beijing are observing with growing concern how their largest debtor country, the US, continues to drive down the value of the dollar with its lax monetary policy.
Switch in Strategy
This has recently prompted the Chinese to increasingly invest their reserve stockpile in non-dollar currencies. One of the leading proponents of this diversification is Yu Yongding, an influential economist and former advisor to the central bank, the People's Bank of China. Yu is known as "the dollar killer" in Beijing. Although he admits that other currencies "are not necessarily an ideal replacement" for US government bonds, Yu says that this will allow the People's Republic to minimize its losses should the US currency dramatically drop in value.
Last July, China spent €400 million on Spanish 10-year government bonds. During a visit to Beijing in September, Spanish Prime Minister José Luis Rodríguez Zapatero dutifully thanked the Chinese: When China increases its share of Spanish government bonds, he said, it bolsters confidence in the financial markets. He added that he hoped China would purchase even more Spanish government bonds. The cash-strapped southern Europeans are increasingly looking to Beijing to solve their budget woes. But it is difficult to ascertain which countries are being supported by the Chinese state capitalists through government bond purchases.
The investment managers at the State Administration of Foreign Exchange (SAFE) devise their strategies behind the walls of a nondescript large office building in Beijing. They rarely make public statements. Formally, the SAFE answers to the central bank. Last year, People's Bank of China governor Zhou Xiaochuan, 62, caused an international stir when he proposed replacing the dollar with a super-sovereign reserve currency based on the Special Drawing Right (SDR), the IMF's unit of account.
This proposal came from the upper echelons of the Chinese leadership: Zhou, a member of the Central Committee, strictly adheres to the instructions of the Communist Party. It's a similar story with the state-run Chinese Investment Corporation (CIC), which manages some $200 billion of the currency stockpile, with assets in foreign equity funds, mining operations and corporations.
When it was founded three years ago, the CIC was eyed with great suspicion by Europeans. "EU officials came to me and asked me to commit that my investment will not exceed 10 percent," CIC manager Lou Jiwei said last year with undisguised sarcasm. "I said that's fine, then I'm not going." Times have changed. These days, the Chinese rarely encounter resistance like they have faced in Hamburg, where they tried in vain to purchase a stake in the city's port. Across large swathes of Europe, they are now welcomed with open arms.
Greece a Bridgehead for Chinese Trade With Eastern Europe
The People's Republic has primarily set its sights on Greece as a bridgehead for its trade with Eastern Europe. Even before the current debt crisis, Chinese state-owned shipping giant Cosco signed a deal to lease port facilities in Piraeus for 35 years. By 2015, China intends to increase the annual transshipment of containers from the current 800,000 to 3.7 million, Premier Wen announced.
In the Irish town of Athlone, Chinese investors are considering building a gigantic conference and exhibition center for their export industry. From Beijing's perspective, one of the advantages of this location is that Ireland is the only English-speaking country in the euro zone. In Portugal, energy giant China Power International is looking to buy a stake in local provider EDP; both companies want to collaborate to produce renewable energy in Europe, Africa and Brazil.
And in Italy, Prime Minister Silvio Berlusconi even had the Colosseum in Rome bathed in red light for Wen -- and ordered the Chinese characters for "Sino-Italian friendship" projected onto the façade. Wen also promised the Italians that he would double the annual value of trade with them by the year 2015.
By pledging to help the debt-stricken PIIGS countries, China is ultimately boosting its own industry. Beijing also expects the Europeans to be more compliant on the political front: At a summit of EU representatives in Brussels in October, Wen rejected demands to devalue the Chinese currency. China maintains an artificially low exchange rate for the yuan, also known as the renminbi. This allows the Chinese to keep their exports cheap -- including to countries in the euro zone.
During a brief visit with German Chancellor Angela Merkel, Wen secured support for a matter that he had unsuccessfully raised for years: Merkel promised that she would support China's desire to be recognized as a market economy by the EU within five years. This would make it difficult for the EU to slap anti-dumping duties on inexpensive goods from China or denounce the country on charges of forced technology transfer.
The more EU countries become financially dependent on China, the greater the risk that they will end up facing the same dilemma that America has in its dealings with China. "How do you deal toughly with your banker?" US Secretary of State Hillary Clinton wrote, according to US diplomatic cables leaked to Wikileaks.
Beijing is still discussing how much money it actually intends to invest in government bonds from PIIGS countries. The bonds are "far too risky," warns economist Yi Xianrong from the Beijing Academy for Social Sciences, the government think tank. "As long as the EU has not resolved its internal contradictions, China would be better off not buying any government bonds there."
It is only when conducting a "political bargain," says Yi, that it would be clever for China to acquire euro bonds, "but only a few." Minimal investment, maximum influence -- that's been Beijing's strategy with Europe.
Ernst&Young, Lehman Auditors, Face Fraud Charge
by Liz Rappaport and Michael Rapoport - Wall Street Journal
New York Set to Allege Ernst & Young Stood By as Lehman Cooked Its Books
New York prosecutors are poised to file civil fraud charges against Ernst & Young for its alleged role in the collapse of Lehman Brothers, saying the Big Four accounting firm stood by while the investment bank misled investors about its financial health, people familiar with the matter said.
State Attorney General Andrew Cuomo is close to filing the case, which would mark the first time a major accounting firm was targeted for its role in the financial crisis. The suit stems from transactions Lehman allegedly carried out to make its risk appear lower than it actually was. Lehman Brothers was long one of Ernst & Young's biggest clients, and the accounting firm earned approximately $100 million in fees for its auditing work from 2001 through 2008, say people familiar with the matter.
The suit, led by Mr. Cuomo, New York's governor-elect, could come as early as this week. It is part of a broader investigation into whether some banks misled investors by removing debt from their balance sheets before they reported their financial results to mask their true levels of risk-taking, a person familiar with the case said. The state may seek to impose fines and other penalties.
Mr. Cuomo's office has sought documents and information from several firms, including Bank of America Corp., which earlier this year disclosed six transactions that were wrongly classified. Jerry Dubrowski, a Bank of America spokesman, said the bank's practice is to cooperate with any inquiry from regulators.
It is possible that Ernst & Young will try to settle before any suit is filed. The firm declined to comment. A spokesman for the Lehman Brothers estate also declined to comment.
The transactions in question, known as "window dressing," involve repurchase agreements, or repos, a form of short-term borrowing that allows banks to take bigger trading risks. Some banks have systematically lowered their repo debt at the ends of fiscal quarters, making it appear they were less risk-burdened than they actually were most of the time.
Lehman Brothers dubbed transactions of this type "Repo 105." The maneuver came to light in March, when the bankruptcy examiner investigating the firm's collapse more than two years ago found that it moved some $50 billion in assets off its balance sheet. Lehman labeled those transactions as securities sales instead of loans, which led investors to believe the firm was financially healthier than it really was.
The bankruptcy examiner's report and the attorney general's investigation found that Lehman Brothers carried out the Repo 105 transactions on a quarterly basis in 2007 and 2008 without telling investors. Mr. Cuomo's investigation found that Repo 105 transactions started as far back as 2001, said the person familiar with the probe.
The attorney general's investigation, which began after the bankruptcy examiner's report, found that Ernst & Young specifically approved of Lehman's use of Repo 105 transactions and provided the investment bank with a complete audit opinion from 2001 through 2007, said the person.
Mr. Cuomo's office has also been investigating suspected window-dressing transactions at other banks, said the person, and is probing whether they similarly misled investors.
An analysis earlier this year by The Wall Street Journal found that other banks were reducing their level of debt at quarter-end. The attorney general's office has sought documents and information from several firms, including Bank of America Corp., which earlier this year disclosed six transactions that were wrongly classified. The Journal's analysis found that Bank of America was among the most active banks in reducing its debt at reporting time.
The state's investigations into other firms' window dressing are less advanced than its Ernst & Young probe, said a person familiar with the probes. Other regulators have said they are looking into window dressing as well. The Securities and Exchange Commission's investigation into Lehman's collapse is focusing on Repo 105 transactions, said people familiar with the matter. It has proposed new types of disclosures to help investors identify when banks are window dressing. But the SEC has said it hasn't found any widespread inappropriate practices in that area.
Britain's Financial Reporting Council, which oversees corporate reporting rules, is also investigating Ernst & Young's role in the Lehman collapse. The Lehman bankruptcy examiner's report also stated that there may be evidence to support negligence and malpractice claims against Ernst & Young regarding Lehman's audits and its lack of response to a whistle-blower at Lehman who raised red flags about the repo trades.
The whistle-blower was Matthew Lee, a Lehman Brothers senior vice president. He had complained to his boss, and eventually wrote a letter in May 2008 to senior Lehman executives expressing concern that the Repo 105 transactions violated Lehman's ethics code by misleading investors and regulators about the true value of the firm's assets. Days later, Mr. Lee was ousted from the firm.
According to the Lehman bankruptcy examiner's report, Ernst & Young auditors saw the letter, and later interviewed Mr. Lee after he was let go from Lehman. Ernst & Young previously said in a statement that Lehman management determined Mr. Lee's "allegations were unfounded." Mr. Lee couldn't be reached for comment.
Though accounting firms were at the center of the last major corporate scandals nearly a decade ago, they haven't been tied to any of the key causes of the recent crisis. The case could be the last for Mr. Cuomo, the governor-elect of New York, who finishes his term as attorney general at year-end. If the case isn't filed before that, it would likely be handed over to Mr. Cuomo's successor, Eric Schneiderman.
Behind the Jobs Number: A Messy Reality
by Drake Bennett - BusinessWeek
Among the many statistics that economic policymakers look to, none matters more than the "jobs number," and 2010 was the year it refused to drop. Today the national unemployment rate hovers near where it began the year, just shy of 10 percent. For all its totemic power, the jobs number masks a messier reality. It is only an estimate, like a poll or a Nielsen rating, the product of a complex process of research and calculation. Without understanding the assumptions built into the figure, we can't fully understand what it can and cannot tell us.
The poor have always been with us, but the notion of unemployment is more recent. Through the 19th century in Europe and the U.S., there was no need conceptually to separate unemployment and poverty—for everyone except the landed gentry, not working basically meant being poor. English "poor laws" had a distinctly moralistic cast: They required individual parishes to set up almshouses for the "impotent poor" and workhouses for the "able-bodied" poor; beggars and vagrants were thrown in jail and even executed.
It was the Great Depression that changed public attitudes—the ubiquity of joblessness and the way it reached up into the middle class turned what had been seen as an individual moral failing into something else: a symptom of a sick economy. For the first time, governments tried to count the unemployed. The U.S. released its first numbers in 1940. Appropriately enough, the survey that provided the numbers was a Work Projects Administration initiative meant to employ some of the Depression's jobless millions.
Central to this calculation is the notion that to count as unemployed one not only has to want work but to be actively searching for it. The Bureau of Labor Statistics household survey from which the rate is derived defines someone as unemployed only if he or she has searched for a job in the past four weeks: by sending out a résumé, for example, or placing an ad. This makes sense—those not even trying are unlikely to get hired. As the BLS sees it, they are not even part of the labor force. Still, that means the official stat leaves out a lot of men and women who are not working because of the particularly grinding nature of this economy.
The BLS does keep track of these nonemployed workers; it just doesn't categorize them as unemployed. Instead, it describes them as "marginally attached to the labor force." These are people who do not have a job, who would like one, and who have looked in the past year, though not the past four weeks. Many report that they had to stop searching for personal reasons—school or illness or family responsibilities—while others say they are not looking because, in essence, they have given up. That subset is called, aptly, "discouraged workers." If the jobs number included all of these nonworkers, the November 2010 rate of 9.8 percent would climb to 11.3 percent.
Now consider those who are officially counted as employed but who are only working part-time because part-time work is all they can find. If these not-by-choice part-timers are added in, the percentage—no longer an unemployment rate, but something like a measure of the total labor underutilization of the economy—climbs to 17 percent. It's a significantly grimmer picture.
What even that bleak figure leaves out, though, is the dynamic nature of the labor market. No matter what the unemployment rate, workers are constantly moving into and out of the labor force. Even as one middle manager or mechanic is being fired, another somewhere else is getting hired, and while a freshly minted college graduate is just hitting the job circuit, his or her grandfather is preparing to retire.
There is a cyclical, often seasonal quality to labor flows—retail companies hire to deal with the holiday rush, construction picks up in the spring and slacks off in the fall, and the beginning of summer sees the labor force expand when students start their school breaks. The official unemployment number controls for these factors and many others.
What worries economists today is not just the size of the unemployment number but how this flow has slowed and, for a large portion of the labor force, become stagnant. Today, 6.3 million Americans have been unemployed for more than 27 weeks. In December 2007, when the recession started, only 1.3 million were stuck in that category.
These are workers who are not giving up, who are still answering ads and attending networking events and contacting employment agencies. For more than six months they've been unable to find a job, yet haven't quit the fight and dropped into the ranks of the discouraged and marginally attached. They've remained determinedly, even defiantly, part of the "jobs number."
A Lesson for Wall Street About Failure
by David Carr - New York Times
It’s awards season again, and critics and the academy members are deciding on their top film picks of the year. But in many corners of the business community, the issue is already settled: "Waiting for ‘Superman’ " is the year’s must-see film.
On Wall Street and on Silicon Valley office campuses, in hedge fund boardrooms and at year-end Christmas parties, it seems you can’t have a conversation without someone talking about the movie that finally lays bare America’s public education crisis. "Waiting for ‘Superman’ " is one thing that Bill Gates, Steve Jobs and Mark Zuckerberg agree on, Rupert Murdoch talks about to anyone who will listen, David Koch of Koch Industries promotes, and Paul Tudor Jones and many of his hedge fund brethren work to support.
"Waiting for ‘Superman’ " follows five children and their parents as they run a gantlet to gain access to high-performing charter schools because the alternative — the public system — is a complete disaster. The film has caught the imagination of the business community because it represents a reckoning for public education and its chronic failures, making the very businesslike case that large school systems and the unions that go with them must be replaced by a customized, semi-privatized education in the form of charter schools.
Which is odd when you think about it. If you are looking for an American institution that failed the public, made resources disappear without returning value and lacked accountability for its manifest sins, the Education Department would be in line well behind Wall Street.
By now, the notion that business is a place built on accountability and performance should be as outdated as the one-room schoolhouse. Ask yourself, what would happen if American public schools were offered hundreds of billions in bailout money? One outcome is not in the cards: its leaders would not end up back at the trough so quickly, sucking up tens of millions in bonuses as Wall Street has.
If the captains of American business are looking for a holiday movie, I have another suggestion for them. I’m not talking about "Inside Job," which is a scabrous take on the well-documented story of how the American economy was nearly tipped over by business greed and incompetence. Nah, I’d buy them a bucket of popcorn and sit them in front of "The Company Men," a moody and elegiac feature film starring Ben Affleck, Tommy Lee Jones and Chris Cooper as businessmen who have a moment of clarity about how American business lost its soul.
As executives at GTX, a fictitious multinational corporation involved in the transportation business, among other endeavors, they watch as many of their colleagues are laid off to meet inflated earnings targets and as numbers get ginned up to keep the stock price growing and potential acquirers at bay. And then their turn comes.
At that point, "The Company Men" becomes a film about the loss of privilege: Porsches are sold and driven away, access to the private golf club is denied and suburban mansions go on the market. But the movie delivers, over and over, a message that far from being a center of American know-how and ingenuity, much of modern business is now preoccupied with goosing the share price and tricking up the year-end bonus — about getting over by getting by.
The film manages to use the tableau of a bunch of rich guys losing their jobs to reach a fundamental question of this economic age. How can it be that both corporate profits and unemployment are simultaneously high? "When I made the film, I had hoped it would be a historical document, a portrait of a very bad moment in American economic history," said John Wells, an executive producer of the television series "ER" and the director of "The Company Men," who began working on the film in 2007. "Unfortunately, it didn’t turn out that way."
"The Company Men" reflects that America is no longer in the business of building and making actual physical objects. Instead, all the energy and resources go into the kind of financial engineering that creates quarterly numbers that Wall Street buys into. Mr. Wells said that he spent a great deal of time talking with chief executives who run large concerns like his movie’s fictional GTX and said only so much of the blame can be laid at the corner office.
"They are responding to the needs of the market, to the institutional investors — the large mutual funds, the money market funds," he said. "And when you think about it, that implicates all of us because we are all investing in the market one way or another." The movie resonates in the current moment because each day it becomes more clear that the guy at the bar who mutters into his whisky glass about the game being rigged is probably right.
On Dec. 12, my colleague Louise Story chronicled how nine men from various banks meet in secret every month to oversee, and in some aspects control, trading in derivatives, the arcane and often lucrative financial instruments that are used to hedge risk. As her article makes clear, the opacity and secrecy of the systems give banks the upper hand and leaves at their whim the market’s less pedigreed players.
It is a small slice of a large problem of self-dealing and self-enrichment on Wall Street, often at the expense of the rest of us. Decisions made there land hard in the middle places where most of America lives and works.
"You know that show ‘Undercover Boss?’ " Mr. Wells asked, referring to the hit television show on CBS. "I’d like to see a show called ‘Undercover Investor’ where investors go undercover and get a good look at the companies that are being decimated by restructuring plays and roll-ups." He added: "I think so many people are seeing business and how it is conducted in the abstract that they have no idea about how these decisions play out."
Stoneleigh Talks to Mike Ruppert
Nicole Foss extended interview
by Helen Loughrey - Transition Voice
Last month we presented an interview with Nicole Foss that arose from our having met her at the ASPO conference. Contributor Helen Loughrey took that assignment and presented a very readable short interview with Foss, aka Stoneleigh, the co-editor at The Automatic Earth. This month we present the full but unedited version of that interview. Go get a cuppa Joe, and settle in. It takes a while to read. But we think Foss fans will find it worth it.
Loughrey: Of the three storms threatening our modern way of life – Peak Oil, Climate Change and the Economic Crisis – you focus your attention at The Automatic Earth on the third, less widely understood economic storm, specifically deflation. Your career background is in energy and Peak Oil, so why make the economic storm your main focus?
Foss: We were starting to write about finance at the Oil Drum Canada because the time scale is so much shorter than any kind of changes in energy supply or demand. We decided to put the primary focus on finance at The Automatic Earth because of the time scale issue. It doesn’t have to happen tomorrow but the thing about deflation is you often get a certain amount of notice but you never know when it can suddenly go into high speed and it can take you almost by surprise. In September 2008 we came within hours of the global banking system seizing up and so that’s how quickly it can unfold. That’s why we warn people that you can afford to be early preparing for deflation but you simply cannot be late. We want people to prepare soon enough so they don’t lose what they have in the systemic banking crisis. If they are prepared, then they will have the resources to fight the next challenge that comes up, peak oil and climate change. They have to get through the deflationary period if they are going to retain the freedom of action to deal with those crises. Because money is choices: if you have no money, you have no freedom of action, no choice in the world. You are completely at the mercy of what life throws at you.
In the short term the repercussions of the economic storm come faster. In the longer term, the energy storm repercussions will be massive. Actually the finance storm will buy us time in energy terms because demand and price will fall a long way. We will be swimming in energy for a couple years while demand is low. But this also means there will be no additional investment no exploration no maintenance which means the when the energy crisis hits, it will hit with a vengeance. So finance is rewriting the way the energy debate plays out.
Loughrey: Your message is that a severe depression – much worse, and lasting longer, than the 1930’s – is arriving soon due to the ongoing collapse of the credit markets. The government claims to have averted that scenario with the bank bailouts. Wall Street has rebounded with a DOW back up over 11,000. How do you respond to their official pronouncements of a recovery?
Foss: The recovery is an illusion. The measures appear to have worked because there was a stock market rally to support them. Rallies are kind to governments and central banks. They allow their interventions to appear successful because there is a public suspension of disbelief that supports their actions. But this rally is topping and is now very close to a sharp move in the other direction and that is going to undercut support for government policies. If you remember, none of what Hank Paulson did in 2008 worked at all because we were in a declining phase at the time. Declines make central authorities look completely inept. Nothing they do gets any traction. Once we turn the corner into another decline, then nothing they do is going to appear to work. People are going to get angrier and angrier with government.
Loughrey: Many in the peak oil community believe that our current economic woes are the result of an energy price hike a few years ago. You point to other economic causes instead. Why was the energy price hike not a major cause of the recent economic downturn?
Foss: If you look at what happened back then, stocks topped in late 2007 but oil topped in mid 2008. The speculative bubble in oil prices was hot money trying to get out of stocks to find some other place to make money. The spike in mid 2008 to $147 per barrel was a massive speculative bubble. We said at the time that it would be followed by an enormous price crash and it was. This smaller speculative bubble will end the same way. Prices could go down quite sharply as low as $20 a barrel. There will be people who say that this oil price bubble will have caused our looming economic problems but that is not the case. Finance changes happen first. Peaks in energy typically follow peaks in stocks.
Because financial bubbles are Ponzi schemes, and are therefore inherently self limiting, they reach a top and they crash. What happens in the energy sector to oil prices tends to be a consequence of a financial crash, not the cause. Look at what happened in the thirties: the U.S. was the global swing producer for oil; they had a continents worth of the stuff. The only thing they did not have was money because they had a credit crash. You had a massive depression that lasted for ten years because you didn’t have enough money in the system and that is exactly what is coming again. The mechanisms are very much the same. You don’t need to postulate a shortage of energy to precede a financial crisis. Going forward shortages of energy will put a hard lid on any recovery and it will set up very serious political ramifications for resources grabs around the world.
Loughrey: You recently gave a speech at the annual Association for the Study of Peak Oil [ASPO] conference in Washington DC. As a former editor of The Oil Drum Canada, much of what you had forewarned about the banking system has since come to pass. How well is the peak oil community receiving your economic message these days?
Foss: They asked me to come back and speak next year so I think the reception at the conference was quite good. Those who disagreed with me didn’t attempt to argue points with me. One example was Jeff Rubin. To paraphrase, he called my presentation a version of monetarism devised by a non-economist. Which didn’t make sense to me because monetarists don’t recognize the role of credit, and as I say credit is the absolute key to why we are going into a deflation. If anything, the fact that I am not a formally taught economist carried more weight with many who were there at the ASPO conference. I taught myself informally everything I know about economics; it is a fascinating topic. My quest to understand how the world works means studying power relationships and hierarchies and you have to understand the role of money and thus credit to do that.
Loughrey: Many peak oil aware folks are preparing for hyper-inflation. What would a person expecting deflation do in preparation that might not occur to someone expecting inflation?
Foss: Hold cash and get out of debt. Those are the big two. If you are expecting inflation, then you wouldn’t worry about debt. In the 1970’s it made sense to buy the biggest house you possibly could afford. You knew under that in a few years time it would be worth more and your debt would be a smaller proportion of the house value. Similarly you didn’t hold cash when cash wouldn’t hold its value.
I would argue now that cash is what will hold its value while property and other assets will not.
I do have something in common with the inflationists. Both of us would agree that significant economic upheaval is coming. Whether you expect inflation or deflation, it is wise to have supplies stored: things to eat, to use as spare parts, or to trade for things you will need. But in purely financial terms, the deflationary preparation would be the opposite.
Loughrey: What’s your response to the economists’ prescriptions for the United States? You’ve got the Keynesians on one side saying "let’s spend our way out of our troubles" and you’ve got the more austere Chicago boy economics on the other side saying "lets’ drown the baby in the bathwater.”
Foss: And I think a plague on both their houses.
Freidmanites, or the Chicago school, have two big problems. First they do not understand the role of credit in the money supply. They define money too narrowly so they don’t understand why deflation is coming. Secondly they assume away the people. To them, economics is a machine explained by physics without having to understand people. Their economics model cannot describe the real world ever because economies are based in collective human behavior. In a way it is far more important to study human psychology to be able to explain the how the economy works.
To Keynesians I would say when you are in a hole, stop digging. When you are already drowning in debt, why on earth would you decide that more debt is the only thing that you can do to get out of your situation? It isn’t going to work. Keynesianism debt spending is just throwing more money down a giant black whole of credit destruction. Furthermore, it is putting additional excess claims to underlying real wealth in the hands of the very people who are best positioned to know that you’d have to cash those out at the beginning if you are going to get anything for them. So it is tilting the deck in favor of the big boys yet again.
I am in favor of tilting the deck in the other direction, toward the average person. There is very little money coming out of the system, so there is nothing I can suggest to get more wealth out of the system. All I can try to do is to help direct what does come out of the system into the hands of ordinary people because they will do something useful with it for the sake of their friends, families and communities. Ordinary people will apply those resources to real world solutions that genuinely matter. To me that is the single most important thing that I can possibly do. It fits very well with the goals of the Transition movement.
Loughrey: How will the economic and peak oil crises play out for different economic classes?
Foss: Yes it will depend on how much money people have. They may bring in rationing programs but it could be delayed. During the period of deleveraging, there may not be any recognition that low prices are so unaffordable for people. You don’t get pressure for rationing right away. A price spike would be more likely to induce rationing programs later. The more money you have the more access you have to the important things. Many will have to do without.
When you are talking about falling out of a window, how much it hurts depends on what floor you fell out of. Some are only going to fall out of the ground floor window. If you are a small scale farmer with no debt and you didn’t get sucked into buying expensive equipment, you may not notice. Whereas upper middle clas,s who seem to be wealthy but are up to their eyeballs in debt as any subprime borrower, and they have no skills: to them it will feel like falling out of the 100th floor window. So it’s how much money they have going forward that will matter, not how much they’ve had in the past. We will see a big shakeup of who has what. The people who do well are not necessarily going to be the people who are wealthy now. Some of them are going to be so devastated, so incapable of living without pots of money that they may drink themselves to death, like people did in Russia. There’s a whole generation of middle-aged men who had the rug pulled out from under their feet. They were no longer useful and they couldn’t adapt. The women were a lot more flexible i.e. that was then this is now and they got on with it.
Loughrey: Foreclosures have skyrocketed. Do you think foreclosures will accelerate and spread into previously unaffected areas or will the states attorneys general put a stop to it?
Foss: One of the things that will blow up in their faces is the foreclosure problem. There are no good answers no matter what they do to the foreclosure problem. There will be tremendous repercussions for the United States. The entire mortgage industry has been thoroughly grounded in fraud for years. An enormous amount of mortgages written were fraudulent; most of the securitization process was fraudulent; and now the foreclosures are fraudulent too.
Government has a choice: do you support the banks and allow then to foreclose even though they cannot legally prove title? You will piss off ordinary people tremendously. They are going to say you are enforcing fraudulent contracts only against us the little guy. Yet if you do not allow fraudulent foreclosures to proceed, then there will still be enormous anger. Other people who had been paying will be upset that others will get a house for free. They’ll realize that their mortgage notes are fraudulent too and stop paying too. So few people will pay in the end that the banks will fail anyway.
No real good answer. Nothing is going to work.
Loughrey: How bad will it get in terms of turfing people out of their homes?
Foss: It’s very hard to tell. They will try a variety of things which are likely to fail. Many will lose their homes, and banks will fail, so people will lose savings too. I don’t know how many will be thrown out on the streets, how many will walk away, how many will manage to get a free home out of it. I expect a combination of the above.
One thing they could do is force a revaluation of property. But because property has further to fall it would only have to be done again. You can’t do it over and over. You will still crash the banking system because of the extent of leverage; and you can’t keep up with the price of which houses are falling. So it won’t work either. This is the single biggest issue that is going to blow up in people’s faces. The housing crisis will be blamed for what will happen in the stock markets. It won’t be the cause of the market fall but people always look for a cause.
There really is nothing that has a chance of working. Once you have the creation of excess claims on real wealth, you end up living through a depression. The emphasis has been to get borrowing and lending going again which is impossible in phase 2 of a credit crunch. They won’t do the thing that helps, which is what the relocalization community is doing: building food production and self sufficiency.
Loughrey: Some experts have predicted ‘the end of suburbia’ as a result of peak oil. What’s the prognosis for suburban neighborhoods under your deflationary economic scenario?
Foss: I think suburbia is a trap. There are two things that can work: Totally rural or totally urban. If you’re totally urban, you can’t be self sufficient. However whatever centralized services are going to survive, they’re almost certainly going to survive where you are because they don’t have to spread very far. You are more likely to have services like power and heat and gas. You may be able to walk to work or shops, so no need for your own private transportation.
Totally rural can work because although the services aren’t going to go that far out, you still have the potential to be self sufficient. So you can have a well and septic and grow your own food and have solar panels. It is everything in between that doesn’t work. Suburbia will have all of the dependencies and none of the services. So you can’t be self sufficient AND you’re not going to have services. An awful lot of suburbia is going to be unlivable. Suburbia could easily become slums: you would only live there if you had no other choices. Older parts of suburbia may still be walkable or bikable and the soil is better. If people can increase their self sufficiency, it will help.
Loughrey: You recently spoke to some Transition Initiative groups in the UK. The Transition movement designs 15 to 20 -year ‘energy descent action plans’ for small towns and even large cities in an attempt to reduce climate change impact and to prepare for peak oil. How would a deflationary economic scenario affect those preparations and timelines?
Foss: The Transition Movement fits well with my attempts to put resources in the hands of ordinary people at the local level. I am very happy to work with them. I do think they need more of a sense of urgency than they have. And they have to face the financial crisis. When I spoke at the Transition Town conference in England, they didn’t understand finance. To say that I shook them up is a colossal understatement. Now, they do have more of a concept of it. But I think they are still uncomfortable talking about it because they are afraid that people will just become paralyzed with fear. They have to overcome this in order to help people. Otherwise they will not have enough of a sense of urgency and not enough wealth will end up in the hands of ordinary people. But I am hoping to move them along on this.
Secondly, they have to broaden their tent beyond those they already agree with in the environmental and liberal camps. At the Transition Towns conference, it was a homogenous group; there was almost no dissent there. They must reach out to political conservatives, to the unemployed, and to racial minorities. This will take them out of their comfort zone. I believe we must transcend politics. You have to be able to work with those with whom you do not always agree, such as the tea party types. Otherwise the demagogues will try to manipulate the anger and divide us from each other and we will all be worse off. We have to be able to find common ground. They have some good things on the right like their work ethic perspective and self reliance values. If you only focus on what you dislike you can’t build the bridge. Although my instincts are progressive, I think the left can be clueless when it comes to reaching out to others to find common ground. The left, if anything, are more likely to be able to bridge the divide because of their inclusiveness values. So the effort has to come from the left.
Loughrey: Your recent speech in Marquette Michigan focused on resilience and practicalities. What recommendations did you make for those wishing to prepare for the economic storm?
Foss: I am working on a 2nd level presentation that expands on The Century of Challenges. It will address what is resilience and how you assess your vulnerabilities and dependencies and what you need to be thinking about. There are important concepts such as liberty, movements of anger, and the trust horizon to consider. I wanted to emphasize the role of psychological inoculation. If you are expecting something, then it doesn’t come as much of a shock and you don’t feel as much as if the rug has been pulled out from under your feet. You’re less likely to run around like a headless chicken. By providing these psychological inoculations, by warning people what’s coming, I am hoping to keep people out of movements of anger like the tea party. Traumatized people are likely to join movements of anger. I tell people, do not join movements of anger. It sucks all the energy out of you. Then you will not be in a position to help your friends, neighbors and family. It is better to say to oneself this has happened; get over it; and move on. Join something positive and constructive instead. That will matter more. I focus on explaining the human herding side of things so people are more immune to it.
There are many groups such as Transition Movement who are doing this constructive work.
Loughrey: Is there anything else you’d like to say to Transition Voice readers?
Foss: Stay in a constructive positive head space. Make an effort to understand the financial situation to develop your sense of urgency so you can build a different world.