"San Francisco after the earthquake and fire; Turk Street, from the corner of Market and Mason"
Ilargi: There are a number of fallacies - or delusions, if you will- concerning our economies that are set to inflict enormous - in many cases lethal- damage in both our own rich lives and those of people elsewhere in the world who are far less well-off than we still are - for now. These fallacies are closely connected, which adds greatly to their insidiousness as well as the perverse influence they have both on ourselves, and on our awareness of what's happening around us. And whatever there may be that we can't change overnight, we can at least try to comprehend some issues, file them, and move on. Let’s do these first:
- Food prices
There is no economic recovery, there hasn't been one in the past five years, and there won't be one for a very long time to come. Claiming that we are seeing a recovery today equals claiming that a society can borrow its way into recovery. I'm not going there, and I strongly advise you to not do it either.
There will be a Keynesian faction which clings to the theory that says it is indeed possible to borrow your way up, but that's a mere mirage, since it would require a surge in real productivity, i.e. outside of the service industry. Where and how have we increased production since the crisis started? Where have we created the great deal of additional value required to dig ourselves out of the hole? Obviously, nowhere. The vast majority of "jobs created" is in the service sector, while manufacturing today counts for less than 10% of US jobs. And no, flipping burgers does not create value.
For the US economy to recover for real, we would need to see hundreds of thousands of jobs created every month, on top of the 150-250,000 needed to just keep up with population growth. Not happening. It doesn't matter if the BLS says the unemployment rate went from 9.8% to 9.4% on 103,000 jobs created. If and when it issues numbers like that, the BLS itself ceases to matter. To wit, Zero Hedge reports: "Initial Claims Surge To 445K, Not Seasonally Adjusted Claims Surge By 191,686 To 770,413 In One Week".
What has happened that fools people into believing in a recovery are two things:
First, the US government and the Federal Reserve have injected more trillions of dollars into the system than anyone can keep track of. Moreover, they have done so only in those sectors that remain beyond the grasp of the average American. Which means that we see relative highs in the markets, as well as record or near record amounts paid out in bonuses on Wall Street, and at the same time there are record numbers of foreclosures and record or near record unemployment numbers.
While it's true that stock markets have been rising lately, how anyone can see that as proof of a recovery is beyond me. The idea that if you just make the rich richer, the rest will follow, is not even something I want to discuss anymore.
Second, any attempt to maintain what could be considered accounting standards, such as those that would apply to you and me, was given up long ago. The reason for this is that the trillions upon trillions of dollars that were taken away from you and your offspring, and handed to the main banks, would still not have been enough by any stretch of the imagination to keep up even the slightest appearance of solvency for these banks. It's important to let that sink in.
The untold trillions have been only sufficient to pay down the first "level" of debt the banks had accumulated, that part of the debt that could no longer be hidden from view. The rest of the debt, which is far greater than all the trillions handed out so far, remains in dark vaults, treated like some sort of state secrets that can’t be divulged for the next 50 or 100 years. The result is that hardly anyone realizes how big the debt is, and the losses are, and that bank stocks have actually been going up. This is how zombie money is created.
You, too, if you’re a gambling addict, could live for a while pretending you're rich, even after you’ve lost all you have and ten times more, provided you’re capable of hiding your lost wagers. Charles Ponzi and Bernie Madoff did it on their own for years; JPMorgan Chase and Bank of America do it with the full aiding and abetting from Washington, which uses your money to comply with whatever it is Dimon, Blankfein and Moynihan say is needed to stave off a collapse.
In other words, the economy may seem to be recovering, and the banking system may seem to have recovered, but the illusion has come at a gigantic price to the American (and European) societies, and in the end it will not make one iota of difference for the outcome. Then again, let's correct that: it will make a difference, but not - at all- in your favor: the multi-trillion dollar illusion will greatly enhance the misery and destitution on Main Street. All that money could have been used to mitigate and minimize the suffering of the herd; instead, it’s all gone to wolf packs and vampire squids. We’ll yet come to deeply regret this.
The fact that there’s all that zombie money around (or zombie credit, to be precise) leads many to believe the US witnesses inflation. Not true. First off, inflation is not the same as rising prices. Prices can rise because of different causes: scarcity, speculation and (real) inflation. And it’s important to be able to identify which of these causes is in play. If you call all price rises inflation, you lose the ability to distinguish between the causes, which means you lose a crucial analytical tool. There may be those who would like nothing better than for us to lose that tool, but it’s not smart to give in.
I know the media has force-fed the incorrect definition of inflation to the masses, and I know there are plenty of people who say rising prices is all they care about, not monetary theory. However, a clear view of causation is essential when it comes to defining your reaction to rising or falling prices, and prices that rise because of scarcity demand a totally different set of actions than those that do because of a rise in total supply of money and credit, combined with velocity of money, which is what inflation truly is.
The present, incorrect and force-fed "meaning" of inflation as all price rises no matter what their cause is, is relatively new. Rising prices used to be referred to as "(currency) devaluation". Not perfect, but way better than what we have now, where terms like “monetary inflation", "price inflation", "consumer inflation", "energy inflation" all the way down to "cookie inflation" fill the media.
Why is the distinction between the definitions important? Because today in the US both the money/credit supply and the velocity of money are falling (deflation), while some prices are rising, in particular those of food and energy. And no, you can't have deflation in one sector and inflation in the other. That really turns the whole debate into obscure nonsense. It's important that we can determine that if prices rise in times of deflation, the cause for those price rises must be something other than inflation.
In today's world, that something else is speculation. But not of the ordinary kind. What we have right now is zombie money speculation. The same unrecognized losses in the financial system that our governments cover up with criminally negligent accounting non-standards cause prices of oil and food to rise, since that's where the zombie money -inevitably- ends up. And it's not just the banks that invest zombie money, it's all of us.
If banks would have been forced to reveal their losses, the hammering of home prices would have been huge. Since this did not happen, a lot of people are still sitting pretty in their homes, which are way more overvalued -in free market terms- than just about anyone is ready to recognize. Also, if banks had revealed their losses, unemployment rates would have been far higher than they are today.
I know what many are thinking: maybe it's not such a bad idea to cover up those losses. But you're not seeing the whole picture. First, the cover-up has enabled the banks to access your money in order to pay down their debts. And second, zombie money is not the same as real money, as something that has been earned by adding real value. Zombie money is not real.
I read a piece at Zero Hedge the other day by a group that calls themselves the NIA, for National Inflation Association. But they don’t even know what inflation means. Hence their slogan: "Preparing Americans for Hyperinflation". Hey, if you can't define inflation, chances are you’ll miss the truth on hyperinflation too. Look, the US depends for its money and credit supply on international bond markets. Whenever Bernanke turns on his so-called "printing press", which in actual fact is an "additional credit" press, it's not as if free money is created. There‘s interest to be paid on all of it. And while interest rates may be low right now, it's not Bernanke who sets those rates, try as he might to make you think so.
If and when the bond markets decide that the risk on US debt rises enough -or too much-, they will decide what the interest rate is, not Bernanke, and not Geithner. Obviously, with every dollar printed, risk assessments will rise, and the outcome is inevitable: less appetite for US debt (don’t forget that there's plenty zombie money in the bond markets too), and higher rates. And only if and when the US no longer has access to international markets does the option of hyperinflation come into play. Now, I may be quite negative on the prospects for the US economy, but a full separation from global debt markets is a while away yet, and that means the prospect of hyperinflation is as well.
Preparing for hyperinflation is not just useless at this point in time, it's also damaging in that it makes people blind to the real problem: deflation. And before we get to hyperinflation, if we ever do, deflation will cause so much pain and grief and unrest and death, that the very thought of hyperinflation will come to be seen as a highly delusional non-issue.
So how long will the zombie money last? Can it last as long as Bernanke and Geithner and Obama and Dimon want it to? No, in fact, they're fighting a lost battle against time itself.
The zombie money has to disappear, and it will. It all starts and ends with US and European real estate, the one biggest investment of those of us living on Main Street, by far. US home prices have now fallen for 53 consecutive months, despite the fact that Fannie Mae and Freddie Mac buy up and guarantee near 100% of all mortgages, and despite the fact that the Fed has purchased huge swaths of the securities allegedly backed by these mortgages.
All those trillions "worth" of your money haven't been able to prevent that. And no amount of additional trillions will. Foreclosures are setting brand new records across the country, even as banks are ever more nervous about their paperwork, and their balance sheets. It doesn't matter how much money Washington throws at the issue, other than it’ll make you a whole lot poorer, for you’ll never see it back.
A further deterioration in home prices can't be prevented. Fannie and Freddie can’t buy 101% of mortgages; they're buying close to a 100% right now and prices still fall. Wal-Mart greeters, burger flippers and the rest of the great unwashed will not be allowed back into the housing market. There are over 10 million homes on the market, and perhaps twice that if you count all foreclosed properties that banks sit on (and the millions they won’t foreclose on), plus all those that people would like to sell but can't lest they go underwater. And the pool of potential buyers has shrunk with a vengeance since the 2005-6 "heydays". Huge increase in supply, huge decrease in demand; e all know where this will go.
Now, take Fannie and Freddie out of this picture. What do you see? They’ll be taken out in some way, and at some time, and it won’t take years. I know what I see: the housing and mortgage situation in the US has turned into what I've always called the “Bulgaria model”, where you guarantee the mortgage on your neighbor's home, and he guarantees yours; anything goes as long as it's not the free market your politicians and media tell you about. And we know what happened to Bulgaria in the end, don't we?
I’m all for a society, a government, that takes care of the weakest in its midst. I’m all against a government that props up the strongest in its midst, in this case the bankers with bonuses larger in one year than the weaker among us can make in a lifetime, the same bankers who lost more money in bad wagers than the entire country can cough up, and still be economically viable. We’re fast becoming zombie societies.
But first we'll have to live through this:
3: Food prices
Let’s start with the news that the Tunisian president has fled his country, and the military's taken over, according to Al Jazeera. Mass protests are ongoing in Morocco and Algeria. The riots in Tunisia are not all about food prices, but they were certainly a substantial factor. And more, much more, of the same is on the horizon, in many different places. But food prices this time around are not rising because of widespread dramatic shortages, at least not so far. And Lester Brown, much as I like the man, has it completely wrong:
The Great Food Crisis of 2011[..] whereas in years past, it's been weather that has caused a spike in commodities prices, now it's trends on both sides of the food supply/demand equation that are driving up prices. On the demand side, the culprits are population growth, rising affluence, and the use of grain to fuel cars. On the supply side: soil erosion, aquifer depletion, the loss of cropland to nonfarm uses, the diversion of irrigation water to cities, the plateauing of crop yields in agriculturally advanced countries, and -- due to climate change -- crop-withering heat waves and melting mountain glaciers and ice sheets.
In the same vein, the peak oil crowd fails to see what drives up oil prices today. Yes, long term trends affect prices to some extent. But no, Lester, you can't provide an accurate assessment of what’s happening if you don’t include the very obvious contribution of speculation, especially that which originates with zombie money. Ditto for oil prices.
Food prices are rising partly because, let’s not forget, China, unlike the US, does have inflation, with its money supply going through the roof. But much more than that they're rising because we have elected to kill off the principles of our own western economic systems, which were once supposed to be based on free market ideas, that dictate that success is rewarded and failure punished.
They have since come to resemble some kind of sophomore notion of Darwinianism, where the upper alpha rhino gets all the girls and the rest get none at all. And that in turn is supposed to pose as justice in human societies, whereas in reality it’s nothing but what happened in Bulgaria for decades.
The consequence is that the zombie money is now allowed to drive up food prices to levels which make sure that millions of people around the world will go hungry, and will revolt as a result of that. Blankfein, Dimon et al have long since realized that they can't maintain their velvet “God's work" thrones just by robbing Americans of all they're worth. Their losses are far too great. They need to have access to everyone's wealth all over the world.
And since oil and food are traded on international commodity markets, and they have gotten hold of all the money America is worth, and then some, they can play these markets as much as they want, whether it’s wheat or natural gas or gold. People like to claim that gold will rise as the US dollar becomes worth less, but they forget that it’s zombie money that has been buying gold, and that has thus lifted gold prices. Once daylight comes and the zombies are gone, there's only one way left to go for gold prices too.
So, once again, when will the zombie money see daylight?
This could be caused by any of a myriad of choices. We could force all banks to put foreclosed homes on the market, all at once. Or tell the same banks they have no right to foreclose on homes they have no perfect(ly legal) paper trail on. We could force all derivatives contracts out into the open. Or just the mortgage backed securities; that would do it. Provided we fold Fannie and Freddie, and not let the FHA or any of those guys take over.
As I wrote eons ago, even just closing down Fannie and Freddie for business one or two months would probably do the trick. China could wreck the US economy in 5 minutes simply by demanding to know what their purchases of Fannie and Freddie debt are worth (they have a lot of it). Or it could be a small country, maybe not Iceland, but surely Vietnam, or Belgium, or Denmark, insisting on knowing what that paper their banks and pension funds have so heavily invested in is really worth. MBS, or any other species of derivatives, the whole shebang only has a value attached to it by the grace of nobody trying to figure what that value is.
Is US housing debt, and the securities and derivatives based on that debt, a zombie, or a person? It may certainly seem confusing late at night. But then again, you can't have meaningful relationships with zombies, they're sort of one-dimensional. Funny how that resembles the person-rights US companies enjoy,
And frankly, does it really matter? What we know for sure is that the zombie money we elected to have flow through our financial systems is going to kill a lot of people this year. Want to plead innocence? How long do you think that excuse will be accepted?
Where our zombie money kills real people. Today.
US Banks Reporting Phantom Income on $1.4 Trillion Delinquent Mortgages
by Robert Lenzner - Forbes
The giant US banks have been bailed out again from huge potential writeoffs by loosey-goosey accounting accepted by the accounting profession and the regulators. They are allowed to accrue interest on non-performing mortgages " until the actual foreclosure takes place, which on average takes about 16 months.
All the phantom interest that is not actually collected is booked as income until the actual act of foreclosure. As a resullt, many bank financial statements actually look much better than they actually are. At foreclosure all the phantom income comes off gthe books of the banks.
This means that Bank of America, Citigroup, JP Morgan and Wells Fargo, among hundreds of other smaller institutions, can report interest due them, but not paid, on an estimated $1.4 trillion of face value mortgages on the 7 million homes that are in the process of being foreclosed.
Ultimately, these banks face a potential loss of $1 trillion on nonperforming loans, suggests Madeleine Schnapp, director of macro-economic research at Trim-Tabs, an economic consulting firm 24.5% owned by Goldman Sachs. The potential writeoffs could be even larger should home prices continue to weaken, placing more homes in the nomnperforming category on bank balance sheets.
About 6 million homes are still at risk, according to Schnapp, and at least 10% of them are 25% underwater, meaning their market value is 25% less than the mortgage– but the owners are still paying interest to their banks.
Goldman reveals fresh crisis losses
by Francesco Guerrera and Kara Scannell - Financial Times
Goldman Sachs has revealed details of about $5bn in investment losses suffered during the crisis for the first time this week, in a move that will deepen the debate over companies’ financial disclosures. The figures, issued as part of internal reforms aimed at silencing Goldman’s critics, show that the bank suffered $13.5bn in losses from “investing and lending” with its own funds in 2008.
But Goldman’s regulatory filings and its executives’ comments to investors at the time pointed to about $8.5bn of losses arising from its investments in debt and equity, as markets were rocked by the turmoil. The diverging figures, which do not change Goldman’s overall results for 2008, are because of the fact that, like many rivals, the bank did not provide a full breakdown of profits and losses from activities carried out with its own resources.
Goldman broke with that norm this week, adding the new category of “investing and lending” to its results. This was an effort to answer criticism that it puts its interests ahead of its clients’ and to lift some of the secrecy surrounding its business. The revelation of the 2008 loss on its investments supports Goldman’s argument that it did not profit from the crisis.
Lynn Turner, a former chief accountant for the Securities and Exchange Commission, praised Goldman’s move but called for the SEC to look into the bank’s past disclosures. “This sets a good example that others should follow,” he said. “But it does raise the question as to why the management did not provide this view back then and whether the SEC are going to do something about this discrepancy.” Mr Turner said SEC rules required companies to give investors a view, as seen from “the eyes of management”, of their finances: “For such a discrepancy to have arisen, management must have lost an eye.”
People close to the situation said some analysts might have calculated the full extent of the losses on Goldman’s investments by looking at its estimates of losses if markets took a downturn but conceded that the new reporting system provided much more clarity and detail. Under the old system, Goldman included its own investments under the heading “trading and principal investments”, which included short-term activities carried out on clients’ behalf, making it difficult to distinguish between the two. Goldman’s disclosures will put pressure on rivals to follow suit at a time when new US legislation – the “Volcker rule” – seeks to curb banks’ “proprietary activities” on their account.
Housing Market Slips Into Depression Territory
by Cindy Perman - CNBC
As the economy revs back to life, with signs of hiring on the horizon, the housing market is being left behind like Macaulay Culkin in "Home Alone."
In the past few years, we’ve all been careful to choose our words carefully, not calling it a recession until it fit the technical definition and avoiding any inappropriate use of the "D" word — Depression. Things were bad but the broader economy never reached Depression territory. The housing market, on the other hand, just crossed that threshold.
Home values have fallen 26 percent since their peak in June 2006, worse than the 25.9-percent decline seen during the Depression years between 1928 and 1933, Zillow reported. November marked the 53rd consecutive month (4,5 years) that home values have fallen. What’s worse, it’s not over yet: Home values are expected to continue to slide as inventories pile up, and likely won't recover until the job market improves.
And while the president is physically protected in an emergency, whisked to a bunker at an undisclosed location, the actual White House is not: The value of 1600 Pennsylvania Avenue has dropped by $80 million, or nearly 25 percent since the peak of the housing boom. It’s current value is $251.6 million, according to Zillow, down from $331.5 million.
Oh-h say can you see … by the dawn’s ear-ly light …
1 million homes repossessed in 2010
by Les Christie - CNNMoney
Foreclosures were at a record high in 2010, and more than 1 million people lost their homes, even as notices started leveling off during the end year. In total, there were nearly 2.9 million foreclosure notices filed during the year, according to report released Thursday by RealtyTrac. That was a record high, but just 1.7% above 2009. It most certainly would have been higher had notices not plunged in November and December as banks halted tens of thousands of foreclosures in the face of the robo-signing scandal.
"Total properties receiving foreclosure filings would have easily exceeded 3 million in 2010 had it not been for the fourth quarter drop in foreclosure activity," said James Saccacio, RealtyTrac's CEO. "Many of the foreclosure proceedings that were stopped in late 2010 -- which we estimate may be as high as a quarter million -- will likely be re-started and add to [foreclosure] numbers in early 2011."
For the fourth consecutive year, Nevada led the nation in the rate of foreclosures with one of every 11 households there receiving at least one filing in 2010. Still, that constituted a 5.3% improvement from a year earlier. In Arizona, one of every 17 households received a filing in 2010, down 4.5% for the year. Florida's 2010 foreclosures (one in 18 households) dropped 6.1% year-over-year, and California (one in 25) fell 8.5%.
Overall, 2010 was a rough one for the mortgage industry. The big news was the robo-signing scandal, which erupted in the fall amid allegations that banks were foreclosing on homes without having read the documentation. Then, President Obama's efforts to fend off foreclosures foundered as the year wore on and the potential for ever more massive foreclosures ballooned.
At the beginning of 2010, the bloom had not yet faded from Obama's HAMP (Home Affordable Modification Program ) program, and many analysts were optimistic it would help many people save their homes. By April, it became apparent that the program was losing the foreclosure fight; there were reports of 10 new defaults for every HAMP modification and the projections for the number of borrowers who would actually receive a HAMP mod had nose-dived to 1 million from 4 million.
Then the next shoe to drop came in June, with a report from Fitch Ratings that showed HAMP modifications re-defaulting at a high clip. The company forecast that three-quarters of all HAMP mods would ultimately fail. The foreclosure prevention program really started to fade by mid-summer: Fewer than 37,000 loans received HAMP modifications in July, down from more than 50,000 a month earlier. Only 435,000 loans had gotten permanent modifications through the program.
The next few years could be difficult. Some industry analysts, such as Laurie Goodman, head of Amherst Securities mortgage group, say that as many as 11 million mortgage borrowers are in potential danger of default. However, Rick Sharga, RealtyTrac's spokesman, predicted 4 million to 5 million and scoffed at quantifying the magnitude of the potential disaster, comparing it to "taking inventory of deck chairs on the Titanic."
2010 Had Record 2.9 Million Foreclosure Filings
by Susanna Kim - ABC
In 2010, 2.9 million properties received foreclosure filings -- an increase of 2 percent from 2009 and 23 percent from 2008, according to data from the website RealtryTrac.
The figures would have been worse, if not for a surprising decrease in foreclosures toward the end of 2 010. December saw a 30-month low of foreclosures, with filings on 257,747 properties, a drop of 26 p ercent from the previous year. That was the biggest annual drop in foreclosure activity since RealtyTrac first published foreclosure data in January 2005.
"Total properties receiving foreclosure filings would have easily exceeded 3 million in 2010 had it not been for the fourth quarter drop in foreclosure activity," said James J. Saccacio, chief executive officer of RealtyTrac, in a statement. Some economists point to the year's high unemployment levels as a contributing factor to foreclosures.
Saccacio said the decrease in foreclosures in the fourth quarter was in part due to the controversy that started in the fall over foreclosure procedures. He said many major lenders temporarily halted some foreclosures. Earlier this month, the highest court in Massachusetts ruled against U.S. Bancorp and Wells Fargo, invalidating two mortgage foreclosure sales because the banks did not prove they owned the mortgages at the time of foreclosure.
Rick Sharga, senior vice president of RealtyTrac, said it is possible that foreclosure figures could be even higher. RealtyTrac collected its data from over 2,200 counties, accounting for about 92 percent of the nation's population. The figures incorporate the most recent filing from all three phases of foreclosure: default, auction, and real estate owned properties that have been foreclosed on and repurchased by a bank. "We send out contract employees to go into the court houses and hand-collect the records in 2,200 counties across the country," said Sharga. "Less than 6 percent of foreclosure records are online in various public or county databases."
Five states -- California, Florida, Arizona, Illinois and Michigan -- accounted for more than half of the 2.9 million total filings last year.. California had the most foreclosure filings: 546,669, or 4.08 percent of its total housing units. The state of Nevada had the highest state foreclosure rate for the fourth year in a row with its 106,160 filings. One in 11 housing units in Nevada, or 9 percent, received a foreclosure filing last year.
Nevada's foreclosure activity increased in December by 18 percent from the previous month, and 14 percent from last year, despite efforts by legislators. Nevada's foreclosure mediation program, which started in 2009, requires lenders to meet in good faith with state authorities to make foreclosure decisions.
Arizona had the second highest foreclosure rate for the second year in a row with one in 17 housing units, or 5.73 percent, receiving at least one foreclosure filing. The state had a total of 155,878 foreclosures, a decrease of 4 percent from 2009.
Florida had the third highest foreclosure rate with one in 18 housing units, or 5.51 percent, receiving at least one foreclosure filing last year. Florida had 485,286 foreclosed properties in 2010, the second largest total after California.
The seven other states included in the country's 10 highest foreclosure rates by state were California (4.08 percent), Utah (3.44 percent), Georgia (3.25 p ercent) Michigan (3 percent), Idaho (2.98 percent), Illinois, (2.97 percent) and Colorado (2.51 percent).
U.S. Foreclosure Filings May Jump 20% This Year
by Dan Levy and Prashant Gopal - Bloomberg
The number of U.S. homes receiving a foreclosure filing will climb about 20 percent in 2011, reaching a peak for the housing crisis, as unemployment remains high and banks resume seizures after a slowdown, RealtyTrac Inc. said. "We will peak in foreclosures and probably bottom out in pricing, and that’s what we need to do in order to begin the recovery," Rick Sharga, RealtyTrac’s senior vice president, said in an interview at Bloomberg headquarters in New York. "But it’s probably not going to feel good in the process."
A record 2.87 million properties got notices of default, auction or repossession in 2010, a 2 percent gain from a year earlier, the Irvine, California-based data seller said today in a report. The number climbed even after a plunge in filings in the last part of the year -- including a 26 percent drop in December -- as lenders came under scrutiny for their practices.
Foreclosures have weighed down U.S. housing prices as the nation’s unemployment rate is stuck at more than 9 percent. Home values may rise 0.6 percent for the year, the first annual jump since 2006, according to Fannie Mae, the largest U.S. mortgage buyer. They have fallen as much as 33 percent since peaking in 2006, based on the S&P/Case-Shiller Index of 20 cities. Banks seized more than 1 million homes in 2010, according to RealtyTrac. That was up 14 percent from a year earlier and the most since the company began reports in 2005.
About 3 million homes have been repossessed since the housing boom ended in 2006, Sharga said. That number could balloon to about 6 million by 2013, when the housing market may "absorb the bulk of distressed properties," he said.
"What makes this almost inevitable is the fact there are 5 million seriously delinquent loans not yet in foreclosure," Sharga said. "They’ve got to eventually get in the pipeline unless the homeowners cure the defaults." As many as 250,000 foreclosure filings that would have occurred at the end of 2010 were delayed by the ongoing probe into lender practices, according to RealtyTrac. Those proceedings will be pushed into this year, resulting in an "ugly" first quarter, Sharga said.
Attorneys general in all 50 states are investigating whether banks and loan servicers used faulty documents and signatures on loan documents, a process that has come to be known as robo-signing. Companies including JPMorgan Chase & Co., Bank of America Corp. and Ally Financial Inc. halted some repossessions as they reviewed their procedures. Foreclosure filings in December totaled 257,747, the lowest monthly tally since June 2008. The number fell 2 percent from November and 26 percent from a year earlier, the biggest annual decline in RealtyTrac records.
Filings in the fourth quarter fell 8 percent from a year earlier to 799,064. The tally for the three-month period was the lowest since the fourth quarter of 2008. Nevada had the highest U.S. foreclosure rate in 2010 for the fourth consecutive year, with more than 9 percent of the state’s households receiving a filing. Arizona was second at 5.7 percent and Florida third at 5.5 percent. California’s rate was 4.1 percent, Utah’s was 3.4 percent and Georgia’s was 3.3 percent. Michigan, Idaho, Illinois and Colorado rounded out the top 10.
Five states accounted for 51 percent of the U.S. filing total, with almost 1.5 million. California led with 546,669, down almost 14 percent; Florida was second at 485,286, down 6 percent; and Arizona was third at 155,878, down 4 percent. Illinois ranked fourth at 151,304 and Michigan was fifth at 135,874, both down about 15 percent from 2009. Georgia, Texas, Ohio, Nevada and New Jersey also ranked among the top 10, said RealtyTrac, which sells data from counties representing 90 percent of the U.S. population.
Big Banks to New Jersey: Stop Bugging Us About Foreclosure Documents
by Abigail Field - Daily Finance
When New Jersey tightened its rules for foreclosures in response to the crisis over false loan documents, it took the unprecedented step of ordering the six largest servicers -- Ally Bank/GMAC, Bank of America, Citibank, JPMorgan Chase, Wells Fargo and OneWest -- to explain why they should be allowed to continue with their foreclosures. If any of them couldn't adequately justify itself, New Jersey would suspend all the foreclosure actions by that bank in the state and appoint a special master to investigate its past and proposed processes.
On Jan. 5, the banks responded, and in essence each said: Look judge, we're good guys committed to keeping people in their homes whenever possible, and while we admit that in the past we had problems -- teeny-tiny problems -- we've fixed them already.
Most of the banks' briefs then argued, with varying degrees of aggressiveness, that the court doesn't have the power to impose a foreclosure moratorium or appoint a special master because that would break court rules, violate New Jersey's Constitution and the U.S. Constitution -- including the banks' due process rights -- and overstep the judiciary's role. They also claimed it was generally wrong because the banks were regulated federally. Only Chase declined to challenge the court's authority to impose the moratorium or appoint a special master.
However strong these challenges to a potential moratorium and special master may be, the irony of banks arguing that halting foreclosures would break court rules and violate their due process rights is richer than New York cheesecake. After all, the banks' actions in the foreclosure process have systematically involved documents that break court rules and violate homeowners' due process rights, which is what led New Jersey to act in the first place. Irony aside, the banks are essentially saying: If you suspend our foreclosures or appoint a special master to investigate us, we'll sue to stop you.
Although the banks vigorously assert that their document problems never led them to foreclose wrongly and that their records are in impeccable shape, they do admit to errors in their documents, at least to some degree.
Citi conceded the most mistakes:"Of the 4,023 active foreclosures in New Jersey serviced by Citi, only 613 involve affidavits that were prepared under our pre-strengthened processes -- which review is ongoing -- Citi has determined that foreclosure affidavits need to be corrected in 210 cases. Of those 210 cases, a significant percentage contained errors that were actually in the borrowers' favor."
Citi's statement means that using its original procedures, at least one-third of all of its New Jersey foreclosure filings were problematic. Since Citi's review is ongoing, that percentage could rise. Moreover, if some errors were in the borrowers' favor, those errors had to be substantive, not simply a matter of perfect documents signed by someone who "technically" shouldn't have been signing them.
A Pretty Weak Defense
BoA, Chase and Ally/GMACM were more vague. All noted that they are replacing documents, but they assert their foreclosures were appropriate. Each says their records are generally accurate and add something like Ally's statement: "We note that, to the best of our current understanding, GMACM has found no evidence of any loans referred to foreclosure where the borrower was not in default." (Bold in the original.)
"The borrower was always in default" is a pretty weak defense to the legal issues with their court filings, however, because whether or not a borrower is in default isn't the only key fact in a foreclosure case. (Moreover, not every bank could accurately make that claim, particularly BofA.)
For example, if the amount of money the homeowner is supposedly in arrears is incorrectly listed, that affects the borrower's ability to make up the default and become current. Similarly, courts might care if homeowners are told by the bank to default so they can qualify for a home loan modification, and then the bank fails to record their payments and forecloses. Finally, even if a homeowner is in default, the foreclosing company still has to have the right to foreclose.
If a bank lacks the right to foreclose but forecloses anyway, big problems can result. Many recent Massachusetts homebuyers are discovering that they don't really own their homes, because the banks that foreclosed on them and then resold them didn't have the right to foreclose in the first place. That's a nightmare affecting innocent purchasers of foreclosed properties caused purely by the banks carelessness.
The fact that all the borrowers were in default -- as best as the banks can tell -- doesn't mean the foreclosures were proper.
OneWest and Wells Fargo were more aggressive. OneWest proudly emphasized that nationally, 98% of its affidavits in cases were accurate -- meaning that 2% were not. It also asserts that its average error was just 1% of total indebtedness. But that statistic is unhelpful in understanding the impact of the errors on individual homeowners because, by definition, some of the errors were greater than that.
For example, even a small error in the amount needed to bring the loan current can prevent a homeowner from curing the default. Moreover, OneWest's accuracy boast is limited to financial information -- it doesn't address whether or not OneWest always was the bank with the right to foreclose in the case when it did.
Wells Fargo was positively defiant: "Wells Fargo respectfully states that there is no basis for the Court to presume that the data in any, let alone all, the affidavits submitted by Wells Fargo are, or were, factually inaccurate." That's a very bold attitude for Wells to take, given that it has not only used robo-signers but also has failed to prove its standing to foreclose in ongoing court cases.
In one Connecticut case, the judge noted that questions kept "popping out" of Wells Fargo's documents and has demanded more evidence showing Wells really has the right to foreclose. In a Texas case, a Wells Fargo employee swore in a court filing that Wells owned the loan -- until the homeowner's attorney pointed out that Freddie Mac claimed ownership, at which point the Wells person swore that Freddie owned the loan, and Wells just serviced it. Ultimately, the judge concluded Wells could not prove the homeowner owed it anything.
When Wells makes its "respectful" statement to New Jersey, is it counting its affidavits and testimony in these cases as factually accurate? If not, is there some reason Wells thinks its New Jersey documents are so pristine that the court has "no basis" to question them?
Previously Overlooked Criticism
The banks' claims that their past document problems were very limited and technical aren't credible. And it's not just the recent news of foreclosure problems that destroys the banks' credibility: For years, foreclosure defense and bankruptcy attorneys, as well as academics, have pointed out flaws with bank foreclosure documents. All that's new -- new in the last six months or so -- is that the media has been paying attention
University of Iowa law professor Katherine M. Porter used 1,700 bankruptcy cases as the database for her seminal 2008 paper, Misbehavior and Mistake in Bankruptcy Mortgage Claims. Based on the data, she wrote: "mortgage servicers frequently do not comply with the law. . . . The bankruptcy data reinforce concerns about the overall reliability of the mortgage service industry to charge homeowners only the correct and legal amount of the debt."
In her congressional testimony on Oct. 27, Porter noted that before she stopped updating her database more than a year earlier, she had identified some 50 decisions in which judges found "inappropriate foreclosure practices or misbehavior by mortgage servicers or their agents." She gave as an example a bank that had charged a debtor more than $2,000 in "penalty interest" that wasn't owed. The judge found the bank had made identical improper charges in about 50 other cases and as a result, fined the bank $95,000.
Or take the work of Kurt Eggert, professor of law at Chapman University and director of the Elder Law Clinic. Eggert documented problems with mortgage servicing back in 2004, as he explained in his recent congressional testimony. Eggert said:"In 2004, I documented the widespread misbehavior of mortgage servicers, and defined "servicer abuse" as follows:
Abusive servicing occurs when a servicer, either through action or inaction, obtains or attempts to obtain unwarranted fees or other costs from borrowers, engages in unfair collection practices, or through its own improper behavior or inaction causes borrowers to be more likely to go into default or have their homes foreclosed. . . . Servicing can be abusive either intentionally, when there is intent to obtain unwarranted fees, or negligently, when, for example, a servicer's records are so disorganized that borrowers are regularly charged late fees even when mortgage payments were made on time. The types of servicer abuse that my 2004 article discussed are still quite present today."
Or consider the sworn testimony from a former employee of one big Florida foreclosure mill that it used inaccurate documents, including documents listing wrong amounts owed.
And then there are the lawsuits against the banks and their attorneys.
New Jersey separately ordered the 24 companies that have filed at least 200 foreclosure actions in the state in 2010 to show that their processes are sound. If they can't, the state will take further steps. The 24 include 22 private finance companies, Mortgage Electronic Registration System (MERS), and the New Jersey Housing and Mortgage Finance Agency. They have a few more weeks to reply to the court. So, we'll have to wait to see how effectively they defend their practices
Brace Yourself: Our Society Is Going To The Dogs
by Henry Blodget - Tech Ticker
In case you're obsessing about normal problems like your food being overcooked, your clothes not fitting quite right, or your kids not doing their homework, don't bother. Because soon, says trend-forecaster Gerald Celente publisher of The Trends Journal, you're going to have a lot more important things to worry about.
Such as a huge spike in crime, as towns and cities are forced to cut back on police enforcement to pare their massive budget deficits. And higher taxes, as the government tries to save its own skin by producing revenue any way it can. And a loss of liberty, as the government tries to preserve its own power by tracking every aspect of your life.
Fortunately, says Celente, civilization itself will not collapse. But it's going to get really bad for a while.
Bailouts Postponed, But Can't Prevent the "Greatest Depression," Gerald Celente Says
by Peter Gorenstein - Tech Ticker
For the last few years Gerald Celente, publisher of the Trends Journal has come on Tech Ticker and other media outlets talking of a further economic collapse, which he calls "the Greatest Depression." Yes, the economy is not robust, growth still hasn't returned to pre-crisis levels and unemployment remains above 9%. But by most metrics things are getting better, not worse. In the accompany clip, Aaron and Henry ask Celente how he accounts for this.
Celente argues his dire predictions would have come to fruition if it had not been for an unprecedented set of bailouts that continue today. Most shocking to Celente was the disclosure, in late 2010, that the Federal Reserve lent hundreds of billions to foreign banks to bail them out during the height of the crisis in 2008 and 2009. "Absent those kind of schemes, if capitalism take it's course, at some remote level it used to be, we see the crash," he says.
Here's how he puts it in his Top Trends of 2011 release:
"In 2011, with the bailout funds and arsenal of other schemes to prop up the economy depleted, teetering economies will collapse, currency wars will ensue, trade barriers will be erected, economic unions will splinter, and the onset of the 'Greatest Depression' (a trend we forecasted before the massive bailouts existed) will be recognized by everyone…"
The only way to avoid the coming disaster is do what we did coming out of the Great Depression - start manufacturing quality goods the world wants. "You can't print your way out of this," he argues. The only way to do that is to improve productive capacity through either manufacturing industrial goods or technological innovation. Otherwise, Celente says the "Greatest Depression" is inevitable.
S&P Melt Up Price Momentum: A Once In Never Event
by Tyler Durden - Zero Hedge
As part of the most recent observations on the boil up (melt up is so QE1) in the S&P, we find something quite interesting. A quick glance at the chart below shows the general market 45% climb since Bernanke's leak of QE2 in August, as well as the market's 10 day (purple line) and 50 day (green line) moving averages. As a point of reference the S&P has been above the 10 day average for 30 days straight, and above the 50 day average for 92 days straight.
What is remarkable are some statistical findings as pertain to the average's movement with respect to the SMAs. Sentiment Trader points out that while as part of the recent surge in the S&P, the market has gone for "92 days without closing below its 50-day average, which has been matched only 17 other times since 1928." Where it gets scary, is that as pointed out, during this time the market has not closed below the 10 DMA once during the past 30 days.
And as Sentiment Trader notes, "this has never happened before, in 82 years of history." Congratulations to the Centrally Planned Socialist States of America: its Chairman has just made the Guinness Book of Manipulation Records.
Initial Claims Surge To 445K, On Expectations Of 410K, Not Adjusted Claims Surge By 191,686 To 770,413 In One Week
by Tyler Durden - Zero Hedge
So much for that amazing beat in the last 2010 number in initial claims, which is now proven to have been purely a figment of the BLS' imagination and a whole load of guesstimations. Today's initial claims number throws cold water to all those who expected the trend in claims to be improving. At 445K, this was a huge miss to expectations of 410K, and a major deterioration from last week's (upwardly revised of course) 410K (was 409K before).
Elsewhere, continuing claims came at 3,879K on expectations of 4,088K (with the previous naturally revised higher as well from 4,103K to 4,127K).
And the kicker: in NSA terms initial claims were a mammoth 770,413, a 191,686 increase in just one week, and the highest NSA number in one year! The result: the spread between SA (3.1%) and NSA (3.8%) unemployment rate jumps to year highs. Of course, the BLS blames the huge disappointment on "paperwork delays", yet blamed nobody for the amazing beats in the end of 2010 which brought the market to a complete frenzy.
Lastly, completing the trifecta of bad data, those on various forms of extended claims jumped by 130K, confirming that we are nowehere close to dealing with the "99 week completion" cliff issue, as ever more people roll off continuing claims.
NIA Comments On The Upcoming Bursting Of The (Bankruptcy Non-Dischargeable) College Debt Bubble
by Tyler Durden - Zero Hedge
The NIA, better known for cutting straight to the chase and not really mincing its words today focuses on the latest trillion + dollar bubble: that of US higher education, which is getting increasingly more funded directly by the US Government. "The National Inflation Association believes that the United States has a college education bubble that is set to burst beginning in mid-2011. This bursting bubble will have effects that are even more far-reaching than the bursting of the Real Estate bubble in 2006. College education could possibly be the largest scam in U.S. history." And the kicker: unlike housing debt, college debt has that extra oomph to it that it traditionally is not discharged in bankruptcy: as such it is the ultimate subjugation mechanism. This one sure is set to get interesting...
From the NIA:
The National Inflation Association believes that the United States has a college education bubble that is set to burst beginning in mid-2011. This bursting bubble will have effects that are even more far-reaching than the bursting of the Real Estate bubble in 2006. College education could possibly be the largest scam in U.S. history.
NIA's advice to the youth of America today is to think for yourselves. Don't get suckered into overpaying for a college degree that is worthless because everyone else has one. College is only worth attending if you plan on actually learning something there. If you are only going to college because you think a piece of paper is going to help you find a job, you would be much better off skipping college and entering the workforce right now at any entry level job. Your experience will benefit you more than any piece of paper.
The median U.S. home price is currently $170,600, down 26% from its peak of $230,200 in July of 2006. The Dow Jones is currently 11,672, down 18% from its peak of 14,198 in October of 2007. Oil is currently $91 per barrel, down 38% from its peak of $147 per barrel in July of 2008. After the financial panic of 2008, the U.S. saw a collapse in the prices of just about all assets, goods, services, and commodities. Between lost stock market and home equity wealth, Americans lost $10.2 trillion in paper wealth in 2008, and have only recouped a fraction of it since then.
College is the only thing in America that never declined in price during the panic of 2008. It actually rose in price substantially. The annual tuition for a private four-year college was $21,235 in the 2005-2006 school year. Despite Real Estate beginning to collapse in late-2006, college tuition rose by 4.6% in the 2006-2007 school year to $22,218. Despite the stock market beginning to collapse in late-2007, college tuition rose by 6.7% in the 2007-2008 school year to $23,712. Despite oil and other commodities collapsing in late-2008, college tuition rose by 6.2% in the 2008-2009 school year to $25,177. Even after the Dow Jones crashed to a low in early-2009 of 6,469, college tuition still rose by 4.4% in the 2009-2010 school year to $26,273.
Annual tuition for a private four-year college in America is now $27,293, up 29% from five years ago. Meanwhile, the employment situation in the U.S. has deteriorated. There are currently 130.7 million non-farm jobs in America, down 3% from 134.5 million U.S. non-farm jobs in December 2005. 3.8 million jobs have been lost, while the U.S. population has grown by approximately 14 million people during the same time period. We would need to have seen the creation of 6.7 million non-farm jobs just to stay even, but now we are 10.5 million jobs short.
All across America, thousands of students are graduating law school each year with $250,000 in debt, but with no jobs at law firms available to them. 15,000 attorney and legal staff jobs have disappeared since 2008, yet 43,000 law degrees are being handed out each year. Law degrees are losing their value faster than the U.S. dollar is losing its purchasing power. Lawyers are non-producing workers that do nothing to create any real wealth for society. The artificially high incomes of lawyers are made possible entirely by inflation, which steals the wealth from hard working goods producing middle-class Americans and transfers it to those who add no real value to society.
The service sector currently makes up 76.9% of the U.S. GDP. Agriculture, which in 1933 made up 28% of GDP, currently makes up only 1.2% of GDP. The wealth of any country is primarily created at first from the production of food, oil, and precious metals. Secondly, wealth is created from the manufacturing of real consumer goods. After a country generates wealth by producing real things and builds a large domestic pool of savings, it can begin growing a service based economy, just so long as it has enough savings to support it.
During the past decade, an unprecedented number of Americans went to school to become lawyers, because they thought if they became a lawyer they would immediately become rich. 60% of the U.S. Senate and 37% of the House of Representatives are lawyers. The reason we have so many lawyers in Washington is so that they can pass as many new harmful laws and regulations as possible, in order to provide enough work for all of their lawyer friends. All of the needless legislation that is passed each year in order to provide work for lawyers, has the devastating unintended consequence of destroying what little is left of the free market. Small businesses are the backbone of the U.S. economy, but it is now nearly impossible for a small businessman with limited financial resources to build a large successful corporation in any sector, because their legal costs would eat up all of their profits.
Many law students got suckered into going to law school due to deceptive marketing practices. Some law schools are advertising that 90% of graduates are employed within one year of graduating. Sure, maybe 90% of law school graduates were employed a year later, with half of them working at McDonald's, but no law school degree is required for that. Schools are using dozens of unethical tactics to manipulate their numbers while encouraging alumni to falsify the surveys they fill out about their employment situation. Just like we are now seeing countless class action lawsuits against mortgage companies that misled customers about the loans they signed up for, we will soon see a massive number of lawsuits filed against colleges that lied about their job placement rates and average starting salaries of graduates. (At least there will be some work for law school graduates.)
Most Americans today are sheep who believe that the key to success and happiness in life is following the same career paths as everybody else. While everybody went to school to become a lawyer, nobody went to school to become a farmer because Americans didn't see any money in farming. With prices of nearly all agricultural commodities soaring through the roof in 2010 and with NIA expecting this trend to continue throughout 2011, the few new farmers out there are going to become rich while lawyers are standing at street corners with cups begging for money.
The college tuition bubble has been fueled by the U.S. government's willingness to give out easy student loans to anybody who applies for them. If it wasn't for government student loans, the free market would force colleges to provide the best quality education at the lowest possible price. By the government trying to make colleges more affordable, they have actually driven prices through the roof. Colleges have been encouraged to spend recklessly on wasteful construction projects, building new libraries, gyms, sports arenas, housing units, etc. Colleges spent $10.7 billion on construction projects in 2009. Although this is down from an average of $14.7 billion per year colleges spent on construction projects from 2005 to 2007, colleges are still struggling to pay off their old construction related debt. When interest rates start to rise, it will add further upside pressure to college tuition prices.
College students borrowed $106 billion in total student loans for the 2009-2010 school year, up from $96 billion in 2008-2009, $94 billion in 2007-2008, $87 billion in 2006-2007, and $83 billion in 2005-2006. Total student loan debt in the U.S. currently stands at $830 billion and now exceeds credit card debt. President Obama's new student loan bill that was passed last year now makes the government the primary lender to students. By taking the free market out of the student loan business and allowing students to receive loans from the government at artificially low interest rates, colleges will be encouraged to spend more recklessly than ever. None of this wasteful spending is doing anything to improve the quality of education in America.
Over a year ago when NIA was filming 'The Dollar Bubble' in Los Angeles, violent riots broke out at UCLA over a 32% increase in college tuitions (from $7,788 to $10,302). We went to the protest in order to video tape the shocking footage to show you. While we were there we remember thinking to ourselves, why on earth are these students protesting at all? If tuitions are rising by 32% and they are unhappy about it, why don't they quietly and peacefully enroll someplace else for college next semester. If not enough students enroll into UCLA, the university will be forced to either dramatically cut their costs or shut down. UCLA decided to completely ignore the riots and went ahead with the 32% rise in tuitions. Did the students decide to enroll someplace else? Nope, most of them simply took out larger student loans and went back to UCLA. In fact, UCLA reported that they received a record amount of freshman applicants for the next semester.
With all of the technological advancements taking place around the world today, the cost for a college education should be getting cheaper. Americans today can purchase just about any type of product they want over the Internet for substantially less than they can find it in a retail store. When the U.S. dollar collapses and the college bubble bursts, NIA predicts we will see a boom in online education where Americans take all of their courses over the Internet from the comfort of their own home at a fraction of the cost of traditional college.
Later this year, NIA is going to be producing a documentary about America's college education crisis and the college tuition bubble that is about to burst. In the weeks ahead, NIA is going to begin searching for people who deserve to be featured in our documentary. If you are a college student, a recent college graduate, or a current or ex-college professor with an extremely shocking, interesting, and important story that the whole world needs to know about in what will be the most viewed college documentary in world history, please send an email to firstname.lastname@example.org. We would also love to hear from any NIA member who has any ideas of topics that we should cover in this new documentary. Please send all ideas and suggestions to email@example.com.
This will truly be one of the most important documentaries NIA has ever produced. We need to change the mindset in America that only those with college degrees have any chance of becoming successful. Americans have become so brainwashed that even after graduating college with over $50,000 in debt and not being able to find a job, many of them are wasting even more years of their life and getting even deeper into debt to attend a graduate school, for a master's degree that is just as worthless as a bachelor's degree. It is like comparing a $10 bill (master's degree) to a $1 bill (bachelor's degree), they are both worthless pieces of paper with no intrinsic value.
NIA believes that any recent high school graduate with $30,000 saved for college who invests that money into silver and becomes a minimum wage apprentice for the next 4 years, will likely have enough money in 4 years to buy a median priced U.S. home. Not only that, but they will have work place experience that is far more valuable than the worthless college degrees of any of their friends. We must work hard to educate America to the truth if our country is going to have the wherewithal to survive the upcoming bursting college bubble and Hyperinflationary Great Depression.
It is important to spread the word about NIA to as many people as possible, as quickly as possible, if you want America to survive hyperinflation. Please tell everybody you know to become members of NIA for free immediately at: http://inflation.us
The Curse of the First American Austerity Generation: The Student Loan Debt Bubble
by Alan Nasser and Kelly Norman - Counterpunch
It was announced last summer that total student loan debt, at $830 billion, now exceeds total US credit card debt, itself bloated to the bubble level of $827 billion. And student loan debt is growing at the rate of $90 billion a year.
There are far fewer students than there are credit card holders. Could there be a student debt bubble at a time when college graduates' jobs and earnings prospects are as gloomy as they have been at any time since the Great Depression?
The data indicate that today's students are saddled with a burden similar to the one currently borne by their parents. Most of these parents have experienced decades of stagnating wages, and have only one asset, home equity. The housing meltdown has caused that resource either to disappear or to turn into a punishing debt load. The younger generation too appears to have mortgaged its future earnings in the form of student loan debt.
The most recent complete statistics cover 2008, when debt was held by 62 percent of students from public universities, 72 percent from private nonprofit schools, and a whopping 96 percent from private for-profit ("proprietary") schools.
For-profit school enrollment is growing faster than enrollment at public schools, and a growing percentage of students attending for-profit schools represent holders of debt likely to default. In order to get a better handle on the dynamics of student debt growth, it is helpful to sketch the connection between the current crisis in public education and the recent rapid growth of the for-profits.
Crisis of Public Education Precipitates Private Growth
Since the most common advise to the unemployed is to "get a college education", and tuition at public institutions is at least half or less than private-school rates, public higher education institutions have been swamped with an influx of out of work adults. This has resulted in enrollment gluts at many state colleges. At the same time, tuition is increasing just when household income and hence the affordability of higher education are declining.
Here is how this scenario unfolds:
With few exceptions, state-funded colleges and universities set tuition rates based on policy and budget decisions made by state legislatures. High and increasing unemployment and declining wages have resulted in declining public revenues. This in turn leads to budget cut directives from legislative bodies to public higher education institutions, often accompanied by the authority to increase tuition.
For example, a 14 percent budget cut to an institution may be "offset" by giving the governing boards of the school the authority to raise tuition by a maximum of 7 percent. Often the imbalance created by a cut to the base budget and an increase in tuition is made worse by limits on enrollment. A state legislative body may cut an institution's budget, allow it to increase tuition, but not provide per-student funding increases to keep pace with the accelerating enrollment demand.
This affects tuition rates at for-profit institutions. More students who would otherwise attend a state institution or a private, non-profit school are finding themselves without a seat at over-enrolled campuses. More students are pushed into the online and for-profit sectors, and proprietary schools sieze the day by inflating their tuition costs.
Because online colleges lack the enrollment constraints of a physical campus, they are uniquely poised to capture huge proportions of the growing higher education market by starting classes in non-traditional intervals (the University of Phoenix, for example, begins its online classes on a 5-week rolling basis) and without regard to space, charging ever-increasing rates to students who have no other choice.
Instead of waiting for an admissions decision or a financial aid package from a traditional college, students can enroll immediately online. This ease of use and accessibility to any student has allowed the for-profit sector to capture a growing portion of the higher education market and a growing proportion of education-targeted public money. Enrollments at for-profit colleges have increased in the last ten years by 225 percent, far outpacing public institution increases.
Thus, the neoliberal assault on public education not only tends to push more students into private institutions, it also generates upward pressure on tuition costs. This results in growing pressure on enrollees at proprietary schools to take on student loan debt.
How Healthy Are Student Loans?
The extraordinary growth of student debt paralleled the bubble years, from the beginnings of the dot.com bubble in the mid-1990s to the bursting of the housing bubble. From 1994 to 2008, average debt levels for graduating seniors more than doubled to $23,200, according to The Student Loan Project, a nonprofit research and policy organization. More than 10 percent of those completing their bachelor's degree are now saddled with over $40,000 in debt.
Are student loans as financially problematic as the junk mortgage securities still held by the biggest banks? That depends on how those loans were rated and the ability of the borrower to repay.
In the build-up to the housing crisis, the major ratings agencies used by the biggest banks gave high ratings to mortgage-backed securities that were in fact toxic. A similar pattern is evident in student loans.
The health of student loans is officially assessed by the "cohort-default rate," a supposedly reliable predictor of the likelihood that borrowers will default. But the cohort-default rate only measures the rate of defaults during the first two years of repayment. Defaults that occur after two years are not tracked by the Department of Education for institutional financial aid eligibility. Nor do government loans require credit checks or other types of regard for whether a student will be able to repay the loans.
There is about $830 billion in total outstanding federal and private student-loan debt. Only 40 percent of that debt is actively being repaid. The rest is in default, or in deferment (when a student requests temporary postponement of payment because of economic hardship), which means payments and interest are halted, or in forbearance. Interest on government loans is suspended during deferment, but continues to accrue on private loans.
As tuitions increase, loan amounts increase; private loan interest rates have reached highs of 20 percent. Add that to a deeply troubled economy and dismal job market, and we have the full trappings of a major bubble. As it goes with contemporary bubbles, when the loans go into default, taxpayers will be forced to pick up the tab, since just about all loans made before July 2010 are backed by the federal government.
Of course the usual suspects are among the top private lenders: Citigroup, Wells Fargo and JP Morgan-Chase.
Financial Aid and Subprime Lending
A higher percentage of students enrolled at private, for-profit ("proprietary") schools hold education debt (96 percent) than students at public colleges and universities or students attending private non-profits.
Two out of every five students enrolled at proprietary schools are in default on their education loans 15 years after the loans were issued. In spite of this high extended default rate, for-profit colleges are in no danger of losing their access to federal financial aid because, as we have seen, the Department of Education does not record defaults after the first two years of repayment.
Nor have the disturbing findings of recent Congressional hearings on the recruitment techniques of proprietary colleges jeopardized these schools'
access to federal funds. The hearings displayed footage from an undercover investigation showing admissions staff at proprietary schools using recruitment techniques explicitly forbidden by the National Association of College Admissions Counselors. Admissions and enrollment employees are also shown misrepresenting the costs of an education, the graduation and employment rates of students, and the accreditation status of institutions.
These deceptions increase the likelihood that graduates of for-profits will have special difficulties repaying their loans, since the majority enrolled at these schools are low-income students. (Forbes magazine, Oct. 26, 2010, "When For-Profits Target Low-Income Students", Arnold L. Mitchem)
A credit score is not required for federal loan eligibility. Neither is information regarding income, assets, or employment. Borrowing is still encouraged in the face of strong evidence that the likelihood of default is high.
Loaning money to anyone without prime qualifications was "subprime lending" during the ballooning of the housing bubble, when banks were enticing otherwise ineligible candidates to buy houses they could not afford.
Shouldn't easy lending without adequate credit checks to college students with insecure credit also be considered "subprime lending"?
Government Bias Toward Private Education
In 2009 President Obama initially pledged $12 billion in stimulus funds to help community colleges through the economic crisis. Last March that sum was slashed to $2 billion. The umpteenth example of a broken Obama promise.
We see a drastic cut in federal stimulus funding even as state funding for higher education is expected to fall even further. At a time when community colleges across the country are overflowing with returning students seeking new skills and high school graduates who can't afford ever-rising tuition rates at many four-year schools, the majority of education-bound stimulus funds are going to for-profit institutions, not community colleges. (Our home state of Washington illustrates the general direction of the administration's "reform" of higher education: for the first time in the state's history, public funds no longer pay the majority of higher education costs.)
Apart from stimulus funding, overall government student aid is disproportionately aimed at those attending proprietary schools. Nearly 25 percent of federal financial aid is spent on students attending for-profit colleges, even though these colleges enroll less than 10 percent of the nation's college students.
Proprietary schools now rely on federal financial aid – PELL Grants and federal loans – as their primary source of revenue.
Even the most profitable proprietary schools receive the majority of their funding from federal financial aid programs. According to a U.S.-Senate-sponsored study, The University of Phoenix, the largest private university in North America, receives 90 percent of its funding from the federal government. Not-so-incidentally, proprietary schools are among the largest donors to Education Committee members.
Proponents of the system defend it by pointing out that public colleges also rely on taxpayer subsidies for the majority of their revenue. But this overlooks a decisive difference: what proprietary schools don't have that public schools do, is an obligation as a state agency to deliver a high quality education to its students. Instead, proprietary schools have a legal fiduciary duty to their stockholders, like any other for-profit enterprise. As a result, according to a PBS Frontline investigation, the sector spends 20 to 25 percent of its budget on marketing and only 10 to 20 percent on faculty.
The Track Record of For-Profit Colleges
The track record of for-profit colleges does not justify their disproportionate share of government largesse. Drop out rates are higher than they are at public and non-proprietary private schools, often as high as 50 percent. Irrespective of whether a student drops out, the for-profit college has already pocketed tuition and fees. The student is left still burdened with a substantial loan obligation.
As for graduation rates, a 2008 report by the National Center for Education Statistics puts the graduation rate for students at for-profits beginning their studies in 2002 at 22 percent, an 11 percent drop from students enrolling in 2000. The same cohort attending public and private non-profits graduated at rates of roughly 54 percent and 64 percent, respectively. Graduate or not, the debt burden remains.
Suppose the student either seeks to transfer to a public or another non-profit, or completes her studies and enters the job market with a proprietary degree? Many students assume that credits are transferable to a public or nonprofit, but they aren't, so they pay twice to attain their degree. The school holds out the lure of high-paying jobs upon graduation, but either no such jobs exist or they require education or experience beyond what the school provided. Congressional studies have shown that the earnings of proprietary graduates are the lowest of all graduates. According to a 2009 Bloomberg report on salary comparisons between traditional and online degree-holders, graduates with bachelor's degrees from traditional colleges earn a median salary of $55,200, while those with degrees from the University of Phoenix earn only $50,500, and $43,100 from for-profit American Intercontinental.
On top of these earnings and job-prospect disadvantages, proprietary graduates bear the heaviest academic debt burden. The Education Department reports that 43 percent of those who default on student loans attended for-profit schools, even though only 26 percent of borrowers attended such schools. Many of those who attended for-profits don't earn enough to repay their loans. It's not uncommon for a student who either paid out of pocket or took out a loan for a $30,000 degree to find herself stuck in a $22,000 a year job. This only adds insult to injury: a Government Accounting Office study reports that "A student interested in a massage therapy certificate costing $14,000 at a for-profit college was told that the program was a good value. However, the same certificate from a local community college cost $520.00." (GAO, "For-Profit Colleges: Undercover Testing Finds Colleges Encouraged Fraud and Engaged in Deceptive and Questionable Marketing Practices", Nov. 30, 2010)
Paying back student loans out of low income and over a long period of time can rule out the possibility of making other financial investments required for the vanishing American Dream, such as buying a house, or saving for retirement or for one's children's education.
All in all, the for-profits' track record is more than dismaying. In too many cases, students leave proprietary schools in worse financial shape than they were in before they enrolled. The problem is not limited to proprietary graduates: this generation of college grads now possesses more debt than opportunity.
You might think that the unflattering record of for-profit schools would restrain government gift-giving. After all, the Obama administration's current education policy would punish "underperforming" public schools and teachers. But these policies target the public sector exclusively: the aim is to undermine teachers' unions and encourage privatization by boosting charter schools. It is entirely consistent with Washington's agenda that the dismal performance of proprietary schools does not jeopardize their future access to public financial aid funds - as long as the student does not default on their loan within two years of dropping out.
The Career College Association, the lobbying arm of publicly traded colleges, finds all this irrelevant. It relies on a different type of indicator from the rest of the higher education sector to measure the success of its for-profit colleges: stock prices. Remarkable. We see the disproportionate flourishing of "schools" whose primary concern has nothing to do with education.
The Private Lenders: Securitization As Usual
The two largest holders of student loans are SLM Corp (SLM) and Student Loan Corp (STU), a subsidiary of Citigroup. SLM -Sallie Mae- was originated as a Government Sponsored Enterprise (GSE) in 1972. The idea was to prime it for eventual privatization. In 2002 Sallie Mae shed the its GSE status and became a subsidiary of the Delaware-chartered publicly traded holding company SLM Holding Corporation. Finally, in 2004 the company officially terminated its ties to the federal government.
As the nation's largest single private provider of student loan funding, SLM has to date lent to more than 31 million students. In 2009 it lent approximately $6.3 billion in private loans and between $5.5 billion and $6 billion in 2010.
In the 1990s, well before its full privatization, Sallie's operations were increasingly swept into the financialization of the economy. It jumped whole hog onto the securitization bandwagon, lumping together and repackaging a large portion of its loans and selling them as bonds to investors. SLM created and marketed its own species of asset-backed securitized student loans, Student Loan Asset Backed Securities (SLABS). When derivatives trading went through the roof following the 1998 repeal of Glass-Steagal, increasingly diverse tranches of Sallie-Mae-backed SLABS entered the market. The company is now also buying and selling the obligations of state and nonprofit educational-loan agencies.
Student loans were included in the same securities that are blamed for the triggering of the financial crisis, and financial products containing these same student loans continue to be traded to this day. The health of these tranches and securities is, as we have seen, highly suspect.
SLM's risk was minimized as long as the feds guaranteed its loans. But as part of last March's health care legislation, starting in July 2010 federally subsidized education loans were no longer available to private lenders. What do education loans have to do with health care? Since the government took federal loan originations in-house, making them available only through the Department of Education, it no longer has to pay hefty fees (acting as the guarantee) to private banks. The Obama administration expects to save $68 billion between now and 2020. $19 billion of this will be used to pay for the $940 billion health care bill.
While there is scant relief for student borrowers, private banks manage to survive apparent setbacks just fine. SLM will do quite well despite the withdrawal of government backing. The company anticipated the change in government lending policy by executing an ingenious trick as a borrower. Early last year it made its insurance subsidiary a member of the Federal Home Loan Bank of Des Moines, which agreed to lend to big-borrower SLM at the extraordinary rate of .23 percent. And anyhow, subsidized loans are almost always insufficient to cover the entire cost of a college degree. For a while the student gets to enjoy the benefits of a government loan. Interest rates are lower and during deferment interest does not accrue. But eventually many students must also take out a private loan, usually in larger amounts and with higher interest rates which continue to mount during deferment.
The Worst-Case Scenario: Going Bankrupt
Credit card and even gambling debts can be discharged in bankruptcy. But ditching a student loan is virtually impossible, especially once a collection agency gets involved. Although lenders may trim payments, getting fees or principals waived seldom happens.
The Wall Street Journal ran a revealing report on the kinds of situation that can lead to financial catastrophe for a student borrower. ("The $550,000 Student Loan Burden: As Default Rates on Borrowing for Higher Education Rise, Some Borrowers See No Way Out", Feb. 13, 2010) Here is an excerpt illustrating the toll that forced indebtedness can take on the student borrower:
"When Michelle Bisutti, a 41-year-old family practitioner in Columbus, Ohio, finished medical school in 2003, her student-loan debt amounted to roughly $250,000. Since then, it has ballooned to $555,000.
It is the result of her deferring loan payments while she completed her residency, default charges and relentlessly compounding interest rates. Among the charges: a single $53,870 fee for when her loan was turned over to a collection agency.
Although Bisutti's debt load is unusual, her experience having problems repaying isn't. Emmanuel Tellez's mother is a laid-off factory worker, and $120 from her $300 unemployment checks is garnished to pay the federal student loan she took out for her son. By the time Tellez graduated in 2008, he had $50,000 of his own debt in loans issued by SLM... In December, he was laid off from his $29,000-a-year job in Boston and defaulted.
Heather Ehmke of Oakland, Calif., renegotiated the terms of her subprime mortgage after her home was foreclosed. But even after filing for bankruptcy, she says she couldn't get Sallie Mae, one of her lenders, to adjust the terms on her student loan. After 14 years with patches of deferment and forbearance, the loan has increased from $28,000 to more than $90,000. Her monthly payments jumped from $230 to $816. Last month, her petition for undue hardship on the loans was dismissed."
The First Austerity Generation's Job Prospects
Most of those affected by the meltdown of 2008 had completed their education and were either employed or retired. The student loan debt bubble signals a generation that enters the work of paid work cursed with what is more likely than not to be a life of permanent indebtedness and low wages.
The current cohort of indebted students will face earnings prospects far poorer than what job seekers could expect during the period of the longest wave of sustained economic growth and the highest wages in US history, 1949-1973. The present generation will experience the indefinite extension of Reagan-to-Obama low wage neoliberalism.
According to the National Association of Colleges and Employers more than 50 percent of all 2007 college graduates who had applied for a job had received an offer by graduation day. In 2008, that percentage tumbled to 26 percent, and to less than 20 percent in 2009. And a college education has been producing diminishing returns. For while a college degree does tend to correlate with a relatively high income, during the last eight to ten years the median income of highly educated Americans has been declining.
Every two years the Bureau of Labor Statistics issues projections of how many jobs will be added in the key occupational categories over the next ten years. The projected future jobs picture indicates that the grim employment situation is not merely a temporary reflection of the current unusually severe downturn. But you miss this if you get your news only from mainstream sources. The New York Times's report on the most recent BLS projections, released in December 2009, paints an unduly optimistic picture of future employment opportunities. (Catherine Rampell, "Where the Jobs Will Be", Dec. 15, 2009) Here is how a misleading report can be produced without falsifying the facts:
BLS releases two job projections, on the Fastest Growing Occupations and on Occupations With the Largest Job Growth. The Times focuses on the former, where the two fastest growing occupations, biomedical engineers and network systems and data communications analysts, require a college degree. The Times echoes BLS's comment that occupations requiring postsecondary (a bachelor's degree or higher) credentials will grow fastest. This is redolent of the ideology of the "New Economy" : the US is turning into a society of professionals and knowledge workers, and the key to success in this upgraded economy is a college education.
But we need more information, about the degree requirements of the total number of job categories listed in both projections, and about the number of new jobs expected to materialize in each projection.
Of the total jobs listed, only one of five require a postsecondary degree. By far the fastest growing category is biomedical engineers, projected to grow 72.02 percent, from 16,000 in 2008 to 27, 600 in 2018. That's 11,600 new jobs. Is that a lot? Well, compared to what? The percentage figure, 72.02, is high, but what about the number of new jobs? Let's compare that Fastest Growing occupation with retail salespersons, the occupation fifth down on the Largest Growth list. Retail sales workers will grow by a mere 8.35 percent. But that amounts to almost 375,000 new jobs, an increase from 4,489,000 jobs in 2008 to 4,863,000 jobs in 2018. Compare that to the 11,600 new jobs at the top of the Fastest Growing list. Just do the simple math on all the categories on both lists: the great majority of new jobs will be low-paying.
This is a nation of knowledge workers? Most new jobs will offer the kind of wage we would expect from an economy in which, according to one of Obama's most repeated mantras, "we" will "consume less and export more". BLS avers as much when it projects that fewer than 12 million of the 51 million "job openings due to growth and replacement needs" will require a bachelor's degree.
Our first austerity generation will be in debt to its teeth and stuck with low-wage work. The relative penury will require more debt still. Michael Hudson calls this debt peonage. Not to sound like a broken record, but we need to get off our asses and begin taking seriously political organization that goes beyond the ballot box. Not that voting is entirely irrelevant. We can imitate those activists -bankers, hedge fund managers, and corporate CEOs- who stoutly refuse to support, financially or at the ballot box, candidates who will not give them what they want. These days, those folks always get what they want. Liberals and too many Leftists have not learned that elementary political lesson.
Citigroup Was On The Verge Of Failure, New Report Finds; Rescue Was Based On 'Gut Instinct'
by Shahien Nasiripour - Huffington Post
Citigroup, the nation's third-largest bank by assets, was on the verge of being closed by regulators the week of Nov. 24, 2008 as depositors rapidly withdrew money and the bank's counterparties declined to provide it credit, according to a government report released Thursday.
The new findings shed light on the degree to which Citigroup, the financial services behemoth with a long history of finding itself in trouble and receiving government support, was actually in danger of failing during the fall of 2008. Until now, few were aware that Citi was perilously close to being shut down. "We were on the verge of having to close this institution because it can't meet its liquidity Monday morning," said Sheila Bair, chairman of the Federal Deposit Insurance Corporation, during a meeting the previous Sunday night, according to the report by the Special Inspector General for the Troubled Asset Relief Program.
"Without substantial government intervention," said another FDIC official, bank regulators and Citigroup "project that Citibank will be unable to pay obligations or meet expected deposit outflows next week," according to the report.Yet while policy makers unanimously agreed that Citigroup needed additional help -- this was after the megabank had already received $25 billion in TARP funds -- the "strikingly ad hoc" nature of the response was troubling, notes the inspector general, known as SIGTARP.
Citigroup's problems were well known to regulators. In May 2008 -- six months before the second multi-billion dollar infusion of taxpayer cash into the lender -- regulators at Geithner's New York Fed forced the bank to create a plan to strengthen its risk-monitoring practices so it could better judge the bank's exposures. A month later, bank overseers at the Office of the Comptroller of the Currency compelled the bank to enter into another agreement, this time requiring upgrades to the firm's risk management. That agreement is still in effect today, according to SIGTARP's report.
Even so, the consensus to give Citigroup more taxpayer cash "appeared to be based as much on gut instinct and fear of the unknown as on objective criteria," according to the report. One FDIC official told SIGTARP that policy makers "made a judgment call" on the degree of Citigroup's importance to the entire fabric of the financial system.
More than three years later, such judgment calls persist. Treasury Secretary Timothy Geithner, who effectively oversaw Citigroup as the then-president of the Federal Reserve Bank of New York, told SIGTARP during an interview last month that it's not possible to create effective, objective criteria for evaluating the risk a financial firm poses to the system. "It depends too much on the state of the world at the time," Geithner said Dec. 21. "You won't be able to make a judgment about what's systemic and what's not until you know the nature of the shock."
Geithner added that lenders would simply "migrate around" whatever objective criteria policy makers developed in advance. Taxpayers may once again have to support failing financial firms based on gut instinct alone. "In the future we may have to do exceptional things again if we face a shock that large," Geithner said, according to the report. "You just don't know what's systemic and what's not until you know the nature of the shock." The 2010 law overhauling financial regulation, known as Dodd-Frank, gives policy makers "better tools," Geithner said, "but you have to know the nature of the shock."
Given the ambiguity, SIGTARP notes that taxpayers likely won't know the extent to which they'd be on the hook for future shocks to the system until the next crisis. Despite the concerns about how regulators acted and how they might do so in the future, the report cautiously called the taxpayer rescue a success. Citigroup didn't fail, the financial system largely stabilized, and taxpayers turned a profit on their investment.
"We appreciate the report's conclusion that Treasury's investment in Citigroup was successful and that our efforts 'achieved the primary goal of restoring market confidence' during a time of unprecedented turmoil," Tim Massad, the Treasury official now overseeing the taxpayer bailout, said in an e-mailed statement. As for Citigroup, despite a Feb. 22, 2009, e-mail from Bair stating that the bank needed management changes "at the top of the house," much of its senior managers remain, including its chief executive, Vikram Pandit.
In addition, the internal auditor at another government agency, the Securities and Exchange Commission, is probing whether the SEC's top enforcement official, Robert Khuzami, gave preferential treatment to Citigroup executives in the agency's $75 million settlement with the firm last year over its alleged failure to adequately disclose crisis-era risks to investors, reports Bloomberg News.
Simon Johnson: Now US Taxpayers Are Subsidizing Goldman's Investment In Facebook--This Madness Must End!
by Henry Blodget - Tech Ticker
Although most Americans may think that the financial crisis and Wall Street bailouts are now just an embarrassing and regrettable moment in the country's history, this is far from the case, MIT Sloan School of Management professor Simon Johnson says. In fact, the taxpayer subsidies for the major Wall Street banks continue to this day.
These subsidies, professor Johnson says, take the form of special access to the Fed's "discount window" and ongoing, unwritten "Too Big To Fail" guarantees that the US taxpayers will cover any major losses the banks incur--by bailing them out all over again. These subsidies allow the big banks to borrow money at a lower cost than their smaller competitors, and, thereby, win market share and produce higher profits.
Bizarrely, professor Johnson adds, the subsidies mean that the US taxpayer is even subsidizing Goldman Sachs' recent $450 million investment in Facebook, one of the hottest tech companies on the planet. Goldman made the investment in Facebook using money borrowed from the Fed at subsidized rates. If the investment works out, of course, Goldman and its shareholders will keep all the profits. If the investment fails--and enough other things go wrong that Goldman needs another bailout--US taxpayers will pick up the tab.
This heads-I-win, tails-you-lose arrangement contributed to the last financial crisis, professor Johnson says--the crisis that led to the bailouts and almost brought the economy down. And the fact that the arrangement hasn't changed--that US taxpayers are still subsidizing Wall Street risk-taking and implicitly agreeing to cover all major losses--means that Wall Street has just gone right back to gambling up a storm again. And that, professor Johnson predicts, will eventually lead to another financial crisis.
Bill Daley’s Appointment Proves "The Bankers Have Won Completely"
by Peter Gorenstein - Tech Ticker
President Obama's new chief of staff, Bill Daley has been greeted with cheers and jeers - from both sides of the aisle - for his strong business and banking ties. To some, like Sen. Mitch McConnell, it's a positive sign the President has taken more pro-business stance. To Simon Johnson, author of 13 Bankers and the former IMF chief economist, it's a sign "the bankers have won completely."
The fact that President Obama's top aide is the former Midwest chairman of JPMorgan Chase proves "the White House fails to understand that, at the heart of our economy, we have a huge time-bomb," according to Johnson.
Why is Daley's appointment so troubling to Johnson?
"These banks again have unfettered access to the very top of the political decision making in the United States and, reflects the fact their status is completely undiminished, despite all the mistake they made and all the damage they did to the rest of the economy," he tells Henry in this clip.
That time-bomb he was referring to is another credit and banking crisis. Without more reform and a break-up of the 'too big to fail' banks, which is even less likely with Daley as chief of staff, Johnson is convinced banks are destined to repeat the same mistakes. "They have every incentive" to "blow themselves up," he laments, predicting another credit crisis will occur in the next three-to-seven years.
UK banks given go-ahead to pay unlimited bonuses
by Patrick Wintour, Jill Treanor and Allegra Stratton - Guardian
Britain's banks have been given the go-ahead to pay unlimited bonuses, drawing to a close a two-year political battle to rein in the City. After months in which a series of government ministers of all parties have threatened a toughening in the stance over City bonuses, Downing Street said the government did not intend to intervene in the pay of the UK's top bankers.
Ministers are instead hoping for a face-saving deal in which the banks agree to lending targets and improve the way they disclose their pay deals. One of the options being discussed is releasing information on the five highest paid individuals at each bank. "We've made a broad statement which is about the need to see some restraint and some responsibility from the banks, but we are not going to set bonus pools for individual banks," the prime minister's spokesman said.
Labour accused the government of capitulation and letting the bankers off the hook, urging the government to extend the bonus tax, which raised £3.5bn after it was introduced by Alistair Darling as a one-off measure in December 2009. The coalition government replaced that bonus tax with an annual levy on balance sheets which is estimated to yield about £2.5bn a year. Ed Miliband, the Labour leader, said this was, in effect, a tax cut for bankers.
Ministers rejected Labour's proposal, preferring to work a compromise deal that would placate Vince Cable, the Liberal Democrat business secretary who has been pressing for tougher measures. The government said an extension of the bonus tax would be self-defeating because bankers would become more skilled at avoiding the tax. The levy, the Conservatives said, would raise more money in the medium term.
City sources were reassured by the government's milder stance ahead of the appearance of Bob Diamond, Barclays' new chief executive, before a potentially hostile Treasury select committee today. The government's stance will be seen as a retreat from some of the aggressive rhetoric from the Liberal Democrats, but the government believes a hard-headed approach requires the government to focus on disclosure and measures that will improve lending, seen as the single most effective way of helping the British economy recover for recession.
Government sources said even if the government managed to get the size of bonus pools reduced by half from the expected total £7bn projected this year, there would be political flak, and it is better to focus government leverage on increasing net lending to business. Government officials also pointed out the Financial Services Authority has already adopted European Union rules curbing bonuses. Measures include the mandatory deferral of parts of a bonus, retention of portions paid in shares and strict conditions on guaranteed bonuses. The overall aim, the government said, was to curb risky banking practices in the pursuit of higher bonuses.
Nevertheless, Nick Clegg, the deputy prime minister, again urged the bankers to be sensitive. "I totally accept that the kind of sky-high numbers that are bandied about in the City of London seem to come from a parallel universe to many people who are struggling to deal with increased costs and so on. "But I think the key issue of principle is this: those people who are running the state-owned banks, who have benefited from immense generosity from British taxpayers, they have to be sensitive to what British taxpayers want."
The chancellor, George Osborne, will continue to seek an EU-wide deal on disclosure of pay bands above £1m, along the lines proposed by the City grandee Sir David Walker. He had initially proposed a UK-only deal before arguing international competition in banking required an EU-wide deal. It is possible Cable will get a more limited UK deal in the next fortnight, but there are concerns in parts of government that full-pay disclosure requirements will lead to inflationary pay pressures in banking as bankers realise how much their colleagues are being paid.
The banks may be forced to agree to publish deals of their highest five paid staff without identifying them – only HSBC does this at the moment, under the Hong Kong listing rules. Even so, this does not go as far as the proposals outlined by Walker, which Labour was planning to implement. Arguing his bonus tax would raise more than the bank levy Miliband said today: "It cannot be right that, when workers face below-inflation pay increases, if they get any rise at all, and families see prices on the high street rising, senior bankers keep raking in bonuses that are more in one year than most people can earn in a lifetime." He urged ministers to "take action", adding: "They should not get the scale of bonuses that is being talked about."
Miliband also came under pressure to say the Labour government had allowed public spending to get out of control, contributing to the country's record peace-time deficit. The Labour leader is expected to argue in coming weeks that the Labour government had been wrong not to state earlier in public that the banking crash required spending cuts to adjust to sudden and permanent loss in tax receipts. A Comres poll today showed Labour had opened up an an eight point lead over the Conservatives with Labour on 42 and the Conservatives on 34.
Geithner Warned That Future Bailouts Possible - TARP Overseer
by Alistair Barr - Dow Jones Newswires
Treasury Secretary Timothy Geithner warned that the U.S. government may have to bail out major financial institutions again if there's a crisis as big as the last one, according to a report released Thursday by a group overseeing the Troubled Asset Relief Program. "We may have to do exceptional things again if we face a shock that large," Geithner told the Office of the Special Inspector General for TARP in December.
SIGTARP, as the oversight group is known, spoke with Geithner during its investigation of the government bailout of Citigroup Inc. (C) . The group's findings were released Thursday. SIGTARP commended Geithner for his candor about possible bailouts in the future, but the group also said the Treasury secretary's comments highlight that TARP has left a legacy of "moral hazard associated with the continued existence of institutions that remain 'too big to fail.'" "It also serves as a reminder that the ultimate cost of bailing out Citigroup and the other 'too big to fail' institutions will remain unknown until the next financial crisis occurs," SIGTARP added in its report.
Citigroup said in a statement Thursday that when the financial crisis hit in the fall of 2008, it was "well-capitalized and liquid," but faced uncertainty resulting from "dysfunctional markets and a declining stock price." "The government's investment removed that uncertainty," the banking giant said. "As Citi CEO Vikram Pandit has said, we owe a debt of gratitude to the U.S. Government and the American taxpayer for providing Citi with TARP funds," the bank said. "This program restored confidence in the financial system and built a bridge to sound footing for many institutions."
Citigroup shares slipped 3 cents to $5.05 in afternoon trading on Thursday. The stock is down 90% in the past five years. Citigroup almost failed in November 2008, even after getting $25 billion from TARP's Capital Purchase Plan just weeks earlier, SIGTARP said in its report Thursday.
During a late-November weekend, officials including Geithner, then-Treasury Secretary Henry Paulson and FDIC Chairwoman Sheila Bair crafted a rescue for Citigroup that included asset guarantees and a $20 billion capital infusion in exchange for preferred stock in the company. Participants called it "Citi Weekend," according to SIGTARP.
Citigroup initially proposed that the U.S. government guarantee 100% of $306 billion in troubled assets in return for $20 billion of preferred stock. But officials rejected this and made a "take-it-or-leave-it" offer that required the bank to absorb the first $37 billion of losses in the asset pool, plus 10% of any losses beyond that, in return for $7 billion in preferred stock, SIGTARP's report said. Citi executives were concerned that the government's terms were too expensive and some bank insiders recommended against accepting the bailout, SIGTARP said, without identifying these people.
In the end, Citi accepted the deal. It's stock price stabilized, access to credit improved and the cost of insuring the company's debt dropped, SIGTARP reported. Just over a year later, Citi terminated the guarantee program and repaid the $20 billion it got from the government, the oversight group said. Citi also ended up absorbing all losses on assets that were guaranteed by the government. That totaled $10.2 billion by the time the guarantee ended, SIGTARP said.
The U.S. government ended up making more than $12 billion from its rescue of Citi, the group noted. "The Government constructed a plan that not only achieved the primary goal of restoring market confidence in Citigroup, but also carefully controlled the risk of Government loss on the asset guarantee," SIGTARP said. Still, SIGTARP said that the criteria used by government officials to decide whether to save Citi were "strikingly ad hoc." The FDIC's Bair told SIGTARP that the New York Fed warned told her that "problems would occur in global markets" if Citi failed.
"We didn't have our own information to verify this statement, so I didn't want to dispute that with them," Bair added, according to SIGTARP. Pandit told SIGTARP that no one knew what the systemic effect of a Citi failure would be, and that no one wanted to find out. John Reich, then-director of the Office of Thrift Supervision, said during a Nov. 23 FDIC board meeting that "selective creativity" was used to decide which financial institutions were systemic and which weren't. There "has been a high degree of pressure exerted in certain situations, and not in others, and I'm concerned about parity," Reich added, according to SIGTARP.
SIGTARP said this ad hoc approach to massive government bailouts can be avoided if regulators develop objective criteria and a "detailed roadmap" showing how these rules should be applied during future crises. However, Geithner told SIGTARP that it's impossible to develop such criteria because no one knows yet what the nature of another economic shock might be. Financial institutions and markets would just "migrate around" such rules, he added. SIGTARP countered that regulators must not simply accept that Wall Street with work around regulation. Instead, they must "maintain the flexibility to respond in kind."
Whitney Defends Muni Call, Sees 'Indiscriminate Selling'
by Jeff Cox - CNBC
Financial analyst Meredith Whitney is sticking by her call that the nation's municipalities face a wave of defaults, despite a wave of criticism over her prediction that hundreds of local governments would not meet their obligations. In fact, she took the forecast a step further and said when the defaults begin in earnest, it will mark an exodus from the muni bond market.
"When you have the first group of defaults you will see indiscriminate selling that would be a buying opportunity for some," the president of Meredith Whitney Advisory Group said in a CNBC interview. "Because there has been such complacency in the market and muni investors have been talked down to for so long—'There's nothing to worry about, there's nothing to worry about'—they'll just fly."
Whitney is most known for her call, before the financial system collapsed, that Citigroup was facing intense pressure from risky mortgage investments that would severely hamper the company as the subprime mortgage industry was collapsing. Since then, she has garnered headlines for various dire predictions about the state of the banking industry and its inability to recovery because of pressures from the struggling housing market.
But her foray into the municipal bond area has provoked some of the most intense criticism of her calls. Experts from Pimco's Bill Gross to the leader of the National League of Cities have doubted whether the problem with local and state government debt is as bad as Whitney is predicting. "We did this analysis in September," Whitney said. "I was scared to death to publish the analysis, understanding that this was a massive deal, probably the biggest call I ever made. We put thousands of man hours into this project. It took over two years to do."
She defended the call's validity, based on the shaky state of local finance and what she referred to as the "daisy chain" of financing from the federal to state to local governments that would not hold up anymore. Investors can still make money in munis, she said, but need to be very careful in how they proceed.
"You have to know what you own. You have to really do your homework in terms of knowing what supports your bonds," Whitney said. "There are great municipal investments out there, but on a blanket basis you have to be really careful about knowing what cash flows are supporting your investments."
Pimco’s Gross Clashes With Whitney Over Municipal-Bond Outlook
by Darrell Preston and Margaret Brennan - Bloomberg
Bill Gross, who manages the world’s biggest bond fund at Pacific Investment Management Co., clashed with Meredith Whitney, the banking analyst, when he said he doubted there would be many local-government bankruptcies. "Ultimately, municipal bankruptcies will be at a lower level," Gross said today on Bloomberg Television’s "InBusiness" program. "I don’t subscribe to the theory that there will be lots of them."
Whitney, who correctly predicted Citigroup Inc.’s dividend cut in 2008, said on CNBC earlier today that she expected accelerated "outflows" from the municipal-bond market as state finances deteriorate in the next six months. Last month she forecast 50 to 100 "significant" municipal-bond defaults this year totaling "hundreds of billions" of dollars. Gross, 66, said states will continue to face fiscal stress as long as Congress doesn’t subsidize them.
He praised Illinois’s passage of a 67 percent increase in personal income-tax rates early today to help close a $13 billion deficit equal to about half of this year’s spending and California Governor Jerry Brown’s efforts announced this week to close the state’s deficits equal to about 20 percent of spending.
Cities including Detroit and Harrisburg, Pennsylvania, have raised the prospect of bankruptcy. Still, the number of filings has declined. Six entities sought Chapter 9 protection under the bankruptcy code in 2010, compared with 10 in 2009, according to data compiled by James Spiotto, head of the bankruptcy practice at Chapman & Cutler, a Chicago law firm. The biggest last year was a South Carolina toll road with more than $300 million in debt, he said. U.S. states will contend with about $140 billion in deficits in the next fiscal year, the Center on Budget and Policy Priorities, a Washington research group, said in a report issued Dec. 16.
JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon, speaking yesterday at his company’s annual health-care conference in San Francisco, also said he expects more U.S. municipalities to declare bankruptcy and urged caution when investing in the public-debt market. "There have been six or seven municipal bankruptcies already," Dimon said. "Unfortunately you will see more."
Whitney, 41, founder of New York-based Meredith Whitney Advisory Group, said she expected more than 1 million job losses among state and local governments. "There have only been a couple hundred thousand so far," Whitney said. "The biggest cuts will come approaching in the spring. That’s a difficult employment situation to get around." Workers employed by local government fell 0.1 percent to 14.2 million, the smallest number since September 2006, after cities, towns and counties cut 20,000 jobs, the U.S. Labor Department said last week in Washington. Total state payrolls were little changed at 5.2 million last month, the figures show.
JPMorgan's CEO Dimon Says More U.S. Municipalities May File for Bankruptcy
by Christopher Palmeri and Andrew Frye - Bloomberg
JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said he expects more U.S. municipalities to declare bankruptcy and urged caution when investing in the $2.9 trillion public-debt market. "There have been six or seven municipal bankruptcies already," Dimon, 54, said yesterday at his company’s annual health-care conference in San Francisco. "I think unfortunately you will see more."
Cities including Detroit and Harrisburg, Pennsylvania, have raised the prospect of bankruptcy. Still, the number of filings has declined. Five municipal entities sought protection in 2010 compared with 10 in 2009, according to data compiled by James Spiotto, head of the bankruptcy practice at Chapman & Cutler, a Chicago law firm. The biggest last year was a South Carolina toll road with more than $300 million in debt, he said.
U.S. states will contend with about $140 billion in deficits in the next fiscal year, the Center on Budget and Policy Priorities, a Washington research group, said in a report issued Dec. 16. Edmund "Ted" Kelly, CEO of Liberty Mutual Holding Co., said yesterday that his firm had reduced holdings of municipal debt in Connecticut, California and Illinois. "The market is being held up to some extent by the belief that the federal government will bail out" state and local issuers, Kelly said in an interview.
Vallejo, California, filed for bankruptcy in 2008 after failing to win union pay cuts. Detroit Public Schools, which considered bankruptcy protection last year, said this month the district may try a restructuring to deal with a $327 million deficit.
Tax-exempt municipal-bond yields soared amid a U.S. Treasury selloff and expiration of the federally subsidized Build America Bond program in last year’s fourth quarter. The securities lost 4.5 percent in that period, according to the Bank of America Merrill Lynch Municipal Master Index, the worst performance in more than 16 years. "If you are an investor in municipals you should be very, very careful," Dimon said at the conference.
Companies including Allstate Corp., the largest publicly traded U.S. home and auto insurer, have been reducing holdings of municipal debt. Warren Buffett, whose Berkshire Hathaway Inc. trimmed its investment in municipal debt, predicted last year a "terrible problem" for the bonds. Liberty Mutual had about $13.7 billion in municipal securities as of Sept. 30, or about 20 percent of invested assets, compared with $15.5 billion and 23 percent at the end of 2009, according to company statements. The Sept. 30 total includes $372 million from the state of Florida and $278 million from the state of California.
The company, based in Boston, still has holdings from the three states, Kelly said. California and Illinois are rated A1 by Moody’s Investors Service, the lowest among the states and the company’s sixth-highest ranking. Connecticut is rated Aa2, Moody’s fourth-highest. Gregory Whiteley, U.S. government portfolio manager at Los Angeles-based investment firm DoubleLine Capital LP, suggested in a report yesterday that investors consider municipal bonds because the risk of bankruptcy is low. "The financial stress of state and local governments has given rise to an unusual investment opportunity," he wrote.
The Fed Has Spoken: No Bailout for Main Street
by Ellen Brown
The Federal Reserve was set up by bankers for bankers, and it has served them well. Out of the blue, it came up with $12.3 trillion in nearly interest-free credit to bail the banks out of a credit crunch they themselves created. That same credit crisis has plunged state and local governments into insolvency, but the Fed has now delivered its ultimatum: there will be no "quantitative easing" for municipal governments.
On January 7, according to the Wall Street Journal, Federal Reserve Chairman Ben Bernanke announced that the Fed had ruled out a central bank bailout of state and local governments. "We have no expectation or intention to get involved in state and local finance," he said in testimony before the Senate Budget Committee. The states "should not expect loans from the Fed."
So much for the proposal of President Barack Obama, reported in Reuters a year ago, to have the Fed buy municipal bonds to cut the heavy borrowing costs of cash-strapped cities and states. The credit woes of state and municipal governments are a direct result of Wall Street's malfeasance. Their borrowing costs first shot up in 2008, when the "monoline" bond insurers lost their own credit ratings after gambling in derivatives. The Fed's low-interest facilities could have been used to restore local government credit, just as it was used to restore the credit of the banks. But Chairman Bernanke has now vetoed that plan.
Why? It can hardly be argued that the Fed doesn't have the money. The collective budget deficit of the states for 2011 is projected at $140 billion, a mere drop in the bucket compared to the sums the Fed managed to come up with to bail out the banks. According to data recently released, the central bank provided roughly $3.3 trillion in liquidity and $9 trillion in short-term loans and other financial arrangements to banks, multinational corporations, and foreign financial institutions following the credit crisis of 2008.
The argument may be that continuing the Fed's controversial "quantitative easing" program (easing credit conditions by creating money with accounting entries) will drive the economy into hyperinflation. But creating $12.3 trillion for the banks -- nearly ten times the sum needed by state governments -- did not have that dire effect. Rather, the money supply is shrinking - by some estimates, at the fastest rate since the Great Depression. Creating another $140 billion would hardly affect the money supply at all.
Why didn't the $12.3 trillion drive the economy into hyperinflation? Because, contrary to popular belief, when the Fed engages in "quantitative easing," it is not simply printing money and giving it away. It is merely extending CREDIT, creating an overdraft on the account of the borrower to be paid back in due course. The Fed is simply replacing expensive credit from private banks (which also create the loan money on their books) with cheap credit from the central bank.
So why isn't the Fed open to advancing this cheap credit to the states? According to Mr. Bernanke, its hands are tied. He says the Fed is limited by statute to buying municipal government debt with maturities of six months or less that is directly backed by tax or other assured revenue, a form of debt that makes up less than 2% of the overall muni market. Congress imposed that restriction, and only Congress can change it.
That may sound like he is passing the buck, but he is probably right. Bailing out state and local governments IS outside the Fed's mandate. The Federal Reserve Act was drafted by bankers to create a banker's bank that would serve their interests. No others need apply. The Federal Reserve is the bankers' own private club, and its legal structure keeps all non-members out.
Earlier Central Bank Ventures into Commercial Lending
That is how the Fed is structured today, but it hasn't always been that way. In 1934, Section 13(b) was added to the Federal Reserve Act, authorizing the Fed to "make credit available for the purpose of supplying working capital to established industrial and commercial businesses." This long-forgotten section was implemented and remained in effect for 24 years. In a 2002 article called "Lender of More Than Last Resort" posted on the Minneapolis Fed's website, David Fettig summarized its provisions as follows:
- [Federal] Reserve banks could make loans to any established businesses, including businesses begun that year (a change from earlier legislation that limited funds to more established enterprises).
- Reserve banks were permitted to participate [share in loans] with lending institutions, but only if the latter assumed 20 percent of the risk.
- No limitation was placed on the amount of a single loan.
- A Reserve bank could make a direct loan only to a business in its district.
Today, that venture into commercial banking sounds like a radical departure from the Fed's given role; but at the time it evidently seemed like a reasonable alternative. Fettig notes that "the Fed was still less than 20 years old and many likely remembered the arguments put forth during the System's founding, when some advocated that the discount window should be open to all comers, not just member banks." In Australia and other countries, the central bank was then assuming commercial as well as central bank functions.
Section 13(b) was repealed in 1958, but one state has kept its memory alive. In North Dakota, the publicly owned Bank of North Dakota (BND) acts as a "mini-Fed" for the state. Like the Federal Reserve of the 1930s and 1940s, the BND makes loans to local businesses and participates in loans made by local banks. The BND has helped North Dakota escape the credit crisis. In 2009, when other states were teetering on bankruptcy, North Dakota sported the largest surplus it had ever had. Other states, prompted by their own budget crises to explore alternatives, are now looking to North Dakota for inspiration.
The "Unusual and Exigent Circumstances" Exception
Although Section 13(b) was repealed, the Federal Reserve Act retained enough vestiges of it in 2008 to allow the Fed to intervene to save a variety of non-bank entities from bankruptcy. The problem was that the tool was applied selectively. The recipients were major corporate players, not local businesses or local governments. Fettig writes:Section 13(b) may be a memory, . . . but Section 13 paragraph 3 . . . is alive and well in the Federal Reserve Act. . . . [T]his amendment allows, "in unusual and exigent circumstances," a Reserve bank to advance credit to individuals, partnerships and corporations that are not depository institutions.
In 2008, the Fed bailed out investment company Bear Stearns and insurer AIG, neither of which was a bank. John Nichols reports in The Nation that Bear Stearns got almost $1 trillion in short-term loans, with interest rates as low as 0.5%. The Fed also made loans to other corporations, including GE, McDonald's, and Verizon.
In 2010, Section 13(3) was modified by the Dodd-Frank bill, which replaced the phrase "individuals, partnerships and corporations" with the vaguer phrase "any program or facility with broad-based eligibility." As explained in the notes to the bill:Only Broad-Based Facilities Permitted. Section 13(3) is modified to remove the authority to extend credit to specific individuals, partnerships and corporations. Instead, the Board may authorize credit under section 13(3) only under a program or facility with "broad-based eligibility.".
What programs have "broad-based eligibility" isn't clear from a reading of the Section, but long-term municipal bonds are evidently excluded. Mr. Bernanke said that if municipal defaults became a problem, it would be in Congress' hands, not his.
Congress could change the law, just as it did in 1934, 1958, and 2010. It could change the law to allow the Fed to help Main Street just as it helped Wall Street. But as Senator Dick Durbin blurted out on a radio program in April 2009, Congress is owned by the banks. Changes in the law today are more likely to go the other way. Mike Whitney, writing in December 2010, noted:So far, not one CEO or CFO of a major investment bank or financial institution has been charged, arrested, prosecuted, or convicted in what amounts to the largest incident of securities fraud in history. In the much-smaller Savings and Loan investigation, more than 1,000 people were charged and convicted. . . . [T]he system is broken and the old rules no longer apply.
The old rules no longer apply because they have been changed to suit the moneyed interests that hold Congress and the Fed captive. The law has been changed not only to keep the guilty out of jail but to preserve their exorbitant profits and bonuses at the expense of their victims.
To do this, the Federal Reserve had to take "extraordinary measures." They were extraordinary but not illegal, because the Fed's congressional mandate made them legal. Nobody's permission even had to be sought. Section 13(3) of the Federal Reserve Act allows it to do what it needs to do in "unusual and exigent circumstances" to save its constituents.If you're a bank, it seems, anything goes. If you're not a bank, you're on your own.
So Who Will Save the States?
Highlighting the immediacy of the local government budget crisis, The Wall Street Journal quoted Meredith Whitney, a banking analyst who recently turned to analyzing state and local finances. She said on a recent broadcast of CBS's "60 Minutes" that the U.S. could see "50 to 100 sizable defaults" in 2011 among its local governments, amounting to "hundreds of billions of dollars." If the Fed could so easily come up with 12.3 trillion dollars to save the banks, why can't it find a few hundred billion under the mattress to save the states? Obviously it could, if Congress were inclined to put non-bank lending back into the Fed's job description. Then why isn't that being done?
The cynical view is that the states are purposely being kept on the edge of bankruptcy, because the banks that hold Congress hostage want the interest income and the control. An even darker theory is that there is an intentional attempt to break the middle class in order to bring America down to the level of a third world country, a necessary precedent to imposing One World Government. Whatever the reason, Congress is standing down while the nation is sinking.
Congress must summon the courage to take needed action; and that action is not to impose "austerity" by cutting services, at a time when an already-squeezed populace most needs them. Rather, it is to create the jobs that will generate real productivity. To do this, Congress would not even have to go through the Federal Reserve. It could issue its own debt-free money and spend it on repairing and modernizing our decaying infrastructure, among other needed works. Congress' task will become easier if the people stand with them in demanding action, but Congress is now so gridlocked that change may still be long in coming.
In the meantime, the states could take matters in their own hands and set up their own state-owned banks, on the model of the Bank of North Dakota. They could then have their own very-low-interest credit lines, just as the Wall Street banks do. Rather than spending or selling off valuable public assets, or hoarding them in massive rainy day funds made necessary by the lack of ready credit, states could LEVERAGE their assets into a very strong and abundant local credit system, following the accepted business practices of the Wall Street banks themselves.
Fed's Fisher: U.S. asset-buying has reached a limit
by Brian Snyder, Jonathan Spicer - Reuters
The U.S. Federal Reserve should stop expanding its already bloated balance sheet, a top Fed official said on Wednesday, adding he voiced strong concerns about the U.S. central bank's $600-billion bond-buying program when it was decided in November. "Barring some unexpected shock to the economy or financial system, I think we have reached our limit," Dallas Federal Reserve Bank President Richard Fisher said in remarks prepared for delivery to a Manhattan Institute luncheon. "I would be wary of further expanding our balance sheet."
The Fed embarked on its latest round of Treasury securities purchases in November, a controversial "quantitative easing" plan known as QE2 that is meant to kick-start the slow U.S. economic rebound. Fisher, an inflation "hawk", rotates into a voting slot on the Fed's policy-setting panel this year. It was unclear from his prepared remarks whether he was opposed to yet another round of bond-buying, or was advocating that the current program be cut short.
In the past, Fisher questioned the efficacy of QE2, but this week said in a published interview that he expected the program to run its course through the end of June. In his Wednesday speech, Fisher said he expressed "strong concern" about QE2 at the Fed's Nov. 3 meeting, noting there are limits to the central bank's monetary actions. Since then, he said, "recent data make clear that the risks of a double-dip recession and deflation have ebbed and that economic growth and job creation are beginning to flow."
Critics of QE2 warn it lays the groundwork for a sharp ramp-up in inflation, and say it could lead to asset bubbles in unexpected areas of the economy. The unemployment rate fell to 9.4 percent last month, a still-high level that's well above what most Fed officials see as healthy. Data have also shown a boost in U.S. consumer spending and trade, and a drop in jobless benefit claims, suggesting the world's biggest economy is on the mend.
But the recovery is slow. The economy generated fewer jobs than expected last month, and revealed a troubling rise in the number of people exiting the workforce -- some credence for "dovish" backers of QE2. Core inflation is running at about 1 percent, down from 2.5 percent before the recession triggered by the financial crisis. Fisher, in his first public speech of the year, said investment in new jobs remained slow. He repeated that it was up to what he called a newly elected "radical" Congress -- not the Fed -- to make the fiscal and regulatory decisions needed for job creation.
QE2 put the Fed into a tricky political spot, Fisher said. "By this action, we have run the risk of being viewed as an accomplice to Congress' fiscal nonfeasance." Some argue the Fed should begin as early as this year in rolling back its unprecedented stimulus. Fed officials in recent days have begun to detail their stance for the new year, with many rallying behind QE2 before Fed Chairman Ben Bernanke convenes the first Fed policy meeting this year on Jan. 25-26.
Illinois Lawmakers Pass 67% Income Tax Increase
by Tim Jones - Bloomberg
Illinois lawmakers in the waning hours of their term passed a 67 percent income-tax increase, the largest in the state’s history, to help close a $13 billion budget deficit. The boost in the tax rate to 5 percent from 3 percent was approved by both chambers. Governor Pat Quinn, a Democrat, has supported an increase. A new Legislature will be sworn in today.
The increase, intended to last through 2014, is aimed at fixing Illinois’s worst fiscal crisis, including a backlog of more than $6 billion in unpaid bills and almost $4 billion in missed payments to underfunded state pensions. The deficit amounts to about half of planned general-fund spending for this fiscal year, which ends in June. "The wolf is at the door and we have some very difficult decisions to make," said Representative Gregory Harris, a Democrat from Chicago. Democrats in the House of Representatives passed the measure by the minimum necessary vote, 60-57, with no Republican support.
The Senate yesterday also approved a measure to allow the state to borrow $3.7 billion for this fiscal year’s pension payment. Quinn has said he will sign the bill, which passed the House in May. Raising the income-tax rate to 5 percent would generate an extra $6 billion in revenue annually, Illinois Budget Director David Vaught estimated in a July interview. Illinois and other U.S. states will confront deficits totaling $140 billion in the next fiscal year, according to a Dec. 16 report from the Center on Budget and Policy Priorities, a Washington research group.
"There are some actions being taken," Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co., said today in a Bloomberg Television interview with Margaret Brennan. "Illinois -- hooray!" Richard Ciccarone, managing director of McDonnell Investment Management LLC in Oak Brook, Illinois, said, "It’s going to take a long time for the state to rebuild the trust of the marketplace." His firm holds more than $7 billion of municipal bonds. "Investors are concerned about the sustainability of the state’s finances to weather future downturns," he said. "You can’t just keep raising taxes every time there’s a downturn."
Two Bills Died
Two other elements of the Democrats’ budget-balancing plan failed in the House -- a $1 per-pack increase in the cigarette tax and authorization for $8.5 billion in bonds to cover the backlog of unpaid bills. The state’s flat-rate levy on income ranks lower than most in the Midwest, according to a February report by the Federation of Tax Administrators in Washington. Indiana was lowest at 3.4 percent, followed by Michigan, at 4.35 percent. The top rates were 7.85 percent in Minnesota, 6.24 percent in Ohio and 8.98 percent in Iowa, the study showed.
Quinn, elected to his first full term in November, has said that one percentage-point of the income-tax increase, or about $3 billion by Vaught’s analysis, should be dedicated to education. The widening gap between Illinois’s expenses and revenue has drawn criticism from Moody’s Investors Service. The imbalance, and the state’s practice of delaying bill payments, underscores its "chronic unwillingness to confront a long-term, structural budget deficit," Moody’s said in a Dec. 29 study.
Borrowing for Bills
The state continues to borrow to pay its bills. In November, the state sold $1.5 billion of bonds backed by tobacco-settlement payments to help pay vendors. The state had $64 billion of pension assets to pay estimated liabilities of $126.4 billion as of June, about half the amount needed for almost 723,000 workers, retirees and other beneficiaries, according to bond documents.
Illinois and California are rated A1 by Moody’s, the fifth- highest investment grade and the lowest level for any state’s general-obligation debt. Standard & Poor’s rates Illinois slightly higher, at A+, its fifth highest grade, than California, which it gives an A-, four steps above junk status. In September, Moody’s forecast possible "further financial deterioration" in Illinois, citing budget issues. Illinois and Arizona were the weakest states in a Dec. 30 financial-strength index report from BMO Capital Markets analysts led by Justin Hoogendoorn in Chicago
Illinois Senate Authorizes $3.7 Billion Pension Debt
by by Tim Jones - Bloomberg
The Illinois Senate, facing the state’s worst fiscal crisis, cleared the way for the state to borrow $3.7 billion for this fiscal year’s payment into underfunded employee pensions. The bond measure was approved 42-16 in the final hours of the legislative session, moments after the Senate gave final approval to a 67 percent increase in the income-tax rate. Governor Pat Quinn, a Democrat, has said he will sign the bill, which passed the state House of Representatives in May.
Illinois had $64 billion in pension assets to pay estimated liabilities of $126.4 billion to 723,000 retirees and beneficiaries, according to bond documents in June. Senate President John Cullerton said the higher income tax will eliminate the need to borrow for next year’s pension payments. The bond and tax measures were intended to help close a $13 billion budget deficit. Business leaders warned that a failure to adequately fund pensions would leave the retirement plans out of money to pay promised benefits before 2020.
A year ago, the state sold $3.47 billion of taxable pension bonds, paying more than some comparably ranked U.S. companies, according to data compiled by Bloomberg. Illinois borrowed at as much as 4.421 percent on notes maturing in one to five years. That was 1.82 percentage points higher than five-year U.S. Treasuries.
The House defeated two other parts of the budget-balancing package, rejecting a $1 per-pack cigarette-tax increase and a plan to borrow $8.5 billion to cover the unpaid bills. The state sold $1.5 billion of bonds backed by tobacco- settlement payments in November to reduce the backlog of bills from vendors. New York-based Moody Investor’s Service in September forecast possible "further financial deterioration" in the state’s outlook.
The Public-Pension Punching Bag
by Chris Farrell - BusinessWeek
Mention pensions and—until recently—most people pictured a secure income in old age, possibly including happy thoughts of leisurely trips and visits from grandchildren. Assuming they were lucky enough to have a pension, their eyes would glaze over if the conversation steered toward years-of-service formulas, funding ratios, and other aspects of the arcane and obtuse inner workings of pension funds.
No more. The deteriorating condition of many state and local government pension funds has grown into an impassioned topic for cable talk shows. The financial meltdown and economic downturn have made obvious what many experts long knew: Too many state and local governments routinely underfunded their pension plans while the future cost of their retirement payout promises swelled.
Take Illinois, which has funded only 54 percent of its public pension liability, according to the Pew Center on the States. This financing gap translates into a $54.4 billion bill that is more than three times as large as the payroll for current workers participating in the state's pension program. The generosity of many public pensions is an incendiary topic, with taxpayers potentially on the hook for billions and billions in unfunded promises.
"These are structural issues and not just a reflection of where we are at in the economic cycle," says Joshua Rauh, economist at the Kellogg School of Management at Northwestern University. Adds Robert Clark, economist at the Poole College of Management at North Carolina State University: "The next decade will be one of fundamental reform in public sector pensions."
Reforming won't be easy. The harsh fiscal reality is that in most cases, public pension obligations in states and cities can't be changed for existing workers. Those workers will continue to earn their promised pension benefits throughout their government career, although a number of state governments are trying to tinker at the margin, such as by changing cost-of-living payments.
Municipalities in Chapter 9 bankruptcy can renegotiate pensions. (In sharp contrast, companies can freeze promised benefits to-date for their workforce, then modify the plan's future returns). As a consequence, public pension reform will mostly affect new hires. In the current political discussion, it is said that if the 401(k) is good enough for private sector workers, it must be fine for the public sector.
Why Go To "The Lowest Common Denominator?"
Yet three decades after the 401(k) was launched, its own drawbacks are becoming increasingly apparent. "There is certainly 'pension envy' and the answer is, 'let's go to the lowest common denominator,'" says Alicia Munnell, director of the Center for Retirement Research at Boston College. "That doesn't make sense."
Indeed, the heated rhetoric is obscuring the fact that pressure for change offers a real chance at designing a better 401(k)-type pension. Pension experts agree that unlike the current generation of private-sector 401(k)s, public-sector plans should feature a very limited menu of broad, low-fee investment options; mandatory worker participation; a required employer match; and low-cost inflation-hedged annuity options to guarantee a fixed income in retirement. It's an approach the private sector may eventually want to emulate.
"I have grown increasingly frustrated that this is boiling down to a debate of taxpayers versus government workers," says Jeffrey Brown, professor of finance at the College of Business at the University of Illinois at Urbana-Champaign. "The public pensions are ripe for reform and it's a real opportunity for everyone."
A majority of government employees are covered by "defined-benefit" pension plans. To most of us, these are the blue-chip pensions from days past, by which the employer bears all the investment risk and commits to a fixed payout of money based on a salary-and-years-of-service formula. Many more private-sector employers used to offer defined-benefit plans, but they are costly to run and carry onerous obligations toward retirees.
The Age Of Defined-contribution Plans
Companies ended up embracing comparatively cheaper defined-contribution plans, especially the 401(k). In these, employees decide how much money to invest and where to invest it, depending on the limits established by law and the choices offered by the employer. The company might kick in a matching contribution, but employees bear all the investment risk. For instance, according to a June 2010 survey by consultants Tower Watson, 58 of the 100 largest American companies offered new employees only a defined-contribution pension—vs. 10 in 1998—while only 17 of the companies surveyed had a defined-benefit plan, down from 67 in 1998.
To be sure, most public employees have the option of participating in a defined-contribution plan at work, usually as a supplement to the core defined-benefit pension. The 401(k) is the bedrock savings plan in the private sector. Increasingly it's the only option available.
It is now becoming apparent that the future tab for state and local defined-benefit pension plans is even bigger than expected. On average, most public plans assume that they'll earn 7 percent to 8.5 percent on their investments. Yet finance economists argue convincingly that a more realistic range for such a fixed obligation might be 3 percent to 5 percent. The lower number swells the amount state and local governments might have to kick in to pay retirees.
For example, assuming that all state pension liabilities were frozen as of June 2009, Northwestern's Rauh and Robert Novy-Marx of the Simon School of Business at the University of Rochester estimate that unfunded liabilities swell to $3 trillion at a more conservative rate—almost double the $1.8 trillion shortfall under standard public-pension practice. "It isn't a viable funding model," says Olivia Mitchell, an economist at the University of Pennsylvania's Wharton School.
One complication of just replacing pensions with 401(k)-type plans for new government employees is that many state and local workers aren't part of Social Security. They weren't included when Social Security was created in 1935; while growing numbers have been brought into the system, about a third still don't participate. "If you have Social Security, you have a floor, and the private sector would have had a much more difficult time making the shift from defined benefit to defined contribution without Social Security," says Rauh. "If the only thing workers have is a 401(k) plan, they have a great deal of risk."
Social Security Or Deep Cuts?
The solution seems to be either to bring all new state and local workers into Social Security or keep public defined-benefit plans for those workers, dramatically slashing the payout until it essentially mirrors the income-replacement ratios of Social Security.
With a base consisting of Social Security or a truncated, fully funded pension plan, the 401(k)-like portion could be modeled after the federal government's Thrift Savings Plan. This is a voluntary 401(k)-type plan open to all federal employees. Fees are a razor-thin.028 percent—28 cents per $1,000 of investment. However, any state and local government version would have to mandate both employee participation and an employer contribution.
Another widely admired model could be TIAA-CREF for higher education, which similarly offers a limited number of broad-based investment options and low fees. Employees are automatically placed in the plan with mandatory contributions from employer and employee. Perhaps most important, the TIAA portion of the plan offers savers the option of easily transforming some or all of their money into a low-cost guaranteed annuity with a 3 percent minimum annual interest rate. Building into the plan the option of an annuity-like product with a strong inflation hedge could well combine the best of defined contribution and defined benefit plans, says Zvi Bodie, finance economist at Boston University School of Management.
Right now, the prospects for a reasoned overhaul of public pensions seems remote. There is almost a pension panic sweeping state houses and municipal headquarters, hardly an environment conducive to reform. Yet public officials have an opportunity to create a better retirement savings plan that might spark a different kind of pension envy. If this were done right, it could inspire the private sector to follow the public sector's lead.
World's ATMs Pump Billions Into Wrong Places
by William Pesek - Bloomberg
It’s official: the world economy is completely upside down.
What else is one to think as Europe goes hat-in-hand to developing China and feeble Japan? You would think China had better things to do with its cash than shore up a sinking euro zone. The same goes for Japan, where deflation and paralysis may soon deliver the sixth prime minister since September 2007. Japan plans to buy bonds issued by Europe’s financial-aid fund, joining China in assisting a region battling a fast- spreading debt crisis. And does Europe ever need the help. Bailouts of Greece and Ireland merely pave the way to even bigger ones of Portugal, Spain and, perhaps, Italy.
It’s this last economy that should have officials in Beijing and Tokyo thinking twice about loading up on European debt. Yet here’s something even bigger to consider: what the world really needs isn’t China’s and Japan’s excess cash, but more balanced and sustainable growth in Asia’s main economies. Europe’s debt woes are just beginning. No matter what the region’s policy makers do, they’re still stuck with a currency they can’t devalue and massive and growing debt loads. Buying Europe’s debt may Band-Aid things over, but China and Japan can’t stop the inevitable worsening of the euro crisis.
Consider this a "We-Are-the-World" moment. Japan, flush with more than $1 trillion of reserves, also is thinking as much about diplomacy as economics. Helping Europe in its time of need will score points for a nation losing power and prestige. Japan’s aid seems more of a me-too gesture to match China than a long-term strategy.
It doesn’t seem like a huge risk, either. The European Financial Stability Facility will raise as much as 16.5 billion euros ($21 billion) to help bail out Ireland. It plans to issue between 3 billion and 5 billion euros of AAA-rated bonds later this month, of which Japan may buy more than 1 billion euros. As Europe’s debt mess worsens, though, Japan’s investment may go bad in a hurry.
Rather than tossing money around, Japan should get busy reviving its economy once and for all. It should act boldly to encourage entrepreneurship, learn to live without huge government borrowings and zero interest rates, increase immigration, raise productivity and boost competitiveness. Japan is doing none of the above, and that’s detrimental to the outlook for world growth. At least Asia’s second-biggest economy isn’t spreading contagion around the globe in the manner of Europe. A few more years of muddling along and avoiding reform, though, could put Japan in dangerous waters.
The nation’s bond market has long been a financial pressure cooker. Even though public debt is twice the size of the economy, 10-year bond yields are less than 1.2 percent. It makes no fundamental sense, even in an economy facing modest deflation. The risk of a Japanese debt meltdown looms. It’s imperative that Japan learns to grow without adding to the debt.
China, meanwhile, should close the checkbook and instead fix imbalances that destabilize markets. The first step is faster yuan appreciation. China shouldn’t do it because the U.S. is demanding action, but because it’s in China’s interest. Surging food and oil prices will exacerbate overheating risks.
Higher borrowing costs and regulatory tweaks aren’t enough. A big yuan revaluation would help officials in Beijing regain control, while raising the international purchasing power of 1.3 billion people. It’s great that China is voicing support for Europe and backing it up with bond purchases. It would be even better if China restructured on its own.
China’s financial might is a product of its $2.8 trillion of currency reserves. We’re long past the late 1990s when the International Monetary Fund’s vault contained enough liquidity to save countries from ruin. Should Spain come knocking, bigger benefactors will be needed. Yet Asia’s savings won’t be enough if a key economy like Italy crashes, and it can’t be ruled out.
It’s no longer debatable whether the global financial system is upside down. The shift began with the realization that economies such as China, India and Brazil might eclipse the U.S. in the next 30 or 40 years. It got positively tectonic once the savings of developing nations began shoring up economies viewed as role models less than a decade ago.
Things have gone full-circle now that China, a nation struggling to eradicate poverty, is being looked upon to act like some massive bond insurer for the euro zone. The same goes for Japan, which has more than its fair share of budding crises and too much debt of its own. You also know things are wildly off-kilter when the West’s financial rot is seeping into the East. Thailand’s 1997 devaluation set in motion a regional crisis that had the Dow Jones Industrial Average plunging several hundred points on single days. Now, the West is returning the favor.
It’s not surprising officials in Europe would look to Asia for help. It is, after all, where the money is. What would help even more is for Japan and China to get their economies in order. Sadly, neither is.
Euro looks set to win the race to the bottom
by Kenneth Rogoff - Financial Times
Currency movements are notoriously difficult to explain much less predict. Even so, 2010 was an exceptionally tough year. Foreign exchange participants were forced to divine idiosyncratic and conflicting policymaker preferences, to interpret rare events such as Europe’s sovereign debt woes, and to understand obscure policy instruments such as quantitative easing.
The euro/dollar rate, for example, fell from $1.45 to $1.20 in the first half of 2010, only to rise again to over $1.40 in November, before briefly dropping below $1.30 again in its current swoon. Some of this volatility can be ascribed to shifting changing growth data across the Atlantic. But other less concrete factors, such as Europe’s bogus bank stress tests and investor unease with the Fed’s quantitative easing, seemed to play a larger role. Whenever the favoured market explanation of a big exchange rate movement is "the Chinese are buying", one has to wonder whether exchange rates have any anchor in long-term macroeconomic fundamentals.
Entering 2011, our currency crystal ball doesn’t seem to be getting any clearer. All the major regions remain trapped in post-crisis macroeconomic strategies that are either inconsistent, incoherent, or both. US budget policy is deliciously contradictory, cutting taxes while promising to balance the budget later, dramatically expanding entitlements while vowing to rein them in later. And because the dollar is so popular, the US is being sure to print lots of them.
Eurozone macroeconomic policy is incoherent on so many levels, it is hard to know where to begin. The basic strategy is to hope that fiscal tightening in the periphery combined with generous liquidity relief from the core will solve all ills. The only problem is that the populations of Greece, Ireland, Portugal and perhaps Spain, cannot be asked to suffer recession indefinitely so that foreign creditors can be repaid. Rather than contemplate reintroducing the drachma, the eurozone decided to celebrate the New Year by taking in Estonia. Estonia is a great country, and it deserves a lot of support. I grew up on Estonian grandmaster Paul Keres’ chess books. But did it really make sense to add another emerging market at this time?
Then there is China and its quasi fix to the dollar. At one time, China’s policy might have made perfect sense, but today the case for high growth China pegging to low growth US is hard to sustain. China’s peg engenders a plethora of distortions, tilting the economy towards export production and away from output for the domestic market. True, China has not yet experienced the sustained inflation, as it might if its real (inflation adjusted) exchange rate truly was way out of line.
Inflation, however, seems to be taking root in a fashion that could force authorities to act much more decisively, with increasingly few alternatives to allowing a straightforward appreciation of the currency. Indeed, many fast growing emerging markets such as Brazil and India are confronting much the same problem. They do not want their currencies to rise too quickly against the dollar, but their central banks do not want inflation to get out of hand.
How emerging markets resolve these conflicting goals will be a central theme in foreign exchange markets in 2011. Talk of "currency wars" will continue to be accompanied by ever more stringent capital controls. Look for a resurgence of the kind of parallel exchange markets that ruled the earth in the 1950s and early 1960s. In my work with Carmen Reinhart on the history of exchange rate arrangements, we found that in a great many cases, parallel markets allowed many countries a degree of floating even when the official exchange rate was fixed. This is the mirror image of the modern phenomenon whereby many countries that officially have floating rates in fact are better thought of as having pegs.
Finally, there are developed country commodity exporters such as Canada, Australia and New Zealand, whose currencies are likely to continue to appreciate as long as emerging markets continue to thrive, even with their policy inconsistencies.
All in all, 2011 is shaping up as a race to the bottom for currency values. In this currency war, does any country truly want to be the victor? No wonder gold has been so attractive! Which currency will succeed in hugely underperforming in 2011? Recognising the near impossibility of predicting exchange rates, my "money" is still on the euro. I am cautiously optimistic that Europe will find a way to manage its country bankruptcies, but there are no elegant solutions, and the possibility of political paralysis at just the wrong time is significant. The United States’ quantitative easing policy may be obscure and some may see it as cause for alarm. There is a small chance of large catastrophe. But the eurozone, by contrast, has a high chance of a medium size meltdown. The single currency may win the race to the bottom after all.
Kenneth Rogoff is a professor at Harvard University and co-author (with Carmen Reinhart) of ‘This Time is Different: Eight Centuries of Financial Crises’
Europe fears motives of Chinese super-creditor
by Ambrose Evans-Pritchard - Telegraph
The EU authorities fear that China's purpose in buying eurozone debt may be double-edged, intended to push up the euro exchange rate against the yuan and gain advantage for exports.
Herman Van Rompuy, Europe's president, said during a visit to Downing Street that the Chinese may have "political" thoughts in the back of their minds for coming to Europe's help, and gave a strong hint that they are also engaging in currency manipulation. "When they buy euros, the euro becomes stronger and their currency a little bit weaker. That is not neutral in regard to their competitive position. But I go no further in this topic. It could be too delicate," he said.
Mr Van Rompuy nevertheless welcomed the latest purchases of bonds from the eurozone periphery as a valuable gesture of support. "They invested even in some weak countries, so they are very confident in the solvency of some countries," he said. China has emerged as the transforming force in the eurozone debt crisis over recent days, pledging to use part of its €2.87 trillion (£1.82 trillion) reserves to safeguard global stability. The question is whether the Communist regime is hoping to extract strategic concessions in exchange.
The footsteps of a giant creditor were clearly felt in Portugal's bond markets on Wednesday, and again on Thursday in Spain and Italy. Madrid sold €3bn of five-year debt at 4.54pc, a full percentage point jump from November but still below the danger level. Italy also enjoyed a benign auction.
The exact role of China is unclear. Chinese vice-premier Li Keqiang promised to buy Spanish debt during a visit to Madrid last week, reportedly up to €6bn (£5bn). China was the secret buyer in a private placement of €1.1bn of Portuguese debt last week, according to the Wall Street Journal. Finance minister Fernando Teixeira dos Santos said China "may well have been" a key buyer in this week's debt auction.
China was not the only force at work. Traders say the European Central Bank (ECB) acted aggressively behind the scenes, calling some 20 dealers to buy Portuguese debt in the secondary market. This created what amounted to a "short-squeeze" in Portuguese bonds just before auction, causing spreads to tighten dramatically and inflicting damage on market makers acting in good faith. City sources say this has caused some bitterness.
Charles Grant, head of the Centre for European Reform and author of a book on EU-China relations, said China's top goal is to secure an end to the EU arms embargo, imposed after the Tiananmen Square massacre in 1989. It rankles as humiliating treatment for a global superpower that has since changed profoundly. The EU has refused to move on the sanctions until China ratifies the International Covenant of Civil and Political Rights, and China's arrest of Nobel peace dissident Liu Xiaobo has further complicated matters.
Yet Brussels has suddenly begun to shift gear. Baroness Ashton, the EU's foreign policy chief, said the embargo is damaging EU-China ties and called for new thinking to "design a way forward". Mr Grant said Britain, France and Germany are all wary of giving ground, cleaving closely to US policy. Washington views China's growing military might as a strategic threat to the Pacific region. There have already been hot words over the South China Sea, and the Pentagon claims that China has an "operational" ballistic missile able to sink aircraft carriers at long range.
A WikiLeaks cable from the US embassy in Beijing last January cites the EU's mission chief, Alexander McLachlan, saying Spain had tried to curry favour with Chinese leaders, "seeking advantage at other EU states' expense". He said China was fully aware of Madrid's game but was exploiting intra-EU divisions to gain leverage.
China's second goal is to secure market economy status from the EU. This would make it much harder for the EU to impose anti-dumping measures against Chinese imports. As it happens, the EU has just lifted its punitive tariff on Chinese shoes. Mr Grant said Beijing will not risk much cash to woo Europe. "They are very hard-nosed. They may splash some money around for goodwill but they are not going to waste the hundreds of billions that may be needed. Nothing short of meaningful action by Europe's leaders can genuinely stabilise the eurozone," he said.
China's sovereign wealth funds, including the central bank's exchange fund SAFE, have been severely criticised at home for losing money on US investment banks during the credit crisis, or on dollar losses from US Treasury debt. They will be careful about fresh risks in euroland. "It is debatable whether China would actually be willing to become buyer of last resort of the debt of a country close to default," said Julian Jessop from Capital Economics. "Chinese officials are acutely aware of past losses and will not want to be seen to risk their peoples' capital on a lost cause. Their actions frequently fall short of expectations raised by their words."
Simon Derrick, from the Bank of New York Mellon, said that China must find somewhere to recycle its fresh reserves or lose control of its own currency. It is already sated with US assets. Holdings are 65pc in dollars, 26pc in euros, 5pc in sterling and 3pc in the yen. "They may start buying some emerging market bonds but basically the only place they can go is into euros, and buying €6bn of Spanish debt is a good investment if it helps protect their other euro assets," he said.
Mr Derrick said Beijing appears to take the view that the ECB's monetary policy is fundamentally more rigorous than the money-printing ventures of the US Federal Reserve. "The Chinese have made it clear that they don't see any meaningful shift in US policy." In the global beauty contest, Europe's debt still looks less ugly than the main alternative.
European Death Spiral – End Games
by Satyajit Das - Naked Capitalism
Politics now increasingly dominates the economics. Commenting about the EU bailout of Ireland, the Irish Times referred to the Easter Rising against British rule asking: "was what the men of 1916 died for a bailout from the German chancellor with a few shillings of sympathy from the British chancellor on the side". An Irish radio show played the new Irish national anthem to the tune of the German anthem.
In Greece, the severe cutbacks in government spending have resulted in strikes and violent protests on the streets of Athens. Faced with cutbacks in living standards, Europeans are fighting back. The Rolling Stones’ late sixties anthem has been resurrected in Europe: "Everywhere I hear the sound of marching, charging feet, boy/ Summer’s here and the time is right for fighting in the street, boy."
In many countries, governments, often unstable coalitions, are struggling to pass legislation, implementing necessary spending cuts or tax increases. In Ireland, the opposition parties have promised to re-negotiate the bailout package if elected at an election due early in 2011. In Germany, the paymaster and strength behind the EU, Europe’s biggest tabloid Bild asked "First the Greeks, then the Irish, then…will we end up having to pay for everyone in Europe?"
In December 2010, a special EU meeting, convened to discuss the situation, provided a clear pointer to how events might evolve. At the meeting, the German view, set out by Chancellor Angela Merkel, prevailed.
The meeting rejected any attempt to increase the scope and amount of the existing bailout facilities. The E-Bond proposal was quietly shelved. The EU agreed to formalise the ESM through a short amendment to the Lisbon Treaty. The new facility would be inter-governmental with any Euro Zone member having a national right of veto. The facility was highly conditional, capable of being triggered only as a last resort.
A key element was the requirement for "collective action clauses", effectively forcing lenders to bear losses. The provision, which must be included in all European government bonds after June 2013, would require the payment period to be extended in case of a crisis. If the solvency problems persisted, then further extension of maturity, reductions in interest rates and a write-off in the principal would occur. In addition, new bailout funds would automatically subordinate existing debt and have to be paid back first.
Chancellor Merkel’s position reflects the views of the German constitutional court, which endorsed European economic and monetary union prescribed in the 1992 Maastricht treaty only on the basis of the treaty’s no-bail-out provisions. This influences the need to impose losses on investors.
It is clear that the stronger members of the EU, led by Germany, have decided to limit future liability in bailouts. As membership of the Euro prevents large devaluation of the currency, economic adjustment will require reduction of the budget deficit and deflation. As Greece and Ireland demonstrate, more rigorous deficit cutting may not return the countries to solvency. The EU proposals implicitly recognise that over-indebted countries cannot sustain currency debt levels. The reduction of the debt burden will have to come through restructuring or default, with creditors taking losses.
Unless confidence returns rapidly or the EU changes its position, it seems restructuring or defaults by several peripheral European sovereigns may be unavoidable. Investor concerns that the Greek and Irish did not solve the fundamental problems may be confirmed. The safety nets are now seen as unlikely to be large enough to rescue larger countries, like Spain and Italy, if they require support. Investors will need to take losses.
Large volumes of maturing debt mean that the test is likely to come sooner than later. The heavily indebted European sovereign states face $2.85 trillion of maturing debt in the period to 2013. Portugal, Italy, Ireland, Greece and Spain have bond maturities of $502 billion in 2011. The financing needs of Greece, Ireland, Portugal and Spain over the last quarter of 2010 and 2011 are Euro 320 billion, rising to Euro 712 billion if Italy is included. In addition, private sector borrower in these countries face maturities of $988 billion of corporate bonds and $200 billion of syndicated bank loans over the same period. Likelihood of low economic growth, failure to meet IMF plan targets, further banking sector problems and credit downgrades exacerbate the risk.
A Faraway Continent
In the prelude to World War 2, British Prime Minister Neville Chamberlain dismissed the German occupation of Sudeten arguing that it was "a quarrel in a far away country between people of whom we know nothing." North American and Asia have been bystanders as the European crisis developed. Increasing concerns are evident, as European problems now threaten global recovery.
China, which contributed around 80% of total global growth in 2010, has expressed growing concern about the problems in Europe. Trade between China and the EU, its largest export market, totals around $470 billion annually, contributing a trade surplus of Euro 122 billion for China in the first nine months of 2010. Any slowdown in Europe would affect Chinese growth. China is also a major holder of Euro sovereign bonds, standing to lose significantly if problems continue. China has indicated preparedness to use some of its $2.7 trillion of foreign exchange reserves to buy bonds of countries such as Greece and Portugal.
A slowdown in China would affect commodity markets, both volumes and prices, and commodity exporters such as Australia, China and South Africa. Minutes of a 7 December 2010 from the central bank of Australia, one of the world’s best performing economies, indicated increasing concerns about developments in Europe.
A continuation of the European debt problems, especially restructuring or default of sovereign debt, would severely disrupt financial markets. Losses would create concerns about the solvency of banks, in particular European banks. In a repeat of the events of September 2008 (when Lehman Brothers filed for bankruptcy protection and AIG almost collapsed) and April/ May 2010 (prior to the bailout of Greece), money markets could seize up, as trust about the ability of parties to perform contracts evaporated. In turn, this volatility would feed through into the real economy, undermining the weak recovery.
Unless resolved, the European debt problems will affect currency markets and through that channel the global economy. Any breakdown in the Euro, such as the withdrawal of defaulting countries or change in the mechanism, would result in a sharp fall in the new currencies. In turn, this would, in the first instance, result in large losses to holders of debt of those countries from the devaluation.
Depending on the new arrangements, the US dollar would appreciate abbreviating the nascent American recovery. This may compound existing global imbalances and trigger further American action to weaken the dollar. Further rounds of quantitative easing are possible, setting off inflation and de-stabilising, large scale capital flows into emerging markets. In turn, the risk of protectionism, full-scale currency and trade wars would increase. A breakup of the Euro would adversely affect Germany, which has been growing strongly. A return to the Deutschemark or, more realistically, an Euro without the peripheral countries may result in a sharp appreciation of the currency, reducing German export competitiveness.
As the Australian central bank noted in its December 2010 minutes: "… the deterioration in the situation in Europe over the past month had increased the downside risks to the global economy. How this would ultimately play out, and the implications … were difficult to predict. It was possible that conditions could settle down, as they had after the episode of financial instability in May. Alternatively, an escalation of the current problems was not out of the question. If this prompted a fresh retreat from risk-taking in global financial markets, it would probably have more impact … than any trade effect."
Events since the announcement of the bailout package in early 2010 have been reminiscent of 2008. Then, the optimism following bailouts of Bear Stearns and other troubled American banks produced premature. The promise of China to purchase Portuguese bonds is similar to the ill-fated investments of Asian and Middle-Eastern sovereign wealth funds in US and European banks.
Eventually with each successive rescue and the reemergence of problems, the capacity and will for further support diminished. The EU rescue of Greece and Ireland are also reminiscent of US attempts to rescue its banking system, with more and more money being thrown at the problem. The strategy was defective, preventing the creative destruction required to restore the system to health. The actions may have doomed the economy into a protracted period of low growth, laying the foundations for future problems.
At the time of the Greek bailout, the real question was: "If Euro 750 billion isn’t enough, what is?" Increasingly, markets fear that there may not be enough money, to solve the problem painlessly.
In 11 May 1931, the failure of a European bank – Austria’s Credit-Anstalt – was a pivotal event in the ensuing global financial crisis and the Great Depression. The failure set off a chain reaction and crisis in the European banking system. Some 80 years later, European sovereigns may be about to set off a similar sequence of events with unknown consequences. As Mark Twain observed history may not repeat, but it does rhyme.
Spain Sells Maximum Target in First Debt Auction of 2011 as Demand Rises
by Emma Ross-Thomas - Bloomberg
Spain sold 3 billion euros ($3.95 billion) of bonds in its first debt auction of the year, meeting its maximum target as demand increased. The Treasury sold the five-year bonds at an average yield of 4.542 percent, the Bank of Spain said, compared with 3.576 percent the last time the securities were auctioned on Nov. 4. Similar-maturity bonds traded at a yield of 4.630 percent before the auction and demand was 2.1 times the amount sold compared with 1.6 times at the previous sale. Italy, the euro-region’s second most-indebted nation, also sells bonds today.
Spain auctioned bonds after its 10-year borrowing costs rose to the most in a decade on Jan. 10. The gap between Spanish and German yields narrowed for a third day today as European leaders considered bolstering the region’s bailout facility. The spread was 233 basis points after the auction, compared with 240 basis points yesterday. It reached a euro-era high of 298 basis points on Nov. 30, which compares with an average of 15 basis points in the first decade of monetary union.
European governments are considering aid for Portugal, debt buybacks and lower interest rates on loans from the region’s bailout facility as part of a package to quell the financial crisis, according to four people with direct knowledge of the talks. Euro-area finance ministers will discuss elements of the package next week at a meeting in Brussels. The European Commission is considering a proposal to double the size of the 750 billion-euro bailout fund, Expansion reported today, citing people it didn’t identify.
Spain’s Socialist government, which faces its first bond redemptions in April, is trying to prove to investors it can slash the region’s third-largest deficit to 6 percent of gross domestic product this year from 9.3 percent in 2010, and shore up its struggling savings banks. The country faces repayments of 15.5 billion euros in April, data compiled by the Treasury show.
France and Germany veto increase in EU rescue fund
by Ambrose Evans-Pritchard - Telegraph
Germany and France have rejected calls by Brussels for a rapid increase in the size and powers of the EU's rescue machinery, once again exposing serious differences at the heart of monetary union.
Jose Barroso, head of the European Commission, called on EU leaders to boost the firepower of the EU's €440bn (£366bn) bail-out fund and beef up its role, allowing it to intervene with pre-emptive bond purchases to help states under threat. "It is important for the markets to know that Eurozone leaders are committed to do whatever is necessary," he said, hoping for action as soon as early February.
He also proposed a "new phase of European integration" with far-reaching oversight of the budgets, pensions, labour markets, and trade flows of EU states to prevent a recurrence of the imbalances that led to the EMU debt crisis. Mr Barroso said the fund boost was a "precautionary" move, not directed at any one country. The gambit is risky since it may be taken by investors as a sign that Brussels fears imminent contagion to Spain, deemed too big for the current fund.
The response in Paris and Berlin was chilly. "We think the fund is big enough," said Francois Baroin, France's budget minister. German Chancellor Angela Merkel said the bail-out mechanism was "nowhere near exhaustion", adding curtly that she did not wish to debate the matter "any further". Mrs Merkel is wary of attempts by Brussels to bounce her country into an EU debt union, or 'Transferunion' as it is described luridly by Germany's press. Such moves may breach the German constitution.
The dispute overshadowed a well-covered auction of €1.25bn of Portuguese debt, including 10-year bonds at 6.72pc, back below the 7pc danger line. The sale set off a surge in bank stocks in Lisbon, and was greeted with relief across the EMU perihpery. Spain's Ibex index jumped 5.3pc. "The auction was a success from all angles," said Portugal's premier, Jose Socrates. "We do not need help: we can solve our own problems."
Gaven Nolan from Markit said purchases of Portuguese debt by the European Central Bank over the last two days had created good mood music but he doubted whether the bond sale would quell talk of a bailout. "It didn't in the case of Ireland – which was fully funded for months ahead at the time of its bailout – and is unlikely to do so in the case of Portugal. The auction might have bought Portugal some time: it won't divert attention away from low growth prospects," he said.
The interest costs remain crippling for an economy facing contraction of 1.3pc next year, and scant recovery in 2012. The debt trajectory is precarious. The budget deficit will beat the target of 7.3pc of GDP in 2011, but only by use of pension transfers from Portugal Telecom. Mark Ostwald from Monument Securities said confusion over the EU bail-out fund is a reminder of EMU's political limits. "We have gone nowhere since the show of unity in December. 'Mr Market' is still saying to EU leaders that they must come up with a mechanism to transfer money from the rich core to the periphery. We are no closer to that," he said.
Charles Dumas at Lombard Street Research said Germany faces an impossible demand. "If the German people go along with plans to prop up the economies of Club Med to save the euro, it means that they will have to pay subsidies for the next decade or two that significantly exceed what they have had to pay for German reunification," he said. Separately, EU officials have floated proposals for a bank tax to fund the EU's permanent bail-out fund from 2013 onwards. An EU source said member states are "very cautious" about such an intrusion into fiscal sovereignty.
Beatles 'Revolution' Returns Four Decades Later
by Matthew Lynn - Bloomberg
"You say you want a revolution," the Beatles sang in a song that was released in the year that students across Europe famously took to the streets to protest against the established order.
It may not quite be 1968 all over again. Even so, there is a whiff of youthful rebellion in the air. Young people across the region have been staging angry demonstrations in the last few months as government austerity measures take effect. The kids have a better case than their parents did. Even if they are doing so incoherently, the protesters are making a valid point: Europe’s young are being offered a rotten deal.
What we are witnessing may well be the first shots in a long generational war. Whereas the last century was dominated by a battle between classes over how to divide up the economic pie, this one may be over how you divide it up between generations. The protests have been hard to ignore. Greek students took to the streets in October over harsh budget cuts.
In the U.K., plans to triple university fees provoked riots. Demonstrators attempted to smash their way into the Treasury and attacked a car carrying Prince Charles and his wife, Camilla, through central London. In Rome last month, students hurled bottles, threw smoke bombs and dumped manure in the street before charging the barricades to protest against cuts to education spending. The police responded with tear gas. In France, students joined worker protests in October last year against government plans to raise the minimum retirement age to 62 from 60.
It would be simple to dismiss it all as insignificant. Maybe all those students should accept that we live in tough times. They should just get back to the library to study for what will be a tight labor market when they graduate. Then again, perhaps they are justified. At the root of this, many young people sense they are getting a raw deal. This generation will graduate burdened by big debts. If they want to buy a house, it will be cripplingly expensive, and there may not even be any mortgage loans available. Jobs are scarce, and often not very well paid, certainly when the cost of the education required just to get your foot in the door is taken into account.
Governments across Europe are running up vast debts, money that will have to be paid back in higher taxes by today’s 20- somethings. Retirement ages are being raised all the time. This generation may end up working into their 80s. They can forget about spending a few decades cruising around the Mediterranean and touring the Spanish golf courses like their parents.
In the euro area, the costs of austerity packages required to salvage the single currency are being paid by the young rather than the middle-aged or the old. Why? Because as demand collapses, rigid labor markets make it virtually impossible to fire older workers in many countries. So instead, employers just stop hiring -- and that means young people don’t get jobs.
According to Eurostat, the statistical agency of the European Union, the unemployment rate for the under-25s averaged almost 20 percent across the euro area in August 2010. In Spain, it was more than 40 percent. It will soon be normal for Spanish people in their early 20s to be out of work. People are starting to notice that the dice are increasingly stacked against the under-30s.
"As home ownership becomes less accessible to the young, the ending of the retirement age poses challenges for youth employment, and the costs of higher education become punitive, it remains quite plausible that the fault lines of age could become increasingly well defined," a report for the U.K.’s National Centre for Social Research concluded last year.
And yet, it isn’t inevitable that such burdens should be placed on young shoulders. In reality, governments are deliberately loading more and more costs on the young. Static or declining populations, and rising life expectancy, mean the number of older people is rising. The old also vote more: In the British election of 2005, only 48 percent of those in the 25-34 age group voted, compared with 75 percent of the over-65s.
There are more of them, and they vote more, so the incentive for politicians is to constantly favor the old over the young. In practice, that means health spending gets protected, but education spending is cut. Employment rights are protected at the expense of new jobs. Interest rates are held down to support house prices -- good if you already own one, but tough if you don’t.
The net effect is that the system is increasingly unfair to the young. It’s time to find a fairer balance. Maybe retirement ages shouldn’t be raised unless there are enough jobs to absorb young workers. Perhaps education cuts should be matched by reductions in health-care spending. Otherwise, the middle-aged and the elderly will have only themselves to blame if they see a lot more smashed windows and cars in the next few years. And the generational war will be a long one.
U.S. Would Lose War vs. China, Celente Says
by Aaron Task - Tech Ticker
U.S. Defense Secretary Robert Gates dubbed his visit to China this week "productive." Hopefully Sec. Gates knows something we don't because the meetings looked anything but "productive" judging by reports of actual events.
China tested its new stealth fighter jet during Gates' visit, which reportedly came as a surprise to Chinese President Hu Jintao. Less dramatically but perhaps more importantly, China rebuffed Gates' attempts to set a timeline for strategic defense talks. In January, China suspended military ties with the U.S. after America sold arms to Taiwan, which China considers sovereign territory. Hopefully, Gates is right and America and China aren't on a "collision course," as many pundits contend.
Gerald Celente, publisher of The Trends Journal, does not believe conflict with China is inevitable, mainly because there's too much money at stake. "The game is money. That's really the name of the game," Celente says. "China wants business to continue - that's why they're buying up bonds in Europe to keep the Ponzi game afloat. They don't want war it's the last thing they want."
Let's hope he's right. War with China would almost certainly lead to wider conflagration in the region, with devastating consequences and millions of deaths. Furthermore, Celente does not believe America can win. "The U.S. can't beat a bunch of Afghans with sandals on and light arms; they're not going to beat the Chinese," he says. "The U.S. would lose a war" with China. Ultimately, Celente believes Taiwan will become part of China, which pretty much will get to call the shots in the Asia-Pacific region. "Nobody is going to be able to touch China," he predicts. "China wins whatever they want to do in that area."
World moves closer to food price shock
by Gregory Meyer, Javier Blas and Jack Farchy - Financial Times
The world has moved a step closer to a food price shock after the US government surprised traders by cutting stock forecasts for key crops, sending corn and soyabean prices to their highest level in 30 months. The price jump comes after the UN’s Food and Agriculture Organisation warned last week that the world could see repetition of the 2008 food crisis if prices rose further. The trend is becoming a major concern in developing countries.
While officials are drawing comfort from stable rice prices, key for feeding Asia, they warn that a sustained period of high prices, especially in grains such as wheat, would hit poorer countries. Food price hikes have already led to riots in Algeria and Mozambique. "Stocks of corn and soyabean are at incredibly tight levels ... and the markets are surging to incredibly strong prices," Chad Hart, agricultural economist at Iowa State University, said.
Dan Basse, president of AgResource, a Chicago-based forecaster, added: "There’s just no room for error any more. With any kind of weather problem in the upcoming growing season we will make new all-time highs in corn and soy, and to a lesser degree wheat futures." Agricultural traders and analysts warn that the latest revision to US and global stocks means there is no further room for weather problems. The crops in Argentina and Brazil, to be harvested soon, look fragile due to dryness.
Traders are particularly concerned about the cost of vegetable oil, key for developing countries such as China where an emerging middle class is buying more frying oil. The US Department of Agriculture said the ratio of global stocks-to-demand would fall later this year to "levels unseen since the mid-1970s, reflecting an accelerated pace of vegetable oil" consumption for food and fuel.
In Chicago, the price of soyabeans rose as much as 5.2 per cent to $14.20? a bushel, the highest since late 2008. The USDA said that domestic stocks-to-demand would drop to the lowest point in nearly half a century. Corn prices jumped 5 per cent to $6.37 a bushel, the highest level since July 2008. The USDA said that by August the ratio of US corn stocks-to-demand would fall to a surprisingly thin 5.5 per cent, the smallest cushion in 15 years.
The US is the world’s largest corn supplier, meeting more than half of global import needs. Corn is an important ingredient in animal feed, and the tightening market partly reflects stronger appetites for meat in emerging markets. Record ethanol production in the US will also swallow up nearly 40 per cent of the US crop. The boom in agricultural prices has lifted the outlook of the agribusiness sector in the US. Cargill, the world’s largest trader of food commodities, said its profits had tripled year-on-year during the second quarter of its fiscal year.
The shares of Deere & Co, the world’s largest manufacturer of tractors and combines, surged 2.3 per cent, approaching an all-time high. But food companies such as Nestlé fell as analysts said they would struggle to pass rising wholesale costs to consumers.
The Great Food Crisis of 2011
by Lester Brown - Foreign Policy
As the new year begins, the price of wheat is setting an all-time high in the United Kingdom. Food riots are spreading across Algeria. Russia is importing grain to sustain its cattle herds until spring grazing begins. India is wrestling with an 18-percent annual food inflation rate, sparking protests. China is looking abroad for potentially massive quantities of wheat and corn. The Mexican government is buying corn futures to avoid unmanageable tortilla price rises. And on January 5, the U.N. Food and Agricultural organization announced that its food price index for December hit an all-time high.
But whereas in years past, it's been weather that has caused a spike in commodities prices, now it's trends on both sides of the food supply/demand equation that are driving up prices. On the demand side, the culprits are population growth, rising affluence, and the use of grain to fuel cars. On the supply side: soil erosion, aquifer depletion, the loss of cropland to nonfarm uses, the diversion of irrigation water to cities, the plateauing of crop yields in agriculturally advanced countries, and -- due to climate change -- crop-withering heat waves and melting mountain glaciers and ice sheets. These climate-related trends seem destined to take a far greater toll in the future.
There's at least a glimmer of good news on the demand side: World population growth, which peaked at 2 percent per year around 1970, dropped below 1.2 percent per year in 2010. But because the world population has nearly doubled since 1970, we are still adding 80 million people each year. Tonight, there will be 219,000 additional mouths to feed at the dinner table, and many of them will be greeted with empty plates. Another 219,000 will join us tomorrow night. At some point, this relentless growth begins to tax both the skills of farmers and the limits of the earth's land and water resources.
Beyond population growth, there are now some 3 billion people moving up the food chain, eating greater quantities of grain-intensive livestock and poultry products. The rise in meat, milk, and egg consumption in fast-growing developing countries has no precedent. Total meat consumption in China today is already nearly double that in the United States.
The third major source of demand growth is the use of crops to produce fuel for cars. In the United States, which harvested 416 million tons of grain in 2009, 119 million tons went to ethanol distilleries to produce fuel for cars. That's enough to feed 350 million people for a year. The massive U.S. investment in ethanol distilleries sets the stage for direct competition between cars and people for the world grain harvest. In Europe, where much of the auto fleet runs on diesel fuel, there is growing demand for plant-based diesel oil, principally from rapeseed and palm oil. This demand for oil-bearing crops is not only reducing the land available to produce food crops in Europe, it is also driving the clearing of rainforests in Indonesia and Malaysia for palm oil plantations.
The combined effect of these three growing demands is stunning: a doubling in the annual growth in world grain consumption from an average of 21 million tons per year in 1990-2005 to 41 million tons per year in 2005-2010. Most of this huge jump is attributable to the orgy of investment in ethanol distilleries in the United States in 2006-2008.
While the annual demand growth for grain was doubling, new constraints were emerging on the supply side, even as longstanding ones such as soil erosion intensified. An estimated one third of the world's cropland is losing topsoil faster than new soil is forming through natural processes -- and thus is losing its inherent productivity. Two huge dust bowls are forming, one across northwest China, western Mongolia, and central Asia; the other in central Africa. Each of these dwarfs the U.S. dust bowl of the 1930s.
Satellite images show a steady flow of dust storms leaving these regions, each one typically carrying millions of tons of precious topsoil. In North China, some 24,000 rural villages have been abandoned or partly depopulated as grasslands have been destroyed by overgrazing and as croplands have been inundated by migrating sand dunes.
In countries with severe soil erosion, such as Mongolia and Lesotho, grain harvests are shrinking as erosion lowers yields and eventually leads to cropland abandonment. The result is spreading hunger and growing dependence on imports. Haiti and North Korea, two countries with severely eroded soils, are chronically dependent on food aid from abroad.
Meanwhile aquifer depletion is fast shrinking the amount of irrigated area in many parts of the world; this relatively recent phenomenon is driven by the large-scale use of mechanical pumps to exploit underground water. Today, half the world's people live in countries where water tables are falling as overpumping depletes aquifers. Once an aquifer is depleted, pumping is necessarily reduced to the rate of recharge unless it is a fossil (nonreplenishable) aquifer, in which case pumping ends altogether. But sooner or later, falling water tables translate into rising food prices.
Irrigated area is shrinking in the Middle East, notably in Saudi Arabia, Syria, Iraq, and possibly Yemen. In Saudi Arabia, which was totally dependent on a now-depleted fossil aquifer for its wheat self-sufficiency, production is in a freefall. From 2007 to 2010, Saudi wheat production fell by more than two thirds. By 2012, wheat production will likely end entirely, leaving the country totally dependent on imported grain.
The Arab Middle East is the first geographic region where spreading water shortages are shrinking the grain harvest. But the really big water deficits are in India, where the World Bank numbers indicate that 175 million people are being fed with grain that is produced by overpumping. In China, overpumping provides food for some 130 million people. In the United States, the world's other leading grain producer, irrigated area is shrinking in key agricultural states such as California and Texas.
The last decade has witnessed the emergence of yet another constraint on growth in global agricultural productivity: the shrinking backlog of untapped technologies. In some agriculturally advanced countries, farmers are using all available technologies to raise yields. In Japan, the first country to see a sustained rise in grain yield per acre, rice yields have been flat now for 14 years. Rice yields in South Korea and China are now approaching those in Japan. Assuming that farmers in these two countries will face the same constraints as those in Japan, more than a third of the world rice harvest will soon be produced in countries with little potential for further raising rice yields.
A similar situation is emerging with wheat yields in Europe. In France, Germany, and the United Kingdom, wheat yields are no longer rising at all. These three countries together account for roughly one-eighth of the world wheat harvest. Another trend slowing the growth in the world grain harvest is the conversion of cropland to nonfarm uses. Suburban sprawl, industrial construction, and the paving of land for roads, highways, and parking lots are claiming cropland in the Central Valley of California, the Nile River basin in Egypt, and in densely populated countries that are rapidly industrializing, such as China and India. In 2011, new car sales in China are projected to reach 20 million -- a record for any country. The U.S. rule of thumb is that for every 5 million cars added to a country's fleet, roughly 1 million acres must be paved to accommodate them. And cropland is often the loser.
Fast-growing cities are also competing with farmers for irrigation water. In areas where all water is being spoken for, such as most countries in the Middle East, northern China, the southwestern United States, and most of India, diverting water to cities means less irrigation water available for food production. California has lost perhaps a million acres of irrigated land in recent years as farmers have sold huge amounts of water to the thirsty millions in Los Angeles and San Diego.
The rising temperature is also making it more difficult to expand the world grain harvest fast enough to keep up with the record pace of demand. Crop ecologists have their own rule of thumb: For each 1 degree Celsius rise in temperature above the optimum during the growing season, we can expect a 10 percent decline in grain yields. This temperature effect on yields was all too visible in western Russia during the summer of 2010 as the harvest was decimated when temperatures soared far above the norm.
Another emerging trend that threatens food security is the melting of mountain glaciers. This is of particular concern in the Himalayas and on the Tibetan plateau, where the ice melt from glaciers helps sustain not only the major rivers of Asia during the dry season, such as the Indus, Ganges, Mekong, Yangtze, and Yellow rivers, but also the irrigation systems dependent on these rivers. Without this ice melt, the grain harvest would drop precipitously and prices would rise accordingly.
And finally, over the longer term, melting ice sheets in Greenland and West Antarctica, combined with thermal expansion of the oceans, threaten to raise the sea level by up to six feet during this century. Even a three-foot rise would inundate half of the riceland in Bangladesh. It would also put under water much of the Mekong Delta that produces half the rice in Vietnam, the world's number two rice exporter. Altogether there are some 19 other rice-growing river deltas in Asia where harvests would be substantially reduced by a rising sea level.
The current surge in world grain and soybean prices, and in food prices more broadly, is not a temporary phenomenon. We can no longer expect that things will soon return to normal, because in a world with a rapidly changing climate system there is no norm to return to.
The unrest of these past few weeks is just the beginning. It is no longer conflict between heavily armed superpowers, but rather spreading food shortages and rising food prices -- and the political turmoil this would lead to -- that threatens our global future. Unless governments quickly redefine security and shift expenditures from military uses to investing in climate change mitigation, water efficiency, soil conservation, and population stabilization, the world will in all likelihood be facing a future with both more climate instability and food price volatility. If business as usual continues, food prices will only trend upward.