"Frank Mischa, sculptor, Washington, D.C."
Ilargi: From Fraser Nelson's A debt-filled New Year:
"In the original Superman film, the hero rescues Lois Lane as she falls from a skyscraper. ‘Don’t worry, ma’am, I got you,’ he says, midair.
‘You got me? Who’s got you?’ she replies.
This is the question that no one is asking now. If China is lending to us, who is lending to China? If the governments are saving the banks, then who will save the governments? If the European Union is offering a safety net, who would be there to bail out the EU?
There are other questions not being asked: which country, in recent economic history, has successfully borrowed its way out of a debt crisis?"
Ilargi: "Hey, did you hear what Fannie and Freddie did?"
"You know, Fannie Mae and Freddie Mac, the guys who buy all US mortgages."
"Oh, yeah, right, I have heard of them. We own them, right?"
"Well, not so fast, there, boyo, we did hand them hundreds of billions of dollars, but they are still noted on the stock exchange."
"Then they must be worth more than we handed them, no?"
"I doubt it. A lot. Come to think of it, I think their net value is probably way negative."
"Really? So why did we give them all the cash then?"
"Well, first so nobody would notice that they're way worse then broke, and more importantly, second, so nobody would notice that US homes are just about entirely worthless across the board, which, third, dooms the banks. After all, without Fannie and Freddie, these homes would have already lost 80-90% of their so-called value. You don’t think a bank would be foolish enough to give anyone a $300,000 loan who actually needs it to buy a home, do you? "
"I guess not. I sure wouldn't if I were a bank. But if all those homes are really worthless without our money propping them up, doesn't that mean the banks are worthless as well? They hold all that paper, don’t they, the loans, the MBS, you name it, don’t they?"
"They sure do. And by the way, the money propping them up is not our money anymore, the government gave it away."
"Yeah, but didn't they say all of it would be paid back, and then some? We're going to make a profit on it, right?"
"A profit on Fannie and Freddie? Isn't it a bit early in the day for you to be drinking? Look, Fannie and Freddie were broke when "we" took them over, or sort of took them over, that's why we did it in the first place, and since that time home prices are down like 20 or 30%. No profit there. There's some at banks and lenders and servicers, you know, re-calibrating loans and stuff, but that's just window-dressing really. With good bonuses on the ground, mind you."
"Oh boy! So we won’t get those hundreds of billions back anytime soon, then, will we?"
"You'll never ever see them back. That is unless Fannie and Freddie start guaranteeing mortgages for everyone, including the 99'ers and all the rest of the 20% of Americans who are unemployed or underemployed. Which obviously would cost a whole lot more than a few hundred billion. Washington might as well simply buy everybody a home. The only way to get that money back is to spend even more and get deeper into debt."
"So why don't we just get our money back and let Fannie and Freddie go the way of the dodo, you know, release them from their suffering?"
"Because that would kill off both home prices and Wall Street banks. Like in an instant. Main street banks too, by the way, but nobody seems to care about them anymore these days."
"So, seen from a different angle, basically, for a few hundred billion we managed to save the entire financial system? Sounds like a good deal to me! Paulson and Geithner and Bernanke must be very smart men."
"Yeah, that would be great, wouldn't it? But alas, it's not that simple. You see , there are some 30 million Americans who are either jobless or work part-time against their will. Then there's many millions more who flip burgers or greet you at Wal-Mart full time at minimum wage. On top of that you have countless millions with lousy credit scores, with huge debts, that sort of thing. And then of course there are lots of folks who don’t want to buy a home, either because they rent, or because they’re happy where they are and have paid off their mortgage in full, or are close to doing that. Well over a third of US homeowners own their houses outright."
"Where are you going with this? What’s the crux of the story?"
"That the pool of potential home-buyers is shrinking, and fast. And that there are far more homes for sale already than there are potential buyers, even as the banks, as well as Fannie and Freddie, have millions of additional homes in their books that they're not even trying to put on the market. And if you go through a period like this long enough, where potential sellers far outnumber potential buyers, there's only one way to go for prices, even if Fannie and Freddie buy up any and every loan around and put lipstick on them. The official inventory is something like 4 million homes, but the shadow inventory, the homes that have not yet been put on the market, may be as high as 12 million or more. And hardly any buyers left."
"Lovely! So what were you going to ask me before? Something about: did you hear what Fannie and Freddie did?!"
"Oh right, excuse me. Fannie and Freddie settled a dispute with Bank of America over fraudulent loans. Just that they don't call them fraudulent, they use the term "soured". Which, you know, seems fine, BofA buys back loans that they knew anyway were crap. So far, so good. However, when it comes down to it, BofA paid $0.01 on the dollar, at least according to for instance Barry Ritholtz: They paid "$1.28 billion to Freddie Mac to resolve $1 billion in claims currently outstanding. But the kicker is that the deal also covers potential future claims on $127 billion in loans sold by Countrywide through 2008.""
"This is a joke, right?"
"Afraid not. It's a done deal. The separate states are preparing deals with Wall Street too, and pennies on the dollar will be the word."
"But wait, hold on a minute. Doesn't that mean that these loans are in effect VALUED at pennies on the dollar?"
"That would seem to be the only explanation, wouldn't it, in the end? But since none of the parties involved will ever say so, you'll be ridiculed if you make that claim."
"And what's the size of Fannie and Freddie's total mortgage portfolio, you said?"
"I didn't. But it's something like $5.5 trillion."
"And how much of that is "soured"?"
"Not sure. Fannie Mae is on record saying that its total amount in repurchase claims, as in loans they know for sure are garbage and want lenders to buy back, is $7.7 billion."
"$7.7 billion of a $5.5 trillion portfolio? That would mean that about 98.5% of all mortgages Fannie bought are good and fine and solid, no fraud, no liar's loans, no nothing wrong, no need to worry?"
"According to them yes, but who's going to believe that? I think you're on to something when you say this deal effectively means it's more likely the other way around, that only 1,5% are really solid. But I would never say that in public."
"One other thing: so Fannie gets to negotiate these things with BofA head to head, one company vs the other, if I get the drift. Isn't that a bit peculiar? I know you said it isn't our money anymore, but wouldn't it make sense to do these negotiations in the open, so Americans can learn about what happens with their money?"
"HA! Yeah, sure, and let them know what their homes are really worth these days? Believe you me, that's the last thing anybody upstairs would want to happen."
"But isn't it our money, don't we have a right to know how it's spent?"
"No, that's not how it works. Your role is to vote for a figurehead once every four years, who, when elected, gets to do with your money, and that of your children and their children, whatever pleases her/him and especially her/his handlers and sponsors, who often happen to be the every bankers who issued the fraudulent loans. Pure coincidence, mind you. And no, you have no right to check what happens to your money. State security issues, you know? I mean, if other banks would find out how BofA pays off its losses at 1%, and then ships the rest of it to the taxpayer, they might try to cut an even better deal. Can’t have that, now, can we? Instead, they're making you think those 98,5% of loans are good, so you can watch TV in peace, and don‘t worry your simple brain too much about these highly complicated matters that some of our brightest minds take years at Harvard, Yale and Princeton to study."
"So, down the line, when this is all said and done, how much will I, and my kids, wind up in the red?"
"Well, it all depends on how many kids you're planning on having, doesn't it?"
"Look, think of it as nostalgia; it's going to be like it always was around here, and like it still is in many places in the world: the only old-age insurance you're going to have is your children. The more kids you have the more secure you will be. Or feel, at least. Your pension fund is long gone already, they've been buying all the wrong stuff for ages. They get to extend and pretend for a while longer along with the banks, but there's no money left there."
"Oh, hold on, I know where you're going with this, and I can only agree, after what you told me: The USA is not a democracy, it is a banana republic!"
"Well, sort of, but it's just that it looks like you may even have have to do without the bananas. There's a fungus spreading around the globe that kills them all."
"Oh jeez, have mercy, we can't even be a banana republic?! What about my cereal? So what can we be? Peanut democracy? Strawberry state?"
"Yeah, something like that. By the way, I’m not done yet. Did you hear about how Goldman Sachs wants to open Facebook to investors? And did you know that Obama wants to get a JPMorgan exec as his Chief of Staff?"
"No, no, stop it already! I don't care, mate. I've had my fill for the day, enough is enough. I’m going to have a stiff adult beverage or two. And then another or two. And then I think I’m going to find myself a tall bridge, a large jar of quaaludes, a long piece of rope, and a warm gun. I don’t think I want to live in a fruit republic, no matter what flavor it has. And this being the USA, chances are it would be an artificial flavor anyway."
BofA Freddie Mac Putbacks Resolved for $0,01 on the dollar
by Barry Ritholtz - Big Picture
Bank of America settled numerous claims with Fannie Mae for an astonishingly cheap rate, according to a Bloomberg report. A premium of $1.28 billion was paid to Freddie Mac to resolve $1 billion in claims currently outstanding. But the kicker is that the deal also covers potential future claims on $127 billion in loans sold by Countrywide through 2008. That amounts to 1 cent on the dollar to Freddie Mac. Imagine if you had a $500,000 mortgage, and you got to settle it for $5,000 — that is the deal B of A appears to have gotten from Freddie Mac.
B of A also paid $1.52 billion to Fannie Mae to resolve disputes on $3.1 billion in loans (~49 cents on the dollar). They remain liable for $2.1 billion in repurchase requests, as well as any future demands from Fannie Mae. My biggest complaint about the GSEs post government takeover is that they have been used as a back door bailout of the banks. This latest deal reconfirms that view. It's a wonder BofA didn’t rally further than the 6.7% it surged yesterday . . .
BofA pact represents 44% of total Fannie repurchase claims
by Jason Philyaw - Housing Wire
Fannie Mae said the agreement reached with Bank of America regarding repurchase requests on mortgages sold to the GSE by Countrywide Financial Corp. addresses about 44% of the $7.7 billion in repurchase claims the company had outstanding with all of its seller servicers as of Sept. 30. Fannie President and Chief Executive Michael Williams said the BofA agreement is "fair and a responsible resolution of these outstanding claims."
Repurchase requests on some 12,045 loans sold by Countrywide, which Bank of America acquired in early 2008, to Fannie Mae were resolved by the agreement. The pact also addresses another 5,760 loans by allowing the GSE "to bring claims for any additional breaches of our representations and warranties that are identified with respect to those loans." As per the agreement, Bank of America paid $1.34 billion cash to Fannie Mae last week and $1.28 billion to Freddie Mac. "We appreciate Bank of America's work to reach this agreement and look forward to our continued mutual efforts to support the U.S. housing market," Williams said.
The agreement, coupled with Ally Financial's settlement with Fannie Mae, prompted Keefe, Bruyette & Woods to revisit its representations and warranties estimates for the mortgage industry on loans originated specifically to be sold to the GSEs. "Our analysis continues to make us comfortable that our base case loss assumption for rep and warranty losses on loans sold to the GSEs remains reasonable," the investment bank said.
Prior to the settlements, KBW estimated base case losses of $28 billion on loans sold to the GSEs. With the Ally deal, the estimate slid to losses of $26 billion, while the BofA settlement points to losses of $48 billion. "We believe that the Ally Financial numbers are a better template for the industry as a whole because the delinquency rates are closer to industry averages," KBW said. "We believe the Bank of America settlement is a stress case number given the company well-above average delinquency rates."
KBW analysts expect more settlements, but added "settlement clearly comes at a price that might be too high for some originators who believe their underwriting standards were strong." "Originators who do not expect a meaningful increase in losses might choose not to pay for this protection," KBW said. "This suggests that the settlement option will most likely be chosen by weaker originators trying to protect downside risk."
BofA Deal on Loan-Repurchase Demands Sets 'Template' for Banks
by Dawn Kopecki and Hugh Son - Bloomberg
Bank of America Corp.’s agreement to settle Fannie Mae and Freddie Mac’s demands it buy back billions of dollars in faulty loans may pave the way for U.S. lenders to resolve similar disputes with the government-sponsored entities, easing investors’ concerns that costs may surge.
Bank of America’s announcement yesterday that it settled claims on at least $4.1 billion in loans from its Countrywide Financial Corp. unit sent the KBW Bank Index of 24 stocks up 2.3 percent to its highest level since May. A willingness by the GSEs to negotiate may let other lenders cap costs from mounting demands they buy back loans that allegedly had bad or incomplete information about borrowers’ incomes, home values or other data. "It’s unlikely GSE claims could spiral out of control from here," said Chris Kotowski, a managing director of research for Oppenheimer & Co. in New York. "I think that’s a positive broadly for the group," because it eliminates the risk that the liability would be much higher, he said.
Bank of America, the biggest U.S. lender by assets, agreed to pay Fannie Mae and Freddie Mac a total of $2.8 billion to settle claims stemming from the 2008 purchase of Countrywide, which was then the largest mortgage company in the U.S. The government-backed entities have been pressuring lenders to make good on so-called representations and warranties, in which they vouched for the accuracy of loan documents.
‘The Worst Mess’
"You have a template that you can go use to try to clear up these liabilities," said Paul Miller, an analyst with Arlington, Virginia-based FBR Capital Markets and a former examiner for the Federal Reserve Bank of Philadelphia. "Countrywide had the worst mess, so you can probably settle for something less than the BofA settlement." Bank of America’s shares surged 6.7 percent yesterday, the most since May, to $14.19 in composite trading on the New York Stock Exchange. Citigroup Inc. jumped 3.6 percent to $4.90, JPMorgan Chase & Co. climbed 2.7 percent to $43.58 and Wells Fargo & Co. rose 1.9 percent.
Bank of America paid a premium, $1.28 billion, to Freddie Mac to resolve $1 billion in claims currently outstanding because the deal also covers potential future claims on $127 billion in loans sold by Countrywide through 2008, the Charlotte, North Carolina-based lender said in a presentation on its website. The bank paid $1.52 billion to Fannie Mae to resolve disputes on $3.1 billion in loans that were currently outstanding, or about 49 cents on the dollar. Bank of America’s total loss on the loans after recovering collateral and other assets is about 27 percent, said Jerry Dubrowski, a spokesman.
Bank of America is still liable for $2.1 billion in repurchase requests from Fannie Mae as well as any future demands. The agreement also didn’t cover $600 million in buyback demands from Freddie Mac as well as loans covered by the deal that turn out to be fraudulent or violated fair lending laws, said Michael Cosgrove, a spokesman for Freddie Mac. The GSEs are pursuing similar agreements with other lenders, and have already reached deals with JPMorgan on loans sold by Washington Mutual, which JPMorgan acquired in 2008, and with Ally Financial Inc. for loans serviced by GMAC Inc.
JPMorgan didn’t disclose what it paid to resolve the claims or the current outstanding principal on the loans. Ally, formerly known as GMAC, paid $462 million to settle repurchase demands on $84 billion of loans, representing the current unpaid principal balance. Like the deal with Bank of America, the agreements with JPMorgan and Ally didn’t release them from liability for loans they sold to the companies through their parent companies or other affiliates. Freddie Mac and Fannie Mae said they had a combined $13.3 billion in repurchase requests outstanding among all lenders at the end of the third quarter before yesterday’s deal was reached.
Although the deal caps Bank of America’s exposure at Freddie Mac, it doesn’t do the same at Fannie Mae, leaving it vulnerable if the U.S. housing market continues to fall, Miller said. The agreement also doesn’t cover challenges from private insurers, investors or government mortgage bond insurer Ginnie Mae. JPMorgan received requests for files to review about $8.1 billion in loans that may be candidates for buybacks and $2.9 billion in repurchase requests on both "private-label" and GSE loans through the third quarter, it said in a Nov. 4 investor presentation.
"Private label mortgage repurchase losses are a more significant concern for the industry at the current time and this settlement does not change our viewpoint in any way on the likelihood or magnitude of those losses," analysts led by Chris Gamaitoni at Compass Point said in a research note.
In total, repurchase demands may cost the industry between $54 billion and $106 billion, according to Miller, who said yesterday’s deal didn’t change his previous estimates. The industry is also still grappling with record-high foreclosures and an unemployment rate close to 10 percent that are depressing homebuyer demand. The S&P/Case-Shiller index of property values fell 0.8 percent in October from a year earlier, the biggest annual decline since December 2009.
"I don’t think this argument is over with, but you start getting some clarity on some numbers," Miller said. "It doesn’t address the foreclosure issues, the robo signing or private-label, so there are still some outliers out there that can cause some havoc. But it does clean up one of the messes out there." Bank of America was the largest U.S. servicer of home mortgages as of June 30, according to industry newsletter Inside Mortgage Finance. Wells Fargo, JPMorgan, Citigroup and Ally Financial round out the top five.
Is Fannie bailing out the banks?
by Colin Barr - Fortune
Financial stocks just caught fire. Someone must be getting bailed out, right? Why yes, say critics of the giant banks. They charge that Monday's rally-stoking mortgage-putback deal between Bank of America (BAC) and Fannie Mae and Freddie Mac is nothing more than a backdoor bailout of the nation's largest lender. It comes courtesy, they say, of an administration struggling to find a fix for the housing market while quaking at the prospect of another housing-fueled banking meltdown.
Monday's arrangement, according to this view, will keep the banks standing -- but leave taxpayers on the hook for an even bigger tab should a weak economic recovery falter. Sound familiar? "The administration is trying to weave a path between two bad alternatives," said Edward Pinto, a resident scholar at the American Enterprise Institute. "They want to bail out the big banks without doing apparent damage" to the sagging U.S. budget position.
Pinto says truly holding BofA responsible for all the mortgage mayhem tied to its 2008 purchase of subprime lender Countrywide would likely drive it into the arms of the Federal Deposit Insurance Corp., which has enough problems to deal with. Though BofA would surely dispute that analysis, it's easy enough to see where the feds don't want that outcome.
But BofA's many problems aren't the only reason for taking Monday's deal with a grain or two of salt. Critics also question the timing of the settlement, which comes on the heels of a court setback for the banks and a new legal challenge from a big investor. They wonder, given the huge sums being spent to prop up Fannie and Freddie, why the companies didn't get better terms.
And you don't need to be a conspiracy theorist to see that austerity talk in Congress means no more upfront support for financial firms. At a time of double-dipping house prices and nearly 10% unemployment, you can see where some people might find themselves devising new ways to prop up BofA and its housing-exposed rivals JPMorgan Chase, Wells Fargo and Citi. "This looks to me like a gift from Tim Geithner," said Chris Whalen of Institutional Risk Analytics. "There's politics all over this."
Fannie, Freddie and BofA sadly shake their heads at that one. BofA finance chief Chuck Noski spent a Monday conference call describing negotiations over the putbacks as "vigorous." Fannie and Freddie say resolving the mortgage putback issues has been a priority for months, and present BofA's $2.8 billion payment as one that is fair to taxpayers.
Freddie chief Charles Haldeman even says his company, recipient of $64 billion in federal aid over the past two-plus years, "has focused sharply on being a responsible steward of taxpayer funds."
But how sharp is Freddie if all it can do is squeeze a $1.28 billion payment out of a giant customer in exchange for relinquishing fraud claims on $117 billion worth of outstanding loans? The very best its million-dollar executives can do is claw back a penny on each bubbly subprime dollar?
That seems pretty weak even given that this is Congress' favorite subsidy dispenser we're talking about. "How Freddie can justify this decision to settle 'all outstanding and potential' claims before any of the private-label putback lawsuits have been resolved is beyond comprehension," says Rebel Cole, a real estate and finance professor at DePaul University in Chicago. "This smells to high heaven and they should be called out." Freddie declined to comment beyond its public statements and filings, and its regulator, the Federal Housing Finance Agency, didn't comment beyond its celebratory statement.
As for the scope of BofA's problems, the bank stressed in its comments Monday that the settlement with Fannie and Freddie should be viewed separately from the two other mortgage-putback categories: suits filed by the monoline insurance companies that backed many of the questionable loans, and disputes with investors in so-called private label securities, those packaged by Wall Street and sold to investors such as insurers and pension funds.
The $6 billion or so BofA has now paid to settle claims with Fannie and Freddie dwarfs its reserves in the other two channels. But that could change, thanks to recent developments in monoline and private label litigation. In mid-December, a judge ruled that the insurer MBIA can use statistical samples drawn from 6,000 case files to show BofA breached contractual representations and warranties on loans, rather than plowing through each of the 386,000 case files involved in the suit.
The finding, wrote an analyst at Gerson Lehrman Group, "dealt a blow to banks trying to defend themselves against mortgage putback liability," by shortening the path to a trial and reducing plaintiffs' court costs. Then, building on that ruling, insurer Allstate last week sued BofA, alleging that offering paperwork filed during the bubble years by Countrywide misrepresented the condition of loans that backed the bonds Allstate bought.
The insurer claimed offering documents indicated, for instance, that none of the underlying mortgages were secured by houses that were worth less than the loan. But Allstate's analysis found in various cases that between 3% and 15% of underlying houses were worth less than their outstanding mortgages. "That suit is just a slam dunk against BofA," said Cole. "Some of the stuff Countrywide was doing, you gotta be kidding me."
Of course, BofA may yet well win both those cases, or tie them up in court for years, or settle at advantageous terms. Such is the majesty of the taxpayer-backed megabank plying the byways of our legal system. But even as most of Wall Street calls BofA a buy, some contend the market is vastly underestimating the intensity of the mortgage putback pain ahead. Analysts at Iridian Asset Management, for instance, estimated in October that BofA could face between $50 billion and $100 billion of putback-related losses over coming years.
Even without a huge putback tab, the banks could be in for tough times. Falling house prices could lead to rising defaults as more homeowners find themselves owing more than their house is worth. Rising defaults would hit bank capital at a time when many bank business lines, ranging from trading to credit cards, are looking distinctly less profitable. And of course, no one is going to sign up for another round of the Troubled Asset Relief Program, no matter how strenuously the government claims it is turning a profit. Thus the appeal of a policy that would eliminate any need to go before Congress. "They're sending a signal to the banks that now is the time to do a deal and put this stuff behind you," said Pinto.
Goolsbee Says Failure to Raise U.S. Debt Ceiling Would Be 'Catastrophic'
by William McQuillen - Bloomberg
Austan Goolsbee, chairman of the U.S. Council of Economic Advisers, said if Congress fails to raise the debt ceiling, the "impact on the economy would be catastrophic." "I don’t see why anybody’s playing chicken with the debt ceiling," Goolsbee said today on ABC’s "This Week" program. "If we get to the point where we damage the full faith and credit of the United States, that would be the first default in history caused purely by insanity."
The government is slated to hit the legal limit on borrowing, $14.3 trillion, early this year. Congress must agree to raise that ceiling or the U.S. could be forced to default on its obligations. After candidates supported by anti-deficit Tea Party activists were elected on pledges to rein in government spending, some lawmakers have said they would demand budget cuts in exchange for voting to raise the debt ceiling.
The U.S. has a $1.3 trillion federal budget deficit. President Barack Obama’s debt-reduction panel failed last month to agree on its chairmen’s recommendations for ways to reduce the annual deficit to about $400 billion in 2015. The plan would have increased taxes by $1 trillion by 2020 by scaling back or eliminating hundreds of deductions, exclusions or credits such as those allowing homeowners to write off interest on their mortgage payments. It would also have cut individual and corporate income tax rates.
Seeking Common Ground
Goolsbee said he anticipates Obama will find common ground with Republicans on legislation to benefit the economy, citing investment incentives and tax cuts for workers and small businesses, and warned against cutting back on spending needed for economic growth. "The reason the deficit is big this year is because we’re coming out of the worst recession since 1929," Goolsbee said. "That’s the reason. The longer-run fiscal challenge facing the country is important."
Senator Lindsey Graham, a South Carolina Republican, said failing to raise the debt ceiling "would be very bad for the position of the United States in the world at large." Still, he wouldn’t vote to raise it "until a plan is in place" to deal with debt, Graham said on NBC’s "Meet the Press."
Reaching an agreement with Republicans, Obama on Dec. 17 signed an $858 billion bill that extends for two years the Bush- era tax cuts for all income levels. It also continues expanded jobless insurance benefits to the long-term unemployed for 13 months and reduces payroll taxes for workers by two percentage points during 2011.
Goolsbee said the U.S. added 1.2 million private sector jobs in 2010 and cited forecasts for a "continued recovery." The unemployment rate is currently 9.8 percent. "You’re starting to see encouraging signs," Goolsbee said. "And so, you know, we’ve just got to juice this, and pump it up, and get it going faster, but that’s clearly the direction that we’re headed."
Peter Schiff: Obama Administration Admits U.S. Is Running A Ponzi Scheme
A debt-filled New Year
by Fraser Nelson - The Spectator
The Spectator is out today, with a cover story that I would commend to CoffeeHousers. Failure to learn from history usually condemns a nation to repeating its mistakes. That's why we should be nervous that no one seems to have worked out what caused the crash. Little wonder: the guys doing the analysis are the same guys who failed to spot the crisis building up, so it suits everyone to blame the banks. "How was I to know," says everyone from Gordon Brown to Joe the Pundit, "that they were doing all these complex debt swap thingies? They deceived everyone, the bounders." There is another analysis – and it's our cover story, written by Johan Norberg. He has been making his case in a short film (trailer here, if you can stand Brown’s cameo) and a book (for my money, the best written about the crisis). I thought CoffeeHousers may be interested in the bones of his argument – which I flesh out, below.
His analysis is that the hangover is not the problem: the party was. Bubbles always burst. We should ask how a debt bubble was blown in the first place. "Crazy risk-taking by banks is a symptom of the easy money era. Yes, they did outrageous things – but from the tulip bubble onwards, people always do if the supply of money is not properly controlled. What did for Britain (and America) was a fatal fixation with interest rate targeting: the idea that if CPI was about 2 percent then the economy was stable. In fact, this "stability" masked an avalanche of dangerously cheap money, to needlessly counter a benign deflationary shock from China and the Far East. Prices of assets – from fine wine to houses – were soaring. But central banks, and most mainstream commentators, didn't think it was a problem. They all bought into the idea that price stability meant economic stability. The root of the crash was an intellectual error: a rotten idea. And that idea is still with us.
Here is my ten-point breakdown of Norberg's argument. All quotes are from his piece, except point 2 which is from his book. A rather technical point, but a crucial one.
1. There are eerie parallels between 2011 and 2003. “In 2003, after the dotcom crash and the 11 September attacks had sent America into recession, everybody wanted the debt-fuelled consumer binge to continue. Not that they said so in terms. Euphemisms were deployed, then as now: there should be government ‘support’, a little touch of Keynes. The Nobel-winning economist Paul Krugman urged Alan Greenspan to ‘create a housing bubble to replace the Nasdaq [stock market] bubble’. The Fed chairman obliged, cutting interest rates to a new low. In Britain, base interest rates halved between 2000 and 2003. Money was as cheap as it needed to be to get everybody borrowing again, and returning to the market. House prices boomed. It looked like prosperity. Bubbles so often do.”
2. The error of inflation targeting. "In a dynamic economy, with constant innovation, prices often decrease. Let's assume that the real underlying costs fall by 2 per cent, due to increased efficiency. But this development could be counteracted by an increase in the money supply so that price tags in stores indicate a price increase of 1 per cent. The central bank is likely to grab the wrong end of the stick, by concluding that there is no inflation worth mentioning. This will prompt it to cut rates."
Sometimes, the world just gets more efficient – and it should mean falling prices. Norberg quotes James Grant, editor of Grant's Interest Rate Observer (which was calling the asset bubble by its name from 2003 on) in noting that "the price of a basket of good exposed to international competition had fallen by 31 per cent in the years prior to 1886, before the United States had a central bank." As Grant says: "falling prices are a natural byproduct of human ingenuity. Print money to resist the decline, and the next thing you know there's a bubble."
3. Western governments' reliance on debt now is extraordinary. The G7 countries have, on average, 50 percent more debt in 2010 than in 2007. This is an average figure: the below, using IMF data, charts how much debt they have taken on. No prizes for guessing which country raises the average:
4. David Cameron's famous baby. “For all the talk of austerity, governments everywhere plan to get through 2011 and beyond by borrowing like crazy. The world’s rich countries have increased their debt by some 50 per cent over the past three years, according to the IMF. Such statistics can too often seem meaningless, but during the British general election campaign David Cameron found a way to make them real. He unveiled a poster saying that a baby born today would owe £17,000 due to government debt. By his own estimates, that burden will rise to £21,000 within four years. Less than it would have been without the extra belt-tightening, to be sure, but a daunting figure none the less.”
5. The Russian Doll bailouts. “The crash happened because households consumed too much, sending their debts to the banks. The banks sent the debts to the governments — and, as we saw with Ireland, even governments might struggle to meet them. So they are sending their debts to the European Union. But to whom will the EU send the bills when its credit card is maxed out?”
6. The Irish bailout will not be the last of the sovereign debt crisis. “Greece and Ireland aren’t just illiquid, they are insolvent — and nothing is solved by taking new, bigger loans when they can’t pay the old ones. If Ireland or Greece default on their debt, forcing creditors to take steep losses, it might spook the markets and pull out a thread that unravels the garment.”
7. A Eurozone crisis cannot fail to impact Britain. “If the defaults start — or if it dawns on markets that the European Financial Stability Fund doesn’t have half of what it would take to save Spain, the world’s ninth largest economy — then investors might rush for the exit. And this, for David Cameron and George Osborne, would produce some deeply unpleasant surprises. What would happen to the British banks that have lent more than $110 billion to Spain?”
8. In the last debt crisis, the banks fell. This time, it might be governments. "In this regard, 2011 looks horribly like 2008. Yet again, banks are treading water, hoping that they can continue to borrow — and trying to lay their hands on as much capital as possible to cover their losses. Yet their risk is the same as last time. We have seen how jittery world markets can become, and how calamitous the consequences can be. It only took one big bank collapse — Lehman Brothers — to scare the markets so much that they avoided lending to anybody. Then, it was banks that fell like dominoes. Next time, it might be governments."
9. China may be the next bubble to pop. “Beijing has printed yuan and pushed banks and local governments to spend like drunken Keynesians. Absurdly, China’s money supply is now larger than America’s, even though its economy is a third of the size. We can see the results of this stimulus in stock market prices and in new roads, bridges and housing complexes all over the country. Not that anyone wants to travel on those roads or live in those buildings. In August, China’s largest energy company reported that an extraordinary 65.4 million residences have not consumed any electricity in the last six months — a fairly big clue that they lie empty. There are now entire ghost towns, like new Ordos in northern China, where tens of thousands of buildings erected from scratch stand empty. And yet property prices in Ordos have doubled over three years. It’s not popular demand, it’s pure speculation. In some quarters, China is being spoken of as the last, best hope for the world economy. But it might be the next bubble to pop.”
10. We may have tried to fix the old Ponzi scheme with a new one. “In the original Superman film, the hero rescues Lois Lane as she falls from a skyscraper. ‘Don’t worry, ma’am, I got you,’ he says, midair. ‘You got me? Who’s got you?’ she replies. This is the question that no one is asking now. If China is lending to us, who is lending to China? If the governments are saving the banks, then who will save the governments? If the European Union is offering a safety net, who would be there to bail out the EU? There are other questions not being asked: which country, in recent economic history, has successfully borrowed its way out of a debt crisis?”
So could 2011 be the year when the second debt bubble pops? Norberg finishes off with this point:
“’The problem with socialism,’ Lady Thatcher once said, ‘is that eventually you run out of other people’s money.’ This time, it is worse: we are running out of our children’s money, and our grandchildren’s money. We are assuming we will have a never-ending supply of borrowed money, and we have no backup plan if this supply chokes up. Things may feel safe at the moment. We can still borrow easily from international markets. So could Lehman Brothers on 12 September 2008 — the day before the bank imploded.”
It’s not wealth that’s being held off balance sheet
by Max Keiser
This headline is misleading: “A Third Of All The Wealth In The World Is Held In Offshore Banks.” Wealth implies some form of tangible equity but that’s not what’s being held off the global balance sheet. We’re talking about debt, trillions and trillions of debt that has yet to be disclosed, much less written off or ‘sterilized’ with massive Quantitative Easing schemes (of more debt) attempting to keep interest rates low enough so as to not force any of the debtors to pay off any interest on this debt.
Part of this ‘invisible debt’ was flashed before our eyes back in October of 2008 when Hank Paulson threatened to shut down America unless Congress wrote him and his friends at banks all over the world and Wall St. a check for 750 bn. But none of the money Congress gave Hank was used to pay down any of the debt, only pay for the resecuritization (banker and lawyer fees) to service the debt and pay for bonuses and salary (140 bn. in bonuses on Wall St. in 2010).
The debt is still growing ‘off balance sheet.’ It’s frozen in the tundra of near zero percent interest rates engineered by the globe’s CB’s. But now Mother Nature seems to be throwing a brick through the window of complacency and Fed larceny in the form of global weather catastrophes driven by man-made global warming trends – driven in part by the easy credit available to corporations like Exxon – who have been able to extract, process and burn fossil fuels for decades for virtually zero cost (if you net out the environmental damage).
The cheap money put the dollars into the pockets of the AGW terrorists and now that the globe’s weather is causing hundreds of billions of AGW related damages. The ability of CB’s to hold back the tsunami of bad debts held off balance sheet is also crumbling.
Just to repeat, as large as the bailout packages were, none of the trillions used paid down any of the debt. All the existing debt was repackaged, and to pay for that service the actual amount of debt has increased.
AGW is triggering an avalanche of bad debts hitting the world’s visible balance sheet in the form of crashing sovereign bond markets and rising precious metals.
The AGW and corporate/gov’t debt build up – both non accounted for these past several decades – have fed each other and made each other possible and deadly. Without the cheap money, corporations would never have been able to pollute like they have. Without the ability to absorb the debt – as it melts in real time before our denying eyes (unless you own PM’s) – the world credit markets will continue suffering Anthropomorphic Credit Collapse (ACC).
The biggest factor driving PM prices higher is AWG denial and its relationship to interest rate manipulation and debt camouflage.
Michael Hudson on taxes, debt, depression, unproductive income and the 90% income tax
"Take any stock in the United States. The average time in which you hold a stock is–it’s gone up from 20 seconds to 22 seconds in the last year. Most trades are computerized. Most trades are short-term. The average foreign currency investment lasts–it’s up now to 30 seconds, up from 28 seconds last month."
Overheating East to falter before the bankrupt West recovers
by Ambrose Evans-Pritchard - Telegraph
This bear is not for turning. It would be joyous indeed if a fresh cycle of global growth were safely underway, but I don’t believe it. Sorry.
Policy levers in the US, Europe, and Japan remain set on uber-stimulus with the fiscal pedal pressed to the floor and rates near zero everywhere, yet OECD industrial output has not regained the peaks of 2007-2008 by a wide margin. Leading indicators are tipping over again. We are one shock away from a liquidity trap.
The East-West trade and capital imbalances that lay behind the Great Recession are as toxic as ever. Surplus states are still exporting excess capacity with rigged currencies -- the yuan-dollar peg for China and, more subtly, the D-Mark-Latin peg within EMU for Germany.
Dangerously high budget deficits of 6pc, 8pc, or 10pc of GDP in countries with dangerously high public debts near 100pc may have prevented an acute depression, but they have not prevented the weakest rebound since World War Two, and they cannot continue, whatever the assurances of New Keynesians and pied pipers of debt.
Cyclical bulls may see the surge in 10-year US Treasuries -- and therefore mortgages rates -- as a sign that growth is about to blast off: structural bears suspect it may be the first convulsive shudder of bond vigilantes dismayed at the easy willingness of Washington to spend $1.4 trillion above revenues next year, with no credible plan to contain the monster thereafter.
Can bond yields rise on "sovereign risk" even as core prices grind lower towards deflation? Yes, they can, and this baleful possibility is not in the textbooks. Ben Bernanke made a fatal error by launching QE2 too early, with an incoherent justification, by dribs and drabs for fine-tuning purposes. The QE card cannot easily be played a third time. If he now tries to print money on a nuclear scale to crush all resistance and hold down Treasury yields, he risks exhausting Chinese patience and invites the wrath the Tea Party Congress.
Alas, my neck-sticking predictions for 2011 must be as grim as ever. This does not exclude further bear rallies over the Spring on Wall Street and Euro-bourses as institutional mammoths seek to extract themselves from bonds. Europe's insurers have as little as 5pc of assets in stocks, against 15pc or more in the 1990s. Yet it is a double-edged sword if big funds switch en masse into shares. Bond dumping has economic consequences.
Japan will slip back into technical recession. It cannot keep raiding its foreign reserve fund to pay bills. Public debt will spiral up to 235pc of GDP. Interest payments will approach 30pc of tax revenues. Fresh debt issuance will outstrip fresh private savings this year. Dagong, Fitch, and S&P will have to act. Downgrades will come thick and fast. This time they will hurt.
Yes, I thought Japanese bonds would buckle in 2010. The obsolete paradigm survived another year. The longer it takes, the worse it will be. China and India are over-heating, faced with a 1970s choice between choking credit or the onset of stagflation. If they choose the latter to buy time, the politics of food will turn on them with a vengeance.
Vietnam will have to rescue its banking system, kicking off the Asian hard-landing of 2011-2012. The Aussie dollar will come back to earth.
Dylan Grice's rule of thumb at SocGen is that regions coming off a "good crisis" -- Japan in 1987, the US during East Asia’s 1998 blow-up, Chindia this time -- typically pop about two and half years later. The reason they have a good crisis when others bleed is because momentum from credit follies and/or hubris overpowers the external shock, but that contains the seeds of its own destruction.
Speaking of rules, the Atlanta Fed’s law is that every year of debt-based boom is roughly offset by equal years of debt-purge bust, which means a Lost Decade for the old world. I doubt the West will recover soon enough to pick up the growth baton before the East hits tires. We may then have a "sub-optimal equilbrium", that modern euphemism for a trade depression.
Europe is hobbled by its Delors Error. The region makes things that world wants to buy. Its external accounts are in balance. Fiscal policy is more responsible than in Japan, America, or Britain, yet the whole is less than the parts. A dysfunctional currency union engenders chronic crisis at a lower threshold of aggregate debt. Frazzled investors will seize on China’s foray into Iberian debt markets to thin their own holdings, denying the Portugal and Spain much interest relief.
Lisbon may last until March before being forced by yields above 7pc to accept its debt servitude package. At that point the EU will order its €440bn rescue fund to buy Spanish debt pre-emptively, hoping to draw a final line in the shifting sand, with half-hearted solidarity from the European Central Bank. As usual, Frankfurt will fall between two stools, failing either to satisfy Germany by immolating EMU on an altar of Bundesbank purity, or to satisfy everybody else by blitzing QE to save the system.
Bond yields will not fall enough to stop to the vice from tightening in every EMU state south of Flanders. It will become clear that Europe’s scorched-earth rescues cannot work because they offer no means by which victims can clear debt and claw their way back to health.
Ireland's Fine Gael-Labour coalition will take its revenge on Europe for imposing such ruinous terms under Berlin's Diktat. It will restructure senior bank debt, setting an irresistible precedent for the PASOK backbenchers in Greece, the Left wing of the Partido Socialista Obrero Espanol, and America’s insolvent cities. From bank debt to parastatal debt is a hop, and from there to quasi-sovereign debt is a skip. Nobody will utter the word default. They never do. Bondholders `volunteer'.
Pudding bowl haircuts will set off the next wave of distress for Europe’s banks as they try to refinance $1 trillion by 2012, in competition with hungry sovereigns. Gold may slip at first as casino funds cut leverage to meet margin calls, before punching higher to €1300 an ounce as investors seek gold bars in a precautionary move. Talk of capital controls will grow louder.
Year III of the Long Slump is when we confront the Primat der Politik in tooth and claw, the phase when states become erratic, victims fight back, and dissident intellectuals start to inflict damage on failed orthodoxies. The dog that hasn't barked yet is the jobless army in Spain, the 43pc of youths without work. Bark it will when the €420 dole extension expires in February.
The cruelty of Europe’s `internal devaluations’ will become clearer. Wage cuts are tectonic events. They set off the protests that forced Britain and then France off the Gold Standard in the 1930s, and smashed Argentina’s dollar peg a decade ago. What we need is an iTraxx European Wage Index to navigate EMU's treacherous waters from now on. Spain’s Jose Luis Zapatero has barely begun to cut, yet he has already had to impose the first state of emergency since Franco to keep airports open.
Certainly, this is the year when Europe's unions will remember their own warnings twenty years ago that EMU was a "bankers’ ramp", a scheme for the convenience of elites. They will ask louder why crucifixion on a Deutschmark cross is in their interests. Those few and reviled Iberian economists who dare to suggest that monetary union itself is the reason why Spain and Portugal cannot take action to fight the slump, will find a voice in the press at last. Once debate is engaged, it will be impossible to contain.
It would be a mercy if the German constitutional court brought this unhappiness to a swift close by ruling in February that Europe’s rescue machinery is a breach of EU treaty law, and therefore of the Grundgesetz. But it cannot happen, can it? A court order forcing Berlin to suspend payments would drive a stake through the heart of German foreign policy, and for that reason the eight judges must recoil, and the law be damned. One presumes.
Alas, there may be no neat solution, no division into two currency blocs with the South keeping the euro and the North launching the euro-plus, no brave decision by Germany to get out, revalue, and let others recover. Instead, there will be month after month of catfights, and flashes of hatred.
The EU will do just enough to prop up the edifice, but too little to restore lasting confidence. The German bloc will not confront the elemental point that either they agree to pay subsidies – not loans – on a scale equal to Versailles reparations, for year after year, or the South with stay trapped in slump until electorates blow a fuse.
Norway will sail on serenely.
Happy New Year.
Facebook Deal Offers Freedom From Scrutiny
by Miguel Helft - New York Times
In Silicon Valley, going public used to be the ultimate rite of passage for a start-up — a sign it had arrived. No more. With its $500 million infusion from Goldman Sachs and other investors, Facebook is now flush with cash, and a market value of about $50 billion, giving it the financial muscle it needs to compete with better-heeled rivals like Google.
And Facebook hopes for an even bigger advantage from the deal, the ability to delay an initial public offering. That would allow it to remain free of government regulation and from the volatility of Wall Street. It would also allow Mark Zuckerberg, the company’s chief executive, to retain near absolute control over the company he co-founded in a Harvard dorm room in 2004.
This strategy was unthinkable in Silicon Valley just a few years ago, when hundreds of start-ups with scant revenue and no profits, like Pets.com and Webvan, raced to go public, and investors eagerly lined up to buy their shares. Lots of people would stand in line to buy shares in Facebook, but for now, only an exclusive few — wealthy clients of Goldman Sachs — will be able to. On Monday, Goldman e-mailed certain clients, offering them the chance to invest in the company.
That offer is the latest sign of the emergence of active markets in the shares of closely held companies. Those markets are helping successful start-ups like Facebook develop the financial wherewithal to compete in the big leagues of business. They have also become an avenue for venture capitalists and start-up employees to cash in their stock, turning many overworked engineers into instant millionaires.
And so a young mogul like Mr. Zuckerberg, the world’s youngest billionaire at age 26, can enjoy many of the benefits of going public without having to tie the knot with Wall Street. Other hot technology companies like Twitter, Zynga and Groupon are also tapping secondary markets to keep stock market investors at bay. They are in no rush to go public and no longer need the bragging rights that a stock offering used to bestow.
"This is a topsy-turvy world," said Scott Dettmer, a founding partner of Gunderson Dettmer, a law firm that has advised venture capitalists, start-ups and entrepreneurs since the 1980s. He added that even a few years ago, "there were all sorts of business reasons to go public, but for entrepreneurs it was also a badge of honor." Perhaps more than any company founder, Mr. Zuckerberg, who declined to comment for this article, has frequently expressed his disinterest in Wall Street, though Facebook is clearly not above taking its cash. He passed on opportunities to make a killing, for example, when, at age 22, he rejected billion-dollar offers for Facebook.
"Mark would absolutely prefer not have an I.P.O. until he absolutely has to," said David Kirkpatrick, the author of "The Facebook Effect." "He absolutely doesn’t want to sacrifice control because he believes that his vision is necessary to keep powering the company forward." Mr. Zuckerberg’s quest to keep Facebook private, though, will not last forever. Federal regulations require companies with 500 or more investors to disclose their financial results, eliminating one of the principal advantages of staying private.
The Goldman Sachs investment, for a stake of less than 1 percent in the company, is formulated in part to skirt those rules. But it may help for only a limited amount of time. The Securities and Exchange Commission is investigating private company trades in secondary markets, and regulators may decide that what is good for Facebook is not necessarily good for the investing public.
Still, the huge cash infusion is a coup both for Mr. Zuckerberg, who is said to own about a quarter of the company, and Facebook. The deal gives the company cash to hire employees or build data centers. It also puts Facebook, which makes most of its money through advertising, on a path to surpass Google, by some measures, as the most successful Internet company to come out of Silicon Valley. Facebook is on track to bring in as much as $2 billion in revenue this year.
The deal with Goldman values Facebook at nearly twice the $27 billion that Google was worth after its first day as a public company in August 2004. Google did not cross the $50 billion mark until about six months later. The two companies have become enemies, but their founders share a deep suspicion of Wall Street, born in part from witnessing the devastation that followed the dot-com bubble. Like Mr. Zuckerberg, the founders of Google, Larry Page and Sergey Brin, set up two classes of shares, which kept them in control after the public offering. They also vowed not to be beholden to short-term investors.
Mr. Zuckerberg is exhibiting many of the same misgivings about the stock market. Mr. Zuckerberg has frequently demurred when asked about an eventual public offering. One of Facebook’s earliest investors said recently that the company would not go public before 2012. But Mr. Zuckerberg is benefiting from the fast-growing market for trading in the shares of privately held tech companies, which the Google founders did not have. Through private exchanges like Secondmarket and Sharespost, and through direct transactions between investors, closely held companies, their investors and their employees have been able to sell their shares to others. For start-ups today, that has opened new options to going public.
"Companies have financing alternatives that they didn’t have," said Marc Bodnick, a managing partner at Elevation Partners, which invested in Facebook in the last year. Those alternatives have become more attractive for companies, in part because of the increased regulations imposed on public companies but also because of the rise in short-term trading, which leaves some executives feeling they have lost control of their companies.
Ben Horowitz, a partner with Andreessen Horowitz, a venture capital firm, said the cost of being a public company had risen to about $5 million a year, from about $1 million a year. Mr. Horowitz, an early employee of Netscape, said that such costs would have eaten into the meager profits of the pioneering Internet company when it went public in 1995.
Additionally, accounting and legal requirements have become distractions for many start-ups, said Mr. Horowitz, whose firm is an investor in Facebook. Those distractions are bothersome for strong-willed entrepreneurs like Mr. Zuckerberg. "If you’re 30 years old and you think you’re building a business that’s going to be a 100-year-old business, what year you’re public doesn’t really matter," Mr. Bodnick said. "But if you think the steps you’re taking are laying the groundwork to long-term strategic growth, it’s good to be quiet, it’s good to be out of the light."
Still, some experts say that the option to remain private is a luxury that only few start-ups will be able to enjoy. "Things have changed dramatically for the 2 percent of companies that stand out from the pack like Facebook," said Lise Buyer, the principal of the Class V Group, which advises private companies about going public. Ms. Buyer, a former Google executive who was involved in its public offering, added: "If you are a semiconductor, or a biotech company, or an enterprise software company, you are not going to have investors throwing money at you without any disclosure."
Facebook (Effectively) Just Announced Plans To Go Public
by Nicholas Carlson - Business Insider
The wait is over! Facebook is going to have to register as a public company – and soon. At least, that's the opinion of Michigan law professor Adam Pritchard, one of the top securities law professors in the country and author of the authoritative text book, "Securities Regulation: The Essentials." Why now? The answer is the Securities Exchange Act of 1934, rule 12g5-1(b)(3), of course. For those not blessed with immediate and total recall of all acts of Congress, let us explain.
The SEC requires companies with more than $10 million in assets and 499 shareholders to register as public companies. Importantly, this does not mean that these companies have to list on the public markets, just that they have to disclose their financials – stuff like profits, revenues, and top executive hires and departures. Today, it was reported that Facebook has agreed to allow Goldman Sachs to sell $1.5 billion worth of its stock at a $50 billion valuation to high net worth Goldman clients. It's expected the private offering will sell out. You'd think this would put Facebook's shareholder count well above 500.
According to the New York Times, however, Goldman and Facebook have a plan to get around this limit. Andrew Ross Sorkin writes that "Goldman is planning to create a "special purpose vehicle" to allow its high-net-worth clients to invest in Facebook." "While the S.E.C. requires companies with more than 499 investors to disclose their financial results to the public, Goldman’s proposed special purpose vehicle may be able get around such a rule because it would be managed by Goldman and considered just one investor, even though it could conceivably be pooling investments from thousands of clients."
Clever – and Close! But no cigar. Our top securities law professor, Adam Pritchard, doesn't think Goldman's plan is going to work. Why?
Let's go through Rule 12g5-1 of the Securities Exchange Act of 1934 for the answer.
(Bear with us. We promise securities law has never been more dramatic.)
Rule 12g5-1 starts out sounding very optimistic for Goldman and Facebook's plans. Section A reads…"For the purpose of determining whether an issuer is subject to [the 500 shareholder limit that would requirement it to disclose financials] securities shall be deemed to be "held of record" by each person who is identified as the owner of such securities on records of security holders maintained by or on behalf of the issuer, subject to the following…Securities identified as held of record by one or more persons as trustees, executors, guardians, custodians or in other fiduciary capacities with respect to a single trust, estate or account shall be included as held of record by one person."
Translation: A trust or corporation – or "special purpose vehicle," in Goldman's parlance – can be considered a SINGLE shareholder, even if it has multiple beneficiaries, as Goldman's "special purpose vehicle" will. All the Goldman clients who buy Facebook shares are "beneficiaries." So far, Rule 12g makes it sound like Goldman and Facebook are in the clear. Party for Mark Zuckerberg, who never wants to have to share any of Facebook's financials!
But wait, Rule 12g5-1 goes on – with a twist! Section B, paragraph 3 reads…"Notwithstanding paragraph (a) of this section…If the issuer [Facebook] knows or has reason to know that the form of holding securities of record is used primarily to circumvent the provisions of Section 12(g) or 15(d) of the Act, the beneficial owners of such securities shall be deemed to be the record owners thereof."
If the primary reason Goldman created the "special purpose vehicle" was to avoid crossing Facebook's 500 shareholder limit, then Goldman's many clients are all each considered individual shareholders in the company.
Says Professor Pritchard: "If Facebook is selling to [Goldman] knowing this is going to happen, then they are on their way to having to register the company as a public company with the SEC." A reminder: If Facebook is forced to register, it will not HAVE to offer stock to the public. But since it will be forced to disclose its financials anyway, we expect the company will go ahead and offer up some second class (non-voting) shares.
So what's going on? Didn't Mark Zuckerberg want to wait until 2030 (or never) to go public?
Here's what we would speculate happened: Thanks to it's popularity on secondary markets and an SEC investigation into that popularity, Facebook has finally resigned itself to an IPO. It shopped the IPO to the major investment banks. Goldman won because it promised to raise $2 billion for Facebook at an incredible $50 billion valuation. Smartly, Goldman decided not to pour its own $2 billion into Facebook, but turn around and offer its clients "pre-boarding" into the IPO through this "special purpose vehicle." It gets the IPO and a flashy product its private wealth clients will go nuts for.
Albert Edwards, SocGen bear, takes a bite out of China
by Nils Pratley - Guardian
Stock markets ended 2010 on an upbeat note. The FTSE 100 index reclaimed the 6000 mark before slipping back, but still registered a 9% gain, while the S&P 500, the most widely watched US index, has regained the level seen before the collapse of Lehman Brothers. There is an air of optimism among investors and a confidence among economists that a much feared double-dip recession has been avoided. A tough moment, then, to be bearish?
Not for Albert Edwards, the best known and longest-standing bear in the City. He has seen nothing to dent his Ice Age thesis – the term he coined as long ago as 1996 to describe the relative decline of equities versus bonds. He thinks there may still be another Japanese-style economic "lost decade" to endure. "Big structural bear markets take 19 years on average and have four recessions," he says. "We've had two."
Edwards is thus sticking to two eye-catching predictions. Stock markets will revisit their March 2009 lows (3512 for the FTSE 100). And, despite the hints in recent months of a return of inflation, gilt yields will fall below 2% (from 3.5% today) as deflationary forces reassert themselves. Oh, and for good measure, prepare for the hard landing in China and the crash in commodity prices.
Ridiculous? Well, remember that Edwards' Ice Age call in 1996 has proved to be a winner: even if you include the stock market's dotcom bubble years at the end of the 1990s, equities are still a long way behind bonds since 1996.
Remember, too, that Edwards' forecasts were generally rubbished at the time. His dismissing of the supposed Asian Miracle in the mid-1990s as "Noddynomics" was resented – until the Asian currency crisis of 1998.
To Edwards' amusement (he includes selected "fan mail" in his latest research pack), correspondents to his employer were still trying to get him sacked in 2000. "Send this old, sclerotic and dangerous man into pension or – this would be much better – take him to prison," said one. "He's obviously ill and not qualified to be chief strategist of Dresdner Kleinwort. I hope his prophecy will destroy his career for the next thousand years."
In fact, the Ice Age prophecy has been the making of Edwards' career. He started out in the Bank of England's economics department, spend three years in fund management and then had a 19-year stint at Kleinwort until 2007.
He and his colleagues (at the French bank Société Générale) have been the top-rated analysts in the "global strategy" category for seven consecutive years, despite being too quick out of the blocks with some of their predictions.
"Often the call is right but it is early and the clients know that," says Edwards, 49. His research is also a model of brevity (others produce 100-page tomes; SocGen's strategists regard 10 pages as a long read) and throws punches – especially at the "criminally negligent" central bankers in the US and UK who allowed house prices to escalate and ruinous levels of debt to accumulate.
At times, though, during the great banking bust, Edwards' views have come dangerously close to becoming consensus wisdom. The same cannot be said about his view on China. "The biggest risk to market valuations and to sentiment generally is a China hard landing," he says. "In reality, China is a much more potentially volatile economy than people think.The Chinese situation is the one that could come out of nowhere because people are not considering it as a serious possibility."
But hasn't China been gloriously unaffected by the turmoil in the west, producing growth of 10% or so with little difficulty? Edwards' argument is that "when you have a good crisis, success can become a curse". Japan, he points out, sailed through the 1987 stock market crash. Similarly, the US economy escaped with a shallow recession after the bursting of the dotcom bubble; house prices started to rise as the authorities declared a period of stable inflation and "great moderation" to be under way.
"Then what happens is that housing and credit bubble goes out of control," argues Edwards. "You tap your foot on the brakes and the whole thing starts crashing and you can't control it on the downside," he says. "China is exactly the same. It had a very good crisis in 2007, opened the credit floodgates, got a house price bubble going, and they're now trying to tap their foot on the brakes."
In Edwards' view, China is a "freak economy"; its investment-to-GDP ratio is off the scale in terms of size and endurance. "In development history, Korea is the only one that got close. It then collapsed. China is basing a growth model on the most unstable part of GDP. The Chinese authorities have recognised this and are trying to steer the economy over to consumption – which is fine, but it will take a long time."
The danger, he suggests, is that China has produced such strong growth for such a long time that investors assume the process will last indefinitely. "There is too much confidence in the lack of volatility. If you get a zero or a small minus for Chinese GDP, in the great scheme of long-term development it's not a great problem. But it's a bit like investing in Nasdaq stocks in 2000 – there would be a big adjustment in price. There is an investment edifice built on the idea that China is the new growth engine of the world."
For statistical support, he points to the OECD's leading indicator of economic activity, which measures factors such as electricity production, freight activity and money supply. In China, it is slowing rapidly, even though commodity prices are as elevated as they were in early 2008 (prices then plunged). Something has to give – and probably sooner than most people assume. The degree of "push-back" from clients to his view on China reminds him of the resistance to his bearish calls on the dotcom and east Asian bubbles.
Closer to home, the Ice Age thesis suggests disappointments for the economy are inevitable. Edwards points to Japan, which enjoyed occasional strong rallies in share prices without conquering its long decline. "During the deleveraging process in early 1990s, the economy was incredibly vulnerable to renewed recession." The lesson, he argues, is that "to avoid recession you need to stimulate all the way through the deleveraging phase". That makes Austerity UK more vulnerable to recession than the US.
But even the US, where monetary and fiscal stimuli have been greater, is "spewing money out but just kicking the can down the road for a bit". He expects the public appetite for retrenchment to fade when recessions return. The middle classes have been "totally shafted" by a house price bubble that created the illusion of prosperity.
"In the US, one in eight are on food stamps. Japan was a cohesive society that shared its pain collectively. That is not how it stacks up in the US, UK, Spain, Greece etc. You have much more fractious environment to have a lost decade in. The ructions for society will be far worse."
So Edwards' answer to the question that obsesses investors at the moment – are we past the worst? – is a resounding "no". Or, as his final research piece of 2010 put it: "I've been doing this job long enough to recognise when the markets are entering a new phase of madness that leaves me scratching my head with bemusement.
The notion that we are back in a sustainable economic recovery is as ludicrous as it was in 2005-07. But investors are backon the dance floor, waltzing their way towards the next, inevitable implosion[, which] yet another they will no doubt claim in retrospect was totally unpredictable!"
China's war on inflation a threat to global recovery
by Graham Ruddick - Telegraph
China's Premier Wen Jiabao has vowed to step up the country's fight against inflation, increasing the likehood of further interest rate rises that could threaten the strength of a global economic recovery.
Mr Wen's pledge to curb inflation came as new government figures revealed that measures already taken are leading to a slowdown in manufacturing growth.
Speaking on a trip to supermarkets in Inner Mongolia over the weekend, Mr Wen said: "The central government has taken a slew of steps to stabilise prices. We will put it higher up on our agenda."
Chinese inflation is at the highest rate for more than two years – 5.1pc – sparking fears in the government of social unrest as the price of food soars. China raised interest rates for the second time in three months on Christmas Day, lifing them 0.25 to 5.81pc.
Policymakers have also raised the amount of money banks must keep in reserve in an effort to restrain bank lending that has powered the economy but also driven up prices.
However, a clampdown by China on inflation threatens to slow the growth of the domestic and global economy, which has been heavily reliant on the strength of the world's second largest economy. Stock markets around the world slid after the country raised interest rates over Christmas.
A survey by the state-affiliated China Federation of Logistics and Purchasing (CFLP) shows manufacturing expansion eased in December, with the Purchasing Managers Index falling from 55.2 to 53.9. The decline – based on a survey of 820 companies – was the first in five months and economists have attributed the slowdown to the government's inflation policies.
Although any measurement above 50 represents growth, the PMI survey also showed slowing expansion in new orders, which fell to 55.4 from 58.3, and output, from 58.5 to 57.5. "This suggests a very strong tightening force at work which could be the tightening in financial conditions which has been more than we previously expected," Goldman Sachs said.
On December 31, the central bank governor Zhou Xiaochuan pledged to keep prices "basically stable" this year with a shift to a "prudent" monetary policy from the "moderately loose" stance taken as the country tried to drive growth. His tone was markedly different from 12 months ago, when he earmarked "defeating the international financial crisis" as the crucial task.
The bank chief's comments were supported by Mr Wen, who in a rare radio appearance faced callers angry about rising prices. "I can tell everybody, the government has complete confidence in tiding over this difficult stage," he said. The price of basic foods has doubled in some parts of China and there are fears that a freezing winter could drive prices up further. High inflation has been driven by aggressive lending by banks following the financial crisis and Beijing's ¥4 trillion (£389bn) spending programme.
However, a subindex by the CFLP of input prices for raw materials, energy and supplies fell sharply to 66.7 in December from 73.5 in November, indicating that policies to stabilise prices have met with initial success. Ken Peng, an economist at Citigroup said: "I do not see much risk of a sharp economic slowdown."
It's only a matter of time before China's housing bubble bursts
by Wu Guangqiang - Shanghai Daily
Despite a multitude of measures, many of them considered decisive and effective, taken by the central government to curb wild property prices, the overheating Chinese home market shows few signs of cooling-off.
Property developers everywhere are competing to break records for the highest land-bidding prices, hence, we see a series of "kings of the land," referring to lots acquired at the highest bid.
What's more, the fever for land acquisition is spreading from the major cities, mostly coastal ones, to medium and small cities. The masses are puzzled.
On the one hand, the authorities spare no efforts to rein in soaring prices. The population, trusting the government, had high hopes that it would bring down the prices in a swoop. Premier Wen Jiabao has several times expressed determination to achieve this objective. On the other hand, developers have never shown a shred of willingness to cave in, and by pushing the prices so high they are protesting their commanding edge.
As a result, the longer people wait, the higher the prices. Frustrated people are even beginning to doubt that authorities have silver bullets, and scrambling to buy before prices rise further. This is a vicious cycle, making it more difficult to control prices.
The People's Daily has been bashing tudi caizheng, or "land revenue," meaning taxes and fees local governments levy on developers and other land users. Almost everyone knows that tudi caizheng is at least partly responsible for the ever-inflating bubble.
National data shows, during 2001-2003, the total land-sales revenue was over 0.91 trillion yuan (US$137 billion), accounting for 35 per cent of total fiscal revenue. The figure for 2009 rose to 1.5 trillion yuan, equivalent to 46 per cent of the total. This year's figure is expected to surpass 2 trillion yuan, an astronomical one.
In the breakdown, the combined land revenues for Beijing, Tianjin and Shanghai - whose housing prices are among the nation's highest - are expected to hit 400 billion yuan, 20 percent of the expected national total of 2 trillion yuan. In contrast, the combined GDP of these three cities accounts for only 11 percent of the national total. Many other cash-strapped cities and counties are virtually running on land sales.
Since the 1990s, China's urbanization and industrialization has been dominated by local governments and features vast urbanization. The adoption of the "revenue-sharing-scheme" in 1994 gave governments great incentive to sell as much land as possible at top prices. While the ingenious model did spur economic development, it sowed seeds of risks.
With farm land disappearing around cities, vegetables and other food are more expensive; conflicts - many bloody and even deadly - are escalating between demolition teams and home owners. Tudi caizheng is now dismissed as unsustainable. There are calls for reform.
The tricky question now is how we can expect insatiable officials and developers, who are usually in cahoots to boost land prices, to part with their long-savored meat. If this craziness carries on, there will be a day when all land is sold, ending most cities's land-generated growth.
Despite wide concern over rising risks, few seriously think the bubble is likely to burst here, as it did in Japan, Ireland and now in Spain. The latest buzzword is "rigid demand" for homes, meaning demand is endless considering the huge population and booming economy.
There seems to be a "China Myth." Is that true? A study of the Japanese property bubble may be helpful. In the heyday of Japanese prosperity, the land value of Tokyo alone exceeded that of the entire US. Japanese tycoons were considering buying up America. What happened later is history.
Wandering around newly completed residential areas near my home in Shenzhen - stacked with gleaming apartments, I find 80 per cent of the units are still unoccupied one year after completion. The same is true in Beijing. Prices have made ownership impossible for most buyers. So, it's a matter of time before the bubble bursts, I think.
When a rope is strained beyond its limits, it snaps, which is common sense.
World on red alert over China's inflation
by Malcolm Moore - Telegraph
China could be hit by inflation of 7pc to 8pc over the next two months, panicking Beijing's policy-makers into dramatically raising interest rates, economists have warned. The prospect of at least four further interest rate rises in the world's second-largest economy is likely to alarm global markets, which tumbled in shock at China's decision to raise rates on Christmas Day.
However, inflation has become the central concern for the Communist Party, which is struggling to contain growing outrage in the People's Republic over rising prices. "If you look at the sequential growth over the last two months, inflation is rising at double digits. In the very worst-case scenario, if Beijing does not take action, we could see double-digit inflation this year," said Yu Song, chief China economist at Goldman Sachs.
At stake is the future of the global economy, according to Andy Xie, the former China economist at Morgan Stanley. Writing in Caixin, a Chinese magazine, he said that the two most likely candidates to trigger the next financial crisis are either the US's sovereign debt or China's inflation.
"You can describe the global economy as a race between the US and China to see who goes down first," he wrote. "If China manages its inflation, the US will cause the next crisis. But if China suffers a hard landing, the US trade deficit might even halve because of lower import prices. That would boost the dollar's value. The US would have lower financing costs for its debt and could enjoy a period of good growth."
In food markets around Shanghai, the price of meat and vegetables has risen by at least 50pc in the past year, sparking anger among poorer shoppers who spend up to half of their income on food. In some parts of China, the price of basic foods has doubled and shoppers in the southern city of Shenzhen have even taken to skipping across the border to Hong Kong to buy their daily groceries. On the Chinese internet, the Chinese character "Zhang", which means "inflate", has been picked as the word of the year.
Now, a freezing winter is threatening to further push up food prices and global commodities such as copper have already broken through record levels, a combination that spells further inflation. "If there is a recovery in the West, and global commodity prices continue to rise, that could feed problems in China," said Li Wei, an economist at Standard Chartered, based in Shanghai. "I would not be surprised to see inflation touching 7pc or 8pc in the first half of the year."
In response, said Mr Li, the Chinese government would push out all the stops. "The government has been quite cautious so far, but it will have no option but to focus on inflation going forward. At least four more interest rate hikes and significant controls on bank lending, particularly in January, are required," he said. Other economists expressed concerns that the authorities may already have left it too late. Diana Choyleva, at Lombard Street Research in Hong Kong, said that China was "behind the curve" in dealing with inflation and now risks "a hard landing in 2011".
The official Communist party line is that inflation will run at 4pc this year, and that the Chinese government's "capacity to combat inflation is quite strong". Behind the scenes, however, panicky officials have already released large shares of government food reserves in order to calm prices. The ministry of Civil Affairs has also ordered emergency measures to help poor Chinese cope with inflation over the Chinese New Year period, a key national holiday.
Meanwhile, Wen Jiabao, the Chinese prime minister, has taken the rare step of appearing on radio to reassure the public. "I can tell everybody, the government has complete confidence in tiding over this difficult stage together with the masses," said Mr Wen. Responding to a caller angry about rising prices, Mr Wen added: "Indeed, in recent times prices have risen across the nation and under these circumstances the lives of low and middle-income earners are evidently more difficult."
Inflation remains a deeply emotional and political issue in China and the Communist Party is keenly aware that periods of high inflation have caused turmoil in the past. Inflation is widely blamed for having helped fuel the popular unrest that led to the Tiananmen Square protests in 1989. "Since I was a kid I was told that one of the reasons the Communists came to power was because the previous Nationalist government had caused hyperinflation," said Goldman Sachs' Mr Yu. "In the early 1990s we saw inflation hit 24pc or 25pc. If we got that kind of inflation again, I think it is pretty clear that some senior officials would be forced to resign," he added.
Two recent surveys, one by a government think tank and one by the People's Bank of China, have revealed that inflation is already causing deep resentment. According to the 2011 Social Blue Paper from the Chinese Academy of Social Sciences, residents in smaller cities and the countryside are especially dissatisfied with their lives, despite their per-capita income rising 9.7pc after inflation.
A questionnaire given to 20,000 banking customers in 50 cities also detected the same trend, with 74pc of respondents saying that prices in China are now "unbearably high". During China's last inflationary cycle, the government tackled the issue extremely aggressively, hiking interest rates eight times by a total of 189 basis points, or 1.89pc points, over a 21-month period from April 2006 to December 2007. Nevertheless, inflation continued to rise, peaking in February 2008 at 8.7pc. "I think we could see a repeat of that," admitted Mr Yu.
In addition, China is likely to impose higher reserve ratios on its banks and to allow its currency to rise in order to fend off the threat of "hot money" inflows from overseas speculators looking to take advantage of the relative weakness of the yuan and attractive interest rates. The consensus is that the yuan will be allowed to appreciate by 6pc against the dollar this year, and the currency has already reached its highest level since its landmark revaluation in July 2005. "The government appears to have given a signal that it will use both interest rates and the exchange rate to fight inflation, including imported inflation," said a trader at a Chinese commercial bank in Shenzhen.
However, some analysts are fearful that a heavy-handed approach by Beijing to calm inflation and slow the economy could have a knock-on effect for the rest of the world, which is now looking to China as a major pillar of global growth. Already, Chinese bonds have become the worst performing among Asian markets, returning just 1.7pc in 2010. The Shanghai Stock Exchange, meanwhile, has fallen by 16pc over the year, making it the worst benchmark index among the 21 countries in the MSCI Emerging Markets index.
Michael Pettis, a professor of economics at Peking University, said that inflation would naturally unwind because of China's "severely repressed financial system". He explained that the negative real interest rates at Chinese banks would put "significant downward pressure" on household income as a share of China's GDP. "And as household income declines relative to GDP, so does consumption relative to GDP," he said.
Meanwhile, as Chinese households buy less, producers would be spurred, again by the low real cost of borrowing, to invest in manufacturing capacity. "When the borrowing cost is negative in real terms, companies tend to borrow and produce more, since even if it is not economically viable it is still profitable," he said. "There is an automatic stabilisation so that inflation never turns out as bad as a monetarist might normally expect," he said.
This is likely to be doubly true in 2011, since bank loan quotas have been maintained at 7.5 trillion yuan (£750bn) for the year and the government will be keen to step up investment ahead of China's next five-year plan in 2012, when its next generation of leaders take over. "This isn't, however, a free lunch" said Mr Pettis. "It tends to be a trade-off of consumer price inflation for excess capacity and asset price inflation. It is pretty clear that this is what we are seeing in China."
China backs Spain to emerge from crisis
China is confident Spain will recover from its economic crisis and Beijing will buy Spanish public debt despite market fears of an Irish-style bailout, a top Chinese official said Monday. The comments by Vice Premier Li Keqiang were made in an op-ed piece in Spain's leading daily El Pais one day ahead of his arrival in Madrid for a three-day official visit, the start of a European tour that will also include Britain and Germany.
"Since China is a responsible investor country in the long-term on the European financial markets, and in particular in Spain, we have confidence in the Spanish financial market, which has been translated into the acquisition of its public debt, something we will continue to do in the future," he said. "China supports the measures adopted by Spain for its economic and financial readjustment, with the firm conviction that it will achieve a general economic recovery", said Li, who is widely tipped to become China's next premier.
Investors have shown deep concern over the annual deficit being racked up by the Spanish government and its heavy reliance on the bond markets, leading them to demand higher and higher returns. An economic and financial rescue for Spain would be far bigger than anything seen to date in Europe: the size of its economy is twice that of Greece, Ireland and Portugal combined. Spanish public debt rose to 57.7 percent of GDP at the end of September from 53.2 percent at the end of 2009.
Chinese state media on Monday also quoted Beijing's ambassador to Madrid as saying China is willing to make "positive efforts" to help Spain with its economic recovery.
Li's meetings this week with Prime Minister Jose Luis Rodriguez Zapatero and Finance Minister Elena Salgado will "play a key role" in financial stabilisation, Xinhua news agency quoted the ambassador, Zhu Bangzao, as saying. Their talks will focus on expanding trade and economic cooperation and will also help "restore market confidence," Zhu said.
The Spanish economy, the EU's fifth largest, slumped into recession during the second half of 2008 as the global financial meltdown compounded the collapse of the once-booming property market. It emerged with tepid growth of just 0.1 percent in the first quarter of 2010 and 0.2 percent in the second, but then stalled with zero percent growth in the third.
Gerald Celente: Mystery Trend & 2011 Economic Outlook
U.S. Consumer Bankruptcies Hit 5 - Year High In 2010
by Jonathan Stempel - Reuters
The number of U.S. consumers who filed for bankruptcy protection in 2010 was the highest in five years, and the figure could rise as Americans struggle with excess debt in an uncertain economy, a report issued Monday said. Roughly 1.53 million consumer bankruptcy petitions were filed in 2010, up 9 percent from 1.41 million in 2009, according to the American Bankruptcy Institute, citing data from the National Bankruptcy Research Center. Filings in December totaled 118,146, up 4 percent from a year earlier and 3 percent from November's total.
The full-year total is the highest since the 2.04 million recorded in 2005, when there was a rush to seek bankruptcy protection ahead of a stricter federal law taking effect in October of that year. Samuel Gerdano, executive director of the ABI, said filings are rising even as consumers try to cut spending and debt after the 2008 financial crisis and accompanying recession, and with the unemployment rate at 9.8 percent. He said there is usually a 12- to 18-month lag between declines in consumer spending and bankruptcy levels.
According to the Federal Reserve, U.S. consumer credit outstanding has fallen in 19 of the last 21 months for which data are available, declining to $2.41 trillion in October 2010 from $2.57 trillion in January 2009. "Consumers have been on sort of a strike when it comes to taking on more debt, as they become more aware of the dangers of high debt burdens in a weak economy," Gerdano said.
Robert Lawless, a bankruptcy professor at the University of Illinois College of Law in Champaign, said the pace of filings may peak in early 2011 but that full-year filings could drop by a single-digit percentage. "Consumer debt is declining, which means the incentive for taking the legal step of filing for bankruptcy is going down," he said. "I suspect borrowing demand has also gone down, but the bigger reason is that lenders are less willing to lend."
There were 2.94 million U.S. consumer bankruptcy filings in 2009 and 2010, the most over a two calendar year period since the 3.6 million recorded in 2004 and 2005. "The (2005) law was supposed to reduce filings, but we are very close to levels we were at then," Gerdano said. "The laws of economic gravity are more powerful than the laws passed by Congress."
European debt markets 'face second credit crisis'
by Harry Wilson - Telegraph
European debt markets could be hit by a second credit crisis within months as fears grow over the huge volume of new bonds that must be sold by governments and banks in 2011.
Banks alone must refinance about €400bn (£343bn) of debt in the first half of the year, but add in the more than €500bn European governments must replace over the same period, as well as further hundreds of billions of euros of mortgage-backed debt maturing and there is the potential for chaos in the credit markets. "What we are looking at here clearly has the potential to become a second credit crunch. However, this time it would be much worse than before," said Celestino Amore, founder of IlliquidX, which specialises in trading hard-to-price debt.
"Governments have been able to slow down the process, but the problems did not go away. There remains trillions of dollars of debt that must be refinanced or sold." Mr Amore predicts a rush to sell assets, much like that which kicked off the first credit crunch in the summer of 2007. However, many fund managers and other large institutional investors are looking to reduce their exposure to bonds, leading to warnings that there will not be enough demand to buy all the debt banks and governments will need to sell.
Last week the Centre for Economic and Business Research said a new eurozone crisis was its top prediction for 2011, pointing out that Spain and Italy alone must refinance more than €400m of bonds in the spring. Several banks are already understood to have created what one debt market banker described as "get ugly early strategies" in the hope they will be able to help their clients sell their bonds. "I think you're going to see everyone rush to sell bonds very early in January, because no one wants to take the chance of missing whatever funding window is available," said the banker.
The chief executive of one major UK retail bank told The Sunday Telegraph that he thought things could get "sticky" in the first half and that his bank was accelerating its issuance plans. The European Central Bank warned in its latest financial stability review published last month of a risk of "increasing competition for funding". In particular, the ECB gave warning of the continued uncertain macroeconomic outlook and market concerns over the financial position of some peripheral eurozone countries.
The Bank of England has also issued similar warnings and last month said that UK and European banks remained vulnerable to "strains in funding markets". "This reflects their continued dependence on short-term domestic and foreign currency wholesale funding and the challenge of refinancing or replacing substantial amounts of term loans and public sector support by the end of 2012," said the Bank in its latest financial stability report.
Credit Suisse analysts have pointed out that the funding position of European banks deteriorated in the second half of last year, putting more pressure on banks to sell even more bonds in the first half of 2011 if their funding is not to get "more stretched". Credit Suisse added that funding was likely to be increasingly expensive for most banks, presenting problems in particular for large retail banks that were unable quickly to change the pricing of their products to reflect their higher funding costs.
Smithers & Co. Finds That S&P Is Now Over 70% Overpriced Based On CAPE And q
by Tyler Durden - Zero Hedge
When we last looked at the updated CAPE and q S&P valuation readings as compiled quarterly by Smithers & Co, the market was only 48% overvalued. It is therefore not surprising that following one of the most ridiculous melt ups in the past two years (and we have had many in that period) that following the firm's most recent Z1 update of the CAPE (Cyclically Adjusted PE) and Tobin q chart, the S&P is now well over 70% overpriced. This is obviously amateur hour. With the Bernanke Put having eliminated all risk and stock trading lab rats now concerned about being bumped up in a higher tax bracket, not to mention that the S&P 500 20 day historical vol just hit 39 year lows, please wake us up only when this number is in the 4 digit range.
From Smithers & Co.
With the publication of the Flow of Funds data up to 30th September 2010 (on 8th December 2010), we have updated our calculations for q and CAPE. There has been little change in the underlying value of the market, but the rise in share prices has meant that non-financials are 74% overpriced according to q and listed shares, including financials, are 73% overpriced according to CAPE.
The calculations include the data published in Z1 Table B.102 as at 30th September, 2010, while that for CAPE includes the EPS on the S&P 500 up to the 30th June, 2010. The chart shows year end values, except for 10th December, 2010. (It should be noted that we use geometric rather than arithmetic means in our calculations). Although the overvaluation of the stock market is well short of the extremes reached at previous year ends in 1929 and 1999, it has reached the other previous peaks of 1906, 1936 and 1968.
It should also be noted that, once the market become significantly overpriced, the degree of overvaluation rises rapidly with further increases in share prices. For example, a 20% rise in share prices, such as occurred from 30th June to 10th December, means that a market which was overvalued by 44% at the end of June will be overvalued by 73% today.
Data for our calculations of q are taken for 1900 to 1952 from Measures of Stock Market Value and Returns for the Non-financial Corporate Sector 1900 - 2002 by Stephen Wright, published in the Review of Income and Wealth (2004) and for 1952 to 2009 from the Flow of Funds Accounts for the United States (“Z1”) published by the Federal Reserve. Data for our calculations of CAPE are taken from the data published on Robert Shiller’s website.
Australians sinking under debt burden
by Nick Gardner - The Sunday Telegraph
Australia is heading for an economic crunch as family finances collapse under the burden of record debts, rising interest rates and utility bills. With banks warning they will be forced to raise mortgage rates by 0.50 per cent in 2011 and Sydney rents forecast to rise by between $160 and $190 a month, according to analysts Residex, householders look set to suffer.
Repossessions and tenant evictions are expected to rise sharply. "It's going to be tough" said Shane Oliver, chief economist at AMP Capital. "Families face many rising costs and while most people have slowed their borrowing, our debt is still growing and that's a big problem." When the global financial crisis hit in 2008, Australians started paying down credit cards and loans, but quickly began piling on the credit again when it became clear we had avoided the worst of the crisis.
According to the Reserve Bank, Australians have added almost $220 billion to household debt levels since the beginning of 2008, taking our borrowings to a record $1.3 trillion. Despite more cautious spending in recent months, household debt is still up by 5.8 per cent on a year ago and a recent survey by Westpac found only about 20 per cent of people thought paying off debts was the best use of their money. Most households in the US, UK and much of Europe are still busily paying down their borrowings, particularly unsecured debts such as personal loans and credit cards.
"Unlike the rest of the world, Australia has slipped back into its old habits," said Steve Keen, professor of economics at the University of Western Sydney. "We're spending ourselves right back into trouble. With so much extra debt to service, we don't need interest rates to reach anything like the 9.6 per cent they hit in 2008. "We may find repossessions spiking much more quickly than they did two years ago."
In the first nine months of 2008, before the RBA began slashing interest rates, 1300 families lost their homes in NSW. Mr Oliver has estimated that debt will become unmanageable for many households when mortgage rates rise from 7.80 per cent to about 8.50 per cent. "At that stage homeowners could hit a wall," he said.
Economists are forecasting three 0.25 per cent rate hikes for 2011, taking the typical mortgage rate to 8.55 per cent. Craig James, chief economist at CommSec, said households may have to pare back budgets. "People can cut back on pay TV, holidays, mobile phones and all types of other discretionary spending," he said.l
Australia Manufacturing Shrinks for Fourth Month on Higher Borrowing Costs
by Michael Heath - Bloomberg
Australian manufacturing contracted in December for a fourth month as higher borrowing costs curbed consumer spending and the nation’s currency surged to a record, eroding export earnings. The performance of manufacturing index fell to 46.3 from 47.6 in November, the Australian Industry Group and PricewaterhouseCoopers said in a survey released in Canberra today. A number below 50 indicates contraction.
The nation’s factories are lagging behind the mining industry, which is expanding to meet rising Chinese demand for raw materials and pushing the job market close to a level the government views as full employment. The Australian currency rose 14 percent against the U.S. dollar last year, driving down the cost of imports and eroding exporters’ competitiveness.
"The continuation of flat conditions in the sector reflects accumulating structural pressures mounting on the industry along with other trade-exposed sectors in the wake of the mining boom," Heather Ridout, chief executive officer of the Australian Industry Group, said in a statement. "These forces are pushing up the level of the dollar and expectations about the directions of interest rates and inflation."
The Reserve Bank of Australia left interest rates unchanged last month after boosting borrowing costs in November to contain expected faster inflation in 2011, citing expectations for a "large expansionary shock" from trade. The bank has increased the overnight cash rate target seven times to 4.75 percent since October 2009. Australia is undergoing a hiring boom as companies including BHP Billiton Ltd. and Rio Tinto Group increase shipments of iron ore and coal to China. Employers added 366,000 jobs in the first 11 months of last year, the most in more than three decades.
The manufacturing survey, which is similar to the U.S. ISM index, polled more than 200 companies about production, new orders, deliveries, inventories and employment.
The contraction was led by a decline for the clothing and footwear industry, today’s report shows. A gauge of employment fell 1.8 points to 44.1 in December, and new orders rose 1 point to 44.3, today’s report showed. An index of production declined 2.4 points to 46.6.
Australia's unhealthy dependence on China
by Financial Follies
Debate is raging over whether China's massive boom in construction and real estate -- which is fueling Australia's commodity exports -- is a bubble waiting to burst. This is a critical question, because Australia's economy has become increasingly dependent on China for growth in its mining exports. In the chart below you can see that Japan, our biggest export market for much of the postwar period, is in a slow and steady decline. In contrast, China's share of our exports is growing exponentially.Like it or not, our economic future is now inextricably linked to that of China. China now accounts for an astounding two-thirds of world iron ore demand, around one-third of aluminium ore demand and more than 45% of global demand for coal, according to this recent paper by the RBA. Thanks to this voracious demand, our terms of trade -- or the ratio of our export prices to import prices -- is the highest it has been since the 1950s.But is this enormous growth in demand from China sustainable? Many economists think not. My favorite China watcher, Michael Pettis of Peking University, has been arguing for some time that China is running up against the limits of it's investment and export-led growth model, and that the days of double digit growth rates will soon be a thing of the past. In a recent blog post, he says:By the end of next year, I suspect that the consensus will be that for the rest of the decade we should expect growth rates in the 6-7% range for China.Pettis describes even this forecast as being "optimistic", and dependent upon China being able to maintain consumption growth of 8-9% a year.If GDP growth slows so substantially, it seems to me that consumption growth of 8-9% will be very hard to maintain, so I would argue that we should be prepared for even lower average growth numbers, perhaps in the 3-5% range... Non-food commodity exporters will be badly hurt.What would the implications be of such a drop in China's growth rate? Fitch Ratings recently performed a "stress test" of what would happen if Chinese growth slowed to 5% in 2011. Their conclusions are very interesting, so I am going to quote at length from the report. Firstly, as you can see below, Fitch expects that such a growth slowdown would cause a major crash in Asian stockmarkets, and a 20% fall in commodities prices.And which countries are most vulnerable to such a slowdown? The chart below confirms that Australia's economy is one of the most commodity-dependent in the world.
Not surprisingly, Fitch identifies iron ore exporters as amongst the biggest potential losers:But perhaps the most interesting section of the report is Fitch's expectations of what would happen to banking systems and financial markets in the event of a sharp slowdown in Chinese growth. Again, I will quote at length, because some very interesting points are raised.Iron ore – used as a key raw material in the steel industry – would be the commodity most affected by a slowdown, with Australian commodity producers in particular being impacted...It is also worth noting that the domestic banks in those overseas countries that provide financing to corporate exporters to China could face potential deterioration in the credit quality of their loan books in the event that demand for their customers’ products declined. This could affect banks in countries such as Hong Kong SAR, Taiwan, Japan, Korea and Australia.Investor risk appetite would likely reduce, increasing volatility in financial markets and resulting in capital flight from perceived riskier assets... Certain types of asset with high levels of correlation to the China growth story could be particularly badly hit, given investors’ ongoing initiatives to gain exposure to China through indirect routes such as commodities (especially copper), correlated currencies (the Australian dollar) and equities of multinational companies with global brands and a China presence...Fitch anticipates that a material slowdown in the Chinese economy would have a negative effect on the willingness of global banking systems to continue providing credit... Those countries with the heaviest reliance on China as a destination for exports (Hong Kong SAR, Taiwan, Japan, Korea, Singapore, Malaysia, Australia, Brazil, Chile, Peru and Russia) could potentially see a retrenchment of their banking systems, with credit availability reducing...This impact could be exacerbated by negative developments in the real estate markets of those countries with strong trade links to China, particularly those where property prices have risen strongly over the past 12–18 months, such as Singapore, Hong Kong, Taiwan and Australia.So let's summarize the implications for Australia of a sharp growth slowdown in China. Firstly, our miners will be heavily hit as Chinese demand contracts and commodity prices drop significantly. The Australian dollar will probably fall sharply. International investors will become risk averse, and may be unwilling to refinance the massive external liabilities of Australian banks without demanding a large risk premium. As credit dries up, Australian property prices will inevitably fall. This is an ugly scenario all round.
China's massive boost to our terms of trade has undoubtedly been a huge boon. Along with the government's massive stimulus, it helped us dodge the worst of the global financial crisis in 2008. But this once in a generation boost to our trade is not going to last forever. We could have spent the last decade prudently running large budget surpluses to create a buffer for when the boom ends. We could have invested more in infrastructure and tried to boost the productivity of the non-mining sector through economic reforms. We could have introduced a sensibly designed tax on the mining sector and invested the proceeds in a fund for Australia's future. But instead, in a decade of what economist Ross Garnaut calls "The Great Complacency", we have inflated a massive housing bubble based on an unsustainable rise in household debt, partly financed by foreign investors who will bail at the first sign of trouble.
Now, even Fitch says it doesn't expect it's "stress case" of 5% growth in China to eventuate in 2011. China's economy is still in the relatively early stages of industrialisation and it's obvious that there is still a lot of growth to come. But there are clearly limits to the pace of this growth, and the growth to come is definitely not going to be in a straight line. The question is: are we prepared for when China inevitably hits a speed bump?
U.S. Home Foreclosures May Top 100,000 In January
by Tamara Keith - NPR
Over the holidays, many lenders put foreclosures on hold. But that temporary freeze is over now. Industry watchers are expecting thousands of foreclosed properties to hit the market in the weeks and months ahead.
Home foreclosure sales slowed down at the end of 2010 for two reasons: the regular holiday foreclosure freezes, and the remnants of the so-called robo-signing scandal.
In the fall, many lenders put evictions on hold while they reviewed their foreclosure procedures. Rick Sharga of RealtyTrac says that's behind us now — and the pace of foreclosure is about to pick up.
"I'd be really, really surprised if we didn't see a probably record quarter in the first quarter of this year," he says. Sharga expects banks to repossess close to 100,000 homes in January alone. "We always have a seasonal uptick in the first quarter," he says, "and I think it will be accelerated because of delays that the servicers will be making up for in the first couple months."
Real estate agents are bracing themselves for an increasing number of vacant homes waiting for buyers. But Lawrence Yun, chief economist at the National Association of Realtors, says it doesn't come as a surprise. "These properties will come onto the market, that is a given," he says. Yun says there is a massive shadow inventory — homes not yet on the market where the owners are more than 90 days behind on their payments. "It's just inevitable that they will go into a foreclosure," he says.
But Yun says he doesn't expect all of those properties to get dumped onto the market in a single month. It will be gradual. But the question is whether the already fragile housing market will be able to handle them. "Hopefully the improving economy, job creation, will provide the necessary housing demand to absorb the shadow inventory that will be reaching the market," he says.
But will there be buyers out there for all of those homes? Yun says he's hopeful, but other economists aren't so sure. Most predict the unemployment rate will remain near 9 percent throughout 2011. People who are unemployed or worried about keeping their jobs aren't going to buy homes. And then there's the issue of loans. Mortgage lenders have so tightened their credit standards that now, even people with relatively good credit scores are having a hard time borrowing the money they need to buy a house.
29% Of Americans Say It's Difficult To Afford Food
by Dave Cohen - Decline of the Empire
The Pew Research Center for the People & the Press released their year-end survey on December 15, 2010. Their pollling revealed that for the public, a tough year ended on a down note.Consistent with the mood of the nation all year, 2010 is closing on a down note. Fully 72% are dissatisfied with national conditions, 89% rate national economic conditions as only fair or poor, and majorities or pluralities think the country is losing ground on nine of 12 major issues.
Pew's survey results are not surprising, and I would cover them in depth if it weren't for some rather important information that was buried in the next to last paragraph.The survey finds that a majority of the public (57%) says it is very difficult or difficult to afford things they really want. About the same percentage said this two years ago (55%). And for many Americans, affording basic necessities remains a struggle – 51% say it is difficult to afford health care, 48% say the same about their home heating and electric bills, and 29% say it is difficult to afford food.
I just quoted Pew, and you read the quote, but I want to make sure all of us truly absorbed what it says. So let me repeat the information as a series of bullet points.
- Affording basic necessities remains a struggle.
- 51% say it is difficult to afford health care.
- 48% say the same about their home heating and electric bills.
- 29% say it is difficult to afford food.
Why isn't this information Front Page News? Can you see the headline? I can see it, splashed across the top of the front page of the New York Times—
29% of Americans Say It's Difficult To Afford Food
Why haven't we seen this headline? Or this one?
48% of Americans Say It's Hard to Pay Their Heating And Electric Bills
January 3rd, the first working day of the new year, is an excellent time to call out those in the media, our elected representatives, those setting policy at the Federal Reserve, others making hay Inside The Beltway, and many, many right-thinking economists—tell me again what a great country this is. Tell me again we're all going to be OK. Tell me again that this isn't an Empire in decline. Tell me again about the "business cycle" and recessions.
Tell me again that wealth inequality is nothing to worry about, or something that need not be discussed. Tell me again how monumentally important the Big Banks are, about how we had to save them to save ourselves. Tell me again that my life would be impossible without Goldman Sachs. Tell me again that the rising stock market is good for us all. Tell me again how soaring corporate profits made overseas are making life better and better for all Americans. Tell me again how making iPhones in China is part of the best of all possible worlds.
Tell me again about how Trickle-Down Economics works. Tell me again about why the 99ers can be written off, if you haven't already forgotten who they are. Tell me again that rising oil and gasoline prices don't matter. Tell me again that there's no food inflation, that the rising cost of groceries is all in our heads. Go ahead, tell me again.
The obvious problem is that anything these media-types or politicians or policy-makers say would be rendered meaningless by these headlines, which is why we don't see them. The gap between the Official Story and day-to-day Reality could hardly be larger. Isn't it shameful that nearly 3 in 10 Americans find it difficult to afford food? That nearly half of them find it hard to pay their utility bills? If it's not, then what is it? Just a minor bump in the road? If you're in the media or Inside the Beltway, and you're shoving this news under the rug—and of course, most of you are doing just that—you yourself are part of our National Shame.
Denial is not just a river in Egypt.
An Extremely Long Metaphor to Explain Mortgage Chaos
by Matt Taibbi - Rolling Stone
>Have multiple relatives en route to my home this morning, but wanted to post a few thoughts on an interesting story that came out this week before I disappear into a weekend of overeating and meaningless NFL games.
The piece, which came out Thursday, is the Washington Post's feature on MERS, the electronic mortgage registration company that is at the center of the foreclosure/mortgage bubble mess. MERS is the brainchild of the mortgage-lending industry and is essentially an effort at systematically evading taxes (more on that in a moment) and hiding information from homeowners in ways that enabled the Countrywides of the world to defraud investors and avoid legal consequences for same.
The idea behind MERS was to wipe away centuries of legal tradition that mandated the physical transfer of loan notes and ownership information. Whereas lenders once were required to physically register with county clerk offices every time a mortgage loan was extended or re-sold, MERS provided an "electronic registry" of mortgage notes where all such transfers were recorded in the wiry brain of a giant computer instead of on paper.
Instead of the individual banks or lenders registering with the counties each time a loan was sold or re-sold, MERS would handle the initial registration and then become the "nominal" note-holder. Then, each time the note was passed on, MERS would record the transaction in its computer -- but no matter who the actual owner of the note was, MERS would remain the legally registered assignee of the note.
Imagine, say, a family of twelve, two elderly parents in Iowa and ten adult children scattered in different states all over the country. Mom and Dad on the farm own one Ford F-150 that they owe $300 a month on. Every month, the truck gets passed to a different family member, who in turn becomes responsible for the monthly payment. But no matter who has the car and whose turn it is to come up with the $300, the truck stays in Dad's name and the money, in the end, comes to Ford Finance via Dad's checking account.
Looking at this as an individual and unique case, you wouldn't think there was much that was inherently wrong with this setup. Obviously the family arrangement violates the spirit of many laws and procedures -- vehicle registration (from month to month, the true owner of the car is hidden from the state), credit application (Pops technically committed credit fraud if he got the car loan in his own name knowing the children would actually be paying), and taxes/fees (the state misses out on its registration fees every month, when the car is informally "sold" from child to child without the nominal paperwork fees being paid to the DMV of the state in question). But again, looking at this as an individual case, not many people would say any of these "violations" were major moral transgressions, if they were really moral transgressions at all. After all, this is family!
But once you take this setup and institutionalize it, and employ it everywhere on a vast scale, it becomes seriously problematic. This is particularly true if, say, Pop begins allowing his kids to "rent" the car out to non-family members, so long as they kick a small fee upstairs. Say it's March and Pop gives the truck to son Jimmy in Toledo; in April Jimmy gives the truck to his buddy Rick in Akron, charging the $300 payment plus a $20 convenience fee. May: Jimmy gives the car to his girlfriend Trudy in Phoenix, telling her to wire $300 plus another $20 back to Pops in Iowa; she in turn lends the car to her occasional lesbian love interest Madison, who begins renting the car on a day-to-day basis in Tuba City as part of her family's Painted Desert Resort and Tourism business, etc. etc. And she's now kicking the fees back to Iowa.
Within a year Pop is buying fifty vehicles an hour and shuttling cars to new customers all over the country, collecting millions in fees every day; he becomes a billion-dollar corporate fixture, hiring the entire local Elks club to come with him to work as support staff.
So now, to take this already absurdly overwrought metaphor one final painful step further, there is a string of grisly homicides being committed on highways across America. Witnesses spot that original F-150 truck and the license plates at each of the murder scenes, but when cops come looking for the truck owner, they find old Pop in a wheelchair in Iowa, alibied on the night of every crime by forty-five fellow members of the Dubuque Elks. They drag Pop into the station to question him, but he won't give up which of his boys did the crimes -- hell, he doesn't know, anyway.
This, roughly, is what MERS is. The functional effect of MERS is to create an obfuscatory wall between the homeowner and the actual owner of his mortgage loan. The problem with MERS is a paradox at the heart of the "ownership" question. On the one hand, MERS is the legal assignee of a lot of these mortgage notes. On the other hand, it's not the "real" owner of the notes, in any way that could ever help you, or the state, or the investors in mortgage-backed securities. From the Post piece:Some state courts agree. The Missouri court of appeals said in June 2009 that MERS lacked the authority to assign a mortgage from one service company to another. Because the transfer by MERS "had no force," the court ruled, the owner of the loan "lacks a legally cognizable interest" and could not pursue the delinquent borrower.In short, the mortgage industry considers MERS owner enough to foreclose on you, but not owner enough to be sued, or reasoned with, or even to provide basic customer service. As noted in the above passage, the courts are beginning to disagree with the industry's position here, but it's a long process. In short this was the perfect ownership structure for a subprime industry geared toward massive fraud and predatory lending, in which mountains of dicey loans were issued factory-style and quickly sold off so that the original lenders could not be on the hook when they blew up.
The Kansas Supreme Court ruled in August 2009 that MERS did not have any interest in the underlying property of a bankrupt borrower whose home was auctioned - even though MERS was listed as the mortgagee. Moreover, the court said that the MERS transfer of the mortgage was invalid because the owner, Sovereign, had never recorded its interest in Ford County, Kan.
It's not a surprise that MERS was at least in part dreamed up by Angelo Mozilo of Countrywide. Again, from the Post piece:The savings and loan crisis had just passed and the mortgage business was picking up again. At the time, an unconventional entrepreneur named Angelo Mozilo was on the MBA board. Eventually Mozilo would pay a $67.5 million to settle Securities and Exchange Commission allegations of fraud and insider trading. But back then Mozilo was one of the industry's most admired executives, known for his inventiveness and technology investments at his firm Countrywide Financial, which in 1992 catapulted to first place among the nation's mortgage originators.Another detail here: for those of you wondering why so many localities are broke, here's one small factor in the revenue drain. Counties typically charge a small fee for mortgage registration, roughly $30. But with MERS, just like with Pop and his pickup truck, you don't need to pay the fee every time there's an ownership transfer. Multiply that by 67 million mortgages and you're talking about billions in lost fees for local governments (some estimates place the total at about $200 billion).
Mozilo began brainstorming with a young MBA technology expert, Brian Hershkowitz, about ways to computerize and centralize the way the industry did business to take it to a new level.
"Angelo Mozilo loved to think about that," Hershkowitz recalled. He was "the inspiration" for what would eventually become MERS.
Outrageously, MERS actually marketed itself to its customers as a way to save money by avoiding the payment of legally-mandated registration fees. Check out this MERS brochure from 2007. It brags on the face page about its fee-avoiding qualities ("MINIMIZE RISK. SAVE MONEY. REDUCE PAPERWORK") and inside the brochure, in addition to boasting about helping clients "Foreclose More Quickly," it talks about how clients save money because MERS "eliminates the need to record assignments in the name of the Trustee."
All of this adds up to a system that enabled the mortgage industry to avoid keeping any kind of proper paperwork on its frantic, coke-fueled selling and re-selling of mortgage-backed securities during the bubble, and to help the both the Countrywide-style subprime merchants and the big banks like Goldman and Chase pull off the mass sales of crappy loans as AAA-rated securities.
Anyway, the Post has some amazing factoids in it. I took particular note of this passage:But critics say promises of transparency and of ironing out wrinkles in record-keeping haven't panned out. [MERS], which tracks more than 60 percent of the country's residential mortgages but whose parent company employs just 45 people in a Reston office building, is on the firing line now.Emphasis mine there. Forty-five people, tracking 67 million mortgages. Does anyone wonder why the system is in chaos?
US house prices – Roll out the welcome mat for a double-dip
by Alexander Gloy - Lighthouse Investment Management
Let’s take a look at the situation after the October data from the Case-Shiller home price index has come in:
You see all major metropolitan areas peaking between March and May 2010 (the end of the first-time home-buyer tax credit). After only 8 months in positive territory, the overall index comprising 20 cities is back into the red (-1% in October). 14 out of 20 regions now show declining house prices.
Prof. Robert Shiller (one of the creators of the index) pointed out that 6 out of 20 cities in the index have hit new lows (even lower than in early 2009). He said that the economy would face “serious worries” if house prices kept falling this fast.
Why did he say “this fast”? To understand, you have to look at the annualized rate of change of the last 3 months. And it is not a pretty picture:
While the 10-city index dropped an annualized 8.8% in the three-month period from July to October 2010, the 20-city index fell at a rate of 10.4%.
The annualized three-month rate of change gave an early warning sign went it went into negative territory in June 2006, while both the 10-city and 20-city only showed declining house prices in January of 2007.
Equally, the three-month rate of change signaled a trend reversal in April, May and June of 2009, while the overall index did not turn positive until February 2010.
Investors would have been wise to heed these signals – both on the way down and on the way up. As declining house prices were the trigger for the biggest financial crisis since the Great Depression it is only a matter of time until financial markets react to the new realities of house prices: a double-dip.
Foreclosure Deals to Start With Big Lenders, Iowa Says
by Margaret Cronin Fisk and Prashant Gopal - Bloomberg
The five largest loan servicers, including Bank of America Corp. and JPMorgan Chase & Co., may be the first to settle with the 50 state attorneys general probing foreclosure practices, Iowa Attorney General Tom Miller said. No settlements have been reached yet, Miller said yesterday in a phone interview.
The other three are Citigroup Inc., Wells Fargo & Co. and Ally Financial Inc., said Miller, the leader of the 50-state investigation. The five have 59 percent of the U.S. market, Miller said. "What we’re looking at is five separate agreements with the five largest servicers," Miller said. "We’re still a ways away" from reaching agreements, he said. "We’re working very hard to figure out what should be in the settlement."
All 50 U.S. states are investigating whether banks and loan servicers used false documents and signatures to justify hundreds of thousands of foreclosures. The probe, announced Oct. 13, came after JPMorgan and Ally Financial’s GMAC mortgage unit said they would stop repossessions in 23 states where courts supervise home seizures, and Bank of America, the largest U.S. lender, froze foreclosures nationwide.
The probe has since widened to include other mortgage practices, with attorneys general suggesting a potential resolution should include improving the loan modification process, barring foreclosures when people are modifying loans and creating a general fund to compensate homeowners who may have been victims of wrongful foreclosures.
Miller said the attorney-general group has had at least one face-to-face meeting with representatives from all five of the largest banks, along with "follow-up phone calls." The group will reach individual settlements rather than a global agreement with the servicers, he said. "It won’t be the same document for everybody," he said. "There are differences in the companies and in performances."
The group isn’t pursuing a criminal investigation, Miller said. "Our focus is to reform the servicing process and that’s inherently civil, not criminal," he said.
In an interview last week, Miller said the group might consider matters including whether servicers are charging borrowers appropriate fees. "We hear stories far too often of it taking months before servicers get back to people, or they lose documents and that they don’t modify a loan when it makes sense," Miller said last week.
The 50-state group "offers one of the most promising avenues to increasing loan modification and servicer accountability that we have seen so far," said Paul Leonard, California director for the nonprofit Center for Responsible Lending in Durham, North Carolina. He said the group would act more independently than Congress or federal regulators because of the influence of industry lobbyists in Washington. "The attorneys general come at this with a fresh eye," Leonard said in an interview yesterday. "They can assess and make changes that they feel necessary."
Texas 2011 Budget Shortfall: $25 Billion
by Texas Tribune
A budget shortfall as high as $25 billion is projected as lawmakers head into the 2011 legislative session, according to estimates from economists and the comptroller's office. Texas writes budgets biennially, or in two-year terms, so the shortfall affects the 2012-2013 state budget. Leadership in the Texas Legislature, which is dominated by fiscal conservatives, is not expected to support attempts to raise taxes to fill the multibillion-dollar hole. But social service advocates say the state's safety net system can't afford any further budget cuts.
How the state fell into a hole
Declining sales tax receipts and the recession: State lawmakers write a budget based on an educated guess of how much money will be available to spend during the period for which they're writing a budget. For example, in 2009, lawmakers wrote a budget for 2010-2011. State government gets about 60 percent of its revenue from sales taxes, so when there's a dramatic drop in state revenues, or collections, there's less money to spend. During the economic recession of 2008-2009, Texas saw a drop in state revenues for 14 straight months.
Structural deficit: Some budget watchers say lawmakers created a "structural" deficit in 2005, when lawmakers cut school property taxes by one-third and expanded the business tax to make up the difference. But the business tax brings in billions less each year than the property tax did, meaning that with every new budget, lawmakers must find more and more extra money to make up the difference. The structure of the revenue system creates deficits each year.
Options to fill the hole
Budget cuts: In 2003, lawmakers used massive cuts and increases in fees to fill a $10 billion budget hole. Gov. Rick Perry has said those measures can be used again in the 2011 session. In 2010, state agencies were already advised to cut 5 percent from their budget requests, which was projected to save about $1 billion. The comptroller said in 2010 that she trusted lawmakers to make up the rest.
Increasing revenue: There are various ways this can occur, but lawmakers must approve them, which makes some of them much more likely than others.
- Draining the Rainy Day Fund: The Rainy Day Fund allows states to set aside excess revenue for use in times of unexpected revenue shortfall. It can plug holes in the budget, defend against an economic perfect storm and keep the deficit clouds at bay. Using the fund itself isn’t particularly easy. If the comptroller says that revenue will decrease between legislative sessions or if a budget deficit unexpectedly develops, it requires a three-fifths vote to transfer money away from the fund. Of course, if members want to use the money for any other situation — like say, a budget shortfall — then they’ll need to reach two-thirds of their colleagues, an even higher threshold.
- Cost-shifting: Cost-shifting refers to transferring the burden of paying for a service from the state government to its beneficiaries. The best-known example from 2003 was the deregulation of tuition at public universities. Those with state-subsidized health insurance also had to shoulder higher costs — including $790 million in new co-pays, premiums and other costs.
- Fees: Since it's politically unpalatable to raise taxes, lawmakers in the past have raised fees in places that many Texans would not notice or be affected by. In 2003, lawmakers established a quality-assurance fee for facilities for the developmentally disabled ($54 million) and added a $1,000-a-year charge for three years for motorists' first driving-while-intoxicated conviction.
- Gambling: In light of the budget situation, lawmakers are considering casino gambling as a possible new revenue stream. But there's infighting among industry groups over which industry — track owners or destination resort casino backers — get preferential treatment in the lawmaking process. If a casino gambling bill actually passed, Texans would then vote to approve them. It would take another few years for the industry to grow in Texas and provide billions promised in increased revenue. But some tax revenue, like money from casino licenses, could flow into state coffers more quickly.
- Personal income tax: Texas has no personal income tax, and most Republican leadership in Texas say it will never happen. But progressive economists argue that a personal income tax is the only way to grow revenue over time because a property tax and sales tax system will not be enough to continue funding programs and services.
Illinois Has Days to Plug $13 Billion Deficit That Took Years to Produce
by Tim Jones - Bloomberg
Illinois lawmakers will try this week to accomplish in a few days what they have been unable to do in the past two years -- resolve the state’s worst financial crisis. The legislative session that began today as the House convened will take aim at a budget deficit of at least $13 billion, including a backlog of more than $6 billion in unpaid bills and almost $4 billion in missed payments to underfunded state pensions.
The fiscal mess is largely of the lawmakers’ own making, and failure to address the shortages threatens public schools, local governments and other public services, said Dan Hynes, the state’s outgoing comptroller. "We’ve reached a very critical and concerning point," Hynes said in an interview in his Chicago office, with packing boxes stacked in the corner. "What’s missing right now is a general understanding by the public of where we are, of how bad it is, and what the fallout would be if we don’t deal with it properly."
What the public may not appreciate, Wall Street does. Illinois shares with California the lowest U.S. state credit rating from Moody’s Investors Service, which in September forecast possible "further financial deterioration." Unlike California, Moody’s assigned Illinois a negative outlook. Illinois’s deficit, about half its $26 billion general-fund budget, puts it among the U.S. states confronting $140 billion in shortfalls in the coming fiscal year after closing $160 billion in gaps this year, according to the Center on Budget and Policy Priorities, a Washington research group.
Debt Costs Rising
Hynes, 42, predicted the deficit might rise to $15 billion by midyear, and that prospect has come with a price tag. The cost of insuring Illinois debt against default rose to a five- month high last week as the state headed into this year without a plan to finance a $3.7 billion pension-fund contribution. Insuring $10 million of Illinois debt against default cost $350,000 a year on Dec. 29, more than California’s $298,000, according to data compiled by Bloomberg. Illinois and Arizona were the weakest states in a Dec. 30 financial-strength index report from the Chicago office of BMO Capital Markets, a financial services company.
Lawmakers meeting in Springfield will consider spending cuts, an expansion of casino gambling and a proposal from Democratic Governor Pat Quinn to borrow $15 billion to pay overdue bills and help fill the budget hole. The bill before the House would create five new casinos, including one in Chicago, and authorize electronic gaming at horse-racing tracks and nine existing casinos. The measure has passed the Senate.
Quinn, 62, also has proposed boosting the state income tax to 4 percent from 3 percent, raising about $3 billion a year. The governor needs Senate approval of a borrowing plan to make this year’s payment into the pension funds. The Illinois State Board of Investments will start buying back assets sold to pay benefits if lawmakers approve the debt sale, William Atwood, executive director of the panel, said in an interview on Bloomberg Television today.
The three pensions run by the board, which manages $10 billion, have been selling assets to pay retirees since Illinois failed to contribute for the fiscal year that began July 1. Borrowing by Illinois is what credit analysts, Hynes and bond investors point to as a major reason why the state’s financial standing fell so far so fast.
Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co. in Newport Beach, California, said Illinois was one of the states whose debt he would avoid. "Illinois is probably in the worst shape," Gross said in a Dec. 28 interview on CNBC.
The widening gap between Illinois’s expenses and revenue drew criticism from Moody’s. The disparity underscored the state’s "chronic unwillingness to confront a long-term, structural budget deficit," it said in a Dec. 29 study. The worst financial crisis since the Great Depression and politicians’ unwillingness to cut budgets explain the descent since 2008, said Tom Johnson, president of the nonpartisan Taxpayers’ Federation of Illinois. Annual sales and income-tax revenue fell for the first time in modern history, he said.
"The state was hoping for a quick recovery or inflation, and they didn’t get it," Johnson said in a telephone interview. "And there was no appetite to reduce the escalating costs of spending."
‘Revenues Went South’
The falloff in revenue aggravated the state’s historic practice of delaying payments to vendors and carrying those costs on from one year to the next. "Revenues went south, spending went north," Johnson said. "It’s unsustainable." The current-year budget deficit of $13 billion is roughly half the size of the state’s general-fund budget. Borrowing to pay bills continues. In November the state sold $1.5 billion of bonds backed by tobacco settlement payments to help pay vendors.
"We have seen a lot of the budgetary tools that really don’t qualify as real solutions used, whether it’s short-term borrowing, pension borrowing, delays in payments, the sale of future revenues," Hynes said. Illinois business leaders have warned that the state’s failure to properly fund pensions means the plans will run out of money to pay promised benefits before the decade ends. "We’re in the midst of the most severe financial crisis in recent memory," Miles White, chairman of Abbott Park, Illinois- based Abbott Laboratories, said Sept. 27 at a forum on state affairs.
"The state has been spending $3 for every $2 it takes in, and borrowing to cover its current operating expenses," said White, chairman of the Civic Committee of the Commercial Club of Chicago. The state had $64 billion of assets to pay estimated liabilities of $126.4 billion as of June, or less than half the amount needed for almost 723,000 workers, retirees and other beneficiaries, according to bond documents.
The question facing lawmakers is whether they can reverse the slide into more debt. The gravity of the situation is registering with the General Assembly, said James Nowlan, a former member of the state House and now a senior fellow at the University of Illinois Institute of Government & Public Affairs. "I think they’re finally educated that all the one-time adjustments and shenanigans have been pulled, and they are now facing the fiscal abyss," Nowlan said in a telephone interview. "But maybe I’m too hopeful."
Jerry Brown Says California Budget He Proposes Next Week Will Be 'Painful'
by Christopher Palmeri and Michael B. Marois - Bloomberg
Jerry Brown said the budget he’ll propose as California’s new governor, 36 years after he first stepped into the job, will be "painful." Brown, 72, a Democrat who served two terms as governor from 1975 to 1983, faces a self-described "day of reckoning" over a $28 billion budget gap that promises battles with lawmakers, unions and investors threatening to shun the bonds of the most- indebted state.
"The budget I present next week will be painful but it will be an honest budget," Brown said at his inauguration today in Sacramento, the state capital. "It is a tough budget for tough times." Brown takes over the U.S. state with the largest economy, the biggest population and the highest deficit. He thanked his predecessor, Arnold Schwarzenegger, who grappled with shortfalls that totaled $100 billion combined since June 2008. Brown said he wouldn’t raise taxes without public approval.
Brown has pledged an austerity budget, due Jan. 10, that will be free from gimmicks and that will skirt the gridlock that forced the state to pay bills with IOUs two years ago. His budget reductions may include eliminating local redevelopment agencies, shrinking social-service benefits, slashing aid to state universities and closing parks, the Sacramento Bee reported today, citing a source close to Brown.
"If you look at Jerry’s history, in 1975 the first thing he did was cut Ronald Reagan’s budget," said David Shulman, a senior economist with the Anderson Forecast at the University of California, Los Angeles. "The Democratic legislature didn’t like it, but his poll numbers were high. It wouldn’t surprise me if he did that again."
The son of former two-term governor Edmund G. "Pat" Brown, the younger Brown earned the nickname "Governor Moonbeam" for his support of programs such as a state-sponsored space program in the 1970s. His first two terms were immortalized in the song "California Uber Alles" by the punk- rock band Dead Kennedys, which included the lyrics "Mellow out or you will pay!"
The audience laughed in the middle of the oath when Chief Justice Tani Cantil-Sakauye asked Brown to repeat that he had no mental reservation about taking the job. "Really, no mental reservation," Brown joked.
Brown faces a super-size version of the stress governors confront coast to coast. States will contend with about $140 billion in deficits in the next fiscal year after closing $160 billion in gaps this year, the Center on Budget and Policy Priorities, a Washington research group, estimated Dec. 16. Brown’s budget task was eased by voters’ decision in November to allow lawmakers to authorize spending plans with a simple majority, doing away with a 77-year-old rule requiring a two-thirds vote. "The day of reckoning is upon us and I’m determined to bite the bullet and get it done," Brown said in Los Angeles last month.
Brown is likely to call for a special election to ask voters for money, said Jaime Regalado, executive director of the Edmund G. Brown Institute of Public Affairs -- named for Jerry Brown’s father -- at California State University, Los Angeles. Options include extending temporary tax increases on income, retail sales and vehicle registrations put in place in 2009. They are set to expire this year. "What he’s doing is setting up expectations of a very dire situation and choice for Californians," Regalado said in a telephone interview. "But it’s going to be the voters’ choice of what services they want to keep -- and for those that they keep, are they willing to be taxed for them."
The governor inherits the nation’s third-highest unemployment rate at 12.4 percent, what the treasurer’s office says is $88.3 billion of bond debt and as much as $500 billion of pension liabilities following the longest recession since World War II. Brown, the former state attorney general, succeeds Schwarzenegger, the movie star and former body-building champion swept into office in 2003 through the unprecedented recall election of Gray Davis, a Democrat. Schwarzenegger, a Republican, couldn’t seek re-election because of term limits.
Brown takes charge of a state whose $1.89 trillion economy is bigger than Russia’s. It is home to 14 percent of the companies in the Standard & Poor’s 500 Index including Apple Inc., Google Inc., Chevron Corp. and Wells Fargo & Co.
The new governor brings "a tell-it-like-it-is sober approach to the problems facing California," Eli Broad, the billionaire philanthropist, long-time Brown supporter and former SunAmerica Inc. chief executive officer, said in a telephone interview. "People are waiting for some plain talk and are tired of politicians using smoke and mirrors to solve the problems of the state."
While Democrats control both the Senate and the Assembly, they lack a so-called supermajority of 60 percent. Starting a ballot measure that would extend temporary levies, or increase taxes and fees, would need the assent of two-thirds of lawmakers or a citizen initiative drive. California shares with Illinois the lowest credit rating of any state from Moody’s Investors Service. The A1 grade is Moody’s fifth-highest. Standard & Poor’s rates California A-, its fourth-lowest level for investment-quality securities. Only Illinois and Arizona are financially weaker than California, according to a Dec. 30 report from BMO Capital Markets in Chicago.
Betting on California
Investors are betting that California will surmount its difficulties. The extra yield that buyers want for 10-year California bonds compared with top-rated municipal bonds fell to 115 basis points Dec. 30, from 150 on March 11, the 2010 peak. A basis point is one-one hundredth of a percent. The Bloomberg California Index of stocks outperformed the S&P 500 by 1.63 percentage points in 2010.
Curbing the cost of state workers’ salaries and their pensions may put Brown at odds with the labor unions that supported his campaign, such as the 120,000-member California Federation of Teachers. The state will spend $9.2 billion on payroll this year, according to the Finance Department. Payments to the two public-employee pensions, the largest in the U.S., will consume 5 percent of the general fund.
Brown signed legislation during his first term that gave teachers and state workers the right to bargain collectively, which Schwarzenegger and other Republicans later criticized. Brown won office in November, defeating Meg Whitman, 54, a former EBay Inc. chief executive officer who poured at least $141.6 million of her own fortune into the campaign, a U.S. record for self-funding by a candidate.
The governor, who ran for president unsuccessfully three times, studied Buddhism in Japan, worked with Mother Teresa in India, and was elected mayor of Oakland in 1998. Since 2007, as attorney general, he had been the state’s top law-enforcement officer. As governor in the 1970s, he shunned the official mansion and predecessor Reagan’s Cadillac limousine in favor of a two- bedroom apartment near the Capitol and a Plymouth Satellite he drove himself. He dated rock star Linda Ronstadt and they were featured together on the cover of Newsweek magazine in April 1979.
For his first inauguration, he took the oath of office in the Assembly chambers followed by an eight-minute speech. He declined to have an inaugural ball and instead celebrated with dinner at a Chinese restaurant in Los Angeles. Four years later, he gave another short inaugural speech in Sacramento and then ordered food from a Chinese restaurant that he ate with friends and staff in his office. This year, Brown was sworn in at a Sacramento auditorium with seating for 3,849. He planned a private reception later in the day at the nearby state railroad museum.
Strained States Turning to Laws to Curb Labor Unions
by Steven Greenhouse - New York Times
Faced with growing budget deficits and restive taxpayers, elected officials from Maine to Alabama, Ohio to Arizona, are pushing new legislation to limit the power of labor unions, particularly those representing government workers, in collective bargaining and politics.
State officials from both parties are wrestling with ways to curb the salaries and pensions of government employees, which typically make up a significant percentage of state budgets. On Wednesday, for example, New York’s new Democratic governor, Andrew M. Cuomo, is expected to call for a one-year salary freeze for state workers, a move that would save $200 million to $400 million and challenge labor’s traditional clout in Albany.
But in some cases — mostly in states with Republican governors and Republican statehouse majorities — officials are seeking more far-reaching, structural changes that would weaken the bargaining power and political influence of unions, including private sector ones.
For example, Republican lawmakers in Indiana, Maine, Missouri and seven other states plan to introduce legislation that would bar private sector unions from forcing workers they represent to pay dues or fees, reducing the flow of funds into union treasuries. In Ohio, the new Republican governor, following the precedent of many other states, wants to ban strikes by public school teachers.
Some new governors, most notably Scott Walker of Wisconsin, are even threatening to take away government workers’ right to form unions and bargain contracts.
"We can no longer live in a society where the public employees are the haves and taxpayers who foot the bills are the have-nots," Mr. Walker, a Republican, said in a speech. "The bottom line is that we are going to look at every legal means we have to try to put that balance more on the side of taxpayers."
Many of the proposals may never become law. But those that do are likely to reduce union influence in election campaigns, with reverberations for both parties. In the 2010 elections, Republicans emerged with seven more governor’s mansions and won control of the legislature in 26 states, up from 14. That swing has put unions more on the defensive than they have been in decades.
But it is not only Republicans who are seeking to rein in unions. In addition to Mr. Cuomo, California’s new Democratic governor, Jerry Brown, is promising to review the benefits received by government workers in his state, which faces a more than $20 billion budget shortfall over the next 18 months. "We will also have to look at our system of pensions and how to ensure that they are transparent and actuarially sound and fair — fair to the workers and fair to the taxpayers," Mr. Brown said in his inaugural speech on Monday.
Many of the state officials pushing for union-related changes say they want to restore some balance, arguing that unions have become too powerful, skewing political campaigns with their large war chests and throwing state budgets off kilter with their expensive pension plans. But labor leaders view these efforts as political retaliation by Republicans upset that unions recently spent more than $200 million to defeat Republican candidates.
"I see this as payback for the role we played in the 2010 elections," said Gerald W. McEntee, president of the American Federation of State, County and Municipal Employees, the main union of state employees. Mr. McEntee said in October that his union was spending more than $90 million on the campaign, largely to help Democrats. "Now there’s a bull’s-eye on our back, and they’re out to inflict pain," he said.
In an internal memorandum, the A.F.L.-C.I.O. warned that in 16 states, Republican lawmakers would seek to starve public sector unions of money by requiring each government worker to "opt in" before that person’s dues money could be used for political activities. "In the long run, if these measures deprive unions of resources, it will cut them off at their knees. They’ll melt away," said Charles E. Wilson, a law professor at Ohio State University.
Of all the new governors, John Kasich, Republican of Ohio, appears to be planning the most comprehensive assault against unions. He is proposing to take away the right of 14,000 state-financed child care and home care workers to unionize. He also wants to ban strikes by teachers, much the way some states bar strikes by the police and firefighters. "If they want to strike, they should be fired," Mr. Kasich said in a speech. "They’ve got good jobs, they’ve got high pay, they get good benefits, a great retirement. What are they striking for?"
Mr. Kasich also wants to eliminate a requirement that the state pay union-scale wages to construction workers on public contracts, even if the contractors are nonunion. In addition, he would like to ban the use of binding arbitration to settle disputes between the state and unions representing government employees. Labor leaders, who argue that government employees are not overpaid, worry that many of these measures have a much better chance of enactment than in previous years because of Republican electoral gains and recession-ravaged taxpayers’ reduced sympathy toward government workers.
The A.F.L.-C.I.O.’s internal memo warned labor leaders, "With the enormous losses in state legislatures around the country, we will face not only more attacks on working families and their unions — we will face more serious attacks, particularly in the formerly blue or purple states that are now controlled by a Republican trifecta." It pointed in particular to six states, including several former union strongholds, where Republicans control the governor’s mansion and both houses of the legislature: Indiana, Maine, Michigan, Ohio, Pennsylvania and Wisconsin.
Naomi Walker, the A.F.L.-C.I.O.’s director of state government relations, said many voters would oppose the antiunion efforts. "I think folks in these states are going to ask whether this is the right time to weaken unions when corporations are amassing more power than ever," she said. "We’ve been fighting against privatizing Social Security and sending jobs offshore and to get the best deal for the unemployed. It would be a lot easier for Republicans if unions weren’t there to throw up these roadblocks."
Union leaders particularly dread the spread of right-to-work laws, which prevail in 22 states, almost all in the South or West. Under such laws, unions and employers cannot require workers to join a union or pay any dues or fees to unions to represent them. Unions complain that such laws allow workers in unionized workplaces to reap the benefits of collective bargaining without paying for it. Pointing to lower wages in right-to-work states, unions say the laws lead to worse wages and benefits by weakening unions.
But lawmakers who are pushing right-to-work laws argue that they help attract investment. "The folks who work day-to-day in economic development tell us that the No. 1 thing we can do to make Indiana more attractive to business is to make Indiana a right-to-work state," said Jerry Torr, an Indiana state representative who backs such legislation.
Some union leaders say that proposals like right-to-work laws, which have little effect on state budgets, show that Republicans are using budget woes as a pretext to undercut unions. "They’re throwing the kitchen sink at us," said Randi Weingarten, president of the American Federation of Teachers. "We’re seeing people use the budget crisis to make every attempt to roll back workers’ voices and any ability of workers to join collectively in any way whatsoever."
A group composed of Republican state lawmakers and corporate executives, the American Legislative Exchange Council, is quietly spreading these proposals from state to state, sending e-mails about the latest efforts as well as suggested legislative language. Michael Hough, director of the council’s commerce task force, said the aim of these measures was not political, but to reduce labor’s swollen power. "Government budgets have grown and grown because of the cost of employees’ pensions and salaries," he said. "Now we have to deal with that."
Public Employee Unions Face Outrage as Budget Crises Grow
by Michael Powell - New York Times
Ever since Marie Corfield’s confrontation with Gov. Chris Christie this fall over the state’s education cuts became a YouTube classic, she has received a stream of vituperative e-mails and Facebook postings. "People I don’t even know are calling me horrible names," said Ms. Corfield, an art teacher who had pleaded the case of struggling teachers. "The mantra is that the problem is the unions, the unions, the unions."
Across the nation, a rising irritation with public employee unions is palpable, as a wounded economy has blown gaping holes in state, city and town budgets, and revealed that some public pension funds dangle perilously close to bankruptcy. In California, New York, Michigan and New Jersey, states where public unions wield much power and the culture historically tends to be pro-labor, even longtime liberal political leaders have demanded concessions — wage freezes, benefit cuts and tougher work rules.
It is an angry conversation. Union chiefs, who sometimes persuaded members to take pension sweeteners in lieu of raises, are loath to surrender ground. Taxpayers are split between those who want cuts and those who hope that rising tax receipts might bring easier choices. And a growing cadre of political leaders and municipal finance experts argue that much of the edifice of municipal and state finance is jury-rigged and, without new revenue, perhaps unsustainable. Too many political leaders, they argue, acted too irresponsibly, failing to either raise taxes or cut spending. A brutal reckoning awaits, they say.
These battles play out in many corners, but few are more passionate than in New Jersey, where politics tend toward the moderately liberal and nearly 20 percent of the work force is unionized (compared with less than 14 percent nationally). From tony horse-country towns to middle-class suburbs to hard-edged cities, property tax and unemployment rates are high, and budgets are pools of red ink.
A new regime in state politics is venting frustration less at Goldman Sachs executives (Governor Christie vetoed a proposed "millionaire’s tax" this year) than at unions. Newark recently laid off police officers after they refused to accept cuts, and Camden has threatened to lay off half of its officers in January. Fred Siegel, a historian at the conservative-leaning Manhattan Institute, has written of the "New Tammany Hall," which he describes as the incestuous alliance between public officials and labor.
"Public unions have had no natural adversary; they give politicians political support and get good contracts back," Mr. Siegel said. "It’s uniquely dysfunctional." Even if that is so, this battle comes woven with complications. Across the nation in the last two years, public workers have experienced furloughs and pay cuts. Local governments shed 212,000 jobs last year.
A raft of recent studies found that public salaries, even with benefits included, are equivalent to or lag slightly behind those of private sector workers. The Manhattan Institute, which is not terribly sympathetic to unions, studied New Jersey and concluded that teachers earned wages roughly comparable to people in the private sector with a similar education.
Benefits tend to be the sorest point. From Illinois to New Jersey, politicians have refused to pay into pension funds, creating deeper and deeper shortfalls. In California, pension costs now crowd out spending for parks, public schools and state universities; in Illinois, spiraling pension costs threaten the state with insolvency.
And taxpayer resentment simmers.
Trouble in New Jersey
To venture into Washington Township in southern New Jersey is to walk the frayed line between taxpayer and public employees, and to hear anger and ambivalence. So many Philadelphians have flocked here over the years that locals call it "South Philly with grass."
These expatriates tend to be Democrats and union members, or sons and daughters of the same. But property taxes are rising fast, and voters favored Governor Christie, a Republican. Bill Rahl, a graying plug of a retiree, squints and holds his hand against his throat. "I’m up to here with taxes, I can’t breathe, O.K.?" he says. "I don’t know about asking anyone to give up a pension. Just don’t ask for no more."
Governor Christie faced a vast deficit when he took office last January, and much of the federal stimulus aid for schools was exhausted by June. So he cut deeply into state aid for education; Washington Township lost $900,000. That forced the town to rely principally on property taxes. (Few states lean as heavily on property taxes to finance education; New Jersey ranks 45th in state aid to education.) The town turned its construction office over to a private contractor and shed a few employees.
Assemblyman Paul D. Moriarty, a liberal Democrat, served four years as mayor of Washington Township. As the bill for pension and health benefits for town employees soared, he struggled to explain this to constituents. "We really should not receive benefits any better than the people we serve," he says. "It leads to a lot of resentment against public employees."
All of which sounds logical, except that, as Mr. Moriarty also acknowledges, such thinking also "leads to a race to the bottom." That is, as businesses cut private sector benefits, pressure grows on government to cut pay and benefits for its employees. Robert Master, political director for the Communication Workers of America District 1, which represents 40,000 state workers, speaks to that difficulty.
"The subtext of Christie’s message to a lot of people is that ‘you’re paying for benefits you’ll never have,’ " he says. "Our challenge is how to defend middle-class health and retirement security, not just for our members but for all working families, when over the past 30 years retirement and health care in the private sector have been essentially demolished."
This said, some union officials privately say that the teachers’ union, in its battle against cuts to salaries and benefits, misread Mr. Christie and the public temperament. Better to endorse a wage freeze, they say, than to argue that teachers should be held harmless against the economic storm.
In the past, union leaders, too, have proven adept at winning gains not just at the bargaining table. In 2000, union lobbyists persuaded legislators to cut five years off the retirement age for police and firefighters — a move criticized as a budget-buster by a state pension commission. The next year, the budget still was flush and union leaders persuaded the Republican dominated legislature to approve a 9 percent increase in pension benefits. (The legislators added a sweetener for their own pensions.)
Those labor leaders, however, proved less successful in persuading their legislative allies to pay for such benefits. For much of the last two decades, New Jersey has shortchanged its pension contribution. Governor Christie talked about tough choices this past year — then skipped the state’s required $3.1 billion payment. Now New Jersey has a $53.9 billion unfunded pension liability.
A recent Monmouth University/Gannett New Jersey poll found a narrow plurality of respondents in the state in favor of ditching the pensions for a 401(k)-type program. Public pensions, however, run the gamut, from modest (the average local government pensioner makes less than $20,000 a year while teachers draw about $46,000) to the gilded variety for police and firefighters, some of whom collect six figures. And then there’s the political class, which has made an art form of pension collection.
Some politicians draw multiple pensions as county legislators, called freeholders, and as prosecutors or union leaders. Back in Washington Township, people tend to talk of state government as a casino with fixed craps tables. A white-haired retired undercover police officer, whose wrap-around shades match his black Harley-Davidson jacket, pauses outside the Washington Township municipal building to consider the many targets. He did not want to give his name.
"Christie has all the good intentions in the world but has he hit the right people?" he says. "I understand pulling in belts, but you talking about janitors and cops, or the free-loading freeholder?"
Good Jobs, at What Cost??
So how much is too much? On their face, New Jersey’s public salaries are not exorbitant. The state has one of the highest per-capita incomes in the country, and the average teacher makes $66,597, which even with benefits is on par with or slightly behind similarly educated private sector workers, according to Jeffrey H. Keefe, a Rutgers professor who studied the issue for the liberal-leaning Economic Policy Institute.
Mr. Keefe, however, uncovered some intriguing class splits. Blue-collar public workers make more money than their private sector counterparts. For such jobs, public unions have established a higher wage floor. The sense that public workers enjoy certain advantages is not a mirage. Public employees pay into their pension funds, but health benefits often come at a fraction of the cost of most private sector packages.
Government employment also tends to be more secure. When the economy crashed, federal stimulus dollars safeguarded many public jobs. The alternative, many economists point out, was to force towns and cities into extensive layoffs, even as unemployment hovered around 10 percent and millions of Americans sought help from public agencies. But it accentuated the perception that public workers, however tenuously, inhabited a protected class. That’s a tough sell in Washington Township.
Ask Michael Tini, 54, who works as a card dealer in Atlantic City, about teacher salaries and benefits and he taps his head, not unsympathetically. "Look, I understand that teachers are the brains of the operation, O.K.? But my hours are cut, and my taxes are killing me." He taps his head again. "They have got to take it in the ear, too."
When States Default: 2011, Meet 1841
by Dennis K. Berman - Wall Street Journal
and values soared. States splurged on new programs. Then it all went bust, bringing down banks and state governments with them. This wasn't America in 2011, it was America in 1841, when a now-forgotten depression pushed eight states and a desolate territory called Florida into the unthinkable: They defaulted on debts.
This was an incredible step, even then. Fledgling U.S. states like Indiana and Illinois were still building credibility on global debt markets. They rightly feared "a prejudice so deep and wide" that they could never sell bonds in Europe again, said one banker. Their paranoia would be familiar to the shell-shocked California and Illinois of 2011. Each is beset by budget problems so great that some have begun debating default or bankruptcy. These worriers may draw comfort from the state crises that raged and retreated long ago. Most of the states eventually paid off their debts, and changed their laws to safeguard their finances, helping make U.S. states some of the world's best credits.
Congress, meanwhile, helped set a precedent that still holds: In 1843, it rejected an elaborate plan for a bailout, with one critic later observing it would "cause recklessness and extravagance" among the states. Surely, someone will dust off those ideas in 2011. Yet for all their similarities, there was an ominous difference from now: Leaders and citizens of the 1840s were more willing to accept new taxes to pay for the infrastructure and to defend, in the earnest words of the time, their "moral duty" of meeting debts. In Indiana and Ohio, property taxes went up eightfold in the early 1840s. New York, Pennsylvania, Maryland, and Massachusetts all installed state property taxes, the first in 40 years for Pennsylvania.
"People didn't want to raise taxes but they did," says John J. Wallis, a University of Maryland economic historian. He traces our current states crises back to those defaults in 1841, after which legislators amended constitutions to clamp down on new borrowing. Over time, these rules have been perverted by politicians, meaning that "constitutional rules have made it harder to raise taxes than to raise expenditures," he says.
There were differences between today and 19th century. Then, expensive state programs weren't for government pensions or Medicaid. They were for roads and canals. And in today's slow-growth economy, raising taxes won't solve all of the states' fiscal woes. Any real solution will require wholesale cuts in government programs and spending, too. When the defaults began in January 1841, investors dumped state bonds, pushing yields above 12% in early 1841, and to nearly 30% by 1842. The consequences of those defaults would last for decades: Among historians, the rule of thumb is that U.S. states would pay interest rates one percentage point higher than Canadian issuers the rest of the 19th century. To this day, Mississippi hasn't paid back some of those bonds, even after a 100-year English bid to collect.
The defaults weren't crippling. U.S. states went back into the public markets in the railroad boom of the 1850s, most of them armed with stronger safeguards for creditors and new constitutions. Could states default today without causing another 1841? Randall Kroszner, a former Fed governor and University of Chicago professor, calls it as a long shot. "Only if there were a clear legal framework, and a clear way in which people would be treated, and not interminable delays through the courts," he says. "States should be very averse to defaulting."
For Mr. Wallis, the lessons of the 1840s are bracingly clear. Taxpayers and politicians have lost the connection between borrowing and costs. So taxpayers must be willing to approve tax rises as a direct part of new borrowing plans. "There is nothing wrong with raising taxes to support government services that voters want and are willing to pay for," he says. But government needs to be set up "so that both voters and legislatures are forced to make decisions about taxing, spending, and borrowing simultaneously."
How I Missed the 'Housing Recovery' of 2010
by Caroline Baum - Bloomberg
When I saw the headline last week, "Housing Recovery Stalls," my first reaction was to kick myself for having missed yet another milestone in the U.S. economy’s long rehabilitation process.
Then I came to my senses. What housing recovery? If there is, or was, one, it is nowhere to be found in the data. Homebuilder sentiment, new home sales and single-family housing starts, which, in that order, lead the complex of residential real estate indicators, are bumping along the bottom. There was no recovery to stall. There was a brief incentive-driven pick-up in sales in 2009 and the first half of 2010 that faded the minute the home purchase tax credit expired.
As it turns out, the "recovery" referred to in the headline was in house prices, which rebounded modestly when sales improved. The "stall" was their renewed slide, based on the S&P Case-Shiller Home Price Index. Prices fell in all 20 metropolitan statistical areas in October compared with September, according to the Case-Shiller report.
And not a moment too soon. Unless there’s a spontaneous surge in housing demand, prices will have to fall to allocate the bloated inventory of unsold homes. Various government initiatives, including the first-time homebuyer tax credit, have distorted the market and delayed the inevitable. The law of supply and demand is one of the inviolable rules of microeconomics. Given the tendency of many macroeconomists to forget the basics, a brief review is in order.
Less Is More
The demand curve is downward sloping. What that means is demand for any good or service isn’t fixed. It depends on the price. A $1,000 cashmere sweater will find a lot more takers when it’s marked down to $500 in a post-Christmas sale. In general, the lower the price, the greater the quantity demanded. Producers respond in the opposite manner. Higher prices are an incentive to provide more of a good or service, which is why the supply curve is upward sloping.
The point at which consumers wish to buy what producers want to sell is called the equilibrium price, which isn’t fixed and responds to changes in market conditions, technology, the population, incomes or the prices of other goods and services. These forces cause shifts in the demand or supply curves, producing a new equilibrium price.
The U.S. just experienced the biggest speculative boom/bust in housing in history, a massive outward shift in the supply curve. Anyone expecting home prices to rise in the face of a glut of unsold homes is counting on either an act of God to destroy huge swaths of the housing stock (a shift back in the supply curve) or an influx of new immigrants needing shelter (a shift out in the demand curve.) Neither is likely, although acts of God are notoriously hard to predict.
The inventory of existing homes stood at 3.71 million in November, about where it was four years ago, according to the National Association of Realtors. Add to it the 197,000 new homes for sale and anemic demand, and the unavoidable conclusion is that home prices need to fall further to attract buyers.
It would take 16 months to deplete the inventory at October’s sales pace, according to CoreLogic, a real-estate research firm in Santa Ana, California. (CoreLogic uses its own sales data, collected from 2,000 county recorders across the country, instead of the NAR’s statistics on home purchases.) "Previously when the months’ supply was that high, home prices were falling at a 10 to 15 percent annual rate," said Sam Khater, senior economist at CoreLogic. "If it remains that high, that’s where prices are headed."
If the visible supply is depressing current prices, the shadow inventory, or properties that are seriously delinquent, in foreclosure or owned by lenders, will be a drag on future prices, Khater said in a telephone interview. The shadow supply, which was eight months in October, is being constrained by foreclosure moratoriums in various parts of the country while the government investigates shoddy paperwork by lenders.
Short of a spontaneous burst in housing demand, which seems unlikely, there is no way to reduce the supply of homes for sale -- for the market to clear -- without price declines. (Think cashmere sweater sale.) The sooner that happens, the better.
In the meantime, the U.S. economy will have to recover without help from housing, which, along with manufacturing, is one of the business cycle’s traditional leaders. These two interest-rate-sensitive sectors account for five of the 10 components of the Index of Leading Economic Indicators: building permits; the manufacturing workweek; manufacturers’ new orders for capital goods and consumer goods; and supplier deliveries. The LEI rose 1.1 percent in November, with nine of the 10 components showing an increase, according to the Conference Board.
The one outlier? Building permits. Enough said.
Europe’s Young Grow Agitated Over Future Prospects
by Rachel Donadio - New York Times
Francesca Esposito, 29 and exquisitely educated, helped win millions of euros in false disability and other lawsuits for her employer, a major Italian state agency. But one day last fall she quit, fed up with how surreal and ultimately sad it is to be young in Italy today.
It galled her that even with her competence and fluency in five languages, it was nearly impossible to land a paying job. Working as an unpaid trainee lawyer was bad enough, she thought, but doing it at Italy’s social security administration seemed too much. She not only worked for free on behalf of the nation’s elderly, who have generally crowded out the young for jobs, but her efforts there did not even apply to her own pension. "It was absurd," said Ms. Esposito, a strong-willed woman with a healthy sense of outrage.
The outrage of the young has erupted, sometimes violently, on the streets of Greece and Italy in recent weeks, as students and more radical anarchists protest not only specific austerity measures in flattened economies but a rising reality in Southern Europe: People like Ms. Esposito feel increasingly shut out of their own futures. Experts warn of volatility in state finances and the broader society as the most highly educated generation in the history of the Mediterranean hits one of its worst job markets.
Politicians are slowly beginning to take notice. Italy’s president, Giorgio Napolitano, devoted his year-end message on Friday to "the pervasive malaise among young people," weeks after protests against budget cuts to the university system brought the issue to the fore.
Giuliano Amato, an economist and former Italian prime minister, was even more blunt. "By now, only a few people refuse to understand that youth protests aren’t a protest against the university reform, but against a general situation in which the older generations have eaten the future of the younger ones," he recently told Corriere della Sera, Italy’s largest newspaper.
The daughter of a fireman and a high school teacher, Ms. Esposito was the first in her family to graduate from college and the first to study foreign languages. She has an Italian law degree and a master’s from Germany and was an intern at the European Court of Justice in Luxembourg. It has not helped. "I have every possible certificate," Ms. Esposito said dryly. "I have everything except a death certificate."
Even before the economic crisis hit, Southern Europe was not an easy place to forge a career. Low growth and a corrosive lack of meritocracy have long posed challenges to finding a job in Italy, Greece, Spain and Portugal. Today, with the added sting of austerity, more people are left fighting over fewer opportunities. It is a zero-sum game that inevitably pits younger workers struggling to enter the labor market against older ones already occupying precious slots.
As a result, a deep malaise has set in among young people. Some take to the streets in protest; others emigrate to Northern Europe or beyond in an epic brain drain of college graduates. But many more suffer in silence, living in their childhood bedrooms well into adulthood because they cannot afford to move out. "They call us the lost generation," said Coral Herrera Gómez, 33, who has a Ph.D. in humanities but still lives with her parents in Madrid because she cannot find steady work. "I’m not young," she added over coffee recently, "but I’m not an adult with a job, either."
There has been a national debate for years in Spain about "mileuristas," a nickname for college graduates whose best job prospects may well pay just 1,000 euros a month, or $1,300. Ms. Herrera is at the lower end of the spectrum. Fed up with earning 600 euros a month, or $791, under the table as a children’s drama teacher, Ms. Herrera said she had decided to move to Costa Rica this month to teach at a university.
As she spoke in a cafe in Madrid, a television on the wall featured a report on the birthday of a 106-year-old woman who said that eating blood sausage was the secret to her longevity. The contrast could not have been stronger. Indeed, experts warn of a looming demographic disaster in Southern Europe, which has among the lowest birth rates in the Western world. With pensioners living longer and young people entering the work force later — and paying less in taxes because their salaries are so low — it is only a matter of time before state coffers run dry.
"What we have is a Ponzi scheme," said Laurence J. Kotlikoff, an economist at Boston University and an expert in fiscal policy. He said that pay-as-you-go social security and health care were a looming fiscal disaster in Southern Europe and beyond. "If these fertility rates continue through time, you won’t have Italians, Spanish, Greeks, Portuguese or Russians," he said. "I imagine the Chinese will just move into Southern Europe."
The problem goes far beyond youth unemployment, which is at 40 percent in Spain and 28 percent in Italy. It is also about underemployment. Today, young people in Southern Europe are effectively exploited by the very mechanisms created a decade ago to help make the labor market more flexible, like temporary contracts. Because payroll taxes and firing costs are still so high, businesses across Southern Europe are loath to hire new workers on a full-time basis, so young people increasingly are offered unpaid or low-paying internships, traineeships or temporary contracts that do not offer the same benefits or protections.
"This is the best-educated generation in Spanish history, and they are entering a job market in which they are underutilized," said Ignacio Fernández Toxo, the leader of the Comisiones Obreras, one of Spain’s two largest labor unions. "It is a tragedy for the country."
Yet many young people in Southern Europe see labor union leaders like Mr. Fernández, and the left-wing parties with which they have been historically close, as part of the problem. They are seen as exacerbating a two-tier labor market by protecting a caste of tenured older workers rather than helping younger workers enter the market. For Dr. Kotlikoff, the solution is simple: "We have to change the labor laws. Not gradually, but quickly."
Yet in Greece, Italy, Portugal and Spain, any change in national contracts involves complex negotiations among governments, labor unions and businesses — a delicate dance in which each faction fights furiously for its interests. Because older workers tend to be voters, labor reform remains a third rail to most politicians. Asked at a news conference last year about changing Italy’s de facto two-tier system, Italy’s center-right finance minister, Giulio Tremonti, said simply, "You can’t make violent changes to the system."
New austerity measures in Spain, where the overall unemployment rate is 20 percent, the highest in the European Union, are further narrowing the employment window. Spain has pledged to raise its retirement age to 67 from 65, but incrementally over the next 20 years. "Now people are being sent into early retirement at age 55," said Sara Sanfulgencio, 28, who has a master’s degree in marketing but is unemployed and living in Madrid with her mother, who owns a children’s shoe store. "But if I haven’t started working by age 28 and I already have to stop at 55, it’s absurd."
In Italy, Ms. Esposito is finishing her lawyer traineeship at a private firm in Lecce. It pays little but sits better on her conscience than her unpaid work for the government. "I’m a repentant college graduate," she said. "If I had it to do over again, I wouldn’t go to college and would just start working."
Whose line is it?
by Tyler Durden - Zero Hedge
Guess what extremely charismatic (if extremelier teleprompted) future leader of the free world uttered the following rhetorically elegant, if completely and utterly hollow, words:
"The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. Government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our Government’s reckless fiscal policies. … Increasing America’s debt weakens us domestically and internationally. Leadership means that ‘the buck stops here. Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better."
If you said Barack H. Obama, give yourself a golfclap. And if you are scratching your head furiously at the seemingly unbelievable hypocrisy after how just four years later, the president's own economic advisor Austin Goolsbee said that a refusal by the Senate to increase the government’s debt
ceiling would be “catastrophic” and a sign of "insanity" don't worry, you are not alone. In fact, very few people can believe the self-professed "insanity" of the very people who four years ago were all about prudent fiscal behavior but now couldn't give a rat's ass about drowning the country in $150 billion in debt each and every month.
And some other observations on the teleprompter's facility with swaying in the wind via the National Review Online:
In 2007 and in 2008, when the Senate voted to increase the limit by $850 billion and $800 billion respectively, Obama did not bother to vote. (He did vote for TARP, which increased the debt limit by $700 billion.)
Sen. Jim DeMint (R., S.C.) told Human Events in an interview released today that the decision about the debt ceiling “needs to be a big showdown” in the Senate.
“We are going to cut [spending] necessary to stay within the current levels, which is over $14 trillion,” said DeMint.
If by "big showdown", DeMint means the latest pathetic theater of, for and by the government, which pretends to care about the middle class, while continuing to pander to the top 0.1% of US society, then he is absolutely spot on.
But yes, the president is correct. Americans do deserve better... than the corrupt puppet frauds that are allegedly representing their interests in the judicial, legislative and executive branches of the Wall Street purchased US government.
New Year’s Hope against Hope
by Joseph E. Stiglitz - Project Syndicate
The time has come for New Year’s resolutions, a moment of reflection. When the last year hasn’t gone so well, it is a time for hope that the next year will be better.
For Europe and the United States, 2010 was a year of disappointment. It’s been three years since the bubble broke, and more than two since Lehman Brothers’ collapse. In 2009, we were pulled back from the brink of depression, and 2010 was supposed to be the year of transition: as the economy got back on its feet, stimulus spending could smoothly be brought down.
Growth, it was thought, might slow slightly in 2011, but it would be a minor bump on the way to robust recovery. We could then look back at the Great Recession as a bad dream; the market economy – supported by prudent government action – would have shown its resilience.
In fact, 2010 was a nightmare. The crises in Ireland and Greece called into question the euro’s viability and raised the prospect of a debt default. On both sides of the Atlantic, unemployment remained stubbornly high, at around 10%. Even though 10% of US households with mortgages had already lost their homes, the pace of foreclosures appeared to be increasing – or would have, were it not for legal snafus that raised doubts about America’s vaunted "rule of law."
Unfortunately, the New Year’s resolutions made in Europe and America were the wrong ones. The response to the private-sector failures and profligacy that had caused the crisis was to demand public-sector austerity! The consequence will almost surely be a slower recovery and an even longer delay before unemployment falls to acceptable levels. There will also be a decline in competitiveness. While China has kept its economy going by making investments in education, technology, and infrastructure, Europe and America have been cutting back.
It has become fashionable among politicians to preach the virtues of pain and suffering, no doubt because those bearing the brunt of it are those with little voice – the poor and future generations. To get the economy going, some people will, in fact, have to bear some pain, but the increasingly skewed income distribution gives clear guidance to whom this should be: Approximately a quarter of all income in the US now goes to the top 1%, while most Americans’ income is lower today than it was a dozen years ago. Simply put, most Americans didn’t share in what many called the Great Moderation, but was really the Mother of All Bubbles. So, should innocent victims and those who gained nothing from fake prosperity really be made to pay even more?
Europe and America have the same talented people, the same resources, and the same capital that they had before the recession. They may have overvalued some of these assets; but the assets are, by and large, still there. Private financial markets misallocated capital on a massive scale in the years before the crisis, and the waste resulting from underutilization of resources has been even greater since the crisis began. The question is, how do we get these resources back to work?
Debt restructuring – writing down the debts of homeowners and, in some cases, governments – will be key. It will eventually happen. But delay is very costly – and largely unnecessary.
Banks never wanted to admit to their bad loans, and now they don’t want to recognize the losses, at least not until they can adequately recapitalize themselves through their trading profits and the large spread between their high lending rates and rock-bottom borrowing costs. The financial sector will press governments to ensure full repayment, even when it leads to massive social waste, huge unemployment, and high social distress – and even when it is a consequence of their own mistakes in lending.
But, as we know from experience, there is life after debt restructuring. No one would wish the trauma that Argentina went through in 1999-2002 on any other country. But the country also suffered in the years before the crisis – years of IMF bailouts and austerity –from high unemployment and poverty rates and low and negative growth.
Since the debt restructuring and currency devaluation, Argentina has had years of extraordinarily rapid GDP growth, with the annual rate averaging nearly 9%from 2003 to 2007. By 2009, national income was twice what it was at the nadir of the crisis, in 2002, and more than 75% above its pre-crisis peak.
Likewise, Argentina’s poverty rate has fallen by some three-quarters from its crisis peak, and the country weathered the global financial crisis far better than the US did –unemployment is high, but still only around 8%. We could only conjecture what would have happened if it had not postponed the day of reckoning for so long – or if it had tried to put it off further.
So this is my hope for the New Year: we stop paying attention to the so-called financial wizards who got us into this mess – and who are now calling for austerity and delayed restructuring – and start using a little common sense. If there is pain to be borne, the brunt of it should be felt by those responsible for the crisis, and those who benefited most from the bubble that preceded it.
How Did a Relatively Small Number of Subprime Loans Cause a Record Crisis?
by William K. Black - Benzinga
A number of analyses of the U.S. and global crisis begin by attempting to explain what they assume to be a paradox -- how could so small a market segment (subprime housing and CDOs backed by subprime) have caused (1) the largest financial bubble in history, (2) a U.S. economic crisis, and (3) a nearly global crisis? To these scholars the obvious answer is that subprime lending could not have caused this traumatic trifecta. It follows that the importance of subprime lending must be overstated and there must be other, more powerful causes of the trifecta.
I will show that the focus on subprime loans was excessive and allude briefly to the points I have made in prior columns about the variant causes of the global crisis. The next column will address in more detail how criminologists determine the true incidence of mortgage fraud. Subprime loans were and are a serious problem, but there has been a destructive overemphasis on subprime loans as the core of the U.S. crisis. "Liar's" loans are a far greater problem, and most problem subprime loans are actually liar's loans. While the nonprime mortgage industry's preferred euphemisms were "alt-a" and "stated income" loans, it was the industry that accurately dubbed them liar's loans. It was the industry that created liar's loans and it is liar's loans that made so many officers wealthy.
The industry pitched liar's loans to the regulators on a series of bright shining lie -- that they were equivalent to the risk of prime loans and simply underwritten on an alternative basis because the borrowers were entrepreneurs who could verify their incomes. The further lie was that liar's loans were distinct from subprime loans, which were only made to those with serious credit defects with conventional underwriting. The reality is that there is an easy means for small business owners to verify their income -- by authorizing the IRS to provide information from their tax returns to the lender via IRS Form 4506.
There were two groups of borrowers who had acute needs to avoid disclosing their income and wealth -- those engaged in tax fraud evaders and those seeking to deceive their spouses or defraud their prior spouses and children in order to evade alimony and child support payments. (Remember when one of "C's" in lending referred to "character" and we taught loan officers why one should not lend to those of bad character?) People who will cheat their kids are certain to be willing to cheat their lender.
The purpose of liar's loans was to create endemic fraud throughout the mortgage process - from origination to the sale of collateralized debt obligations (CDOs) backed by liar's loans ("cradle to grave" fraud). The lies in liar's loans were so endemic and so egregious that the financial version of "don't ask; don't tell" was essential at every step of the process. Liar's loans were also perfect for the loan origination level variant of "don't ask; don't tell."
Liar's loans were not underwritten. The borrower did ask about income, but only in the sense made famous by Monty Python ("wink, wink; nod, nod"). The lender agreed that it would not verify the borrowers' "stated income" (and often the borrowers' jobs and assets). As I have explained in prior columns, the lenders that specialized in making liar's loans frequently outsourced much of the job of finding the borrowers who would take out the liar's loans to loan brokers. Studies by various state attorney generals, white-collar criminologists, and private and public investigators have confirmed that it is lenders and their agents (loan brokers and loan officers) who overwhelmingly put the lies in liar's loans. There are independent analytical reasons to believe these findings.
- Doing so maximized the lenders' (and their loan brokers') reported (albeit fictional) income (and their controlling officers' bonuses). The greater the stated income, the more likely the loan would be made, the larger the size of the loan, and the greater the resale value of the loan in the secondary market. Each of these elements drove the agents' and loan officers' compensation up - and by very large amounts.
- By inflating the borrowers' stated income, the lender and its brokers could make the loan appear to be less risky and sell it for a premium to the secondary market greatly inflating the borrower's stated income. The liar's loan lenders could also make the loan appear to be less risky to the regulators (though unregulated mortgage bankers probably made most of the liar's loans), credit rating agencies, and auditors.
These entities typically treated the (fictional, far reduced) "debt-to-income" ratio arising from inflating the borrower's stated income as if it were real. (In reality, this willingness to believe, without real due diligence, the lies that would make these professionals wealthy was another variant of "don't ask; don't tell.") It was not exactly difficult for anyone in the trade to figure out that must never treat as truthful the stated income in something the trade called a "liar's" loan.
Indeed, the ability of everyone in the trade to know that they should never treat the loans as honest was made even more simple when the mortgage lending industry's own experts as deserving of that label because such loans were "an open invitation to fraudsters" (MARI 2006) - during what the FBI had termed as early as September 2004 to be an "epidemic" of mortgage fraud. Depressing the real debt-to-income ratio by inflating reported income was a useful lie to everyone with a financial stake in the liar's loan machine - which was most of our largest financial firms in the U.S.
- Not verifying the borrowers' stated income simultaneously facilitated the lenders' and their brokers' ability to sell fraudulent loans at a premium in the secondary market and minimized risk of the lenders' and their brokers' controlling officers being sanctioned for their frauds essential to their origination and sale of liar's loans. The brokers and lenders obviously, could not verify the fictional incomes that they had inflated. They would have had three choices. They could have honestly sought to verify something they knew to be false - which would have prevented the loans from being made and dramatically reduced their income.
They could have claimed that they had verified the income but provided no records of their efforts at verification or the borrowers' true income. That strategy would have added another act of fraud (a false certification of verification) while providing no credible evidence. The other alternative would be for the brokers and officers to forge documents purporting to show that they had conducted due diligence as to the borrowers' true income and attesting to the accuracy of the stated income.
This strategy would have made it simple for the Justice Department to convict the loan brokers and officers. The ideal strategy is for the loan brokers and officers to do no underwriting of the stated income and to purport that the borrowers' credit rating (FICO score), in conjunction with the fraudulent LTV and debt-to-income ratios, proves that the loan has risk characteristics equivalent to prime loans. FICO scores, of course, can never demonstrate that the borrower has the capacity to repay a home loan and there are common scams that use someone with a good FICO score as a shill to obtain a loan.
Liar's loans were equally useful in facilitating accounting control fraud by those involved in the CDO process. The secondary market had to rely on "don't ask; don't tell" to be able to securitize and sell CDOs. CDOs were largely backed by liar's loans and fraud was so endemic and so obvious among liar's loans if one engaged in due diligence that it was ideal to claim that liar's loans required no meaningful due diligence and could not be the subject of meaningful due diligence because there were no underwriting files to review because the lender did no real underwriting.
Again, consider what would have happened if the securitizers, credit rating agencies, or auditors had actually looked at any reliable sample of the liar's loans for evidence of fraud. They would have reported, as did Fitch in November 2007, that there was evidence of fraud in the nearly every file. If they asked, they could not sell. Their files would show that they knew they were knowingly selling securities backed primarily by fraudulent loans - and claiming the CDOs were "AAA."
Liar's loan borrowers had no leverage to create a "Gresham's" dynamic among appraisers. There is no honest reason why a mortgage lender would inflate the appraised value and the size of the loan. Causing or permitting large numbers of inflated appraisals is a superb "marker" of accounting control fraud by the lender because the senior officers directing an accounting control fraud do maximize short-term reported (fictional) income (and real losses) by inflating appraisals and stated income.
As I have noted, and will return to in future columns in more detail, lenders and their agents frequently suborned appraisers by deliberately creating a Gresham's dynamic to try to induce them to inflate market values, leaked the loan amount to the appraisers, drove the appraisal fraud, and made it endemic. As with inflating income in order to minimize the reported debt-to-income ratio, inflating the appraisal allowed everyone with a financial stake in the lies to minimize the reported loan-to-value (LTV) ratio and allow everyone to pretend that the loan was far less risky because it had such a large (but yet again fictional) equity cushion.
Given that we know that appraisal fraud was endemic, that endemic appraisal fraud is impossible without being led or permitted by the lenders and their agents, and that no honest lender would permit or cause widespread inflated appraisals, the logical inference is that the lenders and their agents led both the stated income and the appraisal fraud.
Only the lenders and their agents had the inside information and expertise to know how to optimize the deceit in the loan application process. Many of the housing speculators who bought a material number of homes and sought to flip them were industry insiders, and many of them also committed fraud by indicating that they intended to make each of the houses (simultaneously) their principal dwelling.
These professionals would have known of the details of the lenders' term sheets and could have picked the debt-to-income and LTV ratios (and sometimes had illegal side deals with appraisals to inflate the appraisals to secure the desired LTV. The great bulk, however, of those that borrowed through liar's loans were not financially sophisticated and had no way of knowing how much they needed to inflate reported income to hit the "sweet spot" that would maximize the loan broker's and the loan officer's fees and bonuses. Loan brokers willing to specialize in making liar's loans had to be able to lead the lies about the borrowers' income that would maximize the loan broker's fees.
The fact that the lenders and their agents specializing in making liar's loans led the stated income frauds does not, of course, mean that the borrowers had no ethical responsibility or culpability. As I will show in future columns, there are millions of cases of mortgage fraud through liar's loans. There are doubtless hundreds of thousands of borrowers who knew that the incomes the brokers and officers told them to report on the loan applications were false.
Yes, it does appear to have been common for the loan brokers and officers to create the false loan applications and even forge the borrowers' signatures. Some of the lenders are reported to have referred to these practices as "Arts and Crafts" weekends. We don't know how common this level of lender fraud was because the regulatory agencies and prosecutors have not publicly reported their investigations. Indeed, there is no public evidence that the regulators or prosecutors are even conducting comprehensive investigations of the endemic accounting control fraud by the lenders that made large amounts of liar's loans.
We now have the analytical basis to begin to explain the supposed paradox as to how such a relatively small number of subprime loans caused an intense global crisis. Here are the central points, which I will flesh out in future columns.
- Many subprime loans were also liar's loans
- Many hybrid loans existed with greatly reduced underwriting
- There were, and are, no official definitions of the loan categories "alt-a", "subprime", or the many hybrid forms
- Because there is no definition and the categories of "subprime" and "liar's" loans are not mutually exclusive, there is inherent uncertainty and a need to use judgment to form useful estimates. Credit Suisse reported (2007) that 49% of new originations in 2006 were "alt-a" loans (i.e., liar's loans). The incidence of fraud among liar's loans found in most independent studies is 80% or above.
If the Credit Suisse figure is even close to accurate (and some caution is vital there), then we are suffering from over a million cases of mortgage fraud annually in 2005 and 2005 and the frauds were growing in 2007 until the secondary market collapsed. Data on criminal referrals are, when extrapolated, consistent with that level of fraud incidence. The supposed paradox arises from a factual error. Nonprime loans were common. Liar's loans grew massively and hyper-inflated the financial bubble.
The size of the bubble and the fraud losses were enormous relative to bank capital. Indeed, the very lack of reliable data on the true composition of liar's loans (Fannie, Freddie, and Lehman all reported them as "prime" loans for most purposes) in mortgage portfolios and CDOs was itself one of the factors driving systemic risk. Investors, rightly, feared that most large financial institutions had huge exposures to fraudulent loans.
- At law, fraud's defining element is deceit. The fraudster gets the victim to trust him and then betrays that trust. This is why control fraud by our elite financial institutions is such a powerful acid to erode trust. Trust is vital to an effective economy. Markets shut down in the crisis because bankers no longer trusted other bankers' asset valuations.
- Other nations (Iceland and to a far lesser extent Ireland) that have had moderately serious investigations of the causes of their crises have produced reports that provide compelling evidence of accounting control fraud as major drivers in their crises. Spain is notorious for its' banks' accounting abuses, but Spain has not provided any true investigative reports.
- The FDIC and OTS created a data base well after the crisis began. It sought (false) precision at the cost of analytical usefulness. It creates a false dichotomy between "alt-a" and "subprime" based on reported FICO scores (which it implicitly assumes to be real). The result is that one cannot use the data to study loans made without underwriting. That category - the single most important characteristic for studying, measuring, and predicting losses - does not exist in their data. It is vital that researchers understand that the FDIC mortgage data base is unreliable and it is vital that the FDIC create a new, reliable data base.
Soon To-Be Ex-Congressman John Hall Warns Against Creeping Fascism
by David Freedlander - New York Observer
In a wide-ranging interview before he prepares to leave the House of Representatives, Hudson Valley Congressman John Hall warned that the nation could quickly descend into Fascism if more is not done to curb the influence of corporate money in politics.
Speaking about the Citizen's United decision, which allowed unregulated flow of cash into campaign coffers, Hall said, "I learned when I was in social studies class in school that corporate ownership or corporate control of government is called Fascism. So that's really the question— is that the destination if this court decision goes unchecked?"
Hall said that the flow of corporate dollars is why he and the Democrats lost control of Congress. "The country was bought," he said. "The extremist, most recent two appointees to the Supreme Court, who claimed in their confirmation hearings before the Senate that they would not be activist judges, made a very activist decision in that it overturned more than a century of precedent. And as a result there were millions of extra dollars thrown into this race."
The extra money floating around, he said, compounded the Democrats weaknesses on the economy, unemployment and the mortgage crisis. And he said that for of the accomplishments of the lame duck Congress, their failure to pass the Disclose Act—which would have at least forced corporations to reveal who they were donating to—stood out a black mark on the session.
"We are talking about supposedly wholesome names like Revere America, American Crossroads, Americans for Apple Pie and Motherhood—if somebody hasn't trademarked that one I probably should. The fact is you can call it anything and the money could be coming from BP or Aramco or any corporation domestic or foreign," Congressman Hall said.
Hall was elected to Congress in 2006, ousting incumbent Republican Sue Kelly in a district that has come to be seen as one of the nation's quintessential swing districts. Kelly was first elected in 1994, when Republicans took control of the House. Hall, a former front man for the rock bank Orleans, lost this year to Nan Hayworth, a wealthy ophthalmologist.
He rebuffed the idea that Democrats over-reached, noting that his Republican colleagues were frequent lunch guests of the White House, but he and his Democratic counterparts seldom were. And he defended the health care vote which many pundits saw as dooming Democratic chances. "[Congressman] Hank Johnson of Georgia told our caucus before the [health care] vote that we should be willing to lose our seats over this vote. And I think he was right about that. I don't think that is the only reason why I lost but if it is I am ok with it."
Hall declined to comment on his future plans. Rumors have been floating around that he is up for a job in the Obama administration or with soon-to-be Governor Andrew Cuomo, possibly as head of the Department of Environmental Conversation. Hall said that he had been contacted by the Cuomo transition team, but that no offer had been made and that he had not decided what to do next.
He said that he has already been approached by the Democratic Congressional Campaign Committee about running again in 2012, but noted that if he really wanted to he would need to be out raising money already, and Hall seemed relieved to not be. "I am not saying I am done but I am also not saying I am not done. It would depend on the situation," he said. "It's too soon to tell at this point."
Political essay by 93-year-old tops Christmas bestseller list in France
by Angelique Chrisafis - Guardian
Proving that age is no boundary to publishing success, the French book world has been taken by storm by a surprise Christmas bestseller: a political call to arms by Stéphane Hessel, 93. The unlikely publishing sensation is a former resistance hero whose 30-page essay, Indignez-vous!, calls on readers to get angry about the state of modern society.
Launched in October by Indigène, a small publisher working out of an attic in Montpellier, southern France, the book had a tiny first print-run, 6,000, and sold for €3, unprecedentedly cheap in a country where book prices are regulated and kept high by the law. Hessel's success has stunned France. After two months on the bestseller lists, the book has spent five weeks at number one, beating Michel Houellebecq's award-winning latest novel La Carte et le Territoire and a host of Christmas fiction. It has sold 600,000 copies and – publishers predict it will reach a million. Translations are underway for Italy and other European markets.
The book's soaring sales reflect a general mood of French exasperation at the social inequalities of Nicolas Sarkozy's presidency. But the phenomenon is mostly down to Hessel's charisma and his life story.
Hessel was born in Berlin in 1917 and emigrated to France aged seven. His free-spirited mother, Helen Grund-Hessel, inspired the novel Jules et Jim, which became Francois Truffaut's film about a love-triangle of two male friends and a woman who loves them both. During the Nazi occupation of France, Hessel joined the French resistance, was caught, tortured and and deported to Buchenwald and Dora concentration camps where he escaped hanging. After the war, he helped to draft the universal declaration of human rights and later became a diplomat.
Hessel's book argues that French people should re-embrace the values of the French resistance, which have been lost, which was driven by indignation, and French people need to get outraged again. "This is an appeal to citizens, young and old, to take responsibility for the things in our society that don't work," he said. "I wish every one of you to find your own reason for indignation. It's precious."
Hessel's reasons for personal outrage include the growing gap between the very rich and the very poor, France's shocking treatment of its illegal immigrants, the need to re-establish a free press, protecting the environment, the plight of Palestinians and the importance of protecting the French welfare system. He calls for peaceful and non-violent insurrection.
Sylvie Crossman, a former Le Monde foreign correspondent who co-founded Hessel's publishers, said the book was like a new, "adapted" version of Charles de Gaulle's rallying resistance appeal from London on 18 June 1940. She said the book had been a success because it gave hope to people from a real fighter who was not just an armchair intellectual.
Yes, We Have No Bananas
by Mike Peed - New Yorker
Abstract: a reporter at large about Tropical Race Four, a soil-borne fungus threatening Cavendish banana cultivation. More than a thousand kinds of banana can be found worldwide, but a variety called Cavendish, which a nineteenth-century British explorer happened upon in a household garden in southern China, represents ninety-nine per cent of the banana export market.
The vast majority of banana varieties are not viable for international trade: their bunches are too small, or their skin is too thin, or their pulp is too bland. Although Cavendishes need pampering, they are the only variety that provides farmers with a high yield of palatable fruit that can endure overseas trips without ripening too quickly or bruising too easily. The Cavendish, which is rich in Vitamins B6 and C, has high levels of potassium, magnesium, and fibre; it is also cheap—about sixty cents a pound. In 2008, Americans ate 7.6 billion pounds of Cavendish bananas, virtually all of them imported from Latin America.
Your supermarket likely sells many varieties of apples, but when you shop for bananas you usually have one option. The world’s banana plantations are a monoculture of Cavendishes. Tells about an Australian fruit farmer named Robert Borsato. Several years ago, Borsato noticed a couple of sick-looking plants on a neighbor’s property. When the plants were cut open, they smelled like garbage, and their roots were so anemic that the plants could barely stay upright. Borsato feared that he was seeing the symptoms of a pestilence that had wiped out the Cavendish across Asia: Tropical Race Four, a soil-borne fungus that is known to be harmful only to bananas.
Tropical Race Four appeared in Taiwan in the late eighties, and destroyed roughly seventy per cent of the island’s Cavendish plantations. In Indonesia, more than twelve thousand acres of export bananas were abandoned; in Malaysia, a local newspaper branded the disease "the H.I.V. of banana plantations." When the fungus reached China and the Philippines, the effect was equally ruinous. Australia was next. Scientists believe that Tropical Race Four, which has caused tens of millions of dollars’ worth of damage, will ultimately find its way to Central America—and to the fruit that Americans buy.