"Dr. Bunnell's embalming establishment in the field, Army of the James"
Ilargi: Yesterday's events in Tucson must have many wondering where the US as a society, and as a policital en economic system, is headed. There is no doubt that irreversible changes are coming our way. Still, maybe all this is just part of a inevitable, protracted and ongoing process of decay. Ashvin explains:
"Not one has shown an iota of fear of death. They want to end this agony."
- Jack Kevorkian
Perhaps what we need as a society is a better understanding of "efficiency", since it is such a key aspect of all complex systems. Take the human body, for example, which is perhaps the most complex life form that has evolved on Earth. After increasing specialization and inter-connection of various bodily components through millions of years of evolution, the systems of the human body have become extremely efficient at their specific functions. The arteries, veins and capillaries of the cardiovascular system have evolved an intricate fractal design that competently delivers oxygen and nutrients to all of the body's cells as necessary.
What's important to understand is that every systemic component of the body has a specific function that serves to keep the body alive, growing and relatively stable over periods of time. These functions take place without any regard to concepts of fairness or equality. If my individual skin cells had an emergent sense of self-aware conscience (like me), then they would probably be very upset with my brain cells, which are much fewer in number and receive a disproportionate share of my resource intake (the brain receives 20% of the body's blood). In fact, the comfortable brain cells typically remain alive for a person's entire lifetime, while the average skin cell lasts for about a couple of weeks before it dies off and is replaced.
This systems theoretical framework of understanding applies just as well to our global economic, social, cultural and political structures. These evolved systems are amazingly efficient at keeping the overarching human civilization "alive", growing and relatively stable. Consistent material growth is achieved by exploiting limited resources and concentrating such resources in centralized structures through various mechanisms of action. Just as a biological species must eventually adapt to its surroundings or go extinct, human socioeconomic systems that are inefficient at promoting consistent growth/concentration will be marginalized, modified or replaced.
Of course, socioeconomic evolution takes place much more rapidly than its biological counterpart. Over the last few hundred years, every dominant system of human civilization has evolved to efficiently maintain the status quo processes of material growth and wealth concentration. These systems will almost always sacrifice "fairness" and "equality" for efficiency, because the former have no role in preserving the overarching civilization as it has come to exist. Each one of these systems also has its own unique evolutionary function:
Economic System - Here is the foundational system of human civilization, as it allows vital resources to be extracted, manipulated and traded between humans. As greater resource pools are generated between diverse economic actors, larger populations of humans can be supported in a given area and more complex forms of social and political organization can be established. The Industrial Revolution took this logic to its parabolic extreme and has obviously allowed immense growth in net wealth and "standards of living". This system, similar to the human cardiovascular system, must deliver a disproportionate share of resources to centralized structures that are vital to maintaining/growing the current body of civilization (i.e. developed countries, large corporations, prominent corporate executives, strategic political groups, etc.)
Social System -The dominant social structure is best described as one containing hierarchical class divisions determined by levels of material wealth. It is an inevitable byproduct of industrial economic evolution, and primarily serves to reinforce the legitimacy of the naturally-occurring wealth disparity in our world. People in the developed world, especially, are socially conditioned by parents, teachers, public figures, etc. to believe that everyone has an opportunity to be materially "successful", and to look down on those who happen to fall short. The severe stigmas that attach to poverty and homelessness, or even an "average" lifestyle, ensure that the distressing symptoms of economic growth/concentration will be tolerated for some time.
Cultural System - Many people describe developed societies as having "consumption cultures", and that is probably the most apt description. Material consumption, of course, is absolutely necessary for the consistent material growth of human civilization, and therefore this cultural system is naturally dominant. The need to continually increase wealth concentration (due to limited resources), however, means that only specific segments of civilization can be imbued with this cultural feature, which comes at the expense of the less materially fortunate. A consumption culture provides an extremely efficient mechanism for directing resources to various centralized structures, since economic actors (individuals, corporations, governments) within it deeply believe such a process to be "normal" , routine and beneficial to all.
Political System - The political systems of Western nations are currently, without a doubt, the most "corrupt" in the world, and this nature is typically criticized as being a disease marked by inefficiency. Corruption, however, could just as easily be described as a highly efficient means of maintaining the structures of global society by promoting growth and wealth concentration. It provides wealthy economic entities with direct access to sovereign power, a sweeping dominion conditionally granted by the people to their respective states. This power essentially allows the elites to force people in a certain direction through physical or financial coercion. It also allows them to use threats of violence or violence itself to obtain valuable resources and economic concessions. No other political system, such as one more "representative" or "democratic", would have allowed human civilization to achieve material growth/concentration at the frightening pace and scale that we have witnessed to date.
Still, there are many different types of economic, social, cultural and political systems that have emerged and/or survived in various regions of the world in the last few hundred years. It is true that not all of these systems have evolved to efficiently maintain/grow the existing civilization, and some of them may even be in direct opposition to the status quo. However, it is clear that systems which have failed to adapt to the dominant environment have been thoroughly isolated or have struggled to survive before simply going extinct. Eventually, they have all ended up as minor infections subject to the brutal mercy of a healthy immune system.
Some may point to China as an exception, since it is a country with a "Communist" economic/political system that has thrived in recent years. While it is true that they have been materially successful, it is only because they have adapted to the dominant economic, social, cultural and political modes of operation. There are many fundamental similarities between their models of speculative financial investment, bureaucratic government, careless environmental policy, pronounced socioeconomic division, etc.and ours. We cannot let simple labels or mainstream conventions distract us from the systemic reality lying underneath. Despite their different and misleading labels, all of these dominant systems in global civilization have evolved to efficiently promote material growth and concentrate wealth.
Of course, the life of every system eventually comes to its material end. The skin begins to sag and lose color, the bones becomes fragile, the blood flow meets increasing resistance and mental processes start to fade. The "immune system" of our global civilization is not nearly as effective as it used to be, and even the slightest infection could bypass its defenses and spell society's demise. Efficient systems will always and forever become fragile and burn themselves out, given enough time. It may take millions of years to occur in large biological or ecological systems, but it only takes a few human generations in socioeconomic ones. The evolved systems of global civilization are absolutely necessary for its survival, and they are all quickly deteriorating now. Given the surety of this impending death, the only thing left to fear is the possibility that our society dies in bitter and painful agony, rather than a state of composed dignity.
Banks Lose Pivotal Mortgage Case
by Denise Lavoie and Michelle Conlin - AP
The highest court in Massachusetts ruled against U.S. Bancorp and Wells Fargo & Co. Friday in a pivotal mortgage foreclosure case that could spark more turmoil and uncertainty in a housing market already mired in depression. The Supreme Judicial Court affirmed a lower court judge's ruling invalidating two mortgage foreclosure sales because the banks, in their capacity as trustees for mortgage securities, did not prove that they actually owned the mortgages at the time of foreclosure.
The decision, which highlights the failure of financial firms to adhere to the rules that govern mortgage-backed securities, is likely to lead more borrowers to sue bank servicers and trustees for wrongful foreclosures. It's unclear what the ruling means for people who were forced from their homes after defaulting on their loans or for those who purchased houses in foreclosure sales. "There are now thousands of these homes that have been purchased through foreclosures handled in a very similar fashion where the titles are defective," said Ward P. Graham, a Massachusetts title attorney who co-authored a friend-of-the-court brief in the case on behalf of the Real Estate Bar Association for Massachusetts, Inc.
Last fall, the banking industry's foreclosure machine came under intense scrutiny with revelations that low-level employees called "robo signers" powered through hundreds of foreclosure affidavits a day without verifying a single sentence. At the time, analysts warned that the banks' allegedly fraudulent document procedures could imperil their ability to prove that they owned the mortgages. The Massachusetts ruling stokes those concerns.
"This decision is going to raise serious problems in hundreds of thousands of foreclosure cases," said homeowner-defense attorney Thomas Cox, a Maine attorney who was one of the first to put the robo signing scandal in the national spotlight. "It has the potential to require that foreclosures be done over, and I think there's going to be significant turmoil nationally. There's going to be major uncertainty."
In the Massachusetts case, the Supreme Judicial Court found that the banks, who were not the original mortgagees, did not show that they held the mortgages at the time of foreclosure. As a result, the court found, the banks did not demonstrate that the foreclosure sales were valid. The banks argued that the securitization documents they submitted were sufficient to prove they owned the mortgages before the publication of the notices of sale and the foreclosure sales.
Wells Fargo said in a statement Friday that as trustee of a securitized pool of loans, it expected those servicing the loans to abide by all applicable state laws, including those governing foreclosure sales. The San Francisco bank was a trustee of the securitized trust in question. American Home Mortgage Servicing Inc., was the servicer.
In a separate statement U.S. Bancorp said the judgment has no financial impact on the company. "The issues addressed by the court revolved around the process of servicing the loan on behalf of the securitization trust, which was performed in this case by the servicer, American Home Mortgage," the bank, which is based in Minneapolis, said. It later issued another statement saying that as a trustee of the securitization trust that it has no responsibility for the terms of the underlying mortgage, foreclosure procedure, the conduct of the servicer, the process by which the mortgage is transferred to the trust, or the sufficiency of the mortgage documentation."
American Home Mortgage Servicing, which is based in Coppell, Texas, said in a statement that the "decision is of limited applicability because it is based on law that is unique and specific to Massachusetts. The decision does not extend to foreclosures in other states."
Attorney Paul Collier III, who represents Antonio Ibanez, one of the homeowners in the case, said the ruling affects thousands of mortgages in Massachusetts and could have a far-reaching impact on the nation's banking industry. "For homeowners and foreclosures in general, it means that any mortgage foreclosure which was initiated by a securitized trust at a time when the trust had not obtained a mortgage assignment which gave it the lawful right to do so is void. Those homeowners, like Mr. Ibanez, still own the property," Collier said.
It's up to lawmakers to take action to remove the uncertainty over mortgages raised by the decision, said Massachusetts Secretary of State William Galvin. Without legislative action, the court's ruling will have a "chilling effect" on the real estate market, he said. The broader implications of the case sent bank stocks lower, with Wells Fargo stock falling 65 cents, or 2 percent, to close at $31.50. It earlier traded as low as $30.64. Stock in U.S. Bancorp slid 20 cents to close at $26.09, after dropping as much as 2.4 percent after the ruling.
Banks Court More Woe on Foreclosures
by David Reilly - Wall Street Journal
Make that strike two for banks.
Twice in recent weeks, state courts have dealt the banks a blow in disputes related to soured mortgages. That has rightly set investors on edge—bank stocks tumbled Friday on the latest decision—and provided a stark reminder that foreclosure and mortgage-repurchase problems are far from over.
The latest legal setback came when Massachusetts' highest court on Friday ruled that U.S. Bancorp and Wells Fargo improperly foreclosed on two properties because they couldn't prove they actually owned the mortgages. In December, the New York State Supreme Court said insurer MBIA could use statistical sampling of loans, rather than combing through thousands individually, in a suit against Bank of America's Countrywide over losses on mortgages it insured. If other courts do likewise, this could counter banks' strategy of fighting cases on a loan-by-loan basis.
The Massachusetts ruling is especially significant. Although it won't necessarily apply in other states, the decision suggests foreclosure-related problems aren't merely procedural, as banks have argued. Rather, documentation issues may call into question the actual ownership of billions of dollars of mortgages bundled into securities and sold to investors.
Banks have maintained that mortgage ownership was properly transferred to securitization trusts and that proper procedures were followed in splitting a mortgage, or legal right to foreclose, from a promissory note, or the borrower's IOU. The Massachusetts decision calls that into question.
Bank investors cheered earlier in the week when BofA reached a $2.8 billion deal with Fannie Mae and Freddie Mac over problem loans. But legal decisions like these may bolster mortgage-bond investors' chances of offloading toxic loans—and forcing banks to shoulder the losses
Facing Scrutiny, Banks Slow Pace of Foreclosures
by David Streitfeld - New York Times
An array of federal and state investigations into the way banks foreclose on delinquent homeowners has contributed to a sharp slowdown in foreclosures across the country, especially in hard-hit cities like [Phoenix]. Over the last several months, some banks have been reluctant to seize homes from distressed borrowers, economists and government officials say, as they face scrutiny from regulators and the prospect of sanctions when investigations wrap up in the coming weeks and months.
The Obama administration, in its most recent housing report, said foreclosure activity fell 21 percent in November from October, the biggest monthly decline in five years. Here in Phoenix, foreclosures fell by more than a third in the same period, reflected in the severe drop in foreclosed homes being auctioned on the courthouse plaza. “There’s no product, just nothing to buy,” complained Sean Waak, an agent for investors, during a recent auction.
The pace of foreclosures could be curtailed further by courts. In a closely watched case, the highest court in Massachusetts invalidated two foreclosures in that state on Friday. The court ruled that two banks, U.S. Bancorp and Wells Fargo, failed to prove they owned the mortgages when they foreclosed on the homes.
If the slowdown continued through this month and into the spring, it could be a boost for the economy. Reducing foreclosures in a meaningful way would act to stabilize the housing market, real estate experts say, letting the administration patch up one of the economy’s most persistently troubled sectors. Fewer foreclosures means that buyers pay more for the ones that do come to market, which strengthens overall home prices and builds consumer confidence in housing. “Anything that buys time, that reduces the supply of houses coming onto the market, is helpful,” said Karl Guntermann, a professor of real estate finance at Arizona State University.
It is not that borrowers have stopped defaulting on their mortgages. They are missing payments as frequently as ever, data shows. But the lenders are not beginning formal foreclosure proceedings or, when they are, do not complete them with an auction sale. And in the most favorable outcome for distressed borrowers, some lenders are modifying loans so foreclosure becomes unnecessary.
The drop in foreclosures began in late September when some lenders were revealed to have been using so-called robo-signers to process thousands of foreclosures without verifying the accuracy of the data. As the investigations into the problems proceeded, the uncertainty caused many lenders to become more cautious. Their foreclosure procedures, the banks have repeatedly said, are sound. But preliminary results of several of the investigations have indicated substantial problems. Coordinating many of the inquiries is the Financial Fraud Enforcement Task Force, established by President Obama.
“The administration is committed to taking appropriate action on these issues where wrongdoing has occurred,” said Melanie Roussell, an administration spokeswoman. The diminished supply of foreclosed homes has already had an effect on prices at the auctions on the courthouse plaza here, bidders said.
Houses change hands on the plaza with a minimum of ceremony. Three sets of trustees hired by the banks sit a few feet apart, their backs to a statue of a naked family looking for all the world as if its members had just been cast out of their home. The trustees call off properties in a monotone to bidders clustered around them. Winners must immediately hand over a $10,000 deposit in the form of a cashier’s check.
On a recent afternoon, one bidder, Pam Mullavey of Infoclosure, found herself in a bidding war with Chris Romuzga of Posted Properties for a 2001 house that had fetched $644,000 at the very peak of the boom. This time around, the bank set the floor at $271,000. Ms. Mullavey and Mr. Romuzga rapidly pushed up the price in varying increments of $100 and $500. Mr. Romuzga’s client had planned to pull out at $307,000 but asked him to keep bidding as Ms. Mullavey sailed on. Her winning bid was $310,100, well above what a similar house might have fetched just a few months ago.
“Sometimes I wonder why people are bidding so much,” Ms. Mullavey said. For Mr. Romuzga, it was the fourth time that afternoon he had been outbid. Only once had he secured a property. The investors’ frustration could be a good thing for Phoenix homeowners, who have seen values fall 54.5 percent since 2006. In the last few months, home prices have started to drop again. A decline in foreclosures, economists say, could break the fall.
Cameron Findlay, chief economist with the mortgage company LendingTree, said that the shifting behavior of lenders had helped change perceptions about the foreclosed. “Initially, society’s view was to run them out of the house,” he said. That resulted in vacant and dilapidated homes, which blighted neighborhoods and drove potential buyers away. “People should be hopeful the modification programs work — for their own benefit,” said Mr. Findlay.
More than four million households are in serious default and vulnerable to losing their homes. Lenders maintain that cases of borrowers improperly foreclosed are extremely rare. But the Federal Reserve, which is investigating lenders’ policies in conjunction with other banking regulators, has found significant weaknesses in risk management, quality control, auditing and compliance.
Another investigation is being conducted by the Federal Housing Administration, which is examining whether loan servicers are exhausting all legally required options before foreclosing on government-insured mortgages. An agency spokeswoman said that initial reviews indicated “significant differences” in efforts by servicers to keep borrowers in their homes.
A third investigation is being conducted by the Executive Office for U.S. Trustees, part of the Justice Department. It is looking into documentation errors by lenders and their law firms in homeowners’ bankruptcy filings.
At the state level, there is a joint effort by all 50 state attorneys general, with the specific goal of changing the face of foreclosure in America by making it more difficult for lenders to act against homeowners. The effort, led by Iowa’s attorney general, Tom Miller, is in flux as several prominent attorneys general left office and their replacements decide whether to make foreclosure reform a priority.
There have been many attempts during the housing crash to stem the flow of foreclosures, only fitfully successful. Some experts think neither federal reforms nor any agreements brokered by the attorneys general will make much of a difference. “Whether it is really true that there are millions of foreclosures that could be avoided if servicers were just more willing to do more modifications that make sense — meaning overall losses would be less than would otherwise be the case — is far from clear, and in fact highly unlikely,” said Tom Lawler, an economist.
Loan servicers are not set up to identify the true financial picture of each borrower having trouble, Mr. Lawler said, and cannot easily figure out who is likely to stop paying without a modification and who will keep sending a check every month. The courthouse plaza bidders in Phoenix do not believe their livelihood is threatened. By the end of January, several bidders predicted, lenders would gear up and foreclosures would once again be abundant.
In the meantime, Tom Peltier watched unhappily as a house started at $68,000 and quickly spiraled up. He finally locked it in at $98,500. “That was about 20 grand more than I wanted to pay,” said Mr. Peltier, who planned to rent it to his sister as soon as he moved out the former owner.
Expect Even More Fees From Banks This Year
by Robin Sidel and Dan Fitzpatrick - Wall Street Journal
Banks, in an attempt to wring more revenue out of customer accounts, are conjuring up new ways to raise fees on basic products like debit cards, cash machines and checking accounts. As regulation curtailing the financial institutions from levying certain charges on consumers has mounted over the past year, banks have had to dream up new fees to replace those now trimmed by laws.
Banks are considering additional fees on credit cards and checking accounts. But they also are looking at new ways to make money on cash machines and especially debit cards as regulators pinch the cards' conventional revenue streams. Banks are thinking about imposing annual fees of $25 or $30 on debit cards, according to people familiar with bank strategies. Some also are considering limiting the number of debit-card transactions that a customer can make each month, these people say. Another idea circulating in the industry: limiting the size of a purchase that a customer could make with a debit card.
New debit-card fees are "definitely a 2011 issue," says Robert Hammer, who runs a banking-industry consulting firm in Thousand Oaks, Calif. "The question is which quarter it will be and which bank will go first." People familiar with banks' thinking say several companies also are considering raising fees on automated-teller machines for noncustomers, which currently average $1.63 per transaction.
Banks also are continuing to add fees to checking accounts, a trend that began last year. Next month, for example, customers of the former Washington Mutual will see their free checking accounts replaced by fee-based accounts from J.P. Morgan Chase, which bought WaMu in 2008. Customers can avoid the fees if they meet certain criteria such as maintaining balances.
Bank of America will soon begin testing fees of $6 to $9 a month on its most basic checking account, according to a person familiar with the plan. Customers will have no options to waive that monthly fee. Accounts with more features can have monthly fees ranging from $8.95 to $25. Those can be waived if customers maintain certain balances, use credit cards, do their banking online or have a mortgage with the bank.
The Bill Daley Problem
by Simon Johnson - Huffington Post
Bill Daley, President Obama's newly appointed chief of staff, is an experienced business executive. By all accounts, he is decisive, well-organized, and a skilled negotiator. His appointment, combined with other elements of the White House reshuffle, provides insight into how the president understands our economy -- and what is likely to happen over the next couple of years. This is a serious problem. This is not a critique from the left or from the right. The Bill Daley Problem is completely bipartisan -- it shows us the White House fails to understand that, at the heart of our economy, we have a huge time bomb.
Until this week, Bill Daley was on the top operating committee at JP Morgan Chase. His bank -- along with the other largest U.S. banks -- have far too little equity and far too much debt relative to that thin level of equity; this makes them highly dangerous from a social point of view. These banks have captured the hearts and minds of top regulators and most of the political class (across the spectrum), most recently with completely specious arguments about why banks cannot be compelled to operate more safely. Top bankers, like Mr. Daley's former colleagues, are intent of becoming more global -- despite the fact that (or perhaps because) we cannot handle the failure of massive global banks.
The system that led to the crisis of 2008, and the recession that has so severely damaged so many Americans, encouraged excessive risk-taking by major private sector financial institutions and, yes, Fannie Mae, Freddie Mac, and other Government Sponsored Enterprises (although these were most definitely not the major drivers of the crisis -- see 13 Bankers). Today's most dangerous government sponsored enterprises are the largest six bank holding companies: JP Morgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley. They are undoubtedly too big to fail -- if they were on the brink of failure, they would be rescued by the government, in the sense that their creditors would be protected 100 percent. The market knows this and, as a result, these large institutions can borrow more cheaply than their smaller competitors. This lets them stay big and -- amazingly -- get bigger.
In the latest available data (Q3 of 2010), the big 6 had assets worth 64 percent of GDP. This is up from before the crisis -- assets in the big six at the end of 2006 were only about 55 percent of GDP. And this is up massively from 1995, when these same banks (some of which had different names back then) were only 17 percent of GDP. No one can show significant social benefits from the increase in bank size, leverage, and overall riskiness over the past 15 years. The social costs of these banks -- and their complete capture of the regulatory apparatus -- are apparent in the worst recession and slowest recovery since the 1930s.
Paul Volcker gets it; no wonder he has resigned. Mervyn King, governor of the Bank of England, gets it. Tom Hoenig, president of the Kansas City Fed, gets it. Elizabeth Warren, the tireless champion of consumer rights, gets it. Gene Fama, father of the efficient financial markets view, gets it better than anyone. I discussed the issue in public for two hours at the American Financial Association (AFA) meetings in Denver on Friday with two presidents of the AFA (Raghu Rajan and John Cochrane) and a Nobel Prize winner (Myron Scholes). This is not a left-wing or marginal group -- there must have been at least 500 people in the audience (video will be available). The top minds in academic finance understand the problem vividly and are articulate about it -- there is no rebuttal to the points being made by Anat Admati and her distinguished colleagues.
This is not a left-right issue -- again, look at the list of people who co-signed Professor Admati's recent letter to the Financial Times. This is a question of technical competence. Do the people running the country -- including both the executive branch and the legislature -- understand economics and finance or not? If the country's most distinguished nuclear scientists told you, clearly and very publicly, that they now realize a leading reactor design is very dangerous, would you and your politicians stop to listen? Yet our political leadership brush aside concerns about the way big banks operate. Why?
Top bankers, including Bill Daley, have pulled off a complete snow job -- including since the crisis broke in fall 2008. They have put forward their special interests while claiming to represent the general interest. Business and other groups, of course, do this all the time. But the difference here is the scale of the too big to subsidy -- measured in terms of its likely future impact on our citizenship and our fiscal solvency, this will be devastating. Most smart people in the nonfinancial world understand that the big banks have become profoundly damaging to the rest of the private sector. The idea that the president needed to bring a top banker into his inner circle in order to build bridges with business is beyond ludicrous.
Bill Daley now controls how information is presented to and decisions are made by the president. Daley's former boss, Jamie Dimon, is the most dangerous banker in America -- presumably he now gets even greater access to the Oval Office. Daley is on the record as opposing strong consumer protection for financial products; Elizabeth Warren faces an even steeper uphill battle. Important regulatory appointments, such as the succession to Sheila Bair at the FDIC, are less likely to go to sensible people. And in all our interactions with other countries, for example around the G20 but also on a bilateral basis, we will pursue the resolutely pro-big finance views of the second Clinton administration.
Top executives at big U.S. banks want to be left alone during relatively good times -- allowed to take whatever excessive risks they want, to juice their return on equity through massive leverage, to thus boost their pay and enhance their status around the world. But at a moment of severe financial crisis, they also want someone in the White House who will whisper at just the right moment: "Mr. President, if you let this bank fail, it will trigger a worldwide financial panic and another Great Depression. This will be worse than what happened after Lehman Brothers failed."
Let's be honest. With the appointment of Bill Daley, the big banks have won completely this round of boom-bust-bailout. The risk inherent to our financial system is now higher than it was in the early/mid-2000s. We are set up for another illusory financial expansion and another debilitating crisis.
Bill Daley will get it done.
Debt default fears will spread to US and Japan, warns Citigroup's Willem Buiter
by Emma Rowley - Telegraph
Fears about the finances of eurozone nations will spread around the world to engulf the US and Japan, former Bank of England policy maker Willem Buiter has warned.
Worries about the risk of a sovereign state defaulting on its debt, which thrust the eurozone into crisis, will soon encompass the two major economies as well, according to Citigroup economists led by Mr Buiter, who sat on the Bank's Monetary Policy Committee. The team has published a note forecasting much more strife to come in the wake of Greece and Ireland's recent bail-outs and eurozone governments' borrowing costs hitting record highs.
"Despite the recent drama, we believe we have only seen the opening and second act, with the rest of the plot still evolving," the team wrote. "There is no absolutely safe sovereigns." There are likely to be several sovereign debt restructurings in the next few years, the analysts said, with Portugal likely to need to access the emergency funding facilities soon. Against this backdrop, the US and Japan - dubbed the "fiscal sustainability deniers" - cannot keep ignoring the question of how safe their public finances are, the team said.
The fears about default will encompass the two economies "before long", they argued - particularly if a default is defined not just as a failure to meet the debt contract, but also as inflicting severe losses on debt holders through deliberately-engineered inflation or weakening the currency. "Both Japan and US public finances are unsustainable, in our view, and in the absence of credible and substantial fiscal tightening both would eventually face painful discipline through the markets," the economists wrote.
It is only a matter of time before the US will have to raise funds by issuing debt offering "significantly higher" returns to bondholders, to reflect the level of risk surrounding it, they added. While the break-up of the eurozone was seen as very unlikely, the analysts believe there is a risk that a lagging member state could leave the monetary union "in a fit of populist and nationalist rage" if they do not get enough external support, despite the high costs of exiting the euro.
There is also a risk that if a weaker member seems to get too much financial help, a major player could depart "on a wave of domestic populist outrage" about having to fund bail-outs. The economists called for a much bigger liquidity support facility and for a restructuring of the debt of the EU's failing banks and insolvent nations.
Bernanke Rules Out State, Local Bailouts
by Jon Hilsenrath and Neil King Jr. - Wall Street Journal
Federal Reserve Chairman Ben Bernanke on Friday ruled out a central bank bailout of state and local governments strapped with big municipal debt burdens, saying the Fed had limited legal authority to help and little will to use that authority. "We have no expectation or intention to get involved in state and local finance," Mr. Bernanke said in testimony before the Senate Budget Committee. The states, he said later, "should not expect loans from the Fed."
The $2.9 trillion municipal-bond market has been stung recently by worries that some cash-strapped cities or states won't be able to pay off or roll over debt. Costs have risen broadly for municipal borrowers. The market also faces challenges from the expiration of the Build America Bonds program, which helped cities and states borrow $165 billion at interest rates held down by federal subsidies.
Some analysts speculate the Fed could jump into the market by purchasing muni debt or lending to struggling borrowers. The Fed only has legal authority to buy muni debt with maturities of six months or less that is directly backed by tax or other assured revenue, which makes up less than 2% of the overall market. The Dodd-Frank financial-regulation law enacted last year further tied the Fed's hands, Mr. Bernanke noted, by barring the central bank from lending to insolvent borrowers or pursuing bailouts of individual borrowers.
Mr. Bernanke played down the risk of a major municipal-bond crisis, noting that muni markets have been functioning normally, with healthy trading volumes and lots of issuance. But he said that if municipal defaults did become a problem, it would be in Congress's hands, not his. "This is really a political, fiscal issue," he said.
Lawmakers also are drawing a line in the sand. Senior House Republicans say they will oppose any state requests for money. "If we bail out one state, then all of the debt of all of the states is almost explicitly put on the books of the federal government," House Budget Committee Chairman Paul Ryan said Thursday. At least three House committees are planning hearings on local budget woes. Rep. Devin Nunes (R., Calif.) plans to introduce a bill to require states to disclose the size of their public-pension obligations in order to keep their federal tax-exempt bonding authority.
The bill, the Public Employee Pension Transparency Act, will explicitly bar state and local governments from receiving help from the federal government to cover their pension obligations. "There are 242 Republicans, and I can't imagine one that would be in favor of a bailout," Mr. Nunes said.
Many Democrats are wary as well. "We need to be prepared with a plan in case we are approached by one or more states," said Sen. Kent Conrad, (D., N.D.), chairman of the Budget Committee. Neither the House nor the Senate would be "very interested in bailouts to states," he added. In 2010, there were five municipal bankruptcy filings, down from 10 filings in 2009, according to a recent report from Bank of America Merrill Lynch. Through Dec. 1, there was $4.25 billion of municipal debt in default, which represents 0.15% of the total market, the report said.
On a recent broadcast of CBS's "60 Minutes," Meredith Whitney, a banking analyst who recently turned to analyzing state and local finances, said the U.S. could see "50 to 100 sizable defaults," in 2011 amounting to "hundreds of billions of dollars." Mr. Bernanke described that as a "pessimistic view" that he didn't entirely agree with.
San Joaquin Valley's Chowchilla defaults on a bond
by Lee Romney - Los Angeles Times
Reflecting the struggles many cities face, the town fails to make a payment on the bond issued in flusher times to renovate City Hall. But an official says reserves will be drawn down to cover the payment.
The San Joaquin Valley town of Chowchilla — known for its dairy farms and prisons — has defaulted on a municipal revenue bond, underscoring the tight times and drastic choices faced by struggling California cities. The city, which has a skeletal manufacturing base, failed to make its January payment on a bond issued in much flusher times to renovate the ample City Hall, which houses a government that has seen a 45% cut in its workforce since mid-2009.
But Assistant City Administrator Wayne Padilla said Thursday that he had negotiated with the bond trustee to draw down on bond reserves Friday and make the January payment, the last one due for this fiscal year.
The default comes as the city of Bell in Los Angeles County teeters on the edge of insolvency because of inflated salaries and alleged fraud and other cities struggle with unfunded pension obligations and ballooning healthcare costs.
Chowchilla, which has been hit hard by plummeting home prices, an unemployment rate near 18% and commercial vacancies, has cobbled together one-time plans to plug this year's $1-million budget shortfall. But more solutions are in order if the city hopes to avert an eventual repossession of its seat of government, which includes 5,000 square feet of commercial space that now sits empty.
"The question remains, 'What do we do about the debt next year?' " said Padilla, who is also the city's finance director. "The decision hasn't been made one way or another whether we're going to be able to make the debt payments."
Chowchilla, cleaved by California Highway 99 and known for its annual Western Stampede, expected $4.1 million in revenue this fiscal year, but faced $5.2 million in budgeted expenses. It failed to make its January bond payment after drawing down on reserves to make a payment last summer, he said.
Other cities are also feeling the pinch. The Bay Area's Vallejo took the most extreme route when it filed for bankruptcy in 2008 after it became clear that the city's police and fire labor contracts sucked up much of its general fund. Tom Dresslar, spokesman for California Treasurer Bill Lockyer, said he hoped Chowchilla "will be an isolated case.... There's no imminent threat of widespread municipal defaults in California." But he called it "another black eye" for the state.
"Our concern is when a city defaults on its bond payments, if nothing else, the reputation will stain," he said. "It bleeds onto other local issuers and the state.... It's an event that California does not need. We've got enough problems operating in the market."
Municipal bond analysts agreed Thursday but stressed that a wave of other cities — particularly those with investment ratings that must go to market regularly to borrow cash — are not likely to follow suit. Chowchilla had no underlying investment grade, though the bond insurer was rated.
"It's a remote location without major industry, without a major investment grade rating," said Chris Ihlefeld, co-portfolio manager with New Mexico-based Thornburg Investment Management, which manages a limited-term California fund. "If you were going to anticipate a default anywhere, a city like Chowchilla doesn't surprise me at all."
Ihlefeld added that events like these create opportunities. "There's a general perception among municipal bond buyers, 'Let's avoid any and all things California,' and that's just not the truth," he said. "Most of California is actually doing fine. Even if there is a measure of weakness, which we've all been dealing with, there is a huge gulf between a municipality experiencing some weakness and the probability of a municipal default happening."
David Mora, West Coast manager for the International City-County Management Assn., called the default "a last resort option. We'll probably see a few more as the finances of all local government really comes under considerable pressure," he said. But "bonds generally have the first call on city revenue."
Padilla took over as Chowchilla's finance director in 2009 to discover that the city was already in default on some Mello-Roos bonds, which are issued by certain voter-designated cities, counties and special districts to finance major improvements and services. Money that was dedicated to the bond payments had gone into the general fund instead, leading city leaders to mistakenly believe they had a million-dollar surplus.
It disappeared overnight, as Padilla set the other bond matter right. The city also suffered from the whiplash that has visited many communities. Bay Area and other urban refugees flowed in during the housing boom, plopping down cash for second homes and retirement living near the Pheasant Run Golf Club. But the economy caught up with the town of 19,000 residents, nearly 8,000 of whom are prisoners. In addition to farms, there are two car dealerships, a small shopping center and an insulation and brake manufacturer, making for a thin sales tax base.
These days, Padilla is not alone in doing two jobs. The acting city administrator doubles as the police chief. And the town's public information officer heads what's left of the gutted parks and recreation department. Still, Padilla said, he considers Chowchilla fortunate. Employees who remained after the job cuts agreed to furloughs, and the police agreed to give up leave time guaranteed in their contract. "Unlike a Vallejo or some other cities, we didn't have protracted negotiations," he said.
And in a series of City Hall meetings to puzzle through the crisis, he said, many residents have seemed open to the possibility that "one or two tax measures" could be placed on the ballot to get through tough times. Chowchilla Chamber of Commerce member Lee Brock said he believes Chowchilla is no worse off than a lot of places. Sure, the fancy City Hall was finished "at the worst time," considering that houses that were selling for $475,000 are now sitting empty at $200,000.
But his Brock Locksmithing has weathered the storm, meeting a frenzy of demand from lenders. "I'm optimistic," said Brock, 66, who was on his way out the door Thursday to re-key another foreclosed house for another bank. "But I think it's going to take a little while."
Bond wave strikes on both sides of Atlantic
by Jennifer and Michael Mackenzie - Financial Times
Companies on both sides of the Atlantic have embarked on an early-year rush to issue debt in an effort to secure financing before any rise in borrowing costs. The surge in bond issuance on Tuesday came amid optimism about the US economy’s growth prospects and corporate earnings. An estimated $35.6bn in dollar-denominated bonds were priced on Tuesday, according to Dealogic.
In the US, General Electric’s finance arm led the issuance wave with the sale of $6bn of debt. Europe’s banks also raised more than €7bn ($9bn) in covered bonds – that market’s busiest day in more than a year. On Monday, Warren Buffett’s Berkshire Hathaway sold the first corporate debt of the year, with the $1.5bn bond offering setting a positive tone for the dollar markets, the most important source of debt financing for companies and banks around the world.
On Tuesday, others including Met Life and General Electric Capital, the group’s financing arm, were planning deals. January is typically a frenetic month for debt markets as investors look to put fresh funds to work and treasurers aim to secure some of their funding before entering the “blackout” period around corporate earnings.
However, this year the urge has only been made stronger by the economic outlook, which has fuelled expectations that interest rates could rise. “The incentives stack up for issuers to hit the debt market as hard and as quickly as they can,” said Bill Cunningham, co-head of global active fixed income at State Street Global Advisers. “There is a lot of debt to get done this year and there’s an element of first-mover advantage right now,” said Chris Tuffey, co-head of credit capital markets at Credit Suisse. “We’re seeing a good pipeline of deals building, but the strong volumes could belie the underlying market – the European sovereign issue hasn’t gone away and people are still worried about the economic outlook,” he said.
This week has been also supercharged by a rush to complete deals ahead of Thursday’s holiday across much of Europe. “Its not the first time we’ve seen a rally in the first week. We need to see a few more days before really knowing how strong this is,” said Frederic Zorzi, global co-head of the syndicate team at BNP Paribas. The surge in bond issuance on Tuesday came as most equity markets rose to start the year on better growth prospects for the US economy and corporate earnings.
In Europe, Angst Fills Sovereign Bond Gap
by Mark Gongloff - Wall Street Journal
The cost of insuring some European government debt against default hit a record after regulators issued proposed rules on bank bailouts that would hurt bondholders. The move higher reflects a widening gap between what the market is saying and how the major ratings companies judge these countries. "Further downgrades are certain, and we have not seen the last screen shot of this movie yet," said Lena Komileva, head of G-7 market economics at Tullett Prebon, a brokerage firm in London.
The costs of insuring against a default by Western European sovereign borrowers in the credit-default-swap market surged, briefly touching a record on Thursday, according to data provider Markit. Swaps prices for Spain, Belgium and Ireland closed at records, according to Markit. The gap between yields on most European sovereign bonds and relatively safe German debt also widened.
The angst among investors seemed inspired by a European Union proposal that bondholders should share the future cost of bailing out European banks. In the case of a government bailout, the plan said that senior bondholders would suffer losses before a taxpayer-funded bailout. Theoretically, this should be a boon to government bonds, as it would take some of the burden of bailouts away from the government. But investors may have feared that the proposal was a hint that bondholders also might be forced to take haircuts on sovereign debt in the future, as well.
Even before Thursday's flare-up, the credit-default-swap and bond markets already suggested high and rising investor worry about the credit-worthiness of not only financially strapped nations on the periphery of the euro zone, but some core nations, too. The credit-default-swaps market suggests that Portugal, Ireland, Italy, Greece and Spain still are all rated too highly by the three leading global rating firms, Fitch Ratings, Moody's Investors Service and Standard & Poor's. Italy should be rated BB by this measure, and other countries in financial distress like Portugal, Spain, Greece and Ireland should be rated B, according to an analysis by Markit.
All of those implied ratings are in "junk-bond" territory, or below investment grade. Only Greece is rated below investment grade by any major ratings firms. Markit's analysis assigns implied ratings to a country based on how its credit-default-swaps price compares with those of other countries. Belgium has a similar swaps price as Italy and so gets a similar implied credit rating. Credit-default-swaps prices also suggest European nations such as Belgium, France and the U.K. also might be at risk of a ratings downgrade of at least one notch. The latter two nations have AAA ratings by all three ratings companies.
Downgrades could raise government borrowing costs and add to market anxiety. A downgrade to junk status would force some investors to sell out because they can hold debt rated only as investment grade. "Markets see the agencies are behind the curve," said Win Thin, a currency strategist at Brown Brothers Harriman.
Large, multinotch downgrades of government debt, as occurred in Europe in 2010 and in the Asian debt crisis in the late 1990s, can create the impression that ratings firms are playing catch-up.
They also can make matters worse for countries by creating market turmoil that raises borrowing costs. A five-notch downgrade of Ireland by Moody's in December coincided with a one-day, 0.22 percentage-point widening of Irish bond spreads over German bunds and a 0.15 percentage-point increase in Irish credit-default-swaps prices.
The ratings firms acknowledge the gaps between market indicators and their own ratings, but said this should be expected given the volatility of markets and their ratings approach, which seeks to focus on longer-term fundamentals. All three noted that they were downbeat about Greece long before the market was. "In October 2009, market indicators implied Greece was rated Aa2, while we were at A1 on review for downgrade," said Bart Oosterveld, chief credit officer of public-sector finance at Moody's. "Bond-spread implied ratings for Greece as late as fall 2008 implied an Aaa rating."
"For many years, we rated countries like Greece and other southern euro-zone countries substantially lower than others in the euro zone at a time when the market consistently valued their debt on a par with AAA-rated countries such as Germany," said S&P spokesman David Wargin. "Now, the market has swung to the opposite side and is more pessimistic than we are about medium-term default risk for Greece."
The ratings firms argue that the multinotch downgrades of European countries last year came as a result of new fundamental information in the market, and that they came as little surprise to markets and so created little relative turmoil. Credit-default-swaps prices, the ratings firms and analysts note, are influenced by much more than default risk. They include premiums for other risks, including liquidity and volatility. "I think it's hard to say the CDS market is being wrong or unfair or irrational," said William Porter, head of European credit strategy at Credit Suisse.
Though European nations may not be as overrated as implied by the credit-default-swaps market, they are overrated nevertheless, based on fundamentals, said Mr. Thin at Brown Brothers Harriman. His model crunches budget deficits, economic growth, inflation and other metrics to measure where European countries should be rated. Mr. Thin said his model has roughly tracked market expectations for ratings throughout the crisis and now imply that Italy and Portugal are overrated by two ratings firms, while Greece, Ireland and Spain are overrated by all three.
Why The Decline In The Headline Unemployment Rate Is Actually Bad News
by Bill McBride - Calculated Risk
An interesting question is why the unemployment rate fell so sharply, even with relatively few payroll jobs added (103,000 jobs added in December).
First, it is important to remember that there are two separate surveys for the Employment Situation Summary. The unemployment rate comes from the Current Population Survey (CPS: commonly called the household survey), a monthly survey of about 60,000 households.
The payroll jobs number comes from Current Employment Statistics (CES: payroll survey), a sample of "approximately 140,000 businesses and government agencies representing approximately 410,000 worksites". See this post for a discussion of the two surveys.
The following table is based on the Household survey (all seasonally adjusted):
The household survey measures percentages for the 60,000 households (unemployment rate, participation rate) and then the BLS derives the other numbers based on the population estimate.
So the estimated number of unemployed dropped by 556,000. Some of this decline was due to higher employment, but some was also due to the decline in participation - even while the population increased.
The table helps explain why the reported unemployment rate fell from 9.8% to 9.4%. A key reason was the decline in the participation rate. If the participation rate had held steady at 64.5%, then the unemployment rate would have only declined to 9.64%.
So almost 2/3rds of the decline in the unemployment rate was related to the decline in the participation rate. Some of the decline might be from workers going back to school, but some is probably due to people just giving up.
A large portion of the decline in the participation rate was for people in the 16 to 24 age group. According to the BLS, the 16 to 24 civilian labor force declined by 244 thousand. Most of these people will probably return to the labor force as the economy improves - and that will put upward pressure on the unemployment rate.
Another group that saw a decline in the participation rate was men in the key 25 to 54 age group. I wonder if these people are just giving up?
Click on graph for larger image.
Here is a repeat of the graph showing the unemployment rate (red), the participation rate (blue), and the employment-population ratio (black).
The participation rate has fallen sharply from 66% at the start of the recession to 64.3% in December. That is almost 4 million workers who are no longer in the labor force and not counted as unemployed in U-3, although most are included as "discouraged workers" or "Marginally Attached to Labor Force" in U-6.
A decline in the unemployment rate mostly due to a decline in the participation rate is not good employment news.
Inside December Jobs Report, Labor Force Hits 'Stunning New Low'
by Lila Shapiro - Huffington Post
After a week of promising signs for an improving economy, the news from Friday's Bureau of Labor Statistics report on the state of jobs in America is bleaker than anticipated.
Although the unemployment rate fell to 9.4 percent from 9.8 percent in December, bringing the total number of officially unemployed Americans to 14.5 million, only 103,000 jobs were added in December according to the Labor Department's BLS report -- a number significantly lower than expected. (The Wall Street Journal reported that many Wall Street analysts were predicting "at or above 200,000" new jobs.)
The news gets worse: less than half of the drop in unemployment rate can be attributed to new job creation -- the other half came from 260,000 Americans who have dropped out of the labor force altogether. This brings the percentage of Americans who are either employed or actively looking for work down to 64.3 percent, what economist Heidi Shierholz calls "a stunning new low for the recession."
"The overarching story here is that this represents the continued slog of the recovery." Shierholz, of the Washington, D.C.-based Economic Policy Institute, said. "It's the same old bright spots that we've been seeing, we continue to see: temporary help services, health jobs, restaurants and bars -- all up." The report shows some growth in health care and leisure services, with most other industries staying static.
"Hiring is picking up. but I think this report underlies that it's going to be a gradual process," IHS Chief U.S. Economist Nigel Gault said. "Overall it wasn't a bad report." Gault added though, that we really need twice this many jobs added per month, month after month, to see any substantial improvement in the unemployment rate.
In December, hispanic and black Americans continued to be hit hardest by unemployment. "I think this is the lowest employment-to-population ratio we've ever had for Hispanic Americans," economist Dean Baker said, also noting a 2.2 percent raise in the unemployment rate for Hispanic bringing the unemployment percent up to 32.2 (not seasonally adjusted).
For all the economists we spoke to, the drop in the labor force stuck out as the most arresting detail. "We have now added jobs every single month for a year," Schierholz said. "So you would think that there would be labor force growth, these missing workers starting to come back in. Not only is that not happening, it's actually starting to go in the other direction. There's never been a pool of missing workers this large. It's not clear to me when they'll come back."
Death To The New Monetary Consensus And Quantitative Easing
by L. Randall Wray - Benzinga
Over the past decade and a half a new approach to macroeconomics was developed. In a sense, it integrated the old Bastard “Keynesian” ISLM model that we all learned in intermediate macroeconomics with a Monetarist-inspired “Taylor Rule” for formulating monetary policy and a dynamic “Phillips Curve” to determine inflation. We do not need to go deeply into the technical details. What is important is that it relegated fiscal policy to the backburner and brought monetary policy front and center.
Unlike Milton Friedman's monetarism, the Fed would not adopt a money growth rule, but rather would focus directly on inflation. Adjustment of the fed funds rate would allow it to keep inflation in check. On this view, policy does not work directly but rather indirectly through influence on market expectations. Hence, the word “consensus” has a dual meaning: first it refers to the “consensus” among macroeconomists that the aforementioned integration brings the various approaches under one big tent.
The second refers to the Fed's attempt to achieve a consensus of market participants and policy makers on the goals of policy. The consensus idea is that inflation slows growth so it must be diligently fought. The Fed will keep inflation expectations low, inflation will be low, and growth will be robust. But in truth, every link in that sentence is a delicious illusion. The Fed supposedly manages expectations by convincing markets that it controls inflation, and so long as it controls expectations it can control inflation. But if it cannot control expectations it cannot manage inflation and all bets are off. What a flimsy reed upon which to hang public policy!
And in any case, why should low inflation generate robust growth? Because—well, because the Fed says it will, contrary to all evidence. There are, quite simply, no plausible theories or empirical studies that show that the low-to-moderate inflation rates common in the developed post-war world affect growth rates. Chairman Greenspan simply made the (false) claim so often that it was picked up by the media, by policy-makers, and by economists without any justification. Like almost everything Greenspan ever claimed, it is just dead wrong.
Returning to the obsession with control over expectations, out in the real world, expectations alone cannot govern any economic phenomena: inflation expectations will determine actual inflation only if those with ability to influence prices act on those expectations. And inflation below the high double digits has never proven to be a barrier to economic growth. Let us take the current experience as an example. We have moved on to QE2, an application of the NMC that will have the Fed engage in another round of asset purchases.
Helicopter Ben is supposedly injecting trillions of dollars of money into the economy to create expectations of inflation—to counter the deflationary real world forces. And many wingnuts actually ARE expecting inflation—running around like Chicken-Littles, buying gold and screaming about hyperinflation and collapse of the dollar. And, yet, no inflation. Why not? Because those who might have pricing power—corporations and organized labor—cannot create inflation. Workers cannot increase their wages given massive global unemployment, and firms cannot increase prices in the face of competitive pressures. So no matter how strong is the will to believe, it has no purchase against the facts of experience.
The wingnuts will be proven wrong. The Fed cannot create inflation. It is within the power of the central bank to lower the price of reserves—the overnight rate--as close to zero as it wants. It can also lower longer term rates on assets it is willing to buy, but there is a nonzero practical limit to that based on what Keynes called the square rule (as long term rates fall, the dangers of capital losses should they rise easily swamp any yields).
Quantitative easing supposedly pumps money into the economy to generate spending in order to create expectations of inflation. But all it really amounts to is substituting reserves for treasuries on bank balance sheets—lowering their interest earnings. QE won't work because:
- additional bank reserves do not enable or encourage greater bank lending;
- the interest rate effects are small at best, and are swamped by private sector attempts to deleverage;
– The best estimate based on NYFed work: QE2 will lower long term rates by 18 basis points
- purchases of Treasuries are simply an asset swap that reduces the maturity of private sector assets, but does not raise private sector incomes; and
- given the reduced maturity of private sector portfolios, reduced interest income could actually be deflationary.
But we knew all that—Japan has been doing QE for 20 years, trying to create expectations of inflation in the face of deflationary headwinds. Twenty years later, they still have falling real estate prices, deflation, and no recovery (indeed, the worst economic collapse of any of the major developed nations since the crisis began).
As they say, history doesn't repeat itself but in this case it rhymes nicely. Only insanity would lead us to follow Japan's path while expecting different results. Japan relied mostly on monetary policy to generate recovery. It allowed its financial institutions to hide bad assets. It refused to deal directly with insolvencies and collapsing real estate prices. True, its budget deficit expanded, but this was mostly a passive response to destruction of tax revenue. So far, the US is adopting exactly the same policies—but it (arguably) suffering to a much greater extent due to massive and pervasive fraud.
And Washington is not only looking the other way, it is actually promoting fraud to allow the banksters to try to generate another bubble. In short, the public policy response has been (mostly) based on the theory that we need Money Manager capitalism and that the only hope is to generate another bubble.
It won't work. Financialization is the problem, not a sustainable economic strategy. We need to turn instead to an updated Keynesian-Minskian New Deal based on jobs, growing wages, consumption—especially public consumption, constrained and downsized finance, and greater equality. Monetary policy also has to be downsized, while fiscal policy has to play a bigger role. Not fine-tuning but a positive and permanent presence to counter and guide and supplement the private purpose. It is an audacious hope at this point.
Goldman's Shady Facebook Deal
by Nomi Prins - Daily Beast
Facebook and Goldman Sachs unleashed a tech investing mania this week compared far and wide with the euphoric 1990s dot-com run-up. By arranging a $500 million private investment, at a staggering $50 billion valuation, Goldman at once delayed a Facebook public offering (now expected in 2012), prompted a likely LinkedIn IPO, and thrilled its clients, who clamored for a piece of Mark Zuckerberg's behemoth.
But for all the nostalgia for pre-IPO "friends and family" stock in Pets.com, the dot-com era comparisons are off base. Instead, Goldman's Facebook deal mirrors the subprime collateralized debt obligation deals that blew up entire companies, as well as crater-size hole in our economy. In fact, what Goldman just engineered might well be worse.
Let me explain. When I joined Goldman as a Managing Director in early 2000, right after the dot-com bubble burst, the hot new profit area was credit derivatives and CDOs. In fact, one of my jobs was managing a team that worked on the analytics of that business. At the time, CDOs were mostly stuffed with relatively solid high yield corporate loans and bonds, and sometimes credit default swaps.
I left the firm, and banking business, in 2002, before they began recklessly stuffing subprime assets into that pipeline. No matter, as the game remained the same: get the business, rake in the fees—and pawn off the overpriced goods on the clients (even the “shitty deals” so Goldman’s not holding the bag. That dirty formula cost Goldman a $550 million fine less than six months ago.
Yet the Facebook phenomenon shows us that nothing has changed. Goldman again moved aggressively to get the business—investing $75 million into Facebook early, at a low valuation, through one of its hedge funds, in the same way it used to get CDOs rolling—again will rake in the fees (to the tune of $60 million—upfront) and again will pawn off the overvalued results to its clamoring clients, who don't have nearly as much information as Goldman.
If you're one of those investors, here's the deal in a nutshell: You get to buy shares, forking over 5 percent of any possible gains, on top of a 4 percent placement fee and a 0.5 percent expense reserve fee (so you're down 10 percent before the game starts) in a private company that doesn't have to disclose any pertinent financial information to you or any regulator for 15 months. For the privilege, Goldman gets its eight-digit windfall.
Forget their fees for a moment, though. Recall that what killed the CDO market, aside from the crappy deals, crappy collateral and overall shadiness: lack of liquidity. Investors stopped buying CDO pieces, and trading desks stopped making markets in them. Game over. That's why this deal, albeit in something with more potential than a basket of subprime assets, is worse than a CDO: Investor illiquidity begins on day one. The rich Goldman clients who must pony up a minimum $2 million investment aren't allowed out until 2013. No exceptions. Ditto Facebook employees (although they were allowed to cash out about $100 million last year). But Goldman is. Whenever it wants "without notice to the fund or investors in the fund."
CDOs were private, unregulated, overvalued, disclosure-lite, fee-intensive deals. The Facebook deal is private, unregulated, overvalued, disclosure-lite, and fee intensive. CDOs sold like mad— until they didn't. That can happen here. At the end of the holding period, there may be no bid for Facebook shares anywhere near the price paid. Plus, by that time all the enthusiastic global users of Facebook may have dropped it for thenextgreatfad.com taking the advertiser money along with them.
The Facebook deal sucks so badly that one of Goldman Sachs' own funds didn't want a single share of it. Richard Friedman, who runs the money for past and present Goldman partners, among others, said, thanks, but no thanks. That should tell everyone something.
But for investors, just like with the CDO business, the Facebook deal has an important "sellability" factor and high-profile support—a.k.a. Goldman's. Formidable support begets higher initial evaluations. The CDO pitch: House prices will always go up, and thus subprime CDOs will always hold value. The Facebook pitch: Social-media revenue will, so social-media websites will always hold value.
Goldman does seem to have learned one lesson. One of the problems brought up by the Abacus CDO deal that prompted the $550 million fine was the idea that Goldman was helping one client short the deal against another client. To avoid another uncomfortable SEC incident, and the nuisance of public scrutiny, they've put the sell possibility right out front: a disclaimer allowing them to dump their shares, or perhaps short them, at any point. Which is extra convenient, since Goldman is privy to far more information about Facebook than the people they would sell them to: insider trading in the public markets—upfront and legal here.
At that point, Goldman could bank more fees by offering its shares to everyone that couldn't get into the deal during the first oversubscribed round. The firm is even creating a new private-equity fund, Goldman Sachs Partners Private Opportunities Fund, where investors can buy into Facebook, and Goldman will extract a different fee—a straight hedge-fund fee of 1.5 percent of invested capital and 20 percent of profits above 8 percent.
So while Facebook and CDOs would seem to have nothing in common, they share that magic Goldman intangible: timing. During the height of the subprime and toxic-asset crisis, Goldman, even better than its competitors, timed when to invest with or against clients, what to hold on its books, and when to fold. It's doing it again. And no one seems to have learned anything from either of the last two busts.
SEC Investigating Calpers on DIsclosures
by Mary Williams Walsh and Louise Story - New York Times
Federal regulators are investigating whether California violated securities laws and failed to provide adequate disclosure about its giant public pension fund, according to a person with knowledge of the investigation.
The Securities and Exchange Commission normally polices companies, but last year it brought its first enforcement action ever against a state, accusing New Jersey of securities fraud for misleading bond investors about the condition of its pension fund. The commission signaled, in its settlement with New Jersey, that it was going to look more broadly at the pension disclosures of states and cities.
The fund, the California Public Employees’ Retirement System, known as Calpers, lost about a quarter of its total investment portfolio during the financial crisis, leaving the state responsible for replacing billions of dollars each year and contributing to its huge deficit. The question is whether California adequately disclosed in the preceding years how risky the pension investments were and how much money it might need to cover any shortfall.
But it is unclear whether investigators are focusing on those risks or on possible conflicts of interest in steering investments to related parties, the subject of a separate investigation by the attorney general of California.
S.E.C. officials declined to confirm an investigation, citing agency rules. But the person with knowledge of the investigation said it was among the agency’s top priorities. A spokeswoman for Calpers, which is America’s largest pension fund with assets of about $220 billion, said it had not been contacted by the S.E.C. about its accounting or about financial disclosures. “The SEC has an ongoing look at pension funds in California” because of revelations about the use of placement agents who recommended investment managers, said Patricia Macht, a spokeswoman for Calpers.
Along with concerns about the use of placement agents, regulators have grown increasingly concerned about whether states may have hidden financial weaknesses, particularly in their pension portfolios, and whether investors who buy municipal bonds can fully appreciate the risks. A spokesman for the California state treasurer’s office, which is responsible for disclosures to bondholders, said “we provided all material information about pension fund issues at all times.”
California has not defaulted on any debts and says its bonds are safe. But the state has been grappling with big, structural budget deficits every year, and cannot easily increase revenue because of voter-approved tax caps. The state’s credit has been downgraded as these financial problems have intensified, and the downgrades have in turn lowered its bonds’ value. Had investors been able to clearly see the pension risks, they might have steered clear of California’s debt or demanded a higher yield.
If federal investigators are able to make a case that California misled investors about the risk in its pension fund, it would send a powerful signal to other public funds, which almost without exception base their financial reporting on average annual investment returns of about 8 percent a year, something hard to defend in today’s markets, no matter what the investment mix.
The S.E.C.’s goal is to force public pension funds to be more open, not just about their investments but about how their risk may affect the finances of the state. It is unlikely that the S.E.C. would impose any penalty because that would force taxpayers to pay for wrongs they knew nothing about. In the New Jersey case, the S.E.C. imposed no penalty but publicized the case in hopes it would be a deterrent.
Any accusation of securities fraud could take years because public finance is a new area for the S.E.C. and any case would rely on novel legal theories. It would be a blow to Calpers, which has used its institutional clout for years to promote good corporate governance and truth in accounting. Calpers has recently pushed for boardroom reforms at JPMorgan Chase, Goldman Sachs, Apple, and BP, among others. And it has sued Moody’s, Fitch and Standard & Poor’s, accusing them of giving “untrue, inaccurate and unjustifiably high” ratings to structured investment vehicles that failed in the mortgage collapse.
Its activism has served as a role model for smaller public pension funds that have also had losses, but might not have been able to challenge corporate governance practices on their own. But now the tables have turned, because S.E.C. investigators hope to use Calpers as an example in a case about of how misleading pension disclosures can amount to securities fraud, according to the person with knowledge of the investigation. Like most public plans, Calpers has maintained that its accounting methods are appropriate and that it is in full compliance.
Calpers has lately been under fire for a big benefit increase in 1999. At that time the fund ran various assumptions on how its investments might do. It discussed them in a public meeting but the state did not put them into its bond prospectus, which was the responsibility of the state treasurer, then Phil Angelides, who also sat on the board of Calpers.
In the years after that, Calpers stepped up its investments in real estate, riding the market up and then crashing when the housing bubble burst. The worst case, created by Calpers’ staff, turned out to be oddly prescient. It said the state might have to come up with $3.95 billion a year in fresh money for the pension fund by the end of 2010. In fact, the state has to contribute $3.88 billion. Mr. Angelides, now chairman of the Financial Crisis Inquiry Commission, was not available to comment Thursday because the commission was finishing its report.
David Crane, an aide to then Gov. Arnold Schwarzenegger, said last year in legislative testimony that he found it “nothing short of astonishing” that Calpers had “promoted the largest nonvoter-approved debt issuance in California history” without revealing the risks or conflicts of interest involved.
“Frankly, I’ve never seen anything like the Calpers sales document, which makes even Goldman Sachs’s alleged nondisclosure look like child’s play,” said Mr. Crane, who testified at a time when the S.E.C. was suing Goldman Sachs over alleged disclosure violations in connection with mortgage-backed securities.
When (derivatives) counterparties collapse
by Tracy Alloway - FT Alphaville
Lehman Brothers — not just the catalyst of the recent financial crisis, but also the reason for a helluvalot of legal wrangling, notably in the heady sphere of derivatives. In fact, just before FT Alphaville left for Christmas, an interesting case covering a vital piece of derivatives documentation made its way through the English courts. Now that we’ve had time to digest it (and our Christmas cookies) we’d like to share.
So lie back and think of swaps — vanilla and more complex. Or better yet — lie back and think of counterparty risk management.
Before the Lehman-spurred crisis, most risk management seemed focused on things like hedge funds. Now though, we have a cast of counterparty monsters that include everything from monoline insurers to banks like Lehman and even (gulp) sovereigns. Focus, for now, though, on Lehman.
Vanilla swaps are governed by the Isda Master Agreement — which is basically the bible of the derivatives industry. Not only does it enable you to trade with the big boys of Wall Street, but it also governs the way you’re meant to do it. According to the Isda Master then, when one counterparty to a swap defaults (à la Lehman) the non-defaulting party can opt to close out the swap at fair value. Such close-outs are even allowed under the safe harbour provisions of strict US bankruptcy laws (instead of automatic stay). However, the rights to close out under safe harbour provisions have to be exercised within a “reasonable period of time” — something we learned in the 2009 Lehman vs Metavante Technologies case.
Back over to the English courts for now though and the question of what happens when the non-defaulting party elects not to close out the swap. Section 2(a)(iii) in the Isda Master says that payment obligations are subject to the “condition precedent that no Event of Default or Potential Event of Default with respect to the other party has occurred and is continuing”. That’s legal speak for payment obligations are dependent upon a counterparty not being in default. So can a non-defaulting counterparty not only elect to not close out, but also to suspend making payments? Or, the equivalent of having your (vanilla swap) cake and eating it too?
We want you to meet JFB Firth Rixson Inc, FR Acquisitions Corp (Europe) Ltd, BEIG Midco Ltd and KP Germany Zweite GmbH — four companies that opted to not only not close out their interest rate swaps with Lehman Bros after its bankruptcy, but also stopped making payments. In 2010 the swaps were out-of-the-money for the companies (or, in the money to Lehman) to the tune of about £60m. Unsurprisingly, the Lehman estate challenged their decision in the English courts.
The court decision (in a nutshell) ruled in favour of the companies — non-defaulting counterparties could indeed choose not to close out swaps and suspend making payments after their other counterparty defaults. BUT those counterparties would have to make good on those payments if the default were ever cured. There’s a whole host of English anti-deprivation law (which basically seeks to protect assets that would otherwise benefit the creditors of an insolvent estate) to go along with the ruling. Essentially though, Lehman lost, and companies won.
What though of the Isda Master Agreement? According to Clifford Chance (which represented BEIG Midco Ltd) the court ruling was effectively a win for the Isda Master — it meant the document “does what it says on the tin.” It’s worth noting though, that questions over more complex swaps are still hovering in the background. For instance, we can expect another dose of anti-deprivation debate when the UK Supreme Court considers flip clauses this March. The Lehman estate also still has the option to appeal against some of the court’s decisions in this swap ruling (including those on anti-deprivation).
Not to mention what’s going on across the Atlantic. We name-checked Metavante earlier for a reason. A US bankruptcy court ruled in September 2009 that the company fell outside of safe harbour provisions because they didn’t close out their swaps within a “reasonable period of time;” Metavante was still obligated to pay. Meanwhile Section 2(a)(iii) became far less relevant for swaps with US-based dealers.
So for the moment, we have a bizarre situation where counterparty risk is still (attempting to be?) dealt with by what’s meant to be coordinated regulation (viz the Isda Master doc) but there remain major splits between the two sides of the Atlantic in the way the regulations/provisions/sections etc. are legally enforced.
Go long lawyers.
Fed Moves To Gut Predatory Lending Regulation
by Zach Carter - Huffington Post
The Federal Reserve is pushing a new mortgage regulation that would effectively eliminate the most powerful federal remedy for predatory lending. The regulation would severely limit a practice called "rescission," used to strike down demonstrably-illegal or fraudulent loan contracts and void a bank's ill-gotten gains from such predatory lending practices. When a mortgage borrower wins a rescission case in court, the bank loses the right to foreclose, and has to give up all profits from interest and fees on the loan. The borrower still has to repay the principal -- the original amount of money extended by the bank -- but can't be kicked out of the house.
Under the Fed's new proposal, however, borrowers would be required to pay off the balance of the loan before the bank loses its right to foreclose -- that means borrowers could still lose their homes, even in cases where banks have broken the law. Unsurprisingly, banks support the move, but consumer advocates say this would essentially make rescission worthless to borrowers.
"The ... proposal would eviscerate the single most effective tool that homeowners have to stop foreclosures and avoid predatory loans," reads a letter penned by Margot Saunders of the National Consumer Law Center and signed by 16 national public interest groups, along with 33 state housing and legal aid groups and 144 individual attorneys. "Passage of the proposed rule will considerably exacerbate foreclosure statistics in this nation."
Six Democratic senators, led by Sherrod Brown of Ohio, also urged the Fed to reconsider its rule in a Monday letter. "In this time of record foreclosures and reports of systemic problems with the operations of the largest mortgage servicers, the proposed revisions are unfortunate and unnecessary," the letter reads. "The mortgage market needs greater oversight and accountability to restore borrower confidence lost in the mortgage crisis. The proposed rules would undermine this goal." The signatories included outgoing Senate Banking Chairman Chris Dodd (Conn.), incoming Chairman Tim Johnson (S.D.), and Sens. Jack Reed (R.I.), Daniel Akaka (Hawaii) and Jeff Merkley (Ore.).
The controversy comes as the U.S. mortgage market enters one of the bleakest years in its history. Foreclosures continue at a record pace, slowed only briefly by recent concerns that borrowers were being improperly evicted due to bank errors. At the end of September, nearly 1 million homes were in foreclosure, according to data collected by the foreclosure analyst RealtyTrac. According to the Center for Responsible Lending, 2.5 million homes were lost to foreclosure between January 2007 and the end of 2009, and another 5.7 million stand in "imminent" danger of foreclosure today.
"There are thousands of rescission cases in hundreds of courtrooms all across the country," Center for Responsible Lending spokeswoman Kathleen Day said. "Rescission is a main tool for fighting foreclosures." The proposed change is part of a larger package of rules the Fed hopes to adopt, several of which appear designed to protect the public from shady financial hucksters.
But while consumer groups are enthusiastic about some of the possible new regulations, they are so worried by the rescission changes that they are asking the Fed to withdraw the whole package. If winning a predatory lending case still means losing their home and owing hundreds of thousands of dollars to the bank that ruined them, they say, many consumers would prefer not to fight.
Dozens of other consumer advocacy organizations and concerned citizens have also sent the Fed comments on new rules. Many of the comments from individuals were more colorful than the letter penned by Saunders. All Fed regulations are open to public comment from anyone, but it is unusual to see a high volume of individuals weigh in on a technical consumer protection rule. "I view this as nothing less than a criminal ploy to shove hard working Americans out of their homes and onto the streets," wrote Ann Capotosto in an undated comment letter. "It is immoral and must be stopped."
"Think of mankind for once, please," requested Larissa Cavanaugh in a Dec. 4 letter. "Have you lost your minds?" inquired Beth Findsen in another letter from Dec. 4. "In the depths of an unprecedented catastrophe for the middle class, related to the predatory loans and their rapacious securitization by the financial industry, resulting in millions of middle class Americans losing all of their wealth and their homes, you want to loosen TILA? Are you tone deaf? Have you lost your humanity entirely?"
Ron Paul: "The U.S. Government Must Admit It Is Bankrupt"
by Tyler Durden - Zero Hedge
Any time you bring the two Pauls together in an interview, and start discussing items such as the debt ceiling, government spending, and monetary policy you know the results will be good. Sure enough, in this rare ABC interview with father and son, the sparks fly, and among the topic touched is the most popular story on Zero Hedge from yesterday, namely President Obama fabulous hypocrisy, who after bashing the debt ceiling as a senator 4 years ago, has bet the outcome of his entire economic policy on maxing out every single credit card available to him.
Paul's response: "we have to face the fact that we are bankrupt and we can't pay our bills." Not exactly the kind of thing one wants to hear if one's name is Hu Jintao. That said you know the Paul-led interrogation of Bernanke will be something else, even if it is ultimately totally fruitless.
China’s monetary tightening will be felt around the globe
by Henny Sender - Financial Times
Jung An Credit Co provides funds to small businesses both around its Shenzhen headquarters and elsewhere in China — but only when it can receive money from the Chinese banks since it itself doesn’t have deposits to recycle. In recent months, it has had to turn away as many as half its potential borrowers for lack of funds.
Meanwhile, 1,300 kilometres and a world away, in Shanghai, International Far Eastern Leasing, one of the biggest non-banks in China, has commitments from banks that amount to twice its balance sheet and has no problem helping its customers finance purchases of everything from MRI scanning machines to printing presses.
China has been veering away from the easy money policies that it embraced in the wake of the global financial crisis for months. With inflation more than 5 per cent, especially for politically sensitive foodstuffs and property, dealing with rising prices has become top priority in Beijing. So far, the effects have been uneven as the varying circumstances of Jung An and Far Eastern suggest.
Meanwhile, parsing lending data and other indicators of monetary policy has become a global pastime. The extent to which China will embrace tightening in earnest today has consequences that resonate far beyond China itself, influencing growth and the price of commodities everywhere. If lending growth continues at a rapid pace, it could reinforce fears of overheating, wasteful investment and a new round of non-performing loans. But if growth slows down too sharply, all over the world prices for everything from gold to pork could drop and factories and ports fall silent as orders from previously voracious customers in China fall.
Banking regulators have recently said that they won’t adopt explicit lending targets for the year. The central bank, the People’s Bank of China, has already raised interest rates twice recently and hiked the amount of money Chinese banks have to leave on deposit with it six times in 2010. But real interest rates remain negative. Last year, the Chinese banks lent a total of about Rmb7,500bn.
In December, Fitch came out with a report that suggested credit flows in China are as high this year as last — they are just less visible. “Lending has not moderated, it has merely found other channels,” the Fitch report states. Fitch said banks were evading stricter lending quotas by securitising loans, selling them to trust companies and then going out and booking more loans. The timing of the Fitch report is particularly sensitive since the market is already spooked by the inflation numbers and the prospect of further monetary tightening.
For the first 11 months of 2010, official new loan creation amounted to some Rmb7,460bn, according to figures from JPMorgan, confirming the Fitch report. Yet, at the same time, the real economy is showing signs of cooling, suggesting that there has been some effect of the regulators’ efforts to move to at least a more neutral money policy. For example, the favorite indicator of Morgan Stanley’s China strategist Jerry Lou is airline bookings, which he says points to a drastic slowing. Others see signs that the property market and areas of heavy investment, such as steel, are cooling as well. Moreover, interbank rates have jumped.
So today China faces two challenges. It must drain excess liquidity which has fuelled unacceptably speedy rises in property prices and overinvestment in sectors such as steel. But it must also try to change the allocation of capital. In the past, the large state-owned enterprises could always count on their bankers to channel funds to them. But today, the structure of the economy is changing. Small and medium-sized enterprises account for more than 60 per cent of economic activity.
Yet in the good times when money flows generously, they still get only 30 per cent of the financing. And when times are bad, they are the first to get cut off — with the smallest being the most vulnerable. That means the modest clients of Jung An can’t get money to support their small business operations, providing bottled water to small chain stores, or operating small spas or printing operations.
Chinese officials are constantly calling on the United States to act responsibly as printers of the world’s reserve currency. At the same time, the world might say to China that what it does will increasingly have global consequences as well. For years, capital in China has arguably been too cheap because of imposed limits on rates and a high savings rate. Indeed, the world has become hooked on cheap capital on both sides of the Pacific.
In recent years, China has done an impressive job in supporting growth without generating excessive inflation. And China is immeasurably stronger than in the mid-nineties when inflation was in double digits and there was far less quality to its economic growth. Back then, it hardly mattered beyond China’s borders. This time, it is a different matter.
China Buys More EU Debt
by Owen Fletcher - Wall Street Journal
China has been increasing its holdings of European Union countries' debt, including Spanish government debt, since the outbreak of the European sovereign debt crisis, Chinese Vice Commerce Minister Gao Hucheng said in a statement. China's latest comments of reassurance for Spain and other European countries amid the euro-zone crisis come as political and corporate leaders increasingly see China as a source of capital. China's foreign-exchange reserves are by far the world's largest, totaling $2.648 trillion at the end of September.
China maintains confidence in European and Spanish financial markets and believes they will overcome the current crisis, Mr. Gao said in the statement on the Ministry of Commerce's website Thursday. "We will continue to buy debt and work together with Spain," said Mr. Gao, who is accompanying Chinese Vice Premier Li Keqiang on a visit to Spain and other European countries.
The exact amount of bonds China buys "depends on the timing and volume of issuances by the Spanish government, as well as the bonds' prices in the primary and secondary markets," Mr. Gao said. Spanish daily El Pais on Thursday cited Spanish government sources as saying China has committed to buy about €6 billion ($7.89 billion) worth of Spanish sovereign debt. The report couldn't be immediately confirmed.
People's Bank of China Vice Governor Yi Gang, also in Spain, said China is willing to discuss with Europe the diversification of international reserve currencies, the state-run Xinhua News Agency reported. It is also willing to discuss with Europe the formation of a stable reserve currency system in which the supply and total quantity of reserve currency are orderly and controllable, Mr. Yi said. The report didn't elaborate on the comment. China is keen to diversify more of its foreign-exchange reserves away from U.S. dollar-denominated assets.
"Reserve managers around the world are looking to buy assets in currencies that are new to them, like the South Korean won and the Australian dollar," said Neil Mellor, a currencies analyst at Bank of New York Mellon in London. "The problem is that there are very few markets deep enough to take the amounts that China wants to dump."
Mr. Yi reiterated that China will adopt a "prudent" monetary policy to allow China's monetary conditions to return to normal levels, Xinhua said. China will also continue to improve the yuan's exchange-rate formation mechanism and will steadily promote market-oriented interest rate overhauls, he said. Among key economic issues currently are how China can use macroeconomic policies to address inflationary pressures, and unconventional monetary policy measures adopted by the European Central Bank, Mr. Yi said.
The PBOC official added that Chinese and European financial institutions can strengthen cooperation in areas including increasing capital strength and improving the risk-sharing system, and should explore developing financial instruments and hedging devices that meet the needs of the Chinese and European markets, Xinhua reported.
China Land Sales up 70% in 2010
by Esther Fung - Wall Street Journal
China's land sales rose 70% in 2010, Minister of Land and Resources Xu Shaoshi said Friday, raising expectations that the government would intensify efforts to curb rising property prices. Property developers paid 2.7 trillion yuan ($407 billion) worth of land for residential and commercial property development last year, up from the 1.59 trillion yuan recorded in 2009, when land sales rose 63% on-year.
"Urban development has become more dependant on land transactions, resulting in an uneven allocation of benefits and social discontent, hence there is a need to reform the land transaction process," Mr. Xu said in a webcast of the ministry's annual working conference. In the first three quarters of 2010, Xu said land supply increased during the first three quarters of 2010 and the land prices were steady. However, in the last quarter, both the land prices and supply rose, posing challenges to the government's property-control policy.
China will further reform its land auction process and strengthen tightening measures targeting land use, the minister added. Mr. Xu didn't elaborate on what changes may be made to the auction process. He reiterated that the ministry will increase its supervision of land usage, and pledged to end land hoarding and publish information about illegal behaviour by property developers.
Land auction prices in several cities have hit record highs in recent weeks, and many analysts and homebuyers see the auctions as a major factor in the country's high property prices. Mr. Xu reiterated the ministry's commitment to allocating 70% of the residential land supply to the development of subsidized public apartments and small- and medium-sized homes, and to ensuring adequate land for the construction of 10 million affordable homes this year.
China implemented a series of tightening measures last year, including limiting households' home purchases and hiking interest rates, to prevent overly high prices. However, officials have said recently the measures haven't been implemented well enough and property price movements have yet to meet their expectations.
Portuguese borrowing costs hit record
by Jill Treanor - Guardian
Portugal bore the brunt of concerns about the eurozone today when its borrowing costs shot to record levels ahead of a bond auction next week and amid uncertainty over EU plans to avoid future bank bailouts by taxpayers. The yield – or interest rate – on its 10-year bonds rose through 7.1%, knocking share prices in Lisbon and raising fresh fears about the health of the country's banks.
Planned sales of Portuguese government bonds next week will be closely scrutinised for the interest rate that investors demand to buy the bonds. If this spikes sharply, it could provoke concerns that Portugal will find it increasingly difficult to raise funds on the financial markets. The Swiss National Bank confirmed it had stopped accepting Portuguese government securities as collateral. Irish bonds have also been taken off its list of acceptable instruments that can be exchanged for fresh funds.
While Portugal was centre stage, bond yields for other governments also rose while the cost of insuring a basket of European government bonds was also higher. An indicator used to measure anxiety about the strength of European banks, the Markit iTraxx Senior Financials index, rose towards levels last seen in March 2009.
The cost of insuring individual banks was up as well, including Spain's Santander, as investors digestednew proposals from Brussels that would force bondholders to accept losses if a bank ran into difficulty. As most banks were rescued by the taxpayer rather than becoming insolvent, bondholders have not suffered the losses incurred by shareholders but the EU wants to ensure this can happen in the future to avoid taxpayer bailouts.
But there are now concerns that bond investors will demand higher interest rates from banks when they issue bonds which, in turn, could increase the cost of borrowing for bank customers looking for mortgages or other loans. Ireland, which has accepted an €85bn (£72bn) bailout, is keen to return to the financial markets to raise funds, the National Treasury Management Agency stressed today. But the country's borrowing costs stand at more than 9%, which is regarded as prohibitively high.
Germany and France want Portugal to accept bailout
by Brian Rohan - Reuters
Germany and France want Portugal to accept an international bailout as soon as possible in order to prevent its debt crisis spreading to other countries, German magazine Der Spiegel reported on Saturday. Without citing its sources, the magazine said government experts from both European heavyweights were concerned Lisbon will soon not be able to finance its debt at reasonable rates, after its borrowing costs rose at the end of last year.
Berlin and Paris also want euro zone countries to publicly commit to do whatever it takes to protect the bloc's single currency, including topping up a 750 billion euro ($968 billion) rescue fund if necessary. Portugal is viewed by many economists as the peripheral euro zone country that is most likely to follow Ireland and Greece to seek an international bailout as it grapples to cut its debts and borrowing costs. It holds its first bond auction of the year next week.
Bubbles Galore Will Make 2011 Year to Remember
by William Pesek - Bloomberg
Welcome to the year of the bubble.
It may seem an odd assertion at a time when many key economies are in, or on the verge of, recession. Yet near-zero interest rates in Washington, Tokyo and Frankfurt have a way of wreaking havoc with markets and human psychology. It’s not a reach to say we have a bubble in bubbles. The forces that will make for an interesting 2011 go beyond monetary policies. A variety of market-shaking bubbles might inflate before our eyes -- some in asset markets, others in flawed perceptions. Here are eight.
No. 1. Hot money. It’s terrific that the MSCI AC Asia Pacific Index jumped 14 percent last year, far outpacing MSCI’s broader indexes. It would be better, though, if the gains had more to do with fundamentals and less with ultra-low rates.
The Bank of Japan’s largess has long seeped overseas to boost stock, bond and property prices near and far. The so- called yen-carry trade -- borrowing cheaply in yen and using the funds for riskier bets overseas -- was the forerunner of a similar dollar trade. Federal Reserve policies sent tidal waves of liquidity toward Asia in 2010. It could reach disastrous proportions, leaving a trail of ruin in its wake.
No. 2. Decoupling theory. The bubble here is the unsustainable belief that Asia can grow rapidly no matter what happens among the biggest economies. Don’t bet on it. It’s great that China is growing 9.6 percent and that India is zooming along at 8.9 percent.
Nothing, though, would serve Asia better than a rebound in growth in the U.S., euro zone, Japan and the U.K, which combined make up $34 trillion in annual output. Asia has done a stellar job staying afloat since Wall Street’s collapse in 2008. Developing economies may be able to live for a couple of years without the majors. Good luck keeping up that performance in the year ahead.
No. 3. Food prices. A Jan. 3 Times of India headline raised a question in many an Asian mind: “Can government do nothing legally to check prices?” The answer is, Not much.
The United Nations’ Food and Agriculture Organization predicts that the global cost of importing foodstuffs totaled $1.026 trillion in 2010, compared with $893 billion in 2009. We haven’t seen anything yet. Imbalances in supply and demand and regional trade rigidities will accelerate the trend, swamping developing nations with the most basic of problems: Filling the bellies of those powering their economic rise.
No. 4. Income inequality. Surging prices of everything from food to transportation pushed Indonesian inflation to a 20-month high in December. The trajectory of everyday prices is a fast- developing setback to Asia’s efforts to narrow its gaping rich- poor divide.
Rising costs for cooking-oil, rice and fish may mean little to the average Goldman Sachs Group Inc. staffer. To a family living on $3 a day and already spending two-thirds of income on food, they are devastating. Rising wealth disparities could foreshadow a year of tensions, as failed harvests and inflation cause famines, riots, hoarding and trade wars worldwide. The bubble here would be one in human suffering.
No. 5. Wacky weather. Australia’s experience tells the story. A few months ago, drought was imperiling its economic outlook. Today floods that some are characterizing as “biblical” have economists calculating the implications for commodity prices.
Forget temperatures and focus on the increasing frequency of freaky weather patterns from Miami to Mumbai. Now, economist Dennis Gartman, who writes a Suffolk, Virginia-based newsletter, says investors should sell the Australian dollar against the euro as flooding threatens exports of coal and wheat. Funny how it takes Mother Nature to make anyone bullish on the euro.
No. 6. Currency reserves. Why any economy needs $2.7 trillion of them is beyond me. And it’s not just China that is trapped into adding to its currency stockpile to keep its existing holdings from losing value. Japan has more than $1 trillion, while Taiwan, South Korea, Hong Kong, Singapore and Thailand have a combined $1.3 trillion. Talk about an unproductive use of wealth -- and a risk that’s growing by the day with no easy fix in sight.
No. 7. Geopolitical risks. Leave it to Kim Jong-Il to remind investors that the biggest surprises aren’t coming from economic or corporate reports, but rogue regimes like Kim’s in North Korea. Expect Pyongyang’s provocations to increase exponentially in frequency and seriousness.
Also expect a bull market in territorial disputes. Faced with growing uncertainty, governments are desperate to placate the masses. The desire to unify the home population may lead to growing rifts between neighbors. Those seeking shelter from these brewing storms explains why gold is almost $1,400 an ounce.
No. 8. Group of 20. Any optimism that European officials can avert disaster might be seen as irrational. The same goes for the belief that China can grow about 10 percent annually forever or that Japan’s leaders can defeat deflation. The real perceptions bubble is that a disparate grouping of 20 nations can tame out-of-whack markets and imbalances that were decades in the making. The year ahead might turn any, or all, of these accepted wisdoms on their head.
In Black America, The Depression Rolls On
by Peter S. Goodman - Huffington Post
The latest snapshot of the American job market, released by the Labor Department on Friday, confirms what most ordinary people already knew without need of a government report: Little is improving quickly or broadly enough to dislodge the anxiety that has taken up long-term residence in many communities. The unemployment rate fell to 9.4 percent in December, from 9.8 percent the month prior. But that had little to do with people actually finding work, and much to do with the jobless simply giving up and halting their searches, dropping out of the statistical pool known as the labor force.
A deeper dive past the headline numbers reveals a reality that ought to trigger national alarm but hasn't for the simple reason that it is already embedded in the country we have unfortunately become: the Divided States of America. Among white people, the unemployment rate dropped in December to 8.5 percent -- hardly acceptable, but manageable were the government spending more to expand a fraying social safety net and generate jobs. For black Americans, the unemployment rate was 15.8 percent.
Professional economists will not pause for an instant at those figures. It is a truism that the black unemployment rate generally runs double the white one, and yet when did that become acceptable? How can there be so little discussion about a full-blown epidemic of joblessness in the African-American community, as if the commonplace incidence of despair -- and, more recently, reversed progress -- somehow amounts to old news?
"Can you imagine any other group at that level of unemployment and the media dismissing it as not important?" the Rev. Jesse Jackson asked during an interview this week. He described deteriorating inner-city, predominantly-black communities in Chicago and Detroit. In New York, a recent study found that more than one-third of African-American men aged 16 to 24 were unemployed between early 2009 and the middle of last year.
"These are the same areas that were targeted for foreclosure by the banks, through reverse redlining," Jackson said, referring to the way subprime lending operations preyed with particular dispatch on minority communities. "These are the same areas that have less access to transportation, which makes it nearly impossible to get to where the jobs are. You are structurally locked out of economic participation and growth."
The picture becomes more vivid still using a broader Labor Department measure known as underemployment, which counts jobless people along with those who are working part-time for lack of full-time work, or who have given up looking for work but are eager for jobs. Among African-Americans, the underemployment rate was running just under 25 percent late last year, according to an analysis of government data by the Economic Policy Institute in Washington. That compared to a rate of about 15 percent for white Americans.
Nearly 15 years have passed since the publication of "When Work Disappears," a masterful book by sociologist William Julius Wilson describing in compelling detail the impact on working class African-American neighborhoods suffering large job losses: in a word, disintegration. Little has changed since then except for an acceleration of the slide. There is no magic bullet for urban strife in poor communities, but if you had to pick one thing that can fix a great deal in one shot, a paycheck is as good as it gets, as Wilson's book makes clear.
A job is a source of pride, a reason to get out of bed, an imperative to take care of one's health, and -- if the economy is functioning properly -- a justification to keep going and strive for better. A job is reason to steer clear of drugs and alcohol, and an alternative to the risk of earning money through crime. A job allows households to function, keeping families together, and proving children with the support they need.
When jobs disappear so, too, do these sources of social cohesion, these motives to avoid trouble, these reasons for navigating the commonplace difficulties of any human day. Anger builds, which can lead to violence. Economic necessity motivates people to look for creative ways to earn money, sometimes taking them outside the law. Wilson convincingly argues that morally loaded, often-racist depictions of inner-city black poverty have tended to distract many Americans from the single greatest factor behind the troubles that have claimed once-vigorous communities -- the steady bleeding of decent paychecks.
When Wilson's book was published back in 1996, the black unemployment rate sat at just above 10 percent. By 2000, with the American economy in the midst of a historic boom, it had dropped to 7 percent. But by early last year -- following eight years of lean job creation and then two years of the worst recession in a half-century -- the black unemployment rate exceeded 16 percent, or 1 in 6.
Drill deeper into the Labor Department data, and the numbers get more disturbing still. Among black men between the ages of 25 and 29, the unemployment rate was just under 21 percent in December. And that actually constituted an improvement from the 25.7 percent it reached in the spring of 2009, during the worst of the Great Recession. In short, over the last decade, most of black America has been effectively ensnared in an endless recession that became flat-out catastrophic when the rest of the county officially sunk into the downturn in the fall of 2007.
Even among black college graduates, the unemployment rate sat at just under 8 percent in December -- four times the rate in late 2006, back when the economy was still producing jobs. By contrast, the unemployment rate for white college graduates sat at 4.3 percent in December, roughly double the rate at the beginning of the recession.
It is difficult to absorb these numbers without coming to a simple conclusion: In black America, a veritable depression is still unfolding, tearing at communities that had previously seen substantial progress, turning first-time homeowners into foreclosure victims and transforming proud college graduates into bewildered jobless people, unclear why their hard work and education have failed to translate into the step up they were supposed to in the movie trailer version of the American dream.
And yet, the political system is busy with other things, such as how to blame union labor for local budget disasters -- caused by financial services companies that pay their executives seven- and eight-figure sums -- or how to cut the federal budget deficit by depriving people of health care. In Washington, the leadership of both parties seems stuck in the mode of trying to manufacture the illusion of a recovery -- via photo ops at factories and pontificating about spending cuts -- while doing little or nothing to bring a real recovery about.
Meanwhile, whole swaths of the economy are falling away, going uncounted in the monthly Labor Department surveys and little-regarded by politicians. In the calculus of American power, just as in the reports used by our economic experts to set policy, it's as if much of black America has simply ceased to exist.
Fannie, Freddie may rule mortgages to 2012 as treasury plan due
Treasury Secretary Timothy F. Geithner will report to Congress this month on how to rebuild the U.S. mortgage finance system amid a growing consensus that Fannie Mae and Freddie Mac won’t be dismantled anytime soon. Though Republicans have won a stronger hand in Congress, their push to end Fannie Mae and Freddie Mac’s dominance in the mortgage market is unlikely to succeed before the 2012 elections, lawmakers and analysts said.
While some lawmakers want to end all government mortgage guarantees, Geithner has indicated he may support a limited federal role in line with proposals being circulated by banking regulators, policy shops and business groups. What unites nearly all players is the view that the housing market is too fragile at the moment to function without Fannie Mae and Freddie Mac, which own or guarantee more than half of all U.S. home loans.
“If you could do it in one year, that would be great,” said Representative Randy Neugebauer, a Texas Republican who favors an incremental transition to a fully private system. “I don’t think you can do it in a year.” Neugebauer, who will chair the oversight and investigations panel of the House Financial Services Committee, said he was concerned about the potential damage from hasty legislation. “We have to do it in such a way that we don’t blindside the marketplace,” he said.
Until September 2008, Washington-based Fannie Mae and Freddie Mac of McLean, Va., were private companies backing home mortgages with an implicit government guarantee and large portfolios of mortgage-backed securities. Billions of dollars in losses stemming from subprime mortgages pushed them to the brink of collapse. The federal government placed them in conservatorship and took almost an 80 percent stake in both.
Firms with a financial stake in the housing market are paying close attention to the debate over the future of Fannie Mae and Freddie Mac. While lenders such as Wells Fargo & Co., Bank of America Corp., JP Morgan Chase & Co., and PHH Corp. are testing the waters for home loans without government guarantees, their role is small. The two government-supported firms, the Federal Housing Administration and other government agencies guarantee more than 96 percent of the U.S. mortgages now being written -- more than double what the government backed before the credit crisis. The two firms’ portfolios of loans and mortgages mushroomed to $4.77 trillion at the end of the third quarter from $463 billion three years earlier, according to company filings.
Price to Taxpayers
That has come at a price to the Treasury. Since the government seizure the firms have received more than $151 billion in aid, following $240 billion in losses, and have returned about $17 billion in dividends to the government. Republicans railed against Democrats for leaving the two government-supported firms out of last year’s overhaul of financial rules. Instead, the Dodd-Frank Act requires only that Geithner deliver a blueprint to Congress in January.
“Taxpayers are continually losing money on these failed enterprises, and at some point, we must say enough is enough,” Representative Scott Garrett, a New Jersey Republican, said last May during the debate over finance rules. Garrett, who sponsored legislation to phase out Fannie Mae and Freddie Mac, said he found it “mind-blowing” that Democrats delayed the discussion. Congress had no choice but to delay, said Martin Baily, former chairman of the Council of Economic Advisers under President Clinton and leader of a group organizing studies for a new housing-finance market at the Brookings Institution. “The truth is that Fannie Mae and Freddie Mac are all we have right now in the mortgage market,” Baily said.
As Treasury prepares its blueprint for the future, policymakers are examining outside proposals. Among them are plans outlined in a staff paper from the Federal Reserve Bank of New York; a report by the Washington-based Center for American Progress, a policy group; and a study by the Financial Services Roundtable’s Housing Policy Council. Each aims to bring more private capital into the mortgage market while providing an explicit government guarantee that would preserve investor confidence in mortgage-backed securities and support the continuation of the 30-year fixed-rate mortgage.
“A reasonable fraction of investors would not want to invest in the securities without that guarantee, and that could restrict credit in the mortgage market,” said Akiva Dickstein, a managing director in charge of mortgage portfolios at BlackRock Inc., which manages $3.45 trillion in assets. “That does seems to be the consensus, that the government role should be limited but that they should be the insurer of last resort,” he said.
The plans have some common elements. They would replace Fannie Mae and Freddie Mac with companies that would purchase standardized 30-year mortgages from loan originators and bundle them into a few types of securities. Those new firms, which would be tightly regulated, could be privately owned, mutually owned or cooperatives controlled by the mortgage originators. Unlike Fannie Mae and Freddie Mac, they wouldn’t maintain large investment portfolios. They would only purchase mortgages in which borrowers had made substantial down payments, perhaps 20 percent or more.
The down payments and the capital of the companies securitizing the mortgages would be two cushions against losses by investors in the bundled securities, as well as any private mortgage insurance borrowers might purchase. Another guarantee, provided by a federal agency, would kick in only after those cushions were exhausted, according to the plans.
“What we want is a federal backstop only on the mortgage- backed securities, not the agency issuing them,” said John Dalton, chairman of the housing policy council of the Financial Services Roundtable and former president of another government mortgage insurer, the Government National Mortgage Association, known as Ginnie Mae. Under the proposals the new federal agency would charge fees or premiums to build a reserve fund to cover losses, similar to how the Federal Deposit Insurance Corp. operates, and those costs would be passed to the borrowers.
“Those are all layers of protection that weren’t mandated in the past,” said Sarah Rosen Wartell, executive vice president of the Center for American Progress. “In that system you have put 95 percent of the risk on the private sector, in contrast to where we are today.” In addition, the companies securitizing mortgages would no longer have a responsibility to finance affordable housing for lower income families, as Fannie Mae and Freddie Mac were expected to do in return for their implicit government backing. The Fed paper suggested that could become the duty of the Federal Housing Administration.
Geithner, who has not publicly discussed the details of the plan Treasury is drafting, suggested the direction when he spoke in August to a conference on the future of housing finance. “I believe there is a strong case to be made for a carefully designed guarantee in a reformed system, with the objective of providing a measure of stability in access to mortgage finance, even in future economic downturns,” Geithner said. “The challenge is to make sure that any government guarantee is priced to cover the risk of losses, and is structured to minimize taxpayer exposure.”
Peter Wallison, a former general counsel at the Treasury Department and member of the Federal Crisis Inquiry Commission, denied there was any consensus on a role for government and said he was organizing Republicans to fight the idea. “There is no such thing as a ‘limited’ role if there’s a crisis, which we just saw,” he said. “Fannie Mae and Freddie Mac should be gradually reduced in size and importance by slowly reducing the upper limit on conforming mortgages.”
However the issue is decided, there is a consensus on the timing. “Nothing requires that Congress do anything before the 2012 election,” said Wallison. Wartell agreed. “I don’t think it’s likely we’ll have legislation in the next two years,” she said. “This is an evolutionary process.”
BP likely to face criminal charges
by Ed Crooks and Sylvia Pfeifer - Financial Times
BP is set to face criminal charges over last year’s oil spill in the Gulf of Mexico, US legal experts say, after the National Commission concluded this week that it was caused by “a failure of management”. Criminal charges could greatly increase the penalties facing BP and threaten staff with jail over the disaster.
BP’s shareholders were relieved that the commission, set up by President Barack Obama, in a chapter released in advance of its full report next week, did not provide clear evidence of “gross negligence”, which would result in higher civil penalties. But a criminal case requires a lower threshold of simple negligence and could result in penalties running into tens of billions of dollars.
David Uhlmann, of the University of Michigan, an ex-chief of the environmental crimes section of the US Department of Justice, said that if the assessment were right, a criminal prosecution seemed inevitable. “The only questions regarding criminal charges are when they will be brought, under which statutes, and whether individuals will be charged,” he said. Daniel Jacobs, a former DoJ official now at American University in Washington, warned that the commission’s conclusion of “systemic” failures in the oil industry and its regulators would not necessarily reduce BP’s liability.
Eric Holder, the attorney-general, announced last June that his department had launched a criminal investigation into BP. The DoJ said on Friday that its investigation was ongoing.
Under the Clean Water Act of 1972, one of the laws cited in the civil action against BP launched by the DoJ last month, companies face penalties of $1,100 per barrel spilt, or $4,300 per barrel if found to be grossly negligent. Government scientists have estimated that 4.9m barrels of oil came out of the well, although BP believes it was much less.
There is not much case law establishing the standard for a finding of gross negligence under the act, but it usually requires recklessness or a failure to exercise any concern for safety.
US legal experts generally believe the commission’s findings do not provide a conclusive case for finding BP grossly negligent; however, they do not rule it out. But as established in a case known as Hanousek, decided in the Supreme Court in 2000, a criminal prosecution requires only that the violation was caused by negligence.
A criminal prosecution would be kept separate from the civil action but can be launched while the civil action is under way. BP would not comment on the threat of criminal charges. It said the commission, like other inquiries, had concluded that “the accident was the result of multiple causes, involving multiple companies”.
Transocean, which also had a role on the Deepwater Horizon rig and has also been criticised by the commission, said: “The procedures being conducted in the final hours were crafted and directed by BP engineers and approved in advance by federal regulators. Based on the limited information made available to them, the Transocean crew took appropriate actions to gain control of the well.”
John Coffee, a professor at Columbia Law School, said one possibility would be for the DoJ to offer a “deferred prosecution agreement”, with BP accepting responsibility and a large fine without being convicted.