"Walkerville, Ontario, Rack warehouse, Hiram Walker & Sons"
Financial Threats to Power
This is part 2 of a series. Part 1, "The Math is Different at the Top", briefly discussed a simple paradigm that has governed human societies since at least the Industrial Revolution - the one which dictates that most major economic policies implemented throughout the world have benefited ever fewer and more centralized institutions of power. This straightforward logic accelerated greatly after World War II and the explosion of debt-dollar finance in the 1970s (elimination of gold standard), but was taken to its ridiculous extreme after the onset of the global financial crisis in 2007-08.
We were repeatedly told that major financial institutions were in "deep trouble" after the American sub-prime housing meltdown, yet these very institutions reported all-time record revenues and corresponding bonuses in 2009-2010, just one year after the global economy was on the brink of collapse. Meanwhile, wealth inequality in terms of incomes, financial worth and net worth has never been greater in the developed world. Regardless of whether this phenomenal transfer of wealth was a premeditated, coordinated effort by global financial elites, or a more "natural" result of financial evolution in a capitalist system, it is undeniable that the practical effects are the same - the rich get richer and more powerful while the poor get poorer and more desperate.
It is the latter fact that potentially poses a serious threat to the financial elites and their existing structures of power, as perhaps evidenced by the popular revolts throughout Africa and the Middle East, and to a lesser extent, the EU periphery and South Asia. This article will explore specific developments of the ongoing financial crisis from the perspective of financial elites, and their goals of maintaining the global structures of power that provide order. The financial crisis reflects a systemic, structural instability that may reverse the global trend towards increased socioeconomic complexity, which has always fed into and off of the concentration of wealth and power.
Complexity as a function of finance, therefore, is perhaps measured best by levels of global wealth inequality, and as mentioned before, these levels are still getting worse (more unequal). However, there comes a tipping point at which an overly-complex system begins to consume itself, as the peripheral networks and central hubs become less stable and less attached to the overall structure of the system. In this sense, the more damaging a crisis is to the ability of populations around the world to maintain their relative share of the global wealth pie, meager as it may be, the more difficult it will be for existing financial elites to maintain global complexity, order and control.
The bottom of this pyramid (~70% of world's adult population) primarily represents the poorest regions and countries of the world, where people have lived meager existences (by material Western standards) for so long now that they simply do not expect any better, which also means that they have minimal psychological attachment to shaky promises of financial prosperity. Many segments of Africa (>90% of continent's population), South Asia (>90% of India's population), Latin America and the Middle East fall into this category, and the latest financial crisis has sadly made the living situation worse for them, due to increases in food/energy costs largely fueled by speculative debt.
As discussed in Part I, it is unlikely that sociopolitical disruptions in these regions, chaotic as they may get, will significantly loosen the financial elites' grip on the levers of power, and could even serve to tighten it (i.e. justifications for U.S. military interventions in the Middle East to secure oil reserves). Indeed, such disruptions in these regions were, in the past, intentionally orchestrated by the elites during the latter half of the 20th century in order to extract crucial resources and political concessions. Furthermore, many of the countries in these regions were dominated or manufactured by European colonialism over centuries , and are therefore no strangers to systematic exploitation and oppression.
Notable exceptions to this "rule" may be Pakistan and India, as they both have nuclear arsenals and the latter is absolutely critical to the global telecommunications industry (these countries will be discussed more in Part III, in the context of short-term environmental crises). We must, then, turn our focus to the middle and upper segments of this pyramid, which represent 30% of the world's adult population. China contains a full third of the people in the middle segment ($10K-$100K), and its population has become increasingly dependent on stability in global financial markets.
An article from the Shanghai Daily News suggests that Chinese elites may actually be targeting a 30% reduction in real estate prices through higher interest rates, property taxes and more regulatory hurdles to purchasing property, in a "Thunder Attack" designed to deflate the Chinese housing bubble. . While this information does not qualify as much more than a speculative rumor at this point, it suggests that high-level Chinese officials, at the very least, are fully aware of the bubble and its inevitable implosion.
At the very most, it implies that these officials and their sponsors are going to prematurely throw the citizens of China into a deflationary recession, in which the financial winners and losers can be hand-picked, a la Lehman, and all of the remaining losses can be borne by taxpayers. It is true that, given the level of housing inflation in China (which may be extremely under-estimated by official data ), it would be prudent for officials to implement some measures designed to cool down speculation and help borrowers pay off their debts, but there is an inherent conflict of interest contained within such measures. Any policies that provide systemic relief to debtors will be adverse to the interests of financial elites, so we can expect that none will be undertaken, and instead Chinese officials will follow the Japan-U.S. precedent of "extend and pretend".
China has had the fastest rate of economic growth for years now and boasts the second-largest economy in the world, but despite or because of this fact, income inequality has gotten much worse between urban and rural segments of the population and significantly less than 10% of the population is defined as being a part of the "middle class". . Many of these people have been incentivized to invest their savings into stocks and real estate in recent years, as the interest paid on savings does not even come close to keeping pace with the rate of domestic inflation. Already, the Shanghai Stock Index has lost more than 50% from its peak in 2007, and real estate prices will follow suit soon enough. . It then becomes evident that mounting instability in financial markets could generate substantial sociopolitical unrest among large swaths of the seemingly comfortable urban population, which will realize that, contrary to popular belief, they had never left their rural countrymen behind.
Of course, China is also the largest exporter and second-largest importer of material goods in the world, which makes it extremely significant to economic trends in developed states. Europe, Japan and the U.S. alone comprise 77% of the wealth pyramid's upper segment (net worth between $100K-$1M), and their populations hold at least half of their net worth in financial assets (bonds and equities) and have the highest levels of debt in the world. From this fact alone, we see why another crash in the real estate, equity and credit markets of these regions, fueled by the ongoing financial crisis, would obliterate much of the current and future (expected) wealth of the world, greatly reducing complexity and potentially throwing a huge monkey wrench into the schemes of global elites.
Yet, it is undeniable that these schemes have continued on since 2007, as governments in these regions have subsidized financial losses and supported fraudulent accounting practices to hide them. The "blood funnel" of powerful financial institutions has kept them alive by draining productive capital from workers, taxpayers and gullible investors. How long can this process continue in the face of increasing market instability, rising unemployment, deteriorating public finances and corresponding sociopolitical decay?
Perhaps the more disturbing question is whether financial and sociopolitical deterioration will sharply reduce global complexity, as reflected by wealth/power inequality, or instead will provide the elites with an opportunity to concentrate even more power in the bowels of international institutions such as the IMF and World Bank. John Perkins, in the Prologue to Confessions of an Economic Hitman, provides a stunning example of how the latter logic has prevailed in regions such as Latin America, and describes its general mechanism of action:
In 2003, I departed Quito [Ecuador] in a Subaru Outback and headed for Shell [named after the oil company] on a mission that was like no other I had ever accepted. I was hoping to end a war I had helped create. As is the case with so many things we EHMs [economic hit men] must take responsibility for, it is a war that is virtually unknown anywhere outside the country where it is fought. I was on my way to meet with the Shuars, the Kichwas, and their neighbors the Achuars, the Zaparos, and the Shiwiars -- tribes determined to prevent our oil companies from destroying their homes, families, and lands, even if it means they must die in the process. For them, this is a war about the survival of their children and cultures, while for us it is about power, money, and natural resources. It is one part of the struggle for world domination and the dream of a few greedy men, global empire.
That is what we EHMs do best: we build a global empire. We are an elite group of men and women who utilize international financial organizations to foment conditions that make other nations subservient to the corporatocracy running our biggest corporations, our government, and our banks. Like our counterparts in the Mafia, EHMs provide favors. These take the form of loans to develop infrastructure -- electric generating plants, highways, ports, airports, or industrial parks. A condition of such loans is that engineering and construction companies from our own country must build all these projects. In essence, most of the money never leaves the United States; it is simply transferred from banking offices in Washington to engineering offices in New York, Houston, or San Francisco.
Despite the fact that the money is returned almost immediately to corporations that are members of the corporatocracy (the creator), the recipient country is required to pay it all back, principal plus interest. If an EHM is completely successful, the loans are so large that the debtor is forced to default on its payments after a few years. When this happens, then like the Mafia, we demand our pound of flesh. This often includes one or more of the following: control over United Nations votes, the installation of military bases, or access to precious resources such as oil or the Panama Canal. Of course, the debtor still owes us the money -- and another country is added to our global empire.
In the developed world, our "favors" came in the form of high-limit credit cards, zero-down mortgages and publicly-financed entitlements. Now, the powerful banks (through their puppet politicians) have come to our doorsteps, demanding their pound of flesh, which takes the form of subsidies for the extremely rich and austerity for everyone else. Perhaps the most vivid examples of this mafioso dynamic have taken place in Europe, where many EU members (Germany, France, Italy, Spain, Greece, etc.) and the UK have hoisted "harsh" austerity plans on their citizens.
The citizens of Ireland are currently facing an austerity plan worse than anyone else, as the ruling party agreed to tackle 40% of their proposed budget reduction (8% of GDP) in 2011 alone , but there has been very little popular dissent in response. Greece has experienced some extremely violent protests over the last year, but Athens is a far cry from Berlin or London. Students in the UK held a rowdy protest over tuition hikes at the end of last year, but so far none of the European protests/riots have influenced any significant changes in economic or political policies. . Continued deterioration in global financial markets will lead to stronger and more frequent popular outbursts, and politicians may be forced to ease up on austerity measures as their respective elections draw near. These concessions could keep European populations relatively obedient and docile for another year or so, but they will ultimately be too few, offered way too late.
In the U.S., President Obama's proposed budget for 2011, which was released two months after he extended the Bush tax cuts for the wealthiest Americans (projected to increase the federal deficit by almost $900B over two years ), would allegedly reduce the deficit by $1.1T over the next decade. This reduction would be achieved in part by cutting financial aid and heating energy subsidies to those Americans already living below the poverty line. While the politicians have not yet mustered the courage to touch Medicare and Social Security, their financial masters are already figuring out how to manipulate public perception for their benefit (Bloomberg, Oct. 2010):
"Almost three in five say privatization of the Medicare program, with assistance for low-income seniors, should be considered when lawmakers discuss how to close the budget gap. A majority, though, oppose raising the age at which people can start receiving Medicare benefits.
Americans are narrowly against lawmakers considering Social Security privatization as a means to reduce the deficit. Forty-eight percent say that should be off the table versus 44 percent who want the possibility looked at. Almost three in four favor lawmakers studying removal of the Social Security tax cap so wages over $107,000 a year are taxable.
More than 55 percent of those surveyed under the age of 65 say they aren’t confident they’ll get the same benefits from Social Security and Medicare that seniors are getting today."
There is no doubt that entitlement spending needs to and will be reduced, but it is the context in which this reduction takes place that is most important. Benefit cuts combined with privatization would be ideal for the financial elites, as that frees up money to pay interest on federal debt and provides them more funds on which to levy hefty fees and commissions. The process is even more stark at the state level, where governments are beginning to slash every part of their budgets except the one most exploitative and burdensome, interest paid on debt owed to bankers.
In fact, the main reason why municipalities are so cash-starved right now is that banks are refusing to roll over the unproductive debt that they saddled on these communities in the first place. At the same time, they can use speculative financial instruments (i.e. CDS) to short municipal bonds and profit from deterioration in public finances. If I was a completely objective observer, who had left the ground and was floating through the upper levels of the Earth's atmosphere, then I would be forced to remark that this controlled demolition, frustrating and chaotic up close, is simply beautiful from miles away.
Still, the financial contract killers are not finding their hits so easy to carry out in states such as Wisconsin, Nevada, Ohio, Indiana and New Jersey. Governors and Congressmen in these states have attempted to implement legislation that would block the ability of public unions to engage in collective bargaining over their salaries and benefits, which would then make it easier to shove the elites' austerity agenda down their throats. The protesting public union workers may still be ignorant of the economic reality they are bound to face, but they do show us that values of self-dignity and communal, organized resistance still remain active in the center of a cold and soulless financial empire.
It is certainly premature to declare some kind of popular victory in the developed world, but, by the same token, the elites can hardly afford to ignore the new, tricky variables now incorporated into their equations. Large segments of the populations in China, Europe and the U.S. are beginning to face the very real prospect that the wealth they currently have will quickly deform into a distant memory, and the wealth they expected to have was never meant to be. Through social media, telecommunications and sheer will power, the disenchanted have an ability to share their frustrations and organize demonstrations on a meaningful scale.
There is still a legitimate possibility that those people living in "central hubs" of our global network will remain brainwashed a bit too long, and/or their efforts to confront the financial elites will fall a hair too short. It would certainly be a mistake to underestimate the tendency of financially-enslaved people to follow their fellow lemmings right off the edge of a cliff. However, there are more fundamental, non-financial systems that pose a near-term threat to those attempting to maintain a global network of power. While financial capitalism has been a large force behind the expansion of socioeconomic complexity (and corresponding wealth/power inequality) in recent years, energy and environmental resources are ultimately the bedrock foundations of every complex system on Earth.
The third article in this series will focus on ecosystem degradation, energy scarcity and climate change as major complications to the otherwise simple calculations of global financial elites. Any wealth that manages to survive the worst phases of the global financial crisis will only be as valuable as the Earth's environmental and energy systems allow it to be. It will certainly be difficult to continue concentrating wealth when there is very little left to concentrate, but, at the same time, it would be naive to assume that the elites have not considered critical issues such as peak oil and climate change. Next time, we will explore the plausibility of less than 0.5% of the global human population being able to control the other 99.5% as the world burns around them.
Four time bombs that will blow up Wall Street
by Paul B. Farrell - MarketWatch
Too late to jail bank CEOs; only revolution will succeed
Put Goldman Sachs CEO Lloyd Blankfein in jail for six months, and all this will stop, all over Wall Street and America, a former congressional aide tells Matt Taibbi in his latest Rolling Stone attack, "Why Isn’t Wall Street in Jail? Financial crooks brought down the world’s economy — but the feds are doing more to protect them than to prosecute them."
Taibbi’s right, everyone knows Wall Street’s run by a bunch of dictators who are doing more damage to democracy and capitalism than North Africa’s dictators. But jail the CEOs of Goldman, Citi, B. of A. or my old firm Morgan Stanley? Too late.
Only a revolution will stop Wall Street’s self-destructive capitalism. And watching the people revolt against dictators like Mubarak and Gadhafi reminds us of the spirit that sparked America’s revolution in 1776. But today we need a 1930s-style revolution. During the S&L crisis two decades ago America had a backbone, indicted 3,800 executives and bankers. Today’s leaders have no backbone. Besides jail time won’t reform the darkness consuming Wall Street’s soul. We’re all asleep, in denial about the moral crisis facing America. Yes, we need a new revolution.
Jail time? We’ve heard that many times before. Journalists have been beating that dead horse for three years. Jailing CEOs made sense in early 2009. But our naïve president missed that opportunity, instead surrounded himself with Wall Street insiders as Bush did with Blankfein’s predecessor. Trojan Horses manipulating a Congress filled with clueless Dems mismanaging tired Keynesian theories.
Taibbi got it right: Washington’s error was in protecting Wall Street’s billion-dollar crooks when they should have been prosecuting CEOs for criminal behavior in getting us into the 2008 mess. So today, the political statute-of-limitations has run. Jail solution is wishful thinking, like praying to the tooth fairy for a miracle. Time for action. Time for a revolution on Wall Street.
Jail Wall Street? Old news. They got away with it. We chickened out
"Jail Bank CEOs" makes a great sound bite in the cable pundits’ echo chamber. Remember Taibbi’s earlier indictment of Goldman Sachs: the "world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money." But so what? Just three years after Wall Street’s crooks "brought down the world’s economy" Goldman’s Blankfein and his buddies are paying record bonuses, and laughing at us.
Seriously, think about it folks: Since the 2008 meltdown magazines and newspapers have analyzed the 2008 crash to death. It really is old news, history. Journalists churned out book after book: "Greenspan’s Bubbles," "House of Cards," "Trillion Dollar Meltdown," "13 Bankers," "Dumb Money," "Bailout Nation," "All the Devils Are Here," "The Big Short," "Too Big to Fail," "The Failure of Capitalism," "This Time is Different," "And Then the Roof Caved In," on and on, ad nauseum. All talk, no action, and no effect.
Get it? With every book, every editorial, every expose the past three years, Wall Street bankers actually grew stronger, got richer, more arrogant, bolder on bonuses, impervious to attacks, even taunting us, like the dictators Mubarak, Ben Ali and Gadhafi, confident they could do no wrong, confident no one would rebel. Jail? Our moment to act is long past. We blinked.
Yes folks, Wall Street is the "Comeback Kid" story of the 21st century. Like a terrorist in a horror film, Wall Street thrives on threats. Three short years ago, Wall Street was virtually bankrupt, a ward of the state. We could have jailed "just one" of them back then, when they were down for the count. Instead, we bailed them out! Made them richer. Gave them $13.7 trillion, loans, credits, cash, asset buyouts. Gave them keys to the Treasury. They didn’t just recover, they "ran the tables," to use a blackjack/pool metaphor. Now Wall Street dictators have absolute power, ruling Washington, America, you and me.
Yes, America’s bankrupt, but the rich just do not care
Admit it, we lost the opportunity. Jail a bank CEO and Wall Street will miraculously reform? You’re joking, right? Wall Street got away with a "legal" bank heist. Today the should-be/would-be inmates are running the prison.
Wall Street’s corrupt banks have lost their moral compass … their insatiable greed has become a deadly virus destroying its host nation … their campaign billions buy senate votes, stop regulators’ actions, manipulate presidential decisions. Wall Street money controls voters, runs America, both parties. Yes, Wall Street is bankrupting America.
Wake up America, listen:
- "Our country is bankrupt. It’s not bankrupt in 30 years or five years," warns economist Larry Kotlikoff, "it’s bankrupt today."
- Economist Peter Morici: "Capitalism is broken, America’s government is two bankrupt political parties bankrupting the country."
- David Stockman, Reagan’s budget director: "If there were such a thing as Chapter 11 for politicians" the "tax cuts would amount to a bankruptcy filing."
- BusinessWeek recently asked analyst Mary Meeker to run the numbers. How bad is it? America really is bankrupt, with a "net worth of a negative $44 trillion." Bankrupt.
And it will get worse. Unfortunately, nothing can stop America’s self-destructive Wall Street bankers. They simply do not care that their "doomsday capitalism" is destroying themselves from within, and is bankrupting America too.
One mega-millionaire sent me an email after reading my Jan. 4 column, "America’s worst 10 years start now.""Paul, you may well be right about the coming decade, but the rich exist in a different world from the one you write about. They live privileged lives in gated communities. Meet for holidays at the world’s elite resorts. The richest just aren’t worried about today’s economy like your readers. Their issues revolve around who’s the best masseuse, best Pilates teacher, best concierge medical doctor, which private school to choose, what investments they are making at this time, etc.
Folks at the top are not concerned with the underlying deterioration of America, except in the abstract, because they aren’t directly affected. That’s why no amount of information from you will ever change things. To them, it’s irrelevant. Best wishes, always enjoy your stuff."
4 ticking time bombs that will ignite the Wall Street revolution
Yes, the rich live in a different world. And no, information won’t change them. But a revolution will. Revolutions build slowly over a long time. Then, suddenly, a critical mass, a flash point, something totally unexpected ignites the ticking bomb. It happened recently in a remote Tunisian village. Mohamed Bouazizi, a 26-year-old college graduate, unable to pay bribes, set himself on fire to protest police confiscation of his unlicensed vegetable cart. That triggered a revolution. And his death rapidly led to the collapse of a 24-year dictatorship.
Today we have four hot time bombs, tick-ticking, soon to make history; any one can easily accelerate the revolution that’s already killing Wall Street from within.
- Wealth gap: Super-Rich vs class wars, death of democracy
The gap: In one generation, America’s wealthiest 1% has exploded from 9% to 23% of America’s income, while middle-class income has stagnated. Even Buffett admits: "There’s class warfare, all right, but it’s my class, the rich class, that’s making war, and winning." But my rich friend tells the real story, of their social disconnect. The rich just don’t care. They live in a different world, live by a self-centered code lacking a moral compass. The public welfare is honored only if supported by tax benefits. The wealth gap is widening and soon something unpredictable will ignite a Wall Street revolution.
- Wall Street’s doomsday capitalism vs rule by anarchy
A key Supreme Court decision accelerated and codified Wall Street’s ability to use billions stolen from taxpayers to lobby Washington and solidify its power, all for its own self-interest, through campaign payola, senators’ votes, presidential access, manipulation of regulators, grabbing tax benefits, etc. And it’s every man and woman for themselves. Don’t believe it? Know this, democracy is dead and you’re in denial. Wall Street CEOs and Forbes 400 billionaires are either engaged in a secret conspiracy, or a classic anarchy picking apart America, oblivious of the fact they are setting up the next big revolution.
- Pentagon’s perpetual war machine vs America’s budget time bomb
The mathematics of our $75 trillion Social Security and Medicare deficits often seem insurmountable, but can be recalibrated. However, the war-loving mindset of America’s neocons — fueled by China’s military actions, the insatiable expansion of our military spending and a Pentagon prediction that global population growth — is putting more and more pressure on the world’s scarce resources, and will, in turn, increase global wars and the demand for more war spending, increasing the risk of sudden revolutions everywhere.
- Global population explosion vs resources, jobs, better lifestyles
As the world population explodes from 7 billion to 10 billion in the next generation, the demand for more jobs and the pressure on scarce resources will increase, while expectations will fall as the ratio of haves to have-nots increases, making the world all around Wall Street a burning powder keg setting up a revolution.
Bottom line: Forget jailing Wall Street’s dictators. It’s naïve and too late. We missed that opportunity. But a revolution will do the trick, give us a second chance to jail the crooks. Until then, remember, these four factors are building to a head, merging into a critical mass that will accelerate into a revolution and destroy Wall Street from within: The widening wealth gap, capitalism’s new rule-by-anarchy, the high cost of feeding the Pentagon’s costly war machine, and the huge global population explosion.
It’s Time to Face the Fiscal Illusion
by Tyler Cowen - New York Times
Fiscal policy debates often focus on technocratic questions about how much money the government should spend and when, yet the actual course of events depends not on the experts but on politics. The more that our government runs up unfunded obligations and debt, the more we are setting a trap for ourselves.
James M. Buchanan, a Nobel laureate in economics — and my former colleague and now professor emeritus at George Mason University — argued that deficit spending would evolve into a permanent disconnect between spending and revenue, precisely because it brings short-term gains. We end up institutionalizing irresponsibility in the federal government, the largest and most central institution in our society. As we fail to make progress on entitlement reform with each passing year, Professor Buchanan’s essentially moral critique of deficit spending looks more prophetic.
We are fooling ourselves most of all. United States government debt in public hands is now more than $9 trillion, but most people still don’t realize what it will take to pay that off.
Here’s an example: Say that you have $20,000 inTreasury bills. You probably believe that you own $20,000 in wealth. This will encourage you to spend and come up with ambitious plans. Yet someone — quite possibly you — will be taxed in the future to pay off the government debt. The $20,000 may be needed in order to do that.
The illusion is this: A government bond represents both a current asset and a future liability, yet for most people, those future tax payments feel less concrete and less real than the dollars they’re holding in a money market account. The field of behavioral economics analyzes imperfections in market decision-making, but the biggest practical problems often involve our inaccurate perceptions of what the public sector is up to and how much it will affect us.
In this case, the sorry truth is that our savings aren’t worth as much as many of us think, and a rude awakening is coming. One way or another, some of our savings will be taxed away to make good on governmental commitments, like future Medicare benefits, which we currently are framing as personal free lunches.
Keynesian economics talks of the "fiscal illusion" created by government debt: the issuance of such debt can stimulate the economy in the short run by encouraging a false perception of wealth and thus bolstering consumer spending. But, eventually, the books must balance. There is then a fiscal crunch, a sudden retrenchment of plans and great rancor over budgets, as we have been seeing lately at both the federal and the state level.
The famous Keynesian rejoinder, "In the long run we are all dead," is less comforting when that long run comes into sight. Short-run planning is a hard carousel to stop, especially when there are frequent election cycles, but the federal government must act soon. Limiting Medicare and Social Security spending involves re-indexing benefits, adjusting eligibility ages, shifting the growth rates of costs and making other changes that have their full fiscal impact only over the longer run.
Yet we are postponing even these actions. Experts’ recommendations might lead us toward a fiscal smooth landing, but at this point the fiscal illusion — and not the advice of experts — is in control. So Professor Buchanan’s argument is ringing true.
The technocratic Keynesian recommendation was to run deficits in bad times and surpluses in good times. But except for one stretch during the Clinton administration, this notion has been broken since the early 1980s. In the United States, at least, Keynesian economics has failed to find the necessary political institutions to enact and sustain a wise version of the theory.
Now that fiscal constraints are starting to bite, many politicians are afraid to reform or even to discuss changes in the largest problem areas: Medicare and Medicaid. Yes, some laudable cost controls on Medicare are embedded in the new health care law, but they’re not enough. Most likely, we will end up making other spending cuts that won’t solve our fiscal problems — and in areas that could instead benefit from Keynesian employment stimulus. These kinds of knee-jerk, poorly reasoned decisions are what happens when fiscal illusion reigns.
Fiscal austerity may sometimes sound like a dogmatic religion, but fixed principles often help us do the right thing, especially when temptation beckons. Professor Buchanan argued that the real choice was between a religion of budget balance and a rule of illusion. Seeking an optimal technocratic path is not on the menu.
SO, given this mess, what should be done?
As Matthew Yglesias from the Center for American Progress has proposed, President Obama could pledge to veto any budget that increases the projected medium-term deficit, relative to the status quo. He should include in that veto threat any deficit increases that arise from annual budgetary gimmicks like patches to the alternative minimum tax or the "doc fix" adjustment of Medicare reimbursement rates.
Such an announcement would not fix health care costs, but it would force us to recognize them, and would move us away from purely short-term planning. It would force the government to consider both spending cuts and tax increases. In any case, the rigor of the numbers will soon sweep away the fiscal illusion. The only question is whether we will end the charade on our own terms or continue to play the fool.
Mervyn King is right. If the banks face no risk, we shall all go down
by Charles Moore - Telegraph
They are the trade unions of the modern era, sick dinosaurs that crush ordinary citizens
Governors of the Bank of England are, rightly, cautious people. Their remarks can move markets. They must steer the way between exuberance and gloom. So they tend not to say very much. Historically, the Governor's most important organ was not his tongue but his eyebrows. If he raised them quizzically, the bankers of the City of London got the message.
But nowadays, in our rough world, you need more than eyebrows. Ever since and even – though too sotto voce – before the credit crunch, the present Governor, Mervyn King, has been conveying to our great bankers a profound criticism of how they behave and the system which permits them. They do not seem to care. Bob Diamond, of Barclays, even thinks that the "time for remorse is over".
In my interview with the Governor in today's paper, he takes this criticism to a new, general, moral level. This is not a grudge match between men who mess with money, but the product of long reflection, observation and supervision. Mr King has been at the Bank for 20 years this week. These are his thoughts on what he calls "a period of immense historical significance". We are hearing the philosopher King.
The Governor visits manufacturing and service industries all over the country, and is constantly impressed by the trouble they take to know their customers, and their "pride in their products". He notes that they pay much lower rewards than the banks. The banks, on the other hand, decided that it was all right to "bet with other people's money", and to exploit the "gullible". They created all sorts of instruments just for playing the casino (he uses that word) with one another, and ended up with trust breaking down. So the system collapsed.
But then came the "too big to fail" problem. We couldn't let the banks collapse because they would bring us all down. In 2008-9, we performed an appalling, but necessary rescue. And now it could very well happen all over again! Banks which we, the taxpayers, rescued are doing the same business once more, and paying themselves the same piles of money, because they still have no "downside" risk. Mr King wants the independent banking commission to solve this: "The concept of being too important to fail should have no place in a market economy."
Is the Governor right? Central bankers, as well as big bankers, did not cover themselves with glory. Critics would say that he got many things wrong himself. He should (as he admits) have warned earlier. He should have acted faster when the interbank market froze in 2007. He should have done more quantitative easing (or less). Perhaps so, but Mervyn King's broad argument is surely right, and it matters hugely not just for finance, but for politics, and for all of us. Anthony Trollope wrote a brilliant novel about a financial collapse called The Way We Live Now. That was in the 1870s. The King critique goes to the heart of the way we live in 2011.
Too many current attacks on bank bonuses miss the point. There is no "right" amount of money. It is not fine to earn a quarter of a million but "obscene" to get £5 million. But what is true is that people who accumulate very large sums tend to think they are brilliant. In a proper market economy, if they are not brilliant, they get their comeuppance. In the too-big-to-fail economy, they just go on getting rich, paid for by the rest of us who go on getting poorer. Like Mr King, I am surprised that people are not even angrier.
So we still have a fragile financial system. Worse, the basis on which we accept our economic arrangements is undermined. One of Mr King's most powerful points is that, over the 30 years which started with Margaret Thatcher, we came to agree that useless jobs should not be subsidised. We reduced the power of the trade unions and accepted market discipline. It worked.
General prosperity rose. But then the credit crunch came and "surprise, surprise, the institutions bailed out were those at the heart of the crisis". Greed and foolishness were rewarded and prudence was punished. Eventually, people will not accept this. Why are those in power finding this so hard to handle? Partly, it is for good reasons. We want to maintain a banking system. Many bankers are conscientious and able people. We do not want a panic.
But there are worse reasons. One is mental confusion. In the late 1970s, when the trade union bosses were too powerful, it was not obvious to all that they should be cut down to size. Many argued that the better way was to get close to the leaders, involve them in economic decisions, give them "beer and sandwiches" at No 10. This was crazy, yet psychologically understandable.
The equivalent today is to go on about how important the big banks are to the British economy, burble about the need to reward talent, and just look pleased when profits climb back up again. Yet our "zombie" banks, which are kept alive only by the taxpayer, actually resemble those heavy industries of the 1970s – British Leyland, the National Coal Board. Their power lies not in the good they can do, but in the havoc they could wreak.
You will hear how wonderful it is that London is a great financial centre, so open to the world. We certainly don't want a siege economy, but is it unmitigatedly marvellous that we give such free, unquestioned access to some of the murkiest people on the planet? Houses in the middle of London are now wildly expensive because they are a form of legalised international money laundering. To whose benefit is that?
It is objected that Britain must be a "global player", and that we must not let our banking talent disappear. But the trouble is, as Mervyn King has said elsewhere, that great international banks are "global in life, but national in death". These huge, smelly, sick dinosaurs are now squashing ordinary British citizens. I find it hard to believe that many other countries are longing to take the weight of this risk upon themselves.
In some ways, our banking problem is even worse than our trade union one 30 years ago, because of the lure of money. Most powerful people in the country – especially in London – have a strong motive to suck up to the big banks. If you work in the arts, if you are a politician, or a retiring permanent secretary, or a senior army officer, if you run a university, a charity or a political party, you will want bankers as your friends, and so you will blanch at Mr King's frankness. Well, a lot of my best friends are bankers (though possibly rather fewer if they have got to the end of this article), but I'm glad someone is speaking up against a world where morality has simply turned upside down.
Mervyn King: We prevented a Great Depression... but people have the right to be angry
by Charles Moore - Telegraph
Before the war," says Mervyn King, "my father worked on the railways. In the war, he was in the Royal Engineers and helped with the planning of D-Day. After it, he trained on a demobbed soldiers’ programme to become a teacher. He was also a Methodist local preacher. He died only a few weeks ago. At his funeral, I said that he was always a preacher and a teacher – some might say it runs in the family – I am proud of that." A hint of deep emotion is visible behind the famous thick spectacles.
The Governor of the Bank of England is sitting in his large and elegant office, leaning forward in an austere upright chair that he says is better for his back. All around him are the trappings of his venerable institution. A butler in the Bank’s famous pink coat comes in with a silver coffee pot. But the small, round, soft-spoken man in the chair is not a City grandee, but a teacher, a preacher, an intellectual.
It is 20 years this week since Mr King walked into the Bank, hired as its chief economist. His previous experience had been wholly academic. But "I wanted to see policy-making from the inside". The year after he arrived, Britain fell out of the Exchange Rate Mechanism, and Mr King’s ideas about inflation-targeting came to the fore. In 1997, on a Bank Holiday, Eddie George the then governor, called him into the office in which we are now sitting to tell him that Gordon Brown would announce Bank independence the following day. "So you can’t leave now, can you?" said Mr George. He couldn’t.
The next year, Mr King became deputy governor. In 2003, he succeeded George. He has seen more "policy-making from the inside" than he could ever have dreamed – "a period of immense historical significance". The young Mervyn "really wanted to read cosmology" but could not find the right undergraduate course, so he went up to King’s College, Cambridge, in 1966, as a mathematician, but switched immediately to economics.
He loved Cambridge, but economics was too much "harking back" to Keynes. It was in postgraduate work at Harvard that he "learnt that economics could be a serious discipline". Being a bright young man, he gave "excessive weight" to economic models. "You feel, 'My models will make a big difference.’ As I get older, I give more weight to history. Alfred Marshall [the founder of Cambridge economics] was absolutely right that you should do the mathematics but then burn the paper and write it down in words." Maths and models should be "aids to thinking, not substitutes for it". He thinks people should have remembered that during the financial crisis.
Tell me, I say, what a layman should read to understand that great disaster in which we are still embroiled. There are two books, he says. One is Walter Bagehot’s 19th-century classic, Lombard Street, with its "wonderful description of the people who made the money markets work – they’re exactly the same now – and his popularisation of the idea of the lender of last resort". The other, about the credit crunch itself, is The Big Short by Michael Lewis. It explains, says Mr King, why a few people did not believe that the lending in the US subprime market was going to work but "how difficult it was for them to make the bet they wanted to make and how the great banking machine was all geared to do the opposite".
Now, the Governor is off on why all this has a moral dimension: "The more I’ve thought about how labour markets work, the more I’ve realised that there are hardly any jobs whose tasks you can describe exactly. Nowadays, most jobs have the property that employees can choose to do them well or badly, so employers need to think about the long-term welfare of the staff not just pay today." It follows that moral attitude is vital. Industry often understands this well. Nissan in Sunderland asks all its workers for ideas to raise productivity, and, says Mr King, it benefits.
The Governor makes a point of visiting manufacturing and service industries all over the country. Such firms pay far lower rewards than financial services but have "an incredibly successful record. They care deeply about their workforce, about their customers and, above all, are proud of their products". With the banks, it’s different: "There isn’t that sense of longer-term relationships [hence the demise of the local bank manager]. There’s a different attitude towards customers. Small and medium firms really notice this: they miss the people they know."
He also thinks that there is "too much weight put on the importance and value of takeovers". They make short-run profits but "it doesn’t make sense to destroy a company with a reputation". Since the Big Bang in the late 1980s, Mr King goes on, too many in financial services have thought "if it’s possible to make money out of gullible or unsuspecting customers, particularly institutional customers, that is perfectly acceptable". Good businesses "keep a clear vision of who their customers are, and are run by people who don’t think they should simply maximise profits next week". But in the past 25 years, banks have increasingly "taken bets with other people’s money".
That is bad enough, but it gets much worse "if the rules of the game are that they get bailed out if it all goes wrong". In this weird atmosphere, banks eventually stopped trusting one another. "Financial services don’t like the word 'casino’, but instruments were created and traded only within the financial community. It was a zero sum game. No one knew which ones were winners when the crisis hit. Everyone became a suspect. Hence, no one would provide liquidity to any of those institutions."
Northern Rock could have been avoided if Britain had not been "the only G7 country not to have had a statutory resolution process. We had been war-gaming one, but the legislation wasn’t ready". In Mr King’s opinion: "If we had not stepped in for RBS and HBOS, all the British banks would have suffered runs. They didn’t understand the nature of the risks they were taking." But was the Governor himself blameless? Has he ever given the Queen the answer to her famous question: "If these things were so big, why did no one see them coming?"
He says he did have a meeting with the Queen last year. I smile at the thought – King and Queen, as it were. What did they say to one another? I think the Governor would like to tell me more, but he reins himself in: after conversations with the Queen, he reminds me, "one must never breathe a word to another mortal". He thinks her questions are good questions. His answer to Her Majesty is that "everyone did see it coming but no one knew when. It’s like an earthquake zone. You should be trying to build buildings in ways which are more robust". But he does include himself in the criticism. "I wish I’d spoken out more forcefully about the build-up of leverage."
He does believe, however, that the Bank’s remedies have been right. "Quantitative easing" is a new phrase, but "it is really very traditional monetary policy. For the first time in my life, the amount of money was growing too slowly". What was done in 2008 and 2009 "prevented a repetition of the Great Depression".
The Bank pushed out money and "bought private not public sector paper", so that non-bank institutions could benefit. It stayed away from choosing which assets to favour. Some central banks, however, went further and were seen to "intervene in the credit allocation machine. It’s made life more difficult. It’s seen as quasi-political, quasi-fiscal, We deliberately stayed away from that". But although Mr King thinks the worst of the crisis was handled correctly, he does not think we are out of the woods. "We allowed a [banking] system to build up which contained the seeds of its own destruction", and this has still not been remedied: "We’ve not yet solved the 'too big to fail’ or, as I prefer to call it, the 'too important to fail’ problem. The concept of being too important to fail should have no place in a market economy."
I quote to him the recent remarks of Stephen Hester, the chief executive of the largely publicly owned RBS, in which he seemed simultaneously to say that RBS should pay little tax because it had made little profit, but also that it should pay big bonuses because its investment arm had made big profits. Wasn’t there some sort of contradiction? Mr King nods. The remark illustrates, he says, the clash between the needs of high-street banking and the ambitions of investment banking.
The key question, in his view, is not why an individual bank says it needs to pay bonuses (the reason cited is always the need to keep talent), but: "Why do banks in general want to pay bonuses? It’s because they live in a 'too big to fail’ world in which the state will bail them out on the downside." They are tempted to excessive risk and excessive payments: "It is very unproductive to single out individuals. Bankers were given incentives to behave the way they did. That’s what needs to change. We must resolve this problem." He has high hopes that the independent banking commission will do so. In the Governor’s mind, this is not ultimately a technical but a moral question. It goes to the heart of whether people are ready to accept life in a free economy.
Over the past 30 years, he says: "We changed Britain away from a sclerotic economy with inefficiencies and problems in labour relations. Everyone got to the point where we no longer expected government to bail us out. Everyone bought in to market discipline. We were all better off. It was working very successfully." But now, people have every right to be angry, because "out of what seems to them a clear blue sky", the crisis comes, they find they do lose their jobs and there’s the sharpest fall in world trade since the 1930s.
"But, surprise, surprise, the institutions bailed out were those at the heart of the crisis. Hedge funds were allowed to fail, 3,000 of them have gone, but banks weren’t." Could there be a repeat? "Yes! The problem is still there. The 'search for yield’ goes on. Imbalances are beginning to grow again."
I want the Governor’s own estimation of how he is handling the hangover after the party. Is it true, as Ed Balls was reported to be alleging, that he is too political (which means, from Mr Balls’s mouth, too Tory)? Mr King tactfully refuses to accept that this is necessarily the shadow chancellor’s view: "He was reported by the Financial Times as saying that. I prefer to read what people actually say. I don’t take newspaper headlines at face value." His general point, though, is simple: "It is inconceivable that the Governor has no view on the size of the deficit and the need to reduce it. It would be a dereliction of duty for me not to warn. You need a credible plan to reduce it, over the lifetime of a Parliament. But it is for ministers, not for me, to say how this should be done."
He believes that the need to reduce the deficit is common ground between the parties and claims to have had "a good relationship with all three chancellors on his watch". What about with the man who was one door up from Alistair Darling in Downing Street? Mr King smiles thinly: "That is for others to say ... we worked well together during the recapitalisation." He feels strongly that the independence which Mr Brown established works well. WikiLeaks caught him out saying that David Cameron and George Osborne, in opposition, were too inexperienced. That is not his view now: "I think people learn very quickly on the job."
Here we are though, I complain, with inflation 100 per cent higher, at four per cent, than the two per cent it is supposed to be. The mathematician in him laughs at that way of putting it: "If our target was zero per cent and we had an inflation rate of 0.1 per cent, we would be infinitely above target!". Yes, but he was always an inflation "hawk". Is he still? "Yes. It’s odd to read that I am terribly doveish.
Before the crunch, there were 14 occasions where I was in a minority in voting for higher rates. Since then, there has been one occasion where I was in a minority the other way." He is emphatic that he wishes to get back to the target, and that they will: "That is why I stayed at the Bank [for his second term]." After this, the worst financial crisis in living memory, "if people can look back and say that inflation came back in line, that would be a very significant achievement".
He does not use the word, but he is clearly talking about his legacy after he leaves in 2013. He also feels very sorry for the victims of inflation, especially savers suffering "a sharp squeeze in living standards. It is deeply troubling for them. They were prudent before the crisis". But if he were to put up interest rates too soon it would be, as he recently said, the "futile gesture" from the Battle of Britain sketch in Beyond the Fringe.
The squeeze on living standards is "inevitable" because of overseas prices of oil and other commodities and deficit reduction, so surely, says the Governor, one cannot argue that "what Britain needs is a deeper recession". Of course, rates will have to rise at some point and there is a "perfectly reasonable case for doing it now", but it is a matter of looking ahead for 18 months to two years, a matter of calculating "the balance of risk". He says the squeeze in living standards has been "sharp and prolonged" and they "will be squeezed a bit more this year" before "almost certainly" picking up after that.
We are moving towards the end, and I bring him back to the main message of the preacher. In a recent speech, Mervyn King quoted Tolstoy’s line that "Happiness is less important than trying to live in the right way". What is the right way? Mr King sees the task as one of getting back to where we were before all this. "Britain is well placed to be an international banking centre, but we can’t afford to be if, now and again, it depends on the UK taxpayer."
We must get rid of the idea that "if something is growing rapidly, it must be good. Every supervisor should say: 'The banks I should worry about are not only the ones that are losing money but the ones who are making a lot of money.’?" He goes on: "What I’ve tried to do my whole time at the Bank is to set general rules. You can’t rely on the wisdom of individuals. Before I leave, I want to make sure that the right framework is in place for monetary policy, financial stability and banking supervision [a function the Coalition is now returning to the Bank]."
Does he enjoy it all? Wouldn’t this man of ideas be happier in his large library? His eyes gleam. "I’m looking forward to getting back to my books [current reading includes Niall Ferguson’s book on civilisation and Chinua Achebe’s Anthills of the Savannah] and to watching cricket and playing tennis. But I wouldn’t have missed this for the world. Enjoyment is the wrong word, because of the pressure. I never expected to see a crisis of this size, but it is fascinating and a privilege to be doing this job."
Since he is so uncomfortable with the culture of banking, wouldn’t he rather have been an industrialist? "No, I admire people like John Rose at Rolls-Royce or John Parker at the National Grid", but the job is "an intellectual challenge first and foremost, where I must see issues clearly and speak about them openly". Sort of like being a professor, only much, much more exciting.
We discuss bank notes. Mr King has decided that the next £50 notes should depict the inventive and manufacturing partnership of Matthew Boulton and James Watt. But he is even prouder of having picked Adam Smith for the £20. Smith provides the model of the right way: his economic theory in The Wealth of Nations was wise and true, but Smith’s other book, The Theory of Moral Sentiments proves, says Mr King, that "there’s more to life than economics. The two must be taken together".
MERS? It May Have Swallowed Your Loan
by Michael Powell and Gretchen Morgenson - New York Times
For more than a decade, the American real estate market resembled an overstuffed novel, which is to say, it was an engrossing piece of fiction. Mortgage brokers hip deep in profits handed out no-doc mortgages to people with fictional incomes. Wall Street shopped bundles of those loans to investors, no matter how unappetizing the details. And federal regulators gave sleepy nods. That world largely collapsed under the weight of its improbabilities in 2008.
But a piece of that world survives on Library Street in Reston, Va., where an obscure business, the MERSCorporation, claims to hold title to roughly half of all the home mortgages in the nation — an astonishing 60 million loans. Never heard of MERS? That’s fine with the mortgage banking industry—as MERS is starting to overheat and sputter. If its many detractors are correct, this private corporation, with a full-time staff of fewer than 50 employees, could turn out to be a very public problem for the mortgage industry.
Judges, lawmakers, lawyers and housing experts are raising piercing questions about MERS, which stands for Mortgage Electronic Registration Systems, whose private mortgage registry has all but replaced the nation’s public land ownership records. Most questions boil down to this: How can MERS claim title to those mortgages, and foreclose on homeowners, when it has not invested a dollar in a single loan?
And, more fundamentally: Given the evidence that many banks have cut corners and made colossal foreclosure mistakes, does anyone know who owns what or owes what to whom anymore?
The answers have implications for all American homeowners, but particularly the millions struggling to save their homes from foreclosure. How the MERS story plays out could deal another blow to an ailing real estate market, even as the spring buying season gets under way.
MERS has distanced itself from the dubious behavior of some of its members, and the company itself has not been accused of wrongdoing. But the legal challenges to MERS, its practices and its records are mounting.
The Arkansas Supreme Court ruled last year that MERS could no longer file foreclosure proceedings there, because it does not actually make or service any loans. Last month in Utah, a local judge made the no-less-striking decision to let a homeowner rip up his mortgage and walk away debt-free. MERS had claimed ownership of the mortgage, but the judge did not recognize its legal standing. "The state court is attracted like a moth to the flame to the legal owner, and that isn’t MERS," says Walter T. Keane, the Salt Lake City lawyer who represented the homeowner in that case.
And, on Long Island, a federal bankruptcy judge ruled in February that MERS could no longer act as an "agent" for the owners of mortgage notes. He acknowledged that his decision could erode the foundation of the mortgage business. But this, Judge Robert E Grossman said, was not his fault. "This court does not accept the argument that because MERS may be involved with 50 percent of all residential mortgages in the country," he wrote, "that is reason enough for this court to turn a blind eye to the fact that this process does not comply with the law." With MERS under scrutiny, its chief executive, R. K. Arnold, who had been with the company since its founding in 1995, resigned earlier this year.
A birth certificate, a marriage license, a death certificate: these public documents note many life milestones. For generations of Americans, public mortgage documents, often logged in longhand down at the county records office, provided a clear indication of homeownership. But by the 1990s, the centuries-old system of land records was showing its age. Many county clerk’s offices looked like something out of Dickens, with mortgage papers stacked high. Some clerks had fallen two years behind in recording mortgages.
For a mortgage banking industry in a hurry, this represented money lost. Most banks no longer hold onto mortgages until loans are paid off. Instead, they sell the loans to Wall Street, which bundles them into investments through a process known as securitization. MERS, industry executives hoped, would pull record-keeping into the Internet age, even as it privatized it. Streamlining record-keeping, the banks argued, would make mortgages more affordable.
But for the mortgage industry, MERS was mostly about speed — and profits. MERS, founded 16 years ago by Fannie Mae, Freddie Macand big banks like Bank of America and JPMorgan Chase, cut out the county clerks and became the owner of record, no matter how many times loans were transferred. MERS appears to sell loans to MERS ad infinitum.
This high-speed system made securitization easier and cheaper. But critics say the MERS system made it far more difficult for homeowners to contest foreclosures, as ownership was harder to ascertain. MERS was flawed at conception, those critics say. The bankers who midwifed its birth hired Covington & Burling, a prominent Washington law firm, to research their proposal. Covington produced a memo that offered assurances that MERS could operate legally nationwide. No one, however, conducted a state-by-state study of real estate laws.
"They didn’t do the deep homework," said an official involved in those discussions who spoke on condition of anonymity because he has clients involved with MERS. "So as far as anyone can tell their real theory was: ‘If we can get everyone on board, no judge will want to upend something that is reasonable and sensible and would screw up 70 percent of loans.’ " County officials appealed to Congress, arguing that MERS was of dubious legality. But this was the 1990s, an era of deregulation, and the mortgage industry won. "We lost our revenue stream, and Americans lost the ability to immediately know who owned a piece of property," said Mark Monacelli, the St. Louis County recorder in Duluth, Minn.
And so MERS took off. Its board gave its senior vice president, William Hultman, the rather extraordinary power to deputize an unlimited number of "vice presidents" and "assistant secretaries" drawn from the ranks of the mortgage industry. The "nomination" process was near instantaneous. A bank entered a name into MERS’s Web site, and, in a blink, MERS produced a "certifying resolution," signed by Mr. Hultman. The corporate seal was available to those deputies for $25.
As personnel policies go, this was a touch loose. Precisely how loose became clear when a lawyer questioned Mr. Hultman in April 2010 in a lawsuit related to its foreclosure against an Atlantic City cab driver.
- How many vice presidents and assistant secretaries have you appointed? the lawyer asked.
- "I don’t know that number," Mr. Hultman replied.
- "I wouldn’t even be able to tell you, right now."
- In the thousands?
Each of those deputies could file loan transfers and foreclosures in MERS’s name. The goal, as with almost everything about the mortgage business at that time, was speed. Speed meant money.
Alan Grayson has seen MERS’s record-keeping up close. From 2009 until this year, he served as the United States representative for Florida’s Eighth Congressional District — in the Orlando area, which was ravaged by foreclosures. Thousands of constituents poured through his office, hoping to fend off foreclosures. Almost all had papers bearing the MERS name. "In many foreclosures, the MERS paperwork was squirrelly," Mr. Grayson said. With no real legal authority, he says, Fannie and the banks eliminated the old system and replaced it with a privatized one that was unreliable.
A spokeswoman for MERS declined interview requests. In an e-mail, she noted that several state courts have ruled in MERS’s favor of late. She expressed confidence that MERS’s policies complied with state laws, even if MERS’s members occasionally strayed. "At times, some MERS members have failed to follow those procedures and/or established state foreclosure rules," the spokeswoman, Karmela Lejarde, wrote, "or to properly explain MERS and document MERS relationships in legal pleadings." Such cases, she said, "are outliers, reflecting case-specific problems in process, and did not repudiate the MERS business model."
MERS’s legal troubles, however, aren’t going away. In August, the Ohio secretary of state referred to federal prosecutors in Cleveland accusations that notaries deputized by MERS were signing hundreds of documents without any personal knowledge of them. The attorney general of Massachusetts is examining a complaint by a county registrar that MERS owes the state tens of millions of dollars in unpaid fees.
As far back as 2001, Ed Romaine, the clerk for Suffolk County, on eastern Long Island, refused to register mortgages in MERS’s name, partly because of complaints that the company’s records didn’t square with public ones. The state Court of Appeals later ruled that he had overstepped his powers. But Judith S. Kaye, the state’s chief judge at the time, filed a partial dissent. She worried that MERS, by speeding up property transfers, was pouring oil on the subprime fires. The MERS system, she wrote, ill serves "innocent purchasers." "I was trying to say something didn’t smell right, feel right or look right," Ms. Kaye said in a recent interview.
Little about MERS was transparent. Asked as part of a lawsuit against MERS in September 2009 to produce minutes about the formation of the corporation, Mr. Arnold, the former C.E.O., testified that "writing was not one of the characteristics of our meetings." MERS officials say they conduct audits, but in testimony could not say how often or what these measured. In 2006, Mr. Arnold stated that original mortgage notes were held in a secure "custodial facility" with "stainless steel vaults." MERS, he testified, could quickly produce every one of those files.
As for homeowners, Mr. Arnold said they could log on to the MERS system to identify their loan servicer, who, in turn, could identify the true owner of their mortgage note. "The servicer is really the best source for all that information," Mr. Arnold said. The reality turns out to be a lot messier. Federal bankruptcy courts and state courts have found that MERS and its member banks often confused and misrepresented who owned mortgage notes. In thousands of cases, they apparently lost or mistakenly destroyed loan documents.
The problems, at MERS and elsewhere, became so severe last fall that many banks temporarily suspended foreclosures. Some experts in corporate governance say the legal furor over MERS is overstated. Others describe it as a useful corporation nearly drowning in a flood tide of mortgage foreclosures. But not even the mortgage giant Fannie Mae, an investor in MERS, depends on it these days. "We would never rely on it to find ownership," says Janis Smith, a Fannie Mae spokeswoman, noting it has its own records.
Apparently with good reason. Alan M. White, a law professor at the Valparaiso University School of Law in Indiana, last year matched MERS’s ownership records against those in the public domain. The results were not encouraging. "Fewer than 30 percent of the mortgages had an accurate record in MERS," Mr. White says. "I kind of assumed that MERS at least kept an accurate list of current ownership. They don’t. MERS is going to make solving the foreclosure problem vastly more expensive."
The Sarmientos are one of thousands of American families who have tried to pierce the MERS veil. Several years back, they bought a two-family home in the Greenpoint section of Brooklyn for $723,000. They financed the purchase with two mortgages from Lend America, a subprime lender that is now defunct. But when the recession blew in, Jose Sarmiento, a chef, saw his work hours get cut in half. He fell behind on his mortgages, and MERS later assigned the loans to U.S. Bank as a prelude to filing a foreclosure motion.
Then, with the help of a lawyer from South Brooklyn Legal Services, Mr. Sarmiento began turning over some stones. He found that MERS might have violated tax laws by waiting too long before transferring his mortgage. He also found that MERS could not prove that it had transferred both note and mortgage, as required by law. One might argue that these are just legal nits. But Mr. Sarmiento, 59, shakes his head. He is trying to work out a payment plan through the federal government, but the roadblocks are many. "I’m tired; I’ve been fighting for two years already to save my house," he says. "I feel like I never know who really owns this home."
Officials at MERS appear to recognize that they are swimming in dangerous waters. Several federal agencies are investigating MERS, and, in response, the company recently sent a note laying out a raft of reforms. It advised members not to foreclose in MERS’s name. It also told them to record mortgage transfers in county records, even if state law does not require it. MERS will no longer accept unverified new officers. If members ignore these rules, MERS says, it will revoke memberships.
That hasn’t stopped judges from asking questions of MERS. And few are doing so with more puckish vigor than Arthur M. Schack, a State Supreme Court judge in Brooklyn. Judge Schack has twice rejected a foreclosure case brought by Countrywide Home Loans, now part of Bank of America. He had particular sport with Keri Selman, who in Countrywide’s court filings claimed to hold three jobs: as a foreclosure specialist for Countrywide Home Loans, as a servicing agent for Bank of New York and as an assistant vice president of MERS. Ms. Selman, the judge said, is a "milliner’s delight by virtue of the number of hats that she wears."
At heart, Judge Schack is scratching at the notion that MERS is a legal fiction. If MERS owned nothing, how could it bounce mortgages around for more than a decade? And how could it file millions of foreclosure motions? These cases, Judge Schack wrote in February 2009, "force the court to determine if MERS, as nominee, acted with the utmost good faith and loyalty in the performance of its duties." The answer, he strongly suggested, was no.
Bricks and slaughter
by Andrew Palmer - Economist
Property is widely seen as a safe asset. It is arguably the most dangerous of all
There are plenty of candidates, from the ghost estates of Ireland to the foreclosure signs on American homes. But as a symbol of the property cycle that still distorts the world economy, the Burj Khalifa in Dubai takes some beating.
The world’s tallest building is literally built on sand. Its height, at half a mile (838 metres), violates a basic rule of commercial property: when land is plentiful, build outward to use up as much of it as possible. The building opened in January 2010, just weeks after the emirate announced a standstill on debts largely incurred on glitzy property projects. Its name was hastily changed from Burj Dubai to Burj Khalifa to honour the ruler of Abu Dhabi for sending bail-out funds to its fellow emirate. A year on, tourists cluster at its base to take photos or to visit the observation deck; inside, many of the flats lie empty.
Dubai’s record-breaker is also a powerful emblem of forgetfulness. According to Andrew Lawrence of Barclays Capital, the construction of exceptionally tall buildings is a reliable indicator of economic crises in the making. From the time the first skyscraper went up—the Equitable Life Building in New York, in 1870—to the completion of the Empire State Building (1931) and the World Trade Centre (1972) in the same city and the Petronas Towers in Kuala Lumpur (1998), great height has usually coincided with big trouble.
Mr Lawrence’s theory is not perfect, but it feels right. Property moves in cycles, and the more ambitious the scale of construction on the way up, the steeper the drop on the way down. A sharp turn in the property cycle is a serious matter. The five big banking blow-ups in the rich world before the latest crisis (Spain in the 1970s, Norway in the 1980s and Sweden, Finland and Japan in the 1990s) had property at their heart. Banking crises in the developing world have also tended to happen at the peak of housing booms or just after a bust in prices.
Not all booms are alike. There were many reasons for the housing bubble that has now burst, from huge amounts of global liquidity seeking high returns to the rise of private-label securitisation. But it is striking how often property causes financial trouble. "We do not want to fight the last war," says one European banking regulator, referring to property busts, "but the fact is that we keep fighting the same war over and over."
Markets remain horribly fragile. Dud commercial-property assets clog banks’ balance-sheets. House prices in America and several European markets are still falling. This special report will argue that the effects of property booms and busts can be made less damaging, but that the asset itself is inherently unsafe. Another rich-world bubble may be unlikely in the near term, but things feel very different in emerging markets. In China in particular, the worry is about another bubble that could shake the world economy. And even in developed markets, property, which many people regard as stable, will always be prone to volatility.
Why is property so dangerous? One obvious answer is the sheer size of the asset class. The aggregate value of property held by American households in the peak year of 2006 was $22.7 trillion, their biggest single asset by a wide margin (pension-fund reserves were next, at $12.8 trillion). Working out the figures in other countries involves much more guesswork.
Back in 2002 this newspaper reckoned that residential property in the rich world as a whole was worth about $48 trillion and the commercial sort $15 trillion: if you allow for property-price changes in the intervening period, the current values, even after the bust, would be $52 trillion and $28 trillion (see chart 1), or 126% and 67% respectively of the rich countries’ combined GDP in 2010. Whatever the precise number, property is so big that when credit conditions loosen it is likely to absorb a lot of the extra liquidity; and when something goes wrong the effects will be serious.
An even bigger reason to beware of property is the amount of debt it involves. Most people do not borrow to buy shares and bonds, and if they do, the degree of leverage usually hovers around half the value of the investment. Moreover, when stock prices fall, borrowers can usually get their loan-to-value ratios back into balance by selling some of the shares. By contrast, in many pre-crisis housing markets buyers routinely took on loans worth 90% or more of the value of the property. Most had no way of bringing down their debt short of selling the whole house. Gearing in commercial property was lower but in the boom years it still regularly touched 80-85% (it is now back to 60-65% for new borrowing in the rich world).
With only a small sliver of their own capital to protect them, many owners were quickly pushed into negative equity when property prices fell. As borrowers defaulted, the banks’ losses started to erode their own thin layers of capital. "Banks are leveraged and property is leveraged, so there is double leverage," says Brian Robertson, who runs HSBC’s British and European operations and used to be the bank’s chief risk officer. "That is why a property crash is a problem for the banks."
Property bubbles almost always start because fundamentals such as population growth, interest rates and economic expansion are benign. A shrinking population weighs on Germany’s housing market, for example, and a rising one underpins long-term confidence in America’s. These fundamentals explain why many market participants are able to persuade themselves that huge price rises are justified and sustainable. Chastened regulators now talk about a presumption of guilt, not innocence, when prices look frothy. That is because property markets are inefficient in several ways which make it more likely that they will overshoot.
For the lenders, property is attractive in part because it attracts lower capital charges than most other assets. That makes sense—the loan is secured by a tangible asset that will retain some value if the borrower defaults—but it can also lead to overlending. Indeed, one of the bigger ironies of the property bubble was that lenders and investors probably thought they were being relatively prudent.
Capital charges are higher for commercial property than for homes but banks can still be seduced by the apparent stability of a real asset producing predictable cash flows. "Commercial real estate is often a borrower of last resort," says Bart Gysens, an analyst at Morgan Stanley. "It tends to be willing to absorb a bit more debt if and when banks and debt markets want to provide it."
Collateralised lending offers a degree of protection to the individual lender, but it has some unfortunate systemic effects. One is the feedback loop between asset prices and the availability of credit. In a boom, rising property prices increase the value of the collateral held by banks, which makes them more willing to extend credit. Easier credit means that property can sell for more, driving up house prices further. The loop operates in reverse, too. As prices fall, lenders tighten their standards, forcing struggling borrowers to sell and speeding up the decline in prices. Since property accounts for so much of the financial system’s aggregate balance-sheet, losses from real-estate busts are likely to be synchronised across banks.
Borrowers, too, contribute to the inefficiency of property markets, particularly on the residential side. Some people think that renting will enjoy a renaissance as a result of the crisis, but few expect a wholesale, permanent shift in attitudes. Unlike other assets, housing is seen both as an investment and something to consume. In its latest survey of consumer attitudes in July 2010, Fannie Mae, one of America’s two housing-finance giants, found that Americans wanted to buy houses for a range of reasons, from providing a safe environment for their children and having more control over their living space to making a financial return. In China there is another item to put on the list: for many young men owning a property is a prerequisite for attracting a wife.
This mixture of motives can be toxic for financial stability. If housing were like any other consumer good, rising prices should eventually dampen demand. But since it is also seen as a financial asset, higher values are a signal to buy.
And if housing were simply a financial investment, buyers might be clearer-eyed in their decision-making. People generally do not fall in love with government bonds, and Treasuries have no other use to compensate for a fall in value. Housing is different. Greg Davies, a behavioural-finance expert at Barclays Wealth, says the experience of buying a home is a largely emotional one, similar to that of buying art. That makes it likelier that people will pay over the odds. Commercial property is a more rational affair, although hubris can play a part: there is nothing like a picture of a trophy property to adorn a fund manager’s annual report.
Once house prices start to rise, the momentum can build up quickly. No single individual (except, perhaps, Warren Buffett) can push up a company’s share price by buying its stock at an inflated price, but the price of residential property is set locally by the latest transactions. The value of any particular home, and the amount that can be borrowed against it, is largely determined by whatever a similar house nearby sells for. One absurd bid can push up prices for lots of people.
As prices rise, property is arguably more likely than many other asset classes to encourage speculation. One reason is that property is so much part of everyday life. People do not gossip about the value of copper and tin, but they like to talk about how much the neighbour’s house went for. They watch endless TV shows about houses and fancy themselves as interior designers, able to raise the price of their home with a new sofa and artful lighting. Eventually the temptation to take a punt on property becomes overwhelming. "Speculation is a bit like sex," says Robert Shiller of Yale University, a long-standing observer of speculative bubbles. "People who have lots of sex are not approved of but they are thought to live life with gusto. People eventually decided to try for themselves."
Even the risk-averse may well respond to rising prices by entering the market. Everyone needs somewhere to live, and many want to own their own homes. The amount of space that people need increases predictably over time as they find partners and have children. James Banks, Richard Blundell and Zoë Oldfield of Britain’s Institute for Fiscal Studies and James Smith of RAND, an American think-tank, find that this gives people an incentive to buy early in order to protect themselves against the risk of future price increases that would make houses unaffordable.
Another reason for momentum in property markets is the fact that there are no short-sellers. If you think property is overpriced, it is difficult to profit from that view. As Adam Levitin of Georgetown University Law Centre and Susan Wachter of the University of Pennsylvania pointed out in a recent paper on the causes of the housing bubble in America, it is impossible to borrow the Empire State Building in order to sell New York real estate short.
HSBC probably came closest by selling its Canary Wharf tower in London for £1.1 billion ($2.18 billion) in 2007 and buying it back from its debt-laden Spanish owners for £250m less in late 2008—the greatest short sale in the history of property, says one observer. Some investors infamously did make money from betting against American subprime mortgages, but their real achievement was to find a way of doing so, by buying up credit-default swaps that paid out when mortgage-backed securities soured.
There have been attempts to create instruments that allow property to be hedged or shorted. Mr Shiller himself has been involved in launching derivatives linked to home-price indices for both large and small investors, but with limited success to date. Commercial-property derivatives, however, are gaining ground.
Such products are conceptually appealing but face several obstacles. Some are common to all financial innovations: new products lack enough liquidity to lure buyers in, for example. Others are more specific to property. Individual properties and neighbourhoods differ, which makes it hard to construct accurate hedges. Government interventions to shore up the housing market add an extra element of unpredictability. And since house-price cycles tend to last for a long time, says Mike Poulos of Oliver Wyman, a consultancy, it can be expensive to sustain a short position.
Up, up and away with the fairies
The effects of buying a home when prices are rising are insidious. A 2008 paper by Hugo Benitez-Silva, Selcuk Eren, Frank Heiland and Sergi Jiménez-Martín used the Health and Retirement Study, a biennial survey of Americans over the age of 50, to compare people’s estimates of the value of their homes with actual values when a sale took place. The authors found that homeowners overestimate the value of their homes by an average of 5-10%.
Those who had bought during good times tended to be more optimistic in their valuations, whereas those who had bought during a downturn were more realistic. Expectations of higher prices explain why bubble-era buyers were more willing to buy risky mortgage products and take on ever greater quantities of debt. The amount of mortgage debt in America almost doubled between 2001 and 2007, to $10.5 trillion.
The rich-world buyers of today ought to be more realistic about the future value of their homes, but attitudes are deeply entrenched. When asked to rate the safety of various investments, two-thirds of the respondents in the Fannie Mae survey classed homeownership as a safe investment, compared with just 15% for buying shares. Only savings accounts and money-market funds, both of which enjoyed an explicit government guarantee during the financial crisis, scored higher than homes. Homeowners who were "under water" on their mortgages (ie, they owed more than their properties were worth) were just as sure as everyone else that housing was a safe investment.
If the Burj Khalifa shows that memories of property cycles are short, the Fannie Mae survey suggests that some of the lessons are never taken on board at all. Given the state of residential property around the rich world, perhaps the victims are suffering from post-traumatic amnesia.
Hey, S.E.C., That Escape Hatch Is Still Open
by Gretchen Morgenson - New York Times
It's hard to say what’s more exasperating: the woeful performance of the credit ratings agencies during the recent mortgage securities boom or the failure to hold them accountable in the bust that followed.
Not that Congress hasn’t tried, mind you. The Dodd-Frank financial reform law, enacted last year, imposed the same legal liabilities onMoody’s, Standard & Poor’sand other credit raters that have long applied to legal and accounting firms that attest to statements made in securities prospectuses. Investors cheered the legislation, which subjected the ratings agencies to what is known as expert liability under the securities laws.
But since Dodd-Frank passed, Congress’s noble attempt to protect investors from misconduct by ratings agencies has been thwarted by, of all things, the Securities & Exchange Commission. The S.E.C., which calls itself "the investor’s advocate," is quietly allowing the raters to escape this accountability.
When Dodd-Frank became law last July, it required that ratings agencies assigning grades to asset-backed securities be subject to expert liability from that moment on. This opened the agencies to lawsuits from investors, a policing mechanism that law firms and accountants have contended with for years. The agencies responded by refusing to allow their ratings to be disclosed in asset-backed securities deals. As a result, the market for these instruments froze on July 22.
The S.E.C. quickly issued a "no action" letter, indicating that it would not bring enforcement actions against issuers that did not disclose ratings in prospectuses. This removed the expert-liability threat for the ratings agencies, and the market began operating again. At the time, the S.E.C. said its action was intended to give issuers time to adapt to the Dodd-Frank rules and would stay in place for only six months. But on Jan. 24, the S.E.C. extended its nonenforcement stance indefinitely. Issuers are selling asset-backed securities without the ratings disclosures required under S.E.C. rules, and rating agencies are not subject to expert liability.
Martha Coakley, the attorney general of Massachusetts, has brought significant mortgage securities cases against Wall Street firms — and she is disturbed by the S.E.C.’s position. Last week, she sent a letter to Mary Schapiro, the chairwoman of the S.E.C., asking why the commission was refusing to enforce its rules and was thereby defeating Congressional intent where ratings agencies’ liability is concerned.
"We wanted to make clear that we see this as a problem and important enough that we would like an answer," Ms. Coakley said in an interview last week. "They are either going to enforce this or say why they are not. As a state regulator, we don’t enforce Dodd-Frank, but we certainly deal with the fallout when it is not enforced." An S.E.C. spokesman, John Nester, said that the agency would respond to Ms. Coakley.
Meredith Cross, director of the S.E.C.’s division of corporation finance, explained the agency’s decision to stand down on the issue: "If we didn’t provide the no-action relief to issuers, then they would do their transactions in the unregistered market," she said. "You would impede investor protection. We thought, notwithstanding the grief we would take, that it would be better to have these securities done in the registered market."
Unfortunately, the S.E.C.’s actions appear to continue the decades of special treatment bestowed upon the credit raters. Among the perquisites enjoyed by established credit raters is protection from competition, since regulators were required to approve new entrants to the business. Regulators have also sanctioned the agencies’ ratings by embedding them into the investment process: financial institutions post less capital against securities rated at or above a certain level, for example, and investment managers atinsurance companies andmutual funds are allowed to buy only securities receiving certain grades.
This is a recipe for disaster. Given that ratings were required and the firms had limited competition, they had little incentive to assess securities aggressively or properly. Their assessments of mortgage securities were singularly off-base, causing hundreds of billions in losses among investors who had relied on ratings.
That the S.E.C.’s move strengthens the ratings agencies’ protection from investor lawsuits, which runs counter to the intention of Dodd-Frank, is also disturbing. Moody’s and Standard & Poor’s have argued successfully for years that their grades are opinions and subject to the same First Amendment protections that journalists receive. This position has made lawsuits against the raters exceedingly difficult to mount, a problem that Dodd-Frank was supposed to fix.
I asked RepresentativeBarney Frank, the Massachusetts Democrat whose name is on the 2010 financial reform legislation, if he was concerned that the S.E.C.’s inaction was enabling ratings agencies to evade liability. Mr. Frank said he believed the S.E.C.’s move was part of a longer-term strategy to eliminate investor reliance on ratings and remove, at long last, all references to credit ratings agencies in government statutes. Indeed, the S.E.C. proposed a new rule last week that would eliminate the requirement that money market funds buy only securities with high credit ratings. If the rule goes through, fund boards would have to make their own determinations that the instruments they buy are of superior credit quality.
Still, Mr. Frank said, the commission could do a better job of explaining that its nonenforcement stance is part of an effort to reduce reliance on ratings. "The message should not be lax enforcement by the S.E.C.; it should be a lack of confidence in the ratings," he said.
The problem is that it could take years to rid the investment arena of all references to ratings. In the meantime, the S.E.C. is letting the ratings agencies escape accountability once again. Moreover, investors are right to fear that the S.E.C. may be capitulating to threats by the ratings agencies to boycott the securitization market as long as they are subject to expert liability. After all, Moody’s and S.& P. have succeeded before in derailing attempts by legislators to bring accountability to asset-backed securities.
Back in 2003, for example, Georgia’s legislature enacted one of the toughest predatory-lending laws in the nation. Part of the law allowed issuers of and investors in mortgage pools to be held liable if the loanswere found to be abusive. Shortly after that law went into effect, the ratings agencies refused to rate mortgage securities containing Georgia loans because of this potential liability. The law was soon rewritten to eliminate the liability, allowing predatory lending to flourish.
It is certainly important that the S.E.C. work to eliminate references to ratings in the investment arena, and to reduce investor reliance on them. But Congress couldn’t have been clearer in its intent of holding the agencies accountable. That the S.E.C. is undermining that goal is absurd in the extreme.
Budget held hostage, Day 155
by Charles Riley - CNN Money
Friday was the 155th day the federal government has operated without a budget, and some lawmakers spent it arguing over nickels and dimes. Republican Sens. Jim DeMint of South Carolina and Tom Coburn of Oklahoma introduced a bill Friday that would save a little more than $400 million a year by stripping all federal funding for the Corporation for Public Broadcasting. That's $400 million with an "m," not a "b" -- and it pales in comparison to the roughly $3.5 trillion the government will spend this year.
Still, the senators framed the issue as a fiscal plus. "Our nation is on the edge of bankruptcy and Congress must make some tough choices to rein in spending, but ending taxpayer subsidies of public broadcasting should be an easy decision," DeMint said in a statement. Indeed, every little bit counts. But a squabble over funding for NPR and PBS does nothing to advance the discussion over the prime issue in the next two weeks: How to avoid a government shutdown.
Lawmakers' deadline is March 18, when the latest short-term spending bill -- the fifth this year -- expires. That's the game of chicken the government has been playing since the fiscal year started on Oct. 1. On Friday, President Obama sent his top lieutenants to Capitol Hill to start negotiations with Republicans on a compromise bill. It would appear that little progress was made. The White House put an additional $6.5 billion in cuts on the table, but Republicans are hoping to cut ten times that, and have already passed a bill in the House that would do just that.
The bill is called H.R. 1, and it would also strip funds for public broadcasting. Democrats in the Senate, as well as President Obama, have declared that bill a non-starter. They object not only to the total amount of spending cuts, but the ideological bent of some items. As if to prove their point, DeMint railed against NPR and PBS for accepting donations from liberal organizations like MoveOn.org and a group backed by liberal financier George Soros in an op-ed published Friday in the Wall Street Journal.
"Highly successful, brand-name public programs like Sesame Street make millions on their own," DeMint said, citing sales from toys and consumer products. "With earnings like that, Big Bird doesn't need the taxpayers to help him compete against the Nickelodeon cable channel's Dora the Explorer." A spokeswoman for Sesame Workshop, which produces "Sesame Street," would not comment on the proposal, but the company's website says that 93% of production costs for the show are covered by licensing activities or corporate sponsorships.
The bill introduced Friday by Coburn and DeMint might be the start of an effort to isolate some of those controversial political issues and jump them onto another legislative track. But regardless of the legislative vehicle, stripping public broadcasting of funds will be met with a fierce outcry from supporters of NPR and PBS.
There is already a small army of lobbyists on Capitol Hill lobbying in defense of the funding, which the organizations insist provide a crucial boost to their budgets. A vast majority of federal funds directed to CPB trickle down to local stations, and if those funding levels are cut, supporters of public broadcasting say, many stations, especially in rural areas, would be significantly impacted.
And that, after years of fighting over the issue, seems to be where the two sides part. "The federal government has no business picking winners and losers in today's highly competitive media environment. NPR and CPB will do just fine without largesse from Washington," Coburn said in a statement.
Why employee pensions aren't bankrupting states
by Kevin G. Hall - McClatchy Newspapers
From state legislatures to Congress to tea party rallies, a vocal backlash is rising against what are perceived as too-generous retirement benefits for state and local government workers. However, that widespread perception doesn't match reality.
A close look at state and local pension plans across the nation, and a comparison of them to those in the private sector, reveals a more complicated story. However, the short answer is that there's simply no evidence that state pensions are the current burden to public finances that their critics claim.
Pension contributions from state and local employers aren't blowing up budgets. They amount to just 2.9 percent of state spending, on average, according to the National Association of State Retirement Administrators. The Center for Retirement Research at Boston College puts the figure a bit higher at 3.8 percent.
Though there's no direct comparison, state and local pension contributions approximate the burden shouldered by private companies. The nonpartisan Employee Benefit Research Institute estimates that retirement funding for private employers amounts to about 3.5 percent of employee compensation.
Nor are state and local government pension funds broke. They're underfunded, in large measure because — like the investments held in 401(k) plans by American private-sector employees — they sunk along with the entire stock market during the Great Recession of 2007-2009. And like 401(k) plans, the investments made by public-sector pension plans are increasingly on firmer footing as the rising tide on Wall Street lifts all boats.
Boston College researchers project that if the assets in state and local pension plans were frozen tomorrow and there was no more growth in investment returns, there'd still be enough money in most state plans to pay benefits for years to come.
"On average, with the assets on hand today, plans are able to pay annual benefits at their current level for another 13 years. This assumes, pessimistically, that plans make no future pension contributions and there is no growth in assets," said Jean-Pierre Aubry, a researcher specializing in state and local pensions for the nonpartisan Center for Retirement Research at Boston College.
In 2006, when the economy was humming before the financial crisis began, the value of assets in state and local pension funds covered promised benefits for a period of just over 19 years.
At the bottom of Aubry's list is Kentucky, which would have enough assets to cover 4.7 years. Other states do much better: North Carolina local government pensions are funded to cover 19 years of promised benefits; Florida's state plan could cover 17 years; and California's plans about 15 years.
"On the whole, the pension system isn't bankrupting every state in the country," Aubry said.
States having the biggest problems with pension obligations tend to be struggling with overall fiscal woes — New Jersey and Illinois in particular. Many states are now wrestling with underfunding because they didn't contribute enough during boom years.
Most state and local employees government across the nation have defined-benefit plans that promise employees either a percentage of their final salary during retirement or some fixed amount. The Bureau of Labor Statistics estimates that 91 percent of full-time state and local government workers have access to defined-benefit plans.
Several states_ including Florida, Georgia, Ohio, Colorado and Washington_ have adopted competing defined-contribution plans, or a hybrid plan that provides government employees both a partial defined benefit in retirement and a supplementary defined-contribution plan.
Defined-contribution 401(k) plans divert on a tax-deferred basis a portion of pay, generally partially matched by the employer, into an account that invests in stocks and bonds. In 1980, 84 percent of workers at medium and large companies in the U.S. had a defined-benefit plan like those still predominate in the public sector. By last year, just 30 percent of workers in these larger companies were covered under such plans.
Defenders of the public pension system say anti-government, anti-union elected officials and interest groups have exaggerated the problem to score political points, and that as the economy heals, public pension plans will gain value and prove critics wrong.
"There's a window that's closing as market conditions improve and interest rates rise, the funding of these plans is going to look better than depicted by some," insisted Keith Brainard, the director of research for the National Association of State Retirement Administrators in Georgetown, Texas.
Critics of public sector pensions paint the problem with a broad brush.
"Unionized government workers have tremendous leverage to negotiate their own wages and benefits. They funnel tens of millions of dollars to elect candidates who will sit across from them at the negotiating table," said Thomas Donohue, the chief executive of the U.S. Chamber of Commerce, in a Feb. 24 blog post. "This self-dealing has resulted in ever-increasing wage and benefit packages for unionized government workers that often far outstrip those for comparable private-sector workers."
In a Feb. 23 radio interview, Rep. Devin Nunes, R-Calif., called federal stimulus efforts to rescue the economy "essentially a federal bailout of public employee unions." Nunes described money owed to state pensioners as a crisis "about ready to happen."
Except that two out of every three public-sector workers aren't union members.
The Bureau of Labor Statistics reported in January that 31.1 percent of state public-sector workers were unionized in 2010, compared with 26.8 percent of federal government employees. The highest percentage of unionization, 43.3 percent, was found in local government, where police officers and firefighters work. Teachers can fall into either state systems or local government.
Ironically, in Wisconsin, where Republican Gov. Scott Walker is trying to weaken public-sector unions and reduce pension benefits, he's exempted police and firefighters, who are among the most unionized public employees. And Wisconsin's public-sector pension plan still has enough assets today to cover more than 18 years of benefits.
The most recent Public Fund Survey by the National Association of State Retirement Administrators showed that, on average, state and local pensions were 78.9 percent funded, with about $688 billion in unfunded promises to pensioners. Critics suggest that the real number is at least $1 trillion or higher, using less-optimistic market assumptions.
The unfunded liabilities would be a problem if all state and local retirees went into retirement at once, but they won't. Nor will state governments go out of business and hand underfunded pension plans over to a federal regulator, as happens in the private sector. State and local governments are ongoing enterprises.
The flow of employees into retirement matches up with population trends in states, with Northeastern states with declining populations, particularly Rhode Island, seeing more stress on their pension systems than Southern and Western states, where there's been vibrant population growth.
Another misperception tied to the pension debate is that while the private sector has shed jobs during the economic crisis, state and local government employment has grown — and pensions along with it.
Since September 2008_ when state and local government employees numbered 19,385,000 and the economic crisis turned severe — the governments' payrolls shrunk by 407,000, to 18,978,000 this January, according to Bureau of Labor Statistics data.
When calculating from December 2007_ the month that the National Bureau of Economic Research determined was the start of the Great Recession_ state and local government employment has fallen by 703,000 jobs amid a downturn that cost the nation more than 8 million jobs overall.
"The down economy has had an effect, and the loss of employment outside the public sector has created a contrast" said Brainard, of the National Association of State Retirement Administrators.
Also fueling backlash is the perception that state and local workers don't contribute to their own retirement funds the way private sector workers do.
Four states have non-contribution public pension plans_ Florida, Utah, Oregon and Connecticut. Missouri until recently had a non-contribution policy for state workers, as did Michigan until 1997. Michigan workers hired before 1997 still don't pay toward their pensions, and some teachers in Arkansas don't have to contribute toward theirs. Tennessee doesn't require contributions from most workers and employees in the state higher education system.
Those notable exceptions aside, most states require employee contributions. The midpoint for these contributions for all states and the District of Columbia is 5 percent of pay, according to academic and state-level research. That contribution rate climbs to 8 percent for the handful of states whose workers or teachers are prohibited from paying into the federal Social Security program.
By comparison, private-sector workers shoulder a bit more of the burden.
In its data for 2010, Fidelity Investments, the largest administrator of private-sector 401(k) retirement plans, showed employee contribution rates in its plans averaged 8.2 percent of pre-tax pay.
Separately, the Employee Benefits Research Institution estimates that most private-sector employers match up to 50 percent of employee contributions up to the first 6 percent of salary.
The utility or burden of either type of retirement plan depends on whether the plan is measured by what it delivers to an individual, or by how much it delivers to all workers receiving retirement benefits from their employer.
"It really comes down to what you are attempting to do," said Dallas Salisbury, the president of the nonpartisan Employee Benefit Research Institute.
Viewed through the lens of an employee, defined-benefit plans are more cost-effective at providing a pre-determined level of benefits to an employee. But the shortcoming of these plans is that they reward seniority. For workers with a shorter tenure, they're far less generous in retirement.
This fairness issue is one reason why 401(k) plans have grown steadily in prominence since the mid-1980s. From the payroll perspective of an employer, these defined-contribution plans produce at least some retirement income for the greatest number of employees, and the plans can move with employees who change jobs.
Inflation Endangering Chinese 'Dream' Spurs Wen Pledge to Rein In Prices
by Kevin Hamlin - Bloomberg
Premier Wen Jiabao’s pledge to stem inflation underscored forecasts for more interest-rate increases as a jump in food and housing prices risks sparking public anger. Wen, in his opening speech to the annual National People’s Congress conclave in Beijing two days ago, said that reining in consumer and property prices is the nation’s top priority. That will be welcome to fruit vendor Song Zhiqiang, 56, of the southwestern city of Guiyang, who says: "My rent’s doubled in a year and my family’s food budget has increased to 3,000 yuan," or $456, from 1,200 yuan.
Policy makers’ 4 percent inflation target for this year was exceeded by almost a percentage point in February, according to the median estimate in a Bloomberg News survey. Without higher deposit rates to encourage saving, and a stronger currency to ease import costs, the risk is that price pressures will keep escalating in coming months. "The skew of risks is very much for an extended period of uncontained inflation," said Glenn Maguire, chief Asia economist at Societe Generale SA in Hong Kong. "The danger is that inflation spikes as high as 10 percent in the third quarter, causing households tremendous pain and fuelling widespread social discontent."
For their part, investors have signaled diminished concern that Wen’s government will tighten monetary policy so fast that it will hobble growth in the world’s fastest-expanding major economy. The benchmark Shanghai Composite Index of stocks has climbed in five of the past six weeks, closing on March 4 at the highest level since mid-November.
Additional increases in benchmark interest rates and banks’ reserve requirements may help to bring price pressures under control, Maguire said. Nomura Holdings Inc. forecasts 0.75 percentage point of interest-rate increases by year-end, along with gains in banks’ reserve ratios. The key one-year lending rate is 6.06 percent after three increases since mid-October and the deposit rate is 3 percent. The yuan, described as "substantially undervalued" by the U.S., traded at 6.5686 per dollar on March 4.
"Exorbitant" house price increases in some cities are a top public concern, Wen told the thousands of lawmakers gathered in Beijing, adding that the government will curb speculation and "adjust and improve" real-estate tax policies. The budget for this year shows a 35 percent increase in spending on low-income housing.
With real-estate values climbing in the aftermath of the record credit boom unleashed during the global financial crisis, slums have emerged in cities including Beijing and Shanghai as migrant workers and cash-strapped urban youth seek an affordable place to live. "My dream of owning a house is drifting further away because home prices have increased by a huge margin, outpacing my salary gains," said Tao Jianyi, 32, an electrical engineer in Beijing. "The government has a lot to do to make homes affordable and within the reach of ordinary income earners."
At the congress, official reports confirmed targets of 4 percent inflation and 8 percent economic growth for this year and showed that the nation will spend more on the internal police force than the armed forces. An online call for protests in China, inspired by uprisings in the Middle East, has highlighted the risk of social unrest. The government has deployed hundreds of police in Beijing and Shanghai after an open letter called for "jasmine" rallies, named after the January uprising in Tunisia that overthrew President Zine El Abidine Ben Ali.
Across the country, consumer prices rose an annual 4.9 percent in January as food costs jumped, while in Beijing, new home prices climbed 6.8 percent. In February, inflation was 4.8 percent, according to the median forecast in a survey of 22 economists. That number is due to be announced this week. In his speech, Wen said that keeping prices stable is the "top priority in macroeconomic control" for this year and the government aims to narrow the widening gap between rich and poor "as soon as possible."
"People in China are very unhappy," said Huang Yiping, an economics professor at Peking University in Beijing. "Inflation driven by food prices is very destabilizing for the economy and society because it’s reducing everybody’s purchasing power and mostly it damages the welfare of low-income households." Wen had already disclosed that the nation will cut its annual growth target to 7 percent in the five-year plan running from 2011 to 2015 from 7.5 percent in the previous period.
While such targets are routinely surpassed -- annual growth averaged 11 percent in the past five years -- the new goal may signal that the government accepts that the expansion will moderate as part of reshaping the economy. Wen, who describes China’s growth model as "unsustainable," aims to curb dependence on exports and investment and bolster consumer demand. This year, subsidies for urban low-income earners and farmers and continued incentives for rural purchases of home appliances may help to boost spending, Wen said. The government plans more increases in minimum wages and to raise the income- tax threshold from 2,000 yuan.
"We still only expect glacial changes in the composition of China’s economy in the coming five years," said Shen Minggao, head of China research at Citigroup Inc. in Hong Kong. "In the past, numerous reform efforts were delayed or gutted on downside risks to growth and upside risks to inflation."
In Guiyang, fruit seller Song’s expenses are surging at the same time as his sales have slowed because of rising prices, he said. The price of apples has leapt 40 percent from a year earlier to 7 yuan a jin (half a kilogram) and water melons are up 20 percent, he added. "I want to bring my wife’s aging parents to live with us in the city from 100 kilometers away but we just can’t afford it," he said. "Five years ago rents were cheaper and making money was easier."
Moody’s cuts Greek rating, stokes debt fears
by William L. Watts - MarketWatch
Greece calls rating cut ‘unjustified, incomprehensible’
Moody’s Investors Service on Monday cut Greece’s sovereign debt rating three notches to B1, infuriating the Greek government and slightly denting the euro amid renewed worries about the ability of Greece and other debt-loaded euro-zone governments to avoid default.
Moody’s, which assigned a negative outlook to Greece’s ratings, highlighted the government’s difficulties with revenue collection and said there is a risk that Athens might not meet the criteria for continued support from the International Monetary Fund and the European Union after 2013, which may result in a voluntary restructuring of existing debt. Moody’s said the decision to cut Greece’s rating from B1 reflected concerns that the "fiscal consolidation measures and structural reforms that are needed to stabilize the country’s debt metrics remain very ambitious and are subject to significant implementation risks, despite the progress that has been made to date."
‘Unjustified’ and ‘incomprehensible’
The Greek government slammed the downgrade as "completely unjustified." In a strongly worded statement, the Finance Ministry said the decision "does not reflect an objective and balanced assessment of the conditions Greece is presently facing." The ministry called the timing and multi-notch nature of the downgrade "incomprehensible" and said the action raised a number of questions.
Gary Jenkins, head of fixed-income research at Evolution Securities, said Moody’s arguments appear "reasonable enough" and that the agency’s concerns about the potential for a voluntary restructuring "represent pretty much a consensus view. Although maybe without the use of the word ‘voluntary.’" Greece has implemented sweeping and controversial austerity measures, including wage freezes and tax hikes, as it struggles to cut a massive debt pile. Athens was forced last year to accept a 110 billion euro ($153.8 billion) bailout from the European Union and International Monetary Fund in order to avoid default.
The yield on Greek 10-year government bonds rose to 12.12 % on Friday, moving back above the 12% level for the first time since January, Jenkins said, while the two-year spread had hit 15.22%. "The report may revive concerns over the sovereign debt problems of the periphery economies in the region," said Boris Schlossberg, director of currency research at GFT. The issue has largely disappeared from the headlines over the past several months as traders focused on the robust growth of the core European economies and the possibility of ECB rate hikes within the next month, he said.
The Greek government said Moody’s analysis overlooks a rise in revenues equal to almost 6% of gross domestic product following the adoption of the 2010 budget, despite a 4.5% contraction in GDP, and anticipates the failure of measures that are yet to be voted on or are in the early stages of implementation. The ministry said the cut underlines "the misaligned incentives and the lack of accountability of credit-rating agencies," which it said are now competing with each other to identify the risks that will lead to the next crisis after having "completely missed" the build-up to the 2008 financial crisis.
The ministry said "unbalanced and unjustified rating decisions, such as Moody’s today, can initiate damaging self-fulfilling prophecies and certainly strengthen the arguments for tighter regulation of the rating agencies themselves."
European Central Bank Wants to Unload PIIGS Bonds
During the crisis, the European Central Bank began buying up bonds from debt-ridden countries like Greece. Now the bank wants to transfer responsibility for those securities to the EU's euro rescue fund. Meanwhile, the parliamentary group of German Chancellor Angela Merkel's conservatives have issued a resolution opposing such bond purchases. At the peak of the debt crisis in Europe, the European Central Bank committed a break with tradition that many at the time considered to be a cardinal sin. The bank began buying up massive amounts of sovereign bonds from euro-zone countries that faced the risk of insolvency and which were having trouble selling their bonds on the public market.
Now the ECB wants to stop the practice. Sources with direct knowledge of the developments have told SPIEGEL that the central bank, in internal discussions, is pressuring governments of the 17 euro-zone countries to transfer the bonds purchased to the European Union's euro rescue fund, the European Financial Stability Facility (EFSF). The calls are being led by ECB President Jean-Claude Trichet of France, who wants to free the bank of the burden, the sources said. The ECB is seeking to transfer a package of bonds valuing a total of €77 billion ($107.5 billion), but so far the member states have expressed little enthusiasm for the idea.
Movement on the front could now come from a less obvious corner -- that of German Chancellor Angela Merkel and Finance Minister Wolfgang Schäuble. Merkel's conservative Christian Democratic Union (CDU) party's group in parliament is strictly opposed to the purchase of state bonds through the EFSF, but SPIEGEL has learned from sources that neither Merkel nor Schäuble feels bound in their vote in Brussels to the parliamentary group's position. The chancellor and finance minister are opposed to the direct purchase of bonds by the EFSF, but they are not opposed to troubled countries taking loans from the rescue fund in order to buy back their own bonds from the market. Because the bonds would be bought back at a discount rate, the private sector would also be held indirectly liable for the losses, fulfilling a key demand that Merkel has been pushing for.
'No Room for Interpretation'
The development, however, could spark yet another round of bickering in Merkel's coalition government. Senior members of parliament in Merkel's CDU, its Bavarian sister party the Christian Social Union (CSU) and the business-friendly Free Democratic Party (FDP), are already warning the chancellor not to take their message lightly. "We have made it clear that we reject any form of a buying program for state bonds -- there is no room for interpretation," said Michael Meister, deputy chairman of the joint CDU and CSU party group in parliament. In recent days, the parliamentary group, which dictates the CDU and CSU's joint stances in the Bundestag, passed a resolution together with FDP parliamentary leaders, stating that the purchase of state bonds of ailing euro-zone member states by other countries should be "ruled out."
Initially, firmer language had been planned in the resolution, with a call for an explicit ban on such bond purchases. But after Merkel intervened and went to the chairman of the parliamentary group, Volker Kauder, the language was watered down. Instead of a blanket ban, the parliamentary group states only that it "expects" such a ban to be implemented. The CDU's Meister, however, cautioned that the implementation of any deal would still require the approval of both Germany's federal parliament, the Bundestag, as well as the Bundesrat, the upper legislative chamber that represents the states and also has the right of co-determination on many important issues. Merkel's coalition government does not currently hold a majority in the Bundesrat. "The federal government would be well advised not to disappoint us too much," he said.
Michael Fuchs, likewise a deputy chair of the conservatives' parliamentary group, has also expressed his opposition to such bond-buying programs. He warned that Greece cannot become the model for how European countries can "inexpensively dispose of part of their debt." Meanwhile, FDP finance expert Hermann Otto Solms has said he is also "strictly opposed to allowing the rescue fund to provide loans to indebted nations to buy back their state bonds." He said it was questionable whether such actions could be reconciled with Germany's constitution. "What is being proposed here is nothing other than a transfer union through the back door," Solms claimed.
Bar to be raised for EU bank stress test
by Patrick Jenkins and Brooke Masters - Financial Times
European banking regulators are preparing to introduce a "near fail" category into the new stress test process as part of a mechanism to force recapitalisations on weaker banks. The European bank stress tests of a year ago saw all but seven of the 91 banks in the exercise pass a 6 per cent tier one capital threshold, a measure of financial strength. But their credibility was called into question when two Irish banks that had passed the test had to be bailed out only four months later.
This time, the tests, being administered by the new European Banking Authority, which replaced the Committee of European Banking Supervisors, will be designed to be more robust. The EBA said last week that it planned to test the banks against both a baseline and an extremely negative macroeconomic situation, as well as country-specific shocks on property prices, interest rates and government borrowing. Details of those scenarios, and the methodology by which they will be applied, are to be made public in coming weeks, following discussions with the banks and national regulators. The actual testing is due to begin next month, with the results set to be made public in June.
Recognising the shortcomings of last year’s exercise, Andrea Enria, new chairman of the EBA, told the Financial Times he was determined to make the exercise more credible – and to use it as a trigger for a thorough recapitalisation of Europe’s weakest banks. "What I would very much like to see is not a simple pass-fail outcome to these tests – if you pass, nothing to be done, if you fail, you have to raise capital by that amount," Mr Enria said. "It would be nice to have supervisory actions also for banks that have maybe passed the test, but are very close or have other areas of concern." As a mechanism to achieve that, he said "supervisory action might include also pressure on [dividend] distributions".
Although the EBA does not have the powers to order a bank directly to seek fresh capital, it does have greater authority than its predecessor body to pressure national regulators to carry out its wishes. Analysts believe the basic parameters for the test will be similar to last year’s. It will again exclude a stress scenario for eurozone sovereign default – deemed too politically sensitive – though that is set to be a factor in a separate liquidity stress test to assess the strength of banks’ operational funding, which will not be published. The test is also expected to stick to a definition of "tier one" capital, rather than the stricter "core tier one" – essentially just equity – which international regulators are pushing banks towards.
Flat-Earth European Central Bank misreads oil spike again, and kicks Spain in the teeth
by Ambrose Evans-Pritchard
The European Central Bank has once again risen to the bait. Faced with an oil supply shock that deflates incomes, it plans to tighten the vice yet further with a knee-jerk rate rise in April. The demarche is reckless, politically-motivated, and risks causing yet another spasm of the EMU debt crisis. If recovery proves to be more fragile than it looks – vulnerable to a fiscal squeeze in the West and a credit squeeze in the East – this ECB error will have global ramifications. The ECB's governors might usefully study Systematic Monetary Policy and the Effects of Oil Price Shocks, a seminal work in 1997 by a Professor Ben Bernanke of Princeton.
The reason why such shocks often lead to slumps is because policymakers make a hash of it. "The majority of the impact of an oil price shock on the real economy is attributable to the central bank’s response, not the inflationary pressures engendered by the shock," wrote Bernanke. No doubt ECB governors need to prove their hawkishness after Bundesbank chief Axel Weber walked out of the Eurotower in disgust, more or less stating that he did not wish to take over a body that had departed so far from orthodoxy, and succumbed to political pressure by purchasing the bonds of bankrupt states. They are right to be worried. The euro lives or dies on German sufferance. The unwritten contract of Maastricht is that EMU must be run on German terms, with a German veto over monetary policy. This contract is being tested.
Dr Weber could hardly have done more to fuel the raging flames of euroscepticism in Germany, where 189 professors have warned of "fatal consequences" if the EU crosses the Rubicon to a `transfer union’ of shared debt liabilities. The three Bundestag blocs in Angela Merkel's coalition have issued a paper virtually ordering her to resist demands for yet more bail-out concessions at this month’s EU summit. So yes, the ECB has a credibility problem in Germany. Yet to raise rates into an oil shock – as it did July 2008 when the global system was already buckling – is the central banking cousin of Flat Earth belief. This is not a repeat of 2008, of course, yet something is still deeply wrong. The M3 money supply contracted in January and December. It has been negative since August (from €9.52 trillion to €9.48 trillion), and so has narrow M1. Private credit is growing at just 2pc.
This is the same bank that sat on its hands through the torrid autumn of 2005, keeping real rates negative as M3 growth rose at 8pc (double the ECB’s reference rate of 4.5pc), and as the Irish/Club Med property bubbles spiralled out of control. Germany needed rates below the Euroland equilibrium at that moment. This is dirty secret that almost everybody in the German policy debate now chooses to forget, or never acknowledged. The ECB discriminated against Club Med. I should have thought Spain could sue the bank for misconduct at the European Court over that breach of its mandate. Spain is now being whacked again. One-year Euribor rates jumped 14 basis points to 1.92pc within hours after ECB chief Jean-Claude Trichet uttered the code words "strong vigilance". As the ECB knows, this is the rate used to price most Spanish mortgages.
Homeowners due for rescheduling in March will take the hit immediately. Fresh waves will follow each month, with knock-on effects for banks and Cajas already grappling with record defaults. Fitch Ratings said on Friday that the financial system will need €38bn in fresh capital to right the ship. The Spanish might justly feel aggrieved, and judging by the comment threads of the Madrid press – "Put Trichet on trial", "Leave the EU immediately", "Create a currency for the South" – a vocal minority of Spaniards are going through their moment of EMU Epiphany. Spain is doing what is required: slashing its twin deficits; biting the bullet on the Cajas (unlike Germany with the Landesbanken); and boosting exports faster than France or Italy. But Spain's chances of pulling through without a blow-up are contingent on EU authorities not committing another of their serial stupidities.
It was Mrs Merkel's call for creditor haircuts in October that pulled the rug from under the Irish, and set off EMU's Autumn contagion. Now the ECB is tossing its own hand-grenade into the peripheral debt markets, and doing so before there is any grand deal by EU leaders on a viable EU rescue machinery. A month ago Mr Trichet sought to dampen prospects of a rate rise, insisting that inflation was "contained". Since then there has been a Mid-East revolution, the loss of 1m barrels of day (bpd) of Libyan oil, and a $15 premium on Brent crude to reflect the risk of Saudi revolt? This is dramatic, but not in itself inflationary. Oil supply shocks depress the rest of the economy. They drain demand, acting as a tax siphoned off to Mid-East rentiers or the Kremlin. Headline inflation rises, but it signals the opposite of what is happening below the water line.
The ECB seems caught in a 1970s time-warp, wedded to the fallacy that the Yom Kippur oil shock caused the Great Inflation. The actual cause was rampant growth of the broad money supply, US spending on the Vietnam War and the Great Society, and a near ubiquitous picture of over-stimulus and over-heating across the West. It was a demand story, not a supply shock. Chalk and cheese. The West is not over-heating today, except perhaps Germany, and that may not last as China slows. The eurozone grew just 0.3pc in the fourth quarter of 2010. The UK contracted. The US labour participation rate has continued falling over the last year to 64.2pc, the lowest since 1984.
Yes, China, India, and Brazil are overheating, pushing up global crude, metal, and grain prices. China alone is adding 850,000 bpd of oil demand each year, eating deep into global spare capacity. This is indeed a commodity demand story for the BRICs, but it has the characteristics of a supply shock for the West. There is nothing the ECB can usefully do about this, and it is suicidal to try. It is the task of the People's Bank to curb China’s credit bubble. Trichet invoked the ECB's shibboleth of "second round" inflation effects. This is a sick joke as Spain and Portugal cut public wages by 5pc, Italy imposes a pay-freeze, and Ireland cuts the minimum wage by 11pc.
What he really meant is that settlements in Germany are creeping up. The car workers union IG Metall has secured a pay deal of 3pc to 3.5pc. Higher pay in Germany is exactly what is needed to help narrow the North-South gap in competitiveness without forcing wage deflation on Club Med, and it is exactly what the EMU-lords refuse to countenance. So the whole Euroland system must have a 1930s deflation bias. It is twelve years since the launch of EMU. There has been no meaningful convergence of the disparate economies since then. The one-size-fits-all monetary policy continues to cause havoc. All that changes with the evolving economic cycle is a rotation in the locus of stress, and a change in its features. Meanwhile, everything is tilted to meet the German imperative, but not enough to satisfy Germany. Nobody is satisfied. Membership of monetary union as currently constructed is like walking with a sharp stone in your shoe, forever. You can put up with it, or take the stone out.
Rich rush for insurance cover amid Middle East turmoil
by Julia Kollewe - Guardian
Insurers have been inundated with requests for cover from wealthy individuals, oil traders and multinationals in North Africa and theMiddle East amid fears that civil unrest will spread further across the region.
Andrew Brooks, chief executive of Ascot Underwriting, a Lloyd's of London insurer, said the company had received 40 enquiries from the region in a morning last week: "Ascot has seen a substantial up-tick for insurance enquiries in the Middle East. Initially, these were mainly from individuals trying to protect their personal assets such as fine art and property in Egypt and Bahrain, but as the unrest has spread into Libya, we have seen oil companies and oil traders enquiring about the availability of insurance products to protect their assets."
He recounted that one person wanted extra cover for an art collection worth $3m (£1.84m) in Cairo while oil traders in Libya fear stocks being seized as the country edges towards civil war. Some oil and gas companies are scrambling to get forced abandonment cover for their mobile equipment, such as rigs.
Ascot's chairman, the former MI6 chief Sir Richard Dearlove, said the security situation posed the most severe challenge since 9/11: "The potential for those accustomed to benign market conditions to take losses on a scale not seen since the period after 9/11 will be severe. A shake-up in the [insurance] market, which is overdue, looks imminent." Underwriters and brokers expect premiums to go up as a result of the turmoil. Stephen Ashwell, head of Global Response at insurer Hiscox, said: "Last week we had a queue from our box at Lloyd's that stretched all the way down Lime Street. I haven't seen such an upsurge in business since 9/11."
He said clients were looking for broader cover that protects them against any eventuality from political violence to war and terrorism. One problem is that reinsurers, the majority of which moved to exclude terrorism from their standard policies after the 9/11 attacks, are now likely to restrict their riots and strikes coverage to minimise their losses.
London is the centre of the global terrorism and political violence insurance market. Hiscox said most of the enquiries were coming from local companies and multinationals operating in Bahrain, but also Egypt and Libya and, interestingly, Saudi Arabia, Dubai and the United Arab Emirates, which have yet to encounter any political unrest. Similarly, Alex Clayton, executive director of brokerage Willis' Global Markets International division, said enquiries from Bahrain had doubled, in particular from hotel and shopping mall operators, and insurance rates are "definitely going up".
"We are seeing more of the banks and financiers who lend money to big oil and infrastructure projects insisting companies have political violence cover in the event a property is attacked." Clayton said most of Willis' clients have civil commotion cover under their All-Risk insurance policies, but those that don't are rushing to get standalone political violence insurance. He also noted that last year's riots in Thailand were defined as terrorism by the Thai government, so if the Egyptian government decided to go down the same route, some companies would not be covered for terrorism under their All-Risk policies.
Brooks said: "Some insurance companies only look at aggregation on a country-by-country basis, but now all markets will have to look at cross border exposure." He added the situation was highly unpredictable and could easily implode. He drew an analogy with the break-up of the former Yugoslavia and its civil war following the end of the Soviet Union, saying tribal groups could come to the fore, resulting in a "Balkanisation of the Middle East".
Portugal hovers on the verge of crisis as eurozone argues over integration
by Heather Stewart - Guardian
Portugal's cost of borrowing is now over 7% and analysts believe a bailout is just weeks away. But help from the EU may be delayed by a damaging row over closer economic co-operation
Ireland's election winner, Enda Kenny, jetted off to Helsinki this weekend to lobby for a reduction to the swingeing interest payments on its €85bn bailout, and for a more hands-off approach from Brussels on spending cuts. Kenny, who is finalising a coalition that would make him Ireland's new prime minister, hopes that backing from the rightwing EU leaders' meeting in Finland, which Germany's Angela Merkel will be attending, will strengthen his hand at a critical summit in Brussels on Friday. But for the eurozone's leaders, Ireland's anger is just one symptom of a deeper crisis.
Portugal, long considered likely to be the next European country to reach crisis point, with its hefty debt burden and struggling economy, is seeing yields on its government bonds rise above 7% (see chart) – something that, as City consultancy Fathom points out, Greece and Ireland were only able to withstand for a couple of weeks before accepting a bailout.
Meanwhile, European Central Bank president Jean-Claude Trichet has ratcheted up the pressure by signalling that he is ready to raise interest rates, making life even harder for Portugal and the other "peripheral" economies. "What this has done is make it much more likely that Portugal is going to have to ask for finance," says David Owen of City firm Jefferies. Yet with Portugal's plight becoming urgent, the EU remains locked in a row about who should pay the price for the boom and bust of the past decade.
Officially, Friday's summit is to discuss proposals for a "competitiveness pact". A controversial first draft of the pact was presented by German chancellor Angela Merkel and French president Nicolas Sarkozy last month; it would have allowed Europe's giant Financial Stability Facility to pour money into Portugal in exchange for eurozone member states signing up to much closer co-ordination of economic policy on issues including corporation tax, wage bargaining and the retirement age.
However, most other eurozone countries – including the Irish, who want to hang on to their ultra-competitive 12.5% corporation tax rate – reacted furiously to the Franco-German proposals, which they saw as threatening their sovereignty. In an effort to pick up the pieces, a compromise proposal has been drawn up that will be discussed at this week's summit. But analysts remain concerned that it fails to tackle the real issues.
Away from the political top table, it is widely believed that there will have to be a restructuring of some of the debts of Greece, Ireland and Portugal – in other words, an acceptance that creditors, including Germany's banks, won't get all their money back. "In the short term, the existential threat is the financial crisis. Dealing with that will have to involve reducing the debt burden on the three small states [Greece, Ireland and Portugal], and moving to recapitalise the banks in the periphery, and in the core," says Simon Tilford, chief economist at the Centre for European Reform.
Owen at Jefferies agrees that the banks in the wealthier "core" states of France and Germany are painfully exposed. "Some of the big holders of Portugal, Ireland and Greek paper are the banks, and the banks are in the core. Everyone is exposed to everyone else. That's why this problem is so intractable, and it's not in anyone's interests for anyone to default."
Europe's leaders are well aware of the scrutiny they face from the markets, so they are likely to cook up some kind of deal this week; but without solid proposals for a Portuguese bailout and a wider debt restructuring, the eurozone will be left stumbling towards its next crisis. "I think this could potentially be a very tricky month for the euro – it's a car crash waiting to happen," says Michael Derks of foreign exchange broker FxPro. "I think Portugal is weeks away, and I think Portugal will be the trigger."
Time and again since the onset of the credit crunch, European leaders have struggled to co-ordinate a convincing response to events, eventually being forced to act by financial markets. "It's Groundhog Day," says Owen. There is another major summit on 24 March, but by then time will be running out for Portugal. Kenny may win a hint of concessions in Brussels next week, but wrangling over a few million euros with Dublin will be the least of the eurozone's worries.
Spanish town reintroduces peseta to boost economy
by Sarah Rainsford - BBC
A small town in northern Spain has decided to reintroduce the old Spanish currency - the peseta - alongside the euro to give the local economy a lift. Shopkeepers in Mugardos want anyone with forgotten stashes of the old cash at home to come and spend it.
It is nine years since the peseta was official currency in Spain. But Spain's economic crisis has forced some to be inventive. The hard times have seen thousands of businesses close and more than two million jobs go.
More than 60 shops in Mugardos, a small fishing town in Galicia on Spain's northern coast, are accepting the peseta again for all purchases, alongside the euro. It is an attempt to get cash registers ringing - and help lift the town out of a long and painful economic slump. Shopkeepers were sceptical at first, but they now say the scheme is a great success.
People are travelling into Mugardos from outside just to spend the old currency they never got round to converting. One man visited the local hardware store this week with a 10,000-peseta note he had found at home, and had no idea what to do with. He is now the happy owner of a sandwich toaster. The euro was introduced here in January 2002. Spaniards then had another three months to exchange their old currency at any bank.
That cash can still be converted today, but only at the Bank of Spain itself, and it says a staggering 1.7bn euros ($2.4bn) of cash is still unaccounted for - stashed, perhaps, then forgotten; piles of coins that slipped down the backs of sofas; or even big notes kept by collectors. That is the reserve the shopkeepers of Mugardos are hoping to tap and give a desperately needed boost to business.
Still, the Bank of Spain estimates that almost half the country's millions of missing pesetas will never be recovered - despite their value. It believes many left the country long ago, in the purses and pockets of tourists.
Gloomy Malthus provides food for thought as world's appetite builds
by Liam Halligan - Telegraph
Everyone knows that economics is often labeled the "dismal science". But few could tell you that this pejorative description dates back to an insult originally thrown at the classical economist, Thomas Malthus.
For it was Malthus who, in a path-breaking 1798 essay, grimly observed that populations expand geometrically while food supplies increase only arithmetically. In other words, mankind faces serious problems because population growth, by definition, will eventually outstrip the planet’s ability to provide food.
At some point, argued Malthus, the demands of the human race will exceed agricultural capacity, sparking violence, population decline and radical social change. A highbrow version of the man with the "End is Nigh" sandwich board, Malthus banged his "impending catastrophe" drum until his death in 1834 – hence the "dismal" sobriquet.
Since then, the world population has risen 5-fold, to 6.8bn people. But new technology has delivered better irrigation, powerful fertilizers and pesticides – boosting land yields and proving Malthus seemingly wrong. Perhaps the gloomy old boy wasn’t wrong, though, just ahead of his time. For in the last few years, as population projections have spiraled, and food prices with them, Malthus has started to look pretty smart.
The United Nations index of global food prices hit yet another record high in February – the eighth successive monthly increase. The respected UN index - which tracks prices of cereals, meat, dairy, oils and sugar – is now up 40pc on a year ago and 5pc above its June 2008 peak. The price of corn – a widespread staple crop – is now 95pc higher than a year ago. While there were many factors behind the outbreak of dissent in Libya, soaring food prices were the catalyst. A wave of price-related resentment has swept across a number of North African nations and could yet cause a political eruption in the Gulf.
Since before the days of Malthus, economists have tracked the natural swing and counter-swing of food prices, as production has responded with a lag to price signals and the vagaries of the weather. But maybe Malthus was right and that self-correcting cycle is now over.
The world population has surged 18pc since 2000. Meanwhile, except during the global financial crisis of late 2008 and early 2009, the cost of food has steadily risen. The suggestion is that, just like the market for oil and metals, food and other "soft commodities" have become locked in a "super cycle", the implications of which are only just beginning to be understood.
Even the deadly-sober, politically constrained economists at the International Monetary Fund now admit that something might be up. The recent food price surge stems partly from temporary factors such as last summer’s drought in Central Europe, argued an IMF article released last week. But the main reasons relate to "structural changes in the global economy that will not be reversed", which means "the world may need to get used to higher food prices".
The US Department of Agriculture has also weighed-in last week, forecasting even higher farm-gate prices for corn and wheat during the 2011 harvest season, given that the tightness of soft commodity markets. That means "policymakers … will need to confront the challenges posed by food prices that are both higher and more volatile than the world has been used to".
This trend, as with so much else these days, is being driven by the rise of India, China and the other large emerging markets. As incomes in these hugely populous countries keep rising, their new middle classes are rapidly shifting from a vegetable to an animal-based diet. Meat is an extremely crop-intensive form of protein, as any vegetarian will tell you. So this massive wealth-driven Eastern diet-switch is fuelling the demand for soft commodities.
In addition, we’ve embarked on a biofuels revolution - reaping energy from crops. Over the past six years, as global energy use has escalated, the output of oil and other fossil fuels has barely responded – not least due to looming supply constraints, as the world’s big oil wells deplete, with very few new crude sources coming on-stream. Biofuels from grain, sugar and oil seed are now starting to plug the gap.
Accounting for 2.5pc of global energy use, biofuels are now serious business. Boosted by huge Western government subsidies, they’re set to meet more than 10pc of global energy needs by 2030. The trouble is that biofuels are shifting land use away from crops for food – which, in turn, is pushing food prices up. The extent of this land shift is uncertain. But a recent Friends of the Earth report said that in Africa, the European-led biofuels land-grab is "under-estimated and out-of-control . . . causing conflict and threatening food-security". So even mainstream environmentalists now feel that biofuels, designed to lower our hydrocarbon addiction, are actually counter-productive given their impact on food.
Most mainstream economists – perhaps scared of the "dismal" label - remain sanguine about global food markets. While they recognize that oil is subject to finite supply constraints – there is only so much crude in the world – they feel that because food can be grown, there is no long-term problem.
I accept that there are vast areas of the world – Russia and Africa, for example – that could theoretically raise their agricultural output. But it is vital to understand that food production itself is also a very energy-intensive business – itself highly-reliant on oil. From the fertilizers and pesticides used to treat the earth, to the machines needed to sow, reap, process, package and distribute goods to market, crude features extremely heavily in the global food supply-chain.
As a UN report commented last week "rising oil prices could further exacerbate an already precarious situation in food markets, adding even more uncertainty to the price outlook just as plantings for crops in some of the major growing regions are about to start".
Not only by encouraging the switch to biofuels, but also by exacerbating food production and distribution costs, high oil prices can drive up food prices too – even though only oil is non-renewable. Last week, global oil markets tightened further, with Libya’s production now down at least 1m barrels per day – around 1.3pc of global production. As a result, futures contracts scraped $120 a barrel and UK petrol prices climbed above £1.30 a litre.
In the coming months, rising oil prices will bid up food costs further. More expensive food, in turn, could spark yet more unrest in the world’s oil-producing hot-spots. What we are witnessing in global commodity markets cannot be dismissed as "speculation". These price rises represent the reassertion, after a credit-crunch induced hiatus, of long-term "structural" trends.
The analysis above poses some very serious questions for energy-importing nations like the UK. Addressing them will take years, decades even. Here and now, though, we need to accept that in the months to come, among rising fuel and food costs, inflationary expectations will soar. This week, the Bank of England’s Monetary Policy Committee must decide if it will grasp the nettle and raise interest rates. With CPI inflation having been above the 3pc "upper limit" for 20 of the last 36 months, and commodity prices set to send the index into orbit, further delay will leave the Bank’s credibility in tatters.
None of this is good news, of course. Some readers will accuse me of being miserable – even if they suspect I’m right. But that was good enough for Malthus. So it’s good enough for me.