"B.E.F. camp, Anacostia, encampment of World War I veterans (the Bonus Army) and their families in Washington, D.C."
Ilargi: Even now the two Washington sides are close to inking a deal -though it could still fail, even be filibustered-, it won’t solve any real issues.
If and when the deal causes America to be perceived as stronger and less risky than Europe, that will merely lead to a higher dollar vs the euro, and that in turn will kill US exports, which will lead to lower employment, lower tax revenues, lower consumption rates, and all that stuff.
And even then: in what could be an ominous sign, the US dollar is losing against the Euro this morning, not gaining. Makes you wonder how long this round of debt -ceiling- relief will work. [Update: alright, now the dollar is rising, as European markets tank]
On the real issues, nothing has changed since at least the demise of Bear Stearns and Lehman, and arguably way before that. There is too much debt in the system, way too much, perhaps as much as 10, 100 or even 1000 times too much.
The rate of economic growth that would be required to flush out that debt is not only unrealistically high, it's downright physically impossible. And besides, Q1 US GDP was revised down to 0.4% last week, which takes it straight into the realm of mere marginal statistical errors. So the only ways to pay the debt is through budget cuts and tax increases. In the foreseeable future, we’ll see lots of the former and none of the latter.
So don't believe any of the talk about recovery; there isn't any today, there hasn't been any in the past 5 years, and there won't be none for a long time to come. A government spending itself into colossal new debt levels can perhaps create the illusion of recovery for a limited period of time (check), but it will all end up just making things worse down the line. For the people, that is. Not for the politicians and financiers who make the decisions.
And don’t believe that a last minute August 2 debt ceiling agreement solves anything either, since why should anyone on Main Street be happy just because their government has just allowed itself to get even deeper into debt?
The picture has just simply been wrong from the start: a ceiling is too positive of an image: we should perhaps do better to be talking about a debt dungeon.
That would convey the underlying reality much more accurately. Washington’s not raising a ceiling, it's digging an ever deeper, damp and darkened hole for US taxpayers and their children. Whatever comes out of the talks, and something will since no-one wants to take the blame of failure, will materialize as even more hardship for even more Americans.
Watch what will happen to Social Security. With Medicare. They're going to strip it to the bone, layer by layer. They'll do it slowly, so you won't even remember after a while what there used to be. Like many won't remember what is was like to own a home and be happy about it, what it was like to have a job that paid the bills and left some money on the side for fun things for the kids.
The present deal on the table skirts the entitlement conundrums almost entirely: the one thing that has been pushed through is that Medicare providers would be hit if the soon to be erected Super Congress (how’s that for democracy?), a bipartisan committee that will formulate the next rounds of cuts, can't agree on those next rounds. Here’s wondering why and how they would agree on anything, let alone anything that actually benefits their voters.
We're on a road to nowhere, mostly because there's nowhere to go that we would like to go to. We don't like the options available, but they are the only options we have, even if we insist on denying it. All the options we have will lead us down the slope; there's no way up anymore.
What we could and arguably should do is to try and find ways to soften the blow, to improve the way we travel on the way down. To achieve that, we need to get rid of the people who now make the decisions. And that will be very hard. There are only two political parties in America, and they might as well be one. None represent the interests of the people. Not that it’s any different in Europe, mind you.
Once a society or country allows money to enter its politics, the outcome is inevitable: the money interests will come to rule that country. This is evident all over the western world, whether you look at the Greek, Irish and other EU bail-outs, or at the debt dungeon debate the US is presently digging its way into ever deeper, with the respective bills handed to the people and their children.
As we speak, and as we watch the wall-sized media coverage of the debt dungeon chasm, municipalities and counties are on the cusp of bankruptcy. Services will be cut across the board. That is our future.
A future that won't involve growth, but which be all about austerity and cutting back and outright poverty for rapidly increasing numbers of people. Just not for the politicians and their puppeteers, not for those who get to decide who will hurt the most.
That is the main issue today. Who are you going to let decide how bad your future will be? If you opt for Washington, anyone in Washington, or Brussels if you're in Europe, your future will hurt something bad. When it comes to that future of yours and, of your offspring, the debt dungeon debate is the wrong focus. There's nothing beneficial for you in there.
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'It’s All Cuts'
by Michael McAuliff, Sam Stein and Elise Foley - Huffington Post
Congressional leaders and President Obama on Sunday night announced they've cut a deal to avert a historic U.S. default, saying they have assembled a framework that cuts some spending immediately and uses a "super Congress" to slash more in the future.
The deal calls for a first round of cuts that would total $917 billion over 10 years and allows the president to hike the debt cap -- now at $14.3 trillion -- by $900 billion, according to a presentation that House Speaker John Boehner (R-Ohio) made to his members. Democrats reported those first cuts at a figure closer to $1 trillion. It was unclear Sunday night why those two estimates varied. The federal government could begin to default on its obligations on Aug. 2 if the measure is not passed.
The next round of $1.5 trillion in cuts would be decided by a committee of 12 lawmakers evenly divided between the two parties and two chambers. This so-called super Congress would have to present its cuts by Thanksgiving, and the rest of Congress could not amend or filibuster the recommendations. But if the super Congress somehow failed to enact savings, the measure requires automatic cuts worth at least $1.2 trillion. Those cuts would be split equally between military and domestic programs. Social Security, Medicaid and programs for the poor would be spared, but Medicare providers -- not beneficiaries -- would take a hit.
White House officials confirmed that there would not be an extension of unemployment benefits as part of the final package. The administration had insisted that an extension be part of the grand bargain it was negotiating with Boehner. But when those discussions fell apart, so too did efforts to ensure that unemployment insurance was part of a final package. A senior administration aide added that the president would push for an extension in the months, if not weeks, ahead.
Some observers scored one victory for the president -- the second round of cuts do not kick in until 2013, when the Bush-era tax cuts are set to expire. Having a fresh round of deficit reduction that is all cuts with no revenues could give the White House ammunition to end the tax cuts on wealthier Americans, as it failed to do last winter.
Though none of the leaders sounded pleased about the deal, they said they were relieved it may present a chance to avert default. President Obama seemed especially dissatisfied with the idea of the super committee, saying the leaders should have been able to accomplish all the cuts now. "Is this the deal I would have preferred? No," Obama said. "I believe that we could have made the tough choices required -- on entitlement reform and tax reform -- right now, rather than through a special congressional committee process."
The two Senate party heads also expressed qualified support for the deal. "Leaders from both parties have come together for the sake of our economy to reach a historic, bipartisan compromise that ends this dangerous standoff," Majority Leader Harry Reid (D-Nev.) said on the Senate floor Sunday night. "At this point I think I can say with a high degree of confidence that there is now a framework to review that will ensure significant cuts in Washington spending," said Minority Leader Mitch McConnell (R-Ky.) "We can assure the American people tonight that the United States of America will not for the first time in our history default on its obligations," McConnell added.
In spite of the guarded optimism, all sides will face quite a sales job in getting enough lawmakers in the middle to accept a deal. Liberals were extremely displeased with the final result of the talks, which began with Democrats saying there should be no strings attached to a debt limit increase that would enable the country pay its bills. Then they insisted that if deficit reduction was going to be linked to the debt limit, then closing loopholes and raising taxes on the rich had to be part of the deal.
They lost completely on both counts, and House Republicans managed to pull the entire deal further and further to the right, even inserting a requirement into the agreement for a vote on a balanced budget amendment to the U.S. Constitution.
Both the Congressional Black Caucus and the Progressive Caucus in the House had called emergency meetings for Monday as details of the plan started to leak. They seemed likely to oppose the deal.
One top House aide said his boss would vote against the measure, and the aide predicted Minority leader Nancy Pelosi (D-Calif.) would not be eager to whip her members to get on board.\ "This is going to be close. I think in the end, the president and Nancy are going to have to twist arms, and I'm not sure how hard she'll work to do that," the aide said, noting that Pelosi still remembers the infamous TARP vote where she delivered 150 of her members but Boehner did not get 100 of his.
Many of Boehner's freshman Tea Party members also are likely to find the proposal tough to swallow, since many wanted no hike in the borrowing limit to begin with. They also wanted the passage of a balanced budget amendment to be a prerequisite for increasing the debt ceiling. Both sides can afford to lose members if 217 representatives can still back the plan.
Boehner's talk to his 240 members Sunday night had the greatest note of triumph. "Now listen, this isn’t the greatest deal in the world," he said, according to remarks his office sent out. "But it shows how much we’ve changed the terms of the debate in this town."
He also sounded a note of vindication. "There is nothing in this framework that violates our principles. It’s all spending cuts. The White House bid to raise taxes has been shut down," Boehner crowed. "And as I vowed back in May -- when everyone thought I was crazy for saying it -- every dollar of debt-limit increase will be matched by more than a dollar of spending cuts."
Notably, Pelosi was the only of the four congressional leaders not to pledge support for the plan. "I look forward to reviewing the legislation with my Caucus to see what level of support we can provide," she said in a statement.
A deal that found the lowest-common denominator
by Ezra Klein - Washington Post
Assuming no hiccups in the House -- and that might be a big assumption -- we’ve got a deal. The deficit-reduction side includes $1 trillion in cuts now, $1.5 trillion (or more) in deficit reduction later, and a vote on a balanced budget amendment. Meanwhile, it raises the debt ceiling by $900 billion immediately, and either $1.5 trillion (if the second deficit reduction package or a balanced budget amendment passes) or $1.2 trillion (if neither pass) later. Either way, the Treasury should have plenty of borrowing authority to get us to 2013.
Behind the deal is a creative way out of the impasse that’s held up the negotiations: how do you get "balanced approach" if Republicans refused to consider revenues? The solution that both sides seem to have settled on is to substitute defense cuts where taxes would otherwise have gone.
In the initial $900 billion in cuts, almost half will come from "security spending" (which includes defense, homeland security, veteran’s benefits, the State Department, etc). Defense is the big money there, and, according to the White House’s fact sheet, it will take a full $350 billion in cuts on its own. But the real hit comes in stage two: if the second round of deficit reduction isn’t signed into law, the "trigger" that will make automatic spending cuts absolutely savages defense spending.
Let’s stop there and talk about the trigger, as it’s arguably the most important part of the deal. In his remarks on Friday, President Obama said he would support a trigger if it was done in "a smart and balanced way." The implication was that it had to include tax increases as well as spending cuts, as a trigger with just spending cuts wouldn’t force Republicans to negotiate in good faith. The trigger in this deal does not include tax increases.
What it includes instead are massive cuts to the defense budget. If Congress doesn’t pass a second round of deficit reduction, the trigger cuts $1.2 trillion over 10 years. Fully half of that comes from defense spending. And note that I didn’t say "security spending." The Pentagon takes the full hit if the trigger goes off.
The other half of the trigger comes from domestic spending. But Social Security, Medicaid and a few other programs for the poor are exempted. So the trigger is effectively treating defense spending like it comprises more than half of all federal spending. If it goes off, the cuts to that sector will be tremendous -- particularly given that they will come on top of the initial round of cuts. Whether you think the trigger will work depends on whether you think the GOP would permit that level of cuts to defense.
If the trigger "works," of course, it’s never used. Instead, the bipartisan committee produces $1.5 trillion (or more) in deficit reduction, Congress passes their plan and the president signs it. But why should we believe that will happen? If Republicans and Democrats couldn’t agree on major deficit reduction this year, why is it going to be any easier in an election year?
The answer is supposed to be the trigger. Those cuts are meant to be so brutal that neither party will risk refusing a deal. But a deal means taxes, or at least is supposed to mean taxes. And Speaker John Boehner is already promising that taxes are off the table.
In a presentation to his members, Boehner says that the rules governing the committee "effectively [make] it impossible for Joint Committee to increase taxes." Specifically, he’s arguing that using the Congressional Budget Office’s "current-law baseline" makes tax increases impossible, as that baseline assumes the expiration of the Bush tax cuts, and so, if you touched taxes at all, you’d have to raise taxes by more than $3.6 trillion or the CBO would say you were cutting taxes and increasing the deficit.
Confused? That seems to be the point. Boehner is misleading his members to make them think taxes are impossible under this deal. But make no mistake: The Joint Committee could raise taxes in any number of ways. It could close loopholes and cap tax expenditures. It could impose a value-added tax, or even a tax on carbon. The Congressional Budget Office would score all of this as reducing the deficit under a current-law baseline. The only thing that wouldn’t reduce the deficit is going after part of the Bush tax cuts. That means they’re likely to go untouched in this deal.
That’s actually good news for...people who want to raise taxes. The Bush tax cuts will still be set to expire in 2012, which means that if Democrats get some revenue as part of this deal, they’ll be able to get more revenue if Congress gridlocks over the Bush tax cuts in 2012.
But that’s really a technicality. Boehner is promising that he’ll oppose any deal that includes revenue, and unless he decides to break his promise next year, that means the House is unlikely to pass any deal that includes revenue. So that leaves us with three options: 1) there’s no deal and the trigger goes off, 2) the Democrats agree to $1.5 trillion in further spending cuts alongside zero dollars in tax increases, or 3) Republicans agree to revenues.
The upside of this deal is that "the debt ceiling will cave in and Congress will create a global financial crisis for no reason" is not one of the potential outcomes. So that’s something.
The downside is that we actually haven’t come that far: we’re still pretending that a deal a few months from now will somehow be easier than a deal today, we’re moving to austerity budgeting -- note that neither unemployment insurance nor the payroll tax cut are extended -- while the economy remains weak, and we’re putting off the decisions about what to cut and how to handle taxes.
And that gets to the truth of this deal, and perhaps of Washington in this age: it’s all about lowest-common denominator lawmaking. There are no taxes. No entitlement cuts. No stimulus. No infrastructure. Less in actual, specific deficit reduction than there was in the Simpson-Bowles, Ryan, or Obama plans, and even than there was in the Biden/Cantor or Obama/Boehner talks. The two sides didn’t concede more in order to get more. They conceded almost nothing in order to get a trigger and a process, not to mention avoid a financial catastrophe.
There’s reason to be skeptical that a trigger and a process will do much to change these basic dynamics. We’ve now attempted to get a deficit-reducing grand bargain by yoking it to both a near-shutdown and a near-default, not to mention a series of negotiations, commissions, and senatorial gangs. None of it has been enough. And that’s because bipartisan commissions and terrible consequences have not been enough to convince Republicans to agree to revenues, and revenues are fundamental to large deficit-reduction compromise.
Perhaps this deal signals the end of the need to actually reach an agreement, however. If the Joint Committee fails, the trigger begins cutting spending. If negotiations over taxes fail, the Bush tax cuts expire and revenues rise by $3.6 trillion. Neither scenario is anyone’s first choice on policy grounds. But you can get to both scenarios without Republicans explicitly conceding to higher taxes or Democrats explicitly conceding to entitlement cuts in the absence of higher taxes. Politically, that’s the lowest-common denominator, and that might mean it’s also the only deal the two parties can actually make. But that’s because it’s the only deal that doesn’t require, well, making a deal.
Gerald Celente on US debt insanity: Collapse inevitable
The President Surrenders
by Paul Krugman - New York Times
A deal to raise the federal debt ceiling is in the works. If it goes through, many commentators will declare that disaster was avoided. But they will be wrong.
For the deal itself, given the available information, is a disaster, and not just for President Obama and his party. It will damage an already depressed economy; it will probably make America’s long-run deficit problem worse, not better; and most important, by demonstrating that raw extortion works and carries no political cost, it will take America a long way down the road to banana-republic status.
Start with the economics. We currently have a deeply depressed economy. We will almost certainly continue to have a depressed economy all through next year. And we will probably have a depressed economy through 2013 as well, if not beyond.
The worst thing you can do in these circumstances is slash government spending, since that will depress the economy even further. Pay no attention to those who invoke the confidence fairy, claiming that tough action on the budget will reassure businesses and consumers, leading them to spend more. It doesn’t work that way, a fact confirmed by many studies of the historical record.
Indeed, slashing spending while the economy is depressed won’t even help the budget situation much, and might well make it worse. On one side, interest rates on federal borrowing are currently very low, so spending cuts now will do little to reduce future interest costs. On the other side, making the economy weaker now will also hurt its long-run prospects, which will in turn reduce future revenue. So those demanding spending cuts now are like medieval doctors who treated the sick by bleeding them, and thereby made them even sicker.
And then there are the reported terms of the deal, which amount to an abject surrender on the part of the president. First, there will be big spending cuts, with no increase in revenue. Then a panel will make recommendations for further deficit reduction — and if these recommendations aren’t accepted, there will be more spending cuts.
Republicans will supposedly have an incentive to make concessions the next time around, because defense spending will be among the areas cut. But the G.O.P. has just demonstrated its willingness to risk financial collapse unless it gets everything its most extreme members want. Why expect it to be more reasonable in the next round?
In fact, Republicans will surely be emboldened by the way Mr. Obama keeps folding in the face of their threats. He surrendered last December, extending all the Bush tax cuts; he surrendered in the spring when they threatened to shut down the government; and he has now surrendered on a grand scale to raw extortion over the debt ceiling. Maybe it’s just me, but I see a pattern here.
Did the president have any alternative this time around? Yes.
First of all, he could and should have demanded an increase in the debt ceiling back in December. When asked why he didn’t, he replied that he was sure that Republicans would act responsibly. Great call. And even now, the Obama administration could have resorted to legal maneuvering to sidestep the debt ceiling, using any of several options. In ordinary circumstances, this might have been an extreme step. But faced with the reality of what is happening, namely raw extortion on the part of a party that, after all, only controls one house of Congress, it would have been totally justifiable.
At the very least, Mr. Obama could have used the possibility of a legal end run to strengthen his bargaining position. Instead, however, he ruled all such options out from the beginning. But wouldn’t taking a tough stance have worried markets? Probably not. In fact, if I were an investor I would be reassured, not dismayed, by a demonstration that the president is willing and able to stand up to blackmail on the part of right-wing extremists. Instead, he has chosen to demonstrate the opposite.
Make no mistake about it, what we’re witnessing here is a catastrophe on multiple levels.
It is, of course, a political catastrophe for Democrats, who just a few weeks ago seemed to have Republicans on the run over their plan to dismantle Medicare; now Mr. Obama has thrown all that away. And the damage isn’t over: there will be more choke points where Republicans can threaten to create a crisis unless the president surrenders, and they can now act with the confident expectation that he will.
In the long run, however, Democrats won’t be the only losers. What Republicans have just gotten away with calls our whole system of government into question. After all, how can American democracy work if whichever party is most prepared to be ruthless, to threaten the nation’s economic security, gets to dictate policy? And the answer is, maybe it can’t.
Muddying the Budget Waters With Social Security
by Tara Siegel Bernard - New York Times
All the political wrangling over the budget in Washington has been focused on one theme: how much the government should cut and when those cuts should take effect.
But for all of the difficulty lawmakers are having now, their hardest decisions may come this fall when they do battle over which government programs to cut back. And one program that has already been put on the table for discussion is Social Security, even though it has not contributed to the budget deficit.
There is no question the program needs to be tweaked so it can remain solvent for decades to come. And experts say the problem is not that difficult to solve, as long as it is dealt with relatively soon.
The proposed changes would have tinkered with one of the most beloved features of Social Security: the cost of living adjustment, which helps benefits keep pace with inflation so the elderly maintain their purchasing power. The proposed changes would link benefits to a new measure of inflation — one that is projected to rise more slowly than the current index.
"It amounts to a benefit cut," Alicia H. Munnell, the director of the Center for Retirement Research at Boston College, said.
The proposal, which emerged as a potential bargaining chip earlier in the budget debate, caused Social Security preservationists to cringe. And that is a big reason they argue that any changes should not be fast-tracked as part of the broader deficit debate.
If no changes are made, the program’s reserves are now projected to be exhausted in 2036, a year earlier than last year’s projection. Then the taxes collected would be enough to pay only about 75 percent of benefits through 2085, according to the latest annual report from the agency’s trustees.
The shortfall can largely be attributed to demographic shifts. The coming wave of baby boomers will strain the system, while the number of workers paying into the system is declining. On top of that, people are living longer, and the weak economy is not helping matters.
Changing the cost of living adjustment is just one of several ways to bolster Social Security’s finances. Suggestions have included gradually increasing the retirement age or raising the amount of income subject to Social Security payroll taxes.
The Obama administration’s deficit-reduction commission proposed switching to the new type of index because, members said, it would be more accurate. Unlike the current measure, it takes into account that people tend to change their buying habits when prices rise, substituting cheaper items for more expensive ones. If, for instance, the price of apples goes up, people may instead buy pears, if they are cheaper. The current index assumes that if the price of apples go up, people will just buy fewer apples.
But there is a question of whether the elderly and disabled can make the same substitutions as working people. "If you are down to paying your rent and your food, and the price of your food goes up, you probably just eat less," Ms. Munnell said.
In addition, the slower rise in benefits would compound over time. That means the older that retirees grew, the bigger the pinch they would feel, especially people who depended heavily on the program. About 43 percent of single people and 22 percent of married couples rely on the benefits for more than 90 percent of their income, the Social Security Administration says. More than half of couples and 73 percent of singles draw more than half their income from the program.
So how much would this cost? Over the last decade or so, the "chained CPI-U" — that is the name of the new proposed index — has risen 0.3 percentage points a year less than the measure used now, according to Stephen Goss, the chief actuary at Social Security. And he expects that would continue in the future.
Consider a worker who retired at 65. After 10 years, the worker would receive 3.7 percent less in benefits than he would receive under the current system; after 20 years, 6.5 percent; and 9.2 percent after 30 years, according to Mr. Goss’s calculations. (He ran the numbers in response to a request by Representative Xavier Becerra, a Democrat from California who is the ranking member of the Ways and Means subcommittee on Social Security).
Let’s assume the retiree had a monthly benefit of $1,261, or $15,132 annually. But as he aged, his benefits would not rise as quickly as they would have under the current system. At 75, he would receive $560 less a year under the new system compared with the current one. At 85, he would receive $984 less, and, at 95, he would receive $1,394 a year less. These changes would resolve about 23 percent of the program’s current shortfall, according to Social Security’s actuaries.
But what is most irksome to some critics is that the proposed index has been called "more accurate." It may be more accurate for the broader population, they say, but that doesn’t necessarily hold for retirees. (It would, however, save $112 billion over 10 years, according to the Congressional Budget Office).
If accuracy, and not cost savings, is the goal, they suggest further analysis of an experimental "elderly" index that accounts for the fact that older people spend a greater share of their budget on medical care. That index is estimated to increase about 0.2 percentage point more each year than the broader indexes. In fact, Ms. Munnell said that moving to the elderly index — and adding the mechanism to account for substituting cheaper items when prices rise — might make more sense.
Referring to the chained CPI-U index, Ms. Munnell said, "It’s not the worst proposal that could be put in place," especially when considering that other ideas, like providing an increase in benefits at age 85, could offset some of the reduction. "It’s just that people aren’t candid when they talk about it. That’s the real problem."
And that is the issue hanging like a dark cloud over the broader discussion to bolster Social Security, especially in such a politically charged atmosphere.
Many people misunderstand how the program operates. Payroll taxes stream into the trust fund that is used to pay current retirees’ benefits. When there is a surplus, that money is invested in a special type of Treasury bond that pays interest to the trust fund. At the end of last year, the trust fund had about $2.6 trillion. And though last year was the first year since 1983 that the fund paid out more than it received in tax revenue, it still continued to grow because of the interest accrued — and it is estimated to continue to grow through 2022.
Since the money in the trust fund is held in Treasury securities, taxes collected are essentially being lent to the federal government to pay for whatever it wants (and this allows the government to borrow less from the public). That is where some of the confusion comes into play about how Social Security is used to pay for things that are unrelated to the program. But it is really no different from China lending the government money by investing in Treasuries.
"Social Security does not, and cannot by law, add a penny to the federal debt," said Nancy Altman, co-director of Social Security Works, an advocacy organization that promotes the preservation of the program. "It, by law, cannot pay benefits unless it has sufficient income to cover the cost, and it has no borrowing authority to make up any shortfall."
And, she added, it is not in crisis. "Its long-range funding shortfall should be dealt with on its own legislative vehicle, separate from deficit-reduction talks and after those talks are concluded," she added.
The budget proposal from the bipartisan group of Congressmen known as the Gang of Six and the president’s deficit-cutting commission did state that Social Security should be reformed for its own sake — and that any savings must go toward solvency. There are many ideas on how to achieve that balance. Here’s hoping our leaders will evaluate them on their own merit.
America is merely wounded, Europe risks death
by Ambrose Evans-Pritchard - Telegraph
We have a glimmer of hope. The key indicators of the US money supply are at last firing on all cylinders, a dramatic turn for the better that would normally signal recovery or even a mini-boom within the next six to 12 months.
Needless to say, these are not normal times. The US and EU debt crises are feeding on each other in a dangerous synergy, with fears of a fiscal "sudden stop" in Washington causing global risk aversion and aggravating tremors in the Spanish and Italian bond markets. It is a pre-taste of the "catastrophe" predicted by the Fed’s Ben Bernanke if politicians fail to control their passions.
And yet, data from the St Louis Fed show that America’s M2 money supply grew at a 6.4pc annual rate in the second quarter, accelerating to 12.2pc in June. The compound annual rate of change has exceeded 40pc over recent weeks.
The broader M3 indicator (including large savings deposits) is growing at the optimal rate of around 5pc. It has been an uncannily accurate lead indicator at each twist and turn of our economic drama over the past five years, and is telling us now that the Fed’s kindling wood has at last begun to ignite the damp coals of the US financial system. There is no longer a 1930s liquidity trap. We can infer that the housing market may be nearing the end of its deep slump.
The economy is curing itself in time-honoured fashion. Whether this monetary cure will be allowed to run its course depends on politicians in Washington, Berlin, Rome and Madrid. My recurring nightmare ever since the Western debt edifice began to crumble four years ago is that the denouement would track the events of mid-1931, when leaders failed to reform a destructive fixed exchange system (Gold Standard) and the fuse finally detonated on Europe’s banking system. It was when political blunders turned recession into the Great Depression, and ideology intruded with a vengeance.
The narrative of 1931 is already well-known to readers. France sabotaged a rescue of Vienna’s Credit Anstalt because of strategic disputes with Germany. This set off a financial chain reaction. Frightened markets tested the weak links of the Gold Standard. They withdrew funds from Britain after naval ratings "mutinied" over pay cuts. Contagion spread back to New York. By October 1931 the international system had collapsed, though the full horror did not become evident until the next year. A string of countries retreated into variants of autarky, or fascism, or both. Communists and Nazis together won more than half the seats in the Reichstag election of July 1932.
It is far from clear that the international order is more secure today than it was in the seemingly calm days of May 1931, so one cannot lightly forgive the reckless brinkmanship on Capitol Hill over recent days. I write before knowing the outcome of weekend talks but we can rule out any form of US default. President Barack Obama can invoke the 14th Amendment in extremis, or issue a Bush-style "Catastrophic Emergency" directive.
The more plausible risk is that the debt ceiling is not raised, forcing a ferocious fiscal squeeze to avoid default. Washington would have to slash spending at an annual rate equal to 11pc of GDP, and do so in a disorderly fashion that would shatter confidence. There are historical cases of respectable growth following fiscal contractions, not least in Britain after 1932 and 1993, but the scale of cuts needed to close America’s double-digit deficit at a stroke is of an entirely different order. You do not have to be Keynesian to see the dangers of such a violent shock in an over-leveraged economy.
If cuts continued into September without either side blinking, the knock-on effects might rapidly set off serial defaults by states and an implosion of the $2.5 trillion municipal bond market. The bankruptcy saga of Jefferson County, Alabama, is a foretaste. Maryland, Virginia, South Carolina, New Mexico and Tennessee have all be put on negative watch. California has had to raise an emergency $5bn loan. Nevada is spending half its tax-take on debt service costs, and Michigan 40pc. These states are hanging on by their fingernails.
Yet if disaster is an outside risk in America, it is an odds-on likelihood in Europe. It is already clear that the latest EU summit deal is too little to stop a spiralling crisis in confidence, let alone acknowledge that North and South have diverged too far to share a currency union. Spanish and Italian yields are back to pre-summit danger levels, and might fly out of control at any moment unless a lender-of-last resort steps in to guarantee the market.
The European Central Bank still refuses to do so, and the EFSF bail-out fund cannot legally do so until all national parliaments ratify the summit deal to widen its remit. Yet these chambers have shut down for the summer. Europe’s leaders have gone on holiday. The €440bn EFSF is an any case too small. The bond vigilantes broadly agree that the EFSF needs €2 trillion in pre-emptive firepower to forestall a twin crisis in Italy and Spain, though quite how France might pay for this without being drawn into the maelstrom itself is an open question.
Germany’s "triangulating" finance minister Wolfgang Schauble has once again over-promised in Brussels, only to retreat under pressure in Berlin. There will be no "carte blanche" for EFSF bond purchases. So will Germany do whatever it takes to uphold monetary union in its current form, or will it not? We are no wiser.
As the details dribble out from the summit deal, we can now see that Greece will enjoy no debt relief despite having been pushed into default. Citigroup said the net effect will increase Greece’s debt by a further 4pc of GDP to more than 160pc next year. Since this is obviously untenable, Greece will need a third rescue. The EU has brought about the first sovereign default in Western Europe since the Second World War and set a fateful precedent without actually resolving the Greek problem. This is the worst of all worlds.
Moody’s cited the summit terms as a key reason why it put Spain on negative watch last week. "Pressures are likely to increase still further following the official package for Greece, which has signaled a clear shift in risk for bondholders of countries with high debt burdens or large budget deficits," it said. EU ineptitude - or rather, German, Dutch and Finnish unwillingness to face up to the implications of EMU - have raised the risk of a traumatic August crisis in Italy and Spain. EU leaders are bringing about exactly what they pledged to avoid.
The US cannot insulate itself against the consequences of Europe’s elemental EMU blunder, but it can mitigate the effects by restoring order in its own political house. The Fed has already bought a degree of insurance by gunning the money supply in advance. The executive institutions of the US government are viable and still functioning. We can only pray that at least one half of the Atlantic system holds relatively firm. If both go down together, buy a shotgun and prepare for 1932.
Optimism on Wall St. Tempered by Hurdles
by Eric Dash - New York Times
After an anxious weekend spent glued to their BlackBerrys and iPhones, bankers and investors breathed a sigh of relief Sunday as lawmakers forged an agreement to raise the nation’s debt ceiling ahead of Monday’s trading.
The doomsday discussions that dominated conversations of late quickly faded as political leaders in Washington first signaled a compromise was close, then finally announced a deal on Sunday night. Wall Street was hesitant to declare total victory, though, because lawmakers still faced the hurdle of getting a bill through both chambers of Congress.
The optimism was further tempered by the broader economic challenges that continue to confront the United States and global markets. "The debt ceiling is out of the way, but the current picture is far from rosy," said Ajay Rajadhyaksha, head of United States fixed-income and securitized strategy at Barclays Capital. "Economic growth is so much weaker than many people thought just six months ago, and we are heading into a period of austerity."
Analysts and investors warned that the markets could remain turbulent in the weeks ahead. Besides sluggish economic growth, the threat of a ratings downgrade on United States debt and Europe’s continuing financial troubles loom.
Still, the first signs of market reaction to the deal were positive. Stock markets in Japan and South Korea picked up steam as the deal was announced by President Obama, and they rallied close to 2 percent by midday. Futures contracts on the American stock market also jumped, indicating that Wall Street may recoup some of the past week’s losses once trading starts in New York on Monday.
Gold, a traditional haven that struck record highs amid the uncertainty of the past weeks, fell 1 percent to $1,610 an ounce. Oil rose about $1, to $97 a barrel. In the currencies markets, the dollar gained against the yen and the Swiss franc after falling last week. It was barely changed against the euro.
For Wall Street executives, it was a roller-coaster weekend. Although optimistic that Congress would reach an 11th-hour agreement, bankers had been planning for the worst in case a deal was not struck. But there was little of the market panic that in the 2008 financial crisis had bankers traders stuck at their desks for much of every weekend. Citigroup, Goldman Sachs and Morgan Stanley executives were monitoring the news from home.
"Everybody still has the fireman boots and fireman hat on, but there is a significant sigh of relief these guys are moving in the right direction," said one senior Wall Street executive, who spoke on condition of anonymity on Sunday afternoon as the deal was coming together. At JPMorgan Chase, Jamie Dimon huddled with his senior managers at the bank’s Park Avenue headquarters. Bank executives also set up a war room at an operations center in Columbus, Ohio, to react to customer issues stemming from the political developments — just as they did for natural catastrophes like Hurricane Katrina.
By Sunday night when the deal had been announced, lobbyists and financial executives were almost gleeful. "This is huge," said Scott E. Talbott of the Financial Services Roundtable, an industry lobbying group. "It provides much-needed certainty during an uncertain economic time." Mr. Talbott said his group was still reviewing details of the deal, but would likely move forward with a lobbying blitz over the next two days. "We will light it up with Hill visits, joint-letters, and encourage our member companies to consider contacting members of Congress, too," he added.
Indeed, BlackRock, the giant asset manager, issued a statement urging lawmakers to take prompt action. "Every day of delay in resolving this situation will erode economic confidence, jeopardize job creation and undermine the credibility of the United States in global financial markets," it said.
With the deal yet to be approved by lawmakers, Chase announced that it would temporarily waive overdraft fees and other account charges for Social Security recipients, military workers and other federal employees if their government-issued checks were not posted. Last week, the Navy Federal Credit Union pledged that it would advance pay to active military and civilian defense workers in the event of a breach of the debt ceiling.
Investors were hopeful that approval of the deal by Congress would cause the markets to rebound. after tumbling 3.9 percent last week. "It isn’t a ‘grand bargain’ to cut the deficit — that would have been great for the market," said Byron Wien, the vice chairman of Blackstone Advisory Partners. But he said that the current blueprint, if passed, at least deals with the debt ceiling and that the government’s bills will be paid. "This is a positive, but there was so much negative momentum going into the weekend," he added.
Indeed, some investors cautioned that failure to pass the bill would be catastrophic, recalling how the market dropped precipitously in 2008 when Congress initially voted down a huge bailout package for the nation’s banks. "You are looking at Dow 10,000 if this doesn’t get resolved in a very short period of time," said M. Jake Dollarhide, chief executive of Longbow Asset Management in Tulsa, Okla. That would be a 21 percent drop from where the Dow Jones industrial average closed on Friday.
Even as attention has shifted to the domestic fiscal problems, the European Union financial health continues to deteriorate despite a second bailout package it put in place for Greece last month in an effort to stem its sovereign debt crisis. In one sign of worsening trouble, the spreads on credit-default swaps on the debt of Italy and Spain are nearing their widest level of the year. Investors are betting that those countries are becoming more likely to default on their debts.
Meanwhile, new data released on Friday showed the United States economy had experienced a significant slowdown during the first half of 2011, underscoring the weakness of the recovery. And the political mayhem in Washington has done little to bolster consumer confidence, a crucial economic engine. Daniel J. Arbess, manager of the Xerion fund at Perella Weinberg Partners in New York, said the fiscal problems in the United States and Europe were "chronic and will be persisting" for some time. "Investors need to get used to them," he said. "No single episode of tension is the ultimate one, nor is any patch the ultimate solution."
From Big Spending to Big Cuts, While the Economy Stalls
by Binyamin Appelbaum and Catherine Rampell - New York Times
The nation’s political leaders agreed on Sunday to spend and invest less money in the American economy, a step that economists said risks the reversal of a faltering recovery, in the hope of improving the nation’s long-term prosperity.
The emerging outlines of a deal to cut spending by at least $2.4 trillion over 10 years, with a multibillion-dollar down payment later this year, would complete an about-face in the federal government’s role from outsize spending in the immediate aftermath of the recession to outsize cuts in the future.
Last week brought the disconcerting news that the economy grew no faster than the population during the first six months of the year, in part because of spending cuts by state and local governments. Now the federal government is cutting, too. "Unemployment will be higher than it would have been otherwise," Mohamed El-Erian, chief executive of the bond investment firm Pimco, said Sunday on ABC. "Growth will be lower than it would be otherwise. And inequality will be worse than it would be otherwise." He added, "We have a very weak economy, so withdrawing more spending at this stage will make it even weaker."
The agreement would end months of single-minded debate about the federal debt that has diverted Washington’s attention from broader economic questions, and indeed threatened the health of financial markets as investors watched and wondered whether the United States might really decide, quite voluntarily, to leave some bills unpaid. If both chambers of Congress give their approval by Tuesday night, the government will have averted the danger of a self-inflicted financial crisis, but only at the expense of public confidence in its ability to address the nation’s broader economic malaise.
The looming challenges include a renewal of the standoff over the federal budget at the end of September, and the scheduled expiration at the end of 2012 of the broad tax cuts passed during the administration of President George W. Bush. President Obama said Sunday night that the deal "begins to lift the cloud of debt and the cloud of uncertainty that hangs over the economy." He added that political leaders now "should be devoting all of our time" to the nation’s broader economic challenges.
But economists say the deal could complicate that task. There is broad agreement that the United States needs to pay down its debts, but most economists say the government should have waited a year or more for the economy to strengthen. "We sure missed a big window of opportunity to reduce our debt in those strong years when asset prices were booming," said Carmen Reinhart, senior fellow at the Peterson Institute for International Economics and co-author of "This Time Is Different," a history of debt crises. "Instead we’re stuck trying to do it now, when the economy is so weak."
The economy grew at an annual rate of only 0.8 percent during the first half of the year. Millions of homes remain empty. Twenty-five million Americans could not find full-time jobs last month. And even without the debt ceiling deal, federal spending is in rapid decline. Little remains of the federal stimulus money. Payroll tax cuts are set to expire at the end of the year.
The combination of the budget-cutting government’s plans and the grim economic news is likely to increase pressure on the Federal Reserve, which will hold a scheduled meeting on Aug. 9, to reconsider its declaration earlier this summer that it has done enough to aid the economic recovery.
After four years of extraordinary efforts to promote growth, including a continuing campaign to hold down interest rates for at least a few more months, officials at the central bank say they are reluctant to do more. But the Fed’s chairman, Ben S. Bernanke, said if the economy deteriorates and there is a growing risk of deflation or a broad decline in prices, policy makers could act.
The Fed’s options include pledging to maintain low interest rates for a specified period of time or increasing its holding of government debt in a bid to further reduce rates. "It’s difficult to find a textbook to tell you what should you do now," said Torsten Slok, chief international economist at Deutsche Bank.
The Republican authors of the debt ceiling deal say that cutting the size of government will increase economic growth down the road because federal borrowing soaks up money otherwise available to private businesses and federal spending distributes that money inefficiently.
Some conservative economists argue that even the immediate impact of a deal could be positive. Classic economic theory holds that people respond to the growth of government by spending less of their own money, because they assume that taxes will increase. A reduction in the federal debt therefore should encourage people to spend more of their money.
"From an accounting point of view, it seems obvious that you would reduce G.D.P. if you cut government spending," said Randall Kroszner, an economics professor at the University of Chicago and a former Fed governor appointed by Mr. Bush. "But the key is really the impact on consumption and investment. If you reduce government spending and if people think that reduces uncertainty about the tax burden down the line, they may be more comfortable with spending."
Economists who have examined the historical record, however, say the evidence is clear that the immediate impact of spending cuts outweighs any short-term benefits to confidence. "When you look at the history of these things, the finding is that we shouldn’t be kidding ourselves," said Paolo Mauro, chief of the fiscal affairs department at the International Monetary Fund and the editor of a book of case studies, "Chipping Away at Public Debt." "When you do fiscal adjustment in the near term, it does have an adverse impact on economic growth."
Northrop Grumman, a major military contractor, is a case in point. The company said Wednesday that second-quarter sales were depressed by the confusion in Washington. "Uncertainties surrounding the debt ceiling and future defense budgets caused our customers to move more slowly and spend more conservatively," the chief executive, Wesley G. Bush, told analysts. "We did not see the recovery in spending that one might have expected."
The deal on the table on Sunday, however, is likely to include reductions in defense spending. The broader impact depends on the details. The cuts stretch over a decade, and the White House has pushed to limit the impact by delaying the largest cuts, giving the economy time to recover. And the value of federal spending also varies widely. Some spending is wasteful. "Cutting infrastructure spending is generally thought to be a bad idea, but if that money was being spent on a bridge to nowhere, it’s not so concerning," Mr. Mauro said.
Another feature that could limit the economic impact is an agreement to negotiate more than half of the cuts over the next several months. Ms. Reinhart said countries often did the greatest economic damage by agreeing on cuts at the 11th hour, in the desperate rush to complete a deal, without sufficient attention to the particulars. "That’s when politicians make the worst decisions often — they cut the things that would yield short-term revenues," Ms. Reinhart said. "They cut discretionary spending in the ways that if you really thought about it, they wouldn’t do it that way."
Running out of options
by Buttonwood - Economist
Governments in the rich world have painted themselves into a corner
Economic policy in the developed world over the past 25 years has followed one overriding principle: the avoidance of recession at all costs. For much of this period monetary policy was the weapon of choice. When markets wobbled, central banks slashed interest rates. A by-product of this policy was a series of debt-financed asset bubbles. When the last of those bubbles burst in 2007 and 2008, the authorities had to add fiscal stimulus and quantitative easing (QE) to the policy mix.
The subsequent huge rise in budget deficits was largely the result of a collapse in tax revenues that had been artificially inflated by the debt-financed boom. Britain and America ended up with deficits of more than 10% of GDP, shortfalls that were unprecedented in peacetime.
Those deficits may have been necessary to avoid a repeat of the Depression. Economists will probably still be debating this issue in 75 years’ time, just as they still discuss whether Franklin Roosevelt’s New Deal programme was effective in the 1930s. But the "shock and awe" approach to Keynesian stimulus has an unfortunate consequence. Any decline in the deficit, even to a still whopping 8% of GDP, acts as a contractionary force on the economy: either the government is spending less or taxing more.
As a result governments are reluctant to cut the deficit too quickly for fear of sending their economies back into recession. But unless there is a rapid recovery, the debt will keep piling on, making the ultimate problem harder to solve.
Turning to monetary policy, interest rates are 1.5% or below in most of the developed world and are negative in real terms (the Bank of England kept rates at 2% or more for the first 300 years of its existence). In a normal recovery central banks would be looking to increase rates from crisis levels by now. But high debt ratios (particularly in the household sector) make central banks very uneasy about raising interest rates for fear of ushering in another round of the credit crunch.
With the big exception of the European Central Bank, most have repeatedly postponed the moment at which monetary policy is tightened. The parallels with Japan, where interest rates have been at rock-bottom for a decade, are striking.
As for QE, it is hard to tell how successful it has been as a strategy in reviving the economy although it certainly seems to have helped to prop up equity markets. Central banks seem reluctant to push it much further at the moment. But there is no suggestion that the economy is strong enough for them actively to unwind the policy by selling assets back to the markets.
In all three cases the story is the same. Governments and central banks have thrown a lot of stimulus at the economy and the result has been a fairly sluggish recovery. They have painted themselves into a corner. They cannot go forward, in the sense that there is little political or market appetite for more stimulus. But it is also hard for them to go back.
Withdrawing stimulus is not just risky economically, but hard politically, too. In Britain a sluggish second-quarter growth rate of 0.2% has led to talk that the coalition government needs to slow the pace of its austerity programme. But if you actually look at the data, the government has barely begun its deficit-cutting work. In the first three months of the fiscal year public spending is £5.2 billion ($8.5 billion) higher than in the same period of 2010-11, or £3.6 billion higher if interest payments are excluded.
An increase in joblessness, leading to higher benefit payments, is not the cause: the unemployment rate is lower than it was a year ago. A rise in value-added tax may have eaten into consumer demand (tax revenues are £5.3 billion higher than in the same period of 2010-11) but VAT also rose in January 2010 and GDP jumped by 1.1% in the second quarter of that year.
The danger for Britain is not just that its deficit-cutting strategy may have an adverse effect on growth. It is also that sluggish growth may prevent it from cutting its deficit significantly. Tim Morgan of Tullett Prebon, a broker, calculates that if the British economy grows at 1.4% annually, half the expected rate, the budget deficit will still be more than 8% of GDP in 2015.
In a sense, the bill has come due for the past 25 years. A policy of avoiding small recessions has resulted in the biggest downturn since the 1930s. Public finances turned out to be weaker than politicians thought. As a result, they have used up all their ammunition tackling the current crisis. Governments in the rich world will have very few options left if the economy weakens again.
Debt Ceiling Impasse Rattles Short-Term Credit Markets
by Nelson D. Schwartz and Azam Ahmed - NYT Dealbook
The reverberations of Washington’s impasse over a debt deal are already being felt in the short-term credit markets, a key artery of the economy that daily supplies trillions of dollars of credit.
Over the last week, big banks and companies have withdrawn $37.5 billion from money market funds that invest in Treasury debt and other ultra-safe securities, the biggest weekly drop this year. Meanwhile, in the vast market for repurchase agreements, in which many financial firms make short-term loans to one another, borrowers are beginning to demand higher yields.
These moves underscore how companies and big financial institutions are beginning to rethink their traditional view that notes issued by the United States Treasury are indistinguishable from cash, even though many experts say they think it is unlikely that the government would miss payments on its obligations. The $37.5 billion drop, reported Thursday in a weekly survey by the Investment Company Institute, echoed what other analysts were seeing.
In the first three days of this week, investors pulled $17 billion from funds that invested only in government securities, a reversal of the daily inflows of $280 million for much of July, said Peter Crane, the president of Crane Data, which tracks money market mutual funds. "It’s big, no doubt about it," he said. "Seventeen billion isn’t a run, but it’s definitely indicative that investors are shifting their assets. If this were to continue for another week or two, it would be very disturbing."
Though lawmakers have been clashing all week on proposals to cut the deficit and raise the debt limit ahead of an Aug. 2 deadline set by the Treasury Department, bond markets have largely shrugged off the risk of a default or a downgrade of the Washington’s AAA credit rating.
Interest rates on longer-term Treasuries have held steady, but the yield on notes coming due next week, after the deadline, has moved sharply higher in recent days. The yield on Treasury bills coming due Aug. 4 jumped five basis points to 15 basis points, a significant move for a security that carried a yield close to zero earlier this month, said Jim Caron, head of interest rate strategy at Morgan Stanley.
"It’s a tell-tale sign of something that could reverberate if it spreads to other markets, and all the uncertainty with the debt ceiling is the functional equivalent of a tightening," Mr. Caron said. "I don’t think there is a default risk at all but the market is saying it’s not going to take any chances."
While money market fund managers say they are not seeing a sizable wave of redemptions yet, they are setting aside more cash, leaving it at custodial bank accounts in case investors demand their money back. At Fidelity, the Boston-based firm that has $442 billion in money market assets, managers are avoiding Treasury bills that come due on Aug. 4 and Aug. 11, however unlikely a technical default may be.
"We are positioning our portfolio to respond to a downgrade or a default and we are positioning the fund to respond to redemptions," said Robert Brown, president of money markets at Fidelity. Mr. Brown would not say how much cash was being kept at hand, but said "it’s a higher balance than one would expect to see."
In the commercial paper market, where companies raise funds for their short-term borrowing needs, buyers are also seeking shorter-term paper. In the last week, investors have shown signs of wanting quick access to their money, with financial borrowers raising on Wednesday only $1 million in notes that come due in 81 days or more, according to the Federal Reserve. That is down from $479 million on July 22.
At the same time, the amount of commercial paper issued with a duration of just one to four days rose to $920 million, from $771 million. "Investors are scrambling to bolster their liquidity profile," said Chris Conetta, head of global commercial paper trading at Barclays Capital. "They understand that a default or downgrade could be a big, systemic event."
In the repurchase market, known as the repo market, borrowers take loans and in exchange hand over a little more than the equivalent loan amount in securities. Because of their risk-free status, Treasuries are highly favored as collateral, estimated to account for about $4 trillion in the repo markets.
The fear is that if the United States credit rating drops, the value of those treasuries could respond in kind. Borrowers would then have to post more collateral to obtain their loans, effectively raising the cost of borrowing. That could ripple into the broader market, raising interest rates on all types of loans, analysts warn.
"The repo market is a pressure point because it can have an impact on overall credit availability, which bleeds through to mortgage rates," said Robert Toomey, managing director at the Securities Industry and Financial Markets Association. "Treasuries become a little less attractive if they are more expensive to finance."
The overnight repo rate, which started the week at about three basis points, was about 17 basis points Thursday evening, according to Credit Suisse. That means that to finance $100 million overnight in the repo market it would now cost about $472 per day, up from about $83 on Monday.
"It’s a bigger deal than a lot of people recognize," said Howard Simons, a strategist at Bianco Research, a bond market specialist. "If you downgrade the securities you have to put more up for collateral and that affects pretty much everybody out there who has held these in reserve. I don’t care if you’re a bank, insurance company, exchange or clearinghouse."
To be sure, most observers say the ripples in the repo market will not be anything like those felt in the fall of 2008, when creditors lost faith in the ability of banks to pay back their short-term loans. That caused a problem for companies like General Electric, which struggled to finance its daily operations as a result. Back then, the sharp drop-off in repo lending helped bring the financial system to its knees.
"I think people are looking at the U.S. as the cleanest shirt in the dirty laundry pile," said Jason New, a senior managing director at GSO Capital Partners. "To me, the downgrade is not dropping a boulder in a still lake. This is dropping a pebble, but nevertheless there are still ripples."
Jobs Deficit, Investment Deficit, Fiscal Deficit
by Laura D'Andrea Tyson - New York Times
Like many economists, I believe that the immediate crisis facing the United States economy is the jobs deficit, not the budget deficit. The magnitude of the jobs crisis is clearly illustrated by the jobs gap – currently around 12.3 million jobs.
That is how many jobs the economy must add to return to its peak employment level before the 2008-9 recession and to absorb the 125,000 people who enter the labor force each month. At the current pace of recovery, the gap will be not closed until 2020 or later.
The Hamilton Project, the Brookings Institution
History suggests that recovery from a debt-fueled asset bubble and ensuing balance-sheet recession is long and painful, with significantly slower growth in gross domestic product and significantly higher unemployment for a least a decade. Right now it looks as though the United States is following this pattern.
The jobs gap is primarily the result of the dramatic collapse in aggregate demand that began with the financial crisis of 2008. Even with unprecedented amounts of monetary and fiscal stimulus, the recovery that began in June 2009 has remained anemic, because consumers, the major driver of private demand, have curbed their spending, increased their saving and started to deleverage and reduce their debt — and they still have a long way to go.
As I asserted in my last post (and many other economists, including Lawrence Summers, Alan Blinder, Christina Romer, Peter Orzsag and Robert Shiller, have made this point, too), the jobs gap warrants additional fiscal measures to increase private-sector demand and promote job creation.
Sadly, current signals from Washington indicate that such measures will not be taken.
Instead, the risk grows that large, premature cuts in government spending will reduce aggregate demand, will tip the economy back into recession and drive the unemployment rate back into double digits.
Even if no budget deal is reached and no major spending cuts are made in the near future, there is now a serious risk that the rating agencies will downgrade government debt because of the political stalemate over a long-run deficit reduction plan. That would almost surely produce higher interest rates that could sink the economy into recession again.
Although the jobs gap and the high unemployment rate are the immediate problems in the American labor market, they are not the only ones. And there is no sign that the budget negotiations in Washington are going to address these other problems, either.
Even before the onslaught of the Great Recession, the labor market was in serious trouble. Job growth between 2000 and 2007 was only half what it had been in the preceding three decades.
Bureau of Economic Analysis, Bureau of Labor Statistics, McKinsey Global Institute
Productivity growth was strong, but far outpaced compensation growth. Between 2002 and 2007, productivity grew by 11 percent, but the hourly compensation of both the median high-school-educated worker and the median college-educated worker fell.
Lawrence Mishel and Heidi Shierholz, Economic Policy Institute
During the same period, the real median income for working-age households declined by more than $2,000. The 2002-7 recovery was the only American recovery on record during which the income of the typical working family dropped.
Lawrence Mishel and Heid Sheirholz, Economic Policy Institute
And despite the recovery, job opportunities continued to polarize. Employment grew in high-education, high-wage professional technical and managerial occupations and in low-education, low-wage food-service, personal-care and protective-service occupations; employment fell in middle-skill, white-collar and blue-collar occupations. The drop in middle-income manufacturing jobs was especially precipitous.
Bureau of Labor Statistics, National Bureau of Economic Research, McKinsey Global Institute
To fashion the appropriate policy responses to these long-term structural problems in the labor market, it is first necessary to understand their causes. The key contributors are three:
1. Skill-biased technological change that has automated routine work while increasing the demand for highly educated workers with at least a college education, preferably in science, engineering or math.
2. Globalization or the integration of labor markets through trade and more recently through outsourcing.
3. The declining competitiveness of the United States as a place to do business.
Recent studies by Michael Spence and Sandile Hlatschwayo (discussed last week in Economix by Uwe Reinhardt) and by David Autor describe how technological change and globalization are hollowing out job opportunities and depressing wage growth in the middle of the skill and occupational distributions.
Many of the workers and jobs adversely affected by technological change and globalization are in the tradable goods sector, primarily in manufacturing. Nor is the United States labor market the only one to be affected by these forces: the polarization of employment opportunities is also occurring in the other advanced industrial countries.
Many of them, like Germany, are doing something about it. The United States is not. According to a recent McKinsey study, the United States is becoming a less attractive place to locate production and employment compared with many other countries.
McKinsey Global Institute
A newly published study by the Information Technology and Innovation Foundation reaches a similar conclusion. The United States is underinvesting in three major areas that help a country create and retain high-wage jobs: skills and training of the work force, infrastructure, and research and development.
Spending in these areas currently accounts for less than 10 percent of all federal government spending, and this share has been declining over time. And that’s despite the fact that the borrowing costs of the federal government have been near historic lows and much lower than the returns on economically justifiable investments in these areas.
Such investments fall into the "non-security discretionary spending" category of the federal budget, the category in line to be cut to historic lows to reduce the government deficit over the next decade.
In my previous Economix post, I said a budget deal should pair fiscal measures aimed at job creation now with a credible plan to reduce the deficit gradually and that both should be passed at once as a package. I also urged that the plan include an unemployment rate target that would postpone serious deficit-reduction measures until the target had been achieved.
I also think the plan should include a separate capital budget that distinguishes government spending on education, infrastructure and research as investments with committed revenues over several years. A capital budget would close the investment deficit in those areas that strengthen American competitiveness and promote high-wage job creation. None of the budget plans currently under debate include a separate capital budget.
The labor market is suffering from two problems: an immediate jobs gap, primarily the result of inadequate demand, and a long-term shortfall in rewarding employment opportunities for American workers, primarily the result of structural forces.
As a result of these forces, even when demand has recovered, many of the good jobs lost during the last decade will not be replaced by new good jobs without significant public investments to strengthen the attractiveness of the United States as a production location.
So far, the deficit-reduction proposals attracting attention do not address the labor market’s dual problems and leave many American workers and their families to face another lost decade.
Insiders selling at unusually fast pace
by Mark Hulbert - MarketWatch
Bad news, stock-market bulls: Corporate insiders are selling their companies’ shares at an abnormally fast pace.
In fact, one measure of that selling activity shows insiders of NYSE- and AMEX-listed companies recently were selling at the fastest rate since data began being collected in the early 1970s, four decades ago.m On the theory that insiders know more about their companies’ prospects than do the rest of us, this is an ominous sign.
Corporate insiders, of course, are a company’s officers, directors and largest shareholders. They are required to file a report with the Securities and Exchange Commission more or less immediately upon buying or selling shares of their companies, and the SEC makes those reports public.
One firm that gathers and analyzes the data is Argus Research, which publishes its findings in the Vickers Weekly Insider Report. One indicator that the firm calculates is a ratio of the number of shares that insiders have sold in the open market to the number that they have purchased. In the week ending last Friday, according to the latest issue of the Vickers report, this sell-to-buy ratio stood at 6.43 to 1. This is higher than 95% of other weeks’ readings over the last decade.
That’s ominous enough, but consider last week’s sell-to-buy ratio for just those issues listed on the NYSE or AMEX. That came in at 13.10 to 1, which is the highest reading for this ratio since when Vickers began collecting the data, which was October 1974.
Is there any way for a bull to wriggle out from underneath the weight of these high readings? Perhaps, though it’s not easy. One counterargument bulls can make is that it’s entirely normal for insiders to sell when the market rallies, and therefore such selling does not carry particularly bearish significance. But the stock market hasn’t exactly been rallying all that strongly. To be sure, the latest sell-to-buy ratio reflects last week, not the current one, and that week did have a better tone than the current one — but not all that great a tone.
In any case, the other occasions in recent years in which the sell-to-buy ratio rose to close to the same level it is today were on the heels of more or less uninterrupted rallies over the previous two or three months. That’s not the case now, of course, suggesting that insider selling this time around may not be so benign.
Another bullish counterargument is that the volume of insider transactions last week was light, as it usually is during earnings season. That’s because insiders are either reticent to buy or sell their companies’ shares in the days and weeks before their companies report earnings, for fear of being charged with acting improperly. But I’m not sure how much weight to put on this argument. There still were several hundred firms with insider activity last week, and it’s unclear why earnings season would have discouraged just those insiders who otherwise were interested in buying.
Furthermore, it’s worth remembering that the extensive Vickers database encompasses many other earnings seasons besides the current one. Also, the latest insider sell-to-buy ratio is higher than almost all comparable readings from those prior seasons.
Perhaps the strongest counterargument the bulls can muster at this point is that the insiders are not infallible. That indeed is true. Still, researchers report that they have been more right than wrong. At a minimum, I think we can all agree it can’t be good news that insiders recently have been selling at such a fast pace.
For Investors, Cash Is King
by Liz Rappaport and Matt Phillips - Wall Street Journal
Investors, companies and small savers are stashing billions of dollars in plain-vanilla bank accounts, taking cash out of short-term markets, in an effort to shield themselves from any market convulsions caused by Washington's stalemate over the debt ceiling. The movement of money, akin to that during the peak of the 2008 financial crisis, is one more sign that skittishness is on the rise as officials in Washington remain deeply divided about ways to reduce the deficit and lift the debt ceiling ahead of the Aug. 2 deadline.
Failure to reach an agreement by Tuesday could cause the U.S. to default on its debt and lead to an unprecedented downgrade of its triple-A rating, two events that some worry would roil financial markets around the globe. The ultradefensive stance of investors and corporations, while a natural precaution, may also have the unintended side effect of curbing the amount of money flowing through the financial system.
The pullback is adding to the stress in short-term markets. Treasury bill yields have soared in recent days, albeit from low levels. One-month bill yields rose to 0.17% Friday, up from 0.10% Thursday. At the end of June, they were essentially yielding nothing.
In the commercial paper market, where money funds lend to companies and banks for anywhere from one day to a year, most lending has been restricted to overnight. In the market for repurchase agreements, or "repos," in which investors use Treasury securities as collateral for short-term funds, the cost of borrowing has jumped from near zero to 0.15% in recent days.
The stocks of real-estate investment trusts that buy mortgage-backed securities and use them in the repo market tumbled as concerns rose about their ability to fund themselves at current levels. The Dow Jones Industrial Average fell 96.87 points to a one-month low of 12143.24, ending its worst week in more than a year. Gold hit a record of $1,628.30 per troy ounce. The yield on the 10-year Treasury note, which is still seen as a safe haven, dropped to 2.804%, its lowest close since last November. Yields fall as prices rise.
Money funds, which hold nearly $2.7 trillion in total assets, now have about half of their portfolios in securities that mature in seven days or less, said trading executives. Investors in these funds have also turned to cash, pulling out $9 billion every day over the past week, and the pace is accelerating. Money fund managers and corporate treasurers often increase the amount of cash they hold at the end of each month to meet monthly obligations, but the massive flows into federally insured bank accounts Thursday and Friday are much larger than usual, said people familiar with the matter. These bank accounts yield nothing, but are considered safe because they are insured by the Federal Deposit Insurance Corp.
"If any one of those markets freezes next week, there's no telling where it will be, so it's best to have (cash) in a couple of different places," said Anthony Carfang of Treasury Strategies, which advises corporate treasurers.
Money market funds are stashing their cash in bank accounts at their main custody banks, including Bank of New York and J.P. Morgan Chase & Co., according to people familiar with the matter. These custody banks are typical safe-havens when financial markets go haywire. They act as protectors of assets, cash and securities held as collateral for short-term loans for their clients, and they process payments and settle trades in the repo market. Money market funds, banks, hedge funds and other institutional investors can easily move money at their custody banks in short periods of time.
Federal Reserve officials have been watching developments in short-term lending markets closely, and see the build-up of deposits at banks as one of many signs of rising angst in the financial system. But observers stress that the financial markets are better positioned now than they were during the financial crisis. Banks are far less reliant on finding cash in overnight markets to keep operating and are less reliant on debt to amplify returns.
Corporations are following the same route. Glass and ceramics maker Corning Inc. has moved about 16% of its cash, or $1 billion of its $6.4 billion pool, into non-interest-bearing bank accounts insured by the FDIC over the past few weeks for fear that the Treasury bond market and other financial markets become volatile, said the company's Treasurer, Mark Rogus. Previously, Corning invested all of its cash in Treasurys and money market funds that invest in Treasury bonds and other government-backed debt that matured in three months or less. The $1 billion covers about three months of Corning's bills, said Mr. Rogus.
Money market funds and companies are able to go to cash because of a clause in the Dodd-Frank law, which provides unlimited FDIC insurance to all funds in non-interest bearing accounts at U.S. insured institutions. The clause, which expires on Dec. 31, 2012, was included in the law to replace the Term Account Guarantee Program, a financial crisis-era program that expired on Dec. 31, 2010, and served a similar purpose.
The desire for cash has also spread to individuals. Jeffrey Rubin, who runs a medical malpractice law firm, says he sold his stocks and moved his cash out of money market funds into an insured brokerage account. The total amount was about $1 million. "Though this is only a short term measure, and maybe a bit overdoing it, I just don't trust the uncertainty," Mr. Rubin says.
State Street Global Advisers' U.S. Treasury money market fund now has an average weighted maturity of about 2.5 days, compared to an average of about 34 days for the typical institutional Treasury fund, and down from 6 days at the end of June. It also has more than 90% overnight liquidity. "In the current market environment, preservation of capital and access to immediate liquidity are the priorities," a State Street spokeswoman said. Morgan Stanley's Treasury fund also said it is keeping maturities short in response to a volatile environment.
Doubts fuel investor guessing game
by Dan McCrum and Michael Mackenzie - FT
A high stakes guessing game has broken out on Wall Street: what might investors have to sell if the US government loses its triple A credit rating for the first time?
Even with a deal to raise the debt ceiling appearing more likely than last week, the Washington acrimony required to get there has left few analysts confident that Congress can agree sufficient deficit reduction measures to placate Standard & Poor’s, the rating agency most negative in its outlook for US government finances.
S&P wants to see $4,000bn in cuts, far more than any of the proposals being discussed. But it is understood that the agency is unlikely to rush out with any statements if a deal is reached that delivers a deficit reduction well below this figure.
Estimates for asset sales range from virtually nothing to $300bn of Treasury selling that one very large sovereign wealth fund is using as its base assumption after conversations with its broker dealers. JPMorgan puts the upper bound of holdings at bond funds which might be forced sellers at $40bn, a small fraction of the $10,000bn market.
The broader effect, however, could be a rise in interest rates that pushes up the cost of all forms of debt, threatening the fragile global recovery. Many eyes are fixed on money market funds, an important source of short-term funding for many businesses and financial institutions. It was a rush of withdrawals in 2008 that caused a breakdown in the commercial paper markets, deepening the financial crisis.
The funds would not have to sell Treasuries in the event of a downgrade, but could become forced sellers if they were hit by redemptions. Money market funds suffered their largest outflows since January this week as investors redeemed a net $32bn from the sector, according to data from Lipper, a research company.
Barclays Capital estimates that prime and government-only money market funds own $660bn of direct Treasury debt bonds issued by government-sponsored agencies like Fannie Mae and Freddie Mac, and also hold an additional $470bn in security repurchase, or "repo", positions. That accounts for 47 per cent of money fund assets.
"At the moment, there is little question that news about the US credit rating is unnerving money fund investors fearful about protecting their principal," said Joe Abate, strategist at Barclays.
Meanwhile asset managers maintain that a downgrade will not produce a wave of forced selling. A survey of 29 investors by UBS found very few potential sellers of Treasuries. In the event of a downgrade, hedge funds were the only respondents who would sell and they were outnumbered by peers who would be buyers. Central banks and sovereign wealth funds would do nothing, the survey found.
"The Treasury market remains the primary beneficiary of global reserves amid a lack of alternatives," said Ira Jersey, strategist at Credit Suisse. "A downgrade will convey no new fundamental information," he added. George Goncalves, head of interest rate strategy at Nomura Securities does not expect long-term investors will sell their holdings of US Treasuries.
The effects could be felt in sales of more risky assets, however. Separately managed accounts held at asset managers for central banks and some large sovereign wealth funds and businesses often have average credit quality criteria that are effectively double A. "You could see people being forced to sell lower-rated corporates or high yield debt to get the average credit quality of that portfolio back to that double A standard", said the head of one asset management business.
Yet a US downgrade is not a certainty and Moody’s and Fitch may not follow any S&P cut. Last week, Fitch Ratings said: "In a moderate downgrade scenario, Treasuries are expected to remain the benchmark security that anchors global fixed income markets for the foreseeable future. Their status as the global benchmark security is bolstered by the underlying strength of the US economy, Treasuries’ deep liquidity and fundamental role in the global financial architecture, and the lack of comparable, marketable alternatives."
Moody’s, which last month initiated a review of the US sovereign rating said late on Friday that its "review for downgrade will more likely than not conclude with a confirmation of the Aaa rating, albeit with a shift to a negative outlook."
That Aug. 2 Deadline? It May Be Impossible, Veteran Lawmakers Say
by Jackie Calmes - New York Times
Here is advice from veterans of past budget battles in Congress that went to the brink: This time, be afraid. Be very afraid.
The seemingly unbridgeable impasse between the two parties as the deadline for raising the nation’s debt limit approaches has Tom Daschle losing sleep, as he never did when he was a Senate Democratic leader in the mid-1990s and Congressional Republicans forced government shutdowns rather than compromise on spending cuts. "That was nothing compared to this. That was a shutdown of the government; this could be, really, a shutdown of the entire economy," Mr. Daschle said. "You can’t be too hyperbolic about the ramifications of all this."
Democrats and Republicans with legislative experience agree that even if both sides decided Saturday to raise the $14.3 trillion borrowing ceiling and to reduce future annual deficits, it would be extremely difficult for the compromise measure to wend its way through Congress before Tuesday’s deadline, given Congressional legislative procedures. But such a bipartisan deal seemed virtually impossible on Friday, as House Republicans approved their bill and dug in deeper against compromise with President Obama.
Any possibility of avoiding an economy-shaking default seemed to rest on hopes of a so-far nonexistent compromise in the Senate — between the majority leader, Harry Reid, Democrat of Nevada, and the Republican minority leader, Senator Mitch McConnell of Kentucky — that could pass by Tuesday and then be sent to the House. That would force Speaker John A. Boehner to decide at the 11th hour whether to hold a House vote on a bill that would not get many Republican votes, forcing him to rely on Democrats and perhaps further weaken his leadership, or to risk blame for an economic crisis.
"He’s going to have to pass it with Democratic votes. That’s going to be a tough decision, but he doesn’t have any choice at that point, particularly if the markets are reacting," said Tom Davis, a former House Republican leader from Virginia. "That’s the position they’ve got themselves in." But, he added: "The stakes are much higher here. If interest rates start spiking up, it’s going to cost us a lot more than anything you could save. They’re playing brinkmanship with our credit rating. That’s not very smart."
Mr. Davis recalled his vote in late September 2008 for the $700 billion Troubled Asset Relief Program that President George W. Bush sought to rescue a financial system near collapse. "I hated TARP, but no one had a better alternative," he said. But most of his Republican colleagues opposed the rescue measure and helped defeat it, sending the stock markets tumbling even as the vote was taking place. That reaction forced the Republicans to retreat, and days later a bailout bill carried on a second try.
Mr. Davis predicted that the current standoff over the debt limit could end similarly. "When the markets react" — as early as Monday if there is no compromise in sight — "I think the politicians will act," he said.
Yet many of the Congressional Republicans who won office last November with the help of the antigovernment Tea Party movement, giving their party control of the House, campaigned on promises to resist any government bailouts and to oppose an increase in the debt limit. Some lawmakers have been quoted describing the debt-limit vote as a way to make up for Republicans’ support of the bank rescue three years ago.
Against that backdrop, major business groups issued statements on Friday reiterating their calls for a deal, but with a heightened note of alarm. The Business Roundtable, an association of executives of some of the country’s largest corporations, sent a letter to the White House and Congress warning that "inaction poses an unacceptable financial risk to the nation’s economic growth and job creation" — this on a day when the latest economic data confirmed that growth slowed in the second quarter with the fallout of Japan’s tsunami, Europe’s debt crisis and upheaval in the Middle East.
"Failure to Raise Debt Ceiling Could Turn the Economy Back Into a Recession" was the headline on a statement from the U.S. Chamber of Commerce. "I’ve never seen people genuinely worried like this," said Vin Weber, a former representative from Minnesota, now a Republican strategist who has been meeting with other Republicans, including lawmakers, this week. "This time you have people who genuinely don’t know what the outcome is going to be, and they’re worried that the wrong outcome could genuinely be disastrous."
Goldman Sachs rates desk hemorrhages traders
by Lauren Tara LaCapra - Reuters
More than a dozen traders have quit Goldman Sachs Group Inc's North American government bonds and derivatives trading desk in New York in recent months as the bank takes fewer risks and big bonuses for ambitious traders dry up.
Goldman has been handing out promotions and better pay to its salespeople rather than the traders who manage the bank's inventory of securities and derivatives, people familiar with the bank's operations said. The changes reflect Goldman's shift toward client trading and away from making money by betting for its own account, those sources said. Weak trading in general has compounded Goldman's difficulties as it struggles to earn profits from clients without the help of its market bets, analysts said.
It makes sense for Goldman management to reward sales staff over traders these days, said Susquehanna Financial Group analyst David Hilder. "The client franchise is paramount," said Hilder. "You need sales people to deal with and talk to the clients. Over the long term, that's more important than a few guys trading bonds."
Among the recent departures is Brian Mooney, an interest-rate derivatives trader who spent 22 years at Goldman before joining Bank of America Corp's Merrill Lynch this week, according to three sources who know about the move. Mooney's exit follows that of Glenn Hadden, the former head of Goldman's U.S. Treasury bond trading desk, who left last year to run Morgan Stanley's global rates trading group in January.
At least nine other traders from the rates desk have left for jobs at competitors this year, including UBS AG, Nomura Holdings Inc, Jefferies Group Inc and JPMorgan Chase & Co, or hedge funds like Stark Investments near Milwaukee. Among their ranks were more junior traders, some of whom were seen as rising stars at Goldman. Goldman has been laying off traders since March, but there has also been a flood of voluntary exits that began late last year and continued through the second quarter, sources said.
Colin Corgan, a respected partner on the rates desk, retired in late 2010. In March, Craig Reynolds, a former top interest-rate swaps trader at Goldman, left to become head of Bank of America Merrill Lynch's North American interest-rate trading desk. Goldman has given additional responsibilities to remaining staffers and promoted others. For instance, Jonathan Hall, a rates trader in London, was tapped to oversee the entire U.S. rates trading operation after Hadden left. But the bank has kept many of the seats empty as it looks to keep staffing levels tight.
Some traders that have left the bank said they fear Goldman may turn into just another investment bank, and they wanted to leave while it was still seen as prestigious on Wall Street. "Working for Goldman is no longer different than working for anybody else," said one former Goldman trader who left this year. "At the same time, if you have Goldman on your resume, that's still a premium. People are monetizing the Goldman premium now because two years from now you won't be able to." "Goldman Sachs is totally committed to the interest rate products business," said spokesman Michael DuVally. The bank is staffed appropriately for the business, he added.
Specter Of The Volcker Rule
Goldman's North American rates-trading desk handles some of the most actively traded markets in the world, including U.S. Treasury bonds and U.S. dollar interest-rate swaps. The desk is to some degree shielded from a financial reform provision called the Volcker rule that will prevent banks from gambling on market direction.
The rule is not in effect yet, but even once it is implemented, banks will still be allowed to take proprietary positions in the Treasury market and hedge against risk using related derivatives. Nonetheless, traders who left Goldman's rates desk complained they were hamstrung by aggressive risk managers who limited position sizes and second-guessed trades. They also said they were being asked to take on more responsibilities with less pay as Goldman tries to cut costs.
In announcing quarterly results last week, Chief Financial Officer David Viniar said Goldman plans to lay off about 1,000 people this year to reduce expenses by $1.2 billion and may slash employee pay if business doesn't pick up. The rates-trading desk is among the largest in Goldman's enormous fixed income, currency and commodities trading business, known as FICC. Over the last six quarters, FICC trading has suffered as clients pulled back from the market.
Goldman detailed a 53 percent decline in second-quarter FICC revenue last week. Revenue there has dropped by 46 percent, on average, in each of the past four quarters. Goldman does not break out rates trading numbers, but said revenue there dropped "significantly."
Goldman's client business has gained traction in some rates-trading areas -- for example, the bank boosted market share in U.S. Treasury trading this year to 12.2 percent from 10.7 percent, according to a Greenwich Associates survey. Yet higher market share does not always amount to better profits, Greenwich said. Narrowing bid-ask spreads, increasing use of electronic trading and competition for big institutional clients' business are pressuring rates-trading profits.
"The market's shift in emphasis from structured products to rates products has already reduced the profitability of fixed income for sell-side firms," said Greenwich Associates consultant Woody Canaday.
Debt Crisis? Bankruptcy Fears? See Jefferson County, Ala.
by Campbell Robertson and Mary Williams Walsh - New York TImes
A few hundred miles north of here, politicians are fighting over debt. It is a spirited debate, full of discussions about what kind of country will be left for future generations and pledges not to kick the can down the road.
But one does not have to go far to see that possible future. Welcome to Jefferson County. This is the end of the road, where the can cannot be kicked any farther. There are lessons for everyone here, and they are all painful: lessons for those who are not concerned about the prospect of mounting debt, for those who insist that steep cuts can be relatively painless, for those who think the bill for big spending can safely be put off into the future, for those who have blind faith in the market and for those who think the government can always be relied upon to protect the interests of the people.
All of these beliefs have led to a place where the government can no longer borrow and the little cash on hand is being demanded by creditors, where the Sheriff’s Department cannot afford to respond to traffic accidents and hundreds of county workers are sitting at home, temporarily or possibly permanently out of work. They have also led to a widely held conclusion among residents that no one is on their side. "I get tired of them dumping on the little people," said Deb Passmore, 58, who had to shut down her Laundromat several years ago when the sewer and water bills reached $500 a month.
The prospect of county bankruptcy, which would be the largest of its kind in United States history, has gone from being an unwelcome mark of distinction to something that many residents insist should have happened a long time ago.
It still stings to think about how things got this way, how county residents are stuck with the tab from a reckless binge by Wall Street bankers, middlemen and crooked politicians, a greed-fueled spree that none of the voters actually wanted or even knew was happening. But residents know that complaints about fairness have not made that debt, all $3.2 billion of it, go away.
"What are you going to do?" said Steve Mordecai, 50, who was eating lunch at Ted’s, a meat-and-three place here that is somewhat less crowded than usual on Fridays, given that so many county employees are no longer working. "The county created the mess," Mr. Mordecai said. "Now we have to pay it back."
The story that ends in overspending excess began in neglect: in 1996, the federal government accused Jefferson County of sending raw sewage into area rivers and demanded that it rebuild its dilapidated sewer system. Such a project would be costly, but officials hoped to avoid unpopular rate increases first by pushing that cost into the future, and then by adding a maze of derivatives that were supposed to shield the county from interest-rate increases.
But the bond deals were fraught with pay-to-play scandals. Four county commissioners were convicted of taking bond-related bribes. Two bankers are fighting federal accusations that they made secret payments, and in 2009 J.P. Morgan forfeited $752 million to settle a complaint by the Securities and Exchange Commission.
The complicated bond-and-derivative structures failed during the financial turmoil of 2008, leaving the county with a $3.2 billion debt to pay, faster than planned. Sewer revenues that were pledged to pay the debt cannot keep up. The problems keep compounding: federal prosecutors have taken a derivatives consultant to court on bid-rigging charges. And the Internal Revenue Service is investigating whether the sewer bonds really should have been marketed as tax exempt.
But the fiscal crisis went from a simmer to a full boil in April, when the Alabama Supreme Court declared a major county tax unconstitutional. Shortly afterward, with the county reeling from the severe shortfall in general funds, a court-appointed receiver recommended a steep increase in county sewer rates, and also laid claim to the county’s only cash reserves, saying they were needed to bolster the sewer system’s finances.
At the end of June, Gov. Robert Bentley declared a shaky truce while negotiations took place. On Thursday, the County Commission announced that it was entering a seven-day standstill period to consider a settlement offer from the creditors, an announcement that was met with grumbles across most of the county.
"They should have filed for bankruptcy 10 years ago," said Howard Faulk, an owner of Sophie’s Deli across the street from the county courthouse, where the lines for county business are hours long but the parking is free because the county cannot afford parking attendants. "If you’re standing in water this deep," Mr. Faulk asked, his hand at his neck, how much deeper can it get?
But any residents who think a bankruptcy will simply wipe the debt clean are probably in for a bleak surprise. Chapter 9 of the federal bankruptcy code, the one local governments use, does not work like Chapter 11, where corporations restructure and bondholders routinely suffer losses.
In fact, Chapter 9 was amended in 1988 with the specific goal of making clear that certain types of municipal bonds would keep on paying even in bankruptcy, said James E. Spiotto, a bankruptcy specialist with the firm of Chapman Cutler. The bonds issued to finance Jefferson County’s giant sewer project are this type. "The whole purpose is to assure the market that in times of distress, the bonds will be paid," Mr. Spiotto said in an interview.
Many citizens of the county speak bitterly of a perception that other parts of Alabama think of the county as unworthy of help. Even one of the county’s own state senators blocked a plan to allow Jefferson to raise revenue to replace some of what was taken away by the April court decision, thus forcing layoffs. "In Alabama, Jefferson County is Chinatown," said David Mowery, a Montgomery political consultant, using the metaphor for hopeless inscrutability from the Roman Polanski film of the same name. "Forget it," he said, summing up the general attitude toward the county. "There’s nothing you can do about it."
But as Alabama’s own governor learned over the spring and summer, you cannot just forget Jefferson County, where Birmingham is the county seat. If it goes down, it takes the state — and the state’s credit — with it. This realization prompted the governor to intervene when the county was near declaring bankruptcy at the end of June.
Still, little of this reassures the people slogging through here, who realize that life will get harder before it gets better. The only consolation is gallows humor and signs they might not be alone. "I used to think what awful leadership we have in Jefferson County," said Phillip Winette, 58, who runs a printing company. "But now I’m watching the debate on a national level. It’s an epidemic."
Central Falls bankruptcy decision set for Monday
by Erika Niedowski - AP
The state-appointed receiver overseeing Central Falls is expected to announce Monday whether he will file for bankruptcy on behalf of the cash-strapped city.
A senior adviser to Gov. Lincoln Chafee said Friday that the receiver Robert G. Flanders will work through the weekend to determine whether Central Falls should file for federal bankruptcy protection -- a rare step for a municipality -- as a way to begin its financial recovery. Stephen Hourahan said negotiations between Flanders and union groups continue, meanwhile.
Many of the 141 police, fire and other municipal retirees who are being asked to accept voluntary pension and benefit cuts have said they want more time to decide, but the deadline to return their paper ballots was Thursday.
Flanders' office said that 57 requested additional time, 37 voted to reject the proposal and 12 voted to accept it. Flanders noted that nine of the 12 who voted yes would not have had their benefits reduced under the plan and would therefore save the city no money. Thirty-five other retirees did not respond. Flanders has said that municipal bankruptcy is "much more likely" if the retirees, and other groups, don't accept major concessions. The pension cuts aim to save the city around $2.5 million.
Central Falls has $80 million in unfunded pension and benefits obligations and projected deficits of $25 million over the next five years. Mayor Charles Moreau and City Council President William Benson, both of whom were relegated to advisers after the state receiver stepped in, say Chapter 9 bankruptcy is the only way the city can dig itself out of the fiscal mess.
"I don't think he's got a choice," said Benson, who has been critical of Flanders. "We can't get back on our feet this way. He hasn't brought a nickel in, how can it be anything but bankruptcy?" Benson said he had no indication what course the receiver's office will take. "They don't talk to us. They tell us nothing," he said.
The council, which has not convened in well over a year because of a legal fight over whether they are allowed to, has set a meeting for Thursday evening at City Hall. Central Falls is about seven miles north of Providence.
Emanuel vows no tax hikes to bridge $635.7 million budget gap
by Hal Dardick - Chicago Tribune
Mayor Rahm Emanuel today said next year's city budget hole is nearly $636 million and he won't use one-time fixes or reserves to fix it. "Today is to inform the public who pays the bills of the size and the scope of the problem," Emanuel said at a City Hall news conference. "The system needs reform. It is calling out for it."
Emanuel also said he won't raise taxes on Chicagoans who feel "nickeled and dimed" until the city's financial structure gets reformed. "I can't ask people to pay more into a system that needs to be fundamentally restructured," he said.
Without significant changes in how the city operates, the city budget gap would widen in coming years to $741.4 million in 2013 and $790.7 million in 2014, the administration estimates. Much of the budget imbalance results from long-term union contracts with locked-in raises, rising health care costs for workers and increased borrowing in recent years that brought higher interest payments.
The budget figures do not include shortfalls in city pension systems, which could add costs of $500 million or more annually in coming years. Absent changes in the pension systems or new revenue sources, that could result in a doubling of the city property tax, according to The Civic Federation, a non-partisan budget watchdog group. Emanuel is required to present his budget outlook by July 31.
Release of the preliminary figures is the first step in fashioning a budget for the coming year. Emanuel’s task will be to find ways to close that gap without tapping one-time revenue sources, as former Mayor Daley did repeatedly in recent years.
Emanuel, who personally briefed City Council committee chairmen on the budget this morning, told them he has asked his department heads to come up with ideas to close the gap. His appearance at the briefings was a break from past practice, when Daley had his financial chiefs present the news to aldermen.
In May, Daley said he anticipated a budget shortfall next year of $587 million, but incoming Emanuel administration officials have said they anticipated it would be higher. Last year, the city plugged a budget gap of $655 million largely by dipping into dwindling reserves, refinancing debt and drawing money from once-sacrosanct special taxing district funds.
During his first couple of months in office, Emanuel has taken steps to curtail spending. He announced plans to cut $75 million from this year’s $6.15 billion spending plan, and he has pushed unions to make concessions, so far to little avail. Critics note that even in 2007, when the economy peaked, the city faced a budget gap of $95 million, and spending has only increased since.
Colorado bank failures this year could cost the FDIC $1 billion
by Aldo Svaldi - Denver Post
The five bank failures represent one-fifth of the FDIC fund's overall losses this year
Five Colorado bank failures this year could cost the nation's deposit insurance fund slightly more than $1 billion. That represents a fifth of the $5 billion in overall losses to the fund from bank failures through July 22, said Federal Deposit Insurance Corp. spokesman Greg Hernandez. Only Georgia, with 16 failures costing $1.5 billion, has taken a bigger bite. Colorado and Georgia combined account for half of the hit to the FDIC fund this year.
That $1 billion exceeds the $970.6 million that three Colorado bank failures in 2009, led by Greeley's New Frontier Bank, cost the fund. Deposit insurance protects individual bank accounts for up to $250,000 and is a key reason why the country doesn't see bank runs during a financial crisis. But when banks fail, surviving banks pick up the tab, through higher premiums to replenish the fund. Those costs eventually pass down to customers and investors. And if things ever got bad enough, taxpayers could be asked to ante up.
"There is a bit of moral hazard involved in deposit insurance," said Matt Anderson, a managing director at Trepp, an Oakland firm that does analysis on commercial real estate and banking. The moral hazard exists because bankers and investors, knowing they won't be fully liable if a bank collapses, may take bigger risks. Although bank failures almost always wipe out the money investors put into banks, they also leave behind much bigger messes for everyone else to clean up. "It is frustrating, but we built a business model that can absorb it," said Mariner Kemper, chief executive of UMB Financial Corp. "I try not to think about it too much."
The loss a failed bank passes on to the deposit insurance fund is one measure of its failure to properly price risk, said Denver banking consultant Larry Martin. The losses at the five Colorado banks represent about 22 percent of their assets, which are made up mostly of loans. "That is probably pretty much ballpark with what has been going on so far nationally," Anderson said.
His measures show that the bank failures in June nationwide passed on losses of 25 percent of assets, up from a 19 percent rate in April. Three failed Colorado banks — FirsTier, Colorado Capital Bank and Signature Bank — face potential losses equal to about a third of their assets. What is more remarkable about those percentages is that they come after a borrower's equity in the project is consumed and after the bank has eaten through its capital cushion of 8 percent to 12 percent.
Even in the pre-crisis days, it wasn't unusual for banks to lend only 70 percent or less of the value of a project, although some banks pushed that amount up to win business in an overheated market. So how is it possible for bankers to get the valuation of collateral backing loans wrong by such a wide margin? About 80 percent of bank failures in this cycle are tied to commercial real estate, the remaining 20 percent to mortgages, Anderson said.
Raw land and construction projects in particular are hard to value and volatile. But they also generate larger fees upfront than other loans. Easy credit fuels higher prices, which supports larger loans, which fuels higher prices, until the whole thing collapses. Empty land or unfinished strip malls don't generate rents and, when a bust sets in, aren't worth even a fraction of the amount loaned against them. Many community banks focused on commercial real estate because that was the need in their communities and larger institutions were not providing money, said Don Childears, CEO of the Colorado Bankers Association.
But more than a specific sector, an inability of some bankers and bank directors to ask the question "what if" paves the road to ruin, Martin said. What if land prices fall 50 percent, what if this project doesn't get built, what if our loan portfolio is too concentrated in one loan type? "They have rose-colored glasses on, and they don't think beyond their nose," said Martin, who as an outside adviser tries to get bankers to look at the big picture.
Failure carries a long tail. Bank directors, unlike directors of corporations, are liable beyond their investment, Childears said. The FDIC can and will sue them for up to three years after a failure, Hernandez said. The FDIC is pursuing claims against 248 bankers and bank directors seeking to recover $6.8 billion against their professional liability policies, Hernandez said. That is driving up insurance premiums surviving banks have to pay for their directors and officers, adding another cost to the system, Martin said.
Failures also depress the price of collateral backing other loans in a market, weakening the balance sheet of the remaining banks. Colorado's hit to the insurance fund matched the deficit the deposit insurance fund was running as of March 31. The fund since has come into the black, in part because losses are declining in most states, Colorado being an exception. Back in 2009, bank failures cost the fund $37 billion, followed by a $23 billion loss in 2010 and only $5 billion so far this year, Hernandez said.
HSBC to Cut 30,000 Jobs
by Margot Patrick - Wall Street Journal
HSBC Holdings PLC on Monday said it is slashing around 30,000 jobs to cut costs and revamp its business, as the banking giant follows through on a May plan to withdraw from some countries and refocus its operations on high-growth markets.
On top of 5,000 jobs already under the ax in the U.S., U.K., France, Latin America and Middle East, around 25,000 further roles will be cut between now and 2013, Group Finance Director Iain Mackay told reporters. He said the bank is still hiring in some countries, though, and that the net headcount reduction could be much smaller.
HSBC made the announcement as it reported first-half net profit attributable to shareholders rose 35% to $8.9 billion from $6.6 billion, mainly from the effect of previously-flagged lower tax charges. Revenue was flat at $35.7 billion, with weakness in Europe and HSBC's Global Banking & Markets division offsetting double-digit percentage revenue growth in Hong Kong, the rest of Asia Pacific and Latin America.
HSBC shares were recently up 4.3% after trading up by about 1.5% just before the announcement. European and Asian stock indexes rose Monday after the U.S. late Sunday announced a last-minute agreement to raise its debt ceiling, averting a possible default. Mr. McKay said the agreement is welcome and will hopefully foster more stability in financial markets. HSBC Chief Executive Stuart Gulliver in May presented a strategic plan for the bank to shave up to $3.5 billion from its annual cost base by 2013, exit retail banking in some countries and tap a growing base of wealthy consumers in target markets.
So far, the bank has said it will stop offering retail banking in Russia and Poland, and has started reorganizing its operations in several other countries. The bank late Sunday said it was selling 195 retail-banking branches in upstate New York to First Niagara Financial Group Inc. for $1 billion in cash, a move Mr. Gulliver had said was under consideration in May.
Millions face pension poverty as 'golden' era ends
by James Hall - Telegraph
Up to 14 million workers will retire with pensions far smaller than those enjoyed by their parents, a report warns today, as the "golden generation" of retirement schemes comes to an end.
Almost three quarters of private sector staff will be unable to "adequately exist" when they retire due to a low level of savings and the complex, costly and inefficient pensions system, the report claims. Many workers retiring after 2020 are told to expect a "bleak old age", even taking into account pension reforms that will force employees to save for their retirement.
The grim financial outlook contrasts sharply with conditions enjoyed by the recently retired. Figures show that the net income of pensioners has grown by 47 per cent in real terms since 1999. Today’s report, written by Lord McFall of Alcluith, the former chairman of the Treasury select committee, warns that those who retire in the coming decades will do so on significantly reduced pensions. "A golden sunset is giving way to a bleak dawn," said Lord McFall.
The report, from the independent Workplace Retirement Income Commission, of which Lord McFall is chairman, comes as both the private and public sectors are grappling with the cost of pensions amid rising life expectancy. The Department of Work and Pensions will publish statistics this week suggesting that some children born today can expect to live to 120.
Lord McFall sets out 16 recommendations for creating a stronger, more stable pensions system. The findings will be presented to Steve Webb, the pensions minister. The report lists a raft of grievances about pension provision. It points out that the value of pensions has been hit by the global recession, low investment returns, increases in household debt, drops in real incomes and low interest rates. It suggests that there is a lack of trust in the system and says that private company pensions are often opaque and confusing for workers.
The report warns that workers must receive a better deal from their pensions if they are to bother saving for retirement. It also calls for an increase in minimum contributions to pension pots. Last year, only 36 per cent of those aged between 16 and 64 were actively contributing to a private pension, the report states. Over the past 10 years, the proportion of men saving into a pension has fallen from 49 per cent to 38 per cent, while for women it has dropped from 36 per cent to 33 per cent.
Lord McFall warned that although millions of workers would be enrolled automatically into workplace pension schemes from next year, up to nine million "may still fall through the cracks" by opting out. He said that a further five million workers did not earn enough to qualify for the auto-enrolment system, meaning that a potential 14 million people faced having an inadequate pension to live off. "In a rich nation such as ours, this is scandalous," he added.
The report states: "The shape of workplace pensions is changing and there seems to be little to suggest that trend will be reversed." The commission’s recommendations include the establishment of an independent standing commission on pensions. It also suggests that companies should offer workers free independent financial advice worth up to £500 free of tax.
The Government has outraged the unions with plans to force public sector workers to pay higher pension contributions. But these schemes are substantially more valuable than the majority in the private sector. Treasury figures show that a mid-level teacher retires with a pension pot equivalent to £500,000 — 20 times more than the average private sector worker.
Neil Carberry, director for employment at the CBI, broadly welcomed the latest proposals. "This report rightly identifies the need to do more to boost savings for retirement, and makes some helpful recommendations about how to build a culture of saving in the UK," he said. "However, the commission’s proposal to consider increasing the minimum compulsory pension contribution in 2017 is not the right answer. The current plan to introduce a floor of eight per cent saving from next year remains the best way to ensure more people who can afford to save do so."
Europe's Big Oil Sees Output Fall
by Alexis Flynn - Wall Street Journal
Most European major oil companies posted a surge in quarterly profits last week, but their results were overshadowed by a trend that continues to trouble Wall Street and corporate boardrooms: Nearly every major oil company reported year-to-year oil-and-gas output declines, often in the double-digits.
Big Oil is throwing huge resources at the problem with more open embrace of unconventional petroleum developments, high-risk exploration in frontier areas and corporate restructuring. But even if these strategies work in some cases, there is little doubt that anemic petroleum output signals a long-term challenge confronting the sector.
The particulars varied across the sector. BP PLC's 11% output drop was fueled in part by the continued hit from its reduced activity in the U.S. Gulf of Mexico after last year's disastrous spill. Italian giant Eni SpA's production fell 15% due to its disproportionate exposure to war-ravaged Libya. Spain's Repsol YPF SA, whose output fell 17%, was affected by both Libya and the U.S. Gulf, as well as by labor unrest in Argentina. Norway's Statoil ASA saw a 16% output decline largely on production outages and maintenance in its home market in the North Sea. French oil major Total SA's output slipped 2% from a year earlier, mostly due the loss of Libyan crude.
Oil giants are more vulnerable to operational problems in part because of their declining dominance over key resources. Whereas in 1973, independent oil firms controlled three quarters of the world's reserves, they hold as little as 10% today, according to some estimates. That has forced oil majors to rely to a greater extent on costly unconventional plays such as shale gas, deepwater exploration, and Arctic exploration.
Investment in conventional assets accounted for 63% of the majors' total capital expenditure between 2001 and 2005, research by Wood Mackenzie showed, with this proportion set to fall to 40% between 2011 and 2015.
Last week's reports showed that the two biggest oil giants, Royal Dutch Shell PLC and Exxon Mobil Corp., were somewhat better positioned than their smaller peers, in light of their capacity to progress capital-intensive projects. Another standout, Wall Street darling BG Group PLC, the only European oil major to report higher year-to-year output, has prospered from recent discoveries in the hot Brazil offshore region.
Yet there are problems even with these templates. Though demand for natural gas remains solid, natural gas prices could see further weakness in light of surging North American shale gas output and economic weakness in Europe and the U.S.
The push for more exploration has ignited interest in Africa following new seismic results and recent discoveries in Ghana and Uganda. But it's a risky and capital-intensive game and one requiring a fleetness of foot to grasp opportunities and adapt quickly to contrary political circumstances. Industry anecdotes abound of how some of the most lucrative recent discoveries on the continent were once passed up by reluctant majors.
Consolidation offers another way forward, yet few expect large corporate mergers between integrated oil giants in light of antitrust concerns and today's high oil prices. More likely is a deal akin to Exxon's purchase of U.S. unconventional-gas specialist XTO, a major factor in Exxon's standout 10% rise in production in the quarter. Wood Mackenzie's Simon Flowers predicts more such "infill acquisitions," but says "large-scale acquisition is not likely in the near term."
Another possibility is the flowering of deals between private oil giants and emerging state-controlled firms like Brazil's Petrobras, Russia's OAO Rosneft and China's CNPC. BP's failed share swap and Arctic exploration deal with Rosneft was an example and illustrates the lengths to which companies are prepared to go to gain access to their potentially lucrative reserves.
Wall Street will likely push harder for some sort of tangible action from Big Oil in the coming months. The sector trades at a significant discount to the oil price itself, a factor that could sharpen calls for share buybacks and more special dividends. The recent move by ConocoPhillips to hive off its downstream business lifted the Texas company's share price and spawned questions for the rest of the sector. But so far, most of Conoco's peers have dismissed the idea as impractical in light of the advantages of the conventional integrated model.