Wednesday, April 14, 2010

April 14 2010: A fragile teetering tower of debt

Marion Post Wolcott Soul Trailer December 1940
"Itinerant preacher from South Carolina saving souls of construction workers at Camp Livingston job near Alexandria, Louisiana"

Ilargi: I watched footage today of adult women and men who’d been abused by priests when they were kids, and whose main concern was to regain their faith and their place in the church. They even traveled all the way from the States to the Vatican, hoping the pope would actually and personally receive a letter they wrote. Of course the Vatican just brushed these poor folks off without a listen. Got to do better than a letter if you want your faith back, so seems to be the message. The Vatican has paid over $1 billion in hush and blood money so far, and them robes don’t come cheap. 10 hail mary’s and an open wallet might get you right back where you once thought you belonged. And do bring the kids.

There isn't really any difference between blind faith in Rome and blind faith in Washington, though, is there? Benedict, Obama, they all have a billion souls depending on them for faith, hope, charity and salvation. And whatever they do to you, you keep coming back for more. Because in your eyes, they’re the only game in town.

Or so I was thinking anyway when I saw that JPMorgan announced a $3.3 billion profit, while the bank still owes the US taxpayer $41 billion+. Now, I can't speak for you, but if someone owes me a big wad of cash, and instead of paying me back first, goes all prancing about town ordering champagne and farm fish eggs, I’m thinking kneecaps. Not the White House, though. And I know why. The $41 billion (and a lot more if you include the WaMu and Bear Stearns takeovers) is not owed to the White House. It’s owed to you, poor sodding anonymous you.

Major US banks have close to half a trillion dollars worth of junior lien mortgage loans on their books. Junior basically means anything not first mortgage, like home equity loans (my house is an ATM), second mortgages (an ATM with a different name), and more creativeness like that. All quite jolly and innovative and brilliant, providing it’s not your money at stake. But it is, and that’s the catch.

The problem with the junior liens is that they will be wiped out first, under "normal" circumstances, when a loan goes bad, when there’s a default, a repo, ... or even a modification. The big lenders got rid of just about any and all first lien loans through securitization, but they hold just a little bit more of the juniors still on their own books. And like so many other US loan portfolio's, government endorsed reality- and gravity-bending of FASB accounting standards make them look real fine and healthy, thank you very much.

Shahien Nasiripour lays it all out for everyone to see in the HuffPost:
JPMorgan Chase Argues Against Mortgage Modifications, Citing Sanctity Of Contracts
If a borrower loses his home to foreclosure, the first lien is repaid first off the subsequent sale. Whatever proceeds are left go to second and subsequent liens; if nothing is left -- for instance, if an underwater borrower is foreclosed on and the sale of the foreclosed home doesn't even satisfy the outstanding first lien -- then the second and subsequent liens are worthless. They don't get a penny. Based on that priority of payments, holders of first lien mortgage debt argue that those holding junior liens should take the first hit when it comes to modifying mortgages -- after all, if the home enters foreclosure, that's how it will play out.

Since nearly all mortgage modifications involve homeowners who are likely to default, investors argue that the second-lien holders should write down their holdings, take their losses, and get out of the way so troubled homeowners -- free of junior-lien debt obligations -- will have a chance to stay in their homes. Investors, after all, want homeowners to stay in their homes so they can continue getting paid; a foreclosed home rarely results in a profit to investors. Megabanks, thus, should reduce the amount borrowers owe them on those junior liens, argue investors, economics, consumer advocates and mortgage bond analysts.

[..] the big banks that own that junior lien debt aren't going to cut mortgage principal and take losses on their holdings without a fight, as emphasized by JP Morgan Chase's Lowman in his remarks. "Realistically, as the process winds through, those second [liens] are going to get wiped out," White said. "[The banks are] just in denial about that." The problem is so huge -- $448 billion huge -- that if the banks were to write down their positions and take the appropriate losses, some think it could necessitate a second bailout. But until those homes are actually sold in a forced sale -- like a foreclosure sale -- the banks can keep pretending their holdings are worth more than they really are, White said.

"I guess the banks would rather keep getting those monthly payments," he said. "And if they can get payments for another six months to a year, they figure, why not? "The problem with that logic is if the home is foreclosed, the second lien is going to go away,"[..]

It is of course completely idiotic that JPMorgan first suggests mortgage mods might bring the bank down, only to declare "healthy" profits 2 days later. There’s only one issue at play here, really: JPMorgan has such a huge amount of decrepit mortgages on its books that the ability to keep them there without any modifications is the one thing that allows the bank to announce a profit, which in turn permits it to pay out dividends and bonuses, as well as dupe investors into believing that its shares are properly valued, not hugely inflated through federally sanctioned accounting tricks. No modifications, no forced write-downs.

Another round of bail-outs? Well, yes please, but we can wait till November, and we’ll get by on the 0% borrowing and 5% lending back to the government scheme. For now, that is.

Whether it’s a priest molesting your kid, or an elected representative molesting yours and your kid's future welfare, it's, down the line, not that much of a difference, is it?

Yeah, the stock markets are up, S$P 500 crossed 1200, Hurrah and Hallelujah. But guys, one more time, that S$P 1200 number is 100% dependent on the fact that Washington has thrown YOUR money into the casino pit. That’s why there's happy traders out there, that’s why there’s pundits and TV stations declaring victory over the recession. Without your money, 90% of Wall Street would be a ghost street. And instead of insisting on payback, Obama lets JPMorgan declare a new spring with a $3.3 billion profit, without demanding your $41 billion back first. Even though JPMorgan would have been a dead duck in the polluted shallow water without your money. Is that what you elected him to do?

I’m thinking the politicians in Washington have the idea that they can do with as much of your money as they want whatever they see fit to do with it, including furthering their own careers, and that they’ve completely lost sight of who pays for all that. And I’m wondering where the difference lies between a priest abusing your confidence and a politician doing the same. Maybe it’s time to make up your own mind for a change, and simply get out of the game on all ends.

Ilargi: Please don’t forget to visit our sponsors, or to donate directly to The Automatic Earth. There’s a many much worse things you could with your time and money. We are working on a large deepening and expansion of TAE, and we won’t be able to do that without you.

Ilargi: Brilliant bit by Graham Summers. What more would you need to know?

It's Impossible To "Get By" In The US
by Graham Summers

While the market cheers on the fantastic job “growth” of March 2010, the more astute of us are concerned with a growing tide of personal bankruptcies. March 2010 saw 158,000 bankruptcy filings. David Rosenberg of Gluskin-Sheff notes that this is an astounding 6,900 filings per day.

This latest filing is up 19% from March 2009’s number which occurred at the absolute nadir of the economic decline, when everyone thought the world was ending. It’s also up 35% from last month’s (February 2010) number.

Given the significance of this, I thought today we’d spend some time delving into numbers for the “median” American’s experience in the US today. Regrettably, much of the data is not up to date so we’ve got to go by 2008 numbers.

In 2008, the median US household income was $50,300. Assuming that the person filing is the “head of household” and has two children (dependents), this means a 1040 tax bill of $4,100, which leaves about $45K in income after taxes (we’re not bothering with state taxes).  I realize this is a simplistic calculation, but it’s a decent proxy for income in the US in 2008.

Now, $45K in income spread out over 26 pay periods (every two weeks), means a bi-weekly paycheck of $1,730 and monthly income of $3,460. This is the money “Joe America” and his family to live off of in 2008.

Now, in 2008, the median home value was roughly $225K. Assuming our “median” household put down 20% on their home (unlikely, but it used to be considered the norm), this means a $180K mortgage. Using a 5.5% fixed rate 30-year mortgage, this means Joe America’s 2008 monthly mortgage payments were roughly $1,022.

So, right off the bat, Joe’s monthly income is cut to $2,438.

According to the US Department of Agriculture, the average 2008 monthly food bill for a family of four ranged from $512-$986 depending on how “liberal” you are with your purchases. For simplicity’s sake we’ll take the mid-point of this range ($750) as a monthly food bill.

This brings Joe’s monthly income to $1,688.

Now, Joe needs light, energy, heat, and air conditioning to run his home. According to the Energy Information Administration, the average US household used about 920 kilowatt-hours per month in 2008. At a national average price of 11 cents per kilowatt-hour this comes to a monthly electrical bill of $101.20.

Joe’s now down to $1,587.

Now Joe needs to drive to work to make a living. Similarly, he needs to be able to drive to the grocery store, doctor, etc. According to AAA, the average cost per mile of driving a minivan (Joe’s a family man) in 2008 was 57 cents per mile. This cost is based on average fuel consumption, tires, maintenance, insurance, license and registration, and average loan finance charges.

Multiply this cost by 15,000 miles per year and you’ve got an annual driving bill of  $8,550. Divide this into months (by 12) and you’ve got a monthly driving bill of  $712.

Joe’s now down to $877 (I’m also assuming Joe’s family only has ONE car). Indeed, if Joe’s family has two cars (one minivan and one sedan) he’s already run out of money for the month.

Now, assuming Joe’s family is one of the lucky ones (depending on your perspective) they’ve got medical insurance. Trying to find an average monthly medical insurance premium for a family in the US is extremely difficult because insurance plans have a wide range in deductibles, premiums, and co-pays. But according to eHealth Insurance, the average  monthly premium for family policies in February 2008 was $369.

So if Joe has medical insurance on his family, he’s now down to $508. Throw in cell phone bills, cable TV and Internet bills, and the like, and he’s maybe got $100-200 discretionary income left at the end of the month.

This analysis covers all of the basic necessities of the average American household: mortgage payments, food, energy, gas, driving expenses, and medical insurance. It also assumes that Joe:

1)    Didn’t overpay for his house
2)    Made a 20% down-payment of $45K on his home purchase
3)    Has no debt aside from his mortgage (so no credit card debt, student loans, etc)
4)    Only has one car in the family and drives 15,000 miles per year
5)    Keeps his energy bill reasonable
6)    Does not eat out at restaurants ever/ keeps food expenses moderate
7)    Has no pets
8)    Pays for health insurance but has no monthly medical expenses (unlikely with two kids)
9)    Keeps his personal budget under control regarding cable TV, Internet, and the like
10)    Doesn’t spoil his kids with toys, gadgets, trips to the movies, etc.
11)    Doesn’t take vacations.

Suffice to say, I am assuming Joe maintains EXTREMELY conservative spending habits. Personally, I know NO ONE who meets all of the above criteria. However, even if the above assumptions applied to the average American, you’re still only looking at $100-200 in “wiggle” room for spending per month!

If Joe:

1)    Overpaid on his house
2)    Didn’t have a full 20% down payment
3)    Owns two cars
4)    Eats at restaurants
5)    Splurges on heating & A/C bills
6)    Has any medical expenses aside from monthly premiums…

… he is running into the red EVERY month.

I also wish to note that my analysis didn’t include real estate taxes and numerous other expenses that most folks have to pay. So even if you are extremely frugal and careful with your money, it is impossible to “get by” in the US without using credit cards, home equity lines of credit or burning through savings. The cost of living is simply TOO high relative to incomes.

This is why there simply cannot be a sustainable recovery in the US economy. Because we outsourced our jobs, incomes fell. Because incomes fell and savers were punished (thanks to abysmal returns on savings rates) we pulled future demand forward by splurging on credit. Because we splurged on credit, prices in every asset under the sun rose in value. Because prices rose while incomes fell, we had to use more credit to cover our costs, which in turn meant taking on more debt (a net drag on incomes).

And on and on.

Does this mean the market is about to tank? Not necessarily, stocks have been disconnected from reality since November if not July. Bubbles (and we ARE in a bubble) take time to pop and this time around will be no different.

Can You Handle The Truth?
by David Rosenberg

There seems to be so much commentary on the big recovery because of course that is what people think the equity market is telling them. But reality bites. First, there has only been one quarter of positive growth in real GDI which has diverged from real GDP at a record rate, which is one reason why the NBER is still so reluctant to make the end-of-the-recession call.

After all, a recovery premised on the Fed’s incursion into the home loan market, the government’s move to buy equities and allow banks to manufacture their own earnings stream and at the same time embark on a borderline welfare state path whereby almost one-fifth of personal income is coming from the generosity of Uncle Sam – well, who wouldn’t be questioning the veracity of the recovery. We know. The equity market. The same equity market that peaked in the very same quarter that the recession started back in 2007Q4. What a leading indicator!

Here are some stylized facts worth considering:
  • The FASB 157 changes a year ago have allowed the banks to post great credit-related earnings even as their asset base shrinks. Ex-financial earnings are up the grand total of 5% in the past 12 months. That doesn’t look so V-shaped to us – far less than the market would have you believe.

  • Inventories will only take you so far in an expansion - -to perpetuate the inventory cycle, final sales have to come through. In a normal post- recession recovery, final sales growth averages nearly 5% in the first two quarters. This time around, the big rebound has been barely over 1.5% -- and with record amounts of government stimulus.

  • If the savings rate continues along the path it has been on so far this year it will be back at zero by mid-summer.

  • It is amazing how many people believe that home prices are stabilizing in the United States when there is so much evidence to the contrary. The FHGA price index is down two months in a row. Ditto for the LoanPerformance house price survey. The Radar Logic 25 MSA price index has deflated now for three months running. The key Case-Shiller index has yet to decline but that is only due to the generosity offered by the seasonal factors – the raw data show four declines in a row. With the new unsold housing inventory rising back to a nine-month high of 9.2 months’ supply, and to a six-month high of 8.6 months’ in the resale market, why would anyone think that there could be anything but downside to housing values?

  • We get this all the time – looking at US profits in the context of US GDP is misleading because so much of the earnings pie is being influenced by the global economy. Really? Well, which countries does the US really do business with because last we saw, shipments bound for the BRICs account for barely more 1% of U.S. GDP. Europe is three times as important and again, last we saw, the EMU economy stagnated in Q4. When you dig through the National Accounts data, what is apparent is that total earnings derived from the non-U.S. economy are actually down 7.6% YoY. This has been, and remains largely a story of the financial sector being able to manufacture their own model-based credit-improvement-led profits rebound.

  • While everyone gazes at the drib-drab improvement in jobless claims and the BLS data showing renewed job growth in the private sector, how much better have conditions improved in the labour market when Congress yet again passes a bill to extend jobless benefits? The grim reality is that the U.S. labour market is so weak that the average number of weeks that the unemployed have been without work at a record 31 weeks is now higher than in Newfoundland (17 weeks) where much of the workforce is seasonal in nature.

    It doesn’t take a rocket scientist to know that after an 8.4 million slide in payrolls to levels prevailing a decade ago, that we have likely hit some point of inertia. But to describe the job market environment as anything but grim – as difficult as it is to speak the truth – is nothing less than dishonest; at a minimum, irresponsible.

  • There is pervasive belief that housing has hit bottom and about to bounce. At 10, the NAHB customer traffic sub index is back to where it was when the equity market thought the world was coming to an end back in March/09. How does that comport with a housing recovery view that has become so prevalent?

Yes consumer spending is doing better this quarter on the back of tax refunds, extended jobless benefits, strategic mortgage defaults, and while the labour market has indeed improved, wages are still deflating, especially in the private sector. Basically, what has happened so far this year is that the savings rate has managed to come back down from 4% to 3.1% and if not for that drawdown, consumer spending would actually have contracted in both January and February.

From our lens, it is one thing to talk about consumer spending but it is even more important to analyze what the underpinnings are and whether they will be sustained. There is nothing organic about this consumer bounce in Q1, and households know it, which is why every measure of confidence and sentiment, while off last year’s depressed lows, are still at levels consistent with a deep recession.

So much is being made of the fact that the BLS employment data have turned, but as we saw in the head fakes of 2002, all bets are off until the ADP survey - - which hit a fresh low in March but this receives scant attention - -provides confirmation.

Tower of debt will force a roll back of the free markets
by Russell Napier

More than 20 years ago Margaret Thatcher asserted that 'You can't buck the market' and that 'there is no such thing as society.' The world changed. Today the Conservative party's leader David Cameron is keen to '...assert a fundamental truth: that markets are a means to an end, not an end in themselves. Markets are there to serve our society, not to suck the joy out of it or trample over its values.' The world is changing again. The real fundamental truth is that the free market system has buckled under the pressure from a very different system which has stubbornly refused to change.

In North Asia society prefers a system which targets full capacity and full employment and has little interest in maximising returns on capital. This system insists on bucking the market and the long held consensus view was that it would fail. As we enter the second decade of the twenty first century it is now evident that, in preventing the deflation mandated by the North Asian system, we have passed the zenith of the free market system. If markets are 'to serve our society', for which read fund our governments, then they will have to be controlled.

Over the past few decades the 'free' adjustable system has, not surprisingly, taken the path of least resistance when faced with an opposing system rigidly designed to over-produce. It had shunned competition in those areas of over-production and adapted to consume the cheap products provided at uneconomic rates. When funds were not readily available for consumption it turned to readily available cheap debt in an era when over production and central bank purchases of western government debt kept inflation and thus interest rates low.

In this process of adaptation it was easy to believe that it was the parasite (consumer) which was growing strong at the expense of the host (producer). Cheap debt enabled strong consumption and rising asset prices produced the illusion of reasonable savings to provide for an ageing population. However the time came when the limits to leverage were reached. The decline in demand which ensued threatened to bring to pass the deflationary bust which the western authorities had fought for almost two decades. The consensus opinion was that it was the over-producing North Asian model which would fail. However year after year Japanese society weathered dire economic conditions rather than abandon their focus on over production and over employment.

In China a buoyant free market system did develop but the core of the system continued to over-produce fed by the milk cow of a command economy banking system. Just when it looked like the rest of Asia had been forced to capitulate to free market forces in 1997 governments prevented a free market in their exchange rates and joined the over-production party. Alan Greenspan spent most of his career fighting off the deflation which the North Asian model threatened. By 2008 monetary policy was no longer sufficient and a mighty fiscal response was thrown against the deflationary dynamic.

The refusal to accept the deflation imposed by the North Asian model has produced massive government intervention and pushed fiscal debt to GDP sharply higher. Western governments are left with no option but to restrict and corral markets and force private sector capital into action in support of public debt markets. Only such actions, or rapidly declining demand for debt in the private sector, can support the scale of public debt burden now developing. At times there will be evidence that the G7 plan to rebalance global growth with higher consumption in the emerging world is working. In a free market system, replete with players desperate for a return to business as usual, such signs will be greeted with great fanfare. Expect the first trumpet of joy to sound as China returns to the steady but slow appreciation of its exchange rate relative to the US dollar.

However the simple truth is that it is too late for the free markets. The roll back of the free market has already begun, driven by the necessity to support a fragile teetering tower of public debt. Commercial banks' new capital adequacy ratios already require banks to hold higher levels of government debt. In due course a transaction tax on financial instruments, apart from government debt, will come to pass. A 'Buffett' tax which makes short termism expensive and forces owners to engage with managers will come to be seen as the natural solution to produce markets which 'serve our society.'

The ultimate weapon to force private savings to fund governments will be capital controls. To support public debt to GDP levels not seen since the second world war, we are likely to see a return to similar forms of market constraints which were necessary in that era. The 'new normal' is not sub par economic growth. The new normal is the roll back of the free markets.

Economics may be dismal, but it is not a science
by John Kay

A remarkably distinguished group of economists gathered last weekend for the inaugural conference of the Institute for New Economic Thinking, an initiative of George Soros. They were soul searching over the failures of economics in the recent crisis. Such failures are most evident in two areas: the inadequacies of the efficient market hypothesis, the bedrock of modern financial economics, and the irrelevance of recent macroeconomic theory.

The central idea of the efficient market hypothesis is that prices represent the best estimate of the underlying value of assets. This thesis has recently taken a battering. The boom and bust in the money markets was precipitated by a US housing bubble. That bubble followed the New Economy fiasco and was preceded by the near-failure of Long Term Capital Management, a hedge fund designed to showcase sophisticated financial economics.

The macroeconomics taught in advanced economics today is largely based on analysis labelled dynamic stochastic general equilibrium. The unappealing title gives the game away: the theorists are mostly talking to themselves. Their theories proved virtually useless in anticipating the crisis, analysing its development and recommending measures to deal with it. Recent economic policy debates have not only largely ignored DSGE, but have also been remarkably similar to the economic policy debates of the 1930s, although they have been resolved differently. The economists quoted most often are John Maynard Keynes and Hyman Minsky, both of whom are dead.

Both the efficient market hypothesis and DSGE are associated with the idea of rational expectations – which might be described as the idea that households and companies make economic decisions as if they had available to them all the information about the world that might be available. If you wonder why such an implausible notion has won wide acceptance, part of the explanation lies in its conservative implications. Under rational expectations, not only do firms and households know already as much as policymakers, but they also anticipate what the government itself will do, so the best thing government can do is to remain predictable. Most economic policy is futile.

So is most interference in free markets. There is no room for the notion that people bought subprime mortgages or securitised products based on them because they knew less than the people who sold them. When the men and women of Goldman Sachs perform "God’s work", the profits they make come not from information advantages, but from the value of their services. The economic role of government is to keep markets working.

These theories have appeal beyond the ranks of the rich and conservative for a deeper reason. If there were a simple, single, universal theory of economic behaviour, then the suite of arguments comprising rational expectations, efficient markets and DSEG would be that theory. Any other way of describing the world would have to recognise that what people do depends on their fallible beliefs and perceptions, would have to acknowledge uncertainty, and would accommodate the dependence of actions on changing social and cultural norms. Models could not then be universal: they would have to be specific to contexts.

The standard approach has the appearance of science in its ability to generate clear predictions from a small number of axioms. But only the appearance, since these predictions are mostly false. The environment actually faced by investors and economic policymakers is one in which actions do depend on beliefs and perceptions, must deal with uncertainty and are the product of a social context. There is no universal economic theory, and new economic thinking must necessarily be eclectic. That insight is Keynes’s greatest legacy.

75% Of Homeowners Already In Obama's Loan Modification Plan Still Underwater
by Shahien Nasiripour

More than three-quarters of homeowners who have had their monthly mortgage payments reduced under the Obama administration's primary foreclosure-prevention program owe more on their mortgage than their house is worth, according to a new report by government auditors. Over half of the roughly 170,000 distressed borrowers who have gone through the program are seriously underwater, meaning they have negative equity of at least 25 percent, the report shows, citing data through February. In other words, for every $1.00 their home is worth, they owe at least $1.25.

The average homeowner that's received a five-year modified mortgage under the administration's plan had negative equity of about 35 percent prior to the program, according to a Wednesday report by the Congressional Oversight Panel, a federal bailout watchdog. After modification, that burden actually increased for the average homeowner, who is now underwater by more than 43 percent, according to the bailout watchdog's report. Research shows that the more under water homeowners are, the more likely they are to fall behind on payments, default, or walk away.

But that data understates the problem, the report said. Those figures are for first-lien home mortgages only. Debt owed on junior liens, like second liens and home equity lines, isn't part of that calculation. The Obama administration estimated last April that "up to 50 percent of at-risk mortgages currently have second liens." "If junior liens were to be included, the percentage would be significantly higher," the report notes. "The continuing deep level of negative equity for many HAMP permanent modification recipients makes the modifications' sustainability questionable; even with more affordable payments, deeply underwater borrowers may remain tempted to strategically default or may be compelled to because core life events, such as death, divorce, disability, marriage, child birth, job loss, or job opportunities necessitate a move."

HAMP refers to the administration's Home Affordable Modification Program, which seeks to lower troubled borrowers' monthly payments primarily through interest rate cuts. Strategic defaults occur when homeowners are able to make the payments, yet willingly choose not to and instead walk away from the mortgage. Recent research estimates strategic defaults are on the rise. "Negative equity is the single most important driver of defaults," Laurie S. Goodman, senior managing director at Amherst Securities and a top mortgage bond analyst, said in February during a panel discussion at the American Securitization Forum's annual conference.

After months of sustained criticism -- including by the bailout watchdog and by Democrats in Congress -- the Treasury Department finally outlined a plan late last month that calls for principal reductions, which is the only way to address the problem posed by underwater homeowners. (Absent a rise in property values, the only way to give borrowers equity is to reduce the overall amount owed). But that plan doesn't kick in until the fall. Meanwhile, the foreclosure crisis does not show any signs of abating, the panel's chair, Harvard Law professor Elizabeth Warren, said during a Tuesday evening conference call with reporters.

Her panel's report notes that "principal forbearance was rare and principal forgiveness rarer still." Deferred principal accounted for about 28 percent of the mortgage modifications, while "only" six percent of them involved principal cuts. An additional six percent incorporate principal cuts and deferred principal. "[T]he Panel has concerns as to whether the modifications make homeownership sufficiently affordable to avoid foreclosure, given borrowers' broader circumstances. As noted previously, the program...without considering the existence of junior liens, leaves borrowers still paying a significant percentage of their income for housing," the report notes. "This is particularly problematic because most HAMP modification recipients are underwater.
"This points to the problem with the lack of principal forgiveness in HAMP up to this point. Lack of principal forgiveness means that homeowners will continue to be underwater. It also means that more of each payment will be going to interest, rather than paying down principal, and it may mean that some borrowers have to pay for a longer period of time. All of these factors increase the re-default risk on modified mortgages, and to the extent that a permanent modification is not sustainable, it merely delays a foreclosure and the stabilization of the housing market."

Less than a quarter of eligible homeowners have converted from temporary trial modification plans into five-year plans, the report notes. Treasury originally forecast up to a 75 percent conversion rate. And while it's too early to tell the rate at which these modified loans will default, Treasury estimates a 40 percent re-default rate, the report notes, citing testimony from Treasury officials. The administration originally promised to help three to four million homeowners avoid foreclosure.

The panel estimates that in the end as few as 276,000 foreclosures will be averted. Last year lenders foreclosed on more than 2.8 million homes, according to real estate research firm RealtyTrac. The firm estimates three million homes will get foreclosure notices this year; more than one million of them will be repossessed by lenders. "For every borrower who avoided foreclosure through HAMP last year, another 10 families lost their homes. It now seems clear that Treasury's programs, even when they are fully operational, will not reach the overwhelming majority of homeowners in trouble," the panel's report notes.

In an e-mail to reporters, Treasury spokeswoman Meg Reilly said that the department's latest monthly report on HAMP will show that more than 230,000 homeowners have transitioned into five-year modification plans. Additional 108,000 have been approved and are awaiting borrower acceptance. The report is expected to be released Wednesday, Reilly wrote.

One issue that's been pondered by investors and housing analysts, but hasn't been fully addressed by policymakers is the supposed backdoor-bailout nature of the HAMP program. While it's supposed to help homeowners, many have criticized its design as benefiting the mortgage servicers instead. The four biggest mortgage servicers are the four biggest banks -- Bank of America, JPMorgan Chase, Citigroup and Wells Fargo -- and taxpayers pay them for every successful modification. Also, because those modifications rely primarily on interest rate cuts, rather than principal writedowns, they end up increasing troubled homeowners' amount of overall debt, according to the panel's report.

"HAMP's original emphasis on interest rate reduction, rather than principal reduction, benefits lenders and servicers at the expense of homeowners," the report reads. "Lenders benefit from avoiding having to write down assets on their balance sheets and from special regulatory capital adequacy treatment for HAMP modifications. Mortgage servicers benefit because a reduction in monthly payments due to an interest rate reduction reduces the servicers' income far less than an equivalent reduction in monthly payment due to a principal reduction.

"Servicers are thus far keener to reduce interest rates than principal. The structure of HAMP modifications favors lenders and servicers, but it comes at the expense of a higher redefault risk for the modifications, a risk that is borne first and foremost by the homeowner but is also felt by taxpayers funding HAMP." Treasury allocated $50 billion to help struggling homeowners, with an additional $25 billion for government-backed housing giants Fannie Mae and Freddie Mac. The nation's four biggest banks by assets received a combined $140 billion alone in initial taxpayer bailout money.

"Foreclosure prevention is not just the right thing do for suffering Americans, but it is the linchpin around which all other efforts to achieve financial stability revolve," said Richard H. Neiman, New York's top bank regulator and a member of the Congressional Oversight Panel. Over the past two months alone more than 450,000 homes have received a foreclosure notice. Slightly more than 100,000 homeowners have been helped by Treasury's anti-foreclosure efforts over the same time period. "In the final reckoning, the goal itself seems small in comparison to the magnitude of the problem," the panel said in its report.

Small-Business Confidence in U.S. Dropped in March
by Shobhana Chandra

Confidence among U.S. small businesses fell in March to the lowest level since July 2009 as executives grew more concerned about earnings and sales, a private survey found. The National Federation of Independent Business’s optimism index dropped to 86.8 last month from 88 in February, the Washington-based group said today. Seven of the index’s 10 components declined last month and two were unchanged from February.

"Usually we see the small businesses leading the way out since they’re the first ones to see the consumer come back, but what’s happened this time is the consumer didn’t come back," William Dunkelberg, the group’s chief economist, said today in a Bloomberg Radio interview. While purchases have increased, "there’s not enough sales to go around to make the whole population of small businesses very healthy," he said. A gauge of expectations for business conditions six months from now was the sole component that improved from the prior month, rising one point. The report also showed that while workforce reductions may be over, small businesses weren’t ready to add workers or spend more on new equipment.

The measure of earnings expectations showed the biggest decline in March, falling 4 points to minus 43 percent. Thirty- four percent of respondents cited "poor sales" as the top business concern, the same as in February, and the net percent of owners projecting higher sales, adjusting for inflation, fell to minus 3 percent. A gauge of whether firms think this is a good time to expand dropped 2 points to a net 2 percent. The survey’s net figures are calculated by subtracting the percent of business owners giving a negative answer from those giving a positive response.

A net minus 2 percent of respondents plan to hire over the next three months, down one point from February. Nine percent of firms said they currently had job openings that were hard to fill, compared with 11 percent a month earlier, a "negative" for hope that the unemployment rate will drop, Dunkelberg said. Plans for capital investment fell one point to a net 19 percent.

The share of owners who said they expect credit conditions to ease in the coming months fell 2 points to a net reading of minus 16 percent. The report is at odds with recent data showing the world’s largest economy is emerging from the deepest recession since the 1930s. Employers increased payrolls by 162,000 in March, the most in three years, while the unemployment rate held at 9.7 percent. The NFIB report was based on 948 survey responses through March 31. Small businesses represent more than 99 percent of all U.S. employers and have created 64 percent of all new jobs in the past 15 years, according to the U.S. Small Business Administration.

Ilargi: Saying that the economy depends on finance is the same as saying it depends on taxpayer money. The financial institutions wouldn’t exist anymore without that money. It’s also the same as saying the economy depends on funny and fuzzy accounting practices, without which the financials would be going going gone as well. All in all, not that solid of a basis, wouldn’t you agree?

The Economy Is Back To Being Ridiculously Overdependent On Finance Again
by Joe Weisenthal

David Rosenberg made a point similar to this yesterday.  But in case it isn't clear, the rebound in financial earnings has put the banking sector to basically right back to where it was before the crisis.  (Well, they're not quite at peak profits yet, but as a segment of the economy that's ridiculously big compared to the rest of the economy, all your dreams of a mean-reversion have been dashed).

This Bloomberg chart comes from Paul Kedrosky:


JPMorgan Chase reports $3.3 billion profit
by David Ellis

JPMorgan Chase reported a $3.3 billion profit for the first quarter Wednesday, even as its results were tempered by ongoing losses in consumer loan portfolios. Profits were up 55% from a year ago. On a per share basis, the New York City-based bank said it earned 74 cents a share during the quarter, easily topping Wall Street's consensus estimate of 64 cents a share. Jamie Dimon, the company's chairman and CEO, credited the firm's investment banking business, particularly its fixed income division, for helping to lift the bank's fortunes in the latest quarter.

The company also said it planned on adding 9,000 jobs in the U.S., although it did not provide a time frame as to when those workers would be hired. There were also encouraging signs within its consumer loan-related businesses, namely a widespread decline in provisions, or money set aside to cover future loan losses. The number of consumers behind on their payments also improved during the quarter. The bank said the percentage of its credit card holders who were 30 days behind on a payment was 5.62%, down from 6.28% in the fourth quarter.

Still, Dimon was cautious to sound the all-clear signal, noting that credit trends were susceptible to further disruptions. "Ultimately, the health of these portfolios will track the health of the economy," he said in a statement. Along those lines, JPMorgan Chase still reported some credit trouble spots. The number of borrowers with good credit that had fallen behind on their home loans, for example, continued to march higher in the first quarter.

JPMorgan's latest results are likely to set a high bar for the rest of the nation's top banks due to report in the coming weeks. On deck is rival Bank of America, which will deliver its results before Friday's opening bell. Citigroup and Wells Fargo are scheduled to report their first quarter results next week. JPMorgan Chase shares gained more than 3% in pre-market trading Wednesday on the news. 

JPMorgan Chase Argues Against Mortgage Modifications, Citing Sanctity Of Contracts
by Shahien Nasiripour

With millions of homeowners losing their homes to foreclosure during this recession, megabank JPMorgan Chase plans to argue against the Obama administration's latest weapon in its fight to stem the problem -- principal cuts for struggling borrowers -- by citing the sanctity of contracts and the borrower's "promise to repay." In testimony to be delivered Tuesday afternoon, David Lowman, chief executive officer for home lending at the "Too Big To Fail" behemoth, will fight back against the program which calls for lenders and investors to decrease the outstanding debt owed on a home mortgage. While his competitors at Bank of America, Wells Fargo and Citigroup plan to dance around the issue -- judging from their prepared remarks -- Lowman cut right to it: borrowers don't deserve it.

"Like all loans, mortgage contracts are based on a promise to repay money borrowed," Lowman's prepared remarks read. "Importantly, there is no provision in the mortgage contract, express or implied, that the lender will restore equity or reduce the repayment amount if the value of the collateral -- be it a home, a car or a stock market investment -- depreciates. "If we re-write the mortgage contract retroactively to restore equity to any mortgage borrower because the value of his or her home declined, what responsible lender will take the equity risk of financing mortgages in the future? What responsible regulator would want lenders to take such risk?"

In January, the firm's chairman and chief executive, Jamie Dimon, told the panel investigating the roots of the financial crisis that, prior to the collapse, JPMorgan Chase did not conduct any stress tests that showed house prices falling. "I would say that was probably one of the big misses," Dimon said. "We stressed almost everything else, but we didn't see home prices going down 40 percent." So the firm made loans, arguably not knowing that the value of the assets backing those loans might one day significantly decline in value. Lowman will effectively tell the House Financial Services Committee that it's the homeowner's responsibility to bear the losses that came as a result.

JPMorgan Chase received $25 billion in a taxpayer-funded bailout, which it has since repaid; it absorbed Bear Stearns and Washington Mutual in 2008 through sweetheart deals that offloaded most of the cost and risk onto taxpayers; and it also received $41 billion in cheap funding through a taxpayer-backed debt issuance program from the FDIC, money that has not been repaid..

The bank's arguments against principal cuts amount to an "argument against modifications in general," said Alan White, a law professor and contracts expert at Valparaiso University who has written extensively on mortgages and foreclosures. "The point about the sanctity of contracts is okay, but where does that get us in the discussion?" he asked. "The moral absolutism of the contract doesn't advance the discussion of how you deal with a national crisis." White also pointed out that "the contract is not absolute." Bankruptcy, in which some debts are completely extinguished, is just one example in which contracts are rewritten. "People go back and rewrite contracts all the time," he said. "Just look at AIG and the United States, for instance."

Congress wants to know why the administration's foreclosure-prevention efforts haven't performed as promised. Its principal initiative, the Home Affordable Modification Program, seeks to lower troubled borrowers' monthly payments by modifying their mortgages primarily through lower interest rates. But not enough homeowners have been helped. And the program does virtually nothing to help homeowners who owe more on their mortgage than the home is worth, otherwise known as being "underwater."

Enter principal cuts. Mortgage bond analysts, consumer advocates, economists, and housing experts nearly unanimously agree that the best way to modify a mortgage that keeps homeowners out of foreclosure is to cut the overall amount owed -- the principal. That hasn't happened, though. Megabanks and investors are locked in a battle -- the banks don't want to cut principal, while investors do -- with distressed homeowners stuck in the middle. The chair of the House panel calling Tuesday's hearing, Barney Frank (D-Mass.), has called for the megabanks to write down mortgage principal -- now.

Here's what's going on:
The nation's four biggest banks collectively own about $448 billion in junior liens -- those loans taken out on a property in addition to the more standard first-lien mortgage, like second liens, home equity loans and so forth -- as of Dec. 31, 2009, according to regulatory filings with the Federal Reserve. That's nearly 45 percent of all outstanding junior-lien home mortgages in the U.S., Federal Reserve data show. The problem is that it's those holdings that are complicating efforts to modify home mortgages. Nearly two-thirds of all home mortgages are held as securities by investors worldwide, most of which are based on first-lien debt. Banks only hold a bit more than a quarter of all outstanding home mortgage debt, Fed data show.

If a borrower loses his home to foreclosure, the first lien is repaid first off the subsequent sale. Whatever proceeds are left go to second and subsequent liens; if nothing is left -- for instance, if an underwater borrower is foreclosed on and the sale of the foreclosed home doesn't even satisfy the outstanding first lien -- then the second and subsequent liens are worthless. They don't get a penny. Based on that priority of payments, holders of first lien mortgage debt argue that those holding junior liens should take the first hit when it comes to modifying mortgages -- after all, if the home enters foreclosure, that's how it will play out.

Since nearly all mortgage modifications involve homeowners who are likely to default, investors argue that the second-lien holders should write down their holdings, take their losses, and get out of the way so troubled homeowners -- free of junior-lien debt obligations -- will have a chance to stay in their homes. Investors, after all, want homeowners to stay in their homes so they can continue getting paid; a foreclosed home rarely results in a profit to investors. Megabanks, thus, should reduce the amount borrowers owe them on those junior liens, argue investors, economics, consumer advocates and mortgage bond analysts.

Their argument is "quite reasonable," White said. But the big banks that own that junior lien debt aren't going to cut mortgage principal and take losses on their holdings without a fight, as emphasized by JP Morgan Chase's Lowman in his remarks. "Realistically, as the process winds through, those second [liens] are going to get wiped out," White said. "[The banks are] just in denial about that." The problem is so huge -- $448 billion huge -- that if the banks were to write down their positions and take the appropriate losses, some think it could necessitate a second bailout. But until those homes are actually sold in a forced sale -- like a foreclosure sale -- the banks can keep pretending their holdings are worth more than they really are, White said.

"I guess the banks would rather keep getting those monthly payments," he said. "And if they can get payments for another six months to a year, they figure, why not? "The problem with that logic is if the home is foreclosed, the second lien is going to go away," White said. Last year lenders foreclosed on more than 2.8 million homes, according to real estate research firm RealtyTrac. The firm estimates three million homes will get foreclosure notices this year; more than one million of them will be repossessed by lenders.

Banks Fight to Block Derivatives Rules
by Damian Paletta and Scott Patterson

Democrats Push Restrictions on Derivatives Trading; Showdown Looms in Senate

Senate Democrats, resisting a last-ditch lobbying push from big Wall Street firms, are moving toward a sweeping revamp of financial regulation that would squeeze banks' lucrative derivatives-trading business. nWall Street giants Goldman Sachs Group Inc., J.P. Morgan Chase & Co. and Morgan Stanley had been pressing hard in recent days to dilute provisions of the bill that would change the rules for derivatives trading. But the Obama administration, which has made this one of its priorities for the financial-regulatory bill, has pushed back hard and appears to be succeeding. That's drawing Republican complaints that the pending rewrite of the rules of finance will put the economy at risk.

The battle is the latest clash between Wall Street and the White House as the administration pushes for the most sweeping revamp of financial regulation since the Great Depression, following the recent crisis. Wall Street firms, among other interests, are scurrying to protect their franchises and profits. Derivatives are financial instruments that derive their value from the movement of something else—for instance, the price of wheat or other commodities, or the level of interest rates. In recent years, a strain of derivatives known as credit-default swaps (in effect, a bet on a borrower's ability to repay a debt) has exploded. Derivatives figured in the global financial crisis, though their precise role is a subject of debate.

The bankers' lobbying has focused on the Senate Agriculture Committee, which Wall Street hoped would produce a friendlier bill than an alternative from the Senate Banking Committee. But it became clear Tuesday that the Agriculture Committee's chairman, Arkansas Democrat Blanche Lincoln, is now expected to introduce a bill with provisions that bankers oppose and the White House supports.

In the past few days, officials from Goldman's New York headquarters came to Washington to meet with the Agriculture Committee staff. A prominent J.P. Morgan official, Blythe Masters, a frequent contributor to Democrat campaigns, has both testified in public and met privately with the panel's aides. Earlier this year, J.P. Morgan hosted Sen. Lincoln in New York where she met with senior executives. The bank's political action committee contributed $5,500 on Jan. 14 to her reelection campaign.

Trading in derivatives is concentrated in five large Wall Street banks—J.P. Morgan, Goldman, Morgan Stanley, Bank of America Corp. and Citigroup Inc. The business produced revenues of about $20 billion last year, according to Comptroller of the Currency and industry estimates. Unlike stocks and bonds, which are traded in public, most derivative deals are private agreements between two parties. Goldman, J.P. Morgan and Morgan Stanley have at least one common objective: To thwart or dilute proposals that would push trading in most derivatives onto exchanges or to "clearinghouses," which are middleman institutions set up to handle big transactions between banks.

Their main concern: Trading on exchanges or via clearinghouses could reveal more details about the pricing and structure of the deals, potentially benefiting rivals and clients, and in the process eating into profits. Banks have also argued that any requirements that their customers use standardized derivative products, instead of individually customized deals, would limit customers' flexibility. Spokesmen for Morgan Stanley and Goldman Sachs declined to comment on lobbying efforts.

"Watering down and delaying reform can have a major benefit for" the banks, says Robert Litan, an economist and former Clinton administration antitrust official who now follows financial regulatory matters at the Kauffman Foundation, a nonprofit research group focused on entrepreneurship in Kansas City. On the high-stakes derivatives fight, the banks have an army of allies: the large numbers of industrial companies using derivatives to hedge against everything from swings in interest rates and currency values to the price of wheat and oil. Officials from dozens of these "end users," as they're known, plan to come to Washington next week to press their case.

Using clearinghouses can reduce risk to the overall financial system. Because they are usually backed by a group of Wall Street firms, if any one firm were to fail, the clearinghouse would remain able to make good its promises. Derivatives woes played a significant role in the failure of some financial firms, including American International Group Inc., which provided guarantees it couldn't meet when the financial system unraveled in 2008. The outcome of the financial regulatory bill, of which derivatives are a big part, largely depends now on Senate Republicans. The House passed a version late last year with provisions on derivatives closer to Wall Street's position than the White House's. The Senate is expected to turn to its version at the end of this month; Democrats need at least a few Republican votes to overcome the potential of a filibuster.

Talks between Republicans and bankers have intensified. Senate Minority Leader Mitch McConnell, a Kentucky Republican, went to New York last week for several fund-raisers and met with the Association of Mortgage Investors. On Tuesday, as it became clear Sen. Lincoln wasn't moving toward Republicans on the derivatives issue, Sen. McConnell took to the Senate floor and blasted the Democrats. "We must not pass the financial-reform bill that's about to hit the floor," he said. "The fact is, this bill wouldn't solve the problems that led to the financial crisis. It would make them worse." President Barack Obama is to meet Wednesday with congressional leaders of both parties to press his case for passing a bill, including the new rules for derivatives.

Banks Resist Plans to Reduce Mortgage Balances
by David Streitfeld

In a rebuff to the Obama administration, two big banks on Tuesday drew a line in the sand on cutting the mortgage balances of beleaguered homeowners, saying that the tool would be applied sparingly. The idea of reducing loan principals last month became a centerpiece of the administration’s efforts to help seven million households threatened with foreclosure. But an official at one of the banks, David Lowman of JPMorgan Chase, said principal reduction could reward households for consuming more than they could afford, might punish future homeowners by raising the cost of borrowing and in any case was simply unworkable.

"We are concerned about large-scale broad-based principal reduction programs," Mr. Lowman, the bank’s chief executive for home lending, testified during a hearing of the House Financial Services committee. Mr. Lowman’s comments were briefly echoed in more restrained form by an executive from Wells Fargo. "Principal forgiveness is not an across-the-board solution," said the executive, Mike Heid, co-president of Wells Fargo Home Mortgage. Two other bankers who testified, from Bank of America and Citigroup, largely avoided the issue.
The government modification program has been under attack by lawmakers and community groups for doing too little too slowly. The Congressional Oversight Panel is issuing a report Wednesday that says, "Treasury’s response continues to lag well behind the pace of the crisis." In response, the Treasury Department said that its latest modification report, also to be released Wednesday, showed that the number of permanent modifications grew in March to 230,000 households, an increase of 35 percent from the previous month. The Treasury also stressed it was still introducing programs, including those aimed at reducing mortgage principal.

The testimony on Tuesday, however, offered the first public acknowledgment that these latest foreclosure prevention measures might encounter some resistance among banks, ultimately rendering them less effective than hoped. One of the new government programs will require lenders to strongly consider reducing the mortgage balance for distressed borrowers who qualify for the government’s modification plan. A more radical plan urges lenders to refinance loans for borrowers who may be solvent but who owe much more on their homes than they are worth. Many of these loans have been securitized into investment pools but are serviced by the big banks.

The investment pool would get the mortgage off its books for the current market value of the property — less than it is owed, perhaps, but more than it would receive if the house went into foreclosure. The borrower would receive a new government-insured loan at market value, presumably making him less likely to walk away. It is this last program that seemed to irk JPMorgan Chase.\ "If we rewrite the mortgage contract retroactively to restore equity to any mortgage borrower because the value of his or her home declined, what responsible lender will take the equity risk of financing mortgages in the future?" Mr. Lowman asked in his prepared comments.

In any case, he said, Chase cannot rewrite most of these deals. The bank’s contractual arrangements with the investors do not allow for principal reduction. Furthermore, Mr. Lowman argued, the cost of reducing principal will be built into future loans, resulting in less access to credit and higher costs for consumers. What Chase — one of the strongest of the big banks — might be really worried about is not the primary mortgages it services but the $133 billion in home equity loans and lines of credit it carries on its own books.

The question of what happens to these secondary loans in a mortgage modification was at the heart of the Congressional hearing on Tuesday. Investors who own the primary loans argue that the others should be second in line, getting only the money that is left over after they have been satisfied. But banks like Chase, which own the majority of second loans, want a better deal. Since they have the power to disrupt any modification, the result so far has been a standoff.

Alan M. White, an assistant professor at Valparaiso University School of Law who has closely studied the various modification plans, said, "Chase and Wells are attacking a straw man. Nobody is arguing for across-the-board principal reduction. But I think that they feel a need to push back hard on any attempts to get them to write down the troubled second mortgages and home equity lines of credit in their portfolios." Mr. Lowman emphasized the moral side of the issue. Mandating write-downs in home equity loans would be a particularly bad idea, he said, because these loans were simply used to consume rather than pay for housing.

Bank of America Now Supports Cramdown, Giving Judges Authority To Modify Some Home Mortgages
by Shahien Nasiripour

Bank of America, the nation's largest lender and its biggest bank by assets, now supports changing the law to give federal judges the power to modify mortgages in bankruptcy. The bank joins Citigroup, the nation's third-largest bank by assets, in supporting a change to existing law to give homeowners more leverage. Unlike other forms of debt, bankruptcy judges presently lack the power to change mortgage terms. The banking and home mortgage industry want to keep it that way -- by not allowing judges the authority to change the terms, troubled homeowners are at the mercy of their lenders. They take what they get.

But Tuesday, before a nearly-empty Congressional hearing room, Barbara J. Desoer, president of Bank of America Home Loans, said her bank now supports leveling that playing field. "As we've gone through the lessons that we've learned with modifications and other programs, there probably is some segment of borrowers for whom that would be an appropriate alternative," Desoer said before the House Financial Services Committee. "So you would support that in some circumstances?" asked Rep. Brad Miller (D-N.C.) in a follow-up to his original question. "In some circumstances, yeah," Desoer responded.

In December, the House failed to pass an amendment to its financial reform bill that would have given judges this authority, despite the fact that it passed the chamber the previous March. The Senate defeated it the next month after banks and mortgage lenders of all sizes mobilized to kill the measure. Bank of America, though, is the nation's largest lender and servicer of home mortgages. Desoer oversees a home mortgage unit that accounts for "about 20 percent of the U.S. mortgage origination market, with a $2 trillion servicing portfolio serving nearly 14 million customer loans," according to the bank's website.

Its support now gives homeowner advocates in Congress added ammunition to pressure lenders to either do more to give distressed homeowners sustainable mortgage modifications, or to threaten the rest of the mortgage industry with the possibility of reintroducing a bill that would allow federal judges the authority to unilaterally do it on their own. Citigroup supported the change last year as Congress debated the proposal. Its position has not changed, bank spokeswoman Molly Meiners told the Huffington Post. Together, Bank of America and Citigroup hold a combined $4 trillion in assets, according to regulatory filings with the Federal Reserve.

After Desoer appeared to qualify her support, committee Chairman Barney Frank (D-Mass.), who supports giving judges the authority to treat home mortgages like other forms of consumer debt, interjected in hopes of getting additional clarification. "Obviously the law would have to be modified to allow that circumstance," he said. "We should make clear that we can't change the bankruptcy law obviously case by case, so it would have to be an [inaudible] change."

Miller then asked a follow-up question. "You would support a legislative change in the bankruptcy law to allow the modification of home mortgages in bankruptcy?" he asked Desoer. "Yes," she replied. "And I believe that there is a segment of borrowers for whom that is the appropriate alternative, subject to them having gone through qualification for HAMP, or something like that, and failed." HAMP refers to the administration's main foreclosure-prevention initiative, the Home Affordable Modification Program. "There is a segment of borrowers for whom that might be an appropriate alternative, yes," Desoer added.

In an interview after the hearing, Frank told HuffPost that Bank of America's new position was "encouraging." "We may be able to reopen that," Frank said. "And of course, Citi stayed with it. We now have two of the four [biggest banks in the country]" supporting judicial mortgage modifications. Frank added that he would tell the House Judiciary Committee about Bank of America's now-public position. Judiciary has jurisdiction over bankruptcy law, he said. "Maybe we can revisit this," Frank said.

Odds are slim. Banks still wield tremendous influence in the Capitol. "I'm not confident. I'm hopeful," said Frank. "Look, you've got the credit unions, the community banks -- people tend to overestimate the importance of the big banks. Frankly, it's the smaller entities that have more political clout, and I don't see that this has moved us elsewhere. It's helpful, but it's not conclusive." The panel was quickly reminded that Bank of America and Citi were alone in their support for homeowners.

Mike Heid, co-president of Wells Fargo Home Mortgage, butted in after Desoer finished responding to Miller, and added his two cents: "I think you'd have to ask yourself whether a change in bankruptcy law is really the best way -- and the fastest way -- to achieve assistance for homeowners. I think there's other alternatives," Heid said in a response to a question that wasn't asked of him. Miller quickly retorted, "We're trying to do other alternatives now, and have been for three years, and without much to show for it." Last year lenders foreclosed on more than 2.8 million homes, according to real estate research firm RealtyTrac. The firm estimates three million homes will get foreclosure notices this year; more than one million of them will be repossessed by lenders.

Lehman Channeled Risks Through ‘Alter Ego’ Firm
by Louise Story and Eric Dash

It was like a hidden passage on Wall Street, a secret channel that enabled billions of dollars to flow through Lehman Brothers. In the years before its collapse, Lehman used a small company — its "alter ego," in the words of a former Lehman trader — to shift investments off its books. The firm, called Hudson Castle, played a crucial, behind-the-scenes role at Lehman, according to an internal Lehman document and interviews with former employees. The relationship raises new questions about the extent to which Lehman obscured its financial condition before it plunged into bankruptcy.

While Hudson Castle appeared to be an independent business, it was deeply entwined with Lehman. For years, its board was controlled by Lehman, which owned a quarter of the firm. It was also stocked with former Lehman employees. None of this was disclosed by Lehman, however.

Entities like Hudson Castle are part of a vast financial system that operates in the shadows of Wall Street, largely beyond the reach of banking regulators. These entities enable banks to exchange investments for cash to finance their operations and, at times, make their finances look stronger than they are. Critics say that such deals helped Lehman and other banks temporarily transfer their exposure to the risky investments tied to subprime mortgages and commercial real estate. Even now, a year and a half after Lehman’s collapse, major banks still undertake such transactions with businesses whose names, like Hudson Castle’s, are rarely mentioned outside of footnotes in financial statements, if at all.

The Securities and Exchange Commission is examining various creative borrowing tactics used by some 20 financial companies. A Congressional panel investigating the financial crisis also plans to examine such deals at a hearing in May to focus on Lehman and Bear Stearns, according to two people knowledgeable about the panel’s plans. Most of these deals are legal. But certain Lehman transactions crossed the line, according to the account of the bank’s demise prepared by an examiner of the bank. Hudson Castle was not mentioned in that report, released last month, which concluded that some of Lehman’s bookkeeping was "materially misleading." The report did not say that Hudson was involved in the misleading accounting.

At several points, Lehman did transactions greater than $1 billion with Hudson vehicles, but it is unclear how much money was involved since 2001. Still, accounting experts say the shadow financial system needs some sunlight. "How can anyone — regulators, investors or anyone — understand what’s in these financial statements if they have to dig 15 layers deep to find these kinds of interlocking relationships and these kinds of transactions?" said Francine McKenna, an accounting consultant who has examined the financial crisis on her blog, re: The Auditors. "Everybody’s talking about preventing the next crisis, but they can’t prevent the next crisis if they don’t understand all these incestuous relationships."

The story of Lehman and Hudson Castle begins in 2001, when the housing bubble was just starting to inflate. That year, Lehman spent $7 million to buy into a small financial company, IBEX Capital Markets, which later became Hudson Castle. From the start, Hudson Castle lived in Lehman’s shadow. According to a 2001 memorandum given to The New York Times, as well as interviews with seven former employees at Lehman and Hudson Castle, Lehman exerted an unusual level of control over the firm. Lehman, the memorandum said, would serve "as the internal and external ‘gatekeeper’ for all business activities conducted by the firm."

The deal was proposed by Kyle Miller, who worked at Lehman. In the memorandum, Mr. Miller wrote that Lehman’s investment in Hudson Castle would give the bank and its clients access to financing while preventing "headline risk" if any of its deals went south. It would also reduce Lehman’s "moral obligation" to support its off-balance sheet vehicles, he wrote. The arrangement would maximize Lehman’s control over Hudson Castle "without jeopardizing the off-balance sheet accounting treatment." Mr. Miller became president of Hudson Castle and brought several Lehman employees with him. Through a Hudson Castle spokesman, Mr. Miller declined a request for an interview.

The spokesman did not dispute the 2001 memorandum but said the relationship with Lehman had evolved. After 2004, "all funding decisions at Hudson Castle were solely made by the management team and neither the board of directors nor Lehman Brothers participated in or influenced those decisions in any way," he said, adding that Lehman was only a tenth of Hudson’s revenue. Still, Lehman never told its shareholders about the arrangement. Nor did Moody’s choose to mention it in its credit ratings reports on Hudson Castle’s vehicles. Former Lehman workers, who spoke on the condition that they not be named because of confidentiality agreements with the bank, offered conflicting accounts of the bank’s relationship with Hudson Castle.

One said Lehman bought into Hudson Castle to compete with the big commercial banks like Citigroup, which had a greater ability to lend to corporate clients. "There were no bad intentions around any of this stuff," this person said. But another former employee said he was leery of the arrangement from the start. "Lehman wanted to have a company it controlled, but to the outside world be able to act like it was arm’s length," this person said. Typically, companies are required to disclose only material investments or purchases of public companies. Hudson Castle was neither. Nonetheless, Hudson Castle was central to some Lehman deals up until the bank collapsed.

"This should have been disclosed, given how critical this relationship was," said Elizabeth Nowicki, a professor at Boston University and a former lawyer at the S.E.C. "Part of the problems with all these bank failures is there were a lot of secondary actors — there were lawyers, accountants, and here you have a secondary company that was helping conceal the true state of Lehman." Until 2004, Hudson had an agreement with Lehman that blocked it from working with the investment bank’s competitors, but in 2004, that deal ended, and Lehman reduced its number of board seats to one, from five, according to two people with direct knowledge of the situation and an internal Hudson Castle document. Lehman remained Hudson’s largest shareholder, and its management remained close to important Lehman officials.

Hudson Castle created at least four separate legal entities to borrow money in the markets by issuing short-term i.o.u.’s to investors. It then used that money to make loans to Lehman and other financial companies, often via repurchase agreements, or repos. In repos, banks typically sell assets and promise to buy them back at a set price in the future. One of the vehicles that Hudson Castle created was called Fenway, which was often used to lend to Lehman, including in the summer of 2008, as the investment bank foundered. Because of that relationship, Hudson Castle is now the second-largest creditor in the Lehman Estate, after JPMorgan Chase. Hudson Castle, which is still in business, doing similar work for other banks, bought out Lehman’s stake last year. The firm’s spokesman said Hudson operated independently in the Fenway deal in the summer of 2008.

Hudson Castle might have walked away earlier if not for Fenway’s ties to Lehman. Lehman itself bought $3 billion of Fenway notes just before its bankruptcy that, in turn, were used to back a loan from Fenway to a Lehman subsidiary. The loan was secured by part of Lehman's investments with a California property developer, SunCal, and those investments also collapsed. At the time, other lenders were already growing uneasy about dealing with Lehman. Further complicating the arrangement, Lehman later pledged those Fenway notes to JPMorgan as collateral for still other loans as Lehman began to founder. When JPMorgan realized the circular relationship, "JPMorgan concluded that Fenway was worth practically nothing," according the report prepared by the court examiner of Lehman.

Morgan Stanley Property Fund Faces $5.4 Billion Loss
by Anton Troianovski and Lingling Wei

Morgan Stanley has told investors in its $8.8 billion real-estate fund that it may lose nearly two-thirds of its money from bum property investments, according to fund documents reviewed by The Wall Street Journal. That would likely make it the biggest dollar loss—$5.4 billion—in the history of private-equity real-estate investing. Over the past 20 years, Morgan Stanley's real-estate unit was one of the biggest buyers of property around the world, doing some $174 billion in deals since 1991, mostly with money raised from pension funds, college endowments and foreign investors. The losses come from investments in properties such as the European Central Bank's Frankfurt headquarters, a big development project in Tokyo and InterContinental hotels across Europe, among others.

The loss also represents a huge challenge for the firm as it tries to resuscitate its Morgan Stanley Real Estate Funds business, known as Msref. The firm has reinstated Owen Thomas, the executive who helped create Msref, as head of the real-estate business and brought in an outsider, real-estate-debt veteran John Klopp, to lead its property business in the Americas. The soured investments made by the $8.8 billion fund, Msref VI International, continue to be a distraction for Morgan Stanley as it tries to extricate the fund from complex deals around the world. In many cases, the company can't walk away from foundering investments because the fund made billions of dollars in guarantees.

Morgan Stanley now is negotiating with lenders to reduce the fund's obligations on the money it borrowed, its interest payments, renovation costs and other expenses. Adding to the difficulties, the economic downturn and big real-estate losses have rattled some of Msref's core investors, leading to a challenging fund-raising environment. Morgan Stanley has sought to raise a new, $10 billion fund, Msref VII Global. But it hasn't been easy. For example, the public-employee pension fund in Contra Costa County, Calif., made a tentative $75 million commitment to Msref VII in 2008, but, in February 2009, rescinded it after its chief investment officer wrote a memorandum citing uncertainty over the future of Morgan Stanley, and of its real-estate business in particular.

Morgan Stanley ended up settling for about half of its initial fund-raising target for Msref VII, people familiar with the matter say. A Morgan Stanley spokeswoman declined to comment about the losses. She emphasized the company's long-term commitment to real-estate investing. The company's real-estate group has "a longstanding history of investing through many different business cycles over the past two decades," the spokeswoman said in a statement. "We are committed to managing through this cycle and moving our real-estate business forward."

Msref VII is forging ahead with deals for shopping centers in the U.K. and the U.S. In addition to Mr. Klopp, the firm recently hired its former co-head of European real-estate investing, Olivier de Poulpiquet, to head its European real-estate business. The returns of Msref VI could still improve if the global economy recovers faster than expected. Morgan Stanley's success or failure at reviving its business will help determine whether private-equity shops run by investment banks play as big a role in real estate in the upcoming decade as they did in the past two.

Some of Morgan Stanley's Wall Street competitors, such as Citigroup Inc., have scaled back or sold off their property-fund businesses. Proposed new regulations in Washington could limit banks' ability to manage real-estate funds. The struggling Msref VI fund once projected a 22.1% average annual return on its commercial-real-estate deals around the world. When times were good, the fund generated fat fees for various segments of the bank. In 2007 alone, Morgan Stanley earned $104 million in acquisition fees, $22 million in fund-management fees, $13 million in financing fees, $36 million in real-estate-management fees, and $21 million in financial-advisory fees, according to fund documents reviewed by the Journal.

But when the commercial-property bubble popped, the fund turned into a major headache. As credit conditions worsened, Morgan Stanley executives had to spend increasing amounts of their time disentangling the fund's complex deals. About 20% of the $8.8 billion raised for the fund came out of the pockets of Morgan Stanley and its employees. By mid-2009, Morgan Stanley had fully written down its exposure to reflect deep losses in the fund, according to a person familiar with the matter.

In South Korea, Msref VI expects to lose its $350 million investment in an office building called Seoul Square, according to fund documents. A group of investors acquired it in 2007 for $1 billion—the highest price ever paid for a Seoul office building—with Msref VI taking a majority stake. The third-quarter report floated the possibility of walking away from the deal—but the fund wouldn't be able to do that before making good on $91 million in renovations, guaranteed interest payments, and other obligations, the report said. Morgan Stanley is still negotiating with lenders and hasn't made the decision to walk away, a person familiar with the matter said. The building is known to Seoul residents for the giant digital display mounted on its façade.

In some cases, Morgan Stanley has extricated itself after lenders agreed to reduce some of the fund's guarantees. In Germany, the fund on Jan. 1 handed a $2.9 billion portfolio of German office buildings back to the lender, Royal Bank of Scotland Group PLC, according to a February presentation to investors. The fund's third-quarter report also said it would return an $800 million portfolio of 10 European hotels, including Hiltons, to lender Barclays Capital, a unit of Barclays PLC.

While numerous other real-estate funds may lose more than half their values, the dollar value of the $5.4 billion loss at Msref VI International is likely to dwarf the losses at many competitors because of the fund's large size. According to data firm Preqin, only two other real-estate funds—managed by Blackstone Group LP and Lone Star Funds—had even raised more than $5.4 billion from investors. As of Sept. 30, Blackstone's $10.9 billion fund had an unrealized, marked-to-market loss of about 60% and less than half of investors' money had been spent, according to a report by the Oregon public-employee pension fund. Lone Star's $7.5 billion fund was up about 15%, according to the report.

Former WaMu CEO Blames Regulators’ 'Too Clubby to Fail' Attitude
by John D. Mckinnon and Dan Fitzpatrick

Former Washington Mutual Inc. Chief Executive Kerry Killinger scoffed at lawmakers who blamed him for the largest bank failure in U.S. history, accusing regulators of helping only financial institutions deemed "too clubby to fail." The 60-year-old Mr. Killinger's defiant, two-hour testimony at Tuesday's hearing by the Senate Permanent Subcommittee on Investigations was marked by confrontations with lawmakers who claimed he repeatedly ignored warnings that the overinflated real-estate bubble was about to burst. But the former CEO held his ground, insisting the Seattle thrift's seizure in September 2008 could have been avoided if regulators had offered the same help given to other battered banks, including capital infusions.

"For those that were part of the inner circle and were 'too clubby to fail,' the benefits were obvious," Mr. Killinger said. "For those outside the club, the penalty was severe." A spokesman at the Office of Thrift Supervision, the federal agency that seized Washington Mutual, declined to comment on Mr. Killinger's testimony. Mr. Killinger's comments were a contrast to the low profile he has kept since the collapse. He shuttles between homes in Palm Desert, Calif., and a gated community in Seattle, and has avoided public events and new business ventures, according to people familiar with the situation.

He was forced to break his silence by the Democratic-led Senate subcommittee, which is trying to build momentum for pending financial-overhaul legislation. Democrats also are eager to show they are dealing forcefully with financial wrongdoing at banks and securities firms. In another sign of the get-tough posture toward icons of the financial crisis, former Lehman Brothers Holdings Inc. Chairman and CEO Richard Fuld Jr. is scheduled to testify next week before the House Financial Services Committee. The Senate panel's findings about Washington Mutual could aid continuing investigations that include a criminal probe of the thrift's collapse led by the U.S. Attorney's Office in Seattle.

On Tuesday, lawmakers cited evidence Mr. Killinger and other Washington Mutual executives tolerated fraudulent lending, knowingly dumped problem loans on investors and did too little, too late to stem problems once they threatened to sink the thrift. Sen. Carl Levin (D., Mich.), the subcommittee's chairman, chastised Mr. Killinger for not being more concerned about signs of trouble. "It seems to me if you're not disturbed by this, you should be," Mr. Levin said, referring to a company plan to sell off loans that executives knew would perform poorly.

"I'm troubled if it was just on the basis of performance," Mr. Killinger responded. "I would have inquired more. I would have wanted more information." Mr. Levin then said to Mr. Killinger: "I guess that's progress." Earlier in the hearing, James Vanasek, a former chief risk officer at Washington Mutual, said he repeatedly tried to get the thrift to tighten its lending standards.

Mr. Killinger said directors approved a higher-risk lending strategy in 2005 but didn't follow through with "many aspects" of the plan. As the housing market worsened, the company curtailed its lending volume and stopped making mortgages through outside brokers. If executives had foreseen the steep plunge in real-estate values, "we would have taken more Draconian measures," Mr. Killinger told lawmakers. The former CEO insisted Washington Mutual had opportunities to sell itself in early 2008. Sen. Tom Coburn of Oklahoma, the committee's ranking Republican, pressed Mr. Killinger to identify the potential buyers, telling the former CEO that he could disclose the information in private.

Some of Mr. Killinger's recollections differ from those of people who worked with him closely as Washington Mutual deteriorated. Executives have complained privately that he didn't move fast enough once the housing crisis erupted and was hurt by indecision and the same unwavering optimism that fueled him during the mortgage boom. In a 2007 memo to directors, Mr. Killinger recommended that Washington Mutual increasingly emphasize home-equity loans, option adjustable-rate mortgages and subprime loans.

While he warned an "an asset price bubble could deflate at any time," adding that "housing prices are declining in many areas of the country and sales are rapidly slowing," Mr. Killinger predicted delinquencies would "start peaking within the next few quarters," according to a copy of the memo reviewed by The Wall Street Journal. The memo said there was "no way for the company to achieve earnings targets without more loan activity." Mr. Killinger declined to comment about the 2007 memo, but a person close to the former CEO said he intended to implement this plan only when it was prudent to do so. "Actions speak even louder," this person said. "What the bank was actually doing was...pulling back from this strategy." This person also said Mr. Killinger was decisive while trying to diversify the company and its balance sheet and looking for potential merger partners.

As the company's financial condition deteriorated, Mr. Killinger frequently kept his head down and shoulders slumped in a crouch during meetings with other executives, according to several people who attended the meetings. "A lot of life became: What is Kerry thinking?" said one former executive. A person close to Mr. Killinger said if the CEO had put his head down in a meeting it was because of exhaustion from working long hours while trying to turn the firm around. Mr. Killinger was ousted about three weeks before Washington Mutual failed. The thrift was sold to J.P. Morgan Chase & Co. On Tuesday, Mr. Killinger said at the hearing he still thinks "Washington Mutual could have and should have been one of those surviving banks."

Rampant Fraud and Financial Collapse
by Zach Carter

There are two types of financial outrages: acts that are outrageously illegal, and acts that are, outrageously, legal. Yesterday's Senate hearing on the rise and fall of Washington Mutual was a rare examination of the former outrage, documenting the pervasive practice of fraud at every level of the now-defunct bank's business.

All of Washington Mutual's sketchy practices can be traced back to rampant fraud in its mortgage lending offices. The company repeatedly performed internal audits of its lending practices, and discovered multiple times that enormous proportions of the loans it was issuing were based on fraudulent documents. At some offices, the fraud rate was on new mortgages over 70%, and at yesterday's hearing, the company's former Chief Risk Officer James Vanasek described its mortgage fraud as "systemic."

When most people think of mortgage fraud, they think of a clever borrower conning an unwitting banker into extending him a loan he cannot afford. But this isn't really how fraud usually works in the mortgage business. According to the FBI, 80% of mortgage fraud is committed by the lender, so it shouldn't be surprising that WaMu's internal audits concluded that its widespread fraud was being "willfully" perpetrated by its own employees. The company also engaged in textbook predatory lending across all of its mortgage lending activities--issuing loans based on the value of the property, while ignoring the borrower's ability to repay the loan.

These findings alone are pretty bad stuff in the world of white-collar crime. For several years, WaMu was engaged in fraudulent lending, WaMu managers knew it was engaged in fraudulent lending, and didn't stop it. The company was setting up thousands, if not millions of borrowers for foreclosure, while booking illusory short-term profits and paying out giant bonuses for its employees and executives. During the housing boom, WaMu Chairman and CEO Kerry Killinger took home between $11 million and $20 million every single year, much of it "earned" on outright fraud.

But the WaMu scandal gets much worse. WaMu is routinely referred to as a pure mortgage lender, one whose simple business model can be contrasted with the complex wheelings and dealings of Wall Street titans like Lehman Brothers and Bear Stearns. That characterization is grossly inaccurate. WaMu was very heavily engaged in the business of packaging mortgages into securities and marketing them to investors. This is a core investment banking function, something ordinary mortgage banks like WaMu were legally barred from engaging in until 1999, when Congress repealed the Glass-Steagall Act, a critical Depression-era reform.

Securitization is immensely profitable, and under the right circumstances, it allows banks to dump risky mortgages off their books at a profit. That's exactly what WaMu did. Even after internal audits flagged specific loans as fraudulent, WaMu's securitization shop still went ahead and packaged those exact same loans into securities, and sold them to investors. Knowingly peddling fraudulent securities is a straightforward act of securities fraud, one made all the more severe by the fact that WaMu never told its investors it had sold them securities full of fraudulent loans. The only question now is whether anyone will be personally held accountable for the act.

So far, we've got fraud on fraud-- but wait! The WaMu saga actually gets worse still. When the mortgage market started falling apart, WaMu ordered a study on the likelihood that one if its riskiest mortgage products, the option-ARM loan, would begin defaulting en masse. The report concluded that, indeed, option-ARMs were about to default like crazy, within a matter of months. Option-ARMs feature a low introductory monthly payment for a few years, often so low that borrowers actually end up going deeper into debt, despite making their regular payments. After a few years, the monthly payment increases dramatically--sometimes by as much as 400 percent. Suddenly this cheap loan is outrageously unaffordable, and if home prices decline, borrowers are immediately headed for foreclosure.

Now, most would-be homeowners are not very interested in this kind of loan. It seems dangerous, because it is dangerous. So WaMu actively coached its loan officers to persuade skeptical borrowers into accepting this predatory garbage instead of an ordinary mortgage. This assault on its own borrowers is only half of WaMu's option-ARM hustle. For a while, Wall Street investors really liked option-ARMs. They were inherently risky, which meant they were much more profitable, if you ignored the risk that they might someday default, and Wall Street was all too happy to engage in this kind of creative accounting.

But when WaMu conducted its study on looming option-ARM defaults, the prospect of heavy, imminent losses did not convince the company to abandon the business. Instead, WaMu began issuing as many option-ARMs as it could. The idea was to jam as many of these loans into its securitization machine as it could before investors decided to stop buying option-ARM securities altogether. That means WaMu was knowingly setting up both borrowers and investors for a fall. The company was actually trying to extend loans that it knew would be disastrous for its borrowers--and then selling them to investors that it knew would end up taking heavy losses. Whether or not this constitutes illegal fraud will depend on some technicalities, but it is clearly an act of outrageous deception.

When the securitization markets finally froze up, WaMu got stuck with billions in terrible, terrible loans it had issued, and the company failed spectacularly. One of the few good calls the U.S. government made during the financial crisis was the decision not to extend bailout funds to WaMu, not to save the jobs of its executives, and allow the company to fail. It was seized by the FDIC in late September 2008, and immediately sold to J.P. Morgan Chase, at no cost to taxpayers.

But WaMu's story is nevertheless rife with implications here for Wall Street reform. First, regulation matters. Everything WaMu did could have been stopped not only by an engaged regulator who worried about the company's bottom line, but by a regulator who cared about consumer protection in any degree whatsoever. WaMu's regulator, the Office of Thrift Supervision, didn't care about either, but it was particularly uninterested in consumer protection rules, because those often conflict with bank profitability. If we establish a new regulator that is charged only with writing and enforcing consumer protection rules, it won't worry about how profitable consumer predation might be, it will simply crack down on it. In the process, it could actually protect the company's bottom line (Salon's Andrew Leonard has been emphasizing this point for some time).

Second, at yesterday's hearing, former WaMu Chief Risk Officer James Vanasek acknowledged that his bank would not have been able to wreak so much economic destruction without the repeal of Glass-Steagall, which barred any mixing between complex Wall Street securities dealings and ordinary, plain-vanilla banking. He even went so far as to offer a tepid endorsement for reinstating the law.

A lot of predatory mortgage firms didn't run their own securitization shops--they sold their loans directly to Wall Street firms, which handled the securitization on their own. So proponents of the Glass-Steagall repeal (most of them employed at one point or another by a major banking conglomerate) argue that the crisis would have occurred with our without the repeal. That argument is basically a distraction, as the WaMu case reveals. Over the course of just a few years, WaMu's entire mortgage banking operation transformed from a boring, profitable, plain-vanilla enterprise, into a feeding trough for its risky securitization activities. There is simply no way that transformation could have occurred without the lure of easy in-house securitization profits.

It is possible to conceive of a mortgage crisis taking place without the repeal of Glass-Steagall, but it is utterly impossible to imagine a mortgage crisis as severe as the one we are still living through. It will be very surprising if criminal charges are not soon filed against some of WaMu's former executives. But WaMu isn't the only bad actor from the financial crisis. This is basically how the entire U.S. mortgage market operated for at least five years. Dozens of lenders who are still active, many of them saved by generous taxpayer bailouts, were engaged in similar activities. There's only one way to churn out billions of dollars worth of lousy mortgages for several years, and it involves a prolonged campaign of fraud and deception.

US Trade Gap Grows, Driven by Imports
by Sudeep Reddy

The U.S. trade deficit widened in February as an improving economy led consumers to buy more clothes, electronics and other goods from abroad. A rise in imports—as firms restocked inventories with goods from abroad—outweighed a small uptick in exports, which still reached their highest level since October 2008, the Commerce Department said. That sent the deficit to $39.7 billion from $37 billion in January. The worsening gap lowered estimates for overall U.S. economic growth in the first quarter by as much as half a percentage point. Many economists now expect growth to register at an inflation-adjusted annual rate of about 2.5%.

Separately, a measure of small-business confidence fell in March due to weak sales and continued uncertainty about the economy. The National Federation of Independent Business index of optimism among small businesses fell 1.2 points in March to 86.8. "The March reading is very low and headed in the wrong direction," said Bill Dunkelberg, the group's chief economist. "Something isn't sitting well with small-business owners. Poor sales and uncertainty continue to overwhelm any other good news about the economy."

The increases in both imports and exports, though at a slower pace than in the second half of last year, underscored how improving economic conditions around the world continued to boost trade activity. U.S. exports rose 0.2% as improvement in sales of semiconductors and auto products helped offset declines in aircraft sales and agricultural goods. Imports rose 1.7% in part due to higher oil prices, along with U.S. purchases of a range of consumer goods and services. Imports of autos and food slipped. "Higher oil prices and a slowly improving economy are leading to more and more money flowing out of the U.S. economy into other countries," said Joel Naroff of Naroff Economic Advisors. The higher deficit means much of the improvement in the economy is going to firms abroad rather than in the U.S.

As consumer confidence improves, Americans are growing more comfortable buying new autos, computers and other longer-lasting products. U.S. firms that had pared their inventories during the economic downturn are now buying more of those goods to satisfy the rising demand—driving an increase in imports that is expected to continue in the coming months. While the U.S. trade deficit widened, the gap with China fell in February to its lowest since March 2009. Imports from China fell 7% to $23.4 billion, the lowest since last May. Exports to China dropped slightly to $6.9 billion.

The latest data came amid increasing U.S. pressure on China to allow its currency to appreciate. Many U.S. lawmakers and other critics say that country's stance has made Chinese exports artificially cheaper, harming companies that are trying to compete with producers in China. Earlier this week, China reported a global trade deficit of $7.2 billion in March—from a surplus of $7.6 billion in February—as its imports of commodities soared. As a result, "economic tensions over trade between the U.S. and China should ease over the next few months as markets prepare for the revaluation of the yuan," said economist Joseph Brusuelas of Brusuelas Analytics. Separately, the Labor Department said import prices rose 0.7% in March due to higher oil prices. But non-petroleum prices posted their first monthly decline since July 2009, underscoring that underlying inflation in the U.S. remained tame.

Funds shun Europe as 'no-go zone' after Greek crisis
by Ambrose Evans-Pritchard

Global fund managers have changed their views of the euro area dramatically since the Greek crisis erupted last year and exposed the deep structural flaws in monetary union. "Europe has become a no-go zone," said Patrik Schowitz, equity strategist at Bank of America Merrill Lynch. "As recently as five months ago investors regarded Europe as the most attractive play on global economic recovery". The bank's monthly survey of funds found that a net 18pc are underweight stocks in Europe. They are giddily optimistic about the "Goldilocks" recovery in the US, Asia, and emerging markets, increasing risk exposure to the highest since January 2006.
Cash levels have fallen to just 3.5pc, a time-honoured signal that stock markets have become too frothy. Stocks fell over the following month on four of the five occasions when this happened before. "This is an amber warning light that, short-term, the market may be slightly overbought," said Mr Schowitz. The potential trigger for a sell-off would be a jump in yields on 10-year US Treasuries much above 4pc. There was mixed news yesterday for Greece, which managed to raise €1.6bn in short-term funds from investors in a heavily-bid auction.

George Papaconstantinou, finance minister, said the country would not tap the €45bn (£40bn) rescue fund from the EU and IMF agreed over the weekend. He said: "Our aim remains – and I believe we will continue to do it – to continue to freely borrow from the markets, as we did today [Tuesday] with the issue of six- and 12-month treasury bills."

However, Greece had to pay 4.85pc or 430 basis points above German rates to borrow one-year money. Reliance on short-term funds stores up roll-over problems for next year. Yields on 10-year bonds rose 16 basis points to 6.85pc, suggesting that bond vigilantes remain cautious on Greek debt. The Athens bourse slipped 1pc. "There are still questions that need to be answered on the EU deal," said Julian Callow from Barclays Capital. "Greece has a Herculean task ahead. The economy is contracting yet fiscal tightening has hardly begun. We expect growth of minus 4.3pc this year, and minus 1.9pc in 2011 which will be difficult for debt dynamics."

Opposition politicians in Athens have begun to question whether it is in the country's interests to accept harsh wage deflation in order to pay foreign creditors. "This is usury: we need restructuring of debts," said the Righti-wing LAOS party. Such views are gaining support in parts of the ruling PASOK party, raising the risk that it will splinter as further austerity is imposed. Diplomats see a direct parallel with Oskar Lafontaine's Linke movement drawn from the Left-wing of Germany's Social Democrats.

Some Respite for Greece in Successful Debt Sale
by Jack Ewing and David Jolly

Investors enthusiastically snapped up Greek short-term securities on Tuesday after European Union leaders pledged to stand behind the country’s debt. Greece sold 1.56 billion euros ($2.12 billion) in high-yield debt that effectively carries a European Union guarantee. Investors bid 3.9 billion euros on Tuesday for the 600 million euros of 52-week Treasury bills, the Greek Public Debt Management Agency said, meaning the offer was oversubscribed 6.54 times. An auction of 26-week bills, also seeking 600 million euros, drew bids totaling 4.6 billion euros, for an oversubscription ratio of 7.67. The demand allowed Greece to sell 780 million euros of bills in each auction.

But economists warned that Greece still faced immense long-term problems. In the worst case, Greece could still default, analysts said. More likely, in coming years it will require serial bailouts by its euro zone partners. "Even under relatively conservative assumptions the Greek debt situation is unsustainable," said Erik F. Nielsen, the chief European economist at Goldman Sachs in London and a former International Monetary Fund official. "Something has to give."

Left to fend for itself, Greece would probably run out of money and default, analysts say. But other European countries are likely to conclude, however reluctantly, that continuing to support Greece is less costly than letting the country go under. A Greek default would cause borrowing costs to spike in other overly indebted countries like Spain, creating a much graver crisis that would threaten the credibility of the euro.

"Greece is too small to fail," said Stuart Green, economist at HSBC Bank in London. "The policy of E.U. leaders is to nip the problem in the bud with Greece before it becomes more expansive."
Still, the successful bond sale seemed to validate the decision by European governments on Sunday to provide 30 billion euros in loans if Greece was unable to raise money at a reasonable cost. The International Monetary Fund is expected to provide another 15 billion euros in aid.

The demand on Tuesday for Greek debt also seemed to indicate that Athens would not need to ask for the help right away. "We can turn our attention with greater calm to domestic challenges and promote the necessary changes," Prime Minister George A. Papandreou said, according to Reuters. However, the rates on the notes — 4.85 percent for the 52-week bills and 4.55 percent for the 26-week bills — were more than double those Greece paid on Jan. 12 on similar maturities. In addition, yields on debt with maturities of two or more years were still at least 6 percent in Tuesday trading, meaning the government will have to pay a high price as it seeks to refinance 40 billion euros more in debt this year. "There seems a strong chance that the government will eventually be forced to seek funds from the rest of the euro zone," Ben May, of Capital Economics in London, wrote in a note.

The need to refinance debt is only the most immediate of Greece’s problems. The Greek government has based its plans to shrink the budget deficit, which is nearly 13 percent of its gross domestic product, on a modest economic downturn of 0.3 percent this year. The government expects growth to resume in 2011. But economists at UBS, the Swiss bank, warn that those assumptions could be way too optimistic. UBS forecast a plunge in G.D.P. of 5 percent this year and next as cuts in public sector wages and other austerity measures feed through into the broader economy. If so, Greece could become caught in a vicious circle where declining output undercuts attempts to reduce the ratio of borrowing to G.D.P. The debt burden would increase at the same time the government’s ability to pay was declining.

European leaders will also be mindful of how deeply exposed their own banks are to Greece. All told, Greece owes 252.8 billion euros to European banks. The country’s debt situation is certain to be a main topic yet again when European Union finance ministers meet in Madrid beginning late Thursday. Ultimately, Greece’s fate rests on the ability of Mr. Papandreou and his government to create a more competitive economy. As a euro member, though, Greece cannot take the traditional route to competitiveness in world markets and devalue its currency to cut the price of its exports.

"The only way to be competitive is by adjusting costs, and that means wages going down," said Diego Iscaro, an economist at IHS Global Insight in London. "That is likely to be a long and painful process."

Chanos part 1: "Greece Is A Prelude"
by Vince Veneziani

Last week had the opportunity to visit Kynikos Associates in Manhattan and speak with its President, famed short-seller  James S. Chanos.

The billionaire hedge funder is the stuff of legend. He made a killing shorting companies like Tyco, Worldcom, and of course, Enron. Chanos spoke with us at length on everything from how he discovered Enron's problems to the issues at hand with Greece to the ongoing problems in China.

We'll be running several posts on our Q&A sessions with Chanos throughout the week.

Today we talk about Dubai, Greece, and the role of derivatives in these markets.


Business Insider: Let's talk about Dubai and Greece. Dubai - was it just a case of a nation that saw too much growth and excessive debt?

Jim Chanos: No, no. Dubai was a property bubble. Plain and simple. Go to Dubai and see what happened. It was…what I call it the "Edifice complex" - it's just, we can grow by putting up lots and lots of buildings and trying to attract people to come here, stay here, and put up offices here and sooner or later, you put up too many. And whether it's the Palm Island project or the indoor ski resort or, you know, take your pick because everyone has lots of Dubai stories. At first it seemed plausible and economic and by the end of the boom, they were putting on drawing boards all kinds of crazy projects. So it didn't take a rocket scientist to see the excesses. They were pretty visible to the naked eye.

Greece is a different issue. We're not involved. We don't trade sovereign debt, we don't trade CDSes. You know I feel bad for my mother country in that they're going through a lot of austerity now and I actually think that the Prime Minister and his team are doing the right thing. I met with them recently, actually, in Washington [DC] and they gave a pretty rational response to a problem that they, quite frankly, inherited.

You know they came in and discovered the hole in the budget deficit and discovered a lot of the off balance sheet stuff that was not of their doing. And he's taking the politically unpopular step of extending the retirement age and cutting government wages not knowing if it's going to be enough and so far the market is pretty skeptical, but I think the Greek government is being more courageous than some of the other western-European governments who aren't addressing these issues and are going to be facing these same problems like Greece down the road. So Greece is a prelude to the problems that a lot of other countries will face that have made promises to their people without the ability to pay for them.

Papandreou and his team know they were dealt a bad hand. I think they're trying to navigate a tough course and I wish them luck - it's going to be tough. But I think they're being rational about it, I think they're trying the right policies, but I'm not enough of an expert to say if it's going to be enough for them.

BI: I heard from Kyle Bass that Greece has defaulted on their debt a lot of times in the past 200 years...

JC: Yes, but so has France, so has Germany, so has Argentina - a number of western sovereign countries have defaulted repeatedly over the past 200 years. If you take a look at the recent book by Ken Rogoff, "It's Different This Time," where you have a table of these defaults - Greece is not alone in that table. Some would say that when the US rescinded the gold standard in the 1930s, that we did too. So you know, everyone points out Greece's default record, but the history of a lot of sovereign nations is not a good one when it comes to lending them money.

BI: I would imagine, especially in regard to Argentina. It was very guilty in the last century. But with Greece, do you see an easy fix for the problem?

JC: They're embarked on what they should be doing. I don't think that austerity is going to be easy because of the political ramifications and that is the real problem that they're fighting. They're fighting both financial market perceptions and a bad domestic political situation. It's a tough one. It's really a tough set of problems. The solutions to both are almost diametrically opposite. And so he [Papandreou] is going to pay the price politically. Are they going to get EU help and IMF help? Everything seems uncertain now. But as I said, I was at least impressed that Papandreou's team understood the problem and understood the issues and understood the magnitude of the problems even if it wasn't of their doing. And they're taking tough domestic political steps that I think a lot of other governments would be afraid to take. So I have to admire them for that.

BI: With Greece, it was revealed recently that Goldman got them into these currency swaps that caused problems.

JC: Who knows? I don't want to comment on the specifics of that situation, but I think that you have a lot of sovereign banks in Europe that were also pretty much knee-deep in a lot of this stuff. There were Greek banks themselves that were trading derivatives. We did a survey of all the Greek banks as to how much of their pre-tax profit was from trading activities, including derivatives, and in many cases it was north of 20, 30%. It's the nature of the current financial system...just how much of the profits of our banking system globally come from trading derivatives and debt. It's a lot.

: And do you think that derivatives are ultimately a good thing that are there for proper hedging and speculation?

JC: I always laugh when I hear someone talking about "Well, we can't have somebody buying CDSes on debt that they don't own. If they don't own the underlying..."

BI: A naked CDS.

JC: Yes, a naked CDS. But what people forget is that the CDS market was created exactly for that. Because if you are a creditor of that government with a non-marketable instrument, say Greece owes you money, say Greece has promised to fund your projects. You don't own a Greek bond. You can't market that IOU, but you have economic risk. Your project may be imperiled if Greece cannot fund it as promised. The only way you can hedge that off is through the CDS market.

So that's exactly why the CDS market was invented. Not just to hedge sovereign debt instruments, because you can simply sell those instruments if you're bearish! It's actually to hedge off non-marketable instrument risk. We saw the same thing during the banking crisis when people started saying "Oh there's been an explosion of buying CDSes on banks, and short-selling the shares of banks in the Spring and Fall of '08."

BI: So they're offsetting risk.

JC: Yes. What I kept saying was: "Um, you might want to check with the other banks, because the biggest exposure that banks have is to each other. Their own counterparties!"

BI: Systemic risk.

JC: Yes, it's systemic. And so it can be very much in the interest of bank A to sell-short bank B shares, or buy CDSes on bank B, because they have exposure to bank B. It's the responsible thing to do as a fiduciary, and yet if everyone does it at the same time, it's destabilizing because everyone is selling.

The whole CDS market criticism to me is a little bit specious in that CDSes were specifically to hedge off or speculate, to be fair, non-marketable financial exposure to companies or governments. We saw it in Enron, actually because there was a nascent CDS market in Enron debt when Enron went under, and there was a huge explosion towards the very end of Enron's corporate life, in short-selling and CDS buying, and it was not primarily hedge funds and speculators - it was people who had had counterparty risk to Enron. Enron would be unable to perform under a contract and suddenly people realized they could abrogate that contract.

So before we throw the baby out with the bathwater, and talk about naked CDSes or whatever, we ought to start thinking about what exactly CDSes were set up to do. Derivatives in and of themselves are not evil. There's nothing evil about how they're traded, how they're accounted for, and how they're financed, like any other financial instrument, if done properly.

Long Term Capital [Management] know, almost brought the system down simply by leveraging government bonds 100-to-1. They didn't need CDSes.

BI: Right...

JC: Yes, as I've said...people don't think the whole thing through. And you know, I knew clients of Bear Stearns during the real estate boom. Bear Stearns had funding commitments to these people. And the only way they could get their projects funded was if Bear Stearns Realty went under, was to buy CDSes on Bear Stearns. Same thing with Lehman.

We saw it in the AIG situation where people were trying to hedge off their AIG exposure, and the government made good on AIG. This was the inter-connected nature of the risk in those markets, the over-concentration in a number of very large players, coupled in many cases with poor accounting. So it all was a witches brew that has led to the current set of problems. But before we completely blame derivatives for the downfall of western civilization, we have to first understand what they're really all about.

Chanos part 2: China's High-Rise Property House Of Cards
by Vince Veneziani

Business Insider: So moving on to China...

Jim Chanos: Yup!

BI: You're short China, it's a big thing...

JC: We're not actually short China. We are short entities that are selling into China.

BI: Ah, OK.

JC: There is a big misconception that has been posted out there, but our China call is a simple one: there's a property bubble going on. I'm not making a call on the Chinese economy, although it will have a problem when the property bubble bursts. We're not making a call on the currency on whether it'll appreciate or, god forbid, depreciate. What we're simply saying is you are seeing an epic building boom in China and more interestingly, an epic high-rise building boom in China.

It's not just high speed rail and airports and new roads. That's only a very small part of their infrastructure spending. This is primarily a story about people putting up high rise office buildings and condos in the big cities. That's what it is.

So when you look at it like that, the data supports it. I mean, people have taken a shot at us because "Mr. Chanos has never been to mainland China." Well hell, I didn't work at Enron either. Or "Oh, but he doesn't speak Mandarin."

Whatever. It doesn't matter. Using the Chinese government's own numbers as well as some western entities that are on the ground there, the numbers are what they are. The square footage being built is what it is. You can see it when you go there. It is a high-rise construction boom.

So when you look at it through that prism, you can begin to make some assessments. We've seen similar bubbles in Dubai, Miami - scores of other entities have gone through this and it never ends well.

Now, the real argument in China seems to be - the argument I think carries the most water for the China bulls - is somehow the government is going to be able to manage this. That they're going to let the air out of the bubble gently. That 9 guys who sit on the central committee of the country who got us into this mess are going to get us out of this mess. I wouldn't want to bet on that.

BI: Right.

JC: History tells us that it's a bad bet. And that somehow the government will, if I overpay for a condo, somehow bail me out. And again, I generally think that that's a bad bet. Whether you're Chinese or American, it doesn't matter; it's a bad bet almost anywhere.

The Chinese bubble has its own interesting set of anecdotes and circumstances and one of the more interesting ones from our perspective as a westerner is that when people were buying 2 and 3 condos in Miami for example, they would rent the 2nd or 3rd condo to try and get some rental income. In China, that's not the case.

BI: People are just buying.

JC: They're empty shells. When you buy a condo, you're getting an empty shell and nothing more. By and large most of the developments are 1100 square foot boxes. And they [the owners] don't rent them because people want to keep them basically as pristine as possible for when they flip them because new is better than old. So ironically, you have people that are buying multiple condos here to speculate who are carrying themselves - there's no rental income.

The other interesting thing about the boom here is that it is completely high end. When people talk to me about China's "migration of people" into the cities and the population and blah blah blah, and the growth of the economy, I said "That's all and good but they're putting up the equivalent of New York City highrises at almost New York City prices for a populous that is 1/10th of that per-capita income." So this building boom is aimed at: A) the corporate market, corporate highrises and office buildings or B) very high end of the residential market. It's not the masses - it's for people speculating.

BI: I've heard that a lot of families in China are maxing out as much as they can in terms of credit and borrowing in order to get into this.

JC: They have to! Keep in mind that the average median income in China, and it's only slightly higher in the cities, is something like $3500 per person. Typical second-tier city real-estate prices have now gone above $100 a square foot. So a typical 100 square meter condo is probably going to cost you after all your expenses (if you build it out to live) $120,000 to $140,000 US. Well say you're a dual income couple and you make $7000 to $10,000 a year total. OK? Even if you put down the 20% down that everyone's pointing to, that's 20% on your purchase price. You're still paying mortgage interest of probably ... 60 to 100% of your income, pretax.

BI: Pretax?

JC: Pretax. And that's not super high end - that's an urban couple, dual-wage earners in a second-tier city. So it's already getting to the absurd in terms of prices relative to incomes. And the problem is construction is 50-60% of China's GDP. And of that, the vast majority is this type of construction. There's going to be a real brick wall here being hit at 200 MPH - it's just a matter of when.

BI: So when do you see the bubble bursting for China?

JC: Well, always with these things, we're often early and it appears we're early here too. But the good news  for office building bubbles is that they're pretty tangible. So when you see the apartments stop selling, when you stop seeing foundations being laid, and holes in the ground, when you see the cranes not going up anymore, buildings being half-complete - that'll tell you you're at the end.

China’s March Property Prices Jump a Record 11.7%
by Chia Peck Wong

China’s property prices rose at a record pace in March, indicating government efforts to stem gains aren’t working and more drastic measures may be needed amid concern of a bubble in the nation’s housing market. Residential and commercial real-estate prices in 70 cities climbed 11.7 percent from a year earlier, the National Bureau of Statistics said on its Web site. The data goes back to 2005. China has raised mortgage rates and re-imposed a sales tax on homes in the first two months of the year to reduce the risk of asset bubbles. The government announced in March developers will have to pay a higher deposit for land purchases and banned banks from lending to builders found to be hoarding land or holding back home sales in anticipation of higher prices.

"The property tax may come, and that would push some potential buyers on the sideline," Lee Wee Liat, a Hong Kong- based analyst at Nomura Holdings Inc., said before today’s announcement. "If that’s not effective, they will impose some more measures." China has passed a plan to impose a property tax on home purchases and may start a trial in Beijing, Shanghai, Chongqing and Shenzhen, reported April 8, without saying where it got the information. On the same day, the Shanghai Municipal Housing Support and Building Administration Bureau said any study of a property tax in the city is "entirely normal."

Haikou, a city on the southern island of Hainan, had the biggest price gain, with a 53.9 percent jump, the statistics bureau data showed. Sanya, also in Hainan, followed with a 52.1 percent increase. The property market in the world’s third-biggest economy is in a bubble that may burst by as early as this year, hedge fund manager James Chanos said in an interview last week. China is "on a treadmill to hell," according to Chanos, who said in January the nation is Dubai times a thousand. "They can’t afford to get off this heroin of property development. It is the only thing keeping the economic growth numbers growing."

Home prices in China may continue to rise between now and September due to a shortage of supply, Nomura’s Lee said. "Last year, some developers were skeptical about the price increases and cut back on construction starts until the fourth quarter, so there’s no supply in the market," he said. "Whatever the developers are putting out, people are grabbing." While home prices may cool in the fourth quarter, values may still rise 15 percent for the full year, he said.

Chinese developers have announced increases in first- quarter sales. Evergrande Real Estate Group Ltd. said April 2 sales jumped 175 percent in the first three months of this year to 8.53 billion yuan ($1.25 billion). China Overseas Land & Investment Ltd., a Hong Kong-traded builder controlled by the Chinese construction ministry, said on April 8 sales rose 48.3 percent to HK$13.7 billion. To damp speculation, the government in January re-imposed a tax on homes sold within five years of their purchase, after having cut the taxable period to two years in January 2009 to bolster a then flagging market. The People’s Bank of China is targeting a drop of 22 percent in new lending this year from 2009’s record 9.59 trillion yuan and told banks twice this year to set aside more cash as reserves. The first quarter result is due on April 15.

China Metal Quotas Limit U.S. Smart-Bomb Output, Lawmakers Told
By Peter Robison and Gopal Ratnam

The U.S. military depends on China for the metals required to build smart bombs, night-vision goggles and spy radar, according to a report to Congress obtained by Bloomberg News.China controls 97 percent of production of materials known as rare earth oxides, giving it "market power" against the U.S., the Government Accountability Office said in the report. The materials -- found inGeneral Dynamics Corp.’s M1A2 Abrams tank and Aegis SPY-1 radar made byLockheed Martin Corp. -- are so irreplaceable that suppliers to military equipment makers could be buying from China for years to come, the GAO said.

The U.S. needs to rebuild a domestic industry for the metals after mining in the U.S. lapsed and production migrated to Chinese suppliers, according to members of Congress including U.S. Representative Mike Coffman, a Colorado Republican. "The People’s Republic of China is not an ally of the United States," Coffman, who asked for the GAO report, said in an interview in February. "They feel increasing leverage. This gives them another tool."

The U.S. Department of Defense is investigating potential "vulnerabilities" in the supply chain and will produce its own report by the end of September, the GAO said. Pentagon spokesman Geoff Morrell did not immediately respond to an after-hours e- mail seeking comment. Spokesmen for Lockheed, based in Bethesda, Maryland, and General Dynamics of Falls Church, Virginia, declined to comment on rare earths ahead of the report’s release. The report is due to be made public tomorrow, according to a person with direct knowledge of the matter.

The issue gained attention last year when China’s Ministry of Industry and Information Technology said supplies were running short of two rare-earth elements, also in demand for wind turbines and hybrid cars. The ministry’s press office didn’t respond to faxed questions asking for comment. China established domestic production quotas on rare-earth materials and decreased export quotas, increasing prices, the GAO report said. The nation also increased export taxes to a range of 15 to 25 percent, raising prices for non-Chinese competitors, it said.

Shortages of some elements "already caused some kind of weapon system production delay," the GAO said, citing a 2009 National Defense Stockpile report. The term "rare earths" refers to a group of 17 chemically similar metallic elements, including lanthanum, cerium, neodymium, europium and yttrium. While they’re actually relatively abundant in the earth’s crust, finding deposits significant enough to mine is less common, the U.S. Geological Survey says. China, the countries that made up the former Soviet Union and the U.S. have the largest reserves.

A U.S. mine in Mountain Pass, California, owned by Molycorp Minerals LLC, was once the world’s dominant producer. It closed a separation plant in 1998 after regulatory scrutiny of its wastewater line and suspended mining in 2002, the GAO said. As mining lapsed, so did companies that turned the ore into metals found throughout U.S. weapons systems, the GAO said. Magnequench International Inc., a maker of neodymium magnets, closed an Indiana plant in 2003 and moved equipment to China. By the end of 2005, magnet makers in Kentucky and Michigan also closed. "Government and industry officials told us that where rare earth materials are used in defense systems, the materials are responsible for the functionality of the component and would be difficult to replace without losing performance," the GAO report said.

It cited several specific weapons systems, including the M1A2 Abrams tank, which has a navigation system that uses samarium cobalt magnets with samarium metal from China; the DDG- 51 Hybrid Electric Drive Ship Program, which contains neodymium magnets from China; and Lockheed Martin’s Aegis SPY-1 radar, which has samarium cobalt magnets that will need to be replaced during its 35-year lifetime.Coffman, a former U.S. Marine who serves on the House Armed Services Committee, inserted an amendment into the fiscal 2010 defense spending bill requesting the study. The GAO was required to determine which defense systems are dependent on rare earth metals. The report was due by April 1.

Molycorp, based in Coffman’s home state in Greenwood Village, Colorado, and backed by shareholders including Resource Capital Funds, Pegasus Capital Advisors LP and Traxys North America, plans to raise $450 million to $500 million to resume mining by 2012. Even if it does, the U.S. would still lack companies to process the metals, the GAO said. It may take two to five years to develop a pilot plant to refine oxides to metal, and foreign companies own patents over neodymium magnets that don’t expire until 2014, the report said.Rebuilding a U.S. rare earth supply chain may take up to 15 years, the GAO said, citing industry estimates. That is dependent on infrastructure investment, developing new technologies and acquiring patents, it said.

Japan mulls monetisation of public debt and yen devaluation
by Ambrose Evans-Pritchard

Japan’s ruling party has called for drastic monetary easing to devalue the yen by 30pc and halt the slide into deflation, putting it on a collision course with the Bank of Japan. A draft by 130 lawmakers from premier Yukio Hatoyama’s Democratic Party of Japan said the country needs a radical shift towards growth policies, calling for an inflation target above 2pc. The exchange rate should be steered to ¥120 against the dollar, from the current ¥90.

Shizuka Kamei, financial affairs minister, said the central bank must monetise government debt to support the market for state bonds and prevent deflation becoming deeply lodged in the economy. The Bank of Japan’s governor, Masaaki Shirakawa, told lawmakers that it would illegal to fund state spending by printing money. "History has proven that central banks directly buying government securities caused severe inflation and dealt a blow to the economy. The BoJ is now providing adequate funds," he said. Tokyo is still able to issue 10-year bonds at ultra-low rates of 1.4pc, relying on a captive savings market, even though gross public debt will reach 225pc of GDP this year, the highest in the world.

However, there are growing fears of a "malign scenario" where rising rates set off a debt compound spiral. The IMF has warned that borrowing costs may rise sharply as Japan’s aging crisis bites in earnest. Junko Nishioka, an economist for RBS, said the BoJ is haunted by hyperinflation after World War Two. It is afraid debt monetisation could back-fire, triggering the very crisis that everybody fears. "We don’t think a fiscal accident is likely yet. Pension funds will keep buying debt for another five or six years. After that pressure increases," she said.

Icelandic Report on Crash Pins Blame
by Leigh Phillips

A scathing report on the financial crisis that savaged Iceland fingers acts of "extreme negligence" by politicians, bankers, and regulators but spares Britain. Iceland's leading politicians, bankers and regulators all engaged in acts of "extreme negligence" that predictably led to the country's financial crash in 2008, a government investigation into the banking crisis has found. A 2,300-page report by a Special Investigation Commission of Iceland's Althingi, the north Atlantic island's parliament, published on Monday (12 April) is scathing in its criticisms, notably of former prime minister Geir Haarde, the chairman of the central bank, David Oddsson (the architect of the privatisation of the banking sector in the 1990s), finance and commerce ministers, central bank governors and the chief financial regulator. A separate parliamentary committee is to now consider whether legal action is to be taken against those it alleges to have been responsible.

Reflecting on the findings of the "truth commission," Prime Minister Johanna Sigurdardottir said: "The private banks failed, the supervisory system failed, the politics failed, the administration failed, the media failed, and the ideology of an unregulated free market utterly failed." The crucial conclusion of investigators is that the growth in the banking sector – 20 times its original size in the space of seven years – outstripped the country's ability to cover liabilities and regulators' ability and willingness to monitor the sector. The central bank did not maintain sufficient foreign currency reserves, the report underscored, and the deposit guarantee fund was too tiny to cover any failure, let alone a failure by all three of the main banks – Glitnir, Kaupthing and Landsbanki. Slamming the financial supervision authority (FME), the probe said it "did not enforce the legal provisions which were at its disposal even when they saw laws being broken."

The report also described how the largest shareholders in each of the banks were each of their institutions' largest borrowers, and "had an abnormally easy access to loans in these banks, apparently in their capacity as owners... [raising] questions as to whether the lending is done at arms length." Glitnir for example regularly loaned sums to investment house Baugur, and its holdings in a number of UK high-street firms. One of the bank's major stakeholders was also the owner of Baugur. The report also will deliver some good news to the UK, long cast as a villain in its attempts to recover money lost in the collapse of Landsbanki online banking firm Icesave. The document details how in 2008, Landsbanki and the British Financial Services Authority (FSA) held intense discussions over whether to restructure Icesave as a UK subsidiary rather than as a branch of the parent company.

Had Landsbanki gone ahead with the change, Icesave depositors would have been covered by the UK's deposit insurance scheme, letting Iceland off the hook for the billions in deposits – the source of the grievance between London and Reykjavik and a major threat to the Icelandic government's EU membership ambitions. The report found that Landsbanki was reluctant to make the change as it would have meant that the funds deposited by customers would not be so readily available for use by Landsbanki directly. The truth commission also found that funds from some banks had been withdrawn by "insiders" just days before the banks closed their doors, a finding that may be taken up by state prosecutors.

Nassim Taleb Thinks Krugman And Tom Friedman Are Wildly Dangerous, And He Wouldn't Mind Running Over An Economist In His Car
by Joe Weisenthal

Eliot Spitzer was not robust because a single sex scandal derailed his career.

Nouriel Roubini is robust because he has vulva castings on the wall of his apartment, and it doesn't derail him at all.

Understand this dichotomy, and you'll begin to understand Nassim Taleb's conception of a robust society where we wouldn't have financial crises like the one we just came through.

Still don't get the significance of the Spitzer and Roubini examples?

Ok, let's use a financial example.

When Jerome Kerveil lost billions for SocGen, it wasn't because his trades specifically cost the firm billions. It was because, in the process of liquidating $50 billion or so of assets, the bank depressed the market to such an extent that they lost billions.

Had SocGen and Kerveil been a tenth of its size, that same liquidation wouldn't have cost the bank much at all.

Thus SocGen was not robust, but a similar firm 1/10th as big would have been.

All of the above are examples given to us by The Black Swan author during a recent night out in Manhattan.

That came about due to some interactions we had over Twitter, which Taleb is using to publish a hundreds of aphorisms that many find to be brilliant, obnoxious, arrogant, and addicting.

More than anything else, Taleb is obsessed with robustness, a topic he returned to several times during our night out.

It's something he first started hitting on in The Black Swan, and as the Spitzer, Roubini, and SocGen examples demonstrate, it's a very broad concept.

Norman Mailer, says Taleb, was robust, because "he had six mistresses" and nobody cared. The chairman of a large bank worth $100 million is not robust, because a blackmailer who has knowledge of some infidelities could extort him for $75 million.

Our conversation, over 3 plates of oysters, two servings of shrimp, and a few drinks* ranged from fitness (we both share an interest in evolutionary fitness and the teachings of fitness guru/economist Art De Vany), finance, global warming, and who is a danger to society.

There were two names he insisted I include: Paul Krugman and Thomas Friedman.

"Paul Krugman is a danger to society!"

"He uses the wrong mathematics, that's how I knew he was a fluke."

Why? It's because Krugman is pushing to create a society that is less robust. Taleb, who characterizes himself as a libertarian, even goes one step further: "The definition of a robust society: where Paul Krugman could exist without harming others."

Even worse though is Krugman's fellow NYT pundit, Thomas Friedman, who with his book about globalization, "is the biggest danger."

I challenged Taleb on his anti-expert mentality, and told him my contention that much of the appeal of someone slamming these luminaries is that it makes normal people feel good about themselves.

He kind of sidestepped the question, saying that there are plenty of experts who he doesn't slam, like, say, dentists, because their knowledge, and their arrogance isn't dangerous. What's dangerous is the arrogance of someone with the power to influence policy.

After dinner, we talked fitness, and he asked me how I became familiar with Art de Vany. I told him it was through the blogger and econ prof Tyler Cowen, which immediately set Taleb off.

"That guy's a bullshitter," noting that Cowen admits to writing about books he only reads parts of.

"How can you write a review of a book you haven't read?" presumably referring to this Slate review.

His advice to Cowen: "Read much fewer books, read them slowly, turn off your internet connection, and then come back."

As the night ended, Taleb gave me a brief ride in his White Lexus Hybrid towards a better place to pick up a cab. As we left the parking garage, a couple walked in the direction of the car, and he made a comment about not wanting to run them over.

Unless the guy was an economist, in which case,  that would be a "benefit to society."

Vice President Biden Lends His Prestige To Robert Rubin's Relaunch
by Dan Froomkin

Robert Rubin, the ultimate symbol of the Democratic Party's coziness with Wall Street fat cats, has kept a relatively low profile in Washington ever since the financial world he helped remake exploded in late 2008.

As Treasury Secretary in the Clinton administration, Rubin was a key proponent of the extreme financial deregulation that eventually brought the economy to its knees; after leaving government, he proceeded to enrich himself to the tune of $126 million while driving Citigroup to the edge of bankruptcy.

But Rubin is leaping back into the Washington policy-making scene next week, with a splashy relaunch of his pet think-tank, the Hamilton Project, housed at the Brookings Institution. As founder of the project, he will deliver the opening remarks and speak on one of the two panels

And the Democratic Party, rather than keep Rubin at an extreme distance, is apparently welcoming him back with open arms. The event's keynote speaker is none other than Vice President Joe Biden.

Rubin, even in exile, has continued to be an influential behind-the-scenes player, speaking regularly to proteges (many of them alums of the Hamilton Project) who occupy top economic-policy positions in the Obama administration -- they include Treasury Secretary Tim Geithner, White House budget chief Peter Orszag, and key White House advisers Jason Furman and Michael Froman, just for starters.

And the Rubinites, amazingly enough, are riding high these days. They feel like they saved the financial world -- at what they consider a relatively low cost. The millions of lost jobs and homes are considered unfortunate collateral damage.

Nevertheless, there's still a lot of legitimate populist anger at the plutocrats who enabled the crisis, profited from it, and walked away intact. And nobody embodies that role better than Rubin.

As one prominent player in the financial reform movement told HuffPost angrily: "That's exactly what the Democratic Party needs right now. We need to make clear to everybody that we are the party of Robert Rubin. That will get us all kinds of good will."

But Jared Bernstein, Biden's top economic adviser, told HuffPost that the measure of the vice president's views "is what he says, not where he says it."

Biden "speaks to all wings of the party. His last big economic speech was at CAP [the Center for American Progress], and a few weeks ago, we were talking middle-class economics in a factory down in North Carolina. A few weeks before that, we were at the AFL-CIO executive council meeting, the SEIU [Service Employees International Union] annual convention, and about a dozen other labor meetings in the past eight months."

Also attending the event: Sen. Sherrod Brown of Ohio, considered one of the most progressive voices in his chamber. His office made it clear he was there not to endorse the Rubinite position, but to confront it.

"He is attending the conference so that he continues to be a loud voice for a national manufacturing policy among economists," Brown spokesman, Meghan Dubyak, wrote in an email to HuffPost. "His message will be that too much emphasis has been placed on Wall Street and financial services at the expense of manufacturing communities across the nation."

As for Rubin himself, what is the man who's been almost exactly 180 degrees wrong on the major economic issues of his time thinking these days? Well, in an essay published by Newsweek late last year, Rubin worried about too much spending on job-creation, opposed forcing the riskiest derivative contracts onto public exchanges, resisted an accounting reform that would require financial institutions to assess their assets based on actual market prices rather than just making things up, and warned against what he calls impractical proposals to break up "too big to fail" banks. His most pressing concern was the federal deficit.

All in all: A decidedly Wall Street rather than Main Street agenda.

Baffled by Health Plan? So Are Some Lawmakers
by Robert Pear

It is often said that the new health care law will affect almost every American in some way. And, perhaps fittingly if unintentionally, no one may be more affected than members of Congress themselves. In a new report, the Congressional Research Service says the law may have significant unintended consequences for the "personal health insurance coverage" of senators, representatives and their staff members.

For example, it says, the law may "remove members of Congress and Congressional staff" from their current coverage, in the Federal Employees Health Benefits Program, before any alternatives are available. The confusion raises the inevitable question: If they did not know exactly what they were doing to themselves, did lawmakers who wrote and passed the bill fully grasp the details of how it would influence the lives of other Americans?

The law promises that people can keep coverage they like, largely unchanged. For members of Congress and their aides, the federal employees health program offers much to like. But, the report says, the men and women who wrote the law may find that the guarantee of stability does not apply to them. "It is unclear whether members of Congress and Congressional staff who are currently participating in F.E.H.B.P. may be able to retain this coverage," the research service said in an 8,100-word memorandum. And even if current members of Congress can stay in the popular program for federal employees, that option will probably not be available to newly elected lawmakers, the report says.

Moreover, it says, the strictures of the new law will apply to staff members who work in the personal office of a member of Congress. But they may or may not apply to people who work on the staff of Congressional committees and in "leadership offices" like those of the House speaker and the Democratic and Republican leaders and whips in the two chambers. These seemingly technical questions will affect 535 members of Congress and thousands of Congressional employees. But the issue also has immense symbolic and political importance. Lawmakers of both parties have repeatedly said their goal is to provide all Americans with access to health insurance as good as what Congress has.

Congress must now decide what steps, if any, it can take to deal with the problem. It could try for a legislative fix, or it could adopt internal policies to minimize any disruptions. In its painstaking analysis of the new law, the research service says the impact on Congress itself and the intent of Congress are difficult to ascertain. The law apparently bars members of Congress from the federal employees health program, on the assumption that lawmakers should join many of their constituents in getting coverage through new state-based markets known as insurance exchanges. But the research service found that this provision was written in an imprecise, confusing way, so it is not clear when it takes effect.

The new exchanges do not have to be in operation until 2014. But because of a possible "drafting error," the report says, Congress did not specify an effective date for the section excluding lawmakers from the existing program. Under well-established canons of statutory interpretation, the report said, "a law takes effect on the date of its enactment" unless Congress clearly specifies otherwise. And Congress did not specify any other effective date for this part of the health care law. The law was enacted when President Obama signed it three weeks ago. In addition, the report says, Congress did not designate anyone to resolve these "ambiguities" or to help arrange health insurance for members of Congress in the future.

"This omission, whether intentional or inadvertent, raises questions regarding interpretation and implementation that cannot be definitively resolved by the Congressional Research Service," the report says. "The statute does not appear to be self-executing, but rather seems to require an administrating or implementing authority that is not specifically provided for by the statutory text." The White House said last month that Mr. Obama would voluntarily participate in the health insurance exchange, though the law does not require him or other administration officials to do so. His participation as president may depend on his getting re-elected in 2012.

Representative Jason Chaffetz, Republican of Utah, said lawmakers were in the same boat as many Americans, trying to figure out what the new law meant for them. "If members of Congress cannot explain how it’s going to work for them and their staff, how will they explain it to the rest of America?" Mr. Chaffetz asked in an interview. The provision governing members of Congress can be traced to the Senate Finance Committee. When the panel was working on the legislation last September, Senator Charles E. Grassley, Republican of Iowa, proposed an amendment to require that elected federal officials and all federal employees buy coverage through an exchange, "rather than using the traditional Federal Employees Health Benefits Program."

A scaled-back version of the amendment, applying to members of Congress and their aides, was accepted in the committee without objection. "The whole point is to make sure political leaders live under the laws they pass for everyone else," Mr. Grassley said Tuesday. "In this case, after the committee completed its work, the coverage provision was redrafted by others, and that’s where mistakes were made. Congress can and should act to correct the mistakes." The federal employees program, created in 1959, now provides coverage to eight million people and, according to the Congressional Research Service, is the largest employer-sponsored health insurance program in the country.

US Faces Shortage of Doctors
by Suzanne Sataline And Shirley S. Wang

As Ranks of Insured Expand, Nation Faces Shortage of 150,000 Doctors in 15 Years

The new federal health-care law has raised the stakes for hospitals and schools already scrambling to train more doctors. Experts warn there won't be enough doctors to treat the millions of people newly insured under the law. At current graduation and training rates, the nation could face a shortage of as many as 150,000 doctors in the next 15 years, according to the Association of American Medical Colleges. That shortfall is predicted despite a push by teaching hospitals and medical schools to boost the number of U.S. doctors, which now totals about 954,000.

The greatest demand will be for primary-care physicians. These general practitioners, internists, family physicians and pediatricians will have a larger role under the new law, coordinating care for each patient. The U.S. has 352,908 primary-care doctors now, and the college association estimates that 45,000 more will be needed by 2020. But the number of medical-school students entering family medicine fell more than a quarter between 2002 and 2007. A shortage of primary-care and other physicians could mean more-limited access to health care and longer wait times for patients.

Proponents of the new health-care law say it does attempt to address the physician shortage. The law offers sweeteners to encourage more people to enter medical professions, and a 10% Medicare pay boost for primary-care doctors. Meanwhile, a number of new medical schools have opened around the country recently. As of last October, four new medical schools enrolled a total of about 190 students, and 12 medical schools raised the enrollment of first-year students by a total of 150 slots, according to the AAMC. Some 18,000 students entered U.S. medical schools in the fall of 2009, the AAMC says.

But medical colleges and hospitals warn that these efforts will hit a big bottleneck: There is a shortage of medical resident positions. The residency is the minimum three-year period when medical-school graduates train in hospitals and clinics. There are about 110,000 resident positions in the U.S., according to the AAMC. Teaching hospitals rely heavily on Medicare funding to pay for these slots. In 1997, Congress imposed a cap on funding for medical residencies, which hospitals say has increasingly hurt their ability to expand the number of positions. Medicare pays $9.1 billion a year to teaching hospitals, which goes toward resident salaries and direct teaching costs, as well as the higher operating costs associated with teaching hospitals, which tend to see the sickest and most costly patients.

Doctors' groups and medical schools had hoped that the new health-care law, passed in March, would increase the number of funded residency slots, but such a provision didn't make it into the final bill. "It will probably take 10 years to even make a dent into the number of doctors that we need out there," said Atul Grover, the AAMC's chief advocacy officer. While doctors trained in other countries could theoretically help the primary-care shortage, they hit the same bottleneck with resident slots, because they must still complete a U.S. residency in order to get a license to practice medicine independently in the U.S. In the 2010 class of residents, some 13% of slots are filled by non-U.S. citizens who completed medical school outside the U.S.

One provision in the law attempts to address residencies. Since some residency slots go unfilled each year, the law will pool the funding for unused slots and redistribute it to other institutions, with the majority of these slots going to primary-care or general-surgery residencies. The slot redistribution, in effect, will create additional residencies, because previously unfilled positions will now be used, according to the Centers for Medicare and Medicaid Services.

Some efforts by educators are focused on boosting the number of primary-care doctors. The University of Arkansas for Medical Sciences anticipates the state will need 350 more primary-care doctors in the next five years. So it raised its class size by 24 students last year, beyond the 150 previous annual admissions. In addition, the university opened a satellite medical campus in Fayetteville to give six third-year students additional clinical-training opportunities, said Richard Wheeler, executive associate dean for academic affairs. The school asks students to commit to entering rural medicine, and the school has 73 people in the program.

"We've tried to make sure the attitude of students going into primary care has changed," said Dr. Wheeler. "To make sure primary care is a respected specialty to go into." Montefiore Medical Center, the university hospital for Albert Einstein College of Medicine in New York, has 1,220 residency slots. Since the 1970s, Montefiore has encouraged residents to work a few days a week in community clinics in New York's Bronx borough, where about 64 Montefiore residents a year care for pregnant women, deliver children and provide vaccines. There has been a slight increase in the number of residents who ask to join the program, said Peter Selwyn, chairman of Montefiore's department of family and social medicine.

One is Justin Sanders, a 2007 graduate of the University of Vermont College of Medicine who is a second-year resident at Montefiore. In recent weeks, he has been caring for children he helped deliver. He said more doctors are needed in his area, but acknowledged that "primary-care residencies are not in the sexier end. A lot of these [specialty] fields are a lot sexier to students with high debt burdens."

U.S. Flag Recalled After Causing 143 Million Deaths
by The Onion

"I believe in adequate defense at the coastline and nothing else. If a nation comes over here to fight, then we'll fight. The trouble with America is that when the dollar only earns 6 percent over here, then it gets restless and goes overseas to get 100 percent. Then the flag follows the dollar and the soldiers follow the flag."
Major General Smedley Darlington Butler

Citing a series of fatal malfunctions dating back to 1777, flag manufacturer Annin & Company announced Monday that it would be recalling all makes and models of its popular American flag from both foreign and domestic markets.

Representatives from the nation's leading flag producer claimed that as many as 143 million deaths in the past two centuries can be attributed directly to the faulty U.S. models, which have been utilized extensively since the 18th century in sectors as diverse as government, the military, and public education.

"It has come to our attention that, due to the inherent risks and hazards it poses, the American flag is simply unfit for general use," said Annin & Company president Ronald Burman, who confirmed that the number of flag-related deaths had noticeably spiked since 2003. "I would like to strongly urge all U.S. citizens: If you have an American flag hanging in your home or place of business, please discontinue using it immediately."

Added Burman, "The last thing we would want is for more innocent men and women around the world to die because of our product."

Millions of U.S. flag–related injuries and fatalities have been reported over a 230-year period in locations as far flung as Europe, Cuba, Korea, Gettysburg, PA, the Philippines, and Iraq. In addition, the company found that U.S. flag exports to Vietnam during the late 1960s and early 1970s resulted in hundreds of thousands of deaths, a clear sign that there was something seriously wrong with its product.

Despite fears about the flag's safety—especially when improperly used or manipulated in ways not originally intended—sales continued unabated over the years, potentially putting billions of unsuspecting people in danger.

"At first, we wanted one of our flags in every home in America," Burman said. "Unfortunately, the practical applications of this product are far outnumbered by the risks it presents. Millions have died needlessly, and when you ask people why, they point to the flag."

Added Burman, "Frankly, we should have pulled it off the market decades ago."

Studies conducted by the Annin & Company research and development department revealed that faulty U.S. flags have caused more than just injuries and deaths. During the mid-1950s, the flags were found to have the bizarre side effect of causing fear, paranoia, and hysterical behavior among millions of Americans. This was dismissed as an isolated event until September 2001, when similar symptoms reemerged on a massive scale.

As hazardous as the flags may be on their own, Annin & Company officials claimed the products become even more dangerous when used in conjunction with other common household items.

"When combined with alcohol, excessive patriotism, grief, or well-intentioned but ultimately misguided ideals, U.S. flags transform into ticking time bombs, just waiting to go off," Burman said.

Manufacturers are addressing the flag's unsafe and potentially lethal alignment of stars and stripes by designing a revised model that they hope will cut down on deaths in the United States and overseas, where experts say the flag is nearly 1,000 times as deadly.

In the meantime, Annin & Company is advising all Americans to either ship their flags back to the manufacturer or, if no time permits, dispose of them in an efficient manner.

"I understand that people might be reluctant to stop using a product they have found to be reliable over the years," Burman told reporters. "But I can't in good conscience allow them to use something I know to be dangerous. We'll try to make adjustments soon and come up with something that benefits everybody rather than hurting them."

Added Burman, "In the interim, I would recommend that all Americans switch to the Canadian flag, which seems to be working just fine."


John said...

Good introduction with lots of "goodies" to think about. Thanks for your tireless work and efforts. As complex as the financial and business world has become, it does take daily reading and contemplation to just "sort of" understand what lies just below the surface of the many stories that are present each day. That said, I suspect that is one of many reasons so many people have chosen to bury their head in the sand and just try to stay "even" not realizing that "even" doesn't get one very far in our "new" world these days. John

jal said...

I cannot let some of yesterday's comment go without comments.

@ VK
“For example, MIT's Feb 2009 Technology review -
Lamarckian evolution, which states that acquired characteristics can be passed on to offspring.”

“Madison anthropologist John Hawks estimates that positive selection just in the past 5,000 years alone — around the period of the Stone Age — has occurred at a rate roughly 100 times higher than any other period of human evolution. Many of the new genetic adjustments are occurring around changes in the human diet brought on by the advent of agriculture, and resistance to epidemic diseases that became major killers after the growth of human civilizations.”
I am of another completely different camp of thinking.

1. There has not been positive selections. We are less able to survive in ANY environment than our forefathers. We have DEVOLVED and lost many of the characteristics that we had and should have improved to make us better at survival. We fell out of the trees we did not come down willingly. (eg. Therefore, I don’t have a beautiful tail)

2. In order for acquired characteristics to be able to be passed on to offspring, there is a need for a mechanism that impresses “knowledge” on the future embryo. That is done by what is referred to as “instinct”.

Our instinctive abilities are pitiful compared to anything that is alive that you want to use as a comparison.

Steve From Virginia said...

I can't tell whether Russell Napier is speaking with a sense of quiet satisfaction or is about to cry ...

(Tower of debt will force a roll back of the free markets

By Russell Napier FT)

Jim R said...

Anthropologists will say just about anything -- the 'science' of anthropology is only slightly more precise than economics.

The authors of The Beak of the Finch tracked populations of the birds on one of the smaller Galapagos Islands, observing evolution in action. Turns out that it is driven by boom/bust cycles in the finch population, which for this island is dependent on climate. As the Southern Oscillation brings alternating rain and drought to the islands, the finch populations rise and fall.

During the boom times, the finches breed like crazy, and freely hybridize with related species. A lot of maladaptive characteristics appear in successive generations. The population burgeoned.

During the bust times, the surviving finch females become very selective about their mates and put a lot more effort into raising fewer chicks. Most or all of the maladapted individuals die off as the population crash.

All indications are that we've just had one heckuva boom ourselves, and our species is now headed for the other half of the cycle.

Unknown said...

Okay Illargi... enough carping about Obama. WHAT WOULD YOU DO... other than what he has done ? Please spell it out in specifics please ? Thanks...

Greenpa said...

VK: from previous thread: "The findings may lead to a very broad rethinking of human evolution, Hawks says,"

Just so you know; beware of any statement in the press; including the scientific press, about "we found this surprising" and "this may cause a broad rethinking".

My friends and I regularly exchange emails on this kind of thing- it's really dismaying that these guys are "surprised" by stuff we all took totally for granted 20 years ago. We're guessing that became part of the problem; we talked it out, moved on, and quit talking about it. So the youngsters are making new discoveries all the time- which if they'd done a reasonable literature search would have found tons of info. But they didn't.

I didn't find any of the data in your post surprising; on the contrary, it was all what I would expect. The interpretations of the data, though- some pretty goofy stuff there.

The problem with the "discovery" that epigenetic information can be passed to other generations is not at all surprising. What the excited guys have not figured out is that such changes are often reversible- perhaps 3 or 4 generations down the road. It was all an intrinsic aspect of the species ability to adapt- they just never knew that your genome was that adaptable and flexible; they keep thinking what they see right now today "is" the genome. And boy, is it ever not.

lautturi said...

Here's something seriously funny if you feel depressed with our situation.

Chronicles of Gord, a videogame rental keeper in Canada in early 2000s. Lots and lots of very short stories about youngsters and their parents - sometimes trying to fool Gord, sometimes just being themselves (=us?). Somehow these stories fit to the current question "where are we coming from" very well.

Be warned, you can spend hours reading the stuff (and laughing your butt off). Then again one can't stop wondering about the monkey.

Slightly off topic, yes, but one needs to remember how to smile (my face is aching).

Unknown said...
This comment has been removed by the author.
Unknown said...

Benedict, Obama, they all have a billion souls depending on them...

Hah! When I first read that, I saw it as "Benedict Obama" as in "Benedict Arnold," the traitorous general who sold out U.S. forces to the British and Canadians. (I realize that Stoneleigh might have a different opinion of the original Mr. Arnold's worthiness.) But like Arnold, Obama sold out the hopes of millions of American souls who thought he might be a change from Banking As Usual.

OTOH, the in-crowd seems to be getting away with the hopey-changey green-shootey "recovery." I'm getting close to being the last hold-out who thought it wasn't real, and maybe soon I'll throw in the towel of my doubts. That will leave Ilargi as the last skeptic standing...

woodsy_gardener said...

"Okay Illargi... enough carping about Obama. WHAT WOULD YOU DO... other than what he has done ? Please spell it out in specifics please ? Thanks..."

Yes, indeed, please spell it out.

You have a wicked sense of humor Illargi.

I have no $$ to contribute, just my appreciation of TAE. I've been with y'all back to the Oil Drum.

Deflation, not inflation--no way, but intelligent writing so I kept reading. I'm glad I did and I bet you are glad that Leanan pushed you to get your own blog.

We are living in interesting times. Thank you for the analysis and thank Stoneleigh for being an angel. Good luck to everyone on TAE.

LANFU Late at night, fucked up.

Lukas said...

To Greyzone (from yesterday's thread):

You make some good points but I disagree with your theory which you consider as a fact. However, it is just a hypothesis, quite an old one and highly controversial. I would say my own objections:
1) I am still awed how people overestimate results of the cognitive sciences. Don't be confused of so many research papers etc. In fact, we know so little. Only tool, which can be used at the end, is the human brain which I found self-limiting. It was actually the human brain which created evolutionary biology , right? So how can you trust it if it is completely determined by genes? Oh, you may say that it is based on the observation of the real world - whose representation is create where? Well.. human brain.
2) This theory does not explain altruism. I disagree that the only explanation of altruism is too increase your "fitness". Try reading Tzetvan Todorov who shows that nevermind how bad things are, there are always some people who can manage not to run wild. Not the most of the people but also not a few who could be ignored.
3) If you accept that your life is completely controlled by your genes which are playing their evolutionary games, how can you even live with that feeling?

Ilargi said...

"Okay Illargi... enough carping about Obama."

There's not nearly enough carping about him, wish there would be much more, it'd to the country a lot of good. Can't get worse than this.

WHAT WOULD YOU DO... other than what he has done ? Please spell it out in specifics please ? Thanks..."

After 15 months of misery, I'd have to go with Jim Rogers: "If I were the US administration, I'd resign..."

Barring the courage to do that, I'd say get your nose out of the bankers' asses, demand the people's money back, apologize for all you've done and jump off a cliff.

Or, barring the courage to do that as well, wait till someone pushes you. Shouldn't be long.

Obama is singlehandedly responsible for the cover up and 'justification' of losing the American people approximately $1 trillion each and every month for 15 months now, and that's only going to get worse. The longer you try to hide toxic material, the harder it gets to do that.

He makes no attempts to create a society, what he delivers instead is a fuming garbage heap.


carpe diem said...

Ahimsa (from yesterday),

Thanks for the awesome websight! I wasn't aware of it. I am familiar with a lot of the poetry especially from the Japanese and Chinese hermits and Thomas Merton.
One of my favorite books: The Wonders of Solitude
Edited by Dale Salwak. A book of quotes from some of the worlds greats who valued their solitude.

Today there is an excellent article (on line) in the New York Times, bottom of the page under 'Home and Garden'. The article is called 'Embracing a Life of Solitude'. Worth a read for everybody interested in solitude as well as survival mechanisms on the doomstead! Some nice photos included of people who have chosen to live in the middle of nowhere.

Peace and Love

zander said...

@ bigelow from yesterday

What I had in mind was closer to the nonviolent resistance philosophy of Gandhi.
Look, we all know right from wrong, to take one small e.g. from many we could simply have refused to participate in the credit expansion we are now at the mercy of, lived within our means you know? bought what we paid for with money we had already EARNED. how easy is that? and we had the power to do so, now I know that is hopelessly idealistic in the extreme, I accept that, however you can't have it both ways, idealistic or not it was so easy to just not go there but now that we have it is not possible to blame anything/one other than ourselves, extrapolate this logic to most other problems we have today and you'll find that simply not particpating in the first place (dead easy) means no problem in the future. Iknow the benefit of hindsight is a wonderful thing but hindsight notwithstanding, we cannot absolve the boomer gen. of the blame for things which were clearly of their own doing and could have been avoided.
sorry to labour the point but...

Anyhow I believe VK's gen will do much the same thing, maybe not him personally but as a unit they will.
I fear extinction and a long human-free rehabilitation may be the only cure for this planet.


zander said...

Carpe diem.

The Wonders of Solitude is indeed a cracking read.
I also highly recommend : Solitude by Anthony Storr and Party of one by Anneli Rufus, both excellent.


Peter said...

VK's post was excellent, thanks for letting him be heard Ilargi. One solution I've recently found may be of interest to readers here. A Swiss mathematician has created an online game (the Karus Game) that is NOT gambling or a scam, but a way for us to pool our resources and help each other. Available around the world. See for more info; if you want to know more, write me at

Malmo's Ghost said...

Greece formally calls on IMF for assistance. Good? Bad?

Anyone out there have a view on the IMF? Don't they exploit for a living?

Zeke said...

Frankly, I'm appreciative of Obama. It gives people a single entity to "piss and moan" about. This is called "focus". Otherwise our whining would have to be spread across multiple administrations, Congress, US military, economists, economic theories, people who made fortunes during the build up to the debacle, voters, etc. Such thinking is "defocusing" and confuses the typical American mind.

Since Obama isn't doing a single thing that hasn't been standard American practice since our founding fathers, I simply don't waste my time or the time of those around me with senseless ranting about "who's to blame and how things oughta be". From the very beginning powerful financial intersts have run the country and buying votes with alcohol, money, favors or whatever was the needed bribe.

The reality is, of course, each of us believes "I" have the solution when, of course, we really have an "opinion" we believe to be the solution. But then I've been watching this thing coming longer than many of you have been alive. I've watched the same old scammers elected to public office time after time. Every so often a scam becomes so large it actually surfaces from the depths. Then we get the hue and cry. Multiple year/million $ "investigations" are done by people in office for decades and it all slides beneath the surface again. Such is life!!

jal said...

Re.: Obama path

First, identify the real problem.
Death-Spiral Intercept

The inherited problem was debt.

Here is what Karl says,
“The 2000s were marked by even more leverage.  Why?  Because it was the only way to get return left.  The Government, having stepped in to support the economy with $500+ billion annually in deficit spending, was unable to pull back without instantaneously crashing the economy”

“What we're doing now will inevitably lead to another crisis, this one much worse than the last.  Burdened with the bad paper they refused to unload, the banks will get into cash flow trouble as their attempt to extract ever-larger amounts of money from everyone else in society to paper over their own insolvency will ultimately fail.”

Remember ... the bankers stole ALL the money. The savers are the losers.

What mechanisms can be used to replace the money that the savers thought they had in their saving accounts?

The banking system and the stock markets were given money by the government so that the savers would be rescued. The rescue was not for the bankers and other middle men.

Ask yourself what would happen if all the savers were told that the middle men had lost 50% or all of their savings.

You all know that there would have been riots in the streets.

The pumping up has been achieved. Now is the time for the savers to take their money from the middle men before its all gone again.

That is where we are today.
There is another problem coming up.

A Tax Revolt Movement.

The people do not want to pay for those government debts and they do not want to do without the government services.
They want the banks to pay back all the money that they were given by the government and they want to see individuals in jail for their fraudulent actions.

But ... but ... Its impossible to do. The innocent savers are going to be the ones left out in the cold. It means ... uncontrolled default ... an uncontrolled jubilee ... seniors rioting in the street.

See ... GREECE!

Now ... before pushing Obama off a cliff, who will step up to the plate and do a CONTROLLED RESET of the economy.

You are dammed, if you do, and dammed, if you don’t!


Bigelow said...


O.k., there are lots of Boomers and their participation in materialistic lifestyles and bubble manias, in part, lead to our present circumstances. To round that out please consider what has happened to the Boomer’s public purse. The country is bankrupt, and there is little opportunity to offer subsequent generations.

The US public endured decades of thefts of federal government assets. $2.3 Trillion dollars of public money is missing and unaccounted for in 2001 from the Defense Department and $77.2 Billion is missing from HUD in ’98 & ‘99 (page 4). The infamous Arthur Anderson L.L.P. noted$2.4 Billion was missing from the Bureau of Indian Affairs during the 1970s and ‘80s. And “who in their right mind would send 363 tons of cash into a war zone?” --Waxman $12 Billion in cash lost in Iraq in 2003. A huge and mostly incalculable amount of thefts, depending only on how far and extensively we could look; which we can't because much of it hides behind the fact that the Federal government hasn’t had an audit in years, plus arrogant deceptions like SEC mulled national security status for AIG details.

To top off the decades of preliminary fraud, theft has been abandoned in favor of plain wholesale looting and pillaging. As Ilargi points out “Obama is single handedly responsible for the cover up and 'justification' of losing the American people approximately $1 trillion each and every month for 15 months now, and that's only going to get worse.” Sticker Shock: $23.7 Trillion Bailout? Who got the benefit of those trillions of missing taxes and revenue dollars? Can’t say it was the greedy, narcissistic Boomers.

All gone. What is left is massive public debts; debts that will paid for by selling more public assets, raising taxes and eliminating paying any promises to Boomers and their subsequent generations. My neighbor loves his hot tub.

carpe diem said...

Thank you Zander. Will check out the books you mention. The more the merrier.

Malmo's Ghost said...

Retail is starting to jump back in the market. ISEE is at an insane, all time high--viz, non institutional folks think the market is going much higher. Likely a good fade.

Premiums are quite low so puts at 6 months out might be a good bet.

Gravity said...

The ash cloud expelled from the icelandic vulcano will apparently necessitate the grounding of flights across europe for the next few days, which presents a rare opportunity to monitor continental temperature fluctuations caused by the temporary reduction of airline exhaust, similar to the observed post-911 fluctuation, when all flights were grounded. Ashtonishingly, I dont remember whether the measured fluctuation involved a shockingly large increase or decrease of the average temperature across the continetal US by >2 degrees. I can think of mechanisms to go either way, with very different climatological implications.
Anyway, the ash cloud itself should interfere with those measurements, however, the constant exhaust from airtravel apparently does produce an unexpectedly strong ambient temperature differential, which is not accounted for in climatological models very much.

Also, towering inferno.

Mike said...

El G,

(And astrology buffs) you might find this one interesting, a recent interview with Arch Crawford whom you have referenced before:

Arch Crawford on Gold Seek Radio

Arch sees fireworks in July with astrological alignments not seen in 10000 yrs... is crash astrology window May 1 - Nov 1.. with a Crazy July...

Anonymous said...

Carpe diem,

Yes, is a wonderful website.

Thought Meng-hu's review of Anthony Storr's excellent book, "Solitude" (recommended by Zander) might be of interest:

Salwak's book is great. I'll check out the NYT article. Thanks.


Anonymous said...

So it's the tea partiers who are the threat? WAKE UP!

GOP Official and Boyfriend Beaten Bloody

The above is not an isolated case. There are now articles from left wing publications urging liberals to infiltrate tea party organizations and commit acts of vandalism, racism, and anything else that can discredit the tea party movement.

Just who are the real brownshirts here? I say it's Obama and his fascist followers, all wrapped nice and neatly around the finger of Wall Street. And that is what fascism really is, folks - a deep interlocking marriage between large corporations and the state.

And when you look at the "Billion Dollar Man" (Obama and what he raised via corporate donations to get elected), you sure have your charismatic, fascist thug (who violates existing law at will) to achieve his goals. And amazingly he's supposedly well versed in contract law!

The United States is marching right into the maws of fascism, just like people such as Kunstler predicted. But what Kunstler and others can't see is that it is "mainstream" liberalism that is the primary agent of fascism now. Yes the GOP enabled it, but now the liberals own it and are marching in lockstep right towards the concentration camps.

Now be good little Germans... er, Amerikans, and sing the praises of the bastard in the White House who is not one bit different in important actions from his predecessor. After all, I'm sure he'll give some uplifting speech soon (and then do the exact opposite thing, as usual).

P.S. With hundreds of felony violations revealed during Congressional testimony on Tuesday about the bankers, AND with the Attorney General of the United States being a direct subordinate of Obama, you have to ask "Where are the indictments?" And there are none, folks. None. Nada. Zip. Zero.

Actions speak louder than words. Watch what Mr. Charisma does, not what his lying tongue says.

Bigelow said...


Shouldn't the Racketeer Influenced and Corrupt Organizations Act be applied to the Democratic and Republican government?

...Could be a long wait.

Gravity said...

"The ultimate weapon to force private savings to fund governments will be capital controls. To support public debt to GDP levels not seen since the second world war, we are likely to see a return to similar forms of market constraints which were necessary in that era. The 'new normal' is not sub par economic growth. The new normal is the roll back of the free markets."

This might translate into a rollback of inalienable property rights and further authorization of centralised theft and extortion, then, likely degenerating into the wholesale confiscation of pensions. Could this theme also include limitations on withdrawals or the occasional bank holiday?
Generally, I don't think an ideal free market can exist at all under the monopolised money creation of banking cartels, nontheless, it seems obvious that cognitively captured governments, in desperate attempts to finance the unfinanceable, will increasingly produce restrictive and dysfunctional market policy for the belittled people, while simultaneously negating traditionally competitive market mechanisms by directly benefitting the largest financial entities, who will never be effected as much by said controls in their own dealings, while being assured of perpetual funding generated by plundering peoples properties.

jal said...

@ Greyzone

Your hatred of "ism" is obvious.

The enemy is debt.

Debt has won over all "the rules of law".

""Where are the indictments?" And there are none, folks. None. Nada. Zip. Zero."

Instead,you should ask, "Where are the innocent that can run things according "to the rule of law".

There are no "rule of law".
The laws were abandoned to prevent the savers from finding out that they had been fleeced by the middle men.

Tristram said...

OK, going overnight with a big short in Wells Fargo. Ready for the crash. Tap tap tap ...

The market doesn't seem to care, however, about employment, or foreclosures, or all that negative ninny stuff. All the news is good. I got a call today from a friend who said he has put $100K back in the market in the last month. "I'm bullish" he declared, having already mentally banked Apple at $300, Intel a double, and the indexes back to their pre-crash highs.

P.S. quote of the day from Nouriel Roubini: "Baby, you were great. Before you get dressed, would you mind sitting on this plaster?"

Bigelow said...


You may have to wait on WFC til Monday. Luck.

Gravity said...

After listening to Crawfords dire astromarketology predictions, I can't help but rewonder whether any existent transfer mechanisms that would allow such minute gravimetric pertubations to effect the affairs of men and markets would also require that capital is subject to gravity, such as in my favorite delusion, so that capital exhibits the property of having quantifiable invariant mass in addition to attaining relativistic mass, or if such a mechanism would merely require that the human mind and consciousness habitually exhibit fixed and transient masslike properties, perhaps by virtue of being composed of fractalined massive charged particles, thereby being conveniently susceptible to planetary movements at arbitrary distances. More plausible explanations not forthcoming, such nonsense would have to suffice if one is inclined to take these predictions seriously, if not, then still.

scandia said...

@Muagabe...what crash? CBC radio reports/interviews with TPTB and their PR agents have announced that the recession is over! Hurrah! It is now spoken off as that past recession and how silly we have all been to become fearful as this " past " recession wasn't even as bad as the 2 recessions previous to this past one. Well thank god for that eh? Furthermore the RE market was very strong in march, markets still hot in TO but balanced everywhere else...
I am so pissed off as I just about had a couple of friends thinking seriously about a change in life style/expectations. Damn!
Another pundit to-day said that the Ontario has a strong economy. Its as if deficits don't exist! And Ottawa has become cuckoo land with everyone denying they said anything about the disgraced cabinet minister who resigned but noone knows why.It's another state secret.Denial from the very mouths that spoke of booze, cocaine and influence peddling! I heard them with my own ears for " shitz sake!!! Absolutely crazy times....oh well as long as the good times roll back in who cares about truth and justice?
And to top off this newsworthy day my credit union(Desjardins) called this aft. to say my $1000 GIC is not the kind of business they want. I have to have a minimum of 5 grand now.Minimum term now one year. So much for customer loyalty that I expected from a credit union. Gotta watch those expectations.
Jeez...think I'll just take the cash.

Stoneleigh said...

There may be a talk in NYC added to the agenda for my trip to New York State. No details yet, other than that it would have to be on either the 22nd or 23rd of April. The 22nd would probably be better from my point of view.

Unknown said...

Remind me never to get driving directions from Greyzone, who is apparently unable to tell Left from Right.

I haven't seen the left-wing incitement of violence against the tea party that he describes. But if such leftist thuggery exists--and frankly, if Andrew Breitbart is riding this particular hobbyhorse, I suspect it doesn't--then those involved are dupes as well as thugs, if they're in fact working to advance Obama's fascist agenda.

Rather, what I see on the left is rage against Obama for making move after move that supports the corporatist agenda, in glaring contrast to his populist campaign rhetoric--and frustration with the right-wing Wurlitzer for duping useful idiots into thinking that Obama's service to the status quo is somehow socialism. (Or fascism. Whatever.)

And thus is an accurate but inchoate sense of something seriously amiss with society diverted into misplaced rage. Divide and conquer, and the looting can go on for just a bit longer.

Bigelow said...

“More plausible explanations not forthcoming…”

“Arch Crawford's Crawford Perspectives (down 7.2% according to the Hulbert Financial Digest compared to a gain of 27.10% for the dividend-reinvested Wilshire 5000 Total Stock Market Index), was the top performing letter in 2008. ( See Jan. 9 column.) It's famous for its astrology perspective, something that few Wall Streeters will admit to sharing, although it's actually not that uncommon.

Whatever. Crawford lost money this year -- not a lot, and it's really only 11th from the bottom, but I felt like including it. Crawford has had a checkered -- but by no means catastrophic -- career, and the letter probably should be credited with its strong medium-term record, up 6.95% annualized over three years against negative 5.73% annualized for the total return Wilshire 5000.”
Bottom 10 (OK, 11) letters of 2009

“What should be your response to Prechter's latest advice?

[…] has one of the best stock market timing records over the last two years of any that the Hulbert Financial Digest monitors.

On the other hand, Prechter's longer-term record couldn't be more different. The last time that his newsletter recommended that traders be long stocks was in 1997, some 12 years ago. In fact, during the bull market of the 1990s, traders following his advice spent most of the time short the market or in cash.

This helps to explain why the newsletter's timing advice for traders is in last place for performance over the last 20 years among all stock market timing strategies tracked by the Hulbert Financial Digest.”
Short term vs. long-term

jal said...

If the volcano continues for more than a couple of days ... consider ... black swan event

Ilargi said...

New post up.

Foreclosures will be the wrecking ball for the American economy.


scrofulous said...

" There's not nearly enough carping about him, [Obama] wish there would be much more,...."

Right on ilargi, lets carp on, Obama has stalled the collapse till who knows when! Chee my garden is in and I have stored as big a pile of dung as the mayor of my town.

Anonymous said...

Ilargi: Barring the courage to do that, I'd say get your nose out of the bankers' asses, demand the people's money back, apologize for all you've done and jump off a cliff.

William Wallace: Before we let you leave, your commander must cross that field, present himself before this army, put his head between his legs, and kiss his own arse.

Interestingly Ilargi's quote instantly reminded me of Wallace's quote. Brought a smile to my face! That aside the fit is lock and key... Same ole story same ole battle.