Thursday, May 6, 2010

May 6 2010: And out of the blue came the credit crunch

Lewis Wickes Hine And Harry met Sallie October 1908
"Grafton, West Virginia. Harry and Sallie. Driver in Maryland Coal Co. Mine near Sand Lick. Was afraid to be photo'd because we might make him go to school. Probably 12 years old."

Ilargi: It’s hard to keep track of which development is more exciting these days, isn’t it? American Idol without the bad vocals.

  • British elections? Ok, not that one, that’s for people more boring than I am bored. (This just in: It’s the Tories, but they’re short. Look for street fighting men)

  • Gulf of Mexico? Strong candidate, but the real impact will take a while to sink in (not good in times of instant gratification). When all the lying and posturing is done and gone, we can all try and connect our driving habits to a quadrillion dead birds, turtles and amoeba.

  • Greece? Yeah, sure, but nobody died there today that we can figure, so it’s a bit of an anti-climax. We were all sort of silently hoping that the cruel Spartans would take over in a brilliant and extremely violent flash, weren’t we? Or maybe even Alexander the Great, for that matter, as long as something TV news worthy that would outdo yesterday's three dead happened. Hey, well, maybe tomorrow, right?

  • So how about a 9.09%, 987 point, drop in the Dow? Well, yeah, that got tons of grown up male panties wettin' and -a-goin' for sure. Websites that couldn't be reached, dozens of emails in my inbox in minutes, the whole world’s expanded platoon of I-think-I know -something-you-don't, I’m-in-da-know thrillseekers was activated seemingly within milliseconds. Only to find out and prove to the planet that for once in his life, Jim Cramer was right. Thanks a zillion, boys, that's just what we needed.

And while you’re at it, give the man kudo's for what you didn't see: the Procter and Gamble number that humbled the markets down today was false from the beginning and all the way after that. And y'all ran with it. And so now you'll have to eat Cramer Crow. Good luck on that one. And next time, bring -even- more dry panties. When things move too fast for you to see, you got to take a step back. Nobody ever told you?

Here's the low point in that sequence, it lasted just a few seconds and went up like a space ship again after that:

That would have been something if it had stuck. It didn’t, though, and that was obvious from the get-go.

Still, however, market moves were significant. And none more than the plunge of the Euro vs the US dollar. I don't think that had much to do with Procter and Gamble either, for what it's worth. Europe's strongest members countries, Germany, France, Holland, have been on a course to bring the Euro down for months now, and they now get what they wanted all along. I still see little or no sign that people even begin to understand how important exports are in a world where the only money you don't have to borrow to quench your deficits will have to come from exports. The point is that in such a world it's neither good nor useful to have the strongest currency. Why else would China remain USD-pegged, for Mother Mary's sake??

Europe is posing and playing terribly weak, if you may believe the American and other English-language media, even some German papers chime in, if they're not outright dropping into the great-beyond abyss, but the thing is, that suits continental Europe just fine.

In "normal" times, a strong currency is the way to go. These are not normal times. I’ve called it beggar-thy-currency before, and that attitude stands. And Germany is winning. Here’s the 5 day chart:

Very hefty and all, but then there's the 5 year chart:

Just to show you that what happens to the Euro isn't moving any tectonic plates for now. It's not all that dramatic, nothing that can’t be overseen. At least not yet. One thing it does, though, is take any wind out of any sails of Obama's plans to double US exports within 5 years. That can't happen with a relatively strong US dollar, and the EU won't let the Euro rise again in the foreseeable future, not if they can help it.

And yes, Greece remains a weak spot and a talking point, And so do Portugal , Ireland, Spain, and, after the election, Britain. But then, so do California, Fresno, Oakland, San Diego, Los Angeles.

There's nothing unexpected in there. And there’s nothing about one region, one continent, being far worse off than another either. Forget about that. We're all Greece, and we’re all Latvia, and Detroit, and Jefferson County, and New Orleans, and LA. There's no winners, there's only losers, billions of them. OK, maybe there’s a few winners, Blankfein and Geithner and Obama and Sarkozy and Merkel and W and Putin and Wen Jinbao. But their victories are Pyrrhic in nature once what happened in Athens yesterday starts happening all over the place.

As Gerald Celente says: If people lose everything, and they have nothing left to lose, they lose it.

Don’t be blinded or focus too much on what happens in one single day. Especially if you’re focused on stock markets. Try to recognize the longer trend.

What goes on now is what we at the Automatic Earth have been saying all along would happen. What we see is a world (or a large part of it) that is deeply steeped in unprecedented debt, and that has its hopes to rise above the debt pinned on a fairy tale of unprecedented growth.

And then came the credit crunch.

What we have said hasn't changed even a notch in the past years. What we didn't see, just like professional forecaster Gerald Celente, is to what extent governments would use any and all taxpayer funds they could lay their hands on to postpone the inevitable. As I’ve said before, it’s not even that governments would try that’s surprising, it's that people accept it in silence. Except, that is, today, for those in Athens.

What we see today, in Greece and on Wall Street, is that the picture we have painted for a long time is ever more becoming a picture of people's daily life. More so right now for readers in Riga and Piraeus, granted (and we do have readers there), but they are just the front lines for what is going on all around us everywhere, and what will shape all of our lives.

There's no pitchforks or nooses that will prevent us from going down severely in living standards. All we have left when it comes to dealing with all this is grace. Which happens to be increasingly hard to find. Maybe someone will find a way to make money on that too: long pitchforks, short grace.

We’re never going to come back to where we once were. We’ll be forever much poorer than we were way back when. And we will have to figure out a way to deal with that, or we will be figured out for what we really are. And left to regret it.

Capital Markets May Face Deepest Crisis in 100 Years
by John Glover

Capital markets may be facing the biggest crisis in a century with governments all but powerless to ward off a sovereign debt disaster, according to Gary Jenkins at Evolution Securities Ltd. Investors greeted plans for a 110 billion-euro ($143 billion) bailout of Greece by shunning the bonds of Europe’s debt-ridden nations on concern the aid package won’t solve the country’s deficit crisis or prevent contagion. Credit-default swaps on Greece, Spain, Portugal and Italy surged and the euro tumbled. “The capital markets could soon be in the midst of the largest financial crisis of the last 100 years,” said London- based Jenkins, Evolution’s head of credit strategy.

“With government debt itself perceived to be the problem the potential for political and economic change is much greater.” While the bailout package reduces the “very real risk” of a Greek default, it doesn’t change investors’ view that the country’s debt will be restructured in the medium term, Jenkins said. The European Central Bank may be asked to buy government bonds should markets continue to tumble, he said. Such purchases would mean either buying bonds on the secondary market -- the more likely option -- or promising to finance Greece’s planned bond redemptions, or both, according to Padhraic Garvey, a strategist at ING Groep NV in Amsterdam.

‘Nuclear Option’
The ECB purchasing bonds “would be the nuclear option as it would taint the ECB both politically and in terms of its asset/liability mix,” Garvey wrote in a note to investors. “That said, if we approach the brink, it may just be the only viable option left. Only the ECB can print euros to save the system.” Other possibilities include governments forcing domestic investors to buy their bonds, or “for policy makers and Greek holders alike to cross their collective fingers and hope that some positive follow-through begins to dominate in the weeks and months to come,” Garvey wrote. 

The problem with doing nothing is that Portugal, Spain and Ireland risk being “dragged further into the Greek slipstream,” according to Garvey. “These are worrying times, and in fact more worrying than last week,” when the bailout package from the EU and the International Monetary Fund was in prospect, Garvey wrote. “This week, both of those items are now behind us and thereby in the price.”

Batten down the hatches for decade of austerity
by Mike Dolan

Greece's debt crunch, for all its peculiarly domestic and euro zone ingredients, should be an ear-splitting alarm call for Western governments faced with one of the biggest fiscal hangovers in history.

The scale of the task facing governments in the United States, Europe and Japan to return debt burdens to pre-crisis levels of 2007 could, by some estimates, usher in a decade of severe austerity through the teen years of the new century. For sure, the impact of this latest episode both for Greece itself and Europe's single currency will be profound. The budget squeeze needed to secure the 110 billion euro (94 billion pounds) bailout from its neighbours and the International Monetary Fund will inevitably shrink Greeks' standard of living and sorely test the social contract with their government. For the euro zone, the lack of a fiscal backstop for its one-size-fits-all monetary policy has been badly exposed and the delays in agreeing the rescue merely intensified the crisis. But while euro-sceptic voices may justifiably shout "I told you so", this is hardly the time for "schadenfreude".

Credit Crisis - The Sequel
For many, this is just a snapshot of "Credit Crisis, Part 2" -- a sequel to the 2007/08 shock to over-borrowed households and banks that required unprecedented government financial rescues and dramatic easing of interest rates and credit policy. Goverments effectively nationalised large chunks of the private sector debt burden in order to buy their economies time and prevent deep recession morphing into depression. Now those same governments are in another race against time to work off those debts -- treading a fine line between shock therapy to their domestic economies and alienating nervous global creditors. As Greece found out to its cost, the cat-and-mouse game with foreign lenders can be treacherous. Any market doubt about debt "sustainability" could see funding costs soar and trigger what some have termed a "death spiral" that feeds off itself.

But convincing creditors of debt "sustainability" is like convincing them you will survive a leap from a first floor window -- you might do, but no one's quite sure until you try. "After the recent collapse in fiscal positions, simply stabilising debt levels relative to GDP may not be enough to placate markets," JPMorgan economists told clients last week. "Perhaps a more reasonable path to 'sustainability' would be to reduce the levels of debt back to their pre-crisis levels over 10 years."

Decade Of Austerity
The JPMorgan economists said their calculations, while highly sensitive to growth and interest rate assumptions, showed the task ahead for the world's major economies was daunting. Because the scapel is unlikely to be taken to public finances in earnest before 2012, it worked out what primary budget surpluses -- which exclude debt interest payments -- would be needed in the major economies to cut 2013 debt -to-gross-domestic-product ratios back to 2007 levels by 2023. The upshot was the United States needed a sustained primary surplus of nearly 4 percent of GDP for 10 years to reduce a 2013 debt ratio of 101 percent back to 2007 levels of 62 percent. 

That compares to an estimated 2010 U.S. primary deficit of some 7 percent of GDP. To put it in some context, it would exceed the massive U.S. budgetary correction after World War Two when, according to IMF data, it took 17 years to 1963 get a bloated U.S. debt-to-GDP ratio of 108 percent back down to 1941 levels of 42 percent. In that correction, the primary balance averaged only 1.4 percent of GDP and was in surplus 14 of the 17 years. And this time around, governments have the added problem of an expected explosion of entitlement spending as the baby boomer generation starts retiring in droves over the next 10 years. It's not just the United States.

JPMorgan's calculations show Britain would need even bigger surpluses of up to 5 percent a year for 10 years to 2023 and Japan would need a whopping primary surplus of almost 7 percent of GDP by the same metrics. The euro zone as a whole -- despite big national variations obvious in the heat felt by Greece, Portugal and Spain -- needs a still hefty but more modest 2.7 percent primary surplus due to the more stable position of its "core" in Germany and France. One implication of all these numbers is official interest rates will likely need to remain as low as possible for as long as feasible both to control parallel debt servicing and to prevent spending cuts and taxes from clobbering the economy.

The Greek bailout gives us a glimpse of just what those measures might look like -- slashed pension benefits, salary freezes, extraordinary levies and steep sales tax rises. And while a Goldman Sachs study of big fiscal retrenchments since 1975 showed that leaning toward expenditure cuts rather than tax rises has been more successful in cutting debt, lifting growth and buoying markets, it rarely happens without a push. "Decisive expenditure-driven fiscal adjustments are politically difficult to implement and tend to take place only following a change in government and/or once bond markets force the government's hand," Goldman economists concluded. The Greek experience should be a powerful nudge for all.

Whether Oil Slick or Financial Crisis, Those Who Cause Catastrophes Should Pay
by Christoph Schwennicke

What do the oil slick in the Gulf of Mexico and the Greek crisis have in common? Both are man-made disasters. But while BP plans to shoulder the costs of the catastrophe it has caused, the financial wizards behind the euro crisis are not being held to account.

At the moment, two catastrophic waves are crashing on the world's shores. In the Gulf of Mexico, an oil slick of unimaginable size is sloshing onto the beaches of Florida and the conservation areas of Louisiana surrounding the mouth of the Mississippi River. And, in Europe, a financial tsunami is rolling over Greece and threatening to swamp the entire southern coast of the Continent.

In affected regions of the United States, a national state of emergency has been declared, and the military and the president are getting involved. In Europe, politicians hesistated before taking action -- and, in doing so, helped make the wave that threatens to drown the entire common currency even more monstrous.

Both of these catastrophes are man-made rather than acts of God, such as the volcanic eruptions in Iceland. And, in both cases, the principle regarding who pays the piper should apply: Whoever made this mess should be significantly involved in the effort and costs of cleaning it up.

In the case of the oil slick off the American coast, that principle is being followed -- and it doesn't even seem to be an issue up for debate. The victims of the spill -- in this case, the fishermen -- are suing BP because it was the explosion of that company's oil platform that caused the catastrophe. Likewise, BP is also paying for the involvement of the US Coast Guard and other specialists, who are doing everything they can to contain the spread of the massive oil slick. US President Barack Obama made this crystal clear when he visited the Gulf Coast on Sunday.

In the case of Greece, this principle isn't functioning quite as well. But why is it that something that is so clear-cut on the high seas is so controversial in high finance? These are the facts: Greece and Europe's other problem countries pursued bad economic policies and lived completely beyond their means despite the fact that they had pledged to do just the opposite when they signed on to join the euro zone. Given these actions, the EU and the other members of the euro zone are politely demanding -- and completely rightfully so -- that these black sheep set their houses in order.

It's about More than Greece and the Euro

To be clear, the principal blame for the financial crisis lies with those states -- and Greece, in particular -- that have been driven into or toward the crisis by their own inefficiency and corruption. For this reason, any idea that leads to stricter monitoring of them is justified. In the worst of cases, it must be possible to deprive an EU country of its voting rights if its proposed national budget doesn't satisfy the demands of stability. Moreover, when the abuse is serial, it would be desirable to curtail the offending country's right to set its own budget and see Brussels dispatch a "savings commissioner," for example, to serve as both an emissary and shadow finance minister.

At the same time, it's also true that speculators working at major banks around the world swarmed these ailing countries and downright harried them to death. Like gamblers at a horserace, they put wagers down on Greece, Spain and Portugal -- in this case, betting that the horse would stumble mid-way through the race. In essence, they bet against the euro.

In fact, the reasons for having the winners of this game help shoulder the costs brought on by its consequences are even more compelling than they are in the case of the oil catastrophe in the Gulf of Mexico. Politicians from various parties should not try to gain advantage by bickering about who addressed this matter earlier or more decisively, and perhaps they should even introduce some new taxes on the financial markets.

Indeed, there's more at stake here than political gain, Greece or even the euro. What's really at stake here is governments' monopoly on power. In democracies around the world, there's a growing feeling that politicians are powerless in the face of global casino capitalism. The world's politicians need to both clarify and show who's boss -- and who makes the rules.

Granted, it will be much harder to make a clear-cut and airtight case for major claims for compensation than it will be against BP in the oil catastrophe. The circumstances are more complex, and it will be harder to establish the individual guilt of the perpetrators. Moreover, there's isn't a legal forum that politicians can go before to sue the giants for compensation. And there isn't a pot that the damages could come from. Perhaps the mega-speculators and the investment banks should be forced to contribute massive sums to a type of reinsurance organization that can come to the rescue when these kinds of catastrophes happen.

Profit at Any Price

Since this kind of after-the-fact claim is so difficult, it is all the more important to act before it's too late. In other words, we need to get financial players on the hook as fast as possible lest something like this happen again. The fact is that their unchecked "Change nothing!" attitude after the "big bang" of almost two years ago is the real cause of this mess and must urgently be stopped up -- just like the wells that are still spewing up oil unchecked on the ocean floor off America. From the corner offices of the wizards of finance all the way down to teller counter of the rural savings & loan, the attitude has remained exactly the same: profit at any price.

The obscene mindset of people like Fabrice Tourre continues to hold sway in vast swathes of the financial landscape. The Goldman Sachs fixed-asset guru devised investment products knowing full well that it was extremely likely that they would see a massive loss in value -- and still sold them to customers. When questioned about his responsibility vis-à-vis his clients before the US Senate's Permanent Subcommittee on Investigations last Tuesday, Tourre said that he had no obligation to serve as an adviser to "highly sophisticated" clients, such as Germany's IKB bank. In other words: They should have known what they were paying for.

The staid bankers of yore have morphed into pushers who sell financial products that they don't back themselves as well as -- in ideal circumstances -- insurance for investors who want to short them. At a certain point, these bankers seem like nothing more than slick used-car dealers who unload clunkers re-painted to look like luxury sedans on clueless customers at an exorbitant price.

Waiting for Reform

Yet, a financial crisis was not supposed to be allowed to happen again. Almost exactly a year ago, German Chancellor Angela Merkel stood in the gaudy hall of a London hotel next to French President Nicolas Sarkozy and made a big song and dance about how leaders convened there for the G-20 summit urgently needed to hammer out and agree upon joint policies for regulating the global financial markets. That determination came in the wake of the first explosion on the global financial stage ignited by the collapse of Lehman Brothers. However, nothing concrete has happened since then. Not in London, and not at the subsequent summit in Pittsburgh.

And, now, we have the second explosion. And this time, it's not a bank that is in trouble. No, this time it's a country, and one whose potential collapse could precipitate a domino effect across Europe. How can any world leader be so narrow-minded as to want to fight against the rigorous and tight regulation of these dangerous financial business practices? Does any country really believe that its sheer size or better knowledge of how the industry works makes it more immune than other countries? If so, it is naïve. Everyone could be affected by the consequences.

The Need for Ruthlessness

Of course, we still have to dispel with the argument being made by banking lobbyists, namely, that if they are held monetarily accountable for the crisis in Greece, they might even collapse themselves. But this argument only holds water when it comes to the forthcoming emergency aid, and it can be taken into political consideration. The issue here is a contribution -- and not a contribution that bleeds the banks to death. What's more, in the end, they will profit from the funds they have made available because it increases the chances that they will get back the money they've lent to the Greek government.

But when you move away from the issue of this emergency aid and toward the issue of the stricter regulation of international financial markets, this argument doesn't hold water either. If everyone is facing the same new restrictions, everyone's ability to compete should remain the same.

Big companies both enjoy the opportunities and assume the risks of their operations, whether they be on the high seas or in the financial markets. Chances are that the oil disaster and its astronomical costs will endanger BP's survival, just like the horrific tanker accident off the coast of Alaska 21 years ago threatened its competitor Exxon.

When it comes to their dealings with players in the financial markets, European politicians must be as hard-nosed as President Obama has been with BP. If you cause a catastrophe, you should have to pay for it -- even if it pushes you to the precipice. It can't be that those who cause catastrophes can use their alleged "systematic" importance to justify carrying on with business as usual and that governments around the world put their clean-up efforts on hold.

There's a lesson to be learned from the Exxon Valdez disaster from 1989: The oil company has been making a tidy profit for years, but the fishermen in Alaska are still waiting for the fish to return.

UK budget deficit 'to surpass Greece's as worst in EU'
by Katie Allen

The UK budget deficit will swell this year to overtake Greece, becoming the worst in the European Union, the European commission said today in a stark warning on the eve of the election. The commission's spring economic forecasts put the UK deficit for this calendar year at 12% of GDP, the highest of all 27 EU nations and worse than the Treasury's own forecasts. The country's budget shortfall was the third largest in the EU last year but will overtake both Greece and Ireland this year, according to the forecasts. Greece's measures to tackle its public finances problems are seen cutting the deficit there to 9.3% of GDP.

Worries about Britain's public finances – in their worst state since the end of the second world war – continue to unnerve financial markets and analysts are divided over whether a hung parliament will have the clout to rapidly reduce the deficit. "The first thing for the new government to do is to agree on a convincing, ambitious programme of fiscal consolidation in order to start to reduce the very high deficit and stabilise the high debt level of the UK," said European economic and monetary affairs commissioner Olli Rehn. "That's by far the first and foremost challenge of the new government. I trust whatever the colour of the government, I hope it will take this measure."

The deficit forecasts are an improvement on the commission's last outlook for the UK but they still paint a gloomier picture than the government itself. In financial year terms, the commission's forecasts are for a worse deficit than predicted by Alistair Darling at his March budget. In 2010/11 the commission puts the deficit at 11.5% of GDP, compared with Darling's forecast for an 11.1% ratio of public sector net borrowing – the gap between tax and spending – to GDP.

The EU's executive did double its forecast for UK growth this year to 1.2% from 0.6%, in line with a March budget forecast for 1-1.5%. But in 2011 it warns growth will only pick up to 2.1%, significantly below a Treasury forecast of 3-3.5%. It described a "a slow start to a protracted recovery", highlighting pressures on private consumption, a key growth driver, from employment worries and stagnant wages.

Freddie Mac Asks for Another $10.6 Billion
by Nick Timiraos

Freddie Mac says it will need an injection of $10.6 billion from the U.S. Treasury after posting a $6.7 billion loss for the first quarter, as the weak housing market continued to burn a hole in the company's balance sheet. Freddie, which had a loss of $9.8 billion a year earlier, said that the brunt of its losses resulted from accounting changes that took effect Jan. 1 and brought some $1.5 trillion in mortgage guarantees onto its balance sheet.

Freddie Mac and its larger sibling, Fannie Mae, were taken over the by the government in 2008 through a legal process known as conservatorship. The government has said it would put unlimited amounts of capital into the companies to keep them afloat over the next three years. Freddie's request for more aid, its first in three quarters, will bring the government's tab for both companies to $136.2 billion. Freddie has lost $82 billion over 10 of the past 11 quarters, or nearly twice the amount it earned in the previous 30 years. But there are some early signs that a more stable economy could stanch losses. The number of loans that were 90 days or more delinquent at the end of March fell to 4.13% from 4.20% in February, the first monthly decline in over three years.

"Though more needs to be done, we are seeing some signs of stabilization in the housing market, including house prices and sales in some key geographic areas," said Freddie Mac Chief Executive Charles E. Haldeman, Jr. in a statement. The ongoing effort by the federal government to help troubled borrowers modify their mortgages has slowed down the foreclosure process, and analysts say that has made it harder to judge whether the worst has passed for the housing-finance giants.

The earnings report came as Republicans introduced a measure that would end within two years the government conservatorship of the companies, placing them into receivership, a form of bankruptcy restructuring, if they weren't viable. While the amendment would appear to face an uphill battle, it could force Democrats to take a politically dicey vote. Introduced by Sen. John McCain (R., Ariz.) as an amendment to the financial-regulatory bill before the Senate, the measure would sharply reduce the companies' mortgage holdings over the next three years. It would also repeal expanded limits that have allowed the firms to buy larger loans in high-cost markets and would set new down-payment standards for loans the companies can buy.

Republicans have increasingly argued that the financial-regulatory bill isn't addressing one of the key contributors to the housing collapse, but the Obama administration says it would rather deal separately with Fannie and Freddie next year once housing markets are more stable. Analysts have warned that the longer the companies are used to provide mortgage credit, the harder it will become to wean the country from those subsidies and to revamp the firms. "We need to reform them," says Christopher Mayer, a professor of finance and economics at Columbia Business School. "But if we were to just pull them out ... that would be really dangerous. Swaths of the country would get hammered because there's no credit for housing."

The current financial-regulatory bill "is already fiendishly complicated," says Karen Shaw Petrou, an analyst at Federal Financial Analytics. "There's no denying that Fannie and Freddie need ultimate resolution ... but because markets are so fragile, one needs to be really, really careful."

Goodbye, stimulus. Hello, state budget cuts
by Tami Luhby

Think states have made deep spending cuts? You ain't seen nothing yet. States have been struggling with huge budget gaps since 2008, but this year could be worse as federal stimulus funds wind down. Until now, stimulus money spared governors and state lawmakers from making some of the most brutal budget cuts. But with this lifeline running out, officials are looking at making significant cutbacks to public services, particularly schools and health programs. "The stimulus funds have staved off what could have been even deeper cuts," said Todd Haggerty, policy associate at the National Conference of State Legislatures. "You're seeing states now are coming to that point where they will have to make additional cuts or find new sources of revenue for fiscal 2011 and that will continue in fiscal 2012."

Stimulus safety net
As of mid-April, states and localities have received nearly $109 billion since the American Recovery & Reinvestment Act was passed in February 2009, according to the U.S. Government Accountability Office. The vast majority of that money went to help states maintain their Medicaid services and education funding in the face of steep drops in tax revenues due to the recession. In all, the stimulus funds helped plug between 30% and 40% of the $291 billion in budget gaps that states have faced over the past two years, experts said. But Recovery Act money will only be sufficient to plug 20% or less of the coming fiscal year's shortfalls, according to the Center on Budget and Policy Priorities. By fiscal 2012, most of the money will be gone. Already, many states will have used up much of their education allotments by the start of fiscal 2011, which begins on July 1 in 46 states. And the Medicaid assistance will dry up by the end of the year, unless Congress extends it.

What'll they tax next?
Compounding the problem is that many states have already slashed services and raided their rainy day funds to balance their budgets, as they are required to do. And a recent analysis by the Rockefeller Institute shows that the all-important personal income tax revenue for April is likely to decline steeply. All this means that state officials are being forced to make some of the tough decisions they've been able to put off for the past 18 months. "States had this one-time money that helped them bridge a difficult period in state finances," Haggerty said. "Now they have to face the absence of those funds and a whole new set of difficult issues."

Cuts on the horizon
Meanwhile, states are looking to Capitol Hill to renew some of the stimulus provisions, particularly the increased federal funding for Medicaid. Both the Senate and House have passed a six-month, $25 billion Medicaid extension, but they have to find a way to pay for it before sending it to President Obama for his signature. At least 21 states, in fact, have already included the extension in their fiscal 2011 budgets, according to the Center on Budget and Policy Priorities. If the measure doesn't become law, these states would be in big trouble and would have to make even deeper cuts, said Nick Johnson, director of the center's state fiscal project. In Pennsylvania, for instance, that extension translates into $850 million.

Without it, the state would have to slash half its funding for domestic violence and rape crisis services and chop 25% off the budget for child welfare services, Gov. Ed Rendell wrote in a letter last month to his state's congressional delegation. In addition, state payments to hospitals, doctors and nursing homes would be reduced. "If the extension of federal fiscal relief is not enacted, most states will have to lay off thousands of workers and make wrenching cuts to public and private sector services," he said. School districts, meanwhile, are also feeling the pain. Some 275,000 education jobs could be eliminated in the coming school year due to budget cuts, according to a new survey by the American Association of School Administrators. This would nearly wipe out the estimated 300,000 jobs saved by stimulus funds. 

"Faced with continued budgetary constraints, school leaders across the nation are forced to consider an unprecedented level of layoffs that would negatively impact economic recovery and deal a devastating blow to public education," said Dan Domenech, executive director of the association, which is pushing Congress to give states additional funds for education. Take New York as an example. Some 14,800 teachers -- 8,500 of them in New York City -- could lose their jobs if Gov. David Paterson's proposed $1.4 billion cut in state education aid is enacted, according to a survey by the New York State Council of School Superintendents and the New York State School Boards Association. That represents 10% of the city's teachers and 4.1% of educators elsewhere in the state. (Some school districts have negotiated concessions from their unions that will save some jobs.)

 Another 2,600 non-teaching staff, including student support staff, administrators, and other employees, such as custodians, kitchen workers and bus drivers, would also be laid off. Stimulus funds had staved off some of these harsh cuts. But New York only has $700 million left of the $2.7 billion it received to prop up education aid, said David Albert, spokesman for the school boards association. "This is the largest state aid cut we've seen in the last two decades," he said. "If you think this year is bad, next year is going to be worse because stimulus will run out."

Los Angeles on the Brink of Bankruptcy
by Richard Riordan and Alexander Rubalcava

Los Angeles is facing a terminal fiscal crisis: Between now and 2014 the city will likely declare bankruptcy. Yet Mayor Antonio Villaraigosa and the City Council have been either unable or unwilling to face this fact. According to the city's own forecasts, in the next four years annual pension and post-retirement health-care costs will increase by about $2.5 billion if no action is taken by the city government. Even if Mr. Villaraigosa were to enact drastic pension reform today—which he shows no signs of doing—the city would only save a few hundred million per year. 

Los Angeles's fiscal woes can be traced to two numbers: 8% and 5,000. Eight percent has been the projected annual rate of return on the assets in Los Angeles pension funds. Four years ago, we strenuously warned Mr. Villaraigosa of the dangers behind the myth of that 8%, only to be told by the city controller's office that our warnings were "based on faulty assumptions which are largely disputed."

How faulty were our assumptions? Over the last decade, the two main pension funds in Los Angeles have seen their assets grow at just 3.5% and 2.8% annually. Five thousand is the number of employees added to the city's payroll during Mr. Villaraigosa's first term as mayor. According to California's Economic Development Department, when Mr. Villaraigosa took office there were 4.73 million jobs in Los Angeles and 252,000 unemployed people. Today, there are just 4.19 million jobs in Los Angeles and over 632,000 unemployed people. The mayor can't control the economy, but he could have chosen to control spending to keep the size of government proportional to the size of the local economy. Instead he's done the opposite: squeezing the city's productive workers to fund the salaries, pensions and other benefits of government workers.

How have city leaders responded to the crisis? Pension officials have played accounting games, like smoothing the investment return over seven years rather than five years. This is designed to dilute the near-term effect of the financial meltdown at the expense of much higher payments later. The City Council, wincing at the mere thought of layoffs, chose to shrink the work force through an early retirement program for city workers. This costly program, suggested by union leaders, will not be paid off for 15 years. And most egregiously, rather than laying off employees, city officials have shifted certain workers to agencies like the Department of Water and Power and the airport, which have their own funding. 

In order to pull the city back from the brink and put Los Angeles on the road to recovery, the following steps must be taken:
  • Defined benefit pensions must be replaced with 401(k) accounts for new employees.
  • Current employees must pay much more than 6% (or 9% in the case of public safety employees) of their salaries for their pension benefits. At a time when the city is contributing over 25% of payroll to the pension funds, this is only fair.
  • Increase the retirement age to 65.
  • Reduce city staff back to 2005 levels. Since the police and fire departments represent more than 80% of the city budget, they must also be forced to run more efficiently.
  • Eliminate the $300 million spent on costly retiree health-care benefits. City workers who retire before they are eligible for Medicare enjoy health insurance subsidies up to $1,200 a month, courtesy of Los Angeles. 

We can no longer afford to subsidize these Cadillac plans. As a result of his delays in responding to the city's fiscal emergency, Mr. Villaraigosa has squandered not just his career, but his relevancy. He continues to insist that bankruptcy is not an option for Los Angeles even as anyone who can count understands there is no other option. Meanwhile, Los Angeles is still the best place to live—ask anyone who enjoys its beaches, mountains and climate. If the mayor wants to keep it this way, he'd better act now.

Mr. Riordan is a former mayor of Los Angeles. Mr. Rubalcava is the president of Rubalcava Capital Management, an investment advisory firm.

Oakland faces pension costs, higher taxes
by Matthai Kuruvila

Oakland voters will likely be asked in November to approve higher taxes to halve a $42 million deficit, but even if they agree, the city will face an even deeper crisis within months. Ballooning pension costs will push the city's projected deficit to $58.7 million by July 2011. The biggest portion of that budget shortfall is a debt payment of $43.9 million due July 1, 2011, to the old Police and Fire Retirement System. The payment would be more than 10 percent of the roughly $400 million city budget.

The looming crisis prompted great concern at last week's meeting from two council members, Pat Kernighan and Ignacio De La Fuente. When the council refused to ask staff to prepare a report on the impending budget woes, the typically mild-mannered Kernighan did not restrain herself. "If that doesn't happen, you guys are crazy and irresponsible!" she exclaimed. Kernighan said voters will not approve an $18.2 million public safety parcel tax, which would require a two-thirds vote, if they understand that the budget problem will only worsen later. The council is considering placing the parcel tax and a $2.4 million utility users tax, which would require a majority vote, on November's ballot to help reduce the $42 million deficit projected for the fiscal year that begins July 1.

Single biggest issue
The costs of benefits to retirees appears to be the single biggest issue facing Oakland. Not only are the costs growing, but the city has not been funding them adequately, some council members said. Last year, Oakland was supposed to pay $85.7 million for retiree medical care, according to a city staff report. But the city only paid $12.5 million, the report said. "This is not sustainable," said De La Fuente. "There's no way that those things can continue."

Part of the city's problem is that tax revenues - including sales, hotel and real estate taxes - have been plummeting. The other is that the investments that undergird the pension system have lost much of their value during this recession. But the scale of benefits are fixed. The Police and Fire Retirement System, at the center of next year's budget woes, is one of the pension funds that is threatening to swamp the city's budget. It was created for police and fire employees hired before July 1976. There's only one active employee eligible for the system and 1,194 retirees or spouses receive those benefits. The plan pays up to 66.7 percent of salary. The salaries, however, aren't based on pay from the 1970s or '80s. Instead, they're based on current pay.

Current pay
"If you were a captain who worked the graveyard shift, your pension would go up if the salary of a captain working the graveyard shift goes up now," said City Administrator Dan Lindheim. This generous pension system, known as PFERS to city officials, was approved by Oakland voters in 1976. "PFERS is locked in stone," Lindheim said. "It's impossible to change." But the recession has bludgeoned the pension's investments. Between July 2007 and July 2009, the PFERS fund lost $219 million - or 38 percent of its value.

Adding to the city's woes is that in 1997, Oakland issued a bond that relieved the city from using its general fund to pay its PFERS obligations. But that break ends July 1, 2011, at which point the city will have to pay PFERS from the general fund. City staff have proposed a solution: issue another bond. But that idea has some council members concerned. "We want to make sure that that proposal doesn't push this off to the future so future residents don't have to pay for it," Councilwoman Jane Brunner said in an interview. Police and fire unions point to the millions they've already volunteered in pay and holiday concessions last year.

Nonetheless, De La Fuente sees no option but to ask the police and fire unions, who have closed contracts, to voluntarily start changing the pension system. He wants a two-tier system, where new hires get lesser benefits. In addition, police are currently the only city employee group who do not contribute to their pension. Firefighters contribute 13 percent of their salaries, nonsworn city employees contribute 8 percent. "I believe that it's in their best interest to control the costs," said De La Fuente.

San Diego sues its pension system
by Craig Gustafson

Workers may help pay for investment losses

The city of San Diego is suing its retirement system in a dispute regarding how much financial responsibility, if any, city workers should bear for a pension deficit topping $2 billion. If successful, the lawsuit could lead to city workers helping pay for the pension fund’s investment losses rather than the current practice of having taxpayers make up for any deficiencies. The potential taxpayer savings have been estimated at $40 million for the fiscal year that begins July 1. The lawsuit is based on City Attorney Jan Goldsmith’s interpretation of the city charter. He says that document, essentially a city constitution, states that the city and its employees shall contribute “substantially equal” amounts to pension obligations each year.

Labor leaders strongly disagree with Goldsmith and say his theory runs contrary to how past city attorneys have interpreted the charter for decades. They fear that Goldsmith’s reading could result in lower-level workers being hit with an extra $4,000 bill for their pensions in years when investments slump. The City Council unanimously approved the lawsuit in closed session last week, and Goldsmith filed it Monday in Superior Court. He is asking Judge Joan Lewis to force the San Diego City Employees’ Retirement System to increase employee contribution rates so workers will pay what he says is their fair share of $80 million. That is the portion of this year’s $232 million city pension payment that Goldsmith estimates can be attributed to investment losses.

The lawsuit comes after Goldsmith asked the pension board to adhere to his interpretation of the city charter when setting contribution rates last month. Board members declined his request, saying they read the charter differently. Goldsmith said the board is, in essence, imposing a burden on taxpayers without proper authority. The city and unions have to agree to any terms other than an even split, he said. “We can’t have the pension board rewriting our charter, and that’s essentially what they’ve been doing,” he said. “This isn’t about sticking it to anybody; this is about enforcing what the charter says.”

Mark Sullivan, the pension board’s president, said he was surprised by the lawsuit. He said the pension system’s staff will gather today to review the lawsuit before responding. Frank De Clercq, head of the firefighters union, said he is disappointed that another pension issue is headed for court. He said it would be easier if the council passed an ordinance to define exactly what is meant by “substantially equal” in the charter. Representatives for three of the city’s largest unions — representing police, white-collar and blue-collar workers — did not return calls for comment Tuesday.

The pension fund requires annual contributions from the city and its workers in order to pay current and future retiree benefits. Through past labor deals, the city has typically paid its half as well as a portion of its employees’ contributions. The city’s annual payment and the contribution rate for employees are set by the pension board each year, based on an actuarial evaluation that includes the prior year’s investment performance.

Councilman Carl DeMaio, an advocate for pension changes, said the potential for increased contributions from workers — and, in turn, less take-home pay — could push unions to the bargaining table and lead to benefit reductions that lessen the burden for taxpayers. “We’ve been pursuing pension reform from a number of angles, and I don’t believe that you ever are going to find a silver bullet to undo the city’s pension mess, but this is one of the arrows in the quiver,” he said of the lawsuit.

At an April 16 pension hearing, attorney Ann Smith, who represents the Municipal Employees Association, the city’s largest union, said the interpretation made by Goldsmith would have devastating effects on city workers if applied. “The idea that you would collect in one year from an employee what investment losses might be is a construct that is totally ludicrous and not at all consistent with any of the guiding principles for this system or the guiding principles of law,” she said. The judge is expected to rule on the issue before the city makes its annual pension payment July 1.

San Diego City Charter
“The city shall contribute annually an amount substantially equal to that required of the employees for normal retirement allowances, as certified by the actuary, but shall not be required to contribute in excess of that amount, except in the case of financial liabilities accruing under any new retirement plan or revised retirement plan because of past services of the employees.”

Pension Payment By The Numbers
$232 million: San Diego’s pension payment due July 1
$80 million: portion of payment attributed to investment losses
$40 million: portion of those losses that the city wants employees to pay
9,000: number of unionized employees who could be affected

Long-Term Unemployment: 80 Percent Of Americans Jobless Last Summer Still Out Of Work
by Arthur Delaney

Just one in five people who were out of work last summer have found jobs since then. Of more than a thousand unemployed people surveyed by Rutgers University researchers last August, just 21 percent had landed a job by March, a followup survey reveals. Two-thirds remained "unemployed" according to the government's definition -- the rest gave up looking for work altogether, either going to school or retiring early. "It's a pretty grim study," said Cliff Zukin, one of the authors of the report at the John J. Heldrich Center for Workforce Development at Rutgers. Here's how this grim finding looks graphically:

Of the people who found work, only 13 percent found full-time jobs, and 61 percent said their new gig was just "something to get you by while you look for something better." Seventy percent have been looking for work for longer than six months, the survey found -- up from 48 percent in the summer. (In March, the number of people out of work for that length of time increased by 414,000 month to 6.5 million, representing 44.1 percent of all unemployed.) To cope, 70 percent dipped into retirement funds, 56 percent borrowed money from family or friends and 45 percent turned to credit cards. Forty-two percent skimped on medical care, 20 percent moved in with family or friends and 18 percent visited a soup kitchen. "The cushion's completely gone," said Zukin. "I think we're looking at more cutting the core... It's a much deeper economic gash this time."

But while the employment situation has worsened, feelings have muted. In August, the intensity of people's distress was the salient thing. For instance, 79 percent of the unemployed described themselves as "stressed" -- that number dropped to 49 percent in March. There was a similar drop in people describing themselves as depressed, anxious, helpless, angry, hopeless, hopeful or motivated. "My guess is that it's harder to sustain that emotion, which is based on upheaval, as it becomes normal to you," said Zukin (who stressed that he is not a psychologist). "So they're dealing with it better. Being unplugged for a long time makes you make your piece with it." Long-term unemployment is even worse for people over 50, only 12 percent of whom found jobs since August. One of the survey respondents explained a common view of jobless folks over 50: age discrimination is to blame.

"Although there is nowhere on a CV/resume that you state your age, employers can tell how many years you have worked," the person wrote. "I have been interviewed for positions requiring experience by managers more than half my age, and they can barely contain their disdain -- despite the fact that my work experience is far greater than theirs." Unemployment for people over 55 has surged by 331 percent over the past decade, according to the AARP. Age-discrimination complaints to the Equal Employment Opportunity Commission office have been higher since the start of the current recession than in any previous two-year period.

Gerald Celente: One Sane Voice
Celente predicts wars and much other mayhem.

Audio only, but an absolute treat for the not-too faint of heart.

  • If people lose everything, and they have nothing left to lose, they lose it

  • All the debt is just digital money not worth the paper it’s not printed on

Still, Celente sees a way out: buy a candle for your loved ones, but make sure you buy a candle from a local candle maker at a local store.

The $2.3 Trillion Garage Sale
by Daniel Gross

Having waged a battle against financial mayhem for the last two years, the Federal Reserve is tentatively declaring victory. As it guaranteed debt and swapped cash for all sorts of assets, the Fed's balance sheet grew—from about $850 billion in assets before the crisis to about $2.3 trillion this spring. The binge included the purchase of $1.25 trillion of mortgage-backed securities issued by Fannie Mae and Freddie Mac. But in testimony to Congress in March, Federal Reserve Chairman Ben Bernanke said the purchases were coming to a close and that the Fed was now seeking to lessen its burden. The Fed is now discussing how to sell off these new assets.

The prospect of the Fed dumping hundreds of billions of dollars of bonds and mortgage-backed securities onto the market has unsettled some market watchers. But they shouldn't worry—too much.Each week, the Fed's H.4.1. publication gives a snapshot of the Fed's balance sheet. Table 10 provides the headline number: $2.334 trillion on April 28, down $7.1 billion from the week before. The Fed, for example, has $90 billion tied up in investments related to stricken insurance company AIG—loans to the company, preferred stock in two AIG subsidiaries, and Maiden Lane II and Maiden Lane III, the vehicles created to remove toxic assets from AIG's balance sheet. But as I documented in a recent column, that's all on a glide path to going away. The closing of the sales of Alico and AIA will return $50 billion to the Fed, and the Maiden Lane vehicles are generating sufficient income to pay down the debt extended to them—and then some.

Meanwhile, many of the market and asset guarantees that the Fed put into place in '08 are expiring. At its peak, the commercial paper funding facility, which guaranteed short-term corporate debt, held more than $300 billion. Now its balance is down to zero. The Term Asset-backed Lending Facility, or TALF, which was started in late 2008 to revive the market for loans backed by assets like car loans and credit card receivables, is closing to new business in June. TALF's balance stands at $45.3 billion, down from more than $48 billion in March. Why? Some of the three- and five-year loans guaranteed by TALF have already been paid off. This balance should shrink to zero by 2013.

The Fed's balance sheet will also diminish as bonds that it has acquired mature and pay off. The Fed, in the past year, bought some $169 billion in corporate debt issued by Fannie Mae and Freddie Mac. (This is debt backed by the company's credit, not by its mortgages.) About $44 billion of those bonds, or 25 percent of the total, mature in the next year.

The largest single item on the Fed's balance sheet is the $1.1 trillion in mortgage-backed securities it has acquired since the meltdown began. These are bonds issued by Fannie Mae and Freddie Mac and guaranteed by the U.S. government. The Fed has signaled that its buying campaign is over. And while the mortgages backing these bonds don't mature for 15 to 30 years, many of them will be disappearing from the Fed's balance sheet in the near future as people pay down, prepay, refinance, and sell homes. An informed analyst might presume that some $200 billion of that portfolio will mature or be paid down by the end of 2011. And as those bonds disappear, the Fed is not replacing them with new ones.

The last large item is $776 billion in U.S. Treasury securities, which have traditionally been the core holding of the Fed. (Before Bear Stearns went under, the Fed had about $713 billion in such securities.) As was the practice before the crisis started, the Fed rolls over maturing government debt into new government debt.

The bottom line? The Fed wants to get the junk off its balance sheet and return to a situation in which it has about $1 trillion in assets, the lion's share of them in the form of government bonds. To do so, it will need to rid itself of about $1.3 trillion in assets. That's a lot. But when you add up the components of the balance sheet that are shrinking, the task doesn't seem quite as daunting. By the end of 2011, by my rough calculations, at least $300 billion of the Fed's current assets will be gone with a substantial additional amount on the way out—and all without the Fed having to stage a huge sale of assets.

The Fed will be left with a large portfolio of government-guaranteed mortgage-backed securities and the difficult chore of weaning the economy off its diet of rock-bottom interest rates. Ben Bernanke and his colleagues have a long way to go in deleveraging. But if the broader economy and markets cooperate for another few quarters, a few miles may be shaved off the Fed's debt-reducing marathon.

The U.S. Trade Gap Won't Go Away
by Peter Coy

The U.S. trade deficit shrank like a puddle in the hot sun in 2008 and 2009 as appetite for imports melted in the recession and Asian export markets grew. With the U.S. economy now improving, the gap is widening again, dashing hopes that the U.S. is anywhere close to rebalancing trade with the rest of the world. On Apr. 30 the Commerce Dept. announced that the economy grew at an estimated annual rate of 3.2 percent in the first three months of the year, propelled by stronger consumer spending and business investment. The bad news is that a lot of that consumption and investment went for imports. While exports grew at a 5.8 percent rate, imports grew at an annual rate of 8.9 percent. Overall, the trade deficit nicked 0.6 percentage points from the growth rate.

The broadest measure of the trade deficit peaked in 2006 at just over $800 billion, or 6 percent of gross domestic product. (These numbers describe the current account, which includes trade in goods and services as well as cross-border investment income.) By 2009 it was a little more than $400 billion, just under 3 percent of GDP. But by the second half of 2009, the gap had already come off its bottom—rising 18 percent from the second to the fourth quarter. "We would expect [the trade deficit] to grow a little bit faster than the overall economy," says Ethan Harris, chief economist at Bank of America Merrill Lynch.

The quick resurgence shows that the recession didn't reduce U.S. overdependence on imports; by permanently closing many factories, it probably helped hollow out the U.S. economy, making it harder to balance trade. As General Electric Chief Executive Officer Jeffrey Immelt said in a recent speech, China is likely to surpass the U.S. in manufacturing output in the next few years. "In Reagan's time, America was the world's biggest exporter by far," said Immelt. "Today, we're fourth."

Growth Handicap
The problem with a big trade deficit is that it adds to the debt of the U.S., already the world's biggest borrower. It also saps growth, because U.S. consumer demand is being met by foreign rather than domestic production. "Americans won't have jobs," says Peter Morici, a University of Maryland economist. Industrial America's plight can be encapsulated in a few incredible numbers. According to the Bureau of Labor Statistics, U.S. employment in manufacturing over the past six months has been the lowest since March 1941, before the U.S. entered World War II. The March total was a little under 11.6 million workers, down 19 percent in just the past five years.

Productivity advances account for some job reductions, but that's not the whole story: Manufacturing's share of GDP shrank from 25 percent in the 1960s to 15 percent in 2000 and just 11 percent in 2008, according to data from the Commerce Dept.'s Bureau of Economic Analysis. Many of the most powerful U.S. manufacturers produce their goods for foreign customers in overseas locales, which does nothing to shrink the trade deficit. General Motors is going gangbusters in China, where it announced that it's on track to reach its target of 2 million annual vehicle sales four years ahead of schedule. Most of those GM cars, however, are made in the mainland. Likewise, Eaton, the Cleveland-based equipment maker, gets 55 percent of its sales outside the U.S. Spokeswoman Kelly Jasko says, "Our philosophy is to manufacture in the zone of currency."

Exports' Rise Surpassed By Imports'
True, manufacturing is rebounding from its recession trough, and exports are growing. They rose 14 percent in the 12 months through February. David Huether, chief economist at the National Association of Manufacturers, says "the idea that we don't have the capacity to sell product overseas is off base" and predicts that trade is "going to be one of the durable bright spots for the next [few] years." Exports of scrap iron and steel have more than doubled from 2005 to 2009, with more than one-third going to China. On Apr. 26, Caterpillar announced a swing to a first-quarter profit from a year-earlier loss thanks to improved conditions, "particularly in the developing economies."

Still, brisk growth in China, India, and other Asian nations isn't triggering purchases of U.S. goods as strongly as it might. That's because much of the growth in Asian trade is within the region, says Frederic Neumann, co-head of Asian economics research for HSBC in Hong Kong. Europe, a more receptive market for the U.S., is weak. Rising imports are the other culprit. Imports for the 12 months through February grew faster than exports, increasing 21 percent. In the first two months of 2010, the U.S. bought nearly $15 billion worth of advanced technology products such as computers from China, but sold China only $3 billion in high-tech goods, according to Commerce data.

Higher oil prices exacerbate the U.S. trade deficit. Yet even in volume, U.S. imports of all goods will grow nearly as much as exports this year, estimates Michael Englund, chief economist of Action Economics in Boulder, Colo. He concludes: "This [trade deficit] doesn't seem to be a problem that's entirely self-correcting."

The bottom line:

A large economy like the U.S. needs a manufacturing base to be an export power. That source of strength seems to be fading.

Moment of Truth for U.S. Productivity Boom
by Justin Lahart

As the long recession lifts, American businesses are grappling with a big question: Are we working smarter, or simply working harder? The answer will say a lot about the strength of the economy in the coming years. Fearing for their jobs, American workers are scrambling to produce more for every hour of work. Call it the hustle factor. At the same time, new machinery and new ways of doing things are boosting productivity. Call it the brain factor. Both forces are at work: Productivity in the fourth quarter 2009 rose 5.8% from a year earlier, the biggest jump since 2002. Unlike recent downturns, when productivity shrank and then rebounded, it kept growing throughout most of the past recession. Now the question is whether the biggest gains have come from hustle or brains.

An important indicator comes Thursday when the Labor Department releases first-quarter productivity figures. Economists polled by Dow Jones Newswires estimate productivity rose at a 2.5% annual rate, less than half its 6.9% growth rate in the fourth quarter. Most economists think it will be harder to sustain gains built on working harder. If productivity slows over the coming quarters—say, falling back closer to its 50-year average growth rate of 2.1%—it has big implications. Lower productivity actually should reduce short-term unemployment because companies have to hire more workers to do the same amount of work.

It's a different story over the long run. One reason the U.S. enjoys a high standard of living is that its workers have historically been among the world's most productive. They make more goods and services per hour than workers in most other countries—and get higher wages in return. If productivity growth slows here, wage growth is likely to be anemic. "I think that most of this [productivity increase] is temporary and it's particularly dramatic because a lot of people were scared," says Dale Jorgenson, a Harvard University economist who expects productivity growth to slow to 2% over the next year.

Some of the productivity gains experienced by K&S Tool and Manufacturing in High Point, N.C., are almost certainly temporary, says Joe Hughes, who helps run the company his father started out of the family garage in 1974. K&S, a machine shop, makes everything from roll bars for forklifts to components for giant electric motors. The recession wasn't kind to it. The company had about 100 employees in mid-2008, but had cut back to about 60 by April 2009 as customers slashed orders. Business is now picking up. And the payroll has edged up to about 70 workers. But the company is only adding workers when absolutely necessary, opting instead to handle increases by getting more work from existing hands.

Much of the company's productivity gain comes from changes in the way people work—rather than new technology or other physical changes. Mr. Hughes, the boss, has started doing work that was previously done by skilled hourly employees. When the company got a contract last summer from Caterpillar Inc. to make a new engine part, Mr. Hughes went into the shop, designed the part and set up the machines so they could do the work. Similarly, another manager now spends part of his time helping to load and unload trucks.

Ostensibly, the company is getting more out of its workers because two of its managers are doing tasks formerly done by hourly employees. But the ultimate impact on cost and efficiency is more difficult to gauge. When Mr. Hughes is on the plant floor futzing with machines, he isn't courting new customers. "Hidden in the productivity figures are things like that," he says. Normally, productivity slows and shifts into reverse when a recession hits, as companies cut output faster than they shed workers. Then, as the recession ends, productivity rebounds sharply because companies are hesitant to hire workers until they're sure the pickup in business will last. This time around, productivity dipped at a slight, 0.5% annual rate in the first quarter of 2008, near the beginning of the recession, and then rebounded.

That's a sign of how quickly companies cut jobs in response to the downturn. Even with the recent gains in payrolls, there are 8.2 million fewer jobs in the U.S. than there were before the recession started in late 2007. In the past, the large productivity gains that came with recessions faded quickly, with companies hiring shortly after the economy began to recover. But that hasn't been the case recently. During the late 1990s technology boom, U.S. companies poured huge amounts of money into computer and other equipment. When the 2001 recession hit, the technology investments meant that many jobs were obsolete, says Mr. Jorgenson, the Harvard economist. "Companies pulled the plug…and sent those people home," he says.

That process continued after the recession ended, leaving productivity unusually elevated. It was an important reason why the economy didn't start consistently adding jobs until September 2003—nearly two years after the end of the recession. Companies didn't invest nearly as much in the 2000s as they did in the 1990s. Still, they're finding ways to get more out of their workers. Consider Greensboro, N.C.-based Unifi Inc., a maker of polyester yarn. The company was pouring cash into new equipment a decade ago. Unifi's capital expenditures in the five years leading up to the 2001 recession topped $700 million. It was quite different this time. Unifi was generating less cash and had just $50 million in capital spending in the five years before the recession. But the company has still managed to lift productivity.

The upshot of this is visible at Unifi's Yadkinville plant, where it "textures" yarn—a process that gives it bulk and strength. The plant is the size of 16 football fields and is lined with machines that stretch and heat the yarn. Scattered workers dart here and there. Most of this automation was added years ago. "Every piece of equipment we have here is pre-2000," says Unifi Chief Executive William Jasper. "We have to find out how to be more efficient with what we have."

Last year, the plant focused on reducing how often yarn breaks during the texturing process. Each time that happens, machines are shut down, yarn is wasted, and workers have to spend time clearing up the problem. The company held a brainstorming session and came up with around 25 cheap fixes. Then, it ran statistical tests to determine which of the fixes would make a difference. "Creelers," whose job it is to splice strands of yarn together with a heat gun, were told to be more vigilant about removing stray bits of yarn. That tiny change eliminated many of the breaks. But a tough job climate is also prompting workers to do more. "I feel like I work harder," says Jamie Barber, 34 year old, who has spent 12 years as a creeler.

North Carolina's Piedmont region used to be dotted with textile companies and furniture manufacturers, but those businesses went into sharp decline in the 1990s as competition from lower-cost overseas producers heated up. The economy has become more diversified in recent years with more jobs in logistics and technology. Still, it was hit hard by the recession—unemployment in the region was 11.3% in March, up from 5.2% two years earlier. One reason companies in the area are more productive is that they retained their strongest workers. Greensboro-based RF Micro Devices Inc. specifically looked at worker productivity before doing layoffs at a plant making chips used in mobile phones and other wireless devices. It reduced its work force there from about 425 employees to about 325.

"We don't really have a lot of dead wood and we didn't before—that was what was so painful about it," says Dan Pfabe, director of manufacturing at the plant. Lately, RF Micro Devices has rehired some of those workers. Even though they may not be as productive as workers who weren't laid off, Mr. Pfabe is glad they were still available. Completely new employees take time to learn things like putting on the specialized suits worn in the clean rooms, and that cuts into overall worker productivity.

Old Dominion Freight Line Inc. is another company finding ways to work smarter. At its big service center in Greensboro, S.C., workers use forklifts to shuttle freight from truck to truck along a 1,200-foot-long loading dock. There are surgical pads headed to Bethpage, N.Y., high-performance tires en route to Cleveland and Dell computers bound for Dothan, Ala. Before the recession, each worker on the loading dock moved an average of 2,600 pounds of freight an hour. Now they're averaging 3,400 pounds. How did they do it?

In addition to putting in more effort, workers on the dock say they have been paying more care to how they stack and pack loads. That saves labor costs. If a bundle of reinforcement bars comes undone while it's being transported to a distant city, then the worker who unloads it at the other end has to spend 10 minutes putting it back together. Old Dominion is also making investments to boost productivity. The forklifts now carry computers so workers from their seats can enter loads into the service center's freight-management system. They used to have to climb off their forklift and punch it in at a keypad next to each door in the loading dock.

Tim McBride, the manager of the service center, says the productivity gains on the loading dock will stick. But he also thinks there's no way that gains of that magnitude can be repeated anytime soon. As the freight business continues to recover, the company will likely have a harder time meeting the increased workload without hiring more workers. Still, certain jobs are gone forever in this region. Visitors stepping out of the elevator to visit Bouvier Kelly's offices in downtown Greensboro used to be greeted by a receptionist. Now they're greeted by a bell. The small advertising firm went from 18 employees two years ago to 13 today, and now everybody shares in tasks, like answering the phones and letting visitors in the front door, once done by people who aren't there anymore. Such cuts are happening nationwide as companies trim office and administrative staff.

Some of that productivity has come at a price, says Pete Parsells, a partner in the firm. He feels the extra work is preventing him from doing things that, while they may not immediately add to the bottom line, pay off over time. He's hoping, for instance, the company will hire someone to help coordinate customer accounts so that he can spend more time with clients. "I would like to do more bigger picture stuff," he says. "I would like to talk to clients about a product they're going to launch in 2011. Not selling anything, just talking—it really helps."

Senate majority leader Harry Reid Backs Breaking Up Banks, Auditing Fed
by Ryan Grim

Harry Reid will make sure that an amendment to break up megabanks and cap their size comes up for a vote, the Senate majority leader said. He added that he was leaning heavily toward voting for the amendment, cosponsored by Sens. Sherrod Brown (D-Ohio) and Ted Kaufman (D-Del.). Reid will also support an amendment from Sen. Bernie Sanders (I-Vt.) that will authorize an audit of the Federal Reserve, he said. On Wednesday, Reid was noncommittal when asked by reporters at a briefing about the two major amendments. In an interview in his office with the Huffington Post on Thursday, Reid went further when asked if he'd considered the amendments since the briefing. "I'll probably vote for it," Reid said.

Does that mean it'll come up for a vote? "Oh, it's going to come up. I'll make sure it comes up," said Reid of the Brown-Kaufman amendment. "Unless my staff convinces me differently. But what I know about it, I'll vote for it." Reid said he has not been lobbied by the White House to oppose either Brown-Kaufman or the Sanders amendment. "No one's talked to me," he said. Economists largely agree that the only way to end the bailout of big banks is to reduce banks to a size small enough so that if they fail, they don't bring down the entire system.

Reid's support gives a major boost to two amendments that have surged in the past few days and are now within a shot of passage. Brown-Kaufman is "among the most deeply dreaded by Wall Street," the New York Times wrote Thursday. Reid's backing gives Brown-Kaufman two powerful backers. On Tuesday, Reid second in command, Majority Whip Dick Durbin (D-Ill.), said on the Senate floor he was backing the measure. "I would say that [of] all the many amendments which will be offered, this is clearly a game changer," said Durbin.

"I am supportive of this amendment, even though I know that some of my friends in the banking -- some of my friends in the banking industry won't be happy with that. What they're talking about is dealing with the concentration of wealth and the concentration of economic power to a level which can literally bring the economy down. That's what we went through leading into this recession. That's what led to the massive taxpayer bailout. And that's what the Brown-Kaufman amendment addresses foursquare."

UPDATE: Sen. Michael Bennet (D-Colo.), who had previously voted against a previous iteration of an audit of the Fed, will support the Sanders amendment, his spokesman Adam Bozzi tells HuffPost. Meanwhile, Greg Sargent reports that Sen. Al Franken (D-Minn.) will vote for Kaufman-Brown.

Meredith Whitney Doesn't See `Earnings Power' at Banks

Meredith Whitney, chief executive officer of Meredith Whitney Advisory Group LLC, talks with Bloomberg's Jonathan Weil about the outlook for U.S. bank earnings. Whitney also discusses banks' dividend payouts, investment strategy in banking stocks and the Securities and Exchange Commission's fraud lawsuit against Goldman Sachs Group Inc. They speak at the Bloomberg Markets Global Hedge Fund and Investor
Summit in New York.

Blankfein Defends Goldman's Ethics
by Joe Bel Bruno and Brett Philbin

Lloyd C. Blankfein continued to defend Goldman Sachs Group Inc.'s reputation on Wednesday in comments to some of the firm's wealthiest clients. The embattled chairman and chief executive, who last week was grilled by a Senate subcommittee looking into Goldman's role in the financial crisis, said the firm will always put clients first. He said there is also a silver lining to the civil-fraud charges leveled against the firm by the Securities and Exchange Commission: It allows the firm to re-examine how its business practices.

"Frankly, at this point we have to go with an open mind and determine what we may be doing wrong," Mr. Blankfein told customers of its private-wealth-management business during a 30-minute conference call. "On a very microscopic level, we're going to use this as an opportunity for a deep dive on our practices and how we run things." He pledged to clients that he wants Goldman to "be the leader in things like ethics, in putting clients first." Mr. Blankfein added "we don't want people to be OK with Goldman Sachs. We want people to be bragging that they have their accounts with Goldman Sachs."

The conference call comes as Mr. Blankfein has come under heavy scrutiny amid a political storm swirling around the company, and questions about his own future as the firm's leader. Goldman is battling a federal criminal investigation and last month's lawsuit filed by the Securities and Exchange Commission. In the past few weeks, Goldman executives have been flying around the world to meet with clients and address questions about the firm's ethics. Mr. Blankfein himself told those on the conference call that he will be holding more calls with customers, something he admitted not pursuing actively in the past. Mr. Blankfein acknowledged that a "certain amount of fatigue has set in" for wealthy clients who have seen and read extensive coverage of the firm's practices since the SEC charged the investment bank with fraud nearly three weeks ago.

Mr. Blankfein also addressed Goldman's market making business, which, along with its mortgage department, lies at the heart of the SEC charges and potential criminal probe. As a market maker, or an institution that matches buyers and sellers and can hold securities or take positions on them, Mr. Blankfein said Goldman wasn't acting in an advisory capacity to investors. "We are not telling [clients] what to do," he said, adding "that the way we put the client first is to get them the best price under all market circumstances." When asked whether Goldman sold clients a structured product that was designed to fail, Mr. Blankfein said "it would never be acceptable to us to create an investment designed to fail to anyone in the mark

Cracking down on Wall Street crooks

Dylan Ratigan talks to Eric Dinallo, Candidate for NY State AG and former State Superintendent of Insurance

Goldman Sachs Credit Rating Threatened By Fitch
Fitch Ratings said Wednesday that Goldman Sachs' recent legal troubles and the evolving regulatory landscape might lead the agency to eventually review the bank's top-tier credit rating. Fitch Ratings, a major credit ratings agency, said in a release that it left Goldman Sachs Group Inc.'s rating of "A+" alone for now given its strong performance. Fitch noted that Goldman "consistently" outperforms its global banking peers.

However, Fitch said it lowered its long-term view of Goldman's debt ratings because of the legal issues Goldman is facing, which could hurt its reputation and ability to generate revenue. "Goldman's franchise and market position are potentially vulnerable to scrutiny by stakeholders" and, like its peers, "may be affected by the industry's regulatory evolution," Fitch said in a statement. A spokesman for Goldman declined to comment. Investors seemed to show little concern about Fitch's view. Goldman shares rose $1.25 to $150.70 in afternoon trading.

Congress is currently debating a potential overhaul of financial regulations that could include restricting trading by big Wall Street banks. Goldman Sachs was one of the most profitable banks throughout the credit crisis and during the ongoing recovery. It has used what some consider aggressive trading strategies to increase earnings. Such strategies have resulted in scrutiny by the Securities and Exchange Commission. The SEC accused Goldman of fraud in its dealings of mortgage securities that it created before the credit crisis erupted. Many blame risky securities like those tied to subprime mortgage securities for worsening the financial crisis. The Justice Department has opened a criminal investigation in Goldman's packaging of the securities.

What-Ifs for Goldman Sachs: Can Blankfein Survive?
by Susanne Craig and Joann S. Lublin

Some executives and powerful alumni of Goldman Sachs Group Inc. are talking about whether Chief Executive Lloyd C. Blankfein can survive the legal and public-relations storm swirling around the company, according to people familiar with the situation. The conversations being held among some partners, managing directors and other current and former executives are informal, and there appear to be no plans for a management shake-up. The various hypothetical scenarios include whether Mr. Blankfein should resign, whether there should be a broader house-cleaning of top Goldman management or whether to separate the chairman and CEO posts now held by Mr. Blankfein.

In one possibility being discussed, Henry Paulson, who stepped down as Goldman's chief executive in 2006 to become Treasury secretary, would take the chairman job, these people said. But one person familiar with Mr. Paulson's thinking said he would never return to Goldman. Goldman declined to comment on the internal conversations. On the surface, Mr. Blankfein's support remains unwavering as the New York company battles a federal criminal investigation and last month's civil-fraud lawsuit filed by the Securities and Exchange Commission. Less than a week after the suit was filed, Mr. Blankfein got a standing ovation at a meeting of Goldman executives, according to people who were there.

Nevertheless, the open discussions inside Goldman about life after Mr. Blankfein show that the firm is being rattled by the turmoil. In addition, several large Goldman shareholders said they support keeping Mr. Blankfein and President Gary D. Cohn in their current jobs. That endorsement could disappear, though, if the company suffers another "self-inflicted wound" that sinks its stock price, said one large investor. Some shareholders said the tide could turn against Mr. Blankfein if Goldman shares fall below their current book value of about $122. The stock is down 19% since the SEC's lawsuit was filed but slipped just five cents on Tuesday to $149.45 in 4 p.m. New York Stock Exchange composite trading at 4 p.m., bucking the overall market's steep decline.

"We are very supportive of management and think the SEC case is weak, but at a certain point we can't afford not to ask for a management change," said one major Goldman shareholder, adding that the company needs to somehow escape its quagmire in the next month or so. Allegiance to Mr. Blankfein among Goldman investors will be tested Friday at the company's annual meeting in lower Manhattan. Among seven shareholder proposals in the proxy statement is one that would split the posts of chairman and CEO, meaning Mr. Blankfein would have to relinquish his chairman duties. Goldman's board has recommended voting against the breakup. The proposal is nonbinding, but it could be hard for directors to ignore if it passes.

Julie Tanner, assistant director of socially responsible investing at Christian Brothers Investment Services Inc., the New York firm that proposed the move, said it could attract strong support even from shareholders who typically pay little attention to corporate-governance-related proposals. "There is a lot of shareholder sentiment against the company right now," she said. Proxy adviser Glass, Lewis & Co. supports the resolution, while rival RiskMetrics Group Inc. opposes it. Last year, 38 proposals favoring a separate chairman won an average of 34% of the votes cast, up from 28 proposals in 2008 that got an average of 29% support, according to a RiskMetrics analysis of about 7,500 U.S. companies it covers.

"I don't think splitting Goldman's two top roles would get the heat off them from the SEC, but it would be the right thing to do," said Gary Wilson, a former chairman of Northwest Airlines Corp. who now serves on the boards of Yahoo Inc. and CB Richard Ellis Group Inc. If Mr. Blankfein steps down as chairman, top Goldman executives and alumni are discussing who might quickly fill the gap. One camp is pressing for Goldman's board to bring back Mr. Paulson as chairman. While such a move might help restore confidence, it also could undermine Mr. Paulson's legacy as Treasury secretary during the financial crisis and fuel longstanding criticism that Goldman is a revolving door between Wall Street and Washington.

Arthur Levitt, a former chairman of the SEC who now advises Goldman on public policy and other matters, also has been raised as a possibility for chairman. The 79-year-old Mr. Levitt likely would refuse the post because it is too demanding given his age, said someone familiar with the situation. Some investors expect the firm's troubles to end in a settlement with the SEC, which alleged that Goldman and trader Fabrice Tourre sold a collateralized debt obligation called Abacus 2007-AC1 without disclosing that hedge-fund firm Paulson & Co. helped to pick some of the underlying mortgage securities and was betting on the financial instrument's decline.

There are no signs of an imminent deal. Such an agreement could be one of the largest settlements in Wall Street history but will likely be difficult to reach, partly because the two sides are so far apart in their view of the firm's behavior. Some shareholders predict that Mr. Blankfein would have to resign as chief executive as part of a settlement with the SEC, a huge concession. Goldman has said that all clients in the disputed Abacus deal were sophisticated investors who got the information they needed to make an informed decision. The SEC claims the firm duped investors with a product designed to fail.

Can Warren Buffett (and Andrew Ross Sorkin) Save Goldman Sachs?
by Michael Wolff

Business reporters love successful people. One reason more scrutiny was not brought to bear on financial institutions during the boom years by more reporters is that financial institutions are (or were) run by successful people.

You can’t argue with success.

Of course there are fewer successful people today. Even people who still have a lot of money, like partners at Goldman Sachs, now find themselves in an equivocal position. They have diminished reputations, which means they have diminished power, which could mean they will have diminished fortunes (although that hasn’t happened yet).

Andrew Ross Sorkin, the New York Times business reporter, may be even more in love with successful people than most of his colleagues. This is because he is charming and young and successful people love him back.

Sorkin went out the other day to Omaha to attend the annual meeting of Berkshire Hathaway at the invitation of its CEO, Warren Buffett, the most successful man in America. Sorkin was actually there as part of a three-person panel of journalists to question Buffett. That is, Buffett loves Sorkin, and Sorkin was there expressly to love Buffett in return.

Sorkin then wrote about the meeting in the Times using the most successful man in America’s defense of Goldman Sachs as a way to help rehabilitate the firm. This is, on Buffett’s part (and, no doubt, on the part of Goldman’s PR strategists), a precise and canny use of the New York Times, possibly the most significant outlet for making, preserving, and protecting the reputations of successful people. It is also canny on Sorkin’s part to have placed himself smack in the middle of the matrix for success. (The most canny business reporters are not only smitten by the success of successful men, but are always figuring out a way to get some of it for themselves.)

Sorkin does point out that Buffett, with a $5 billion investment in Goldman, has a mother of a conflict of interest (as does Sorkin himself, in writing this article, having been Buffett’s guest). But Sorkin’s sleight of hand is to say, “Cynics might regard Mr. Buffett’s statements as predictably self-serving.” In other words, if you do regard it this way, you’re demoted—you’re a cynic rather than a successful person. But his larger point is clear: Regardless of Buffett’s conflict, because he is the most successful man in America his logic is of a much higher order than less successful people (like the SEC or prosecutors), or even Sorkin himself, who, like other business reporters, has been distancing himself from Goldman Sachs.

Buffett’s argument is that Goldman shouldn’t be liable for not disclosing what might be pertinent information about a security it was marketing because investors should be able to judge for themselves the intrinsic value of the security (ie, that’s investing). In other words, sophisticated investors shouldn’t need (and don’t deserve) efforts to regulate and bring transparency to the market. Which, if you think about it, would make a good part of the SEC’s job meaningless. If it’s fishy, you should be able to smell it, is in essence Buffett’s principle, which, following Buffett’s logic, ought to have saved the financial system from caving, except it didn’t.

Anyway, my friend Andrew Sorkin, too young and successful to be much of a cynic (or to value cynicism), got to Omaha and found himself in the presence of success too large to question. To be so starstruck happens, at one time or another, to all of us. But I would have thought we’d come finally to understand that as a business model, being starstruck—loving success for itself—is broken.

Rep. Grayson: Geithner Blocking Fed Audit Out of ‘Conflict of Interest’
by Rick Klein

With a fight looming on the Senate floor over a proposal to open the Federal Reserve up to audits, a Democratic House member who’s leading that push said today that the Obama administration is seeking to block it out of “one of the biggest conflicts of interest I’ve ever seen.” Rep. Alan Grayson, D-Fla., said on ABC’s “Top Line” today that Treasury Secretary Tim Geithner is intervening to block the proposal to shield from scrutiny actions he took as president of the New York Fed, a post he assumed in 2003.

“When Tim Geithner says that he doesn't want to see the Fed audited, what he's really saying is he doesn't want to see Tim Geithner audited,” Grayson said. “He was the head of the New York Fed for years and years. This audit would apply to him. And the actions he took -- which he can now take in secret and, when this bill passes, will no longer be secret -- we'll be able to see and understand the decisions that he made that among other things put huge amounts of bailout money into the hands of private interests.” Grayson added: “It's one of the biggest conflicts of interest I've ever seen.”
Grayson, a member of the House Financial Services Committee, said opening the Fed up for audits -- as the House bill, in an amendment he co-authored with Rep. Ron Paul, R-Texas, would provide for -- is a critical piece of financial regulatory reform. “The Fed doesn't want to be audited. Who does? Do you want to be audited? I don't want to be audited, but sometimes it's necessary,” he said. “When you're handing out a trillion dollars at a time -- a trillion dollars at a time, which works out to $3,000 for every man woman and child in this country -- don't we have a right to know what happened to it?”

Grayson added: “It's central to the bill. We've had secret bailouts from the Fed to private interests now for the past two years without any exposure whatsoever. … We need to know what happened to our money, because when the Fed hands out our money, every dollar in your pocket, every dollar in your checking account, every dollar in your 401(k) becomes that much cheaper and less in value.” Treasury officials did not immediately respond to requests for comment. Opponents of subjecting the Fed to audits argue that the central bank needs to operate in secrecy to set monetary policy free of political influences.

Grayson also had harsh words for Republicans who are suggesting the Obama administration was wrong to read Miranda rights to terror suspect Faisal Shahzad: “Look, for eight years the Republicans tried to shred the constitution when they were in charge. You'd think they would give up on it when they were no longer in charge.” He was more generous in his overall assessment of the president’s liberal chops. Grayson has positioned himself as something of a champion on the left, with active fundraising on some of his more outspoken comments at his Website,

“I think the president is making reasonable progress in the things that matter to Americans. I think health care reform is a tremendous generational accomplishment; it's a landmark for this whole generation, and I think the president is making systematic efforts in other areas too. As you can tell from my tie, I wish he'd make more of an effort to end the wars in Afghanistan and Iraq.” About his ties -- Grayson is semi-famous for his range of money-themed neckwear -- the congressman wasn’t opening himself up to any audits. He wouldn’t give up the location of his favorite tie shop: “You know if I told you, I'd have to kill you,” he said.

Are the ratings agencies credit worthy?
by Kevin Voigt

Their decisions on Greece, Spain and Portugal sparked a market freefall last week and spurred a $145 billion bailout plan. A powerful U.S. congressman characterizes them as the triggermen of the 2008 global financial crisis. And yet a spokesperson for the European Union seemed to be speaking for much of the world when he asked at an April 28 press conference, "Who is Standard & Poor's by the way?"

On both sides of the Atlantic, rancor is growing against the triumvirate of companies -- Standard & Poor's, Moody's Investor Service and Fitch Ratings -- that make independent decisions on credit worthiness of government bonds, businesses and financial products. "Regulators and investors are addicted to credit ratings like heroin," said Frank Portnoy, author and director of the Center on Corporate and Securities Law at the University of San Diego. "The only problem with them is they are false. Every academic study shows they substantially lag the market. So why is everyone on the edge of their seats with these ratings announcements?"

The slow rolling Greek debt crisis quickly sped downhill last week after Standard & Poor's downgraded Greek bonds to junk status. The threat of a debt contagion across Europe was heightened when Standard & Poor's also downgraded the investment grade of Portugal and Spain.

Who are the credit ratings agencies?
Credit ratings agencies had a starring role in the financial crisis, after the firms blessed mortgage-backed securities with AAA ratings -- the safest rating possible -- and fed the global mania for these risky investments. A report released two weeks ago by a U.S. congressional committee showed that the ratings agencies knew their risk model was flawed in 2006, but didn't act until July 2007 when it downgraded billions worth of subprime securities.

U.S. Sen. Carl Levin, chairman of the Senate committee investigating the crisis, characterized the mass downgrade as "the trigger" that sparked the financial crisis. Frustration with the ratings agencies is palpable in Brussels, where the Greek debt crisis is threatening the foundations of the European monetary union: "We of course expect that credit rating agencies, like other financial players, and in particular during this difficult and sensitive period, act in a responsible and rigorous way," said Chantal Hughes, a spokesperson for the EU Commissioner for internal market, at a press conference last week.

What Greece's debt rating downgrade means
And yet the big three credit ratings agencies are so tightly woven into fabric of global business, attempts to reign in the industry in the U.S. and Europe are fraught with difficulties. "Ratings are now very much embedded into regulations," said Patricia Langohr, professor of economics at ESSEC Business School in France and co-author of "The Rating Agencies and their Credit Ratings." Since 1975, regulations in U.S. require bond issuers to use either Standard & Poor's, Moody's or Fitch to rate the credit worthiness of the investments; internationally, the Basel II accord for the capital banks are also impacted by ratings from the credit agencies. "Hence, if you, as an issuer want your debt to be widely accepted and bought by the market, you will have it rated by a suitable credit rating agency," Langohr said.

The 'Big Three' are valued for judging investments by the same yardstick -- with ratings ranging from AAA for safest investments and D for the worst -- across international markets. But the fact that the ratings agencies are paid by the issuers of the bonds creates an inherent conflict, critics say. "It's like you're paying your professor to give you a grade," Langohr said. The downgrades of mortgage-backed securities in 2007 and the sovereign debt of Greece last week to junk status both created ripple affects that quickly sped across the globe -- in part because many governments prohibit institutional investors, such as pension funds, from investing in low-rated bonds.

"The problem is that as soon as a rating drops to junk level, then many investors for regulatory purposes have to sell," Langohr said. "The ratings have so much power, they become a self-fulfilling prophecy." The credit ratings agencies walk a tightrope between the demands of issuers and investors who both crave high and stable ratings. "It's sort of like the Italian scientist who got sued because he forecast an earthquake and it happened," said Alan Laubsch, founding member of RiskMetrics Group and a former vice president for JPMorgan. "You want to be very, very sure before you make a call. You may be detecting a lot of red flags in the market, but you may trigger a panic."

On the other hand, "if you wait until the last minute when it's obvious, you trigger this mad rush ... it's as if you're saying `this boat doesn't float so well' while it's already sinking," Laubsch said. As seen by the rapid-fire events after Greece was downgraded, "you cause an even more crowded rush to the exit, because any reaction under stress is going to be more severe," he adds. The tendency of credit ratings agencies to act conservatively means that they often fail to predict when firms and governments are in trouble, Portnoy said. "You saw that not just with Lehman Brothers and Bear Stearns, but with Enron, with Orange County (California, which went bankrupt in 1994), with AIG -- they all had AAA ratings before they went bust," Portnoy said.

Martin Winn, vice president of communications for Standard & Poor's in Europe, disagrees that the ratings agency acts too slow. "We actually started downgrading Greece in 2004 and have always rated it lower than other Eurozone markets, even when markets for many years treated Greek debt as broadly equivalent with its AAA-rated peers," Winn said in an e-mail. "What we have seen in recent months is the market catching up with our long held view that there is real divergence of sovereign credit risk in the Eurozone."

Regarding criticism within the EU that Standard & Poor's should have waited until after EU-IMF bailout before judging Greece's credit worthiness, he said the agency does expect the bailout to give Greece some "breathing space in the short term. "However, our focus is on the longer term economic and fiscal challenges that Greece faces. In particular, we have revised our economic assumptions for Greece and now expect nominal GDP not to regain its 2008 level until 2017," Winn said. "In our view, that will make its task in achieving fiscal consolidation even tougher."

For the ratings imbroglio over mortgage-backed securities in the U.S., the fee structure wasn't the problem, Winn said. "The real issue here is that the regrettable performance of our ratings of US residential mortgage securities from 2005-07 resulted from the fact that S&P, like other market participants, took into account a possible decline in US housing but not of the severity and speed that occurred," he said. "We have drawn lessons from this and made important changes to the transparency, criteria, governance and quality of our ratings." Critics say that is not enough. They want to see restrictions in the U.S. requiring credit ratings from the 'Big Three' eliminated to introduce more market competition. Langohr wants to see investor associations "rate the raters" for their transparency, accuracy and timeliness.

Late last year, the European Union modified rules governing ratings agencies that require more disclosure, forbids side businesses in "advisory services" and forbids agencies from rating financial products without adequate information on the investments. But all eyes are now on U.S. legislators as they debate the Wall Street reform and its impact on credit agencies. Critics also want the U.S. to revisit rules that protect credit ratings agencies from being sued. The credit ratings agencies say their opinions are protected by the First Amendment as form of free speech. "Unlike the other so-called gatekeepers -- investors, issuers, auditors and others -- who are potentially liable if there is a false statement in registration -- credit ratings agencies are not," Portnoy said.

A list of the credit worthiness of a sampling of nations as listed by Standard & Poor's.
  • AAA
    Australia, Austria, Canada, Denmark, Finland, France, Germany, Netherlands, Luxembourg, the Netherlands, Norway, Singapore, Sweden, Switzerland, UK, USA
  • AA+
    Belgium, Hong Kong, New Zealand
  • AA
    Abu Dhabi, Ireland, Japan, Slovenia, Spain
  • AA-
    Kuwait, Qatar, Saudi Arabia, Taiwan
  • A+
    Chile, China, Cyprus, Italy, Slovak Republic
  • A
    Bahrain, Czech Republic, Israel, South Korea, Malta, Oman, Trinidad and Tobago
  • A-
    Aruba, Botswana, Estonia, Malaysia, Poland, Portugal
  • BBB+
    Bahamas, South Africa, Thailand
  • BBB
    Bulgaria, Croatia, Lithuania, Russia, Mexico
  • BBB-
    Brazil, Hungary, Iceland, India, Kazakhstan, Morocco, Peru
    BB+ (Junk status) Considered highest speculative grade by market
  • BB+ participants
    Azerbaijan, Colombia, Egypt, Greece, Panama, Romania

1 in 9 Canadians Admit to Experience Homelessness or Close to it
by Alexander Stewart

A survey conducted for the Salvation Army has suggested that nearly one in nine Canadian adults has revealed to experience homelessness or come close to it at some point. However, in some provinces, the figure is as high as one in five, as the aftermaths of the recession goes on. Respondents included in Saskatchewan and Manitoba posted the highest rate, with nearly 20% admitting that they had been homeless or near to it. The Salvation Army revealed that it witnessed the demand for general social services climb by more than 25 per cent during the economic downturn in 2009, and it helped more than one million people with food, clothing and other necessities. 

It uncovered that in shelter bed occupancy rates in the Ottawa marked a rise of more than nine per cent in 2009, and shelter-bed stays were 12 per cent longer than in 2008. Some non-governmental sources estimate Canada's true homeless population, not just those living in emergency shelters, to be between 200,000 and 300,000", posted the report for the Sheldon Chumir Foundation for Ethics in Leadership, which was published in 2007. In addition, a report entitled Homelessness in a Growth Economy: Canada's 21st Century Paradox posted that the latest federal estimate rendered the figures for homeless in Canada to touch 150,000 in 2005.

Many possible triggers for wider euro debt crisis
by Brian Love

Europe may be months, conceivably weeks away from an expanded debt crisis that cuts more countries off from access to the markets and forces fresh emergency action by rich governments or the European Central Bank. The many potential triggers for an expanded crisis include a failed bond auction, any signs that Athens or donor nations were backing away from a 110 billion euro ($141 billion) bailout of Greece, and a freezing up of Europe's interbank money market.

For now, Portugal, Ireland and Spain, widely seen as the next possible "dominos" after Greece, remain in significantly better shape. The interbank market is far from grinding to a halt as it did after Lehman Brothers collapsed in late 2008. But the spread of investor jitters in the past 24 hours, affecting markets as distant as yen swaps in Tokyo, suggests market conditions could deteriorate as rapidly as they did during the global financial crisis of 2007-2009. "In my view there is a 10-20 percent chance that at least one more country will need rescuing as it finds itself shut out of the markets," said Marco Annunziata, chief economist at Italy's UniCredit bank. "If it happens, it is most likely to happen in the coming six months."

Lena Komileva, head of G7 market economics at money broker Tullett Prebon, said the crisis over Greece's solvency had morphed into a capital markets crisis, and the markets had begun to feed on their own momentum. "Another credit event similar to Greece can happen within weeks," she said. German Chancellor Angela Merkel and top economic policy makers in the euro zone appeared to recognize this in their warnings about the risk of an expanded crisis on Wednesday. "It's absolutely essential to contain the bushfire in Greece so that it will not become a forest fire and a threat to financial stability for the European Union and its economy as a whole," said European Monetary Affairs Commissioner Olli Rehn.

Greece became unable to finance its debt at affordable rates when its 10-year government bond yield soared near 10 percent in April. The euro zone's other weak countries have not reached that stage; Portugal's yield was below 6 percent on Wednesday. Portugal sold 500 million euros in six-month Treasury bills on Wednesday at a yield of 2.955 percent, which was about four times the rate at the last such sale on March 3 but was well below maximum levels in the secondary market. This was seen as a moderately positive sign by analysts. Spain is expected to succeed in selling 2-3 billion euros of government bonds on Thursday, although at a much higher yield than in its last auction, analysts said.

Nevertheless, every debt sale by weak euro zone states in coming months is likely to be viewed as a potential flashpoint for an expanded crisis. Portugal plans to offer more T-bills on May 19 and Spain plans another bond sale on May 20. Annunziata estimated Spain's bond spreads were still low enough for it to borrow at current rates for at least a year or more without doing serious damage to its finances. Portugal can keep borrowing at current rates for at least a year, he said. But he added, "The problem, as for exchange rates, is also the speed of the movement. If spreads keep widening then markets could more quickly lose confidence and the problem would be the quantity of available financing, not the cost."

Meanwhile, the Greek bailout package announced this week imposes such harsh austerity measures on Greece that the markets will continue doubting the country's political will and economic ability to stick to the package. Any sign that the government of Prime Minister George Papandreou was backing off from key fiscal reforms in the face of public opposition could raise the prospect of a Greek debt restructuring or default, triggering an expanded crisis.

The European Commission and the International Monetary Fund will monitor Greece's progress every quarter and link aid disbursements to those reviews. The reviews could become triggers for an expanded crisis if Germany, where public opinion strongly opposes helping Greece, decides Athens is not meeting aid conditions and balks at a disbursement. The markets could also panic if commercial banks around Europe, which have cut off funding lines to Greek banks, decide to do the same to banks in Portugal, Ireland and Spain.

So far the stresses in the money markets do not approach those seen at the peak of the global crisis. The two-year euro zone swap spread, which measures the aversion of lenders to deal with any but the most creditworthy borrowers, has widened to 65 basis points, its widest since mid-March 2009, but is far below the record 130 bps hit in October 2008. However, large Spanish and Portuguese banks are having to pay a higher price to access the interbank market, and this premium could widen if sovereign debt markets sink further.

Emergency Steps
The political difficulty of assembling an international bailout for a country -- the Greek bailout was preceded by months of wrangling between angry governments -- suggest the ECB would be the first institution to respond to an expanded crisis. It could reintroduce emergency measures taken during the global crisis, resuming a programme of lending in dollars and Swiss francs over six- and 12-month maturities, or extending its promise to lend banks all the weekly funds they need at fixed rates beyond mid-October.

It might also abandon minimum credit rating requirements for more countries' sovereign bonds when they are used as collateral in its money market operations, as it did for Greece this week. Its most radical step would be to buy countries' bonds from the secondary market, shouldering their debt -- though that would be hugely controversial and hurt the ECB's reputation for conservative monetary policy. Analysts think it might pledge some 200 billion euros in such purchases. "They've a huge amount of armoury at their disposal. They can do a huge amount of things and I think they will be able to stabilize the market at some point," said UBS chief European economist Stephane Deo.

An expanded crisis could also prompt a fresh bailout effort by rich euro zone governments desperate to preserve confidence in their currency and protect their banks from defaults. Analysts estimate a bailout of Portugal, Ireland and Spain might cost around 400 billion euros. But the political difficulties of agreeing on an expanded bailout could dwarf the challenge which Greece posed. The European Commission is to propose a permanent mechanism for handling such crises on May 12, possibly drawing on a German proposal for a European Monetary Fund. But actually creating the mechanism might require contentious changes to the European Union Treaty that would require many months.

Regardless of how Europe resolved an expanded debt crisis, the reputation of its key economic institutions, which failed to act quickly and decisively to address Greece's troubles, would likely suffer lasting damage among investors. Stephen Jen, managing director of macroeconomics and currencies at BlueGold Capital, said Portugal would probably also need emergency aid from the EU and the IMF. "This short-term fix could have serious negative... consequences for Europe, the IMF, the ECB and the euro," he said, predicting both Greece and Portugal would likely reschedule their debts eventually. "I maintain my view that there will be no happy ending for Greece."

Merkel plea to save Europe as contagion hits Iberia
by Ambrose Evans-Pritchard

Europe's debt markets are flashing danger signals after spreads on Iberian debt reached the highest level since the launch of the euro and investors rushed for safety into German notes, prompting warnings from German Chancellor Angela Merkel that the European Project itself is at risk. "Contagion pressures continue to rage unabated," said Marco Annunziata, Europe economist at UniCredit. "The flames have rushed through the firewall of the IMF/EU programme for Greece and now threaten other peripheral countries." "While the sell-off on sovereign bond markets so far remains discriminating, the risk that it might suddenly mutate into irrational panic can no longer be ignored. Eurozone policymakers need to take further steps quickly," he said. 

Mrs Merkel made a moving plea to the Bundestag to support the €110bn (£93bn) rescue for Greece. "Nothing less than the future of Europe is at stake. The happy tale of German history since World War Two and our emergence as a free, united, and strong country cannot be separated from the European Union. We owe decades of peace and prosperity to the understanding of our neighbours," she said. "Europe today is looking to Germany. As the strongest economy in Europe, Germany has a special responsibility and it takes this responsibility to heart. "Immediate help is needed to ensure the financial stability of the eurozone. This must be done to avoid a chain-reaction to the European and international financial system, and contagion to other eurozone states. There is no alternative." 

Belated support from Berlin has failed to stop the crisis escalating. Spreads on Portuguese 10-year bonds soared to a post-EMU record of 290 basis points above Bunds; Spanish spreads rose to 131. Bank shares in Madrid slid again, with falls of 4.9pc for Banco Popular, 3.6pc for BBVA, and 2.5pc for Santander. Bundesbank chief Axel Weber said there was a "grave threat of contagion", echoing the formula now being used by German officials to justify the rescue. Berlin hopes the wording will head off a legal challenge at the constititional court. Flight to safety has driven the yield on two-year German debt to an all-time low of 0.59pc. Andrew Guy, managing director of ADG, said the rate had dropped below the three-month euribor rate in a sign of stress. "The last time this happened was August 2007 at the beginning of the financial crisis," he said. 

One credit expert said events risk mutating into a full-blown `Lehman disaster' unless the European Central Bank opts for massive bond purchases. Spreads on Greek debt exploded again as tens of thousands of demonstrators took to the streets and three people died in an attack on the Marfin Bank in Athens. "A demonstration is one thing, murder is quite another," said premier George Papandreou. The key cities were paralized by a general strike. "The country cannot surrender without a fight," said Yiannis Panagopoulos, head of the GSEE private sector union. Unity fractured further after the New Democracy oppostion party broke ranks and votee against the austerity measures.

Markets view the EU-IMF package for Greece as a politically-shaped response that cannot work because it shuts off the twin cures of debt restructuring and devaluation, leaving the burden of adjustment on the Greek people. If Greeks come to view the plan as a rescue for foreign banks and funds – as many already do – there is no chance of carrying the nation through five years of harsh austerity. Dominique Strauss-Khan, the head of the IMF, admitted that the plan was flawed, telling Le Parisien that the EU was charging excessive interest rates at 5pc. He said Europe must "urgently" create some form of fiscal union to shore up EMU, describing the euro as a half-finsihed job. Many investors view the EU-IMF plan as a "quick fix" that puts off the day of reckoning. Bill Gross, head of the US bond fund Pimco, said a "restructuring event" was inevitable in the end.

Julian Callow from Barclays Capital said Greece must reduce its primary budget balance by 14.5pc of GDP over five years, a task that is "unprecedented in European experience". The country will end up with a debt of 151pc, even it if complies. Since tax rises and wage cuts entail a protracted slump that crushes tax revenue, Greece may find itself in a deflationary spiral that feeds on itself. There is mounting concern that the IMF is squandering its fire-power on a dubious plan, rather than ring-fencing Greece with a controlled default and reserving its clout to defend a more credible line on Iberian debt – which is what really matters for Europe's banks. By failing to fix achievable priorities, the IMF risks a drift into deeper crisis.

Crisis Deepens; Chaos Grips Greece
by Sebastian Moffett and Alkman Granitsas

Greece's fiscal crisis took a new turn to violence Wednesday when three people died in a firebomb attack amid a paralyzing national strike, while governments from Spain to the U.S. took steps to prevent the widening financial damage from hitting their own economies. U.S. Treasury officials have been quietly urging their European and International Monetary Fund counterparts to put together a Greek rescue plan more quickly to contain the damage, it emerged Wednesday, as U.S. policy makers worry the continent's problems could undermine a U.S. recovery much as U.S. housing woes hammered Europe in 2008.

In Spain, rival political leaders came together Wednesday with an agreement that aims to shore up shaky savings banks by the end of next month. Banks in France and Germany, which are among Greece's top creditors, pledged to support a Greek bailout by continuing to lend to the country. Investors, meanwhile, are pouring money into bonds of countries seen as less exposed to the crisis, from Russia to Egypt. Anxiety over the euro-zone economies sent the euro down to about 1.29 to the dollar, its lowest level in more than a year. The Dow Jones Industrial Average fell for the second straight day, losing 58.65 points, or 0.54%, to close at 10868.12.

Greece's 24-hour nationwide general strike brought much of the country to a standstill, closing government offices and halting flights, trains and ferries. At the same time, tens of thousands of protesters marched through Athens in the largest and most violent protests since the country's budget crisis began last fall. Angry youths rampaged through the center of Athens, torching several businesses and vehicles and smashing shop windows. Protesters and police clashed in front of parliament and fought running street battles around the city. Witnesses said hooded protesters smashed the front window of Marfin Bank in central Athens and hurled a Molotov cocktail inside. The three victims died from asphyxiation from smoke inhalation, the Athens coroner's office said. Four others were seriously injured there, fire department officials said.

A police spokesman said eight fires in Athens office buildings and bank buildings had been brought under control. Later Wednesday, black smoke billowed from fires on one of Athens's main shopping streets. Glass shards and smoldering garbage littered the sidewalks. Greek Prime Minister George Papandreou condemned the violence. "Everyone has the right to protest," he said in a statement to parliament. "But no one has the right to violence and especially violence that leads to the death of our compatriots."

Wednesday's protests were sparked by Greece's weekend agreement to adopt austerity measures in exchange for a €110 billion ($143 billion) bailout loan from the European Union and the IMF. Unions challenged Greece's parliament, which could consider the measures as soon as Thursday, to vote them down. The general strike marks the broadest challenge to date to the government of Mr. Papandreou, which is pressed to pass the austerity legislation to unlock bailout funds to meet a debt payment later this month that it otherwise couldn't meet.

The protests also brought out many Greeks who were resigned to belt-tightening. Their unhappiness at the cuts was matched with rancor toward a generation of politicians who they say spurred the crisis with decades of corruption, kickbacks and accounting legerdemain aimed at obscuring to the EU the true level of Greece's annual deficits. "For 30 years the Greek people have been held hostage," said Periandros Athanassakis, 48, a garbage collector in Piraeus, the port near Athens. "Those who stole the money should pay." Some officials saw in Wednesday's protests the seeds of broader discontent. "We may have an uprising in the making," one senior Greek official said.

Greeks generally don't blame Mr. Papandreou for the country's problems, however, saying he inherited them from predecessors. It was his administration, elected in October, that announced the government's budget deficit for 2009 would be equivalent around 13% of gross domestic product, compared with the 6% claimed by the previous administration. Mr. Papandreou's approval ratings are higher than those of the leader of the main opposition party. Analysts also said the shock of Wednesday's deaths could nudge Greece's fractious political parties toward closer cooperation in dealing with the crisis and making it easier to pass reforms. "This changes the political scene," said George Sefertzis, an independent political commentator with the Athens consultancy Evresis. "There is no doubt that the deaths ease some of the political pressure."

Under terms of the bailout deal, Greece's government has announced a €30 billion package that will slash public-sector wages, cut pensions, freeze public- and private-sector pay, liberalize Greece's labor laws and raise some taxes. In Berlin on Wednesday, Chancellor Angela Merkel called on parliament to approve Germany's contribution of €22.4 billion in loans to Greece. German public opinion opposes a Greek bailout but Ms. Merkel said it was essential. "Europe stands at a crossroad," she said. "With us, with Germany, there can and will be a decision which lives up to the political, historical situation."

In Greece's northern city of Thessaloniki, there were reports of violence as police clashed with demonstrators who were attacking shop fronts amid a rally that drew at least 20,000 protesters to the streets. Police officials estimated there were 20,000 protesters in Athens. Union officials said union-affiliated protesters alone totaled more than 60,000. Others put the number higher still. "This rally was double the size of the largest rally that has ever been held in Greece," said Spyros Papaspyros, president of Adedy, a civil-service umbrella union. "If the government doesn't listen, there will be more strike action next week."

The day's general strike, the year's third, shut ministries and public offices. State hospitals and public utilities operated with skeleton staff. Shopkeepers joined the strike at midday, while journalists, bank workers, teachers, court workers, lawyers and doctors also walked off the job. Many Greeks taking part in the demonstration saw little alternative than to accept the government measures and brace for a long, deep recession. "I don't expect the measures to be withdrawn," said Pericles Papapetrou, 61, an architect and engineer who used to be mayor of the town of Elefsina. But, he said, the measures "could lead to extreme situations, such as an increase in crime, and also to an explosion of young people with no future."

Artemis Batzak Panayou, a cleaning lady working for a local government, saw her €1,200 monthly salary, on which she supports three children, cut by €250 at the beginning of the year. She believes it will fall further. "There is no way to survive on the daily wages in the public sector," she said, adding: "Greece won't be fixed until all the crooks are removed from government."

Hugh Hendry halfway lost among a bunch of who-are-you's

Time for capital controls in Europe?
by Ambrose Evans-Pritchard

Greek contagion has become dangerous. If Greece is Europe’s Bear Stearns, we risk a rapid escalation to Europe’s Lehman in the rest of Club Med — or the GIPS as they are now called by Morgan Stanley (PIGS are banned) There is a big difference with Bear Stearns/Lehman. Europe’s banks shared much of the damage from the American property crash, leaving them with waifer-thin capital ratios and a large book of losses yet to be disclosed. Some Landesbanken still hold Icelandic debt at face-value.

These banks now face a second hit from Greece and Southern Europe. They are on their own. The US banks have minimal exposure to this EMU mess. Let me be clear, the sky will not fall — unless the EU authorities let it fall. They have the wherewithal to head off a catastrophic systemic crisis, if they can overcome their national quarrels, muster political leadership, and move fast enough. As Jacques Cailloux at RBS and others have been saying for nearly two weeks now, the European Central Bank must come down off its high horse and launch a massive purchase of eurozone bonds — ie QE, printing money, eurocopters, call it what you want — which means tearing up the EU rule book in the process.

If they refuse to do this, they must expect to see their short careers in Frankfurt come to a swift end, and to see the Eurotower in Frankfurt boarded up. Will it happen today when the ECB’s governing board meets in Lisbon? Almost certainly not. The Germans are adamantly opposed, fearing the Weimar virus. Axel Weber from the Bundesbank has has already fired a warning shot. So once again, the EU response is being paralysed by the conflicting philosophies of the Teutonic and Latin camps.

There is a second option that almost nobody has talked about yet to my knowledge: capital and exchange controls. The longer this crisis drags out, the more likely it becomes. This is not a prediction that the EU will slam on controls, or a claim that they have any plan to do so. I have no such information. But what I do know is that such options were studied earlier this decade, just in case. This document is sitting in a drawer at the Directorate of Economic and Monetary Affairs in Brussels. It was written by a small cellule of EU officials in 2003 or 2004 (If I remember correctly) under prodding from Paris. It explores the legal basis for measures to stabilise the euro and EMU.

After combing through the EU treaties and court judgments, it concluded that Brussels may impose “quantitative restrictions” on capital inflows. Free movement of capital in the EU is not an “absolute freedom” and could be limited in an emergency. “Should extremely disturbing capital movements endanger the operation of economic and monetary union, Article 59 EC (Maastricht) provides for the possibility to adopt restrictive measures for a period not exceeding six months,” it says. It would be renewable every six months. Any decision would be taken by EU finance ministers under qualified majority voting, so no country could veto it.

The document was shown to me by one of the authors at the time. Part of it was later included in a published report, but nobody noticed — except Bernard Connolly, former currency chief at the Commission and later global strategist at Banque AIG. He always suspected that the EU experiment would end in capital controls. So has the bond crash in southern Europe reached the point where it is “extremely disturbing” and “endangers” monetary union? You be the judge.

Aid for Greece Hasn't Stopped Euro's Slide
by Michael Kröger

Despite the 110 billion euro aid package offered to Greece over the weekend, investors still don't believe the country can solve its financial woes. The euro continues to slide and the European Central Bank doesn't have many arrows left in its quiver. Jose Luis Rodriguez Zapatero is not generally considered to be a firebrand. The Spanish prime minister seldom loses his temper. But on Tuesday, he was clearly perturbed as he stepped before reporters' microphones in Brussels. Rumors have been circulating on the financial markets that Spain will soon be making a request to euro-zone countries for aid similar to the kind recently offered Greece. "That is complete madness," Zapatero hissed.

But Zapatero's eruption did little to calm the markets -- indeed it may actually have fanned the flames of mistrust. Even the confirmation by the ratings agency Fitch that it was not downgrading Spanish debt did little to calm investors. In just a few hours of trading, risk premiums on credit default swaps for Spanish bonds jumped by 18 percent. A rumor of unknown provenance, a nervous denial from a head of government -- it doesn't take much these days to stir up the financial markets. To make matters worse, the US ratings agency Moody's announced that it may downgrade Portuguese debt yet again.

Under Intense Pressure
The impression is growing that fewer and fewer investors are prepared to bet even a single cent on European sovereign bonds or on the euro. The mistrust is no longer limited to countries like Greece, Spain and Portugal. The problem has become much bigger: The entire European common currency has come under intense pressure. On Tuesday night, the euro's value dropped below $1.30 for the first time since April 2009. On Thursday morning, it was trading below $1.28 -- and drifting downward. Experts like Ansgar Belke from the German Institute of Economic Research (DIW) predict that it could fall to $1.20, while analysts from the Bank of New York Mellon say it could drop to $1.10.

Other forecasts are even more dire. "I can easily imagine the euro reaching parity with the dollar by the end of the year, give the markets' tendency to exaggerate," says Anton Börner, president of the Federation of German Wholesale and Foreign Trade. A devaluation of the euro does not, of course, represent a major problem. On the contrary, many have long been complaining about how expensive the euro had become relative to the dollar. Business in China had also suffered, given that the Chinese yuan is pegged to the dollar. That pressure is now dissipating. Indeed, aside from making trips to the US slightly more expensive for Europeans than they have been in the past, there are few disadvantages to a lower euro exchange rate.

But the dropping exchange rate is symptomatic of a phenomenon that does represent significant dangers to the European common currency. "The financial markets simply no longer have faith that Europe will be able to get its debt crisis under control," says Manfred Jäger, a financial market expert at the German Economic Institute in Cologne, says. Mohamed El-Erian, a manager at Pimco, a global leader in the bond market, is even clearer, writing in the Financial Times that, while the €110 billion aid package agreed on by euro-zone countries together with the International Monetary Fund over the weekend may solve Greece's immediate liquidity problems, it will not solve the country's more fundamental solvency issues. Others fear that the money pledged to Athens won't even be enough to bridge the next three years.

Athens has announced numerous austerity measures to get Greece's yawning budget deficit under control -- the most recent package will be adopted by the Greek parliament on Thursday. Still, even as the government has said it will be saving up to €10 billion in 2013 and 2014, the Financial Times Deutschland is reporting that concrete plans for where the cuts are to be made have yet to be announced. A gap of €900 million for 2012 also remains to be filled. Whether Greeks will support the draconian savings measures also remains in doubt, given the rising intensity of the protests there. Just how dramatic the situation has become can be seen by the decision of the European Central Bank to discard its own regulations and accept junk-rated government bonds from Greece as collateral for loans. "That is a blatant violation of its own rules," said Belke of the DIW. "Market actors will remember it for a long time."

Darkening Clouds
The ECB is concerned that the current anxiety on the financial markets could ultimately become an uncontrollable panic threatening the survival of Europe's common currency. Axel Weber, president of Germany's national bank, the Bundesbank, warns that, were Greece to default, it would "represent a serious risk to the stability of the currency union and the financial system, given the current, fragile state of the markets." He says that such a scenario could result in the problem spreading to other euro-zone countries.

Many observers think that the ECB, at a regular scheduled meeting on Thursday, could decide to buy up more Greek bonds. Others predict that the ECB might have to come up with a plan to help other euro-zone countries currently facing difficulties -- like Spain. European banks, after all, own huge quantities of bonds from Greece and other wobbly euro-zone members. Should the ECB follow such a path, it would be one of the last weapons available to ward off a Greek bankruptcy. And should it fail, the clouds hanging low over the euro would darken considerably.

Even the bears aren't bearish enough on Spain's coming sovereign debt problem
by Daryl G. Jones

We often say that investors can be bullish, bearish, or not enough of either. "Our debt is clean, we will not have to ask for help," said Elena Salgado, Spain's finance minister, on April 30th, appealing to the bulls. That is, if there are any bulls left in sovereign debt. Currently, there is no shortage of bearish sentiment regarding global sovereign debt issues. In recent weeks, Greece, Portugal, and Spain have all had their credit ratings downgraded, with Greece taking on junk status.

Yet despite this flurry of negative news, I would submit that investors are still not bearish enough, particularly on Spain.Historically, Greece is consistently an early and serial sovereign debt defaulter. As a result, it is difficult to consider Greece anything but a leading indicator for sovereign debt issues. While Iceland, Ireland, and Portugal all matter to a degree and will likely have accelerating debt issues, we view Spain as the key mispriced and misunderstood sovereign debt risk globally.

Why Spain is mispriced, and why it really matters
Spain, especially relative to Greece and Portugal, has a sizable economy. According to the most recent estimates from the World Bank, Spain was the 9th largest economy in the world in 2009 with a GDP of $1.4 trillion. From a pure geography perspective, it is the second largest country by land size, after France, in the European Union. It also has a government budget that is more than four times that of Greece, and a commensurate debt balance.

There are two ways we look at how likely a country is to default on its debt. First, we consider the ratio of budget deficit-to-GDP. Here, Spain is clearly in trouble. As of the end of 2009, Spain's ratio was 11.2% of GDP, and set to accelerate in 2010. Historically, anything beyond 10% is in the danger zone of potential for sovereign debt downgrades, and will lead to an acceleration of borrowing costs. Based on that metric, Spain will need roughly 150 billion euros in debt to fund its budget this fiscal year. Our second metric, the ratio of debt-to-GDP, does not look as bad for Spain, with the ratio being a lower than the EU average of 54%.

Yet while favorable at first glance, the reality is that this ratio has doubled in the last year. This ratio will continue to grow as the Spain's budget becomes ever more funded by debt. More importantly, Spaniards have a substantial amount of outstanding debt that has to be rolled over this year. Estimates suggest the figure could be as high as 225 billion euros, of which foreigners hold almost 45%. Considering that the total proposed Greek bailout is 146 billion euros over three years, any potential bailout -- and to be clear, we are not there yet -- would be of an exponentially larger scale than Greece.

The rain in Spain is due to the (subdeveloped) plain
As recently as a few years ago, Spain's leadership in growth and stability were a beacon with the European Union. The reality though, was that Spain's economic growth was predicated on the construction and housing industries. Spain was the poster child for the global housing and real estate boom, bubble, and subsequent bust. In fact, home building and construction spending represented 20% of GDP and 12% of employment at the peak. With an economy that has limited exports, the evaporation of the construction sector as a major engine of growth and employment suggests the Spanish government's estimates of 3% GDP growth in 2011 and beyond are overly optimistic.

Not surprisingly, as went the global construction market, so accelerated Spain's unemployment. Currently Spain's unemployment is sitting at just north of 20%. Both the Sudan and the West Bank are currently more employed than Spain. There is good news, though: according to Minister Salgado only 290,000 jobs were destroyed in the first quarter of 2010. Good news, of course, is always relative. Another debt issue as it relates to Spain's fiscal health is private indebtedness, currently at 178% of GDP, according to the recent S&P report that downgraded Spain's long-term sovereign debt. A substantial portion of this debt relates to mortgages and home financing. While defaults have been increasing -- doubling for the last three years in fact -- we believe they are set to accelerate one again due to unemployment and the timing of benefits.

Spain has a very generous unemployment system that pays the unemployed 65% of the average national earnings for up to two years for those who have worked for the prior six years. The risk, of course, is that as these benefits begin to run out, the ability of the unemployed to pay their mortgages diminishes substantially, which could lead to broad issues for the Spanish banking system. As noted in the introductory quote, the Spanish leadership does not believe they have to ask for help. In the short term that may be true. In the longer term, they will have to show that they can help themselves. Spain is not Greece, we agree with that. But if the Spaniards do not change their trajectory, they have the potential to be much more than Greece. And that potential is still not priced into the market for their sovereign debt.

Euro weakens as investors shun Greece debt
by Ambrose Evans-Pritchard

The euro continued to weaken and bond investors remained nervous of ahead of a crucial European Central Bank meeting and a "crossroads" summit of eurozone leaders. The single currency fell to a 14-month low against the dollar of $1.2737 and spreads on Greek, Spanish and Portuguese government bonds continued to widen. Financial markets want to see what the ECB governors will say as they try to rein in the Greek debt crisis and keep it from overwhelming the 16-nation eurozone.

European shares edged higher on Thursday as investors focused on corporate news from BNP Paribas and Commerzbank rather than fears of contagion from Greek debt crisis which has depressed markets this week. London's FTSE 100 was up 0.4pc as the country went to the polls, Germany's DAX rose 0.6pc and France's CAC 40 gained 0.5pc. Senitment was not helped as Moody's ratings agency said banking systems in Portugal, Italy, Spain, Ireland and Britain would be threatened if the debt crisis spread around Europe.

The ECB meeting got underway in Lisbon as Greece braced for more protests and European Union leaders sought to contain the biggest challenge yet to Europe's fledgling single currency. Jean-Claude, the ECB President, is under pressure to do more to calm markets after a €110bn (£95bn) bailout for Greece from the eurozone and International Monetary Fund failed to assuage concerns. The central bank left its benchmark interest rate unchanged at a historic low Thursday but all eyes are on what Mr Trichet will say when he comments on the decision later.

Any decision on how to defend the euro, such as assets purchase, reintroducing emergency lending measures and diluting collateral rules further, will face opposition. Axel Weber, the Bundesbank President, yesterday said the threat of contagion from Greece´s fiscal crisis doesn´t merit "using every means", rebuffing calls for the ECB to consider buying government bonds. US economist Nouriel Roubini said the main issue is not Greece, "but the gathering contagion to the rest of the eurozone".

The cost of borrowing for Portugal and neighbouring Spain has climbed as public deficits have ballooned to more than three times above the eurozone's limit of 3pc of output. Yesterday, Greek President Carolos Papoulias said the nation had "reached the edge of the abyss" after a firebomb hurled during protests left three people dead in a bank. Earlier, Asian markets fell heavily, with Japan's index down 3.3pc, although Wall Street was expected to edge up on the open.

Pimco attacks ratings agencies over Greek crisis
by Angela Monaghan

Pimco has launched a scathing attack on the ratings agencies, accusing them of allowing the crisis in Greece to occur because of their "blind faith" in sovereign solvency. Bill Gross, managing director of the world's largest bond house, said Moody's, Standard & Poor's and Fitch lacked common sense and had foisted AAA ratings and the idea that countries do not go bust on "unsuspecting" investors. "Their warnings were more than tardy when it came to the Enrons and the Worldcoms of 10 years past, and most recently their blind faith in sovereign solvency has led to egregious excess in Greece and their southern neighbours," he said.

"The result has been the foisting of AAA ratings on an unsuspecting (and ignorant) investment public who bought the rating service Kool-Aid that housing prices could never really go down or that countries don't go bankrupt." Mr Gross appeared to ridicule the decision by S&P to downgrade Spain one notch to AA from AA+, and to caution the country that it could face another downgrade. "Oooh – so tough!," he said. He also criticised Moody's and Fitch for maintaining Spain's AAA rating, despite a 20pc unemployment rate, a recent current account deficit of 10pc, a record of defaulting 13 times in the past two centuries, and despite its bonds already trading at Baa levels.

"Their quantitative models appeared to have a Mensa-like IQ of at least 160, but their common sense rating was closer to 60, resembling an idiot savant with a full command of the mathematics, but no idea of how to apply them," he said of the ratings agencies. S&P and Fitch declined to comment. Moody's did not respond. The ratings agencies have played a prominent role during the crisis as countries including Greece have allowed deficit levels to spiral. The UK has been warned that it could be stripped of its prestigious AAA rating if a credible plan to reduce the record deficit is not produced by the next government.

Despite his strongly-worded criticism, Mr Gross said the ratings agencies could not die altogether, because they served a necessary and productive purpose when properly managed and regulated. "A certain portion of the investment world will always need them to "justify" the quality of their portfolios. Governments and regulatory bodies say so – it's the law," he said. However Mr Gross advised investors seeking to profit at their expense to "dismiss" the ratings agencies. He said ratings services were overpriced, "as well as subject to the influence of the issuer, which in turn muddles their minds and clouds their judgment to say the least.

Merkel plea to save Europe as contagion hits Iberia
by Ambrose Evans-Pritchard

Europe's debt markets are flashing danger signals after spreads on Iberian debt reached the highest level since the launch of the euro and investors rushed for safety into German notes, prompting warnings from German Chancellor Angela Merkel that the European Project itself is at risk. "Contagion pressures continue to rage unabated," said Marco Annunziata, Europe economist at UniCredit. "The flames have rushed through the firewall of the IMF/EU programme for Greece and now threaten other peripheral countries." "While the sell-off on sovereign bond markets so far remains discriminating, the risk that it might suddenly mutate into irrational panic can no longer be ignored. Eurozone policymakers need to take further steps quickly," he said.
Mrs Merkel made a moving plea to the Bundestag to support the €110bn (£93bn) rescue for Greece. "Nothing less than the future of Europe is at stake. The happy tale of German history since World War Two and our emergence as a free, united, and strong country cannot be separated from the European Union. We owe decades of peace and prosperity to the understanding of our neighbours," she said. "Europe today is looking to Germany. As the strongest economy in Europe, Germany has a special responsibility and it takes this responsibility to heart. "Immediate help is needed to ensure the financial stability of the eurozone. This must be done to avoid a chain-reaction to the European and international financial system, and contagion to other eurozone states. There is no alternative."

Belated support from Berlin has failed to stop the crisis escalating. Spreads on Portuguese 10-year bonds soared to a post-EMU record of 290 basis points above Bunds; Spanish spreads rose to 131. Bank shares in Madrid slid again, with falls of 4.9pc for Banco Popular, 3.6pc for BBVA, and 2.5pc for Santander Bundesbank chief Axel Weber said there was a "grave threat of contagion", echoing the formula now being used by German officials to justify the rescue. Berlin hopes the wording will head off a legal challenge at the constititional court.

Flight to safety has driven the yield on two-year German debt to an all-time low of 0.59pc. Andrew Guy, managing director of ADG, said the rate had dropped below the three-month euribor rate in a sign of stress. "The last time this happened was August 2007 at the beginning of the financial crisis," he said. One credit expert said events risk mutating into a full-blown `Lehman disaster' unless the European Central Bank opts for massive bond purchases. Spreads on Greek debt exploded again as tens of thousands of demonstrators took to the streets and three people died in an attack on the Marfin Bank in Athens. "A demonstration is one thing, murder is quite another," said premier George Papandreou.

The key cities were paralized by a general strike. "The country cannot surrender without a fight," said Yiannis Panagopoulos, head of the GSEE private sector union. Unity fractured further after the New Democracy oppostion party broke ranks and votee against the austerity measures. Markets view the EU-IMF package for Greece as a politically-shaped response that cannot work because it shuts off the twin cures of debt restructuring and devaluation, leaving the burden of adjustment on the Greek people. If Greeks come to view the plan as a rescue for foreign banks and funds – as many already do – there is no chance of carrying the nation through five years of harsh austerity

Dominique Strauss-Khan, the head of the IMF, admitted that the plan was flawed, telling Le Parisien that the EU was charging excessive interest rates at 5pc. He said Europe must "urgently" create some form of fiscal union to shore up EMU, describing the euro as a half-finsihed job. Many investors view the EU-IMF plan as a "quick fix" that puts off the day of reckoning. Bill Gross, head of the US bond fund Pimco, said a "restructuring event" was inevitable in the end.

Julian Callow from Barclays Capital said Greece must reduce its primary budget balance by 14.5pc of GDP over five years, a task that is "unprecedented in European experience". The country will end up with a debt of 151pc, even it if complies. Since tax rises and wage cuts entail a protracted slump that crushes tax revenue, Greece may find itself in a deflationary spiral that feeds on itself. There is mounting concern that the IMF is squandering its fire-power on a dubious plan, rather than ring-fencing Greece with a controlled default and reserving its clout to defend a more credible line on Iberian debt – which is what really matters for Europe's banks. By failing to fix achievable priorities, the IMF risks a drift into deeper crisis.

Greece’s Stumble Follows a Headlong Rush Into the Euro
by Dan Bilefsky

The economic challenges facing the European Union unsettled investors around the globe on Tuesday as hundreds of demonstrators took to the streets in Greece, unfurling banners over the Acropolis to protest the government’s new austerity measures. It was not supposed to be this way when Greece, eager to join first the European Union, then the euro zone, pledged financial overhaul. “Now we are paying the price for the fact that we lived above our means, with amazing profligacy, and failed to reduce the role of the state,” said Yannos Papantoniou, the former Greek finance minister. “Some say we should have done more.”

The recent crisis is in many ways a peculiarly Greek tragedy. It is rooted in an ancient nation’s epic spending and abetted by the hubris of European leaders whose desire for integration at any cost compelled them to allow political considerations to trump economic realities. In April 1997, Mr. Papantoniou implored his fellow European Union officials at a meeting in Brussels to print some of the future euro notes in Greek letters. A stern-faced Theodor Waigel, Germany’s finance minister at the time, weighed in. Latin characters only, he insisted.

Besides, as Mr. Papantoniou recalls the argument by Mr. Waigel, poor small Greece was in no position to make demands. “He said to me, ‘What makes you think you will ever be in the euro?’” Mr. Papantoniou, a socialist who shepherded Greece’s entry into the euro, had the last word. “I fought hard, and placed a bet with him then and there — and I won.” Now, as Greece’s European Union partners prepare to bail out the debt-ridden country — the first time the 16-nation euro zone has been forced to rescue one of its members — many critics, inside and outside of the country, are wishing that Mr. Papantoniou had lost his bet. Concerns are growing that contagion could spread to other countries on Europe’s southern tier and even infect the Continent’s banking system.

By some accounts, Europe’s current plight can be traced to 1981, when Greece, still emerging from the aftermath of a military dictatorship, rushed to join the European Community — 14 years ahead of the much richer Austria, Finland and Sweden and even five years before Spain and Portugal. At the time, President Francois Mitterrand of France opposed the bloc’s southward expansion, fearing that countries like Greece were not ready. But those in favor of expansion carried the day, arguing that linking countries like Greece, Spain and Portugal to European structures was the best means to modernize their fragile democracies.

And for Europe’s classically educated leaders, who viewed Greece as the cradle of democracy, tying the poor Balkan country to Western Europe, despite its geographic remoteness at the time from the other European Community members, was, Mr. Papantoniou recalled, “an historic mission.” During its first decade of membership, the European Union’s generous subsidies helped catapult Greece out of its Balkan backwardness. By the time 1997 came around, and Europe’s leaders prepared to introduce the single currency, some were hailing Greece, enjoying steady economic growth of more than 3 percent under the then Socialist government of the prime minister, Costas Simitis, as a plucky economic stalwart.

For Athens, Mr. Papantoniou recalled that joining the euro was a matter of pride and necessity, as it would stabilize the country’s economy by fending off predatory speculators, while allowing Greece access to credit at low interest rates because it was part of the rich euro club. “Once we were in line to join the euro, we started to transform from a third world country to one that aspired to look more like Switzerland,” he said. But Greece’s path to the euro was far from assured. Public opinion in Germany, scarred by the memory of wartime hyperinflation, was always wary of giving up the Deutsche mark, and the German government insisted on tough conditions for the countries that wanted to join. Budget deficits were supposed to be below 3 percent of gross domestic product; debt was not to exceed 60 percent of G.D.P. and inflation could not top 3 percent.

In December 1996, the currency’s rules were toughened in a so-called Stability Pact, intended to punish with costly fines countries that persistently broke the rules once inside the euro zone. The unspoken intention was to raise the barrier for Southern European countries, which were seen as having looser, more inflationary economic policies. Germany wanted the fines to be automatic, but other countries, led by France, put the onus of enforcement on political leaders in the European Union. (No country, Greece included, has ever been fined even though the rules have been routinely broken by most countries in the euro zone.)

The euro was fundamentally a political creation, which meant that the rules could be bent when deciding whom to admit. So, when 11 nations locked their currencies in January 1999 — the first stage in the creation of the euro — they included Italy, Belgium, Spain and Portugal. Greece failed to join because of budgetary and inflationary problems. The European Central Bank expressed concern about Greek finances as early as 2000, noting in a report that Greece’s total debt was far above the prescribed limit. Still, Athens kept up the pressure to be admitted in time for the introduction of euro notes and coins in 2002. Mr. Simitis, who had taught at a German university in the 1970s, adroitly lobbied German politicians and bankers, mindful of their resistance.

In the end, Greece joined a year earlier than expected, in January 2001. It had — on paper — slashed its budget deficit. And, while it had not reduced its debt enough, it invoked the precedents of other countries, like Italy and Belgium, that had been allowed in despite breaching the limit. The political imperative of keeping the euro on track silenced any critics. “At the time there were clear indications that the Greeks were forging the data, especially data on deficits to make their public finance situation look more benign than it really was,” said Jürgen von Hagen, professor of economics at the University of Bonn. “But European governments did not want to pay attention. For political reasons they wanted Greece in.”

The laxity with regard to fiscal discipline extended to the biggest players in the euro club. In 2002, 2003 and 2004, even Germany and France breached the deficit rules, creating a dangerous precedent. By 2004, it was clear that the Greek economic data was faulty. The European Union opened its first investigation into Greece’s deficit. Despite evidence compiled by Eurostat, the union’s official statistics agency, that Athens had fudged its numbers, European officials made clear that ejecting Greece from the euro zone was not an option.

Mr. Papantoniou, the former finance minister, blamed the discrepancy in the deficit figures on a change of accounting rules under the center-right government of Kostas Karamanlis, who came to power after the Socialists were ousted in March 2004 and altered the way military spending had been calculated. “It’s a big lie that the Greeks falsified the statistics,” he said. Tommaso Padoa-Schioppa, a former executive board member of the European Central Bank, recalled that after questions arose about the accuracy of Greek financial data, many countries shot down attempts to strengthen Eurostat’s oversight powers

“The fact is that an opportunity was lost at the time,” he said. “Greece is to blame for its poor management of public finance and competitiveness. But the peers have to be blamed for not doing their job sufficiently well.” But even apart from the statistics debacle, Greece’s economy soon lurched from bad to worse. Mr. Karamanlis went on a spending spree to prepare for the 2004 Summer Olympics; the increased security costs imposed after the Sept. 11 terrorist attacks in 2001 pushed the price tag even higher.

More broadly, said Yiannis Stournaras, a leading economist and former adviser to the ruling Socialist Party, Greece treated entry into the euro as an invitation to party. “Instead of cutting the deficit and liberalizing the economy,” he said, “the country continued to spend.” Governments on both the left and right failed to overhaul a bloated public sector. The latest demonstrations in response to the government’s new austerity measures have been largely peaceful and muted by Greek standards, suggesting that a majority of Greeks are now resigned to more fundamental change, the type that it has skirted for several decades.

Iceland Arrests Ex-Kaupthing Bank CEO
Icelandic authorities arrested the former chief executive of collapsed bank Kaupthing on Thursday—the first high-profile banker to be detained in the wake of the tiny Nordic country's financial crisis. The special prosecutor tasked with investigating the Icelandic banking crash of October 2008 said that Hreidar Mar Sigurdsson is suspected of falsifying documents and breaking laws on stock trading for personal gain.

Mr. Sigurdsson is being held in police custody until a bail hearing Friday at the Reykjavik District Court. Prosecutor Olafur Thor Hauksson said he planned to ask that the former banker be kept in custody for two weeks to prevent the possibility of him tampering with evidence or interfering with the ongoing investigation. Mr. Sigurdsson can appeal to the Supreme Court if the prosecutor's request is granted in the district court. Mr. Hauksson was appointed by the Iceland's post-crisis government to investigate whether there was any criminal activity in the lead up to the banking crash that crippled Iceland's economy, sending its currency into a tailspin, frightening off foreign investors and forcing out the country's former leaders.

Britain's Serious Fraud Office is still carrying out its own investigation into suspected fraud at Kaupthing, with a focus on efforts by the bank to attract British investors to its "high yield" deposit account, Kaupthing Edge. About 30,000 British individuals, companies and organizations made an investment. When it opened the investigation in December, the British agency said it would work with the Icelandic special prosecutor as it also looked closely at a series of decisions that appear to have allowed substantial value to be extracted from the bank in the weeks and days prior to its collapse. The demise of Kaupthing, one of several Icelandic banks to collapse, sparked a political row between Reyjkavik and London because it failed after the British government invoked antiterrorist legislation to freeze the U.K. assets of another collapsed Icelandic bank, Landsbanki.

Britain's Treasury said the move was necessary to ensure the money that British savers had placed in the bank would not be whisked back to Iceland. But Iceland's prime minister at the time, Geir Haarde, blasted the move as an "unfriendly act" and blamed the decision for inspiring panic that led to the subsequent collapse of Kaupthing. A cross-party committee of British lawmakers was later critical of London's handling of the situation, saying that the government's statements on the ability and willingness of Reykjavik to compensate non-Icelandic account holders was "ultimately unhelpful."

Forget sub-prime mortgages. It's the sub-prime financial system we need to fix
by Nouriel Roubini and Stephen Mihm

An extract from a new book by Nouriel Roubini and Stephen Mihm.

For the past half century, academic economists, Wall Street traders, and everyone in between have been led astray by fairy tales about the wonders of unregulated markets and the limitless benefits of financial innovation. The crisis dealt a body blow to that belief system, but nothing has replaced it. That’s all too evident in the timid reform proposals currently being considered in the United States and other advanced economies.

Even though they have suffered the worst financial crisis in generations, many countries have shown a remarkable reluctance to inaugurate the sort of wholesale reform necessary to bring the financial system to heel. Instead, people talk of tinkering with the financial system, as if what just happened was caused by a few bad mortgages. Throughout most of 2009, Goldman Sachs chief executive Lloyd Blankfein repeatedly tried to quash calls for sweeping regulation of the financial system. In speeches and in testimony before Congress, he begged his listeners to keep financial innovation alive and “resist a response that is solely designed to protect us against the 100-year storm”.

That’s ridiculous. What we’ve experienced wasn’t some crazy once-in-a-century event. Since its founding, the United States has suffered from brutal banking crises and other financial disasters on a regular basis. Throughout the 19th and early 20th centuries, crippling panics and depressions hit the nation again and again. The crisis was less a function of sub-prime mortgages than of a sub-prime financial system. Thanks to everything from warped compensation structures to corrupt ratings agencies, the global financial system rotted from the inside out. The financial crisis merely ripped the sleek and shiny skin off what had become, over the years, a gangrenous mess. The road to recovery will be a long one.

For starters, traders and bankers must be compensated in a way that brings their interests in alignment with those of shareholders. That doesn’t necessarily mean less compensation, even if that’s desirable for other reasons; it merely means that employees of financial firms should be paid in ways that encourage them to look out for the long-term interests of the firms. Securitisation must be overhauled as well. Simplistic solutions, such as asking banks to retain some of the risk, won’t be enough; far more radical reforms will be necessary. Securitisation must have far greater transparency and standardisation, and the products of the securitisation pipeline must be heavily regulated. Most important of all, the loans going into the securitisation pipeline must be subject to far greater scrutiny.

The mortgages and other loans must be of high quality, or if not, they must be very clearly identified as less than prime and therefore risky. Some people believe that securitisation should be abolished. That’s short-sighted: properly reformed, securitisation can be a valuable tool that reduces, rather than exacerbates, systemic risk. But in order for it to work, it must operate in a far more transparent and standardised fashion than it does now. Absent this shift, accurately pricing these securities, much less reviving the market for securitisation, is next to impossible. What we need are reforms that deliver the peace of mind that the Food and Drug Administration (FDA) did when it was created.

Let’s begin with standardisation. At the present time, there is little standardisation in the way asset-backed securities are put together. The “deal structures” (the fine print) can vary greatly from offering to offering. Monthly reports on deals (“monthly service performance reports”) also vary greatly in level of detail provided. This information should be standardised and pooled in one place. It could be done through private channels or, better, under the auspices of the federal government. For example, the Securities and Exchange Commission (SEC) could require anyone issuing asset-backed securities to disclose a range of standard information on everything from the assets or original loans to the amounts paid to the individuals or institutions that originated the security. 

Precisely how this information is standardised doesn’t matter, so long as it is done: we must have some way to compare these different kinds of securities so they can be accurately priced. At the present time, we are stymied by a serious apples-and-oranges problem: the absence of standardisation makes comparing them with any accuracy impossible. Put differently, the current system gives us no way to quantify risk; there’s far too much uncertainty. Standardisation, once achieved, would inevitably create more liquid and transparent markets for these securities. That’s well and good, but a few caveats also come to mind.

First, bringing some transparency to plain-vanilla asset-backed securities is relatively easy; it’s more difficult to do so with preposterously complicated securities like Collateralised Debt Obligations (CDOs), much less chimerical creations like the CDO2 and the CDO3. Think for a moment about what goes into a typical CDO. Start with a thousand different individual loans, be they commercial mortgages, residential mortgages, auto loans, credit card receivables, small business loans, student loans, or corporate loans. Package them together into an asset-backed security (ABS). Take that ABS and combine it with 99 other ABSs so that you have 100 of them. That’s your CDO. Now take that CDO and combine it with another 99 different CDOs, each of which has its own unique mix of ABSs and underlying assets.

Do the maths: in theory, the purchaser of this CDO is supposed to somehow get a handle on the health of 10m underlying loans. Is that going to happen? Of course not. For that reason, securities like CDOs — which now go by the nickname of Chernobyl Death Obligations — must be heavily regulated if not banned. In their present incarnation, they are too estranged from the assets that give them value and are next to impossible to standardise. Thanks in large part to their individual complexity, they don’t transfer risk so much as mask it under the cover of esoteric and ultimately misleading risk-management strategies. In fact, the curious career of CDOs and other toxic securities brings to mind another, less celebrated acronym: GIGO, or “garbage in, garbage out”. 

Or to use a sausage-making metaphor: if you put rat meat and trichinosis-laced pig parts into your sausage, then combine it with lots of other kinds of sausage (each filled with equally nasty stuff), you haven’t solved the problem; you still have some pretty sickening sausage. The most important angle of securitisation reform, then, is the quality of the ingredients. In the end, the problem with securitisation is less that the ingredients were sliced and diced beyond recognition than that much of what went into these securities was never very good in the first place. Put differently, the problem with originate-and-distribute lies less with the distribution than with the origination. What matters most is the creditworthiness of the loans issued in the first place. 

Equally comprehensive reforms must be imposed on the kinds of deadly derivatives that blew up in the recent crisis. So-called over-the-counter derivatives — better described as under-the-table — must be hauled into the light of day, put on central clearing houses and exchanges and registered in databases; their use must be appropriately restricted. Moreover, the regulation of derivatives should be consolidated under a single regulator. The ratings agencies must also be collared and forced to change their business model. That they now derive their revenue from the firms they rate has created a massive conflict of interests. Investors should be paying for ratings on debt, not the institutions that issue the debt. Nor should the rating agencies be permitted to sell “consulting” services on the side to issuers of debt; that creates another conflict of interests. Finally, the business of rating debt should be thrown open to far more competition. At the present time, a handful of firms have far too much power.

Even more radical reforms must be implemented as well. Certain institutions considered too big to fail must be broken up, including Goldman Sachs and Citigroup. But many other, less visible, firms deserve to be dismantled as well. Moreover, Congress should resurrect the Glass-Steagall banking legislation that it repealed a decade ago but also go further, updating it to reflect the far greater challenges posed not only by banks but by the shadow banking system. These reforms are sensible, but even the most carefully conceived regulations can go awry. Financial firms habitually engage in arbitrage, moving their operations from a well-regulated domain to one outside government purview.

The fragmented, decentralised state of regulation in the United States has exacerbated this problem. So has the fact that the profession of financial regulator has, until very recently, been considered a dead-end, poorly-paid job. Most of these problems can be addressed. Regulations can be carefully crafted with an eye toward the future, closing loopholes before they open. That means resisting the understandable impulse to apply regulations only to a select class of firms — the too-big-too-fail institutions, for example — and instead imposing them across the board, in order to prevent financial intermediation from moving to smaller, less-regulated firms.

Likewise, regulation can and should be consolidated in the hands of fewer, more powerful regulators. And most important of all, regulators can be compensated in a manner befitting the key role they play in safeguarding our financial security. Central banks arguably have the most power — and the most responsibility — to protect the financial system. In recent years, they have performed poorly. They have failed to enforce their own regulation, and worse, they have done nothing to prevent speculative manias from spinning out of control. If anything, they have fed those bubbles, and then, as if to compensate, have done everything in their power to save the victims of the inevitable crash.

That’s inexcusable. In the future, central banks must proactively use monetary policy and credit policy to rein in and tame speculative bubbles. Central banks alone can’t handle the challenges facing the global economy. Large and destabilising global current account imbalances threaten long-term economic stability, as does the risk of a rapidly depreciating dollar; addressing both problems requires a new commitment to international economic governance. The International Monetary Fund (IMF) must be strengthened and given the power to supply the makings of a new international reserve currency. And how the IMF governs itself must be seriously reformed.

For too long, a handful of smaller, ageing economies have dominated IMF governance. Emerging economies must be given their rightful place at the table, a move reinforced by the rising power and influence of the G20 group. All of these reforms will help reduce the incidence of crises, but they will not drive them to extinction. As the economist Hyman Minsky once observed: “There is no possibility that we can ever set this right once and for all; instability, put to test by one set of reforms, will, after time, emerge in a new guise.” Crises cannot be abolished; like hurricanes, they can only be managed and mitigated. Paradoxically, this unsettling truth should give us hope.

In the depths of the Great Depression, politicians and policy-makers embraced reforms of the financial system that laid the foundation for nearly 80 years of stability and security. It inevitably unravelled, but 80 years is a long time — a lifetime. As we contemplate the future of finance from the mire of our own recent Great Recession, we could do well to try to emulate that achievement. Nothing lasts forever, and crises will always return. But they need not loom so large; they need not overshadow our economic existence. If we strengthen the levees that surround our financial system, we can weather crises in the coming years. Though the waters may rise, we will remain dry. But if we fail to prepare for the inevitable hurricanes — if we delude ourselves, thinking that our antiquated defences will never be breached again — we face the prospect of many future floods.


EconomicDisconnect said...

Spot on and a great write up. There is so much being exposed today and while it relastes to the stock market action (they could not hide that) it is but a reflection of all that is around us.

VK said...

So now what will CNBC's propaganda machine use, that fat fingering is being carried over into the Asian markets? That a 4%+ decline in the Nikkei is cool?

The USD/JPY action led the way, the charts are clear on that. Something is brewing, either in China or Japan. If the Chinese bubble bursts we're going to see a massive flight to safety to the YEN IMO.

EBrown said...

I spent a few more hours on the hill today and saw some "flies" going tree to tree, but thy were few and far between. I wonder what drives insects to move about. Yesterday seemed like a perfect day to me, sunny 60s to 70s and no wind. All I saw was that one bumble. Today was chilly, cloudy, rained breifly a few times and there were gusts of wind. If I were a small winged insect I'd have gone out yesterday and sat under a leaf today. But today I saw at least a few flies, though not what I'd consider a reasonable number with how many blossoms there are to be visited. Perhaps poor weather deters insectivorous birds so the flies brave the breeze and rain in return for less predation. I didn't see any swallows today and I've been seeing them fairly regularly recently... I wonder...

Stoneleigh said...

For what it's worth, I don't think the 'PPT' has any real power at all. They're just the little man behind the curtain whom everyone thinks is powerful. It's just a confidence trick to keep ordinary people invested - thinking that someone is watching their backs. No one is watching their backs. Quite the opposite in fact. The confidence trick is all about keeping the little people invested as the insiders cash out. It's about creating a new group of empty bag holders, as it always is.

Today's move is a foretaste of what's to come as the next phase of the decline gets underway - extreme volatility driven by fear. Did you see the rioting in Greece? All of us will be doing that soon enough. The austerity measures will be crushing. The little people who just lost whatever they had in the markets will be primed to lose whatever they have in the banks followed by whatever they thought they had in entitlements - pensions, medicare etc.

This is how excess claims are extinguished - on the backs of people who worked hard all their lives only to be sold an impossible dream.

We had a gift of an extra 6 months to prepare. People were complaining that the downturn didn't come soon enough. Be careful what you ask for - you might get it. When the next phase of the decline gets underway we will wish the rally had continued longer.

We can expect downward momentum to build. Markets don't crash right out of the gate once the mood turns, but declines do unfold rapidly in comparison with advances, because fear is a much sharper emotion than hope and greed.

This phase of the decline is likely to ride on a wave of sovereign debt contagion. Contagion is just another name for the spread of fear, with no rational component at all. IMO Europe will be at its centre, with some of the largest housing bubbles in the world and far too much exposure to each other's bad debts. In bad times Europeans are likely to remember that they didn't like each other much only a few short decades ago. (And I say this as a European who has always been a great fan of unity.)

Stoneleigh said...


The yen will go through the roof IMO. The yen carry trade fueled global liquidity for years and has yet to unwind. When it does it will amount to a moon shot that could even outshine the expected rise in the USD.

The Chinese bubble is indeed self-limiting, as all bubbles are. I think China is the empire in the ascendancy, but not until it lives through the set back at the dawn of the Chinese Century, as the US lived through the set back at the dawn of the American century in the 1930s. All of us are in for a brutal decade at the least.

In China's case the gender imbalance will give them a convenient standing army with which to press their advantage - not yet, but eventually. No challenger takes on a hegemonic power without first weakening it (as in giving it enough rope to hang itself).

VK said...

Thanks for the much needed comments Stoneleigh. I am still frazzled by what I witnessed today!! It was epic.
Time to say the Lloyd's prayer :p

Fuser said...

I wonder if Cramer would have looked as correct if the market shot up 1,000 points. I'm guessing he would have claimed it was the ultimate rally and proof the world economy was stronger than any expected.

Shamba said...

Say, haven't we met Harry and Sallie before? (They seem a bit familiar but I'm not sure.)
They look well, :) Maybe better than the rest of us, if we watched financial "events" today.

I'm NOT complaining about seeing H and S again, I'm just wondering.

peace, Shamba

Ric said...

As Gerald Celente says: If people lose everything, and they have nothing left to lose, they lose it.

Actually, there are two collapses--one public and the other unspeakable. Most on this board are legitimately concerned about collapsing social systems--and we're concerned about what the other guy does. We're concerned about our families and wherewithal. The unspeakable collapse is mental--when people's minds go. This is where most of our fear comes from--what will we do when the other guy loses it? Few people consider the process of one's own mind going. We tend to think such events are impossible, improbable, unbelievable, or inconceivable. Until it happens. People talk about preparing "mentally"--but IMO I've seen little mental preparation for mental collapse anywhere on online discussion boards. Social collapse is a normal, rational process that readjusts unsustainable enthusiasms and ideas--so is mental collapse.

I've had several conversations with an ex-member of this board who speaks graphically about his own mental collapse after losing his job. What's interesting to me is that posting to this board then became irrelevent to him as his mind adjusted to how to survive his collapse. The point about collapse is not that it happens, or can't happen, or how to prevent it--but what happens afterward. The sun rises and there's a new system--a new person. Whether this new system and/or person is worth anything depends on the people, luck, and preparation.

EconomicDisconnect said...

I was on vacation and just noticed Stoneleigh will be in Massachusetts on May 21!!!!!!! I am so excited! I will so be there. I will recruit more readers from the area. Email to follow. What a treat.

Stoneleigh said...


What's interesting to me is that posting to this board then became irrelevent to him as his mind adjusted to how to survive his collapse. The point about collapse is not that it happens, or can't happen, or how to prevent it--but what happens afterward.

I hope this board can be a place where people can come and share their feelings about what is happening to them and to those around them. Feelings shared need not hit quite so hard. We have broad shoulders here. People can cry on them if they need to.

Stoneleigh said...


I'll see you there :)

Anonymous said...

Stoneleigh wrote "I hope this board can be a place where people can come and share their feelings about what is happening to them and to those around them. "

What I see of those around me is shopping fever. The malls in Denver are packed to the doors. The Apple stores are a mob scene.

On the other hand, being in the construction industry, I hear that sales are down in roofing even with record hailstorms last year. Painting and stucco companies that a few years ago were turning down work are now going bankrupt. New construction is so slow it's almost at a standstill.

Where are those hoards at the mall getting their disposable income? There is a very palpable and confusing mixed message in Denver.

I have also spent time in Santa Monica and the Chicago area recently and everything in those places seems normal -- even euphoric.

I really don't get it. I don't know if it's just construction that's taking one for the team, or what.

el gallinazo said...

I love Gerald Celente and think he is really in touch with what's happening, but his prediction that the US government is going to devalue the dollar baffles me. Uncle Benny has been trying to devalue the dollar for quite a while now without success. Back in the good old days of FDR it was simple:

1) Confiscate all the private gold
2) Change the redemption of FRN from $20 per ounce to $35 an ounce.

But we live in a fiat currency now where the dollar is marked to fantasy. Its value is two parts psychological habit and inertia and one part fear of the taxman. So how exactly is this dollar to be devalued? And what exactly does this mean? Devalue it in terms of forex to the Euro and the Yen? Devalue it in relationship to how many eggs or chicken feet you can buy with one?

No one wants to devalue its currency more than Japan and look at the success they are having with it (snark).

$$$Dollar$$$ said...


Do you think we will get out of 2010 before the decline starts? I am hoping we can at least make it to 2011 before the wheels fall of the bus. That said, with what happened today I certainly don't have confidence it won't.

snuffy said...

Hi folks.Its snuffy,back from the tech wars.

I dropped out of here to gamble on re-establishing myself in a field I had not done in a very,very long time...and won big.2 fat contacts..a bunch of money..all the bills&taxes paid..
Details will need to remain sketchy....
I got my Groove back...

And I saw a lot of dark things out on "the road"....Dead factories.The worst roads I have ever seen in a city...lots and lots and lots of un-employed folks.

Those that are working have very careful blinders on...dont want to see whats happening...ignoring as much as they can...dont speak of it,dont want to talk of it...I talked to one guy from Detroit who spoke in a hushed tone about talk of tearing down half or more of his city...

I gambled and it worked.I am high prep mode and have had a silly grin on my face for a couple of weeks....

Wheres El G?

later..I have to sleep.


el gallinazo said...

Hey Snuffy,

Great to have you back on board. And congratulation on your good luck which I am sure involved a lot of hard and smart work.

I am in Panama but will be moving on to Argentina before the month is out. Have a lovely buzzardess there.

Punxsutawney said...

Regarding Bees,

I have found here in Oregon that Mason bees do quite well. They originally adopted us when they found that the holes in a large decorative rock on our porch are perfectly sized for nesting. (Fortunately our instint was to figure out what they were, not to grab a can of RAID). Since learning a bit more about them, we put out a couple of nesting containers full of tubes as well and they fill up each year. Tubes should be changed each year to lessen the chance of parasites and disease.

I can't say how good a job they do at pollinating, but the crab-apple is full of fruit every year.

Otherwise the bumble bees do a great job on the sunflowers late in the summer, but I don't usually see many early in spring though I did see one checking out the blue berries this evening.

Anonymous said...

Forgive my niggling (or don't) but:


"There are" versus "there is".

Let's undo your use of the "there's" contraction to find out how this works (or doesn't work, as the case may be):

1) "There's no winners"

Is really:

There is no winners.

Which should obviously read:

There are no winners.

2) "there's only losers"

Is really:

there is only losers

Which should obviously read:

there are only losers

3) "There's no pitchforks or nooses"

Is really:

There is no pitchforks or nooses

Which should obviously read:

There are no pitchforks or nooses

4) "there's isn't"

Is really:

there is is not

Which should obviously read:

there is not

(this one is probably a legitimate typo but you use "there's" so regularly incorrectly one can't make that assumption)


All of which is to say, you have so much important information to share, why not do it using the best language possible?

Starcade said...

That was not a fat finger.

That was either somebody jawboning somebody and LITERALLY saying _and executing_ "The world's going to end if you don't bail out Greece right fucking now!!!", or a basic admission that there is NOTHING in this market but government intervention and HFT.

That is, there are NO BIDS AT ALL after a very narrow (and upward) motif. And that's across the board.

There was at least one rumor that said this thing was actually caused when all the meaningful Euro banks just stopped lending -- completely. As in zero liquidity left.

That is what makes that Euro chart scary -- it's already down about 5% in one week -- and, at the rate it's falling, you might be looking at parity with the US Dollar by summer.

Starcade said...

Stoneleigh, today reinforced my conviction that the government effectively owns all stocks, any time it really so chooses -- and that the PPT exists, and it's the only reason we didn't circuit-breaker out down 20% today.

Starcade said...

$$$Dollar$$$: The only way we get out of the summer is if some massive manipulation happens.

People very close to me will be dead very, very soon as a result. I just pray they don't kill me with them.

Lukas said...

This is a quick decline but remember, this is the level DOW was at its January highs. I would not be surprised if stocks made new highs in one month or two - but who knows? Anyway, being safe is the best you can do, I can agree with that.

zander said...

@Ric and Stoneleigh,

I've done what I believe to be some mental prep for whats next, but again I wont know what it's like until it hits me in the face so psychological prep. may be moot. Also done some austerity prep. it comes easier to a Scot :)

Hi again Snuffy, always liked your contributions when I first came here.


Stoneleigh said...


I'm very pleased to see you back and extremely happy for your good fortune. May Lady Luck continue to smile on you :)

Linda said...

I was relieved when the DOW fell yesterday. I have no exposure, but it's weird how it keeps going up inspite of everything. It's like watching a child play on a windowsill. I think (psychologically) the fall will be easier if it's not so high to begin with, though the result will be the same. Here's to a lower market today, too.

Dan said...

The sheer amount of systemic DEBT is truly stunning. Virtually incomprehensible. Between the outright frauds of securitization and OTC trading in derivatives, we're talking literally hundreds of trillions of dollars in public and private debt. We crossed the Rubicon viz dramatic social change decades ago, and now the forces are coalescing. I still think that we're looking at events that will unfold over years, decades....but those events will be quite dramatic, millions will suffer, and I am fearful.

Zaphod said...

What happens when human market trading - individuals saying, "hmm, I think I'll sell this and buy that" on a human timescale of weeks, days, and minutes gives way to automated trading and preset limit orders and stop-losses with nanosecond timescales? Well, that's a massive reduction of time-constant, and that can reduce the stability of the system. When you see a system "hitting the rails" like stocks at $0, you can bet there is an inherent stability issue.

Anybody who has ever tried driving at night in the rain on an unfamiliar curvy road knows what happens when you go too fast -- the time-constant of your reaction and control loop becomes too small relative to that of the newly emerging road situation. Slow down, or you'll wreck.

Anybody who has ever invested significantly in a very small company sees this too -- the trading flux just isn't enough to let you get out in a heartbeat, and your have to plan ahead and dribble out your trades or you'll collapse the price single-handedly.

The issue today is that massive, high-trade-rate stocks behaved just like some no-name stock, with too many computers trying to dump at once.

I hear the NYSE said it wasn't their computers, and in a sense it wasn't and in another sense it was. Their computers are just one part of the unstable system, and most likely if their computers HAD been significantly slower the humans involved would have naturally dampened the response. Hard to be sure, though, as people can provide their own positive feedback loop to destabilize a situation.

It will be interesting if the system develops oscillations, and routinely starts slamming stocks high and low in rapid succession.

soundOfSilence said...

Paleocon said:

It will be interesting if the system develops oscillations, and routinely starts slamming stocks high and low in rapid succession.

I've only skimmed the 1st part of it -but interesting article over on ZH along the lines of "someone turned everything off."

Tinfoil hat and crack pot theories aside for the moment I am a firm believer that certain things happen for a reason.

Greenpa said...

Stoneleigh- " All of us are in for a brutal decade at the least. "

Oh, you crazy optimist, you. :-)

Greenpa said...

Ok, so- what if...

I have a weird thought for youse guys to process. I've never heard of this trick, but of course it's likely it's been thunk of before, or even done somewhere...

Greece really went over the cliff when its interest rates got too high. That's also when people become unable - and unwilling- to keep paying their credit card bills.

What if- in the desperation of the moment- the entire world could be convinced to enforce a "temporary" freeze on interest rates? For everything? And possibly even; in the spirit of attempting to save civilization, agree that for the next 2 years, ALL debts will only accrue 2%, uncompounded?

Ok, now, first of all, I realize fully this will happen immediately after they start holding ice hockey tournaments in Hell.

Just as a thought experiment. I said years ago here that the only possible way out would be a Jubilee- which is only when they add the Winter Olympics to the hockey tournaments- but still.

This would be like an "Interest Jubilee". Universal agreement to just hold off a bit on getting even filthier rich- so you don't actually kill all your customers.

Anything like that ever been done? Suggested?

Ilargi said...

"What if- in the desperation of the moment- the entire world could be convinced to enforce a "temporary" freeze on interest rates? For everything?"

It would instantly kill off $600-800 trillion in interest rate swaps. There would be no economies to speak of anymore.

Rumor said...

Glad to see some people back from the big bad world to visiting the board again. Lots of good chatter today. Snuffy, good to hear you've had some luck, and welcome back.

Greenpa said...

Ilargi: "It would instantly kill off $600-800 trillion in interest rate swaps. There would be no economies to speak of anymore."

So what you're saying is the "real" economies of the world are now so completely entangled with the fantasy economies of the "financial sector" (a phrase which sends into paroxysms of laughter) - that any tampering with the fantasies will crash it all.

Oh, well.

Rumor said...

Ian Welsh: "I have long argued that municipal bond default will become an attractive option in the near future for many political stakeholders because once the first few large municipalities default, the rest of the marginal municipalities won’t be able to access credit at non-credit card rates anyways."

Good post by Ian that ties Greece to the US municipal budget problems. Would apply just as well to US states; just add a few months/couple years.

Rumor said...

Garth Turner is still pimping bank stocks and other "blue chip" preferred stocks in the wake of yesterday's market slip.

"Is this a rerun of the collapse of autumn, 2008? Beats me. But I’m not going to bet against it. I said a few days ago the world is too damn volatile and unpredictable not to be carrying your Swiss Army knife at all times. This is why I like liquid investments that actually pay me money, instead of real assets that cost.

... Should you run screaming in all directions? Sure, then get out your cheque book and start buying stuff. If histor’s any guide (and it beats the bullion doomers), the more markets fall, the more they’ll retrace. Those who stood in the eye of the storm last March and defiantly leaked against the wind ended up with a 55% gain. Hard to see how the world will need less oil, for example, or fertilizer for crops or medicines for an aging population. Buy low, sell high. This is low.

Bigelow said...

Ilargi is quoted in
US Government Now 96.5% of the Mortgage Market Q1, 2010 SmirkingChimp

scrofulous said...

Looks like Snuffy isn't alone:

Looks like lotsa guys and gals climbing back onto the hi ho it's off to look for work we go waggon.

Oh well I guess yesterday was fun for all around here ... well for about 15 minutes or so anyway. LOL

el gallinazo said...


Have you factored in the $2T treasury deficit (well over 10% of this years real GDP) and the Fed's real (unaudited) balance sheet into your green shoots? Makes a nice smoke though. I'm glad for Snuffy that he got some good work, and we all gotta try to eat, but it doesn't mean that one must be stupid. And the thing that Greece goes to prove is that shifting the private debt of the banksters to sovereign debt is not a bottomless pit and Wile E. is closing in on splat time.

Phlogiston Água de Beber said...

Greenpa said...

So what you're saying is the "real" economies of the world are now so completely entangled with the fantasy economies of the "financial sector" (a phrase which sends into paroxysms of laughter) - that any tampering with the fantasies will crash it all.

Did you not wonder if there wasn't some little reason why Bernankenstein and Hankula sat there in front of Barney's committee waving their ridicules three page bill, lying about what they were going to do with the money and looking for all the world like they just heard Martians had landed in New Jersey?

Remember that little story I wrote a while back about the population bomb and the debt bomb being strapped together? Someday one of them is gonna blow and take the other one out with it. Sorry, no do overs. Time travel sure would be handy to have about now. Wouldn't it?

el gallinazo said...

The herd has been seeing red and stampeding down the ravine toward the cliff overlooking the canyon around the globe for several days. And now the PPT has hired Clint to head 'em off and turn them back up the ravine on their home turf of the S&P500. It's Stoneleigh's panicked herd against the Fed's taxpayer credit card handed out the the Primary Dealers. That's entertainment.

Fresh panties ...........check
Depends ...................check
sixpack ......................check

Guess I'm ready for the Thrilla with Godzilla.

Ilargi said...

"So what you're saying is the "real" economies of the world are now so completely entangled with the fantasy economies of the "financial sector" (a phrase which sends into paroxysms of laughter) - that any tampering with the fantasies will crash it all."

Well, I never said "any" tampering, of course, but about a dozen or so times the annual global GDP says rates WILL move, in one direction or another, and you suggest not moving them at all anymore. That would surely have consequences. Like bickering over which party pays which counterparty, and what.

Anonymous said...

I've seen little mental preparation for mental collapse anywhere on online discussion boards.

i have been talking about losing my mind for a long time on my favorite blogs. cause it is the truth, and life is a lot more fun this way. all my golf buddies know i am nuts. even the old judge i play with, says he is really happy that he is deaf when he plays with me.

ditto in boulder, it is packed with rich white chicks spending hundreds at whole foods, and apple stores. course, apple stores don't take cash or checks, so it is right up every buddies alley. all the college kids have iphones and ipads so there is no broadband left in the air. heavens†
ps i like reading all of the posts today, comforting.

zander said...

Sorry to bang the drum about that pesky little oil incident thingy but the UK news is wall to wall hung parliament with NO coverage whatsoever of any other topic.
Just a quick resume from anyone will do.

Ta in advance


Wolf at the Door said...

Truly fascinating week. Another one for the history books.

For those that are sensitive to such things you can almost feel the shift in the winds of mood over the past week. The end of the week action prompted me to order another Berkey and buy a lot more food. Probably pissing in the wind but things are getting ever stranger at an accelerating pace. Also finally prompted me to take action and start the process of removing my remaining cash out of the banking system. I feel like a nut but as far as I am concerned me and my family are on lockdown red alert as of this week forward.

Hope you guys got bandwidth.

scandia said...

@Zander, When the UK chose to run an American style election I wondered silently if that would include the ballot counting fraud? Now I read that thousands could not vote, locked out, police investigating the process and the account? Have you any up to date news?

Anonymous said...


Snuffy, glad to hear from you. I have been wondering about you and your bees just in the past two days.

So, a new business. I too have been casting about for a while and something came up just this evening. It might pan out, it might not, so I will not say anything more than that it is very basic and non-discretionary as Jeffrey Brown would say.


Ric said...

I've done what I believe to be some mental prep for whats next, but again I wont know what it's like until it hits me in the face so psychological prep. may be moot.

Hi Z,
I'm in Southern California and you're across the Atlantic--good luck over there!

Since you mention it, I'll describe it a little more thoroughly. Mental prep is a subtle issue that most people go about wrong. You raise the question: if you don't know what's going to hit, how can you prepare for it? The way I see it, mental prep is having a stance that's comfortable facing the complete unknown--it's an attitude about reality that all of us as adults slowly develop all our lives, if we don't give up. As we mature, we better see that reality is indeed the great absolute unknown. Most of us live from illusion to illusion--and as long as it "works" that fine. Greenpa mentioned above the "fantasy" of the "financial sector." It's startling to see the illusions other people think are "real," which are actually quite fantastical.

A humble way to think about facing the unknown is to see that it is actually facing reality. On a daily, practical basis this is what young children do each day they get out of bed. For a three year old, the world is a complete unknown--everything outside the door is unknown. Does this impending unknown overwhelm them so much it drives them to drink or drugs or denial? How do children face the complete unknown that is the world? Generally, they face the day with 1) faith their parents will look after them so they can, 2) go through the day with a spirit of play.

But as adults, we no longer can rely on parents to look after us; yet we must face the unknown in the same way with: 1) faith we'll encounter the unknown and survive and 2) a spirit of wonder. My experience is without these two elements, the unknown overwhelms people. I honestly think most of us take ourselves far too seriously when it comes to preparing and being "ready." Yes, as mature adults we make ALL THE PREPARATIONS WE POSSIBLY CAN! But at the same time we have to be prepared for losing everything--for all our plans coming to nothing. Then what do we do? Go nuts? Start killing? What do we do? If we face the complete unknown with 1) the faith it'll be okay (easier said than done!) and 2) a spirit of the wonder about this incredible, unknown world we live in, we'll move like humans till we meet our end.

Bigelow said...


Track the Gulf of Mexico oil spill movement in animated graphic Watch up to May 7th

Bigelow said...

Oil spill update May 7

Bigelow said...

“Old-style market-makers are standing aside as panicky orders pour in, and they look straight at shadow liquidity providers and say, "No thanks. You battle bots take it". And, they don't.“
The Run on the Shadow Liquidity System

zander said...

@ Scandia

Yeah thats true but it was small scale and was due to the polling stations being overwhelmed by the unexpectedly big turnouts rather than any sort of irregularity or skullduggery. Actually I got weary of the spectacle and fell asleep not long into it so I missed all that uproar and woke up to the hung parliament result, what a damp squib, every one of them is a grade A twat, I shoulda stayed out in the hills :) looks like coalition between tories and libs on the cards, that'll fall apart and there'll be a new election in 6-12 months IMO. Glad to report BNP vote totally disintegrated.


zander said...

Thanks Ric,

I'm fairly grounded in reality but I cant allow myself to suppose that I might lose everything, because although you may well be correct, if I adopt that train of thought I may well lose that great feeling you mention in .."and 2) a spirit of the wonder about this incredible...." and then the moment I'm actually living in will be haunted by that spectre.
Touch wood, I've always been blessed with a happy disposition, life's greatest gift, (alongside good health) I'm confident that might see me through. Money doesn't mean shit to me and yet I'm strangely drawn to the impending financial calamity, I wonder sometimes if subconsciously I hoped for this as an anti-materialist. morbid eh?

Great perspective you got there.


zander said...

Thanks Bigelow.


el gallinazo said...

Alan Grayson does a nice stand-up routine on how the Usaco taxpayer came to own the Red Roof Inns. And the last 15 seconds made it clear that the "progressive" caucus in the House does not favor auditing the Fed. Glad I burned my card yesterday.

There is no named movement in the USA to join. Kuchinich and Sanders are giving hand jobs for a price. The Tea Party are hateful idiots with Sarah Palin as a spokesidiot. Libertarians should be thrown into Ayn Rand's casket. We are all dressed up with no where to go.

I just got my divorce manual from the USA yesterday and am studying it. One must apply for a divorce at an embassy or consulate outside its borders and apparently the waiting time is now over a year and growing.

As a Usaco citizen living outside of the USA, its hard as hell to get a bank account because thanks to the "Patriot Act," non-Usaco banks don't want Usaco spooks hanging all over them. They just don't want the aggravation.

EconomicDisconnect said...

Quote of the day via TBP(Barry Ritholtz):

As a client of mine recently put it regarding flight to safety:
The U.S. is the best looking horse…at the glue factory

Instant classic!

Anonymous said...

el gallinazo
you got attitude.
guess it works from panama soon to be argentina.
happy for you†
curious how you deleverage (divorce)
just my 2¢'s†

$$$Dollar$$$ said...

el gal - Japan and the United States are the only countries in the world that tax their citizens no matter where they are. Iran, Venezuela, North Korea, Cuba and all of the other "terrorist" countries don't do this. Think about that for a second. Forced slavery anyone? Anyhow, do you really think they are going to make it easy for you to get off of their captive gravy train? Think about that for a second also.

el gallinazo said...

Re Divorcing the USA

An anonymous poster on ZH yesterday gave a link for a 24 page pdf manual he had written. It's quite interesting and well written. Of course you have to pick your new country first and get a passport there, or you are struck in place. Practically, it is of greater utility for the very wealthy, but it appeals to me ideologically.

Anonymous said...

El G said:

"There is no named movement in the USA to join. Kuchinich and Sanders are giving hand jobs for a price. The Tea Party are hateful idiots with Sarah Palin as a spokesidiot. Libertarians should be thrown into Ayn Rand's casket. We are all dressed up with no where to go."

True, true... This is why I'm focusing on cultivating my garden.

VK said...

Japan and the United States are the only countries in the world that tax their citizens no matter where they are.

Might I suggest you incorporate yourself? I hear in the US they fawn over you and literally do anything they can to raise your status to that above mere mortals all the while you pay minimum to no tax ala BP. You also get to pick and choose laws to your liking and get the choicest pickings of taxpayer largesse. While the law turns a blind eye to any mess you create and any stink you make. The only negative I can think of is all the slobbering politicians will do over you.

scandia said...

Came across this Truthout article by Greg Palast over on Jesse's Cafe American-

SlickOperator:The BP I've Known Too Well

Has BP " changed its spots "? Are they now experiencing a " change of heart"?
I've caught myself believing that the Gulf oil rupture is such an unprecedented disaster/crisis that BP would now join the Commons .
Ha, I've been caught believing our politicos would seek Commons status as well.
Both think guns and money trump universal law, trump death. This elite idiot class think they are rich.
Not that the Commons can stand up proud when their voice and action is that of a mob.
I've caught myself believing there is something I must do, that there is something I can do beyond protecting my own ass.
Posting this at 3 A.M. unable to sleep....

Jeotsu said...

Regarding getting mentally prepared-

It might be interesting to look at the model of Civil Defense, for countries that still practice the idea. I am not talking the "run to the fallout shelters- here come the nukes!" version I knew about growing up in the USA, but rather the more prosaic and practical natural-disaster kind.

Lots of thought and disucssion has gone into developing "resiliency" for cities and communities, the profound knowledge that come the day Murphy will find all your single points of failure, and that your depot of relief supplies will be the first building to catch fire.

We do get some training in dealing with "psychological casualties", and discussing the realities of USAR (urban search and rescue) in a post-earthquake city is sobering to say the least.

Here on TAE talk about decline of social order in a financial catastrophe- the unexpected failure of key services, possible disruptions of food and water distribution. Just what I am waiting for in a big earthquake.

Of course, the problem is that in this disaster there will be no army of helpers riding over the hill to save you, as everywhere is in the same boat.

As a final note, one of the things we are very reliant on in the case of a major disaster is "emergent volunteers". These are the people who stand up and try to help when things go badly wrong. One of my main jobs as a CD volunteer in charge of my local area is to try and organize these emergent volunteers to ameliorate the carnage. Just the sort of "community building" Stoneleigh talks of, just after the disaster has struck.

Bukko Boomeranger said...

Re: USA and Japan being the only countries that tax their citizens living overseas -- Canada is worse.

I filled out my Caunckrainian income tax form a couple of weeks ago, and it made me declare how much money I earned when I lived in Australia. I'm not even a freaking citizen, just a migrant labourer, and I lived in their country for less than two months during 2009. But still I had to declare my Aussie salary, converted into Canadian dollars. (Luckily, tax rates in Oz are higher than they are in the Great Wet North, so I was home free.)

And the U.S. doesn't start demanding taxes on your overseas money until you exceed an income threshold, which is somewhere between $75,000 and $80,000. I don't know the exact figure this year because my wife did the American taxes. I get to do the Canadian and Australian ones. Lucky us -- we get to file tax returns in three countries this year!

As far as mental preparedness, Ms. Bukko and I have been living under a doomcloud ever since Nov. 2, 2004. (U.S. election night, you might recall.) We have run to a hidey-hole, hunkered down and stocked up. I try to be thankful for every day when there's food to eat and water coming out of the tap. I know it's going to end, and it seems a miracle to have it now. I hope the memory of the good times will give me comfort when the bad times come, however short my life will be then.

As I go through life and look at everything around me, I think the equivalent to that morbid thing prisoners in Louisiana's execution cellblock used to shout when a condemned inmate was being marched to the electric chair: "Dead man walking!" Only in my mind it's "Dead civilization walking."

It aids my mental prep that I'm simultaneously reading Jim Kunstler's "Long Emergency" book and the nuclear apocalypse novel "On the Beach." The latter was something I asked my wife to get me as a present on my recent birthday because it's set in Melbourne, Australia, where we used to live, and the place names give me a nostalgic feeling of homesickness. As the Salvos' banner said in that most morbid of movies: "There is still time, brothers."

Linda said...

@El G: Never heard the term "spokesidiot" before. Love it. Also never heard of the divorce manual thing. Love that, too, but must be kind of scary.

@Wolf at the Door: Agree completely with feeling nuts changing your money around. I'm out of equities, but still have a lot of bond exposure in the secondary market, which Stoneleigh cautions against. I resign to call my planner & sell all that, too, but then he'll say, "You will not make any money at all then." Yeah, well, I also won't nicotene my rompers when the stock market, etc, goes to zero.

bluebird said...

@Linda - What the planner does not say, is that they don't make money either, from the fees, when people cash out their accounts.

jal said...

I got my first thank you, (and maybe a little bit of respect), from a member of the family who followed my advise and cashed out some money from the market before the down turn.

Other members of the family, that relied on their financial advisors, will probably avoid me for fear of hearing the famous words, "I told you so".
( I would never be that cruel)

Greenpa said...

El Gall- "We are all dressed up with no where to go."

For the moment. Everyone should keep in mind that the conditions are RIPE RIPE RIPE for charismatic leaders to appear and bloom.

I.E.: Jesus, Mohammed, Hitler, and Ayn Rand can show up any time. Plus con-persons claiming to be those dudes, and others.

Joining one of these shindigs early can both be a really good personal security move, and a good way to do some useful herd steering.

Wolf at the Door said...

@ Linda,

"Agree completely with feeling nuts changing your money around."

I was a believer in the system up until around 2003. Wasted a bunch of time prior to that trying to accumulate as many clown-bucks as possible only to begin to realize that there was no point to this path, especially with the long term viability of the system dependent upon impossible mathematical assumptions (like all ponzi's).

Since then (it took a while to completely "convert" from system acoloyte to full blown critic as I simply had trouble accepting and believing the inescapable conclusion that all of the data was pointing too) I have been slowly but surely dissasociating myself from the system to the degree that I can (I have 2 young ones so I am not completely free to act).

So I have been preparing mentally for a long time but it still feels surreal to be finally executing on these long established plans.

HappySurfer said...

Hey Snuffy

Good to see you back and had a bit of luck in your life - may the grin last a long time


Archie said...

re: Deepwater Horizon catastrophe.

This article is a bit dated but it is still very much a captivating read. Fantastic photos as well.

el gallinazo said...

Linda and others:

You all ought to listen to Arch Crawford's last interview. I had heard him on Frisby's podcast a little over a year ago, but I didn't pay much attention. Crawford is primarily an astrological market analyst. I was listening to it on an iPod and busy at the time, so not paying much attention. Anyway, on another (excellent) Frisby interview with Prechter earlier in the year, Frisby asks Prechter as to the timing of his predictions. Prechter replies that he has never been very good with month-to-month timing and that Frisby ought to check out Crawford who is the absolute best at this. Frisby replied that Crawford had been on the show an odd year ago and how does Prechter think this astrological stuff works. Prechter replies that he has absolutely no idea and doesn't wish to be drawn into the discussion other than it apparently does as Crawford is so good.

I actually studied astrology back in the 60's, I lost interest in it rapidly, but I still clearly remember the "body of knowledge," and understand exactly what Crawford is talking about. I wish I could hold on to languages with what memory I have for this astrological stuff :-(

The interviewer is really quite good here. And Crawford is really quite intelligent despite his Carolina accent. (I am currently quite prejudiced but at least he is named Arch and not Bubba.) He actually knows the exact difference between a dirty bomb and a nuclear explosion.

Anyway, worth a listen. The short answer is that he sees TSHTF last week of July / first week August.

el gallinazo said...

Re the Sally Meets Harry intro photo:

At the risk of being crude (It's not actually not much of a risk - more of a sure thing), living on STJ for 13 years got me quite used to donkeys braying at all times of day or night. We have at least 300 feral donkeys on that small island.

Seeing the picture of the boy and mule with the sub-title, I couldn't help but imagine the mule in a posh NYC restaurant in Meg Ryan's place faking an orgasm at full volume. See, I told you it was a sure thing.

Robert said...

Al Gore's latest mansion

el gallinazo said...

Robert said...
Al Gore's latest mansion

Very tasteful. And I am sure that it could run off of two solar panels (the size of Rhode Island). Actually, the aerial view shows **no** panels. I feel sorry for Rhode Island with Al usurping all their sunlight. Went to school there.

i took shit for not caring whether Gore or W won in 2000 just as I took shit for not caring about McInsane or Obumma in 2008. Well plummas are used to taking shit so it didn't bother me.

Speaking of that, the island sink in the middle of a huge kitchen would be a real challenge to vent properly. Wouldn't want the Gore feces stinking up the Gore kitchen.

There are many lessons to be learned from this one minute video beyond an appreciation of baroque music. But the one not to be learned is to become a climate change denier. Just realize that the elite will, in full hypocrisy, try to profit off the death of the planet.

I am sure Al has some bullshit line about trading for green credits.

Shamba said...

@El G,

For what it's worth, Crawford is not the only astrologer who sees some extremely big critical situation developing in late July and August. I hardly know anything about astrology beyond sun sign generalizations and some here will think its completely kooky subject to address anyway.

Apparently, there is a formation of planets in certain shouses called the Cardinal Grand Cross. And there are several other types of "crosses" hapenning this May-September.

I couldn't ever find on the net an answer to the question of how long has it been since this formation has occurred in the past.

anyway, peace to you all this nice Spring day,

Stoneleigh, Safe Travels always!

Erin Winthrope said...


1) Is anyone surprised by the rise in the price of gold? It's being treated as a safety asset rather than a risk asset.

2) Is anyone surprised by the drop in 10yr and 30yr US Treasury yields? It seems that Hugh Hendry might have been correct all along.

3) Perhaps the most important question of the hour: Will quantitative easing by the ECB temporarily calm the markets? This is the major question in my mind. All bullish market participants are screeming at the "weak" and "useless" and "indecisive" European leaders to approve quantitative easing. Bullish market participants act as though this action will at least temporarily calm the markets with regard to fears of debt contagion. Obviously, adding more debt to a debt problem won't work in the medium term. Nevertheless, the argument is that ECB debt purchases will force down sovereign bond yields and calm the markets. Ilargi and Stoneleigh have argued the opposite (I think). I&S say quantitative easing (QE) won't work because the bond markets will punish money printers: Money printing for sovereign bond purchases (QE) will feed irrational fears of inflation and ultimately result in higher bond yields. I'm always confused by this issue. It seems to me, in the short term at least, quantitative easing would succeed in driving bond yields lower buy creating a new buyer for bonds (the ECB) with a limitless supply of cash (the printing press). What do I&S think will happen if the ECB chooses the "nuclear option?" Will Portuguese and Spanish bond yields rise or fall?

zander said...


Can you direct me to the Crawford inter view you recommend, I remember Prechter mentioning this in an interview as well. memory blur.



zander said...

"On July 27-30, Mars is conjunct Saturn at 0 degrees Libra, opposing Uranus at 0 Aries, and Jupiter at 3 degrees Aries (opposition to Mars and Saturn) squaring Pluto at 3 degrees Capricorn. A massive T square involving 5 planets."

Give me a beer.


scandia said...

@Shamba, " nice spring day"...We are have extremely strong winds with a threat of snow. Freaky for May!

time travel, astrology...what an interesting board!

ApleAnee said...

Well, so much for the box. Off to Costco to buy fish for the deep freeze.

Ilargi said...

New post up:

Stoneleigh: The Imperial Eurozone (With All That Implies)