Friday, August 13, 2010

August 13 2010: Bubble Psychology and Lessons from History

Marion Post Wolcott Don’t look down July 1940
"Miners' children crossing swinging bridge from their homes into town, Hazard, Kentucky"

Stoneleigh: Nearly three years after the October 2007 market peak, which we are still well below, people have diverging opinions as to where the larger market trend is headed. At The Automatic Earth we have consistently said that this bear market is by no means over. The recent year long counter-trend rally is over in our opinion, and phase two of the credit crunch is beginning. We expect phase two to be have considerably greater impact, especially on the real economy, than phase one. 

The rally reignited hope and spawned much talk of green shoots of recovery. We saw a temporary resurgence of confidence, which brought with it a corresponding resurgence of liquidity, which slowed the worsening of the fundamentals. With the rally over we can expect confidence to leach away, and liquidity to contract sharply as a result. However, mainstream commentators and political leaders will continue to speak of green shoots of recovery all the way down. This is an established pattern of denial, as a closer look at history will show.

Henry Blodget at Business Insider had a good article recently on the comparison between the Great Depression of the 1930s and the situation today:
Remember: In 1930, They Didn't Know It Was "The Great Depression" Yet
In the past year, we've written a lot about the similarity between the rally of early 1930 and the one we had through April of this year. The early 1930 rally came after the market had fallen nearly 50% in the fall of 1929.  The spring 1930 rally took the market up nearly 50% again, to a level that was only about 20% below the previous peak.  

That rally, of course, was also the biggest sucker's rally in history.  After the market peaked in April 1930, it crashed again, eventually ending up down 89% from the 1929 high and more than 80% from the 1930 high.  The market did not reach the 1930 high again for another quarter of a century.

While the timescale is longer for our current fall from the final high and subsequent rally, the pattern is similar. So are the perceptions of prospects going forward, as we will see.

Where credit markets lead, the real economy will follow, but not immediately. There is always a time-lag between the rapid events in finance and the much slower response of the real economy. It simply takes time for real businesses to run out of orders, lay people off and eventually go out of business. This means that the scale of an impending depression is not evident in its initial stages. Since the credit markets turned at the end of April, it seems a good time to take a more in-depth look at where we are going, and what the lessons of the past have to tell us about how such events are perceived as they unfold.

For starters, no market ever moves in only one direction. There are always counter-trend moves, some of which are very substantial. For instance, some of the largest short-term upward moves happened during the crash following on from 1929. In addition there were longer counter-trend moves which kept hope alive throughout a massive deleveraging:

We can expect to see such moves as well, and we can expect people to cast the most favourable light on every upswing, as if it was the dawn of a return to the previous 'golden age'. Actually, extreme volatility is a sign of fear, and when fear is in control, markets are an exceptionally dangerous place to be. The potential to be whipsawed in both directions on a moment's notice is very high, as is the risk that governments will rewrite the rules of the game, usually in a counter-productive way that will compound the pain.

An essential companion to Blodget's article can be found in Colin Seymour’s The Pompous Prognosticators Hall of Fame (with additional quotes here):

Note for instance, the following observations of the day, and where they fell in the timeline of the crash and subsequent depression:
#5: "Stock prices have reached what looks like a permanently high plateau."
• Irving Fisher, Ph.D. in economics, Oct. 17, 1929

#7: "The Wall Street crash doesn't mean that there will be any general or serious business depression... For six years American business has been diverting a substantial part of its attention, its energies and its resources on the speculative game... Now that irrelevant, alien and hazardous adventure is over. Business has come home again, back to its job, providentially unscathed, sound in wind and limb, financially stronger than ever before."
• Business Week, November 2, 1929

#13: "The spring of 1930 marks the end of a period of grave concern...American business is steadily coming back to a normal level of prosperity."
• Julius Barnes, head of Hoover's National Business Survey Conference, Mar 16, 1930

#15: "While the crash only took place six months ago, I am convinced we have now passed through the worst -- and with continued unity of effort we shall rapidly recover. There has been no significant bank or industrial failure. That danger, too, is safely behind us."
• Herbert Hoover, President of the United States, May 1, 1930

#19: "Stabilization at [present] levels is clearly possible."
• Harvard Economic Society, Oct 31, 1931

#20: "All safe deposit boxes in banks or financial institutions have been sealed... and may only be opened in the presence of an agent of the I.R.S."
• President F.D. Roosevelt, 1933

Clearly, there was no recognition of the scale of the depression until the point where the credit markets bottomed in 1932/33, though Roosevelt might have known something. As we now know, the depression still had years to run.

Well, there was this lonely voice, 6 years later:
"We are spending more money than we have ever spent before, and it does not work. After eight years we have just as much unemployment as when we started, and an enormous debt to boot".
• U.S. Treasury Secretary Henry Morgenthau, May 1939

We are seeing the exact same psychology of denial playing out now, as our present depression also has years left to run. Check this 2009 graph from Chris Martenson:

#1: "At this juncture . . . the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained".
• Ben Bernanke, March 28, 2007, in a statement to Congress’ joint economic committee

"This is far and away the strongest global economy I’ve seen in my business lifetime."
• Henry Paulson, US Treasury Secretary, July 12th, 2007

This country has endured tough times before. Every time, this economy has bounced back better and stronger than before. The foundation is solid."
• President George W. Bush, March 14, 2008

#6: The worst is likely to be behind us . . . . "  
• Hank Paulson, May 7, 2008

"These institutions [Fannie and Freddie] are fundamentally sound and strong. There is no reason for the kind of [stock market] reaction we’re getting."
• Christopher Dodd, July 12, 2008, Chair, Senate Banking Committee, Financial Post

"The US will emerge from this recession, stronger than before…"
• President Barack Obama, February 24, 2009

#9: I think all of our efforts, so far, have produced results. … And I think as those green shoots begin to appear in different markets and as some confidence begins to come back that will begin the positive dynamic that brings our economy back. … I do see green shoots"
• Ben Bernanke, March 15, 2009

Market psychology is a fascinating subject. As we have pointed out before, markets are driven by perception, not by reality.  The drive for opinion-validating consensus is very strong. People would rather be wrong along with everyone else than right alone. See for instance, from The Automatic Earth in December 2008:
Markets and the Lemming Factor:
"Some trends are persistent enough that they eventually attract a very wide pool of participants, as apparent gains amongst one's peers eventually overcome the caution even of many inherently skeptical people. When they last long enough to overcome the caution of bankers, the result is easy credit to fuel the fire, and a blatant disregard for systemic risk.

This is how the largest speculative bandwagons are formed - the ones that become manias and eventually lead to ruin for a large percentage of the population. Prices are continually pushed up, irrespective of any reasonable objective measure of value, by those who think that it doesn't matter how much they pay for something if there will always be a Greater Fool who will pay even more.

The evidence of pyramid dynamics - where insiders and early movers benefit at the expense of later generations destined to become empty-bag holders - should be abundantly clear. The pool of Greater Fools is not limitless."

Mainstream commentators typically extrapolate current (or even former) trends forward, which amounts to hitting the gas while looking only in the rearview mirror. That is a virtual guarantee of a nasty accident, as there is no attempt to anticipate and prepare for critical  trend changes. Leaders, whatever they may understand (and I doubt if they have any advantage in this department), can only cheerlead, for fear of precipitating the very crisis they and others fear.

The mainstream has a vested interest in a continuation of periods which have been exceptionally kind to them, hence conventional wisdom can remain unchanged, despite accumulating evidence to the contrary, for quite long periods of time. Only when it is far too late, and the house of cards has already fallen, will the masses hear an acknowledgement that the economy is in trouble.

The psychology of typical small-scale fluctuations plays out like this:

Click to enlarge

The psychology of a major bubble follows a similar pattern, but having risen to ridiculous levels of leverage, has very much further to fall. Much greater collective psychological extremes are experienced in a rare period of manic optimism, and its inevitable aftermath:

We are just past the point labeled 'Return to Normal', which corresponds to just after the end of the great sucker rally of 1930.
Henry Blodget:
The rally that recently ended in April 2010 came after a crash that was actually slightly more severe than the 1929 crash (53% versus 48%).  It took the market up nearly 80% from the low!  The recent rally also lasted longer than the 1930 rally did--a year, as opposed to 6 months.[..]

Importantly, we won't know for sure what today's market is until we look at it with the genius of 20/20 hindsight. As Peter Schiff pointed out recently--and David Rosenberg observes today--even as late as 1931, they didn't know they were in a "Great Depression" yet. On the contrary, the promise from the White House was that "prosperity is just around the corner."

Clearly we have a long way to fall in the next leg of deflationary deleveraging that is now underway, and the effects on the real economy will begin to be felt in the not too distant future.

Those who do not learn the lessons of history are destined to repeat them.

America Is A 'Bankrupt Mickey Mouse Economy'
by Patrick Allen - CNBC

America is a "Mickey Mouse economy" that is technically bankrupt, according to Jochen Wermuth, the Chief Investment Officer (CIO) and managing partner at Wermuth Asset Management. "America today looks like Russia in 1998. Consumers, companies and the government are all highly indebted. America as a result is a bankrupt Mickey Mouse economy," Wermuth told CNBC.

The comments followed news that the Fed was extending its quantitative easing program following what the Federal Open Market Committee (FOMC) described as a fall in the pace of growth in output and employment. The Fed has spent the past three years on a route of aggressive rate cuts and purchases of trillions in various securities but it is running out of measures it can take, Pimco's co-CEO Mohamed El-Erian told CNBC.

Wermuth is a fund manager heavily invested in Russia and says if the same International Monetary Fund (IMF) team that managed the financial crisis in the former super power in 1998 now turned up at the US Treasury, they would withdraw support for current US policy immediately. "The big evil for the IMF in Russia in 1998 was the prospect of the central bank funding government debt. The Fed is now even buying mortgage-backed securities," he noted.

"Even before the (Troubled Asset Relief Program) and the expansion of the Fed's balance sheet, total US public and private debt as a percentage of GDP in the US stood at 290 percent, that figure is now far higher," Wermuth added. "US credit risk is huge and America has two options, either default or let the currency depreciate substantially against currencies such as the yuan and the rouble," he explained.

"Last night's news from the Fed simply creates the right conditions for dollar weakness and a reduction in US liabilities to foreign investors and governments," Wermuth said.

U.S. Is Bankrupt and We Don't Even Know It
by Laurence Kotlikoff - Bloomberg

Let’s get real. The U.S. is bankrupt. Neither spending more nor taxing less will help the country pay its bills. What it can and must do is radically simplify its tax, health-care, retirement and financial systems, each of which is a complete mess. But this is the good news. It means they can each be redesigned to achieve their legitimate purposes at much lower cost and, in the process, revitalize the economy. Last month, the International Monetary Fund released its annual review of U.S. economic policy. Its summary contained these bland words about U.S. fiscal policy: "Directors welcomed the authorities’ commitment to fiscal stabilization, but noted that a larger than budgeted adjustment would be required to stabilize debt-to-GDP."

But delve deeper, and you will find that the IMF has effectively pronounced the U.S. bankrupt. Section 6 of the July 2010 Selected Issues Paper says: "The U.S. fiscal gap associated with today’s federal fiscal policy is huge for plausible discount rates." It adds that "closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 percent of U.S. GDP." The fiscal gap is the value today (the present value) of the difference between projected spending (including servicing official debt) and projected revenue in all future years.

Double Our Taxes
To put 14 percent of gross domestic product in perspective, current federal revenue totals 14.9 percent of GDP. So the IMF is saying that closing the U.S. fiscal gap, from the revenue side, requires, roughly speaking, an immediate and permanent doubling of our personal-income, corporate and federal taxes as well as the payroll levy set down in the Federal Insurance Contribution Act.

Such a tax hike would leave the U.S. running a surplus equal to 5 percent of GDP this year, rather than a 9 percent deficit. So the IMF is really saying the U.S. needs to run a huge surplus now and for many years to come to pay for the spending that is scheduled. It’s also saying the longer the country waits to make tough fiscal adjustments, the more painful they will be. Is the IMF bonkers? No. It has done its homework. So has the Congressional Budget Office whose Long-Term Budget Outlook, released in June, shows an even larger problem.

‘Unofficial’ Liabilities
Based on the CBO’s data, I calculate a fiscal gap of $202 trillion, which is more than 15 times the official debt. This gargantuan discrepancy between our "official" debt and our actual net indebtedness isn’t surprising. It reflects what economists call the labeling problem. Congress has been very careful over the years to label most of its liabilities "unofficial" to keep them off the books and far in the future.

For example, our Social Security FICA contributions are called taxes and our future Social Security benefits are called transfer payments. The government could equally well have labeled our contributions "loans" and called our future benefits "repayment of these loans less an old age tax," with the old age tax making up for any difference between the benefits promised and principal plus interest on the contributions. The fiscal gap isn’t affected by fiscal labeling. It’s the only theoretically correct measure of our long-run fiscal condition because it considers all spending, no matter how labeled, and incorporates long-term and short-term policy.

$4 Trillion Bill
How can the fiscal gap be so enormous? Simple. We have 78 million baby boomers who, when fully retired, will collect benefits from Social Security, Medicare, and Medicaid that, on average, exceed per-capita GDP. The annual costs of these entitlements will total about $4 trillion in today’s dollars. Yes, our economy will be bigger in 20 years, but not big enough to handle this size load year after year. This is what happens when you run a massive Ponzi scheme for six decades straight, taking ever larger resources from the young and giving them to the old while promising the young their eventual turn at passing the generational buck.

Herb Stein, chairman of the Council of Economic Advisers under U.S. President Richard Nixon, coined an oft-repeated phrase: "Something that can’t go on, will stop." True enough. Uncle Sam’s Ponzi scheme will stop. But it will stop too late. And it will stop in a very nasty manner. The first possibility is massive benefit cuts visited on the baby boomers in retirement. The second is astronomical tax increases that leave the young with little incentive to work and save. And the third is the government simply printing vast quantities of money to cover its bills.

Worse Than Greece
Most likely we will see a combination of all three responses with dramatic increases in poverty, tax, interest rates and consumer prices. This is an awful, downhill road to follow, but it’s the one we are on. And bond traders will kick us miles down our road once they wake up and realize the U.S. is in worse fiscal shape than Greece. Some doctrinaire Keynesian economists would say any stimulus over the next few years won’t affect our ability to deal with deficits in the long run.

This is wrong as a simple matter of arithmetic. The fiscal gap is the government’s credit-card bill and each year’s 14 percent of GDP is the interest on that bill. If it doesn’t pay this year’s interest, it will be added to the balance. Demand-siders say forgoing this year’s 14 percent fiscal tightening, and spending even more, will pay for itself, in present value, by expanding the economy and tax revenue. My reaction? Get real, or go hang out with equally deluded supply-siders. Our country is broke and can no longer afford no- pain, all-gain "solutions."

Laurence J. Kotlikoff is a professor of economics at Boston University and author of "Jimmy Stewart Is Dead: Ending the World’s Ongoing Financial Plague with Limited Purpose Banking."

Deflation's Coming, Says Gary Shilling, And It's Going To Clobber The Stock Market
by Henry Blodget - Yahoo

All through the market rally and budding economic recovery of the past 18 months, most people concluded that the crisis was over and it was time to start worrying about inflation again.  But strategist Gary Shilling of A. Gary Shilling & Co. stuck by his guns: It was DEFLATION we needed to worry about, Gary said.  And it was BONDS, not stocks, that investors should be buying.

Well, Gary's bearishness on the stock market caused him to miss a nice run, but he has been dead right about bonds. And he has also been right about the potential for deflation--as evidenced by the recent Consumer Price Index numbers and the fact that most other strategists have come to agree with him.

So what's Gary's current outlook? Same as it ever was: Prepare for chronic deflation, buy bonds, and sell stocks. Why is Gary still expecting deflation? Because consumers still have way too much debt, and this debt will take decades to work off.  Also, consumers are saving money again, which means they aren't spending it.  Banks have plenty of cash and reserves, but the demand for money just isn't there. And when consumers are strapped and credit is contracting, prices tend to fall. Gary's biggest concern about his deflationary outlook, in fact, is that most strategists have come to agree with him (the crowd is often wrong).  But, for now, is sticking with his call.

Why Bernanke is right to fret about deflation
by James Mackintosh - Financial Times

A week is a long time in the markets. Just seven days ago, a summer rally in equities was under way and investors were playing down speculation that the US Federal Reserve might start buying bonds once again. Since then, the combination of the Fed’s decision to roll over maturing bonds into Treasuries, gloomy economic data in the US, eurozone and China, and a lower growth forecast from the Bank of England have killed the market recovery.

More importantly, they have also raised the spectre of deflation, or falling prices. Investors in index-linked bonds are yet to price in deflation. But inflation expectations are tumbling. In the US, the break-even rate, calculated from Treasury bond prices, suggests inflation will average 1.69 per cent over the next 10 years, down sharply on the week and far below the 2.44 per cent of April. In Germany, it is just 1.5 per cent.

It is worth considering what a deflationary world would look like for investors, if only to understand why Ben Bernanke, the Fed’s chairman, is so keen to avoid it. The best example is Japan, still mired in deflation two decades after its extraordinary property and stock market bubbles burst. While we’ve all got used to Japanese government bonds yielding next to nothing, they were yielding more than 7 per cent at the market’s 1989 peak. In a cautionary note for western investors, Japan remained in denial about deflation for years. It took eight years for 10-year yields to fall to 1 per cent, during which time the Nikkei 225 average fell almost two-thirds.

Even perma-bears do not expect the 10-year US Treasury yield to drop to 1 per cent (2 per cent is the pessimists’ target, down from about 2.7 per cent now), but if deflation is allowed to take hold, 1 per cent would not be unrealistic. Repeat the Japanese experience for the S&P 500, and it suggests the index could fall to 560, well below last year’s dismal low. Mr Bernanke is right to fret.

US Trade Deficit Explodes
by Tim Duy - Fed Watch

In his recent NYT editorial, US Treasury Secretary Timothy Geithner proclaimed:
Even the surge in imports, which lowered the rate of increase of G.D.P., actually reflects healthy and growing American demand.

I imagine that he must then be thrilled by today's trade report, which revealed the trade deficit swelled by $7.9 billion on the back of an explosion of imports.  Analysts were quick to note that the new figures will contribute to another downward revision to the already disappointing Q2 GDP report:
"The wider-than-expected trade gap points in itself points to a 0.4 percentage point downward revision to GDP growth, which needs to be added to the 0.8 percentage point estimated downward revision coming from construction and inventories. Added together, these revisions at this point suggest second-quarter real GDP growth will barely be above 1% (call it 1.1%–1.2%)," said John Ryding and Conrad DeQuadros at RDQ Economics.
Peter Newland of Barclays Capital says that his firm’s tracking estimate for second-quarter GDP is now at just 0.3% growth. Economist Nouriel Roubini  puts the figure at 1.2%.

I think you can argue a trade deficit reflects solid demand growth when the economy is operating near potential, or at least looks headed toward potential.  I think such an analysis is ludicrous when unemployment hovers near double digits.  Clearly, we have unused capacity.  Yet no way to utilize it?  Instead, I think the import surge reflects the deeply embedded structural imbalance in which US demand spending is increasingly satisfied with overseas production.  In essence, you can stimulate domestic demand, but that demand is offset by an increased import bill.  It is, of course, considered crass to suggest the import picture is an impediment to US growth.  At least departing CEA Chair Christina Romer was willing to acknowledge the import picture may be a little important:
A bit of you keeps saying that if only those were American products, think of how high GDP growth would have been.

Indeed.  The import surge, perhaps, is in part temporary.  From Bloomberg:
The expiration of export-tax rebates on some Chinese commodities beginning in July may also cut U.S. imports from China in coming months, helping to narrow the deficit and thus contributing to growth in the third quarter, said Bandholz.

I am not really counting on that story, but one can hope.  Note that in the earlier interview,  Romer shifts quickly to the export story.
People are buying things. Importantly, exports are growing at 10%. We’ve always said that we have a demand problem and that one way to deal with it is to get foreigners to buy more of our products.

 Geithner too is enamored with the potential of export growth:
Exports are booming because American companies are very competitive and lead the world in many high-tech industries

Federal Reserve Chairman Ben Bernanke also places significant weight on the export picture:
At the same time, rising U.S. exports, reflecting the expansion of the global economy and the recovery of world trade, have helped foster growth in the U.S. manufacturing sector.

Unfortunately, all look to be behind the curve on the trend in real exports:

Combined trends in exports and imports are simply not supportive of economic growth.  And, given the current state of the global financial architecture, where the US is expected to be the repository of global savings, it is difficult to see how the external sector contributes positively to the recovery.

Wall Street's "Perverse Incentive Structures" Guarantee Another Crisis, Says Bill Black
by Peter Gorenstein - Yahoo

The Obama Administration says the recently signed Dodd-Frank Law, the biggest bank overhaul in decades, will ensure against another financial crisis.  William Black Associate Professor of Economics and Law at the University of Missouri-Kansas City couldn’t disagree more.

"They haven’t dealt with any of the fundamental perverse incentive structures that cause these recurrent, intensifying crises," he tells Tech Ticker. In other words, the incentive to take excessive short-term risk in exchange for a multi-million dollar bonus is still very much intact. "Your pay should be based on long term performance instead of short term results which are easy to gimmick through accounting," he says. 

Excessive pay on Wall Street, which Black says is the biggest culprit of the financial crisis, is just one reason we’re likely to witness another crisis in the not so distant future. Financial regulation reform also fails to deal with the "professional compensation" structure, says Black, a former federal regulator during the Savings & Loan Scandal. By that, he means the continued reliance on lawyers, appraisers, rating agencies and auditors ensures these professionals will remain the "most valuable allies to the frauds."

We’re also no safer with the Dodd-Frank law than without it simply because, as a whole, the financial system doesn’t believe in regulation, Black observes. "It’s the ideology [which says] 'you can never regulate effectively', so why bother to try." Finally, Black says, the law fails to end ‘Too Big to Fail’. As long as this policy exists we’re guaranteed to face more bailouts. "Why would we allow these systemically dangerous institutions to continue?," he wonders.

The End Of Retirement As We Know It
by Megan McArdle - The Atlantic

"I don't know if it's ever going to be realistic that everyone saves enough to spend the last third of their life on vacation."

That quote is from Allison Schrager, and it's my favorite line in my newest column for the magazine. The column is on the equity premium, why it might not be realistic to expect such high returns from the stock market in the future--and what that implies for our retirement savings if this turns out to be the case. That's what I thought of when I read this, from Jon Cohn:

But ask yourself the same question you should have been asking then: To what extent is the problem that the retirement benefits for unionized public sector workers have become too generous? And to what extent is the problem that retirement benefits for everybody else have become too stingy?

I would suggest it's more the latter than the former. The promise of stable retirement--one not overly dependent on the ups and downs of the stock market--used to be part of the social contract. If you got an education and worked a steady job, then you got to live out the rest of your life comfortably. You might not be rich, but you wouldn't be poor, either.

Unions, whatever their flaws, have delivered on that for their members. (In theory, retirement was supposed to rest on a "three-legged stool" of Social Security, pensions, and private benefits.) But unions have not been able to secure similar benefits for everybody else. That's why the gap exists, although perhaps not for long.

The fact is that local and state governments have promised a lot more than they can deliver financially, in part because people love public services but hate to pay the taxes for them. In the short term, then, budget cuts are probably inevitable. And, in this political universe, the likely alternative to reducing public employee compensation is cutting essential services for people who are just as worthy and quite likely more needy.

In the long term, though, it seems like we should be looking for ways make sure that all workers have a decent living and a stable retirement, rather than taking away the security that some, albeit too few, have already. But that's a conversation about shared vulnerability and shared prosperity--a conversation we don't seem to be having right now.

It was nice that a combination of rising life expectancy and broader pension coverage allowed a large segment of American workers to take what amounted to a multi-decade vacation.  (Though this was never quite as widespread as people now "remember").  But this was never going to be sustainable.  Retirement experts typically say that retirees should shoot for 75-90% of their working income in retirement (the theory being that some expenses fall, but other expenses rise, and you don't need to save for retirement when you're already retired).

That's fine when the ratio of workers to retirees is 1:12, as it was within the Social Security system in the early years.  But by the time you get to 5:1, it starts to pinch--assuming everyone has the same income, each worker has to toss at least 15% of their own income into the pot to support the retirees.  Once you get to 2:1--which is where we're rapidly headed--33% of your income is going to support someone in retirement.  Woe betide you if you also have kids.

It's important to note that this is true no matter how retirement is funded.  Whether you collect a dividend check, get a corporate pension, or live off your social security, your retirement is funded by real claims on the output of people in the workforce.  Private pensions have a couple of advantages:  the investments that fund them actually help make the economy more productive, unlike transfer payments; and they aren't necessarily indexed to inflation, so over time, as incomes grow, it becomes easier to support the older retirees.  But they don't eliminate the problem; they merely mitigate it.

Mathematically, society simply cannot have a high and growing dependency ratio--at least, not if the retirees expect to be supported in the style to which they have become accustomed.  (I take it that this is what is meant by "a decent living and a stable retirement").  We can warehouse people in spartan old folks homes (or treat them like kids and move them into the spare bedroom), in which case they can enjoy a lengthy retirement.  Or they can retire for less time, and live more lavishly.  But there is no conceivable system that is going to allow the vast majority of the population to spend a full third of their adult life in retirement, at anything like the same standard of living they had when they were working.  Jon Cohn's wish to spread the bounty of pubic sector pensions more broadly seems like, well, wishful thinking.

U.S. initial weekly jobless claims total 484,000, a five-month high
by Ruth Mantell - MarketWatch

The number of initial claims for regular state unemployment insurance benefits reached the highest level since February in the week ended Aug. 7, rising 2,000 to a total of 484,000, the Labor Department reported Thursday. Economists polled by MarketWatch had expected a level of 463,000 for first-time claims. The four-week average of initial claims -- a more accurate gauge of employment trends -- also rose, up 14,250 to 473,500. This level was the highest since February as well.

While initial claims are down about 13% from the prior year's level, the data still reflect U.S. decidedly sluggish hiring trends. The government recently estimated that the unemployment rate remained at 9.5% in July, unchanged from June. For the week ended July 31, the initial-claims level was revised higher to 482,000 from a previous estimate of 479,000. The number of workers who continued to receive state unemployment checks fell by 118,000 in the week ended July 31, to 4.45 million. The four-week average of these continuing claims dropped to 4.52 million, down 64,500.

All told, about 9.8 million people were collecting some type of unemployment benefit in the week ended July 24, up from about 8.6 million in the prior week. Much of the gain is from resumed payments to beneficiaries following Washington's recent approval of new federal funds for extended benefits. Extended benefits financed by the federal government are offered to some workers after they exhaust state unemployment insurance, which usually lasts 26 weeks. Benefits have been extended for up to 99 weeks in the states worst hit by the recession.

Obama Falls Short; Gary Shilling Sees 10 Years of Low Growth + Rising Unemployment
by Aaron Task - Yahoo

A new WSJ/NBC poll shows 64% of Americans believe the economy hasn't hit bottom, up from 53% in January. And about two-thirds say President Obama has fallen short on handling the economy and the budget deficit. Obama's "big mistake was over-promising in a situation where it was very difficult for anyone to deliver," says Gary Shillling, president of A. Gary Shilling & Co. "They obviously didn't understand the depth of the problem," he said, referring to the administration's promise in 2009 that unemployment would peak at 8% if the $787 billion stimulus package was passed.

The real problem, Shilling says, is the deleveraging process. Given the decades it took for the leverage to build up, it's folly to think the deleveraging process can be quick and painless, he says. "It isn't just that 2008 was a bad dream from which we've awoken and it's back to business as usual." Indeed, Shilling says Americans are right to believe the economy hasn't bottomed yet; in fact, he says we're just at the beginning of a prolonged period of economic malaise.

Shilling's forecast is that U.S. GDP growth will average just 2% for the next 10 years. That isn't terrible but is a long way from the 3.3% growth he says is necessary to keep the unemployment rate steady. As a result, he expects the pressure to increasingly mount on politicians to do "something" to fight joblessness. The problem, however, is "push is coming to shove in the sense of the political need for stimulus compared to the size of the deficit," Shilling says. "I think they've reached a Mexican standoff" in Washington.

'99ers' looking for help, hold rally on Wall St. to demand unemployment benefits
by Lore Croghan - NY Daily News

They call themselves "99ers" - out-of-work job-hunters in dire straits because their unemployment benefits have run out. They turned to the Internet for solace. Now they're turning into a grassroots political movement. They're staging a protest rally on Wall Street Thursday at Federal Hall, just steps from the New York Stock Exchange, where they will demand that Congress broaden unemployment benefits to include them. "People went online to commiserate and gripe, then became more desperate and looked for ways to make political gestures," said 99er Michael White, a founder of the Unemployed Workers Action Group, which is sponsoring the rally.

Since the spring, thousands of 99ers have mustered online to organize "fax attacks" on legislators, circulate petitions that say, "I Am Unemployed and I Will Be Voting November 2010" and share YouTube videos about suicides among their ranks. More recently they decided to kick it up a notch with public demonstrations. "When you're losing your home because you're broke, you don't feel comfortable anymore just sending emails and faxes," said White, 58, an unemployed video editor in Los Angeles. He and his wife, who has a minimum-wage job, will have to move out of their apartment and live with her family if he doesn't find work soon.

The 99ers' name refers to the maximum number of weeks for unemployment payouts in states with the highest jobless rates. New York was among them until last month, when the statewide rate inched below 8.5% and knocked down the local limit to 93 weeks. The city's unemployment rate was 9.5%, but that doesn't matter. "Their government is forcing them into poverty," said upper West Side resident Kian Frederick, an unemployed union organizer, who volunteered to coordinate Thursday's rally.

Despite their growing online activism, 99ers feel ignored by the wider world. "What's wrong with our situation is if we were all in one long bread line, people could see our suffering," said Yvonne Fitzner, 67, an out-of-work personal assistant whose unemployment benefits ran out in March. "We're invisible." The upper East Side resident, who plans to attend the rally, subsists on food stamps and Social Security. She covered a $2,050 deductible for needed surgery last fall with $10 and $25 donations friends tucked into greeting cards.

She has stopped buying asthma medicines, gotten rid of her cable TV, long-distance phone service and gym membership and spent the summer with no air conditioner in her rented studio apartment because she can't afford to buy one. Fitzner has applied for endless job openings, from public relations director to juice bar worker. It galls her to hear some politicians call the unemployed lazy. "There's a lot of anger at Congress," she said.

Unemployment drives more home sellers to cut price
by Lynn Adler - Reuters

Owners cut prices on one-quarter of U.S. homes listed for sale in July, a fourth straight monthly rise, as job market fallout trumped record low mortgage rates, real estate website said on Wednesday. Sellers in the 50 largest cities slashed $30.1 billion from prices on houses on the market as of August 1, up from $27.3 billion in the prior month, San Francisco-based Trulia said in a report provided to Reuters before official release. Unemployment near 10 percent, wage cuts, restrictive lending practices and home values that have fallen below their mortgage balances have left many potential buyers unable to take advantage of low rates.

"With one out of every four homes experiencing at least one price reduction, sellers are feeling no relief this summer in a market climate of fewer qualified buyers and widespread uncertainty about the job market," said Pete Flint, Trulia chief executive. The average discount on homes reduced at least once held at 10 percent from the original asking price in July from June. "If buyers are unqualified to buy, it doesn't matter how low interest rates are or how discounted a home is," Flint said in a statement, adding that the housing market will bounce around the bottom for months.

Unemployment remained at 9.5 percent in July but would have been higher if discouraged Americans had not dropped out of the workforce. The housing market is still gaining equilibrium in the aftermath of up to $8,000 in buyer tax credits that ended on April 30. The credit forced sales into spring months at the expense of summer activity. During the spring sales rush, sellers cut prices by much smaller amounts totaling $22.8 billion in March and $25 billion in April, according to Trulia.

U.S. 30-year mortgage rates averaged 4.56 percent in July, according to home funding company Freddie Mac, and have since drifted to a record low under 4.50 percent. Nonetheless, in half of the 50 largest cities, sellers last month lowered prices on at least 30 percent of the homes for sale. Foreclosures continue to weigh on prices. The real estate market will keep languishing until the job market recovers, said Trulia's Tara Nelson. "Sellers need to continue to be very aggressive with pricing to compete against all the low-priced short sales and foreclosures that they'll be on the market with, for a long time to come," she said.

Minneapolis led in price cuts for a fourth straight month, with 42 percent of listings lowered at least once. The average discount was 9 percent for a total of $33.8 million in reductions, Trulia said, citing rising inventory and mounting competition. Las Vegas had the biggest spike in the share of sellers cutting prices at 18 percent, a 56 percent surge, while New Yorkers cut prices on 20 percent of the listings, a 15 percent jump in the month.

Cities in California were among those with the largest increases in the share of sellers slicing prices. Price-cutting on luxury homes listed at $2 million or more had an average discount of 14 percent from the original listing price, Trulia said. Homes in this category account for less than 2 percent of total inventory, but almost one-quarter of the total dollars slashed from asking prices.

US banks seizing homes at record levels
by James Quinn - Telegraph

Repossessions of houses and flats by major US banks is at close to an all-time high as the American housing market continues to struggle. Major US banks wrote off approximately $8bn (£5.1bn) on mortgages in the first three months of this year, on track to repeat – or even surpass - last year's full-year total of $31bn. The news could have severe implications for the wider financial market, given it was problems in the US housing market which triggered the credit crisis back in 2007.
Fresh data shows that the number of US homes being repossessed due to mortgage arrears rose to 92,858 last month, up 9pc on June and up 6pc from the same month last year. The figure is just 1pc below the all-time high – recorded in May this year – and comes amid renewed concerns about the amount banks are writing-off in mortgage-related losses. Bank repossessions increased on a year-over-year basis in July for the eight straight month in a row.

According to industry researcher RealtyTrac – which provided the repossession statistics - the total number of US mortgage holders receiving a foreclosure notice – either a default notice, a notice of auction or a repossession order – rose by 4pc in July to 325,229. RealtyTrac's Rick Sharga said he does not believe the US foreclosure rate will peak until some time next year, noting that July marked the 17th consecutive month that foreclosure activity was above 300,000 mortgages. "Repossessions coupled with the fact that we're still looking at 5m seriously delinquent loans, many of which would normally already be in foreclosure, really suggests that what the banks are doing is managing inventory levels," said Mr Sharga.

But the problem is not just those mortgage holders who have already received foreclosure notices. Earlier this week, research from property information website Zillow found that more than 20pc of US mortgages are 'under water' and subject to negative equity. "It is the paramount challenge facing housing markets," said Stan Humphries, Zillow's chief economist. "We already have had record levels of foreclosure and, combined with high unemployment, negative equity is very toxic to the market." The situation is being compounded by the slowdown in the sales market, with existing home – as opposed to newly built – sales falling by 5.1pc in June, as prices remain volatile.

Feds rethink policies that encourage home ownership
by Paul Wiseman - USA TODAY

Just how much should Uncle Sam do to help Americans buy their own homes? For 70 years — and for the last 15 in particular — the answer has been: Whatever it takes. Now, policymakers are pausing to reconsider. In the next few months, they'll weigh whether there can be too much of a good thing when it comes to helping families finance the American Dream. The rethink could mean a shake-up for a mortgage market addicted to government subsidies.

"This process of figuring out the government's role is going to involve some hard choices," says Alyssa Katz, author of Our Lot: How Real Estate Came to Own Us. "The moment you start changing the nature of what is guaranteed by the government, what is subsidized, you start to change the alignment of winners and losers. ... We took for granted that anyone could get a mortgage." Using guarantees and tax breaks, the government pushed homeownership past 69% in 2004. Then it all came crashing down.

Housing prices started crumbling in 2007, panicking financial markets, forcing the government to seize mortgage giants Fannie Mae and Freddie Mac, and pushing the economy into the worst recession since the 1930s. Homeownership has fallen below 67%. Now, Washington is preparing to rebuild the national mortgage market atop the ruins of Fannie and Freddie. The proposal, due early next year from the Obama administration, could make it harder to buy a home by reducing available credit or requiring bigger down pay-ments. Low-income renters might get more government help.

Congressional Republicans doubt the administration has the nerve to make bold changes. They say the White House squandered an opportunity to deal with what they see as the No. 1 problem — limiting taxpayer losses on Fannie Mae and Freddie Mac — in an overhaul of financial regulations Congress passed last month. "What you've seen is two years of lip service," says Rep. Spencer Bachus of Alabama, ranking Republican on the House Financial Services Committee. "The administration and the congressional Democrats have not shown any willingness to address the issue other than to talk about it and have planning sessions."

Other critics say eliminating or overhauling Fannie and Freddie isn't enough: The government must reconsider such bedrocks of housing policy as the mortgage interest deduction and the tax exemption of most capital gains from home sales. They say these misguided or outdated government policies encourage the United States to massively overinvest in housing, shortchanging other parts of the economy. "There's only so much subsidy to go around at the end of the day," Katz says.

The administration isn't tipping its hand in advance of a conference next Tuesday on housing finance reform in Washington. But officials insist that big changes are coming to housing finance. Treasury Secretary Timothy Geithner has said the reforms must: continue to make mortgage credit widely available; promote affordable housing for home buyers and renters alike; protect consumers from predatory lending; and promote financial stability.

"We have committed to having a proposal in place by early next year," says Federal Housing Administration Commissioner David Stevens. "This is not about delaying. This is about being thoughtful." Policymakers are moving cautiously because the housing market is on government life support two years after the worst of the financial crisis. "Even today, private capital has not yet fully returned to this market," Jeffrey Goldstein, the Treasury Department's undersecretary for domestic finance, wrote recently. "Fannie Mae, Freddie Mac and other government entities guarantee more than 90% of newly originated mortgages. They are practically the only game in town." (In 2005, they accounted for just a third of the market.)

Square 1: Fannie & Freddie
Whatever Washington does in the next few months will likely focus on Fannie and Freddie. The housing giants buy mortgages from banks and other lenders. Usually, they package the mortgages into securities and sell them to investors. Sometimes, they keep the mortgages in their own portfolios. The idea: to create a thriving secondary market in mortgages. By selling their mortgages to Fannie and Freddie, banks clear room on their balance sheets to make more loans, ensuring a plentiful supply and making it easier for home buyers to find financing.

Fannie (established by Congress in 1938) and Freddie (1970) were private, profit-seeking companies, but they operated with the implicit understanding that taxpayers would bail them out if they ran into trouble. That assumption gave them access to low-cost financing. They made enormous profits, paid their top executives extravagant salaries and accumulated outsize influence in Washington. They used their clout to lobby for bare-minimum levels of capital to cushion against losses.

Thin capital proved lethal when Fannie and Freddie caught the virus that infected the rest of the financial system in the mid-2000s: irrational exuberance about housing prices. The mortgage giants had strayed from conventional mortgages. In 2000, they held few securities backed by subprime or undocumented Alt-A loans from private lenders; by 2007, those mortgages accounted for nearly a quarter of their portfolios.

When housing prices collapsed, Fannie and Freddie were sitting on huge losses. The government seized the two companies, making explicit Uncle Sam's implicit guarantee. Geithner says regulators couldn't just let the mortgage giants fail without risking "devastating consequences for the housing finance system and the broader economy." The Congressional Budget Office estimates that bailing out Fannie and Freddie will cost taxpayers $389 billion between 2009 and 2019.

Just about everyone agrees that Fannie and Freddie, known as government-sponsored enterprises or GSEs, were built around a fatally flawed model — one in which investors and executives pocketed profits and taxpayers absorbed losses. "After reform, the GSEs will not exist in the same form as they did in the past," Geithner told Congress in March. "Private gains will no longer be subsidized by public losses."

House Republicans are calling for Fannie and Freddie to be put out of business within four years. Democrats don't go that far: "We know we have to replace them," says Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee. Whatever supplants Fannie and Freddie in the mortgage business, Frank says, should be either 100% private or 100% public, not a hybrid.

In April, Treasury and the Department of Housing and Urban Development asked various players in the housing market, from lenders to advocates for the homeless, to weigh in on reform proposals. Many call for Fannie and Freddie to be replaced by private firms that enjoy straightforward government support but have a narrower mission and are far more tightly regulated than the failed housing giants.

Tinkering with housing finance is like playing with political dynamite, says Raj Date, executive director of the Cambridge Winter Center for Financial Institutions Policy. Fannie and Freddie "actually do provide a very large subsidy to homeowners who borrow money," he says. "Here's the thing about upper-middle-income suburban homeowners: They vote. When you take away a huge housing subsidy, they notice."

30-year mortgages
One example: Freddie and Fannie, with their government backing, allowed the proliferation of 30-year, fixed-rate mortgages — a product that lenders would otherwise shun. Reason: Long-term, fixed-rate loans struggle in any interest rate scenario. If rates rise, banks are squeezed, because their revenue remains fixed even though they have to pay more for deposits and other funding. If rates fall, homeowners refinance. "No rational market participant is going to bear that risk," Date says.

Long-term fixed-rate mortgages make sense only if the government is absorbing some of the risk. Reforming housing finance, Date says, could jeopardize the future of long-term, fixed-rate mortgages or raise interest rates on them, perhaps a quarter to half a percentage point. Even if the government doesn't make radical changes in the way housing is financed, it likely will shift emphasis away from encouraging homeownership and toward helping low-income families find affordable apartments to rent. "We have to be very pro-homeownership," Housing Commissioner Stevens says. But "we strongly believe in a balanced housing policy. ... Not everybody was prepared to own a home."

Until now, government policy has been lopsided in favor of putting people into houses of their own. The Congressional Budget Office reports that government subsidies for homeownership, including the mortgage interest deduction, reached $230 billion last year. That compares with $60 billion in tax breaks and federal spending programs supporting the rental market. A lot of renters could use the help, the CBO says. In 2007, 45% of tenants spent more than 30% of their incomes on shelter — the threshold for affordable housing — compared with 30% of homeowners.

Things are worse for the poorest renters, households earning 30% or less of the median income in their area: The National Low Income Housing Coalition found that 71% of the poorest households spent more than half their income on rent in 2008.

Rent consumes half of Dorotha Allamand's $1,300 monthly Social Security check. The retired nurses' aide lives in Gridley, Calif., alone except for her three cats. She's on a two-year waiting list for Section 8 rental housing assistance and faces a three-year wait for a senior citizens' housing program. "So here I am, hoping from month to month that I have a roof over my head and enough to eat," she says.

Sheila Bair, chairman of the Federal Deposit Insurance Corp., asked recently "whether federal policy is devoting sufficient emphasis to the expansion of quality affordable rental housing." Owning a home, she said, might not work for everybody.

A post-WWII push
Before World War II, would-be home buyers faced huge obstacles. Banks demanded 50% down payments for mortgages that would last just five or six years; then, the homeowners would have to cough up the balance in a balloon payment. Homeownership remained mired around 40%. Then came government support for homeownership through Fannie, Freddie, the Veterans Administration and the Federal Housing Administration, a government agency that insures mortgages. The new long-term, fixed-rate mortgages, encouraged by Fannie and later Freddie, made housing payments affordable to ordinary families. The mortgage interest deduction, which cost the Treasury $80 billion in 2009 alone, made homeownership even more attractive.

Housing has an enormous impact on the economy: Harvard University's Joint Center for Housing Studies reports, for instance, that cutbacks in home building and remodeling slashed a full percentage point off economic growth in 2007 and almost that much in 2008. But urban studies specialist Richard Florida, author of The Great Reset: How New Ways of Living and Working Drive Post-Crash Prosperity, says that federal programs to promote homeownership don't make as much economic sense as they used to. When families bought suburban homes after World War II, the benefits rippled throughout the economy: U.S. manufacturers cranked out refrigerators and ovens for the kitchen, televisions and sofas for the living room, dressers and vanities for the bedroom, cars to carry Dad from the suburbs to his office downtown.

"It worked fabulously," says Florida, a professor at the University of Toronto's Rotman School of Management. "It really primed the pump of America's industrial machine." These days, not so much: Appliances and furniture usually aren't Made-In-America anymore. Neither, increasingly, are cars. A housing boom doesn't deliver the bang for the buck that it used to, Florida argues. High homeownership rates also impose economic costs. They lock workers into houses that can be tough to sell, especially in recessions, so it's harder for them to move to find new jobs. The percentage of Americans changing addresses hit a record low 11.9% in 2008 before bouncing up a bit last year; the so-called moving rate exceeded 20% as recently as 1985.

Florida has found that U.S. cities with high homeownership rates tend to lag behind other cities in job creation and earnings. He argues that the government should nudge the homeownership rate lower, perhaps to around 55%, by cutting the subsidies that prop it up. Would anyone in Washington risk political hara-kiri by killing housing subsidies to the middle class? "What really causes the decline of nations is when they become sclerotic, when they get locked into public policy approaches that don't work," Florida says. "I'm an optimist. ... We have reinvented ourselves before." But for now, he says, "Everybody is talking around the problem. We need to wake up."

U.S. Plans More Aid for Jobless Homeowners
by David Streitfeld - New York Times

In an acknowledgment that the foreclosure crisis is far from over, the Obama administration on Wednesday pumped $3 billion into programs intended to stop the unemployed from losing their homes. to buy or refinance. Unemployed homeowners who live in communities where values have fallen sharply are often unable to sell. Their foreclosures weaken neighborhoods and create a vicious circle by further undermining the market.

To try to break this pattern, the Treasury Department said it was adding $2 billion to its Hardest Hit Fund, roughly doubling its size. The fund, first announced by President Obama in February and expanded in March, goes to housing finance agencies in various states to create local aid programs. Most of the state programs from the first two rounds are barely under way, but Treasury officials said it was clear that more funds were needed. "In this very deep recession, people have tended to be out of work a little longer," Herbert M. Allison Jr., assistant secretary for financial stability, said. "That’s why we think this additional relief for people searching for a job is so important."

The second program, announced by the Department of Housing and Urban Development, will draw on $1 billion authorized by the new financial overhaul law. The agency said it would work with local aid groups to offer bridge loans of up to $50,000 to eligible borrowers to help them pay their mortgage principal, interest, insurance and taxes for up to 24 months. The loans will be interest-free. Until now, the Hardest Hit Fund had been projected to help about 140,000 borrowers. Treasury officials said that number would grow with the new infusion of money, but offered no estimate. HUD also did not say how many homeowners would be eligible for its program.

If the new money is spent in the same way as the previous money, both programs would eventually aid about 400,000 borrowers — a large number, but not when set against the 14.6 million unemployed or three million contemplating foreclosure. Over the last two years, the government has deployed many programs to help housing. It pushed interest rates down, offered tax credits and set up an ambitious mortgage modification program. Yet housing remains feeble and seems poised after a brief respite this year to become weaker again.

"I think all these government programs are helpful, but I wouldn’t look for them to cure the recession or even what ails housing," said the economist Karl E. Case. "At best, they’re preventing things from getting much worse." The Hardest Hit Fund will draw on the $45.6 billion set aside for housing in the Troubled Asset Relief Program, the rescue measure begun at the height of the financial crisis in the fall of 2008. Initially, the fund gave $1.5 billion to five hard-hit states: Arizona, California, Florida, Michigan and Nevada. The second round in March of $600 million went to North Carolina, Ohio, Oregon, Rhode Island and South Carolina.

The expanded list of states eligible for the latest funding includes Alabama, Illinois, Kentucky, Mississippi and New Jersey, as well as the District of Columbia. Each state’s share of the money is based on its population. Many of the programs involve direct assistance. Ohio, for instance, said it would use its $172 million to aid 15,356 homeowners by helping bring delinquent mortgages current for owners experiencing hardship because of a loss of income. The assistance will last up to 12 months.

The other housing money in the Troubled Asset Relief Program is earmarked for the modification programs ($30.6 billion) and a Federal Housing Administration refinancing program ($11 billion). The administration can shift money between the programs only until Oct. 3, the two-year anniversary of the program. HUD said it was in the process of determining which communities would receive its money and how exactly the process would work. "We’re still in the design phase," said Bill Apgar, HUD senior adviser for mortgage finance.

HUD Offers Interest-Free Loans to Reduce Foreclosures
by Lorraine Woellert and Kathleen M. Howley - Bloomberg

The Obama administration will offer $1 billion in zero-interest loans to help homeowners who’ve lost income avoid foreclosure as part of $3 billion in additional aid targeting economically distressed areas. The Department of Housing and Urban Development plans to make loans of as much as $50,000 for borrowers "in hard hit local areas" to make mortgage, tax and insurance payments for as long as two years, according to a statement released today. The Treasury Department will also provide as much as $2 billion in aid under an existing program for 17 states and the District of Columbia, according to the statement.

The initiatives will help "a broad group of struggling borrowers across the country and in doing so further contribute to the administration’s efforts to stabilize housing markets and communities," Bill Apgar, HUD’s senior adviser for mortgage finance, said in the statement. The new loan program, funded under the Wall Street overhaul President Barack Obama signed into law last month, is part of a broader effort to aid unemployed homeowners in the wake of the worst economic crisis since the Great Depression.

The $2 billion in Treasury aid announced today doubles the amount already sent to housing agencies in states with unemployment rates at or above the national average during the past 12 months. The U.S. unemployment rate probably will average 9.6 percent in 2010, based on the median estimate of 74 economists in a Bloomberg poll. That would be the highest annual rate since 1983.

Accelerating Foreclosures
The joblessness is helping accelerate foreclosures. A record 269,962 U.S. homes were seized in the second quarter, according to RealtyTrac Inc. Foreclosures probably will top 1 million this year, the Irvine, California-based data company said in a July 15 report. "The housing sector continues to be a huge drag on the economy," said Ted Gayer, an economist at the Washington-based Brookings Institution. "We still have excess inventory -- all the government programs we’ve had haven’t prevented that."

HUD’s Emergency Homeowners Loan Program aims to help people who have experienced a "substantial reduction" in income because of involuntary unemployment, underemployment or a medical condition, according to the statement. Aid recipients must be at least three months delinquent on loans and have "a reasonable likelihood" of being able to resume payments and other housing expenses within two years, HUD said. Borrowers must live in the home and demonstrate a good payment history prior to their loss of income.

"A program of this size is not going to make a large difference, but it’s a bridge," said Joel Naroff, president of Naroff Economic Advisors in Holland, Pennsylvania. "We need the housing market to stabilize, because the better the housing market is the stronger the economic recovery is going to be."

30,000 line up for housing vouchers, some get rowdy
by Craig Schneider - The Atlanta Journal-Constitution

Thirty thousand people showed up to receive Section 8 housing applications in East Point Wednesday, suffering through hours in the hot sun, angry flare-ups in the crowd and lots of frustration and confusion for a chance to receive a government-subsidized apartment.

The massive event sometimes descended into a chaotic mob scene filled with anger and impatience. Some 62 people needed medical attention and 20 of them were transported to a hospital, authorities said. A baby went into a seizure in the heat and was stabilized at a hospital. People were removed on stretchers and when a throng of people who had been waiting hours in a line were told to move to another line, people started pushing, shoving and cursing, witnesses said.

Still, officials of East Point declared the day a success. Nobody was arrested and nobody was seriously injured, they said. It was an assessment roundly challenged by many of the people who had to go through it. Kim Lemish, executive director of the East Point Housing Authority, said the event marked the first time the city has offered Section 8 housing applications since 2002. The waiting list that lasted eight years had depleted, she said, and the agency was beginning a new one. So people braved all the physical difficulties just to get on a waiting list that could keep them waiting for years.

Lemish said the agency had expected about 10,000 people but three times as many showed up. Many were just accompanying those looking for an application. Some 13,000 applications were handed out. Concern is rising that a similar scene could occur Thursday when the housing authority of this small city begins accepting the completed applications. Wednesday's event was only to hand out the paperwork. The housing authority will begin accepting applications at 9 a.m. Some of the crowd waited for two days at the Tri-Cities Plaza shopping center. As the temperature rose Wednesday, people fell ill.

Sgt. Cliff Chandler, spokesman for the East Point Police Department, said a toddler was treated earlier in the morning for "some type of seizure," Chandler said. "A lot of  it was heat and some was health-related issues" such people not taking their medications, Chandler said. By the time everyone had left around 2 p.m., the temperature had climbed into the low 90s. East Point police, some wearing riot helmets, were patrolling the area. Firefighters and EMTs were attending to people who were overheating in the sun. Police from College Park, Hapeville, Fulton County and MARTA assisted in crowd control. Chandler said there were no arrests.

Felecia McGhee told the AJC she arrived around 6:30 a.m. Wednesday. She said the major problem began when people started breaking into the line and then officials handing out applications started moving those areas and those line breakers. She said she saw at least two small children trampled when the crowd rushed the building where the applications were to be handed out. "It's a real mess out here," she said. Channel 2 Action News reporter Mike Petchenik  said fights were breaking out and police had to stop people who were storming the door. Channel 2 reporter Tom Jones said, "There are thousands, I mean, thousands of people here. I’ve seen people fall out from the heat."

By late morning the crowd had thinned considerably and people were walking up and getting their applications without delay. But just before the 1 p.m. deadline, a line of about 200 people had formed. Shortly after 1 p.m., several people ran across the parking lot to get in line but were told by police that the line was closed. Emergency personnel brought in a pickup truck full of bottled water and were handing it out to the crowd. A sign on the door of the office explained that only applications were being handed out.

"The housing authority will be issuing applications Wednesday, August 11, starting at 9 a.m. Everyone in line by 1 p.m. on the 11th will receive an application. ... No Section 8 vouchers are available at this time. There are no public housing units available at this time. You're applying for the waiting list only." The Housing Choice Voucher Program, called Section 8, subsidized the rents of low-income families living in apartments and houses that are privately owned. The federal program makes up the difference in rent that the poor can afford and the fair market value for each area.

The federal government has specific standards for its subsidized properties but at the same time landlords are assured an income. Only families with incomes no more than half the median income for the area qualify. The median income for the East Point area is less than $32,000, according to Census data. It is up to the renter to find a place that meets HUD standards, which includes being 90 percent to 110 percent of the "local fair market rent."

Borrowers Refuse To Pay Billions In Home Equity Loans
by David Streitfeld - New York Times

During the great housing boom, homeowners nationwide borrowed a trillion dollars from banks, using the soaring value of their houses as security. Now the money has been spent and struggling borrowers are unable or unwilling to pay it back. The delinquency rate on home equity loans is higher than all other types of consumer loans, including auto loans, boat loans, personal loans and even bank cards like Visa and MasterCard, according to the American Bankers Association.

Lenders say they are trying to recover some of that money but their success has been limited, in part because so many borrowers threaten bankruptcy and because the value of the homes, the collateral backing the loans, has often disappeared. The result is one of the paradoxes of the recession: the more money you borrowed, the less likely you will have to pay up. "When houses were doubling in value, mom and pop making $80,000 a year were taking out $300,000 home equity loans for new cars and boats," said Christopher A. Combs, a real estate lawyer here, where the problem is especially pronounced. "Their chances are pretty good of walking away and not having the bank collect."

Lenders wrote off as uncollectible $11.1 billion in home equity loans and $19.9 billion in home equity lines of credit in 2009, more than they wrote off on primary mortgages, government data shows. So far this year, the trend is the same, with combined write-offs of $7.88 billion in the first quarter. Even when a lender forces a borrower to settle through legal action, it can rarely extract more than 10 cents on the dollar. "People got 90 cents for free," Mr. Combs said. "It rewards immorality, to some extent."

Utah Loan Servicing is a debt collector that buys home equity loans from lenders. Clark Terry, the chief executive, says he does not pay more than $500 for a loan, regardless of how big it is. "Anything over $15,000 to $20,000 is not collectible," Mr. Terry said. "Americans seem to believe that anything they can get away with is O.K." But the borrowers argue that they are simply rebuilding their ravaged lives. Many also say that the banks were predatory, or at least indiscriminate, in making loans, and nevertheless were bailed out by the federal government. Finally, they point to their trump card: they say will declare bankruptcy if a settlement is not on favorable terms.

"I am not going to be a slave to the bank," said Shawn Schlegel, a real estate agent who is in default on a $94,873 home equity loan. His lender obtained a court order garnishing his wages, but that was 18 months ago. Mr. Schlegel, 38, has not heard from the lender since. "The case is sitting stagnant," he said. "Maybe it will just go away." Mr. Schlegel’s tale is similar to many others who got caught up in the boom: He came to Arizona in 2003 and quickly accumulated three houses and some land. Each deal financed the next. "I was taught in real estate that you use your leverage to grow. I never dreamed the properties would go from $265,000 to $65,000."

Apparently neither did one of his lenders, the Desert Schools Federal Credit Union, which gave him a home equity loan secured by, the contract states, the "security interest in your dwelling or other real property." Desert Schools, the largest credit union in Arizona, increased its allowance for loan losses of all types by 926 percent in the last two years. It declined to comment.

The amount of bad home equity loan business during the boom is incalculable and in retrospect inexplicable, housing experts say. Most of the debt is still on the books of the lenders, which include Bank of America, Citigroup and JPMorgan Chase. "No one had ever seen a national real estate bubble," said Keith Leggett, a senior economist with the American Bankers Association. "We would love to change history so more conservative underwriting practices were put in place."

The delinquency rate on home equity loans was 4.12 percent in the first quarter, down slightly from the fourth quarter of 2009, when it was the highest in 26 years of such record keeping. Borrowers who default can expect damage to their creditworthiness and in some cases tax consequences. Nevertheless, Mr. Leggett said, "more than a sliver" of the debt will never be repaid.

Eric Hairston plans to be among this group. During the boom, he bought as an investment a three-apartment property in Hoboken, N.J. At the peak, when the building was worth as much as $1.5 million, he took out a $190,000 home equity loan. Mr. Hairston, who worked in the technology department of the investment bank Lehman Brothers, invested in a Northern California pizza catering company. When real estate cratered, Mr. Hairston went into default.

The building was sold this spring for $750,000. Only a small slice went to the home equity lender, which reserved the right to come after Mr. Hairston for the rest of what it was owed. Mr. Hairston, who now works for the pizza company, has not heard again from his lender. Since the lender made a bad loan, Mr. Hairston argues, a 10 percent settlement would be reasonable. "It’s not the homeowner’s fault that the value of the collateral drops," he said.

Marc McCain, a Phoenix lawyer, has been retained by about 300 new clients in the last year, many of whom were planning to walk away from properties they could afford but wanted to be rid of — strategic defaulters. On top of their unpaid mortgage obligations, they had home equity loans of $50,000 to $150,000. Fewer than 5 percent of these clients said they would continue paying their home equity loan no matter what. Ten percent intend to negotiate a short sale on their house, where the holders of the primary mortgage and the home equity loan agree to accept less than what they are owed. In such deals primary mortgage holders get paid first.

The other 85 percent said they would default and worry about the debt only if and when they were forced to, Mr. McCain said. "People want to have some green pastures in front of them," said Mr. McCain, who recently negotiated a couple’s $75,000 home equity debt into a $3,500 settlement. "It’s come to the point where morality is no longer an issue." Darin Bolton, a software engineer, defaulted on the loans for his house in a Chicago suburb last year because "we felt we were just tossing our money into a hole." This spring, he moved into a rental a few blocks away. "I’m kind of banking on there being too many of us for the lenders to pursue," he said. "There is strength in numbers."

Bill Black: U.S. Using "Really Stupid Strategy" to Hide Bank Losses
by Peter Gorenstein - Yahoo

109 U.S. banks have failed so far this year, 23 in this quarter alone. These failures may not cost depositors, but they do come at a steep cost to the FDIC. As discussed here with ValuEngine’s Richard Suttmeier, the FDIC Deposit Insurance has already spent $18.93 billion this year, "well above the $15.33 billion prepaid assessments for all of 2010."  The situation is likely even worse than the FDIC portrays, says William Black Associate Professor of Economics and Law at the University of Missouri-Kansas City.

"The FDIC is sitting there knowing that it has both the residential disaster and the commercial real estate disaster [and] knowing it doesn’t have remotely enough funds to pay for it," he says. What the FDIC should really be doing, Black argues, is raise its assessments to better reflect the true state of the banking system. However, that would turn an already precarious position into crisis as it would cause more banks would fail. The other option, though not politically plausible, would be to ask the Treasury Department or Congress for more funds.

Therefore, we’re left in our current situation. "That also means we’re following a Japanese type strategy of hiding the losses," he says. "This is a really stupid strategy and it’s ours." It’s also not a money-making strategy for stock investors. Black reminds us Japan’s Nikkei is still worth about 75% less than it was before their bubble burst in late 1989.

American families are digging deep to pay for college
by Lauren Young - Reuters

In the wake of the housing bust and a sagging economy, American families are scrambling to pay for college, according to the latest research from Sallie Mae, which was conducted by Gallup. With the cost of private universities now topping $35,000 for tuition, fees, room and board each year, Americans are tapping retirement accounts, asking extended family members to help out with college costs and keeping kids at home for the first few years of school to cut down on living expenses. One worrisome trend: Parents who took money from their retirement accounts withdrew an average of $8,554 in 2010 compared to $5,318 in 2009.

To pay for college, families are also borrowing more heavily from traditional sources including financial aid. And usage of 529 college savings plans is on the rise. "Families are digging deeper and taking a number of measures to make college more affordable," says Bill Diggins, senior consultant with Gallup. "They see great value in college. It’s an investment in the future. Most strongly agree that a college degree is more important now than ever."

The findings of Sallie Mae’s study are different from another study conducted by Country Financial which shows that fewer Americans think college is a good investment. The Sallie Mae study found that 83 percent strongly agree (by rating 5 on a scale of 1 to 5) that college is "an investment in the future," virtually unchanged over the past three years. Why the discrepancy? The Sallie Mae study focused on families with kids who are actually in college or college-bound (families of undergraduate students aged 18 to 24) as opposed to the general population. "These are actual consumers of a college education," says Sarah Ducich, Sallie Mae’s senior vice president of public policy.

15 Economic Statistics That Just Keep Getting Worse
by Michael Snyder - Economic Collapse

A little over a week ago, U.S. Treasury Secretary Timothy Geithner penned an article for the New York Times entitled "Welcome To The Recovery" in which he touted the great strides that the U.S. economy was making.  But with unemployment still dangerously high and with foreclosures and personal bankruptcies continuing to set all-time records, should we really be talking about a "recovery"?  The truth is that the numbers don't lie, and statistic after statistic shows that the economic fundamentals continue to get progressively worse. 

The U.S. government can continue to try to pump up with economy with more debt, but the reality is that there is not going to be a legitimate "recovery" until consumer spending rebounds.  Consumer spending makes up the vast majority of U.S. GDP.  But without good jobs, consumers are not going to be able to spend money.  Unfortunately, our jobs base continues to be erode as millions upon millions of middle class jobs are shipped over to China, India and dozens of third world nations by the global predator corporations that now dominate the world economy.

The U.S. government cannot create real wealth out of thin air.  It can borrow even more money and flood the economy with even more paper currency, but the short-term "buzz" that creates does absolutely nothing to solve our long-term economic problems.

It is the private sector that actually creates wealth.  But unfortunately, over the last several decades we have allowed that wealth to become highly concentrated.  Now the giant global predator corporations have decided that American workers aren't really that desirable after all.  They are slowly taking away their factories and their offices and they are moving them to where people are willing to work for one-tenth the pay. 

So where does that leave middle class American "consumers"?

Well, it leaves us in a world of hurt.

The following are 15 key economic statistics that just keep getting worse and which reveal the horrific economic plight in which we now find ourselves.... 

1 - The number of Americans who are receiving food stamps rose to a new all-time record of 40.8 million in May.  The number of Americans receiving food stamps has set a new all-time record for 18 months in a row.  But there is every indication that things are going to get even worse.  The U.S. Department of Agriculture projects that the number of Americans on food stamps will increase to 43 million in 2011. 

2 - The U.S. economy lost 131,000 more jobs during the month of July.  But the truth is that the U.S. economy has been bleeding jobs for a long time.  According to one analysis, the United States has lost 10.5 million jobs since 2007.  Meanwhile, immigrants (both legal and illegal) continue to pour into this nation in unprecedented numbers.

3 - Americans who are out of work are finding it incredibly difficult to get back into the workforce.  In the United States today, the average time needed to find a job has risen to an all-time record of 35.2 weeks.

4 - The U.S. government keeps trying to pump up the economy with debt, and in the process things are getting wildly out of control.  According to a U.S. Treasury Department report to Congress, the U.S. national debt will top $13.6 trillion this year and climb to an estimated $19.6 trillion by 2015.

5 - The interest on all of this debt is becoming increasingly oppressive.  As of July 1st, the U.S. government had spent $355 billion so far in 2010 on interest payments to the holders of the national debt.  The total for 2010 should be somewhere in the neighborhood of $700 billion.  According to Erskine Bowles, one of the heads of Barack Obama's national debt commission, the U.S. government will be spending $2 trillion just on interest on the national debt by 2020.  Keep in mind that the entire U.S. government budget is less than $4 trillion for the entire year of 2010.

6 - If the U.S. government was forced to use GAAP accounting principles (like all publicly-traded corporations must), the annual U.S. government budget deficit would be somewhere in the neighborhood of $4 trillion to $5 trillion.

7 - Social Security will pay out more in benefits in 2010 than it receives in payroll taxes.  This was not supposed to happen until at least 2015.  In the years ahead, these new "Social Security deficits" are projected to be absolutely catastrophic

8 - There are simply far too many retirees and not nearly enough workers to support them.  Back in 1950 each retiree's Social Security benefit was paid for by 16 workers.  Today, each retiree's Social Security benefit is paid for by approximately 3.3 workers.  By 2025 it is projected that there will be approximately two workers for each retiree.

9 - Wealth continues to become highly concentrated at the top.  Since 1973, the average CEO’s salary has increased from 26 times the median income to over 300 times the median income.

10 - According to a poll taken in 2009, 61 percent of Americans "always or usually" live paycheck to paycheck.  That was up significantly from 49 percent in 2008 and 43 percent in 2007.

11 - The Mortgage Bankers Association recently announced that more than 10% of all U.S. homeowners with a mortgage had missed at least one mortgage payment during the January to March time period.  That was a new all-time record and represented an increase from 9.1 percent a year ago.

12 - A recent survey of last year's college graduates found that 80 percent moved right back home with their parents after graduation.  That was up substantially from 63 percent in 2006.

13 - During the first quarter of 2010, the total number of loans that are at least three months past due in the United States increased for the 16th consecutive quarter.

14 - The total number of U.S. bank failures passed the 100 mark in July of this year.  In 2009, the total number of U.S. bank failures did not pass the century barrier until October.

15 - The U.S. dollar continues to rapidly decline in value.  An item that cost $20.00 in 1970 would cost you $112.35 today.  An item that cost $20.00 in 1913 would cost you $440.33 today.

Any rational observer (and clearly U.S. Treasury Secretary Timothy Geithner does not qualify) can see that the foundations of the U.S. economy are coming apart.  The rapidly accumulating mountain of debt that has fueled our "prosperity" is impossible to repay and is going to progressively choke the life out of our economic system.  The good jobs that we have allowed to be shipped out of our country are never coming back.  Every single day, more wealth flows out of this country than flows into it.

Anyone who claims that things are getting "better" is either ignorant, completely deluded or is purposely lying. 

The U.S. economy is not getting "better".

The U.S. economy is dying.

You should adjust your plans accordingly.

Irish debt under fire on fresh bank jitters
by Ambrose Evans-Pritchard - Telegraph

Ireland’s borrowing costs have begun flashing warning signs again on fears the full damage from the country’s banking crisis has yet to surface. Spreads on Irish 10-year bonds reached 297 basis points over German Bunds on Wednesday amid reports the European Central Bank (ECB) is intervening to shore up Irish debt, a reversal of the bank’s plans to withdraw emergency support. The euro fell almost three cents against the dollar from $1.32 to $1.29.

Patrick Honohan, governor of Ireland’s central bank and a member of the ECB’s council, dismissed the bond jitters as yet another spasm by jumpy and emotional markets. "The spreads are a setback for our hopes of a narrowing to reflect the fiscal credibility of the country. I don’t look at them every day but at this level they are ridiculous," he told The Daily Telegraph, speaking at his office in the heart of Dublin. He said critics are failing to recognise the dynamism of Irish exports as the country quickly returns to a current account surplus, or the revolution in public accounts as tax reform kicks in.

The latest jitters stem from the escalating costs of Ireland’s rescue of Anglo Irish Bank (AIB). The European Commission revealed this week that it had approved government support worth €24.3bn (£20bn) for the bank, significantly higher than estimates by Dublin earlier this spring. Dr Honohan fumed at the mere mention of AIB, which brought the country to its knees two years ago in much the same way the Icelandic banks crippled their host state. "They were egregious, in a league of their own," he said. "If it hadn’t been for them the losses would have been manageable. The net cost to the Irish state of recapitalising the banks is €25bn, or 15pc to 16pc of Irish GDP. It is nearly all the result of AIB."

Dr Honohan is a poacher-turned-gamekeeper, an arch-critic brought in last year to clean house at the central bank. A professor at Trinity College Dublin, he used to work for both the IMF and World Bank. He had condemned the government just a few months before his appointment in a paper entitled "What went wrong in Ireland". His long-standing argument is that the genuine Celtic Tiger of the 1990s gave way to a foolish credit bubble over the next decade under "complacent and permissive" bank regulation and the failure of the political class to understand that a small economy on the edges of a currency union must use fiscal policy to prevent overheating.

"There was complacency about joining the single currency in a number of countries. People thought things would take care of themselves, and they have had more than a wake-up call," he said. The cardinal error in Ireland was to stand idly by as the ECB’s ultra-low interest rates set off an explosive property boom. Real rates averaged minus 1pc for almost a decade. Instead, the government made matters worse by relying on "fair weather" taxes – capital gains, property, and corporate taxes – that created windfall revenues and flattered public accounts, until it all ended with a crash.

Dr Honohan knows as well as anybody that Ireland has little headroom for error. The IMF expects public debt to reach 96pc of GDP by 2012, near the tipping point when debt dynamics become unstable. Under Ireland’s rescue programme the viable core of AIB’s business will be cut from the wreckage and relaunched as a new entity. Bad debts are already parked at Ireland’s National Asset Management Agency (NAMA) at an average "haircut" of 50pc. Antonio Garcia Pascual, at Barclays Capital, said the NAMA strategy initially won plaudits but is increasingly viewed by markets as "a very costly approach". There are growing doubts over the exposure of Irish banks to British property.

Fergal O’Brien, chief economist for the Irish Business and Employers Federation, said another threat is creeping up on the banks. They issued tracker mortgages during the boom at rates that are now underwater. "This has become a big problem. The banks are locked into loss-making contracts," he said.

For the past year, Ireland has been touted as the model of fiscal rectitude, proof that countries can pull themselves out of a tailspin if they act fast. It is the laboratory for debt-hangover cures in the eurozone. The nation has certainly been bold, cutting public wages by 13pc (including pension levies) to restore competitiveness. This is known as an "internal devaluation" in IMF parlance, the only option left for a country that cannot devalue its currency.

Less clear is whether it can work. The budget deficit seems stuck at 14pc of GDP, and unemployment has risen to 13.7pc. The severity of the slump is eating away at the tax base. Critics say the country is chasing its tail. Under the deflation, nominal GDP has contracted by almost 20pc. Yet the debt stock has risen. Ireland is uncomfortably close to a debt-deflation trap along the classic lines described by Irving Fisher in the 1930s.

Dr Honohan said the tax take is a lagging indicator. Revenues are "undershooting a little" but there is nothing yet to worry about. Asked about the risk of a Fisherite deflation spiral, he waved his hands in protest and said the country was at no risk of being pushed "head over tail downwards" by the discipline of EMU membership. Yet a great deal of unhappiness could have been avoided if Ireland’s leaders had understood the nature of the game earlier. "The lesson is that if you want to join a currency union with low inflation, you had better not get out of line."

Spanish Crisis Threatens Second Front as Catalonia Rates Rise
by Emma Ross-Thomas and Esteban Duarte - Bloomberg

Prime Minister Jose Luis Rodriguez Zapatero may face a second front in his battle to contain Spain’s fiscal crisis as borrowing costs for the country’s regional governments climb. Catalonia, which accounts for a fifth of Spanish gross domestic product, has been shut out of public bond markets since March and the extra yield it pays over national government debt has almost tripled this year. Galicia, in the northwest, has asked to freeze payments of debt it owes the central government and the Madrid region postponed a bond sale last month.

Spain’s regions, which borrowed at similar rates to the central government before the global credit crisis started in 2007, are key players in Zapatero’s drive to get his budget in order and push down the country’s borrowing costs. They control around twice as much spending as the state, employ more than half of all public workers and piled on debt during the recession.

"If investors focused more on the problems in the regions, they would be less optimistic on Spain’s central government debt, and see that the rally in July was a bit overdone," said Olaf Penninga, who helps manage 140 billion euros ($182 billion) at Rotterdam-based Robeco Group, and sold Spanish bonds last year. "If the central government has to help the regions it would aggravate an already bad situation."

Risk Premium
The yield on 10-year Spanish government bonds has dropped 79 basis points to 4.09 percent since June 16, according to Bloomberg generic prices. The extra return investors demand to hold the debt rather than German equivalents was at 165 basis points today, down from a euro-era high of 221 points two months ago. Banks are nevertheless charging Catalonia more for loans than the building companies stung by Spain’s construction slump.

The region, which attracts more tourists than any other in Spain, paid 300 basis points more than three-month Euribor for 1 billion euros of four-year bank loans last month, a spokesman said. Fomento de Construcciones & Contratas SA, Spain’s fourth- largest builder, said on Aug. 2 it agreed to pay a 260-basis point spread to extend 1.1 billion euros of loans until 2014.

While government records on Aug. 9 show that Catalonia sold 1 billion euros of five-year debt via savings bank La Caixa in June, it hasn’t issued a benchmark-sized bond in public markets since March even after taking a road show to Asia in April. "Debt markets closed" as Greece’s fiscal crisis spread through the euro region in the second quarter, said spokesman Adam Sedo last month. At 5.5 percent, the yield on Catalan 10-year bonds is on a par with Peru.

Greek Fate
The regions’ budget problems come as Zapatero tries to convince investors that Spain can avoid the fate of Greece, which was forced to seek a European Union-led bailout this year after its deficit ran out of control. Zapatero, his popularity slumping in opinion polls, is pushing through the deepest austerity measures in three decades and borrowing costs have declined since officials last month published stress tests on Spanish banks. The regions’ borrowing difficulties will likely complicate their relationship with the Madrid government. While Catalonia is pushing for more autonomy and Spanish law prevents the central government from bailing out the provinces, some investors expect it would do so if necessary.

‘Big Brother’
"There’s a certain perception that there’s a big brother standing behind," said Diego Fernandez, a fund manager who helps oversee 240 million euros at Inverseguros in Madrid and is cutting holdings of regional debt. "There could be a region that has more difficulties and so would need some help, which wouldn’t materialize as a bailout but as some kind of larger transfer."

The EU got around its own no-bailout clause in May and backstopped countries threatened by contagion from Greece’s crisis. Letting a region fail would also push up Spain’s own bond yields and would be "suicide," said Jose Carlos Diez, chief economist at Intermoney Valores, Spain’s biggest bond dealer. "It would be absurd -- you don’t let a bank fail but you let a region fail?" he said.

Catalonia isn’t the only region that may hurt Spain’s budget battle. The autonomous community of Madrid postponed a bond sale on July 30 because of "market conditions." Galicia is lobbying Finance Minister Elena Salgado to put a moratorium on 2.6 billion euros it owes the central government and to double the time it has to pay the money back. Salgado refused on July 27.

Debt Load
Regional debt has soared since the end of the decade-long real estate boom that provided local leaders with a surge in tax revenues. While provinces are required by law to balance their books, their overall debt load rose to 9 percent of GDP in the first quarter compared with 5.5 percent at the peak of the boom. The regions have agreed to cut their combined deficit to 2.4 percent of GDP in 2010 instead of 3.2 percent planned at the start of the year. The shortfall will widen to 3.3 percent of GDP next year compared with a previous forecast of 4.2 percent. Zapatero forecasts the national deficit will narrow to 6 percent next year from 11.2 percent in 2009.

That hasn’t stopped Fitch Ratings giving four provinces a negative outlook on Aug. 4, meaning it now has all 10 of the regions it covers on notice for possible downgrades. Its ratings range from A+ for Catalonia and Valencia -- the lowest since Fitch started rating them -- to AA for Madrid, while the Basque Country is the only region rated AAA. Fitch cut its rating on Spain to AA+ May 28. Any deterioration in the regions’ credit quality, coupled with one of the highest private debt loads in the euro area, could undo Zapatero’s efforts and push up Spain’s own borrowing costs, Penninga said. "This crisis can come back to haunt Spain again," he said.

German Debt Ratio May Rise To 90% Of GDP On Bank Bailout
by Andrea Thomas - Dow Jones Newswires

The bailout of Germany's banking sector may swell the country's public debt rate to 90% of gross domestic product, Die Zeit weekly newspaper reports Wednesday. The weekly based this estimate on a recent decision by Eurostat requiring Germany to include the balance sheets of public-owned bad banks--set up to help financial institutions offload toxic and non-strategic assets--into its overall debt ratio.

State-owned WestLB AG bank has already offloaded EUR77 billion into such a rescue bank. Going by the Eurostat decision, EUR54 billion of WestLB's toxic assets transferred to the bad bank must be included in Germany's overall debt level. Finance ministry spokeswoman, Jeanette Schwamberger, said the "winding-down entity of WestLB has already been included in the government's recently published calculations of the debt level."

In July, it forecast Germany's debt level will rise from 73.1% in 2009 to 79% of GDP in 2010, 80% in 2011, to 80.5% respectively in 2012 and 2013 before easing to 80% in 2014. Die Zeit said that if nationalized mortgage lender Hypo Real Estate is added to the equation, Germany's debt level could widen to 90%. However, the impact from Hypo Real Estate is yet unclear because a rescue bank hasn't been set up and it's unknown how big the volume will be, according to Schwamberger.

Hypo Real Estate has said it plans to offload EUR210 billion into such a bad bank, but has already added that it might need less fresh capital than previously said. A consolidation of assets might reduce the widening of Germany's debt. A debt ratio of 90% of GDP would be much higher than the 60% threshold set under the European Union's Maastricht Treaty.

China Said to Order Banks to Reclaim Loans From Trust Companies
by Bloomberg News

China’s banking regulator ordered banks to transfer off-balance-sheet loans onto their books and make provisions for those that may default, three people with knowledge of the situation said. The assets linked to wealth management products provided by trust companies must be shifted onto banks’ balance sheets by the end of 2011, the people said, declining to be identified as the matter isn’t public. Lenders should prepare provisions equal to 150 percent of potential losses, they said.

China’s move may increase pressure for capital-raising at the country’s banks, which Fitch Ratings last month said had more than 2.3 trillion yuan ($339 billion) of off-balance sheet assets. It also underscores concerns about the health of the banking industry after a person with knowledge of the matter said regulators last month ordered lenders to conduct stress tests to gauge the impact of a 60 percent drop in home prices.

The regulator’s order "will plug the loophole that more and more banks now employ to get around government lending curbs," said Liao Qiang, a Beijing-based analyst at Standard & Poor’s. Bringing loans back on to the balance sheet will restrict banks’ ability to expand lending while "their capital requirement will increase," Liao said. Larger banks will be required to maintain the mandated capital adequacy ratio of 11.5 percent after taking the off- balance-sheet loans back onto their books, the people with knowledge of the matter said. Smaller Chinese lenders are required to meet a 10 percent ratio.

Global Push
Banking stocks gained in early trading in Shanghai after tumbling yesterday. Industrial & Commercial Bank of China Ltd., the nation’s largest, rose 0.2 percent to 4.16 yuan as of 10:50 a.m. and China Minsheng Banking Corp. gained 1.1 percent after reporting first-half profit rose to 8.9 billion yuan, beating analysts’ estimates. A China Banking Regulatory Commission press official, who declined to be identified because of the agency’s rules, confirmed the regulator sent a notice on cooperation between banks and trust companies. The regulator will make a public statement soon, she said, without giving a specific time period.

Limited Impact
"They want to strengthen their monitoring of the systematic risk related to off-balance sheet management of bad debts," said Wang Qing, Hong Kong-based economist at Morgan Stanley. "In the near term, the impact on banks’ earnings will be quite limited." Globally, regulators are pushing banks to increase capital and improve the quality of their balance sheets in the wake of the credit crisis, which forced dozens of U.S. and European banks to accept state bailouts. A report by bankruptcy examiner Anton Valukas into the collapse of Lehman Brothers Holdings Inc. found the investment bank used off-balance sheet transactions to downplay its leverage in 2007 and 2008.

The Basel Committee on Banking Supervision last month proposed restrictions on how much banks can borrow in order to rein in their risk-taking. Chinese banks last year extended a record $1.4 trillion of new loans, and regulators are concerned defaults may rise as the economy slows. Data yesterday showed Chinese property prices rose at the slowest pace in six months in July after the government cracked down on speculation to prevent asset bubbles. "The regulators are concerned about non-performing loans, but they are also concerned about growth," Lu Ting, a Hong Kong-based economist at Bank of America Corp., said in a Bloomberg TV interview. "It’s impossible for them to cut off loan supply in the next few months."

Fund Raising
China aims to cap new loans at 7.5 trillion yuan this year and lenders have advanced 4.6 trillion yuan in the first half. New loans amounted to 532.8 billion yuan last month, the central bank said today. Standard & Poor’s said on July 23 banks will need to raise more funds to cope with tighter capital requirements and loan growth. A week earlier, Fitch said first-half Chinese lending was higher than official data suggest as more loans were repackaged into investment products.

The nation’s five largest banks, including Agricultural Bank of China Ltd., are raising more than a combined $60 billion to replenish capital, which would bolster their ability to absorb bad loans after last year’s record new loans. China’s benchmark Shanghai Composite Index dropped 2.9 percent yesterday, the most in six weeks, after slower-than- estimated import growth fueled concern the world’s third-largest economy is losing steam. Imports expanded 22.7 percent in July, less than the 30 percent median estimate of 29 economists in a Bloomberg survey.

China's Fabricated High-Tech Boom
by By Zhou Qiong and Yang Aili - Caixin

How tax incentives for high-tech companies have helped forge a massive industry in application processing

In order to promote technological innovation, three government agencies introduced the High-tech Enterprise Certification Management Policy (High-tech Policy) in 2008. The Ministry of Science and Technology (MOST), Ministry of Finance and the State Administration of Taxation jointly introduced a tax incentive policy to companies with a high-tech certification. From the standard 25 percent corporate tax rate, the tax for high-tech companies was slashed to 15 percent.

After the policy took effect, middlemen agencies that collected fees on the new application process sprouted across the country overnight. The number of agencies in Beijing reached 300, the most in the country. The Yangtze and Pearl River Deltas came in second to Beijing. A cottage industry emerged as a result of the policy adjustment, including accounting firms, law firms, intellectual property firms and various consulting firms. These firms offer professional services not only to handle the application process for high-tech companies, but also help fabricate conditions for clients to gain certification.

And along with the arrival of the 10 percent tax reduction was the birth of "false high-tech companies." An official at the MOST who asked to remain anonymous said, "At least 50 percent of the companies that have already received high-tech certification are not truly qualified. They were certified under falsified materials."

Faked Background
According to the High-tech Policy, to obtain certification, companies must meet six requirements. For example, the company must own the intellectual property of the core technology for its main products or services; more than 30 percent of the company's workforce must hold university degrees, and 10 percent of the employees must work in research and development department; and the company's research and development budget must account for three to six percent of its total sales.

Senior tax lawyer Liu Tianyong told Caixin that since the Corporate Income Tax Law was implemented on January 1, 2008, domestic and foreign companies have lost all room for tax breaks. The High-tech Policy filled this gap, and encouraged companies to become certified. Currently, nearly 20,000 companies have received certification and approximately 70 percent of them achieved it from the help of agencies. Caixin found that several agencies accepted nearly every company that walked through its doors. "If you don't meet the conditions, we'll create the conditions. Whatever you lack, we can help you fix it," said one agency owner.

In Guangzhou, one agency claimed to have connections with the national and local ministries of science and technology. They boasted that since 2008, they have helped more than 10 companies receive certification successfully each year. In a telephone call, the representative at this agency said that intellectual property was the most difficult condition to apply. He added, "The rest is simple. All the other requirements can be adjusted to suit the application." But even for intellectual property, this agency claimed it could source an idea unique enough for qualification. "We can help a company buy a patent. Depending on the situation, it only costs between 10,000 yuan and 100,000 yuan."

False Prosperity
Manipulation of the high-tech enterprise certification is excessively lenient, making room for falsified declarations. This tradition of leniency in the last 20 years has made the total number of high-tech companies and their output value seem unbelievably high. In 1991, The State Council issued the "Conditions and Rules for National High-tech Industrial Development Zones and High-tech Company Certifications" which stipulated that high-tech companies that set up in high-tech industrial development zones can enjoy beneficial financial, tax and trade policies.

Since then, the government has included high-tech companies and their output value as part of local officials' performance reviews. The same MOST official said, "Some local officials further relax the conditions for entry into high-tech zones in order to achieve better performance. Anybody can get in and benefit from the advantageous policies. But in fact, the number of companies that qualify for high-tech certification would be very few. So everyone has adopted a lenient attitude."

By the end of 2007, the number of high-tech enterprises in China was 56,047 with an output value of 2.21 trillion yuan. Cai Qixiang, former deputy director of the Guangdong Province Science and Technology Committee, said, "Some people are very happy to see the numbers. They say we're about to catch up with the United States. But actually, what many companies do has nothing to do with technology. They're just assemblers. Many of our high-tech companies are not the same as those in the United States."

Even though the latest High-tech Policy set stricter standard on technological research and development investment, it still did not change the situation. Beginning in March of 2009, the Ministry of Finance, National Audit Office and other departments conducted spot tests of 116 high-tech companies in Beijing, Shanghai and elsewhere. Of those, 85 companies – or 73 percent – were found to not meet the conditions. These companies' tax breaks were valued at 3.63 billion yuan.

Rethinking Policy
With so many companies falsifying information to achieve high-tech status, a strict crackdown is developing from the nation's leadership. Currently, some company's high-tech certifications are being revoked, while others will face stricter review this year. Most companies bought five-year exclusive patents in order to gain the privileges and tax breaks that come with the high-tech status. As soon as they received the certification, they rarely put research findings into production.

The MOST official pointed out that government is unable to classify companies using simple labels and give differential treatment because of a "high-tech" or "non high-tech" tag. He said that the concept of the High-tech Policy was not bad, but the execution has brought a series of negative effects, such as company rankings, interference in a fair competitive environment and disruption of the market order. "Traditional administrative approval system is not only bad for efficiency, but also makes room for corruption and leads companies to the wrong direction."

A president in research and development for Greater China at a multinational company believes that if the government wants to push companies to innovate, it needs to encourage real innovative behavior, regardless of the company's scale, profits and ratio of employees with advanced degrees. He suggests that the Chinese government focus on protecting intellectual property rights and building a fair and transparent competitive environment.

1 yuan = 14 U.S. cents

Wells Fargo Ordered To Pay $203 Million In Fees Over 'Unfair' Charges
by Eileen Aj Connelly - AP

A federal judge in California ordered Wells Fargo & Co. to change what he called "unfair and deceptive business practices" that led customers into paying multiple overdraft fees, and to pay $203 million back to customers. In a decision handed down late Tuesday, U.S. District Judge William Alsup accused Wells Fargo of "profiteering" by changing its policies to process checks, debit card transactions and bill payments from the highest dollar amount to the lowest, rather than in the order the transactions took place. That helped drain customer bank accounts faster and drive up overdraft fees, a policy Alsup referred to as "gouging and profiteering."

The ruling detailed the experiences of two Wells Fargo customers who used their debit cards for multiple small purchases, and were then charged hundreds in overdraft fees because the order the purchases were cleared by the bank depended on the amounts. The judge found the customers, who were part of a class action, were not properly informed of the bank's policies on processing payments and were unaware the bank would allow debit purchases to go through when their accounts were overdrawn.

"Internal bank memos and e-mails leave no doubt that, overdraft revenue being a big profit center, the bank's dominant, indeed sole, motive was to maximize the number of overdrafts," Alsup wrote. That policy would "squeeze as much as possible" from customers with overdrafts, in particular from the 4 percent of customers who paid what he called "a whopping 40 percent of its total overdraft and returned-item revenue."

The judge dismissed Wells Fargo's arguments that customers wanted and benefited from the policies, and detailed evidence he said showed efforts to obscure the practices in statements and other materials. Wells Fargo's online banking system, for example, would display pending purchases in chronological order, "leading customers to believe that the processing would take place in that order." "The supposed net benefit of high-to-low resequencing is utterly speculative," he wrote. "Its bone-crushing multiplication of additional overdraft penalties, however, is categorically assured."

Alsup also criticized the bank for allowing overdraft purchases after accounts had been drained by offering a "shadow line of credit" that customers were unaware existed. The decision noted that the Federal Reserve has outlawed some of the practices detailed in the case, most notably debit card overdrafts permitted without customers agreeing to accept overdraft protection. Judge Alsup ordered Wells Fargo to stop posting transactions in high-to-low order by Nov. 30 and to reverse overdraft fees charged to customers from Nov. 15, 2004, to June 30, 2008, as a result of the policy. A study cited in the decision by a Wells Fargo witness put the restitution at "close to $203 million."

Wells Fargo spokeswoman Rochele Messick said the bank is "disappointed" with the ruling. "We don't believe the ruling is in line with the facts of this case and we plan to appeal," she said. Messick noted that Wells Fargo changed its policies earlier this year, and customers can no longer incur more than four overdraft charges in one day. Wells Fargo shares closed Wednesday trading down $1.47, or 5.3 percent, at $26.30, as the broader markets dropped sharply on economic concerns, with banks being particularly hard hit. The case, heard in the U.S. District Court for Northern California, is Gutierrez vs. Wells Fargo.

Global Youth Unemployment Reaches New High
by Matthew Saltmarsh - New York Times

Youth unemployment across the world has climbed to a new high and is likely to climb further this year, a United Nations agency said Thursday, while warning of a "lost generation" as more young people give up the search for work. The agency, the International Labor Organization, said in a report that of some 620 million young people ages 15 to 24 in the work force, about 81 million were unemployed at the end of 2009 — the highest level in two decades of record-keeping by the organization, which is based in Geneva.

The youth unemployment rate increased to 13 percent in 2009 from 11.9 percent in the last assessment in 2007. "There’s never been an increase of this magnitude — both in terms of the rate and the level — since we’ve been tracking the data," said Steven Kapsos, an economist with the organization. The agency forecast that the global youth unemployment rate would continue to increase through 2010, to 13.1 percent, as the effects of the economic downturn continue. It should then decline to 12.7 percent in 2011.

The agency’s 2010 report found that unemployment has hit young people harder than adults during the financial crisis, from which most economies are only just emerging, and that recovery of the job market for young men and women will lag behind that of adults. The impact of the crisis also has been felt in shorter hours and reduced wages for those who maintain salaried employment.

In some especially strained European countries, including Spain and Britain, many young people have become discouraged and given up the job hunt, it said. The trend will have "significant consequences for young people," as more and more join the ranks of the already unemployed, it said. That has the potential to create a " ‘lost generation’ comprised of young people who have dropped out of the labor market, having lost all hope of being able to work for a decent living."

The report said that young people in developing economies are more vulnerable to precarious employment and poverty. About 152 million young people, or a quarter of all the young workers in the world, are employed but remain in extreme poverty in households surviving on less than $1.25 a person a day in 2008, the report said. "The number of young people stuck in working poverty grows, and the cycle of working poverty persists," the agency’s director-general, Juan Somavia, said.

Young women still have more difficulty than young men in finding work, the report added. The female youth unemployment rate in 2009 stood at 13.2 percent, compared with the male rate of 12.9 percent. The gap of 0.3 percentage point was the same as in 2007. The report studied the German, British, Spanish and Estonian labor markets and found that Germany had been most successful in bringing down long-term youth unemployment. In Spain and Britain, increases in unemployment were particularly pronounced for those with lower education levels.

Data from Eurostat, the European Union’s statistical agency, show Spain had a jobless rate of 40.5 percent in May for people under 25. That was the highest level among the 27 members of the European Union, far greater than the 9.4 percent in Germany in May and 19.7 percent in Britain in March.

Number of people working beyond 65 soars
by Harry Wallop - Telegraph

The number of people working beyond the age of 65 is rising at the fastest rate since records began, official figures indicate, as thousands of pensioners attempt to boost their income in retirement. In the last three months an extra 40,000 people over the age of 65 have joined the work force, taking the total number to 823,000. This is the highest number since the Office for National Statistics started keeping these figures in 1992. The highest quarterly jump previously was no more than 26,000. It means that one in 12 people over 65 are now working.
The figures suggest that thousands of pensioners are going back to work to fund their slim incomes, or that they are not in a financially strong enough position to retire in the first place, according to experts. Some are also actively choosing to work longer. They are the latest data to demonstrate how the recession has changed the face of Britain's workforce, leading to far more part-time workers and older workers, while leaving many more young people out of work for more than two years.

Ros Altman, who used to advise the Government on pensions, said: "This is a reflection of things to come. For some people working longer is not terrible. "But if they are forced to work longer because they have to, or they have no money to fund their retirement, then this is clearly a problem. And come next year the time bomb goes off – this is when the first baby boomer hits the age of 65. Then wave after wave will retire and we have to find a way to fund their pensions, and we have to do so urgently."

Last month the Government proposed scrapping the default retirement age in an attempt to keep people in the workforce for longer to ease the pensions crisis. It has also suggested that the retirement age rises to 66 far sooner than previously proposed. The current ratio of four working adults for every pensioner will fall to three within a decade and two by 2040. Laith Khalaf, pension analyst at Hargreaves Lansdown, the independent financial advisers, said: "Most of us want to retire as soon as possible, but many people find they just can't afford to. The state pension is just too measly, and private pensions aren't adequate enough to cover the shortfall."

The state pension is £97.65 a week, equating to an average annual income of £5,078. And according to Hargreaves Lansdown, the average private sector worker is retiring with a pension equating to no more than £2,145. Part of the reason for the small private pensions has been because of falling annuity rates, the figure used to calculate most pensions, in the wake of the emergency measures to prop up the economy during the financial crisis.

Wilson Wong, senior researcher at the Work Foundation think tank, said: "Many people have seen their pension fall in value by 20 per cent to 30 per cent since 2008, and a lot have thought 'this is not enough to retire on. I've got to carry on working.' There will be a lot more in that position as time goes on." Many of those working beyond the age of 65 are doing so to help support their children or grandchildren. Emma Soames, the editor at large of Saga Magazine, said: "Many, many more people still have mortgages when they reach the age of 60 or 65. They either borrowed too much, or moved, or divorced, or remortgaged to support their children."

According to Aviva, 12 per cent of people aged 65 to 74 have a mortgage. And the outstanding amount for this age group, an average size of £59,858. The trend for older working – the number of over 65s working has doubled in less than a decade – is also a reflection of the better health of many older people, as well as a desire by some to keep active. The figures were published as part of the ONS monthly update on unemployment, which indicated the number of people in work had jumped by far more than most economists had expected.

Overall, unemployment in the three months to June fell by 49,000 to 2.46 million, the Office for National Statistics said. The number of people in work jumped by 184,000 – the largest quarterly jump since 1989 – to 29 million. However, this figure included a record number of part-time workers, up 115,000, taking the total to 7.84 million. Economists warned that the number of people out of work was likely to rise soon, once the full-scale of the public sector cuts are felt.

Michelle Mitchell, charity director of Age UK, said: "The number of people aged 65 and over still in work has been rising steadily, even during the recession. Many of them already have access to employment and simply intend to carry on working either because they find their jobs fulfilling or – as it is the case for many – because they need to shore up their personal finances hit by the recession. "For tens of thousands of them, the Default Retirement Age at 65 is a pending threat and the Government should stand by its proposal to scrap it from next year."

Jim Hillage, director of Research at the Institute for Employment Studies, pointed out that public sector workers were already feeling the pinch, with fewer vacancies available. He said: "We are now beginning to see the early signs of the public sector downturn, with vacancy numbers across public sector industries beginning to contract sharply. As these trends gather pace in the coming months, overall unemployment is likely to rise unless the recovery in the private sector will be sufficient to compensate for significant public sector job losses."

David Kern, Chief Economist at the British Chambers of Commerce (BCC), said: "While recent labour market trends are welcome, it is important to bear in mind that we have not yet seen the negative impact on jobs that will result from the tough measures announced in the Budget." The BCC believes that unemployment will peak at 2.65 million next year. A spokesman for the Department for Work and Pensions said: "Many older people want to work over the age of 65 and have a wealth of skills and experience that are not being used. "We want to get rid of the default retirement age so that if people want to work they can do so. By spending longer in the workforce they can have a better pension in retirement."

Prechter: The Last Time The Market Looked Like This Was Right Before The '87 Crash

Financial markets: Derivative dilemmas
by Aline van Duyn - Financial Times

Ari Bergmann is putting the finishing touches to a course he will begin teaching at New York University in a few weeks. Yet, in spite of his best efforts, much of the curriculum cannot yet be written. That is because of a big battle that is about to explode, on Wall Street and in the deepest bowels of Washington. Mr Bergmann will teach people ranging from investors to corporate treasurers how to spot financial risks and how to manage them. The tools used to do this are derivatives, which he first traded in the 1980s – contracts whose value is linked to a financial instrument, from the rate of interest paid on US government bonds to the price of oil.

The derivatives market is one of the biggest in the world. At the end of last year, contracts with a face value of $636,431bn were swirling around the world’s financial system, according to the Bank of International Settlements. Just 3.4 per cent of the total were traded on exchanges. The rest – $614,674bn worth, equivalent to nearly 10 years of global economic output – were agreed and traded in private markets, under terms struck directly between the buyers and sellers.

Over the next year, an entirely new rulebook is to be drawn up for this privately traded part of the financial markets, also called over-the-counter (OTC) derivatives. President Barack Obama’s signature on the Dodd-Frank Wall Street Reform and Consumer Protection Act on July 21 started the countdown. The legislation covers many parts of the financial system. Title seven – the part that deals with derivatives – is "among the most far-reaching and controversial sets of statutory changes" included in the new laws, according to lawyers at Cadwalader, Wickersham & Taft.

But whereas in theory the business is about to be revolutionised, in reality any changes will be preceded by bitter haggling over precisely what the rules prescribe – and proscribe. Crucially for banks, investors and the future health of world economies, just how far-reaching the outcome will be depends in large part on the decisions made by the two Washington regulators who will police a market that grew dramatically in recent decades without direct oversight.

The two – the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) – have increased their staff numbers in anticipation of the rule-writing and their huge extra enforcement duties. For the most part, the rules have to be written by July 2011. These are regulators that usually write just a handful of new rules every year but, thanks to the new legislation, there will be more than 100 definitions and rules to get through. "Many of the key terms in the derivatives legislation are either undefined or are left for the regulators to fill in," says Cadwalader.

The root cause of the financial crisis involved losses on risky US mortgages. The entire global financial system was exposed to these mortgages after hundreds of billions of dollars of complex securities linked to them were sold to investors from Illinois to Iceland. Derivatives were the building blocks for those securities. The degree to which derivatives had created a dangerously interconnected financial system became clear amid the collapse of Bear Stearns, Lehman Brothers and AIG in 2008. A default by one bank at the centre of a tangled web of derivatives contracts could paralyse the entire financial system, because the derivatives could become worthless if the bank writing the contract went under.

"In the wake of the recent financial crisis, over-the-counter derivatives have been blamed for increasing systemic risk," said Federal Reserve Bank of New York staff in a paper earlier this year. "OTC derivatives serve a vital role in financial markets but deficiencies in the market design and infrastructure allowed for misuse of these instruments, exacerbating the recent financial meltdown." Regulators have swept in to restore confidence in markets before.

After the crash of 1929, the SEC was set up to police the equity markets and create structures that would reassure investors the cards were not stacked against them. The CFTC, with its roots in commodity markets, has done the same for exchange-traded futures. Now, the regulators will try to do the same for derivatives markets. "The Wall Street reform bill will for the first time bring comprehensive regulation to the over-the-counter derivatives marketplace," says Gary Gensler, chairman of the CFTC. The new rules will "lower risk, promote transparency and protect the American public", he adds.

Yet to be decided
Now that US financial reform has been signed into law by President Barack Obama, regulators have until July 2011 to work out the details
• Who qualifies as a "swap dealer"? A bank, an oil group’s derivatives trading arm, a small trading firm? How much capital is required?
• What type of swap will have to be cleared? Will regulators make clearing compulsory for large categories of financial instrument or take a case-by-case approach? Will there be limits on whether banks can own clearing houses?
• What kind of entity will qualify as a trading platform? Will trading over the phone be permitted or must it all be electronic? Must large trades be reported immediately? How much information about trades has to be made public?
• How much data do swap dealers and investors have to hand over to regulators, and how quickly? Who will be able to see this?

Under the new regulations, the derivatives world will be divided in two. On one side will be those products that are widely used, simple in structure and actively traded: standardised derivatives. Those will be pushed on to clearing houses to make the financial system less vulnerable to the default of a big derivatives dealer. Clearing houses can reduce counterparty and systemic risks by standing in the middle of trades – though there of course remains a risk the clearing house itself may fail. The clearing house has a pool of capital and collects collateral and margin – up-front payments against possible losses. If these resources are not enough to cover a default by a member, the others are supposed to cough up.

Cleared derivatives will also have to be traded on electronic systems – although exactly how those systems will be defined, and how quickly and frequently price information has to be made public remains to be resolved. Mr Bergmann, who advises investors on derivatives strategies, says public pricing would reduce the chances that buyers – such as municipalities or small pension funds – would overpay. Customers who pay banks too much would soon know if the value is lower than they thought. If the contracts are centrally cleared, they would have to come up with an extra margin to pay the clearing house as soon as the price falls. "Mispricing of derivatives has often not been discovered until it is a disaster," says Mr Bergmann. "In theory, with widespread clearing people will know about it before it becomes a disaster."

Once regulators determine what part of the OTC derivatives or swaps markets has to be cleared, the remaining part will also be policed. No one knows what proportion will be uncleared, or what the targets are, although for all derivatives the more heavily regulated exchange-traded futures market provides the likely standard. "Look at the way futures have traded on exchanges," says Viral Acharya, professor of finance at NYU’s Stern business school. "Similar practices, in one way or another, will be applied to OTC derivatives under new regulations. There will be more capital required, less leverage and less opacity."

How regulators decide the clearing houses should hold the collateral against trades, and the extent to which derivatives users can offset positions against each other, will also be key. Banks have built huge internal clearing systems in recent decades, divisions usually called "prime brokerage". Through these, big institutional investors or hedge funds can buy and sell all kinds of financial instruments – from bonds to credit derivatives to currency swaps to commodity investments – and offset them against one other. If an investor has to pay for each part of the trade – usually called a "leg" – having to hand over cash for each piece could add up. If the positions are offset, the trade can be done much more cheaply.

"We still don’t know what kinds of trades will be profitable or which of our customers will have to change their investment strategies," says the head of prime brokerage at one big bank. These questions about the costs also mean that the risks of the clearing houses and the business model behind them cannot be properly worked out – leaving investors in limbo. "When we use a clearing house, we have to be able to make a case as to why we think they are financially sound," says the head of trading at one of the biggest institutional investors. "We cannot determine this until we know what the new rules will be."

There is a lot to play for. According to Tabb Group, the biggest derivatives dealers generate revenues of $40bn a year from the OTC business. As the rules are rewritten there will be much behind-the-scenes jostling as current derivatives big-shots – which include all the Wall Street banks – try to hang on to market share and newcomers try to muscle in. "This is a big business opportunity," says Larry Tabb, chief executive of Tabb Group.

The cast of characters embraces not only big banks such as Goldman Sachs, JPMorgan Chase, Morgan Stanley, Barclays Capital and Deutsche Bank but exchanges such as CME Group, Nasdaq OMX, NYSE Euronext and Intercontinental Exchange, which want clearing business. It also includes smaller banks and brokers that do not currently trade derivatives – for instance Nomura and Jefferies, as well as inter-dealer brokers including Icap, and other financial groups that want to get into clearing or trading, from Tradeweb to State Street to tiny start-up brokerage firms.

The outcomes will affect investors, banks and companies that use derivatives extensively for hedging. The end result will also depend on what happens in Europe. "A lot of these things won’t work well if one centre applies rules that are not as strict," says Mr Arachya. With the answers to the questions about the future shape of the derivatives markets now in the hands of staff and commissioners at the regulators, the CFTC’s Mr Gensler says CFTC and SEC teams have already met five or six times since the legislation was passed. A series of public hearings is expected to be held from September onwards.

The potential for turf wars is of concern, as is the possibility of disruption to investment and trading activities. "The enormity of the proposed changes could result in both short-term pain for users of swaps and participants in the derivatives markets generally, and long-term unintended and undesirable changes in the marketplace," say lawyers at Jones Day. "The extent to which the rulemaking process will provide the necessary clarity will depend in part on how well the CFTC and SEC are able to work together in areas of potentially overlapping jurisdictions."

Whatever the case, the coming months will determine what is ultimately discussed in Mr Bergmann’s course about risks and markets. Not for nothing is the biggest section in his course outline entitled: "Derivatives: weapons of mass destruction or weapons of mass protection?"

The route to regulation diverges for Europe and America

The dog days of summer may not seem the most productive time to dive into derivatives reform. But in Paris on Wednesday the few securities regulators, derivatives brokers and lawyers not on holiday gathered for a public hearing on a critical aspect of the reforms that are still being thrashed out in Europe. At issue was the question of which over-the-counter derivatives are sufficiently standardised to be required to trade on exchanges. The Committee of European Securities Regulators, the umbrella group for the region’s watchdogs, convened the hearing as it finalises recommendations for reform. These will be fed to the European Commission in Brussels, which is working on proposals that will head to the European parliament.

Yet, with the US having passed the Dodd-Frank act to regulate this market in July, Europe is trailing. The parliament’s legislation is unlikely to be ready to be enacted for another year. Moreover, Europe has split the question of how OTC derivatives are traded from that of clearing, which helps protect the financial system from the effects of a trading default. The former is being handled under the Commission’s review of the 2007 Markets in Financial Instruments Directive to increase competition in share trading.

Differences have emerged that many say make it unlikely the biggest capital markets will end up with the same reforms. Barney Reynolds of London-based law firm Shearman & Sterling says: "Some elements of the US legislation have run ahead of global regulatory thinking and the key question now is whether the EU follows." Europe concurs on the main thrust, insisting on greater use of clearing of OTC derivatives, and that they should be traded on exchanges and other electronic platforms. But it has no Volcker-style rule forcing banks to spin off proprietary trading.

In addition, Brussels has so far stopped short of granting exemptions from clearing for OTC derivatives for industrial companies – an issue on which businesses such as airlines, Daimler, the automotive group, and EADS, the aerospace group, are still lobbying furiously, arguing that this will incur costs that drain corporate cash. Finally, bureaucrats in Brussels appear lukewarm on granting the foreign exchange markets an exemption from clearing – as granted, under certain circumstances, in the US.

Sharon Bowles, chair of the European parliament’s economic and monetary affairs committee, plays down concern over divergence: "I bet you we won’t end up being too far apart," she told the Financial Times last month. Yet there is a growing risk of regulatory arbitrage, where market participants shop around for the most favourable set of rules. The main beneficiaries will be Asian centres only too keen to build up derivatives and clearing businesses of their own.


Anonymous said...

And to add quotes to the fire, here is the full set of nonsensical quotes I posted about a year ago on my blog.

Famous Economic Quotes From The First Great Depression

As Stoneleigh notes, they border on the absurd. Of course, the quotes associated with the current depression border on the absurd, except to those who simply want to believe just to believe.

Unknown said...

Stoneleigh will present in Ottawa on Wednesday, August 18th at 7pm at the Hintonburg Community Centre, 1064 Wellington Street, Ottawa, Ontario.

Hope to see you there!

John said...

Greystone, nice review, I copied it last year and have it on the clipboard above my desk. Whenever I am not sure about all the craziness going on I take it down, read it, smile, put it back in it's place and go on as I continue to. Thanks for the reminder and your frequent posts.John

Bigelow said...

Deflation to Be or Not to Be -Martin Armstrong (pdf)

pfh said...

Really nice collection of curves. thanks. Isn't the main lesson of history that no one ever learns from history on this one very special super-seduction of money that goes so badly wrong over and over and over again.

I think how peculiarly powerful and invisible the underlying problem is help locate exactly what does it.

To keep a sure bet in finance you milk it till the market collapses, hoping to snatch and run just in time to keep some extra for yourself. To keep a sure bet in nature you switch from using your winnings to multiply your bets to spending them on completing what you started to make it last.

One is treating reality as just information, and the other treating reality as the place you live it.

Bukko Boomeranger said...

I didn't see the phrase "green shoots" anywhere in the intraDepression HappySpeak. Too bad! It would have been an even more powerful propagandaphrase back then when a larger percentage of the population actually handled green shoots because they worked on farms. Then again, they'd be people who knew bullshit when they smelt it. Even whiffing it with their ears.

Another difference between the stock market then and now is that there was not the hidden manipulation to pump those numbers by the Federal Reserve, the federal government or bankmaggots like there is now. They didn't have a PPT or QE to funnel imaginary money to buy SPY or ETFS or other derivatives that are used to boost the market's image.

I do not pay attention to the "market" numbers. They are like a single vital sign on a patient in my hospital. You can have a great vital sign in one system -- like, your temperature is normal -- but if your heart rate has exploded to 180 beats per minute at the same time, or your blood pressure is 55/15, that rosy temperature means nothing. As does the DOW.

VK said...

Man this was a depressing post, for the future of life as we know it :-(

The DE's of the future


Any other DE's anyone can think of?

zander said...


Here's a good link on why a US attack on Iran is unlikely, and BTW check the Canada invasion reference - astounding, that doesn't bode well for the future in your neck of the woods IMO.


zander said...

@Scandia and Elg.

Sorry, I meant that link for Elg but I'm sure it'll be of interest to you anyway :)


scandia said...

@Zander...yes Cdns do seem aware that the US has plans drawn up to invade Canada. So far we elect gov'ts that just give the country away,lock ,stock,barrel of oil and water. Especially the water as corporate efforts to privatize water are intense and, so far, very successful.
Control of the water supply will bring any people to their knees.

....there is a bright spot. See MaxKeiser and the article of on Tony Blair. Perhaps the Pope will call upon divine justice and arrange the same fate for Blair that Blair arranged for Dr. David Kelly. Blair is damaging the image of the Pope and the Catholic Church. I doubt Ratzinger or whatever his name is at all pleased.
And there must be a growing number of made men/women sleeping less well as they imagine themselves being caught up in the net descending on Blair. One of them may think it prudent to remove the charismatic Mr Blair from the world stage.
So I hope...

scandia said...

@VK..." Depose", " Defend","Deter"

scandia said...

@ Zander...furthermore re a US invasion of Canada the Cdn military is so deeply embedded with the US military that they are incapable of defending Canada from a US invasion. And our politicians play war games with the military so they are no longer psychologically capable of resisting an American invasion either. Our sovereignty is an illusion.

jal said...

Forget the possibility of another bigger war. (Military conflict)

War would need/consumes/destroy TOO many resources that would not be available for the pleasure of the 1% of the population.

USA just approved another $600M to increased BORDER SECURITY. There will be another 1,500 soldiers doing nothing productive and sitting around preventing some poor mexican from entering the USA.

In a few years that fence and those soldiers will be used to prevent Americans from crossing the border in their attempt to get cheap medical services and medication.


Ka said...


DEpopulation, through a series of DEcimations.

Perhaps at some point DEfenestrations. ¡Es DEmasiado!

zander said...


Who knows, maybes the Canadian military/establishment will become complicit in the invasion to ensure themselves a place at the new table of Amerada.
what a thought.
You know I'm beginning to wonder about the whole Blair thing, you might be right he may be in for a fall OR be tossed to the lions, I dunno why, but dragnets trawling through other issues seem to keep coming up bearing a Tony Blair and I'm starting to think (again, is that hope?) there might just be a reckoning for Blair and for sure the Kelly saga might be the catalyst, I'm not one for con theories but this stinks to the high heavens, a profesional man of Kelly's standing hacks his wrists to pieces with a blunt boy scout pen knife, hardly any blood found at the scene ( he bled to death as per coroners report) and no note, nothing, left for the wife and kids???
I'm Not having it, summats up here one way or another.
His wife seemingly doesn't want an inquest, but that could be construed as a: there's nothing up, or b: she's not having it either but doesn't want someone taking a zippo to the the sword of damocles should she dare to rock the boat and is subsequently found at the edge of a quiet wood having successfully self decapitated using a lollipop stick.

@ Jal

"Forget the possibility of another bigger war.War would need/consumes/destroy TOO many resources that would not be available for the pleasure of the 1% of the population."



carpe diem said...

DElerious, DEranged, DEfunct, DEend

Bukko Boomeranger said...

VK said...

Any other DE's anyone can think of?

This is covered by the last "De" on your list, but I'm expecting DEpopulation of the Earth...

Anonymous said...

"D" is for destiny:

A few more moons, a few more winters, and not one of the descendants of the mighty hosts that once moved over this broad land or lived in happy homes, protected by the Great Spirit, will remain to mourn over the graves of a people once more powerful and hopeful than yours. But why should I mourn at the untimely fate of my people? Tribe follows tribe, and nation follows nation, like the waves of the sea. It is the order of nature, and regret is useless. Your time of decay may be distant, but it will surely come, for even the White Man whose God walked and talked with him as friend to friend, cannot be exempt from the common destiny. We may be brothers after all. We will see.

Anonymous said...



Gravity said...

Deliverance. For the longest time I wouldn't believe that soylent green shoots are made out of people, until I saw the endless fields of harvest, where necrobankers liquidate the living and feed them intravenously to the dead.

Unknown said...


Toronto is a huge bubble city. you should speak here

Anonymous said...

Another great analysis, Stoneleigh. I second the request for you to come and give a talk in Toronto.

Stoneleigh said...

I can manage Toronto easily enough. I could probably fit it in on my way to Ohio (about September 7th). If someone would like to organize a talk, let me know. I know we have a fair few readers in the area.

Inconsolable Underwing said...




Unknown said...

@ Alexander Ac
Reply to Alexander who was asking why the German economy grew 2.2%:
The Chinese have been recently heavily importing the well known high quality cars, saving the German car industry who grew from 12-17%.
In addition the port of Hamburg has seen an increase of 10% in containerships to China.
My interpretation of the facts:
Chinese new rich are the only world super power in this moment in time, are deciding the fate of us all and are buying only high quality products.
My recommendation:
Stay tuned in, what China will do next.

Alexander Ac said...

I translated this excellent post into slovakian language and have added few graphs:

there are some othe indicators, that oil prices should go down:

Alexander Ac said...

Hi Sailor man,

thanks! I knew that Germany has export-based economy (thats we weaker Euro is good for them), but I did not know that China could be fueling this export... times are changing... China is interesting country but debt is growing there faster than GDP, AFAIK...

scandia said...

" Petraeus hedges on US exit date from Afganistan"

Looks like Obama and the US administration have a rogue general on their hands.

Archie said...

• "Every time Congress makes a joke it's a law, and every time they make a law it's a joke."

• "We hold the distinction of being the only nation that is goin' to the poorhouse in an automobile."

• "This would be a great world to dance in if we didn't have to pay the fiddler."

• "My idea of an honest man is a fellow who declares income tax on money he sold his vote for."

- Will Rogers

This is a very nice article commemorating Will Rogers death 75 years ago. Oh that there were someone today that commanded national respect AND was worthy of it.

Anonymous said...

If someone else can take on organizing a Toronto talk and visit from Stoneleigh, I'd be willing to volunteer and help out. Contact: ineffable27 (at) yahoo (dot) com

VK said...

Consumer metrics is now showing the economy is contracting at a 4.84pc pace. In about a month I reckon, we'll be beating the 2008 low and carry on southward.

So anyway, watched this interesting documentary on Banking with Hitler (UKTV History) and how the BIS was set up and how they supported Hitler with the aid of the rest of Europe's central bankers and major financiers in the US who continued to reap interest profit from the Germans and how the Germans invested towards the end of the war via the BIS in the Allied countries in order to earn income to rebuild from etc post war. The history of the BOE's Lord Norman Montague is also suspect and fascinating.

A fascinating history showing the power and might of the Central Bankers and Financiers, the motive for profit is above all else. So I expect that even in the midst of chaos, the elite shall prosper as they always have. A cruel world we live in but power is power and money is money.

RobertM said...

I aligned up the two charts to see how much correlation there was. See what you think.

Spence Cooper said...

Good article, Stoneleigh. Thanks.

Draft said...

Stoneleigh -

I've heard you make the comment that folks should invest in short term government debt via treasurydirect in addition to keeping cash.

But is there a way to put money into and take it out of treasurydirect without doing so via a bank account? Because I thought the main point of putting money in treasurydirect was to avoid keeping money in a regular bank.

Ilargi said...

New post up.

Deflation and you: Acting perfectly sensibly


Max Weber said...

The only thing missing is Americans who will stand up for justice and freedom. Of course these "leaders" will lead America around by the nose to enrich themselves and their friends. This is all the quotes show. They KNOW they are lieing. If you think you and I are well informed imagine these leaders... in fact, "Bankruptcy 1995" showed the US government was bankrupt in the sense of how a business goes bankrupt; but, the reality is they are never bankrupt as long as there are enough Middle Class Americans to steal from ...