Pike's Peak, Colorado
Ilargi: OK, so the BLS Establishment Survey Data say that in March, nonfarm payroll employment rose by 162,000 (quite a bit less than the consensus among "experts"). Not a terribly reliable or important number, if you ask me, but of course people will milk it for what they can. What strikes me is a number in the Household Survey Data:
The number of long-term unemployed (those jobless for 27 weeks and over) increased by 414,000 over the month to 6.5 million.
That's almost 7% in one month, and that is downright scary. Of course, we've talked about this till the cows were home, fed, bathed, and left the barn again, but it still bears repeating that discussing US employment, for instance the initial jobless claims data, has become a futile exercise, if not an outright affront to the people, if the EUC (Emergency Unemployment Compensation) numbers are not included.
It may make for a nice feel-good story to claim that less people have jumped onto the front of the wagon, but it's simply deceitful not to mention the number that have fallen off the back. Over 44% of jobless Americans are now unemployed for more than 27 weeks. Hence, the EUC component of the stats, the by now 6.5 million who largely depend on the emergency money Congress just last week refused to extend, is now probably the most important segment of the unemployment numbers, or at least should be if the fudging would end. At present, it’s exceedingly hard to figure out where they show up in the various sets of supplied data.
And this whole focus on short term versus long term is increasingly becoming an issue in the overall economy, as well as, obviously, its data sets. We’ll have to see if the 162,000 jobs the BLS Establishment Survey Data is real, and how real it is. Note, for instance, that the ADP reported a loss of 23,000 jobs in the private sector just a few days ago. The gain may therefore stem from government jobs alone, most of which would be temp Census ones.
An increase of close to 7% in long-term unemployment is far scarier than a bunch of temp jobs is reason to cheer, that much should be clear. And there are probably millions of additional people who fall outside the scope of even these numbers. After all, don’t let's forget the difference between U3 (steady at 9.7%), U6 (rose to 16.9%) or even John Williams' SGS Alternate, which presumable has stayed near 22%. + 162,000 may be the best number in three years, but what's it mean when you know that fudging is the name of the game?
Just as long term unemployment is the real story when it comes to jobs, housing has its own version of long-term trouble. The Wall street Journal has an anonymous editorial titled The Permanent Mortgage Crisis, and that pretty much sums up the core of it all. It provides an incomplete summary of failed programs: Hope Now Alliance, Hope Now, Hope for Homeowners, foreclosure moratoriums promoted by Fannie Mae, Freddie Mac and Barney Frank, $127 billion that taxpayers have thus far poured into Fan and Fred, Federal Reserve's purchase of $1.25 trillion in mortgage-backed securities, expansion of the 2008 First-Time Home Buyer Tax Credit, Home Affordable Modification Program, that show that untold billions of your money have been spent to no avail (other than propping up the lenders that originated and/or securitized the loans), while home prices keep on dropping (as per Case-Shiller) and the foreclosures problem is now so out of hand that nobody seems to want to talk about real numbers anymore.
Meanwhile, Fannie and Freddie both report record numbers of loan delinquencies, over 5.5% now, which, given that they hold some $5.5% trillion of the stuff, indicates a potential additional loss of more than $300 billion that you will have to fork over, and believe you me, that’s just for starters. There are millions of people left out there who’ve been trying to hang on, have been spending their reserves just to stay in the house they love but paid too much for, and even IF there are a few more jobs available (big question mark), mean wages will certainly be less than what they were before, and foreclosure proceedings are set to keep coming, if not increase.
We are engaged in a futile attempt to return to a situation that no longer exists, and that was made possible by enormous amounts of cheap empty credit to begin with. Unless we will, and we want to for that matter, restart the money-for-nothing paradigm, which incidentally got us where we are now, home prices will have to come down substantially. Think 50% for starters. That would return some sort of health to the entire system. At those price levels, also, people wouldn't have to make all that much money to be able to afford their homes.
Alas, we are caught in the bind of what once was, all government policy is based on the past, even if that past was clearly a bubble to which no-one should want to return.
So why do we do it? Because the banking system took all those mortgages for homes at hugely inflated prices, and leveraged them to the hilt in order to issue securities and other derivatives. If we would acknowledge that that game is over, and get back to more sane levels of both wages and home prices, the banks would collapse. And by now, you are just about 100% responsible for all the banks' losses. So be careful what you wish for.
The mantra is that all hell would break loose if the casino on Wall Street would be allowed to fail. But it will fail regardless. SO why do we do it? Look at this:
CME working with Fannie, Freddie on swapsExchange operator CME Group Inc is working with mortgage lending giants Fannie Mae and Freddie Mac to design a clearing facility for the $414 trillion global market for interest-rate swaps.
Know what I mean? The numbers are just too huge. And what on earth are two semi-private 100% taxpayer supprted entities doing betting on interest-rate swaps? What sort of world do we live in?
There's no-one in your government who knows how to solve the riddle, even if they would be inclined to do so at the risk of their own positions (yeah, that's a good laugh). And so the next step is inevitable:
"That’s not an iceberg, captain, and even if it were, it’d be way too small to sink us".
And the band played on, a mournful tune in a minor key, about a tragic species that once ruled, but failed to comprehend its own shortcomings, and got too close to its own sun.
Ilargi: Please, with your loved ones, do have a happy Easter break, or whatever version of the ancient pagan spring ritual you prefer, and don’t forget to visit our sponsors, or donate directly to The Automatic Earth. There’s a many much worse things you could do this weekend, and few better.
The Permanent Mortgage Crisis
One more housing bailout to prolong the market agony.
Last Friday the White House announced its latest plan to prevent mortgage foreclosures, and earlier this week the famous Case-Shiller index found mostly flat home prices in January with analysts warning about a new wave of foreclosures to come. You can't blame the latest proposal for that outcome, but what about the previous 10 or 20 federal housing rescue plans?
We're supposed to believe that this latest effort to build an artificial floor under home prices will perform:
- better than the Hope Now Alliance announced by President Bush in October 2007;
- better than the revised Hope Now program announced two months later;
- better than Hope for Homeowners, which was passed by Congress and signed by Mr. Bush in 2008;
- better than the foreclosure moratoriums promoted by Fannie Mae, Freddie Mac and Representative Barney Frank into early 2009;
- better than the $127 billion that taxpayers have thus far poured into Fan and Fred, much of it for foreclosure relief;
- better than the Federal Reserve's purchase of $1.25 trillion in mortgage-backed securities;
- better than last year's expansion of the 2008 First-Time Home Buyer Tax Credit to up to $8,000;
- better than the billions in stimulus dollars that have been spent "to restore neighborhoods hardest hit by concentrated foreclosures," according to the White House;
- better than the $1.5 billion announced earlier this year to state housing finance agencies in the electorally hard-hit areas of Arizona, California, Florida, Michigan and Nevada, and $600 million more this week for other states certified as political disaster areas;
- and certainly better than Mr. Obama's year-old Home Affordable Modification Program to offer mortgage modifications to troubled borrowers or his companion program to offer generous refinancing. We could go on, but you get the joke, even if the housing market hasn't.
Here's a heretical thought: What if Washington had simply let housing prices fall on their own to find their natural bottom? The pain would have been more severe more quickly for some owners who bought more expensive homes than they could afford. But the pain might also be over by now as housing markets cleared faster, and housing might be contributing to a healthier economic expansion. Instead we are heading toward year five of the housing recession, with Washington proposing even more ideas to prolong the agony. One senior banking regulator we talk to calls it "extending and pretending."
But how long can troubled borrowers even pretend? The latest Mortgage Metrics report from the Comptroller of the Currency shows that most of the loans modified in the first quarter of 2009 had gone bad again within nine months—52% were more than 60 days delinquent. The highlights of the latest plan are increased incentives for banks to reduce mortgage principal for troubled borrowers, reduced mortgage payments for unemployed borrowers, more regulatory barriers for banks wishing to foreclose, and a new ability of underwater borrowers to refinance into taxpayer-backed loans from the Federal Housing Administration.
Watching its previous failures, Team Obama will now emphasize reducing principal instead of merely lowering monthly mortgage payments for some years. The White House no doubt noticed that many of the loans modified outside of the various government programs—with aggressive principal reductions—had better re-default rates. But this doesn't mean that such reductions are always a good idea. Many of these private reductions were the result of legal settlements, not business decisions. Obviously if taxpayers chip in to provide equity to millions of underwater borrowers, the borrowers will have less incentive to default. But how many more borrowers will be motivated to seek assistance when the subsidies become more generous?
A lower mortgage bill is surely a relief to an unemployed worker, but what he really needs is a job, and we see nothing in this plan (or any other Washington scheme) to encourage job creation. To the extent that these payments are merely unemployment benefits laundered through the mortgage system and thus reduce incentives to find work, the jobless rate will stay higher for longer and the entire economy will be worse off. Potentially the most expensive part of this plan for taxpayers is the new Federal Housing Administration refinancing option. (Yes, that is the same FHA that is already struggling under mortgage losses and announced last year that its capital had fallen below the level required by law.)
Taxpayers will be required to stand behind a "homeowner" who owes mortgage debt equal to 115% of the value of the home and whose monthly mortgage bill is up to 31% of total income. Message to owners who borrowed responsibly: Next time, don't be such a sap. You'll also be pleased to know the Administration says the price tag on this latest housing plan won't exceed the $50 billion already earmarked for mortgage relief in the Troubled Asset Relief Program. Just don't expect it to end the mortgage crisis.
Will A Perfect Prediction of the Financial Crisis Perfectly Predict a New Crisis?
by Michael David White
We are all going to die, but I hope not in the “extended period” of our current low-interest-rate environment. On the subject of a financial crisis ahead, I pull out this old prediction of crisis to boast about its obvious stunning acumen and to mark its 2-year April Fools’ Day anniversary (see image below). I also call attention to a secondary use of this ancient document: Does it predict a new crisis on top of the old crisis? Is new-crisis prediction as simple as predicting a bimbo eruption of Tiger textings?
The short answer is the probability of a new gargantuan crisis is far more obvious now than it was April 1, 2008. We now can see with confident clarity the explosive panic creators which promise a new crisis, if it should erupt, that it will be of far greater severity than our recent explosion of financial destruction. What are those obvious signs?
The housing market is exhibit A. Less than 1% of 1% of 1% of 1% of the people in the world slightly understands that the housing market in the United States is dead, but that government intervention is pumping formaldehyde into the body and painting blue lips with liquid white out. Everything is fine if you live in a wax museum and enjoy sex with blow up dolls.
The data prove that the bubble must exhale more. Is this scary? Does it scare you that housing prices would fall by 50% to 75% tomorrow should we close Uncle Sam’s Mortgage Shop (Read that last sentence five times, then go on.)?
Our USA-today real estate market bubble is two or three times any previous bubble of the last 120 years, but many of the rest of the world’s housing markets are psychedelic free-verse manic mombos following a guitar-line-in-their-head of Jerry Garcia on his day of 10,000 hits. God rest his soul.
These Europeans and others make us into little quiet wall flowers. Since our 30% property fall is a bank buster their psychedelia ain’t nothing. A bigger housing bubble leads to a bigger bank crisis. What if the United States has the conservative mortgage market? The thought that this could be true makes me seriously consider a future in Scientology.
What else? Add to toil and trouble reckless government spending at home and abroad, new awful exploding fecal colonies of sovereign debt, high unemployment, and it is ridiculous to deny the possibility of a gargantuan fall. Last by not least? Our governors do not comprehend that killing a credit crisis requires fantastic debt destruction. They are running in the wrong direction.
If Ben and Tim don’t know about destroying debt in a credit crisis, then the recent crisis hasn’t been managed. And if you don’t manage a crisis, is that a negative indicator?
At least we have a president who left graduate school a callow vain fellow yet when thrown into the blood sweat and tears of business and politics, he erased a lifelong petty jealousy of majoritarians with a deep respect for capital and free markets. He embraced the American project. In the history of the world we have contributed a thousand parts good for every one part bad in the ancient war on poverty and ignorance.
With his medical reform, President Obama has reversed what was an inevitable national bankruptcy via exploding medical costs. He has now forced creative and destructive competition among insurers. We will see their numbers fall from one thousand to perhaps 20 or 10.
My prediction is cut-throat competition will cut medical care costs by half. Everybody can be covered easily. Radical competition drives prices down radically. Huge new wealth will be available for education and investment. Even the 100-year-flood in our housing bubble and its massive wealth destruction cannot stop us.
April Fools’ Day Fool you fool! Your president hates markets and free enterprise because he can’t stand to be less important than any person, place, or thing. President Obama’s medical reform merely speeds our journey into national bankruptcy. April Fools’ Day you pedantic sycophantic weasel. You and the president are one and the same personality. Civilization falls to adolescent psychopathic vanity.
Fannie Delinquencies Reach All-Time High at 5.52%
- Fannie Single-Family Mortgage Delinquencies Grow to 5.38%
- Fannie’s MBS Issuance Slides 31% in October
- Fannie’s Serious Delinquencies Nears 5% in November
- Fannie Mae Serious Mortgage Delinquencies Rise Above 5%
- Fannie, Freddie’s Portfolios Diverge in February; Delinquencies Keep on Increasing
While serious delinquencies in the Fannie Mae portfolio continue to reach new heights in January, mortgage-backed securitization (MBS) issuance dropped for the second month in a row in February, according to its monthly report. The serious delinquency rate at Fannie climbed to 5.52% in January – the most recent month of data – up 14 bps from December and doubling the 2.77% rate in January 2009. The single-family delinquency rate remains below the 4.03% rate in the portfolio of its brother Freddie Mac . Multi-family loans in the Fannie portfolio slipped into serious delinquency at a 0.69% rate in January, up from 0.63% in December.
Fannie issued $43.9bn in mortgage-backed securities (MBS) in February, a 7% drop from the $47.6bn mark in January and a 2.8% decrease from the $45.2bn issued in February 2009. MBS issuances reached its peak in the last year in June 2009, when Fannie issued more than $130bn in MBS. Fannie’s book of business declined at an annualized rate of 1% in February. The gross mortgage portfolio also fell at an annualized rate of 14.2%. The new numbers came in a week after Timothy Geithner, secretary of the US Treasury Department, stressed the need of a process that would reform the GSE’s and remove “the umbrella of public protection” before Congress.
Following Fannie's Record Delinquencies, Freddie Just Reported New Record For Loans Seriously Delinquent
by Tyler Durden
Yesterday we noted that Fannie just announced a record number of delinquencies at 5.52%. Today, not to be outdone, Freddie follows up and discloses that total delinquent loans also hit another fresh high of 4.08%, an increase from January's 4.03% and double the 2.13% from last February. Also yesterday we noted that CMBS delinquencies are likely in the 6-7% range, as both the residential and commercial real estate market continue experiencing unprecedented weakness.
Also, as reader Tin Cup points out, "The credit enhanced book of business (loans insured by the private mortgage insurers) also hit a record high or 8.59%, up from 8.52% in January (and also double last year’s 4.54%). Again, despite trillions being throw at the housing market, delinquencies continue to rocket upwards."
Sure enough, the market continues to ignore all negative news and just focuses on the direct consequences of a waning fiscal and monetary stimulus program.
CME working with Fannie, Freddie on swaps
Exchange operator CME Group Inc is working with mortgage lending giants Fannie Mae and Freddie Mac to design a clearing facility for the $414 trillion global market for interest-rate swaps. "We have been working with them to help structure our cleared interest-rate swap offering," CME CEO Craig Donohue said on Tuesday at the Reuters Global Exchanges and Trading Summit in New York. "I imagine that we, among others, will be competing to try to win business from them as we introduce our interest-rate swaps clearing solution." Fannie Mae and Freddie Mac, which were seized by the U.S. government in September 2008, will start moving their swaps to centralized clearing within months, their federal regulator said earlier in March.
Regulators want to shift more over-the-counter derivatives -- seen by some as a cause of the recent financial crisis -- into clearinghouses where they are seen as posing less of a systemic risk.
Fannie and Freddie's combined $3 trillion portfolio makes them the biggest swaps holders in the United States. "That's a big opportunity for us," said Donohue, adding that CME was also working with a broad range of other market participants. "Fannie and Freddie are significant customers of CME interest rate products and typically use our Treasury note and bond and interest-rate products to hedge interest rate risk."
Using CME to clear interest-rate swaps would also provide additional capital efficiencies, he said. CME has faced an uphill battle against rival IntercontinentalExchange in providing clearing for credit default swaps, the first over-the-counter derivative deemed by regulators to be ripe for clearing. ICE has cleared more than $6.4 trillion of the swaps since it began providing the service little more than a year ago. CME has done a fraction of that. "It has been a challenge for us," Donohue acknowledged, of CDS clearing. "Our biggest focus is on the rates swaps market." While ICE has not said whether it will pursue clearing of interest-rate swaps, CME will face at least two competitors for Fannie Mae and Freddie Mac's business.
LCH.Clearnet, Europe's largest independent clearinghouse, dominates clearing of interest-rate swaps between dealers and since December has offered clearing for hedge funds and other so-called buy-side firms. CME will also compete with Nasdaq OMX Group's majority-owned clearinghouse, the International Derivatives Clearing Group. Asked if CME would win the race against rivals to clear interest-rate swaps, Donohue said it was too soon to tell. He also declined to say whether CME would be ready to clear interest-rate swaps in the time frame laid out by Fannie Mae and Freddie Mac. "It's hard to declare a front runner before the race has begun," he said.
Cash-Poor Cities Take On Unions
Mayor Antonio Villaraigosa once organized for a teacher's union here, and later ran a branch of the American Federation of Government Employees. That makes him an unlikely advocate for cutting the benefits of the city's workers. But with the city facing a budget deficit that could drain its reserves by summer, Mayor Villaraigosa wants to re-open contract talks with 45,000 cops, firefighters, librarians and other city employees in hopes of persuading them to contribute more to their pensions and health-care costs. His deputy chief of staff, Matt Szabo, puts it bluntly: "Unions have priced themselves out of a job."
Nationwide, politicians looking for budget cuts are confronting politically powerful unions that represent state and local government employees—15% of U.S. workers and organized labor's biggest stronghold. In Memphis, the city's health-care committee recently recommended raising current and retired employees' health-insurance premiums by as much as 15%. And Toledo's city council last week wrung $3.1 million in concessions from its firefighters' union as part of a measure to close its budget gap. Similar things are happening at the state level. Over the past two years, 17 states have cut benefits for employees or increased the amount that individuals must contribute to their pension plans. Three of those states—Kentucky, Texas and Vermont—did both, according to the Pew Center on the States, a public-policy think tank.
At the heart of this fight is an unbalanced equation: The economy is shrinking cities' and states' tax income as their pension and health-care costs have soared. As a result, some governments are diverting money from services to cover benefits, or raising taxes and fees. That doesn't sit well with some taxpayers—many frustrated at seeing their own benefits being cut by private-sector employers. So governments are seeking cuts in union benefits long considered sacrosanct. This has risks. Public-employee unions are among the biggest political spenders, and their members vote in droves. Also, cutting benefits could make it tougher to keep the best employees.
It is tough to compare government pay to private-sector pay because many government jobs—firefighters, police officers—don't have private counterparts. But, on average, government workers make more in wages and benefits. In December, state and local governments spent an average of $39.60 in wages and benefits per hour worked on their employees, versus an average $27.42 for private employers, the Labor Department said. The fight over benefits represents a defining moment for public employees and their unions.
Government is by far the most unionized sector of the work force, and among the few places left where blue-collar workers can retire with traditional lifetime pensions. In 2009, the nation's 7.9 million unionized government workers eclipsed the number of private-sector union members for the first time since the Labor Department began keeping track in 1983. "What comes out of all these negotiations will set the tone for public employees for a while," says Ken Jacobs of the Center for Labor Research and Education at University of California, Berkeley.
In New Jersey, outrage over state deficits helped Republican Chris Christie defeat incumbent Democrat Jon Corzine last November. A few weeks after Mr. Christie's victory, a Quinnipiac University poll found that three-fourths of state voters supported a wage freeze for state workers, and 61% favored layoffs. Last month, Gov. Christie signed a set of bills that would, among other things, cut pension benefits for future employees. Public-employee unions argue that it's unfair to penalize them for a financial crisis that isn't their fault. They say cities and states are opportunistically taking advantage of a short-term crisis to gut benefit plans in place for decades.
Many private-company workers have seen their retirement accounts shrivel, while public-sector benefits have been relatively unscathed. Defined-contribution plans such as 401(k)s had $3.33 trillion in assets at the end of 2009, down 4% from $3.48 trillion in 2006, according to the Federal Reserve. Such accounts have lost value even though companies and workers contributed $100 billion over that period. The rise in public-sector benefits has attracted the ire of citizens like Paul Nelson, a semi-retired investor in Upper Saddle River, N.J. Mr. Nelson, 59 years old, has a son at Northern Highlands Regional High School, where the principal says the school may have to cut teachers and increase class size. "Most public employees have retirement and health-care plans that private-sector employees can only dream of," says Mr. Nelson.
Virtually all full-time state- and local-government employees have access to retirement plans, and most are employer-funded. By contrast, only three-quarters of full-time workers in the private sector have access to retirement benefits. Disparities like these give politicians ammunition for cost-cutting. "Public-employee benefits have to be reined in," says Andrew Koenig, a Republican state representative in Missouri. Mr. Koenig is sponsoring a bill in his state that, over the next several decades, would shift away from a defined-benefit plan, where an employer puts as much money into a pension fund as needed to cover future retirement benefits. It would be replaced with a 401(k)-type of plan (similar to those now in place at many private-sector employers) where workers absorb the market's ups and downs.
Some argue that just because corporations have trimmed employee benefits doesn't mean the government should as well. "There has been an attack on American private-sector workers and benefits, with 401(k)s replacing traditional pensions," says Teresa Ghilarducci a professor at the New School for Social Research in New York City, "and they have failed" at providing retirement security. At the root of governments' problems today are promises made in past decades. As a group, state and local governments have promised an estimated $3.35 trillion in pension and health-care benefits to be paid over the next three decades, but are estimated to have 70% of the money to cover those payments, according to the Pew Center on the States. Pension and health costs can consume 20% of city and state budgets.
California offers a view of the fallout. The state's largest pension fund, the California Public Employees' Retirement System, known as Calpers, is estimated to be only 57% to 65% funded. Having suffered investment losses in recent years, the state has had to dip deeper into its revenues to make up the funding gap. Last year, a budget impasse forced the state to issue IOUs for taxpayer refunds. It wasn't long ago that California was going the other way, based on a different set of assumptions. In 1999, the state's Democratic-controlled legislature and then-governor Gray Davis passed a law expanding benefits for many state employees.
A proposal prepared by Calpers—the $200 billion fund that manages money for 1.6 million of the state's employees, retirees and their beneficiaries—forecast that the boosted benefits would be paid for entirely by investment gains. "There are only two ways you can have this problem: One, the promised benefits are too big, or two, not enough money was put away," says David Crane, special adviser for Gov. Arnold Schwarzenegger. California's contribution to its public-employee pension fund is projected at $3.5 billion in the fiscal year starting July 2010, 4% of the state's general-fund budget, the highest proportion in state history. In Los Angeles, the battle is spilling into the public, including at a noisy City Council meeting in February. On the agenda was a plan to cut 1,000 workers and reopen contracts. Union members turned out to voice opposition.
Art Sweatman, a tree surgeon for the Department of Public Works, showed up wearing baseball cap that read "Deadwood." It was a reference to comments by Mayor Villaraigosa last year in which he said a new early-retirement program could rid the city of "deadwood" employees. "We have to let them know we're here," says Mr. Sweatman, a member of the Service Employees International Union local 721. Mr. Sweatman's union says it is trying to meet the city half way. Local 721 has agreed to early-retirement programs and furlough days, says executive director John Tanner, but it has resisted health or pension rollbacks. "Our goal was to get through this without layoffs or cost-shifting on health care," he says.
Government benefits are almost as old as government itself. Military pensions stretch back to the Roman Empire, predating private-sector benefits by centuries. The U.S. offered retirement pay to soldiers who fought in the revolutionary war, and by 1930 the federal government gave pensions to all its employees. Pensions at private-sector employers came into widespread use only after World War II. Lee Craig, an economics professor at North Carolina State University, says pressure has been building for years to cut government benefits, with the financial crisis accelerating that. "Their promises have finally outstripped the growth of their tax bases," he says.
California's Santa Barbara County, a coastal area known for wineries and Spanish architecture as well as Michael Jackson's former Neverland Ranch, has seen tax revenues fall over the past three years. The county has reduced its work force by 7.5% and management salaries have been frozen since 2008. At a workshop conducted by the county's executive office, representatives from two dozen departments—the sheriff's office, mental services, and public works, among others—were required to suggest cuts. The proposals included eliminating two Spanish-speaking interpreters in the public defender's office, closing a camp for delinquent teenage boys that opened in 1944, and reducing staff in a child-abuse prevention program. Another proposed move could add four to six more weeks to the wait for food stamps.
In Redding, Calif., the mayor and city council are asking city workers to contribute 7% to 9% of their salaries to their pension funds; currently the city picks up that tab. Patrick Jones, who runs his family's gun shop in addition to serving as part-time mayor, says if the council doesn't win concessions it might use a November ballot initiative to ask voters to demand that the city negotiate benefit cuts. That move, he said, would give the city leverage in any union negotiations. "We're just trying to get as many tools as possible to quicken the time it takes" to get concessions, Mr. Jones says.
One group fighting back in Redding is the International Brotherhood of Electrical Workers, which represents 53 electrical workers on the city payroll. One recent morning, about two dozen members gathered in the "bull room," where linemen and electricians meet to get their work assignments. The workers listened to union representative Ray Thomas update them on the contract fight. Mr. Thomas said he hasn't any intention of agreeing to benefit cuts, but told his workers not to expect much. "If it doesn't screw the future, it's something we'll have to discuss," Mr. Thomas said. A member of the audience raised his hand and asked if it was true that deputy sheriffs in surrounding Shasta County had been considering a plan to pay more of their retirement costs. "Did they vote to accept that?" another asked. Mr. Thomas nodded his head yes.
Fed Ends Its Purchasing of Mortgage Securities
The Federal Reserve’s single largest intervention to prop up the American economy, its $1.25 trillion program to buy mortgage-backed securities, came to a long-anticipated end on Wednesday. The program has been credited with holding mortgage interest rates at near-record lows and slowing the nationwide decline in home prices that threatened to send the economy into an extended slump. When the central bank announced the program two days before Thanksgiving 2008, the spread, or difference, between the rates for a 30-year fixed-rate mortgage and a 10-year Treasury note exceeded 2.5 percentage points, or 250 basis points, nearly twice the typical spread.
Demand for mortgage bonds had been frozen since the federal takeover of Fannie Mae and Freddie Mac, the giant mortgage-finance companies, in September 2008. “We were in a deflationary spiral, causing mortgages to go underwater, more foreclosures and a further decline in housing prices,” said Susan M. Wachter, professor of real estate and finance at the Wharton School of the University of Pennsylvania. “The potential maelstrom of destruction was out there, bringing down not only the housing market but the overall economy. That’s what was stopped.” She called the Fed’s mortgage purchases “the single most important move to stabilize the economy and to prevent a debacle.”
The program was initially for $500 billion. The purchases began in January 2009, and in March, the Fed raised the goal to $1.25 trillion. The purchases were to end by Dec. 31, but in September, the Fed said the purchases would taper off more slowly, ending on March 31. The purchases caused rates for 30-year mortgages, which exceeded 6 percent in late 2008, to fall to below 5 percent by March 2009. They are hovering slightly above 5 percent today. Economists had feared that mortgage interest rates would climb sharply after the 15-month program, but those fears have abated in recent weeks. Fed policy makers have suggested that they would consider resuming the purchases if conditions warranted it, but only as a last resort.
“Financial markets have improved considerably over the last year, and I am hopeful that mortgages will remain highly affordable even after our purchases cease,” Janet L. Yellen, the president of the Federal Reserve Bank of San Francisco, said in a speech on March 23. “Any significant run-up in mortgage rates would create risks for a housing recovery.” Ms. Yellen is President Obama’s choice to be the next vice chairwoman of the Fed, after Donald L. Kohn retires in June, but she has not been formally nominated.
Lawrence Yun, chief economist at the National Association of Realtors, said the private market for mortgage-backed securities had sufficiently recovered for the Fed program to end without a hiccup. “Just as the Fed is stepping out, private investors appear to be stepping in,” Mr. Yun said. “As long as there are buyers on Wall Street for mortgages, it should have no impact on consumers. Having said that, it’s possible that the mortgage rate could be higher later in the year, but that would be due to macroeconomic forces unrelated to the Fed purchase program.”
A major factor in that recovery was the government’s announcement last December that it would guarantee debts owed by and securities issued by Fannie and Freddie, according to David Crowe, chief economist at the National Association of Home Builders. While the future of the two mortgage-finance entities remains uncertain, the government backing has been particularly reassuring for foreign investors, including the Chinese and Japanese central banks, that hold securities based on mortgages originated in the United States, Mr. Crowe said.
Another reason mortgage interest rates are not expected to rise sharply is that the supply of the securities has not increased substantially, said Michael Fratantoni, vice president for single-family research at the Mortgage Bankers Association. “Home sales really are running at quite a slow pace, and we haven’t seen much of a spring buying season yet, so there haven’t been a lot of mortgages originated or securities issued,” Mr. Fratantoni said. He projected that as the job market recovered, mortgage rates for 30-year mortgages would rise to 5.8 percent or so by the end of the year.
For consumers, the biggest impact of the Fed purchases was to encourage mortgage refinancing, Mr. Fratantoni said. “Although they did induce some additional sales, more importantly, the Fed enabled a lot of homeowners to have lower monthly payments,” he said. Brent W. Ambrose, professor of real estate in the Smeal College of Business at Pennsylvania State University, said the Fed had “done a credible job of telegraphing what its intentions were,” giving the markets ample time to prepare for the end of the program.
The Employment Situation - March 2010
from the U.S. Bureau of Labor Statistics
Nonfarm payroll employment increased by 162,000 in March, and the unemployment rate held at 9.7 percent, the U.S. Bureau of Labor Statistics reported today. Temporary help services and health care continued to add jobs over the month. Employment in federal government also rose, reflecting the hiring of temporary workers for Census 2010. Employment continued to decline in financial activi- ties and in information.
Household Survey Data
In March, the number of unemployed persons was little changed at 15.0 million, and the unemployment rate remained at 9.7 percent.
Among the major worker groups, the unemployment rates for adult men (10.0 per- cent), adult women (8.0 percent), teenagers (26.1 percent), whites (8.8 per- cent), blacks (16.5 percent), and Hispanics (12.6 percent) showed little or no change in March. The jobless rate for Asians was 7.5 percent, not seasonally adjusted.
The number of long-term unemployed (those jobless for 27 weeks and over) increased by 414,000 over the month to 6.5 million. In March, 44.1 percent of unemployed persons were jobless for 27 weeks or more.
The civilian labor force participation rate (64.9 percent) and the employment- population ratio (58.6 percent) continued to edge up in March. (See table A-1.)
The number of persons working part time for economic reasons (sometimes re- ferred to as involuntary part-time workers) increased to 9.1 million in March. These individuals were working part time because their hours had been cut back or because they were unable to find a full-time job.
Jobless Claims Drop Slightly
The number of workers filing new claims for jobless benefits continued to fall last week, bolstering expectations that claims appear to be back on a clear downward trend as the labor market slowly heals. Meanwhile, U.S. construction spending dropped a fourth consecutive month in February. Separately, the Institute of Supply Management's manufacturing index posted a strong gain for March, rising to 59.6 from 56.5 a month earlier. The March number was the strongest since July 2004. Readings above 50 indicate expansion. Prices and inventories showed the strongest expansion, while the employment subindex ticked down. New orders and production were both up modestly.
The Labor Department said in its weekly report Thursday that initial claims for jobless benefits declined by 6,000 to 439,000 in the week ended March 27. The previous week's level was revised upward to 445,000 from 442,000. Economists surveyed by Dow Jones Newswires expected initial claims to decrease by 2,000. The four-week moving average, which aims to smooth volatility in the data to help paint a better picture of the underlying trend, fell to the lowest level since Sept. 13, 2008 for the week ending March 27. The Labor Department said the four-week moving average went down by 6,750 to 447,250 from the previous week's revised average of 454,000. Total claims lasting more than one week, meanwhile, declined to levels last seen in December 2008.
The latest decline in jobless claims falls in line with economists' expectations that claims are finally back on a downward path after being stuck in a lull since the beginning of the year. Even if unemployment figures start to show some improvement, however, economists and other experts also don't expect to see major gains in labor market conditions for 2010. Forecasters are expecting the national 9.7% unemployment rate in Friday's monthly jobs report to hold steady, suggesting the pace of new hiring is still slow. And any gains that may be shown in the March job figures may not suggest a full turnaround since some of it may be driven by temporary things like government hiring for the Census.
In addition, a report this week by Automatic Data Processing Inc. and consultancy firm Macroeconomic Advisers actually reported an unexpected 23,000 decline in private-sector jobs when forecasters surveyed by Dow Jones had expected to see a 50,000 gain. As a response to the unemployment situation, the Obama administration recently unveiled a series of expansions to foreclosure prevention programs that target in part unemployed Americans. One program, known as the Home Affordable Modification Program or HAMP, would let unemployed homeowners that meet certain criteria temporarily reduce their mortgage payments to an affordable level while they look for work.
Congress has also sought to respond to the jobs crisis with several legislative packages. One bill, which was passed recently by the U.S. Senate, would provide tax credits to workers who hire the unemployed. Another proposal still in the works is a bill to provide tax credits to small businesses. That proposal was approved by the U.S. House, but still must be voted on by the Senate. In the Labor Department's Thursday report, the number of continuing claims -- those drawn by workers for more than one week in the week ended March 20 -- decreased by 6,000 to 4,662,000 from the preceding week's revised level of 4,668,000.
The unemployment rate for workers with unemployment insurance for the week ended March 20 was 3.6% -- unchanged from the prior week's rate. The largest increase in initial claims for the week ended March 20 occurred in Illinois due to layoffs in the construction, trade, and manufacturing sectors. The largest decrease in claims occurred in California.
Construction Spending Falls Again
U.S. construction spending dropped a fourth consecutive month in February, dragged lower by a sagging commercial real estate market and a weak housing sector that are restraining the economy's recovery. Spending decreased by 1.3% in February, to a seasonally adjusted annual rate of $846.23 billion compared to the prior month, the Commerce Department said Thursday. January spending was revised down, falling 1.4% instead of 0.6% as previously estimated. Spending fell 3.4% in December and 2.5% in November. The 1.3% decrease in February matched the forecast of economists surveyed by Dow Jones Newswires. Spending on residential construction in February slid 2.1% to $258.49 billion, after rising 0.7% in January. Groundbreaking on houses is down because of slack demand for new homes.
Buyers brave enough to ignore high unemployment in the U.S. are taking advantage of low interest rates and signing contracts for cheaper used homes, which are a better deal because of the wave of foreclosures in the market. Spending on non-residential projects decreased 1.0%. Outlays dropped for hotels, hospitals, schools, churches, and roads. Office construction spending fell 2.6% and commercial spending dropped 3.2%. Vacancy rates are rising and loans for building are difficult to secure. By sector, private construction spending during February decreased by 1.2% to $553.49 billion. Spending was down 1.7% in January. Public-sector spending decreased in February 1.7% to $292.74 billion.
French workers threaten to blow up closing factory
Workers at a factory north of Paris are threatening to set fire to a huge gas tank to protest the planned closure of the factory. About 50 workers at Sodimatex, which makes car rugs, have been occupying the site in Crepy-en-Valois since Thursday. They are pressuring the company for better compensation. A union representative said Friday that "determined" workers have not backed down from their threat to set fire to a 1,300-gallon gas tank just outside the factory. Gas canisters were also seen on the roof. Plant closings have led French workers to increasingly militant behavior, with numerous cases of boss-nappings over the past year and one other case of a threat to blow up a factory.
Treasury Unemployment Benefit Outlays Surge To All Time High
by Tyler Durden
Even as the BLS and DOL would like us to believe that the unemployment picture is getting better, we present a chart comparing the initial and continued claims as presented by the Dept. of Labor and compare these to actual government outlays. Even as the two combined series have been declining (offset by increasing much discussed EUCs), the most recent Unemployment Insurance Benefit outlay reported by the Treasury (as of March 30 - there is still one more day of data for March), just hit an all time record high of $15.4 billion.What this means is that in March the average paycheck from Uncle Sam for sitting dong nothing, surged to an all time high of $1,447/month.
Fair enough, the spike may be due to a surge in EUCs one may say. Well, here is a chart of the reported EUCs added to the disclosed Initial and Continued claims:
Indeed, even the worst case reported picture of America's jobless seems to have plataued in the upper 10 million range, after hitting a record of 11.1 million in late January.
So what happens when one divides the total population collecting benefits (I.C.+C.C.+EUC) by the actual UST outlays? We get a very curious chart:
It appears that in March either the government decided to payout an additional roughly 20% per unemployment paycheck, or once again, there is a shadow population of beneficiaries, which are not caught in any of the standard cohorts. Keep in mind that the average monthly paycheck has traditionally been indicated as being about $1,000.
What are we missing here?
Previous Employment Levels Founded On High Credit Limits
The uptick in unemployment is directly correlated to the extreme tightening in credit standards we've seen over the past year or so. The environment of lax credit "easy money" we experienced over the past several decades artificially inflated the perceived purchasing power of households by most likely several magnitudes. If someone had $2,000 in bank but had a $10,000 credit card, there was no reason this person couldn't ratchet up credit card debt to the hilt and pay it off slowly. This was no doubt due to confidence in "job security." If I feel confident that I will have a job one year from now, I then believe that I will be able to finance any debt I may incur for the foreseeable future and can continue spending well beyond my earned income.
However, the underlying "bid" in the job market over the past several decades was ironically and without doubt directly correlated to this lax credit environment. In this environment, if someone with $2,000 in the bank had purchasing power of $10,000 and was more than willing to spend up to that amount + a percentage of earned income, then the demand for goods and services throughout the economy was in fact significantly driven by that credit portion of someones purchasing power and hence employers were bidding for labor based on a demand for goods and services founded on credit lines. In other words, high credit lines were producing "job security" which was producing demand based on easy access to credit lines...which was producing "job security", etc
Now what we've experienced over the past year or so is a significant retraction of those credit lines down to levels equivalent to real earned income. In other words, someone with $2,000 in the bank now most likely only has access to $5,000 in credit and that credit is most likely already spent. In other words, $5,000 of purchasing power has been eliminated from the economy and hence the demand for goods and services must be adjusted downward by the same amount unless the decrease is offset by an increase in spending by cash (which we know is not the case).
Therefore, employers must now adjust their expectations of production to this lower level of demand which requires the need for less labor. Therefore, the bid for labor declines significantly, unemployment rises, and the level of "job security" declines. In the short-term this produces an increase in cash saving levels, and a decrease in demand for goods and services. The labor market is adjusting to a new paradigm in credit standards which are certain to remain for several years until cash levels increase to a level which allows for the re-extension of credit and confidence by creditors that those debt levels will be repaid in a timely fashion.
In other words, expect unemployment to remain relatively high for several years until cash savings levels increase dramatically and credit lines begin to be re-extended. However, expect even when those credit lines are re-extended they will be to a much lower level than their previous highs as the market has seen the consequences of extremely easy access to credit, and hence the lows and new historical averages in unemployment will begin to rise in response to new lower levels of credit.
Long-Term Unemployed Clouds the Jobs Picture
New jobs numbers will be released Friday morning, and they are expected to show, at last, some significant creation of new jobs. A cheer will go up at the White House at this sign that the long climb out of the recession's unemployment hole may have begun. But any cheering will be tempered by nagging concern over an insidious problem lurking within the numbers: the startling number of Americans who have fallen into the ranks of not just the unemployed, but the long-term unemployed. The numbers of long-term unemployed—defined as those unable to find a job for six months or longer—are swelling because of the peculiar causes and character of this deep recession. The consequences are troubling: The long-term unemployed tend to be particularly hard to get back into jobs, and they generate their own set of social problems along the way.
President Barack Obama and his team are particularly worried about the phenomenon, and have set out to find ways to combat it. But they're finding policy prescriptions limited by politics and money. Statistics from the Bureau of Labor Statistics tell the grim story. The number of long-term unemployed in February rose to more than six million, fully double the number in the same month one year earlier. Just over 40% of Americans out of work now fall into the category of the long-term unemployed.
More startling, the problem is markedly worse in this recession than even in the deep slide of 1981 and 1982. During that painful recession, the overall unemployment rates were just as bad as now, but the problem of the long-term unemployed was far less acute. At the peak of the unemployment scourge in 1981 and 1982, the share of jobless Americans classified as long-term was 26%, compared to the 40% today. (The numbers would actually be worse if they included those who have simply dropped out of the work force in frustration.)
In large measure, of course, any calamitous recession is going to produce a big chunk of long-term unemployed. But in this one, the problem is especially pronounced. One way American workers have traditionally recovered from job loss is by being mobile—that is, by being willing and able to move to where new jobs are being created. But this recession was caused, in the first instance, by a housing crisis, which also has significantly restricted workers' mobility. Even workers willing to move find that the collapsed housing market has left their house underwater—that is, worth less than the mortgage they owe on it—so they can't absorb the loss a sale entails. Or they can't find a buyer at all. Workers are stuck because of their houses.
In addition, many families now cope by having both spouses work. So even if the main bread-winner loses his or her job, the second job of the other spouse becomes a crucial lifeline the family is loath to give up by moving to a new city. Oh, and the places to which Americans usually flee to find hope—well, they're pretty hopeless themselves this time around. California, Nevada, Florida, the normal hot-spots of growth, all now have jobless problems worse than the nation at large thanks to their housing busts. More broadly, and perhaps most troubling, the long-term unemployment problem fits into a long-term pattern in which the old job skills of many Americans no longer match the job requirements in an information-age economy.
Behind these economic problems lie substantial social problems. Experience has shown that those out of work the longest also find it hardest to get back into the work force, particularly in jobs that match their previous earning power. Research also shows the long-term unemployed tend to have more health problems, and that, not surprisingly, their children get less education and, in turn, inherit their own problems when they enter the job market. So what can be done? To some extent, says Robert Reischauer, president of the Urban Institute and former head of the Congressional Budget Office, "the answer is, we're doing it."
Congress has extended unemployment benefits for longer periods to help workers cope (which, some analysts argue, may actually exacerbate the problem a bit by giving the jobless a reason to decline jobs not to their liking). Government training programs and community college opportunities are being expanded. A jobs bill Congress recently passed gives employers a tax credit for hiring workers unemployed for two months or more. But skeptics doubt such credits actually create new jobs, but rather just give a break for jobs that would have been filled anyway. What some in the administration would really like is to launch a new infrastructure program, to fund more transportation projects and programs to make buildings more energy-efficient, thereby soaking up some of the many construction workers in the long-term unemployed category.
That would require more deficit spending on a new stimulus bill, which is politically impossible this election year. So if Mr. Obama still looks a bit grim even as he talks about an improving jobs picture, it's partly because nobody has a good solution to this troublesome piece of the puzzle.
Geithner: Bailouts 'Deeply Unfair,' Financial System Was Run In A 'Crazy Way'
Treasury Secretary Timothy Geithner said Thursday it's "deeply unfair" that some financial institutions that got taxpayer-paid bailouts are emerging in better shape from the recession than millions of ordinary Americans.
He acknowledged public outrage over that and said people watched with disdain as Washington protected high-risk banks and investment houses, even as the national unemployment rate was soaring to double-digit levels for the first time in a generation.
But in a nationally broadcast interview, Geithner also argued that President Barack Obama had no choice when confronted with a financial crisis. "As the president has said, we had to do some very unpopular things," Geithner said. "People looked at what had happened." "It's not fair. It's deeply unfair," he said. "He (Obama) had to decide whether he was going to act to fix it or stand back ... and that would have been calamitous for the American economy."
The government eventually embarked on a program of assisting the threatened financial institutions, and the sweeping, multibillion-dollar Troubled Asset Relief Program (TARP) created as a bailout engine. Geithner also said that administration officials are "very worried" about recovering the more than 8 million jobs lost in the recession. But he noted that business growth has been improving and expects the economy "is going to start creating jobs again." The secretary agreed that the national jobless rate -- now at 9.7 percent -- is "still terribly high and is going to stay unacceptably high for a very long time" because of the damage caused by the recession.
"Just because this was the worst economic crisis since the Great Depression," Geithner said, "a huge amount of damage was done to businesses and families across the country ... and it's going to take us a long time to heal that damage. " More than 11 million people now are drawing unemployment insurance benefits, and the overall jobless rate of 9.7 percent understates the true level of economic misery because many people who give up looking for work are no longer in the official count of the unemployed. The Bureau of Labor Statistics on Friday will release a report on conditions in the labor markets in March.
Geithner said he hopes skeptical voters will note legislation moving through Congress to bring reforms to the financial system. "What happened in our country should never happen again," he said. "People were paid for taking enormous risks. It was a crazy way to run a financial system." Geithner said, "It's the government's job ... to do a better job of restraining that kind of risk-taking."
Fed Reveals Bear Stearns Assets It Swallowed in JPMorgan Chase Takeover
After months of litigation and political scrutiny, the Federal Reserve yesterday ended a policy of secrecy over its Bear Stearns Cos. bailout. In a 4:30 p.m. announcement in a week of congressional recess and religious holidays, the central bank released details of securities bought to aid Bear Stearns’s takeover by JPMorgan Chase & Co. Bloomberg News sued the Fed for that information.
The Fed’s vehicle known as Maiden Lane LLC has securities backed by mortgages from lenders including Washington Mutual Inc. and Countrywide Financial Corp., loans that were made with limited borrower documentation. More than $1 billion of them are backed by “jumbo” mortgages written by Thornburg Mortgage Inc., which now carry the lowest investment-grade rating. Jumbo loans were larger than government-sponsored mortgage buyers such as Fannie Mae could finance -- $417,000 at the time.
“The Fed absorbed that risk on its balance sheet and is now seen to be holding problematic, legacy assets,” said Vincent Reinhart, a resident scholar at the American Enterprise Institute in Washington who was the central bank’s monetary- affairs director from 2001 to 2007. “There is both an impairment to its balance sheet and its reputation.” The Bear Stearns deal marked a turning point in the financial crisis for the Fed. By putting taxpayers at risk in financing the rescue, the central bank was engaging in fiscal policy, normally the domain of Congress and the U.S. Treasury, said Marvin Goodfriend, a former Richmond Fed policy adviser who is now an economist at Carnegie Mellon University in Pittsburgh.
“Lack of clarity on the boundary between responsibilities of the Fed and of the Congress as much as anything else created panic in the fall of 2008,” Goodfriend said. “That created a situation in which what had been a serious recession became something near a Great Depression.” Central bankers also created moral hazard, or a perception for investors that any financial firm bigger than Bear Stearns wouldn’t be allowed to fail, said David Kotok, chief investment officer at Cumberland Advisors Inc. in Vineland, New Jersey.
Policy makers’ resolve was tested months later by runs against the largest financial companies. Lehman Brothers Holdings Inc. collapsed into bankruptcy in September 2008. The ensuing panic caused the Fed to take even more emergency measures to push liquidity into markets and institutions. It rescued American International Group Inc. from collapse and allowed Goldman Sachs Group Inc. and Morgan Stanley to convert into bank holding companies, putting them under greater oversight by the central bank. “Letting somebody fail early would have been a better choice,” Kotok said. “You would have ratcheted moral hazard lower and Lehman wouldn’t have been so severe.”
The Bear Stearns assets include bets against the credit of bond insurers such as MBIA Inc., Financial Security Assurance Holdings Ltd. and a unit of Ambac Financial Group, putting the Fed in the position of wagering companies will stop paying their debts. The Fed disclosed that some of Maiden Lane’s assets were portions of commercial loans for hotels, including Short Hills Hilton LLC in New Jersey, Hilton Hawaiian Village LLC in Hawaii, and Hilton of Malaysia LLC, in addition to securities backed by residential mortgages.
More than a year after Washington Mutual, the largest U.S. savings and loan, was purchased by JPMorgan Chase in a distressed sale arranged by the Federal Deposit Insurance Corp., the home loans that helped bring down the Seattle-based thrift live on in the Maiden Lane portfolio. For example, 94 percent of the mortgages in one security, called WAMU 06-A13 2XPPP, required limited documentation from borrowers, meaning the lender often didn’t ask customers for proof of their incomes. Almost 10 percent of the borrowers whose mortgages make up the security have been foreclosed on, and almost a quarter are more than two months late with payments, according to data compiled by Bloomberg.
The portfolio also includes $618.9 million of securities backed by Countrywide, mortgages now rated CCC, eight levels below investment grade. All the underlying loans are adjustable- rate mortgages, with about 88 percent requiring only limited borrower documentation, according to Bloomberg data. About 33.6 percent of the borrowers are at least 60 days late. Countrywide is now part of Charlotte, North Carolina-based Bank of America Corp. Maiden Lane has $19.5 million of securities from a series of collateralized debt obligations called Tropic CDO that are backed by trust preferred securities of community banks and thrifts. CDOs are investment pools made up of a variety of assets that provide a flow of cash.
Trust preferred securities, or TruPS, have characteristics of debt and equity and their interest payments are tax- deductible. The securities created by Bear Stearns are rated C, one level above default, by Moody’s Investors Service and Fitch Ratings. CDO securities have tumbled in value as banks are failing at the fastest rate in 17 years, according to data compiled by Bloomberg. The average price of TruPS CDO debt of this rating is pennies on the dollar, according to Citigroup Inc. “The trust of the taxpayer was abused,” said Janet Tavakoli, president of Chicago-based financial consulting firm Tavakoli Structured Finance Inc. CDOs rated CCC and lower “have a high likelihood of default,” she said.
Chairman Ben S. Bernanke defended the Bear Stearns deal as a rescue of the financial system. He said in a speech at the Kansas City Fed’s annual Jackson Hole, Wyoming conference in August 2008 that a sudden Bear Stearns failure would have caused a “vicious circle of forced selling” and increased volatility. “The broader economy could hardly have remained immune from such severe financial disruptions,” Bernanke said in the speech. The Fed chief, who took office in 2006 and began his second term as chairman this year, also has repeatedly called for an overhaul of financial regulations that would allow authorities to take over a failing financial institution and oversee an orderly unwinding of its positions.
Bernanke said last year that nothing made him “more angry” than the AIG case, blaming the insurer for making “irresponsible bets” and a lack of regulatory oversight for the debacle. Officials “had no choice but to try and stabilize the system” by aiding the firm in September 2008, he said. Yesterday’s release by the Fed, through its New York regional bank, also identified securities acquired in the bailout of AIG held in vehicles known as Maiden Lane II and III.
Assets in Maiden Lane II totaled $34.8 billion, according to the Fed, which set their current market value in its weekly balance sheet at $15.3 billion. That means Maiden Lane II assets are worth 44 cents on the dollar, or 44 percent of their face value, according to the Fed. Maiden Lane III, which has $56 billion of assets at face value, is worth $22.1 billion, or 39 cents on the dollar, according to the Fed’s weekly balance sheet. A similar calculation for the Bear Stearns portfolio couldn’t be made because of outstanding derivatives trades. “The Federal Reserve recognizes the importance of transparency to its financial stability efforts and will continue to review disclosure practices with the goal of making additional information publicly available when possible,” the New York Fed said in yesterday’s statement.
The central bank said it reached agreement on “issues of confidentiality” for the assets with JPMorgan Chase, which bought Bear Stearns in 2008, and AIG. New York-based JPMorgan and AIG would incur the first losses on the portfolios. In April 2008, Bloomberg News requested records under the federal Freedom of Information Act from the Fed’s Board of Governors related to JPMorgan’s acquisition of Bear Stearns. The central bank responded that records retained by the New York Fed “were proprietary records of the Reserve Bank, and not Board records subject” to the request, court records show.
Bloomberg filed suit in November 2008 in U.S. District Court in New York, challenging the Fed’s denial, as well as the denial of a separate request made in May 2008, seeking records of four other emergency lending programs. The district court held that the Fed should release documents related to those four programs, and should search documents held by the New York regional bank to determine whether any of them should be considered records of the board of governors. The U.S. Court of Appeals on March 19 upheld the district court’s ruling on the lending programs. Representative Darrell Issa of California said in a statement that yesterday’s disclosure may “signal a new willingness to cooperate with Congress as we investigate how these bailout deals were structured and what the decision making process entailed.”
The Fed in Hot Water
by Robert Reich
The Fed has finally came clean. It now admits it bailed out Bear Stearns -- taking on tens of billions of dollars of the bank's bad loans -- in order to smooth Bear Stearns' takeover by JP Morgan Chase. The secret Fed bailout came months before Congress authorized the government to spend up to $700 billion of taxpayer dollars bailing out the banks, even months before Lehman Brothers collapsed. The Fed also took on billions of dollars worth of AIG securities, also before the official government-sanctioned bailout.
The losses from those deals still total tens of billions, and taxpayers are ultimately on the hook. But the public never knew. There was no congressional oversight. It was all done behind closed doors. And the New York Fed -- then run by Tim Geithner -- was very much in the center of the action.
This raises three issues.
- First, only Congress is supposed to risk taxpayer dollars. The Fed is not part of the legislative branch. Its secret deals, announced almost two years after they were done, violate the democratic process, if not the Constitution itself. Thomas Jefferson put a stop to Alexander Hamilton's idea of a powerful central bank out of fear it would be unaccountable to the public. The Fed has just proven Jefferson's point.
- Second, if the Fed can secretly bail out big banks, the problem of "moral hazard" - bankers taking irresponsible risks because they know they'll be rescued - is far greater than anyone assumed after Congress and the Bush and Obama administrations bailed out the banks. Big banks will always be too big to fail because they know the Fed will secretly back them up if they get into trouble, even if Congress won't do it openly.
- Third, the announcement throws a monkey wrench into the financial reform bill now on Capitol Hill, which gives the Fed additional authority by, for example, creating a consumer protection bureau inside it. Only yesterday, Sen. Jim DeMint (R-S.C.) blasted the Dodd bill for expanding the Fed's authority "even as it remains shrouded in secrecy."
The Fed has a big problem. It acts in secret. That makes it an odd duck in a democracy. As long as it's merely setting interest rates, its secrecy and political independence can be justified. But once it departs from that role and begins putting billions of dollars of taxpayer money at risk -- choosing winners and losers in the capitalist system -- its legitimacy is questionable.
That it chose to reveal the truth about its activities during a week when Congress is out of town, when much of official Washington and the Washington media have gone on vacation, and only after several federal courts have held that the Fed must release documents related to its bailout of Bear Stearns, suggests it would rather remain secret than become transparent.
Much of what Ben Bernanke and Tim Geithner did (when Geithner was at the New York Fed) in 2008 was presumably necessary. But the public has no way of knowing. The public doesn't even know who else the Fed has bailed out, or what entities it will bail out in the future. All we know is the Fed secretly bailed out Bear Stearns and AIG and thereby subjected taxpayers to risks that remain even today, without informing the public. That's not a record on which to build public trust.
JPMorgan’s Dimon Regrets Using FDIC Guarantee Program
JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said he regrets using the Federal Deposit Insurance Corp.’s guarantee program to issue $40 billion in unsecured debt during the height of the financial crisis. “We didn’t need it,” Dimon, 54, said in his annual letter to shareholders, which was released yesterday. “And it just added to the argument that all banks had been bailed out and fueled the anger directed toward banks.” Dimon said the New York-based company was “highly criticized” for issuing debt backed by the FDIC and for accepting $25 billion from the Troubled Asset Relief Program. The company repaid all TARP funds in June, stopped using the FDIC’s program last April and shunned participation in other federal programs “to avoid the stigma,” he said.
JPMorgan, which ranks second behind Bank of America Corp. in deposits and assets among U.S. lenders, remained profitable through the crisis with combined net income of $17.3 billion in the last two years. The company issued $20.8 billion in FDIC- guaranteed long-term debt in 2008, and $19.7 billion in 2009. “It was not a question of access or need,” Dimon said of the FDIC program, whose government backing helped keep interest rates low. “The markets always were open to us, but the program did save us money.”
Dimon apologized for what he said were the bank’s mistakes. He said the two biggest were lowering mortgage underwriting standards and making too many leveraged loans that “may have contributed to the financial crisis.” At the same time, he claimed some credit for helping to stabilize markets through JPMorgan’s purchases of Bear Stearns and Washington Mutual.He also sought to deflect some of the public anger toward financial companies and to correct the perception that all banks would have failed if the federal government hadn’t intervened. “We should acknowledge that the worst offenders among financial companies no longer are in existence,” Dimon said. “And while it is true that some of the surviving banks would not, or might not, have survived, not all banks would have failed.”
Dimon, who took over as CEO in 2005, said his “number-one priority” this year is to find his successor. “Poor CEO succession has destroyed many a company,” Dimon said, adding that the board believes there are several strong internal candidates that could “do my job today.” He said JPMorgan will continue rotating senior staff across the business to ensure they could smoothly take over the company. The company also intends to expand retail banking, which accounted for $97 million of JPMorgan’s $11.7 billion in net income last year. Dimon said the bank will add 2,700 personal bankers, 400 investment sales representatives and 120 more branches this year, even though consumer lending lost $3.8 billion in 2009. The bank plans to ramp up its branch expansion in California and Florida over the next two years, building on its acquisition of Washington Mutual, he said.
Automakers Report Rise in Sales, Helped by Incentives
Big discounts last month, led by Toyota’s efforts to overcome damage to its reputation from recent recalls, made March one of the best months in years for new-vehicle sales in the United States. Toyota said Thursday that its sales increased 41 percent from March 2009. That compares with a 12 percent decline in January and February. Sales of the models that Toyota has recalled since November rose 48 percent in March after dropping 11 percent the previous two months. Sales of two sport-utility vehicles on the recall list, the Rav4 and Highlander, more than doubled.
Toyota sold 558 more of the recalled models, which include the Camry and Corolla sedans, in March than in January and February combined. “Toyota’s strong sales performance in March reflects our customers’ continued confidence in the safety and reliability of our vehicles and their trust in the brand,” Don Esmond, senior vice president for automotive operations for Toyota Motor Sales U.S.A. said in a statement. “We are standing by our cars, and we’re grateful that our customers are standing by Toyota.” Nearly all automakers reported increases for March, and several analysts projected that total sales for the industry surged about 30 percent from a year ago.
The Ford Motor Company said its sales rose 40 percent. Ford’s sales rose 36 percent in the first quarter over all. General Motors said sales of the four brands that it would continue to operate increased 43 percent and that its total sales rose 21 percent. Buick sales jumped 76 percent. Sales of the four brands that G.M. is selling or closing fell 88 percent, as the inventory runs out. Hyundai’s sales increased 15 percent. Chrysler’s sales dropped 8 percent, however.
Toyota, after recalling more than eight million vehicles worldwide as it tried to resolve complaints about unintended acceleration, focused on pushing sales last month with deals that it described as unprecedented. Toyota buyers could get zero percent financing for five years or low lease payments on many models. G.M., Ford, Honda and Chrysler were among the other carmakers dangling no-interest loans in front of shoppers. But G.M. said its overall spending on incentives fell by 42 percent, or $2,000 a vehicle, from a year ago.
G.M.’s vice president for United States marketing, Susan Docherty, said a quarter of vehicles sold were new for the 2010 model year and came with very few discounts. G.M. does not want to begin relying on incentives again to artificially raise sales, she said. “We’ve been down that road before and we know it’s a dead end,” Ms. Docherty said on a conference call. “It’s really important that we earn our market share. We’re not interested in buying it.”
Toyota, meanwhile, increased its incentive spending by 43 percent, or nearly $700 a vehicle, according to estimates from Edmunds.com. The offers seemed to be more successful than even company executives anticipated. “February was tough, but once the new incentives came out it was good times again,” said Barry Jackson, the general manager of Sandy Springs Toyota, north of Atlanta. “Toyota has never been known for big incentives on their cars, so people are taking advantage.”
Mr. Jackson said his dealership moved 23 new vehicles on Wednesday, including two Prius hybrids to a man who had never owned a Toyota and originally came in looking for only one. “He ended up leasing two of them because the payments were so low,” he said. Analysts expected the industry’s retail selling rate, which excludes bulk sales to rental car companies and other fleet operators, to be at the highest level since 2008, aside from the months in 2009 when the government’s cash-for-clunkers program suddenly increased demand.
Greece May Be Heading to 'Square One' as Bonds Fall
Europe’s week-old rescue plan for Greece has so far failed to do what its leaders predicted: reduce borrowing costs for the region’s most indebted country. The yield on 10-year Greek government bonds has increased 25 basis points since EU leaders agreed to the aid blueprint on March 25, reaching a one-month high of 6.529 percent yesterday. The yield eased to 6.525 percent today, still more than double the rate on comparable German debt. Seven-year bonds sold by Greece on March 29 fell for a third day today. “What they were hoping for was to set up some sort of arrangement that never has to be used,” said Phyllis Reed, head of bond research in London at Kleinwort Benson, which manages about $32 billion. “The markets have sniffed that out and it seems like we’re heading back to square one.”
As borrowing costs increase, the risk is that EU leaders will have to deploy a rescue mechanism that still needs to be fleshed out. That would push them to decide the role of the Washington-based International Monetary Fund in any rescue and force the head of Europe’s biggest economy, German Chancellor Angela Merkel, to counter public opinion by funding a bailout with taxpayers’ money. So far, EU officials say they expect Greek yields to decline as the government in Athens carries out a plan to reduce its deficit to 8.7 percent of gross domestic product from 12.7 percent last year. European Central Bank President Jean-Claude Trichet said yesterday investors will “progressively recognize” the steps taken by Greece. EU spokesman Amadeu Altafaj said that Greece’s deficit-cutting plan is “on track.”
The aid facility, a combination of IMF and EU bilateral loans, will only be triggered if Greece runs out of fund-raising options. Greek Prime Minister George Papandreou, who has to raise as much as 11.6 billion euros by the end of May, welcomed the plan last week as “very satisfying.” Since then, the extra yield investors demand to hold Greek 10-year bonds instead of German equivalent has risen to 342 basis points, compared with 305 points on March 26. The yield on Greek two-year bonds rose to 5.17 percent today from 5.119 yesterday. “Markets don’t believe that Greece will be able to see things through,” said Razeen Sally, senior lecturer in international political economy at the London School of Economics, in a telephone interview.
The EU’s bailout plan was complicated by Merkel’s push for an IMF role in the run up to last week’s summit. She argued that German taxpayers shouldn’t fund Greek excess, a position backed by sixty-one percent of Germans, a Financial Times/Harris poll showed on March 22. The final EU agreement nevertheless failed to outline the terms on which the IMF would co-finance a rescue, a lack of clarity that could pave the way for a power struggle. IMF Managing Director Dominique Strauss-Kahn said on March 30 the lender would set the terms of any loans to Greece just as it does with other countries. Trichet said before the summit that ceding control to the IMF would be “very, very bad.” He later changed his tone to say he was “pleased” with the outcome. “It’s supposed to be a joint EU-IMF thing, but it sounds like the IMF have plans of their own,” said Reed. “There are still a lot of question marks.”
Some strategists say it’s too soon to say the EU plan has failed to steer Greek bonds lower as the most recent austerity plan, announced on March 3, still needs to be implemented. “It’s taking time to get the belief factor working,” said Padhraic Garvey, head of investment-grade bonds at ING Groep NV in Amsterdam. “It took six to nine months before Ireland’s story become credible and the Greek story will take longer.” The premium on bonds issued by Ireland, which is also cutting wages to reduce the region’s second-largest deficit, was 138 basis points today, compared with 247 points a year ago. Trichet reiterated his view yesterday that Greece’s deficit-cutting plans, which aim to push the shortfall below the EU’s limit of 3 percent of GDP by 2012, are “convincing.” Papandreou called on his ministers on March 30 to intensify their work to meet the budget plan. Greek officials may not have long to convince investors that the government deserves to pay lower interest rates.
“Over the course of the summer I think we’ll run into a more difficult atmosphere on the markets,” said Frank Schaeffler, a lawmaker from Merkel’s Free Democrat coalition partners, in a telephone interview. “Then we’ll find out whether Greece can pull it off or not, over the course of the summer.” With investors keeping up the pressure, Greek opposition politicians are criticizing the EU plan. Coalition of the Left deputy Dimitris Papadimoulis yesterday mocked Finance Minister George Papaconstantinou for comparing aid to a “loaded gun” that would threaten markets. “The gun,” he said, “has proved to be a water-pistol.”
The IMF should impose default on Greece to end the charade
by Ambrose Evans-Pritchard
I just had lunch with Carmen Reinhart, author of `This Time is Different: Eight Centuries of Financial Folly” and a world authority on sovereign defaults.
Suitably, she was wearing a medallion of a Spanish silver coin dating from 1580, celebrating Philip II’s third default in eighteen years.
These magnificent defaults did not stop Spain launching the Armada against Elizabethan England a little later, or attempting to roll back the Protestant Reformation in a last maniacal attempt to impose Habsburg-Papal absolutism on free thinkers, but it did cripple some great European banking dynasties — about 20 in all.
The Fuggers bit the dust. They were the richest family in Christendom in the 16th Century and bankers to the Counter-Reformation, the Citigroup of their day. This cleared the way for rise of Dutch and Anglo-Scottish finance, and the great power shift to the North Atlantic.
Read: “Lending to the Borrower From Hell: Debt Default In the Age of Phillip II, 1556-1598″ by Maucio Drelichman and Hans-Joachim Voth for details on why the banks kept lending after each default.
But I digress. Professor Reinhart said Greece cannot hope to escape from its debt trap under the current EU austerity plan. The cure of devaluation is blocked by EMU membership. The restrictive monetary policy of the European Central Bank — a contraction of both M3 money and lending to firms, record low core inflation — must inevitably unleash deflationary forces in Club Med states already trapped in credit busts.
A country can in theory deflate its way back to competitiveness by an `internal devaluation’, ie relative wage cuts, in this case by 20pc to 25pc.
Benito Mussolini cut wages by 20pc or so in 1928 when Italy returned to Gold with his Lira Forte policy, but he had Fascist controls on the unions, and Camicie Nere to assist. Italy was not in any case facing the aftermath of a property boom.
It may not be possible for a country to execute such a policy when it already has a public debt above 100pc of GDP, or in Greece’s case nearing 130pc by next year. Debt dynamics take over. The policy leads to a self-feeding spiral in compound interest. This will become evident very soon if — as some economists predict — Greece’s economy contracts by 4pc to 5pc this year.
Ireland is experimenting with this cure. We are seeing the consequences. Nominal GDP has fallen 18.7pc since the top of the boom, according to Barclays Capital.
Real GDP has fallen by less, 12.6pc. The rest is the effect of deflation. But what matters most for debt is nominal GDP. The same debt load has to be financed from a nominal economy that has shrunk by almost a fifth. That is why deflation can be so deadly, as it was from 1930-1933.
It is no surprise that the losses of the Irish banks are now proving catastrophic. They cannot be isolated from the Irish state. As Ian Campbell at Breaking Views writes, the country is now at a risk of debt spiral. The budget deficit was 11.7pc of GDP last year, despite spending cuts. Irish GDP fell a further 2.3pc in the 4th quarter. There is no longer any low-lying fruit for the tax authorities. Further austerity would cut deep into the muscle and bone of the Irish welfare system.
Ireland may yet recover. It has a vibrant export base and a very flexible economy. Leadership has been superb. The plan is at least “doable”, although a weak sterling next door makes the task that much harder.
Greece is another story. It did not invest its EU and EMU windfalls in a well-educated workforce and high-tech enterprise. It spent the money on public payrolls – and submarines — and cut the retirement age as low as 54 for some. We will find out whether it has now gone beyond the point of no return.
Professor Reinhart said Europe will have to bite the bullet and accept `debt-restructuring’ or grapple with unending disaster. Since Germany obviously will not agree to provide the massive long-term finance at cheap rates needed to nurse Greece through the crisis – let alone direct subsidies – there is no alternative: lenders must agree to stretch maturities on Greek debt, and accept an interest rate haircut. “I don’t think the markets have yet understood this,” she said with dry understatement.
She said the model is the Uruguay default in 2003, conducted under the auspices of the IMF when she was working at the Fund. “Everybody got together in a civilized way, and it was very successful,” she said.
The average haircut was 13pc. Maturities were shuffled. Uruguay was praised all round.
Greece is a tougher nut to crack. French banks with €80bn and German banks with €40bn (and British banks too) that bought so much Greek debt at a few basis points over German Bunds in 2006 and 2007 will have to accept a bigger discount to atone for their epic error, perhaps 25pc — though Prof Reinhart did not put a figure on it.
At least US subprime had the excuse of being opaque. It was always obvious that Greek bonds was not equivalent to German bonds, and that country in a currency union running a current account deficit of 15pc of GDP was trouble waiting to happen. Creditors bought the debt on the basis of a political calculation, that EMU would bail out Greece if necessary. It was pure moral hazard.
This “pre-emptive restructuring”, in IMF lingo, has to be handled with care. “When people say there is no contagion risk because Greece is small, they are completely wrong. Thailand was a lot smaller in 1997, and look what happened.” Indeed, it set off the Asian financial crisis.
A Greek default would be twice the size of the two largest defaults in history put together — Argentina and Russia — at least in nominal terms, nearing €300bn. The “demonstration effect” in a long string of countries both inside and beyond EMU might be chilling.
In Uruguay’s case it took a recognition that the country was trapped in an untenable situation after Argentina defaulted next door and devalued by two-thirds.
But is anybody in a position of power in Europe yet willing to contemplate such a solution for Greece? Is France? or Germany? or the European Commission? Or is the ruling machinery of EMU so twisted in ideological knots, and prey to conflicting national agendas, that nothing can be done beyond staging empty summits in Brussels that gain less and less market traction each time? This last deal has been tested within days. Greek spreads are through the roof again. Tuesday’s €1bn snap issue of bonds was horrendous.
In my view, the IMF should not agree to take part in a joint rescue with the EU unless it calls the shots. It should take charge and impose a Uruguay solution. If the Europeans demur — as they surely will — it should make it clear that creditors from the US, China, Japan, Canada, Saudi Arabia, et al, will not waste their IMF money prolonging a dysfunctional foolery by EU institutions. It should walk away, and slam the door.
On a parting note, Professor Reinhart says the only budget deficit that matters in a crisis is the “cash deficit”, and this reached 16pc of GDP in Greece last year — not the 12.7pc officially registered under “accrual” accounting.
As countries near default, they typically find all kinds of way to disguise their troubles, by shifting debts between government agencies and delaying payments.
“In the end, everything comes out of the woodwork. You realize that it is even worse than you thought,” she said.
PIIGS Claims On European Banks: $1.5 Trillion; France Most On Hook In PIIGS Implosion
by Tyler Durden
Here is one reason why Europe, while doing everything it can to make it seem (politically) like a bailout of Greece is out of the question, is and will continue to do all in its power to prevent a domino effect within the PIIGS countries: actually make that 1.5 trillion reasons. According to the IMF, the total amount of foreign claims, in this case focusing on Southern Europe countries, better known as PIIGS, on European international banks is $1.54 trillion. And while many have claimed that Germany would stand to lose the most from an implosion in the European periphery, that is in fact not true true: with $781 billion, France has much more at stake than Germany, whose banks have "just" $522 billion in "Southern European" claims. And while the IMF cut German GDP forecasts in large part due to the country's exposure to Southern Europe, it appears that France is next on the chopping block.
This is shown in the chart below:
The source of the above data is IMF report titled: "Germany: 2010 Article IV Consultation—Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Germany" in which the Greek rescue ranger (funded to a great part by the US) decided to cut Germany's 2010 GDP forecast from 1.5% to 1.2%, and 2011 from 1.9% to 1.7%. In the report, the IMF notes:
"Simulation exercises suggest that German banks could suffer significant losses from commercial real estate investments in the U.S. and Spain, and more generally from exposures to Southern Europe. The simulations also suggest that a reassessment of risks associated with claims on Southern Europe could have a large impact on capital flows within Europe, as German (and also French) banks would significantly reduce their foreign claims to restore capital ratios."
One observation from the above chart is that the US at least will not be majorly impacted in a worst case scenario as it has the least amount of exposure, with just $118 billion. The same can not be said for France, Germany or the UK, which as we pointed out earlier, have a combined of over $1.5 trillion in net exposure.
What is sure, however, is that since IMF has just cut German GDP forecasts, using the same arguments and methodology, France is next.
When observing just this phenomenon, BTIG's Mike O'Rourke notes with a dose of sarcasm:
There is a touch of irony here. In his memoir, Treasury Secretary Paulson recounts an episode during the Bear Stearns meltdown when Deutsche Bank CEO Joseph Ackermann asked why Deutsche should do business with any U.S. investment bank. There is no doubt, Ackermann gets high marks for exercising good judgment, on the other hand, his tact was reminiscent of Bear Stearns during the LTCM crisis in 1998. Earlier this month, Ackermann found himself lobbying for a Greek rescue commenting “If we can’t stabilize the country, then the next problem after Greece would be the banks.” Ackermann also stated that “If it really comes down to a question of rescue or no rescue, I’m convinced it should be a rescue.”
We have previously demonstrated that Deustche Bank's assets as a percentage of German GDP is 84%. Should Ackerman be in need of a bailout, the same will be true for Germany as a failure of the PIIGS would lead to a failure of DB, and likely Germany itself. Yet once again France avoids the focus: the country's top three banks: BNP Paribas, Credit Agricole, and SocGen: have assets accounting for 237% of French GDP! Who knows how much of this is collateralized by the banks $781 billion in PIIGS exposure. How has France managed to squeak through the cracks for so long? It appears that the country is in a much more dire situation vis-a-vis deterioration in the European periphery than anyone else, in terms of both exposure and risk concentration.
China's credit curbs pose mounting risk to commodities
by Ambrose Evans-Pritchard
The big global banks are quietly preparing for a slide in commodity prices over coming months as China clamps down on excess lending and the US Federal Reserve takes away the liquidity pot. "We believe overheating risks in China are escalating," said Michael Lewis, commodities chief at Deutsche Bank. "Heading into the second quarter, we believe China will become the main source of event risk for commodity markets, specifically industrial metals."
Mr Lewis said Beijing is likely to slash growth in spending on infrastructure from 120pc last year to just 7pc this year. Deutsche expects China's central bank to cut loan quotas by almost a quarter to 7.5 trillion yuan ($1.1 trillion) this year, raise rates, and tighten reserve rules to choke inflation, while local authorities take their own measures to curb the property boom. Lead, zinc, copper, and nickel are all highly leveraged to China's building cycle.
The Royal Bank of Scotland echoed the concerns, saying China has kept the prices of raw materials buoyant by sucking in the world's supply. "A hefty proportion of these imports have undoubtedly been stockpiled, some by private speculators. We do not believe that much unreported stock has yet been eroded," said the bank's commodity team, Nick Moore and Stephen Briggs. "Our central theme remains to be wary of a general price lapse for the commodity complex over the next six months – not a major price collapse, more of a hiatus. Then sunlit uplands beckon," they said. RBS said a surge of pent-up supply from mines is "waiting in the wings to make its grand entrance" just at the wrong moment as the global recovery goes through a patch of turbulence.
The family of energy, metals, and farm goods has already lagged equity prices since the start of the year. The Reuters/Jefferies CRB commodities index peaked in January and is threatening to slip below its 50-day moving average, a key technical level. This may offer a better gauge of underlying monetary forces in the world economy than stock markets. The M3 money supply has been contracting since mid-2009 in both the US and the eurozone. It has been slowing in other areas such as Saudi Arabia, where the M3 growth rate has fallen for five months.
The faltering commodity rally has been disguised by the strength of oil, itself sui generis because OPEC can defend the price by cutting output. Crude flirted with $85 a barrel on Thursday, but may struggle if OECD stocks remain above average levels for long. Sugar has crashed 47pc since its speculative peak in February, punctured by the effects of record planting and the waning weather effects of El Niño – now giving way to La Niña's dry winds over Brazil. Natural gas prices are down by a third. A surge in shale gas supply in Pennsylvania and Colorado unlocked by new technology has combined with a flood of liquefied natural exports from Qatar and Malaysia. Supply has met demand with a vengeance.
Wheat, corn, zinc, soybeans, uranium, and cocoa, are all down this year. But while every commodity has its own story, the sector as whole moves in rhythm with the global liquidity cycle. It is eagerly watched for clues, like the Baltic Dry Index for bulk shipping. The BDI has fallen by a third since November. The 90pc rise in iron ore contracts extracted last week by Rio, BHP Billiton, and Vale for the next quarter may soon look inflated. RBS is most bearish on gold, forecasting a 17pc drop to $925 an ounce later this year. The metal will lose its 'anti-dollar' appeal as the dollar grinds higher and the Fed tightens, but shoot to fresh records above $1,300 by 2013.
The bank sees parallels with the commodity rally of 1982, which faltered after nine months as the US economy tipped into a double-dip recession. Raw material prices then relapsed for another couple of years. "We expect the path ahead to be strewn with many risks associated with unwinding strategies, rising rates and taxes, and the debt burden," it said. Of course, China was a marginal force at the time. It consumed 5pc of global metal supply, compared to 40pc today. Paul Volcker was Fed chairman, executing a ferocious monetary squeeze. Ben Bernanke is a different animal.
Deutsche Bank is looking back further, eyeing the choppy action on Wall Street in the mid-1930s when sharp swings in confidence led to deep corrections. The ups and downs of the US stock market over the last year have mimicked the action between March 1933 and February 1934. The curiosity is whether this pattern – perhaps coincidental – will continue to hold. Wall Street fell 22pc the late Spring and early summer of 1934.
Deutsche Bank lists plenty of risks, not least a Greek default that spreads contagion, a larger bond market crisis in big industrial states, and regulatory overkill on banks. But the greatest looming danger is a Sino-American showdown over the yuan. "Political rigidities appear to be building both within China to resist change, and within China's trading partners -prominently the US – to try to force change. This is a toxic mix."
China’s Debt Bubble: When Will the Ponzi Unravel?
by Yves Smith
Independent Strategy’s latest report, “China’s credit bubble: the missing piece in the jigsaw” makes a persuasive case that China’s debt fueled growth model is due for a hard landing, but the timing is uncertain, since the debt is funded internally.
China is barely past an episode of dealing with banks chock full of bad loans (there were debates among Western analysts in 2002 and 2003 as to how bad the damage was and whether the remedies were sufficient). On a more fundamental level, China has copied the Japanese mercantilist development model pretty much wholesale. It arguably hit the wall with the 1985 Plaza accord, when the US found the continued trade deficits unacceptable and succeed in organizing a G5 intervention to drive up the yen (that succeeded too well, the yen overshot, leading to the Louvre accord to push up the greenback). Japan’s central bank lowered interest rates to stoke asset prices in the hopes that the wealth effect would produce higher domestic consumption and offset the effect of the fall in exports.
We all know how that movie ended.
This piece does a concise job of recapping some of the troubling conditions undergriding the seemingly robust Chinese economy. A particularly striking one is the dramatic fall in the productivity of borrowing. In 2000, it took only 1.5 RMB of credit growth to produce an additional RMB of GDP growth. It now takes 6 RMB of credit to produce 1 RMB of GDP growth. It has become conventional to decry borrowing in the US because it has supported consumption, but debt that supports unproductive investment (factory overcapacity, overbuilding of high end housing, land speculation) is no better.
Some key sections of the report:We now know that much of the credit explosion in 2009 that boosted economic growth went into local government entities where it was wasted on unproductive real estate and infrastructure projects. These entities are mostly insolvent and will create huge bad debts for the banks as credit is tightened this year….
China is an economy where bank credit equals 130% of GDP — twice the penetration of peer emerging markets and where credit grew by one-third last year, adding money to the system equal to nearly 40% of GDP….
…the total borrowing of LGFVs [Local Government Financing Vehicles]is Rmb11trn ($1.6trn), which breaks down roughly into Rmb7trn borrowed for infrastructure spending and Rmb4trn for ‘other’ purposes. These figures match China’s domestic credit growth in 2009 of about one-third of GDP and go a long way to explaining the credit bubble (we knew about the lenders, but little about the borrowers).
LGFV debt is big enough to be a potential source of major macro-economic instability. LGFV borrowing adds about another 30% of GDP to public sector debt; is equivalent to 25% of outstanding bank credit; and more than 80% of new bank loans during the 2009 credit bubble. This hidden debt is equivalent to 225% of bank equity capital, meaning that a loss-given-default ratio of 30% would wipe out two-thirds of existing bank equity.
If you add in LGFV debt (and other unconsolidated forms of state credit) to total government debt, China’s gross sovereign debt to GDP is closer to 70%. And remember that 60% of GDP in government debt is the level at which Reinhart and Rogoff estimate that average GDP growth rates in emerging economies will be reduced by 2% pts after a financial crisis.
This LGFV edifice will not survive credit tightening, because it is a Ponzi-type pyramid built upon borrowing more to service existing borrowings….the problem is economically huge. LGFVs are not going to be borrowing and spending any more. And if infrastructure investment drove 90% of 2009 GDP growth and 70-80% of this was down to insolvent LGFVs, where will the growth in credit and GDP come from now?
The report forecasts a large decline in growth rates, as well as land and real estate prices, since LGFVs will need to liquidate holdings to try to pay off non-performing loans.
PIMCO fears UK 'debt trap'
by Ambrose Evans-Pritchard
The US bond fund PIMCO has warned that Britain risks a vicious circle of rising debt costs as global investors demand a penalty fee on gilts to protect against inflation. Bill Gross, the fund's chief and emminence grise of bond vigilantes, said the UK was on its list of "must avoid" countries along with Greece and others in eurozone's Club Med. The flood of British debt is likely to "lead to inflationary conditions and a depreciating currency", lowering the return on bonds. "If that view becomes consensus, then at some point the UK may fail to attain escape velocity from its debt trap," he wrote in his April monthly note. Mr Gross said the UK is not yet in crisis but gilts are sitting on a "bed of nitroglycerine" and must be handled delicately. Spreads on 10-year gilts have crept up to 14 basis points above those of Spain, itself in some difficulty.
Professor Carmen Reinhart, an expert on sovereign defaults at Maryland University and author of This Time is Different: Eight Centuries of Financial Folly, said Britain's trump card is a debt maturity of over fourteen years, much higher than the US or the big eurozone states. This greatly reduces roll-over risk or the danger of a "sudden death" crisis in the event of a shock. "What we found in our research is that countries nearing default start to rely on ever shorter debt maturities and issue more bonds in foreign currencies. The UK has done neither," she said.
"Britain may need a scare to force the politicians to act, just like the Canadians in the early 1990s when they started to trade like an emerging market. The lesson in these cases is that the sooner it happens the better. The risk for America is that their status as holder of the world's reserve currency will let them delay," she said. However, there are risks that Britain will have trouble finding creditors to finance a deficit of 12pc of GDP now that the Bank of England has halted quantitative easing. The Bank has soaked up £200bn of gilts, more than the Treasury's total debt issuance over the last year.
Michael Saunders from Citigroup said the UK has "no credible medium-term path back to fiscal sustainability". Little is being done to confront the "cuckoo in the nest": the 28pc of public spending going to welfare payments. He said inflation may spike to 4pc this year, leaving gilts nakedly exposed. Spyros Andreopoulos from Morgan Stanley said Britain's long-term debt maturities paradoxically create a "greater temptation to inflate" since it is harder for bond vigilantes to punish the country. He said the risk will rise once the budget deficit comes back under control and there is less new debt to finance, arguably in two to three years.
For now, Greece remains the immediate worry. Last week's deal by Europe's leaders to create a joint IMF-EU support facility has failed to restore confidence, largely because there is no clear trigger and because it does not offer the long-term cheap financing that Greece needs to recover. Yields on 10-year Greek bonds have risen to 340 basis points over Bunds, leaving investors who took up a €5bn (£4.4bn) issue on Monday with a big capital loss. A €1bn snap auction on Tuesday made matters worse, yielding under €400m. Greece's Public Debt Management Agency said the country needs to raise a further €32bn this year, including €11.6bn by late May.
German deficit hits record level in '09
Germany's total public sector budget deficit hit a record 105.5 billion euros (93.9 billion pounds) last year, the Federal Statistics Office said on Wednesday. The deficit, combining a funding shortfall at federal, state and local government levels -- as well as the balance of the social security systems -- broke a previous record of 74.1 billion euros from 2003, the preliminary Office figures showed. In 2008, the deficit was 5.2 billion euros, it said.
Germany's economy contracted by some five percent in 2009 -- its worst postwar slump -- leading to a sharp drop in tax revenues. The state also spent billions of euros propping up the labour market and pumping money into struggling banks. Economists have forecast the 2010 deficit could exceed last year's. The Kiel-based IfW economic think tank forecast the 2010 shortfall could reach some 130 billion euros.
Japan’s $15 Trillion Not Enough to Make It a Buy
by William Pesek
Here we go again. Every few years, investors get all enthusiastic about Japan. This time the recovery is for real, they argue. This time real change is afoot. This time buy yen-denominated assets and don’t look back, they conclude. The end result tends to be disappointment. This latest episode of euphoria is likely to be more of the same. It brings to mind Charles Schulz’s “Peanuts” cartoon: Charlie Brown, Lucy and the football. Time and time again, Lucy convinces Charlie Brown she’ll hold the ball for him to kick only to yank it away at the last second. Every time, he lands flat on his back, pondering his gullibility.
Bullishness on Japan often seems that way. Investors notice business sentiment perking up and unemployment stabilizing and decide -- wrongly -- that the great rally we’ve been waiting for since 1989 is on. This pattern may be playing out yet again. It’s hardly surprising things feel better. Violent drops in growth tend to be followed by sharp upswings. A multitude of variables, including inventory adjustments, policy measures and what economists call “favorable base effects” explain this. When industrial production collapses by almost 40 percent from peak-to-trough, says Maya Bhandari of Lombard Street Research Ltd. in London, the snapback will be big. “Looking through these gyrations is vital,” she says.
Investors are cheered that firms including Toshiba Corp. are boosting investment -- and they are buying Japanese stocks. Deflation is far more important, though. As we’ve seen this last decade, sliding prices are a growth killer. They leave executives stingy with wages and drive households to save, rather than consume. The result is a slow ratcheting down of living standards over time. The real problem is that officials see deflation as the cause of the problems, not a manifestation. You can see that in how quickly Finance Minister Naoto Kan turned on the Bank of Japan, complaining that its 0.1 percent overnight lending rate is too high.
If only Kan understood price declines are less about the supply of yen than weak demand. Wages slid for a 21st month in February, extending their longest losing streak in seven years. As long as workers aren’t reaping the benefits of export-led growth, consumer prices will fall. The fact Kan’s Democratic Party of Japan is missing that point gets us to the second reason this recovery will fizzle.
An historic election in August thrust Prime Minister Yukio Hatoyama into power. It ended 54 years of virtually uninterrupted rule by the Liberal Democratic Party and promised a new era of enlightened policy making. Eight months later, he is merely another unpopular and distracted Japanese leader. Not unlike President Barack Obama in the U.S., Hatoyama was elected to govern differently -- to shake up the status quo and take on a ruling elite more interested in their party than their nation’s people. Instead, he has been neutered by finance scandals. Plans to trim wasteful public works spending and shift government spending away from corporations to households are taking a backseat to political bickering. The buzz has turned to how much longer Hatoyama will be around.
The rise of China, India and South Korea means the world won’t wait for Japan to rethink its rickety model. Japan needs to be 100 percent focused on raising its competitiveness, strengthening its safety social net, increasing productivity, preparing for an aging population, boosting the birthrate and allowing more immigration. Japan is not about to crash; some $15 trillion of household savings will cushion any fall. Yet tackling these challenges is vital to instilling confidence. If you want Japan’s aggressive savers to spend more, convince them things will be better over the next 10 years than the last 10. Watching Japan Airlines Corp. go bankrupt, Toyota Motor Corp. crash, Sony Corp. eat Apple Inc.’s dust and China gaining on Japan hardly helps. Nor does talk of a Japanese debt crisis.
Hatoyama’s economic team is focused elsewhere. Kan, the second finance minister in six months, is leaning on the central bank to pump more yen into the economy. The truth is, Japan must find an exit strategy from the 1990s. It hasn’t learned how to live without zero interest rates and the world’s biggest public debt.
All this neglect gets us back to Lucy, Charlie Brown and the football. Now that the Nikkei 225 Stock Average is above 11,000 and approaching the levels at which it was trading before the collapse of Lehman Brother Holdings Inc. in September 2008, Japan’s challenges are getting short shrift. Sure, growth will benefit from improving global conditions and that dynamic could boost the Nikkei a bit. That’s not enough for Japan. It’s been putting off major upgrades for so long that policy makers don’t know where to begin. It means Japan will continue to underperform. For you would-be Charlie Browns thinking it’s safe to take another kick at Japan’s ball, be warned: Lucy may be waiting to spirit it away yet again.
Aon reports woeful year end for Britain’s final salary pensions
The aggregate pension fund deficit shown in company accounts for the 200 largest UK privately sponsored pension schemes increased from £36bn in March 2009 to £93bn at the end of March 2010.
This is according to Aon Consulting, which stated more than half of companies are about to report huge increases in their final salary pension scheme deficits in their 31 March company accounts, with the aggregate deficit increasing by £57bn. The employee benefits and risk management firm reported for many businesses, the increased deficits appeared incomprehensible during a period that the assets of these pension schemes have increased by £118bn. The accounting liabilities of those schemes, however, have ballooned by £175bn to £591bn.
According to Aon the increases in the scheme liabilities have been caused by falling AA corporate bond yields (6.9 per cent to 5.6 per cent) and rising expectations of future long-term inflation (3 per cent to 3.9 per cent). Marcus Hurd, head of corporate solutions at Aon Consulting, said: "Pension deficits are once again dominating the board room. This year's 31 March company accounts will make sorry reading for companies with final salary pension schemes.
"These numbers will only increase the number of companies looking at restructuring their pension arrangements, including those that have put off the decision during the economic downturn. "It is a harsh reality that you cannot look at pension scheme assets and liabilities in isolation. The financial sophistication is there for companies to hedge a significant proportion of pension scheme risk, so it remains surprising that many are still so significantly exposed. "On this occasion, however, even those that did hedge their pension risk are feeling the pain, as the pension scheme accounting measure moves back to something nearer reality."
US Private-Firm Pensions Face Deadline for Funding Level
The financial crisis has left some private pension plans struggling to meet a looming deadline that could force businesses and charities to pay hundreds of millions of dollars into their plans. To avoid what they say would be cuts necessary to fund the plans, these businesses and nonprofits are asking Congress for extra time to meet the deadlines. The showdown stems from a 2006 law that required most private pensions to meet annual funding targets. On Thursday, the companies and nonprofits that sponsor these plans must declare their funding statuses. The law has a 96%-funded target for 2010; the next pension payment is due April 15.
Among those urging the option of an extension are Easter Seals, Girl Scouts of the USA and the New York-Presbyterian Hospital, in addition to FirstGroup PLC unit Greyhound Lines Inc., Land O' Lakes Inc. and Sears Holdings Corp., according to a letter to Congress they signed. "We've already cut every expense we could cut," says Katy Beh Neas, vice president of government relations at Easter Seals, a nonprofit for people with disabilities. "So the relief we're hoping Congress will provide will be very meaningful to us."
Unlike public pension plans, private pension systems have annual federal-funding target requirements. The concern is the employer can go bankrupt—generally not an option with states. If the pension is poorly funded and the company fails, the federal pension-guaranty fund could be on the hook. The targets have risen gradually in recent years, just as the economy tanked. In 2006, Congress raised the funding target for most private-sector pension plans to 100% for 2011, compared with the previous target of 90% funding. Companies that have shortfalls in their pension funding have seven years to meet the target, although plans that fall below a 60% funding level must be frozen.
Because funding requirements are more strict, private pensions are generally in better shape than public ones, which often delay contributions to help improve annual budgets. The U.S. corporate pension funding level was at 85% at the end of 2009, according to Goldman Sachs Global Markets Institute, compared with an average 65% for public pension funds, according to Wilshire Consulting.
Many companies say their pensions should be fully funded; the issue, they say, is time. Under bills in Congress, employers for two years would pay only interest on the shortfall; they would then have an additional seven years to meet the full funding target. The bill would also provide a choice of amortizing that shortfall over 15 years. The pending legislation has largely brought together groups that are usually on opposing sides, such as business and labor, and Democrats and Republicans. But some Democratic legislators and pension-rights advocates are seeking restrictions to ensure companies that receive the extra time use the relief for its intended purpose.
The Pension Rights Center, a consumer organization, advocates that firms seeking an extension make matching contributions to the pension fund if firms pay out excessive executive compensation or dividends to shareholders, among other restrictions. One bill passed in the Senate in March but is being held up in the House because of debate over these types of conditions. It is unclear what would happen if legislation doesn't pass in April; retroactive relief is one option. Norman Stein, senior policy adviser to the center and professor at the University of Alabama School of Law, says there are firms in need of relief. But he worries funding relief could be abused since firms wouldn't have to show anything to prove they need the extension. "These companies have a lot of ingenious advisors, and there is also a shortage of policing," he said.
California-based Con-way Inc., a California-based freight-transportation company, is one company lobbying for relief. In January 2008, Con-way's pension plan was overfunded, at 108%, and had a total asset value of $1.1 billion. In the financial crisis, the pension fund's value fell by 40%, bringing the funding status to just over 60%. The funding level was around 77% at the end of 2009, with an asset value of $902.3 million. Con-way expects its required pension contribution to go up by several times the $33 million average amount it has been putting in over the past few years, says Randy Mullett, vice president of government relations for Con-way.
Con-Way instituted a 5% pay cut last year for most employees, while top management saw a 10% cut last year, Mr. Mullett says. Capital expenditures had been averaging $250 million a year but dropped to $30 million in 2009. "If this gets dragged out much longer, companies are going to have to start making decisions on where they're going to get this pension funding," Mr. Mullett said. The Easter Seals funding level was at 78% at the end of the Aug. 31, 2008, fiscal year, the latest year for which it has official figures. The organization has cut $1.5 million from its budget over the past 16 months. Ms. Neas says the organization will likely have to take out a $4 million loan to meet its pension-funding requirement for the coming fiscal year if relief isn't granted.
RBS to Sell Commercial Mortgage Debt, Ending Drought
Royal Bank of Scotland Group Plc is selling bonds backed by commercial mortgages from several borrowers in the first sale of its kind since June 2008, gauging investor demand for the debt amid climbing defaults. The $309.7 million offering, backed by 81 properties in states from New York to Missouri, includes $240.8 million in top-rated securities, according to people familiar with the sale who declined to be identified because terms are private. Of those properties, 78 are retail sites, the people said.
The new issue highlights a challenge facing Wall Street in reviving the $700 billion market as delinquencies rise and the value of mortgages fluctuates. Unlike other banks working on sales, U.K.-based RBS skirted the risk of holding the debt by not closing the loans as they were being pooled, the people said. RBS bankers have been arranging the deal for several months, they said. “Nobody wants to sit with a huge book of business they haven’t sold,” said John Levy, president of Richmond, Virginia- based real estate investment banking firm John B. Levy & Co. “Accumulating this stuff for the long term is a problem. What if the music stops again?”
Bank of America Corp., JPMorgan Chase & Co., Deutsche Bank AG, Wells Fargo & Co. and Goldman Sachs Group Inc. are all approaching borrowers with terms for commercial mortgages to be packaged into securities and keeping the loans on their books until they’re sold, according to people familiar with the discussions. That exposes the banks to risk because they need several months to assemble the mortgages from different borrowers, and it’s hard to guard against price swings on the debt in the interim, the people said.
In February of 2009, RBS said it would transfer 540 billion pounds ($820 billion) of toxic assets, including commercial property loans, into a new unit to be wound down or sold over three to five years. RBS CEO Stephen Hester said at a Jun. 16 conference that the bank would “never lend as much to real estate as we did, because we lent too much.” The largest loan in the new offering is a $77.7 million mortgage on the 1,022,692-square-foot South Plains Mall in Lubbock, Texas, home to J.C. Penney and Dillard’s. A $72.6 million loan on Four New York Plaza in New York is the second largest. JPMorgan Chase & Co. occupies about 75 percent of the 22-story building.
Sales of commercial mortgage-backed securities plummeted to $11.2 billion in 2008 from a record $232.4 billion in 2007 as the credit market seized up, according to data compiled by Bloomberg. Even with U.S. government aid, only $3.04 billion of the bonds were sold last year, the data show. Those sales were backed by loans to a single borrower. As of the end of February, late payments occurred on about 6.29 percent of commercial mortgages bundled and sold as bonds, more than five times the rate a year ago, according to Fitch Ratings. That figure may climb to 12 percent in 2012, the ratings service said.
Top-rated commercial mortgage-backed securities yield about 2.45 percentage points more than Treasuries, compared with 10.29 percentage points a year ago, according to a Barclays Plc index. Investor demand for such debt has been strong, and other banks will be watching how the RBS deal sells to set the bar on where to price loans for future offerings, according to James Grady, a managing director at Deutsche Asset Management in New York. “A data point on where investors are interested will help underwriters feel more confident,” Grady said. The last so-called multiborrower offering for commercial mortgage-backed bonds was a $1.09 billion sale in June 2008 from Bank of America that contained debt on 140 properties, according to a prospectus.
Wall Street's Brand New Growth Sector: Helping The Government Screw The Taxpayers
by Nicole Gelinas
Wall Street and the City of London can relax and learn to love financial-regulatory “reform.” Sure, Western governments vow to rein in bankers and speculators. But the politicians also offer a way for Wall Street to evade new rules that would restrict their profits. As long as financiers employ their creativity to help governments conceal and expand public-sector obligations, rather than use that creativity to expose those obligations as untenable, they’ll be OK.
The blueprint is in Sen. Chris Dodd’s reg-reform bill. The bill promises to “restore America’s financial stability.” A new Financial Stability Oversight Council (FSOC) would scan transactions and accounts for potential threats.
Yet the bill signals the FSOC: don’t look for risk in government securities markets. Consider the section that governs banks’ trading. It directs regulators to prohibit banks and their holding companies from proprietary trading and equity-fund sponsorship. But there’s an exception. Banks could trade in “obligations of the United States” and GNMA and Fannie Mae securities, as well as in state, city, and local public-authority debt.
The bill gives other financial firms a pass on government debt, too. Dodd wants regulators to set debt limits on systemically risky companies that aren’t banks. But, the bill says, “the rules … shall not apply” for proprietary trades in federal, mortgage-agency, or state and local government debt.
The same principle holds for securitization. The bill would require underwriters to retain risk in the debt-backed securities they sell. But it offers “a total or partial exemption of any securitization, as may be appropriate in the public interest” (hint: mortgages).
The pols want “financial stability,” then, but only if it doesn’t affect the capacity of government -- and favored constituencies like homeowners -- to borrow profligately and cheaply. To ensure institutional demand for its debt and for the debt of cash-strapped cities, states, and homeowners, Washington would disproportionately encourage banks and other institutions to use such debt as trading-profit fodder.
Ironically, these exemptions would add to systemic risk. Trading in government and mortgage securities is tricky, especially if interest rates become volatile. Trading exclusively in such securities – since the feds would have made other investments either off-limits or more expensive – is even riskier.
The “Orderly Liquidation Fund” that the Dodd bill would create to pay for future bailouts wouldn’t be of much help in a government-debt crisis, either. The bill would require the FDIC to invest the fund’s $50 billion in … government debt.
Systemic risk would multiply for another reason. Big financial firms would quickly learn that the government wants its target markets to move in only one direction.
That is, Washington would let bankers and big speculators profit from their innovations as long as those innovations were helping the government to issue debt. Proprietary trading to bet on rising Treasury and muni-bond prices and low interest rates: good. Prop trading to bet against Treasuries, muni bonds, and the Fed: bad, and probably unpatriotic, too.
Europe’s experience demonstrates this truth. European leaders are up in arms about credit-default swaps and “exotic” derivatives – because speculators have started using these instruments to bet against Greece and the euro. The European pols didn’t mind, though, when financial innovators were using the same instruments to help Greece borrow impossible amounts, making the debt seem less risky than it was through illusory hedges.
And today, Europe’s leaders look benignly on another financial innovation: the City’s new pension-longevity derivatives. Pension derivatives could help hide governments hide another untenable risk: unaffordable pension liabilities. Under the few deals done so far, pension-fund managers have paid financial institutions a fee in return for “insurance” that retirees will outlive their pension plan’s money.
Without capital and trading rules, the “insurers” in capital-markets pension derivatives may someday find themselves unable pay hundreds of billions of dollars in liabilities, just as AIG, in 2008, couldn’t make good on its monolithic mortgage bet.
But Europe doesn’t seem too worried now. Look for the U.S. to be just as calm when this innovation reaches our shores. Once state and local politicians figure out that the big, bad banks can help them lop a few billion dollars’ worth off their pension liabilities, they won’t want Washington interfering with this gift – and so it won’t.
Successful regulatory “reform,” then, in Washington’s view, would focus financial innovation on increasing and hiding government liabilities, crowding out real market signals and private investment. Wall Street and the City quickly would learn that all the West wants is help suspending its disbelief about how much it owes for as long as possible.
It’s absurd in the last measure. But it could go on for a long time – as Washington and the rest of the West employ regulatory forbearance to support the financial instruments of self-preservation.
Nicole Gelinas, author of After The Fall: Saving Capitalism From Wall Street – and Washington, is a Chartered Financial Analyst (CFA) charterholder and contributing editor to the Manhattan Institute’s City Journal.
Looting Main Street
by Matt Taibbi
If you want to know what life in the Third World is like, just ask Lisa Pack, an administrative assistant who works in the roads and transportation department in Jefferson County, Alabama. Pack got rudely introduced to life in post-crisis America last August, when word came down that she and 1,000 of her fellow public employees would have to take a little unpaid vacation for a while. The county, it turned out, was more than $5 billion in debt — meaning that courthouses, jails and sheriff's precincts had to be closed so that Wall Street banks could be paid.
As public services in and around Birmingham were stripped to the bone, Pack struggled to support her family on a weekly unemployment check of $260. Nearly a fourth of that went to pay for her health insurance, which the county no longer covered. She also fielded calls from laid-off co-workers who had it even tougher. "I'd be on the phone sometimes until two in the morning," she says. "I had to talk more than one person out of suicide. For some of the men supporting families, it was so hard — foreclosure, bankruptcy. I'd go to bed at night, and I'd be in tears."
Homes stood empty, businesses were boarded up, and parts of already-blighted Birmingham began to take on the feel of a ghost town. There were also a few bills that were unique to the area — like the $64 sewer bill that Pack and her family paid each month. "Yeah, it went up about 400 percent just over the past few years," she says.
The sewer bill, in fact, is what cost Pack and her co-workers their jobs. In 1996, the average monthly sewer bill for a family of four in Birmingham was only $14.71 — but that was before the county decided to build an elaborate new sewer system with the help of out-of-state financial wizards with names like Bear Stearns, Lehman Brothers, Goldman Sachs and JP Morgan Chase. The result was a monstrous pile of borrowed money that the county used to build, in essence, the world's grandest toilet — "the Taj Mahal of sewer-treatment plants" is how one county worker put it. What happened here in Jefferson County would turn out to be the perfect metaphor for the peculiar alchemy of modern oligarchical capitalism: A mob of corrupt local officials and morally absent financiers got together to build a giant device that converted human shit into billions of dollars of profit for Wall Street — and misery for people like Lisa Pack.
And once the giant shit machine was built and the note on all that fancy construction started to come due, Wall Street came back to the local politicians and doubled down on the scam. They showed up in droves to help the poor, broke citizens of Jefferson County cut their toilet finance charges using a blizzard of incomprehensible swaps and refinance schemes — schemes that only served to postpone the repayment date a year or two while sinking the county deeper into debt. In the end, every time Jefferson County so much as breathed near one of the banks, it got charged millions in fees. There was so much money to be made bilking these dizzy Southerners that banks like JP Morgan spent millions paying middlemen who bribed — yes, that's right, bribed, criminally bribed — the county commissioners and their buddies just to keep their business. Hell, the money was so good, JP Morgan at one point even paid Goldman Sachs $3 million just to back the fuck off, so they could have the rubes of Jefferson County to fleece all for themselves.
Birmingham became the poster child for a new kind of giant-scale financial fraud, one that would threaten the financial stability not only of cities and counties all across America, but even those of entire countries like Greece. While for many Americans the financial crisis remains an abstraction, a confusing mess of complex transactions that took place on a cloud high above Manhattan sometime in the mid-2000s, in Jefferson County you can actually see the rank criminality of the crisis economy with your own eyes; the monster sticks his head all the way out of the water. Here you can see a trail that leads directly from a billion-dollar predatory swap deal cooked up at the highest levels of America's biggest banks, across a vast fruited plain of bribes and felonies — "the price of doing business," as one JP Morgan banker says on tape — all the way down to Lisa Pack's sewer bill and the mass layoffs in Birmingham.
Once you follow that trail and understand what took place in Jefferson County, there's really no room left for illusions. We live in a gangster state, and our days of laughing at other countries are over. It's our turn to get laughed at. In Birmingham, lots of people have gone to jail for the crime: More than 20 local officials and businessmen have been convicted of corruption in federal court. Last October, right around the time that Lisa Pack went back to work at reduced hours, Birmingham's mayor was convicted of fraud and money-laundering for taking bribes funneled to him by Wall Street bankers — everything from Rolex watches to Ferragamo suits to cash. But those who greenlighted the bribes and profited most from the scam remain largely untouched. "It never gets back to JP Morgan," says Pack.
If you want to get all Glenn Beck about it, you could lay the blame for this entire mess at the feet of weepy, tree-hugging environmentalists. It all started with the Cahaba River, the longest free-flowing river in the state of Alabama. The tributary, which winds its way through Birmingham before turning diagonally to empty out near Selma, is home to more types of fish per mile than any other river in America and shelters 64 rare and imperiled species of plants and animals. It's also the source of one of the worst municipal financial disasters in American history.
Back in the early 1990s, the county's sewer system was so antiquated that it was leaking raw sewage directly into the Cahaba, which also supplies the area with its drinking water. Joined by well — intentioned citizens from the Cahaba River Society, the EPA sued the county to force it to comply with the Clean Water Act. In 1996, county commissioners signed a now-infamous consent decree agreeing not just to fix the leaky pipes but to eliminate all sewer overflows — a near-impossible standard that required the county to build the most elaborate, ecofriendly, expensive sewer system in the history of the universe. It was like ordering a small town in Florida that gets a snowstorm once every five years to build a billion-dollar fleet of snowplows.
The original cost estimates for the new sewer system were as low as $250 million. But in a wondrous demonstration of the possibilities of small-town graft and contract-padding, the price tag quickly swelled to more than $3 billion. County commissioners were literally pocketing wads of cash from builders and engineers and other contractors eager to get in on the project, while the county was forced to borrow obscene sums to pay for the rapidly spiraling costs. Jefferson County, in effect, became one giant, TV-stealing, unemployed drug addict who borrowed a million dollars to buy the mother of all McMansions — and just as it did during the housing bubble, Wall Street made a business of keeping the crook in his house. As one county commissioner put it, "We're like a guy making $50,000 a year with a million-dollar mortgage."
To reassure lenders that the county would pay its mortgage, commissioners gave the finance director — an unelected official appointed by the president of the commission — the power to automatically raise sewer rates to meet payments on the debt. The move brought in billions in financing, but it also painted commissioners into a corner. If costs continued to rise — and with practically every contractor in Alabama sticking his fingers on the scale, they were rising fast — officials would be faced with automatic rate increases that would piss off their voters. (By 2003, annual interest on the sewer deal had reached $90 million.) So the commission reached out to Wall Street, looking for creative financing tools that would allow it to reduce the county's staggering debt payments.
Wall Street was happy to help. First, it employed the same trick it used to fuel the housing crisis: It switched the county from a fixed rate on the bonds it had issued to finance the sewer deal to an adjustable rate. The refinancing meant lower interest payments for a couple of years — followed by the risk of even larger payments down the road. The move enabled county commissioners to postpone the problem for an election season or two, kicking it to a group of future commissioners who would inevitably have to pay the real freight.
But then Wall Street got really creative. Having switched the county to a variable interest rate, it offered commissioners a crazy deal: For an extra fee, the banks said, we'll allow you to keep paying a fixed rate on your debt to us. In return, we'll give you a variable amount each month that you can use to pay off all that variable-rate interest you owe to bondholders.
In financial terms, this is known as a synthetic rate swap — the spidery creature you might have read about playing a role in bringing down places like Greece and Milan. On paper, it made sense: The county got the stability of a fixed rate, while paying Wall Street to assume the risk of the variable rates on its bonds. That's the synthetic part. The trouble lies in the rate swap. The deal only works if the two variable rates — the one you get from the bank, and the one you owe to bondholders — actually match. It's like gambling on the weather. If your bondholders are expecting you to pay an interest rate based on the average temperature in Alabama, you don't do a rate swap with a bank that gives you back a rate pegged to the temperature in Nome, Alaska.
Not unless you're a fucking moron. Or your banker is JP Morgan.
In a small office in a federal building in downtown Birmingham, just blocks from where civil rights demonstrators shut down the city in 1963, Assistant U.S. Attorney George Martin points out the window. He's pointing in the direction of the Tutwiler Hotel, once home to one of the grandest ballrooms in the South but now part of the Hampton Inn chain.
"It was right around the corner here, at the hotel," Martin says. "That's where they met — that's where this all started."
They means Charles LeCroy and Bill Blount, the two principals in what would become the most important of all the corruption cases in Jefferson County. LeCroy was a banker for JP Morgan, serving as managing director of the bank's southeast regional office. Blount was an Alabama wheeler-dealer with close friends on the county commission. For years, when Wall Street banks wanted to do business with municipalities, whether for bond issues or rate swaps, it was standard practice to reach out to a local sleazeball like Blount and pay him a shitload of money to help seal the deal. "Banks would pay some local consultant, and the consultant would then funnel money to the politician making the decision," says Christopher Taylor, the former head of the board that regulates municipal borrowing. Back in the 1990s, Taylor pushed through a ban on such backdoor bribery. He also passed a ban on bankers contributing directly to politicians they do business with — a move that sparked a lawsuit by one aggrieved sleazeball, who argued that halting such legalized graft violated his First Amendment rights. The name of that pissed-off banker? "It was the one and only Bill Blount," Taylor says with a laugh.
Blount is a stocky, stubby-fingered Southerner with glasses and a pale, pinched face — if Norman Rockwell had ever done a painting titled "Small-Town Accountant Taking Enormous Dump," it would look just like Blount. LeCroy, his sugar daddy at JP Morgan, is a tall, bloodless, crisply dressed corporate operator with a shiny bald head and silver side patches — a cross between Skeletor and Michael Stipe.
The scheme they operated went something like this: LeCroy paid Blount millions of dollars, and Blount turned around and used the money to buy lavish gifts for his close friend Larry Langford, the now-convicted Birmingham mayor who at the time had just been elected president of the county commission. (At one point Blount took Langford on a shopping spree in New York, putting $3,290 worth of clothes from Zegna on his credit card.) Langford then signed off on one after another of the deadly swap deals being pushed by LeCroy. Every time the county refinanced its sewer debt, JP Morgan made millions of dollars in fees. Even more lucrative, each of the swap contracts contained clauses that mandated all sorts of penalties and payments in the event that something went wrong with the deal. In the mortgage business, this process is known as churning: You keep coming back over and over to refinance, and they keep "churning" you for more and more fees. "The transactions were complex, but the scheme was simple," said Robert Khuzami, director of enforcement for the SEC. "Senior JP Morgan bankers made unlawful payments to win business and earn fees."
Given the shitload of money to be made on the refinancing deals, JP Morgan was prepared to pay whatever it took to buy off officials in Jefferson County. In 2002, during a conversation recorded in Nixonian fashion by JP Morgan itself, LeCroy bragged that he had agreed to funnel payoff money to a pair of local companies to secure the votes of two county commissioners. "Look," the commissioners told him, "if we support the synthetic refunding, you guys have to take care of our two firms." LeCroy didn't blink. "Whatever you want," he told them. "If that's what you need, that's what you get. Just tell us how much."
Just tell us how much. That sums up the approach that JP Morgan took a few months later, when Langford announced that his good buddy Bill Blount would henceforth be involved with every financing transaction for Jefferson County. From JP Morgan's point of view, the decision to pay off Blount was a no-brainer. But the bank had one small problem: Goldman Sachs had already crawled up Blount's trouser leg, and the broker was advising Langford to pick them as Jefferson County's investment bank.
The solution they came up with was an extraordinary one: JP Morgan cut a separate deal with Goldman, paying the bank $3 million to fuck off, with Blount taking a $300,000 cut of the side deal. Suddenly Goldman was out and JP Morgan was sitting in Langford's lap. In another conversation caught on tape, LeCroy joked that the deal was his "philanthropic work," since the payoff amounted to a "charitable donation to Goldman Sachs" in return for "taking no risk."
That such a blatant violation of anti-trust laws took place and neither JP Morgan nor Goldman have been prosecuted for it is yet another mystery of the current financial crisis. "This is an open-and-shut case of anti-competitive behavior," says Taylor, the former regulator.
With Goldman out of the way, JP Morgan won the right to do a $1.1 billion bond offering — switching Jefferson County out of fixed-rate debt into variable-rate debt — and also did a corresponding $1.1 billion deal for a synthetic rate swap. The very same day the transaction was concluded, in May 2003, LeCroy had dinner with Langford and struck a deal to do yet another bond-and-swap transaction of roughly the same size. This time, the terms of the payoff were spelled out more explicitly. In a hilarious phone call between LeCroy and Douglas MacFaddin, another JP Morgan official, the two bankers groaned aloud about how much it was going to cost to satisfy Blount:
LeCroy: I said, "Commissioner Langford, I'll do that because that's your suggestion, but you gotta help us keep him under control. Because when you give that guy a hand, he takes your arm." You know?
MacFaddin: [Laughing] Yeah, you end up in the wood-chipper.
All told, JP Morgan ended up paying Blount nearly $3 million for "performing no known services," in the words of the SEC. In at least one of the deals, Blount made upward of 15 percent of JP Morgan's entire fee. When I ask Taylor what a legitimate consultant might earn in such a circumstance, he laughs. "What's a 'legitimate consultant' in a case like this? He made this money for doing jack shit."
As the tapes of LeCroy's calls show, even officials at JP Morgan were incredulous at the money being funneled to Blount. "How does he get 15 percent?" one associate at the bank asks LeCroy. "For doing what? For not messing with us?"
"Not messing with us," LeCroy agrees. "It's a lot of money, but in the end, it's worth it on a billion-dollar deal."
That's putting it mildly: The deals wound up being the largest swap agreements in JP Morgan's history. Making matters worse, the payoffs didn't even wind up costing the bank a dime. As the SEC explained in a statement on the scam, JP Morgan "passed on the cost of the unlawful payments by charging the county higher interest rates on the swap transactions." In other words, not only did the bank bribe local politicians to take the sucky deal, they got local taxpayers to pay for the bribes. And because Jefferson County had no idea what kind of deal it was getting on the swaps, JP Morgan could basically charge whatever it wanted. According to an analysis of the swap deals commissioned by the county in 2007, taxpayers had been overcharged at least $93 million on the transactions.
JP Morgan was far from alone in the scam: Virtually everyone doing business in Jefferson County was on the take. Four of the nation's top investment banks, the very cream of American finance, were involved in one way or another with payoffs to Blount in their scramble to do business with the county. In addition to JP Morgan and Goldman Sachs, Bear Stearns paid Langford's bagman $2.4 million, while Lehman Brothers got off cheap with a $35,000 "arranger's fee." At least a dozen of the county's contractors were also cashing in, along with many of the county commissioners. "If you go into the county courthouse," says Michael Morrison, a planner who works for the county, "there's a gallery of past commissioners on the wall. On the top row, every single one of 'em but two has been investigated, indicted or convicted. It's a joke."
The crazy thing is that such arrangements — where some local scoundrel gets a massive fee for doing nothing but greasing the wheels with elected officials — have been taking place all over the country. In Illinois, during the Upper Volta-esque era of Rod Blagojevich, a Republican political consultant named Robert Kjellander got 10 percent of the entire fee Bear Stearns earned doing a bond sale for the state pension fund. At the start of Obama's term, Bill Richardson's Cabinet appointment was derailed for a similar scheme when he was governor of New Mexico. Indeed, one reason that officials in Jefferson County didn't know that the swaps they were signing off on were shitty was because their adviser on the deals was a firm called CDR Financial Products, which is now accused of conspiring to overcharge dozens of cities in swap transactions. According to a federal antitrust lawsuit, CDR is basically a big-league version of Bill Blount — banks tossed money at the firm, which in turn advised local politicians that they were getting a good deal. "It was basically, you pay CDR, and CDR helps push the deal through," says Taylor.
In the end, though, all this bribery and graft was just the table-setter for the real disaster. In taking all those bribes and signing on to all those swaps, the commissioners in Jefferson County had basically started the clock on a financial time bomb that, sooner or later, had to explode. By continually refinancing to keep the county in its giant McMansion, the commission had managed to push into the future that inevitable day when the real bill would arrive in the mail. But that's where the mortgage analogy ends — because in one key area, a swap deal differs from a home mortgage. Imagine a mortgage that you have to keep on paying even after you sell your house. That's basically how a swap deal works. And Jefferson County had done 23 of them. At one point, they had more outstanding swaps than New York City.
Judgment Day was coming — just like it was for the Delaware River Port Authority, the Pennsylvania school system, the cities of Detroit, Chicago, Oakland and Los Angeles, the states of Connecticut and Mississippi, the city of Milan and nearly 500 other municipalities in Italy, the country of Greece, and God knows who else. All of these places are now reeling under the weight of similarly elaborate and ill-advised swaps — and if what happened in Jefferson County is any guide, hoo boy. Because when the shit hit the fan in Birmingham, it really hit the fan.
For Jefferson County, the deal blew up in early 2008, when a dizzying array of penalties and other fine-print poison worked into the swap contracts started to kick in. The trouble began with the housing crash, which took down the insurance companies that had underwritten the county's bonds. That rendered the county's insurance worthless, triggering clauses in its swap contracts that required it to pay off more than $800 million of its debt in only four years, rather than 40. That, in turn, scared off private lenders, who were no longer interested in bidding on the county's bonds. The banks were forced to make up the difference — a service for which they charged enormous penalties. It was as if the county had missed a payment on its credit card and woke up the next morning to find its annual percentage rate jacked up to a million percent. Between 2008 and 2009, the annual payment on Jefferson County's debt jumped from $53 million to a whopping $636 million.
It gets worse. Remember the swap deal that Jefferson County did with JP Morgan, how the variable rates it got from the bank were supposed to match those it owed its bondholders? Well, they didn't. Most of the payments the county was receiving from JP Morgan were based on one set of interest rates (the London Interbank Exchange Rate), while the payments it owed to its bondholders followed a different set of rates (a municipal-bond index). Jefferson County was suddenly getting far less from JP Morgan, and owing tons more to bondholders. In other words, the bank and Bill Blount made tens of millions of dollars selling deals to local politicians that were not only completely defective, but blew the entire county to smithereens.
And here's the kicker. Last year, when Jefferson County, staggered by the weight of its penalties, was unable to make its swap payments to JP Morgan, the bank canceled the deal. That triggered one-time "termination fees" of — yes, you read this right — $647 million. That was money the county would owe no matter what happened with the rest of its debt, even if bondholders decided to forgive and forget every dime the county had borrowed. It was like the herpes simplex of loans — debt that does not go away, ever, for as long as you live. On a sewer project that was originally supposed to cost $250 million, the county now owed a total of $1.28 billion just in interest and fees on the debt. Imagine paying $250,000 a year on a car you purchased for $50,000, and that's roughly where Jefferson County stood at the end of last year.
Last November, the SEC charged JP Morgan with fraud and canceled the $647 million in termination fees. The bank agreed to pay a $25 million fine and fork over $50 million to assist displaced workers in Jefferson County. So far, the county has managed to avoid bankruptcy, but the sewer fiasco had downgraded its credit rating, triggering payments on other outstanding loans and pushing Birmingham toward the status of an African debtor state. For the next generation, the county will be in a constant fight to collect enough taxes just to pay off its debt, which now totals $4,800 per resident.
The city of Birmingham was founded in 1871, at the dawn of the Southern industrial boom, for the express purpose of attracting Northern capital — it was even named after a famous British steel town to burnish its entrepreneurial cred. There's a gruesome irony in it now lying sacked and looted by financial vandals from the North. The destruction of Jefferson County reveals the basic battle plan of these modern barbarians, the way that banks like JP Morgan and Goldman Sachs have systematically set out to pillage towns and cities from Pittsburgh to Athens. These guys aren't number-crunching whizzes making smart investments; what they do is find suckers in some municipal-finance department, corner them in complex lose-lose deals and flay them alive. In a complete subversion of free-market principles, they take no risk, score deals based on political influence rather than competition, keep consumers in the dark — and walk away with big money. "It's not high finance," says Taylor, the former bond regulator. "It's low finance." And even if the regulators manage to catch up with them billions of dollars later, the banks just pay a small fine and move on to the next scam. This isn't capitalism. It's nomadic thievery.
Is America ‘Yearning for Fascism’?
by Chris Hedges
The language of violence always presages violence. I watched it in war after war from Latin America to the Balkans. The impoverishment of a working class and the snuffing out of hope and opportunity always produce angry mobs ready to kill and be killed. A bankrupt, liberal elite, which proves ineffectual against the rich and the criminal, always gets swept aside, in times of economic collapse, before thugs and demagogues emerge to play to the passions of the crowd. I have seen this drama. I know each act. I know how it ends. I have heard it in other tongues in other lands. I recognize the same stock characters, the buffoons, charlatans and fools, the same confused crowds and the same impotent and despised liberal class that deserves the hatred it engenders.
“We are ruled not by two parties but one party,” Cynthia McKinney, who ran for president on the Green Party ticket, told me. “It is the party of money and war. Our country has been hijacked. And we have to take the country away from those who have hijacked it. The only question now is whose revolution gets funded.”
The Democrats and their liberal apologists are so oblivious to the profound personal and economic despair sweeping through this country that they think offering unemployed people the right to keep their unemployed children on their nonexistent health care policies is a step forward. They think that passing a jobs bill that will give tax credits to corporations is a rational response to an unemployment rate that is, in real terms, close to 20 percent. They think that making ordinary Americans, one in eight of whom depends on food stamps to eat, fork over trillions in taxpayer dollars to pay for the crimes of Wall Street and war is acceptable. They think that the refusal to save the estimated 2.4 million people who will be forced out of their homes by foreclosure this year is justified by the bloodless language of fiscal austerity. The message is clear. Laws do not apply to the power elite. Our government does not work. And the longer we stand by and do nothing, the longer we refuse to embrace and recognize the legitimate rage of the working class, the faster we will see our anemic democracy die.
The unraveling of America mirrors the unraveling of Yugoslavia. The Balkan war was not caused by ancient ethnic hatreds. It was caused by the economic collapse of Yugoslavia. The petty criminals and goons who took power harnessed the anger and despair of the unemployed and the desperate. They singled out convenient scapegoats from ethnic Croats to Muslims to Albanians to Gypsies. They set in motion movements that unleashed a feeding frenzy leading to war and self-immolation. There is little difference between the ludicrous would-be poet Radovan Karadzic, who was a figure of ridicule in Sarajevo before the war, and the moronic Glenn Beck or Sarah Palin. There is little difference between the Oath Keepers and the Serbian militias. We can laugh at these people, but they are not the fools. We are.
The longer we appeal to the Democrats, who are servants of corporate interests, the more stupid and ineffectual we become. Sixty-one percent of Americans believe the country is in decline, according to a recent NBC News/Wall Street Journal poll, and they are right. Only 25 percent of those polled said the government can be trusted to protect the interests of the American people. If we do not embrace this outrage and distrust as our own it will be expressed through a terrifying right-wing backlash.
“It is time for us to stop talking about right and left,” McKinney told me. “The old political paradigm that serves the interests of the people who put us in this predicament will not be the paradigm that gets us out of this. I am a child of the South. Janet Napolitano tells me I need to be afraid of people who are labeled white supremacists but I was raised around white supremacists. I am not afraid of white supremacists. I am concerned about my own government. The Patriot Act did not come from the white supremacists, it came from the White House and Congress. Citizens United did not come from white supremacists, it came from the Supreme Court. Our problem is a problem of governance. I am willing to reach across traditional barriers that have been skillfully constructed by people who benefit from the way the system is organized.”
We are bound to a party that has betrayed every principle we claim to espouse, from universal health care to an end to our permanent war economy, to a demand for quality and affordable public education, to a concern for the jobs of the working class. And the hatred expressed within right-wing movements for the college-educated elite, who created or at least did nothing to halt the financial debacle, is not misplaced. Our educated elite, wallowing in self-righteousness, wasted its time in the boutique activism of political correctness as tens of millions of workers lost their jobs. The shouting of racist and bigoted words at black and gay members of Congress, the spitting on a black member of the House, the tossing of bricks through the windows of legislators’ offices, are part of the language of rebellion. It is as much a revolt against the educated elite as it is against the government. The blame lies with us. We created the monster.
When someone like Palin posts a map with cross hairs on the districts of Democrats, when she says “Don’t Retreat, Instead—RELOAD!” there are desperate people cleaning their weapons who listen. When Christian fascists stand in the pulpits of megachurches and denounce Barack Obama as the Antichrist, there are messianic believers who listen. When a Republican lawmaker shouts “baby killer” at Michigan Democrat Bart Stupak, there are violent extremists who see the mission of saving the unborn as a sacred duty. They have little left to lose. We made sure of that. And the violence they inflict is an expression of the violence they endure.
These movements are not yet full-blown fascist movements. They do not openly call for the extermination of ethnic or religious groups. They do not openly advocate violence. But, as I was told by Fritz Stern, a scholar of fascism who has written about the origins of Nazism, “In Germany there was a yearning for fascism before fascism was invented.” It is the yearning that we now see, and it is dangerous. If we do not immediately reincorporate the unemployed and the poor back into the economy, giving them jobs and relief from crippling debt, then the nascent racism and violence that are leaping up around the edges of American society will become a full-blown conflagration.
Left unchecked, the hatred for radical Islam will transform itself into a hatred for Muslims. The hatred for undocumented workers will become a hatred for Mexicans and Central Americans. The hatred for those not defined by this largely white movement as American patriots will become a hatred for African-Americans. The hatred for liberals will morph into a hatred for all democratic institutions, from universities to government agencies to the press. Our continued impotence and cowardice, our refusal to articulate this anger and stand up in open defiance to the Democrats and the Republicans, will see us swept aside for an age of terror and blood.
James Lovelock: Climate change could quite easily lead to a physical war
by Leo Hickman
As you travel along the drive to James Lovelock's house, located in a remote, wooded valley on the Cornwall-Devon border, you pass a sign by a gated cattle grid. "Experimental station," it reads. "Site of a new natural habitat. Please do not trespass or disturb."
Thirty years ago, Lovelock planted 20,000 trees to create the much more biodiverse habitat around his home. But you suspect that, had this fiercely independent scientist and globally respected environmental thinker been around 3.8 billion years ago when life first erupted on this planet, he would have organised a similar notice to be placed somewhere prominent. After all, Lovelock – now into his 90s but still fit enough to be invited aboard Richard Branson's soon-to-launch commercial spacecraft – is the man who first developed the "Gaia theory" in the late 1960s: the still-challenging idea that Earth is one giant, self-regulating organism whose equilibrium is being very much disturbed by the actions of one species. Lovelock has been warning with increasing urgency that the survival of that species – Homo sapiens – is now gravely threatened by the "Revenge of Gaia", the title of one of his more recent bestselling books.
He is billed as an Old Testament-style prophet for our times, predicting fire and brimstone for a damned generation if it does not urgently and radically change its polluting ways. But in person Lovelock has a becalming presence, even when firing off verbal thunderbolts at the various "dumbos" with whom we have bestowed our collective fate: namely, "the politicians, scientists and lobbyists". The past four months, he says, have only hardened his disdain for this grouping; a turbulent period that has seen efforts to tackle climate change undermined by the online release of the hacked University of East Anglia emails, the failure of the Copenhagen climate conference, the (forced) admission by the Intergovernmental Panel on Climate Change that its latest report contained some minor mistakes, and the onset of an exceptionally cold winter across some parts of the northern hemisphere.
Leaning back into his swivel chair in his modest office-cum-laboratory, from where he writes and conducts the odd commissioned experiment for the Ministry of Defence and MI5 ("it's nothing that interesting; just health-and-safety work", he says when probed for more detail), Lovelock directs his first wave of ire at the reports that climate scientists had been caught up in the email scandal. He was, he says, "utterly disgusted" when he first heard about the allegations. (He didn't read the actual emails when they were posted online, adding that: "Oddly, I felt reluctant to pry.") During this discussion, Lovelock recalls the "corruption of science" that occurred during the attempts to link chlorofluorocarbons with the hole in the ozone layer in the 1980s. "Fudging the data in any way whatsoever is quite literally a sin against the holy ghost of science. I'm not religious, but I put it that way because I feel so strongly. It's the one thing you do not ever do."
Lovelock says the events of the past few months have seen him warm to the efforts of some climate sceptics: "What I like about sceptics is that in good science you need critics that make you think: 'Crumbs, have I made a mistake here?' If you don't have that continuously, you really are up the creek. "The good sceptics have done a good service – but some of the mad ones, I think, have not done anyone any favours. Some, of course, are corrupted and employed by oil companies and things like that. Some even work for governments. For example, I wouldn't put it past the Russians to be behind some of the disinformation to help further their energy interests. But you need sceptics, especially when the science gets very big and monolithic."
And the sceptics are right, he says, to be deeply distrustful of scientists who are overly reliant on computer models, particularly when it comes to predicting future climate scenarios: "We're not that bright an animal. We stumble along very nicely and it's amazing what we do do sometimes, but we tend to be too hubristic to notice the limitations. If you make a model, after a while you get suckered into it. You begin to forget that it's a model and think of it as the real world." It is obvious, both from talking to Lovelock and reading his work, particularly his most recent books, that he doesn't have the highest opinion of mankind's capabilities to see the long game and act accordingly.
"I don't think we're yet evolved to the point where we're clever enough to handle as complex a situation as climate change," he responds, when asked whether we are up to the task as a species of tackling climate change. "We're very active animals. We like to think, 'Ah yes, this will be a good policy,' but it's almost never that simple. Wars show this to be true. People are very certain they are fighting a just cause, but it doesn't always work out like that. Climate change is kind of a repetition of a wartime situation. It could quite easily lead to a physical war."
Hopelessness is a response, one senses, never far from a Lovelock audience. He is not one to toss around crumbs of comfort when he believes they're not justified, and displays a great deal of contempt for what he believes to be the naive idealism and ideologies of much of the current environmental movement – a significant proportion of which still looks up to him with a certain reverence. For example, it was his high-profile switch a few years ago to promoting nuclear energy as the best hope for saving ourselves that helped convince many environmentalists to rethink their instinctive opposition to this technology. Now, he says, he is not convinced that any meaningful response to "global heating", as he likes to call it, can be achieved from within the modern democracies of the western world.
"We need a more authoritative world," he says resolutely. "We've become a sort of cheeky, egalitarian world where everyone can have their say. It's all very well, but there are certain circumstances – a war is a typical example – where you can't do that. You've got to have a few people with authority who you trust who are running it. They should be very accountable too, of course – but it can't happen in a modern democracy. This is one of the problems. "What's the alternative to democracy? There isn't one. But even the best democracies agree that when a major war approaches, democracy must be put on hold for the time being. I have a feeling that climate change may be an issue as severe as a war. It may be necessary to put democracy on hold for a while."
But with public confidence in climate science taking such a knock in recent months, what will it take to convince the public that urgent action really is required to reduce greenhouse gas emissions – or, as is Lovelock's preference, to adapt and prepare the lifeboat for a changing climate? "There has been a lot of speculation that a very large glacier in Antarctica is unstable," he says, referring to Pine Island glacier or "the Pig", as the scientists now monitoring it like to call it. "If there's much more melting, it may break off and slip into the ocean. I'd say the scientists are not worried about it, but they are keeping a close watch on it. It would be enough to produce an immediate sea level rise of two metres – something huge. And tsunamis. That would be the sort of event that would change public opinion – or a return of the dustbowl in the American midwest. Another IPCC report won't be enough; we'll just argue over it like now."
(I later contact Dr Robert Bindschadler, the Nasa scientist who leads the team monitoring the Pig. "No one expects full collapse of the system as quickly as [in the next] 100 years," Bindschadler responds, "'but even if it did, the mean rate of sea level rise would 'only' triple the current rate of rise. No one would get their feet wet overnight.") On a noticeboard behind Lovelock hangs a photograph of a huge wind turbine. As an active anti-wind farm campaigner, does it infuriate him that so much investment is now being poured into renewable energy infrastructure? "I've always said that adaptation is the most serious thing we can do," he says. "Are our sea defences adequate? Can we prevent London from flooding? This is where we should be spending our billions. If wind turbines really worked, I wouldn't object to them. To hell with the aesthetics, we might need them to save ourselves. But they don't work – the Germans have admitted it.
"It's like the Common Agricultural Policy, which led to corruption and inefficiencies. A common energy policy across Europe is not a good idea. I'm in favour of nuclear for crowded places like Britain for the simple reason that it's cheap, effective and exceedingly safe when you look at the record." His views on carbon emissions trading, as is being touted by the EU and others, are equally dismissive: "I don't know enough about carbon trading, but I suspect that it is basically a scam. The whole thing is not very sensible. We have this crazy idea that we are setting an example to the world. What we're doing is trying to make money out of the world by selling them renewable gadgetry and green ideas. It might be worthy from the national interest, but it is moonshine if you think what the Chinese and Indians are doing [in terms of emissions]. The inertia of humans is so huge that you can't really do anything meaningful."
Lovelock freely admits that, at 90, he won't be around to see the results of the "experiment" humans are currently conducting with the atmosphere. It's what, in part, gives him the licence to speak with such frankness. But for anyone younger, Lovelock's prognosis for our species is hard to hear, let alone accept. That a black, rain-laden cloud is welling up over the nearby moorland as I set off to leave only acts to darken the mood.