Crowd watching the news line on the Times building at Times Square, New York CIty
Ilargi: I like Henry Blodget, CEO at Business Insider slash Clusterstock. I do. He's smart, he's "on", and he must work very hard. And Henry keeps on coming up with these great angles on the housing mess. But alas, then he keeps drawing the same strange conclusions. Below is his (second?) take on a report by T2 Partners.
The data are awful, do download the original. And Henry's take-away from it? Still the same as before: "Prices still have a 10%-15% to fall and won't recover[.] quickly".
When looking at this, I simply don't get how anyone can see a mere 10% further reduction in home prices. The walls of Jericho are just starting to come down, and according to the Case-Shiller index 32% has been shaved off home "values" nationally already. Still, only 10% more to go? What will make the plunge stop? Granted, and in Henry's defense, the T2 people run of their own rails too. Their conclusions seem to all be based on home prices reverting to trendlines.
Which in turn would presumably lead to what they call affordable prices:
But affordability, believe it or not, is not an abstract term, it actually depends instead on what people can afford, which is heavily dependent on what they earn. Fast increasing unemployment numbers don’t bode well at all for that. And that is where the real issue is: The US unemployment rate reached yet another record this week, at 9.4%, and there's no sign of that downward -or is that upward?!- trend abating. Moreover, foreclosures are at thus far unknown levels, driven largely by those same unemployment levels.
And except for multi-trillion dollar government (read: taxpayer) subsidies, there is nothing out there that would keep neither employment figures nor home prices tied to any pre-established trendline. The Obama administration subsidies, bail-outs and stimulus plan are rapidly making the medium- to long term view far worse, not better. The main problem we face is an unbelievable overextension into DEBT, and the US administration draws the population deeper into DEBT. It really is that simple. Anything else is based on faith, hope and charity, not fact.
Now, if you like the belief approach to national finances, be my guest. From where I’m sitting, though, I see only deterioration of the underlying foundations of the economy. According to John Williams’s Shadowstats, one in 5 Americans is unemployed according to U6 calculations. Officially, it’s one in 6. And one in 6 is also the number of homeowners that are underwater, that owe more on their home than it's worth.
Let's try a thought experiment. Imagine what would happen to the housing market if Fannie Mae and Freddie Mac were not present, not active. And the Federal Housing Administration. And the Federal Home Loan Banks system. (I know, it sounds like Bulgaria, doesn't it?). Once you got that picture down, try to figure out how much longer do you think that East Bloc system will continue to function in the US. As in: China doesn’t buy GSE debt anymore, they prefer sovereign debt by now. And despite the weird convoluted status that Fannie and Fred enjoy, their debt issues are not sovereign.
And what’s coming down the line is this: Giant-sized additional losses, for both banks and private borrowers.
And then, as I’ve mentioned before, there are large amounts of homes that are either foreclosed but not added to the market, or for which lenders simply hold off on finishing the foreclosure proceedings. A home in limbo is a home that doesn't drag down the stats any further. Rumors of active government pressure behind the aforementioned two approaches may not be 100% confirmed, but we can all see the logic that would hypothetically lead to similar policies. And why would a lender get aggressive about pesky proceedings throwing families out on the street, or be pro-active in offloading properties, if the government makes it worth their while to not do so?
And that is the one and only true thing that remains here, isn’t it, the single issue that will survive all the shenanigans thrown at us in droves on a daily basis, until we can’t be confident any longer that we can add 2 + 2. You see, if home prices would simply revert to trendlines, as Henry and the T2 folks would have us believe, then there would have to be some sort of absolution from the behemoth outsized amounts of debt that went into buying those homes. Or, for Wall Street, issuing trillions of dollars in mortgage backed securities, and covering the risks those carried with OTC derivatives "worth” tens of trillions, and so on.
There is a problem with that trendline idea, one that everyone, up to and including T2 and Henry Blodget tries to avoid living up to. The very thing that got us so far above the trendline 110% guarantees that we'll fall WAY below the trendline. And then some. And then we’ll just keep on falling. Until we have all paid off our debts, individuals, corporations, banks and governments.
And guess what? We haven't paid but a few percent so far, if that, and the government is even fast adding more debt. And yet, U6 unemployment stands at 20%+ according to Williams, there are literally millions of foreclosure proceedings floating around our neighborhoods as we speak, and home prices are dropping like so many plagues of locusts do when the food runs out. All of which still precedes the avalanche of Option ARM, Alt-A and prime loans defaults that we already know will be washing over our towns, shores and forests in the next few years.
I could advise you not to believe a word you read, but that would include mine own. Still, perhaps that's the best way to go. But to narrow it down a little: don't believe anything the mortgage industry, the banking industry, the government, and most of all anyone who talks about restoring to existing trendlines tries to convince you of. It won't happen. They’re all full of it, full of something. Something that will not be of benefit to you.
There is neither a realistic bottom in sight for US home prices, not for unemployment numbers. This thing you know as "your society" is falling apart at the seams, and nobody knows where or when it will stop falling, not even me. I do know, however, that it won't stop where you would like it to.
You will never get back to where you think you once were. Getting back into the old game is not an option, that ship has sailed. The sooner you realize that, the more chance you have of minimalizing the suffering of those around you, and of yourself. And that's the best anyone can do for you. The rest is only there to make you temporarily feel good, so you won't pay attention to where your money's disappearing to.
The Five Waves Of The Housing Collapse
Whitney Tilson and Glenn Tongue of T2 Partners believe the housing-market collapse will have five distinct phases. In their opinion, we're just finishing up Phase 2 and moving into Phase 3.
Here are three excerpts from T2's recent presentation on the housing and mortgage collapse. The full presentation is embedded below. You can also download it here.
The Past: Losses Mostly Behind Us:
• Wave #1: Borrowers committing (or the victim of) fraud & speculators, who defaulted quickly. Timing: beginning in late 2006 (as soon as home prices started to fall) into 2008. Mostly behind us.
• Wave #2: Borrowers who defaulted when their mortgages reset due to payment shock. Timing: early 2007 (as two-year teaser subprime loans written in early 2005 started to reset) to the present. Now tapering off as low interest rates mitigate payment shock.
The Future: Losses Mostly Ahead of Us
• Wave #3: Prime loans (most of which are owned or guaranteed by the GSEs) defaulting due to job loss and home price declines (i.e., underwater homeowners). Timing: started to surge in early 2008 to the present.
• Wave #4: Jumbo prime, second lien and HELOCs (most of which are on banks’ books) defaulting due to job loss and home price declines/ underwater homeowners. Timing: started to surge in early 2008 to the present.
• Wave #5: Losses among loans outside of the housing sector, the largest of which will be in the $3.5 trillion area of commercial real estate. Timing: started to surge in early 2008 to the present.
Importantly, Whitney and Glenn believe that recent signs of stabilization in the housing market are a HEAD FAKE. Prices still have a 10%-15% to fall and won't recovery quickly.
Rather than representing a true bottom, recent signs of stabilization are likely due to two short-term factors:
1. Home sales and prices are seasonally strong in April, May and June due to tax refunds and the spring selling season
2. A temporary reduction in the inventory of foreclosed homes
– Shortly after Obama was elected, his administration promised a new, more robust plan to stem the wave of foreclosures so the GSEs and many other lenders imposed a foreclosure moratorium
– Early this year, the Obama administration unveiled its plan, the Homeowner Affordability and Stabilization Plan, which is a step in the right direction – but even if it is hugely successful, we estimate that it might only save 20% of homeowners who would otherwise lose their homes
– The GSEs and other lenders are now quickly moving to save the homeowners who can be saved – and foreclose on those who can’t
– This is necessary to work our way through the aftermath of the bubble, but will lead to a surge of housing inventory later this year, which will further pressure home prices
Here's what will likely drive future losses:
1. The Economy • Especially unemployment
2. Interest rates • Ultra-low rates have helped mitigate some of the damage • But if the recent spike in rates continues, it could lead to an even greater surge in defaults and losses
3. Behavior of homeowners who are underwater [Approx 30% of mortgages right now]
- Roughly one-fourth of homeowners with mortgages are currently underwater, some deeply so
- For many, it is economically rational for them to walk – so called “jingle mail” – but how many will do so?
- There is little historical precedent – we are in uncharted waters
- As home prices continue to fall and homeowners become more and more underwater, they are obviously more likely to default, thereby creating a vicious cycle, but what exactly will the relationship be? Have millions of foreclosures led to a diminution of the stigma of losing one’s home?
- Our best guess is that there will be rough symmetry: for homeowners 5% underwater, an additional 5% will default due to being underwater; 10% underwater will lead to 10% more defaults, and so forth
Ilargi: I don't know Obama's econo man Goolsbee. But this is one amazing line:
“I don’t know why the Bush administration handed them money and shoved the problem onto the next guy,”
That dumb? You think?
Obama Officials See Hope in Jobless Numbers, Defend GM Plan
White House officials said they see encouraging signs in the slowing rate of job losses and defended the Obama administration’s handling of the bankruptcy of General Motors Corp. Companies shed 345,000 jobs last month, fewer than expected and the lowest number since September, the Department of Labor reported June 5. Unemployment rose to 9.4 percent. “Hopefully, that is a sign that this is turning,” David Axelrod, senior adviser to President Barack Obama, said on CNN’s “State of the Union” television program. “While it’s going to take some time for these unemployment numbers to turn around, for the momentum to completely stop and turn in the other direction, it feel as if we’re moving.”
Axelrod and Obama economic adviser Austan Goolsbee defended Obama’s moves on the economy, including his decision to seek a $787 billion economic stimulus and the handling last week of the bankruptcy of General Motors. Goolsbee, appearing on “Fox News Sunday,” said Obama brokered the best deal possible with GM after the Bush administration gave the automaker billions in loans the month before leaving office. “I don’t know why the Bush administration handed them money and shoved the problem onto the next guy,” Goolsbee said.
The Obama plan was criticized on the Fox program by Thayer Capital Partners Chairman Fred Malek and Google Inc. Chief Executive Officer Eric Schmidt for favoring labor unions over the company’s bondholders. “What this amounts to is a bailout for the unions at the expense of the secured creditors,” Malek said. Goolsbee said the administration drove a hard bargain with labor unions, winning concessions on pay, benefits and pensions. “In the Obama plan, it asks more and received more from the unions and the other stakeholders than the people who objected to the bailout last November asked for,” he said. “All the stakeholders have made sacrifices.”
While Goolsbee conceded unemployment numbers were higher than the 8 percent the administration had projected, he said that helps make the case for economic stimulus legislation enacted right after Obama took office in January. He called the jobless numbers “a terrible number, but it’s a substantial improvement.” When asked whether the U.S. was bound for double-digit unemployment, Goolsbee said the economy continues to face a “rough patch” and jobless numbers are “likely going to be a little higher.”
Birth Death Adjustment Goosed NFP
For the past few years, I have been railing about data nonsense such as Core CPI, Birth/Death adjustment, Home Affordability Index, etc. I sometimes forget that not every current TBP reader has been tracking this stuff since the mid-2000s with us. Several comments yesterday, and a kindly email asking me if I knew about U6 (heh) or about the BDA, led me to today’s post.
A quick refresher on the Birth Death adjustment: In 2001, the Bush administration directed the BLS to compensate for the tendency of the Establishment Survey to miss new business formation and the impact on employment. Previously, BLS tended to under report new jobs in the beginning of a a cycle turn. What the new B/D Adjustment series did was take new incorporation filings per state, and deduce from them that new jobs were being created. (That took effect around 2003).
This improved somewhat the ability to capture new jobs at the start of the cycle. But the flaw in the adjustment was that the model radically overstated job creation at the end of the cycle. Say a firm goes out of business, or lays off 100s of workers. They form new shops, incorporating these start ups. According to the BLS, that is job creation. But in reality, a steady paycheck with benefits has now been transformed into a start up with none of the above. And as we know, 90% of all new businesses eventually fail.
How misleading is the BD adjustment at the end of the cycle? Consider that in 2007, 75% of the BLS newly created jobs were due to the B/D adjustment. That did a nice job masking the actual problems beneath the surface. Which brings us to Friday’s NFP report. As the chart below shows, as GDP has plummeted, the BD adjustment has created ever more jobs. Is that reasonable? Does that reflect reality? Or, is it another version of 2007 data stream creating a misleading construct of reality? I suspect it's the latter . . .
Source: Mike Panzner
The caveat is the BDA end-of-quarter data can be a little volatile on a monthly basis (see actual data below). Note also Bloomberg’s data only goes back to 1/31/00.
Principal over principle
"Those are my principles and if you don't like them ... well, I have others." - Groucho Marx
American comedian Groucho Marx well captured the fragility and even the existential angst of society's moral compass in the face of economic hardship. He certainly was an authority on the subject, having delivered some of his most memorable work during and in the aftermath of the 1929 stock market crash and the Great Depression that followed. Well equipped with sharp observation skills and self-deprecating wit, Groucho practically invented one-liners that have since become the staple of comedy in the English-speaking world.
Something vastly different from one-liners now appears to dominate the English-speaking world; this is the steady deterioration of the moral compass in each society. We have witnessed epochal events that highlight the abrupt nature of change in these societies: Americans now appear to endorse large-scale government intervention in their economy to the point where "Too big to fail" has become automatic if not official policy response to qualifying corporate crises; the British public are aghast at discovering that their parliamentarians had their hands in the proverbial tills; in Australia, events have taken a rather nasty turn with an increased incidence of attacks on students from Asia and in particular, India (ironically or otherwise, the Asian country with arguably the highest number of English speakers).
The word "principal" in finance is used to signify amounts of money involved; it appears that a careless word play could help translate problems with such principal amounts - as evidenced by the global financial crisis over the past few months - into the very core of society; a reordering of a moral compass that goes to the heart of the working principles in any society.
Prima facie, I would argue that the proximate motivation for these changes, be it in government policy, the actions of individuals or those of parliamentarians, is the deterioration of the economy. There have of course been historical parallels for such abrupt changes in societies that confront deteriorating prospects which are explained later in this article.
Before delving into the details of the above stories, I must perhaps highlight a point of major irritation in the financial media and especially blogs. This is the frequent incidence of Spoonerism on the use of "principal" and "principle". Far too many times, I have been told the following or variants of the same:
- XYZ person has loose principals.
- The bank wrote off its principle loan amount.
- In principal, I agree with these comments.
- Issuer X defaulted on their bond, principle amount of $Y.
For the record, useful definitions of the two words follow:
- Principal: adjective First or highest in rank, importance, value, etc; chief, foremost. noun A chief or head of an organization; something of primary importance. law A person who authorizes another (an agent) to represent him or her. finance A capital sum, the main amount of a loan or investment - as distinguished from interest or profit.
- Principle: noun A fundamental assumption - The principles of physics dictate that you cannot travel faster than the speed of light. A generally acceptable rule of action or behavior - moral principles.
Communists, thieves and racists
The US government has taken it on itself to rescue sectors and companies in the US economy that are deemed "too big to fail", which I presume means "politically inexpedient to be seen allowing to fail". In a recent Wall Street Journal opinion piece entitled "Too Fat to Fail", Daniel Henninger notes:So far Mr Obama has used his personally exciting presidency for initiatives that are spending public money on a scale not seen since ancient Egypt. Besides Obama Motors ($60 billion to $100 billion), there is Obama-Care for health insurance ($1.2 trillion over 10 years), the stimulus ($800 billion), a global-warming offensive called cap and trade that hopes to siphon hundreds of billions of dollars from the economy, and a fiscal year 2010 budget of $3.59 trillion. Out of these mists of federal "investment" they promise five million "green collar jobs". Only public-sector lifers could believe, or assert, anything so fantastic.
Then there is the never-ending march of the financial-rescue armies - TARP, TALF, PIPP, EESA. The Federal Reserve's balance sheet stands at some $2 trillion and growing. Last week, Treasury floated the possibility of a single financial regulator for the entire banking system. All this is the Obama government's idea of innovation. It is all public sector because all any of them know is public sector.
Over the past few months, I have written a number of articles that highlight the dangers of government intervention into the world economy, essentially a seemingly Luddite harking back to the time before market capitalism took hold of Anglo-Saxon economies. My sentiments were echoed in the wonderful Mises.Org website on June 4, in an article "The Age of Folly" by the redoubtable Llewellyn H Rockwell, Jr that contains the following observations:They are unavoidable features of the world, ones which the political class is forever attempting to override. The economy had been on a false foundation for some years, and the housing sector in particular had become wildly overbuilt and rested on bad debt. What can politicians do about this? Absolutely nothing. Economic foundations are built by private investment. Government has no resources of its own to build a foundation.
It can only rob people of their property and thereby divert resources from where they belong to where they ought not to be ... By the fall and winter, it became clear that the war on recession was not working and the economy was sinking further. Rather than give up, Bush pushed so hard that he managed to throw us all in the arms of a socialist who knows nothing about economics and has surrounded himself with big shots who affirm him in his ignorance - people like Paul Krugman, who are wedded to antique mythologies about the glories of government power ... And so we live through it again.
We see the fools trying this and that with our lives and liberty, promising glorious results around the corner. Well, by now, we've been around the corner, the next one and the next one, and it gets worse with each turn. These people are driving us right into the abyss, and let's be clear that this is not the fault of private investors or savers or foreigners or stock jobbers. It is the fault of the managers of this recession: the government, whoever is or has been in charge, and the Fed that operates on government authority.
As if to echo the fears of what happens when interventionist politicians take charge of the economy, an expense scandal has erupted in the United Kingdom with significant abuses reported by the left-leaning Labour Party that has been in power for the past 12 years. In a series of exposes that began in the Daily Telegraph about a month ago, salacious details of the country's members of parliament (MPs) claiming excessive personal expenses back from the government (and therefore the taxpayer) have been brought to light.
The aftermath, which has been described as a "challenge to the very foundations of British democracy", has been the vast number of resignations of MPs as well as (more recently) members of the cabinet. In an extraordinary move, the speaker of parliament was forced to step down after it was shown that members of his team had actively colluded with MPs to abuse the system. The resignation of the speaker was the first since 1695.
Writing in the Financial Times, political columnist Philip Stephens observed the following on May 21:England likes to think of itself as the mother of parliaments, the cradle of modern democracy. Never mind the minor contributions made by the American constitution or France's declaration of the rights of man; nothing can compete with the 1,000 years of history that stand behind the House of Commons. The English have long been immodest in this respect. I well recall when France's then president Francois Mitterrand invited Margaret Thatcher to join the bicentenary celebrations of the French Revolution. With her customary tact, and a selective reading of history, the British prime minister arrived in Paris brushing aside the significance of Bastille Day. The gist of her remarks was that English (and British) democracy did not rest on a single great convulsion such as that of 1789.
It had been built on the much firmer foundations of accumulated wisdom and historical convention ... That said, the affair has been a salutary reminder of the manifest flaws of a smug institution. Most obviously, it has revealed a legislature that has never quite admitted that things have changed. This was a world of honorable members whose dignity did not allow for public scrutiny or accountability. Born of the age of deference, it had never really escaped it. So we are at the end of an era. Just as the Profumo scandal of 1963 opened up the establishment to the public gaze, so parliament can never again slam the door of the Westminster club against outside scrutiny.
Mr Stephens leaves unsaid the notion of what exactly happens at the end of an era (he suggests cosmetic changes such as more power to local governments); the dangers for the UK are of course that the only political parties that have been left untouched by the current scandal are those on the extreme fringe of British politics, namely the racist British National Party (BNP) and the anti-European UK Independence Party (UKIP).
On the subject of racists and the far right, from Down Under we have stories of increased violent attacks on Asian immigrants. The Voice of America reported the following on June 4:Australian Prime Minister Kevin Rudd has condemned as "senseless acts of violence" a series of race attacks on Indian students in Melbourne. The Indian high commissioner is demanding greater protection for Indians studying in Australia, as state authorities in the southern state of Victoria draw up new laws to crack down on hate crimes. A series of assaults on Indian students in Australia prompted about 3,000 people to take part in a recent rally in Melbourne to demand greater protection from the authorities, who are accused of doing too little to stem the violence. There were ugly clashes between protesters and police.
More than a dozen people were arrested ... In the past year, about 70 attacks on young Indians in Melbourne have been reported and there are claims by community groups that the vast majority have been racially motivated ... Victoria Police Chief Simon Overland insists that students, in general, have become "easy targets" for opportunistic criminals. "It's partly violence against Indian students," he said. "It's escalating robberies and we have used the term 'soft-target robberies'. Now, the Indian students have taken that as referring directly to them; it's not. What we have seen is that robberies are now happening more directed against people in the street, directed against people who are wandering around with laptop computers, mobile phones, iPods, cash. And, if they're alone, they're vulnerable." ... The attacks have caused diplomatic friction between Canberra and New Delhi.
Australia is no stranger to the rise of the far right during times of economic strife. The recession of the early 1990s (starting in 1989) pushed to the fore one Pauline Hanson and the politics of the One Nation party. She was briefly notorious in the mid-1990s for capitalizing on the fears of Australians for their jobs; and indeed her first speech to the Australian House of Representatives contained the following "gem":Immigration and multiculturalism are issues that this government is trying to address, but for far too long ordinary Australians have been kept out of any debate by the major parties. I and most Australians want our immigration policy radically reviewed and that of multiculturalism abolished. I believe we are in danger of being swamped by Asians. Between 1984 and 1995, 40% of all migrants coming into this country were of Asian origin. They have their own culture and religion, form ghettos and do not assimilate. Of course, I will be called racist but, if I can invite whom I want into my home, then I should have the right to have a say in who comes into my country. A truly multicultural country can never be strong or united ...
We have seen this film before
I started this article by pointing out that social degradation and economic declines go hand-in-hand. The worst such example in modern history was most certainly Nazi Germany, where the rise of Adolf Hitler was predicated on a nasty bout of inflation, unemployment and social unrest that followed World War I. The Wikipedia entry for the rise of the Third Reich makes the following observations:The Third Reich arose in the wake of the national shame, embarrassment, anger and resentment which resulted from the Treaty of Versailles. Versailles, a harsh treaty offered to the vanquished Germans after a brutal war, provided for:
- Germany's acceptance of and admission to sole responsibility for causing World War I.
- The permanent forfeiture of various German territories and the demilitarization of other German territory.
- The payment by Germany of heavy reparations, in money and in kind, such payments being justified in the Allied view by the War Guilt clause.
- Unilateral German disarmament and severe military restrictions.
Other conditions fostering the rise of the Third Reich include nationalism and Pan-Germanism, civil unrest attributed to Marxist groups, the worldwide economic depression of the 1930s (spurred by the stock market crash in the US), the reaction against the counter-traditionalism and liberalism of the Weimar period, and the rise of communism in Germany, as reflected by the growth of the KPD, the Communist Party of Germany.
Many voters, seeking an outlet for their frustrations and an expression for their repudiation of parliamentary democracy which seemed incapable of keeping a government in power for more than a few months, began turning their support towards the far right and far left of the political spectrum, opting for extremist political parties such as the Nazi Party. The Nazis offered promises of strong authoritarian government in lieu of effete parliamentary republicanism, civil peace, radical changes to economic policy (including elimination of unemployment), restored national pride (principally through the repudiation of Versailles) and racial cleansing, implemented in part by active suppression of Jews and Marxists, all under the banner of national unity and solidarity in lieu of the partisan divisiveness of democracy and the class divisiveness of Marxism.
Reading this bit of history and comparing it to the events of the three countries we mention above, it is clear that some of the trends are in place, namely:
- The rise of communism, as evidenced by the nationalization of capitalist enterprises such as banks , insurance companies and even automotive companies in the US.
- Loss of public confidence in the instruments of government such as the UK parliament.
- A rise in efforts towards ethnic cleansing or at least racially inspired violence as shown in the case of Australia.
The English-speaking world should certainly thank its lucky stars that not all of the above events have occurred in the same country, for surely that country would be on the road to becoming a menace to its neighbors and perhaps even to the world at large; but taken as a whole, the trend appears unmistakably negative.
Investors ask Supreme Court to delay Chrysler sale
Indiana pension funds asked the U.S. Supreme Court on Sunday to immediately delay the sale of bankrupt automaker Chrysler LLC to a group led by Italian carmaker Fiat SpA while they challenge the deal. The request, which moves the legal battle to the highest court in the United States, was filed after a U.S. appeals court in New York approved Chrysler's sale to a group led by Fiat, a union-aligned trust and the U.S. and Canadian governments. The Chrysler ruling could set a precedent for the case of General Motors Corp, which is using a similar quick sale strategy in its bankruptcy in New York.
The appeals court late on Friday stayed the closing of the sale until Monday afternoon, giving the pension funds time over the weekend to ask the Supreme Court to block the sale while they appeal. The pension funds, which hold about $42 million of Chrysler's $6.9 billion in secured loans, have argued the sale unlawfully rewarded unsecured creditors such as the union ahead of secured lenders and that Chrysler was pursuing an illegal reorganization plan through a sham sale.
"The need for the court to review the profound issues presented by Chrysler's novel bankruptcy sale far outweighs the cost of delaying" a sale, lawyers for the pension funds and the Indiana attorney general said in seeking an immediate stay. The three state pension and construction funds also argued the U.S. government, which kept Chrysler afloat with emergency loans before the automaker's bankruptcy and financed its Chapter 11 filing, overstepped its authority by using bailout funds Congress intended for banks.
"The public is watching and needs to see that, particularly, when the system is under stress, the rule of law will be honored and an independent judiciary will properly scrutinize the actions of the massively powerful executive branch," the lawyers said. "The issues presented by this case are of immediate and enduring national significance," they said. Without a stay from the Supreme Court, the sale will close on Monday, the lawyers said. A federal bankruptcy judge in New York and the three-judge panel of the appeals court rejected the funds' arguments in approving the sale.
Attorneys for Chrysler, the U.S. government and Fiat all have argued the sale should be allowed to go forward. Fiat can walk away from the deal if it does not close by June 15. The request to stay the deal was filed with Supreme Court Justice Ruth Bader Ginsburg, who has responsibility for such emergency matters from the New York-based appeals court. Ginsburg could act on her own or could refer the matter to the full court. A stay from the full court would require the votes of five of the nine Supreme Court members.
Banks Use Conversions for 22% of Stress-Test Funds
Bank of America Corp. and nine U.S. lenders, facing a June 8 deadline to explain their capital- raising plans to regulators, are relying on preferred-stock conversions for 22 percent of their fundraising.
Bank of America needed to raise the most, $33.9 billion, in response to U.S. stress tests and will use share conversions to account for $9.5 billion, according to data compiled by Bloomberg. Banks are crafting packages that include common stock offerings, preferred share swaps and the sale of securities or assets.
Collectively, the 10 banks told by regulators to raise $74.6 billion have announced plans covering $70.6 billion of the gap, with some including Bank of America expecting to “comfortably” beat its target. They’ll get about $15.4 billion from preferred stock conversions, a tactic that improves the gauges of financial health that the government is focusing on without bringing additional cash into the company. “Conversions from preferred to common don’t do anything; you can just ignore them,” said Christopher Whalen, managing director of Institutional Risk Analytics, in an interview this week. “It makes the ratios look better, but it doesn’t increase the capital in the house.”
The Federal Reserve completed stress tests on 19 of the biggest U.S. lenders last month and found nine didn’t need any more capital, including Goldman Sachs Group Inc. and American Express Co. The tests were designed to show how the nation’s biggest financial firms would fare in a deeper, longer recession. The capital already raised is made up of $32.2 billion from selling common shares, which the Fed has said should be the “dominant element” of a bank’s Tier 1 capital ratio. In addition to Bank of America, New York-based Citigroup Inc. used preferred share conversions to close its $5.5 billion shortfall found by the stress tests. Ohio’s Fifth Third Bancorp and KeyCorp are also converting preferred shares.
Bank of America’s Tier 1 capital -- a basic measurement of a bank’s ability to absorb losses -- was “not in question,” said Jerry Dubrowski, a spokesman for the Charlotte, North Carolina-based bank, the biggest in the U.S. by assets. “They sought an increase in the common component of our capital and that’s what we’ve done.” The Fed’s demand for more capital has made banks focus more on common equity instead of relying on preferred shares, said Lawrence Kaplan, a former attorney at the Office of Thrift Supervision who now works at the law firm Paul, Hastings, Janofsky & Walker LLP in Washington. “Clearly, common stock is the best,” he said.
Banks offering shares are taking advantage of a market rebound that sent the KBW Bank Index up 113 percent from its March 6 low. Investors avoided buying shares of banks in January and February amid speculation lenders would be nationalized. “Three or four months ago, no one seemed like they were going to be able to raise capital ever again; now they are doing overnight deals,” said David Ellison, who manages more than $2 billion at Arlington, Virginia-based FBR Fund Advisors Inc.
Ellison runs FBR’s Small Cap Financial and Large Cap Financial mutual funds, whose largest allocations include banks and savings institutions. Both funds are beating the Standard & Poor’s 500 Index this year, with the large cap fund advancing 13 percent and the small cap index rising 6.9 percent. The S&P 500 has increased 4.3 percent this year through yesterday. “There are also still a lot of questions about the banking industry, the regulatory framework,” said Josh Siegel, co- founder of New York-based StoneCastle Partners LLC, which manages about $2.3 billion, including stakes in Bank of America, Citigroup and JPMorgan Chase & Co. “There’s just too much money sitting on the sidelines in cash that just can’t keep earning zero, it needs at the moment to find some place to go.”
Lenders are still contending with rising defaults and increasing unemployment, and the Federal Deposit Insurance Corp. reported a 21 percent jump in “problem” banks during the first quarter. Regulators seized 36 lenders so far this year and troubled assets at banks rose to 1.62 percent from 1.14 percent at the end of last year. The FDIC said 22 percent of U.S. banks reported a net loss during the period. “It was a pleasant surprise that a common equity window opened up,” David Hendler, a CreditSights Inc. analyst, said in an interview. Tactics such as preferred share exchanges may be “rearranging some of the deck chairs on the Titanic, but at least you have a chair that has a seatbelt.”
Bank Accused of Pushing Mortgage Deals on Blacks
As she describes it, Beth Jacobson and her fellow loan officers at Wells Fargo Bank “rode the stagecoach from hell” for a decade, systematically singling out blacks in Baltimore and suburban Maryland for high-interest subprime mortgages. These loans, Baltimore officials have claimed in a federal lawsuit against Wells Fargo, tipped hundreds of homeowners into foreclosure and cost the city tens of millions of dollars in taxes and city services.
Wells Fargo, Ms. Jacobson said in an interview, saw the black community as fertile ground for subprime mortgages, as working-class blacks were hungry to be a part of the nation’s home-owning mania. Loan officers, she said, pushed customers who could have qualified for prime loans into subprime mortgages. Another loan officer stated in an affidavit filed last week that employees had referred to blacks as “mud people” and to subprime lending as “ghetto loans.”
“We just went right after them,” said Ms. Jacobson, who is white and said she was once the bank’s top-producing subprime loan officer nationally. “Wells Fargo mortgage had an emerging-markets unit that specifically targeted black churches, because it figured church leaders had a lot of influence and could convince congregants to take out subprime loans.” Ms. Jacobson’s account and that of the other loan officer who gave an affidavit, Tony Paschal, both of whom have left Wells Fargo, provide the first detailed accusations of deliberate racial steering into subprimes by one of the nation’s top banks.
The toll taken by such policies, Baltimore officials argue, is terrible. Data released by the city as part of the suit last week show that more than half the properties subject to foreclosure on a Wells Fargo loan from 2005 to 2008 now stand vacant. And 71 percent of those are in predominantly black neighborhoods. Judge Benson E. Legg of Federal District Court had asked the city to file the additional paperwork and has not decided whether the lawsuit can go forward.
Wells Fargo officials have declined detailed interviews since Baltimore filed suit in January 2008. In an e-mail statement on Friday, a spokesman said that only 1 percent of the city’s 33,000 foreclosures have come on Wells Fargo mortgages. “We have worked extremely hard to make homeownership possible for more African-American borrowers,” wrote Kevin Waetke, a spokesman for Wells Fargo Home Mortgage. “We absolutely do not tolerate team members treating our customers or others disrespectfully or unfairly, or who violate our ethics and lending practices.”
City and state officials across the nation have investigated and sometimes sued Wells Fargo over its practices. The Illinois attorney general has investigated whether Wells Fargo Financial violated fair lending and civil rights laws by steering black and Latino homeowners into high-interest loans. New York’s attorney general, Andrew M. Cuomo, raised similar questions about the lending practices of Wells Fargo, JPMorgan Chase and Citigroup, among other banks. The N.A.A.C.P. has filed a class-action lawsuit charging systematic racial discrimination by more than a dozen banks, including Wells Fargo.
At the heart of such charges is reverse redlining, specifically marketing the most expensive and onerous loan products to black customers. The New York Times, in a recent analysis of mortgage lending in New York City, found that black households making more than $68,000 a year were nearly five times as likely to hold high-interest subprime mortgages as whites of similar or even lower incomes. (The disparity was greater for Wells Fargo borrowers, as 2 percent of whites in that income group hold subprime loans and 16.1 percent of blacks.)
“We’ve known that African-Americans and Latinos are getting subprime loans while whites of the same credit profile are getting the lower-cost loans,” said Eric Halperin, director of the Washington office of the Center for Responsible Lending. “The question has been why, and the gory details of this complaint may provide an answer.” The affidavits of the two loan officers seem to bolster Baltimore’s lawsuit. Mr. Paschal, who is black and worked as a loan officer in Wells Fargo’s office in Annandale, Va., from 1997 to 2007, offers a sort of primer on Wells Fargo’s subprime marketing strategy by race.
In 2001, he states in his affidavit, Wells Fargo created a unit in the mid-Atlantic region to push expensive refinancing loans on black customers, particularly those living in Baltimore, southeast Washington and Prince George’s County, Md. “They referred to subprime loans made in minority communities as ghetto loans and minority customers as ‘those people have bad credit’, ‘those people don’t pay their bills’ and ‘mud people,’ ” Mr. Paschal said in his affidavit. He said a bank office in Silver Spring, Md., had an “affinity group marketing” section, which hired blacks to call on African-American churches.
“The company put ‘bounties’ on minority borrowers,” Mr. Paschal said. “By this I mean that loan officers received cash incentives to aggressively market subprime loans in minority communities.” Both loan officers said the bank had given bonuses to loan officers who referred borrowers who should have qualified for a prime loan to the subprime division. Ms. Jacobson said that she made $700,000 one year and that the company flew her and other subprime officers to resorts across the country. “I used to joke that ‘I’ll pay for your kids to go to private school if you give me clients,’ ” Ms. Jacobson said in the interview.
Loan officers employed other methods to steer clients into subprime loans, according to the affidavits. Some officers told the underwriting department that their clients, even those with good credit scores, had not wanted to provide income documentation. “By doing this, the loan flipped from prime to subprime,” Ms. Jacobson said. “But there was no need for that; many of these clients had W2 forms.” Other times, she said, loan officers cut and pasted credit reports from one applicant onto the application of another customer. These practices took a great toll on customers. For a homeowner taking out a $165,000 mortgage, a difference of three percentage points in the loan rate — a typical spread between conventional and subprime loans — adds more than $100,000 in interest payments.
The accusations contained in the affidavits, which were given to Relman & Dane, a civil rights law firm working with the City of Baltimore, have not drawn a specific response from Wells Fargo. But city officials say the conclusion is clear. “They confirm our worst fears: that this is not just a case based on a review of numbers and a statistical analysis,” said the city solicitor, George Nilson. “You don’t have to scratch your head and wonder if maybe this was just an accident. The behavior is pretty explicit.” Both sides expect to appear in court at a hearing in the case in late June.
Bank-run dark pools swelling in U.S. stock markets
Big banks are executing an increasing percentage of U.S. stock trades within their own walls, capitalizing on the credit crisis and enticing the most active traders away from the traditional exchanges. "Dark pools," where orders are anonymously matched so that traders do not alert the wider market to their intentions, have triggered concerns that stock pricing may not be transparent. But the growth of those run by broker-dealers such as Goldman Sachs and Credit Suisse are squeezing other "dark" electronic trading venues, as well as exchanges, resulting in lower fees.
The bank-run dark pools have only recently gained some traction in Europe, while other countries, such as Canada, are watching closely for signs of success or failure as U.S. equity markets fragment into some 40 venues. Although executives and market watchers expect to see new U.S. rules to ensure public and accurate pricing of stocks, they also expect the private pools to grow beyond the relatively small niche they now occupy. "The dark pools are definitely going to grow; the wild card is any new regulation," said Dmitri Galinov, director and head of liquidity strategy at Credit Suisse's advanced execution services, running the bank's CrossFinder dark pool.
Banks' internal dark pools have benefited from Regulation NMS, rules enacted in the last few years to help investors get the best price, and from the pricing of stocks in smaller increments, known as decimalization. Dark pools owned by brokers and large market makers accounted for 70 percent of all dark U.S. equity volume in April, up from 64 percent in December and from 58 percent a year earlier, according to Rosenblatt Securities, a widely referenced agency broker that tracks 18 dark pools. Overall, dark market share rose last year, but in the last eight months hit a ceiling near 9 percent of the U.S. market.
Dark pools, which usually publish trades to the consolidated tape with little detail well after they are executed, have been around for decades, but their brands have gained more exposure in the last few years. Goldman's Sigma X was the largest in April, followed by market maker GETCO's Execution Services, and Credit Suisse's CrossFinder -- the winners benefiting from the collapse of other investment banks such as Lehman Brothers.
Justin Schack, vice president of market structure analysis at Rosenblatt, said broker-run dark pools had grown because they're faster, cheaper and open to algorithms -- the computerized trading programs that dominate the market, especially during volatile periods such as last year's crash. "Market structure has changed over the last five or six years in ways that favor small size, rapid-fire trading," Schack said. The most successful bank-run dark pools have steady participation from individuals, or retailers, whose standing trade orders are gobbled up by high-frequency players who use algorithms and account for about 65 percent of the market.
The U.S. market share of larger exchange operators NYSE Euronext and Nasdaq OMX, which run the New York Stock Exchange and Nasdaq Stock Market, respectively, has dropped in the last year as BATS Exchange, Direct Edge, and the dark pools gained ground. While the competition has driven down trading fees, an internal pool also reduces the parent bank's exchange costs by integrating orders from customers and in-house trading desks. "Brokers are doing a better job of harnessing all our order flow before it goes to the public exchanges," said Rishi Nangalia, managing director and global head of business development of Goldman's electronic trading.
But regulators, exchanges and others have raised concerns that dark pools do not publicize their quotes, that there is a general lack of comprehensive data on them, and that some provide early messages, or "looks," to specific market players about upcoming orders. "I am concerned that (undisplayed quotes) may not promote public confidence in the equity markets," James Brigagliano, co-acting director of the U.S. Securities and Exchange Commission's trading and markets division, told a major market structure conference in New York last month.
Most executives at bank-run dark pools told Reuters they would welcome new U.S. oversight, but noted that competing trading venues help lower trading costs. Others see the growth in these dark pools as an experiment in progress. "There would be instant vilification from the rest of the public" if a Canadian bank launched an internal dark pool, Doug Clark, managing director of quantitative execution services at Bank of Montreal's capital markets division, told Reuters on the sidelines of a trading conference here. "So I don't think they're going to do it."
Last week, NYSE Euronext urged the SEC to examine the impact of the early looks at some U.S. venues. But without new regulation, bank-sponsored dark pools will continue to swell, said Rosenblatt's Schack. "Most brokers want to execute trades as quickly and cheaply as possible," he said. "I don't know that we've reached the limit because there are some firms with big equity businesses out there that still haven't maximized the potential to internalize orders in their dark pools."
Place Your Wagers
by Brian Pretti
To the point, I want to take a very quick look in this discussion at the complexion and rhythm of US household wages and salaries, and broader personal income circumstances of the moment. The important issue to forward investment actions and thinking being, in a world where corporations have taken a literal machete to employment costs all in the interest of preserving nominal profits and profit margins, are they essentially destroying the very source from which future aggregate demand will be driven within the context of a macro household balance sheet deleveraging environment that continues for some time to come? Moreover, have we entered a bit of a vicious cycle in terms of labor market pressure feeding into wage pressure, feeding into consumption pressure that further constricts corporate profits, ultimately leading to even further pressure on labor costs? Current circumstances are very much unlike any prior US economic cycle of the last thirty to forty years at least. Let me try to tie together a number of broader themes I have been discussing for a while now.
The concept that deleveraging is a big macro construct of the moment. We see it directly at the household, corporate and financial sector levels. As a counterpoint, it’s the government who is leveraging up to try to maintain price and broader economic stability as an offset. Directly to the point, in an economy very much dependent on consumer spending, absent households releveraging their balance sheets (which is absolutely not occurring, nor will it), the character of wages, salaries and broader personal income growth becomes the key driver of a potential forward consumer spending and broader economic recovery. US economic recoveries in recent decades have shared three identical character traits – pent up demand for houses goosing purchases and ultimately new construction, pent up demand for autos goosing purchases and ultimately new production, and consumer credit balances taking off northward in an environment of renewed optimism. For now, these three character traits are missing from the broader economic equation. The deleveraging process occurring directly before our eyes at the household level tells us that the character of wages, salaries and personal income takes center stage in the potential for a consumer led US economy recovery, or not. Could this very set of facts and the eventual broader realization of these facts be the basis upon which another potential leg down in the economy and markets occurs? For now the financial markets have a head of steam. Momentum and the gravitational pull of the markets upon those underweight their asset allocation mandates is driving the short term. Important to realize just what we are looking at.
Before taking even one step further, in all sincerity, I am not walking through this discussion to incite pessimism. Far from it. We all very much need to respect the power and magnitude of money being thrown at the US economy and financial markets at the current time. If the Fed/Treasury/Administration make good on their current promises of borrowing, printing and guaranteeing (forward liabilities), we’re talking about roughly $13 trillion dollars here. Make no mistake about it, there simply is no precedent at all in the entirety of US experience for this type of stimulus as a percentage of GDP being thrown at the financial sector, credit markets, economy and financial markets. Will it have a positive impact on both the economy and financial markets for a time, both in real terms and perceptually? Without question. Our interests should be to look past stimulus at the then underlying sustainable character of the economy, or otherwise.
In the importance of looking ahead and trying to anticipate and develop a game plan for all potential outcomes, we need to at least address the scenario of a failed consumer response to stimulus. How would that come about and what would it mean to the markets? The financial markets appear to be responding just fine to stimulus, but what about the heart of the US economy that is consumers? Further, it’s important to at least think about potential outcomes with a bit more seriousness right now given that the equity markets have come an incredible way in terms of price appreciation based on the conceptual ideas of “less bad” and “green shoots.” I fully expect macro economic stats to continue to get less bad ahead as the stimulus money increasingly presses into the real economy and financial markets over the summer and fall of this year. But, as is always true in our investment thinking at all points in time, we also need to be on the lookout for what could hurt us. What might change the trajectory of consensus thinking? Secondly, the equity market will soon transition from celebrating conceptual “less bad” toward beginning to actually assess the quality and character of supposed “good.” It’s in this transition period to come where we’ll really need to keep our eyes and minds wide open.
Although both labor market conditions and employment, and salary and benefit trends have been lagging indicators in past economic cycles, it’s the nature of the US credit cycle that is the big “it’s different this time” issue. While the world seems obsessed with focusing on the supply and availability of credit, I strongly suggest it’s the demand side of the equation for credit in aggregate that is the key focal point in a household balance sheet deleveraging environment. So if indeed deleveraging at the household level has just gotten started and is in no way even close to a conclusion, then that leaves the character of wages and salaries as a key forward driver for aggregate demand (and clearly by definition retail sales). Has the green shoots crowd thought this one through? Could this set of dynamics, or the perceptual realization of these dynamics be potential catalysts for further pressure on the real economy and financial markets ahead? Again, stimulus will have its day and produce some type of results. But in terms of the non-stimulus character of the real economy, the wage and salary issue is simply critical as we try to anticipate forward demand. In an environment of deleveraging and deflation, employment trends and monthly labor numbers become leading indicators as opposed to lagging. The more folks that lose jobs, the lesser the potential for forward consumption when the need of households to pay down debt still exists. Less forward consumption means lower corporate profits, which means more forward pressure on wages and employment counts. And that cycles right back into further subdued consumption. We'll explain more below and look at supporting data. Our current circumstances are so unlike any period in recent US history that economic signposts and markers of the last three to four decades may be quite misleading in the current cycle. Although it may sound crazy, part of our thinking must at least allow for some possibility that everything we've learned about past economic cycles of the last half century will be wrong in this.
And to try to intelligently guess at what may be to come in terms of financial market perceptual turning points ahead, let’s have a quick multi-decade look at the history of the US employment cost index. Please remember that the Employment Cost Index (ECI) that comes to us courtesy of our wonderful friends at the Bureau of Labor Stats (yes, the same folks responsible for the payroll numbers) is made up of two key components – wages and benefits. As you can see below, the current (as of 1Q) year over year change in the ECI is the lowest number in the history of the data. Again, we should not be expecting fireworks, especially in the midst of a deep recession. But in the absence of household credit acceleration, what you see below is the key to future reacceleration of aggregate demand, or otherwise as the case may be.
Very quickly, the history of the two components of the ECI (wages and benefits) is seen below. The year over year change in wages has never been this low in the records of the data. And in terms of growth in benefit costs, we’re pushing historical lows as we speak. What does all of this mean? It tells us labor is under serious total compensation pressure. And since benefit costs to employers are falling rapidly, this tells us one of two things is correct. Either employees are simply losing employer sponsored benefits they will need to make up on their own out of wages or total household resources, or their personal participatory costs in employer sponsored benefits are climbing rapidly (think co-pays, etc.). Either way, labor is under serious wage and benefit pressure, really unlike anything seen over the prior three decades at least.
One last corroborative chart. This is the history of the year over year change in US wages and salaries from the personal income numbers. Drawn in the chart with red bars are all of the recessions since 1960 to show you that the year over year change in wages and salaries has actually been quite the tell tale sign of official recession conclusions over this time. Will it be so again? One more time, never over the history of the data have we seen this type of pressure on wages.
IF you believe that the credit cycle for households is clearly in the reconciliatory repair shop at the moment and not about to reemerge any time soon, then by default wages and salaries become the key to potential forward recovery in macro US economic final demand. Employers have acted swiftly and strongly to attempt to maintain profits and profit margins by attacking labor costs. But it’s these very labor costs that will theoretically allow their and other employees to buy their production. The ultimate Catch-22 in a post credit cycle bubble environment? If there is to be any next leg down for the financial markets, it’s this realization that may be the driver of the perceptual shift, or disappointment in the rate of level of economic liftoff. But certainly as per the character of the financial markets recently, this perceptual shift is not yet upon us. Again, all in the spirit of simply trying to anticipate forward outcomes over the remainder of this year and into early next amidst the celebratory environment of the moment.
Let’s quickly walk through the remaining components of “household financial wherewithal” outside of wages and salaries to get a broader sense of the current circumstances surrounding the character of personal income. As a quick punch line, we believe it’s the Fed and Treasury that are in good part acting to hold up the US credit markets in the current environment. In part although it’s really always this way in meaningful recessions, the Government is also the key support mechanism in upholding personal income as of now. Quite the dual roles – holding up the US credit markets and the character of personal income as it now presents itself. And at least as of yet, Atlas has not shrugged. We’ll roll through these components in rapid-fire fashion to give you a sense of what is going on.
Since we looked at wages and salaries above, no need for extended commentary. Point being, on a year over year rate of change basis, wage and salary growth is negative as of recent monthly data. This has not been seen over the history of the data. Wage and salary growth is not contributing positively to personal income, at least not now.
Next up in the personal income roster of possibilities is proprietor’s income. Simply, non-wage categorized income of folks who own businesses. A good read on the smaller business community? Indeed. As of now we’re at a rate of change contraction low not seen since the early 1980’s recessions. Not a positive contributor to personal income flexibility for now.
Above we looked briefly at employer benefit costs in the employment compensation data numbers. Employers have been cutting back on benefits. Not a wild new revelation by any means and pretty darn easy to do in the current labor market. Within the personal income data, employer “supplements” to wages and salaries also in part measure the issue of benefits, but there are some differences. Included in the supplements data are things like pension contributions. To be honest, employers contribute to pensions only when they HAVE to. As you look at the chart below, the moves up in the rate of change numbers have coincidentally come after declines in general equity market values. In other words, employers needed to reseed underfunded pension obligations. Anyway, in broad terms the year over year change in employer supplements isn’t exactly doing a Herculean job of adding to personal income character at the moment. Plus, as is intuitively clear, "supplements" to wages are not cash in the pockets of households. So regardless of positive or negative rate of change levels, these numbers really never find their way into immediate spendable cash flow.
Quite noticeably the next PI component has reached a record low in terms of now being a rate of change drag on household personal income circumstances of the moment. Below we’re looking at income from assets, virtually 100% driven by household interest, dividend and rental income streams. As described, a record rate of change contraction for the entire history of the data is what characterizes the present.
So in a bit of quick summation, at the current time we have the year over year change in wages and salaries, proprietors income and income from assets all in negative rate of change territory. They are ALL contracting year over year. For now, employer supplements are registering a 2.5% year over year gain, but again this is not current cash in employee pockets (and can even represent higher unemployment insurance payments, which would not surprise us at all as being a current driver of theoretical strength). So just what the heck is a positive when it comes to personal income as these key fundamental components of personal income are all heading south coincidentally?
Positives? Look no further than the final two components that join in the mix of characterizing the totality of bottom line personal income – government social transfer payments and personal taxes. And guess who has the most influence over both of these? You bet, the Government. You can see the longer-term history of the year over year change in government social benefit payments in the chart below. We’re now as high as anything seen since the early 1990’s, excluding the one-shot tax rebates under the Bush stimulus plan a while back.
Remember, it isn’t that this is something bad. Increased social benefits need to occur during recessions, as has exactly been the history of the US for five decades now. We just need to make sure that we are aware of just what personal income character consists of in order to hopefully look ahead and make intelligent judgments regarding the true drivers of the real economy, equity sectors and corporate earnings.
Of course rounding out the field is the character of personal taxes right about now. First, it should be no surprise at all that they are down given the initial effects of the Obama stimulus plan in terms of immediate tax relief at the household level. Secondly, the decline in corporate taxes with the drop in earnings is a given, but that’s not shown below. As you can see in the chart that follows, the year over year decline in personal only income taxes is pushing toward the lows seen over the entire history of this data.
The prior cycle drop in the rate of change in personal taxes during the 2001 downturn was all about the vanishing act put on by capital gains taxation in the wake of the tech/dotcom stock implosion. At the moment, the current impact of the loss of capital gains revenues is minor compared to the loss of non-cap gain related personal income taxes. The current cycle is all about folks losing their jobs, seeing a reduction in interest and dividend income, and the softening in rents due to the home foreclosure issue forcing rental inventories to near historic highs. This is real people losing fundamentally real income that is translating into the big year over year drop in personal taxes. But to the bottom line of the equation that is pretax income less taxes, this is an academic benefit to net after-tax personal income.
By now you get the picture, so I will not belabor the point. As I stated last month in the “Of Fingers And Dikes” discussion, I believe the Fed/Treasury/Administration has had a huge hand in supporting and anesthetizing the US credit markets (inclusive of LIBOR). Without governmental/Fed/Treasury support, there is no way the headline credit market data would be showing us as much perceptual healing as has been the case up to this point. Of course the key question remains, just when can these folks take their collective fingers out of the multiple holes in the US credit market dike? For that, we have no answer. In like manner, at least as per the data above, it sure appears as if the US government is now a major infrastructural support to the character of personal income circumstances of the moment. Again, this is not wrong and this is not bad. This pattern repetition is seen in EVERY recession of the last five decades at least. It’s just that never have we had the annual rate of change in wages and salaries, proprietor’s income, and income from other assets all in negative rate of change territory on a simultaneous basis over the prior five decades. That highlights and reinforces the role of the US government in holding up the current character of personal income.
So as we step back and contemplate the relationship of labor market conditions, consumer confidence, retail sales trends historically and what the equity market is discounting in price in terms of an economic recovery to come, we need to ask ourselves once again, just who (or whom) will fund higher household consumption ahead at the margin absent renewed household balance sheet releveraging? Will it be government transfer payments and lower taxes? Moreover, households have shown us they have begun to increase their savings rates. How can we have much higher consumption ahead accompanied by higher savings rates when the key core components of personal income are all in year over year contraction mode? As I have said in so many discussions recently, I keep coming back to the key forward focal point that is the consumer.
The financial markets are trying their best to discount a typical consumer and/or corporate demand led economic recovery of the type seen over the past half century. Yet when looking at things like the credit markets, personal income circumstances and the complexion of household balance sheets crying out for deleveraging, current conditions are quite different than any recession of the prior half-century, with the government acting as Atlas holding up the world of "demand," per se, for now. Just what type of a valuation multiple do we put on a financial market under these character circumstances? This is a very important question the financial markets will be facing head on during the second half of this year and early next. For now, the key recovery fingerprints of every single economic recovery of the last half century are missing from the current puzzle (housing demand, auto demand and reacceleration in consumer credit growth). Standing in for these classic drivers is the US government. For how long will this be the case and what should investors be paying for this stand in role? Yes, the old market saw is hokey, but I can’t get this one out of my mind. First price, then optimism…then earnings. There can be no break in the chain in cyclical bull market character, and the first two have already gone a long way in terms of playing out. Absent household balance sheet reacceleration in leverage it sure seems a good bet forward corporate earnings are now as dependent on household wages, salaries and broader personal income as at any time in recent memory. And corporations to protect margins and nominal profits are pressuring wages and salaries downward. Time to place your wagers as we look ahead?
Poking Holes in a Theory on Markets
For some months now, Jeremy Grantham, a respected market strategist with GMO, an institutional asset management company, has been railing about — of all things — the efficient market hypothesis. You know what the efficient market hypothesis is, don’t you? It’s a theory that grew out of the University of Chicago’s finance department, and long held sway in academic circles, that the stock market can’t be beaten on any consistent basis because all available information is already built into stock prices. The stock market, in other words, is rational.
In the last decade, the efficient market hypothesis, which had been near dogma since the early 1970s, has taken some serious body blows. First came the rise of the behavioral economists, like Richard H. Thaler at the University of Chicago and Robert J. Shiller at Yale, who convincingly showed that mass psychology, herd behavior and the like can have an enormous effect on stock prices — meaning that perhaps the market isn’t quite so efficient after all. Then came a bit more tangible proof: the dot-com bubble, quickly followed by the housing bubble. Quod erat demonstrandum.
These days, you would be hard-pressed to find anybody, even on the University of Chicago campus, who would claim that the market is perfectly efficient. Yet Mr. Grantham, who was a critic of the efficient market hypothesis long before such criticism was in vogue, has hardly been mollified by its decline. In his view, it did a lot of damage in its heyday — damage that we’re still dealing with. How much damage? In Mr. Grantham’s view, the efficient market hypothesis is more or less directly responsible for the financial crisis.
“In their desire for mathematical order and elegant models,” he wrote in his firm’s quarterly letter to clients earlier this year, “the economic establishment played down the role of bad behavior” — not to mention “flat-out bursts of irrationality.” He continued: “The incredibly inaccurate efficient market theory was believed in totality by many of our financial leaders, and believed in part by almost all. It left our economic and government establishment sitting by confidently, even as a lethally dangerous combination of asset bubbles, lax controls, pernicious incentives and wickedly complicated instruments led to our current plight.
‘Surely, none of this could be happening in a rational, efficient world,’ they seemed to be thinking. And the absolutely worst part of this belief set was that it led to a chronic underestimation of the dangers of asset bubbles breaking.” (Mr. Grantham concluded: “Well, it’s nice to get that off my chest again!”) I couldn’t help thinking about Mr. Grantham’s screed as I was reading Justin Fox’s new book, “The Myth of The Rational Market,” an engaging history of what might be called the rise and fall of the efficient market hypothesis.
Mr. Fox is a business columnist for Time magazine (and a former colleague of mine) who has long been interested in academic finance. His thesis, essentially, is that the efficient marketeers were originally on to a good idea. But sealed off in their academic cocoons — and writing papers in their mathematical jargon — they developed an internal logic quite divorced from market realities. It took a new group of young economists, the behavioralists, to nudge the profession back toward reality.
Mr. Fox argues, echoing Mr. Grantham, that the efficient market hypothesis played an outsize role in shaping how the country thought and acted in the last 30-plus years. But Mr. Fox parts company with him by also arguing that the effect wasn’t necessarily all bad. As for the question of whether an academic theory hatched in Chicago led to the financial crisis, suffice it to say that some questions can never be answered definitively. Which isn’t to say they shouldn’t be asked.
“There are no easy ways to beat the market,” Mr. Fox said when I spoke to him a few days ago. If you want to point to the single best thing the efficient market hypothesis taught us, that is the lesson: we can’t beat the market. Indeed, the vast majority of professional money managers can’t beat the market either, at least not on a regular basis.
As Mr. Fox describes it, much of the early academic work that led to the efficient market theory was aimed at simply showing that most predictive stock charts were glorified voodoo — just because a pattern had developed didn’t mean it would continue, or even that it had any real meaning. Dissertations were written showing how 20 randomly chosen stocks outperformed actively managed mutual funds. (Hence the phrase “random walk,” to connote the near impossibility of beating the market regularly.) Mr. Thaler, the Chicago behavioralist, says that evidence on this point — “the no free lunch principle,” he calls it — is clear and convincing.
In time, this insight led to the rise of passive index funds that simply matched the market instead of trying to beat it. Unless you’re Warren Buffett, an index fund is where you should put your money. Even people who don’t follow that advice know they should. As it turns out, Mr. Grantham was an early advocate of index funds, mainly for unsophisticated investors who have no hope of beating the market. But he also believes that professionals should do better precisely because, as he puts it, “the market is full of major league inefficiencies.”
“There are incredible aberrations,” he told me over lunch not long ago. “The U.S. housing market in 2007. Japan in the 1980s. Nasdaq. In 2000, growth stocks were three times their fair value. We were quoted in The Economist in 2000 saying that the Nasdaq would drop by 75 percent. In an efficient world, you wouldn’t have that in a lifetime. If the market were truly efficient, it would mean that growth stocks had become permanently more valuable.”
As Mr. Grantham sees it, if professional investors had been willing to acknowledge these aberrations — and trade on the fact that the market was out of whack — they should have been able to beat the market. But thanks to the efficient market hypothesis, no one was willing to call a bubble a bubble — because, after all, stock prices were rational.
“It helped mold the ‘this time it’s different’ mentality,” he said. Indeed, professional money managers who tried to buck the tide wound up losing their jobs — because everybody else was making money by riding the bubble for all it was worth. Meanwhile, government officials, starting with Alan Greenspan, were unwilling to burst the bubble precisely because they were unwilling to even judge that it was a bubble. “Our default reflex is that the world knows what it is doing, and that is extravagant nonsense,” Mr. Grantham said.
But as much as I’ve admired Mr. Grantham’s writings over the years, I think the truth, in this case, is a little more subtle. Given the long history of bubbles, I suspect this crisis would have taken place with or without the aid of the efficient market hypothesis. People thought “it’s different this time” in the 1920s, long before anyone was writing about efficient markets. And over the course of history, professional money managers have been just as fearful of bucking the trend as they were during the Internet bubble.
Mr. Fox sees it somewhat differently. On the one hand, he says, the efficient market theoreticians always assumed that smart market participants would force stock prices to become rational. How? By doing exactly what they don’t do in real life: take the other side of trades if prices get out of whack. Their ivory tower view reflected an idealized market that simply doesn’t exist.
On the other hand, Mr. Fox says, what was truly pernicious about the efficient market hypothesis is the way it allowed us to put asset prices on a pedestal that they never deserved. Stock options — supposedly based on a rational price — became prevalent in part because higher stock prices were supposed to be the rational reward for good performance.
Or take the modern emphasis on market capitalization. “At some point in the early 1990s (or maybe it was in the late 1980s), market capitalization became accepted as the best measure of a company’s importance,” Mr. Fox wrote me in an e-mail message. “Before then it was usually profits or revenue. I think that’s a classic example of the way efficient market theory seeped into popular discourse and shaped how we perceived the world. It wasn’t entirely stupid — profits and revenue are flawed, limited measures, and market value does tell you something useful about a company. But it was another one of the ways in which asset prices came to rule the world, which eventually turned out to be a bad thing.”
A few days ago, I called Burton G. Malkiel, the Princeton economist, to ask him what he thought of Mr. Grantham’s theories. Mr. Malkiel is the author of “A Random Walk Down Wall Street,” surely one of the greatest popularizers of any academic theory that’s ever been written. “It’s ridiculous” to blame the financial crisis on the efficient market hypothesis, Mr. Malkiel said. “If you are leveraged 33-1, and you’re holding long-term securities and using short-term indebtedness, and then there’s a run on the bank — which is what happened to Bear Stearns — how can you blame that on efficient market theory?”
But then we started talking about bubbles. “I do think bubbles exist,” he said. “The problem with bubbles is that you cannot recognize them in advance. We now know that stock prices were crazy in March of 2000. We know that condo prices were nuts.” I thought to myself: if a smart guy like Burton Malkiel had to wait for the Internet bubble to end to realize we had been in one, then maybe Mr. Grantham has a point after all.
Free Botox Offered For Unemployed
Colleen Delsack is a 47-year-old single mother who can't seem to find a steady job, and she worries that her age may have something to do with it. So she joined dozens of other unemployed workers Friday to take advantage of free Botox wrinkle injections offered by a Virginia clinic. "Age is a handicap," said Delsack, whose home has gone into foreclosure in the 18 months since she lost her job as an account executive with a printing and document-management company.
"There's so much competition," she said while waiting to receive about a half-dozen small injections to ease fine lines around her eyes and on her forehead. "And we're up against kids coming out of college and not making the salaries that we've had." In an increasingly youth-obsessed culture, Delsack isn't the only one feeling apprehensive about her age in the workplace. The Equal Employment Opportunity Commission says it received 24,582 complaints of age discrimination in the 12-month period ending in September. That's a 29 percent increase from the previous year. "We can't say for sure why everything is up across the board, but we have a few guesses, one being economic conditions," commission spokeswoman Christine Saah Nazer said. She noted that complaints generally intensify when the job market deteriorates.
The number of Americans looking for work continues to climb. The Labor Department announced Friday that employers cut 345,000 jobs in May. That was less than economists projected, but the unemployment rate surged to a higher-than-expected 9.4 percent from 8.9 percent in April. The growing ranks of the unemployed include Benita Jenkins of Washington, who was among the first in line Friday at the Reveal clinic near the Pentagon to accept the unusual offer of free Botox injections. Jenkins, who would not reveal her age but appeared to be in her mid- to late 40s, said she was laid off in February from a small nonprofit company where she led a $12 million capital campaign. She has received Botox injections before but had to stop pampering herself when money began running out.
She hopes improving her appearance will help, at least psychologically, in future job interviews. "This is the longest I've ever gone in my life without work," Jenkins said. She's been on about a half-dozen interviews in recent months. And while she's seen nothing overt, Jenkins sometimes feels her age and salary requirements have counted against her. Still, it's a tough thing to prove -- so she decided to get a little touchup just to be safe. "You're more likely to be perceived in a better light if you look good," she said.
Botox, which paralyzes facial muscles to make lines fade, is the No. 1 minimally invasive cosmetic procedure in the U.S., according to the American Society of Plastic Surgeons. More than 5 million treatments were done last year. Shannon Ginnan, a doctor at the clinic, said his patients are primarily women, but include people of various ages, races and socio-economic backgrounds. He said it's important for anyone seeking a Botox treatment to have realistic expectations. Deep skin wrinkles, for instance, will not disappear completely. Some people also experience slight bruising after receiving injections. The cost of a single treatment can vary from $300 to $500, according to Reveal. Results typically last four to six months.
Job recruiter Laura Baker said doing well on a job interview, regardless of age, is all about exuding confidence. "It's important when you're feeling down to treat yourself, to get a pick-me-up," said Baker, who works with the headhunting company Friends & Company. "Whether it's Botox or something else, it's that fresh approach you need." Mari Negron, 49, of Arlington, has also struggled to find work. She can't be sure whether age is a factor, but she is certain about one thing: All the worry of trying to find a job is taking its toll, and a little Botox can't hurt. "I think I'm stressed out," she said. "I don't know what to do really."
The Charm Offensive
This week, Team Obama took their dog and pony show on the road. Treasury Secretary Geithner went to China, Fed Chairman Bernanke to Capitol Hill, and the President himself began a Mideast tour in Saudi Arabia. This full-court press is not coincidental, and comes just as the federal government has begun unloading trillions of dollars in new Treasury obligations. The coordinated charm offensive is meant to assure the world-at-large that the United States can repay these obligations without destroying the dollar.
Given the renewed weakness in the dollar and the recent expressions of concern from China, our largest creditor, about the safety of its current holdings, this is no easy sell. Not only must our leaders convince holders of our debt not to sell what they already own, but to back up the truck and buy a whole lot more. The hope is that a dream team consisting of a charismatic politician, a skilled Wall Street banker with longstanding ties to China, and a respected Fed Chairman, can close the deal. However, no matter how slick the sales pitch, no amount of lipstick can dress up this pig.
The most obvious fear the trio must address is that oversized deficits will persist indefinitely. Reading from a carefully scripted rebuttal book, all three proclaim that as soon as the stimulus revives our economy, the government will take all necessary steps to reign in the deficits that result. Bernanke’s testimony showcases this rhetorical shift. The Fed Chairman claimed that catastrophe has been averted and that the recession is nearly over. As a result, he advised Congress to now focus on debt management. How he expects them to do that was left unexamined.
Setting aside the fact that the recession is far from over and that the stimulus will actually weaken the economy in the long run, Bernanke’s words were less a practical guide to Congress than a bromide for our foreign creditors. Meanwhile, Obama carefully peppers his speeches with calls for Americans to live within their means, to save more and spend less, to produce more and consume less. But nothing in the government’s current fiscal or monetary policy will encourage such behavior. In fact, the objective of economic stimulus is to prevent such changes from taking place!
The laughter of Chinese students that greeted Secretary Geithner at Peking University shows how ridiculous this spiel sounds overseas. Actions speak louder than words, and the actions of the current Administration are deafening. Multi-trillion dollar deficits, bailouts, nationalizations, quantitative easing, and grandiose plans for government-provided healthcare, education, and alternative energy, render all their claims of future prudence meaningless. If our leaders will not make tough choices now, why should anyone believe they will do so later when those choices will be even harder to make?
Of course, it’s not just major holders, like China and Saudi Arabia, that need to be convinced. Since the largest holders are already in so deep, they have the greatest short-term incentive to play ball. While throwing good money after bad is certainly a lousy investment strategy, it is politically expedient as it delays the need to officially acknowledge losses. The spin is designed to keep all the smaller, more nimble holders from dumping their Treasuries. The major holders can publicly pledge their commitment to Treasuries, while they privately planning their exit strategies, as long as they feel that the smaller holders won’t spook the market by front-running their trades.
However, once the psychology turns, there is no way to stop the rush for the exits. Remember how quickly the secondary market for subprime mortgages collapsed? One day, investors were lining up to buy; the next day, the stuff couldn’t be given away. Make no mistake about it, we are issuing subprime paper and no amount of political spin can alter that reality. Bogus credit ratings aside, I think the world already knows this and it’s just a matter of time before someone admits it.
In the meantime, by continuing to lend, our creditors merely supply us the shovels to dig ourselves into an even deeper economic hole. Their credit enables our government to grow when it needs to shrink, finances bailouts of companies that should be allowed to fail, and enables a nation that should be saving and producing to continue borrowing and spending. As a result, the more money the world loans us, the less capable we are of paying it back. I really wish the world would stop doing us favors, as neither party can afford the consequences.
For an timely example, just look at California. With an unmanageable $20 billion deficit, California recently asked Washington for a bailout. With none immediately forthcoming, California was forced to make real and needed budget cuts. The hard choices, which will benefit California in the long run, would not have been made if federal funds had been committed. We all should be so lucky.
Beyond oil: a Switzerland in the sands
It's reality TV, but not as we know it. While we have been gripped by the rise and fall of Susan Boyle on Britain's Got Talent, viewers in Qatar are tuning in to Stars of Science, a new reality show beamed across the Arab world, where brainy youngsters compete to produce the best invention. Among the hopefuls is Hashem al-Sada, a 22-year-old Qatari who is not a star on YouTube, but has devised a tent fitted with solar panels for electricity generation. The show has deliberately eschewed the cruelty of booting out losing candidates: instead, they are invited to team up with successful competitors.
Stars of Science encapsulates the huge faith Qatar puts in research and innovation; the contrast between it and our version of reality TV also says something about the arrogance of assuming western cultural values are automatically superior, though that's another story. It is not just the TV that is different in Doha. Flying from a downbeat London into the vast, pristine international air terminal is like arriving in another world. The commercial property market in the UK is on its knees, but in the West Bay business district gleaming towers are springing up in the blistering 50C heat. They bear witness to the determination to reduce Qatar's dependence on oil and gas by building a sort of Canary Wharf in the desert - only without the excessive bonuses and the ruinous risk-taking.
While Gordon Brown's grip on government has been weakened by the crunch and the MPs' expenses scandal, the Emir of Qatar, Sheikh Hamad Bin Khalifa al-Thani, does not have to deal with the inconvenience of an electorate and has been able to press quietly ahead with plans to diversify the economy. Dr Tidu Maini is executive chairman of the Qatar Science and Technology Park, set up to commercialise research in energy, the environment, healthcare and IT; he recently established an experimental facility with Qatari company GreenGulf to study solar-to-electricity conversion methods. "Instead of putting our money into a solar company in the UK or Germany, we are investing in our own country," he says. "There is nobody doing what we are doing in a comprehensive and strategic way."
With a dry smile, he adds: "But it's easy for us because we are a small country and don't have a corrupt parliament." As Britain remains in recession, Qatar's per capita income has crossed the $70,000 (£43,000) a head mark, making it one of the wealthiest nations in the world. The Qatar Central Bank estimates growth of 7-9% for this year; the IMF predicts growth of 15-18%. Whatever: these are figures Alistair Darling would give his second home for. Dubai, which has little in the way of oil and gas, may have gone through a highly leveraged boom and bust (see below), but Qatar is in a very different position.
It is currently running a small budget deficit - the first for nearly a decade - because oil prices have been low, although if they show a sustained improvement, that will be eradicated by the end of the fiscal year.
But it has a good credit rating, and, most important, it has about 90 years' worth of oil reserves and more than 200 years of gas production. Not that there is any schadenfreude at Dubai's downfall; the feeling is that the whole region will have to support Dubai for the sake of collective credibility. Neither have the Qataris got too overwrought about the recent rise in the oil price to a six-month high above $67 a barrel, which has led some commentators to speculate about a resurgence of the petro-powers. Opec, the oil producers' cartel, wants to see the price stabilise at around $75 a barrel, which it reckons is the level needed to ensure investment in new supplies. Whether or not that pans out, the Qataris are interested in moving beyond petro-power and rebasing their economy so they are not hostage to a volatile oil price.
Ahmad Anani, a partner in the Al-Tamimi law firm in Doha, says: "I don't think Qatar perceives itself as a petro-power in the conventional sense ... There is no interest in flexing their muscles like Vladimir Putin, or in blowing money in Mayfair casinos. They are using the money to develop the country." Qatar has been cushioned from the global downturn by its position as the world's leading exporter of liquefied natural gas (LNG) - gas that has been turned into liquid form, making it easier to ship around the world. The UK is a big customer: the Queen and the Emir opened a new LNG terminal in Milford Haven last month. But despite the fact that LNG is a superb resource, the Qataris see no reason to rest on their laurels.
Phillip Thorpe, chairman and chief executive of the Qatar Financial Centre (QFC) Regulatory Authority, says: "Whether oil is at a sustainable level is anyone's guess. The real point is that there has been a maturity around the way the government is approaching oil and gas revenue. It is a wonderful bounty today, but what about tomorrow? There are decades of gas reserves and you would think it's a good reason to go to the beach - but that is not future-proofing the economy." Thorpe is a key player in one form of future-proofing: the push to turn Doha into a regional financial centre - a Switzerland in the sand, with insurance and wealth management as major elements.
The QFC's headquarters, where Thorpe has his offices, are in a building that is only a few years old - though that makes it practically an ancient monument by the standards of West Bay. It started in 2005; now it has 113 staff and licensed its 100th institution at the end of last year, a Qatari full-service Islamic bank. Next month it will launch Qatar Insurance Services, a system for processing and trading between insurers and reinsurers, with 17 firms as strategic partners.
Another major initiative is the setting up of the Qatar Finance and Business Academy, to try to ensure there are enough well-trained local staff to run a 21st-century financial centre. Jon Morton, QFC's director for financial development and a former deputy principal of Henley Management College, says: "We need to concentrate on middle-management talent - things like the English language, and a focus on the customer, not an internal focus."
The structure and the skills of the population are a serious challenge. Of the 1.5 million residents, only around 250,000 or so are native Qataris; the rest are expats. It means very few people will be supporting what could be a very large and turbocharged economic engine. Mohamad Moabi, assistant general manager with Qatar National Bank, says: "The challenge is to develop citizens for a post-oil economy. A knowledge-based economy is very important."
To that end, education is free from kindergarten to university level. The seriousness of the commitment to learning is manifest in Education City, a 14 sq km development on the outskirts of Doha that houses not only schools but outposts of leading US universities such as Cornell, Georgetown and Carnegie Mellon. As one British expat sighs: "If my kids were Qatari citizens, all my worries about education would be over."
Dr Mohamed Fathy Saoud, president of the Qatar Foundation, which backs Education City, says: "Human resources are more important than oil and gas resources. We are bringing one of the brightest facets of western civilisation to the region: the top universities. If you talk to people on the street they will be opposed to what the US and the UK did in Iraq, but this project is saying 'look beyond that to what these countries have contributed to education and research'." The sheer pace of economic development is throwing up social and cultural issues. One is the situation of women. The Emir's consort, Sheikha Mozah, plays a highly visible role in a region where royal wives until recently were rarely seen and certainly never heard.
While it is a deeply conservative society, Qatari women can vote, drive and play a full part in the workplace: headscarves are a frequent sight, but the dress code for women is not as strict as in Saudi. Dr Sheikha Abdulla al-Misnad, president of Qatar University, says about half her staff and 70% of her students are women. "We are very proud of how well our young women are doing, but there is an issue about our young men. Girls work hard and get better grades in high school, while young men drop out." Girls have been high achievers partly because of cultural expectations, she adds.
"Society expects women to work in a safe and professional environment, in a high status job, not to be in low-skill jobs and this is part of the reason why they are they are so determined to succeed academically. It is creating social problems because women are finding their marriage suitors are less qualified. "The number of single women is increasing. It is difficult for lots of young professional women to find a husband. People don't have taboos about women in education because when education started in Qatar it started for both men and women from the outset, unlike many universities in the West which had been were exclusively for men for decades before women were granted access to higher education."
None the less, the divide may be creating social tensions simply because the women are finding many eligible bachelors less qualified than they are. While the Qataris are keen to show visitors their sunlit uplands, one does have a sense of a reserved, multi-layered, complex society where difficult topics are not discussed, particularly with western journalists. Qatar has been keen to establish itself as the focal point of the new Arab media: its flagship broadcaster is Al-Jazeera, founded in 1996 and regulated by the UK's Ofcom in the hope of fending off accusations of bias, and the Doha Centre for Media Freedom was set up last year.
Participants don't pull punches in the Doha Debates, a forum for free speech tackling the region's thorniest issues. In the most recent, the vote was in favour of letting Muslim women marry men of their choice. However, the media has a deferential air and the line is that the press should be free, but "respectful". Thorpe, who was pushed out of his job as head of the Dubai financial regulator after objecting to interference from above, says he is able to operate in Qatar without fear or favour: "The message being sent out by the Emir and the government is that everyone has to abide by the rules." But it's important to remember who makes the rules. The Emir, who deposed his father in a bloodless coup in 1995, may be an enlightened monarch who has moved towards democracy, but there is no doubt who is in charge.
The credit crunch has led to greater questioning of the western economic and social model. As Moabi says: "Excessive risk-taking and innovation in financial products really hurt the financial system ... Who would have thought that GM would be filing for bankruptcy? We don't have MPs abusing expenses, or Madoffs. Our image of western people is not tarnished, but our image of the system is." Like the UK, Qatar is a small nation punching above its weight. Like the UK, it wants to become a knowledge-based economy. Like Tony Blair, it has a leader who believes in education, education, education. Perhaps - unlike the UK, which failed to husband its oil wealth - it will make wise use of its windfall.
Aid for Swedish banks hit by crisis in Latvia
The European Bank for Reconstruction and Development is poised to announce a financial support package for Swedish banks battered by the deepening financial crisis in Latvia. Pressure has been mounting on the Latvian government, led by prime minister Valdis Dombrovskis, to devalue its currency, the lat, since Riga failed to raise funds at a government debt auction last week, despite having already received an emergency bailout from the International Monetary Fund in December.
The London-based EBRD took a 25% stake in Latvian bank Parex in April. As the economy has deteriorated in recent weeks, it has been in urgent talks with Swedbank, SEB and Nordea, which have major operations in the tiny Baltic state. As western governments bail out their banking sectors, the EBRD is concerned about the flow of lending in eastern Europe drying up.
Any deal would be likely to echo a €430m package for Unicredit, announced jointly with the European Investment Bank earlier this year, which was aimed at supporting loans to small businesses and energy efficiency projects. The International Monetary Fund is urging Riga to make more radical budget cuts, before it will disburse a second tranche of financial support. Erik Berglöf, the EBRD's chief economist, said: "As a government, they are trying to do a very difficult thing: to achieve an internal adjustment by cutting government expenditure to a degree that is very painful for the population."
Accounting board could lose power to set rules
Sir David Tweedie, chairman of the International Accounting Standards Board (IASB), is to be grilled on Tuesday by European finance ministers and senior EU commissioners. The development comes as speculation mounts that the IASB will be reformed as a result of the financial crisis. It could even lose its powers to set international accounting standards. A senior source close to the European Commission said: "There's a lot of anxiety in many countries and they wonder if the IASB is the right body for future rule setting. The clock is ticking."
A growing body of opinion is unhappy with the IASB. It approved accounting principles that allowed financial institutions to book profits from unrealised assets. The principle, enshrined in a rule called IAS 39, arguably allowed banks to fuel a speculative frenzy using financial instruments, and exacerbated institutions' deterioration as values plunged. There are also concerns among European power brokers, particularly within France and Germany, that the IASB is an "interconnected old boy's network". A third of its board had worked for KPMG or firms that KPMG later acquired.
A senior City fund manager said: "There's a recognition on the part of fund managers that there needs to be some changes to accounting regulations that were brought in during the good times. And there's a lot of resistance from technical accounting specialists who believe they have the true view of life." A spokesman for the IASB said: "We're planning to provide a response of the IASB to the financial crisis, including an update to replace IAS 39."
Securitization: The Biggest Rip-off Ever
Is it possible to make hundreds of billions of dollars in profits on securities that are backed by nothing more than cyber-entries into a loan book? It's not only possible; it's been done. And now the scoundrels who cashed in on the swindle have lined up outside the Federal Reserve building to trade their garbage paper for billions of dollars of taxpayer-funded loans. Where's the justice? Meanwhile, the credit bust has left the financial system in a shambles and driven the economy into the ground like a tent stake.
The unemployment lines are growing longer and consumers are cutting back on everything from nights-on-the-town to trips to the grocery store. And it's all due to a Ponzi-finance scam that was concocted on Wall Street and spread through the global system like an aggressive strain of Bird Flu. The isn't a normal recession; the financial system was blown up by greedy bankers who used "financial innovation" game the system and inflate the biggest speculative bubble of all time. And they did it all legally, using a little-known process called securitization.
Securitization--which is the conversion of pools of loans into securities that are sold in the secondary market--provides a means for massive debt-leveraging. The banks use off-balance sheet operations to create securities so they can avoid normal reserve requirements and bothersome regulatory oversight. Oddly enough, the quality of the loan makes no difference at all, since the banks make their money on loan originations and other related fees. What matters is quantity, quantity, quantity; an industrial-scale assembly line of fetid loans dumped on unsuspecting investors to fatten the bottom line.
And, boy, can Wall Street grind out the rotten paper when there's no cop on the beat and the Fed is cheering from the bleachers. In an analysis written by economist Gary Gorton for the Federal Reserve Bank of Atlanta’s 2009 Financial Markets Conference titled, "Slapped in the Face by the Invisible Hand; Banking and the Panic of 2007", the author shows that mortgage-related securities ballooned from $492.6 billion in 1996 to $3,071.1 in 2003, while asset backed securities (ABS) jumped from $168.4 billion in 1996 to $1,253.1 in 2006. All told, more than $20 trillion in securitized debt was sold between 1997 to 2007. How much of that debt will turn out to be worthless as foreclosures skyrocket and the banks balance sheets come under greater and greater pressure?
Deregulation opened Pandora's box, unleashing a weird mix of shady off-book operations (SPVs, SIVs) and dodgy, odd-sounding derivatives that were used to amplify leverage and stack debt on tinier and tinier scraps of capital. It's easy to make money, when one has no skin in the game. That's how hedge fund managers and private equity sharpies get rich. Securitization gave the banks the opportunity to take substandard loans from applicants who had no way of paying them back, and magically transform them into Triple A securities.
"Abra-kadabra". The Wall Street public relations throng boasted that securitization "democratized" credit because more people could borrow at better rates since funding came from investors rather than banks. But it was all a hoax. The real objective was to turbo-charge profits by skimming hefty salaries and bonuses on the front end, before people found out they'd been hosed. The former head of the FDIC, William Seidman, figured it all out back in 1993 when he was cleaning up after the S&L fiasco. Here's what he said in his memoirs:“Instruct regulators to look for the newest fad in the industry and examine it with great care. The next mistake will be a new way to make a loan that will not be repaid.” (Bloomberg)
That's it in a nutshell. The banks never expected the loans would be paid back, which is why they issued them to ninjas; applicants with no income, no collateral, no job, and a bad credit history. It made no sense at all, especially to anyone who's ever sat through a nerve-wracking credit check with a sneering banker. Trust me, bankers know how to get their money back, if that's their real intention. In this case, it didn't matter. They just wanted to keep their counterfeiting racket zooming ahead at full-throttle for as long as possible. Meanwhile, Maestro Greenspan waved pom-poms from the sidelines, extolling the virtues of the "new economy" and the permanent high plateau of prosperity that had been achieved through laissez faire capitalism.
Now that the securitization bubble has burst, 40% of the credit which had been coursing into the economy has been cut off triggering a 1930's-type meltdown. Fed chief Bernanke has stepped into the breach and provided a $13 trillion dollar backstop to keep the financial system from collapsing, but the broader economy has continued its historic nosedive. Bernanke is trying to fill the chasm that opened up when securitization ground to a halt and gas started exiting the credit bubble in one mighty whooosh. The deleveraging is ongoing, despite the Fed's many programs to rev up securitization and restore speculative bubblenomics.
Bernanke's latest brainstorm, the Term Asset-backed securities Lending Facility (TALF), provides 94 percent public funding for investors willing to buy loans backed by credit card debt, student loans, auto loans or commercial real estate loans. It's a "no lose" situation for big investors who think that securitized debt will stage a comeback. But that's the problem; no one does. Attractive, non recourse (nearly) risk free loans have failed to entice the big brokerage houses and hedge fund managers. Bernanke has peddled less than $30 billion in a program that's designed to lend up to $1 trillion. It's been a complete bust.
To understand securitization, one must think like a banker. Bankers believe that profits are constrained by reserve requirements. So, what they really want is to expand credit with no reserves; the equivalent of spinning flax into gold. Securitization and derivatives contracts achieve that objective. They create a confusing netherworld of odd-sounding instruments and bizarre processes which obscure the simple fact that they are creating money out of thin air. That's what securitization really is; undercapitalized junk masquerading as precious jewels. Here's how economist Henry CK Liu sums it up in his article "Mark-to-Market vs. Mark-to-Model":"The shadow banking system has deviously evaded the reserve requirements of the traditional regulated banking regime and institutions and has promoted a chain-letter-like inverted pyramid scheme of escalating leverage, based in many cases on nonexistent reserve cushion. This was revealed by the AIG collapse in 2008 caused by its insurance on financial derivatives known as credit default swaps (CDS).....
The Office of the Comptroller of the Currency and the Federal Reserve jointly allowed banks with credit default swaps (CDS) insurance to keep super-senior risk assets on their books without adding capital because the risk was insured. Normally, if the banks held the super-senior risk on their books, they would need to post capital at 8% of the liability. But capital could be reduced to one-fifth the normal amount (20% of 8%, meaning $160 for every $10,000 of risk on the books) if banks could prove to the regulators that the risk of default on the super-senior portion of the deals was truly negligible, and if the securities being issued via a collateral debt obligation (CDO) structure carried a Triple-A credit rating from a “nationally recognized credit rating agency”, such as Standard and Poor’s rating on AIG.
With CDS insurance, banks then could cut the normal $800 million capital for every $10 billion of corporate loans on their books to just $160 million, meaning banks with CDS insurance can loan up to five times more on the same capital. The CDS-insured CDO deals could then bypass international banking rules on capital. (Henry CK Liu, "Mark-to-Market vs. Mark-to-Model" http://www.henryckliu.com/page191.html )
The same rule applies to derivatives (CDS) as securitized instruments; neither is sufficiently capitalized because setting aside reserves impairs one's ability to maximize profits. It's all about the bottom line. The reason credit default swaps are so cheap, compared to conventional insurance, is that there's no way of knowing whether the dealer has the ability to pay claims.
It's fraud, on a gigantic scale, which is why the financial system went into full-blown paralysis when Lehman Bros defaulted. No one knew whether trillions of dollars in counterparty contracts would be paid out or not. There are simply more claims on wealth than there is money in the system. Bogus mortgages and phony counterparty promises mean nothing. "Show me the money". The system is underwater, and it cannot be fixed by more of the Fed's presto liquidity. Here's what Gary Gorton says later in the same article:"A banking panic means that the banking system is insolvent. The banking system cannot honor contractual demands; there are no private agents who can buy the amount of assets necessary to recapitalize the banking system, even if they knew the value of the assets, because of the sheer size of the banking system. When the banking system is insolvent, many markets stop functioning and this leads to very significant effects on the real economy...."
Indeed. The shadow banking system has collapsed, not because the market is "frozen" or because investors are in a state of panic after Lehman, but because derivatives and securitization have been exposed as a fraud propped up on insufficient capital. It's snake oil sold by charlatans. That's why European policymakers are resisting the Fed's requests to create a facility similar to the TALF to start up securitization again. Here's a revealing clip from the Wall Street Journal which explains what's going on behind the scenes:"Bankers are pushing European policy makers to consider a U.S.-style program to aid the region's economy by reviving the moribund market for bundled consumer loans. Officials at the European Securitisation Forum, a trade group representing banks and other market participants, said Tuesday that central bankers should consider stepping in with a program similar to the U.S. Federal Reserve's Term Asset-Backed Securities Loan Facility, or TALF, which provides loans to private investors who buy new securities tied to consumer loans...
After suffering heavy losses on securities stuffed with poorly made loans, investors are reluctant to wade back in, and Europe lacks big players like the Pacific Investment Management Co. in the U.S., whose buying can mobilize other investors....The market also faces uncertainty over how European regulators will change the rules of the game, in part by imposing tougher capital requirements on banks, the main buyers of securitized assets in Europe. One European Commission proposal would dramatically hike the capital required of banks holding a securitized asset if the originator allowed its share of that asset to fall below a 5% threshold....
Paul Sharma of Britain's Financial Services Authority said regulatory action is likely to shrink the investor base for ABS, in part by increasing the capital cushions banks will have to hold against ABS holdings in their trading books. He also argued that ABS were inappropriate for banks to hold as liquid assets, because they have proven difficult to sell in a market crisis.
"There is very much a query in the minds of regulators as to whether there is a significant future for securitization," said Mr. Sharma, though he added his own view was that the market did have a future role." ("In Europe, a U.S. Way To Fix ABS Market?" Neil Shah and Stephen Fidler, Wall Street Journal)
See? In Europe regulators still do their jobs and make sure that financial institutions have money before they create trillions of dollars in credit. They don't stick with their heads in the sand while crooked bankers fleece the public. Bernanke's job is to step in and put an end to the hanky-panky, not add to the problems by restoring a credit-generating regime that transferred hundreds of billions of dollars from hard-working people to fatcat banksters and Wall Street flim-flammers.
Mixed fortunes for EU leaders
Germany’s ruling Christian Democrats slipped back and other governments braced themselves for electoral embarrassment on Sunday as recession-hit voters turned to protest parties or failed to cast ballots at all in elections to the European parliament. The centre-right CDU-CSU alliance of Angela Merkel, Germany’s chancellor, was set to win 38 per cent of the vote, down from 44 per cent in 2004, according to exit polls. Her Social Democrat coalition partners were expected to achieve roughly the same result as in 2004 - 21 per cent.
The result was reasonably encouraging for Ms Merkel, since the liberal Free Democrats – her preferred government partners after next September’s national election – were projected to score 10 per cent, up from 6 per cent in 2004. In what was the largest multi-national ballot in history, voters in 19 European Union countries went to the polls on the fourth and final day of an election in which some 375m people in 27 states were eligible to cast ballots.
The parliament is the EU’s only directly elected institution and has increased its powers over the past 20 years to the point where it enjoys as much influence as national governments in setting 75 per cent of EU legislation.
Centre-right parties were expected to remain the largest single group in the 736-seat parliament, but far right, nationalist and anti-EU parties looked set to win up to 50 seats. Governments in many countries, especially the UK, where Gordon Brown, prime minister, is struggling for his political life, anticipated punishment at the hands of voters angry and frightened at Europe’s worst recession since the 1930s. “The results are going to be terrible. There’s no point beating about the bush on that,” Peter Hain, Mr Brown’s secretary of state for Wales, told Sky News. “Terrible for Labour and, I suspect, terrible for all the mainstream parties.”
Pollsters predicted a surge in support for the anti-EU UK Independence party, partly thanks to an expenses scandal that has shattered public trust in members of parliament. Across Europe, evidence of anti-government protest votes appeared in Ireland, where the ruling Fianna Fáil party appeared in danger of losing its European parliament seat for the Dublin area, and in Latvia, where an opposition party representing Russian-speakers made strong gains.
In Austria, a group led by Hans-Peter Martin, a journalist who campaigns against corruption in the European parliament, was set to take 18 per cent of the vote. Two far-right parties were on course to win a combined 17.5 per cent. In neighbouring Slovakia, the ultra-nationalist SNS party was poised to claim its first seat in the EU legislature.
Geert Wilders’ populist, anti-Islamic Party for Freedom finished second in the Netherlands and seized four of the 25 Dutch seats in the parliament. EU policymakers were hoping that this election, the seventh to the European parliament, would reverse an unbroken trend of declining voter participation ever since direct elections to the legislature were introduced in 1979. First signs were that the turnout would be close to the 45.7 per cent recorded in the 2004 elections. In France, 14.8 per cent of voters had cast ballots by midday, up from 13.7 per cent in 2004.
In Slovakia, turnout was a wretched 19 per cent – but it was slightly up on 17 per cent five years ago. On the Mediterranean island of Malta, turnout was 79 per cent, slightly down from 82 per cent. EU officials say a low turnout is disappointing because the parliament is poised under the bloc’s Lisbon treaty to win even greater powers. But they console themselves with the thought that turnout in US mid-term congressional elections over the past 30 years has hovered around 40 per cent.
UK construction industry frozen in worst slump since winter of 1963
The biggest fall in construction output since Britain was engulfed by the "big freeze" of 1963 led to an even bigger slump in the economy during the first quarter of this year than the 1.9% drop originally estimated, the government signalled today. City analysts said a 9% fall in a sector that straddles housebuilding, commercial property and repairs to existing buildings would shave a further 0.3 points off GDP in the first three months of the year. A 2.2% drop in GDP would be the weakest since the 2.4% contraction in the autumn of 1979.
In its early estimate of first-quarter GDP, the Office for National Statistics (ONS) had pencilled in a decline of 2.4% in construction output during the winter, but it said todaythat the severity of the recession was greater than in any of the three major postwar downturns in the 1970s, 1980s and 1990s. The last time building sites were as quiet as during early 2009 was when a blizzard on Boxing Day in 1962 heralded a spell of freezing weather that lasted until early March. Between January and March this year, private housebuilding was down 10% in the first quarter while public housebuilding dipped by 9%. With demand for both residential and commercial property weak, construction output in January to March was 6% lower than in the same months of 2008.
"The 9% drop in construction output now reported is massively more than the 2.4% quarter-on-quarter decline that was contained in the latest national accounts data, which showed that GDP contracted by 1.9% quarter-on-quarter in the first quarter," said Howard Archer of IHS Global Insight. "Although construction output only accounts for 6% of GDP, the ONS has indicated that revised data are likely to show that GDP contraction was 0.3 percentage points higher at 2.2% quarter-on-quarter in the first quarter."
Recent surveys of construction have suggested that the first quarter marked the low point for the sector. The Chartered Institute of Purchasing and Supply/Markit index has risen from a trough of 27.8 in February to 45.9 in May. A reading below 50 indicates contraction in the sector. The ONS said officials were working on a new estimate of GDP in the first quarter following the release of the construction data.
Again, China's Electric Consumption Does Not Support Official Growth Statistics
China's power consumption in May continued to decline. Although the National Bureau of Statistics denied the conflict between economic growth and power consumption decline since the beginning of the year, Zhao Bingren, ex-chairman of China Electricity Regulatory Commission, expressed his doubt on economic statistics reported by some areas.
According to the figures from the State Grid, power generation in the last 11 days of May dropped 5.7% year on year, higher than the decline in the second 10 days of May, mainly because working days in the last 11 days of May this year are lower than that in the previous year, as the Dragon Boat Festival occurred at the end of May. The power generation situation in Yunnan and the south of Hebei is apparently better than that in the rest of China, due to the increase in steel production in the south of Hebei and supportive policies towards high energy-consuming industries in Yunnan.
However, power generation is still hovering at low levels in most areas with intensive high energy-consuming industries. In May, decrease in power consumption in Shanxi and Inner Mogolia stood at 5% to 6%, higher than the average level of the country. Power consumption decrease in Guangdong, Shanghai, and Zhejiang reached about 10%, 13.6%, and 6.1%, all higher than the country's average.
“During January and May, electricity demand dropped about 4% year on year,” revealed Zhao Guobao, vice director of the National Development and Reform Commission and director of the National Energy Administration. According to the research of the National Energy Administration, change in product structure and decrease in inventory of high energy-consuming products is an important reason for the conflict among energy consumption, electricity consumption, and GDP growth.
Zhao Bingren said statistics reported by some local governments representing drastic economic growth might not be true. “I visited two provinces, and think their statistics are not true. They can never make up two important figures: power consumption and transportation. ” Power consumption in Sichuan dropped 9.9% in the first quarter, but its economic growth in the same period reached 10.8%. The local government explained the economic growth is mainly led by the post-disaster reconstruction. “I don't know how the economy grows in this area,” said Zhao Bingren.
Shao Bingren is now vice director of the Committee of Population, Resources and Environment of the NPC. He thinks the economic situation in China is not so optimistic. The government's investment has mainly flowed to state-owned enterprises and infrastructure construction, instead of the whole society. In the first quarter investment in non state-owned sectors dropped by 3.3%, and the investment decline in foreign-invested and private enterprises is even bigger.
The export situation has not been improved, and internal demand has not been well stimulated. Financing difficulties of many small and medium enterprises have not been solved. The employment situation is still severe.
Chavez to expand Venezuela oil nationalizations
President Hugo Chavez has already nationalized most of Venezuela's energy industry and is preparing to bring chemicals under his wing, but he may still target firms running gas and oil services. A former soldier inspired by Cuba's Fidel Castro, Chavez has made energy nationalization the linchpin in his drive to build his own brand of socialism. He has also taken over assets in telecommunications, power, steel and banking.
Over the last month, Chavez has seized a gamut of mostly small oil service companies along with U.S.-owned gas compression units, adding to the mammoth heavy oil projects Venezuela took over in 2007. The government is now mopping up what is left, preparing to take a majority stake in the OPEC nation's main private petrochemical projects and possibly eyeing natural gas. But the really lucrative area of the oil business that Chavez has not yet touched is oil well services such as drilling rigs run by global giants like Halliburton, Schlumberger and Baker Hughes.
"To the extent that the higher value service companies, the drilling companies, refuse to accept the terms that are on offer or refuse a write-down on their debt, they too will be vulnerable to a takeover," said Patrick Esteruelas of Eurasia Group in New York. Chavez has not said the companies are in the spotlight but the government is committed to nationalizing all of what it considers strategic parts of the economy. "We are determined to regain full petroleum sovereignty and it turns out that in Venezuela almost everything was privatized," Chavez told reporters in Argentina in May.
Halliburton and Schlumberger declined to comment about recent nationalizations, while Baker Hughes did not immediately respond to a request for comment. These companies provide a range of services including exploration and enhancing output at existing fields. Their takeover could have repercussions in production and future investment in one of the world's major oil exporters. Flush with oil cash, Chavez has often compensated nationalized companies fairly, but the 2007 takeovers in the oil industry led to lawsuits from ConocoPhillips and Exxon Mobil.
State oil company PDVSA ran up $14 billion debts with all the service companies when oil prices plunged over the last year. Those debts preceded the takeover of smaller transport and water and gas injection firms in May. Companies that do not resolve disputes with PDVSA could be headed for trouble. Oil prices have been on the rise in recent weeks and could provide a way for PDVSA to pay off its debts, or to pay for more takeovers. The service companies hit in May, including Williams Companies Inc, may be compensated with bonds rather than cash, according to Venezuela law.
Big players like Halliburton and Schlumberger have so far avoided public spats with the government over debts, but smaller companies such as driller Helmerich and Payne, Ensco have gone as far as to stop working rigs over fees in arrears. Earlier this year, PDVSA seized a rig owned by Ensco and in May the U.S. company said it sought to terminate its contract in Venezuela. Chavez's favored model for running nationalized industries is via joint ventures where the private partners have a 40 percent stake. He has used that arrangement for oil upgrading projects worth billions of dollars, as well as the steel industry.
The proposed law for petrochemical companies also limits private participation in projects to 40 percent, with the government taking its usual 60 percent stake. The law should easily pass through the Chavez-ally controlled national assembly and could see reduced holdings for companies such as U.S. chemical maker FMC Corp. privately held Koch Industries and Japan's Mitsui, Mitsubishi Corp and Mitsubishi Gas Chemical. Such a model could be acceptable to oil service companies with a long-term view on Venezuela who want to keep close to some of the world's largest oil reserves, regardless of the current unstable business climate.
France's Total SA and Norway's StatoilHydro received around $1 billion of compensation after reducing their holdings in the 2007 takeovers. Britain's BP Plc and the U.S. company Chevron Corp also remained as minority partners. Venezuela's largely undeveloped natural gas sector is also ripe for a regulation shake up, since under the present law gas projects can be 100 percent privately owned, against the grain of Chavez's socialist ideals.
What went wrong with Latvia?
The first Latvian words I learned were the ones plastered over Riga’s art nouveau façades and brand-new office parks: “iznoma” (“for rent”) and “pardod” (“for sale”). In 2008, Latvia had the world’s fastest-falling house prices, and they’re still dropping. One morning in Café Osiris, Katja Jekaterina, who recently lost her job in real estate, gestured at some property speculators at a nearby table. “They bought a luxury car, a boat, a house, with leverage of 100 per cent because it was possible,” she said. “Now they have this boat and this car but they do not have the gasoline for it.” Every month Jekaterina herself needs to find €700 – her mortgage loan is in euros. If Latvia devalues the lats, she’s in trouble.
Few countries in history have risen and fallen as fast as Latvia. From 1991 to 2004, this country of 2.3 million people went from Soviet republic to member of the European Union and Nato. From 2004 through 2007 Latvia was probably Europe’s fastest-growing economy, with annual expansion above 10 per cent. People who had lived in rundown Soviet communal apartments, sharing one bathroom between several families, were suddenly buying BMWs.
Now Latvia probably beats Iceland to the title of Europe’s worst-hit country. The Latvian central bank predicts that the economy will shrink by 18 per cent this year; Iceland expects its decline to be a mere 10.6 per cent. Altogether, economists predict Latvia’s gross domestic product will drop by about a quarter between 2008 and 2010 – not far off the 30 per cent that the US shrank during the Great Depression. If other countries have economic hangovers, Latvia is in intensive care, having years of champagne pumped from its stomach.
The country’s new prime minister, 37-year-old Valdis Dombrovskis, has said Latvia will go bankrupt this month if the International Monetary Fund doesn’t stump up the next tranche of its promised package of $7.5bn on time. He was speaking metaphorically, since a state cannot go bankrupt like an unfashionable nightclub. However, if Latvia doesn’t get the IMF money, it might struggle to pay debt, or even have to devalue. If that happened, Latvia could take down other shaky eastern European currencies with it. Devaluation remains unlikely, but the ratings agency Standard & Poor’s has given Latvia “junk bond” status with a negative outlook. Where did this wannabe Nordic nation go wrong?
One day I drove around Riga with Jan Jörnmark, a Swedish economist, Baltic-lover and cult photographer of post-industrial landscapes. As a connoisseur of urban detritus, he loved the place. “It’s like Andy Warhol: in the future everyone will be a millionaire for 15 minutes,” he said. All over town Jörnmark found the universal mark of an abandoned building site: one guy left behind to guard the equipment, living in a shack with his German shepherd dog. We passed half-built office blocks, signs promising “Premium klases” apartments, and two Jaguar dealerships within a kilometre of each other. The roads themselves are emptying: sales of new cars have dropped 80 per cent in a year.
. . .
Most of Latvia’s pain is yet to come. The newly sacked get unemployment benefit for six months, and few homeowners have yet defaulted on their mortgages. But already middle-aged men in Soviet-style caps are queuing at the free Hare Krishna kitchen just down the street from Osiris, Riga’s ultimate western café. We visited Alberta iela, the street in Riga that is the epitome of Jugendstil, the Germanic variant of art nouveau. In “coffee & lunch”, a café named in the faux-casual lower-case English that was the signature of the boom worldwide, a British real-estate speculator is asking a Latvian: “How can I view one of these apartments?” Riga’s house prices peaked at €2,000 per square metre, before dropping by more than half.
That evening, Jörnmark and I drove to Riga’s seaside resort of Jurmala, along a motorway so smooth that in Soviet days it was nicknamed “Ten minutes in America”. Jurmala is Latvia’s boom and bust in one package; a gorgeous jumble of detritus from different eras. It has decrepit wooden 19th-century villas, brick remains of Soviet sanatoria and spanking new condos, finished just before the bust and never inhabited by humans. We strolled along Jurmala’s sandy beachfront, past locals walking their dogs or their children in the evening sunlight. It was like a tourist brochure. If Latvia ever devalues, flights into Riga will be jammed with speculators.
Ingrida Bluma mounted the Latvian rollercoaster just as the 20-year-ride began, and got off just before it broke down. As chief executive of Hansabank, she was funder-in-chief of the boom. We met in a coffee house in Riga, where she paid for her own raisin biscuits (“I made sure I did not leave the bank until I was financially secure”) and told me her bank’s story. It began in 1991, when a young Latvian wanted to go on a banking course in Stockholm.
To get on it he needed a letter of recommendation from a bank. Unfortunately, he didn’t work for a bank. So he founded one – on paper, at least. The new bank (which had neither customers nor employees) wrote him a letter of recommendation, and so he got to Stockholm. On the course he met Bluma, a fellow Latvian. “In the first week he invited me to work at his bank,” she recalled. “Within three months in Sweden I realised he didn’t have a bank! There was only the recommendation letter.”
But when they came home, in 1992, he created a real bank. At first it was only the 62nd biggest in Latvia, but dozens of others collapsed in the various crises of the 1990s, and his bank kept growing. Many Latvians were opening their very first bank accounts. “I think we established our mortgage department in 1997 or ’98,” said Bluma. “‘Department’ is probably too big a word, because in the beginning we only had two people there.”
. . .
The bank got taken over by Hansabank, which in turn was bought by Sweden’s Swedbank. Led by Bluma, the Latvian branch lent billions of euros, helping people buy flats and German cars. After the USSR broke down, countries such as Ukraine and Moldova were unsure which model to pursue, but nobody in the new Latvian establishment had any doubt. Latvia saw itself as a western nation in an unfortunate location. In 2004 it joined Nato and the EU. It then set its final target in westernisation: adopting the euro. As a preliminary, it pegged the lats to the euro – a policy that with hindsight looks like a death wish.
But as late as 2004, few Latvians lived like Europeans. Some still inhabited Soviet communal apartments. Now they wanted their rewards. Daunis Auers, a British-Latvian political scientist at the University of Latvia, identifies the difference with the Icelandic collapse: “In Iceland there was a lot of speculation on the markets. But in Latvia people were finally buying the western consumer products they had been promised since 1990.” The money was flooding in to help them do it. It came from Latvians working in Britain and Ireland, from the EU, from foreign investors, but, above all, from Scandinavian banks.
Lending to a country whose last successful experience of capitalism had ended before 1940 was a leap of faith. Nonetheless, Scandinavian banks threw money at Latvians. Some of the boom-era television ads for consumer loans are legendary. One featured a beautiful blond family at a drive-in window, where instead of ordering hamburgers, they get loans to buy their fantasies. The payoff line: “And of course: a trip to Egypt!” Other connoisseurs prefer the one that shows a young man and an old man driving BMWs. The old man exclaims: “I’ve saved all my life to buy a car like this!” The young man says: “And I just leased it!”
Peasants in the countryside mostly just sat out the boom in the homes they had been given after the USSR collapsed. However, Riga’s impatient new middle classes put out both hands to catch the money. They almost all borrowed in euros, paying interest rates of just a few per cent while Latvian inflation was at 15 per cent. In other words, they were being paid to borrow. Better yet, there was no capital-gains tax on property, which, incidentally, made buying apartments an excellent way to launder money.
Estonia, Latvia and Lithuania became the “Baltic tigers” – an epithet that, we now know, prophesied doom. Much of Latvia’s “growth” came from construction and from speculators selling each other flats, but few people worried about that then. Almost everyone had jobs and money. Wages rose by 30 per cent a year, or double the inflation rate. Income per person jumped (gauged by purchasing power parity) to about $17,000 a year, higher than Poland. And you could always borrow more.
Some Latvians assumed the growth would continue until they caught up with their fellow Nordics. In 2007 Swedbank commissioned a survey of people’s financial expectations. Martins Kazaks, the bank’s Latvian chief economist, says: “If I recall correctly, about a quarter of respondents expected that over the next three years their real incomes would grow 30 per cent a year in nominal terms. Which is kind of odd.” It all sounds absurd now, but during the boom the banks did brilliantly. Swedbank was getting 25 per cent of operating profits from the Baltics. In February 2007, just before the Baltic boom ended, the bank’s share price peaked at SKr285. It’s now about SKr60.
. . .
But even before the crash, many insiders realised the game was up. In 2006 Bluma and other bankers went to the government and suggested it slow down the economy and property market. Recalling this in the coffee house, she spoke slowly, precisely, searching for the right words in English as she tried to understand what had happened. “I think this was one of our major mistakes – we were too slow with it,” she said. “And we were too soft. We said we need a government budget without deficit. They said this is impossible this year; maybe two years later. We said okay.”
Late in 2006 Bluma resigned from Hansabank for “personal reasons”. A senior official at the Bank of Latvia quit too, to study Buddhism abroad. A friend of his insists that the man’s interest in Buddhism was longstanding, but it did look awfully as though the crew were leaving the sinking ship. “My own role in these years – frankly I am probably not objective,” Bluma said. She paused, then added: “What I personally still feel: responsible. I think about Hansabank. I hope that in three years time Hansabank will be a really successful bank in Latvia. Then I will feel happy about it.” After which, being a prudent lady, she swept her uneaten raisin biscuits into a bag and took them home.
Banks lend money. The politicians and regulators should have cooled down the economy, but they didn’t. In the end, said Kazaks, the crash was a government mistake. The question then becomes: why did Latvia blow up its bubble when experts kept telling it not to? From 2004, Latvian politicians were finally free to do as they liked. For years they had listened to westerners telling them what to do to get into the EU; now they were in. Ainars ?lesers, a politician who once campaigned as “Superman”, wrote in 2004: “One should quit warning about some kind of economic overheating. We ought to push the pedal to the metal.” Even if inflation hit 15 per cent, Latvia was a special case. The laws of economics didn’t apply.
After the bubble burst the country’s finance minister was asked what had happened. “Nothing special,” he replied, helplessly. This is now a Latvian catchphrase. Some people have put in on their T-shirts. It sums things up nicely: the crash was nothing special, or exactly what you would expect given government policy. This is how a country can blow a bubble that will definitely burst: 1) Run high inflation; 2) Borrow profusely; 3) Import much more than it exports; 4) Build an economy on speculation in assets; 5) Put no public funds aside for a rainy day; 6) Meanwhile, peg its currency to a stable currency. Latvia ticked every box.
When the global crisis hit, banks stopped lending. Latvia’s second largest bank, Parex, collapsed and was nationalised. Vyacheslav Dombrovsky, assistant professor at the Stockholm School of Economics in Riga, imagines that future economics textbooks will include a box on the Latvian bust of 2008, as the perfect case study in overheating. One afternoon in Riga I went to ask Europe’s youngest prime minister what had happened to Latvia. Dombrovskis is one of the Latvians who rose fast after the USSR collapsed. A decade ago he was a research assistant in the electrical engineering faculty of the University of Maryland.
Later, he briefly served as finance minister. He was then lucky enough to spend the boom in Brussels, as a member of the European Parliament. This allowed him to return home in February with clean hands and take on the lowly temp job that is Latvian prime minister. Dombrovskis is a physicist-turned-economist, and that’s exactly what he looks like, with his straight brown hair, ill-fitting suit and unpretentious glasses. He tore open a plastic box of cream, poured it into his coffee and talked like an economics teacher who is disappointed in his class.
He had stern words for Latvian consumers: “Of course there was too much optimism, in Latvia and I would say in most of the world. People were kind of expecting growth continuing forever, and here we are in this very difficult situation.” He had stern words for Scandinavian banks: “To borrow irresponsibly you need someone to lend irresponsibly.” But above all, Dombrovskis had stern words for his own predecessors: “Government was quite clearly ignoring some of the fundamental rules of economy.”
. . .
He was happy talking about numbers, but when I asked him to describe the pain ordinary Latvians were now suffering, he was stuck. Instead of empathy, he offered more numbers: the recent 15 per cent cut in state salaries, the coming cut of 20 per cent more, the freezing of pensions, etcetera etcetera. Nobody can dismiss this man as a touchy-feely Clintonian. However, everybody I met in Latvia agreed with his central point: the economy collapsed largely because Latvia’s politicians had been incompetent. Krista Baumane, development director of the think-tank Providus, says: “The politicians grew up in the Soviet Union. In a way you feel sorry for them: how were they supposed to know how to govern a democratic country if they never lived in one themselves?”
The political elite is not only small – drawn just from ethnic Latvians – but much of it is also corrupt. A World Bank report some years ago grouped Latvia with the “Stans” of central Asia when it came to corruption. So, in Latvia state companies sometimes get sold off cheaply, bridges get built expensively, and some politicians get rich. “People are worn out by the political elite,” Dombrovskis told me. “We have something amongst the lowest approval rating of parliament in the whole EU.” Latvians repeatedly kicked the bums out. Until 2006, every parliamentary election was won by a party formed less than 12 months earlier. But the politicians never seemed to improve.
Now the IMF is taking over. As a condition for handing over the $7.5bn, it has demanded that Latvia limit its budget deficit to 5 per cent. But Einars Repse, Latvia’s new finance minister, has drawn up a budget that foresees a deficit of 7 per cent of GDP. In other words, he is hoping to persuade the IMF to accept new terms. His intentions may in any case prove irrelevant. Latvia’s central bank says the budget deficit “could be as wide as 12 per cent”. On April 2, the IMF refused to pay one tranche of the package. Now Latvia is begging it for leniency.
When the Latvian bubble burst, Olga Kotova called together the employees of her tableware company. “You know,” she told them, “it’s going to be shit. Not for a month, not for two months, but for a couple of years at least. Your salary will be cut, my salary will be cut.” And some people would be sacked. Their sector had shrunk 40 per cent. Kotova is a strawberry-blonde ethnic Russian who became chief executive of Arkolat in 2008, just after Latvia’s collapse. “I actually thought my employees would perceive it in the worst way,” she told me. “They had bought flats, they had bought cars.
But after we had the meeting, from the way they reacted, I was very close to tears. They said, ‘If we all try to stick together, we will make it.’” How did she explain their phlegmatism? “That’s a good thing about people in this part of Europe,” she replied. “We have been through difficult times. Our parents have been through difficult times. We understand a crisis. We will just go through it.” Many people I spoke to in Riga made Kotova’s point: Latvians had had ample experience of crises over the last century. “They are not as spoiled as Swedes and Icelanders,” said Anders Paalzow, Swedish rector of the Stockholm School of Economics in Riga.
That may explain the calmness that Mats Staffansson, Sweden’s ambassador, perceives in Riga. But there’s another reason: although the Latvian bust has been fantastic, so was the boom. Incomes are plummeting from unprecedentedly high levels. Dombrovskis told me that, “From the point of view of wage levels, we will be probably broadly back to the level of 2006.” That, he said, was “sad but not disastrous”, even if Latvians had more debt than in 2006, and unemployment was now 11 per cent and rising.
Latvians remember worse times. In April, Eurobarometer, the polling arm of the European Commission, polled 27,218 people in the 27 EU countries about the economic crisis. Latvians are probably the hardest-hit Europeans. Yet, Eurobarometer found, they were also among the four most optimistic nations about the future impact of the crisis on the world. Given this country’s history, an economic depression is only a blip.
Bankers perpetuate crisis
During the past decade, the major reserve central banks have become the most powerful destabilizing force behind the world economy. Their policy of excessive monetary expansion and negative real interest rates aimed at boosting credit, real aggregate demand and employment, and depreciating exchange rates (tantamount to competitive devaluations that became a scourge during the Great Depression) has forced unprecedented flow of credit into the subprime market, the only market that can absorb, unproductively and without limit, such massive credit flows.
Credit expansion of this size will never be repaid. This cheap money policy has bankrupted, or will bankrupt, advanced banking systems and has inflicted trillions of dollars in bailout debt on taxpayers. It has eroded real savings and, therefore, the capital base for real economic growth.
During 2008-2008, national savings fell drastically in many industrial countries, becoming negative in the US, as external current deficits widened to record levels. Negative real interest rates and never-ending liquidity growth ignited exorbitant speculation in assets prices, commodities, housing, and currencies. Such speculative inflation has rewarded borrowers and speculators and drastically impoverished workers; it has brought the world economy to a standstill and has sharply contracted trade and employment.
In conjunction with record fiscal deficits, cheap money policy has derailed real economic growth in many advanced countries. The US economy contracted at an annual rate of 6% per year in real terms during 2008Q4-2009Q1, with unemployment rising to 8.9% of the labor force. The German economy, Europe's largest, contracted at the rate of 3.8% per year in the first quarter of this year. The Japanese economy contracted at the rate of 3.5% per year in 2008Q4. Exports of major industrial countries have plummeted at an unprecedented rate in 2008-2009, a rate that has not been exceeded in the post-World War II era.
Notwithstanding these ominous clouds, the Group of 20 in its April 2009 London summit called for ramping up fiscal deficits, further unleashing of credit, both domestically and internationally, and disbanding fiscal and monetary discipline. Accordingly, reserve central banks have cut interest rates to zero or zero bound.
To force interest rates to zero bound, reserve central banks will have to keep pumping more and more liquidity. The consequences of this policy are risky and could turn out to be disastrous. Zero interest rates and unlimited liquidity without limit will only provide fuel for even more speculation, cause a huge transfer of wealth to borrowers and speculators, require formidable taxation, and distort completely the price and allocation mechanism in market-based economies. The real economic rate of growth will be depressed in line with prevailing negative real interest rates. Social discontent could grow in the midst of inflation and unemployment as witnessed by recent demonstrations in Europe.
To protect borrowers - and preventing the needed adjustment in speculative housing prices, in the price of basic necessities and in depreciating currencies - reserve central banks have pursued an outright re-inflationary policy. By shoveling trillions of dollars to the subprime mortgage and consumer borrowers, central banks have deliberately assumed the risk of large default losses.
Federal Reserve chairman Ben Bernanke as has effectively summarized the doctrine of reserve central bankers: "Final demand should be supported by fiscal and monetary stimulus." Hence, reserve central bankers believe in fiscal and monetary expansion to counteract economic recession and reject price and market adjustment mechanisms. They have already announced that economic recovery is underway and will firm up in the second-half of 2009. Maybe they should sell options and futures on their economic outlook predictions!
Economists have not unanimously accepted demand policies relying on large fiscal deficits and money expansion to boost real economic growth in the past. Adam Smith argued that excessive government employment would be at the expense of capital accumulation and would cause a declining trend in output as attested by the following quote:Great nations are never impoverished by private, though they sometimes are by public, prodigality and misconduct. The whole, or almost the whole public revenue, is in most countries employed in maintaining unproductive hands. Such are the people who compose a numerous and splendid court, a great ecclesiastical establishment, great fleets and armies, who in time of peace produce nothing, and in time of war acquire nothing which can compensate the expense of maintaining them, even while the war lasts.
Such people, as they themselves produce nothing, are all maintained by the produce of other men's labor. When multiplied, therefore, to an unnecessary number, they may in a particular year consume so great a share of this produce, as not to leave a sufficiency for maintaining the productive laborers, who should reproduce it next year. The next year's produce, therefore, will be less than that of the foregoing, and if the same disorder should continue, that of the third year will be still less than that of the second.
Those unproductive hands, who should be maintained by a part only of the spare revenue of the people, may consume so great a share of their whole revenue, and thereby oblige so great a number to encroach upon their capitals, upon the funds destined for the maintenance of productive labor, that all the frugality and good conduct of individuals may not be able to compensate the waste and degradation of produce occasioned by this violent and forced encroachment.
Adam Smith distinguished between productive and unproductive labor. Productive labor is defined as the labor that produces real goods such as food products, machinery, medicines, and clothing. Unproductive labor is defined as labor that produces services such as churchmen, lawyers, public service, and the army. If the government expands its deficits, it will divert large quantities of subsistence goods to unproductive labor. Consequently, real capital cannot be replaced, let alone increased, which causes an economic recession.
This could provide an explanation why US House Speaker Nancy Pelosi's US$160 stimulus package in 2008 failed to induce economic recovery. In similar fashion, President Barack Obama's stimulus package of $787 billion and projected fiscal deficit of $1.85 trillion in 2009 could absorb a larger share of subsistence goods of productive labor, reduce real investment, and depress growth. Adam Smith's model can also be applied to the world crude oil market. Given the rigidity of crude oil output at 85 million barrels per day (mbd), an increase of unproductive use by 5 mbd, as a result of fiscal stimuli, will cut productive use by the same quantity. With such a drastic reduction in oil use, productive sectors, including farmers, will suffer a decline in their real output.
French economist Jean-Baptiste Say (1767-1832) criticized the argument in support of monetary expansion to expand demand. He articulated the principle that it is production that opens the demand for products. This principle is known as Say's Law or the Law of Markets. Say denounced the policy of printing money as a way to create demand. This policy erodes savings and damages economic growth as clearly stated in the following quote:The same principle leads to the conclusion, that the encouragement of mere consumption is no benefit to commerce; for the difficulty lies in supplying the means, not in stimulating the desire of consumption; and we have seen that production alone furnishes those means.
Thus, it is the aim of good government to stimulate production, of bad government to encourage consumption. Wherever, by reason of the blunders of the nation or its government, production is stationary, or does not keep pace with consumption, the demand gradually declines, the value of the product is less than the charges of its production; no productive exertion is properly rewarded; profits and wages decrease; the employment of capital becomes less advantageous and more hazardous; it is consumed piecemeal, not through extravagance, but through necessity, and because the sources of profit are dried up.
The laboring classes experience a want of work; families before in tolerable circumstances, are more cramped and confined; and those before in difficulties are left altogether destitute. Depopulation, misery, and returning barbarism, occupy the place of abundance and happiness.
Say considered money as a mean of exchange and a store of value. Credit should be made only out of deposited savings and should not be used to expand demand beyond supply as such distortion will only lead to inflation, bankruptcies, recession, and unemployment.
Certainly, Keynesian economists have not accepted Say's Law and live in the never-never land where the economy suffers from excess supply, and thus they see a role for fiscal deficits to expand aggregate demand. Nonetheless, both Smith and Say realized the dangers of expanding demand beyond a level that would cause encroachment on capital and a reduction of economic growth. Their argument can be supported by recent US gross domestic product (GDP) data that showed real private-goods production falling at 0.5% in 2007 and 3% in 2008.
The G-20 has been totally oblivious to basic principles set out by the classical economists regarding macroeconomic balances and necessity of preserving growth and capital accumulation. Central bankers who have gone beyond Keynesian economics, which sought to expand public works to directly create employment, have held a similar attitude. Their actions to push directly trillions of dollars to consumers does not guarantee employment creation as under Keynesian public works proposals and could even reduce employment through tarnishing savings as clearly observed in the recent economic and financial crisis.
If Smith and Say were alive to advise the G-20 regarding appropriate policies to restore stability and economic growth, their prescriptions would be very different from the policies adopted by G-20 in the London summit that consisted of blowing up fiscal deficits and forcing credits through unorthodox money policies to subprime consumers.
The calamities of the monetary and fiscal policies during 2000-2008 can be summarized as follows: bankruptcies of the banking system, commodity inflation, food and energy shortages, falling real savings, large external current accounts, declining real output, and higher unemployment. The G-20 policymakers ignored all these calamities and decided to renew what they have called monetary aggression accompanied by trillions of dollars in fiscal stimulus. The inflationary aspect has been dismissed completely as non-existent because leading economies enjoy price stability with core inflation at 1-2% a year.
Central bankers should stop bankrupting the financial system and destroying the value of money. Their unorthodox policy of shoveling trillions to consumers at zero interest rates is a direct way of destroying the financial system, including central banking itself. The financial system is no longer intermediating between savers and investors but is instead the promoter of speculative activities. Central bankers should renounce policies for depressing interest rates, reinflating housing and basic necessities prices, and depreciating exchange rates. These policies will kill savings and depress real growth rates. Policymakers should address food and energy shortages, as these shortages will seriously constrain capital formation and economic growth. They should stimulate private investment through tax incentives and competitiveness.
Fiscal policy should be directed to enhancing economic growth through spending on infrastructure, health, and education. Policymakers should extricate inflationary pressures through stable monetary policy and market determined interest rates. Countries will grow only after they stabilize their economies and renounce unsustainable fiscal deficit and monetary policy. The world economy could be heading toward inflation that could surpass that of the 1970s, and the global economic recovery could be foiled for some time to come. If the oil price races again to $147 per barrel and beyond, Bernanke would certainly put the blame on China, emerging countries, and oil producers as he did in the past.
So far monetary policy has only disrupted world economic growth and distorted prices. By quadrupling food prices, it has eroded tremendously real incomes of workers and fixed income pensioners. It has taxed onerously poor people in developing countries. Every economy has bright economic growth potential, but such a destabilizing monetary policy can only perpetuate financial disorder and economic stagnation. Economic growth has never been equated to the printing of more and more money. Economic growth is limited by real resource constraints such as land and labor, while money printing has no constraint whatsoever.
Hossein Askari is professor of international business and international affairs at George Washington University. Noureddine Krichene is an economist at the International Monetary Fund and a former advisor, Islamic Development Bank, Jeddah.