Outskirts of El Paso, Texas. "Young Negro wife cooking breakfast. 'Do you suppose I'd be out on the highway cooking my steak if I had it good at home?' Occupations: hotel maid, cook, laundress"
Ilargi: Whenever I try to avoid the subject of Fannie and Freddie these days, I seem to get drawn right back into the topic of troubled US states. And when avoiding them, somehow I'm back with Fan and Fred. Got to go with the flow,I guess. Also, I've seen a ton of attention for these subjects, not just for what I’ve written about them recently, but also on a much wider scale, which increasingly includes the main stream media.
As for American real estate, though, I must say I have yet to see anyone denouncing the role the government plays in that market, even if some seem to come closer. It's not a right-wing issue or anything, it's nothing to do with big government. The problem is that government guarantees cause people to grossly overpay for their homes.
Apart from the lunatic amounts in fail-out capital injected into the nation's major -and major-league broke- lenders, Fannie and Freddie serve to provide the by far largest taxpayer funded subsidy to the banking system. That is wrong on a million different levels, but nowhere more so than in the carefully maintained delusion that this entire swindle actually performs a socially beneficial function and helps people fulfill their dreams. What it does in reality is help banks, not homebuyers. The latter of course have no vested interest in paying higher prices than they would have if the government would step away from the housing market.
90% of all mortgage loans are now government backed. As prices keep falling, and they will, the combination of inventory, job losses and foreclosures make it inevitable, the American people, whose credit stands behind the purchases and loans, is on the hook for the losses.
Look, a California Budget Project report states that 40% of working-age Californians are jobless. The way that reflects on the housing market is simple: there won't be one. No matter what the government does, that market is dead and gone.
And look at what's happening with US consumer credit. Anyone want to argue for a recovery in the face of these numbers?
US Consumer Credit Tumbled in July
Americans reduced their borrowing a sixth consecutive time during July in a bad omen for any easy economic turnaround. Consumer credit outstanding tumbled a seasonally adjusted annual rate of 10.4% to $2.472 trillion, the Federal Reserve said Tuesday. The $21.6-billion drop in borrowing was a record.
Wall Street projected a $3.5 billion decline in consumer credit during July. Borrowing in June fell $15.5 billion, revised down from $10.3 billion.
The Fed data Tuesday said revolving credit, which includes credit card use, dropped in July by $6.1 billion to $905.6 billion, or 8.1%. Nonrevolving credit, including automobile and mobile home loans, decreased by 11.7%, or a record $15.4 billion to $1.566 trillion. The consumer credit data exclude home mortgages and other real estate-secured loans.
Have we accepted these insane anomalies as normal now? The Federal Reserve revised its reported June numbers by 50%? And "Wall Street" in its estimate for July was off by some 500%?! Doesn't it make you want to ask at the top of your voice: Who are these people, what are their agenda's, and what are their credentials?
And how come nonrevolving credit drops by 11.7% with all the loans added through the Cash for Clunkers program? What then will September numbers look like?
Turning back to real estate (but keeping consumer credit numbers handy), here's a useful piece by Adam Brochert:
Real Estate - The 800,000 Pound Deflationary Gorilla
- We are not close to a bottom in the real estate market and it is essentially almost impossible for it to come before the 2011-2012 time frame. If our government insists on continuing to subvert what's left of the free market system in real estate, it may take another decade to find the bottom.
- Here's a recent headline for you: "Nine years worth of condos flood uptown Charlotte."This is Charlotte, North Carolina folks. We're not talking about an obvious place like southern Florida, California, or Las Vegas. We're talking about a fairly typical non-coastal American city ([..]. Nine years supply at the current sales pace while credit continues to get tighter and unemployment is still rising?!
- Real estate is dead. Who can revive it? Government can (NOT). But that won't stop government from trying. "Stimulus" buying incentives trying to revive a burst bubble is a waste of people's hard-earned money and won't stop the slide in real estate prices, but it will destroy taxpayer wealth and lock unsuspecting citizens into debt on a depreciating asset.
- Fannie and Freddie have "backed more than 70 per cent of new home loans since 2008."
- The government is now backing 90% of new mortgages [..].
- The housing wealth effect in reverse is also a powerful deflationary concept. People in aggregate can no longer use their homes as ATMs by taking out home equity lines of credit and other cash-out refinances to fuel consumption. Predictions that half of U.S. mortgages will be underwater by 2011 are not one crazy bear's thoughts, they are mainstream views!
- With banks unwilling and/or unable to lend (because they are scared and/or insolvent) and with citizens broke, drowning in debt and fearing a pink slip every day, the private, non-federal, for-profit federal reserve bank corporation is not going to be able to spark price inflation in asset classes like stocks, commodities or corporate bonds. And you can forget real estate. This popped bubble ain't coming back for at least a generation.
But the pits in my view once more goes to professional political enabler and facilitator James Lockhart, who blames Congress for Fannie and Freddie's imminent demise. Lockhart, ever since he came on board in 2006, first at the OFHEO and later at FHFA, actively and energetically pushed for Fan and Fred to increase their portfolio's, their maximum loan sizes, the whole package. He was put in that place to do exactly that. And now, as the walls are crumpling, he's out the door to a private gig where his rolodex is a priced asset. This part of US politics is truly sickening.
Congress Failed to Save Fannie, Freddie: Lockhart
The collapse of Fannie Mae and Freddie Mac one year ago was the result of bad government policy that took too long to be corrected, Jim Lockhart, the GSE's former regulator, told CNBC. “The problem was that Congress allowed them to be leveraged well over 100 to one, and we were asking since the day I took the job, three and a half years ago, for legislation to fix it,” said Lockhart, who recently left the FHFA to take a job with billionaire investor Wilbur Ross.
Today's main Fan and Fred piece comes from the Washington Post, which apparently has also woken up to the bloated role Washington plays in the US housing market.
Major U.S. Role in Mortgages Shaping Entire Market
- [..] the government's newly dominant role -- nearly 90 percent of all new home loans are funded or guaranteed by taxpayers -- has far-reaching consequences for prospective home buyers and taxpayers.
- Nearly one-third of those who obtained home loans during the boom years of 2005 and 2006 couldn't get one today [..] Many of these borrowers were never really able to afford their homes and should not have gotten loans.
Ilargi: I would put that number at two-thirds, and most likely higher. After all, if it were just 30%, why does the government need to guarantee 90% of all mortgages? That makes no sense.
- [..] taxpayers are on the hook for most of the loans that are still being made if they go bad. And they are also on the line for any losses in the massive portfolios of old loans at Fannie Mae and Freddie Mac, which own or back more than $5 trillion in mortgages.
- [..] the Federal Housing Administration, another source of government support for home loans, is quickly eating through its financial cushion as losses mount. The outlay has already reached about $1 trillion over the past year and is rising. During that time, the government has pumped more money into the mortgage market than has been spent on Medicare or Social Security or the defense budget, more even than Washington has paid to bail out banks and other struggling companies.
- "Absent government intervention, there would be no lending," said Nicolas P. Retsinas, director of Harvard University's center for housing studies. Government officials generally agree that it would be better for private lenders to resume their traditional role as major providers of finance for home loans. But policymakers now face some tough choices. They must decide how to reduce support for the mortgage market without letting it collapse.
- The Federal Housing Administration, meantime, is dramatically increasing the amount of home loans it insures. Its share of new mortgages jumped from 1.8 percent in 2006 to 18 percent so far this year, according to Inside Mortgage Finance. It expects to insure about $400 billion this year. Several other agencies, such as the Department of Veterans Affairs, also provide mortgage guarantees.
- All told, the government now stands behind 86 percent of all new home loans, up from about 30 percent just four years ago (!!!)
- Some people who are no longer eligible for loans elsewhere have turned to FHA, which does not demand top-notch credit scores or sizable down payments. But for some consumers, such as Lisa McCracken of Stafford County, the FHA's minimum 3.5 percent down payment can be a stretch.
- Taxpayers could be hit with a staggering tab even if a small proportion of loans go bad. Fannie and Freddie now own or guarantee more than $5 trillion in home loans. (That equals two-thirds of the debt the U.S. government owes.) And many could be in trouble. Mortgages owned and backed by the companies often required down payments of no more than 10 percent.
With housing prices down sharply, many borrowers are underwater, owing more than their home is worth, so they cannot sell or refinance to pay off troubled loans. As the economy has deteriorated, delinquencies are spiking and losses are mounting. In the past year and half, the companies have posted more than $150 billion in losses.
- Nearly 8 percent of FHA loans at the end of June were either 30 days late or in the process of foreclosure, according to the Mortgage Bankers Association. That compares with 5.4 percent of such loans a year ago. As a result, FHA has been exhausting much of its loss reserves, which are funded by premiums paid by borrowers.
The reserves currently stand at an estimated 3 percent of all outstanding loans, half of what they were just a year ago. If the reserves fall below the 2 percent threshold set by Congress, they could require a taxpayer bailout.
- "Having the government this heavily into the mortgage market is inherently a dangerous thing for taxpayers," said Anthony Sanders, a finance professor at George Mason University. "We've already gone through one big bubble and burst, and right now the taxpayers are on the hook for a substantial amount of money."
Fannie and Freddie are bleeding money one year after they were taken over. That’s not a surprise, that was built into the design. This is a crime that will go unpunished. After all, who's the guilty party? The government. All members of Congress and everyone in the White House for the past 70 years.
Fannie Mae, Freddie Mac Struggle A Year After Takeover
- Fannie had nearly $171 billion in troubled loans as of June and had set aside $55 billion to cover those losses, while Freddie had nearly $78 billion in troubled loans and reserves of only $25 billion. "It's much worse than anybody thought," said Paul Miller, an analyst with FBR Capital Markets.
- Barclays Capital predicts the companies will need anywhere from $160 billion to $200 billion out of a potential $400 billion lifeline, which the Obama administration expanded from the original $200 billion set last fall. Most analysts don't expect the money to be returned anytime soon, if at all.
- "What will ultimately end up happening," said Barclays analyst Ajay Rajadhyaksha, "is that the U.S. taxpayer swallows the bill."
- "We've been the mortgage market," said John Koskinen, Freddie Mac's chairman. "Without that financing availability, people would not have been able to get a mortgage."
That takes care of Fannie and Freddie. They’ll be liquidated, with the American people on the hook for all the losses, which will rise into the trillions of dollars. Not that you’ll be told, some sort of bad bank will be initiated to keep the losses hidden for years to come. And since the show must go on, or else Wall Street will turn into a garbage heap, here’s the leading contender to be one of the main successors.
FHA Likely To Be The Next Shoe To Drop
- HUD's audit for FY08 (which ended 9/30/08) showed that the FHA capital ratio declined dramatically from 6.4% to 3.0%, but projected that it would remain above its statutory minimum of 2% going forward. Conditions have changed drastically since that time [..]
- In June, even the HUD Inspector General conceded that, "if more pessimistic assumptions are factored in, the ratio could dip below 2 percent in succeeding years requiring an increase in premiums or Congressional appropriation intervention to make up the shortfall."
Your next line of losses is in the mail. This won't stop until it's way too late.
US Consumer Credit Tumbled in July
Americans reduced their borrowing a sixth consecutive time during July in a bad omen for any easy economic turnaround. Consumer credit outstanding tumbled a seasonally adjusted annual rate of 10.4% to $2.472 trillion, the Federal Reserve said Tuesday. The $21.6-billion drop in borrowing was a record. Wall Street projected a $3.5 billion decline in consumer credit during July. Borrowing in June fell $15.5 billion, revised down from $10.3 billion. The last time credit fell six straight times was in the second half of 1991.
The Fed data don't show whether the decline is the result of banks cutting off credit to consumers or consumers choosing to pay down their existing debts. The consumer credit report is an indicator of spending by Americans. Consumer spending makes up 70% of gross domestic product, which is the broad measure of U.S. economic activity. People, afraid of unemployment and stuck under high household debt, aren't spending briskly, a restraint that held the economy in a slump and is seen preventing a quick recovery. Analysts expect more deleveraging by U.S. households.
The Fed data Tuesday said revolving credit, which includes credit card use, dropped in July by $6.1 billion to $905.6 billion, or 8.1%. Nonrevolving credit, including automobile and mobile home loans, decreased by 11.7%, or a record $15.4 billion to $1.566 trillion. The consumer credit data exclude home mortgages and other real estate-secured loans. These tend to be highly volatile from month to month and are frequently revised. But the report still has interesting details on how Americans finance their lifestyles.
Study: 2 out of 5 working-age Californians jobless
On this Labor Day weekend, many Californians find themselves more in need of work than a holiday. A report released Sunday says two of five working-age Californians do not have a job, underscoring the challenges in one of the toughest job markets in decades. A new study has found that the last time employment levels among this group were this low was February 1977. The study was done by the California Budget Project, a Sacramento-based nonprofit research group that advocates for lower- and middle-income families.
The report said that California now has about the same number of jobs as it did nine years ago, when the state was home to 3.3 million fewer working-age people. California Budget Project executive director Jean Ross recommended Congress adopt a second extension of unemployment insurance benefits. Those checks pay between $200 and $1,800 a month depending on a worker's previous earnings. On Friday, the U.S. Labor Department reported that the nation's jobless rate had climbed to 9.7 percent, the highest since 1983.
Major U.S. Role in Mortgages Shaping Entire Market
In the go-go years of the U.S. housing boom, virtually anybody could get a few hundred thousand dollars to buy a home, and private lenders flooded the market, aggressively pursuing borrowers no matter their means or financial history. Now the pendulum has swung to the other extreme. Only one lender of consequence remains: the federal government, which undertook one of its earliest and most dramatic rescues of the financial crisis by seizing control a year ago of the two largest mortgage finance companies in the world, Fannie Mae and Freddie Mac.
While this made it possible for many borrowers to keep getting loans and helped protect the housing market from further damage, the government's newly dominant role -- nearly 90 percent of all new home loans are funded or guaranteed by taxpayers -- has far-reaching consequences for prospective home buyers and taxpayers. The government has the power to decide who is qualified for a loan and who is not. As a result, many borrowers among both poor and rich are frozen out of the market.
Nearly one-third of those who obtained home loans during the boom years of 2005 and 2006 couldn't get one today, according to mortgage industry analysts. Many of these borrowers were never really able to afford their homes and should not have gotten loans. But many others could, and borrowers like them are now running into tougher government standards. At the same time, taxpayers are on the hook for most of the loans that are still being made if they go bad. And they are also on the line for any losses in the massive portfolios of old loans at Fannie Mae and Freddie Mac, which own or back more than $5 trillion in mortgages.
There is growing evidence that many loans being guaranteed by the government have a significant risk of defaulting. Delinquencies are spiking. And the Federal Housing Administration, another source of government support for home loans, is quickly eating through its financial cushion as losses mount. The outlay has already reached about $1 trillion over the past year and is rising. During that time, the government has pumped more money into the mortgage market than has been spent on Medicare or Social Security or the defense budget, more even than Washington has paid to bail out banks and other struggling companies.
"Absent government intervention, there would be no lending," said Nicolas P. Retsinas, director of Harvard University's center for housing studies. Government officials generally agree that it would be better for private lenders to resume their traditional role as major providers of finance for home loans. But policymakers now face some tough choices. They must decide how to reduce support for the mortgage market without letting it collapse. And they must decide what kind of support the government should provide in the long run. "The problem was a long time brewing, and the problems in our mortgage finance system will take a long time to repair," said Michael Barr, the Treasury's assistant secretary for financial institutions.
Fannie Mae and Freddie Mac were chartered by Congress four decades ago to create a marketplace where mortgage lenders could sell the loans they made and use that money to make more loans. The two companies were owned by private shareholders and for a fee guaranteed investors in mortgage loans that they would get paid. After the government seized Fannie and Freddie, it offered them an unlimited line of credit and pledged to inject up to $400 billion to keep them solvent. But this is not the only form that government involvement in housing finance takes.
The Federal Reserve is purchasing hundreds of billions of dollars of mortgages with the aim of ultimately owning $1.25 trillion worth. This buying spree has flooded the mortgage market with money, forcing down interest rates and assuring lenders they have somewhere to sell their loans. The Treasury Department has a similar, though smaller, program. The Federal Housing Administration, meantime, is dramatically increasing the amount of home loans it insures. Its share of new mortgages jumped from 1.8 percent in 2006 to 18 percent so far this year, according to Inside Mortgage Finance. It expects to insure about $400 billion this year. Several other agencies, such as the Department of Veterans Affairs, also provide mortgage guarantees.
All told, the government now stands behind 86 percent of all new home loans, up from about 30 percent just four years ago, according to Inside Mortgage Finance. Fannie and Freddie had long played a dominant role in the mortgage market, providing traditional 30-year, fixed-rate loans. But earlier this decade, they faced competition from banks and other lenders promoting exotic mortgages, such as those that did not require proof of income or were available to people with checkered credit histories. With housing prices on the rise, these loans became ever more prevalent, and lenders figured that a struggling borrower could always get out from under a loan by selling or refinancing his home.
For the first time in decades, the rate of home ownership ticked up, reaching 69.2 percent. Many first-time buyers were of lower income, and many such buyers were black or Hispanic. Fannie and Freddie, afraid of losing more market share, also began funding risky loans. Then, in 2006, the housing market began to tumble and many people couldn't or wouldn't pay their loans. Lenders and mortgage financiers suffered staggering losses. New loans dried up. Interest rates spiked. With investor confidence in Fannie and Freddie crumbling and the global economy at stake, the government seized the firms, nationalizing the U.S. housing finance system.
Many borrowers had been put into loans they could not afford, and when the mortgages failed the results were catastrophic, precipitating the financial crisis. The tighter market that emerged -- whether the consequence of stricter government standards or an industry retreat from risky practices -- now excludes some groups of aspiring home buyers. "People say, 'Well that's good because of lots of people who got loans in the past shouldn't have gotten those loans at all,' " said Keith Gumbinger, a vice president at research firm HSH Associates. "But there were tiny niche markets for whom those products were originally intended, and those people who legitimately need them now won't get them."
Although Fannie and Freddie don't make loans, they effectively set standards for the mortgage industry by detailing what kind of loans they will purchase from lenders and at what cost. The companies, for instance, require documentation of income and have increased fees on loans for people who lack stellar credit and hefty down payments, especially those looking to buy condominiums. All but gone are subprime mortgages, initially meant to help people with blemished credit until they could get another loan. All but gone are the no-money-down mortgages used by four out of 10 first-time home buyers in 2005 and 2006. Those loans originally catered to wealthy borrowers with great credit who wanted to buy a home without having to liquidate their investments.
And the advances in minority and low-income home ownership recorded earlier this decade have largely proved to be a mirage. The U.S. homeownership rate has declined to 67.4 percent. Some people who are no longer eligible for loans elsewhere have turned to FHA, which does not demand top-notch credit scores or sizable down payments. But for some consumers, such as Lisa McCracken of Stafford County, the FHA's minimum 3.5 percent down payment can be a stretch. McCracken, a traveling nurse, has been scrimping to raise the down payment, living with her parents to save money. "I think I can swing it, but it won't be easy," she said. "I'll be wiping out a lot of my savings to buy a house."
The self-employed face difficulties because they tend to have a tough time documenting their income, as required by Fannie Mae, Freddie Mac and FHA loans. Donald Prieto, who owns a roof contracting business in San Diego, has shelved his plans to buy a new home. Five years ago, he and his wife purchased a small home without having to verify his income. They have made their payments on time, have maintained solid credit scores and have plenty of cash in the bank, he said. Now, they have three children. They want a larger home, but several lenders have turned them away because he does not have two years' worth of paychecks to show.
For that reason, Prieto has incorporated his company and started cutting himself formal paychecks. "No bank wants to take risks anymore, and I understand that," Prieto said. "I just have to wait." Other would-be buyers -- including investors, second-home and condo buyers, and people who need exceptionally large loans dubbed "jumbos" -- have fewer options than before. Earlier this summer, Philip Zanga, an investor, signed a contract on a $367,000 condo in Bethesda this summer and paid a $15,000 deposit. He planned to put down 60 percent, but his loan was rejected. Investors and loans for condos are both deemed risky by Fannie and Freddie. "Why turn away someone willing to put 60 percent down?" asked Avi Galanti, Zanga's real estate agent. "What's the risk in that?"
Taxpayers could be hit with a staggering tab even if a small proportion of loans go bad. Fannie and Freddie now own or guarantee more than $5 trillion in home loans. (That equals two-thirds of the debt the U.S. government owes.) And many could be in trouble. Mortgages owned and backed by the companies often required down payments of no more than 10 percent. With housing prices down sharply, many borrowers are underwater, owing more than their home is worth, so they cannot sell or refinance to pay off troubled loans. As the economy has deteriorated, delinquencies are spiking and losses are mounting. In the past year and half, the companies have posted more than $150 billion in losses.
Similar risks threaten to engulf FHA. Nearly 8 percent of FHA loans at the end of June were either 30 days late or in the process of foreclosure, according to the Mortgage Bankers Association. That compares with 5.4 percent of such loans a year ago. As a result, FHA has been exhausting much of its loss reserves, which are funded by premiums paid by borrowers. The reserves currently stand at an estimated 3 percent of all outstanding loans, half of what they were just a year ago. If the reserves fall below the 2 percent threshold set by Congress, they could require a taxpayer bailout.
"Having the government this heavily into the mortgage market is inherently a dangerous thing for taxpayers," said Anthony Sanders, a finance professor at George Mason University. "We've already gone through one big bubble and burst, and right now the taxpayers are on the hook for a substantial amount of money."
Fannie Mae, Freddie Mac Struggle A Year After Takeover
Many questions remain about Fannie and Freddie's future, but several things are clear: The companies are unlikely to return to their former power and influence, the bailout is sure to cost taxpayers even more money and the government will have a big role in the U.S. mortgage market for years to come.
Fannie Mae was created in 1938 in the aftermath of the Great Depression. It was privatized 30 years later to limit budget deficits during the Vietnam War. In 1970, the government formed its sibling and competitor Freddie Mac. The companies boomed over the past decade, buying mortgages from lenders, pooling them into bonds and selling them to investors. But critics called them unnecessary, arguing that Wall Street could support the mortgage market itself. That argument has faded in the wreckage of the failed loans that led to the housing bust. Investors have fled any mortgage investment that doesn't have the government standing behind it.
"No longer is anyone arguing that the private sector can handle this on its own," said Jaret Seiberg, an analyst at Washington Research Group. The government stepped in to take control of the two companies on the weekend of Sept. 6, after they were unable to raise money to cover soaring losses and their stock prices plunged. A year later, the government controls nearly 80 percent of each company, and their problems are growing as defaults and foreclosures continue to skyrocket. The percentage of homeowners who have missed at least three months of payments is normally under 1 percent for both companies. Now it's nearly 4 percent for Fannie and 3 percent for Freddie.
Fannie had nearly $171 billion in troubled loans as of June and had set aside $55 billion to cover those losses, while Freddie had nearly $78 billion in troubled loans and reserves of only $25 billion. "It's much worse than anybody thought," said Paul Miller, an analyst with FBR Capital Markets. It could be another year before the final taxpayer tab for Fannie and Freddie is known, and that outcome will depend on when delinquencies and foreclosures finally crest. Barclays Capital predicts the companies will need anywhere from $160 billion to $200 billion out of a potential $400 billion lifeline, which the Obama administration expanded from the original $200 billion set last fall. Most analysts don't expect the money to be returned anytime soon, if at all.
"What will ultimately end up happening," said Barclays analyst Ajay Rajadhyaksha, "is that the U.S. taxpayer swallows the bill." Despite federal control, Fannie and Freddie have recently surged on Wall Street. The companies said Friday that they now comply with New York Stock Exchange requirement for an average closing price of $1 a share or more. But most analysts still say the companies' stocks will be worthless in the long term. The Obama administration doesn't expect to announce its plans for the two companies until early next year, but powerful interest groups aren't waiting until then. The Mortgage Bankers Association on Wednesday offered a detailed plan to replace Fannie and Freddie with several federally-regulated private companies.
That proposal still retained a big government role, giving those companies the ability to issue mortgage bonds formally guaranteed by the federal government. In the meantime, both Fannie and Freddie have been drafted to implement the Obama administration's effort to attack the foreclosure crisis. Freddie Mac now has about 600 workers either modifying loans or monitoring compliance with the program's rules. Fannie Mae said it has added hundreds of employees to work on foreclosure prevention efforts.
The early results have been disappointing. For example, while Fannie or Freddie refinanced 2.9 million loans from January through July, only about 60,000 were taking advantage of an Obama administration plan to help "underwater" borrowers who owe more than their homes are worth. At the same time, nearly 70 percent of U.S. mortgages made in the first half of this year went through Fannie or Freddie, up from 62 percent last year, according to Inside Mortgage Finance, a trade publication. That's a big change from three years ago, when the risky lending market was still alive and Fannie and Freddie's share was down to 33 percent. "We've been the mortgage market," said John Koskinen, Freddie Mac's chairman. "Without that financing availability, people would not have been able to get a mortgage."
Fannie and Freddie don't directly make loans, but they exert enormous influence over the industry by issuing detailed standards for the loans they will purchase. Lenders must feed their borrowers into Fannie and Freddie's computer systems, which evaluate borrowers based on their credit scores and the size of their down payment. Both companies, facing huge losses, have kept those standards tight, frustrating many. Eric Delgado, a mortgage broker in Rockville, Md., says there's zero flexibility with either company. Either borrowers qualify or they don't. No arguing. No excuses.
But some in the industry say the restrictions are long overdue after several years of lending excesses. "You needed to bring some reality to the market," said Michael Moskowitz, chief executive of Equity Now, a New York-based mortgage lender, which does about 80 percent of its business with Fannie and Freddie. Fannie Mae CEO Michael Williams declined an interview request, but said in an e-mailed statement that "it is not enough to help a borrower own a home. We must also help ensure that they will be able to stay in the home over the long term."
Congress Failed to Save Fannie, Freddie: Lockhart
The collapse of Fannie Mae and Freddie Mac one year ago was the result of bad government policy that took too long to be corrected, Jim Lockhart, the GSE's former regulator, told CNBC. “The problem was that Congress allowed them to be leveraged well over 100 to one, and we were asking since the day I took the job, three and a half years ago, for legislation to fix it,” said Lockhart, who recently left the FHFA to take a job with billionaire investor Wilbur Ross.
“It didn’t happen until a little over a year ago and by then it was only about 40 days until the conservatorship.” Even though Freddie reported a small profit last quarter, Lockhart said he does not think that will continue. What's more, Fannie and Freddie will also not be able to repay the government in full to cover the cost of their bailouts, he said.
Lockhart was more positive about the prospects for the housing market, saying he expects an increase in prices in 2010, the first in several years. “I think we are starting to stabilize,” said Lockhart. “I think some of the programs that have been put in place, they are little slow, but we are starting to get progress on the refinancing program, the modification program and certainly mortgage rates are at a point were they are very attractive.”
Fannie, Freddie Fall on Lockhart Comments
Fannie Mae and Freddie Mac shares were falling Tuesday after their former regulator predicted they are never going to fully repay their debts to the U.S. government. James Lockhart, the former director of the Federal Housing Finance Agency and currently a vice chairman at W.L. Ross, appeared Tuesday on CNBC's "Squawk Box" program to discuss the likelihood that Fannie, Freddie and AIG would repay their government debt. After rising initially, shares of Fannie and Freddie recently were falling 6.8% to $1.65 and 3.6% to $1.90, respectively.
Though he declared himself "not an expert on AIG's ability to pay," he did note that the firm has assets it can sell off in an attempt to accomplish that goal. That stands in contrast to Fannie and Freddie, which Lockhart said were allowed by Congress to be leveraged over 100 to 1. "I've said and I continue to say that unfortunately the U.S. will probably not be repaid for its full investment in Fannie and Freddie," Lockhart said. He also predicted that the small profit Freddie reported in the last quarter will not continue.
Speculators have driven the stocks of both Fannie and Freddie up more than 150% in the last month, and both companies' shares were up on Tuesday morning, along with other distressed financials Citigroup and CIT Group. AIG shares were an exception, down more than 9% recently.
Real Estate - The 800,000 Pound Deflationary Gorilla
by Adam Brochert
The housing market is rapidly deteriorating under the surface. A housing price collapse is a highly deflationary event because it affects so many banks and individuals. We are not close to a bottom in the real estate market and it is essentially almost impossible for it to come before the 2011-2012 time frame. If our government insists on continuing to subvert what's left of the free market system in real estate, it may take another decade to find the bottom.
Here's a recent headline for you: "Nine years worth of condos flood uptown Charlotte."This is Charlotte, North Carolina folks. We're not talking about an obvious place like southern Florida, California, or Las Vegas. We're talking about a fairly typical non-coastal American city (I mean no offense to those in Charlotte who believe they are above or below average). Nine years supply at the current sales pace while credit continues to get tighter and unemployment is still rising?!
Banks are now hiding foreclosures and refusing to list foreclosed homes on the market! Even worse, banks are allowing people who stop paying their mortgage to stay in their homes for 2 YEARS OR MORE without taking back the house.
This means that there is an absolutely huge pent-up supply of homes that will need to be sold onto the market eventually. This supply will hit right as the psychology for "investing" in real estate turns seriously south. People will be looking to rent, not buy, and yet an absolute flood of homes will need to be brought to market in this environment. By the way, the ability of people to buy (due to worsening unemployment and and ever tightening lending standards) will have decreased further as this supply eventually makes its way to the market. Many of these homes will be rented, forcing rents to decline as well (which in turn lowers the value of a home for a potential investor looking to buy a rental property).
Real estate is dead. Who can revive it? Government can (NOT). But that won't stop government from trying. "Stimulus" buying incentives trying to revive a burst bubble is a waste of people's hard-earned money and won't stop the slide in real estate prices, but it will destroy taxpayer wealth and lock unsuspecting citizens into debt on a depreciating asset.
According to an article in the Financial Times, Fannie and Freddie have "backed more than 70 per cent of new home loans since 2008."These loans, of course, will go bad in high numbers. Fannie and Freddie also have $5.5 trillion of outstanding debt and guarantees on securities and a combined $1.5 trillion of mortgages and mortgage-backed securities on their balance sheets according to the same article as well as getting heavily involved in the "loan modification" push from the current administration. The government is now backing 90% of new mortgages according to a different article in the Washington Post, since private banks are smart enough to stop making loans in this environment. So, the taxpayer will get ass-raped (again) as this house of cards is allowed to gradually collapse and implode. Anyone with any common sense can see that this is a huge pending disaster that now cannot be avoided, but I guarantee that politicians will act surprised when this causes a second (and third) real estate and fiscal crisis.
The moral hazards now in place have staggering implications. If your neighbors can live in their house for free, why should you pay the mortgage? If you're going to have to pay for the housing crisis anyway via taxes and looting of the U.S. Treasury by the banks, why not get something for yourself and/or your family by living for free and then walking away (might as well trash the place on the way out, too, just to get even and let off a little steam). I am not advising such behavior (though walking away may well be the best option for many individuals depending on state law and specific circumstances and I understand the frustration behind a "trash out"), but I am saying that such thinking and actions make sense to a significant portion of those who currently hold a mortgage. And for those who don't follow such things, this is not a subprime borrower issue (that's yesterday's news!), this is a prime borrower issue!
The housing wealth effect in reverse is also a powerful deflationary concept. People in aggregate can no longer use their homes as ATMs by taking out home equity lines of credit and other cash-out refinances to fuel consumption. Predictions that half of U.S. mortgages will be underwater by 2011 are not one crazy bear's thoughts, they are mainstream views! People who owe more on their homes than they are worth feel poorer and act accordingly (in aggregate). This decreases consumption and the consumer is needed to get "growth" back on track in the U.S.
And what about commercial real estate? Everyone knows this shoe is dropping right here and right now as retailers, restaurants and real estate-related businesses (among other types of businesses) see their sales drop off a cliff and are unable to make lease payments. Here's a brief summary of some ballpark numbers of the size of the problem, though I note with amusement that the author of this piece is already calling for a bailout (when in doubt, put it on the taxpayers' tab!).
All this real estate debt and all the pending defaults that will help lower the staggering amount of debt outstanding are highly deflationary. They will ensure a steady and high rate of bank failures for at least the next few years. To make things worse, the FDIC is essentially bankrupt already and we are just getting started with the bank failures. The FDIC is also conveniently ignoring undercapitalized banks for as long as possible (because they are broke and don't want the bad press of tapping their U.S. Treasury line of credit, which of course they are going to have to do eventually). This will end up costing taxpayers even more money when the involved banks are finally placed into receivership.
With banks unwilling and/or unable to lend (because they are scared and/or insolvent) and with citizens broke, drowning in debt and fearing a pink slip every day, the private, non-federal, for-profit federal reserve bank corporation is not going to be able to spark price inflation in asset classes like stocks, commodities or corporate bonds. And you can forget real estate. This popped bubble ain't coming back for at least a generation. Even once we hit bottom, we will scrape along the bottom for a few (several?) years.
This so-called gloom and doom is good news for savers and renters! Not only will home prices continue to fall, but rents will fall as well, so it will be cheaper and cheaper to live on a monthly expense basis and you will be able to save more money each year to buy a house in the future. This, of course, assumes that you can keep your job and income level and you put your savings in a safe place.
Consider putting some of those savings into physical Gold on the next Gold price drop, as Gold will continue to rise relative to real estate prices and provides insurance against a currency event that won't stop deflation but will devalue the U.S. Dollar significantly. Here's a chart stolen from an article by Adrian Ash at bullionvault.com (and defiled with my scribbles) that shows how much further housing prices will drop when priced in Gold before we reach "the" bottom in real estate in the U.S.:
There will be deals of a lifetime in real estate (even better than this one, which by the way shows that we have moved beyond the 1st inning in this real estate collapse) over the next decade for those who are patient and who can maintain some capital. In the mean time, the ongoing real estate bubble popping is an 800,000 pound deflationary gorilla that cannot be ignored in the inflation vs. deflation debate.
FHA Likely To Be The Next Shoe To Drop
The FHA is a big reason that home prices haven't fallen even further. The FHA's aggressive lending programs have continued throughout the housing downturn, causing its market share of the mortgage industry to grow from 2% in 2005 to 23% today. The FHA is an even larger percentage of the new home mortgage industry, with nearly 25% market share, according to HUD.
The FHA insurance fund, however, is likely running dry. According to a report from mortgage finance experts (click here to read the report), the FHA will not meet its minimum requirement as of its fiscal year-end, which is only 27 days from now. For months, we have been investigating this and reporting our findings to our clients.
While almost all of the experts believe that Congress would support the FHA if necessary (it's currently self-funded), we wonder if FHA officials will be under pressure to continue tightening their lending policies, which currently allow 96.5% mortgages to people with 600 FICO scores. Already, FHA has contracted its own standards to require a 10% down payment for those with credit scores below 500.Claims against the insurance fund have climbed, with roughly 7% of all FHA-insured loans now delinquent.
Given the FHA's September 30 fiscal year-end, this financial reality will come to light about the same time that other market forces run out of steam:
- Just as the $8,000 tax credit expires.
- Just as more of the stalled REO currently held on banks' balance sheets will be coming to market.
The culmination of all these factors means housing could see another leg down later this year or early next year.
Here are key reasons FHA is volatile:
- Growing Pains: FHA lending has propped up the housing market since credit tightened and seller-funded down payment assistance went away last fall. The staff required to manage and oversee the tremendous growth has had difficulty keeping pace.
- Subprime Wolves: Thousands of mortgage brokers who focused on the subprime market rebranded themselves by shifting into the FHA-backed business. Approved FHA lenders grew from just over 9,600 at the end of FY07 to nearly 14,000 today, according to HUD.
- Shifting Distribution: Last November's housing bill increased the size of the loans that the FHA could guarantee. As a result, FHA lending in high-cost states rose rapidly - California, Nevada and even Florida saw their percentage of originations spike. But these are also the states where collateral value has declined the most.
- No Guard Dog: It's hard to imagine, but the FHA has no Chief Credit Risk Officer, according to several industry experts including Ann Schnare, a leading FHA and mortgage finance expert with Empiris LLC. A HUD source says they are monitoring risk, however, and FHA Commissioner David Stevens expressed his personal concern in a USA Today article this week.
HUD's audit for FY08 (which ended 9/30/08) showed that the FHA capital ratio declined dramatically from 6.4% to 3.0%, but projected that it would remain above its statutory minimum of 2% going forward. Conditions have changed drastically since that time, and none of the volatile points listed above were factored into that projection.
In June, even the HUD Inspector General conceded that, "if more pessimistic assumptions are factored in, the ratio could dip below 2 percent in succeeding years requiring an increase in premiums or Congressional appropriation intervention to make up the shortfall."
In a study funded by Genworth Financial, Schnare, along with Michael Goldberg of Credit Facilitator Solutions, conducted their own analysis to come up with a more realistic projection of the FHA's capital ratio. Factoring in assumptions about future house price trends and economic conditions from Economy.com, they predict that we'll see a huge capital shortfall against the statutory minimum capital ratio of 2% by the end of this fiscal year - a shortfall of $3 billion in FY09 and $4 billion in FY10.
Recognizing that many of the market forces buoying FHA lending are running out of steam, there is a new effort on Capitol Hill aimed at FHA reform. The bill is officially titled HR 3146, or 21st Century FHA Housing Act of 2009, and its primary focus is to beef up the FHA to handle the swell of new business and to develop a mechanism to take punitive action against unscrupulous lenders and brokers.
Without a strong and active FHA, millions of potential home buyers lose access to mortgage credit. While the FHA is self-funded, it carries the full faith and credit guarantee of the U.S. government. Since taxpayers will be on the hook for credit losses, we suspect that a number of elected officials will call for the FHA to reduce risk. At the very least, expect even tighter credit to have a serious impact on home sales.
In summary, watch the growing controversy regarding the FHA very carefully. The decisions made to allow the FHA to continue lending will have a huge impact on the housing market, particularly when so few entry-level buyers have a substantial down payment.
They Left Fannie Mae, but We Got the Legal Bills
by Gretchen Morgenson
Precisely one year ago, we lucky taxpayers took over Fannie Mae and Freddie Mac, the mortgage finance giants that contributed mightily to the wild and crazy home-loan-boom-turned-bust. In that rescue operation, the Treasury agreed to pony up as much as $200 billion to keep Fannie in the black, coughing up cash whenever its liabilities exceed its assets. According to the company’s most recent quarterly financial statement, the Treasury will, by Sept. 30, have handed over $45 billion to shore up the company’s net worth.
It is still unclear what the ultimate cost of this bailout will be. But thanks to inquiries by Representative Alan Grayson, a Florida Democrat, we do know of another, simply outrageous cost. As a result of the Fannie takeover, taxpayers are paying millions of dollars in legal defense bills for three top former executives, including Franklin D. Raines, who left the company in late 2004 under accusations of accounting improprieties. From Sept. 6, 2008, to July 21, these legal payments totaled $6.3 million.
With all the turmoil of the financial crisis, you may have forgotten about the book-cooking that went on at Fannie Mae. Government inquiries found that between 1998 and 2004, senior executives at Fannie manipulated its results to hit earnings targets and generate $115 million in bonus compensation. Fannie had to restate its financial results by $6.3 billion. Almost two years later, in 2006, Fannie’s regulator concluded an investigation of the accounting with a scathing report. “The conduct of Mr. Raines, chief financial officer J. Timothy Howard, and other members of the inner circle of senior executives at Fannie Mae was inconsistent with the values of responsibility, accountability, and integrity,” it said.
That year, the government sued Mr. Raines, Mr. Howard and Leanne Spencer, Fannie’s former controller, seeking $100 million in fines and $115 million in restitution from bonuses the government contended were not earned. Without admitting wrongdoing, Mr. Raines, Mr. Howard and Ms. Spencer paid $31.4 million in 2008 to settle the litigation. When these top executives left Fannie, the company was obligated to cover the legal costs associated with shareholder suits brought against them in the wake of the accounting scandal.
Now those costs are ours. Between Sept. 6, 2008, and July 21, we taxpayers spent $2.43 million to defend Mr. Raines, $1.35 million for Mr. Howard, and $2.52 million to defend Ms. Spencer. “I cannot see the justification of people who led these organizations into insolvency getting a free ride,” Mr. Grayson said. “It goes right to the heart of what people find most disturbing in this situation — the absolute lack of justice.” Lawyers for the three executives did not returns calls seeking comment.
An additional $16.8 million was paid in the period to cover legal expenses of workers at the Office of Federal Housing Enterprise Oversight, Fannie’s former regulator. These costs are associated with defending the regulator in litigation against former Fannie executives. This tally of taxpayer legal costs took several months for Mr. Grayson to extract. On June 4, after Congressional hearings on the current and future status of Fannie and Freddie, he requested the information from the Federal Housing Finance Agency, now their regulator. He got its response on Aug. 26.
The lawyers’ billable hours, meanwhile, keep piling up. As the F.H.F.A. explained to Mr. Grayson, the $6.3 million in costs generated by 10 months of legal defense work for Mr. Raines, Mr. Howard and Ms. Spencer includes not a single deposition for any of them. Instead, those bills covered 33 depositions of “other parties” relating to the shareholder suits and requiring the presence of the three executives’ counsel.
One of Mr. Grayson’s questions about these payments remains unanswered — whether placing Fannie Mae into receivership, rather than conservatorship, would have negated the agreement to cover the former executives’ legal costs. Choosing conservatorship allowed Fannie to stabilize and meant that it was going to continue to operate, not wind down immediately. But, Mr. Grayson pointed out: “If these companies had gone into receivership instead of conservatorship, the trustee in bankruptcy or the receiver would have been free, legally, to reject these contracts that called for indemnification. Raines, Howard and Spencer would have had to pay their own fees.”
When asked about this, Fannie’s regulator, the F.H.F.A., waffled. “Whether these costs could have been avoided would depend on the facts and circumstances surrounding any receivership,” it said. “It is possible that receiverships could have reduced the costs of the litigation, but by no means certain.” Mr. Grayson said he intended to find out whether there are any legal options under the conservatorship to stop paying for the defense of the Fannie Mae three. “When did Uncle Sam become Uncle Sap?” he said. “In a situation where billions of losses have already occurred, is it really asking too much that people pay their own legal fees?”
While the $6.3 million paid to defend Mr. Raines, Mr. Howard and Ms. Spencer is a pittance compared with other bills coming due in the bailout binge, it is still disturbing for these costs to be covered by those who had nothing to do with the problems and certainly did not benefit from them. The money may be small, but the episode’s message looms large: those who presided over this debacle aren’t being held accountable. “It is wrong in a very deep sense,” Mr. Grayson said. “The essence of our society is that people who do good things are rewarded and people who do bad things are punished. Where is the punishment for Raines, Howard and Spencer? There is none.”
Excess Liquidity Game Is Coming To An End
by Tyler Durden
In his daily notes, Rosie looks at what is sure to cause a few sleepless nights to all trend chasers who believe that the trillions in excess liquidity will be there to forever prop up artificially high stock prices. News flash - it won't, and it has already started to contract aggressively, yet computers seem to have problems with pulling down St. Louis Fed time series in their quest to constantly front-run one another.
Below are the three main charts of money aggregate levels over the past three months. As one can see, M1, M2 and MZM have commenced contracting at an alarming rate, implying that sooner rather than later, PMs will be forced to take out that rusty calculator and do some good old fashioned portfolio rebalancing and relative value digging, as the Fed can only prop the stratospheric equity prices so high before everything comes crashing down.
Here is Rosenberg's direct quote:
It is interesting that the equity market has begun to wobble (fade last Friday’s rally on such low volume) because we have noticed that some key liquidity indicators are not behaving very well, all of a sudden. M1 fell 1.0% in the August 24th week and over the past four weeks is down at a 6.5% annual rate. M2 has contracted in each of the past four weeks too and over that time has slipped at a 12.2% annualized pace, which is a near-record decline. We see the same trend in the broad MZM money measure — off at a 15.8% annual rate over the past month. Bank credit also remains in a fundamental downtrend — contracting at an epic 9% annualized pace over the past four weeks.
So for the first time in the post-WWII era, we have deflation in credit, wages and rents, and from our lens this is a toxic brew that in the end will ensure that the focus on capital preservation and income orientation will be the winning strategy over a strict reliance on capital appreciation.
As a reminder, by fundamental value we mean something a little more tangible than "sentiment" which was the reason for JPM's earlier upgrade of GE which seems to be the driving force for most of today's stock moves (aside from Bernanke's crusade to destroy the dollar at all costs of course).
To end, here is another quote from Rosie which may explain much of the recent ebulience in the equity market:
In case you are wondering how it is that the housing market has suddenly sprung back, it’s because the era of free money is back, courtesy of the benevolent U.S. government. The FHA’s share of the mortgage market has ballooned from a residual 3.0% in 2006 to 23.0% currently as the government moves in to replace the private subprime lending industry. So now we are back to the thought process that insuring mortgages with a 3.5% down payment is a good thing for the economy — little surprise that the FHA delinquency rate has soared to nearly 8.0% from 5.4% a year ago, and the taxpayer is on the hook. How is it that there is no public outrage for a government policy of giving another shot of scotch to the drunken sailor is totally beyond our comprehension.
G20 rules spark fears of more bank bail-outs
France and Germany may be forced to semi-nationalise more of their stricken banks after the G20 imposed new, stricter rules on banks' balance sheets. Despite resistance from French and German finance ministers, the G20 has insisted that banks will in the future have to raise more capital to shore up their balance sheets, and that only the highest quality of capital - such as shareholder equity - will be counted. According to G20 insiders, the move is a particular blow to some of the leading European banks, which are likely as to have to raise more capital, implying further taxpayer bail-outs.
Although coverage of the summit in London on Saturday was dominated by the G20's proposed clampdown on bonuses, sources say that the agreement on capital may be far more important for the banking system in the long run. In a move which is intended to bolster the Basel rules on banking regulation, the G20 said that in the future banks must raise more capital, must devise so-called "living wills" to ensure they can be dismantled less painfully and must be subject to an overall leverage ratio. The rules imply that it will be extremely difficult in the future for banks to generate the high levels of profits they did in the run-up to the crisis.
US Treasury Secretary Tim Geithner has proposed setting up a new system of bank accounting rules by 2012, but the French and Germans lobbied hard behind the scenes at the weekend to scrap such plans, instead falling back on the existing Basel II rules, which the US has not yet adopted. Insiders said this owed much to the fact that to meet the more stringent US proposals Continental European banks would likely have to raise significantly more equity. Suspicions abound that while Anglo-Saxon banks faced instant writedowns in the early months of the crisis, their European counterparts may suffer far more in its closing stages.
The G20 meeting, which precedes a heads-of-state summit in Pittsburgh later this month, agreed to impose unprecedented new restraints on bankers' pay. Under the new proposals, to be firmed up by the Financial Stability Board in the next fortnight, banks will have to spread out bonus payments over three years, and will have to insist on being able to claw back cash payments if their own health deteriorates after the bonus has been paid.
Angela Knight, chief executive of the British Bankers' Association, said the majority of the recommendations had already been taken on board in Britain but expressed concern about the claw-back proposal. She said: "This will require careful consideration and I'm not sure about the legal framework." She added: "We have gone a lot further on pay in this country than France and Germany. They were making the most of it but there's a lot of difference between rhetoric and what countries actually do."
Regulators agree tough rules on bank capital
Regulators have agreed tough new rules for banks that flesh out proposals agreed by the G20 group of nations over the weekend that would force many in Europe to raise tens of billions of euros in capital in coming months. The rules will force banks to substantially improve the quality and extent of the capital buffers they hold to absorb shocks. At least half of the capital cushion of banks must comprise common equity and retained earnings under measures agreed by the powerful Basel committee of central bank governors and bank regulators, according to people familiar with the discussions.
The committee also agreed to put “hard” limits how much banks can borrow. It is likely to set a ceiling on borrowings of no more than 25 times assets. There will be no exceptions for less risky assets. Moreover, it also agreed that bank supervisors should be able to limit the ability of banks to make payouts to shareholders through dividends or buy-backs when times are good, enabling them to build “counter-cyclical” buffers against bad times. The Basel committee is expected to put out concrete proposals by the end of the year and adjust them by the end of 2010 after carrying out an impact assessment.
European banks are expected to be hardest hit by the Basel committee moves as complex securities constitute a large part of their capital cushions than their US peers. The securities, a mixture of debt and equity, are known as hybrid capital. The list of banks that need to raise common equity could include Germany’s Commerzbank and Lloyds Banking Group in the UK, as well as French and Italian banks, assuming the Italians participate in the coming weeks in the planned issue of so-called Tremonti bonds. Analysts forecast rights issues from early 2010. Kian Abouhossein, analyst at JPMorgan, said: “I think the first banks to be forced to raise equity will be those that have hybrid capital from governments.”
Hybrid capital covers a variety of instruments, such as preference shares, that are not pure equity but have traditionally been deemed close enough to it to count towards a bank’s tier one capital ratio – the key measure of financial strength. Some European banks have traditionally held a lot of their capital in hybrid form in an effort to minimise the dilution to equity investors from having to raise fresh funds. Regulators in Europe have allowed banks to hold more hybrid capital than their US counterparts – up to a third of total tier one capital in some jurisdictions. But that has proved problematic in the financial crisis, since hybrid capital does not have the same loss-bearing capacity as true shareholders’ equity.
Some banks – from Royal Bank of Scotland to Switzerland’s UBS – have been buying back their own hybrid debt at knock-down prices in recent months in a tactic aimed at boosting core tier one ratios with the profit on the transactions. But many German banks, in particular, still have very high levels of “hybrid” capital and, in contrast to other countries, there has been little or no fresh equity issuance to offset it.
Current market rebound not a 'real recovery': UNCTAD
A UN think tank on trade warned Monday that the current financial market rebound is not a "real recovery" and that any world economic growth recorded in 2010 was unlikely to exceed 1.6 percent. "The depth of the recession has been so important that of course there will be a rebound ... but we still do not see that this is a real recovery," said Supachai Panitchpakdi, secretary general of the United Nations Conference on Trade and Development (UNCTAD). "The actual increase in the commodities prices is mainly driven by appetite for more risk," he added.
This appetite could also be "reversed at short notice, depending on the pace of recovery and financial market sentiment." Improving economic data including slowing job losses have been heralded by financial markets as green shoots of economic recovery, but UNCTAD poured cold water on the optimism. Chief economist Heiner Flassbeck said the markets had been fuelled by financial speculation that in turn was driven by expectations of recovery. "But anticipation of recovery is just a fiction, it is not there," he added.
The UNCTAD report noted rather that "tumbling profits in the real economy, previous over-investment in real estate and rising unemployment will continue to constrain private consumption and investment for the foreseeable future." "Against this background, global GDP growth may turn positive again in 2010, but it is unlikely to exceed 1.6 percent," it added.
The report also slashed its 2009 forecast from a growth rate of 2.9 percent predicted last September to a contraction of about 2.7 percent. Developed economies should post a 4.1 percent contraction, with Japan showing the deepest shrinkage of 6.5 percent over 2009. Latin America is forecast to post a 2.0 percent contraction. Africa and Asia should hold up the overall global economy, with average growth of 1.2 percent for Africa and 2.6 percent for Asia. As countries sought to emerge from the recession, Panitchpakdi pointed out, attempts to tackle climate change represented a "new opportunity for new investment."
"Climate change mitigation does not contradict development goals but is a process of structural change worldwide that offers enormous economic opportunities for enhancing development," said UNCTAD. This is particularly true for developing countries, which stood to gain if they were able to tap the opportunity to produce their own green products rather than relying on western imports, added Detlef Kotte, an UNCTAD economist. "It is important to review the concept of climate change mitigation. We can see it not only as a cost but as a process that creates income. There are huge market opportunities in more environmentally-friendly goods," he explained.
UN wants new global currency to replace dollar
The dollar should be replaced with a global currency, the United Nations has said, proposing the biggest overhaul of the world's monetary system since the Second World War. In a radical report, the UN Conference on Trade and Development (UNCTAD) has said the system of currencies and capital rules which binds the world economy is not working properly, and was largely responsible for the financial and economic crises. It added that the present system, under which the dollar acts as the world's reserve currency , should be subject to a wholesale reconsideration.
Although a number of countries, including China and Russia, have suggested replacing the dollar as the world's reserve currency, the UNCTAD report is the first time a major multinational institution has posited such a suggestion. In essence, the report calls for a new Bretton Woods-style system of managed international exchange rates, meaning central banks would be forced to intervene and either support or push down their currencies depending on how the rest of the world economy is behaving.
The proposals would also imply that surplus nations such as China and Germany should stimulate their economies further in order to cut their own imbalances, rather than, as in the present system, deficit nations such as the UK and US having to take the main burden of readjustment. "Replacing the dollar with an artificial currency would solve some of the problems related to the potential of countries running large deficits and would help stability," said Detlef Kotte, one of the report's authors. "But you will also need a system of managed exchange rates. Countries should keep real exchange rates [adjusted for inflation] stable. Central banks would have to intervene and if not they would have to be told to do so by a multilateral institution such as the International Monetary Fund."
The proposals, included in UNCTAD's annual Trade and Development Report , amount to the most radical suggestions for redesigning the global monetary system. Although many economists have pointed out that the economic crisis owed more to the malfunctioning of the post-Bretton Woods system, until now no major institution, including the G20, has come up with an alternative.
Does the world have the courage to deal with its debts?
Deflation is spreading from the core of the global system to the most unexpected regions of the world. It has even reached Latin America. Prices are sliding in Peru, Chile, Colombia, Paraguay, Bolivia, Ecuador, Guatemala, and El Salvador, to the consternation of everybody. Enough of the world has already fallen so far into pre-deflation conditions that any misjudgment by the big central banks from now risks setting off a chain-reaction that may prove very hard to stop. CPI inflation has dropped to –2.2pc in Japan (a modern record), -2.1pc in the US, -1.8pc in China, -1.4pc in Spain, -0.7pc in France, and -0.6pc in Germany.
This was not anticipated by the authorities anywhere, so we should be wary of their assurances now that we face nothing more than a brief dip in prices before rising energy costs bring inflation back into familiar and safe territory. No doubt prices will rebound as the "base effect" of oil prices kicks in. But by how much; for how long? The sum of economists in the world (outside Japan) familiar with the cultural and psychological dynamics of deflation can fit into one London bus, and most are historians of the 1930s. If PIMCO guru Bill Gross and hedge fund manager Paul Tudor Jones are right in fearing that the US economy will tip back into a "W-shaped" recession as the sugar rush of fiscal stimulus fades, we may wake up to find that we have baked deep deflation into the pie for 2010 and 2011. The G20's talk of "exit strategies" and rate rises will seem surreal.
White House aides are already mulling another blast of spending. It won't fly. We have hit the political limits of such extravagance almost everywhere. The fiscal crutches of recovery are going to be knocked away, with outright tightening in a slew of states nearing the danger point of debt-compound spirals. This will occur in a world where excess capacity is already at post-War highs. It reeks of deflation. Irving Fisher explained why the self-correcting mechanism of economies breaks down in his Debt Deflation Theory of Great Depressions in 1933: "Over indebtedness to start with, and deflation following soon after". Most of the West has exactly that, but worse – debt is much higher.
He coined the term "swelling dollar" to describe how falling prices and incomes raise the real burden of debts, leading to asphyxiation. There is a "swelling yen" in Japan today. Earnings were down 4.8pc in July from a year earlier. Bonuses fell 11pc. Wholesale prices fell a record 8.5pc. Yes, Japan rebounded in the second quarter as shipping finance came back from the dead. The free fall has stopped. That is all. Industrial output was still down 23pc in July year-on-year. What matters for debt service is that Japan's economy has shrunk by a tenth. Debt has not shrunk. It is rising. The public debt will rocket to 215pc this year.
China is in better shape but it is remarkable that there should be any deflation at all in a year when banks have let rip on credit, doubling lending to $1.1 trillion in the first six months. The money has leaked into property and the Shanghai stock market; or worse, it has been spent building yet more excess plants to produce goods the world cannot yet absorb. This is much like the late phase of America's Roaring Twenties when asset prices reached their crescendo even as the underlying economy – burdened with over-capacity – tipped into deflation.
Beijing is at last tightening credit, mostly by stealth. We will learn soon whether Market Maoists are better at pricking asset bubbles than Ben Strong's Fed in the 1920s, or Ben Bernanke's Fed today. I suspect that Dr Bernanke is more worried about deflation than he dares to let on. His ex-colleague Frederic Mishkin let slip last month that the Fed would be showering more money on the economy (buying US Treasuries), not less, were it not for market angst over the monetization of US deficits.
Bernanke is learning that he cannot in fact administer the anti-deflation medicine he talked about so confidently seven years ago. He can act only if and when the danger is so blindingly obvious that resistance crumbles. There are three ways out of our mess. We can pursue 1930s liquidation that purges debt through mass default. Such Calvinist destruction cannot be imposed on a modern democracy. We can devalue debt by deliberate inflation. This will backfire as bond vigilantes boycott government debt - unless rigged by capital controls or "administrative measures". You see where this leads.
Or we can try to right the ship by paying down our debts, very slowly, by sweat and toil, navigating a treacherous course between the Scylla and Charybdis of the twin-flations, for as long as it takes. This is the only responsible course left we as we face the devastating consequences of our own credit delusions. Are we up it?
China, Bernanke, and the price of gold
China has issued what amounts to the “Beijing Put” on gold. You can make a lot of money, but you really can’t lose. I happened to see quite a bit of Cheng Siwei at the Ambrosetti Workshop, a gathering of politicians and global strategists at Lake Como, including a dinner at Villa d’Este last night at which he listened very attentively as a number of American guests tore President Obama’s economic and health policy to shreds.
Mr Cheng was until recently Vice-Chairman of the Communist Party’s Standing Committee, and is now a sort of economic ambassador for China around the world — a charming man, by the way, who left Hong Kong for mainland China in 1950 at the age of 16, as young idealist eager to serve the revolution. Sixty years later, he calls himself simply “a survivior”. What he said about US monetary policy and gold – this bit on the record – would appear to validate the long-held belief of gold bugs that China has fundamentally lost confidence in the US dollar and is going to shift to a partial gold standard through reserve accumulation.
He played down other metals such as copper, saying that they could not double as a proxy currency or store of wealth. “Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not stimulate the market,” he said. In other words, China is buying the dips, and will continue to do so as a systematic policy. His comment captures exactly what observation of gold price action suggests is happening. Every time it looks as if the bullion market is going to buckle, some big force steps in from the unknown.
Investors long-suspected that it was China. We later discovered that Beijing had in fact doubled its gold reserves to 1054 tonnes. Fait accompli first. Announcement long after. Standing back, you can see that the steady rise in gold over the last eight years to $994 an ounce last week – outperforming US equities fourfold, even with reinvested dividends – has roughly tracked the emergence of China as a superpower in foreign reserve holdings (now $2 trillion).
As I have written in today’s paper, Mr Cheng (and Beijing) takes a dim view of Ben Bernanke’s monetary experiments at the Federal Reserve. “If they keep printing money to buy bonds it will lead to inflation, and after a year or two the dollar will fall hard. Most of our foreign reserves are in US bonds and this is very difficult to change, so we will diversify incremental reserves into euros, yen, and other currencies,” he said. This line of argument is by now well-known. Less understood is how much trouble the Fed’s QE policies are causing in China itself, where they have vicariously set off a speculative boom on the Shanghai exchange and in property. Mr Cheng said mid-level house prices are now ten times incomes.
“If we raise interest rates, we will be flooded with hot money. We have to wait for them. If they raise, we raise.” “Credit in China is too loose. We have a bubble in the housing market and in stocks so we have to be very careful, because this could fall down.” Of course, China cold end this problem by letting the yuan rise to its proper value, but China too is trapped. Wafer-thin profit margins on exports mean that vast chunks of Chinese industry would go bust if the yuan rose enough to close the trade surplus. China’s exports were down 23pc in July from a year before even at the current exchange rate, and exports make up 40pc of GDP. “We have lost 20m jobs in this crisis,” he said.
China’s mercantilist export strategy has led the country into a cul-de-sac. China must continue to run its trade surplus. It must accumulate hundreds of billions more in reserves. Ergo, it must buy a great deal more gold. Where is the gold going to come from?
Beijing to sell first yuan bonds in Hong Kong
Beijing will sell some $876 million of government bonds denominated in the mainland's yuan for the first time in Hong Kong this month, the Finance Ministry said Tuesday, in a move to expand the international use of its tightly controlled currency. The 6 billion yuan ($876 million) bond sale is slated for Sept. 28, the ministry said. Hong Kong is Chinese territory but has its own currency and regulatory system and often is used by Chinese companies to deal with foreign investors.
The yuan, also known as the renminbi, or people's money, does not trade on global markets despite China's huge foreign trade, but Beijing is gradually expanding its use abroad. Chinese officials are concerned about the stability of the dominant U.S. dollar and have called for the creation of a new global reserve currency. The bond sale is "certainly a push to internationalize the renminbi," said Zhang Bin, a specialist in international finance at the Chinese Academy of Social Sciences, a government think tank. "It will increase renminbi business overseas and be conducive to the development of renminbi markets."
Beijing signed a currency swap deal with Argentina in March and has promised to lend yuan to the central banks of South Korea, Malaysia, Indonesia and Belarus in the event of a financial emergency. That could lead to the currency's use in private transactions. A few mainland institutions, including state-owned China Construction Bank Ltd. and Bank of China Ltd., have issued yuan-denominated bonds in Hong Kong. Premier Wen Jiabao, the mainland's top economic official, has promised to strengthen trade and finance links with Hong Kong. Other officials have said it might become the center for handling finance in yuan outside the mainland.
"This measure has significant impact on promoting the depth and breadth of the Hong Kong bond market and strengthening Hong Kong's position as an international financial center," the territory's government said in a statement. The Finance Ministry gave no details of who would handle the bond issue. Two banks—London-based HSBC Holdings and Hong Kong-based Bank of East Asia—said in May they had become the first nonmainland companies approved to sell yuan bonds.
Regulator: China firms may sue over derivatives
China's State-owned Assets Supervision and Administration Commission said on Monday it would support government-run firms that take legal action over heavy losses suffered due to bad derivatives deals. The regulatory watchdog said some firms had already notified foreign banks that they were considering legal action over contracts for oil-related structured options. The remarks came about a week after a report said Chinese state-owned enterprises may default on commodities contracts they have signed with foreign banks to cut massive losses from derivatives deals.
"The move is a justified action to safeguard one's rights and interests in the commercial context," the agency said in a statement sent to AFP, without naming the firms or foreign banks involved. "SASAC is giving great attention and support (to this) and the relevant trade counterparties should cooperate," it said in the statement. The agency added it was conducting an internal investigation into oil-related structured option deals. "(We) support companies' efforts to cut their losses as much as possible... through negotiation and managing their positions through legal means and reserving the right to take legal action," it said.
The agency ordered state firms in March to reconsider their derivative investments overseas and back out of high-risk contracts after several Chinese firms reported huge losses. State-owned carriers Air China, China Eastern and Shanghai Airlines have reported losses of almost two billion dollars since last year on aviation fuel hedging contracts. Late last month, Caijing magazine reported, citing an unnamed state enterprise executive, that only 31 state-owned firms were licensed to enter into such deals, while many more were apparently doing so.
China's Fat Banking Years Are Fading, And Risks Are Rising
Since the stock-holding reform, China's banking sector has seen some years of fat profits, but now for the first time it is experiencing a real test of the economic cycle. There has already been a substantial decline in profits, and accumulating non-performing loans (NPLs) and credit risk are likely to become apparent with the withdrawal of the government's stimulus policies.
The oceanic lending spree in the first half of 2009 has put enormous capital pressure on the banks. The China Banking Regulatory Commission (CBRC), seriously concerned that bad debts will rise while the quality of capital declines, is studying how to deduct subordinated debt capital instruments held by banks from subordinate capital. CBRC has recently issued a "Notice on Improving the Capital Supplement Mechanism for Commercial Banks (draft)," requiring commercial banks to deduct subordinated debt cross-held between banks from the subordinate capital in calculating their capital adequacy ratios.
The deduction will decrease banks' capital adequacy, putting constraints on lending and limiting the supply of funds in demand by the real economy during the fragile recovery. Brokerages and institutions have reported that this provision, if implemented, will drop total capital adequacy levels by nearly one percentage point and cut new lending by about 600-700 billion yuan. CBRC says this policy will help optimize the structure of investors of subordinated debt capital instruments, and will not reduce the circulation of subordinated debt by commercial banks.
The new regulation has triggered dissatisfaction among banks. Frank Newman, chairman of Shenzhen Development Bank, hopes that the new regulation will be applied to future issuance rather than that already issued, and a gradual approach will be adopted during this change. Guo Shuqing, chairman of China Construction Bank, says his bank has not reached a consensus on this issue so far. An increase in the capital adequacy ratio is only a part of risk control, and does not necessarily mean the higher, the better.
CBRC says some share-holding commercial banks have taken on potential risks, and the increased lending has led to capital adequacy nearing 8%, the minimum regulatory standard. CBRC chairman Liu Mingkang has consistently adhered to a cautionary approach and warned banks when the new lending took off in the first half. CBRC has suspended the approval of new business for banks with capital adequacy lower than 9%, including Shanghai Pudong Development Bank, China Minsheng Bank, and China Merchants Bank, among others.
The interest rate differential (IRD) has been the main source of profit for banks. In 2008, though, the central bank cut interest rates five times, and removed controls over the size of loans, leading to lower loan prices and IRD narrowing. In accordance with established practice, the loan re-pricing began at the beginning of 2009, so it had limited impact on the performance of banks last year but its impact on banking sector profits this year is showing.
The first half of 2009 saw 7.37 trillion yuan hit the economy, 2.3 times that in the same period in 2008, and the total capital of the five biggest banks, ICBC, Agricultural Bank, Bank of China, Construction Bank, Bank of Communications, increased by 27.7%, year-on-year. It appears that the increasing base meant greater profits. However, the vast credit growth has not offset the narrowing of IRD and decreasing loan yields, and banking sector profits this year have declined substantially from last year's.
The huge lending has also masked NPLs. If things go wrong with new loans, it usually takes two years for the effect to show. The abundant liquidity has partially revived many weak companies, so the realization of NPLs is delayed. Credit risk is still the major problem. For firms in a difficult operating environment, liquidity will play only a temporary role in easing pressures, and once they mount up NPLs will proliferate.
Most new lending has gone mainly to infrastructure projects and the government financing platform. Regulator's statistics show that in less than a year and a half, the debt of the government financing platform has increased by 3.5 trillion yuan, of which nearly 85% comes from bank loans. Analysts worry that banks' credit risks are supported by the state, and many projects relying on their own cash flow are unable to repay without that state support.
China Sovereign-Wealth Fund May Invest in U.S. Real Estate
China's sovereign-wealth fund is looking to invest in U.S. real estate, including potentially snapping up distressed mortgage securities through a U.S.-government program, according to people familiar with the matter. In recent weeks, officials from China Investment Corp. have held talks with U.S. private-equity fund managers, including BlackRock Inc., Invesco Ltd. and Lone Star Funds, about investment opportunities in beaten-down property assets, from mortgages backed by offices, hotels and other commercial property to ownership interests in actual buildings, according to the people with knowledge of the issue.
As part of its U.S. investment strategy, CIC also is considering investing through the U.S. Treasury's Public-Private Investment Program, known as PPIP, that is designed to rid banks of toxic mortgage securities by enticing investors to buy these assets with unprecedented U.S. government-provided financing, these people say. CIC and spokespeople at BlackRock, Invesco and Lone Star declined to comment.
The discussions come as CIC, which had nearly $300 billion in assets at the end of last year, is moving aggressively to deploy its capital after sitting on the sidelines for much of 2008 amid the global financial crisis. Falling property values world-wide, meanwhile, are creating opportunities for cash-rich buyers. Property markets have plunged since the credit-market crisis that began two years ago.
In the U.S., commercial-property values have dropped 35% from the peak, according to analysts. In a sign of its growing appetite for foreign real-estate investments, CIC recently invested in Goodman Group, a large real-estate trust in Australia, and bought a stake in Songbird Estates PLC, the majority shareholder of Canary Wharf Group, an owner and developer of office towers and retail stores in London.
In addition, CIC has committed about $800 million to a Morgan Stanley global property fund that intends to raise more than $5 billion and invest in real estate world-wide, according to a person familiar with the matter. A Morgan Stanley spokeswoman declined to comment. CIC has plenty of cash. A large chunk of its assets is tied up in its holdings in Chinese banks, but it started 2009 with more than $97 billion in cash, money-market funds and short-term notes.
Last year, CIC deployed just $4.8 billion in global financial markets. This year, with the fund seeking higher returns, it invested that much in a single month, CIC Chairman Lou Jiwei said last month. He said that if CIC's returns going forward are good enough, it might ask the government to give it more of China's $2.132 trillion in foreign-exchange reserves to invest. One sign of its goal to further diversify those holdings came earlier this year, when it promoted Hu Bing, who was in charge of CIC's fixed-income investment, to head a new private-equity division named Private Market Investment Department and which includes real estate.
Mr. Hu, a former market supervisor at China Securities Regulatory Commission, the country's securities watchdog, had worked at Lehman Brothers in New York before going back to China early this decade. To be sure, CIC and other sovereign-wealth funds face considerable obstacles to investing in U.S. real estate. Economic distress has resulted in growing protectionism on Capitol Hill, with some lawmakers blaming China for helping create a credit bubble in the U.S. by investing heavily in U.S. government bonds.
Any large-scale foreign acquisitions of U.S. property could lead to a political backlash reminiscent of the 1980s, when Japanese companies invested about $77 billion in the U.S. property markets and bought assets such as Rockefeller Center and the Pebble Beach golf course. CIC is unlikely to replicate those showy investments. It consistently has taken minority stakes, often below 10%, as CIC executives recognize the fund's lack of management expertise and the potential political ramifications of buying control.
To minimize political risk, CIC's "debut in the U.S. property market likely will be double arm's-length investments," meaning through U.S. fund managers and then with a minority stake in the fund, as opposed to direct stakes in properties, says Michael McCormack, an executive director at Z-Ben Advisors, a consulting firm in Shanghai. Politically, the woes in the U.S. marketplace might work in the favor of foreign investors like CIC this time around. U.S. real-estate executives are lobbying to amend tax laws to encourage overseas capital to flow into U.S. real estate, in an effort to help prevent a further decline in commercial-property values.
About 30 years ago, the resentment of foreign investors flocking to the U.S. to buy up land was so strong that it led the Congress to pass a tax act that ended up discouraging foreign investors from buying all kinds of commercial property in the U.S. Under current law, a foreign investor is taxed on any capital gains from the sale of a U.S. property interest. By comparison, a foreign investor generally doesn't have to pay taxes on gains from the sale of shares in a U.S. company. "Simple reforms could be made that would help address the equity shortfall our markets need to recover," says Jeffrey Deboer, president of Real Estate Roundtable, a trade group that is spearheading the lobbying efforts to modify the law to encourage foreign investments in U.S. real estate.
So far, CIC's foray into the international markets, including its stakes in Blackstone Group LP and Morgan Stanley, has been marked with big losses, at least on paper. But it recently signaled a willingness to reopen the purse, selecting both firms to help oversee new investments in hedge funds. This year, it bought stakes in China-focused alternative asset-management firm Citic Capital Holdings Ltd. and U.S. asset manager BlackRock and has been in discussions about allocating billions more to hedge funds.
It is unclear how much CIC intends to allocate to U.S. real estate. But in order to achieve any meaningful diversification in its portfolio by adding property exposure, the fund would need to set aside between $4 billion and $10 billion to global property investments in the next year and a half, Mr. McCormack estimates. By 2014, CIC's U.S. property investments alone could amount to more than $20 billion, he says.
According to the people with knowledge of CIC's plans, the fund is looking at a wide range of potential investments by hiring U.S. real-estate fund managers that specialize in investing in both property "debt" like commercial-mortgage-backed securities, or CMBS, and "equity," such as interests in real-estate companies.
CIC's interest in the Treasury's PPIP program isn't surprising given the potentially high returns promised by the U.S. government-provided financing. To help banks sell their hard-to-value mortgage assets and thus unclog their balance sheets, Uncle Sam essentially will contribute both equity and debt. The government will match dollar-for-dollar the equity that investors put up and will provide attractive debt financing for the acquisitions.
The PPIP program specifically allows for foreign sources of investment. However, the program limits investment by a single investor to no more than 9.9% to help assuage any concerns that any one investor -- like China -- could control too much, according to government officials. A Treasury spokeswoman declined to comment.
Auto Loans Spinning Out of Control
by Jim Quinn
For the last three decades, millions of Americans have been living in Beverly Hills. But how can this be?
Only 35,000 people reside in the actual city of Beverly Hills, California, but millions have acted like they live in Beverly Hills -- where the median household income is $125,000.
The median household income in the US is $50,000. There are 116 million households in the US; only 12 million households have an income of $125,000 or more, and there are 60 million households making less than $50,000.
But why shouldn’t the 60 million households be entitled to live like the top 10%? This is America, where the American dream of wealth and riches is achievable. Just one small problem: Millions have chosen to live like the privileged Beverly Hills elite without doing the work to earn their way into the top 10%.
It appears that the psychology of the nation transformed in the early 1980s.
Was it the optimistic message of “Morning in America” preached to the country by Ronald Reagan? Was it because the youngest Baby Boomers were turning 35, entering their prime spending years? Or, was it the long-term decline in interest rates from 18% to 1% over two decades? Whatever the rationale, millions are now drowning in a deep pool of debt.
There are 230 million cars in the US and about 200 million drivers. We are a car-crazed nation, with the number of cars per person 40% higher than Europe, 500% higher than China and 6,200% more than India.
In 1970, when I was seven, the number of cars per 1,000 people was 529. Today, it's 765, a 45% increase in three decades. Suburban dwellers have a love affair with their cars.
The average price of a new car now exceeds $30,000. That is a nice chunk of change. I have a mental block paying that much money for an asset that losses 20% of its value in the first year of ownership.
My price limit is $20,000. I finance my cars over four years and try to get 10 years out of them. The six years of no payments goes directly into savings.
My frugality probably harks back to my father buying used cars throughout my childhood -- when it seemed cars were a means of transportation, not a symbol of success.
It appears that expensive luxury cars are often an attempt at filling a psychological or emotional void in people’s lives. We spend half our lives in cubicles or offices and the other half in our houses with gates and fences to keep people at a distance. The only time we are seen by others is on the highways and byways. An expensive sports car tells the world you are a success and is a futile attempt at increasing your perceived happiness.
This brings me to the conundrum that has confounded me as I drive to work each day. There appear to be many more BMW and Mercedes vehicles on the road than people with enough income to own one of these vehicles. How can this be? After a little research, it became quite clear: Borrow today, live like a hotshot, roll the loan or lease into the next loan or lease in three years, and don’t be troubled about the future.
According to the Federal Reserve, consumer non-revolving debt grew to $1.6 trillion today from $300 billion in 1980. About $1 trillion of this is auto loans.
The average automobile loan today is for 63 months, with some going as high as 84 months -- compared with an average of less than 48 months in the early 1990s.
In 1997, banks financed an average 89% of a new vehicle's price. The average loan amount was $17,000. In 2007, banks financed 101% of a new vehicle’s price (because consumers borrowed to cover the amount they were upside down on their trade-in). The average loan amount is now $29,000. A full 40% of all trade-ins involve upside-down car loans.
The average American car “owner” is in debt up to their eyeballs and upside down on their loan, but at least they look like a million bucks.
Of course, it takes two to tango.
A car buyer with no money wouldn’t be able to drive that beautiful BMW X5 or that Mercedes ML350 unless someone loans them the money to do so. This is where the creative geniuses from Wall Street entered the picture.
Auto loans were securitized into packages and sold off to investors. The banks and finance companies who initiated the loans didn’t care if the loans went bad because their sole intent was to move cars off the lots, not lose sleep about silly details like credit scores, income, or ability to pay back the loan.
It worked wonders for the car companies. Annual sales rolled along at a 16 million-per-year clip. Car executives and bankers made ungodly salaries and bonuses.
Then reality set in. Many borrowers couldn’t really afford their loans. Delinquency rates have soared to all-time highs in the 10% range, and are headed higher. The securitization market froze, and annual sales have plunged below 10 million units. Another Wall Street success story.
Car companies’ ability to make extremely low payments through long-term loans and leases is why an average person earning $50,000 a year can drive a BMW and resemble someone making $150,000 per year.
Chrysler and Ford (F) generated 20% of their car sales through leases, while GM (GMGMQ) led the pack at 40% of their sales. Many of these leases were for SUVs and other giant gas guzzlers. When gas prices soared in 2008, the residual value of these gas guzzlers plummeted as the resale market disappeared.
Ford and Chrysler have written off billions. The king of the hill, GMAC, accumulated $33 billion of lease assets and is slowly but surely writing off $14 million of these “assets” -- while the taxpayer funds their future bad leases.
Leases have made it possible for millions of Americans to drive the hottest wheels their limited budgets wouldn’t permit them to buy. Auto makers loved leases because they could sell higher-priced vehicles, which generate a gusher of profits in the short-term.
By piling on inducements of their own, such as rebates or 0% financing deals, auto makers were able to subsidize consumers' lease payments further. As a result, Americans have had access to vehicles their parents never even dreamed of driving -- usually costing between $40,000 to $60,000. The Wall Street Journal describes a common scenario:
For Richelle Babcock, a mother of two young boys in Ann Arbor, Mich., leasing has made it possible to get new cars every couple of years. A few years ago, she took advantage of a trade-in deal and other incentives Chrysler was offering and got a $180-a-month lease on a 2006 Jeep Commander with a sticker price of about $35,000. There's "no way," Ms. Babcock says, that she would have bought the Commander outright. "I don't want to have to own it and drive it forever." Indeed, in December she turned it in and instead leased a new 2008 Commander. Her payment roughly doubled, but that's mainly because the lease is much less restrictive about her annual mileage.
It’s Ms. Babcock's right to get a new car every two years, but it's also important for her to have college education funds for her two boys, an emergency fund with six months of living expenses, and a decent-size retirement account -- because part of the overarching problem is the fact that some consumers aren't distinguishing a need from a want.
This brings me to the chapter in this horror story that really sticks in my craw. I drive through West Philadelphia every day. The neighborhoods are decrepit, with boarded up houses, trash strewn vacant lots, grade schools that resemble prisons, and a substantial number of unemployed folks shuffling about from morning to night.
These neighborhoods appear to have five times as many BMWs and Mercedes as my suburban upper-middle class neighborhood.
According to the US Census, West Philly has a large proportion of high school dropouts who are living in poverty; and my neighborhood is occupied by people who are five times higher on the income scale.
Click to enlarge
Easy money allows the poor to live like the rich. This explains why some people in West Philly are able to drive $50,000 one-year-old BMWs, while I choose to drive an eight-year-old CRV with 130,000 miles. My choice was to finance my $20,000 car over four years at 7%. I had a $500 monthly payment for four years, and then was able to save $500 per month for the next six years, banking $36,000 in savings. The auto financing companies -- GMAC, Ford Credit, and Chrysler Credit -- offer rebate incentives, seven-year loans, and 0% interest to entice everyone to drive BMWs and Mercedes for a monthly payment less than $500. Those making little money are more likely drawn to three-year leases with even lower monthly payments (you can lease a BMW for $399 per month or less). And once you’re lured into three-year leases or seven-year loans, you're ensnared in a lifetime of car payments, never saving a dime.
Over four decades, my method will leave me with $200,000 of savings. A perpetual car payment will leave you with $0 of savings.
Millions have chosen this negligent path. Some not only pursued this path, they hurtled themselves down it by borrowing against their houses to buy cars. Californians and Floridians were the worst offenders.
A drug addict still needs a dealer to get their fix. Politicians in Washington, with their cohorts in crime -- the Federal Reserve and the banks -- provided the drug of easy money.
The combination of a psychological need to appear successful and easy money has created a deadly recipe for the middle class, which tends to drive modest cars for 10 years and save for the future.
The black magic of securitization has allowed banks and finance companies to bestow credit cards and car loans to high school dropouts that make $20,000 per year in West Philly, with no concern about getting repaid. They packaged this future bad debt, paid off Moody’s and S&P to rate it AAA, and dumped it on suckers throughout the world.
Now, auto loan delinquency rates are at all-time highs -- 1.7 million cars were repossessed in 2008, with another 2 million likely to be repossessed in 2009.
Underprivileged people in West Philadelphia often don’t realize that politicians and bankers are keeping them entrapped in poverty by providing them with easy credit and persuading them that making perpetual payments for cars, TVs, and other material goods is a normal lifestyle.
When reality sets in and these people stop making their payments, it’ll be no trouble for them.
As the financial system came crashing down due to the millions of bad loans made by the banks, their protectors -- Hank (Goldman) Paulson and Ben (Helicopter) Bernanke -- funneled trillions of your tax dollars, your children’s tax dollars, and their children’s tax dollars to the banks that committed these crimes.
Many low-income people in West Philly don’t pay taxes, so they got to drive BMWs and watch 52-inch TVs for awhile, and ultimately left relatively unscathed. The middle class is paying the bill, losing millions of jobs while seeing their 401ks drop by 40% -- and they’re still driving their 10-year-old cars.
See also: Living In Beverly Hills
U.S. August Bailout Update: $393 Billion Outstanding
Starting with this post, we’ll be updating you every month on the status of the taxpayer-funded bailouts we track in our database—namely the TARP and government rescue of Fannie Mae and Freddie Mac. Recent reports have drawn attention to the billions in revenue that the Treasury Department has collected from companies early in returning their TARP investments. While those returns have been encouraging, there’s no question that the taxpayer remains deep in the red.
In total, $392.6 billion remains outstanding to 641 recipients ($297 billion under the TARP and $95.6 billion that’s gone to Fannie and Freddie). That total excludes the 35 companies that have returned a total of $71.6 billion. In August, the Treasury invested $129.8 million in nine banks (see our time line for more details). It also put $10.7 billion more into Fannie Mae.
The Treasury will likely invest or spend billions more. Fannie and Freddie will probably need billions more in assistance. And two major bailout programs have yet to start shelling out committed funds. Treasury plans to use up to $30 billion for its toxic securities program, which could begin this month. It has also set aside $50 billion for its mortgage modification program, which is already well underway. Under the program, participating loan servicers are only paid subsidies if the loans they modify survive a three-month trial period without defaulting.
Forty-two servicers have signed up, and roughly 235,000 trial modifications, of the administration’s projected total of up to 4 million, had been started by the end of July. There is also a major commitment to AIG that may cost taxpayers more. The company has to date received $41.5 billion, but Treasury has committed to providing $28 billion more if it’s needed.
That said, money is flowing in as it’s flowing out. The TARP has two main sources of revenue: quarterly dividend or interest payments and warrant redemptions. Unlike returned money, which can be used again, the Treasury is obligated to use that revenue to pay down the national debt. You can see our catalogue of all dividend and interest payments here. The vast majority of recipients pay a dividend at a rate of five percent annually. Companies that got special aid, like AIG and Citigroup, pay higher rates. So far, bailout recipients have paid $9.6 billion in dividends.
That amount includes the $2.1 billion in dividends paid by Fannie and Freddie. Those payments are a bit of a mirage, however. The rate is set at ten percent but will jump to 12 percent if the companies miss a payment, so neither has. But since the companies rely on taxpayer money to remain solvent, dividend payments are “effectively funded from equity drawn from the Treasury,” as Fannie Mae stated in a recent regulatory filing (PDF). In other words, until the companies stop losing money, Treasury will continue to pay the dividends to itself.
So far, the Treasury, through refunded TARP investments, has collected $2.8 billion in exchange for its warrants. The stock warrants, which give the U.S. the right to buy equity in the companies at a set price, came as a condition of the investments. When companies refund the Treasury’s money, the warrants are either sold back to the company or auctioned off. Put all that together, and you get a total of $12.4 billion in revenue. Compared to the $392.6 billion in bailout funds still outstanding, it’s reason for cooling any thoughts, at least for now, of the taxpayer pulling a profit.
A Threat to Fair Elections: Supreme Court Decision on Corporate Donations
The Supreme Court may be about to radically change politics by striking down the longstanding rule that says corporations cannot spend directly on federal elections. If the floodgates open, money from big business could overwhelm the electoral process, as well as the making of laws on issues like tax policy and bank regulation. The court, which is scheduled to hear arguments on this issue on Wednesday, is rushing to decide a monumental question at breakneck speed and seems willing to throw established precedents and judicial modesty out the window.
Corporations and unions have been prohibited from spending their money on federal campaigns since 1947, and corporate contributions have been barred since 1907. States have barred corporate expenditures since the late 1800s. These laws are very much needed today. In the 2008 election cycle, Fortune 100 companies alone had combined revenues of $13.1 trillion and profits of $605 billion. That dwarfs the $1.5 billion that Federal Election Commission-registered political parties spent during the same election period, or the $1.2 billion spent by federal political action committees.
The Supreme Court has repeatedly upheld the limitations on corporate campaign expenditures. In 1990, in Austin v. Michigan Chamber of Commerce, and again in 2003, in McConnell v. Federal Election Commission, it made clear that Congress was acting within its authority and that the restrictions are consistent with the First Amendment. In late June, the court directed the parties to address whether Austin and McConnell should be overruled. It gave the parties in Citizens United v. Federal Election Commission a month to write legal briefs on a question of extraordinary complexity and importance, and it scheduled arguments during the court’s vacation.
All of this is disturbing on many levels. Normally, the court tries not to decide cases on constitutional grounds if they can be resolved more simply. Here the court is reaching out to decide a constitutional issue that could change the direction of American democracy. The court usually shows great respect for its own precedents, a point Chief Justice John Roberts made at his confirmation hearings. Now the court appears ready, without any particular need, to overturn important precedents and decades of federal and state law. The scheduling is enormously troubling. There is no rush to address the constitutionality of the corporate expenditures limit. But the court is racing to do that in a poorly chosen case with no factual record on the critical question, making careful deliberation impossible.
Most disturbing, though, is the substance of what the court seems poised to do. If corporations are allowed to spend from their own treasuries on elections — rather than through political action committees, which take contributions from company employees — it would usher in an unprecedented age of special-interest politics. Corporations would have an enormous say in who wins federal elections. They would be able to use this influence to obtain subsidies, stimulus money and tax loopholes and to undo protections for investors, workers and consumers. It would take an extraordinarily brave member of Congress to stand up to agents of big business who then could say, quite credibly, that they would spend whatever it takes in the next election to defeat him or her.
The conservative majority on the court likes to present itself as deferential to the elected branches of government and as minimalists about the role of judges. Chief Justice Roberts promised the Senate that if confirmed he would remember that it’s his “job to call balls and strikes and not to pitch or bat.” If the court races to overturn federal and state laws, and its well-established precedents, to free up corporations to drown elections in money, it will be swinging for the fences. The American public will be the losers.
Why some economists could see the crisis coming
From the beginning of the credit crisis and ensuing recession, it has become conventional wisdom that “no one saw this coming”. Anatole Kaletsky wrote in The Times of “those who failed to foresee the gravity of this crisis” – a group that included “almost every leading economist and financier in the world”. Glenn Stevens, governor of the Reserve Bank of Australia, said: “I do not know anyone who predicted this course of events. But it has occurred, it has implications, and so we must reflect on it.” We must indeed.
Because, in fact, many had seen it coming for years. They were ignored by an establishment that, as the former Federal Reserve chairman Alan Greenspan professed in his October 2008 testimony to Congress, watched with “shocked disbelief” as its “whole intellectual edifice collapsed in the summer [of 2007]”. Official models missed the crisis not because the conditions were so unusual, as we are often told. They missed it by design. It is impossible to warn against a debt deflation recession in a model world where debt does not exist. This is the world our policymakers have been living in. They urgently need to change habitat.
I undertook a study of the models used by those who did see it coming.* They include Kurt Richebächer, an investment newsletter writer, who wrote in 2001 that “the new housing bubble – together with the bond and stock bubbles – will [inevitably] implode in the foreseeable future, plunging the US economy into a protracted, deep recession”; and in 2006, when the housing market turned, that “all remaining questions pertain solely to [the] speed, depth and duration of the economy’s downturn”. Wynne Godley of the Levy Economics Institute wrote in 2006 that “the small slowdown in the rate at which US household debt levels are rising resulting from the house price decline, will immediately lead to a sustained growth recession before 2010”. Michael Hudson of the University of Missouri wrote in 2006 that “debt deflation will shrink the ‘real’ economy, drive down real wages, and push our debt-ridden economy into Japan-style stagnation or worse”. Importantly, these and other analysts not only foresaw and timed the end of the credit boom, but also perceived this would inevitably produce recession in the US. How did they do it?
Central to the contrarians’ thinking is an accounting of financial flows (of credit, interest, profit and wages) and stocks (debt and wealth) in the economy, as well as a sharp distinction between the real economy and the financial sector (including property). In these “flow-of-funds” models, liquidity generated in the financial sector flows to companies, households and the government as they borrow. This may facilitate fixed-capital investment, production and consumption, but also asset-price inflation and debt growth. Liquidity returns to the financial sector as investment or in debt service and fees.
It follows that there is a trade-off in the use of credit, so that financial investment may crowd out the financing of production. A second key insight is that, since the economy’s assets and liabilities must balance, growing financial asset markets find their counterpart in a growing debt burden. They also swell payment flows of debt service and financial fees. Flow-of-funds models quantify the sustainability of the debt burden and the financial sector’s drain on the real economy. This allows their users to foresee when finance’s relation to the real economy turns from supportive to extractive, and when a breaking point will be reached.
Such calculations are conspicuous by their absence in official forecasters’ models in the US, the UK and the Organisation for Economic Co-operation and Development. In line with mainstream economic theory, balance sheet variables are assumed to adapt automatically to changes in the real economy, and can thus be safely omitted. This practice ignores the fact that in most advanced economies, financial sector turnover is many times larger than total gross domestic product; or that growth in the US and UK has been finance-driven since the turn of the millennium.
Perhaps because of this omission, the OECD commented in August 2007 that “the current economic situation is in many ways better than what we have experienced in years . . . Our central forecast remains indeed quite benign: a soft landing in the United States [and] a strong and sustained recovery in Europe.” Official US forecasters could tell Reuters as late as September 2007 that the recession in the US was “not a dominant risk”. This was well after the Levy Economics Institute, for example, predicted in April of that year that output growth would slow “almost to zero sometime between now and 2008”.
Policymakers have resisted inclusion of balance sheets and the flow of funds in their models by arguing that bubbles cannot be easily identified, nor their effects reliably anticipated. The above analysts have shown that this is, in fact, feasible, and indeed essential if we are to “see it coming” next time. The financial sector is just as real as the real economy. Our policymakers, and the analysts they rely on, ignore balance sheets and the flow of funds at their peril – and ours.
*‘No One Saw This Coming’: Understanding Financial Crisis Through Accounting Models, MPRA
Lobbyists Feel the Pinch As Downturn Hits K Street
In a year when Washington's influence industry should be thriving, with epic battles over health-care and energy legislation, lobbying in many sectors is in marked decline as defense contractors, real estate firms and other companies pull back in a down economy. Overall spending on lobbying has leveled off for the first time in a decade, according to disclosure data filed with Congress. Lobbying revenue for many of the city's most powerful advocacy firms, including bellwethers such as Patton Boggs and Akin Gump Strauss Hauer & Feld, plunged 10 percent or more in the first half of the year.
Washington also has 2,200 fewer registered lobbyists than it did a year ago, the lowest tally since shortly after George W. Bush took office in January 2001. The economy is the primary reason for the slump, according to many lobbyists and public-interest experts. Companies tied to home building, defense, transportation, agriculture and other struggling sectors have pared back on lobbying expenses this year, sometimes dramatically so, according to data analyzed by the Center for Responsive Politics at the request of The Washington Post.
"If you can't make payroll, and you can't get bridge loans like you used to, you have to make a choice: Do you want to pay people to represent you in Washington or delay laying people off?" said Nicholas W. Allard, co-chairman of public policy and administrative law at Patton Boggs. "In tough economic times, it tends to depress the traditional lobbying services." Lobbying has been a major growth industry in Washington for the past decade. Spending on lobbying more than doubled to $3.3 billion last year from $1.44 billion in 1999, according to disclosure records. The number of registered lobbyists rose in most of those years, peaking at more than 15,000 in 2007. That total has shrunk to 12,500.
Lobbying insiders say factors other than the economy are driving down the numbers. Trade groups and private corporations, for example, increasingly are pouring resources into television ads, grass-roots organizing and other advocacy efforts not counted under the narrow definition of lobbying required for House and Senate disclosure forms. The Campaign Media Analysis Group estimates that $75 million has been spent this year on television spots related to the health-care debate. Much of that effort is aimed at Congress, but none of it is considered lobbying. "There are many people in Washington who are lobbying by any common definition of it but don't have to register," CRP spokesman David Levinthal said. "You never truly see the full picture."
The Obama administration also claims some credit for cooling the ardor for lobbyists in Washington, enacting stringent new guidelines that restrict lobbyist contact with the government and aim to make the process more transparent. Some public-interest-group activists have withdrawn their lobbying registrations as a result. The formidable defense industry, reeling from tens of thousands of layoffs, has cut back expenditures by 17 percent this year. That was true even with the lobbying effort triggered by Defense Secretary Robert M. Gates's cancellation of the F-22 fighter jet and other major weapons projects, which had long survived thanks to the lobbying prowess of major contractors. Northrop Grumman has slashed its spending for lobbying in half, and Boeing and Lockheed Martin each have reduced spending by more than $1 million.
Other declining sectors include finance, insurance and real estate (down 5 percent); communications and transportation (each down 6 percent); and energy and natural resources, where record expenditures by the oil and gas lobby were not enough to counter an overall decrease of 16 percent. Some companies, such as the Lehman Brothers investment bank, no longer exist in the aftermath of last year's financial collapse. Other firms that have been partly taken over by the government, such as General Motors and American International Group, have dropped or sharply curtailed lobbying activities. Bank of America, Citigroup and many other banks have reduced lobbying budgets by hundreds of thousands of dollars.
The Mortgage Insurance Companies of America trade group slashed lobbying spending by 61 percent during the first half of this year, and the Mortgage Bankers Association cut back 24 percent. Steve O'Connor, the MBA's senior vice president for government affairs, said the group has reduced its use of outside consultants, but he added that "we're as busy as ever." "I think this is likely a temporary adjustment," O'Connor said about the overall trend. "It's just like any business cycle."
Perhaps the most startling decline comes in a category at the center of this year's hottest political debate. The health sector, which includes hospitals, nursing homes and pharmaceutical companies, spent $22 million less in the first half of 2009 than it did in the first half of last year, amounting to a decline of 9 percent, according to the data. The health sector still ranks as one of the top spenders in Washington -- more than $240 million so far this year. That decline masks spending increases by the pharmaceutical lobby, though, which is far ahead of its pace in 2008.
The cutbacks have hurt the bottom line of many major Washington lobbying firms. Standard-bearers including DLA Piper, Paul Hastings, Cassidy & Associates and Hogan & Hartson reported millions in reduced business. One prominent exception is the Podesta Group, which has expanded dramatically thanks to its strong Democratic connections. Smith W. "Smitty" Davis, a partner at Akin Gump, said that although much of corporate America was "feeling pinched" earlier in the year, spending could pick up in coming months with an improving economy and increased activity in Congress.
"The trend has been for companies to realize that Washington is going to affect their lives on policy issues," Davis said. "There's no reason why lobbying should not feel some downturn, given what the economy is doing. But as that comes back, I expect lobbying to come back even more." Craig Holman, the legislative representative for Public Citizen, agrees. "The more the federal government gets involved in the economic sector," he said, "the more businesses will spend on lobbying practices."
CalPERS chief actuary silenced for telling truth
The California Public Employees Retirement System is trying to tamp down public concern after its chief actuary candidly said last month that government pension costs are "unsustainable." The portfolio value of the nation's largest public pension fund, battered by the stock market and the real estate downturn, declined about 24 percent, or roughly $58 billion, in the fiscal year that ended June 30. The system serves 1.6 million public employees, retirees and their families across the state. They need not worry. Their pensions won't be affected.
Instead, state and local governments across California will have to cut services — or, less likely, raise taxes — to make up for the losses if the economy doesn't come roaring back. CalPERS is trying to soften the blow by forcing future generations to absorb a larger part of the hit. Nevertheless, the impact will start to be felt with the 2011-12 fiscal year. Pension costs are typically measured as a percentage of payroll. Government agencies in CalPERS, for example, currently set aside for pensions about 17 percent of payroll for most workers, what are known as "miscellaneous" employees, and about 27 percent for police and firefighters. At a seminar in Sacramento, Ron Seeling, the chief actuary, described what's to come.
"I don't want to sugarcoat anything," Seeling said. "We are facing decades without significant turnarounds in assets, decades of — what I, my personal words, nobody else's — unsustainable pension costs of between 25 percent of pay for a miscellaneous plan and 40 to 50 percent of pay for a safety plan (police and firefighters) "... unsustainable pension costs. We've got to find some other solutions." It was at least the second time Seeling made the comments, but the first time they were widely disseminated. Credit Ed Mendel, who runs Calpensions.com, with capturing Seeling's comments and publishing them. Some newspaper editorial boards around the state have picked up on the remarks and highlighted them as the first public admission by CalPERS of what many have been warning: Pension costs are rising faster than we can afford and dependence on hefty investment returns to pay the bill is risky.
At CalPERS, my request to talk to Seeling about his comments was denied. Instead, public information officers told me that he misspoke — that he reversed his clauses. What he meant to say, I was told, was "Without significant turnarounds in assets, we are facing decades of unsustainable pension costs ... " In other words, they were suggesting, he wasn't predicting long-run shortfalls, he was hypothetically speculating on what would happen if markets fail to rebound. Moreover, they emphasized, it was his personal comments, not the official CalPERS position. That clarification is hardly reassuring. It shows once again that CalPERS is banking on the economy to soar back. And, somehow, we're supposed to be comforted that the comments of the chief actuary were his personal view rather than the system's official position.
To be fair, until last year, CalPERS had a solid record of investment returns. And, even with last year's losses, the system has met its 7.75 percent annual investment target over the past 20 years. But the agency has been acting as if the market could only go up — and has failed to require employers to keep contributing when times were good. Thus, while the state and local governments have been approving increasingly richer pension benefits for public employees over the past decade, CalPERS has not been setting contribution rates accordingly.
As a result, the pension system went from having well over 100 percent of its targeted funds at the start of the decade to 80 percent to 85 percent funded on June 30, 2008. That was before the stock market burst. The next funding reports from the agency are certain to be much worse, perhaps below 70 percent. In other words, CalPERS has failed to ensure that government agencies are paying in enough money to fully fund the promised pensions. As a result, future generations will be stuck with the bill or the resulting cuts in public services. Yet, when CalPERS's top actuary comes clean about the problem, the agency tries to silence him.
Barack Obama accused of making 'Depression' mistakes
Barack Obama is committing the same mistakes made by policymakers during the Great Depression, according to a new study endorsed by Nobel laureate James Buchanan. His policies even have the potential to consign the US to a similar fate as Argentina, which suffered a painful and humiliating slide from first to Third World status last century, the paper says. There are "troubling similarities" between the US President's actions since taking office and those which in the 1930s sent the US and much of the world spiralling into the worst economic collapse in recorded history, says the new pamphlet, published by the Institute of Economic Affairs.
In particular, the authors, economists Charles Rowley of George Mason University and Nathanael Smith of the Locke Institute, claim that the White House's plans to pour hundreds of billions of dollars of cash into the economy will undermine it in the long run. They say that by employing deficit spending and increased state intervention President Obama will ultimately hamper the long-term growth potential of the US economy and may risk delaying full economic recovery by several years. The study represents a challenge to the widely held view that Keynesian fiscal policies helped the US recover from the Depression which started in the early 1930s. The authors say: "[Franklin D Roosevelt's] interventionist policies and draconian tax increases delayed full economic recovery by several years by exacerbating a climate of pessimistic expectations that drove down private capital formation and household consumption to unprecedented lows."
Although the authors support the Federal Reserve's moves to slash interest rates to just above zero and embark on quantitative easing, pumping cash directly into the system, they warn that greater intervention could set the US back further. Rowley says: "It is also not impossible that the US will experience the kind of economic collapse from first to Third World status experienced by Argentina under the national-socialist governance of Juan Peron." The paper, which recommends that the US return to a more laissez-faire economic system rather than intervening further in activity, has been endorsed by Nobel laureate James Buchanan, who said: "We have learned some things from comparable experiences of the 1930s' Great Depression, perhaps enough to reduce the severity of the current contraction. But we have made no progress toward putting limits on political leaders, who act out their natural proclivities without any basic understanding of what makes capitalism work."
In August, QE hit the economy
by Alice Cook
What are UK banks up to? Last month, their cash deposits at the Bank of England fell by 6 percent. In crude cash terms, banks withdrew almost ₤10 billion.
In the previous six months, banks had accumulated huge deposits. This was due to quantitative easing. The BoE was buying up bank holdings of Treasury paper. In return, it paid for this paper by increasing bank deposits held at the Bank of England. This was how the BoE were "printing cash"; it was generating big increases in reserve balances.
In principle, UK banks could have withdrawn that cash and used it to create new credit. However, during the first half of this year, banks preferred to park the money in the vaults of the Bank of England. That all changed in August, when for the first time since QE began, deposits shrank.
There is, of course, no explanation from the BoE about this recent development. The most likely story is that banks are beginning to lend again. The question, however, who are their new customers?
The most recent lending data, which goes up to June, shows that banks have a strong preference for mortgage lending. On a net basis, mortgage lending is still growing, although not at the levels seen during the recent bubble. Corporate lending, on the other hand, was shrinking rapidly. Meanwhile, unsecured consumer credit was rather flat.
Has QE unleashed a new housing bubble? It is early days, but the signs are really bad. The pick up in house prices since QE began has been remarkable. It is likely that house prices will record positive growth this year.
Since QE began, the BoE has pumped in breathtaking amounts of liquidity into the banks. In six short months, the BoE has created around 15 percent of GDP in new cash. That is a lot of spending power to throw into an economy with declining output. So far, that money has been held in the BoE. Now, banks are starting to pump it into the economy. It is highly doubtful that the economy can absorb such a massive increase in liquidity without sparking off a further round of asset inflation and a rising price level.
Can the BoE quickly withdraw this liquidity, should things get out of control? It is going to be really hard. There is only one mechanism; sell the government paper that they have accumulated. If they start to unwind, they are likely to cause a run on UK gilts, and interest rates will spike. This could, of course, push the UK straight back into recession.
So, the UK economy seems to be heading towards one of two extreme outcomes; another bubble or a double dip recession. Moreover, this mess was caused by one bad policy mistake being followed with another.
There are days, when I really wonder if the BoE know what they are doing. Today was one of those days.
Before we crucify the bank MDs
“Our society is now based on consumption .. 70 per cent of the GDP. This is more than we produce. So to pay our bills, we use funny money invented in 1913 with the creation of the Federal Reserve and the fiat dollar based on credit (debt).. the fractional reserve system.
In 1930’s you bought what you could afford. You saved up to buy your home. The easy credit of the 90’s has destroyed the country. Now you borrow what you can’t afford .. and the nation’s done the same.” “Phantom dollars, printed out of thin air, backed by nothing … and producing next to nothing … defines the ‘Bailout Bubble.’ Just as with the other bubbles, so too will this one burst. But unlike Dot-com and Real Estate, when the “Bailout Bubble” pops, neither the President nor the Federal Reserve will have the fiscal fixes or monetary policies available to inflate another.”
“This is much bigger than the Dot-com and Real Estate bubbles which hit speculators, investors and financiers the hardest. However destructive the effects of these busts on employment, savings and productivity, the Free Market Capitalist framework were left intact. But when the ‘Bailout Bubble’ explodes, the system goes with it.
The above are extracted statements made on the US and world economy by Gerald Celente, the head of the Trends Research Institute, a top trend-forecasting agency in the world. He had predicted accurately a number of previous events such as the 1987 stock market crash, the 1998 Russian economic collapse, the 2000 Dot-Com bubble burst, the 2001 recession, the US housing market collapse of 2008, among others. You may be wondering what this has got to do with the Nigerian banks and their MDS. The answer is a lot. In the current world economy, a bank will typically extend credit to borrowers in excess of the fund reserve it carries at any point in time in a practice known as fractional reserve banking.
By doing so, banks effectively increases the total money supply in the system above that of the total amount of fiat money in existence. Fiat money is a term used to define money that is not backed by reserves of another commodity such as gold, silver, or other tangible mineral or asset. The reality of this practice is that a bank will not have access to sufficient cash (fiat money) to meet all the obligations it has to depositors if they all decide to withdraw the balance of their accounts or deposits. Fiat money is usually given value by the government. The United States switched indefinitely to fiat money in 1971, with many developed countries’ currencies fixed relative to the US dollar. Our banking system is not home grown. Our financial theories and economic systems are largely wholesale adoption of western systems.
The migration to fiat money system created limitless opportunities for all sorts of sophisticated financial instruments. The elaborate banking schemes had one common framework: work with institutional investors to drive prices upwards. This trend is quite noticeable in real estate, stock, oil and other trades that yield heavy returns over a short period. It is inevitable that such practices must accompany a financial system that is not hedged against commodity or real production. The manipulated upward price movements become replacements for traditional commodities or real production in a reliable Risk Management System. Governments, central banks, institutional investors and banks become allies in the paper money, credit and debt systems supported by weak foundations. The United States bail out money comes from printed money backed by nothing as the Trends Report indicates. The N400b bank rescue fund is also printed (Fiat) money. The ultimate consequence is uncontrolled inflation. One would ask some of these questions concerning the Nigerian scenario
Is the CBN interested in saving depositors funds or saving the face-value of the depositor’s funds while over 80 per cent of the value (purchasing power) is lost? With widespread corruption of the financial system in many western countries, how do we develop a transparent home grown system given our long history of corruption? When current corrupt bank MDs and board members are removed, how do the replacements function in a predominantly lazy and corrupt environment? Can we rely on foreign risk management ‘experts’ to rescue us when they have failed in their countries? True risk management will never violate time tested values.
As the bank executives are punished, how do we punish the many in the society who steal or embezzle in many forms? Politicians who steal the people’s money, workers who award inflated contracts to cronies for bribes and settlements, lecturers who award marks for cash, mechanics who damage vehicles for quick gain, workers who cheat employers by habitual lateness or absence, customs officials who cheat the government, school proprietors who buy exam papers for students to give a false impression of excellence, lecturers who embark on a strike for wage increase in a downturn economy, the man or woman who exchanges his vote for cash during elections, the policeman who collects bribes to free guilty criminals,..?
If the US is suffering the pangs of failure of the financial system with their level of production, how do we, in Nigeria survive when we consume everything, import everything and produce almost nothing? We better brace up for the hard reality. We’ll be extremely lucky if it is just 5 banks. Dominant societal values inform dominant behaviour of people at work, home, and social circles. There are no short cuts. We either work, work and work our way to growth or we all pay the price. There is no cheating the natural laws of the universe.