"John Henry, contraband and servant, at headquarters, 3d Army Corps, Army of the Potomac, Bealeton, Virginia"
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We have had generous donations over the past year, and we truly are deeply and humbly grateful to all of our donors and supporters. However, if we are to go where we want to be, we’ll need both more revenue and a more steady and reliable source of it.
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Ilargi: This is part 3 of Ashvin Pandurangi's 3-part series The Debt-Dollar Discipline. Part 1 is here, Part 2 is here.
The Debt-Dollar Discipline: Part III - Future Reorganization
"There are more ideas on earth than intellectuals imagine. And these ideas are more active, stronger, more resistant, more passionate than ''politicians'' think. We have to be there at the birth of ideas, the bursting outward of their force: not in books expressing them, but in events manifesting this force, in struggles carried on around ideas, for or against them." - Michel Foucault
Parts I and II of this series explored the relatively rapid emergence and collapse of global society's debt-dollar discipline, formalized by the Bretton Woods Agreement of 1945, which established the dollar as a global reserve currency. This financial order, currently being disassembled, was analyzed in the context of Foucault's theory of disciplinary society and Holling's adaptive cycle of complex ecosystems. . The fourth phase of this cycle, following release, is a reorganization of the system's components at a different scale and in a different form. Although the new organizational form will certainly be different from the previous one, it could retain similar properties and evolve in a similar manner, depending on the extent to which previous structures survive the release phase.
The specific behaviors of a complex system in chaotic release cannot be predicted with any significant degree of accuracy. Broad-based outcomes, however, can be analyzed according to their likelihoods of occurrence, given our knowledge of the present circumstances and the dynamic behavior of complex systems. Once it is established that existing structures of the global financial system will be radically simplified, once can ask to what extent this simplification can be managed and what general forms of organization may emerge.
A highly-debated issue surrounding the collapse of debt-dollar discipline is whether financial structures in the developed world will first simplify through an episode of significant deflation, or instead an episode of hyperinflation and an ensuing currency crisis. Numerous articles have been written on this topic, including this probabilistic assessment I wrote summarizing some of the main factors involved (for the U.S.), and so that topic will not be rehashed here. Instead, the final part in this series will explore more generalized "big picture" issues, introducing Deleuze's theory of "control society" and then returning to Foucault's original analysis of discipline.
Visions of Comprehensive Control
An insightful reader of Part I in this series directed me towards another French philosopher who can shed some light on potential outcomes of systemic release, named Gilles Deleuze (1925-1995). He wrote a few essays in the 1990s about the post-WWII transition from Foucault's disciplinary society to a "control society" in the developed world. Although I had never heard of Deleuze's work before, his ideas are remarkably similar to those laid out in the prior two articles of this series. In his essay, Postscript on the Societies of Control , he even made reference to what I have termed "debt-dollar discipline", and its fundamental importance to the underlying structures of power:
"Perhaps it is money that expresses the distinction between the two societies best, since discipline always referred back to minted money that locks gold as numerical standard, while control relates to floating rates of exchange, modulated according to a rate established by a set of standard currencies. The old monetary mole is the animal of the space of enclosure, but the serpent is that of the societies of control."
Deleuze correctly perceived the parasitic nature of the financial capitalist system, which had managed to commandeer and expand the disciplinary functions of institutions operating under the framework of industrial capitalism. Instead of enclosed institutions methodically disciplining "individuals" to be more specialized and efficient, the control society features "free-floating" corporate networks that continuously interact and dominate the lives of the consuming masses. The latter essentially reflects a transition from a production-based society to a consumption-based one, in which the power structures wish to "sell services and buy stocks".
One can debate whether these new structures of power reflect the emergence of a distinct "control society" that is non-disciplinary, or rather a more complex and abstract iteration of disciplinary society, as was suggested in Part I and Part II. It appears to me that the evolutionary state of a complex system is entirely dependent on its initial conditions and previous states, which would then suggest that Deleuze's "control society" is simply a novel mode of exerting Foucauldian discipline. Regardless, it is critical to understand the new control (or disciplinary) mechanisms articulated by Deleuze in order to get a general sense of where global society may be headed.
The disciplinary society of the 19th and early 20th century was primarily marked by the factory system and its machines of production, while the financial disciplinary society has been marked by the corporate system and computer technology. Deleuze explained that financial power structures use these new technologies to influence the interactions of those existing under them in a limitless fashion. Individuals are no longer viewed as component parts of a mechanistic group, but as data sets that can be constantly "modulated" by corporate marketing and political propaganda.
Electronic banking records can track financial transactions, library records can track the dispersion of knowledge, satellite GPS systems can track movement through space and the Internet can track electronic communications. Every aspect of a person's existence under the financial system is monitored, analyzed, molded and exploited to extract economic rents. These new "control" mechanisms are largely masked from public awareness by the financial system's evolved complexities. Indeed, as Deleuze proclaims, "the coils of a serpent are even more complex than the burrows of a molehill".
The question then becomes to what extent these elements of Deleuze's "control society" can survive the ongoing collapse of Foucault's disciplinary society, including the elimination of debt-dollar discipline. Some people argue, as an extension of Deleuze's thoughts, that financial power structures will not disappear, but will rather be re-organized at an even higher level of centralized control. The system will be less complex in the sense that there is more explicit top-down control, instead of reliance on "self-regulating" networks, but complexities associated with technological control will be retained. The financial crisis will be used as a justification for eliminating the fiat currencies of nation-states and establishing a global currency of exchange, to be managed by an institution such as the IMF. .
This currency will not merely inherit the reserve status of debt-dollars, but will be the primary means of domestic and international exchange for all countries. Not only that, but the entire political and economic apparatuses of sovereign states will be subject to the rules of global institutions, and control technologies will be used to maintain and reinforce this new order. Perhaps each country will be allocated a set amount of public credit that can be used for domestic spending, as long as they maintain adequate tax revenues to service the debt. In such a manner, the complex mechanisms of Orwellian control will be fully revealed to a global population that has no effective means of resistance.
A limited version of this scenario is already playing out in Europe, where sovereign states such as Greece and Ireland (and soon Italy, Spain, Portugal) are forced to "resolve" their debt crises by accepting IMF-sponsored "bailouts" with numerous conditions attached. These conditions effectively erode national sovereignty and compel the citizens of such states to subsidize the re-establishment of financial discipline. State politicians who rely mostly on financiers and other institutional actors for re-election, rather than actual voters, will voluntarily accept these oppressive packages. The subsidies will take the form of higher taxes, fewer entitlements and/or higher costs of living due to a devalued currency.
As explained in Part II's section on "financial conservation", austerity programs implemented under a financial disciplinary system will actually serve to make sovereign debt problems worse, and will ultimately collapse the underlying currency. The conditional "bailouts" are essentially a clever ruse designed to make sovereign states entirely dependent and subservient to global power structures. These states will continue to pay interest on public debt for some time, and once they become utterly insolvent from a combination of deleveraging, austerity and speculation, they will be systematically put into "receivership", paving the way for the new global currency and control society to emerge.
On the other hand, Europe also illustrates a socioeconomic dynamic that may preclude the establishment of this global control society. Citizens of states currently undergoing austerity programs have already begun protesting, striking and rioting in large numbers, after relatively small tax increases, tuition hikes or spending cuts have been made or proposed. These initial austerity measures are by no means insignificant, but are rather perceived as portending the future suffering to be imposed on the middle and lower classes of developed society. Therefore, as the financial power structures proceed forward with their "plans" of global control, they will encounter a disproportionately powerful resistance by the global population.
Deleuze himself stated that, with respect to the evolving control society, "there is no need to fear or hope, but only to look for new weapons". The virtually organized attacks by the international hackers described in Part II are a great example of such a new weapon (hacks and viruses were explicitly mentioned by Deleuze), and it already appears to be working. Popular forms of resistance, such as those mentioned above, also seem to be an effective method of disrupting attempts at control. Perhaps the most potent weapon that will be used against attempts to form a global control society derive from the foundational system of all organizational forms, the energy system.
Foucault's industrial disciplinary society, and Deleuze's financial control society by evolutionary extension, were entirely made possible by the discovery and vast utilization of incredibly efficient fossil fuels. The International Energy Agency's 2010 report officially confirmed what peak oil theorists have been emphatically stating for decades, mainly that the world's conventional oil production terminally peaked in 2006. Those people who had been following the IEA's annual reports would have noticed that they consistently ratchet down their estimates of future oil production rates each year, and this trend can be expected to continue in upcoming years. .
Machines of societal oppression, whether they are assembly equipment or computerized devices, cannot continue to function at their current rates of activity without access to increasing amounts of net energy. Currently, there are no forms of renewable energy or technologies of energy efficiency in place which could realistically offset the terminal declines in net energy faced by global society. The time after which a wide-scale implementation of such energy infrastructure becomes impossible is approaching very soon, if it has not already passed.
For this reason, it is highly unlikely that the release of financial disciplinary structures will lead to re-organization at a more centralized level of operation anytime soon. It is significantly more likely that developed societies will re-organize at much smaller scales of economic and political activity, in which states, cities and local communities become more important to the "individual" than regional blocs or even nations. People will be forced to rely on their immediate environments as a means of acquiring basic goods and services. The mechanisms of discipline and control, if they exist at all, will only be able to operate within a localized range for limited purposes.
This scenario should not be taken lightly, however, because it will certainly involve a transitional period rife with disorder and violence. These symptoms are especially likely if there is an initial period of physical conflict between governmental power structures and their resistant populations, which should be expected. Although the increasingly impoverished citizenry of the world obviously outnumber the disciplinary elites by a large factor, these elites have a not-so-secret weapon to combat many of the obstacles mentioned above. With that sullen thought in mind, we can then bring the discussion back to Foucault's original analysis of discipline.
Of Militarism and Monastic Order
"The lyricism of marginality may find inspiration in the image of the ''outlaw,'' the great social nomad, who prowls on the confines of a docile, frightened order." - Foucault
According to Foucault, the roots of discipline can be traced back to two very different organizations. . The first one is the army, which, throughout history, has disciplined its soldiers to be obedient, self-regulating and deadly efficient by implementing strict restrictions on their movement through time and space. Everything about a soldier's existence in the barracks is tightly controlled through confined quarters, strict daily schedules, drill exercises, required conduct, etc. Although modern global society is publicly characterized as a place of diplomacy and peaceful negotiation, it has actually retained the most deadly military forces with the most deadly weaponry to match.
The U.S. military, for example, may eventually face a legitimacy crisis of its own, but the unwavering loyalty of its commanders and soldiers should not be underestimated. The structures of command within the military are kept almost entirely under the purview of the executive branch, and this design will make it difficult for elements of popular dissent to infiltrate its operations. After all, it is only natural that the institution to first, and most powerfully, implement disciplinary principles within human civilization should be the last to lose that disciplinary character.
In this sense, military institutions and arsenals provide the last line of "defense" for desperate power structures battling the scarcity of vital resources and the chaos of popular dissent. Indeed, the U.S. has already strategically positioned its military throughout the Middle East, which is obviously the most oil-rich region in the world. . When availability and expense begin threatening the U.S. share of global oil production, these forces can be readily mobilized to secure production facilities and trade routes. There is no doubt, however, that such actions by the U.S. will be met with even more popular resistance than it is currently experiencing.
It is also most likely the case that detailed plans are already in place to institute martial law on the American population in the event of disciplinary break down. A program called "Unified Quest 2011", consisting of wargames, seminars, workshops and conferences, is self-described as being "the Army Chief of Staff’s primary mechanism to explore enduring challenges and the conduct of operations in a future operational environment." . It would be naive to assume that American states and cities are not some of the "future operational environments" that they are preparing to conduct operations in. The government, of course, will insist that it is simply maintaining stability and doing what's best for its citizens, but the crucial question is whether the masses will voluntarily submit.
The U.S. citizenry is the most heavily armed in the world (90 guns per 100 people ), and they may refuse to submit without a fight. The American people were more than willing to relinquish many of their Constitutional rights after 9/11 for the sake of perceived security, but this time the circumstances will be drastically different. There will be millions of painfully destitute people, who possess rapidly diminishing faith in their government's ability to aid or protect them, and have precious little to lose from active resistance. During the chaotic, unpredictable release of a complex system, even the best laid schemes of disciplinary governments and their military forces could go awry.
The discussion then turns to Foucault's second foundational disciplinary institution, which is the monastery. . Like the army, it too has administered strict temporal and spatial rules to discipline its monks. They were disciplined to live a solitary, materially detached existence through silent meditation, physical isolation and restrictions on property ownership. The obvious difference, however, was that these disciplinary mechanisms were mostly implemented for the benefit of the practicing monk. In fact, traditional monasteries were focused on separating their monks out from the grasp of other disciplinary institutions in society.
One could argue over whether such separation was actually more "beneficial" for the monastic society, but it is clear that their form of discipline was fundamentally different from the others. Unlike the original army, which disciplined its soldiers to be killing machines for the benefit of existing power structures, the original monastery disciplined its monks to discover a natural order and attain a peaceful state of mind. According to Foucault, the structured drill exercises performed by soldiers carried an entirely different connotation than the mental exercises of monks, despite their similar disciplinary elements. Monastic discipline reflected a profound respect for natural systems of egalitarian existence, rather than man-made organizations of distributed power.
During the growth of debt-dollar discipline, many of the monasteries had transformed to resemble other disciplinary institutions of modern society, acquiring vast estates and even securing funds through financial investments. Still, there are others which have retained their original character and purpose, and in such institutions lie dormant the qualities of humanity long forgotten, but never ceasing to exist. A humanity that thrives on its ability to be self-sufficient, respectful of its natural environment and, perhaps most importantly, comfortable with its own relations of social order.
There will always be some form of discipline exerted on the individual human being, whether it is a function of biology, ecology, economic relations or a combination of those and other systems. The critical factor is the underlying purpose of such discipline, and the extent to which an individual is aware of its influence. It is now clear that, regardless of how economic and political systems devolve and reconstitute themselves from here, human populations around the world will experience at least a few moments in which they are freed from their disciplinary chains. In these crucial moments, many people will die and many more will suffer, because it is indeed true that "freedom of conscience entails more dangers than authority or despotism". Nevertheless, it is now humanity's mission to ensure that the spirit of monastic order prevails over militaristic oppression when these moments finally end.
Perhaps national institutions of power in the developed world are simply incapable of voluntarily downsizing and guiding us towards such order. Individual human beings, however, are not required to be identified as a function of the broader group they compose, and alienated by such artificial distinctions. Foucault's disciplinary machine manufactured "individuals" from the bowels of a highly-structured group, so as these structures of power collapse, we must look to form new types of groups from the virtues of well-constituted individuals. Many of us have already found such people, and we are sure to meet many more along our undiscovered paths. We must simply remember that we are no longer helpless victims of systematic oppression, but the righteous outlaws of disciplinary society.
Oregon aid agencies brace for tens of thousands losing unemployment benefits
by Richard Read - The Oregonian
Oregon's social-services safety net is in danger of snapping as unemployment benefits expire for tens of thousands in the coming months. Each week, about 600 Oregonians exhaust jobless benefits. In January, about 4,000 a week will lose coverage. And state officials expect those numbers to spike in April when more than 35,000 people will exhaust benefits in a single week.
Faced with the projections, Oregon Gov.-elect John Kitzhaber will consider asking the Legislature to extend unemployment benefits at the state level, a spokeswoman for his transition team said Friday. If Congress acts within days to extend emergency unemployment compensation nationally, 14,000 fewer Oregonians will lose benefits in April. But President Barack Obama's proposed extensions, tied to continuing Bush-era tax cuts, won't do anything for those who exhaust the maximum 99 weeks of jobless benefits.
Oregon social-service agency managers say they don't know how they'll handle the fallout, the size of which catches some by surprise. Already they can't provide enough rent and energy assistance for thousands. "I had heard there'd be an increase, but I had no idea it was going to be that much," said Sharon Hills, executive director of the Society of St. Vincent de Paul's Portland council, whose utilities-assistance program is already overwhelmed. "I don't know where we're going to get more money to handle that, unless some huge donations come in."
The mass exhaustion of benefits, an echo effect of the great recession, is unprecedented in Oregon as the jobless rate remains stuck at 10.5 percent, state Employment Department officials say. Other states expect similar effects, including Washington, where officials don't yet have specific projections. In Oregon, almost one out of five people already is on food stamps. A record 741,419 Oregonians are on the supplemental nutritional assistance program, a number bound to increase as more people lose unemployment benefits, said Gene Evans, Human Services Department communications officer. "That's got to be so frightening for individuals and families, seeing the end approaching," Evans said.
James Mitchell, a 64-year-old Southeast Portland man, knows just how it feels. After working in stock brokerages for 36 years, he lost his job in early 2009. Unless a job offer shows up soon, Mitchell will become one of Oregon's roughly 21,000 so-called 99ers, the unemployed people who have exhausted their maximum benefits this year. Washington state has 32,000. "This is just as scary as people lobbing mortars over your head at 2 o'clock in the morning," said Mitchell, a Vietnam veteran. His weekly check is $391, far short of his mortgage payment. "It's not just me," Mitchell said. "This is going to affect an awful lot of people in a horrifying way very soon if something's not done."
Jean DeMaster, executive director of Human Solutions, an east Portland and Multnomah County nonprofit, sees people in desperate straits after their unemployment runs out. "They're unable to pay the rent, unable to keep their utilities on," DeMaster said. "We see parents who are trying and trying and trying to find jobs, and they just can't find anything in this economy."
On the first day of each month, people line up for rental assistance at Human Solutions, which has enough for 40 families and between 200 and 400 waiting. The organization also provides energy assistance, but that federal program will be cut 59 percent starting in January if Congress doesn't act within days, compounding effects of the unemployment expirations. Callers trying to reach Neighborhood House get a recorded message saying the social service agency is taking applications from Portland Water Bureau customers who need help paying bills. The recording says Neighborhood House's energy-assistance waiting list is full. Rental assistance won't be available until January.
Salvation Army managers in Oregon see people who used to give donations coming in for help. Maj. James Sloan, who oversees Portland-area operations, says the organization helps an average 3,100 families a month. That's up 30 percent from three years ago. Salvation Army workers are bracing for increased demand if as many unemployed workers exhaust benefits as predicted. "I don't know what those numbers you're describing will actually do to us," Sloan said. "At this point I'm not sure how we would handle that increase if it were to come at us."
In November, about 2,500 Oregonians exhausted jobless benefits, said Craig Spivey, a state Employment Department spokesman. The number of people on regular unemployment benefits has dropped, he said, from 104,000 a year ago to 87,000 this week. But almost 80,000 people are on some form of extended benefits, Spivey said. A large number of those people working their way through the unemployment pipeline will result in April's big spike, he said.
Has Oregon ever had a spike as high? "Not in the 25 years I've been involved in this," Spivey said. State officials will release November's unemployment rate on Tuesday. Kitzhaber, who faces a $3.5 billion state-budget gap, hasn't decided whether to ask legislators to extend jobless benefits, said Amy Wojcicki, a transition-team spokeswoman. Already state workers, saddled with furlough days, hiring freezes and vacant positions, struggle to keep up with food-stamp applications. "The governor elect will look at the extension of unemployment benefits in the context of the state budget as a whole," she said, "before he makes his recommendations to the Legislature."
Market alarm as US fails to control biggest debt in history
by Liam Halligan - Telegraph
US Treasuries last week suffered their biggest two-day sell-off since the collapse of Lehman Brothers in September 2008. The borrowing costs of the government of the world’s largest economy have now risen by a quarter over the past four weeks.
Such a sharp rise in US benchmark market interest rates matters a lot – and it matters way beyond America. The US government is now servicing $13.8 trillion (£8.7 trilion) in declared liabilities – making it, by a long way, the world’s largest debtor. Around $414bn of US taxpayers’ money went on sovereign interest payments last year – around 4.5 times the budget of America’s Department of Education.
Debt service costs have reached such astronomical levels even though, over the past year and more, yields have been kept historically and artificially low by "quantitative easing (QE)" – in other words, Federal Reserve Chairman Ben Bernanke’s virtual printing press. Now borrowing costs are 28pc higher than a month ago, with the 10-year Treasury yield reaching 3.33pc last week, an already eye-watering debt service burden can only go up.
Few on this side of the Atlantic should feel smug. The eurozone’s ongoing sovereign debt debacle has pushed up Germany’s borrowing costs by 27pc over the last month – to 3.03pc. The market has judged that if Europe’s Teutonic powerhouse wants the single currency to survive, it will ultimately need to raise wads of cash to absorb the mess caused by other member states’ fiscal incontinence.
While the UK isn’t ensnared in monetary union, gilt yields have also spiralled 18pc since the start of November – to 3.55pc. British Government debt is officially £1.05 trillion. We are fast approaching a debt-to-GDP ratio of 100pc, compared to 30pc just a decade ago. If you add off-balance-sheet liabilities to Government estimates, including the bank bail-outs which disgracefully remain "off the books", the UK already owes more than an entire year’s national income. In the medium-term, this is surely incompatible with a Triple AAA credit rating.
Even with gilt yields ultra-low, courtesy of British QE, the UK is still spending £42bn a year servicing sovereign debt – up 50pc since 2008. The Coalition is talking tough about reining-in the annual budget deficit, but our burgeoning debt stock means interest payments are anyway set to reach £70bn – twice the defence budget – by 2015. And those numbers rest on low gilt-yield assumptions that will be blown out of the water if this recent bond market implosion is the start of a trend.
Some say that growing signs of a US economic recovery are positive for stocks, which means money is being diverted out of Treasuries, so lowering their price, which pushes up yields. That’s wishful thinking. Sovereign borrowing costs have just surged in the US – and therefore elsewhere – because a politically-wounded President Obama caved-in and extended the Bush-era tax cuts, combining them with a $120bn payroll tax holiday.
Lower taxes, and the certainty of lower taxes, may bolster business investment and growth. That’s the logic employed by those painting last week’s global yield spike in a positive light. Government borrowing costs rose in America and elsewhere, they say, as a re-bounding US economy is now drawing investors’ cash away from sovereign bonds and towards more productive uses.
The reality is, though, that the market is increasingly alarmed at the rate of increase of the US government’s already massive liabilities. America’s government debt is set to expand by a jaw-dropping 42pc over the next few years, reaching $19.6 trillion by 2015 according to Treasury Department estimates presented (amid very little fanfare) to Congress back in June. Since then, government spending has risen even more. So US debt service costs, like those of many other Western nations, are expanding rapidly in terms of both the volumes of sovereign instruments outstanding, and the yields on each bond.
The new worry in the market is that this latest round of tax cuts could add another $1 trillion to the US deficit, on top of the already horrendous numbers produced in June. With opinion now deeply split about the wisdom of yet another round of QE, bond investors are getting increasingly worried that the Fed will turn off the funny-money and the sugar-rush will fade. Meanwhile, the US has very few plans – and none of them remotely credible – to get to grips with the biggest debt in history.
America has lately been very happy for small eurozone members to endure most of the adverse publicity related to the sovereign bond crisis. But, as of last week, the Western government debt debacle has entered the big league. We’re going to hear a lot more about the US government’s borrowing costs over the coming months – and the related "contagion" of other countries’ treasury bills, as America’s funding issues focus attention on the scale and ratcheting interest costs of sovereign debts in other large economies too.
Until now, market attention has oscillated between the eurozone and the States, with one region’s debt instruments benefiting from the woes of the other. Last week marked a turning point. Western sovereign instruments were hammered across the board – with traders making little distinction between the debts of Germany or Japan. There’s a lot more of this to come.
Investors en masse are parking ever more cash in alternative asset classes, such as commodities, other tangible assets and emerging market sovereign debts. The pool of money available to finance Western government borrowing is, in relative and maybe even in absolute terms, starting to shrink. This is extremely worrying – not least because of the industrialised world’s demography. Our ageing population means that higher future borrowing requirements are practically guaranteed, even if our politicians become paragons of fiscal virtue – which, of course, they won’t. As one economist I admire recently quipped: "Expecting today’s Western leaders to run fiscal surpluses is like expecting dogs to stockpile sausages".
Just a few months ago, it was only newspaper scribblers like me, and other naturally dissenting voices, who dared to be openly critical of grotesquely irresponsibly policies such as QE. Yet increasing numbers of important voices are now saying that, in fact, the Emperor has no clothes. Last week the patience of many bond traders snapped too. That marked a very important moment.
The US will continue to run a budget deficit of in excess of 10pc of GDP for at least another year. This is in marked contrast to most other advanced economies, where the fiscal axe is now being swung, with consolidation now beginning in earnest. The danger is that the bond markets won’t care – and almost all Western sovereign instruments will become burdened with a big risk premium, even the bonds of those countries which have actually bitten the bullet and started to impose serious fiscal reforms. If ministers in Britain and Germany would like to know in advance what this feels like and the domestic political havoc it can cause, they should talk to their Irish counterparts.
Over the coming months, the world’s appetite for dollar assets will be very severely tested – perhaps very close to destruction. America boasts the world’s reserve currency, of course, but its ability to borrow from the rest of the world is not without limit. Last week’s US tax move poses great dangers. There is little point in a fiscal giveaway that’s cancelled out by higher rates. All you end up with is even more sovereign debt. Upgraded growth forecasts don’t cause yield spike like that we saw last week – and its absurd to suggest that they do. There’s a new mood in the bond markets – a mood of zero tolerance.
U.S. Posts $150.4 Billion November Budget Deficit
by Jeff Bater - Wall Street Journal
The U.S. government ran its 26th straight monthly budget deficit in November amid wrangling over a package that would extend big tax cuts to Americans trying to recover from recession. The Treasury Department, in its regular budget monthly statement, said the government spent $150.4 billion than it collected in the second month of fiscal 2011. Economists surveyed by Dow Jones Newswires had expected a shortfall of $126.5 billion. November is traditionally a month for deficits.
The Treasury report, detailing the government's spending programs, prompted an economic research firm, Macroeconomic Advisers, to lift its forecast for economic growth from October through December by four-tenths of a percentage point, to 2.7%. Last month's red ink pushes up the deficit to $290.8 billion for the fiscal year, which began Oct. 1. That figure is a little smaller than the deficit during the same period last year. But President Barack Obama's administration expects the deficit to top $1 trillion in this fiscal year.
Washington has spent in excess of $1 trillion during each of the last two fiscal years, as revenues were reduced by the deep recession. At the same time, the economic slump and Wall Street bailout raised the government's expenses. The November deficit marked the government's 26th shortfall in a row. As the deficit continues growing, Washington is in the midst of working out key tax legislation. The Senate unveiled final details of a broad tax bill—and its 10-year price tag of $858 billion—and began debate Thursday night on the package. Earlier in the week, Mr. Obama struck a deal with Republicans in Congress to extend for two years tax cuts enacted under former President George W. Bush.
The budget statement Friday said federal spending totaled $585.7 billion so far this fiscal year, with revenues at $294.9 billion. In the last two months, the federal government spent $128.3 billion on defense, $36.8 billion in interest payments on its debt, and $20.0 billion for unemployment benefits. The U.S. budget deficit in fiscal 2010, at $1.294 trillion, was the second-highest ever, behind the record 2009 deficit of $1.416 trillion.
The administration last July said it was projecting a 2011 budget deficit of $1.416 trillion. But Michael Feroli, an analyst at J.P. Morgan Chase, said Friday he expects the budget gap to set a new record in fiscal 2011, reaching $1.5 trillion as the government pays for the extension of tax cuts. The tax package prompted Mr. Feroli to raise his forecast of 2011 economic growth by half of a percentage point. This also came after the Fed, to spur the weak economy, announced a decision last month to buy $600 billion in U.S. Treasury notes.
"Because the added growth from the package should be concentrated in the first half of next year, we now believe the Fed will not seek to increase asset purchases beyond the currently scheduled $600 billion amount when it reviews the program next June," he said in a research note.
NY Fed to Buy $105 Billion in Treasurys Over Next Month
by Michael S. Derby - Wall Street Journal
The Federal Reserve Bank of New York said Friday it will buy $105 billion in Treasury debt over the coming month. The bank said in a press release the purchases will include $75 billion done under the new program to buy $600 billion in longer term government bonds by the middle of next year. The remaining $30 billion will be purchases related to reinvestment of the proceeds of the Fed’s mortgage holdings.
The Fed operations will comprise 18 auctions occuring between Dec. 13 and Jan. 11, and will target a range of conventional and inflation indexed government bonds. The next auction schedule is expected to be made public on Jan. 12, 2011. The Fed is buying Treasurys in a bid to lower borrowing costs and spur better levels of economic growth, which policymakers hope will lower unemployment and push inflation back toward levels they deem consistent with stable prices.
The Collapse of the USSA
by Jeff Berwick - Dollar Vigilante
Incoming Speaker of the House, John Boehner, fresh off of ridding Congress of those out-of-control, tax and spend Democrats announced his first big plan to cut the budget today and he started close to home - in his and other congressman and senator budgets.
“I’m gonna cut my budget — my leadership budget — 5 percent,” he said, in video released by CBS. ”I’m gonna cut all the leadership budgets by 5 percent. I’m going to cut every committee’s budget by 5 percent. And every member is going to see a 5 percent reduction in their allowance. All together. that’s 25, 30 million dollars that likely would be one of the first votes we cast. We can start with ourselves.”
Wow! $30 million out of a $3.9 trillion budget. That's 0.000007%!
Just out of curiosity, I went to the US Debt Clock website and timed how long it took for the US national debt to increase by $30 million. The amount of time? 13 minutes.
Therefore, if the amount of time spent enacting this budget cut takes up more than 13 minutes it will, literally, be a waste of time.
To be fair to John Boehner, we're sure he has other big plans to cut the budget. But, here is the problem, even if he cut the US government discretionary spending by 100%, it still isn't enough. Just take a look at the numbers:
Here is the 2010 tax receipts for the US federal government:
- $1.061 trillion – Individual income taxes
- $940 billion – Social Security and other payroll tax
- $222 billion – Corporation income taxes
- $77 billion – Excise taxes
- $23 billion – Customs duties
- $20 billion – Estate and gift taxes
- $22 billion – Deposits of earnings
- $16 billion – Other
Now, notice how the US government includes Social Security tax, taken off of paychecks as being INCOME?? No company could ever do that. But the US government can. Why? Because they've got all the guns and can do what they want.
But the money taken in from payments into Social Security is obviously not real income of the government. That money, theoretically, is supposed to be set aside to pay for Social Security in the future.
So, if you exclude Social Security receipts, the total "income" (tax/theft) of the federal government for 2010 was $1.44 trillion.
Here are the Mandatory and Discretionary spending numbers for 2010:
Mandatory spending: $2.184 trillion
- $677.95 billion – Social Security
- $571 billion – Other mandatory programs
- $453 billion – Medicare
- $290 billion – Medicaid
- $164 billion – Interest on National Debt
- $11 billion – Potential disaster costs
Discretionary spending: $1.368 trillion
- $663.7 billion – Department of Defense (including Overseas Contingency Operations)
- $78.7 billion – Department of Health and Human Services
- $72.5 billion – Department of Transportation
- $52.5 billion – Department of Veterans Affairs
- $51.7 billion – Department of State and Other International Programs
- $47.5 billion – Department of Housing and Urban Development
- $46.7 billion – Department of Education
- $42.7 billion – Department of Homeland Security
- $26.3 billion – Department of Energy
- $26.0 billion – Department of Agriculture
- $23.9 billion – Department of Justice
- $18.7 billion – National Aeronautics and Space Administration
- $13.8 billion – Department of Commerce
- $13.3 billion – Department of Labor
- $13.3 billion – Department of the Treasury
- $12.0 billion – Department of the Interior
- $10.5 billion – Environmental Protection Agency
- $9.7 billion – Social Security Administration
- $7.0 billion – National Science Foundation
- $5.1 billion – Corps of Engineers
- $5.0 billion – National Infrastructure Bank
- $1.1 billion – Corporation for National and Community Service
- $0.7 billion – Small Business Administration
- $0.6 billion – General Services Administration
- $19.8 billion – Other Agencies
- $105 billion – Other
The numbers are pretty simple. The US government had total real tax receipts of $1.44 trillion in 2010. This only pays for 66% of the Mandatory Spending, even if you got rid of 100% of the discretionary spending.
In other words, in order to balance the budget the government would have to cut 100% of Discretionary Spending and 34% of Mandatory Spending. What would that look like?
To do this, they would have to close every military base and lay-off every serviceman in the Armed Forces, close every public school and fire every teacher, shut down the Department of Homeland Security and every other government agency and, as well, cut all Social Security, Medicare and Medicaid spending by 34%.
John Boehner's got quite a bit further to go!
But whether he does the cutting himself or not, these cuts will have to be made. They will either be made by choice or by force as the rest of the world is about to take away the US' credit card. When they do, and that time is very near, the USSA will collapse just as the USSR did, and for the same reasons: Because they both were or became centrally planned, socialist/communist economies.
Banks' Exposure Grows in Eurozone
by Nina Koeppen - Wall Street Journal
Banks' total exposure to Ireland and the southern rim of the euro zone in the second quarter was greater than previously thought, according to data from the Bank for International Settlements published Sunday.
The data confirm that German and French banks are among the world's largest creditors to the region. France's total exposure to Greece stood at $83.1 billion at the end of the second quarter, comprising $57.3 billion in foreign claims and $25.7 billion in "other exposure," or the positive market value of derivative contracts, guarantees extended and credit commitments. The BIS data on banks' "other exposure" hadn't been previously published, resulting in a greater exposure than estimated.
German banks' total exposure to Greece stood at $65.4 billion, mirroring $36.8 billion in foreign claims and $28.6 billion in other exposure. With an exposure of $186.4 billion, German banks had the second-largest exposure to Ireland, after the U.K., where banks' exposure amounted to $187.5 billion at the end of the second quarter.
The BIS's data illustrate how costly it would be if struggling Greece or Ireland were forced to restructure their debts as part of a bailout, as some commentators had argued. Both countries required a bailout because of a crippling debt crisis. With a total exposure of $98.3 billion, Spanish banks had the largest exposure to Portugal. German banks topped the list of Spanish creditors, with a total exposure of $216.6 billion; French banks' total exposure to Spain stood at $201.3 billion.
BIS said the total consolidated foreign exposures of BIS-reporting banks to Greece, Ireland, Portugal and Spain stood at $2.281 trillion. At $1.613 trillion, foreign claims represented just over 70% of that amount. As the consolidated banking statistics don't include a currency breakdown, BIS said it is hard to say how much foreign claims had changed from the previous period.
"On the admittedly imperfect assumption that all foreign claims on these countries are denominated in euros, the quarter saw a combined decline of $107 billion," BIS said. "This amount is considerably smaller than the $276 billion contraction that would be obtained by simply taking the difference between the outstanding stocks—measured in U.S. dollars—at the respective ends of the first two quarters of 2010."
Low interest rates failing to rescue British households from £1.45 trillion in debts
by Philip Aldrick - Telegraph
Low interest rates are not fixing Britain's household debt burden, a damning survey for the Bank of England has found. The study, conducted by NMG Financial Services Consulting, shows that almost half of all households are concerned about their debt – largely because soaring credit card rates are eroding savings from lower mortgage costs.
The research contradicts comments made by Lord Young, the Tory peer who resigned as an adviser to David Cameron after saying "the vast majority of people in the country today have never had it so good" since the Bank slashed rates to 0.5pc. Despite record low interest rates, half of respondents reported a fall in monthly disposable income after tax, mortgage, rent, bills and other loan payments. Nearly a third, 29pc, said their debt concerns had risen over the past two years, compared with just 12pc who are now less worried.
The survey paints a deeply troubling picture of a nation still struggling to pay off its debts despite the historically low rate environment. UK consumer borrowings are around £1.45 trillion and have not begun to shrink. The Bank has already warned that more than one in two people with "unsecured" debts, such as credit cards or personal loans, are struggling to cope.
Rates on credit cards have risen from 17.8pc in November 2007 to 18.7pc, according to the Bank, despite a cut in base rates from 5.75pc to 0.5pc. In addition, NMG notes that 48pc of all households are on fixed-rate mortgages, "paying about £680 a month in comparison with about £530 a month for those on trackers or variable rates" for equivalent sized mortgages. Households with high loan-to-value (LTV) mortgages or renting are struggling the most, the survey says, with the proportion resorting to credit card debt rising: "The fraction of high LTV mortgagors with unsecured debt had risen between the 2009 and 2010 surveys, from 68pc to 92pc."
"Looking ahead, if the increase in debt burden and repayment problems is a leading indicator of households' financial difficulties, the proportion of households falling behind on payments may pick up from current levels." Despite the high debt burden, households have not used low rates to pay off mortgages. "The share of income devoted to servicing secured debt tends to fall as interest rates fall.
However, in 2010 the proportion of households devoting more than 20pc of income to mortgage repayments had fallen only slightly since 2008," the survey finds. More households have fallen behind on "bills and credit commitments" than last year, and the proportion struggling to keep up has risen from 34pc to 40pc – particularly for those with credit card debt or personal loans.
Borrowers who said their credit card debts or personal loans have become a burden increased to 51pc – the highest level in the 15 years the research has been running. The Bank notes: "The burden of unsecured debt has risen this year, most likely reflecting a combination of weak earnings growth and the interest rates on unsecured debt remaining high despite falls in Bank rate."
Some 45pc of households are now concerned about their overall debt levels, with 11pc "very concerned". For renters and high LTV mortgage households, the majority are worried, while low LTV and outright owners are comfortable with their situation. NMG carried out the survey in late September 2010 on about 2,000 British households on behalf of the Bank.
EU to target private lenders in future bail-outs
The EU plans to make private lenders cover the losses of any future eurozone debt crisis, the BBC has learned. The decision may significantly raise the future cost of borrowing for over-indebted eurozone governments. It is part of a new permanent scheme - to be funded by eurozone governments, but not the UK - to replace existing bail-out funds that expire in 2013.
The new mechanism will need a treaty change, which may lead to ratification problems in the Irish Republic. The details of the proposed European Stability Mechanism are included in a draft European Union communique obtained by the BBC. The changes come too late for the Republic of Ireland, which was forced by European partners to foot the bill for rescuing its banks in order to get an 85bn euro bail-out.
In future, Brussels may require a crisis-stricken eurozone government to force losses on its existing private lenders - including investors in government bonds - before it would provide a bail-out package. And if a government got into trouble later down the line, it would be required to default on its other debts, while continuing to make payments on its rescue loans. "That won't please the markets, who thought that holding government bonds was as safe as cash deposits," says BBC business correspondent Joe Lynam.
From June 2013, government bonds will also have to include "collective action clauses", which would make it much easier for an insolvent government to get the consent of its lenders to any future debt write-offs. Together, the changes mean a government's private-sector lenders will face a much bigger risk of losing their money. And this means they are likely to charge the more heavily indebted eurozone member states a higher interest rate.
The rhetoric in the communique comes in stark contrast to the actual bail-out of the Irish Republic in November. In that rescue, Brussels is accused of having insisted that Dublin honour in full its guarantee of the Irish banks. Many Irish are angry that this has landed taxpayers with the bill for repaying loans made to its insolvent banks. However, with European banks dangerously undercapitalised, European leaders feared that a default by the Irish banks could trigger a Europe-wide banking crisis.
Separately, the EU is planning to carry out a new, and much stricter, set of stress tests on its big banks this year. The tests will determine how much capital the banks need to absorb future losses. The previous stress tests, held over the summer, were criticised for failing to consider the possibility of a default by a eurozone government.
The planned Lisbon Treaty amendment is short and open-ended, leaving European leaders flexibility to structure the new arrangement however they choose. It states only that: "The Member States whose currency is the euro may establish a stability mechanism to safeguard the stability of the euro area as a whole. The granting of financial assistance under the mechanism will be made subject to strict conditionality."
The amendment may also open the way towards a common eurozone government bond at a later date. This was a solution to the eurozone debt crisis proposed by Luxembourg Prime Minister Jean-Claude Juncker and Italian Finance Minister Giulio Tremonti, but rejected by Germany. Ratification of the treaty change may prove a challenge in some countries. The Irish Republic's constitution requires a referendum at a time when the public is angry with Europe over the harsh terms of their bail-out. In the UK, the amendment is not expected to trigger a referendum.
The draft communique states that EU members outside the eurozone - such as the UK - may choose to participate in the new bail-out arrangement "on an ad hoc basis". However, right-wing members of his Conservative party may demand that Prime Minister David Cameron use the opportunity to negotiate UK opt-outs from existing treaty requirements. The communique also said that the EU will endorse making Montenegro an official candidate to join the European Union, meaning the country can begin formal accession negotiations.
The eurozone is in bad need of an undertaker
by Ambrose Evans-Pritchard - Telegraph
The EU’s Franco-German "Directoire" and the European Central Bank have between them ruled out all plausible solutions to the eurozone’s debt crisis. There will be no Eurobond, no increases in the EU’s €440bn (£368bn) rescue fund, and no mass purchases of Spanish and Italian bonds by the ECB. Nothing. The system is political and constitutionally paralysed. Spain and Portugal will be left nakedly exposed before their funding crunch in January.
It is entirely predictable that Angela Merkel and Nicolas Sarkozy would move so quickly to shoot down last week’s Eurobond proposal, issuing pre-emptive warning before this week’s EU summit that they will not accept "a bundling together of all Europe’s debts". How can Germany or France agree lightly to plans that amount to an EU debt union, with a common treasury, tax system, and budget policy, the stuff of civil wars and revolutions over the ages? To do so is to dismantle the ancient nation states of Europe in all but name.
Even if Chancellor Merkel wished to take this course – and even if the Bundestag approved it – the scheme would still be torn to pieces by the German constitutional court unless legitimised by radical EU treaty changes, which would in turn take years, require referenda, and face populist revolt in half Europe.
What the German people are being asked to do is to surrender fiscal sovereignty and pay open-ended transfers to Southern Europe, taking on a burden up to six times reunification with East Germany. "If we pool the debts of the countries in the south-west periphery of Europe, we are blighting our children’s future: the debt levels are astronomic," said Hans-Werner Sinn, head of Germany IFO institute. Any attempt to prop up the status quo will cement the current account imbalances of EMU’s North and South, to the detriment of both sides. "I doubt that the current leaders of Europe fully understand the economic implications of their decisions. They are repeating the mistakes that Germany made over reunification," he told the Handelsblatt.
Transfers to the East are still running at €60bn a year two decades after the fall of the Berlin Wall. There has been no meaningful East-West convergence for the last 15 years. To those who blithely argue that EMU is a good racket for German exporters because it locks in Germany’s competitive advantage, he retorts that a trade surplus is the flip side of a capital deficit. Germany has seen €1 trillion – or two thirds of its entire savings since 2002 – leak out to fund the EMU party, gutting investment at home. This is toxic for Germany too.
It is no surprise to eurosceptics that Europe should have reached this fateful point where leaders must choose between the twin traumas of EMU break-up or giving up their countries. Nor is it a surprise to an inner-core of schemers within the EU system, who have always calculated that they could exploit such a crisis to catalyse political union. However, it is a big surprise to Europe’s leaders, and they do not know what to do about it.
Chancellor Merkel and President Sarkozy seem unwilling even to boost the firepower of the European Financial Stability Facility, though in this they may be right. The drama has moved beyond the point where headline "shock and awe" pledges can achieve anything. Markets are already looking beyond the debt-stricken periphery to the creditor core, fearing that bail-out costs will themselves create a chain of contamination. Credit default swaps on France have risen above 100 basis points, where they linger stubbornly.
A Fitch report on the European Stability Mechanism (ESM) said the new rescue fund "could result in lower ratings" on the risky sovereigns because the EU would have instant debt seniority, leaving private bondholders exposed to the risk of bigger haircuts. To make matters worse, debt restructuring would depend on the whim of politicians. The incoherence of the rescue machinery itself is feeding the debt crisis.
So as EU leaders flounder, the task of saving monetary union falls to the ECB. Yet it too has declined the burden, refusing to go nuclear with bond purchases. "Each country needs to be held responsible for its own debt," said Germany’s monetary avenger at the ECB, Jurgen Stark. He was joined last week by Mario Draghi, Italy’s governor and candidate for ECB chief, who said it was not the job of a central bank to carry out fiscal rescues. "We could easily cross the line and lose everything we have, lose independence, and basically violate the Treaty," he said.
Indeed. Maastricht forbids the ECB from buying the debt of eurozone states except for specific purposes of liquidity management. But this saga no longer has anything to do with liquidity. Southern Europe faces a solvency crisis. The ECB has postponed its threat to pull away the lending props beneath the banking systems of the PIGS. Beyond that it has limited itself to tactical strikes in the small illiquid debt markets of Ireland and Portugal, buying enough bonds to ram down yields and burn a few hedge funds.
The effect has faded within days. It had little impact on Spanish and Italian bonds in any case. Spanish 10-year yields reached 5.45pc last week, far above 5pc level where compound arithmetic comes into play. At the end of the day, debtor governments still have to persuade Japanese life insurers, Mideast wealth funds, or French and German banks, to put up real money to buy their bonds at a bearable interest rate. Credit Agricole said last week that it would hold back at next week’s auction of Spanish debt because it is not yet clear whether the ECB will back-stop the country. "The risk is simply too large for our appetite," it said.
So we drift on with rising yields into 2011, when Portugal must raise €38bn, Belgium €85bn, Spain €210bn, and Italy €374bn – according to Goldman Sachs. Europe’s leaders still seem to hope that brisk global growth will lift everybody off the reefs. That too is wishful thinking. Recovery brings its own set of problems, and will make intra-EMU tensions even worse. Germany will hit the inflation buffers and force the ECB to raise interest rates before the trickle down benefits of trade have begun to make any difference in the closed economies of the South. Floating Euribor rates that determine 98pc of mortgages in Spain have been shooting up already, even as wages fall. The vice is still tightening on Spain.
The reflex of the EU elites is to blame this structural mess on lack of statesmanship. "There is something surreal about the unfolding financial crisis," said Stefano Micossi from the College of Europe, the sanctum sanctorum of the European Project. "Leaders grudgingly do what is needed to prevent disaster at the last minute before it is too late, and the next minute they go back to the behaviour that brought them against the wall in the first place. The eurozone is in bad need of a psychiatrist," he wrote at VoxEU.
"If the eurozone follows this path, either all of the sovereign debts become German public debt, or the euro will collapse," he said.This is admirably candid in one sense, but is today’s crisis really just a failure of leadership? Was EMU not dysfunctional from the first day? Did it not inflict negative real interest rates on Club Med and Ireland in the boom years, driving them into distastrously pro-cyclical policies?
Did it not lock in chronic imbalances between North and South? Has it not left victim states trapped in debt deflation or slumps which have gone too far to respond an austerity cure, and from which there seems to be no escape on terms acceptable to Germany? Should we blame the current hapless leaders, or the guilty men of Maastricht who created this doomsday machine? If the project itself is rotten, surely what the eurozone needs most is an undertaker.
1.6 Million Put Off Retirement
by Mark Whitehouse - Wall Street Journal
1.6 million: The number of older Americans in the labor force as a result of the financial crisis. The financial crisis has been hard on just about everyone. But for older folks, the pain is proving particularly deep and lasting — a problem that could put a drag on the economy for many years to come.
People approaching retirement age are suffering on all fronts. Even with the Dow above 11,000, their stock holdings are worth less than they were back in 2006. Fixed-income investments hardly provide any income. Home prices remain depressed. As a result, more older people are trying to make up lost ground by staying at work longer or rejoining the labor force – precisely at a time when finding a job is exceedingly difficult.
In a new paper, two economists at the Chicago Fed — Eric French and David Benson — estimate that the labor-participation rate among people 51 to 65 years old is 2.9% higher as a result of their financial losses alone. That’s about an added 1.6 million people staying in jobs or looking for work. In most states of the world, anything that motivates more people to work would be beneficial for the economy. Older folks have valuable skills and experience, and their participation increases the nation’s potential to produce goods and services.
But at a time when the economy is already running far below its potential, the added labor supply serves to boost the unemployment rate, as more people compete for scarce jobs. Since August, the unemployment rate for people 55 and older has averaged 7.3%, the highest level since at least 1948.
Meanwhile, if people can’t rebuild their retirement nest eggs, they’ll have to cut back on spending in old age more than they already do. That’s a problem for companies hoping to sell them everything from health care to cars. And if more of an aging population winds up relying on the state for support, that doesn’t bode well for the government’s efforts to get its long-term finances back in order.
Obama-GOP Tax Cut Bill Turning Into 'Christmas Tree' Tinseled With Gifts For Lobbyists, Lawmakers
by Frederic J. Frommer and Mary Clare Jalonick - AP
In the spirit of the holiday season, President Barack Obama's tax-cut deal with Republicans is becoming a Christmas tree tinseled with gifts for lobbyists and lawmakers. But that hardly stopped the squabbling on Friday, with Bill Clinton even back at the White House pleading the president's case. While Republicans sat back quietly, mostly pleased, Democrats and other liberals were going at each other ever so publicly. As Clinton lectured on Obama's behalf, Vermont independent Bernie Sanders castigated the agreement for the TV cameras in the mostly empty Senate chamber.
The tax deal, reached behind the scenes and still informal, now includes ethanol subsidies for rural folks, commuter tax breaks for their cousins in the cities and suburbs and wind and solar grants for the environmentalists – all aimed at winning votes, particularly from reluctant Democrats. The holiday additions are being hung on the big bill that was Congress' main reason for spending December in Washington, long after the elections that will give Republicans new power in January.
The measure will extend Bush-era tax cuts, averting big tax increases for nearly all Americans, and keep jobless benefits flowing. Republicans generally liked that agreement, worked out by Obama and GOP leaders. Democrats generally didn't, hence the add-ons. It's all expected to come to a decisive vote next week, total cost by the latest congressional estimate: $857.8 billion.
On Friday, there were contrasting events for public consumption. On Capitol Hill, Sanders spoke vigorously for 8 1/2 hours in a virtually empty chamber, urging defeat of a measure he said would give "tax breaks to millionaires and billionaires who don't need it." He finally ended his speech, conceding "It has been a long day." At the White House, Obama turned over the briefing room microphone to former President Clinton who declared, "I don't believe there is a better deal out there." All sides, he said, "are going to have to eat some things they don't like."
The add-ons were being attached behind the scenes. Almost $5 billion in subsidies for corn-based ethanol and a continuing tariff to protect against ethanol imports were wrapped up and placed on the tree Thursday night for farm-state lawmakers and agribusiness lobbyists. Environmentalists won more grants for developers of renewable energy, like wind and solar. For urban lawmakers, there's a continuation of about-to-expire tax breaks that could save commuters who use mass transit about $1,000 a year. Other popular tax provisions aimed at increasing production of hybrid automobiles, biodiesel fuel, coal and energy-efficient household appliances would be extended through the end of 2011 under the new add-ons.
The package also includes an extension of two Gulf Coast tax incentive programs enacted after Hurricane Katrina to spur economic development in Mississippi, Louisiana and Alabama. The ethanol money was added despite a growing congressional opposition to subsidizing the fuel after decades of government support. Last month, 17 Republican and Democratic senators wrote to leaders calling the tax breaks "fiscally indefensible," since there's already a law in place that requires ethanol be blended into gasoline.
"Historically the government has helped a product compete in one of three ways: Subsidize it, protect it from competition or require its use. We understand that ethanol may be the only product receiving all three forms of support from the U.S. government at this time," the senators wrote. But ethanol still has powerful supporters on Capitol Hill, including Iowa Sen. Charles Grassley, the top Republican on the Senate Finance Committee and a key negotiator on the Senate tax bill. Adding the ethanol tax breaks was designed to help shore up the votes of many rural Democratic as well as Republican senators.
But while the add-ons may have won more votes for the Obama-GOP deal the Senate, their potential impact is less clear in the House, where Democrats have criticized the package as a tax giveaway to the rich. Minnesota Rep. Collin Peterson, a conservative Democrat who steps downs as chairman of the House Agriculture Committee in January, says he would have voted against the bill if it had contained some of the clean energy tax incentives and nothing for ethanol. "I know this will help some members in the House, different parts of this will help different members," he said.
Still, Peterson said the credits for the corn-based fuel probably won't last forever. He said Rep. Jim Clyburn of South Carolina, the House's No. 3 Democrat, told the caucus it was important to include ethanol in the bill, and some members booed him. That wouldn't have happened a few years ago, Peterson said. Rep. Earl Pomeroy, D-N.D., who lost re-election in November, sponsored the House version of legislation extending the ethanol tax breaks. But he says he still can't support the bill because of his opposition to provisions cutting estate taxes for the wealthiest Americans. "There may be some that vote for the package that otherwise hate it because of the ethanol provision, but my sense is that ethanol alone isn't going to be something that puts us over the top," he said.
A spokesman for Rep. Earl Blumenauer, D-Ore., a leader in the effort to win tax credits for wind and solar energy, said his boss still hasn't been won over yet on the package. He said the extension was necessary but not sufficient for Blumenauer's support. "His vote will depend on what the final version looks like," said spokesman Derek Schlickeisen. Rep. Jay Inslee, a Washington Democrat, also was not won over by the renewable energy extension, despite being a big supporter of the program.
"It's one of the best things we have in the federal government for job creation. It is incredibly important. And it's nuts not to finance it by simply letting the upper-income tax brackets expire," he said. "I think there's a better deal out there potentially available and we ought to fight for it." And there's the possibility the added goodies will have opposite the intended effect for some lawmakers. Rep. Jeff Flake, R-Ariz., said the add-ons could turn his fiscally conservative colleagues against the bill. "You don't want to be accused out there of supporting stimulus three," he said. "It will knock some votes off in the House, but more than anything it will show the voters out there that things haven't changed with Republicans."
Germany Signals Support for Euro-Zone Members
by Jack Ewing - New York Times
In a shift of tone that may signal more commitment to keep the euro zone in one piece, Germany’s finance minister ruled out the possibility that any country would ever be ejected from the European monetary union, and said calls to restore the Deutsche mark were “unrealistic nostalgia.”
The comments by Wolfgang Schäuble, the German finance minister, may indicate that Europe’s biggest economy is becoming more willing to finance measures ensuring that countries like Greece and Ireland do not default on their debt. Fears that German enthusiasm for the euro was waning have contributed to turmoil on global financial markets in recent weeks, as investors increasingly factor in the risk that the euro zone could break up. Borrowing costs have risen not only for overly indebted countries, but for healthy countries like Germany as well.
European heads of government will hold a summit meeting this week to try to establish a permanent mechanism for dealing with debt crises. They are under pressure to convince financial markets that the euro is solid before global bond trading picks up from its December lull. Along with Chancellor Angela Merkel of Germany, Mr. Schäuble has often taken a hard line toward the countries that have caused the crisis. In March, he told the Bild newspaper that it should be possible to eject members of the monetary union who were unable to get their budgets under control.
Such statements seem to be a response to widespread resentment in Germany at having to bail out Greece and Ireland. German reluctance to agree to aid measures has slowed down European decision-making and contributed to anxiety in financial markets. But recently, German leaders have been trying to reaffirm their commitment to the euro. Guido Westerwelle, the foreign minister, said last week that Germany was determined to defend the euro and “anybody who wants to destroy the euro will realize that he cannot succeed.”
In an interview with Bild published on Sunday, Mr. Schäuble reversed his earlier position on countries that would drop the currency. “Even if only a small country were to leave, the consequences would be unforeseeable,” he said. Referring to the bankruptcy of Lehman Brothers in 2008 that nearly caused a global financial collapse, Mr. Schäuble said, “Let us not make the same mistake twice.”
In contrast to earlier statements that seemed to play to popular opinion, Mr. Schäuble stressed the benefits that Germany enjoyed because of the euro. He said it angered him when “people who know better” called for a return to the Deutsche mark. “Anyone who looks at the development of the German economy knows that our international integration is greater than any other economy,” Mr. Schäuble said. “Without the euro our own currency would experience a rise in value with negative consequences for exports.”
Bild, which offers its working-class readers a daily dose of scandal and sex, is Germany’s most widely read newspaper. It has frequently helped inflame taxpayer resentment at having to rescue other countries. German politicians often speak to the newspaper when they want to convey a message to common citizens. Economists point out that Germany is one of the main beneficiaries of the euro, which has prevented countries like Italy from devaluing their currencies to obtain a price advantage on world markets. German growth has been among the fastest in Europe this year, and unemployment has been falling.
Mr. Schäuble told Bild that younger people might not appreciate to what extent the European Union and the euro had contributed to peace since World War II. “We must not squander the historic opportunity of a common Europe,” he said.
A Secretive Banking Elite Rules Trading in Derivatives
by Louise Story - New York Times
On the third Wednesday of every month, the nine members of an elite Wall Street society gather in Midtown Manhattan. The men share a common goal: to protect the interests of big banks in the vast market for derivatives, one of the most profitable — and controversial — fields in finance. They also share a common secret: The details of their meetings, even their identities, have been strictly confidential.
Drawn from giants like JPMorgan Chase, Goldman Sachs and Morgan Stanley, the bankers form a powerful committee that helps oversee trading in derivatives, instruments which, like insurance, are used to hedge risk. In theory, this group exists to safeguard the integrity of the multitrillion-dollar market. In practice, it also defends the dominance of the big banks.
The banks in this group, which is affiliated with a new derivatives clearinghouse, have fought to block other banks from entering the market, and they are also trying to thwart efforts to make full information on prices and fees freely available. Banks’ influence over this market, and over clearinghouses like the one this select group advises, has costly implications for businesses large and small, like Dan Singer’s home heating-oil company in Westchester County, north of New York City.
This fall, many of Mr. Singer’s customers purchased fixed-rate plans to lock in winter heating oil at around $3 a gallon. While that price was above the prevailing $2.80 a gallon then, the contracts will protect homeowners if bitterly cold weather pushes the price higher. But Mr. Singer wonders if his company, Robison Oil, should be getting a better deal. He uses derivatives like swaps and options to create his fixed plans. But he has no idea how much lower his prices — and his customers’ prices — could be, he says, because banks don’t disclose fees associated with the derivatives. "At the end of the day, I don’t know if I got a fair price, or what they’re charging me," Mr. Singer said.
Derivatives shift risk from one party to another, and they offer many benefits, like enabling Mr. Singer to sell his fixed plans without having to bear all the risk that oil prices could suddenly rise. Derivatives are also big business on Wall Street. Banks collect many billions of dollars annually in undisclosed fees associated with these instruments — an amount that almost certainly would be lower if there were more competition and transparent prices.
Just how much derivatives trading costs ordinary Americans is uncertain. The size and reach of this market has grown rapidly over the past two decades. Pension funds today use derivatives to hedge investments. States and cities use them to try to hold down borrowing costs. Airlines use them to secure steady fuel prices. Food companies use them to lock in prices of commodities like wheat or beef.
The marketplace as it functions now "adds up to higher costs to all Americans," said Gary Gensler, the chairman of the Commodity Futures Trading Commission, which regulates most derivatives. More oversight of the banks in this market is needed, he said. But big banks influence the rules governing derivatives through a variety of industry groups. The banks’ latest point of influence are clearinghouses like ICE Trust, which holds the monthly meetings with the nine bankers in New York.
Under the Dodd-Frank financial overhaul, many derivatives will be traded via such clearinghouses. Mr. Gensler wants to lessen banks’ control over these new institutions. But Republican lawmakers, many of whom received large campaign contributions from bankers who want to influence how the derivatives rules are written, say they plan to push back against much of the coming reform. On Thursday, the commission canceled a vote over a proposal to make prices more transparent, raising speculation that Mr. Gensler did not have enough support from his fellow commissioners.
The Department of Justice is looking into derivatives, too. The department’s antitrust unit is actively investigating "the possibility of anticompetitive practices in the credit derivatives clearing, trading and information services industries," according to a department spokeswoman. Indeed, the derivatives market today reminds some experts of the Nasdaq stock market in the 1990s. Back then, the Justice Department discovered that Nasdaq market makers were secretly colluding to protect their own profits. Following that scandal, reforms and electronic trading systems cut Nasdaq stock trading costs to 1/20th of their former level — an enormous savings for investors.
"When you limit participation in the governance of an entity to a few like-minded institutions or individuals who have an interest in keeping competitors out, you have the potential for bad things to happen. It’s antitrust 101," said Robert E. Litan, who helped oversee the Justice Department’s Nasdaq investigation as deputy assistant attorney general and is now a fellow at the Kauffman Foundation. "The history of derivatives trading is it has grown up as a very concentrated industry, and old habits are hard to break."
Clearing involves keeping track of trades and providing a central repository for money backing those wagers. A spokeswoman for Deutsche Bank, which is among the most influential of the group, said this system will reduce the risks in the market. She said that Deutsche is focused on ensuring this process is put in place without disrupting the marketplace. The Deutsche spokeswoman also said the banks’ role in this process has been a success, saying in a statement that the effort "is one of the best examples of public-private partnerships."
Established, But Can’t Get In
The Bank of New York Mellon’s origins go back to 1784, when it was founded by Alexander Hamilton. Today, it provides administrative services on more than $23 trillion of institutional money. Recently, the bank has been seeking to enter the inner circle of the derivatives market, but so far, it has been rebuffed. Bank of New York officials say they have been thwarted by competitors who control important committees at the new clearinghouses, which were set up in the wake of the financial crisis.
Bank of New York Mellon has been trying to become a so-called clearing member since early this year. But three of the four main clearinghouses told the bank that its derivatives operation has too little capital, and thus potentially poses too much risk to the overall market. The bank dismisses that explanation as absurd. "We are not a nobody," said Sanjay Kannambadi, chief executive of BNY Mellon Clearing, a subsidiary created to get into the business. "But we don’t qualify. We certainly think that’s kind of crazy."
The real reason the bank is being shut out, he said, is that rivals want to preserve their profit margins, and they are the ones who helped write the membership rules. Mr. Kannambadi said Bank of New York’s clients asked it to enter the derivatives business because they believe they are being charged too much by big banks. Its entry could lower fees. Others that have yet to gain full entry to the derivatives trading club are the State Street Corporation, and small brokerage firms like MF Global and Newedge.
The criteria seem arbitrary, said Marcus Katz, a senior vice president at Newedge, which is owned by two big French banks. "It appears that the membership criteria were set so that a certain group of market participants could meet that, and everyone else would have to jump through hoops," Mr. Katz said. The one new derivatives clearinghouse that has welcomed Newedge, Bank of New York and the others — Nasdaq — has been avoided by the big derivatives banks.
Only the Insiders Know
How did big banks come to have such influence that they can decide who can compete with them? Ironically, this development grew in part out of worries during the height of the financial crisis in 2008. A major concern during the meltdown was that no one — not even government regulators — fully understood the size and interconnections of the derivatives market, especially the market in credit default swaps, which insure against defaults of companies or mortgages bonds. The panic led to the need to bail out the American International Group, for instance, which had C.D.S. contracts with many large banks.
In the midst of the turmoil, regulators ordered banks to speed up plans — long in the making — to set up a clearinghouse to handle derivatives trading. The intent was to reduce risk and increase stability in the market. Two established exchanges that trade commodities and futures, the InterContinentalExchange, or ICE, and the Chicago Mercantile Exchange, set up clearinghouses, and, so did Nasdaq.
Each of these new clearinghouses had to persuade big banks to join their efforts, and they doled out membership on their risk committees, which is where trading rules are written, as an incentive. None of the three clearinghouses would divulge the members of their risk committees when asked by a reporter. But two people with direct knowledge of ICE’s committee said the bank members are: Thomas J. Benison of JPMorgan Chase & Company; James J. Hill of Morgan Stanley; Athanassios Diplas of Deutsche Bank; Paul Hamill of UBS; Paul Mitrokostas of Barclays; Andy Hubbard of Credit Suisse; Oliver Frankel of Goldman Sachs; Ali Balali of Bank of America; and Biswarup Chatterjee of Citigroup.
Through representatives, these bankers declined to discuss the committee or the derivatives market. Some of the spokesmen noted that the bankers have expertise that helps the clearinghouse. Many of these same people hold influential positions at other clearinghouses, or on committees at the powerful International Swaps and Derivatives Association, which helps govern the market.
Critics have called these banks the "derivatives dealers club," and they warn that the club is unlikely to give up ground easily.
"The revenue these dealers make on derivatives is very large and so the incentive they have to protect those revenues is extremely large," said Darrell Duffie, a professor at the Graduate School of Business at Stanford University, who studied the derivatives market earlier this year with Federal Reserve researchers. "It will be hard for the dealers to keep their market share if everybody who can prove their creditworthiness is allowed into the clearinghouses. So they are making arguments that others shouldn’t be allowed in."
Perhaps no business in finance is as profitable today as derivatives. Not making loans. Not offering credit cards. Not advising on mergers and acquisitions. Not managing money for the wealthy.
The precise amount that banks make trading derivatives isn’t known, but there is anecdotal evidence of their profitability. Former bank traders who spoke on condition of anonymity because of confidentiality agreements with their former employers said their banks typically earned $25,000 for providing $25 million of insurance against the risk that a corporation might default on its debt via the swaps market. These traders turn over millions of dollars in these trades every day, and credit default swaps are just one of many kinds of derivatives.
The secrecy surrounding derivatives trading is a key factor enabling banks to make such large profits. If an investor trades shares of Google or Coca-Cola or any other company on a stock exchange, the price — and the commission, or fee — are known. Electronic trading has made this information available to anyone with a computer, while also increasing competition — and sharply lowering the cost of trading. Even corporate bonds have become more transparent recently.
Trading costs dropped there almost immediately after prices became more visible in 2002. Not so with derivatives. For many, there is no central exchange, like the New York Stock Exchange or Nasdaq, where the prices of derivatives are listed. Instead, when a company or an investor wants to buy a derivative contract for, say, oil or wheat or securitized mortgages, an order is placed with a trader at a bank. The trader matches that order with someone selling the same type of derivative.
Banks explain that many derivatives trades have to work this way because they are often customized, unlike shares of stock. One share of Google is the same as any other. But the terms of an oil derivatives contract can vary greatly. And the profits on most derivatives are masked. In most cases, buyers are told only what they have to pay for the derivative contract, say $25 million. That amount is more than the seller gets, but how much more — $5,000, $25,000 or $50,000 more — is unknown. That’s because the seller also is told only the amount he will receive. The difference between the two is the bank’s fee and profit. So, the bigger the difference, the better for the bank — and the worse for the customers.
It would be like a real estate agent selling a house, but the buyer knowing only what he paid and the seller knowing only what he received. The agent would pocket the difference as his fee, rather than disclose it. Moreover, only the real estate agent — and neither buyer nor seller — would have easy access to the prices paid recently for other homes on the same block.
An Electronic Exchange?
Two years ago, Kenneth C. Griffin, owner of the giant hedge fund Citadel Group, which is based in Chicago, proposed open pricing for commonly traded derivatives, by quoting their prices electronically. Citadel oversees $11 billion in assets, so saving even a few percentage points in costs on each trade could add up to tens or even hundreds of millions of dollars a year.
But Mr. Griffin’s proposal for an electronic exchange quickly ran into opposition, and what happened is a window into how banks have fiercely fought competition and open pricing. To get a transparent exchange going, Citadel offered the use of its technological prowess for a joint venture with the Chicago Mercantile Exchange, which is best-known as a trading outpost for contracts on commodities like coffee and cotton. The goal was to set up a clearinghouse as well as an electronic trading system that would display prices for credit default swaps.
Big banks that handle most derivatives trades, including Citadel’s, didn’t like Citadel’s idea. Electronic trading might connect customers directly with each other, cutting out the banks as middlemen.
So the banks responded in the fall of 2008 by pairing with ICE, one of the Chicago Mercantile Exchange’s rivals, which was setting up its own clearinghouse. The banks attached a number of conditions on that partnership, which came in the form of a merger between ICE’s clearinghouse and a nascent clearinghouse that the banks were establishing. These conditions gave the banks significant power at ICE’s clearinghouse, according to two people with knowledge of the deal. For instance, the banks insisted that ICE install the chief executive of their effort as the head of the joint effort. That executive, Dirk Pruis, left after about a year and now works at Goldman Sachs. Through a spokesman, he declined to comment.
The banks also refused to allow the deal with ICE to close until the clearinghouse’s rulebook was established, with provisions in the banks’ favor. Key among those were the membership rules, which required members to hold large amounts of capital in derivatives units, a condition that was prohibitive even for some large banks like the Bank of New York. The banks also required ICE to provide market data exclusively to Markit, a little-known company that plays a pivotal role in derivatives. Backed by Goldman, JPMorgan and several other banks, Markit provides crucial information about derivatives, like prices.
Kevin Gould, who is the president of Markit and was involved in the clearinghouse merger, said the banks were simply being prudent and wanted rules that protected the market and themselves. "The one thing I know the banks are concerned about is their risk capital," he said. "You really are going to get some comfort that the way the entity operates isn’t going to put you at undue risk."
Even though the banks were working with ICE, Citadel and the C.M.E. continued to move forward with their exchange. They, too, needed to work with Markit, because it owns the rights to certain derivatives indexes. But Markit put them in a tough spot by basically insisting that every trade involve at least one bank, since the banks are the main parties that have licenses with Markit.
This demand from Markit effectively secured a permanent role for the big derivatives banks since Citadel and the C.M.E. could not move forward without Markit’s agreement. And so, essentially boxed in, they agreed to the terms, according to the two people with knowledge of the matter. (A spokesman for C.M.E. said last week that the exchange did not cave to Markit’s terms.) Still, even after that deal was complete, the Chicago Mercantile Exchange soon had second thoughts about working with Citadel and about introducing electronic screens at all. The C.M.E. backed out of the deal in mid-2009, ending Mr. Griffin’s dream of a new, electronic trading system.
With Citadel out of the picture, the banks agreed to join the Chicago Mercantile Exchange’s clearinghouse effort. The exchange set up a risk committee that, like ICE’s committee, was mainly populated by bankers. It remains unclear why the C.M.E. ended its electronic trading initiative. Two people with knowledge of the Chicago Mercantile Exchange’s clearinghouse said the banks refused to get involved unless the exchange dropped Citadel and the entire plan for electronic trading. Kim Taylor, the president of Chicago Mercantile Exchange’s clearing division, said "the market" simply wasn’t interested in Mr. Griffin’s idea.
Critics now say the banks have an edge because they have had early control of the new clearinghouses’ risk committees. Ms. Taylor at the Chicago Mercantile Exchange said the people on those committees are supposed to look out for the interest of the broad market, rather than their own narrow interests. She likened the banks’ role to that of Washington lawmakers who look out for the interests of the nation, not just their constituencies.
"It’s not like the sort of representation where if I’m elected to be the representative from the state of Illinois, I go there to represent the state of Illinois," Ms. Taylor said in an interview. Officials at ICE, meantime, said they solicit views from customers through a committee that is separate from the bank-dominated risk committee. "We spent and we still continue to spend a lot of time on thinking about governance," said Peter Barsoom, the chief operating officer of ICE Trust. "We want to be sure that we have all the right stakeholders appropriately represented."
Mr. Griffin said last week that customers have so far paid the price for not yet having electronic trading. He puts the toll, by a rough estimate, in the tens of billions of dollars, saying that electronic trading would remove much of this "economic rent the dealers enjoy from a market that is so opaque." "It’s a stunning amount of money," Mr. Griffin said. "The key players today in the derivatives market are very apprehensive about whether or not they will be winners or losers as we move towards more transparent, fairer markets, and since they’re not sure if they’ll be winners or losers, their basic instinct is to resist change."
In, Out and Around Henhouse
The result of the maneuvering of the past couple years is that big banks dominate the risk committees of not one, but two of the most prominent new clearinghouses in the United States. That puts them in a pivotal position to determine how derivatives are traded. Under the Dodd-Frank bill, the clearinghouses were given broad authority. The risk committees there will help decide what prices will be charged for clearing trades, on top of fees banks collect for matching buyers and sellers, and how much money customers must put up as collateral to cover potential losses.
Perhaps more important, the risk committees will recommend which derivatives should be handled through clearinghouses, and which should be exempt. Regulators will have the final say. But banks, which lobbied heavily to limit derivatives regulation in the Dodd-Frank bill, are likely to argue that few types of derivatives should have to go through clearinghouses. Critics contend that the bankers will try to keep many types of derivatives away from the clearinghouses, since clearinghouses represent a step towards broad electronic trading that could decimate profits.
The banks already have a head start. Even a newly proposed rule to limit the banks’ influence over clearing allows them to retain majorities on risk committees. It remains unclear whether regulators creating the new rules — on topics like transparency and possible electronic trading — will drastically change derivatives trading, or leave the bankers with great control. One former regulator warned against deferring to the banks. Theo Lubke, who until this fall oversaw the derivatives reforms at the Federal Reserve Bank of New York, said banks do not always think of the market as a whole as they help write rules.
“Fundamentally, the banks are not good at self-regulation,” Mr. Lubke said in a panel last March at Columbia University. “That’s not their expertise, that’s not their primary interest.”
The Nerve to Say No
by Gretchen Morgenson - New York Times
Deciding what to do with Fannie Mae and Freddie Mac, the taxpayer-owned mortgage giants that helped set the financial crisis in motion, will be a huge job for Congress next year. The man in the middle of that melee is likely to be Joseph A. Smith Jr., the commissioner of banks for North Carolina since 2002. In November, the Obama administration nominated him to head the Federal Housing Finance Agency, Fannie and Freddie’s regulator.
Last Thursday, Mr. Smith’s confirmation hearing took place. Beyond prepared remarks, Mr. Smith said little at the brief and sparsely attended hearing. Richard Shelby of Alabama, the ranking Republican on the Senate Banking Committee, questioned Mr. Smith about his plans for the agency and asked him to reply in writing. On Tuesday, the committee will consider the nomination.
Mr. Smith’s bona fides are many. He has both industry and regulatory experience: before he became commissioner, he was a lawyer in private practice and a general counsel for Centura Banks, now a unit of RBC Bank. When he has testified before Congress in recent years, he has shown a keen interest in saving taxpayers from institutions that are too large and interconnected to be allowed to fail.
In March 2009 for example, he told the Senate Banking Committee: "As we work through a federal response to this financial crisis, we need to carry forward a renewed understanding that the concentration of financial power and a lack of transparency are not in the long-term interests of our financial system, our economic system or our democracy." Amen.
If this Mr. Smith goes to Washington as head of F.H.F.A., he will face a monumental challenge at a crucial time: how to protect taxpayers from even greater losses incurred by Fannie and Freddie as Congress considers what to do with the companies. Since they collapsed into conservatorship in September 2008, Fannie and Freddie have received $151 billion in taxpayer assistance. More will almost certainly be needed.
Because subsidizing housing through Fannie and Freddie is a time-honored tradition in Washington, Mr. Smith is sure to encounter enormous political interference as he walks the tightrope of overseeing the mortgage giants and working with Congress to determine their fate. Through a spokeswoman, Mr. Smith declined to comment last week on his plans for the two companies because the confirmation process is still going on.
This year, Edward J. DeMarco, the acting director of F.H.F.A. and a career public servant, has done an admirable job of trying to minimize taxpayer losses generated by the companies. He has been forceful in demanding that banks buy back dubious loans they sold to Fannie and Freddie during the mortgage mania. Mr. DeMarco’s agency also issued subpoenas last July to institutions that packaged mortgages into securities that were sold to Fannie and Freddie. Although the materials received through those subpoenas have not been disclosed, the subpoenas themselves made it clear that Mr. DeMarco was eager to go after anybody who might have offloaded sketchy loans onto taxpayers.
Mr. DeMarco is staying on at the agency as its chief operating officer after the new director arrives. And if Mr. Smith becomes the director, it is imperative that he also keep applying Mr. DeMarco’s buyback pressure on the banks.
Mr. Smith would also do well to follow another of Mr. DeMarco’s leads: pushing back against the growing chorus of groups arguing for an explicit government guarantee of all mortgages going forward. After what we have been through, isn’t it incredible that anyone could argue for government guarantees of all mortgages? Yet that’s just one of the many perverse "solutions" that have been floated in the aftermath of the crisis.
"The proposals are all similar," said Edward Pinto, former chief credit officer at Fannie Mae in the late 1980s and a real estate finance consultant and resident fellow at the American Enterprise Institute, a conservative think tank. "They say the private mortgage market cannot exist without some type of explicit guarantee, that the government will be the catastrophic backstop and that it will be well-capitalized. But the problem with guarantees is the private sector ends up benefiting from the gains while sticking taxpayers with the losses."
In addition to shielding taxpayers from having to backstop an ever-expanding financial safety net for errant bankers, we also need protection from ballooning losses at Fannie and Freddie. This will require the F.H.F.A. to take other crucial steps.
Janet Tavakoli, president of Tavakoli Structured Finance, a consulting firm in Chicago, has provided a to-do list for officials at F.H.F.A. In a presentation to the agency’s supervision summit meeting last Wednesday in Washington, Ms. Tavakoli said that if the agency hoped to determine the credit risk lurking inside Fannie and Freddie, it needed to ascertain two things: the probability of default on those loans and the loss rates when probable defaults actually occur.
"They have to do their own statistical sampling of their portfolios to get a realistic idea of what those numbers are," Ms. Tavakoli said in an interview. "And it has to be rigorous because we don’t know what kinds of impairments to expect from risky new mortgage products combined with a damaged economy and housing market." The F.H.F.A. cannot rely on estimates from the credit ratings agencies about the extent of those losses, Ms. Tavakoli said. "The whole idea of relying on third parties has not worked," she said. "Once you feel better about the quality of your information, you’ll feel more confident about making your next decision."
She also advised the F.H.F.A. to conduct a thorough fraud audit on the portfolios held by Fannie and Freddie to identify any improprieties that may have been involved in the loans the companies purchased. "Fannie Mae and Freddie Mac have inherited a system that is hostile toward them fixing this mess," Ms. Tavakoli said. "They need to stand up to the pressure they are going to get from Congress to give imprudent loans to people to provide a fake stimulus to the economy. But it didn’t work before and it won’t work now."
In an interview Friday, Mr. DeMarco said: "I recognize that the policy discussion about the future of housing finance will be difficult and may take a while. If there were easy answers, we would have put them out there by now. But the key job for F.H.F.A. is to ensure that the functioning of the enterprises in conservatorship continues and that new business they take on is safe and sound while this takes place."
It could not be clearer that should Mr. Smith win the leadership of the F.H.F.A., he’ll have to stand up for the taxpayer. That also means he will have to stand against increasingly powerful banks that — despite the magnitude of the crisis — have managed to avoid, circumvent or co-opt policy makers, law enforcement officials and regulators.
Risky Borrowers Find Credit Available Again, at a Price
by Eric Dash - New York Times
Credit card offers are surging again after a three-year slowdown, as banks seek to revive a business that brought them huge profits before the financial crisis wrecked the credit scores of so many Americans.
The rise is striking because it includes offers to riskier borrowers who were shunned as recently as six months ago. But this time, in contrast to the boom years, when banks "preapproved" seemingly everyone, lenders are choosing their prospects more carefully and setting stricter terms to guard against another wave of losses. For consumers, the resurgence of card offers, however cautious, provides an opportunity to repair damaged credit and regain the convenience of paying with plastic. But there is a catch: the new cards have higher interest rates and annual fees.
Lenders are "tiptoeing their way back into the higher-risk pool of customers," said John Ulzheimer, president of consumer education at SmartCredit.com. In extending credit again to riskier borrowers, lenders are looking beyond standard credit scores, on the theory that some people who may seem to be equivalent credit risks on the surface may show differences in spending or other behavior — like registering on a job Web site — that suggest variations in their ability to keep up with payments.
Industry consultants, in their attempt to feed the demand for finer classifications of borrowers, have coined new labels to describe different borrowers with similar credit scores. One is "strategic defaulters," whose credit scores were damaged because they walked away from a home when its value dropped below what was owed on the mortgage. These borrowers made a bad bet on real estate but may otherwise be prudent risks because they make a good living.
Similarly, "first-time defaulters" once had a strong credit record but ran into financial trouble during the recession. Typically, these borrowers fell behind on some sort of loan payment after losing a job, not from taking on too much debt. By contrast, there are "sloppy payers," who pay only some bills on time; "abusers," who are defiant about paying; and "distressed borrowers," who simply do not have the means to pay.
The goal is to weed out the latter groups to identify consumers whose credit scores are blemished but who still have the money to pay their bills. "Lenders want to prove to themselves that it is worth taking a higher risk," said Brad Jolson, an executive of the decision management company FICO, who has helped several card companies analyze their customer base.
This new approach to assessing default risk is emblematic of the challenge faced by the many banks that were hobbled by the financial crisis: They desperately want to grow again, but the memory of a near-death experience makes them wary about taking outsize risks.
Lenders have taken $189 billion in credit card losses since 2007, according to Oliver Wyman Group, a financial consultancy. That was a significant part of the $2 trillion or so that banks are estimated to have lost since the crisis began, and a contributor to the government bailout of the banking system.
To stem losses, lenders halted new card offers to all but their most affluent customers. At the same time, more than eight million consumers stopped using their credit cards, in a sign of the nationwide belt-tightening, according to TransUnion, the credit bureau. Millions more borrowers who still have cards have been compelled to pay down their balances, or are more often choosing to use cash. That has had a big impact on lenders’ bottom lines. Credit cards once gave the banking industry as much as a quarter of its profits; today those profits have all but vanished and lenders are seeking ways to replace them.
Now that the losses have stabilized, lenders have set out to revive their card businesses, and mail offers to riskier borrowers are roaring back. HSBC mailed more than 16 million card offers to this group in the third quarter of this year, Citigroup 14 million and Discover 10 million, all roughly tenfold increases over the same period last year, according to Synovate Mail Monitor, a market research firm. Capital One’s rate rose fiftyfold, to 22 million.
Many of the new lower-end cards start with high interest rates and annual fees, because new federal rules limit the ability of lenders to change the terms after payments are missed. Capital One, for example, is offering low-end cards that carry interest rates of 18 percent or higher and annual fees of up to $50.
In all, lenders will send about 2.5 billion credit card offers by the end of the year, Synovate estimates, compared with more than six billion in 2005, the peak year. The bulk of this year’s mailings are still going to affluent people, with just 17 percent going to borrowers with blemished credit. That compares with about 39 percent in 2007 and a low of 7 percent in late 2009.
The response to the card campaigns has been strong, with roughly 4 percent of these riskier borrowers submitting applications. That is about 10 times the typical response rate for the group, though that may be partly explained by the absence of offers over the last two years.
After racking up more than $17,000 in credit card charges, Sue Talkington, 69, a retired saw mill worker living in Modesto, Calif., started working with a credit counselor in September to start paying down her debt. Then, last month, right after she had cut up three credit cards, she received an application for a new Capital One card, the second pre-approved mail offer she has received recently.
She says she was stunned. "I’m trying to get out of debt, so why would I want a credit card to get into more debt?" Ms. Talkington asked. "It really shows me how much greed there is out there," she added. Card issuers "aren’t interested in helping me get back on track with a credit card," she said. "They just want my money."
Since the mass marketing of credit cards began decades ago, lenders have waited for years to extend credit to borrowers like Ms. Talkington who have fallen on hard times — a process sometimes called "rehabilitating the customer." But these days, rehab is happening faster because the lenders cannot afford to wait.
Citigroup is testing a credit card with training wheels, known as CitiMax, devised for customers whose credit was damaged by the recession. Borrowers are required to link their credit card account to a checking, savings or brokerage account so that Citi can withdraw money if a payment is missed. Branch workers for Bank of America and Wells Fargo are steering more customers denied a traditional credit card toward "secured" cards, backed by a deposit that the owner is not permitted to touch.
Wells says that more than a third of secured cardholders receive a traditional credit card after 12 months. "I graduated, as they call it, to the unsecured," said Joshua Hoglan, 26, a college student from Las Vegas who says he became a more responsible borrower after making timely payments on a Wells secured credit card he applied for in early 2008. He called graduation "a great relief."
Max Keiser: On the Edge with Paul Craig Roberts