Les Leopold: Why Do We Save Billionaires, but Not Teachers?

Les Leopold: Why Do We Save Billionaires, but Not Teachers?: "

This week thousands of New Jersey public school students walked out of class to protest draconian school budget cuts. 'Save my teacher,' their signs read. In a state that is home to a bevy of high finance billionaires, with the highest per capita income in the nation, teachers are being sacked left and right. In our town half the student body protested outside the high school. Perhaps the protesters should turn their eyes towards the twenty-five top hedge fund honchos who took in $25 billion in 2009. Their 'earnings' alone could fund 658,000 entry level teachers.

It's ironic that the battlefield in this war over resources is public education. Because the public remains entirely uneducated about the connection between those billionaires and school budget cuts. We are clueless about what the Wall Street billionaires do to earn their riches and whether it's of any value. We might be able to understand 'weapons of mass destruction,' but financial weapons of mass destruction are way beyond us.

The new earning reports are good, we read. The giant financial institutions are back to making billions through 'trading.' So are these bankers grown-up versions of kids trading baseball cards--or are they robber barons? Are they enriching our society or siphoning off its wealth? Maybe the marching students of New Jersey could ask Governor Christie to explain.

Here's what we do know for sure. Our modern financial honchos are very different from the robber barons of old. Everybody knew that Rockefeller meant oil, Ford meant cars and Carnegie meant steel.

Yes, today, we know that Gates and Jobs mean computers. But who the hell is David Tepper, and what does he produce with his Appaloosa hedge fund? He must have done something pretty impressive to earn $4 billion (not million) in 2009, the worst financial year since the Great Depression, with 29 million Americans unemployed or forced into part-time work. Then again, how much would he have 'earned' had we not provided more than $8 trillion in bailout funds, loans and guarantees to the collapsed financial sector?

Mr. Tepper lives in New Jersey where the governor has gone to war with the teachers, hoping to break the union and balance the budget on the backs of our students. But Governor Christie's enthusiasm for a balanced budget only goes so far: He's resolutely opposed to reinstituting the 'millionaires' tax' -even though the state's fiscal crisis is a direct consequence of what millionaires and billionaires did on Wall Street.

Mr. Tepper's personal income for 2009 would have covered the salaries of 62 percent of public school teachers--who reach 855,600 students. (Mean salary $57,645 )

But let's not lay it all on Tepper's shoulders. Andrew J. Hall once worked for the financial basket case called Citigroup. When it became clear that his $100 million bonus was embarrassment for the bailed out bank, his own financial group was sold to Occidental Petroleum. He's an oil trader.

Can some well-educated New Jersey public school student please explain: What's an oil trader? We say it's all about gambling - me included. But does that mean that when he wins someone else loses? Can he make bets where no one loses? Or does the house lose? Are we the house and lose by paying more for gas? Or, is Mr. Hall really a shining green knight who is helping to reduce global warming by driving up the price of oil? We don't know enough to even ask.

And unfortunately we also don't know enough to ask the most important question of all: Do these financial barons create economic value or are they just siphoning off wealth from other parts of the economy? Is their work productive or are they just blowing air into the next financial bubble that will explode in our faces?

Because we don't know, we also can't discuss how our system assigns economic value to what each of us does. Something is really screwed up when we award billions to Wall Street elites for doing things we don't comprehend, even as we lay off teachers by the thousands.

It's the invisible hand of the free market, we're told. Invisible is right. We can't see, feel, touch or even fathom the outlines of our current financial system. If we were able to shine a bright light on the financial machinations happening right now on Wall Street, we might find that our financial free markets are not all that free. We might find that a few large financial institutions have a stranglehold over many financial markets and are sucking all the money out of them. We might find a massive array of government subsidies in the form of asset guarantees and cheap borrowing facilities. We might discover that like the robber barons of old with their all-powerful 'trusts,' the largest financial institutions have invented new forms of monopoly power and political influence.

How much does President Obama himself know about what our modern-day barons really do? You've got to wonder when he calls Jamie Dimon and Lloyd Blankfein 'savvy businessmen' and says he doesn't 'begrudge' them their 'success and wealth.' As the Goldman Sachs scandal unfolds from civil to criminal charges, the President may be finding out more than he wanted to know about just what the JP Morgan and Goldman Sachs execs have been up to.

The President is not alone in accepting the equation that wealth = success = deserving of our admiration. Without much reflection many of us assume that because the rich are successful, their work must have great value. But since we don't really know what they do, their financial haul may not in fact reflect any real contribution to our society. Ask Tony Soprano.

As we stumble around in a fog of confusion about the financial industry, more and more of our economy is being eaten up by it. Financial profits and bonuses are soaring again. The share of all corporate profits that come from finance jumped from about 7 percent in 1948 to nearly 35 percent just before the recent crash. And they are rising back up to those levels right now. (You want to see some scary pictures? Check out the financial graphs at Tradersnarrative.com.)

We were once told by gurus like Robert Rubin and Alan Greenspan that this brave new financial world was the key to a bright future. The great new service sector was supposed to replace our old, polluting industrial jobs with clean, high-paying jobs in finance. American investors would be the bankers of the world. We did it better and smarter than everyone else.

But is ripping off consumers with hidden credit card fees a worthwhile activity? How about placing layers of fantasy finance bets on subprime mortgages? Is buying and selling millions of credit default swaps on Greek bonds that you don't own a constructive activity? Would the world really suffer if we did some heavy financial industry trust-busting? We need to know more, much more.

So how do we find out? Our journalists and commentators have to dig deeper. We can't be cowed by the enormous wealth these 'successful' financiers have amassed, even if some of them are progressive philanthropists.

It's good for America to see its bankers parade before congressional committees and offer spirited defenses of the indefensible. The more the American people can hear banking tycoons trying to justify their existence, the angrier they'll become. But the investigations have to go deeper. Yes, Goldman Sachs seems to have pulled off a slimy scam by building securities they knew would tank and helping a hedge fund billionaire bet against them. But it's what they do every day that really matters. We need to ask: How are your activities helping to build a better America? How are you helping to put our people to work? Do you know? Do you care?

And then we have to decide: Should we reinstitute Eisenhower-era taxes on the super-rich? Should we tax the hell out of financial gambling? Should we cut financial institutions down to size? Should we value teachers more than we value hedge fund billionaires?

Maybe the marching students already know the answers.

Les Leopold is the author of The Looting of America: How Wall Street's Game of Fantasy Finance destroyed our Jobs, Pensions and Prosperity, and What We Can Do About It Chelsea Green Publishing, June 2009."

(Via Huffington Blog.)

Meet the Real Villain of the Financial Crisis.

Op-Ed Contributor: Meet the Real Villain of the Financial Crisis.: "Blame Congress for the meltdown, not Goldman Sachs. "

(Via NYT > Opinion.)

William J. Astore: American Kleptocracy: How Fears of Socialism and Fascism Hide Naked Theft

William J. Astore: American Kleptocracy: How Fears of Socialism and Fascism Hide Naked Theft: "

Crossposted with TomDispatch.com.

Kleptocracy -- now, there’s a word I was taught to associate with corrupt and exploitative governments that steal ruthlessly and relentlessly from the people. It’s a word, in fact, that’s usually applied to flawed or failed governments in Africa, Latin America, or the nether regions of Asia. Such governments are typically led by autocratic strong men who shower themselves and their cronies with all the fruits of extracted wealth, whether stolen from the people or squeezed from their country’s natural resources. It’s not a word you’re likely to see associated with a mature republic like the United States led by disinterested public servants and regulated by more-or-less transparent principles and processes.

In fact, when Americans today wish to critique or condemn their government, the typical epithets used are ‘socialism’ or ‘fascism.’ When my conservative friends are upset, they send me emails with links to material about ‘ObamaCare’ and the like. These generally warn of a future socialist takeover of the private realm by an intrusive, power-hungry government. When my progressive friends are upset, they send me emails with links pointing to an incipient fascist takeover of our public and private realms, led by that same intrusive, power-hungry government (and, I admit it, I’m hardly innocent when it comes to such ‘what if’ scenarios).

What if, however, instead of looking at where our government might be headed, we took a closer look at where we are -- at the power-brokers who run or influence our government, at those who are profiting and prospering from it? These are, after all, the ‘winners’ in our American world in terms of the power they wield and the wealth they acquire. And shouldn’t we be looking as well at those Americans who are losing -- their jobs, their money, their homes, their healthcare, their access to a better way of life -- and asking why?

If we were to take an honest look at America’s blasted landscape of ‘losers’ and the far shinier, spiffier world of ‘winners,’ we’d have to admit that it wasn’t signs of onrushing socialism or fascism that stood out, but of staggeringly self-aggrandizing greed and theft right in the here and now. We’d notice our public coffers being emptied to benefit major corporations and financial institutions working in close alliance with, and passing on remarkable sums of money to, the representatives of ‘the people.’ We’d see, in a word, kleptocracy on a scale to dazzle. We would suddenly see an almost magical disappearing act being performed, largely without comment, right before our eyes.

Of Red Herrings and Missing Pallets of Money

Think of socialism and fascism as the red herrings of this moment or, if you’re an old time movie fan, as Hitchcockian MacGuffins -- in other words, riveting distractions. Conservatives and tea partiers fear invasive government regulation and excessive taxation, while railing against government takeovers -- even as corporate lobbyists write our public healthcare bills to favor private interests. Similarly, progressives rail against an emergent proto-fascist corps of private guns-for-hire, warrantless wiretapping, and the potential government-approved assassination of U.S. citizens, all sanctioned by a perpetual, and apparently open-ended, state of war.

Yet, if this is socialism, why are private health insurers the government’s go-to guys for healthcare coverage? If this is fascism, why haven’t the secret police rounded up tea partiers and progressive critics as well and sent them to the lager or the gulag?

Consider this: America is not now, nor has it often been, a hotbed of political radicalism. We have no substantial socialist or workers’ party. (Unless you’re deluded, please don’t count the corporate-friendly ‘Democrat’ party here.) We have no substantial fascist party. (Unless you’re deluded, please don’t count the cartoonish ‘tea partiers’ here; these predominantly white, graying, and fairly affluent Americans seem most worried that the jackbooted thugs will be coming for them.)

What drives America today is, in fact, business -- just as was true in the days of Calvin Coolidge. But it’s not the fair-minded ‘free enterprise’ system touted in those freshly revised Texas guidelines for American history textbooks; rather, it’s a rigged system of crony capitalism that increasingly ends in what, if we were looking at some other country, we would recognize as an unabashed kleptocracy.

Recall, if you care to, those pallets stacked with hundreds of millions of dollars that the Bush administration sent to Iraq and which, Houdini-like, simply disappeared. Think of the ever-rising cost of our wars in Iraq and Afghanistan, now in excess of a trillion dollars, and just whose pockets are full, thanks to them.

If you want to know the true state of our government and where it’s heading, follow the money (if you can) and remain vigilant: our kleptocratic Houdinis are hard at work, seeking to make yet more money vanish from your pockets -- and reappear in theirs.

From Each According to His Gullibility -- To Each According to His Greed

Never has the old adage my father used to repeat to me -- ‘the rich get richer and the poor poorer’ -- seemed fresher or truer. If you want confirmation of just where we are today, for instance, consider this passage from a recent piece by Tony Judt:

In 2005, 21.2 percent of U.S. national income accrued to just 1 percent of earners. Contrast 1968, when the CEO of General Motors took home, in pay and benefits, about sixty-six times the amount paid to a typical GM worker. Today the CEO of Wal-Mart earns nine hundred times the wages of his average employee. Indeed, the wealth of the Wal-Mart founder’s family in 2005 was estimated at about the same ($90 billion) as that of the bottom 40 percent of the U.S. population: 120 million people.

Wealth concentration is only one aspect of our increasingly kleptocratic system. War profiteering by corporations (however well disguised as heartfelt support for our heroic warfighters) is another. Meanwhile, retired senior military officers typically line up to cash in on the kleptocratic equivalent of welfare, peddling their ‘expertise’ in return for impressive corporate and Pentagon payouts that supplement their six-figure pensions. Even that putative champion of the Carhartt-wearing common folk, Sarah Palin, pocketed a cool $12 million last year without putting the slightest dent in her populist bona fides.

Based on such stories, now legion, perhaps we should rewrite George Orwell’s famous tagline from Animal Farm as: All animals are equal, but a few are so much more equal than others.

And who are those ‘more equal’ citizens? Certainly, major corporations, which now enjoy a kind of political citizenship and the largesse of a federal government eager to rescue them from their financial mistakes, especially when they’re judged ‘too big to fail.’ In raiding the U.S. Treasury, big banks and investment firms, shamelessly ready to jack up executive pay and bonuses even after accepting billions in taxpayer-funded bailouts, arguably outgun militarized multinationals in the conquest of the public realm and the extraction of our wealth for their benefit.

Such kleptocratic outfits are, of course, abetted by thousands of lobbyists and by politicians who thrive off corporate campaign contributions. Indeed, many of our more prominent public servants have proved expert at spinning through the revolving door into the private sector. Even ex-politicians who prefer to be seen as sympathetic to the little guy like former House Majority Leader Dick Gephardt eagerly cash in.

I’m Shocked, Shocked, to Find Profiteering Going on Here

An old Roman maxim enjoins us to ‘let justice be done, though the heavens fall.’ Within our kleptocracy, the prevailing attitude is an insouciant ‘We’ll get ours, though the heavens fall.’ This mindset marks the decline of our polity. A spirit of shared sacrifice, dismissed as hopelessly naïve, has been replaced by a form of tribalized privatization in which insiders find ways to profit no matter what.

Is it any surprise then that, in seeking to export our form of government to Iraq and Afghanistan, we’ve produced not two model democracies, but two emerging kleptocracies, fueled respectively by oil and opium?

When we confront corruption in Iraq or Afghanistan, are we not like the police chief in the classic movie Casablanca who is shocked, shocked to find gambling going on at Rick’s Café, even as he accepts his winnings?

Why then do we bother to feign shock when Iraqi and Afghan elites, a tiny minority, seek to enrich themselves at the expense of the majority?

Shouldn’t we be flattered? Imitation, after all, is the sincerest form of flattery. Isn’t it?

William J. Astore is a TomDispatch regular; he teaches History at the Pennsylvania College of Technology and served in the Air Force for 20 years, retiring as a lieutenant colonel. He may be reached at wjastore@gmail.com.

Copyright 2010 William J. Astore"

(Via Huffington Blog.)

2010 Midterms: Jobs vs. Wars in California

2010 Midterms: Jobs vs. Wars in California: "

Do you know someone in California? Have they seen this?

California’s economy is in a tailspin. One in 5 Californians is out of work. Over three quarters of a million have lost their homes. Desperately needed social services have been cut to the bone. Yet residents of our state continue to pay for a senseless war in Afghanistan that’s not making us safer – a war that has cost California taxpayers nearly $38 billion already.

OK, hold on a minute. $38 billion for war? Just from California? Take a look at California’s financial situation:

Jaws dropped from coast to coast at the size of [California's] $26.3 billion shortfall, a quarter of the general fund. Even more astounding was state leaders’ difficulty in reaching a budget deal—not just this year, but year after year. With its repeated use of borrowing and IOUs, the Golden State has become the poster child for fiscal irresponsibility.

That’s right, their apocalyptic budget crisis is actually much less than they’re spending on the war in Afghanistan. $26 billion for the budget vs $38 billion for war. And what do they actually get for that money? It’s not like it’s way better to live in California thanks to the war. In fact, it’s actually getting much, much worse.

The depth of the crisis faced by California screams out from the cold hard data. Over one in five Californians are unemployed, underemployed, or have simply given up searching for work. Nearly another one in five lives in poverty. Low-income workers fortunate to have a job have seen their wages decline since 2006 – with middle income worker salaries remaining stagnant. 8.2 million Californians – up from 6.4 million in 2007 – lack health coverage.[...]

Over three-quarters of a million California families were ousted from their homes in 2008 and 2009. The Center for Responsible Lending projects another 2 million foreclosures through 2012 – with nearby homes losing an average of over $50,000 in value. 2.4 million California borrowers – 35 percent of all properties with a mortgage – are currently under water (e.g. owe more on their home than it’s currently worth). By 2011, that number will increase to nearly 70 percent of homeowners.

It’s just dizzying. We’re looking at the vaporization of California’s social fabric, something we supposedly care a lot about it in Afghanistan. And yet all they need is a little over half what they’re spending on crooked dope dealers, murderous robots, and Soviet-style police states. Look at the ridiculous stuff they have to cut thanks to the war:

As Californians depend on core public programs in increasing numbers and need – from the state’s welfare-to-work program (CalWORKS) to In-Home State Services to the Healthy Families Program – the state’s ongoing budget shortfalls have lead to draconian cuts in the very services that have functioned as a lifeline for millions and prevented a more pronounced economic collapse.

Yep, at some point up in Sacramento, the people’s representatives got together and decided, ‘Sorry guys, we just don’t have room for HEALTHY FAMILIES anymore.’ If that doesn’t deserve a giant, full-throated WTF, I don’t know what does. Go read the whole thing, I could literally spend this entire post just block-quoting all the crazy programs they had to cut. 35,000 fewer college students? Come on now, is the debate really going to be Healthy Families vs. War?

If you’re having deja vu, that’s because we’ve had the California conversation before about Winograd and Harman. Jane Harman is just one of the California politicians finding themselves on the wrong side of the Healthy Families vs. War debate. And she’s taking a vicious beating from challenger Marcy Winograd on exactly those grounds. Remember what Winograd said in that Politico piece?

‘As we approach our state party convention, we are prepared for a floor fight — Winograd vs. Harman. But it’s not just about the two of us. This is a fight to determine: Jobs vs. Wars, Homes vs. Banks, Your Street vs. Wall Street,’ Winograd wrote in the appeal.

‘Jobs vs Wars.’ Very clear. And that wasn’t just about the party convention, she’s still saying it:

Winograd pointed out that she shares the ILWU´s historical commitment to ending unnecessary wars and investing resources in strengthening our middle class. ‘Our district alone has spent almost 3-billion dollars to wage perpetual wars in Iraq and Afghanistan. In Congress, I will vote to end the squandering of taxpayer dollars better spent on explicit federal job creation.’

Remember, Harman is the one who said a withdrawal would create ‘grievous risks’ for our national security. She’s like The Afghanistan War Candidate, the Senator from ISAF. She voted down H.Con.Res 248, a clear sign that she sees $38 billion for military aggression as better for California than $26 billion for little things like healthy families and jobs. And y’know, it’s stupid that we even have to have this conversation about Harman and all the other Team War politicians. The solution is so mind-numbingly simple:

Today, U.S. Senator Russ Feingold (D-WI) and U.S. Representatives Jim McGovern (D-MA) and Walter Jones (R-NC) announced they are introducing legislation requiring the president to develop a flexible timetable to draw down U.S. troops from Afghanistan, in order to enhance our national security and reduce the burden on our armed forces and on taxpayers. The bipartisan, bicameral legislation would require the president to provide a plan for drawing down our forces in Afghanistan. The legislation also increases oversight by the Special Inspector General for Afghanistan Reconstruction (SIGAR) over work done by private contractors with records of waste, fraud and abuse in order to safeguard U.S. taxpayer dollars.

Set a date and get out. That’s it. We’ll even be ‘flexible’ with it, so that if Godzilla or the conquering Martians appear in Afghanistan, we’ll definitely consider keeping troops there. But as long as we’re there in the middle of an Afghan civil war and blowing all our jobs and families money on Hamid Karzai’s Excellent Adventure, we set a date and get the hell out. Super easy. If Harman could get on board with the people of her state and end this war, all of this awful stuff we’re talking about would just vanish. Harman would be a hero, California’s budget would stabilize, and Winograd would be back organizing voters for Democrats like Harman. But no, Harman and dozens of other politicians in California insist on making Jobs vs. Wars a fight.

Last month, facing tuition and fee hikes of over 30 percent, public university students all over California said enough is enough, organized and went on strike. Now these students have a new message: California is wasting tens of billions of dollars on war even while making public education accessible only to the rich.

We can’t afford to continue a war that does nothing to make us safer.

So, take that video above and forward it to the people you know in California. Let them know that the solution to their budget crisis is ending the war in Afghanistan. Let them know there are candidates out there somewhere who do side with families against the wasteful spending in Washington. All it takes is a little public pressure. And don’t forget to join us on Rethink Afghanistan’s Facebook page. Collaborate with the tens of thousands of others around the country working to bring this war to an end.

I am the Afghanistan Blogging Fellow for The Seminal and Brave New Foundation. You can read my work on The Seminal or at Rethink Afghanistan. The views expressed below are my own."

(Via Firedoglake.)

Are Interest Rate Derivatives a Ticking Time Bomb?

Guest Post: Are Interest Rate Derivatives a Ticking Time Bomb?: "

→ Washington’s Blog

Derivatives are the world’s largest market, dwarfing the size of the bond market and world’s real economy.

The derivatives market is currently at around $600 trillion or so (in nominal value).

In contrast, the size of the worldwide bond market (total debt outstanding) as of 2009 was an estimated $82.2 trillion.

And the CIA Fact Book puts the world economy at $58.07 trillion in 2009 (at official exchange rates).

Interest rate derivatives, in turn, are by far the most popular type of derivative.

As Wikipedia notes:

The interest rate derivatives market is the largest derivatives market in the world. The Bank for International Settlements estimates that the notional amount outstanding in June 2009 were US$437 trillion for OTC interest rate contracts, and US$342 trillion for OTC interest rate swaps. According to the International Swaps and Derivatives Association, 80% of the world’s top 500 companies as of April 2003 used interest rate derivatives to control their cashflows.

So interest rate derivatives are the world’s largest market.

The largest interest rate derivatives sellers include Barclays, Deutsche Bank, Goldman and JP Morgan. While the CDS market is dominated by American banks, the interest rate derivatives market is more international.

In comparison to the almost $500 trillion in interest rate derivatives, BIS estimates that there were ‘only’ $36 trillion in credit default swaps as of June 2009. Credit default swaps were largely responsible for bringing down Bear Stearns, AIG (and see this), WaMu and other mammoth corporations.

Where’s the Danger?

In 2003, John Hussman wrote:

What is not so obvious is the extent to which the U.S. economy and financial markets are betting on the continuation of unusually low short-term interest rates and a steep yield curve. This doesn’t necessarily resolve into immediate risks, but it could profoundly affect the path that the economy and financial markets take during the next few years, by making the unwinding of debt much more abrupt.

In response to very low short-term interest rates, many U.S. corporations have swapped their long-term (fixed interest rate) debt into short-term (floating interest rate) debt, to the extent that an increase in short-term rates could substantially raise default risks. Similarly, a growing proportion of homeowners have refinanced their mortgages into adjustable rate structures that are also sensitive to higher short-term yields. Finally, profitability in the banking system is unusually dependent on a steep yield curve, with a widening net interest margin (the difference between long-term rates banks charge borrowers and the lower short-term rates they pay depositors) …

***

According Bank for International Settlements, the U.S. interest rate swap market [has] nearly doubled in size in the past two years. The reason this figure is so enormous is that there are usually several links in the chain from borrower to investor. A risky borrower may enter a swap with bank A, which then takes an offsetting swap position with bank B (earning a bit of the credit spread as its compensation), and so on, with a cheerful money market investor at the end of the chain holding a safe, government backed security, oblivious to the chain of counterparty risk in between.

Aside from the risk that any particular link in this chain might be weak (know thy counterparty), the U.S. financial system has gone one step further. In order to hedge against the risk of defaults, banks frequently lay credit risk off by entering ‘credit default swaps’ with other banks or insurance companies. These swaps essentially act as insurance policies for credit risk.

***

In short, the U.S. financial system is in a delicate balance. On the issuer side, a great many borrowers have linked their debt obligations to short-term interest rates. This is tolerated by the financial system because the debt has been swapped out through financial intermediaries, so investors get to hold relatively safe instruments like bank deposits and Fannie Mae securities. This mountain of debt in the U.S. financial system – tied to short-term interest rates – is ultimately and perhaps somewhat inadvertently backed by the U.S. government.

On the investor side, Asian governments intent on holding their currencies down relative to the U.S. dollar have purchased a great deal of U.S. government and agency debt – effectively ‘buying dollars.’ … A reduction of demand for U.S. short-term debt, either by foreign governments (particularly in the event that Asian governments decide to revalue their currencies) or by U.S. investors, could have very undesirable consequences.

All of which is why the U.S. is now extremely dependent on short-term interest rates remaining low indefinitely.

In March 2009, Martin Weiss wrote:

Until the third quarter of last year, the banks’ losses in derivatives were almost entirely confined to credit default swaps — bets on failing companies and sinking investments.But credit default swaps are actually a much smaller sector, representing only 7.8 percent of the total derivatives market.

***

Thus, considering their far larger volume, any threat to interest rate derivatives could be far more serious than anything we’ve seen so far.

And Monday, Jerome Corsi argued that cities, states and universities might be wiped out by changes in interest rates:

As interest rates begin to rise worldwide, losses in derivatives may end up bankrupting a wide range of institutions, including municipalities, state governments, major insurance companies, top investment houses, commercial banks and universities.

Defaults now beginning to occur in a number of European cities prefigure what may end up being the largest financial bubble ever to burst – a bubble that today amounts to more than $600 trillion.

***

A popular form of derivative contracts was developed to permit one money manager to ‘swap’ a stream of variable interest payments with another money manager for a stream of fixed interest payments.

The idea was to use derivative bets on interest rates to ‘hedge’ or balance off the risks taken on interest-rate investments owned in the underlying portfolio.

If an institutional investment manager held $100 million in fixed-rate bonds, for example, to hedge the risk, should interest rates rise or fall in a manner different than projections, a purchase of a $100 million variable interest rate derivative could be constructed to cover the risk.

Whichever way interest rates went, one side to the swap might win and the other might lose.

The money manager losing the bet could expect to get paid on the derivative to compensate for some or all of the losses.

In the strong stock and mortgage markets experienced beginning in the historically low 1-percent interest rate environments of 2003 through 2004, the number of hedge funds soared, just as the volume of derivative contracts soared from a mere $300 trillion in 2005 to the more than $600 trillion today.

Are Hussman, Weiss and Corsi right to be worried about an interest rate derivatives time bomb?

Well, the Wall Street Journal noted today in a story about the Federal Reserve:

There are reasons to be concerned about the Fed’s paper-thin capital position. It has a more risky portfolio than it’s ever had before, including $1.25 trillion in mortgage securities that could lose market value if interest rates rise, if defaults climb or if it has to sell them quickly. A 4% loss on that portfolio would equal almost all of its capital.

Of course the Fed can print money itself. (As opposed to a bank, which depends on the backing of depositors and other creditors to fund its operations.)

In other words, private banks and other private institutions which hold large positions in mortgage securities could be wiped out if interest rates rise.

And because the interest derivative market dwarfs the size of the CDS market, there is a much larger risk.

Unsophisticated Entities Getting Taken by Interest Rate Derivatives Salesmen

In 2008, Bloomberg pointed out that the SEC was investigating shady interest rate derivatives sales by JP Morgan and Morgan Stanley to school districts.

In 2009, New York Times writer Floyd Norris noted:

On the front page of The Times today, Don van Natta Jr. has a good article about the woes of little towns and counties in Tennessee that bought interest-rate derivatives sold by Morgan Keegan, an investment bank based in Memphis.

It turns out that these municipalities did not understand the risks they were taking. The derivatives have now blown up, and the officials are blaming the bank.

Matt Taibbi also recently noted that JP Morgan used interest rate swaps to decimate a small Alabama town:

The initial estimate for this project was $250 million. They ended up spending about $3 billion on this. And they ended up owing about $5 billion in the end, after you look at all the refinancing and the interest rate swaps and everything.

As the Bloomberg, Times and Taibbi stories hint, many unsophisticated schools, cities, states and universities were played by the big interest rate derivatives sellers, just as many people were played by the CDS sellers. So the fallout will likely be substantial.

But Aren’t Interest Rate Derivatives Straightforward and Useful?

You might assume that interest rate derivatives appear to have a much more straightforward, legitimate business purpose than credit default swaps.

Yes, maybe. But the people thought the credit default swap salespeople and their bosses didn’t really didn’t understand them.

And as George Soros pointed out in 1994, the excessive use of dynamic hedging can and often does backfire:

I must state at the outset that I am in fundamental disagreement with the prevailing wisdom. The generally accepted theory is that financial markets tend toward equilibrium and, on the whole, discount the future correctly. I operate using a different theory, according to which financial markets cannot possibly discount the future correctly because they do not merely discount the future; they help to shape it. In certain circumstances, financial markets can affect the so-called fundamentals which they are supposed to reflect. When that happens, markets enter into a state of dynamic disequilibrium and behave quite differently from what would be considered normal by the theory of efficient markets. Such boom/bust sequences do not arise very often, but when they do they can be very disruptive, exactly because they affect the fundamentals of the economy…

The trouble with derivative instruments is that those who issue them usually protect themselves against losses by engaging in so-called delta, or dynamic, hedging. Dynamic hedging means, in effect, that if the market moves against the issuer, the issuer is forced to move in the same direction as the market, and thereby amplify the initial price disturbance. As long as price changes are continuous, no great harm is done, except perhaps to create higher volatility, which in turn increases the demand for derivatives instruments. But if there is an overwhelming amount of dynamic hedging done in the same direction, price movements may become discontinuous. This raises the specter of financial dislocation. Those who need to engage in dynamic hedging, but cannot execute their orders, may suffer catastrophic losses.

This is what happened in the stock market crash of 1987. The main culprit was the excessive use of portfolio insurance. Portfolio insurance was nothing but a method of dynamic hedging. The authorities have since introduced regulations, so-called ‘circuit breakers’, which render portfolio insurance impractical, but other instruments which rely on dynamic hedging have mushroomed. They play a much bigger role in the interest rate market than in the stock market, and it is the role in the interest rate market which has been most turbulent in recent weeks.

Dynamic hedging has the effect of transferring risk from customers to the market makers and when market makers all want to delta hedge in the same direction at the same time, there are no takers on the other side and the market breaks down.

The explosive growth in derivative instruments holds other dangers. There are so many of them, and some of them are so esoteric, that the risks involved may not be properly understood even by the most sophisticated of investors. Some of these instruments appear to be specifically designed to enable institutional investors to take gambles which they would otherwise not be permitted to take ….

Doug Noland wrote an intriguing article in 2001 – based on the research of Bruce Jacobs (doctorate in finance from Wharton, co-founder of Jacobs and Levy Equity Management) on portfolio insurance – arguing that interest rate derivatives were widely being used without understanding the risks they create for the system (warning: this is long … go get some caffeine, sugar or exercise, and then come back and keep reading):

I would like to suggest moving Bruce Jacobs’ excellent book, Capital Ideas and Market Realities to the top of reading lists. From the forward by Nobel Laureate Harry M. Markowitz: ‘Many observers, including Dr., Jacobs and me, believe that the severity of the 1987 crash was due, in large part, to the use before and during the crash of an option replication strategy known as ‘portfolio insurance.’ In this book, Dr. Jacobs describes the procedures and rationale of portfolio insurance, its effect on the market, and whether it would have been desirable for the investor even if it had worked. He also discusses ’sons of portfolio insurance,’ and procedures with similar objectives and possibly similar effects on markets, in existence today.’From Dr. Jacobs’ introduction: ‘This book … examines how some investment strategies, especially those based on theories that ignore the human element, can self-destruct, taking markets down with them. Ironically, the greatest danger has often come from strategies that purport to reduce the risk of investing.

***

‘In 1987, as in 1998, strategies supported by the best that finance theory had to offer were overwhelmed by the oldest of human instincts – survival. In 1929, in 1987, and in 1998, strategies that required mechanistic, forced selling of securities, regardless of market conditions, added to market turmoil and helped to turn market downturns into crashes. Ironically, in 1987 and 1998, those strategies had held out the promise of reducing the risk of investing. Instead, they ended up increasing risk for all investors.’

***

I would like to explore the concepts behind the current dangerous fad of derivatives as a mechanism to insure against rising interest rates, as well as the momentous ramifications to both financial market and economic stability from these instruments that rely on dynamic hedging strategies. From Jacobs: ‘Option replication requires trend-following behavior – selling as the market falls and buying as it rises. Thus, when substantial numbers of investors are replicating options, their trading alone can exaggerate market trends. Furthermore, the trading activity of option replicators can have insidious effects on other investors.’

Dr. Jacobs adeptly makes the important point that the availability of portfolio insurance during the mid-1980s played a significant role in fostering speculation that led to the stock market bubble and the crash that followed in October 1987. ‘Rather than retrenching and reducing their stock allocations, these investors had retained or even increased their equity exposures, placing even more upward pressure on stock prices. And, of course, as equity prices rose more, ‘insured’ portfolios bought more stock, causing prices to rise even higher…Ironically, the dynamic trading required by option replication had created the very conditions portfolio insurance had been designed to protect against – volatility and instability in underlying equity markets.And, tragically, portfolio insurance failed under these conditions (because…it was not true insurance). The volatility created by the strategy’s dynamic hedging spelled its end.’

***

‘In the months following the (1987) crash, a number of investigative reports examined the trading data for the crash period. The Securities and Exchange Commission and the Brady Commission (the Presidential Task Force), for two, found that the evidence implicated portfolio insurance as a prime culprit.’ …

Dr. Jacobs’ wonderful effort explains … the potential dangers of a complex financial theory taken up with little appreciation of its suitability for real-world conditions and applied mechanistically with little regard for its potential effects. It is a story about how a relatively small group of operators, in today’s complicated and interconnected marketplaces, can wreak havoc out of all proportion to their numbers…it is a story of unintended consequences. For synthetic portfolio insurance, although born from the tenets of market efficiency, affected markets in very inefficient, destabilizing ways. And option replication, although envisioned as a means for investors to transfer and thereby reduce unwanted risk, came to be a source of risk for all market participants.’

Unfortunately, this language seems at least as applicable to today’s interest rate derivative market as it was for equity portfolio insurance. It is certainly our view that the contemporary U.S. and global financial system characterized by unfettered money, credit and speculative excess creates unprecedented risk for all market participants, as well as citizens both at home and abroad. Not only have flawed theories prevailed and past crises been readily ignored, derivatives (interest rate in particular) have come to play a much greater role throughout the U.S. and global financial system. The proliferation of derivative trading is a key element fostering credit excess and a critical aspect of the monetary processes that fuel recurring boom and bust dynamics, as well as the general instability wrought by enormous financial sector leveraging and sophisticated speculative strategies. This certainly makes the proliferation of interest rate derivatives significantly more dangerous than stock market derivatives. Under these circumstances, it does seem rather curious that more don’t seriously question the soundness of this unrelenting derivative expansion. Unfortunately, ignoring the dysfunctional nature of the current system does not assist in its rectification – anything but. Indeed, it is my view that these previous market dislocations will prove but harbingers of a potentially much more problematic crisis that is quietly fermenting in the U.S. (global) credit system.

***

Clearly, the gigantic interest rate derivative market should be recognized as a very unusual beast. Instead of providing true interest rate hedging protection, this is clearly the financial sector having created a sophisticated mechanism that, despite its appearance, is limited to little more than ‘self insurance’ – ‘The Son of Portfolio Insurance.’ I have written repeatedly that markets cannot hedge themselves, and that derivative ‘insurance’ is different in several critical respects from traditional insurance. From Dr. Jacobs: ‘Synthetic portfolio insurance differs from traditional insurance where numerous insured parties each pay an explicit, predetermined premium to an insurance company, which accepts the independent risks of such unforeseeable events as theft or fire. The traditional insurer pools the risks of many participants and is obligated, and in general able, to draw on these premiums and accumulated reserves, as necessary, to reimburse losses. Synthetic portfolio insurance also differs critically from real options, where the option seller, for a premium, takes on the risk of market moves.’ Such exposure to unrelated events is far different from exposure to a market dislocation. Quoting leading proponents of portfolio insurance from 1985, ‘it doesn’t matter that formal insurance policies are not available. The mathematics of finance provide the answer…The bottom line is that financial catastrophes can be avoided at a relatively insignificant cost.’Amazingly, such thinking persists to this day. The above language, of course, is all too similar to the flawed analysis/erroneous propaganda that is the foundation for the proliferation of hedging strategies and the explosion of derivative positions. Dynamic hedging makes two quite bold assumptions that become even more audacious as derivative positions balloon: continuous markets and liquidity. As writers of technology puts …experienced, individual stocks often gap down significantly on earnings or other disappointing news, not affording the opportunity to short the underlying stock at levels necessary to successfully hedge exposure. And when the entire technology sector was in freefall, market illiquidity made it impossible for players to dynamically hedge the enormous amount of technology derivatives (put options) that had been written over the boom (especially during the final stage of gross speculation). The buying power necessary to absorb the massive shorting necessary for derivative players to offload exposure (through shorting stocks or futures) was nowhere to be found – so much for assumptions.

Granted, derivatives can be a very effective mechanism for individual participants to shift risk to others, but a proliferation of these strategies significantly influences their effectiveness and general impact. The availability of inexpensive ‘insurance’ heightens the appetite for risk and exacerbates the boom. This characteristic has significant ramifications for both the financial system and real economy. It also creates completely unrealistic expectations for the amount of market risk that can be absorbed/shifted come the inevitable market downturn. Many adopt strategies to purchase insurance at the first signs of market stress. Once again, the market cannot hedge itself, and the tendency is for derivative markets operating in a speculative environment to transfer risk specifically to financial players with little capacity to provide protection in the event of severe financial market crisis.

***

There is another key factor that greatly accentuates today’s risk of a serous market dislocation, that was actually noted by the BIS: ‘Net repayments of US government debt have affected the liquidity of the US government bond market and the effectiveness of traditional hedging vehicles, such as cash market securities or government bond futures, encouraging market participants to switch to more effective hedging instruments, such as interest rate swaps.’

This is actually a very interesting statement from the BIS. First, it is an acknowledgement that ‘liquidity’ and the ‘effectiveness of traditional hedging vehicles’ have been impaired, concurrently with the exponential growth of outstanding derivative positions. This is not a healthy divergence. We have posited that the explosion in private sector debt, having been the leading factor fueling U.S. government surpluses, has produced The Great Distortion. As such, the viability of hedging strategies such as those that entailed massive Treasury securities sales in 1994 is today suspect. There are fewer Treasuries and a much less liquid Treasury market, in the face of unimaginable increases in risky private-sector securities and hedging vehicles. And while this momentous development has not yet created significant market disruption, the true test will come in an environment of generally increasing interest rates. Rising market rates will dictate hedging-related securities sales, and will test the liquidity assumptions that lie at the heart of derivative strategies. It is certainly my view that models that rely on historical relationships between public and private debt are increasingly inappropriate in today’s bubble environment, as are the associated assumptions of marketplace liquidity. Importantly, dynamically shorting securities in the liquid Treasuries market is no longer a viable method for the financial sector to hedge the enormous interest rate risk that they have created. The ‘answer’ to this dilemma, apparently, has been an explosion of ‘more effective hedging instruments, such as interest rate swaps (from the BIS).’ We very much question the use of the adjective ‘effective.’ …

All the same, the interest rate swaps market remains Wall Street’s favorite ‘Son of Portfolio Insurance.’ A similar pre-’87 Crash perception of a ‘free lunch’ conveniently opens the door to playing aggressively in a speculative market. But an interest rate swap is only a contact to exchange a stream of cash flows, generally with one party agreeing to pay a fixed rate and the other party a floating rate (settling the difference with periodic cash payments). With characteristics of writing an option, the risk of loss is open ended for those taking the floating side of the swap trade. There’s no magic here, with one party a loser in this contract in the event of a significant jump in market rates. In such an event, this ‘loser’ will certainly plan to dynamically hedge escalating exposure. If you are on the ‘winning’ side, you had better accept the fact that the greater your ‘win,’ the higher the probability of a counterparty default. Somewhere along the line, these hedging strategies must be capable of generating the necessary cash flow to pay on derivative ‘insurance’ in the event of higher interest rates. Obviously, the highly leveraged and exposed financial institutions that comprise the swaps market have little capacity to provide true insurance. In a rising rate environment, these players will have enough problems of their own making as they are forced to deal with their own bloated balance sheets, mark-to-market losses [what a quaint notion], and other interest rate mismatches, let alone enormous off-balance sheet exposure. As I have written previously, purchasing large amounts of protection against sharply higher interest rates from the U.S. financial sector makes about as much sense as the failed strategy of contracting with Russian banks for protection against a collapse in the ruble. Sure, one can play this game, but we are all left to hope that the circumstances never develop where there is a need to collect on these policies.

***
At some point, higher interest rates will force the financial sector to short securities to dynamically hedge the massive interest rate exposure that has been created. What securities will be sold and from where will buyers be found with the necessary $100s ($ trillion plus?) of billions of liquidity? Will agency securities be aggressively shorted? What are the ramifications of such a development to a market that is almost certainly highly leveraged with enormous speculative trading? I can assure you that these are questions that the derivative players would rather not contemplate, let alone discuss. …The problem is that the strong perception that has developed that holds that the Fed will ensure that interest rates and liquidity conditions remain market friendly is actually the key assumption fostering the explosion in interest rate derivatives and reckless risk-taking. It should be clear that the assumptions of liquidity make no sense whatsoever without the unspoken assurances from the Federal Reserve. The resulting proliferation of derivatives, then, has played a momentous role in the intermediation process whereby endless risky loans are transformed into ‘safe’ securities and ‘money.’ The credit system’s newfound and virtually unlimited capability of fabricating ‘safe’ securities and instruments is the mechanism providing unbounded availability of credit – the hallmark of ‘New Age Finance.’ It is the unbounded availability of credit that, at this very late stage of the cycle, that creates extreme risk of dangerous financial and economic distortions, including the distinct possibility of heightened inflationary pressures. Ironically, the proliferation of interest rate derivatives has created the very conditions that they had been designed to protect against – volatility and instability in the underlying credit market, as well as acute vulnerability to the real economy.

***

The bad news is that there sure is a lot riding on what appears to be one massive and increasingly vulnerable speculation and derivative bubble that fuel the perpetuation of the historic U.S. Credit Bubble. I have said before that I see the current bets placed in the U.S. interest rate market as probably ‘history’s most crowded trade.’

Conclusion

Most economists and financial institutions assume that interest rate derivatives help to stabilize the economy.

But cumulatively, they can actually increase risky behavior, just as portfolio insurance previously did. As Nassim Taleb has shown, behavior which appears to decrease risk can actually mask long-term risks and lead to huge blow ups.

Moreover, there is a real danger of too many people using the same strategy at once. As economist Blake LeBaron discovered last year, when everyone is on the same side of a trade, it will likely lead to a crash:

During the run-up to a crash, population diversity falls. Agents begin using very similar trading strategies as their common good performance is reinforced. This makes the population very brittle…

Given that the market for interest rate derivatives is orders of magnitude larger than credit default swap market – let alone portfolio insurance – the risks of a ‘black swan’ event based on interest rate derivatives should be taken seriously.

Anything that is orders of magnitude larger than the global economy could be risky – one unforeseen event and things could destabilize very quickly. Too much of anything can be dangerous. Water is essential for life … but too much and you drown.

But I am confident that no one – even the people that design, sell or write about the various interest rate derivatives – really know how much of a danger they do or don’t pose to the overall economy. In addition to all of the other complexities of the instruments, the very size of the market is unprecedented. Independent risk analysts would do a great service if they quantified and modeled the risk.

Finally, even if the widespread use of interest rate derivatives does not harm the economy as a whole, it will certainly harm the cities, states and other governmental and quasi-governmental entities which are on the wrong side of the trade. My hunch is that – just as the fraud in the CDO and CDS markets was exposed when the ‘water level’ of the economy fell, exposing the rocks underneath – rising interest rates will reveal massive fraud in the interest rate derivative market."

(Via naked capitalism.)

Robert L. Borosage: The Big Fix (Hold on to your Wallets)

Robert L. Borosage: The Big Fix (Hold on to your Wallets): "

The drumbeat about deficits has reached deafening levels. The president warns about 'out of control' spending. Fed Chair Ben Bernanke calls for bringing deficits down. The opinion pages bristle with rants about the U.S. turning into Greece, headed to default. Next week, the first session of the president's 'National Commission on Fiscal Responsibility and Reform' will convene. The next day, shamelessly, the two co-chairs and the staff director (all committed deficit hawks) will grace a forum sponsored by the Peterson Foundation, established by Wall Street billionaire Pete Peterson largely to gin up hysteria about America's long term deficits.

Premature Ejaculation

This potion is being served long before its time. Sure, deficits are big and the projections are scary. But the economy is struggling to get out of a big hole. Unemployment is still near 10%. Foreclosures are still rising. Banks aren't lending; businesses aren't hiring. Deficit spending is critical to what little growth we've seen.

The president and the Congress should be focused on jobs, not deficits. Ironically, when pushed, most of the purveyors of the hysteria agree. Bernanke admits we shouldn't roll back the spending too soon, and is keeping interest rates (for the banks) near zero. David Walker, head of the Peterson Foundation, agrees deficits might be larger in the short run to create jobs and help get the economy going. But these cautions can't be heard amid the clamor about deficits.

The Elite's Big Fix

Consider this another example of Naomi Klein's 'shock doctrine.' Not wanting to let the crisis go to waste, an elite consensus is congealing on how to bring the deficits down.

Call it the big fix. 'Everything is on the table,' we're told. That's code for a trade-off. Republicans accept tax increases; Democrats accept spending cuts.

But the fix is in the details. On the revenue side, the favored vehicle is a value added tax (VAT). The VAT is essentially a hidden sales tax, levied at each stage of a product's production. Conservatives, who, unlike Dick Cheney, believe deficits matter, accept it because it is regressive, taxing spending, not investment or wealth. Liberals accept it because it is hidden, and could generate a lot of revenue.

The debate has already begun around the VAT. John McCain, in his new guise as conservative partisan, brought a resolution to the Senate denouncing the VAT as a 'massive tax increase that will cripple families on fixed income.' Eighty-five Senators voted for the non-binding resolution, including all six members of the President's Commission. The administration has since denied that it has any designs on a VAT. But these protestations are simply reflections on how serious the move towards a VAT has become.

On the spending side, cuts in Social Security, Medicare and domestic spending are targeted. The Republican co-chair of the President's Commission, former Senator Alan Simpson is an infamous scourge of Social Security. The Democratic co-chair Erskine Bowles favored the Clinton effort to privatize it. The deal is foreshadowed by the president's budget which calls for a three year freeze on domestic discretionary spending, and 'pay-go' limits on entitlements, insisting that any increase in entitlements be paid for.

All this is wrapped in gauzy poll designed packaging. A VAT will sold as a corporate tax reform. Entitlements, we're told, must be brought under control as the boomers age. Domestic spending is rife with waste, fraud and abuse.

Stuff and Nonsense

There's only one problem with this consensus -- it is both wrong-headed and dangerous. It ignores how we got into this hole, is blind to the challenges the country faces, and offends the values that made this country great. Here's a little common sense:

1. Ignore False Prophets

As Dean Baker has pointed out, the elite deficit agenda is being peddled by the same folks that profited from the bubble bust economy that drove us over the cliff. Wall Street moguls Pete Peterson and Robert Rubin, leaders of the effort, have preached against deficits for years, arguing that they would eventually lead to recession. They never uttered a word about the housing bubble, the financial casino, the excesses and frauds of Wall Street that actually blew up the economy. They made a lot of money along the way. But their profits don't make them sound prophets.

2. Get the Question Right First

The question isn't how we raise taxes, cut spending and balance the budget. The question is how we return to an economy of full employment with a broad and prosperous middle class. If we create a prosperous and growing economy, wages will go up, revenues will go up, spending on unemployment and misery will go down, and budgets will come into greater balance. Growth is an essential precondition to sound finances. We last had debt of this size relative to the economy at the end of World War II. We invested in the GI Bill and educated a generation. We built the interstate highways. We transferred war industries to private companies. We launched the Marshall Plan, and created markets for products in Europe. And we grew our way out of the debt burdens over time, as we built the middle class society that was America's pride.

3. Wrong diagnosis, wrong remedy

To understand what remedy is, you've got to have a clear view of what the problems are. The irony of the elite consensus is that in every particular, it ignores the problems we face, and calls for remedies that would make things worse.

Consider:

We don't have an 'entitlements problem.' Social Security is in surplus and, if the economy grows and workers capture a fair share of the productivity they help generate, Social Security will be in surplus as far as the eye can see.

We also don't have a 'Medicare problem.' We have a broken health care system. The source of virtually the entire long term projected deficits comes from soaring health care costs. We're spending 50% more than other industrial countries per capita and getting worse results in terms of good health. The new health care reform does offer some hope of reducing the rate of cost increase. A single payer system -- extending Medicare to all - would do far more. But the problem isn't entitlements or greedy geezers, but a broken health care system.. Cutting Medicare and Social Security won't solve that problem.

Consider:

We now suffer Gilded Age inequality. The wealthiest 1% of Americans not only pockets 21% percent of the national income; they hold more than one-third of the privately held wealth. Plus they've enjoyed the largest tax cuts over the last decades. IRS figures show that the wealthiest 400 Americans -- averaging over $263 million in income in 2006 -- now pay taxes at a rate (17%) lower than their chauffeurs.

Yet the elite consensus is pushing a VAT that will burden the working and middle class far more than the wealthy. Instead we should be talking about increasing top end tax rates, taxing unearned income at the same rate as earned income (last done when Reagan was president), and cracking down on tax avoidance schemes, levying a speculation tax on short-term financial speculation, reviving the estate tax. And of course, we need to set a 'price on carbon,' a regressive tax no doubt, but one that at least is focused on taxing spending on what we need to reduce.

Consider:

On the spending side, we spend almost as much on the military as the rest of the world combined. We spend more to defend South Korea than the South Koreans do. We police the world and maintain an empire over some 750 bases. And, the military is by far the largest cesspool of waste, fraud and abuse in government. The Defense Department's books are in such disarray that none of the services can be audited, much less pass an audit.

At the same time, we have a debilitating domestic public investment deficit that is rapidly getting worse. As the president has said, we need to build a new foundation for our economy. And that requires investing in education and training so our children get the best education in the world; investing in research and development so we remain on the cutting edge of invention and science; building a 21st Century infrastructure - from a smart electric grid, to fast trains, cutting edge broadband, and renewable energy. And we've got to rebuild a basic infrastructure - from schools to sewers to bridges - that is aged and literally falling apart. Sure, if the Congress is ready to take on entrenched interests, we can cut a lot of fat out of domestic spending (consider subsidies for Big Oil, Big Agra, and Big Pharma for starters), but in the end we should be spending more, not less on vital domestic investments.

So it makes no sense at all to focus on domestic spending cuts, and leave the military off the table.

Beware Bipartisan Blight

Most Americans want the two parties to work together to solve problems. But when the parties come together to do something big, Americans should be particularly vigilant. Too often, that reflects a strong elite consensus, willing and able to purchase support on both sides of the aisle.

The elite consensus described above already has a lot of momentum and money behind it. You'll see publicists from AEI on the corporate right joining those from the Center for American Progress, on the center-left. Clinton's former Treasury Secretary Robert Rubin joining Nixon's former Commerce Secretary Pete Peterson. Editorial boards will echo established authority.

But trust your common sense. The reality is that they have it wrong. If we follow their advice now, we're likely to suffer a renewed recession. And their prescriptions will make America more unequal and less secure. We'll continue to squander resources across the world, while failing to build a sound foundation for the future at home. America's broad middle class, the pride of our democracy, will continue its decline. And our politics and our lives will get nastier and more brutish.

This post is part of the two-week long Virtual Summit on Fiscal and Economic Responsibility for People Who Did Not Wreck the Economy,, hosted by Campaign for America's Future."

(Via Huffington Blog.)

Noam Chomsky Has ‘Never Seen Anything Like This’

Noam Chomsky Has ‘Never Seen Anything Like This’: "

By Chris Hedges

America’s greatest intellectual says, ‘The mood of the country is frightening. The level of anger, frustration and hatred of institutions is not organized in a constructive way. It is going off into self-destructive fantasies.’

"

(Via Truthdig: Drilling Beneath the Headlines.)

Robert L. Borosage: Was Bernie Madoff the Exception or the Rule?

Robert L. Borosage: Was Bernie Madoff the Exception or the Rule?: "

Were the big banks all knowingly running Ponzi schemes? That's the question that arises from the stunning hearings held this week by the Senate Permanent Committee on Investigations, chaired by Senator Carl Levin, on the collapse of Washington Mutual, the largest thrift failure in the U.S. Faced with looking like fools or knaves, the barons of the big banks -- from Robert Rubin to Lloyd Blankfein to WaMu's Kerry Killinger -- have chosen, not surprisingly, the fool. But the WaMu hearings -- and Zach Carter's stunning running commentary on them -- suggest that while Bernie Madoff may have been the extreme, he wasn't the exception. (Note: Carter blogs for the Campaign for America's Future which I co-direct)

The Levin hearings show that WaMu systematically peddled loans to people it knew could not pay them back. This wasn't an accident. Levin exposed a WaMu internal audit that reviewed 132 loans, and found 115 involved confirmed fraud, with 80 having 'unreasonable' income -- meaning the income listed on the loan was so preposterous that any reasonable person, much less a trained loan officer, would have called it into question. The audit resulted in no -- zero, nada -- changes in WaMu's lending practices. Fraud wasn't a problem; it was the business plan.

As Carter summarizes:

According to the FBI, 80% of mortgage fraud is committed by the lender. We're not talking about stupid loan officers allowing borrowers to get away with something crazy that is bad for the bank. We're talking about clever loan officers pushing fraudulent documents in order to score bigger paychecks, and bank executives looking the other way so that they can keep getting big paychecks from the securitization machine. This isn't a problem unique to WaMu. This is how the U.S. mortgage system operated for half a decade.

WaMu particularly pushed predatory option-ARM loans, loans with an initial monthly payment so low that it often didn't even pay off the interest on the loan. Then after a couple of years, the monthly payment explodes -- and the loan becomes unaffordable.

WaMu actively trained its personnel to convince skeptical borrowers to take these loans because option-ARMS received a very high yield when packaged into securities. So WaMu's compensation schemes rewarded loan officers for the number of loans sold, not the quality of the loans. Stunningly, Levin cited internal memos showing that even loan officers under investigation for fraud were rewarded with trips to Hawaii and the Bahamas for their high production.

WaMu packaged the fraudulent loans into securities and sold them to investors, or peddled the loans to investment banks that did the same. Even after WaMu's own internal audits reported that a high percentage of the loans were fraudulent, WaMu still sold them to investors. Worse, even after WaMu's own study showed that the default rates on option-ARMS were going to be staggering, WaMu rushed to peddle even more of these loans to investors on an 'urgent' basis. As Carter reports, 'They not only packaged existing option-ARM loans into securities, they issued as many new option-ARMs as possible, in order to score securitization profits before the market collapsed.' CEO Kerry Killinger testifies that he doesn't know if it would have been appropriate to tell investors what the company knew about default rates. 'I don't know what actually happened,' says Killinger.

As Carter summarizes, this was essentially a Ponzi scheme, similar to Madoff's:

Making truckloads of fraudulent loans can only end in disaster, but WaMu [executives weren't] really interested in the long-term picture. They were only interested in their ability to book these loans for big, short-term profits. Even when those bad loans finally took the company under, it had been, in a sense, a success. Its executives had already made millions.

WaMu's [executives were] in many ways operating a simple Ponzi scheme. Their risky loans were going bad, but the company was trying to counter those inevitable losses with the short-term profits from issuing more risky loans. That's basically how Bernie Madoff's scam worked, except he wasn't using make-believe loan profits, he was using make believe stock returns. So long as the bubble keeps growing, the scam could keep moving. But when the bubble burst, there was no way to keep issuing lots of loans in an economy where home prices were plunging.

The one divergence from the Ponzi scheme is securitization -- if WaMu could dump the bad loans off its books, then it wouldn't have to eat the inevitable losses. But that doesn't reflect well on WaMu-- it means [the executives] were deceiving and abusing investors.

Why run this scheme that would lead to the ruin of the bank? Because the executives were making out like, well, like bandits. Killinger, the CEO of WaMu, was taking home 11 to 20 million a year during the housing boom.

As Carter ponts out, what WaMu was doing in mortgages -- originating mortgages that they knew would default, cutting them up into securities, and marketing them to investors without notice -- isn't much different than what Goldman Sachs was doing in synthetic subprime CDOs -- creating securities that it knew would fail in order to bet against them, while selling them to investors without notice.

These guys weren't fools. They knew what they were doing. They knew that the music would stop someday, and the reckoning would come, or more likely, the Feds would step in and bail them out. (Amazingly Killinger is still outraged that WaMu wasn't bailed out rather than put out of business). But they kept dancing because they were cleaning up along the way.

In the last two weeks, the Financial Crisis Inquiry Commission and the Levin Hearings provide a stunning picture of the industry. The good cop, FCIC, treats the bankers as experts, listens to their opinions, and lets them claim the role of fools. 'We didn't know.' 'We didn't realize housing prices wouldn't always go up'. ' We weren't responsible.'

Then yesterday, the bad cop -- the Levin committee -- exposed the inner working of what Bill Black calls 'control fraud,' a business model based upon fraud as central to its profitable operations. It is hard to believe that WaMu or Madoff is an exception. Levin should probe every major bank engaged in the securitization of mortgages. Is it likely that their bank officers were fools? Or that they were prepared to turn their heads or hold their noses because the rewards were so great? Ignorance is their defense, not their condition. They knew what they were doing. The rest is for a prosecutor to sort out."

(Via Huffington Blog.)

The Price of Assassination

The Price of Assassination: "Whether or not drone missile strikes and assassination plots are legal, are they a good idea?"

(Via NYT > Opinion.)

No Money for Jobs Bill

No Money for Jobs Bill: "

Now that Washington finally focuses on jobs, guess what? There's no money left. After bailing out banks, boosting war spending, and expanding health care, both Democrats and Republicans are putting the brakes on job relief, despite its polling status as the issue of most concern to most Americans.

Our $12.8 trillion national debt is suddenly a big worry on Capitol Hill after months of spending in all directions. Senate Budget Committee Chairman Kent Conrad is refusing to use money left over from the fund that bailed out banks, automakers and insurers and using it for President Obama's jobs bill.

The North Dakota Democrat's opposition could scuttle the $80 billion-plus infusion of cash to build roads and schools, help local governments keep teachers on the payroll, and provide rebates for homeowners who make energy-saving investments.

Without a break in this logjam, Democrats would face voters in November's congressional races having done nothing about their constituents' biggest worry."

(Via Craig Crawford's Trail Mix.)

Driven to Destruction – The Cost of the Car Culture

Driven to Destruction – The Cost of the Car Culture: "

Consider the following statistics:

1) There are 115 million households in the United States.

2) 58.1% of American households have at least two cars. 20.1% have three or more.

3) The IRS currently estimates that it costs 50 cents a mile to maintain a personal automobile.

4) The average American vehicle drives 12,334 miles each year.

Do the math, and you’ll discover that if every American household with more than one car gave up one of its cars, the total savings would be nearly 412 billion dollars per year. What if our country embarked on a ten-year program to build a high-speed rail system, and we used the money that we’re spending on our additional automobiles? We could finance a system worth over 4 trillion dollars.

Admittedly, in today’s political climate, such a program will never happen. But the hypothetical exercise reminds us how wasteful our ‘one-person, one-car’ system of transportation is, and how much better things could be if we could break out of the car culture that has gripped the United States for over 60 years now.

In the coming months, there will be a series of articles on the Seminal called ‘Driven to Destruction.’ It will unearth some of the sordid history of how the country became so car-dependent, how this dependency has become harmful in so many ways, and how we can begin to move forward to a more sane and sustainable system of transportation.

Please come along for the ride!"

(Via Firedoglake.)

Bank of International Settlements’ Tough Assessments Don’t Bode Well for World Economy

Guest Post: Bank of International Settlements’ Tough Assessments Don’t Bode Well for World Economy: "

→ Washington’s Blog

In a new report, the Bank for International Settlements (BIS) – often called the ‘central banks’ central bank’ – points out that bond investors are not as smart as they think, that Western debt is much higher than officially reported (since contingent liabilities and pension debts are excluded from official numbers), and that the recovery of the world economy may be crushed by fiscal problems.

The report states:

According to the OECD, total industrialised country public sector debt is now expected to exceed 100% of GDP in 2011 – something that has never happened before in peacetime. As bad as these fiscal problems may appear, relying solely on these official figures is almost certainly very misleading. Rapidly ageing populations present a number of countries with the prospect of enormous future costs that are not wholly recognised in current budget projections. The size of these future obligations is anybody’s guess. As far as we know, there is no definite and comprehensive account of the unfunded, contingent liabilities that governments currently have accumulated.

For background on the effect of aging populations on the economy, see this.

The report includes the following chart on age-related expenditures by country (click for clearer image):

Ambrose Evans-Pritchard succinctly summarizes BIS’ findings:

Official debt figures in the West are ‘very misleading’ since they fail to take in account the contingent liabilities and pension debts that have mushroomed over recent years.

BIS writes:

More worryingly, the current expansionary fiscal policy has coincided with rising, and largely unfunded, age-related spending (pension and health care costs). Driven by the countries’ demographic profiles, the ratio of old-age population to working-age population is projected to rise sharply. Interestingly, this rise is concentrated in countries such as Japan, Spain, Italy and Greece, which are already laden with relatively high debts (Graph 2, left-hand panel). Added to the effects of population ageing is the problem posed by rising per capita health care costs.

In other words, BIS is slamming the Western nations for failing to budget for their rapidly aging populations and to set aside adequate funds during the boom. As Evans-Pritchard puts it:

BIS lamented the lack of any systematic data on the scale of unfunded IOUs that care-free politicians have handed out like confetti.

(And, of course, America has been spending money on both guns and butter).

Indeed, here are some recent stories about America’s pension crisis:

• Barron’s ran a story on March 15th called ‘The $2 Trillion Hole: Promised pensions benefits for public-sector employees represent a massive overhang that threatens the financial future of many cities and states.’

• Huffington Post ran a story April 5th entitled ‘‘Something’s Got To Give’: Massive Pension Fund Shortfalls Threaten To Bankrupt States’

• World Net Daily ran a story the same day called ‘America’s future? U.S. cities going bust: Public employee pensions burdening states, localities ‘

• The Los Angeles Times ran an op-ed on April 6th – written by the special advisor to Califonria Governor Arnold Schwarzenegger for jobs and economic growth – entitled ‘California’s $500-billion pension time bomb: The staggering amount of unfunded debt stands to crowd out funding for many popular programs. Reform will take something sadly lacking in the Legislature: political courage.’

The BIS report further points out that bond traders overestimate their timing and forecasting skills:

So far, at least, investors have continued to view government bonds as relatively safe. But bond traders are notoriously short-sighted, assuming they can get out before the storm hits: their time horizons are days or weeks, not years or decades. We take a longer and less benign view of current developments, arguing that the aftermath of the financial crisis is poised to bring a simmering fiscal problem in industrial economies to boiling point. In the face of rapidly ageing populations, for many countries the path of pre-crisis future revenues was insufficient to finance promised expenditure.

Further, BIS notes:

The risk that persistently high levels of public debt will drive down capital accumulation, productivity growth and long-term potential growth. Although we do not provide direct evidence of this, a recent study suggests that there may be non-linear effects of public debt on growth, with adverse output effects tending to rise as the debt/GDP ratio approaches the 100% limit (Reinhart and Rogoff (2009b)).

Actually, as Reinhart and Rogoff showed last December, 90 percent is the threshold:

The relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more. We find that the threshold for public debt is similar in advanced and emerging economies…

And, as Forbes noted about America:

Add the unfunded portion of entitlement programs and we’re at 840% of GDP.

And see this and this.

BIS concludes with this bearish scenario:

If countries do not retrench quickly, they will create a market fear of ‘monetization’ that becomes self-fulfilling. ‘Monetary policy may ultimately become impotent to control inflation, regardless of the fighting credentials of the central bank’ it said.

Some states may be tempted to carry out a creeping default by stoking inflation. ‘The payoff to do this rises the bigger the debt, the longer its average maturity, the bigger the fraction held by foreigners.’ The BIS said the danger that any government would consciously take this path is ‘not insignificant’ in the longer run.

Of course, a brutal fiscal purge in every major country at once itself poses a danger. The result would be to crush recovery and tip the world economy back into crisis, making deficits worse again.

Ultimately, though, the primary cause of this acute stage of the global debt crisis is very simple.

As BIS warned in 2008, nations worldwide were bailing out their private banks by transferring toxic risk from the banks onto the sovereigns’ own books. The giant banks are, of course, still drowning in debt and – using real world accounting – insolvent, due to all of their gambling schemes gone wrong and toxic assets. The ‘too big to fails’ all over the world have acted like a drowning man who grabs onto someone else and – thrashing around wildly – ends up drowning both.

I don’t yet have an opinion on whether it’s a good idea or not, but debt repudiation appears to be a growing response to the debt crisis.
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(Via naked capitalism.)