"North Dakota landscape, McHenry County"
Stoneleigh: In all the talks I have done, there has been only one person who has been critical to the point of dismissiveness, and that is Jeff Rubin, former chief economist of the CIBC Bank in Canada. When asked at the 2010 ASPO-USA conference in Washington DC about his opinion of my work, he called it (paraphrased) “a bastardized form of monetarism devised by a non-economist”. I did not have a chance to respond at the conference, although I have challenged Mr Rubin to a debate on monetary theory on Jim Puplava's Financial Sense Newshour programme.
My critique of Mr Rubin's statement would begin with his labeling of my position as a form of monetarism. While I do regard the monetary supply as a critical factor, I define it very differently than do monetarists. In my opinion, monetarists disregard the elephant in the room in their dismissal of the vital role of credit in the effective money supply.
In my opinion, they correctly identify the importance of the money supply, and specifically changes to it as a vital driver of prices, but then fail to recognize that the overwhelming percentage of the money supply is composed of credit. As it is the collapse of credit that defines the bursting of a financial bubble, neglecting this element means not understanding where we are going and why. As Ben Barnanke is a monetarist, the implications of this lack of understanding are significant.
Essentially, there are two kinds of inflation. As inflation is defined as an increase in the supply of money and credit relative to available goods and services, one can achieve inflation either by increasing the money component (as in Weimar Germany or modern Zimbabwe) or the credit component. In the former case, one divides the underlying real wealth pie into smaller and smaller pieces. In the latter case, which represents our situation, one does not subdivide the real wealth pie, but instead creates multiple and mutually exclusive claims to the same pieces of pie.
A credit expansion thus creates excess claims to underlying real wealth, and we have just lived through the largest credit expansion in human history. In other words, we are all playing a giant game of musical chairs, only there is perhaps one chair for every hundred people playing the game. You can imagine what will happen when the music stops. The free-for-all grab for an available chair represents the extinguishing of excess claims to underlying real wealth, and is deflation by definition. This will represent the end of extend-and-pretend, and the recognition that there is only so much to go around.
In addition, Mr Rubin took exception to my discussion of the velocity of money as an important factor determining how financial crisis will play out in practice. The velocity of money is in fact a critical factor. It is an expression of how rapidly money circulates in an economy. If very little money is at rest, and most of the effective money supply is in circulation, many transactions will occur, it will be simple to connect buyers and sellers, and the economy will be healthy.
The problem in a depression is that the small number of people who still have access to money (after the collapse of credit) will be hanging on to it for dear life, as they will have no idea when they will earn any more in an era of high unemployment and instability. This means that very little of the small amount of existing cash will be in circulation. Most of it will be at rest, being hoarded by people, and companies and banks.
Money is the lubricant in the economy in the same way that motor oil is the lubricant in our cars. Without sufficient lubricant, the engine will seize up. This is exactly what happened in the 1930s - the economy had a seizure. When this happens, it is almost impossible to connect buyers and sellers for lack of a medium of exchange.
In the 1930s we had plenty of everything - energy, resources, labour etc - except money. Perverse things happen under such circumstances. In the 1930s it was very difficult to connect farmers with a product to sell with the hungry people who wanted that product. Since demand is not what one wants, but what one can pay for, under conditions of little circulating money, there is very little demand. In the 1930s, farmers dumped milk in ditches while people were starving to death down the road. Perverse things happen during an economic seizure. This is where we are headed again, and we need to be aware of the implications in order to prepare for them.
A dramatic fall in the velocity of money will greatly compound the collapse of the money supply due to the evaporation of credit. This is a dynamic that everyone needs to understand.
Mr Rubin, unlike most economists, does understand that resource limitations are real, and hence writes about peak oil. This is an important element of understanding. However, it is equally important to understand that a credit expansion brings forward aggregate demand, borrowing it from the future. Because our access to cheap credit put so much extra purchasing power in our hands, we can purchase many things we could not otherwise have done.
The debt created by this additional purchasing power must be repaid though, and when it is, it will be subtracted from future aggregate demand. This is a critical part of the dynamic leading to economic depression, yet it is a factor that modern economists cannot seem to understand. If we are to understand how the world works, we will have to discard the neo-classical model of economics that comprehensively fails to reflect reality, and has become a religion rather than the science it purports to be.
Debt Delenda Est
by Bill Bonner - Daily Reckoning
The subject is debt; it needs to go away.
Debt was the market's bête noire, this week and last. In Europe, it snatched up the Irish and carried them off. Then it attacked the Portuguese. Everyone knew the periphery states were going broke. Their cost of borrowing soared. Then, when the search parties reached them, the Irish turned them away. Debt has it usefulness, the Irish figured. They held out until Wednesday, apparently negotiating terms of their own rescue.
In America, municipal debt collapsed by nearly 10% over the last two weeks. It became more and more obvious that state and local governments were headed for default too. California might get a bailout...but California, like Ireland, is a sovereign state. It could refuse. Borrowers worried that Californians and the Irish might prefer to default like honest incompetents rather than submit to the rescuers' demands.
Debt is underrated. For one thing, it is more reliable than asset values. The crisis of '07-'09 wiped out about a third of the world's equity and property wealth. And it disappeared 7 million jobs in America alone. But debt survived intact. In terms of the cash flow needed to support it, debt actually grew larger.
Central planners can make a recession appear to go away. With enough hot money, they might warm up asset prices or soothe the swelling unemployment rate. But debt doesn't cooperate. Neither monetary policy nor fiscal policy will make it go away. Debt demands honesty. The debtor has to fess up, admitting that he is a fool or a knave. Either he owns up to his mistake and defaults...or he cheats.
"With all due respect, US policy is clueless," said German Finance Minister Wolfgang Schauble. "It's not that the Americans haven't pumped enough liquidity into the market. Now to say let's pump more into the market is not going to solve their problem."
The English speakers conveniently misunderstand the debt problem. The authorities worked hard not to see the debt crisis coming. They made their careers and reputations by not understanding it. Thousands of them work for governments and central banks...if they caught on to the problem now, they'd probably have to resign.
They pretend that the problem is a lack of "liquidity." Or a failure of capitalism. Or that the regulators dropped the ball. It is none of those things. Each of those problems can be "solved." Short liquidity? The feds can add some; as much as you want. Did capitalism lose its way? No problem again, the authorities will apply more central planning. Not enough regulation? Are you kidding; adding regulation is what they do best.
The real problem is debt. In Ireland, for example, investors, householders and bankers all lost their heads in the bubble era. Your editor bought a house in Ireland in 2006. He knew perfectly well it was overpriced. He had walked the streets of Dublin. He had seen storefronts offering property, not just in Dublin...but in Dubrovnik. He had heard people say that "property never goes down."
Now his house is worth about half what he paid for it - if he could find a buyer. There is no reason to expect that house to ever recover - at least in real terms - to the level it was 3 years ago. That wealth has disappeared. Along with it went the banks' collateral and the value of the debt it backed. It is all dead. It is no more. It has ceased to be. It is past tense. But, rather than let the banks' bondholders take the losses they deserved - in rushed the financial authorities with guarantees and more credit. Ireland's deficit rose to a staggering 30% of GDP. Its national debt will rise from 100% of GDP to 120%.
Meanwhile, California is moving closer to bankruptcy - and borrowing more too. The state is $25 billion in the hole, with no plausible plan to get out. The Milken Institute says unfunded pension liabilities will rise to $10,000 per capita by 2013 - the equivalent of an extra $40,000 mortgage for every household. Like Ireland, California cannot pay the debts it has incurred. The federal government will offer a bailout...but with strings attached.
And soon, the bailers will be in trouble too. According to The Wall Street Journal, a combination of 15 major national governments will have to borrow a total of more than $10 trillion next year, to finance deficits and repay maturing bonds. That's 27% of their total economic output. It also is equal to about twice the entire world's annual savings.
The authorities warn about the risk of "contagion." They sweat to "calm" the markets. But why bother? Debt of this magnitude cannot be repaid. It has gone bad. At least give it a decent burial.
Road map that opens up shadow banking
by Gillian Tett - Financial Times
This week, a senior banker friend gave me a poster that had been created by downloading a chart recently produced by economists at the New York Federal Reserve.* It was shocking stuff. Entitled The Shadow Banking System, the graphic depicts how money goes round the modern world, particularly (but not exclusively) in the US. At the top lies a smart section labelled the “Traditional Banking System”, in which a simple flow of boxes explains how investors’ funds are deposited with traditional commercial banks, which then transform this into long and short-term loans, and equity.
So far, so comprehensible. But most of the poster is dominated by two sections called the “cash” and “synthetic” shadow banking systems, or those “financial intermediaries that conduct maturity, credit and liquid transformation without access to central bank liquidity or public sector credit guarantees”, as the associated NY Fed working paper says. These flows are so extraordinarily complex that hundreds of boxes create a diagram comparable to the circuit board of a high-tech gadget. Even as poster size, it is difficult to decode.
But it should be mandatory reading for bankers, regulators, politicians and investors today. Indeed, they might do well to hang similar posters next to their desks, for at least three reasons. For one thing, this circuit board is a reminder of how clueless most investors, regulators and rating agencies were before 2007 about finance. After all, during the credit boom, there was plenty of research being conducted into the financial world; but I never saw anything remotely comparable to this road map.
That was a striking, terrible omission. The Fed now estimates that in early 2008 shadow banking was $20,000bn in size, dwarfing the $11,000bn traditional banking system. And though this shadow system has now shrunk to a “mere” $16,000bn, this remains bigger than traditional banking, at some $13,000bn. Little wonder, then, that so few people immediately appreciated the significance of the seizing up of shadow banking in 2007.
But secondly, this poster is also a reminder that many things about the modern financial system remain mysterious – even today. On the edges of the circuit board, the NY Fed economists list all the government programmes that have supported the system since 2007 (and, in effect, replaced shadow banks when they suffered runs). This “shadow, shadow bank system” – as it might be called – looks complex and baffling too. And in practical terms, the sheer breadth and complexity of that box makes it hard to know what will happen if – or when – government aid disappears.
Then, there is the current regulatory debate. So far this year, the Financial Stability Board and other international bodies have focused most of their reform attention on issues such as bank capital, and systems of oversight for large, systemically important banks. Next year, though, Mario Draghi, head of the FSB, wants to start discussing the shadow banking world.
Many national regulators are keen to do this too as they recognise the danger of looking at regulation just in terms of institutions. After all, the crisis has shown how risky it is to have $16,000bn worth of maturity transformation without any backstop, or clear rules. This week, for example, Adair Turner, head of the Financial Services Authority, the UK regulator, promised more scrutiny. Earlier this year Paul Tucker, deputy UK central bank governor, suggested that it was time to see which parts of the system were benign – or not.** The US government is now considering whether to extend the regulatory umbrella to large, non-bank institutions such as Citadel or GE Capital.
But whether this desire for a debate turns into sensible reform remains unclear. For getting politicians to focus on the issue may not be easy in 2011. There is already considerable regulatory fatigue. There are also other, more urgent distractions, such as the sovereign debt crises. And shadow banking issues rarely seem “sexy” in political terms, unless they involve hedge funds (which pose less systemic threat than, say, the vast $3,000bn-odd money market fund sector.)
So for my money, the best thing the NY Fed could do right now is print thousands of copies of that poster – and dispatch it across the world. I suspect it would be far more persuasive about the need for debate than any number of pious G20 speeches. After all, a key reason why that circuit board became so complex was that bankers were trying to arbitrage the last two sets of Basel rules. If shadow banking continues to be ignored (ie politicians focus just on the traditional banks) there is every chance Basel III will simply produce another complex labyrinth that will go largely ignored. Until the next crisis.
Just When You Thought You Knew Something About Mortgage Securitizations
by WilliamBanzai7 - Zerohedge
Dan Edstrom is a guy who is in the right place at the right time.
His profession? He performs securitization audits (Reverse Engineering and Failure Analysis) for a company called DTC-Systems.
The typical audit includes numerous diagrams including the following:
- Transaction Parties and Flow (similar to the chart below, but much easier to understand)
- Note exchanged for a bond
- Foreclosure parties
- Priority of Payments from the Security Instrument (Mortgage, Deed of Trust, Security Deed or Mortgage Deed)
- Priority of Payments from the Pooling and Servicing Agreement
This diagram shows that they are not following the borrowers instructions in the security instrument.
Source of Payments for Distributions--This diagram is extremely complex and shows that the miscellaneous proceeds specified in the security instrument (and in the SEC Filings) should be applied to the sums secured by the obligation upon the event of a loss in value of the property, whether or not then due, with the remainder, if any, returned to the borrower. This document combines UCC 3-602(a), UCC 9-315, UCC 9-336, UCC 2-609, and UCC 3-501 together with NY Code Section 4545 and the SEC Filings to show that the miscellaneous proceeds can be applied to the borrowers obligation.
The following flow chart reverse engineers the mortgage on the Ekstrom family residence. It took Dan over one year to take it this far and it clearly demonstrates what happens when there are too many lawyers being manufactured.
Take a look at this chart and then decide how long you think it will take for Barney Frank and Eric Holder to sort everything out. There is a link to an expandable version at the end of this post.
Dan will be lecturing on this subject on December 11, 2010 if you are interested in learning more about who is the holder of your mortgage note. Here is the link to the Seminar:
and here is a link to a LARGE VERSION of the Chart:
U.S. in Vast Insider Trading Probe
by Susan Pulliam, Michael Rothfeld,Jenny Strasburg and Gregory Zuckerman - Wall Street Journal
Federal authorities, capping a three-year investigation, are preparing insider-trading charges that could ensnare consultants, investment bankers, hedge-fund and mutual-fund traders and analysts across the nation, according to people familiar with the matter.
The criminal and civil probes, which authorities say could eclipse the impact on the financial industry of any previous such investigation, are examining whether multiple insider-trading rings reaped illegal profits totaling tens of millions of dollars, the people say. Some charges could be brought before year-end, they say. The investigations, if they bear fruit, have the potential to expose a culture of pervasive insider trading in U.S. financial markets, including new ways non-public information is passed to traders through experts tied to specific industries or companies, federal authorities say.
One focus of the criminal investigation is examining whether nonpublic information was passed along by independent analysts and consultants who work for companies that provide "expert network" services to hedge funds and mutual funds. These companies set up meetings and calls with current and former managers from hundreds of companies for traders seeking an investing edge.
Among the expert networks whose consultants are being examined, the people say, is Primary Global Research LLC, a Mountain View, Calif., firm that connects experts with investors seeking information in the technology, health-care and other industries. "I have no comment on that," said Phani Kumar Saripella, Primary Global's chief operating officer. Primary's chief executive and chief operating officers previously worked at Intel Corp., according to its website.
In another aspect of the probes, prosecutors and regulators are examining whether Goldman Sachs Group Inc. bankers leaked information about transactions, including health-care mergers, in ways that benefited certain investors, the people say. Goldman declined to comment. Independent analysts and research boutiques also are being examined. John Kinnucan, a principal at Broadband Research LLC in Portland, Ore., sent an email on Oct. 26 to roughly 20 hedge-fund and mutual-fund clients telling of a visit by the Federal Bureau of Investigation.
"Today two fresh faced eager beavers from the FBI showed up unannounced (obviously) on my doorstep thoroughly convinced that my clients have been trading on copious inside information," the email said. "(They obviously have been recording my cell phone conversations for quite some time, with what motivation I have no idea.) We obviously beg to differ, so have therefore declined the young gentleman's gracious offer to wear a wire and therefore ensnare you in their devious web."
The email, which Mr. Kinnucan confirms writing, was addressed to traders at, among others: hedge-fund firms SAC Capital Advisors LP and Citadel Asset Management, and mutual-fund firms Janus Capital Group, Wellington Management Co. and MFS Investment Management. SAC, Wellington and MFS declined to comment; Janus and Citadel didn't immediately comment. It isn't known whether clients are under investigation for their business with Mr. Kinnucan. The investigations have been conducted by federal prosecutors in New York, the FBI and the Securities and Exchange Commission.
Another aspect of the probe is an examination of whether traders at a number of hedge funds and trading firms, including First New York Securities LLC, improperly gained nonpublic information about pending health-care, technology and other merger deals, according to the people familiar with the matter. Some traders at First New York, a 250-person trading firm, profited by anticipating health-care and other mergers unveiled in 2009, people familiar with the firm say.
A First New York spokesman said: "We are one of more than three dozen firms that have been asked by regulators to provide general information in a widespread inquiry; we have cooperated fully." He added: "We stand behind our traders and our systems and policies in place that ensure full regulatory compliance." Key parts of the probes are at a late stage. A federal grand jury in New York has heard evidence, say people familiar with the matter. But as with all investigations that aren't completed, it's unclear what specific charges, if any, might be brought.
The action is an outgrowth of a focus on insider trading by Preet Bharara, the Manhattan U.S. Attorney. In an October speech, Mr. Bharara said the area is a "top criminal priority" for his office, adding: "Illegal insider trading is rampant and may even be on the rise." Mr. Bharara declined to comment. Expert-network firms hire current or former company employees, as well as doctors and other specialists, to be consultants to funds making investment decisions. More than a third of institutional investment-management firms use expert networks, according to a late-2009 survey by Integrity Research Associates LLC in New York.
The consultants typically earn several hundred dollars an hour for their services, which can include meetings or phone calls with traders to discuss developments in their company or industry. The expert-network companies say internal policies bar their consultants from disclosing confidential information. Generally, inside traders profit by buying stocks of acquisition targets before deals are announced and selling after the targets' shares rise in value. The SEC has been investigating potential leaks on takeover deals going back to at least 2007 amid an explosion of deals leading up to the financial crisis. The SEC sent subpoenas last fall to more than 30 hedge funds and other investors.
Some subpoenas were related to trading in Schering-Plough Corp. stock before its takeover by Merck & Co. in 2009, say people familiar with the matter. Schering-Plough stock rose 8% the trading day before the deal plan was announced and 14% the day of the announcement. Merck said it "has a long-standing practice of fully cooperating with any regulatory inquiries and has explicit policies prohibiting the sharing of confidential information about the company and its potential partners."
Transactions being focused on include MedImmune Inc.'s takeover by AstraZeneca Plc in 2007, the people say. MedImmune shares jumped 18% on Apr. 23, 2007, the day the deal was announced. A spokesman for AstraZeneca and its MedImmune unit declined to comment. Investigators are also examining the role of Goldman bankers in trading in shares of Advanced Medical Optics Inc., which was taken over by Abbott Laboratories in 2009, according to the people familiar with the matter. Advanced Medical Optics's shares jumped 143% on Jan. 12, 2009, the day the deal was announced. Goldman advised MedImmune and Advanced Medical Optics on the deals.
In subpoenas, the SEC has sought information about communications—related to Schering-Plough and other deals—with Ziff Brothers, Jana Partners LLC, TPG-Axon Capital Management, Prudential Financial Inc.'s Jennison Associates asset-management unit, UBS AG's UBS Financial Services Inc. unit, and Deutsche Bank AG, according to subpoenas and the people familiar with the matter.
Among hedge-fund managers whose trading in takeovers is a focus of the criminal probe is Todd Deutsch, a top Wall Street trader who left Galleon Group in 2008 to go out on his own, the people close to the situation say. Prosecutors also are investigating whether some hedge-fund traders received inside information about Advanced Micro Devices Inc., which figured prominently in the government's insider-trading case last year against Galleon Group hedge fund founder Raj Rajaratnam and 22 other defendants.
Fourteen defendants have pleaded guilty in the Galleon case; Mr. Rajaratnam has pleaded not guilty and is expected to go to trial in early 2011. Among those whose AMD transactions have been scrutinized is hedge-fund manager Richard Grodin. Mr. Grodin, who received a subpoena last fall, didn't return calls. An AMD spokesman declined to comment.
Banks’ Self-Dealing Super-Charged Financial Crisis
by Jake Bernstein and Jesse Eisinger - Pro Publica
Over the last two years of the housing bubble, Wall Street bankers perpetrated one of the greatest episodes of self-dealing in financial history.
Faced with increasing difficulty in selling the mortgage-backed securities that had been among their most lucrative products, the banks hit on a solution that preserved their quarterly earnings and huge bonuses:
They created fake demand.
A ProPublica analysis shows for the first time the extent to which banks -- primarily Merrill Lynch, but also Citigroup, UBS and others -- bought their own products and cranked up an assembly line that otherwise should have flagged. The products they were buying and selling were at the heart of the 2008 meltdown -- collections of mortgage bonds known as collateralized debt obligations, or CDOs.
As the housing boom began to slow in mid-2006, investors became skittish about the riskier parts of those investments. So the banks created -- and ultimately provided most of the money for -- new CDOs. Those new CDOs bought the hard-to-sell pieces of the original CDOs. The result was a daisy chain that solved one problem but created another: Each new CDO had its own risky pieces. Banks created yet other CDOs to buy those.
Individual instances of these questionable trades have been reported before, but ProPublica's investigation, done in partnership with NPR's Planet Money, shows that by late 2006 they became a common industry practice.
significant portions of other Merrill CDOs.
ProPublica also found 85 instances during 2006 and 2007 in which two CDOs bought pieces of each other. These trades, which involved $107 billion worth of CDOs, underscore the extent to which the market lacked real buyers. Often the CDOs that swapped purchases closed within days of each other, the analysis shows.
There were supposed to be protections against this sort of abuse. While banks provided the blueprint for the CDOs and marketed them, they typically selected independent managers who chose the specific bonds to go inside them. The managers had a legal obligation to do what was best for the CDO. They were paid by the CDO, not the bank, and were supposed to serve as a bulwark against self-dealing by the banks, which had the fullest understanding of the complex and lightly regulated mortgage bonds.
It rarely worked out that way. The managers were beholden to the banks that sent them the business. On a billion-dollar deal, managers could earn a million dollars in fees, with little risk. Some small firms did several billion dollars of CDOs in a matter of months.
"All these banks for years were spawning trading partners," says a former executive from Financial Guaranty Insurance Company, a major insurer of the CDO market. "You don't have a trading partner? Create one."
The executive, like most of the dozens of people ProPublica spoke with about the inner workings of the market at the time, asked not to be named out of fear of being sucked into ongoing investigations or because they are involved in civil litigation.
Keeping the assembly line going had a wealth of short-term advantages for the banks. Fees rolled in. A typical CDO could net the bank that created it between $5 million and $10 million -- about half of which usually ended up as employee bonuses. Indeed, Wall Street awarded record bonuses in 2006, a hefty chunk of which came from the CDO business.
The self-dealing super-charged the market for CDOs, enticing some less-savvy investors to try their luck. Crucially, such deals maintained the value of mortgage bonds at a time when the lack of buyers should have driven their prices down.
But the strategy of speeding up the assembly line had devastating consequences for homeowners, the banks themselves and, ultimately, the global economy. Because of Wall Street's machinations, more mortgages had been granted to ever-shakier borrowers. The results can now be seen in foreclosed houses across America.
The incestuous trading also made the CDOs more intertwined and thus fragile, accelerating their decline in value that began in the fall of 2007 and deepened over the next year. Most are now worth pennies on the dollar. Nearly half of the nearly trillion dollars in losses to the global banking system came from CDOs, losses ultimately absorbed by taxpayers and investors around the world. The banks' troubles sent the world's economies into a tailspin from which they have yet to recover.
It remains unclear whether any of this violated laws. The SEC has said that it is actively looking at as many as 50 CDO managers as part of its broad examination of the CDO business' role in the financial crisis. In particular, the agency is focusing on the relationship between the banks and the managers. The SEC is exploring how deals were structured, if any quid pro quo arrangements existed, and whether banks pressured managers to take bad assets.
The banks declined to directly address ProPublica's questions. Asked about its relationship with managers and the cross-ownership among its CDOs, Citibank responded with a one-sentence statement:
"It has been widely reported that there are ongoing industry-wide investigations into CDO-related matters and we do not comment on pending investigations."
None of ProPublica's questions had mentioned the SEC or pending investigations.
Posed a similar list of questions, Bank of America, which now owns Merrill Lynch, said:
"These are very specific questions regarding individuals who left Merrill Lynch several years ago and a CDO origination business that, due to market conditions, was discontinued by Merrill before Bank of America acquired the company."
This is the second installment of a ProPublica series about the largely hidden history of the CDO boom and bust. Our first story looked at how one hedge fund helped create at least $40 billion in CDOs as part of a strategy to bet against the market. This story turns the focus on the banks.
Merrill Lynch Pioneers Pervert the Market
By 2004, the housing market was in full swing, and Wall Street bankers flocked to the CDO frenzy. It seemed to be the perfect money machine, and for a time everyone was happy.
Homeowners got easy mortgages. Banks and mortgage companies felt secure lending the money because they could sell the mortgages almost immediately to Wall Street and get back all their cash plus a little extra for their trouble. The investment banks charged massive fees for repackaging the mortgages into fancy financial products. Investors all around the world got to play in the then-phenomenal American housing market.
The mortgages were bundled into bonds, which were in turn combined into CDOs offering varying interest rates and levels of risk.
Investors holding the top tier of a CDO were first in line to get money coming from mortgages. By 2006, some banks often kept this layer, which credit agencies blessed with their highest rating of Triple A.
Buyers of the lower tiers took on more risk and got higher returns. They would be the first to take the hit if homeowners funding the CDO stopped paying their mortgages. (Here's a video explaining how CDOs worked.)
Over time, these risky slices became increasingly hard to sell, posing a problem for the banks. If they remained unsold, the sketchy assets stayed on their books, like rotting inventory. That would require the banks to set aside money to cover any losses. Banks hate doing that because it means the money can't be loaned out or put to other uses.
Being stuck with the risky portions of CDOs would ultimately lower profits and endanger the whole assembly line.
The banks, notably Merrill and Citibank, solved this problem by greatly expanding what had been a common and accepted practice: CDOs buying small pieces of other CDOs.
Architects of CDOs typically included what they called a "bucket" -- which held bits of other CDOs paying higher rates of interest. The idea was to boost overall returns of deals primarily composed of safer assets. In the early days, the bucket was a small portion of an overall CDO.
One pioneer of pushing CDOs to buy CDOs was Merrill Lynch's Chris Ricciardi, who had been brought to the firm in 2003 to take Merrill to the top of the CDO business. According to former colleagues, Ricciardi's team cultivated managers, especially smaller firms.
Merrill exercised its leverage over the managers. A strong relationship with Merrill could be the difference between a business that thrived and one that didn't. The more deals the banks gave a manager, the more money the manager got paid.
As the head of Merrill's CDO business, Ricciardi also wooed managers with golf outings and dinners. One Merrill executive summed up the overall arrangement: "I'm going to make you rich. You just have to be my bitch."
But not all managers went for it.
An executive from Trainer Wortham, a CDO manager, recalls a 2005 conversation with Ricciardi. "I wasn't going to buy other CDOs. Chris said: 'You don't get it. You have got to buy other guys' CDOs to get your deal done. That's how it works.'" When the manager refused, Ricciardi told him, "'That's it. You are not going to get another deal done.'" Trainer Wortham largely withdrew from the market, concerned about the practice and the overheated prices for CDOs.
Ricciardi declined multiple requests to comment.
Merrill CDOs often bought slices of other Merrill deals. This seems to have happened more in the second half of any given year, according to ProPublica's analysis, though the purchases were still a small portion compared to what would come later. Annual bonuses are based on the deals bankers completed by yearend.
Ricciardi left Merrill Lynch in February 2006. But the machine he put into place not only survived his departure, it became a model for competitors.
As Housing Market Wanes, Self-Dealing Takes Off
By mid-2006, the housing market was on the wane. This was particularly true for subprime mortgages, which were given to borrowers with spotty credit at higher interest rates. Subprime lenders began to fold, in what would become a mass extinction. In the first half of the year, the percentage of subprime borrowers who didn't even make the first month's mortgage payment tripled from the previous year.
That made CDO investors like pension funds and insurance companies increasingly nervous. If homeowners couldn't make their mortgage payments, then the stream of cash to CDOs would dry up. Real "buyers began to shrivel and shrivel," says Fiachra O'Driscoll, who co-ran Credit Suisse's CDO business from 2003 to 2008.
Faced with disappearing investor demand, bankers could have wound down the lucrative business and moved on. That's the way a market is supposed to work. Demand disappears; supply follows. But bankers were making lots of money. And they had amassed warehouses full of CDOs and other mortgage-based assets whose value was going down.
Rather than stop, bankers at Merrill, Citi, UBS and elsewhere kept making CDOs.
The question was: Who would buy them?
The top 80 percent, the less risky layers or so-called "super senior," were held by the banks themselves. The beauty of owning that supposedly safe top portion was that it required hardly any money be held in reserve.
That left 20 percent, which the banks did not want to keep because it was riskier and required them to set aside reserves to cover any losses. Banks often sold the bottom, riskiest part to hedge funds. That left the middle layer, known on Wall Street as the "mezzanine," which was sold to new CDOs whose top 80 percent was ultimately owned by ... the banks.
"As we got further into 2006, the mezzanine was going into other CDOs," says Credit Suisse's O'Driscoll.
This was the daisy chain. On paper, the risky stuff was gone, held by new independent CDOs. In reality, however, the banks were buying their own otherwise unsellable assets.
How could something so seemingly short-sighted have happened?
It's one of the great mysteries of the crash. Banks have fleets of risk managers to defend against just such reckless behavior. Top executives have maintained that while they suspected that the housing market was cooling, they never imagined the crash. For those doing the deals, the payoff was immediate. The dangers seemed abstract and remote.
The CDO managers played a crucial role. CDOs were so complex that even buyers had a hard time seeing exactly what was in them -- making a neutral third party that much more essential.
"When you're investing in a CDO you are very much putting your faith in the manager," says Peter Nowell, a former London-based investor for the Royal Bank of Scotland. "The manager is choosing all the bonds that go into the CDO." (RBS suffered mightily in the global financial meltdown, posting the largest loss in United Kingdom history, and was de facto nationalized by the British government.)By persuading managers to pick the unsold slices of CDOs, the banks helped keep the market going. "It guaranteed distribution when, quite frankly, there was not a huge market for them," says Nowell.
The counterintuitive result was that even as investors began to vanish, the mortgage CDO market more than doubled from 2005 to 2006, reaching $226 billion, according to the trade publication Asset-Backed Alert.
Citi and Merrill Hand Out Sweetheart Deals
As the CDO market grew, so did the number of CDO management firms, including many small shops that relied on a single bank for most of their business. According to Fitch, the number of CDO managers it rated rose from 89 in July 2006 to 140 in September 2007.
One CDO manager epitomized the devolution of the business, according to numerous industry insiders: a Wall Street veteran named Wing Chau.
Earlier in the decade, Chau had run the CDO department for Maxim Group, a boutique investment firm in New York. Chau had built a profitable business for Maxim based largely on his relationship with Merrill Lynch. In just a few years, Maxim had corralled more than $4 billion worth of assets under management just from Merrill CDOs.
In August 2006, Chau bolted from Maxim to start his own CDO management business, taking several colleagues with him. Chau's departure gave Merrill, the biggest CDO producer, one more avenue for unsold inventory.
Chau named the firm Harding, after the town in New Jersey where he lived. The CDO market was starting its most profitable stretch ever, and Harding would play a big part. In an eleven-month period, ending in August 2007, Harding managed $13 billion of CDOs, including more than $5 billion from Merrill, and another nearly $5 billion from Citigroup. (Chau would later earn a measure of notoriety for a cameo appearance in Michael Lewis' bestseller "The Big Short," where he is depicted as a cheerfully feckless "go-to buyer" for Merrill Lynch's CDO machine.)
Chau had a long-standing friendship with Ken Margolis, who was Merrill's top CDO salesman under Ricciardi. When Ricciardi left Merrill in 2006, Margolis became a co-head of Merrill's CDO group. He carried a genial, let's-just-get-the-deal-done demeanor into his new position. An avid poker player, Margolis told a friend that in a previous job he had stood down a casino owner during a foreclosure negotiation after the owner had threatened to put a fork through his eye.
Chau's close relationship with Merrill continued. In late 2006, Merrill sublet office space to Chau's startup in the Merrill tower in Lower Manhattan's financial district. A Merrill banker, David Moffitt, scheduled visits to Harding for prospective investors in the bank's CDOs. "It was a nice office," overlooking New York Harbor, recalls a CDO buyer. "But it did feel a little weird that it was Merrill's building," he said.
Under Margolis, other small managers with meager track records were also suddenly handling CDOs valued at as much as $2 billion. Margolis declined to answer any questions about his own involvement in these matters.
A Wall Street Journal article ($) from late 2007, one of the first of its kind, described how Margolis worked with one inexperienced CDO manager called NIR on a CDO named Norma, in the spring of that year. The Long Island-based NIR made about $1.5 million a year for managing Norma, a CDO that imploded.
"NIR's collateral management business had arisen from efforts by Merrill Lynch to assemble a stable of captive small firms to manage its CDOs that would be beholden to Merrill Lynch on account of the business it funneled to them," alleged a lawsuit filed in New York state court against Merrill over Norma that was settled quietly after the plaintiffs received internal Merrill documents.
Banks had a variety of ways to influence managers' behavior. Some of the few outside investors remaining in the market believed that the manager would do a better job if he owned a small slice of the CDO he was managing. That way, the manager would have more incentive to manage the investment well, since he, too, was an investor. But small management firms rarely had money to invest. Some banks solved this problem by advancing money to managers such as Harding.
Chau's group managed two Citigroup CDOs -- 888 Tactical Fund and Jupiter High-Grade VII -- in which the bank loaned Harding money to buy risky pieces of the deal. The loans would be paid back out of the fees the managers took from the CDO and its investors. The loans were disclosed to investors in a few sentences among the hundreds of pages of legalese accompanying the deals.
In response to ProPublica's questions, Chau's lawyer said, "Harding Advisory's dealings with investment banks were proper and fully disclosed."
Citigroup made similar deals with other managers. The bank lent money to a manager called Vanderbilt Capital Advisors for its Armitage CDO, completed in March 2007.
Vanderbilt declined to comment. It couldn't be learned how much money Citigroup loaned or whether it was ever repaid.
Yet again banks had masked their true stakes in CDO. Banks were lending money to CDO managers so they could buy the banks' dodgy assets. If the managers couldn't pay the loans back -- and most were thinly capitalized -- the banks were on the hook for even more losses when the CDO business collapsed.
Goldman, Merrill and Others Get Tough
When the housing market deteriorated, banks took advantage of a little-used power they had over managers.The way CDOs are put together, there is a brief period when the bonds picked by managers sit on the banks' balance sheets. Because the value of such assets can fall, banks reserved the right to overrule managers' selections.
According to numerous bankers, managers and investors, banks rarely wielded that veto until late 2006, after which it became common. Merrill was in the lead.
"I would go to Merrill and tell them that I wanted to buy, say, a Citi bond," recalls a CDO manager. "They would say 'no.' I would suggest a UBS bond, they would say 'no.' Eventually, you got the joke." Managers could choose assets to put into their CDOs but they had to come from Merrill CDOs. One rival investment banker says Merrill treated CDO managers the way Henry Ford treated his Model T customers: You can have any color you want, as long as it's black.
Once, Merrill's Ken Margolis pushed a manager to buy a CDO slice for a Merrill-produced CDO called Port Jackson that was completed in the beginning of 2007: "'You don't have to buy the deal but you are crazy if you don't because of your business,'" an executive at the management firm recalls Margolis telling him. "'We have a big pipeline and only so many more mandates to give you.' You got the message." In other words: Take our stuff and we'll send you more business. If not, forget it.
"All the managers complained about it," recalls O'Driscoll, the former Credit Suisse banker who competed with other investment banks to put deals together and market them. But "they were indentured slaves." O'Driscoll recalls managers grumbling that Merrill in particular told them "what to buy and when to buy it."
Other big CDO-producing banks quickly adopted the practice.
A little-noticed document released this year during a congressional investigation into Goldman Sachs' CDO business reveals that bank's thinking. The firm wrote a November 2006 internal memorandum about a CDO called Timberwolf, managed by Greywolf, a small manager headed by ex-Goldman bankers. In a section headed "Reasons To Pursue," the authors touted that "Goldman is approving every asset" that will end up in the CDO. What the bank intended to do with that approval power is clear from the memo: "We expect that a significant portion of the portfolio by closing will come from Goldman's offerings."
When asked to comment whether Goldman's memo demonstrates that it had effective control over the asset selection process and that Greywolf was not in fact an independent manager, the bank responded: "Greywolf was an experienced, independent manager and made its own decisions about what reference assets to include. The securities included in Timberwolf were fully disclosed to the professional investors who invested in the transaction."
Greywolf declined to comment. One of the investors, Basis Capital of Australia, filed a civil lawsuit in federal court in Manhattan against Goldman over the deal. The bank maintains the lawsuit is without merit.
By March 2007, the housing market's signals were flashing red. Existing home sales plunged at the fastest rate in almost 20 years. Foreclosures were on the rise. And yet, to CDO buyer Peter Nowell's surprise, banks continued to churn out CDOs.
"We were pulling back. We couldn't find anything safe enough," says Nowell. "We were amazed that April through June they were still printing deals. We thought things were over."
Instead, the CDO machine was in overdrive. Wall Street produced $70 billion in mortgage CDOs in the first quarter of the year.
Many shareholder lawsuits battling their way through the court system today focus on this period of the CDO market. They allege that the banks were using the sales of CDOs to other CDOs to prop up prices and hide their losses.
"Citi's CDO operations during late 2006 and 2007 functioned largely to sell CDOs to yet newer CDOs created by Citi to house them," charges a pending shareholder lawsuit against the bank that was filed in federal court in Manhattan in February 2009. "Citigroup concocted a scheme whereby it repackaged many of these investments into other freshly-baked vehicles to avoid incurring a loss."
Citigroup described the allegations as "irrational," saying the bank's executives would never knowingly take actions that would lead to "catastrophic losses."
In the Hall of Mirrors, Myopic Rating Agencies
The portion of CDOs owned by other CDOs grew right alongside the market. What had been 5 percent of CDOs (remember the "bucket") now came to constitute as much as 30 or 40 percent of new CDOs. (Wall Street also rolled out CDOs that were almost entirely made up of CDOs, called CDO squareds.)
The ever-expanding bucket provided new opportunities for incestuous trades.
It worked like this: A CDO would buy a piece of another CDO, which then returned the favor. The transactions moved both CDOs closer to completion, when bankers and managers would receive their fees.ProPublica's analysis shows that in the final two years of the business, CDOs with cross-ownership amounted to about one-fifth of the market, about $107 billion.
Here's an example from early May 2007:
- A CDO called Jupiter VI bought a piece of a CDO called Tazlina II.
- Tazlina II bought a piece of Jupiter VI.
Both Jupiter VI and Tazlina II were created by Merrill and were completed within a week of each other. Both were managed by small firms that did significant business with Merrill: Jupiter by Wing Chau's Harding, and Tazlina by Terwin Advisors. Chau did not respond to questions about this deal. Terwin Advisors could not reached.
Just a few weeks earlier, CDO managers completed a comparable swap between Jupiter VI and another Merrill CDO called Forge 1.
Forge has its own intriguing history. It was the only deal done by a tiny manager of the same name based in Tampa, Fla. The firm was started less than a year earlier by several former Wall Street executives with mortgage experience. It received seed money from Bryan Zwan, who in 2001 settled an SEC civil lawsuit over his company's accounting problems in a federal court in Florida. Zwan and Forge executives didn't respond to requests for comment.
After seemingly coming out of nowhere, Forge won the right to manage a $1.5 billion Merrill CDO. That earned Forge a visit from the rating agency Moody's.
"We just wanted to make sure that they actually existed," says a former Moody's executive. The rating agency saw that the group had an office near the airport and expertise to do the job.
Rating agencies regularly did such research on managers, but failed to ask more fundamental questions. The credit ratings agencies "did heavy, heavy due diligence on managers but they were looking for the wrong things: how you processed a ticket or how your surveillance systems worked," says an executive at a CDO manager. "They didn't check whether you were buying good bonds."
One Forge employee recalled in a recent interview that he was amazed Merrill had been able to find buyers so quickly. "They were able to sell all the tranches" -- slices of the CDO -- "in a fairly rapid period of time," said Rod Jensen, a former research analyst for Forge.
Forge achieved this feat because Merrill sold the slices to other CDOs, many linked to Merrill.
The ProPublica analysis shows that two Merrill CDOs, Maxim II and West Trade III, each bought pieces of Forge. Small managers oversaw both deals.
Forge, in turn, was filled with detritus from Merrill. Eighty-two percent of the CDO bonds owned by Forge came from other Merrill deals.
Citigroup did its own version of the shuffle, as these three CDOs demonstrate:
- A CDO called Octonion bought some of Adams Square Funding II.
- Adams Square II bought a piece of Octonion.
- A third CDO, Class V Funding III, also bought some of Octonion.
- Octonion, in turn, bought a piece of Class V Funding III.
All of these Citi deals were completed within days of each other. Wing Chau was once again a central player. His firm managed Octonion. The other two were managed by a unit of Credit Suisse. Credit Suisse declined to comment.
Not all cross-ownership deals were consummated.
In spring 2007, Deutsche Bank was creating a CDO and found a manager that wanted to take a piece of it. The manager was overseeing a CDO that Merrill was assembling. Merrill blocked the manager from putting the Deutsche bonds into the Merrill CDO. A former Deutsche Bank banker says that when Deutsche Bank complained to Andy Phelps, a Merrill CDO executive, Phelps offered a quid pro quo: If Deutsche was willing to have the manager of its CDO buy some Merrill bonds, Merrill would stop blocking the purchase. Phelps declined to comment.
The Deutsche banker, who says its managers were independent, recalls being shocked: "We said we don't control what people buy in their deals." The swap didn't happen.
The Missing Regulators and the Aftermath
In September 2007, as the market finally started to catch up with Merrill Lynch, Ken Margolis left the firm to join Wing Chau at Harding.
Chau and Margolis circulated a marketing plan for a new hedge fund to prospective investors touting their expertise in how CDOs were made and what was in them. The fund proposed to buy failed CDOs -- at bargain basement prices. In the end, Margolis and Chau couldn't make the business work and dropped the idea.
Why didn't regulators intervene during the boom to stop the self-dealing that had permeated the CDO market?
No one agency had authority over the whole business. Since the business came and went in just a few years, it may have been too much to expect even assertive regulators to comprehend what was happening in time to stop it.
While the financial regulatory bill passed by Congress in July creates more oversight powers, it's unclear whether regulators have sufficient tools to prevent a replay of the debacle.
In just two years, the CDO market had cut a swath of destruction. Partly because CDOs had bought so many pieces of each other, they collapsed in unison. Merrill Lynch and Citigroup, the biggest perpetrators of the self-dealing, were among the biggest losers. Merrill lost about $26 billion on mortgage CDOs and Citigroup about $34 billion.
Tent Cities, Homelessness And Soul-Crushing Despair: The Legacy Of Decades Of Government Debt And Mismanagement Of The Economy
by Michael Snyder - Economic Collapse
For decades, our politicians have been deeply addicted to government debt, they have stood idly by as millions of our jobs have been shipped overseas and they have passed countless business-crushing regulations and they never thought that it would catch up with us. Well, it has. America has been living in the biggest debt bubble in the history of the world, and now that bubble is starting to pop. There has never been such an extended period of unemployment in the United States since the Great Depression, and millions of Americans are losing their homes. Homelessness is skyrocketing, tent cities are popping up everywhere and countless numbers of American families are experiencing the soul-crushing despair that comes from desperately trying to hang on for month after month after month.
Now, because of the horrific hole that our politicians have dug for us, we are faced with some heartbreaking choices. For example, right now the U.S. Congress is deciding whether or not to extend long-term unemployment benefits for the nation's jobless.
Extending those benefits through the end of February would add another $12.5 billion to the U.S. national debt. But not doing it would cut off the only lifeline that many Americans have just in time for the holidays.
The extension of jobless benefits that was passed last summer expires on December 1st. If these long-term benefits are not renewed, approximately 2 million unemployed Americans will lose their checks.
But what can the U.S. Congress do? Just keep going into endless amounts of debt? As I have written about previously, the United States is never going to see another balanced budget ever again under the current system. The U.S. government is flat out broke. Somehow our politicians desperately need to find a way for the federal budget to stop hemorrhaging red ink.
There is no more "extra money" to spend. The U.S. government has piled up the biggest mountain of debt in the history of the world and we are headed for a complete and total economic disaster because of it.
But what are we going to do? Are we going to let millions of Americans starve in the streets?
It's not just the rapidly rising number of homeless Americans that is the problem. Millions of Americans are not going to be able to heat their homes this winter. Millions of others are going to have to choose between buying medicine and buying food because they will not be able to afford both.
How would you like to be at a point where you could not go to the doctor because you knew that you could not pay the deductible?
How would you like to be at a point where you had to decide whether to buy diabetes medicine or to buy macaroni and cheese to feed your family?
More than 42 million Americans are now on food stamps, and that number keeps going up month after month after month.
Just think about that.
42 million Americans would not be able to eat if the U.S. government did not give them handouts.
The safety net is getting awfully crowded.
If you really want to see some soul-crushing desperation, go check out the flood tunnels under the city of Las Vegas. But do not do this alone - it is very dangerous down there. Today, there are hordes of "tunnel people" who call those dark tunnels home. Nobody knows for sure how many people are down there (some people say that it is well into the thousands), but everyone agrees that the number is rapidly growing.
But in many major U.S. cities there are no flood tunnels to go to. Instead, in many areas of the United States huge tent cities have sprouted. The following is a video news report from the BBC about the tent cities that are popping up all over America....
But it is not just "drug addicts" and the "mentally ill" that are going to these tent cities. One anonymous unemployed woman identified only as "Kaynonymous" is a highly educated professional who figures that she will end up in a tent city soon....
"I'm a 99er too. 53, female, single and once on track with an IT career. No one in their right mind would consider me for an IT position after being gone from the field for over 2 years. I have officially been a 99er since May 2010. In Aug. 2010 all of my savings and retirement funds were finally depleted--not only can I no longer make my mortgage payment, I can no longer afford utilities either. I'm just not sure that the 99ers ever had a voice outside of union organizers and even with them it was too little too late. Guess I'll be seeing ya'll in the soup kitchens and tent cities. I do still have my tent..."
So we should just extend the long-term unemployment benefits, right? Well, according to a recent poll commissioned by the National Employment Law Project, 73 percent of Americans want Congress to continue paying out extended unemployment benefits.
But it is not just that simple.
America is broke.
The entire financial system is dying.
The U.S. government desperately needs to stop spending so much money.
But how can we turn our backs on people who are desperately hurting?
There are millions of Americans that have just about reached the end of their ropes. For example, one 43-year-old woman named Jacqueline recently expressed some of the extreme frustration that she is experiencing on her blog....
I am one of the 6 million poor, unemployed middle-aged Americans struggling without any safety net or income other than food stamps. I have resorted to salvaging scrap metal just to survive while keeping up an increasingly hopeless job search. On May 4th, 2010 just three weeks before my 43rd birthday ago I got slapped with a diagnosis of very early stage glaucoma when I had a six year long overdue optical exam for badly needed new glasses. Without treatment — including ophthalmologist’s glaucoma monitoring exams — I will end up blind and permanently disabled. It’s not a matter of “if”, it’s a matter of when.
As a society, we will be judged by how we treat those who are the most vulnerable. It can seem easy to bash those who have lost everything, but someday you might end up in that position. In the following video, police in St. Petersburg, Florida are seen using box cutters to slice up the tents that the homeless were sleeping in....
Hopefully you were deeply disturbed by that video.
We have gotten ourselves into a giant mess, and things are only going to get worse.
Unfortunately, some extremely painful decisions are going to have to be made.
The truth is that we are so deeply in debt that the U.S. government just cannot be spending any extra money right now.
However, we also cannot turn our backs on millions of American families that are going to lose their homes and go hungry if we do not help them.
So what do we do?
What hurting Americans need most of all are not handouts - what they really need are good jobs.
But good jobs are being shipped overseas at a breathtaking pace. The United States has lost approximately 42,400 factories since 2001. The greatest economic machine in the history of the world is literally having its guts ripped out, and most of you kept voting in jokers who supported all of this deindustrialization.
For decades, our politicians kept telling us how wonderful globalization would be for America. We didn't listen when Ross Perot warned us about "the great sucking sound" that these "free trade" agreements would bring about.
Well, look how all of that turned out. In 1985, the U.S. trade deficit with China was 6 million dollars for the entire year. In the month of August alone, the U.S. trade deficit with China was over 28 billion dollars.
In case you can't figure it out, that means that 28 billion dollars of our national wealth was transferred to China in just one month.
This is happening month after month after month.
"This will keep America on its toes. America is going to have to compete. There is going to be a tug-of-war within the US between those who see globalization as a threat and those who accept we live in a open integrated world, which has challenges and opportunities."
Yes, globalization is a threat. We should have never merged our economy with the economy of China where workers make less than a tenth of what an American worker makes.
Jobs are flooding out of the U.S. and they are flooding into places like India and China where labor is far, far cheaper.
But without good jobs, how in the world are average Americans going to pay the bills?
The answer is that an increasing number of them are not. 1.41 million Americans filed for personal bankruptcy in 2009 – a 32 percent increase over 2008.
Incomes are going down. According to the U.S. Census Bureau, median household income in the United States fell from $51,726 in 2008 to $50,221 in 2009.
Things are getting worse instead of getting better.
And things are going to continue to get worse because the U.S. government goes into more debt every single month, most state and local governments go into more debt every single month, and thanks to America's exploding trade deficit, tens of billions of our national wealth gets transferred out of the United States every single month.
The U.S. economy is dying. There are going to be even more tent cities and even more hungry Americans. The scale of the economic nightmare that we are facing in the years ahead is going to be unimaginable.
So if you get to enjoy a warm dinner and you get to sleep in a warm bed tonight, please consider yourself to be very fortunate. Someday soon you also may find those things cruelly stripped away from you.
Few Businesses Sprout, With Even Fewer Jobs
by Justin Lahart and Mark Whitehouse
Fewer new businesses are getting off the ground in the U.S., available data suggest, a development that could cloud the prospects for job growth and innovation. In the early months of the economic recovery, start-ups of job-creating companies have failed to keep pace with closings, and even those concerns that do get launched are hiring less than in the past. The number of companies with at least one employee fell by 100,000, or 2%, in the year that ended March 31, the Labor Department reported Thursday.
That was the second worst performance in 18 years, the worst being the 3.4% drop in the previous year. Newly opened companies created a seasonally adjusted total of 2.6 million jobs in the three quarters ended in March, 15% less than in the first three quarters of the last recovery, when investors and entrepreneurs were still digging their way out of the Internet bust.
Research shows that new businesses are the most important source of jobs and a key driver of the innovation and productivity gains that raise long-term living standards. Without them there would be no net job growth at all, say economists John Haltiwanger of the University of Maryland and Ron Jarmin and Javier Miranda of the Census Bureau. "Historically, it's the young, small businesses that take off that add lots of jobs," says Mr. Haltiwanger. "That process isn't working very well now."
Ensconced in a strip mall behind a Carpeteria outlet, Derek Smith has been tinkering for two years with a wireless electrical system that he says can help schools and office buildings slash lighting bills. With his financing limited to what he earns as a wireless-technology consultant, he has yet to hire his first employee.
This is a far cry from his last start-up, which he cofounded in 2002. At the two-year mark, that company, which makes radio-tracking gear for hospital equipment, had five employees, about $1 million in funding from angel investors and offices with views of downtown San Diego. "When I started this the plan was to go out and raise a bunch of money," says Mr. Smith, who is 36 years old. That was in late 2008, just as financial markets around the world collapsed. "I quickly discovered I can't do what I did before."
Tough economic times have pushed more Americans into business for themselves, working as consultants or selling wares online. But many are not taking the additional step of forming a company and hiring employees. For people like Mr. Smith, lack of funding seems to be the biggest problem. Two traditional sources of start-up cash—home-equity loans and credit cards—have largely dried up as banks wrangle with massive defaults and a moribund housing market. Venture-capital firms that typically invest in young companies, as well as angel investors that focus on early-stage start-ups, are pulling back as they struggle to sell the companies they already own.
Venture-capital firms invested $25.1 billion in the year that ended in September, up 10% from the same period a year earlier but still down 27% from two years earlier, according to Dow Jones VentureSource. Angel investment amounted to $8.5 billion in the 2010 first half—30% below the average level in the five years leading up to the financial crisis, estimates Jeffrey Sohl, director of the Center for Venture Research at the University of New Hampshire. "I've never seen seed capital so low," says Mr. Sohl. "This is alarming."
Some entrepreneurs say it's not all about financing, though. They express concern about taxes, health-care costs and the impact that wrangling in Washington over the federal budget deficit will have on them. "I can't determine what the cost of providing health care for employees would be," says Kevin Berman, 47, who is starting a local-produce company in Orion Township, Mich., called Harvest Michigan. Starting a company "is harder than it was at any time I can remember."
San Diego has long been one of the nation's entrepreneurial hotbeds, a culture that dates back to the 1960s with the founding of Linkabit Corp., a communications company whose alumni have launched scores of technology companies. A 1970s biotechnology start-up, Hybritech Inc., gave rise to a thriving biotechnology industry. Lately, though, the pace of start-ups securing funding in San Diego has been slowed at the University of California at San Diego center that helps researchers move their work into the commercial sphere. "Investors are moving away from early-stage companies," says Rosibel Ochoa, director of the William J. von Liebig Center. "Nobody wants to touch them."
Scarce funding is putting researchers like Deli Wang in a bind. The 42-year-old engineering professor is an expert on nanowires, thread-like structures with widths less than a thousandth the diameter of an average human hair. He has a plan to make light-emitting diodes using nanowires that, he says, would be far more efficient than existing alternatives. Investors, he says, are interested—if they can see a prototype. Building one would cost Mr. Wang $200,000 that he doesn't have. "We're kind of stuck," he says.
To be sure, some companies are still getting started, particularly in biotechnology, where cash-rich pharmaceutical concerns are eager buyers and investors. In the first half of 2010, health care and biotech accounted for 44% of all angel investments, Mr. Sohl says. And in many cases, entrepreneurs today don't need as much money, or as many people, to start new businesses. Software, communications technology and high-tech equipment are far cheaper and far more powerful than they were a decade ago.
At Mr. Smith's one-man San Diego start-up, Tesla Controls Corp., circuit boards, semiconductor chips and other components litter a plastic folding table he uses as a workbench. "The hardware stuff is all cheaper," he says. "Any of these chips are $5 or less." Much of Mr. Smith's economizing is the result of necessity. With a family to support, he doesn't want to borrow against his house. Angel investors, if interested, would demand a larger stake at a lower price than he can stomach. And the small stake he still has in his earlier start-up, Awarepoint Corp., is only paper wealth.
The lack of funding is slowing him down. And the day a week he spends on consulting takes away from the time that he can devote to his new company. "I would love to be able to hire other people," he says. "But right now I can't."
Prime U.S. Mortgage Foreclosures Hit Record as Unemployment Hurts Finances
by Kathleen M. Howley - Bloomberg
Foreclosures on prime fixed-rate mortgages in the U.S. jumped to a record in the third quarter as unemployment strained household budgets of the most creditworthy borrowers.
The inventory of homes in foreclosure financed by prime fixed-rate loans rose to 2.45 percent from 2.36 percent in the previous three months, the Mortgage Bankers Association said in a report today. New foreclosures rose to 0.93 percent from 0.71 percent. Both numbers were the highest in the 12 years since the Washington-based trade group started tracking the categories.
Homeowners are falling behind on their mortgage payments as job cuts make it difficult for them to cover their bills, said Michael Fratantoni, the Mortgage Bankers Association’s vice president of research and economics. The unemployment rate has stayed above 9 percent for 18 consecutive months, the longest stretch since 1983, according to the Bureau of Labor Statistics. “The increase in these plain-vanilla type of loans to the highest numbers ever show us it really is being driven by the economic environment,” Fratantoni said in a telephone interview. “It’s not going to turn around until we get more significant job growth.”
New foreclosures against all types of mortgages, which also include subprime, rose to 1.34 percent, the highest level in a year, according to the report. The overall inventory of loans in foreclosure dropped to 4.39 percent from 4.57 percent as some mortgages were modified by servicers, companies that administer payments. Those modified loans may reappear as foreclosures in future quarters because of redefaults, said Fratantoni.
The share of mortgages with overdue payments dropped to 9.13 percent in the third quarter from 9.85 percent in the prior period, the trade group’s report showed. The rate was 9.64 percent a year earlier. The decline was led by mortgages 90 days or more overdue, those most likely to go into foreclosure. That category fell almost half a percentage point from the second quarter to 4.34 percent, which may also be a reflection of the increase in modified loans, Fratantoni said. “The modification programs have helped a number of borrowers, but at the same time we do see redefault rates of around 50 percent at 12 months,” Fratantoni said.
Servicers modified 108,946 mortgages in the second quarter using the Obama administration’s primary anti-foreclosure plan, the Home Affordable Modification Program, or HAMP. That was an 8.7 percent increase from the prior period, according to U.S. Treasury Department data. Using private programs, the companies altered an additional 164,473 home loans, a gain of 25 percent, the data show.
Almost half of the mortgages modified in 2009’s first quarter, before HAMP began in March of that year, were overdue by 90 days or more in this year’s second quarter, according to Treasury Department data. Mortgages overdue by more than three months typically are considered in default, while home loans overdue by fewer days are called delinquent.
Modifications using the HAMP guidelines have a better track rate than non-government programs, the data show. Six months after changing mortgage terms, 11 percent of HAMP modifications were delinquent, compared with 22 percent of loans renegotiated using other means, according to Treasury. HAMP lowers mortgage payments to about a third of borrowers’ income by temporarily reducing interest, lengthening the term of the loan and deferring principal payments.
Today’s Mortgage Bankers Association report doesn’t include much data related to foreclosure freezes that began in late September after questions arose about the integrity of court filings, Fratantoni said. Attorneys general in all 50 states are conducting probes into foreclosure practices after allegations surfaced that mortgage industry employees signed legal documents without ensuring their accuracy. “We really don’t know what impact the halt will have, though it certainly will put upward pressure on some of the foreclosure numbers,” Fratantoni said. “We’re looking to the fourth quarter or 2011’s first quarter to see the results.”
U.S. Homeowners Drop Out of Foreclosure Program Amid Record Defaults
by Lorraine Woellert and Clea Benson - Bloomberg
U.S. homeowners are dropping out of the Obama administration’s foreclosure prevention program at a faster rate than they are joining it, according to figures released today by the U.S. Treasury Department.
Borrowers aided by the Home Affordable Modification Program grew to nearly 520,000 in October, up 23,750 from a month earlier, the Treasury said in its monthly report. The increase was less than five percent. A total of 36,300 borrowers have dropped out of the plan for failing to make their payments, an increase of 24 percent from a month earlier.
At a congressional hearing earlier in the day, lawmakers said HAMP, which pays lenders to modify loans and reduce monthly payments for struggling borrowers, isn’t doing enough to help homeowners falling behind on their mortgages amid high unemployment and depressed real estate values. “It’s safe to say that HAMP isn’t meeting its goal of preventing foreclosures,” Representative Maxine Waters, a California Democrat, said at a House Financial Services subcommittee hearing after the Treasury provided a preview of the report.
The Treasury and the Department of Housing and Urban Development issue monthly progress reports on HAMP, a $50 billion program authorized by Congress in 2009. The program was targeted to reach more than 3 million homeowners by paying mortgage servicers $1,000 to rewrite loan terms and $1,000 annually as long as the borrower participates, up to three years.
Foreclosures Outpace Modifications
The 520,000 homeowners helped by the plan since it was launched in March 2009 contrast with high rates of foreclosure, even among the most creditworthy borrowers. Administration officials emphasized the report’s positive news, especially the cumulative number of borrowers who have received loan modifications supported by the program.
At the same time, the officials acknowledged that the program is struggling to slow the tide of foreclosures at a time of economic hardship. Foreclosures on prime fixed-rate mortgages in the U.S. jumped to a 12-year record in the third quarter as unemployment strained household budgets, the Mortgage Bankers Association reported today. “While we cannot stop every foreclosure, we know that more has to be done to reach homeowners in distress and to help unemployed borrowers,” HUD Assistant Secretary Raphael Bostic said in a written statement.
The program has been faulted by lawmakers and watchdogs including Neil Barofsky, special inspector general for the Troubled Asset Relief Program, for the high number of recipients who default on mortgages after getting the government aid. Banks seized more than 93,000 homes in October, according to Irvine, California-based data seller RealtyTrac Inc. There were nearly 3.3 million foreclosure starts from September 2009 through September 2010, according to LPS Applied Analytics in Jacksonville, Florida.
Mortgage servicers say they are trying to balance the needs of borrowers and the demands of investors who own their loans. “We’ve reached a crossroad between modification efforts now and the reality of foreclosure. Despite our best efforts and numerous programs, for some customers foreclosure will be unavoidable,” said Rebecca Mairone, default servicing executive for Bank of America Corp. home loans, at today’s House hearing.
The Waiting Game on Inflation
by Floyd Norris - New York Times
The core rate of inflation fell to a record low in the United States last month, rekindling fears of deflation and warnings that the Federal Reserve might have to take even more aggressive steps to keep inflation as high as it wants it to be. “In the short run, disinflationary forces in Western economies, especially the U.S., appear too powerful to be overwhelmed by the recent loosening of monetary policy,” said Richard Batty, an investment strategist at Standard Life Investments, a Scottish firm.
Since the collapse of the housing market in the United States and the beginning of the global financial crisis, the Federal Reserve has made avoiding deflation a major priority, recalling the experience of Japan after its bubble burst in the early 1990s. The Fed has set an annual inflation target of 2 percent or a little lower, but is not getting it.
The latest figures, released this week, showed that overall inflation in consumer prices was 1.2 percent in the 12 months through October, while the core inflation rate — excluding food and energy — rose just 0.6 percent. The previous low for that index, of 0.7 percent, came in the 12 months through February 1961, when the economy was in recession.
As the accompanying chart indicates, the core inflation figures are charting a path roughly similar to one shown in Japan 15 years earlier. That has been true despite a much stronger reaction by the American central bank, which was determined not to make the same mistakes the Japanese made.
Deflation is feared for several reasons. If consumers come to expect it, as happened in Japan, there is a strong incentive to delay purchases while waiting for a lower price. That can restrain economic activity and increase unemployment. In addition, deflation places downward pressure on asset prices, worsening the situation of those who are indebted.
The latest announced move by the Fed, called QE2 in the media as a shorthand for the second round of quantitative easing, calls for the central bank to purchase $600 billion of longer-term Treasuries in coming months. While the Fed has traditionally conducted its open market operations using short-term Treasury bills, rates on those are already close to zero, forcing the bank to move out the maturity spectrum if it wants to stimulate the economy.
That move has been denounced overseas as an effort to reduce the value of the dollar, something Fed officials deny, and inside the country as an effort to print money and support big government that would lead to runaway inflation.
This week, a group of Republicans proposed to change the Fed’s dual legal mandate, which calls on it both to keep inflation tame and to fight unemployment. “It’s time to return the Federal Reserve to the singular mission of protecting the fundamental strength and integrity of the dollar,” said Representative Mike Pence of Indiana, a Republican and chief sponsor of the proposal.
There are times when the dual mandate seems contradictory, but this is not one of them, and it is unlikely the Fed would change course if it had a single mandate. The political criticism could make it harder for the Fed to continue acting if the economy remains weak and inflation keeps falling after QE2 is completed. But it might conclude it had no choice.
“To change inflation expectations permanently,” wrote Mr. Batty of Standard Life, “a much larger monetary response would be needed from the U.S. and Western authorities than that already announced. In summary, if central bankers decide that higher inflation must be engineered, then investors should anticipate another phase of extraordinary policy measures through QE3.”
Outraged Yet? What if the Fed Buys Munis?
by John Melloy - CNBC Fast Money
California’s delay of a $10 billion municipal bond sale has only fueled existing chatter on trading floors that the Federal Reserve would take the extraordinary step of buying these securities just as it has with Treasuries. Chairman Ben Bernanke would pursue this unprecedented route, if he thought necessary, even after the vocal criticism he’s received for his second round of quantitative easing, they said.
“Given the recent bond offering by California appears to have been given the cold shoulder by the public, might they turn to the Fed?” asks Art Cashin, director of NYSE floor operations at UBS Financial Services, in his widely-read morning note to clients. Cashin has often referred to a 2002 speech by Bernanke on deflation, where the Chairman hints at buying all kinds of securities as a playbook for the current crisis.
“The Fed has the authority to buy foreign government debt, as well as domestic government debt,” said then-Governor Bernanke, to the National Economists Club in Washington D.C.
“Because some of these alternative policy tools are relatively less familiar, they may raise practical problems of implementation and of calibration of their likely economic effects," he added. "For this reason, as I have emphasized, prevention of deflation is preferable to cure. Nevertheless, I hope to have persuaded you that the Federal Reserve and other economic policymakers would be far from helpless in the face of deflation, even should the federal funds rate hit its zero bound.”
Municipal bonds, funds and ETFs have gotten slammed the last two weeks as states and counties sell more bonds to cover year-end spending. A possible compromise on the Bush dividend and capital gains taxes has also caused some investors to flee this sector since its attractiveness is partly based on its function as a tax shelter.
“The Fed could buy munis and it would be rather like the ECB buying Greek debt,” said Patty Edwards of Trutina Financial. “With the tax cuts being extended, munis won’t have the same demand that they would have if tax rates jumped. And that could lead to issues for the muni markets.”
Edwards and other money managers have said talk of this move has been around for a while and exists today even with the current backlash against “QE2”. Notable economists wrote an open letter to the Fed last week arguing against the ongoing buying of $600 billion in Treasury securities that the FOMC announced earlier this month. Republican Congressmen, both current and incoming, have been in up in arms about the move, becoming unlikely allies with central banks from China to Brazil, who have accused Bernanke of essentially exporting inflation to their countries.
“With election results, it’s going to aggravate many to bail out states, but I could see it happening,” said Steve Grasso of Stuart Frankel. “My feel is they will have to regardless of political environment.”
The PowerShares Insured Cali Muni Bond Fund is down 6 percent in five days, but only down about a half percent today. The iShares S&P National AMT-Free Municipal Bond Fund has lost five percent of its value this month. “We're a bit away from a crisis feeling in the sector and the recent performance is certainly within the normal boundaries of supply/demand imbalance-driven volatility,” said Ben Thompson, who manages $7 billion for Samson Capital Advisors.
Many investors agree with Thompson that it won’t be needed. Some even question the legality for the central bank to even do so. But we didn’t think the government would one day be the biggest seller in an initial public offering of General Motors either. “If the U.S. economy takes another leg down, Bernanke will buy everything,” said Peter Boockvar, equity strategist at Miller Tabak. “Even things in your attic.”
The Men Who Killed the Economy
by Niall Stanage - Daily Beast
Ireland’s economic troubles threaten the financial health of Europe and even the U.S. At the heart of the multibillion-dollar crisis are two highflying bankers who some say took the country for a ride.
Ireland was hailed as an economic miracle not so long ago. Now, it’s an economic basket-case that threatens the financial health not just of Europe but of the U.S. as well. But the outsize role of two men in this financial meltdown is a little-known story offering a salutary lesson about the dangers of greed, groupthink, and lax regulation as anything that has taken place on this side of the Atlantic.
Sean FitzPatrick was the CEO of Anglo Irish Bank from 1986 to 2005. At that point, he assumed the chairmanship, and David Drumm, his protégé, became the bank’s leader. The two men built the bank from a tiny operation—it had eight employees when FitzPatrick took over—to something that looked like an international powerhouse. Looks were deceptive. The bank would be its nation’s downfall.
During the boom years, Anglo expanded its market share by reckless lending, especially to property developers. More established, conservative Irish banks began to ape some of the same tactics to ward off the new contender. Then, the property bubble popped and the whole house of cards tumbled. The Irish government took control of Anglo in January 2009. It has been hurling taxpayers’ money into an apparently bottomless pit ever since. Irish Finance Minister Brian Lenihan originally estimated the cost of propping up the bank at $6.1 billion. He admitted two months ago that it would actually be between $39.8 billion and $46.7 billion.
The price tag has propelled Ireland’s deficit to hitherto unimaginable levels—and this, in turn, now necessitates international intervention. “The banks are gobbling up the state,” is the verdict of Martina Devlin, an Irish newspaper columnist and the co-author of Banksters, a 2009 book tracing the roots of the collapse. Brian Lucey, a Trinity College, Dublin finance professor, says that the feeling on the streets of the Irish capital is that “the republic has been raped, torn apart” by the bankers and their political friends. At the heart of the rapaciousness, at least in the public mind, are FitzPatrick and Drumm.
FitzPatrick was once one of the heroes of Celtic Tiger Ireland. An ebullient former accountant with a fondness for bowties, he was known as “Seanie Fitz” to his many social acquaintances. For those on the way up, FitzPatrick was someone to whom it was useful to pay obeisance. Devlin recalls seeing the banker’s aura in full effect at a 2007 charity function. “It really was like the parting of the Red Sea,” she tells The Daily Beast. “People actually did step aside for him.”
FitzPatrick knew some things that the general public did not—notably, that he held personal loans amounting to well over $110 million from the bank. He used the money to finance a host of exotic ventures: a share in a Nigerian oil well; an interest in a casino in Macau; a property investment in Budapest. There were even plans to get into the movie-financing business. The eventual discovery of these loans precipitated FitzPatrick’s departure from the company in December 2008. David Drumm followed him out the door the next day.
Prior to becoming CEO, Drumm had made his name at Anglo by expanding its U.S. business. Drumm did not share FitzPatrick’s taste for the limelight but he was just as aggressive about growing the business. The attitude was apparently widespread at Anglo. During a court case in April, an Irish property developer, Michael Daly, described how the company was “extremely anxious” to lend him money during the boom years, in the process allegedly dismissing the need to secure large loans as “a formality.”
The duo’s downfall has had its share of drama. Irish police arrested FitzPatrick in March this year, though he was released without charge soon afterward. In July, a Dublin court took 12 minutes to declare him bankrupt. Around $95 million of the loans he took from the bank have never been repaid. (Calls and emails to a lawyer identified in previous media reports as representing FitzPatrick were not returned.)
Drumm has embarked on a more circuitous path. Anglo says that it is owed around $11.5 million by him. When negotiations over a settlement broke down in Ireland, he filed for bankruptcy in Massachusetts, a move widely seen as an attempt to frustrate the bank.
Drumm has considerable assets in the area, though at least one residence in Wellesley, a tony Boston suburb, is owned by a trust, thus shielding it from repossession. He also owns a home in Chatham on Cape Cod, which is valued at around $3 million. Drumm’s pushback against the bank received a boost this week, when a court-appointed official in charge of overseeing the bankruptcy process claimed that Anglo acted fraudulently in its dealings with him. Still, many Irish people look askance at Drumm’s efforts, which include an attempt to countersue Anglo for causing him mental distress.
“It shows an extraordinarily brass neck,” says Martina Devlin. The imminent international bailout, meanwhile, is a source of real desolation to the citizens of a nation that, not so long ago, seemed to have finally transcended its impoverished history.
Killian Forde, a Dublin city councilman and a member of the opposition Labor Party, described the scene in one quintessential Irish setting on Wednesday evening. “I went to the pub and there were only about 10 or 15 people there, because people don’t have the money to go to the pub anymore,” he said. “But the ones who were there were hopping mad. And behind the anger, there was just this sense of failure—total and utter failure. People kept saying: ‘This is pathetic.’”
Forde is among those who note that every scintilla of blame cannot be put on FitzPatrick and Drumm. He says that the banking crisis has shined a light upon “just how small Ireland is, and how interconnected the bankers are with the politicians.” Brian Lucey, the Trinity College professor, also wonders if part of the anger directed at FitzPatrick is rooted in a kind of national self-disgust about the way avarice took hold in the boom years. “When we hold a mirror up to ourselves, we see Sean FitzPatrick’s face looking back,” he says.
Still, there is no mistaking the depth of public rage. In May, an effigy of FitzPatrick was burned on the streets of Dublin. Forde says he believes that David Drumm is now held in even greater opprobrium—if such a thing is possible—because of his departure to the U.S. “He is just considered a scumbag,” he says. “I would think his life would be in serious danger if he came back here.”
In 2007, Sean FitzPatrick, then seen as a leading captain of industry, complained publicly about governmental interference and “McCarthyism.” “The tide of regulation has gone far enough,” he protested. “Our wealth creators should be rewarded and admired, not subjected to levels of scrutiny which convicted criminals would rightly find intrusive.”
In Ireland, as in the U.S., the debate about who the real criminals are may be only just beginning.
European Central Bank tightens screw on Ireland, Portugal and Spain
by Ambrose Evans-Pritchard - Telegraph
The European Central Bank (ECB) has issued a clear warning that it will press ahead with plans to raise interest rates and withdraw lending support for banks despite the eurozone debt crisis, even if this risks pushing Ireland, Portugal and Spain into deeper trouble.
“The central bank must guard against the danger that the necessary measures in a crisis period evolve into a dependency as conditions normalise,” said Jean-Claude Trichet, the ECB’s president. Luxembourg’s ECB governor, Yves Mersch, echoed the warnings, saying the bank could not continue “cleaning up” in crises. “If rates are low for too long, this leads to a higher risk appetite. We will pay the price if we fail to confront these inevitable dangers,” he said.
More than 98pc of Spanish mortgages are priced off the floating Euribor rate. Any ECB rate rise would be devastating given that there is already a glut of 1.5m homes coming on to the market, according to consultants RR de Acuna.
The ECB warnings came as a troika of officials from the ECB, the Commission, and the International Monetary Fund began a fact-finding mission in Dublin, examining books to determine whether Ireland is strong enough prop up its banking system. Finance minister Brian Lenihan admitted that Dublin was considering “substantial contingency capital” to boost banks, but denied that this would burden the Irish state.
Dublin insists that there is no threat to Ireland’s 12.5pc corporation tax rate but Mary Lou McDonald from Sinn Féin said the country was essentially under foreign occupation. “Officials from the EU and IMF and any other vultures circling around this country should be told to get lost.” Central bank governor Patrick Honohan said a rescue would amount to “tens of billions”. The Irish state is funded until June but this is proving no defence against a run on the banking system.
The euro recovered against the dollar and Europe’s bourses rallied on hopes that the Irish crisis has been contained, but Fitch Ratings said there was still “considerable uncertainty” about the fate of Irish bank debt and bondholder losses. Credit default swaps on Irish, Greek, Portuguese and Spanish debt continued to hover at high levels yesterday amid confusion over the contagion risk. Any bail-out depletes the EU’s €440bn (£374bn) rescue fund, reducing the safety buffer for other countries.
Each rescue reduces the number of donor states able to support the EU safety net, and tests political patience in Germany. “There is a danger that once Ireland has been dealt with markets will concentrate even more on countries such as Portugal and Spain,” said Ulrich Leuchtmann of Commerzbank. Rescue loans for Ireland – as for Greece – add to the debt load without tackling the core problem of solvency. A view is taking hold in the markets that this policy merely delays the inevitable day of EMU debt restructuring.
Ireland bailout worth 'tens of billions' of euros, says central bank governor
by Julia Kollewe - Guardian.
The Irish central bank governor this morning gave the first official confirmation that a rescue package worth "tens of billions" of euros was being prepared to shore up Ireland's embattled banking sector. Speaking as Ireland prepared to open its books to financial experts from the European Union, European Central Bank and International Monetary Fund, Patrick Honohan said he was expecting a "very substantial loan" from the EU and the IMF.
He told RTE's Morning Ireland: "It's my expectation that will happen, yes … absolutely. It will be a large loan because the purpose of the amount to be advanced or to be made available to be borrowed is to show Ireland has sufficient firepower to deal with any concerns of the market." He added: "The ECB would not send large teams if they didn't believe first of all that they could agree to a package – that there is a programme that is fully acceptable to them that could be designed, and that it is likely to be accept to the Irish government and the Irish people."
Asked how much the loan would be worth, he said: "Tens of billions, yes. I don't know that any precision has been put on it yet." IMF officials are already in Dublin, and formal talks between the Irish government are due to begin tomorrow morning. Britain is still considering whether, and how, to support Ireland. David Cameron told MPs this afternoon that any bilateral loan to Dublin would push up the UK's deficit. "A bilateral loan is money that you have to go out and raise in order to lend it," Cameron explained.
However, if Britain takes part in a rescue through the European Commission's €60bn European financial stability mechanism, this would not count as an additional spending commitment.
Stock markets rally
City analysts believe that any loan from the IMF would be offered at a lower rate than borrowing from the financial markets. David Buik at BGC Partners said: "The facility is rumoured to have a coupon of 5% on it – a hell of a lot cheaper than the bond market, which will metaphorically take the skin off your face."
Irish borrowing costs fell on the news, with the yield – or total rate of return – on 10-year Irish government bonds dropping from 8.3% last night to 8.1%. Stock markets rallied today as investors awaited the outcome of the meetings. The FTSE 100 index climbed over 82 points to 5774 in afternoon trading. In Asia, Japan's Nikkei closed 2.06% higher at 10,013.63 while Hong Kong's Hang Seng was up 1.82% at 23,637.39 and South Korea's benchmark index rose 1.62% to 1927.86.
Giulia Comotti, currency analyst at Barclays Capital, said a decision on the type of financial aid for Ireland is expected to be taken within days. "Key elements to stabilise the financial system should include a full and prompt resolution of non-viable banks, as well as considerably higher capital buffers in viable banks than currently available – such buffers would help reassure depositors and financial markets of the sufficiency of capital to absorb any additional unexpected losses in viable credit institutions. It seems indeed that the rescue package could be delivered fairly quickly," Comotti said.
French economy minister Christine Lagarde also tried to calm fears that the crisis could split the single currency area. "No, there is no risk of [the eurozone] breaking up," Lagarde told France Inter radio this morning.
Officials See Irish Rescue at 50 Billion Euros, at Least
by Matthew Saltmarsh - New York Times
The financial support program being discussed between Ireland and potential donors should amount to at least €50 billion, officials with knowledge of the talks said Friday. The ultimate size would depend on whether Dublin takes the money merely to shore up and restructure its crippled banks, or whether a larger package is offered to take Ireland out of the government borrowing markets for some years, said the officials, who were not permitted to speak publicly.
Ireland admitted Thursday that it was likely to accept international aid, despite reservations about losing control of its purse strings. The government is holding discussions with the International Monetary Fund, the European Commission and European Central Bank in Dublin. The talks are set continue next week.
If the parties agree to a package covering only Ireland’s banking sector, the total could be limited to €50 billion, or $68 billion, the officials said. If the decision is taken to take Ireland out of the sovereign debt market for some years — as was the case with Greece’s €110 billion package this year — then it would rise closer to €100 billion.
Bill Murray, an I.M.F. spokesman in Washington, said it was “too early” to speculate on the outcome or timing of the talks. Typically, I.M.F. financing programs take several days — sometimes longer — to negotiate. Speaking to the French daily Le Monde, a senior European official, Klaus Regling, said that the mission would need around two weeks to identify financing needs in the banking sector and identify reforms. Mr Regling, head of the European Financial Stability Facility, the euro zone's temporary safety net, said there would be no problem raising funds.
Amadeu Altafaj, a spokesman for the European Commission, also declined to comment on the state of the talks. Anticipation of a rescue brought some relief on financial markets. The yield on benchmark 10-year Irish bonds fell 9 basis points to 7.8 percent Friday and the Irish Overall Index of stocks was up 0.9 percent in late trading in Dublin. But analysts cautioned a bailout of Ireland may not necessarily spell an end to the debt crisis in the euro area.
Alfred Steinherr, a former chief economist at the European Investment Bank, said that whatever the outcome of the Dublin talks, the issue of a restructuring of sovereign debt would have to be broached by the wider euro area. “Once we find a solution to Ireland, then we can turn to Portugal,” he said. “How many guarantees will the E.U. be able to provide?”
Such a restructuring — sometimes referred to more starkly as default — would probably involve the negotiated or forced lengthening of government bond maturities and possibly changes to interest rates paid by governments to bondholders, Mr. Steinherr said. European officials have admitted that such issues are forming part of discussions now underway — driven by Berlin — on the creation of a permanent fund to replace the temporary ones, which expire in 2013.
The negotiators in Dublin appear to be focusing on the banks — the winding down of non-viable lenders and, potentially, the restructuring and recapitalization of viable institutions — rather than Dublin’s fiscal position. Any funding package “would likely have fiscal conditions, but we would not expect something similar to the heavy reform agenda set for Greece,” the Barclays Capital analysts Antonio Garcia Pascual and Piero Ghezzi said in a note.
For two years now, “Ireland has been implementing fiscal and financial policy measures broadly in line with what an EU-I.M.F. program would have recommended.” The Irish community minister Pat Carey said Friday that a four-year fiscal plan for making €15 billion in savings from 2011 to 2014 would be published early next week, according to Reuters.
Still, one issue surrounding austerity conditions remains to be resolved: differences between Ireland and its European partners over whether to raise Dublin’s ultra-low corporate tax rate. France and Germany consider this rate to be a distortion, while Dublin remains convinced that is crucial to attracting investment and restarting the growth needed to fill state coffers.
Another issue that will have to addressed — perhaps after any aid agreement — is funding for Ireland’s lenders by the E.C.B., which is expected to wind down extraordinary liquidity support from early next year. Barclays said Irish-domiciled banks are the biggest borrowers at the E.C.B., and have borrowed around €130 billion.
Speaking at the Dublin airport on Friday, embattled Irish Prime Minister Brian Cowen vowed to get the “best possible outcome” for the Irish people in the talks, Reuters reported. Andrew Rowan, an analyst at UBS, said in a recent note that the E.C.B. might compensate weak banks from Ireland and elsewhere with “some form of enhanced liquidity provision at shorter terms throughout 2011, given the dependence of sections of the euro-area banking system on E.C.B. funding.”
Ireland denies 'surrendering sovereignty' over bail-out
Irish prime minister Brian Cowen has dismissed claims his government had surrendered the country's sovereignty, as International Monetary Fund and European officials pore over its accounts to find a solution to the debt crisis.
Mr Cowen said the economy remains strong and sustainable and that Ireland was working with its euro partners to work out "the best options". "There is no question of loss of sovereignty for Ireland," he said. It will be the sovereign decision of the Irish Government on behalf of the Irish people that will decide what shape any package would be where we can decide that's in our best interests."
Mr Cowen's government has faced a barrage of criticism from the opposition and media at home and abroad after it was confirmed the IMF and EU were beginning meetings with the Government in Dublin. There have also been repeated accusations that ministers tried to cover-up the extent of the negotiations between officials which first took place in Brussels late last week.
Patrick Honohan, Governor of Ireland's Central Bank, brought some clarity early on Thursday when he said he expects the country to get a loan worth "tens of billions" of euros through an IMF-EU rescue package. “It will be a large loan because the purpose of the amount to be made available or to be advanced is to show Ireland has sufficient firepower to deal with any concerns of the market. We’re talking about a substantial loan," Mr Honohan told state broadcaster RTE. “It is my expectation that will happen, absolutely," he said, although he added that a final decision had not been reached.
The yield on the Irish 10-year bond fell seven basis points to 7.55pc after his comments, but remains at crippling levels. Finance Minister Brian Lenihan has said another option being examined would be contingency capital - effectively a multi-billion emergency credit line or overdraft for banks. Mr Cowen repeated that "no formal application" has been made for a bail-out or loans. However, "technical discussions" with the EU were intensifying since the meeting of EU finance ministers in Brussels earlier this week, he said.
Olli Rehn, Europe's economics commissioner, said on Wednesday that Ireland is not strong enough to back-stop a banking system that has been shut out of capital markets and suffered a haemorrhage of bank deposits. "The Irish banking sector has to be made viable and sustainable," he said.
Chancellor George Osborne has said the UK stands ready to play its full part in any rescue. "Ireland is our closest neighbour and it's in Britain's national interest that the Irish economy is successful and we have a stable banking system," he said in Brussels. On Wednesday, Mr Cowen insisted that the Irish state is fully-funded until June and did not need a bail-out. "What we're involved in here is working with colleagues in respect of currency problems and euro issue problems that are affecting Ireland," he said.
Enda Kenny, Fine Gael opposition leader, ridiculed the claim, accusing him of raising the "white flag" and subjecting the country to the "dictates" of foreign masters. Officials from the European Central Bank, the Commission, and the IMF are taking part in the "Troika" mission, which Dublin called a "consultation". French finance minister Christine Lagarde said a package may be agreed within days.
Dublin hopes to dress up any bail-out as aid for banks rather than the state, but the distinction became meaningless when Ireland guaranteed its banks in September 2008. "The two are inextricably merged: it's an omelette that is impossible to unscramble," said Professor Brian Lucey from Trinity College Dublin. He estimates the total cost of rescuing Anglo Irish and absorbing toxic debt through the 'bad bank' NAMA at €85bn.
Analysts say the state may have to inject up to €15bn into Bank of Ireland and Allied Irish (AIB) after the pair lost almost €20bn of deposits in the early autumn. The ECB wants to extricate itself from the role of propping up the Irish banking system - and therefore the state - with loans equal to 80pc of Irish GDP. Any bail-out will be on softer terms than the "Memorandum" imposed on Greece.
The country has already slashed spending and cut public wages by 13pc. Brussels is clearly pushing Ireland into a rescue before it needs one in order to stem contagion to Portugal and Spain, so Dublin can hope to extract guarantees on Irish sovereignty and its 12.5pc corporation tax rate, which that has been crucial in luring Google, Microsoft, Pfizer, and others to Ireland. LCH Clearnet doubled its margin requirement to 30pc for Irish bonds despite the likely rescue.
Julian Callow from Barclays Capital said Ireland faces a "truly daunting task" trying to tackle both its financial and fiscal crises at the same time. "The country still has the highest budget deficit in the eurozone despite austerity cuts. The deficit is 12pc of GDP this year after stripping out bank rescue costs, the same as last year. This is what concerns investors," he said.
Irish showdown over corporate tax
by Peter Spiegel, Gerrit Wiesmann and Ben Hall - Financial Times
French and German officials are pressing Ireland to increase its low corporate tax rate in return for an aid package, setting the stage for a showdown over a policy long resented by Dublin’s European partners. Ireland views the corporate tax rate, set at 12.5 per cent, as the cornerstone of its industrial policy. On Thursday Irish officials reiterated their determination to protect it. “It’s non-negotiable,” Mary Coughlan, the deputy prime minister, told parliament.
French, German and European officials told the Financial Times that the tax rate had emerged as a major point of contention as negotiators from the European Union and International Monetary Fund arrived in Dublin to discuss a potential bail-out. One European official involved in the talks said that the corporate tax increase would be a casus belli with the Irish, and that Dublin’s strident objections could well keep it out of any final package.
Irish officials are convinced there are other measures they can take to rein in the deficit. European officials do not think Dublin has many alternatives. A French official said that the low corporate tax rate was seen by some elsewhere in Europe as “almost predatory”. “They need lots of money and we note they have a corporation tax rate that is very low,” the official said. “Supply must follow demand.” “Without an increase in tax intake, the deficit can’t be reined in,” added a German government official, though he added that the size of any corporate tax increase had yet to be discussed. “That depends on [Ireland’s] financing needs, which are still unclear.”
The standoff demonstrates how politically explosive the negotiations have become, with Ireland fiercely defending its sovereignty and potential lenders seeking concrete assurances that their aid will be repaid. Ireland’s central bank governor said Dublin was “definitely likely” to ask for a loan totalling “tens of billions” of euros. “We’re an island nation in a larger grouping [of nations],” said Danny McCoy, head of IBEC, the Irish business lobby. “We set up our [tax] structures in a way that facilitates our people to do the best for themselves. That’s true sovereignty. And to put pressure on us to change is ill-advised. It will not help us solve the problem. It certainly won’t put the bond markets at ease.”
Olli Rehn, the EU’s top economic official, has implied that he backs a corporate tax rise, saying Ireland should no longer consider itself a low-tax nation. “The IMF, ECB and European Commission must realise that any increase in our corporation tax rate would ultimately make us more economically dependent, not less so on our European Union partners,” said Peter Keegan, Ireland country head for Bank of America Merrill Lynch.
IMF chief Dominique Strauss-Kahn urges leaders to cede more sovereignty to EU
by Philip Aldrick - Telegraph
European nations need to cede more of their sovereignty and hand greater powers to the centre to avoid future crises, the head of the International Monetary Fund has said. In what are likely to prove controversial proposals, Dominique Strauss-Kahn, the IMF managing director, called on the European Union to move responsibility for fiscal discipline and structural reform to a central body that is free from the influences of member states.
In a speech in Frankfurt addressing the sovereign debt crisis engulfing Europe once again, he said: “The wheels of co-operation move too slowly. The centre must seize the initiative in all areas key to reaching the common destiny of the union, especially in financial, economic and social policy. Countries must be willing to cede more authority to the centre.”
Europe is plagued by crisis because member states put too much faith in banks and let their public finances run out of control. Greece has already been bailed out and Ireland is expected to agree a €100bn (£85bn) rescue within days. Portugal is also at risk.
Mr Strauss-Kahn did not name any individual eurozone members, but warned: “The sovereign crisis is not over.” Reform is vital but, he said: “The area’s institutions were simply not up to the task of managing a crisis – even setting up a temporary solution proved to be a drawn-out process. “One [solution] is to shift the main responsibility for enforcement of fiscal discipline and key structural reforms away from the Council. This would minimize the risk of narrow national interests interfering with effective implementation of the common rules.”
Handing greater powers to the centre would lead to a greater loss of sovereignty for each of the eurozone’s member states. Monetary policy is already under the control of the European Central Bank, with national governments holding on to fiscal authority.
In proposals that are likely to play into the hands of eurosceptics in the UK and elsewher, Mr Strauss-Kahn recommended more tax harmonisation and a larger central budget. Reiterating a now common theme, he added that the euro area needs to rebalance – with Germany reducing its dependence on exports and other nations shrinking current account deficits.
To manage and monitor the changes, he argued for a larger central budget – funded by “more transparent EU-wide instruments—such as a European VAT, or carbon taxation and pricing”. Alongside tighter fiscal controls, he said labour market reforms in the euro area need to be centralised. “The euro area cannot achieve its true potential with a bewildering patchwork of segmented labour markets,” he said.
“These barriers exacerbate the diverging economic fortunes that threaten the euro area today. It is time to create a level playing field for European workers, especially in the area of labour taxation, social benefits systems and portability, and employment protection legislation.” He added: “The only answer is more cooperation, and greater integration.”
The Texas Fix Is Unlikely for Ireland
by Floyd Norris - New York Times
Texas may not look much like Ireland. But at different times, each was deemed a model of rapid economic growth, envied and resented by neighbors. During those boom times, each had banks that went crazy, making so many speculative loans that the banking system was doomed when the bubble burst.
The difference was in what happened after the fall. The United States let the Texas banking industry collapse, with out-of-state banks picking up the pieces as the national deposit insurance fund suffered substantial losses. Ireland instead decided to bail out the banks and nurse them back to health as institutions based in Ireland, not controlled in some other country, and there was no European burden-sharing. That decision may end up bankrupting Ireland. It certainly has led to a deep and enduring recession.
Texas banks got into their mess because of the great oil boom prompted by the Iranian revolution in 1979. In 1980 and 1981, Texas grew rapidly while the overall American economy stagnated. The banks piled in and made huge profits. Real estate prices rose, and there was a surge in construction.
When it ended, the banks gradually folded, and tales of excess became legendary. The era was exemplified by Penn Square Bank in Oklahoma, a neighboring oil producer whose economy outpaced even that of Texas in 1980 and 1981. It featured a colorful executive named Bill Patterson who became famous for, among other things, drinking beer out of a cowboy boot. He was also good at making insider loans that were never repaid.
At the time, there was hand-wringing about how Texas could function without banks. Just fine, it turned out.
Texas ended up with a lack of bank headquarters. That may have reduced support for local charities, not to mention demand for Dallas office space, but there was no shortage of banking offices willing to take deposits and make loans. The Texas economy recovered.
Ireland’s economy was the envy of Europe a few years ago. In 2007, when France and Germany were growing at about 2 percent a year, Ireland’s growth was almost 7 percent. It was known as the Celtic Tiger and was widely celebrated for the combination of low tax rates and fast growth. The banks grew rapidly and piled on property loans. In the early part of this decade, home prices grew at rates comparable to those in Phoenix and Las Vegas.
The banker who came to epitomize that era was Sean FitzPatrick, the chief executive of Anglo Irish Bank, which grew faster than the others by focusing on property lending above all else. He is remembered as the man who, in good times, denounced bank regulation as “corporate McCarthyism.” He also turned out to be good at making secret loans to himself that did not work out.
Ireland has now taken over Anglo Irish, and it has bailed out all the other big banks. But it is not clear how much more money will be necessary. That depends on how bad the loans are, and given the record of the banks it is easy to understand why lenders are hesitant to believe their latest numbers. The Irish banks are increasingly dependant on the European Central Bank for funding, something that makes the central bank nervous, and much of this week was spent on negotiations about some sort of European bailout.
When the crisis struck, Ireland was the first country to adopt fiscal austerity, and was widely praised for that. Such cutbacks may have been necessary, but a result has been to worsen the recession and put more downward pressure on property prices, which in turn made the banks suffer even more.
During the boom, there was a similar circle, but then it seemed virtuous. Lending enabled people to buy property at ever increasing prices, and the boom in construction made the economy keep growing. At Allied Irish Banks, the largest of the Irish banks and one that seems to have been no more irresponsible than the rest, the book of loans doubled between 2004 and 2007. More than a third of the loans were for construction or unimproved property, while a quarter were for home mortgages.
By the end of 2007, home prices had been falling for more than a year, but the bank continued to finance new construction projects and boasted that only six-tenths of 1 percent of its loans were impaired. Now, even after dumping many of its worst loans onto a government bailout bank, a tenth of all its loans are impaired.
The bank is still private, and its shares trade as if there is a little value left. The government wants it to remain private and eventually return to being a normal bank, but it is hard to see how the bank can regain the confidence of investors. Earlier this year the bank borrowed money with a government guarantee, but still had to offer to buy back its bonds if the investor wanted. This week it disclosed that some investors did want their money back. The Irish bank bailout now looks more like the first part of a crisis, not the resolution of one.
The European Union likes to compare itself to the United States. The German finance minister, in lecturing the United States a few weeks ago, said the Americans should not worry about their trade deficit with Germany, but look instead to the country’s trade balance with the total euro zone. Nobody worried about Europe’s balance with any particular American state, he noted.
If the euro zone were more like the United States, this problem would be far less severe. At its economic peak, Ireland accounted for only 2.4 percent of euro zone gross domestic product, while Texas provided 8.2 percent of the G.D.P. of the United States when its banks were about to go down. So it should have been less of a problem for banks outside Ireland to step in than it was for non-Texas institutions to move in then.
Perhaps the attractions of the Irish retail market could have persuaded some German or French banks to take over Irish institutions. The cost to the government would still have been great, but not open-ended, and Ireland would now have a functioning banking system.
To be sure, that might not have happened. The Irish crisis came along as the rest of the world also suffered, and there were bailouts in many places. But it would have been more likely with fewer barriers to cross-border transactions. There were European banking systems that escaped relatively unscathed.
In Europe, it is every country’s banking system for itself. Ireland had the misfortune of having a banking system that was relatively large compared to the size of the country, and of having presided over one of the most speculative property booms. The rest of Europe, which still resents Ireland’s earlier apparent success, wants to offer as little help as it can without destroying the euro.
Texas greatly benefited from the fact the American economy was integrated, with a central government that could and would help out. Ireland can only wish Europe could be more like that.
Unemployment benefits to end for 2 million Americans
by Steve Nuñez - KGUN9
The House of Representatives voted down a bill to extend jobless benefits. Republicans blocked the measure arguing it would add to the deficit. Meanwhile, two million people will lose their benefits by the end of the year. And while Arizona's unemployment rate has dropped to 9.5%, competition for jobs is up. At One Stop, Pima County's employment services center, a sign placed near the entrance seems to greet the unemployed with a message of hope. It reads, "A Better Job Awaits."
But 58-year old Guadalupe Ayon is still waiting for that so-called "better job." His wait has lasted two very long years. Tucson's construction industry has dropped 37% over the last two years. This sharp decline forced the company he worked for to shut down. Ayon has been unemployed ever since.
We wanted to know if Ayon really is doing all he can to find a job. 9OYS Reporter Steve Nuñez asked him if he'd say "yes" to any job that comes his way. "Absolutely, that's my philosophy," said Ayon. "We have to grab whatever becomes available."
Right now, Arizona's jobless rate is showing signs of improvement. Unemployment dropped two-tenths of a percentage point from 9.7% to 9.5% in October. Ed Westbrook, an employment specialist, confirmed to 9OYS that companies are, one again, hiring. However, Westbrook said he's also seen another trend that's making it difficult for some people to land a job. He said the unemployed he advises fail to sell their skills. "People don't know how to look for work," said Westbrook. "Believe it or not, when you interview you're marketing yourself and so a lot of people don't have the skills of marketing themselves."
9OYS tested this theory on Ayon. When Nuñez asked why an employer should hire him, Ayon simply stated, "At my age, I'm better responsible." Point proven. In Pima County, the competition is tough. There could be 44,000 unemployed workers competing for the 400 jobs listed at One Stop, alone. Ayon claims he's filling out at least seven applications per week, but he's yet to receive a call back, an interview or a job offer. He denies he'd turn down a job even at a fast food restaurant.
Ayon also denies he's milking the system to live off his $262 weekly government check especially now that benefits could end at the end of this year. "I don't know what's going to happen," said Ayon. "We're going to have to go to bankrupt most of us and still not be able to pay for the very minimum expenses in our homes."
One Stop is concerned that if Congress holds firm and does not extend unemployment benefits it could lead to another economic downturn. That's because the unemployed would not be able to pay for necessities such as electricity, water, gas, and not to mention, food. The employment services center does not believe holiday temp jobs will make much of a difference to the local job market. The seasonal part-time jobs often pay less than unemployment which is about $1,100 per month.
Failure to pass unemployment insurance extension could cost billions
by Alana Semuels - Los Angeles times
Letting the nation's unemployment benefits expire could drain billions from the economy and cost millions of jobs, according to two reports out this week. On Thursday, House Republicans voted to deny an unemployment benefits extension, unhappy with the method planned to fund it.
Ending federal extensions would drain the economy of $80 billion of purchasing power, according to a report by the U.S. Congress Joint Economic Committee. Every dollar spent on benefits increases the gross domestic product by $1.60, the report said. "Workers receiving unemployment insurance payments are typically cash-strapped and will spend their benefits quickly," the report said. They spend about $6.5 billion a month on the local economy to buy essentials such as food, clothing and utilities.
"A failure to extend the unemployment insurance program could hamper the fragile recovery," the report said. It predicts that consumer spending will fall by $50 billion over the next year if benefits are not extended, and that economic growth will be reduced by 0.4 percentage points by February 2011. A similar report from the California Budget Project warns that allowing unemployment benefits to lapse at the end of November could deal a critical blow to the retail sector. That sector provides jobs to one out of nine Californians.
Unemployment benefits put $225 million into the nation's economy every day in 2010, the report said. Some economists worry that if jobless workers keep receiving extensions, they will stop looking for work. But the dearth of jobs in the labor market makes that point moot, the California Budget Project said. "Cutting off federally supported unemployment insurance benefits would make unemployed workers more desperate to find work, but it would not make them more likely to find work, because jobs are scarce," the report said.